Cantel Medical Corp (CMD) Q1 2021 Earnings Call Transcript

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Cantel Medical Corp (CMD)
Q1 2021 Earnings Call
Dec 8, 2020, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to your Cantel First Quarter 2021 Earnings Call. [Operator Instructions] At this time, it is my pleasure to turn the floor over to your host, Matt Micowski, Vice President of FP&A and Investor Relations. Sir, the floor is yours.

Matthew C. Micowski -- Vice President, Financial Planning & Analysis and Investor Relations

Good morning, everyone. On today's call, we have Chuck Diker, Chairman of the Board; George Fotiades, Chief Executive Officer; Peter Clifford, President and Chief Operating Officer; Seth Yellin, Executive Vice President and Chief Growth Officer; Shaun Blakeman, Senior Vice President and Chief Financial Officer; and Brian Capone, Senior Vice President, Corporate Controller and Chief Accounting Officer.

Earlier this morning, the company issued a press release announcing the financial results for the first quarter of fiscal year 2021. In addition, we have posted a supplemental presentation to complement today's call. This presentation, along with reconciliations of non-GAAP references, 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. Additional information concerning forward-looking statements is contained in our supplemental presentation and earnings release.

The company will also be making references on today's call to non-GAAP financial measures. Reconciliations of these financial measures to the most directly comparable GAAP financial measurements are provided in today's earnings press release.

With that said, I'll now turn the call over to George.

George L. Fotiades -- Chief Executive Officer

Thank you, Matt. Our performance in the first quarter demonstrated the unique nature and relevance of our infection prevention and control offering and the strength of Cantel's operating discipline. Most importantly, we continued our steadfast focus on employee safety, which has yielded uninterrupted service to customers.

What's clear from the external data and our own results is that we are outperforming the recovery and procedures. We estimate based on independent third-party data that in our first quarter through October 31, U.S. endoscopy procedures were down about 6% to 8% below year ago. During the same time, Cantel consumable and chemistry products were flat to up low-single digits versus year ago depending on the category.

Similarly, in dental, while U.S. procedures appear to be down 15% to 20% year-over-year, our dental business was up nearly 2% organically, reflecting similar outperformance versus the underlying market.

We are experiencing more revenue per procedure as a result of our strength in PPE, the uptake in our new products and the adoption of heightened infection prevention protocols, utilizing more of our solutions.

Over the last eight months, we have embedded a disciplined operating focus into the company. At the time of the Hu-Friedy acquisition, we knew we would eventually bring our dental business to a 25% EBITDA margin, given, first, the traditional margin profile of the legacy Hu-Friedy business; second, the impact of synergies; and third, specific operating improvements in the legacy Crosstex business. But as demonstrated this quarter, this has happened on an accelerated timetable, especially with the quicker recovery in procedures.

Here is a key takeaway. This operating discipline is in place across all of our businesses. We are making progress on several other fronts. Peter will talk about our early traction with Cantel 2.0 initiatives, our new product launches with Scope Buddy Plus tubing sets, and the DEFENDO Cleaning Adapter Valve have generated momentum.

Hu-Friedy launched a new ergonomic scaler -- just as their manual scalers have seen renewed preference versus ultrasonic scalers -- to minimize risk of aerosol production in the dental office.

Yesterday, we announced a collaboration with Censis Technologies, the innovative leader in surgical instruments and asset management systems. This will be a significant impetus to enhancing and scaling up our track and trace and workflow technology solutions in the endoscopy suite with a premier partner.

Shaun will speak to how our operating performance and disciplined working capital management is generating strong cash performance.

We have accelerated our debt repayments over the past few months. Earlier this month, we paid down our revolver by an additional $50 million, bringing our total debt paydown to $125 million thus far in fiscal 2021, and we expect to continue to pursue this accelerated repayment path in 2021.

I know we will be asked what elective procedure volumes and revenue performance looks like in our second quarter? So far, November, the first month of the quarter, performed similar to October in terms of day rate revenue in medical and dental. As we pointed out on our last call, the second quarter does have four fewer shipping days than the first quarter.

As for the rest of the quarter, it's wait and see. We all see the same headlines. What we do know is that as we exit the winter months and calendar year 2021 unfolds, we are expecting to gradually see 100% recovery in procedures, particularly as vaccination programs gain traction.

We also know, regardless of exactly what level procedures are at, that we continue to perform better than procedure levels given our comprehensive offering and the critical nature of the solutions we bring to our customers.

Last quarter, we gave guidance on EBITDAS margin exiting the year. We said at least 19%. We are updating this guidance to at least 22% EBITDAS margin exiting our fourth quarter.

Now, given Q1 EBITDAS margin of just under 26%, this guidance of at least 22% models in a return to normalized operating expense spending in the upcoming quarters. Our performance this quarter demonstrates the earnings power of our businesses when volumes return to normal levels.

The enhanced operating discipline we have deployed, coupled with the strength of our suite of infection prevention and control solutions and recent traction in our Cantel 2.0 programs, gives us confidence in our ability to sustain these operating levels and continue to build on them in the future.

So with that, Shaun?

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

Thanks, George, and good morning, everyone. I'm going to go through our key financial results with brief commentary. Following that, I'd like to provide additional details that give context to the financial results during COVID.

Of course, the standard reported financial details are available in the earnings deck for you to follow along and we can cover any additional questions you may have during the question-and-answer session.

