CANTEL MEDICAL CORP.
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") is intended to help you understand Cantel and its
subsidiaries. The MD&A is provided as a supplement to and should be read in
conjunction with the consolidated financial statements and the accompanying
notes included elsewhere in this report. Our financial statements have been
prepared in accordance with generally accepted accounting principles in the
United States ("GAAP").
Overview
Cantel is a leading provider of infection prevention and control products and services in the healthcare market, specializing in the following reportable segments: Medical, Life Sciences, Dental and Dialysis. Most of our equipment, consumables and supplies are used to help prevent the occurrence or spread of infections. We operate our four segments through wholly-owned subsidiaries in theU.S. and internationally. COVID-19 The unprecedented nature of the COVID-19 pandemic has adversely impacted the global economy and has had, and will continue to have a significant direct and indirect effect on our businesses and operations. The extent to which these events may impact our business, financial condition, results of operations and cash flows, will depend on future developments which are highly uncertain and many of which are outside our control. Such developments include the ultimate geographic spread and duration of the pandemic, new information which may emerge concerning the severity of the COVID-19 virus, the effectiveness and intensity of measures to contain the COVID-19 virus and address its impacts, and the economic impact of the pandemic and the reactions to it. Such developments, among others, depending on their nature, duration and intensity, have had and could have an adverse effect on our business, financial condition, results of operations and cash flows. To date, we have been able to continue our operations with limited disruptions in supply and manufacturing. Although, it is difficult to predict the broad macroeconomic effects that the COVID-19 virus will have on industries or individual companies, we have assessed the possible effects and outcomes of the pandemic on, among other things, our supply chain, customers and distributors, discounts and rebates, employee base, product sustainability, research and development efforts, product pipeline and consumer demand. We have implemented several measures to proactively reduce operating costs, conserve liquidity and navigate through this unprecedented situation. These management cost reduction measures include salary reductions, employee furloughs, reductions to travel and expenses and the deferral of certain operating and capital expenditures. We continue to actively manage our daily cash flows and continue to evaluate additional measures that will reduce operating costs and conserve cash. The COVID-19 pandemic negatively impacted net sales and the related operations of both our Medical and Dental segments during the second half of fiscal 2020. Gross profit as a percentage of sales for those periods was negatively impacted by decreased net sales in both the Medical and Dental segments but did benefit from certain actions taken by management to reduce variable costs in response to lower sales volume. Operating expenses as a percentage of sales decreased due to cost savings initiatives and other measures taken by management to offset the loss of sales volume due to the COVID-19 pandemic during the second half of fiscal 2020. See "Results of Operations" for a more detailed discussion. Fiscal 2020 Summary Key GAAP financial results for fiscal 2020 compared with fiscal 2019 were as follows: •Net sales increased by 10.7% to$1,016,048 from$918,155 , with organic sales decline of 6.0%; •Net income decreased by 75.1% to$13,708 from$55,042 ; and •Earnings per diluted share decreased by 75.4% to$0.32 from$1.32 . Key Non-GAAP financial results for fiscal 2020 compared with fiscal 2019 were as follows: •Non-GAAP net income decreased by 29.4% to$69,852 from$98,999 ; •Non-GAAP earnings per diluted share decreased by 30.4% to$1.65 from$2.37 ; and •Adjusted EBITDAS increased by 1.1% to$176,702 from$174,848 . Please see a description of our Non-GAAP Financial Measures below.
(dollar amounts in thousands except share and per share data or as otherwise specified) 23
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K Acquisitions Fiscal 2020 OnOctober 1, 2019 , we purchased all of the issued and outstanding membership interests ofHu-Friedy Mfg. Co. LLC ("Hu-Friedy"), for total consideration (net of cash acquired), excluding acquisition-related costs, of$716,542 , consisting of$662,151 of cash and$54,391 of common stock consideration (subject to adjustment), plus contingent consideration payable in cash. The additional contingent consideration payments were (i) subject to the achievement of certain commercial milestones throughMarch 31, 2021 ranging from zero to a maximum of$50,000 and (ii) contingent upon changes in our common stock price from the date of closing through a future date subject to a registration rights agreement. Hu-Friedy is a leading global manufacturer of instruments and instrument reprocessing systems serving the dental industry and is included in our Dental segment. During the second quarter of fiscal 2020, we paid$25,000 to settle a portion of the contingent consideration arrangements related to net sales achieved for the twelve month period endedDecember 31, 2019 . During the third quarter of fiscal 2020, we made payments totaling$35,000 to (i) repurchase a portion of the shares from the seller which were included in the equity consideration transferred at closing and (ii) settle a contingent consideration arrangement entered into at closing which was based on changes in our common stock price. For the remaining contingent consideration arrangement related to net sales and gross profit percentage, we reduced the fair value from a liability of approximately$17,210 to zero due to the impact of the COVID-19 pandemic on Hu-Friedy's current and expected performance. See Note 3 to our consolidated financial statements in Part II, Item 8 of this report.
Results of Operations
The following table gives information as to the percentages of net sales represented by items reflected in our consolidated statements of income.
Year Ended July 31 , Percentage Change
Statement of income data 2020 2019 2018 2020 / 2019 2019 / 2018
Net sales $ 1,016,048 100.0 % $ 918,155 100.0 % $ 871,922 100.0 % 10.7 % 5.3 %
Cost of sales 580,075 57.1 % 490,701 53.4 % 457,951 52.5 % 18.2 % 7.2 %
Gross profit 435,973 42.9 % 427,454 46.6 % 413,971 47.5 % 2.0 % 3.3 %
Selling 157,732 15.5 % 140,232 15.3 % 129,642 14.9 % 12.5 % 8.2 %
General and administrative 197,562 19.4 % 172,383 18.8 % 138,019 15.8 % 14.6 % 24.9 %
Research and development 32,372 3.2 % 31,320 3.4 % 24,646 2.8 % 3.4 % 27.1 %
Total operating expenses 387,666 38.1 % 343,935 37.5 % 292,307 33.5 % 12.7 % 17.7 %
Income from operations 48,307 4.8 % 83,519 9.1 % 121,664 14.0 % (42.2) % (31.4) %
Interest expense, net 41,355 4.1 % 9,505 1.0 % 5,289 0.6 % 335.1 % 79.7 %
Other income - - % (1,305) (0.1) % (1,138) (0.1) % - % - %
Income before income taxes 6,952 0.7 % 75,319 8.2 % 117,513 13.5 % (90.8) % (35.9) %
Income taxes (6,756) (0.6) % 20,277 2.2 % 26,472 3.1 % (133.3) % (23.4) %
Net income $ 13,708 1.3 % $ 55,042 6.0 % $ 91,041 10.4 % (75.1) % (39.5) %
(dollar amounts in thousands except share and per share data or as otherwise specified) 24
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K
The following table gives information as to the net sales by reportable
segment and geography, as well as the related percentage of such sales to the
total net sales.
