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CMN > SEC Filings for CMN > Form 10-Q on 10-Jun-2013All Recent SEC Filings

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Form 10-Q for CANTEL MEDICAL CORP


10-Jun-2013

Quarterly Report


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, 2013 compared with the three and nine months ended April 30, 2012.

Liquidity and Capital Resources provides an overview of our working capital, cash flows, contractual obligations, 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 and services in the healthcare market, specializing in the following operating segments:

† Endoscopy: Medical device reprocessing systems, disinfectants, detergents and other supplies used to high-level disinfect flexible endoscopes. This segment also offers disposable infection control products intended to eliminate the challenges associated with proper cleaning and sterilization of numerous reusable components used in gastrointestinal (GI) endoscopy procedures.

† 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.

† Healthcare Disposables: Single-use, infection prevention and control products used principally in the dental market including face masks, sterilization pouches, towels and bibs, tray covers, saliva ejectors, germicidal wipes, plastic cups, and disinfectants. This segment also offers a broad suite of biological and chemical indicators for purposes of sterility assurance monitoring.

† Dialysis: Medical device reprocessing systems, sterilants/disinfectants, dialysate concentrates and other supplies for renal dialysis.

† Therapeutic Filtration: Hollow fiber membrane filtration and separation technologies for medical applications. (Included in the 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 the All Other reporting segment.)

† Chemistries: Sterilants, disinfectants and decontamination services used in various applications for infection prevention and control. (Included in the All Other reporting segment.)

Most of our equipment, consumables and supplies are used to help prevent or control the occurrence or spread of infections.

See our Annual Report on Form 10-K for the fiscal year ended July 31, 2012 (the "2012 Form 10-K") and our Condensed Consolidated Financial Statements for additional financial information regarding our reporting segments.

Significant Activity

(i) For the three and nine months ended April 30, 2013 compared with the three and nine months ended April 30, 2012, net sales increased by 8.0% and 8.1%, respectively, and net income increased 10.1% and 33.8%, respectively. We continue to benefit from having a broad portfolio of infection prevention and control products sold into diverse business segments, where approximately 74% 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:

† higher sales and profitability in our Healthcare Disposables segment, primarily due to the November 1, 2012 acquisition of SPS Medical Supply Corp., increased demand for our face masks and sterility assurance products and improved gross profit percentage,

† improved profitability in our Endoscopy segment for the nine months ended April 30, 2013 principally due to (i) a shift of product mix to higher margin products including increases in sales volume of endoscope reprocessing disinfectant and consumable products as a result of the increased field population of equipment, as well as disposable infection control products used in gastrointestinal (GI) endoscopy procedures as a result of new product introductions, (ii) a favorable net change of $882,000 in general and administrative expenses relating to fair value adjustments of contingent consideration and a price floor financial instrument as further described in Notes 3 and 6 to the Condensed Consolidated Financial Statements, (iii) the inclusion in our first quarter of fiscal 2012 of $1,519,000 in one-time acquisition related charges for the Byrne Acquisition and (iv) lower commission expense,

† improved sales in our Water Purification and Filtration segment primarily relating to increased sales of our capital equipment, consumables and service in the dialysis industry mainly attributable to new product introductions such as our heat sanitizable water purification systems, which are sold at higher average selling prices than the systems with the traditional non-heated sanitization technology,


† improved sales and profitability in our Therapeutic Filtration segment due to the market shortage of certain filters as a result of damage done from an earthquake to the manufacturing facilities of a large competitor,

† the implementation of various cost control initiatives such as the closing of our Japan location in July 2012 as part of our decision to service our Japan customers in a more cost effective manner,

† lower interest expense notwithstanding additional borrowings for the acquisition of the SPS Business and our agreement to acquire the hemodialysis water business from Siemens Industry, Inc. and Siemens Canada Limited (collectively, "Siemens"), and

† favorable tax impacts of Federal tax legislation enacted in January 2013 and the finalization of tax examinations in March 2013.

