ITEM 2.
|
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
|
The following Managements 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 continuing operations for the three months ended October 31, 2007
compared with the three months ended October 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:
Water
Purification and Filtration
: Water purification equipment and services,
filtration and separation products, and disinfectants for the medical,
pharmaceutical, biotech, beverage and commercial industrial markets.
Dialysis
:
Medical device reprocessing systems, sterilants/disinfectants, dialysate
concentrates and other supplies for renal dialysis.
Healthcare
Disposables
: 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.
Endoscope
Reprocessing
: Medical device reprocessing systems and
sterilants/disinfectants for endoscopy.
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.
23
See our Annual Report on Form 10-K for the fiscal year ended July 31,
2007 (the 2007 Form 10-K) and our Condensed Consolidated Financial Statements
for additional financial information regarding our reporting segments.
Significant Activity
(i)
Distributors
of our dental products have undergone consolidation during fiscal 2007, which
adversely impacted sales of our Healthcare Disposables segment in our first
quarter of fiscal 2008 and our fourth quarter of fiscal 2007 due to
rationalization of duplicate inventories in the consolidated companies and, to
a lesser extent, the loss of some private label business. We cannot predict
what impact consolidation in this industry will have on future sales of our
healthcare disposable products.
(ii)
Fiscal
2007 acquisitions: We acquired GE Water & Process Technologies water
dialysis business (the GE Water Acquisition or GE Water) on March 30, 2007
and Twist 2 It Inc. (Twist) on July 9, 2007, as more fully described in Note
3 to the Condensed Consolidated Financial Statements.
(iii)
Acquisitions
during the three months ended October 31, 2007: We acquired Dialysis Services,
Inc. (DSI) on August 1, 2007, Verimetrix, LLC (Verimetrix) on September 17,
2007, and Strong Dental Products, Inc. (Strong Dental) on September 26, 2007,
as more fully described in Note 3 to the Condensed Consolidated Financial
Statements.
(iv)
A
stronger Canadian dollar and Euro against the United States dollar impacted our
results of operations for the three months ended October 31, 2007, compared
with the three months ended October 31, 2006, as more fully described elsewhere
in this MD&A. The increase in values of the Canadian dollar and Euro were approximately
9.9% and 9.5%, respectively, for the three months ended October 31, 2007
compared with the three months ended October 31, 2006, based upon average
exchange rates reported by banking institutions.
Results of
Operations
The results of
operations described below reflect the continuing operating results of Cantel
and its wholly-owned subsidiaries, except where otherwise indicated.
Since the GE
Water and Twist acquisitions were completed on March 30, 2007 and July 9, 2007,
respectively, their results of operations are included in our results of
operations for the three months ended October 31, 2007 and are excluded from
our results of operations for the three months ended October 31, 2006.
Additionally, the acquisitions of DSI, Verimetrix and Strong Dental had an
insignificant effect on our results of operations for the three months ended
October 31, 2007 due to the small size of these businesses and the inclusion of
their results of operations for only the portion of the three months ended
October 31, 2007 subsequent to their acquisition dates. Their results of
operations are excluded for the three months ended October 31, 2006.
The Olympus
distribution agreements with our wholly-owned subsidiary, Carsen Group Inc. (Carsen),
as well as Carsens active business operations, terminated on July 31, 2006, as
24
more fully described elsewhere
in this MD&A and Note 15 to the Condensed Consolidated Financial
Statements. Accordingly, Carsen is reported as a discontinued operation for the
three months ended October 31, 2007 and 2006.
For the three
months ended October 31, 2007 compared with the three months ended October 31,
2006, discussion herein of our pre-existing business refers to all of our
reporting segments with the exception of the operating results of the GE Water
Acquisition included in our Water Purification and Filtration reporting
segment, as well as the discontinued operations of Carsen.
The following
discussion should also be read in conjunction with our 2007 Form 10-K.