Year Ended July 31,
Net sales by segment 2020 2019 2018
Medical $ 468,078 46.1 % $ 523,669 57.0 % $ 473,937 54.4 %
Life Sciences 195,410 19.2 % 194,950 21.2 % 211,210 24.2 %
Dental 322,398 31.7 % 167,680 18.3 % 155,180 17.8 %
Dialysis 30,162 3.0 % 31,856 3.5 % 31,595 3.6 %
Total net sales $ 1,016,048 100.0 % $ 918,155 100.0 % $ 871,922 100.0 %
Net sales by geography
United States $ 742,410 73.1 % $ 665,661 72.5 % $ 643,744 73.9 %
International 273,638 26.9 % 252,494 27.5 % 228,178 26.1 %
Total net sales $ 1,016,048 100.0 % $ 918,155 100.0 % $ 871,922 100.0 %
The following table gives information as to the amount of income from operations, as well as income from operations as a percentage of net sales, for each of our reportable segments.
Year Ended July 31,
Income from operations 2020 2019 2018
Medical $ 56,065 12.0 % $ 98,356 18.8 % $ 86,833 18.3 %
Life Sciences 26,904 13.8 % 17,528 9.0 % 35,100 16.6 %
Dental 3,378 1.0 % 25,313 15.1 % 31,707 20.4 %
Dialysis 7,480 24.8 % 4,922 15.5 % 7,380 23.4 %
Operating income by segment 93,827 9.2 % 146,119 15.9 % 161,020 18.5 %
General corporate expenses 45,520 4.4 % 62,600 6.8 % 39,356 4.5 %
Income from operations $ 48,307 4.8 % $ 83,519 9.1 % $ 121,664 14.0 %
Fiscal 2020 compared with Fiscal 2019
Total net sales increased by$97,893 , or 10.7%, to$1,016,048 for fiscal 2020 from$918,155 for fiscal 2019. The 10.7% increase in net sales includes an increase of 17.1% in net sales due to acquisitions (offset by dispositions), offset by a decrease of 6.0% in organic sales and a decrease of 0.4% due to foreign currency translation. International net sales increased by$21,144 , or 8.4%, to$273,638 for fiscal 2020 from$252,494 for fiscal 2019. The 8.4% increase in international net sales consists of a 13.6% increase due to acquisitions (net of dispositions), offset by a decrease of 3.8% in organic sales and a decrease of 1.4% due to foreign currency translation. Medical. Net sales decreased by$55,591 , or 10.6%, for fiscal 2020 compared with fiscal 2019, which consisted of a 10.0% decrease in organic sales and a decrease of 0.6% due to foreign currency translation. The decrease in organic sales was primarily driven by decreased global sales for all products lines due to the COVID-19 pandemic. Although certain international and domestic regions were impacted at different times during the latter half of the fiscal year, the postponement of certain surgical and elective medical procedures in order to prioritize/conserve available health care resources dramatically impacted our volume during the third quarter. The temporary restrictions at hospitals and the closures of ambulatory surgery centers significantly reduced sales of our procedural room products, chemistry and capital equipment, and to a somewhat lesser extent, service revenues were negatively impacted as service technicians had limited access to certain customer locations as a result of the pandemic. Surgical and elective procedures resumed during the fourth quarter of fiscal 2020 and our volume has begun to gradually recover. We expect these trends to gradually improve into fiscal 2021, but we cannot predict such trends with certainty beyond the end of our first quarter of fiscal 2021. Life Sciences. Net sales remained relatively flat as they increased by$460 , or 0.2%, for fiscal 2020 compared with fiscal 2019. The increase in net sales was driven by 2.0% organic sales growth, offset by dispositions. The increase in sales was primarily driven by the increase in sales of portable reverse osmosis units and the stabilization of capital equipment sales in our hemodialysis water business, mostly offset by the disposition of our high purity water business inCanada , which occurred in
(dollar amounts in thousands except share and per share data or as otherwise specified) 25
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K the second quarter of fiscal 2019. As the majority of our Life Sciences business supports non-elective medical treatment, the COVID-19 pandemic has not negatively impacted this business. If the pandemic continues beyond the end of our fiscal year, it could potentially impact capital equipment volume and future service revenues. Foreign currency translation decreased net sales by 0.1% for fiscal 2020. Dental. Net sales increased by$154,718 , or 92.3%, for fiscal 2020 compared with fiscal 2019, which consisted of a 95.5% increase due to acquisitions offset by a 3.2% organic sales decrease. The Hu-Friedy acquisition contributed$148,317 of net sales for fiscal 2020. The COVID-19 pandemic has significantly impacted the Dental segment as a result of the postponement of most dental procedures during the third quarter due to the closure of many dental offices inthe United States resulting from federal, state and local government guidelines. Many dental procedures have resumed during the fourth quarter of fiscal 2020 and our volume has begun to gradually recover. We expect these trends to gradually improve into fiscal 2021, but we cannot predict such trends with certainty beyond the end of our first quarter of fiscal 2021. Dialysis. Net sales decreased by$1,694 , or 5.3%, for fiscal 2020 compared with fiscal 2019. The decrease was primarily due to the loss of concentrate business in certain international regions.
