Cantel Medical Corp (CMD) Q4 2020 Earnings Call Transcript

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Cantel Medical Corp (CMD)
Q4 2020 Earnings Call
Mar 9, 2021, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to the Cantel Second Quarter 2021 Earnings Call. At this time, all participants have been placed on a listen-only mode and the floor will be opened for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Ryan Lada. Sir, the floor is yours.

Ryan Lada -- Vice President, Investor Relations

Thank you and 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 second quarter of the 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 will now turn the call over to George.

George L. Fotiades -- Chief Executive Officer

Good morning. Our performance in the second quarter was strong and we saw sustained demand at heightened levels for our infection prevention and control solutions in both our Medical and Dental segments.

Our financial results this quarter exceeded our expectations as strength in our recurring revenue categories and new products drove top line performance, while volume leverage and continued operating discipline delivered strong earnings performance. This outperformance was also made possible by the diligence and commitment of our employees, which has enabled continual service to our customers and ultimately their patients from the very beginning of the pandemic. We thank our 3,700 employees globally for their dedication to our Cantel mission.

Consistent with my comments last quarter, we again outperformed underlying elective procedure volume globally in our second quarter. Based on independent third-party data, we estimate that in our second quarter through January 31st, U.S. endoscopy procedures were down 10% to 12% versus a year ago. We saw procedure volumes in November and December consistent with earlier fall levels with a larger drop in volumes in January, driven by the post holiday surge in COVID cases.

During the same time, Medical recurring revenue products, categories that most closely parallel endoscopy procedure volumes, performed much better than procedures, and we were down 2.8% versus a year ago. In fact, sequentially from our first quarter with four fewer business days, we actually saw a modest uptick in our day rate for these products.

Similarly in Dental, we estimate U.S. dental procedures were down 10% to 15% versus the prior year, while our Dental business during the same period was up over 4% organically in the U.S. The continued outperformance of our business compared to the underlying procedure volume trends indicates continued market adoption of our infection prevention solutions and demonstrates the strength and value of the critical products we bring to our customers on a daily basis.

In the quarter, we continue to make progress on our Cantel 2.0 growth initiatives. In Europe, commercial excellence remains a key initiative, and we saw the European team deliver an outstanding performance. While we estimate that European endoscopy procedures were down 15% to 20% across the region year-over-year, we saw our recurring revenue products grow 5% organically versus year ago on an FX-neutral basis, especially on our higher margin recurring revenue products.

We are extremely encouraged by the results and traction we are now seeing in this region. We are particularly excited with the performance of our new products, which includes SCOPE BUDDY PLUS, the DEFENDO Cleaning Adapter and HuFriedy's Harmony Ergonomic Scalers. Demand for these important products enable the Company to continue to gain share of wallet in what we refer to as the complete circle of protection.

In addition, our surgery center and key account director initiatives are showing strong momentum, and we anticipate they will contribute to further growth in the back half of fiscal year '21.

Finally, our Life Sciences business performed consistent with the ongoing objective of delivering stable operating profit and strong cash flows. The bottom line is that we believe the combination of early progress on Cantel 2.0 initiatives and new products are helping us outperform underlying procedures. They are enabling our customers to treat patients safely and efficiently by adopting Cantel's infection prevention and control solutions, at a time of heightened sensitivity.

Simply put, we expect to see continued benefit from these initiatives over the back half of fiscal year '21, leading us to emerge from the pandemic a stronger Company. In our second quarter, we again benefited from our focus on operational rigor and discipline, our daily management, strategic resourcing and expense control coupled with favorable product mix and volume leverage enabled us to exceed our profit expectations for the quarter.

As you may recall, last quarter, we provided updated guidance of exiting fiscal year 2021 at a 22%-plus EBITDAS margin. Given our execution so far we're even more confident in our ability to achieve this guidance. This EBITDAS guidance already factors in a return to more normalized operating expense in the remainder of the fiscal year 2021. Looking at our third quarter, which began February 1st, so far, our Medical and Dental segments continued to perform well.

As I pointed out earlier, we saw some procedural softness in January versus November and December, which continued in early February as several large U.S. health systems suspended elective procedures with the increase in COVID rates after the New Year. These systems have mostly returned to elective procedures, and with that, order rates have followed. With the sustained rollout of the vaccine, we expect to see improvement in procedure volumes and likely a return to 100% exiting our fiscal year.