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
|
|
|
|
October 31,
|
|
|
|
2007
|
|
2006
|
|
|
|
(Dollar amounts in thousands)
|
|
|
|
$
|
|
%
|
|
$
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Water Purification and Filtration
|
|
$
|
15,953
|
|
26.5
|
|
$
|
9,971
|
|
19.8
|
|
Dialysis
|
|
15,455
|
|
25.8
|
|
13,538
|
|
26.8
|
|
Healthcare Disposables
|
|
13,966
|
|
23.3
|
|
15,407
|
|
30.5
|
|
Endoscope Reprocessing
|
|
11,145
|
|
18.6
|
|
8,511
|
|
16.9
|
|
All Other
|
|
3,486
|
|
5.8
|
|
3,057
|
|
6.0
|
|
|
|
$
|
60,005
|
|
100.0
|
|
$
|
50,484
|
|
100.0
|
|
Net Sales
Net sales increased by $9,521,000, or 18.9%, to $60,005,000 for the
three months ended October 31, 2007 from $50,484,000 for the three months ended
October 31, 2006. Net sales of our pre-existing business increased by
$3,704,000, or 7.3%, to $54,188,000 for the three months ended October 31, 2007
compared with the three months ended October 31, 2006. Net sales contributed by
the GE Water Acquisition for the three months ended October 31, 2007 were
$5,817,000.
Net sales were positively impacted for the three months ended October
31, 2007 compared with the three months ended October 31, 2006 by approximately
$192,000 due to the translation of Euro net sales primarily of our Endoscope
Reprocessing and Dialysis operating segments using a stronger euro against the
United States dollar.
In addition, net sales were positively impacted for the three months
ended October 31, 2007 compared with the three months ended October 31, 2006 by
approximately $147,000 due to the translation of Canadian dollar net sales
primarily of our Water Purification and Filtration operating segment using a
stronger Canadian dollar against the United States dollar.
The increase in net sales of our pre-existing business for the three
months ended October 31, 2007 was principally attributable to increases in
sales of endoscope reprocessing products and services, dialysis products and
therapeutic filtration products, partially offset by a decrease in sales of
healthcare disposables products.
25
Net sales of
endoscope reprocessing products and services increased by $2,634,000, or 30.9%,
for the three months ended October 31, 2007, compared with the three months
ended October 31, 2006, primarily due to (i) an increase in demand for our
endoscope disinfection equipment internationally and disinfectants and product
service both in the United States and internationally, (ii) 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 was done during a significant
portion of the three months ended October 31, 2006, and (iii) approximately
$356,000 in incremental net sales due to the acquisition of Verimetrix on
September 17, 2007. 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 $640,000 for the three months ended October 31, 2007
compared with the three months ended October 31, 2006.
Net sales of dialysis products and services increased by $1,917,000, or
14.2%, for the three months ended October 31, 2007, compared with the three
months ended October 31, 2006, due to an increase in demand from customers,
both in the United States and internationally, for dialysate concentrate (a
concentrated acid or bicarbonate used to prepare dialysate, a chemical solution
that draws waste products from a patients blood through a dialyzer membrane
during hemodialysis treatment), as well as an increase of approximately
$640,000 in net sales as a result of shipping and handling fees, such as
freight, invoiced to customers during the three months ended October 31, 2007
(related costs of a similar amount are included within cost of sales). The
majority of this amount related to three of our larger customers who were
responsible for transportation related to the products they purchased from us
during the three months ended October 31, 2006; subsequently, we became
responsible for the transportation and invoiced them for such costs.
Net sales contributed by the Therapeutic Filtration operating segment
were $1,934,000, an increase of 31.5%, for the three months ended October 31,
2007 compared with the three months ended October 31, 2006. The increase in
sales during the three months ended October 31, 2007 was primarily due to the
recommencement in February 2007 of sales of filters manufactured by us on an
OEM basis for a single customers hydration system. This customer had
previously experienced a voluntary recall of the system (unrelated to our
product) and was not purchasing filters until their sales of hydration systems
recommenced. There can be no assurance that future sales of such filters will
continue at current levels.
Net sales of
water purification and filtration products and services from our pre-existing
business increased by 1.7% for the three months ended October 31, 2007 compared
with the three months ended October 31, 2006, primarily due to an increase in
service revenue from the improved density and efficiency of our pre-existing
service delivery network partially due to recent acquisitions. This increase
was partially offset by a decrease in commercial and industrial (large capital)
sales as a result of our decision made in early fiscal 2007 to refocus that
portion of the water purification and filtration equipment business by
eliminating contracts with low profitability; as such, revenue growth in the
pre-existing business of this segment was moderated by this activity during the
three months ended October 31, 2007. With respect to GE Water, which is
excluded from the above discussion of our pre-existing business, sales of water
purification and filtration products and services increased by 16.5% for the
three months ended October 31, 2007, compared with the three months ended July
31, 2007, due to improved sales
26
opportunities within the
installed equipment base of business as a result of combining GE Water with our
pre-existing water purification and filtration business.
