**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-Q**

 
| **x** | **Quarterly   Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of   1934** |
|-------|------------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended April 30, 2011.**

 

**or**

 
| **o** | **Transition Report pursuant to Section 13 or   15(d) of the Securities Exchange Act of 1934** |
|-------|-----------------------------------------------------------------------------------------------------|

 

**For the transition period from            to           .**

** **

**Commission file number:   001-31337**

** **

**CANTEL MEDICAL CORP.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                          | ** ** | **22-1760285**                                              |
|-------------------------------------------------------|------------|-------------------------------------------------------------|
| (State or other jurisdiction of                       |       | (I.R.S. employer                                            |
| incorporation or organization)                        |       | identification no.)                                         |
|                                                  |       |                                                        |
| **150 Clove Road, Little   Falls, New Jersey 07424**  | ** ** | **(973) 890-7220**                                          |
| (Address of principal executive   offices) (Zip code) |       | (Registrant’s telephone number,   including area code) |

 

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

 

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

 

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

 

| Large accelerated filer o                  |   | Accelerated filer x         |
|-------------------------------------------------|--------|----------------------------------|
|                                            |   |                             |
| Non-accelerated filer o                    |   | Smaller reporting company o |
| (Do not check if a smaller reporting   company) |   |                             |

 

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

Number of shares of Common Stock outstanding as of May 31, 2011: 17,210,353.

 

 

 

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PART I - FINANCIAL INFORMATION

ITEM 1. - FINANCIAL STATEMENTS

CANTEL MEDICAL CORP.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollar Amounts in Thousands, Except Share Data)

(Unaudited)

 
| ** **                                                                                                                                                                                                                        | ** ** | **April 30,** | ** ** | **July 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                        | ** ** | **2011**           | ** ** | **2010**          | ** ** |
| **Assets**                                                                                                                                                                                                                        |       |               |       |              |       |
| Current assets:                                                                                                                                                                                                                   |       |               |       |              |       |
| Cash and cash equivalents                                                                                                                                                                                                         |       | $                  | 16,039     |              | $          | 22,612 |   |
| Accounts receivable, net of allowance for doubtful   accounts of $862 at April 30 and $870 at July 31                                                                                                                   |       | 44,309             |       | 31,870            |       |
| Inventories:                                                                                                                                                                                                                      |       |               |       |              |       |
| Raw materials                                                                                                                                                                                                                     |       | 17,419             |       | 14,003            |       |
| Work-in-process                                                                                                                                                                                                                   |       | 5,736              |       | 5,153             |       |
| Finished goods                                                                                                                                                                                                                    |       | 16,183             |       | 15,466            |       |
| Total inventories                                                                                                                                                                                                                 |       | 39,338             |       | 34,622            |       |
| Deferred income taxes                                                                                                                                                                                                             |       | 2,916              |       | 2,420             |       |
| Prepaid expenses and other current assets                                                                                                                                                                                         |       | 3,639              |       | 3,207             |       |
| Total current assets                                                                                                                                                                                                              |       | 106,241            |       | 94,731            |       |
| Property and equipment, net                                                                                                                                                                                                       |       | 35,097             |       | 35,243            |       |
| Intangible assets, net                                                                                                                                                                                                            |       | 40,681             |       | 32,717            |       |
| Goodwill                                                                                                                                                                                                                          |       | 134,702            |       | 116,783           |       |
| Other assets                                                                                                                                                                                                                      |       | 1,482              |       | 1,191             |       |
|                                                                                                                                                                                                                              |       | $                  | 318,203    |              | $          | 280,665 |   |
| **Liabilities and stockholders’   equity**                                                                                                                                                                                   |       |               |       |              |       |
| Current liabilities:                                                                                                                                                                                                              |       |               |       |              |       |
| Current portion of long-term debt                                                                                                                                                                                                 |       | $                  | 30,000     |              | $          | 10,000 |   |
| Accounts payable                                                                                                                                                                                                                  |       | 13,039             |       | 9,640             |       |
| Compensation payable                                                                                                                                                                                                              |       | 8,184              |       | 10,675            |       |
| Accrued expenses                                                                                                                                                                                                                  |       | 8,084              |       | 6,370             |       |
| Deferred revenue                                                                                                                                                                                                                  |       | 7,316              |       | 4,233             |       |
| Acquisitions payable                                                                                                                                                                                                              |       | 2,723              |       | —            |       |
| Income taxes payable                                                                                                                                                                                                              |       | 55                 |       | 66                |       |
| Total current liabilities                                                                                                                                                                                                         |       | 69,401             |       | 40,984            |       |
| Long-term debt                                                                                                                                                                                                                    |       | —             |       | 11,000            |       |
| Deferred income taxes                                                                                                                                                                                                             |       | 18,093             |       | 17,868            |       |
| Other long-term liabilities                                                                                                                                                                                                       |       | 1,152              |       | 1,408             |       |
|                                                                                                                                                                                                                              |       |               |       |              |       |
| Stockholders’ equity:                                                                                                                                                                                                        |       |               |       |              |       |
| Preferred Stock, par value $1.00 per share;   authorized 1,000,000 shares; none issued                                                                                                                                            |       | —             |       | —            |       |
| Common Stock, par value $.10 per share; authorized   30,000,000 shares; April 30 - 19,076,853 shares issued and 17,217,888   shares outstanding; July 31 - 18,272,574 shares issued and 16,866,284   shares outstanding |       | 1,908              |       | 1,827             |       |
| Additional paid-in capital                                                                                                                                                                                                        |       | 108,893            |       | 94,714            |       |
| Retained earnings                                                                                                                                                                                                                 |       | 135,077            |       | 120,363           |       |
| Accumulated other comprehensive income                                                                                                                                                                                            |       | 9,387              |       | 8,045             |       |
| Treasury Stock, at cost; April 30 - 1,858,965   shares; July 31 - 1,406,290 shares                                                                                                                                      |       | (25,708            | )          | (15,544           | )          |
| Total stockholders’ equity                                                                                                                                                                                                   |       | 229,557            |       | 209,405           |       |
|                                                                                                                                                                                                                              |       | $                  | 318,203    |              | $          | 280,665 |   |

 

See accompanying notes.

 

2

----

 

CANTEL MEDICAL CORP.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollar Amounts in Thousands, Except Per Share Data)

(Unaudited)

 
| ** **                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **April 30,**               | ** ** | **April 30,**              | ** ** |
| ** **                              | ** ** | **2011**                         | ** ** | **2010**                        | ** ** | **2011** | ** ** | **2010** | ** ** |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Net sales                               |       | $                                | 82,619     |                            | $          | 66,559 |   | $ | 235,633 |   | $ | 204,141 |   |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Cost of sales                           |       | 51,317                           |       | 39,866                          |       | 144,747 |   | 120,866 |   |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Gross profit                            |       | 31,302                           |       | 26,693                          |       | 90,886 |   | 83,275 |   |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Expenses:                               |       |                             |       |                            |       |   |   |   |   |
| Selling                                 |       | 11,505                           |       | 9,348                           |       | 31,928 |   | 26,583 |   |
| General and administrative              |       | 10,439                           |       | 9,149                           |       | 29,863 |   | 27,726 |   |
| Research and development                |       | 1,715                            |       | 1,342                           |       | 4,779 |   | 3,764 |   |
| Total operating expenses                |       | 23,659                           |       | 19,839                          |       | 66,570 |   | 58,073 |   |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Income before interest and income taxes |       | 7,643                            |       | 6,854                           |       | 24,316 |   | 25,202 |   |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Interest expense                        |       | 195                              |       | 233                             |       | 698 |   | 959 |   |
| Interest income                         |       | (24                              | )          | (19                             | )          | (62 | ) | (35 | ) |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Income before income taxes              |       | 7,472                            |       | 6,640                           |       | 23,680 |   | 24,278 |   |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Income taxes                            |       | 2,424                            |       | 2,366                           |       | 7,937 |   | 8,960 |   |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Net income                              |       | $                                | 5,048      |                            | $          | 4,274 |   | $ | 15,743 |   | $ | 15,318 |   |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Earnings per common share:              |       |                             |       |                            |       |   |   |   |   |
| Basic                                   |       | $                                | 0.29       |                            | $          | 0.25 |   | $ | 0.92 |   | $ | 0.91 |   |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Diluted                                 |       | $                                | 0.29       |                            | $          | 0.25 |   | $ | 0.91 |   | $ | 0.90 |   |
|                                    |       |                             |       |                            |       |   |   |   |   |
| Dividends per common share              |       | $                                | —     |                            | $          | — |   | $ | 0.06 |   | $ | 0.05 |   |

 

See accompanying notes.

