|
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 continuing operations for the three
and six months ended January 31, 2008 compared with the three and six
months ended January 31, 2007.
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.
24
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 during the six
months ended January 31, 2008 and our fourth quarter of fiscal 2007 due to
the loss of some private label business, and with respect to our first quarter
of fiscal 2008 and our fourth quarter of fiscal 2007, rationalization of
duplicate inventories in the consolidated companies. 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 six months ended January 31, 2008: 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 and six months ended January 31, 2008,
compared with the three and six months ended January 31, 2007, as more
fully described elsewhere in this MD&A. The increase in values of the
Canadian dollar and euro were approximately 16.5% and 12.5%, respectively, for
the three months ended January 31, 2008 compared with the three months
ended January 31, 2007, and approximately 13.2% and 11.0%, respectively,
for the six months ended January 31, 2008 compared with the six months
ended January 31, 2007, 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 and six months ended January 31,
2008 and are excluded from our results of operations for the three and six
months ended January 31, 2007. Additionally, the acquisitions of DSI,
Verimetrix and Strong Dental had an insignificant effect on our results of
operations for the three and six months ended January 31, 2008 due to the
small size of these businesses and the inclusion of their results of operations
for only the portion of the six months ended January 31, 2008 subsequent
to their acquisition dates. Their results of operations are excluded for the
three and six months ended
25
January 31, 2007.
The Olympus distribution
agreements with our wholly-owned subsidiary, Carsen Group Inc. (“Carsen”), as
well as Carsen’s active business operations, terminated on July 31, 2006,
as 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 and six months ended January 31, 2008
and 2007.
For the three and six months
ended January 31, 2008 compared with the three and six months ended January 31,
2007, 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
|
|
Six
Months Ended
|
|
|
|
|
January 31,
|
|
January 31,
|
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
|
(Dollar
amounts in thousands)
|
|
|
|
|
$
|
|
%
|
|
$
|
|
%
|
|
$
|
|
%
|
|
$
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Water Purification and Filtration
|
|
$
|
18,069
|
|
29.7
|
|
$
|
10,166
|
|
19.7
|
|
$
|
34,022
|
|
28.1
|
|
$
|
20,137
|
|
19.7
|
|
|
Dialysis
|
|
14,692
|
|
24.1
|
|
14,776
|
|
28.6
|
|
30,147
|
|
24.9
|
|
28,314
|
|
27.7
|
|
|
Healthcare Disposables
|
|
13,985
|
|
23.0
|
|
13,775
|
|
26.7
|
|
27,951
|
|
23.1
|
|
29,182
|
|
28.6
|
|
|
Endoscope Reprocessing
|
|
10,799
|
|
17.7
|
|
9,365
|
|
18.1
|
|
21,944
|
|
18.2
|
|
17,876
|
|
17.5
|
|
|
All Other
|
|
3,365
|
|
5.5
|
|
3,553
|
|
6.9
|
|
6,851
|
|
5.7
|
|
6,610
|
|
6.5
|
|
|
|
|
$
|
60,910
|
|
100.0
|
|
$
|
51,635
|
|
100.0
|
|
$
|
120,915
|
|
100.0
|
|
$
|
102,119
|
|
100.0
|
|
Net Sales
Net
sales increased by $9,275,000, or 18.0%, to $60,910,000 for the three months
ended January 31, 2008 from $51,635,000 for the three months ended January 31,
2007. Net sales of our pre-existing business increased by $3,281,000, or 6.4%,
to $54,916,000 for the three months ended January 31, 2008 compared with
the three months ended January 31, 2007. Net sales contributed by the GE
Water Acquisition for the three months ended January 31, 2008 were
$5,994,000.
Net
sales increased by $18,796,000, or 18.4%, to $120,915,000 for the six months
ended January 31, 2008 from $102,119,000 for the six months ended January 31,
2007. Net sales of our pre-existing business increased by $7,076,000, or 6.9%,
to $109,195,000 for the six months ended January 31, 2008 compared with
the six months ended January 31, 2007. Net sales contributed by the GE
Water Acquisition for the six months ended January 31, 2008 were
$11,720,000.
Net sales were positively
impacted for the three and six months ended January 31, 2008 compared with
the three and six months ended January 31, 2007 by approximately $343,000
and $535,000, respectively, 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
26
dollar.
