Stericycle Inc (SRCL) 2003 Q2 法說會逐字稿

Good day, ladies and gentlemen. 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. If anyone should require assistance during the conference, please press star, then press zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference conference over to your host, Liz Brandel, VP of Finance.

Thank you, I'll 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, 10-Qs, as well as its other filings with the S.E.C. could affect 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 disclose any revisions to forward-looking statements or any facts, events or circumstances after this date that may bear upon forward-looking statements.

During the conference call we may refer to our total debt to capitalization percentage. This is calculated by using the total debt as numerator and the total debt plus preferred stock plus shareholder equity in the denominator. We consider this ratio to be a good indicator of the strength of a company's balance sheet. It is not a measure in accordance with GAAP accounting principles and is not a measure of net income, cash flow or liquidity.

We also may talk about EBITDA, which is calculated as the sum of net income plus income expense, income tax expense, depreciation expense and amortization expense. We consider EBITDA to be a widely accepted financial indicator of a company's ability to service debt, fund capital expenditures, pay interest and taxes and expand its business. EBITDA may be calculated differently by different companies and is not a measure in accordance with GAAP accounting principles. EBITDA funds may not be available for management's discretionary use due to legal or functional limitations, debt service, et cetera.

With that I'd like to pass the call over to Mark Miller.

Thanks, Liz. Well, good afternoon and welcome to our second quarter 2003 conference call. With me today are Frank Ten Brink, Chief Financial Officer, Rich Kogler, Chief Operating Officer, and you heard from Liz, Vice President of Finance.

Once again we're extremely pleased with the record results achieved by the team in second quarter. On a comparative basis, net income in the quarter grew by more than 34.7% and EBITDA reached 34.7 million dollars approximately 30.7% of revenues. We finished Q2 2003 with an earnings per share as reported of 34 cents, up 29.5% over the 26 cents reported in Q2 of '02. Once again, for 28 out of 28 consecutive quarters since '96 we've either met or exceeded expectations for the companies performance .

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

Thank you. First revenues. We had an outstanding quarter as revenues grew 13.9 million in the quarter to 113.2 million, up 14% from 99.3 million in the second quarter of 2002. Excluding international machinery revenues of .4 million in the quarter, revenues were up 14.9%.

Acquisitions, less than 12 months old contributed 10.9 million to revenue growth in the quarter. Excluding acquisitions, small customer revenues grew over 10.5% due to our continued focus on Steri-Safe and large customer revenues decreased 3% due to our increased efforts to improve large customer margins. Customer revenue mix was approximately 60% in small and 40% in large customers. Gross profit as a percent of revenue increased from 40.5% in the second quarter of 2002 to 43.2% in the second quarter of '03. The improvement resulted from better margins in our LQG business sector, integration synergies from acquisitions, continued success on the rollout of Steri-Safe, both penetration and mix, lower variable costs, partially offset by higher insurance and employee benefit costs.

SG&A, excluding amortization was 15.1% of revenues versus 14.5% in the prior year. The absolute dollars spent was up primarily due to higher revenues from internal growth and acquisitions, higher fringe costs and investment spending related to programs such as Buyer Systems and Steri-Safe.

Operating income rose 23.4% to 31.3 million in the quarter from 25.3 million in the second quarter of '02. As a percent of revenue, operating income increased from 25.5 percent to 27.3 percent.

Net interest expense was lower in the second quarter of '03 versus the second quarter of '02 by approximately 2.1 million due to lower interest rates and lower debt outstanding. In addition, we had 1.4 million in premium interest payment related to the repurchase of 8.6 million of our senior subordinated debt and .2 million non-cash write-up of deferred financing fees related to the above-mentioned repurchase.

At the end of the second quarter the balances of our term A loan were 97.1 million and 42.5 million for the term B loan. As previously reported, on May 27th, '03, we repurchased 6.6 million of our 12 and 3/8 senior subordinated note. We repurchased an additional 2 million on June 30, '03. The total outstanding for our senior subordinated bonds, at the end of the quarter, was 50.9 million.

Net income. As a result of sales growth, margin improvement and de-leveraging, net income for the second quarter rose 34.7% to 15.5 million from 11.5 million last year. The quarter included approximately 1.6 million of charges related to the repurchase of our bonds or on an after tax basis 2 cents per share fully diluted.

EBITDA increased 21.3% to 34.7 million versus the 28.6 million in the prior year. EBITDA, as a percent of revenues, was 30.7% in the quarter up from 28.8% in the prior year. Our debt to EBITDA ratio on a consolidated basis was 1.57.

Now to the balance sheet. During the quarter we continued to make significant progress in improving our balance sheet. Our debt to book cap at the end of the quarter was 34.1%, down from 39.1% at the end of 2002, and 43.9% at the end of the second quarter of last year. In the second quarter our total debt decreased by 31.2 million, due to repayments.

During the quarter our capital spending was 4.7% of revenues, or 5.3 million. DSO on the quarter was 53 days versus 57 days a year ago and two days lower than the previous quarter.

Now some selected balance sheet numbers. Cash and equivalents, 6.8 million. Accounts receivable, 64.7 million. Current assets, 92.4 million. Total assets, 695.9 million. Short-term debt, 18.6 million. Long-term debt, 185.8 million, with a total debt of 204.4 million. Total net worth, 394.4 million. De-appreciation in the quarter was 3.7 million. Amortization was .4 million.

