Stericycle Inc (SRCL) 2002 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Stericycle second quarter earnings conference call.

At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time.

As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, , Vice President of Finance.

Ms. , you may begin.

Good afternoon.

I will be reading the safe harbor statement.

Statements by Stericycle in this conference call, which are not strictly historical, are forward looking. Forward-looking statements involve known and unknown risks and should be viewed with caution.

Factors described in the company's form 10-K, as well as its other filings with the SEC, could effect the company's actual results and could cause the company's actual results to differ materially from expected results. The company makes no commitment to revisions to forward-looking statements or any facts, events or circumstances after this date that may bear up forward-looking statements.

I'll now turn the call over to Mark Miller, Chief Executive Officer.

Thank you.

Good afternoon. Welcome to our second quarter call.

With me today besides , are Frank ten Brink, our Chief Financial Officer and Rich Kogler, our Chief Operating Officer.

We're really pleased with the record result achieved by the team in the second quarter of 2002. After pro forma adjustments for the adoption of 142 and taking into effect for the two-for-one stock split, which was effective at the close of business at the end of May, our net income grew by more than 56.9 percent, and EBITDA reached $28.6 million.

Stericycle finished the second quarter of 2002 with an earnings per share of 26 cents a share, up nearly 45 percent over the 18 cents comparable prior period. For 24 consecutive quarters since our IPO in 1996, we have either met or exceeded expectations for our company's performance.

With that brief overview, I'll turn the call over to Frank, who will walk you through the financials.

ten Brink: Thanks, Mark.

We had an outstanding quarter, as revenues grew $10.7 million in the quarter to $99.3 million, up 12.1 percent from $88.5 million in the second quarter of last year. Small customer revenues grew over 9 percent and large customer revenues grew over 5 percent. The customer revenue mix, excluding International Machinery with revenues of 1.1 million, was approximately 58 percent in small and 42 percent in large customers.

Gross profit as a percent of revenue increased from 39.8 percent in the second quarter of last year to 40.5 percent in the second quarter of this year. The improvement resulted from better productivity and leveraging our infrastructure, partially offset by higher operating costs.

SG&A expenses, excluding amortization, was 14.5 percent of revenues versus 14.4 percent in the prior year due to higher investment spending, R&D and costs.

The operating income after the pro forma adjustment to 2001 resulting from the adoption of FAS-142 rose 16.2 percent to 25.3 million in the quarter from 21.8 million in the second quarter of 2001. As a percent of revenue, operating income increased from 24.6 percent last year to 25.5 percent in the second quarter of this year.

Net interest on other items, other expenses were 350,000 which includes minority interest franchise stacks as a miscellaneous charges. The net interest expense was lower in the second quarter of 2002 versus the second quarter of 2001 by approximately 3 million due to lower interest rates and lower debt outstanding.

During the quarter, we increased our revolver borrowing capacity from 80 million to 105 million which resulted in a one time interest expense of 223,000 and we also repurchased 1.6 million of our high yield subordinated debt which included a 252,000 premium interest payment. Presently, 125 million of our floating rate debt is hedged at an average 3 month LIBOR rate of approximately 5.2 percent.

Net income and EPS. As a result of margin improvement and de-leveraging, net income for the second quarter adjusted for the FAS-142 changes rose 56.9 percent to 11.5 million from 7.4 million last year. On an apples to apples basis, i.e. adjusted for FAS-142, EPS increased by 44.9 percent from 18 cents last year to 26 cents this year.

EBITDA increased to 28.6 million versus 24.9 million in the prior year and our debt to EBITDA ration on a consolidated basis was 2.24.

Next, the balance sheet. During the quarter we continued to make progress in improving our balance sheet position. Our DSO improved from 70 days a year ago to 60 days last quarter and now at 57 days this quarter. Our debt to book cap at the end of the quarter was 44 percent down from 47 percent at the end of the first quarter. Through the end of July, 2002 we have repaid over 48 million of our debt this year, year to date. During the quarter, our capital spending was 3 and a half percent of revenue, approximately 3 and a half million.

