Cantel Medical Corporation (CMD) CEO Jorgen Hansen on Q3 2018 Results - Earnings Call Transcript

| About: Cantel Medical (CMD)

Cantel Medical Corporation (NYSE:CMD) Q3 2018 Earnings Conference Call May 31, 2018 11:00 AM ET

Executives

Milicent Brooks - Head, Corporate Communications

Chuck Diker - Chairman

Jorgen Hansen - President and Chief Executive Officer

Peter Clifford - Executive Vice President and Chief Financial Officer

Seth Yellin - Executive Vice President, Strategy and Corporate Development

Brian Capone - Vice President, Corporate Controller

Analysts

Mike Matson - Needham & Company

Larry Keusch - Raymond James

Mitra Ramgopal - Sidoti

Operator

Greetings and welcome to the Cantel Medical Corp Third Quarter 2018 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Milicent Brooks, Head of Corporate Communications at Cantel Medical. Thank you, Ms. Brooks. You may begin.

Milicent Brooks

Thank you, Doug and good morning everyone. On today’s call, we have Chuck Diker, Chairman of the Board; Jorgen Hansen, President and Chief Executive Officer; Peter Clifford, EVP and Chief Financial Officer; Seth Yellin, EVP, Strategy and Corporate Development; and Brian Capone, VP, Corporate Controller.

Earlier this morning, the company issued a press release announcing the financial results for the third quarter of fiscal year 2018. In addition, we have posted a supplemental presentation to complement today’s call. This presentation can be found on Cantel’s website in the Investor Relations section under Presentations.

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 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. The company will also be making references on today’s call to the non-GAAP financial measures, non-GAAP EBITDAs, non-GAAP operating income, non-GAAP gross profit, non-GAAP diluted earnings per share and net debt. Reconciliations of these financial measures to the most directly comparable GAAP financial measurements are provided in today’s earnings release.

With that, I am pleased to introduce to you, Jorgen B. Hansen, President and CEO.

Jorgen Hansen

Thank you, Milicent and welcome everyone. I will start off with some brief opening comments, followed by Peter who will take us through our third quarter 2018 financial results. Finally, we will open the call for Q&A.

We are very pleased with our results this quarter. We grew reported sales by 13.1%, with 7.6% organic growth. Our three major segments performed well despite headwinds related to timing of shipments and tough comparable growth in selected markets versus prior year. In addition, we closed a highly strategic acquisition, which adds new capabilities to help drive growth in the mid-term. Endoscopy sales grew by 18% with organic growth of 8.1% driven primarily by procedural product services and chemistries. Despite new entrants into procedural products space, this category provided another quarter of solid opportunity in growth rates.

Total recurring revenue was up 16.1% in the quarter, which was slightly offset by capital due to difficult prior year comparable sales. In March, we closed our acquisition of Aexis Medical, which addresses an important customer need for tracking, documentation and analyzing reprocessing workflows to drive best-in-class infection prevention processes. This platform increases the value of our unique full set of protection that we currently offer to customers in the GI suite as well as providing a meaningful expansion opportunity into the Central Sterile Department and Operating Room.

Water Purification and Filtration recorded revenue growth of 9.2% for the quarter led by strong results in chemistry, consumables and service. Orders on capital, specifically medical water were down this quarter, but partially due to one of our key customers moving toward a dual-sourced approach. Strategically, we are expanding into new adjacent higher margin technologies in markets and distribution. As an example, we shipped 2 of our REVOX low-temp sterilization systems in the current quarter to one of the world’s leading medical device manufacturers and we are excited about the future opportunities in this new emerging business segment.

Revenue in our Healthcare Disposables segment increased by 6.5% with organic growth of 5.3%, which is approximately 2x the market driven by demand for our strategic branded portfolio which grew 9%. This category was led by our waterline disinfection and mask franchises. From a geographic perspective, our international operations continued their high growth story with sales increasing 25.6% led by Germany, Australia and China. This includes the impact of the acquisition of Aexis Medical in Belgium, the BHT Group in Germany and our Australia distributor. International organic growth was up 3.6% impacted by difficult comparables in the prior year with record capital sales in the UK. U.S. sales were up 9.2% and 8.9% organically versus prior year and performed well across all business segments.

With that, I will hand over to Peter to discuss the financial results.

