Welcome to the STERIS Financial 2012 Third Quarter Conference Call. [Operator Instructions] At the request of STERIS, today's call will be recorded for instant replay. I would now like to introduce today's host, Julie Winter, Director of Investor Relations. Ma'am, you may begin.

Thank you, Wendy, and good morning, everyone. It's my pleasure to welcome you to STERIS’ Fiscal 2012 Third Quarter Conference Call. Thank you for taking the time to join us. As usual, participating in the call this morning are Walt Rosebrough, our President and CEO, and Mike Tokich, our Senior Vice President and CFO. If you haven't seen a copy of our earnings release, please visit our investor relations website at steris-ir.com and now just a few words of caution before we begin. This webcast contains time sensitive information that is accurate only as of today, February 7, 2012. 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 related to the company, its performance or its industry, that are intended to qualify for protection under the Private Securities Litigation Reform Act of 1995. No assurance can be given as to any future financial results. Actual results could differ materially from those in the forward-looking statements. The company does not undertake to update or revise these forward-looking statements, even if events make it clear that any projected results, expressed or implied, in this or other company statements will not be realized. Investors are further cautioned not to place undue reliance on any forward-looking statement. These statements involve risks and uncertainties, many of which are beyond the company's control. Additional information concerning factors that could cause actual results to differ materially is contained in today's earnings release. And lastly, as a reminder during the call we may refer free cash flow, backlog, debt-to-capital or days sales outstanding, all of which are defined and reconciled as appropriate in our most recent 10-K filings. With those cautions, I will hand the call over to Mike. Mike?

Thank you, Julie, and good morning, everyone. It is my pleasure to be with you this morning to review our third quarter financial results. Similar to prior calls I will make some comments on the quarter before turning the call over to Walt for his remarks. Before I start with a review of the income statement, please note that my references to the prior-year's operating results exclude the pretax charge related to the SYSTEM 1 class action settlement and the tax benefit from the SYSTEM 1 Rebate Program liability. Please refer to today's earnings release for a complete reconciliation to GAAP numbers. Total company revenue grew 8% during the third quarter driven by 7.5% increase in volume, a 1.2% increase from our acquisition of Sercon offset by a slight decline in pricing of 0.5%. We had no material impact from currency fluctuations in the quarter. Gross margin in the quarter declined 280 basis points to 38.9%. Factors influencing gross margin in the quarter included a 30% reduction in SYSTEM 1 and SYSTEM 1E consumable volumes, a shift in mix during the quarter towards capital equipment, a decline in pricing and an inventory write-off of $1.1 million relating to our European consolidation efforts. EBIT including restructuring expense for the quarter was $53.7 million or 15.1% of sales. During the quarter, we incurred restructuring expenses of $1.2 million due to a loss on the pending sale of our Switzerland manufacturing facility, which is part of our European consolidation efforts. EBIT excluding restructuring expense was $54.9 million or 15.5% of sales. The decline to EBIT margin is due to lower gross margin detainment, an increase in R&D spending and the impact of continued investments for the long term. As we explained last quarter, we have incurred expenses related to product reliability issues and…

Thank you, Mike, and good morning, everyone. We appreciate you taking the time to be with us today. Our third quarter performance is similar to our second quarter. We had solid revenue growth and strong free cash flow. Our profitability, however, was impacted by certain investments we continued to make for the long-term benefit of our customers and the company. From a top line perspective, all 3 of our business segments reported solid growth marking our fourth consecutive quarter of growth across each segment. Of note, our Healthcare segment reported 22% growth in capital equipment or 6% excluding the SYSTEM 1E units shipped during the quarter. In a macro environment that continues to be challenging, we are encouraged by those results. As I discussed last quarter, we had anticipated that the delay in V-PRO shipments would benefit us in the second half of the year. And we did see a nice revenue improvement in that product line during the quarter. In addition, our Reliance EPS and our line of washer/disinfectors experienced solid growth. In our surgical business unit, we saw good growth in our lighting and integration lines. Our Healthcare consumables business outside of SYSTEM 1 and SYSTEM 1E related items continues to grow in line with surgical procedure volumes in the low single-digits. Life Sciences built on its earlier solid performance through the third quarter. The highlight was a 25% growth in capital equipment revenue as we continue to see more purchases of replacement equipment by our pharma customers. Our Isomedix unit had another good quarter in both revenue and in profitability. As Mike has already addressed we continue to invest for the long term, which is impacting our profitability. The general categories are similar to last quarter. Transition related costs for our Europe and Erie consolidation efforts as…

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

[Operator Instructions] Our first question is from Robert Goldman with CL King.

