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

Steris Corp. (NYSE:STE)

F3Q08 Earnings Call

January 30, 2008 10:00 am ET

Executives

Aidan Gormley - Director, Investor Relations

Walter Rosebrough - President and Chief Executive Officer

Michael Topich - Vice President and Corporate Controller

Analysts

Steven Missen - Mindpro Capital

Greg Halter - Great Lakes Review

Joshua Zable - Natixis Bleichroeder

Jason Ronovech - Paradigm Capital

Mike Hughes - Delaware Investments

Sam Shapiro - Shapiro Capital

Operator

Welcome to the Steris fiscal 2008 third quarter conference call. (Operator Instructions) I would now like to introduce today’s host, Mr. Aidan Gormley. Sir you may begin.

Aidan Gormley

Good morning everyone. It’s my pleasure to welcome you to Steris Corporation’s 2008 third quarter call. For your reference the earnings announcement went out by PR news wire this morning. If you didn’t get a chance to get a copy of it, it’s available at Steris-IR.com. Joining me this morning are Walt Rosebrough, our President and Chief Executive Officer and Mike Topich, Vice President and Corporate Controller. I just wanted to remind you that the web cast today contains time sensitive information that is accurate only as of today, January 30, 2008. Any redistribution, retransmission, or rebroadcast of the call without the express written consent of Steris Corporation is prohibited. I would also to remind you that the discussion today 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 our 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, express 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, as if that wasn’t enough, concerning factors that could cause actual results to differ materially is contained in today’s earnings release. During the call we will be referencing certain non-GAAP measures. These could include measures such as free cash flow, backlog, debt-to-capital, and day sales outstanding. All of which you’ll find in our most recent 10K filing, along with a reconciliation to the corresponding GAAP number. So with those cautions I’d like to hand you over Mike who will begin our financial review. Mike?

Michael Topich

Thank you Aidan. Good morning everyone. It is my pleasure to be with you this morning to discuss our financial performance during the third quarter of fiscal 2008. After my comments, I’ll turn the call over to Walt for his remarks. Let me begin with the income statement. Third quarter revenue increased 5%, reflecting growth in all three business segments. For the quarter, pricing contributed 2% and changes in foreign currency rates contributed another 2%. Gross margin in the quarter was 41.5%, compared with 42.7% in the prior year. Although we have been successful in implementing price increases and are benefiting from labor savings resulting from our transfer of manufacturing operations from Erie to Mexico, we are still incurring significant cost increases relating to raw materials and inflationary increases in labor and freight.

As a percent of revenue, operating expenses were 30.8% in the third quarter, compared with 31.4% in the prior year period. Selling, general, and administrative expenses, as a percentage of revenue, improved 30 basis points while research and develop expenses increased 50 basis points. Due to a continued emphasis on new product development and product enhancement efforts, the effective tax rate for the quarter was 33.1% compared with 36.2% in the prior year quarter. The fiscal 2008 quarter was favorably impacted by discrete item adjustments and a change in estimate on a permanent tax adjustment. For the full year, the company anticipates its effective tax rate to be approximately 36.5%.

Net income was $21.8 million or $0.34 per diluted share in the third quarter of fiscal 2008, as compared to $21.3 million or $0.33 per diluted share in the prior year period. As a reminder, our profitability was impacted by restructuring expenses which negatively impacted diluted earnings per share in the third quarter of fiscal 2008 and fiscal 2007 by $0.01 and $.04 respectively. In addition, the fiscal 2007 third quarter included a gain related to our discontinued operations which contributed one penny to diluted earnings per share. Moving on to segment results, healthcare revenue increased 5% in the quarter, driven by strong growth in consumable revenue of 12% and service revenue growth of 7%.

Capital revenue was essentially flat during the quarter as we are experiencing a slower than anticipated ramp up in production levels at our new Monterrey, Mexico manufacturing facility which along with order growth has lead to record backlog levels. Backlog in the healthcare segment increased 14% sequentially and 22% year-over-year to reach $107.3 million. The healthcare segment continues to be impacted by significant cost increases relating to raw materials and inflationary increases in labor and freight which more than offset the benefits achieved from pricing and labor savings in Mexico. In addition, the segment incurred higher operating costs as we continue to invest in the development and marketing of new products along with added selling expenses relating to our growth initiatives. As a result, the segment operating margin rate was 11.9% compared with 12.2% in the same quarter last year.

Life sciences revenue increased 5% compared with the prior year, driven by growth across a broad array of product lines. Consumables revenues grew 8%, service revenue grew 5% and capital revenue grew 4%. While the segment experienced growth in the research capital market, delayed project activity among customers in pharmaceutical manufacturing affected revenue in the quarter. Backlog for life sciences in the quarter increased 30% year-over-year and 1% sequentially to a record $58.3 million. Life sciences reported operating income of $800,000 in the quarter, compared with $2.5 million in the same period last year.

Operating income was negatively impacted by increased research and development expenses related to product enhancements and by foreign exchange translation. Isomedix services revenue grew 4% by routine price increases and increased demand from our core medical device customers. Isomedix reported operating income of $6.4 million in the quarter, compared with $5.7 million in the prior year period. The increase in operating income reflects the increased volumes and pricing. Turning to the balance sheet, our DSO level was 59 days, compared with 64 days in the third quarter of last year, reflecting an increased focus on payment collection efforts, especially within Europe. Total inventory at quarter end was $164.4 million, compared to $147 million in the prior year quarter. The difference reflects increased raw material costs, new product inventory and targeted inventory production levels in anticipation of increased volumes in the quarter.

