STERIS plc

NYSE:STE

Earnings Call Transcript 2021-Q2

[Operator]

[00:00:02] Good morning, everyone, and welcome to STERIS plc second quarter, twenty twenty one conference call, all participants will be in a listen. Only mode to you need assistance policing all conference specialists by pressing the star key, followed by zero. After today's presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. At this time, I'd like to turn the call over to Julie Winter, vice president of Investor Relations man. Please go ahead.

[Julie Winter, Investor Relations]

[00:00:34] Thank you, Jamie, and good morning, everyone, on today's Call. We have Walter Rosebrough, our President and CEO, Mike Tokich, senior vice president and CFO, and Dan Carestio, our Chief Operating Officer. I do have a few words of caution before we open for comments for management.

[00:00:53] This webcast contains time sensitive information that is accurate only as of today, any distribution, retransmission or rebroadcast of this call without the express written consent of Staros is strictly prohibited. Some of the statements made during this review are or may be considered forward looking statements. Many important factors could cause actual results to differ materially from those in the forward looking statements, including without limitation. Those risk factors described in stereoscope securities filings. The company does not undertake to update or revise any forward looking statements as a result of new information or future events or developments versus FEC filings are available through the company and on our website. In addition, and today, it's called land gap, financial measures, including adjusted earnings per diluted share, adjusted operating income, constant currency, organic revenue growth and free cash flow will be used.

[00:01:58] Additional information regarding these measures, including definitions, is available in today's release with reconciliations between gap and non gap financial measures. Non gap financial measures are presented during this call with the intent of providing greater transparency to supplemental financial information used by management and the board of directors in their financial analysis and operational decision making. With those questions, I will hand over to Mike.

[Michael Tokich]

[00:02:29] Thank you, Julie. Good morning. Everyone is once again, my pleasure to be with you this morning to review the highlights of our second quarter performance for the quarter consecrates organic revenue increase two percent, driven by one hundred basis points of volume and one hundred basis points of price. Constant currency organic revenue for the quarter includes a total of about five million dollars for prior year. Tuck in acquisitions primarily in health care, spread across capital equipment, consumables and service. Gross margin for the quarter was up one hundred and forty basis points to forty five percent and benefited from a mix price and productivity. Even margin for the quarter was twenty two point five percent of revenue, an increase of two hundred twenty basis points from the second quarter last year due to higher gross margin attainment and lower operating expenses, mainly for travel, sales and marketing and compensation due in part from business disruption from covid-19. The adjusted tax rate in the quarter was twenty one point one percent and includes the benefit of stock compensation offset by unfavorable discrete item adjustments. That income in the quarter grew 13 percent to one hundred twenty seven point three million and earnings increased to a dollar forty eight per diluted share as compared to a dollar thirty two per diluted share in the prior year. Our balance sheet is a continued source of strength for the company, considering our cash position of three hundred twelve million access to available credit lines and a low leverage ratio. We are well positioned from a liquidity standpoint, even reflecting the anticipated additional leverage for the key surgical acquisition. Our debt levels remain so solidly in our comfort zone. During the second quarter, capital expenditures totaled forty three point nine dollars million, while depreciation and amortization was fifty four point four million dollars. Free cash flow for the first half was one hundred eighty five point six dollars million, an increase of twenty three point six dollars million over the first half of last year, primarily due to improvements in net income and working capital, somewhat offset by higher capital expenditures. With that, I will now turn the call over to Walt for his remarks.

[Walter Rosebrough, President and Chief Executive Officer]

[00:04:47] Thanks, Mike, and good morning all. I hope you all have voted or will later today. We are pleased to be with you to report such encouraging results for our second quarter, which reflect the resilience of our business and the good work done by Styris associates. In total, constant currency organic revenue grew two percent year over year and improved substantially on a sequential basis. We benefited from the continued recovery in procedure volumes during the quarter, as well as continued strength in segments with exposure to covid-19 related products and services. I release walks through the details, but I will touch on a few highlights of the quarter. Lifesciences grew 16 percent in the second quarter, continuing its strong performance in particular for consumables. Well, it's difficult to dissect the thirty 31 percent consumables growth in the quarter. We believe the underlying growth rate remained in the lower teens and the balance of the growth is due to covid-19 prebuy in anticipation of vaccine production demand, as we've said all year. We do not anticipate maintaining these growth percentage levels in perpetuity. In particular, our fourth quarter has difficult comparisons as last year's fourth quarter was the beginning of the lifescience consumables, significant covid-19 related revenue uptick. Rebounding from first quarter levels, our asset segment grew nine percent year over year in the quarter, benefiting from continued demand for covid-19 products, sterilization, as well as a significant recovery of procedure related medical device sterilization volumes. As we said in prior quarters, we continue to invest aggressively in capacity expansions at Høst, reflecting our long term expectations for the growth in this business.

