10-Q 1 hyh3q2016form10q.htm FORM 10-Q Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
OR
o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________  
Commission file number 001-36440
 
halyardhealthlogoa07.jpg
HALYARD HEALTH, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
46-4987888
(State or other jurisdiction of
incorporation)
 
(I.R.S. Employer
Identification No.)
5405 Windward Parkway
Suite 100 South
Alpharetta, Georgia
30004
(Address of principal executive offices)
(Zip code)
(678) 425-9273
(Registrant's telephone number, including area code)
 
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  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
  
Accelerated filer
o
Non-accelerated filer
o (Do not check if a smaller reporting company)
  
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o    No  x
As of October 31, 2016 there were 46,674,183 shares of the Corporation's common stock outstanding.    
 





Table of Contents


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


PART I – FINANCIAL INFORMATION
Item 1. Financial Statements

HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENTS
(in millions, except per share amounts)
(Unaudited)

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Net Sales
$
397.5

 
$
389.5

 
$
1,182.3

 
$
1,173.0

Cost of products sold
259.5

 
258.5

 
767.1

 
775.0

Gross Profit
138.0

 
131.0

 
415.2

 
398.0

Research and development
10.9

 
10.2

 
29.1

 
22.5

Selling and general expenses
100.3

 
97.2

 
301.0

 
300.2

Goodwill impairment

 
475.5

 

 
475.5

Other expense and (income), net
5.9

 
9.3

 
13.5

 
(2.0
)
Operating Profit (Loss)
20.9

 
(461.2
)
 
71.6

 
(398.2
)
Interest income
0.2

 

 
0.5

 
0.2

Interest expense
(8.4
)
 
(7.8
)
 
(24.7
)
 
(25.0
)
Income (Loss) Before Income Taxes
12.7

 
(469.0
)
 
47.4

 
(423.0
)
Income tax provision
(3.6
)
 
(1.5
)
 
(17.6
)
 
(17.8
)
Net Income (Loss)
$
9.1

 
$
(470.5
)
 
$
29.8

 
$
(440.8
)
 
 
 
 
 
 
 
 
Earnings (Loss) Per Share
 
 
 
 
 
 
 
Basic
$
0.19

 
$
(10.10
)
 
$
0.64

 
$
(9.46
)
Diluted
0.19

 
(10.10
)
 
0.63

 
(9.46
)


See Notes to Condensed Consolidated Financial Statements.

3


HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)
(Unaudited)

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Net Income (Loss)
$
9.1

 
$
(470.5
)
 
$
29.8

 
$
(440.8
)
Other Comprehensive (Loss) Income, Net of Tax
 
 
 
 
 
 
 
Unrealized currency translation adjustments
(0.5
)
 
(12.5
)
 
3.0

 
(22.3
)
Defined benefit plans
0.1

 

 
0.2

 
0.2

Cash flow hedges
0.2

 
(1.4
)
 
1.7

 
(1.6
)
Total Other Comprehensive (Loss) Income, Net of Tax
(0.2
)
 
(13.9
)
 
4.9

 
(23.7
)
Comprehensive Income (Loss)
$
8.9

 
$
(484.4
)
 
$
34.7

 
$
(464.5
)


See Notes to Condensed Consolidated Financial Statements.



4


HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except share data)
(Unaudited)

 
September 30,
2016
 
December 31,
2015
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
86.7

 
$
129.5

Accounts receivable, net of allowances
189.1

 
224.7

Inventories
298.7

 
303.2

Prepaid expenses and other current assets
31.1

 
18.6

Total Current Assets
605.6

 
676.0

Property, Plant and Equipment, net
265.0

 
279.5

Goodwill
1,031.9

 
945.2

Other Intangible Assets, net
176.7

 
82.6

Deferred Tax Assets
12.2

 
14.9

Other Assets
3.6

 
2.0

TOTAL ASSETS
$
2,095.0

 
$
2,000.2

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current Liabilities
 
 
 
Trade accounts payable
$
166.5

 
$
163.2

Accrued expenses
144.2

 
152.0

Total Current Liabilities
310.7

 
315.2

Long-Term Debt
589.4

 
578.1

Deferred Tax Liabilities
63.4

 
23.8

Other Long-Term Liabilities
30.0

 
27.8

Total Liabilities
993.5

 
944.9

 
 
 
 
Commitments and Contingencies

 

 
 
 
 
Stockholders’ Equity
 
 
 
Preferred stock - $0.01 par value - authorized 20,000,000 shares, none issued

 

Common stock - $0.01 par value - authorized 300,000,000 shares, 46,674,183 outstanding at September 30, 2016 and 46,614,947 outstanding at December 31, 2015
0.5

 
0.5

Additional paid-in capital
1,530.4

 
1,518.0

Accumulated deficit
(389.2
)
 
(419.0
)
Treasury stock
(1.9
)
 
(1.0
)
Accumulated other comprehensive loss
(38.3
)
 
(43.2
)
Total Stockholders’ Equity
1,101.5

 
1,055.3

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
2,095.0

 
$
2,000.2



See Notes to Condensed Consolidated Financial Statements.


5


HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED CASH FLOW STATEMENTS
(in millions)
(Unaudited)

 
Nine Months Ended
September 30,
 
2016
 
2015
Operating Activities
 
 
 
Net income (loss)
$
29.8

 
$
(440.8
)
Depreciation and amortization
48.4

 
48.6

Stock-based compensation expense
12.3

 
14.1

Goodwill impairment

 
475.5

Net loss (gain) on asset dispositions
3.8

 
(7.6
)
Changes in operating assets and liabilities, net of acquisition:
 
 
 
Accounts receivable
11.0

 
33.1

Inventories
14.8

 
(40.5
)
Prepaid expenses and other assets
3.1

 
(1.9
)
Accounts payable
4.1

 
33.2

Accrued expenses
10.8

 
(37.3
)
Other
5.8

 
(1.8
)
Cash Provided by Operating Activities
143.9

 
74.6

Investing Activities
 
 
 
Capital expenditures
(21.7
)
 
(64.4
)
Acquisition of business, net of cash acquired
(175.0
)
 

Proceeds from dispositions of property

 
7.8

Cash Used in Investing Activities
(196.7
)
 
(56.6
)
Financing Activities
 
 
 
Line of credit facility proceeds
72.0

 

Line of credit facility repayments
(62.0
)
 

Debt repayments

 
(51.0
)
Purchase of treasury stock
(0.9
)
 
(1.0
)
Proceeds from the exercise of stock options
0.2

 
1.2

Cash Provided by (Used in) Financing Activities
9.3

 
(50.8
)
Effect of Exchange Rate Changes on Cash and Cash Equivalents
0.7

 
(3.7
)
Decrease in Cash and Cash Equivalents
(42.8
)
 
(36.5
)
Cash and Cash Equivalents - Beginning of Period
129.5

 
149.0

Cash and Cash Equivalents - End of Period
$
86.7

 
$
112.5



See Notes to Condensed Consolidated Financial Statements.


6


HALYARD HEALTH, INC. AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1.    Accounting Policies
Background and Basis of Presentation
Halyard Health, Inc. is a global business which seeks to advance health and healthcare by preventing infection, eliminating pain and speeding recovery. Our products and solutions are designed to address some of today’s most important healthcare needs, namely, preventing infections and reducing the use of narcotics while helping patients move from surgery to recovery. We market and support the efficacy, safety and economic benefit of our products with a significant body of clinical evidence. We operate in two business segments: Surgical and Infection Prevention (“S&IP”) and Medical Devices. References to “Halyard,” “Company,” “we,” “our” and “us” refer to Halyard Health, Inc.
Interim Financial Statements
We prepared the accompanying condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the instructions to the Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and the condensed consolidated financial statements in this Quarterly Report on Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2015. Our unaudited interim condensed consolidated financial statements contain all material adjustments which are of a normal and recurring nature necessary to fairly state our financial condition, results of operations and cash flows for the periods presented.
Use of Estimates
Preparation of our condensed consolidated financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting periods. Estimates are used in accounting for, among other things, distributor rebate accruals, future cash flows associated with impairment testing for goodwill and long-lived assets, loss contingencies, deferred tax assets and potential income tax assessments. Actual results could differ from these estimates, and the effect of the change could be material to our financial statements. Changes in these estimates are recorded when known.
Annual Goodwill Impairment Test
We test goodwill for impairment annually or more frequently whenever events or circumstances more likely than not indicate that the fair value of the reporting unit may be below its carrying amount. The fair value of our reporting units were estimated using a combination of income (discounted cash flow analysis) and market approaches. Both approaches are dependent upon several assumptions regarding future periods, including assumptions with respect to future sales growth, commodity costs and a terminal growth rate. A weighted average cost of capital (“WACC”) was used to discount future estimated cash flows to their present values. The WACC was based on externally observable data considering market participants’ cost of equity and debt, optimal capital structure and risk factors specific to our company. In addition, the market approach estimated the fair value of our business based on comparable publicly-traded companies in our industry.
We have completed the required annual goodwill impairment testing as of July 1, 2016, and the fair values for both our S&IP and Medical Devices reporting units were substantially in excess of their respective net asset carrying values.
New Accounting Standards
In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-15, Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments. This ASU provides guidance on the presentation and classification of certain specific cash receipts and payments in the statement of cash flows and is intended to reduce diversity in practice. This ASU is effective for annual periods, and interim periods within those annual periods beginning after December 15, 2017, but earlier adoption is permitted. This ASU is to be applied using a retrospective transition method to each period presented. Application of this ASU is not expected to have a material effect on our financial position, results of operations or cash flows.
In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. This ASU simplifies several aspects of accounting for share-based payment transactions including the accounting for income taxes, forfeitures, statutory tax withholding requirements and classification on the statement of cash flows. Under this ASU, all excess tax benefits or deficiencies are recognized as income tax expense or benefit in the income statement and the pool of windfall tax benefits as a component of additional paid-in capital is eliminated. In regards to forfeitures, companies may make a one-time policy election to use an estimated forfeiture rate or account for forfeitures as they occur. The policy election regarding

