Cantel Medical Corp.
Q2 2008 Earnings Call Transcript

Published: 31 Mar 2008

[Operator:]

Greetings ladies and gentlemen and welcome to the Cantel Medical Corp. second quarter 2008 conference call. At this time, all participants are on listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require the operator assistance during the call, please press “Star 0” on your telephone keypad. As a reminder, the conference is being recorded. It is now my pleasure to introduce your host, Mr. Richard Moyer, from Cameron Associates. Thank you sir, you may begin.

[Richard Moyer:]

Thank you Ryan. Before we get started, I would like to remind everyone that this conference call may contain forward-looking statements. Forward-looking statements involve risks and uncertainties, including without limitation the risks detailed in the filings and reports with Securities and Exchange Commission. Such statements are only projections and actual results may differ materially from those projected. Now I would like to turn the call to over to Scott Jones, President and CEO of Cantel Medical. Go ahead Scott.

[Scott Jones:]

Thanks, Dick and good morning everyone. Welcome to our second quarter 2008 earnings conference call. With me today are Charles Diker, Chairman, Andrew Krakauer, Chief Operating Officer, Craig Sheldon, Chief Financial Officer, Steven Anaya, VP and Corporate Controller of the company. We’ll all be available for questions and answers after our formal remarks. I think what you’ll see here today is a Cantel from an operating perspective is on very solid footing. Our legacy issues in terms of the clean up of the Dyped MDS Unit in Europe are behind us. We’ve reported strong top line growths, strong growths in EBITDA margins across our segments. We’ve either held or improved our operating margins, we have very strong balance sheet and now more than ever we have a strong flow of new product introductions in our pipeline. So, the common substance as it is that we have really injected a marketing and R&D character to the company and we’re making terrific progress there. As we look forward into the future, the question we asked ourselves is, “Where is the catalyst, How do we create fast growth in an otherwise moderately growing industry?” And as we look at those questions strategically, there are three very clear elements in our mind. Number one is to create breakthrough product introductions that will change the way that infection prevention and control is done. Number two is to leverage our very solid branding reputation across the market by creating product extensions and successfully watching those. And number three is to leverage our existing and our new products and move them into alternative markets. In all three cases, we are very active and in our forthcoming basis we will be announcing some exciting news in the not-too-distant future. About a year ago, 12 months ago, we delineated five key strategic priorities for the company. And I personally, I’m a believer of saying what you do and doing what you say. So, in order to be accountable for the execution against those priorities, our first list down then will go back, will run through our progress to date and then we’ll go through the financials. By way of reminder, the five goals were as follows

[Craig Sheldon:]