It's Bob Goldman. A couple of questions. First, it's my understanding that on February 2 the customers of SYSTEM 1 had a deadline to send to you at STERIS details of their transition plan from SYSTEM 1 to something else. SYSTEM 1E or a competitive device. Could you provide us some granularity on what those customers have said? How many of them are going to transition to the 1E?

Bob, you're generally correct on the transition program. That is that customers, if they are continuing to use S20 or SYSTEM 1, and are looking for our support that they do -- it is required that they send in their certificate of transition. That certificate of transition though does not give information on what they are transitioning to or from. So other than the fact that people are sending in transition documents saying, we are transitioning later than February 2, and some indication of when they expect to be transitioning, we have no other granularity on that issue.

Okay. So just so I'm clear on it. The FDA did not require nor have the customers suggested what they're transitioning to.

That’s correct. On the form that we receive back, which is the certificate of transition, it does not state what they are transitioning to and it's -- there is no request of what they are transitioning to. And I'm confident, Bob, that would be, I think, potentially considered confidential information if -- for other vendors if the FDA required that and sent it to us. So I'm confident that's why they would not do that.

And just one point of clarification, Bob, we will accept certificates of transition ongoing. We didn't have to have them in by February 2. So we can get them today, next week, a month from now and effectively turn people back on for support of SYSTEM 1. Just for clarification.

Okay. So they were not required to get you that letter by February 2?

The hospitals -- nothing is required of the hospital really if you boil it down. We cannot support them if they don't have the transition document to us. So we cannot continue to sell them S20. We cannot support the device if they don't have that in. So effectively, Bob, if they want to continue they have to get that certificate of transition to us. If they want to place an order on February 3, they have to have it to us on February 2.

And if they haven't submitted to you yet, you cannot support them after February 2, is that correct?

It is correct that we cannot support them until they give us their certificate. So if they give us their certificate on the 4th we can ship on the 5th for example. So we wouldn't expect, frankly, we wouldn't expect a lot of these to come in 3 months from now, right? We would expect them to come in over days and a couple of weeks, not months.

Okay. And then one other question on the investments you're making, Walt, this year, the $24 million. You mentioned $5 million in the third quarter, $7 million in the fourth projected, could you give us a little bit more detail on what you're doing and as a result what, if any, are the associated expense savings when you look out towards fiscal 2013 and beyond?

Well, I would split it, Bob, into 2 categories. One category in general is the transition costs in both Europe and Erie and we're seeing the tail of those transition costs if you will. And we have talked about the going forward -- first of all there's a reduction in the cost obviously. And then there are going-forward savings. And, Mike, you may want to mention those.

Yes. Those are -- we'll a couple million dollar savings as we go into next fiscal year associated with both of transitions, both Erie consolidation project and then also the move from Erie, Pennsylvania to Mentor, Ohio, we'll see some cost savings there. But we're talking about $3 million to $5 million in total. And then the other piece, Walt, if you want to address the product reliability.

The other piece is what I talked about in SYSTEM 1E is we are doing a lot of work with our customers to: a, help them ascertain what their water quality is; b, ascertain how they -- what they can do to fix it; c, working with our devices to work with them through this process until they get that done. And then lastly the field corrections that we have talked about with the SYSTEM 1E to make the device more robust against a wider range of water quality. And so that expense will be disappearing as we complete that.

Our next question is from Jason Rodgers with Great Lakes Review.

Could you talk about raw material cost for the quarter, the impact, and then what you're looking for in your outlook?

