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Cantel Medical Corp. (NYSE:CMN)

F2Q09 Earnings Call

March 9, 2009 11:00 am ET

Executives

Andrew A. Krakauer – President

Charles M. Diker – Chairman of the Board

Craig A. Sheldon – Senior Vice President & Chief Financial Officer

Roy Malkin – President & Chief Executive Officer of Minntech

Steven C. Anaya – Vice President & Controller

Analysts

Mitra Ramgopal - Sidoti & Co.

Mark Cooper - Wells Capital Management

Operator

Good morning and welcome to the Cantel Medical Corp.’s second quarter earnings conference call. (Operator Instructions) Please note this conference is being recorded.

Now I would like to turn the conference over to Andrew Krakauer, President of the company. Mr. Krakauer you may begin.

Andrew A. Krakauer

Thank you [Nikki] and welcome to our second quarter fiscal year 2009 conference call. Before we begin I would like to remind everyone that this conference call may contain forward-looking statements. All forward-looking statements involve risks and uncertainties including without 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. Well good morning to everyone. With me today on our call are Chuck Diker, Chairman of the Board; Craig Sheldon, Senior Vice President and Chief Financial Officer; Roy Malkin, President and CEO of our Minntech subsidiary; and Steve Anaya, VP and Controller of the company.

About three months ago on Cantel’s first quarter conference call I expressed my continued optimism about the future of Cantel and our prospects to grow profitably. Well, our second quarter of performance supports that optimism as the results were outstanding. In fact, it was one of our best quarters in many years. Before Craig and I address the details I just want to thank our loyal and dedicated employees for their impressive accomplishments in a difficult economy.

We reported second quarter earnings of $0.23 per share compared to the prior year’s second quarter earnings of $0.13 per share and an increase in net income of 75%. Very broadly our positive results were mostly due to improved gross margins and operating expense leverage, driven by our numerous profit improvement and sales and marketing initiatives. Most importantly this quarter with our success in expanding the sales mix of higher margin disposables including disinfectants, sterilants, parts and filters. We also made continued progress with programs to improve manufacturing costs as well as with our company wide efforts to tightly control operating expenses.

Again in this quarter Cantel benefited from having a broad portfolio of infection prevention and control products sold into diverse business segments. Our Endoscope Reprocessing, Dialysis and Therapeutic Filtration segments produced exceptional results while our other reporting segments performed reasonably well. There is no assurance that this across the board performance can be achieved every quarter, especially given the economic downturn. However, these results do demonstrate the fundamental strength of our businesses and the earnings potential of the company.

Now the best performance of the quarter was in Endoscope Reprocessing, which was also the star performer last quarter. In this quarter we enjoyed a sales increase of 11%, primarily due to gains in the United States which came mostly from sterilants, disinfectants, service and accessories. This growth was aided by higher selling prices and the continued improvement in our direct portion of U.S. sales and service. We are now seeing the payoff after years of investing heavily in sales, marketing and R&D in this business. Additionally, we are also benefiting from recent manufacturing cost reduction activities.

I am very impressed with the accomplishments of the Endoscope Reprocessing team and especially the success of our direct U.S. sales and service group. Overall the increase in sales of these higher end improving margin product lines, coupled with the cost reduction programs, drove operating margins to over 13% for the segment. Now we are seeing some slowdown in equipment sales of endoscope processors to hospitals worldwide and we expect this to continue in the near term. However we have a large installed base of equipment upon which we can offer consumables and service. And we should continue to experience reasonable growth in these areas, especially where we have our large direct sales and service force in the United States.

Now another positive note. Last week we received FDA 510(k) approval to market our state-of-the-art Advantage Plus Reprocessor and the new high level disinfectant, Rapicide PA. And with this clearance we are now free to sell this latest technology system with its environmentally friendly chemistry here in the United States as well as worldwide.

Our Dialysis business also had excellent performance in the second quarter. On a sales increase of about 4%, operating income was higher by 32%. In the reuse business sterilant sales were higher and demand for our Renatron equipment was strong.

Additionally we received some very large international orders for dialysate concentrate. The net result of these favorable sales and our Minntech team’s continuous skillful efforts to reduce the manufacturing and distribution costs in this business was to further improve operating margins.

