UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
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| For the quarterly period ended January 31, 2007. | |
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| or | |
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| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period from to .
Commission file number: 001-31337
CANTEL MEDICAL CORP.
(Exact name of registrant as specified in its charter)
Delaware |
| 22-1760285 |
(State or other jurisdiction of |
| (I.R.S. employer |
incorporation or organization) |
| identification no.) |
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150 Clove Road, Little Falls, New Jersey |
| 07424 |
(Address of principal executive offices) |
| (Zip code) |
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Registrant’s telephone number, including area code (973) 890-7220 | ||
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Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Large accelerated filer o |
| Accelerated filer x |
| Non-accelerated filer o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Number of shares of Common Stock outstanding as of February 28, 2007: 15,505,760.
PART I—FINANCIAL INFORMATION
ITEM 1.—FINANCIAL STATEMENTS
CANTEL MEDICAL CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollar Amounts in Thousands, Except Share Data)
(Unaudited)
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| January 31, |
| July 31, |
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| 2007 |
| 2006 |
| ||
Assets |
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Current assets: |
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Cash and cash equivalents |
| $ | 16,726 |
| $ | 29,898 |
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Accounts receivable, net of allowance for doubtful accounts of $1,000 at January 31 and $929 at July 31 |
| 26,570 |
| 23,718 |
| ||
Inventories: |
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Raw materials |
| 10,548 |
| 9,692 |
| ||
Work-in-process |
| 3,942 |
| 3,717 |
| ||
Finished goods |
| 11,557 |
| 10,533 |
| ||
Total inventories |
| 26,047 |
| 23,942 |
| ||
Deferred income taxes |
| 1,397 |
| 1,481 |
| ||
Prepaid expenses and other current assets |
| 2,876 |
| 1,288 |
| ||
Assets of discontinued operations |
| 91 |
| 2,121 |
| ||
Total current assets |
| 73,707 |
| 82,448 |
| ||
Property and equipment, net |
| 38,430 |
| 38,104 |
| ||
Intangible assets, net |
| 40,821 |
| 43,219 |
| ||
Goodwill |
| 72,157 |
| 72,571 |
| ||
Other assets |
| 1,755 |
| 1,885 |
| ||
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| $ | 226,870 |
| $ | 238,227 |
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Liabilities and stockholders’ equity |
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Current liabilities: |
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Current portion of long-term debt |
| $ | 5,000 |
| $ | 4,000 |
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Accounts payable |
| 9,284 |
| 8,062 |
| ||
Compensation payable |
| 4,187 |
| 4,120 |
| ||
Earnout payable |
| — |
| 3,667 |
| ||
Accrued expenses |
| 6,584 |
| 7,633 |
| ||
Deferred revenue |
| 1,750 |
| 1,859 |
| ||
Income taxes payable |
| — |
| 2,377 |
| ||
Liabilities of discontinued operations |
| 347 |
| 7,379 |
| ||
Total current liabilities |
| 27,152 |
| 39,097 |
| ||
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Long-term debt |
| 31,000 |
| 34,000 |
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Deferred income taxes |
| 21,998 |
| 22,021 |
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Other long-term liabilities |
| 2,436 |
| 2,304 |
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Stockholders’ equity: |
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Preferred Stock, par value $1.00 per share; |
| — |
| — |
| ||
Common Stock, par value $.10 per share; authorized 30,000,000 shares; January 31 — 16,445,889 shares issued and 15,502,759 shares outstanding; July 31 — 16,149,489 shares issued and 15,399,102 shares outstanding |
| 1,645 |
| 1,615 |
| ||
Additional capital |
| 72,015 |
| 69,171 |
| ||
Retained earnings |
| 73,633 |
| 69,395 |
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Accumulated other comprehensive income |
| 5,722 |
| 6,715 |
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Treasury Stock, at cost; January 31 — 943,130 shares; |
| (8,731 | ) | (6,091 | ) | ||
Total stockholders’ equity |
| 144,284 |
| 140,805 |
| ||
|
| $ | 226,870 |
| $ | 238,227 |
|
See accompanying notes.
1
CANTEL MEDICAL CORP.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollar Amounts in Thousands, Except Per Share Data)
(Unaudited)
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| Three Months Ended |
| Six Months Ended |
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| January 31, |
| January 31, |
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| 2007 |
| 2006 |
| 2007 |
| 2006 |
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Net sales: |
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Product sales |
| $ | 46,263 |
| $ | 43,300 |
| $ | 91,534 |
| $ | 87,141 |
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Product service |
| 5,372 |
| 4,040 |
| 10,585 |
| 8,011 |
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Total net sales |
| 51,635 |
| 47,340 |
| 102,119 |
| 95,152 |
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Cost of sales: |
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Product sales |
| 27,835 |
| 27,522 |
| 55,712 |
| 54,564 |
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Product service |
| 4,279 |
| 2,980 |
| 8,717 |
| 5,789 |
| ||||
Total cost of sales |
| 32,114 |
| 30,502 |
| 64,429 |
| 60,353 |
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Gross profit |
| 19,521 |
| 16,838 |
| 37,690 |
| 34,799 |
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Expenses: |
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Selling |
| 5,729 |
| 4,114 |
| 11,439 |
| 8,627 |
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General and administrative |
| 8,058 |
| 7,268 |
| 15,596 |
| 14,488 |
| ||||
Research and development |
| 1,222 |
| 1,415 |
| 2,388 |
| 2,635 |
| ||||
Total operating expenses |
| 15,009 |
| 12,797 |
| 29,423 |
| 25,750 |
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Income from continuing operations before |
| 4,512 |
| 4,041 |
| 8,267 |
| 9,049 |
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Interest expense |
| 759 |
| 1,082 |
| 1,522 |
| 2,332 |
| ||||
Interest income |
| (160 | ) | (149 | ) | (450 | ) | (361 | ) | ||||
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Income from continuing operations before |
| 3,913 |
| 3,108 |
| 7,195 |
| 7,078 |
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Income taxes |
| 1,661 |
| 1,234 |
| 3,220 |
| 2,986 |
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Income from continuing operations |
| 2,252 |
| 1,874 |
| 3,975 |
| 4,092 |
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Income from discontinued operations, |
| 18 |
| 2,191 |
| 263 |
| 3,851 |
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Loss on disposal of discontinued |
| — |
| (136 | ) | — |
| (268 | ) | ||||
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Net income |
| $ | 2,270 |
| $ | 3,929 |
| $ | 4,238 |
| $ | 7,675 |
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Earnings per common share: |
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Basic: |
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Continuing operations |
| $ | 0.15 |
| $ | 0.12 |
| $ | 0.26 |
| $ | 0.26 |
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Discontinued operations |
| — |
| 0.14 |
| 0.01 |
| 0.25 |
| ||||
Loss on disposal of discontinued |
| — |
| (0.01 | ) | — |
| (0.01 | ) | ||||
Net income |
| $ | 0.15 |
| $ | 0.25 |
| $ | 0.27 |
| $ | 0.50 |
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Diluted: |
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Continuing operations |
| $ | 0.14 |
| $ | 0.11 |
| $ | 0.25 |
| $ | 0.25 |
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Discontinued operations |
| — |
| 0.14 |
| 0.01 |
| 0.23 |
| ||||
Loss on disposal of discontinued |
| — |
| (0.01 | ) | — |
| (0.01 | ) | ||||
Net income |
| $ | 0.14 |
| $ | 0.24 |
| $ | 0.26 |
| $ | 0.47 |
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See accompanying notes.
2
CANTEL MEDICAL CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar Amounts in Thousands)
(Unaudited)
|
| Six Months Ended |
| ||||
|
| January 31, |
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| 2007 |
| 2006 |
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Cash flows from operating activities |
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Net income |
| $ | 4,238 |
| $ | 7,675 |
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Adjustments to reconcile net income to net |
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Depreciation and amortization |
| 4,816 |
| 5,524 |
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Stock-based compensation expense |
| 415 |
| 678 |
| ||
Amortization of debt issuance costs |
| 171 |
| 170 |
| ||
Loss on disposal of fixed assets |
| 9 |
| 83 |
| ||
Deferred income taxes |
| (26 | ) | (503 | ) | ||
Excess tax benefits from stock-based compensation |
| (423 | ) | (621 | ) | ||
Changes in assets and liabilities: |
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|
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Accounts receivable |
| (2,923 | ) | 1,260 |
| ||
Inventories |
| (2,153 | ) | (3,076 | ) | ||
Prepaid expenses and other current assets |
| (1,590 | ) | (321 | ) | ||
Assets of discontinued operations |
| 2,023 |
| 543 |
| ||
Accounts payable and accrued expenses |
| 226 |
| (3,663 | ) | ||
Income taxes payable |
| (1,832 | ) | (1,112 | ) | ||
Liabilities of discontinued operations |
| (7,007 | ) | 2,069 |
| ||
Net cash (used in) provided by operating activities |
| (4,056 | ) | 8,706 |
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Cash flows from investing activities |
|
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|
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Capital expenditures |
| (2,883 | ) | (1,550 | ) | ||
Proceeds from disposal of fixed assets |
| 11 |
| 143 |
| ||
Acquisition of Crosstex, net of cash acquired |
| (3,667 | ) | (68,114 | ) | ||
Other, net |
| (1 | ) | (9 | ) | ||
Net cash used in investing activities |
| (6,540 | ) | (69,530 | ) | ||
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Cash flows from financing activities |
|
|
|
|
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Borrowings under term loan facility, net of |
| — |
| 39,399 |
| ||
Borrowings under revolving credit facility, net of |
| — |
| 27,635 |
| ||
Repayments under term loan facility |
| (2,000 | ) | (16,750 | ) | ||
Repayments under revolving credit facility |
| — |
| (5,800 | ) | ||
Proceeds from exercises of stock options |
| 1,489 |
| 1,111 |
| ||
Excess tax benefits from stock-based compensation |
| 423 |
| 621 |
| ||
Purchases of treasury stock |
| (2,260 | ) | — |
| ||
Net cash (used in) provided by financing activities |
| (2,348 | ) | 46,216 |
| ||
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Effect of exchange rate changes on cash and |
| (228 | ) | 995 |
| ||
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Decrease in cash and cash equivalents |
| (13,172 | ) | (13,613 | ) | ||
Cash and cash equivalents at beginning of period |
| 29,898 |
| 33,335 |
| ||
Cash and cash equivalents at end of period |
| $ | 16,726 |
| $ | 19,722 |
|
See accompanying notes.
3
CANTEL MEDICAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The unaudited Condensed Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles for interim financial reporting and the requirements of Form 10-Q and Rule 10.01 of Regulation S-X. Accordingly, they do not include certain information and note disclosures required by generally accepted accounting principles for annual financial reporting and should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Annual Report of Cantel Medical Corp. (“Cantel”) on Form 10-K for the fiscal year ended July 31, 2006 (the “2006 Form 10-K”), and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.
The unaudited interim financial statements reflect all adjustments (of a normal and recurring nature) which management considers necessary for a fair presentation of the results of operations for these periods. The results of operations for the interim periods are not necessarily indicative of the results for the full year.
The Condensed Consolidated Balance Sheet at July 31, 2006 was derived from the audited Consolidated Balance Sheet of Cantel at that date.
Cantel had five principal operating companies at each of January 31, 2007 and July 31, 2006. Crosstex International, Inc. (“Crosstex”), Minntech Corporation (“Minntech”), Mar Cor Purification, Inc. (“Mar Cor”), Biolab Equipment Ltd. (“Biolab”) and Saf-T-Pak, Inc. (“Saf-T-Pak”), all of which are wholly-owned operating subsidiaries. In addition, Minntech has three foreign subsidiaries, Minntech B.V., Minntech Asia/Pacific Ltd. and Minntech Japan K.K., which serve as Minntech’s bases in Europe, Asia/Pacific and Japan, respectively.
On July 31, 2006, Carsen Group Inc. (“Carsen”) closed the sale of substantially all of its assets to Olympus America Inc. and certain of its affiliates (collectively, “Olympus”) under an Asset Purchase Agreement dated as of May 16, 2006 among Carsen, Cantel and Olympus, as more fully described in Note 15 to the Condensed Consolidated Financial Statements. As a result of the foregoing transaction, Carsen no longer has any remaining product lines or active business operations. The businesses of Carsen, previously reported in the Endoscopy and Surgical, Endoscope Reprocessing and All Other reporting segments, are reflected as a discontinued operation in our Condensed Consolidated Financial Statements and have been excluded from segment results for all periods presented. Net sales, cost of sales, operating expenses, interest expense and income taxes attributable to Carsen’s operations have been aggregated into a single line, income from discontinued operations, net of tax, on the Condensed Consolidated Statements of Income. Additionally, the assets and liabilities related to the discontinued operations have been segregated from continuing operations in the Condensed Consolidated Balance Sheets.
We currently operate our business through six operating segments: Dental, Dialysis, Water Purification and Filtration, Endoscope Reprocessing, Specialty Packaging and Therapeutic Filtration. The Specialty Packaging and Therapeutic Filtration operating segments are combined in the All Other reporting segment for financial reporting purposes.
4
Throughout this document, references to “Cantel,” “us,” “we,” “our,” and the “Company” are references to Cantel Medical Corp. and its subsidiaries, except where the context makes it clear the reference is to Cantel itself and not its subsidiaries.
Reclassifications
Certain distribution and warehouse expenses of Crosstex have been reclassified from amounts previously reported in our quarterly Form 10-Q’s for fiscal 2006 to conform with the accounting policies of Cantel which require such costs to be classified as cost of sales. These reclassifications affect cost of sales, gross profit and general and administrative expenses of our Dental segment, and therefore our consolidated amounts.
Note 2. Stock-Based Compensation
The following table shows the allocation of total stock-based compensation expense relating to continuing operations recognized in the Condensed Consolidated Statements of Income for the three and six months ended January 31, 2007 and 2006:
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| Three Months Ended |
| Six Months Ended |
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| January 31, |
| January 31, |
| ||||||||
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| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
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Cost of sales |
| $ | 15,000 |
| $ | 10,000 |
| $ | 14,000 |
| $ | 32,000 |
|
Operating expenses: |
|
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|
|
|
|
|
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| ||||
Selling |
| 43,000 |
| 34,000 |
| 69,000 |
| 87,000 |
| ||||
General and administrative |
| 153,000 |
| 203,000 |
| 322,000 |
| 497,000 |
| ||||
Research and development |
| 6,000 |
| 4,000 |
| 10,000 |
| 12,000 |
| ||||
Total operating expenses |
| 202,000 |
| 241,000 |
| 401,000 |
| 596,000 |
| ||||
Stock-based compensation before income taxes |
| 217,000 |
| 251,000 |
| 415,000 |
| 628,000 |
| ||||
Income tax benefits |
| (68,000 | ) | (66,000 | ) | (173,000 | ) | (159,000 | ) | ||||
Total stock-based compensation expense, net of tax |
| $ | 149,000 |
| $ | 185,000 |
| $ | 242,000 |
| $ | 469,000 |
|
For the three and six months ended January 31, 2007, the above stock-based compensation expense before income taxes was recorded in the Condensed Consolidated Financial Statements as stock-based compensation expense and an increase to additional capital. The related income tax benefits (which pertain only to options that do not qualify as incentive stock options) were recorded as an increase to long-term deferred income tax assets (which are netted with long-term deferred income tax liabilities) or a reduction to income taxes payable, depending on the timing of the deduction, and a reduction to income tax expense.
Most of our stock options are subject to graded vesting in which portions of the option award vest at different times during the vesting period, as opposed to awards that vest at the end of the vesting period. We recognize compensation expense for options subject to graded vesting using the straight-line basis, reduced by estimated forfeitures. Total unrecognized stock-based compensation expense related to total nonvested stock options was $1,474,000, net of tax, at January 31, 2007 with a remaining weighted average period of 32 months over which such expense is expected to be recognized. Such unrecognized stock-based compensation expense increased during the three months ended January 31, 2007 due to additional employee stock option grants.
5
On February 1, 2007, the Company granted 150,000 shares of restricted stock to certain of its employees which had a market price $16.25 per share based on the closing price of Cantel stock on that date. Total unrecognized stock-based compensation expense, net of tax, related to this February 1, 2007 grant was approximately $1,332,000 with a weighted average period of 36 months over which such expense is expected to be recognized.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions for options granted during the three and six months ended January 31, 2007 and 2006:
Weighted-Average |
| Three Months Ended |
| Six Months Ended |
| ||||
Black-Scholes Option |
| January 31, |
| January 31, |
| ||||
Valuation Assumptions |
| 2007 |
| 2006 |
| 2007 |
| 2006 |
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Dividend yield |
| 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % |
Expected volatility (1) |
| 0.361 |
| 0.518 |
| 0.371 |
| 0.530 |
|
Risk-free interest rate (2) |
| 4.60 | % | 4.19 | % | 4.61 | % | 4.27 | % |
Expected lives (in years) (3) |
| 4.05 |
| 4.67 |
| 4.06 |
| 4.84 |
|
(1) Volatility was based on historical closing prices of our Common Stock.
