ITEM 1. Business
General
Business and Products
Sybron Dental Specialties, Inc. is a leading global manufacturer and marketer of a broad range of consumable dental products and related small equipment and a manufacturer and distributor of products for use in infection prevention in both the medical and dental markets. Our subsidiaries operate in two business segments:
• Professional Dental. We develop and manufacture a variety of branded dental consumable products and consumable infection prevention products sold through independent distributors to the dental industry worldwide, as well as to medical markets; and
• Specialty Products. We develop, manufacture, and market an array of consumable orthodontic products, endodontic products and implants to orthodontists, endodontic specialists, oral surgeons, prosthodontists, and periodontists worldwide. This segment was previously referred to as the Orthodontics segment. The name was changed to more accurately describe the products of this segment. The composition of the segment has not changed.
Our primary subsidiaries in each of our business segments are as follows:
Professional Dental
Specialty Products
Kerr Corporation
Ormco Corporation
Kerr Italia S.p.A
Ormco B.V.
Sybron Canada Limited
Ormodent Group
Pinnacle Products, Inc.
Allesee Orthodontic Appliances, Inc.
KerrHawe S.A.
Innova LifeSciences Corporation
Metrex Research Corporation
SpofaDental a.s.
We market our products in the United States and abroad under brand names such as Kerr®, Ormco®, Metrex®, Pinnacle®, Demetron®, KerrHawe®, AOA™, SybronEndo™, and Innova™ which are well recognized in the dental and orthodontics industries.
History
Sybron Dental Specialties, Inc. was incorporated in Delaware on July 17, 2000. At the time of our incorporation we were a wholly-owned subsidiary of Apogent Technologies Inc. (“Apogent”), which in August 2004 was acquired by and became a wholly-owned subsidiary of Fisher Scientific International Inc. We were created to effect the spin-off by Apogent of its dental business in December 2000. Apogent distributed to its shareholders, by means of a pro rata distribution, all of our outstanding common stock together with related preferred stock purchase rights (the “spin-off”). As a result, we became an independent, publicly traded company.
Terms; Year References
When we use the terms “SDS,” “we,” “us,” “Company,” or “our” in this report, unless the context requires otherwise, we are referring to Sybron Dental Specialties, Inc. and its subsidiaries and their respective predecessors that comprised Apogent’s dental business prior to the spin-off. Our fiscal year ends September 30. All references to a particular year mean the fiscal year ended September 30 of that year, unless we indicate otherwise.
Business Strategy
The key elements of our strategy to become a premier global supplier of high quality dental, infection prevention, orthodontic, dental implants and endodontic products are:
Develop Innovative Products. We strive to consistently develop and introduce innovative products. We believe that product innovation allows us to maintain our competitive position and helps fuel our internal growth. We also believe that our emphasis on new product development enables our sales force to remain effective in creating demand among dentists and orthodontists. Our dedicated research and development team regularly interacts with practicing clinicians to understand and assess new product opportunities in the marketplace.
Consistently Improve Our Efficiency. We continuously pursue opportunities to maximize cost savings. As a result, we regularly evaluate our manufacturing processes to determine optimal production strategies, and we will transfer production from one facility to another or rationalize higher-cost facilities when necessary. In addition, we consistently seek to rationalize manufacturing, warehousing and customer service operations to centralized facilities wherever possible. In fiscal 2004, we consolidated five of SpofaDental’s facilities into one facility, located in the Czech Republic, which now handles all of SpofaDental’s manufacturing and distribution. We also closed our production facility in Tijuana, Mexico during fiscal 2004 and transferred the production from that facility to our other facilities in Mexico.
Increase Revenue Opportunities Within Existing Marketplace. We continuously seek to broaden our portfolio of product offerings to maximize the opportunities within our existing customer base. For example, through acquisitions, we acquired products such as chair covers, barrier products, infection prevention products and disposable air/water syringes, dental implants, and through our research and development efforts, we added new products such as our Premise™ nanocomposite, HiRes magnification loupe, and Damon™ 3 self-ligating bracket.
Expand the Marketplace. We seek to expand the market for our products through product innovation. We believe that our technological leadership enables us to increase the number of uses and users of our products. For example, we believe our aesthetic brackets have increased the number of adults who are willing to undergo orthodontic treatment for functional or cosmetic reasons.
Pursue Strategic Acquisitions. Although debt reduction is an important priority, we will continue to pursue selective strategic acquisitions. We have significant experience in acquiring and integrating companies. We pursue acquisition opportunities that:
• enhance our sales growth;
• offer complementary product lines;
• expand our geographic reach; or
• offer us access to new markets.
Since 1993, we have made 30 acquisitions in the United States and abroad. Since the beginning of fiscal 2001, we have completed eight acquisitions, the most recent of which was the acquisition in October 2004 of Innova LifeSciences Corporation (“Innova”), a Canadian manufacturer of dental implants. In July 2004, we acquired a business from Bioplant Products, Inc. that manufactures and sells products for use in bone generation following the extraction of a tooth. In August 2003, we acquired SpofaDental a.s., a leading manufacturer of consumable dental supplies in Central and Eastern Europe.
We have been able to use our existing distribution channels to market many of the product lines we have acquired and we have achieved other synergies, such as the elimination of duplicative administrative or other functions or the combining of manufacturing operations with some of these acquisitions.
Business Segments
Professional Dental. Products in our Professional Dental business segment include light cured composite filling materials and bonding agents, amalgam alloy filling materials, dental burs, impression materials,
magnification lenses, and curing lights used in general dentistry; waxes, specialty burs, investment and casting materials, equipment and accessories used in dental laboratories; and disposable infection prevention products for dental equipment and offices.
Our Professional Dental products are primarily manufactured by Kerr Corporation and its affiliates, such as Sybron Canada Limited and KerrHawe. Kerr’s products, which are generally sold through independent dental distributors, are designed to help dentists deliver more effective and efficient treatment to their patients. Kerr has expanded its product line through new product development and through acquisitions.
Expansion of products in this segment through acquisitions include the 1994 purchase of Demetron Research Corp., a manufacturer of lights used by dentists to cure composite filling materials applied to teeth. These products complemented Kerr’s line of composite filling materials, which it enhanced by acquiring E&D Dental Products, Inc. and its line of composites in 1996. Kerr added to its offering of dental lab products with the acquisition of belle de st.claire inc. in 1996. In 1997, it added diamond dental burs to the considerable line of dental burs manufactured by Sybron Canada Limited, with the acquisition of the assets of Precision Rotary Instruments, Inc. In 1999, Pinnacle Products, Inc. became a part of our organization, which enabled us to add dental disposable infection prevention products such as plastic coverings (barriers) for dental equipment and filters for evacuation units to this business segment. In the second quarter of 2000, we added Safe-Wave Products, Inc., a manufacturer of disposable tips and adapters for air/water syringes used in dental operatories. In the first quarter of 2001, we acquired certain assets of the dental division of Special Metals Corporation, a contract manufacturer and supplier of alloy powders used in Kerr’s Tytin® and Tytin® FC dental amalgams, assuring continued access to this technology. In the third quarter of 2001, we acquired all of the capital stock of Hawe Neos, a Swiss manufacturer and wholesaler of consumable dental products in the areas of prevention, restoration and pharmaceutical. In February 2002, we acquired certain assets of Surgical Acuity, Inc., a Wisconsin manufacturer of magnification lenses and fiberoptic lighting systems. In the fourth quarter of 2003, we acquired all of the capital stock of SpofaDental a.s., a leading manufacturer of consumable dental supplies in Central and Eastern Europe. In the fourth quarter of 2004, we acquired a business from Bioplant Products, Inc. that manufactures and sells products for use in bone generation following the extraction of a tooth. For a more complete description of our acquisitions during fiscal years 2004, 2003 and 2002, please see Note 15 to our consolidated financial statements in Item 8 of this Annual Report.
Products in the Professional Dental business segment, including dental related infection prevention products, are sold both domestically and internationally through dental distributors. Kerr has approximately 90 sales personnel in the United States and approximately 110 abroad dedicated to the Professional Dental business segment sales.
Our Professional Dental companies are committed to increasing their market share through new product development and promotional activities. Their promotional activities create demand for their new products. The sales growth resulting from this demand is augmented by modest growth in the domestic market for traditional dental consumables. We believe opportunities for growth exist in international markets. As economies in the emerging markets of Eastern Europe, South America and the Far East continue to develop, the demand in those regions for dental products should grow. We also believe our Professional Dental companies are positioned to take advantage of such development due to their extensive experience in selling internationally and the quality of their existing international dealer network.
The Professional Dental business segment accounted for approximately 55.0%, 58.4% and 61.2% of our consolidated net sales in 2004, 2003 and 2002, respectively.
Specialty Products. Products in our Specialty Products business segment include a broad range of orthodontic appliances such as brackets, bands and buccal tubes, wires and elastomeric products as well as endodontic products and implants. Brackets, bands, buccal tubes and wires are manufactured from a variety of metals to exacting specifications for standard use or to meet the custom specifications of a particular orthodontist. Elastomeric orthodontic products include rubber bands and power chains to consolidate space. Products in this
area also include orthodontic instruments and general orthodontic supply products. These products have historically been manufactured and marketed by Ormco, which sells its products directly to orthodontists. Ormco expanded its orthodontics product line through the acquisition of E.T.M. Corporation (a manufacturer of orthodontic hand instruments) and Allesee Orthodontic Appliances, Inc. (a manufacturer of custom-made positioners, retainers and other accessories) in 1994. In 1998, we significantly enhanced the orthodontics line through a merger with LRS Acquisition Corp., the parent of “A” Company Orthodontics, which is a manufacturer and developer of brackets, archwires and related products. We also expanded our direct business in France by acquiring the Ormodent group of companies, Ormco’s French distributor. In 2000, we again expanded our product line with the acquisition of Professional Positioners, Inc., a manufacturer of orthodontic retainers and positioners and LPI Ormco, the former distributor of Ormco products in Austria. In the first quarter of 2001, we completed the acquisition of certain assets of Optident, Ltd., the former exclusive authorized distributor of Ormco “A” Company products in the United Kingdom. In 2002, we began marketing our Ormco branded orthodontic products in Spain directly through our local sales force, which previously had been associated with our distributor in Spain. For a more complete description of our acquisitions during fiscal years 2004, 2003 and 2002, please see Note 15 to our consolidated financial statements in Item 8 of this Annual Report.
In 1995, we added endodontic products to the Specialty Products segment, which has a separate endodontic direct sales force, with the acquisition of Excellence in Endodontics, Inc., a manufacturer of products for endodontic procedures. We expanded our endodontic product offerings in this segment in 1996 when we acquired the assets of Analytic Technology Corporation, a manufacturer of endodontic equipment. In 1998, we added a line of nickel-titanium endodontic instruments with the acquisition of the dental business of Tycom Corporation. In 1999, we vertically integrated our Tycom product line in Europe with the purchase of Endo Direct Ltd., the exclusive European importer of Tycom’s endodontic products.
In the first fiscal quarter of 2005, we entered into the dental implant market through our acquisition of Innova LifeSciences Corporation, a Canadian manufacturer and seller of dental implants. Innova’s products are sold in North America, the United Kingdom and Australia through a direct sales force of approximately 20 salespersons and through distributors in other countries throughout the world. For a more complete description of our Innova acquisition, please see Note 20 to our consolidated financial statements in Item 8 of this Annual Report.
Orthodontic products in the Specialty Products business segment are marketed by approximately 105 direct salespersons in the United States, Austria, Belgium, Canada, Australia, Germany, France, Ireland, Japan, Mexico, New Zealand, the Netherlands, Portugal, Spain, Switzerland and the United Kingdom, and by dealers and distributors in other parts of the world. Ormco’s direct sales force, dealers and distributors are supported by trade journal advertising, trade shows, seminars and telemarketing.
The market for traditional orthodontics products is relatively mature domestically, and is experiencing modest growth. We expect the international market for orthodontics products to be a growth opportunity as interest in orthodontics for cosmetic reasons grows worldwide. We believe Ormco is well positioned to compete both domestically and internationally because its marketing philosophy is geared toward making orthodontic practices more efficient through product innovation and customer service.
Ormco’s endodontic sales team sells our endodontic products both directly to end-users and through distributors (which had previously been handled primarily by our Professional Dental business segment). The endodontic team has approximately 20 direct salespersons in the United States. The sales force markets our endodontic products directly to endodontic specialists in the United States and Canada and provides support to our dealers and helps sell products to the general dental community through a dealer network in those countries. In other parts of the world, our endodontic products are sold by dealers and distributors.
The Specialty Products business segment accounted for approximately 45.0%, 41.6% and 38.8% of our consolidated net sales in 2004, 2003 and 2002, respectively.
Financial information about our business segments is presented in Note 17 to our consolidated financial statements in Item 8 of this Annual Report.
We believe we are well positioned to take advantage of the opportunities that exist to grow our business, such as the opportunities that we think will arise from the trends of an increasing worldwide population, growth in the population of people 65 and older, natural teeth being retained longer, and increased spending on dental health in developing nations.
International
In addition to the United States, products in our Professional Dental business segment are manufactured at facilities in Canada, Switzerland, Czech Republic, Italy and Mexico. These products are sold internationally through dealers, and supported by sales offices in Europe, Japan and Australia. The products in our Specialty Products business segment are manufactured in the United States, Canada and Mexico and sold internationally through a combination of a direct sales force and a distribution network to orthodontists, endodontic specialists, oral surgeons and periodontists.
Domestic and international sales of our products by business segment are as follows:
Our international business is subject to the risk of fluctuations in the exchange rates of various foreign currencies and other risks associated with foreign trade. For the years 2004, 2003 and 2002, our net sales outside the United States accounted for approximately 46%, 43%, and 41%, respectively, of consolidated net sales. See Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations “International Operations” and Item 7A - Quantitative and Qualitative Disclosures About Market Risk for further information concerning the possible effects of foreign currency fluctuations and currency hedges intended to mitigate their impact.
We have included other financial information about our business segments and foreign operations in Note 17 to our consolidated financial statements in Item 8 of this Annual Report.
Competition
We compete against numerous other companies in our business segments, some of which have substantially greater financial and other resources than us. We believe the breadth of our product lines and the strength of our well established brands provide us with a competitive advantage. Our widely recognized Kerr and Ormco brand names have been used for more than 100 years and 40 years, respectively. We believe these strong brands, our leading market positions and our programs to educate dental practitioners about techniques and products provide us with an excellent platform to pursue our growth initiatives. There can be no assurance, however, that we will maintain our competitive advantages or that we will not encounter increased competition in the future.
Our principal competitors in the Professional Dental business segment are Dentsply International Inc., 3M ESPE, and Ivoclar Vivadent Group. In the Specialty Products business segment, we compete with numerous companies in the United States. We compete primarily on the basis of product quality, the level of customer
service, price and new product offerings. Our competitors include 3M Unitek (an affiliate of 3M Company), GAC International (a subsidiary of Dentsply), American Orthodontics, Nobel Biocare and Straumann.
Research and Development
We have a number of research and development programs in our business segments, which we consider to be of importance in maintaining our market positions. We spent approximately $11.5 million, $10.2 million and $10.4 million on research and development in 2004, 2003 and 2002, respectively.