 

3

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CANTEL MEDICAL CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollar Amounts in Thousands)

(Unaudited)

 
| ** **                                                                           | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                           | ** ** | **April 30,**              | ** ** |
| ** **                                                                           | ** ** | **2011**                        | ** ** | **2010** | ** ** |
|                                                                                 |       |                            |       |   |   |
| **Cash flows from operating   activities**                                           |       |                            |       |   |   |
| Net income                                                                           |       | $                               | 15,743     |   | $ | 15,318 |   |
| Adjustments to reconcile net income to net cash   provided by operating activities:  |       |                            |       |   |   |
| Depreciation                                                                         |       | 5,039                           |       | 4,721 |   |
| Amortization                                                                         |       | 4,190                           |       | 3,842 |   |
| Stock-based compensation expense                                                     |       | 2,553                           |       | 2,270 |   |
| Amortization of debt issuance costs                                                  |       | 240                             |       | 333 |   |
| (Gain) loss on disposal of fixed assets                                              |       | (8                              | )          | 224 |   |
| Deferred income taxes                                                                |       | (1,195                          | )          | (847 | ) |
| Excess tax benefits from stock-based compensation                                    |       | (491                            | )          | (283 | ) |
| Changes in assets and liabilities, net of assets   acquired and liabilities assumed: |       |                            |       |   |   |
| Accounts receivable                                                                  |       | (11,643                         | )          | 662 |   |
| Inventories                                                                          |       | (1,056                          | )          | (6,668 | ) |
| Prepaid expenses and other current assets                                            |       | (899                            | )          | 72 |   |
| Accounts payable and other current liabilities                                       |       | 3,601                           |       | (1,902 | ) |
| Income taxes payable                                                                 |       | 1,454                           |       | (291 | ) |
| Net cash provided by operating activities                                            |       | 17,528                          |       | 17,451 |   |
|                                                                                 |       |                            |       |   |   |
| **Cash flows from investing   activities**                                           |       |                            |       |   |   |
| Capital expenditures                                                                 |       | (4,695                          | )          | (4,203 | ) |
| Proceeds from disposal of fixed assets                                               |       | 45                              |       | 5 |   |
| Earnout paid to Twist seller                                                         |       | —                          |       | (157 | ) |
| Acquisition of Gambro Water                                                          |       | (21,630                         | )          | — |   |
| Acquisition of ConFirm                                                               |       | (7,500                          | )          | — |   |
| Purchase of convertible note receivable                                              |       | —                          |       | (300 | ) |
| Other, net                                                                           |       | (227                            | )          | (197 | ) |
| Net cash used in investing activities                                                |       | (34,007                         | )          | (4,852 | ) |
|                                                                                 |       |                            |       |   |   |
| **Cash flows from financing   activities**                                           |       |                            |       |   |   |
| Borrowings under revolving credit facility                                           |       | 28,000                          |       | — |   |
| Repayments under term loan facility                                                  |       | (7,500                          | )          | (7,500 | ) |
| Repayments under revolving credit facility                                           |       | (11,500                         | )          | (10,800 | ) |
| Proceeds from exercises of stock options                                             |       | 1,999                           |       | 2,006 |   |
| Dividends paid                                                                       |       | (1,029                          | )          | (840 | ) |
| Excess tax benefits from stock-based compensation                                    |       | 491                             |       | 283 |   |
| Purchases of treasury stock                                                          |       | (906                            | )          | (289 | ) |
| Net cash provided by (used in) financing   activities                                |       | 9,555                           |       | (17,140 | ) |
|                                                                                 |       |                            |       |   |   |
| Effect of exchange rate changes on cash and cash   equivalents                       |       | 351                             |       | 338 |   |
|                                                                                 |       |                            |       |   |   |
| Decrease in cash and cash equivalents                                                |       | (6,573                          | )          | (4,203 | ) |
| Cash and cash equivalents at beginning of period                                     |       | 22,612                          |       | 23,368 |   |
| Cash and cash equivalents at end of period                                           |       | $                               | 16,039     |   | $ | 19,165 |   |

 

See accompanying notes.

 

4

----

 

**CANTEL****MEDICAL****CORP**.

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

(Unaudited)

 

**Note 1.                   Basis of Presentation**

 

The unaudited Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles for interim financial reporting and the requirements of Form 10-Q and Rule 10.01 of Regulation S-X. Accordingly, they do not include certain information and note disclosures required by generally accepted accounting principles for annual financial reporting and should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Annual Report of Cantel Medical Corp. (“Cantel”) on Form 10-K for the fiscal year ended July 31, 2010 (the “2010 Form 10-K”) and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.

 

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

 

The Condensed Consolidated Balance Sheet at July 31, 2010 was derived from the audited Consolidated Balance Sheet of Cantel at that date.

 

Cantel had five principal operating companies at each of April 30, 2011 and July 31, 2010; Minntech Corporation (“Minntech”), Crosstex International Inc. (“Crosstex”), Mar Cor Purification, Inc. (“Mar Cor”), Biolab Equipment Ltd. (“Biolab”) and Saf-T-Pak Inc. (“Saf-T-Pak”), all of which are wholly-owned operating subsidiaries. In addition, Minntech had three foreign subsidiaries at each of April 30, 2011 and July 31, 2010; Minntech B.V., Minntech Asia/Pacific Ltd. and Minntech Japan K.K., which serve as Minntech’s bases in Europe, Asia/Pacific and Japan, respectively.

 

During our fourth quarter of fiscal 2010, we changed our internal reporting processes to include a new operating segment called Chemistries to reflect the way the Company, through its executive management, manages, allocates resources and measures the performance of its businesses. This new operating segment is the combination of a small portion of our existing sterilant business, comprised of products sold on an OEM basis and previously recorded in our Water Purification and Filtration segment, and a new business operation that was created to capitalize on our chemistry expertise and expand our product offerings in existing and new markets within the infection prevention and control arena. As a result of this internal reorganization, certain research and development projects were reclassified among segments. All prior period segment results have been restated to reflect this change.

 

We currently operate our business through seven operating segments: Water Purification and Filtration (through Mar Cor, Biolab and Minntech), Healthcare Disposables (through Crosstex), Endoscope Reprocessing (through Minntech), Dialysis (through Minntech), Therapeutic Filtration (through Minntech), Specialty Packaging (through Saf-T-Pak) and Chemistries (through Minntech). The Therapeutic Filtration, Specialty Packaging and Chemistries operating segments are combined in the All Other reporting segment for financial reporting purposes.

 

5

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On February 11, 2011, our Crosstex subsidiary acquired certain net assets of ConFirm Monitoring Systems, Inc. (“ConFirm”), as more fully described in Note 3 to the Condensed Consolidated Financial Statements. ConFirm’s results of operations are included in our results of operations for the three and nine months ended April 30, 2011 subsequent to its acquisition date and are excluded from the three and nine months ended April 30, 2010.

 

On October 6, 2010, our Mar Cor subsidiary acquired from Gambro Renal Products, Inc. (“GRP”) and a Swedish-based affiliate of GRP (collectively, “Gambro”) certain net assets and the exclusive rights in the United States and Puerto Rico to manufacture and sell Gambro’s water treatment products used in the production of water for hemodialysis (“Gambro Water” or the “Gambro Acquisition”), as more fully described in Note 3 to the Condensed Consolidated Financial Statements. Gambro Water’s results of operations are included in our results of operations for the three and nine months ended April 30, 2011 subsequent to its acquisition date and are excluded from the three and nine months ended April 30, 2010.

 

On June 1, 2010, we acquired all of the issued and outstanding stock of Purity Water Company of San Antonio, Inc. (“Purity”), as more fully described in Note 3 to the Condensed Consolidated Financial Statements. Purity’s results of operations are included in our results of operations for the three and nine months ended April 30, 2011 and are excluded from the three and nine months ended April 30, 2010.

 

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

 

***Subsequent Events***

 

We performed a review of events subsequent to April 30, 2011. Based upon that review, no subsequent events occurred that required updating to our Condensed Consolidated Financial Statements or disclosures.

 

6

----

 

**Note 2.                   Stock-Based Compensation**

 

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

 
| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                               | ** ** | **April 30,**               | ** ** | **April 30,**              | ** ** |
| ** **                                                               | ** ** | **2011**                         | ** ** | **2010**                        | ** ** | **2011** | ** ** | **2010** | ** ** |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Cost of sales                                                            |       | $                                | 31,000     |                            | $          | 36,000 |   | $ | 101,000 |   | $ | 95,000 |   |
| Operating expenses:                                                      |       |                             |       |                            |       |   |   |   |   |
| Selling                                                                  |       | 100,000                          |       | 115,000                         |       | 316,000 |   | 294,000 |   |
| General and administrative                                               |       | 733,000                          |       | 511,000                         |       | 2,114,000 |   | 1,859,000 |   |
| Research and development                                                 |       | 7,000                            |       | 8,000                           |       | 22,000 |   | 22,000 |   |
| Total operating expenses                                                 |       | 840,000                          |       | 634,000                         |       | 2,452,000 |   | 2,175,000 |   |
| Stock-based compensation before income taxes                             |       | 871,000                          |       | 670,000                         |       | 2,553,000 |   | 2,270,000 |   |
| Income tax benefits                                                      |       | (319,000                         | )          | (239,000                        | )          | (927,000 | ) | (822,000 | ) |
| Total stock-based compensation expense, net of tax                       |       | $                                | 552,000    |                            | $          | 431,000 |   | $ | 1,626,000 |   | $ | 1,448,000 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Decrease in earnings per common share due to   stock-based compensation: |       |                             |       |                            |       |   |   |   |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                    |       | $                                | 0.03       |                            | $          | 0.03 |   | $ | 0.10 |   | $ | 0.09 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Diluted                                                                  |       | $                                | 0.03       |                            | $          | 0.03 |   | $ | 0.09 |   | $ | 0.09 |   |

 

The above stock-based compensation expense before income taxes was recorded in the Condensed Consolidated Financial Statements as stock-based compensation expense and an increase to additional paid-in capital. The related income tax benefits were recorded as an increase to long-term deferred income tax assets (which are netted with long-term deferred income tax liabilities) and a reduction to income tax expense.

 

All of our stock options and stock awards (which consist only of restricted stock) are subject to graded vesting in which portions of the award vest at different times during the vesting period, as opposed to awards that vest at the end of the vesting period. We recognize compensation expense for awards subject to graded vesting using the straight-line basis over the vesting period, reduced by estimated forfeitures. At April 30, 2011, total unrecognized stock-based compensation expense before income taxes related to total nonvested stock options and stock awards was $4,213,000 with a remaining weighted average period of 15 months over which such expense is expected to be recognized.

 

We determine the fair value of each stock award using the closing market price of our Common Stock on the date of grant. Such stock awards are deductible for tax purposes and were tax-effected using the Company’s estimated U.S. effective tax rate at the time of grant.

