Acquisitions

3 Months Ended

Oct. 31, 2011

Acquisitions

Acquisitions

Note 3.                   Acquisitions

Byrne Medical, Inc. Disposable Endoscopy Products Business

On August 1, 2011 our Minntech subsidiary acquired the business and substantially all of the assets of Byrne Medical, Inc. (“BMI”), a privately owned, Texas-based company that designs, manufactures and sells an innovative array of disposable infection control products intended to eliminate the challenges associated with proper cleaning and sterilization of numerous reusable components used in gastrointestinal (GI) endoscopy procedures.  Excluding acquisition-related costs of $1,099,000 (of which $626,000 and $473,000 was recorded in general administrative expenses in the three months ended October 31, 2011 and fiscal 2011, respectively) we paid an aggregate purchase price of $100,000,000 (which price is potentially subject to a net asset value adjustment), comprised of $90,000,000 in cash and $10,000,000 in shares of Cantel common stock that is subject to both a multi-year lock-up and three-year price floor (described below). The stock consideration consisted of 401,123 shares of Cantel common stock and was based on the closing price of Cantel common stock on the NYSE on July 29, 2011 ($24.93). In addition there is up to a $10,000,000 potential cash contingent consideration payable to BMI over two years based on the achievement by the acquired business of certain targeted amounts of gross profit. A portion of the purchase price (including the stock consideration) was placed in escrow as security for indemnification obligations of BMI and its principal stockholder, Mr. Byrne. In addition, we purchased certain land and buildings utilized by the Byrne Medical Business from Byrne Investments LLC, an affiliate of Mr. Byrne, for $5,900,000.

We account for contingent consideration by recording the fair value of contingent consideration as a liability and an increase to goodwill on 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 Condensed Consolidated Statements of Income.  Accordingly, on August 1, 2011 we increased acquisitions payable and goodwill by $2,700,000 to record our initial estimated fair value of the contingent consideration that would be earned over the two years ending July 31, 2013. At October 31, 2011, we remeasured the fair value of the contingent consideration to be $2,800,000 and recorded the $100,000 change in fair value as an increase to acquisitions payable and general and administrative expenses in the Condensed Consolidated Financial Statements.

Subject to certain conditions and limitations, under the price floor referred to above, we agreed that if the aggregate value of the stock consideration is less than $10,000,000 on July 31, 2014, we will pay to BMI in cash or stock (at our option) an amount equal to the difference between $10,000,000 and the then value of the shares (based on the closing price of Cantel common stock on the NYSE on July 31, 2014). This three-year price floor is a free standing financial instrument that we are required to record as a liability at fair value on the date of acquisition and continually re-measure the liability at each balance sheet date by recording changes in the fair value through our Condensed Consolidated Statements of Income. Accordingly, on August 1, 2011 we increased acquisitions payable and goodwill by $3,000,000 to record our initial estimated fair value of the three-year price floor. The fair value of this liability was determined using the Black-Scholes option valuation model. At October 31, 2011, we remeasured the fair value of the price floor to be $2,418,000 and recorded the $582,000 change in fair value as a decrease to both acquisitions payable and general and administrative expenses in the Condensed Consolidated Financial Statements.

Additionally, the $10,000,000 stock portion of the purchase price was measured at fair value, which was determined using put option valuation models, to account for the discount for the multi-year lock up feature that prohibits the sellers of the Byrne Medical Business from trading the 401,123 shares of Cantel common stock during the three or four year lock-up period, which period is dependent upon whether BMI’s principal stockholder is employed by us on August 1, 2014. As a result of our valuation, the fair value of the 401,123 shares was determined to be $7,640,000, of which $7,310,000 was considered purchase price and $330,000 was determined to be compensation expense that will be expensed on a straight-line basis over the minimum lock up period of three years. The determinations of fair value using option-pricing models are affected by our stock price and risk free interest rate as well as assumptions regarding a number of subjective variables, including, but not limited to, the expected stock price volatility of our Common Stock over the expected life of the instrument and the expected dividend yield.