Our research and development expenditures by business segment are as follows:
Our business segments devote resources to the development and introduction of new products. These efforts are critical to meeting the needs of today’s dentists, endodontists and orthodontists. In the Professional Dental segment, product development requires diverse technical expertise and knowledge of various market trends, which we possess. Kerr takes advantage of its expertise and knowledge by working closely with dentists to develop new and improved products. The sales from recently introduced products, such as our Premise nanocomposite, the LEDemetron 1 curing light, the OptiDisc polishing disc and CaviWipes disinfecting towelettes have contributed to Kerr’s total net sales. In the Specialty Products segment, Ormco’s sales force maintains direct contact with orthodontists to identify market trends. Ormco works closely with orthodontists to improve existing products and develop new products primarily through programs such as its Insider program in which selected orthodontists assist Ormco in designing, developing and ultimately educating users on new product and technique innovations. In recent years, Ormco has introduced a number of new products, which have contributed significantly to its sales. Examples of those products include the Damon™ 3 brand self-ligating bracket, the Elements Obturation device (the newest product in our Elements equipment series), the re-engineered Inspire Ice product line, Damon™ 2 brand self-ligating bracket, the Synthesis brand straight wire appliance, the Titanium Orthos® brand orthodontic bracket, and the K-3 NiTi rotary files.
Employees
Our companies employed 4,140 people at September 30, 2004. In the United States, the Professional Dental segment’s 157 hourly employees at the Romulus, Michigan facility are members of the United Auto Workers Union. Our current labor contracts relating to that facility will expire on January 31, 2005. We are currently in negotiations to extend the union agreements until January 31, 2008. Many of our non-management employees in Europe are subject to national labor contracts, which are negotiated from time to time at the national level between the national labor union and employees’ council. Once national contracts are set, further negotiation can take place at the local level. Such negotiations can affect local operations. We have had no work stoppages related to national contracts. We believe our relations with employees are generally good.
Patents, Trademarks and Licenses
Our subsidiaries’ products are sold under a variety of trademarks and trade names. We own all of the trademarks and trade names we believe to be material to the operation of their businesses, including the Kerr®, Orascoptic®, KerrHawe®, Demetron®, SpofaDental®, Pinnacle®, Ormco®, SybronEndo®, AOA®, Damon™, Metrex®, and Innova™ trademarks, each of which we believe to have widespread name brand recognition in their respective field and all of which we intend to continue to protect. Our subsidiaries also own various patents, employ various patented processes, and from time to time acquire licenses from owners of patents to apply patented processes to their operations or to sell patented products. Except for the trademarks referred to above, we do not believe any single patent, trademark or license is material to the operations of our business as a whole.
Regulation
Medical Devices
Certain of our products are medical devices that are subject to regulation by the United States Food and Drug Administration (the “FDA”) and by the counterpart agencies of the foreign countries where our products are sold. Some of the regulatory requirements of these foreign countries are more stringent than those applicable in the United States. Our medical devices distributed in the European countries are CE marked per the European Medical Device Directives, 93/42/EEC. Products that are CE marked may move freely in the twenty five European Union States and the three European Economic Area States. Our worldwide facilities that are engaged in the manufacturing of Class IIa and Class IIb medical devices as defined by the European Medical Device Directives are ISO 13485 certified. Additionally, our medical devices distributed in Canada are licensed according to the Canadian Medical Device Regulations. Each facility manufacturing or distributing Class II and Class III medical devices holds a Certificate of Registration for a Quality Management System as defined in the Canadian Medical Devices Regulations. Pursuant to the Federal Food, Drug, and Cosmetic Act (the “FDCA”), the FDA regulates virtually all phases of the manufacture, sale, and distribution of medical devices, including their introduction into interstate commerce, manufacture, advertising, labeling, packaging, marketing, distribution and record keeping. Pursuant to the FDCA and FDA regulations, certain facilities of our operating subsidiaries are registered with the FDA as medical device manufacturing establishments. The FDA and our ISO Notified Bodies regularly inspect our registered and/or certified facilities.
The FDA classifies medical devices into Class I, II, or III. Pursuant to section 510(k) of the FDCA, the manufacturer or initial distributor of a Class I or II device that is initially introduced commercially on or after May 28, 1976 must notify the FDA of its intent to commercially introduce the device through the submission of a premarket notification (a “510(k)”). Before commercial distribution can begin, the FDA must review the 510(k) and clear the device for commercial distribution. The FDA normally has 90 days to review the 510(k) and grant or deny clearance to market on the basis that it is or is not substantially equivalent to a device marketed before May 28, 1976. Alternatively, the FDA may postpone a final decision and require the submission of additional information, which may include clinical data. If additional information is required, review and clearance of a 510(k) may be significantly delayed. In order to clear a Class I or II device for marketing, the FDA must determine, from the information contained in the 510(k) and any additional information that is submitted, that the device is substantially equivalent to one or more Class I or II devices that are legally marketed in the United States. Certain Class I devices are exempt from the 510(k) premarket notification requirement and manufacturers of such products may proceed to market without any submission to the FDA. If a device is not considered “substantially equivalent,” it is regulated as a Class III medical device. In general, a Class III medical device must be expressly approved by the FDA for commercial distribution pursuant to the submission of a premarket approval application (“PMA”). A PMA must contain, among other information, substantial information about the manufacture of the device and data from adequate and well-controlled clinical trials that demonstrate that the device is both safe and effective. The PMA approval process is substantially more complex and lengthy than the 510(k) premarket notification process.
A medical device, whether exempt from premarket notification, cleared for marketing under the 510(k) pathway, or cleared pursuant to a PMA approval, is subject to ongoing regulatory oversight by the FDA to ensure compliance with regulatory requirements, including, but not limited to, product labeling requirements and limitations, including those related to promotion and marketing efforts, current good manufacturing practices and quality system requirements, record keeping, and medical device (adverse event) reporting.
All of our dental and orthodontic treatment products and high level disinfectants and sterilants, sold in the United States, are regulated as Class I or Class II medical devices by the FDA. In Canada, our high level disinfectants and sterilants, hard surface disinfectants and topical anti microbial infection prevention products, are regulated as drug products and are required to hold a Drug Identification Number (DIN) prior to sale. Our manufacturing facilities for these products are required to comply with the Good Manufacturing Practices for drug products as defined in Part C of the Canadian Food and Drug Regulations.
Dental mercury is currently regulated by the FDA as a Class I device (not exempt from the 510(k) premarket notification requirement), and amalgam alloy is regulated as a Class II device. On February 20, 2002, the FDA published for comment a guidance in which it proposes to regulate encapsulated mercury and amalgam alloy, like those sold by Kerr, as a single Class II device. It also proposed the reclassification of dental mercury as a Class II device, so as to conform to the Class II designation for amalgam alloy and to the proposed Class II designation for encapsulated mercury and amalgam alloy. As Class II devices, encapsulated mercury and amalgam alloy will be subject to special controls. The special controls may include, among other things, recommendations and guidance for the form and content of product labeling. The guidance document contains proposed recommendations regarding the handling and storage of encapsulated mercury and amalgam alloy, as well as warnings to be added to the labeling.
All dental amalgam filling materials, including Kerr’s dental amalgam products, contain mercury. The use of mercury in various products, including dental amalgams, is being examined by various groups and U.S. and foreign governmental agencies as a part of an effort to reduce the amount of mercury to which individuals are exposed and that is discharged into the environment. We are aware of at least one foreign government agency that, as a result of a study it conducted, has proposed a plan that would discontinue the use of amalgams once a suitable alternative is found.
Various groups, who have expressed concerns about the health effects allegedly caused by the mercury in amalgams, are active in lobbying state, federal and foreign lawmakers and regulators to pass laws or adopt regulatory changes or recommendations regarding the use of dental amalgams. To date, these efforts have resulted in restrictions on or recommendations against the use of amalgams in certain clinical situations in some states and countries. The actions have generally been taken to reduce human exposure to mercury where other safe and practical alternatives to dental amalgam exist.
In the United States, the FDA’s Dental Devices Panel, the National Institute of Health and the United States Public Health Service have indicated that the use of amalgams does not cause verifiable adverse effects in patients who have amalgam fillings. All of these agencies have recommended further research on the subject and, in large part because of their initiatives, research with respect to potential health effects of dental amalgams is ongoing at various places around the world.
Over-the-Counter Drug Products
Certain of our products, namely our topical antimicrobial infection prevention products, are subject to regulation by the FDA as over-the-counter drug products. In order to market a product as an over-the-counter drug, we are required to comply with current Good Manufacturing Practice regulations for drug products, which include certain requirements relating to testing and labeling of these products. Each new product is listed with the FDA; however, there is no requirement for premarket submissions or approvals as long as the product is recognized as safe and effective by the FDA.
Federal Insecticide, Fungicide and Rodenticide Act
Certain of our infection prevention products are classified as pesticides and are subject to regulation by the United States Environmental Protection Agency (“EPA”) under the Federal Insecticide, Fungicide and Rodenticide Act (“FIFRA”) and by various state environmental agencies under the laws of those states. Under FIFRA, no one may sell, distribute or use a pesticide unless it is registered with the EPA. Registration includes approval by the EPA of the product’s label, including the claims and instructions for use. The producer of a pesticide must provide data from tests performed according to EPA guidelines. These tests are designed to determine whether a pesticide has the potential to cause adverse effects on humans, wildlife, plants and possible ground or surface water contamination. Testing must also be submitted to support the claims on the product labeling. Separate registrations must be obtained from the EPA and each state in which the product is sold. Registrations must be renewed annually. The regulations also require producers to report adverse events associated with their products to the EPA. Failure to pay registration fees or provide necessary testing data, or
evidence that the product is the cause of an adverse effect on humans or the environment, could result in fines and/or the cancellation of a FIFRA registration.
Environmental, Health and Safety Matters
Our operations entail a number of environmentally sensitive production processes. Compliance with environmental laws and regulations, along with regulations relating to workplace safety, is a significant factor in our businesses. Our domestic facilities are subject to federal, state and local laws and regulations concerning, among other things, solid and hazardous waste disposal, air emissions and waste water discharge, and our foreign facilities are subject to their respective local laws and regulations regarding the environment. Our operations are also subject to regulation relating to workplace safety, both in the United States and abroad. Violations of any of these laws and regulations or the release of toxic or hazardous materials used in our operations into the environment could expose us to significant liability. Similarly, third party lawsuits relating to environmental and workplace safety issues could result in substantial liability.
Raw Materials
We purchase a wide range of raw materials and supplies from a number of suppliers and do not rely on sole sources to any material extent. We do not foresee any significant difficulty in obtaining necessary materials or supplies.
Reliance on Key Distributors
A substantial portion of our sales is made through major independent distributors. While no single distributor accounted for more than 10% of our sales in 2004, we believe that the loss of either one of our top two distributors, the only distributors who account for more than 5% of our consolidated net sales and who sell primarily into the dental segment, could have a material adverse effect on our results of operations or financial condition until we find alternative means to distribute our products.
Transactions and Agreements Between Apogent and SDS
In order to effect the spin-off in December 2000, Apogent and SDS entered into a number of interrelated agreements. Certain of these agreements define the ongoing relationship between the parties after the spin-off and are briefly described below. Because these agreements were negotiated while we were a wholly-owned subsidiary of Apogent (which is now a wholly-owned subsidiary of Fisher Scientific International Inc.), they are not the result of negotiations between independent parties. In the future, additional or modified agreements, arrangements and transactions may be entered into and such agreements and transactions will be determined through arm’s-length negotiations.
Assignment and Assumption Agreement
Pursuant to the General Assignment, Assumption and Agreement Regarding Litigation, Claims and Other Liabilities, in general, we and our U.S. subsidiaries indemnify Apogent and its subsidiaries and affiliates against liabilities, litigation and claims actually or allegedly arising out of the dental business, including discontinued operations within those business segments. Similarly, Apogent and its U.S. subsidiaries indemnify us and our subsidiaries and affiliates against liabilities, litigation and claims actually or allegedly arising out of Apogent’s laboratory business, including discontinued operations within those business segments, and other items not transferred to us. In circumstances in which any liability of Apogent and SDS is joint, the parties will share responsibility for such liability on a mutually agreed basis consistent with the allocation of the business segments.
Insurance Matters Agreement
An Insurance Matters Agreement governs the rights and obligations of Apogent and us with respect to various pre-existing contracts insuring Apogent and covering risks associated with, or arising out of, the dental business. The types of policies covered by the Insurance Matters Agreement include, without limitation, automobile liability, comprehensive and general liability. The Insurance Matters Agreement also establishes certain procedures for dealing with pending litigation, new litigation and the resolution of disputes between the parties concerning that agreement.
Available Information
Our Internet address is www.sybrondental.com. There we make available, free of charge, our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information found on our website is not part of this or any other report we file with or furnish to the SEC.
Forward-Looking Statements
All statements other than statements of historical facts included in this Annual Report, including without limitation, statements in Item 1 - Business, Item 3 - Legal Proceedings and Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report, and other statements located elsewhere in this Annual Report, in each case regarding the prospects of our industry and our prospects, plans, financial position, and business strategy, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “anticipate,” “believe,” “continue,” “estimate,” “expect,” “goal,” “objective,” “outlook,” “could,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “should,” or “will” or the negative of these terms or other comparable terminology. You should read statements that contain these words carefully because they:
• discuss our future expectations;
• contain projections of our future results of operations or our financial condition; or
• state other forward-looking information.
We believe it is important to communicate expectations to our investors. However, forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by any forward-looking statements. These factors include, among other things, those listed in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations “Cautionary Factors.” Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results. Those statements, such as the one made in the immediately preceding section, “Business Strategy” regarding our intent to pursue our acquisition strategy, concern, among other things, our intent, belief or current expectations with respect to our operating and growth strategies, our capital expenditures, financing or other matters, regulatory matters pertaining to us specifically and the industry in general, industry trends, competition, risks attendant to foreign operations, reliance on key distributors, litigation, environmental matters, and other factors affecting our financial condition or results of operations. Such forward-looking statements involve certain risks and uncertainties, many of which are beyond our control, that could cause actual results to differ materially from those contemplated in the forward-looking statements.
All subsequent forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements included in this document. These forward-looking statements speak only as of the date of this Annual Report. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise and do not intend to update these statements unless the securities laws require us to do so.
ITEM 2.
ITEM 2. Properties
We operate manufacturing facilities in the United States and certain foreign countries. The following table sets forth information regarding our principal properties by business segment. Properties with less than 20,000 square feet of building space have been omitted from this table.
We consider our plants and equipment to be well maintained and suitable for their purposes. We review our manufacturing capacity periodically and make the determination as to our need to expand or, conversely, rationalize our facilities. We consolidated five of our Eastern European facilities into one site in fiscal 2004, and closed one of our manufacturing facilities in Mexico. In the event that we determine a need to expand our facilities, we expect to fund such expansions through internally generated funds or borrowings under our credit facility, which is described in Note 7 to our consolidated financial statements in Item 8 of this Annual Report. All of our owned domestic properties are encumbered under our credit facility. Our facility in Bioggio, Switzerland is encumbered by a mortgage given to the former shareholder of Hawe Neos as security for certain indemnification obligations we gave to the former shareholder of Hawe Neos.
The facility we closed in Mexico, a 32,000 square foot facility in Tijuana, Mexico is currently held for sale.
ITEM 3.
ITEM 3. Legal Proceedings
We or our subsidiaries are at any one time parties to a number of lawsuits or subject to claims arising out of our respective operations, including products liability, patent and trademark, or other intellectual property infringement, contractual liability, workplace safety and environmental claims and cases, some of which involve claims for substantial damages. We or our subsidiaries are vigorously defending lawsuits and other claims against us. Pursuant to the agreements described above between Apogent and us relating to the spin-off, we will indemnify Apogent and its subsidiaries against costs and liabilities associated with past or future operations of the dental business, and Apogent will indemnify us and our subsidiaries against costs and liabilities associated with past or future operations of the laboratory business. See Item 1 - Business “Transactions and Agreements Between Apogent and SDS.” of this Annual Report. We believe that any liabilities which might be reasonably expected to result from any of our or our subsidiaries’ pending cases and claims would not have a material adverse effect on our consolidated results of operations or financial condition, even if we are unable to recover amounts that we expect to recover with respect to those pending cases and claims through insurance, indemnification arrangements, or other sources. There can be no assurance as to this, however, or that litigation having such a material adverse effect will not arise in the future. For information about our legal expense related to patent litigation please see Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations “ Overview.”
