Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Steris Corporation (NYSE:STE)

F2Q09 (Qtr End 09/30/08) Earnings Call Transcript

October 30, 2008, 10:00 am ET

Executives

Julie Winter – Manager, IR

Walter Rosebrough – President and CEO

Michael Tokich – SVP and CFO

Analysts

Greg Halter – Great Lakes Review

Joshua Zable – Natixis Bleichroeder

Daniel Owczarski – Avondale Partners

John Emrich – Ironworks Capital

Mitra Ramgopal – Sidoti

Gary Kelly [ph] – Ironworks Capital

Heidi Lawrence – George Weiss

Mike Hughes – Delaware Investments

Andrew Wam [ph] – FAF Advisors

Operator

Welcome to the STERIS fiscal 2009 second quarter conference call. All lines will remain in listen-only until the question-and-answer session. At that time, instructions will be given should you wish to participate. At the request of STERIS, today's call will be recorded for instant replay.

I would now like to introduce today's host, Julie Winter, Manager of Investor Relations. Ma'am, you may begin.

Julie Winter

Thank you, Angela and good morning, everyone. It's my pleasure to welcome you to STERIS Corporation's Fiscal 2009 Second Quarter Conference Call. Thank you for taking the time to join us this morning.

If you haven't seen a copy of our earnings release issued via PR Newswire this morning, please visit our Investor Relations Web site at steris-ir.com.

Participating in the call this morning, are Walt Rosebrough, our President and CEO, and Mike Tokich, our Senior Vice President and Chief Financial Officer.

Now just a few words of caution before we begin. This webcast contains time sensitive information that is accurate only as of today, October 30, 2008. Any redistribution, retransmission or rebroadcast of this call without the express written consent of STERIS is strictly prohibited.

I would also like to remind you that this discussion may contain forward-looking statements relating to the company, its performance or its industry, that are intended to qualify for protection under the Private Securities Litigation Reform Act of 1995. No assurance can be given as to any future financial results. Actual results could differ materially from those in the forward-looking statements. The company does not undertake to update or revise these forward-looking statements, even if events make it clear that any projected results, expressed or implied, in this or other company statements will not be realized.

Investors are further cautioned not to place undue reliance on any forward-looking statement. These statements involve risks and uncertainties, many of which are beyond the company's control. Additional information concerning factors that could cause actual results to differ materially is contained in today's earnings release. As a reminder, during the call, we will refer to certain non-GAAP measures including free cash flow, backlog, debt to capital and days sales outstanding. All of which you will find in our most recent 10-K filing along with a reconciliation to the corresponding GAAP number.

With those cautions, I'd like to hand the call over to Walt who will comment on the quarter. Walt?

Walter Rosebrough

Thanks, Julie, and good morning, everyone. And thank you all for joining us again this morning. I will focus on the highlights of the quarter and will then turn the call over to Mike to review our financial performance in more detail.

We started this fiscal year with a good first quarter and I'm pleased that the people of STERIS have delivered a second strong quarter. All three of our segments delivered solid growth and the cost reduction activities we have put in place helped drive continued improvement in earnings.

Now, when you look at our performance this quarter, and for the first half of the year, I need to remind you that we implemented a few changes at the beginning of this fiscal year in an effort to level out our production and reduce the historic seasonality in our business.

As a result, we expect our performance will be more evenly distributed throughout this year when compared to prior years. This is causing a timing of our comparisons with last year to look a little bit strong in the first half and will continue to have implications for growth rates in the second half of the year although in the opposite direction.

Taking a minute to review our segment performance, Healthcare delivered another quarter of double-digit growth, driven in part by new products as well as growth in large project orders. Backlog and orders have both continued to grow, giving us confidence in our near-term performance.

We've not yet felt any significant pinch from the broader economic issues facing the general markets but we are spending time talking with our customers to better understand the potential impact on their spending in the coming months. We have seen some delay of projects in international businesses, where local currencies have weakened significantly in the past few weeks.

Our Life Science segment grew faster than we had anticipated which we believe is largely timing. The year-over-year comparison is also strong since we had a weak second quarter last year in that segment. Much to their credit, the Life Science team continues to manage expenses to improve profitability, even in the face of a continued slowdown in the North American pharmaceutical market.

Last, but not least, our Isomedix segment had another solid quarter. As you saw in our press release, we sold a Chicago area ethylene oxide facility to one of our customers during the quarter, which added to the segment's profitability. This was nearly a captive plant for one customer and the transaction benefited both us and our customer.

It is consistent with our strategy to optimize existing facilities and invest in additional capacity where we have growth opportunity. For the full year, we anticipate that the gain on the sale will approximately offset lost profits from the facility.

Based on our year-to-date performance, for the total company, we are adjusting our outlook for the full year. We now anticipate that revenue will be on the high-end of our previously communicated range of 4% to 6%, reflecting a stronger year for our Healthcare segment than we had originally thought.

We don't believe we will maintain double-digit growth levels, but are comfortable with high single digit growth for the segment for the full year. Our expectations for Life Science are unchanged. While we now anticipate Isomedix growth will be in the low single digits due to the facility sale I mentioned earlier.

