Cantel Medical Corp.
Q2 2019 Earnings Call Transcript

Published: 2 Mar 2019

[Operator:]

Greetings! Welcome to Cantel Medical Corp’s, Second Quarter and Fiscal Year 2019 Earnings Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note this conference is being recorded. I will now turn the conference over to Milicent Brooks. Thank you Ms. Brooks, you may now begin.

[Milicent Brooks:]

Thank you, Robin. Good morning everyone. On today’s call we have Chuck Diker, Chairman of the Board; Jorgen Hansen, President and Chief Executive Officer; Peter Clifford, EVP and Chief Financial Officer; Seth Yellin, EVP, Strategy and Corporate Development; and Brian Capone, Senior Vice President, Corporate Controller and Chief Accounting Officer. Earlier this morning, the company issued a Press Release announcing the financial results for the second quarter of fiscal year 2019. In addition, we have posted a supplemental presentation to complement today’s call. This presentation can be found on Cantel’s website in the Investor Relations section under Presentations. Before we begin, I would like to remind everyone, that this conference call may contain forward-looking statements. All forward-looking statements involve risks and uncertainties, including, without limitation, the risks detailed in the company’s filings and reports with the Securities and Exchange Commission. Such statements are only predictions and actual results may differ materially from those projected. Additional information concerning forward-looking statements is contained in our Supplemental Presentation and Earnings Release. The company will also be making references on today’s call to the non-GAAP financial measurements, non-GAAP EBITDAS, non-GAAP income from operations, non-GAAP gross profit, non-GAAP diluted earnings per share and net debt. Reconciliations of these financial measures to the most directly comparable GAAP financial measurements are provided in today’s earnings release. With that, I’m pleased to introduce to you, Jorgen B. Hansen, President and CEO.

[Jorgen Hansen:]

Thank you, Milicent. And welcome, everyone. I will start off with some brief opening comments, followed by Peter who will take us through our second quarter 2019 financial results. Finally, we will open up the call for Q&A. We are pleased to see continued strong double-digit sales growth in our medical segment, which was partly offset by softer results in our Life Sciences and Dental businesses. We grew reported net sales by 5.4% with 5.3% organic growth. Total growth on a constant currency basis was 6.4%. Medical sales grew by 10.2%, driven by double-digit growth in North America and APAC, with organic growth of 11.3%. Total recurring revenue was up 10.4% in the quarter, while capital equipment sales grew by 9.4%. Capital equipment in US continues to be strong with installed rates back at normalized levels, giving us confidence in the health of the U.S., AER market. Life Sciences has reported a revenue decrease of 0.9% for the quarter, driven by soft capital equipment placements, as previously guided. M&A growth from the CES acquisitions of 4.4%, offset partly by a decrease of 1.6% due to the disposition of our high-purity water business in Canada. Orders for Hemodialysis Water equipment were down this quarter, due to the cyclical headwinds in one of our key customers moving toward a dual source approach. Revenue in our Dental segment decreased by 0.4% with an organic decline of 0.7%. This was mainly due to the continuing inventory adjustments by our distribution partners. While our performance was lower than expected, out the door sales with our distribution partners to end users were in the mid-single digits, which gave us confidence in the underlying demand for our products. In addition, the result was impacted by a temporary supply shortage in a key chemistry product line for alternate care market. Given the restoration of our product supply, we expect this to improve in the second half of the fiscal year. To further strengthen our leading [4.00] branded portfolio, we closed the acquisition of Vista Research Group in the second quarter and completed the acquisition of Omnia on the first day of February. We expect the profile of our core Dental business will return to the growth territory and our recently closed acquisitions will accelerate growth to the mid-teens for our Dental segment in the second half of the year. From a geographic perspective, our international sales increased by 7.3%, driven by 11.3% organic growth. On a constant currency basis, EMEA increased 9%, partly held back by capital shipments, delays which we anticipate will improve in the second half of the year. APAC increased 25% led by excellent performance in China, despite tariff headwinds. U.S. sales grew by 4.7% in total and 3.2% organically versus prior year. With that, I’ll hand over to Peter to discuss the financials results.

