UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.   20549

 

Form 10-Q

 

☒Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended January 31, 2017.

 

or

 

☐Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from            to           .

 

Commission file number:   001-31337

 

CANTEL MEDICAL CORP.

(Exact name of registrant as specified in its charter)

 

| Delaware                        |   | 22-1760285          |
|---------------------------------|--------|---------------------|
| (State or other jurisdiction of |   | (I.R.S. employer    |
| incorporation or organization)  |   | identification no.) |

 

 

| 150 Clove Road, Little Falls, New Jersey |   | 07424      |   | (973) 890-7220                                       |
|------------------------------------------|--------|------------|--------|------------------------------------------------------|
| (Address of principal executive offices) |   | (Zip code) |   | (Registrant's telephone number, including area code) |

 

Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

| Large accelerated filer ☒ | Accelerated filer ☐ | Non-accelerated filer ☐ | Smaller reporting company ☐ |
|----------------------------------|----------------------------|--------------------------------|------------------------------------|

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

 

Number of shares of common stock outstanding as of February 28, 2017: 41,724,077.

 

 

 

			 		

			 		

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PART I – FINANCIAL INFORMATION

ITEM 1. – FINANCIAL STATEMENTS

CANTEL MEDICAL CORP.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollar Amounts in Thousands, Except Share Data)

(Unaudited)

 

|                                                                                                                                                                                                                                            |                     |                   |                     |                |   |     |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------|------------------------|--------------------------|---------------------|--------|----------|--------|
|                                                                                                                                                                                                                                            |                     | January 31,  |                     | July 31,  |   |
|                                                                                                                                                                                                                                            |      | 2017                   |      | 2016                |   |
| Assets                                                                                                                                                                                                                                          |                     |                   |                     |                |   |     |   |
| Current assets:                                                                                                                                                                                                                                 |                     |                   |                     |                |   |     |   |
| Cash and cash equivalents                                                                                                                                                                                                                       |                     | $                      | 24,351                   |                | $      | 28,367   |   |
| Accounts receivable, net of allowance for doubtful accounts of $1,436 at January 31 and $1,850 at July 31                                                                                                                                       |                     |                   | 100,112                  |                |   | 93,332   |   |
| Inventories, net                                                                                                                                                                                                                                |                     |                   | 96,150                   |                |   | 91,486   |   |
| Prepaid expenses and other current assets                                                                                                                                                                                                       |                     |                   | 13,059                   |                |   | 9,557    |   |
| Total current assets                                                                                                                                                                                                                            |                     |                   | 233,672                  |                |   | 222,742  |   |
| Property and equipment, net                                                                                                                                                                                                                     |                     |                   | 83,042                   |                |   | 74,604   |   |
| Intangible assets, net                                                                                                                                                                                                                          |                     |                   | 128,667                  |                |   | 111,719  |   |
| Goodwill                                                                                                                                                                                                                                        |                     |                   | 302,637                  |                |   | 280,318  |   |
| Other assets                                                                                                                                                                                                                                    |                     |                   | 5,212                    |                |   | 5,149    |   |
|                                                                                                                                                                                                                                            |                     | $                      | 753,230                  |                | $      | 694,532  |   |
| Liabilities and stockholders’ equity                                                                                                                                                                                                     |                     |                   |                     |                |   |     |   |
| Current liabilities:                                                                                                                                                                                                                            |                     |                   |                     |                |   |     |   |
| Accounts payable                                                                                                                                                                                                                                |                     | $                      | 30,018                   |                | $      | 26,263   |   |
| Compensation payable                                                                                                                                                                                                                            |                     |                   | 19,568                   |                |   | 25,555   |   |
| Accrued expenses                                                                                                                                                                                                                                |                     |                   | 20,141                   |                |   | 20,283   |   |
| Deferred revenue                                                                                                                                                                                                                                |                     |                   | 22,077                   |                |   | 20,173   |   |
| Income taxes payable                                                                                                                                                                                                                            |                     |                   | 338                      |                |   | 4,061    |   |
| Total current liabilities                                                                                                                                                                                                                       |                     |                   | 92,142                   |                |   | 96,335   |   |
|                                                                                                                                                                                                                                            |                     |                   |                     |                |   |     |   |
| Long-term debt                                                                                                                                                                                                                                  |                     |                   | 149,000                  |                |   | 116,000  |   |
| Deferred income taxes                                                                                                                                                                                                                           |                     |                   | 24,201                   |                |   | 23,579   |   |
| Other long-term liabilities                                                                                                                                                                                                                     |                     |                   | 4,727                    |                |   | 4,248    |   |
|                                                                                                                                                                                                                                            |                     |                   |                     |                |   |     |   |
| Commitments and contingencies                                                                                                                                                                                                                   |                     |                   | —                 |                |   | — |   |
|                                                                                                                                                                                                                                            |                     |                   |                     |                |   |     |   |
| Stockholders’ equity:                                                                                                                                                                                                                    |                     |                   |                     |                |   |     |   |
| Preferred Stock, par value $1.00 per share; authorized 1,000,000 shares; none issued                                                                                                                                                            |                     |                   | —                 |                |   | — |   |
| Common Stock, par value $.10 per share; authorized 75,000,000 shares; issued January 31  - 46,178,384 shares, outstanding January 31 - 41,721,636 shares; issued July 31 - 46,084,047 shares, outstanding July 31 - 41,708,214 shares |                     |                   | 4,618                    |                |   | 4,608    |   |
| Additional paid-in capital                                                                                                                                                                                                                      |                     |                   | 170,601                  |                |   | 165,573  |   |
| Retained earnings                                                                                                                                                                                                                               |                     |                   | 376,002                  |                |   | 342,053  |   |
| Accumulated other comprehensive (loss)                                                                                                                                                                                                          |                     |                   | (15,728)                 |                |   | (11,795) |   |
| Treasury Stock, at cost; January 31 - 4,456,748 shares at cost; July 31 - 4,375,833 shares at cost                                                                                                                                              |                     |                   | (52,333)                 |                |   | (46,069) |   |
| Total stockholders’ equity                                                                                                                                                                                                               |                     |                   | 483,160                  |                |   | 454,370  |   |
|                                                                                                                                                                                                                                            |                     | $                      | 753,230                  |                | $      | 694,532  |   |

 

See accompanying notes.

2

			 		

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CANTEL MEDICAL CORP.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollar Amounts in Thousands, Except Per Share Data)

(Unaudited)

 

 

|                       |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
|----------------------------|--------------------------|------------------------|--------------------------|------------------------|--------------------------|----------------|--------------------------|--------|--------------------------|--------|--------|---------|--------|
|                       |                     | Three Months Ended     |                     | Six Months Ended       |                     |
|                       |                     | January 31,  |                     | January 31,  |                     |
|                       |      | 2017                   |      | 2016                   |      | 2017           |      | 2016   |      |
| Net sales                  |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Product sales              |                     | $                      | 163,904                  |                   | $                        | 138,702        |                     | $      | 330,805                  |   | $      | 272,508 |   |
| Product service            |                     |                   | 20,913                   |                   |                     | 19,569         |                     |   | 41,737                   |   |   | 39,542  |   |
| Total net sales            |                     |                   | 184,817                  |                   |                     | 158,271        |                     |   | 372,542                  |   |   | 312,050 |   |
|                       |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Cost of sales              |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Product sales              |                     |                   | 81,755                   |                   |                     | 72,979         |                     |   | 165,371                  |   |   | 142,120 |   |
| Product service            |                     |                   | 14,585                   |                   |                     | 12,955         |                     |   | 29,187                   |   |   | 26,395  |   |
| Total cost of sales        |                     |                   | 96,340                   |                   |                     | 85,934         |                     |   | 194,558                  |   |   | 168,515 |   |
|                       |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Gross profit               |                     |                   | 88,477                   |                   |                     | 72,337         |                     |   | 177,984                  |   |   | 143,535 |   |
|                       |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Expenses:                  |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Selling                    |                     |                   | 26,910                   |                   |                     | 22,620         |                     |   | 54,803                   |   |   | 44,080  |   |
| General and administrative |                     |                   | 28,465                   |                   |                     | 22,252         |                     |   | 58,468                   |   |   | 44,449  |   |
| Research and development   |                     |                   | 4,489                    |                   |                     | 3,069          |                     |   | 9,037                    |   |   | 6,834   |   |
| Total operating expenses   |                     |                   | 59,864                   |                   |                     | 47,941         |                     |   | 122,308                  |   |   | 95,363  |   |
|                       |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Income from operations     |                     |                   | 28,613                   |                   |                     | 24,396         |                     |   | 55,676                   |   |   | 48,172  |   |
|                       |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Interest expense           |                     |                   | 1,145                    |                   |                     | 893            |                     |   | 2,257                    |   |   | 1,659   |   |
| Interest income            |                     |                   | (19)                     |                   |                     | (22)           |                     |   | (38)                     |   |   | (43)    |   |
|                       |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Income before income taxes |                     |                   | 27,487                   |                   |                     | 23,525         |                     |   | 53,457                   |   |   | 46,556  |   |
|                       |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Income taxes               |                     |                   | 9,417                    |                   |                     | 8,136          |                     |   | 16,587                   |   |   | 16,913  |   |
|                       |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Net income                 |                     | $                      | 18,070                   |                   | $                        | 15,389         |                     | $      | 36,870                   |   | $      | 29,643  |   |
|                       |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Earnings per common share: |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |    |   |
| Basic                      |                     | $                      | 0.43                     |                   | $                        | 0.37           |                     | $      | 0.88                     |   | $      | 0.71    |   |
| Diluted                    |                     | $                      | 0.43                     |                   | $                        | 0.37           |                     | $      | 0.88                     |   | $      | 0.71    |   |
| Dividends per common share |                     | $                      |  —           |                   | $                        |  — |                     | $      | 0.07                     |   | $      | 0.06    |   |

 

 

See accompanying notes.

 

3

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CANTEL MEDICAL CORP.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollar Amounts in Thousands)

(Unaudited)

 

 

|                               |                     |                   |                     |                   |                     |    |                     |   |                     |   |   |    |   |
|------------------------------------|--------------------------|------------------------|--------------------------|------------------------|--------------------------|---------|--------------------------|--------|--------------------------|--------|--------|---------|--------|
|                               |                     | Three Months Ended     |                     | Six Months Ended       |                     |
|                               |                     | January 31,  |                     | January 31,  |                     |
|                               |      | 2017                   |      | 2016                   |      | 2017    |      | 2016   |      |
|                               |                     |                   |                     |                   |                     |    |                     |   |                     |   |   |    |   |
| Net income                         |                     | $                      | 18,070                   |                   | $                        | 15,389  |                     | $      | 36,870                   |   | $      | 29,643  |   |
|                               |                     |                   |                     |                   |                     |    |                     |   |                     |   |   |    |   |
| Other comprehensive income (loss): |                     |                   |                     |                   |                     |    |                     |   |                     |   |   |    |   |
| Foreign currency translation       |                     |                   | 2,588                    |                   |                     | (7,199) |                     |   | (3,933)                  |   |   | (8,026) |   |
| Total other comprehensive loss     |                     |                   | 2,588                    |                   |                     | (7,199) |                     |   | (3,933)                  |   |   | (8,026) |   |
|                               |                     |                   |                     |                   |                     |    |                     |   |                     |   |   |    |   |
| Comprehensive income               |                     | $                      | 20,658                   |                   | $                        | 8,190   |                     | $      | 32,937                   |   | $      | 21,617  |   |

 

See accompanying notes.

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CANTEL MEDICAL CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollar Amounts in Thousands)

(Unaudited)

 

 

 

|                                                                              |                     |                   |                     |   |                     |     |   |
|-----------------------------------------------------------------------------------|--------------------------|------------------------|--------------------------|--------|--------------------------|----------|--------|
|                                                                              |                     | Six Months Ended       |                     |
|                                                                              |                     | January 31,  |                     |
|                                                                              |      | 2017                   |      | 2016   |      |
| Cash flows from operating activities                                              |                     |                   |                     |   |                     |     |   |
| Net income                                                                        |                     | $                      | 36,870                   |   | $                        | 29,643   |   |
| Adjustments to reconcile net income to net cash provided by operating activities: |                     |                   |                     |   |                     |     |   |
| Depreciation                                                                      |                     |                   | 7,148                    |   |                     | 5,693    |   |
| Amortization                                                                      |                     |                   | 7,966                    |   |                     | 6,391    |   |
| Stock-based compensation expense                                                  |                     |                   | 5,038                    |   |                     | 3,595    |   |
| Amortization of debt issuance costs                                               |                     |                   | 201                      |   |                     | 201      |   |
| Loss on disposal of fixed assets                                                  |                     |                   | 402                      |   |                     | 111      |   |
| Fair value adjustments to acquisition related liabilities                         |                     |                   | 18                       |   |                     | (571)    |   |
| Deferred income taxes                                                             |                     |                   | 821                      |   |                     | 688      |   |
| Excess tax benefits from stock-based compensation                                 |                     |                   |  —           |   |                     | (1,541)  |   |
| Changes in assets and liabilities, net of effects of business acquisitions:       |                     |                   |                     |   |                     |     |   |
| Accounts receivable                                                               |                     |                   | (2,651)                  |   |                     | (3,021)  |   |
| Inventories                                                                       |                     |                   | (1,008)                  |   |                     | (4,251)  |   |
| Prepaid expenses and other current assets                                         |                     |                   | (3,628)                  |   |                     | (5,034)  |   |
| Accounts payable and other current liabilities                                    |                     |                   | (2,543)                  |   |                     | (1,681)  |   |
| Income taxes                                                                      |                     |                   | (3,633)                  |   |                     | (1,952)  |   |
| Net cash provided by operating activities                                         |                     |                   | 45,001                   |   |                     | 28,271   |   |
|                                                                              |                     |                   |                     |   |                     |     |   |
| Cash flows from investing activities                                              |                     |                   |                     |   |                     |     |   |
| Capital expenditures                                                              |                     |                   | (14,416)                 |   |                     | (7,635)  |   |
| Proceeds from disposal of fixed assets                                            |                     |                   | 26                       |   |                     | 35       |   |
| Acquisition of businesses, net of cash acquired                                   |                     |                   | (58,348)                 |   |                     | (81,104) |   |
| Other, net                                                                        |                     |                   | 61                       |   |                     | 212      |   |
| Net cash used in investing activities                                             |                     |                   | (72,677)                 |   |                     | (88,492) |   |
|                                                                              |                     |                   |                     |   |                     |     |   |
| Cash flows from financing activities                                              |                     |                   |                     |   |                     |     |   |
| Borrowings under revolving credit facility                                        |                     |                   | 61,000                   |   |                     | 83,000   |   |
| Repayments under revolving credit facility                                        |                     |                   | (28,000)                 |   |                     | (28,000) |   |
| Dividends paid                                                                    |                     |                   | (2,921)                  |   |                     | (2,502)  |   |
| Excess tax benefits from stock-based compensation                                 |                     |                   |  —           |   |                     | 1,541    |   |
| Purchases of treasury stock                                                       |                     |                   | (6,264)                  |   |                     | (3,432)  |   |
| Net cash provided by financing activities                                         |                     |                   | 23,815                   |   |                     | 50,607   |   |
|                                                                              |                     |                   |                     |   |                     |     |   |
| Effect of exchange rate changes on cash and cash equivalents                      |                     |                   | (155)                    |   |                     | (502)    |   |
|                                                                              |                     |                   |                     |   |                     |     |   |
| Decrease in cash and cash equivalents                                             |                     |                   | (4,016)                  |   |                     | (10,116) |   |
| Cash and cash equivalents at beginning of period                                  |                     |                   | 28,367                   |   |                     | 31,720   |   |
| Cash and cash equivalents at end of period                                        |                     | $                      | 24,351                   |   | $                        | 21,604   |   |

 

See accompanying notes. 