And now some selected balance sheet numbers. Cash and cash equivalents was 9.5 million. Net accounts receivable 61.3 million. Total current assets 94.9 million. Total assets 622.9 million. Short term debt 5.1 million and long-term debt 235.7 million for a total debt of 240.8 million. The net worth of the company 308 million. Depreciation 3.1 million in the quarter and amortization at 1/2 million during the quarter.

Now a brief recap of the six-month numbers. For the six months ended June 30th, 2002, revenues increased 196.3 million, an increase of 12.6% from the same period a year ago. Gross profit as a percent of revenue expanded from 39.7% for the six month last year to 40.3% for the same period ending this year. Earnings per share after pro forma adoption of increased 44.8% to 49 cents from 34 cents per diluted share in the same period a year ago. This concludes the financial period, or section and I will now turn it over to Rich.

Thanks, Frank. Another a strong performance by the operating team quarter resulted in continued margin improvement. We recently upgrade our system to allow the transportation managers to individually analyze and compare the productivity of each route. The steady increase in operating margins is a direct result of this operating focus on driver efficiency increasing the density of our routes and leveraging our treatment plants. As a result of our strong internal growth, we experienced increased wage volume that helped base load the plants and reduce our per unit processing costs. In several markets, we added new non-incinerate treatment capacity to address this added volume. The resulting decrease in long-haul transportation expense and processing costs helped drive operating margin improvement, also.

We enjoyed strong top-line growth this quarter as the sales and marketing teams pushed ahead in all sectors of our business. The domestic rollout of the compliance program continues with the team focusing on new account growth, conversion of our existing transaction customers and service upgrades. At present, over 37,000 customers are on the subscription model, which equates to approximately 15% of our targeted account base. Based on the performance of our sales team in the first half of this year, we feel very comfortable with our previously announced goal of 18% of the customers on the subscription program by year end.

During the quarter we also grew our revenue base. The sales team secured 56 new hospital contracts and 10 new back-up contracts. The team remains committed to expanding the gross margins of the existing customers through improving pricing and modifying service. With this recent activity we currently have approximately 140 hospital back-up contracts in place. These contracts, as you know, provide a dual benefit -- good margins for the back-up services and favorable positioning as these customers move towards outsourcing.

At the close of the quarter we had signed up over 4800 new small customer service agreements. Thanks to the hard work and dedication of sales teams, we grew our customer base to over 279,000 customers, of which approximately 4770 are large accounts and the remainder are small. Now, I'll turn it back over to Mark.

Thanks, Rich. Clearly, Stericycle had another exceptional quarter with new record highs and revenues, gross margins, EBITDA, cash flow and earnings per share, all contributing to exceptional value creation for our shareholders. We're really excited about the multitude of opportunities, which lie ahead that continued to add expansion of value for our company.

I'd like to provide some insight into our current outlooks for the remainder of 2002. Obviously, keep in mind that these are forward-looking statements.

Current analyst EPS estimates for 2002 range from 97 cents per share to 99 cents per share. We believe that analysts, after detailed review of their models, will potentially raise their estimates to the range of $1 to $1.03 per share, which we are comfortable with. This assumes an average share count of slightly over 45 million shares for the year.

I'd like to provide some fine-tuning to that outlook for 2002. Prior to this call, analyst revenue estimates for 2002 range from $397 million to approximately $399 million, with modest variations depending on assumptions, acquisitions and international revenues in the year. Based upon our performance this quarter and the tune of acquisitions, we believe that analysts may adjust their 2002 revenue estimates upward to between $398 to $400 million.