 

7

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A summary of nonvested stock award activity follows:

 
| ** **                               | ** ** | ** **         | ** ** | **Weighted**        | ** ** |
|------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                               | ** ** | **Number of** | ** ** | **Average**         | ** ** |
| ** **                               | ** ** | **Shares**         | ** ** | **Fair Value** | ** ** |
|                                     |       |               |       |                |       |
| Nonvested stock awards at July 31, 2010  |       | 158,652            |       | $                   | 13.89      |   |
| Granted                                  |       | 162,550            |       | 18.53               |       |
| Vested                                   |       | (49,610            | )          | 15.03               |       |
| Nonvested stock awards at April 30, 2011 |       | 271,592            |       | $                   | 16.45      |   |

 

There were no option grants during the three and nine months ended April 30, 2011. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model with the following assumptions for options granted during the three and nine months ended April 30, 2010:

 
| **Weighted-Average**           | ** ** | ** **                       | ** ** | ** **                      | ** ** |
|--------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **Black-Scholes Option**  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
| **Valuation Assumptions** | ** ** | **April 30, 2010**     | ** ** | **April 30, 2010**    | ** ** |
|                           |       |                             |       |                            |       |
| Dividend yield (1)             |       | 0.51                             | %          | 0.02                            | %          |
| Expected volatility (2)        |       | 0.459                            |       | 0.454                           |       |
| Risk-free interest rate (3)    |       | 1.97                             | %          | 1.96                            | %          |
| Expected lives (in years) (4)  |       | 3.50                             |       | 3.58                            |       |

 

----

(1)          We declared our first dividend in January 2010. Since we did not issue dividends prior to that date, the dividend yield was zero for options granted prior to January 2010.

(2)          Volatility was based on historical closing prices of our Common Stock.

(3)          The U.S. Treasury rate on the expected life at the date of grant.

(4)          Based on historical exercise behavior.

 

Additionally, all options were considered to be deductible for tax purposes in the valuation model, except for certain options granted to employees residing outside of the United States. Such non-qualified options were tax-effected using the Company’s estimated U.S. effective tax rate at the time of grant. For the three and nine months ended April 30, 2010, the weighted average fair value of all options granted was approximately $6.70 and $5.70, respectively.  The aggregate intrinsic value (i.e., the excess market price over the exercise price) of all options exercised was $1,019,000 and $3,184,000 for the three and nine months ended April 30, 2011, respectively, and $683,000 and $1,490,000 for the three and nine months ended April 30, 2010, respectively.

 

A summary of stock option activity follows:

 
| ** **                    | ** ** | ** **         | ** ** | **Weighted**            | ** ** |
|-------------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                    | ** ** | **Number of** | ** ** | **Average**             | ** ** |
| ** **                    | ** ** | **Shares**         | ** ** | **Exercise Price** | ** ** |
|                          |       |               |       |                    |       |
| Outstanding at July 31, 2010  |       | 1,427,863          |       | $                       | 15.95      |   |
| Exercised                     |       | (641,729           | )          | 17.54                   |       |
| Expired                       |       | (33,250            | )          | 21.88                   |       |
| Outstanding at April 30, 2011 |       | 752,884            |       | $                       | 14.33      |   |
|                          |       |               |       |                    |       |
| Exercisable at July 31, 2010  |       | 778,864            |       | $                       | 16.76      |   |
|                          |       |               |       |                    |       |
| Exercisable at April 30, 2011 |       | 312,414            |       | $                       | 13.76      |   |

 

8

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Upon exercise of stock options or grant of stock awards, we typically issue new shares of our Common Stock (as opposed to using treasury shares).

 

If certain criteria are met when options are exercised or restricted stock becomes vested, the Company is allowed a deduction on its United States income tax return. Accordingly, we account for the income tax effect on such income tax deductions as a reduction of deferred income tax assets (which are netted with long-term deferred income tax liabilities) and as a reduction of income taxes payable. For the nine months ended April 30, 2011 and 2010, such income tax deductions reduced income taxes payable by $1,458,000 and $976,000, respectively.

 

We classify the cash flows resulting from excess tax benefits as financing cash flows on our Condensed Consolidated Statements of Cash Flows. Excess tax benefits arise when the ultimate tax effect of the deduction for tax purposes is greater than the tax benefit on stock compensation expense which was determined based upon the award’s fair value.

 

**Note 3.                   Acquisitions**

 

***ConFirm Monitoring Systems, Inc.***

 

On February 11, 2011, our Crosstex subsidiary acquired certain net assets of ConFirm relating to its sterilization monitoring business. ConFirm is a private company based in Englewood, Colorado with pre-acquisition annual revenues of approximately $4,000,000 relating to biological monitoring services for dental and other healthcare customers located primarily in North America. The company offers both a mail-in service and in-office spore test kits for healthcare professionals to verify the performance of their sterilizers in accordance with industry guidelines for daily or weekly testing. ConFirm is included in our Healthcare Disposables segment. Total consideration for the transaction, excluding transaction costs of $52,000, was $7,500,000 plus contingent consideration of up to an additional $1,000,000 based upon achievement of specified sales levels through January 31, 2012. We account for contingent consideration in accordance with Accounting Standards Codification (“ASC”) 805, *“Business Combinations,”* (“ASC 805”), which requires us to record the fair value of contingent consideration as a liability and a reduction of goodwill at the date of the acquisition and continually re-measure the liability at each balance sheet date by recording changes in the fair value through our Condensed Consolidated Statements of Income.  Accordingly, on February 11, 2011 we increased acquisitions payable and decreased goodwill by $656,000 to record our initial estimated fair value of the contingent consideration that would be earned by January 31, 2012. At April 30, 2011, we re-measured the liability and determined the estimated fair value had not changed.

 

9

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

 
| ** **                            | ** ** | **Preliminary** | ** ** |
|---------------------------------------|------------|-----------------|------------|
| ** **                            | ** ** | **Allocation**  | ** ** |
| Net Assets                            |       |            |       |
| Current assets                        |       | $               | 1,399,000  |   |
| Property, plant and equipment         |       | 93,000          |       |
| Amortizable intangible assets:        |       |            |       |
| Customer relationships (10-year life) |       | 2,290,000       |       |
| Trade name (6-year life)              |       | 470,000         |       |
| Technology (5-year life)              |       | 110,000         |       |
| Non-compete agreement (8-year life)   |       | 30,000          |       |
| Current liabilities:                  |       |            |       |
| Accounts payable                      |       | (244,000        | )          |
| Deferred revenue                      |       | (1,226,000      | )          |
| Contingent consideration              |       | (656,000        | )          |
| Net assets acquired                   |       | $               | 2,266,000  |   |

 

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

 

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

 

The acquisition of ConFirm is included in our results of operations for only the portion of the three and nine months ended April 30, 2011 subsequent to its acquisition date and is excluded from our results of operations for the three and nine months ended April 30, 2010. Pro forma consolidated statements of income data have not been presented due to the insignificant impact of this acquisition.

 

***Gambro Water***

 

On October 6, 2010, our Mar Cor subsidiary acquired from Gambro certain net assets and the exclusive rights in the United States and Puerto Rico to manufacture and sell Gambro’s water treatment products used in the production of water for hemodialysis. Immediately following the acquisition, we commenced sales and service of all Gambro water products, components, parts and consumables solely intended for the United States and Puerto Rico markets. The manufacturing of these products has been transitioned into our own manufacturing facility in Plymouth, Minnesota. With annual pre-acquisition revenues of approximately $14,000,000 (approximately 75% of such revenues are from one customer), the Gambro Acquisition expands our Water Purification and Filtration’s annual business in terms of sales, particularly with respect to product and service sales volumes in both existing and new dialysis clinics across the United States and Puerto Rico. Total consideration for the transaction, excluding acquisition-related costs of approximately $240,000, was approximately $23,697,000, of which $3,100,000 will be paid in six equal quarterly payments ending April 2012. As of April 30, 2011, $1,033,000 of the $3,100,000 has been paid. The Gambro Acquisition is included in our Water Purification and Filtration operating segment.

 

10

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

 
| ** **                                                 | ** ** | **Preliminary** | ** ** |
|------------------------------------------------------------|------------|-----------------|------------|
| ** **                                                 | ** ** | **Allocation**  | ** ** |
| Net Assets                                                 |       |            |       |
| Current assets (principally inventories)                   |       | $               | 3,180,000  |   |
| Property, plant and equipment                              |       | 11,000          |       |
| Amortizable intangible assets:                             |       |            |       |
| Technology (8-year life)                                   |       | 1,170,000       |       |
| Customer relationships (11.5-year weighted average   life) |       | 6,640,000       |       |
| Non-compete agreement (14-year life)                       |       | 1,050,000       |       |
| Current liabilities                                        |       | (63,000         | )          |
| Net assets acquired                                        |       | $               | 11,988,000 |   |

 

There were no in-process research and development projects acquired in connection with the acquisition. The excess purchase price of $11,709,000 was assigned to goodwill, which is deductible for income tax purposes over fifteen years.

 

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

 

For the three and nine months ended April 30, 2011 subsequent to its acquisition, Gambro Water contributed approximately $3,656,000 and $8,608,000, respectively, to our net sales and $395,000 and $670,000, respectively, to our income before interest and income taxes, excluding acquisition-related costs of $240,000. Such operating performance may not necessarily be indicative of future operating performance. The results of operations of Gambro Water were excluded from the three and nine months ended April 30, 2010. Pro forma consolidated statement of income data has not been presented due to the unavailability of pre-acquisition Gambro Water financial statements, since Gambro Water did not maintain separate financial statements related to these purchased assets, and the insignificant impact of this acquisition on our consolidated net income in fiscal 2011 subsequent to its acquisition date.

 

***Purity Water Company of San Antonio, Inc.***

 

On June 1, 2010, Mar Cor acquired all of the issued and outstanding stock of Purity, a private company based in San Antonio, Texas with pre-acquisition annual revenues of approximately $2,300,000 that designs, installs and services high quality, high purity water systems for use in laboratory, industrial, medical, pharmaceutical and semiconductor environments. Total consideration for the transaction was $2,014,000.