On the bottom-line we currently anticipate our earnings per diluted share to exceed the high-end of our previous range by as much as $0.15 or up to $1.80. As you know, we are making a number of assumptions in these estimates, including a modest increase in material costs and slight weakening of the US dollar.

I will now hand over the call to Mike Tokich who will review the numbers in more detail. Michael?

Michael Tokich

Thank you, Walt. Good morning, everyone. It is my pleasure to be with you this morning to discuss our financial performance for the second quarter of fiscal 2009. Let me begin with an overview of the income statement.

Second quarter revenue increased 10%, reflecting growth in all reportable business segments. Organic growth for the quarter was 9% with 7% from volume and 2% from pricing. Foreign currency translation contributed 1%. Gross margin in the quarter was 41%, an increase of 30 basis points compared with the second quarter of last year.

The improvement in gross margin reflects pricing and productivity improvements, partially offset by increases in raw materials and freight, plus an unfavorable impact from foreign currency exchange rates.

As a percentage of revenue, earnings before interest and taxes were 14.5% in the second quarter, an increase of 550 basis points compared with the prior year period. The improvement reflects higher gross margin attainment, improved operating expense leverage, and the gain on the sale of our Isomedix facility. The effective tax rate for the quarter was 36%, compared with 37.4% in the prior year quarter.

Net income was $28.8 million or $0.48 per diluted share, compared with net income of $16 million or $0.25 per diluted share in the second quarter of fiscal 2008. During the quarter, EPS was favorably impacted by $0.02 from the gain on sale of our Isomedix facility.

Moving on to our reportable segments, Healthcare revenue increased 10% in the quarter, driven by growth in capital equipment revenues of 14%, as we continue to benefit from our new product offerings and orders for large projects. The remainder of the Healthcare business also performed well, with both service and consumable revenue growing 7%. Demand trends continue to be strong with record backlog levels of $124 million at the end of the second quarter.

The Healthcare segment revenue grew nicely on a global basis with 9% growth in the U.S. and 13% growth internationally during the quarter. The Healthcare segment operating margin rate was 14.4% compared with 10.4% in the same quarter last year. The improvement in operating margin rate was driven by increased volumes, higher gross margins and improved operating expense leverage.

Life Sciences revenue grew 9% compared with the prior year, driven by 17% growth in capital equipment revenues, primarily due to the timing of shipments and a weak second quarter last year. While we did have pockets of strength within the segment, we continue to experience an anticipated slowdown in spending from our North American pharmaceutical customers.

We do not anticipate sustaining this capital equipment growth rate during the second half of the year. Also contributing to the quarter for Life Sciences, consumable revenue grew 8% and service revenue grew 2%.

Backlog levels for Life Sciences declined 16% to $49 million in the quarter as compared with the same period last year. For the second quarter, Life Sciences revenue grew 2% in the United States and 23% internationally. Life Sciences operating margin rate was 10.9% compared with 6.4% in the same quarter last year. The improvement in operating margin rate was driven by increased volumes and lower operating expense levels.

Isomedix Services revenue grew 6% driven by increased demand from medical device customers and modest increase in price. Isomedix reported an operating margin rate of 27.6% compared with 20.4% in the prior year period. During the quarter, Isomedix sold a facility to a privately held customer, which added $2.1 million to the segment's profitability.

Turning to the balance sheet, our DSO level was 58 days, an improvement of five days as compared with the second quarter of last year. Total inventory at quarter-end was $161.3 million compared with $157.7 million in the prior year quarter. Capital expenditures for the quarter were $10.3 million, and depreciation and amortization were $14.4 million.

The first half of fiscal 2009 was another strong period of cash generation. Free cash flow in the first half of this year was $57.3 million compared with free cash flow of $31.6 million in the same period last year. The year-over-year improvement in cash flow largely reflects the increase in earnings and the Isomedix sale which added $9.5 million to free cash flow.

Given our strong balance sheet and free cash flow position along with our low net debt to total capital ratio of 10.8%, we continue to be active with our share repurchase program. Since the beginning of this fiscal year, we have repurchased 1,986,000 shares of common stock at an average price of $30.99. Approximately $217 million remains under our current share repurchase authorization.

As previously announced during the quarter, we completed a private placement of $150 million in long-term debt with maturities ranging from 5 years to 12 years. Approximately half of those proceeds were used to pay down our existing credit facility. By completing this transaction, we were able to lock in favorable long-term rates.

This concludes my review of the second quarter results. I will now turn things back over to Julie to begin the Q&A portion of our call. Julie?

Julie Winter

Thank you, Walt and Mike, for your comments. We're now ready to begin the Q&A session. Angela, will you please give the instructions and we'll begin.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Daniel Owczarski with Avondale Partners. Your line is open.

Julie Winter

Dan?

Walt Rosebrough

Sounds like we may have a technical glitch, operator.

Operator

One moment, please. It looks like we have a question from Greg Halter with Great Lakes Review. Your line is open, sir.

Greg Halter – Great Lakes Review

Hello. I am on if you can hear me.

