Haemonetics Corp (HAE) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2012 Haemonetics Corp earnings conference call. My name is Derek, and I'll be your operator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of the conference. (Operator Instructions).

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Gerry Gould, Vice President of Investor Relations. Please proceed.

Thank you, Derek. Good morning. Thank you for joining Haemonetics second-quarter fiscal '12 earnings conference call and webcast. Today, I'm joined by Brian Concannon, President and CEO, and Chris Lindop, CFO and Vice President of Business Development.

Please note that our remarks today include statements that could be characterized as forward-looking. Our actual results may differ materially from the anticipated results. Additional information concerning factors that could cause actual results to differ materially is available in our 10-K and 10-Qs.

On today's call, Brian will review the highlights of the quarter. Chris will review our operating performance and annual guidance in more detail. And then Brian will close with summary comments.

Before I turn the call over to Brian, I would like to mention the treatment in our adjusted results of certain items which, by their own nature and size, affect the comparability of our financial results. Consistent with our past practice, we have excluded certain charges from the adjusted financial results that we will be talking about today.

In our fiscal '12 second quarter, adjusted results exclude $8.5 million net in pretax restructuring and other costs associated with both cost-reduction and reorganization initiatives implemented during the year. We also exclude customer claims for HS core plasma inventory.

These costs were partially offset by $1.6 million of contingent consideration income related to the resolution of a previously estimated contingent purchase price for an acquired business.

In our fiscal '11 second quarter, adjusted results exclude $1.1 million in pretax restructuring and deal integration costs associated with our Global Med acquisition, which were offset by $1.9 million of contingent consideration income, which was also excluded from our adjusted results.

Finally, as is our normal practice, our press release and website include a complete P&L and balance sheet, as well as reconciliations between our GAAP results and our adjusted results. With that, I will turn the call over to Brian.

Thanks, Gerry, and good morning, everyone. Let me begin by updating you on the quality issues with our OrthoPAT and HS Core products. You will recall that at the beginning of fiscal '12, we implemented a voluntary recall of our OrthoPAT devices manufactured prior to 2002. This decision was made after a review of service and repair records, which indicated high levels of maintenance associated with blood spills and inappropriate cleaning. The recall required the return for replacement of approximately half of our fleet of OrthoPAT devices. Our recovery plan anticipated manufacturing up to 1200 devices with improvements that would enhance the reliability, creating a more robust blood management product, thereby improving the overall customer experience.

As of the end of the second quarter, we shipped over 500 replacement devices, and we are now building 50 devices per week. This will ramp up to 90 devices per week beginning in November. As we said last quarter, we will complete building all replacement devices before the end of the fiscal year.

You will also recall that we had to substitute our HS Core Bowl with a more costly and consequently less profitable product. As a reminder, HS stands for High Separation, and this bowl is a differentiated product used in Europe to collect plasma for transfusion. These actions were taken in response to customer complaints received about isolated instances of benign particulate found in plasma collected on the HS bowl.

The good news is that we have determined root cause for the particulate, and we expect to complete corrective actions by the end of the fiscal year. Until then, we will continue to provide our customers with a substitute product. These actions impact gross profit, as the substitute product has a higher cost.

So what changed in the quarter? The short answer is that we underestimated the impact that these two significant quality issues would have on our business. This impact was not just in the cost of quality or the effect that these quality issues had on the product lines in question, but the impact that they had on the business in total as we diverted resources to focus on quality improvement. The cost of this is an incremental $12 million in fiscal '12.

The bulk of this $12 million can be attributed to three areas. Number one, the cost of quality that directly relates to the quality issues and resulting investments in our quality system. Number two, other sales and gross profit that are delayed due to the focus on quality. And number three, structural cost savings that are delayed due to diverting resources to address quality improvements.

Let me provide you with more detail. The first area, the cost of quality, is worth about $4 million. This is incremental to what we told you in the first quarter, and split evenly between OrthoPAT lost sales and gross profit that we will not recover as rapidly as we originally thought in fiscal '12, and incremental spending to remediate the quality issues and at the same time upgrade our quality system.

Let me pause here for a moment to give you a bit more color on why the ramp-up in sales will be slower than originally thought. Early in the recall process, we had supply-chain issues, including the lack of availability of certain parts and supplies. This caused the build of replacement units to lag behind its intended schedule. As I said a moment ago, we are now meeting our product schedule and increasing production even more beginning in November.

Further, as we work closely with our customers retraining them on the replacement devices, they are providing us with additional input about improvements they would like to see with the OrthoPAT. We've been able to incorporate this feedback into our next-generation device, the OrthoPAT Advance, which will be launched in early fiscal '13 with subsequent upgrades to be added later in the fiscal year. Make no mistake about it -- we are committed to making the OrthoPAT the robust, reliable blood management tool our customers require to address their self-salvage needs in orthopedic surgery. And we are investing the time and money now to do this right.

The second area is related to sales and gross profit that we will not realize in fiscal '12 in surgical products. This is also worth roughly $4 million. Our sales and service resources have been devoted to the OrthoPAT recall, and have not been able to spend as much time on the launch of our newest cell-salvage device, the Cell Saver Elite. We are making progress with this new device and we will still see sales increase in the back half of fiscal '12, but not as rapidly as we originally thought.