Regardless of the underlying market dynamics, we remain confident in our ability to outperform underlying procedure volumes. We also believe the need for enhanced infection prevention solutions will continue long into the future, driven by now embedded clinical point of care protocols, enhanced compliance with regulatory requirements, and professional association guidelines. We previously announced on January 12th, 2021 that Cantel and STERIS had entered into a definitive agreement to merge these two great companies.

Since that time, we have been making steady progress on addressing the necessary steps to consummate this transaction. The merger agreement was submitted in January and STERIS filed a registration statement on March 2nd, which included a preliminary version of the proxy. Shaun will speak to you fully on our financials in a moment, but it is worth noting that given our continued strong performance in cash generation, we have again accelerated our debt repayment. Earlier this month, we paid down our revolver by an additional $50 million, bringing our total debt pay down to $175 million so far in fiscal 2021.

This met the higher end of our revised guidance for $155 million to $175 million in total debt pay down in all of fiscal 2021 that Shaun provided on our first quarter earnings call. We will continue to evaluate opportunities to further improve our balance sheet in the back half of fiscal 2021.

So with that, I'll turn it over to 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 Q&A. Net sales increased 1.9% year-over-year in the second quarter '21 versus prior year and 1.1% on a constant currency basis. The FX impact was 0.8% and organic growth was 1.1%. This significantly exceeded our Q2 expectations as we continue to see elevated demand for our infection prevention products in both Medical and Dental.

The Medical segment increased by 0.1% on an organic basis in the quarter. On a constant currency basis, capital equipment decreased 5% with recurring revenue increasing 1% in the period versus the prior year. It is important to note that while capital sales were down versus the prior year, we still maintained a robust backlog throughout the quarter, representing continued strong underlying demand.

While endoscopy procedures have stabilized near our first quarter levels, we are pleased that we continue to outperform the market in our recurring revenue categories. The Dental segment grew 4.3% on an organic basis, primarily driven by modest improvement in underlying dental procedures, combined with continued demand for infection prevention products in the dental market, inclusive of PPE and disinfectant chemistries.

Life Sciences declined negative 8% on an organic basis, primarily due to lower portable reverse osmosis machine sales. As in the first quarter, this decrease was primarily driven by a strong increase in demand in the latter half of fiscal 2020 for our portables, as customers requested these units during the height of the pandemic. Sequentially, from our first quarter of fiscal 2021 we showed growth of positive 1.4%.

In the Dialysis segment, we saw organic growth of 35.6% primarily driven by favorable comps due to prior year production delays. Turning to consolidated margins, our GAAP gross margins increased by 640 basis points to 48.8% versus 42.4% in the second quarter 2020, while non-GAAP gross margins increased by 190 basis points year-over-year to 49%.

The expansion was driven by increased volumes combined with continued discipline in managing manufacturing costs. Favorable mix contributed due to higher sales of consumable products. With these volume levels and continued operating discipline, we believe we will continue to operate at an expanded margin profile over the prior year.

GAAP op profit increased 316.4% year-over-year to $31.6 million. On a non-GAAP basis, op profit increased 30% year-over-year to $58.6 million. Our cost discipline around discretionary spend is ongoing, and we will continue to take a cautious approach with opex given the ongoing uncertainty surrounding COVID. We still expect opex to modestly increase each quarter stabilizing around $90 million to $95 million run rate by Q4 depending on volumes.

Moving to tax rates, GAAP effective tax rate for the quarter was a provision of 25.2% as compared to the prior year benefit of 14.7%. The current year provision is driven by our geographic mix of income and partially offset by the unfavorable impact associated with our stock-based compensation expense. The prior year income tax benefit was primarily driven by our pre-tax loss that quarter and was offset by period costs related to the Hu-Friedy acquisition. The non-GAAP effective tax rate came in at 25% as compared to the prior year rate of 25.9%. This decrease was driven by geographic income mix.