Net sales of
healthcare disposable products decreased by 9.4% for the three months ended
October 31, 2007 compared with the three months ended October 31, 2006,
primarily due to a high level of demand during the three months ended October
31, 2006 for face mask products due to a heightened awareness of avian flu
prevention. Additionally, distributors of our dental products have undergone consolidation
during 2007, which adversely impacted sales of our Healthcare Disposables
segment for the three months ended October 31, 2007 compared with the three
months ended October 31, 2006 due to rationalization of duplicate inventories
in the consolidated companies and, to a lesser extent, the loss of some private
label business.
Increases in
selling prices of our products did not have a significant effect on net sales
for the three months ended October 31, 2007, except as explained above
regarding our Endoscope Reprocessing segment as well as the invoicing of
shipping and handling fees in our Dialysis segment.
Gross profit
Gross profit
increased by $3,037,000, or 16.7%, to $21,206,000 for the three months ended
October 31, 2007 from $18,169,000 for the three months ended October 31, 2006.
Gross profit of our pre-existing business increased by approximately
$1,557,000, or 8.6%, to $19,726,000 for the three months ended October 31, 2007
compared with the three months ended October 31, 2006. Gross profit contributed
by the GE Water Acquisition for the three months ended October 31, 2007 was
approximately $1,480,000.
Gross profit
as a percentage of net sales for the three months ended October 31, 2007 and
2006 was 35.3% and 36.0%, respectively. Gross profit as a percentage of net
sales of our pre-existing business for the three months ended October 31, 2007
was 36.4%. Gross profit as a percentage of net sales for the GE Water
Acquisition for the three months ended October 31, 2007 was approximately 25.4%.
The gross
profit percentage of our pre-existing business for the three months ended
October 31, 2007 increased compared with the three months ended October 31,
2006 primarily due to an increase in gross profit percentage in our Endoscope
Reprocessing segment as a result of selling our Medivators brand endoscope
reprocessing equipment, high-level disinfectants, cleaners, consumables and
product service directly to customers through our own United States field sales
and service organization instead of through a distributor as was done during a
significant portion of the three months ended October 31, 2006. Partially
offsetting this increase was a decrease in gross profit percentage attributable
to sales mix, including a decrease in sales of higher margin healthcare
disposables products such as face masks and increases in sales of lower margin
dialysate concentrate and water purification services.
With respect to the increase in the amount of gross profit (as opposed
to the discussion of gross profit percentage), increases in net sales as
explained above constitute the most significant factor in the increase in gross
profit.
27
Operating Expenses
Selling
expenses increased by $1,079,000, or 18.9%, to $6,789,000 for the three months
ended October 31, 2007, from $5,710,000 for the three months ended October 31,
2006, primarily due to higher compensation expense of approximately $790,000
primarily relating to commissions on increased sales by our endoscope reprocessing
direct sales network and the increased headcount due to the GE Water
Acquisition, as well as an increase of approximately $110,000 in advertising
and marketing expense primarily related to our Healthcare Disposables and
Endoscope Reprocessing segments.
Selling
expenses as a percentage of net sales were 11.3% for both the three months
ended October 31, 2007 and 2006.
General and administrative expenses increased by $1,419,000, or 18.8%,
to $8,957,000 for the three months ended October 31, 2007, from $7,538,000 for
the three months ended October 31, 2006, principally due to an increase in
stock-based compensation expense of $316,000; foreign exchange losses of
approximately $260,000 associated with translating certain foreign denominated
assets into functional currencies as well as the translation of expenses of our
international subsidiaries using a significantly stronger Canadian dollar and
Euro against the United States dollar; an increase of $246,000 in amortization
expense of intangible assets primarily relating to our acquisitions of GE
Water, Twist, DSI, Verimetrix and Strong Dental; an increase of approximately
$460,000 in compensation expense including approximately $100,000 directly
relating to the inclusion of the DSI, Verimetrix and Strong Dental acquisitions
for the three months ended October 31, 2007; and severance expense related to
the relocation of our Medivators manufacturing operations from the Netherlands
to the United States.
General and administrative expenses as a percentage of net sales were
14.9% for both the three months ended October 31, 2007 and 2006.