Now a brief recap of the six month numbers. For the six months ended June 30th, '03, revenues increased to 225.5 million, an increase of 14.8% from the same period a year ago. Gross profit as a percent of revenue expanded from 40.3% for the six months ended June 30th, '02 to 42.6% for the same period ended this year. Earnings per share increased 34.1% to 66 cents a share, from 49 cents per diluted share in the same period a year ago.

This includes a strong financial picture for the second quarter and we will now turn it over to Rich.

Thanks, Frank. The operating team delivered another solid performance in this quarter. They focused on the basic blocking and tackling of our business, improving productivity while controlling or reducing overall operating expenses. Their hard work and continuing efforts helped us achieve record gross margin expansion. The entire Stericycle operating team pulled together in support of our national rollout of the new BioSystems operating infrastructure. In multiple locations across the country our transportation plant teams are working hard to put in place the permits, equipment and procedures needed to support the new and exciting offering. Through the remainder of the year the operating team will remain heavily involved in the BioSystems rollout and will lend crucial support to this important initiative.

Our hard working, dedicated sales team played an important role in helping us achieve another record quarter. Through their efforts we continued to grow the small customer segment of our business. Each quarter Steri-Safe reaches more and more of our new and existing customer. We are extremely pleased with the success of the Steri-Safe program. In the second half of this year the team will remain focused on new Steri-Safe sales, customer conversions and the migration of existing customers into higher program levels.

Our major account executives continue to seek out large customer opportunities and in the quarter they secured 48 new LQG contracts, all at or above our target margins. However, their primary focus is on improving the margins of low margin accounts. In anticipation of the upcoming BioSystems national rollout, we asked our sales team to accelerate the pace of the LQG margin improvement project. This company-wide program is the top priority for every one of our major account reps. As we previously described, we require all the reps to identify unacceptable margin accounts and implement a specific action plan to improve these accounts. In many instances, the account is brought to our target margins by matching service revenues. Sales teams worked exceptionally hard and on this initiative and the results of their efforts can be clearly seen in our steadily improving margins.

Of course, we accepted not every low margin account will be improved. As we work the program and particularly as we ramp up the pace, we find some low or negative margin customers that will not accept any changes in pricing or service levels. After considering all options, we may elect to terminate our relationship with the customer rather than continue to perform the work at uneconomical levels.

This quarter we made the decision to stop servicing certain LQG customers representing total annualized revenues of approximately $4 million. These were accounts with unacceptably low or even negative gross margins. Although this had the effect of reducing our LQ revenues, excluding acquisitions in this quarter by 3% versus the prior year, we're extremely pleased that our margins on the same base of business expanded 36% year-over-year. Although it's always difficult to end a customer relationship, our entire sales organization is fully committed to returning the LQ business to a sustainable, economically viable level.

Now I'd like to provide an update on BioSystems. The integration of the existing business in the Stericycle seems to meet or exceed our expectations and we've had successful cross-sells in both direction in those geographies where BioSystems and Stericycle currently overlap. We're working hard on all aspects of our national rollout. We've obtained permits in a number of our target geographies which allow us to move ahead with the installation of equipment and related operating infrastructure. Permitting efforts continue and we expect to receive additional approvals in the quarters ahead.

We're encouraged by the strong interest shown by potential customers. Because of this and the fact that permits were received, we've decided to increase our sales and marking efforts to capitalize on this early interest in the exciting new opportunity. We now have received permits to potentially reach a little over a third of the U.S. market. Our goal is to obtain permits to reach more than 50% of the markets by early 2004.

Summarizing the second quarter, we now have over 60,000 small accounts on the Steri-Safe compliance program, equal to approximately 24% of our eligible SQG base. At the end of the quarter we had signed up over 3900 new small customer service agreements, and thanks to the continuing hard work and efforts of the sales team, we currently have more than 298,000 accounts with over 293,000 small and the remainder large.

Now I'll turn it back to Mark.

Thanks, Rich. I'd like to provide updated insight into our currents outlook for fiscal 2003. Please keep in mind these are forward-looking statements. Our 2003 guidance includes the charges of 3.2 million dollars, or more than 4 cents per share, which we have incurred in the first half for the buy back of the senior subordinated bonds, but does not include additional repurchases of bonds or other non-routine items for the remainder of the year.

Current analyst EPS estimates when adjusted for bond repurchase for '03 range from $1.38 to $1.39 per share. We believe analysts after detailed review of their models will potentially raise their estimates to a range of 1..39 to 1.41, which we are comfortable with. This assumes an average share count of slightly over 46.1 million shares for the full year.

I'd like to provide some fine tuning for the outlook for '03. We believe analyst estimates for revenues for the full year will be in the range of 454 to 460 million with modest variations depending on assumptions in international and acquisition revenues. These estimates would include internal growth rates on small accounts of 9 to 10%, of plus or minus 3% on large accounts due to the successful efforts on Steri-Safe and large account margin enhancement programs. International equipment sales may range between 0 and 2 million, depending on obtaining permit amendments. We've already obtained initial permit approvals for projects in Asia and have applied for additional capabilities at these sites. Due to the timing of the requested permit additions, we may not be able to ship equipment in the latter half of '03.

We believe analysts will increase their estimates for net income to approximately 63.8 to 65 million dollars and annual estimates for EBITDA may be increased to, approximately, 138 to 141 million with depreciation and amortization expense of about 17 million dollars.

Closing, we'd like to thank our customers first and foremost for their loyal support, all the employees out there for incredible efforts. Great, great quarter. Finally, our shareholders who collectively provided us with the resources to build a first rate industry leading company.