 

11

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

 
| ** **                                      | ** ** | **Final**      | ** ** |
|-------------------------------------------------|------------|----------------|------------|
| ** **                                      | ** ** | **Allocation** | ** ** |
| Net Assets                                      |       |           |       |
| Current assets                                  |       | $              | 493,000    |   |
| Property, plant and equipment                   |       | 185,000        |       |
| Amortizable intangible assets:                  |       |           |       |
| Trade name (3-year life)                        |       | 10,000         |       |
| Non-compete agreement (5-year life)             |       | 38,000         |       |
| Customer relationships (9-year life)            |       | 433,000        |       |
| Current liabilities                             |       | (347,000       | )          |
| Noncurrent deferred income tax liabilities, net |       | (15,000        | )          |
| Net assets acquired                             |       | $              | 797,000    |   |

 

There were no in-process research and development projects acquired in connection with the acquisition. The excess purchase price of $1,217,000 was assigned to goodwill. Such goodwill, all of which is non-deductible for income tax purposes, has been included in our Water Purification and Filtration reporting segment.

 

The primary reason for the acquisition was to add a base of business and expand the Mar Cor service network in the southwest United States. Following the acquisition, Purity was merged with, and into, Mar Cor.

 

The acquisition of Purity is included in our results of operations for the three and nine months ended April 30, 2011 and is excluded from our results of operations for the three and nine months ended April 30, 2010. Pro forma consolidated statements of income data have not been presented due to the insignificant impact of this acquisition.

 

**Note 4.                   Recent Accounting Pronouncements**

 

In December 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2010-29, *“Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations, a consensus of the FASB Emerging Issues Task Force,”* (“ASU 2010-29”), which addresses the diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for material business combinations. The amendments specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) had occurred at the beginning of the comparable prior annual reporting period only. Additional amendments expand supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective for fiscal years beginning after December 15, 2010 and is applied prospectively to business combinations completed after that date. Accordingly, we will apply ASU 2010-29 to material business combinations that occur after July 31, 2011. The adoption of this updated disclosure guidance will not have any impact upon our financial position and results of operations.

 

In January 2010, the FASB issued ASU 2010-06, “*Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements,”*(“ASU 2010-06”). Reporting entities will have to provide information about movements of assets among Levels 1 and 2, and a reconciliation of purchases, sales, issuance, and settlements of activity

 

12

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valued with a Level 3 method, of the three-tier fair value hierarchy established by ASC 820, “*Fair Value Measurements and Disclosures,”* (“ASC 820”), as more fully described in Note 7 to the Condensed Consolidated Financial Statements. ASU 2010-06 also clarifies the existing guidance to require fair value measurement disclosures for each class of assets and liabilities. ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009 for Level 1 and 2 disclosure requirements, which was adopted in our third quarter of fiscal 2010, and after December 15, 2010 for Level 3 disclosure requirements, which we adopted in our third quarter of fiscal 2011. The adoption of ASU 2010-06 did not have any impact upon our financial position or results of operations since it related to additional disclosure requirements.

 

In October 2009, the FASB issued ASU 2009-13, *“Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force,”* (“ASU 2009-13”), which amends ASC 605-25, “*Revenue Recognition-Multiple-Element Arrangements.” *ASU 2009-13 provides principles for the allocation of consideration among multiple-element arrangements, allowing more flexibility in identifying and accounting for separate deliverables. ASU 2009-13 introduces an estimated selling price method for allocating revenue to the elements of a bundled arrangement if vendor-specific objective evidence or third-party evidence of selling price is not available and significantly expands related disclosure requirements. This standard is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Accordingly, we adopted ASU 2009-13 on August 1, 2010. The adoption of ASU 2009-13 did not have a material effect on our financial position or results of operations.

 

**Note 5.                   Other Comprehensive Income**

 

The Company’s comprehensive income for the three and nine months ended April 30, 2011 and 2010 is set forth in the following table:

 
| ** **                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **April 30,**               | ** ** | **April 30,**              | ** ** |
| ** **                   | ** ** | **2011**                         | ** ** | **2010**                        | ** ** | **2011** | ** ** | **2010** | ** ** |
|                         |       |                             |       |                            |       |   |   |   |   |
| Net income                   |       | $                                | 5,048,000  |                            | $          | 4,274,000 |   | $ | 15,743,000 |   | $ | 15,318,000 |   |
| Other comprehensive income:  |       |                             |       |                            |       |   |   |   |   |
| Foreign currency translation |       | 997,000                          |       | 1,195,000                       |       | 1,342,000 |   | 1,245,000 |   |
| Comprehensive income         |       | $                                | 6,045,000  |                            | $          | 5,469,000 |   | $ | 17,085,000 |   | $ | 16,563,000 |   |

 

**Note 6.                   Derivatives**

 

We account for derivative instruments and hedging activities in accordance with ASC 815, *“Derivatives and Hedging,”* (“ASC 815”), which requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not designated as hedges must be adjusted to fair value through earnings. If the derivative is designated as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in the fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of the change in fair value of a derivative that is designated as a hedge will be recognized immediately in earnings. As of April 30, 2011, all of our derivatives were designated as hedges.

 

13

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Changes in the value of (i) the Canadian dollar against the United States dollar, (ii) the euro against the United States dollar and (iii) the British pound against the United States dollar affect our results of operations because a portion of the net assets of our Canadian subsidiaries (which are reported in our Specialty Packaging and Water Purification and Filtration segments)  are denominated and ultimately settled in United States dollars, but must be converted into its functional Canadian dollar currency. Furthermore, certain cash bank accounts, accounts receivable, and liabilities of our United States subsidiaries, Minntech and Mar Cor, are denominated and ultimately settled in euros or British pounds, but must be converted into their functional United States currency.

 

In order to hedge against the impact of fluctuations in the value of (i) the Canadian dollar relative to the United States dollar, (ii) the euro relative to the United States dollar and (iii) the British pound relative to the United States dollar on the conversion of such net assets into the functional currencies, we enter into short-term contracts to purchase Canadian dollars, euros and British pounds forward, which contracts are generally one month in duration. These short-term contracts are designated as fair value hedge instruments. There were three foreign currency forward contracts with an aggregate value of $4,379,000 at April 30, 2011, which covered certain assets and liabilities that were denominated in currencies other than our subsidiaries’ functional currencies. Such contracts expired on May 31, 2011. These foreign currency forward contracts are continually replaced with new one-month contracts as long as we have significant net assets at our subsidiaries that are denominated and ultimately settled in currencies other than their functional currencies. Under our credit facilities, such contracts to purchase Canadian dollars, euros and British pounds may not exceed $12,000,000 in an aggregate notional amount at any time. For the three and nine months ended April 30, 2011, such forward contracts partially offset the impact on operations relating to certain assets and liabilities that were denominated in currencies other than our subsidiaries’ functional currencies and resulted in a net currency conversion loss, net of tax, of $54,000 and $139,000, respectively, on the items hedged. Gains and losses related to the hedging contracts to buy Canadian dollars, euros and British pounds forward were immediately realized within general and administrative expenses due to the short-term nature of such contracts. We do not hold any derivative financial instruments for speculative or trading purposes.

 

**Note 7.                   Fair Value Measurements**

 

***Fair Value Hierarchy***

 

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

 

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

 

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

 

Level 3: Unobservable inputs for the asset or liability.

 

14

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

 

As of April 30, 2011 and July 31, 2010, our financial assets that are re-measured at fair value on a recurring basis include bank deposits, certificates of deposit and money market funds that are classified as cash and cash equivalents in the Condensed Consolidated Balance Sheet. As there are no withdrawal restrictions, they are classified within Level 1 of the fair value hierarchy and are valued using quoted market prices for identical assets. In addition, we have a contingent consideration liability recorded within acquisitions payable relating to the acquisition of ConFirm, as further described in Note 3 to the Condensed Consolidated Financial Statements. The fair value of this liability was based on future sales projections of the ConFirm business under various potential scenarios for the one year period ending January 31, 2012 and weighting the probability of these outcomes.  At the date of the acquisition, these cash flow projections were discounted using a rate of 7%. The discount rate was based on the weighted average cost of capital of the acquired business plus a credit risk premium for non-performance risk. This analysis resulted in an initial contingent consideration liability of $656,000, which will be adjusted periodically by recording changes in the fair value through our Condensed Consolidated Statements of Income driven by the accretion of the liability for the time value of money and changes in the assumptions pertaining to the achievement of the specified sales levels. This fair value measurement was based on significant inputs not observed in the market and thus represented a Level 3 measurement. At April 30, 2011, we re-measured the liability and determined that the estimated fair value had not changed.

 

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

 
| ** **                                | ** ** | **April 30, 2011** | ** ** |
|-------------------------------------------|------------|------------------------------|------------|
| ** **                                | ** ** | **Level 1**             | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Assets:                                   |       |                         |       |   |   |   |   |   |   |
| Cash and cash equilavents:                |       |                         |       |   |   |   |   |   |   |
| Bank deposits and certificates of deposit |       | $                            | 12,123,000 |   | $ | — |   | $ | — |   | $ | 12,123,000 |   |
| Money markets                             |       | 3,916,000                    |       | — |   | — |   | 3,916,000 |   |
| Total assets                              |       | $                            | 16,039,000 |   | $ | — |   | $ | — |   | $ | 16,039,000 |   |
|                                      |       |                         |       |   |   |   |   |   |   |
| Liabilities:                              |       |                         |       |   |   |   |   |   |   |
| Contingent consideration                  |       | $                            | —     |   | $ | — |   | $ | 656,000 |   | $ | 656,000 |   |
| Total liabilities                         |       | $                            | —     |   | $ | — |   | $ | 656,000 |   | $ | 656,000 |   |
|                                      |       |                         |       |   |   |   |   |   |   |
| ** **                                | ** ** | **July 31,   2010**          | ** ** |
| ** **                                | ** ** | **Level 1**                  | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Assets:                                   |       |                         |       |   |   |   |   |   |   |
| Cash and cash equilavents:                |       |                         |       |   |   |   |   |   |   |
| Bank deposits and certificates of deposit |       | $                            | 17,696,000 |   | $ | — |   | $ | — |   | $ | 17,696,000 |   |
| Money markets                             |       | 4,916,000                    |       | — |   | — |   | 4,916,000 |   |
| Total assets                              |       | $                            | 22,612,000 |   | $ | — |   | $ | — |   | $ | 22,612,000 |   |

 

There were no liabilities measured at fair value on a recurring basis at July 31, 2010.

