ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help you understand Cantel Medical Corp. (“Cantel”). The MD&A is provided as a supplement to and should be read in conjunction with our financial statements and the accompanying notes. Our MD&A includes the following sections:
Overview
provides a brief description of our business and a summary of significant activity that has affected or may affect our results of operations and financial condition.
Results of Operations
provides a discussion of the consolidated results of operations for the three and nine months ended April 30, 2017 compared with the three and nine months ended April 30, 2016.
Liquidity and Capital Resources
provides an overview of our working capital, cash flows, 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 global company dedicated to delivering innovative infection prevention products and services for patients, caregivers, and other healthcare providers which improve outcomes, enhance safety and help save lives. We operate our business through the following four operating segments: Endoscopy, Water Purification and Filtration, Healthcare Disposables and Dialysis. Most of our equipment, consumables and supplies are used to help prevent the occurrence or spread of infections.
See our Annual Report on Form 10-K for the fiscal year ended July 31, 2016 (the “2016 Form 10-K”) and Note 15 to our Condensed Consolidated Financial Statements for additional information regarding our reporting segments.
Significant Activity
(i)
Some of our key financial results for the three and nine months ended April 30, 2017 compared with the three and nine months ended April 30, 2016 were as follows:
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Net sales increased by 10.6% to $192,113,000 from $173,703,000 for the three months ended April 30, 2017 and 16.2% to $564,655,000 from $485,753,000 for the nine months ended April 30, 2017; organic sales (i.e. excluding acquisitions and foreign currency translation) increased by 7.4% and 11.6% for the three and nine months ended April 30, 2017, respectively.
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Gross profit as a percentage of net sales increased to 47.6% from 46.2% for the three months ended April 30, 2017 and 47.7% from 46.1% for the nine months ended April 30, 2017.
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Net income under United States generally accepted accounting principles (GAAP) increased by 24.9% to $17,511,000 from $14,019,000 for the three months ended April 30, 2017 and 24.5% to $54,381,000 from $43,662,000 for the nine months ended April 30, 2017.
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After adjusting net income for amortization expense and atypical items, non-GAAP net income increased by 17.2% to $21,377,000 from $18,243,000 for the three months ended April 30, 2017 and 21.7% to $64,251,000 from $52,776,000 for the nine months ended April 30, 2017, as further described and reconciled to net income in “Non-GAAP Financial Measures” in this MD&A.
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Adjusted earnings before interest, taxes, depreciation, amortization and stock-based compensation expense (“Adjusted EBITDAS”) increased by 11.5% to $38,813,000 from $34,822,000 for the three months ended
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April 30, 2017 and 18.5% to $118,911,000 from $100,315,000 for the nine months ended April 30, 2017, as further described and reconciled to net income in “Non-GAAP Financial Measures” in this MD&A.
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We continue to benefit from having a broad portfolio of infection prevention and control products sold into diverse business segments, where approximately 73% of our net sales are attributable to consumable products and service. The primary factors that contributed to this financial performance, as further described elsewhere in this MD&A, were as follows:
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significantly higher sales and profitability in our Endoscopy segment principally due to (i) increases in demand for higher margin products, such as disposable infection control products used in GI endoscopy procedures, and endoscope reprocessing disinfectants and service as a result of the increased field population of equipment and to a much lesser extent, (ii) the inclusion of sales of an acquisition completed in the first quarter of our prior fiscal year,
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higher sales and improved profitability in our Water Purification and Filtration segment primarily due to increases in demand for our capital equipment in the dialysis industry attributable to the growing number of dialysis patients and clinics in the United States,
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enhanced profitability in our Healthcare Disposables segment mainly due to (i) increased sales of higher margin products such as sterility assurance and waterline disinfection products, (ii) lower manufacturing costs and (iii) the inclusion of sales of recent acquisitions, and
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the recording of atypical tax benefits during our first quarter of fiscal 2017, which decreased our effective tax rate, as further explained within “Non-GAAP Financial Measures” elsewhere in this MD&A.
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The above factors were partially offset by:
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our strategic decision to invest in various growth initiatives designed to expand into new markets and gain or maintain market share in our three largest segments, and
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the impact of costs associated with restructuring initiatives, as further described within “Non-GAAP Financial Measures” elsewhere in this MD&A.
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(ii)
We sell our dialysis products to a concentrated number of customers. Sales in our Dialysis segment have been adversely impacted in recent years by the decrease in demand for our products that are used by dialysis centers that reuse dialyzers, such as our sterilant products and RENATRON
®
reprocessing equipment. This reduction in dialysis sales has reduced overall profitability in this segment relative to prior years. Our market for dialysis reprocessing products is limited to dialysis centers that reuse dialyzers, which market has been decreasing in the United States despite the environmental advantages and our belief that the per-procedure cost of re-use dialyzers is more economical than single-use dialyzers. Based on discussions with customers, we expect the downward trend in re-use dialyzers in the United States will continue during the remainder of fiscal 2017 and thereafter. A substantial reduction of our dialysis re-use business will likely have a significant adverse effect on our dialysis segment and reduce our margins and net income in that segment as well as result in potential future impairments of long-lived assets. Such reduction would also adversely affect our consolidated results of operations. See “Risk Factors” in the 2016 Form 10-K.
(iii)
In our current fiscal year, we acquired (i) all the issued and outstanding stock of Accutron, Inc. (“Accutron”) on August 1, 2016 (the “Accutron Acquisition”), (ii) certain net assets of Vantage Endoscopy Inc. (“Vantage”) related to the distribution and sale of our Medivators endoscopy products in Canada (the “Vantage Acquisition”) and (iii) certain net assets of CR Kennedy & Company Pty Ltd. (“CR Kennedy”) related to its distribution and sale of our Medivators endoscopy products in Australia (the “CR Kennedy Acquisition”), as more fully described in Note 3 to the Condensed Consolidated Financial Statements.
(iv)
In our prior fiscal year, we acquired (i) all of the issued and outstanding stock of Medical Innovations Group Holdings Limited and certain affiliated companies (collectively, “MI”) on September 14, 2015 (the “MI Acquisition”) and (ii) certain net assets of North American Science Associates, Inc.’s Sterility Assurance
Monitoring Products division on March 1, 2016 (the “NAMSA Acquisition”), as more fully described in Note 3 to the Condensed Consolidated Financial Statements.
