Cantel Medical Corp.
Q4 2007 Earnings Call Transcript

Published: 9 Oct 2007

[Operator:]

Good morning. Welcome to the Cantel Medical Corporation fourth quarter fiscal 2007 conference call. Today’s call is being recorded and will be available for replay beginning today and through October 10th by dialing 1-877-660-6853 and using passcode 286 and conference ID number 257125. This call is also being simultaneously broadcast live over the Internet on VCall.com and a replay of the webcast will be available on VCall for 30 days. I would now like to turn the call over to Richard Moyer of Cameron Associates.

[Richard Moyer:]

Thank you. Before we get started, 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 limitations 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. Now I would like to turn the call over to R. Scott Jones, President and CEO of Cantel Medical. Go ahead, Scott.

[R. Scott Jones:]

Good morning, everyone, and welcome to our fourth quarter and fiscal year-end earnings call. With me today are

[Craig Sheldon:]

Thank you, Scott and good morning, everyone. Let me go through some of the numbers for the quarter and the year. Let me start off by indicating that the GE Water acquisition, which we completed on March 30, is included in our consolidated results of operations for the last four months of fiscal 2007. So that would include the entire fourth quarter since the date of the acquisition on March 30, and GE Water is not included in our results of operations for any portion of fiscal 2006. Also, we completed the Twist acquisition in our healthcare disposables segment on July 9 and the impact on operations for the portion of the month of July from this deal is inconsequential. Finally, the three acquisitions completed subsequent to the end of the year-- DSI, Verimetrix and Strong Dental -- are not reflected in our results for any of the periods presented. As Scott mentioned, revenues for the fourth quarter and the fiscal year increased by 25% and 14% respectively compared to last year's periods, and without the impact of the GE acquisition. I would point out that GE contributed revenues of $4.994 million in the fourth quarter and $6.949 million for the fiscal year. So without these revenues, the organic growth was up 15% for the fourth quarter and 10% for the fiscal year. Income from continuing operations for the company in the fourth quarter more than doubled to $1.899 million. This compares to $922,000 in the fourth quarter of last year. For fiscal 2007, income from continuing operations increased by 22% to $8.104 million and this compares to $6.653 million in fiscal 2006. For both the fourth quarter as well as the fiscal year, the year-over-year increase in earnings resulted primarily from improved performance in our dialysis segment, as well as continued growth in the water purification, specialty packaging and therapeutics segments. Also for the year, healthcare disposables was also an important contributor to our improved performance. One more item I would like to point out about the GE Water Dialysis acquisition. In fiscal 2007, this acquisition contributed approximately $1.1 million in incremental operating earnings. After you consider the interest and the one-time acquisition costs and you tax effect everything, GE Water added approximately $0.01 of incremental earnings per share to the company, for the four months. Now I would like to go back and look at a few other components of the income statement. Starting out with gross profit percentage for the fourth quarter, it decreased to 33.8%, and that compares to 34.6% in the same quarter of last year. This decrease was primarily attributable to sales mix in both our dialysis and water purification segments and that includes the addition of GE Water. Those sales carry a margin of approximately 28%. For the year, the gross profit percentage was 36.1% so it was virtually flat compared with last year at 36.0%. Looking at operating expenses for the fourth quarter, $17.087 million. That's an increase of 17% compared to last year's fourth quarter and that's 27% of revenues. That's an improvement over the 29% of revenues last year. For the full fiscal year, operating expenses were $62.173 million. That’s an increase of 15% compared to fiscal 2006. As a percentage of revenues, that would be 28%, which is the same as the 28% last year. First focusing on the gross dollar increases in operating expenses, this was primarily attributable to the U.S. direct sales and service initiative for the endoscope reprocessing business; the infrastructure and the transaction costs associated with our acquisition of GE Water; as well as additional investments in personnel to support growth both in the selling areas and the G&A areas. This was across virtually all of our product segments. I also wanted to point out when you look at operating expenses as a percentage of revenue -- and I mentioned that it was 27% in the quarter, which is an improvement from 29% in last year's fourth quarter -- this was by and large due to the GE Water acquisition. So even though GE Water only contributed a gross profit percentage of about 28%, the infrastructure is very, very small with that acquisition and thus we have excellent drop through to the operating earnings line. Moving down to interest expense for the quarter, net interest was $962,000 in the fourth quarter. That compares to $705,000 in last year's fourth quarter. The acquisition of GE Water contributed about $413,000 in interest expense for the fourth quarter, so without GE Water, our interest would have been much lower than last year. That's due to significant repayments of debt over the past year. For the full fiscal year, interest expense decreased to $2.737 million. That compares to $3.393 million in fiscal 2006. Again, that is despite the acquisition of GE, which carried interest expense of about $570,000. So overall, a very significant reduction in interest and once again that's due to significant repayments of debt over the past year. Lastly on the income statement, our effective tax rate. A bit of a complicated discussion, but important to go into a little bit of depth here. I will start out by indicating that in the fourth quarter, our overall effective tax rate was 38%. This is a dramatic improvement over last year's fourth quarter, when it was 56.5%. For the full fiscal year, the effective tax rate was 42.5%, compared to fiscal 2006 of 44.3%. Additionally, the fourth quarter was a big improvement over the first nine months of the fiscal year, where you may recall we carried an effective tax rate of 43.8%. Let me start off by pointing out, and this is a repeat of a discussion from last quarter, that the reason for the very high effective tax rate, both in the initial nine months of this year as well as all fiscal 2006, was principally attributable to the geographic