Cantel Medical Corp.
Q1 2018 Earnings Call Transcript

Published: 7 Dec 2017

[Operator:]

Greetings and welcome to the Cantel Medical Corp First Quarter 2018 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] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Milicent Brooks, Director of Corporate Communications. Thank you, Ms. Brooks, you may begin.

[Milicent Brooks:]

Thank you, Doug, and 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, VP, Corporate Controller. Earlier this morning, the Company issued a press release announcing the financial results for the first quarter fiscal year 2018. In addition, we have posted a supplemental presentation that complements today's call. This presentation can be found on Cantel's website and the Investor Relations section under Presentation. Before we begin, I would like to remind everyone that this is a conference call may contains 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. The Company will also be making references on today’s call to the non-GAAP financial measurements, non-GAAP EBITDAS, non-GAAP operating income, 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 am 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 you through our first quarter fiscal year 2018 financial results. Finally, we'll open the call for Q&A. We are extremely pleased with our results this quarter. We grew reported net sales by 13.3% and 8.6% organic growth. Our three major segments experienced strong growth and we were able to mitigate most of the impact from the hurricanes in August and September. Industry sales grew by 19.8% with organic growth of 10.7%, driven primarily by strength in all of our reoccurring revenue products including chemistries, placebo products and services. We continue to see prior period Cantel's placements driving strong ongoing chemistry and consumable sales into their installed base. Margins were flat when we adjusted for the BHT Group acquisition. Water Purification and Filtration recorded solid revenue growth of 7.4% for the quarter led by equipment sales and service revenue. Operating margin expanded due to product mix and lower warranty expenses. This margin accretion has helped offset continued commercial divestments in this business. Revenue in our Healthcare Disposables segment increased by 5.7% organically, primarily driven by demand for our branded portfolio which includes our DentaPure online business, our sterility assurance product lines and branded facemasks, all of which continue to be important differentiator for this segment. This portfolio grew by 10% and offset declines in our legacy business. From a regional perspective, our international expansion has continued to generate impressive performance with 39.2% growth year-over-year. This includes the first quarter acquisition of BHT Group in Germany and our Canadian and our Australia distributor, which we acquired in fiscal year 2017. International organic growth was up 15.7% driven by Asia-Pacific and now to BRIC markets in Europe. U.S. sales were up 6.9% organically versus prior year performed well across all business segments, which was notable giving our tough prior year comparable of 26.4% growth. Overall, the first quarter provided satisfactory results and our expectations for the remainder for the year are in line with our previously stated guidance for fiscal year 2018. With that, I will hand it over to Peter to discuss the financial results.

[Peter Clifford:]