Walt Rosebrough

Good morning, Greg.

Greg Halter – Great Lakes Review

Good morning. Let me see, where should I start here? Regarding Isomedix facility, when was that sold during the quarter? I guess why was it sold?

Walt Rosebrough

The transaction date was September 29th. So it was near the – actually at the end of the second quarter.

Greg Halter – Great Lakes Review

Okay. And you mentioned the gain of I think $2.1 million in operating income as a benefit to the segment. Is that included in the overall income statement in SG&A or cost of goods sold or elsewhere?

Michael Tokich

It is actually as part of SG&A. It's a $2.1 million was recorded as a benefit that offset SG&A expenses for the quarter.

Greg Halter – Great Lakes Review

Okay. And your share count from quarter-to-quarter I think increased by about 800,000 shares, yet you bought about a million shares through October 29. Just wondered if you could provide some comment on why the share count went up and where you stand currently on the share count.

Michael Tokich

We actually have seen a slight increase basically because of the number of options being exercised at the higher level prices of approximately $37, $38 during the quarter.

Greg Halter – Great Lakes Review

Okay.

Michael Tokich

Right now, we stand roughly about 60 million shares outstanding from a diluted standpoint.

Greg Halter – Great Lakes Review

And that includes the buyback through October 29?

Michael Tokich

Correct.

Greg Halter – Great Lakes Review

Okay. And I know you made some comments about the dollar with strength being beneficial to the company. How much assistance did that provide in the quarter and how much would you expect going forward if we stay at around 130 on the euro?

Michael Tokich

For the quarter, FX helped our revenue growth by approximately $2 million. And actually from an operating income standpoint, we had a slight positive impact of approximately $600,000. But if you look at the full year – if you look at the first half, our revenues were favorably impacted by $5.9 million, but we did see negative operating income impact of $2.5 million. So even though the dollar did strengthen in the second quarter, it was not enough to offset the weakness in the first quarter.

Greg Halter – Great Lakes Review

Okay. And your – I know you did the private placement and your cash went up from I think $49 million to $160 million. Obviously, your debt increased as well from about $178 million to $250 million on a sequential basis. Is the differential there just the free cash flow as well as the – I guess some of that is from the Isomedix facility sale?

Michael Tokich

That is correct, Greg. Yes.

Greg Halter – Great Lakes Review

Okay. And do you have any short-term debt currently?

Michael Tokich

We have approximately $800,000 of short-term debt.

Greg Halter – Great Lakes Review

Minimal. Alright. That's all for now. Thanks.

Michael Tokich

Thanks, Greg.

Operator

And it looks like our next question comes from Joshua Zable with Natixis Bleichroeder. Your line is open.

Joshua Zable – Natixis Bleichroeder

Can you hear me?

Julie Winter

Yes.

Joshua Zable – Natixis Bleichroeder

Great. Congratulations on another great quarter here, guys. Great work.

Julie Winter

Thanks, Josh.

Walt Rosebrough

Thanks, Josh.

Joshua Zable – Natixis Bleichroeder

Couple of questions. First of all, as far as the general hospital spending goes, obviously, the backlog is at record levels. I know you guys have been very clear about – the growth looks strong in the beginning half of the year and it may look appear weaker just on a comparable basis. But can you just talk about – we've heard from a number of companies, hospital spending or hospitals are delaying purchases at least in the fourth quarter. Maybe you can talk about what you're seeing specifically, if anything's changed in October. Maybe why, if you're not seeing anything, what gives you the confidence that you're not going to or to the extent that what makes you guys different. I know it's a lot of questions in one, but –

Walt Rosebrough

Joshua, I guess – I would start by saying what makes us different is we were probably little more cautious starting out. We said from the beginning that we were concerned about our – what was going to happen with the elections and everything. So I would say our general forecast was probably a little cautious relative to the average bear. And so that would be for the first statement. The second statement is we generally have not seen weakness to-date in our order patterns or we're not seeing cancellations. The kind of things that would give you real pause. So we just have not seen that to-date. And so – since we have – we have no ability to forecast something we haven't seen. We're clearly talking to customers about those things and we're not hearing that that is – that's in their plans, in our business. Clearly, they have had some weakness in terms of their revenues and they're seeing margin squeezes in the hospital industry. And how that affects – of course, they're going to be more cautious I think going forward. We have not seen that. You also have to remember, we have two components of our business, a consumables piece and a capital piece. The consumables piece will follow more – I'll call it their general spending patterns. And so we may see I think a slower growth in that than we might have otherwise seen. But again I think we were little cautious going in.

On the capital side, that tends to be people just making decisions right, slowing things or delaying things. We may see some delay, but we tend to be a little further out in time. So we may see some delay and we've been – again, we think we've been cautious about that, particularly comes to our Q4 which is the calendar Q1. As I mentioned, we have seen – really about the only thing we've seen to-date is some international orders where again, in the current where the currencies have weakened dramatically and they are pushing things off in time. We have not seen cancellations yet there either. By the way, there's always things pushing in and out in this business, and so you're looking for a differential of a differential. So far we have not seen that occurring.