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CANTEL MEDICAL CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1.Basis of Presentation

 

The unaudited Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles for interim financial reporting and the requirements of Form 10-Q and Rule 10.01 of Regulation S-X. Accordingly, they do not include certain information and note disclosures required by generally accepted accounting principles for annual financial reporting and should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Annual Report of Cantel Medical Corp. (“Cantel”) on Form 10-K for the fiscal year ended July 31, 2016 (the “2016 Form 10-K”) and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.

 

The unaudited interim financial statements reflect all adjustments (of a normal and recurring nature) which management considers necessary for a fair presentation of the results of operations for these periods. The results of operations for the interim periods are not necessarily indicative of the results for the full year.

 

The Condensed Consolidated Balance Sheet at July 31, 2016 was derived from the audited Consolidated Balance Sheet of Cantel at that date.

 

 As more fully described in Note 15 to the Condensed Consolidated Financial Statements, we operate our business through the following four operating segments: Endoscopy, Water Purification and Filtration, Healthcare Disposables and Dialysis. 

 

We operate our four operating segments through wholly-owned subsidiaries in the United States and internationally. Our principal operating subsidiaries in the United States are Medivators Inc., Mar Cor Purification, Inc., Crosstex International, Inc. and SPS Medical Supply Corp. Internationally, our primary operating subsidiaries include Cantel Medical (UK) Limited, Cantel (UK) Limited, Cantel Medical Asia/Pacific Pte. Ltd., Cantel Medical Devices (China) Co., Ltd., Biolab Equipment Ltd., Medivators B.V. and Cantel Medical (Italy) S.r.l.

 

In our current fiscal year, we acquired all of the issued and outstanding stock of Accutron, Inc. (“Accutron”) on August 1, 2016 and certain net assets of Vantage Endoscopy Inc. (“Vantage”) on September 26, 2016 and entered into a definitive agreement to purchase certain net assets of CR Kennedy & Company Pty Ltd. (“CR Kennedy”), which is anticipated to close on or around April 1, 2017, as more fully described in Note 3 to the Condensed Consolidated Financials Statements.

 

In our prior fiscal year, we acquired 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 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. 

 

Throughout this document, references to “Cantel,” “us,” “we,” “our,” and the “Company” are references to Cantel Medical Corp. and its subsidiaries, except where the context makes it clear the reference is to Cantel itself and not its subsidiaries.

 

Subsequent Events

 

We performed a review of events subsequent to January 31, 2017. Based upon that review, no subsequent events occurred that required updating to our Condensed Consolidated Financial Statements or disclosures.

 

Note 2.        Recent Accounting Pronouncements

 

In January 2017, the Financial Account Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-04, “Intangibles – Goodwill and Other” (“ASU 2017-04”) to simplify the test for goodwill impairment. The revised guidance eliminates the existing Step 2 of the goodwill impairment test which required an entity to compute 

6

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the implied fair value of its goodwill at the testing date in order to measure the amount of the impairment charge when the fair value of the reporting unit failed Step 1 of the goodwill impairment test. Under the revised guidance, an entity would recognize an impairment charge for the amount by which the carrying amount of the reporting unit exceeds its fair value; however, the loss recognized would not exceed the total amount of goodwill allocated to the reporting unit. The guidance will be applied on a prospective basis on or after the effective date. ASU 2017-04 is effective for fiscal years beginning after December 31, 2018 (our fiscal year 2020) and early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of ASU 2017-04 is not expected to have a significant impact on our financial position and result of operations.

 

In January 2017, the FASB issued ASU No. 2017-01,  “Business Combinations (Topic 805)”  (“ASU 2017-01”) to clarify the definition of a business. The revised guidance creates a more robust framework to use in determining whether a set of assets and activities is a business. The guidance will be applied on a prospective basis on or after the effective date. ASU 2017-01 is effective for fiscal years beginning after December 15, 2017 (our fiscal year 2019), including interim periods within that reporting period. We are currently in the process of evaluating the impact of ASU 2017-01 on our financial position and result of operations.

 

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows” (“ASU 2016-15”). This new guidance will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017 (our fiscal year 2019). ASU 2016-15 will require adoption on a retrospective basis unless it is impracticable to apply, in which case we would be required to apply the amendments prospectively as of the earliest date practicable. We are currently in the process of evaluating the impact of ASU 2016-15 on our financial position and result of operations. 

 

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”), which simplifies the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements. The new guidance also requires that all tax-related cash flows resulting from share-based payments to be reported as operating activities in the Condensed Consolidated Statements of Cash Flows. We early adopted ASU 2016-09 on August 1, 2016 on a prospective basis. As a result, we no longer record excess tax benefits as an increase to additional paid-in capital, but effective August 1, 2016, we record such excess tax benefits as a reduction of income tax expense, which amounted to $45,000 and $2,286,000, respectively, for the three and six months ended January 31, 2017, as further described in Notes 4 and 12 of the Condensed Consolidated Financial Statements. In addition, we elected to record excess tax benefits as an operating cash flow prospectively and not adjust the prior year period. As such, the current period excess tax benefits were reflected as an operating cash flow rather than a financing cash flow on our Condensed Consolidated Statement of Cash Flows for the six months ended January 31, 2017. Furthermore, we have elected to account for forfeitures as they occur, rather than estimate expected forfeitures over the course of a vesting period since forfeitures have been insignificant historically.

 

In February 2016, FASB issued ASU 2016-02, “Leases (Topic 842)” (“ASU 2016-02”).  The new guidance requires the recording of assets and liabilities arising from leases on the balance sheet accompanied by enhanced qualitative and quantitative disclosures in the notes to the financial statements.  The new guidance is expected to provide transparency of information and comparability among organizations. ASU 2016-02 is effective for fiscal years beginning after December 31, 2018 (our fiscal year 2020), including interim periods within that reporting period.  Early adoption is permitted as of the beginning of an interim or annual period. We are currently in the process of evaluating the impact of ASU 2016-02 on our financial position and results of operations.

 

In September 2015, the FASB issued ASU 2015-16, “Simplifying the Accounting for Measurement-Period Adjustments (Topic 805)” (“ASU 2015-16”). The new guidance requires an acquirer in a business combination to recognize a measurement-period adjustment during the period in which it determines the amount, and eliminates the requirement for an acquirer to account for measurement-period adjustments retrospectively. The acquirer must also disclose the amounts and reasons for adjustments to the provisional amounts. ASU 2015-16 is effective for fiscal years beginning after December 15, 2016 (our fiscal year 2018), including interim periods within that reporting period.  Accordingly, we will adopt ASU 2015-06 in our first quarter of fiscal 2018. The adoption of ASU 2015-06 is not expected to have a significant impact upon on our financial position and results of operations.

 

In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330) Simplifying the Measurement of Inventory,” (“ASU 2015-11”).  The new guidance more closely aligns the measurement of inventory in U.S. GAAP with 

7

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the measurement of inventory in International Financial Reporting Standards by requiring companies using the first-in, first-out and average costs methods to measure inventory using the lower of cost and net realizable value, where net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. ASU 2015-11 is effective for fiscal years beginning after December 15, 2016 (our fiscal year 2018), including interim periods within that reporting period. We are currently in the process of evaluating the impact of ASU 2015-11 on our financial position and results of operations.

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”), which will supersede the revenue recognition requirements in Accounting Standards Codification 605, “Revenue Recognition.” ASU 2014-09 is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. It also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, significant judgments and changes in judgments, and assets recognized from costs incurred to obtain or fulfill a contract. In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606),” which defers the effective date of ASU 2014-09 by one year to fiscal years beginning after December 15, 2017 (our fiscal year 2019), including interim periods within that reporting period. In May 2016, the FASB issued ASU 2016-12, “Revenue from Contracts with Customers (Topic 606),” (“ASU 2016-12”), which provided narrow scope improvements and practical expedients relating to ASU 2014-09. We intend to adopt ASU 2014-09 and ASU 2016-12, as required, on August 1, 2018 and are currently in the process of completing the initial assessment of the impact that this new revenue recognition standard will have on our consolidated financial statements.

 

Note 3.Acquisitions

 

Fiscal 2017

 

CR Kennedy & Company Pty Ltd.

 

On November 23, 2016, we entered into an acquisition agreement to purchase certain endoscopy-related net assets of CR Kennedy related to its distribution and sale of our Medivators endoscopy products in Australia (the “CR Kennedy Business” or the “CR Kennedy Acquisition”). The CR Kennedy Business is a full sales and service organization and our exclusive distributor of Medivators-branded automated endoscope reprocessors, chemistries, procedure room products and other consumables in Australia and had pre-acquisition annual revenues (unaudited) of approximately $14,000,000. The total consideration for the transaction is approximately $10,000,000, excluding acquisition costs. This acquisition, which is anticipated to close on or around April 1, 2017 subject to satisfaction of certain closing conditions, will be included in our Endoscopy segment and is not expected to have a significant effect on our consolidated results of operations.

 

The principal reasons for the CR Kennedy Acquisition is (i) to sell our Endoscopy products and services on a direct basis in Australia, (ii) the establishment of a platform in Australia where we can sell additional Cantel products on a direct basis and (iii) the expectation that the acquisition will be accretive to our earnings per share (“EPS”) in fiscal 2018 and beyond.

 

Vantage Endoscopy Inc.’s Medivators® Endoscopy Business

 

On September 26, 2016, we acquired certain net assets of Vantage related to its distribution and sale of our Medivators endoscopy products in Canada (the “Vantage Business” or the “Vantage Acquisition”).  Vantage was our exclusive distributor of Medivators capital equipment (e.g., automated endoscope reprocessors) and related consumables and accessories in Canada and had pre-acquisition adjusted annual revenues (unaudited) of approximately $11,000,000. The total consideration for the transaction, excluding acquisition-related costs, was $4,044,000. The Vantage Business is included in our Endoscopy segment.

 

The principal reasons for the Vantage Acquisition were (i) to sell our Endoscopy products on a direct basis in Canada, one of our largest markets outside of the United States, (ii) the establishment of a platform in Canada where we can sell additional products on a direct basis such as our endoscopy procedure products and transport and storage systems and (iii) the expectation that the acquisition will be accretive to our EPS in fiscal 2017 and beyond. Such reasons constitute the significant factors that contributed to a purchase price that resulted in recognition of goodwill.

8

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The Vantage Business is included in our results of operations for the three months ended January 31, 2017 and the portion of the six months ended January 31, 2017 subsequent to its acquisition date and is not included in the three and six months ended January 31, 2016. This acquisition did not have a significant effect on our consolidated results of operations in the three and six months ended January 31, 2017 due to the size of the acquisition in relation to our overall consolidated results of operations.

 

Accutron, Inc. 

 

On August 1, 2016, we acquired all of the issued and outstanding stock of Accutron, a private company with pre-acquisition annual revenues (unaudited) of approximately $21,500,000 (the “Accutron Business” or the “Accutron Acquisition”).  The Accutron Business designs, manufactures and sells nitrous oxide conscious sedation equipment and single use nasal masks for use in dental procedures.  The total consideration for the transaction, excluding acquisition-related costs, was $53,049,000.  The Accutron Business is included in our Healthcare Disposables segment.

 

The purchase price was preliminarily allocated to the assets acquired and assumed liabilities based on estimated fair values as follows:

|                                                           |   |        |        |
|----------------------------------------------------------------|--------|-------------|-------------|
|                                                           |   | Preliminary |
| Net Assets                                                |   | Allocation  |
| Current assets                                                 |   | $           | 5,879,000   |
| Property, plant and equipment                                  |   |        | 1,676,000   |
| Amortizable intangible assets (9- year weighted average life): |   |        |        |
| Customer relationships (8- year life)                          |   |        | 12,800,000  |
| Technology (10- year life)                                     |   |        | 10,000,000  |
| Brand names (10- year life)                                    |   |        | 2,000,000   |
| Deferred income tax assets                                     |   |        | 112,000     |
| Current liabilities                                            |   |        | (1,407,000) |
| Net assets acquired                                            |   | $           | 31,060,000  |

 

There were no in-process research and development projects acquired in connection with the acquisition. The excess purchase price of $21,989,000 was assigned to goodwill. Such goodwill, all of which is deductible for income tax purposes, is included in our Healthcare Disposables segment.

 

The principal reasons for the Accutron Acquisition were (i) to broaden our Healthcare Disposable segment’s product portfolio by adding conscious sedation equipment and single-use nasal masks, (ii) the opportunity to cross-sell our existing Healthcare Disposable products, (iii) the addition of a high margin, branded product portfolio with compelling infection prevention benefits and (iv) the expectation that the acquisition will be accretive to our EPS in fiscal 2017 and beyond. Such reasons constitute the significant factors that contributed to a purchase price that resulted in recognition of goodwill. 

 

The Accutron Business is included in our results of operations for the three and six months ended January 31, 2017 and is not included in the three and six months ended January 31, 2016. This acquisition did not have a significant effect on our consolidated results of operations in the three and six months ended January 31, 2017 due to the size of the acquisition in relation to our overall consolidated results of operations.

 

Fiscal 2016

 

North American Science Associates, Inc. 

 

On March 1, 2016, we acquired certain net assets of North American Science Associates, Inc.’s Sterility Assurance Monitoring Products division, a business with pre-acquisition adjusted annual revenues (unaudited) of approximately $5,700,000 (the “NAMSA Business”). The business manufactures a broad suite of high-quality biological and chemical indicators which are used to accurately monitor the effectiveness of sterilization processes primarily for manufacturers of medical device, life science and other products. The total consideration for the transaction, excluding 

9

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acquisition-related costs, was $13,424,000. The NAMSA Acquisition is included in our Healthcare Disposables segment. 

 

The principal reasons for the NAMSA Acquisition were (i) the ability to broaden our Healthcare Disposable segment’s presence into the industrial market, (ii) the opportunity to cross-sell our existing Healthcare Disposable products, (iii) the strategic benefit and cost savings to our overall sterility assurance monitoring business, (iv) to enhance our new product development and overall research and development capabilities and (v) the expectation that the acquisition will be accretive to our EPS in fiscal 2017 and beyond.

 

The NAMSA Business is included in our results of operations for the three and six months ended January 31, 2017 and is not included in the three and six months ended January 31, 2016. This acquisition did not have a significant effect on our consolidated results of operations in the three and six months ended January 31, 2017 due to the size of the acquisition in relation to our overall consolidated results of operations.

