Cantel Medical Corp.
Q2 2013 Earnings Call Transcript

Published: 7 Mar 2013

[Operator:]

Greetings, and welcome to the Cantel Medical Corp.'s Second Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Krakauer, President and CEO of Cantel Medical Corp. Thank you, sir, you may begin.

[Andrew A. Krakauer:]

Okay. Well, thank you, Brenda, and welcome to our second quarter fiscal year 2013 conference call. Before we start, 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. Okay. With that said, good morning to everyone. With me on our call today are Chuck Diker, Chairman of the Board; Jorgen Hansen, Executive Vice President and Chief Operating Officer; Craig Sheldon, Senior Vice President, Chief Financial Officer and Treasurer; and Seth Yellin, Vice President of Corporate Development. Cantel Medical recorded the best quarter in the company's history in the second quarter of fiscal year 2013, even after excluding some favorable adjustments. We reported second quarter GAAP earnings of $0.38 per share compared to the prior year second quarter earnings of $0.27 per share. On a normalized basis, as reported in our press release, we reported $0.36 per share compared to $0.29 per share in the prior year, an increase of approximately 22%. Sales in the quarter grew to 9% to a record $106.4 million, exceeding the $100 million mark for the first time. This quarter's great performance continue to illustrate the 3 profit drivers I discussed last quarter which are evolving in our business model, first and foremost is our demonstrated success in our strategies

[Craig A. Sheldon:]

Okay. Thank you, Andy, and good morning to everyone. I'd like to turn our attention now to the earnings release, which was distributed this morning. And as always, I'll start by going down the income statement. As Andy indicated, sales increased by 9.3% in the second quarter to $106 million, another all-time sales record for our company as we surpassed the $100 million quarterly mark. For the 6 months, sales increased by 8.1%. Top line growth was driven by Water Purification and Healthcare Disposables, and includes $4.7 million in sales contributed by our SPS acquisition. But even without the SPS contribution, sales still increased by 5% in the second quarter. As for their -- some of our big recent acquisitions, Byrne Medical, which is in our Endoscopy segment, as you recall, was acquired on August 1, 2011, the first day of the prior fiscal year, so that acquisition is fully reflected in operating results for all periods presented. The SPS Medical acquisition was acquired on November 1, 2012. So that was the first day of our second fiscal quarter this year. Therefore, the acquisitions reflected in the full second quarter of this year and not in last year's results at all. Gross profit in the second quarter was 42.4%, up from 42.0% in last year's second quarter. I know I should mention that this year's second quarter gross profit would have been 43.0% if not for acquisition accounting charges and severance charges, which we consider to be atypical and not reflective of our ongoing business. That's all part of the $0.02 that Andy mentioned in the beginning of the call. For the 6 months, GP percentage was 43.1% compared to 41.3% last year. A higher GP percentage in the current year periods was attributable principally to favorable product mix, such as endoscopic processing consumables, procedural products, which is the Byrne Medical business, face masks and sterility assurance products, and that includes the SPS products, as well as higher production volumes leading to favorable manufacturing variances and overhead absorption. I also wanted to mention, with regards to the new medical device tax, the cost to our company was $322,000 in the second quarter, which was 0.03% negative to our gross profit percentage. Now we only incurred this tax for 1 month, because it commenced on January 1. So in the future, as we have that for the full quarter, it will be closer to a 1% negative impact on our GP percentage, which translates to about between $0.02 and $0.025 per share, that will be on a quarterly basis. Moving down to operating expenses. Gross operating expenses increased by only $628,000 in the second quarter, and that's 2% above last year's second quarter. For the 6 months, operating expenses increased by $1.2 million, which is also a 2% increase. Now there is a little bit of noise within operating expenses, again, part of the $0.02 that Andy alluded to at the beginning of the call. We have a significant positive effect from acquisition accounting adjustments, medical recurring fees. Again, these are atypical and not representative of future core operating expenses, so that would increase the operating expenses without those items. However, this positive impact was also -- was offset by the new infrastructure from the SPS acquisition. And those items pretty much offset. So even if you pull all of those items out, operating expenses still went up by about 2% in the second quarter. As we have reported over the last couple of years, we have invested substantially in sales and marketing, as well as R&D functions. These investments are now built into our base operating expenses and are paying off. Having said this, we have spent a considerable amount of time clarifying future growth opportunities including new products, as well as international expansion. And we do expect to see increased future sales in R&D investments related to ongoing initiatives. Operating income for the quarter overall reporting a substantial 28% increase compared to last year's second quarter, and for 6 months to date, 37% increase. For the second quarter, once again, as Andy discussed, and we indicated in our earnings release, we had about $850,000 or $0.02 of our earnings this quarter attributable to events, which are not reflective of the ongoing business. However, notwithstanding these non-core items, operating earnings in the second quarter still increased to a robust 22%. As we have already discussed, the substantial increase reflects many factors including solid core growth from both Healthcare Disposables and Water Purification, contributions from recent acquisitions, strong gross profit margins and very careful management of operating expenses. Our interest expense decreased substantially this year, which is reflective of debt repayments. Total interest expense in the second quarter is only $775,000, which is extremely low particularly given that we've borrowed over the years for acquisitions including $37 million borrowed in the second quarter for the SPS acquisition, yet we still managed to reduce interest expense. We continue to repay borrowings quickly with strong cash flow and very low interest rates. Our effective tax rate for the second quarter was 35.0%, and for the year-to-date, 36.3%, very close to -- right in line with my comments from prior quarters. As I've indicated in the past, the overall effective rate is difficult to predict and directly impacted by geographic mix and the timing and extent of new tax legislation. However, currently, we have about 90% -- 97% of our pretax income is generated in the U.S. So assuming no legislative changes in tax rates or credits which probably will happen but if you assume that there wouldn't be any, I would expect our effective tax rate in future quarters to be close to 37%. And I would also note that year-to-date this year, we would have been closer to 37.1% if not for a onetime favorable item in the second quarter, and that was the retroactive reinstatement of research experimentation credit, which contributed about $0.01 to our earning, that was all part of the fiscal cliff negotiations that happened at the end of the year. Moving on to our balance sheet. It remains very strong with $26.8 million in cash and cash equivalents at January 31, $86.7 million in working capital and a current ratio of 2.7