[Peter Clifford:]

Thanks, John. And good morning, everyone. Before we take a few moments to walk through the 2Q ‘19 financial results, I wanted to remind everyone that due to the prior year passing of the U.S. Tax Cuts and Jobs Act, we made a year-to-date true-up to our tax reserve in 2Q ‘18 to bring our tax provision in line with our estimated effective tax rate of 28%. This onetime benefit has created a difficult comparable for our second quarter results year-over-year. On a consolidated basis, top line net sales increased 5.4% year-over-year in 2Q ‘19 versus the prior year, and 6.4% on a constant currency basis. The consolidated net sales walk elements were

[Jorgen Hansen:]

Thank you, Peter. Let me transition into a brief update on our strategic priorities, as well as comments on our fiscal year 2019 guidance. We continue to drive to our five-year strategic plan to double sales and profits by fiscal year 2021 through new products, market expansion and M&A supported by the transformation of our operating model. We have launched five new products this year; most notably our BHT E series AER, which feature our proprietary requisite PA chemistry. We continue to see strong performance of our new FUJI valve and remain encouraged by the last prospective order pipeline of our ADVANTAGE Pass-Thru AER platform in North America as well as the strong market response of our Syclone Amalgam Separator by our dental customers. Finally in line with our strategy, we continue to invest in R&D across the company, especially in key technologies such as REVOX Sterilization platform and remain confident in our new product development pipeline. On the acquisition front, we remain very active. We announced earlier in the quarter the acquisition of Omnia S.p.A., an Italian based maker of dental surgical consumable products, with a focus on procedure room setup and cross contamination prevention. This acquisition will serve as a platform to drive our market expansion for the province European Dental business. In addition, we are pleased to announce the acquisition of the Vista Research Group in January. The Vista product helped complete our Dental borderline portfolio. With this addition, we have a differentiated offering which positioned us well to drive compliance and infection prevention in this rapidly growing and important category. We remain encouraged by the activity in our M&A pipeline and we are actually working on additional important opportunities. A key pillar in our five-year strategic plan is transforming our operating model to drive efficiency and scale to support organic, as well as acquired growth. As discussed at our last call, we are making major investments in fiscal year 2019 to drive toward this important objective. We are extremely pleased that our ERP platform implementation went live on February 4 in our Medical business, covering our two main U.S. sites as well as our European Distribution Center with no product supply and disruption. This is a tremendous accomplishment by our team that will enable us a very important step in modernizing the company, providing a platform that can help drive process efficiency and margin expansion. The impact of these important investments, including the ERP platform and REVOX in second quarter ‘19 EPS was $0.05. We are updating our guidance for the fiscal year 2019 to include the acquisition of Omnia, Vista and to reflect the challenging Hemodialysis Water environment. We anticipate reported revenue growth of 5% to 6%, with organic growth of 3.5% to 4.5% and headwind FX of 1%, announced acquisition of 3% and dispositions of 0.5%. We estimate the Medical business will continue to grow approximately 10% with Dental at a low single-digit organic growth and reported revenue in the mid-teens. The Life Science business is expected to decrease in the mid-single digits. In terms of earnings, we anticipate the total fiscal year 2019 GAAP EPS of $2.91 -- $1.91 to $1.96 and non-GAAP EPS of $2.34 to $2.39. In the supplement presentation, we have included a bridge that walks our original guidance to a revised guidance. Let me briefly provide some added color and clarity on those changes. We lowered the midpoint sales guidance from $933 million to $920 million, a change of $13 million. The key drivers of this change are Hemodialysis Water sector has softened significantly since our original guidance, causing a $17 million headwind. As we shared in our original guidance, we expected Life Science to be flat. We now expect it to be down to the mid-single digits due to the aforementioned industry challenges; FX impact of a near grade of $5 million headwind caused by the strengthening of the dollar, partially offset by M&A that added $11 million. We have lowered our mid-point non-GAAP EPS guidance from $2.59 to $2.37, a change of $0.22. The key drivers of the changes are, the Hemodialysis Water flow through impacting $0.16, higher interest rate expense causing $0.02 driven primarily by the purchase of our facility in Minnesota and tax rate driving $0.02, our internal view was 24.5% for the year and now it’s 25.3%. We continue to experience difficult operating environment in our Hemodialysis Water business. In response and as part of our five-year strategic planning process, we are actively exploring all options to drive profitable growth and strengthen our Life Science segments, including new technology investments, cost structure alignment and continued M&A activity. Notwithstanding these short term challenges, we remain highly confident in our team, our strategy, our leadership in infection prevention, and our strong competitive position in the markets we serve. I would like to thank our 2,800 loyal and hardworking team members for their efforts and achievements this quarter and our entire company takes great pride in our mission to provide infection – provide solutions to mitigate infections, improve patient safety and outcomes and ultimately help save lives. Thank you for listening. I look forward to speaking with you on our third quarter earnings call in May. Rob, we’re now ready to take questions.