7


forfeitures applies only to instruments with service conditions; the requirement to estimate the probability of achieving performance conditions remains. For statutory tax withholding requirements, this ASU allows for net settlement up to the employer’s maximum statutory tax withholding requirement. Formerly, only the minimum statutory tax withholding requirement was allowed to be met through net settlement while retaining equity classification. This ASU is effective for annual periods, and interim periods within those annual periods beginning after December 15, 2016. Earlier adoption is permitted in any interim or annual period for which financial statements have not yet been issued. The application of this ASU in regards to the accounting for income taxes, forfeitures and statutory tax withholding requirements should be applied using a modified retrospective application with a cumulative effect adjustment to additional paid-in capital as of the beginning of the period of adoption. The presentation of employee taxes paid on the statement of cash flows should be applied retrospectively. The adoption of this ASU is not expected to have a material effect on our financial position, results of operations or cash flows.
In February 2016, the FASB issued ASU No. 2016-02, Leases. This ASU requires the recognition of assets and liabilities for leases with lease terms of more than twelve months. The recognition, measurement and presentation of expenses and cash flows arising from a lease will depend primarily on its classification as a finance or an operating lease, with the classification criteria for distinguishing between the two being similar to the classification criteria for distinguishing between capital and operating leases under current GAAP. However, unlike current GAAP, recognition of finance and operating leases on the balance sheet is required, and additional disclosures are required to help financial statement users to better understand the amount, timing and uncertainty of cash flows arising from leases. This ASU requires modified retrospective application for existing leases. This ASU will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, however, earlier application is permitted. The adoption of this ASU will require us to recognize assets and liabilities for operating leases we have entered into for our principal executive offices as well as certain warehouse, manufacturing and distribution facilities globally. We have not yet determined the impact recognition of such assets and liabilities will have on our financial position, results of operations and cash flows.
In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Liabilities. This ASU requires equity investments, except those accounted for under the equity method or those that result in consolidation of the equity investee, to be measured at fair value with changes in fair value recognized in net income. However, equity investments without readily determinable fair values may be measured at cost less impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments in the same issuer. In addition, this ASU provides for a qualitative impairment assessment for equity investments that do not have readily determinable fair values. This ASU also clarifies that entities should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. This ASU should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The provisions related to equity investments that do not have readily determinable fair values should be applied prospectively to such equity investments that exist as of the date of adoption. This ASU will be effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2017. Early adoption of this ASU is permitted. The impact of this ASU is not expected to have a material effect on our financial position, results of operations and cash flows.
In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers, which, along with subsequent amendments, provides a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most current revenue recognition guidance. ASU 2014-09 provides for a principles-based, five-step approach to measure and recognize revenue from contracts with customers. ASU 2014-09 is effective for public entities for annual and interim periods beginning after December 15, 2017. Early adoption for annual and interim periods beginning after December 15, 2016 is permitted. The guidance permits two implementation approaches, one requiring retrospective application of the new ASU with restatement of prior years and one requiring prospective application of the new ASU with disclosure of results under old standards. During 2016, we expect to complete an evaluation of the effects adoption of this ASU may have on our financial position, results of operations and cash flows.
Note 2.     Business Acquisition
On May 2, 2016, Halyard acquired all of the issued and outstanding capital stock of Medsystems Holdings, Inc. (“Medsystems”) a Delaware corporation, for a purchase price of $175 million, net of cash acquired (the “Acquisition”). The Acquisition was funded with a combination of cash on hand and our Revolving Credit Facility (see Note 5, “Debt”). Medsystems owns and conducts its primary business through CORPAK Medsystems (“Corpak”). Corpak’s innovative enteral access solutions and portfolio of nasogastric feeding tubes complements our existing enteral feeding products and creates a complete offering of enteral feeding solutions within our Medical Devices segment.
In conjunction with the Acquisition, we identified intangible assets related to currently marketed products and in-process research and development (“IPR&D”) that we expect will yield economic benefits in the future. The identified intangible assets include technology, trademarks and customer relationships that were combined into composite intangible assets by product line in consideration of the following:

8


Our intent was to acquire the product portfolio and the related technology.
The trademarks will only be used to market the products associated with the existing technologies. Accordingly, their remaining economic lives are similar.
The customer base was considered, but was not identified as a separate intangible asset because the related cash flows are not separable from the related technology.
Low historical customer turnover rates supports longer lives for customer relationships which is consistent with the estimated remaining useful lives for the acquired technologies and trademarks.
The fair value amounts have been determined using preliminary estimates. A preliminary valuation was completed in July 2016 and we believe it will be finalized by the end of 2016. The preliminary allocation of the purchase price was as follows (in millions):
 
Purchase Price
Allocation
Current assets acquired net of liabilities assumed
$
13.9

Property, plant and equipment
4.4

Identifiable intangible assets, excluding IPR&D
105.1

Identifiable IPR&D
5.7

Deferred tax liabilities
(39.5
)
Goodwill
85.4

Total
$
175.0

Identifiable IPR&D includes a number of products that we expect to launch in 2017. Goodwill arising from the Acquisition is not fully tax deductible. The identifiable intangible assets, excluding IPR&D, include the following (in millions):
 
Fair Value
 
Weighted Average Useful Lives (Yrs)
Portfolio of disposables
$
102.9

 
15
Enteral access technology
2.2

 
6
Total
$
105.1

 
 
Corpak’s results have been included in the accompanying condensed consolidated income statement following the Acquisition on May 2, 2016. Corpak’s revenue of $13 million for the three months ended September 30, 2016 and $22 million from the date of Acquisition through September 30, 2016 is included in “Net Sales” in the accompanying condensed consolidated income statements. Due to the integration of Corpak’s portfolio of products into our existing digestive health products in the Medical Devices segment, earnings directly attributable to Corpak are not available.
The following unaudited pro forma information is presented in the table below for the three and nine months ended September 30, 2016 and 2015 as if the Acquisition had occurred on January 1, 2015 (in millions, except per share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended
September 30,
 
2016
(Unaudited)
 
2015
(Unaudited)
 
2016
(Unaudited)
 
2015
(Unaudited)
Net sales
$
397.5

 
$
403.1

 
$
1,199.8

 
$
1,212.6

 
 
 
 
 
 
 
 
Net income
11.1

 
(469.5
)
 
34.6

 
(442.6
)
 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.24

 
$
(10.07
)
 
$
0.74

 
$
(9.50
)
Diluted
0.24

 
(10.07
)
 
0.74

 
(9.50
)
The pro forma financial information has been adjusted to include the effects of the Acquisition, including acquisition-related costs, amortization of acquired intangibles, incremental interest expense and related tax effects. The pro forma financial information is not necessarily indicative of the results of operations that would have been achieved had the Acquisition taken place as of January 1, 2015.

9


Upon Acquisition, we initiated activities to integrate the operations of Corpak into our company. These activities include, but not limited to, integration of corporate functions, information technology and alignment with our operations.
For the three and nine months ended September 30, 2016, we have incurred $3 million and $10 million, respectively, for the acquisition and integration activities described above, consisting primarily of severance and benefits, consulting, legal and other costs. These costs are included in “Cost of products sold” and “Selling and general expenses” in the accompanying condensed consolidated income statements.
Restructuring
In June 2016, we initiated a restructuring plan to close the Medsystems corporate headquarters and operating facility in Buffalo Grove, Illinois and consolidate operations into our existing corporate and operational facilities by the third quarter of 2017 (the “Plan”). We expect to incur costs of $7 million related to this Plan, consisting primarily of severance and benefits, accelerated depreciation and lease termination costs. For the three and nine months ended September 30, 2016, we have accrued $1 million and $4 million, respectively for severance and benefits for employees impacted by the Plan. In each of the three and nine months ended September 30, 2016, we have paid $1 million to affected employees. The remaining accrual for severance and employee benefits was $3 million as of September 30, 2016.
Note 3.    Supplemental Balance Sheet Information
Accounts Receivable
Accounts receivable consist of the following (in millions):
 
September 30, 2016
 
December 31, 2015
Accounts receivable
$
190.5

 
$
226.3

Allowances and doubtful accounts
(1.4
)
 
(1.6
)
Accounts receivable, net
$
189.1

 
$
224.7

Inventories
Inventories at the lower of cost (determined on the LIFO/FIFO or weighted-average cost methods) or market consist of the following (in millions):
 
September 30, 2016
 
December 31, 2015
 
LIFO
 
Non-
LIFO
 
Total
 
LIFO
 
Non-
LIFO
 
Total
Raw materials
$
50.7

 
$
0.9

 
$
51.6

 
$
49.7

 
$
1.1

 
$
50.8

Work in process
52.8

 
0.7

 
53.5

 
46.1

 
0.1

 
46.2

Finished goods
144.2

 
45.7

 
189.9

 
165.8

 
46.3

 
212.1

Supplies and other
0.1

 
12.9

 
13.0

 
0.1

 
11.6

 
11.7

 
247.8

 
60.2

 
308.0

 
261.7

 
59.1

 
320.8

Excess of FIFO or weighted-average cost over LIFO cost
(9.3
)
 

 
(9.3
)
 
(17.6
)
 

 
(17.6
)
Total
$
238.5

 
$
60.2

 
$
298.7

 
$
244.1

 
$
59.1

 
$
303.2


10


Property, Plant and Equipment
Property, plant and equipment consists of the following (in millions):
 
September 30, 2016
 
December 31, 2015
Land
$
2.2

 
$
2.1

Buildings
86.2

 
86.7

Machinery and equipment
504.2

 
492.8

Construction in progress
18.5

 
18.3

 
611.1

 
599.9

Less accumulated depreciation
(346.1
)
 
(320.4
)
Total
$
265.0

 
$
279.5

Depreciation expense was $11 million and $32 million for the three and nine months ended September 30, 2016, respectively, compared to $10 million and $29 million for the three and nine months ended September 30, 2015, respectively.
Goodwill and Intangible Assets
The changes in the carrying amount of goodwill by business segment are as follows (in millions):
 
S&IP
 
Medical Devices
 
Consolidated
 
Goodwill
 
Accumulated Impairment
 
Goodwill, net
 
Goodwill
 
Accumulated Impairment
 
Goodwill, net
 
Goodwill, net
Balance at December 31, 2015
$
740.8

 
$
(474.0
)
 
$
266.8

 
$
678.4

 
$

 
$
678.4

 
$
945.2

Goodwill acquired

 

 

 
85.4

 

 
85.4

 
85.4

Currency translation adjustment
0.4

 

 
0.4

 
0.9

 

 
0.9

 
1.3

Balance at September 30, 2016
$
741.2

 
$
(474.0
)
 
$
267.2

 
$
764.7

 
$

 
$
764.7

 
$
1,031.9

In connection with the Acquisition, we acquired $6 million of indefinite-lived intangible assets related to in-process research and development projects that we expect to launch in 2017.
Intangible assets subject to amortization consist of the following (in millions):
 
September 30, 2016
 
December 31, 2015
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying Amount
Trademarks
$
126.5

 
$
(93.2
)
 
$
33.3

 
$
126.6

 
$
(90.3
)
 
$
36.3

Patents and acquired technologies
253.9

 
(128.4
)
 
125.5

 
149.1

 
(117.3
)
 
31.8

Other
55.6

 
(43.4
)
 
12.2

 
55.1

 
(40.6
)
 
14.5

Total
$
436.0

 
$
(265.0
)
 
$
171.0

 
$
330.8

 
$
(248.2
)
 
$
82.6

Amortization expense for intangible assets was $6 million and $16 million for the three and nine months ended September 30, 2016, respectively, compared to $6 million and $19 million for the three and nine months ended September 30, 2015, respectively. We estimate amortization expense for the remainder of 2016 and the following four years and beyond will be as follows (in millions):
For the years ending December 31,
 