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
Executive Officers of the Registrant
Set forth below are the names, ages, positions and experience of our executive officers. All executive officers hold office at the pleasure of the Board of Directors.
Name
Age
Positions and Experience
Floyd W. Pickrell, Jr.
President and Chief Executive Officer of Sybron Dental Specialties, Inc. since August 1993; served as Chairman of the Board of our subsidiary Kerr Corporation from August 1993 to December 2000, and Chairman of the Board of our subsidiary Ormco from February 1993 to December 2000; served as President of Kerr from August 1993 until November 1998; joined Ormco in 1978 and served as Ormco’s President from March 1983 until November 1998; previously served as Ormco’s Vice President of Marketing and as its National Sales Manager.
Daniel E. Even
President of Ormco since April 1998; Executive Vice President and General Manager of Ormco from 1993 until November 1998; Director of Allesee Orthodontic Appliances since July 1994; joined Ormco in 1979 and held various management positions at Ormco including Vice President of Marketing and Research & Development.
Steven J. Semmelmayer
President of Kerr Corporation since November 1998; Executive Vice President and General Manager of Kerr from 1993 until November 1998 and Director and Chief Executive Officer of Pinnacle Products since October 1998; joined Ormco in 1979 and held various management positions with Ormco including National Sales Director prior to being transferred to Kerr.
Stephen J. Tomassi
Vice President-General Counsel and Secretary of Sybron Dental Specialties, Inc. since October 2000; joined Apogent in 1988 as Corporate Counsel, becoming Assistant General Counsel in June 1992, and continued to serve in that role until the spin-off; previously in private practice from 1984 to 1988 with the law firm of Halling & Cayo.
John A. Trapani
Vice President of Human Resources of Sybron Dental Specialties, Inc. since October 2000; joined Ormco in October 1983 as Vice President of Human Resources; served, at various times, as Vice President of Human Resources for Kerr and Ormco; previously served as Manager of Employee Relations and Manager of Administration for Rockwell International B-1 Division; and Manager of Disney University and Manager of Employment for Walt Disney Productions Studios and WED Enterprises.
Gregory D. Waller
Vice President-Finance, Chief Financial Officer and Treasurer of Sybron Dental Specialties, Inc. since August 1993; formerly the Vice President and Treasurer of Kerr, Ormco and Metrex; joined Ormco in December 1980 as Vice President and Controller; served as Vice President of Kerr European Operations from July 1989 to August 1993.
Frances B. L. Zee
Vice President of Regulatory Affairs and Quality Assurance of Sybron Dental Specialties, Inc. since October 2000; served, at various times, as Vice President of Regulatory Affairs and Quality Assurance of Kerr and Ormco; joined Ormco in May 1983 as Manager of Quality Assurance and later became Director of Regulatory Affairs and Quality Assurance.
On November 15, 2004 we announced that Greg D. Waller, Vice President-Finance, Chief Financial Officer and Treasurer, intends to retire in 2005. Mr. Waller will remain in his current position until at least April 1, 2005, and possibly longer depending on the progress of our search for his replacement. Subsequent to his retirement, Mr. Waller will remain as a consultant to us for a period of at least one year.
PART II
ITEM 5.
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Shares of our common stock are traded on the New York Stock Exchange (“NYSE”) under the symbol “SYD.” The following table sets fourth the range of high and low sales prices per share of common stock as reported by the NYSE for each quarter of the two most recent fiscal years.
Since our inception, we have not paid any dividends on our Common Stock and have no current intention to pay cash dividends on our Common Stock. See Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations “Liquidity and Capital Resources,” and Note 7 to our consolidated financial statements contained in Item 8 of this Annual Report, for a description of certain restrictions on our ability to pay dividends. Subject to such limitations, any future dividends will be at the discretion of our Board of Directors and will depend upon, among other factors, our earnings, financial condition and other requirements.
As of December 6, 2004, there were 592 record holders of our common stock (excluding participants in securities position listings).
Issuer Purchases of Equity Securities
The table below sets forth information with respect to shares repurchased from an employee in the fourth quarter of fiscal 2004 in connection with the payment of withholding taxes and the purchase price due in connection with the exercise of stock options.
ITEM 6.
ITEM 6. Selected Financial Data
The following table sets forth our selected consolidated financial information for each of the five years in the period ended September 30, 2004. This selected financial information should be read in conjunction with Item 7
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
We are a leading global manufacturer and marketer of a broad range of consumable dental products and related small equipment, and a manufacturer and distributor of products for use in infection prevention in both the medical and dental markets. Prior to December 11, 2000, we were a wholly-owned subsidiary of Apogent Technologies Inc., which is now a wholly-owned subsidiary of Fisher Scientific International Inc. On December 11, 2000, Apogent spun off its dental business by way of a pro rata distribution to its shareholders of all of our outstanding common stock together with related preferred stock purchase rights. As a result of the spin-off, we became an independent, publicly traded company.
Our two business segments are Professional Dental and Specialty Products. In fiscal 2003 we began reporting in the Specialty Products segment the net sales of certain endodontic products whose sales were previously included in the net sales of the Professional Dental segment. At the commencement of the 2004 fiscal year we added to the net sales of the Specialty Products segment the net sales of certain other endodontic products that were also previously included in the net sales reported for the Professional Dental segment. We did not restate the operating results of either the Professional Dental segment or the Specialty Products segment for the periods prior to the periods in which the reporting of the net sales of the endodontic products changed. While it would have been possible to restate the net sales for the prior periods to reflect the change, it was impracticable to restate the prior period operating results as the effect the change in net sales had on selling, general and administrative expenses could not be calculated. The change in the recording of the endodontic products net sales from the Professional Dental segment to the Specialty Products segment did not impact the consolidated results of operations for any of the fiscal year periods reported herein.
Our corporate general and administrative expenses have been allocated to the segments using the same ratio as the ratio of the segment’s net sales to our total net sales. The allocation is made without regard to the level of the benefit each segment received from the corporate expenses. The corporate general and administrative expenses include certain legal and other expenses which may be associated with only one segment. However, as a result of our method of allocating those expenses, a portion of the cost is reflected in both our Professional Dental and Specialty Products segments. For example, in fiscal 2004 expenses of $2.6 million associated with patent litigation involving only the Specialty Products segment were allocated to both the Professional Dental segment (55%) and Specialty Products segment (45%).
The following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes contained in Item 8 of this Annual Report.
Overview
Based upon the information we have available to us, we estimate the growth of the worldwide dental market for the type of products we sell to be between 4% and 6% percent, with the U.S. market growing at the upper end of the range. The factors that we believe will allow the market to continue to grow in the 4% to 6% range are, among others things, a steadily growing demand by consumers for endodontic, periodontic, orthodontic, cosmetic and other specialized procedures in an effort to retain and improve the appearance of their natural teeth; the aging baby-boomer segment of the population who we think are more likely to require repair and reconstructive dental procedures, such as root canals and the placement of crowns or bridges; technological advances in dental products which reduce both the discomfort to the patient and the treatment time thereby attracting more patients;
an increasing worldwide population, creating more dental patients; and an expected growth in per capita and discretionary incomes in emerging nations which should result in healthcare, including dental services, becoming a greater priority.
Our worldwide net sales grew from $526.4 million in fiscal 2003 to $574.0 million in fiscal 2004, a 9% increase. Our fiscal 2004 net sales increase is due to favorable foreign currency fluctuations of 3.8%, internal growth of 3.1% and acquisitions of 2.1%. Both our overall net sales growth rate and our internal net sales growth rate in fiscal 2004 were less than they were in fiscal 2003, which experienced an overall net sales growth of 15.3% and internal growth rate of 8.4%. We define internal net sales as total net sales excluding foreign currency fluctuations and the impact of acquisitions made in the past twelve months.
The slowness we experienced in our internal net sales growth rate was the result of the negative internal growth experienced by our Professional Dental segment. Our Professional Dental segment had negative internal growth of 2.5% for the 2004 fiscal year. If we exclude equipment sales from the calculation of our Professional Dental segment internal net sales, the segment experienced positive internal growth of 1.3% over the prior year period; although that rate is still below the segment’s historical growth rate of 4% to 6%. The decrease in net sales in fiscal 2004 compared to fiscal 2003 was the greatest in the U.S. market. The decrease was largely due to the decrease in the sales of our LED curing light; the customer purchases made at the end of fiscal 2003 of our Professional Dental segment products in advance of a price increase scheduled to take effect at the beginning of fiscal 2004; the adjustments made by the largest customer of our dental burs in its inventory levels due to a configuration change in the packaging of their products which resulted in a temporary reduction in their purchases of dental burs; a decline in the demand for dental amalgam products; a reduction in the growth of our dental composite products to a single digit increase; and a delay in the launch of our new impression material, impacting the ability to grow what is a significant product line for our Professional Dental segment.
We expect to continue to experience a decline in the net sales of our LED curing light, which was introduced in the first quarter of fiscal 2003 and generated significant net sales during the 2003 fiscal year. Unlike our consumable product sales which generate consistent sales as the products cannot be reused, a curing light has a life span of 4 to 5 years. As a result, the sales made of that product in fiscal 2003 were not repeated in fiscal 2004 and are expected to continue to decline. We anticipate the sales of Premise, our new dental composite, and Kavitan LC, our new glass ionomer, will be additive to the sales of our other dental composites, resulting in greater growth in fiscal 2005 for that product line. Likewise, StandOut, our new impression material is expected to increase the sales of our impression materials. We expect the sales of our dental burs to return to their normal levels as the packaging reconfiguration for our largest customer has been completed.
As a result of the various measures we have undertaken, we anticipate that our internal growth rate in fiscal 2005 will return to our historical levels.
In contrast to the decrease in the internal net sales growth rate of our Professional Dental segment, our Specialty Products segment had an internal growth rate in fiscal 2004 of 10.8%. The majority of the growth occurred in the U.S. market which had an internal net sales growth of 13.5%, while the internal net sales growth in all other markets grew at 7.9%. The internal net sales growth rates in fiscal 2003 were 7.9% for the U.S. market and 10.3% for all other markets. The increase in net sales is a result, in part, of an increase in demand for our Damon 2 self-ligating bracket; the net sales of our Inspire® Ice clear-ceramic bracket, which was introduced in the first quarter of 2004; the sales of our Damon 3 self-ligating bracket which was introduced in the third quarter of fiscal 2004; the increase in sales of our Ni-Ti endodontic files; and an increase in the sales of certain of our orthodontic arch wires.
We intend to continue to focus our selling efforts on the Damon self-ligating bracket system and our Inspire Ice and Titanium Orthos® brackets. We believe those product lines present us with a series of differentiated products which will continue to create selling opportunities that will allow us to achieve internal sales growth in 2005 at the upper end of our historical 4% to 6% internal growth rate; although reductions in the payments under certain governmental health reimbursement programs, such as those in Germany where reimbursement programs
exist, could impact our selling efforts. As we focus on our efforts on our newer products, we expect to experience a decline in our more traditional bracket product line.
Operating income for fiscal 2004 was $113.4 million, representing a slight increase from the corresponding fiscal 2003 period operating income of $112.0 million. As a percent of sales our operating income decreased from 21.3% in fiscal 2003 to 19.8% in fiscal 2004. Our operating income in fiscal 2004 was negatively impacted by $1.5 million incurred in the closure of Ormco’s production facility in Tijuana, Mexico and an increase in our selling, general and administrative expenses due to the costs incurred in the evaluation of prospective mergers and acquisitions, the expense of our Sarbanes-Oxley Section 404 compliance efforts, the charges caused by our foreign currency zero cost collar hedges, and legal expenses associated with certain patent litigation relating to the Specialty Products business segment. We do not expect to incur any significant charges connected to the Tijuana facility closure and anticipate a reduction in the costs associated with the patent litigation in fiscal 2005.
Interest expense in fiscal 2004 was $19.5 million or $2.1 million less than the prior year period. The decrease was a result of lower average debt in the year of $249.1 million, or $66.4 million less than in the prior year period, partially offset by an increase in the average interest rate to 7.7%, from 6.7% in the prior year period. The increase in the average interest rate was the result of the pay down of our floating rate debt, which carried a lower interest rate than our fixed rate debt. We expect to see a slight increase in our average interest rate in fiscal 2005 as we anticipate interest rates will continue to rise and as we continue to pay down our lower interest rate debt.
Income taxes in fiscal 2004 were $30.6 million or 33.0% of income before taxes as compared to income taxes of $32.1 million, or 35.9% of income before taxes in fiscal 2003. The reduction in our tax rate is primarily attributable to the benefits resulting from the consolidation of several of our European facilities into Switzerland, which has a lower tax rate. We do not anticipate any further reduction in our tax rate, unless there is a substantial change in the geographical mix of our products, which we do not expect. We are currently evaluating the impact of the American Jobs Creation Act of 2004 (the “Jobs Creation Act”). Should we decide to repatriate earnings of non-U.S. subsidiaries under the terms of the Jobs Creation Act, there may be an impact on our tax rate.
Year Ended September 30, 2004 Compared to the Year Ended September 30, 2003
Net Sales
Overall Company. Net sales for the twelve months ended September 30, 2004 increased by $47.6 million, or 9.0%, from the corresponding 2003 fiscal year.
Professional Dental. Increased net sales in the Professional Dental segment resulted primarily from: (a) the net sales of products from acquired companies (approximately $12.9 million), (b) net sales of new products (approximately $11.2 million), and (c) favorable foreign currency fluctuations (approximately $10.0 million). The increase in net sales was partially offset by: (a) decreased net sales of existing products (approximately $19.6 million), (b) a decrease in net sales due to the transfer to the Specialty Products segment (approximately $4.9 million) of the European endodontic product sales, and (c) increased rebate payments (approximately $1.3 million).
Specialty Products. Increased net sales in the Specialty Products segment resulted primarily from: (a) net sales of new products (approximately $11.2 million), (b) favorable foreign currency fluctuations (approximately $10.3 million), (c) increased net sales of existing products (approximately $9.6 million), (d) an increase in net sales due to the transfer from the Professional Dental segment (approximately $4.9 million) of the European endodontic product sales, and (e) decreased rebate payments (approximately $3.3 million).
Gross Profit
Overall Company. Gross profit for the twelve months ended September 30, 2004 increased by $25.5 million or 8.8% from the corresponding fiscal 2003 period. Our gross profit as a percent of sales remained relatively stable in fiscal 2004 when compared to fiscal 2003. We expect a slight improvement in our gross margin in fiscal 2005, as a result of the foreign currency hedges we have in effect for fiscal 2005.
Professional Dental. Increased gross profit in the Professional Dental segment resulted primarily from: (a) gross profit derived from the net sales of products of acquired companies (approximately $6.7 million), (b) gross profit relating to new products (approximately $6.4 million), (c) favorable foreign currency fluctuations (approximately $5.1 million), and (d) favorable manufacturing variances (approximately $1.6 million). The increase in gross profit was partially offset by: (a) decreased net sales of existing products (approximately $11.9 million), (b) a decrease in sales of higher margin products (approximately $1.5 million), (c) increased rebate (approximately $1.3 million), (d) decreased gross profit due to the transfer to the Specialty Products segment (approximately $1.2 million) of the European endodontic product line, and (e) inventory adjustments (approximately $0.4 million).
