Cantel Medical (CMD) 10-Q2021 Q1 Quarterly report

 

 

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

 

 

Number of shares of common stock outstanding as of November 30, 2020: 42,244,649.

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.

Cantel is a leading provider of infection prevention products and services in the healthcare market, specializing in the following reportable segments: Medical, Life Sciences, Dental and Dialysis. See Note 15, “Reportable Segments.” Most of our equipment, consumables and supplies are used to help prevent the occurrence or spread of infections.

The unaudited Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) 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 GAAP 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. on Form 10-K for the fiscal year ended July 31, 2020 (the “2020 Annual Report on 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, 2020 was derived from the audited Consolidated Balance Sheet of Cantel at that date. Certain prior year amounts have been reclassified to conform to the current year presentation.

In March 2020, the World Health Organization categorized the novel Coronavirus disease 2019, or (COVID-19) as a pandemic. We are subject to risks and uncertainties as a result of the COVID-19 pandemic. Considerable uncertainty still surrounds the COVID-19 virus and its potential effects, and the extent of and effectiveness of responses taken on international, national and local levels. Measures taken to limit the impact of COVID-19, including shelter-in-place orders, social distancing measures, travel bans and restrictions, and business and government shutdowns, continue to create significant negative economic impacts on a global basis. The extent of the impact of the COVID-19 pandemic on our business remains uncertain and difficult to predict, as the response to the pandemic continues to evolve.

During the second half of fiscal 2020, the COVID-19 pandemic negatively impacted net sales and the related operations of both our Medical and Dental segments as a result of the postponement of elective medical procedures and routine dental procedures. Towards the end of fiscal 2020, we experienced gradual improvements in these respective businesses as restrictions were lifted and limitations eased. In the first quarter of fiscal 2021, patient procedure volume trends have improved as demand for both medical and dental procedures have increase during this period.

While we currently expect to see improvement in the remainder of fiscal 2021, the effects of the COVID-19 pandemic remains fluid and continues to evolve differently across various geographies. We believe it is likely to continue to experience unexpected impacts on our business due to the resurgence of the virus occurring in cities across the globe.

In preparing the Condensed Consolidated Financial Statements, management is required to make estimates and assumptions, including estimates and assumptions specific to any impact that the COVID-19 pandemic will have on our operations and cash flows. The estimates and assumptions used by management affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements, and the reported amounts of net sales and expenses during the reporting periods. Changes to estimates related to the COVID-19 disruptions could result in other impacts, including but not limited to goodwill and long-lived asset impairment charges, inventory write downs and bad debt expense. Actual results could differ from these estimates and the differences could be material. If historical experience and other factors used by management to make these estimates do not reasonably reflect future activity, our results of operations, financial position and cash flows could be adversely impacted.

We performed a review of events subsequent to October 31, 2020 through the date of issuance of the accompanying unaudited consolidated interim financial statements.

In August 2018, the FASB issued ASU 2018-13, “Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”) to modify the disclosure requirements on fair value measurements in ASC 820, “Fair Value Measurement.” ASU 2018-13 is effective for fiscal years beginning after December 15, 2019 (our fiscal year 2021), including interim periods within that reporting period. We adopted ASU 2018-13 on August 1, 2020. The adoption of ASU 2018-13 did not have a material impact on our financial position, results of operations or cash flows.

In January 2017, the FASB issued ASU 2017-04, “(Topic 350) Simplifying the Test for Goodwill Impairment,” (“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 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. 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, 2019 (our fiscal year 2021) and early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We adopted ASU 2017-04 on August 1, 2020. The adoption of ASU 2017-04 did not have a material impact on our financial position, results of operations or cash flows.

In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments,” (“ASU 2016-13”) to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendments in this ASU replace the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019 (our fiscal year 2021). We adopted ASU 2016-13 on August 1, 2020. The adoption of ASU 2016-13 did not have a material impact on our financial position, results of operations or cash flows.

 

The following pro forma summary of operations presents our operations as if the Hu-Friedy acquisition had occurred as of the beginning of fiscal 2019. In addition to including the results of operations of this acquisition, the pro forma information gives effect to amortization of the step-up in inventory, depreciation of the step-up in property and equipment, the interest on additional borrowings, the amortization of intangible assets and the issuance of shares of common stock. On an actual basis, the

Hu-Friedy acquisition contributed $60,806 and $18,725 to our consolidated net sales for the three months ended October 31, 2020 and 2019 respectively.

The pro forma information presented above does not purport to be indicative of the results that actually would have been attained had the Hu-Friedy acquisition occurred as of the beginning of fiscal 2019.