Research and
development expenses (which include continuing engineering costs) decreased by
$176,000 to $990,000 for the three months ended October 31, 2007, from
$1,166,000 for the three months ended October 31, 2006, primarily due to less
development work on the European version of our MDS endoscope reprocessor.
Interest
Interest
expense increased by $459,000 to $1,222,000 for the three months ended October
31, 2007, from $763,000 for the three months ended October 31, 2006, primarily
due to the increase in average outstanding borrowings as a result of financing
the purchase prices of the acquisitions of GE Water, DSI, Verimetrix and Strong
Dental.
Interest
income decreased by $143,000 to $147,000 for the three months ended October 31,
2007, from $290,000 for the three months ended October 31, 2006, primarily due
to a decrease in average cash and cash equivalents.
Income from continuing operations before
income taxes
Income from continuing operations before income taxes increased by
$113,000 to $3,395,000 for the three months ended October 31, 2007, from
$3,282,000 for the three months ended October 31, 2006.
28
Income taxes
The
consolidated effective tax rate was 42.9% and 47.5% for the three months ended
October 31, 2007 and 2006, respectively.
Our results of
continuing operations for the three months ended October 31, 2007 and 2006
reflect income tax expense for our United States operations at its combined
federal and state statutory tax rate, which resulted in an overall United
States effective tax rate for the three months ended October 31, 2007 of 38.7%.
A tax benefit was not recorded on the losses from operations at our Netherlands
subsidiary for the three months ended October 31, 2007 and 2006, thereby
causing our overall effective tax rate to exceed the statutory rate. The
results of continuing operations for our subsidiaries in Canada, Japan, and
Singapore did not have a significant impact on our overall effective tax rate
for the three months ended October 31, 2007 due to the size of those operations
relative to our United States and Netherlands operations.
The decrease
in the overall effective tax rate for the three months ended October 31, 2007,
compared with the three months ended October 31, 2006, was principally due to
the geographic mix of pretax income including the decrease in losses related to
our Netherlands operations for which no income tax benefit was recorded.
In July 2006,
the FASB issued FIN No. 48, which 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 and therefore was adopted on August 1, 2007. The adoption of FIN No.
48 did not have a material effect on our financial position or results of
operations since, after our completion of our evaluation, we did not record an
increase or decrease to our income taxes payable or deferred tax liabilities
related to unrecognized income tax benefits for uncertain tax positions.
We record
liabilities for an unrecognized tax benefit when a tax benefit for an uncertain
tax position is taken or expected to be taken on a tax return, but is not
recognized in our Condensed Consolidated Financial Statements because it does
not meet the more-likely-than-not recognition threshold that the uncertain tax
position would be sustained upon examination by the applicable taxing
authority. At October 31, 2007 and July 31, 2007, we had liabilities relating
to approximately $700,000 of unrecognized tax benefits recorded in our
Condensed Consolidated Financial statements. The majority of such unrecognized
tax benefits originated from acquisitions. Accordingly, any adjustments upon
resolution of income tax uncertainties that predate or result from acquisitions
are recorded as an increase or decrease to goodwill. Therefore, if the
unrecognized tax benefits are recognized in our financial statements in future
periods, there would not be a significant impact to our effective tax rate on continuing
operations. We do not expect such unrecognized tax benefits to significantly
decrease or increase in the next twelve months. Generally, the Company is no
longer subject to federal, state or foreign income tax examinations for fiscal
years ended prior to July 31, 2002.
Our policy is
to record potential interest and penalties related to income tax positions in
interest expense and general and administrative expense, respectively, in our
Condensed Consolidated Financial Statements. However, such amounts have been
insignificant due to the amount of our unrecognized tax benefits relating to
uncertain tax positions.