Capital expenditures were $17.6 million and depreciation and amortization was $16 million during the quarter. For the full year, we continue to anticipate the capital expenditures will be approximately $55 million, while depreciation and amortization will be approximately $60 million. Looking at cash flow, our net cash provided by operations for the first nine months of fiscal 2008 was $94.5 million compared with net cash provided by operations of $41.4 million in the first nine months of fiscal 2007. Free cash flow was $60.1 million in the first nine months of fiscal 2008, compared with free cash flow of $10.9 million in the same prior year period. The year-over-year improvement in free cash flow was driven by a reduction in accounts receivable balances and a prior year payment of $27.6 million to the IRS for tax expenses previously incurred.

During the third quarter of fiscal 2008, the company completed the sale of its Erie, Pennsylvania manufacturing facility which added $4.7 million to free cash flow. During the quarter, we repurchased 1.5 million shares of common stock for a total amount of $40.6 million. For the first nine months of the fiscal year, we repurchased 3.4 million shares of common stock for a total of amount of $96.3 million. Currently we have approximately $225 million remaining under our current share repurchase authorization program.

For the fiscal year, the company continues to anticipate free cash flow of approximately $80 million. This concludes my review for the third quarter. I will now turn the call over to Walt for his remarks.

Walter Rosebrough

Thanks Mike and good morning everyone. I want to also add my thanks for all of you taking the time to be with us today. I’d like to share my perspective on the quarter and also highlight some of the significant trends we are seeing in our business. Generally speaking demand trends continue to be positive. We sustained revenue growth in all three segments this quarter and demand is even more robust as evidenced by record backlog levels. In fact, our year-to-date order growth is 8% across the entire business. The single biggest issue, versus our expectations, was that our revenue is constrained by delays in our ramp up at our new Mexican production facility. I’m going to focus on that issue for a few minutes because there is a bit of short term bad news but the overall and long term news is good.

Although the plant is now running at about our average monthly production rate for this year, as you know we expected to ship significantly more product in the back half of the year than we did in the first half. The production ramp-up delays have prevented us from shipping product commensurate with our order rate and our plan. Even though our capacity continues to grow, we will not ship as much as planned in the fourth quarter. If we were able to ship all, or nearly all of the orders we have in-house for the fourth quarter, as we have in past years, we would exceed our revenue estimates for the year. We now expect to be below our revenue plan for the year despite an actual order pattern that is better than anticipated and that would sustain our original projections.

The good news is that generally our lead time requirements from customers are long for these capital products so there has been minimal, if any impact, on our ability to meet customer requirements. The other good news is that although we are disappointed that the plant has come up to speed a bit slower than we planned, we are very pleased that the steepest part of the ramp-up is behind us. I mentioned in the call last quarter that I have not yet visited the Monterrey plant. Since that call, I have reviewed the plant and I am impressed with the facility and the people. I’m greatly encouraged by the fact that we are now producing at run rates that meet normal customer requirements. Unfortunately we just can’t catch up to our higher than normal year-end shipments all at once. I’m confident we will be able to work down the backlog next year, just not at the rate that would allow us to hit our planned performance in the fourth quarter.

The other good news is that we are seeing a positive impact of lower costs at this facility and we expect the impact to grow as we get fully up to speed. Ignoring the impact of slower revenue recognition from the plant, the transfer will have a net positive impact of $4 million to $6 million in pre-tax operating profit this year. That is compared with our original estimate of $6 million to $8 million. We believe our long term estimates of annual savings are still very much on track.

Now let me take a moment to discuss each segment. First regarding healthcare, our largest segment, the demand trends in healthcare are generally positive with solid order growth and record backlog levels. Although Mexico production levels muted volume growth, we did achieve pricing improvement as well as the labor savings from our move to Mexico. Supplementing general market demand, we continue to make progress with our new products. For example, the response to the third quarter introduction of our new LED light has been outstanding. We have fared very well in head-to-head trials and expect a continued increase in volume levels during the fourth quarter and beyond. This product is consistent with our strategy of offering a better and broader array of products in to the operating room sweep to deliver better performance and reduce costs for our customers; at the same time, increasing our revenue per room opportunity. Also within healthcare, our reliant TPS product continues to gain momentum as an alternative to the use of aldehyde systems for high level disinfections in GI departments. And finally, we are in the process of launching our new v-probe VHP sterilizer. The V-probe 1 technology platform is environmentally friendly, safe, and easy to use. It offers substantial processing capacity and is designed to compete with existing low temperature gas sterilization systems. These systems are used to process heat sensitive medical devices in hospital sterile processing departments. These new products are expected to supplement an already broad portfolio solutions to address the critical infection prevention needs of our customers.

In terms of overall profitability in healthcare, while we have improved pricing and captured labor savings, lower volume throughput and increased raw material costs have offset those improvements. Additionally, we have invested in selling and marketing expenses to launch our new offerings and new product development to develop recent released and future new products. While we expect margin improvement in the fourth quarter for healthcare, as we increase production levels we will fall short of our overall expected profitability for the year in that segment.

Turning now to life sciences, revenue growth in life sciences remains modest this quarter relative to the double digit increases we anticipated. While we have made a significant turnaround in our research business, our North American pharmaceutical customers have been cautious with manufacturing expansions and in some cases we have seen projects delayed that we originally believed would generate revenue for us in this fiscal year. Continued growth in overall drug consumption levels is a positive micro trend for us. And our business is more a function of the volume of drug consumption than drug pricing. We anticipate a continued shift in pharmaceutical manufacturing to facilities outside North America and are positioned to capitalize on that trend. In fact, during the third quarter we did see significant year-over-year growth in our Asian operations. However, lower than planned volumes in our pharmaceutical manufacturing business, along with foreign exchange variances due to the fact that we are often selling European and Canadian built product into the U.S., as well as some delays in cost reducing product redesign efforts has had a detrimental impact on margins in this business. As a result, we anticipate the revenue growth and margins for the full year will be below where we expected them to be.