Peter Clifford

Thanks, Jorgen. Good morning, everyone. Let’s take a few moments to walk through 3Q ‘18 financial results. On a consolidated basis, our top line net sales increased 13.1% year-over-year in 3Q ‘18 versus the prior year and 11.6% on a constant currency basis. The consolidated net sales walk elements were organic came in at 7.6%; M&A came in at 4%; and FX was a tailwind of 1.5%. Gross margins for the quarter, GAAP gross margins expanded by 60 basis points to 48.2% versus the prior year of 47.6%. Non-GAAP gross margins expanded by 40 basis points year-over-year although when adjusted for the segment recast and dilution from BHT, we expanded our core 150 basis points operationally year-over-year.

Operating expenses for the quarter, GAAP operating expenses increased by $13.6 million or 21.3% in 3Q ‘18 compared to the prior year. The impact of acquired costs from acquisitions was roughly $3.8 million or 6%. Note we had $3.5 million of one-time expenses related to a legal settlement and business optimization. The balance was purposeful investment in line with our strat plan initiatives.

Operating profit for the quarter, GAAP op profit decreased 1.4% year-over-year to $27.1 million, while our non-GAAP op profit increased 10.1% year-over-year to $36.3 million. Our quarter effective tax rate on a GAAP basis, the overall ETR for the quarter was 26.7% as compared to the prior year rate of 33.6%. The impact of federal statutory rate change provided a benefit of approximately $2.1 million during the quarter. This was partially offset by state taxes. On a non-GAAP basis, our non-GAAP effective tax rate came in at 28.3% as compared to a prior year of 33%. Again, the key driver for the impact of federal statutory rate change provided a benefit of approximately $2.8 million during the quarter again partially offset by state taxes.

As we look forward to the balance of the year based upon our current geographic composition of profits and information available, we anticipate that our non-GAAP full year rate as well as our rate for the fourth quarter will be around 28.5% to 29% that we intend to reinvest approximately $0.03 or $0.04 of a tax benefit in 4Q ‘18 we will provide guidance on how to model the reinvestment for fiscal year 2019 on our fourth quarter earnings call in September.

EPS for the quarter, GAAP EPS increased 7% year-over-year to $0.45, while our non-GAAP EPS increased 16.6% year-over-year to $0.60. Adjusted EBITDAS for the quarter, our 3Q adjusted EBITDAS came in at $43.6 million, up 12.3% year-over-year, while our adjusted EBITDAS for the last 12 months was $176.4 million, up 14.8% year-over-year. Our 3Q cash from operations came in at $35.3 million, up 24.5% year-over-year.

Now, let’s provide some insight into the segment results. For Endoscopy segment for the quarter, sales grew 18% year-over-year to $118.4 million. Our organic was 8.1%. Our GAAP op profit increased 10.8% to $20.5 million, while our non-GAAP op profit increased 22.6% to $26.3 million providing strong leverage. For our Water segment for the quarter, sales grew 9.2% year-over-year to $52.3 million. Organic was 8.9% driven by strength of the backlog. Note, our backlog did see compression of roughly $3 million during the quarter driven primarily by our medical water business offset by modest increases in our non-core specialty water business. GAAP op profit increased 7.8% to $8.5 million, while our non-GAAP op profit increased 11.7% to $9.3 million returning to a leverage profile.

For our HCD segment for the quarter, sales grew 6.5% year-over-year to $38.5 million. Organic was 5.3%. Our GAAP op profit increased 18.7% to $7.6 million, while our non-GAAP op profit increased 16.1% to $9 million again providing strong leverage. For our Dialysis segment for the quarter, sales expanded 4.9% year-over-year to $8 million and our GAAP and non-GAAP op profit decreased by 23%.

Now, I’d like to hit a few balance sheet and liquidity details. Our balance sheet remains very strong with significant capacity. We ended the quarter with $51.9 million in cash and cash equivalents, $177.1 million in working capital. Our gross debt ended the quarter at $169 million. This includes $82.3 million of borrowings this year to fund the acquisition of the BHT and Aexis Medical. We have paid down debt at $12 million in 3Q ‘18. Our net debt is $117.1 million and our net debt to adjusted EBITDAS is 0.66. Capital expenditures were $10.3 million. As we have signaled previously, CapEx will remain elevated for the next four to six quarters to support our ERP implementation project. As a reminder, we will be filing our 10-Q tomorrow.

I will now hand the call back to Jorgen for closing remarks.

Jorgen Hansen

Thank you, Peter. Overall, we are very pleased with our performance this quarter, the positive trajectory of our business and our strong competitive position in the markets we serve. Looking at our M&A pipeline, we are encouraged with the opportunities we see across all of our divisions as well as the adjacencies in life sciences, chemistries and other key strategic areas. We are optimistic that we have more to share on acquisitions over the next several quarters.