[00:06:46] As anticipated, our health care segment continued to be impacted by some disruption in procedures in the quarter, declining three percent year over year, but improving nicely on a sequential basis. Both consumables and service rebounded from first quarter levels, with consumables revenue growing six percent year over year while service revenue was flat.

[00:07:10] Capital equipment shipments in the segment declined as we anticipated those shipments were down 14 percent versus the second quarter of last year. As you know, we break our capital business into either large projects or replacements. We were pleasantly surprised to see replacement orders rebounding sequentially in the quarter, reflecting a return to more normal procedure volumes. Capital equipment orders have grown sequentially through October from the low point in May and have returned to about last year's levels. Like most in our space, while we are pleased to see the sequential improvements in revenue from procedures to date, there is significant uncertainty in the coming months as the covid-19 pandemic appears to be escalating in many areas around the world. We have seen recent procedure declines in parts of Europe. It is too soon to tell what we will experience going forward in Europe and in the US in the next six months. That said, we are not planning a significant disruption of procedure volumes in the second half of our year, as a result, we're planning for sequential revenue growth in the second half to result in about flat year over year revenue, excluding any impact from the anticipated key surgical acquisition. Well, we are quite pleased with recent trends, the situation is fluid and difficult to predict. We still consider our health care capital equipment portfolio to have the greatest downside risk in the near term.

[00:08:49] If procedures continue to improve, when the pandemic subsides, we will expect some costs in operations to start coming back to more normal levels in the second half of the year, which will limit our bottom line percentage growth somewhat.

[00:09:03] As we said all along, we manage this business for the long haul.

[00:09:07] Our actions during this pandemic reflect that approach, including our decision to avoid unpaid layoffs or furloughs related to covid-19. We've worked hard to maintain jobs and compensation for our people, putting programs in place to take care of those who need extra support and providing paid furlough for those people in operations that were impacted by a decline in the business due to the pandemic. Total cost for covid-19 programs and expenses were four and a half billion dollars in our second fiscal quarter, about half of what we saw in Q1.

[00:09:41] Normally, our approach to investments has not changed. We continue to expand our Høst footprint and to invest in R&D. We have introduced a full suite of surgical products this year, including new operating room lights, several new surgical tables and a next generation or a system. And the infection prevention side of our business recently launched products include our new smaller footprint, steam sterilizers and more rapid biological indicators, among others. We do not expect a consequential slowdown in our new product development efforts or in spending for R&D as a result of the pandemic.

[00:10:20] Before we open the Q&A, I would like to again thank steers people for their commitment to our customers who have continued to be the heroes on the front lines of this pandemic.

[00:10:32] While there is uncertainty in the near term, given the covid-19 situation, we like the positioning of our global global portfolio during the pandemic as well as when we come out of it. We are working toward completing the previously announced acquisition of key surgical by calendar year end and look forward to welcoming these people to this Derris family.

[00:10:55] We stand ready to capture additional opportunity and continue to believe that the long term future for us is bright. With that, I will turn the call over to Julie to open for Q&A.

[Julie Winter, Investor Relations]

[00:11:06] Thank you, Mike and Rob, for your comments. Jamie, would you please give me instructions and we'll get started on Q&A?

[Operator]

[00:11:14] Ladies and gentlemen, at this time, we'll begin the question and answer session to ask a question. You may press star and then one using a touch to a telephone. If you are using a speakerphone, we ask that you please pick up the handset before pressing the keys to ensure the best sound quality.