In addition, net sales were
positively impacted for the three and six months ended January 31, 2008
compared with the three and six months ended January 31, 2007 by
approximately $307,000 and $454,000, respectively, 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 and six months
ended January 31, 2008 was principally attributable to increases in sales
of water purification and filtration products and services and endoscope
reprocessing products and services. The increase in net sales of our
pre-existing business for the six months ended January 31, 2008 was also
affected by an increase in sales of dialysis products during the three months ended
October 31, 2007, partially offset by a decrease in sales of healthcare
disposables products during the three months ended October 31, 2007.
Net sales of water
purification and filtration products and services from our pre-existing
business increased by 18.8% and 10.8% for the three and six months ended January 31,
2008, respectively, compared with the three and six months ended January 31,
2007, 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 and an increase in demand for our water purification
equipment from dialysis customers. This increase was partially offset by a
decrease in commercial and industrial (large capital) equipment sales as a
result of our decision made in early fiscal 2007 to refocus our efforts on
selling large capital equipment with standardized designs instead of customized
designs that have historically provided lower profitability. 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 approximately 15.0% for the three months ended January 31,
2008 and 9.9% for the three months ended October 31, 2007, when each three
month period is compared with the post-acquisition period ended July 31,
2007, due to improved sales 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 endoscope
reprocessing products and services increased by 15.3% and 22.8% for the three
and six months ended January 31, 2008, respectively, compared with the
three and six months ended January 31, 2007, 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) approximately $568,000 and $924,000 in incremental
net sales for the three and six months ended January 31, 2008,
respectively, due to the acquisition of Verimetrix on September 17, 2007,
and (iii) with respect to the first three months of the six months ended January 31,
2008, approximately $640,000 in higher net sales due to 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. Additionally, although this
distributor continued to purchase high-level disinfectants, cleaners, and
consumables from us and provide product service to our customers during the
three and six months ended January 31, 2008 and 2007, we have been
gradually converting the sale of such items to our direct sales and service
force at higher selling prices. The increase in demand for our disinfectants
and product service is also attributable to the increased field population of
equipment and our ability to convert users of competitive disinfectants to our
products.
27
Net sales of dialysis
products and services increased by 6.5% for the six months ended January 31,
2008, compared with the six months ended January 31, 2007, as a result of
an increase in net sales during the first three months of the six months ended January 31,
2008 due to (i) 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
patient’s blood through a dialyzer membrane during hemodialysis treatment), and
(ii) shipping and handling fees, such as freight, invoiced to three of our
larger customers who were previously responsible for transportation related to
the products they purchased from us (related costs of a similar amount are
included within cost of sales); subsequently, we became responsible for the
transportation and invoiced them for such costs.
Net sales of healthcare
disposable products increased by 1.5% and decreased by 4.2% for the three and
six months ended January 31, 2008, respectively, compared with the three
and six months ended January 31, 2007. The decrease for the six months
ended January 31, 2008, compared with the six months ended January 31,
2007, was primarily due to (i) a high level of demand during the first
three months of the six months ended January 31, 2007 for face mask
products due to a heightened awareness of avian flu prevention, and (ii) distributors
of our dental products had undergone consolidation during 2007, which has
adversely impacted sales of our Healthcare Disposables segment due to the loss
of some private label business, and with respect to the first three months of
the six months ended January 31, 2008, rationalization of duplicate
inventories in the consolidated companies.
Increases in selling prices
of our products did not have a significant effect on net sales for the three
and six months ended January 31, 2008, 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 $1,965,000, or 10.1%, to $21,486,000 for the three months
ended January 31, 2008 from $19,521,000 for the three months ended January 31,
2007. Gross profit of our pre-existing business increased by approximately
$287,000, or 1.5%, to $19,808,000 for the three months ended January 31,
2008 compared with the three months ended January 31, 2007. Gross profit
contributed by the GE Water Acquisition for the three months ended January 31,
2008 was approximately $1,678,000.