Thank you Scott and good morning everyone. What I wanted to do is just spend a couple of minutes and go through the press release that you have in your hands that went out this morning. And I wanted to start it off by just quickly running through the impact to some of the acquisitions that we’ve done the last six months, six to nine months. Starting with GE water, which as you well know, we acquired GE water on March 30, 2007. That was the end, near of the end of our 3rd quarter last year. So, the GE acquisition is fully end of in the results of operations both for the first quarter and the full six months of fiscal 2008 and that is not included in the comparable periods of last year. And as Scott has indicated earlier, we have a very strong performance in growth from GE throughout this fiscal year. The Twist acquisition on our healthcare disposable segment, small acquisition that we did in July of 2007, again, here we find excellent results from Twist, since we acquired that company. Twist is also included both for the full quarter as well as the full six months of this year and it’s not included in the comparable periods from last year. On addition, we did as you are aware of, three small acquisitions in our first quarter fiscal 2008. "DSI", small water business included in our water purification segment on August 1st, the "Strong Dental" acquisition which was closed in the late September and the "Verimetrix" acquisition which was a mid-September acquisition, all that was in our endoscope reprocessing segment. All three of these acquisitions as Scott has alluded to represent a product line extensions. They’re fully included in the fiscal 2008 results from the days of respective acquisitions. So they’re all in there for the full quarter and the second quarter but only part of the six-month period and they are not included in last year’s comparable periods. I mean, really all these other than GE water, again because they were small acquisitions although clearly adding, you know, incremental income to the company were not significant as far as the accretion at this point. Looking at the income statement analysis, Scott mentioned sales in the quarter up by 18% compared to last year and for the six months, the increase was 18.4%. And the organic growth without GE is 6.4% for the quarter and 6.8% to the six months and also just to repeat what Scott said because this is important, we are not really taking credit in the organic growth for the fact that we have fairly significantly grown the GE business since we acquired that company. But it is GE products; we’ve considered that all as part of the acquisition growth. So, all in all, pretty good performance on the top line. As the gross profit of the company is 35.3% in the second quarter. That compares to 37.8% in last year’s second quarter and it was down for the six months as well. Also 35.3% of the six months that compares to 36.9% in last year’s six months. We’ve had a number of issues that　have impacted gross profit percentage and I do want to spend a bit of it here is because it is a very important area for the company. Scott went through a couple of them but there are few more issues that we’ve had to deal with. I wanted to start out with the GE business. We had mentioned this in the past that the GE business comes with margins somewhere in the area of 28.5% so right off the bat; we are bringing our fairly significant business into our company that has average margins lower than the prior average of the company. So, right there at that would be somewhat of a drag on a gross profit percentage. And I would attribute approximately 1/3 of the decline in the gross profit percentage specifically to the mix that came in with the GE acquisition. And I am going to come back to the GE acquisition in a second. Much more of other sale mix is concerned; we definitely have gotten hurt there as well. So, although the sales were very strong, we haven’t had the favorable sales mix so far this year. I give you a few examples of that, the face mask sales have been down compared to the prior year. That was principally due to some rather significant orders for the flu preparation sales that we had gotten the last year. And we haven't had a repeat of that thus far this year; the dialysate concentrate business particularly in the 1st quarter of this year was stronger than last year. And that is you know is a very low margin business. So, that’s brought the margins down. We’ve also just continued to have to battle some price pressure in our dialysis business on the sales scale on to large national change. So, although that business has been quite significant, the other pricing there has always been a challenge. So, we continue to work on that. We go back to GE for a moment, in addition to the fact that we’ve brought a 28.5% margin business into the company. The transition of the GE business has been something that has occupied a lot of our time in the first six months of this year, as you probably are aware, we have mentioned this last quarter. We have now completed the transition. The GE business has moved into a new manufacturing facility on our pre-existing campus out in Minnesota, where we have our Minntech business. We spent an awful lot of time and effort and man hours this year so far getting that business set up. That has brought a lot of cost into the company, a lot of over time that has to some extent been a drag on the margins in our water business. So, they’re not good from that perspective. We anticipated that that would happen and the good news there is that is a very correctable situation. That overtime will now disappear. We certainly don’t expect a repeat of that as we move into the second half of the year. We do view the transition as substantially completed at this point and we fully expect to see meaningful improvement on our gross profit percentage on our water business. So that’s very good news and I do want to mention one more point on the GE 28.5% margins that that business, I had mentioned this last quarter. The operating expense structure for the GE business is very, very efficient. So, although it has hurt us on some of gross profit percentage line, it is definitely helped us on the operating expense area. And that’s something that’s really important to see that whole, the whole picture with GE. The next item in terms of gross profit, Scott had mentioned the manufacturing cost issue that we’ve faced. We have seen this in many areas in our business from chemicals, resin to paper and many other areas as well, that is largely a factor of the economy. We have worked extremely hard to negotiate the best prices that we can get. There is an ongoing process. Wherever we can, we have passed price increases along to our customers which are been very helpful to absorb, you know, good chunk of those price increases. But this is an ongoing battle that we’ll have and we will not stop working hard to contain these cost increases because it is clearly having an effect on our gross profit percentage. We’ve also seen increases in the cost of transportation largely related to the cost of oil. Here, we have done in my view, particularly a good job, particularly; I mean our Minntech business which is dialysis and endoscope reprocessing, of passing those cost increases along to our customers, to get them, to help absorbing some of those cost. But nonetheless, has been a factor on the margins as well. But I guess on summary on the gross margins, it clearly has our full attention at this point. We