Gross Profit
Gross profit increased by$8,519 , or 2.0%, to$435,973 for fiscal 2020 from$427,454 for fiscal 2019. Gross profit as a percentage of net sales for fiscal 2020 and 2019 was 42.9% and 46.6%, respectively. The increase in gross profit for fiscal 2020 primarily relates to the operations associated with the Hu-Friedy acquisition, partially offset by the amortization of the step-up in acquired inventory. The increase was partially offset by decreases in net sales in both the Medical and Dental segments due to the COVID-19 pandemic and the related excess capacity costs and changes in product mix, partially offset by certain actions taken by management to reduce variable costs in response to lower sales volume due to the COVID-19 pandemic. The decrease in gross profit as a percentage of net sales was driven by the leverage constraints of our fixed manufacturing costs in relation to lower sales bases and the inventory step-up amortization. Operating Expenses Operating expenses increased by$43,731 , or 12.7%, to$387,666 for fiscal 2020 from$343,935 for fiscal 2019, primarily due to the acquired operations of Hu-Friedy and Omnia, partially offset by actions taken by management to reduce costs to offset the loss of sales volume due to the COVID-19 pandemic (including salary reductions, employee furloughs and reductions to travel and expenses). Operating expenses as a percentage of net sales for fiscal 2020 and 2019 were 38.1% and 37.5%, respectively. Selling expenses increased by$17,500 , or 12.5%, to$157,732 for fiscal 2020 from$140,232 for fiscal 2019, primarily due to the acquired operations of Hu-Friedy, partially offset by decreased commissions due to lower net sales volumes due to the COVID-19 pandemic. Selling expenses as a percentage of net sales were 15.5% and 15.3% for fiscal 2020 and 2019, respectively. General and administrative expenses increased by$25,179 , or 14.6%, to$197,562 for fiscal 2020 from$172,383 for fiscal 2019. The increase was primarily due to Hu-Friedy and Omnia operations, certain transaction and integration-related costs (including fair value adjustments to contingent consideration arrangements), restructuring-related costs, higher amortization expense and elevated depreciation expense related to our new ERP platform and our new Medical headquarters inMinnesota . These increases were partially offset by the reduction in the fair value of contingent consideration associated with the Hu-Friedy acquisition and the reduction in variable expenses from cost actions taken by management during the latter half of the fiscal year in response to lower sales volume due to the COVID-19 pandemic. General and administrative expenses as a percentage of net sales were 19.4% and 18.8% for fiscal 2020 and 2019, respectively. Research and development expenses (which include continuing engineering costs) increased by$1,052 , or 3.4%, to$32,372 for fiscal 2020 from$31,320 for fiscal 2019. The increase was primarily a result of the acquired operations of Hu-Friedy and increased spending in our Life Sciences segment, partially offset by a reduction in research and development expense in our Medical segment. Research and development expenses as a percentage of net sales were 3.2% and 3.4% for fiscal 2020 and 2019, respectively.
(dollar amounts in thousands except share and per share data or as otherwise specified) 26
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K
Operating Income
Medical. Operating income decreased by$42,291 , or 43.0%, for fiscal 2020 compared with fiscal 2019. The decrease was primarily due to the impact of the COVID-19 pandemic on net sales and gross profit noted above, restructuring-related charges, elevated depreciation expense associated with our new ERP platform and our new Medical headquarters inMinnesota , partially offset by the decrease in certain operating expenses resulting from management cost reduction measures taken in response to the COVID-19 pandemic (including salary reductions, employee furloughs and reductions to travel and expenses) and to a lesser extent, lower sales commissions. Life Sciences. Operating income increased by$9,376 , or 53.5%, for fiscal 2020 compared with fiscal 2019. The increase was primarily due to a reduction of this segment's overall expense base as a result of the disposition of our high purity water business inCanada , improved sales performance, particularly higher sales of our portable reverse osmosis units as noted above. Dental. Operating income decreased by$21,935 , or 86.7%, for fiscal 2020 compared with fiscal 2019. The decrease was primarily due to certain acquisition and integration-related costs, inventory step-up amortization, and higher depreciation and amortization expense primarily as a result of the intangible assets associated with the Hu-Friedy acquisition. The latter half of the fiscal year was negatively impacted by the COVID-19 pandemic as net sales decreased by approximately 75% during the third quarter of fiscal 2020. Management has taken certain cost reduction measures (including salary reductions, employee furloughs and reductions to travel and expenses) in response to the COVID-19 pandemic which have partially offset the impact of decreased net sales. We expect operating income to gradually improve during fiscal 2021 as our Dental business begins to recover from the COVID-19 pandemic.
Dialysis. Operating income increased by
General Corporate Expenses
General corporate expenses include unallocated corporate costs primarily related to executive management personnel, as well as costs associated with certain facets of our acquisition and integration programs (including fair value adjustments to contingent consideration) and costs of being a publicly traded company. Such expenses decreased by$17,080 , or 27.3%, for fiscal 2020 from fiscal 2019. The decrease was primarily due to the reduction in the fair value of contingent consideration associated with the Hu-Friedy acquisition and the reduction in variable expenses from cost actions taken by management (including salary reductions, employee furloughs and reductions to travel and expenses) in response to the COVID-19 pandemic. These cost decreases were partially offset by an increase in acquisition-related and transaction charges incurred in connection with the Hu-Friedy acquisition.
Interest Expense, Net
Interest expense, net increased by$31,850 , or 335.1%, to$41,355 for fiscal 2020 from$9,505 for fiscal 2019. The increase resulted from an increase in the average outstanding debt, which includes both the term loan and revolver borrowings made to support the funding of the Hu-Friedy acquisition and to increase our liquidity. In addition, interest expense has also increased as a result of theMay 2020 issuance of convertible debt, which was also done to increase our liquidity in response to the COVID-19 pandemic. Interest expense, net includes non-cash interest of$2,348 and$594 for fiscal 2020 and 2019, respectively, related to the amortization of debt issuance costs. Non-cash interest of$1,370 related to the amortization of the discount on the convertible debt was also included in fiscal 2020. Non-cash interest of$1,562 related to the amortization of the loss on terminated interest rate swaps was also included in fiscal 2020. We expect interest expense to be elevated during fiscal 2021 as a result of a full year of interest expense associated with our convertible debt and the amortization of the loss on terminated interest rate swaps. Other Income
Other income of
Income Taxes
Our consolidated income taxes decreased to a benefit of$6,756 for fiscal 2020 from a provision of$20,277 for fiscal 2019. The effective tax rate for fiscal 2020 was a benefit of 97.2% and a provision of 26.9% for fiscal 2019. The tax benefit in
(dollar amounts in thousands except share and per share data or as otherwise specified) 27
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K fiscal 2020 was primarily driven by a provision under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), which allowed us to carry back taxable losses up to five years, including years when the federal statutory tax rate was 35%. This was partially offset by excess tax charges related to share-based compensation, and to a lesser extent, the jurisdictional tax structure of the acquired Hu-Friedy international operations.