(2) The U.S. Treasury rate on the expected life at the date of grant.
(3) Based on historical exercise behavior.
With respect to stock options granted during the three months ended January 31, 2007, we reassessed both the expected option life and stock price volatility assumptions by evaluating more recent historical exercise behavior and stock price activity; such reevaluation resulted in reductions in both the expected option lives and volatility.
Additionally, all options were considered to be non-deductible for tax purposes in the valuation model, except for options granted during the six months ended January 31, 2007 and 2006 under the 1998 Director’s Plan and certain options under the 1997 Employee Plan. Such non-qualified options were tax-effected using the Company’s estimated U.S. effective tax rate at the time of grant. For the three and six months ended January 31, 2007, the weighted average fair value of all options granted was approximately $5.35 and $5.42, respectively. For the three and six months ended January 31, 2006, the weighted average fair value of all options granted was approximately $8.53 and $9.31, respectively. The aggregate intrinsic value (i.e. the excess market price over the exercise price) of all options exercised was approximately $132,000 and $2,224,000 for the three and six months ended January 31, 2007, respectively, and $598,000 and $1,478,000 for the three and six months ended January 31, 2006, respectively.
6
A summary of stock option activity follows:
|
|
| Weighted |
| ||
|
| Number of |
| Average |
| |
|
| Shares |
| Exercise Price |
| |
|
|
|
|
|
| |
Outstanding at July 31, 2006 |
| 2,373,699 |
| $ | 11.98 |
|
Granted |
| 462,000 |
| 15.06 |
| |
Canceled |
| (174,623 | ) | 18.86 |
| |
Exercised |
| (296,400 | ) | 6.45 |
| |
Outstanding at January 31, 2007 |
| 2,364,676 |
| $ | 12.77 |
|
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| |
Exercisable at July 31, 2006 |
| 2,125,735 |
| $ | 12.07 |
|
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| |
Exercisable at January 31, 2007 |
| 1,777,456 |
| $ | 12.31 |
|
Upon exercise of stock options, we typically issue new shares of our Common Stock (as opposed to using treasury shares).
If certain criteria are met when options are exercised or the underlying shares are sold, the Company is allowed a deduction on its income tax return. Accordingly, we account for the income tax effect on such income tax deductions as additional capital (assuming deferred tax assets do not exist pertaining to the exercised stock options) and as a reduction of income taxes payable. For the six months ended January 31, 2007 and 2006, options exercised resulted in income tax deductions that reduced income taxes payable by $611,000 and $829,000, respectively.
We classify the cash flows resulting from excess tax benefits as financing cash flows on our Condensed Consolidated Statements of Cash Flows. Excess tax benefits arise when the ultimate tax effect of the deduction for tax purposes is greater than the tax benefit on stock compensation expense (including tax benefits on stock compensation expense that has only been reflected in the pro forma disclosures) which was determined based upon the award’s fair value.
The following table summarizes additional information related to stock options outstanding at January 31, 2007:
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| Options Outstanding |
| Options Exercisable |
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| Weighted |
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| Weighted |
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| Average |
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| Average |
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| ||||
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| Remaining |
| Weighted |
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| Remaining |
| Weighted |
| ||||
|
| Number |
| Contractual |
| Average |
| Number |
| Contractual |
| Average |
| ||||
Range of Exercise |
| Outstanding |
| Life |
| Exercise |
| Exercisable |
| Life |
| Exercise |
| ||||
Prices |
| At January 31, 2007 |
| (Months) |
| Price |
| At January 31, 2007 |
| (Months) |
| Price |
| ||||
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|
|
|
|
|
| ||||
$2.27 — $3.88 |
| 525,375 |
| 20 |
| $ | 2.97 |
| 525,375 |
| 20 |
| $ | 2.97 |
| ||
$7.62 — $14.83 |
| 899,450 |
| 34 |
| $ | 11.37 |
| 478,730 |
| 22 |
| $ | 9.87 |
| ||
$15.23 — $29.49 |
| 939,851 |
| 40 |
| $ | 19.58 |
| 773,351 |
| 36 |
| $ | 20.16 |
| ||
$2.27 — $29.49 |
| 2,364,676 |
| 33 |
| $ | 12.77 |
| 1,777,456 |
| 27 |
| $ | 12.31 |
| ||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total Intrinsic |
| $ | 11,353,935 |
|
|
|
|
| $ | 10,022,835 |
|
|
|
|
| ||
7
A summary of our incentive equity plans follows:
2006 Incentive Equity Plan
On January 10, 2007, the Company terminated our existing stock option plans and adopted the Cantel Medical Corp. 2006 Incentive Equity Plan (the “2006 Plan”). The 2006 Plan provides for the granting of stock options (including incentive stock options), restricted stock awards, stock appreciation rights and performance-based awards (collectively “equity awards”) to our employees and non-employee Directors. The 2006 Plan does not permit the granting of discounted options or discounted stock appreciation rights. The maximum number of shares as to which stock options and stock awards may be granted under the 2006 Plan is 1,000,000 shares, of which 500,000 shares are authorized for issuance pursuant to stock options and stock appreciation rights and 500,000 shares are authorized for issuance pursuant to restricted stock and other stock awards. At January 31, 2007, no equity awards were granted under this plan; however, 150,000 shares of restricted stock awards were granted to certain employees on February 1, 2007. The 2006 Plan expires on November 13, 2016.
1997 Employee Plan
A total of 3,750,000 shares of Common Stock was reserved for issuance or available for grant under our 1997 Employee Stock Option Plan, as amended, which was terminated on January 10, 2007 in conjunction with the adoption of the 2006 Plan. Options outstanding under this plan:
· were granted at the closing market price at the time of the grant,
· were granted either as incentive stock options or stock options that do not qualify as incentive stock options,
· are usually exercisable in three or four equal annual installments contingent upon being employed by the Company during that period, and
· typically expire five years from the date of the grant.
At January 31, 2007, options to purchase 1,808,176 shares of Common Stock were outstanding under the 1997 Employee Plan. No additional options will be granted under this plan.
1991 Directors’ Plan
A total of 450,000 shares of Common Stock was reserved for issuance or available for grant under our 1991 Directors’ Stock Option Plan, which expired in fiscal 2001. All options outstanding at January 31, 2007 under this plan do not qualify as incentive stock options, have a term of ten years and are fully exercisable. At January 31, 2007, options to purchase 59,625 shares of Common Stock were outstanding. No additional options will be granted under this plan.
1998 Directors’ Plan
A total of 450,000 shares of Common Stock was reserved for issuance or available for grant under our 1998 Directors’ Stock Option Plan, as amended, which was terminated on January 10, 2007 in conjunction with the adoption of the 2006 Plan. Options outstanding under
8
this plan:
· were granted to directors at the closing market price at the time of grant,
· were granted automatically to each newly appointed or elected director to purchase 15,000 shares,
· were granted annually on the last day of our fiscal year to each member of our Board of Directors to purchase 1,500 shares (assuming the individual was still a member of the Board of Directors, 50% are exercisable on the first anniversary of the grant of such options and 50% are exercisable on the second anniversary of the grant of such options),
· were granted quarterly on the last day of each of our fiscal quarters to each non-employee director who attended that quarter’s regularly scheduled Board of Directors meeting to purchase 750 shares (100% are exercisable immediately),
· have a term of ten years if granted prior to July 31, 2000 or five years if granted on or after July 31, 2000, and
· do not qualify as incentive stock options.
At January 31, 2007, options to purchase 265,125 shares of Common Stock were outstanding under the 1998 Directors’ Plan. No additional options will be granted under this plan.
Non-plan options
We also have 231,750 non-plan options outstanding at January 31, 2007 which have been granted at the closing market price at the time of grant and expire up to a maximum of ten years from the date of grant. These non-plan options do not qualify as incentive stock options.
Note 3. Acquisitions
Crosstex
On August 1, 2005, we acquired Crosstex, a privately held company founded in 1953 and headquartered in Hauppauge, New York. Crosstex is a leading manufacturer and reseller of single-use infection control products used principally in the dental market. Crosstex products include face masks, patient towels and bibs, self-sealing sterilization pouches, tray covers, sterilization packaging accessories, surface barriers including eyewear, aprons and gowns, disinfectants and deodorizers, germicidal wipes, hand care products, gloves, sponges, cotton products, cups, needles and syringes, scalpels and blades, and saliva evacuators and ejectors.
Under the terms of Stock Purchase Agreements with the five stockholders of Crosstex, pursuant to which we acquired all of the issued and outstanding capital stock of Crosstex, we paid an aggregate purchase price (excluding any earnout) of approximately $77,863,000, comprised of approximately $69,843,000 in cash consideration and 384,821 shares of Cantel common stock (valued at $6,737,000) to the former Crosstex shareholders, and transaction costs of $1,283,000. The purchase price included the retirement of bank debt and certain other liabilities of Crosstex. Of this purchase price, $2,900,000 was held in escrow for a period of eighteen months from the closing date as security for the seller’s indemnification obligations under the purchase agreement. The escrowed funds were released in full to the sellers on January 31, 2007. In addition to this purchase price, there is a further $12,000,000 potential earnout
9
payable to the sellers of Crosstex over three years based on the achievement by Crosstex of certain targets of (i) earnings before interest and taxes and (ii) gross profit percentage. For the initial post-acquisition year ended July 31, 2006, the full potential earnout for year one of $3,667,000 was earned by the sellers of Crosstex and therefore represented additional purchase price, bringing the aggregate earned purchase price to $81,530,000. The additional earnout purchase price for fiscal 2006 was reflected in the accompanying Condensed Consolidated Balance Sheets as additional goodwill and as a separate item within current liabilities at July 31, 2006. Such amount was paid in October 2006. For the fiscal years ending July 31, 2007 and 2008, an additional earnout of $3,667,000 and $4,666,000, respectively, is available to the sellers of Crosstex if the specified targets of earnings before interest and taxes, and gross profit percentage, are achieved. Such additional earnout, if achieved, would represent additional purchase price and therefore be recorded as additional goodwill when earned.
Since the acquisition was completed on the first day of fiscal 2006, the results of operations of Crosstex are included in our results of operations for the three and six months ended January 31, 2007 and 2006. As a result of the acquisition, we added a new reporting segment known as Dental.
Operating income added by Crosstex excludes interest expense associated with the Company’s borrowings related to the acquisition. The segment operating income for the three and six months ended January 31, 2006 also excludes non-recurring charges directly related to the acquisition which were incurred by us upon the closing of the acquisition. Such non-recurring charges include (i) debt issuance costs relating to the term loan facility of approximately $160,000 and (ii) incentive compensation for an officer of Cantel of approximately $345,000. The aggregate amount of such charges was approximately $505,000 (or $318,000, net of tax) and has been included within general corporate expenses in our segment presentation in Note 13 to our Condensed Consolidated Financial Statements. However, included within our Dental segment operating income for the first three months of the six months ended January 31, 2006 was amortization related to the step-up in the value of inventories of $658,000 (included within cost of sales).
The reasons for the acquisition of Crosstex were as follows: (i) the complementary nature of the companies’ infection prevention and control products; (ii) the addition of a market leading company in a distinct niche in infection prevention and control; (iii) the increase in the percentage of our net sales derived from recurring consumables; (iv) the opportunity to utilize Crosstex as a sizeable platform to acquire additional companies in the healthcare consumables industry; (v) the expectation that the acquisition will be accretive to our earnings per share; and (vi) the opportunity for us to further expand our business into the design, manufacture and distribution of proprietary products. Such reasons constitute the significant factors which contributed to a purchase price that resulted in recognition of goodwill.
10
The purchase price (including the fiscal 2006 earnout) was allocated to the assets acquired and assumed liabilities based on estimated fair values as follows:
| Final |
| ||
Net Assets |
| Allocation |
| |
Cash and cash equivalents |
| $ | 4,264,000 |
|
Accounts receivable |
| 4,387,000 |
| |
Inventories |
| 7,291,000 |
| |
Other current assets |
| 731,000 |
| |
Total current assets |
| 16,673,000 |
| |
Property and equipment |
| 13,809,000 |
| |
Non-amortizable intangible assets—trade names (indefinite life) |
| 5,200,000 |
| |
Amortizable intangible assets: |
|
|
| |
Non-compete agreements (6-year life) |
| 1,800,000 |
| |
Customer relationships (10-year life) |
| 17,900,000 |
| |
Branded products (10-year life) |
| 8,700,000 |
| |
Total amortizable intangible assets (9-year weighted average life) |
| 28,400,000 |
| |
Other assets |
| 50,000 |
| |
Current liabilities |
| (4,571,000 | ) | |
Noncurrent deferred income tax liabilities |
| (16,241,000 | ) | |
Net assets acquired |
| $ | 43,320,000 |
|
There were no in-process research and development projects acquired in connection with the acquisition. The excess purchase price of $38,210,000 was assigned to goodwill. Such goodwill, all of which is non-deductible for income tax purposes, has been included in our new Dental reporting segment. Included in cash and cash equivalents was $1,370,000 funded by the selling stockholders and utilized for the payment in August 2005 of current liabilities (included above and reflected within cash flows from investing activities in our Condensed Consolidated Statements of Cash Flows for the six months ended January 31, 2006) directly resulting from the acquisition.
Fluid Solutions
On May 1, 2006, Mar Cor purchased certain net assets of Fluid Solutions, Inc. (“Fluid Solutions”), a company with annual revenues of approximately $5,000,000 based in Lowell, Massachusetts that designs, manufactures, installs and services high quality, high purity water systems for use in biotech, pharmaceutical, research, hospitals, and semiconductor environments. Total consideration for the transaction was $2,959,000.
The purchase price was allocated to the assets acquired and assumed liabilities based on estimated fair values as follows:
| Final |
| ||
Net Assets |
| Allocation |
| |
Current assets |
| $ | 1,486,000 |
|
Property and equipment |
| 887,000 |
| |
Non-amortizable intangible assets - trade names (indefinite life) |
| 214,000 |
| |
Amortizable intangible assets - customer relationships (4-year weighted average life) |
| 220,000 |
| |
Current liabilities |
| (430,000 | ) | |
Net assets acquired |
| $ | 2,377,000 |
|
11
The excess purchase price of $582,000 was assigned to goodwill. Such goodwill, all of which is deductible for income tax purposes, has been included in our Water Purification and Filtration reporting segment.
The reasons for the acquisition were as follows: (i) the opportunity to add a base of business and expand the Mar Cor service network in a region that has a concentration of life science companies as well as healthcare and research institutions; (ii) further develop the Fluid Solutions water business to serve the New England dialysis market; (iii) the potential revenue and cost savings synergies and efficiencies that could be realized through optimizing and combining the acquired assets (including Fluid Solution employees) into Mar Cor; and (iv) the expectation that the acquisition will be accretive to our future earnings per share.
Since the acquisition was completed on May 1, 2006, the results of operations of Fluid Solutions are included in our results of operations for the three and six months ended January 31, 2007 and are excluded from our results of operations for the three and six months ended January 31, 2006. Pro forma consolidated statement of income data for the three and six months ended January 31, 2006 have not been presented due to the insignificant impact of this acquisition.
Note 4. Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FIN No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN No. 48”). FIN No. 48 clarifies the accounting and reporting for uncertainties in income tax law. FIN No. 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. We are currently in the process of evaluating the effect of FIN 48 on our financial position and results of operations and are therefore unable to estimate the effect on our overall results of operations or financial position.
Note 5. Comprehensive Income
The Company’s comprehensive income for the three and six months ended January 31, 2007 and 2006 is set forth in the following table:
|
| Three Months Ended |
| Six Months Ended |
| ||||||||
|
| January 31, |
| January 31, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net income |
| $ | 2,270,000 |
| $ | 3,929,000 |
| $ | 4,238,000 |
| $ | 7,675,000 |
|
Other comprehensive income (loss): |
|
|
|
|
|
|
|
|
| ||||
Unrealized loss on currency hedging, |
| — |
| (202,000 | ) | — |
| (567,000 | ) | ||||
Foreign currency translation, net of tax |
| (1,052,000 | ) | 2,133,000 |
| (993,000 | ) | 3,892,000 |
| ||||
Comprehensive income |
| $ | 1,218,000 |
| $ | 5,860,000 |
| $ | 3,245,000 |
| $ | 11,000,000 |
|
12
Note 6. Financial Instruments
We account for derivative instruments and hedging activities in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), as amended. SFAS 133 requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not designated as hedges must be adjusted to fair value through earnings. If the derivative is designated as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in the fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of the change in fair value of a derivative that is designated as a hedge will be immediately recognized in earnings.
