Welcome to the STERIS Fiscal 2014 Third Quarter Conference Call. [Operator Instructions] At the request of STERIS, today’s call will be recorded for instant replay. And now I'd now like to introduce today’s host, Julie Winter, Director of Investor Relations. Thank you. You may begin.

Thank you, Jane, and good morning, everyone. It’s my pleasure to welcome you to STERIS’s Fiscal 2014 Third Quarter Conference Call. Thank you for taking the time to join us this morning. As usual, participating in this call are Walt Rosebrough, our President and CEO; and Mike Tokich, our Senior Vice President and CFO. Now just a few words of caution before we begin. This webcast contains time-sensitive information that is accurate only as of today. Any redistribution, retransmission, or rebroadcast of this call without the express written consent of STERIS Corporation 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. Company does not undertake, 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 statements. 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 may refer to non-GAAP measures including adjusted earnings, free cash flow, backlog, debt-to-capital and days sales outstanding, all of which are defined and reconciled as appropriate in today’s press release or our most recent 10-K filing, both of which can be found on our website at steris-ir.com. With those cautions, I will hand the call over to Mike.

Thank you, Julie. Good morning everyone. It is my pleasure to be with you this morning to review our third quarter financial results. Following my remarks, Walt will provide his perspective on key elements of the quarter and review our outlook for the full fiscal year. As usual, my comments this morning will focus on our adjusted results. Please see the reconciliation table included in our press release for additional details. Let me now begin with a review of our third quarter income statement. Total revenue grew 7% during the third quarter driven by a 5% increase in organic volume, a 1.5% increase from acquisitions and a 50 basis point improvement in pricing. Foreign currency was neutral to revenue during the quarter. During the quarter, we experienced double digit revenue growth in the United States offset by an 8% decline in international revenues. Gross margin dollars increased 6% in the quarter, due mainly to the increase in revenue. Gross margin as a percentage of revenue for the quarter was flat at 40.4%. We have several factors impacting gross margin in the quarter. Medical device excise tax continue to reduce gross margins by 50 basis points year-over-year. On top of that, we had anticipated that our in-sourcing projects would be net P&L neutral in the third quarter; instead, we incurred almost $2 million in expense during the quarter. For the full year, our expectations now include approximately $6 million of insourcing expenses, about double from what we anticipated last quarter. In addition, gross margin during the quarter was impacted by approximately $1 million due to organic investments we have made to expand our Spectrum instrument repair business into new territories throughout the United States. The increase in volume did improve EBIT by 8% to $62.5 million in the quarter. EBIT at…

Thanks, Michael, and good morning, everyone. Thanks for joining us to review our third quarter results and our outlook for the rest of the year. As you have heard from Mike, we had another good quarter, although it was not as strong as we had anticipated. There are a few reasons for that which I will address in my comments. Mike has already reviewed our segment, so I’d like to touch on a few broad highlights. From a geographic perspective, we had very good growth in the United States, where revenue grew 12% in the quarter. This reflected double digit organic growth in all 3 segments and we are clearly very pleased with that performance. Within healthcare we were also pleased to see strength on an organic basis in the U.S. across all product areas: capital equipment, consumables and service. We continue to see a stable to modest growth business outlook in the U.S. and our strong third quarter shipment bubbles and record backlog in healthcare at the end of the quarter reflects that strength. Outside the U.S., we faced challenges in several markets that have hindered our revenue growth and profitability. This is due to weakness in certain countries that have historically been strong for STERIS. Much of Southeast Asia and certain countries in Latin America have been particularly hard hit this year from a STERIS perspective. Some of the issue is the general economic dynamics within the given countries and regions and that is compounded by the strengthening of the U.S. dollar and of the euro, which makes our products more expensive than local market competitors. This currency movement has been generally true in both Asia-Pacific and Latin American regions. In terms of our overall profitability, currency has had a negative impact of about 2% on both the…

Thank you, Walt and Mike, for your comments. We’re now ready to begin the Q&A, so Jane, would you please give the instructions and we’ll get started.

[Operator Instructions]. Our first question comes from Dave Turkaly with JMP Securities.