Fiscal 2019 compared with Fiscal 2018
For a discussion of fiscal 2019 compared with fiscal 2018, see Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year endedJuly 31, 2019 .
Non-GAAP Financial Measures
In evaluating our operating performance, we supplement the reporting of our financial information determined under generally accepted accounting principles inthe United States ("GAAP") with certain non-GAAP financial measures including (i) non-GAAP net income, (ii) non-GAAP earnings per diluted share ("EPS"), (iii) earnings before interest, taxes, depreciation, amortization, loss on disposal of fixed assets, and stock-based compensation expense ("EBITDAS"), (iv) adjusted EBITDAS, (v) net debt and (vi) organic sales. These non-GAAP financial measures are indicators of our 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, stockholders and other readers of our 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. To measure earnings performance on a consistent and comparable basis, we exclude certain items that affect comparability of operating results and the trend of earnings. These adjustments are irregular in timing, may not be indicative of our past and future performance and are therefore excluded to allow investors to better understand underlying operating trends. The following are examples of the types of adjustments that are excluded: (i) amortization of purchased intangible assets, (ii) acquisition-related items, (iii) business optimization and restructuring-related charges, (iv) certain significant and discrete tax matters and (v) other significant items management deems irregular or non-operating in nature. Amortization expense of purchased intangible assets 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 reduce our 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) fair value adjustments to contingent consideration and other contingent liabilities resulting from acquisitions, (ii) due diligence, integration, legal fees 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 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 these acquisition-related items are irregular and often mask underlying operating performance, we exclude 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. Restructuring-related and business optimization items consist of severance-related costs associated with work force reductions and other restructuring-related activities. Such costs include (i) salary continuation, (ii) bonus payments, (iii) outplacement services, (iv) medical-related premium costs and (v) accelerated stock-compensation costs. Since these restructuring-related and business optimization items often mask underlying operating performance, we exclude 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.
(dollar amounts in thousands except share and per share data or as otherwise specified) 28
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K Excess tax benefits and expenses resulting from stock compensation are recorded as an adjustment to income tax expense. The magnitude of the impact of excess tax benefits generated in the future, which may be favorable or unfavorable, are dependent upon our future grants of equity awards, our future share price on the date awards vest in relation to the fair value of awards on grant date and the exercise behavior of our stock award holders. Since these tax effects are largely unrelated to our results and unrepresentative of our normal effective tax rate, we excluded their impact on net income and diluted EPS to arrive at our non-GAAP financial measures. We are required under GAAP to separately account for the liability (debt) and equity (conversion option) components of our convertible debt issued inMay 2020 . Accordingly, we are required to recognize non-cash interest expense that is associated with the debt discount component recorded in equity. Since the amortization of the debt discount is a non-cash expense, we excluded its impact on net income and diluted EPS to arrive at our non-GAAP financial measures as we believe that the exclusion of the non-cash interest expense provides investors an enhanced view of our operational performance related to cash flow and liquidity. As a result of terminating our interest rate swaps during fiscal 2020, we recorded a loss in other comprehensive income which is required by GAAP to be amortized through interest expense through the original maturity date of the swaps. Since the amortization of the loss is a non-cash expense, we excluded its impact on net income and diluted EPS to arrive at our non-GAAP financial measures as we believe that the exclusion of the non-cash interest expense provides investors an enhanced view of our operational performance related to cash flow and liquidity. Fiscal 2020 During fiscal 2020, we recorded a discrete tax benefit related to a provision under the federal CARES Act, which allowed us to carryback taxable losses up to five years. As we believe that this item was not representative of our normal effective tax rate, we excluded its impact on net income and diluted EPS for fiscal 2020 to arrive at our non-GAAP financial measures. During fiscal 2020, we completed the disposition of a dental product line, which resulted in a pre-tax loss of$127 through general and administrative expenses. Since we believe that this loss was not representative of our ordinary course past or future expenses, we made an adjustment to our net income and diluted EPS for fiscal 2020 to exclude this loss to arrive at our non-GAAP financial measures.
Fiscal 2019
During fiscal 2019, we recorded specific discrete tax items associated with our international operations that were unrelated to fiscal 2019. As we believe that these items were not representative of our normal effective tax rate, we excluded their impact on net income and diluted EPS for fiscal 2019 to arrive at our non-GAAP financial measures. During fiscal 2019, we completed the disposition of our high purity water business inCanada , which resulted in a pre-tax gain of$1,305 through other income. As we believe that this gain was not representative of past or future operations, we made an adjustment to our net income and diluted EPS for fiscal 2019 to exclude this gain to arrive at our non-GAAP financial measures. During fiscal 2019, we recorded an adjustment to a minor litigation matter in our consolidated financial statements. Since we believe that these costs were irregular and mask our underlying operating performance, we made an adjustment to our net income and diluted EPS for fiscal 2019 to exclude such costs to arrive at our non-GAAP financial measures.
Fiscal 2018
In 2017, the Tax Cuts and Jobs Act (the "2017 Tax Act") significantly revisedU.S. tax law by, among other provisions, (a) lowering the applicableU.S. federal statutory income tax rate from 35% to 21%, (b) creating a partial territorial tax system that includes imposing a mandatory one-time transition tax on previously deferred foreign earnings, (c) creating provisions regarding the (1) Global Intangible Low Tax Income, (2) the Foreign Derived Intangible Income deduction, and (3) the Base Erosion Anti-Abuse Tax and (d) eliminating or reducing certain income tax deductions, such as interest expense, executive compensation expenses and certain employee expenses. During fiscal 2018, we recorded a one-time net benefit as a provisional estimate of the net accounting impact of the 2017 Tax Act in accordance with Staff Accounting Bulletin No. 118 ("SAB 118"). Since we believe that the net favorable tax benefit was largely unrelated to our results and not representative of
(dollar amounts in thousands except share and per share data or as otherwise specified) 29
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K
our normal effective tax rate, we excluded its impact on net income and diluted EPS for fiscal 2018 to arrive at our non-GAAP financial measures.
