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CMN > SEC Filings for CMN > Form 10-K on 30-Sep-2013All Recent SEC Filings

Show all filings for CANTEL MEDICAL CORP

Form 10-K for CANTEL MEDICAL CORP


30-Sep-2013

Annual Report


Item 7. 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 fiscal 2013 compared with fiscal 2012, and fiscal 2012 compared with fiscal 2011.

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.

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 high-level disinfection 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. In addition, our therapeutic filtration business and chemistries business, formerly included in our All Other reporting segment, have been integrated with our Water Purification and Filtration segment for both operating and reporting purposes. Therapeutic filtration includes hollow fiber membrane filtration and separation technologies for medical applications. Chemistries include certain sterilants, disinfectants and decontamination services used in various applications for infection prevention and control.

† 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 manufactures and provides biological and chemical indicators for sterility assurance monitoring services in the acute-care, alternate-care and dental markets.

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

† 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. (The Specialty Packaging operating segment is reported in the Other reporting segment.)

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


Significant Activity

(i) In fiscal 2013 compared to fiscal 2012, net sales and net income increased by 10.0% and 25.2%, 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:

† improved sales and profitability in our Water Purification and Filtration segment primarily relating to (i) higher sales of our capital equipment, consumables and service in the dialysis industry mainly attributable to the increased overall demand driven by the growing number of dialysis patients and clinics in the United States and our new product introductions such as our heat sanitized water purification systems, which are sold at higher average selling prices than the systems with the traditional non-heated sanitization technology, (ii) the market shortage of certain therapeutic filters as a result of damage done from an earthquake to the manufacturing facilities of a large competitor and (iii) increased demand for our sterilants from other manufacturers in the United States,

† 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 sales and profitability in our Endoscopy segment in fiscal 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) the inclusion in our first quarter of fiscal 2012 of $1,519,000 in one-time acquisition related charges for the Byrne Acquisition and
(iii) lower commission expense,

† 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 acquisitions of SPS Medical Supply Corp. and Siemens Industry, Inc.'s and Siemens Canada Limited's (collectively, "Siemens") hemodialysis water business, and

† the impairment of an investment during the second quarter of fiscal 2012, as more fully described in Note 21 to the Consolidated Financial Statements and elsewhere in this MD&A.

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 $2,087,000 in fiscal 2013 in medical device excise tax 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 approximately $696,000 in one-time acquisition related charges for acquisitions completed in fiscal 2013,


† an unfavorable net change of $591,000 in general and administrative expenses relating to favorable fair value adjustments of contingent consideration and a price floor financial instrument that were more favorable in the prior year compared with the current year, as further described in Notes 3 and 6 to the Consolidated Financial Statements, 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 in fiscal 2013 compared with fiscal 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, sterilants and dialysate concentrate products, as more fully described elsewhere in this MD&A. This reduction in dialysis sales has reduced overall profitability in this segment as compared with profitability in fiscal years prior to 2012. 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 material decrease in the market for reprocessing products is likely to result in a significant loss of net sales and a lower level of profitability in this segment in the future. See "Risk Factors" elsewhere in this Form 10-K.

(iii) In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 was signed into law. 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 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 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 Consolidated Financial Statements.

(vii) The Company issued 15,044,000 additional shares of common stock in connection with a three-for-two stock split effective in the form of a 50% stock dividend paid on July 12, 2013 to stockholders of record on July 1, 2013. This stock split was in addition to the three-for-two stock split effective in the form of a 50% stock dividend paid on February 1, 2012, as more fully described elsewhere in this MD&A.

(viii) On October 31, 2012, our Board of Directors approved an 18% increase in the semiannual cash dividend to $0.0367 per share ($0.055 per share on a pre-split basis) of outstanding common stock, which was paid on each of December 14, 2012 and July 31, 2013, as more fully described elsewhere in this MD&A.

(ix) 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.

(x) On August 1, 2011, the start of fiscal 2012, 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 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 created earnings volatility as further described elsewhere in this MD&A and in Notes 3 and 6 to the 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 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 Consolidated Financial Statements.

(xii) In fiscal 2011, we acquired the Gambro Business on October 6, 2010 and the ConFirm Monitoring Business on February 11, 2011, as more fully described in Note 3 to the 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 portion of fiscal 2013 subsequent to their acquisition dates, and are not included in our results of operations for fiscals 2012 and 2011. The SPS Business is included in the Healthcare Disposables segment and the Eagle Pure Water Business is included in the Water Purification and Filtration segment.

On March 22, 2013, Mar Cor entered into an agreement to acquire the Siemens Water Business by gradually transitioning customer service agreements to Mar Cor, which the majority of such contracts were transitioned as of July 30, 2013, the deemed acquisition date. Consequently, the results of operations of the Siemens Water Business had an insignificant impact on our results of operations in fiscal 2013 and are not included in our results of operations in fiscals 2012 and 2011. The Siemens Water Business is included in our Water Purification and Filtration segment.

Since the acquisition of the Byrne Medical Business was completed on August 1, 2011, its results of operations are included in our results of operations for fiscals 2013 and 2012 and are not reflected in our results of operations for fiscal 2011. The Byrne Medical Business is included in the Endoscopy segment.