Current analyst estimates for net income average approximately $44.4 million to $45.4 million. Depending on adjustment for the higher revenues, improved margins offset by related operating expenses and strategic investments, and lower net interest expense, analysts may adjust their 2002 net income estimates upward to a range of $45.8 million to $46.5 million. 2002 annual analyst EBITDA estimates may be increased from approximately $112.5 to $113.5 million to $113.5 to $114.5 million, with depreciation and amortization expense of approximately $15 million for the year.

I'd like to thank our customers first and foremost for their loyal support. Our employees, all of you who are listening or listen to replays, thanks for your incredible efforts for the first half of this year. And, finally, to our shareholders, who collectively have provided with the resources to build a first-rate industry-leading company.

Thanks for our prepared comments today. And the operator will now open it up for question and answer.

Thank you.

If you have a question at this time, please press the one key on your touch-tone telephone. If your question has been answered, or you wish to remove yourself from the queue, please press the pound key.

One moment for questions.

Our first question is from of Bear Stearns.

Good afternoon.

Just two quick questions. Your gross margins for the quarter were significantly better than - or, you know, were better than we were looking for. This 40.5 percent, is this a new level, and can we get better from here going forward? That's my first question.

And the second question is, over the last couple of quarters is seems like you've signed on a lot more large accounts than I remember. Is there some type of driver, is there some industry fundamentals where you're seeing more hospital or large quantity generator conversions?

Thanks.

Thanks.

On the first question on margins, we were pleased with the expansion of margins. Obviously, we continue to see modest increases in PO costs and other expenses. We're working our program and growing our smaller accounts better, increased penetration with Sterr-Safe. And our margin improvement program on large accounts has brought us to a new level.

And assuming, you know, similar conditions for those variable expenses that I mentioned, in the latter half of this year we would anticipate that there's still margin improvement opportunities from where we're at today. In terms of the new account growth on large quantity generators, I think that's just really driven by the continual marketing effort and as customers out there look at who they should pick for a vendor, we believe we have an advantage that those customers who really understand their true liability, it's important for them to select a vendor that has the resources to make it happen. Obviously, highly competitive market, lots of activity going on, but we continue to take those contracts that make economic sense for us.

But there are no, I guess, environmental or legislation or anything like that that's new that's driving, you know, hospitals to outsource or anything like that?

Well I think you obviously have the regulatory framework of the incinerator shutdowns we've had from a competitive environment, as you know, a couple of competitors that had failed earlier in the year which probably caused some concern for some institutions where their service was suddenly terminated by a failed operation.

Also, I think, in general, hospitals, although they're having some improved economic environment are constantly trying to look at how can they be more cost competitive, but also manage their risks in a better way. So, you know, it's a little bit of come at a time telling, but we continue to make progress.

OK, and how many hospitals converted from on-site to off-site this quarter?

We just had a couple this quarter.

OK.

We think, as we've mentioned in prior calls, that of the roughly 300 medical waste incinerators remaining, the ones that have shutdown incinerators and transitioned or have signed up backup, the others are trying to remain and time will tell. We'll see whether they pass their tests coming up before year end and how they do in years to come.

OK. Great, thanks, so much.

Our next question is from Howard Kopeke of UBS Warburg.

Actually, it's Ron Diral for Howard . Hi, guys. Just a quick question on the new hospital contracts, could you give comment on how many of those were pulled through the backup contracts as kind of like a pipeline issue, and then also on the new small accounts; what percentage of the new small were signed up as program, thanks?

On the new accounts that came through backup program, there's about 3 I think that were transition and the vast majority on were people that we're offering to and electing to the program. We're very pleased with the progress period to period. If you'll recall, our original goal was to go out of this year and hit the 18 percent level. We were at 11 percent at the end of Q1 and now at about 15 percent. So, we continue to see the vast majority of new people offered the program but also a large number of people that are under existing contacts upgrade to the program as well.

Right, thank you.

Our next question is from Kevin Munroe of Thomas Weisel Partners.

Good afternoon. A couple of questions, first, can you tell me what internal growth was, you know, before the acquisitions?

The internal growth rates, the two numbers that I've given is a little over 9 percent on SKU and a little over 5 percent on the .