That's all for our prepared comments, operator, I'd like to open it up for question and answer..

If you have a question at this time, please press the 1 key on your touch tone telephone. If your question has been answered or you wish to remove yourself from the queue press the pound key. Our first question is from Sheetal Mehta from Bear Sterns.

Good afternoon. A couple questions. First maybe I'll stick to BioSystems. You guys got some permits, you're starting to rollout. Can you talk about a couple things? The interest so far that you've gotten from your large customers and how you expect to, maybe, price this service relative to other services that you provide, and then regarding marketing, is it something that you're just going to allow your field reps to market or are you going to do a direct to consumer marketing campaign like you did for Steri-Safe.

Several questions. I hope I'll get them all. First of all, in terms of interest level, we've actually been pleasantly surprised in that regard. We have not, obviously, begun our two-customer marketing activities, but we have had inquiries from existing Stericycle customers in other geographies who have heard about the program and its success over the years on the East Coast. So, we're encouraged by the pent up interest and demands.

In terms of the actual pricing, this would be priced on a service offering basis. So, a customer would need to determine what level and frequency of service they so desire, what activities they would like us to do. So, it will be an account by account buildup of a price for that service offering.

As far as the third part of the yes on marketing activities, our plan is to do a direct sales and marketing as oppose to direct mail activity, because we have people in resources in all of these geographies, we think we have the ability to reach out directly to the accounts. We may supplement that with invoiced offers, direct mail and the like, but this will be more direct face-to-face sales activity.

Okay. Then just to follow up on that, you may not be able to give pricing, but you had mentioned last quarter that you expect revenues per customer could actually be more than double what -- you know, what you currently have. Do you have any goals in terms of what you expect your penetration to be as you roll out maybe by the end of the year or into next year?

As far as revenue per count, yes, it's correct as you mention. We are estimating 35 to 45 thousand dollar opportunity per account.

As far as penetration, we have not given guidance. We will in our next call as we do with all of our conference calls in the third quarter call. We give our preliminary guidance for the subsequent year and then fine-tune that when we do our Q4 call.

Okay. Great. Then one last question and I'll get back in queue. The dropped large accounts that you had in the quarter of $4 million annualized was more than we saw last quarter. Do you think that we're topping out at this point, because it was such a high priority, or do you think that perhaps next quarter we could see, you know, 5 or 6 million dollars of dropped annualized revenues, or do you think it will start to trail off from here?

I think the issue, we don't really have a feel on the pace as to which quarter things fall in. I think we were fortunate in this quarter, because there was a couple of pretty big contracts that we would have loved to have gotten out earlier and we just didn't have the ability, timing wise, to do it and some events occurred that allowed us to gracefully exit those. But you know, it's still a clear priority for us. Although we've had success in bringing our gross margins on a blended basis up, we're a long way from having our total LQG business fixed. So, as Rich mentioned, we want to keep the pace, try to get more and more of that activity. But we still have a lot of heavy lift to go do over the years to come.

Okay. Do you have a sense of where LQG margins are nowadays?

On a blended basis for the quarter we've 22 to 23% roughly.

Okay. Thanks so much.

The next question from Lorraine Maikis of Merrill Lynch.

Thank you. Just touching on LQGs for one more minute, what can we expect from this program going forward? I mean, will this be a real focus over the next few quarters in order to get ready for BioSystems?

I think the focus will continue over the next several quarters. I don't know that we're going to be able to have as dramatic of improvement. We are really pleased in this quarter to be able to have 36% year to year growth in gross margins. So, I'm not sure how many quarters in a row over the next couple of years we can keep a 36%-plus compound growth rate up on that. But there's still, you know, a lot of work to be done. But each one of these is an account by account discussion. So, really tough to call what Q3 and Q4 might look like at this point.

You mentioned last quarter that you had gotten through about 2 million in revenues in the first quarter. Is there a specific piece of your revenue that you're targeting at this point and do you have a percentage of completion that you've done so far?

In terms of the revenues that we're focusing on are the accounts that are way below what would even be considered economically viable business. This would be where, as we've mentioned, we run as a total company blending around 15% SG&A. So, anything that isn't even high teens or 20% just isn't economically viable, particularly in the large quantity sector. So, that's the group that we focus on.

The way that we tackle it is each geography, they take their 10 or 12 worst accounts and try to work account by account. Sometimes we can get improvements through just changes in efficiencies that really don't change the contract relationship, but make the stop more efficient and improve our margins. Other times it's through other dynamics, such as waste minimumization programs that actually expand our dollars earned, or sometimes we just have to wait until there's a chance to renegotiate or exit the agreement.

Okay. Moving onto BioSystems, could you walk us through a time line of what happens once you get the permit, just including the timing of putting the wash line in, the rollout, et cetera?

Well, in terms of timing process, as Rich had mentioned, we've received permits. We've now begun to invest in the infrastructure of the washing systems in critical areas. That from a timing standpoint, our goal is to be ready at the beginning of '04, early '04 to have ability to reach and service over 50% of the potential market, which we think is a very nice base for us to go tackle on. Then obviously with our infrastructure that we have in place of 97 transfer collection domiciles and ability to transfer in, we have unique advantage that we can work on a hub and spoke basis around that infrastructure. So, the future decisions as to what additional cap ex or wash systems are required would be driven on just straight IR type calculations of the transportation distances vis-a-vis the volume. So, we're really feeling good about it.

The permits that we were focusing on are coming through. There's obviously several others that are in queue, but we haven't seen anything to date to give us pause that that's not going to happen.