 

Medical Innovations Group Holdings Limited 

 

On September 14, 2015, we acquired all of the issued and outstanding stock of MI, a private company with pre-acquisition annual revenues (unaudited) of approximately $28,500,000 providing specialized endoscopy medical devices and products primarily in the United Kingdom (the “MI Business”). Principal products of MI include proprietary short-term and long-term endoscope transport and storage systems, a comprehensive range of endoscopic consumable accessories, OEM mobile medical carts, as well as specialized products for patient warming and patient transfer. With an employee base of approximately 100 individuals, including a complete sales organization and a manufacturing facility in Southend-on-Sea, England, the addition of MI complements our existing endoscopy business in the United States, the United Kingdom and other global markets. The MI Business is included in our Endoscopy segment. The total consideration for the transaction, excluding acquisition-related costs, was $79,597,000, net of an estimated $212,000 net asset value adjustment to be paid by the sellers.

 

The principal reasons for the MI Acquisition were (i) the global expansion of our infection prevention and control product offerings in Endoscopy, (ii) the opportunity to sell our existing endoscopy products to MI’s installed base, (iii) the ability to combine the MI sales force with our existing United Kingdom organization to create what we believe will be a dominant UK sales force in endoscopy product sales and service, (iv) to achieve cost savings through various operating synergies, (v) the ability to leverage our direct sales force to accelerate the growth of MI products in the U.S. and various international markets, and (vi) the expectation that the acquisition will be accretive to our EPS in fiscal 2017 and beyond. Such reasons constitute the significant factors that contributed to a purchase price that resulted in recognition of goodwill. The MI Acquisition is included in our results of operations for the three and six months ended January 31, 2017, the three months ended January 31, 2016 and the portion of the six months ended January 31, 2016 subsequent to its acquisition date.

 

10

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Note 4. Stock-Based Compensation

 

The following table shows the income statement components of stock-based compensation expense recognized in the Condensed Consolidated Statements of Income:

 

 

|                                               |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |           |   |
|----------------------------------------------------|--------------------------|------------------------|--------------------------|------------------------|--------------------------|----------------|--------------------------|--------|--------------------------|--------|--------|----------------|--------|
|                                               |                     | Three Months Ended     |                     | Six Months Ended       |                     |
|                                               |                     | January 31,  |                     | January 31,  |                     |
|                                               |      | 2017                   |      | 2016                   |      | 2017           |      | 2016   |      |
|                                               |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |           |   |
| Cost of sales                                      |                     | $                      | 92,000                   |                   | $                        | 121,000        |                     | $      | 202,000                  |   | $      | 200,000        |   |
| Operating expenses:                                |                     |                   |                     |                   |                     |           |                     |   |                     |   |   |           |   |
| Selling                                            |                     |                   | 310,000                  |                   |                     | 248,000        |                     |   | 939,000                  |   |   | 438,000        |   |
| General and administrative                         |                     |                   | 1,685,000                |                   |                     | 1,478,000      |                     |   | 3,838,000                |   |   | 2,903,000      |   |
| Research and development                           |                     |                   | 29,000                   |                   |                     | 28,000         |                     |   | 59,000                   |   |   | 54,000         |   |
| Total operating expenses                           |                     |                   | 2,024,000                |                   |                     | 1,754,000      |                     |   | 4,836,000                |   |   | 3,395,000      |   |
| Stock-based compensation before income taxes       |                     |                   | 2,116,000                |                   |                     | 1,875,000      |                     |   | 5,038,000                |   |   | 3,595,000      |   |
| Income tax benefits                                |                     |                   | (731,000)                |                   |                     | (661,000)      |                     |   | (1,770,000)              |   |   | (1,274,000)    |   |
| Excess tax benefits                                |                     |                   | (45,000)                 |                   |                     |  — |                     |   | (2,286,000)              |   |   |  — |   |
| Total stock-based compensation expense, net of tax |                     | $                      | 1,340,000                |                   | $                        | 1,214,000      |                     | $      | 982,000                  |   | $      | 2,321,000      |   |

 

The above stock-based compensation expense before income taxes was recorded in the Condensed Consolidated Financial Statements as stock-based compensation expense and an increase to additional paid-in capital, which was determined based upon the award’s fair value at the time the award was granted.  

 

Income tax benefits on stock-based compensation expense were recorded as an increase to deferred income tax assets (which are netted with deferred income tax liabilities) and a reduction to income tax expense. If certain criteria are met when options are exercised or restricted stock awards become vested, the Company is allowed a deduction on its United States income tax return. Accordingly, we account for the income tax effect on such income tax deductions as a reduction of previously recorded deferred income tax assets and as a reduction of income taxes payable. 

 

Excess tax benefits arise when the ultimate tax effect of the deduction for tax purposes is greater than the income tax benefit on stock-based compensation described above. Prior to the adoption of ASU 2016-09 on August 1, 2016, the differences noted above between actual tax deductions and the previously recorded deferred income tax assets were recorded as additional paid-in capital. For the three and six months ended January 31, 2016, income tax deductions of $128,000 and $3,169,000, respectively, were generated, of which $76,000 and $1,628,000, respectively, were recorded as a reduction in income tax expense over the equity awards’ vesting period and the remaining excess tax benefits of $52,000 and $1,541,000, respectively, were recorded as an increase to additional paid-in capital. As a result of the adoption of ASU 2016-09, we no longer record excess tax benefits as an increase to additional paid-in capital, but record such excess tax benefits prospectively as a reduction of income tax expense. For the three and six months ended January 31, 2017, income tax deductions of $169,000 and $5,545,000, respectively, were generated, of which $124,000 and $3,259,000, respectively, were previously recorded as a reduction in income tax expense over the equity awards’ vesting period and the remaining excess tax benefit of $45,000 and $2,286,000, respectively, were recorded as a reduction in income tax expense. In addition, we elected to record excess tax benefits as an operating cash flow prospectively and not adjust the prior year period. As such, the current period excess tax benefits were reflected as an operating cash flow rather than a financing cash flow in our Condensed Consolidated Statement of Cash Flows for the six months ended January 31, 2017.

 

All of our stock options and restricted stock awards are expected to be deductible for tax purposes, except for certain stock awards granted to employees residing outside of the United States, and were tax-effected using the Company’s estimated U.S. effective tax rate at the time of grant.

 

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 awards subject to graded vesting using the straight-line basis over the vesting period. 

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In October 2016, we granted for the first time to certain employees both equity awards with performance conditions and equity awards with market conditions, each granted with the same overall fair value. 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 are 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.

At January 31, 2017, total unrecognized stock-based compensation expense, before income taxes, related to total nonvested stock options and restricted stock awards was $14,080,000 with a remaining weighted average period of 22 months over which such expense is expected to be recognized. Most of our nonvested awards relate to restricted stock awards. 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 performance-based stock award 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 on the date of grant using the following assumptions: 

 

|                                              |   |                       |   |
|---------------------------------------------------|--------|----------------------------|--------|
| Performance Share Unit                            |   | Six Months Ended           |   |
| Valuation Assumption                              |   | January 31, 2017 |   |
|                                              |   |                       |   |
| Volatility of common stock                        |   | 27.75                      | %      |
| Average volatility of peer companies              |   | 32.98                      | %      |
| Average correlation coefficient of peer companies |   | 35.35                      | %      |
| Risk-free interest rate                           |   | 0.96                       | %      |

 

A summary of nonvested stock award activity follows:

 

|                                                 |                     |                     |                     |           |                     |           |                     |      |                     |            |   |   |
|------------------------------------------------------|--------------------------|--------------------------|--------------------------|----------------|--------------------------|----------------|--------------------------|-----------|--------------------------|-----------------|--------|--------|
|                                                 |      |      |      |           |      |           |      |      |      |            |   |   |
|                                                 |                     | Number of           |                     | Number of |                     | Number of |                     | Total     |                     | Weighted        |   |
|                                                 |                     | Shares                   |                     | Shares         |                     | Shares         |                     | Number of |                     | Average         |   |
|                                                 |                     | Time-Based               |                     | Sales-Based    |                     | TSR Based      |                     | Shares    |                     | Fair Value |   |
|                                                 |                     |                     |                     |           |                     |           |                     |      |                     |            |   |   |
| Nonvested stock awards at July 31, 2016    |                     | 331,367                  |                     |  — |                     |  — |                     | 331,367   |                     | $               | 46.09  |   |
| Granted                                              |                     | 75,385                   |                     | 12,810         |                     | 9,800          |                     | 97,995    |                     |            | 82.47  |   |
| Canceled                                             |                     | (3,658)                  |                     |  — |                     |  — |                     | (3,658)   |                     |            | 55.74  |   |
| Vested                                               |                     | (191,181)                |                     |  — |                     |  — |                     | (191,181) |                     |            | 41.84  |   |
| Nonvested stock awards at January 31, 2017 |                     | 211,913                  |                     | 12,810         |                     | 9,800          |                     | 234,523   |                     | $               | 64.60  |   |

 

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There were no option grants during the three and six months ended January 31, 2017. The fair value of each option grant in the prior year was estimated on the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions:

 

|                          |                     |                       |   |   |
|-------------------------------|--------------------------|----------------------------|--------|--------|
| Weighted-Average              |      |        |   |   |
| Black-Scholes Option     |                     | Six Months Ended           |   |   |
| Valuation Assumptions    |                     | January 31, 2016 |   |   |
|                          |                     |                       |   |   |
| Dividend yield                |                     | 0.22                       | %      |   |
| Expected volatility (1)       |                     | 55.90                      | %      |   |
| Risk-free interest rate (2)   |                     | 1.41                       | %      |   |
| Expected lives (in years) (3) |                     | 5.00                       |   |   |

----

|  | (1) |  | Volatility was based on historical closing prices of our common stock. |
|--|-----|--|------------------------------------------------------------------------|

|  | (2) |  | The U.S. Treasury rate based on the expected life at the date of grant. |
|--|-----|--|-------------------------------------------------------------------------|

|  | (3) |  | Based on historical exercise behavior. |
|--|-----|--|----------------------------------------|

 

Additionally, all options were considered to be deductible for tax purposes in the valuation model. Such non-qualified options were tax-effected using the Company’s estimated U.S. effective tax rate at the time of grant. For the six months ended January 31, 2016, these non-qualified options had a weighted average fair value of $26.49.

 

There were no option exercises during the three and six months ended January 31, 2017 and 2016. 

 

Note 5.Inventories, Net

 

A summary of inventories is as follows:

 

|                                      |                     |                   |                     |                |   |        |   |
|-------------------------------------------|--------------------------|------------------------|--------------------------|---------------------|--------|-------------|--------|
|                                      |                     | January 31,  |                     | July 31,  |   |
|                                      |      | 2017                   |      | 2016                |   |
|                                      |                     |                   |                     |                |   |        |   |
| Raw materials and parts                   |                     | $                      | 44,475,000               |                | $      | 45,867,000  |   |
| Work-in-process                           |                     |                   | 14,172,000               |                |   | 13,178,000  |   |
| Finished goods                            |                     |                   | 44,549,000               |                |   | 37,831,000  |   |
| Reserve for excess and obsolete inventory |                     |                   | (7,046,000)              |                |   | (5,390,000) |   |
| Total                                     |                     | $                      | 96,150,000               |                | $      | 91,486,000  |   |

 

 

 

 

 

 

Note 6.Derivatives

 

We recognize all derivatives on the balance sheet at fair value. Derivatives that are not designated as hedges must be adjusted to fair value through earnings. If the derivative is designated as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in the fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of the change in fair value of a derivative that is designated as a hedge will be recognized immediately in earnings. As of January 31, 2017, all of our derivatives were designated as hedges. We do not hold any derivative financial instruments for speculative or trading purposes.

 

Changes in the value of the Euro, British Pound, Singapore dollar, Canadian dollar and the Chinese Renminbi against the United States dollar affect our results of operations because certain cash bank accounts, accounts receivable, and liabilities of Cantel and its subsidiaries are denominated and ultimately settled in United States dollars or these foreign currencies, but must be converted into each entity’s functional currency.

 

In order to hedge against the impact of fluctuations in the value of the Euro, British Pound, Canadian dollar and Singapore dollar relative to the United States dollar on the conversion of such net assets into the functional currencies, we enter into short-term contracts to purchase Euros, British Pounds, Canadian dollars and Singapore dollars forward, which contracts are one-month in duration. These short-term contracts are designated as fair value hedge instruments. There were eight foreign currency forward contracts with a notional value of $16,792,000 at January 31, 2017, which covered certain assets and liabilities that were denominated in currencies other than each entity’s functional currency. 

13

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Such contracts expired on February 28, 2017. These foreign currency forward contracts are continually replaced with new one-month contracts as long as we have significant net assets that are denominated and ultimately settled in currencies other than each entity’s functional currency. Such forward contracts partially offset the impact on operations relating to certain assets and liabilities that were denominated in currencies other than each entity’s functional currency resulting in net currency conversion losses, net of tax, of $171,000 and $221,000, respectively, for the three and six months ended January 31, 2017 on items hedged. For the three and six months ended January 31, 2016, our forward contracts partially offset the impact on operations relating to certain assets and liabilities that were denominated in currencies other than each entity’s functional currency resulting in net currency conversion losses, net of tax, of $214,000 and $306,000, respectively, on the items hedged. Gains and losses related to hedging contracts to buy Euros, British Pounds, Canadian dollars and Singapore dollars forward are immediately realized within general and administrative expenses due to the short-term nature of such contracts. We do not currently hedge against the impact of fluctuations in the value of the Chinese Renminbi relative to the United States dollar because this specific foreign currency exposure is currently not deemed significant. Additionally, we do not hedge transactions associated with the funding of international acquisitions due to the short-term nature of the foreign currency exposure.

 

Note 7.Fair Value Measurements

 

Fair Value Hierarchy

 

We apply the provisions of Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” (“ASC 820”), for our financial assets and liabilities that are re-measured and reported at fair value each reporting period and our nonfinancial assets and liabilities that are re-measured and reported at fair value on a non-recurring basis. We define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three level fair value hierarchy to prioritize the inputs used in valuations, as defined below:

 

Level 1: Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in active markets.

 

Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

 

Level 3: Unobservable inputs for the asset or liability.

 

Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis

 

Our financial assets that are re-measured at fair value on a recurring basis include money market funds that are classified as cash and cash equivalents in the Condensed Consolidated Balance Sheets. These money market funds are classified within Level 1 of the fair value hierarchy and are valued using quoted market prices for identical assets.