The above factors were partially offset by:

† decreases in sales volume of our endoscope reprocessing equipment as these capital equipment sales were elevated in prior periods partially as a result of our participation in a major initiative by the Veterans Administration to upgrade their hospitals' endoscope reprocessing equipment as well as regulatory issues experienced by a major competitor,

† the recording within cost of sales of $854,000 and $1,176,000 for the three and nine months ended April 30, 2013, respectively, in medical device excise tax in cost of sales as part of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, which became effective January 2013,

† incurring costs for personnel changes primarily relating to severance and recruiting a Chief Operating Officer during the nine months ended April 30, 2013,

† incurring approximately $226,000 in costs related to the March 2013 agreement to acquire the hemodialysis water business from Siemens, and

† decreases in net sales in our Dialysis operating segment, although we have been able to minimize the adverse impact to the segment's profitability for the three and nine months ended April 30, 2013 compared with the three and nine months ended April 30, 2012.

(ii) We sell our dialysis products to a concentrated number of customers. Sales in our Dialysis segment were adversely impacted by the decrease in demand for our RENATRON® reprocessing equipment and sterilants, as more fully described elsewhere in this MD&A. This reduction in dialysis sales has reduced overall profitability in this segment from historic levels. 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 reuse dialyzers is more economical than single-use dialyzers. A further decrease in the market for reprocessing products is likely to result in continued loss of net sales and a lower level of profitability in this segment in the future. See "Risk Factors" in the 2012 Form 10-K.

(iii) In March 2010, President Obama signed into law the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010. The legislation imposes a significant new tax on medical device makers in the form of an excise tax on certain U.S. medical device sales beginning in January 2013. Since a significant portion of our sales are considered medical device sales under this new legislation, our gross profit percentage is being adversely affected beginning in January 2013, as more fully described elsewhere in this MD&A.

(iv) On March 22, 2013, our Mar Cor subsidiary entered into an agreement to acquire from Siemens certain net assets of Siemens' hemodialysis water business (the "Siemens Water Business" or the "Siemens Water Acquisition"), as more fully described in Note 3 to the Condensed Consolidated Financial Statements.

(v) On December 31, 2012, our Mar Cor subsidiary acquired certain net assets of Eagle Pure Water Systems, Inc. (the "Eagle Pure Water Business" or the "Eagle Pure Water Acquisition"), as more fully described in Note 3 to the Condensed Consolidated Financial Statements.

(vi) On November 1, 2012, our Crosstex subsidiary acquired all the issued and outstanding stock of SPS Medical Supply Corp. (the "SPS Business" or "SPS Medical"), as more fully described in Note 3 to the Condensed Consolidated Financial Statements.

(vii) On October 31, 2012, our Board of Directors approved an 18% increase in the semiannual cash dividend to $0.055 per share of outstanding common stock, which was paid on December 14, 2012 to shareholders of record at the close of business on November 14, 2012, as more fully described elsewhere in this MD&A.

(viii) In order to more fully capitalize on the strength of the Medivators brand name currently used in our endoscopy business, we decided to change the name of Minntech Corporation to Medivators Inc. ("Medivators"). The name change was effective on August 1, 2012.

(ix) The Company issued 9,955,000 additional shares of common stock in connection with a three-for-two stock split effected in the form of a 50% stock dividend paid on February 1, 2012 to stockholders of record on January 23, 2012, as more fully described elsewhere in this MD&A.

(x) On August 1, 2011, the start of our prior fiscal year, our Medivators subsidiary acquired the business and substantially all of the assets of Byrne Medical, Inc. ("BMI"), as more fully described in Note 3 to the Condensed Consolidated Financial Statements. Certain components of the acquisition's purchase price were recorded at fair value and are continually re-measured at each balance sheet date, which has the potential for creating earnings volatility as further described elsewhere in this MD&A


and in Notes 3 and 6 to the Condensed Consolidated Financial Statements.