It looks like in Healthcare, a good performance and even pricing overall for you guys positive. I guess I can't help myself now that we're into this ACA, and the calendar changed, any new thoughts there on the capital spending environment? I know your backlog is large, so I'd imagine – I mean any update in terms of how you see things playing out this year and next?

I'm certainly not going to try for next year. But for this year, I would say we are generally experiencing similar kind of trends as we were last year. That is most of our customers, when we talk to them, are saying that they're going to be spending about the same in capital for our type of equipment that they did in 2013, or maybe up a little bit, a couple percentage points, very similar to our conversation last year at this time. Having said that, we have heard from a number of customers that they are going to – even though their plan is to do kind of flat or up a couple percentage points, that they're going to hang onto a few of those dollars early on in the year to see how things work out for them, and so we’re seeing some people being more cautious at the front end of the year. The counter of that is we've actually seen several of those people who said they were holding on starting to release funds. So at this point I'd say it’s too early to call. I think hospitals will be a bit cautious going into this year. But we’re already seeing them beginning to implement their plans. And you're right, we do have a solid backlog right now which is a good thing to have at this point in time.

As a quick follow-up, you mentioned M&A and the pipeline being slow. How broad do you envision that Spectrum business becoming? And what kind of coverage do you have today? Are there a lot of opportunities specifically in that area for you guys to get larger?

Well, we believe that there's a lot of opportunity. First we think that business is a growing business, and then second, we think we can grow within that business. We do have parts of the country where we’re geographically stronger and parts of the country where we’re geographically weaker. And like all service businesses it is somewhat local, and so we think we have opportunity there.

Our next question comes from Larry Keusch with Raymond James.

Well, I just want to make sure that I’m understanding one aspect here. You mentioned that -- or Mike may have mentioned it, on a pretax basis you’re still anticipating the same amount of savings associated with the insourcing programs, but at the same time you obviously spoke to delays and issues that cropped up as you kind of put this all together. So what allows you to catch up to get to where you thought you were going to be in that? How do we get comfortable with that?

Yes, I would say it would not be a fair characterization to say that we will catch up. That is, and I’m going to separate 2 conversations, one is where we will eventually be and the other is when we will eventually be there. So far in the work that we are doing, we are – for the -- I’ll call it the percentage of work that’s complete, the number of parts and/or products that we have completed, we are seeing the expected level of savings in those parts and products. And so we’re not seeing anything that discourages us from feeling that the ultimate savings objectives and for that matter, quality and delivery objectives will not be met. The issue is -- and this percentage is not at all correct, but let’s say we thought we were supposed to be 40% down the path today or 50% down the path today, we’re only 20 or 30% down the path today. So we will be slower than we originally expected and that slowness creates – there's front end costs that we load in. We've purchased machinery which we’re not appreciating which is not -- some of it not running at full capacity or the capacity we expected. We have spent money in order to do the work and we’re not receiving as much benefit as we expected. So it’s strictly a matter of kind of the percentage of amount of work we have done and we’ve -- probably it's a bit more work than we thought originally to get that amount done. But the percentage of work that we have done compares to the percentage we thought we would be. So we’re not at all dissuaded from our view of $8 million to $10 million, it’s just a matter of when it comes in the door. And our expectation still is that relatively speaking we’ll be in that $4 million to $7 million range for next year; this calendar year, our fiscal next year we'll be in that $4 million to $7 million range. We’re not feeling like we’re going to off of that. But so I think -- I hope I’ve been clear on kind of the ultimate objective which will be later than we originally expected, and the timing of that objective. But in terms of the actual work that we had done to-date, we are seeing the kind of improvements that we expected.

Okay, that was really helpful, and then just 2 quick financial questions. So again I just wanted to make sure that I’m clear, as you think about the fourth quarter that you are suggesting that you do anticipate gross margin being higher but to get to the implied EPS that you’re talking about, the majority of the leverage is going to come from SG&A, that’s one question? And then also on the effective tax rate given where you are for the 9 months and what you’re suggesting for the year end, the fourth quarter tax rate implied would be lower than the kind of first half of the year which I’ll call more normalized, and again I just wanted to make sure I’m thinking about that and if that’s true, why would that be the case.