 

In connection with our June 2014 acquisition of PuriCore International Limited, a UK endoscopy company, (“Cantel Medical (UK)”), we acquired a contingent guaranteed obligation to reimburse an endoscope service company for endoscope repair costs it incurs when servicing its customers’ endoscopes that are damaged by one of Cantel Medical (UK)’s discontinued endoscope reprocessing machine models. Although the terms of the guarantee provide for no limit to the maximum potential future payments, we estimated the fair value of the liability on the date of the acquisition to be approximately $1,414,000. This fair value measurement was based on significant inputs not observed in the market and thus represents a Level 3 measurement. The fair value of the contingent guaranteed obligation was based on the estimated cost to repair endoscopes that may be damaged by one of Cantel Medical (UK)’s discontinued endoscope reprocessing machine models that remain in the marketplace, the historical frequency of claims and the likely timeframe that each machine will continue to be used. As such, the determination of the fair value of this contingent guaranteed obligation is subjective in nature and can be impacted by significant changes in third party service repair rates, the frequency of claims and a change in the expected life of these discontinued machines.  At the date of the acquisition, the cash flow projection relating to this contingent guaranteed obligation was discounted using a rate of 10.1%, which was based on the weighted average cost of capital of the acquired business plus a credit risk premium for non-performance risk. This liability is adjusted periodically by the reimbursement of repair costs, as well as recording changes in the fair value through our Condensed Consolidated Statements of Income driven by the time value of money and changes in the assumptions that were initially used in the valuation. Given the subjective nature of the assumptions used in the determination of fair value, we may potentially have earnings volatility in our future results of operations. However, the 

14

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largest factor for the decrease in the initial fair value from $1,414,000 at June 30, 2014 to $323,000 at January 31, 2017 was the reimbursement of repair costs. 

 

On November 5, 2013, we recorded a $1,720,000 liability for the estimated fair value of an assumed contingent obligation payable to the Israeli Government relating to the acquisition of a private Israeli company that developed the Jet Prep® Endoscopic Flushing Device, a novel single-use irrigation and aspiration catheter to improve visualization during colonoscopy procedures (“Jet Prep”). This fair value measurement was based on significant inputs not observed in the market and thus represent Level 3 measurements. This liability is adjusted periodically by recording changes in the fair value through our Condensed Consolidated Statements of Income driven by the time value of money and changes in assumptions that were initially used in the valuation. The different likely scenarios of future sales projections used in our fair value determination at January 31, 2017 along with the requirement to repay at least the original seed funding with interest to the Israeli Government resulted in a fair value of $1,138,000 at January 31, 2017. 

 

The fair values of the Company’s financial instruments measured on a recurring basis were categorized as follows:

 

 

|                               |                     |                       |                     |         |                     |           |                     |   |           |   |   |      |   |
|------------------------------------|--------------------------|----------------------------|--------------------------|--------------|--------------------------|----------------|--------------------------|--------|----------------|--------|--------|-----------|--------|
|                               |                     | January 31, 2017 |                     |
|                               |      | Level 1               |      | Level 2 |      | Level 3   |      | Total  |           |
| Assets:                            |                     |                       |                     |         |                     |           |                     |   |           |   |   |      |   |
| Cash and cash equivalents:         |                     |                       |                     |         |                     |           |                     |   |           |   |   |      |   |
| Money markets                      |                     | $                          | 723,000                  |         | $                        | —       |                     | $      | —       |   | $      | 723,000   |   |
| Total assets                       |                     | $                          | 723,000                  |         |                     |  — |                     | $      |  — |   | $      | 723,000   |   |
|                               |                     |                       |                     |         |                     |           |                     |   |           |   |   |      |   |
| Liabilities:                       |                     |                       |                     |         |                     |           |                     |   |           |   |   |      |   |
| Accrued expenses:                  |                     |                       |                     |         |                     |           |                     |   |           |   |   |      |   |
| Assumed contingent obligation      |                     | $                          | —                 |         | $                        | —       |                     | $      | 12,000         |   | $      | 12,000    |   |
| Contingent guaranteed obligation   |                     |                       |  —           |         |                     | —       |                     |   | 281,000        |   |   | 281,000   |   |
| Total accrued expenses             |                     |                       |  —           |         |                     |  — |                     |   | 293,000        |   |   | 293,000   |   |
| Other long-term liabilities:       |                     |                       |                     |         |                     |           |                     |   |           |   |   |      |   |
| Assumed contingent obligation      |                     |                       | —                 |         |                     | —       |                     |   | 1,126,000      |   |   | 1,126,000 |   |
| Contingent guaranteed obligation   |                     |                       | —                 |         |                     | —       |                     |   | 42,000         |   |   | 42,000    |   |
| Total other long-term liabilities: |                     |                       |  —           |         |                     |  — |                     |   | 1,168,000      |   |   | 1,168,000 |   |
| Total liabilities                  |                     | $                          |  —           |         | $                        |  — |                     | $      | 1,461,000      |   | $      | 1,461,000 |   |

 

 

|                               |                     |                    |                     |         |                     |           |                     |   |           |   |   |      |   |
|------------------------------------|--------------------------|-------------------------|--------------------------|--------------|--------------------------|----------------|--------------------------|--------|----------------|--------|--------|-----------|--------|
|                               |                     | July 31, 2016 |                     |
|                               |      | Level 1            |      | Level 2 |      | Level 3   |      | Total  |           |
| Assets:                            |                     |                    |                     |         |                     |           |                     |   |           |   |   |      |   |
| Cash and cash equivalents:         |                     |                    |                     |         |                     |           |                     |   |           |   |   |      |   |
| Money markets                      |                     | $                       | 740,000                  |         | $                        | —       |                     | $      | —       |   | $      | 740,000   |   |
| Total assets                       |                     | $                       | 740,000                  |         |                     |  — |                     | $      |  — |   | $      | 740,000   |   |
|                               |                     |                    |                     |         |                     |           |                     |   |           |   |   |      |   |
| Liabilities:                       |                     |                    |                     |         |                     |           |                     |   |           |   |   |      |   |
| Accrued expenses:                  |                     |                    |                     |         |                     |           |                     |   |           |   |   |      |   |
| Assumed contingent obligation      |                     | $                       | —                 |         | $                        | —       |                     | $      | 12,000         |   | $      | 12,000    |   |
| Contingent guaranteed obligation   |                     |                    |  —           |         |                     | —       |                     |   | 366,000        |   |   | 366,000   |   |
| Total accrued expenses             |                     |                    |  —           |         |                     |  — |                     |   | 378,000        |   |   | 378,000   |   |
| Other long-term liabilities:       |                     |                    |                     |         |                     |           |                     |   |           |   |   |      |   |
| Assumed contingent obligation      |                     |                    | —                 |         |                     | —       |                     |   | 1,126,000      |   |   | 1,126,000 |   |
| Contingent guaranteed obligation   |                     |                    | —                 |         |                     | —       |                     |   | 75,000         |   |   | 75,000    |   |
| Total other long-term liabilities: |                     |                    |  —           |         |                     |  — |                     |   | 1,201,000      |   |   | 1,201,000 |   |
| Total liabilities                  |                     | $                       |  —           |         | $                        |  — |                     | $      | 1,579,000      |   | $      | 1,579,000 |   |

 

15

----

 

A reconciliation of our liabilities that are measured and recorded at fair value on a recurring basis using significant unobservable inputs (Level 3) for the last six quarters is as follows:

 

|                                                                                           |   |          |           |       |          |           |                          |   |      |   |   |      |   |
|------------------------------------------------------------------------------------------------|--------|---------------|----------------|------------|---------------|----------------|-------------------------------|--------|-----------|--------|--------|-----------|--------|
|                                                                                           |   |          |           |       | Jet Prep |           | Cantel Medical (UK) |   |      |   |   |
|                                                                                           |   | Jet Prep |           | Assumed    |          | Contingent     |                          |   |      |   |
|                                                                                           |   | Contingent    |           | Contingent |          | Guaranteed     |                          |   |      |   |
|                                                                                           |   | Consideration |           | Obligation |          | Obligation     |                          | Total  |      |
| Balance, July 31, 2015                                                               |   | $             | 751,000        |       | $             | 1,138,000      |                          | $      | 888,000   |   | $      | 2,777,000 |   |
| Total net unrealized (gains) losses included in general and administrative expense in earnings |   |          | (612,000)      |       |          | —       |                          |   | 20,000    |   |   | (592,000) |   |
| Settlements                                                                                    |   |          | —       |       |          | —       |                          |   | (120,000) |   |   | (120,000) |   |
| Foreign currency translation                                                                   |   |          | —       |       |          | —       |                          |   | (15,000)  |   |   | (15,000)  |   |
| Balance, October 31, 2015                                                            |   |          | 139,000        |       |          | 1,138,000      |                          |   | 773,000   |   |   | 2,050,000 |   |
| Total net unrealized losses included in general and administrative expense in earnings         |   |          | 4,000          |       |          | —       |                          |   | 17,000    |   |   | 21,000    |   |
| Settlements                                                                                    |   |          | —       |       |          | —       |                          |   | (100,000) |   |   | (100,000) |   |
| Foreign currency translation                                                                   |   |          | —       |       |          | —       |                          |   | (53,000)  |   |   | (53,000)  |   |
| Balance, January 31, 2016                                                            |   |          | 143,000        |       |          | 1,138,000      |                          |   | 637,000   |   |   | 1,918,000 |   |
| Total net unrealized losses included in general and administrative expense in earnings         |   |          | 5,000          |       |          | —       |                          |   | 15,000    |   |   | 20,000    |   |
| Settlements                                                                                    |   |          | —       |       |          | —       |                          |   | (95,000)  |   |   | (95,000)  |   |
| Foreign currency translation                                                                   |   |          | —       |       |          | —       |                          |   | 12,000    |   |   | 12,000    |   |
| Balance, April 30, 2016                                                              |   |          | 148,000        |       |          | 1,138,000      |                          |   | 569,000   |   |   | 1,855,000 |   |
| Total net unrealized (gains) losses included in general and administrative expense in earnings |   |          | (148,000)      |       |          |  — |                          |   | 12,000    |   |   | (136,000) |   |
| Settlements                                                                                    |   |          | —       |       |          | —       |                          |   | (196,000) |   |   | (196,000) |   |
| Foreign currency translation                                                                   |   |          | —       |       |          | —       |                          |   | 56,000    |   |   | 56,000    |   |
| Balance, July 31, 2016                                                               |   |          |  — |       |          | 1,138,000      |                          |   | 441,000   |   |   | 1,579,000 |   |
| Total net unrealized losses included in general and administrative expense in earnings         |   |          |  — |       |          | —       |                          |   | 9,000     |   |   | 9,000     |   |
| Settlements                                                                                    |   |          | —       |       |          | —       |                          |   | (70,000)  |   |   | (70,000)  |   |
| Foreign currency translation                                                                   |   |          | —       |       |          | —       |                          |   | (31,000)  |   |   | (31,000)  |   |
| Balance, October 31, 2016                                                            |   |          |  — |       |          | 1,138,000      |                          |   | 349,000   |   |   | 1,487,000 |   |
| Total net unrealized losses included in general and administrative expense in earnings         |   |          |  — |       |          | —       |                          |   | 9,000     |   |   | 9,000     |   |
| Settlements                                                                                    |   |          |  — |       |          | —       |                          |   | (47,000)  |   |   | (47,000)  |   |
| Foreign currency translation                                                                   |   |          |  — |       |          | —       |                          |   | 12,000    |   |   | 12,000    |   |
| Balance, January 31, 2017                                                            |   | $             |  — |       | $             | 1,138,000      |                          | $      | 323,000   |   | $      | 1,461,000 |   |

 

Assets Measured and Recorded at Fair Value on a Non-Recurring Basis

 

We re-measure the fair value of certain assets, such as intangible assets, goodwill and long-lived assets, including property, equipment and other assets, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, and goodwill and intangible assets with indefinite lives are reviewed for impairment at least annually, as further described in Note 8 to the Condensed Consolidated Financial Statements. As the inputs utilized for our periodic impairment assessments are not based on observable market data, but are based on management’s assumptions and estimates, our goodwill, intangibles and long-lived assets are classified within Level 3 of the fair value hierarchy on a non-recurring basis. Management concluded on July 31, 2016 that none of our long-lived assets, including goodwill and intangibles with indefinite-lives, were impaired and no other events or changes in circumstances have occurred during the six months ended January 31, 2017 that would indicate that the carrying amount of our long-lived assets may not be recoverable.

 

Disclosure of Fair Value of Financial Instruments

 

As of January 31, 2017 and July 31, 2016, the carrying amounts for cash and cash equivalents (excluding money markets), accounts receivable and accounts payable approximated fair value due to the short maturity of these instruments. We believe that as of January 31, 2017 and July 31, 2016, the fair value of our outstanding borrowings 

16

----

 

under our credit facility approximated the carrying value of those obligations since the borrowing rates were at prevailing market interest rates.

 

Note 8.Intangible Assets and Goodwill

 

Our intangible assets with definite lives consist primarily of customer relationships, technology, brand names, non-compete agreements and patents. These intangible assets are being amortized on the straight-line method over the estimated useful lives of the assets ranging from 3-20 years and have a weighted average amortization period of 12 years. Amortization expense related to intangible assets was $4,057,000 and $7,966,000 for the three and six months ended January 31, 2017, respectively, and $3,297,000 and $6,391,000 for the three and six months ended January 31, 2016, respectively. Our intangible assets that have indefinite useful lives, and therefore are not amortized, consist of trademarks and trade names.

 

The Company’s intangible assets consist of the following:

 

 

|                                 |                     |                       |        |                     |        |                     |                     |   |        |   |
|--------------------------------------|--------------------------|----------------------------|-------------|--------------------------|-------------|--------------------------|--------------------------|--------|-------------|--------|
|                                 |                     | January 31, 2017 |        |
|                                 |      |        |        |      | Accumulated |      |      |   |        |
|                                 |                     | Gross                      |        | Amortization             |        | Net                      |                     |
| Intangible assets with finite lives: |                     |                       |        |                     |        |                     |                     |   |        |   |
| Customer relationships               |                     | $                          | 113,700,000 |                     | $           | (29,434,000)             |                     | $      | 84,266,000  |   |
| Technology                           |                     |                       | 42,261,000  |                     |        | (14,166,000)             |                     |   | 28,095,000  |   |
| Brand names                          |                     |                       | 8,119,000   |                     |        | (2,819,000)              |                     |   | 5,300,000   |   |
| Non-compete agreements               |                     |                       | 3,092,000   |                     |        | (1,311,000)              |                     |   | 1,781,000   |   |
| Patents and other registrations      |                     |                       | 2,694,000   |                     |        | (983,000)                |                     |   | 1,711,000   |   |
|                                 |                     |                       | 169,866,000 |                     |        | (48,713,000)             |                     |   | 121,153,000 |   |
| Trademarks and tradenames            |                     |                       | 7,514,000   |                     |        |  —           |                     |   | 7,514,000   |   |
| Total intangible assets              |                     | $                          | 177,380,000 |                     | $           | (48,713,000)             |                     | $      | 128,667,000 |   |

 

