Cantel Medical Corp.
Q1 2017 Earnings Call Transcript

Published: 8 Dec 2016

[Operator:]

Greetings, and welcome to the Cantel Medical Corp. First Quarter 2017 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Milicent Brooks, Director of Corporate Communications. Thank you. Ms. Brooks, you may now begin.

[Milicent Brooks:]

Thank you, Doug. Welcome everyone to our first quarter fiscal year 2017 earnings conference call. I would like to remind everyone that this conference call may contain forward-looking statements. All forward-looking statements may 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. With that I am pleased to introduce to you Jorgen B. Hansen, President and CEO of Cantel Medical Corp.

[Jorgen B. Hansen:]

Thank you, Milicent, and welcome everyone. With me on the call today are Chuck Diker, Chairman of the Board; Peter Clifford, Executive Vice President and Chief Financial Officer; Seth Yellin, Executive Vice President, Strategy and Corporate Development; and Steve Anaya, Senior Vice President and Chief Accounting Officer. First, I’ll provide you with my opening comments followed by Peter who will discuss our first quarter fiscal year 2017 financial results. Finally, I’ll provide segment highlights and additional perspective on the state of our business before we open the call for Q&A. Now, let’s move to the first quarter highlights. Cantel Medical achieved record performance this first quarter. Sales increased by 22.1% with strong underlying organic sales growth of 15.8%, contributing to double-digit organic sales growth in 11 out of the past 13 quarters. GAAP earnings were up 32.4% to $0.45 per share, while non-GAAP earnings were up 24.4% to $0.51 per share, continuing our strong earnings growth over the past several years. In addition, we were pleased to announce two acquisitions during this quarter in our Endoscopy and our Healthcare Disposables segments. We also commercialized several new products and expanded our direct sales efforts, which I will discuss later in the call. This quarter’s performance was our strongest yet and the outlook for our business remains strong. With that, I will hand over to Peter to walk us through our quarterly financials.

[Peter Clifford:]

