Cantel Medical Corp.
Q3 2017 Earnings Call Transcript

Published: 8 Jun 2017

[Operator:]

Greetings, and welcome to the Cantel Medical Corp. Third 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. It is now my pleasure to introduce your host, Milicent Brooks, Director of Corporate Communication. Thank you, Ms. Brooks, you may begin.

[Milicent Brooks:]

Thank you, Doug. Welcome everyone to our third quarter fiscal year 2017 earnings conference call. The Company issued a news release earlier this morning announcing the financial results for the third quarter. In addition, we have posted supplemental presentation to complement this morning's discussion. This presentation can be accessed on Cantel's Web site in the Investor Relations section under Presentations. Before I 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 SEC. 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 Brian Capone, VP Corporate Controller. First, I'll provide you with some brief opening remarks, followed by Peter, who'll discuss our third quarter fiscal year 2017 financial results. Finally, I'll provide some segment highlights and additional perspective on the state of our business before we open the call for Q&A. Now, let's move into the first quarter highlights. This was a strong quarter where sales increased by 10.6% with underlying organic growth of 7.4%. We delivered significant leverage to earnings on both GAAP and non-GAAP basis. GAAP net income in the quarter was 24.9% while non-GAAP net income was 17.2%. As I will discuss later in the call, we saw very strong performance this quarter in our international regions. Also, we are pleased to announce the successful completion of an important acquisition in the Australian market. This quarter's performance was in line with our expectations and outlook for our business remained strong. With that, I will hand over to Peter, to walk us through our quarterly financials.

[Peter Clifford:]

Thanks, John. Let's take a few minutes to walk through the 3Q '17 financial results. On a consolidated basis, our top line sales grew 10.6% year-over-year; consolidated sales walk elements for organic came in at 7.4%; M&A provided 4.4%; and FX was a headwind of 1.2%. Gross margins, GAAP gross margins expanded 140 basis points to 47.6% versus 46.2% last year. Non-GAAP gross margins expanded 150 basis points. As is always our goal, we’ll continue to try and expand gross margins slowly and steadily. This is the 14th quarter in a row we've expanded our non-GAAP gross margin rates year-over-year. Operating expenses, GAAP operating expenses increased by $6.9 million or 12.2% in 3Q compared to last year. The impact of acquired cost from acquisitions were roughly $2.9 million or 5%. 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 18% year-over-year to $27.4 million, while non-GAAP op profit increased 12.1% year-over-year to $33 million, providing modest leverage. Our effective tax rate came in at 33.6%, down 380 basis points from prior year rate of 37.4%. Key drivers for our domestic tax and issues at both the state and federal level drove 400 basis of improvement. We would expect GAAP effective tax rates close to the third quarter rate for the balance of the year. Our GAAP EPS increased 23.5% year-over-year to $0.42, while our non-GAAP EPS increased 15.9% year-over-year to $0.51. Our 3Q adjusted EBITDAS came in at $38.8 million, up 11.5% year-over-year. While our rolling 12-month adjusted EBITDAS came in at $156.5 million or up 19.3% year-over-year. 3Q cash flow from operations came in at $28.4 million, up 20.6% year-over-year, while our year-to-date cash flow from operations came in at 41.7% year-over-year. I’ll also provide some insight into the segment results. For our endo segment, sales grew 9.2% year-over-year to just over $100 million; organic was 9.9%; our GAAP op profit increased 13.7%, while our non-GAAP op profit increased 14.6% providing strong leverage. For our water segment, sales grew 7.4% year-over-year to $47.9 million; our organic was 7.5%, driven by strong backlog of capital sales orders. Our GAAP op profit increased 13.1%, while our non-GAAP op profit increased 10.9%. For our healthcare disposal segment, sales grew 21.5% year-over-year to $36.2 million. Organic was 0.6%, driven by prior year comp of 13% plus organic. GAAP op profit increased 3.7%, while our non-GAAP op profit increased 7.9%. For our dialysis segment, sales increased 3.5% year-over-year to $7.6 million and our GAAP op profit increased 29%. Now, I would like to hit a few balance sheet and liquidity details. Our balance sheet remains incredibly strong with significant capacity. We ended the quarter with $30.9 million in cash and cash equivalents, and also with $150.1 million in working capital. Gross debt ended the quarter at $145 million. This includes $74 million of borrowings this year to fund the acquisition of Accutron, our Canadian Endoscopy distributor and our Australian Endoscopy distributor. We continue to pay down significant levels of debt. We paid down $17 million during 3Q '17 after paying down $12 million in 2Q '17, and $16 million in the first quarter of '17. Our net debt is $114.1 million and our net debt to adjusted EBITDAS is $0.73. Capital expenditures were $6.3 million. As we have signaled CapEx, we’ll remain elevated for the next eight quarters to support our ERP implementation project. I'd like to alert everyone we’ll be filing our 10-Q before the close of the business today.