mix of our pre-tax income, and more specifically, the losses that we incurred at our Netherlands operation. We had indicated last quarter that we expected to get a significant improvement in our tax rate in the fourth quarter as we wound down the R&D efforts at our Netherlands business and relocated the business to the U.S. I'm pleased to say that we've accomplished that, as I mentioned, coming in with a rate of 38% in the fourth quarter. Looking ahead to fiscal 2008, I would expect our overall effective tax rate to be approximately 40% next year, or perhaps slightly lower, although I would caution that it is very difficult to predict our effective tax rate with any precision due to the uncertainty over where our pre-tax income is going to fall. That is certainly good news on the tax front. Now taking a little more specific look at some of our operating segments. Let me start out with the water segment. As Scott had indicated, the revenues for the fourth quarter in water were up 58%, or 10% on an organic basis compared to last year and for the fiscal year revenues were up 35%, or 16% organically without GE Water. The operating earnings for our water purification and filtration business in the fourth quarter were $1.616 million. That compares to $631,000 in the same quarter of last year. For the full fiscal year, operating earnings in water were $4.414 million. That compares to $2.758 million in fiscal 2006. The year-over-year increases in operating earnings were substantial, primarily attributable to the contribution of the GE Water acquisition which in the fourth quarter, GE Water contributed approximately $800,000 in operating earnings. For the four months since the date of the acquisition, contributed approximately $1.1 million in operating earnings. Once again, as I pointed out before, these operating earnings does not include the one-time acquisition charges which we report as part of corporate expenses and does not include the interest expense which is on a separate line. But equally important, if you pull out the effect of the GE Water operating earnings, we still have very nice growth in excess of 20% in operating earnings for the quarter and the year, due to the increased sales of capital equipment and service in our existing business. So all in all, we are extremely pleased with the strong start to the GE Water acquisition. As we move into fiscal 2008, I would anticipate even further improvements. As we gain some operating efficiencies, we will leverage the additional sales against our existing infrastructure and we will continue to make improvements in our supply chain management. Dialysis revenues for the fourth quarter went up by 19% compared to last year, and for the year were flat. Looking at operating earnings for our dialysis business in the fourth quarter, $2.26 million, a significant improvement over the $1.96 million in last year's fourth quarter. For the fiscal year -- and this again, is despite the fact that sales for the year were flat in dialysis -- the operating earnings were $8.117 million; again, a significant improvement over the $6.915 million in fiscal 2006. So once again, although the revenues clearly were impacted by the industry consolidation as we've already reported, the earnings were sustained, and in fact improved considerably, due to favorable product and customer mix, particularly in the concentrated area where we got rid of a lot of very low margin or no margin business. Additionally, the strength of our key reuse customers is very, very strong and we have been able to lower manufacturing and distribution costs. So really, when we look back at this dialysis segment and we see that we had for the year 17% overall growth in earnings during 2007, we view this as being extremely impressive, given the dynamic changes that have occurred in this industry. Our renal team really deserves just a tremendous amount of credit for their perseverance through all this industry consolidation. Moving onto our healthcare disposable segment, again, formerly called dental, our revenues for the fourth quarter were down by 2% and for the fiscal year revenues were up by 6% versus last year. Operating earnings in this segment for the fourth quarter were $1.794 million compared to $2.185 million in the same quarter last year. For fiscal 2007, operating earnings were $8.753 million compared to $7.917 million in fiscal 2006. Really, the year-over-year trend in earnings is tied directly into the trend in the sales volume of the business. Endoscope reprocessing revenues for the fourth quarter were up by 39% over last year, and for the full fiscal year up by 28%, compared to last year. The endoscope reprocessing business had an operating loss in the fourth quarter of $115,000. This compares to an operating loss in last year's fourth quarter of $596,000. For the full fiscal year we had an operating loss of $509,000 and this compares to operating earnings of $2.451 million in fiscal 2006. We reported extensively before the reasons why we've had losses in the business this year. Just once again quickly, we sustained losses primarily due to our substantial investments in our U.S. direct sales and service initiative, as well as the continued development of the MediVators Advantage product line. That's our former Dyped product line, as Scott reported before. As you may recall in last year's fourth quarter, the reason we had a loss there is because we had incurred some expenses of about $800,000 last year to commence our direct sales strategy in preparation for the termination of the Olympus distribution agreement. In our therapeutic filtration segment, revenues for the fourth quarter were up by 41% versus last year and for the year, revenues were up by 11%. The operating earnings for therapeutic in the fourth quarter were $430,000. This compares to $117,000 last year. For the year, operating earnings were $1.385 million. This compares to $1.046 million in fiscal 2006. Here again, the growth in earnings was primarily driven by increased revenue volume and this includes the recommencement of our Vapotherm sales. In our specialty packaging segment, our revenues for the fourth quarter were up by 9% and for the fiscal year up by 34% compared to last year. The operating earnings really followed this trend. For the fourth quarter, operating earnings for specialty packaging were $186,000. This compares to $50,000 last year. Fiscal 2007 operating earnings were $1.908 million and this compares to $676,000 in fiscal 2006. So again, significant revenue growth, including our high margin compliance training products. So all in all, just a fantastic year for our specialty packaging business. A few quick comments on the balance sheet. As always, we continue to have a very strong balance sheet. At July 31st we had $15.9 million in cash and cash equivalents, a current ratio of 2.1