During fiscal 2018, the Israeli Government notified us that they would forgive any future amounts due under a contingent obligation payable from a previous acquisition. As a result of this formal notification, we reduced the$1,138 contingent obligation payable to$0 during fiscal 2018, resulting in a gain through other income. Since we believe that this gain was irregular, we made an adjustment to our net income and diluted EPS for fiscal 2018 to exclude this gain to arrive at our non-GAAP financial measures. During fiscal 2018, we settled a patent infringement matter and also recorded an adjustment to another minor litigation matter in our consolidated financial statements. Since we believe that these costs were irregular and mask our underlying operating performance, we made an adjustment to our net income and diluted EPS for fiscal 2018 to exclude such costs to arrive at our non-GAAP financial measures. During fiscal 2018, we recorded a$2,785 valuation allowance on deferred tax assets related to a prior acquisition. Since we believe that this tax adjustment was related to acquired net operating losses and is not representative of our normal effective tax rate, we excluded its impact on net income and diluted EPS for fiscal 2018 to arrive at our non-GAAP financial measures.
The reconciliations of net income and diluted EPS to non-GAAP net income and non-GAAP diluted EPS were calculated as follows:
July 31,
2020 2019 2018
Net income/Diluted EPS, as reported $ 13,708 $ 0.32
24,944 0.59 16,021 0.38 13,267 0.32
Acquisition-related items, net of tax(2) 22,564 0.54 9,689 0.23 2,835 0.07
Restructuring-related charges, net of tax(3) 16,626 0.39 18,015 0.43 4,658 0.11
Non-cash interest, net of tax(4) 2,220 0.05 - - - -
Litigation matters, net of tax(1) - - 134 - 1,637 0.04
Loss on debt extinguishment, net of tax(4) - - - - 91 -
Gain on disposition of business, net of tax(5) 95 - - - - -
Loss on disposition of product line, net of
tax(1) - - (943) (0.02) - -
Resolution of contingent liability(5) - - - - (1,138) (0.03)
Excess tax benefits(6) 559 0.01 (584) (0.01) (2,173) (0.05)
Tax matters(6) (10,864) (0.25) 1,625 0.04 (5,872) (0.13)
Non-GAAP net income/Non-GAAP diluted EPS
$ 98,999 $ 2.37 $ 104,346 2.51
________________________________________________
(1)Amounts were recorded in general and administrative expenses. (2)In fiscal 2020, pre-tax acquisition-related items of$20,121 were recorded in cost of sales and$9,978 were recorded in general and administrative expenses. In fiscal 2019, pre-tax acquisition-related items of$351 were recorded in net sales,$537 were recorded in cost of sales and$12,241 were recorded in general and administrative expenses. In fiscal 2018, pre-tax acquisition-related items of$893 were recorded in cost of sales and$3,154 were recorded in general and administrative expenses. (3)In fiscal 2020, pre-tax restructuring-related items of$6,490 were recorded in cost of sales and$16,092 were recorded in general and administrative expenses. In fiscal 2019, pre-tax restructuring-related items of$2,243 were recorded in cost of sales,$21,507 were recorded in general and administrative expenses and$1,305 were recorded in other income, net. In fiscal 2018, pre-tax restructuring-related items of$1,517 were recorded in cost of sales and$3,814 were recorded in general and administrative expenses (4)Amounts were recorded in interest expense, net. (5)Amounts were recorded in other income. (6)Amounts were recorded in income taxes. 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 have on net income. In particular, acquisitions have historically resulted in significant increases in amortization of purchased intangible assets that reduce net income. Additionally, we regard EBITDAS as a useful measure of operating
(dollar amounts in thousands except share and per share data or as otherwise specified) 30
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K
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 non-GAAP adjustments to
net income discussed above. We use adjusted EBITDAS when evaluating operating
performance because we believe the exclusion of such adjustments, 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:
July 31,
2020 2019 2018
Net income, as reported $ 13,708 $ 55,042 $ 91,041
Interest expense, net 41,355 9,505 5,289
Income taxes (6,756) 20,277 26,472
Depreciation 30,441 21,510 17,473
Amortization 32,961 20,849 17,357
Loss on disposal of fixed assets 1,399 1,592 768
Stock-based compensation expense 12,076 15,562 9,615 EBITDAS 125,184 144,337 168,015 Acquisition-related items(1) 29,187 13,129 4,047
Restructuring-related charges(1) 22,204 18,524 5,001 Litigation matters
- 163 2,345
Loss on disposition of product line 127 - - Gain on disposition of business - (1,305) Resolution of contingent liability - - (1,138) Adjusted EBITDAS$ 176,702 $ 174,848 $ 178,270
________________________________________________
(1)Excludes stock-based compensation expense.
We define net debt as long-term debt (bank debt excluding unamortized debt issuance costs) plus the convertible debt (excluding unamortized debt issuance costs and unamortized discount), less cash and cash equivalents. Each of the components of net debt appears on our consolidated balance sheets and in our notes to the consolidated financial statements included in Part II, Item 8 of this report. 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. (Unaudited) July 31, 2020 July 31, 2019 Long-term debt (excluding debt issuance costs)$ 945,375 $
233,000
Convertible debt (excluding debt issuance costs and discount)
168,000 -
Less cash and cash equivalents (277,871) (44,535)
Net debt $ 835,504 $ 188,465
We define organic sales as net sales less (i) the impact of foreign currency
translation, (ii) net sales related to acquired businesses during the first
twelve months of ownership and (iii) dispositions 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 and dispositions because the nature, size, and number of
acquisitions and dispositions can vary dramatically from period to period and
can obscure underlying business trends and make comparisons of financial
performance difficult.
(dollar amounts in thousands except share and per share data or as otherwise specified) 31
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K
The reconciliation of net sales growth to organic sales growth for total net
sales and net sales of our four reportable segments were calculated as follows:
Medical Life Sciences Dental Dialysis
Net Sales Net Sales Net Sales Net Sales Net Sales
Net sales growth 10.7 % (10.6) % 0.2 % 92.3 % (5.3) %
Impact due to foreign currency
translation (0.4) % (0.6) % (0.1) % - % (0.1) %
Sales related to acquisitions 17.1 % - % (1.7) % 95.5 % - %
Organic sales growth (6.0) % (10.0) % 2.0 % (3.2) % (5.2) %
Liquidity and Capital Resources
We assess our liquidity in terms of our ability to generate cash to fund operating, investing and financing activities. Significant factors affecting the management of liquidity are cash flows generated from operating activities, capital expenditures, acquisitions of businesses and cash dividends. Cash provided by operating activities continues to be a primary source of funds. As necessary, we have supplemented our operating cash flow with borrowings from our revolving credit facility and other financing resources, such as convertible debt, to fund our acquisitions and related business activities.