[Operator:]

Thank you. [Operator Instructions] The first question today is coming from the line of Larry Keusch with Raymond James. Please proceed with your question.

[Larry Keusch:]

Thank you. Good morning, everyone.

[Jorgen Hansen:]

Good morning, Larry.

[Larry Keusch:]

Good morning. Two questions; I guess the first one Jorgen is just thinking about the LRP. I guess the real question there is, is it still intact given what we’re seeing for this year, and within that context, the sort of 8% to 10% organic that you had been targeting?

[Jorgen Hansen:]

Yeah, so we still are very confident in our long term 2021 strategic plan and as we talked about, at our previous calls, the pressure we have right now is really isolated to our Life Science business, which we are working actively to resolve. So for this year, as you can see our guidance obviously from an organic perspective is below the 8% to 10%, but we do believe that we have strategies and activities both organic and inorganic that can bring us back into the box over the next two years. So we still stick into that – to our long-term target. Just want to qualify also that, this is the midpoint of our strategic plan and we are in process of updating our next five years outlook. So we will be talking about that in our Q1 call of 2020.

[Larry Keusch:]

Okay, that’s helpful. And then I guess the other thing that I just want to really try to wrap my arms around is the medical water business, and I recognize some of the issues with one of your customers going dual source. But I guess what I’m more interested in is your thoughts around whether this is a temporal issue with this overall water market for medical usage or is this really a structural headwind that we are now beginning to face?

[Jorgen Hansen:]

Yeah, so as you know Larry, we’ve been a leader in Hemodialysis Water for close to 20 years and have a dominating market share in the U.S., in this area. If you look over the last three or four years, we really have – we are really coming out of the peak in central orders, peaking in ‘18 and ‘17 where we were close to 500 – over 500 centrals per year. If you go back to ‘16 that level was above 400 and historically we’ve been installing above 400. So we think for ‘19 our outlook is we’re back to this 400 installed level. And what happened in the meantime really was, let’s say a very aggressive de novo build by the major OEMs, and you could go back and look at their earnings calls that were recently out over the last eight to 10 days. They have been looking at getting better utilization of those clinics. So on an overall industry perspective, this is really a cyclical issue and then in addition to this we have this dual source strategy by one of the OEMs that we’re also working through. So if you look at ‘19, we still believe that we will see those headwinds cyclical and dual source. And also in the beginning of financial year ‘20, you’ll see that’s because it will go through the calendar year and then beyond that we are expecting a normalization. And then what we are doing meanwhile is really focusing on all the categories in our Life Science segment that will be anticipated, but we helped to improve the overall picture for that segment.

[Larry Keusch:]

Okay, perfect. Thanks very much.

[Operator:]

Thank you. The next question comes from the line of Matthew Mishan with KeyBanc Capital Markets. Please proceed with your questions.

[Matthew Mishan:]

Yeah, good morning, and thank you for taking the questions. My first one is like a follow-up to one of Larry’s. If you – if structurally in that medical dialysis business, if you’re thinking that there may be a market share shift toward either Peritoneal or Home Hemodialysis. How do you – can you participate in that growth and play a role in infection prevention there?