Net sales increased 15.5% year-over-year in the first quarter '21 versus prior year and 14.7% on a constant currency basis. M&A accounted for 16.5% of the increase and the FX impact was 0.8%, both of which were offset by an organic decline of negative 1.8%. This significantly exceeded our Q1 expectations, with procedural volumes and demand for infection prevention products in both medical and dental accelerating throughout the first quarter.

The Medical segment decreased by negative 2.2% on an organic basis in the quarter. Capital Equipment decreased 20%, with recurring revenue increasing 2% in the period versus the prior year. It is important to note that while capital sales declined, we built robust backlog during the quarter, representing strong underlying demand.

While underlying endoscopy procedures have returned faster than anticipated, our outperformance in our recurring revenue categories above procedural growth indicates market share gains we are seeing with our differentiated infection prevention offering.

The Dental segment grew 65.1% on a reported basis, driven by the acquisition of Hu-Friedy and increased 1.8% on an organic basis, primarily driven by the recovery of dental procedures, combined with increased demand for infection prevention products in the dental market, inclusive of PPE and disinfectant chemistries.

Overall, we believe these results reflect the power of the combined Hu-Friedy Group portfolio, especially in an environment of increasing sensitivity to infection prevention protocols.

Life Sciences declined 7.3% on an organic basis, primarily due to lower portable reverse osmosis machine sales. This decrease was primarily driven by demand in the back half of fiscal year 2020, as customers requested these units during the height of the pandemic.

In the Dialysis segment, we saw organic growth of 8.3%.

Turning to consolidated margins. Our GAAP gross margins increased by 460 basis points to 49.6% versus 45% in our 1Q 2020, while non-GAAP gross margins increased by 280 basis points year-over-year to 50.1%. The expansion was driven by the return of volumes, combined with our more disciplined approach in managing manufacturing costs, as well as favorable mix due to the higher sales of consumable products. More importantly, at these volumes, we believe we should sustain gross margin expansion going forward.

Moving down to op profit. GAAP op profit increased 249.1% year-over-year to $50.4 million. On a non-GAAP basis, op profit increased 52% year-over-year to $64.5 million.

Our cost discipline around discretionary spend is ongoing and we will continue to take a cautious approach with opex, given the uncertainties surrounding COVID. I expect opex to remain relatively flat sequentially in our second quarter on the lower end of $85 million to $90 million guided previously and stabilizing around $90 million to $95 million run rate by Q4, depending on volumes.

Moving on to tax rates. The GAAP effective tax rate for the quarter was 28.2% as compared to the prior year rate of 33.8%. This decrease was driven by lower permanent items in the U.S. and favorable geographic income mix.

The non-GAAP effective tax rate came in at 25% compared to the prior year rate of 25.9%. This decrease was driven by geographic income mix. As a result, GAAP earnings per share increased 307.1% year-over-year to $0.57. Non-GAAP earnings per share increased 38.5% year-over-year to $0.90. Finally, adjusted EBITDAS came in at $76.3 million, up 48.6% year-over-year.

I will now move on to the key cash flow and balance sheet items. Cash flow from operations for the quarter came in at $62 million, an increase of 594.3% year-over-year. And we ended the quarter with $258 million in cash. Working capital decreased 9% sequentially to $426.9 million, primarily driven by a decline in cash on hand, which was used to repay some of our revolver. Accounts receivable increased 7%. Inventory declined 2% and accounts payable increased 12%, all on a sequential basis. In addition, capex was $5.5 million this quarter, which also decreased sequentially.

Gross debt ended the quarter at $1,038.4 million, while net debt was $780.4 million. Our net debt to adjusted EBITDAS ratio was 3.93 times. As a reminder, we were able to pay down $75 million of our revolver in September.

A key element of our Cantel 2.0 initiatives has been to drive operating and working capital improvements. Our heightened operating discipline, coupled with the full implementation of SAP in the U.S., is driving greater insight into our operating metrics, enabling us to better manage our business. We will continue to drive operating efficiencies and expect to continue to pay down additional debt in fiscal year 2021.

During the last call, we mentioned our intent to pay down at least $125 million in the fiscal year. Given our stronger than expected performance and cash position through the first quarter, we were able to pay down an incremental $50 million of our revolver in November, bringing our total debt paydown to $125 million, completed four months into our fiscal year.

With our strong operating cash flows, we anticipate paying down an additional $55 million to $75 million of debt during the remainder of the fiscal year.

Although we still feel it's prudent to refrain from providing guidance for the full year, I'd like to provide some color on the second quarter. In terms of revenue, it's important to remember that we have four less shipping days in our second quarter due to the winter holiday season, which we would expect to impact the Medical and Dental business to the tune of approximately $3.8 million per day.

In addition, due to normal seasonality tied to the dental school business, you should assume there is a $5 million seasonal demand in our Dental segment in the first quarter that will not repeat in the second quarter.

Finally, given the increase in COVID spread across the globe, we anticipate that procedures will continue to stay in line with the past few months until the pandemic starts to become more controllable.

As a reminder, we will be filing our 10-Q by the end of this week.

I will now hand it over to Peter to provide a few operational updates.

Peter Clifford -- President and Chief Operating Officer

Thanks, John, and good morning, everyone. I want to take this time to share some insight into what we've learned over the past 90 days. These observations have and will continue to impact the actions that we take in near and long-term to execute on our strategy.

At the forefront of the changes that we see is that healthcare providers have fundamentally changed their IP&C protocols in a permanent way. These new protocols are allowing procedure capacity to safely recover faster than anticipated in most geographies.