Joshua Zable – Natixis Bleichroeder

Just when you say you're further out in time, is it a function of they place the order and you guys have to install it so it takes longer so once they're committed they're sort of committed that they can't pull out whereas, say, some other device that they could kind of bring in or bring out – as soon as they buy it. Is that why you're kind of different?

Walt Rosebrough

If you're in the middle of a refurbishing of an operating room and that is one of your principal sources of revenue. Once you started it, it's gone, hard to stop. If they haven't started, that's a different question. But once you started, it's hard to stop. It is a revenue generating part of the system. So that could be an answer. The other side is, as you guys know, we have and we mentioned before, we have a number of new products on the market. And so it's difficult – if your new products are doing well which ours are, sometimes you're seeing gains in that new product offset by general loss. It's hard to figure out which of those two – as long as the net's positive, it's still positive. So that could be another explanation. But this point, we just have not seen reductions in those order rates.

Joshua Zable – Natixis Bleichroeder

Alright. That's great. Great to see.

Walt Rosebrough

By the way, Josh, you know me, I am cautious about that. I am not telling you that we won't see it. I'm just saying we haven't seen it to-date.

Joshua Zable – Natixis Bleichroeder

Sure. No. I guess I am just we've heard a number of people say it and I don't want to beat the dead horse. It's just a question of is there maybe there was some rational explanation as to kind of something about your equipment. Obviously, if they need a new one, there is no getting around it. But as far as replacing, the pushback one would make is if an autoclave lasts 30 years, why do I need a new one today when I can buy it next year or two years or three years.

Walt Rosebrough

That's absolutely correct. And again I would say some of it could be the longer duration project orientation, if you will. And those projects are continuing to come to completion. But the rest I cannot answer any more than those guys who are subject to completely just replacement. They're going to see it quicker, I would think.

Joshua Zable – Natixis Bleichroeder

Okay. And then just quickly on the Life Sciences, the backlog is down. Like you said, just a function of the pharmaceutical companies having issues out there that we all know about. Is that a safe way to think about it?

Walt Rosebrough

I think that's a very safe way to think about it.

Joshua Zable – Natixis Bleichroeder

Cool.

Walt Rosebrough

Again, it's largely the North American side, yes.

Joshua Zable – Natixis Bleichroeder

SG&A, obviously lower. I know you got a benefit from the sale of Isomedix facility. Just as far as how do we think about your SG&A going forward? Was this just a really good cost cutting quarter or could we potentially see – is this sort of a new model way of running the company?

Walt Rosebrough

We've said from the beginning that we did that the one-time cut a couple quarters ago. And we said we weren't just doing a one-time cut and go feast or famine, we're staying on a different diet. And we intend to stay on a different diet. So I would expect to see continued cost – what's right word? Relative cost improvements.

Joshua Zable – Natixis Bleichroeder

Okay. Great. And then just following up on the Isomedix, I think Greg asked, just to be clear, you guys sold the facility. From a growth perspective and again, I know you guys have been very clear about the second half of the year relative to comps being more challenging. But when I think about Isomedix having lost this facility, should we think about growth sort of slowing down there being affected by this in any way?

Walt Rosebrough

Clearly – I'll call it there is a one-time – if you think of it as same store kind of analogy –

Joshua Zable – Natixis Bleichroeder

Exactly.

Walt Rosebrough

There is clearly a reduction because there is – that store is gone. And that cut – it's largely, by the way, that was largely one customer that was the predominant part of that business and they're gone. But there is – that business is always a business of customers who do some of their sterilization themselves and then put some of their sterilization out to us. Some customers do all their sterilization on an outsource basis. And this customer continues to work with us on an outsource basis in other facilities. It turns out that it was a good – it's a good deal for them and a good deal for us. We're continuing to expand. As you've seen, we've put capital into that business and we will continue to put capital into that business expanding facilities. And we want to get them expanded where the business is or actually the old Wayne Gretzky comment where the business is going. And that's what we're doing. We try to get long-term commitments with our customers when we do that. So I wouldn't suggest that it will reduce growth – on a same store basis, we would not suggest this is a growth reducer. And we fully expect growth next year because we're bringing other capacity online. But clearly, it drops growth a bit in that kind of a one-time down shift, if you will.

Michael Tokich

Josh, we have reduced the outlook for Isomedix revenue growth from mid single digits to low single digits, just based upon the sale of that one facility.

Joshua Zable – Natixis Bleichroeder

Okay. That's what I figured. And then just a question relative to the outlook and I'll get off. You guys made comments about foreign exchange. I know you talked a little bit about that and material costs. None of us can predict where oil is going or where foreign currency is going. We would rather we probably be sitting at a computer at home, trading, but that being said, I guess I'm trying to understand as far as you're looking at – the dollar has strengthened. So as we go forward the year, just to be clear on your language, you're assuming the dollar will effectively weaken from here out or you're assuming the dollar is flat. And then on the – I guess that's the first part. Material cost, I know there is sort of a lag effect. In other words, when you buy something it takes a little bit while to get through to the COGS. So obviously your materials that you bought a while ago are probably more expensive than the ones you're buying now so that will obviously hurt gross margin sort of – or in the way we think about it. That's still flowing through. But are you suggesting that you expect the sort of volatility of the prices, the low prices now to come up? Or are you just sort of giving us the heads up that we shouldn't expect to see gross margin expansion immediately because there has to be a flow through? I don't know if those questions are clear.