At October 31, 2020, 763,315 nonvested restricted stock awards were outstanding under the 2016 plan. NaN options were outstanding under the 2016 plan. At October 31, 2020, 51,760 shares were collectively available for issuance pursuant to restricted stock and other stock awards, stock options and stock appreciation rights.

The following table shows the components of stock-based compensation expense recognized in the condensed consolidated statements of income:

At October 31, 2020, total unrecognized stock-based compensation expense related to total nonvested stock options and restricted stock awards was $36,996 with a remaining weighted average period of 21 months over which such expense is expected to be recognized.

We determined the fair value of our market-based restricted stock awards using a Monte Carlo simulation on the date of grant using the following assumptions:

A summary of nonvested stock award activity for the three months ended October 31, 2020 is as follows:

A summary of stock option activity for the three months ended October 31, 2020 is as follows:

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. For the three months ended October 31, 2020, income tax deductions of $1,698 were generated, of which $2,778 was recorded as a reduction in income tax expense over the equity awards’ vesting period and the remaining excess tax expense of $1,080 was recorded as an increase in income tax expense. For the three months ended October 31, 2019, income tax deductions of $2,022 were generated, of which $2,581 were recorded as a reduction in income tax expense over the equity awards’ vesting period and the remaining excess tax expense of $559 was recorded as an increase to income tax expense.

The following table gives information as to the net sales disaggregated by geography and product line:

At October 31, 2020, the estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied (or partially unsatisfied) was approximately $81,556, primarily within the Medical segment. We expect to recognize revenue on approximately 70% of these remaining performance obligations over the remainder of fiscal 2021 and fiscal 2022. These performance obligations primarily reflect the future product service revenues for multi-period service arrangements.

A summary of contract liabilities activity follows:

Our contract liabilities arise primarily in the Medical and Life Sciences segments when payment is received upfront for various multi-period extended service arrangements. We expect to recognize substantially all of this revenue over the next twelve months.

We adopted ASC 842, effective August 1, 2019, using the modified retrospective transition approach with optional transition relief, and recognized the cumulative effect of applying the new leasing standard to existing contracts on our condensed consolidated balance sheet on August 1, 2019. Our lease portfolio consists primarily of real estate, equipment and vehicles. We have approximately 90 real estate leases with lease terms ranging from 1 year to 16 years, which include our corporate headquarters, regional headquarters, and other facilities for sales and administration, warehousing, manufacturing and training. Our equipment leases primarily consist of furniture, computers and other office equipment.

Supplemental balance sheet information related to our leases follows:

At October 31, 2020, maturities of lease liabilities for the periods set forth below were as follows:

Supplemental income statement information related to our leases follows:

Supplemental cash flow information related to leases follows:

_______________________________________________

In order to hedge against the impact of fluctuations in the value of the Euro, British Pound, Canadian dollar, Australian dollar, Singapore dollar and Chinese Renminbi relative to the U.S. dollar on the conversion of such net assets into the functional currencies, we enter into short-term forward contracts to purchase or sell Euros, British Pounds, Canadian dollars, Australian dollars, Singapore dollars and Chinese Renminbi, which contracts are one-month in duration. These short-term contracts are designated as fair value hedge instruments. There were 6 foreign currency forward contracts with an aggregate notional value of $63,836 and $81,677 at October 31, 2020 and July 31, 2020, respectively, which covered certain assets and liabilities that were denominated in currencies other than each entity’s functional currency. For the three months ended October 31, 2020 and 2019, the settlements of our forward contracts resulted in immaterial amounts of currency conversion gains and losses on the hedged items in the aggregate.

In order to hedge against the impact of fluctuations in the interest rate associated with our variable rate borrowings, in fiscal 2019, we entered into 2 interest rate swaps with a combined notional value of $150,000, expiring on June 28, 2023. The swaps fixed interest rates at 2.265%. In March 2020, we terminated our existing interest rate swaps and entered into a new interest rate swap (the “March 2020 Swap”) with a notional value of $500,000, which fixed interest rates at 1.297% and was set to expire on September 6, 2024. As the original forecasted hedged transactions (interest payments on variable rate debt) are still probable to occur, the $8,534 net loss related to the terminated swaps reported in accumulated other comprehensive income on the termination date will be amortized to interest expense through June 28, 2023, the original maturity date of the swaps.