Our products, services, clinical expertise, education and training are providing differentiated solutions to enhance patient safety and efficiency of practice for our customers. The procedures we support -- often considered elective -- are critical to hospital, ASC and dental suite profitability. And as we head into the winter season, we anticipate that healthcare providers will protect and sustain these procedures differently than what was experienced this past spring.

The demand for more IP&C solutions and stronger compliance to existing standards highlights the critical nature of Cantel solutions, which are enabling us to outperform procedure volumes and gain share in our Medical and Dental segments.

Our assessment of procedures during 1Q '21 placed dental procedures in the range of 80% to 85% of pre-COVID levels while medical procedures were approximately 90% to 95% of pre-COVID levels. While this is positive news, we do expect patient safety concerns to be higher over the next several weeks.

Regardless of any potential near-term impact due to COVID, we are bullish on what we believe the market environment for our products and solutions will look like in the spring, with or without a COVID vaccine.

It is worth noting that through November, our daily order intake rates have continued to outpace sales in both medical and dental. This trend, along with the operating enhancements that we've made over the past nine months, bolsters our confidence in the future.

While there is much to do, we know how to manage what is in our control, including our cost structure, discretionary spending, working capital, debt service and taking care of our employees during challenging times.

Moving to Cantel 2.0 and starting out with our U.S. medical commercial initiatives, in the ASC space, we have launched what we term spring training for 1H '21 on schedule.

Critical activities that we have focused on in 1Q '21, that will continue through 2Q '21, all ASC sales reps will complete their basic and advanced training courses on selling the full bag by the end of 2Q '21, driving targeted equipment placement program wins across this segment of the market. We are already seeing traction in the market, related to these initiatives.

To put our 1Q '21 efforts into context, through the fourth month, we have already matched our full-year '20 pipeline and are outpacing placements. Executing in infection prevention efficiency reviews in the ASC clinics, which is key to establishing our brand and value proposition, while generating actionable VOC insights and significant positive feedback from an underserved market. Refining our field sales toolkit by improving our value-selling calculators, better designed programs and promotions, strengthening our clinical education materials, all aimed at crystallizing our value proposition.

We are very encouraged by the early feedback from ASC practitioners regarding our ability to effectively capture the value from the solutions that we provide.

In addition to the progress made in ASCs, we have concurrently accelerated our plans in the hospital setting with positive results. Some of the key highlights include, field reps have all completed their advanced full bag training courses. To remind you, we recently configured our medical sales organization from product specialists to full bag reps to better sell the full Cantel portfolio.

Our first U.S. inside sales team is now fully operational and closed their first orders in October. This is an initiative that will take time to develop, but we think is a must-have, given the access issues that continue to impact the provider landscape due to COVID.

New capital programs have been incredibly successful, doubling our normal backlog to $14 million at the end of 1Q '21. Our continued investment in the Key Account Director or KAD program, has given us a unique advantage given its IP&C educational nature, allowing our teams unprecedented access, even as facilities are locked down.

To give some perspective on the traction of the KAD program initiatives, we have seen faster than average growth in these accounts with approximately 30% higher organic consumable growth compared to accounts not partnered with a KAD program, needless to say that our programs in the U.S. are in full swing and progressing nicely.

In Europe, we continue to gain traction in our commercial excellence initiatives. In terms of our people, nearly all of our reps have completed their full bag training course work that has been deployed throughout the U.S. team, with a focus on consumables. This training will be bringing them in line with standards we have set for our U.S. team.

We have put new processes and programs in place, resulting in early wins this past quarter where we outperformed procedures by double-digits in terms of reoccurring revenue streams.

We anticipate that these results will continue to strengthen as our initiatives become standard work over the next couple of quarters.

In Dental, we have executed our numerous initiatives ahead of schedule that have positively impacted the quarter. Out-the-door sales from distributors to customers remain robust, and most categories up double digits with PPE and back-to-practice kits leading the way.

Clinical education and training has been a unique strategy for our Dental segment, providing IP&C guidance along with our core infection prevention portfolio to pull through incremental revenue as clinics get back to more normal operations.

In terms of core operations, we have made significant headway in preparation of our SAP go-live, which we expect to occur in the spring, further simplifying the business.

As I wrap up Dental, I want to highlight a significant achievement that was mentioned earlier in the call. We initially released a synergy target when we acquired Hu-Friedy and were clear that it was not where we expected to be. We are pleased to report that we have already exceeded our year three target by accelerating the execution of cost synergies between the legacy businesses. This execution has enabled us to exceed our two-year to three-year target of approximately 25% plus EBITDAS ahead of schedule.

Moving over to R&D. We continue to make traction with our launch of both the Scope Buddy Plus and DEFENDO Cleaning Adapter Valve, with both franchises gaining share in attractive margin categories. Specifically, in Scope Buddy Plus, we penetrated 250 customer accounts in the first quarter, driving approximately $5 million in both capital and consumable revenue.

In DCA, we are targeting our largest length of scope [phonetic] customers first, and have seen approximately 15% penetration during the first quarter.

Finally, I'd like to provide an update on our project to add mask capacity globally. We have received our first two mask machines into our Rochester facility and should have them up and running during the month of December. We are expecting to receive our next two machines into our Italian facility in December and have them certified and up and running in February. The last four machines should be in place by May to June timeframe in Rochester.

As I mentioned on the last call, due to government subsidies, we will be able to significantly increase our mask capacity, while spending very little in terms of net capex.