Specialty Products. Increased gross profit in the Specialty Products segment resulted primarily from: (a) favorable foreign currency fluctuations (approximately $10.3 million), (b) gross profit relating to new products (approximately $6.5 million), (c) increased net sales of existing products (approximately $5.3 million), (d) decreased rebate (approximately $3.3 million), (e) increased gross profit due to the transfer from the Professional Dental segment (approximately $1.2 million) of the European endodontic product line, and (f) inventory adjustments (approximately $0.2 million). The increase in gross profit was partially offset by: (a) a decrease in sales of higher margin products (approximately $2.1 million), (b) costs related to the closure of the manufacturing facility in Mexico (approximately $1.5 million), (c) increased royalty expense (approximately $0.7 million), and (d) unfavorable manufacturing variances (approximately $0.5 million).
Selling, General and Administrative Expenses
Overall Company. Selling, general and administrative expenses for the fiscal year ended September 30, 2004 increased by $24.1 million or 13.5% from the corresponding fiscal 2003 period. As previously discussed,
all corporate general and administrative expenses are allocated to the Professional Dental and Specialty Products segments in proportion to each segment’s net sales, regardless of the extent to which a particular expense may relate to one segment or the other. The total allocation increased from $22.5 million in fiscal 2003 to $27.0 million in fiscal 2004. The largest contributors to the increase in corporate office general and administrative expenses were an increase in legal expenses (approximately $2.6 million) and an increase in expenses related to our efforts to fully document and test our internal control over financial reporting (approximately $1.3 million). The increase in legal expenses was predominately caused by the increase in expenses associated with certain patent litigation to which we are a party. We do not anticipate our patent litigation expenses to continue at the same level in fiscal 2005.
Professional Dental. Increased selling, general and administrative expenses in the Professional Dental segment resulted primarily from: (a) expenses of an acquired company (approximately $4.6 million), (b) an increase in expenses relating to foreign currency fluctuations (approximately $3.7 million), (c) increased selling and marketing expenses (approximately $1.1 million), and (d) increased general and administrative expenses (approximately $0.8 million). The increase in selling, general and administrative expenses was partially offset by: (a) the absence of restructuring charges in fiscal 2004 (approximately $0.3 million) and (b) a reduction of research and development expenses (approximately $0.1 million).
Specialty Products. Increased selling, general and administrative expenses in the Specialty Products segment resulted primarily from: (a) increased selling and marketing expenses (approximately $6.2 million), due to the increase in net sales, (b) increased general and administrative expenses (approximately $5.1 million), (c) increased expenses related to foreign currency fluctuations (approximately $1.9 million), and (d) increased research and development expenses (approximately $1.1 million).
Operating Income
As a result of the foregoing, operating income for the fiscal year ended September 30, 2004 increased by 1.2% or $1.4 million from operating income for the corresponding 2003 period.
Interest Expense
Interest expense was $19.5 million in 2004, a decrease of $2.1 million from the corresponding 2003 period. The decrease resulted from reduced average debt balances from $315.5 million in fiscal 2003 to $249.1 million in fiscal 2004, partially offset by an increase in the average interest rate on debt from 6.7% in fiscal 2003 to 7.7% in fiscal 2004 on our long term debt. The debt that was repaid in fiscal 2004 was adjustable rate debt with a lower average interest rate than the remaining debt.
Income Taxes
Taxes on income in 2004 were $30.6 million, or 33.0% of income before taxes, a decrease of $1.5 million from the prior year taxes on income of $32.1 million, or 35.9% of income before taxes. The reduction in our tax rate in fiscal 2004 from the prior fiscal year is primarily attributable to the benefits resulting from the consolidation of several of our European facilities into Switzerland, which has a lower tax rate.
Year Ended September 30, 2003 Compared to the Year Ended September 30, 2002
Net Sales
Overall Company. Net sales for the twelve months ended September 30, 2003 increased by $69.7 million, or 15.3%, from the corresponding 2002 fiscal year.
Professional Dental. Increased net sales in the Professional Dental segment resulted primarily from: (a) net sales of new products (approximately $16.2 million), (b) favorable foreign currency fluctuations (approximately $12.6 million), (c) the net sales of products from acquired companies (approximately $6.9 million), (d) increased net sales of existing products (approximately $4.2 million), and (e) decreased rebate payments (approximately $0.7 million). The increase in net sales was offset by a decrease in net sales due to the transfer to the Specialty Products segment (approximately $12.5 million) of the endodontic product sales.
Specialty Products. Increased net sales in the Specialty Products segment resulted primarily from: (a) increased net sales of existing products (approximately $22.6 million), (b) an increase in net sales due to the transfer from the Professional Dental segment (approximately $11.1 million) of the endodontic product sales, (c) favorable foreign currency fluctuations (approximately $8.9 million), and (d) net sales of new products (approximately $4.6 million). The increase in net sales was offset by increased rebate payments (approximately $5.6 million).
Gross Profit
Overall Company. Gross profit for the twelve months ended September 30, 2003 increased by $35.0 million or 13.7% from the corresponding fiscal 2002 period.
Professional Dental. Increased gross profit in the Professional Dental segment resulted primarily from: (a) gross profit relating to new products (approximately $9.0 million), (b) favorable foreign currency fluctuations (approximately $6.3 million), (c) gross profit derived from the net sales of products from acquired companies (approximately $4.2 million), (d) increased net sales of existing products (approximately $2.7 million), and (e) decreased rebate (approximately $0.7 million). The increase in gross profit was partially offset by: (a) decreased gross profit due to the transfer to the Specialty Products segment (approximately $7.8 million) of the endodontic product line, (b) unfavorable manufacturing variances (approximately $2.2 million), (c) a decrease in sales of higher margin products (approximately $1.2 million), (d) increased royalty expense (approximately $0.8 million), and (e) inventory adjustments (approximately $0.1 million). The decrease in gross margin percent is attributable to the transfer of the endodontic product line to the Specialty Products segment, product mix and unfavorable manufacturing variances from decreased manufacturing volumes in certain facilities due to our increased focus on inventory management.
Specialty Products. Increased gross profit in the Specialty Products segment resulted primarily from: (a) increased net sales of existing products (approximately $12.0 million), (b) favorable foreign currency
fluctuations (approximately $8.8 million), (c) increased gross profit due to the transfer from the Professional Dental segment (approximately $6.5 million) of the endodontic product line, (d) favorable manufacturing variances (approximately $2.8 million), and (e) gross profit relating to new products (approximately $2.8 million). The increase in gross profit was partially offset by: (a) increased rebate (approximately $5.6 million), (b) increased royalty expense (approximately $1.6 million), (c) inventory adjustments (approximately $1.1 million), and (d) a decrease in sales of higher margin products (approximately $0.4 million).
Selling, General and Administrative Expenses
Overall Company. Selling, general and administrative expenses for the fiscal year ended September 30, 2003 increased by $15.2 million or 9.3% from the corresponding fiscal 2002 period.
Professional Dental. Increased selling, general and administrative expenses in the Professional Dental segment resulted primarily from: (a) increased general and administrative expenses of approximately $6.9 million primarily attributable to higher incentive compensation related to the improved performance in fiscal 2003 over fiscal 2002, (b) an increase in expenses relating to foreign currency fluctuations (approximately $3.9 million), and (c) expenses of acquired companies (approximately $3.0 million). The increase in selling, general and administrative expenses was partially offset by: (a) decreased amortization expense of goodwill and other intangible assets (approximately $6.3 million), (b) the absence of restructuring charges in fiscal 2003 (approximately $3.3 million), (c) decreased research and development expenses (approximately $0.3 million), and (d) decreased selling and marketing expenses (approximately $0.1 million).
Specialty Products. Increased selling, general and administrative expenses in the Specialty Products segment resulted primarily from: (a) increased selling and marketing expenses (approximately $6.2 million), consistent with the increase in sales, (b) increased general and administrative expenses of approximately $6.0 million primarily attributable to higher incentive compensation related to the improved performance in fiscal 2003 over fiscal 2002, and (c) increased expenses related to foreign currency fluctuations (approximately $2.0 million). The increase in selling, general and administrative expenses was partially offset by: (a) a decrease in amortization expense of goodwill and other intangible assets (approximately $2.6 million) and (b) decreased research and development expenses (approximately $0.2 million).
Other, Net
Included in other, net for the fiscal year ended September 30, 2003 is a gain from the sale of our San Diego facility for approximately $0.8 million.
Operating Income
As a result of the foregoing, operating income for the fiscal year ended September 30, 2003 increased by 21.4% or $19.8 million from operating income for the corresponding 2002 period.
Interest Expense
Interest expense was $21.6 million in 2003, a decrease of $4.3 million from the corresponding 2002 period. The decrease resulted from reduced average debt balances from $350.6 million in fiscal 2002 to $315.5 million in fiscal 2003, and reduced average interest rates from 7.3% in fiscal 2002 to 6.7% in fiscal 2003 on our credit facility.
Income Taxes
Taxes on income in 2003 were $32.1 million, or 35.9% of income before taxes, an increase of $11.4 million from the prior year taxes on income of $20.7 million, or 39.0% of income before taxes. Excluding a benefit of a tax settlement in Canada of $0.9 million, the taxes on income were $33.0 million in 2003. The increase in taxes was primarily due to higher taxable earnings, partially offset by the decrease in our effective tax rate due to lower foreign tax rates.
Critical Accounting Estimates
We believe the following critical accounting estimates, among others, affect significant judgments and estimates used in the preparation of our consolidated financial statements. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for determining the carrying values of assets and liabilities that are not readily apparent from other sources and are inherently uncertain. As a result, changes in estimates, assumptions and general market conditions on which our judgments and estimates are based, could cause actual results to differ materially from future expected results.
• Pension and Other Postretirement Benefits - We have two non-contributory defined benefit pension plans that cover all regular United States based employees with more than five years of service. Our accumulated benefit obligation, the fair value of plan assets and the amount of annual pension cost are calculated based on a number of actuarial assumptions including an expected long-term return on plan assets, assumed rates of compensation increase and the discount rate used to calculate the actuarial present value of benefit obligations to be paid in the future. In developing these assumptions, we evaluate input from our actuaries as well as information available from the securities markets. The assumptions and factors used by us may differ materially from actual results due to changing market conditions, earlier or later retirement ages or longer or shorter life spans of participants. These differences may result in a significant impact to the amount of pension obligation or expense recorded by us. The actuarial assumptions are evaluated annually as of the beginning of each fiscal year.
At October 1, 2004, the discount rate was 6.25%. To the extent the discount rate increases or decreases, the projected pension obligation is decreased or increased, accordingly. The estimated effect of a 1.0% decrease in the discount rate would increase the projected pension benefit obligation by $23.8 million and increase annual pension expense by $3.4 million.
The expected long-term rate of return on the pension plan assets is the weighted average rate of the long-term investment return expected on those assets. To the extent the actual rate of return on assets realized over the course of a year is greater than the assumed rate, that year’s annual pension expense is not affected. Rather, the gain would reduce future pension expense over a period of approximately 12 to 18 years. As of October 1, 2004, we utilized 8.75% as the expected long-term rate of return on plan assets. The estimated effect of a 1.0% decrease in the expected long-term rate of return on plan assets would decrease the projected pension obligation by $2.7 million and increase annual pension expense by $0.1 million.
The assumed average rate of compensation increase is the average annual compensation increase expected over the remaining employment periods for the participating employees. At October 1, 2004, we utilized a rate of 4.0%. This rate is utilized principally in calculating the pension obligation and annual pension expense. The estimated effect of a 1.0% increase in the assumed rate of compensation increase would increase the projected pension obligation by $2.1 million and increase annual pension expense by $0.5 million.
Based on market conditions, and based on information from our actuaries and investment advisors, we increased our discount rate from 6.0% to 6.25% as of June 30, 2004. We maintained our expected rate of compensation increase at 4.0% and our expected return on plan assets at 8.75%.
• Goodwill - Goodwill is initially recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. We perform an annual review in the first quarter of each year, or more frequently if indicators of potential impairment exist, to determine if the recorded goodwill is impaired. Our impairment review process compares the fair value of the reporting unit to its carrying value, including the goodwill related to the reporting unit. To determine the fair value, our review process uses the income method and is based on a discounted future cash flow approach that uses estimates including the following for the reporting units: revenue based on market segment growth rates and our market segment share; estimated costs; and appropriate discount rates based on the particular segment’s weighted average cost of capital. Our estimates of market segment growth, our market segment share and costs are based on historical data, internal estimates, and external sources, all of which are developed as part of our long-range planning process. We test the reasonableness of the inputs and outcomes of our discounted cash flow analysis by comparison to available and comparable market data. No impairment charges for goodwill was recorded in the year ended September 30, 2004.
• Long-Lived Assets - We assess the impairment of long-lived assets when events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Factors that we consider in deciding when to perform an impairment review include significant under-performance of a business or product line in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in our use of the assets. Recoverability of assets that will continue to be used in our operations is measured by comparing the carrying amount of the assets to the related total future net cash flows. If an asset’s carrying value is not recoverable though the related cash flows, the asset grouping is considered to be impaired. The impairment is measured by the difference between the asset’s carrying amount and its fair value, based upon the best information available, including market prices or discounted cash flow analysis. Future events could cause us to conclude that impairment indicators exist and that certain of our long-lived assets are impaired. Any resulting impairment loss could have an adverse impact on our results of operations.
• Inventories - The valuation of inventory requires us to estimate obsolete and excess inventory. The determination of obsolete and excess inventory requires us to estimate the future demand for our products. The estimates of future demand for our products are based in part upon historical sales data and estimated future demand based on the information we currently have available to us. If our forecasted demand for specific products is greater than actual demand and we fail to reduce manufacturing output or sell existing inventory accordingly, we could be required to record additional inventory reserves, which would have a negative impact on our gross margin.
• Net Sales - Rebate Accruals - We have various rebate programs in each of our business segments. Each rebate program has different criteria for calculating rebate payments. As part of our revenue recognition policy, we estimate future rebate payments and establish accruals at the time of sale based on these estimates. Our accruals for rebates are estimated based on customers’ historical and estimated future performance against the terms and conditions of our rebate programs, which are typically on a calendar year basis. If we were to change any of these assumptions or judgments, it could cause a material increase or decrease in the amount of revenue that we report in a particular period.
Acquisitions
As discussed in Item 1 - Business “Research and Development,” we have maintained an active program of development and introduction of new products. We believe that introducing new products is important to maintain our competitive position. We have also pursued numerous acquisition opportunities, completing 30 acquisitions since 1993. Acquisitions completed since the beginning of fiscal 2002 are as follows:
Company Acquired
Acquisition
Date
Acquisition
Type
Description
Professional Dental:
Surgical Acuity, Inc.
2/02
Asset
Manufacturer of magnification lenses and fiber-optic lighting systems used for illumination during dental procedures
SpofaDental a.s
8/03
Stock
Manufacturer of consumable dental supplies
Bioplant Products, Inc.
7/04
Asset
Manufacturer of bone regeneration product
Specialty Products:
Innova LifeSciences Corporation
10/04
Stock
Manufacturer of dental implants and attachments
These acquisitions included in our business segments are consistent with our strategy of acquiring product lines that can be manufactured in existing facilities, sold through existing sales and distribution networks or that expand our geographic reach. We intend to continue to seek out acquisition candidates consistent with our strategy. However, there can be no assurance of the number or size of future acquisitions.
Restructuring Charges
In fiscal 2004, we implemented and completed a plan to close our facility in Tijuana, Mexico by the end of the first quarter of fiscal 2005, and as a result of this plan, recorded restructuring charges of $1.5 million ($1.0 million after tax) in the fiscal year ended September 30, 2004. The charges are comprised of severance and termination costs associated with the 246 employees whose employment we terminated as a result of the closure and recorded as a component of cost of goods sold in the fiscal year. Of the $1.5 million in restructuring charges $0.3 million remains in accrued liabilities until all severance is paid.