 
2016
 
$
5.7

2017
 
21.4

2018
 
19.2

2019
 
15.4

2020
 
13.1

Thereafter
 
96.2

Total
 
$
171.0


11


Accrued Expenses
Accrued expenses consist of the following (in millions):
 
September 30, 2016
 
December 31, 2015
Accrued rebates
$
51.5

 
$
73.9

Accrued salaries and wages
49.1

 
34.5

Accrued taxes - income and other
7.0

 
15.3

Other
36.6

 
28.3

Total
$
144.2

 
$
152.0

Other Long-Term Liabilities
Other long-term liabilities consist of the following (in millions):
 
September 30, 2016
 
December 31, 2015
Taxes payable
$
3.0

 
$
1.3

Accrued compensation benefits
9.7

 
9.5

Other
17.3

 
17.0

Total
$
30.0

 
$
27.8

Note 4.    Fair Value Information
The following fair value information is based on a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The three levels in the hierarchy used to measure fair value are:
Level 1 - Unadjusted quoted prices in active markets accessible at the reporting date for identical assets and liabilities.
Level 2 - Quoted prices for similar assets or liabilities in active markets. Quoted prices for identical or similar assets and liabilities in markets that are not considered active or financial instruments for which all significant inputs are observable, either directly or indirectly.
Level 3 - Prices or valuations that require inputs that are significant to the valuation and are unobservable.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
In the three and nine months ended September 30, 2016, there were no transfers among Level 1, 2 or 3 fair value determinations.
The derivative liabilities for foreign exchange contracts were not significant as of September 30, 2016 and $2 million as of December 31, 2015. Derivative liabilities are included in the condensed consolidated balance sheet in accrued expenses. The derivative assets for foreign exchange contracts as of September 30, 2016 were $1 million. Derivative assets for foreign exchange contracts were not significant as of December 31, 2015. These derivatives are classified as Level 2 of the fair value hierarchy. The fair values of derivatives used to manage foreign currency risk is based on published quotations of spot currency rates and forward points, which are converted into implied forward currency rates.
The following table includes the fair value of our financial instruments for which disclosure of fair value is required (in millions):
 
 
 
September 30, 2016
 
December 31, 2015
 
Fair Value
Hierarchy
Level
 
Carrying
Amount
 
Estimated
Fair
Value
 
Carrying
Amount
 
Estimated
Fair
Value
Assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
1
 
$
86.7

 
$
86.7

 
$
129.5

 
$
129.5

Liabilities
 
 
 
 
 
 
 
 
 
Senior Unsecured Notes, net of Unamortized Discount
1
 
246.4

 
256.4

 
245.9

 
252.5

Senior Secured Term Loan, net of Unamortized Discount
2
 
333.0

 
340.1

 
332.2

 
337.3


12


Cash equivalents are recorded at cost, which approximates fair value due to their short-term nature. The fair value of the Senior Unsecured Notes was based on observable quoted prices on an active primary exchange. The fair value of our Senior Secured Term Loan was based on observable quoted prices in a secondary market.
Note 5.     Debt
As of September 30, 2016 and December 31, 2015, our debt balances were as follows (in millions):
 
Weighted-Average Interest Rate
 
Maturities
 
September 30, 2016
 
December 31, 2015
Revolving Credit Facility
2.74
%
 
2019
 
$
10.0

 
$

Senior Secured Term Loan
4.00
%
 
2021
 
339.0

 
339.0

Senior Unsecured Notes
6.25
%
 
2022
 
250.0

 
250.0

Unamortized Debt Discounts and Issuance Costs:
 
 
 
 

 

Senior Secured Term Loan
 
 
 
 
(6.0
)
 
(6.8
)
Senior Unsecured Notes
 
 
 
 
(3.6
)
 
(4.1
)
Total Debt
 
 
 
 
$
589.4

 
$
578.1

Senior Secured Term Loan and Revolving Credit Facility
The senior secured term loan (the “Term Loan Facility”) is under a credit agreement that includes a five-year senior secured revolving credit facility allowing borrowings of up to $250 million, with a letter of credit sub-facility in an amount of $75 million and a swingline sub-facility in an amount of $25 million (the “Revolving Credit Facility”, and together with the Term Loan Facility, the “Senior Credit Facilities”). The Senior Credit Facilities are secured by substantially all of our assets located in the United States and a certain percentage of our foreign subsidiaries’ capital stock.
Borrowings under the Term Loan Facility bear interest, at our option, at either (i) a reserve-adjusted LIBOR rate, subject to a floor of 0.75%, plus 3.25%, or (ii) a base rate, subject to a floor of 0.75%, (calculated as the greatest of (1) the prime rate, (2) the U.S. federal funds effective rate plus 0.50% or (3) the one month LIBOR rate plus 1.00%) plus 2.25%. As of September 30, 2016, the interest rate in effect for the Term Loan Facility was 4.00%.
Borrowings under the Revolving Credit Facility bear interest, at our option, at either (i) a reserve-adjusted LIBOR rate, plus a margin ranging between 1.75% to 2.50% per annum, depending on our consolidated total leverage ratio, or (ii) the base rate plus a margin ranging between 0.75% to 1.50% per annum, depending on our consolidated total leverage ratio. The unused portion of the Revolving Credit Facility is subject to a commitment fee equal to (i) 0.25% per annum, when our consolidated total leverage ratio is less than 2.25 to 1.00 or (ii) 0.40% per annum, otherwise. As of September 30, 2016, we had $10 million of borrowings and letters of credit of $4 million outstanding under the Revolving Credit Facility, leaving $236 million available for borrowing.
On May 2, 2016, we borrowed $72 million under our Revolving Credit Facility to partially fund our acquisition of Medsystems. See Note 2, “Business Acquisition” for a description of this acquisition. By September 30, 2016, we had repaid $62 million of the borrowings on our Revolving Credit Facility. As of September 30, 2016, the interest rate in effect for the Revolving Credit Facility was 2.77%.
Senior Unsecured Notes
The senior unsecured notes (the “Notes”) will mature on October 15, 2022 and interest accrues at a rate of 6.25% per annum and is payable semi-annually in arrears on April 15 and October 15 of each year.
Note 6.    Accumulated Other Comprehensive Income
The changes in the components of Accumulated Other Comprehensive Income (“AOCI”), net of tax, are as follows (in millions):

13


 
Unrealized
Translation
 
Cash Flow
Hedges
 
Defined Benefit
Pension Plans
 
Accumulated
Other
Comprehensive
Income
Balance, December 31, 2015
$
(40.4
)
 
$
(1.2
)
 
$
(1.6
)
 
$
(43.2
)
Other comprehensive income
3.0

 
1.7

 
0.2

 
4.9

Balance, September 30, 2016
$
(37.4
)
 
$
0.5

 
$
(1.4
)
 
$
(38.3
)
The changes in the components of AOCI, including the tax effect, are as follows (in millions):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Unrealized translation
$
(0.5
)
 
$
(12.5
)
 
$
3.0

 
$
(22.3
)
 
 
 
 
 
 
 
 
Defined benefit pension plans
0.1

 

 
0.2

 
0.2

Tax effect

 

 

 

Defined benefit pension plans, net of tax
0.1

 

 
0.2

 
0.2

 
 
 
 
 
 
 
 
Cash flow hedges
0.2

 
(2.0
)
 
2.1

 
(2.3
)
Tax effect

 
0.6

 
(0.4
)
 
0.7

Cash flow hedges, net of tax
0.2

 
(1.4
)
 
1.7

 
(1.6
)
 
 
 
 
 
 
 
 
Change in AOCI
$
(0.2
)
 
$
(13.9
)
 
$
4.9

 
$
(23.7
)
Note 7.     Stock-Based Compensation
Aggregate stock-based compensation expense for the three and nine months ended September 30, 2016 was $3 million and $12 million, respectively, compared to $3 million and $14 million, respectively, for the three and nine months ended September 30, 2015. Stock-based compensation expense related to stock options was $1 million and $4 million, respectively for the three and nine months ended September 30, 2016 compared to $1 million and $5 million, respectively for the three and nine months ended September 30, 2015. Stock-based compensation expense related to restricted share units was $1 million and $4 million, respectively, for the three and nine months ended September 30, 2016 compared to $2 million and $9 million, respectively, for the three and nine months ended September 30, 2015.
In the nine months ended September 30, 2016, we issued approximately 230,000 restricted share units for which vesting is conditioned on meeting a defined measure of total shareholder return (“TSR units”) over a restricted period of three years. Total shareholder return is measured as our stock price performance over the restricted period compared to a defined group of peer companies. The expense recognition for TSR units differs from awards with service and performance conditions in that the expense is recognized over the restricted period regardless of whether the total shareholder return target is met or not, while expense for awards with service and performance conditions is recognized based on the number of awards expected to vest. The fair value of restricted share units with a TSR vesting condition is determined using a Monte Carlo simulation which incorporates a volatility assumption based on the average stock price volatility for a peer group of companies over a period of three years, which matches the restricted period. For the awards granted in the three and nine months ended September 30, 2016, the assumed volatility was 25% and the weighted average fair value per TSR unit was $38.64. In the three and nine months ended September 30, 2016, stock-based compensation expense related to TSR units was $2 million and $4 million, respectively.
Note 8.    Commitments and Contingencies
We are subject to various legal proceedings, claims and governmental inspections, audits or investigations pertaining to issues such as contract disputes, product liability, tax matters, patents and trademarks, advertising, governmental regulations, employment and other matters, including the matters described below. Under the terms of the distribution agreement we entered into with Kimberly-Clark Corporation (“Kimberly-Clark”) prior to our spin-off, legal proceedings, claims and other liabilities that are primarily related to our business are our responsibility and we are obligated to indemnify and hold Kimberly-Clark harmless for such matters (“Indemnification Obligation”). For the three and nine months ended September 30, 2016, we have incurred $5 million and $15 million, respectively, for such matters. In the prior year, we incurred $9 million for each of the three and nine months ended September 30, 2015 for such matters.