 

A reconciliation of the contingent consideration liability that is measured and recorded at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended April 30, 2011 is as follows:

 

15

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| ** **                                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                   | ** ** | **April 30, 2011**     | ** ** | **April 30, 2011**    | ** ** |
|                                                                         |       |                             |       |                            |       |
| Beginning balance                                                            |       | $                                | —     |                            | $          | — |   |
| Total net unrealized (gains)/losses included in   earnings                   |       | —                           |       | —                          |       |
| Total net unrealized (gains)/losses included in   other comprehensive income |       | —                           |       | —                          |       |
| Transfers into level 3 (gross)                                               |       | —                           |       | —                          |       |
| Transfers out of level 3 (gross)                                             |       | —                           |       | —                          |       |
| Net purchases, issuances, sales and settlements                              |       | 656,000                          |       | 656,000                         |       |
| Ending balance                                                               |       | $                                | 656,000    |                            | $          | 656,000 |   |

 

There were no such recurring measurements using significant unobservable inputs for the three and nine months ended April 30, 2010.

 

***Assets Measured and Recorded at Fair Value on a Nonrecurring Basis***

 

We re-measure the fair value of certain assets, such as intangible assets, goodwill and long-lived assets, including property and equipment and convertible notes receivable, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, and goodwill and intangible assets with indefinite lives are reviewed for impairment at least annually.**In performing a review for goodwill impairment, management uses a two-step process that begins with an estimation of the fair value of the related operating segments by using average fair value results of the market multiple and discounted cash flow methodologies, as well as the comparable transaction methodology when applicable. The first step is a review for potential impairment, and the second step measures the amount of impairment, if any. In performing our annual review for indefinite lived intangibles, management compares the current fair value of such assets to their carrying values. With respect to amortizable intangible assets when impairment indicators are present, management determines whether expected future non-discounted cash flows is sufficient to recover the carrying value of the assets; if not, the carrying value of the assets is adjusted to their fair value. With respect to long-lived assets, an assessment is made to determine if the sum of the expected future non-discounted cash flows from the use of the assets and eventual disposition is less than the carrying value. If the sum of the expected non-discounted cash flows is less than the carrying value, an impairment loss is recognized based on fair value. As the inputs utilized for our periodic impairment assessments are not based on observable market data, our intangibles, goodwill and long-lived assets are classified within Level 3 of the fair value hierarchy on a non-recurring basis. On April 30, 2011, management concluded that no events or changes in circumstances have occurred during the nine months ended April 30, 2011 that would indicate that the carrying amount of our intangible assets, goodwill and long-lived assets may not be recoverable.

 

***Disclosure of Fair Value of Financial Instruments***

 

As of April 30, 2011 and July 31, 2010, the carrying amounts for cash and cash equivalents, accounts receivable and accounts payable approximated fair value due to the short maturity of these instruments. We believe that as of April 30, 2011 and July 31, 2010, the fair value of our outstanding borrowings under our credit facilities approximated the carrying value of those obligations since the borrowing rates were at prevailing market interest rates, principally under LIBOR contracts ranging from one to twelve months.

 

16

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**Note 8.                   Intangible Assets and Goodwill**

 

Our intangible assets with definite lives consist primarily of customer relationships, technology, brand names, non-compete agreements and patents. These intangible assets are being amortized using the straight-line method over the estimated useful lives of the assets ranging from 3-20 years and have a weighted average amortization period of 10 years. Amortization expense related to definite life intangible assets was $1,465,000 and $4,190,000 for the three and nine months ended April 30, 2011, respectively, and $1,270,000 and $3,842,000 for the three and nine months ended April 30, 2010, respectively. Our intangible assets that have indefinite useful lives and therefore are not amortized consist of trademarks and trade names.

 

The Company’s intangible assets consist of the following:

 
| ** **                             | ** ** | **April 30, 2011** | ** ** |
|----------------------------------------|------------|------------------------------|------------|
| ** **                             | ** ** | ** **                   | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Gross**                    | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| Intangible   assets with finite lives: |       |                         |       |   |   |   |   |
| Customer   relationships               |       | $                            | 35,206,000 |   | $ | (14,577,000 | ) | $ | 20,629,000 |   |
| Technology                             |       | 9,865,000                    |       | (5,901,000 | ) | 3,964,000 |   |
| Brand   names                          |       | 9,745,000                    |       | (5,284,000 | ) | 4,461,000 |   |
| Non-compete   agreements               |       | 2,981,000                    |       | (1,820,000 | ) | 1,161,000 |   |
| Patents   and other registrations      |       | 1,286,000                    |       | (366,000 | ) | 920,000 |   |
|                                   |       | 59,083,000                   |       | (27,948,000 | ) | 31,135,000 |   |
| Trademarks   and trade names           |       | 9,546,000                    |       | — |   | 9,546,000 |   |
| Total   intangible assets              |       | $                            | 68,629,000 |   | $ | (27,948,000 | ) | $ | 40,681,000 |   |

 
| ** **                             | ** ** | **July 31, 2010** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | ** **                  | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Gross**                   | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| Intangible   assets with finite lives: |       |                        |       |   |   |   |   |
| Customer   relationships               |       | $                           | 26,205,000 |   | $ | (12,102,000 | ) | $ | 14,103,000 |   |
| Technology                             |       | 9,267,000                   |       | (6,085,000 | ) | 3,182,000 |   |
| Brand   names                          |       | 9,556,000                   |       | (4,829,000 | ) | 4,727,000 |   |
| Non-compete   agreements               |       | 1,901,000                   |       | (1,536,000 | ) | 365,000 |   |
| Patents   and other registrations      |       | 1,251,000                   |       | (307,000 | ) | 944,000 |   |
|                                   |       | 48,180,000                  |       | (24,859,000 | ) | 23,321,000 |   |
| Trademarks   and trade names           |       | 9,396,000                   |       | — |   | 9,396,000 |   |
| Total   intangible assets              |       | $                           | 57,576,000 |   | $ | (24,859,000 | ) | $ | 32,717,000 |   |

 

Estimated amortization expense of our intangible assets for the remainder of fiscal 2011 and the next five years is as follows:

 
| Three   month period ending July 31, 2011 |   | $         | 1,479,000 |   |
|-------------------------------------------|--------|-----------|-----------|--------|
| Fiscal   2012                             |   | 5,491,000 |      |
| Fiscal   2013                             |   | 5,416,000 |      |
| Fiscal   2014                             |   | 5,212,000 |      |
| Fiscal   2015                             |   | 5,024,000 |      |
| Fiscal   2016                             |   | 1,855,000 |      |

 

17

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Goodwill changed during fiscal 2010 and the nine months ended April 30, 2011 as follows:

 
| ** **                     | ** ** | **Water**               | ** ** | ** **       | ** ** | ** **      | ** ** | ** **   | ** ** | ** **         | ** ** | ** **   | ** ** |
|--------------------------------|------------|-------------------------|------------|------------------|------------|-----------------|------------|--------------|------------|--------------------|------------|--------------|------------|
| ** **                     | ** ** | **Purification**        | ** ** | **Endoscope**    | ** ** | **Healthcare**  | ** ** | ** **   | ** ** | ** **         | ** ** | **Total**    | ** ** |
| ** **                     | ** ** | **and Filtration** | ** ** | **Reprocessing** | ** ** | **Disposables** | ** ** | **Dialysis** | ** ** | **All Other** | ** ** | **Goodwill** | ** ** |
|                           |       |                    |       |             |       |            |       |         |       |               |       |         |       |
| Balance,   July 31, 2009  |       | $                       | 38,375,000 |             | $          | 9,648,000       |       | $            | 50,630,000 |               | $          | 8,133,000    |       | $ | 8,209,000 |   | $ | 114,995,000 |   |
| Acquisition                    |       | 1,217,000               |       | —           |       | —          |       | —       |       | —             |       | 1,217,000    |       |
| Foreign   currency translation |       | 255,000                 |       | —           |       | —          |       | —       |       | 316,000            |       | 571,000      |       |
| Balance,   July 31, 2010  |       | 39,847,000              |       | 9,648,000        |       | 50,630,000      |       | 8,133,000    |       | 8,525,000          |       | 116,783,000  |       |
| Acquisitions                   |       | 11,709,000              |       | —           |       | 5,234,000       |       | —       |       | —             |       | 16,943,000   |       |
| Foreign   currency translation |       | 431,000                 |       | —           |       | —          |       | —       |       | 545,000            |       | 976,000      |       |
| Balance,   April 30, 2011 |       | $                       | 51,987,000 |             | $          | 9,648,000       |       | $            | 55,864,000 |               | $          | 8,133,000    |       | $ | 9,070,000 |   | $ | 134,702,000 |   |

 

On July 31, 2010, we performed impairment studies of the Company’s goodwill and trademarks and trade names and concluded that such assets were not impaired.