In September 2002, we recorded a restructuring charge of approximately $3.7 million ($2.4 million after tax). The charge is primarily comprised of severance and termination costs associated with the 71 employees whose employment we terminated as a result of the consolidation of several of our European facilities into our Hawe Neos facility in Switzerland. Of the $3.7 million restructuring charge, approximately $3.1 million is related to cash payments for severance and contractual obligations, $0.3 million for the cash payment of tax liabilities included in income taxes payable while the balance of approximately $0.3 million relates to non-cash charges. We completed the 2002 restructuring in fiscal 2004, and made an adjustment to restructuring charges of approximately $0.2 million, primarily for the over accruals for anticipated costs associated with severance and related costs. A balance of $0.3 million remains in our accrued tax liability until it is remitted.
The 2002 restructuring charge activity since September 30, 2002 and its components are as follows:
(a) The amount primarily represents the charges for severance and termination costs associated with the 71 employees primarily located at several facilities throughout Europe whose employment we terminated as a result of the 2002 European restructuring plan.
(b) Amount represents lease payments on exited facilities.
(c) Amount represents write-offs of inventory and fixed assets associated with discontinued product lines.
(d) Amount represents $0.3 million for tax liabilities included in income taxes payable.
(e) Amount represents certain contractual obligations.
In June 1998, we recorded a restructuring charge of approximately $14.6 million (approximately $10.7 million after tax) for the rationalization of certain acquired companies, combination of certain duplicate production facilities, movement of certain customer service and marketing functions, and the exiting of several product lines. In fiscal 2004 we made an adjustment to restructuring charges of approximately $0.2 million to adjust the accrual primarily representing over accruals for anticipated costs associated with the restructuring activity. A balance of $0.7 million remains in accrued tax liability until it is remitted or the tax period ends.
The 1998 restructuring charge activity since June 30, 1998 and its components are as follows:
(a) The amount primarily represents severance and termination costs related to the 154 employees whose employment was terminated as a result of the 1998 restructuring plan. An adjustment of approximately $1.2 million was made in fiscal 1999 to adjust the accrual primarily representing over accruals for anticipated costs associated with outplacement services, accrued fringe benefits, and severance associated with employees who were previously notified of termination and subsequently filled other company positions.
(b) Amount represents lease payments and shutdown costs on exited facilities.
(c) Amount represents write-offs of inventory and fixed assets associated with discontinued product lines.
(d) The charge of $0.7 million represents a statutory tax relating to assets transferred from an exited sales facility in Switzerland.
(e) Amount represents certain contractual obligations.
International Operations
A substantial portion of our sales, income and cash flows is derived internationally. The financial position and the results of operations from substantially all of our international operations, other than most U.S. export sales, are measured using the local currency of the countries in which such operations are conducted and are then translated into U.S. dollars. While the reported income of foreign subsidiaries will be impacted by a weakening or strengthening of the U.S. dollar in relation to a particular local currency, the effects of foreign currency
fluctuations are mitigated by the fact that our subsidiaries’ operations are conducted in numerous foreign countries and, therefore, in numerous foreign currencies. In addition, our U.S. export sales may be impacted by foreign currency fluctuations relative to the value of the U.S. dollar, as foreign customers may adjust their level of purchases upward or downward according to the weakness or strength of their respective currencies versus the U.S. dollar.
From time to time we employ currency hedges to mitigate the impact of foreign currency fluctuations. We have hedged our foreign currency exposure to protect against currency fluctuations in fiscal 2005 by securing monthly zero cost collar contracts with a notional amount of approximately $48.4 million for the euro, a notional amount of approximately $6.5 million for the Japanese yen, and a notional amount of approximately $5.2 million for the Australian dollar. A total currency loss in the amount of $5.2 million was recognized in the consolidated statement of income for the fiscal year ended September 30, 2004, while a currency loss of $0.3 million (net of income tax), representing the fair value of the zero cost collars, was recorded in accumulated other comprehensive income (loss), a component of stockholders’ equity (see Note 10 to the consolidated financial statements in Item 8 of this Annual Report). Additionally, in June 2002, we entered into cross currency debt swap transactions to hedge our net investment in Hawe Neos and Sybron Dental Specialties Japan. The agreements were contracts to exchange a U.S. dollar principal amount of $45.0 million in exchange for a Swiss franc principal amount of 67.5 million at the termination date of June 15, 2007 and a U.S. dollar principal amount of $4.0 million in exchange for a Japanese yen principal amount of 486 million at the termination date of June 15, 2007. For fiscal year 2004, the fair value of the cross currency debt swap transaction loss (net of income tax) included in the cumulative translation adjustments was $6.7 million. For additional information regarding foreign currency risk management please refer to Item 7A
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.
Foreign Exchange Currency Risk Management
We operate internationally; therefore, our earnings, cash flows, and financial position are exposed to foreign currency risk from foreign currency denominated receivables and payables, forecasted sales transactions, as well as net investments in certain foreign operations. These items are denominated in foreign currencies, including but not limited to the euro, Japanese yen, Swiss franc, Mexican peso, Canadian dollar, Czech koruna and the Australian dollar.
For fiscal year 2005, our projected total foreign currency exposure is estimated to be approximately 80.8 million euros, 786.7 million Japanese yen, 7.7 million Canadian dollars, 17.5 million Australian dollars, 11.6 million Mexican peso, 60.8 million Czech koruna, and 18.1 million Swiss francs. We have put in place a strategy to manage our euro, Japanese yen, and Australian dollar cash flow exposure through the use of zero cost collar contracts. There were no such contracts in place for the Canadian dollar, Mexican peso, Czech koruna and Swiss franc at September 30, 2004.
In December 2003, as well as in January, May, and June 2004, we entered into a series of zero cost collar contracts to hedge intercompany transactions with a total notional amount of 39.0 million euros, 720.0 million Japanese yen, and 7.2 million Australian dollars for fiscal year 2005.
For fiscal year 2004, an unrealized loss of $0.3 million (net of income tax), representing the fair value of the zero cost collars, is included in accumulated other comprehensive income (loss). In addition, none of the foreign currency cash flow hedges have been discontinued.
Zero cost collar contracts in place as of September 30, 2004 are as follows (in thousands, except rates):
In January, March, April, and May 2003, we entered into a series of zero cost collar contracts to hedge our intercompany transactions with a total notional amount of 42.0 million euros and 720.0 million Japanese yen for fiscal year 2004. Both the euro zero cost collar contracts and the Japanese yen zero cost collar contracts for fiscal year 2004 matured on September 30, 2004.
For fiscal year 2003, approximately $2.0 million of loss (net of income tax) representing the fair value of the zero cost collars, is included in accumulated other comprehensive income (loss), related to the foreign currency zero cost collar transactions. In addition, none of the foreign currency cash flow hedges has been discontinued.
Zero cost collar contracts in place as of September 30, 2003 are as follows (in thousands, except rates):
In July and November 2002, the Company entered into a series of zero cost collar contracts to hedge its intercompany transactions with a total notional amount of 40.5 million euros for fiscal year 2003. Also, in June 2002, the Company entered into a zero cost collar contract to hedge a total notional amount of 720.0 million Japanese yen for fiscal year 2003. Both the euro zero cost collar contracts and the yen zero cost collar contract for fiscal year 2003 matured on September 30, 2003.
During the year ending September 30, 2005, approximately $0.5 million of loss in accumulated other comprehensive income (loss) related to the zero cost collars are expected to be reclassified into foreign exchange loss/gain as a yield adjustment of the hedged foreign currency representing the fair value of the zero cost collars.
In June 2002, we entered into four cross currency debt swap transactions to hedge our net investment in Hawe Neos and one cross currency debt swap transaction to hedge our net investment in SDS Japan. The agreements have effective dates of June 27, June 28, and July 1, 2002, and are contracts to exchange U.S. dollar principal aggregating a total amount of $45.0 million in exchange for a Swiss franc principal aggregating a total amount of 67.5 million and U.S. dollar principal amount of $4.0 million in exchange for a Japanese yen amount of 486.0 million. Both the Swiss franc contracts and the Japanese yen contract mature on June 15, 2007. The mechanics of the agreements are similar to the original cross currency debt swap terminated on June 6, 2002. However, the fixed interest rate to be paid to us on the U.S. dollar leg of the agreements is a rate equal to the Senior Subordinated Notes rate of 8 1/8% while the fixed interest rate to be paid by us on the Swiss franc leg of the agreements ranges from 6.39% to 6.45% and the Japanese yen leg of the agreements is 3.65%, with the interest payments due semi-annually.
The following are the details of the cross currency debt swaps (amounts in millions, except rates):
For fiscal 2004, an unrealized loss of $6.7 million (net of income tax), representing the fair value of the cross currency debt swap, was included in accumulated other comprehensive income (loss).
Interest Rate Exposure - Interest Rate Risk Management
We use our Credit Facility and Senior Subordinated Notes to finance our operations. The Credit Facility exposes us to variability in interest payments due to changes in interest rates. If interest rates increase, our interest expense increases. Conversely, if interest rates decrease, our interest expense also decreases. We entered into interest rate swap agreements to manage fluctuations in cash flows resulting from interest rate risk. These interest rate swaps change a portion of our variable-rate cash flow exposure to fixed-rate cash flows. We continue to assess our exposure to interest rate risk on an ongoing basis.
The table below provides information about our debt obligations that are sensitive to changes in interest rates as of September 30, 2004. For these debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. Weighted average variable rates are based on implied forward 3-month LIBOR rates in the yield curve at the reporting date. The information is presented in U.S. dollar equivalents.
For fiscal year ended 2004, the total net cost of converting from floating rate (3-month LIBOR) to fixed rate from a portion of the interest payments under our long-term debt obligations was approximately $1.7 million. At September 30, 2004, an unrealized loss of $1.0 million (net of income tax) is included in accumulated other comprehensive income. Below is a table listing the interest expense exposure detail and the fair value of the interest rate swap agreements as of September 30, 2004 (in thousands):
For fiscal year ended 2003, the total net cost of converting from floating rate (3-month LIBOR) to fixed rate from a portion of the interest payments of the debt obligation was $1.2 million. Below is a table listing the interest expense exposure detail (in thousands), including the notional amount as of September 30, 2003:
For fiscal year ended 2002, the total net cost of converting from floating rate (3-month LIBOR) to fixed rate from a portion of the interest payments of the debt obligation was $4,542. Below is a table listing the interest expense exposure detail (in thousands), including the notional amount as of September 30, 2002:
The fair value of interest rate swap agreements designated as hedging instruments against the variability of cash flows associated with floating-rate, long-term debt obligations are reported in accumulated other comprehensive income (loss). These amounts subsequently are reclassified into interest expense as a yield adjustment in the same period in which the related interest on the floating-rate debt obligations affects earnings.
Item 8.
Item 8.
Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
SYBRON DENTAL SPECIALTIES, INC.
Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of September 30, 2004 and 2003
Consolidated Statements of Income for the years ended September 30, 2004, 2003 and 2002
Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the years ended September 30, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended September 30, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Sybron Dental Specialties, Inc.:
We have audited the accompanying consolidated balance sheets of Sybron Dental Specialties, Inc. and subsidiaries as of September 30, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended September 30, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sybron Dental Specialties, Inc. and subsidiaries as of September 30, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 2004, in conformity with U.S. generally accepted accounting principles.
As discussed in Notes 1 and 6 to the consolidated financial statements, the Company changed its method of accounting for goodwill and intangible assets as of October 1, 2002.
/s/ KPMG LLP
KPMG LLP
Costa Mesa, California
November 15, 2004
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2004 and 2003
See accompanying notes to consolidated financial statements.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended September 30, 2004, 2003 and 2002
See accompanying notes to consolidated financial statements.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
For the Years Ended September 30, 2004, 2003 and 2002
See accompanying notes to consolidated financial statements.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended September 30, 2004, 2003 and 2002
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
S YBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended September 30, 2004, 2003 and 2002
(In thousands, except share and per share amounts)
(1) Summary of Significant Accounting Policies
The subsidiaries of Sybron Dental Specialties, Inc. (“SDS” or “the Company”) are leading manufacturers of value-added products for the professional dental, including infection prevention, and orthodontic markets in the United States and abroad (see Note 17).
(a) Principles of Consolidation and Fiscal Year End
The consolidated financial statements reflect the operations of SDS and its wholly-owned subsidiaries. The term “Apogent” as used herein refers to Apogent Technologies, Inc. and its subsidiaries. The Company’s fiscal year ends on September 30. All significant intercompany balances and transactions have been eliminated. The fiscal years ended September 30, 2004, 2003 and 2002 are hereinafter referred to as “2004”, “2003”, and “2002”, respectively.
(b) Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include investments in debt obligations with original maturities of three months or less.
(c) Inventories
Inventories are stated at the lower of cost or market, using the first-in, first-out (FIFO) method. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. The Company regularly reviews inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If the Company’s review indicates a reduction in utility below carrying value, the Company reduces its inventory to a new cost basis.
(d) Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is calculated over the estimated useful lives of depreciable assets (5 to 40 years for land improvements, buildings and building improvements, and 3 to 20 years for machinery and equipment) using the straight-line method. The Company assesses the recoverability of assets by comparing the carrying amount of an asset to future net cash flows expected to be generated by that asset. If such assets are considered impaired, the impairment to be recognized is measured by the amount by which the carrying amounts of the assets exceed the fair value of the assets.
(e) Goodwill and Intangible Assets
Beginning in fiscal 2003 with the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” goodwill is no longer amortized, but tested for impairment at least annually. Before fiscal 2003, goodwill was amortized over 5 to 40 years.
Intangible assets are recorded at cost and are amortized using the straight-line method, over their estimated useful lives and are reviewed for impairment in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.”
(f) Revenue Recognition
The Company recognizes revenue upon shipment of products when risks and rewards of ownership pass, persuasive evidence of a sales arrangement exists, the price to the buyer is fixed or determinable, and
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
collectibility of the sales price is reasonably assured. Sales incentives are offered to our customers based on sales volume requirements. These incentives are recorded initially based on estimates by the Company and accounted for as a reduction of sales.
(g) Shipping and Handling Costs
The shipping and handling costs included in selling, general and administrative expense for the years ended September 30, 2004, 2003 and 2002 are approximately $13,565, $12,060 and $10,804, respectively.
(h) Income Taxes
Income taxes are accounted for under the asset and liability method wherein deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company was included in the consolidated income tax return filed by Apogent through December 11, 2000, but has been responsible for its own filings since the spin-off. U.S. income tax payments, refunds, credits, provisions and deferred income tax components prior to the spin-off were allocated to SDS in accordance with Apogent’s tax allocation policy. Such policy allocated income tax components included in the consolidated income tax return of Apogent to SDS to the extent such components were generated by or related to SDS.
(i) Research and Development Costs
Research and development costs are charged to selling, general and administrative expenses in the period they are incurred. Research and development costs for 2004, 2003 and 2002 were approximately $11,480, $10,218 and $10,399, respectively.
(j) Foreign Currency Translation
The functional currency for the Company’s foreign operations is the applicable local currency. The translation from the applicable foreign currencies to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. The gains or losses, net of applicable deferred income taxes, resulting from such translations are included in accumulated other comprehensive income (loss), a component of stockholders’ equity. Gains and losses resulting from foreign currency transactions are included in selling, general and administrative expenses. Foreign currency transaction gains for 2004 and 2003 were approximately $1,444 and $561, respectively, while the foreign currency transaction loss for 2002 was approximately $123.
(k) Pensions
The Company and its subsidiaries participate in various pension plans covering substantially all employees. U.S. and Canadian pension obligations are funded by payments to pension fund trustees. Other foreign pensions are funded as expenses are incurred. The Company’s policy is generally to fund at least the minimum amount required under the Employee Retirement Income Security Act of 1974, as amended, for plans subject thereto.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(l) Deferred Financing Fees
Deferred financing fees are capitalized in other assets in the accompanying consolidated balance sheets and amortized as a separate component of other income (expense) over the life of the related debt agreements.