As a result, our GAAP EPS increased year-over-year to $0.27. Non-GAAP EPS increased 29.5% year-over-year to $0.79. And finally, adjusted EBITDAS came in at $71 million, up 27.3% year-over-year. Cash flow from operations for the quarter came in at $47.7 million, an increase of 152.1% year-over-year, and we ended the quarter with $243.1 million in cash. Working capital decreased 5% sequentially to $403.5 million, primarily driven by a small decline in cash on hand from repaying our revolver. Accounts receivable was flat, inventory increased 4%, and accounts payable increased 16%, all on a sequential basis.

In addition, capex was $11.5 million this quarter, an increase from Q1 to what should be a more normal run rate to our capex. With our $50 million of debt pay down early in the quarter, gross debt ended the quarter at $988.4 million, while net debt was $745.3 million. Our net debt to adjusted EBITDAS ratio was 3.49 times. We continue to drive operating and working capital improvements. During the last quarter call, we updated our guidance to pay down $155 million to $175 million in fiscal year 2021.

Given our continued strong performance and cash position through the second quarter, we offered to pay down another $50 million of our revolver in March, bringing our total debt paydown to $175 million year-to-date, meeting the high end of our revised fiscal year 2021 guidance in our first eight months. We expect a similar operating cash flow profile through the remainder of our fiscal year 2021 with some potential variability driven by the timing of tax payments and expected refunds from the CARES Act.

However, I also expect some increased outflows in the latter half of this year due to acquisition earn-outs and merger-related expenses. Although, we are not going to provide formal guidance, I do want to provide some color on our Q3 expectations. We expect Q3 revenue to remain relatively flat to modestly up sequentially to our somewhat stronger than expected Q2.

Early February started off a bit soft following the post holiday surge in COVID cases, but that was short-lived. As we exited February, we saw a return to stronger order rates and expect to see ongoing improvements through Q3. In aggregate, however, we are still seeing and expect the same picture we laid out last quarter on a year-to-date basis with a procedure recovery trajectory continuing through our Q3 and reaching 100% in Q4.

As previously guided, we continue to expect to see a modest ramp up in operating expense for the rest of the fiscal year. As previously stated, we will continue to maintain strict operating discipline and prepare for any unexpected fluctuations in procedure recovery due to COVID. We feel confident that we will meet or exceed our Q4 exiting guidance of 22% plus EBITDAS. As a reminder, we will be filing our 10-Q by the end of this week. I'll now hand it back over to George for closing remarks.

George L. Fotiades -- Chief Executive Officer

Thanks, Shaun. Let me sum up by saying that the key takeaway for this past quarter is that we are continuing to execute both commercially and operationally. This execution coupled with increased underlying procedures and our initiatives will position us to continue to outperform the market and deliver continued financial performance.

Before we get into the Q&A, I did want to highlight that for the purposes of this call, we will only be taking questions regarding Cantel's financial performance that we are reporting on today, and will not be taking questions concerning the announced transaction with STERIS. As mentioned previously, STERIS has recently filed a Form S-4 registration statement and that filing contains considerable information about the transaction, and we would refer you to this filing for information regarding the transaction.

With that, we're now happy to answer any questions about our earnings release or performance.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, the floor is now open for questions. [Operator Instructions]. Our first question today is coming from Matt Mishan. Your line is live.

Matthew Mishan -- KeyBanc -- Analyst

Hey, good morning and thank you for taking the questions, and you guys are clearly not nailing anything in here. So two questions, the first one I have is, the procedures that were put off in January and February, is the tick back up you're seeing now, the quick pick up, was that because those were rescheduled procedures that were just put off and there was a backlog of people to get to as like a catch-up. And then I'll ask my second one, the capital equipment backlog that's been built up, I'm just curious if that's new demand from your initiatives or catch-up from the previous year?

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

Yeah, Matt, let me take the capital question here. Look, we've been pretty aggressive here for the last six to nine months in terms of some programs targeting capital. So our win rate on capital has been north of our traditional hit rate, and we expect to see much of that backlog ship in the back half of this year. So, as you know, our first half of the year, we saw modest headwinds from the prior year. We would expect capital growth to be positive in the back half of '21.

George L. Fotiades -- Chief Executive Officer

Matt, with -- this is George. With respect to the procedures question you asked, look, it's hard for us to know in the data that we collected of people who were having scheduled starting in that particular data whether it's carry over, the thing we know about colonoscopy is that people -- this is not like a missed cleaning or a dental appointment, people need to get the colonoscopy done. So there's clearly catching up that's happening in addition to new ones that are being scheduled.