(v)
In December 2015, a law was enacted that included a two-year moratorium on the medical device excise tax, which favorably impacts our gross profit, as more fully described elsewhere in this MD&A.
(vi)
On October 14, 2016, our Board of Directors approved a 17% increase in the semiannual cash dividend to $0.07 per share of outstanding common stock, which was paid on January 31, 2017 to shareholders of record at the close of business on January 17, 2017, as more fully described elsewhere in this MD&A.
Results of Operations
The results of operations described below reflect the operating results of Cantel and its wholly-owned subsidiaries. The following tables give information as to the net sales by reporting segment and geography (which represent the geographic area from which the Company derives its net sales from external customers), as well as the related percentage of such sales to the total net sales.
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Three Months Ended
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Nine Months Ended
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April 30,
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April 30,
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(Amounts in Thousands)
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2017
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2016
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2017
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2016
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$
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%
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$
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%
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$
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%
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$
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%
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Net Sales by Segment
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Endoscopy
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$
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100,349
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52.2
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%
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$
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91,892
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52.9
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%
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$
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288,544
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51.1
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%
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$
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244,992
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50.4
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%
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Water Purification and Filtration
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47,940
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25.0
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%
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44,645
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25.7
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%
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145,233
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25.7
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%
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132,609
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27.3
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%
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Healthcare Disposables
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36,177
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18.8
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%
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29,779
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17.1
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%
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108,256
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19.2
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%
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83,157
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17.1
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%
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Dialysis
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7,647
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4.0
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%
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7,387
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4.3
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%
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22,622
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4.0
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%
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24,995
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5.2
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%
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Total net sales
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$
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192,113
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100.0
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%
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$
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173,703
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100.0
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%
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$
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564,655
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100.0
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%
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$
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485,753
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100.0
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%
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Net Sales by Geography
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United States
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$
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146,032
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76.0
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%
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$
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134,690
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77.5
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%
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$
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442,658
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78.4
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%
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$
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377,405
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77.7
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%
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International
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46,081
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24.0
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%
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39,013
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22.5
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%
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121,997
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21.6
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%
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108,348
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22.3
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%
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Total net sales
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$
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192,113
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100.0
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%
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$
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173,703
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100.0
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%
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$
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564,655
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100.0
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%
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$
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485,753
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100.0
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%
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The following table gives information as to the amount of operating income, as well as operating income as a percentage of net sales, for each of our reporting segments.
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Three Months Ended
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Nine Months Ended
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April 30,
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April 30,
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2017
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2016
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2017
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2016
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Operating
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% of
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Operating
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% of
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Operating
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% of
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Operating
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% of
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(Amounts in Thousands)
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Income
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Net Sales
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Income
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Net sales
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Income
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Net sales
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Income
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Net sales
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Endoscopy
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$
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18,514
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18.4
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%
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$
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16,279
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17.7
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%
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$
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54,853
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19.0
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%
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$
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43,402
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17.7
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%
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Water Purification and Filtration
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7,842
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16.4
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%
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6,934
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15.5
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%
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25,167
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17.3
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%
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22,336
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16.8
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%
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Healthcare Disposables
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6,392
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17.7
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%
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6,162
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20.7
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%
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20,857
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19.3
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%
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18,195
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21.9
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%
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Dialysis
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2,315
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30.3
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%
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1,795
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24.3
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%
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6,275
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27.7
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%
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6,216
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24.9
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%
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Operating income by segment
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35,063
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18.3
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%
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31,170
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17.9
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%
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107,152
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19.0
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%
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90,149
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18.6
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%
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General corporate expenses
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(7,619)
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(7,907)
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(24,032)
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(18,714)
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Income from operations
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$
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27,444
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14.3
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%
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$
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23,263
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13.4
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%
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$
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83,120
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14.7
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%
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$
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71,435
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14.7
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%
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Net Sales
Total net sales increased by $18,410,000, or 10.6%, to $192,113,000 for the three months ended April 30, 2017 from $173,703,000 for the three months ended April 30, 2016. The 10.6% increase in net sales for the three months ended April 30, 2017 includes (i) a 7.4% increase in organic sales, (ii) a 4.4% increase in sales due to acquisitions and (iii) a 1.2% decrease due to foreign currency translation.
Total net sales increased by $78,902,000, or 16.2%, to $564,655,000 for the nine months ended April 30, 2017 from $485,753,000 for the nine months ended April 30, 2016. The 16.2% increase in net sales for the nine months ended April 30, 2017 includes (i) a 11.6% increase in organic sales, (ii) a 5.8% increase in sales due to acquisitions and (iii) a 1.2% decrease due to foreign currency translation.
International net sales increased by $7,068,000, or 18.1%, to $46,081,000 for the three months ended April 30, 2017, compared with the three months ended April 30, 2016. The 18.1%, increase in net sales consist of (i) an increase of 18.6% in organic net sales, (ii) an increase of 5.1% in net sales due to acquisitions and (iii) a decrease of 5.6% in net sales due to foreign currency translation.
International net sales increased by $13,649,000, or 12.6%, to $121,997,000 for the nine months ended April 30, 2017, compared with the nine months ended April 30, 2016. The 12.6% increase in net sales consist of (i) an increase of 10.2% in organic net sales, (ii) an increase of 7.3% in net sales due to acquisitions and (iii) a decrease of 4.9% in net sales due to foreign currency translation.
For the three and nine months ended April 30, 2017, the increase in domestic organic net sales was primarily attributable to increases in net sales of products and services in our three largest segments, (i) Endoscopy, (ii) Water Purification and Filtration and (iii) Healthcare Disposables, and the increase in international organic net sales was primarily attributable to increases in net sales in our Endoscopy segment, as further described below.
Gross Profit
Gross profit increased by $11,127,000, or 13.9%, to $91,448,000 for the three months ended April 30, 2017 from $80,321,000 for the three months ended April 30, 2016. Gross profit as a percentage of net sales for the three months ended April 30, 2017 and 2016 was 47.6% and 46.2%, respectively.
Gross profit increased by $45,576,000, or 20.4%, to $269,432,000 for the nine months ended April 30, 2017 from $223,856,000 for the nine months ended April 30, 2016. Gross profit as a percentage of net sales for the nine months ended April 30, 2017 and 2016 was 47.7% and 46.1%, respectively.