(m) Advertising Costs
Advertising costs included in selling, general and administrative expenses are expensed as incurred and were $4,734, $4,211 and $5,062 in 2004, 2003 and 2002, respectively.
(n) Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
(o) Derivative Financial Instruments
The Company uses derivative financial instruments to manage its foreign currency, interest rate exposures, and certain net investments. The Company does not hold or issue financial instruments for trading purposes. The notional amounts of these contracts do not represent amounts exchanged by the parties and, thus, are not a measure of the Company’s risk. The net amounts exchanged are calculated on the basis of the notional amounts and other terms of the contracts, such as interest rates or exchange rates, and only represent a small portion of the notional amounts. The credit and market risk under these agreements is minimized through diversification among counter parties with high credit ratings. Depending on the item being hedged, gains and losses on derivative financial instruments are either recognized in the results of operations as they occur or are deferred until the hedged transaction occurs. Derivatives used as hedges are effective at reducing the risk associated with the exposure being hedged and are designated as a hedge at the inception of the derivative contract. Accordingly, changes in the fair value of the derivative are highly correlated with changes in the fair value of the underlying hedged item at the inception of the hedge and over the life of the hedge contract. The fair value of interest rate swaps that are terminated or required to be de-designated due to an event that negates the probability of the hedged forecasted transaction from taking place (as may be required by a refinancing), is removed from the unrealized loss or gain on derivative instruments recorded in accumulated other comprehensive income and the fair value is reclassified into earnings immediately. For cross currency debt swaps, the fair value remains in currency translation adjustment, a component of accumulated other comprehensive income (loss), until sale or upon complete or substantially complete liquidation of the Company’s net investment.
(p) Environmental Expenditures
Environmental expenditures that relate to current ongoing operations or to conditions caused by past operations are expensed. The Company determines its liability on a site by site basis and records a liability at the time when the liability is probable and can be reasonably estimated. The estimated liability is not reduced for possible recoveries from insurance carriers.
(q) Comprehensive Income (Loss)
The components of accumulated other comprehensive income (loss) consist of translation adjustments, minimum pension liability adjustments, and unrealized gains (losses) on derivative instruments and are included on the accompanying consolidated statements of stockholders’ equity and comprehensive income, net of tax.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(r) Stock-Based Compensation
The Company applies the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” As permitted by SFAS No. 123, the Company continues to follow the guidance of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” as amended. Consequently, compensation related to stock options reflects the difference between the grant price and the fair value of the underlying common shares at the grant date. The Company issues stock options to employees with a grant price equal to the market value of common stock on the grant date.
If the Company had elected to recognize compensation cost based on the fair value at the date of grant, consistent with the method as prescribed by SFAS No. 123, net income would have changed to the pro forma amounts indicated below:
The pro forma net income may not be representative of future disclosures since additional options may be granted in varying quantities in future years.
Pro forma information regarding net income and earnings per common share has been estimated at the date of grant using the Black-Scholes option-pricing model based on the following assumptions:
The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable and negotiable in a free trading market. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company’s options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in the opinion of management, the existing models do not necessarily provide a reliable single measure of the fair value of its options.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(s) Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per common share:
As of September 30, 2004, 2003 and 2002 there were approximately 60,000, 787,869 and 7,477 shares of common stock issuable upon the exercise of stock options, respectively, not included in the above denominator as their effect is antidilutive.
(t) Reclassification
Certain amounts in the prior year consolidated financial statements have been reclassified to conform to the current year presentation.
(2) Business and Credit Concentrations
Certain of the Company’s Professional Dental products are sold through major distributors selling into primarily the dental segment. No single customer accounted for more than 10% of the Company’s consolidated net sales in 2004 or 2002, however, in 2003 one customer did account for sales in excess of 10% of the Company’s consolidated net sales. Accounts receivable from each of these distributors was less than 10% of the outstanding consolidated accounts receivable balances at September 30, 2004 and 2003.
(3) Inventories
Inventories at September 30, 2004 and 2003 consist of the following:
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(4) Income Taxes
Total income tax expense (benefit) for the years ended September 30, 2004, 2003 and 2002 is allocated as follows:
The domestic and foreign components of income before income taxes are as follows:
Income tax expense differed from the amounts computed by applying the U.S. Federal income tax rate of 35 percent to income before income taxes in 2004, 2003 and 2002 as a result of the following:
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The significant components of deferred income tax expense (benefit) for 2004, 2003 and 2002 are as follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at September 30, 2004 and 2003 are presented below.
The change in the net deferred tax liabilities contains $182 of deferred tax assets and $170 of deferred tax liabilities related to the fair values of the Company’s derivative financial instruments and pensions, respectively. The net change in the total valuation allowance for the years ended September 30, 2004 and 2003 was a decrease of $7 and $41, respectively. The valuation allowance for deferred tax assets as of the beginning of fiscal 2004 was $611. The valuation allowance relates primarily to net operating loss carry forwards in certain foreign jurisdictions, in which there is a history of pre-tax accounting losses. Management is unable to conclude that there will be pre-tax accounting income in those jurisdictions in the near term. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.
At September 30, 2004, the Company has an aggregate of $1,725 of foreign net operating loss carry forwards from certain foreign jurisdictions, the majority of which expire between 2005 and 2014.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Accumulated earnings of foreign subsidiaries at September 30, 2004, 2003 and 2002 of approximately $105,000, $71,000, and $51,000 respectively, have been reinvested in the business and no provision for income taxes has been made for the repatriation of these earnings.
President Bush recently signed the American Jobs Creation Act of 2004 (the Jobs Creation Act). The Jobs Creation Act contains a number of provisions that might affect the Company’s future effective tax rate. The most significant provision would allow the Company to elect to deduct from its taxable income 85% of certain eligible dividends received by the Company from non-U.S. subsidiaries before the end of 2005 if those dividends are reinvested in the U.S. for eligible purposes. The Company is currently evaluating the amount of such eligible dividends that its non-U.S. subsidiaries will remit, as well as the effects the Jobs Creation Act will have on its effective tax rate and deferred tax assets and liabilities.
(5) Property, Plant and Equipment
Major classifications of property, plant and equipment at September 30, 2004 and 2003 are as follows:
(6) Goodwill and Intangible Assets
In June 2001, the FASB issued SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 requires that the purchase method of accounting be used for all business combinations. SFAS No. 141 specifies criteria that intangible assets acquired in a business combination must meet to be recognized and reported separately from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized to earnings, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
The Company adopted the provisions of SFAS No. 141 as of July 1, 2001, and SFAS No. 142 as of October 1, 2002. Upon adoption of SFAS No. 142, the Company was required to evaluate its existing intangible assets and goodwill that were acquired in purchase business combinations, and make any necessary reclassifications in order to conform with the new classification criteria in SFAS No. 141 for recognition separate from goodwill.
Intangible Assets
The Company was required to reassess the useful lives and residual values of all intangible assets acquired, and make any necessary amortization period adjustments by the end of the first interim period after adoption. If an intangible asset was identified as having an indefinite useful life, the Company was required to test the intangible asset for impairment in accordance with the provisions of SFAS No. 142 within the first interim
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
period. Impairment is measured as the excess of carrying value over the fair value of an intangible asset with an indefinite life. Any impairment loss was to be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period. The Company did not record any impairment charge upon the adoption of SFAS No. 142.
Goodwill
In connection with the SFAS No. 142 transitional goodwill impairment evaluation, SFAS No. 142 required the Company to perform an assessment of whether there was an indication that goodwill was impaired as of the date of adoption, October 1, 2002. To accomplish this, the Company identified its reporting units and determined the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of October 1, 2003 and 2002. The Company then determined the fair value of each reporting unit and compared it to the carrying amount of the reporting unit. The Company has determined that no goodwill impairment existed as of September 30, 2004 and 2003.
The Company recorded amortization expense of goodwill and certain other intangible assets in the amount of $8,859 for the fiscal year ended September 30, 2002. No amortization expense was recorded for goodwill or those certain other intangible assets deemed to have indefinite lives for the subsequent fiscal years because those items are no longer being amortized under the provisions of SFAS No. 142.
The following table reconciles previously reported net income as if the provisions of SFAS No. 142 were in effect in fiscal 2002:
The following table details the balances of the goodwill assets by reporting segment as of September 30:
The increase in goodwill in fiscal 2004 from the prior fiscal year is due to acquisition goodwill of $6,299, a favorable foreign currency fluctuation of $3,769 and other of $110. The increase in goodwill from $241,405 in fiscal 2002 to $258,590 in fiscal 2003 is due to acquisition goodwill of $10,251, a favorable foreign currency fluctuation of $6,407 and other of $527.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table details the balances of the amortizable intangible assets as of September 30, 2004:
The following table details the balances of the amortizable intangible assets as of September 30, 2003:
The following table represents the estimated amortization (calculated as of September 30, 2004) for each of the years indicated:
(7) Long-Term Debt
Credit Facilities and Senior Subordinated Notes: On June 6, 2002, the Company terminated its then existing $450,000 credit facility and entered into a new $350,000 syndicated credit facility for which Credit Suisse First Boston is the administrative agent. The credit facility (the “Credit Facility”), provides for a five-year $120,000 revolving credit facility (the “Revolver”), a seven-year $200,000 term loan (the “Term Loan B”) and a five-year $30,000 revolving credit facility (the “Euro Tranche”). Sybron Dental Specialties, Inc., Kerr Corporation, Ormco Corporation and Pinnacle Products, Inc. (the “Domestic Borrowers”) are joint and several borrowers under the Revolver and the Term Loan B, and Hawe Neos Holding S.A. (“Hawe Neos”) is the borrower under the Euro Tranche. Sybron Dental Specialties became a borrower under the Revolver and Term Loan B as a result of the merger of Sybron Dental Management into Sybron Dental Specialties effective January 1, 2003. In addition to the Credit Facility, the Company also completed on June 6, 2002, the sale of $150,000 of 8 1/8% senior subordinated notes due 2012 (the “Senior Subordinated Notes”) in a private offering. The Company used the proceeds of the Term Loan B, together with the net proceeds from the issuance of the Senior Subordinated Notes, to repay all of the $332,853 of borrowings outstanding as of June 6, 2002 under its previous credit facility.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Credit Facility is jointly and severally guaranteed by Sybron Dental Specialties, Inc., the other Domestic Borrowers and each of the Company’s present and future direct and indirect wholly-owned domestic subsidiaries, and is secured by substantially all assets of each such entity, including the capital stock of each domestic subsidiary. In addition, the Credit Facility is secured by a pledge of 65% of the capital stock of each of the Company’s first-tier material foreign subsidiaries. The Euro Tranche is also guaranteed by certain foreign subsidiaries and is secured by a pledge of 100% of the capital stock of certain foreign subsidiaries and by some of the assets of the Company’s Swiss subsidiary, Hawe Neos, certain direct subsidiaries of Hawe Neos and certain of the Company’s other indirect foreign subsidiaries.
The Credit Facility may be prepaid at any time without penalty except for LIBOR and Euro-LIBOR breakage costs. Under the Credit Facility, subject to certain exceptions, the Company is required to apply all of the proceeds from any issuance of debt, half of the proceeds from any issuance of equity, half of its excess annual cash flow and, subject to permitted reinvestments, all amounts received in connection with any sale of its assets and casualty insurance and condemnation or eminent domain proceedings, in each case to repay the outstanding amounts under the facility.
The Term Loan B amortizes 1% annually for the first six years, payable quarterly, with the balance to be paid in the seventh year in equal quarterly installments. As a result of the upgrade in the Company’s credit rating by Standard & Poor’s and Moody’s Investors Service, the Company amended its credit facility effective July 14, 2004, and received a 50 basis point reduction in the margin on its Term B Loan. The Term Loan B now bears interest, at the Company’s option, at either (a) the LIBOR rate, plus between 175 and 225 basis points, or (b) the Base rate, plus between 75 and 125 basis points, in each case as determined according to the rating of the Credit Facility by Standard and Poor’s and Moody’s. The per annum interest rate ending September 30, 2004 was LIBOR, plus 175 basis points. As of September 30, 2004, the amount outstanding on the Term Loan B was $62,511. The average interest rate at September 30, 2004 on the Term Loan B was 4.79% after giving effect to the interest rate swap agreements the Company had in effect as of that date.
The Revolver bears interest, at the Company’s option, at a per annum rate equal to either (a) the LIBOR rate, plus between 175 and 250 basis points, or (b) the Base rate, plus between 75 and 150 basis points, in each case as determined on a quarterly basis according to a leveraged-based pricing grid with leverage ratios from 1.75x to 3.0x. The per annum interest rate as of September 30, 2004 was LIBOR, plus 200 basis points. The annual commitment fee on the unused portion of the Revolver will vary between 0.375% to 0.5% based on the quarterly leverage ratio. As of September 30, 2004 there was no outstanding balance on the Revolver and the amount available was $115,822. The Revolver also provides for the issuance of standby letters of credit and commercial letters of credit as required in the ordinary course of business. As of September 30, 2004, letters of credit totaling $4,178 were issued.
The Euro Tranche bears interest, at the Company’s option, at Euro-LIBOR or at Base rates with margins identical to those of the Revolver. The annual commitment fee on the unused portion of the Euro Tranche varies between 0.375% to 0.5% based on the quarterly leverage ratio. As of September 30, 2004, there was no outstanding balance under the Euro Tranche and the amount available was $30,000.
The Credit Facility contains certain covenants, including, without limitation, restrictions on: (i) debt and liens, (ii) the sale of assets, (iii) mergers, acquisitions and other business combinations, (iv) transactions with affiliates, (v) capital expenditures, (vi) restricted payments, including repurchase or redemptions of the notes, (vii) the expenditure of more than $100,000 to repurchase or redeem stock from or to pay cash dividends to the Company’s stockholders, and (viii) loans and investments. The Credit Facility also has certain financial covenants, including, without limitation, maximum leverage ratios, minimum fixed charge coverage ratios, minimum net worth and maximum capital expenditures.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Company was in compliance with all such covenants at September 30, 2004.
Long-term borrowings at September 30, 2004 and 2003 consists of the following:
Sale/Leaseback: In 1988, the Company completed the sale and leaseback (the “Sale/Leaseback”) of its then principal domestic manufacturing and office facilities with an unaffiliated third party. The transaction has been accounted for as a financing for financial statement purposes, thus the facilities remain in property, plant and equipment. The transaction was a sale for income tax purposes. The financing obligation is being amortized over the initial 25-year lease term.
The initial term of each lease is 25 years with five five-year renewal options and provides the option to purchase the leased premises at fair market value from June 1, 2008 to May 31, 2009. On the fifth anniversary of the leases and every five years thereafter (including renewal terms), the rent is increased by the percentage equal to 75% of the percentage increase in the Consumer Price Index over the preceding five years. The percentage increase to the rent in any five-year period is capped at 15%. In January 1, 2004, the annual rent payments increased from $1,463 to $1,770. The next adjustment will occur January 1, 2009.
The Company pays all costs of maintenance and repair, insurance, taxes and all other expenses associated with the properties. In addition, each of the leases is unconditionally guaranteed by the Company.
The Company has the option to purchase the facilities according to the terms of any bona fide offer received by the lessor from a third party at any time during the term of the leases. The Company may be obligated to repurchase the property upon the event of a breach of certain covenants or occurrence of certain other events.