(xi) In conjunction with the acquisition of the business and substantially all of the assets of BMI and the impending expiration of our existing credit facility, we entered into a $150,000,000 Second Amended and Restated Credit Agreement dated as of August 1, 2011, as more fully described elsewhere in this MD&A and in Notes 3 and 9 to the Condensed Consolidated Financial Statements. Additionally, in order to protect our interest rate exposure in future years, we entered into interest rate swap agreements in fiscal 2012, as more fully described elsewhere in this MD&A and in Notes 5 and 9 to the Condensed Consolidated Financial Statements.

Results of Operations

The results of operations described below reflect the operating results of Cantel and its wholly-owned subsidiaries. Since the acquisitions of the SPS Business and the Eagle Pure Water Business were consummated on November 1, 2012 and December 31, 2012, respectively, their results of operations are included in the three months ended April 30, 2013 and the portion of the nine months ended April 30, 2013 subsequent to their acquisition dates, and are not included in our results of operations for the three and nine months ended April 30, 2012. The acquisition date of the Siemens Water Acquisition is subsequent to April 30, 2013 as a minimal amount of customer service agreements have been assigned to Mar Cor as of April 30, 2013. Consequently, the results of operations of the Siemens Water Business had an insignificant impact on our results of operations for the three and nine months ended April 30, 2013, and are not included in our results of operations for the three and nine months ended April 30, 2012.

The following discussion should also be read in conjunction with our 2012 Form 10-K.

The following table gives information as to the net sales and the percentage to the total net sales for each of our reporting segments:

                               Three Months Ended                         Nine Months Ended
                                    April 30,                                 April 30,
                            2013                 2012                 2013                 2012
                          (Dollar amounts in thousands)             (Dollar amounts in thousands)
                         $          %         $         %          $         %          $         %

Endoscopy            $   39,694     37.8   $ 38,606     39.7   $ 115,795     37.2   $ 115,037     40.0
Water Purification
and Filtration           29,473     28.0     25,955     26.7      88,099     28.3      76,505     26.6
Healthcare
Disposables              22,674     21.6     19,336     19.9      66,968     21.6      56,668     19.7
Dialysis                  8,072      7.7      8,902      9.1      25,019      8.0      27,180      9.4
All Other                 5,096      4.9      4,439      4.6      15,172      4.9      12,407      4.3
                     $  105,009    100.0   $ 97,238    100.0   $ 311,053    100.0   $ 287,797    100.0

Net Sales

Net sales increased by $7,771,000, or 8.0%, to $105,009,000 for the three months ended April 30, 2013 from $97,238,000 for the three months ended April 30, 2012.

Net sales increased by $23,256,000, or 8.1%, to $311,053,000 for the nine months ended April 30, 2013 from $287,797,000 for the nine months ended April 30, 2012.

The increase in net sales for the three and nine months ended April 30, 2013 was principally


attributable to increases in sales of water purification and filtration products, healthcare disposables products and to a lesser extent, therapeutic filtration products (recorded in the All Other reporting segment).

Net sales of water purification and filtration products and services increased by $3,518,000, or 13.6%, and $11,594,000, or 15.2%, for the three and nine months ended April 30, 2013, respectively, compared with the three and nine months ended April 30, 2012, primarily due to (i) an increase in demand for our water purification capital equipment, consumables and service in the dialysis industry mainly attributable to new product introductions such as our heat sanitizable water purification systems which are also sold at higher average selling prices than systems with the traditional non-heated sanitization technology and (ii) to a lesser extent, price increases on certain water purification products and services, which were implemented to partially offset increased costs.