Thanks, Jorgen. Let’s take a few minutes to walk through the 1Q 2017 financial results. On a consolidated basis, sales grew 22.1% year-over-year. Consolidated sales walk elements were, organic came in at 15.8%; M&A came in at 7.2%; and FX was a headwind of 90 basis points. As Jorgen noted, 11 of our last 13 quarters, we’ve achieved double-digit organic growth. GAAP gross margins expanded 140 basis points to 47.7% versus 46.3% last year, while our non-GAAP gross margins expanded 130 basis points. As is always our goal, we continue to try and expand gross margins slowly and steadily. This is the 12th quarter in a row we’ve expanded our non-GAAP gross margin rates year-over-year. GAAP operating expenses increased by $15 million or 31.7% in 1Q compared to last year. CEO transition costs coupled with net deal costs were roughly $2.1 million or 4%. The impact of acquired costs from acquisitions were roughly $4.3 million or 9%; the balance was purposeful investment in line with our strategic plan initiatives such as Germany go-direct, U.S. territory expansion, R&D and IT. GAAP op profit increased 13.8% year-over-year to $27 million, while our non-GAAP op profit increased 22.2% year-over-year to $34 million, providing modest leverage. Keep in mind, the largest driver of difference between our GAAP and non-GAAP op profit is the last of our CEO transition cost. Our effective tax rate came in at 27.6%, down a 1,050 basis points from the prior year rate of 38.1%. Key drivers were adoption of a new accounting pronouncement on stock compensation accounting drove 160 basis points of improvement. Note, we’ve excluded this impact completely from our non-GAAP results. The new legislation from primarily the new R&D credit becoming permanent, drove 70 basis points, while other tax initiatives drove another 120 basis points. We would expect the GAAP effective tax rates to be back closer to tradition levels in the balance of the year. GAAP EPS increased 32.4% year-over-year to $0.45. Non-GAAP EPS increased 24.4% year-over-year to $0.51. Our 1Q adjusted EBITDAS came in at $40.6 million or up 25.1% year-over-year, while our rolling 12 months adjusted EBITDAS came in at $146.1 million or up 22.7% year-over-year. 1Q cash flow from operations came in strong at $24.9 million, up 65% year-over-year. Now, I’ll provide some insight into the segment results. For our Endo segment, sales grew 31% year-over-year to just under $94 million. Our organic was 27% with CU contributing very minimal tailwind to this growth profile. GAAP gross margins expanded 160 basis points while our non-GAAP gross margins expanded 130 basis points; key drivers were strong mix with continued penetration of our procedural products markets. GAAP op profit expanded 41%, and non-GAAP op profit expanded 32.9%. For our Water segment, sales grew 11.5% year-over-year to $49.9 million, organic was 11.5% driven by a strong backlog of capital sales orders from the second half of 2016. GAAP and non-GAAP gross margins contracted 60 basis points, driven by mix from our strong capital sales. Our GAAP op profit expanded 14.2% and our non-GAAP op profit expanded 11.1%. For our Healthcare Disposables segment, sales grew 34.5% year-over-year to $36.8 million, our organic was 8.5% driven by strengthen in waterline disinfection and sterility assurance. GAAP gross margins expanded 110 basis points while our non-GAAP gross margins expanded 160 basis points. Key drivers were continued strength in branded products, waterline disinfection and sterility assurance. Our GAAP op profit expanded 16.3% in the segment while our non-GAAP op profit expanded 31.1%. For our Dialysis segment, sales contracted 28.3% year-over-year to $7.2 million, driven by continued move to single use in the U.S. and inventory right-sizing with the key APAC OEM. GAAP gross margins contracted 370 basis points driven by lost volume leverage productivity in the plan and GAAP op profit contracted 32.5%. Now, I would like to hit a few balance sheet and liquidity details. Our balance sheet remains incredibly strong with significant capacity. We have over $89 million of unused credit facility as well as $100 million of untapped accordion line at 10/31/16. We ended the quarter with $26.1 million in cash and cash equivalents and $133 million in working capital. Our gross debt ended the quarter at $161 million; this included $61 million of borrowings this year to fund Accutron and Vantage acquisitions. We continue to pay down significant levels of debt. We paid down $16 million during 1Q 2017. Our net debt is $134.9 million and our net debt to adjusted EBITDAS is 0.92. Capital expenditures were high at $8.1 million due to continued investment in our Conroe, Texas facility to support the aggressive growth in our procedure business. As we look forward, we do expect elevated levels of CapEx the next several quarters but below the 1Q 2017 profile. To alert everyone, we will be filing our 10-Q before the close of business today. Thanks, Jorgen.

[Jorgen B. Hansen:]