On the small customer the 9 percent growth, is that, you know, that seems like a slowdown from previous quarters, what's --

No, I think it's right in line with --

It is.

-- the last quarter and, in fact, it's up versus the quarters before that if you look at the trends.

Excluding acquisitions, we were over 9, just under 9.5 in Q1, about a little over 9 this quarter last year so the total year was about 9 and the 2000 was about 8%.

OK. Another question, and it kind of gets back into the large customer side. After September, you know, once the clean air act was in effect and the hospitals pretty much had made their decision, what do you think happens for your growth prospects in the large customer side?

Well, we think it will be similar to what we've been doing over the last several quarters. First of all, when you look at many of our gains, for example, this quarter, we are up about 5% and only a handful of those accounts came from incinerator shut downs. Many of them were people just making decisions to either outsource from other technologies or switch vendors. Now, the remaining ones who have made the investment or are in the process of finalizing their investment still have to go through their Title air test, have to pass that test. More importantly, they have to operate for years to come. So any time they have a burp or a problem or any issue with capital equipment it's going to bring another opportunity where they're going to have to look and say, you know, what is my cost, does this really make sense to keep spending more money and more capital on? So, still, it'll take that period of time. We don't expect any tidal wave but we still think there's opportunities for those accounts as well.

Great. And one more on the increase in your stake there, could you just kind of walk through why you did that and has that been booked on the income statement previously, or will it be going forward?

Now, always has been consolidated because we had majority position so there's really no change before and after. This was an arrangement between a party and that was really hindering for making future improvements in their business. Stericycle, through the original purchase of and , really had a guarantee against that anyway and we stepped in to take that party out and as a result, increase our ownership to the 65.6% and also we're the beneficiary of several agreements of profit sharing right and put rights that we got with that at the same time. But it really allows now operationally, to do the things that they wanted to do.

Great, thank you.

Our next question is from Lorraine of Merrill Lynch.

Thank you. Could you talk a little bit about your own plan to upgrade and what your status is with those.

Sure. Right now, all the plans are Title compliant other than one, Ohio, which is being upgraded as we speak and we finished this month. So, we're basically where we originally predicted, which is we said we would be ahead the September deadline with all the plans being upgraded and ready to comply with the new regulations.

And can you give us an average cost per plant and if you see any leverage potential in the future for capital expenditures?

Well, I think on the cost side it varies, obviously, by cost sided plants and what prior infrastructure it had in place on . Our cap ex guidance that we had given 4 to 5% for last year and this year included both maintenance, Title as well as other physical plant expansions and capacity needs and we've been running well within that guideline. Last year our total was about 4.3%. This quarter, as Frank mentioned, it was about 3.5%. So we're comfortable with that.

As we move forward, there may be some modest buffer for us in terms of cap ex for other investments. But I think for right now for cash modeling purposes or the like if you use a four to five percent range you're safe.

OK. And what percentage of your business comes from mail-in boxes?

is really a small, small part of the business. It's something that has been offered for a number of years by a number of people, and it's really for remote situations, geographic remote locations or people that may have one or two, you know, container needs over the course of a year. Or may have needs in a special situation. But it just has never turned out to be a big portion.

I know that over the years some programs have been offered trying to buffer recycling centers, because if a person - many of the people that are on diabetic regimes that are doing self injection at home, most states either have a free compliance program or do not mandate or have legislative control over those. And so often the instructions may be to put those needles into bottles or other containers. And so we've seen over the last five or six years at the regional and local level sometimes you'll see pushes to try to offer options for diabetic patients to help prevent needle sticks in the recycling centers, but it just hadn't ever panned out to be a big business yet.

OK. And one final question. Now that the September deadline is coming up and most hospitals have switched over, could you talk a little bit about your market share, how you measure that and where you see it going in the future?