The third and final area is worth about $3 million and is related to structural cost reductions that were planned in fiscal '12, but won't be realized as a result of diverting resources to addressing the quality issues. These structural cost reductions are real and will remain as targets for us in fiscal '13.

The bottom line in all of this is that we were too aggressive in our assessment of what it would take to remediate these quality issues and of our ability to return to the market and recover customers impacted by the OrthoPAT device recall.

We have learned, and this will make us a stronger company in the long run. Now this is important, and let me tell you why. First, we believe the majority of the impact of these quality issues will not carry forward into fiscal '13. Importantly, our quality and regulatory organizations have been restructured and strengthened to meet the needs of a blood management company for the future. As such, we anticipate that $3 million to $4 million of annual costs will continue into fiscal '13 to support these incremental resources.

Second, while the recovery of lost sales and gross profit associated with the OrthoPAT device recall is slower than we originally anticipated, improvements early next fiscal year and again approximately 12 months later will produce a device that addresses our customers' most important needs. We remain very bullish in our ability to drive orthopedic cell salvage as a standard of care because of the economic and clinical benefits shown through our IMPACT analysis.

Third, the distraction of the OrthoPAT device recall will soon be behind us, and we can focus our selling efforts on the Cell Saver Elite and the implementation of Blood Management Solutions using our IMPACT selling process. We are already starting to see the results of these efforts as we move into the back half of the year. I will comment on this a bit later.

Fourth, we have maintained those customers who were using our HS Core Bowl, but we have done this by substituting a more costly product that has resulted in lost gross profit. This is gross profit that we will recover when we relaunch the HS Core Bowl in early fiscal '13.

Finally, our attention to these quality issues has resulted in a number of resources being diverted from their normal duties to help determine root cause and remediate these quality issues. This proved successful, but there is no doubt that it prevented us from realizing planned structural cost reductions in fiscal '12. These are cost reductions that have merely been delayed and remain a part of cost reduction efforts in fiscal '13.

While it has come at a cost, Haemonetics is now a stronger Company, strength that will serve us well going forward. This is already evident on the top line. Despite the quality issues and the cost to remediate them, we continue to build momentum, driving revenue growth of 8% in the second quarter. At a time when other companies are challenged to drive growth, we are growing, and with the exception of the OrthoPAT, this growth is spread across all product lines, speaking to the broader strength of our business. This is something that cannot be lost.

Our quality issues are being resolved and the majority of their impact will not repeat, and we are building solid revenue growth, growth that we will sustain going forward. I will speak more about that in a moment.

For now, let me turn the call over to Chris Lindop, our CFO. Chris will cover the underlying trends in each of our product lines, both in the quarter and for the remainder of the year, and he will review in more detail the results of the second quarter and our revised guidance for the full year.

Thanks, Brian. So as Brian said, I'll start by providing more background on the broad-based revenue growth we are seeing, and I will talk in more detail about the impact of the increased cost of poor quality on our margins. I will also review our current revenue, earnings and cash flow guidance for the full year.

Halfway through fiscal '12, we are well on our way to surpassing our full-year revenue guidance of 4% to 6% growth. With 6% top-line growth and [14%] of revenues growing by double-digit percentages to date, we now expect to have 6% to 7% growth for the full year.

Plasma revenues grew organically 14% to $64 million for the quarter, even as we continue to face headwinds in our Japan plasma business, which declined 5% for the second consecutive quarter. You may recall that Japan plasma also declined in fiscal '11 due to a change in collection practices that continues today, albeit at a reduced rate. The impact from the HS Core substitution on Plasma revenue remains nominal.

The steps taken by our commercial Plasma customers to accelerate collection volumes boosted the performance of this important part of our business. Our plasma growth was driven by increased collections in the commercial Plasma business. There were no material market share changes impacting growth in the quarter.

In May, we guided to Plasma growth of 3% to 5% for the year, and we are now confident, based on the trends we are seeing, that we will exceed that target. We now believe we have 11% to 12% growth in plasma this year.

The Software Solutions business also had another good quarter. Sales were up 7% organically to $17 million in the quarter. We remain confident about the outlook for our Software Solutions business, which has a track record of finishing the year strong, and we are confirming our previous guidance of 9% to 11% growth for the full year.

Our Blood Center revenues were up 5% at $54 million for the quarter, well ahead of our fiscal '12 guidance of between 1% and 2% growth. The platelet business, with revenues of $42 million, increased 6% in the quarter, reflecting growth in Japan and some emerging markets.

Red cells delivered $12 million in revenue for the quarter, an increase of 3% year-over-year. As we expected, this market is returning to modest growth in fiscal '12 after two years of declining performance.

We are reaffirming our full-year Blood Center guidance of 1% to 2% growth, reflecting growth in both red cells and platelets.

Moving to the Hospital business, our Hospital products revenue increased 1% to $29 million in the quarter, well behind our full-year growth guidance of 7% to 10%. However, our Hospital products were up 6% in the quarter when you exclude the decline in OrthoPAT related to our voluntary recall. TEG disposables revenue was $6 million, growing 22% in the second quarter, following 19% growth in the first quarter. The TEG disposables revenue growth came from continued penetration at key impact accounts in North America and significant growth in China, where the relative scarcity of blood components has focused healthcare providers on the value of the targeted transfusion medicine which TEG enables.

