Cantel Medical Corp.
Q4 2013 Earnings Call Transcript

Published: 26 Sep 2013

[Operator:]

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

[Andrew A. Krakauer:]

Great. Thank you. Thank you, Melissa, and welcome to our fourth quarter and full 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 limitation, the risks detailed in the company's filings and reports with the Securities and Exchange Commission. Such statements are only predictions and actual results may differ materially from those projected. 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, calling in from China; Craig Sheldon, Senior Vice President and Chief Financial Officer and Treasurer; and Seth Yellin, Senior Vice President, Corporate Development. Cantel Medical achieved record financial performance in the fourth quarter of fiscal year 2013 with solid sales and net income growth. We reported fourth quarter earnings of $0.25 per share as compared to the prior year's fourth quarter adjusted earnings of $0.22 per share. Sales increased 15% in the quarter, of which 10% was organic. Last year's fourth quarter included $0.02 favorable tax benefit for closing our Japan subsidiary. So this quarter's adjusted earnings increase was in the mid-teens and, in fact, would have been over 20% if not for the Medical Device Tax, which was $911,000 for the quarter, which we didn't have last year. Let me make a few brief comments about the performance for the full fiscal year 2013 before moving to some fourth quarter commentary. Fiscal year 2013 was a very successful year for Cantel, as the company's financial performance, by every measurement, significantly improved. Sales grew by 10%, while gross margins expanded by 70 basis points, and would have been higher by 120 basis points, excluding the Medical Device Tax of over $2 million. EPS for the full year still increased by 23% from $0.77 to $0.95. And this followed our stellar fiscal year '12 performance where EPS grew by 48%. EBITDAS for the year grew by 17% to $84 million. And finally, our net debt at the end of the fourth quarter remained at approximately $60 million despite spending over $45 million on acquisitions during the year, which continues to show the great cash flow generation of the company. Even more importantly, not only did we achieve excellent financial performance, but we've positioned Cantel for continued growth in fiscal year 2014 and beyond by successfully integrating our recent acquisitions and continuing to invest in sales and marketing and new product development activities. Most notably in the acquisition area, we made a major entry into the health care sterility assurance market with the acquisition of SPS Medical, and also strengthened our position in the dialysis water purification market, with the addition of the Siemens dialysis water business in the United States and Canada. The overall effect of these efforts leaves Cantel well positioned in infection prevention and control markets with solid underlying growth, and provides the company with much greater potential than we were -- had even just a year ago. I'm pleased that we can make these important investments for the future, while simultaneously producing solid earnings for the year. Now I'll briefly review the major operating segments for the fourth quarter, but first a note. In fiscal year '14, we have realigned our reporting segments, and our fourth quarter fiscal year '13 results and 10-K, to be filed next week, now reflect this new alignment. There will be no change in Healthcare Disposables and Endoscopy segments. However, the Water Purification and Filtration segment now includes Therapeutic Filtration and Chemistry segments, which used to be reported in the Other Operating segment. These 2 segments represent a $14 million profitable business, which is now being managed by our Mar Cor Purification management team. Our goal in this realignment is to develop and invest in the long-term strategies for these businesses, which have operational and commercial synergies with our Water Purification and Filtration segment. Okay. So with that said, all 3 major segments, Endoscopy, Water Purification and Filtration and Healthcare Disposables, performed well in the fourth quarter. After several quarters of tough comparables, our Endoscopy business has outstanding organic growth of 17% over the same quarter last year and 12% growth over the prior quarter, setting a record with sales of $44.5 million. Operating profit for the segment on a reported basis declined 11% or $1 million in the quarter. But more than the entire shortfall can be explained by a $1.5 million of net unfavorable acquisition accounting adjustments, driven mostly from favorable entries in last year's fourth quarter. Our gross margin was also negatively affected by the Medical Device Tax and some lower prices. I am very optimistic that our Medivators Endoscopy business delivered good sales growth and increased operating profits in fiscal year 2014 and beyond. This quarter, we saw a nice increases in our large and growing installed base of endoscopy processing equipment, and this sales growth came from both the United States and international business. Equipment placements drive sales of our higher-margin disinfectants, much of which is our proprietary Rapicide PA chemistry. This quarter, our disinfectants and cleaners category grew by 18%. And this growing installed base of machines also provides great opportunities to expand our service and spare parts businesses, which grew 24% this quarter. On the product development front, we have recently launched or will soon