Cantel Medical Corp.
Q2 2017 Earnings Call Transcript

Published: 9 Mar 2017

[Operator:]

Greetings, and welcome to the Cantel Medical Corporation Second Quarter 2017 Earnings Conference 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. It is now my pleasure to introduce your host, Milicent Brooks. Ma'am, you may begin.

[Milicent Brooks:]

Thank you, Katherine. Welcome everyone to our second quarter fiscal year 2017 earnings conference call. The Company issued a New Release earlier this morning announcing the financial results for the second quarter. In addition we have posted a supplemental presentation to complement this morning's discussion. This presentation can be accessed 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. With that I am pleased to introduce to you Jorgen B. Hansen, President and CEO of Cantel Medical Corp.

[Jorgen Hansen:]

Thank you, Milicent, and welcome everyone. With me on our call today are Chuck Diker, Chairman of the Board; Peter Clifford, EVP and Chief Financial Officer; Seth Yellin, EVP, Strategy and Corporate Development; and Steve Anaya, SVP and Chief Accounting Officer. First, I’ll provide you with some brief opening comments followed by Peter who will discuss our second 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 second quarter highlights. This was another excellent quarter where sales increased by 16.8% with strong underlying organic sales growth of 12.1% making this the 12th quarter of the past 14th quarters with double-digit organic sales growth. GAAP earnings in the quarter were up 16.2% to $0.43 per share while non-GAAP earnings were up 23.8% to $0.52 per share which is a record. This quarter's performance demonstrates the strength of our focused infection prevention strategy operationalized by investing in new products, market expansion and strategic acquisitions supported by continuous improvement. Our global team members continue to execute effectively on our strategic priorities as well as provide best-in-class cost on solutions and our outlook while our business remains strong. With that, I'll hand over to Peter to walk us through the quarterly financials.

[Peter Clifford:]

Thanks Jorgen. Let's take a few moments to walk through the 2Q 17 financial results. On a consolidated basis, the topline sales grew 16.8% year-over-year, consolidated sales walk elements where organic came in at 12.1%, M&A added another 5.8% and FX was a headwind of 1.1%. GAAP gross margins expanded 220 basis points to 47.9% versus 45.7%. Our non-GAAP gross margins expanded 200 basis points. As always our goal is to continue to try and expand gross margins slowly and steadily this is the 13th quarter in a row we've expanded our non-GAAP gross margin rates year-over-year. GAAP operating expenses increased by $11.9 million or 24.9% in 2Q compared to last year. The impact of acquired costs from acquisitions were roughly $3.8 million or 8%. The balance was purposeful investment in line with our strategic plan initiatives such as German, Go-direct U.S. territory expansion, R&D and IT. GAAP profit increased 17.3% year-over-year to $28.6 million while non-GAAP op profit increased 18.6% year-over-year to $33.5 million providing solid leverage. Our effective tax rate came in at 34.3% down 30 basis points from the prior year rate of $34.6 million. Key drivers were new legislation, primarily the R&D credit becoming permanent last year drove 250 basis points of headwind to the effective tax rate in the current year. This prior year headwind was offset by various state and federal initiatives as well as stronger profits outside the U.S. and lower tax jurisdictions. We would expect GAAP effective tax rates to be close to the second quarter rate for the balance of the year. GAAP EPS increased 16.2% year-over-year to $0.43 while non-GAAP EPS increased 23.8% year-over-year to $0.52. 2Q adjusted EBITDAS came in at $39.5 million or up 19.6% year-over-year. Rolling 12-month adjusted EBITDAS came in at $152.6 million or up 22.7% year-over-year. 2Q cash flow from operations came in at $20.1 million or up 52.7% year-over-year. Now I would like to hit a few balance sheet and liquidity details. Our balance sheet remains incredibly strong with significant capacity. We've over $101 million of unused credit facility as well as $100 million of untapped accordion line at 131 2017. We ended the quarter with $24.4 million in cash and cash equivalents and $141.5 million in working capital. Gross debt ended the quarter at $149 million. This includes $61 million of borrowings this year to fund acquisitions of Accutron and our Canadian distributor. We continue to pay down significant levels of debt. We paid down $12 million during Q2 '17 after paying down $16 million in 1Q '17. Our net debt was $124.6 million and our net debt to adjusted EBITDAS is $0.8 to $2. Capital expenditures moderated back down to $6.3 million. As we look forward, we do expect elevated levels of CapEx to support the launching of our ERP project for the next several quarters. Now let's provide some insight into the segment results. For our endoscopy segment, sales were 15.8% year-over-year to just over $94 million. Organic sales came in at 16%. M&A added another 1.9% and FX was a 2.1% headwind. GAAP gross margins expanded 220 basis points while non-GAAP gross margins expanded a 190 basis points. The drivers were strong mix from our continued penetration of the procedural products markets, coupled with strong chemistry sales. GAAP profit expanded 28.1% while non-GAAP op profit expanded 24.5%. For our water segment, sales grew 9.6% year-over-year to $47.4 million. Organic was 9.7% driven by strong backlog of capital sales orders from the second half of 2016. Note we're positioned well for 2H '17 with a record backlog in the capital side of the business. We're entering the third quarter '17 with scheduled backlog meaningfully stronger than 2Q '17. GAAP and non-GAAP gross margins expanded 50 basis points, driven by volume leverage productivity in our plants, coupled with material deflation. GAAP op profit expanded 10.8% while non-GAAP op profits expanded 8.1%. For our healthcare disposables segment, sales grew 35.6% year-over-year to $35.3 million. Organic was 6.5% driven by strength in waterline disinfection and sterility assurance while our Accutron and Vantage acquisitions added another 29.1% while GAAP and non-GAAP gross margins expanded 410 basis points, driven by mix in branded products, waterline disinfection, sterility assurance as well as the accretive nature of our Accutron acquisition. GAAP op profit expanded 24.6% while our non-GAAP op profit expanded 37.5%. For our dialysis segment, sales increased 2.9% year-over-year to $7.8 million driven by modest strength of one of our core North American OEMs. Our GAAP gross margins contracted 30 basis points and our GAAP op profit expanded 23.8% year-over-year. So alert everyone, we'll be filing our 10-Q for the close of business tomorrow.