The higher gross profit as a percentage of net sales for the three and nine months ended April 30, 2017, compared with the three and nine months ended April 30, 2016, was primarily attributable to (i) more favorable sales mix due to increases in sales volume of certain products that carry higher gross margin percentages such as our sterility assurance and waterline disinfection products in our Healthcare Disposables segment, and procedure room products and disinfectants in our Endoscopy segment, (ii) lower manufacturing costs primarily due to cost control initiatives, (iii) increased plant productivity due to the increased sales volume and (iv) a decrease of $2,040,000 for the nine months ended April 30, 2017 in medical device excise tax due to the recent moratorium, as further explained below, partially offset by an increase in net sales of lower margin capital equipment primarily in our Water Purification and Filtration segment.
In December 2015, the Consolidated Appropriations Act of 2016 was signed into law and included a two-year moratorium effective January 1, 2016 on the medical device excise tax, which was a tax on medical device makers in the form of a 2.3% excise tax on all U.S. medical device sales. A significant portion of our net sales are considered U.S. medical device sales and therefore our gross profit percentage will continue to be favorably impacted by this moratorium until the two-year moratorium expires. However, we are investing a significant portion of the savings from this moratorium into sales and marketing and product development initiatives.
We cannot provide assurances that our gross profit percentage will not be adversely affected in the future (i) by uncertainties associated with our product mix, (ii) by price competition, (iii) by legislation relating to the medical device excise tax or (iv) if raw materials and distribution costs increase and we are unable to implement offsetting price increases.
Operating Expenses
Selling expenses increased by $3,622,000, or 13.5%, to $30,509,000 for the three months ended April 30, 2017 from $26,887,000 for the three months ended April 30, 2016. For the nine months ended April 30, 2017, selling expenses increased by $14,345,000, or 20.2%, to $85,312,000 from $70,967,000 for the nine months ended April 30, 2016. For the three and nine months ended April 30, 2017, selling expenses increased primarily due to (i) increased sales and marketing initiatives to expand into new markets, including international markets, and to gain or maintain market share by hiring and training additional sales and marketing personnel and increasing travel budgets primarily in our Endoscopy segment, (ii) the inclusion of selling and marketing expenses of acquisitions, and (iii) increases in annual salaries.
Selling expenses as a percentage of net sales was 15.9% and 15.5% for the three months ended April 30, 2017 and 2016, respectively, and 15.1% and 14.6% for the nine months ended April 30, 2017 and 2016, respectively.
General and administrative expenses increased by $3,098,000, or 11.9%, to $29,204,000 for the three months ended April 30, 2017 from $26,106,000 for the three months ended April 30, 2016. For the nine months ended April 30, 2017, general and administrative expenses increased by $17,117,000, or 24.3%, to $87,672,000 from $70,555,000 for the nine months ended April 30, 2016. General and administrative expenses increased primarily due to (i) increases in annual salaries and incentive compensation including stock-based compensation, (ii) the addition of internal and external resources to address various growth initiatives and compliance requirements, (iii) an increase in amortization expense, primarily during the nine months ended April 30, 2017, related to recent acquisitions and (iv) severance and other restructuring costs primarily in our Endoscopy segment to improve operating efficiencies and realign resources for continued investment in strategic initiatives, partially offset by lower acquisition related items such as transaction and integration charges and fair value adjustments.
Excluding (i) current and prior year amortization expense, (ii) current and prior year acquisition related items such as transaction and integration charges and fair value adjustments, (iii) current and prior year costs associated with the planned retirement of our former Chief Executive Officer and (iv) severance and other restructuring costs, as further described within Non-GAAP Financial Measures elsewhere in this MD&A, general and administrative expenses increased by $3,667,000, or 18.1%, to $23,989,000 for the three months ended April 30, 2017, and $13,373,000, or 23.3%, to $70,793,000 for the nine months ended April 30, 2017. A significant portion of these increases are attributable to the inclusion of general and administrative expenses of our acquisitions.
General and administrative expenses as a percentage of net sales were 15.2% and 15.0% for the three months ended April 30, 2017 and 2016, respectively, and 15.5% and 14.5% for the nine months ended April 30, 2017 and 2016, respectively.
Research and development expenses (which include continuing engineering costs) increased by $226,000, or 5.6%, to $4,291,000 for the three months ended April 30, 2017 from $4,065,000 for the three months ended April 30, 2016. For the nine months ended April 30, 2017, research and development expenses increased by $2,429,000, or 22.3%, to $13,328,000, from $10,899,000 for the nine months ended April 30, 2016. The increase for the three and nine months ended April 30, 2017 was primarily due to additional product development initiatives, primarily in our Endoscopy segment, including projects related to the inclusion of recent acquisitions.
Research and development expense as a percentage of net sales were 2.2% and 2.3% for the three months ended April 30, 2017 and 2016, respectively, and 2.4% and 2.2% for the nine months ended April 30, 2017 and 2016, respectively.
Interest
Interest expense increased by $218,000 to $1,108,000 for the three months ended April 30, 2017 from $890,000 for the three months ended April 30, 2016. For the nine months ended April 30, 2017, interest expense increased by $816,000 to $3,365,000 from $2,549,000 for the nine months ended April 30, 2016. The increases were due to an increase in the average outstanding borrowings due to the funding of recent acquisitions.
Interest income increased by $5,000 to $24,000 for the three months ended April 30, 2017 from $19,000 for the three months ended April 30, 2016. For the nine months ended April 30, 2017 and 2016, respectively, interest income was $62,000.
Income Taxes
A reconciliation of the consolidated effective income tax rate for the nine months ended April 30, 2016 to the nine months ended April 30, 2017 is as follows:
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Consolidated
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Effective
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Income Tax Rate
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April 30, 2016
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36.7
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%
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Differential attributable to:
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Excess tax benefits
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(2.7)
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%
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Acquisition related items, net
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(0.5)
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%
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International operations
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(0.3)
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%
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Other
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(1.3)
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%
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April 30, 2017
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31.9
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%
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The consolidated effective tax rate for the nine months ended April 30, 2017 was favorably affected primarily by the recording of excess tax benefits relating to stock awards that vested in October 2016. As a result of the adoption of ASU 2016-09 on August 1, 2016, we no longer record excess tax benefits as an increase to additional paid-in capital, but record such excess tax benefits on a prospective basis as a reduction of income tax expense, which amounted to $2,191,000 for the nine months ended April 30, 2017, as further described in Notes 2 and 4 of the Condensed Consolidated Financial Statements and in Critical Accounting Policies elsewhere in this MD&A. Since most of our stock awards vest in October annually, we do not anticipate the recording of additional significant excess tax benefits for the remainder of fiscal 2017.