Net sales of healthcare disposables products increased by $3,338,000, or 17.3%, and $10,300,000, or 18.2%, for the three and nine months ended April 30, 2013, respectively, compared with the three and nine months ended April 30, 2012, principally due to (i) the inclusion of $4,687,000 and $9,349,000, respectively, in net sales from the acquired SPS Business on November 1, 2012 and (ii) increases in customer demand in the United States for our face masks and sterility assurance products. These items were partially offset by the loss of some private label business as a result of a customer's decision to purchase certain healthcare disposable products from low cost providers including competitors whose products are manufactured in countries that have lower overall operating costs. In addition, elevated customer demand during our second quarter of fiscal 2013 in advance of known price increases implemented in January 2013 adversely affected customer demand during our third quarter of fiscal 2013 since certain customers had built sufficient inventory levels.

Net sales in the All Other reporting segment increased by $657,000, or 14.8%, and $2,765,000, or 22.3%, for the three and nine months ended April 30, 2013, respectively, compared with the three and nine months ended April 30, 2012. The increase for the three and nine months ended April 30, 2013 was primarily the result of an increase of $605,000 and $2,317,000, respectively, in net sales in our Therapeutic Filtration operating segment due to elevated demand, both in the United States and internationally, for our hemoconcentrator products (a device used to concentrate red blood cells and remove excess fluid from the bloodstream during open-heart surgery). This elevated demand primarily occurred during the first three months of the nine months ended April 30, 2013 as a result of a market shortage of these filters due to damage done from an earthquake to the manufacturing facilities of a large competitor, which were subsequently repaired. However, our third quarter of fiscal 2013 benefited from increased demand as we captured more market share as a result of this event.

Net sales of endoscopy products and services increased by $1,088,000, or 2.8%, and $758,000, or 0.7%, for the three and nine months ended April 30, 2013, respectively, compared with the three and nine months ended April 30, 2012, primarily due to increases in demand in the United States for (i) our disinfectants, service and consumables due to the increase in the installed base of endoscope reprocessing equipment and (ii) our new product introductions of valves, kits and hybrid tubing procedural products (disposable infection control products used in gastrointestinal (GI) endoscopy procedures). These increases were partially offset by a decrease in demand for our endoscope reprocessing equipment as demand had been elevated in the prior year period, as well as overall lower selling prices of approximately $1,170,000 and $1,830,000, respectively. Demand for our endoscope reprocessing equipment had been elevated during the second half of fiscal 2011 and the first half of fiscal 2012 due to our previous investments in new


product offerings and sales and marketing programs, as well as regulatory issues experienced by a major competitor, all of which enabled us to increase our sales of endoscope reprocessing equipment including successfully participating in a major initiative beginning in the second half of fiscal 2011 by the Veterans Administration to upgrade their hospitals' endoscope reprocessing equipment. Beginning in our second quarter of fiscal 2012, this elevated level of capital equipment sales gradually decreased to a similar level that existed prior to the second half of fiscal 2011. However, we expect disinfectants, service, consumables and equipment accessories, which are sold at higher margins, to continue to benefit as we increase the installed base of endoscope reprocessing equipment.

Net sales of dialysis products and services decreased by $830,000, or 9.3%, and $2,161,000, or 8.0%, for the three and nine months ended April 30, 2013, respectively, compared with the three and nine months ended April 30, 2012, due to decreases in demand in both the United States and internationally (including a decrease from our largest dialysis customer, DaVita, Inc. ("DaVita")) for our RENATRON® dialyzer reprocessing equipment, sterilants and dialysate concentrate product (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). 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 reuse dialyzers is more economical than single-use dialyzers. The shift from reusable to single-use dialyzers is principally due to the lowering 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 has been evaluating the economics and other factors associated with single-use versus reuse on a regional basis. This evaluation has resulted in the conversion by DaVita of certain clinics from reuse to single-use and in many cases the opening of new clinics as single-use clinics. A further decrease in the market for reprocessing products is likely to result in continued 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. Additionally, our Dialysis segment is highly dependent upon DaVita as a customer and any further shift by this customer away from reuse would have a material adverse effect on our Dialysis segment net sales.