In the Therapeutic Filtration business, which is part of the other reporting segment, we also had a great performance in the quarter. Sales were up 67% and profits tripled. Sales were higher in both hemoconcentrators and our pediatric filters. Now these sales are driven by our OEM partners and quarterly demand is somewhat cyclical. We are working to expand our current filter offerings and continue our efforts to uncover new applications for our unique hollow fiber membranes and we are collaborating with several companies in this development activity.

Our Water Purification and Filtration segment showed a decline in sales of about 7%. These sales were lower as we experienced some customer delays in the execution of capital equipment orders and there was also an unfavorable comparison to the same period last year when we shipped some very significant commercial and industrial orders that did not repeat in this quarter. Operating income was down about 4% but again operating margins are improving.

I remain very optimistic about our water business. Again we have been consistently improving our operating margins and while we did some slowdown in orders for capital equipment in the first quarter, which affected this quarter’s performance, we have seen a significant increase in capital equipment orders in January and February and a large boost in our backlog. February’s backlog is now about 30% higher than where we were at the end of Quarter 1.

Further, despite having a slower second quarter, overall for the first six months the business has seen sales and profit growth of 4% and 14% respectively. Even more positive, we have enjoyed a steady and substantial growth in the run rate of our disposables business. In fact, the growth rate is about 25% over a year ago’s rate which includes the sales of parts, sterilants and filters. Now this is a key part of our strategy to grow our core order business and to improve the margins and as some of you may remember it was also one of the main implementation goals when we acquired the GE Dialysis Quarter business, and it has been executed very well.

With respect to our other profit improvement programs, we continue to promote and develop new products and continue our work to further improve manufacturing and service margins. Again I am optimistic that the large portion of our water business that is related to dialysis will be somewhat insulated from the economic downturn as the dialysis population continues to grow.

Our Healthcare Disposables business showed sales growth of 3% for the quarter and 8% for the first half of fiscal year ’09. In this business sales performances highly correlated to the number of days available to receive orders, which are generally shipped by the next day. And even though reported sales in the second quarter that you know if you figure a decline from this year’s first quarter, on a days available basis daily sales were actually slightly higher in the second quarter and so we’re at least holding our own if not slightly improving.

We continued to invest in sales and marketing which we view as needed in the current market environment. Now although we implemented a price increase in the last quarter, raw material cost increases that were late in the fiscal year ’08 in the fourth quarter still negatively affected margins in this quarter. We are currently seeing some reductions in material costs now obviously that the price of oil has declined and that should help us as we go forward into the year.

Operating income for the quarter declined by 22%, was down about 6% for the first half. Now more than half of the decline in the quarter related to our increases in sales and marketing expense and one time costs associated with the expansion of our facility in Pennsylvania. We remain very positive about this business and the market for Healthcare Disposables in general and we’ll continue to invest not only in sales and marketing but also in R&D to develop new products and as just noted capacity expansion as well.

While this completes I guess my segment review let me turn it over to Craig Sheldon our CFO and I’ll get back at the end with some brief comments.

Craig A. Sheldon

Thank you Andy and good morning everyone. And what I’d like to focus my discussion on today is the financial statements attached to the earnings release. And I’ll start with the income statement and really just to start with a general comment that the dramatically improved earnings performance in the quarter was really a contribution from every line on the income statement. And you’ll see that as I go through my remarks.

In terms of sales, they increased 2.5% on the second quarter compared to last year’s second quarter. And as Andy has indicated we had very strong performances in Endoscope Reprocessing, Dialysis and our Therapeutic segments. For the six months sales were up 4.9% versus last year, with strong performances in Endoscope Reprocessing, Healthcare Disposables and Water.

Gross profit very pleased to report a dramatic improvement in our gross profit percentage. 37.8% in the second quarter. That’s 2.5 points ahead of last year’s second quarter which was 35.3%. And for the six months GP percentage was up almost a full 2 points, 37.2% and that compares favorably with 35.3% in last year’s six months. We really had some valuable contributions from a number of different areas within our gross profits, none more so than the favorable product mix that Andy alluded to. We had very good sales with high margin products including disinfectants and consumables in Endoscope Reprocessing, sterilants and filters in our Water business, as well as our Therapeutic product sales which are high margin products.