Cash Flows
Net Cash Provided by Operating Activities. Net cash provided by operating activities increased by$69,926 to$136,857 in fiscal 2020 from$66,931 in fiscal 2019, primarily due to increased cash collections of outstanding accounts receivable, the reduction in inventory levels (excluding acquired Hu-Friedy inventory), a reduction in prepaid expenses and a reduction in cash payments resulting from restructuring-related activities (organizational leadership changes made in fiscal 2019). This was partially offset by lower net income, the timing of vendor payments and cash payments associated with Hu-Friedy acquisition-related and transaction costs incurred during the period. Net cash provided by operating activities decreased by$58,981 to$66,931 in fiscal 2019 from$125,912 in fiscal 2018 primarily due to a decrease in net income (after adjusting for non-cash items) associated with restructuring-related initiatives and acquisition-related costs. In addition, inventory purchases were higher due to the anticipation of our ERP go-live in fiscal 2019 and to continue to support demand in our Medical segment. The timing of receipts associated with accounts receivable and the timing of payments associated with accounts payable (both net of acquisitions) also contributed to this decrease. The timing of collections associated with accounts receivable was primarily driven by the implementation of our ERP system in our Medical segment during the second half of fiscal 2019.Net Cash Used in Investing Activities. Net cash used in investing activities increased by$619,830 to$752,859 in fiscal 2020 from$133,029 in fiscal 2019, primarily due to an increase in cash paid for acquisitions, partially offset by a decrease in capital expenditures. Net cash used in investing activities increased by$7,843 to$133,029 in fiscal 2019 from$125,186 in fiscal 2018, primarily due to an increase in capital expenditures, partially offset by a decrease in cash paid for acquisitions. During fiscal 2020, 2019 and 2018, net cash used in investing activities included capital expenditures of$33,796 ,$95,438 and$37,698 , respectively, which included expenditures for ERP software, building improvements and purchases of manufacturing and computer equipment. Capital expenditures for fiscal 2020 decreased significantly when to compared to fiscal 2019 due to a planned reduction in spending in response to COVID-19, and as a result of the ERP system implementation and the purchase of our Medical segment's new headquarters having been completed in fiscal 2019. Net Cash Provided by Financing Activities. Net cash provided by financing activities increased by$837,968 to$852,670 in fiscal 2020 from$14,702 in fiscal 2019, primarily due to borrowings under our credit agreement made to support the Hu-Friedy acquisition and the issuance of convertible debt, partially offset by the payment of debt issuance costs associated with amending our credit agreement and convertible debt issuance. Net cash used in financing activities increased by$42,435 to$14,702 of cash provided in fiscal 2019 from$57,137 of cash used in fiscal 2018, primarily due to a net decrease in borrowings used to support acquisition-related activity, partially offset by an increase in dividend payments.
Dividends
During fiscal 2020, we paid a semi-annual cash dividend of$0.105 per outstanding share of common stock onJanuary 31, 2020 . Certain amendments made to our credit agreement temporarily limit our ability to pay dividends, and therefore, we did not pay our semi-annual cash dividend onJuly 31, 2020 . During fiscal 2019, we paid semi-annual cash dividends that totaled$0.20 per outstanding share of common stock, of which$0.10 per share was paid on each ofJanuary 31 ,
(dollar amounts in thousands except share and per share data or as otherwise specified) 32
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K 2019 andJuly 31, 2019 . Future declaration of dividends and the establishment of future record and payment dates are subject to the final determination of our Board of Directors and are subject to restrictions in our credit agreement discussed below.
Debt
OnJune 28, 2018 , we entered into a Fourth Amended and Restated Credit Agreement (the "2018 Credit Agreement"). The 2018 Credit Agreement refinanced our credit facility under the Third Amended and Restated Credit Agreement datedMarch 4, 2011 , to include a$200,000 tranche A term loan and a$400,000 revolving credit facility. The 2018 Credit Agreement was set to expire onJune 28, 2023 .
First Amendment to Credit Agreement
OnSeptember 6, 2019 , we entered into a First Amendment (the "First Amendment"), amending our Fourth Amended and Restated Credit Agreement. The First Amendment added a$400,000 delayed draw term loan facility (the "Delayed Draw Facility"), in addition to the existing tranche A term loan and existing revolving credit facility. The Delayed Draw Facility and a portion of the revolving credit facility were used to finance a portion of the cash consideration for our acquisition of Hu-Friedy. The remaining proceeds were used to refinance certain existing indebtedness of Cantel and Hu-Friedy, and to pay the fees and expenses incurred in connection therewith, as well as for working capital, capital expenditures and other corporate purposes.
Second Amendment to Credit Agreement
OnMay 11, 2020 , we entered into a Second Amendment (the "Second Amendment") further amending the Fourth Amended and Restated Credit Agreement (as amended, the "Amended Credit Agreement"). The Second Amendment's principal changes include (i) increasing the maximum consolidated leverage ratio covenant for the fiscal quarter endedApril 30, 2020 from 4.25x to 5.25x, (ii) suspending such financial maintenance covenant untilOctober 31, 2021 , (iii) maintaining a minimum liquidity (as defined in the Amended Credit Agreement) of at least$50,000 during the fiscal quarter endedJuly 31, 2020 and$75,000 during each of the following fiscal quarters ending with the fiscal quarter endingJuly 31, 2021 , (iv) requiring us to maintain minimum consolidated EBITDA (as defined in the Amended Credit Agreement) for each period of four fiscal quarters ending on the last day of the fiscal quarters endedJuly 31, 2020 throughJuly 31, 2021 and (v) limiting our ability to pay dividends and repurchase shares of our common stock during the period the consolidated leverage ratio and consolidated interest coverage ratio are suspended. We did not pay our semi-annual cash dividend onJuly 31, 2020 . Pursuant to the Amended Credit Agreement, subject to the satisfaction of certain conditions precedent, including the consent of the lenders, we may from time to time increase our borrowing capacity under the revolving credit facility by, or incur incremental term loans in, an aggregate amount not to exceed the sum of (i) the greater of (x)$300,000 or (y) an amount equal to two times our consolidated EBITDA (as defined in the Amended Credit Agreement), calculated on a pro forma basis, plus (ii) the aggregate principal amount of voluntary prepayments of the revolving loans and term loans, minus the aggregate principal amount of certain incremental secured indebtedness otherwise incurred. The interest rates have been amended so that loans under the Amended Credit Agreement, until the third business day following the date on which a compliance certificate is delivered for the fiscal quarter endingOctober 31, 2021 , bear interest at 2.00% above the base rate for base rate borrowings, or at 3.00% above LIBOR for LIBOR-based borrowings, and also provides for fees on the unused portion of the revolving credit facility at a rate of 0.50%. Thereafter, borrowings bear interest at rates ranging from 0.00% to 1.75% above base rate for base rate borrowings, or at rates ranging from 1.00% to 2.75% above LIBOR for LIBOR-based borrowings, depending on our consolidated leverage ratio, which is the consolidated ratio of total funded debt (minus certain unrestricted cash) to consolidated EBITDA (as defined in the Amended Credit Agreement). The Amended Credit Agreement also provides for fees on the unused portion of the revolving credit facility at rates ranging from 0.20% to 0.50%, depending on our consolidated leverage ratio. Interest rates have also been amended to include a 1.00% floor on all borrowings. As ofJuly 31, 2020 , the average interest rate on our outstanding borrowings was approximately 4.00%. The Amended Credit Agreement contains affirmative and negative covenants reasonably customary for similar credit facilities and is secured by (i) substantially all assets of Cantel and itsU.S. -based subsidiaries, (ii) a pledge by Cantel and itsU.S. -based subsidiaries that guarantees the obligations under the Amended Credit Agreement of all of the outstanding shares of itsU.S. -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.