Finally, turn to Isomedix. Isomedix continued its steady pace of growth with sustained pricing levels and stable volume growth. We recently initiated a capacity expansion at our Minnesota location which will help drive some incremental volume next year. We anticipate little change in the revenue outlook for Isomedix relative to our previous forecast and we may do slightly better than expected in margin rate. Across the entire company we have taken actions to stop planned growth in operating expenses in the third and fourth quarters of this year and we will be continuing to scrutinize those expenses as we complete our planned forecast for next year. In total, largely as a result of the slower than anticipated ramp-up in Mexico, we are adjusting our earning estimates downward to the range of $1.30 to $1.35 per diluted share. Revenue growth will be in the range of 4% to 5% for the full fiscal year. As we progress through the current quarter we will complete a detailed operating plan for fiscal year 2009 and would expect to share our outlook for that year during our fourth quarter conference call in early May. With good market demand, free cash flow in the $80+ million a year range, a strong balance sheet, and new products coming to market, we believe we are well positioned to for the future.

With that I will turn the call back over to Aidan to introduce the Q & A.

Aidan Gormley

Thanks very much Walt and thank you Mike for your comments. We’re now ready to begin the Q & A session so Holly can you just give the instructions and we can get started?

Question-and-Answer Session

Operator

Our first question comes from Steven Missen with Mindpro Capital. Your line is open.

Steven Missen - Mindpro Capital

Yeah, a couple of questions Walt. Obviously it’s been very challenging since you joined the company last year but I know you guys should be able to light the ship. A couple of things regarding operational improvement initiative, what are you guys doing in terms of factoring TPM Six Sigma throughout your plans to overall improve throughput? I know you talked about production levels being down, so what do you plan to do for 2008 to help your plans and prove throughput with some of the different types of initiatives out there?

Walter Rosebrough

I would step back... first of all the production capacity constraint has nothing to do with either lean or six sigma type initiatives. It’s the fact that we started a new plant in Mexico. So first of all that issue is clearly not a function of those variables.

Steven Missen - Mindpro Capital

Okay.

Walter Rosebrough

Having said that, we have, and I’ve been actually pleased since coming on board that the guys in production have begun a couple of years ago working down the TPS, Total Protection System or lean system. We have a long way to go. We are early in that process. But that’s clearly an area that is, in my view, of great interest. Particularly on the manufacturing side, I believe that is the preferred approach to improving our processes and that’s something we will definitely be working on in coming years.

Steven Missen - Mindpro Capital

In terms of metrics to measure manufacturing facilities, are you looking at OE, Rona? A lot of executives in the industry [semiters] are measured upon both types of metrics. How are you guys measuring yourself to see, hey are we doing the right job in the right plant?

Walter Rosebrough

We do look at profitability and return metrics. I will tell you that when you’re really working your way down the lean path the single best metric to look at is inventory because inventory reduction is a significant part of that process, getting flow. And that is clearly where we are not excelling right now, so we have great opportunities for improvement there.

Steven Missen - Mindpro Capital

And what targets do you have for inventory reduction? Have you set any target levels for this year, to reduce it by a certain percentage?

Walter Rosebrough

We have not set those targets as of yet. But I can tell you we’re a long way from them.

Steven Missen - Mindpro Capital

Follow up question. Going into the remainder of ’08 is obviously is very challenging for a lot of factors, you said yourself, what systems or solutions are you going to be putting in place to accelerate your continuous improve initiative and what benefits do you expect to see out of that to let the shareholders know, hey we’re doing the right job?

Walter Rosebrough

The two areas that... again, I’m going to separate two different questions, two different things. The first is kind of the lean initiatives and the two areas that we will clearly be focusing on are quality and inventory. Those are the areas one always focuses on in those processes. So we will be doing that. The second piece again is really – comes back to the question – which in the short run is more significant to our revenue and as a result profitability is moving forward in the Monterrey, Mexico facility ability to produce. And there, again, we are monthly improving that capability and significantly improving that capability and you will see that in our revenues month after month, quarter after quarter. You’ll see it more on a revenue perspective that way. The other measures, the more internal measures are things that we will be looking at. But clearly you’ll be seeing inventory. Our inventory levels are high relative to what they need to be if we’re a lead manufacturer.

Steven Missen - Mindpro Capital

Are you guys putting in new ERP systems to manage that? What are you actually doing? Are you putting in new capacity, hiring more labor from low cost countries? What are you guys doing?

Walter Rosebrough

Okay, two answers. First of all, we do have ERP systems in place. So that’s really not the issue. In fact, if anything, inside the factory as you pull systems you somewhat reduces your reliance on those ERP systems inside the factory, still box to box, you rely on them. The second part of your question is, in Monterrey, clearly one of the things we have been doing over the course of this year is bringing people on board and training. There have been two bottlenecks there. The first has been getting machinery up or back up depending, and we’ve clearly had some constraints there and we are doing a nice job of getting our run time capabilities back up. The second area is the people constraints and we are working diligently to make sure that we get those people in, train them well so they do a quality job and we do not want to lose our focus on quality as we move forward on the quantity side. But clearly we’re doing that and they are making significant progress in that we have ramped up... The people hired have continued to ramp up over the course of this past year. Again, I would step back and say... By the way, it is very disappointing to us as a company and it’s disappointing particularly who are working on that project to be behind what they expected. But having said that, they really got on the ground in Mexico about 18 months ago, so if you think about what they did in transferring a, I don’t know, century old plant out of Erie, Pennsylvania into a green field site in Monterrey, Mexico and getting the kind of cost savings that we will eventually fully achieve, it’s not a small task. I hesitate to say they’ve done a great job, because we’re behind our expectations, but I will tell you it’s not an easy task and they’re doing a nice job.

