Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  x    No  ¨

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  ¨    No  x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by

reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. (See definition of “Accelerated Filer and Large Accelerated Filer” in Rule 12b-2 of the Exchange Act).

Large Accelerated Filer  x Accelerated Filer  ¨ Non-Accelerated Filer  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨    No  x

The aggregate market value of the voting stock held by non-affiliates of the Registrant, computed by reference to the closing price of such stock as of September 30, 2005: $1,626,353,129

The number of Common Shares outstanding as of May 31, 2006: 65,823,853

part I

 

Item 1.

Business

GENERAL DEVELOPMENT OF BUSINESS

Throughout this document, references to “STERIS Corporation,” “STERIS,” or the “Company,” are references to STERIS Corporation and its subsidiaries, except where the context makes it clear the reference is to STERIS Corporation itself and not its subsidiaries. The Company’s fiscal year ends on March 31. References to a particular “year” or “year-end” refer to the Company’s fiscal year.

Description of Business. STERIS Corporation, an Ohio corporation, develops, manufactures, and markets infection prevention, contamination control, microbial reduction, and surgical and critical care support products and services for healthcare, pharmaceutical, scientific, research, industrial, and governmental customers throughout the world. The Company was organized in 1985, re-named STERIS Corporation in 1987, and currently operates in three business segments: Healthcare, Life Sciences, and STERIS Isomedix Services (“Isomedix”).

Recent Events

Fiscal 2006 Restructuring. On January 30, 2006, the Company announced that the manufacturing portion of its Erie, Pennsylvania operations will be transferred to Mexico to reduce production costs and improve the Company’s competitive position. The Company also announced plans for other restructuring actions designed to reduce operating costs within the ongoing operations of both the Healthcare and Life Sciences segments.

During the fourth quarter of fiscal 2006, the Company incurred pre-tax expenses of $25.3 million, primarily for non-cash expenses related to asset write-downs, accelerated recognition of pension and retiree medical benefits, and severance and termination benefits related to the transfer of its Erie, Pennsylvania manufacturing operations to Monterrey, Mexico and other restructuring actions.

As announced on January 30, 2006, the Company anticipates the total costs associated with this transfer over the next several years following fiscal

2006 to approximate $35.0 million, including $18.0 million of restructuring expenses related to the shutdown of manufacturing operations in Erie, Pennsylvania.

Fiscal 2005 Acquisitions. During fiscal 2005, the Company completed three strategic acquisitions that expanded its breadth of product and service offerings and geographic reach.

During the fourth quarter of fiscal 2005, the Company completed the acquisition of FHSurgical SAS (“FHSurgical”), a privately-held manufacturer of surgical tables with a manufacturing facility located in Orleans, France. The acquisition expanded the Company’s European distribution channel and enhanced the Company’s offerings of surgical tables. The acquired business has been integrated into the Company’s Healthcare segment.

During the fourth quarter of fiscal 2005, the Company completed the acquisition of certain assets of Cosmed Group, Inc. (“Cosmed”), a privately-held contract sterilization service provider with corporate offices located in Jamestown, Rhode Island. As a result of this transaction, five additional Ethylene Oxide (“EO”) processing facilities were added to the Isomedix Services segment’s existing network of locations. The acquired Cosmed assets have been integrated into the Company’s Isomedix segment.

During the second quarter of fiscal 2005, the Company completed the acquisition of Albert Browne Limited and its subsidiaries (“Browne”), a privately-held manufacturer of chemical indicators, headquartered in Leicester, England. This acquisition provided the Company with an established European distribution channel and expanded the Company’s offerings of consumable products which are used with its broad line of infection control, sterilization, and decontamination capital equipment. The acquired business has been integrated into the Company’s Healthcare segment.

Life Sciences Renewed Strategic Focus. During the fourth quarter of fiscal 2005, the Company announced that it had completed a detailed analysis of its customers’ needs in the Life Sciences segment and identified several steps to reshape the segment’s product portfolio and improve profitability. As a first

step of this strategy, on January 7, 2005, the Company sold its Detach™ business (automated cleaning systems for comparative medicine). The sale of this business did not have a material impact on the Company’s financial position, results of operations, or cash flows.

On October 31, 2005, the Company announced that it had completed the sale of its lyophilizer (freeze dryer) product line to GEA Group of Germany for 20.8 million euros (approximately $25.2 million). The transaction resulted in an after-tax gain to the Company of approximately $6.2 million. As of March 31, 2006, the gain remains subject to additional adjustments.

These strategic steps are designed to create greater focus and further development of core sterilization, washing, and decontamination product offerings to the pharmaceutical, biopharmaceutical, governmental, and research markets.

INFORMATION RELATED TO BUSINESS SEGMENTS

General Segment Information. The Company operates in three business segments: Healthcare, Life Sciences, and STERIS Isomedix Services. In the sections that follow, the Company has presented detailed information regarding these business segments.

Additional information regarding segment performance for each of the three years in the period ending March 31, 2006 is presented in Note 13 to the Company’s consolidated financial statements titled, “Business Segment Information,” and in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”).

HEALTHCARE SEGMENT

Description of Business. The Company’s Healthcare segment offers capital equipment and accessories utilized within surgical environments, critical care environments, emergency departments, gastrointestinal environments, sterile processing environments, and in infection control processes. The Healthcare segment also offers consumable products and services to the same customer base.

Products Offered. The Healthcare segment offers a range of technologies for sterilizing medical devices and instruments, including low temperature liquid, steam, and EO. These technologies, which meet rigorous

sterility assurance standards and regulations, allow the safe and effective re-use of medical equipment and devices in healthcare facilities throughout the world. The Healthcare segment also offers a variety of automated washer/disinfector systems used as a processing step before sterilization. These systems clean and disinfect a wide range of items from rolling instrument carts and other large healthcare equipment to small surgical instruments. These washing and sterilization products are offered through various brand names that include, but are not limited to: STERIS SYSTEM 1^®, Amsco^®, Hamo™, and Reliance^®.

The segment’s capital equipment offerings also include general and specialty surgical tables, surgical and examination lights, equipment management systems, operating room storage cabinets, warming cabinets, scrub sinks, and other complementary products and accessories for use in hospitals and other healthcare facilities. This broad range of equipment is designed to be used in a wide variety of locations where diagnostic and therapeutic procedures are performed, including emergency rooms, general surgery suites, OB/GYN suites, ICU/CCU suites, and ambulatory surgery sites. These products are offered under various brand names that include, but are not limited to: Harmony™, Amsco^®, SurgiGraphic™, ASC 2000™, Hamo™, Cmax^®, and Hausted^®.

The Healthcare segment also offers infection prevention consumables and supplies that are used to help prevent the spread of infectious diseases and to monitor sterilization and decontamination processes. The segment’s consumables offer quality choices for infection and contamination prevention, including sterility assurance products used in instrument cleaning and decontamination systems and hard surface disinfectants. The segment also offers skin care and hand hygiene solutions for use by care-givers and patients in high risk and routine applications. Consumables are offered under various brand names that include, but are not limited to: Kindest Kare^®, Alcare^®, Verify^®, Browne, and Cal Stat^®.

Services Offered. The Healthcare segment offers various preventive maintenance programs and repair services to support the effective operation of capital equipment over its lifetime. The segment also offers comprehensive sterilization management services to allow healthcare

facilities to meet their instrument reprocessing needs. STERIS field service personnel are available worldwide to install, maintain, upgrade, repair, and troubleshoot equipment. Additionally, STERIS offers other support services such as facility planning, engineering support, device testing, and customer education.

Customer Concentration. The Company’s Healthcare segment operates in the United States and throughout the world offering capital equipment, consumables, and services to large and small customers. For the year ended March 31, 2006, revenues generated by the segment in the United States and internationally amounted to $652.3 million and $164.7 million, respectively. For the year ended March 31, 2006, none of the segment’s customers represented more than 10% of total segment revenues, therefore the loss of any single Healthcare customer is not expected to have a material impact on the segment’s results of operations or cash flows.

Competition. The Company’s Healthcare segment operates in highly regulated environments where the most intense competition results from technological innovations, product performance, convenience and ease of use, and overall cost-effectiveness. The Company competes with a number of large companies with significant product portfolios and global reach, as well as a number of small companies with very limited product offerings with operations in few or single countries. The segment’s competitors include 3M, Becton Dickinson, Belimed, Berchtold, Cardinal, Ecolab, Getinge, Johnson & Johnson, Kimberly-Clark, and Skytron.