 

**Note 9.                   Warranty**

 

A summary of activity in the Company’s warranty reserves follows:

 
| ** **                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **April 30,**               | ** ** | **April 30,**              | ** ** |
| ** **                     | ** ** | **2011**                         | ** ** | **2010**                        | ** ** | **2011** | ** ** | **2010** | ** ** |
|                           |       |                             |       |                            |       |   |   |   |   |
| Beginning   balance            |       | $                                | 1,378,000  |                            | $          | 1,141,000 |   | $ | 1,181,000 |   | $ | 949,000 |   |
| Acquisitions                   |       | —                           |       | —                          |       | 10,000 |   | — |   |
| Provisions                     |       | 863,000                          |       | 420,000                         |       | 2,148,000 |   | 1,370,000 |   |
| Charges                        |       | (772,000                         | )          | (459,000                        | )          | (1,870,000 | ) | (1,217,000 | ) |
| Foreign   currency translation |       | 2,000                            |       | 1,000                           |       | 2,000 |   | 1,000 |   |
| Ending   balance               |       | $                                | 1,471,000  |                            | $          | 1,103,000 |   | $ | 1,471,000 |   | $ | 1,103,000 |   |

 

The warranty provisions and charges during the three and nine months ended April 30, 2011 and 2010 relate principally to the Company’s endoscope reprocessing and water purification products. Warranty reserves are included in accrued expenses in the Condensed Consolidated Balance Sheets.

 

**Note 10.                 Financing Arrangements**

 

Our United States credit facilities, as amended, include (i) a six-year $40.0 million senior secured amortizing term loan facility and (ii) a five-year $50.0 million senior secured revolving credit facility, which both expire on August 1, 2011 (the “U.S. Credit Facilities”). Amounts we repay under the term loan facility may not be re-borrowed. Debt issuance costs relating to the U.S. Credit Facilities were recorded in other assets and are being amortized over the life of the credit facilities. Such unamortized debt issuance costs amounted to approximately $75,000 at April 30, 2011.

 

At April 30, 2011, borrowings under the U.S. Credit Facilities bear interest at rates ranging from 0.50% to 1.50% above the lender’s base rate, or at rates ranging from 1.50% to 2.50% above the London Interbank Offered Rate (“LIBOR”), depending upon our consolidated ratio of debt to earnings before interest, taxes, depreciation and amortization, and as further adjusted under the terms of the facilities (“EBITDA”). At April 30, 2011, the lender’s base rate was 3.25% and the LIBOR rates ranged from 0.28% to 1.21%. The margins applicable to our

 

18

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outstanding borrowings at April 30, 2011 were 0.50% above the lender’s base rate and 1.50% above LIBOR. All of our outstanding borrowings were under LIBOR contracts at April 30, 2011. The revolving credit facility also provides for fees on the unused portion at rates ranging from 0.20% to 0.40%, depending upon our consolidated ratio of debt to EBITDA; such rate was 0.20% at April 30, 2011.

 

The U.S Credit Facilities require us to meet certain financial covenants and are secured by (i) substantially all of our U.S.-based assets (including assets of Cantel, Minntech, Mar Cor, Crosstex and Strong Dental) and (ii) our pledge of all of the outstanding shares of Minntech, Mar Cor, Crosstex and Strong Dental and 65% of the outstanding shares of our foreign-based subsidiaries. Additionally, we are not permitted to pay annual cash dividends on our Common Stock in excess of $3,000,000 without the consent of our United States lenders. As of April 30, 2011, we were in compliance with all financial and other covenants under the credit facilities.

 

On April 30, 2011, we had $30,000,000 of outstanding borrowings under the U.S. Credit Facilities, which consisted of $2,500,000 and $27,500,000 under the term loan facility and the revolving credit facility, respectively, and $22,500,000 was available to be borrowed under our revolving credit facility.  On June 9, 2011, we repaid the remaining $2,500,000 under the term credit facility decreasing our total outstanding borrowings to $27,500,000.

 

The U.S. Credit Facilities have a termination date of August 1, 2011. Although we may repay a portion of our outstanding borrowings under the revolver throughout the remainder of fiscal 2011, we do not presently anticipate paying off the revolver in full by its termination date. We are in discussions with our bank syndicate regarding modifications to our credit facilities, including an extension of the termination date of our revolving facility, and expect to formally modify the revolving credit facility before the expiration date. However, since any modification will not be completed until later in fiscal 2011, the entire outstanding balance of the revolver was reclassified from long-term to current subsequent to July 31, 2010.

 

**Note 11.                 Earnings Per Common Share**

 

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

 

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

 

19

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

 
| ** **                                                                                                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **April 30,**               | ** ** | **April 30,**              | ** ** |
| ** **                                                                                                                                   | ** ** | **2011**                         | ** ** | **2010**                        | ** ** | **2011** | ** ** | **2010** | ** ** |
| Numerator   for basic and diluted earnings per share:                                                                                        |       |                             |       |                            |       |   |   |   |   |
| Net   income                                                                                                                                 |       | $                                | 5,048,000  |                            | $          | 4,274,000 |   | $ | 15,743,000 |   | $ | 15,318,000 |   |
| Less   income allocated to participating securities                                                                                          |       | (77,000                          | )          | (69,000                         | )          | (227,000 | ) | (236,000 | ) |
| Net   income available to common shareholders                                                                                                |       | $                                | 4,971,000  |                            | $          | 4,205,000 |   | $ | 15,516,000 |   | $ | 15,082,000 |   |
|                                                                                                                                         |       |                             |       |                            |       |   |   |   |   |
| Denominator   for basic and diluted earnings per share, as adjusted for participating   securities:                                          |       |                             |       |                            |       |   |   |   |   |
| Denominator   for basic earnings per share - weighted average number of shares outstanding attributable   to common stock                    |       | 16,914,123                       |       | 16,556,724                      |       | 16,810,429 |   | 16,488,107 |   |
|                                                                                                                                         |       |                             |       |                            |       |   |   |   |   |
| Dilutive   effect of stock options using the treasury stock method and the average   market price for the period                             |       | 230,320                          |       | 221,374                         |       | 210,334 |   | 198,032 |   |
|                                                                                                                                         |       |                             |       |                            |       |   |   |   |   |
| Denominator   for diluted earnings per share - weighted average number of shares and common   stock equivalents attributable to common stock |       | 17,144,443                       |       | 16,778,098                      |       | 17,020,763 |   | 16,686,139 |   |
|                                                                                                                                         |       |                             |       |                            |       |   |   |   |   |
| Earnings   per share attributable to common stock:                                                                                           |       |                             |       |                            |       |   |   |   |   |
| Basic   earnings per share                                                                                                                   |       | $                                | 0.29       |                            | $          | 0.25 |   | $ | 0.92 |   | $ | 0.91 |   |
|                                                                                                                                         |       |                             |       |                            |       |   |   |   |   |
| Diluted   earnings per share                                                                                                                 |       | $                                | 0.29       |                            | $          | 0.25 |   | $ | 0.91 |   | $ | 0.90 |   |
|                                                                                                                                         |       |                             |       |                            |       |   |   |   |   |
| Stock   options excluded from weighted average dilutive common shares outstanding   because their inclusion would have been antidilutive     |       | —                           |       | 456,001                         |       | 59,329 |   | 674,776 |   |

 

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

 
| ** **                                                                                                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **April 30,**               | ** ** | **April 30,**              | ** ** |
| ** **                                                                                                                                   | ** ** | **2011**                         | ** ** | **2010**                        | ** ** | **2011** | ** ** | **2010** | ** ** |
| Denominator   for diluted earnings per share - weighted average number of shares and common   stock equivalents attributable to common stock |       | 17,144,443                       |       | 16,778,098                      |       | 17,020,763 |   | 16,686,139 |   |
|                                                                                                                                         |       |                             |       |                            |       |   |   |   |   |
| Participating   securities                                                                                                                   |       | 269,596                          |       | 274,153                         |       | 246,145 |   | 261,653 |   |
|                                                                                                                                         |       |                             |       |                            |       |   |   |   |   |
| Total   weighted average number of shares and common stock equivalents attributable   to both common stock and participating securities      |       | 17,414,039                       |       | 17,052,251                      |       | 17,266,908 |   | 16,947,792 |   |

 

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**Note 12.                 Income Taxes**

 

The consolidated effective tax rate was 33.5% and 36.9% for the nine months ended April 30, 2011 and 2010, respectively. The decrease in the consolidated effective tax rate was principally due to the geographic mix of pre-tax income and the impact of various Federal tax legislation changes, as described below.

 

The majority of our income before income taxes was generated from our United States operations, which had an overall effective tax rate of 35.6% and 37.8% for the nine months ended April 30, 2011 and 2010, respectively. The lower overall effective tax rate for the nine months ended April 30, 2011 was principally caused by (i) Federal tax legislation enacted in December 2010 that enabled us to claim the research and experimentation tax credit and (ii) Federal tax legislation that is now fully phased in, which enabled us to claim a larger income tax deduction offered to United States manufacturers. Approximately 90% of our income before income taxes was generated from our United States operations during the nine months ended April 30, 2011. For the nine months ended April 30, 2010, approximately 95% of our income before income taxes related to our United States operations.

 

Approximately 6% of our income before income taxes was generated from our Canadian operations for the nine months ended April 30, 2011 compared with approximately 3% of our income before income taxes in the prior year period. Our Canadian operations had an overall effective tax rate of 17.1% and 15.5% for the nine months ended April 30, 2011 and 2010, respectively. The low overall effective tax rates for both periods was due to the low corporate tax structure in Canada as well as the recognition of tax benefits upon resolution of income tax uncertainties, as more fully described below.

 

For the nine months ended April 30, 2011 and 2010, approximately 3% and 2%, respectively, of our income before income taxes was generated from our operations in Singapore, a country with a low corporate tax structure. The overall effective tax rate for our Singapore operation was 14.3% and 13.5% for the nine months ended April 30, 2011 and 2010, respectively.

 

Approximately 1% of our income before income taxes was generated from our subsidiary in Japan for the nine months ended April 30, 2011 compared with a small loss in the prior year period. Due to the uncertainty of our Japan subsidiary utilizing tax benefits in the future, a tax benefit was not recorded on the losses from operations at our Japan subsidiary during the nine months ended April 30, 2010, thereby adversely affecting our overall consolidated effective tax rate in the prior year period. For the nine months ended April 30, 2011, our Japan operation was slightly profitable and we recorded no income taxes due to the existence of net operating loss carryforwards.