29
Stock-Based Compensation
The following table shows the income statement components of
stock-based compensation expense relating to continuing operations recognized
in the Condensed Consolidated Statements of Income for the three months ended
October 31, 2007 and 2006:
|
|
Three Months Ended
|
|
|
|
October 31,
|
|
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Cost of sales
|
|
$
|
13,000
|
|
$
|
(1,000
|
)
|
Operating expenses:
|
|
|
|
|
|
Selling
|
|
29,000
|
|
26,000
|
|
General and administrative
|
|
485,000
|
|
169,000
|
|
Research and development
|
|
5,000
|
|
4,000
|
|
Total operating expenses
|
|
519,000
|
|
199,000
|
|
Stock-based compensation before income
taxes
|
|
532,000
|
|
198,000
|
|
Income tax benefits
|
|
(204,000
|
)
|
(105,000
|
)
|
Total stock-based compensation expense, net
of tax
|
|
$
|
328,000
|
|
$
|
93,000
|
|
For the three months ended October 31, 2007 and 2006, the above
stock-based compensation expense before income taxes was recorded in the
Condensed Consolidated Financial Statements as stock-based compensation expense
(which decreased both basic and diluted earnings per share from income from
continuing operations by $0.02 and $0.01 for the three months ended October 31,
2007 and 2006, respectively) and an increase to additional capital. The related
income tax benefits (which pertain only to stock awards and 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 option and nonvested stock awards are subject to
graded vesting in which portions of the 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 awards subject to graded vesting
using the straight-line basis, reduced by estimated forfeitures. At October 31,
2007, total unrecognized stock-based compensation expense, net of tax, related
to total nonvested stock options and stock awards was $2,436,000 with a
remaining weighted average period of 28 months over which such expense is
expected to be recognized.
We determine the fair value of each nonvested stock award using the
closing market price of our Common Stock on the date of grant. In fiscal 2007,
175,000 nonvested stock awards were granted with a weighted average fair value
of $16.57. Such stock awards remain nonvested and outstanding at October 31,
2007. Prior to February 1, 2007, the Company only granted stock options and not
stock awards. Such nonvested stock awards are deductible for tax purposes and
were tax-effected using the Companys estimated U.S. effective tax rate at the
time of grant.
Additionally, we estimate the fair value of each option award on the
date of grant using the Black-Scholes option valuation model. All options
granted during the three months ended October 31, 2007 and 2006 are deductible
for tax purposes and were tax-effected using the Companys estimated U.S.
effective tax rate at the time of grant. For the three months ended October 31,
2007 and 2006, the weighted average fair value of all options granted was
30
approximately $5.98 and $6.26,
respectively. The aggregate intrinsic value (i.e. the excess market price over
the exercise price) of all options exercised during the three months ended
October 31, 2007 and 2006 was approximately $1,874,000 and $2,092,000,
respectively.
Upon exercise of stock options or grant of nonvested shares, 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 three months ended October 31, 2007 and 2006, options
exercised resulted in income tax deductions that reduced income taxes payable
by $690,000 and $566,000, 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 past pro forma disclosures relating to fiscal
years prior to August 1, 2005) which was determined based upon the awards fair
value.
Liquidity and Capital Resources
Working capital
At October 31, 2007, the Companys working capital was $51,434,000,
compared with $40,760,000 at July 31, 2007. This increase in working capital
was principally due to increases in cash, as described below, accounts
receivable due to an increase in sales, and inventories due to planned increases
in stock levels of certain products primarily in our Endoscope Reprocessing
segment.
Cash flows from operating activities
Net cash provided by operating activities was $992,000 for the three
months ended October 31, 2007, compared with net cash used in operating
activities of $3,521,000 for the three months ended October 31, 2006. For the
three months ended October 31, 2007, 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 income
taxes payable (due to the timing associated with tax payments). These items
were partially offset by increases in accounts receivable (due to an increase
in sales) and inventories (due to planned increases in stock levels of certain
products primarily in our Endoscope Reprocessing segment).
For the three months ended October 31, 2006, the net cash used in
operating activities was primarily due to an increase in inventories (due to
planned increases in stock levels of certain products) and decreases in
liabilities of discontinued operations (due to the wind-down of Carsens
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 Carsens operations).
31
Net cash provided by operating activities related only to continuing
operations was $993,000 and $1,027,000 for the three months ended October 31,
2007 and 2006.
Cash flows from investing activities
Net cash used in investing activities was $14,901,000 and $5,468,000
for the three months ended October 31, 2007 and 2006, respectively. For the
three months ended October 31, 2007, the net cash used in investing activities
was primarily for the acquisitions of DSI, Verimetrix and Strong Dental, a
payment for an acquisition earnout to the former owners of Crosstex and capital
expenditures. For the three months ended October 31, 2006, the net cash used in
investing activities was primarily for an acquisition earnout payment to the
former owners of Crosstex and capital expenditures.