Finally SG&A spending, you're using a little bits of different approach for BioSystems than you did for Steri-Safe. Could you just talk about the cost in implications of this new program?

In terms of the investment in SG&A?

Yes.

Well, obviously in our guidance that we gave, we're assuming that we will be doing some modest ramp ups in SG&A spend, not out of line with our historical patterns where we were about 15.4% in this quarter. I think that will be a similar level. Obviously, it can move 10 to 15 basis points depending on what's going on in given quarter. But that's kind of the level we're going to start off with. As we see early successes in new geographies, we may take a period of time and put additional resources behind it. But we think the returns would justify it.

The next question from Kevin Monroe of Thomas Weisel Partners.

Good afternoon. Is there anything else going on in large customer segment besides just the churn? Are volumes down or any impact from volumes being weaker than expected?

It's interesting. On volumes we obviously have quite a bit of data on accounts. We've looked back in over a several-year period with some major accounts, some of which are in the public domain and others. We've seen a couple where there's modest variationings, but then we see Surgi-Centers picking up the volume, but nothing material at this point.

Also, the other factor on our business is, as you know, we have some of our accounts are set up on a fixed monthly fee. So, if there is softness of volume that can help us. But most of them are either container or some type of unit metric in the larger accounts. For us that just creates some efficiencies for us. But in terms of the context to total volume, we just haven't seen any really dramatic swings at this point.

Another question. The midpoint of your new revenue guidance for '03, basically it assumes an incremental 7 million relative to the first half revenue that you put up. In light of kind of the churn you're seeing in large customer base, what gives you the confidence that you can do an incremental 7 million in the second half where the first half you've only -- the first and second quarter you've only done maybe 1 or 2 million more in the second quarter than you did in the first quarter? Do you kind of follow what I'm getting at?

Yeah. I think the high end of the range would be, if you assume that there is some international in the latter part of the year, would lead you towards the high end of the range. If you take out all international equipment, you're going to be more towards the lower end of the range. So, the key difference there would be international equipment shipped.

Okay. And the gross margin -- last question. On the gross margins, you actually had a -- you know, from first quarter to second quarter you actually had a reduction in your cost of goods sold. Is that from the churning off of these large customers, or is there something else going on on the gross margin line?

Well, more than half of the improvement is coming from just working the basic programs that we talked about here, which is, you know, the LQG margin expansion program and the shedding of unprofitable work, Steri-Safe and the mixed shift. About a third of that then comes on top of that from, I guess, the fourth leg of what I think the company does well, which is integrating acquisitions. We're getting the synergies out of the acquisitions that we did late last year. We got a small uptick from energy. About a couple hundred thousand dollars of effect.

Okay. Thank you.

And the next question is from Amanda Tepper of J. P. Morgan.

Good afternoon, you guys.

Hi.

I think I can think of a few things that haven't been asked yet. Not to beat the dead horse first on the large customers, but if you took out the roughly 4 million of annualized accounts that you called, can you tell me what your internal growth would have been?

If you took those out, you probably are going to get very close to what the run rate was, which was somewhere around 3 to 4%.

3 to 4%. Okay. So, it's just working through that over however many quarters it will take?

Yeah, it's a continued effort in that sector to continue to look on the low margin accounts that for us are not economically long-term viable. And also where the customer is not really willing to look at paradigm shift from a service point of view and making it a win-win.

Right. Okay. Now, on the small customer side, you're ahead of the penetration rate we had had. What kinds of penetration in terms of cross-selling Steri-Safe into small customers, what kinds of goal have you built into your guidance for the rest of the year?

What we've assumed in our guidance original goal, which we're still comfortable with, is to hit close to 70,000 accounts going out of this year. We're about 60,000 cumulative and still seem to be on that pace. I think that's a save a sumption for now.

Okay. Just on the growth for a minute, and then I have a margin question. The organic growth was a little bit less this quarter than it was last quarter on the small customer base. Is there anything -- is it going to be more closer to 10 than 11 going forward? Is there anything particular going on there?

We were a little over 10.5 versus approximately 11%. I'm not sure at this point.

Where that will fall out for the rest of the year?

Enough to call the 10 or 20 basis points.

Sure. Okay. Then, on the margin side, the big picture question is, you know, these margins -- your gross margins are so high. How high do you see them going over the rest of the year? How much of what happened this quarter came from what you did with the accounts on the large generator side as opposed to margins on Steri-Safe?

I think again, as Rich said, a little over half was working the LQG margins, looking at the mix improvement in Steri-Safe. So, that's an important contributor to the margin improvement that we foresee will continue to help us going forward. So, it's not something that we will lose. Then again, obviously the synergies we obtained is the key that will also continue to go, energy a very small percentage point, could go up or down a little bit as we see right now for the remainder of the year. We have included that year-over-year a slight increase in those energy costs. And so, we feel we're covered on that points.

Do you hedge that at all?

We don't hedge that at this time, no.

Okay. Great. Thank you very much.

Thank you.

The next question from Mark Italiente from Alliance Capital.

Hi. Good afternoon. So, what's the process to exit an account? Are you contracted with an account? You have to wait for the contract to come up for renewal? Or how does that work? Can you cancel it at any time?

It actually varies by contract and generally you have to wait towards either some change of service dynamic or contract renewal trigger. In one case we were lucky. We're into a contract that we had picked up through an acquisition that they'd entered into an agreement with a hospital, a very large hospital that was actually years ago planning to put on site. The hospital had negotiated an exit clause trigger, and we kept hoping that some day they'd exit it, because it was really a cash consumer for us. So, it really ends up being kind of an account by account basis as to whether it triggers. Sometimes we were able to negotiate and for us we would have a notice and exit period, as well. Usually that's the exception versus the rule.