[00:11:31] Once again, that is Star and then one to ask a question. We'll pause momentarily to assemble the roster. And our first question today comes from David Turkaly from JMP Securities. Please go ahead with your question.

[David Turkaly, JMP Securities]

[00:11:48] Ok, good morning. For my baby, 100 basis points you talked about in price, I know you may not want to get into super detail about that, but I think that's a little better than what you've seen of late. And I was wondering if you just might comment on, you know, where you're gaining that in particularly in this environment.

[Walter Rosebrough, President and Chief Executive Officer]

[00:12:09] Yeah, yeah, one hundred basis points, typically, we are somewhere between 50 and 100 basis points this quarter, obviously we were we were at that 100 basis points level and we are actually seeing price across all three of our segments in the second quarter.

[00:12:24] So I would not point out one individual one, but just across across each of our segments.

[David Turkaly, JMP Securities]

[00:12:30] Great now and a quick follow up, you know, you mentioned you call that some working capital improvements. I'm just curious if we should view some of those as, you know, permanent or sort of a one time, or how are you looking at some of those improvements and how should we look at them moving forward? Thank you.

[Walter Rosebrough, President and Chief Executive Officer]

[00:12:47] Yeah, I would say that, you know, from a working capital improvement standpoint, we've actually been successful in reducing our days. Sales outstanding pretty significantly this year, although that is a little bit of math, if you will, because as as if it does drop the days, sales outstanding do increase or decrease year over year. And we have been offsetting inventory. Inventory is on the rise. We continue to have higher inventory levels because we are maintaining both surety of supply and we are level loading. So I would say that, you know, DSOs favorable a couple of days, we should be able to continue to drive that at least this the remainder of this fiscal year. I don't know about next fiscal year. And I would also say that inventory, our projection is inventory would still be elevated by the end of the fiscal year. So I would say those two will pretty much naturally offset and we will continue to see as long as we see net income growth, we will continue to see free cash flow. Generation, in addition to our capital expenditures are also up. And we, as we've spoken about many times, we do anticipate spending over one hundred million dollars in expansion, capital growth for Høst. So don't be surprised if you see year over year growth in CapEx. By the by the end of the fiscal year, we were up 13 million dollars in the first half and we projected to be more than that up for the full year.

[Michael Tokich]

[00:14:16] And I would add another temporal one is government tax payments have been deferred related to the pandemic act.

[David Turkaly, JMP Securities]

[00:14:26] Got it. Thank you.

[Walter Rosebrough, President and Chief Executive Officer]

[00:14:27] There's a mixed bag there, I would say, you know, obviously the government payments are temporal capital spending is more longer term. And I think as Mike is the if you look a bit longer term, the inventory and receivables will probably revert back to their more normal levels over time.

[Operator]

[00:14:52] In our next question comes from Matthew Mishan from KeyBanc. Please go ahead with your question.

[Matthew Mishan, KeyBanc Capital Markets]

[00:14:59] Hey, good morning, guys. I didn't quite catch all of the all the guidance for the back half, did you did you say you're going to be year over year flat sort of full year on organic growth basis? And what are you what is that what are you implying for the second half versus the first half? I didn't I didn't catch it all. I just want to clarify.

[Walter Rosebrough, President and Chief Executive Officer]

[00:15:23] Yeah, Matt, first of all, well, first of all, good morning, but after good morning, we're not guiding, just to be clear, but, you know, we have to plan even independent of the fair amount of uncertainty that's going on. And so we're we're planning roughly flat year over year revenue. And that's largely speaking kind of all the same constant currency, not constant currency. There's there's essentially no in fact, I think no. Or inorganic growth in the back half of the year. So that that's an irrelevancy unless key comes in place. And we're not talking about key, but orders of magnitude. We're kind of thinking flattish. And it's it's our consumables business or recurring revenue business is continuing to grow with some conservatism on what's capital is going to do for the back half of the year.

[Matthew Mishan, KeyBanc Capital Markets]

[00:16:22] Ok, understood. And then and then the contribution, just for clarity purposes, the contribution from talking M&A over the next several quarters. I'm assuming that that weighs a little bit as those anniversary OIBDA zero zero, it's tiny this quarter might five million dollars this quarter.