OrthoPAT disposables revenue was $7 million in the quarter, down 12%, or about $1 million. This was much the same as in the first quarter, with the ramp-down in our active installed base in Q1 matching the recovery which began late in Q2.

As Brian mentioned, the OrthoPAT fleet recall is having a negative impact on disposables' growth rates. However, it should be noted that although approximately half of our fleet has been recalled, our OrthoPAT revenue is down only 13% year to date. The team continues to do a good job managing the recall and retaining our customers.

During the quarter, we ramped up manufacturing to replace this important installed base with newer and more reliable equipment. This is having a positive effect. We still anticipate gradual improvements in momentum for the OrthoPAT in the back half of the year, driven by the new machine placements.

Surgical disposables revenue was $16 million in the quarter, a 1% increase year over year. You will recall that we launched our new Elite cell salvage device in North America and Europe in the first quarter. Initial interest in this device is strong, and we are seeing good results in competitive settings. We expect to see this positively impact growth, but later in the year, building on this competitive momentum as our sales force completes the recall activities with our customers and shifts the focus more on Elite.

Our expectation for Hospital disposables for the year is no longer 7% to 10% growth. Replacement of the recalled portion of our OrthoPAT fleet in the back half of the year and the acceleration of Elite are now expected to impact revenues by the end of this fiscal year. We are expecting, and our revised guidance reflects, that Hospital disposables revenues will be flat to 2% growth for the full year.

Equipment revenues were $15 million in the quarter, up 4%. As we've noted in the past, equipment sales can be less steady than our disposables business, based on the timing of orders. For the full year, we are confirming our original equipment revenue growth guidance of mid-single-digit percentages.

Currency in fiscal '12 is expected to benefit revenues by approximately 2%, as it is now believed that yen and euro rates will remain relatively strong through the fiscal year. Due to our currency hedging program, this will not impact the bottom line. So we now anticipate revenue growth at or above the top end of our previously stated 4% to 6% range for the full year, and we're updating our guidance to 6% to 7% growth.

Now I'll review the rest of the P&L results, and please note these numbers are adjusted, as Gerry said. Second-quarter fiscal '12 gross profits were $91 million, up $4 million or 4%. Gross margin was 50.9%, down 170 basis points from a gross margin of 52.6% in the second quarter of fiscal '11.

Quality issues accounted for $3.3 million, or in excess of 180 basis points, of that gross margin decline. Additionally, we had delays in our gross margin improvement initiatives, representing another $300,000, or roughly 20 basis points of margin.

For the full year, we last guided to gross margin improvement in excess of 100 basis points, based on a combination of leveraging our growth and structural cost savings. The acceleration of our Plasma business has put pressure on our margin due to mix, and increased quality spending and cost savings delays related to the quality improvement efforts also pressure margin. We currently expect gross margin for the full year of approximately 52%, which will be 50 basis points down, below fiscal 2011.

Operating expenses were $66 million in the quarter, up $6 million, or 10%. Incremental expenses related to investments in quality, sales and marketing resources and R&D funding. We are likely to maintain spending at approximately this level for the rest of the year, with the benefit of ongoing costs savings initiatives being reinvested to continue the acceleration of top-line growth.

Operating income was $25.5 million in the quarter, down $2.6 million. Operating margin was 14.2%, down 270 basis points, reflecting $4 million of costs and loss margin related to the quality issues.

For the year, we had guided to operating margin improvements of approximately 10 to 20 basis points. But considering our latest outlook, we expect operating margins to be down 180 to 200 basis points for the full year.

Our tax rate was 28.1% in the quarter, down from 29.2% in the prior year, and our full-year outlook for the tax rate is approximately 28.5%.

Adjusted earnings per share were $0.72, down 9%, reflecting the impact of poor quality in the second quarter. Quality-related issues are estimated to have impacted our quarterly results by about $0.12 in the quarter.

We have also increased our guidance for transformational costs that we exclude from our GAAP results in arriving at adjusted earnings. We are actively advancing the transformational activities focused on the infrastructure supporting the research, manufacturing, supply chain and software organizations which we told you about earlier this year. We initially expected to spend approximately $8 million on those changes, and currently expect to spend just under $10 million.

In addition, we have identified nonrecurring costs which we have excluded from the adjusted results that we have discussed. Those costs include a reserve of $2.4 million established this quarter for claims that our European HS Bowl customers have made. In total, we expect to exclude approximately $13 million to $14 million of transformational and other costs, and $1.6 million of contingent consideration income from our adjusted results this fiscal year.

As in the past, our website includes revenue and income statements in areas which are based on the elements of guidance provided to my comments for the full year.

Moving to the cash flow, in the first six months of fiscal '12, we generated $33 million of free cash flow, after making net investments of $24 million in capital expenditures and before funding cash transformation costs of $4 million.