[Andrew A. Krakauer:]

Thank you, Craig. While this quarter exemplifies why we are so optimistic about the future of Cantel, we showed good sales growth of 9%, and then leveraged the sales increase to an approximately 22% increase in normalized EPS. This type of growth has been our historical model now for the past 6 years. We've demonstrated consistent growth following our three-pronged approach

[Operator:]

[Operator Instructions] Our first question comes from the line of Mitra Ramgopal with Sidoti.

[L. Mitra Ramgopal:]

Andy, I just want to get a sense in terms of margins as we go forward. I think this is about 4 quarters now, we are seeing about 43% on the gross margin, you did talk about some headwinds going forward but is this sort of the new base and potentially can go even higher?

[Andrew A. Krakauer:]

Well, again, I guess the way we look at it is, again, I look at it by businesses, all of our businesses have targets to improve their gross margins. And the products that we are pushing are higher margins generally than our corporate average and certainly higher than the product that they're replacing. But obviously, it's a mix of any 1 given quarter. So for example, while we are growing our margins in our Water business by selling all that large cap equipment, our large cap equipment though have lower margins. So if we're very successful in capital equipment sales and endoscopy and in water, that could hurt the overall average but always improving compared to what we were selling in the past. So I guess the answer is we're certainly not going backwards and the goals of our acquisition program are only look for product, it's for company that would increase the margins of our company. All the programs we have in place are, in fact, focusing on products all with higher margins, so I think, given the dramatic improvement that we've made, notwithstanding the medical device tax, this is a good level and then we should look for continuous improvement, slow but steady improvement.

[L. Mitra Ramgopal:]

Okay. And you talked in terms of the Healthcare Disposables segment did benefit little from price increases, was that the only segment where you try to implement that or is it something going forward we should be looking for?

[Andrew A. Krakauer:]

In terms of price increases, again, this is a constant -- we try to implement price increases based on, obviously, our internal cost increases for people, material, et cetera, et cetera. We've had some limited price increases in Water, we've had some limited price increases in Healthcare Disposables. A lot of our -- a lot of the Water business and a lot of the -- and certainly, all of the -- most of the Endoscopy business that are under long-term contracts, that get negotiated sometimes every year, sometimes, the GPO contracts, every 3 years. And we do our best to make our cases to our customers. But I would say, as a general rule though, it is -- we're not going to be testing on the medical device tax in any easy way. Well, obviously, those customers and hospitals et cetera, they all have, as they pointed out to us repeatedly, increasing costs related to the Affordable Care Act. And they're not looking for any special increases related to this tax but we will do our effort to increase pricing as we do at normal contract renewals based on the overall normal cost increases and -- but it will not be large but we should get some, we deserve to get some.

[L. Mitra Ramgopal:]

Great. And then just a few big picture questions. On the acquisition front, clearly, Byrne Medical and SPS, et cetera, had just been great additions for you, I don't know if you could comment a little in terms of the pipeline and the opportunities you're seeing out there?

[Andrew A. Krakauer:]

I'll let Seth Yellin address that.

[Seth Yellin:]

This is Seth here. We have a very rich pipeline right now that we're excited about and we are looking at acquisitions across all our segments, both domestically and internationally. For obvious reasons, I won't talk about specifically what we're looking at but we're very excited about what we see in front of us and we hope to be able to execute on that in the very short term.