LIFE SCIENCES SEGMENT

Description of Business. The Company’s Life Sciences segment is a provider of integrated and validated capital equipment, cleaning chemistries, and service solutions to the pharmaceutical and research market and defense and industrial decontamination markets. Within the pharmaceutical and research market, the segment is focused on delivering capital equipment, consumables, and related services to global pharmaceutical companies and private and public research facilities. Within the defense and industrial decontamination markets, the segment is focused on the development of decontamination technologies for a

variety of applications and customers. The segment’s offerings to government, military and aerospace customers focus on vaporized hydrogen peroxide (“VHP^®”) and modified VHP technologies for use in decontaminating military command centers, aircraft and vehicles, and sensitive equipment. For industrial markets, the segment is focused on developing decontamination solutions for hospital, transportation, and food and beverage customers. Offerings to this customer base are similar to those offered to government, military and aerospace customers; however, the markets are primarily non-military and typically require regulatory approval.

Products Offered. The Life Sciences segment offers capital equipment and accessories to the target customer base described in the preceding paragraph. Washers offered by the segment provide efficient cleaning of various large and small materials and components utilized in pharmaceutical and industrial manufacturing processes, such as glassware, vessels, equipment parts, drums, and hoses. Sterilizers offered by the segment provide an efficient and effective way to sterilize and decontaminate medical equipment and research tools used in the pharmaceutical and research environments, and assist in mitigating the risk of contamination. VHP^® technology offered by the segment is used to create safer environments within emergency vehicle interiors and exteriors, high-containment bio-safety labs, and other closed room environments. The segment’s products are offered under various brand names that include, but are not limited to: Amsco^®, Hamo^®, Reliance^®, and Finn-Aqua^®.

The Life Sciences segment also offers infection prevention consumables and supplies that are used to prevent the spread of infectious diseases and to monitor sterilization and decontamination processes. The segment’s consumables offer quality choices for infection and contamination prevention, including products used in instrument cleaning and decontamination systems and hard surface disinfectants. The segment also offers skin care and hand hygiene solutions for use in high risk and routine applications. Consumables are offered under various brand names that include, but are not limited to: Kindest Kare^®, Alcare^®, Verify^®, and Cal Stat^®.

Services Offered. The Life Sciences segment offers various preventive maintenance programs and repair services to support the effective operation of capital equipment over its lifetime. The segment also offers a variety of consulting services focused on biological and chemical contamination remediation and recovery solutions, risk/threat assessment, and biological contaminant mapping and assessment. STERIS field service personnel are available worldwide to install, maintain, upgrade, repair, and troubleshoot capital equipment. Additionally, STERIS offers general sterilization consulting services and other support services such as facility planning, engineering support, device testing, cleaning, evaluation, and customer education.

Customer Concentration. The Company’s Life Sciences segment operates in the United States and throughout the world offering capital equipment, consumables, and services to large and small customers. For the year ended March 31, 2006, revenues generated by the segment in the United States and internationally amounted to $153.0 million and $62.8 million, respectively. For the year ended March 31, 2006, none of the segment’s customers represented more than 10% of total segment revenues, therefore the loss of any single Life Sciences customer is not expected to have a material impact on the segment’s results of operations or cash flows.

Competition. The Company’s Life Sciences segment operates in highly regulated environments where the most intense competition results from technological innovations, product performance, convenience and ease of use, and overall cost-effectiveness. Consolidations and reduced capital spending within the Company’s pharmaceutical customer base also results in intense competition. The Company competes with a number of large companies with significant product portfolios and global reach, as well as a number of small companies with very limited product offerings with operations in a few or single countries, for pharmaceutical, research and industrial customers. The Company competes with a small number of large companies for defense and aerospace customers. The Company’s performance within this market, which primarily includes governmental-type customers, is partially dependent on government funding and

budgetary appropriations. The segment’s primary competitors include Bioquel, Fedegari Autoclavi, Getinge, MECO, and Scientek.

STERIS ISOMEDIX SERVICES SEGMENT

Description of Business. Through a North American network of 21 facilities, STERIS Isomedix Services offers a comprehensive array of contract sterilization services using Gamma Irradiation (“Gamma”), Electron Beam Irradiation (“E-Beam”), and EO technologies. This segment offers sterilization, microbial reduction, and materials modification services to companies that supply products to the healthcare, industrial, and consumer product industries.

Services Offered. Isomedix utilizes Gamma, E-Beam, and EO technologies to sterilize a wide range of products. Gamma, using cobalt-60 isotope, and E-Beam, using accelerated electrons, are irradiation processes. EO is a gaseous process predominately used in the sterilization of surgical kits. Gamma and EO utilization account for greater than 90 percent of the overall industrial contract sterilization marketplace with E-Beam representing the remainder. The Isomedix locations are concentrated in major North American population centers and core distribution corridors, primarily in the Northeast, Midwest, Southwest, and southern California. Isomedix’s understanding of supply chain management enables it to adapt to increasing imports and changes in manufacturing points-of-origin. Isomedix’s growth is driven in part by demographics, mainly the aging baby boomer population and rising life expectancy. These events strengthen demand for medical procedures, driving increased consumption of single use devices and surgical kits. Isomedix’s technical services group provides support to customers in all phases of the sterilization design process, including product development, materials testing, and sterility validation.

Customer Concentration. The Company’s Isomedix Services segment operates in North America. For the year ended March 31, 2006, revenues generated by the segment in the United States and Canada amounted to $120.2 million and $7.2 million, respectively. The segment’s services are offered to large and small customers throughout the footprint of the Isomedix network. For the year ended March 31, 2006, none of

the segment’s customers represented more than 10% of total segment revenues. Primarily due to the fixed cost nature of the business, the loss of a single Isomedix customer could have a material impact on the segment’s results of operations or cash flows but would not have a material impact on the Company.

Competition. Isomedix operates in a highly regulated industry and competes in North America with Sterigenics International, Inc., other smaller contract sterilization companies and manufacturers that sterilize products in-house.

INFORMATION WITH RESPECT TO STERIS’S BUSINESS IN GENERAL

Sources and Availability of Raw Materials. The Company purchases in the ordinary course of business raw materials, sub-assemblies, components, and other supplies essential to the Company’s operations from numerous suppliers in the United States and abroad. The principal raw materials that the Company uses to conduct operations include stainless steel, organic chemicals, and plastic components. These raw materials are obtainable from several sources and are generally available within the lead times specified to vendors. Raw materials for which there are few sources, such as cobalt-60 isotope used within the Company’s Isomedix Services segment, generally are supported by longer-term supply contracts.

The Company has recently experienced increased prices for raw materials such as stainless steel, other metals, and chemicals, which are important to the Company’s operations. Although cost and availability are unpredictable, the Company has not experienced, and does not foresee, extraordinary difficulty in obtaining the materials, sub-assemblies, components, or other supplies necessary for its business operations.

Intellectual Property. The Company protects its technology and products by, among other means, filing United States and foreign patent applications. There can be no assurance, however, that any patent will provide adequate protection for the technology, system, product, service, or process it covers. In addition, the process of obtaining and protecting patents can be long and expensive. The Company also relies upon trade secrets, technical know-how, and continuing technological innovation to develop and support its competitive position.

 

As of March 31, 2006, the Company held 284 United States patents and 740 foreign patents and had 91 United States patents and 590 foreign patents pending. Patents for individual products extend for varying periods according to the date of patent filing or grant and legal term of patents in various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage, and the availability of legal remedies in the country.

The Company’s products are sold around the world under various brand names and trademarks. The Company considers its brand names and trademarks to be valuable in the marketing of its products. As of March 31, 2006, the Company had a total of 529 trademark registrations in the United States and in various foreign countries in which the Company conducts business.

Research and Development. Research and development constitutes an important part of the Company’s activities. For the years ended March 31, 2006, 2005, and 2004, research and development expenses totaled $33.6 million, $31.5 million, and $27.6 million, respectively. The majority of these expenses relate to Company sponsored activities associated with the research and development of commercial products.

Quality Assurance. The Company manufactures, assembles, and packages products in the United States and throughout the world. Each of the Company’s production facilities are dedicated facilities, which focus on particular processes and products. The Company’s success depends upon customer confidence in the quality of the production process and the integrity of the data that supports the Company’s product safety and effectiveness. The Company has implemented quality assurance procedures related to the quality and integrity of scientific information and production processes. Throughout the world, all of the Company’s manufacturing and contract sterilization facilities are either ISO9001:2000 or ISO13485:2003 certified at a minimum.