Furthermore, we are pleased by the strength of our new product development pipeline. We have recently launched DEFENDO [indiscernible] Valve that is the only single-use valve for high volume [indiscernible]. This new innovation addresses an unmet clinical need for infection reduction and importantly will improve the experience for both patients and clinicians doing procedures. This product introductions, coupled with the recently launched ADVANTAGE Pass-Thru Automated Endoscope Reprocessor and our Eon portable reverse osmosis water purification system will continue to enhance our market leadership position in fiscal year 2018 and beyond.

Taken together, we expect to continue to perform in line with our 5-year strategic plan objectives to double sales and profits by 2021. As demonstrated this quarter, this will be achieved by a new product development, market expansion, strategic acquisitions supported by continuing evolution of the Cantel operating market. With the benefit of the tax legislation changes we anticipate fiscal year 2018 non-GAAP EPS of $2.47 to $2.50 inclusive of announced acquisitions.

In line with the spirit of the legislation, our revised guidance incorporates the plan to reinvest part of the tax benefit back into the company, which will start in the fourth quarter. In our earnings call presentation, we have included a chart to help model the estimated tax rates for fiscal year 2019. This tax benefit would accelerate plans we already had in place to invest additional resources in both the business and our team members. These plans include advancing new product development, enhancing total rewards for employees and accelerating facility expansion to support our growth. As an example, we recently committed to a new building in Minnesota to provide space capacity and drive process efficiency as we continue to grow and add talent.

In closing, I would like to thank our 2,500 loyal and hardworking team members for their efforts and achievements this quarter. Our entire company takes great pride in our mission to provide solutions to mitigate infections, improve patient safety and outcomes, and ultimately help save lives. Thank you for listening. I look forward to speaking with you on our fourth quarter earnings call in September. Doug, we are now ready to take questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Mike Matson with Needham & Company. Please proceed with your question.

Mike Matson

Yes, thanks for taking my questions. I guess just wanted to start with the Endoscopy business, I think the slides mentioned there was a difficult comp in the UK, can you just talk about what caused that and can you quantify the impact of that at all?

Peter Clifford

Yes. If you think back to our prior year in the UK, we probably only shipped about 25% of our AERs in the first half of the year, with the bulk coming in the third and fourth quarter of last year. So, we had a very capital intense third and fourth quarter in the UK and it was heavily slanted towards the third quarter. To give some perspective, our EMEA business would have grown 7% organically, if we excluded the UK business. So it was much stronger than the reported 3.6%.

Mike Matson

Okay. And then you had also mentioned that capital growth was normalizing in the U.S., can you explain what that means?

Jorgen Hansen

Yes, this is Jorgen, hi, Mike. If you think of that – if you think back to well, a few years back 2011 and ‘12 and ‘16 and ‘17 we had really a windfall in capital related to be caused in the market and we are selling capital and really elevated levels in the U.S. And that is now I would say back to more of a normalized growth level. Just as an example we sold up to 1,000, 1,100 machines in the U.S. in ‘16/17 and that’s now down sort of in the 600 to 700 level, which is still a very nice growth rate when you look at the business long-term and we still win new market shares everyday out there and we are defending and growing our sort of two-thirds market share. So it’s just more like getting into a more regular non-event impacted business.

Mike Matson

Okay, that makes sense. Alright and then just one more on the water business, so it’s continuing to see kind of its high single-digit organic growth, I know you have talked about that kind of being a mid single-digit business over the longer run, but what’s driving higher growth and is it sustainable? And then you mentioned this medical device kind of opportunity in that business, can you maybe talk about that? And that’s all I have. Thanks.

Peter Clifford

You want to take that?

Jorgen Hansen

Yes. So I mean just if you think about the water business it is sort of a mid single-digit business longer term and it’s quite cyclical if you look at the longer term trend onboard, we have had years where business was flat and we had years like this where we had close to 10% growth sort of averaging around 5%, 6% growth. What we are talking about is that we are starting to see growth drivers and other things than our traditional medical water business. We sold a couple of our REVOX low-temp sterilization systems this quarter into one of leading manufacturers of medical devices and we are starting to build a meaningful pipeline in this product, which is really providing a novel technology, great margins and also great consumable stream as we develop this business, still early stage, but interesting things going on there. And likewise, we have other businesses under our water segment. Chemistries, we see good development there and also filtration, so a lot of interesting things going on to create a sustainable long-term growth path for our water business.

Mike Matson

Thank you.

Operator

[Operator Instructions] Our next question comes from the line of Larry Keusch with Raymond James. Please proceed with your question.