What percentage of revenues would you say are still left to be revisited?

In terms of percent of LQG, we're probably in the 30s, 30-some-odd percent.

Of business you either wants to make more profitable or exit?

Yeah.

Okay. BioSystems, are you licensed anywhere else other than FarmingDale at this point?

Yes. We've received permits now. To put it in perspective, the FarmingDale facility would give us a reach to roughly 10% of the potential market. The new permits that we've already obtained that we're installing equipment in will bring us a totals of about 33%. Our goal is to be ready at launch in early '04 at being able to reach over 50% of the potential market. So, we're seeing those permits come through, tracking as we had expected. A couple have actually come in sooner than expected. But so far I'm not going to -- that's going very well for us.

Just to clarify, a third of the U.S. markets have been permitted, but a third of the market has not been set up in terms of the wash lines have been installed and used, is that correct?

Yeah. So, the 33%, is just a matter of us, we're in the process right now of installing equipment, connecting, bolting systems in and getting ready to go, to go through installation and checkout. Those will be ready to begin their marketing programs and then obviously parallel paths. We have other permits and equipment build in process, as well.

I should have asked my first question better. So, orange FarmingDale, what other facilities have the wash lines up and running?

We don't have any others that actually have final stage operation on wash line. The other permits that have been obtained, equipment is being built and installed as we speak. But they are not through final testing. By the end of this quarter, what percent of that third do you think will have active facilities? I think realistically for us, our main target is in Q4 to be at the mode of clearly seeing that the 33% are done and nailed and that the others are on their way to hit our 50% goal for early 03 launch.

Okay. I'll let someone else ask some questions. Thanks very much.

Thanks, Mark.

The next question from Tom Ford of Lehman Brothers.

Thank you. Good afternoon, guys.

Hi.

Just a couple questions. Number 1, in terms of the breakdown of information, have you guys thought at all about breaking out Steri-Safe and BioSystems separate?

Actually, that's a good question. One of the things that we are frying to work through and will probably do in concert with our 2004 planning process is to figure out what are the appropriate metrics. I know that in the past we've had confusion where when we talk about account numbers, it was much cleaner and simpler when we had just a [INAUDIBLE] service. But now that we've had BioSystems, for example, we have already had large quantity customers which are both on the BioSystems service and Steri-Safe service request combined billing. That makes it much tougher to track. So, what we're kicking around right now is how to do it in a good metric that provides everybody good, clear visibility as to, you know, what's our activity in traction in BioSystems with history, and then also in terms of Steri-Safe. So, stay tuned. We're going to be working on how to provide comparables and so everybody has the history comparables, as well.

Okay. And I don't know. I may have missed it on Steri-Safe. What was the penetration rate at the end of the quarter?

We had reached 60,000 accounts, which is about 24% of eligible accounts.

Okay. And then premium level?

Actually a very nice uptick there. We had about 10% in the higher levels. This is for those not familiar with it. We have multiple levels of program and our select and preferred in the quarter where people pick the higher level programs, such as select preferred. In Q2 it was about 10% in the quarter.

And do you think -- I mean, what are you guys tobacco in in terms of the guidance for your assumptions for the second half of the year?

In terms of the percent tickup?

Mm-hmm.

Now we're assuming that we'll make some continued traction. At year end we're looking for penetration of about 70,000 accounts. And in terms of the higher levels, I think we're still in search early innings, we haven't assumed dramatic change. To refresh everybody's memory, in Q4 we were running about 5%, in Q1 about 7 to 8%. We've made some improvements in Q2 to about 10%. But we're not assuming in our numbers any dramatic shift that we all of a sudden figure out the keys to the kingdom and move to 50% real quick.

Okay. Just one other kind of line ever questions here was with respect to BioSystems. How -- I mean, how long does it take once you get the permit? I mean, what's kinds of the time frame to actually get the equipment installed? And then you were talking about some internal. It seemed like you run -- I guess it's just kind of kicking the tires to make sure everything runs appropriately. But do you have a sense of how long that takes?

Yeah. Once the equipment arrives at a facility, it's not all that complicated. If they're in midshift, they may be 60 days or 90 days, depending on when they can cut in and lock it in. Then we go through a checkout period to just make sure that everything's hooked up right and working properly.

But then obviously, there's a whole series of other things other than just hooking in the wash line. Its's bringing on the sales team. We're working simultaneously, our training programs for everybody, our start-up in terms of operational in-service personnel, people to work through and train through how to install the account. So, there's a whole series of simultaneous activities going on. So, it's not just about a piece of equipment arrives at a plant, four bolts go in the grounds around we plug it into the wall. There's a lot of parallel activities.

Okay. Then just to make absolutely sure, there is no guidance with respects to BioSystems in terms of the numbers that you provided, right?

That's right.

Okay. Then just lastly, you had mentioned on the call last quarter that there were Stericycle-only accounts within the existing BioSystems service region that had expressed interest. I was just wondering where is that and was there any revenue contributed from that in this quarter, in the seconds quarter?

Yeah. In Q2 there wouldn't have been revenues from that. They had closed some new business and signed agreements. I don't believe those have started yet. They're in process of growing through installations. But again, just to temper everyone, the guidance we gave prior, these are not big numbers that would affect our Q3 or Q4-type number. You know, a handful of accounts at 35 or 45 thousand, although better margins and the like, isn't going to have material swings on our EPS guidance.