During the three and six months ended January 31, 2006, Carsen purchased and paid for a substantial portion of its products in United States dollars and sold its products in Canadian dollars, and was therefore exposed to fluctuations in the rates of exchange between the United States dollar and the Canadian dollar. In order to hedge against the impact of such currency fluctuations on the purchases of inventories, Carsen entered into foreign currency forward contracts on firm purchases of such inventories in United States dollars. These foreign currency forward contracts were designated as cash flow hedge instruments. Recognition of losses related to the Canadian foreign currency forward contracts was deferred within other comprehensive income for the three and six months ended January 31, 2006 until settlement of the underlying commitments, and realized gains and losses were recorded within cost of sales (which is included within income from discontinued operations) upon settlement. All outstanding Canadian foreign currency forward contracts were settled before the sale of substantially all of Carsen’s assets to Olympus on July 31, 2006; therefore Carsen no longer has any such foreign currency forward contracts.
In addition, changes in the value of the euro against the United States dollar affect our results of operations because a portion of the net assets of our Netherlands subsidiary (which are reported in our Dialysis and Endoscope Reprocessing segments) are denominated and ultimately settled in United States dollars but must be converted into its functional euro currency. In order to hedge against the impact of fluctuations in the value of the euro relative to the United States dollar, we enter into short-term contracts to purchase euros forward, which contracts are generally one month in duration. These short-term contracts are designated as fair value hedge instruments. There was one foreign currency forward contract amounting to €384,000 at January 31, 2007 which covers certain assets and liabilities of Minntech’s Netherlands subsidiary which are denominated in United States dollars. Such contract expired on February 28, 2007. Under our credit facilities, such contracts to purchase euros may not exceed $12,000,000 in an aggregate notional amount at any time. For the three and six months ended January 31, 2007, such forward contracts were effective in offsetting most of the impact of the strengthening of the euro on our results of operations. Gains and losses related to the hedging contracts to buy euros forward are immediately realized within general and administrative expenses due to the short-term nature of such contracts. We do not hold any derivative financial instruments for speculative or trading purposes.
As of January 31, 2007, the carrying amounts for cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to the short maturity of these instruments. We believe that as of January 31, 2007, the fair value of our outstanding borrowings under our credit facilities approximates the carrying value of those obligations based on the borrowing rates which are comparable to market interest rates.
13
Note 7. Intangibles and Goodwill
Our intangible assets with definite lives consist primarily of customer relationships, technology, brand names, non-compete agreements and patents. These intangible assets are being amortized on the straight-line method over the estimated useful lives of the assets ranging from 3-20 years and have a weighted average amortization period of 10 years. Amortization expense related to intangible assets was $1,146,000 and $2,299,000 for the three and six months ended January 31, 2007 and $1,351,000 and $2,497,000 for the three and six months ended January 31, 2006, respectively. Our intangible assets that have indefinite useful lives and therefore are not amortized consist of trademarks and tradenames.
The Company’s intangible assets consist of the following:
| January 31, 2007 |
| ||||||||
|
|
|
| Accumulated |
|
|
| |||
|
| Gross |
| Amortization |
| Net |
| |||
Intangible assets with finite lives: |
|
|
|
|
|
|
| |||
Customer relationships |
| $ | 23,330,000 |
| $ | (6,057,000 | ) | $ | 17,273,000 |
|
Technology |
| 8,894,000 |
| (3,329,000 | ) | 5,565,000 |
| |||
Brand names |
| 8,700,000 |
| (1,305,000 | ) | 7,395,000 |
| |||
Non-compete agreements |
| 1,969,000 |
| (619,000 | ) | 1,350,000 |
| |||
Patents and other registrations |
| 353,000 |
| (56,000 | ) | 297,000 |
| |||
|
| 43,246,000 |
| (11,366,000 | ) | 31,880,000 |
| |||
Trademarks and tradenames |
| 8,941,000 |
| — |
| 8,941,000 |
| |||
Total intangible assets |
| $ | 52,187,000 |
| $ | (11,366,000 | ) | $ | 40,821,000 |
|
| July 31, 2006 |
| ||||||||
|
|
|
| Accumulated |
|
|
| |||
|
| Gross |
| Amortization |
| Net |
| |||
Intangible assets with finite lives: |
|
|
|
|
|
|
| |||
Customer relationships |
| $ | 23,411,000 |
| $ | (4,778,000 | ) | $ | 18,633,000 |
|
Technology |
| 8,880,000 |
| (2,929,000 | ) | 5,951,000 |
| |||
Brand names |
| 8,700,000 |
| (870,000 | ) | 7,830,000 |
| |||
Non-compete agreements |
| 1,969,000 |
| (469,000 | ) | 1,500,000 |
| |||
Patents and other registrations |
| 343,000 |
| (46,000 | ) | 297,000 |
| |||
|
| 43,303,000 |
| (9,092,000 | ) | 34,211,000 |
| |||
Trademarks and tradenames |
| 9,008,000 |
| — |
| 9,008,000 |
| |||
Total intangible assets |
| $ | 52,311,000 |
| $ | (9,092,000 | ) | $ | 43,219,000 |
|
Estimated amortization expense of our intangible assets for the remainder of fiscal 2007 and the next five years is as follows:
Six month period ending July 31, 2007 |
| $ | 2,363,000 |
|
Fiscal 2008 |
| 4,529,000 |
| |
Fiscal 2009 |
| 4,209,000 |
| |
Fiscal 2010 |
| 3,991,000 |
| |
Fiscal 2011 |
| 3,777,000 |
| |
Fiscal 2012 |
| 3,359,000 |
|
14
Goodwill changed during fiscal 2006 and the six months ended January 31, 2007 as follows:
|
|
|
|
|
|
|
| Water |
|
|
|
|
| ||||||
|
|
|
|
|
| Endoscope |
| Purification |
|
|
| Total |
| ||||||
|
| Dialysis |
| Dental |
| Reprocessing |
| and Filtration |
| All Other |
| Goodwill |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Balance, July 31, 2005 |
| $ | 8,415,000 |
| $ | — |
| $ | 6,258,000 |
| $ | 11,437,000 |
| $ | 7,009,000 |
| $ | 33,119,000 |
|
Acquisitions |
| — |
| 34,543,000 |
| — |
| 582,000 |
| — |
| 35,125,000 |
| ||||||
Earnout on acquisition |
| — |
| 3,667,000 |
| — |
| — |
| — |
| 3,667,000 |
| ||||||
Adjustments primarily relating to income tax exposure of acquired businesses |
| (153,000 | ) | — |
| — |
| (66,000 | ) | (87,000 | ) | (306,000 | ) | ||||||
Foreign currency translation |
| — |
| — |
| 94,000 |
| 396,000 |
| 476,000 |
| 966,000 |
| ||||||
Balance, July 31, 2006 |
| 8,262,000 |
| 38,210,000 |
| 6,352,000 |
| 12,349,000 |
| 7,398,000 |
| 72,571,000 |
| ||||||
Foreign currency translation |
| — |
| — |
| 27,000 |
| (200,000 | ) | (241,000 | ) | (414,000 | ) | ||||||
Balance, January 31, 2007 |
| $ | 8,262,000 |
| $ | 38,210,000 |
| $ | 6,379,000 |
| $ | 12,149,000 |
| $ | 7,157,000 |
| $ | 72,157,000 |
|
On July 31, 2006, we performed impairment studies of the Company’s goodwill and trademarks and tradenames and concluded that such assets were not impaired.
Note 8. Warranty
A summary of activity in the Company’s warranty reserves follows:
| Three Months Ended |
| Six Months Ended |
| |||||||||
|
| January 31, |
| January 31, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Beginning balance |
| $ | 593,000 |
| $ | 519,000 |
| $ | 619,000 |
| $ | 581,000 |
|
Provisions |
| 229,000 |
| 154,000 |
| 414,000 |
| 328,000 |
| ||||
Charges |
| (198,000 | ) | (203,000 | ) | (409,000 | ) | (440,000 | ) | ||||
Foreign currency translation |
| — |
| 1,000 |
| — |
| 2,000 |
| ||||
Ending balance |
| $ | 624,000 |
| $ | 471,000 |
| $ | 624,000 |
| $ | 471,000 |
|
The warranty provisions and charges during the three and six months ended January 31, 2007 and 2006 relate principally to the Company’s endoscope reprocessing products.
Note 9. Financing Arrangements
In conjunction with the acquisition of Crosstex, we entered into amended and restated credit facilities dated as of August 1, 2005 (the “2005 U.S. Credit Facilities”) with a consortium of United States lenders to fund the cash consideration paid in the acquisition and costs associated with the acquisition, as well as to modify our existing United States credit facilities. The 2005 U.S. Credit Facilities include (i) a six-year $40.0 million senior secured amortizing term loan facility and (ii) a five-year $35.0 million senior secured revolving credit facility. In addition, we agreed to repay the July 31, 2005 outstanding borrowings of $15,750,000 under our original term loan facility within ninety (90) days from the closing. In October 2005, such amount was repaid primarily through the repatriation of funds from our foreign subsidiaries. Amounts we repay under the term loan facility may not be re-borrowed. Additionally, we incurred debt issuance costs of approximately $1,426,000, of which $160,000 of third-party costs was recorded in general and administrative expenses during the three months ended October 31,
15
2005 in accordance with applicable accounting rules. The remaining $1,266,000 of costs was recorded in other assets and is being amortized over the life of the credit facilities.
Borrowings under the 2005 U.S. Credit Facilities bear interest at rates ranging from 0% to 0.75% above the lender’s base rate, or at rates ranging from 1.0% to 2.0% above the London Interbank Offered Rate (“LIBOR”), depending upon our consolidated ratio of debt to earnings before interest, taxes, depreciation and amortization, and as further adjusted under the terms of the 2005 U.S. Credit Facilities (“EBITDA”). At January 31, 2007, the lender’s base rate was 8.25% and the LIBOR rates ranged from 5.30% to 5.35%. The margins applicable to our outstanding borrowings at January 31, 2007 were 0.25% above the lender’s base rate and 1.50% above LIBOR. All of our outstanding borrowings were under LIBOR contracts at January 31, 2007. The 2005 U.S. Credit Facilities also provide for fees on the unused portion of our facilities at rates ranging from 0.20% to 0.40%, depending upon our consolidated ratio of debt to EBITDA; such rate was 0.30% at January 31, 2007.
The 2005 U.S. Credit Facilities require us to meet certain financial covenants and are secured by (i) substantially all of our U.S.-based assets (including assets of Cantel, Minntech, Mar Cor and Crosstex) and (ii) our pledge of all of the outstanding shares of Minntech, Mar Cor and Crosstex and 65% of the outstanding shares of our foreign-based subsidiaries. Additionally, we are not permitted to pay cash dividends on our Common Stock without the consent of our United States lenders. As of January 31, 2007, we are in compliance with all financial and other covenants under the 2005 U.S. Credit Facilities.
On January 31, 2007, we had $36,000,000 of outstanding borrowings under the 2005 U.S. Credit Facilities, all of which was under the United States term loan facility. The maturities of our United States term loan facility are described in Note 12 to the Condensed Consolidated Financial Statements.
Note 10. Earnings Per Common Share
Basic earnings per common share are computed based upon the weighted average number of common shares outstanding during the period.
Diluted earnings per common share are computed based upon the weighted average number of common shares outstanding during the period plus the dilutive effect of common stock equivalents using the treasury stock method and the average market price of our Common Stock for the period.
16
The following table sets forth the computation of basic and diluted earnings per common share:
|
| Three Months Ended |
| Six Months Ended |
| ||||||||
|
| January 31, |
| January 31, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
Numerator for basic and diluted earnings per share: |
|
|
|
|
|
|
|
|
| ||||
Income from continuing operations |
| $ | 2,252,000 |
| $ | 1,874,000 |
| $ | 3,975,000 |
| $ | 4,092,000 |
|
Income from discontinued operations |
| 18,000 |
| 2,191,000 |
| 263,000 |
| 3,851,000 |
| ||||
Loss on disposal of discontinued operations |
| — |
| (136,000 | ) | — |
| (268,000 | ) | ||||
Net income |
| $ | 2,270,000 |
| $ | 3,929,000 |
| $ | 4,238,000 |
| $ | 7,675,000 |
|
|
|
|
|
|
|
|
|
|
| ||||
Denominator for basic and diluted earnings per share: |
|
|
|
|
|
|
|
|
| ||||
Denominator for basic earnings per share — weighted average number of shares outstanding |
| 15,506,432 |
| 15,487,275 |
| 15,488,224 |
| 15,446,887 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Dilutive effect of options using the treasury stock method and the average market price for the year |
| 557,580 |
| 882,297 |
| 563,807 |
| 963,664 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Denominator for diluted earnings per share—weighted average number of shares and common stock equivalents |
| 16,064,012 |
| 16,369,572 |
| 16,052,031 |
| 16,410,551 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Basic earnings per share: |
|
|
|
|
|
|
|
|
| ||||
Continuing operations |
| $ | 0.15 |
| $ | 0.12 |
| $ | 0.26 |
| $ | 0.26 |
|
Discontinued operations |
| — |
| 0.14 |
| 0.01 |
| 0.25 |
| ||||
Loss on disposal of discontinued operations |
| — |
| (0.01 | ) | — |
| (0.01 | ) | ||||
Net income |
| $ | 0.15 |
| $ | 0.25 |
| $ | 0.27 |
| $ | 0.50 |
|
|
|
|
|
|
|
|
|
|
| ||||
Diluted earnings per share: |
|
|
|
|
|
|
|
|
| ||||
Continuing operations |
| $ | 0.14 |
| $ | 0.11 |
| $ | 0.25 |
| $ | 0.25 |
|
Discontinued operations |
| — |
| 0.14 |
| 0.01 |
| 0.23 |
| ||||
Loss on disposal of discontinued operations |
| — |
| (0.01 | ) | — |
| (0.01 | ) | ||||
Net income |
| $ | 0.14 |
| $ | 0.24 |
| $ | 0.26 |
| $ | 0.47 |
|
Note 11. Income Taxes
The consolidated effective tax rate was 44.8% and 42.2% for the six months ended January 31, 2007 and 2006, respectively.
Our results of continuing operations for the three and six months ended January 31, 2007 and 2006 reflect income tax expense for our United States and international operations at their respective statutory rates. Our United States operations had an effective tax rate of 37.7% for the six months ended January 31, 2007. Our international operations include our subsidiaries in Canada, Singapore and Japan, which had effective tax rates for the six months ended January 31, 2007 of approximately 36.9%, 20.0% and 45.0%, respectively. A tax benefit was not recorded for the six months ended January 31, 2007 and 2006 on the losses from operations at our Netherlands subsidiary, thereby causing the overall effective tax rates to exceed statutory rates.
17
The higher overall effective tax rate for the six months ended January 31, 2007, compared with the six months ended January 31, 2006, was principally due to losses related to our Netherlands operation for which no income tax benefit was recorded and the geographic mix of pretax income.
12. Commitments and Contingencies
Long-term contractual obligations
Aggregate annual required payments over the next five years and thereafter under our contractual obligations that have long-term components are as follows:
|
| Six Months |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
|
| Ended |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
|
| January 31, |
| Year Ending July 31, |
| |||||||||||||||||
|
| 2007 |
| 2008 |
| 2009 |
| 2010 |
| 2011 |
| Thereafter |
| Total |
| |||||||
|
| (Amounts in thousands) |
| |||||||||||||||||||
Maturities of the |
| $ | 2,000 |
| $ | 6,000 |
| $ | 8,000 |
| $ | 10,000 |
| $ | 10,000 |
| $ | — |
| $ | 36,000 |
|
Expected interest payments |
| 1,197 |
| 2,128 |
| 1,657 |
| 1,050 |
| 369 |
| — |
| 6,401 |
| |||||||
Minimum commitments under |
| 1,521 |
| 2,544 |
| 2,341 |
| 1,740 |
| 1,163 |
| 2,134 |
| 11,443 |
| |||||||
Minimum commitment under |
| 4 |
| — |
| — |
| — |
| — |
| — |
| 4 |
| |||||||
Note payable - Dyped |
| 551 |
| 648 |
| — |
| — |
| — |
| — |
| 1,199 |
| |||||||
Deferred compensation and other |
| 94 |
| 180 |
| 42 |
| 34 |
| 406 |
| 1,012 |
| 1,768 |
| |||||||
Minimum commitments under |
| 17 |
| 44 |
| 66 |
| 99 |
| 147 |
| 2,620 |
| 2,993 |
| |||||||
Employment agreements |
| 1,634 |
| 3,679 |
| 967 |
| 140 |
| 116 |
| 122 |
| 6,658 |
| |||||||
Total contractual obligations |
| $ | 7,018 |
| $ | 15,223 |
| $ | 13,073 |
| $ | 13,063 |
| $ | 12,201 |
| $ | 5,888 |
| $ | 66,466 |
|
(1) The expected interest payments under the credit facilities reflect an interest rate of 6.81%, which was our interest rate on outstanding borrowings at January 31, 2007.
Operating leases
Minimum commitments under operating leases include minimum rental commitments for our leased manufacturing facilities, warehouses, office space and equipment.