[Jorgen Hansen:]

Thank you, Peter. Overall, we are pleased with our results this quarter with 10.6% sales growth, driving 23.5% GAAP EPS growth and 15.9% non-GAAP EPS growth. As indicated on our last earnings call, our organic growth in this quarter was lower than prior periods, given the very high mid-teen organic growth in the prior year. Yet, we still delivered solid overall growth and nice leverage to the bottom line. Now, let me provide some high level commentary on the results of each of our three major business segments. Our industrial segment had an excellent quarter with total sales growth of 9.2% and organic growth of 9.9%. This is compared to our prior year exceptional organic growth in the third quarter of fiscal year '16 of over 33%, so a very satisfactory performance. As a reminder, in the third quarter last year, we were still experiencing tailwinds from our competitor, having significant issues with the FDA that did not repeat this year. Sales were led by our Procedural Products categories, Consumables, Service and Chemistries, while our capital equipment sales lack slightly given the exceptional strength in the same quarter last year. Importantly, those capital placements in prior periods will continue to drive strong ongoing chemistry in consumable sales growth into that installed base. Our water purification and filtration segment showed good growth of 7.4% for the quarter, led by equipment sales up 15%. These results were in line with our expectations, and the capital backlog hit a gain at record levels, which makes us confident of continued equipment growth in the coming quarters. We are pleased with the operating leverage shown in this quarter despite continued investments into the business to drive future growth. In our healthcare disposables segment, we had total sales growth of 21.5%, inclusive of the contribution from our higher businesses, while organic growth was 0.6% against the very strong prior year quarter which grew by over 13.4%. We are encouraged by performance of our strategic growth categories, which grew double-digits, offset by modest declines in our lower value legacy products. Our strategic growth categories include DentaPure waterline disinfection business, our leading sterility assurance product lines and our branded product facemasks, which continues to be an important differentiator in this segment. In addition, we saw good performance from our Accutron business and we are pleased with the results of this acquisition. Looking at our results on a geographic basis, we are encouraged by the strength of our international business. Our international operations grew organically by 18.6%, which reflects good sequential acceleration in growth last year driven by strong performance in the UK, France and Germany, as well as continued healthy growth in our Asia-Pacific region. We are pleased by these results and look forward to continue growth in these important international markets. Now, transitioning to M&A. We have a robust pipeline of acquisition targets, which is a critical element in our five year strategy. In April, we successfully completed the acquisition of our distributed industrial business in Australia. While still early, we are optimistic about the results we are seeing out of our new team down on that. With acquisition of Canada and Australia distributor businesses as well as the organic growth investments in our operations in Germany and France this year, we feel good about our direct sales footprint on a global basis. Our goal for the next few years is to establish our leadership position in all of our live in direct international markets and continue