[Jorgen Hansen:]

I would say that the Home Hemodialysis is still a very small part of the business or of the overall dialysis market and we definitely think there is a place. But if you look at the next sort of three to five years, it’s our assumption that we will have a fairly minimal impact on the business we are in. So our assumption is that we will still participate in a sort of a low-single digit underlying growth for, let’s say clinic dialysis and then alongside that you would see a slow pickup of home-based clinics. And so the question, will we participate in that home-based treatments? Nothing immediate that we have, but we do have brought down certain projects over time, so there will be a little bit of business for us in that segment as well.

[Matthew Mishan:]

Okay, and then on medical, your second half medical growth looks like it’s decelerating a little bit from the first half growth. Can you talk about some of the drivers of that? And maybe some of the moving pieces around the timing of the ERP implementation? Did you send some shipments before the go-live and maybe there’ll be some give back in the second half?

[Peter Clifford:]

Yeah, let me address sort of just the Life Science medical water view revenue. Look, we were watching orders closely after 1Q. We took in about $39 million of orders, which is very soft for us in the second quarter, and as Jorgen mentioned, we’ve had the opportunity to obviously listen to some of our larger OEMs in this space in their earnings call and their guidance for this year. You know we’re expecting CapEx to be pretty constraint and that is what we’re seeing. It’s not just one customer; the base in medical water is down across the customer base, and as well in January we saw an unusually high number of units move out. Traditionally our month three, we tend to see about 20% of our central’s kind of operating, yet rescheduled out to future quarters and this January we saw nearly 50% of the orders kind of move out. So again, consistent with the language from our customers, hence why we’ve adopted a more pessimistic view of the space in the back half of the year. And as Jorgen mentioned, with our July 31 year end, yet CapEx on a calendar year basis for our customers is going to be challenged and really our medical water starts to impact at least the first half for us of ‘20. As it relates to SAP go live, we actually did not see any extra shipments out. It was one of our issues of wanting to position the go-live the first day of the quarter was really to make sure that we were in a position that if we had any disruption then we will have plenty of time for recovery, which candidly as we talked through some of our KPIs. Knock-on-wood, we’ve gotten off to a really strong start post go-live and we did build as mentioned about $3 million or $4 million worth of buffer inventory in the last month of the quarter and really most of that went out to our international markets to make sure that if we didn’t have any disruption, that the guys furthest from the home-base would be fine. And again so far, knock-on-wood, shipments invoicing seems to be going really well for the first couple of weeks of this quarter.

[Matthew Mishan:]

Alright, and then last question. Can you talk a little bit about the Dental margins in the quarter; the pullback there and what you are expecting in the second half?

[Peter Clifford:]

Yeah, margin picture there is – you know our Dental business was probably impacted the most with our livable wage actions that were taken in the fourth quarter last year, which was raising some of the lowest wages in the plants both in upstate New York, as well as Pennsylvania, and as well as adopting a new benefits program in those businesses. So that’s the bulk of the pressure, coupled with some modest material inflation that we’re starting to see in that business and we’ve since taken price increase actions early in the year to try and counterbalance some of that. So our first quarter price realization was candidly a little weaker in that business and we expected, and it was a bit stronger in 2Q, so I think our margin profile should stabilize now for the back half of the year.

[Matthew Mishan:]

Alright. Thank you.

[Operator:]

Our next question is from the line of Mike Matson with Needham & Company. Please proceed with your questions.

[Mike Matson:]

Yeah, thanks. Thanks for taking my questions. I just wanted to go back to the Life Sciences business again. Jorgen, you kind of made a comment that you are kind of looking at all options there. So does that include selling or divesting that business? And you know if so, would you retain the REVOX part of that or would that go along with it?

[Jorgen Hansen:]

No, it doesn’t. I mean we are regularly looking at our portfolio on an annual basis and through our strategic plan looking at where to best deploy our capital and best deploy our investments, but a sale is not on the table at this point. What is on the table is really to look at both organic and inorganic growth opportunities. The purpose of changing the name of the segment to Life Science is really with lot of intent that we are looking at other areas that can shift this business to be less dependent on capital. And you followed us long enough to know that if you go back three and four years, we actually have had other years where our Medical Water business were going backwards and being a company focused on growth and being a company focused on the market expansion, it’s obviously something that we are trying build in areas that are more in a – let’s say, recurring revenue profile. Our Life Science business today is about 60% capital, 40% recurring. The total company is 75/25 in terms of reoccurring versus capital. So we are looking at a host of options in that business. I would say all options are on the table, but at this point we really are focused on building the right long-term strategy for this segment.