[Jorgen Hansen:]

Thank you, Peter. We are very pleased with the overall results this quarter. While we had three U.S. shipment day in the quarter, as well as the seasonal holiday, we still saw good sequential growth in the daily sales rate. We are encouraged with the trajectory of our Company. Now let me provide some high level commentary on the results of our three major segments, our strategy and thought of the remainder of the fiscal year 2017. Our Endoscopy segment had a great quarter with organic growth at 16%. This marked the 50th consecutive quarter with double-digit organic growth for the segment led by strong sales in chemistries and procedural products. In addition we saw solid sales expanding globally particular in our North American and Asia Pacific regions. Our Healthcare Disposables segment had another strong quarter with overall revenue growth of 35.6%, and underlying organic growth of 6.5%. This organic growth performance was driven by strength in our waterline disinfection and stability assurance categories. Overall our focused commercial efforts drove 11% organic growth for branded product portfolio which now makes over two-thirds - mix up over two-thirds of this segment. We have fees for the integration of the Accutron business and its performance continues to meet our high expectations. We are optimistic about the future growth and margin opportunities what this important product portfolio will provide. In our Water Purification and Filtration segment, a continued strength of the backlog of our hemodialysis central water segment translated into strong shipments in the second quarter. Organic growth of the segment was 9.7% driven by higher capital equipment sales. We are encouraged by this segment growth and for the third consecutive quarter the backlog is at a record high which bodes well for future periods. We're very pleased with the financial performance this quarter as we did have a good sales growth in all segments and favorable operating leverage overall. Business to resolve off all focus on execution off - laid out in our strategic plan which are new product development, global market expansion and strategic acquisitions supported by the continued improvement of the Cantel operating model. Let me briefly touch on each of these important areas. We continue to have great adoption of new products in our three major business segments. In our endoscopy segment, our complete portfolio of automated reprocessors, chemistries, dryness storage cabinets at the traction, scope transportation as well as novel procedure products, is delivering competitive full circle of infection prevention solution into GI endoscopy market. We're confident that with this model we are on the fast track to global market leadership in infection prevention in endoscopy. In our Healthcare Disposables segment our portfolio of infection prevention, protection, our compliance solutions led by our that biological monitoring category, protection equipment and in waterline disinfection is driving market leading growth. And in Water Purification and Filtration segment in addition to our market leading hemodialysis water platform, we saw positive early adoption of our REVOX sterilization technology. Looking at market expansion, we continue to build our international capabilities, most notably with investments in our direct sales operation in Germany and China. Also we're pleased to announce last month that we entered into a definitive agreement to acquire all procedure products in endoscopy processing business from our Australian distributor, CR Kennedy. This transaction is expected to close early April. We see good opportunity for our business expansion in Australia across all our divisions and a direct sales operation is a critical step to achieve our growth objectives in that region. CR Kennedy has been a great partner for Cantel for many years, we thank them for their support and partnership and we welcome our Australian team to the Cantel family. This Australian acquisition is the second go-direct here this year following the acquisition of our Canadian distributor last quarter. We are very encouraged by our acquisition pipeline and we are optimistic about our ability to continue to execute strategic transactions in the coming quarters. The final pillar of our strategy is the Cantel operating model which is the backbone to support our growth. The move to a single IT technology platform is a key component in our operating model and we are about to embark on a global ERP implementation. The new ERP platform will replace the many different systems we have in place and will give us an opportunity to improve processes, drive efficiency and enable us to scale effectively across our Company. We have selected SAP as our platform and implementation which will start next quarter was less than approximately three years. Looking forward we're optimistic about the opportunities for our company and we have confidence to continue our strong performance. That being said, it's worth noting that the second half of fiscal year 2016 results were exceptionally strong with total revenue growth of over 20% in the second half of 2016 versus growth of just under 15% in the first half. While we expect good absolute performance in the back half of 2017 it's worth recognizing that we'll have some challenging year-over-year comparable in second half. Overall, we do anticipate good growth for the year and while it's still early, we believe that we are on track to achieve the targets set out for the first year of our five-year strategic plan. Before I close, I would like to extend a warm welcome to Tony who has recently been appointed as member of Cantel's Board of Directors [indiscernible] and is a great addition to our Board and to our company. I would also like to welcome Dottie Donnelly who recently joined our company as our new SVP and Chief Human Resource Officer. Dottie is an accomplished executive who brings over 20 years of experience in human resources for meeting companies including J&J, Merck and most recently Bristol-Myers Squibb. Her successful track record in tele-management, succession planning, change management as well as her experience in organizational leadership in complex business environment makes her a terrific asset to Cantel. All in all, we're very pleased with the solid results and our performance in the first half of the year. Our entire company takes great pride in our mission to provide solutions to mitigate infections, improve patient safety and outcomes and ultimately help stabilize. I thank our 2300 loyal and hard-working team members for their efforts and achievements in this quarter. Thank you for listening. I look forward to speaking with you on our third quarter earnings call in June. We're now ready to take questions.