Dyped note payable and other long-term liabilities
In conjunction with the Dyped acquisition on September 12, 2003, we issued a note with a face value of €1,350,000 ($1,505,000 using the exchange rate on the date of the acquisition). At January 31, 2007, $1,199,000 of this note was outstanding using the exchange rate on January 31, 2007. Such note is non-interest bearing and has been recorded at its present value of $1,136,000 at January 31, 2007. The current portion of this note is recorded in accrued expenses and the remainder is recorded in other long-term liabilities.
Also included in other long-term liabilities are deferred compensation arrangements for certain former Minntech directors and officers.
18
License agreement
On January 1, 2007, we entered into a license agreement with a third-party which allows us to manufacture, use, import, sell and distribute certain thermal control products relating to our Specialty Packaging segment. In consideration, we agreed to pay a minimum annual royalty payable each calendar year over the license agreement term of 20 years. At January 31, 2007, we had minimum future royalty obligations of approximately $2,993,000 related to this license agreement.
Note 13. Operating Segments
We are a leading provider of infection prevention and control products in the healthcare market. Our products include specialized medical device reprocessing systems for renal dialysis and endoscopy, dialysate concentrates and other dialysis supplies, water purification equipment, sterilants, disinfectants and cleaners, hollow fiber membrane filtration and separation products for medical and non-medical applications, and specialty packaging for infectious and biological specimens. We also provide technical maintenance for our products and offer compliance training services for the transport of infectious and biological specimens.
In accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”), we have determined our reportable business segments based upon an assessment of product types, organizational structure, customers and internally prepared financial statements. The primary factors used by us in analyzing segment performance are net sales and operating income.
The Company’s segments are as follows:
Dialysis, which includes disinfection/sterilization reprocessing equipment, sterilants, supplies and concentrates related to hemodialysis treatment of patients with acute kidney failure or chronic kidney failure associated with end-stage renal disease. Additionally, this segment includes technical maintenance service on its products.
Dental, which includes single-use infection control products used principally in the dental market such as face masks, patient towels and bibs, self-sealing sterilization pouches, tray covers, sterilization packaging accessories, surface barriers including eyewear, aprons and gowns, disinfectants and deodorizers, germicidal wipes, hand care products, gloves, sponges, cotton products, cups, needles and syringes, scalpels and blades, and saliva evacuators and ejectors.
Water Purification and Filtration, which includes water purification equipment design and manufacturing, project management, installation, maintenance, deionization and mixing systems, as well as hollow fiber filter devices and ancillary products for high-purity fluid and separation applications for the medical, pharmaceutical, biotechnology, research, beverage and semiconductor industries. Additionally, this segment includes cold sterilant products used to disinfect high-purity water systems.
Endoscope Reprocessing, which includes endoscope disinfection equipment and related accessories and supplies that are sold to hospitals, clinics and physicians. Additionally, this segment includes technical maintenance service on its products.
19
All Other
In accordance with quantitative thresholds established by SFAS 131, we have combined the Specialty Packaging, and Therapeutic operating segments into the All Other reporting segment.
Specialty Packaging, which includes specialty packaging and thermal control products, as well as related compliance training, for the safe transport of infectious and biological specimens and thermally sensitive pharmaceutical, medical and other products.
Therapeutic Filtration, which includes hollow fiber filter devices and ancillary products for use in medical applications that are sold to biotech manufacturers and third-party distributors.
The operating segments follow the same accounting policies used for our Condensed Consolidated Financial Statements as described in Note 2 to the 2006 Form 10-K.
Information as to operating segments is summarized below:
|
| Three Months Ended |
| Six Months Ended |
| ||||||||
|
| January 31, |
| January 31, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net sales: |
|
|
|
|
|
|
|
|
| ||||
Dental |
| $ | 13,775,000 |
| $ | 13,108,000 |
| $ | 29,182,000 |
| $ | 26,235,000 |
|
Dialysis |
| 14,776,000 |
| 15,250,000 |
| 28,314,000 |
| 31,513,000 |
| ||||
Water Purification and Filtration |
| 10,166,000 |
| 9,053,000 |
| 20,137,000 |
| 17,050,000 |
| ||||
Endoscope Reprocessing |
| 9,365,000 |
| 7,130,000 |
| 17,876,000 |
| 14,502,000 |
| ||||
All Other |
| 3,553,000 |
| 2,799,000 |
| 6,610,000 |
| 5,852,000 |
| ||||
Total |
| $ | 51,635,000 |
| $ | 47,340,000 |
| $ | 102,119,000 |
| $ | 95,152,000 |
|
|
|
|
|
|
|
|
|
|
| ||||
Operating Income: |
|
|
|
|
|
|
|
|
| ||||
Dental |
| $ | 1,859,000 |
| $ | 2,130,000 |
| $ | 4,880,000 |
| $ | 3,766,000 |
|
Dialysis |
| 2,260,000 |
| 1,473,000 |
| 4,013,000 |
| 3,990,000 |
| ||||
Water Purification and Filtration |
| 1,040,000 |
| 675,000 |
| 1,455,000 |
| 1,673,000 |
| ||||
Endoscope Reprocessing |
| 110,000 |
| 868,000 |
| (449,000 | ) | 1,959,000 |
| ||||
All Other |
| 859,000 |
| 440,000 |
| 1,490,000 |
| 1,050,000 |
| ||||
|
| 6,128,000 |
| 5,586,000 |
| 11,389,000 |
| 12,438,000 |
| ||||
General corporate expenses |
| (1,616,000 | ) | (1,545,000 | ) | (3,122,000 | ) | (3,389,000 | ) | ||||
Interest expense, net |
| (599,000 | ) | (933,000 | ) | (1,072,000 | ) | (1,971,000 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Income before income taxes |
| $ | 3,913,000 |
| $ | 3,108,000 |
| $ | 7,195,000 |
| $ | 7,078,000 |
|
20
Note 14. Legal Proceedings
In the normal course of business, we are subject to pending and threatened legal actions. It is our policy to accrue for amounts related to these legal matters if it is probable that a liability has been incurred and an amount of anticipated exposure can be reasonably estimated.
On January 25, 2007, the Eighth Circuit Court of Appeals in St. Louis affirmed the decision of the United States District Court, District of Minnesota, to grant Minntech’s Motion for Summary Judgment in the previously reported antitrust lawsuit commenced by HDC Medical, Inc. in November 2003. As a result of the ruling and the expiration of time for any further appeal by the plaintiff, the complaint against Minntech, a wholly-owned subsidiary of Cantel, has been dismissed and the case terminated without any liability to Minntech.
As previously reported, in July 2006, we received a letter from the “Sellers” of Biolab Equipment Ltd. claiming that the Contingent Payment under the Biolab Stock Purchase Agreement is payable to the Sellers. In January 2007, after one of the two Sellers represented by legal counsel withdrew his claim, we settled the dispute by payment of a nominal sum (without admitting any liability).
Note 15. Discontinued Operations
On July 31, 2006, Carsen closed the sale of substantially all of its assets to Olympus under an Asset Purchase Agreement dated as of May 16, 2006 among Carsen, Cantel and Olympus. Olympus purchased substantially all of Carsen’s assets other than those related to Carsen’s Medivators business and certain other smaller product lines. Following the closing, Olympus hired substantially all of Carsen’s employees and took over Carsen’s Olympus-related operations (as well as the operations related to the other acquired product lines). The transaction resulted in an after-tax gain of $6,776,000 and was recorded separately on the Consolidated Statements of Income for the year ended July 31, 2006 as gain on disposal of discontinued operations, net of tax. In connection with the transaction, Carsen’s Medivators-related assets as well as certain of its other assets that were not acquired by Olympus were sold to our new Canadian distributor of Medivators products.
The purchase price for the net assets sold to Olympus was approximately $31,200,000, comprised of a fixed sum of $10,000,000 plus an additional formula-based sum of $21,200,000. In addition, Olympus is paying Carsen 20% of Olympus’ revenues attributable to Carsen’s unfilled customer orders (“backlog”) as of July 31, 2006 that were assumed by Olympus at the closing. Such payments to Carsen are made following Olympus’ receipt of customer payments for such orders. As of January 31, 2007, approximately $300,000 related to such backlog has been recorded as income and has been reported in income from discontinued operations, net of tax, in the Condensed Consolidated Statements of Income.
The $10,000,000 fixed portion of the purchase price was in consideration for (i) Carsen’s customer lists, sales records, and certain other assets related to the sale and servicing of Olympus products and certain non-Olympus products distributed by Carsen, (ii) the release of Olympus’ contractual restriction on hiring Carsen personnel, (iii) real property leases (which were assumed or replaced by Olympus) and leasehold improvements, computer and software systems, equipment and machinery, telephone systems, and records related to the acquired assets, and (iv) assisting Olympus in effecting a smooth transition of Carsen’s business of distributing and servicing Olympus and certain non-Olympus products in Canada. Cantel has also agreed (on
21
behalf of itself and its affiliates) not to manufacture, distribute, sell or represent for sale in Canada through July 31, 2007 any products that are competitive with the Olympus products formerly sold by Carsen under its Olympus Distribution Agreements.
The $21,200,000 formula-based portion of the purchase price was based on the book value of Carsen’s inventories of Olympus and certain non-Olympus products and the net book amount of Carsen’s accounts receivable and certain other assets, all at July 31, 2006, subject to offsets, particularly for accounts payable of Carsen due to Olympus.
Net proceeds from Carsen’s sale of net assets and the termination of Carsen’s operations were approximately $21,100,000 (excluding the backlog payments) after satisfaction of remaining liabilities and taxes.
As a result of the foregoing transaction, which coincided with the expiration of Carsen’s exclusive distribution agreements with Olympus on July 31, 2006, Carsen no longer has any remaining product lines or active business operations.
The net sales and operating income attributable to Carsen’s business (inclusive of both Olympus and non-Olympus business, but exclusive of the sale of Medivators reprocessors) constitute the entire Endoscopy and Surgical reporting segment and Scientific operating segment, which historically was included within the All Other reporting segment.
Operating results attributable to Carsen’s business are summarized below:
|
| Three Months Ended |
| Six Months ended |
| ||||||||
|
| January 31, |
| January 31, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net sales |
| $ | 126,000 |
| $ | 14,285,000 |
| $ | 1,360,000 |
| $ | 26,705,000 |
|
|
|
|
|
|
|
|
|
|
| ||||
Operating income |
| 27,000 |
| 3,410,000 |
| 407,000 |
| 6,005,000 |
| ||||
Interest expense |
| — |
| 15,000 |
| — |
| 30,000 |
| ||||
Income before income taxes |
| 27,000 |
| 3,395,000 |
| 407,000 |
| 5,975,000 |
| ||||
Income taxes |
| 9,000 |
| 1,204,000 |
| 144,000 |
| 2,124,000 |
| ||||
Income from discontinued operations, net of tax |
| $ | 18,000 |
| $ | 2,191,000 |
| $ | 263,000 |
| $ | 3,851,000 |
|
|
|
|
|
|
|
|
|
|
| ||||
Loss on disposal of |
|
|
|
|
|
|
|
|
| ||||
discontinued operations |
| $ | — |
| $ | (210,000 | ) | $ | — |
| $ | (413,000 | ) |
Income tax benefit |
| — |
| (74,000 | ) | — |
| (145,000 | ) | ||||
Loss on disposal of discontinued operations, net of tax |
| $ | — |
| $ | (136,000 | ) | $ | — |
| $ | (268,000 | ) |
Included in net sales for the three and six months ended January 31, 2007 are sales that did not meet the Company’s revenue recognition policy as of July 31, 2006 and $300,000 of backlog payments. For the three and six months ended January 31, 2006, the disposal of discontinued operations represents severance expense which was included in the $6,776,000 gain on sale recorded on July 31, 2006.
22
Cash flows attributable to discontinued operations comprise the following:
|
| Six Months ended January 31, |
| ||||
|
| 2007 |
| 2006 |
| ||
|
|
|
|
|
| ||
Net cash (used in) provided by operating activities |
| $ | (4,721,000 | ) | $ | 6,378,000 |
|
Investing and financing activities of our discontinued operations did not result in any net cash for the three and six months ended January 31, 2007 and 2006.
The components of assets and liabilities of discontinued operations in the Condensed Consolidated Balance Sheets and the activity during the six months ended January 31, 2007 are as follows:
|
| July 31, |
| Recorded as |
| Amounts |
| January 31, |
| ||||
|
| 2006 |
| Income (Expense) |
| Settled |
| 2007 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Current assets: |
|
|
|
|
|
|
|
|
| ||||
Accounts receivable, net |
| $ | 655,000 |
| $ | 297,000 |
| $ | (877,000 | ) | $ | 75,000 |
|
Inventories |
| 695,000 |
| (695,000 | ) | — |
| — |
| ||||
Prepaids and other current assets |
| 771,000 |
| (5,000 | ) | (750,000 | ) | 16,000 |
| ||||
Assets of discontinued operations |
| $ | 2,121,000 |
| $ | (403,000 | ) | $ | (1,627,000 | ) | $ | 91,000 |
|
|
|
|
|
|
|
|
|
|
| ||||
Current liabilities: |
|
|
|
|
|
|
|
|
| ||||
Accounts payable and accrued expenses |
| $ | (3,098,000 | ) | $ | (211,000 | ) | $ | 3,110,000 |
| $ | (199,000 | ) |
Compensation payable |
| (1,195,000 | ) | (42,000 | ) | 1,236,000 |
| (1,000 | ) | ||||
Deferred revenue |
| (1,063,000 | ) | 1,063,000 |
| — |
| — |
| ||||
Income taxes payable |
| (2,023,000 | ) | (144,000 | ) | 2,020,000 |
| (147,000 | ) | ||||
Liabilities of discontinued operations |
| $ | (7,379,000 | ) | $ | 666,000 |
| $ | 6,366,000 |
| $ | (347,000 | ) |
The liabilities at January 31, 2007 are expected to be settled prior to July 31, 2007.
Note 16. Minntech/Medivators-Olympus Distribution Agreement
On August 2, 2006, we commenced the sale and service of our Medivators brand endoscope reprocessing equipment, high-level disinfectants, cleaners and consumables through our own United States field sales and service organization. Our direct sale of these products is the result of our decision that it is in our best long-term interests to control and develop our own direct-hospital based United States distribution network and, as such, not to renew Olympus’ exclusive United States distribution agreement when it expired on August 1, 2006.
Throughout the former distribution arrangement with Olympus, we employed our own personnel to provide clinical sales support activities as well as an internal technical and customer service function, depot maintenance and service and all logistics and distribution services for the Medivators/Olympus customer base. This existing and fully developed infrastructure will continue to be a critical factor in our new direct sales and service strategy.
During the seven-year period following the expiration of the distribution agreement with Olympus on August 1, 2006, Olympus will have the option to provide certain ongoing support functions to its existing customer base of Medivators products, subject to the terms and conditions of the agreement. In addition, Olympus may continue to purchase from Minntech for resale in connection with such support functions, Medivators accessories, consumables, and replacement and repair parts, as well as RapicideÒ disinfectant.
23
17. Repurchase of Shares
On April 13, 2006, our Board of Directors approved the repurchase of up to 500,000 shares of our outstanding Common Stock. Under the repurchase program we repurchase shares from time-to-time at prevailing prices and as permitted by applicable securities laws (including SEC Rule 10b-18) and New York Stock Exchange requirements, and subject to market conditions. The repurchase program has a one-year term ending April 12, 2007.
The first purchase under our repurchase program occurred on April 19, 2006. Through November 30, 2006, we had repurchased 464,800 shares under the repurchase program at a total average price per share of $14.02. Of the 464,800 shares, 161,800 shares were repurchased during the six months ended January 31, 2007. No additional purchases have been made since November 2006. Therefore, at January 31, 2007, the maximum number of additional shares that may be purchased under the program is 35,200 shares.
24
ITEM 2. |
| MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS |
|
| OF OPERATIONS. |
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help you understand Cantel Medical Corp. (“Cantel”). The MD&A is provided as a supplement to and should be read in conjunction with our financial statements and the accompanying notes. Our MD&A includes the following sections:
Overview provides a brief description of our business and a summary of significant activity that has affected or may affect our results of operations and financial condition.
Results of Operations provides a discussion of the consolidated results of operations for the three and six months ended January 31, 2007 compared with the three and six months ended January 31, 2006.
Liquidity and Capital Resources provides an overview of our working capital, cash flows, and financing and foreign currency activities.
Critical Accounting Policies provides a discussion of our accounting policies that require critical judgments, assumptions and estimates.
Forward-Looking Statements provides a discussion of cautionary factors that may affect future results.
Overview
Cantel is a leading provider of infection prevention and control products in the healthcare market, specializing in the following operating segments:
· Dental: Single-use, infection control products used principally in the dental market including face masks, towels and bibs, tray covers, saliva ejectors, germicidal wipes, plastic cups, sterilization pouches and disinfectants.
· Dialysis: Medical device reprocessing systems, sterilants/disinfectants, dialysate concentrates and other supplies for renal dialysis.
· Endoscope Reprocessing: Medical device reprocessing systems and sterilants/disinfectants for endoscopy.