Steven Missen - Mindpro Capital

Okay and final question from me on ’08. What would you say is the top challenge that you want to tell shareholders you’re taking on and what is the goal you would like to accomplish in your first full year as CEO of Steris?

Walter Rosebrough

I think we’ll talk more about our significant objectives and challenges in the next conference call. But we clearly have issues. But right now, I’ll tell you in the short strokes our number one challenge is getting Monterrey fully up to speed. That’s not what I would have told you the day I walked in the door but as of about 60 days ago, I would have clearly said that’s the number one challenge and we are moving forward on that.

Steven Missen - Mindpro Capital

Thank you very much.

Walter Rosebrough

Thank you.

Operator

Greg Halter with Great Lakes Review, your line is open.

Greg Halter - Great Lakes Review

Thank you. Good morning.

Walter Rosebrough

Good morning Greg.

Greg Halter - Great Lakes Review

You talked in your release about routine pricing within the Isomedix division or segment? Can you discuss what sort of range that pricing increases came out to be?

Walter Rosebrough

Yeah. I mean typically in Isomedix we’re able to capture ongoing price increases so it wasn’t something specific, which is why we described it as routine Greg. Usually in the Isomedix business we’re able to capture 2 to 3 percentage points of growth from pricing.

Greg Halter - Great Lakes Review

Okay.

Walter Rosebrough

Generally in the range of inflation with the exception of where we can... There are certain products that have fast turn-around demand or issues related to specific types processing where we’re able to capture a little bit more.

Greg Halter - Great Lakes Review

Okay. Given all the increased worries over food and food supply and so forth, is anything new or different happening within the Isomedix business or any of your other businesses relative to food safety?

Walter Rosebrough

It’s really not a focus going forward for Isomedix. It hasn’t been for some time. The vast majority of our volumes in Isomedix are what I call medical related. As we announced before, we’re applying our proprietary VHP technology in the food and beverage industry with a specific research agreement with Tetrapak. So those are the opportunities that we’re limited to today. It’s a future area of focus but not a significant drive strategically at this point in time.

Greg Halter - Great Lakes Review

Okay. Can you comment on how large your business outside of either North America or outside of the United States as a percentage of the total?

Walter Rosebrough

For the quarter, we were approximately 23% international revenues.

Greg Halter - Great Lakes Review

Okay. And, relative to Europe, which I think is somewhere between 10% and 15% of the total, you had some commentary a couple of quarters ago or maybe last quarter about returning that particular area to profitability or increasing the profitability there and just wondered if you could comment on how things are moving in that direction?

Walter Rosebrough

I think we’ve seen good improvement, significant improvement in fact, in our European operations from profitability standpoint. I think we had originally said that our initial goal is to get to break even level and we’ve been able to achieve that this year.

Greg Halter - Great Lakes Review

Okay, great.

Walter Rosebrough

Having said that, “break even,” obviously that a long term goal and we intend to improve that going forward.

Greg Halter - Great Lakes Review

Okay. And relative to Mexico, are there any further restructuring charges or expenses anticipated out of that move, the transition from Erie to Mexico?

Walter Rosebrough

Yeah, for the fourth quarter we’re anticipating approximately another million dollars in the fourth quarter for restructuring expenses relating to that move.

Greg Halter - Great Lakes Review

And will that be it, or will there be more that bleed over into fiscal ’09?

Walter Rosebrough

Currently we believe that that will be the end of the restructuring charges for the Mexico move.

Greg Halter - Great Lakes Review

Okay. You had some commentary about the orders and so forth given the Mexican plant situation and just wanted to confirm or reiterate your comments on the loss or potential loss of orders or any that have actually occurred relative to what’s going on there. Have you seen anything in that area or just if you could expand on your previous comments?

Walter Rosebrough

I guess my comments pretty well stand but I will expand a little bit. Again, these are capital items that are... typically planned well in advance by our customers and we have, because again relatively long lead times, we have some amount of flexibility in working with our customers moving... They may have said, gee they’re going to get this thing two months in advance of when they plan on putting it into place and then their project slips a little bit and we work with them. We work with them anyway. It’s not unusual for us to have built something and somebody calls and says hey, “keep it on the shelf for another month, please.” So we have a fair amount of ability to mix and match and move products, so if we have a customer that needs something quickly we can substitute for somebody who’s not as --- who doesn’t have such an urgent need. So we really haven’t seen significant issues there. That’s not to say... it is more challenging at this moment than it is typically for us, but we’re not seeing losses as a result of that. And because we’re ramping up our production ramp up is ramping up faster than our growth, I do not see that being short term or long term problem.

Greg Halter - Great Lakes Review

Okay. Good.

Walter Rosebrough

I will say though, it’s worth mentioning that orders... It is common for us to have orders that are not just Mexican production. So, for example they may have an order for two sterilizers that are coming out of Mexico and a washer coming out of Canada and, particularly for international orders or lights and tables because they’re going to do a whole new operating room and some place internationally or domestically it’s very common for washers and sterilizers to be shipped at the same time. So, if we ask our customers to take the sterilizer two weeks late, they’re not hot to take the washer. So, although the Mexico production issue is the issue that is causing some of those delays, it does cause delays across our capital operation. So we will... if you understand the logic there?

Greg Halter - Great Lakes Review

Right.