[Walter Rosebrough, President and Chief Executive Officer]

[00:16:43] And by the time we get to the third quarter, I believe almost every one of those will anniversary. So it will be, if not zero, very, very close to zero. So we won't even speak to it.

[Matthew Mishan, KeyBanc Capital Markets]

[00:16:53] I think everyone's happy about that.

[Walter Rosebrough, President and Chief Executive Officer]

[00:16:57] We're unhappy. We like to have more. But but we've got a significant one coming, so that's fine.

[Matthew Mishan, KeyBanc Capital Markets]

[00:17:04] All right. And then the life sciences business and maybe I have to ask you, what is the capacity you could you're about a two hundred million dollar business right now, plus or minus. What is the capacity you could produce it if customers said, just give me everything you got, are you kind of maxing it out at this point at plus 30 percent? Or could it or could you actually kind of flex that up even further?

[Walter Rosebrough, President and Chief Executive Officer]

[00:17:30] Yeah, we're not capacity constrained at this point, man, and, you know, barring the ability to get the components, which I'm not aware of any where we are struggling. So but, you know, you always have to pay attention to supply chain issues. But barring some supply chain issue that I'm on and where we could go a great deal, you have to remember that most of our work in this space in an IPG and lifescience are sharing factories. And so the capacity of those shared factories is greater now if everything goes up 50 percent and that's a problem. But, you know, the capacity that we have in the combined life sciences facilities, I don't feel that we have a significant capacity issues.

[Matthew Mishan, KeyBanc Capital Markets]

[00:18:25] All right. And then I realized this last one. I realize it's a tough question given the volatility and the overall breadth of your portfolio. But how much do you how much do you think you're outperforming your end markets by with with share gains? It just it just it just seems like you're you're just well above where the market will be.

[Walter Rosebrough, President and Chief Executive Officer]

[00:18:47] I don't know about quantity, and particularly in short terms, that it's very difficult to have a feel for us versus everybody else, if you will, as everybody reports, it's helpful. But we have a lot of competitors that are not public, so it's still difficult to get that overall reach. But I think we are confident that we're we're getting more than our fair share of wallet in virtually all of our spots.

[Matthew Mishan, KeyBanc Capital Markets]

[00:19:16] Thank you very much, Julie.

[Operator]

[00:19:21] Our next question comes from Larry Keusch from Raymond James. Please go ahead with your question.

[Lawrence Keusch, Raymond James]

[00:19:26] Great, thanks. Good morning, everyone. I guess first question here is, you know, one of the really interesting things about the Stairs portfolio is that, you know, you essentially have all these different businesses that, you know, can benefit and serve as hedges, you know, within within during the pandemic. They're obviously parts of the business that that are impacted as well. So really, what I was just trying to understand for the quarter, is there any way to help quantify what you think the amount of tailwind was for revenue in the quarter? And conversely, what you think the amount of headwind was for the quarter?

[Walter Rosebrough, President and Chief Executive Officer]

[00:20:10] Well, Larry, I guess that's a tough question to answer, but I I think the easiest way to quantify it overall is, you know, we're running flat, which is better than, um, again, the segments that we tend to work in, all things being equal about flat in revenue. And we did not anticipate Frico would be in flat. So we would have said we would plan on being up probably this year. We would have expected to be a high single term, maybe even into the low double digit numbers. And as a result, I would argue that we're probably about 10 percent negative headwind versus tailwind plus or minus a little bit. So orders of magnitude, that would be our best answer. And, you know, the places are obvious, right? In a city where we're doing PPY and in LifeScience, where we're gearing up for the vaccines, we're getting a nice tailwind, but we're procedural based company and health care and procedures have gotten beat up. So that's been the opposite side of the equation.

[Lawrence Keusch, Raymond James]

[00:21:16] Ok, very good to two other ones on on on life sciences. So, you know, well, I guess I'm just trying to again, understand, you know, how we should think about the exposure there to vaccine production. So I'm wondering if you can talk a little bit about, you know, are you are you exposed more to one type of vaccine technology versus another? Are you exposed to very specific customers that if they make it through, you know, that's that's a positive. And if they don't, that perhaps doesn't impact, you know, positively impacting as much. And I guess the other part of that question is, you know, as you've seen the improvements in the business and and the profits come through, how are you are you letting that drop to the bottom line? Are you investing that again? I'm just trying to think forward a little bit on this as to how you manage, you know, the the margins as you come off the other side of this.