Gross
profit increased by $5,002,000, or 13.3%, to $42,692,000 for the six months
ended January 31, 2008 from $37,690,000 for the six months ended January 31,
2007. Gross profit of our pre-existing business increased by approximately
$1,872,000, or 5.0%, to $39,562,000 for the six months ended January 31,
2008 compared with the six months ended January 31, 2007. Gross profit
contributed by the GE Water Acquisition for the six months ended January 31,
2008 was approximately $3,130,000.
Gross profit as a percentage
of net sales for the three months ended January 31, 2008 and 2007 was
35.3% and 37.8%, respectively. Gross profit as a percentage of net sales of our
pre-existing business for the three months ended January 31, 2008 was
36.1%. Gross profit as a percentage of net sales for the GE Water Acquisition
for the three months ended January 31, 2008 was approximately 28.0%.
28
Gross profit as a percentage
of net sales for the six months ended January 31, 2008 and 2007 was 35.3%
and 36.9%, respectively. Gross profit as a percentage of net sales of our
pre-existing business for the six months ended January 31, 2008 was 36.2%.
Gross profit as a percentage of net sales for the GE Water Acquisition for the
six months ended January 31, 2008 was approximately 26.7%.
The gross profit percentage
of our pre-existing business for the three and six months ended January 31,
2008 decreased compared with the three and six months ended January 31,
2007 primarily due to (i) a change in sales mix, including a decrease in
sales of certain higher margin healthcare disposables products such as face
masks, and increases in sales of Renalin
®
sterilant to large
national chains that typically receive more favorable pricing, lower margin
water purification services, and with respect to the first three months of the
six months ended January 31, 2008, lower margin dialysate concentrate, (ii) an
increase in manufacturing and shipping costs in all of our operating segments,
and (iii) inefficiencies in our Water Purification and Filtration segment
as a result of the integration of the GE acquisition into our pre-existing
business, which is now substantially complete. Partially offsetting this
decrease was an increase in gross profit percentage in our Endoscope
Reprocessing segment as a result of selling our Medivators brand endoscope
reprocessing equipment and related products and 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 first
three months of the six months ended January 31, 2007. Additionally,
although this distributor continued to purchase high-level disinfectants,
cleaners, and consumables from us and provide product service to our customers
during the three and six months ended January 31, 2008 and 2007, we have
been gradually converting the sale of such high margin items to our direct
sales and service force resulting in an increase in gross profit percentage.
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.
Operating Expenses
Selling
expenses increased by $1,107,000, or 19.3%, to $6,836,000 for the three months
ended January 31, 2008, from $5,729,000 for the three months ended January 31,
2007, primarily due to higher compensation expense of approximately $940,000,
including travel costs, primarily relating to the increased headcount resulting
from the GE Water Acquisition and commissions on increased sales by our
endoscope reprocessing direct sales network, as well as
an increase of
approximately $110,000 as a result of translating selling expenses of our
international subsidiaries using a significantly stronger Canadian dollar and
euro against the United States dollar.
Selling
expenses increased by $2,186,000, or 19.1%, to $13,625,000 for the six months
ended January 31, 2008, from $11,439,000 for the six months ended January 31,
2007, primarily due to higher compensation expense of approximately $1,800,000,
including travel costs, primarily relating to the increased headcount resulting
from the GE Water Acquisition and commissions on increased sales by our
endoscope reprocessing direct sales network, as well as
an increase of
approximately $170,000 as a result of translating selling expenses of our
international subsidiaries using a significantly stronger Canadian dollar and
euro against the United States dollar.
29
Selling expenses as a percentage of net sales were
11.2% and 11.1% for the three months ended January 31, 2008 and 2007, and
11.3% and 11.2% for the six months ended January 31, 2008 and 2007.
General and administrative
expenses increased by $909,000, or 11.3%, to $8,967,000 for the three months
ended January 31, 2008, from $8,058,000 for the three months ended January 31,
2007, principally
due to an increase of $314,000 in amortization
expense of intangible assets primarily relating to our acquisitions of GE
Water,
Twist, DSI, Verimetrix and Strong
Dental
; an increase in stock-based compensation expense of $275,000; an
increase of approximately $300,000 in compensation expense primarily due to
additional headcount in our Water Purification and Filtration segment and
severance expense related to the relocation of our Medivators’ manufacturing
operations from the Netherlands to the United States; and an increase of
approximately $160,000 as a result of translating general and administrative
expenses of our international subsidiaries using a significantly stronger
Canadian dollar and euro against the United States dollar.