[R. Scott Jones:]

There you have it. I will make a few comments and then we will ramp up and take questions and answers. In summary, let me recap our thoughts. The stage is set. We are building value across all of our segments. We have had a terrific top line growth, our investments are now beginning to pay off in terms of revenues. We now need to drill down and harvest the synergies that we've proposed and acquired under our acquisitions, as well as the cost savings that have been put in place throughout the year. Lastly, we will see a continued focus on marketing and product development as we fill out our segments with proprietary new products. This is very much a priority for us going forward. So with that, one more reminder. That is that our 10-K will be filed no later than Monday, so more detail will be following in the 10-K. Operator, let's go ahead and open for questions.

[Operator:]

Your first question comes from Michael Gaugler - Brean Murray.

[Michael Gaugler:]

I will start off with the endo reprocessing segment. As we look forward to potential profits and margins, would you expect those to be in line with the company average?

[R. Scott Jones:]

They will certainly get there. We have full expectations that once we are up to a steady state with the launch of our new product and full penetration with our MediVators sales force that the endoscope reprocessing segment will be very much at par with the rest of the segment. Now that, of course, will take time. We are expecting to return to profitability forthwith. But that will ramp up over time and it won't be an immediate return to those levels, but we will certainly get there.

[Michael Gaugler:]

Last quarter, the acquisition-related charges that we saw for the deals that were consummated in '07, are they essentially behind you now?

[R. Scott Jones:]

The acquisition charges for those acquisitions are behind us. They are specific to those acquisitions that we did.