Yes, let me address the tax issue first. Most of that differential that we have seen is due to specific discrete item adjustments which has caused our rate to be higher in the third quarter. And we anticipate favorable discrete item adjustments in the fourth quarter which is going to cause our rate to be lower, to give you some perspective there as to why we believe your thinking is correct on the tax rate. And as far as improvements in the fourth quarter, obviously the biggest one that Walt talked about is our bonus and that is about a $5 million impact, year-over-year reduction in SG&A expense versus higher SG&A expenses in last year’s fourth quarter. So that is the big improvement, in addition to the volume that we anticipate coming through which should help our gross margin both dollars and percent in the fourth quarter.

I used that word loosely, when you said improvement, as it relates to our bonus, but we are a pay for performance company and we have that culture. And last year we had an exceedingly strong finish and so we were above our bonus levels, our 100% level. This year we hit what we had told you we were going to hit. We will be below our 100% bonus level. So the differential is something under 100% for this year versus something over 100% last year.

Our next question comes from Chris Cooley, with Stephens.

Could you help me out just briefly first on the margin side? Specifically what I want to better understand is the operating margin for life sciences in the quarter. Strong growth there in both consumables and service with the lower capital component. I would have thought that the operating would have been higher. Can you just kind of walk us through the puts and takes there and I guess what’s implicit and why it snaps back in the fiscal 4Q? And kind of along those same lines, with Isomedix it’s pretty much in line with expectations for us. But I'm wondering if we can get that business back up over 30% again or at 30%? Is that just a function of utilization? And I've just got one follow-up.

Yes, Chris, in regards to the Life Sciences operating margin, I mean last quarter we set a record operating margin of almost 22% or so and we said that, that is not something that we believe is sustainable. We believe that upper teens in this business is where our sustainability lies. And your point is well taken about capital, but it really is the mix as every quarter we have different products that are selling and those products tend to have higher or lower gross margins generating that. So it’s really all about the mix within this quarter and the lower volume compared to the prior year that is driving that EBIT margin percent a little bit lower.

And I guess the follow-on to Isomedix is Isomedix will wax and wane somewhat as we bring capacity on and fill that capacity. And we did again set kind of a high watermark earlier in the year. And we are going to as always -- we used to have kind of larger chunks of capacity coming in and out, we're trying to have those capacity increases or improvements build more ratably over time. Every once in a while you have to build a whole new facility and then you see significant capacity cost early on. But we always strive for improvements in our margins. But I think Isomedix was getting – is getting right up there. It is worth mentioning that they have significant capital expenditure exposure, so they need to have those good margins on an ROS basis to have appropriate capital returns, which they do have. But we’re pushing pretty high watermarks on Isomedix right now.

Understood. And then if I could just follow back up on the insourcing discussion. Appreciate the prepared remarks and that you still expect to see the $4 million to $7 million in pretax cost savings from related initiative there in fiscal ‘15. But what I wasn’t clear about was if there was a updated timeline and when you thought you could actually bring this project to completion? And I know you don't want to give ‘15 guidance yet, but can you give us maybe some color around a little bit of a delay here but when you think you might bring this to a close?

Sure, Chris. And I think I spoke about this last quarter if not the quarter before a little more broadly about what we’re kind of loosely characterizing as this project. It’s really not this project, it’s really kind of the way forward for us and that’s the first point. The second point is that this is not a project; this is 6 or 7 projects, some of which are across multiple plans. And so some of those projects are dependent on each other and some of them are independent of each other. And so there's not a real answer to the, when will the project be concluded. Now what we have described to you all in terms of the orders of magnitude spending and the orders magnitude savings, we’re clustering those several projects into a project if you will. But we’ll start new ones next year, next year, next year, I'm sure. The order of magnitude of these are fairly significant which is why we group them together and look for that $8 million to $10 million savings. Some of them are coming kind of to conclusion right now and others are continuing. I think now we would say obviously the $4 million to $7 million, since that’s roughly half of what the objective is, we should expect that we’re about half complete in this coming – our current coming fiscal year, and then the balance will come in the following year. I would think that all or virtually all would be completed in the FY '16 timeframe. Certainly we would be expecting that $8 million to $10 million to be almost all captured if not all captured in that FY '16.