[Operator:]

[Operator Instructions] Our question is coming from Raymond Myers of Benchmark.

[Raymond Myers:]

Great. Thanks for taking the questions and good morning, Jorgen. First, want to ask you about the water business, because overall, the business has been performing exceptionally well. And in water in particular, that's an area of welcomed strength in Q1. And given the commentary of the strong backlog, which you repeated now in this release, we've been anticipating a little bit higher strength in the water business in the fiscal second quarter. And comment as to whether there has been any change from your expectation in water and what you're expectation is for the rest of this year.

[Jorgen Hansen:]

So I was trying to make sure I understand your questions Ray. You are asking whether we had expected higher than reported growth in water?

[Raymond Myers:]

Yes, that's basically given commentary about the strong backlog, sequential decline water from year-over-year.

[Jorgen Hansen:]

So the growth in water has significant stepped up this year over last year and the 9.6% or 9.7% growth is certainly in line or better than the historic growth rate we've seen in that business. So I'll say we're very happy with results and actually significantly over our expectation for sales in this quarter.

[Peter Clifford:]

I'll just say with this being such a long cycle business, obviously again as we communicated last year, we view by order intake that it was going to be a tough 2016 equally though as we hedge strong orders in the second half of '16 and the first half of this year. It's helpful that we can see the backlog in front of us in that business and as we called out we are starting the third quarter with shippable schedule, shippable backlog that is actually meaningfully stronger than the second quarter.

[Jorgen Hansen:]

And also remember Ray this all is organic growth, there is no acquisitions in the segment so is that very satisfactory result for us.

[Raymond Myers:]

Yes, thank you. Thanks for helping me get a sense of that. And not to detract from the organic growth; it's strong. Is there any change in the number of selling days? I understand there may have been fewer selling days in fiscal Q2. How much did that impact results in the quarter?

[Peter Clifford:]

Yes it is actually to get grounded on the days for the year the first quarter had 65 days we dropped to 61 shipped days in the second quarter and obviously that is also the period with the December, January and November holidays, so third quarter we bounced back and picked back up to two days worth 63 days in the third quarter and 63 days in the fourth quarter.

[Jorgen Hansen:]

So I mentioned Ray in my commentary that actually our day rate sequentially grew from Q1 to Q2.

[Raymond Myers:]

Very good. And can we quantify how much impact that had in sales, or do we just do the math on the number of days and that pretty well sets it?