Yes, Jason. Raw material cost for our third quarter were basically flat. For the year-to-date we are about a negative -- just over $4 million for the year-to-date through December. And we're expecting a slight -- sorry the increase in costs for the fourth quarter but nothing too material is the outlook that we're assuming.

Okay. And can you talk a little bit about the regions in the quarter overseas and how Europe performed as well as Asia Pacific and Latin America?

Sure. We had very strong performance in Asia Pacific. In Latin America it was below our expectation but not significantly below our expectations. Largely in the new Sercon unit where we're a bit behind what our expectations were. In Europe they had modest growth, lower single-digit growth and given the pressure in that environment we were feeling pretty good about them maintaining that side on the Healthcare. Life Science actually had strong growth in the period. So on average we were in the mid to upper single-digit growth in Europe. So good strong performance in that region of the world.

Okay. And then Healthcare was up 22% for capital equipment. Do you have that figure -- what that figure would be excluding Sercon?

There's a couple of steps here, Jason. So excluding SYSTEM 1E our growth would have been about 6% in Healthcare capital equipment. Excluding Sercon, we'd be 2% to 3%.

Our next question comes from Mitra Ramgopal with Sidoti.

A couple of questions. First, I think the investment spending for fiscal 2012 you indicated was about $24 million. I wasn't sure if you can give us a preliminary stance on an apples-to-apples basis what that would look like fiscal 2013.

Well, we haven't done the forecast for 2013 but the expenses that relate to the Europe and Erie transition will largely go away. There may be modest expenses next year but it would be modest. The SYSTEM 1E type of expenses, we again are not -- we haven't forecast that number yet. But we are beginning to see a reduction or an improvement in the uptime particularly in the last month or so. Our uptime or frequency of calls, if you will, dropped by about 30%. So we are anticipating that going down over the course of next year.

I would caution you, Mitra, not to just back out and assume that $24 million goes completely away because about half of that is being absorbed through bonus because we are not -- we are assuming zero bonus payouts this year. So that's about $12 million. So the next is about $12 million in total that is impacting. As Walt said, we probably will experience some of the SYSTEM 1E warranty costs next year also. I just want to caution you there.

No. That’s very helpful. And again as we look at the units that you expect to transition over on the SYSTEM 1E side, is there a way of helping us in terms of how much of that might be sort of high utilization versus low by your customers? Or too early?

At this point we still I think are suggesting that it will be, as best we can tell, roughly our average utilization. And we've said kind of historically that we expect the range of 30% to 40% of if you will from the beginning of time couple of years ago, 30% to 40% of the [indiscernible] volume is kind of the range we're looking at right now.

Okay. And again, Walt, finally if you look at the last 2 years, clearly it's been a difficult environment. And we've seen the earnings go -- it's sort of flattened here and I know you're not providing any guidance yet for fiscal 2013. But as we look out ahead, do you get the sense that you're pretty much now at the bottom or the inflection point in terms of where things stand with the transition, the investments you're making, and other initiatives you have in place?

We still have the SYSTEM 1 transition is not over and of course it fell all through the course of the year. So even when you hit the bottom of that, you still have some SYSTEM 1 if you will hang over going into next year. When you look out long-term though and of course some of these costs that we have will go away as we've talked about before. If you look out in the long-term we're still feeling like high single-digit, low double-digit growth rates are what we should be expecting. Order of magnitude, that's our view of the longer term.

And finally, are you noticing any pickup really in the hospital spending environment for you?

Most of what we see -- I guess I'd say 2 things. We look at the same third party things that you look at and hearing from hospital folks, we're kind of seeing their conversation is around flat to up a little, flat to up a few points next year. We don't have a whole lot of visibility out beyond that. And so I think at this point that's kind the way we are seeing their overall spending pattern.

[Operator Instructions] Our next question is from Jose Haresco with JMP Securities.

Couple of questions. You had spoken last quarter on this, that there would be like $6 million of expenditure. [indiscernible] you eat through much of that, and in fiscal Q3, there's $7 million more coming in Q4. That’s a big chunk so is that a pulling forward of expenses? Or was there something in the quarter that kind of caught you guys by surprise that you realized we need to spend another $7 million?