Government Regulation. The Company’s business is subject to varying degrees of governmental regulation in the countries in which operations are conducted. The

general trend is toward regulation of increasing stringency. In the United States, the development, manufacture, sale, and distribution of the Company’s products and services are subject to regulation by the Food & Drug Administration (“FDA”), the United States Environmental Protection Agency (“EPA”), the United States Nuclear Regulatory Commission (“NRC”), and other governmental authorities. International operations are also subject to a significant degree of government regulation and country-specific rules and regulations. Government regulations include detailed inspection of, and controls over, research and development, clinical investigations, product approvals and manufacturing, marketing and promotion, sampling, distribution, record-keeping, storage, and disposal practices.

The cost of compliance with applicable regulations represents a significant expense to the Company, and such past, current, or future regulations or their interpretation or application could have a material adverse impact on the Company. Further, additional governmental regulation may be established that could prevent, delay, revoke, or result in the rejection of regulatory clearance of the Company’s products. The effect of governmental regulation or interpretation or application thereof, which may arise from current or future legislation or administration, cannot be predicted.

Failure to comply with any applicable regulatory requirements could result in sanctions being imposed on the Company, including warning letters, injunctions, monetary penalties, enforcement actions, investigations, cost recovery actions, civil litigation, failure of the FDA or foreign agencies to grant or maintain clearance or approval of equipment or devices, product recalls, operating restrictions, and/or other administrative, civil, and criminal sanctions. The Company has previously received warning letters, paid civil penalties, conducted product recalls, and has been subject to other regulatory sanctions. The Company believes that it is currently in conformity in all material respects with applicable regulatory requirements. However, there can be no assurance that future or current regulatory, governmental, or private action will not have a material adverse effect on the Company or

its performance, results, or value. Also, see Part I, Item 3, “Legal Proceedings.”

Environmental Matters. The Company is subject to various laws and governmental regulations concerning environmental matters and employee safety and health in the United States and in other countries. The Company has made, and intends to continue to make, significant expenditures for compliance with these laws and regulations. The Company cannot predict with certainty future capital expenditures or operating costs associated with environmental law and regulation compliance. The Company believes that it is currently in conformity in all material respects with applicable environmental, health, and safety requirements. However, there can be no assurance that future or current regulatory, governmental, or private action will not have a material adverse effect on the Company or its performance, results, or value. Also, see Part I, Item 3, “Legal Proceedings.”

In accordance with Financial Accounting Standards Board Interpretation No. 47 (“FIN No. 47”) “Accounting for Conditional Asset Retirement Obligations – an Interpretation of FASB Statement No. 143,” the Company has identified certain conditional asset retirement obligations at various current manufacturing and distribution facilities. Using investigative, remediation, and disposal methods that are currently available, the Company believes that the estimated cost of these obligations is not significant.

In the event any future loss contingency related to environmental matters or conditional asset retirement obligations significantly exceeds the current amount estimated, the recording of the ultimate liability may result in a material impact on net income for the annual or interim period during which the additional costs are accrued. Although management does not believe that any potential liability ultimately attributed to the Company for its environmental-related matters or conditional asset retirement obligations will have a material adverse effect on the Company’s financial condition, liquidity, or cash flow due to the extended period of time during which environmental investigation and remediation takes place, no such assurance or an estimate of the potential

impact on the Company’s operations can be made due to the aforementioned uncertainties.

The Company expects these contingent environmental-related liabilities and conditional asset retirement obligations to be resolved over an extended period of time. The Company is unable to provide a more specific time frame due to the indefinite amount of time to conduct investigation activities at any site, the indefinite amount of time to obtain governmental agency approval, as necessary, with respect to investigation and remediation activities, and the indefinite amount of time necessary to conduct remediation activities.

Competition. The markets in which the Company’s business is conducted are highly competitive and often highly regulated. Competition is intense in all of the Company’s business segments and includes many large and small competitors. Important competitive factors include product design and quality, safety, ease of use, product serviceability, and price. The Company anticipates that it may face increased competition in the future as new infection prevention, sterile processing, contamination control, and surgical support products and services enter the market. Numerous organizations are believed to be working with a variety of technologies and sterilizing agents. In addition, a number of companies have developed disposable medical instruments and other devices designed to address the risk of decontamination.

The Company believes that its long-term competitive position depends on its success in discovering, developing, and marketing innovative, cost-effective products and services. The Company focuses significant resources on research and development and management believes the Company is positioned to compete globally in search of technological innovations. In addition to expenditures related to research and development, the Company continues to invest in quality control, customer programs, distribution systems, technical services, and other information services.

There can be no assurance that new products or services developed by the Company’s competitors will not be more commercially successful than those provided or developed by the Company in the future. In

addition, some of the Company’s existing or potential competitors may have greater financial, technical, and human resources than the Company. Accordingly, the Company’s competitors may succeed in developing and commercializing products more rapidly than the Company.

The principal means of competition vary among product categories and business segments, and are discussed in more detail in the section above titled, “Information Related to Business Segments.”

Employees. As of March 31, 2006, the Company had approximately 5,100 employees throughout the world. Management considers its relations with employees, including employees covered under collective bargaining agreements, to be good. Collective bargaining agreements with certain employees located at the Erie, Pennsylvania operations expire in June 2007. The Company expects to negotiate with the applicable unions the effects of the transfer of its Erie, Pennsylvania manufacturing operations to Monterrey, Mexico.

Methods of Distribution. As of March 31, 2006, the Company employed direct field sales and service representatives numbering 1,206 and 318 in the United States and in international locations, respectively. Sales and service activities are supported by a staff of regionally based clinical specialists, system planners, corporate account managers, and in-house customer service and field support departments. The Company has also contracted with distributors in select markets.

Customer training is an important aspect of the Company’s business. In addition to training at customer locations, the Company provides a variety of courses for customers at the Company’s training and education centers throughout the world and over the internet. The programs enable customers to understand the science, technology, and operation of the Company’s products. Many of the operator training programs are approved by professional certifying organizations and offer continuing education credits to eligible course participants.

Seasonality. The Company’s financial results have been, from time to time, subject to seasonal patterns. Historically, sales of certain of the Company’s product

lines have been weighted toward the latter part of each fiscal year as a result of customer buying patterns and other factors. There can be no assurance that such patterns or trends will continue.

International Operations. The Company has operations outside of the United States. These operations are conducted through the Company’s subsidiaries and involve the same business segments as the Company’s domestic operations. Revenues from operations outside of the United States amounted to $234.7 million, or 20.2%, of the Company’s total revenues for the year ended March 31, 2006. Revenues from Europe, Canada, and other international locations amounted to 56.0%, 22.3%, and 21.7%, respectively, of total international revenues for the year ended March 31, 2006.

For a geographic presentation of revenues for the three years ended March 31, 2006, see Note 13 to the Company’s consolidated financial statements titled, “Business Segment Information,” and Item 7, “MD&A.”

The Company’s operations are subject, in varying degrees, to a number of inherent risks. These risks include, among other things, foreign currency exchange rate fluctuations, exchange controls and currency restrictions, changes in local economic conditions, unsettled political, regulatory or business conditions, and government-sponsored boycotts and tariffs on the Company’s products or services.

Depending on the direction of change relative to the U.S. dollar, foreign currency exchange rate fluctuations can increase or reduce the reported dollar amounts of the Company’s net assets and results of operations. Revenues were unfavorably impacted by $2.2 million, or 0.2%, and net income was negatively impacted by $0.3 million, or 0.5%, during fiscal 2006 as a result of foreign currency movements relative to the U.S. dollar. The Company cannot predict future changes in foreign currency exchange rates or the effect they will have on the Company’s operations.

 

Backlog. Backlog is defined by the Company as the amount of unfilled capital purchase orders at a point in time. At March 31, 2006, the Company’s backlog amounted to $104.5 million, of which $62.0 million and $42.5 million related to the Company’s Healthcare and Life Sciences segments, respectively. At March 31, 2005, the Company’s backlog orders amounted to $108.0 million, of which $65.4 million and $42.6 million related to the Company’s Healthcare and Life Sciences segments, respectively. The majority of backlog orders in both years were expected to ship in the subsequent fiscal year.

Availability of Securities and Exchange Commission Filings. The Company files annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports, and other information with the Securities and Exchange Commission (“SEC”). Copies of these materials can be obtained by visiting the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549 or by accessing the SEC’s website at http://www.sec.gov. Information on the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, as soon as reasonably practicable after such materials are filed with or furnished to the SEC, the Company makes copies available to the public, free of charge, on or through the investor relations section of its website at http://www.steris-ir.com. Also available on the Company’s website are the Company’s Corporate Governance Guidelines, Director Code of Ethics, and Code of Business Conduct, as well as Charters of the Audit and Financial Policy Committee, Compensation and Corporate Governance Committee, and the Compliance Committee of the Company’s Board of Directors. Information on the Company’s website is not incorporated into this annual report.