Larry Keusch

Yes, hi. Good morning, everyone. So I just wanted to start with Endoscopy, so relative to our model, Endoscopy was really the big variance, everything else came in at or above what we have been anticipating. So, I guess the question is it sounds like the extent that there were any tough comps it was primarily in capital, you clearly knew about that tough comp. So, I guess the question is relative to your expectations how did Endoscopy capital come in and to the extent that it was a little bit later where potentially was that – where was that coming from?

Jorgen Hansen

I would say that, I think its great question, Larry I mean that endo sales of all came in very much as we expected and we have had a good line of sight into the capital comps. I would say we talked about the UK was probably little lighter than we had hoped for. The NHS are really holding back on spending in the UK right now, so that impacted our ability to really push little harder on capital in the UK market. I would say the U.S. is very much in line with what we expected. Again, we have a very strong pipeline. But as it is with capital business, it really depends on our customer’s ability to pickup sales. So, we do know that some orders were pushed from the third quarter probably into the fourth quarter and even into next year as a natural cycle. So, I would say, in conclusion very much that performance in line with what we expected for the quarter.

Larry Keusch

Okay. And then one more on that and just a couple of other very quick ones, but so it sounds like there was a timing of order issue or at least observation within this quarter, so maybe some of that falls in the fourth quarter as you talked about or into next year, you still have a lot of international expansion opportunity, you still have opportunities for procedural products growth in the U.S. and o-U.S. etcetera. So, there still seems like there is a lot of opportunity to continue to grow this global business at healthy rate. So, is it still fair to look at the business longer term as kind of this 10% low double-digit grower or should we be thinking this quarter sort of suggest that, that perhaps the growth is decelerating some?

Jorgen Hansen

Well, it’s a great – you made all the right points, Larry. I mean this is – there is a lot of opportunity in this business particularly on our procedure side. We are probably penetrated 28% to 30% in the U.S. and the procedural product penetration, o-U.S. as you know is much smaller. In addition, we think the market – underlying market is very sound. I am sure you, I know, you put out of piece on the new guidelines from the American Cancer Society yesterday moving the screening recommendation from 50 to 45, which meaningfully expands the market and also something that we see as an upside long-term, it’s not going to change the market tomorrow, but it will help continue the opportunity for us to grow this business in a meaningful manner. So, we still feel that with international opportunities, with the good changes that we see in the U.S. with the competitiveness of our product portfolio we will be able to grow this business in sort of the low double-digit range longer term, but we will have quarters like this where capital maybe a bit low or other things that impacting. So, it’s not going to be every single quarter. That’s for sure.

Larry Keusch

Okay, perfect. Understood. Last two for me. Just on the guidance, what changed in the organic revenue and M&A guidance outlook for the year and again based on our model it would seem to imply that that you are looking at mid single-digit organic growth in the fourth quarter and again just want to see if we are thinking about that correctly? And if so why would that be the case?

Peter Clifford

Yes, Larry. Our range sort of as you know implies sort of 223 to 227 in the fourth quarter and what’s different than 9 to 12 months ago when we came out with the original guidance is as we have articulated on the last couple of calls, our water business grew bad, we can see out a couple of quarters with the backlog and we have been signaling the last couple of quarters that there has been some compression in the backlog there as the business is lumpy and it does have a cycle to it. So, as we think about the fourth quarter of last year on water business is when it really started to accelerate. We were just over $51 million in revenue last year in the fourth quarter. So, that’s a comp that’s going to be meaningfully tougher with the compression of the backlog. And then as Jorgen said, I think the one difference is probably U.S. capital is a bit softer than we suspected. And I think internally we have gone back and looked at literally the last 10 years of AER sales. And as Jorgen was articulating that, there is a nuance pattern that seems to be there in the ‘11 ‘12 bubble and in the ‘16 ‘17 that really did 2 years coming out of both of those upticks, you can really see there has been a more than a pull-head effect, where the 2 years following those bubbles the business has been pretty flat on capital. I think honestly that’s probably what we didn’t see. When we started the year that we are seeing as we get to the back half of this year on the Endoscopy business is that U.S. capital is going to be a little bit tougher environment that what we anticipated. We still think the prospects long-term are how we have thought about the business of 5% U.S. capital growth is sustainable, but we do think coming out of these issues on the recalls that it does seem to bring a nuance for 2 years where the business is sort in that 650 to 750 annual units and is more flattish than that necessarily typical 5% growth.

Larry Keusch

Okay, perfect. Thanks very much guys.

Jorgen Hansen

Thanks, Larry.

Operator

Our next question comes from the line of Mitra Ramgopal with Sidoti. Please proceed with your question.

Mitra Ramgopal

Yes, hi. Good morning. Just a couple of questions. First, just regarding R&D obviously increased sequentially and definitely year-over-year, I was wondering if it’s already reflecting some of the tax reinvestment?