[Daniel Carestio]

[00:22:31] Hey, Larry, this is Dan. Maybe I can give you a little information on the market in particular, you know, with vaccines, that's really instead a sweet spot in terms of our everything. Auction is, by definition, aseptic manufacturing. So it's manufactured in a sterile environment and, you know, near sterile clean rooms. And the products that we that we sell and the services that we have are used to ensure that those environments can operate in an aseptic manner. And in addition to what we're selling into vaccine from life sciences, we've also seen a significant uptick in demand in Høst in terms of bio precursor. These are bags or liner's or tubing sets and things like that used and used in aseptic manufacturing specifically for vaccines. And I wouldn't say that any one company or another in terms of the customers we serve is more has a higher demand or a lesser demand based on their methods are all basically very similar methods in vaccine production. And I'll require an aseptic environment.

[Walter Rosebrough, President and Chief Executive Officer]

[00:23:42] And, Larry, I guess we're broadly enough across, obviously, if if all of our best customers happen to be the lucky ones, we're better. And if there's a couple that are not our best customers are the hot ones, that'll be a little worse. But I think we're pretty confident that the pre buys that we're seeing are a function of the people who are likely candidates. So we're pretty comfortable that we will see an ongoing effect in I think in the short to intermediate term, it's unlikely it's going to shrink. It's just it can't keep growing 30 percent a year forever.

[Lawrence Keusch, Raymond James]

[00:24:21] Ok. And on the margin question around here, you are investing against the profitability there. How are you doing that?

[Walter Rosebrough, President and Chief Executive Officer]

[00:24:29] Yeah, great question. You know, part of the margin expansion is strictly a function of mix. And so, you know, some of that's just natural. But and secondly, as most companies, we were not at all clear how ugly this thing was going to get when it started. And so, you know, we shut down hiring in certain places. You know, we kept spending in the R&D functions. I thought the long term future we kept spending. But on the short to intermediate term things, we kind of took a step back and and we'll pick some of that back up as we see the I'll call it the long term look going forward, we're increasingly comfortable as as you might expect, but there's still a lot of uncertainty out there and we're watching it. You know, normally we watch quarter to quarter watch and week to week right now. And, you know, there are so many things going on, some of which can be very positive and some of which could not be not so positive. And so we're just being careful. So we'll lag the the spending probably a little bit for a while, and then we'll catch up at the appropriate time.

[Lawrence Keusch, Raymond James]

[00:25:41] Got it. And then last one for me, ASTM, you know, margins just continue to be very impressive and continue to move higher. You know, how do we think about these kind of do you think this is kind of cliquish margins here? Are you have some of this incremental volume comes in, whether it be around Lifesciences or other sterilization needed for the pandemic, is that coming in at a higher price? And that's influencing the margins higher? Just again, trying to think about how we should, you know, really think about that. That's a longer term margin in that business.

[Walter Rosebrough, President and Chief Executive Officer]

[00:26:16] The Asti business, as you know, and we're very happy with the margins in that business, obviously, but that's our rules. And, you know, when you're plowing a hundred million or so every time you turn around to grow capacity, the ROIC is not extraordinary. It's good. I mean, we're not complaining about the ROIC in that space. It's it's a very good investment. But but we're putting a lot of money to make that money in place to make that money. So, you know, I would not characterize it as over the top in terms of when you look at our CEO, we think there's room for improvement as those new facilities mature. You know, if you look back and, you know, you were with us some time ago when every time we had a plant, we had to knock off 50 to 100 basis points because each plant affected the overall our OS. Today we have, you know, over 50 plants. So one plant make that much difference. But if you look plant by plant, those newer plants are not making that kind of money on an hourly basis. Well, on our OS or ROIC basis that the than the older plants are. So, you know, it's a function of those things.

[Lawrence Keusch, Raymond James]

[00:27:31] Ok, very good. Thanks very much. Appreciate it.

[Operator]

[00:27:36] In our next question comes from Chris Cooley from Stephens, Inc. Please go ahead with your question.

