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CMN > SEC Filings for CMN > Form 10-Q on 9-Jun-2014All Recent SEC Filings

Show all filings for CANTEL MEDICAL CORP

Form 10-Q for CANTEL MEDICAL CORP


9-Jun-2014

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, 2014 compared with the three and nine months ended April 30, 2013.

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 high-level disinfection of numerous reusable components used in gastrointestinal endoscopy procedures. Additionally, this segment includes technical maintenance service on its products.

† 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 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.

See our Annual Report on Form 10-K for the fiscal year ended July 31, 2013 (the "2013 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, 2014 compared with the three and nine months ended April 30, 2013, net sales increased by 14.3% and 14.9%, respectively, and net income increased 13.9% and 12.2%, respectively. 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:

† higher sales and improved gross profit percentage in our Endoscopy segment principally due to (i) a shift of product mix to primarily higher margin products including increases in sales volume of endoscope reprocessing disinfectant, service, equipment accessories and filter products as a result of the increased field population of equipment and disposable infection control products used in gastrointestinal endoscopy procedures and
(ii) increased demand for our endoscope reprocessing equipment,

† higher sales and improved 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 both the growing number of dialysis patients and clinics in the United States, as well as our new product introductions such as our heat sanitized water purification systems, which carry higher average selling prices than the systems with the traditional non-heated sanitization technology, and the acquisition of the dialysis water business from Siemens Industry, Inc. and Siemens Canada Limited (collectively, "Siemens"), and (ii) increased demand for our water purification equipment used for commercial and industrial (large capital) applications, and

† higher sales and improved profitability in our Healthcare Disposables segment primarily due to (i) the prior year inclusion of only six months of the results of operations of SPS Medical Supply Corp. ("SPS Medical") following its acquisition on November 1, 2012 (the "SPS Acquisition") and
(ii) the increased demand for our face masks, cups, disinfectants and sterility assurance products.


The above factors were partially offset by:

† our strategic decision to invest in sales and marketing initiatives in our three largest segments and corporate internal and external resources designed to expand into new markets and gain or maintain market share while also addressing new compliance requirements,

† unfavorable net changes of $380,000 and $2,558,000 for the three and nine months ended April 30, 2014 compared with the three and nine months ended April 30, 2013, respectively, of fair value adjustments of contingent consideration, a price floor financial instrument and an assumed contingent liability recorded in general and administrative expenses in our Endoscopy segment as the majority of these fair value adjustments were more favorable in the prior year, as further described in Note 6 to the Condensed Consolidated Financial Statements,

† an increase of $1,645,000 within cost of sales for the nine months ended April 30, 2014 compared with the nine months ended April 30, 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,

† decreases in sales volume of certain therapeutic filters in our Water Purification and Filtration segment as sales of these filters were elevated in prior periods due to a market shortage as a result of damage done from an earthquake to the manufacturing facilities of a large competitor,

† decreases in net sales and profitability in our Dialysis operating segment, as further described below,

† an increase in bad debt expense primarily associated with a single customer,

† the inclusion of the initial operating expenses of $210,000 and $415,000 in our Endoscopy segment for the three and nine months ended April 30, 2014, respectively, relating to the November 5, 2013 acquisition of Jet Prep Ltd., as more fully described in Note 3 to the Condensed Consolidated Financial Statements, with no corresponding sales as the commercialization of the product has just begun, and

† an increase in costs associated with our acquisition program for the nine months ended April 30, 2014 compared with the nine months ended April 30, 2013.

(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 sterilants, RENATRON® reprocessing equipment 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 prior periods. 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" in the 2013 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 imposed 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 4, 2014, we entered into a $250,000,000 Third Amended and Restated Credit Agreement with our senior lenders to refinance our working capital credit facilities, as more fully described in Note 9 to the Condensed Consolidated Financial Statements.

(v) On June 3, 2014, we entered into a definitive stock purchase agreement to acquire all the issued and outstanding capital stock of PuriCore International Limited, as more fully described in Note 3 to the Condensed Consolidated Financial Statements (the "PuriCore Acquisition").

(vi) On January 7, 2014, Crosstex' subsidiary acquired all the issued and outstanding stock of Sterilator Company, Inc. ("Sterilator"), as more fully described in Note 3 to the Condensed Consolidated Financial Statements (the "Sterilator Acquisition").