Walter Rosebrough

So that’s why the impact can be greater than just the delay in Mexico. Again, it’s not a customer impact. They take it two weeks later. They’re happy to take it two weeks later, but that’s something ... you know there’s a washer sitting in Quebec waiting to go with the sterilizer that can’t go out of Mexico for example.

Greg Halter - Great Lakes Review

Okay. And relative to your... the brochure in the hospital area I know you had indicated the first orders from five hospitals on the last call, has that ramped up from that level and can you provide any additional input relative to that product?

Walter Rosebrough

As I mentioned last time, that practice is going to be a concept sale and we had a kind of cluster of orders. I think we’ve had a couple since then, but it’s in that range. We’re in the single digit numbers, not in the double digit numbers in orders and I expect that will be slow and it will ramp up. I do think the product has a solid potential in that arena, but it’s a concept sale and we’re going to have to work that one.

Greg Halter - Great Lakes Review

Okay. Anything new to report on the DOJ investigation?

Walter Rosebrough

There’s really nothing to report.

Greg Halter - Great Lakes Review

Okay. And system one, I would expect there’s got to be a replacement cycle coming on, or maybe it already has. I just wonder if you could speak to that.

Walter Rosebrough

Well, I will say as a general statement that one of the areas that I feel strongly about is that all capital types of equipment will last virtually to infinity if you don’t give customers a reason to change and so I would say that about system one and every other one of our pieces of capital equipment. If we don’t do something to cause our customers to want to change because we’re doing something better for them so we have a technological reason to change the market size for the business will be smaller than it should be. We don’t speak to kind of new product releases until it’s time, but as a statement of generality, you can assume that to be the case of kind of every product we have on the shelf.

Greg Halter - Great Lakes Review

Okay. That’s good to hear. That’s kind of refreshing actually. And one last one if I might? Just wondering if I could get your thoughts on the either hospital construction or hospital spending environment, currently?

Walter Rosebrough

You know, right now our pattern of orders as well as activity is strong. And we’ve been in kind of a strong market for a reasonable period. I think, I think... not I think, I know that healthcare spending is a political question as much or more than a demand question. The underlying demand is virtually infinite. It is a political question in... we’ll be facing that political question sometime next year. In the end I don’t see... there are ups and downs year-over-year, but in the end the long term demand has been very positive and I expect it to be.

Greg Halter - Great Lakes Review

Okay. Thank you very much.

Operator

Joshua Zable with Natixis, your line is open.

Joshua Zable - Natixis Bleichroeder

First of all on pricing, I know you said you did get a price increase through... but we’ve heard obviously raw material costs keep going up. I guess this is sort of a two-part question. One is it just a simple price increase or is this sort of a raw material increase and on a go-forward basis is that something we can see going forward? You know, obviously I think most customers understand what’s going out there on the material side. And then B, are we seeing any sort of tapering off of these costs in any way, just given the way certain materials have acted?

Walter Rosebrough

The biggest material that caught us this year Josh, as you know is stainless steel. We got hammered early in the year. The good news is that prices seem to be moderating. Actually, we got hammered some late last year and then early this year. That price seems to be moderating. Not that it’s dropping significantly but it’s not rising as it was.

Joshua Zable - Natixis Bleichroeder

Right.

Walter Rosebrough

And so, you know, I think, touch wood, the worst of that is over. We have had a couple of other; I would call them relatively routine cost increases. And then we had a couple of things on our plate that we had hoped to moderate prices on, that is to redesign our way out of. Some of which we’ve been able to do and some of which we have not been able to do. But I do think the... this quarter, as well as the going quarter coming, the fourth quarter. We don’t see the ramp up we saw in the first half of the year. In terms of price, it’s kind of... the good news and bad news is we negotiate price in a two-fold way with our predominantly healthcare customers particularly the U.S. hospital customers. As you know, there are buying groups and we negotiate those kind of on an annual basis and we fix our prices so we pretty much live with material cost increases. Of course we try to forecast them, we try to build them into our prices and then we try to recapture, just as you said when things get a little out of hand we try to recapture in subsequent periods. We have some ability to do that and we have moderated our discounting because there is some individual projects discounted outside the group purchasing order agents. We have moderated that as a result of the steel prices, stainless steel prices I should say.

Joshua Zable - Natixis Bleichroeder

Okay, then on the foreign exchange you guys obviously benefited. Can you just give us an idea of how to think about it, you know going forward? Obviously you’ve given us revenue guidance for the fourth quarter so, it’s less important. But on a more future, sort of looking into next fiscal year, I know you don’t want to give formal guidance but just as far as whether or not, you know, it should be a benefit or a hindrance, I guess.

Walter Rosebrough

Well if the exchange rates continue as they are, we should be getting a benefit and I would say that benefit should be around a 1% benefit as it is for the year, this year. So that’s the best guess we have at this point and time.

Joshua Zable - Natixis Bleichroeder

Okay. No, that’s helpful.

Walter Rosebrough

You know Josh, as well as most domestic manufactures know the dollar softens when you’re selling outside the U.S. You get a little wind and that’s what’s happened to us here.

Joshua Zable - Natixis Bleichroeder

Uh, that’s great. And then, just again going back to... you know you sort of broke out the 5% with the FX and the price increases. We really appreciate that and you said the order increases 8%. I guess just to reiterate and understand, because I’m getting 1% of volume there, but I subtract the other two... but that’s more of a function of sort of capacity or manufacturing issues than order patterns.

Walter Rosebrough

That’s exactly correct Josh.

Joshua Zable - Natixis Bleichroeder

Okay. Then just turning quickly to Europe, I know you guys have launched a product relatively recently, it’s been a couple of quarters now. Can you just talk about sort of market share there and what sort of you’re seeing? Obviously you guys are having significantly more share in the U.S. and sort of efforts are going on over there to take more shares.