have already taken corrective action where we can. As I’ve mentioned, it’s an ongoing process. We anticipate taking further corrective action down the road. We continue to look at where our customer prices, our position and what else can be absorbed along those fronts and as I’ve mentioned, in terms of the larger group, we fully expect improvement on those gross profit percentages as we streamline the business and complete this transition of the GE business. Moving down to operating expenses, for the quarter and of course we’re going to see year-over-year increases here for quarter, 11.7%, and for the 6 months, the year-over-year increase is 13.9%. Fully expected, you know, we have done the five acquisitions in the passed nine months. So we have all the infrastructures of those acquisitions that we’ve had to absorb. With sales increasing over last year, we’ve naturally paid our higher commission to expense on those higher sales. And by the way, the infrastructure of the acquisition has included pretty substantial amount of intangible on asset amortization which is down in the G&A area in our income statement. And when you see the 10Q that comes out next week, we will, for the first time on our cash flow statement be clearly breaking out the amortization versus the depreciation because the amortization continues to be a big number and I think it’s important for everybody to understand exactly how that is impacted the income statement. We also had some severance expense associated with our Netherlands business. We mentioned this in the first quarter that we have had some there and have a little bit more to come in the second quarter and so that is now happened. We have also had some impact on the foreign currency which on the bottom line basis has cost us a penny on the second quarter and we actually taken some measures to hedge and minimize that number would have been at least doubled that had we not had some hedging programs in place. But we’re looking at further action where we can hope to minimize the future impact of the currency. But those are some of the bigger reasons for the gross or increase on the operating expenses. Now, when you look at those expenses as a percentage of sales, the picture looks pretty good. For the second quarter, operating expenses where 27.5% sales, that’s down from 29.1% in last year’s second quarter. For the six months period 27.7% of sales versus 28.8% sales last year, and again, that’s display all these additional amortization that we’ve had to absorb. So, we’re pretty pleased with that picture. We feel that the operating expenses are well controlled. There are always areas where you can continue to assess and where you might be our cut back in expenses and we will continue this to work hard in that area but we do feel that we’ve leverage our sales pretty well. But in terms of operating income, then these all translates in the growth on that line of 4.7% on the second quarter versus last year. An 11.62% gross, both are gross numbers versus the comparable periods of last year. At the interest expense line is completely reflective of the borrowings that were necessary to do the acquisitions. We are very optimistic in this area as well. Both from the standpoint that we will continue to pay off debt as well as the fact that was the reductions and the interest rates and the way our interest expense is structured right now. We are predominantly on livewire contracts that are staggered over various time periods over the course of the next six months or so in a very gradual but consistent way. The contracts that we have will be rolling off. They’ll be replaced with new contracts at significantly lower interest rates. So, we do look for a predominantly improvement in this expense as we move down the road. Another area where we expect more improvement is in income taxes. As you may recall, we have really battled with some higher tax rates over the past couple of years which is almost entirely related to the fact that we were losing money in our Netherlands operation and unfortunately cannot record income tax benefits against those losses. We expected that those losses will continue to come down. In fact, they have. I am pleased to report for the second quarter that our tax rate is now 40.4%. Our effective tax rate and our pre-tax income that brings our year to date effective tax rate down to 41.6% both figures much lower than last year, I’m sorry, let me repeat those numbers. For the quarter, the effective tax rate 40.4% of for the six months, 41.6%, both numbers below the prior year numbers. Yeah, I still feel we have room for improvement there. I feel the normalized effective tax rate on the company should be closer to 39%. We know that because we know what all the statutory rates are in the various jurisdictions and by far the largest businesses in the US where we have rates below 40%. So, we will continue to work on those taxes and I am very optimistic that we can bring that down below 40% as we move toward the end of the year. So, that’s that pretty much is the picture on the tax area, the earnings per share than as you can see was $0.13 versus $0.14 last year and for the year-to-date period at $0.25 the same as it was in the prior year six months. Taking a quick look at the balance sheet, it remains very strong. We have $14.2 million in cash equivalence on our balance sheet at the end of January, $51.6 million in the working capital at the end of January compared to 40.8 million at the end of July. So, that’s going up quite a bit. As the current ratio has shown considerable improvement, 2.6 to one versus 2.1 to one of the end of July of funded debt, alright is now at 66.8 billion, of course going up in the first quarter is we did these three additional acquisitions. But it is down from $17.5 million in the end of October. We brought that down closed to $4 million in the second quarter alone. Debt equity ratio remains in very good shape at .41. We continue to have an incredibly strong relationship with our three bank syndicates that we’ve been with in the same three banks for all large national players. We’ve had this relationship now for many years and I consider this to be as strongest as ever were. Shareholder’s equity has increased with now at a $163.8 million at the end of January. That’s up from a $155.1 million at the end of July. But we will continue as we move to the second half of our year. Continue our focus on optimizing our business performance both from the existing businesses as well as getting more incremental value from the acquisitions and in the other areas that Scott mentioned, and definitely looking to continue to reduce this debt level as we move through the balance of the year. The EBITDA jut the repeat the numbers quickly that Scott had mentioned earlier. For the second quarter, EBITDA is $8.2 million up substantially from the $7.1 million in last year’s second quarter and for the year-to-date period, $16.1 million compared to $13.5 million in last year’s six-month period. The accounts receivable is sitting at about 51 days. So, that’s comparable to where it has been in the past. The inventory turnover is $4.8, that’s approximately where it was in the past. The inventory balance is a little bit higher right now but that is due to plants strategic buy-ins of products in three of our segments before price increases. Se, we’re definitely keeping our eye on our inventory levels. So, that’s a quick look at the press release. At this point, Ryan well. I turn the call back over to you.