Item 1A. Risk Factors

The following are certain risk factors that could affect the Company’s business, financial condition and results of operations. These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report on Form 10-K because these factors could cause the actual results and financial condition to differ materially from those projected in forward-looking statements. The risks that are highlighted below are not the only ones that the Company faces. Additional risks and uncertainties not presently known by the Company or that the Company currently deems immaterial may also affect the Company’s business. If any of the following risks actually occur, the Company’s business, financial condition, value, or results of operations could be negatively affected.

The businesses in which the Company competes are highly competitive, and if the Company fails to compete successfully, the Company’s sales and results of operations may be negatively affected.

The Company operates in a highly competitive global environment and competes in each of its businesses with other broad line manufacturers and many smaller competitors specializing in particular products, primarily on the basis of brand, product quality, price, warranty, delivery, service and technical support. The Company anticipates that it may face increased competition in the future as new infection prevention, sterile processing, contamination control and surgical support products and services enter the market. Numerous organizations are believed to be working with a variety of technologies and sterilizing agents. In addition, a number of companies have developed disposable medical instruments and other devices designed to address the risk of decontamination. If the Company’s products, services, support, distribution and/or cost structure do not enable it to compete successfully, the Company’s sales, results of operations, or value may be negatively affected.

 

The Company’s success depends on its ability to design, manufacture, distribute and achieve market acceptance of new products with higher functionality and lower costs.

The Company sells to customers in industries that are characterized by technological change, product innovation and evolving industry standards and in which product price is a key consideration in customers’ purchasing decisions. The Company is engaged in product development and improvement programs and must continue to design and improve innovative products, effectively distribute and achieve market acceptance of those products, and reduce the costs of producing its products to compete successfully with its competitors. If the Company’s competitors’ product development capabilities become more effective than the Company’s, if competitors’ new or improved products are accepted by the market before the Company’s products, or if competitors are able to produce products at a lower cost and thus offer products for sale at a lower price, the Company’s business, financial condition and results of operations could be adversely affected.

The consolidation of health care and pharmaceutical customers and the Company’s competitors could result in a loss of customers or more significant pricing pressures.

Numerous initiatives and reforms initiated by legislators, regulators and third-party payors to reduce health care costs have contributed to a consolidation trend among the Company’s customers. Some of the Company’s competitors have been able to reduce production costs and have lowered the purchase prices of their products in an effort to attract customers. This has resulted in greater pricing pressures. Further consolidation could result in a loss of customers or more significant pricing pressures.

If the Company’s cost reduction and restructuring efforts are ineffective, the Company’s sales and profitability could be negatively impacted.

The Company may not be successful in achieving expected operating efficiencies and operating cost reductions, and may experience business disruptions, associated with cost reduction and restructuring activities, including the restructuring

activities announced in January 2006 and, in particular, the transfer of the Erie, Pennsylvania manufacturing operations to Mexico. These efforts may not produce the full efficiency and cost reduction benefits that the Company expects. Additionally, any benefits may be realized later than expected, and the costs of implementing these efforts may be greater than anticipated. The Company may undertake additional cost reduction efforts, which could result in future charges. The Company may be adversely affected and could experience business disruptions with its customers and elsewhere if its cost reduction and restructuring efforts prove ineffective.

Decreased availability or increased costs of raw materials or energy costs could increase the Company’s costs of producing its products or limit its ability to produce its products.

The Company purchases raw materials, energy supplies, fabricated components and services from a variety of suppliers. Raw materials such as stainless steel and petroleum-based chemicals are considered key raw materials. The availability and prices for raw materials and energy supplies are subject to volatility and are influenced by worldwide economic conditions, speculative action, world supply and demand balances, inventory levels, availability of substitute materials, currency exchange rates, anticipated or perceived shortages, and other factors. Where appropriate, the Company may employ contracts with suppliers, both domestically and internationally. From time to time, however, the prices and availability of raw materials or energy supplies fluctuate due to global market demands, which could impair the Company’s ability to procure necessary materials or produce products or could increase the cost of such materials or products. Inflationary and other increases in costs of these raw materials have occurred in the past and may recur from time to time. In addition, freight costs associated with shipping and receiving product and sales are impacted by fluctuations in the cost of energy. A reduction in the supply or increase in the cost of oil and gas could negatively impact the Company’s ability to manufacture its products and could increase the cost of

production. The Company’s results of operations may be harmed by shortages in supply or increases in prices to the extent increased costs cannot be passed on to its customers.

The Company’s operations and those of its suppliers are subject to hazards and other risks, any of which could interrupt production or operations or otherwise adversely affect the Company’s performance, results, or value.

The Company’s operations and those of its suppliers are subject to business continuity and other risks, including, but not limited to:

 

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explosions, fires, inclement weather and disasters;

 

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mechanical failures;

 

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unscheduled downtime;

 

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labor difficulties;

 

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an inability to obtain or maintain any required licenses or permits;

 

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disruption of communications;

 

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inability to hire or retain key management or employees;

 

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loss of key executives; and

 

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disruption of supplies and distribution.

The occurrence of any of these problems could cause disruption, delay, or otherwise adversely affect the productivity and profitability of a particular manufacturing facility, or the Company’s operations as a whole, during and after the period of these operating difficulties. Certain of these operating problems may also cause personal injury and loss of life, severe damage to or destruction of property and equipment. Furthermore, the Company is subject to present and future claims with respect to workplace exposure, workers’ compensation and other matters. Although the Company maintains property and casualty insurance of the types and in the amounts that the Company believes are customary for its industries, the Company is not fully insured against all potential hazards incident to its business.

The Company conducts its manufacturing, sales and distribution operations on a worldwide basis and is subject to the risks associated with doing business outside the United States.

The Company has significant international operations, including operations in Europe, Asia and Latin America. The Company is subject to a number of risks that are inherent in manufacturing, sales, services, and other operations internationally, including:

 

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risks associated with foreign currency exchange rate fluctuations;

 

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difficulties in enforcing agreements and collecting receivables through some foreign legal systems;

 

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foreign customers may have longer payment cycles than customers in the United States;

 

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tax rates in certain foreign countries that may exceed those in the United States and foreign earnings that may be subject to withholding requirements;

 

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tax laws that restrict the Company’s ability to use tax credits, offset gains, or repatriate funds;

 

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the imposition of tariffs, exchange controls or other trade restrictions including transfer pricing restrictions when products produced in one country are sold to an affiliated entity in another country;

 

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general economic and political conditions in countries where we operate or where end users of the Company’s products reside;

 

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difficulties associated with managing a large organization spread throughout various countries;

 

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difficulties in enforcing intellectual property rights and weaker intellectual property rights protection in some countries; and

 

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difficulties associated with compliance with a variety of laws and regulations governing international trade.

Many countries also have a significant degree of political, social, and economic uncertainty or unrest that may impede the Company’s ability to implement and achieve its international growth objectives. In addition, compliance with multiple and potentially conflicting international laws and regulations, import and export limitations and exchange controls is burdensome and expensive.

Changes in government and other third-party payor reimbursement levels could negatively impact the Company’s sales and profitability.

The Company’s products are sold to health care providers, hospitals, and other providers. Many of these providers are reimbursed for the health care services provided to their patients by third-party payors, such as government programs, including Medicare and Medicaid, private insurance plans, and managed care programs. Many of these programs set maximum reimbursement levels for these health care services in the United States. If the third-party payors deny coverage or reduce their current levels of reimbursement for health care services or if the Company’s costs of production increase faster than increases in reimbursement levels, it may limit the ability of these providers to purchase the Company’s products, such as capital equipment, or the Company may be unable to sell its products on a profitable basis.

Outside the United States, reimbursement systems vary significantly by country. Many foreign countries have government-managed health care systems that govern reimbursement for health care services. The ability of hospitals and other providers supported by such systems to purchase the Company’s products is dependent, in part, upon public budgetary constraints. If health care providers outside the United States do not obtain adequate levels of reimbursement from third-party payors, international sales of the Company’s products may decline, which could adversely affect the Company’s total sales and could have a material adverse effect on our business, financial condition and results of operations.

The Company is subject to extensive regulatory requirements and must receive and maintain regulatory clearance or approval for certain products or operations.

The Company’s operations are subject to extensive regulation in the United States and in other countries where the Company does business. Government regulation applies to nearly all aspects of testing, manufacture, safety, labeling, storage, recordkeeping, reporting, promotion, distribution, and the import or export of medical devices. In general, unless an exemption applies, a sterilization, decontamination, or medical device must receive regulatory approval or clearance before it can be marketed or sold. The Company can offer no assurance that a particular device will be approved or cleared or that such approval or clearance will be maintained by any applicable regulatory agency.