 

|                                 |                     |                     |        |                     |        |                     |                     |   |        |   |
|--------------------------------------|--------------------------|--------------------------|-------------|--------------------------|-------------|--------------------------|--------------------------|--------|-------------|--------|
|                                 |                     | July 31, 2016  |        |
|                                 |      |      |        |      | Accumulated |      |      |   |        |
|                                 |                     | Gross                    |        | Amortization             |        | Net                      |                     |
| Intangible assets with finite lives: |                     |                     |        |                     |        |                     |                     |   |        |   |
| Customer relationships               |                     | $                        | 100,649,000 |                     | $           | (24,689,000)             |                     | $      | 75,960,000  |   |
| Technology                           |                     |                     | 32,767,000  |                     |        | (11,813,000)             |                     |   | 20,954,000  |   |
| Brand names                          |                     |                     | 6,194,000   |                     |        | (2,394,000)              |                     |   | 3,800,000   |   |
| Non-compete agreements               |                     |                     | 3,092,000   |                     |        | (1,193,000)              |                     |   | 1,899,000   |   |
| Patents and other registrations      |                     |                     | 2,508,000   |                     |        | (913,000)                |                     |   | 1,595,000   |   |
|                                 |                     |                     | 145,210,000 |                     |        | (41,002,000)             |                     |   | 104,208,000 |   |
| Trademarks and tradenames            |                     |                     | 7,511,000   |                     |        | —                 |                     |   | 7,511,000   |   |
| Total intangible assets              |                     | $                        | 152,721,000 |                     | $           | (41,002,000)             |                     | $      | 111,719,000 |   |

 

Estimated annual amortization expense of our intangible assets for the remainder for fiscal 2017 and the next five years is as follows:

 

|                                            |                     |   |       |
|-------------------------------------------------|--------------------------|--------|------------|
| Six month period ending July 31, 2017 |      | $      | 7,912,000  |
| 2018                                            |                     |   | 15,590,000 |
| 2019                                            |                     |   | 15,266,000 |
| 2020                                            |                     |   | 13,514,000 |
| 2021                                            |                     |   | 13,188,000 |
| 2022                                            |                     |   | 12,450,000 |

 

17

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Goodwill changed during fiscal 2016 and the six months ended January 31, 2017 as follows:

 

|                                |                     |                     |        |                     |         |                     |                     |     |                     |                     |   |                     |                     |   |        |   |
|-------------------------------------|--------------------------|--------------------------|-------------|--------------------------|--------------|--------------------------|--------------------------|----------|--------------------------|--------------------------|--------|--------------------------|--------------------------|--------|-------------|--------|
|                                |      |      |        |      | Water        |      |      |     |      |      |   |      |      |   |        |
|                                |                     |                     |        |                     | Purification |                     | Healthcare               |     |                     |                     |   | Total                    |                     |
|                                |                     | Endoscopy                |        | and Filtration      |         | Disposables              |                     | Dialysis |                     | Goodwill                 |   |
|                                |                     |                     |        |                     |         |                     |                     |     |                     |                     |   |                     |                     |   |        |   |
| Balance, July 31, 2015    |                     | $                        | 87,007,000  |                     | $            | 58,872,000               |                     | $        | 87,939,000               |                     | $      | 8,133,000                |                     | $      | 241,951,000 |   |
| Acquisitions                        |                     |                     | 40,047,000  |                     |         |  —           |                     |     | 4,351,000                |                     |   |  —           |                     |   | 44,398,000  |   |
| Foreign currency translation        |                     |                     | (6,039,000) |                     |         | 8,000                    |                     |     |  —           |                     |   |  —           |                     |   | (6,031,000) |   |
| Balance, July 31, 2016    |                     |                     | 121,015,000 |                     |         | 58,880,000               |                     |     | 92,290,000               |                     |   | 8,133,000                |                     |   | 280,318,000 |   |
| Acquisitions                        |                     |                     | 2,173,000   |                     |         |  —           |                     |     | 21,989,000               |                     |   |  —           |                     |   | 24,162,000  |   |
| Foreign currency translation        |                     |                     | (1,875,000) |                     |         | 32,000                   |                     |     |  —           |                     |   |  —           |                     |   | (1,843,000) |   |
| Balance, January 31, 2017 |                     | $                        | 121,313,000 |                     | $            | 58,912,000               |                     | $        | 114,279,000              |                     | $      | 8,133,000                |                     | $      | 302,637,000 |   |

 

On July 31, 2016, we performed impairment studies of the Company’s goodwill and indefinite lived trademarks and trade names and concluded that such assets were not impaired. While the results of these annual reviews have historically not indicated impairment, impairment reviews are highly dependent on management’s projections of our future operating results and cash flows (which management believes to be reasonable), discount rates based on the Company’s weighted average cost of capital and appropriate benchmark peer companies. Assumptions used in determining future operating results and cash flows include current and expected market conditions and future sales forecasts. Subsequent changes in these assumptions and estimates could result in future impairment. Although we consistently use the same methods in developing the assumptions and estimates underlying the fair value calculations, such estimates are uncertain by nature and can vary from actual results. At July 31, 2016, the fair value of all of our reporting units exceeded book value by substantial amounts. However, we believe the most significant assumptions impacting the impairment assessment of Dialysis relate to the assumed rate in which annual sales will decline as well as the expected future operating efficiencies included in our projections of future operating results and cash flows of this segment. If future operating results and cash flows are substantially less than our projections, future impairment charges may be recorded. On January 31, 2017, management concluded that no events or changes in circumstances have occurred during the six months ended January 31, 2017 that would indicate that the carrying amount of our intangible assets and goodwill may not be recoverable.

 

Note 9.Warranties

 

A summary of activity in the warranty reserves follows:

 

 

|                         |                     |                   |                     |                   |   |           |                     |   |        |   |   |        |   |
|------------------------------|--------------------------|------------------------|--------------------------|------------------------|--------|----------------|--------------------------|--------|-------------|--------|--------|-------------|--------|
|                         |                     | Three Months Ended     |                     | Six Months Ended       |   |
|                         |                     | January 31,  |                     | January 31,  |   |
|                         |      | 2017                   |      | 2016                   |   | 2017           |      | 2016   |        |
|                         |                     |                   |                     |                   |   |           |                     |   |        |   |   |        |   |
| Beginning balance            |                     | $                      | 2,831,000                |                   | $      | 1,847,000      |                     | $      | 2,575,000   |   | $      | 1,740,000   |   |
| Acquisitions                 |                     |                   |  —           |                   |   |  — |                     |   | 121,000     |   |   | 28,000      |   |
| Provisions                   |                     |                   | 1,169,000                |                   |   | 854,000        |                     |   | 3,085,000   |   |   | 1,759,000   |   |
| Settlements                  |                     |                   | (1,353,000)              |                   |   | (655,000)      |                     |   | (3,099,000) |   |   | (1,478,000) |   |
| Foreign currency translation |                     |                   | 20,000                   |                   |   | (79,000)       |                     |   | (15,000)    |   |   | (82,000)    |   |
| Ending balance               |                     | $                      | 2,667,000                |                   | $      | 1,967,000      |                     | $      | 2,667,000   |   | $      | 1,967,000   |   |

 

The warranty provisions for the three and six months ended January 31, 2017 and 2016 relate principally to the Company’s endoscope reprocessing and water purification equipment. Warranty reserves are included in accrued expenses in the Condensed Consolidated Balance Sheets.

 

Note 10.Financing Arrangements

 

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 

18

----

 

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. Furthermore, we incurred debt issuance costs of $1,318,000 relating to the 2014 Credit Agreement which was recorded in other assets along with the remaining unamortized debt issuance costs of $512,000 relating to our former revolving credit facility. The total of these two amounts is being amortized over the life of the 2014 Credit Agreement. At January 31, 2017, unamortized debt issuance costs recorded in other assets amounted to $763,000.

 

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 January 31, 2017, the lender’s base rate was 3.75% and the LIBOR rates ranged from 0.77% to 1.33%. The margins applicable to our outstanding borrowings were 0.50% above the lender’s base rate or 1.50% above LIBOR. All of our outstanding borrowings were under LIBOR contracts at January 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 0.25% at January 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 January 31, 2017, we had $149,000,000 of outstanding borrowings under the 2014 Credit Agreement. Subsequent to January 31, 2017, we repaid $4,000,000 resulting in total outstanding borrowings of $145,000,000 at March 9, 2017, none of which is required to be repaid until March 2019. 

 

Note 11.Earnings Per Common Share

 

Basic EPS is computed based upon the weighted average number of common shares outstanding during the year. Diluted EPS is computed based upon the weighted average number of common shares outstanding during the year plus the dilutive effect of common stock equivalents using the treasury stock method and the average market price of our common stock for the year.

 

We include participating securities (unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents) in the computation of EPS pursuant to the two-class method. Our participating securities consist solely of unvested restricted stock awards, which have contractual participation rights equivalent to those of stockholders of unrestricted common stock. The two-class method of computing earnings per share is an allocation method that calculates earnings per share for common stock and participating securities.

 

19

----

 

The following table sets forth the computation of basic and diluted EPS available to shareholders of common stock (excluding participating securities):

 

|                                                                                                                                          |                     |                   |                     |                   |                     |       |                     |   |                     |   |   |           |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------------------------|------------------------|--------------------------|------------------------|--------------------------|------------|--------------------------|--------|--------------------------|--------|--------|----------------|--------|
|                                                                                                                                          |                     | Three Months Ended     |                     | Six Months Ended       |                     |
|                                                                                                                                          |                     | January 31,  |                     | January 31,  |                     |
|                                                                                                                                          |      | 2017                   |      | 2016                   |      | 2017       |      | 2016   |      |
| Numerator for basic and diluted earnings per share:                                                                                           |                     |                   |                     |                   |                     |       |                     |   |                     |   |   |           |   |
| Net income                                                                                                                                    |                     | $                      | 18,070,000               |                   | $                        | 15,389,000 |                     | $      | 36,870,000               |   | $      | 29,643,000     |   |
| Less income allocated to participating securities                                                                                             |                     |                   | (103,000)                |                   |                     | (126,000)  |                     |   | (237,000)                |   |   | (244,000)      |   |
| Net income available to common shareholders                                                                                                   |                     | $                      | 17,967,000               |                   | $                        | 15,263,000 |                     | $      | 36,633,000               |   | $      | 29,399,000     |   |
|                                                                                                                                          |                     |                   |                     |                   |                     |       |                     |   |                     |   |   |           |   |
| Denominator for basic and diluted earnings per share, as adjusted for participating securities:                                               |                     |                   |                     |                   |                     |       |                     |   |                     |   |   |           |   |
| Denominator for basic earnings per share - weighted average number of shares outstanding attributable to common stock                    |                     |                   | 41,485,557               |                   |                     | 41,360,279 |                     |   | 41,444,304               |   |   | 41,321,762     |   |
|                                                                                                                                          |                     |                   |                     |                   |                     |       |                     |   |                     |   |   |           |   |
| Dilutive effect of stock options using the treasury stock method and the average market price for the year                               |                     |                   | 74,582                   |                   |                     | 44,096     |                     |   | 73,279                   |   |   | 42,727         |   |
|                                                                                                                                          |                     |                   |                     |                   |                     |       |                     |   |                     |   |   |           |   |
| Denominator for diluted earnings per share - weighted average number of shares and common stock equivalents attributable to common stock |                     |                   | 41,560,139               |                   |                     | 41,404,375 |                     |   | 41,517,583               |   |   | 41,364,489     |   |
|                                                                                                                                          |                     |                   |                     |                   |                     |       |                     |   |                     |   |   |           |   |
| Earnings per share attributable to common stock:                                                                                              |                     |                   |                     |                   |                     |       |                     |   |                     |   |   |           |   |
| Basic earnings per share                                                                                                                      |                     | $                      | 0.43                     |                   | $                        | 0.37       |                     | $      | 0.88                     |   | $      | 0.71           |   |
|                                                                                                                                          |                     |                   |                     |                   |                     |       |                     |   |                     |   |   |           |   |
| Diluted earnings per share                                                                                                                    |                     | $                      | 0.43                     |                   | $                        | 0.37       |                     | $      | 0.88                     |   | $      | 0.71           |   |
|                                                                                                                                          |                     |                   |                     |                   |                     |       |                     |   |                     |   |   |           |   |
| Stock options excluded from weighted average dilutive common shares outstanding because their inclusion would have been antidilutive     |                     |                   |  —           |                   |                     | 15,000     |                     |   |  —           |   |   |  — |   |

 

A reconciliation of weighted average number of shares and common stock equivalents attributable to common stock, as determined above, to the Company’s total weighted average number of shares and common stock equivalents, including participating securities, is set forth in the following table:

 

 

|                                                                                                                                               |                     |                   |                     |                   |                     |       |                     |       |                     |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------|------------------------|--------------------------|------------------------|--------------------------|------------|--------------------------|------------|--------------------------|
|                                                                                                                                               |                     | Three Months Ended     |                     | Six Months Ended       |                     |
|                                                                                                                                               |                     | January 31,  |                     | January 31,  |                     |
|                                                                                                                                               |      | 2017                   |      | 2016                   |      | 2017       |      | 2016       |      |
| Denominator for diluted earnings per share - weighted average number of shares and common stock equivalents attributable to common stock |                     | 41,560,139             |                     | 41,404,375             |                     | 41,517,583 |                     | 41,364,489 |                     |
|                                                                                                                                               |                     |                   |                     |                   |                     |       |                     |       |                     |
| Participating securities                                                                                                                           |                     | 233,128                |                     | 343,346                |                     | 271,408    |                     | 344,004    |                     |
|                                                                                                                                               |                     |                   |                     |                   |                     |       |                     |       |                     |
| Total weighted average number of shares and common stock equivalents attributable to both common stock and participating securities      |                     | 41,793,267             |                     | 41,747,721             |                     | 41,788,991 |                     | 41,708,493 |                     |

 

 

 

20

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Note 12.Income Taxes

 

A reconciliation of the consolidated effective income tax rate for the six months ended January 31, 2016 to the six months ended January 31, 2017 is as follows:

 

|                          |   |                      |   |   |
|-------------------------------|--------|---------------------------|--------|--------|
|                          |   | Consolidated              |   |   |
|                          |   | Effective                 |   |   |
|                          |   | Income Tax Rate |   |   |
| January 31, 2016    |   | 36.3                      | %      |   |
| Differential attributable to: |   |                      |   |   |
| Excess tax benefits           |   | (4.3)                     | %      |   |
| Other                         |   | (1.0)                     | %      |   |
| January 31, 2017    |   | 31.0                      | %      |   |

 

The consolidated effective tax rate for the six months ended January 31, 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 $45,000 and $2,286,000 for the three and six months ended January 31, 2017, respectively, as further described in Notes 2 and 4 of the Condensed Consolidated Financial Statements. 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.  

 

We record liabilities for an unrecognized tax benefit when a tax benefit for an uncertain tax position is taken or expected to be taken on a tax return, but is not recognized in our Condensed Consolidated Financial Statements because it does not meet the more-likely-than-not recognition threshold that the uncertain tax position would be sustained upon examination by the applicable taxing authority. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon settlement with the tax authorities. Any adjustments upon resolution of income tax uncertainties are recognized in our results of operations. Our policy is to record potential interest and penalties related to income tax positions in interest expense and general and administrative expense, respectively, in our Condensed Consolidated Financial Statements. However, such amounts have historically been insignificant due to the minimal amount of our unrecognized tax benefits relating to uncertain tax positions. For the three and six months ended January 31, 2017 and fiscal 2016, we have not had any uncertain tax positions in which a liability would be recorded.

 

The Company concluded an audit by the Internal Revenue Service (“IRS”) for fiscal years 2013 and 2012 and is currently undergoing an audit by the IRS for fiscal year 2015. With respect to state or foreign income tax examinations, we are generally no longer subject to examinations for fiscal years ended prior to July 31, 2008.