[Scott Jones:]

Yeah, Craig, thank you. I’m going to really abbreviate my comments because we’ve gone fairly long. I think, the bottom line is we got our tie on the bone. We have got a lot of moving pieces. We’re making progress across the board. Surely, our top priority is to get this progress at the top line and the margin line all the way down the EPS so that we can turnout to continuous EPS growth. So, we feel as though these investments we’re making now were, as I’ve said earlier, let’s focus on mediation and completely focus on high growth opportunities for the future and we look forward to announcing some of those before too long. So with that, Ryan, operator, would you please turn over for, turn the call over for questions.

[Operator:]

Yes. Thank you ladies and gentlemen. At this time, we’ll be conducting a question and answer session. (Operator Instructions) Our first question comes from the line of Michael Gaugler with Brean Murray, Carret & Company Michael Gaugler - Brean Murray, Carret & Company Good morning everyone!

[Scott Jones:]

Good morning Mike! Good morning! Michael Gaugler - Brean Murray, Carret & Company I wanted to follow up on some of Craig’s comments regarding interest expense. I was wondering when we could expect to potentially see interest expense decline and if you have a quarter that would be terrific.

[Craig Sheldon:]

Before 1

[Craig Sheldon:]

Actually, it’s between 2% and 3% consistent with last quarter. And it’s same as last quarter. Michael Gaugler - Brean Murray, Carret & Company Alright.

[Craig Shedon:]

And that’s net of, frankly that’s net of, you know the tail end of the clean up. It has got a little severance in there, a little bit of warranty adjustment. So, I think we indicated last quarter that there would be, you know, we would have the tail end of that legacy class. So, net of those were comparable for the prior quarter. Michael Gaugler - Brean Murray, Carret & Company Are you looking for increasing profitability in that segment now on the sales forward basis?

[Craig Sheldon:]

Yes, you bet. Well, we are looking forward to increased profitability. I couldn’t tell you Michael, you know, whether that’s going to be linear or non-linear over, you know, over the quarters but certainly, you know, we have a lot of optimism as far as it’s getting back to a very typical, typical margins in that segment as we go forward. Michael Gaugler - Brean Murray, Carret & Company And then one final question. You have alluded to some acquisition opportunities. As you look across the business segments, where do the most promising opportunities lie at the moment?

[Craig Sheldon:]

Well, certainly, you know, we love the water segment and, you know, I would think that that would be a priority one. We are very committed to the healthcare disposable segment and continue to look at ways that we can take those products into the acute care setting both through acquisitions as well as the alternate channel program. Those are the two primaries but, you know, if we see, you know, obviously synergistic acquisitions in other segments, we will evaluate those on a one off basis but primarily those two segments. Michael Gaugler - Brean Murray, Carret & Company All right, thanks gentlemen.

[Craig Sheldon:]

Thanks Mike.

[Operator:]

Once again, if you have a question, please press “Star 1” on your touchtone phone. Our next question comes from the line of Mitra Ramgopal of Sidoti & Company.

[Mitra Ramgopal:]

Yes. Hi, good morning guys!

[Craig Sheldon:]

Good morning Mitra !

[Mitra Ramgopal:]

I believe you said the organic growth in the quarter was about 6% and I think the first half is 7%?

[Craig Sheldon:]

Yes.

[Mitra:]

Where do you see that going over the remainder of the year and as you look out to fiscal ’09?

[Craig Sheldon:]

Well, you know there are a number of off-setting components to that. You know, we’re ratably climbing in our Medivator’s sales. So, that’s, you know, that’s done the nice job for us. We’ve got terrific growth in water. You know, we see a return to some growth in healthcare disposables. Our underlying markets, you know, if you were to blend all the underlying markets, you probably see 5%-6%. So, we’d like to continue outpacing our markets and, you know, once we introduce some of these real novel product editions, you know, we’d like to see that take off beyond that.

[Mitra Ramgopal:]

Now, do you see that sort of getting back to maybe a double-digit organic growth or you’re going to be even more progressing sort of increase price to do acquisition with the, generate them this on top line.