14


The only exception to the Indemnification Obligation relates to the pain pump litigation referenced in this paragraph. We are one of several manufacturers of continuous infusion medical devices, such as our ON-Q PAINBUSTER pain pumps, that are involved in several different pending or threatened litigation matters from multiple plaintiffs alleging that use of the continuous infusion device to deliver anesthetics directly into a synovial joint after surgery resulted in postarthroscopic glenohumeral chondrolysis, or a disintegration of the cartilage covering the bones in the joint (typically, in the shoulder). Plaintiffs generally seek monetary damages and attorneys’ fees. While Kimberly-Clark is retaining the liabilities related to these matters, the distribution agreement between us and Kimberly-Clark provides that we will indemnify Kimberly-Clark for any such claims or causes of actions arising after the spin-off.
We have an Indemnification Obligation for, and have assumed the defense of, the matter styled Bahamas Surgery Center, LLC v. Kimberly-Clark Corporation and Halyard Health, Inc., f/k/a Prime Healthcare Centinela, LLC, et al. v. Kimberly-Clark Corporation, et al., No. 2:14-cv-08390-DMG-SH (C.D. Cal.), filed on October 29, 2014. In that case, the plaintiff brings a putative class action asserting claims for common law fraud (affirmative misrepresentation and fraudulent concealment) and violation of California’s Unfair Competition Law in connection with our marketing and sale of MicroCool surgical gowns. On March 21, 2016, we moved to dismiss the non-California plaintiffs, and on May 26, 2016, the court issued an order dismissing them. On June 14, 2016, the court granted the plaintiffs’ unopposed motion to dismiss Prime Healthcare Centinela, LLC and one of the other two remaining California plaintiffs, leaving only the current named plaintiff, Bahamas Surgery Center, LLC. On June 1, 2016, the plaintiff moved for class certification of a California-only damages class and a California-only injunctive relief class. Although the plaintiff did not also move for certification of a nationwide class to determine liability, damages, or injunctive relief, it did move for certification of a nationwide “issue” class purporting to resolve certain issues allegedly “common” to members of that class. On July 8, 2016, we moved for summary judgment. The parties also remain engaged in discovery. We intend to continue our vigorous defense of the matter.
In June 2015, we were served with a subpoena from the Department of Veterans Affairs Office of the Inspector General (“VA OIG”) seeking information related to the design, manufacture, testing, sale and promotion of MicroCool and other Company surgical gowns, and, in July 2015, we also became aware that the subpoena and an earlier VA OIG subpoena served on Kimberly-Clark requesting information about gown sales to the federal government are related to a United States Department of Justice (“DOJ”) investigation. In May 2016, we were also served with a subpoena from the Department of Justice seeking further information related to Company gowns. The Company is cooperating with the VA OIG’s request and the DOJ investigation.
On October 12, 2016, after the DOJ submitted filings on behalf of itself and various States declining to intervene in two qui tam matters, both matters were unsealed. One of those matters is U.S. ex rel. Shahinian, et al. v. Kimberly-Clark Corporation, No. 2:14-cv-08313-JAK-JPR (C. D. Cal.), filed on October 27, 2014. The other of those matters is U.S. ex rel. Edgett, et al. v. Kimberly-Clark Corporation, Halyard Health, Inc., et al, No. 3:15-cv-00434-B (N.D. Tex.), filed on February 9, 2015. Both cases allege, among other things, violations of both the federal and state False Claims Acts in connection with the marketing and sale of certain surgical gowns. The plaintiff-relators can elect to move forward with these cases, despite the declinations by the DOJ and the various States, though the complaints have not been served as of this time. We expect that we have an Indemnification Obligation for these two matters under the distribution agreement with Kimberly-Clark.
We were served with a complaint in a matter styled Jackson v. Halyard Health, Inc., Robert E. Abernathy, Steven E. Voskuil, et al., No. 1:16-cv-05093-LTS (S.D.N.Y.), filed on June 28, 2016. In that case, the plaintiff brings a putative class action against the Company, our Chief Executive Officer, our Chief Financial Officer and other defendants, asserting claims for violations of the Securities Exchange Act, Sections 10(b) and 20(a). The plaintiff alleges that the defendants made misrepresentations and failed to disclose certain information about the safety and effectiveness of our MicroCool gowns and thereby artificially inflated the Company’s stock prices during the respective class periods. The alleged class period for purchasers of Kimberly-Clark securities who subsequently received Halyard Health securities is February 25, 2013 to October 21, 2014, and the alleged class period for purchasers of Halyard Health securities is October 21, 2014 to April 29, 2016. We intend to vigorously defend this matter.
We were also served with a complaint in a matter styled Margaret C. Richardson Trustee of the Survivors Trust Dated 6/12/84 for the Benefit of the H&M Richardson Revocable Trust v. Robert E. Abernathy, Steven E. Voskuil, et al., No. 1:16-cv-06296 (S. D. N. Y.), filed on August 9, 2016. In that case, the plaintiff sues derivatively on behalf of Halyard Health, Inc., and alleges that the defendants breached their fiduciary duty, were unjustly enriched, and violated Section 14(A) of the Securities and Exchange Act in connection with Halyard Health, Inc.’s marketing and sale of MicroCool gowns. We intend to vigorously defend this matter.
We operate in an industry characterized by extensive patent litigation and competitors may claim that our products infringe upon their intellectual property. Resolution of patent litigation or other intellectual property claims is typically time consuming and costly and can result in significant damage awards and injunctions that could prevent the manufacture and sale of the affected products or require us to make significant royalty payments in order to continue selling the affected products. At any

15


given time we may be involved as either a plaintiff or a defendant in a number of patent infringement actions, the outcomes of which may not be known for prolonged periods of time.
We maintain general and professional liability, product liability and other insurance in an amount that we believe is reasonably adequate to insulate us from material liability for claims. However, our insurance policies may not cover all of these matters and may not fully cover liabilities arising out of these matters. In addition, we may be obligated to indemnify our directors and officers against these matters. Although the results of litigation and claims cannot be predicted with certainty, we believe that the ultimate disposition of these matters, to the extent not previously provided for, will not have a material adverse effect, individually or in the aggregate, on our financial condition, results of operations or liquidity. However the above matters, regardless of the outcome, could disrupt our business and result in substantial costs and diversion of management attention.
We are subject to federal, state and local environmental protection laws and regulations with respect to our business operations and are operating in compliance with, or taking action aimed at ensuring compliance with, these laws and regulations. None of our compliance obligations with environmental protection laws and regulations, individually or in the aggregate, is expected to have a material adverse effect on our business, financial condition, results of operations or liquidity.
Note 9.    Derivative Financial Instruments
The derivative liabilities for foreign exchange contracts were not significant as of September 30, 2016 and $2 million as of December 31, 2015. Derivative liabilities are included in the condensed consolidated balance sheet in accrued expenses. The derivative assets for foreign exchange contracts as of September 30, 2016 were $1 million. Derivative assets for foreign exchange contracts were not significant as of December 31, 2015.
For derivative instruments that are designated and qualify as cash flow hedges, gains or losses recognized to earnings were not significant in the three and nine months ended September 30, 2016 and 2015. As of September 30, 2016, the aggregate notional values of outstanding foreign exchange derivative contracts designated as cash flow hedges were $35 million. Cash flow hedges resulted in no significant ineffectiveness in the three and nine months ended September 30, 2016 and 2015. For the three and nine months ended September 30, 2016 and 2015, no gains or losses were reclassified into earnings as a result of the discontinuance of cash flow hedges due to the original forecasted transaction no longer being probable of occurring. At September 30, 2016, amounts to be reclassified from AOCI during the next twelve months are not expected to be significant. The maximum maturity of cash flow hedges in place at September 30, 2016 is September 2017.
Gains or losses on undesignated foreign exchange hedging instruments are immediately recognized in other income and expense, net. These gains or losses have not been significant for the three and nine months ended September 30, 2016 and 2015. The effect on earnings from the use of these non-designated derivatives is substantially neutralized by the transactional gains and losses recorded on the underlying assets and liabilities. As of September 30, 2016, the notional amount of these undesignated derivative instruments was $7 million.
Note 10.    Earnings Per Share (“EPS”)
Basic EPS is calculated by dividing net income by the weighted average number of common shares outstanding during each period. Diluted earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding and the effect of all dilutive common stock equivalents outstanding during each period, as determined using the treasury stock method.

16


The calculation of basic and diluted earnings per share for the three and nine months ended September 30, 2016 and 2015 is set forth in the following table (in millions, except per share amounts):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Net income (loss)
$
9.1

 
$
(470.5
)
 
$
29.8

 
$
(440.8
)
 
 
 
 
 
 
 
 
Weighted Average Shares Outstanding:
 
 
 
 
 
 
 
Basic weighted average shares outstanding
46.7

 
46.6

 
46.6

 
46.6

Dilutive effect of stock options and restricted share unit awards
0.5

 

 
0.4

 

Diluted weighted average shares outstanding
47.2

 
46.6

 
47.0

 
46.6

 
 
 
 
 
 
 
 
Earnings (Loss) Per Share
 
 
 
 
 
 
 
Basic
$
0.19

 
$
(10.10
)
 
$
0.64

 
$
(9.46
)
Diluted
$
0.19

 
$
(10.10
)
 
$
0.63

 
$
(9.46
)
Restricted share units (“RSUs”) contain provisions allowing for the equivalent of any dividends paid on common stock during the restricted period to be reinvested into additional RSUs at the then fair market value of the common stock on the date dividends are paid. Such awards are to be included in the EPS calculation under the two-class method. Currently, we do not anticipate paying any cash dividends for the foreseeable future and our outstanding RSU awards are not material in comparison to our weighted average shares outstanding. Accordingly, all EPS amounts reflect shares as if they were fully vested and the disclosures associated with the two-class method are not presented herein.
For the three and nine months ended September 30, 2016, 1.0 million and 1.6 million of potentially dilutive stock options and restricted share units were excluded from the computation of earnings per share as their effect would have been anti-dilutive.

17


Note 11.    Business Segment Information
Information concerning unaudited consolidated operations by business segment is presented in the following table (in millions):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Net Sales
 
 
 
 
 
 
 
S&IP
$
248.8

 
$
257.4

 
$
760.2

 
$
767.5

Medical Devices
145.2

 
126.1

 
413.4

 
375.3

Corporate and Other
3.5

 
6.0

 
8.7

 
30.2

Total Net Sales
397.5

 
389.5

 
1,182.3

 
1,173.0

 
 
 
 
 
 
 
 
Operating Profit (Loss)
 
 
 
 
 
 
 
S&IP
22.2

 
26.3

 
71.9

 
71.3

Medical Devices
31.9

 
28.5

 
90.6

 
86.6

Corporate and Other(a)
(27.3
)
 
(31.2
)
 
(77.4
)
 
(82.6
)
Goodwill impairment

 
(475.5
)
 

 
(475.5
)
Other (expense) and income, net(b)
(5.9
)
 
(9.3
)
 
(13.5
)
 
2.0

Total Operating Profit (Loss)
20.9

 
(461.2
)
 
71.6

 
(398.2
)
 
 
 
 
 
 
 
 
Interest income
0.2

 

 
0.5

 
0.2

Interest expense
(8.4
)
 
(7.8
)
 
(24.7
)
 
(25.0
)
Income (Loss) before Income Taxes
$
12.7

 
$
(469.0
)
 