On May 13, 2020, in connection with the Second Amendment to our credit agreement, we terminated the March 2020 Swap and entered into a new interest rate swap (the “May 2020 Swap”) with a notional value of $500,000, which included a LIBOR floor of 1.00%, fixed interest rates at 2.08% and will expire on September 6, 2024. As the original forecasted hedged transactions related to the March 2020 Swap (interest payments on variable rate debt) are still probable to occur, the $19,980 net loss related to the terminated swaps reported in accumulated other comprehensive income on the termination date will be amortized to interest expense through September 6, 2024, the original maturity date of the swap. The new interest rate swap reflects the 1.00% LIBOR floor included in the Amended Credit Agreement, which allows for continued hedge accounting treatment. Changes in the fair value of the amended interest rate swap contract will continue to be recognized in other comprehensive income.

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.

The fair value of the interest rate swaps, all of which qualify for cash flow hedge accounting, is recorded on our condensed consolidated balance sheet as an asset or liability with the related gains or losses reported as a component of accumulated other comprehensive income. The changes in fair value are reclassified from accumulated other comprehensive income into earnings in the same period that the hedged items affect earnings. The valuation technique used to determine fair value is the income approach. Under this approach, we use projected future interest rates, which fall into Level 2 of the fair value hierarchy as

defined by ASC 820, as provided by counterparties to the interest rate swap agreements and the fixed rates that we are obligated to pay under the agreements. See Note 8, “Derivatives” for additional information.

For the Hu-Friedy acquisition, additional purchase price payments were (i) contingent upon the achievement of certain commercial milestones through March 31, 2021, 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. We estimated the aggregate fair value of these contingent consideration arrangements to be $38,371 at the date of acquisition, which was reported separately in our consolidated balance sheet. For the contingent consideration arrangements based upon the achievement of certain commercial milestones, the initial value assigned at the date of acquisition was determined on the basis of forecasted sales and gross profit percentage of Hu-Friedy products over the next twelve to eighteen months. During the second quarter of fiscal 2020, we paid $25,000 to settle a portion of this contingent consideration arrangement related to net sales achieved for the twelve month period ended December 31, 2019. 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 $0 due to the impact of the COVID-19 pandemic on Hu-Friedy’s current and expected performance.

For the contingent consideration arrangement based upon changes in our common stock price through a future date, we were required to pay to the sellers of Hu-Friedy an amount in cash equal to $35,000 minus the aggregate net proceeds received by the seller in connection with a future equity issuance if the amount of such aggregate net proceeds was less than $35,000. The initial fair value assigned to this contingent consideration arrangement was determined based on the closing price of our common stock at the date that the acquisition closed (October 1, 2019) relative to the contracted stock price stipulated in the purchase agreement. On February 13, 2020, we entered into a stock repurchase agreement with Dental Holding LLC, the former owners of Hu-Friedy (the “Repurchase Agreement”). The Repurchase Agreement amended the Hu-Friedy purchase and sale agreement and the related registration rights agreement to provide that we repurchase a portion of the shares from the seller included in the equity consideration transferred at a price per share of $64.51 (the “Repurchase”), which equals the closing price of shares of our common stock traded on the New York Stock Exchange on February 12, 2020. The Repurchase of 438,359 common shares was completed on February 13, 2020, and the shares were thereafter canceled and retired. The Hu-Friedy purchase and sale agreement further required us to pay to the seller an amount in cash equal to $35,000 minus the aggregate net proceeds received by the seller from an equity issuance if the amount of such aggregate net proceeds was less than $35,000 (the “True-Up Obligation”). The Repurchase Agreement further amended the purchase and sale agreement to provide that in satisfaction of the True-Up Obligation, we make a payment to the sellers in an amount equal to $6,721 to settle the contingent obligation, which amount equals $35,000 minus the aggregate amount of $28,279 paid to Dental Holding as consideration for the Repurchase. These payments were made to Dental Holding on February 13, 2020.

We are required to reassess the fair value of contingent consideration payments on a periodic basis. Although we believe our assumptions are reasonable, different assumptions or changes in the future may result in different estimated amounts.

The fair values of our financial instruments measured on a recurring basis were categorized as follows:

At October 31, 2020 and July 31, 2020, 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 estimate the fair value of our convertible debt carried at face value less unamortized discount and issuance costs on a quarterly basis for disclosure purposes. The estimated fair value of our convertible debt is determined by Level 2 inputs and is based on observable market data including prices for similar instruments. At October 31, 2020 and July 31, 2020, the fair value of our convertible debt was $226,066 and $224,330, respectively.