to accelerate growth and profitability of each of these regions. Looking forward, we are confident in the growth opportunities we see in each of our major segments. Over the course of this year, we have enhanced our R&D organization and filled key roles to support new product development. We recently launched AXESS, our new low profile nitrous oxide nasal mask in a new range of endoscopy storage cabinets designed to safely store and protect flexible endoscopes, thus mitigating cost contaminations. In addition, we are accelerating our cadence of new product launches, including important procedural endoscopy products and next generation sensor and portable water purification systems. As we have discussed previously, we are embarking on a global ERP implementation, which will last for approximately three years. We are taking a careful faced approach to this implementation across our different businesses to minimize the disruption and overall risk. This new ERP platform will replace the many different systems we have today and will allow the Company to realize efficiencies and continue to scale effectively as we grow. As a result of these strategic investments, we expect to continue to perform in line with objectives of our five year strategic plan. As we stated previously, our strategic plan envisions the Company doubling its sales and profits between fiscal year ’16 and fiscal year ’21. With this plan, we are targeting annual sales growth of just under 15% that is made up of annual growth of 8% to 10% on an organic basis with acquisitions making of the remainder. We expect fiscal year 2017 to be no different and our full year results should be consistent with this overall strategy. For the full year of 2017, we anticipate total revenue growth of 14.5% to 15.5% with acquisitions contributing approximately 5% to 5.5% to total sales growth. We anticipate total FY ’17 GAAP EPS of $1.70 to $1.74 and non-GAAP EPS of $2.05 to $2.07. Taking together, 2017 will be very much a Cantel like year despite challenging year-over-year comparison affecting the quarterly results. Going forward, our goal is to provide the investor community annual guidance to provide better insight and transparency regarding our thoughts and the future outlook. We are currently in our budgeting process for fiscal year 2018 and we anticipate providing FY ’18 guidance to our investors on our fourth quarter earnings call in September. Before I close, I would like to welcome Brian Capone, our new Vice President Corporate Controller to the Cantel team. Brian is a senior finance executive with over 19-years of leadership experience on company such as Stryker, C. R. Bard, Janssen Corporation and Quest Diagnostics. He’s successful track record in SEC filings reporting technical accounting, P&L management, M&A due diligence and acquisition integration makes him a key asset to Cantel. As previously announced, Steve Anaya, SVP and Chief Accounting Officer, would be leaving the Company after 15 years of service. I would like to thank Steve for the valuable contributions he has made to the Company, and wish him well as he embarks on the phase on his career. Overall, we are very pleased with our quarterly results and our year-to-date performance. Our entire Company takes great pride in our missions to buy solutions to mitigate infections, improve patient safety and outcomes, and ultimately help save lives. I thank our 2,300 loyal and hard working team members for their efforts and achievements this year. Thank you for listening. I look forward to speaking with you on our fourth quarter earnings call in September. Doug, we are now ready to take questions.