[Michael Gaugler:]

Finally, how does the pipeline for new opportunities look? I know that you were looking a little bit towards the west coast to build out the water treatment platform a bit more. Are you seeing anything interesting at the moment?

[R. Scott Jones:]

The pipeline looks great. We want to give credit to our corporate development function. Under Seth Siegel's leadership we have really identified a tremendous pipeline. As you can imagine, you've got to turn over a lot of stones before you find the right acquisition. So it's a matter of timing. We find we would like to continue fleshing out our service delivery network and we have identified an opportunity on the west coast. We've identified another larger opportunity that has several geographic fill-ins for us. So it's a matter of timing and valuation. Hopefully before long we will be able to execute on those opportunities.

[Operator:]

Your next question comes from Mitra Ramgopal - Sidoti & Co.

[Mitra Ramgopal:]

The organic growth for the year, was it 10% for the top line?

[R. Scott Jones:]

That's correct.

[Mitra Ramgopal:]

As you look out to '08 do you expect that to hold steady or even improve further?

[R. Scott Jones:]

We've got some good momentum across all of our segments at this point and again, we never know. There are no guarantees in terms of industry consolidation anywhere. Our objective is certainly to maintain that momentum that we have right now. So it is certainly our goal to keep up the pace.

[Mitra Ramgopal:]

I know you did address the dialysis line, but clearly the number this quarter was probably the best we've seen for some time. Anything in particular that is a good run rate to use going forward?

[R. Scott Jones:]

It's two things. As I mentioned, the consolidation with Fresenius and Renal Care Group is behind us so that certainly had a big impact on certainly the first couple of quarters in the year. Our largest client is growing very rapidly and we continue, as I said, fourth quarter we had 33% growth in Renatron unit sales. So that's terrific. In those numbers however, and I will let Roy Malkin comment on this as well, in those numbers we continued to have a very robust set of orders for dialysate concentrate. And that includes the company that does single use. We are also a big vendor to them. So it's a mix of Renatron sales, both from the U.S. and International as well as very strong orders for the concentrate. Roy, do you want to add anything to that?

[Roy Malkin:]

I think you are right on, Scott. The major impact in the fourth quarter was some substantial sales to Latin America of our concentrate product. As we've reported over the last few years, we have really taken advantage of opportunities where they exist and last quarter was a very, very good quarter for us. Also, we had an excellent quarter in Asia for our renal product. So all in all, I think that renal growth will remain reasonably constant this year. That really depends on our continued success in Latin America.

[R. Scott Jones:]

What I would add is what we're seeing is procedure growth is growing in the upper single-digits. If I were to gauge what the appropriate growth would be in the segment, I would rather link it to what procedure growth is at, so 7% or 8% is probably reasonable. It takes a while to translate procedure growth into our order rate, but that's what I think we would like to think of it as for the coming year.

[Mitra Ramgopal:]

With regard to stock compensation expense, I know it picked up a little this year. Looking ahead to fiscal '08, should we assume it's going to be pretty flat?

[R. Scott Jones:]

The majority of the stock comp expense is divesting of existing options and restricted shares that had been issued years ago. So that's the majority of our stock expense and as we add new executives, a vital part of the yearly compensation for the leadership team is the equity compensation. So we would expect to layer on more equity as the years go by. But again, really, the bulk of it is the legacy vesting.

[Operator:]

Your next question comes from Mark Cooper - Wells Capital.

[Mark Cooper:]

Did you give us the D&A and the cash flow number for the fourth quarter or for the year?

[R. Scott Jones:]

The cash flow will be in the 10-K. Is the D&A in there also?

[Craig Sheldon:]

Yes. Everything will be in the 10-K.

[R. Scott Jones:]

That, as I said, will be out no later than Monday. It is probably the best source of that.

[Mark Cooper:]

You don't have that information now?

[R. Scott Jones:]

Just hold on that because we are still under audit at this point and we are just not ready to file the K.

[Operator:]

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

[R. Scott Jones:]

That about wraps it up. Once again, thank you for your continued interest and support. I look forward to interacting with all of you. If you have any questions, please feel free to call. Thank you.