Since we will be continually remeasuring both the contingent consideration liability and the three-year price floor liability at each balance sheet date and recording changes in the respective fair values through our Condensed Consolidated Statements of Income, we will potentially have significant earnings volatility in our future results of operations until the completion of both the two year period relating to the contingent consideration and three year period relating to the price floor.

The components of the purchase price recorded on August 1, 2011, as explained above, consist of the following:

Cash (including purchase of buildings)	$	95,900,000
Fair value of the Cantel common stock with the mult-year lock-up	7,310,000
Total consideration paid at August 1, 2011	103,210,000
Price floor	3,000,000
Contingent consideration	2,700,000
Total purchase price recorded at August 1, 2011	$	108,910,000

In connection with the acquisition, we acquired certain tangible assets including accounts receivable, inventories and equipment and assumed certain liabilities of BMI including trade payables, sales commissions payable and ordinary course business liabilities.

In conjunction with the acquisition of the Byrne Medical Business and the impending expiration of our existing credit facility, we entered into a $150,000,000 Second Amended and Restated Credit Agreement dated as of August 1, 2011 with our senior lenders to fund the cash consideration paid in and the costs associated with the acquisition, as well as to refinance our existing working capital credit facilities, as more fully described in Note 10 to the Condensed Consolidated Financial Statements.

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

	Preliminary
Net Assets	Allocation
Current assets:
Accounts receivable	$	4,303,000
Inventory	4,200,000
Other assets	588,000
Property, plant and equipment	10,233,000
Amortizable intangible assets (lives are a preliminary estimate):
Customer relationships (15-year life)	25,300,000
Trade name (10-year life)	2,200,000
Technology (8-year life)	11,900,000
Non-compete agreement (14 year-weighted-average life)	2,000,000
Other assets	105,000
Current liabilities	(2,277,000		)
Other liabilities	(85,000		)
Net assets acquired	$	58,467,000

There were no in-process research and development projects acquired in connection with the acquisition. The excess purchase price of $50,443,000 was assigned to goodwill. Such goodwill, all of which is deductible for income tax purposes over fifteen years, has been included in our Endoscopy segment.

For the twelve months ended December 31, 2010, BMI’s latest audited fiscal year, BMI generated revenues and gross profit of $34,293,000 and $21,991,000, respectively.

Since the acquisition was completed on the first day of fiscal 2012, the results of operations of the Byrne Medical Business are included in our results of operations for the three months ended October 31, 2011 and are excluded from the three months ended October 31, 2010.  As a result of the acquisition, we changed the name of our reporting segment previously known as Endoscope Reprocessing to Endoscopy. The operations of the Byrne Medical Business are fully included within our Endoscopy segment.

For the three months ended October 31, 2011, the Byrne Medical Business added the following to the Endoscopy segment in our Condensed Consolidated Financial Statements:

	Three Months Ended
	October 31, 2011
Net sales	$	11,492,000
Operating income	$	2,042,000
Identifiable assets (including $10,560,000 of long-lived assets)	$	112,803,000
Capital expenditures	$	277,000
Depreciation and amortization	$	1,204,000

Excluding non-recurring charges directly related to the acquisition, the Byrne Medical Business added $3,079,000 to the segment operating income for the three months ended October 31, 2011. Such non-recurring charges include (i) acquisition-related charges of approximately $626,000 which were recorded in general administrative expenses in the three months ended October 31, 2011 and (ii) a net fair value change of $411,000 to the acquisition date inventory, contingent consideration liability and three year price floor liability as further described above. Additionally, the segment operating income for the three months ended October 31, 2011 excludes debt issuance costs relating to the Second Amended and Restated Credit Agreement of approximately $1,405,000, which is being amortized to interest expense over the life of the credit facilities, and interest expense relating to the borrowings under our credit facilities to fund a significant portion of the purchase price.