(dollar amounts in thousands except share and per share data or as otherwise specified) 33
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K We were in compliance with all financial and other covenants under the Amended Credit Agreement atJuly 31, 2020 . For further information regarding the Amended Credit Agreement, including a description of affirmative and negative covenants, see Note 11 to our consolidated financial statements in Part II, Item 8 of this report. Based on our current estimates regarding the magnitude and length of the disruptions to our business, we do not anticipate the COVID-19 disruptions to our business will impact our ability to maintain compliance with our debt covenants for at least the next 12 months. However, the ultimate magnitude and length of time that the disruptions from COVID-19 will continue is highly uncertain. See Item 1A. "Risk Factors" for further information of the risks associated with the compliance of our Amended Credit Agreement.
Convertible Notes
OnMay 15, 2020 , we issued$168,000 aggregate principal amount of 3.25% convertible senior notes due 2025 (the "Notes") in a private placement, including pursuant to the grant to the initial purchasers of$140,000 aggregate principal amount of the Notes, an option to purchase up to an additional$28,000 aggregate principal amount of Notes. The private placement offering closed onMay 15, 2020 . The initial conversion price is$41.51 per share of common stock (based on an initial conversion rate of 24.0912 shares of common stock per$1,000 principal amount of Notes) and will be subject to adjustment if certain events occur. The net proceeds from this offering were approximately$162,977 (including net proceeds relating to the issuance of the additional Notes), after deducting the initial purchasers' discount and before the cost of offering expenses. As required by the Amended Credit Agreement, we were required to apply at least 50% of the amount by which the net proceeds exceeded$100,000 , or$31,500 , to the repayment of debt under our credit facilities in fiscal 2020. We intend to use the remaining proceeds for general corporate purposes.
Financing Needs
AtJuly 31, 2020 , our total debt (excluding debt issuance costs and unamortized discount) of$1,113,375 , net of our cash and cash equivalents of$277,871 , was$835,504 . Stockholders' equity as of that date was$729,599 . Our reportable segments generate significant cash from operations. AtJuly 31, 2020 , we had a cash balance of$277,871 , of which$64,381 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 indefinitely reinvested and unavailable for repatriation. We believe that our current cash position, including the proceeds we received as part of the Notes offering inMay 2020 , and our anticipated cash flows from operations in the upcoming quarters as we recover from the COVID-19 pandemic 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. AtSeptember 25, 2020 , approximately$75,000 was available under our Amended Credit Agreement.
Inflation
Although overall inflation did not have a significant effect on our business, an increase in commodity prices can adversely affect our gross margins. Specifically, our businesses can be adversely impacted by rising fuel and oil prices and are heavily reliant on certain raw materials, such as chemicals, paper, resin, stainless steel and plastic components. From time to time, we experience price increases for raw materials. If we are unable to implement price increases to our customers, our gross margin could be adversely affected.
(dollar amounts in thousands except share and per share data or as otherwise specified) 34
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K
Commitments and Contractual Obligations
As ofJuly 31, 2020 , aggregate annual required payments over the next five years and thereafter under our contractual obligations that have long-term components are as follows: Year Ended July 31, 2021 2022 2023 2024 2025 Thereafter Total Maturity of the credit facility$ 7,375 $ 29,500 $ 29,500 $ 29,500 $ 849,500 $ -$ 945,375 Expected interest payments under the credit facility 48,715 47,978 46,798 45,618 10,665 - 199,774 Convertible debt - - - - 168,000 - 168,000 Operating lease obligations 10,938 8,976 7,903 6,739 5,011 11,279 50,846 Capital lease obligations 1,446 1,432 1,425 1,434 1,422 922 8,081 Other long-term obligations(1) 547 1,323 1,156 224 49 1
3,300
Total contractual obligations
_______________________________________________
(1)Includes uncertain tax positions
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe 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. Our significant accounting policies are described more fully in Note 2 to our consolidated financial statements in Part II, Item 8 of this report. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
We have recorded goodwill, trademarks, trade names and brand names, all of which have indefinite useful lives and are therefore not amortized. All of our indefinite-lived intangible assets and goodwill are reviewed for impairment 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. Our management is responsible for determining if impairment exists and considers a number of factors, including third-party valuations, when making these determinations. 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 our 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 and earnings 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. As a result of the COVID-19 pandemic and the impact to our sales volume and related income from operations within our Dental reporting unit, our share price decline, as well as the general uncertainty and volatility in the economic environments in which we operate, we engaged a third-party valuation firm to perform quantitative interim goodwill and indefinite-lived intangible asset impairment tests as ofApril 30, 2020 , as summarized below.Goodwill . In estimating the Dental reporting unit's fair value, we performed an extensive valuation analysis, utilizing both income and market-based approaches. The determination of the fair value of the Dental reporting unit requires us to make
(dollar amounts in thousands except share and per share data or as otherwise specified) 35
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K significant estimates and assumptions that affect the reporting unit's expected future cash flows. These estimates and assumptions, utilizing Level 3 inputs, primarily include, but are not limited to, market multiples, control premiums, the discount rate, terminal growth rates, operating income before depreciation and amortization, and capital expenditures forecasts. As a result of this analysis, we have determined that the fair value of our Dental reporting unit was in excess of its carrying value as ofApril 30, 2020 , by approximately$153,000 , or 15.2%. From a sensitivity perspective, if the discount rate used for the Dental reporting unit had been hypothetically increased by 100 basis points, the Dental reporting unit's fair value would approximate its carrying value. During the fourth quarter of fiscal 2020, we updated our quantitative analysis. The fair value of our Dental reporting unit was in excess of its carrying value by approximately$133,000 , or 13.2%. In addition, if our analysis in the future indicates additional unfavorable impacts related to the ongoing COVID-19 pandemic, an increase in discount rates, or a degradation in the overall markets served by our Dental reporting unit, it could result in an impairment of the carrying value of goodwill to its implied fair value. There can be