Yeah. In terms of our business, we still see tremendous opportunity. The way we think about our business within North America is about a $3 billion opportunity. Obviously the pieces of that consist of the medical waste services. More exciting for us in terms of growth and expansion of margins is our safety compliance and training opportunities, as well as some select product supply.

In terms of the hospital universe, we continue to selectively grow that business. As you know, it's not great margins. We've had some modest improvement, but it's still a long way from where it needs to be. So our focus in that hospital sector will be to continue to just upgrade our book of business.

In terms of the share side of the equation, in the larger count universe, which obviously includes hospitals, blood banks, pharmaceutical companies and others, we're less than a third of that penetration roughly. And in terms of the infectious waste services market, less than 25 percent. And if you look at the combined market of med waste services, plus the other opportunities against the $3 billion, we're less than half of that.

Thank you.

Our next question is from of Bank of America Securities.

Yeah, one of the things I think I heard is you were talking about - did you expand multiple facilities and shorten your transportation distance? Is that what I heard?

We had one new plant come on line.

One new plant.

And we have expanded a couple of other facilities so that we were able to take the waste that is in that local geography and treat it right there, as opposed to having to transport it to another plant that had capacity. So it does resolve in an operating margin improvement, because you get rid of the transportation component. You also operate a plant at a higher production level which obviously drives your unit costs down.

Yes. One of the -- and this question is related to the article that was in this week's on the market share. There was a quote about handling 91 percent of the large hospital -- or the large waste generators in California; was that an accurate statistic?

Not sure on the exact calc of that stat. What we believe or are estimating it to be is a calculation of the waste processed by commercial facilities in the State from the large generators. So, obviously, it wouldn't include any waste treated by any generator themselves, waste sent out of State and other methodology. So it's really not a representation of the entire market and obviously the service areas are far broader than just the State.

Got it. Thank you.

Our next question is from Larry Taylor of CSFB.

Hi, this is Michelle Dragonetti for Larry Taylor. Also in the press recently, there's been some talk about a lack of future acquisition opportunities for growth, do you feel that there's enough opportunity within the markets you already serve to, you know, increase root density and add on new customers within the roots that you're already serving to, you know, experience growth in those ways, rather than just, you know, just to focus on acquisitions?

Yeah, I think it's -- that's a very important point. One of the things that if you look at the data and look at the models that are out there, we don't give our guidance or forecasts based on future acquisitions and haven't for quite some time. So, I don't think the expectation side of it or the forward models or forward guidance plays in acquisitions into our business plan. We have a pool of candidates. There's a couple of dozen mom and pop companies. There's plenty of opportunities out there for us. But we're also an extremely disciplined buyer and for us it's a make versus buy decision because we can invest in our sales marketing resource and expand our position geographically and also expand our and other revenue streams. So, acquisitions for us is a nice to have, it's not a necessity in our business.

All right. And, do you have a sense of how much future growth you expect to get from sign up of existing customers and the expansion or, you know, continued roll out of some of the training programs that you currently offer?

Yeah, in terms of trying to put in perspective the growth potential of it, as you can see, for a number of years now, we've continued on our internal growth to expand at very nice clips and those rates stepping up year to year and quarter to quarter.

In addition to further penetration, we're still in the early innings of the opportunity because we're only now at about 15 percent of our target account base on the entry level of the program. That entry level of the program is just a modest step up from the revenue opportunity of the base business, but as they move to the different programs, they can essentially double the revenue stream per account. So, you know, our business strategy and focus right now is continue to drive the introduction of the program, continue the penetration of the existing base because behaviorally what we see happen is that the early adopters started using our program and have gotten used to the value of the tools, they're upgrading to higher levels. So it saves them more money but generates additional revenue and margins for us.

Great, thanks so much.

Our next question is from William Brady of Presido Management.

Great quarter, guys. I have a couple of question. You said you had about 24 in the pipeline but what dollar revenue does that represent?