Right. Okay. All right. Thanks.

The next question from John Boxler of Fahnestock and Company.

Hi, gentlemen. Could you just go over again on the small accounts on the Steri-Safe, what was the total count on the small accounts at the end of the quarter? I thought it was 293,000. Maybe you can --

Oh, it's -- the total number of accounts on the Steri-Safe program is 60,000. Total number of small accounts is 293,000.

That includes both Steri-Safe and transactional.

Yes.

I believe from the opening comments you said you added 3,900 new Steri-Safe in the quarter?

Yes. The numb accounts majority of which were Steri-Safe.

Oh, you added 3900 small accounts, but those were not all Steri-Safe?

The majority was, yes.

Okay. What's the percentage sign-up of the new accounts when you get them, then, that you automatically or immediately get into Steri-Safe.

It's over 90%.

Over 90%. Okay. So, it seems like we do a great job on getting the new customer convinced on the Steri-Safe. What seems to be the resistance on the older accounts, then?

The older accounts, we've been running at a pace of 3,000 to 5,000 new captures per quarter. The older accounts right now have been predominantly marketed through direct mail and invoice stuffers. So, it's just a process of getting people's attention. But there's not a lot of resource that's required to capture those additional thousand or 2,000 per period. I think the reason we're as successful in face to face activities is that you have somebody who's in the process of thinking about a decision, and it's pretty simple sell.

One last question. Is there a churn rate, then rs, that you have on that business? And what's the lengths of the term on the Steri-Safe portion of the business?

Steri-Safe agreements are typically five years in length with renewals on them. Obviously, we just began the program a few years ago so there really isn't an interesting churn level measurement at this point this time. Very sticky. But to put it in perspective, on our old transactional base of business and hospital business, we enjoyed about 95% revenue retention rates.

Great. Thanks so much, guys.

The next question is from Greg Halter of LJR Great Lake review.

Hello, guys. Good quarter. I wonder if you could bring us up to date on any changes in federal rules, regulations on waste pickup and so on, if there's anything out there of that nature?

I haven't seen anything on a federal level, and even in terms of proposed regs that are in the works at this point.

Okay. Great. So, it's status quo?

Yeah.

And relative to auto [INAUDIBLE], incineration and ETD, any significant changes there in percentage of waste in each one of those areas?

No, not at this time.

Okay. Finally, we had been look for 15 or so million the capital expenditures. Do you still expect that number to be around, I think, 4.5% or so of revenues?

Yeah. Cap ex, including BioSystems, will be in the range of the guidance we gave before, which is 18 to 20 million, which is around 4% revenue.

Okay. Great. Thank you very much.

Once again, if you have a question, please press the 1 keep on your touch-tone telephone. We have a follow-up from Sheetal Mehta.

Hey, there. Just a couple quick follow-ups. First, did you see what 3Cl revenues were in the quarter?

3CI revenues were 3.5 million.

Second of all, can you actually quantify the number of large accounts that were actually dropped last quarter and this quarter? You added 48 large accounts in the quarter. Does that reflect -- I suppose those are the added. But then what was subtracted in terms of total accounts?

The quantities, it's 48 new. There's approximately roughly about 40 that were lost, and then we acquired some in the quarter. That total then combined was the increase for the quarter.

Okay. Great. Then just a kind of a generic question. We've heard a lot about procedural volumes being down in hospitals and just general hospitalizations being slower. You mentioned that you haven't seen any -- a whole lot of variation in the large quantity generated volumes. But can you just address that? Have you seen that in the marketplace at all?

You know, where we see it is that when you look at account specifics, you might see some of the accounts that are in the public domain that have talked about admissions down and some outpatient procedures, outpatient surgery down. We may see a half a percent or 1% variance, but for us, if that's an account that is billed on a fixed fee or container, it doesn't materially affect our revenues. Then also on the flip side we've seen others in that same space go up a half a percent or 1% kinds of numbers. Then when we compare and analyze Surgi-centers, we see often where you might have the unit volume affect of the outpatient surgery procedures that may be dribbling out of the hospital space, being picked up by Surgi - centers in the area. They tend to be the less complicated surgeries that can be done efficiently in out patient. They also tend to be some of the higher margin surgeries. There are some attacks on the hospital space, which is from, quite frankly, from our standpoint makes economic sense for the healthcare system and makes really good economic sense for us because our margins are so much better.

Right. Okay. And then, I'm sorry. Just one last question. Can you give us an update on the lawsuits or the lawsuit that's pending, I think from the private individual, and then if there's just anything new on the legal front in terms of new investigations or the like?

I'll answer your second question first. There's nothing new or any kinds of inquiries that we've received. As far as the previously -- or the lawsuits we've previously discussed, just for anybody who's not familiar with them, they're private party lawsuits.

As far as the previously -- or the lawsuits we've previously discussed, just for anybody who's not familiar with them, they're private party lawsuits. They relate the same allegations that the Utah and Arizona Attorney Generals made, which we had previously denied. Those lawsuits are now in the process of being consolidated, which will allow us to efficiently manage them. We still think based on the advice of our council that they're baseless and without merit and we intends to vigorously defend them.

Do you know how many later are in total for those that are being consolidated?

There are currently six.

Okay. Thank you.

I think just another point to add to that, obviously the size of the pie doesn't change. If there's six people or four people or the number of people, it doesn't affect the implications.

The next question from Larry Taylor of CSSB.