Since the acquisitions of the Gambro Business and ConFirm Monitoring Business were completed on October 6, 2010 and February 11, 2011, respectively, their results of operations are included in our results of operations for fiscals 2013, 2012 and the portion of fiscal 2011 subsequent to their respective acquisition dates. The Gambro Business is included in the Water Purification and Filtration segment and the ConFirm Monitoring Business is included in the Healthcare Disposables segment.

During the fourth quarter of fiscal 2013, we changed our internal reporting processes by combining our Therapeutic Filtration and Chemistries operating segments, previously reported in the Other reporting segment, with our Water Purification and Filtration reporting segment to reflect the way the Company, through its executive management, manages, allocates resources and measures the performance of its businesses. All periods presented have been restated to reflect these changes.

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

                                                    Year Ended July 31,
                                         2013              2012              2011
                                               (Dollar amounts in thousands)
                                       $        %        $        %        $        %
Endoscopy                           160,317    37.7   153,224    39.6   102,484    31.9
Water Purification and Filtration   134,196    31.6   114,609    29.7   104,308    32.4
Healthcare Disposables               90,904    21.4    76,229    19.7    70,202    21.8
Dialysis                             33,148     7.8    35,644     9.2    38,055    11.8
Other                                 6,461     1.5     6,784     1.8     6,602     2.1
                                    425,026   100.0   386,490   100.0   321,651   100.0


Fiscal 2013 compared with Fiscal 2012

Net Sales

Net sales increased by $38,536,000, or 10.0%, to $425,026,000 in fiscal 2013 from $386,490,000 in fiscal 2012.

The increase in net sales in fiscal 2013 was principally attributable to increases in sales of water purification and filtration products and services, healthcare disposables products and endoscopy products and services.

Net sales of water purification and filtration products and services increased by $19,587,000, or 17.1%, in fiscal 2013 compared with fiscal 2012 primarily due to (i) an increase in demand for our water purification capital equipment, consumables and service in the dialysis industry mainly as a result of the growing number of dialysis patients and clinics in the United States and our new product introductions such as our heat sanitized water purification systems, which are sold at higher average selling prices than systems with the traditional non-heated sanitization technology, (ii) 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) 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, (iii) increased demand for our sterilants from other manufacturers in the United States and (iv) 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 $14,675,000, or 19.3%, in fiscal 2013 compared with fiscal 2012 principally due to (i) the inclusion of $13,945,000 in net sales from the acquired SPS Business on November 1, 2012,
(ii) increases in customer demand in the United States for our face masks and sterility assurance products and (iii) to a lesser extent, price increases on certain healthcare disposables products, which were implemented to partially offset increased costs. 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.

Net sales of endoscopy products and services increased by $7,093,000, or 4.6%, in fiscal 2013 compared with fiscal 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 (i) a decrease in demand for our endoscope reprocessing equipment as demand had been elevated in the prior year period and (ii) overall lower selling prices of approximately $3,240,000 principally related to procedural products partly as a result of our strategic growth plan, which includes securing new sales to Group Purchasing Organizations (GPOs) which typically receive discounted selling prices as a result of their purchasing volume. 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 $2,496,000, or 7.0%, in fiscal 2013 compared with fiscal 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 material 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. 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 $19,309,000, or 11.8%, to $183,476,000 in fiscal 2013 from $164,167,000 in fiscal 2012. Gross profit as a percentage of net sales in fiscals 2013 and 2012 was 43.2% and 42.5%, respectively.

The higher gross profit as a percentage of net sales in fiscal 2013 compared with fiscal 2012 was primarily due to (i) 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 and procedural products in our Endoscopy segment and filters and sterilants in our Water Purification and Filtration segment as well as decreases in sales volume of lower margin products such as endoscope reprocessing equipment in our Endoscopy segment, as discussed above and (ii) the inclusion in fiscal 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 $2,087,000 for a new excise tax on qualified U.S. medical device sales beginning January 2013, (ii) lower selling prices of certain products primarily in our Endoscopy segment partly as a result of our strategic growth plan, which includes securing new sales to Group Purchasing Organizations (GPOs) which typically receive discounted selling prices as a result of their purchasing volume, (iii) $498,000 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, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 was signed into law. 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" elsewhere in this 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 lower cost locations, as explained below), Endoscopy (primarily due to our growth strategy as explained above) 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 lower cost locations such as China, Southeast Asia and certain locations within North America due to lower overall costs despite expensive shipping costs, quality concerns, sustainability issues and other matters. 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 lower cost competition from products produced in other geographic locations.

Operating Expenses

Selling expenses increased by $2,620,000, or 4.7%, to $57,786,000 in fiscal 2013 from $55,166,000 in fiscal 2012 primarily due to the inclusion of selling expenses relating to the November 1, 2012 acquisition of the SPS Business and increased investments to further develop and support our sales team such as hiring additional sales personnel primarily in our Water Purification and Filtration and Endoscopy segments, funding increased travel budgets and providing annual raises, partially offset by approximately $800,000 in lower commissions primarily due to a change in the structure of our Endoscopy sales commission plan as well as less sales of higher commission products.


Selling expenses as a percentage of net sales were 13.6% and 14.3% in fiscals 2013 and 2012, respectively.

General and administrative expenses increased by $5,559,000, or 11.7%, to $53,182,000 in fiscal 2013 from $47,623,000 in fiscal 2012 primarily due to
(i) the inclusion of general and administrative expenses of the acquired SPS Business on November 1, 2012, (ii) higher personnel costs primarily relating to additional personnel, annual salary raises, employee benefit costs, recruiting . . .

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