[L. Mitra Ramgopal:]

And again, in terms of -- I know you can't get specific but if we look at the size of the acquisitions of the Byrne, for example, and SPS is very different in terms of revenue contribution, et cetera. Again, is there sort of any limitations that you put on this?

[Seth Yellin:]

No. I think, to be honest, we have the acquisitions we're exploring that are early stage companies with near -- with 0 in sales to companies that are well established with an excess of $50 million to $60 million in sales, so we're looking at a wide array of companies. And our goal, of course, if we're to look at acquisitions that has the ability to move the needle but we'll execute on deals as they become available and as we're able to proceed on terms and prices that make sense to us.

[L. Mitra Ramgopal:]

And again, the deals are really to expand what you already offer in terms of health care, water, et cetera, as opposed to anything very different?

[Seth Yellin:]

Well, certainly, [indiscernible] within the infection control umbrella. We are looking at businesses that fall within each of our existing parallels, and we're exploring some transactions that fall outside of our core categories but make a logical sense from a strategic perspective within the infection prevention and control focus we have.

[L. Mitra Ramgopal:]

And Andy, if you could comment a little more in terms of a potential for the RAPICIDE OPA you recently introduced and maybe looking out over the next 12 months and beyond, are there any new chemistries and products that you would consider significant to move the needle?

[Andrew A. Krakauer:]

Well, you're right. RAPICIDE OPA, in fact, was press released yesterday at our formal corporate beginning of sales to the marketplace in yesterday's press release. I'm optimistic but I don't want to give a forecast. I'm optimistic that this product serves in multiple customers and will be sold by multiple sales teams because it has such great benefits in automated reprocessing, as well as manual applications in hospitals and alternative care sites and dental offices. But I don't know if I want to predict it. I mean, the introduction of new chemistries takes time. It takes trials, in some cases, it takes contracts. So I'm optimistic that it will be a significant contributor in 2014, but I would not be looking for a lot -- necessary a lot in the next 6 months as it gets introduced. As far as other chemistries go, we are still increasing our penetration with our existing chemistry RAPICIDE PA. We are growing our Actril admin care products and pharmaceutical clean rooms and look for that to continue. So we have a lot of existing chemicals and chemistry that are on nice growth projection. Now longer term, we do have, I'll just say, a few interesting chemistries that are under development. They're still probably more than 2 years away but they're going to be significant players for us as you look at the medium term. And as we get closer, I guess we'll probably talk about them but I don't like to talk about things that are really at least more than 1 year away. But what I can tell you is we're working hard in what we think could be some very interesting chemistries.

[L. Mitra Ramgopal:]

Sure. That's very helpful. And finally, I think you've talked about international expansion as a nice opportunity. I think roughly about 85% of your business relatively comes from the U.S. Do you see that changing meaningfully over the next year or 2 or is this more of a 5-year plan?

[Andrew A. Krakauer:]

Well, I've spent a lot of time talking to Jorgen and he just came back from Asia and spent a long time in Europe hitting with the teams and laying out some strategies. I'm going to let Jorgen Hansen, our COO, speak to that.

[Jorgen B. Hansen:]

Thanks, Andy. I mean, obviously, we do have a great growth potential, both in Europe and in Asia, and we're right now putting together some very exciting plans for those specific markets. We think we will have softer growth in markets outside the U.S. in the next coming years. But obviously, for this to have significant impact to our company, it would be sort of a midterm outlook. So in the next couple of years, we will introduce more products. We would look at various go-to-market strategies. We will work with new business models in some of the key markets like China where we already have a good platform. So it will be something that would be a growth driver for us in the next several years. And then we would look 5 years out, we anticipate we would have that significant -- very significant -- more significant presence in those markets.

[Andrew A. Krakauer:]

Yes. And one other thing, I'd like to just add, Mitra, it's not just about products but it's also about decision, strategy decisions such as timely putting our plans on the ground in Asia that could be a source of lower-cost chemistries and maybe even lower-cost equipment. These are all parts of the strategy that could really accelerate the opportunities. And also, for the first time, I'd say that we are seriously looking at a number of acquisitions in Asia, as well as in Europe, and that could significantly make a difference. It gives -- it could give us more bulk and especially if it's a good established operation. So we are very excited about the opportunity. We obviously need to implement, execute, but it's a major commitment for the company and I'd say more now than anytime in the past.

[Operator:]

[Operator Instructions] It seems there are no further questions at this time. I would like to turn the floor back over for closing comments.

[Andrew A. Krakauer:]

Okay. Well, again, thanks, everybody, for listening. We look forward to talking about our third quarter in 3 months. Thanks a lot.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.