launch several new endoscopy disposable product lines, which we expect will begin to generate positive sales momentum as we go forward in fiscal year 2014. We also remain very confident in the strength and capability of the entire Medivators United States' direct sales and service team and their ability to effectively launch and grow our full product portfolio. Further, we are in the process of adding a number of additional sales and marketing resources to this team to support fiscal year 2014 growth. Our Healthcare Disposables Crosstex business had been a strong performer all year, especially after the acquisition of SPS Medical in November of 2012. Fourth quarter sales grew by 22% driven by sales of SPS products, which greatly added to our sterility assurance offering. We are very pleased with the integration of SPS Medical, and the business has performed to our very high expectations. We are also excited about the opportunities to leverage our combined SPS-Crosstex product lines outside the demo market into the physician office and hospital markets. Operating profits grew by 45%, primarily because of the incremental SPS Medical product sales, but also for some underlying operating leverage. We had improved gross margins due to sales of higher-margin products, such as face masks, and the continuing growth of our ConFirm line of sterility assurance products. Additionally, we saw a very well-controlled operating expense growth during the quarter. As we go forward, I remain optimistic about the growth of the Healthcare Disposables business, with the help of our increasing presence in the sterility assurance markets for new opportunities in hospital and alternate-care markets and with international sales growth. In 2014, we are making substantial investments to increase our presence in international markets, as well as new product development. Our Water Purification and Filtration segment also had strong performance all year. Even before considering the additions of Therapeutic Filtration and Chemistries to the segment, the legacy business had record sales of $32.1 million in the quarter, representing year-over-year growth of 17%, 13% of that organic; and 9% growth over the prior quarter, 6% of that organic. Including the new realignment, the business had sales of $35.7 million and were 16% ahead of last year's fourth quarter, while operating income rose 60% -- over 60%. Operating income growth was driven by the strong performance of the legacy Water business and significant cost reductions and restructuring in the Chemistries part of the business, which was really completed in the beginning of fiscal year 2013 and have benefited us all year. I will expand on the Therapeutic Filtration and Chemistries business performance starting next quarter, but let me just point out that Mar Cor and the legacy Water Purification and Filtration segment already includes successful and growing Filtration and Disinfectant Chemistry businesses, which share technology and manufacturing with the Therapeutic Filtration and Chemistry businesses now being added to the segment. It's just a logical step to have Mar Cor management assume responsibility for these related businesses, and I expect to see greater focus on our total portfolio of these higher-margin products as we go forward. During the fourth quarter, we continue to see product mix shifts to our heat-based disinfection, central and portable water purification systems, which provide great benefits to our customers and their patients. Sales of these more advanced machines, which sell for higher ASPs, average selling prices, continue to grow as a percentage of the total sales. This quarter, 70% of our new central system shipments and 75% of our new orders for these central shipment -- systems were heat-based CWP systems. And now turning to the portables. Almost half of the portable system shipments are now heat-based disinfection units as well. We expect to see the adoption rates for this newer and higher value-technology platforms to grow, as customers are clearly recognizing the performance benefits and cost savings provided by these new products. On a further positive note, water purification equipment orders greatly exceeded the very strong shipments, leading to another quarter end with a record backlog, which bodes well for continued growth over the next few quarters. Adding to our optimism about the future of our Water Purification business is the integration of the Siemens dialysis water business that we announced on March 25. We are now mostly completed transferring hundreds of new customer contracts to Mar Cor Purification that will add approximately $9 million in new business in fiscal year 2014. We will now be able to better utilize our large service network and have another install base of machines to target for upgrading to our new CWP technology. Overall, we remain very optimistic that we continue the great momentum we achieved in fiscal year 2013 in the Water Purification and Filtration business. In the Dialysis segment, as expected, fourth quarter sales declined 4%, primarily due to decline in lower margin concentrate, partially offset by higher sales of reused chemicals. Operating profit increased 25%, as lower margin concentrate sales were offset by higher margins sterilant sales, as well as operating efficiencies. We had some nice sales of reused chemicals in international markets, particularly in Asia, which more than offset declines in the United States. Okay. So that's the brief overview. Now I'll turn it over to our CFO, Craig Sheldon, to go over some financial details.