Walt Rosebrough

(inaudible) Josh, first of all, the flow through for us is relatively quick in weeks and months, not months and years. So it doesn't take a year for the flow through to occur. That's point one. And as a general statement, we have some that is slightly different, but as a general statement that's true. Secondly, clearly in the last 30 days, we've seen a weakening of many of our material component costs. Stainless steel has continued to stay even to weaken. Steel is starting to soften a little bit. Oil clearly has softened significantly. On the other hand, we do have some chemistry that require the same chemicals that farm products do and those are definitely not weakening. In fact, they've gone up significantly. We had contracts in place, those contracts ended so some of those have gone up. So we still have a mixed bag of material. But the bigger issue is, just as you say, it's getting more and more difficult for anyone to forecast material costs these days. We're seeing some pretty wide swings in some pretty short-time periods. As a general statement, our forecasts are where our materials outlook was toward the end of this quarter. And as a general statement, our foreign exchange was where our outlook was toward the end of this quarter. The dollar has strengthened a little bit since then so our outlook has that historic 30 days ago kind of look. But – if it stays kind of where it is, it's not significantly material. But if it moves up 10% or 15% or down 10% or 15%, we're going to move with it.

Joshua Zable – Natixis Bleichroeder

So I guess it's safe to say it's an issue of given the volatility to an extent you're building in some conservatism in terms of the dollar could weaken and other material prices that have come in could go up again. That's not unreasonable to expect, I'm just saying that's kind of the way you're playing it?

Walt Rosebrough

That is exactly – we're not trying to give you a signal it takes four years for a cost to go through or four years for FX to go through. We're trying – we're just seeing there is a fair amount of volatility here and we'll travel with that volatility.

Joshua Zable – Natixis Bleichroeder

Great. Thanks for taking all my questions, guys. Congrats again. Awesome job.

Walt Rosebrough

Thank you, Josh.

Operator

(Operator instructions) And our next question comes from Daniel Owczarski with Avondale Partners. Your line is open.

Daniel Owczarski – Avondale Partners

Can we try this again? Can you hear me?

Walt Rosebrough

Yes, sir.

Julie Winter

Hi, Dan.

Daniel Owczarski – Avondale Partners

Hi, guys. Congratulations.

Julie Winter

Thanks.

Walt Rosebrough

Thank you.

Daniel Owczarski – Avondale Partners

Walt, you had mentioned large project orders being a little bit of a dragger for the quarter. Is there any way to quantify how that compared to last year and what is driving large project orders?

Walt Rosebrough

Dan, I don't know – I don't have those numbers off the top of my head, but we have seen in the last year an increase in the amount of our businesses coming through as a part of a large project or total package. And we think a lot of that's because we've improved our products in the class, if you will. So if you have a better table and a better light and you're doing things together, then it's easier to drive a complete project as opposed to a piece. And secondly, there have been a lot of – I'll call it building and/or refurbishment of large projects out there so they're coming in, in bigger clumps. And we’ve obviously worked to do a better job on those large projects. So I would put those two factors together.

Daniel Owczarski – Avondale Partners

Okay. And then on capital equipment sales, I think we've asked you in the past whether these can be like leading indicators for consumables and services down the road. Is that the case or is a good chunk of this capital equipment more like lighting where they're one-time in nature?

Walt Rosebrough

Yes, I don't view capital and consumables necessarily being leading or lagging indicators to each other. Consumables obviously travel more directly with – I'll call it basic hospital demand. So either admissions and patient days type things or surgical procedures, depending of what type of consumable it is. And so those kind of travel with general demand. Capital is far more dependent on what their capital spending decisions are. I will say it's a lot – capital tends to be a little more volatile as a general statement than consumables for that reason. Because it's decision-based as opposed to kind of routine operation based.

Daniel Owczarski – Avondale Partners

Okay. Just last question, going to the Isomedix warning letter. Is that specific to the Rhode Island facility those issues that came up? Or are those same processes, procedures in that other Isomedix facilities and could they be exposed to warning letters as well?

Walt Rosebrough

All of our facilities – Isomedix is one of the most highly regulated businesses that you can have because we're rated by the FDA, the EPA, the NRC Regulatory Commission, so the NRC. We have all kinds of regulations. They are routinely inspected by all of the above and so we are always subject to inspections. Having said that, the specific citing or the specific warning letter does relate only to that facility in Rhode Island. It's only subject to that facility in Rhode Island. And that warning letter in our view has no impact on our other facilities, per se. And we do have – we have generally similar processes in all those facilities, but they're all at different levels of automation and different levels of how they work in terms of – and by the way, and some are very different processes. Some of our facilities are ETO facilities. Others are radiation facilities. So there is a wide variation among – if you put all the facilities together. So I don't see this as being a – I'll call it systemic issue that this relates to. But clearly, we always want to take learnings we have from one facility and apply them to the others and we're doing that.