The principal reasons for the acquisition of the Byrne Medical Business were as follows: (i) the complementary nature of its infection prevention and control business which further expands our business into hospital and outpatient center-based GI endoscopy; (ii) the addition of a market leading, high margin business in a familiar segment in infection prevention and control; (iii) the increase in the percentage of our net sales derived from recurring consumables; (iv) the expectation that the acquisition increases overall corporate gross margin percentage and will be accretive to our future earnings per share; (v) the belief that the endoscopy market will convert from re-using to disposing of certain components in GI endoscopy; and (vi) the opportunity for us to further expand our business into the design, manufacture and distribution of proprietary products. Such reasons constitute the significant factors that contributed to a purchase price that resulted in recognition of goodwill.

Selected unaudited supplemental pro forma consolidated statements of income data for the three months ended October 31, 2011 and 2010 assuming that the Byrne Medical Business was included in our results of operations as of August 1, 2010 (the beginning of our fiscal 2011) are as follows:

	Three Months Ended
	October 31,
	2011		2010
Net sales	$	93,262,000	$	80,817,000
Net income	$	7,276,000	$	4,746,000
Earnings per share:
Basic	$	0.41	$	0.27
Diluted	$	0.41	$	0.27
Weighted average common shares:
Basic	17,747,000		17,287,000
Diluted	17,933,000		17,394,000

Supplemental pro forma data for the three months ended October 31, 2011 was adjusted to exclude acquisition-related costs of $626,000 and a fair value adjustment charge of $893,000 related to the step-up in the fair value of inventories. The three months ended October 31, 2010 supplemental pro forma data was adjusted to include these amounts. In addition, in order to affect the unaudited pro forma consolidated statement of income data for the three months ended October 31, 2010, the operating results of Cantel for the three months ended October 31, 2010 were consolidated with the operating results of the Byrne Medical Business for the third quarter of its fiscal year ended December 31, 2010 and were further adjusted to include (i) amortization of intangible assets and depreciation and amortization of property and equipment based upon the preliminary appraised fair values and useful lives of such assets, (ii) interest expense including interest on the senior bank debt at an effective interest rate of 2.98% per annum and amortization of new debt issuance costs over the life of the credit facilities, (iii) the elimination of certain expenses unrelated to the acquired assets of the Byrne Medical Business; (iv) the elimination of incentive compensation for the former primary owner in excess of incentive compensation consistent with the terms of his new employment contract; (v) a decrease of $40,000 to general and administrative expense relating to a net change in fair value of the contingent consideration and the three-year price floor solely to reflect the passage of time (the three months ended October 31, 2011 includes a decrease to general and administrative expenses to reflect the actual net fair value adjustment of $482,000 relating to such items as further described above) and (vi) income tax expense calculated using our fiscal 2011 consolidated U.S. effective tax rate. All other operating results reflect actual performance.

This pro forma information is provided for illustrative purposes only, and does not necessarily indicate what the operating results of the combined company might have been had the acquisition actually occurred at the beginning of fiscal 2011, nor does it necessarily indicate the combined company’s future operating results.

ConFirm Monitoring Systems, Inc.

On February 11, 2011, our Crosstex subsidiary acquired the ConFirm Monitoring Business, a private company based in Englewood, Colorado with revenues relating to biological monitoring services for dental and other healthcare customers located primarily in North America. The company offers both a mail-in service and in-office spore test kits for healthcare professionals to verify the performance of their sterilizers in accordance with industry guidelines for daily or weekly testing. The ConFirm Acquisition is included in our Healthcare Disposables segment. Total consideration for the transaction, excluding transaction costs of $52,000, was $7,500,000 plus contingent consideration of up to an additional $1,000,000 based upon achievement of specified sales levels through January 31, 2012.

We account for contingent consideration by recording the fair value of contingent consideration 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 Condensed Consolidated Statements of Income.  Accordingly, on February 11, 2011 we increased acquisitions payable and goodwill by $656,000 to record our initial estimated fair value of the contingent consideration that would be earned by January 31, 2012. At July 31, 2011, we increased acquisitions payable to $775,000 by recording the $119,000 change in the fair value through our Consolidated Statements of Income for the year ended July 31, 2011. At October 31, 2011, the fair value of this contingent consideration liability decreased to $689,000. The $86,000 change in fair value was recorded as a decrease to acquisitions payable and general and administrative expenses in the Condensed Consolidated Financial Statements at October 31, 2011. This change in estimated fair value was driven by changes in the assumptions pertaining to the achievement of the specified sales levels, partially offset by the accretion of the liability for the time value of money.