[Craig A. Sheldon:]

Okay. Thank you, Andy, and good morning, everyone. And I'd like to shift our focus now to the earnings release that went out early this morning. So I'll start with the income statement, and as Andy indicated, sales increased by 15.5% in the fourth quarter compared to last year's fourth quarter, to a record $114 million. For the full fiscal year, sales increased by 10%. This top line growth for both periods was driven by our 3 largest segments

[Andrew A. Krakauer:]

Okay. Thanks, Craig. So now, just a few summary. This summary, because it's a year end, might be a little longer than my normal summaries. But in any case, in summary, fiscal year 2013 was an outstanding year for Cantel Medical. The momentum of our strong fourth quarter propels us into a promising fiscal year 2014. This quarter exemplifies why we are so optimistic about the future of Cantel. We showed excellent sales growth of 15%, and if not for the Medical Device Tax, would have leveraged the sales increase over a 20% increase in EPS. We continue to demonstrate consistent growth through execution of our 3-pronged strategy

[Operator:]

[Operator Instructions] Our first question comes from the line of Tom Gunderson with Piper Jaffray.

[Thomas J. Gunderson:]

Andy, in your final summary, you touched on the 3 points that I had written down and I wanted to talk on, so maybe we can go through this quickly. But it was on sales and marketing initiatives, international expansion and endoscopy growth. On the sales and marketing initiatives, as Craig said, that has increased in the second half of previous year, and you said in your summary, continuing into '14. My question is, when -- should we start to expect a return on the top line from those investments that were made in second half '13, maybe even now? Or should we expect that to start to happen later in '14?

[Andrew A. Krakauer:]

Well, let me put it this way. Some of the expenses and people that we put in place are in the field generating sales. So for sure, some of the investments are helping to grow incrementally sales even as we go forth into the first and second quarter. The overwhelming majority of the investments that we're making in '14 are new positions, a lot of them in international, and they clearly will take a longer period of time to start, at least, maybe paying back in full. I mean, I think, in general -- again, and when you add 2 new, obviously, highly paid senior sales executives that we'll be announcing next week, I mean, they'll instantly change the world and things start accelerating. But we expect to see benefits as we go through the quarters. So I think it's a combination of things. Not every investment doesn't payback for 6 months or 9 months, especially when you put a guy on the ground who's now asking -- calling on customers and getting sales. So I guess, the point that we're making is, in general, the expense growth will certainly exceed the immediate benefit for, maybe on average, a couple of quarters. But we're always growing sales with investments that we've made, which are supposed to help pay for these incremental expenses, at least partially. So it's not just blindly throwing in resources. I mean, we expect benefits to start coming after we put them on the ground, 3 months and 6 months. Some of them more -- some of them take longer and some of them don't. I mean, I don't really know how to answer that question other than what I just said. Is that helpful?

[Thomas J. Gunderson:]

Yes, it is. It's what we expect. The new part today was that you're going to accelerate that investment, and so I just wanted to make sure that we're watching the returns from the previous investments, and you explained that quite well, so I appreciate that. The second area is international. You've got your COO calling in from Shanghai and you're making -- you're hiring 15 sales and marketing people for Asia coming up here. Can you give us a little bit more color on that? What -- for '13, what was the U.S./o U.S. split? And how do you see that different growth rates going forward in '14?

[Andrew A. Krakauer:]

I'll give my perspective, and if Jorgen want to add, I'll leave it up to him. But I don't want to just have him answer that question from Shanghai when he's not here, plus he's on a cell phone. As you could see, even from our report, the report we just reported in the fourth quarter, our international sales are starting to make a difference. It was a big part of why our Endoscopy business had growth this quarter. It was also the only reason our Dialysis business, which has normally been reporting flat to down actually reported an increase in profits because we have some nice chemistry sales in Asia. So there's no question that the -- we expect, as we go into '14, to see the 12% or 18% with Canada, to see that percentage start to grow immediately as part of Cantel's sales. And certainly, some of that, we expect to be profitable. A lot of investments in places like China are breakeven as you go or maybe a little bit profitable. But other parts of Asia, we expect to see some nice growth. Some of the investments are going direct as well. So in certain countries, we are going direct. I mean, we did recently in Singapore last year. We are now in Malaysia. There's a couple of other that we'll be talking about as we go forward. So I don't want to give a prediction other than our aspiration in this doubling sales and profits by -- end of fiscal year 2018 is to bring international sales to 30% of sales. Some of that will have to come through acquisitions. A lot of that will have to come with investment in infrastructure. So fiscal year '14 is the beginning of that. I shouldn't even say it's the beginning of that major investment. We have 19 people in Asia 2 years ago, and then 30 a year ago, and then 35 or 36 and we'll be around 45 or 50 at the end of this year. So we have been making these investments, but particularly with Jorgen and part of the reason he is in Shanghai is actually reviewing our international strategy for '14 and beyond and also our strategy for China. We have -- we believe that we have products and the people and the opportunities to achieve that 30% of our business over the next 5 years. It's clearly an investment thesis for '14. But we could have some work -- profitable chemistry sales that will help pay for that, while others are longer-term investments.

[Thomas J. Gunderson:]

And then you touched on this with Endoscopy. It was clearly a strong outstanding quarter from the revenue standpoint, and you said some of that came from new international. Is there anything -- as you look at those sales in Q4, was there anything unusual or onetime stocking orders with a new distributor or hospital system, or something that you wouldn't say could be repeated going forward?