General and administrative
expenses increased by $2,328,000, or 14.9%, to $17,924,000 for the six months
ended January 31, 2008, from $15,596,000 for the six months ended January 31,
2007, principally
due to an increase of approximately $760,000 in
compensation expense primarily due to additional headcount in our Water
Purification and Filtration segment, severance expense related to the
relocation of our Medivators’ manufacturing operations from the Netherlands to
the United States and incentive compensation relating to the DSI, Verimetrix
and Strong Dental acquisitions; an increase in stock-based compensation expense
of $591,000; an increase of $560,000 in amortization expense of intangible
assets primarily relating to our acquisitions of GE Water,
Twist, DSI, Verimetrix and Strong Dental
;
and an increase of approximately $390,000 as a result of foreign exchange
losses associated with translating certain foreign denominated assets into
functional currencies as well as the translation of general and administrative
expenses of our international subsidiaries using a significantly stronger Canadian
dollar and euro against the United States dollar.
General and
administrative expenses as a percentage of net sales were 14.7% and 15.6% for
the three months ended January 31, 2008 and 2007, and 14.8% and 15.3% for
the six months ended January 31, 2008 and 2007.
Research and development
expenses (which include continuing engineering costs) decreased by $261,000 to
$961,000 for the three months ended January 31, 2008, from $1,222,000 for
the three months ended January 31, 2007. For the six months ended January 31,
2008, research and development expenses decreased $437,000 to $1,951,000, from
$2,388,000 for the six months ended January 31, 2007. The decrease in
research and development expenses for the three and six months ended January 31,
2008, compared with the three and six months ended January 31, 2007, is
primarily
due to less development work on the European version of our MDS
endoscope reprocessor.
Interest
Interest expense increased by $496,000 to $1,255,000
for the three months ended January 31, 2008, from $759,000 for the three
months ended January 31, 2007. For the six months ended January 31,
2008, interest expense increased by $955,000 to $2,477,000, from $1,522,000 for
the six months ended January 31, 2007. For the three and six months ended January 31,
2008, interest expense increased
primarily due to the
increase in average outstanding borrowings as a result of
30
financing the purchase prices of the
acquisitions of GE Water, DSI, Verimetrix and Strong Dental.
Interest income decreased by
$10,000 to $150,000 for the three months ended January 31, 2008, from
$160,000 for the three months ended January 31, 2007. For the six months
ended January 31, 2008, interest income decreased by $153,000 to $297,000,
from $450,000 for the six months ended January 31, 2007. For the three and
six months ended January 31, 2008, interest income decreased 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 decreased by $296,000 to $3,617,000 for the
three months ended January 31, 2008, from $3,913,000 for the three months
ended January 31, 2007. For the six months ended January 31, 2008,
income from continuing operations before income taxes decreased by $183,000 to
$7,012,000, from $7,195,000 for the six months ended January 31, 2007.
Income taxes
The consolidated effective
tax rate was 41.6% and 44.8% for the six months ended January 31, 2008 and
2007, respectively.
Our results of continuing
operations for the three and six months ended January 31, 2008 and 2007
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 six months ended January 31, 2008 of
38.5%. The results of continuing operations for our Canadian subsidiaries
reflect an overall effective tax rate for the six months ended January 31,
2008 of 25.0%. A tax benefit was not recorded on the losses from operations at
our Netherlands subsidiary for the six months ended January 31, 2008 and
2007, thereby causing our overall effective tax rate to exceed the statutory
rate. The results of continuing operations for our subsidiaries in Japan and
Singapore did not have a significant impact on our overall effective tax rate
for the six months ended January 31, 2008 due to the size of those
operations relative to our United States, Canada and Netherlands operations.
The decrease in the overall
effective tax rate for the six months ended January 31, 2008, compared
with the six months ended January 31, 2007, 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, and
the recently enacted Canadian federal statutory tax rate reductions as applied
to existing deferred income tax liabilities.
In July 2006, the FASB
issued Interpretation No. 48,
“Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”
(“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.
31
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 January 31, 2008 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.