$
47.4

 
$
(423.0
)
______________________________
(a)
Corporate and Other for the three and nine months ended September 30, 2016 includes $16 million and $48 million, respectively, of general expenses, $7 million and $11 million, respectively, of post spin-related transition expenses, $4 million and $15 million, respectively, of acquisition, integration and restructuring expenses related to the Acquisition (See Note 2, “Business Acquisition”) and $0 million and $4 million, respectively, of costs related to corporate sales. Corporate and Other for the three and nine months ended September 30, 2015 includes $13 million and $36 million, respectively, of general expenses and $16 million and $46 million, respectively, of post spin-related transition expenses and $2 million and $0 million of costs, respectively, from corporate sales.
(b)
Other expense includes amounts incurred related to litigation matters. See Note 8, “Commitments and Contingencies.”
Note 12.    Supplemental Guarantor Financial Information
The Notes (described in Note 5, “Debt”) are guaranteed, jointly and severally by each of our domestic subsidiaries that guarantees the Senior Credit Facilities (each, a “Guarantor Subsidiary” and collectively, the “Guarantor Subsidiaries”). The guarantees are full and unconditional, subject to certain customary release provisions as defined in the Indenture dated October 17, 2014. Each Guarantor Subsidiary is directly or indirectly 100%-owned by Halyard Health, Inc. Each of the guarantees of the Notes is a general unsecured obligation of each Guarantor Subsidiary and ranks equally in right of payment with all existing and future indebtedness and all other obligations (except subordinated indebtedness) of each Guarantor Subsidiary.
The following condensed consolidating balance sheets as of September 30, 2016 and December 31, 2015 and the condensed statements of income for the three and nine months ended September 30, 2016 and 2015 and cash flows for the nine months ended September 30, 2016 and 2015 provide condensed consolidating financial information for Halyard Health, Inc. (“Parent”), the Guarantor Subsidiaries on a combined basis, the non-guarantor subsidiaries on a combined basis and the Parent and its subsidiaries on a consolidated basis. The following condensed consolidating financial information contains preliminary purchase accounting allocations.
The Parent and the Guarantor Subsidiaries use the equity method of accounting to reflect ownership interests in subsidiaries that are eliminated upon consolidation. Eliminating entries in the following condensed consolidating financial information represent adjustments to (i) eliminate intercompany transactions between or among the Parent, the Guarantor Subsidiaries and the non-guarantor subsidiaries and (ii) eliminate the investments in subsidiaries.

18


HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING INCOME AND COMPREHENSIVE INCOME STATEMENTS
(in millions)

 
Three Months Ended September 30, 2016
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Net Sales
$

 
$
370.7

 
$
105.2

 
$
(78.4
)
 
$
397.5

Cost of products sold

 
250.4

 
87.5

 
(78.4
)
 
259.5

Gross Profit

 
120.3

 
17.7

 

 
138.0

Research and development

 
10.9

 

 

 
10.9

Selling and general expenses
8.4

 
77.9

 
14.0

 

 
100.3

Other expense and (income), net
0.7

 
6.5

 
(1.3
)
 

 
5.9

Operating (Loss) Profit
(9.1
)
 
25.0

 
5.0

 

 
20.9

Interest income

 

 
0.6

 
(0.4
)
 
0.2

Interest expense
(8.4
)
 
(0.3
)
 
(0.1
)
 
0.4

 
(8.4
)
(Loss) Income Before Income Taxes
(17.5
)
 
24.7

 
5.5

 

 
12.7

Income tax benefit (provision)
6.6

 
(9.4
)
 
(0.8
)
 

 
(3.6
)
Equity in earnings of consolidated subsidiaries
20.0

 
1.1

 

 
(21.1
)
 

Net Income
9.1

 
16.4

 
4.7

 
(21.1
)
 
9.1

Total other comprehensive loss, net of tax
(0.2
)
 
(1.0
)
 
(0.5
)
 
1.5

 
(0.2
)
Comprehensive Income
$
8.9

 
$
15.4

 
$
4.2

 
$
(19.6
)
 
$
8.9



19


HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING INCOME AND COMPREHENSIVE INCOME STATEMENTS
(in millions)


 
Three Months Ended September 30, 2015
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Net Sales
$

 
$
360.2

 
$
112.5

 
$
(83.2
)
 
$
389.5

Cost of products sold

 
247.7

 
94.0

 
(83.2
)
 
258.5

Gross Profit

 
112.5

 
18.5

 

 
131.0

Research and development

 
10.2

 

 

 
10.2

Selling and general expenses
7.2

 
75.4

 
14.6

 

 
97.2

Goodwill impairment

 
456.5

 
19.0

 

 
475.5

Other (income) and expense, net
(0.5
)
 
10.8

 
(1.0
)
 

 
9.3

Operating Loss
(6.7
)
 
(440.4
)
 
(14.1
)
 

 
(461.2
)
Interest income

 

 
0.5

 
(0.5
)
 

Interest expense
(8.0
)
 
(0.3
)
 

 
0.5

 
(7.8
)
Loss Before Income Taxes
(14.7
)
 
(440.7
)
 
(13.6
)
 

 
(469.0
)
Income tax benefit (provision)
3.9

 
(6.4
)
 
1.0

 

 
(1.5
)
Equity in earnings of consolidated subsidiaries
(459.7
)
 
6.1

 

 
453.6

 

Net Loss
(470.5
)
 
(441.0
)
 
(12.6
)
 
453.6

 
(470.5
)
Total other comprehensive income (loss), net of tax

 
0.3

 
(13.9
)
 
(0.3
)
 
(13.9
)
Comprehensive Loss
$
(470.5
)
 
$
(440.7
)
 
$
(26.5
)
 
$
453.3

 
$
(484.4
)


20


HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING INCOME AND COMPREHENSIVE INCOME STATEMENTS
(in millions)

 
Nine Months Ended September 30, 2016
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Net Sales
$

 
$
1,094.2

 
$
318.8

 
$
(230.7
)
 
$
1,182.3

Cost of products sold

 
730.3

 
267.5

 
(230.7
)
 
767.1

Gross Profit

 
363.9

 
51.3

 

 
415.2

Research and development

 
29.1

 

 

 
29.1

Selling and general expenses
29.1

 
228.7

 
43.2

 

 
301.0

Other expense and (income), net
0.3

 
26.5

 
(13.3
)
 

 
13.5

Operating (Loss) Profit
(29.4
)
 
79.6

 
21.4

 

 
71.6

Interest income
0.2

 

 
1.9

 
(1.6
)
 
0.5

Interest expense
(24.9
)
 
(1.3
)
 
(0.1
)
 
1.6

 
(24.7
)
(Loss) Income Before Income Taxes
(54.1
)
 
78.3

 
23.2

 

 
47.4

Income tax benefit (provision)
20.4

 
(29.4
)
 
(8.6
)
 

 
(17.6
)
Equity in earnings of consolidated subsidiaries
63.5

 
13.5

 

 
(77.0
)
 

Net Income
29.8

 
62.4

 
14.6

 
(77.0
)
 
29.8

Total other comprehensive income, net of tax
4.9

 
3.5

 
2.2

 
(5.7
)
 
4.9

Comprehensive Income
$
34.7

 
$
65.9

 
$
16.8

 
$
(82.7
)
 
$
34.7




21


HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING INCOME AND COMPREHENSIVE INCOME STATEMENTS
(in millions)

 
Nine Months Ended September 30, 2015
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Net Sales
$

 
$
1,085.1

 
$
339.7

 
$
(251.8
)
 
$
1,173.0

Cost of products sold

 
738.3

 
288.5

 
(251.8
)
 
775.0

Gross Profit

 
346.8

 
51.2

 

 
398.0

Research and development

 
22.5

 

 

 
22.5

Selling and general expenses
25.4

 
229.7

 
45.1

 

 
300.2

Goodwill impairment

 
456.5

 
19.0

 

 
475.5

Other (income) and expense, net
(0.9
)
 
15.6

 
(16.7
)
 

 
(2.0
)
Operating (Loss) Profit
(24.5
)
 
(377.5
)
 
3.8

 

 
(398.2
)
Interest income
0.3

 

 
2.3

 
(2.4
)
 
0.2

Interest expense
(25.8
)
 
(1.3
)
 
(0.3
)
 
2.4

 
(25.0
)
(Loss) Income Before Income Taxes
(50.0
)
 
(378.8
)
 
5.8

 

 
(423.0
)
Income tax benefit (provision)
17.3

 
(30.6
)
 
(4.5
)
 

 
(17.8
)
Equity in earnings of consolidated subsidiaries
(408.1
)
 
22.2

 

 
385.9

 

Net (Loss) Income
(440.8
)
 
(387.2
)
 
1.3

 
385.9

 
(440.8
)
Total other comprehensive loss, net of tax

 

 
(23.4
)
 
(0.3
)
 
(23.7
)
Comprehensive Loss
$
(440.8
)
 
$
(387.2
)
 
$
(22.1
)
 
$
385.6

 
$
(464.5
)


22


HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
(in millions)


 
As of September 30, 2016
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
Current Assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
18.9

 
$
9.6

 
$
58.2

 
$

 
$
86.7

Accounts receivable, net
3.1

 
531.5

 
221.0

 
(566.5
)
 
189.1

Inventories

 
255.8

 
42.9

 

 
298.7

Prepaid and other current assets
5.5

 
19.3

 
7.0

 
(0.7
)
 
31.1

Total Current Assets
27.5

 
816.2

 
329.1

 
(567.2
)
 
605.6

Property, Plant and Equipment, net

 
219.9

 
45.1

 

 
265.0

Investment in Consolidated Subsidiaries
2,058.2

 
288.6

 

 
(2,346.8
)
 

Goodwill

 
1,004.0

 
27.9

 

 
1,031.9

Other Intangible Assets, net

 
176.7

 

 

 
176.7

Other Assets
1.1

 
2.5

 
12.2

 

 
15.8

TOTAL ASSETS
$
2,086.8

 
$
2,507.9

 
$
414.3

 
$
(2,914.0
)
 
$
2,095.0

 
 
 
 
 
 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
Current Liabilities
 
 
 
 
 
 
 
 
 
Trade accounts payable
$
389.5

 
$
298.4

 
$
40.5

 
$
(561.9
)
 
$
166.5

Accrued expenses
4.5

 
112.2

 
32.8

 
(5.3
)
 
144.2

Total Current Liabilities
394.0

 
410.6

 
73.3

 
(567.2
)
 
310.7

Long-Term Debt
589.4

 

 

 

 
589.4

Other Long-Term Liabilities
1.9

 
83.7

 
7.8

 

 
93.4

Total Liabilities
985.3

 
494.3

 
81.1

 
(567.2
)
 
993.5

Total Equity
1,101.5

 
2,013.6

 
333.2

 
(2,346.8
)
 
1,101.5

TOTAL LIABILITIES AND EQUITY
$
2,086.8

 
$
2,507.9

 
$
414.3

 
$
(2,914.0
)
 
$
2,095.0


23


HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
(in millions)

 
As of December 31, 2015
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
Current Assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
92.3

 
$

 
$
39.7

 
$
(2.5
)
 
$
129.5

Accounts receivable, net
3.0

 
440.8

 
221.7

 
(440.8
)
 
224.7

Inventories

 
258.4

 
44.8

 

 
303.2

Prepaid and other current assets
5.0

 
10.8

 
3.0

 
(0.2
)
 