Daniel Owczarski – Avondale Partners

Okay. Thank you.

Operator

And it looks like our next question comes from John Emrich with Ironworks Capital. Your line is open, sir.

John Emrich – Ironworks Capital

Could you just repeat the answer to the question about what foreign exchange added to the top and bottom line in the quarter?

Michael Tokich

Certainly. For the quarter, FX impact on revenues were about $2 million positive. And then on an operating income standpoint, they were approximately $600,000 positive for the quarter.

John Emrich – Ironworks Capital

And it's just – I'm new to the story, it's just not intuitive to me for a U.S. company, I'm not sure. How does the sudden strengthening of the dollar help you? Has it – what is your set up that caused that?

Walt Rosebrough

The cost side of the equation and we have a significant amount of our manufacturing facilities outside the U.S.

John Emrich – Ironworks Capital

Got you.

Walt Rosebrough

So the three currencies that we tend to look at are the Canadian dollar, the Peso and the Euro where we have manufacturing facilities outside the U.S.

John Emrich – Ironworks Capital

And how does it help revenue?

Walt Rosebrough

It doesn't – it can help revenue on sales outside the U.S.

John Emrich – Ironworks Capital

Okay. Great. Thanks.

Walt Rosebrough

It's strictly a mathematical equation.

John Emrich – Ironworks Capital

Yes. Thank you.

Operator

Our next question comes from Mitra Ramgopal from Sidoti. Your line is open.

Mitra Ramgopal – Sidoti

Just few questions. First, you had really nice volume in the quarter. I don't know if you can give us a sense as to how much of that really came from new products?

Michael Tokich

From a Healthcare standpoint, we actually saw about a third of our capital growth coming from new products. New products continue to be something that we are strengthening as we move forward. We are getting good customer reception for the new products that we continue to introduce.

Mitra Ramgopal – Sidoti

Okay. And what's the pipeline for additional products as we look out over the next 12 months?

Michael Tokich

We don't discuss our new product pipeline, but we have one.

Mitra Ramgopal – Sidoti

Okay. That's fair. I believe you had mentioned on the expense reduction program, you're expecting to realize about 50% to 70% of that in fiscal '09. Is that pretty much the same or are you running ahead of that?

Walt Rosebrough

I think we're pretty much on target.

Mitra Ramgopal – Sidoti

And then on the guidance, I think you said the operating margin was going to be about 12.5% for the year. And if we look at the first half, seem like you were running pretty much at least this last quarter well ahead of that. Anything in particular that might lead to a slowdown in the second half, outside of, say, higher raw material costs?

Walt Rosebrough

First of all, there were a number of unusual items in the first half. So if you back those out – for example, the $2 million of Isomedix. If you back those out, you get different numbers, obviously. So that's the first answer. And the second answer is we are being cautious on the revenue and cost side as we have described.

Mitra Ramgopal – Sidoti

Okay. Thanks again.

Operator

Our next question comes from Greg Halter with Great Lakes Review. Your line is open, sir.

Greg Halter – Great Lakes Review

Thanks for letting me back in. What were your recurring revenues, either consumable, services in the quarter, either percent or dollars?

Michael Tokich

If you look at total, I can give you the breakout of the recurring revenues. If you look at service, service in total, grew 6.8% – sorry 6% and consumables grew 7.5%.

Greg Halter – Great Lakes Review

Okay. And as a percentage of your total revenues?

Michael Tokich

Do you have what the percentage of total revenues is for?

Walt Rosebrough

We don't have the percent, we can give you the numbers.

Greg Halter – Great Lakes Review

The numbers that would be fine.

Julie Winter

$192 million, Greg.

Greg Halter – Great Lakes Review

Okay. Great. And then what is international to the total in terms of revenues?

Walt Rosebrough

International is approximately 24% for the quarter.

Greg Halter – Great Lakes Review

And how does your profitability in international compare to the domestic business?

Walt Rosebrough

Domestic would be slightly more profitable.

Greg Halter – Great Lakes Review

Okay. Any comments on the DOJ or the other FDA issue with System 1?

Walt Rosebrough

No. We continue to work through the process with the agency and there is really nothing new to report.

Greg Halter – Great Lakes Review

Okay. I know you talked about new products and that's an area that seems to be ramping up nicely. Are there any products in particular that you can comment on that have been introduced that are doing especially well?

Walt Rosebrough

We're very pleased with our LED lights. We are – cleaning chemistries, we had couple that are out there now and they're doing nicely. And we're beginning to see – it's still early in its life, but we're beginning to see good tracks on V-PRO.

Greg Halter – Great Lakes Review

Okay. That's good to hear. And also, relative to the competitive environment, any significant changes from getting their Ecolab or any of the others that may be out there?

Walt Rosebrough

I don't think that we've seen any significant change.