Additionally, the Company may be required to obtain approvals, approval supplements or clearances to market modifications to existing products or market existing products for new uses. Regulatory agencies may require manufacturers themselves to make and document determination of whether or not a modification requires an approval, supplement or clearance; however, the regulatory agencies may review and disagree with a manufacturer’s decision. The Company has applied for and received many such approvals in the past. The Company can offer no assurance that it will be successful in receiving approvals in the future or that any regulatory agency will agree with its decisions not to seek approvals, supplements or clearances for particular device modifications. The FDA or other regulatory agencies may require approval or clearances for past or any future modifications or new uses for the Company’s existing products. These submissions may require the submission of additional clinical or pre-clinical data and may be time consuming and costly, and may not ultimately be cleared or approved by the regulatory agencies. If the Company is unable to obtain any required approvals, approval supplements or clearances for any modification to a previously cleared or approved device, the Company may be required to cease manufacturing the modified device or to recall such modified device until appropriate clearance or approval is obtained.

Regulatory agencies may also change policies, adopt additional regulations, or revise existing regulations, each of which could prevent or delay approval or clearance of devices, or could impact the Company’s ability to market a device that was previously cleared or approved.

If the Company fails to comply with the regulatory requirements of the FDA or other applicable regulatory requirements in the United States or elsewhere, the Company may be subject to administratively or judicially imposed sanctions, which could have a material adverse effect on the Company’s business, financial condition and results of operations. These sanctions include warning letters, fines, civil penalties, criminal penalties, injunctions, debarment, product seizure or detention, product recalls and total or partial suspension of production.

In many of the foreign countries where the Company markets its products, the Company is subject to extensive regulations that are comparable to those of the FDA. The failure to receive, or delays in the receipt of, relevant international qualifications could have a material adverse effect on the Company’s business, financial condition and results of operations. Most notably, the regulation of the Company’s products in Europe falls primarily within the European Economic Area. Only medical devices that comply with certain conformity requirements are allowed to be marketed within the European Economic Area.

The Company’s products are subject to recalls, even after receiving FDA or foreign regulatory clearance or approval.

The Company is subject to ongoing medical device reporting regulations that require the Company to report to the FDA or governmental authorities in other countries if its products cause or contribute to a death or serious injury or malfunction in a way that would be reasonably likely to contribute to a death or serious injury if the malfunction were to recur. The FDA and similar governmental authorities in other countries have the authority to require the recall of the Company’s products in the event of material deficiencies or defects in design or manufacturing. In addition, in light of a material deficiency or design defect or defect in labeling, the Company may

voluntarily elect to recall one of its products. A government mandated or voluntary recall could occur as a result of component failures, manufacturing errors or design defects, including defects in labeling. Any recall would divert managerial and financial resources and could harm the Company’s reputation with its customers and with health care professionals who use and recommend the Company’s products. The Company can offer no assurance that it will not have any product recalls in the future or that such recalls would not have a material adverse effect on the Company’s business, financial condition, results of operations, or value.

The Company’s business and financial condition could be adversely affected by the difficulties in acquiring and maintaining a proprietary intellectual ownership position.

The Company’s ability to compete effectively with other companies depends in part on its ability to maintain and enforce the Company’s patents and other proprietary rights, which are essential to its business. The Company relies on a combination of patents, trade secrets, know-how and confidentiality agreements to protect the proprietary aspects of its technology. These measures afford only limited protection, and competitors may gain access to the Company’s intellectual property and proprietary information. The law of patents and trade secrets is constantly evolving and often involves complex legal and factual questions. Litigation has been and may continue to be necessary to enforce the Company’s intellectual property rights, to protect the Company’s trade secrets and to determine the validity and scope of the Company’s proprietary rights. Litigation can be costly and can divert management’s attention from the growth of the business. Additionally, the Company may have difficulties maintaining and enforcing its patents and other proprietary rights in some foreign jurisdictions with weaker intellectual property rights. The Company can offer no assurance that its patents and other proprietary rights will not be successfully challenged or that others will not independently develop substantially equivalent information and technology or otherwise gain access to the Company’s proprietary technology.

 

The Company may be adversely affected by product liability claims, legal actions or other regulatory or compliance matters.

The Company may be subject to a variety of claims, lawsuits, regulatory proceedings, investigations, debarment or other potential risks or liabilities. The Company may be exposed to risks of claims, proceedings, investigations or litigation by government agencies or third parties based on or relating to compliance matters, such as product regulation, tax, employee welfare or benefit plans, employment discrimination, health and safety, environmental, antitrust, customs, import/export, government contract compliance, product safety, financial controls or reporting, intellectual property, and other matters. Any such claims, proceedings, investigations or litigation, regardless of the merits, could result in substantial costs and could harm the Company’s business. Among other risks, proceedings, investigations, litigation or claims also could require the Company to:

 

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cease manufacturing and selling any of the affected products;

 

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redesign or recall the Company’s products, which may not be possible and could be costly and time consuming;

 

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restrict or suspend product sales or other Company activities; or

 

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pay substantial amounts, revise financial statements, or otherwise adversely affect Company performance, results or value.

Additionally, the Company could be the subject of regulatory or other proceedings that could result in the imposition of administratively or judicially imposed sanctions, such as warning letters, fines, civil penalties, criminal penalties, loss of tax benefits, injunctions, product seizure or detention, debarment, product recalls and total or partial suspension of production.

The Company has been, and is currently, the subject of product liability claims and lawsuits relating to its products. The Company faces an inherent business risk of exposure to product liability claims in the event that one of the Company’s products is alleged to have resulted in adverse effects. If there is a significant increase in the number, amount or scope of

the product liability claims, the Company’s business could be adversely affected. Even if the Company is successful in defending against any liability claims, such claims could nevertheless distract management, result in substantial costs, harm the Company’s reputation, adversely affect sales of the Company’s products and otherwise harm the Company’s business, financial condition, results of operations, or value.

Although the Company maintains product liability and other insurance with coverage the Company believes to be adequate, the Company can offer no assurance that any product liability or other claims made against it will not exceed the coverage limits of the Company’s insurance policies or that such insurance will continue to be available on terms the Company views as commercially reasonable or at all. Additionally, the Company is subject to the risk that its insurers will exclude claim coverage for any reason or that the insurers may become insolvent.

The results of legal or regulatory claims, proceedings, investigations or litigation are difficult to predict, and the Company cannot provide any assurance that such matters will not be commenced against it, or that the Company will prevail in any claim, proceeding, investigation or litigation. An unfavorable resolution of any legal, regulatory or compliance matter could materially and adversely affect the Company’s business, results of operations, liquidity, financial condition or value.

The Company may be unable to successfully identify, acquire and integrate strategic acquisition candidates.

The Company’s ability to successfully grow through acquisitions depends upon the Company’s

ability to identify, negotiate, complete and integrate suitable acquisitions, and to obtain any necessary financing. The costs of acquiring other businesses could increase if competition for acquisition candidates increases. Additionally, the success of any acquisition is subject to other risks and uncertainties, including:

 

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the Company’s ability to realize operating efficiencies, synergies or other benefits expected from an acquisition, and possible delays in realizing the benefits of the acquired company or products;

 

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diversion of management’s time and attention from other business concerns;

 

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difficulties in retaining key employees, customers or suppliers of the acquired businesses;

 

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difficulties in maintaining uniform standards, controls, procedures and policies throughout acquired companies;

 

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adverse effects on existing business relationships with suppliers or customers;

 

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the risks associated with the assumption of contingent or undisclosed liabilities of acquisition targets; and

 

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ability to generate future cash flows or the availability of financing.

In addition, an acquisition could materially impair the Company’s results of operations by causing the Company to incur debt or requiring the amortization of acquisition expenses and acquired assets.

Item 1B. Unresolved Staff Comments

None.

Item 3.

Legal Proceedings

The Company may be involved in a number of legal proceedings and claims, which the Company believes arise from the ordinary course of its business, given its size, history, complexity, nature of its business, and industries in which it participates. These legal proceedings and claims generally involve a variety of legal theories and allegations, including without limitation, personal injury (e.g., slip and falls, automobile accidents), product liability (e.g., based on the operation or claimed malfunction of products), product exposure (e.g., claimed exposure to chemicals, asbestos, contaminants), property damage (e.g., claimed damage due to leaking equipment, fire), economic loss (e.g., breach of contract, other commercial claims), employment (e.g., wrongful termination), and other claims for damage and relief.