Endoscopy Segment
Net sales of endoscopy products and services increased by $8,457,000, or 9.2%, for the three months ended April 30, 2017, compared with the three months ended April 30, 2016. For the nine months ended April 30, 2017, net sales of endoscopy products and services increased by $43,552,000, or 17.8%, compared with the nine months ended
April 30, 2016. The 9.2% and 17.8% increases in net sales consist of (i) increases of 9.9% and 17.1%, respectively, in organic net sales, (ii) increases of 1.6% and 2.9%, respectively, in net sales due to acquisitions and (iii) decreases of 2.3% and 2.2% in net sales due to foreign currency translation for both periods. The increase in organic net sales for the three and nine months ended April 30, 2017 was primarily due to increases in demand in the United States and internationally for our (i) procedure room products (disposable infection control products used in GI endoscopy procedures) due to sales and marketing efforts, (ii) disinfectants and service due to the increase in the installed base of endoscope reprocessing equipment and (iii) endoscope reprocessing equipment primarily during our first and second quarters of fiscal 2017 due to our sales and marketing programs. We expect sales of disinfectants, service, filters and equipment accessories, most of which carry higher margins, to continue to benefit as we increase the installed base of endoscope reprocessing equipment. These increases were partially offset by overall lower selling prices principally related to endoscopy reprocessing equipment and procedure room products as a result of our strategic growth plan and increased competition.
The Endoscopy segment’s operating income increased by $2,235,000, or 13.7%, for the three months ended April 30, 2017, compared with the three months ended April 30, 2016, and $11,451,000, or 26.4%, for the nine months ended April 30, 2017, compared with the nine months ended April 30, 2016. The increases were primarily due to increases in sales in the United States and internationally for our endoscopy products and services, as further explained above, partially offset by increased investment in our sales team and other selling initiatives as well as increases in annual salaries, personnel, incentive compensation and restructuring initiatives. Excluding amortization expense as well as atypical items relating to current and prior year acquisition related items and current year restructuring initiatives, as further described within Non-GAAP Financial Measures elsewhere in this MD&A, the Endoscopy segment’s operating income increased by $2,743,000, or 14.6%, and $11,948,000, or 23.4%, for the three and nine months ended April 30, 2017 compared with the three and nine months ended April 30, 2016.
Water Purification and Filtration Segment
Net sales of water purification and filtration products and services increased by $3,295,000, or 7.4%, for the three months ended April 30, 2017, compared with the three months ended April 30, 2016, and for the nine months ended April 30, 2017 by $12,624,000, or 9.5%, compared to the nine months ended April 30, 2016. The increases in net sales of water purification and filtration products and services increased due to increases in demand for our capital equipment in the dialysis industry attributable to the growing number of dialysis patients and clinics in the United States.
The Water Purification and Filtration segment’s operating income increased by $908,000, or 13.1%, for the three months ended April 30, 2017, compared with the three months ended April 30, 2016, and $2,831,000, or 12.7%, for the nine months ended April 30, 2017, compared with the nine months ended April 30, 2016, primarily as a result of higher sales of lower margin capital equipment, as further explained above, and to a lesser extent, a decrease in warranty expenses.
Healthcare Disposables Segment
Net sales of healthcare disposables products increased by $6,398,000, or 21.5%, for the three months ended April 30, 2017, compared with the three months ended April 30, 2016, and for the nine months ended April 30, 2017 by $25,099,000, or 30.2%, when compared to the nine months ended April 30, 2016. The 21.5% and 30.2% increases in net sales consist of (i) an increase of 0.6% and 5.0% in organic net sales and (ii) an increase of 20.9% and 25.2% in net sales due to acquisitions. The increase in organic net sales for the three and nine months ended April 30, 2017 was primarily due to an increase in demand for higher margin products such as sterility assurance and waterline disinfection products, as well as branded products compared to products labeled with our customers’ names.
The Healthcare Disposables segment’s operating income increased by $230,000, or 3.7%, for the three months ended April 30, 2017, compared with the three months ended April 30, 2016, and $2,662,000, or 14.6%, for the nine months ended April 30, 2017 compared with the nine months ended April 30, 2016, primarily due to (i) the increase in higher margin sales, as further explained above, (ii) the inclusion of the Accutron and NAMSA Acquisitions and (iii) lower manufacturing costs, partially offset by increases to annual salaries, the hiring of additional sales personnel and the recording of severance expense. Excluding amortization expense, and to a much lesser extent acquisition related items, as further described within Non-GAAP Financial Measures elsewhere in this MD&A, the Healthcare Disposables segment’s operating income increased by $568,000, or 7.9%, and $5,042,000, or 24.7%, for the three and nine months ended April 30, 2017 compared with the three and nine months ended April 30, 2016, respectively.
Dialysis Segment
Net sales of dialysis products increased by $260,000, or 3.5%, for the three months ended April 30, 2017, compared with the three months ended April 30, 2016, and decreased by $2,373,000, or 9.5%, for the nine months ended April 30, 2017 compared to the nine months ended April 30, 2016. Net sales for the three and nine months ended April 30, 2017 were adversely affected by decreases in demand for our sterilant product and RENATRON
®
reprocessing equipment both internationally and in the United States due to the market shift from reusable to single-use dialyzers, as further described elsewhere in this MD&A. However, for the three months ended April 30, 2017, the decreases in demand for those products were offset by an increase in demand for our lower margin concentrate product.
The Dialysis segment’s operating income increased by $520,000, or 29.0% for the three months ended April 30, 2017, compared with the three months ended April 30, 2016, due to the impact of higher demand for our concentrate product and a decrease in general and administrative expenses as a result of cost control initiatives. For the nine months ended April 30, 2017, compared to the nine months ended April 30, 2016, operating income increased by $59,000, or 0.9%, primarily due to a decrease in general and administrative expenses as a result of cost control initiatives, substantially offset by lower net sales, as further explained above.