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 and six months ended January 31, 2008 and 2007:
|
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
|
January 31,
|
|
January 31,
|
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
$
|
8,000
|
|
$
|
15,000
|
|
$
|
21,000
|
|
$
|
14,000
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
Selling
|
|
23,000
|
|
43,000
|
|
52,000
|
|
69,000
|
|
|
General and administrative
|
|
428,000
|
|
153,000
|
|
913,000
|
|
322,000
|
|
|
Research and development
|
|
3,000
|
|
6,000
|
|
8,000
|
|
10,000
|
|
|
Total operating expenses
|
|
454,000
|
|
202,000
|
|
973,000
|
|
401,000
|
|
|
Stock-based compensation before income taxes
|
|
462,000
|
|
217,000
|
|
994,000
|
|
415,000
|
|
|
Income tax benefits
|
|
(184,000
|
)
|
(68,000
|
)
|
(388,000
|
)
|
(173,000
|
)
|
|
Total stock-based compensation expense, net of tax
|
|
$
|
278,000
|
|
$
|
149,000
|
|
$
|
606,000
|
|
$
|
242,000
|
|
For the three and six months
ended January 31
, 2008 and 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 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. Total stock-based compensation expense,
net of tax, decreased both basic and diluted earnings per share from
32
continuing operations by
$0.02 and $0.01 for the three months ended January 31, 2008 and 2007,
respectively, and by $0.04 and $0.02 for the six months ended January 31,
2008 and 2007, respectively.
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 January 31, 2008, total unrecognized stock-based compensation expense,
net of tax, related to total nonvested stock options and stock awards was
$2,164,000 with a remaining weighted average period of 25 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. As of January 31, 2008, 155,000 stock awards remain
nonvested and outstanding with a weighted average fair value of $16.61. 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 Company’s 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 and
six months ended January 31, 2008 and 2007 are deductible for tax purposes
and 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, 2008,
the weighted average fair value of all options granted was approximately $4.24
and $5.73, respectively. 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. The aggregate intrinsic value (i.e. the excess
market price over the exercise price) of all options was approximately $215,000
and $2,089,000 for the three and six months ended January 31, 2008,
respectively, and $132,000 and $2,224,000 for the three and six months ended January 31,
2007, 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 with respect to incentive stock options 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, 2008 and 2007, options
exercised resulted in income tax deductions that reduced income taxes payable
by $836,000 and $611,000, 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 award’s fair value.
33
Liquidity and Capital Resources
Working capital
At January 31,
2008, the Company’s working capital was $51,551,000, compared with $40,760,000
at July 31, 2007. This increase in working capital was principally due to
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.
Cash flows from operating activities
Net
cash provided by operating activities was $2,887,000 for the six months ended January 31,
2008, compared with net cash used in operating activities of $4,056,000 for the
six months ended January 31, 2007. For the six months ended January 31,
2008, the net cash provided by operating activities was primarily due to net
income after adjusting for depreciation and amortization and stock-based
compensation expense, 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) and
a decrease in compensation payable (due to the payment of prior year incentive
compensation).
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 an
increase in sales) 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).
Net
cash provided by operating activities related only to continuing operations was
$2,926,000 and $665,000 for the six months ended January 31, 2008 and
2007, respectively.
Cash flows from investing activities
Net
cash used in investing activities was $16,111,000 and $6,540,000 for the six
months ended January 31, 2008 and 2007, respectively. For the six months
ended January 31, 2008, 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 six months ended January 31, 2007, 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 $10,984,000 for the six months ended January 31,
2008, compared with net cash used in financing activities of $2,348,000 for the
six months ended January 31, 2007.
For the six months ended January 31,
2008, 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
repayments under the term loan and revolving credit facilities. For the six
months ended January 31, 2007, the net cash
34
used
in financing activities was primarily attributable to repayments under the term
loan facility and the purchases of treasury stock, partially offset by
exercises of stock options.
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 paid 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 were made following Olympus’ receipt of customer payments
for such orders and totaled $368,000. For the three and six months ended January 31,
2007, approximately $126,000 and $300,000, respectively, 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 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.
Cash
flows attributable to discontinued operations comprise the following:
|
|
|
Six
Months Ended January 31,
|
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
|
|
Net cash used in operating
activities
|
|
$
|
(39,000
|
)
|
$
|
(4,721,000
|
)
|
|
|
|
|
|
|
|
|
|
Investing and financing
activities of our discontinued operations did not result in any net cash for
the three and six months ended January 31, 2008 and 2007.