[Craig Sheldon:]

Well, it’s a good question and again, embedded in that question is what’s happening with the economy, you know, we are largely recession proof. You know, most of healthcare is but that doesn’t mean that we won’t be impacted down the line if the economy gets worst. So, if you take the economy out of the question, you know, we’d like to see high single digits maybe than low double digit growth but again, it’s hard to take the economy out of the equation.

[Mitra Ramgopal:]

And I guess, you know, as you’ve missed buy back acquisitions over the past six, nine months, you really haven’t seen it impacting the bottom line that’s far first half of ‘08. Is it prudent to be actively looking to make acquisitions or just kind of focus on what you have and try to just get margins improved and just take care of, you know, the base business…

[Craig Sheldon:]

Yeah, actually Mitra, you know, we have a good track record for integrating acquisitions. The GE, one that we, you know, talked about often is a great example of that. The three proprietary products that we have integrated, two in dental and one in endoscope is doing quite well. It’s just a matter of, you know, when we do acquisitions, we certainly charge it accretion. You know we always have accretion on day one. So, you know, If I were to, give you the short answer to that question, we are absolutely bullish of that doing acquisitions. It’s been our history and we’ve proven that. I think we’re pretty good at it.

[Mitra Ramgopal:]

And the other reason I mentioned it is, you know, as you look at the first half, we annualized that you are actually a little at best flat. Maybe, you know, only modest from fiscal ‘07 and so with, you know, half of dozen acquisitions almost, you know, it’s not being at that.

[Craig Sheldon:]

Well, but I wouldn’t attribute that really to the acquisitions. You know, as we’ve said, we’re fortunately beyond the re mediation stage with the Dyped piece in particular. But we have made very substantial investments in top line growths for the future but as I mentioned 15 resources in marketing and sales and we know that that will translate into growth. So, you know, it may, from the outside in, it may look like we just keep pouring money in and not getting a return. This is a, you know, I would suggest a very different profile of investment and you know, we feel very, very optimistic about the return on these investments. And when the right acquisitions come along, I feel like we need to grab those. You can’t always, you know, as you know, you can’t always control the timing and when the right assets are going to come along so… So, hopefully that answers your questions?

[Mitra Ramgopal:]

Sure. Thanks again guys.

[Operator:]

(Operator Instructions) We have a question from John Rogers - Ferris Baker Watts. .

[John Rogers:]

You mentioned high amortization cost from acquisition and then you also had some increasing commodity cost. Can you quantify that?

[Richard Meyers:]

Craig, do you want to address that?

[Craig Sheldon:]

Yeah, I think the amortization that will be in the Q. We could hold you off until we’ve filed it. Oh we put that in the release, okay. We do not have that in the release. So, if you go to the 3rd piece in the release. So, with that new reconciliation we put in there for EBITDA, you can see the amortization is broken out on that page. For the year-to-date was about $2.8 million versus $2.3 million in last year’s six months.

[John Rogers:]

How much of that is ongoing and how much of that is amortization of customer list or things that something that’s going to be more temporary? It’s going to roll off after a year.

[Craig Sheldon:]

Yeah. All of that, a 100% of that is amortization the way we do in tangible assets.

[John Rogers:]

Uh-huh.

[Craig Sheldon:]

Although there are always some pieces rolling off, substantially, that amortization is going to be there for some time into the future because most of that came in for the acquisitions of, you know, Crosstex three years ago. You know, although that might seem like a long time ago from an amortization perspective. We still have a good life left on those aspects. So, the amortization will continue to be there.

[John Rogers:]

And then, as far as commodity cost, how much did that affect you in aggregate?

[Craig Sheldon:]

Are you saying JT? Are you saying raw material cost?

[John Rogers:]

Raw material cost.

[Craig Sheldon:]

You know, I’m not certain that I can put my finger on that right at this moment. As I’ve mentioned, you know, at any segment is different, first of all. And as I’ve mentioned, we had about to 30% increase in some of our resins. We had increased in paper but certainly not to that extent. Some increase in transportation and other manufacturing cost. But you know, we could probably thin that down if we try but I don’t have that rate at the present.

[John Rogers:]

Okay. Thanks.

[Craig Sheldon:]

Operator, any other calls?

[Operator:]

Seeing, as there are no further questions, do you have any concluding remarks?

[Scott Jones:]

Yes, I mean, we appreciate your support. You know, we are very enthusiastic about the future. We remain confident in our ability to flush out the legacy expenses and really turn this most recent investment into continuous top line and the bottom line growth. So, with that, thank you very much for your attention and we’ll talk to you soon.

[Operator:]

Ladies and gentlemen, this concludes today’s conference. Thank you all to your participation.