I want to take this time to thank our global employees for their extraordinary efforts this quarter in what has been a challenging backdrop. We have over 2,400 team members who go out into the field and come in every day to produce and support our key products and solutions to enable our customers to continue providing care in a safe environment. It is through this hard work and commitment in a difficult environment that we're able to achieve our mission and we are grateful for their contributions.

I'm now going to hand back to George for closing remarks.

George L. Fotiades -- Chief Executive Officer

Thanks, Peter. Before we get into questions and answers, I have a short leadership change for your reference. Many of you have come to know Matt Micowski as the face of Investor Relations for Cantel. Over the past few years, Matt has done an extraordinary job managing both the FP&A function, along with Investor Relations.

And keeping with our guiding principles of continuous development for our employees, Matt has accepted a segment CFO role within the company and has already begun the process of transitioning his responsibilities. Matt has been instrumental in the development of Investor Relations within Cantel, and we would like to thank him for his contributions.

With that, Investor Relations will be formally transitioning to Ryan Lada. Ryan was previously the CFO of our Medical segment and brings strong internal knowledge of the business and financial acumen to the role. We expect to continue to make introductions over the next few weeks.

Please note to contact Ryan for your Investor Relations inquiries going forward.

Let me sum up by saying that the key takeaway for this past quarter is that we are delivering on execution. Execution and continued share gains for our infection prevention and control solutions in our markets and execution with respect to operating discipline and cash management.

So as procedures continue their recovery in 2021, we're confident in the sustainability of our stronger profitability performance.

Okay. So with that, we are now ready for questions.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, the floor is now open for questions. [Operator Instructions] We will take our first question today from Matthew Mishan with KeyBanc. Please go ahead.

Matthew Mishan -- KeyBanc -- Analyst

Good morning, everyone, and thank you very much for all the information; and outstanding quarter, as you kind of progressed through all of this.

Hey, George, first, I just want to get a sense for how should we think about the transition to normalized spending in your business? I'm just trying to understand what's sustainable in the margin profile here and what is going to be changing over the next several quarters?

George L. Fotiades -- Chief Executive Officer

Sure. I think Shaun and I can tag team this question. So look, I think, as we pointed out in the remarks, first and foremost, the big change or transition that's occurred over the past several weeks and months is in the Dental business. We said at the outset before the pandemic with the Hu-Friedy acquisition that we felt we could get this combined business of Hu-Friedy, Crosstex to a 25% EBITDA margin. That's obviously happened on an accelerated basis.

Just to remind everybody, the legacy Hu-Friedy business was around at 22% EBITDA margin. Crosstex had been at a 22% EBITDA margin, although in fiscal year '19, it was underperforming, and that's obviously has changed meaningfully this year.

So this combined, this has gotten to 25% and we made extraordinary progress on the synergies, obviously, the faster recovery in procedures. So look, it's at 30 something percent EBITDA margin in the first quarter. We are saying 25% over time. So obviously, the transition in that has to do with the fact that some operating expense will come back.

When you look at what we've said about the overall EBITDA margin exiting the fourth quarter, I said 22%, we are at EBITDAS. That is, we're at 26% in the first quarter. So, we've obviously carefully looked across the remaining quarters as procedures recover, what becomes a more normalized operating expense.

And look, one thing I can't make more clear is that we have really spent an awful lot of time embedding a cost discipline and an operating discipline in the company. It's been certainly helped by SAP. We've almost looked at things on a zero-based budgeting basis to understand what it takes to run the business on a sustainable basis.

So, we're very confident in how we see the rest of the year unfolding, provided the recovery in procedures, yielding what I've said is our goal at the end of the fourth quarter.

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

Yes. The only thing I would add is, to help out with the numbers, just point back to kind of briefly what I said in the call that we think opex will stay relatively flat going into this quarter, and then we're kind of pegging it at $90 million to $95 million a quarter by Q4 depending on volume. So, again, that's kind of how we'll get back to 22% that George referenced.

Matthew Mishan -- KeyBanc -- Analyst

Okay. Thank you, Shaun. And then I wanted to shift over to capital. My sense on capital is if it's being underutilized, they tend to spend less of it. Looks as if the procedures are going to be under 100% for a period of time. What's driving the backlog of capital in it? And I think what's interesting is your focus moving to -- on the ASCs at this point. Are you kind of hitting these ASCs at the exact right time as procedures are may be moving out of the hospital?

Peter Clifford -- President and Chief Operating Officer

Yes. I'll take that, Matt. Look, first on the capital piece, I think we've been a, sort of, let's say, in terms of looking at bundles where we can leverage both our cabinet opportunity, along with AER, so I think that's been quite successful last four months, five months in both the U.S. and international markets.

And then on the ASC front, look, I think we are hitting it exactly the right time. The VOC has been incredibly strong. We jokingly call the first half of the year, spring training, has really -- yes, the key changes in strategy deployment that we put it in the fourth quarter. We kind of said all along that the first half of the year was really refining what we deployed at the end of the year and the first half to start putting points on the board in the second half.

And so far, as I mentioned in my commentary, we've had a lot of success with our EPP programs; that's again the equipment placement programs, where we bundle consumables to allow folks with maybe constrained capital budgets to bundle where we get advantageous economics, but are able to help customers out. Again, it might have some capital constraints to their budgets. And as mentioned in the commentary, we, through four months have got line of sight to really outpace already the full year fiscal '20 capital deployment and four months already. So, it's off to a strong start is the short answer.