 

 

21

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Note 13.Commitments and Contingencies

 

Long-Term Contractual Obligations

 

As of January 31, 2017, aggregate annual required payments over the remaining fiscal year, the next four years and thereafter under our contractual obligations that have long-term components are as follows:

 

 

|                                                     |   |            |           |                             |   |           |   |   |    |   |   |           |   |   |           |   |   |           |   |   |    |   |
|----------------------------------------------------------|--------|-----------------|----------------|----------------------------------|--------|----------------|--------|--------|---------|--------|--------|----------------|--------|--------|----------------|--------|--------|----------------|--------|--------|---------|--------|
|                                                     |   | Six Months      |           | Year Ending July 31,             |   |
|                                                     |   | Ending July 31, |           | (Amounts in thousands) |   |
|                                                     |   | 2017            |           | 2018                             |   | 2019           |   | 2020   |    | 2021   |   | Thereafter     |   | Total  |           |
| Maturity of the credit facility                          |   | $               |  — |                             | $      |  — |   | $      | 149,000 |   | $      |  — |   | $      |  — |   | $      |  — |   | $      | 149,000 |   |
| Expected interest payments under the credit facility (1) |   |            | 1,840          |                             |   | 3,680          |   |   | 2,147   |   |   |  — |   |   |  — |   |   |  — |   |   | 7,667   |   |
| Minimum commitments under noncancelable operating leases |   |            | 3,281          |                             |   | 5,466          |   |   | 4,381   |   |   | 3,113          |   |   | 2,252          |   |   | 3,575          |   |   | 22,068  |   |
| Compensation agreements                                  |   |            | 5,475          |                             |   | 4,465          |   |   | 886     |   |   | 498            |   |   | 378            |   |   | 583            |   |   | 12,285  |   |
| Assumed contingent liability (2)                         |   |            | 19             |                             |   | 93             |   |   | 188     |   |   | 246            |   |   | 280            |   |   | 439            |   |   | 1,265   |   |
| Contingent guaranteed obligation (3)                     |   |            | 83             |                             |   | 127            |   |   | 117     |   |   |  — |   |   |  — |   |   |  — |   |   | 327     |   |
| Other long-term obligations                              |   |            | 98             |                             |   | 211            |   |   | 100     |   |   | 12             |   |   | 3              |   |   |  — |   |   | 424     |   |
| Total contractual obligations                            |   | $               | 10,796         |                             | $      | 14,042         |   | $      | 156,819 |   | $      | 3,869          |   | $      | 2,913          |   | $      | 4,597          |   | $      | 193,036 |   |

----

|  | (1) |  | The expected interest payments under our credit facility reflect an interest rate of 2.47%, which was our weighted average interest rate on outstanding borrowings at January 31, 2017. |
|--|-----|--|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|  | (2) |  | These future potential payments of an assumed contingent liability relate to the Jet Prep Acquisition, as further described in Note 7 to the Condensed Consolidated Financial Statements, and are reflected in the January 31, 2017 Condensed Consolidated Balance Sheet at its net present value of $1,138,000 using a discount rate of 2.5%. |
|--|-----|--|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|  | (3) |  | These future potential payments of a contingent guaranteed obligation relate to Cantel Medical (UK), as further described in Note 7 to the Condensed Consolidated Financial Statements, and are reflected in the January 31, 2017 Condensed Consolidated Balance Sheet at its net present value of $323,000 using a discount rate of 10.1%. |
|--|-----|--|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Operating Leases

 

Minimum commitments under operating leases include minimum rental commitments for our leased manufacturing facilities, warehouses, office space and equipment.

 

Compensation Agreements

 

We have previously entered into various severance contracts with executives of the Company, including our corporate executive officers and certain of our subsidiary Presidents, which define certain compensation arrangements relating to various employment termination scenarios, and multi-year employment agreements with certain executive officers of businesses we have acquired. Additionally, in March 2016 we entered into a succession plan agreement, due to the planned retirement of our former Chief Executive Officer who was succeeded on July 31, 2016, that requires a total of $4,500,000 in future payments, the majority of which will be paid in fiscal 2017. 

 

Other Long-Term Obligations

 

In relation to the acquisition of our business in Italy on November 3, 2014, we assumed an $843,000 liability to the Bank of Italy as part of funding provided by an Italian government agency, of which $187,000 and $656,000 were recorded in accrued expenses and other long-term liabilities, respectively. Such amount was a portion of the financial support obtained from the Italian government’s Ministry of Education, Universities and Research to fund research and development activity relating to the business’s automated endoscope reprocessors. The liability is payable in semi-annual installments, bears interest at 0.25% per annum and has a maturity date of January 1, 2019. At January 31, 2017, $321,000 is outstanding, of which $160,000 is recorded in accrued expense and $161,000 is recorded in other long-term liabilities. Additionally, other long-term obligations include deferred compensation arrangements for certain former Medivators directors and officers and is recorded in other long-term liabilities.

22

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Note 14.Accumulated Other Comprehensive (Loss) Income

 

The components and changes in accumulated other comprehensive (loss) income were as follows:

 

 

 

 

 

|                                                               |   |                   |         |                   |   |        |   |   |         |   |   |        |
|--------------------------------------------------------------------|--------|------------------------|--------------|------------------------|--------|-------------|--------|--------|--------------|--------|--------|-------------|
|                                                               |   | Three Months Ended     |         | Six Months Ended       |
|                                                               |   | January 31,  |         | January 31,  |
|                                                               |   | 2017                   |         | 2016                   |   | 2017        |   | 2016   |
|                                                               |   |                   |         |                   |   |        |   |   |         |   |   |        |
| Beginning balance                                                  |   | $                      | (18,316,000) |                   | $      | 397,000     |   | $      | (11,795,000) |   | $      | 1,224,000   |
| Other comprehensive income (loss) for foreign currency translation |   |                   | 2,588,000    |                   |   | (7,199,000) |   |   | (3,933,000)  |   |   | (8,026,000) |
| Ending balance                                                     |   | $                      | (15,728,000) |                   | $      | (6,802,000) |   | $      | (15,728,000) |   | $      | (6,802,000) |

 

 

 

 

 

Note 15.Operating Segments

 

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.  Our products include specialized medical device reprocessing systems for endoscopy and renal dialysis, advanced water purification equipment, sterilants, disinfectants and cleaners, sterility assurance monitoring products for hospitals and dental clinics, disposable infection control products primarily for dental and GI endoscopy markets, dialysate concentrates and hollow fiber membrane filtration and separation products. Additionally, we provide technical service for our products.

 

We have determined our reportable business segments based upon an assessment of product types, organizational structure, customers and internally prepared financial statements. The primary factors used by us in analyzing segment performance are net sales and operating income.

 

None of our customers accounted for 10% or more of our consolidated net sales for the six months ended January 31, 2017 and 2016.  

 

The Company’s segments are as follows: 

 

Endoscopy, which includes medical device reprocessing systems, disinfectants, detergents and other supplies used to high-level disinfect rigid endoscopes, flexible endoscopes and other instrumentation and disposable infection control products intended to reduce the challenges with proper cleaning and high-level disinfection of numerous reusable components used in GI endoscopy procedures. In September 2015, this segment commenced the sale of endoscope transport and storage systems, and a number of endoscopy consumable accessories. Additionally, this segment includes technical maintenance service on its products.

 

Water Purification and Filtration, which includes water purification equipment and services, filtration and separation products and disinfectants, sterilization and decontamination products and services for the medical, pharmaceutical, biotech, beverage and commercial industrial markets.

 

Two customers collectively accounted for approximately 50.1% of our Water Purification and Filtration segment net sales for the six months ended January 31, 2017.

 

Healthcare Disposables, which includes single-use, infection prevention healthcare products including face masks, sterilization pouches, towels and bibs, tray covers, saliva ejectors, plastic cups, germicidal wipes and disinfectants, as well as products for maintaining safe dental unit waterlines. This segment also manufactures and sells biological and chemical indicators for sterility assurance monitoring services in the acute-care, alternate-care, dental and industrial (medical device, life science and other manufacturers) markets. In August 2016, this segment commenced the manufacture and sale of nitrous oxide conscious sedation equipment and related single-use disposable nasal masks.

 

Four customers collectively accounted for approximately 48.2% of our Healthcare Disposables segment net sales for the six months ended January 31, 2017. 

 

23

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Dialysis, which includes medical device reprocessing systems, sterilants/disinfectants, dialysate concentrates and other supplies for renal dialysis. Additionally, this segment includes technical maintenance service on its products.

 

Two customers accounted for approximately 40.0% of our Dialysis segment net sales for the six months ended January 31, 2017.

 

The operating segments follow the same accounting policies used for our Condensed Consolidated Financial Statements as described in Note 2 to the 2016 Form 10-K.

 

Information as to operating segments is summarized below:

|                              |                     |                   |                     |                   |                     |        |                     |   |                     |   |   |        |   |
|-----------------------------------|--------------------------|------------------------|--------------------------|------------------------|--------------------------|-------------|--------------------------|--------|--------------------------|--------|--------|-------------|--------|
|                              |                     | Three Months Ended     |                     | Six Months Ended       |                     |
|                              |                     | January 31,  |                     | January 31,  |                     |
|                              |      | 2017                   |      | 2016                   |      | 2017        |      | 2016   |      |
|                              |                     |                   |                     |                   |                     |        |                     |   |                     |   |   |        |   |
| Net sales:                        |                     |                   |                     |                   |                     |        |                     |   |                     |   |   |        |   |
| Endoscopy                         |                     | $                      | 94,367,000               |                   | $                        | 81,458,000  |                     | $      | 188,195,000              |   | $      | 153,100,000 |   |
| Water Purification and Filtration |                     |                   | 47,420,000               |                   |                     | 43,252,000  |                     |   | 97,293,000               |   |   | 87,964,000  |   |
| Healthcare Disposables            |                     |                   | 35,280,000               |                   |                     | 26,026,000  |                     |   | 72,079,000               |   |   | 53,378,000  |   |
| Dialysis                          |                     |                   | 7,750,000                |                   |                     | 7,535,000   |                     |   | 14,975,000               |   |   | 17,608,000  |   |
| Total                             |                     | $                      | 184,817,000              |                   | $                        | 158,271,000 |                     | $      | 372,542,000              |   | $      | 312,050,000 |   |

 

 

|                              |                     |                   |                     |                   |                     |        |                     |   |                     |   |   |         |   |
|-----------------------------------|--------------------------|------------------------|--------------------------|------------------------|--------------------------|-------------|--------------------------|--------|--------------------------|--------|--------|--------------|--------|
|                              |                     | Three Months Ended     |                     | Six Months Ended       |                     |
|                              |                     | January 31,  |                     | January 31,  |                     |
|                              |      | 2017                   |      | 2016                   |      | 2017        |      | 2016   |      |
|                              |                     |                   |                     |                   |                     |        |                     |   |                     |   |   |         |   |
| Operating income:                 |                     |                   |                     |                   |                     |        |                     |   |                     |   |   |         |   |
| Endoscopy                         |                     | $                      | 18,778,000               |                   | $                        | 14,664,000  |                     | $      | 36,339,000               |   | $      | 27,123,000   |   |
| Water Purification and Filtration |                     |                   | 8,405,000                |                   |                     | 7,589,000   |                     |   | 17,325,000               |   |   | 15,402,000   |   |
| Healthcare Disposables            |                     |                   | 7,069,000                |                   |                     | 5,673,000   |                     |   | 14,465,000               |   |   | 12,033,000   |   |
| Dialysis                          |                     |                   | 2,147,000                |                   |                     | 1,734,000   |                     |   | 3,960,000                |   |   | 4,421,000    |   |
|                              |                     |                   | 36,399,000               |                   |                     | 29,660,000  |                     |   | 72,089,000               |   |   | 58,979,000   |   |
| General corporate expenses        |                     |                   | (7,786,000)              |                   |                     | (5,264,000) |                     |   | (16,413,000)             |   |   | (10,807,000) |   |
| Income from operations            |                     |                   | 28,613,000               |                   |                     | 24,396,000  |                     |   | 55,676,000               |   |   | 48,172,000   |   |
| Interest expense, net             |                     |                   | (1,126,000)              |                   |                     | (871,000)   |                     |   | (2,219,000)              |   |   | (1,616,000)  |   |
|                              |                     |                   |                     |                   |                     |        |                     |   |                     |   |   |         |   |
| Income before income taxes        |                     | $                      | 27,487,000               |                   | $                        | 23,525,000  |                     | $      | 53,457,000               |   | $      | 46,556,000   |   |

 

 

 

 

 

 

 

Note 16. Legal Proceedings

 

In the normal course of business, we are subject to pending and threatened legal actions. It is our policy to accrue for amounts related to these legal matters if it is probable that a liability has been incurred and an amount of anticipated exposure can be reasonably estimated. We do not believe that any of these pending claims or legal actions will have a material effect on our business, financial condition, results of operations or cash flows.

24

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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 six months ended January 31, 2017 compared with the three and six months ended January 31, 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 six months ended January 31, 2017 compared with the three and six months ended January 31, 2016 were as follows:

 

|  | · |  | Net sales increased by 16.8% to $184,817,000 from $158,271,000 for the three months ended January 31, 2017 and 19.4% to $372,542,000 from $312,050,000 for the six months ended January 31, 2017; organic sales (i.e. excluding acquisitions and foreign currency translation) increased by 12.1% and 13.9% for the three and six months ended January 31, 2017, respectively. |
|--|--------|--|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|  | · |  | Gross profit as a percentage of net sales increased to 47.9% from 45.7% for the three months ended January 31, 2017 and 47.8% from 46.0% for the six months ended January 31, 2017. |
|--|--------|--|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|  | · |  | Net income under United States generally accepted accounting principles (GAAP) increased by 17.4% to $18,070,000 from $15,389,000 for the three months ended January 31, 2017 and 24.4% to $36,870,000 from $29,643,000 for the six months ended January 31, 2017. |
|--|--------|--|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|  | · |  | After adjusting net income for amortization expense and atypical items, non-GAAP net income increased by 23.8% to $21,551,000 from $17,413,000 for the three months ended January 31, 2017 and 24.2% to $42,874,000 from $34,533,000 for the six months ended January 31, 2017, as further described and reconciled to net income in “Non-GAAP Financial Measures” in this MD&A. |
|--|--------|--|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|  | · |  | Adjusted earnings before interest, taxes, depreciation, amortization and stock-based compensation expense (“Adjusted EBITDAS”) increased by 19.6% to $39,514,000 from $33,047,000 for the three months ended |
|--|--------|--|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

25

----

 

| January 31, 2017 and 22.3% to $80,098,000 from $65,493,000 for the six months ended January 31, 2017 as further described and reconciled to net income in “Non-GAAP Financial Measures” in this MD&A. |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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:

 

|  | · |  | significantly higher sales and profitability in our Endoscopy segment principally due to (i) increases in demand for endoscope reprocessing equipment as well as 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, |
|--|--------|--|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|  | · |  | 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,  |
|--|--------|--|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|  | · |  | 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 |
|--|--------|--|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|  | · |  | the recording of atypical tax benefits, which decreased our effective tax rate, as further explained within “Non-GAAP Financial Measures” elsewhere in this MD&A. |
|--|--------|--|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The above factors were partially offset by:

 

|  | · |  | 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, |
|--|--------|--|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|  | · |  | the impact of costs associated with the planned retirement of our former Chief Executive Officer, as well as restructuring costs, as further described within “Non-GAAP Financial Measures” elsewhere in this MD&A, and |
|--|--------|--|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|  | · |  | a decrease in net sales and profitability in our Dialysis segment in our first quarter of fiscal 2017. |
|--|--------|--|--------------------------------------------------------------------------------------------------------|

 

(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 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 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”) and (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”), 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 

26

----

 

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.