Peter Clifford

I would just say we have had a mission all year to try and purposefully invest more in R&D than we historically have had. I would argue in the first half of the year there wasn’t really much of an impact. In the third quarter, I think there were projects that we have more forcefully leaned on knowing that we would likely have some air cover with the tax benefit and I think you will see more of that more forcefully this quarter here.

Mitra Ramgopal

Okay, thanks. And in terms of how you are viewing your growth opportunities going forward and getting to your 5-year target, I think if you look at organic growth this year it looks like it will be the lowest versus what we have seen over the last 2 years and I was wondering if you feel there is some things you can do to really improve that or you are probably going to be more aggressive on the acquisition front to make up for it?

Peter Clifford

Well, I think as mentioned earlier on this call that we are still very optimistic on the business. We have great end-markets and we have growth – we have great long-term growth opportunities. And obviously as you know coming out of many quarters since we have lost our strategic plan in ‘13 with very solid organic growth. So I don’t really – we don’t believe that we will depart too much from that. We are still very bullish on our product pipeline. We have made lots of investments in our commercial teams and have great confidence that they will continue to deliver and we do see great opportunities in M&A front, but I don’t know if you want to add anything, Seth, on the M&A side?

Seth Yellin

No, I think from an acquisition perspective, we are pretty happy with where we are at in pipeline overall and the opportunities we see in front of us both in our existing businesses and in near adjacencies that we think could be good long-term growth drivers for the company with new technologies and new markets that could be really interesting drivers for us in the medium to longer term as well.

Jorgen Hansen

I just echo that. I think the pillars are still the same. When you think of the Endoscopy business, there is still a meaningful part of the procedural products market that is there to be penetrated. We are not alone anymore in that space, but we have got a commanding share position and the best products. We still have a conversion issue on reuse chemistry machines in the U.S. They are rotate out to single shot chemistry. We still got geographic expansion in really low share position outside the U.S. and capital on our Endoscopy business. And we still have plenty of runway to acquire and growth differentiated products in the ACD space, which we have been doing over the last couple of years. So that continued pivot from private label to branded and continued growth of organically of acquired products into that basket, I think there is still exactly the same as before. I think again we have got a Endo capital issue that we are running our way through, but that’s temporary and we have seen growth rates again returning to as we thought about the business 5% sort of U.S. capital and outside the U.S., our ambition is to try and grow that capital number 2x that.

Seth Yellin

And just to add to Peter’s comments, I mean, if you think about new products you can almost include Aexis Medical information, our latest company, because it’s still a small business that we haven’t even launched in the U.S. yet and information analytics and data capture and big data is the theme everywhere and is the theme from our customers that we are talking to them about every single day and that’s an example of a business that should grow with many times over the next several quarters and years going forward. And obviously right now it’s dilutive from an investment perspective, but can almost be thought about as a product launch.

Mitra Ramgopal

Okay, that’s great. I guess I will just follow-up quickly on the Aexis Medical acquisition and if you could maybe – Seth, if you can just give us a sense of the market maybe overall or international versus domestic etcetera, anything would be helpful?

Seth Yellin

Yes. I mean, I think the market and the demand for a information solution and workflow – reprocessing workflows is high. I mean I don’t know if I want to characterize the market size right now, I think it’s a very developing market, but as we speak it’s rapidly growing. Certainly, this is a product that has a leading solution for track and trace documentation and then the ability to provide additional analytics around reprocessing workflows. Historically, it has been focused primarily in the central sterile department and OR solutions with scheduling and tracking and tracing in hospital partners and in Europe, but they have also quite good products that are applicable to the Endoscopy space and we see the opportunity really to marry this with our overall Endoscopy portfolio and then provide us also greater access to the central sterile department, which as we spoke about many times, central sterile remains a core category or core market that we see good opportunity for continued growth for our overall business and this would be a good entry point for us. So, we are quite optimistic about the potential of this acquisition. For sure, it is an early stage business that has been fairly limited, but we think it has best-in-class technology and represents an attractive opportunity for us to drive growth in both our existing Endoscopy portfolio as well as to provide an access point and growth opportunity in the broader hospital central sterile space, so really optimistic and enthusiastic about the potential market for us.

Mitra Ramgopal

Okay, thanks again for taking the questions.

Jorgen Hansen

Thanks, Mitra.

Operator

There are no other questions in the queue. I would like to hand the call back to management for closing comments.

Jorgen Hansen

Well, thank you for joining the call. We look forward to speak to you at our fourth quarter call in September. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!