Hi. Actually, most of my questions have been answered best of your recollection I do want to ask one more about just large accounts and large account dynamics. Is there anything on the horizon, and I want to take a couple steps back here just to think about things on a more macro basis, that you guys think is going to improve the dynamics there, either from a regulatory standpoint or otherwise? Are we looking at some deadlines or other things that may push some customers your way?

Well, I think the -- what we see in terms of dynamics that push it is more specifics that are going on at the account, and then also within a regional or a district geography, what is the competitive dynamics, as well. As we've talked about many times, if we're in a geography, and let's take an example. If we're looking at an account that is 5% gross margin, that means that the EBIT line, we're losing 10% and we're financing working capital of extended receivables, and we got capital equipment and the like tied up. So, it's just consuming cash for us. In that same scenario, the local competitor, if they decide to take it, it won't probably even be close to making 5% gross margin, because they're much smaller and what happens is we have to be patient. It may take a year or two, but we tend to see that work back.

So, our approach is when we can adapt it, if we can make it a win-win with the customer that,'s our most favorable. But we're also not going to just continue to hold onto revenues that chew up cash and resources without generating value for shareholders while we can apply the same energy toward businesses that do, because when we do see them come back, we tend to get them at very interesting margins.

One sort of housekeeping for you, Frank. The total increase in large accounts, that number was what?

The total percentage increase for large was -- in fact, it was a negative 3%.

Okay.

And on small it was a little over 10.5.

And that's 3% in number?

The 3% in number, it's approximately 40 accounts and a dollar figure point of view from a year-over-year point of view was about 1.1 million in the quarter over the prior year.

Okay. So, 48 new, 40 were lost, you acquired some and that led to a grand total of accounts -- and I apologize if I didn't pick this up earlier in the call.

The total number of accounts at the end of the quarter on the LQ was 5540.

Thank you. Then one other sort of big picture question relating to acquisitions. Can you give us, you know, any more detail there on what opportunities may exist either smaller opportunities or anything larger that may develop?

Well, you know, we continue to work the pipeline, and I think the things that won't change for us is we're going to continue to be disciplined and, you know, right now we see a universe out there potentially of about 40 million of deals that we continually work on. But, you know, timing and which deals come when, as you've always seen, we're a very disciplined buyer and we tends to wait and do things on our own schedule. That's why we don't put anything in the guidance. So, acquisitions are typically up side for us that you've seen.

Terrific. Thanks a lot.

The next question from Steve Domeski of Copper Arch Capital.

Did you guys have any acquisition in the quarter that were unannounced?

We had one acquisition ourselves, a very small one, and 3CI had very small, it was a couple of hundred thousand in revenue themselves.

So, nothing material.

No.

It looks like all the guidance has been going in the right direction, all the though it does look like you reduced revenue from 458 to 466 and brought the upper end down 6 million and the lower end down 4 million. What's the dynamic there we're looking at. Is it just more large attrition.

The predominant element of that change is international. And our Q2 conference call, we had given guidance that international equipment sales could range from -- excuse me -- 3 million to 7 million. And due to timing, just in that process we're in this quarter 0 to 2 million, you have a 5 million dollar swing on the upper end and a 3 million dollar swing on the lower end.

And that actually helps gross margins?

No, actually the gross margin trend wasn't affected in the quarter by the international side of it. It's more just when we actually ship equipment, but not in terms of where we're running on a gross margin basis.

Okay. And then lastly, can you give an update on how the OTC Pharmaceuticals business is performing?

Yeah. Those of you who may not be aware, with the share acquisition there was a small portion of our revenues which we acquired from share related to OTC. That has been tracking very nicely, generates reasonable cash fall through and is actually some expansion opportunities. It's not getting a lot of resource, but the people that are working on it are doing a nice job.

What is's the growth rate in that business?

It's immaterial from total numbers. But they have grown the business and you have a little bit. But it's again, very immaterial in the total schemes. I mean, for them obviously their revenues INAUDIBLE] between around 1.5 to 2 million. So, mean, a hundred thousand swing could be a lot for them.

Okay. Great. Thanks.

Next is a follow-up from John Boxler.

Yes, hi. If we could just go through the same exercise that you did on the large accounts with the actual numbers of the accounts between the, you know, newly-gotten during the quarter acquired, lost and met?

I think quarter over quarter we were at about, last quarter 290,000 accounts. Now we're at about 293,000, a little over that. From that again, you have new accounts of about 3,900. Then you have a small amount of acquired that was really not that material. Then some overall attrition, which again is fired up a couple percent there.

Okay. Thanks.

The next question from Ron Zibelli of Merrill Lynch.

Good afternoon, Mark and Frank.

Good afternoon.

I was wondering, are you still having success in upselling the Steri-Safe customers to the higher levels of service with the higher price?

Yes. Actually, as mentioned in earlier commentary, Ron, the success of upgrading is slow but steady and moving up compared. Compared to last quarter where we had about 7 to 89% of the new Steri-Safe agreements in the quarter at the higher level programs, in Q2 we're about 10%. That's comparable to 5% in Q4. So, we are starting to see as we go through this learning process how to get higher and higher. But we're a long ways away from having it optimize. A lot of that's just due to whether we're putting our priorities and focus. Obviously, first and foremost is as new work is coming in, signing those people up to the program, doing our marketing programs to existing customers, and then doing follow-up marketing now that we're starting to existing Steri-Safe customers offer upgrade programs.

Moving over to the BioSystems side, I know it's early yet and it's a small number of customers, but what are you learning from the early cross-sells that you've made in terms of what you can charge for the service, what the customer is comfortable with in the contracts and how are you modifying your plans based on that?