I would characterize most of that as expenses that were greater than we expected, largely in the area of the SYSTEM 1E. So we did as you recall we said last time that we had -- the spending we already had we were anticipating working to reduce that in this second half. We are working to reduce it. We are seeing some positive results but it did not get reduced as quickly as we anticipated.

Okay. And just remind us again, what are the outstanding issues with the SYSTEM 1E? Uptime, transition and installation? I understand there's still a backlog of installation. So what are the 3 or 4 things that still have to be -- you still have to get under control to get it to where you need to be?

Well the biggest issue for the SYSTEM 1E is what I'll call aborts and possibly nuisance aborts. That is we have put in -- we recognize that there are water issues in the SYSTEM 1E that we want to monitor for. For example, the temperature of the incoming water because the temperature during the process is an important part of the process. So if we get too much cold water coming into the system the system will recognize it will take it too long to get to temperature and as a result will abort. So what we have done -- so that is an example of the kind of thing. The other is it relates to the incoming water quality. It's how much UV light intensity that we receive from the UV lamp, which is pre-treating the water going into the device for rinsing purposes. And if we see that intensity falling or that the water doesn’t allow the transparency if you will of the UV light, we will alarm -- and in both these cases the alarm shut off and we have to have a technician come out. So those are the 2 a high level -- and by far and away the 2 most significant aborts that we are getting. So when they get that abort the technician has to come out, look for the cause of the abort, solve the cause of the abort and then put them back up and running. Those are the most significant frequency issues. And again, the 2 solutions to that are either fronting the SYSTEM 1E with something that improves that incoming water a la a water heater. A la, a, if you have very hard water, a water softener. Those are the typical type solutions. As well as we have worked on our aborts, and this is what I'm talking about the field correction we have coming up, we have worked on our aborts such that for example instead of timing out the water temperature abort in 3 or 4 minutes, it's 8 or 9 minutes or maybe even 10 minutes, which the customers are seeming to prefer over getting an abort. So the water just runs if you will. Just like if you're going to take a shower, you have to let the water run until it gets to temperature, as an example. So those are the kind of things that are in that special 510K that we mentioned and those are all software upgrades.

Okay. And if I remember the number right, you said it was capital equipment without SYSTEM 1E was 6% growth year-over-year?

That was for Healthcare capital equipment, yes.

For Healthcare capital. Okay. And how did disposables and consumables do outside of SYSTEM 1E?

They would have been up from the low single digits.

As I mentioned they're low single digits, kind of in line with surgical growth.

[Operator Instructions] Our next question is from Tyler Kenyon with Northcoast Research.

Tyler Kenyon here in for Dave Keiser. I wanted to ask a few questions just around the change in some of your assumptions, specifically with Healthcare. I know before you had mentioned that you were anticipating growth in the low double-digit. So I guess I wanted to maybe hear from you exactly what maybe had changed in the market to maybe change your assumption there.

I don't know that we've seen an overall change in the market per say. We were just looking -- we're now down to the last quarter, we're looking at the order inputs. Orders and timing of orders. And what we have in backlog and what we will ship for the balance of the year. And we believe that is what our shipments will be. In terms of kind of the market in general, I would say when we talk to our salespeople the, what I'll call the relatively routine orders for capital are going through at the pace that they would have expected and we would have expected. We are seeing a slowdown in some of the large capital orders, large project orders. Again, at this point we see that as temporal. That is not -- they're just getting the jobs done. Their projects are a little bit behind. That kind of thing. Not a slowdown -- we're not seeing capital projects disappearing. We're not seeing capital projects cancelling. It's just the timing of those capital projects. So that's how we characterize the difference.

Okay. And then just follow-up on Life Sciences. I know that you had expected relatively flat growth and you had adjusted that upward to the mid single-digits. So I guess I'm wondering are you just seeing more replacements or are you happening to see maybe an uptick in maybe some of the larger projects ongoing maybe in pharma.

There are a few projects, but the preponderance of the change is replacement. And as you know, they really slowed down a few years back and stayed slow for a pretty good lick. So it's not surprising to see some return of that business.