Cash flows from financing activities
Net cash provided by financing activities was $14,613,000 for the three
months ended October 31, 2007, compared with net cash used in operating
activities of $534,000 for the three months ended October 31, 2006. For the three
months ended October 31, 2007, the net cash provided by financing activities
was primarily attributable to borrowings under our revolving credit facility
primarily related to the acquisitions of DSI, Verimetrix and Strong Dental and
the payment of the acquisition earnout to the former owners of Crosstex,
partially offset by a repayment under the term loan facility. For the three
months ended October 31, 2006, the net cash used in financing activities was
primarily attributable to a repayment under the term loan facility and the
purchases of treasury stock, partially offset by exercises of stock options.
Discontinued Operations -Termination of
Carsens 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 Carsens
assets other than those related to Carsens Medivators business and certain
other smaller product lines. Following the closing, Olympus hired substantially
all of Carsens employees and took over Carsens 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, Carsens 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 paid Carsen 20% of Olympus revenues
attributable to Carsens unfilled customer orders (backlog) as of July 31,
2006 that were assumed by Olympus at the closing. Such payments to Carsen were
made following Olympus receipt of customer payments for such orders and
totaled $368,000. For the three months ended October 31, 2006, approximately
$174,000 related to such backlog was recorded as income and reported in income
from discontinued operations, net of tax, in the Condensed Consolidated
Statements of Income.
Net proceeds from Carsens sale of net assets and the termination of
Carsens operations were approximately $21,100,000 (excluding the backlog
payments) after satisfaction of
32
remaining liabilities and
taxes.
As a result of the foregoing transaction, which coincided with the
expiration of Carsens exclusive distribution agreements with Olympus on July
31, 2006, Carsen no longer has any remaining product lines or active business
operations.
Cash flows
attributable to discontinued operations comprise the following:
|
|
Three Months ended October 31,
|
|
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
$
|
(1,000
|
)
|
$
|
(4,548,000
|
)
|
|
|
|
|
|
|
|
|
Investing and financing activities of our discontinued operations did
not result in any net cash for the three months ended October 31, 2007 and
2006.
At October 31, 2007 and July 31, 2007,
remaining liabilities of our discontinued operations were $88,000 and $97,000,
respectively, and principally related to various taxes expected to be paid in
fiscal 2008.
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 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 Rapicide
Ò
disinfectant. During the three months ended
October 31, 2007 and 2006, Olympus continued to purchase such items from us,
although we have been gradually converting the sale of such items over to our
direct sales and service force.
33
Long-term contractual obligations
Aggregate
annual required payments at October 31, 2007 over the next five years and
thereafter under our contractual obligations that have long-term components are
as follows:
|
|
Nine Months
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
July 31,
|
|
Year Ending July 31,
|
|
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
Thereafter
|
|
Total
|
|
|
|
(Amounts in thousands)
|
|
Maturities of the credit facilities
|
|
$
|
4,500
|
|
$
|
8,000
|
|
$
|
10,000
|
|
$
|
48,050
|
|
$
|
|
|
$
|
|
|
$
|
70,550
|
|
Expected interest payments under the credit
facilities (1)
|
|
3,220
|
|
3,896
|
|
3,321
|
|
356
|
|
|
|
|
|
10,793
|
|
Minimum commitments under noncancelable
operating leases
|
|
2,537
|
|
2,991
|
|
2,347
|
|
1,443
|
|
772
|
|
1,668
|
|
11,758
|
|
Minimum commitments under noncancelable
capital leases
|
|
24
|
|
32
|
|
32
|
|
13
|
|
|
|
|
|
101
|
|
Minimum commitments under license agreement
|
|
44
|
|
82
|
|
123
|
|
183
|
|
212
|
|
3,056
|
|
3,700
|
|
Deferred compensation and other
|
|
119
|
|
153
|
|
34
|
|
406
|
|
406
|
|
606
|
|
1,724
|
|
Employment agreements
|
|
3,407
|
|
1,505
|
|
256
|
|
145
|
|
135
|
|
|
|
5,448
|
|
Total contractual obligations
|
|
$
|
13,851
|
|
$
|
16,659
|
|
$
|
16,113
|
|
$
|
50,596
|
|
$
|
1,525
|
|
$
|
5,330
|
|
$
|
104,074
|
|
(1)
The expected interest
payments under the term and revolving credit facilities reflect interest rates
of 6.45% and 6.12%, respectively, which were our interest rates on outstanding
borrowings at November 1, 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 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, as amended, include (i) a six-year $40.0
million senior secured amortizing term loan facility and (ii) a five-year
$50.0 million senior secured revolving credit facility. Amounts we repay under
the term loan facility may not be re-borrowed. Debt issuance costs relating to
the 2005 U.S. Credit Facilities have been recorded in other assets and are
being amortized over the life of the credit facilities. Such unamortized debt issuance
costs amounted to approximately $1,227,000 at October 31, 2007.