Thanks, John. Good morning everyone. Let’s take a few minutes to walk through the 1Q ’18 financial results. On a consolidated basis, top line, our net sales increased 13.3% year-over-year in 1Q ’18 versus the prior year, at 12.9% on a constant currency basis. The consolidated net sales walk elements were organic came in at 8.6%, M&A came in at 4.3% and FX was a tailwind on 0.4%. Gross margins for the quarter note as a result of an accounting policy change, we’ve reclassified certain administrative cost into cost of goods sold, which negatively impacted gross margins by 70 basis points in the current year GAAP and non-GAAP measures. GAAP gross margins contracted 40 basis points to 47.3% versus 47.7 in 1Q ’17 driven by both the BHT inventory step up cost as well as the impact of the recast. Non-GAAP gross margins expanded 90 basis points year-over-year when factoring in our accounting policy change impact. As a reminder, the BHT business is almost exclusively capital which was dilutive to gross margins by 40 basis points. Operating expenses for the quarter, GAAP operating expenses increased by 6.6 million or 10.5% in 1Q ’18 compared to last year. The impact of the acquired cost from acquisitions was roughly 2.8 million or 4.5%. The balance was purposeful investment in line of our strategic planned initiatives. Operating profit for the quarter, GAAP op profit increased 16.9% year-over-year to 31.6 million while our non-GAAP op profit increased 13.1% year-over-year to 38.4 million. Effective tax rate for the quarter, our GAAP effective tax rate came in at 27.4% down 20 basis points from the prior year rate of 27.6. Key drivers were the benefit from the final resolution of a contingent liability associated with a jet prep acquisition was partially offset by the drop in excess tax benefits related to share based awards. Our non-GAAP effective tax rate came in at 35.5, up 30 basis points from the prior year rate of 35.2. Key drivers were our continued federal and state initiatives were offset of the geographic impact of our restructuring related activities this quarter. EPS for the quarter, GAAP EPS increased 21.9% year-over-year to $0.55 while our non-GAAP EPS increased 12.7% year-over-year to $0.57. Adjusted EBITDAS for the quarter, 1Q adjusted EBITDAS came in at 44.4 million, up 10.8% year-over-year while our adjusted EBITDAS for the last 12 months was a 165.3 million, up 13.1% year-over-year. Cash flow from operations was strong 1Q cash flow from ops came in at 30.1 million up 20.7% year-over-year. Now, let's provide some insight into the segment results. For Endoscopy segment for the quarter sales grew 19.8% year-over-year to just over $112 million. Organic was 10.7% coming off of prior year organic comp of 27%. GAAP op profit increased 12.1% to $19.7 million, while our non-GAAP op profit increased 17.8% to $23.8 million. For our water segment for the quarter, sales grew 7.4% year-over-year to a record $53.6 million. Organic was 7.1% driven by strength of the backlog. Note, our backlog remains stable at just over $66 million even with record sales during the quarter. GAAP op profit increased 13.8% to $10.2 million while our non-GAAP op profit increased 13.1% to $10.6 million providing leverage. For our Healthcare Disposables segment for the quarter, sales grew 5.7% year-over-year to $38.9 million. Organic was also 5.7. Our GAAP op profit increased 20.3% to $8.9 million while our non-GAAP op profit increased 15.8% to $10.5 million providing strong leverage. For our Dialysis segment for the quarter, sales expanded 9.8% year-over-year to $7.9 million, our GAAP op profit increased 15.8% while our non-GAAP op profit increased 15.7. Now, I'd like to hit a few balance sheet and liquidity details. Our balance sheet remains as always incredibly strong with significant capacity. We ended the quarter with $37.2 million in cash and cash equivalents, a $158.1 million working capital. Gross debt ended the quarter at $168 million, this included $61.3 million of borrowings this year to fund the acquisition of BHT. We continue to pay down levels of debt. We paid down $19.3 million in 1Q of '18. Net debt is $130.8 million while our net debt to adjusted EBITDAS is 0.79. Capital expenditures were $6.5 million as we have signaled CapEx will remain elevated for the next six plus quarters to support our ERP implementation project. As a reminder, we'll be filing our 10-Q before the close of business today. I'll now hand the call back Jorgen for closing remarks.

[Jorgen Hansen:]

Thank you, Peter. Overall, we are pleased with our performance this quarter. The positive trajectory of our business and our strong competitive position in the markets we serve. With the completion of the BHT Group acquisition at the start of this quarter, we remain excited about the evolution of our global leadership position in Endoscopy and have high confidence in leveraging this presence for the entire Cantel portfolio, thus by in critical mass and scale on a global basis. From an M&A perspective, we are very encouraged with the help of our pipeline and are optimistic about potential deals in the coming quarters. We are evaluating opportunities to acquire new businesses and technologies in all of our existing segments, as well as exploring potential new verticals within infection prevention. Furthermore, we are pleased by the strength of our new product development pipeline, and look forward to several new product launches in this fiscal year 2018. Taking together, we expect that fiscal year 2018 will be in line with our strategic plan of doubling linked sales and profits by fiscal 2021 executed through new product development, market expansion, strategic acquisitions supported by the continuing evolution of the Cantel's operating model. Before I close I would like to extend a warm welcome to Dr. Peter Pronovost who rejoined our Board last month. He's a physician in critical position and a professor at the Johns Hopkins University School of Medicine. His experience in the areas of patient safety and quality makes him a great addition to our Board and to our company. In closing, I would like to thank our 2,500 loyal and hardworking team members for their efforts and achievements this quarter. Our entire company takes great pride in our mission to 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 second earnings call -- second quarter earnings call in March. Doug, we're now ready to take questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Mike Matson with Needham & Company. Please proceed with your question.

[Mike Matson:]

I guess I just wanted to start with tax reform. You stand out as company within our coverage universe that has a higher tax rate, and so I know there's a lot of moving parts within the legislation, but at this point based on what you know, if the current legislation were to become law. What would that mean for your tax rate? And do you -- even if you can't put a number on it, which I wouldn’t expect, do you expect a significant decline in your tax rate?