Matthew Mishan -- KeyBanc -- Analyst

And then last question. I just wanted to go back to the KAD. I think you said the areas where you have the KADs, you are driving 30% higher consumable growth. Just how the -- how do those KADs drive that higher consumable growth? Is it just that high-touch relationship and them working with those large customers on infection protocols more closely?

Peter Clifford -- President and Chief Operating Officer

Yes, I think the key is back to that access that we talked about. Even during the shutdown periods, we've maintained on that KAD clinician model pretty steady access. So, we've been continually getting in front of IDN groups here over the last five months or six months. And as you said, influencing and changing protocols at different parts during the GI suite and that's been very effective. Again, as we've talked about the ability to sell tops down as a way to, again, simplify and ease the bottoms up going from those full bag reps now in the field on the hospital side.

So, we have been measuring pretty fanatically here the last year and a half, really the areas where we're seeing growth, where we have KAD coverage, where we don't. And the data has always been compelling, and hence why we've continued to increase that investment sequentially from fiscal '20 to '21 and going from 10 KADs to 14 this year.

Matthew Mishan -- KeyBanc -- Analyst

Okay. Hopefully, you guys are modeling spring training after the Yankees and not the Mets, right. Thanks, guys.

George L. Fotiades -- Chief Executive Officer

Next question.

Operator

We'll take our next question from Larry Keusch with Raymond James. Please go ahead.

Larry Keusch -- Raymond James -- Analyst

Thanks. Good morning, everyone. A couple questions. I guess, George, starting with you, just trying to think through kind of the progress that you made, which has been significant in this quarter as you've rolled out this -- your sort of new platforms and selling models, etc. And clearly, you made the point that your revenue growth was ahead of their procedure recovery.

I'm thinking kind of now post-COVID, what's your latest thoughts on sort of how we just should think about the organic growth for this company with what you've achieved thus far? What's the right way to kind of start to think about a more normalized organic growth range for the company?

George L. Fotiades -- Chief Executive Officer

I think this will sound familiar, but I think our confidence level continues to increase. But if you look at the parts, Medical, we -- endoscopy, I think was gaining traction on Cantel 2.0 that we could be at 8 plus percent organic revenue growth. Dental, we think 6% growth; and of course, Life Sciences, we sort of modeled at flat.

I think again, COVID has certainly provided a strong impetus to what we offer to the consumers and has sort of reinforced the importance of the complete bundles that we provide in both places. And we've talked about the question about what transpires in consumer -- customer behavior post-COVID. And I think the changes we're seeing are ones that will be -- become embedded certainly at the hospital, but even in the ASCs and the dental offices. There will be an expectation on the part of patients that these will continue to be embedded protocols. And importantly, we're spending a lot of time trying to talk about the economy of practice in addition to the IPC efficiency of practice, and that's really the message that we were always taking into the dental and we're now taking into the ASC. So, that -- for the ASC, that they continue to be able to regain where they were in terms of efficiency of practice or their throughput, but now with the protocols that we help them put in place.

So, we feel pretty positive about it. I think we've, as Peter pointed out some of these Cantel 2.0 programs, we're starting to refine the KPIs, so that we can track this progress. It's still early days with respect to that. But what we're seeing so far is giving us a lot more confidence around where we're going to be coming out of it.

Larry Keusch -- Raymond James -- Analyst

Okay. That was great. Two other ones. I guess, sort of same -- same sort of question, again either for George or Shaun, on EBITDAS margins. Again, as you start to think out, particularly given your ability to accelerate this Huh-uh-Friedy synergies. Again, I'm sort of thinking past '21 and sort of thinking about more '22 or '23, kind of where do you guys think those EBITDAS margins could head?

And secondarily, Shaun, what -- given the operating expense numbers that you talked about for the 2Q and then as you move into 4Q, that $10 million to $15 million, that it moves higher from where we are today, what's driving that increase in operating expense? Thanks.

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

Okay. I'll start with the simple question about operating expense. And primarily, that's going to be driven incrementally. It's going to be -- a lot of this is going to be discretionary spend. It's still at pretty historically low levels around COVID. We don't anticipate all of that will come back, but we do anticipate that some of it will come back as we're putting out in terms of kind of the informal guidance.

And a little bit of headcount, it would come into play as well. But that's really not a significant driver of the '21 numbers. It's really more just anticipated discretionary spend coming back.

But I would also point out, Larry, that that's also like the lever for us as well in terms of being able to preserve margins going forward. As George just pointed, we have quite a bit of confidence in our ability to operate even in good times and turbulence to maintain that.

As far as going past '21, I know this is one of our favorite topics. But yes, I think it's even relevant answering it in terms of '21 in particular around the gross margin expansion that we do have a lot of confidence, even net of mix that at these volumes and normalized for those volumes that we are driving meaningful margin expansion with our operating discipline into the culture that we've been driving during the pandemic that we didn't let go away.

So, yes, I think it would be our target, if you will, informally to continue to try to look at kind of like that approximately 50 basis point expansion year-over-year going forward in our operating margins.

George L. Fotiades -- Chief Executive Officer

Yes. I think, Larry, we, obviously had -- we did not spend a lot of time in talking about what happens two years or three years from today yet, sort of understanding our growth rates. But look, we said 22% in the fourth quarter. And I'd say, that's a good starting point for next fiscal year.