Those combined probably about 60 million. And, you know, as we've said in prior calls as well, there's no sales guarantee. I don't want anybody to walk away from the call saying that we said we're going to by 60 million. Each one of those, we go through a very disciplined buying process and if the numbers don't make sense, we don't do the transaction. But we've continued over the years to see that pipeline grow. In this quarter, we bought, you know, a little over 3 million in annualized revenue. So, it's really one where we just keep chipping away at it.

OK. Now that you're 15% , have you reset the parallel for the end of the year from 18% upwards?

Well, there's, obviously, we're hopeful to have upside opportunities, but I think we're, for right now, since we've got a few more quarters to go, we're sticking with our 18% or greater going out of the year and we're feeling very comfortable about achieving or exceeding that goal.

OK. Then, can you flesh out your supplies business at this juncture? How many customers and what is the revenue run rate and how fast is this growing?

The supply side is still in just test market stage. So it's not material at this point in time. And we really look at that as a secondary wave, after we've completed the main launch of .

Yeah. So, you prefer not to tell us what the annual run rate is?

No, we don't break that out yet.

OK. Thanks a lot.

Our next question is from Tom Ford of Lehman Brothers.

Good evening, or afternoon, I guess, depending on where you are. Frank, real quick, can you just give me what the percent of debt is, hedged?

ten Brink: It's right now 125 million, out of it's 82%.

Great. OK. And do you, off the top of your head, do you remember a large quantity generator, what was that in terms of mix in first quarter?

ten brink: It was roughly 58%. Same number roughly.

Small

So, from 1Q to 2Q.

ten brink: Yeah.

OK. The change, was that why minority interest in other, I think it was running a little bit lower than it had been in the past quarters?

No. is not in the minority interest part. That's not in there.

OK. So that, all right. In terms of the, Mark, one of the things you'd mentioned was you've always just talked about in terms of focus on the small quantity side and I'm just curious as to whether you see applications to that, to the large quantity side in any way, shape or form?

Actually, it's been from our background, how we started into offering a variety of training and support needs to the small generators originated out of efforts we used to do for free for our customers in the large sector. As we've developed and improved the tool set and toolbox for the small sector, we do have interest in the large quantity generator sector. There's some additional products and modifications that we would probably do to roll it out to that sector to really fully penetrate. But for right now, because the main focus in the large accounts is improve the book of business and its margins, we just have not focused the sales marketing effort on selling those new product services in the . So that is really what we view as kind of a back burner program but a long term play for us.

OK. So a two to three year type horizon maybe?

Yeah, something where we'd want to get well through the early intros of the Steri-Safe program with small quantity generators. And if we see quicker progress on margin expansion in large accounts, then we may introduce it earlier.

OK, great. OK. Rich, do you have the plant utilization rate for the quarter?

We're operating at about 70...

Seventy percent.

Yeah, about 70 percent right now with the additional capacity that we added.

OK. Did that tick down a little bit from 1Q?

Yeah.

Added plant capacity.

OK. And then, lastly, if I have the numbers right, about $41 million of free cash flow in the first six months?

If you look at the cash flow, the cash flow from operations was $49 million. Of that we - year to date we paid $39 million of debt and then used cash for our cap ex.

Right. OK. I'm just - that's why I was stepping it down for the cap ex. I guess I came out with about $41. I mean you gave guidance on some other financial numbers. Any color you want to give on that front?

On what, the free cash flow?

Yeah.

I think if you look for the remainder of the year, I mean you can see from quarter one to quarter two we had a nice improvement in the cash flow from operations. And I think that trend should hold. It gives us the ability to keep repaying and obviously use it for opportunities for acquisitions.

OK, great. Thanks very much.

Our next question is from of .

Hi everyone, and congratulations on the good quarter.

My question is, there was an article in - I don't know if you answered this before, but it mentioned something to the effect of Stericycle being looked at as a potential monopoly. I love all of this growth, but is there a concern that the SEC may start looking at the company for anti-trust violations or anything like that? Is there any concerns along those lines?