 

The results of operations for our Netherlands subsidiary did not have a significant impact on our overall effective tax rate for the nine months ended April 30, 2011 and 2010 due to the size of income before income taxes generated from this operation.

 

We record liabilities for an unrecognized tax benefit when a tax benefit for an uncertain tax position is taken or expected to be taken on a tax return, but is not recognized in our Condensed Consolidated Financial Statements because it does not meet the more-likely-than-not recognition threshold that the uncertain tax position would be sustained upon examination by the applicable taxing authority. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood

 

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of being realized upon settlement with the tax authorities. The majority of our unrecognized tax benefits originated from acquisitions. Any adjustments upon resolution of income tax uncertainties that predate or result from acquisitions are recognized in our results of operations. However, if our unrecognized tax benefits are recognized in our financial statements in future periods, there would not be a significant impact to our overall effective tax rate due to the size of the unrecognized tax benefits in relation to our income before income taxes. Except for decreases due to the lapse of applicable statutes of limitation, we do not expect such unrecognized tax benefits to significantly decrease or increase in the next twelve months.

 

A reconciliation of the beginning and ending amounts of gross unrecognized tax benefits is as follows:

 
| ** **                                         | ** ** | **Unrecognized**      | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **Tax Benefits** | ** ** |
|                                               |       |                  |       |
| Unrecognized   tax benefits on July 31, 2009  |       | $                     | 380,000    |   |
| Lapse   of statute of limitations                  |       | (172,000              | )          |
| Unrecognized   tax benefits on July 31, 2010  |       | 208,000               |       |
| Lapse   of statute of limitations                  |       | (141,000              | )          |
| Unrecognized   tax benefits on April 30, 2011 |       | $                     | 67,000     |   |

 

Generally, the Company is no longer subject to federal, state or foreign income tax examinations for fiscal years ended prior to July 31, 2004.

 

Our policy is to record potential interest and penalties related to income tax positions in interest expense and general and administrative expense, respectively, in our Condensed Consolidated Financial Statements. However, such amounts have been relatively insignificant due to the amount of our unrecognized tax benefits relating to uncertain tax positions.

 

**Note 13.                 Commitments and Contingencies**

 

***Long-term contractual obligations***

 

As of April 30, 2011, aggregate annual required payments over the remaining fiscal year, the next four years and thereafter under our contractual obligations that have long-term components were as follows:

 

22

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| ** **                                                   | ** ** | **Three Months**                | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|
| ** **                                                   | ** ** | **Ending**                           | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **July 31,**                    | ** ** | **Year Ending July 31,** | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **2011**                             | ** ** | **2012**                                | ** ** | **2013**   | ** ** | **2014**   | ** ** | **2015**   | ** ** | **Thereafter** | ** ** | **Total**  | ** ** |
| ** **                                                   | ** ** | **(Amounts in thousands)** | ** ** |
| Maturities   of the credit facilities                        |       | $                                    | 2,500      |                                    | $          | 27,500     |       | $          | —     |       | $          | —         |       | $          | —     |   | $ | — |   | $ | 30,000 |   |
| Expected   interest payments under the credit facilities (1) |       | 142                                  |       | —                                  |       | —     |       | —     |       | —     |       | —         |       | 142        |       |
| Minimum   commitments under noncancelable operating leases   |       | 865                                  |       | 3,064                                   |       | 2,314      |       | 1,940      |       | 1,489      |       | 6,222          |       | 15,894     |       |
| Deferred   compensation and other                            |       | 102                                  |       | 253                                     |       | 38         |       | 33         |       | 34         |       | 132            |       | 592        |       |
| Acquisitions   payable                                       |       | 516                                  |       | 2,207                                   |       | —     |       | —     |       | —     |       | —         |       | 2,723      |       |
| Employment   agreements                                      |       | 709                                  |       | 2,375                                   |       | 121        |       | —     |       | —     |       | —         |       | 3,205      |       |
| Total   contractual obligations                              |       | $                                    | 4,834      |                                    | $          | 35,399     |       | $          | 2,473      |       | $          | 1,973          |       | $          | 1,523      |   | $ | 6,354 |   | $ | 52,556 |   |

 

----

(1) The expected interest payments under the term and revolving credit facilities reflect interest rates of 2.71% and 1.96%, respectively, which were our weighted average interest rates on outstanding borrowings at April 30, 2011.

 

***Operating leases***

 

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

 

***Deferred compensation***

 

Included in other long-term liabilities are deferred compensation arrangements for certain former Minntech directors and officers.

 

***Acquisitions payable***

 

In connection with the Gambro Water acquisition, as more fully described in Note 3 to the Condensed Consolidated Financial Statements, a portion of the purchase price amounting to $3,100,000 is payable in six equal quarterly payments beginning January 2011 and ending April 2012. As of April 30, 2011, $2,067,000 of the $3,100,000 remains payable. In addition, we have estimated $656,000 as the fair value of contingent consideration relating to the acquisition of ConFirm, as further described in Notes 3 and 7 to the Condensed Consolidated Financial Statements, which will be payable after the one year period ending January 31, 2012 assuming the achievement of a contractually specified sales level for such period.

 

***Employment agreements***

 

We had previously entered into various employment agreements with executives of the Company, including our Corporate executive officers and our subsidiaries’ Chief Executive Officers. All of such contracts expired and most were replaced effective January 1, 2010 with severance contracts that defined certain compensation arrangements relating to various employment termination scenarios.

 

23

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**Note 14.                 Operating Segments**

 

We are a leading provider of infection prevention and control products and services in the healthcare market. Our products include specialized medical device reprocessing systems for renal dialysis and endoscopy, dialysate concentrates and other dialysis supplies, water purification equipment, sterilants, disinfectants and cleaners, hollow fiber membrane filtration and separation products for medical and non-medical applications, and specialty packaging for infectious and biological specimens. We also provide technical maintenance for our products and offer compliance training services for the transport of infectious and biological specimens.

 

In accordance with FASB ASC Topic 280, “*Segment Reporting,”* (“ASC 280”), we have determined our reportable business segments based upon an assessment of product types, organizational structure, customers and internally prepared financial statements. The primary factors used by us in analyzing segment performance are net sales and operating income.

 

During our fourth quarter of fiscal 2010, we changed our internal reporting processes to include a new operating segment called Chemistries to reflect the way the Company, through its executive management, manages, allocates resources and measures the performance of its businesses. This new operating segment is the combination of a small portion of our existing sterilant business, comprised of products sold on an OEM basis and previously recorded in our Water Purification and Filtration segment, and a new business operation that was created to capitalize on our chemistry expertise and expand our product offerings in existing and new markets within the infection prevention and control arena. As a result of this internal reorganization, certain research and development projects were reclassified among segments. All prior period segment results have been restated to reflect these changes.

 

The Company’s segments are as follows:

 

**Water Purification and Filtration**, which includes water purification equipment design and manufacturing, project management, installation, maintenance, deionization and mixing systems, as well as hollow fiber filter devices and ancillary products for high-purity fluid and separation applications for healthcare (with a large concentration in dialysis), pharmaceutical, biotechnology, research, beverage, semiconductor and other commercial industries. Additionally, this segment includes cold sterilant products used to disinfect high-purity water systems.

 

Two customers collectively accounted for approximately 37% of our Water Purification and Filtration segment net sales during the nine months ended April 30, 2011.

 

**Endoscope Reprocessing**, which includes endoscope disinfection equipment and related accessories, disinfectants and supplies that are sold to hospitals, clinics and physicians. Additionally, this segment includes technical maintenance service on its products.

 

**Healthcare Disposables**, which includes single-use infection prevention and control products used principally in the dental market such as face masks, sterilization pouches, patient towels and bibs, self-sealing sterilization pouches, tray covers, surface barriers including eyewear, aprons and gowns, disinfectants, germicidal wipes, hand care products, gloves, sponges, cotton products, cups, needles and syringes, scalpels and blades, and saliva evacuators and ejectors.

 

Four customers collectively accounted for approximately 60% of our Healthcare Disposables segment net sales during the nine months ended April 30, 2011.

 

24

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**Dialysis**, which includes disinfection/sterilization reprocessing equipment, sterilants, supplies and concentrates related to hemodialysis treatment of patients with acute kidney failure or chronic kidney failure associated with end-stage renal disease. Additionally, this segment includes technical maintenance service on its products.

 

One customer accounted for approximately 36% of our Dialysis segment net sales during the nine months ended April 30, 2011.

 

**All Other**

 

In accordance with quantitative thresholds established by ASC 280, we have combined the Therapeutic Filtration, Specialty Packaging and Chemistries operating segments into the All Other reporting segment.

 

**Therapeutic Filtration**, which includes hollow fiber filter devices and ancillary products for use in medical applications that are sold to biotech manufacturers and third-party distributors.

 

**Specialty Packaging**, which includes specialty packaging and thermal control products, as well as related compliance training, for the safe transport of infectious and biological specimens and thermally sensitive pharmaceutical, medical and other products.

 

**Chemistries,**which includes sterilants, disinfectants, detergents and decontamination services used in various applications for infection prevention and control.

 

One customer accounted for approximately 10% of our consolidated net sales during the nine months ended April 30, 2011. Such net sales were recorded in our Water Purification and Filtration and Dialysis segments.

 

The operating segments follow the same accounting policies used for our Condensed Consolidated Financial Statements as described in Note 2 to the 2010 Form 10-K.