[Andrew A. Krakauer:]

Let me -- by the way, that's exactly the question that I had when I -- we had -- it's been a long time that we had one quarter ever of about $40 million, and now we have $44.5 million. And a couple of things there. We are -- we do have a growing service business, and that's going to continue. We do have a growing Chemistry business and that's going to continue. And so -- and we have a procedural product business, the old, what we call, the burn business that has tremendous growth opportunities and a whole lot of new products coming out. So from that perspective, I feel that this was just a normal quarter of successful growing businesses. Now we did have a really strong equipment business sales in the fourth quarter, higher than it's been in several quarters. And so as you look at that, you see some really nice growth of our most advanced machine, the Advantage Plus. And there -- and it is spread in the U.S. and in some international markets. Now that is capital, and capital does vary. So I think the answer, I would say is, that it is not unusual for us to have a quarter like this, but we could easily have a quarter like this with $2 million or $3 million less, because that's the capital cycle. So I don't want to analyze like, this quarter, we just got lucky in one country or the one hospital chain. That's the equipment business that we're in. I think I'm optimistic that we are -- we've returned to our normal business, we have a growing -- we're making growing sales investments, we have a growing sales team, we have a stronger product portfolio than we've ever had, procedural reps and our sales team and our reprocessing sales team are working better than ever together, completely combined in the United States. I think that will bring -- even further synergies. So I'm going to say that our $44 million is not a one-off, but I can't tell you that it won't be $41 million next quarter, but we have more $44 million and beyond that quarters to come. That's capital. I can't help it, that's capital.

[Operator:]

[Operator Instructions] Our next question comes from Mitra Ramgopal with Sidoti & Company.

[L. Mitra Ramgopal:]

There's a couple of questions. First, Andy, based on your comments, it seems like everything is just firing on all cylinders, and it doesn't seem like there are any headwinds out there to sort of slow the growth down and that pretty much, you control it in terms of if it's a question of how much investment spending you're going to allocate for this year. Is that fair?

[Andrew A. Krakauer:]

Well, as a person who worries all the time about headwinds, there are plenty of headwinds, but we're just managing them. I mean, there's pricing pressure, there's competition, there's low-cost products and Healthcare Disposables, et cetera. But I would say -- and there's the vagaries of oil prices and all those kinds of things. So there are always headwinds. But I think, in general, I believe what you're saying, which is we are more -- I think we are more in control of what we're going to do next year by the investments that we're making. And we feel confident in our competitive positions in these businesses, and we're going to try to strengthen them with improved products and better distribution capabilities. So -- I just don't want be so cavalier to forget about the fact that we have a lot of competitors who have formed their budgets for next year showing growth and the same growth that we're showing, and we're not -- both companies are not going to get it.

[L. Mitra Ramgopal:]

Right, no. And I know you've talked about investment internationally. Given the success you're having with the Dialysis and Endoscopy business already, are you inclined to be even more aggressive? Or are you just want to sort of play a more safe approach?

[Andrew A. Krakauer:]

Well, I appreciate you calling the number of people we're trying to hire, which was only sales, we didn't talk about some of the other investments. We need an HR person, we need finance people, we're investing in infrastructure in Asia, and that weren't included in the 30. I appreciate that you think maybe it's such a good opportunity, we should expand that. I think that we are trying to do a number of things here. We're trying to invest, I think, at a very accelerated rate in sales and marketing worldwide, and trying to do it in a responsible way that says, somehow we can do these investments, but take many other actions that allow us to at least be able to grow the annual profits. So I like where we are. I think we have more than enough investments that our management team need to manage and manage well. So no, I would not be looking for anymore. I think we're at a very aggressive point where we are.

[L. Mitra Ramgopal:]

Okay. Finally, on the acquisition front, I don't know if you could add a little more color in terms of any -- what you're seeing out there. And as it relates to the different segments, if you're more inclined to focus on your 3 core or move beyond that?

[Andrew A. Krakauer:]

I'll turn it over to Seth.

[Seth Yellin:]

Mitra, it's Seth here, thanks for the question. I don't think that we've said that we have any change in our acquisition strategy. We still have a full pipeline of acquisition opportunities. We're optimistic we're going to see the ability to announce a couple of transactions in the upcoming quarters. I think we continue to evaluate opportunities in certainly all of the 3 core segments in which we operate today, as well as evaluating other adjacent markets that are logical fits within the infection prevention and control and patient safety marketplaces. I think, certainly, as our strategic plan has identified growth aspirations internationally, certainly, much of our acquisition focus has taken a larger share of looking at international opportunities, both for new products, new markets, as well as for international platform type of transactions. So we're undergoing evaluation on a number of opportunities in those categories, and we're quite hopeful and optimistic about the opportunities we see.

[Operator:]

Mr. Krakauer, there are no further questions at this time. I'd like to turn the floor back to you for closing comments.

[Andrew A. Krakauer:]

Okay. Well, great. Well, again, thanks, everybody, for listening. Again, we'll be back in early December with the first quarter results for fiscal year '14. Thanks.

[Operator:]

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