· Water Purification and Filtration: Water purification equipment and services, filtration and separation products, and disinfectants for the medical, pharmaceutical, biotech and other industrial markets.
· Therapeutic Filtration: Hollow fiber membrane filtration and separation technologies for medical applications (included in All Other reporting segment).
· Specialty Packaging: Specialty packaging and thermal control products, as well as related compliance training, for the transport of infectious and biological specimens and thermally sensitive pharmaceutical, medical and other products (included in All Other reporting segment).
Most of our equipment, consumables and supplies are used to help prevent the occurrence or spread of infections.
See our Annual Report on Form 10-K for the fiscal year ended July 31, 2006 (the “2006 Form 10-K”) and our Condensed Consolidated Financial Statements for additional
25
financial information regarding our reporting segments.
Significant Activities
(i) |
| In connection with our decision to not renew Olympus’ exclusive United States distribution agreement when it expired on August 1, 2006, we commenced the sale and service of our Medivators endoscope reprocessing equipment, high-level disinfectants, cleaners and consumables through our own United States field sales and service organization on August 2, 2006, as more fully described elsewhere in this MD&A, “Business — Risk Factors” in the 2006 Form 10-K and Note 16 to the Condensed Consolidated Financial Statements. The operating performance of our endoscope reprocessing business was adversely impacted during the six months ended January 31, 2007, compared with the six months ended January 31, 2006, by unabsorbed infrastructure costs associated with the start-up of the Medivators direct sales and service effort in the United States and the overall integration of our MDS product line (formerly known as Dyped) manufactured in the Netherlands, including delays in the development and launch of this product line. However, the operating performance of both the domestic Medivators product line and the foreign MDS product line improved during the three months ended January 31, 2007, compared with the three months ended October 31, 2006, and we expect continued improvement in the future as we complete the integration of both of these initiatives. |
|
|
|
(ii) |
| The dialysis industry has undergone significant consolidation which adversely impacted sales volume and average selling prices of some of our dialysis products, as more fully described elsewhere in this MD&A and in “Business — Risk Factors” in the 2006 Form 10-K. We believe that the majority of the adverse impact of this consolidation on our operating results has already occurred. |
|
|
|
(iii) |
| The Olympus distribution agreements with Carsen, as well as Carsen’s active business operations, terminated on July 31, 2006, as more fully described elsewhere in this MD&A, “Business — Risk Factors” in the 2006 Form 10-K and Note 15 to the Condensed Consolidated Financial Statements. Accordingly, Carsen is reported as a discontinued operation for the three and six months ended January 31, 2007 and 2006. |
Results of Operations
The results of operations reflect the continuing operating results of Cantel and its wholly-owned subsidiaries.
Certain distribution and warehouse expenses of Crosstex have been reclassified from amounts previously reported in our quarterly Form 10-Q for the three and six months ended January 31, 2006 to conform with the accounting policies of Cantel which require such costs to be classified as cost of sales. These reclassifications affect cost of sales, gross profit and general and administrative expenses of our Dental segment, and therefore our consolidated totals.
The following discussion should also be read in conjunction with our 2006 Form 10-K.
26
The following table gives information as to the net sales from continuing operations and the percentage to the total net sales from continuing operations for each of our reporting segments:
|
| Three Months Ended |
| Six Months Ended |
| ||||||||||||||||
|
| January 31, |
| January 31, |
| ||||||||||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||||||||||
|
| (Dollar amounts in thousands) |
| ||||||||||||||||||
|
| $ |
| % |
| $ |
| % |
| $ |
| % |
| $ |
| % |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Dental |
| $ | 13,775 |
| 26.7 |
| $ | 13,108 |
| 27.7 |
| $ | 29,182 |
| 28.6 |
| $ | 26,235 |
| 27.6 |
|
Dialysis |
| 14,776 |
| 28.6 |
| 15,250 |
| 32.2 |
| 28,314 |
| 27.7 |
| 31,513 |
| 33.1 |
| ||||
Water Purification and Filtration |
| 10,166 |
| 19.7 |
| 9,053 |
| 19.1 |
| 20,137 |
| 19.7 |
| 17,050 |
| 17.9 |
| ||||
Endoscope Reprocessing |
| 9,365 |
| 18.1 |
| 7,130 |
| 15.1 |
| 17,876 |
| 17.5 |
| 14,502 |
| 15.2 |
| ||||
All Other |
| 3,553 |
| 6.9 |
| 2,799 |
| 5.9 |
| 6,610 |
| 6.5 |
| 5,852 |
| 6.2 |
| ||||
|
| $ | 51,635 |
| 100.0 |
| $ | 47,340 |
| 100.0 |
| $ | 102,119 |
| 100.0 |
| $ | 95,152 |
| 100.0 |
|
Net Sales
Net sales increased by $4,295,000, or 9.1%, to $51,635,000 for the three months ended January 31, 2007 from $47,340,000 for the three months ended January 31, 2006. Net sales increased by $6,967,000, or 7.3%, to $102,119,000 for the six months ended January 31, 2007 from $95,152,000 for the six months ended January 31, 2006.
The increase in net sales for the three and six months ended January 31, 2007 was principally attributable to increases in sales of endoscope reprocessing products and services, water purification and filtration products and services, dental products, and specialty packaging products. This increase in net sales was partially offset by decreases in sales of dialysis products.
Sales of endoscope reprocessing products and services increased by 31.3% and 23.3% during the three and six months ended January 31, 2007, respectively, compared with the three and six months ended January 31, 2006, primarily due to an increase in demand for our endoscope disinfection equipment, disinfectants and product service both in the United States and internationally, and an increase in selling prices of our Medivators endoscope reprocessing equipment and related products and service in the United States as a result of selling directly to our customers and not through a distributor, as more fully described elsewhere in this MD&A. The increase in demand for our endoscope reprocessing equipment included the impact of our new direct sales force in the United States as well as strong international sales excluding the MDS product line. The increase in demand for our disinfectants and product service is attributable to the increased field population of equipment and our ability to convert users of competitive disinfectants to our products. The increase in customer prices as a result of the direct sales effort increased sales by approximately $1,300,000 and $1,800,000 for the three and six months ended January 31, 2007, respectively, compared with the three and six months ended January 31, 2006.
Sales of water purification and filtration products and services increased by 12.3% and 18.1% for the three and six months ended January 31, 2007, respectively, compared with the three and six months ended January 31, 2006, primarily due to the acquisition of Fluid Solutions on May 1, 2006 which contributed $1,348,000 and $2,515,000 of incremental net sales for the three and six months ended January 31, 2007, respectively.
27
Sales of dental products increased by 5.1% and 11.2% for the three and six months ended January 31, 2007, respectively, compared with the three and six months ended January 31, 2006, primarily due to increased demand in the United States for our face masks and instrument sterilization pouches, and increases in selling prices of approximately $560,000 and $1,140,000, respectively. Such selling price increases were implemented to offset corresponding supplier cost increases and therefore did not have a significant impact on gross profit.
Net sales contributed by the Specialty Packaging operating segment were $2,069,000 and $3,655,000, an increase of 65.8% and 49.6% for the three and six months ended January 31, 2007, respectively, compared with the three and six months ended January 31, 2006. This increase in sales was primarily due to increased customer demand in the United States for our specialty packaging and compliance training products and increases in selling prices of approximately $220,000, and $410,000 for the three and six months ended January 31, 2007, respectively.
Sales of dialysis products and services decreased by 3.1% and 10.2% for the three and six months ended January 31, 2007, respectively, compared with the three and six months ended January 31, 2006, primarily due to a decrease in demand from customers for dialysate concentrate (a concentrated acid or bicarbonate used to prepare dialysate, a chemical solution that draws waste products from a patient’s blood through a dialyzer membrane during hemodialysis treatment) in the United States (partially offset by increased international demand), lower average selling prices for Renatron equipment (offset by an increase in demand for Renatrons) and Renalin sterilant due to increased sales to large national chains that typically receive more favorable pricing, and reduced demand for Renalin sterilant domestically. Partially offsetting the decrease in sales of dialysis products and services was an increase of approximately $1,095,000 and $1,665,000 in net sales as a result of shipping and handling fees, such as freight, invoiced to customers during the three and six months ended January 31, 2007 (related costs of a similar amount are included within cost of sales). The majority of these amounts related to two of our larger customers who were previously responsible for transportation related to the products they purchased from us; during fiscal 2007, we became responsible for the transportation and invoiced them for such costs.
The dialysis industry has undergone significant consolidation through the acquisition by certain major dialysis chains of smaller chains and independents. In October 2005, DaVita Inc. (“DaVita”), the second-largest dialysis chain in the United States, acquired Gambro AB’s United States dialysis clinic business, Gambro Healthcare, Inc. (“Gambro US”). DaVita/Gambro US are significant customers of our dialysis reuse products and accounted for approximately 29% and 28% of our dialysis net sales for the three and six months ended January 31, 2007, respectively, and 23% and 24% of our dialysis net sales for the three and six months ended January 31, 2006, respectively. The DaVita/Gambro US acquisition has resulted in greater buying power for the larger resulting entity and thereby a reduction in our net sales and profit margins due to reduced average selling prices of our dialyzer reprocessing products beginning in November 2005.
In addition, on March 31, 2006, Fresenius Medical Care (“Fresenius”), the largest dialysis chain in the United States and a provider of single-use dialyzer products, completed its acquisition of Renal Care Group, Inc. (“RCG”). RCG has been a significant customer of our dialysis reuse products. Combined net sales of Fresenius and RCG accounted for approximately 12% and 13% of our dialysis net sales for the three and six months ended January 31, 2007, respectively, and 22% of our dialysis net sales for both the three and six months ended January 31, 2006, respectively. We believe Fresenius has converted most of the dialysis clinics of RCG into single-use facilities, which has adversely affected our sales of reuse dialysis products. In
28
addition, the Fresenius acquisition has resulted in the loss of low margin concentrate business to the RCG dialysis centers since Fresenius manufactures dialysate concentrate. We believe that the majority of the adverse impact of these acquisitions has already occurred and is therefore reflected in the operating results of our dialysis segment for the three months ended January 31, 2007.
Gross profit
Gross profit increased by $2,683,000, or 15.9%, to $19,521,000 for the three months ended January 31, 2007 from $16,838,000 for the three months ended January 31, 2006. Gross profit as a percentage of net sales for the three months ended January 31, 2007 and 2006 was 37.8% and 35.6%, respectively.
Gross profit increased by $2,891,000, or 8.3%, to $37,690,000 for the six months ended January 31, 2007 from $34,799,000 for the six months ended January 31, 2006. Gross profit as a percentage of net sales for the six months ended January 31, 2007 and 2006 was 36.9% and 36.6%, respectively.
The higher gross profit percentage for the three months ended January 31, 2007, compared with the three months ended January 31, 2006, was primarily attributable to an increase in gross profit percentage on our dialysis products due to (i) an improvement in both customer and product mix related to our dialysate concentrate product, which improvements resulted from the Fresenius acquisition of RCG and our strategy of only maintaining concentrate business with an acceptable gross margin, (ii) lower manufacturing costs including the closing of a distribution center and (iii) more favorable transportation costs due to new freight arrangements with certain customers. To a lesser extent, the increase in gross profit percentage was also attributable to water purification and filtration products and services primarily due to lower manufacturing costs and improved overhead absorption as a result of the increase in equipment and service sales. Partially offsetting these increases in gross profit percentage were a lower gross profit percentage on our endoscope reprocessing products and services primarily due to a low level of billable time for our newly developed U.S. field service organization since most machines sold directly to our customers under our new direct sales and service strategy are still under warranty.
The higher gross profit percentage for the six months ended January 31, 2007, compared with the six months ended January 31, 2006, was primarily attributable to a higher gross profit percentage on our (i) dialysis products as explained above and (ii) dental products due to the non-reoccurrence of a $658,000 one-time purchase accounting charge related to our Dental segment’s inventory incurred during the three months ended October 31, 2005. Partially offsetting these increases in gross profit percentage were a lower gross profit percentage on our (i) endoscope reprocessing products and services as explained above, as well as MDS integration costs, and (ii) water purification and filtration products and services during the three months ended October 31, 2006 primarily due to unabsorbed manufacturing overhead, as well as the sale of water purification equipment at lower than normal margins due to start-up costs of a new line of machines.
Operating Expenses
Selling expenses increased by $1,615,000 to $5,729,000 for the three months ended January 31, 2007, from $4,114,000 for the three months ended January 31, 2006. For the three months
29
ended January 31, 2007, selling expenses increased principally due to a higher cost structure of approximately $900,000 for our endoscope reprocessing direct sales network as a result of our decision to not renew Olympus’ exclusive United States distribution agreement when it expired on August 1, 2006, as more fully described elsewhere is this MD&A, an increase of approximately $220,000 in advertising and marketing expense primarily related to our Dental and Endoscope Reprocessing segments and an increase in compensation expense of approximately $140,000 primarily due to additional sales and marketing personnel in our Specialty Packaging and Dental segments.
Selling expenses increased by $2,812,000 to $11,439,000 for the six months ended January 31, 2007, from $8,627,000 for the six months ended January 31, 2006. For the six months ended January 31, 2007, selling expenses increased principally due to a higher cost structure of approximately $1,700,000 for our endoscope reprocessing direct sales network as a result of our decision to not renew Olympus’ exclusive United States distribution agreement when it expired on August 1, 2006, an increase in compensation expense of approximately $280,000 primarily due to additional sales and marketing personnel in our Specialty Packaging and Dental segments and an increase of approximately $275,000 in advertising and marketing expense primarily related to our Dental and Endoscope Reprocessing segments.
Selling expenses as a percentage of net sales were 11.1% and 11.2% for the three and six months ended January 31, 2007, compared with 8.7% and 9.1% for the three and six months ended January 31, 2006. The increase in selling expenses as a percentage of net sales was primarily attributable to the aforementioned factors.
General and administrative expenses increased by $790,000, or 10.9%, to $8,058,000 for the three months ended January 31, 2007, from $7,268,000 for the three months ended January 31, 2006 principally due to increased compensation expense, including additional personnel, of approximately $490,000; increased accounting and other professional fees of approximately $250,000; and the inclusion of approximately $135,000 of expenses related to the Fluid Solutions acquisition. Partially offsetting these increases was a decrease in stock-based compensation of $50,000.
General and administrative expenses increased by $1,108,000, or 7.6%, to $15,596,000 for the six months ended January 31, 2007, from $14,488,000 for the six months ended January 31, 2006 principally due to increased compensation expense, including additional personnel, of approximately $850,000; increased accounting and other professional fees of approximately $335,000; the inclusion of approximately $270,000 of expenses related to the Fluid Solutions acquisition; and an increase of $130,000 in bad debt expense. Partially offsetting these increases were the non-reoccurrences of $345,000 in incentive compensation directly related to the Crosstex acquisition and $160,000 in debt financing costs related to our amended and restated credit facilities, both of which charges were incurred during the first three months of the six months ended January 31, 2006, as well as a decrease in stock-based compensation expense of $175,000.
General and administrative expenses as a percentage of net sales were 15.6% and 15.3% for the three and six months ended January 31, 2007, compared with 15.4% and 15.2% for the three and six months ended January 31, 2006.
Research and development expenses (which include continuing engineering costs) decreased by $193,000 to $1,222,000 for the three months ended January 31, 2007, from $1,415,000 for the three months ended January 31, 2006. For the six months ended January 31,
30
2007, research and development expenses decreased by $247,000 to $2,388,000, from $2,635,000 for the six months ended January 31, 2006. The majority of our research and development expenses related to our MDS endoscope reprocessor and specialty filtration products. The decrease in research and development expense for the three and six months ended January 31, 2007, compared with the three and six months ended January 31, 2006, is due to less development work on the European version of our MDS endoscope reprocessor.
Interest
Interest expense decreased by $323,000 to $759,000 for the three months ended January 31, 2007, from $1,082,000 for the three months ended January 31, 2006. For the six months ended January 31, 2007, interest expense decreased by $810,000 to $1,522,000, from $2,332,000 for the six months ended January 31, 2006. For the three and six months ended January 31, 2007, interest expense decreased primarily due to the decrease in average outstanding borrowings, partially offset by an increase in average interest rates.
Interest income increased by $11,000 to $160,000 for the three months ended January 31, 2007, from $149,000 for the three months ended January 31, 2006. For the six months ended January 31, 2007, interest income increased by $89,000 to $450,000, from $361,000 for the six months ended January 31, 2006. For the three and six months ended January 31, 2007, interest income increased primarily due to an increase in average interest rates for the three and six months ended January 31, 2006.
Income from continuing operations before income taxes
Income from continuing operations before income taxes increased by $805,000 to $3,913,000 for the three months ended January 31, 2007, from $3,108,000 for the three months ended January 31, 2006. For the six months ended January 31, 2007, income from continuing operations before income taxes increased by $117,000 to $7,195,000, from $7,078,000 for the six months ended January 31, 2006.