We have $183 million of cash on hand after have completed a $50 million share repurchase. We continue to have a strong cash generation model. Our free cash flow guidance for fiscal '12, before funding up to the $14 million of cash transformation costs, is approximately $70 million, reflecting reduced earnings guidance.

In summary, in fiscal Q2, we delivered revenue growth in line with the upper end of our guidance range, and we believe we will have 6% to 7% growth this fiscal year. Our gross margin growth was negatively impacted by the quality issues, including the inability to capture targeted cost savings while giving full attention to the quality issues.

Earnings and EPS declined year-over-year, and we have updated our guidance to reflect a $0.35 decline from previous expectations for our earnings per share. We are revising our earnings per share guidance for the full year from a range of $3.35 to $3.45 to a range of $3.00 to $3.10.

Our business fundamentals remain very strong. Our strong cash flow model and ample cash on hand provides us with the flexibility with regard to growth options going forward, at a time when the M&A activity level is fairly robust.

So with that I will turn the call back to Brian for his comments and then we will take your questions.

Thanks, Chris. We take responsibility for the mistakes that we've made, mistakes born out of being overly aggressive in our belief that we could resolve the quality issues more rapidly and with less cost and impact to the business than what we see today.

However, we are using this time and the money we are spending to ensure the underlying strength of our organization. The fundamentals of this Company have never been stronger. We grew revenues 8% in the quarter despite everything else, and this is remarkable considering the economic conditions that exist today.

So let me spend the time I have left explaining why you should feel very good about Haemonetics as we go forward. The revenue growth we are seeing was led by our Plasma business, with another solid quarter of double-digit growth of 14%. This is certainly a good sign, as demand for plasma-derived biopharmaceuticals continues to stabilize.

However, our growth was not simply driven by Plasma, and is broader-based, with growth coming from all productlines with the exception of OrthoPAT.

Software Solutions continues to be that critical enabler of Blood Management Solutions and delivered another solid quarter with 7% growth. And TEG, the product with the highest demand among all IMPACT accounts, had another strong quarter, registering 22% growth as an important blood management tool for our customers.

Importantly, TEG is also gaining adoption in our global markets as well. TEG growth in China was 155%. Now, speaking of IMPACT selling, we continue to make good progress implementing Blood Management Solutions with several key customers. I'll briefly mention a few recent highlights.

Holy Cross Hospital in Florida implemented IMPACT Online and utilized the data to achieve and confirm a greater than 30% reduction in blood utilization in its cardiovascular and orthopedic service lines.

We entered into an agreement for our Blood Management Solutions with Comprehensive Care Services of Michigan, the second-largest US profusion service provider.

We entered into a five-year agreement with Blood Systems Incorporated of Arizona, the second-largest collector of blood in the US, solidifying our red cell and red cell plasma collection business.

We launched our new Cell Saver Elite device in North America in the first quarter. Since launching Elite, we have leveraged this new technology, along with our Blood Management Solutions strategy, to capture competitive accounts. In the past four months, we have won seven competitive conversions representing 39 new device placements, with incremental annual revenues equal to almost 2.5 percentage points of growth on our core North American surgical business. This represents solid progress with this exciting new product at a time when so much of our attention has been on the OrthoPAT recall.

We continue to see success in our IMPACT selling as well. In the quarter, 18 new accounts entered the program, taking advantage of our Blood Management Solutions. This brings our total number of IMPACT accounts to 226.

Our TEG product continues to attract the attention of our customers as well. This is especially true with IMPACT selling, as TEG is used in 50% of all hospital IMPACT accounts today. As I just said, TEG disposables grew 22% in the second quarter, and TEG disposables were up 34% in IMPACT accounts.

IMPACT selling with our Blood Center customers also saw progress, as red cell disposables grew 9% in IMPACT accounts compared to being flat in non-IMPACT accounts.

Now, we still have much work to do as we accelerate IMPACT selling. Our Blood Management Solutions are attracting the attention of our customers and momentum continues to build, only with larger, more prestigious institutions included. And this is happening despite the distraction to our hospital sales organization that has spent much of their time addressing the OrthoPAT recall. We are clearly gaining traction and confidence, and this is just one reason why I remain so optimistic for the future. And we have adjusted our revenue guidance up to reflect this confidence.

Let me update you on our progress with two other key initiatives, blood typing and automated whole blood. First, in blood typing, we have completed the lab clinical study fulfilling the criteria we had set for advancement into full development. Our approach offers a significant reduction in time compared to current device performance. We expect to complete typing in about 10 minutes when fully optimized, and we have successfully demonstrated that we can type red cells at least as accurately as current methods. We are currently determining the best path for development and commercialization of this technology.

We are also making progress with the development of our automated whole blood product, as we are on track to deliver our first automation package to customers by the end of fiscal '13. This will include a new donation workflow module in our software suite and a communications tower for plug-and-play ease-of-use via a new handheld interface. In fiscal '14, we will add two peripherals to make the system paperless, along with the smart rocker, with full data integration.

We have completed development of our new whole-blood collector and it is ready for clinical use, but will not be launched until fiscal '15, when we expect to have a low-cost webset with solutions. This is all consistent with the development plan we introduced at our Investor Day last May.