[Peter Clifford:]

Yes, I think we're obviously encouraged by the discussions being held in Washington on a corporate tax reform. That said I think we're cautious to not get ahead of the process. The legislation still needs to make its way through the House and via the President's desk, but regardless we do, as we've stated on previous calls and one-on-ones that tax reform should provide a meaningful tailwind to Cantel given our U.S.-centric profit profile and we should benefit disproportionately compared to many of our peers. But I think how I would table it is if legislation actually makes it through the House and through the President's desk early in 2018 that we could provide a better update to monetize or give a view of what that might mean at fiscal '18 and '19 from an EPR perspective.

[Mike Matson:]

And then another topic these days among investors is just regarding Amazon and their potential to move into distributing medical supplies or dental products, so just curious what your thoughts are, if they were to make a big push into the dental distribution area? Would that have any kind of impact on your Healthcare Disposables business?

[Jorgen Hansen:]

Great question Mike, this is Jorgen. We don’t have any sort of deep understanding of how that might change the landscape. From our perspective, we're already operating in a quite consolidated by our universe. Amazon has not had any material impact on our business at this point, but it’s certainly something that obviously we are watching. One of the areas that obviously we are mindful of is that with the current distribution setup days and element of promotion and training of proprietary products and technologies, which I’m not sure how it would be done by Amazon. But I think the best we can say now, we are watching the development. We do not have any strong opinion whether this could be a positive or potentially negative development for us, but we feel that we’re in a good position regardless of how the distribution channels evolve overtime.

[Mike Matson:]

Currently though with that part of the Company, is all of that currently being sold through distributors of some sort right now?

[Jorgen Hansen:]

Yes, the bulk of the business, there is a little bit of the sterility insurance that goes through the medical side. It’s a bit of a different channel than the dental piece, but the bulk of the business is still through distribution on the dental side.

[Operator:]

Our next question comes from the line of Raymond Myers from The Benchmark Company. Please proceed with your question.

[Raymond Myers:]

Let me ask you first about the Endo market, another good quarter there. What is happening competitively? And do you expect this growth rate to be able to continue?

[Jorgen Hansen:]

Since our last call, I wouldn’t say there has been a lot of change comparatively. On the capital side, it’s a pretty stable picture, globally obviously with us a client BHT in Germany which were the leader or is the leader in the installed base and new installations. In Germany, we have a strong position there as well. So again on a capital perspective, it’s the same players that we’ve seen for a while. On the procedure side of the business, we are starting to see more activity from more players despite that we have very solid growth and as we have talked about in previous calls, the procedure side of the business is really all about penetration and getting customers access to the infection, the prevention solutions that eliminate the infection risk doing the Endoscopy procedures. So still a lot of opportunity for growth in that particular segment. That said, we are very happy with the growth this quarter coming on top of I would say hyper growth in first quarter of last year, and we feel that the business is in a good trajectory and will continue to be a main contributor for the growth on the Company overall.

[Raymond Myers:]

Very good. Can I follow up on that asking you about the water systems backlog? How high is the backlog now? And how we should view the water systems business after another good quarter? You expect it to reach a new high plateau or will the backlog continue to drive healthy 7% growth going forward?

[Jorgen Hansen:]

Sequentially, the backlog increased about $700,000 from the fourth quarter to the first quarter ending for ‘18. So it’s just above $66 million. As we signaled in the past, look it is a long cycle business and with the lead times, we intend to see the business about two quarters out. So based upon what we can see right now, we see a pretty buoyant market beyond the second quarter, there are two quarters out of it, it tends to be a bit tougher to call the macro environment in that space. But as we circle back to your first question on our strap line inherent 8% that we have been targeting and achieving and continue to aspire towards in future. Embedded in that is sort of water in sort of mid-to-high single digits and HCD in sort of mid-single digits and Endoscopy really in that kind of low teens. So, I think this quarter was completely in line with really what we tend to aspire towards, when you look at our organic growth by segment of being 10.7% in Endo and 5.7% in HCD and 7.4% in water that is really what we drive towards.

[Raymond Myers:]

Right. Good performance on the revenue side, can we next move to the expense side? I understand that you've been consolidating some facilities to lower your cost structure, as well as this quarter we started that the ERP rollout globally. Could you touch on how that is anticipated to improve your cost structure overtime?