[Jorgen Hansen:]

Yes I think that is probably a pretty good way of benchmarking it still and again I think the one caveat from last year's results, I think it was challenging how many people remember that we only had medical innovations in our business where half of the first quarter last year, so it is optically and look like we did grow sequentially in 2016 from 1Q to 2Q really a big piece of that story was getting full three months of sales in the second quarter for medical innovations.

[Raymond Myers:]

Sure. Okay, thanks. And then my last question would be, Jorgen, maybe you could touch on the SAP implementation that you're starting now. Again, how much would that cost through the balance of this year and what are the benefits that you expect to achieve over time?

[Jorgen Hansen:]

So as Peter alluded to we do believe that SAP implementation will take our CapEx up for from the sort of $4 million, $5 million level to between 6 and 8 in the next quarters and so that is kind of the investment level we are running nine different systems today, so we are confident as this is going to be a very beneficial program for us in terms of finding efficiencies for our current business but as important as that is also going to help us when we acquire companies in the future because we will have a very solid system to integrate these businesses into, I'm not going to be able to tell you exactly the sort of dollar return on investment we are looking at that and we have a good business case for this investment for sure.

[Peter Clifford:]

And just to get ballpark we are expecting probably between $16 million and $18 million of CapEx over sort of three year period and as probably $5 million or $6 million of operating expense and again as far as an exact number on the return, I think how I would articulate it is look at this is one of the tools and one of the vehicles for us in the back half of our start point to position ourselves to actually leverage business faster. So it is a requirement if we want to in the back half of this point start to actually get after SG&A leverage.

[Raymond Myers:]

Sure, makes sense. And thank you very much.

[Operator:]

Thank you. Our next question is coming from Ethan Potasnick of Needham & Company.

[Ethan Potasnick:]

Hi, good morning. This is Ethan Potasnick filling in for Mick Madsen. It looks like branded healthcare disposables grew by 11%, while overall organic growth was 6.5%. What portion of sales is from branded, and how long before the overall growth becomes more closely correlated with branded growth?

[Peter Clifford:]

Thanks, good morning Ethan. So you are right 11%, we have 11% of branded products which is now more than two thirds of sales in the health disposable segment and we actually anticipate that is a share will continue to rise, this is where we focus our sales and commercial efforts the products that we launch are all branded. And for example, we buy companies like Accutron that is 100% branded portfolio, it also adds to this back. So it is a very conscious strategy and that's how we anticipate to continue to drive growth in the healthcare disposable segment.

[Ethan Potasnick:]

Okay. Got it, and regarding the segment, so why exactly was healthcare disposables operating margin down 180 basis points? And is there any potential for stabilization in dialysis, given 3% organic growth this quarter? Or will it start to decline again?

[Jorgen Hansen:]

I'll take the healthcare disposable question first. Ultimately there's some acquisition related cost in the second quarter the drove the GAAP results to be down meaningfully on a non-GAAP basis. It was basically modest leverage in the business. We came in about 37.5% expansion and non-GAAP op profit versus sales growth of 35.6. And then for your dialysis piece, I do think we're finally starting to see that business stabilize a bit in terms of one of our larger OEMs. It was exiting the piece of it as I'll say it moderated to their probably likely go-forward rate, but still was a business that we think long-term is probably a 3% to 4% declining year type of business.

[Ethan Potasnick:]

Okay. Got it. And finally, are you guys seeing any change in hospital capital spending given the ACA repeal efforts?

[Jorgen Hansen:]

I think it's too early to say anything about. We will have to wait how that plans out. Hospitals in general have been under pressure for a while but we've seen very good growth in our business and we continue to see strong development in our sales. So we don't -- we haven't seen any change that we haven’t identified anything in particular from the new healthcare reform that we can identify us as downside or upsize for that matter.

[Ethan Potasnick:]

Okay. And then, on your M&A pipeline, do you still expect roughly a deal each quarter?

[Seth Yellin:]

Hi, this is Seth here. I think that we feel pretty good about our pipeline overall and our expectation I think is to or our ambition is to execute three to four transactions a year. How they fall out over the course of the quarters is something of unknown and now necessarily entirely in our control, But I think our objective would be to continue to execute three to four deals over the course on an annualized basis and we feel pretty good about where we stand today with our acquisition pipeline and the opportunities we see ahead of us.

[Ethan Potasnick:]

Okay, great. Thanks guys.

[Operator:]

[Operator Instructions] There appears we have no further questions at this time. Do you have any closing remarks?

[Jorgen Hansen:]

Thank you, everyone for listening and we look forward to speaking to you all at June in Q3 call. Thank you very much.

[Operator:]

Thank you, ladies and gentlemen for your participation. This does conclude the teleconference. You may disconnect your lines at this time and thank you for your participation.