[Operator:]

Thank you. Ladies and gentlemen, at this time, we will be conducting a question-and-answer session [Operator Instructions]. Our first question comes from the line of John Su with Raymond James. Please proceed with your question.

[Unidentified Analyst:]

If we could start with endoscopy; obviously, you had a difficult comp in this quarter, and less selling days. But just looking forward, do you believe you actually have a bit of a benefit on a year-over-year basis in the fourth quarter from a selling day perspective? And the comp obviously eases quite a bit, so from a growth perspective. So I guess the question is should we expect due to those factors, endoscopy to grow to accelerate sequentially from the 3Q?

[Peter Clifford:]

I think as we've articulated in the past, the increase in capital in the prior year was really focused more on both the third and fourth quarter. And as an example, last year in the third quarter as we called out, we have about 33% growth organically within that segment. And we called out about 5% of that was due to CU, it wasn't quite that high in the fourth quarter but it was a similar type of profile. So yes, we do pick up one day year-over-year from the 62 days to 63. But again, I think we're going to continue to feel the effect of that capital comp through the balance of this year, and it'll start to mitigate as we get to the back half of the first quarter of '18.

[Unidentified Analyst:]

And then next question on the water segment, performance continued to be pretty strong there. And just looking back over the last couple of years, most of your M&A has been both within endoscopy and healthcare disposable. So I guess, going forward, can you just give us an idea of maybe just rank order, opportunities that you're seeing and included in that, are there opportunities within the water segment?

[Seth Yellin:]

Hi John, this is Seth here. From an M&A perspective, I think we're looking at acquisition targets in all of our major segments, as well as new verticals as well. I don't know if we could really rank opportunities in terms of priority. I think we look at them fairly agnostically and really think about what is the best strategic fit and what is actionable at the time in which the opportunity presents itself, and act accordingly. I think we see good opportunities and good potential in all of our markets. I think from a market perspective, obviously, the endoscopy market has the largest available TAM. So it feels that that has the most available target accessible. But that doesn't mean there's not a lot of opportunity for us to pursue in our other segments, as well as in the irrigation team as well in the infection prevention universe.

[Jorgen Hansen:]

And maybe just to supplement what Seth says. I mean we’re active in each segment, including in the water segment, and have been working hard on various deals over the last several quarters; sometimes deals work out and sometimes they don't. So it's just been a while since we have something that we're really excited about and then wanted to complete.

[Unidentified Analyst:]

And then just a couple more quick ones; one on product, you mentioned a couple of quarters ago, the launch of a REVOX and some early sort of signs thereof. I think you had somebody at that product to line up; so just any update that you can give us there regarding the technology and what you’re seeing in terms of versus your expectations at this point?

[Jorgen Hansen:]

I will say, we're still very excited about the REVOX sterilization technology, and our pipeline is stronger than ever. I think what we have learned with this kind of product is that a selling cycle is pretty comprehensive. And particularly, when we are looking at using REVOX as a inline sterilization solution at our cost of most manufacturing sites, this just takes a while in terms of validation, testing, and everything else. But we’re very confident on the product. We believe that it has a great future. So far the financial return is not really something that impacts our business. But we anticipate that they will in future quarters for sure.

[Unidentified Analyst:]

And then just the last one. How are you thinking currently about the capital environment in the U.S. as benefits of ACA that accrued to hospitals are starting to fully anniversary?

[Jorgen Hansen:]

You mean the benefits of the Affordable Care Act, is that the question? Just want to make sure I understand that question?

[Unidentified Analyst:]

Yes, exactly. Any benefit that we had seen from the capital environment, it had been relatively strong. So just how are you thinking about that right now.

[Jorgen Hansen:]

No, I think, it's a good question. Our assumption on the capital growth we’ve had in the U.S. has permanently been driven by the recall of Custom Ultrasonic that contributed to about 5% of our growth last year. So even if you look at our industrial business now growing organically just shy of 10% just think about the fact that we are -- we don’t have this one fall anymore at least to a much lesser degree. So that was the biggest impact on the business. There has also been contributing factors to our growth has been the issues around to duodenum scopes that gave us windfall as well. And still continue to drive good growth on the business. And even though how our capital sales this quarter was lagging a bit compared to last year, it's still closer to record levels. We are still very busy putting in capital equipment in the U.S. market. For the Affordable Care Act, we couldn’t detail anything in particular I mean what people are covered to get endoscopies with Affordable Care Act of 20 some million. But we wouldn’t be able to precisely say how that connection is. But those two other factors definitely impacted our sales growth and adoption of our technologies into the U.S. market.

[Operator:]

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

[Mike Matson:]

I guess I just wanted to start with the healthcare disposables business. So you saw some double-digit growth with your branded products. How big of a part of a business are the branded products? And are we ever going to get to the point where that becomes kind of the majority of that business and we could see maybe sustainable high single-digit or better growth?