 

|                              |                     |   |                   |                     |   |                   |                     |   |    |                     |   |   |   |    |                     |   |                     |   |    |                     |   |   |
|-----------------------------------|--------------------------|--------|------------------------|--------------------------|--------|------------------------|--------------------------|--------|---------|--------------------------|--------|--------|--------|---------|--------------------------|--------|--------------------------|--------|---------|--------------------------|--------|--------|
|                              |                     |   | Three Months Ended     |                     |   | Six Months Ended       |                     |
|                              |                     |   | January 31,  |                     |   | January 31,  |                     |
| (Amounts in Thousands)  |                     |   | 2017                   |                     |   |                   | 2016                     |   |    | 2017                     |   |   | 2016   |    |
|                              |      |   | $                      |      | %      |                   |      |   | $       |      | %      |   |   | $       |      | %      |      |   | $       |      | %      |   |
| Net Sales by Segment              |                     |   |                   |                     |   |                   |                     |   |    |                     |   |   |   |    |                     |   |                     |   |    |                     |   |   |
| Endoscopy                         |                     | $      | 94,367                 |                     | 51.1   | %                      |                     | $      | 81,458  |                     | 51.5   | %      | $      | 188,195 |                     | 50.5   | %                        | $      | 153,100 |                     | 49.1   | %      |
| Water Purification and Filtration |                     |   | 47,420                 |                     | 25.6   | %                      |                     |   | 43,252  |                     | 27.3   | %      |   | 97,293  |                     | 26.1   | %                        |   | 87,964  |                     | 28.2   | %      |
| Healthcare Disposables            |                     |   | 35,280                 |                     | 19.1   | %                      |                     |   | 26,026  |                     | 16.4   | %      |   | 72,079  |                     | 19.4   | %                        |   | 53,378  |                     | 17.1   | %      |
| Dialysis                          |                     |   | 7,750                  |                     | 4.2    | %                      |                     |   | 7,535   |                     | 4.8    | %      |   | 14,975  |                     | 4.0    | %                        |   | 17,608  |                     | 5.6    | %      |
| Total net sales                   |                     | $      | 184,817                |                     | 100.0  | %                      |                     | $      | 158,271 |                     | 100.0  | %      | $      | 372,542 |                     | 100.0  | %                        | $      | 312,050 |                     | 100.0  | %      |
|                              |                     |   |                   |                     |   |                   |                     |   |    |                     |   |   |   |    |                     |   |                     |   |    |                     |   |   |
| Net Sales by Geography            |                     |   |                   |                     |   |                   |                     |   |    |                     |   |   |   |    |                     |   |                     |   |    |                     |   |   |
| United States                     |                     | $      | 146,119                |                     | 79.1   | %                      |                     | $      | 123,634 |                     | 78.1   | %      | $      | 296,626 |                     | 79.6   | %                        | $      | 242,715 |                     | 77.8   | %      |
| International                     |                     |   | 38,698                 |                     | 20.9   | %                      |                     |   | 34,637  |                     | 21.9   | %      |   | 75,916  |                     | 20.4   | %                        |   | 69,335  |                     | 22.2   | %      |
| Total net sales                   |                     | $      | 184,817                |                     | 100.0  | %                      |                     | $      | 158,271 |                     | 100.0  | %      | $      | 372,542 |                     | 100.0  | %                        | $      | 312,050 |                     | 100.0  | %      |

 

27

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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.

 

|                              |                     |                   |                     |      |                     |          |      |                     |           |   |   |      |                     |           |                     |   |      |                     |           |   |     |   |   |   |   |
|-----------------------------------|--------------------------|------------------------|--------------------------|-----------|--------------------------|---------------|-----------|--------------------------|----------------|--------|--------|-----------|--------------------------|----------------|--------------------------|--------|-----------|--------------------------|----------------|--------|----------|--------|--------|--------|--------|
|                              |                     | Three Months Ended     |                     |      | Six Months Ended         |          |      |
|                              |                     | January 31,  |                     |      | January 31,    |          |      |
|                              |                     | 2017                   |                     |      | 2016                     |          |      | 2017                     |           |   | 2016   |      |                     |
|                              |      | Operating              |      | % of |      |          | Operating |      | % of      |   |   | Operating |      | % of      |      |   | Operating |      | % of      |   |     |
| (Amounts in Thousands)  |                     | Income                 |                     | Net Sales |                     |          | Income    |                     | Net sales |   |   | Income    |                     | Net sales |                     |   | Income    |                     | Net sales |   |     |
|                              |                     |                   |                     |      |                     |          |      |                     |           |   |   |      |                     |           |                     |   |      |                     |           |   |     |   |   |   |   |
| Endoscopy                         |                     | $                      | 18,778                   |      | 19.9                     | %   |      | $                        | 14,664         |   | 18.0   | %         |                     | $              | 36,339                   |   | 19.3      | %              |           | $      | 27,123   |   | 17.7   | %      |   |
| Water Purification and Filtration |                     |                   | 8,405                    |      | 17.7                     | %   |      |                     | 7,589          |   | 17.5   | %         |                     |           | 17,325                   |   | 17.8      | %              |           |   | 15,402   |   | 17.5   | %      |   |
| Healthcare Disposables            |                     |                   | 7,069                    |      | 20.0                     | %   |      |                     | 5,673          |   | 21.8   | %         |                     |           | 14,465                   |   | 20.1      | %              |           |   | 12,033   |   | 22.5   | %      |   |
| Dialysis                          |                     |                   | 2,147                    |      | 27.7                     | %   |      |                     | 1,734          |   | 23.0   | %         |                     |           | 3,960                    |   | 26.5      | %              |           |   | 4,421    |   | 25.1   | %      |   |
| Operating income by segment       |                     |                   | 36,399                   |      | 19.7                     | %   |      |                     | 29,660         |   | 18.7   | %         |                     |           | 72,089                   |   | 19.4      | %              |           |   | 58,979   |   | 18.9   | %      |   |
| General corporate expenses        |                     |                   | (7,786)                  |      |                     |          |      |                     | (5,264)        |   |   |      |                     |           | (16,413)                 |   |      |                     |           |   | (10,807) |   |   |   |   |
| Income from operations            |                     | $                      | 28,613                   |      | 15.5                     | %   |      | $                        | 24,396         |   | 15.4   | %         |                     | $              | 55,676                   |   | 14.9      | %              |           | $      | 48,172   |   | 15.4   | %      |   |

 

Net Sales

 

Total net sales increased by $26,546,000, or 16.8%, to $184,817,000 for the three months ended January 31, 2017 from $158,271,000 for the three months ended January 31, 2016. The 16.8% increase in net sales for the three months ended January 31, 2017 includes (i) a 12.1% increase in organic sales, (ii) a 5.8% increase in sales due to acquisitions and (iii) a 1.1% decrease due to foreign currency translation.

 

Total net sales increased by $60,492,000, or 19.4%, to $372,542,000 for the six months ended January 31, 2017 from $312,050,000 for the six months ended January 31, 2016. The 19.4% increase in net sales for the six months ended January 31, 2017 includes (i) a 13.9% increase in organic sales, (ii) a 6.5% increase in sales due to acquisitions and (iii) a 1.0% decrease due to foreign currency translation.

 

International net sales increased by $4,061,000, or 11.7%, to $38,698,000 for the three months ended January 31, 2017, compared with the three months ended January 31, 2016. The 11.7% increase in net sales consist of (i) an increase of 9.6% in organic net sales, (ii) an increase of 7.0% in net sales due to acquisitions and (iii) a decrease of 4.9% in net sales due to foreign currency translation.

 

International net sales increased by $6,581,000, or 9.5%, to $75,916,000 for the six months ended January 31, 2017, compared with the six months ended January 31, 2016. The 9.5% increase in net sales consist of (i) an increase of 5.6% in organic net sales, (ii) an increase of 8.5% in net sales due to acquisitions and (iii) a decrease of 4.6% in net sales due to foreign currency translation.

 

For the three and six months ended January 31, 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 Purfication 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 $16,140,000, or 22.3%, to $88,477,000 for the three months ended January 31, 2017 from $72,337,000 for the three months ended January 31, 2016. Gross profit as a percentage of net sales for the three months ended January 31, 2017 and 2016 was 47.9% and 45.7%, respectively. 

 

Gross profit increased by $34,449,000, or 24.0%, to $177,984,000 for the six months ended January 31, 2017 from $143,535,000 for the six months ended January 31, 2016. Gross profit as a percentage of net sales for the six months ended January 31, 2017 and 2016 was 47.8% and 46.0%, respectively. 

28

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The higher gross profit as a percentage of net sales for the three and six months ended January 31, 2017, compared with the three and six months ended January 31, 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 $862,000 and $2,040,000, respectively, 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 Endoscopy and Water Purification and Filtration segments.

 

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 $4,290,000, or 19.0%, to $26,910,000 for the three months ended January 31, 2017 from $22,620,000 for the three months ended January 31, 2016. For the six months ended January 31, 2017, selling expenses increased by $10,723,000, or 24.3%, to $54,803,000 from $44,080,000 for the six months ended January 31, 2016. For the three and six months ended January 31, 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 14.6% and 14.3% for the three months ended January 31, 2017 and 2016, respectively, and 14.7% and 14.1% for the six months ended January 31, 2017 and 2016, respectively.

 

General and administrative expenses increased by $6,213,000, or 27.9%, to $28,465,000 for the three months ended January 31, 2017 from $22,252,000 for the three months ended January 31, 2016. For the six months ended January 31, 2017, general and administrative expenses increased by $14,019,000, or 31.5%, to $58,468,000 from $44,449,000 for the six months ended January 31, 2016. General and administrative expenses increased primarily due to (i) costs incurred in our first quarter of fiscal 2017 associated with the planned retirement of our former Chief Executive Officer, (ii) the inclusion of general and administrative expenses of our acquisitions including increased amortization expense, (iii) increases in annual salaries and incentive compensation including stock-based compensation, (iv) severance and other restructuring costs recorded during our second quarter of fiscal 2017, primarily in our Endoscopy segment, to improve operating efficiencies and realign resources for continued investment in strategic initiatives and (v) the addition of internal and external resources to address various growth initiatives and compliance requirements. 

 

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 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 $4,891,000, or 26.2%, to $23,558,000 for the three months ended January 31, 2017, and $9,707,000, or 26.2%, to $46,803,000 for the six months ended January 31, 2017. A significant portion of these increases are attributable to the inclusion of general and administrative expenses of our acquisitions.

 

29

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General and administrative expenses as a percentage of net sales were 15.4% and 14.1% for the three months ended January 31, 2017 and 2016, respectively, and 15.7%  and 14.2% for the six months ended January 31, 2017 and 2016, respectively.

 

Research and development expenses (which include continuing engineering costs) increased by $1,420,000, or 46.3%, to $4,489,000 for the three months ended January 31, 2017 from $3,069,000 for the three months ended January 31, 2016. For the six months ended January 31, 2017, research and development expenses increased by $2,203,000, or 32.2%, to $9,037,000, from $6,834,000 for the six months ended January 31, 2016. The increase for the three and six months ended January 31, 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 2.4% and 1.9% for the three months ended January 31, 2017 and 2016, respectively, and 2.4% and 2.2% for the six months ended January 31, 2017 and 2016, respectively.

 

Interest

 

Interest expense increased by $252,000 to $1,145,000 for the three months ended January 31, 2017 from $893,000 for the three months ended January 31, 2016. For the six months ended January 31, 2017, interest expense increased by $598,000 to $2,257,000 from $1,659,000 for the six months ended January 31, 2016. The increases were due to an increase in the average outstanding borrowings due to the funding of recent acquisitions. 

 

Interest income decreased by $3,000 to $19,000 for the three months ended January 31, 2017 from $22,000 for the three months ended January 31, 2016. For the six months ended January 31, 2017, interest income decreased by $5,000 to $38,000 from $43,000 for the six months ended January 31, 2016.

 

Income Taxes

 

A reconciliation of the consolidated effective income tax rate for the six months ended January 31, 2016 to the six months ended January 31, 2017 is as follows:

 

|                          |                     |                      |   |   |
|-------------------------------|--------------------------|---------------------------|--------|--------|
|                          |      | Consolidated              |   |   |
|                          |                     | Effective                 |   |   |
|                          |                     | Income Tax Rate |   |   |
| January 31, 2016    |                     | 36.3                      | %      |   |
| Differential attributable to: |                     |                      |   |   |
| Excess tax benefits           |                     | (4.3)                     | %      |   |
| Other                         |                     | (1.0)                     | %      |   |
| January 31, 2017    |                     | 31.0                      | %      |   |

 

The consolidated effective tax rate for the six months ended January 31, 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 $45,000 and $2,286,000 for the three and six months ended January 31, 2017, respectively, 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 $12,909,000, or 15.8%, for the three months ended January 31, 2017, compared with the three months ended January 31, 2016. For the six months ended January 31, 2017, net sales of endoscopy products and services increased by $35,095,000, or 22.9%, compared with the six months ended January 31, 2016. The 15.8% and 22.9% increases in net sales consist of (i) increases of 16.0% and 21.3%, respectively, in organic net sales, (ii) increases of 1.9% and 3.7%, respectively, in net sales due to acquisitions and (iii) decreases of 2.1% in net sales due to foreign currency translation for both periods. The increase in organic net sales for the three and 

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six months ended January 31, 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 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 $4,114,000, or 28.1%, for the three months ended January 31, 2017, compared with the three months ended January 31, 2016, and $9,216,000, or 34.0%, for the six months ended January 31, 2017, compared with the six months ended January 31, 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 severance costs. Excluding amortization expense as well as atypical items relating to current and prior year acquisition related items and current year severance costs, as further described within Non-GAAP Financial Measures elsewhere in this MD&A, the Endoscopy segment’s operating income increased by $4,199,000, or 24.5%, and $9,201,000, or 28.5%, for the three and six months ended January 31, 2017 compared with the three and six months ended January 31, 2016.

 

Water Purification and Filtration Segment

 

Net sales of water purification and filtration products and services increased by $4,168,000, or 9.6%, for the three months ended January 31, 2017, compared with the three months ended January 31, 2016, and for the six months ended January 31, 2017  by $9,329,000, or 10.6%, compared to the six months ended January 31, 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 $816,000 or 10.8% for the three months ended January 31, 2017, compared with the three months ended January 31, 2016, and $1,923,000 or 12.5% for the six months ended January 31, 2017, compared with the six months ended January 31, 2016, primarily as a result of higher sales of lower margin capital equipment, as further explained above. 