Thank you, Peter. The first quarter results demonstrate our very strong start to the year, and we are encouraged with the trajectory of our Company. Now, let me provide some high level commentary on the results of our three major business segments, our strategy, and our outlook for financial year 2017. Our Endoscopy segment continues its strong performance led by outstanding organic growth of 27.4% and a total of sales growth of 31%. This marks the 14th consecutive quarter of double-digit organic growth. Growth in this quarter was led by capital equipment, which grew by 52% while our procedural products portfolio grew by 35%. We continue to see strong uptake of our Advantage family of automated endoscope reprocessors and in our procedural valves and kits. Sales of high-margin chemistries were 19% in the quarter and service grew by 8%. Acquired sales in this quarter included 1.5 months of sales from our Medical Innovations in the UK, and from our direct efforts in Canada. In international markets where we have made investments in marketing and direct sales force, we saw a good growth led by Germany and in Asia Pacific led by China. During the quarter, gross margins expanded by 160 basis points, driven by mix and operational efficiencies being mostly offset by investments in sales and marketing and other operating expenses leading to overall operating profit growth of nearly 41%. Our Healthcare Disposables segment was a strong performer in the quarter with overall revenue growth of 34.5% and solid organic growth of 8.5%. Organic growth in this segment was driven by continued strength of our waterline disinfection category growing by 74% coupled with 17% growth of our biological monitoring product lines. Overall, our focused commercial efforts drove 13% organic growth for our branded product portfolio, which now makes up two-thirds of this segment. In addition to the contribution of the acquired NAMSA product portfolio, this was the first quarter that included the financial results of the Accutron acquisition. Gross margins for this segment expanded by 110 basis points in the quarter, driven by favorable mix and strong volumes, as well as the benefit of the acquired business. This was offset by investment in sales and marketing and back office support that will help drive future growth program of this business. As we alluded to in prior quarters, the strength of the backlog in Water Purification and Filtration translated into strong shipments in the first quarter of this segment. We delivered total sales growth of 11.5%, all of which was organic. Growth this quarter was led by our hemodialysis stem cell [ph] water purification systems and our Life Science high-purity water business. Gross margin for this segment was compressed by 60 basis points due to the negative mix associated with the lower margin capital sales, but operating expenses were well-controlled, leading to operating profit growth in line with sales growth. During the quarter, we were encouraged to see continued demand for our hemodialysis water systems and for the second consecutive quarter our backlog is at a record higher. In addition, we are pleased to make the first information of our new REVOX sterilization platform in this quarter. And while we are in the early stages, we are optimistic about the future of this new low-temperature sterilization platform. In the quarter, we were pleased to announce the completion of two acquisitions. On August 1, the first day of the fiscal year, we acquired Accutron, Inc., the leader of nitrous oxide conscious sedation deliver systems. This type of business, which is focused on single use nasal masks to prevent cross contamination, complements our Healthcare Disposables infection prevention portfolio. In addition, this marks our first entry into dental equipment market, and we see good opportunity for continued growth of this business globally. In late September, we announced acquisition of our Canadian endoscopy assets from Vantage Endoscopy, our distributor of endoscopic processing equipment and consumables. With this acquisition, we established a direct presence in Canada through the formation of Cantel Medical Canada, and have since moved our entire portfolio of endoscopy procedural and repurposing products into this business, selling on a direct basis. In addition, we leveraged this entity to set up a commercial team to drive our Canadian Healthcare Disposables business. We are pleased to welcome this team to Cantel and we are encouraged by the early results of this transaction. We look forward to future growth in Canada for all the Cantel divisions. As discussed at our fourth quarter call in September, we recently launched our new five-year strategic plan with the objective to double sales and profits between the years 2016 and 2021. This will be achieved through execution of our three key priorities, new products; market expansion; and strategic acquisitions, supported by the enhancement of the Cantel operating model. Fiscal year 2017 represents the first year of this strategic plan and the performance on this first quarter exemplifies the execution of the strategy leading to strong growth in our three major segments. During this quarter, we continued to add sales and marketing and R&D -- add to our sales and marketing and R&D organizations. We have also begun investing in critical resources in IT and operations to start planning for the implementation of our new ERP and infrastructure programs respectively. We’ll continue to invest in these areas over the next several quarters as we execute on our plan to develop an operating model that can be flexible and scalable to support continued growth of our Company. Looking forward, we expect to see continued positive momentum in our businesses due to our leadership position in the segments where we compete. That said, we recognize that our organic growth rate was particularly strong in this quarter and this rate is not likely to be sustainable over the long-run. It is also worth noting that the second half of fiscal 2016 was far stronger than the first half. Therefore, we will see more difficult growth comparables in the back half of fiscal year 2017. In addition, we’ll continue to make the investments necessary to support the growth for our long-term plan. We fully expect to realize operational leverage in the back half of our strategic plan horizon but we will need to make upfront investments to support the future potential. You will see some quarters such as this one where we’ve realized nice leverage in earnings per share but there undoubtedly be others where our operating leverage will not be as favorable. That said, our goal is to show solid growth in all periods over the forecast horizon. All-in-all, the first quarter of fiscal year 2017 was a great start of the year, and we are highly encouraged by these early results. Our entire Company takes great pride in our mission to provide products, services and solutions to mitigate infections, improve patient safety and outcomes, and ultimately help save lives. I thank our 2,200 loyal and hardworking employees for their efforts and achievements in this quarter. Thank you for listening. I look forward to speaking with you on our second quarter earnings call in March. We are now ready to take some questions.

[Operator:]

Thank you. Ladies and gentlemen, at this time, we will be a question-and-answer session. [Operator Instructions] Our first question comes from the line of Mike Matson from Needham & Company. Please proceed with your question.