Our next question comes from Erin Wilson with Merrill Lynch.

Could you speak to, I guess the factors impacting the gross margin in the quarter? It was a little soft in light of the seemingly capable product mix. Has there been in any meaningful changes in how your customers are purchasing your product? Is it shifting more to GPOs or what have been the dynamics on that front over the past year or so? And how should we expect that to trend over the next 3 to 5 years?

Erin, I would say there's been no radical change in percentage of business being purchased in GPOs or by GPOs, there's been no significant change in pricing, per se. I think this – and I'm talking now about healthcare, I think where you’re primarily pointing. And if I remember right, our healthcare pricing was up about 0.5 point for the quarter. That’s not unusual kind of number. So I don’t think that we’re seeing any radical shift there. I think most of our products, by far, the vast majority of our products have been on GPO contracts for years, if not decades and we have been working with all of the major GPOs for years, if not decades. It's unlike, I will say unlike, what I'll call the classic physician preference type of medical devices where many of them have not been significantly impacted by GPO pricing and GPO interaction. That’s virtually unheard of in our 85%, 90% of our product. We are almost always under some form of contract. So I don’t know of any significant change this quarter versus last. So the only differences would be those of mix and volume and the factors that drive the change in gross margins on the healthcare side.

In addition, I just want to add that the insourcing and Spectrum investment are all healthcare in gross margin.

And also we put the med device tax in gross margin. Some companies put it in OpEx so you have to pay attention to that. But we’ve discussed all those before, but those would be the drivers as opposed to any kind of, I’ll call it general change in contracting and pricing.

Okay. Got it. That’s helpful. On guidance, it's still a pretty broad range for the fourth quarter. What are kind of the key risks or kind of points of upside that gets either the high versus low end of that range? I know you spoke just a little bit but I’m just trying to get more confident in -- or what gives you confidence, I guess in the ramp up in the fourth quarter.

The range is relatively large for a 1-quarter guidance. We agree with you and the reason for that, it’s also one heck of a big quarter in terms of the performance we’re expecting. I would say the single -- if you took a single point in question, the single point is volume. We have a very big volume keyed up for the quarter. And when you see a backlog as high as ours is, that is not surprising. So the backlog is high, the volume is high. The biggest question will always be in the last 3 weeks, does this customer who had this $3 million project that he supposedly wanted on March 15, all of a sudden their project is 4 weeks late, therefore they want it on April 15. And so the biggest single issue, and that’s true in the capital business, it's true in both Life Science and healthcare. On a percentage basis it's more true in Life Science because they’re smaller, so one big $3 million order changes their numbers a lot. On healthcare, one $3 million order changes it not so much on a percentage basis but it still can drop $1 million or $1.5 million or $2 million to the bottom line depending on what the products are. So it is purely a matter of volume, almost exclusively capital volume that we would expect to be the driver of that question. And as I said, how the hospitals act in their first quarter of this year, with ACA is our fourth quarter. So we put a little more range of uncertainty around that, although again, from everything they’re telling us, we think the calendar year will probably turn out about right. So that’s at a high level. And there will be other bits and bobs, what happens in currency, what happens on a couple of other issues but I would say the big driver is volume.

[Operator Instructions] We have a question from Greg Halter with Great Lakes.

Wonder if you can update us on the share repurchase program, looks like there was maybe $5 million or so in the quarter, but just wanted to get an update there.

Yes, Greg, for the year we’ve spent about $22.5 million and that is about just over 515,000 shares that we bought. And of that about $4 million or just below 90 million shares were bought in the quarter – or sorry, 90,000, yes, not 90 million, sorry. We have $89 million left on the authorization in total that was granted by the board a couple years ago. And again remember, we’re trying to offset any dilution from the option, grants and exercises, I mean that’s really our main purpose right now with our share repurchase program.

Okay. And relative to the tax rate and your indication of not being able to use I think some of the operating losses in certain international locations, any idea when those could be realized or utilized?