 

Healthcare Disposables Segment

 

Net sales of healthcare disposables products increased by $9,254,000, or 35.6%, for the three months ended January 31, 2017, compared with the three months ended January 31, 2016, and for the six months ended January 31, 2017 by $18,701,000, or 35.0%, when compared to the six months ended January 31, 2016. The 35.6% and 35.0% increases in net sales consist of (i) an increase of 6.5% and 7.5% in organic net sales and (ii) an increase of 29.1% and 27.5% in net sales due to acquisitions. The increase in organic net sales for the three and six months ended January 31, 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 $1,396,000, or 24.6%, for the three months ended January 31, 2017, compared with the three months ended January 31, 2016, and $2,432,000, or 20.2%, for the six months ended January 31, 2017 compared with the six months ended January 31, 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 and the hiring of additional sales personnel. 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 $2,339,000, or 37.5%, and $4,486,000, or 34.1%, for the three and six months ended January 31, 2017 compared with the three and six months ended January 31, 2016, respectively.

 

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Dialysis Segment

 

Net sales of dialysis products increased by $215,000, or 2.9%, for the three months ended January 31, 2017, compared with the three months ended January 31, 2016, and decreased by $2,633,000, or 15.0%, for the six months ended January 31, 2017 compared to the six months ended January 31, 2016. Net sales for the three and six months ended January 31, 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, but were offset by an increase in demand for our lower margin concentrate product for the three months ended January 31, 2017. 

 

The Dialysis segment’s operating income increased by $413,000, or 23.8% for the three months ended January 31, 2017, compared with the three months ended January 31, 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 six months ended January 31, 2017, compared to the six months ended January 31, 2016, operating income decreased by $461,000, or 10.4%, primarily due to lower net sales, as further explained above, partially offset by a decrease in general and administrative expenses as a result of cost control initiatives.

 

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 10.1% 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 increased by $2,522,000, or 47.9%, for the three months ended January 31, 2017 compared with the three months ended January 31, 2016, and $5,606,000, or 51.9%, for the six months ended January 31, 2017 compared with the six months ended January 31, 2016, 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) $1,937,000 of costs recorded in our first quarter of fiscal 2017 associated with the planned retirement of our former Chief Executive Officer.

 

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.

 

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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 six months ended January 31, 2017, we made adjustments to net income and diluted EPS to exclude (i) amortization expense and (ii) restructuring charges. Additionally, we made adjustments to the six months ended January 31, 2017 to exclude (i) significant acquisition related items impacting current operating performance including legal, transaction and integration charges, (ii) costs associated with the planned retirement of our former Chief Executive Officer and (iii) 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 six months ended January 31, 2016, we made adjustments to net income and diluted EPS to exclude (i) amortization expense, (ii) significant acquisition related items and (iii) 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 quarter 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 second half 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 six months ended January 31, 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, 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, as further described in Notes 2 and 4 of the Condensed Consolidated Financial Statements and elsewhere in this MD&A. 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 

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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.

 

For the three and six months ended January 31, 2016, the 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     |                     | Six Months Ended       |   |
|                                        |                     | January 31,  |                     | January 31,  |   |
| (Amounts in Thousands)            |      | 2017                   |      | 2016                   |   | 2017           |      | 2016   |           |
|                                        |                     |                   |                     |                   |   |           |                     |   |           |   |   |           |   |
| Net income, as reported                     |                     | $                      | 18,070                   |                   | $      | 15,389         |                     | $      | 36,870         |   | $      | 29,643         |   |
| Intangible amortization (1)                 |                     |                   | 4,057                    |                   |   | 3,297          |                     |   | 7,966          |   |   | 6,391          |   |
| Acquisition related items (2)               |                     |                   |  —           |                   |   | 597            |                     |   | 1,075          |   |   | 1,531          |   |
| CEO retirement costs (1)                    |                     |                   |  —           |                   |   |  — |                     |   | 1,937          |   |   |  — |   |
| Restructuring costs (1)                     |                     |                   | 856                      |                   |   |  — |                     |   | 856            |   |   |  — |   |
| Income tax benefit on above adjustments (3) |                     |                   | (1,432)                  |                   |   | (1,070)        |                     |   | (3,589)        |   |   | (2,232)        |   |
| Excess tax benefit (3)                      |                     |                   |  —           |                   |   |  — |                     |   | (2,241)        |   |   |  — |   |
| Tax legislative changes (3)                 |                     |                   |  —           |                   |   | (800)          |                     |   |  — |   |   | (800)          |   |
| Non-GAAP net income                         |                     | $                      | 21,551                   |                   | $      | 17,413         |                     | $      | 42,874         |   | $      | 34,533         |   |

----

|  | (1) |  | Amounts are recorded in general and administrative expenses. |
|--|-----|--|--------------------------------------------------------------|

|  | (2) |  | For the six months ended January 31, 2017, acquisition related items of $170 were recorded in cost of sales and $905 were recorded in general administrative expenses. For the three and six months ended January 31, 2016, acquisition related items of $311 and $571, respectively, were recorded in cost of sales and $286 and $960 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     |                     | Six Months Ended       |   |
|                                  |                     | January 31,  |                     | January 31,  |   |
|                                  |      | 2017                   |      | 2016                   |   | 2017           |      | 2016   |           |
|                                  |                     |                   |                     |                   |   |           |                     |   |           |   |   |           |   |
| Diluted EPS, as reported              |                     | $                      | 0.43                     |                   | $      | 0.37           |                     | $      | 0.88           |   | $      | 0.71           |   |
| Intangible amortization, net of tax   |                     |                   | 0.07                     |                   |   | 0.06           |                     |   | 0.13           |   |   | 0.11           |   |
| Acquisition related items, net of tax |                     |                   |  —           |                   |   | 0.01           |                     |   | 0.02           |   |   | 0.03           |   |
| CEO retirement costs, net of tax      |                     |                   |  —           |                   |   |  — |                     |   | 0.03           |   |   |  — |   |
| Restructuring costs, net of tax       |                     |                   | 0.02                     |                   |   |  — |                     |   | 0.02           |   |   |  — |   |
| Excess tax benefit                    |                     |                   |  —           |                   |   |  — |                     |   | (0.05)         |   |   |  — |   |
| Tax legislative changes               |                     |                   |  —           |                   |   | (0.02)         |                     |   |  — |   |   | (0.02)         |   |
| Non-GAAP diluted EPS                  |                     | $                      | 0.52                     |                   | $      | 0.42           |                     | $      | 1.03           |   | $      | 0.83           |   |

 

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 

34

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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     |           | Six Months Ended       |   |
|                             |   | January 31,  |           | January 31,  |   |
| (Amounts in Thousands) |   | 2017                   |           | 2016                   |   | 2017           |   | 2016   |   |
|                             |   |                   |           |                   |   |           |   |   |   |   |   |           |   |
| Net income, as reported          |   | $                      | 18,070         |                   | $      | 15,389         |   | $      | 36,870 |   | $      | 29,643         |   |
|                             |   |                   |           |                   |   |           |   |   |   |   |   |           |   |
| Interest expense, net            |   |                   | 1,126          |                   |   | 871            |   |   | 2,219  |   |   | 1,616          |   |
| Income taxes                     |   |                   | 9,417          |                   |   | 8,136          |   |   | 16,587 |   |   | 16,913         |   |
| Depreciation                     |   |                   | 3,694          |                   |   | 2,871          |   |   | 7,148  |   |   | 5,693          |   |
| Amortization                     |   |                   | 4,057          |                   |   | 3,297          |   |   | 7,966  |   |   | 6,391          |   |
| Loss on disposal of fixed assets |   |                   | 178            |                   |   | 11             |   |   | 402    |   |   | 111            |   |
| Stock-based compensation expense |   |                   | 2,116          |                   |   | 1,875          |   |   | 5,038  |   |   | 3,595          |   |
|                             |   |                   |           |                   |   |           |   |   |   |   |   |           |   |
| EBITDAS                          |   |                   | 38,658         |                   |   | 32,450         |   |   | 76,230 |   |   | 63,962         |   |
|                             |   |                   |           |                   |   |           |   |   |   |   |   |           |   |
| Acquisition related items        |   |                   |  — |                   |   | 597            |   |   | 1,075  |   |   | 1,531          |   |
| CEO retirement costs             |   |                   |  — |                   |   |  — |   |   | 1,937  |   |   |  — |   |
| Restructuring costs              |   |                   | 856            |                   |   |  — |   |   | 856    |   |   |  — |   |
|                             |   |                   |           |                   |   |           |   |   |   |   |   |           |   |
| Adjusted EBITDAS                 |   | $                      | 39,514         |                   | $      | 33,047         |   | $      | 80,098 |   | $      | 65,493         |   |

 

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:

 

|                             |   |                   |     |     |   |     |   |
|----------------------------------|--------|------------------------|----------|----------|--------|----------|--------|
|                             |   | January 31,  |     | July 31, |   |
| (Amounts in Thousands) |   | 2017                   |     | 2016     |   |
|                             |   |                   |     |     |   |     |   |
| Long-term debt                   |   | $                      | 149,000  |     | $      | 116,000  |   |
| Less cash and cash equivalents   |   |                   | (24,351) |     |   | (28,367) |   |
| Net debt                         |   | $                      | 124,649  |     | $      | 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 and the Vantage Acquisition in September 2016, 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 

35

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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 January 31, 2017, our working capital was $141,530,000, 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:

 

|                                      |                     |                   |                     |   |   |     |   |
|-------------------------------------------|--------------------------|------------------------|--------------------------|--------|--------|----------|--------|
|                                      |                     | Six Months Ended       |                     |
|                                      |                     | January 31,  |                     |
| (Amounts in Thousands)          |      | 2017                   |      | 2016   |   |
|                                      |                     |                   |                     |   |   |     |   |
| Net cash provided by operating activities |                     | $                      | 45,001                   |   | $      | 28,271   |   |
| Net cash used in investing activities     |                     | $                      | (72,677)                 |   | $      | (88,492) |   |
| Net cash provided by financing activities |                     | $                      | 23,815                   |   | $      | 50,607   |   |

 

Cash Flows from Operating Activities

 

Net cash provided by operating activities increased by $16,730,000, or 59.2%, for the six months ended January 31, 2017, compared with the six months ended January 31, 2016, primarily due to the increase in net income (after adjusting for noncash items such as depreciation, amortization, stock-based compensation expense, fair value adjustments of acquisition related liabilities and deferred income taxes). 

 

Cash Flows from Investing Activities

 

Net cash used in investing activities decreased by $15,815,000, or 17.9%, for the six months ended January 31, 2017, compared with the six months ended January 31, 2016, primarily due to less acquisition related cash consideration in the current period compared to the prior period, partially offset by an increase of $6,781,000, or 88.8%, 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 $26,792,000, or 53.0%, for the six months ended January 31, 2017, compared with the six months ended January 31, 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 

36

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$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 February 28, 2017, the lender’s base rate was 3.75% and the LIBOR rates ranged from 0.77% to 1.33%. The margins applicable to our outstanding borrowings were 0.50% above the lender’s base rate or 1.50% above LIBOR. All of our outstanding borrowings were under LIBOR contracts at February 28, 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 0.25% at February 28, 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 January 31, 2017, we had $149,000,000 of outstanding borrowings under the 2014 Credit Agreement. Subsequent to January 31, 2017, we repaid $4,000,000 resulting in total outstanding borrowings of $145,000,000 at March 9, 2017, none of which is required to be repaid until March 2019.

 

Financing Needs

 

Our operating segments generate significant cash from operations. At January 31, 2017 we had a cash balance of $24,351,000, of which $9,910,000 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 March 9, 2017, $105,000,000 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.

 

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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 are 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 $45,000 and $2,286,000 for the three and six months ended January 31, 2017, respectively, 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.

38

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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.

 

PART II - OTHER INFORMATION

 

ITEM 1.LEGAL PROCEEDINGS

 

None.

 

ITEM 1A.RISK FACTORS

 

There have been no material changes in our risk factors from those disclosed in Part I, Item 1A to our 2016 Form 10‐K. The risk factors disclosed in Part I, Item 1A to our 2016 Form 10-K, in addition to the other information set forth in this report, could materially affect our business, financial condition, or results of operations.

 

39

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ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

The following table represents information with respect to purchases of common stock made by the Company during the current quarter:

 

|     |   |             |   |   |       |   |   |                 |                                  |   |                |                        |   |
|----------|--------|------------------|--------|--------|------------|--------|--------|----------------------|---------------------------------------|--------|---------------------|-----------------------------|--------|
|     |   |             |   |   |       |   |   |                 | Total number of shares |   |                | Maximum number of |   |
| Month    |   |             |   |   | Average    |   |   | purchased as part of |                                  |   | shares that may yet |                        |
| of       |   | Total number of  |   |   | price paid |   |   | publicly announced   |                                  |   | be purchased under  |                        |
| Purchase |   | shares purchased |   |   | per share  |   |   | plans or programs    |                                  |   | the program         |                        |
|     |   |             |   |   |       |   |   |                 |                                  |   |                |                        |   |
| November |   | 164              |   |   | $          | 74.31  |   |                 | —                              |   |                | —                    |   |
| December |   | 80               |   |   |       | 78.75  |   |                 | —                              |   |                | —                    |   |
| January  |   | 347              |   |   |       | 78.06  |   |                 | —                              |   |                | —                    |   |
| Total    |   | 591              |   |   | $          | 77.11  |   |                 | —                              |   |                | —                    |   |

 

 

The Company does not currently have a repurchase program. All of the shares purchased during the current quarter represent shares surrendered to the Company to pay employee withholding taxes due upon the vesting of restricted stock.

 

ITEM 3.DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.MINE SAFETY DISCLOSURES

 

None.

 

ITEM 5.OTHER INFORMATION

 

None.

 

 

 

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ITEM 6.EXHIBITS

|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                             |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1   | -      | Certification of Principal Executive Officer.                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 31.2   | -      | Certification of Principal Financial Officer.                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 32     | -      | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 101    | -      | The following materials from this report, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Comprehensive Income, (iv) the Condensed Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements. |

 

 

 

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

|                |                 |                                                 |
|---------------------|----------------------|------------------------------------------------------|
|                | CANTEL MEDICAL CORP. |
|                |                 |
| Date: March 9, 2017 |                 |
|                |                 |
|                | By:                  | /s/ Jorgen B. Hansen                                 |
|                |                 | Jorgen B. Hansen,                                    |
|                |                 | President and Chief Executive Officer                |
|                |                 | (Principal Executive Officer)                        |
|                |                 |
|                |                 |
|                | By:                  | /s/ Peter G. Clifford                                |
|                |                 | Peter G. Clifford,                                   |
|                |                 | Executive Vice President and Chief Financial Officer |
|                |                 | (Principal Financial Officer)                        |
|                |                 |
|                |                 |
|                | By:                  | /s/ Steven C. Anaya                                  |
|                |                 | Steven C. Anaya,                                     |
|                |                 | Senior Vice President and Chief Accounting Officer   |
|                |                 | (Principal Accounting Officer)                       |

 

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