But what we track -- now, we're able to track, let's say in the aggregate well as understand the difference it's occurring between IDNs and surgery centers, but it's difficult for us to track -- we're not asking people individually whether they're rescheduled brand new. But we obviously know lot of reschedules are going on, as people try to catch up with the -- with the, what they may have had basically been asked by their gastroenterologist to get it done or some other way that they had to -- have it previously scheduled. But we can't discern between whether it's new or rescheduled.

Matthew Mishan -- KeyBanc -- Analyst

All right. Thank you very much.

Operator

Thank you. Our next question today is coming from Larry Keusch. Your line is live.

Lawrence Keusch -- Raymond James -- Analyst

Thank you. Good morning, everyone. Had a couple of questions here. First, I guess George for you. As was indicated on the call, you anticipate procedures being back at 100%, and you articulated in the fourth quarter. I guess, I'm just curious you know, COVID still remains fairly dynamic, the vaccine rollout, variance, second -- maybe a fourth surge. So what kind of gives you confidence that you'll be back at a 100%, because your fourth quarter ends in July, so that's -- that's not too many more months from here? So just wanted to get your thoughts there.

George L. Fotiades -- Chief Executive Officer

I think what we said Larry, if my memory serves me right that we exit the fourth quarter, so we're talking about July 31st or heading into August. I mean, we don't have any guarantee, I mean, we're obviously, we know there's going to be a high correlation with vaccinations obviously, and as those continue to gain traction, that's improvement. Obviously, we've seen improvement even amid COVID from the low levels to where we're at today.

So we're tracking in 90%, at one point, we were 50% and we're at 90% today, and call it that and vaccinations were only perhaps barely a 20% of the population. So I think as the vaccinations get to 50%, 60%, 70%, we think the 90% will continue to push toward 100%, exactly what data falls [Phonetic] we obviously don't have that kind of precision.

But I think we're feeling pretty confident given where they're at today and where the vaccination levels are at that the correlation continue to drive these things closer to 100%, as vaccination percentages increase.

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

I'd just add on, Larry. In February, we were looking at Dental bookings and the data coming out of the back half of February is really probably the strongest that we've heard about or seen in the industry as folks are certain to finally book more of the hygienists appointments. So we're expecting April and May and June and July to be pretty strong or at least probably the peak that we've seen in the last six to nine months.

Lawrence Keusch -- Raymond James -- Analyst

Okay. That's super helpful. Two other ones, I'll just ask them upfront. How do we think about the changes in infection control and prevention protocols that have been put in place both in GI suites, particularly in ASCs and in dental offices, when do those sort of start to lap and you lose some of the benefit of those enhanced protocols? So that's question one, kind of when do those anniversary.

And then secondly, the dental operating margin if I got this right declined sequentially from 30.6% to 26.3%, that's obviously still north of that 25% bogie that you had. But what drove that sequential decline? And how do we think about the ability to now maintain the stability that Dental operating margin are above that 25% rate.

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

So this is Seth. With regard to the lapping of the IP&C procedures, I mean, I think the way to think about it is last spring we certainly saw the slowdown and shutdown of elective procedures, and during that time until sort of mid-summer, practices were largely either shuttered or on very low volumes and they were educating themselves in revising protocols and kind of emerged in the mid-summer timeframe, late summer timeframe, starting to utilize enhanced IP&C protocols and processes.

That said, I think that the volume growth that you will see on top of that, because those remained at very low levels of overall volumes will continue to increase. So I don't know if it's necessarily will be a headwind in the immediate planning period, but certainly we saw adoption of higher standards of IP&C in sort of the late summer, early fall timeframe despite the lower volume levels that were occurring.

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

And regarding the Dental margins, Larry, this is Shaun, you know, listen, we had always said we see that we had 25% plus type business and as we alluded to in the Q1 call, Q1 was really just kind of an unusual positive in terms of all the things that we had going for us in the expenses that were held back due to a lot of COVID related as well as just kicking off the year, and again, as we've kind of alluded to, and not surprisingly, we do expect a steady increase of an operating expense as well as some mix shift right that would be driving that margin down a little bit sequentially from the high point that we saw in Q1.