With the exception of increased sales of low margin concentrate products, which is a product not used in dialyzer reprocessing, sales in our Dialysis segment in recent years have been adversely impacted by the decrease in demand for our sterilants and RENATRON
®
reprocessing equipment principally due to the shift from reusable to single-use dialyzers as a result of the declining cost of single-use dialyzers, the ease of using a dialyzer one time, and the commitment of Fresenius Medical Care, the largest dialysis provider chain in the United States and a manufacturer of single-use dialyzers, to convert dialysis clinics performing reuse to single-use facilities. In addition, DaVita, a customer who accounted for approximately 9.4% of net sales in this segment, has converted certain clinics from reuse to single-use and in many cases utilizes single-use when opening new clinics. Based on discussions with customers, we expect the downward trend in reuse dialyzers in the United States will continue during the remainder of fiscal 2017. A substantial decrease in the market for reprocessing products is likely to result in a significant loss of net sales and a lower level of profitability and operating cash flow in this segment in the future as well as potential future impairments of long-lived assets. Such reduction would also adversely affect our consolidated results of operations. See “Risk Factors” in our 2016 Form 10-K.
General Corporate Expenses
General corporate expenses relate to unallocated corporate costs primarily related to executive management personnel as well as costs associated with certain facets of our acquisition program and being a publicly traded company. Such expenses decreased by $288,000, or 3.6%, for the three months ended April 30, 2017 compared with the three months ended April 30, 2016, primarily due to $1,162,000 of costs recorded in our third quarter of fiscal 2016 associated with the planned retirement of our former Chief Executive Officer, partially offset by (i) the addition of internal and external resources to address various growth initiatives and compliance requirements and (ii) increases in annual salaries and incentive compensation, including stock-based compensation expense. For the nine months ended April 30, 2017 compared with the nine months ended April 30, 2016, general corporate expenses increased by $5,318,000, or 28.4%, primarily due to (i) the addition of internal and external resources to address various growth initiatives and compliance requirements, (ii) increases in annual salaries and incentive compensation, including stock-based compensation expense and (iii) incremental costs associated with the planned retirement of our former Chief Executive Officer, as further explained below in Non-GAAP Financial Measures.
Non-GAAP Financial Measures
In evaluating our operating performance, we supplement the reporting of our financial information determined under accounting principles generally accepted in the United States (“GAAP”) with certain internally driven non-GAAP financial measures, namely (i) non-GAAP net income, (ii) non-GAAP diluted earnings per share (“EPS”), (iii) income before interest, taxes, depreciation, amortization and stock-based compensation expense (“EBITDAS”), (iv) EBITDAS adjusted for atypical items (“Adjusted EBITDAS”), (v) net debt and (vi) organic sales. These non-GAAP financial measures are indicators of the Company’s performance that are not required by, or presented in accordance with, GAAP. They are presented with the intent of providing greater transparency to financial information used by us in our financial analysis and operational decision-making. We believe that these non-GAAP measures provide meaningful information
to assist investors, shareholders and other readers of our Condensed Consolidated Financial Statements in making comparisons to our historical operating results and analyzing the underlying performance of our results of operations. These non-GAAP financial measures are not intended to be, and should not be, considered separately from, or as an alternative to, the most directly comparable GAAP financial measures.
We define non-GAAP net income and non-GAAP diluted EPS as net income and diluted EPS, respectively, adjusted to exclude amortization, acquisition related items, significant reorganization and restructuring charges, major tax events and other significant items management deems atypical or non-operating in nature.
For the three and nine months ended April 30, 2017, we made adjustments to net income and diluted EPS to exclude (i) amortization expense, (ii) significant acquisition related items impacting current operating performance including legal, transaction and integration charges as well as fair value adjustments and (iii) restructuring charges. Additionally, we made adjustments to the nine months ended April 30, 2017 to exclude (i) costs associated with the planned retirement of our former Chief Executive Officer and (ii) the favorable impact of atypical income tax benefits to arrive at our non-GAAP financial measures, non-GAAP net income and non-GAAP diluted EPS.
For the three and nine months ended April 30, 2016, we made adjustments to net income and diluted EPS to exclude (i) amortization expense, (ii) significant acquisition related items, (iii) costs associated with the planned retirement of our former Chief Executive Officer and (iv) with respect to the nine months ended April 30, 2016, the favorable impact of tax legislation to arrive at our non-GAAP financial measures, non-GAAP net income and non-GAAP diluted EPS.
Amortization expense is a non-cash expense related to intangibles that were primarily the result of business acquisitions. Our history of acquiring businesses has resulted in significant increases in amortization of intangible assets that reduced the Company’s net income. The removal of amortization from our overall operating performance helps in assessing our cash generated from operations including our return on invested capital, which we believe is an important analysis for measuring our ability to generate cash and invest in our continued growth.
Acquisition related items consist of (i) prior year fair value adjustments to contingent consideration and other contingent liabilities resulting from acquisitions, (ii) due diligence, integration, legal charges and other transaction costs associated with our acquisition program and (iii) acquisition accounting charges for the amortization of the initial fair value adjustments of acquired inventory and deferred revenue. The adjustments of contingent consideration and other contingent liabilities are periodic adjustments to record such amounts at fair value at each balance sheet date. Given the subjective nature of the assumptions used in the determination of fair value calculations, fair value adjustments may potentially cause significant earnings volatility that are not representative of our operating results. Similarly, due diligence, integration, legal and other acquisition costs associated with our acquisition program, including acquisition accounting charges relating to recording acquired inventory and deferred revenue at fair market value, can be significant and also adversely impact our effective tax rate as certain costs are often not tax-deductible. Since all of these acquisition related items are atypical and often mask underlying operating performance, we excluded these amounts for purposes of calculating these non-GAAP financial measures to facilitate an evaluation of our current operating performance and a comparison to past operating performance.
In fiscal 2016, we announced the retirement of our former Chief Executive Officer and recorded costs associated with his planned retirement in our Condensed Consolidated Financial Statements in the second half of fiscal 2016 and the first quarter of fiscal 2017. Since these costs are atypical and masks our underlying operating performance, we made an adjustment to our net income and EPS to exclude such costs to arrive at our non-GAAP financial measures.
In the second and third quarters of fiscal 2017, we recorded severance and other restructuring costs, primarily in our Endoscopy segment, to improve operating efficiencies and realign resources for continued investment in strategic initiatives. We expect further restructuring costs to occur in the fourth quarter of fiscal 2017. Since restructuring costs have historically been infrequent and masks our underlying operating performance, we have made an adjustment to our net income and EPS to exclude such restructuring costs to arrive at our non-GAAP financial measures.