no assurance that our future goodwill impairment testing will not result in a charge to earnings. Indefinite-lived Intangible Assets. We base our measurement of fair value of our Dental reporting unit's indefinite-lived intangible assets, which primarily consist of the Hu-Friedy brand name, using the relief-from-royalty method. This method assumes that the brand or trade name and trademarks have value to the extent that their owner is relieved of the obligation to pay royalties for the benefits received from them. The fair value determination of the brand name intangible assets required us to make significant estimates and assumptions related to forecasted future cash flows, including the selection of customer attrition rates, royalty rates, terminal growth rates, and discount rates. As a result of this analysis, we have determined that the fair value of the indefinite-lived intangible assets were in excess of their respective carrying value as ofApril 30, 2020 . From a sensitivity perspective, if the discount rate had been hypothetically increased by 100 basis points atApril 30, 2020 , the fair value of these indefinite-lived intangible assets would still exceed their respective carrying value. In addition, if our analysis in the future indicates additional unfavorable impacts related to the ongoing COVID-19 pandemic, an increase in discount rates, or a degradation in the use of the trade names and trademarks, it could result in an impairment of the carrying value of the indefinite-lived intangible assets to their implied fair value. There can be no assurance that our future indefinite-lived intangible asset impairment testing will not result in a charge to earnings. Given the proximity of our annual impairment assessment date, along with the gradual recovery we noted in our Dental reporting unit's performance during the fourth quarter of fiscal 2020 at a level that exceeded our previous expectations, we did not perform an additional quantitative impairment assessment atMay 1, 2020 , rather we qualitatively evaluated the Dental reporting unit goodwill and indefinite-lived intangible assets for impairment and concluded that it was not more likely than not that the fair value of goodwill and indefinite-lived intangible assets were less than their respective carrying values at the annual impairment assessment date.
Business Combinations
Acquisitions require significant estimates and judgments related to the fair value of assets acquired and liabilities assumed. We determine fair value based on the estimated 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. Such initial fair value amounts as well as other acquired assets and liabilities, including deferred tax assets and liabilities, are sometimes refined requiring subsequent adjustments. Certain liabilities and reserves are subjective in nature. We reflect such liabilities and reserves based upon the most recent information available. In conjunction with our acquisitions, such subjective liabilities and reserves principally include contingent consideration, certain deferred income tax liabilities, income tax and sales and use tax exposures, including tax liabilities related to our foreign subsidiaries, as well as reserves for accounts receivable, inventories, warranties and contingent obligations. We account for contingent consideration relating to business combinations as a liability and an increase to goodwill at the date of the acquisition and continually re-measure the liability at each balance sheet date by recording changes in the fair value through our consolidated statements of income. We determine the fair value of contingent consideration based on future operating projections under various potential scenarios and weight the probability of these outcomes. Similarly, other acquisition-related liabilities can be required to be recorded at fair value at the date of the acquisition and continually re-measured at each balance sheet date. The ultimate settlement of liabilities relating to business combinations may be for amounts which are materially different from the amounts initially recorded and may cause volatility in our results of operations. We allocate the purchase price of an acquired company to the tangible and identifiable intangible assets and liabilities acquired, with the remaining amount being recorded as goodwill. Intangible assets primarily include customer relationships, technology, brand names and trademarks. The assignment of fair value to the identifiable intangible assets requires judgment. We apply an income-based valuation methodology in measuring the customer relationships acquired, which include certain
(dollar amounts in thousands except share and per share data or as otherwise specified) 36
--------------------------------------------------------------------------------
Cantel Medical Corp. 2020 Annual Report on Form 10-K assumptions such as forecasted future cash flows, customer attrition rates, terminal growth rates and discount rates. Intangible assets are generally amortized on a straight-line basis, reflecting the pattern in which the economic benefits are consumed, and are amortized over their estimated useful lives. We utilize the relief-from-royalty method to determine the fair value of acquired brand names in a business combination. This method assumes that the brand or trade name and trademarks have value to the extent that their owner is relieved of the obligation to pay royalties for the benefits received from them. Off-balance Sheet Arrangements
As of
Recent Accounting Pronouncements
Refer to Note 2 to the consolidated financial statements in Part II, Item 8 of this report.
Cybersecurity We have established an enterprise risk management committee to monitor and escalate enterprise level issues, including cybersecurity matters, to the appropriate management levels within our organization and to members of our Board of Directors as appropriate. Utilizing an escalation framework, our enterprise risk management committee and internal auditor are charged with reviewing cybersecurity risks and incidents for potential financial, operational, and reputational risks. Matters determined to present potential material impacts to our financial results, operations or reputation are reported by management to the chair of our Audit Committee. In addition, the enterprise risk committee is charged with ensuring that management responsible for overseeing the effectiveness of disclosure controls is informed in a timely manner of known cybersecurity risks and incidents that may materially impact our operations so that timely public disclosure can be made as appropriate. Our directors and executive officers are subject to our Securities Trading Policy, which is designed to facilitate compliance with insider trading laws and governs transactions in our common stock and related derivative securities. Our Stock Trading Policy designates certain blackout periods, dictated by our financial quarters and the release of financial results, during which trading is restricted for individuals in information-sensitive positions, including directors and executive officers. Our Stock Trading Policy also expressly restricts trading at any time while in possession of material non-public information, and permits designated officers to impose additional blackout periods. Cybersecurity risks are one of several matters that may be deemed material information under our Stock Trading Policy, and therefore form the basis of restricting participation in the market outside of a blackout period, or for designating a blackout period.
© Edgar Online, source