[Peter Clifford:]

Yes, ultimately the portfolio has been transitioning for last couple of years, if you went back even two or three years ago, it was probably more about 50%-50%, 60%-40% mix of kind of private label versus branded. And actually, at this point, we’re approaching not quite at 70% we’re probably in the 67% to 68% of the business now is branded. And obviously, that is a conscious choice. And we will continue to move the needle on that mix, and it's one of the things that's driven obviously gross margin accretion in the business. Do we think that that's ever going to get to be a 100 and zero? I don’t. I think private label has a place, but I suspect it's probably more or like an 80-20 mix is probably our aspiration.

[Jorgen Hansen:]

I think it's important too. The reason why we call it out is that the investments we made in sales and marketing into our healthcare disposable segment has really been to drive these products. And we feel really confident that those investments are paying off with double-digit growth on the products that we are focused on that has the highest margin so the net perspective return on the business investments have been very positive. On the flip side, some of our lower margin legacy products have been sliding away and that’s impacting the top line growth. Again, if you see the margin expansion in that segment has been very favorable over the last eight to 12 quarters. So that’s how we’re going to continue to buy value out of this business.

[Mike Matson:]

But do you think there is potential that as that mix continues to shift towards the branded products that the organic growth could improve overtime?

[Jorgen Hansen:]

Yes, I mean, we’ve kind of said. We think of that that business is sort of a mid-single digits kind of organic growth, and that’s candidly been what some of that dissipation of the private label. But even in an improved mix environment, I still think at call it the mid-single digits or almost 2x, the general marketplace in terms of performance.

[Mike Matson:]

And then you mentioned you acquired the Australian distributor. I was just wondering if you could give us some insight to where you stand with this, your international business more broadly in terms of the mix between direct sales versus distribution, and where do you see that going, I guess, over the next few years?

[Jorgen Hansen:]

So I’ll start and hand over to Pete. So we are direct now in 12 markets, including the U.S. And just go back, couple of years back, we basically direct in the U.S. so it's been a big transformation over the last few years. And as we indicated in the call, we believe that we are almost at the finish line in terms of where we need to be direct -- there might be a couple of markets that we will think about in the future. But the fact that we are direct now in all the major markets in Europe, UK, Germany France, Benelux, Italy, are really covering probably 8% of the European market; we are direct in Singapore, Malaysia, China and now Australia key markets there. We might look at couple of initiatives in the next two or three years. But I think it's fair to think about the majority of the investment and going direct early from organic perspective, we are pretty far down the line. The only think I want to add is that obviously we’re still looking for acquisition and some of those markets will be direct, we are looking for more scale. So those are the things that can help drive growth and profitability in the future. And now that we are direct, so that will helps us one of the pipeline as well having people in market watching what's going on and it feeding back to our team, so we connect on opportunities as they arise.

[Peter Clifford:]

I’ll just echo. At this point, the positive spin is where we want to be. And I think now it's a pivot towards optimization and accelerating what we already have.

[Mike Matson:]

And when you say scale in those markets, do you mean buying additional distributors or do you mean buying -- bringing in additional products to sell, or both?

[Jorgen Hansen:]

It could be both. And probably, we will probably spend more on the product side at the moment, because we are direct in all these markets. So there’s not really much of distributor play to made, so I think our attention is more on the product side. But that also, if you cover product company; obviously, that brings typically the sales resources and everything else that we will provide scale.

[Mike Matson:]

And then finally just staying in the international theme. Can you just give us the international constant currency growth this quarter?

[Peter Clifford:]

Yes, we [fell down] on our sales walk there at the beginning, FX was a headwind of 120 basis points on a consolidated basis. And I guess if you wanted to have for the quarter, outside the U.S. grew on a reported basis 18.1% and organically it was 18.6%.

[Mike Matson:]

And that’s organic constant currency or just organic?

[Peter Clifford:]

That’s just organic.

[Operator:]

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

[Raymond Myers:]

Let me ask you first about the sales and marketing expense, it was a quite strong in the quarter. Could you describe what that was? Was it seasonality here in the fiscal quarter and whatever those investments were?