The consolidated effective tax rate for the nine months ended April 30, 2017 was favorably affected by the recording of excess tax benefits relating to stock awards that vested in October 2016. As a result of the adoption of a new accounting pronouncement on August 1, 2016, as further described in Notes 2 and 4 of the Condensed Consolidated Financial Statements and elsewhere in this MD&A, we no longer record excess tax benefits as an increase to additional
paid-in capital, but record such excess tax benefits on a prospective basis as a reduction of income tax expense, which amounted to $2,241,000 in our first quarter of fiscal 2017. Since most of our stock awards were granted annually in our first quarter and vest on the anniversaries of the grant date, we do not anticipate the recording of additional significant excess tax benefits for the remainder of fiscal 2017. The magnitude of the impact of excess tax benefits generated in the future, which may be favorable or unfavorable, are dependent upon the Company’s future grants of stock-based compensation, the Company’s future stock price on the date awards vest in relation to the fair value of awards on grant date and the exercise behavior of the Company’s option holders. Since these favorable tax benefits are largely unrelated to our current year’s income before taxes and is unrepresentative of our normal effective tax rate, we excluded its impact on net income and EPS for our first quarter of fiscal 2017 for the purposes of calculating these non-GAAP financial measures to facilitate an evaluation of our current performance and a comparison to past performance.
The prior year consolidated effective tax rate was favorably affected by tax legislation enacted in the United States and internationally that enabled us to record favorable tax benefits in our second quarter of fiscal 2016 relating to the entire calendar 2015. Since these favorable tax benefits were largely unrelated to our second quarter’s income before taxes and was unrepresentative of our normal effective tax rate, we excluded its impact on net income and EPS for purposes of calculating these non-GAAP financial measures.
The reconciliations of net income to non-GAAP net income were calculated as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
April 30,
|
|
April 30,
|
|
(Amounts in Thousands)
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income, as reported
|
|
$
|
17,511
|
|
$
|
14,019
|
|
$
|
54,381
|
|
$
|
43,662
|
|
Intangible amortization (1)
|
|
|
3,964
|
|
|
3,346
|
|
|
11,930
|
|
|
9,737
|
|
Acquisition related items (2)
|
|
|
720
|
|
|
1,682
|
|
|
1,795
|
|
|
3,213
|
|
CEO retirement costs (1)
|
|
|
—
|
|
|
1,162
|
|
|
1,937
|
|
|
1,162
|
|
Restructuring costs (1)
|
|
|
879
|
|
|
—
|
|
|
1,735
|
|
|
—
|
|
Income tax benefit on above adjustments (3)
|
|
|
(1,697)
|
|
|
(1,966)
|
|
|
(5,286)
|
|
|
(4,198)
|
|
Excess tax benefit (3)
|
|
|
—
|
|
|
—
|
|
|
(2,241)
|
|
|
—
|
|
Tax legislative changes (3)
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(800)
|
|
Non-GAAP net income
|
|
$
|
21,377
|
|
$
|
18,243
|
|
$
|
64,251
|
|
$
|
52,776
|
|
|
(1)
|
|
Amounts are recorded in general and administrative expenses.
|
|
(2)
|
|
For the three and nine months ended April 30, 2017, acquisition related items of $330 and $500, respectively, were recorded in cost of sales and $390 and $1,295 were recorded in general administrative expenses. For the three and nine months ended April 30, 2016, acquisition related items of $388 and $959, respectively, were recorded in cost of sales and $1,294 and $2,254 were recorded in general administrative expenses.
|
|
(3)
|
|
Amounts are recorded in income taxes.
|
The reconciliations of diluted EPS to non-GAAP diluted EPS were calculated as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
April 30,
|
|
April 30,
|
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS, as reported
|
|
$
|
0.42
|
|
$
|
0.34
|
|
$
|
1.30
|
|
$
|
1.05
|
|
Intangible amortization, net of tax
|
|
|
0.07
|
|
|
0.06
|
|
|
0.20
|
|
|
0.16
|
|
Acquisition related items, net of tax
|
|
|
0.01
|
|
|
0.03
|
|
|
0.03
|
|
|
0.05
|
|
CEO retirement costs, net of tax
|
|
|
—
|
|
|
0.02
|
|
|
0.03
|
|
|
0.02
|
|
Restructuring costs, net of tax
|
|
|
0.02
|
|
|
—
|
|
|
0.03
|
|
|
—
|
|
Excess tax benefit
|
|
|
—
|
|
|
—
|
|
|
(0.05)
|
|
|
—
|
|
Tax legislative changes
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(0.02)
|
|
Non-GAAP diluted EPS
|
|
$
|
0.51
|
(1)
|
$
|
0.44
|
(1)
|
$
|
1.54
|
|
$
|
1.26
|
|
|
(1)
|
|
The summation of each diluted EPS amount does not equal the non-GAAP diluted EPS due to rounding.
|
We believe EBITDAS is an important valuation measurement for management and investors given the increasing effect that non-cash charges, such as stock-based compensation, amortization related to acquisitions and depreciation of capital equipment, has on the Company’s net income. In particular, acquisitions have historically resulted in significant increases in amortization of intangible assets that reduce the Company’s net income. Additionally, we regard EBITDAS as a useful measure of operating performance and cash flow before the effect of interest expense and is a complement to operating income, net income and other GAAP financial performance measures.
We define Adjusted EBITDAS as EBITDAS excluding the same atypical items as previously described as adjustments to net income. We use Adjusted EBITDAS when evaluating the operating performance of the Company because we believe the exclusion of such atypical items, of which a significant portion are non-cash items, is necessary to provide the most accurate measure of on-going core operating results and to evaluate comparative results period over period.