[Mike Matson:]

Okay, thanks, that’s helpful. And then you called out the Pass-Thru product. I think in the medical business you mentioned they seen to be strong orders in North America. So what is the outlook there? Do you foresee more of your customers shifting to the Pass-Thru configuration over time and how would that impact the medical business growth?

[Jorgen Hansen:]

Yeah, so here we do – I mean as we talked about on earlier calls in North European markets, Singapore, the other key sort of high-end markets are already dominating. Pass-Thru is already a dominating technology. We are the only company with a Pass-Thru in the U.S. and we have a very solid pipeline today on this platform. As a comparison, a typical – a traditional AR, we sell at a sort of $40,000 price point and a Pass-Thru is about 2x to 2.5x that. So there is a meaningful upside in terms of revenue. Just want to qualify that a Pass-Thru really is something that is used at larger hospital settings with larger volumes and the selling cycle is also a bit longer because it does require reconstruction. But with the different issues you hear about it in the market with pressure on making sure you have the right processes and don’t have any infection prevention issues in GI, it’s certainly something our customers are really starting to be very interested in that, and as I said, we have a very solid pipeline of product in the North American market that we are excited about.

[Mike Matson:]

Okay, thanks. And then just one final one on the – the reinvestments that you are making in fiscal ‘19. I know you’re a long way from giving guidance for fiscal ’20, but you know how should we think about these reinvestments? I mean, I imagine some of them will carry into ‘20, but is there a potential that you could have kind of a spring back of some of that EPS kind of coming back in 2020 in addition to kind of a baseline EPS growth?

[Peter Clifford:]

Yeah. I mean our largest investment obviously is the SAP platform. As we’ve kind of guided at the beginning of the year, most of our acceleration is really in ’21 and we will see some acceleration, an impact in ‘20, but it’s going to be more back half of ‘20 than it is the first half of the year.

[Mike Matson:]

Okay, thank you.

[Jorgen Hansen:]

The biggest part of operation is now a business process that just went live. So we are covering about half the company now. It was a major accomplishment. So the continued roll out will be a little bit smaller in terms of scale, which should also help that picture.

[Mike Matson:]

Okay, thanks a lot.

[Operator:]

[Operator Instructions] The next question is from the line of Mitra Ramgopal with Sidoti. Please proceed with your questions.

[Mitra Ramgopal:]

Yes hi, good morning. First just wanted to start with the Dental space regarding the inventory rightsizing, etcetera. I was wondering if you’re seeing any – if there are any competitive issues there.

[Jorgen Hansen:]

I wouldn’t say we see competitive issues, but this is the industry wide rightsizing of the inventory. If you look at some of the reporting from the OEMs, there’s been a very conscious program if you will over the past six months to significantly reduce the inventory levels and talking to our peers in the business, everyone have seen very soft back half of calendar year ‘19, which we are now slowly starting to see improve, and that’s why we believe that we will go into sort of positive growth territory from organic perspective into the back half of the year. So this is really – like I said, really a rightsizing across the industry. We have great adoption of the new products that we put into the market. We are excited about what we are doing there. We know our distribution partners are very excited about it as well, and as a part of that we used to be only a sort of dental consumable company, but now also with our Accutron, nitrous oxide business related with amalgam separator, we’re now getting into working with other sales teams and the main distributors that drives a nice profitable growth. And even more importantly, we have a solution that we’re selling Dental, a full circle of protection similar like we’ve talked about in our Medical business. So a lot of good stuff going on, a lot of good opportunity for market expansion in the next several quarters in that business and growth more importantly.

[Mitra Ramgopal:]

Okay, that’s great. And on the Omnia acquisition, I was just wondering, are you seeing the growth of that business now and especially the foothold or expansion you have in European market?