As I close, let me leave you with this. This team has encountered adversity in the past and overcome it every time, and this time will be no different. We now fully understand the quality issues, root cause has been determined and remediation plans have been implemented. We now feel very confident that we understand what this will take. We expect this will be behind us in two quarters.

Importantly, we continue to gain traction with Blood Management Solutions and revenue growth is strong. And we are making great progress with our blood typing and automated whole-blood projects, both key growth drivers for the future. I've already said it, but it bears repeating. The fundamentals of this business remain strong and we have much to build upon for the future.

I want to finish by thanking all of our employees for their continued commitment. This team believes in our blood management vision and what it means for the customers we serve. They have devoted long hours to keep the focus on our customers, and this is paying off with solid revenue growth for the second quarter in a row. This is why we feel our best days are still ahead of us.

And now, we would be happy to take your questions.

(Operator Instructions) Dave Turkaly, SIG.

I apologize; I kind of got cut off a little bit during the call. But just very quickly on the incremental charges, I know -- can you just tell us, in terms of the first estimate, who was responsible for kind of coming up with the totality of the numbers you had? And then do you think it is really just lack of experience that kind of led to the revision in terms of these nonrecurring things that you are adding today?

This really comes into three buckets. Ultimately, who is responsible? I am. BM but I would tell you that we made an investment a little less than a year ago with a new leader in our quality and regulatory organization, a gentleman by the name of Warren Nighan, who came from St. Jude. He had the same job there. And Warren was very aggressive as he came on board to really understand our challenges. And clearly we were learning as we went through this.

In the quarter, we completed a major restructuring of that part of our business, and that is really where the costs came from, not just in terms of that cost restructuring, but in the recognition that there was more we need to do from a quality and regulatory standpoint as we went forward.

And then about half of that -- so of that $4 million, $2 million related to that, and another $2 million was just simply being overly aggressive in how rapidly we could ramp back up OrthoPAT sales. So that is the first $4 million we talked about.

The second $4 million really comes from our inability to do all that we had planned; our appetite was too big. We thought we could -- with one quarter behind us, we thought we had enough time in the year to not only address the OrthoPAT but still do a great job launching Elite. We are doing a good job launching Elite, but we haven't been able to pay attention to it as we expected. And so we took down the guidance -- or the growth profile that we had for Elite for the remainder of the year in our surgical products. And that is that surgical products impact of about $4 million.

The final was really in terms of structural cost reductions, and this was a resource issue. As we really started to get through the remediation of the quality issues, we had to take resources that were dedicated to structural cost reductions and move them over to pay attention to what we were doing relative to the resolution of our quality issues across the board. And these are structural cost reductions that we are going to recapture, but it just won't be in this fiscal year. So that is what that rolls up to.

I assume that means that the bonus -- the structure for you guys this year, because of this change, it is probably not going to happen again. Is that fair?

Yes, we will pay bonus per the plan.

Finally -- then this one kind of just looking ahead now -- obviously, the fundamental are strong and your revenue growth is strong. Based on what you are seeing out there, forget about the nonrecurring quality charges, as we look at this area and Haemonetics moving ahead, do you still feel comfortable that mid-single-digit top and double-digit bottom line is kind of a long-term attainable goal for your Company still?

Yes, no question about it, Dave. In fact, as we look into fiscal '13, I think you will see more of the same on the top line, solid mid-single-digit growth, but a return to the bottom line of double-digit earnings-per-share growth.

David Lewis, Morgan Stanley.

Good morning. Just two quick questions. The first, Brian, for you. Can you just give us an update on when the last inspection of the plants involved in both HS Bowl as well as OrthoPAT were, and have you received any 483 letters today?

We just had an inspection of our facility here in Braintree. In fact, in the quarter, we had a number of inspections throughout our entire network of manufacturing facilities. But this was the first inspection here in Braintree, where the majority of the challenges that we've had occurred. That inspection just completed last month, and we had one 483 observation as a result of that inspection.

Okay, and that 483, Brian, was tied to which particular product?

It was not tied to a product. It was tied to a recall and information (multiple speakers). Yes, the follow-up on the software recall.

The inspection of Braintree, Dave, realize that that is a corporate inspection of our entire system.

Totally understand. Thanks for the detail. And then, Chris, I know it is challenging to do so now, but you are talking about ongoing costs of $3 million to $4 million, which is something around $0.10 for next year.

How should we think about fiscal '13? You've always historically been a Company that grows -- call it 10% to 15%, not trying to back you into a corner. Do we think about fiscal '13 as being a growth rate more in line with what you've grown historically or do we think of it as an accelerated year of growth given these one-time issues here in fiscal '12?

I think as Brian said, we are looking at a year next year where we will return to that normal trend of mid-single-digit top-line growth and double-digit bottom-line growth. I don't want to be too much more specific than that, but it will look more like that pattern we've had in the past.

Great. Thank you very much.

Steven Crowley, Craig-Hallum Capital Group.

Good morning, folks. A couple questions for you here. In terms of TEG, which had an impressive year-over-year growth rate in the quarter, I'm wondering -- can you give us some color for how the business did maybe ex China or domestically?

The China business is small at the moment, so it is around $3 million annually -- on an annual basis. So what you're seeing in terms of double-digit growth is very much a domestic story.