The reconciliations of net income to EBITDAS and Adjusted EBITDAS were calculated as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
April 30,
|
|
April 30,
|
|
(Amounts in Thousands)
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income, as reported
|
|
$
|
17,511
|
|
$
|
14,019
|
|
$
|
54,381
|
|
$
|
43,662
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
1,084
|
|
|
871
|
|
|
3,303
|
|
|
2,487
|
|
Income taxes
|
|
|
8,849
|
|
|
8,373
|
|
|
25,436
|
|
|
25,286
|
|
Depreciation
|
|
|
3,774
|
|
|
3,061
|
|
|
10,922
|
|
|
8,754
|
|
Amortization
|
|
|
3,964
|
|
|
3,346
|
|
|
11,930
|
|
|
9,737
|
|
Loss on disposal of fixed assets
|
|
|
87
|
|
|
66
|
|
|
489
|
|
|
177
|
|
Stock-based compensation expense
|
|
|
1,945
|
|
|
2,242
|
|
|
6,983
|
|
|
5,837
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EBITDAS
|
|
|
37,214
|
|
|
31,978
|
|
|
113,444
|
|
|
95,940
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition related items
|
|
|
720
|
|
|
1,682
|
|
|
1,795
|
|
|
3,213
|
|
CEO retirement costs
|
|
|
—
|
|
|
1,162
|
|
|
1,937
|
|
|
1,162
|
|
Restructuring costs
|
|
|
879
|
|
|
—
|
|
|
1,735
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted EBITDAS
|
|
$
|
38,813
|
|
$
|
34,822
|
|
$
|
118,911
|
|
$
|
100,315
|
|
We define net debt as long-term debt less cash and cash equivalents. Each of the components of net debt appears in the Condensed Consolidated Balance Sheets. We believe that the presentation of net debt provides useful
information to investors because we review net debt as part of our management of our overall liquidity, financial flexibility, capital structure and leverage.
The reconciliations of debt to net debt were calculated as follows:
|
|
|
|
|
|
|
|
|
|
April 30,
|
|
July 31,
|
|
(Amounts in Thousands)
|
|
2017
|
|
2016
|
|
|
|
|
|
|
|
|
|
Long-term debt
|
|
$
|
145,000
|
|
$
|
116,000
|
|
Less cash and cash equivalents
|
|
|
(30,873)
|
|
|
(28,367)
|
|
Net debt
|
|
$
|
114,127
|
|
$
|
87,633
|
|
The increase in net debt was the result of an increase in the average outstanding borrowings due to the funding of the Accutron Acquisition in August 2016, the Vantage Acquisition in September 2016 and the CR Kennedy Acquisition in April 2017, partially offset by repayments.
We define organic sales as net sales, calculated according to GAAP, less (i) the impact of foreign currency translation and (ii) net sales related to acquired businesses during the first twelve months of ownership and divestures during the periods being compared. We believe that reporting organic sales provides useful information to investors by helping identify underlying growth trends in our business and facilitating easier comparisons of our revenue performance with prior periods. We exclude the effect of foreign currency translation from organic sales because foreign currency translation is not under management’s control, is subject to volatility and can obscure underlying business trends. We exclude the effect of acquisitions because the nature, size, and number of acquisitions can vary dramatically from period to period and can obscure underlying business trends and make comparisons of financial performance difficult. The reconciliation of net sales to organic sales can be found in “Results of Operations” elsewhere in this MD&A.
Liquidity and Capital Resources
Working Capital
At April 30, 2017, our working capital was $150,135,000, compared with $126,407,000 at July 31, 2016. The increase was primarily due to the impact of the Accutron Acquisition, as further explained in Note 3 to the Condensed Consolidated Financial Statements.
Cash Flows from Operating, Investing and Financing Activities
The significant components of our cash flows were calculated as follows:
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
April 30,
|
|
(Amounts in Thousands)
|
|
2017
|
|
2016
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
$
|
73,384
|
|
$
|
51,803
|
|
Net cash used in investing activities
|
|
$
|
(90,376)
|
|
$
|
(106,916)
|
|
Net cash provided by financing activities
|
|
$
|
19,692
|
|
$
|
49,033
|
|
Cash Flows from Operating Activities
Net cash provided by operating activities increased by $21,581,000, or 41.7%, for the nine months ended April 30, 2017, compared with the nine months ended April 30, 2016, primarily due to the increase in net income (after adjusting for noncash items such as depreciation, amortization and stock-based compensation expense).
Cash Flows from Investing Activities
Net cash used in investing activities decreased by $16,540,000, or 15.5%, for the nine months ended April 30, 2017, compared with the nine months ended April 30, 2016, primarily due to less acquisition related cash consideration in the current period compared to the prior period, partially offset by an increase of $8,507,000, or 69.4%, in capital
expenditures. Such increased level of capital expenditures compared to the prior period is expected to continue for the remainder of fiscal 2017 as we continue to invest in our information technology and manufacturing infrastructures.
Cash Flows from Financing Activities
Net cash provided by financing activities decreased by $29,341,000, or 59.8%, for the nine months ended April 30, 2017, compared with the nine months ended April 30, 2016, primarily due to less borrowings under our credit facility to fund acquisitions in the current period, compared to borrowing to fund the acquisitions in the prior period.
Cash Dividends
On October 14, 2016, our Board of Directors approved a 17% increase in the semiannual cash dividend to $0.07 per share of outstanding common stock, which was paid on January 31, 2017 to shareholders of record at the close of business on January 17, 2017. Future declaration of dividends and the establishment of future record and payment dates are subject to the final determination of the Company’s Board of Directors.
Credit Facility
On March 4, 2014, we entered into a $250,000,000 Third Amended and Restated Credit Agreement (the “2014 Credit Agreement”). The 2014 Credit Agreement includes a five-year $250,000,000 senior secured revolving facility with sublimits of up to $100,000,000 for borrowings in foreign currencies, $30,000,000 for letters of credit and $10,000,000 for swing line loans (the “2014 Revolving Credit Facility”). Subject to the satisfaction of certain conditions precedent including the consent of the lenders, the Company may from time to time increase the 2014 Revolving Credit Facility by an aggregate amount not to exceed $100,000,000. The senior lenders include Bank of America N.A. (the lead bank and administrative agent), PNC Bank, National Association, and Wells Fargo Bank, National Association. The 2014 Credit Agreement expires on March 4, 2019. Additionally, subject to certain restrictions and conditions (i) any of our domestic or foreign subsidiaries may become borrowers and (ii) borrowings may occur in multi-currencies.
Borrowings under the 2014 Credit Agreement bear interest at rates ranging from 0.25% to 1.25% above the lender’s base rate, or at rates ranging from 1.25% to 2.25% above the London Interbank Offered Rate (“LIBOR”), depending upon the Company’s “Consolidated Leverage Ratio,” which is defined as the consolidated ratio of total funded debt to earnings before interest, taxes, depreciation and amortization, and as further adjusted under the terms of the 2014 Credit Agreement (“Consolidated EBITDA”). At May 31, 2017, the lender’s base rate was 4.00% and the LIBOR rates ranged from 1.01% to 1.33%. The margins applicable to our outstanding borrowings were 0.25% above the lender’s base rate or 1.25% above LIBOR. All of our outstanding borrowings were under LIBOR contracts at May 31, 2017. The 2014 Credit Agreement also provides for fees on the unused portion of our facility at rates ranging from 0.20% to 0.40%, depending upon our Consolidated Leverage Ratio; such rate was 0.20% at May 31, 2017.