(vii) On November 5, 2013, our Medivators B.V. subsidiary acquired all the issued and outstanding stock of Jet Prep Ltd. ("Jet Prep"), as more fully described in Note 3 to the Condensed Consolidated Financial Statements (the "Jet Prep Acquisition"). Certain components of the acquisition's purchase price were recorded at fair value and will be continually remeasured at each balance sheet date, which has the potential for creating earnings volatility in the future as further described elsewhere in this MD&A and in Notes 3 and 6 to the Condensed Consolidated Financial Statements.

(viii) 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"), as more fully described in Note 3 to the Condensed Consolidated Financial Statements (the "Siemens Water Acquisition").

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

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


(xi) On October 16, 2013, our Board of Directors approved a 22% increase in the semiannual cash dividend to $0.045 per share of outstanding common stock, which was paid on January 31, 2014 to shareholders of record on January 17, 2014, as more fully described elsewhere in this MD&A.

(xii) The Company issued 15,044,000 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 July 12, 2013 to stockholders of record on July 1, 2013.

Results of Operations

The results of operations described below reflect the operating results of Cantel and its wholly-owned subsidiaries.

Since the PuriCore Acquisition is expected to be completed in June 2014, its results of operations are not included in our results of operations for any periods presented.

Since the acquisitions of Sterilator and Jet Prep were consummated on January 7, 2014 and November 5, 2013, respectively, their results of operations are included in our consolidated results of operations for the three months ended April 30, 2014, the portion of the nine months ended April 30, 2014 subsequent to their respective acquisition dates and are not included in our results of operations for the three and nine months ended April 30, 2013. However, their results of operations had an insignificant effect on our consolidated results of operations due to the small size of these businesses in relation to our overall consolidated results of operations.

On March 22, 2013, Mar Cor entered into an agreement to acquire the Siemens Water Business by gradually assigning and transitioning customer service agreements to Mar Cor. 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 are included in our results of operations for the three and nine months ended April 30, 2014 and are not included in our results of operations for the three and nine months ended April 30, 2013.

Since the SPS Acquisition and the Eagle Pure Water Acquisition were consummated on November 1, 2012 and December 31, 2012, respectively, their results of operations are included in our results of operations for the three and nine months ended April 30, 2014 and are included in our results of operations for the three months ended April 30, 2013 and the portion of the nine months ended April 30, 2013 subsequent to their respective acquisition dates. The results of operations of the Eagle Pure Water Business had an insignificant effect on our consolidated results of operations due to its small size.

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 recast to reflect these changes.

The following discussion should also be read in conjunction with our 2013 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,
                         2014                 2013                 2014                 2013
                       (Dollar amounts in thousands)             (Dollar amounts in thousands)
                      $         %          $         %          $         %          $         %

Endoscopy         $  47,260     39.4   $  39,694     37.8   $ 135,460     37.9   $ 115,795     37.2
Water
Purification
and Filtration       38,281     31.9      32,943     31.4     118,750     33.2      98,473     31.7
Healthcare
Disposables          25,506     21.2      22,674     21.6      76,471     21.4      66,968     21.6
Dialysis              7,349      6.1       8,072      7.7      22,269      6.3      25,019      8.0
Other                 1,662      1.4       1,626      1.5       4,422      1.2       4,798      1.5
                  $ 120,058    100.0   $ 105,009    100.0   $ 357,372    100.0   $ 311,053    100.0

Net Sales

Net sales increased by $15,049,000, or 14.3%, to $120,058,000 for the three months ended April 30, 2014 from $105,009,000 for the three months ended April 30, 2013.

Net sales increased by $46,319,000, or 14.9%, to $357,372,000 for the nine months ended April 30, 2014 from $311,053,000 for the nine months ended April 30, 2013.

The increase in net sales for the three and nine months ended April 30, 2014 was attributable to increases in sales of our three largest segments, Endoscopy, Water Purification and Filtration and Healthcare Disposables.

Net sales of endoscopy products and services increased by $7,566,000, or 19.1%, and $19,665,000, or 17.0%, for the three and nine months ended April 30, 2014, respectively, compared with the three and nine months ended April 30, 2013, primarily due to increases in demand in the United States and internationally for (i) our disinfectants, service, equipment accessories and filters due to the increase in the installed base of endoscope reprocessing equipment, (ii) our valves, kits and tubing procedural products (disposable infection control products used in gastrointestinal endoscopy procedures) and (iii) our endoscope reprocessing equipment. We expect sales of disinfectants, service, equipment accessories and filters, most of which carry higher margins, to continue to benefit as we increase the installed base of endoscope reprocessing equipment. Additionally, the increase was attributable to a higher percentage of customers reimbursing us for freight costs on sales of disinfectants. These increases were partially offset by overall lower selling prices principally related to procedural products as a result of our strategic growth plan as well as increased competition.