Maturities of long-term borrowings reflect the Credit Facility, Senior Subordinated Notes, Sale/ Leaseback, and other long-term debt as of September 30, 2004 as follows:
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(8) Lease Commitments
As of September 30, 2004, minimum rentals, excluding rent payments under the Sale/Leaseback described in Note 7, under capital and noncancellable operating leases consisting primarily of machinery and equipment, and building leases are:
Amortization of assets held under capital leases is included with depreciation expense.
Rental expense under operating leases was $7,151, $6,930 and $5,754 in 2004, 2003 and 2002, respectively.
(9) Fair Value of Financial Instruments
The carrying amounts of financial instruments approximate fair value due to the short maturity of those instruments except as follows:
Long-Term Borrowings
Credit Facility: The fair value of the Credit Facility as of September 30, 2004 approximates the carrying amount, as the interest rates are variable and approximate rates that the Company could obtain under similar terms at the balance sheet date. The fair value of the Company’s Senior Subordinated Notes is based on quoted market prices and was approximately $162,750 at September 30, 2004.
Derivatives: The Company had interest rate swaps, cross currency debt swaps and foreign exchange zero cost collars in place at September 30, 2004 (see Note 10). The fair values of these instruments were provided by third party broker/bankers.
The estimated fair values of the Company’s financial instruments have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimation methodologies may have a material impact on the estimated fair value amounts.
(10) Derivatives
Foreign Exchange Currency Risk Management
SDS operates internationally; therefore, its earnings, cash flows, and financial position are exposed to foreign currency risk from foreign currency denominated receivables and payables, forecasted sales transactions, as well as net investments in certain foreign operations. These items are denominated in foreign currencies, including but not limited to the euro, Japanese yen, Swiss franc, Mexican peso, Canadian dollar, Czech koruna and the Australian dollar.
For fiscal year 2005, the Company’s projected total foreign currency exposure is approximately 80,762 euros, 786,683 Japanese yen, 7,728 Canadian dollars, 17,491 Australian dollars, 11,596 Mexican pesos, 60,761 Czech koruna, and 18,058 Swiss francs. The Company has put in place a strategy to manage its euro, Japanese yen, and Australian dollar cash flow exposure through the use of zero cost collar contracts. There were no such contracts in place for the Canadian dollar, Australian dollar, Mexican peso, Czech koruna and Swiss franc at September 30, 2004.
In December 2003, as well as in January, May, and June 2004, the Company entered into a series of zero cost collar contracts to hedge intercompany transactions with a total notional amount of 39,000 euros, 720,000 Japanese yen, and 7,200 Australian dollars for fiscal year 2005.
For fiscal year 2004, an unrealized loss of $329 (net of income tax), representing the fair value of the zero cost collars, is included in accumulated other comprehensive income (loss). In addition, none of the foreign currency cash flow hedges have been discontinued.
Zero cost collar contracts in place as of September 30, 2004 are as follows:
In January, March, April, and May 2003, the Company entered into a series of zero cost collar contracts to hedge intercompany transactions with a total notional amount of 42,000 euros and 720,000 Japanese yen for fiscal year 2004. Both the euro zero cost collar contracts and the yen zero cost collar contracts for fiscal year 2004 matured on September 30, 2004.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
For fiscal year 2003, approximately $1,961 of loss (net of income tax) representing the fair value of the zero cost collars, is included in accumulated other comprehensive income (loss), related to the foreign currency zero cost collar transactions. In addition, none of the foreign currency cash flow hedges has been discontinued.
Zero cost collar contracts in place as of September 30, 2003 are as follows:
In July and November 2002, the Company entered into a series of zero cost collar contracts to hedge its intercompany transactions with a total notional amount of 40,500 euros for fiscal year 2003. Also, in June 2002, the Company entered into a zero cost collar contract to hedge a total notional amount of 720,000 Japanese yen for fiscal year 2003. Both the euro zero cost collar contracts and the yen zero cost collar contract for fiscal year 2003 matured on September 30, 2003.
During the year ending September 30, 2005, approximately $531 of loss in accumulated other comprehensive income (loss) related to the zero cost collars are expected to be reclassified into foreign exchange loss/gain as a yield adjustment of the hedged foreign currency representing the fair value of the zero cost collars.
In June 2002, the Company entered into four cross currency debt swap transactions to hedge the Company’s net investment in Hawe Neos and one cross currency debt swap transaction to hedge the Company’s net investment in SDS Japan. The agreements are contracts to exchange U.S. dollar principal aggregating a total amount of $45,000 in exchange for a Swiss franc principal aggregating a total amount of 67,500 CHF and U.S. dollar principal amount of $4,000 in exchange for 486,000 Japanese yen. Both the Swiss franc contracts and the Japanese yen contract mature on June 15, 2007. The fixed interest rate to be paid to the Company on the U.S. dollar leg of the agreements is a rate equal to the Senior Subordinated Notes rate of 8 1/8% while the fixed interest rate to be paid by the Company on the Swiss franc leg of the agreements ranges from 6.39% to 6.45% and the Japanese yen leg of the agreements is 3.65%, with the interest payments due semi-annually.
The following are the details of the cross currency debt swaps:
For fiscal 2004, an unrealized loss of $6,737 (net of income tax), representing the fair value of the cross currency debt swap, was included in accumulated other comprehensive income (loss).
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Interest Rate Exposure - Interest Rate Risk Management
The Company uses the Credit Facility and Senior Subordinated Notes to finance its operations. The Credit Facility exposes the Company to variability in interest payments due to changes in interest rates. If the Company’s interest rates increase, interest expense increases. Conversely, if the Company’s interest rates decrease, interest expense also decreases. The Company entered into interest rate swap agreements to manage fluctuations in cash flows resulting from interest rate risk. These interest rate swaps change a portion of the Company’s variable-rate cash flow exposure to fixed-rate cash flows. The Company continues to assess its exposure to interest rate risk on an ongoing basis.
The table below provides information about the Company’s debt obligations that are sensitive to changes in interest rates as of September 30, 2004. For these debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. Weighted average variable rates are based on implied forward 3-month LIBOR rates in the yield curve at the reporting date. The information is presented in U.S. dollar equivalents.
For fiscal year ended 2004, the total net cost of converting from floating rate (3-month LIBOR) to fixed rate from a portion of the interest payments of the debt obligations was $1,695. Below is a table listing the interest expense exposure detail, including the notional amount as of September 30, 2004:
For fiscal year ended 2003, the total net cost of converting from floating rate (3-month LIBOR) to fixed rate from a portion of the interest payments of the debt obligations was $1,220. Below is a table listing the interest expense exposure detail, including the notional amount as of September 30, 2003:
The fair value of interest rate swap agreements designated as hedging instruments against the variability of cash flows associated with floating-rate, long-term debt obligations are reported in accumulated other comprehensive income (loss). These amounts subsequently are reclassified into interest expense as a yield adjustment in the same period in which the related interest on the floating-rate debt obligations affects earnings.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
During the year ended September 30, 2004, an approximate $965 loss (net of income tax) was recorded in accumulated other comprehensive income (loss). The fair values of the interest rate swap agreements as of September 30, 2004 are as follows:
During the year ended September 30, 2003, an approximate $2,116 loss (net of income tax) was recorded in accumulated other comprehensive income (loss). The fair values of the interest rate swap agreements as of September 30, 2003 are as follows:
During the year ended September 30, 2002, an approximate $2,499 loss (net of income tax) was recorded in accumulated other comprehensive income (loss). Fair value of the interest rate swap agreements as of September 30, 2002 are as follows:
(11) Employee Benefit Plans
Pension and Other Postretirement Benefits: The Company participates in various defined benefit pension plans covering substantially all of its U.S. and Canadian employees. The benefits are generally based on various formulas, the principal factors of which are years of service and compensation. The Company’s funding policy is to generally make annual contributions in excess of both the minimum required contributions required by applicable regulations and the amount needed in order to avoid any Pension Benefit Guarantee Corporation (“PBGC”) variable premium payments. Plan assets are invested primarily in U.S. stocks, bonds and international stocks. In addition to the defined benefit plans, the Company provides certain health care benefits for certain US employees, which are funded as costs are incurred. Eligible salaried employees who reached age 55 prior to January 1, 1996 became eligible for postretirement health care benefits only if they reach retirement age while working for SDS. The Company accrues, as current costs, the future lifetime retirement benefits for qualifying active employees. The postretirement health care plans currently follow a policy instituted by the predecessor of Apogent in 1986 where the Company’s contributions were frozen at the levels equal to the Corporation’s contributions on December 31, 1988, except where collective bargaining agreements and voluntary early retirement separation agreements prohibited such a freeze.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following assumptions were used in determining the funded status of the Company’s defined benefit pension plans:
For U.S. pension plans, the overall expected return on assets assumption was based on an asset mix of 70% equity and 30% fixed income. Equity returns were based on capitalization weighted Center for Research in Security Prices (“CRSP”) 1-10 Index from 1926 to 1972 and the Wilshire 5000 Index from 1971 to 2003. Fixed income returns were based on the 5 year Treasury Note from 1926 to 1972 and the Lehman Brothers Intermediate Bond Index from 1973 to 2003. The expected nominal return on this basis is 9.4%. For the Canadian pension plan, the overall expected return on assets assumption was based on an asset mix of 70% equity and 30% fixed income. Equity and fixed income returns were based on Canadian investment manager surveys for the mid to long-term horizon. The expected nominal return on this basis is 8.78%.
The following assumptions were used in determining the accumulated postretirement benefit obligation of the Company’s postretirement healthcare plans.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table provides the amounts recognized in the Company’s consolidated balance sheets:
The following table provides disclosure of the net periodic benefit cost:
At September 30, 2004 and 2003, all plans had projected benefit obligations in excess of fair value of the plan assets. At September 30, 2004 and 2003, the Company’s U.S. pension plans, except the Supplemental Executive Retirement Program, had pension assets in excess of their accumulated benefit obligations. All plans are funded above required funding levels.
An increase of one percentage point in the per capita cost of health care costs associated with the plans for which the Company’s contributions are not frozen would increase the accumulated postretirement benefit obligation and service and interest cost components as of September 30, 2004 by approximately $2,394 and $312, respectively. Similarly, a decrease of one percentage point in the per capita cost of health care costs would decrease the accumulated postretirement benefit obligation and service and interest cost components as of September 30, 2004 by approximately $1,899 and $188, respectively.
Plan Assets
The Sybron Dental Specialties pension plans’ asset allocation by asset category is as follows:
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The target asset allocation of the plan assets of the U.S. pension plans is:
The target asset allocation of the plan assets of the Canadian pension plan is:
Cash Flows
Contributions
The Company expects to contribute approximately $371 to its pension plans in fiscal 2005.
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
Savings Plans: Employees in the United States are eligible to participate in contributory savings plans maintained by the Company under Section 401(k) of the Internal Revenue Code of 1986, as amended (the “Code”). Company matching contributions under the plans, net of forfeitures, were approximately $1,589, $1,497 and $1,482 for 2004, 2003 and 2002, respectively.
(12) Restructuring and Merger and Integration Charges
In fiscal 2004, the Company implemented and completed a plan to close its facility in Tijuana, Mexico and as a result of this plan, recorded restructuring charges of $1,471 ($986 after tax) in the fiscal year ended 2004. The charges are recorded as a component of cost of goods sold and are comprised of severance and termination costs associated with the 246 employees whose employment the Company terminated as a result of the closure. Of the $1,471 in restructuring charges $258 remains in accrued liabilities until all severance is paid.
In September 2002, the Company recorded a restructuring charge of approximately $3,666 ($2,353 after tax). The charge is primarily comprised of severance and termination costs associated with the 71 employees whose employment the Company terminated as a result of the consolidation of several of its European facilities into its Hawe Neos facility in Switzerland. Of the $3,666 restructuring charge, approximately $3,064 is related to
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
cash payments for severance and contractual obligations, $300 for the cash payment of tax liabilities included in income taxes payable while the balance of approximately $302 relates to non-cash charges. The Company completed the 2002 restructuring in fiscal 2004, and made an adjustment to restructuring charges of approximately $200, primarily for the over accruals for anticipated costs associated with severance and related costs. A balance of $300 remains in the Company’s accrued tax liability until it is remitted.
The 2002 restructuring charge activity since September 30, 2002 and its components are as follows:
(a) The amount primarily represents the charges for severance and termination costs associated with the 71 employees primarily located at several facilities throughout Europe whose employment the Company terminated as a result of the 2002 European restructuring plan.
(b) Amount represents lease payments on exited facilities.
(c) Amount represents write-offs of inventory and fixed assets associated with discontinued product lines.
(d) Amount represents $300 for tax liabilities included in income taxes payable.
(e) Amount represents certain contractual obligations.
In June 1998, the Company recorded a restructuring charge of approximately $14,600 (approximately $10,700 after tax) for the rationalization of certain acquired companies, combination of certain duplicate production facilities, movement of certain customer service and marketing functions, and the exiting of several product lines. In fiscal 2004 the Company made an adjustment to restructuring charges of approximately $200 to adjust the accrual primarily representing over accruals for anticipated costs associated with the restructuring activity. A tax liability of approximately $700 remains in the Company’s accrued tax liability until it is remitted.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The 1998 restructuring charge activity since June 30, 1998 and its components are as follows:
(a) The amount primarily represents severance and termination costs related to the 154 employees whose employment was terminated as a result of the 1998 restructuring plan. An adjustment of approximately $1,200 was made in fiscal 1999 to adjust the accrual primarily representing over accruals for anticipated costs associated with outplacement services, accrued fringe benefits, and severance associated with employees who were previously notified of termination and subsequently filled other company positions.
(b) Amount represents lease payments and shutdown costs on exited facilities.
(c) Amount represents write-offs of inventory and fixed assets associated with discontinued product lines.
(d) The charge of $700 represents a statutory tax relating to assets transferred from an exited sales facility in Switzerland.
(e) Amount represents certain contractual obligations.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(13) Stock-Based Compensation
Under SDS’s 2000 Long-Term Incentive Plan (the “2000 Stock Plan”), incentive stock options and nonqualified stock options may be granted to any full-time, non-union employee of SDS or any of its subsidiaries, including any employee who is a member of the Board of Directors, but excluding any director who is not an employee of SDS or any of its subsidiaries. Subject to the terms and provisions of the plan, options may be granted to eligible employees selected by the compensation committee of the Board of Directors, which administers the plan. The committee has the discretion to determine the number of shares subject to options granted and the terms and conditions of the options. The exercise price of an option granted under the plan is determined by the committee, but may not be less than 100% of the fair market value of the underlying SDS common stock on the date of grant.
The total number of shares of SDS common stock authorized for issuance under the 2000 Stock Plan is 5,450,000. Shares available for an award under the 2000 Stock Plan may be either authorized but unissued or reacquired shares. If any award is canceled, terminates, expires or lapses for any reason, any shares subject to such award shall again be available under the plan, subject to such requirements as may be promulgated by the compensation committee. The number of options that may be awarded to any employee during any fiscal year is limited to 1,000,000.
On September 25, 2001, SDS established the Sybron Dental Specialties, Inc. 2001 Long-Term Incentive Plan (the “2001 Stock Plan”). The 2001 Stock Plan permits the granting of nonqualified stock options to any full-time, non-union employee of SDS or any of its subsidiaries, excluding officers or directors of SDS. Subject to the terms and provisions of the 2001 Stock Plan, options may be granted to eligible employees selected by the compensation committee of the Board of Directors, which administers the 2001 Stock Plan. The committee has the discretion to determine the number of shares subject to options granted and the terms and conditions of the options. The exercise price of an option granted under the 2001 Stock Plan is determined by the committee, but may not be less than 100% of the fair market value of the underlying SDS common stock on the date of grant.
The total number of shares of SDS common stock authorized for issuance under the 2001 Stock Plan is 1,000,000. Shares available for an award under the 2001 Stock Plan may be either authorized but unissued or reacquired shares. If any award is canceled, terminates, expires or lapses for any reason, any shares subject to such award shall again be available under the 2001 Stock Plan, subject to such requirements as may be promulgated by the compensation committee.