Okay. And then two things. In terms of the software business, while you've talked positive qualitatively about it, the 6.7% growth was a little bit below what we were thinking and sub 10% for the year to date, and with a contingent payment. So the earnout payment coming off the table, I have to assume this business isn't doing everything you hoped for. And it is a critical piece of the whole Blood Management Solutions story.

So maybe could you talk to us about that equation and how you're adjusting it, and whether or not you are trying to kick it up and whether you can be successful there?

And that just the issue around claims for the HS Bowl, how concerned should we be that you've got some customers that appear unhappy in Europe about that equation?

Brian will take HS Core, and let me talk to the software business. So the phenomenon we are seeing in our software business just now is deals that have been sold and where there are delays in implementing them because of other priorities within the hospitals' software agenda related to electronic health record. And we can see the institutions who are getting to the end of that process and are setting up to implement the systems that we've sold to them. So we have a good visibility of backlog in that business, and have confidence about the year-end. I would look for it.

The contingent payment there was not related to the Global Med acquisition.

No, it was related to a smaller acquisition, which we continue to be incredibly bullish about. This is the BloodTrack acquisition. It is more about the timing. We had set ourselves some aggressive goals in the business combination transaction for the growth of that business. It is going more slowly than that, and we, in a sense, indirectly benefited from that because of the reduction in the purchase price. But we feel no less bullish about that product line, especially in Europe, where certain regulatory issues are driving the need for safety in blood storage at the point of care.

I'll take the HS Core question, Steve. But before I do that, I do want to -- just one comment on your first question on TEG. The point that we are really trying to make on TEG is we are still driving solid double-digit growth in our domestic markets.

But what you -- the comment on China is that you're seeing us now start to impact the markets outside of where we've traditionally grown, and that is the biggest takeaway. This is a great product, it is a clinical sale, and it is getting attention of clinicians around the world. And that is why I wanted to make that point.

Speaking of the HS Core, what I would say here relative to HS Core is that we've maintained all of these customers. This is a product that these customers want to have back. So we've maintained all of these customers; albeit it is with higher-cost products, and that is where the impact is to our gross margin.

We have been in contact with these customers throughout. In fact, they've really helped and worked with us to make sure we truly get at the root cause issue as to why we had that benign particulate in the first place. The claims that we've received are really based off of how they needed to go to market to serve their customers with plasma. Because realize, this plasma product is therapeutic in terms of its use.

We think the 2.4 million claims that we've put there are realistic. And these are not net of any insurance claims. So we still have the opportunity to speak with our insurance carriers.

Importantly, by maintaining all these customers, they are anxious for us to get this product back on the market. Therefore, when we relaunch in fiscal '13, early fiscal '13, we are highly confident we will recapture the lost gross profit that we've suffered. Importantly, we can start to sell this product again because it is a differentiated product, which is a significant -- provides a significant advantage for our plasma customers.

Thanks a lot for all the color.

You're welcome.

Lawrence Keusch, Morgan, Keegan.

Good morning. Chris, I want to make sure that I am fully understanding this. So if we take the initial estimate of the total expenses associated with the recall and remediation, etc., it is $0.25 in the first quarter and now you've added an additional $0.35 in the 2Q when you add in the product sales delays, the cost reduction delays, etc. Is that correct?

Correct.

Okay, so of that $0.60, how much do you think of that as truly contained for fiscal 2012, and not recurring?

Before we go there, just to be clear, that $0.25 is the full impact. $0.08 we had in our guidance, and $0.17 was incremental last quarter.

Okay, perfect.

Important to know that.

Yes, okay, that's fine. So if we call it $0.52, how do you think about what is contained to this year?

Well, we know that we've invested about $0.10 into our quality infrastructure in terms of building out the resources that we need to support the business over and above where we were. The balance of these items, if you take the $0.08 or so of cost reduction, that will come back next year. There is no question in my mind. The whole plan is baked. The challenge is in just implementing it and completely [unlaunching] the switchoff of product between plants in this fiscal year. It is just one thing we can't get at.

The rest of it is revenue growth. And while I'm highly confident that revenue growth will begin in all of these areas, specifically OrthoPAT and Elite next year, I don't think you get two years of growth in fiscal '13, if you understand my point.

Yes, okay. So I haven't done the math yet, but I guess coming back to something you said, of the $3 million to $4 million which you expect to spill in, that is roughly -- that's the $0.08 or so?

The $3 million to $4 million that I was referring to is the structural cost of quality that we've increased, really QA/RA organizational strengthening.

Right. And how much is that is on an EPS basis?

Probably $0.10.

Okay. So if I just take the [340] midpoint of the range where you are now, and I'm just -- what I'm really trying to understand is what is the base that we should be thinking about where you grow off of for the coming year. So again, I'm sorry, if I take the [305] as to where you are now, clearly $0.10 of that continues. And then we need to think about how much of that do you build next year and the following year.

Right. But as we said, we are -- we think it is reasonable to think about next year as being a mid-single-digit top-line growth business and a double-digit bottom-line growth.