[Christopher Cooley, Stephens Inc]

[00:27:43] Good morning and thanks for taking the questions. Well, maybe if we could start with a big picture, one here this morning and kind of falling on what Larry was getting out there, you know, structurally have a lift with your life, science and history franchises seeing accelerating growth. You've taken some costs out of the model through others planned investment going forward. But should we also see over the next 18 months as the business starts to normalize, hopefully, you know, from coded, should we see a natural lift as well in cash flow in the business versus historical levels? Or how do we think about cash flow generation? Not so much for the back half of this fiscal year, but but more so on kind of a go forward basis. Should we see a natural if there are there uses of cash that will start to pick up there, then I've just got a couple of follow ups.

[Walter Rosebrough, President and Chief Executive Officer]

[00:28:41] Yeah, Chris, you know, I would say both in cost and as a result in cash, you know, there's a lot of I'll call it sales and marketing spend. It's not going on in the world right now. And it has a limited detrimental effect because none of our competitors are spending that money either. But when when we return to the more real world, I suspect strongly that we and our competitors are going to put boots on the street more and more and travel more and do a number of things more that we cannot do. So that will that will have some of it. Some normalization effect on earnings and cash will follow naturally with that. So I think that's point one point, too, though. Your points were taken as we grow in profitability and we have mixed more toward some of those higher profit areas, then that profitability will flow through and cash completely. And then the only question is how much we're spending either in acquisition or for organic growth in order to the use of that cash. And and we fully intend to spend as much as we can for those two things, because that's that's what the future cash flow generations are. But if you if you pull out the investment side of it, yes. The cash will grow again. We would we would hope to be able to spend as much of that as possible to grow in the future in a in a reasonable way, organically and through acquisition.

[Christopher Cooley, Stephens Inc]

[00:30:16] Appreciate that. Just two quick follow up for me. The first, could you just remind us when the last time was that you had solidified your raw materials contracts, more specifically for the Cobalt 60 on that front? A lot of discussion about that here as of late, as I'm sure you're aware. And just want to revisit when those were last visited, kind of the terms of those those agreements. And then one other quick follow up. Thanks.

[Walter Rosebrough, President and Chief Executive Officer]

[00:30:48] Hey, Chris, appreciate the question. We do not get into the details of our vendor contracts, just like we don't get in the details of our customer contracts. Suffice it to say that we have visibility for a reasonable time. We tend to do both of those on on a long term basis, particularly in the ASD business and kind of everybody, the the suppliers, the vendors and the and the customers recognize that everyone's in a better spot if we all know what we can and cannot provide and and what people are going to do and not do. So those tend to be intermediate to longer term contracts. And that's that's the case and across the board, understandably so.

[Christopher Cooley, Stephens Inc]

[00:31:33] Last night. And you just want to make sure I'm squaring my assumptions correctly. So. You're in you're essentially flat directional planning for the full fiscal year X key surgical, you are not assuming, I guess, any incremental headwinds from covid-19 in the back half of the year or you are still assuming some incremental headwinds, maybe whether it's from procedure, softness, as you cited parts of Europe now are experiencing, or maybe its purchasing patterns. You know, in prior conversations on these calls, we've talked about, you know, hospitals carrying a little bit higher consumable inventory on site than what they had in the past. Just just wanting to make sure I fully understand what you're banking on when you're talking about getting a flat year over year for the fiscal year. Excuse surgical. Appreciate it. There's a tough fourth quarter. Thank you, Chris.

[Walter Rosebrough, President and Chief Executive Officer]

[00:32:33] Again, I'm telling you, planning and that plan could change next week or next month or so. And that's why we're not giving guidance. There are so many uncertainties right now, both positive and negative, that we think it's uncharacteristically difficult time to forecast. But having said that, in general, we're not anticipating a huge reduction in procedures like we saw in April, May, June or in the March, April, May. We're not anticipating that level of reduction, which was pretty catastrophic. But, you know, we will we do expect tempo changes, kind of spot changes around that's kind of built into our thinking. We again, we do expect and part of that is one offsets the other a bit. We have a little more that we have a little more PPY process. We have a little less we have a little less PPY and a little more of the procedural devices. So, you know, we're balancing those issues. And our best view of that is, is that, you know, we come out of that flat. Having said that, it is we've still given the history that we've seen to date, which is about the best thing we have to work off of and how nice a job the facilities have done with the treatment protocols of covid-19. I think that's kind of grossly misunderstood and under appreciated is the the facilities around the globe.