The FDA and the United States Department of Justice are continuing to conduct an investigation involving the Company’s SYSTEM 1^® sterile processing system. The Company has received requests for documents in connection with the investigation. The Company has been responding to these requests and has been cooperating with the government agencies regarding this matter. There can be no assurance that the ultimate outcome of the investigation will not result

in an action by the government agencies or that the government agencies will not initiate administrative proceedings, civil proceedings or criminal proceedings, or any combination thereof, against the Company.

The Company believes it has adequately reserved for its current litigation and that the ultimate outcome of its pending lawsuits and claims will not have a material adverse effect on the Company’s consolidated financial position or results of operations taken as a whole. Due to their inherent uncertainty, however, there can be no assurance of the ultimate outcome of current or future litigation, proceedings, investigations, or claims or their effect. The Company presently maintains product liability insurance coverage, and other liability coverage in amounts and with deductibles that it believes are prudent.

From time to time, STERIS is also involved in legal proceedings as a plaintiff involving contract, patent protection, and other claims asserted by the Company. Gains, if any, from these proceedings are recognized when they are realized.

Additional information regarding the Company’s commitments and contingencies is included in Item 7, “MD&A,” and in Note 12 to the Company’s consolidated financial statements titled, “Commitments and Contingencies.”

The following is a brief account of the recent business experience of each such executive officer:

Les C. Vinney serves as President and Chief Executive Officer. He assumed this role in July 2000. Mr. Vinney joined the Company’s Board of Directors in March 2000 at the same time as he was appointed to his previous role as the Company’s President and Chief Operating Officer. Mr. Vinney joined STERIS as Senior Vice President and Chief Financial Officer in August 1999. He became Senior Vice President Finance and Operations in October 1999 and President and Chief Operating Officer in March 2000. Prior to his employment with STERIS, Mr. Vinney served as Senior Vice President and Chief Financial Officer at The BF Goodrich Company, a manufacturer of advanced aerospace systems, performance materials, and engineered industrial products. During his eight-year career with BF Goodrich, Mr. Vinney held a variety of senior operating and financial management positions, including Vice President and Treasurer, President and CEO of the former Tremco subsidiary, and Senior Vice President, Finance and Administration of BF Goodrich Specialty Chemicals. Mr. Vinney is a director of Campbell Soup Company.

William L. Aamoth serves as Vice President and Corporate Treasurer. He joined the Company in March

2001 as Corporate Treasurer. Prior to joining the Company, Mr. Aamoth was employed by Hayes Lemmerz International, a manufacturer of automotive wheels, brakes, and related systems, from January 2000 through January 2001, serving as Treasurer. From May 1992 to December 1999, Mr. Aamoth was employed by TRW, Inc., a manufacturer and service provider of automotive, aerospace, and information technology products, serving most recently as Assistant Treasurer, International.

Laurie Brlas serves as Senior Vice President and Chief Financial Officer. She assumed this role when she joined the Company in April 2000. Prior to joining STERIS, Ms. Brlas was employed by OfficeMax, Inc., a retailer of goods and services to business customers and consumers, from September 1995 through April 2000, serving most recently as Senior Vice President and Corporate Controller. Ms. Brlas is a director of Perrigo Company.

Dr. Peter A. Burke serves as Senior Vice President and Chief Technology Officer. He assumed this role in July 2002. Dr. Burke joined the Company in January 2001 as Vice President and Chief Technology Officer. Prior to joining STERIS, Dr. Burke was employed by Carter-Wallace, Inc., a manufacturer and distributor of

consumer and pharmaceutical products, from January 1996 to March 2001, serving most recently as Vice President, Research and Development.

Timothy L. Chapman serves as Senior Vice President, Business Strategy. He assumed this role when he joined the Company in January 2006. Prior to joining STERIS, Mr. Chapman was employed by McKinsey & Company, a professional services firm, from June 1985 through January 2006, serving most recently as Director (Senior Partner) in McKinsey’s Healthcare and Operations practices.

Patricia K. Fish serves as Senior Vice President, Human Resources. She assumed this role when she joined the Company in August 2005. Prior to joining STERIS, Ms. Fish was employed by Sigma Aldrich, a chemical manufacturer, from April 2004 through August 2005, serving most recently as Senior Vice President, Human Resources. From June 2000 to April 2004, Ms. Fish was employed by RehabCare Group, Inc., a provider of rehabilitation program management services, serving most recently as Senior Vice President, Human Resources.

Charles L. Immel serves as Senior Vice President and Group President, Healthcare. He assumed this role in July 2003. He joined the Company in May 2001 and served as Senior Vice President, Sales and Marketing and President, Commercial Products until April 2003. Prior to joining STERIS, Mr. Immel was employed by Baxter Healthcare Corporation, a medical products and services company specializing in critical care applications, from July 1983 to May 2001, serving most recently as Vice President and General Manager of Baxter’s Therapeutic Commercial Business.

Dr. Patrick J. McCullagh serves as Vice President, Global Quality Systems Engineering and Regulatory Affairs. He assumed this role in July 2005. He joined the Company in July 2002 and served as Vice President, Engineering Research until July 2005. Prior to joining STERIS, Dr. McCullagh most recently served as a self-employed technical consultant regarding medical devices, product development, and product submissions from May 2001 to June 2002. Prior to that, he served as Senior Director, Marketing and Sales International with Orquest, a biotechnology company

focused on developing biologically-based implants for orthopedics and spine surgery from May 2000 to May 2001.

Mark D. McGinley serves as Senior Vice President, General Counsel, and Secretary. He assumed this role in April 2005. He joined the Company in March 2002 as Vice President, General Counsel, and Secretary. Prior to joining STERIS, Mr. McGinley was employed by Noveon, Inc., an international specialty chemicals manufacturer. Mr. McGinley also served as Associate General Counsel of The Glidden Company, a producer of specialty products and paints, and was employed by the BF Goodrich Company from 1990 to 2000 in various legal capacities, including General Counsel of the BF Goodrich Sealants, Coatings and Adhesives Group.

Robert E. Moss serves as Senior Vice President and Group President, STERIS Isomedix Services. He assumed this role in April 2005. He served as Vice President and General Manager of STERIS Isomedix Services from 1999 until April 2003 and as Vice President and Group President of STERIS Isomedix Services from March 2003 until April 2005. Mr. Moss joined the Company in 1990 serving as Vice President Operations until 1999. Prior to joining the Company, Mr. Moss held senior leadership positions with Cardinal Health and divisions of American Hospital Supply Corporation, both medical products and services companies.

Gerard J. Reis serves as Senior Vice President and Group President, Life Sciences. He assumed this role in February 2005. He previously served as Senior Vice President and Group President, Defense and Industrial. He joined the Company in July 1994 as Vice President, Administration. He served as Senior Vice President, Administration from October 1999 until April 2003.

Michael J. Tokich serves as Vice President and Corporate Controller. He joined the Company in May 2000 as Assistant Corporate Controller. He became Corporate Controller in December 2000. Prior to joining the Company, Mr. Tokich was employed by OfficeMax, Inc., a retailer of goods and services to business customers and consumers, from July 1994 to May 2000, serving most recently as Divisional Vice President, Assistant Controller.

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following sections of MD&A should be read in conjunction with information contained in Item 1, “Business,” Item 6, “Selected Financial Data,” and information contained in the Company’s consolidated financial statements, included in Item 8, “Financial Statements and Supplementary Data.”

FINANCIAL MEASURES

In the following sections of MD&A and in Item 1, “Business,” the Company, at times, may refer to financial measures that are not required to be presented in the consolidated financial statements under accounting principles generally accepted in the United States. The Company has used the following financial measures that are not required to be presented under United States generally accepted accounting principles in the context of this report: backlog, debt to capital, and days sales outstanding. The Company defines these financial measures as follows:

 

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Backlog – is defined by the Company as the amount of unfilled capital purchase orders at a point in time. The Company uses this figure as a measure to assist in the projection of short-term financial results and inventory requirements.

 

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Debt-to-capital – is defined by the Company as total debt divided by the sum of debt and shareholders’ equity. The Company uses this figure as a financial liquidity measure to gauge the Company’s ability to borrow, provide strength/protection against creditors, fund growth, develop outside of current business operations, and measure the risk of the Company’s financial structure.

 

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Days sales outstanding – is defined by the Company as the average collection period for sales revenues. It is calculated as net accounts receivable divided by the trailing four quarter’s revenues, multiplied by 365. The Company uses this figure to help gauge the quality of accounts receivable and expected time to collect.