At November 30, 2007, borrowings under the 2005 U.S. Credit Facilities
bear interest at rates ranging from 0% to 0.50% above the lenders base rate,
or at rates ranging from 0.625% to 1.75% 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 November
30, 2007, the lenders base rate was 7.50% and the LIBOR rates ranged from
4.69% to 5.46%. The margins applicable to our outstanding borrowings at
November 30, 2007 were 0.00% above the lenders base rate and 1.00% above
LIBOR. All of our outstanding borrowings were under LIBOR contracts at November
30, 2007. The 2005 U.S. Credit Facilities also provide for fees on the unused
portion of our facilities at rates ranging from 0.15% to 0.30%, depending upon
our consolidated ratio of debt to EBITDA; such rate was 0.25% at November 30,
2007.
34
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 October 31, 2007, we
are in compliance with all financial and other covenants under the 2005 U.S.
Credit Facilities.
On October 31, 2007 and November 30, 2007, we had $70,550,000 of
outstanding borrowings under the 2005 U.S. Credit Facilities, which consisted
of $32,500,000 and $38,050,000 under the term loan facility and the revolving
credit facility, respectively.
Operating leases
Minimum
commitments under operating leases include minimum rental commitments for our
leased manufacturing facilities, warehouses, office space and equipment.
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 in Canadian dollars each calendar year over
the license agreement term of 20 years. At October 31, 2007, we had minimum
future royalty obligations relating to this license agreement of approximately
$3,700,000 using the exchange rate at October 31, 2007.
Deferred Compensation
Included in other long-term liabilities are deferred compensation arrangements
for certain former Minntech directors and officers.
Financing needs
At October 31,
2007, we had a cash balance of $17,625,000, of which $10,506,000 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 November 30, 2007,
$11,950,000 was available under our United States revolving credit facility, as
amended.
Foreign currency
During the three months ended October 31, 2007, compared with the three
months ended October 31, 2006, the average value of the Canadian dollar
increased by approximately 9.9% 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 because 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. Additionally, the financial statements
35
of our Canadian subsidiaries
are translated using the accounting policies described in Note 2 to 2007 Form
10-K. Fluctuations in the rates of currency exchange between the United States
and Canada had an overall adverse impact for the three months ended October 31,
2007, compared with the three months ended October 31, 2006, upon our
continuing results of operations of approximately $198,000, net of tax.
For the three
months ended October 31, 2007, compared with the three months ended October 31,
2006, the value of the euro increased by approximately 9.5% 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 because a portion of the
net assets of our Netherlands subsidiary (which are reported in our Dialysis,
Endoscope Reprocessing and Water Purification and Filtration segments) are
denominated and ultimately settled in United States dollars but must be
converted into its functional euro currency. Additionally, financial statements
of our Netherlands subsidiary are translated using the accounting policies
described in Note 2 to the 2007 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 months ended October 31, 2007, compared with the
three months ended October 31, 2006, upon our results of operations of
approximately $32,000, net of tax.
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 1,357,000 at November 30, 2007 which
covers certain assets and liabilities of Minntechs Netherlands subsidiary
which are denominated in United States dollars. Such contract expires on
December 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 months ended October 31, 2007, such forward contracts were
effective in offsetting the impact of the strengthening of the euro on certain
assets and liabilities of Minntechs Netherlands subsidiary that are
denominated in United States dollars. In accordance with Statement of Financial
Accounting Standards (SFAS) No. 133, as amended,
Accounting for Derivative Instruments and Hedging Activities
(SFAS
133), such foreign currency forward contracts are designated as hedges. Gains
and losses related to these 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 October 31, 2007 compared with July 31,
2007, the value of the Canadian dollar increased by approximately 13.1% and the
value of the euro increased by approximately 5.8% compared with the value of
the United States dollar. The total of these currency movements resulted in a
foreign currency translation gain of $3,835,000 during the three months ended
October 31, 2007, thereby increasing stockholders equity.
Changes in the value of the Japanese yen
relative to the United States dollar during the three months ended October 31,
2007, compared with the three months ended October 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.
36
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 healthcare disposable
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 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 customers purchase order
specifies ship-complete as a condition of delivery; revenue recognition on
such sales is deferred until all equipment has been delivered.