The 2014 Credit Agreement contains affirmative and negative covenants reasonably customary for similar credit facilities and is secured by (i) substantially all assets of Cantel and its United States-based subsidiaries, (ii) a pledge by Cantel of all of the outstanding shares of its United States-based subsidiaries and 65% of the outstanding shares of certain of Cantel’s foreign-based subsidiaries, and (iii) a guaranty by Cantel’s domestic subsidiaries. We are in compliance with all financial and other covenants under the 2014 Credit Agreement.
On April 30, 2017, we had $145,000,000 of outstanding borrowings under the 2014 Credit Agreement. Subsequent to April 30, 2017, we repaid $6,000,000 resulting in total outstanding borrowings of $139,000,000 at June 8, 2017, none of which is required to be repaid until March 2019.
Financing Needs
Our operating segments generate significant cash from operations. At April 30, 2017 we had a cash balance of $30,873,000, of which $13,508,000 was held by foreign subsidiaries. Our foreign cash is needed by our foreign subsidiaries for working capital purposes as well as for current international growth initiatives. Accordingly, our foreign unremitted earnings are considered permanently reinvested and unavailable for repatriation.
We believe that our current cash position, anticipated cash flows from operations and the funds available under our 2014 Credit Agreement will be sufficient to satisfy our worldwide cash operating requirements for the foreseeable
future based upon our existing operations, particularly given that we historically have not needed to borrow for working capital purposes. At June 8, 2017, $111,000,000 was available under our 2014 Credit Agreement.
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 disclosures 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.
Information related to our critical accounting policies, estimates, and assumptions is included in our Annual Report on Form 10-K for the fiscal year ended July 31, 2016. Our critical accounting policies, estimates, and assumptions have not changed materially from July 31, 2016, except for stock-based compensation and related income taxes due to the adoption of Accounting Standards Update (“ASU”) 2016-09,
“Improvements to Employee Share-Based Payment Accounting,”
(“ASU 2016-09”) and, for the first time, the issuance of performance-based stock-awards, as more fully explained below and in Notes 2 and 4 to the Condensed Consolidated Financial Statements.
Stock-Based Compensation
Stock compensation expense is recognized for any option or stock award grant based upon the award’s fair value. Our stock options and time-based stock awards are subject to graded vesting in which portions of the awards 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 such awards subject to graded vesting using the straight-line basis over the vesting period. In October 2016, we granted for the first time to certain employees equity awards with performance conditions and equity awards with market conditions. The actual number of equity awards earned and eligible to vest will be determined based on the level of achievement against budgeted revenue and a defined gross profit percentage, with respect to the awards with performance conditions, and the Company’s 3-year relative total stockholder return performance as measured against the S&P Healthcare Equipment Index, with respect to the awards with market conditions. The maximum share attainment of these awards is 200% of the initial granted shares.
We recognize compensation expense for the awards with performance conditions using the accelerated attribution method over the requisite service period for each separately vesting portion of the award when it is probable that the performance condition will be achieved.
We record expense for the awards that are subject to market conditions ratably over the vesting period regardless of whether the market condition is satisfied.
As a result of the adoption of ASU 2016-09 on August 1, 2016, we have elected to account for forfeitures as they occur, rather than estimate expected forfeitures over the course of a vesting period.
We determine the fair value of each time-based stock award and stock award with a performance condition by using the closing market price of our common stock on the date of grant. We determine the fair value of each stock award with market conditions using the Monte Carlo simulation model 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 valuation models is affected by our stock price as well as assumptions regarding a number of subjective variables. These variables may include, but are not limited to, the expected stock price volatility over the term of the expected equity award life, the expected dividend yield, the expected equity award life, the probability of meeting performance objectives and the stock price of our peers in the S&P Healthcare Equipment Index. 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), modifications to existing awards, accelerated vesting related to certain employment terminations, the level of forfeitures, the ability to meet performance objectives and assumptions used in determining fair value.
In addition, as a result of the adoption of ASU 2016-09, we no longer record excess tax benefits relating to stock-based compensation as an increase to additional paid-in capital, but effective August 1, 2016, we record such excess tax benefits prospectively as a reduction of income tax expense, which amounted to $2,191,000 for the nine months ended April 30, 2017, favorably impacting our effective tax rate and net income, as further described elsewhere in this MD&A and in Notes 4 and 12 of the Condensed Consolidated Financial Statements. The magnitude of such impacts, which may be favorable or unfavorable in the future, are dependent upon the Company’s future grants of stock-
based compensation, the Company’s future stock price on the date awards vest compared to the fair value of awards on grant date and the exercise behavior of the Company’s option holders.
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. These statements are based on current expectations, estimates, or forecasts about our businesses, the industries in which we operate, and the current beliefs and assumptions of management; they do not relate strictly to historical or current facts. Without limiting the foregoing, words or phrases such as “expect,” “anticipate,” “goal,” “will continue,” “project,” “intend,” “plan,” “believe,” “seek,” “may,” “could,” and variations of such words and similar expressions generally identify forward-looking statements. 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. We caution that undue reliance should not be placed on such forward-looking statements, which speak only as of the date made. Some of the factors which could cause results to differ from those expressed in any forward-looking statement are set forth under Item 1A of the 2016 Form 10-K, entitled Risk Factors. 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 of 1933 and Section 21E of the Securities Exchange Act of 1934.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in information reported in Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our 2016 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.
Under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer each concluded that the design and operation of these disclosure controls and procedures were effective and designed to ensure that material information relating to the Company, including our consolidated subsidiaries, required to be disclosed in our SEC reports is (i) recorded, processed, summarized and reported within the time periods specified by the SEC and (ii) accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.
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.
On August 1, 2016, we acquired Accutron, as more fully described in Note 3 to the Condensed Consolidated Financial Statements. During the initial transition period following the acquisition, we enhanced our internal control process to ensure that all financial information related to this acquisition was properly reflected in our Condensed Consolidated Financial Statements. We expect all aspects of the Accutron business will be fully integrated into our existing overall internal control structure by the end of fiscal 2017.