Our intangible assets consist of the following:

Amortization expense related to intangible assets was $8,918 and $6,029 for the three months ended October 31, 2020 and 2019, respectively. We expect to recognize an additional $26,434 of amortization expense related to intangible assets for the remainder of fiscal 2021, and thereafter $34,912, $33,641, $32,742, $29,985 and $28,260 of amortization expense for fiscal years 2022, 2023, 2024, 2025 and 2026, respectively.

Goodwill changed during the three months ended October 31, 2020 as follows:

On September 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.

On May 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 ended April 30, 2020 from 4.25x to 5.25x, (ii) suspending such financial maintenance covenant until October 31, 2021, (iii) maintaining a minimum liquidity (as defined in the Amended Credit Agreement) of at least $50,000 during the fiscal quarter ended July 31, 2020 and $75,000 during each of the following fiscal quarters ending with the fiscal quarter ending July 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 ended July 31, 2020 through July 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.

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 ending October 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. 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 of October 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 its U.S.-based subsidiaries, (ii) a pledge by Cantel and its U.S.-based subsidiaries that guarantees the obligations under the Amended Credit Agreement of all of the outstanding shares of its U.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. As of October 31, 2020, we were in compliance with all financial covenants under the Amended Credit Agreement.

During the three months ended October 31, 2020, we were not required to make loan A principal payments. The tranche A term loan is subject to principal amortization, with $7,375 due and payable in the fourth quarter of fiscal 2021, $29,500 due and payable in each of fiscal 2022, 2023 and 2024, with the remaining $450,500 due and payable at maturity on September 6, 2024. During the three months ended October 31, 2019, we made principal payments of $2,375. During the three months ended

October 31, 2020, we repaid $75,000 of the revolving credit facility under the Amended Credit Agreement. In November 2020, we repaid an additional $50,000 of borrowings under our revolving credit facility.

On May 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 on May 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 exceed $100,000, or $31,500, to the repayment of debt under our credit facilities in fiscal 2020.

Due to the cash conversion feature included in the Notes, the carrying value of the Notes was allocated between a liability and an equity component. Upon issuance, the liability component of the convertible debt was $123,346, net of a $40,289 discount and net of debt issuance costs of $4,365. The initial carrying value of the equity component recorded in additional paid-in-capital was $29,184, net of a $10,072 deferred tax liability, $1,377 of debt issuance costs and a $344 deferred tax asset. The $40,289 debt discount and $4,365 of debt issuance costs are amortized as non-cash interest expense over the contractual term of the convertible debt using the effective interest method, at a rate of 9.36%. Cash interest for the three months ended October 31, 2020 was $1,365.

As further described in Note 1 “Basis of Presentation,” the magnitude and depth of disruption to our business resulting from the COVID-19 pandemic continue to remain highly uncertain. However, based on our current estimates, we do not anticipate these disruptions will impact our ability to maintain compliance with our debt covenants through the end of fiscal 2021.

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.

In connection with our response to COVID-19, our ongoing efforts to streamline and consolidate our global operations and integrate the Hu-Friedy acquisition with our legacy Dental business, we have incurred approximately $5,592 and $5,428 of restructuring-related charges in each of the three months periods ended October 31, 2020, and 2019, respectively. The majority of these charges consisted of onetime benefit-related costs (severance, accelerated stock-based compensation costs and other benefit costs) associated with actions taken to reduce headcount. At October 31, 2020 and July 31, 2020, $8,468 and $7,887 was included in compensation payable on our condensed consolidated balance sheet. For the three months ended October 31, 2020, we made $5,011 of severance-related cash payments. The remaining unpaid severance at October 31, 2020, will be paid out ratably during the remainder of fiscal 2021 and into fiscal 2022 in accordance with our employee separation policy.

Basic earnings per common share (“EPS”) is computed based upon the weighted average number of common shares outstanding for the year. Diluted EPS is computed based upon the weighted average number of common shares outstanding for 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. As we expect to settle the principal amount of our outstanding convertible debt in cash and any excess in shares of our common stock, we use the treasury stock method for calculating any potential dilutive effect of the conversion spread on diluted earnings per share, if applicable. The conversion spread will have a dilutive impact on diluted earnings per share of common stock when the average market price of our common stock for a given period exceeds the conversion price of $41.51 per share. Our convertible debt is further described in Note 11, “Financing Arrangements.”

We include participating securities (nonvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents) in the computation of EPS pursuant to the two-class method. Our participating securities consist solely of nonvested 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.

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

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

Our reportable segments are as follows:

 

 

No customer accounted for 10% or more of our consolidated net sales for the three months ended October 31, 2020 and 2019.

Information as to reportable segments is summarized below