18.6

Total Current Assets
100.3

 
710.0

 
309.2

 
(443.5
)
 
676.0

Property, Plant and Equipment, net

 
228.7

 
50.8

 

 
279.5

Investment in Consolidated Subsidiaries
1,750.8

 
277.7

 

 
(2,028.5
)
 

Goodwill

 
918.6

 
26.6

 

 
945.2

Other Intangible Assets, net

 
82.6

 

 

 
82.6

Other Assets
1.4

 
0.3

 
15.2

 

 
16.9

TOTAL ASSETS
$
1,852.5

 
$
2,217.9

 
$
401.8

 
$
(2,472.0
)
 
$
2,000.2

 
 
 
 
 
 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
Current Liabilities
 
 
 
 
 
 
 
 
 
Trade accounts payable
$
251.4

 
$
309.4

 
$
42.7

 
$
(440.3
)
 
$
163.2

Accrued expenses
6.6

 
115.4

 
33.4

 
(3.4
)
 
152.0

Total Current Liabilities
258.0

 
424.8

 
76.1

 
(443.7
)
 
315.2

Long-Term Debt
578.1

 

 

 

 
578.1

Other Long-Term Liabilities
1.8

 
41.6

 
8.2

 

 
51.6

Total Liabilities
837.9

 
466.4

 
84.3

 
(443.7
)
 
944.9

Total Equity
1,014.6

 
1,751.5

 
317.5

 
(2,028.3
)
 
1,055.3

TOTAL LIABILITIES AND EQUITY
$
1,852.5

 
$
2,217.9

 
$
401.8

 
$
(2,472.0
)
 
$
2,000.2


24


HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
(in millions)

 
Nine Months Ended September 30, 2016
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Operating Activities
 
 
 
 
 
 
 
 
 
Cash (Used in) Provided by Operating Activities
$
(6.1
)
 
$
128.1

 
$
21.9

 
$

 
$
143.9

Investing Activities
 
 
 
 
 
 
 
 
 
Capital expenditures

 
(17.8
)
 
(3.9
)
 

 
(21.7
)
Acquisition of business, net of cash acquired
(175.0
)
 

 

 

 
(175.0
)
Intercompany contributions
0.5

 
(101.3
)
 
1.8

 
99.0

 

Cash Used in Investing Activities
(174.5
)
 
(119.1
)
 
(2.1
)
 
99.0

 
(196.7
)
Financing Activities
 
 
 
 
 
 
 
 
 
Intercompany contributions
97.9

 

 
(1.4
)
 
(96.5
)
 

Line of credit facility proceeds
72.0

 

 

 

 
72.0

Line of credit facility repayments
(62.0
)
 

 

 

 
(62.0
)
Purchase of treasury stock
(0.9
)
 

 

 

 
(0.9
)
Proceeds from the exercise of stock options
0.2

 

 

 

 
0.2

Cash Provided by (Used in) Financing Activities
107.2

 

 
(1.4
)
 
(96.5
)
 
9.3

Effect of Exchange Rate on Cash and Cash Equivalents

 
0.6

 
0.1

 

 
0.7

(Decrease) Increase in Cash and Cash Equivalents
(73.4
)
 
9.6

 
18.5

 
2.5

 
(42.8
)
Cash and Cash Equivalents, Beginning of Period
92.3

 

 
39.7

 
(2.5
)
 
129.5

Cash and Cash Equivalents, End of Period
$
18.9

 
$
9.6

 
$
58.2

 
$

 
$
86.7


25


HALYARD HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
(in millions)

 
Nine Months Ended September 30, 2015
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Operating Activities
 
 
 
 
 
 
 
 
 
Cash (Used in) Provided by Operating Activities
$
(27.9
)
 
$
72.6

 
$
29.9

 
$

 
$
74.6

Investing Activities
 
 
 
 
 
 
 
 
 
Capital expenditures

 
(56.6
)
 
(7.8
)
 

 
(64.4
)
Proceeds from property dispositions

 

 
7.8

 

 
7.8

Cash Used in Investing Activities

 
(56.6
)
 

 

 
(56.6
)
Financing Activities
 
 
 
 
 
 
 
 
 
Intercompany contributions
57.3

 
(18.9
)
 
(38.4
)
 

 

Debt repayments
(51.0
)
 

 

 

 
(51.0
)
Purchase of treasury stock
(1.0
)
 

 

 

 
(1.0
)
Proceeds from the exercise of stock options
1.2

 

 

 

 
1.2

Cash Provided by (Used in) Financing Activities
6.5

 
(18.9
)
 
(38.4
)
 

 
(50.8
)
Effect of Exchange Rate on Cash and Cash Equivalents

 

 
(3.7
)
 

 
(3.7
)
Decrease in Cash and Cash Equivalents
(21.4
)
 
(2.9
)
 
(12.2
)
 

 
(36.5
)
Cash and Cash Equivalents, Beginning of Period
101.2

 
3.9

 
43.9

 

 
149.0

Cash and Cash Equivalents, End of Period
$
79.8

 
$
1.0

 
$
31.7

 
$

 
$
112.5



26


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
Halyard is a global company which seeks to advance health and healthcare by preventing infection, eliminating pain and speeding recovery. Our products and solutions are designed to address some of today’s most important healthcare needs, namely, preventing infection and reducing the use of narcotics while helping patients move from surgery to recovery. We market and support the efficacy, safety and economic benefit of our products with a significant body of clinical evidence. We have two business segments: Surgical and Infection Prevention (“S&IP”) and Medical Devices.
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide investors with an understanding of our recent performance, and should be read in conjunction with the condensed consolidated financial statements contained in Item 1, “Financial Statements” in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2015.
The following will be discussed and analyzed:
Acquisition of Medsystems Holdings, Inc.
Overview of Business
Results of Operations
Liquidity and Capital Resources
Legal Matters
New Accounting Standards
Information Concerning Forward-Looking Statements
Acquisition of Medsystems Holdings, Inc.
On May 2, 2016, Halyard acquired all of the issued and outstanding capital stock of Medsystems Holdings, Inc. (“Medsystems”) a Delaware corporation, for a purchase price of $175 million, net of cash acquired (the “Acquisition”). The Acquisition was funded with a combination of cash on hand and our Revolving Credit Facility (see Note 5 to the condensed consolidated financial statements, “Debt”). Medsystems owns and conducts its primary business through CORPAK Medsystems (“Corpak”). Corpak’s innovative enteral access solutions and portfolio of nasogastric feeding tubes complements our existing enteral feeding products and creates a complete offering of enteral feeding solutions within our Medical Devices Segment. Upon Acquisition, we initiated activities to integrate the operations of Corpak into our company. These activities include, but not limited to, integration of corporate functions, information technology and alignment with our operations.
In June 2016, we initiated a restructuring plan to close the Medsystems corporate headquarters and operating facility in Buffalo Grove, Illinois and consolidate operations into our existing corporate and operational facilities by the third quarter of 2017 (the “Plan”). For the three and nine months ended September 30, 2016, we have accrued $1 million and $4 million, respectively for severance and benefits for employees impacted by the Plan. In each of the three and nine months ended September 30, 2016, we have paid $1 million to affected employees and the remaining accrual for severance and employee benefits was $3 million as of September 30, 2016.
For the three and nine months ended September 30, 2016, we have incurred $4 million and $15 million, respectively, for the acquisition, integration and restructuring activities described above, which are included in “Cost of products sold” and “Selling and general expenses” in the accompanying condensed consolidated income statements.
See Note 2 to the condensed consolidated financial statements, “Business Acquisition” for further details regarding the Acquisition, including a preliminary purchase price allocation, and the subsequent integration and restructuring activities.
Overview of Business
Our S&IP market environment remains challenging, yet we continue to defend our leading market positions and have introduced seven new products in the S&IP business so far this year. In the three months ended September 30, 2016, S&IP sales volume decreased by 2% compared to the same period last year but increased by 2% for the nine months ended September 30, 2016. Sales volume was driven by lower volume in surgical drapes and gowns offset by demand for exam gloves primarily in North America and Asia-Pacific. Price erosion continued through the period, causing a 3% decline in S&IP selling prices in each of the three and nine months ended September 30, 2016. Our Medical Devices results were driven by incremental sales from the Acquisition and improved volume across all product categories.

27


Results of Operations
This discussion and analysis compares the results for the three and nine months ended September 30, 2016 to the same periods in 2015.
Net Sales by Segment
(in millions)
Three Months Ended
September 30,
 
 
 
Nine Months Ended
September 30,
 
 
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Net Sales
 
 
 
 
 
 
 
 
 
 
 
S&IP
$
248.8

 
$
257.4

 
(3.3
)%
 
$
760.2

 
$
767.5

 
(1.0
)%
Medical Devices
145.2

 
126.1

 
15.1

 
413.4

 
375.3

 
10.2

Corporate and Other
3.5

 
6.0

 
N.M.

 
8.7

 
30.2

 
N.M.

Total Net Sales
$
397.5

 
$
389.5

 
2.1
 %
 
$
1,182.3

 
$
1,173.0

 
0.8
 %
______________________________
N.M. - Not meaningful
Percentage Change
 
 
 
Changes Due To
Third Quarter
Total
 
Volume(a)
 
Pricing/Mix
 
Currency
 
Other(b)
Consolidated
2
 %
 
 %
 
(2
)%
 
1
 %
 
3
%
S&IP
(3
)
 
(2
)
 
(3
)
 
1

 
1

Medical Devices
15

 
4

 

 
1

 
10

 
 
 
 
 
 
 
 
 
 
Year-to-date
 
 
 
 
 
 
 
 
 
Consolidated
1
 %
 
3
 %
 
(2
)%
 
 %
 
%
S&IP
(1
)
 
2

 
(3
)
 

 

Medical Devices
10

 
4

 

 

 
6

______________________________
(a) Volume excludes Corpak net sales and changes in sales volume to Kimberly-Clark.
(b) Other includes Corpak net sales, changes in sales volume to Kimberly-Clark and rounding.
Third Quarter 2016 Compared to Third Quarter 2015
Net sales for the three months ended September 30, 2016 of $398 million were 2% higher compared to the same period last year primarily due to higher volume in the Medical Devices business, which includes Corpak, partially offset by lower sales of rolled non-woven materials to Kimberly-Clark Corporation (“Kimberly-Clark”) that is included in “Corporate and Other.”
Surgical and Infection Prevention
S&IP net sales decreased 3% to $249 million compared to net sales of $257 million in the prior year due to a 3% price loss, primarily in exam gloves and surgical drapes and gowns, and lower sales volume in surgical drapes and gowns partially offset by volume gains in exam gloves.
Medical Devices
Medical Devices net sales increased 15% to $145 million, compared to net sales of $126 million in the prior year with 11% attributable to the Corpak acquisition and 4% from higher sales volume across all product categories.
First Nine Months of 2016 Compared to the First Nine Months of 2015
Net sales for the nine months ended September 30, 2016 increased 1% compared to last year. Higher sales volume in exam gloves and across all product categories within the Medical Devices business was partially offset by continued price loss in S&IP, lower sales of non-woven materials to Kimberly-Clark that are included in “Corporate and Other” and lower sales volume, particularly in surgical drapes and gowns.
Surgical and Infection Prevention
S&IP net sales decreased by 1% to $760 million compared to $768 million last year. Price loss of 3% and unfavorable sales volume, primarily in surgical drapes and gowns, was partially offset by volume gains in exam gloves.