[Jorgen Hansen:]

I’ll start and handover to Peter. I mean, the bulk of the expansion of our margin investments really are the flow through of the investments we made in the beginning of the year in expanding our U.S. sales team, adding 15 people, our sales reps across couple of EPs, the 15 people we added in Germany as well. So those are the things that are flowing through. We have added resources in France recently as we’re going direct there. And I think those are the major markets that we’re going to invest in.

[Peter Clifford:]

And I just say the only other one that’s more of timing issues is our healthcare disposable business, has a fair amount of sales trade shows and activity in the third quarter. And it's not as quite as heavy in the first half of the year.

[Raymond Myers:]

And can you describe what the contribution was of going direct in Australia? Have you felt the benefit of that yet?

[Jorgen Hansen:]

Well, overall, there it's about $2 million a quarter in sales that’s sort of additional sales pick-up, right.

[Peter Clifford:]

Yes, as we indicated in the release, incrementally, the business should represent about $8 million to the top line, just picking up the distributor margin. And I think we closed the transaction in early April. And so we thought a few months just under, perhaps just under $1 million or so in April.

[Raymond Myers:]

The dialysis business has been quite stable for the last several quarters, more than a year now actually. Is that a new trend or do you still anticipate a secular decline in that business?

[Jorgen Hansen:]

I think, fundamentally, we do not anticipate this business to grow. And if you look at our strategic plan outlook, we are looking at 5% to 7% decline. And however, as of late, we have picked up a couple of additional businesses in that segment, including some [indiscernible] business that we’re selling to one of our major customers, and that has helped us drive little bit of growth. And the business is also still quite resilient in some of our international markets. But again, it’s a major part of our business today and it’s not something that we anticipate will have meaningful impact on our future growth.

[Raymond Myers:]

And then let me ask you about the progress with your business restructuring. And what benefits you expect that to generate, particularly touching on the SAP installation and the facility consolidations. When do you expect all of that to really begin in earnest? And when do -- would you expect the most early benefits of all that?

[Seth Yellin:]

I think we’ve talked about on the ERP project in order for us to realize some leverage in the back half of this [gratifying] period, it's really the investment now. So in terms of meaningful reduction, SG&A as a percentage of sales, it's going be more in the year three, four and five of the strat plan. And as we’ve kind of said, it might be a little bit of a headwind to kind of year one, year two of that profile. And we've been able to rationalize that with our continued gross margin performance is really given us the headwind on that. And I think that will continue to play. As far as restructuring, we're always constantly looking at the business and the footprint. And I would just say the only thing in consequence out there right now is we have given a formal proposal to one of our work councils in one of our manufacturing locations in Europe, and we expect to work through that process here in the fourth quarter, and expect it to be completed before year-end.

[Raymond Myers:]

And just to clarify. Has the SAP and other facility consolidation work begun yet, or is that really ramping now and will grow in the first two years of the strat plan?

[Jorgen Hansen:]

So the SAP is sort of kicking off next month as a project that's where we started blueprinting of this project. So obviously, there's no benefit, only cost, at this point. And in terms of restructuring of our footprint, there's no concrete plans on that other than what Peter mentioned. But we’ll probably address to that as we grow.

[Operator:]

Our next question is a follow-up question from the line of John Su from Raymond James. Please proceed with your question.

[Unidentified Analyst:]

I couldn't help, but notice. I believe you provided some fiscal '17 financial guidance for the first time this fiscal year. So I was just wondering, specifically around the timing of that. Could you just kind of walk us through why now provide that guidance? Thank you.

[Jorgen Hansen:]

I think constantly we've been trying to broaden our coverage here for a while. So we’ve a lot of new people to the Cantel story, and we feel like guidance will help our stakeholders understand our business and our markets a bit better and that’s really the driver.

[Operator:]

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

[Jorgen Hansen:]

Well, again, thank you for listening. I look forward to speaking to you at our next earnings call in September. 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.