Greg Halter – Great Lakes Review

Okay. And one last one, given your strong free cash flow, any thoughts on the merger and acquisition area, either in terms of selling other facilities or purchasing I guess?

Walt Rosebrough

First of all, in terms of selling facilities, the selling or opening – I'll speak specifically to Isomedix, because I think that may be where the question is pointed. As I've said if it's – we will be opportunistic working with our customers on any individual facilities if it makes sense for them and us. And by the same token, we want to grow in areas that are – where we see good long-term business. But as a general statement, we're not looking to pedal facilities. As a general statement, we're not looking to sell off capacity, if you will. As a general statement, we're looking to grow capacity in that business.

Greg Halter – Great Lakes Review

Okay.

Walt Rosebrough

And then in terms of acquisitions in general, we continue to look at our environment for acquisitions. I mentioned to several of you on different occasions that I tend to like – relatively speaking, I like things that are very close to what we're already doing, where we can apply something we know or gather something someone else knows or does better than we do and apply it to our current products and markets. And so that would clearly be an area of interest to us. We are continuing to look in the marketplace and we will announce if we see – we won't be announcing anything until we do something.

Greg Halter – Great Lakes Review

Okay. And I did lie. One last one. Your R&D was down on a sequential basis slightly on a year-over-year and I know it bounces around. But is there anything more to read into that and should it still be about 3% of sales for the year?

Walt Rosebrough

We are not looking to reduce R&D in total in our business. In fact, if anything, on a percentage basis or percentage of our cost basis, we're looking to continue to either stay the same or grow, on a dollar basis, for sure.

Greg Halter – Great Lakes Review

Sounds good and we'll see you in early November.

Walt Rosebrough

Yes, sir.

Michael Tokich

Thanks, Greg.

Operator

Gary Kelly [ph] with Ironworks Capital. Your line is open.

Gary Kelly – Ironworks Capital

Thanks. Just a follow-up on earlier question about the improved operating expense. I'm looking specifically at the SG&A line. You guys showed some I guess very good cost controls. I think it's around 24% of sales. The guidance though kind of implies maybe back to prior levels. Was there a one-time item or some one-time items in SG&A in the quarter as well?

Walt Rosebrough

You may have remembered on the Isomedix sale, we had about a $2 million gain. That gain is reflected as a contra.

Gary Kelly – Ironworks Capital

That specifically – okay so that's in the SG&A line then.

Walt Rosebrough

Yes, sir.

Gary Kelly – Ironworks Capital

Okay. Thanks. And I guess the follow-up on CapEx, should we see that coming down over the next couple of years? I think you're done with the plant moves. I guess what should we kind of be looking at a sort of an ongoing maintenance level of CapEx? And how should I look at that going forward?

Michael Tokich

If you look at CapEx over the last several years, we've actually ran anywhere from $50 million to $55 million, $60 million on an annualized basis. We are projecting about $55 million approximately for this year. Lot of that is really just maintenance capital and specifically maintenance capital for Isomedix facility as we continue to have Cobalt loads in order to continue our processing speed within those Cobalt Isomedix facilities. Normal maintenance associated with our plants from an operating standpoint.

Walt Rosebrough

But I would do a follow on statement of those. First is, clearly we will invest in capital where it makes sense for us to grow. That's clearly in new product development areas as well as any facility expansion or capacity we need to do that. Having said that we want to be as fiscally prudent with capital as we expect to be with operating expenses. And so we will be very careful with that capital spending.

Gary Kelly – Ironworks Capital

That sounds very fair. Just to follow up on that, where would you currently stand on capacity utilization?

Walt Rosebrough

That is a – we have so many businesses in so many different plants. That's a difficult question to answer broadly. But I would say as a general statement, we're not in a high capacity constrained kind of issue in terms of do we need to build a new plant to do – relatively modest growth rates. The answer would be no.

Gary Kelly – Ironworks Capital

Okay. Fair enough. Thank you.

Operator

Our next question comes from Heidi Lawrence with George Weiss. Your line is open.

Heidi Lawrence – George Weiss

Hi, guys. How are you doing?

Michael Tokich

Good.

Walt Rosebrough

How are you, Heidi?

Heidi Lawrence – George Weiss

Good, thanks. Just going back to the SG&A. I'm sorry to keep asking in different ways. If your SG&A was down around $10 million sequentially, can you just give us how much of that was actually from the closing of the Isomedix?

Michael Tokich

$2 million.

Heidi Lawrence – George Weiss

It's $2 million. Okay. Great. And then so for the back half, we shouldn't be expecting that – clearly that's what your guidance suggests, that we shouldn't be expecting that kind of sequential drop-off, right?

Walt Rosebrough

Correct.

Heidi Lawrence – George Weiss

Okay. I think that's it. Thanks, guys.

Michael Tokich

Great. Thanks.

Operator

Our next question comes from Mike Hughes with Delaware Investments. Your line is open, sir.

Mike Hughes – Delaware Investments

Good morning. Couple of questions. I think you said that new products on the Healthcare capital equipment side accounted for about a third of the revenue growth. Do you have a comparable number from a year ago? That's the first question. Second question, how is the plant in Mexico performing now? And should we see incremental margin expansion as that facility runs even more efficiently or is it kind of where it needs to be right now?