No, the SEC, we haven't had anything out of them in terms of looking at this issue. And I think the article also mentioned - in the article - that we did go through a review when we did the acquisition, which is obviously the largest combination and the largest overlap. We went through a process in 1999, went through a second request. And the Department of Justice reviewed and approved that without any restrictions on future acquisitions or divestitures.

And we've also had during that time period several states review that transaction and did not put any restrictions on us, as well. So the additional acquisition candidates that we have in the pipeline are smaller than that require filings.

Good. Thanks a lot.

Our next question is from of .

Good afternoon. I have a few questions here.

In the press release you announced a number of moving parts in your capital structure. I wonder if you could give us an update as to what your overall goals are there. And then can you specifically address the agreement with the convertible preferred holders and how that fits in?

The capitalization, as we said, improved. The goal, as Rich said, in the last quarter range-wise, 35 to 45 percent debt to cap. That would give us a good ability to - maybe with the rating agencies to get some improvement on that front and then give us a very strong long-term balance sheet to utilize all kinds of tools if required from an expansion point of view. As you also saw on preferred, yes at the end of May is when the preferred stops accruing so that will assist then going forward in obviously not being dilutive any more.

Also, based on the 4 percentage point increase in penetration quarter to quarter, it did look like a large number of your existing clients have signed up, did you have any special sales efforts on in the quarter that were targeted directly to existing customers?

Yeah, actually the on-going sales effort consists, as we've talked in the past, of the wave of direct mail, follow-up with telemarketing, follow-up with flyers, reminders, as well as our field force being able to answer questions, presentation at meetings. So, you know, we were on track. Originally, from when we came out of last year at 9 percent to hit our goal of 18 percent or higher by year end we needed to capture, you know, about 2 and a quarter percent on average per quarter and we did about 2 percent in Q1 and picked up in Q2 because of all the activity and push that we put on in the mailing waves and the like in Q1 and we'll continue to do that throughout the year.

OK. Last couple of clean up questions. Frank, if you could address gross margin in your two customer segments relative to the previous few quarters and Rich if you could update us on the customer retention rate?

I think if you look at the large generators, their gross margins are ranging about 15 to 17 percent with new accounts coming in north of 20. On the small customers, that range is the 58 to 61 percent.

And Rich, could you just talk about the customer retention rate in the small quantity generator segment?

Sure. Right now, we retain, on average, about 97, 98 percent of our contracts. So, we have an erosion rate of 2 to 3 percent.

OK. Thank you very much.

Once again, if you have a question please the 1 key. Our next question is from Robert Willody of CSFB.

Hi, Sean Harrington in for Robert Willody. Just on the gross margin improvement, I'm just trying to get my hands on, you know, what you see was the greatest contributor? Was it penetration, was it the add on of all the new small customers; can you just elaborate there, thanks?

Yeah, I think in terms of the step-up, clearly the additional expansion of as well as the growth rate of at a faster clip than large helps us. We also had continued improvement in productivity, as Rich mentioned in his section, the additional plant that we added gave us the capability, shortened some of our transportation costs and gives some operational efficiencies and we did not see as much increase in energy, although we did see increases sequentially quarter to quarter, it wasn't as great in the period. And then, the small tuck ins that we did in Q1 usually in the first 3 to 6 months were going through the integration process and as those are integrated then we get additional flow through as well.

Thank you very much.

Our last question is from Michael McCormack of Gilder Geignan and Hallinsy.

Gilder Giegnan and Hal & Company. Hi, I'm relatively new to the story and I was just wondering since you've had all these tuck in acquisitions, I was wondering, what do you consider organic growth? If you purchase something in the quarter, is that stripped out, or is it if you purchased it in the prior three quarters?