Net sales of water purification and filtration products and services increased by $5,338,000, or 16.2%, and $20,277,000, or 20.6%, for the three and nine months ended April 30, 2014, respectively, compared with the three and nine months ended April 30, 2013, primarily due to (i) increased demand for our water purification capital equipment, consumables and service in the dialysis industry mainly attributable to the increased overall demand driven by both the growing number of dialysis patients and clinics in the United States, as well as our new product introductions such as our heat sanitized water purification systems, which have higher average selling prices than the systems with the traditional non-heated sanitization technology, and the Siemens Water Acquisition,
(ii) price increases on certain water purification and filtration


products, which were implemented to partially offset increasing costs and
(iii) increased demand for our water purification equipment used for commercial and industrial (large capital) applications. These increases were partially offset by a decrease in sales volume of our hemoconcentrator products (filter devices used to concentrate red blood cells and remove excess fluid from the bloodstream during open-heart surgery) for the three and nine months ended April 30, 2014 due to elevated demand in the prior year 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.

Net sales of healthcare disposables products increased by $2,832,000, or 12.5%, and $9,503,000, or 14.2%, for the three and nine months ended April 30, 2014, respectively, compared with the three and nine months ended April 30, 2013, principally due to (i) the inclusion of only six months of net sales of the SPS Business in the nine months ended April 30, 2013 as a result of acquiring SPS Medical on November 1, 2012, (ii) increases in customer demand in the United States for our face masks, cups, disinfectants and sterility assurance products and (iii) price increases on certain healthcare disposables products, which were implemented to partially offset increased costs.

Net sales of dialysis products and services decreased by $723,000, or 9.0%, and $2,750,000, or 11.0%, for the three and nine months ended April 30, 2014, respectively, compared with the three and nine months ended April 30, 2013, primarily due to (i) decreases in demand in the United States (including a decrease from our largest dialysis customer, DaVita, Inc. ("DaVita")) for our 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) and
(ii) lower selling prices which adversely impacted net sales by $305,000 and $456,000 for the three and nine months ended April 30, 2014, respectively. 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 $6,934,000, or 15.2%, to $52,418,000 for the three months ended April 30, 2014 from $45,484,000 for the three months ended April 30, 2013. Gross profit as a percentage of net sales for the three months ended April 30, 2014 and 2013 was 43.7% and 43.3%, respectively.

Gross profit increased by $21,890,000, or 16.3%, to $156,252,000 for the nine months ended


April 30, 2014 from $134,362,000 for the nine months ended April 30, 2013. Gross profit as a percentage of net sales for the nine months ended April 30, 2014 and 2013 was 43.7% and 43.2%, respectively.

The higher gross profit as a percentage of net sales for the three and nine months ended April 30, 2014 compared with the three and nine months ended April 30, 2013 was primarily due to more favorable sales mix in our three largest segments primarily 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 sterilants and certain equipment products in our Water Purification and Filtration segment, disinfectants, equipment accessories, filters and procedural products in our Endoscopy segment, and face masks, disinfectant and sterility assurance products (including sales of products relating to the SPS Acquisition) in our Healthcare Disposables segment. The higher gross profit percentage for the nine months ended April 30, 2014 was also due to the inclusion in the prior year of $417,000 in severance related charges as part of the prior year cost reduction initiatives and a $177,000 one-time acquisition accounting charge relating to the acquired inventory in the SPS Acquisition. These items were partially offset by (i) lower selling prices of certain products primarily in our Endoscopy segment as a result of our strategic growth plan and increased competition and (ii) the incremental impact of $75,000 and $1,645,000 for the three and nine months ended April 30, 2014, compared with the three and nine months ended April 30, 2013, respectively, for a new excise tax on qualified U.S. medical device sales beginning January 2013.

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" in the 2013 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 and increased competition) 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 more 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 or level of sales in the future in our Healthcare Disposables segment as a result of lower cost competition from products produced in other geographic locations.

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