Michael Tokich

From a number standpoint, I can tell you that we are in a much higher position from a growth standpoint with capital equipment than we were a year ago.

Walt Rosebrough

In terms of product as a percent of sales.

Michael Tokich

Right, yes. And then from Mexico standpoint, we have completed that transition back in the fourth quarter of our last fiscal year, fiscal year 2008. We are anticipating $10 million to $15 million of improvement year-over-year from last year and this year. And that basically is a lot of that, if not all of that is due to labor arbitrage in moving the facility from Erie, Pennsylvania to Monterrey, Mexico. So you'll continue to see the impact of that throughout this fiscal year.

Mike Hughes – Delaware Investments

Okay.

Walt Rosebrough

But having said that, all plants can improve all years. So I wouldn't expect – if the plant were still in the area, we would be expecting improvement in Erie. If the plant is in Mexico, we will be expecting improvements in Mexico. But not the step function that you have seen.

Mike Hughes – Delaware Investments

Okay. Last question. The changes that were put in place to mute the seasonality, when exactly did you enact those changes? Was it this quarter or the prior quarter?

Walt Rosebrough

We started working on it eight, nine months ago. And so – and that is largely efforts toward both our sales force and then the way we manage – that we manage shipments. We're working to make sure that we first meet customer demand, second, work to level that operation flow as best we can, and third, of course, we are working to meet our targets. So I think we've kind of reversed that order a little bit to be more sensitive to customer demand first, more sensitive to try to keep level loading in our plants better, second. And we started that work, I would say eight, nine months ago, maybe even a year ago. And certainly – and that will be ongoing work. That's not simple to do. In a perfect world as you grow 10%, you would see a nice 10% ramp up over the course of the year. Never quite works out that way, but the closer you can get to that, the better your operations run.

Mike Hughes – Delaware Investments

When did you – I assume you made changes to the comp plan for the sales force. When were those instituted? Was it the June quarter or September quarter?

Walt Rosebrough

The first of this year.

Mike Hughes – Delaware Investments

Alright. Great. Thank you very much.

Operator

Our next question comes from Andrew Wam [ph] FAF Advisors. You may ask your question, sir.

Andrew Wam – FAF Advisors

Good morning, gentlemen. Great quarter. Going back to the margin question, everybody keeps asking about SG&A. Even after you make the adjustment, it's still – I think it moves it up about 50 basis points to 24.6%. So is the margin that people are concerned about here in the second half? Should we really be thinking more about gross margin – or the cost of goods increasing dramatically in the second half versus the first half? And that's going to cause the changes in the operating margin? Or is there SG&A expense beyond the $2 million that you've already indicated because 24.5% versus first quarter of 28%, I'm not quite sure how we should be modeling the SG&A expense on the second half. And it sounds like on the R&D side, 2.5% to 3% in the second half is a reasonable level.

Michael Tokich

Yes, I think you got to look at both gross margin and SG&A. An SG&A standpoint, not only did we have the $2.1 million favorable impact from the gain on the sale in the first half for SG&A. Your second point was right on. R&D, we are anticipating is going to increase at a much higher rate in the second half. So you have some timing differences. And then with gross margin standpoint, we are anticipating that we're going to have higher raw material costs in addition – from what we've seen in the first half. So it's a combination of all three of those is how I would try and model that.

Andrew Wam – FAF Advisors

Did you guys have or did you give – I want to say last quarter, did you guys give gross margin improvement for the full year – or am I not recalling correctly?

Michael Tokich

We did. In our original guidance, we did give gross margin improvement for the full year.

Andrew Wam – FAF Advisors

Was that about 100 basis points year-over-year or – ?

Michael Tokich

It was actually slightly more than that, but that guidance was based on a different way of how we view the business currently. We have made and we will make changes throughout the year, classification changes, that will affect cost shifting from Op expense to cost of goods sold. You will notice that over the course of the year. But if you look strictly on an operating margin rate, that is where we're focused on.

Andrew Wam – FAF Advisors

So should we really be thinking about the gross margin being around 41% in the second half?

Michael Tokich

There actually be slightly less than that, based upon increased raw material costs.

Andrew Wam – FAF Advisors

Okay.

Michael Tokich

But I would focus on the operating margin at approximately 12.5%.

Andrew Wam – FAF Advisors

Got it. Alright. Thanks a lot, gentlemen.

Michael Tokich

Okay. Thank you.

Operator

I see no further questions at this time. I'll turn the call back for closing remarks.

Julie Winter

This concludes STERIS's fiscal 2009 second quarter conference call. A replay of this call will be available from noon today Eastern time until 5:00 p.m. Eastern time on November 13th. You can access the replay on our Web site or by calling 1-800-756-3940 in the United States and Canada and 1-402-998-0796 internationally. Thank you for joining us and for your interest in STERIS.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Steris Corporation F2Q09 (Qtr End 09/30/08) Earnings Call Transcript
This Transcript
All Transcripts