We consider -- first of all, when we talk about our internal growth rates on small at greater than 9 percent, what's excluded from that is any acquisition accounts that would have gone normally into that category that were done in the last 12 months. Once we own an acquisition for 12 months, then we roll it into the base. And in some ways, it actually suppresses our growth rate. Because, let's take as an example, suppose I purchase a book of business from a small mom and pop that has three or four years left on their contracts. Well, there may be contracts in that book of business that are not economically viable, or borderline, or customers that don't pay their bills, or don't have good regulatory compliance histroy. So we may be actually exiting those agreements over an extended period of time, but we net that against that growth rate.

Yes, that makes a lot of sense. Was the million dollars in sales that you generated in the international equipment the only foreign revenue that was generated in the quarter?

Yes, the international equipment sales is sales of equipment and the transaction. Outside of the U.S., we also have operations in Canada and Mexico, which are integrated into the business where we have either 100 percent or majority-owned subs.

And what would be the percentage of net income that would be attributable from foreign?

Oh, diminimous. You take instrumentation, sales would be, of net income, less than a tenth of a percent, or maybe even smaller. So it's not material.

OK, thanks very much.

We have one more question from of .

Hi, this is for . We have three questions. First is on your current pricing versus pricing by your competition. Can you comment on what's been done recently versus a year ago?

I think in terms of pricing vis-a-vis competition, I would say that varies dramatically by competitor by market. I think the case in point, if you look at earlier in this year, there was a company that had gone bankrupt in the southeast, and they were extremely aggressive on pricing, but their gross margins were such that the total business was negative EBITDA. In that kind of a situation, we, obviously, are dramatically higher in our pricing because we do not like to take on work that we cannot be profitable on.

In terms of all of our business and all of our customers are reviewed on a monthly basis to look and make sure that it is profitable work for us. And often, we enjoy advantages. Because of our size and scale, we have lower operating costs. We can pass savings onto customers and still be profitable where a local competitor who might not be in the same cost situation as us won't be able to get to that level.

I see. But on average, do you see the discrepencies between your pricing and your competitors on generators, or the small?

No, I don't think it's dramatic variances.

Then the next question is regarding acquisitions and what happens after you acquire companies. Do you see a significant change in pricing and how long does it take?

In terms of acquisitions, as we buy something there's an entire book of business that has contractual pricing in terms, as well as often has contracted price changes or price increases built into that group of assets that we buy. When we acquire a company, often with the seller there is some form of revenue guarantee. And as we implement our business plans, if the revenues come in per the contracts and book of business that they've sold to us, then there's no post-closing adjustment to them.

In terms of those contracts that they have, it varies by contract as to what that competitor or that company that we bought had negotiated for their price increase capabilities.

Right. But when you generally roll over those contracts, do you generally see price increases, decreases, and what's the magnitude of that?

Typically, in an order of magnitude, it will be pegged a CPI or some mode. If it's a contract that is completely unprofitable, and it comes - it expires and comes up for renewal, we will offer a new service agreement for that customer at a price that makes economic sense for us and that may be a step up in price or a change or reduction in service level, where we still treat all their material and keep their costs the same. But that allows us to improve our margins, and so we can make it a win-win. So it really ends up being on an account-by-account basis.

And the last question is what is your typical EBITDA margin on companies that you have been acquiring in the last two quarters and also on the ones that you acquired a year ago?

It's really all over. I mean there's no one number in that. It depends on the mix of the customers that they have. Are they more in large or small?

Again, from what we normally have seen is that we pay typically somewhere between, as we said before, between 3.5 to five times multiple. The higher multiple goes along with really a strong book of business. Maybe more granular in the sense that it is more concentrated around the small generators.

And then we normally through integration, as we've said in the past, can maybe get a full multiple from a synergy out of there. And that, again, also depends where it's located and if it's in our geographic expansion.

OK.

This concludes the question-and-answer session. Please continue with any closing remarks.

Well we thank you all for your time and attention. It was a great start of the first half of the year. We look to continue these successful quarters quarter by quarter. And really appreciate all of your support.

We'll talk to you folks later.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may disconnect at this time. Have a good day.