[Peter Clifford:]

Yes, let's take the ERP discussion first. So the timeline for our first sort of go-live, as I think we've shared previously in our first stuff on the slate, the docket is our U.S. Endoscopy business. And so, the team has kicked off that project probably four months ago and is working hard on it. And we intended go-live for our U.S. Endo business is likely the first quarter of '19. And so, each sites after that were probably trailed by about 9 months, so it's going to be a step phase as we go live with various locations and systems. And really what we really get out of it in the long run is an ability to add a lot less fixed cost as we scale. So I don't know that it's going to actually mean it immediate headcount on it as much as a meaningfully reduced new headcount higher and addition rate as we think about the back half of strap plan. And as far as just gross margins for the quarter, again as I announced, we had sort of an accounting pivot. And in one of our businesses, we have some quality-type cost historically gone to administrative cost that really belonging cost-to-good sold. So, we made that shift here in 1Q, '18 that get it consistent with the rest of our segments. And x that item, every one of our divisions was accretive from a non-GAAP gross margin perspective in 1Q '18 versus 1Q '17.

[Operator:]

[Operator Instructions] Our next question comes from the line of Jon Steele from Raymond James. Please proceed with your question.

[Jon Steele:]

If we could just start off with the estimated hurricane impact that you had in the fiscal first quarter. And then, are you still expecting any tail in the second quarter?

[Jorgen Hansen:]

Yes hi, John. As we have talked about, we were able to manage through the two hurricanes quite effectively from an operations perspective our site in Houston, was the site that was impacted where we lost three or four days of manufacturing, but the team did a really nice job to get back online and we gain or get back in manufacturing and rebuilt inventories quickly. So we have not really been able to have a very strong understanding of any top line impact in Q1. We might speculate that some procedures have to be postponed Q1 and will see a little bit of uptick in the second quarter. On the flip side, the second quarter has four less days in the first quarter. So we not really show that it’s going to be a big impact, but so as I would day overall, it’s been a minimal impact to us so far and we did not anticipate any major op sites going forward either.

[Peter Clifford:]

And so pile on to that, I think as far as impacts in 1Q. As Jorgen mentioned via Saturdays and overtime, we're able to only just pull the commitment but in essence, the center is the customer and avoiding disruption there, I thought team did a really nice job, making sure that we didn’t have customer disruption. What we did see is about operating variances that we’re obviously a headwinds on the Endoscopy side and the plans -- from the plan shutdown, but I would argue that a piece of that was offset that the hurricane especially in Florida brought us some increased service business on the water side and just allowed us to have a little better utilization on the service side for water. And the two of those that completely offset but in some ways they nicely offset.

[Jon Steele:]

And then going back to Endo, growth was very strong despite a tough comp, despite some hurricane impact with the double-digit organic growth. Acquisitions also came in a little bit better than we were looking for. So as part of that, can you give us an update on how BHT and C.R. Kennedy are kind of tracking the plan?

[Seth Yellin:]

Hi. Jon. It’s Seth here. I think it still early days with BHT and I think we’re encouraged with what we see. It’s a good business. It’s one that run the process right now integrating into our existing Cantel Medical Germany operation, but I think we’re encouraged with the people and the team that we brought on, and the traction we’re seen to that market. But certainly a lot of work remains for us to complete the integration and to realize the financial objectives set forth in that acquisition. From the C.R. Kennedy transaction, we’re very pleased with the results out of that business. Australia is an important market for us and that team has done exceptionally well and really picking up our full portfolio and executing well in that market. So we’re very pleased with that acquisition.

[Jorgen Hansen:]

And Candidate might add as well, it’s been a great addition to our business and it’s really team that's done a nice job driving all three of our major platforms into the Canadian market. So, we excited to see some of the positive developments by that team as well.

[Jon Steele:]

And then just two more quick ones for me; one, just going back to taxes for a second. I believe on the last call that you said, your '18 guidance was expecting the medical device tax to be out of that guidance. So I was just curious your latest thoughts on that? And is $4 million kind of the right number to think of in terms of expense?

[Jorgen Hansen:]

That’s a good question. I might kind of call that out that as we think through the corporate rate change. At this point, they still haven't addressed the medical device tax issue and other hoping to do that over the next two weeks. But there is a risk come back and in January and that’s not in our guidance. And as I stated on the last call, our fiscal, our last full fiscal year with the med device tax was 4.4 million in 2015. And in 2016, we only had a partial year, which was 2.2 million. And as we sort of pencil with that impact it to where to comeback since we’ve growing meaningfully since 2015, we think that’s a $6 million to $7 million, if they can get that fixed.

[Jon Steele:]

And then last one from me. I think you mentioned that, you’re going to have 7 new product launches in fiscal ’18. So any color there by segment or anything you’re really excited about would be very helpful.