Our next question is from Chris Cooley with Stephens Inc.

I just wanted to touch base on 2 fronts if you could, and following up on the question on Life Sciences. You continue to drive great growth there on the capital side. I was a little surprised at the lag in the rate of year-over-year growth shown in consumables. Could you maybe give us a little bit of color? Are these capital-specific projects and they don't necessarily have the same tail as it pertains to custom chemistries or to the service? Or is that a component that we should see pickup and there's just a lag affect there? Could you maybe give us some color on that? And I have a follow-up.

Yes, Chris. I would say that the biggest differential that we saw in the third quarter regards to the Life Sciences consumables, yes, they did not grow as quickly as we had seen in the past. But I would attribute that more to timing or as you mentioned a lag. It so happened just the end of the quarter happened to fall with holidays and everything else. So we just did not see the shipments at that point in time. But I would attribute more of that to timing. I would not attribute it to anything differential in the marketplace.

Okay. That makes sense. And then on Isomedix, the growth rate there in the quarter, that was the lowest that you guys have had since fiscal 2010. And I realize that you're going to get back to a more normalized environment but you've taken some share, you've expanded capacity. A little surprised to see it drop that much during the quarter as well. Could you maybe give us clarity. Were there any one-time events? Did you see like de-stocking at the manufacturers levels? Anything that would maybe [indiscernible] dropped that by maybe a couple hundred bps in the quarter that brought that back down to that rate?

Chris, it's pretty much the same answer as Life Sciences. As you know, Isomedix had been holding up stronger than we anticipated early in the year. The growth was a little less in the fourth quarter but it was again largely around year-end and it appears to us to have been timing and not a temporal change.

Okay. And if I could squeeze one last one in here. I know it's been a longer call. But just on the BI applications still there in front of the FDA, do you have to get resolution first on your amended 510K now for these software upgrades as they pertain to the pre-treatment of the water before you can see that move forward? I'm just trying to get an understanding of what has to take place there before we can maybe see a BI approved for the 1E.

Yes, Chris. On that, in candor I'm not 100% sure the answer to that question. But timing wise, the special 510K we expect typically that’s in kind of a 30 to 45-day timeframe and we're in that timeframe. So we don't see the BI being held up for the other 510K.

Are they're still questions outstanding on the biological indicator?

We're not aware of any questions outstanding. As far as we know it's internal to the agency processing.

Our next question is from Robert Goldman with CL King.

Just some questions on cash flow and I appreciate you having given out some data on that already. Based on the 9 months of free cash flow and recognizing what your free cash flow was in 2011 for the year, it looks like you might be going at a free cash flow pace for 2012 of about $130 million for the year. And I just wanted to get a sanity check. And also sort of your directional sense on free cash flow growth from whatever the level is in 2012 as you look in the years beyond.

I would say, Bob, we have given guidance of $110 million excluding the impact of the SYSTEM 1 and class action settlements. So we have gone and improved our free cash flow. The big change to that in this quarter, which got us to $58 million for the year-to-date period is we did do a better job of taking down inventory much faster than we had anticipated on our last call. We've got about $26 million of SYSTEM 1E inventory remaining on the balance sheet. Obviously our DSOs did increase but as I tried to explain in my comments that is really exaggerated because of the credits yet to be issued associated with the SYSTEM 1 Rebate Program. Again going out looking at 2013 until we give 2013 we're not going to comment at that point in time. But we feel comfortable in the $110 million range for this fiscal year.

But Bob, I would say as a general statement, we still have inventory to work down. We still have SYSTEM 1E inventory to work down. The transition that we did in Europe where we moved factories, we built inventory in anticipation of that and we still have some of that to work down. So I still see orders of magnitude $15 million, $20 million of inventory that we will continue to work down. So independent of the net income level starts this conversation but I would continue to see inventories work down and I think we have further improvement in our turns. We continue to improve our factories. We're improving response time. The second piece of that is to improve the turns in those factories. So on the inventory side clearly we see ongoing improvement as a percentage of the business. When you look at the receivables picture, our receivables are pretty good actually in the mid-60s with the 1E rebate issue. And the low 60s without it, which puts us well in the range of our compatriots in this business. And so we have pretty good receivables. We continue to work down those receivables. And so we will be working that down. We clearly are having some pressure in Europe on receivables, but that's an area where we clearly will keep focus on that and try to keep our receivables turns looking positive.