[Mike Matson:]

Hi, good morning. Thanks for taking my questions. I guess I just wanted to start, Peter, with the comment around the Custom Ultrasonics benefit, it sounds like there was minimal benefit. But I just want to make sure that I understand this correctly. So, on a year-over-year basis, it didn’t really add to growth but that would still mean that you saw some unit gain, or share gain from them. It just looks comparable to what you saw in the year ago quarter?

[Peter Clifford:]

Yes, I mean, how I would describe is look, the CU situation has died down considerably in the marketplace, and our growth right now is really coming from larger systems deals for the most part and continued execution of the AER installs and just driving that mention to convert the market to single use procedural products. And our best math would say 2% or less is really what the impact on organic growth. So, it’s less than the last couple of quarters. There is still some impact but it’s very minimal; it’s starting to become less-and-less of an issue for us.

[Mike Matson:]

And then, just curious, if you can remind us, what portion of your overall business is from capital. I guess, it’s primarily in Endoscopy and then the Water business. And just what you’re hearing from your customers with regard to calendar 2017, given the potential appeal of the ACA. I mean, I know it sounds like it’s -- looking like it’s going to remain in place for three years, but going to create some uncertainty I think at the hospitals. So, just wondering if you’re worried at all that that could impact the capital portion of your business?

[Peter Clifford:]

When you think about the mix just historically, I mean a generic comment was always sort of 25% capital on a consolidated basis and 75% consumables this quarter were up fractionally from that and that’s really the impact of Accutron coming in and adding a little bit more capital to the portfolio. So, this quarter as an example we were at 27% capital and obviously the rest reoccurring. We think what we see in marketplace in terms of impact on capital sales, really there’s been modest impact if any at all in the U.S., I would say really in the UK we noticed some softness out of the NHS, but otherwise most capital markets have been pretty buoyant.

[Jorgen B. Hansen:]

So, Mike, to your question about the ACAs, we’re obviously following the situation quite closely. And I think we don’t have any other insights that you would have by following the market as well. So, I guess, our best position is wait and see. Obviously, it’s a good thing that patient will have coverage. And I think that if this repeal [ph] is sort of a three-year horizon, we’ll have a lots of time to sort of rebase. But, I guess, best we can say at this point is wait and see, what is the alternative and we’ll take it from there.

[Mike Matson:]

And my final question, just one more sort of policy related, I guess. So, just curious about your M&A pipeline. I mean, last I heard, it seemed like it was pretty full. But, given that you’re buying typically the sort of family-run businesses, I was just wondering could any of these deals sort of get put on hold just pending potential tax changes, some of these owners maybe want to wait and see if tax rates go down or something before they sell their business to you?

[Seth Yellin:]

Mike, it’s Seth here. Right now it’s an unknown. I would say what I’m seeing in our pipeline and the activity we see in the market is very strong continued interest, and with the parties we’re discussing around moving forward transactions, I don’t see any hesitancy from sellers and pursuing what they view as good strong partnerships with the good strategic partner. And overall, we’re quite pleased with the size and scope of our funnel and the productivity we’re seeing. So, as of today, I don’t anticipate any disruption to a deal flow.

[Operator:]

[Operator Instructions] Our next question comes from the line of Raymond Myers from Benchmark. Please proceed with your question.

[Raymond Myers:]

I first want to ask about some of the recent acquisitions, Accutron, and the Canada distribution. Can you discuss your integrating those businesses? And what kind of contributions they were in the quarter? And I suppose Canada would be more for the future. Can you describe what type of contribution you will expect from that?

[Seth Yellin:]

I’ll let Peter speak to sort of the contribution in the quarter from each of the transactions. I think broadly speaking with both the Accutron and the Vantage distribution asset deal, I think we are well-underway with the integration of those transactions into our organizations. Obviously, the Vantage business integrates more fully into our Endoscopy business, but also establishing a standalone Cantel Medical Canada entity. The Accutron business integrates fully into our Healthcare Disposables segment, and that is one of the way, I know we have our teams that are deployed and working with them. And we are very pleased with the level of integration and cooperation and continuity in the businesses that we have acquired.

[Peter Clifford:]

As far as quarter, as we mentioned, the reported growth for Healthcare Disposables as an example is 34.5%; we called our organic at 8.5%, so the 26% is all M&A in Healthcare Disposables; and on the Endoscopy segment of the 31% growth that we called out, really 7.2% of -- that are piece of the M&A and that’s about month and a half of the Medical Innovations impact as we only had 10.5 months in last year plus the Advantage impact. So, it’s really two deals driving the 7.2%.