[00:34:12] And the physicians and nurses around the globe have really improved their knowledge of how to deal with this disease. So even as it heats up some, there are a lot better, a lot better positioned to take care of patients and as a result have done things to be able to continue to operate their procedural spaces. It would only be, in my view, unless it goes a lot worse than anticipated, it would only be patients deciding to do the concern of covid that would reduce the procedures a great deal. So we just have to wait that one out. But in general, we are expecting some spot spot issues around the globe, but not an overwhelming reduction like we saw before. We're expecting to see some additional PPA and processing as a result. And clearly we're anticipating good growth or good volume in the lifescience business for vaccine production. So at a high level, I'd say that's pretty much it. We are being a bit cautious in our view of capital, even though orders have come back quite a bit better than we expected. Being flattish recently is better than our anticipation. But, you know, capital can bounce a little bit. So we're being a little cautious on our thinking about capital.

[Christopher Cooley, Stephens Inc]

[00:35:39] Thank you. You bet.

[Operator]

[00:35:42] Our next question comes from Mike Matson from Needham and Co.. Please go ahead with your question.

[Michael Matson, Needham and Company]

[00:35:48] Yes, so I just want to ask about gross margins. I mean, they were up a fair bit year over year and it sounds like some of that was driven by mix. So is that something that's sustainable? Is that something that could potentially go the other way if your your growth rates kind of revert back to more normalized rates, the different businesses?

[Walter Rosebrough, President and Chief Executive Officer]

[00:36:11] I would say the single biggest thing on the quarter is that you saw that health care capital was down and kind of everything else was up. And so that is a mix effects of health care. Capital comes back over a longer period. You'd expect that mix down. On the other hand, if it comes back and everything's still growing and we do see that in my science growing faster in general than most of the health care space, it's still a positive impact, kind of long term temporal impact on on margins, in my view.

[Michael Matson, Needham and Company]

[00:36:46] Ok, thanks. And then just wanted to follow up on Larry's question about the lifescience business and the potential impact of the vaccine. So how do we think about that, that business as the vaccines start to to be launched? I mean, does does that mean that the demand for your consumables would then decline because there's been cuts, the stocking orders, or would it remain strong as the vaccines are rolled out? Thanks.

[Walter Rosebrough, President and Chief Executive Officer]

[00:37:20] Yeah, you know, we don't have perfect visibility to that. If we did, we would probably be giving differential guidance than what we're giving. But that's a tough call.

[00:37:32] My experience is in this space, the vaccine where I would call it the pharma folks who are running these facilities are the most conservative of our customers when it comes to supply chain. So my suspicion is they're going to hold a fair amount of inventory for a long time until they know that they are in good shape and have, you know, what they're running, how much they're going to have to build and what their requirements are going to be. So I don't think in the short term there's going to be a huge reduction as we work through this. If if indeed they're overstocked, they will slow it down. And if they're not, they won't. But generally speaking, you know, they tend to be kind of conservative on supply chain, appropriately conservative. You know, those factories, you shut one of those things down, you're shutting down millions of dollars a day, not millions of dollars a year. So they're pretty careful about their supply chains. But again, we do not have perfect visibility, just like we don't have perfect visibility to who's going to be building when. I should also mention another effect of this has been our capital in I've talked about capital, health care being at risk, our capital life sciences of all time records, all time record backlog, all time record shipments. I mean, everything you want to look at. So the capital equipment in lifescience is quite strong and we don't see in the short to intermediate term.

[Michael Matson, Needham and Company]

[00:39:08] Ok, thanks. That was very helpful. And then just on that, I heard your commentary around the orders and perving since they kind of bottomed in May. But it does look like the health care backlog was down double digits year over year. So it's not just more of a lagging indicator or something. Is that why that's not not showing in kind of better year over year?