Well, the one nice thing about it, obviously we’ve made a decision that this year we will not be able to use them which is different than our original plan, obviously, as we’ve increased our expected tax rate for the year. The 2 areas that the valuation allowance are put on, we have valuation allowance in a couple different entities. Most of those are indefinite lives so we don’t have a risk of losing those, so as we improve our operations in those foreign entities, we will be able to get really a double benefit as we do get income from those operations and we will be able to use the deferred tax asset here, to also offset the -- and improve the effective tax rate.

And I would even add further, Greg, that it’s not like we had these huge NOLs in these countries, these are relatively small NOLs, so it’s not an overwhelming task to get those back.

If you had to put a percent on the 2 components that you mentioned for the 40%, approximate 40% of tax rate, the discrete items and then these operating losses not being able to use, what kind of percentage would you attribute for each of those?

Yes, about 1/3, 2/3, percent-wise.

Two-thirds for the discrete items?

Yes, I would say definitely 2/3 for the discrete items.

Okay. And on the insourcing, I believe last quarter while you may have mentioned that you’ve been having some difficulty as a lot of people have in obtaining welders, skilled labor issues and so forth, just wondered if you could update us on what you’re seeing in that regard.

That’s exactly right. That was one of the -- in one of the projects that was one on the delaying factors, and we have had – we've made progress in hiring both types of people, both welders and skilled laborers, machine operators really. And we’ve had success adding those people but we continue to add more so -- or want more and need more and add more. So we’re still behind where we’d like to be, but we’ve made progress.

Okay. And relative to your backlog…

I might mention, Greg, we consider all 3 of those items discrete item adjustments. So the characterization, the breakdown of those are all -- they were all temporal discrete item adjustments. And so kind of the breakdown of why they were discrete item adjustments is a bit arbitrary. So there's -- all these apply back to longer periods than the quarter and so we’re taking them in the quarter and that’s why we don’t expect to see a similar number that's in the next quarter for example.

Okay. And that was back on the tax rate, correct?

Back on the tax rate.

Okay. And moving to the backlog. Is it at a record due to Steris not being able to deliver anything or is the demand running ahead of shipments?

No, it’s demand ahead of shipments and/or oftentimes, Greg, we have -- basically our business is in 2 buckets; one we call it replacement and the other is big projects. And the big projects almost always had a future delivery date out 3 months, 6 months, 9 months, those kind of things. And the replacements tend to be more, ship it when you can or ship in a month type of products. And so it’s a mixture of those and that’s what creates the shipping schedules. But we have been ramping up our facilities to be able to ship the numbers that we’re talking about. And we did have -- we have had over the 1.5 months, some of our facilities a little weather delay kind of issue, so we’ve had a couple little shutdowns. I’m talking like a day or 1.5 days because ice or snow or power, like everybody’s having these days. But other than that, we’re not seeing any significant difference.

Any comment on new products on the horizon that you may want to talk about here?

I'm sorry?

Any new products on the horizon that you may want to update us on?

No, we don’t -- as you know we don’t talk about products going forward. Anyway we have -- we are very pleased with our products that we have in the marketplace now. We’ve updated our sterilizer line, it’s doing nicely; we’ve update our V-PRO products, they are moving nicely. On the US Endoscopy side, that’s a business where private development is a key to their success and if you look at the products that they've put out in the last couple of years, they are doing very nicely. They’re probably 40% to 50% of the growth of that business. So kind of across the board we’re feeling good about the products that we have out there. As always, some better than others, but as a general statement we like our product development, what we have in the market and we have more coming. But nothing that I would kind of point out as a single point home run at this point.

All right. And one last one, I believe that we had an estimate for capital expenditures of about $90 million for the year, fiscal year, is that still on track?

Yes, Greg, that is still our estimate, $90 million for the year.

We have another question from Chris Cooley.

Just 2 quickies here. Mike, could you maybe give us some color on the tuck-in acquisition. This is a lot smaller, obviously, than Spectrum or TRE. I’m just trying to get a feel for the multiple and kind of what you got with that. And then maybe from a bigger picture standpoint from Walt’s perspective, you had a great quarter when you looked at capital and you have a record backlog as we go into the fiscal 4Q. Yet capital spending trends really aren’t changing much, at least from what we can see here, new builds aren’t increasing. Can you just maybe -- and you touched on this a little bit in the prior caller, but are you seeing any change in the mix between maybe replacement or competitive bid? Just trying to get a feel for the underlying drivers in the short term for demand.