So we -- our viewpoint is like, look, it's still very, very healthy margins we're seeing out of there. It's really just a combination of some expenses coming back in to Q2 sequentially and a little bit of mix shift that can go either way in each quarter. And quite frankly to Peter's point, right, as you see a lot of kind of like the quarter, hygiene did ramp back up, maybe relative to some of the other stuff that was going like Dental, that's going to continue to drive to higher margin portion of our portfolio as well.

So we still view that as a very healthy business and sustainable at 25% plus.

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

Okay. Great. Thanks guys. Appreciate it.

George L. Fotiades -- Chief Executive Officer

Thanks.

Operator

[Operator Instructions]. Our final question for today is coming from Mike Matson. Your line is live.

Mike Matson -- Needham & Company -- Analyst

Good morning, thanks for taking my questions. I wanted to ask about the difference that you're seeing between your sales growth and the actual procedure growth. So in Dental and Medical, it looks like procedures were down 10%-plus based on the third-party data that you quoted. You were flat to up in both of those businesses. So what's driving that differential? Is it just increased utilization of infection prevention products? And is that something -- is that differential sustainable, in other words, the volume growth, procedure volume growth picks back up, do you think you can continue to outpace the procedure volume by similar amount?

George L. Fotiades -- Chief Executive Officer

Yeah, Mike. There is a couple of pieces there. As it relates to the Medical business as an example of where we're executing beyond sort of the tailwind of IP&C compliance, as you're aware, we started to really make some right hand turns on our EMEA business as an example, over the last nine months, really driving commercial excellence into that region. And if you take a step back, we view Europe this past quarter is probably closer to that 85% to 90% and that business was basically flat to up a couple of points. And at the end of the day, our consumable business as well as our chemistry in this current quarter was nearly double-digit.

So we expect to start putting points on the board in EMEA in the back half of '21. I'm not surprised that we started to see some of that hit in 2Q as well as our ASC story is gaining traction. We feel like we're positioned really well to deliver and put points on the board in the second half of the year as we had committed to earlier. So that's a little bit of [Indecipherable] points on the Medical piece, and on the Dental side, obviously, the IP&C story there is really resonating as well as we've launched the Ergo designed Harmony Scaler at the right time hitting the market, which has obviously given us some tailwind as well.

Mike Matson -- Needham & Company -- Analyst

Okay, thanks. And, I did want to also ask about ASC. So just wondering if you could give us an update on the progress there, the new sales force. And also, do you have a feel for the overall portion of the endoscopy procedures that you're targeting, that are done in ASC as well [Phonetic] as the hospitals?

George L. Fotiades -- Chief Executive Officer

Yeah, Mike, we're still refining what that product portfolio is that's best fitted there. We're getting lots of positive feedback from the space. It continues to influence our value proposition tools that we're developing. We're highly confident that we can start to deliver some differentiated growth there in the back half of this year. We've seen a strong start to capital bookings that was part of the story in the first half of the year where the backlog build is -- are more aggressive stance, and direct committed sales force that's in the channel right now is having some success immediately on capital, and we're continuing to refine that consumable and chemistry story as well.

Mike Matson -- Needham & Company -- Analyst

Okay, great. Thank you.

Operator

Thank you. That's all the time we have for Q&A today. Do you have any closing comments you'd like to finish with?

George L. Fotiades -- Chief Executive Officer

Yeah. First, I'd thank everybody for being on the call today. Obviously, we're very pleased with our results and continue to believe that Cantel with our unique portfolio of products and infection prevention control is going to continue to outperform procedures, and I think as well we expect there to be longevity to our story as these things become part of the natural protocol in dental offices and endoscopy suites as well.

So with that, we thank you for being on the call.

Operator

[Operator Closing Remarks].

Duration: 31 minutes

Call participants:

Ryan Lada -- Vice President, Investor Relations

George L. Fotiades -- Chief Executive Officer

Shaun Blakeman -- Senior Vice President and Chief Financial Officer

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

Matthew Mishan -- KeyBanc -- Analyst

Lawrence Keusch -- Raymond James -- Analyst

Mike Matson -- Needham & Company -- Analyst

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