As we continue to make progress in Europe and build the business in Europe, obviously, that helps improve profitability. So, I would say beyond fiscal year '21, as we get -- fiscal year '22, excuse me, as we get into fiscal year '23, we should pick up another 100 basis points or so on that progress. So, I think, look, our goal is to ultimately get to 24% to 25%. And obviously, this year with what's transpired in the Hu-Friedy acquisition or the synergies and basically a reset on how we look at our operating expense.

And also, I should add too, this is an important point. We've done a lot of things that we promised would transpire and yield benefit, like SAP implementation, for example, and some things we've done on rooftop consolidations that are paying benefit now as well. They were obscured at the outset of the pandemic, obviously, with the revenues. But I think those are other things that are starting to improve as well.

Larry Keusch -- Raymond James -- Analyst

Okay. Very good. Thanks, guys. Appreciate it.

George L. Fotiades -- Chief Executive Officer

You're welcome, Larry.

Operator

We'll take our next question from Mike Matson with Needham & Company. Please go ahead, sir.

Mike Matson -- Needham & Company -- Analyst

Yes. Hey, good morning. Thanks for taking my questions. I guess I just wanted to ask about the ASC setting. So, can you maybe talk about the biggest opportunities there? Is it really around the procedural products? And can you remind us what the penetration of the procedural products is in that setting?

Peter Clifford -- President and Chief Operating Officer

Yes. I'll help with that, Mike. So look, just from a share or positioning there to sort of remind folks, again, we own about 50% of the AER installed base in ASCs, and our best view on proxy for sort of, let's call it the valve business on the ASC side. As we think that market has only penetrated about 15%, so, look, I think as we've -- again, it's early days, three months, four months in. But I think we are really, really excited about -- we see opportunities across the board, whether it's on the capital side of AERs and furthering our share position to making headway on penetrating the cabinet side of the business as well as a whole host of other products like Scope Buddy Plus with the tube set consumables on the back side as well as the valve business; and obviously, we see opportunities for our chemistry business as well on the ASC side, so.

Mike Matson -- Needham & Company -- Analyst

Okay. Thanks. That helpful. And then this capacity expansion you're doing for masks, how confident are you that the demand will still be there by the time you get done with that, given the timing around the vaccines being administered kind of hopefully by middle of next year?

Peter Clifford -- President and Chief Operating Officer

Yes. I think our premise there was, look, the capacity was nearly free, net of the subsidies from the government. So that's the first point. We didn't have to pay a whole lot to get basically in a position to double our mask capacity. We used to have about 190 million to 200 million a year of mask capacity and it's roughly going to double over time. But certainly, look, we think there are protocols that have permanently changed as -- or at least adherence to those protocols that aren't going to go back. And the best example again is on the Dental side where, look, the protocols have been there that hygienists and dentists should be changing their mask after every patient. And the reality is before COVID, that really wasn't always the case. You might have had a practitioner that changed their mask at launch and then again at the end of the day. And I think there has been far greater adherence to changing your mask after every patient. And I think that sticks.

So as an example, I mean that's a doubling or tripling of the requirements on the Dental side as we see that being permanent. So, we do see opportunities to utilize that capacity on the Dental side. And look, I think it also gives us an opportunity to be opportunistic in other markets where we might be able to bundle products together.

Mike Matson -- Needham & Company -- Analyst

Okay. Great. Thank you.

Operator

We'll take our next question from Larry Solow with CJS Securities. Please go ahead.

Larry Solow -- CJS Securities -- Analyst

Great. Good morning, guys. Thanks for certainly a lot of information. Could you just clarify, so on the -- clearly, you beat sort of every line item between little bit higher sales on your pre-announcement and then certainly much greater gross margin expansion. And it sounds like your targets and your EBITDA exiting the year at 22% versus 19%, is most of that adjustment related to your confidence in sort of achieving these higher gross margin levels? And then the operating margin and expense level, there is some room there and maybe there's -- if you don't bring back all those expenses, you will potentially have some more upside, is that a fair way to look at it?

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

Yes, I would say it is. Overall, I'd say the major changes are, previously, we had kind of anticipated that procedural recovery would be somewhere between 90% to 95% by the end of the year. And so, we're more bullish that's going to be at 100% by the end of the year. So that's driving some of that confidence in the expansion that we referenced.

And yes, absolutely, we're getting more confident in our ability to produce the fruits that we knew that we were planting with all the operational initiatives that we had in place.

And again, I think you iterated but that's spot on that there is room in that client that I referenced in the operating expense model. So, that again, as volume fluctuates off of any -- off of anything that we forecast, right, we do have room to pull those levers to maintain margins.

George L. Fotiades -- Chief Executive Officer

Yes. I don't have anything to add except for -- we use the word at least 22%, so just to give a sense of our confidence.

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

Right.

Larry Solow -- CJS Securities -- Analyst

Yes. No, absolutely. And how do you gauge or balance your significant outperformance in revenue or rebound and recovery in revenue versus sort of, obviously, a nice recovery in procedures but not quite to the level that your revenues recovered? Is there some catch-up or -- like these return to work hits and maybe perhaps now that provider is planning on using extra PPE and stuff, are they perhaps buying even extra inventory and stuff? How do you sort of gauge that catch up? Or is there maybe not as much as I'm thinking there is?

Peter Clifford -- President and Chief Operating Officer

Larry, this is Peter. One of the things, obviously, with the Dental side is we have a lot of data on out-the-door by product category and obviously, we prepare that to our purchases from our channel partners. And we've looked at, both on, I'll call it a calendar year-to-date '20 and also just during our first quarter of fiscal '21, the amount of inventory change has been negligible.