In the following sections of MD&A and in Item 1, “Business,” the Company, at times, may also

refer to financial measures which are considered to be “non-GAAP financial measures” under SEC rules. Non-GAAP financial measures used by the Company are as follows:

 

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Free cash flow – is defined by the Company as cash flows from operating activities as presented in the Consolidated Statements of Cash Flows, which are presented in Item 8, “Financial Statements and Supplementary Data,” less purchases of property, plant and equipment, net, which is also presented in the Consolidated Statements of Cash Flows. The Company uses this measure to gauge its ability to fund future growth outside of core operations, repurchase common shares, and pay cash dividends. The following table summarizes the calculations of the Company’s free cash flow for the years ended March 31, 2006 and 2005:

 

Years Ended March 31,		2006		2005
		(dollars in millions)
Cash flows from operating activities		$  162.0		$  148.9
Purchases of property, plant and equipment, net		51.2		56.2
Free cash flow		$  110.8		$    92.7

 

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The Company, at times, may refer to its results of operations excluding certain transactions or amounts that are non-recurring or are not indicative of future results, in order to provide meaningful comparative analysis between the years presented. For example, when discussing changes in revenues, the Company may, at times, exclude the impact of current or prior year business acquisitions.

The Company has presented these financial measures because it believes that meaningful analysis of the Company’s financial performance is enhanced by an understanding of certain additional factors underlying that performance. These financial measures should not be considered an alternative to measures required by accounting principles generally accepted in the United States. The Company’s calculations of these measures may differ from calculations of similar measures used by other companies and investors should be careful when comparing these financial measures to those of other companies.

REVENUES-DEFINED

As required by Regulation S-X, the Company has presented separately on its Consolidated Statements of Income for each year presented, revenues generated as either product revenues or service revenues. In discussing revenues, the Company, at times, may refer to revenues in differing detail than that which is required by Regulation S-X. The terminology, definitions, and applications of terms that the Company uses to describe revenues may differ from terms used by other companies. The Company uses the following terms to describe revenues:

 

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Revenues – The Company’s revenues are presented net of sales returns and allowances.

 

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Product Revenues – Product revenues are defined by the Company as revenues generated from sales of capital equipment, which includes steam and low temperature liquid sterilizers, washing systems, VHP® technology, water stills, and pure steam generators; surgical lights and tables; and the consumable family of products, which includes STERIS SYSTEM 1® consumables, sterility assurance products, skin care products, and cleaning consumables.

 

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Service Revenues – Service revenues are defined by the Company as revenues generated from parts and labor associated with the maintenance, repair, and installation of the Company’s capital equipment, as well as revenues generated from contract sterilization offered through the Company’s Isomedix Services segment.

 

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Capital Revenues – Capital revenues are defined by the Company as revenues generated from sales of capital equipment, which includes steam and low temperature liquid sterilizers, washing systems, VHP® technology, water stills, and pure steam generators; and surgical lights and tables.

 

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Consumable Revenues – Consumable revenues are defined by the Company as revenues generated from sales of the consumable family of products which includes STERIS SYSTEM 1® consumables, sterility assurance products, skin care products, and cleaning consumables.

 

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Recurring Revenues – Recurring revenues are defined by the Company as revenues generated

from sales of consumable products and service revenues.

 

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Acquired Revenues – Acquired revenues are defined by the Company as base revenues generated from acquired businesses or assets and additional volumes driven through acquired businesses or assets. The Company will use such measure for up to a year after acquisition.

GENERAL COMPANY OVERVIEW AND OUTLOOK

The mission of STERIS Corporation is to provide a healthier today and safer tomorrow through knowledgeable people and innovative infection prevention, decontamination and health science technologies, products, and services. The Company’s dedicated employees around the world work together to supply a broad range of solutions by offering a combination of equipment, consumables, and services to healthcare, pharmaceutical, industrial, and governmental customers.

STERIS participates in industries that currently benefit from strong underlying demand, with the bulk of the Company’s revenues derived from the healthcare and pharmaceutical industries. As such, much of the growth in its markets is driven by the aging of the population throughout the world, as an increasing number of individuals are entering their prime healthcare consumption years. In addition, each of STERIS’s core industries also are benefiting from specific trends that drive growth. Within the healthcare market, there is increased concern regarding the level of hospital-acquired infections around the world. The pharmaceutical industry has been impacted by increased FDA scrutiny of cleaning and validation processes, mandating that manufacturers improve their processes. In the contract sterilization industry, where Isomedix competes, an increasing trend toward the outsourcing of sterilization services continues to drive growth.

Beyond STERIS’s core markets, infection-control issues are becoming a global concern, and emerging threats have gained prominence in the news. Through the Life Sciences segment, the Company is actively pursuing new opportunities to adapt its proven technologies to meet the needs of emerging markets such as defense, aerospace, and industrial decontamination.

Several critical actions were taken in fiscal 2006. The sale of the lyophilizer (freeze dryer) business in the third quarter was an important step in the Life Sciences renewed strategic focus. In January 2006, the Company announced the transfer of manufacturing operations from Erie, Pennsylvania to Mexico as a major element of a plan to reduce the cost structure of operations.

Fiscal 2006 revenue growth was fueled by acquisitions completed in fiscal 2005 and moderate growth in recurring revenues from consumable and service offerings.

During fiscal 2005, the Company completed three strategic acquisitions that expanded its breadth of product offerings and global reach. Within the Healthcare segment, the acquisitions of Browne and FHSurgical expanded the Company’s offerings of chemical indicators and surgical tables, respectively, within the European marketplace. Within the Isomedix Services segment, five EO processing facilities acquired from Cosmed expanded the Company’s processing capacity within its North American footprint of strategically located facilities.

The Company’s financial position and cash flows remain strong. Working capital management and reduced capital spending levels resulted in record cash flows from operations of $162.0 million and record free cash flow of $110.8 million. The Company continues to maintain low debt levels with its debt to capital ratio approximating 13.7% at March 31, 2006. The Company’s strong financial position and cash flows currently afford it the financial flexibility to return value to shareholders. The value to shareholders may be in the form of strategic acquisitions that strengthen the Company’s long-term competitive position and potential common share repurchases and cash dividends.

A detailed discussion of the Company’s fiscal 2006 performance is included in the subsection of MD&A titled, “Results of Operations.”

MATTERS AFFECTING COMPARABILITY

Business Acquisitions.  The Company’s operating results for fiscal 2005 include the impact of acquisitions completed during the fiscal year from the date of

acquisition. During fiscal 2005, the Company acquired Browne and FHSurgical and certain assets of Cosmed. During the initial twelve months following its acquisition, Browne contributed $18.7 million ($9.4 million and $9.3 million, in fiscal years 2006 and 2005, respectively) to the Healthcare segment’s revenues. The addition of five EO facilities acquired from Cosmed contributed $25.0 million ($19.1 million and $5.9 million, in fiscal years 2006 and 2005, respectively) to the Isomedix Services segment’s growth in revenues during the initial twelve months following its acquisition for fiscal 2006 and 2005, respectively. The addition of FHSurgical to the Company’s operations contributed $19.7 million to the Healthcare segment’s revenues for fiscal 2006. The acquisition of FHSurgical was completed on March 24, 2005 and, therefore, did not have a material impact on the Company’s fiscal 2005 operating results.

Business Dispositions. On October 31, 2005, the Company completed the sale of its lyophilizer (freeze dryer) product line to GEA Group of Germany for 20.8 million euros (approximately $25.2 million). The transaction resulted in an after-tax gain to the Company of approximately $6.2 million. The freeze dryer product line, based in Cologne, Germany, was part of the Company’s Life Sciences segment. This product line is presented as a discontinued operation in the Company’s financial statements. Revenues, cost of revenues, operating expenses and income taxes attributable to this product line have been aggregated to a single line on the income statement for all periods presented. Segment results for all periods presented exclude the freeze dryer product line and reflect the reallocation of corporate overhead charges to all business segments.

Further information regarding the Company’s discontinued operations is included in Note 2 to the Company’s consolidated financial statements titled, “Business Dispositions.”

Restructuring. On January 30, 2006, the Company announced that the manufacturing portion of its Erie, Pennsylvania operations will be transferred to Mexico to reduce production costs and improve the Company’s competitive position. Plans for other restructuring

actions designed to reduce operating costs within the ongoing operations of both the Healthcare and Life Sciences segments also were approved.

Operating income for fiscal 2006 includes expenses of approximately $25.3 million primarily for non-cash expenses related to asset write-downs, accelerated recognition of pension and retiree medical benefits, and severance and termination benefits related to the transfer and other restructuring actions.

As announced on January 30, 2006, the Company anticipates the total costs associated with this transfer over the next several years following fiscal 2006 to approximate $35.0 million, including $18.0 million of restructuring expenses.