We also got contributions from customer price increases in certain key product areas and overall improved efficiency in our manufacturing, transportation and service functions. This GP percentage improvement was particularly satisfying given the pressure that we’ve experienced over the course of the past year, with increased raw material, manufacturing and shipping costs that have affected virtually every one of our operating segments.

In the operating expense area overall operating expenses were extremely well controlled and we continue to better leverage these expenses against incremental sales. As an example, in the second quarter operating expenses were 27.3% of sales and for the six months 27.2% of sales. So this is improvement over last year when for the full year and fiscal 2008 operating expenses were 27.9% of sales.

And as far as the slight increase in the gross operating expenses it included some areas such as the costs related to the relocation of our Dutch manufacturing operations, as well as continued investments in several areas of the company including some additional sales personnel as well as advertising and marketing, particularly in our Healthcare Disposable segment.

Moving down to operating income, for the second quarter overall we’re reporting almost a 40% increase in operating income compared to last year’s second quarter and about 39% for the year-to-date with operating margins exceeding 10%, so again very very strong performance. When 10-Q is filed later this week you’ll see the segment breakout and with the most significant performances in the second quarter coming from Endoscope Reprocessing, where you’ll see operating income that was six times higher than last year’s second quarter as well as very strong performances in Dialysis and Therapeutics. In both of those segments had approximately a 33% improvement in operating income compared to last year.

I mentioned the 40% improvement in operating income and it gets even better as we continue to move down the income statement with contributions from both interest and income taxes. In the interest expense area, in the second quarter interest was down 42% compared to last year’s second quarter. And for the six months, interest was down 40% compared to last year. And this is reflective of both continual payments of debt over the past year as well as a reduction in average interest rates.

And as far as the average interest rates are concerned we’ve been enjoying significantly reduced LIBOR rates over the course of the past year. You may recall my discussions both in the first quarter as well as last year end where as we had LIBOR contracts that expired we’ve been able to replace them with new LIBOR contracts, mostly 12 month contracts at very favorable rates. Thus on an overall basis we feel our debt is very well protected and we will continue to see meaningful reductions in both outstanding borrowings as well as interest expense throughout the last half of fiscal 2009.

Moving down to income taxes, overall for the second quarter we reported an effective tax rate of 36.7% and this brought our year-to-date effective rate down to 38.0%. Now this rate for the second quarter was a bit lower than we had expected. I’ve mentioned in the past and I will continue to tell you that a normal statutory rate for our company is somewhere in the neighborhood of 38%.

However, as I’ve cautioned you in the past, because of the geographic mix of our operations, we can always have events which might cause the effective rate to be a little bit higher or a little bit lower than the 38%. And that was apparently the case in the second quarter and the biggest item of note was a tax rate reduction in Canada and we were forced to make it a favorable adjustment to our deferred income tax liabilities in Canada because of the rate reduction. And that had the effect of lowering our overall effective rate. Again going forward I think I would focus on a rate somewhere in the ballpark of 38%.

Moving on to the balance sheet which you can see remains very strong with $20.1 million in cash and cash equivalents, $49.3 million in working capital at the end of January. That’s an improvement from $45.6 million at the end of July. Current ratio of 2.4 to 1 at January 31, again an improvement versus the 2.2 to 1 at July 31. Our funded debt at January 31 was $54.3 million. That’s down from $58.3 million at July 31.

And just reflecting back, a little bit over a year ago back to October of last year, after we had done a series of acquisitions, our debt was at a high point of $70.5 million. So as you can see our debt has come down significantly over the course of the past 15 months. During the second quarter we repaid another $3 million in debt. So at the end of January we’re looking at a debt equity ratio of 0.32 and our gross debt compared to rolling 12 month EBITDAS is 1.54. Our net debt or debt less cash is $34.2 million at January 31. That’s a 35% reduction over the past 12 months. I would also like to point out that our net debt to EBITDAS that ratio is now under one turn, so we’re very pleased with that situation.

We continue to maintain a very strong relationship with our key three bank syndicate which includes Bank of America, Wells Fargo and PNC and we appreciate the continued support of that bank group. I would also like to mention that in the third quarter we expect that to get another strong quarter as far as additional debt repayment. We have already repaid another $2 million during February so that doesn’t show up on the balance sheet that was included with the release as it was subsequent to the end of the quarter. And beyond that I anticipate repaying a minimum of another $3 million before the end of April so that would be $5 million altogether. Therefore I expect that our overall debt level will drop below $50 million by the end of the third quarter.