Our next question comes from Jason Rodgers with Great Lakes Review.

Looking at the water issues for the 1E, about what percent of your current 1E customers are experiencing those abort issues? And have you lost any customers because of it?

Yes. It varies by their individual water issue. So they have -- if they have cold water problems, they will get that abort. If they have others -- we do have customers that are not seeing any significant level of aborts. So it does vary around the map. But it is significant and we're again, that's why we are spending so much money to work it down. At this point, and our returns in this product line are exceedingly low, which are typical of our returns in general. Certainly under 1% and the last document that I saw in terms of units lost or those kind of things is 10 or 15 or 20 kind of numbers, not 300 or 500 or 1,000 kind of numbers. So small numbers. This is a very attractive product for customers. But obviously nuisance aborts don't make them happy. That's why we're putting so much field service time and effort and money into it: a, to get them back up quickly; and then, b, to work to resolve the issues.

And once these software upgrades are approved, will this change the cycle time of the 1E at all?

The only place that I'm aware -- generally, no, is the start answer. The only place I'm aware of where the answer might be yes is again just like if you're going to take a shower if they are waiting longer for the water to hit temperature for the first cycle typically of the day, then that may. But that's the question of the water's not warm enough when it's coming in, do you want to abort? Or do you want to let it run for 2 more minutes and warm up. But other than that run time, I'm not aware of any -- it might be 2 seconds or something. I'm not aware of any significant change of cycle time other than again, the front end if you have cold water.

Our next question is from Brad Evans with Heartland.

Just, Walt, you had indicated I think that you're longer term targets are for mid to high single-digit revenue growth, is that correct?

Profitability growth.

Profitability growth. Can you just amplify that a little bit in terms of how do you see -- what does that mean for longer term top line growth do you think over the next say 3 to 5 years?

Again, I'm sure we’ll talk more about that in May, but as a general statement what we said is the market and our revenue growth in that market for our internal only is in the low to mid single-digits that we should be returning -- improving profitability within that and so our profitability be in the high single-digits to low double-digits. And clearly to capture some of that growth we would expect some of it to be through business development. But orders of magnitude, that's the numbers we're thinking of.

Do you think achieving margins that we saw in 2010 fiscal year, are those achievable again in the future do you believe?

We've talked about ranges of margins in this business and in that 15% to 20% range are reasonable margin levels. And clearly we're having some things that are depressing our margins right now and we would expect to grow those back.

So the last question I have is just you look at a lot of angst around the SYSTEM 1E transition. It's created a couple of year transitional period for investors, patient investors and it's obviously reflected in the valuation of the company, which I think most people would argue the company's valued well below -- at least in the marketplaces, is valued well below intrinsic value. And you've done a very good job of returning capital to shareholders. Special dividends and the share buyback, I just wonder whether -- has the board had any vigorous discussion on whether maybe a Dutch tender offer would be an appropriate use of capital considering extremely low interest rates and your underlevered capital structure.

We look at the various ways to use our capital and clearly in rank order we have thought through those components. And the first is to invest in the business and to continue to grow the business that we currently have. Secondly, we don't intend to be cutting dividends and in general we would expect to see dividends rise over time. Thirdly, is for business development opportunities that are tangential to our business so we can place money in businesses where we can gain synergies, either revenue or cost synergies by having them tangential to the businesses we have. And last is obviously share buybacks. And the method or approach to share buybacks we just don't discuss that.

Well, it sure seems like on a risk adjusted basis it's hard to find acquisitions that are as attractive as your own stock at this valuation level. That's just my opinion.

Appreciate it.

[Operator Instructions] I show no other questions at this time. I'll turn the call back to Julie for any closing remarks.

Thanks, Wendy. And thanks, everyone, for joining us today. This concludes our conference call and we'll talk to you next quarter.

Thank you for participating. You may now disconnect.