So, the reality is -- and that's a good news story for us that there isn't any -- there isn't some big restocking going on than what our channel partners are buying is what's going out the door. And on the Medical side as well, I mean the nuance that you have to remember, especially on the consumable side is a lot of these hospitals, a lot of the ASCs don't hold a lot of inventory because they don't have a lot of space to hold inventory.

So, you're talking about a change where maybe some of these holding a couple of days to maybe holding a week, week and a half. So, the reality is we just don't see that behavior happening within our core markets.

And look, I think, at the end of the day, we're seeing that dollar per procedure increase as people again are just paying more attention to the protocols and the importance behind it.

Larry Solow -- CJS Securities -- Analyst

Right. And you mentioned Europe, expansion on improving Europe is part of Cantel 2.0. Are you seeing any differences today in the recovery? Forget the COVID incident, which seems to be worse in the U.S. But just in terms of the customer behavior and whatnot in United States versus the rest of the world, are there any differences as we sort of begin to rebound?

Peter Clifford -- President and Chief Operating Officer

No. I mean, it's been broad-based in the sense of -- i.e., meaning we've seen examples in every geography where there are certain practitioners that are adhering, or in some cases, creating new standards. And again, the example is we've seen pockets in Germany, we've seen pockets in the United States, in Australia. As an example, where we sell 24-hour tube sets and we've seen some clients actually switch that single-use tube sets, as an example, with just the heightened focus on infection prevention around COVID.

Larry Solow -- CJS Securities -- Analyst

Okay. Just perhaps last question. So maybe a little color on the -- you announced this deal with Censis on the trace/tracker. Should we view this as sort of an early stage thing that eventually will contribute meaningful revenue, but sort of a slow grind or how should we sort of look at that?

Seth Yellin -- Executive Vice President, Strategy and Corporate Development

Hi, Larry. This is Seth. We're really encouraged with the partnership that we announced with Censis. We've always viewed track and trace solution as an important additional element to our overall complete circle of protection that ties together the overall nature of the portfolio. And we're very encouraged by the ability to leverage the strength of our partner to help accelerate this offering into the market.

Obviously, these are substantial investments that hospital systems need to make. Those are not quick sales and quick wins, but we have a healthy pipeline and we're encouraged by the interest that we've seen from our customer level, demand for this sort of solution. And we look to roll this out with the developed product in the coming quarters and we anticipate this will be a growth driver for us in fiscal '22 and beyond.

Larry Solow -- CJS Securities -- Analyst

Great. Okay. Great. Just lastly, I'd be remiss if I didn't just give a shout out to Matt. He helped me a lot ramping up. So good luck in your new role. And that's it. I'm all set. Thanks, guys.

George L. Fotiades -- Chief Executive Officer

Yes. That's not going to influence his pay. Thank you.

Operator

We'll take our next question from Mitra Ramgopal with Sidoti. Please go ahead.

Mitra Ramgopal -- Sidoti -- Analyst

Yes. Hi. Good morning. Thanks for taking the questions. Just first one to start on Hu-Friedy. Obviously, you're well ahead in terms of your targets on the cost synergy side. I was just curious as it relates to on cross-selling front, if you're generating incremental revenue there that you had anticipated or if you're already ahead on that front also?

Peter Clifford -- President and Chief Operating Officer

Yes, Mitra. This is Peter. Yes, I mean, look, the back to practice procedural kits on the Dental side that we've been bundling a fair amount of Hu-Friedy with prospects as those dental offices reopened, so that's been a pretty big win. But candidly, the growth drivers are still the same. The IMS setups are progressing. Although our new build facilities have obviously slowed with COVID, but those compliance bundles, the Harmony Scaler we just launched in the month of October, so we had minimal sales in October. But we're excited about what that brings for the rest of the year. Obviously, the surface disinfectants along with PPE has been huge. And then we continue to lean into the GreenLight as a key sterility assurance vehicle to move the whole business forward.

Mitra Ramgopal -- Sidoti -- Analyst

Okay. No, that's great. Thanks. And as it relates to the face masks, face shields, etc. I was wondering if you have any restrictions given the federal subsidies in terms of being able to sell more outside of the U.S.?

Peter Clifford -- President and Chief Operating Officer

No, there is minimal handcuffs on that. We just need to keep that capital actually in the United States. It's pretty much the main requirement on the machines, on the four machines that we got assistance from the U.S. Government on. And it's a similar profile on the two machines that we got in Italy. We need to maintain the capital there, but we can manufacture and export as much product as we need to.

Mitra Ramgopal -- Sidoti -- Analyst

Okay. No, that's great. And as it relates to, I believe you mentioned, we should be expecting some incremental headcount coming on as you go to business. Where do you stand on the salesforce front, especially given the push -- increasing push into ASCs and just building up the business going forward?

Peter Clifford -- President and Chief Operating Officer

Yes. I mean, even during the shutdown here, we protected the investment on the sales side, especially on the medical piece. So, we are staffed now. I think we've mentioned in the opening remarks, we are down. Basically, there's one open position on the inside sales, but we've got that up and running in the first quarter. That team got their first orders in the month of October, really both capital and procedural products here. So, we feel really good that we're positioned as we hit the back half of the year that we've got not only a highly motivated sales team, but no open positions and everybody again trained and ready to roll.