A portion of
our water purification and filtration sales relating to our acquisition of GE
Water are recognized as multiple element arrangements, whereby revenue is
allocated to the equipment and installation components based upon vendor
specific objective evidence which principally includes comparable historical
transactions of similar equipment and installation sold as stand alone
components, as well as an evaluation of unrelated third party competitor
pricing of similar installation.
Revenue on
service sales is recognized when repairs are completed at the customers
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. With respect to certain
service contracts in our Endoscope Reprocessing and Water Purification and
Filtration operating segments, service revenue is recognized on a straight-line
basis over the
37
contractual term of the
arrangement.
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 healthcare disposable 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, dental and water purification and filtration customers, volume
rebates are provided; such volume rebates are provided for as a reduction of
sales at the time of revenue recognition and amounted to $259,000 and $779,000
for the three months ended October 31, 2007 and 2006, respectively. The
decrease in volume rebates for the three months ended October 31, 2007 compared
with October 31, 2006 is primarily due to lower sales in our Healthcare
Disposables segment as more fully described elsewhere in this MD&A. Such
allowances are determined based on estimated projections of sales volume for
the entire rebate agreement periods. 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 healthcare disposable 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; the majority of
our endoscope reprocessing products and services are sold directly to hospitals
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.
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 managements
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
38
managements 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, technology, brand names, non-compete
agreements and patents, are amortized using the straight-line method over their
estimated useful lives which range from 1 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, 2007, management concluded that none of our intangible assets or goodwill
was impaired and no impairment indicators are present as of October 31, 2007.
While the results of these annual reviews have historically not indicated
impairment, impairment reviews are highly dependent on managements 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 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
estimates.
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
39
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,
Share-Based
Payment (Revised 2004)
(SFAS 123R) using the modified prospective
method for the transition. Under the modified prospective method, stock
compensation expense is 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 awards fair value. For fiscal
2005 and earlier periods, we 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 option and nonvested stock awards are subject to
graded vesting in which portions of the 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 awards 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 awards
issued in past years (which level may not be similar in the future),
assumptions used in determining fair value, and estimated forfeitures. We
determine the fair value of each unvested stock award using the closing market
price of our Common Stock on the date of grant. 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 subsequent to October 31, 2006,
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
volatility, and for certain options, the expected option lives.
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
40
a case by case basis. Amounts
are accrued when we, in consultation with counsel, determine that it is
probable 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 effective tax
rate were to change in the future, particularly in the United States, our items
of deferred tax could be materially affected. All of such evaluations require
significant management judgments.
We record liabilities for an unrecognized tax benefit when a tax
benefit for an uncertain tax position is taken or expected to be taken on a tax
return, but is not recognized in our Condensed Consolidated Financial
Statements because it does not meet the more-likely-than-not recognition
threshold that the uncertain tax position would be sustained upon examination
by the applicable taxing authority. The majority of such unrecognized tax
benefits originated from acquisitions and are based primarily upon managements
assessment of exposure associated with acquired companies. Accordingly, any
adjustments upon resolution of income tax uncertainties that predate or result
from acquisitions are recorded as an increase or decrease to goodwill.
Unrecognized tax benefits are analyzed periodically and adjustments are made,
as events occur to warrant adjustment to the related liability.
Business Combinations
Acquisitions require significant estimates and judgments related to the
fair value of assets acquired and liabilities assumed.
Certain liabilities and reserves are subjective in nature. We reflect
such liabilities and reserves based upon the most recent information available.
In conjunction with our acquisitions, such subjective liabilities and reserves
principally include certain income tax and sales and use tax exposures,
including tax liabilities related to our foreign subsidiaries, as well as
reserves for accounts receivable, inventories and warranties. 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.
41
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 in the United States
the adverse
impact of consolidation of dialysis providers and our dependence on a single
dialysis customer
the adverse
impact of consolidation of dental product distributors and our dependence on a
concentrated number of such distributors
uncertainties
related to our Endoscope Reprocessing segment, particularly those relating to
the assumption of direct sales and service of Medivators endoscope reprocessing products in
the United States on August 2, 2006 and the performance of the MDS product line
our dependence on acquiring new businesses
and successfully integrating and operating 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. Consequently, you should not consider the foregoing items to
be a complete list of all potential risks or uncertainties. See Risk Factors
in our 2007 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.
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