Income taxes
The consolidated effective tax rate was 44.8% and 42.2% for the six months ended January 31, 2007 and 2006, respectively.
Our results of continuing operations for the three and six months ended January 31, 2007 and 2006 reflect income tax expense for our United States and international operations at their respective statutory rates. Our United States operations had an effective tax rate of 37.7% for the six months ended January 31, 2007. Our international operations include our subsidiaries in Canada, Singapore and Japan, which had effective tax rates for the six months ended January 31, 2007 of approximately 36.9%, 20.0% and 45.0%, respectively. A tax benefit was not recorded for the six months ended January 31, 2007 and 2006 on the losses from operations at our Netherlands subsidiary, thereby causing the overall effective tax rates to exceed statutory rates.
The higher overall effective tax rate for the six months ended January 31, 2007, compared with the six months ended January 31, 2006, was principally due to losses related to our Netherlands operation for which no income tax benefit was recorded and the geographic mix of pretax income.
31
Stock-Based Compensation
The following table shows the allocation of total stock-based compensation expense relating to continuing operations recognized in the Condensed Consolidated Statements of Income for the three and six months ended January 31, 2007 and 2006:
|
| Three Months Ended |
| Six Months Ended |
| ||||||||
|
| January 31, |
| January 31, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Cost of sales |
| $ | 15,000 |
| $ | 10,000 |
| $ | 14,000 |
| $ | 32,000 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
| ||||
Selling |
| 43,000 |
| 34,000 |
| 69,000 |
| 87,000 |
| ||||
General and administrative |
| 153,000 |
| 203,000 |
| 322,000 |
| 497,000 |
| ||||
Research and development |
| 6,000 |
| 4,000 |
| 10,000 |
| 12,000 |
| ||||
Total operating expenses |
| 202,000 |
| 241,000 |
| 401,000 |
| 596,000 |
| ||||
Stock-based compensation before income taxes |
| 217,000 |
| 251,000 |
| 415,000 |
| 628,000 |
| ||||
Income tax benefits |
| (68,000 | ) | (66,000 | ) | (173,000 | ) | (159,000 | ) | ||||
Total stock-based compensation expense, net of tax |
| $ | 149,000 |
| $ | 185,000 |
| $ | 242,000 |
| $ | 469,000 |
|
For the three and six months ended January 31, 2007, the above stock-based compensation expense before income taxes was recorded in the Condensed Consolidated Financial Statements as stock-based compensation expense and an increase to additional capital. The related income tax benefits (which pertain only to options that do not qualify as incentive stock options) were recorded as an increase to long-term deferred income tax assets (which are netted with long-term deferred income tax liabilities) or a reduction to income taxes payable, depending on the timing of the deduction, and a reduction to income tax expense.
Most of our stock options are subject to graded vesting in which portions of the option award vest at different times during the vesting period, as opposed to awards that vest at the end of the vesting period. We recognize compensation expense for options subject to graded vesting using the straight-line basis, reduced by estimated forfeitures. Total unrecognized stock-based compensation expense related to total nonvested stock options was $1,474,000, net of tax, at January 31, 2007 with a remaining weighted average period of 32 months over which such expense is expected to be recognized. Such unrecognized stock-based compensation expense increased during the three months ended January 31, 2007 due to additional employee stock option grants.
On February 1, 2007, the Company granted 150,000 shares of restricted stock to certain of its employees which had a market price $16.25 per share based on the closing price of Cantel stock on that date. Total unrecognized stock-based compensation expense, net of tax, related to this February 1, 2007 grant was approximately $1,332,000 with a weighted average period of 36 months over which such expense is expected to be recognized.
Upon exercise of stock options, we typically issue new shares of our Common Stock (as opposed to using treasury shares).
If certain criteria are met when options are exercised or the underlying shares are sold, the Company is allowed a deduction on its income tax return. Accordingly, we account for the income tax effect on such income tax deductions as additional capital (assuming deferred tax assets do not exist pertaining to the exercised stock options) and as a reduction of income taxes payable. For the
32
six months ended January 31, 2007 and 2006, options exercised resulted in income tax deductions that reduced income taxes payable by $611,000 and $829,000, respectively.
We classify the cash flows resulting from excess tax benefits as financing cash flows on our Condensed Consolidated Statements of Cash Flows. Excess tax benefits arise when the ultimate tax effect of the deduction for tax purposes is greater than the tax benefit on stock compensation expense (including tax benefits on stock compensation expense that has only been reflected in the pro forma disclosures) which was determined based upon the award’s fair value.
Liquidity and Capital Resources
Working capital
At January 31, 2007, the Company’s working capital was $46,555,000, compared with $43,351,000 at July 31, 2006.
Cash flows from operating activities
Net cash used in operating activities was $4,056,000 for the six months ended January 31, 2007, compared with net cash provided by operating activities of $8,706,000 for the six months ended January 31, 2006. For the six months ended January 31, 2007, the net cash used in operating activities was primarily due to increases in accounts receivable (due to strong sales in the month of January) and inventories (due to planned increases in stock levels of certain products) and decreases in liabilities of discontinued operations (due to the wind-down of Carsen’s operations) and income taxes payable (due to the timing associated with payments), partially offset by net income (after adjusting for depreciation and amortization and stock-based compensation expense) and a decrease in assets of discontinued operations (due to the wind-down of Carsen’s operations). For the six months ended January 31, 2006, the net cash provided by operating activities was primarily due to net income (after adjusting for depreciation and amortization and stock-based compensation expense) and an increase in liabilities of discontinued operations (primarily due to Carsen’s receipt of cash from Olympus relating to the termination of their distribution agreement which could not be recognized as revenue at that time), partially offset by an increase in inventories (due to planned increases in stock levels of certain products) and a decrease in accounts payable and accrued expenses (due to timing associated with payments).
Net cash provided by operating activities related only to continuing operations was $665,000 and $2,328,000 for the six months ended January 31, 2007 and 2006, respectively.
Cash flows from investing activities
Net cash used in investing activities was $6,540,000 and $69,530,000 for the six months ended January 31, 2007 and 2006, respectively. For the six months ended January 31, 2007, the net cash used in investing activities was primarily for the payment of an acquisition earnout to the former owners of Crosstex and capital expenditures. For the six months ended January 31, 2006, the net cash used in investing activities was primarily for the acquisition of Crosstex and capital expenditures.
33
Cash flows from financing activities
Net cash used in financing activities was $2,348,000 for the six months ended January 31, 2007, compared with net cash provided by financing activities of $46,216,000 for the six months ended January 31, 2006. For the six months ended January 31, 2007, the net cash used in financing activities was primarily attributable to purchases of treasury stock and repayments under our credit facilities, partially offset by exercises of stock options. For the six months ended January 31, 2006, net cash provided by financing activities was primarily attributable to borrowings under our credit facilities related to the acquisition of Crosstex, net of debt issuance costs, and proceeds from the exercises of stock options, partially offset by repayments under our credit facilities.
Repurchase of shares
On April 13, 2006, our Board of Directors approved the repurchase of up to 500,000 shares of our outstanding Common Stock. Under the repurchase program we repurchase shares from time-to-time at prevailing prices and as permitted by applicable securities laws (including SEC Rule 10b-18) and New York Stock Exchange requirements, and subject to market conditions. The repurchase program has a one-year term ending April 12, 2007.
The first purchase under our repurchase program occurred on April 19, 2006. Through November 30, 2006, we had repurchased 464,800 shares under the repurchase program at a total average price per share of $14.02. Of the 464,800 shares, 161,800 shares were repurchased during the six months ended January 31, 2007. No additional purchases have been made since November 2006. Therefore, at February 28, 2007, the maximum number of additional shares that may be purchased under the program is 35,200 shares.
Discontinued Operations -Termination of Carsen’s Operations
On July 31, 2006, Carsen closed the sale of substantially all of its assets to Olympus under an Asset Purchase Agreement dated as of May 16, 2006 among Carsen, Cantel and Olympus. Olympus purchased substantially all of Carsen’s assets other than those related to Carsen’s Medivators business and certain other smaller product lines. Following the closing, Olympus hired substantially all of Carsen’s employees and took over Carsen’s Olympus-related operations (as well as the operations related to the other acquired product lines). The transaction resulted in an after-tax gain of $6,776,000 and was recorded separately on the Consolidated Statements of Income for the year ended July 31, 2006 as gain on disposal of discontinued operations, net of tax. In connection with the transaction, Carsen’s Medivators-related assets as well as certain of its other assets that were not acquired by Olympus were sold to our new Canadian distributor of Medivators products.
The purchase price for the net assets sold to Olympus was approximately $31,200,000, comprised of a fixed sum of $10,000,000 plus an additional formula-based sum of $21,200,000. In addition, Olympus is paying Carsen 20% of Olympus’ revenues attributable to Carsen’s unfilled customer orders (“backlog”) as of July 31, 2006 that were assumed by Olympus at the closing. Such payments to Carsen are made following Olympus’ receipt of customer payments for such orders. As of January 31, 2007, approximately $300,000 related to such backlog has been recorded as income and has been reported in income from discontinued operations, net of tax, in the Condensed Consolidated Statements of Income.
34
The $10,000,000 fixed portion of the purchase price was in consideration for (i) Carsen’s customer lists, sales records, and certain other assets related to the sale and servicing of Olympus products and certain non-Olympus products distributed by Carsen, (ii) the release of Olympus’ contractual restriction on hiring Carsen personnel, (iii) real property leases (which were assumed or replaced by Olympus) and leasehold improvements, computer and software systems, equipment and machinery, telephone systems, and records related to the acquired assets, and (iv) assisting Olympus in effecting a smooth transition of Carsen’s business of distributing and servicing Olympus and certain non-Olympus products in Canada. Cantel has also agreed (on behalf of itself and its affiliates) not to manufacture, distribute, sell or represent for sale in Canada through July 31, 2007 any products that are competitive with the Olympus products formerly sold by Carsen under its Olympus Distribution Agreements.
The $21,200,000 formula-based portion of the purchase price was based on the book value of Carsen’s inventories of Olympus and certain non-Olympus products and the net book amount of Carsen’s accounts receivable and certain other assets, all at July 31, 2006, subject to offsets, particularly for accounts payable of Carsen due to Olympus.
Net proceeds from Carsen’s sale of net assets and the termination of Carsen’s operations were approximately $21,100,000 (excluding the backlog payments) after satisfaction of remaining liabilities and taxes.
As a result of the foregoing transaction, which coincided with the expiration of Carsen’s exclusive distribution agreements with Olympus on July 31, 2006, Carsen no longer has any remaining product lines or active business operations.
The net sales and operating income attributable to Carsen’s business (inclusive of both Olympus and non-Olympus business, but exclusive of the sale of Medivators reprocessors) constitute the entire Endoscopy and Surgical reporting segment and Scientific operating segment, which historically was included within the All Other reporting segment.
Operating results attributable to Carsen’s business are summarized below:
|
| Three Months Ended |
| Six Months ended |
| ||||||||
|
| January 31, |
| January 31, |
| ||||||||
|
| 2007 |
| 2006 |
| 2007 |
| 2006 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net sales |
| $ | 126,000 |
| $ | 14,285,000 |
| $ | 1,360,000 |
| $ | 26,705,000 |
|
|
|
|
|
|
|
|
|
|
| ||||
Operating income |
| 27,000 |
| 3,410,000 |
| 407,000 |
| 6,005,000 |
| ||||
Interest expense |
| — |
| 15,000 |
| — |
| 30,000 |
| ||||
Income before income taxes |
| 27,000 |
| 3,395,000 |
| 407,000 |
| 5,975,000 |
| ||||
Income taxes |
| 9,000 |
| 1,204,000 |
| 144,000 |
| 2,124,000 |
| ||||
Income from discontinued operations, net of tax |
| $ | 18,000 |
| $ | 2,191,000 |
| $ | 263,000 |
| $ | 3,851,000 |
|
|
|
|
|
|
|
|
|
|
| ||||
Loss on disposal of discontinued operations |
| $ | — |
| $ | (210,000 | ) | $ | — |
| $ | (413,000 | ) |
Income tax benefit |
| — |
| (74,000 | ) | — |
| (145,000 | ) | ||||
Loss on disposal of discontinued operations, net of tax |
| $ | — |
| $ | (136,000 | ) | $ | — |
| $ | (268,000 | ) |
Included in net sales for the three and six months ended January 31, 2007 are sales that did not meet the Company’s revenue recognition policy as of July 31, 2006 and $300,000 of
35
backlog payments. For the three and six months ended January 31, 2006, the disposal of discontinued operations represents severance expense which was included in the $6,776,000 gain on sale recorded on July 31, 2006.
Cash flows attributable to discontinued operations comprise the following:
|
| Six Months ended January 31, |
| ||||
|
| 2007 |
| 2006 |
| ||
|
|
|
|
|
| ||
Net cash (used in) provided by operating activities |
| $ | (4,721,000 | ) | $ | 6,378,000 |
|
Investing and financing activities of our discontinued operations did not result in any net cash for the three and six months ended January 31, 2007 and 2006.
The components of assets and liabilities of discontinued operations in the Condensed Consolidated Balance Sheets and the activity during the six months ended January 31, 2007 are as follows:
|
| July 31, |
| Recorded as |
| Amounts |
| January 31, |
| ||||
|
| 2006 |
| Income (Expense) |
| Settled |
| 2007 |
| ||||
Current assets: |
|
|
|
|
|
|
|
|
| ||||
Accounts receivable, net |
| $ | 655,000 |
| $ | 297,000 |
| $ | (877,000 | ) | $ | 75,000 |
|
Inventories |
| 695,000 |
| (695,000 | ) | — |
| — |
| ||||
Prepaids and other current assets |
| 771,000 |
| (5,000 | ) | (750,000 | ) | 16,000 |
| ||||
Assets of discontinued operations |
| $ | 2,121,000 |
| $ | (403,000 | ) | $ | (1,627,000 | ) | $ | 91,000 |
|
|
|
|
|
|
|
|
|
|
| ||||
Current liabilities: |
|
|
|
|
|
|
|
|
| ||||
Accounts payable and accrued expenses |
| $ | (3,098,000 | ) | $ | (211,000 | ) | $ | 3,110,000 |
| $ | (199,000 | ) |
Compensation payable |
| (1,195,000 | ) | (42,000 | ) | 1,236,000 |
| (1,000 | ) | ||||
Deferred revenue |
| (1,063,000 | ) | 1,063,000 |
| — |
| — |
| ||||
Income taxes payable |
| (2,023,000 | ) | (144,000 | ) | 2,020,000 |
| (147,000 | ) | ||||
Liabilities of discontinued operations |
| $ | (7,379,000 | ) | $ | 666,000 |
| $ | 6,366,000 |
| $ | (347,000 | ) |
The liabilities at January 31, 2007 are expected to be settled prior to July 31, 2007.
Direct Sale of Medivators Systems in the United States
On August 2, 2006, we commenced the sale and service of our Medivators brand endoscope reprocessing equipment, high-level disinfectants, cleaners and consumables through our own United States field sales and service organization. Our direct sale of these products is the result of our decision that it is in our best long-term interests to control and develop our own direct-hospital based United States distribution network and, as such, not to renew Olympus’ exclusive United States distribution agreement when it expired on August 1, 2006.
Throughout the former distribution arrangement with Olympus, we employed our own personnel to provide clinical sales support activities as well as an internal technical and customer service function, depot maintenance and service and all logistics and distribution services for the Medivators/Olympus customer base. This existing and fully developed infrastructure will continue to be a critical factor in our new direct sales and service strategy.
During the seven-year period following the expiration of the distribution agreement with Olympus on August 1, 2006, Olympus will have the option to provide certain ongoing support functions to its existing customer base of Medivators products, subject to the terms and
36
conditions of the agreement. In addition, Olympus may continue to purchase from Minntech for resale in connection with such support functions, Medivators accessories, consumables, and replacement and repair parts, as well as RapicideÒ disinfectant.