I think what the early learning process is, 1, in terms of what the charges will bear we're finding it's fairly straightforward once you can get the account into the process of gathering the data for them to say, okay, I'm spending this amount in containers, I'm spending this amount in terms of receiving and inventory. Here's what I'm spending in terms of people and head counts. Here's what it's costing me for the risk management, needle stick side, et cetera.

What I think we're learning, which is not too far all of what the BioSystems experience was is that when you get people engaged in that process and they look at the data, we have a pretty compelling sales argument in terms of, you know, you can help by improving your safety at the hospital. You can help improve very precious nursing time instead of the nurses having responsibilities for doing this. You can improve in terms of efficiencies in inventory management, receiving, distribution, and do that without incurring any incremental dollars. Now, the negotiate process is always, you know, how much savings or how much is on the table. But there's plenty of room there for us to work with.

I think what's pleasing to us is that we are capturing new accounts. When we went into the acquisition, we hadn't really assumed that there would be much new capture in that geography, but we're finding through the cross-selling efforts that we are getting people to be interested in the program, getting to do our presentations and getting orders closed.

So, it definitely feels like it's a faster cycle time, sales cycle, as compared to if BioSystems was seeking to initiate a relationship with a customer?

Yeah. I think that's a fair statement, because we have had accounts that were Stericycle customers in their overlap geography that have now signed up on the BioSystems program.

I think the other thing which is still too small a data point to project from, but I find for my own comfort clearly this program worked and was very effective in multiple geographies in the northeast, mid-Atlantic area. What we weren't sure is what would be the interest levels and what would be the blossoming into other geographic areas. We still have to go prove that. But for the first time in a long, long time, I've been in this for 11-plus years, customers calling and saying, when can I have somebody come out and present this program?

When it first happened, we were a little upset, because we thought that our sales force was getting out in front of itself because they don't have the go-ahead to launch. What we found out, it was really customers having heard about the program through other channels. One of them was a consultant who had worked on helping us with cost savings and safety improvements and had seen BioSystems implemented in other hospitals they'd worked with and had great effect in helping in risk management and efficiencies and had mentioned it to the hospital and the hospital had called us.

So, we're starting to see much more interesting dynamic in terms of, you know, are people focused this matter and is it something they believe is an important issue? And I think part of that is driven by just the intense pressure on how valuable nursing time is and how tight people are for nursing staffing and clearly the focus on safety.

That's great. Thanks a lot.

The next question from Elliott Schlang of LJR Great Lakes Review.

Good afternoon. Three quick questions, if I may. Number 1, with the President's new program on dividends, are you giving any thought to the payment of a dividend?

As far as dividends, we obviously are aware of the changes. We have not made any firm decisions about dividending or not. The use of free cash flow, at least in the near term for us, is -- first priority is focusing on clearing out the very expensive 12 and 3/8 paper that we have out in the senior sub bonds, and obviously using cash to invest and grow our business. The thing that is approved and in place is the stock buy back program. But nothing decided or official on dividends.

Second, I noticed intangible assets jumped about 10 million dollars. I assume part of that is up from the small acquisitions that you made. But could you amplify on that?

There were some minor adjustments in the quarter when valuations were done on those that were done in the 4th quarter. That was one of them. A share study was completed, so that moved things in the right buckets at that point. So, you might see some movement then in the quarter. 1, you obviously had for a year to date points of view the share transaction that was included. I'm not sure if you were looking at just Q2 or Q1 and Q2 combined.

I'm looking at June 30 versus December 31.

Yeah, so share would be in there. It's the major contributor that increase.

Last, I assume from your comments before before that the priority acquisition will be in melding gee graphic acquisitions in the same businesses that you're presently in. But perhaps I'm wrong. Is there a chance here that you might make a strategic shift into a new related area?

I think clearly our focus, there's lots of opportunities in the core skill sets and businesses. That will take first priority.

Thank you.

Follow-up from Mark Italianente.

You touched money it in the last caller's question. The debt, you mentioned the guidance is ex- the possible pay down of future debt. What are your thoughts on that?

In terms of bond buy back, as we continue to mark ups there, if bonds are offered to us and the economics makes sense for us to buy them now versus waiting till November of '04 we can take anything that's remaining out under our forced call provision. Then we would negotiate with those through our offering and purchase them as we've done throughout the share. But since it's a very liquid market for those bonds, that woe don't really have a way to forecast what's going to happen on those. But if no one presents them at the right price, we won't buy any and we'll take the rest, whatever, 50.9 million out in November of '04. But if something comes along before then at the right price, then we chip away at it.

Thank you very much.

And there's a follow-up from Tom Ford.

My question has been answered. Thank you.

This concludes the question and answer session. Mr. Miller, I'd like to turn the conference back to you.

Well, thank you, everyone, for participating in the call. Great questions. And it's one where we're extremely pleased with the progress. I think in the time frame that I've been in the business I can only remember a couple of times where we've had sequential improvement in our gross margins like we've seen lately. So, the basic strategy that we've been following for the last seven years, of focusing on driving our small quantity generator, improve our mix, go after the higher margin programs and make sure that everything that we're servicing is eventually generating some cash and value for shareholders, proves out that it's working. We've got an exciting future ahead of us. So, thanks again. We'll look forward to talking to you on the Q3 call.

Ladies and gentlemen, thank you for your participation in today's conditions. This concludes the conference. You may now disconnect. And have a good day.