Sure, Chris. The first question about the tuck-in, that is exactly what it is, it is a tuck-in regional player in the space that Spectrum is in, and it is a nice tuck-in to that. They had a strong market presence in that region and we were able to work it out with the owners who are staying with the business that we would purchase the business and bring it in for the Spectrum family. So it’s a pure Spectrum tuck-in. For businesses this size, we don’t get into the multiples, but I can say it was certainly in the range of what we paid for the Spectrum acquisition. So ballpark similar. But it's $6 million, so it’s not a big business, relatively speaking. The second question you asked about capital spending in general. And I think I’ve tried to answer it and I’ll try to be more clear. In terms of the year going forward, it appears to us from the best information we have that hospitals will be spending something on the order of flat to slightly up in total capital spending. And so not -- this isn't a 10% growth year go forward capital spending. It looks more like again, flat to maybe couple of percentage points. And then the follow-on is do think -- it wouldn’t surprise us if we see a little bit of hesitancy in their first quarter, in terms of order rates and as a result may see a little slowdown in orders. We haven’t really experienced that to-date although there have been people who have projects who have said, hey, we’re going to hold on for a couple of months, see how things go before we make the final commitment. We’re still planning on doing it. And we’ve actually seen a couple…

We have a question from Mitra Ramgopal with Sidoti.

Just following up on that first. Walter, you say the mix that relates to new build outs versus renovation is still around that 60-40 level?

Yes.

Okay. And again, when you look at the healthcare backlog level…

[indiscernible] other way, renovation is more than 60% and new build out -- we don’t really break it that way. We break into is it a big project, because a new tower or a gutted and redone tower to us is the same kind of project. It’s a big project, there's usually lot of dollars involved, there's lot of effort involved. So we kind of look at it as large project versus relatively small in 2 table orders and 2 light orders that kind of things.

Okay. No, that’s good. And again, coming back to the backlog levels that we’ve seen in healthcare. It's clearly, I think about the highest we’ve had in about 3 years. Is it really a case where you’re really encouraged in terms of what you’re seeing with the overall capital spending environment in hospitals, et cetera, starting to be a lot freer with their budgets?

Yes, I’m encouraged when they say they’re going to grow 10%. And they’re not saying that, I’m just not discouraged because they’re not saying they’re going to go down 10% or 20%. I think they’re saying we're staying the course of about what we spent last year and maybe up a couple percentage points. So it’s not like – it's not a gangbuster look in the short run, but nor is it a gloom and doom look. So I'd say we're in the middle. But relatively speaking to what capital can as you know when uncertainty rises, capital can slow down, and at this point we're not seeing it.

Okay. And finally just on the international front, and I know you said sales were certainly a little soft because of lot of country-specific issues. Is there anything you can do in terms of sort of offsetting that or is this pretty much you just have to take a wait and see approach?

Well, I mean of course we work to do better in the countries that are having issues. But I mean if you just kind of think through what's going on in Venezuela, Thailand, Egypt, Argentina, those countries have significant economic and/or political disruption. And since most healthcare is run by government entities or much of healthcare is run by government entities, that can impact particularly capital spending. It may not impact the routine spending as much. So people are still going to the hospital, but folks may not be -- governments may not be deciding to spend a lot of money on capital when they are under significant pressure. Because most governments, as you know, capital is not treated -- capital is treated as an expense so their budget is kind of a cash budget and/or they may have cash issues. The secondary, the piece that pushes that even further is the fact that they are -- is that their currency have fallen. And where we have the areas that I mentioned in Latin America and Asia Pacific, they have fallen versus the dollar and the euro. Since we tend to manufacture things in the U.S. and Europe, that raises our cost relative to either their ability to pay and/or to local manufacturers. So that puts the pressure on our business. But of course, our job is to find ways to lower our cost and have products that are better and look for the opportunities where they apply. That’s what we are doing and intend to do.

I am showing no other questions at this time. I'll now turn the call back for any closing remarks.

Great. Thanks, Jane, and thanks, everybody, for joining us today, and have a great day.

That does conclude today's conference. Thank you for participating, you may now disconnect.