Long-term contractual obligations
Aggregate annual required payments over the next five years and thereafter under our contractual obligations that have long-term components are as follows:
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| Six Months |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
|
| Ended |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
|
| January 31, |
| Year Ending July 31, |
|
|
| |||||||||||||||
|
| 2007 |
| 2008 |
| 2009 |
| 2010 |
| 2011 |
| Thereafter |
| Total |
| |||||||
|
| (Amounts in thousands) |
| |||||||||||||||||||
Maturities of the credit facilities |
| $ | 2,000 |
| $ | 6,000 |
| $ | 8,000 |
| $ | 10,000 |
| $ | 10,000 |
| $ | — |
| $ | 36,000 |
|
Expected interest payments under the credit facilities (1) |
| 1,197 |
| 2,128 |
| 1,657 |
| 1,050 |
| 369 |
| — |
| 6,401 |
| |||||||
Minimum commitments under noncancelable operating leases |
| 1,521 |
| 2,544 |
| 2,341 |
| 1,740 |
| 1,163 |
| 2,134 |
| 11,443 |
| |||||||
Minimum commitment under noncancelable capital lease |
| 4 |
| — |
| — |
| — |
| — |
| — |
| 4 |
| |||||||
Note payable - Dyped |
| 551 |
| 648 |
| — |
| — |
| — |
| — |
| 1,199 |
| |||||||
Deferred compensation and other |
| 94 |
| 180 |
| 42 |
| 34 |
| 406 |
| 1,012 |
| 1,768 |
| |||||||
Minimum commitments under license agreement |
| 17 |
| 44 |
| 66 |
| 99 |
| 147 |
| 2,620 |
| 2,993 |
| |||||||
Employment agreements |
| 1,634 |
| 3,679 |
| 967 |
| 140 |
| 116 |
| 122 |
| 6,658 |
| |||||||
Total contractual obligations |
| $ | 7,018 |
| $ | 15,223 |
| $ | 13,073 |
| $ | 13,063 |
| $ | 12,201 |
| $ | 5,888 |
| $ | 66,466 |
|
(1) The expected interest payments under the credit facilities reflect an interest rate of 6.81%, which was our interest rate on outstanding borrowings at January 31, 2007.
Credit facilities
In conjunction with the acquisition of Crosstex, we entered into amended and restated credit facilities dated as of August 1, 2005 (the “2005 U.S. Credit Facilities”) with a consortium of United States lenders to fund the cash consideration paid in the acquisition and costs associated with the acquisition, as well as to modify our existing United States credit facilities. The 2005 U.S. Credit Facilities include (i) a six-year $40.0 million senior secured amortizing term loan facility and (ii) a five-year $35.0 million senior secured revolving credit facility. In addition, we agreed to repay the July 31, 2005 outstanding borrowings of $15,750,000 under our original term loan facility within ninety (90) days from the closing. In October 2005, such amount was repaid primarily through the repatriation of funds from our foreign subsidiaries. Amounts we repay under the term loan facility may not be re-borrowed. Additionally, we incurred debt issuance costs of approximately $1,426,000, of which $160,000 of third-party costs was recorded in general and administrative expenses during the three months ended October 31, 2005 in accordance with applicable accounting rules. The remaining $1,266,000 of costs was recorded in other assets and is being amortized over the life of the credit facilities.
Borrowings under the 2005 U.S. Credit Facilities bear interest at rates ranging from 0% to 0.75% above the lender’s base rate, or at rates ranging from 1.0% to 2.0% above the London Interbank Offered Rate (“LIBOR”), depending upon our consolidated ratio of debt to earnings
37
before interest, taxes, depreciation and amortization, and as further adjusted under the terms of the 2005 U.S. Credit Facilities (“EBITDA”). At February 28, 2007, the lender’s base rate was 8.25% and the LIBOR rates ranged from 5.30% to 5.35%. The margins applicable to our outstanding borrowings at February 28, 2007 were 0.25% above the lender’s base rate and 1.50% above LIBOR. All of our outstanding borrowings were under LIBOR contracts at February 28, 2007. The 2005 U.S. Credit Facilities also provide for fees on the unused portion of our facilities at rates ranging from 0.20% to 0.40%, depending upon our consolidated ratio of debt to EBITDA; such rate was 0.30% at February 28, 2007.
The 2005 U.S. Credit Facilities require us to meet certain financial covenants and are secured by (i) substantially all of our U.S.-based assets (including assets of Cantel, Minntech, Mar Cor and Crosstex) and (ii) our pledge of all of the outstanding shares of Minntech, Mar Cor and Crosstex and 65% of the outstanding shares of our foreign-based subsidiaries. Additionally, we are not permitted to pay cash dividends on our Common Stock without the consent of our United States lenders. As of January 31, 2007, we are in compliance with all financial and other covenants under the 2005 U.S. Credit Facilities.
On January 31, 2007, we had $36,000,000 of outstanding borrowings under the 2005 U.S. Credit Facilities all of which was under the United States term loan facility.
Operating leases
Minimum commitments under operating leases include minimum rental commitments for our leased manufacturing facilities, warehouses, office space and equipment.
Dyped note payable and other long-term liabilities
In conjunction with the Dyped acquisition on September 12, 2003, we issued a note with a face value of €1,350,000 ($1,505,000 using the exchange rate on the date of the acquisition). At January 31, 2007, $1,199,000 of this note was outstanding using the exchange rate on January 31, 2007. Such note is non-interest bearing and has been recorded at its present value of $1,136,000 at January 31, 2007. The current portion of this note is recorded in accrued expenses and the remainder is recorded in other long-term liabilities.
Also included in other long-term liabilities are amounts due pursuant to deferred compensation arrangements for certain former Minntech directors and officers.
License agreement
On January 1, 2007, we entered into a license agreement with a third-party which allows us to manufacture, use, import, sell and distribute certain thermal control products relating to our Specialty Packaging segment. In consideration, we agreed to pay a minimum annual royalty payable each calendar year over the license agreement term of 20 years. At January 31, 2007, we had minimum future royalty obligations of approximately $2,993,000 relating to this license agreement.
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Financing needs
At January 31, 2007, we had a cash balance of $16,726,000, of which $6,933,000 was held by foreign subsidiaries. We believe that our current cash position, anticipated cash flows from operations, and the funds available under our revolving credit facility will be sufficient to satisfy our cash operating requirements for the foreseeable future based upon our existing operations. At February 28, 2007, all of our $35,000,000 United States revolving credit facility was available.
Foreign currency
During the three and six months ended January 31, 2007, compared with the three and six months ended January 31, 2006, the average value of the Canadian dollar increased by approximately 1.0% and 3.5%, respectively, relative to the value of the United States dollar. Changes in the value of the Canadian dollar against the United States dollar affect our results of operations principally for the following reasons:
(i) Our Canadian subsidiaries (which are included in the Specialty Packaging and Water Purification and Filtration segments) purchase a portion of their inventories, incur certain operating costs and sell a significant amount of their products in United States dollars, and therefore are exposed to realized foreign currency gains and losses upon payment of such payables and the collection of such receivables. Similarly, such United States denominated assets and liabilities must be converted into their functional Canadian currency when preparing their financial statements, which results in realized foreign exchange gains and losses. The increase in the average value of the Canadian dollar, as explained above, primarily resulted in gains for such liabilities and losses for such assets. Since our Canadian subsidiaries had a similar amount of assets and liabilities denominated in United States dollars, the increase in the average value of the Canadian dollar had an insignificant effect on our results of operations for the three and six months ended January 31, 2007.
(ii) Since our Canadian subsidiaries purchase a portion of their inventories, incur certain operating costs and sell a significant amount of their products in United States dollars and record such amounts in their financial statements in their functional Canadian currency, such amounts can be higher or lower based on the change in the average value of the Canadian dollar compared with the prior year. The increase in the average value of the Canadian dollar primarily resulted in such costs and such sales to be recorded at a lower amount for the three and six months ended January 31, 2007, compared with the three and six months ended January 31, 2006. Since our Canadian subsidiaries had significantly more sales of their products in United States dollars than costs paid in United States dollars, the increase in the average value of the Canadian dollar had an insignificant negative impact upon their results of operations for the three and six months ended January 31, 2007 compared with the three and six months ended January 31, 2006.
(iii) The results of operations of our Canadian subsidiaries are translated from their functional Canadian currency to United States dollars for purposes of preparing our Condensed Consolidated Financial Statements. The increase in the average value of the Canadian dollar, as explained above, had an overall insignificant positive impact upon our results of operations due to translating the results of operations for the three and six months ended January 31, 2007 at a higher average currency exchange rate compared with the average
39
currency exchange rate used to translate the results of operations for the three and six months ended January 31, 2006.
During the three and six months ended January 31, 2007, such strengthening of the Canadian dollar relative to the United States dollar had an overall insignificant impact upon our results of continuing operations.
For the three and six months ended January 31, 2007, compared with the three and six months ended January 31, 2006, the value of the euro increased by approximately 9.2% and 6.8%, respectively, relative to the value of the United States dollar. Changes in the value of the euro against the United States dollar affect our results of operations for the following reasons:
(i) Our Netherlands subsidiary (which is reported primarily in our Dialysis and Endoscope Reprocessing segments) maintains a portion of its cash in United States dollars, sells some of its products in United States dollars and pays various liabilities in United States dollars. Therefore, it is exposed to realized foreign currency gains and losses upon activity in such dollar cash accounts, collection of such receivables and payment of such liabilities. Similarly, such United States denominated assets and liabilities must be converted into their functional euro currency when preparing their financial statements, which results in realized foreign exchange gains and losses. The increase in the average value of the euro, as explained above, primarily resulted in gains for such liabilities and losses for such assets. Since our Netherlands subsidiary had more assets than liabilities denominated in United States dollars, the increase in the average value of the euro had an overall adverse affect on our results of operations for the three and six months ended January 31, 2007.
(ii) The results of operations of our Netherlands subsidiary are translated from its functional euro currency to United States dollars for the purpose of preparing our consolidated financial statements. The increase in the average value of the euro, as explained above, had an overall adverse impact upon our results of operations due to translating the fiscal 2006 results of operations (which had an overall loss) at a higher average currency exchange rate compared with the average currency exchange rate used to translate the three and six months ended January 31, 2006 results of operations (which also had an overall loss).
During the three and six months ended January 31, 2007, such strengthening of the euro relative to the United States dollar had an overall adverse impact upon our results of operations of approximately $100,000.
In order to hedge against the impact of fluctuations in the value of the euro relative to the United States dollar on the conversion of such dollar denominated net assets into functional currency, we enter into short-term contracts to purchase euros forward, which contracts are generally one month in duration. These short-term contracts are designated as fair value hedges. There was one foreign currency forward contract amounting to €490,000 at February 28, 2007 which covers certain assets and liabilities of Minntech’s Netherlands subsidiary which are denominated in United States dollars. Such contract expires on March 31, 2007. Under our credit facilities, such contracts to purchase euros may not exceed $12,000,000 in an aggregate notional amount at any time. During the three and six months ended January 31, 2007, such forward contracts were effective in offsetting most of the impact of the strengthening of the euro on our results of operations.
40
In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 133, as amended, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), all of our foreign currency forward contracts were designated as hedges. Gains and losses related to the hedging contracts to buy euros forward are immediately realized within general and administrative expenses due to the short-term nature of such contracts.
For purposes of translating the balance sheet at January 31, 2007 compared with July 31, 2006, the value of the Canadian dollar decreased by approximately 3.8% and the value of the euro increased by approximately 1.4% compared with the value of the United States dollar. The total of these currency movements resulted in a foreign currency translation loss of $993,000 during the six months ended January 31, 2007, thereby decreasing stockholders’ equity.
Changes in the value of the Japanese yen relative to the United States dollar during the three and six months ended January 31, 2007, compared with the three and six months ended January 31, 2006, did not have a significant impact upon either our results of operations or the translation of our balance sheet, primarily due to the fact that our Japanese subsidiary accounts for a relatively small portion of consolidated net sales, net income and net assets.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we continually evaluate our estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our Condensed Consolidated Financial Statements.
Revenue Recognition
Revenue on product sales is recognized as products are shipped to customers and title passes. The passing of title is determined based upon the FOB terms specified for each shipment. With respect to dialysis, therapeutic, specialty packaging and endoscope reprocessing products, shipment terms are generally FOB origin for common carrier and FOB destination when our distribution fleet is utilized (except for one large customer in dialysis whereby all products are shipped FOB destination). With respect to water purification and filtration and dental products, shipment terms may be either FOB origin or destination. Customer acceptance for the majority of our product sales occurs at the time of delivery. In certain instances, primarily with respect to some of our water purification and filtration equipment, endoscope reprocessing equipment and an insignificant amount of our sales of dialysis equipment, post-delivery obligations such as installation, in-servicing or training are contractually specified; in such instances, revenue recognition is deferred until all of such conditions have been substantially fulfilled such that the
41
products are deemed functional by the end-user. With respect to a portion of water purification and filtration product sales, equipment is sold as part of a system for which the equipment is functionally interdependent or the customer’s purchase order specifies “ship-complete” as a condition of delivery; revenue recognition on such sales is deferred until all equipment has been delivered.
Revenue on service sales is recognized when repairs are completed at the customer’s location or when repairs are completed at our facilities and the products are shipped to customers. All shipping and handling fees invoiced to customers, such as freight, are recorded as revenue (and related costs are included within cost of sales) at the time the sale is recognized.
None of our sales contain right-of-return provisions except certain sales of a small portion of our endoscope reprocessing equipment which contain a 15 day right-of-return trial period. Such sales are not recognized as revenue until the 15 day trial period has elapsed. Customer claims for credit or return due to damage, defect, shortage or other reason must be pre-approved by us before credit is issued or such product is accepted for return. No cash discounts for early payment are offered except with respect to a portion of our sales of dialysis and dental products and certain prepaid packaging products. We do not offer price protection, although advance pricing contracts or required notice periods prior to implementation of price increases exist for certain customers with respect to many of our products. With respect to certain of our dialysis and dental customers, volume rebates and trade-in allowances are provided; such volume rebates and trade-in allowances are provided for as a reduction of sales at the time of revenue recognition and amounted to $379,000 and $1,158,000 for the three and six months ended January 31, 2007, respectively, and $393,000 and $482,000 for the three and six months ended January 31, 2006, respectively. Included in the volume rebates for the six months ended January 31, 2006 was the cancellation of a volume rebate program resulting from consolidation in the dialysis industry. Such allowances are determined based on estimated projections of sales volume and trade-ins for the entire rebate agreement periods. Trade-in allowances were not significant for the three and six months ended January 31, 2007 and 2006. If it becomes known that sales volume to customers will deviate from original projections, the volume rebate provisions originally established would be adjusted accordingly.
The majority of our dialysis products are sold to end-users; the majority of therapeutic filtration products and dental products are sold to third party distributors; water purification and filtration products and services are sold directly and through third-party distributors to hospitals, dialysis clinics, pharmaceutical and biotechnology companies and other end-users; and specialty packaging products are sold to third-party distributors, medical research companies, laboratories, pharmaceutical companies, hospitals, government agencies and other end-users. Sales to all of these customers follow our revenue recognition policies. Due to the direct distribution of our endoscope reprocessing products in the United States which commenced on August 2, 2006, a significant portion of our endoscope reprocessing products and services are sold directly to hospitals and other end-users. Previously, the majority of our endoscope reprocessing products and services were sold to third party distributors.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable consist of amounts due to us from normal business activities. Allowances for doubtful accounts are reserves for the estimated loss from the inability of customers to make required payments. We use historical experience as well as current market information in determining the estimate. While actual losses have historically been within
42
management’s expectations and provisions established, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Alternatively, if certain customers paid their delinquent receivables, reductions in allowances may be required.
Inventories
Inventories consist of products which are sold in the ordinary course of our business and are stated at the lower of cost (first-in, first-out) or market. In assessing the value of inventories, we must make estimates and judgments regarding reserves required for product obsolescence, aging of inventories and other issues potentially affecting the saleable condition of products. In performing such evaluations, we use historical experience as well as current market information. With few exceptions, the saleable value of our inventories has historically been within management’s expectation and provisions established, however, rapid changes in the market due to competition, technology and various other factors could have an adverse effect on the saleable value of our inventories, resulting in the need for additional reserves.
Goodwill and Intangible Assets
Certain of our identifiable intangible assets, including customer relationships, brand names, technology, non-compete agreements and patents, are amortized on the straight-line method over their estimated useful lives which range from 3 to 20 years. Additionally, we have recorded goodwill and trademarks and trade names, all of which have indefinite useful lives and are therefore not amortized. All of our intangible assets and goodwill are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, and goodwill and intangible assets with indefinite lives are reviewed for impairment at least annually. Our management is primarily responsible for determining if impairment exists and considers a number of factors, including third-party valuations, when making these determinations. In performing a review for goodwill impairment, management uses a two-step process that begins with an estimation of the fair value of the related operating segments. The first step is a review for potential impairment, and the second step measures the amount of impairment, if any. In performing our annual review for indefinite lived intangibles, management compares the current fair value of such assets to their carrying values. With respect to amortizable intangible assets when impairment indicators are present, management would determine whether non-discounted cash flows would be sufficient to recover the carrying value of the assets; if not, the carrying value of the assets would be adjusted to their fair value. On July 31, 2006, management concluded that none of our intangible assets or goodwill was impaired and no impairment indicators are present as of January 31, 2007. While the results of these annual reviews have historically not indicated impairment, impairment reviews are highly dependent on management’s projections of our future operating results which management believes to be reasonable.
Long-lived assets
We evaluate the carrying value of long-lived assets including property, equipment and other assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. An assessment is made to determine if the sum of the expected future non-discounted cash flows from the use of the assets and eventual disposition is less than the carrying value. If the sum of the expected non-discounted cash flows is less than the carrying value, an impairment loss is recognized based on fair value. With few exceptions, our historical
43
assessments of our long-lived assets have not differed significantly from the actual amounts realized. However, the determination of fair value requires us to make certain assumptions and estimates and is highly subjective, and accordingly, actual amounts realized may differ significantly from our estimate.