And just a brief moment on the cash flow statement. On the third schedule that’s attached to your earnings release you’ll see EBITDAS of very strong $9.9 million in the second quarter and this comes on the heels of $9.6 million in the first quarter. So for the first half of the year, EBITDAS is about 22% of last year’s pace. Our rolling 12 month EBITDAS is $35.2 million and our EBITDAS is approximately three times our net income. And this is reflective of the very strong cash generating capabilities of the company and we believe it’s a very important metric given the significant amount of amortization expense in our income statement that’s related to prior acquisitions.

Our cash flow provided by operations was $7.8 million in the second quarter and so that brings the year-to-date cash flow from operations up to $13.2 million. As you can see, almost every measurement that you look at on the balance sheet or the cash flow statement demonstrates strong cash flow generation capabilities.

And finally just to alert everyone, we will be filing our 10-Q on its normal schedule on or perhaps before Thursday of this week.

So at this time I will turn the call back over to Andy for some closing remarks. Andy.

Andrew A. Krakauer

All right. Thanks Craig. Okay, let me close by saying we had a spectacular quarter. This quarter’s performance continues to demonstrate that we are moving the company in the right direction. We have a strong management group and with their teams are aggressively implementing our growth strategies. And there’s no better example of a strong management team than our Minntech subsidiary and now Roy Malkin the President is on this call. His group and his team manages all the three stars this quarter, Endoscope Reprocessing, Dialysis and Therapeutic Filtration so I’d like to thank Roy and his team.

We continue to focus on new product development, emphasizing sales of higher margin consumables which helped us so much this quarter and building our skills and strength in sales and marketing while continuing to manage and leverage costs and increase manufacturing efficiencies. All of these activities helped us in this quarter and will do so in the future.

Clearly there will be challenges as we go forward, you know, when the exact effects of the economic downturn and the proposed federal budget are still unknown. Nevertheless we are very optimistic that Cantel can continue to grow earnings. And as I pointed out in our press release our competitive advantage lies in our leadership positions in several growing infection prevention and control markets; our quality reputation; and our strong brand recognition. We have proactively developed our overall business to where now approximately 70% of our sales are from disposables and service, and these disposables and service sales are supported by a large installed base of equipment.

We are also managing expenses carefully and are constantly working on profit improvement programs. Additionally, we have a strong balance sheet; good cash generation as Craig just pointed out; and are reducing our debt and related interest expense. And we will continue to look for synergistic acquisitions and have good borrowing capacity.

We are certainly determined to continue to grow the company profitably and let me just leave you with a thought that even in a recession, infections do not go away. Our endoscopy procedures that are important to our business are continuing to grow and clearly dialysis needs to continue for those patients, and that population continues to grow as well. And that bodes well for us overall compared to say other companies.

So thank you for listening this morning. We look forward to speaking with you again at our third quarter results call in June. We’ll be happy to take any questions in a second and just so you know our presentation on the company will be updated for the second quarter results this week.

So with that I’ll turn it over to Nikki.

Question-and-Answer Session

Operator

Okay. Thank you. (Operator Instructions) Your first question comes from Mitra Ramgopal - Sidoti & Co.

Mitra Ramgopal - Sidoti & Co.

Clearly you seem to be making a lot of progress on margins. I don’t know if you can give us a sense of detail going forward how much we can expect the improvement to go. I mean, are we looking at potentially 40% sort of you know too high a threshold?

Andrew A. Krakauer

Well, you know, we obviously had a good quarter because we continue to promote disposables and sterilants and filters. I would say slow and steady improvement is the best way of looking at it, especially with some of the uncertainties as we go forward. So continue to look from here, I would say, for slow and steady improvement. As you know that’s always been my guidance.

Mitra Ramgopal - Sidoti & Co.

And I know do you have much room for quarter price increases or is it sort of pretty much over in light of material costs coming down?

Andrew A. Krakauer

I would say for the rest of this year there is not a lot of room for price increases. So I would say we are where we are for the rest of the year.