Gross profit

Gross profit increased by $2,865,000, or 6.7%, to $45,484,000 for the three months ended April 30, 2013 from $42,619,000 for the three months ended April 30, 2012. Gross profit as a percentage of net sales for the three months ended April 30, 2013 and 2012 was 43.3% and 43.8%, respectively.

Gross profit increased by $12,972,000, or 10.7%, to $134,362,000 for the nine months ended April 30, 2013 from $121,390,000 for the nine months ended April 30, 2012. Gross profit as a percentage of net sales for the nine months ended April 30, 2013 and 2012 was 43.2% and 42.2%, respectively.

The lower gross profit as a percentage of net sales for the three months ended April 30, 2013 compared with the three months ended April 30, 2012 was primarily due to (i) the inclusion of $854,000 for a new excise tax on qualified U.S. medical device sales beginning January 2013, and (ii) lower selling prices of our Endoscopy procedural products as a result of increased competition and new sales to Group Purchasing Organizations (GPOs) which typically receive


discounted selling prices as a result of their purchasing volume. These items were partially offset by a more favorable sales mix due to increases in sales volume of certain products that carry higher gross margin percentages than each segment's prior year overall gross profit percentages such as our face masks and sterility assurance products (including sales of products relating to the newly acquired SPS Business) in our Healthcare Disposables segment, disinfectants in our Endoscopy segment and filters in our Therapeutic Filtration segment as well as decreases in sales volume of lower margin products such as endoscope reprocessing equipment in our Endoscopy segment.

The higher gross profit as a percentage of net sales for the nine months ended April 30, 2013 compared with the nine months ended April 30, 2012 was primarily due to (i) a more favorable sales mix as discussed above and (ii) the inclusion in the prior nine month period ended April 30, 2012 of a $893,000 one-time acquisition accounting charge relating to the acquired inventory in the Byrne Acquisition. These items were partially offset by (i) the inclusion of $1,176,000 for a new excise tax on qualified U.S. medical device sales beginning January 2013, (ii) lower selling prices of our Endoscopy procedural products as a result of increased competition and new sales to Group Purchasing Organizations (GPOs) which typically receive discounted selling prices as a result of their purchasing volume, (iii) $417,000 in severance related charges as part of our cost reduction initiatives and (iv) a $177,000 one-time acquisition accounting charge relating to the acquired inventory in the November 1, 2012 acquisition of the SPS Business.

In March 2010, President Obama signed into law the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010. The legislation imposes a significant new tax on medical device makers in the form of an excise tax on all U.S. medical device sales beginning in January 2013. Since a significant portion of our sales are considered medical device sales under this new legislation, we began recording the excise tax in cost of sales in January 2013 thereby adversely affecting our gross profit percentage. Although we have implemented cost reductions and revenue enhancement initiatives to partially offset this new excise tax, we cannot provide any assurances that we will be successful in further reducing the impact of this tax on our business. Additionally, other elements of this legislation could meaningfully change the way health care is developed and delivered and may materially impact numerous aspects of our business in the future. See "Risk Factors" in our 2012 Form 10-K.

Furthermore, 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 further price competition in certain of our segments such as Healthcare Disposables (due to a more competitive environment as well as competition from products manufactured in China and Southeast Asia, as explained below), Endoscopy (primarily when selling to Group Purchasing Organizations (GPOs) and other price competitive sales) and Dialysis (relating to the market shift from reusable to single-use dialyzers as explained above) or (iii) if raw materials and distribution costs increase and we are unable to implement further price increases. Some of our competitors manufacture certain healthcare disposable products in China and Southeast Asia due to lower overall costs despite expensive shipping costs. Although we believe the quality of our healthcare disposable products, which are generally produced in the United States, are superior, we may experience significant pricing pressure that would adversely affect our gross profit in the future in our Healthcare Disposables segment as a result of low cost competition from products produced in China and Southeast Asia.

Operating Expenses

Selling expenses increased by $856,000, or 6.0%, to $15,096,000 for the three months ended

. . .

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