[Raymond Myers:]

Great. And could you touch on the either revenue or margin contribution of the Canada distribution acquisition?

[Peter Clifford:]

I mean, other than -- obviously, it’s going to help us drive accretive margins to our profile, because we’re in essence eliminating the distributor discount that’s going back as pricing to us. So, it will help us further improve the Endoscopy segment gross margins. But again, it’s a pretty small deal, but it’s nonetheless should have a positive accretive impact on our gross margins in Endoscopy.

[Jorgen B. Hansen:]

Yes. Raymond, I’ll think about this. I mean, it’s a good deal; it has a little bit of an upside this year, but it’s really, looking at long term, bringing efforts together in Canada and having a full team there that can support Endoscopy business after Disposables and Water business as well. That’s really the overall strategy here. So, we are excited about the transaction, and integration is going well. And we think Canada would be a very profitable and good growing market for us long-term.

[Raymond Myers:]

Sounds good. Next, I want to ask about your planned sales force and IT infrastructure spend. I believe on the last call you explained that you would be planning to spend quite a bit this year on that. Can you describe, what you started so far and what type of trajectory we should expect for the rest of the year?

[Jorgen B. Hansen:]

So, Raymond, this is Jorgen. The most significant spend this quarter is actually still in sales. And we now have the full impact of about 15 additional sales people we added in the U.S. where we have to sort of a make a bid on making smaller territories to really drive the very expensive growth we have in the U.S. market. So that’s in this quarter. And we also have our full German team, also about 15, 16 people mostly onboard in this quarter. So that’s by far the biggest investment. In terms of IT, that’s starting to ramp up. We have not committed to ERP solution yet, so that will be something we’ll see in the future quarter with some expenses there. But we have hired several leaders of this business, both on VP and Director level to prepare for this expansion. So, that’s also in this quarter. I don’t know anything else you want to add, Peter?

[Peter Clifford:]

Yes. I would just say, Raymond, I think we will be able to drive a lot more color at the end of next quarter. What we -- our game plan internally here is we are in the throes of final negotiations with two vendors this month. We expect to get across the finish line with one of those and then seek board approval this month. And so, obviously, it would be much easier to quantify sort of CapEx and cash flows from that as we finish the negotiations. But, we’re still calling for discounts right now.

[Raymond Myers:]

Good luck with that. The final question is, have there been any regulatory changes or movement in hospitals’ attitude toward hospital acquired infections?

[Jorgen B. Hansen:]

Well, I wouldn’t say it’s regulatory changes, but as we talked about in past calls, the major change that has impacted us is the focus on hospitals on using single use valves in procedures, and that has been driven by cross-contamination issues that have been prevalent across the country. And so that does have a major impact. I wouldn’t say it’s a regulatory, it’s recommended through some of the endoscopy associations and sterilization organizations. But I would say it’s now being adapted as a standard in the U.S. and we’re also seeing good uptick outside to U.S. So that’s the major impact. There is no other sort of regulatory particularly that has impacted our business in this quarter.

[Operator:]

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

[Mitra Ramgopal:]

Yes. Hi, good morning. Just a couple of questions. First, I know you mentioned, if you look at the Water segment, you’re pretty much at record levels in terms of backlog. I was wondering if you could give us a sense in terms of where the strength is coming from as it relates to new customers or existing customers et cetera.

[Peter Clifford:]

I think again, as we talked about our 2016 results, we had other than one OEM, a pretty strong year and really the order flow from that customer was down last year, started to ramp back up in the second half. And really, we are seeing consistent strength with our top three customers for the last couple months from an order perspective. And our beginning backlog or shippable backlog for 2Q is very similar to 1Q. The only thing I’d tamper that with is we do have three less ship days, production days in the second quarter, and the second quarter is also where we have the holidays. So, it’s a tougher quarter from a shipment perspective or throughput. But again, we’ve got really strong footing as we start the second quarter in the Water business from a backlog perspective.