[Jorgen Hansen:]

Seven is little high. I was meaning to say several but…

[Unidentified Analyst:]

Oh, several.

[Jorgen Hansen:]

Yes, several. Yes, we have product launches coming in all three segments. We have some new line extensions on the procedures side in Endoscopy, which obviously is very important since this is a high growth, high profit area. We are anticipating and planning to launch a new central water systems and portable water systems in our water business, and we are adding a couple of new products in health disposables or rental business as well in the consumable side of the business with some new good technologies and great margins as well. So we feel really good about the pipeline and our ability to continue to drive organic growth through our commercial teams.

[Operator:]

Our next question comes from the line of Mitra Ramgopal from Sidoti & Company. Please proceed with your question.

[MitraRamgopal:]

Just a couple of questions. Hi, Jorgen. First, you had a really nice quarter from the international in terms of the contribution there. And I’m just wondering as you look at potential for margin expansion, the investments you still feel you need to make on international whether it's entering new countries or just continuing to expand sales force or distribution in existing markets?

[Jorgen Hansen:]

Yes, it’s a great question and I think the way to think about this is that we have -- we really have been investing both organically and through M&A in the national markets. The results are really showing now from a growth perspective with almost 16% of organic growth, this quarter over last year. And the focus was now is to continue to drive profitability of these markets and we have good upside. I mean there is no doubt that our U.S. market has much larger, more scale and it's much more mature market from that perspective, and we have lot of opportunities across our international regions, varying some markets we are further down the line in getting to sort of the endpoint of the markets still quite early. But in terms of additional expansion, I think it's more like its incremental as we grow the business we will continue to invest in commercial resources. As Peter mentioned, we have some work upcoming on the ERP side in the next 24 months timeframe which is very important for that reason and the ability to drive leverage throughout our European and Asia-Pacific operations as well.

[Mitra Ramgopal:]

Okay, thanks.

[Jorgen Hansen:]

Yes, we’re pretty good down the line in terms of aggressive in business I would say.

[Mitra Ramgopal:]

And a quick question on the acquisition front. I noticed that you're always looking at opportunities, but I was just trying to get a sense of as you look out over the next several years in terms of candidate. Is the goal going to be pretty much more about expanding within your existing segments or also keeping an eye in terms of expanding that 7 billion end market?

[Peter Clifford:]

I think as we've sort of said on several calls for the last many quarters. We continue to look at new verticals and that remains an important part of our focus in terms of evaluating opportunities and really thinking about strategic fit in the overall umbrella of infection prevention. There are a lot of faces that we can play in infection prevention and we're really trying to find the right opportunities, the right targets that fit a growth profile or margin profile and have an overall portfolio fit with the rest our division that we think would be a good owners of these businesses and they still fit within this strategic focus on infection prevention. But certainly, we're going to continue to do bolt-on acquisitions that fit within our divisions, but we are actively evaluating and looking at new verticals as well as part of our acquisition strategy.

[Mitra Ramgopal:]

And then, there is another follow-up on that front. Are you seeing in terms of valuation changing at all or the markets remains to be stable?

[Jorgen Hansen:]

Look, I think markets remain pretty healthy. I mean I think there are some areas where we've seen expectations above of what we are willing to stretch on. I think we see other areas where we see certainly good values that we think our businesses that we can generate good returns off of. So, it's somewhat target dependent. I wouldn't say we've seen any meaningful shift in the market over the last six months or so. But certainly, things remain pretty healthy and it's competitive in the markets, so we're picking our spots carefully and trying to be disciplined and focused on the targets we pursue.

[Mitra Ramgopal:]

And then, Jorgen, finally just coming back on the product side, I believe you're pretty excited about the REVOX technology and some of the opportunities you see you'll have with that. I was just wondering, if you had any updates on that front for us?

[Jorgen Hansen:]

Yes, it's the REVOX in line sterilization, long-term sterilization platform is certainly something that we have higher long-term expectations for. It's still an early day business where we are still evolving and developing the solutions with our customers, but we do have couple of installations that are now on site with some of the key medical manufacturers in the U.S. and hopefully that will be something that we can continue to expand over the next many forward. So, we still feel quite bullish, but again it's a long-term opportunity for us.

[Operator:]

There are no further questions in the queue. I'd like to hand the call back to management for closing comments.

[Jorgen Hansen:]

Well, thank you everyone for calling in. I look forward to speak to you all at our second quarter call in March. Thank you.

[Operator:]

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time. And have a wonderful day.