At January 31, 2008 and July 31, 2007,
remaining liabilities of our discontinued operations were $53,000 and $97,000,
respectively, and principally related to various taxes expected to be paid by
the end of fiscal 2008.
35
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 has 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 and six months
ended January 31, 2008 and 2007, 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.
Long-term
contractual obligations
As
of January 31, 2008, aggregate annual required payments over the remaining
fiscal year, the next four years and thereafter under our contractual
obligations that have long-term components are as follows:
|
|
|
Six
Months
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
July 31,
|
|
Year
Ending July 31,
|
|
|
|
|
|
|
2008
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
Thereafter
|
|
Total
|
|
|
|
|
(Amounts
in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Maturities of the
credit facilities
|
|
$
|
3,000
|
|
$
|
8,000
|
|
$
|
10,000
|
|
$
|
45,800
|
|
$
|
—
|
|
$
|
—
|
|
$
|
66,800
|
|
|
Expected interest
payments under the credit facilities (1)
|
|
2,195
|
|
4,014
|
|
3,397
|
|
381
|
|
—
|
|
—
|
|
9,987
|
|
|
Minimum
commitments under noncancelable operating leases
|
|
1,659
|
|
2,918
|
|
2,315
|
|
1,437
|
|
766
|
|
1,643
|
|
10,738
|
|
|
Minimum commitments
under noncancelable capital leases
|
|
16
|
|
32
|
|
32
|
|
14
|
|
—
|
|
—
|
|
94
|
|
|
Minimum
commitments under license agreement
|
|
30
|
|
77
|
|
116
|
|
172
|
|
199
|
|
2,875
|
|
3,469
|
|
|
Deferred compensation and other
|
|
108
|
|
153
|
|
34
|
|
406
|
|
406
|
|
606
|
|
1,713
|
|
|
Employment agreements
|
|
1,873
|
|
1,966
|
|
374
|
|
145
|
|
135
|
|
—
|
|
4,493
|
|
|
Total contractual obligations
|
|
$
|
8,881
|
|
$
|
17,160
|
|
$
|
16,268
|
|
$
|
48,355
|
|
$
|
1,506
|
|
$
|
5,124
|
|
$
|
97,294
|
|
(1) The
expected interest payments under the term and revolving credit facilities
reflect interest rates of 6.92% and 6.51%, respectively, which were our
weighted average interest rates on outstanding borrowings at January 31,
2008.
36
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 $1,139,000 at January 31, 2008.
At February 29, 2008, borrowings under the 2005 U.S. Credit
Facilities bear interest at rates ranging from 0% to 0.50% above the lender’s
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
February 29, 2008, the lender’s base rate was 6.0% and the LIBOR rates
ranged from 2.82% to 5.46%. The margins applicable to our outstanding
borrowings at February 29, 2008 were 0.25% above the lender’s base rate
and 1.50% above LIBOR. Substantially all of our outstanding borrowings were
under LIBOR contracts at January 31, 2008. 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 0.30% at February 29, 2008.
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, Crosstex and
Strong Dental) and (ii) our pledge of all of the outstanding shares of
Minntech, Mar Cor, Crosstex and Strong Dental 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, 2008, we are in compliance with all financial
and other covenants under the 2005 U.S. Credit Facilities.
On
January 31, 2008 and February 29, 2008, we had $66,800,000 of
outstanding borrowings under the 2005 U.S. Credit Facilities, which consisted
of $31,000,000 and $35,800,000 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 January 31, 2008, we had minimum future royalty obligations
relating to this license agreement of
37
approximately $3,469,000 using the exchange rate at January 31,
2008.
Deferred Compensation
Included in other long-term
liabilities are deferred compensation arrangements for certain former Minntech
directors and officers.
Financing needs
At January 31, 2008, we had
a cash balance of $14,208,000, of which $9,575,000 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 January 31, 2008,
$14,200,000 was available under our United States revolving credit facility, as
amended.