28


Medical Devices
Medical Devices net sales increased by 10% compared to the prior year with 6% from the Corpak acquisition and 4% from higher sales volume in all product categories.
Net Sales By Geographic Region
(in millions)
Three Months Ended
September 30,
 
 
 
Nine Months Ended
September 30,
 
 
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Net Sales
 
 
 
 
 
 
 
 
 
 
 
North America
$
294.1

 
$
292.7

 
0.5
%
 
$
887.0

 
$
889.4

 
(0.3
)%
Europe, Middle East and Africa
49.6

 
48.9

 
1.4

 
148.6

 
147.1

 
1.0

Asia Pacific and Latin America
53.8

 
47.9

 
12.3

 
146.7

 
136.5

 
7.5

Total Net Sales
$
397.5

 
$
389.5

 
2.1
%
 
$
1,182.3

 
$
1,173.0

 
0.8
 %
Third Quarter 2016 Compared to Third Quarter 2015
Net sales in North America were even in the three months ended September 30, 2016 compared to the prior year. Net sales were driven primarily by the Corpak acquisition and higher sales volume, partially offset by lower sales of rolled non-woven materials to Kimberly-Clark and unfavorable pricing. In our S&IP business, unfavorable pricing for exam gloves was partially offset by higher exam glove sales volume. In our Medical Devices business, there was higher sales volume in interventional pain and respiratory health.
Net sales in Europe, Middle East and Africa increased by 1% primarily due to incremental sales from Corpak and higher S&IP volume in surgical drapes and gowns partially offset by unfavorable pricing.
In Asia Pacific and Latin America, net sales increased by 12% driven primarily by higher sales volume, primarily in exam gloves partially offset by unfavorable pricing, primarily in exam gloves.
First Nine Months of 2016 Compared to the First Nine Months of 2015
Net sales in North America were even in the nine months ended September 30, 2016 compared to the prior year. Lower sales of non-woven materials to Kimberly-Clark were offset by the incremental sales from the Acquisition. S&IP net sales were lower due to price loss, particularly in exam gloves, and lower volume in surgical drapes and gowns partially offset by volume gains in exam gloves. Medical Devices net sales in North America were higher than the prior year primarily due to the Corpak acquisition and higher volume across all product categories.
Net sales in Europe, Middle East and Africa increased by 1% compared to the prior year primarily due to the Corpak acquisition and higher sales volume partially offset by unfavorable pricing. In our S&IP business, price loss, particularly in exam gloves, and unfavorable currency exchange rates were partially offset by higher sales volume in surgical drapes and gowns. In the Medical Devices business, incremental sales volume from Corpak and higher digestive health sales volume were partially offset by unfavorable pricing.
Net sales in Asia Pacific and Latin America increased by 7% primarily due to higher volume, primarily in exam gloves partially offset by unfavorable pricing. In Medical Devices, higher volume was partially offset by unfavorable pricing.

29


Operating Profit by Segment
(in millions)
Three Months Ended
September 30,
 
 
 
Nine Months Ended
September 30,
 
 
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
Operating Profit (Loss)
 
 
 
 
 
 
 
 
 
 
 
S&IP
$
22.2

 
$
26.3

 
(15.6
)%
 
$
71.9

 
$
71.3

 
0.8
 %
Medical Devices
31.9

 
28.5

 
11.9

 
90.6

 
86.6

 
4.6

Corporate and Other(a)
(27.3
)
 
(31.2
)
 
(12.5
)
 
(77.4
)
 
(82.6
)
 
(6.3
)
Goodwill impairment

 
(475.5
)
 
N.M.

 

 
(475.5
)
 
N.M.

Other (expense) and income, net(b)
(5.9
)
 
(9.3
)
 
N.M.

 
(13.5
)
 
2.0

 
N.M.

Total Operating Profit (Loss)
$
20.9

 
$
(461.2
)
 
N.M.

 
$
71.6

 
$
(398.2
)
 
N.M.

______________________________
(a)
Corporate and Other for the three and nine months ended September 30, 2016 includes $16 million and $48 million, respectively, of general expenses, $7 million and $11 million, respectively, of post spin-related transition expenses, $4 million and $15 million, respectively, of acquisition, integration and restructuring expenses related to the Acquisition (See Note 2 to the condensed consolidated financial statements, “Business Acquisition”) and $0 million and $4 million, respectively, of costs related to corporate sales. Corporate and Other for the three and nine months ended September 30, 2015 includes $13 million and $36 million, respectively, of general expenses and $16 million and $46 million, respectively, of post spin-related transition expenses and $2 million and $0 million of costs, respectively, from corporate sales.
(b)
Other expense includes amounts incurred related to litigation matters. See Note 8 to the condensed consolidated financial statements, “Commitments and Contingencies.”
Third Quarter 2016 Compared to the Third Quarter 2015
Operating profit for the three months ended September 30, 2016 was $21 million compared to a $461 million loss in the same period last year. The prior year operating loss was primarily due to a $476 million goodwill impairment charge. Besides the prior-year goodwill impairment charge, S&IP price loss in exam gloves and sterilization along with Acquisition-related costs were partially offset by volume gains across all product categories in the Medical Devices business, lower manufacturing costs and lower spin-related transitional costs.
Surgical and Infection Prevention
S&IP operating profit decreased to $22 million, compared to $26 million in the prior year driven primarily by unfavorable pricing, primarily in exam gloves, partially offset by lower manufacturing costs and favorable currency exchange rates.
Medical Devices
Medical Devices operating profit increased 12% to $32 million, compared to $29 million in the prior year driven by the Corpak acquisition and higher sales volume partially offset by increased research and development spending and higher selling expenses to drive future growth.
First Nine Months of 2016 Compared to the First Nine Months of 2015
Operating profit for the nine months ended September 30, 2016 was $72 million compared to an operating loss of $398 million in the prior year. The operating loss in the prior year was driven by a goodwill impairment charge of $476 million that was partially offset by a $12 million gain that was realized on the sale of an exam glove manufacturing facility in Thailand. Besides the goodwill impairment charge and gain on sale in the prior year, S&IP price loss in exam gloves and sterilization along with Acquisition-related costs were partially offset by volume gains across all product categories in the Medical Devices business, lower manufacturing costs and lower spin-related transition expenses.
Surgical and Infection Prevention
S&IP operating profit increased 1% to $72 million primarily driven by higher sales volumes, favorable currency exchange rates and lower manufacturing costs partially offset by unfavorable pricing.
Medical Devices
Medical Devices operating profit increased to $91 million compared to $87 million in the prior year primarily due to higher sales volumes, favorable currency exchange rates and the effect of the Corpak acquisition partially offset by unfavorable pricing.
Interest Expense
Interest expense on our senior secured term loan, senior unsecured notes and revolving credit facility was $8 million and $25 million for each of the three and nine months ended September 30, 2016 and 2015.

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Provision for Income Taxes
The provision for income taxes was $4 million and $18 million for the three and nine months ended September 30, 2016 compared to $2 million and $18 million for the three and nine months ended September 30, 2015. Our effective tax rate for the three and nine months ended September 30, 2016 was 28% and 37% compared to 0% and (4)% in the three and nine months ended September 30, 2015 primarily due to the goodwill impairment charge in the prior year.
Liquidity and Capital Resources
General
Our primary sources of liquidity are cash on hand provided from operating activities and amounts available under our revolving credit facility. As of September 30, 2016, $67 million of our $87 million of cash and cash equivalents was held by foreign subsidiaries. We consider the undistributed earnings of our foreign subsidiaries to be indefinitely reinvested overseas and currently have no plans to repatriate such earnings. We believe that our ability to generate cash from domestic and international operations and our existing available credit facilities are adequate to fund our requirements for working capital, capital expenditures and other needs for the foreseeable future for both our domestic and international operations. Furthermore, we do not expect restrictions on repatriation of cash held outside of the United States to have a material effect on our overall liquidity, financial condition or results of operations for the foreseeable future.
Operating Activities
Operating activities provided $144 million in the nine months ended September 30, 2016 compared to $75 million in the nine months ended September 30, 2015. Changes in operating assets and liabilities provided $44 million in cash in the nine months ended September 30, 2016 compared to using $13 million of cash in the comparable prior year period. For the remainder of 2016, we expect to use operating cash flow to fund our working capital requirements, capital expenditures and to repay the borrowings on our Revolving Credit Facility.
Investing Activities
Investing activities used $197 million in the nine months ended September 30, 2016 which includes $175 million used in the Acquisition and $22 million of capital expenditures. Investing activities used $57 million in the nine months ended September 30, 2015 which includes $64 million of capital expenditures partially offset by $8 million of proceeds from property dispositions in the same period last year.
Financing Activities
Financing activities provided $9 million in the nine months ended September 30, 2016, primarily composed of $72 million of borrowings from our Revolving Credit Facility to partially fund the Acquisition and subsequent repayments on the Revolving Credit Facility of $62 million. Financing activities used $51 million in the prior year, consisting of long-term debt repayments.
As of September 30, 2016, debt was $589 million and consisted of (i) $333 million, net of unamortized discount, on our Senior Secured Term Loan, (ii) $246 million, net of unamortized discount, on our Senior Unsecured Notes and (iii) $10 million of borrowings from our Revolving Credit Facility.
Funds under the Revolving Credit Facility are available for our working capital and other liquidity requirements. On May 2, 2016, we borrowed $72 million under our Revolving Credit Facility to partially fund our acquisition of Medsystems. See Note 2 to the accompanying condensed consolidated financial statements, “Business Acquisition” for a description of this acquisition. By September 30, 2016, we had repaid $62 million of the borrowings on our Revolving Credit Facility. As of September 30, 2016, we had $10 million of borrowings and letters of credit of $4 million outstanding under the Revolving Credit Facility, leaving $236 million available for borrowing. See Note 5 to the accompanying condensed consolidated financial statements, “Debt” for further details regarding our debt agreements.
We will incur significant interest expense and financial obligations related to our senior notes, secured term loan and revolving credit facility. We will continue to make investments to introduce new products, enhance the efficacy, reliability and safety of our existing products and to maximize cost savings.
Legal Matters
See Item 1, Note 8, “Commitments and Contingencies,” to the condensed consolidated financial statements for a discussion of current legal matters.
New Accounting Standards
See Item 1, Note 1, “Accounting Policies,” to the condensed consolidated financial statements for a discussion of recent accounting pronouncements.