And the color I would add there on that, Larry, is -- and you're really trying to say, okay, so what is that rebound going to look like. You can expect that we will have earnings per share growth at least at the ranges that we have had in the past. And we will provide more color to that as we provide the guidance at the end of next fiscal year to what upside may exist in that as well.

Larry Solow, CJS Securities.

Good morning. Just to follow up on that, and I hate to play Devil's Advocate, but wouldn't -- I would hope that -- this $0.08 incremental just on the cost savings delay, this was on top of $0.37 total on OrthoPAT and HS. And obviously, some of that includes revenue growth estimates. But I imagine some of it is just certainly on the Bowl, that is just basically swapping in a new product. So that should be an easy cost recovery without any earnings growth -- any, excuse me, top-line growth.

And I imagine another piece of it, just on Ortho -- you know, so of that $0.37 is also just on -- not on additional cost savings, but just on higher costs you are incurring today that you shouldn't incur next year. So I would hope that you probably had -- assuming you return to [revenue] double-digit growth in your core business, layering this back in, it should be well on the double-digit side. Right? I mean that's -- I don't think you've given guidance today, but that is sort of how I would look at it. Right? Is that a fair statement?

We aren't giving guidance for next year (multiple speakers). That's it. You are correct in your observation about HS Core. That is, if you will, a peace dividend that comes out of this, and should rebound automatically next year. Similarly with the cost savings, it should rebound automatically next year.

Offset against that is a conscious decision to increase our structural spending around quality and regulatory of around $3 million to $4 million. And you've got to remember that we are not going to fully fund our bonus this year, and we will have to plan to fund that bonus next year.

Right. Just said another way, I think to start the year originally, even with some impact, at least the original $0.08, your gross margin assumptions were bordering around 55%. So assuming most of these things correct themselves, exing out the $3 million to $4 million, which is probably about 50 basis points, assuming it is all in your gross margin, and if you get the revenue growth to return that you expected this year, and even without improvement that we had expected [13] on top of this, you should at least return to the -- maybe a little bit below the 55%, but to the 54% range. Again, I'm not asking for you to say yes or no on the exact number, but --

Directionally that is correct. And it is really driven as much as anything by mix. Because when Elite and OrthoPAT start clicking, as we expect them to do, they carry very attractive gross margins. TEG is an incredibly attractive gross margin product. So when you get a good slug of your growth coming from products with those margins, you will see positive trends. And our quality spend is in our margin.

And look, I know everyone is trying to gauge what is this going to mean six months from now. We will certainly provide that visibility. But these are very fair questions.

That is why we've said we are looking at solid growth on the top line, just like we've seen this year, mid-single-digit, and a return to double-digit growth in earnings per share. The reason why you hear us hesitate there, because we are also looking at, as we get into next fiscal year, some investments in some markets where we see some wonderful growth opportunities.

So don't misread the fact that we are not giving you anything more than what we are giving you there, other than the fact that this is a business that will return right back to its growth profile, which has been a very healthy growth profile, especially in today's environment of mid-single-digit top-line growth and solid double-digit earnings per share growth as we go forward.

Scott Gleason, Stephens.

Thanks for taking my questions. I guess the first question, just if we look at the Blood Banking section of your guys' guidance for this year, 1% to 2% growth, just in light of the strong Plasma number -- or I'm sorry platelet number you guys put up this quarter, that would imply kind of a down second half of the year. Can you talk about that guidance, and I guess are you guys seeing things in terms of distributor inventory levels, or is there anything else going on there?

No, it's not related to distributor inventory levels. We have a big year last year with dengue fever. And the other factor that we know is in the first part of the year, we've benefited from a competitor's quality issue in Japan, which is now resolving itself. And that tends to happen when a competitor has a quality issue, the Japanese Red Cross shifts weight. And both of those are platelet phenomena. So we get a tough comparison year-over-year. Dengue fever was off-the-charts strong last year. We talked about it at the time. And we see -- we'll see a moderation of our growth in Japan, just as our competitor returns to the market.

Great. And just on my follow-up, Brian, you talked about OrthoPAT Advanced. Can you talk about some of the features that product will have maybe that the current OrthoPAT doesn't?

Yes, it really -- I'll answer it in two ways, Scott. The first set of improvements that we'll see in this is really in the electronics and what the device will do. Today, for a clinician to understand the fluid loss from a patient, they have to go through some different measurements and mathematically determine that.

This will do this - the OrthoPAT Advanced will do that for the clinician; they no longer have to do that math on their own. So it's that feature, some upgraded electronics, it will be a little bit better looking in that sense.

The bigger changes are going to happen 12 months later. We've learned a lot as we've talked with our customers. But one of the important things we're getting at, which is a real dissatisfaction, is what's causing the fluid leaks in the first place, which required us to have to go through this recall on those older devices that didn't have the fluid ingress.

And we feel we have found that root cause as well. And that is going to require us to change the header arm of the device, move it in a more secure way in the decking. We are going to improve the centrifuge and its stability within the device. So we are making some very, very important changes to that that will address the biggest dissatisfaction that our customers have, and that is that they have blood leaks with the device to begin with. So these are important upgrades that we believe will position us very strongly as we go forward.

Joshua Zable, WJB Capital.