Asset write-downs include the impairment of buildings, land, manufacturing equipment and office equipment, and the resulting write-down of the

carrying value of these assets to fair value, which represents management’s best estimate of the fair value for the assets to be sold or idled.

International Operations. Because the Company conducts operations outside of the United States using various foreign currencies, its operating results are impacted by foreign currency movements relative to the U.S. dollar. During fiscal 2006, the Company’s revenues were unfavorably impacted by $2.2 million, or 0.2%, and net income was negatively impacted by $0.3 million, or 0.5%, as a result of foreign currency movements relative to the U.S. dollar.

RESULTS OF OPERATIONS

The following subsections provide commentary regarding the results of operations of the Company for fiscal 2006 as compared to fiscal 2005 and for fiscal 2005 as compared to fiscal 2004.

Revenues increased $78.6 million, or 7.3%, to $1,160.3 million for the year ended March 31, 2006, as compared to $1,081.7 million for fiscal 2005. For fiscal 2006, recurring revenues increased 9.6% as compared to fiscal 2005. The recurring revenues increase was generated from an 8.4% increase in consumable revenues driven by the Browne acquisition and a 10.4% increase in service revenues as compared to fiscal 2005. Service revenues, which increased in all segments, were driven by a $22.7 million, or 21.6%, increase in the Isomedix Services segment. Within the Company’s Healthcare and Life Sciences segments, service revenues for fiscal 2006 increased 5.5% and 6.8%, respectively, as compared to fiscal 2005. Capital revenues increased $21.3 million, or 4.4%, during fiscal 2006, as compared to fiscal 2005. The Healthcare segment experienced strong demand for Cmax surgical tables both in the United States and internationally. However, the Healthcare segment’s base capital equipment offering was negatively impacted by softness in overall market demand for products because sterile processing and surgical suite products are generally purchased late in the project cycle, and there was an overall decline in projects entering the completion stage in fiscal 2006 as compared to fiscal 2005. Life Sciences capital revenue reflects pockets of growth in international pharmaceutical production and sales of replacement equipment into the research market.

International revenues for fiscal 2006 amounted to $234.7 million, an increase of $27.7 million, or 13.4%, as compared to fiscal 2005. The increase in year over year international revenues was

attributable to an 11.9% increase in capital revenues primarily within the European and Intercontinental marketplaces. Within Europe, fiscal 2006 capital revenues from the Company’s Healthcare segment increased 38.8% as compared to fiscal 2005 largely attributable to the acquisition of FHSurgical. This increase was partially offset by a decrease of 22.4% in European capital revenues from the Company’s Life Sciences segment during fiscal 2005. The increase in international capital revenues was supplemented by an increase of 15.3% in recurring revenue streams year over year.

United States revenues for fiscal 2006 amounted to $925.6 million, an increase of $50.9 million, or 5.8%, as compared to fiscal 2005. United States revenues were positively impacted by an 8.7% increase in recurring revenues, which were driven by an increase in the Isomedix Services segment’s revenues of 21.6%. Recurring revenues were also positively impacted by service revenue increases of 3.2% and 13.0% in the Healthcare and Life Sciences segments, respectively, and an increase in consumable revenues of 5.2%. Year over year, United States capital revenues increased 1.9% as a result of improved demand from hospital customers during the second half of the fiscal year. The increase in United States capital revenues was driven by increases of 1.1% and 6.6% in the Company’s Healthcare and Life Sciences segments, respectively.

Revenues are further discussed on a segment basis in the section of MD&A titled “Business Segment Results of Operations.”

Gross profit (margin) is impacted by the volume, pricing, and mix of sales of the Company’s products and services, as well as the costs associated with the products and services that are sold. The Company’s gross profit margin declined to 41.7% for fiscal 2006. Overall, fiscal 2006 margins were negatively impacted by increased raw material prices, particularly related to stainless steel, a core material used in the manufacturing of capital equipment, and certain petroleum-based chemicals used in consumables formulations. Gross margins were also negatively

impacted by the increased cost of freight and the addition of operating costs associated with recently acquired businesses and reduced volumes within certain manufacturing processes which resulted in lower fixed cost absorption. Gross margins associated with service offerings reflect increases in labor, fuel and facilities costs.

Gross margins are further discussed on a segment basis in the section of MD&A titled “Business Segment Results of Operations.”

Significant components of total selling, general, and administrative expenses (“SG&A”) are compensation and benefit costs, fees for professional services, travel and entertainment, facilities costs, and other general and administrative expenses. As a percentage of total revenues, SG&A increased 50 basis points to 27.2% for fiscal 2006 as compared to fiscal 2005. The increase includes fourth quarter 2006 expenses of approximately $4 million associated with the termination of certain long-term marketing agreements.

Research and development expenses as a percentage of total revenues remained relatively flat at 2.9% for fiscal 2006 and fiscal 2005. As compared to

fiscal 2005, research and development expenses increased $2.1 million, or 6.6%, during fiscal 2006. The increase in research and development expenses is attributable to the integration of research and development functions of acquired companies and a continued emphasis on new product development, product improvements, and the development of new technological innovations. During fiscal 2006, the Company’s investments in research and development focused on, but were not limited to, enhancing capabilities of delivery systems in the defense and industrial areas, sterile processing combination technologies, and the area of prions.

Restructuring Expense.  In fiscal 2006, the Company recorded $25.3 million in restructuring expenses related to the transfer of the Erie, Pennsylvania manufacturing operations to Monterrey, Mexico and other restructuring actions, including the closure of a sales office in Miami, Florida, rationalization of operations in Finland and the elimination of certain management positions. All such actions are intended to improve the Company’s cost structure. The following is a summary of these primarily non-cash restructuring expenses for fiscal 2006:

 

(dollars in thousands)		March 31, 2006
Asset impairment and accelerated depreciation		$  11,712
Pension curtailment		2,335
OPEB acceleration		8,982
Severance and termination benefits		2,038
Other		241
Total restructuring charges		$  25,308

These costs are primarily associated with the Healthcare business segment with restructuring expenses of $24.8 million and $0.5 million related to the Healthcare and Life Sciences segments, respectively.

The Company anticipates incurring approximately an additional $18.0 million in restructuring expenses over the next two years in connection with the transfer of the manufacturing

operations. Restructuring expenses to be incurred include severance, accelerated depreciation and other expenses. The Company did not incur restructuring expenses in fiscal 2005 or fiscal 2004.

Restructuring expenses have been recognized as incurred as required under the provisions of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” In addition, the property, plant and equipment associated with the Erie, Pennsylvania facility were assessed for impairment under Statement of Financial Accounting Standards No. 144 (“SFAS No. 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets.” Asset impairment and accelerated depreciation expenses primarily relate to an adjustment in the carrying value of the Erie facility to its estimated fair value. In addition, the remaining useful lives of other property, plant and equipment associated with the Erie manufacturing operations were reevaluated based on the plan, resulting in the acceleration of depreciation and amortization of certain assets. These actions have or will impact more than 450 employees during the fourth quarter of fiscal 2006 and over the period in which operations are transferred from Erie, Pennsylvania to Monterrey, Mexico. Additional information regarding the impact of the restructuring actions on the Company’s employee benefit plans is included in Note 11 to the Company’s consolidated financial statements titled, “Benefit Plans.”

Interest expense increased year over year as a result of higher average debt levels and higher interest rates on outstanding debt during fiscal 2006 as compared to fiscal 2005. Interest and other miscellaneous income increased $2.2 million compared to the prior year. This increase resulted primarily from the final settlement of certain working capital adjustments and the resolution of certain indemnification claims pursuant to the terms of the share purchase agreement with respect to the

Company’s acquisition of Hamo Holding AG (“Hamo”), which was completed during fiscal 2004. The settlement occurred in the first quarter of fiscal 2006.

A detailed discussion of the Company’s outstanding debt is included in Note 8 to the Company’s consolidated financial statements titled, “Debt,” and in the subsection of MD&A titled, “Liquidity and Capital Resources.”

The effective income tax rate for fiscal 2006 was 41.8% as compared to 39.5% for fiscal 2005. The higher effective income tax rate for fiscal 2006 is primarily due to ongoing routine IRS audits and the unfavorable impact of losses in international operations. IRS audit assessments related to tax years 1997 through 2001. The impact of reductions in the operating profits generated in international tax

jurisdictions results not only in the inability to utilize operating loss carryforwards but also reduces the Company’s utilization of foreign tax credits against foreign profits taxed in the United States. Additional information regarding the Company’s income tax expense is included in Note 10 to the Company’s consolidated financial statements titled, “Income Taxes.”