Walter Rosebrough

Josh I’m not sure exactly what products you’re talking about.

Joshua Zable - Natixis Bleichroeder

The washers . . .

Walter Rosebrough

Okay. As a general statement... I would say first of all we look at our P & R business as a global business and that business is shifting... if you will from industrialized countries to tax havens and less industrialized countries as the pharma manufacturing is going there and we are, since we have been nouveau in those areas, we have set up operations, in the principal ones and we are picking up share in that... We’ve gone from zero to something and so we are picking up share there. And that’s sort of across the line that they sell. In healthcare, we have grown in Europe more rapidly than we have in the U.S. and I believe that market is not growing faster so I think we’ve picked up a little bit of share but it’s not, it’s not huge share.

Joshua Zable - Natixis Bleichroeder

Okay, great. And then, can you guys. . . I know you sort of alluded to this on the vapor based technology. Obviously, clearly you are making some investments here in R & D. Is there any other new products? I know you’ve gone commercial with certain ones and I know obviously working with Tetrapak developing things. Is there anything else sort of down the pike here that we should be looking for or anything particularly exciting that you guys are developing?

Walter Rosebrough

Josh, I can talk to that just a little bit. The products that Walt mentioned and his comments are the key product launches that we have ongoing. We’re continuing to look at upgrades or developments efforts with our base product lines such as the washer line and the sterilizer line which we hope to be able to introduce in fiscal 2009. So the key is probably the VHP based technology, V-Pro Sure, V-Pro 1, ongoing introduction of Reliance EPS. We have the LED innovations that we're bringing to market, in addition to OR integration products in surgical, then some of the base products such as washers and sterilizers, we're continuing to upgrade those.

Joshua Zable - Natixis Bleichroeder

Okay, great. And then just a couple of questions which you guys probably won’t answer but I got to ask them anyway. Any update on the CFO front?

Walter Rosebrough

You know I don’t have a real update Josh, but I’d rather just tell when I’m there. But I will say I wouldn’t expect to be in the call this time the next call with the same conversation.

Joshua Zable - Natixis Bleichroeder

Okay, that’s helpful. And then, Walt I just want to push you a little bit here. I know you kind of alluded to giving us more details on the next call, but you know you have been there for a while. Unfortunately you probably had to deal with us on some of these manufacturing issues that you didn’t anticipate dealing with, but with that said, can you give us any sort of sense of strategy? I know you obviously talked about sort of capital equipment cycle which is great to hear. Anything else, sort of off the cuff that you’re seeing that you know, really excites you or, you know, that you kind of really want to focus on? Obviously early days here, but just something we can kind of hang on to here and look for?

Walter Rosebrough

Good question. I’m not going to say much Josh. I will say it’s clear the core of the business is the sterilization products in the U.S. in healthcare. And as you radiate out from that, you have growth opportunities. And, you know, I am big on... I’ll call it concentric growth as opposed to trying to go do something brand new. So you can bet it will be something radiating out from those areas. And to be honest with you, I’ve talked about in my conversations, the products we’re launching, what we’re doing. I think that there is some real good movement there and we need to implement what we’re working to do and we need to implement it well. But we’ll talk more next call.

Joshua Zable - Natixis Bleichroeder

All right. Thanks for taking all my questions guys. Welcome to the party Walt.

Walter Rosebrough

Thanks Josh. Next question please.

Operator

Jason Ronovech with Paradigm Capital, your line is open.

Jason Ronovech - Paradigm Capital

Good morning guys. I just wanted to get deeper into the production issues. Can you get more specific? Was it related to supply of components, quality control, and employee turnover?

Walter Rosebrough

I would say... I don’t know if you said three or four things, but minus one you were pretty spot on. We did have two or three things. First, this equipment that we moved down from Erie, Pennsylvania to Monterrey, ranges in ages from relatively new to a couple of years old to close to ancient. And as you might expect, and as we should have expected more, some of those pieces of equipment decided to act out a little bit when they landed and so we’ve had more challenge in bringing some of that equipment up than we expected. I believe, you know at the 90% level that has been taken care of. The second area, and you must have been a manufacturing buff... In terms of supply chains, again... now we expected this and the good news is what the guy did is build up supply chain ahead of the move. So, both in terms of, by the way, finished goods as well as the number of the whip components or raw materials. So they did build up ahead but we had some unexpected difficulties in moving some of that across the borders in the timeframe that we wanted to. So that was a little tougher than, I think some people had estimated. And in addition, because some of the equipment didn’t come up, we outsourced some of those components to other manufacturers, but, you know, we did not give them the lead times that they would expect because we didn’t know we were going to be outsourcing. So in an effort to use the capacity we had, we outsourced. So that’s clearly the secondary of the components for the supply chain. And then the third, and the one that did catch us a little bit unawares and is a piece of the reason we were ramping up kind of nicely and then we hit a state of turnover, late summer, early fall in some of the folks that we hired and that put us behind a little as well. Those three things, it wasn’t kind of one big problem, it was this little problem and that little problem and this little problem and that little problem that came together to put us... and I would say we’re running two to three months behind were we would like to be in terms of ramp up.

Jason Ronovech - Paradigm Capital

What do you still need to do to resolve each of those three issues?