[Mitra Ramgopal:]

Okay, thanks. And then coming back to acquisitions, Seth, I know you’ve been quite busy obviously, but I was wondering if you could talk a little in terms of, as you look at the strategy going forward, clearly like Accutron strengthens your presence in terms of like facemasks et cetera. Are you looking to essentially consolidate your existing areas or it is some holes that you really feel you need to fill as you look at what it’s on Endoscopy or even the Healthcare Disposables?

[Seth Yellin:]

I think we look at each of our businesses and say what are complementary adjacencies where we can expand that circle of infection prevention and where can we compete and where can we add value to that business and think about selling that overall portfolio. So, we’re thinking about each of our businesses and expanding in concentric circles understanding where of those can grow. And obviously there are certain categories where we see obvious gaps that we need to fill, and other categories we see adjacencies that we have a theory that it would work and we spend real time and effort working with our teams in evaluating the potential. And I think Accutron is a good example of looking at small equipment, which is sort of base of that business but thinking about how that expands our overall portfolio entering to the small equipment side, but also where there is a strong consumable stream that that equipment generates that is complementary to our overall healthcare disposables portfolio. So, I think thinking creatively around where we participate today and where we might hope to evolve our portfolios is part of our ongoing work with our divisions. And we see opportunities frankly in each of our divisions to continue that strategy.

[Mitra Ramgopal:]

Thanks. And then how far do you want to -- I know you’ve talked about the five-year plan in terms of going to top line et cetera. I was wondering if you could kind of remind us where you think ultimately your margins can get as you look at your existing mix of business and the things you are adding in terms of the investments you are making.

[Jorgen B. Hansen:]

Well, our five-year plan, as I mentioned is really to double sales and profits over the five-year horizon, which is the trajectory we were on in the previous five-year plan as well. Obviously, now the Company is bigger, so doubling sales and profits is a much bigger task. And part of that needs to be delivered through some continuous improvement on the gross margin lines that we showed at this quarter and is part of our ambition to help finance the rapid growth. So, I think we still have good room there and Accutron is a great example on acquisitions that can help us improve that picture with products that have good margin profiles and fit nicely into our portfolio. And going directly Canada is another way to help that development. But, I would say, still think about us as a long-term Company, we are focused on growth. We are committed to doubling the size of the business, which we require sort of 14% to 15% top line growth including M&A. We’ve done that historically but to consider that in the future, it requires us to do even better. And that’s what we feel we’ll do by investing back into the business very mindfully and strategically to both drive strong organic growth and then support it with smart M&A.

[Operator:]

Our next question is a follow-up question from the line of Mike Matson. Please proceed with your question.

[Mike Matson:]

Thanks for letting me back in. Peter, I just want to go back to -- I don’t want to keep harking on Custom Ultrasonics thing. But just to clarify, the 2% number that you mentioned, I am assuming that’s the impact to the Endoscopy growth rate, not the overall?

[Peter Clifford:]

Exactly.

[Mike Matson:]

And then, I guess, there was this -- there is a bill that’s passed in California around Superbug reporting; in other words if people pass away and there was superbug that caused their death and they have to report that. Is that-- do you think that would help drive your business at all or is that -- is the trend already in place to such a degree that’s something like that’s not really going to drive faster adoption among the hospitals?

[Jorgen B. Hansen:]

I would say, I’d like to add Mike that the growth we have now in the U.S. is probably as fast as we can sort of keep up with 50 some percent capital growth this quarter and 35% procedural products. We are helping customers across the country and globally as well to implement best practices. Our strength to the market is our leadership in infection prevention, not just providing products but also providing guidance, training and full solutions that can help prevent these unfortunate issues that have been in California and in other states in the past. So, I think this is something that we have -- we are in a good trajectory, we have the right solutions, we have the right products but I would not expect further acceleration, just sort of continue to do what we do well.

[Mike Matson:]

Okay.

[Seth Yellin:]

Anytime it’s more transparent and visible of issues but I think that always just helps us tell our compelling story, right?

[Mike Matson:]

Yes. Okay. All right. That’s all I have. Thank you.

[Jorgen B. Hansen:]

Thanks, Mike.

[Operator:]

There are no further questions in the queue. Ladies and gentlemen, this does conclude our conference for today. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.