Mitra Ramgopal -- Sidoti -- Analyst

Okay. Thanks. And then finally on Life Sciences, a little later than I was looking for. What is your best sense in terms of when you expect that to sort of flatten out?

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

Look, it's fairly flat sequentially from 4Q to 1Q. And I would look at the next two quarters and probably say revenue is going to look pretty close to the first quarter in terms of the sort of trading sideways from a revenue perspective. We've seen the backlog kind of stabilize and level off.

This is usually the slowest time of the year, November and December, from an order intake perspective on centrals. As you can imagine, there is not lots of folks wanting to go do new builds in the middle of the winter. So for us, usually the order intake machine starts to accelerate late January and that's kind of how we see the market as orders that we've taken in February and March, because the lead time are not going to shift until the late spring, early summer. And so that's probably how I think about sort of the revenue trajectory.

Mitra Ramgopal -- Sidoti -- Analyst

Okay. Thanks. And then finally just one housekeeping question, I believe, on the interest expense line. I think there was an item that was included in there, some non-cash interest expense. I was just wondering what that amount was, if you had it?

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

Little less than I think about $1.8 million or so. And that's related to the accounting for the convertibles. It's a non-cash item, to your point.

Mitra Ramgopal -- Sidoti -- Analyst

Okay. Okay. Perfect. Thanks again for taking the questions.

Operator

We'll take our next question from Michael Cherny with Bank of America. Please go ahead.

Michael Cherny -- Bank of America -- Analyst

Thanks so much. One just quick clarification, Shaun. You mentioned you expected gross margin expansion to continue. Just wanted to know is that off of the 1Q levels, or is this based on last year, expecting year-over-year gross margin expansion?

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

It would be in reference -- and the best quarter again would be our second quarter of '20, looking at us as a whole with Q3 and fully. So it would be referenced to that. I mean, obviously, Q1 itself, there is a little bit of mix sales in terms of the capital versus consumables mix that will alter going forward. But relative to those volumes and mix, we do expect margin expansion year-over-year.

George L. Fotiades -- Chief Executive Officer

Mike, we refer to our fiscal year '20 second quarter because it was the last pre-COVID quarter.

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

Yes.

Michael Cherny -- Bank of America -- Analyst

That rate, to be clear, it was like 47.1.

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

Yes, it was 47.1. So again, if you want to think about, in general, we'd be targeting around 50 basis point expansion on top of that, maybe a little bit better. That would be a good way to think about it.

Michael Cherny -- Bank of America -- Analyst

Okay. That's a very helpful clarification. And then, I guess, maybe to pull on the mask question and the PPE dynamic infection prevention they're doing within the dental markets. As dentists continue to think about reformatting their workflows, you gave some color around how much they are going to switch out masks. How much are they coming to you in terms of having that strategic discussion to make sure that they are appropriately sourced, especially at a time where there is -- there are some other mask manufacturers that have high levels of quality, but you're also fighting a battle of third-party black market, whatever you want to call it, challenges? And how early, whether it's with mask or some of the other PPE, can you get into those conversations to make it more strategic type sales versus some of the rush demand that you're likely still seeing across the market?

Peter Clifford -- President and Chief Operating Officer

Yes, that's a good question, Michael. I mean, look, we are having those conversations with the larger channel partners. You could think of it is almost getting into a position where ultimately we have dedicated machines and capacity that folks are definitely thinking about how they source strategically differently than they used to. Much of the last five years to 10 years has been just get the cheapest product. And obviously, there's been a sea change on that in terms of people wanting to make sure that they've got multiple sources and ideally, multiple sources with capacity in North America and not getting caught again from an exposure perspective where the entire supply chain that they are buying from was in APAC.

So, we do think there are opportunities to bundle long term and enter long-term relationships and commitments on masks and face shields specifically.

Michael Cherny -- Bank of America -- Analyst

And if I could just -- one more follow-up to that. I apologize if I missed this before. Can you give us a sense of dynamics within that area of pricing that you've seen across your customer base?

Peter Clifford -- President and Chief Operating Officer

Yes, I mean, ultimately, we only change our pricing once a year. So there isn't -- the channel partners, obviously, are able to change their pricing real-time to the market, which I'm sure that they've done. If we've gotten any real benefit, I think, I would categorize it as we have pushed our branded masks very heavily, obviously, the pricing and the margin profile is a bit higher on the branded versus private label. So, from our perspective, our main benefit is really insisting or pushing more forcefully here the branded products.

Michael Cherny -- Bank of America -- Analyst

Got it. Thanks so much.

Peter Clifford -- President and Chief Operating Officer

Yes.

Operator

And this concludes our question-and-answer session. George, we'll turn the floor back to you now for final remarks.

George L. Fotiades -- Chief Executive Officer

All right. Thank you very much for listening and participating today, and we look forward to speaking with you on our second quarter call. Thanks.

Operator

[Operator Closing Remarks]

Duration: 61 minutes

Call participants:

Matthew C. Micowski -- Vice President, Financial Planning & Analysis and Investor Relations

George L. Fotiades -- Chief Executive Officer

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

Peter Clifford -- President and Chief Operating Officer

Seth Yellin -- Executive Vice President, Strategy and Corporate Development

Matthew Mishan -- KeyBanc -- Analyst

Larry Keusch -- Raymond James -- Analyst

Mike Matson -- Needham & Company -- Analyst

Larry Solow -- CJS Securities -- Analyst

Mitra Ramgopal -- Sidoti -- Analyst

Michael Cherny -- Bank of America -- Analyst

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