Walter Rosebrough

Well, you know, they’re largely resolved. We have hired and trained people. We’ve done a number of things to work on retention of the folks we have and of course there’s a classic issue again when you start from ground zero. Like most situations people who have been with you one month or two months or three months or more have to turnover to the people who have been with you for 20 years and as time passes that one is curing itself, if you will. I have a number of people who that have been on board 15, 18, 24 months and they’re... that piece is improving and hopefully we won’t see another spike in that. We don’t intend to. We have clearly worked on that, that piece of the puzzle. We do have virtually all the machines. I’ve forgotten the exact numbers, but we’re in the 80% up time ratio of the machinery and that’s up significantly from where it was three or four months ago. And since a lot of that is what I’ll call infant failure of a type, its infant failure after you move, it’s not infant failure because of the new machine. Once you get past that, you’re pretty well past it. That one we would not expect to replicate, so I think that will continue to improve and we have continued to hire and trade people so we have a higher number of folks than we have had here before and they are being trained and they’re in good shape. I should mention that one other problem we had was we had an outbound transportation problem that was again unexpected. We obviously transported this product from Erie, Pennsylvania all over North America so there was kind of an assumption that it would transport similarly and particularly in the transfer between ... people knew the type of equipment. This stuff is big and heavy and not easy to move around. Particularly between getting trucking folks up to speed on how to handle that as well as the additional handling and customs. We found that we needed to improve our packaging, as well as our training in terms of handling those systems and we’ve gotten that behind us too. Those are the biggest areas that were problems and again there are problems everyday in manufacturing but... we’ve kind of passed the big ones.

Jason Ronovech - Paradigm Capital

So, you’re thinking there’s residual impact on the fourth quarter. In the first quarter there really shouldn’t be any discussion of production problems in Mexico?

Walter Rosebrough

Unless our order, our growth rate goes way up that would be my expectation.

Jason Ronovech - Paradigm Capital

Okay. Thank you.

Operator

Mike Hughes with Delaware Investments, your line is open.

Mike Hughes - Delaware Investments

Good morning, a couple of questions. Just looking at the healthcare backlog, obviously there is... 22% every year. Can you give us an idea of what that number would have been if you didn’t have the production issues in Mexico? Just a rough number.

Walter Rosebrough

Approximately 30% increase was related to Mexico. So sterilizers were approximately $15 million of that increase. Then you’d be back down to around $90 million.

I would say the easiest way to think about is --- and I’m not sure we’ve done that math. And like I said, because it may affect other products as well but kind of the way we’re looking at it is what would we have looked like if we had shipped our growth rate as opposed to shipping what we could produce? Which is normally what you’d expect, right? The backlog rises typically with your growth rate. It doesn’t rise faster than your revenue growth rate --- order growth rate, excuse me. So since I haven’t done that mathematics to know the exact number, it’s a difference between 8% and 5% is not a bad way to look at it. So I would have expected our backlog to be up about 8% consistent with our order rate as opposed to whatever it is... 20% or 30%. Consistent with where we are.

Mike Hughes - Delaware Investments

Okay. And then, you talked about pricing and how that works. The backlog, I’m assuming that you posted these orders over the last, I don’t know, year or so. So is there an issue, is this backlog works through and converts to revenue that it’s going to carry a lower gross margin? Do you kind of need to bleed through that?

Walter Rosebrough

Uh, well that is a “yes” and “no” problem. You are correct. Those orders get booked over time but also our prices have been rising over time. So both numbers are moving. You understand what I’m saying?

Mike Hughes - Delaware Investments

Yes I do.

Walter Rosebrough

Both numbers are moving. I don’t think it’s any worse than what we; have currently experienced. That’s probably the best way to answer the question. Our costs have risen, our prices have risen. They’re both moving and I don’t see that spread rising at this point and time.

Historical turns in backlog, specifically with healthcare is 60 days. It’s longer than that in life sciences, so we may have a little bit more impact in life sciences but our healthcare backlog should be at relatively increased prices at this point.

Mike Hughes - Delaware Investments

Okay. And then on the restructuring costs, I think the current quarter, meaning the December quarter was hit by a penny and you’re saying about a million dollars in the March quarter. Do you have the year-to-date for the first nine months? What that number was?

Walter Rosebrough

Yeah, it was actually $3 million for the first nine months of the year for restructuring expenses. So for the full year we’ll have approximately $4 million impact from restructuring.

Mike Hughes - Delaware Investments

Okay. And then, I think you indicated savings for the full year related to the Mexico transition, $4 million to $6 million. The original plan was $6 million to $8 million. So, you pick up the incremental $2 million next year and then something above and beyond that I assume?

Walter Rosebrough

We’re not ready with the forecast but something above that would be a very good statement.

Mike Hughes - Delaware Investments

Okay. One last question. You mentioned the European margins, I think around break even and you said that wasn’t your long term goal. What’s your long term goal for Europe at this point?

Walter Rosebrough

Again, I don’t have numbers on that, but as a general statement I don’t see any reason that Europe and North America can’t look similar in the long run.

Mike Hughes - Delaware Investments

Okay. Thank you.

Walter Rosebrough

Thank you.

Operator

Sam Shapiro with Shapiro Capital, your line is open.

Sam Shapiro - Shapiro Capital

Walt I want to congratulate you and your management team. You have announced seven straight quarters of disappointments. Statement one. Number two Walt, you’ve been there I think four or five months, when we met you said you were going to buy some stock. You’re making all these statements about what you’re going to do and you don’t own a share of stock, other than what was given to you. I was curious, when can other share holders expect for you to make an investment in all of your conversations that you have made today?