[Seth Yellin:]

Yeah, hi Mitra, it’s Seth here. We’re very pleased with sort of the progress we see today with the Omnia acquisition. We’re just about four weeks at post-close in the transaction and I think integration is proceeding well and the business seems to be performing well. As you mentioned, a key part of the commercial strategy with the Omnia acquisition is to get real commercial acceleration and commercial synergy out of their European commercial infrastructure to drive our full portfolio. And as a great example of that potential of that synergy, just four weeks into post-closing we see already some large orders being placed in the Italian market of our Amalgam Separator product just a few weeks after close. So we’re starting to see good traction with that team, good integration and doing a lot of cross-training and we’re real pleased with the results we are seeing out of that acquisition as well.

[Jorgen Hansen:]

And just not to underestimate the significance of this. I mean before this acquisition we had, give or take two or three people in the European market and now we have a full organization; have a direct presence in Italy; setting up teams; I have set up teams in the key European markets to drive our product portfolio and the order that Seth mentioned on Amalgam Separator, we simply would not have been able to do that just a month ago. So we are very excited about really opening up Europe as a new expansion area for our Dental business, which largely until a month ago was a U.S. business more or less.

[Mitra Ramgopal:]

Okay, thanks for the additional color there. And actually switching on the U.S. side, I believe in the past you have mentioned – you thought the DentaPure Waterline disinfection system, etcetera and the wastewater management there was some new growth categories. I was just wondering if you are seeing any traction there.

[Seth Yellin:]

I think we’re very pleased with sort of the overall portfolio we’ve been able to put together in the dental water system. With the acquisition of the Vista Research group that we announced in January, we’re really able to complete the full portfolio of water solutions for the dental practice, and our objective is really to have a broad portfolio of solutions from water entering the practice to water leaving the practice, as it’s used in every site within the operatory and the overall dental practice, be it at the Steris center and elsewhere. So we think we have an incredibly compelling overall portfolio and a highly differentiated portfolio in what has become a very important and high growth category in Dental waterline and it’s been an exciting and important growth driver for that business that we expect to continue.

[Mitra Ramgopal:]

Okay, thanks. And Jorgen, I just I wanted to touch on the international in terms of the investments you’ve made in the past, building out direct sales and service, and I was just curious if you feel there’s still some more markets you need to get into or is this more a question of trying to consolidate and lever where you are in right now?

[Jorgen Hansen:]

Yeah, that’s a great question Mitra. I would say at this point we really have the key infrastructure we need in most important markets, and all our focus now is to drive deeper growth in those markets and drive the profitability as well. We are coming a long way in our EMEA operation and from Medical or legacy end perspective have another market leader, both from a capital and the procedure product perspective. We have a lot of growth opportunity in our procedure products and that is the fastest growing category in Europe, which is exciting, because we got a lot of room to grow and it also, it absolutely are helping our profitability so we can drive toward U.S. like margins over the next couple of years. From an Asia perspective, Asia-Pacific perspective, we have a great team in Australia and growing the business there, and as I mentioned on our call we have – I wouldn’t call it a hyper growth, but close to hyper growth in our Chinese market, albeit from a small position, but approaching a $20 million business in China, which just a few years back was just a couple of million. And again, we are driving our full portfolio there and our proprietary chemistry, which helps the profit margins. So there’s a couple of white spots. Japan is something we’re not doing too much and we have a very limited presence there, but that would probably be the only area where we would consider to expand over the next period here. But meanwhile, we are laser focused to driving what we have. And now with the acquisition of our Dental business in Italy, we have a real platform where we can drive profitable growth in the Dental business, which is a very – is a really meaningful upside to our Dental business there. We were not able to pursue just a few months back.

[Mitra Ramgopal:]

Okay, thanks, that’s great. And then finally Peter, you know following the Omnia acquisition if you could just remind me as you look in terms of firepower you have for more acquisitions, how much is available under your facility?

[Peter Clifford:]

Yeah. I mean, our facility is – we’ve only used $45 million of our revolver, so we’ve got plenty of capital to deploy.

[Mitra Ramgopal:]

Okay, thanks again for taking the questions.

[Jorgen Hansen:]

Thanks, Mitra.

[Operator:]

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. We thank you for your participation.