Warranties
We provide for estimated costs that may be incurred to remedy deficiencies of quality or performance of our products at the time of revenue recognition. Most of our products have a one year warranty, although a majority of our endoscope reprocessing equipment in the United States carry a warranty period of up to fifteen months. We record provisions for product warranties as a component of cost of sales based upon an estimate of the amounts necessary to settle existing and future claims on products sold. The historical relationship of warranty costs to products sold is the primary basis for the estimate. A significant increase in third party service repair rates, the cost and availability of parts or the frequency of claims could have a material adverse impact on our results for the period or periods in which such claims or additional costs materialize. Management reviews its warranty exposure periodically and believes that the warranty reserves are adequate; however, actual claims incurred could differ from original estimates, requiring adjustments to the reserves.
Stock-Based Compensation
On August 1, 2005, we adopted SFAS No. 123R using the modified prospective method for the transition. Under the modified prospective method, stock compensation expense will be recognized for any option grant or stock award granted on or after August 1, 2005, as well as the unvested portion of stock options granted prior to August 1, 2005, based upon the award’s fair value. For fiscal 2005 and earlier periods, we have accounted for stock options using the intrinsic value method under which stock compensation expense is not recognized because we granted stock options with exercise prices equal to the market value of the shares at the date of grant.
Most of our stock options are subject to graded vesting in which portions of the option award vest at different times during the vesting period, as opposed to awards that vest at the end of the vesting period. We recognize compensation expense for options subject to graded vesting using the straight-line basis, reduced by estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience.
The stock-based compensation expense recorded in our Condensed Consolidated Financial Statements may not be representative of the effect of stock-based compensation expense in future periods due to the level of options issued in past years (which level may not be similar in the future), assumptions used in determining fair value, and estimated forfeitures. We estimate the fair value of each option grant on the date of grant using the Black-Scholes option valuation model. The determination of fair value using an option-pricing model is affected by our stock price as well as assumptions regarding a number of subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the expected option life (which is determined by using the historical closing prices of our Common Stock), the expected dividend yield (which is expected to be 0%), and the expected option life (which is based on historical exercise behavior). If factors change and we employ different assumptions in the application of SFAS 123R in future periods, the compensation expense that we would record under SFAS 123R may differ significantly from what we have recorded in the current period. With respect to stock options granted during the three months ended January 31, 2007, we
44
reassessed both the expected option life and stock price volatility assumptions by evaluating more recent historical exercise behavior and stock price activity; such reevaluation resulted in reductions in both the expected option lives and volatility.
Costs Associated with Exit or Disposal Activities
We recognize costs associated with exit or disposal activities, such as costs to terminate a contract, the exit or disposal of a business, or the early termination of a leased property, by recognizing the liability at fair value when incurred, except for certain one-time termination benefits, such as severance costs, for which the period of recognition begins when a severance plan is communicated to employees.
Inherent in the calculation of liabilities relating to exit and disposal activities are significant management judgments and estimates, including estimates of termination costs, employee attrition, and the interest rate used to discount certain expected net cash payments. Such judgments and estimates are reviewed by us on a regular basis. The cumulative effect of a change to a liability resulting from a revision to either timing or the amount of estimated cash flows is recognized by us as an adjustment to the liability in the period of the change.
Although we have historically recorded minimal charges associated with exit or disposal activities, we recorded $136,000 and $268,000 of severance costs, net of tax, as a loss from disposal of discontinued operations for the three and six months ended January 31, 2006, respectively, related to the sale of substantially all of Carsen’s assets on July 31, 2006.
Legal Proceedings
In the normal course of business, we are subject to pending and threatened legal actions. We record legal fees and other expenses related to litigation as incurred. Additionally, we assess, in consultation with our counsel, the need to record a liability for litigation and contingencies on a case by case basis. Amounts are accrued when we, in consultation with counsel, determine that a liability has been incurred and an amount of anticipated exposure can be reasonably estimated.
Income Taxes
We recognize deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. Deferred tax assets and liabilities also include items recorded in conjunction with the purchase accounting for business acquisitions. We regularly review our deferred tax assets for recoverability and establish a valuation allowance, if necessary, based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. Although realization is not assured, management believes it is more likely than not that the recorded deferred tax assets, as adjusted for valuation allowances, will be realized. Additionally, deferred tax liabilities are regularly reviewed to confirm that such amounts are appropriately stated. Such a review considers known future changes in various effective tax rates, principally in the United States. If the United States effective tax rate were to change in the future, our items of deferred tax could be materially affected. All of such evaluations require significant management judgments.
It is our policy to establish reserves for exposures as a result of an examination by tax authorities. We establish the reserves based primarily upon management’s assessment of
45
exposure associated with acquired companies and permanent tax differences. The tax reserves are analyzed periodically (at least annually) and adjustments are made, as events occur to warrant adjustment to the reserves. The majority of our income tax reserves originated from acquisitions.
Business Combinations
Acquisitions require significant estimates and judgments related to the fair value of assets acquired and liabilities assumed.
Certain liabilities are subjective in nature. We reflect such liabilities based upon the most recent information available. In conjunction with our acquisitions, such subjective liabilities principally include certain income tax and sales and use tax exposures, including tax liabilities related to our foreign subsidiaries. The ultimate settlement of such liabilities may be for amounts which are different from the amounts recorded.
Other Matters
We do not have any off balance sheet financial arrangements, other than future commitments under operating leases and employment and license agreements.
Forward Looking Statements
This quarterly report on Form 10-Q contains “forward-looking statements” as that term is defined under the Private Securities Litigation Reform Act of 1995 and releases issued by the Securities and Exchange Commission (the “SEC”) and within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements are based on current expectations, estimates, or forecasts about our businesses, the industries in which we operate, and the beliefs and assumptions of management; they do not relate strictly to historical or current facts. We have tried, wherever possible, to identify such statements by using words such as “expect,” “anticipate,” “goal,” “project,” “intend,” “plan,” “believe,” “seek,” “may,” “could,” and variations of such words and similar expressions. In addition, any statements that refer to predictions or projections of our future financial performance, anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions about future events, activities or developments and are subject to numerous risks, uncertainties, and assumptions that are difficult to predict including, among other things, the following:
· the increasing market share of single-use dialyzers relative to reuse dialyzers
· the adverse impact of consolidation of dialysis providers
· uncertainties related to our assumption of direct sales and service of Medivators endoscope reprocessing products in the United States on August 2, 2006
· our dependence on a concentrated number of distributors for our dental segment products
· our ability to acquire new businesses and successfully integrate and operate such businesses
· foreign currency exchange rate and interest rate fluctuations
· the impact of significant government regulation on our businesses
You should understand that it is not possible to predict or identify all such factors.
46
Consequently, you should not consider the foregoing items to be a complete list of all potential risks or uncertainties. See “Risk Factors” in our 2006 Form 10-K for a discussion of the above risk factors and certain additional risk factors that you should consider before investing in the shares of our common stock.
All forward-looking statements herein speak only as of the date of this Report. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
For these statements, we claim the protection of the safe harbor for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Exchange Act.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Foreign Currency Market Risk
A portion of our products are imported from the Far East and Western Europe. All of our operating segments sell a portion of their products outside of the United States and our Netherlands subsidiary sells a portion of its products outside of the European Union. Consequently, our business could be materially affected by the imposition of trade barriers, fluctuations in the rates of exchange of various currencies, tariff increases and import and export restrictions, affecting the United States, Canada and the Netherlands.
A portion of our Canadian subsidiaries’ inventories and operating costs (which are reported in the Water Purification and Filtration and Specialty Packaging segments) are purchased in the United States and a significant amount of their sales are to customers in the United States. The businesses of our Canadian subsidiaries could be materially and adversely affected by the imposition of trade barriers, fluctuations in the rate of currency exchange, tariff increases and import and export restrictions between the United States and Canada. Additionally, the financial statements of our Canadian subsidiaries are translated using the accounting policies described in Note 2 to 2006 Form 10-K. Fluctuations in the rates of currency exchange between the United States and Canada had an insignificant impact for the three and six months ended January 31, 2007, compared with the three and six months ended January 31, 2006, upon our continuing results of operations and a negative impact on stockholders’ equity, as described in our MD&A.
Changes in the value of the euro against the United States dollar affect our results of operations because a portion of the net assets of Our Netherlands subsidiary (which are reported in our Dialysis and Endoscope Reprocessing segments) are denominated and ultimately settled in United States dollars but must be converted into its functional euro currency. Additionally, financial statements of the Netherlands subsidiary are translated using the accounting policies described in Note 2 to the 2006 Form 10-K. Fluctuations in the rates of currency exchange between the Euro and the United States dollar had an overall adverse impact for the three and six months ended January 31, 2007, compared with the three and six months ended January 31, 2006, upon our continuing results of operations as described in our MD&A, and had a positive impact upon stockholders’ equity.
47
In order to hedge against the impact of fluctuations in the value of the euro relative to the United States dollar, we enter into short-term contracts to purchase euros forward, which contracts are generally one month in duration. These short-term contracts are designated as fair value hedge instruments. There was one foreign currency forward contract amounting to €384,000 at January 31, 2007 which covered certain assets and liabilities of Minntech’s Netherlands subsidiary which are denominated in United States dollars. Such contract expired on February 28, 2007. Under our credit facilities, such contracts to purchase euros may not exceed $12,000,000 in an aggregate notional amount at any time. For the three and six months ended January 31, 2007, such forward contracts were effective in offsetting most of the impact of the strengthening of the euro on our results of operations.
The functional currency of Minntech’s Japan subsidiary is the Japanese yen. Changes in the value of the Japanese yen relative to the United States dollar for the three and six months ended January 31, 2007 and 2006 did not have a significant impact upon either our results of operations or the translation of the balance sheet, primarily due to the fact that our Japanese subsidiary accounts for a relatively small portion of consolidated net sales, net income and net assets.
Interest Rate Market Risk
We have a United States credit facility for which the interest rate on outstanding borrowings is variable. Therefore, interest expense is principally affected by the general level of interest rates in the United States.
Market Risk Sensitive Transactions
Additional information related to market risk sensitive transactions is contained in Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our 2006 Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES.
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
We, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report on Form 10-Q. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer each concluded that our disclosure controls and procedures are effective in providing reasonable assurance that information required to be disclosed by us in reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the SEC.
We have evaluated our internal controls over financial reporting and determined that no changes occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting, except as
48
described below.
Changes in Internal Control
On August 1, 2005, which was the first day of fiscal 2006, we acquired Crosstex, as more fully described in Note 3 to the Condensed Consolidated Financial Statements. For the three and six months ended January 31, 2007 and 2006, Crosstex represented a material portion of our sales, net income and net assets. In conjunction with the due diligence performed by us in connection with this acquisition, we determined that the overall internal control environment of Crosstex contained a number of significant deficiencies, some of which rose to the level of material weaknesses. Some of the more significant internal control weaknesses included the lack of segregation of duties, the need to hire a principal financial and accounting officer, numerous limitations with respect to the management information systems, lack of application of GAAP in certain aspects of financial reporting, and substandard monthly closing procedures.
We believe we have remedied the majority of the more significant internal control weaknesses at Crosstex. In order to achieve these objectives, we took a number of steps during fiscal 2006 and the six months ended January 31, 2007 including hiring a principal financial and accounting officer at Crosstex in October 2005 and a Controller in December 2006, formalizing the monthly closing procedures and timing, and ensuring consistent and complete application of GAAP. Additionally, we have implemented a number of additional internal control procedures designed to ensure the completeness and accuracy of reported financial information, including periodic physical inventories, monthly account analyses and quarter-end field reviews by representatives of Cantel’s financial and accounting staff. We are relying extensively on detect controls with respect to reported month-end financial information until such time that appropriate prevent controls can be implemented. We have evaluated the management information systems at Crosstex and have selected a replacement of the existing system. The implementation process of this new system has recently commenced and is expected to be completed late in fiscal 2007. Since the acquisition, significant improvements have already been made in the overall Crosstex internal control environment and will continue to be made throughout fiscal 2007. The most significant change anticipated for the remainder of fiscal 2007 is the implementation of a new management information system as discussed above. However, no assurances can be given that the implementation of the new management information system will be completed during fiscal 2007 and that such related controls will be operating effectively by July 31, 2007.
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PART II - OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS |
|
|
| See Part I, Item 1. — Note 14 above. |
|
|
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
Purchase of equity securities by Cantel:
On April 13, 2006, our Board of Directors approved the repurchase of up to 500,000 shares of our outstanding Common Stock. Under the repurchase program we repurchase shares from time-to-time at prevailing prices and as permitted by applicable securities laws (including SEC Rule 10b-18) and New York Stock Exchange requirements, and subject to market conditions. The repurchase program has a one-year term ending April 12, 2007.
The first purchase under our repurchase program occurred on April 19, 2006. Through November 30, 2006, we had repurchased 464,800 shares under the repurchase program. No additional purchases have occurred since that date.
The following table summarizes the repurchase of Common Stock under the repurchase program by quarter during fiscal years 2007 and 2006:
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|
| Total number of shares |
| Maximum number of |
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|
|
| purchased as part of |
| shares that may yet |
| ||||||||
|
| Total number of |
| Average price |
| publicly announced |
| be purchased under |
| ||||||||
Period |
| shares purchased |
| paid per share |
| plans or programs |
| the program |
| ||||||||
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
4/19/06 |
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
through |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4/30/06 |
|
| 123,300 |
|
|
| $14.63 |
|
|
| 123,300 |
|
|
| 376,700 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5/1/06 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
through |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7/31/06 |
|
| 179,700 |
|
|
| $13.88 |
|
|
| 303,000 |
|
|
| 197,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8/1/06 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
through |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10/31/06 |
|
| 89,000 |
|
|
| $13.56 |
|
|
| 392,000 |
|
|
| 108,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11/1/06 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
through |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11/30/06 |
|
| 72,800 |
|
|
| $13.89 |
|
|
| 464,800 |
|
|
| 35,200 |
|
|
50
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On January 10, 2007, the Company held its Annual Meeting of Stockholders for the fiscal year ended July 31, 2006. At the meeting, stockholders voted for the election of ten members of the Company’s Board of Directors to serve until the next annual meeting and until their successors are duly elected and qualified. Stockholders also voted for the approval of the equity incentive plan and the ratification of Ernst & Young LLP to serve as the Company’s independent registered public accounting firm for the fiscal year ending July 31, 2007.
A tabulation of the number of votes cast for, against and withhold, as well as the number of abstentions as to each matter voted on, is set forth below. There were no broker non-votes.
1. |
| Election of Directors |
| Votes |
| Votes |
|
|
|
|
|
|
|
|
|
|
| Robert L. Barbanell |
| 15,310,747 |
| 85,240 |
|
|
| Alan R. Batkin |
| 15,237,642 |
| 158,345 |
|
|
| Joseph M. Cohen |
| 15,198,406 |
| 197,581 |
|
|
| Charles M. Diker |
| 15,236,728 |
| 159,259 |
|
|
| Darwin C. Dornbush |
| 14,886,097 |
| 509,890 |
|
|
| Spencer Foreman, M.D. |
| 15,178,939 |
| 217,048 |
|
|
| Alan J. Hirschfield |
| 15,200,287 |
| 195,700 |
|
|
| Elizabeth McCaughey |
| 15,323,240 |
| 72,747 |
|
|
| R. Scott Jones |
| 15,320,848 |
| 75,139 |
|
|
| Bruce Slovin |
| 15,315,876 |
| 80,111 |
|
|
|
|
|
|
|
|
|
2. |
| Approval of Equity Incentive Plan |
| For |
| Against |
| Abstain |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 11,466,157 |
| 909,812 |
| 25,137 |
|
3. |
| Ratification of Independent Registered Public Accounting Firm |
| For |
| Against |
| Abstain |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 15,305,716 |
| 83,311 |
| 6,960 |
|
51
ITEM 6. EXHIBITS
| 31.1 | — Certification of Principal Executive Officer. |
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|
|
| 31.2 | — Certification of Principal Financial Officer. |
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|
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| 32 | — Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
52
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CANTEL MEDICAL CORP. | ||||
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| ||
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Date: March 12, 2007 |
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| ||
| By: | /s/ R. SCOTT JONES |
| |
|
| R. Scott Jones, President | ||
|
| and Chief Executive Officer | ||
|
| (Principal Executive Officer) | ||
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| ||
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| ||
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| ||
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| ||
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| ||
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| ||
| By: | /s/ CRAIG A. SHELDON |
| |
|
| Craig A. Sheldon, | ||
|
| Senior Vice President and | ||
|
| Chief Financial Officer (Principal | ||
|
| Financial and Accounting Officer) | ||
|
|
| ||
|
|
| ||
|
| |||
| By: | /s/ STEVEN C. ANAYA |
| |
|
| Steven C. Anaya, | ||
|
| Vice President and Controller | ||
53