Walter Rosebrough

Sam, I think I’ll correct you on one statement, that is I have not given forward leaning conversations about whether I am or not buying stock. I clearly have invested both my career and have made a move to Cleveland, Ohio to do this business and I don’t know how much more invested I can get, to be honest with you. Having said that --

Sam Shapiro - Shapiro Capital

But I think that Walt it’s pretty simple, you write a check. That’s how you get invested. You got an $800,000 signing bonus, I believe, and I don’t know of another CEO in the country that has never bought stock in his own company. And I’m not talking about the options that you were given, I’m talking about making an investment with you and your team. I’ve never heard of this before, I’m 66 years old and you joined a company and you haven’t invested $0.10. It’s not like you came from General Motors or Intel. I think it’s reasonable to expect by all the other gentlemen on this phone too, that you get your checkbook out and you buy a couple hundred thousand dollars worth of stock. That makes us all feel better, because if not next quarter we’ll have the same excuses --- delay in Mexico, stainless steel. This has been going on for seven quarters now. I think the shareholders are entitled.

Walter Rosebrough

Sam, I certainly appreciate your comments and understand them. I expect fully to continue to have conversations with you about shareholdings and management and me personally. I do appreciate the comments and I appreciate your views. By the way, I don’t feel like I’ve been given anything. You’re incorrect by the way in the signing bonus amount by actually two or three, and possibly more. That’s thing number 1, and number 2 is I don’t believe I’ve been given anything, by the way I would not expect or want to be given anything, I fully expect to earn it and I fully expect to help this company grow and prosper.

Sam Shapiro - Shapiro Capital

But I don’t think we should sit here and take up too much time, but I think probably you have better relations with other gentlemen on this call than me. So what you’re probably should do in quiet is, why don’t you kind of poll them and say should I own stock? I would be embarrassed if I was a CEO of a company and I didn’t own any stock in the company.

Walter Rosebrough

I appreciate your comments Sam. Thank you.

Sam Shapiro - Shapiro Capital

Thank you.

Operator

Greg Halter with Great Lakes Review, your line is open.

Greg Halter - Great Lakes Review

Hello, I thank you again. You talked about the new product introductions and so forth. I’m just wondering on the other side of things, what you’re doing relative to the sales force? Will that be expanded to commensurate with these new products or will it be the existing people be selling the wider bag, if you will?

Walter Rosebrough

You know we did expand our sales force last year on the hospital side for that purpose. We’ve also, on the P&R side, expanded our sales force and focused it on the large customers in pharma. I fully expect that we will, although I do not have a forecast for exactly what we’re going to do at this point, but the conversation is always an ongoing conversation of business as a general statement, it is very difficult to expand your business significantly if you don’t expand your sales force.

Greg Halter - Great Lakes Review

Okay and one last quick one. I don’t know if it was mentioned but what were consumables and services as a percentage of the total for the quarter?

Walter Rosebrough

Those numbers are coming.

Walter Rosebrough

For the quarter, capital is 41.1% in the quarter, Greg.

Greg Halter - Great Lakes Review

Okay.

Walter Rosebrough

Consumables were 23.2%. Service revenues as a percentage of total revenues were worth 35.7%.

Greg Halter - Great Lakes Review

Okay. Thank you.

Operator

Joshua Zable, with Natixis, your line is open.

Joshua Zable - Natixis Bleichroeder

Thanks very much. Hey guys, just a quick follow up. Just some housekeeping here --- sorry to waste people’s time but just kind of... I know you sort of went over the different segment revenue growth Mike. Can you just go over those, just give us some numbers? I know you generally give us rounded numbers, just in terms of... just literally go through healthcare equipment, consumables, and services. I know Aidan sort of gave us some sort of breakdown, but just so I can update the model.

Michael Topich

Sure. We have for the quarter, for healthcare capital was basically flat, consumables was 12% growth, service was 7% growth, for a total of 5% growth for the quarter in healthcare.

Joshua Zable - Natixis Bleichroeder

Okay.

Michael Topich

Life sciences capital was 4%, consumables were 8%, service was 5%, for a total of 5% for life sciences and then in total capital grew 1%, consumables grew 11%, service grew 6%, for a total of 5% for the whole company.

Joshua Zable - Natixis Bleichroeder

Okay, great. I guess, just related to the guidance here, obviously you gave a range and that’s what it is, but as we think about the fourth quarter numbers, what has to go right for you guys to hit the numbers? Is it basically a matter of executing now that you’ve obviously you’ve sort of found these issues? Not issues, but you sort of have to deal with these capacity constraints and production constraints, or is it hinder on demand as well?

Michael Topich

I would say, with rare exception it is hitting the production constraints, not demand at this point. There can be some ridiculously unexpected change in demand and consumables occurred, you know, that would be obviously a detriment, but there’s no reason to expect that.

Joshua Zable - Natixis Bleichroeder

Sure. No I understand...

Michael Topich

Orders are largely booked for what we’re going to do for the balance of the year so we’re pretty much into execution.

Joshua Zable - Natixis Bleichroeder

Great.

Walter Rosebrough

Just one other thing that I’d would add to that Josh, is that we are assuming a little bit of an easier comparison on raw materials in the fourth quarter as well, so that has to go right as well.

Joshua Zable - Natixis Bleichroeder

Okay, great. Thank you very much guys.

Michael Topich

Thank you.

Operator

I show no other questions at this time. I’ll turn the call back over for any closing remarks.

Walter Rosebrough

Okay, thanks very much Holly. That concludes Steris’ fiscal 2008, third quarter call. I want to let you know that a replay will be available from noon eastern today until 5:00 eastern on February 13, 2008. There’s two ways to access that. You can log onto our website or you can call 1-800-756-3940 in the United States and Canada, or 1-402-998-0796 internationally. Thanks very much for joining us this morning and have a great day.

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 Corp. F3Q08 (Qtr End 12/31/07) Earnings Call Transcript
This Transcript
All Transcripts