Foreign currency
During the three
and six months ended January 31, 2008, compared with the three and six
months ended January 31, 2007, the average value of the Canadian dollar
increased by approximately 16.5% and 13.2%, respectively, relative to the value
of the United States dollar.
C
hanges
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 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 and six months ended January 31,
2008, compared with the three and six months ended January 31, 2007, upon
our continuing results of operations, net of tax, of approximately $92,000 and
$290,000, respectively.
For
the three and six months ended January 31, 2008, compared with the three
and six months ended January 31, 2007, the value of the euro increased by
approximately 12.5% and 11.0%, respectively, relative to the value of the
United States dollar.
C
hanges 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 and six months ended January 31,
2008, compared with the three and six months ended January 31, 2007, upon
our results of operations, net of tax, of approximately $158,000 and $190,000,
respectively.
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.
38
There
was one foreign currency forward contract amounting to €725,000 at February 29,
2008 which covers certain assets and liabilities of Minntech’s Netherlands
subsidiary which are denominated in United States dollars. Such contract
expires on March 31, 2008. 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, 2008, such
forward contracts were effective in offsetting the impact of the strengthening
of the euro on certain assets and liabilities of Minntech’s 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 January 31, 2008
compared with July 31, 2007, the value of the Canadian dollar increased by
approximately 6.4% and the value of the euro increased by approximately 8.4%
compared with the value of the United States dollar. The total of these
currency movements resulted in a foreign currency translation gain of
$2,172,000 during the six months ended January 31, 2008, thereby
increasing 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, 2008, compared with the three and six months
ended January 31, 2007, 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 healthcare
39
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 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.
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 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. 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 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 $595,000 and $854,000
for the three and six months ended January 31, 2008, respectively, and
$379,000 and $1,158,000 for the three and six months ended January 31,
2007, respectively. 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
40
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 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, 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 January 31, 2008. While the results of these annual reviews
have historically not indicated impairment, impairment reviews are highly
41
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 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 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 award’s 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
42
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 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 management’s
assessment of exposure associated with acquired
43
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.
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
·
certain of our businesses are heavily reliant
on certain raw materials which have been experiencing price increases
·
uncertainties related to our Endoscope
Reprocessing segment, particularly those relating to the assumption of direct
sales and service of Medivators endoscope
44
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.
|
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 the 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 and six months ended January 31,
2008, compared with the three and six months ended January 31, 2007, upon
our continuing results of operations and a positive impact on stockholders’
equity, as described in our MD&A.
C
hanges 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
45
denominated and ultimately
settled in United States dollars but must be converted into its functional euro
currency. Additionally, the 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 and six months ended January 31,
2008, compared with the three and six months ended January 31, 2007, upon
our continuing results of operations, and had a positive impact upon
stockholders’ equity, as described in our MD&A.
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 €992,000 at January 31, 2008 which covered
certain assets and liabilities of Minntech’s Netherlands subsidiary which are
denominated in United States dollars. Such contract expired on February 29,
2008. 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, 2008, such forward contracts were
effective in offsetting the impact on operations of the strengthening of the
euro.
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,
2008 and 2007 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
2007 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 design and 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
46
concluded
that the design and operation of 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 described below.
Changes
in Internal Control
On August 1, 2005, which
was the first day of fiscal 2006, we acquired Crosstex. For the three and six
months ended January 31, 2008 and 2007, Crosstex represented a material
portion of our sales, net income and net assets. As more fully described in our
2007 Form 10-K, we have remedied the significant internal control
weaknesses at Crosstex that were identified by us in connection with the due
diligence for this acquisition, including the replacement of the existing
management information system. The implementation process of this new system
commenced during fiscal 2007 and was completed during the three months ended January 31,
2008. During fiscal 2007 and the six months ended January 31, 2008,
numerous temporary control improvements have been made to the existing
management information system for the interim period before the new system was
fully implemented.
On March 30, 2007, we
acquired GE Water as more fully described in Note 3 to the Condensed
Consolidated Financial Statements. During the initial transition period
following this acquisition, we have enhanced our internal control process at
our Mar Cor subsidiary to ensure that all financial information related to this
acquisition is properly reflected in our Consolidated Financial Statements.
During the first three months of the six months ended January 31, 2008,
substantially all aspects of this acquisition was fully integrated into Mar Cor’s
existing internal control structure.
47