Mitra Ramgopal - Sidoti & Co.

And I know you continue to invest in sales and marketing. If you could give us an update with regards to, for example, the size of your sales force now and sort of, you know, the market in terms of expansion there.

Andrew A. Krakauer

Well, in general, we are out the full investment in terms of the numbers of people on the various teams. But on a year-to-year basis that includes some growth from prior year comparisons. But in places like Healthcare Disposables when we’re talking about increases we have – we may increase one sales position still this year. But we are putting a lot more money into reaching our customers as well as just general advertising and promotion of both new products and a slightly different approach because we feel it’s important to get out there and promote our products in this sort of difficult trading time. So it’s not about headcount. In some cases it’s simply about a year-over-year comparison. We’ve made the investments and in some cases it’s heavier spend in actual just marketing and advertising dollars.

Mitra Ramgopal - Sidoti & Co.

You did mention about capacity expansion. If you could say where are you at right now and how [inaudible] would you need to expand?

Andrew A. Krakauer

Well, the expansion we’re talking about is in Healthcare Disposables. We have a very effective and fairly low cost facility in Pennsylvania, and I would almost say rural Pennsylvania. And we have a couple of lines that we’re bringing on to handle some new potential private label business as well as just the general growth in Healthcare Disposables. And so, you know, I don’t have the exact square footage. I think it’s 18,000 square feet or 22,000 square feet expansion onto an existing building. But there was some one time costs to make that happen. But that’s a one time cost and it’s over.

Mitra Ramgopal - Sidoti & Co.

Finally, did you buy back any stock in the quarter?

Andrew A. Krakauer

No. None at all. So the disclosure from our first quarter [few] is still current disclosure.

Operator

Your next question comes from Mark Cooper - Wells Capital Management.

Mark Cooper - Wells Capital Management

Can you elaborate a little bit for me on the – you mentioned you saw some product growth or backlog growth as we turned into the new calendar year here.

Andrew A. Krakauer

Okay. Specifically I was talking about the Water segment. Basically what happened it seems and I can only tell you what it seems like, it seems as if the if it’s a net effect of what’s going on in the economy had slowed down the capital, certainly the release of capital equipment, even in the Dialysis segment where our customers were, I guess, evaluating the need but probably more importantly putting in tighter controls, making more centrally controlled. And so we went for a couple of months going back to the end of last year and really in the first quarter where I would say we had some – even some of our best customers had a slow down with orders. And you know it takes a few months to build. And so that hit the second quarter but that all appears to be opening up, at least Dialysis capital.

And like I said we had very strong quarters in both January and February and here we are in the first week in March and it says – I’ve already read some reports of some significant orders continuing. So I think at the end of the day our Dialysis customers have their programs in place. They obviously need to continue to grow and expand to handle the population. But it wasn’t unexpected what happened in the second quarter but I think the good news is we’ll see improvements in the Water business as we go into the third quarter and beyond.

Mark Cooper - Wells Capital Management

Has there been any changes at all to any bad debt reserves or anything like that that we might be hearing from some other companies about clients paying late or not paying at all?

Craig A. Sheldon

I’ll address that one. This is Craig. The good news there is the answer is no. We historically have had an incredibly low amount of bad debt reserves in any of our segments, and our procedures are generally pretty tight as it is. But given the economic situation we specifically asked all of our subsidiaries to really tighten up their credit review process and take a look at the current portfolio. And everybody has done that and pleased to report we have no increase over our normally low rate of bad debt reserves. And we’ll continue. You know, we don’t take that for granted and we’ll continue to be very, very diligent in that area.

Mark Cooper - Wells Capital Management

And lastly I know you’re filing your Q shortly, but what was CapEx for the quarter? Was it in the $1 million range as in the last couple quarters?

Craig A. Sheldon

I’ll tell you, for the year we’re at about approximately $2.1 million. And I don’t recall exactly what the first quarter number was, but it was probably – we didn’t have a whole lot of – so it’s $2.1 million for the six months.

Operator

Gentlemen, we are showing no questions at this time.

Andrew A. Krakauer

Okay. Well again thanks everybody and we’ll be speaking again in three months.

Operator

Thank you. This concludes today’s conference call. You may now disconnect your lines.

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