Options granted under the 2000 Stock Plan and the 2001 Stock Plan are exercisable up to ten years from date of grant. Stock options vest under the plans subject to the restrictions and conditions that the compensation committee approves. Typically the vesting schedule is 25% per year based on the date of grant.
The 2000 Outside Directors’ Stock Option Plan (the “Directors’ Plan”) is administered by the compensation committee of the Board of Directors. A maximum of 300,000 shares of SDS common stock may be issued pursuant to the exercise of nonqualified stock options granted under the Directors’ Plan. Shares subject to and not issued under an option which expires, terminates or is canceled for any reason shall again become available for the granting of options under the Directors’ Plan. These options are exercisable up to ten years from date of grant and vest on the date of grant.
The granting of options is automatic under the Directors’ Plan. Upon the first meeting of the Board of Directors following the annual meeting of stockholders in 2001 through 2005, each person then serving SDS as a member of the Board of Directors who is not a full-time employee of SDS or its subsidiaries shall automatically be granted an option to purchase 10,000 shares of SDS common stock (subject to appropriate adjustment for
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
stock splits and other changes affecting the common stock). If there is not a sufficient number of remaining available shares under the Directors’ Plan to grant each outside director an option to purchase the number of shares specified, each outside director shall receive an option to purchase an equal number of the remaining available shares, determined by dividing the remaining available shares by the number of outside directors. The exercise price at which shares may be purchased under each option shall be 100% of the fair market value of SDS common stock on the date the option is granted.
At September 30, 2004, 521,318 shares of common stock were reserved for future stock option grants under the above plans.
The following is a summary of the stock option activity since September 30, 2001:
The following table summarizes information regarding options outstanding and options exercisable at September 30, 2004:
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Employee Stock Purchase Plan (“ESPP”) was approved by stockholders at the 2003 Annual Meeting of Stockholders. Under the terms of the ESPP, 446,894 shares of common stock have been reserved and are available for issuance as of September 30, 2004 to employees of the Company, nearly all of whom are eligible to participate. Under the terms of the plan, employees can choose each year to have one to ten percent of their base pay withheld, not to exceed amounts allowed by the Internal Revenue Code, to purchase the Company’s common stock. The purchase price of the stock is 85 percent of the lower of its price at the beginning or end of each six month offering period. During fiscal 2004, 53,106 shares of common stock were purchased at an average price of $22.05 per share. As the initial offering period of the ESPP ended on December 31, 2003, no shares of common stock were purchased under the ESPP prior to fiscal 2004.
(14) Commitments and Contingent Liabilities
The Company or its subsidiaries are at any one time parties to a number of lawsuits or subject to claims arising out of their respective operations, including products liability, patent and trademark or other intellectual property infringement, contractual liability, workplace safety and environmental claims and cases, some of which involve claims for substantial damages. The Company and its subsidiaries are vigorously defending lawsuits and other claims against them. The Company believes that any liabilities which might reasonably be expected to result from any of the pending cases and claims would not have a material adverse effect on the results of operations or financial condition of the Company, even if it is unable to recover amounts that it expects to recover with respect to those pending cases and claims through insurance, indemnification arrangements, or other sources. There can be no assurance as to this, however, or that litigation having such a material adverse effect will not arise in the future.
The Company utilizes third-party insurance for losses and liabilities associated with its operations, including workers compensation. The liability claims are subject to established deductible levels on a per occurrence basis. Losses up to these deductible levels are accrued based upon the Company’s estimates of the aggregate liability for claims incurred based on Company experience.
(15) Acquisitions
The Company has completed three acquisitions since the beginning of 2002. The Company is subject to future purchase price adjustments, based upon earnout provisions, under three of the purchase agreements. The earnout provisions are subject to the achievement of certain financial goals. The acquired companies are all engaged in businesses related to the Company (see Note 17 for a description of business segments).
Acquisition
During fiscal 2004, the Company’s Professional Dental segment completed one acquisition for a business from Bioplant Products, Inc. that manufactures and sells products for use in bone regeneration following the extraction of a tooth. The Company acquired the business in order to expand its offering of restorative products. The Company paid approximately $6,702 for the purchase of the Bioplant Products, Inc. business. The preliminary allocation of the purchase price, based on the estimated fair values of acquired net assets, reflects acquired goodwill of approximately $6,299 with the remaining acquisition cost allocated to the acquired net assets. The results of this acquisition are included in the Company’s results of operations as of the date it was acquired.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Acquisition
During fiscal 2003, the Company completed one stock acquisition in the Professional Dental segment in August 2003. The Company acquired SpofaDental a.s. in order to expand its presence in key Central and Eastern European markets. The purchase price of the stock the Company paid for the acquisition of SpofaDental a.s., including acquisition related expenses, and net of cash acquired, was approximately $16,237. The allocation of the purchase price, based on the estimated fair values of acquired net assets and liabilities assumed, reflects acquired goodwill of approximately $10,251, with the remaining acquisition cost allocated to the acquired net assets. The results of this acquisition are included in the Company’s results of operations as of the date it was acquired.
The following unaudited pro forma financial information presents the consolidated results of the operations of the Company and the purchased businesses referred to above as if the 2004 and 2003 acquisitions had occurred as of the beginning of 2003 after giving effect to certain adjustments, including additional depreciation expense, increased interest expense on debt related to the acquisitions and related tax effects. The pro forma information does not necessarily reflect the results of operations that would have occurred had the Company and the acquired companies constituted a single entity during such periods.
(16) Stockholders’ Equity
Shareholder Rights Plan: On December 8, 2000, the Board of Directors adopted a Rights Agreement pursuant to which Rights are distributed as a dividend at the rate of one Right for each share of common stock, par value $.01 per share, of the Company outstanding upon consummation of the spin-off from Apogent on December 11, 2000, or issued thereafter. Each Right initially will entitle stockholders to buy one one-hundredth of a share of a series of preferred stock for sixty-five dollars. The Rights generally will be exercisable if a person or group acquires beneficial ownership of 15 percent or more of the Company’s common stock or commences a tender or exchange offer upon consummation of which such person or group would beneficially own 15 percent or more of the Company’s common stock. Thereafter, or if thereafter the Company is involved in a merger or certain other business combinations not approved by the Board of Directors, each Right will entitle its holder, other than the acquiring person or group, to purchase common stock of either the Company or the acquirer having a value of twice the exercise price of the Right. The Rights are attached to the common stock unless and until they become exercisable and will expire on December 11, 2010, unless earlier redeemed by the Company for $.01 each, or exchanged by the Company as provided in the Rights Agreement.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Other Comprehensive Income (Loss)
(17) Segment Information
The Company’s operating subsidiaries are engaged in the manufacture and sale of dental products in the United States and other countries. Dental products were categorized in the business segments of Professional Dental and Specialty Products. The Specialty Products segment was previously referred to as the Orthodontics segment. The name was changed to more accurately describe the products of this segment. The composition of the Specialty Products segment has not changed. A description of the business segments follows:
Products in the Professional Dental business segment include light cured composite filling materials and bonding agents, amalgam alloy filling materials, dental burs, impression materials, and curing lights used in general dentistry, filling materials, waxes, specialty burs, investment and casting materials, equipment and accessories used in dental laboratories, disposable infection prevention products for dental equipment, high level disinfectants and sterilants, and enzymatic cleaners and instruments care solutions for medial and dental instruments, surface disinfectant products and antimicrobial skincare products for medical and dental use.
Products in the Specialty Products business segment include a broad range of orthodontic, endodontic and implant products. Brackets, bands, buccal tubes and wires are manufactured from a variety of metals to exacting specifications for standard use or to meet the custom specifications of a particular orthodontist. Elastomeric orthodontic products include rubber bands and power chains to consolidate space. Products in this area also include orthodontic instruments and general orthodontic supply products.
The corporate office general and administrative expenses have been allocated to the segments on the basis of net sales.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Information on these business segments is summarized as follows:
In fiscal 2004 and fiscal 2002, no one distributor accounted for more than 10% of the Company’s consolidated net sales, selling primarily into the dental segment. In fiscal 2003, one customer accounted for more than 10% of consolidated net sales.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table presents the segment assets and expenditures for property, plant and equipment as of September 30, 2004, 2003 and 2002:
The Company’s international operations are conducted principally in Europe. Inter-geographic sales are made at prices approximating market.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(18) Quarterly Financial Information (unaudited)
(a) In the second quarter of fiscal 2004 the Company recorded expenses of $1,500 related to our facility rationalization in Mexico and $700 related to our facility rationalizations in Eastern Europe.
(b) On October 1, 2002, the Company adopted the provisions of the Statement of Accounting Financial Standards No. 142, and accordingly, discontinued amortizing goodwill and certain other intangible assets in fiscal 2003. The Company’s fiscal 2003 results also include a $500 gain, net of tax, on the sale of the San Diego facility in the second quarter and a $900 tax benefit of a settlement in Canada in the fourth quarter.
(c) Restructuring charges were recorded in the amount of $3,666 in the fourth quarter of 2002.
(19) Condensed Consolidating Financial Information
The Company’s domestic subsidiaries are guarantors of the Company’s 8 1/8% Senior Subordinated Notes due 2012, on an unsecured senior subordinated basis. Except to the extent necessary to avoid a fraudulent conveyance, the note guarantees are full and unconditional. The notes and the subsidiary guarantees are unsecured and subordinated to all of the Company’s and the Company’s guarantor subsidiaries’ existing and future unsubordinated debt, including debt under the Credit Facility entered into on June 6, 2002.
Prior to January 1, 2003, Sybron Dental Management was a guarantor subsidiary of the Company’s Senior Subordinated Notes. Effective January 1, 2003, Sybron Dental Management was merged into SDS. Prior period condensed consolidating financial information has been adjusted to reflect this merger.
Below are the unaudited condensed consolidating balance sheets as of September 30, 2004, and 2003, statements of operations for the years ended September 30, 2004, 2003 and 2002, and statements of cash flows
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
for the years ended September 30, 2004, 2003, and 2002, of Sybron Dental Specialties, Inc. and its subsidiaries, reflecting the subsidiary guarantors of the Senior Subordinated Notes.
Certain general corporate expenses have been allocated to the subsidiaries. As a matter of course, the Company retains certain assets and liabilities at the corporate level that are not allocated to the subsidiaries including, but not limited to, certain employee benefit, insurance and tax liabilities. Intercompany balances include receivables/payables incurred in the normal course of business in addition to investments and loans transacted by subsidiaries of the Company with other subsidiaries or with the Company.
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Condensed Consolidating Balance Sheets
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Condensed Consolidating Statements of Operations
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Condensed Consolidating Statement of Cash Flows
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Condensed Consolidating Statement of Cash Flows
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Condensed Consolidating Statement of Cash Flows
(20) Subsequent Event
On October 15, 2004 the Company acquired Innova LifeSciences Corporation (“Innova”), a Canadian manufacturer and marketer of dental implants, for approximately $47,409. Innova markets its products to oral surgeons, periodontists, prosthodontists and general dentists.
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
ITEM 9A.
ITEM 9A. Controls and Procedures
Disclosure Controls and Procedures: The Company’s management, with the participation of the Company’s Chief Executive Office and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
Internal Control Over Financial Reporting: The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, also conducted an evaluation of the Company’s internal control over financial reporting to determine whether any changes occurred during the Company’s fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Based on that evaluation, the Company has concluded that there have been no such changes during the fourth fiscal quarter.
ITEM 9B.
ITEM 9B. Other Information
None.
PART III
ITEM 10.
ITEM 10. Directors and Executive Officers of the Registrant
The information called for by Item 10 of Form 10-K with respect to directors, executive officers and the audit committee is incorporated herein by reference to such information included in the Company’s Proxy Statement for the Annual Meeting of Stockholders to be held February 8, 2005 (the “2005 Annual Meeting Proxy Statement”), under the captions “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance,” and to the information under the caption “Executive Officers of the Registrant” in Part I hereof. Additionally, the information included in the Company’s 2005 Annual Meeting Proxy Statement under the caption “Corporate Governance” is incorporated herein by reference.
The information regarding the Company’s audit committee financial expert set forth under the caption “Audit Committee” in the 2005 Annual Meeting Proxy Statement is incorporated herein by reference.
ITEM 11.
ITEM 11. Executive Compensation
The information called for by Item 11 of Form 10-K is incorporated herein by reference to such information included in the 2005 Annual Meeting Proxy Statement under the captions “Executive Compensation” and “Election of Directors - Directors’ Compensation.”
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information called for by Item 12 of Form 10-K is incorporated herein by reference to such information included in the 2005 Annual Meeting Proxy Statement under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information.”
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions
Any information called for by Item 13 of Form 10-K is incorporated herein by reference to such information included in the 2005 Annual Meeting Proxy Statement under the captions “Election of Directors” and “Certain Relationships and Related Transactions.”
ITEM 14.
ITEM 14. Principal Accountant Fees and Services
The information called for by Item 14 is incorporated herein by reference to such information included in the 2005 Annual Meeting Proxy Statement under the captions “Audit Committee - Independent Auditors’ Fees” and “Audit Committee - Pre-Approval Policy.”
PART IV
ITEM 15.
ITEM 15. Exhibits and Financial Statement Schedules
(a) Documents Filed. The following documents are filed as part of this Annual Report or incorporated by reference as indicated:
1. The consolidated financial statements of Sybron Dental Specialties, Inc. and its subsidiaries filed under Item 8:
Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of September 30, 2004 and 2003
Consolidated Statements of Income for the years ended September 30, 2004, 2003 and 2002
Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the years ended September 30, 2004, 2003 and
Consolidated Statements of Cash Flows for the years ended September 30, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
2. Financial Statement Schedules.
The following report and financial statement schedule should be read in conjunction with the consolidated financial statements set forth in Item 8:
Page
Report of Independent Registered Public Accounting Firm
Schedule II - Valuation and Qualifying Accounts
Schedules other than those listed above are omitted because they are not applicable or because the required information is given in the consolidated financial statements and notes thereto.
3. Exhibits and Exhibit Index.
See the Exhibit Index included as the last part of this report, which is incorporated herein by reference. Each management contract and compensatory plan or arrangement required to be filed as an exhibit to this report is identified in the Exhibit Index by an asterisk following its exhibit number.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
December 14, 2004
SYBRON DENTAL SPECIALTIES, INC.
By:
/S/ FLOYD W. PICKRELL, JR.
Floyd W. Pickrell, Jr.,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Sybron Dental Specialties, Inc.:
On November 15, 2004, we reported on the consolidated balance sheets of Sybron Dental Specialties, Inc. and Subsidiaries as of September 30, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended September 30, 2004, which are included in this Annual Report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in the index on Item 8. This consolidated financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
KPMG LLP
Costa Mesa, California
November 15, 2004
SCHEDULE II
SYBRON DENTAL SPECIALTIES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended September 30, 2004, 2003 and 2002
Note: Above additions and deductions include the effects of foreign currency rate changes.
(a) Non-collectable accounts written off, net of recoveries.
(b) Net disbursements.
(c) Includes reserves of acquired businesses.
SYBRON DENTAL SPECIALTIES, INC.
(THE “REGISTRANT”)
(COMMISSION FILE NO. 1-16057)
EXHIBIT INDEX
TO
2004 ANNUAL REPORT ON FORM 10-K
* Denotes management contract or executive compensation plan or arrangement required to be filed as an exhibit pursuant to Item 15 of Form 10-K
** Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant has omitted certain agreements with respect to long-term debt not exceeding 10% of consolidated total assets. The Registrant agrees to furnish a copy of any such agreements to the Securities and Exchange Commission upon request.