Guys, thanks for taking my questions here. Still have a couple of follow-ups. Chris, I know you walked through the gross margin. Just some more clarity on that as far as this quarter goes.

I'm just trying to figure out product mix, what's sort of the other margins. Because I know you guys talked about part of the sort of taking down of guidance is some of the quality improvements or the cost efficiencies you want to take out of other businesses.

So I guess I'm just trying to understand -- is this sort of all OrthoPAT on the gross profit as we look backwards? Kind of where is Plasma relative to things? Is that improved or is that suffering as well? Just maybe more color again, and just go over -- I know you gave some color earlier. Thanks.

No, Plasma margins are stable. The trend there is obviously increased volume, offset by the fact that we have a new plant that gives us a real competitive advantage, but brings with it some fixed costs that are inevitable. Definitely the right thing to do, and luckily, we are doing it at a time when demand is exploding. And so we are -- those two factors are offsetting.

So the Plasma margins are relatively stable at the moment.

With regard to the rest of the -- with regard to the rest of the margin impact, what I highlighted for you in the quarter was that the gross profit impact was about $3.3 million. And that's we are calling directly the cost of quality. It is not mix in there, other than the fact that part of the cost of quality is a lower-than-expected OrthoPAT performance.

And in addition, we saw about $300,000 related to delayed cost savings initiatives. And as we've highlighted for you on the call, that number will rise for the full year against our expectations.

And so in the quarter, the margin impact is about 180 basis points related to this cost of poor quality, and another 20 basis points related to the slower-than-expected cost savings initiatives we had planned to implement.

And for the full year, we are now predicting margins down 50 basis points, gross margins down 50 basis points, full-year, with the impact of all of these revisions to estimates that we've talked about in the call.

James Sidoti, Sidoti & Company.

Okay, so assuming that you are able to resolve the OrthoPAT issues and get the entire fleet replaced by the end of this fiscal year, as you go into '13, you are going to have a new Cell Saver, a new OrthoPAT and TEG, combined with the IMPACT and IMPACT Online software. Now this business hasn't grown double digits in as long as I can remember. Do you think going into '13 that you finally get the Hospital business up to double-digit growth?

I'm not going to provide guidance on productlines, but yes, we are very, very optimistic about what we are seeing in our Hospital business. Even with our focus on the OrthoPAT, you're seeing progress being made there in our base surgical business. We are seeing some very early successes with our Cell Saver Elite. We are seeing TEG continue to drive significant double-digit growth. And we're moving into markets where we haven't been in the past and we are seeing the acceptance of that product go up dramatically there as well.

Our focus is what we do to fix OrthoPAT, and we've been aggressive here. We feel like we've shaken through so much of this. We've had engineers working with customers to really, truly understand the problems that they've had in the past. And that is why you are seeing a real well laid out plan of not replacing the whole fleet, but about those pre-2002 devices that didn't have the fluid ingress. And then going with the next two revisions, which is OrthoPAT Advance, and then 12 months following that, some significant upgrades to the structure of that device which gets at the biggest problem, which is the blood leak.

So yes, we feel very, very good about where we are heading with this business. And we are not going to rest until we are starting to drive double-digit growth in that business. Is that next year or past that? More to come on that.

All right, and then just a follow-up. Use of cash, you said in the press release you would -- used up the $50 million on stock -- on share buybacks. Do you plan to open up another plan the end of this fiscal year, or what is your strategy for cash regarding the stock buybacks and acquisitions?

Well, it hasn't changed in terms of its priorities. First is on business development and the second is on the stock buyback. Pleased that we were able to complete that in the quarter, and what that has meant for us.

But we still are very, very focused on M&A. In fact, we can only just say that we are very focused on M&A. There is a lot of activity that has taken place out there. We've got the cash and the time to be able to use it wisely to continue to build on our strategy. Read nothing into that. We have been focused on fixing some very, very critical quality issues that we need to get behind us. But we still plan to use that cash wisely as we go forward.

At this time, I am showing no further time for questions and answers. I would like to turn the call back over to Mr. Brian Concannon for any closing remarks.

Thanks, Derek. We've learned a great deal in remediating the current quality issues, and we're implementing changes to our quality and regulatory organizations that will make us a stronger company going forward. We are also making changes to the OrthoPAT product, changes that our customers are asking for, making this product a more robust and reliable orthopedic cell salvage device. And we've launched our new Cell Saver Elite, further enhancing and strengthening our blood management suite of solutions.

We are growing at a time when other companies are challenged to drive growth. And with the exception of OrthoPAT, our growth is broad-based across all of our product lines. We are growing because we are delivering a differentiated suite of products and services. We call this Blood Management Solutions, solutions that reduce costs for our customers and improve clinical outcomes for the patients we serve.

And our IMPACT selling process is making our value proposition very clear to an ever-increasing and impressive list of major customers.

The distractions that (inaudible) company, our quality issues, will soon be behind us. Our efforts will shift to building upon our recent success and driving profitable growth as we meet and exceed our customers' expectations today and in the future. We look forward to sharing our progress with you. Thank you for your time this morning.

Ladies and gentlemen, that concludes today's conference. We thank you for your participation. You may now disconnect. Have a great day.