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

	Final
Net Assets	Allocation
Current assets	$	1,399,000
Property, plant and equipment	93,000
Amortizable intangible assets:
Customer relationships (10-year life)	2,290,000
Trade name (6-year life)	470,000
Technology (5-year life)	110,000
Non-compete agreement (8-year life)	30,000
Current liabilities:
Accounts payable	(244,000		)
Deferred revenue	(1,226,000		)
Net assets acquired	$	2,922,000

There were no in-process research and development projects acquired in connection with the acquisition. The excess purchase price of $5,234,000 was assigned to goodwill, which is deductible for income tax purposes over fifteen years.

The principal reasons for the acquisition were (i) to expand our sterility assurance product portfolio, (ii) to enable cross-selling of our existing products such as our patent-pending Sure-CheckTM sterilization pouch, (iii) to leverage Crosstex’ sales and marketing infrastructure in the dental arena and (iv) the expectation that the acquisition will be accretive to our future earnings per share beyond fiscal 2011. Such reasons constitute the significant factors that contributed to a purchase price that resulted in recognition of goodwill.

The results of operations for the ConFirm Acquisition are included in our results of operations for the three months ended October 31, 2011 and is excluded from our results of operations for the three months ended October 31, 2010. Pro forma consolidated statements of income data have not been presented due to the insignificant impact of this acquisition.

Gambro Business

On October 6, 2010, our Mar Cor subsidiary acquired from Gambro certain net assets and the exclusive rights in the United States and Puerto Rico to manufacture and sell Gambro’s water treatment products used in the production of water for hemodialysis. Immediately following the acquisition, we commenced sales and service of all Gambro water products, components, parts and consumables solely intended for the United States and Puerto Rico markets. The manufacturing of these products has been transitioned into our own manufacturing facility in Plymouth, Minnesota. The Gambro Acquisition expands our Water Purification and Filtration’s annual business in terms of sales, particularly with respect to product and service sales volumes in both existing and new dialysis clinics across the United States and Puerto Rico by 19% (approximately 75% of Gambro Acquisition revenues are from one customer). Total consideration for the transaction, excluding acquisition-related costs of approximately $240,000, was approximately $23,700,000, of which $3,100,000 is being paid in six equal quarterly payments ending April 2012. As of October 31, 2011, $2,066,000 of the $3,100,000 has been paid. The Gambro Acquisition is included in our Water Purification and Filtration operating segment.

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

	Final
Net Assets	Allocation
Current assets (principally inventories)	$	3,080,000
Property, plant and equipment	11,000
Amortizable intangible assets:
Technology (8-year life)	1,170,000
Customer relationships (11.5-year weighted average life)	6,640,000
Non-compete agreement (14-year life)	1,050,000
Current liabilities	(60,000		)
Net assets acquired	$	11,891,000

There were no in-process research and development projects acquired in connection with the acquisition. The excess purchase price of $11,809,000 was assigned to goodwill, which is deductible for income tax purposes over fifteen years.

The reasons for the acquisition were as follows: (i) the expansion of our water purification product line, particularly in the area of cost effective heat sanitizable water purification equipment, (ii) the opportunity to add an installed equipment base of business into which we can (a) increase service revenue while improving the density and efficiency of the Mar Cor service network and (b) drive a greater portion of recurring consumable sales per clinic; (iii) the potential revenue and cost savings synergies and efficiencies that could be realized through optimizing and combining the acquired assets (including Gambro employees) into Mar Cor; and (iv) the expectation that the acquisition will be accretive to our future earnings per share. Such reasons constitute the significant factors that contributed to a purchase price that resulted in recognition of goodwill.

The results of operations of the Gambro Business are included in our results of operations for the three months ended October 31, 2011 and the portion of the three months ended October 31, 2010 subsequent to its acquisition date. Pro forma consolidated statement of income data has not been presented due to the unavailability of pre-acquisition financial statements of the Gambro Business, since the Gambro Business did not maintain separate financial statements related to these purchased assets.