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Information Concerning Forward-Looking Statements
The preceding discussion and analysis summarizes the factors that had a material effect on our results of operations during the three months and nine months ended September 30, 2016 and September 30, 2015 and our financial position as of September 30, 2016 and December 31, 2015. You should read this discussion in conjunction with our historical condensed consolidated financial statements and the notes to those historical condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2015. This MD&A contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts, and can generally be identified by the use of words such as “may,” “believe,” “will,” “expect,” “project,” “estimate,” “anticipate,” “plan,” or “continue” and similar expressions, among others. The matters discussed in these forward-looking statements are based on the current plans and expectations of our management and are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected, anticipated or implied in the forward-looking statements. These factors include, but are not limited to:
general economic conditions, particularly in the United States,
fluctuations in global equity and fixed-income markets,
the competitive environment,
the loss of current customers or the inability to obtain new customers,
litigation and enforcement actions,
price fluctuations in key commodities,
fluctuations in currency exchange rates,
changes in governmental regulations that are applicable to our business,
changes in asset valuations including write-downs of assets such as inventory, accounts receivable or other assets for impairment or other reasons, and
any other matters described elsewhere in this MD&A or in the Risk Factors section of our Annual Report on Form 10-K for the year ended December 31, 2015.
You are cautioned not to unduly rely on such forward-looking statements, which speak only as the date made, when evaluating the information in this Quarterly Report on Form 10-Q. Where, in any forward-looking statement, an expectation or belief as to future results or events is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished.

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Item 4.
Controls and Procedures
With the participation of management, our Chairman and Chief Executive Officer (principal executive officer) and our Senior Vice President and Chief Financial Officer (principal financial officer) carried out an evaluation, pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the “Act”), of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Act) as of the end of the period covered by this report. Based upon that evaluation, our Chairman and Chief Executive Officer and our Senior Vice President and Chief Financial Officer concluded that our disclosure controls and procedures were operating effectively as of September 30, 2016.
Changes in Internal Control Over Financial Reporting
As discussed in Note 2 to the condensed consolidated financial statements in this Form 10-Q, on May 2, 2016, we completed the Medsystems Holdings, Inc. acquisition. The results of operations of the acquired Medsystems business are included in our results of operations beginning May 2, 2016. We are currently in the process of evaluating Medsystems’ internal controls over financial reporting. Other than the changes resulting from the Medsystems acquisition, there have been no changes in our internal control over financial reporting that occurred during three months ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II – OTHER INFORMATION
Item 1. Legal Proceedings
We are subject to various legal proceedings, claims and governmental inspections, audits or investigations pertaining to issues such as contract disputes, product liability, tax matters, patents and trademarks, advertising, governmental regulations, employment and other matters, including the matters described below. Under the terms of the distribution agreement we entered into with Kimberly-Clark Corporation (“Kimberly-Clark”) prior to our spin-off, legal proceedings, claims and other liabilities that are primarily related to our business are our responsibility and we are obligated to indemnify and hold Kimberly-Clark harmless for such matters (“Indemnification Obligation”). For the three and nine months ended September 30, 2016, we have incurred $5 million and $15 million, respectively, for such matters. Amounts incurred related to these matters in the comparable prior year periods were not material.
The only exception to the Indemnification Obligation relates to the pain pump litigation referenced in this paragraph. We are one of several manufacturers of continuous infusion medical devices, such as our ON-Q PAINBUSTER pain pumps, that are involved in several different pending or threatened litigation matters from multiple plaintiffs alleging that use of the continuous infusion device to deliver anesthetics directly into a synovial joint after surgery resulted in postarthroscopic glenohumeral chondrolysis, or a disintegration of the cartilage covering the bones in the joint (typically, in the shoulder). Plaintiffs generally seek monetary damages and attorneys’ fees. While Kimberly-Clark is retaining the liabilities related to these matters, the distribution agreement between us and Kimberly-Clark provides that we will indemnify Kimberly-Clark for any such claims or causes of actions arising after the spin-off.
We have an Indemnification Obligation for, and have assumed the defense of, the matter styled Bahamas Surgery Center, LLC v. Kimberly-Clark Corporation and Halyard Health, Inc., f/k/a Prime Healthcare Centinela, LLC, et al. v. Kimberly-Clark Corporation, et al., No. 2:14-cv-08390-DMG-SH (C.D. Cal.), filed on October 29, 2014. In that case, the plaintiff brings a putative class action asserting claims for common law fraud (affirmative misrepresentation and fraudulent concealment) and violation of California’s Unfair Competition Law in connection with our marketing and sale of MicroCool surgical gowns. On March 21, 2016, we moved to dismiss the non-California plaintiffs, and on May 26, 2016, the court issued an order dismissing them. On June 14, 2016, the court granted the plaintiffs’ unopposed motion to dismiss Prime Healthcare Centinela, LLC and one of the other two remaining California plaintiffs, leaving only the current named plaintiff, Bahamas Surgery Center, LLC. On June 1, 2016, the plaintiff moved for class certification of a California-only damages class and a California-only injunctive relief class. Although the plaintiff did not also move for certification of a nationwide class to determine liability, damages, or injunctive relief, it did move for certification of a nationwide “issue” class purporting to resolve certain issues allegedly “common” to members of that class. On July 8, 2016, we moved for summary judgment. The parties also remain engaged in discovery. We intend to continue our vigorous defense of the matter.
In June 2015, we were served with a subpoena from the Department of Veterans Affairs Office of the Inspector General (“VA OIG”) seeking information related to the design, manufacture, testing, sale and promotion of MicroCool and other Company surgical gowns, and, in July 2015, we also became aware that the subpoena and an earlier VA OIG subpoena served on Kimberly-Clark requesting information about gown sales to the federal government are related to a United States Department of Justice (“DOJ”) investigation. In May 2016, we were also served with a subpoena from the Department of Justice seeking further information related to Company gowns. The Company is cooperating with the VA OIG’s request and the DOJ investigation.
On October 12, 2016, after the DOJ submitted filings on behalf of itself and various States declining to intervene in two qui tam matters, both matters were unsealed. One of those matters is U.S. ex rel. Shahinian, et al. v. Kimberly-Clark Corporation, No. 2:14-cv-08313-JAK-JPR (C. D. Cal.), filed on October 27, 2014. The other of those matters is U.S. ex rel. Edgett, et al. v. Kimberly-Clark Corporation, Halyard Health, Inc., et al, No. 3:15-cv-00434-B (N.D. Tex.), filed on February 9, 2015. Both cases allege, among other things, violations of both the federal and state False Claims Acts in connection with the marketing and sale of certain surgical gowns. The plaintiff-relators can elect to move forward with these cases, despite the declinations by the DOJ and the various States, though the complaints have not been served as of this time. We expect that we have an Indemnification Obligation for these two matters under the distribution agreement with Kimberly-Clark.
We were served with a complaint in a matter styled Jackson v. Halyard Health, Inc., Robert E. Abernathy, Steven E. Voskuil, et al., No. 1:16-cv-05093-LTS (S.D.N.Y.), filed on June 28, 2016. In that case, the plaintiff brings a putative class action against the Company, our Chief Executive Officer, our Chief Financial Officer and other defendants, asserting claims for violations of the Securities Exchange Act, Sections 10(b) and 20(a). The plaintiff alleges that the defendants made misrepresentations and failed to disclose certain information about the safety and effectiveness of our MicroCool gowns and thereby artificially inflated the Company’s stock prices during the respective class periods. The alleged class period for purchasers of Kimberly-Clark securities who subsequently received Halyard Health securities is February 25, 2013 to October 21, 2014, and the alleged class period for purchasers of Halyard Health securities is October 21, 2014 to April 29, 2016. We intend to vigorously defend this matter.

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We were also served with a complaint in a matter styled Margaret C. Richardson Trustee of the Survivors Trust Dated 6/12/84 for the Benefit of the H&M Richardson Revocable Trust v. Robert E. Abernathy, Steven E. Voskuil, et al., No. 1:16-cv-06296 (S. D. N. Y.), filed on August 9, 2016. In that case, the plaintiff sues derivatively on behalf of Halyard Health, Inc., and alleges that the defendants breached their fiduciary duty, were unjustly enriched, and violated Section 14(A) of the Securities and Exchange Act in connection with Halyard Health, Inc.’s marketing and sale of MicroCool gowns. We intend to vigorously defend this matter.
We operate in an industry characterized by extensive patent litigation and competitors may claim that our products infringe upon their intellectual property. Resolution of patent litigation or other intellectual property claims is typically time consuming and costly and can result in significant damage awards and injunctions that could prevent the manufacture and sale of the affected products or require us to make significant royalty payments in order to continue selling the affected products. At any given time we may be involved as either a plaintiff or a defendant in a number of patent infringement actions, the outcomes of which may not be known for prolonged periods of time.
We maintain general and professional liability, product liability and other insurance in an amount that we believe is reasonably adequate to insulate us from material liability for claims. However, our insurance policies may not cover all of these matters and may not fully cover liabilities arising out of these matters. In addition, we may be obligated to indemnify our directors and officers against these matters. Although the results of litigation and claims cannot be predicted with certainty, we believe that the ultimate disposition of these matters, to the extent not previously provided for, will not have a material adverse effect, individually or in the aggregate, on our financial condition, results of operations or liquidity. However the above matters, regardless of the outcome, could disrupt our business and result in substantial costs and diversion of management attention.
We are subject to federal, state and local environmental protection laws and regulations with respect to our business operations and are operating in compliance with, or taking action aimed at ensuring compliance with, these laws and regulations. None of our compliance obligations with environmental protection laws and regulations, individually or in the aggregate, is expected to have a material adverse effect on our business, financial condition, results of operations or liquidity.
Item 6. Exhibits

(a)
Exhibits
Exhibit No. (31)a. Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), filed herewith.
Exhibit No. (31)b. Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act, filed herewith.
Exhibit No. (32)a. Certification of Chief Executive Officer required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code, furnished herewith.
Exhibit No. (32)b. Certification of Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code, furnished herewith.
Exhibit No. (101).INS XBRL Instance Document
Exhibit No. (101).SCH XBRL Taxonomy Extension Schema Document
Exhibit No. (101).CAL XBRL Taxonomy Extension Calculation Linkbase Document
Exhibit No. (101).DEF XBRL Taxonomy Extension Definition Linkbase Document
Exhibit No. (101).LAB XBRL Taxonomy Extension Label Linkbase Document
Exhibit No. (101).PRE XBRL Taxonomy Extension Presentation Linkbase Document


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
HALYARD HEALTH, INC.
 
        (Registrant)
 
 
 
November 3, 2016
By:
 
/s/ Steven E. Voskuil
 
 
 
Steven E. Voskuil
 
 
 
Senior Vice President and
 
 
 
Chief Financial Officer
 
 
 
(Principal Financial Officer)
 
 
 
November 3, 2016
By:
 
/s/ Renato Negro
 
 
 
Renato Negro
 
 
 
Vice President and Controller
 
 
 
(Principal Accounting Officer)


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