[Walter Rosebrough, President and Chief Executive Officer]

[00:39:32] And it is you may recall that in the first quarter we had accounting change that resulted in roughly 15 million dollars of Auri being recognized in the first quarter, that that number for this quarter is probably more than the 10 to 12 million range. But so if you look at this based on on a similar approach, you would see that the backlog is roughly the same, you know, plus or minus a little bit. But so it's down, but it's not down double digits. And and so that's it in the short run. But capital is capital has been under pressure, more pressure than than many of the consumables. And we just have to see just it's nice to see that the replacement business seems to be returning, which is roughly 60 percent of capital orders. So we will see the next several months. It's been sequentially moving in the right direction and we hope it continues that way.

[Michael Matson, Needham and Company]

[00:40:38] Ok, great. Thank you.

[Walter Rosebrough, President and Chief Executive Officer]

[00:40:40] You bet.

[00:40:42] Once again, if you would like to ask a question, please, press star and then one to withdraw your questions, you may press star. And to our next question comes from Michael Pawlak from there. Please go ahead with your question.

[Michael Polark, Baird]

[00:40:56] Hey, good morning, thanks for taking the question, just a couple here curious on PPE and a. Well, do you have a view did it volume from that category in total flat sequentially versus the June quarter up, down? I'm just curious how that that piece is trending.

[Daniel Carestio]

[00:41:16] Yeah, I think it's been more governed by supply than it has been demand at this point. And as the suppliers have ramped up on the raw material, we're seeing similar levels that we saw in Q1, maybe maybe a slight uptick. We do believe they'll be sustained, increased demand at some level for PPY onto the future. As you know, the requirements for those products, for certain procedures have changed even with or without the pandemic.

[Michael Polark, Baird]

[00:41:48] As you fill back up on PPE, is that these kind of elevated new normal levels, let's assume, and electives recover and presumably your global network is quite tight, hence the significant amount of CapEx going into Høst. Are there other issues that arise where preference is discussed between where you make decisions about who gets access to to the facilities and when? Or is there enough capacity such that those those frictions don't arise? I'm just curious how that in a world over the next handful of quarters as we learn to live with those selective recover stays elevated, is there is there a risk that your capacity gets very tight?

[Daniel Carestio]

[00:42:34] Well, one, there's a reason why we're building a number of plants right now across the globe in North America, Europe and Asia. We have more builders going on Nasti than ever in my lifetime right now because we see long term increased demand in terms of customer capacity constraints at a given site. It does happen from time to time. And we work with our customers to cross the alleyway or multiple methods of sterilization so that for some period of time it may not be optimal for their supply chain, but we can get their products sterilized into the market.

[Michael Polark, Baird]

[00:43:12] Helpful? Yeah, no, I would say Mr. Christie always tells me that it's like Jello, there's always room for, always room for one more customer.

[Daniel Carestio]

[00:43:23] And I'm sure you're not running facilities that every hour of the day or is that, you know, we are all set for essentially Christmas Day in the Western world. We run 24/7.

[Michael Polark, Baird]

[00:43:35] Got it. The other topic was S.G. and I just know you're not putting a fine point on the back half, but in the context of of an X key surgical revenue expectation of flat year on year, how would you frame Aschiana dollars for fiscal twenty one in the context of that revenue outlook. Reasonable to expect those dollars are flat. Is there is there quite a bit of such that the ratio is similar year on year for the full year, or would you what do you expect, variance one way or the other.

[Daniel Carestio]

[00:44:11] Yeah, Mike, for the for the first half, obviously, we saw a lot of favorability there in the second half, we would say there's going to be favorability, but nearly not as much. And then obviously for the full year, we would we would expect to see a decline in total. And then obviously, as we look to the to the future, we will give guidance, hopefully, at that point time when we know more. But but definitely, definitely anticipate that we would be spending more operating expenses in the second half of the year versus the first half.

[Michael Polark, Baird]

[00:44:43] Thank you very much.

[Operator]

[00:44:47] And ladies and gentlemen, with that will conclude today's conference. Today's question and answer session, I like to turn the conference back over to management for any closing remarks.

[Julie Winter, Investor Relations]

[00:44:56] Thanks, everybody, for taking the time to join us this morning, stay healthy.

[Operator]

[00:45:04] Ladies and gentlemen, with that will conclude today's conference call, we do thank you for joining you. May now disconnect your lines.