 

Information as to operating segments is summarized below:

 

25

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| ** **                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **April 30,**               | ** ** | **April 30,**              | ** ** |
| ** **                          | ** ** | **2011**                         | ** ** | **2010**                        | ** ** | **2011** | ** ** | **2010** | ** ** |
|                                |       |                             |       |                            |       |   |   |   |   |
| Net   sales:                        |       |                             |       |                            |       |   |   |   |   |
| Water   Purification and Filtration |       | $                                | 23,298,000 |                            | $          | 18,446,000 |   | $ | 67,973,000 |   | $ | 54,556,000 |   |
| Endoscope   Reprocessing            |       | 27,311,000                       |       | 16,310,000                      |       | 74,119,000 |   | 47,087,000 |   |
| Healthcare   Disposables            |       | 18,237,000                       |       | 16,305,000                      |       | 50,903,000 |   | 53,047,000 |   |
| Dialysis                            |       | 9,318,000                        |       | 10,558,000                      |       | 29,326,000 |   | 34,852,000 |   |
| All   Other                         |       | 4,455,000                        |       | 4,940,000                       |       | 13,312,000 |   | 14,599,000 |   |
| Total                               |       | $                                | 82,619,000 |                            | $          | 66,559,000 |   | $ | 235,633,000 |   | $ | 204,141,000 |   |
|                                |       |                             |       |                            |       |   |   |   |   |
| Operating   income:                 |       |                             |       |                            |       |   |   |   |   |
| Water   Purification and Filtration |       | $                                | 1,626,000  |                            | $          | 1,687,000 |   | $ | 5,241,000 |   | $ | 5,381,000 |   |
| Endoscope   Reprocessing            |       | 3,540,000                        |       | 1,551,000                       |       | 10,119,000 |   | 5,245,000 |   |
| Healthcare   Disposables            |       | 2,344,000                        |       | 2,445,000                       |       | 6,962,000 |   | 9,732,000 |   |
| Dialysis                            |       | 2,201,000                        |       | 2,337,000                       |       | 7,464,000 |   | 8,166,000 |   |
| All   Other                         |       | 185,000                          |       | 923,000                         |       | 1,060,000 |   | 3,349,000 |   |
|                                |       | 9,896,000                        |       | 8,943,000                       |       | 30,846,000 |   | 31,873,000 |   |
| General   corporate expenses        |       | (2,253,000                       | )          | (2,089,000                      | )          | (6,530,000 | ) | (6,671,000 | ) |
| Interest   expense, net             |       | (171,000                         | )          | (214,000                        | )          | (636,000 | ) | (924,000 | ) |
|                                |       |                             |       |                            |       |   |   |   |   |
| Income   before income taxes        |       | $                                | 7,472,000  |                            | $          | 6,640,000 |   | $ | 23,680,000 |   | $ | 24,278,000 |   |

 

**Note 15.                 Legal Proceedings**

 

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

 

**Note 16.                 Convertible Notes Receivable**

 

In February 2009, we invested an initial $200,000 in a senior subordinated convertible promissory note issued by BIOSAFE, Inc. (“BIOSAFE”), in connection with BIOSAFE’s grant to us of certain exclusive and non-exclusive license rights to BIOSAFE’s antimicrobial additive. BIOSAFE is the owner of a patented and proprietary antimicrobial agent that is built into the manufacturing of end-products to achieve long-lasting microbial protection on such end-products’ surface. As a result of BIOSAFE’s successful raising of a minimum incremental amount of cash following our investment, we invested an additional $300,000 in notes of BIOSAFE in January 2010 bringing the aggregate investment in BIOSAFE notes to $500,000, as obligated under our agreement with BIOSAFE. We are not obligated to invest any additional funds.

 

The notes mature and are due and payable on June 30, 2011 (“Maturity Date”). The notes accrue interest at a per annum rate of 8% until the Maturity Date or earlier exercise. The entire principal amount and accrued interest are automatically payable in a newly-created series of preferred stock issued upon the closing of BIOSAFE’s next round financing on or before the Maturity Date (“Next Round Financing”) based on a conversion formula.

 

If the Next Round Financing fails to occur by the Maturity Date, the notes, both principal

 

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and interest, will be payable in cash and the automatic conversion will no longer apply. If BIOSAFE defaults on such payment, interest will accrue thereafter at a rate of 12% per annum. Additionally, during the 30-day period following the Maturity Date, we may elect to convert the principal and all accrued interest into shares of common stock of BIOSAFE at a price per share equal to 70% of the fair market value (the “Discount Rate”). No further interest will accrue if we make such election. As of June 9, 2011, the Next Round Financing has not occurred.

 

On June 3, 2011 BIOSAFE requested that the Company and other note holders agree to amend the notes to extend the Maturity Date to December 31, 2011 in consideration for (i) an increase in the interest rate of the notes to 12% per annum (commencing from the effective date of the amendment), (ii) decreasing the Discount Rate to 60% and (iii) certain other benefits to the note holders. Such amendment requires approval of holders representing a majority of the aggregate outstanding principal amount of the notes.

 

In connection with our investment, we entered into a license agreement with BIOSAFE under which we will pay BIOSAFE a fixed royalty percentage of sales of our products containing BIOSAFE’s antimicrobial formulation. This investment, together with the accrued interest, is included within other assets in our Condensed Consolidated Balance Sheets at April 30, 2011 and July 31, 2010. At April 30, 2011, we evaluated this investment for potential impairment and determined that no impairment exists at such date since the carrying value of this investment approximates fair value. However, based upon the evidence evaluated, we will need to conduct another impairment assessment at the end of our fourth quarter.

 

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**ITEM 2.**                  **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help you understand Cantel Medical Corp. (“Cantel”). The MD&A is provided as a supplement to and should be read in conjunction with our financial statements and the accompanying notes. Our MD&A includes the following sections:

 

**Overview** provides a brief description of our business and a summary of significant activity that has affected or may affect our results of operations and financial condition.

 

**Results of Operations** provides a discussion of the consolidated results of operations for the three and nine months ended April 30, 2011 compared with the three and nine months ended April 30, 2010.

 

**Liquidity and Capital Resources** provides an overview of our working capital, cash flows, contractual obligations, financing and foreign currency activities.

 

**Critical Accounting Policies** provides a discussion of our accounting policies that require critical judgments, assumptions and estimates.

 

**Forward-Looking Statements** provides a discussion of cautionary factors that may affect future results.

 

**Overview**

 

Cantel is a leading provider of infection prevention and control products and services in the healthcare market, specializing in the following operating segments:

 

·      Water Purification and Filtration: Water purification equipment and services, filtration and separation products, and disinfectants for the medical, pharmaceutical, biotech, beverage and commercial industrial markets.

 

·      Endoscope Reprocessing: Medical device reprocessing systems, disinfectants, detergents and other supplies used to high-level disinfect flexible endoscopes.

 

·      Healthcare Disposables: Single-use, infection prevention and control products used principally in the dental market including face masks, sterilization pouches, towels and bibs, tray covers, saliva ejectors, germicidal wipes, plastic cups, and disinfectants.

 

·      Dialysis: Medical device reprocessing systems, sterilants/disinfectants, dialysate concentrates and other supplies for renal dialysis.

 

·      Therapeutic Filtration: Hollow fiber membrane filtration and separation technologies for medical applications. (Included in the All Other reporting segment.)

 

·      Specialty Packaging: Specialty packaging and thermal control products, as well as related compliance training, for the transport of infectious and biological specimens and thermally sensitive pharmaceutical, medical and other products. (Included in the All Other reporting segment.)

 

·      Chemistries:  Sterilants, disinfectants, detergents and decontamination services used in various applications for infection prevention and control. (Included in the All Other reporting segment.)

 

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Most of our equipment, consumables and supplies are used to help prevent the occurrence or spread of infections.

 

See our Annual Report on Form 10-K for the fiscal year ended July 31, 2010 (the “2010 Form 10-K”) and our Condensed Consolidated Financial Statements for additional financial information regarding our reporting segments.

 

***Significant Activity***

 

(i)           Net sales increased by 24.1% and 15.4% for the three and nine months ended April 30, 2011, respectively, compared with the three and nine months ended April 30, 2010, to a new record sales level for a three and nine month period. Net income increased by 18.1% and 2.8% for the three and nine months ended April 30, 2011, respectively. We continue to benefit from having a broad portfolio of infection prevention and control products sold into diverse business segments, where approximately 65% of our net sales are attributable to consumable products and service. The primary factors that contributed to this financial performance, as further described elsewhere in this MD&A, were as follows:

 

·                                    significant increases in sales volume of our Endoscope Reprocessing products and services due to increased market demand for our capital equipment, equipment accessories, disinfectants and service as a result of our investments in new product offerings, enhanced sales and marketing programs, our participation in a major capital equipment upgrade initiative by the Veterans Administration, regulatory issues experienced by a major competitor and improved economic conditions relating to capital equipment purchases resulting in substantial increased profitability for this segment,

 

·                                    a decrease in the consolidated effective tax rate primarily due to the geographic mix of pre-tax income and the impact of various Federal tax legislation changes,

 

·                                    increased sales, but an insignificant impact on net income, as a result of our acquisition of the United States water purification business of Gambro Renal Products, Inc. (“GRP”) and a Swedish-based affiliate of GRP (“Gambro Water” or the “Gambro Acquisition”) on October 6, 2010, as more fully described in Note 3 to the Condensed Consolidated Financial Statements,

 

·                                    improved sales in our Water Purification and Filtration segment primarily relating to sales of our capital equipment used for commercial and industrial applications and our sterilants and filters within our installed equipment base of business, and

 

·                                    favorable interest costs due to lower average outstanding borrowings and reduced interest rates.

 

The above factors were partially offset by:

 

·                                    a decrease in gross profit percentage to 37.9% and 38.6% for the three and nine months ended April 30, 2011, respectively, from 40.1% and 40.8% in

 

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the comparative prior year periods due to increases in manufacturing, raw material and distribution costs and unfavorable sales mix attributable to,

 

a)                                      an increase in sales volume of lower margin capital equipment in our Endoscope Reprocessing and Water Purification and Filtration segments including sales associated with the Gambro Acquisition, and

 

b)                                     with respect to the nine months ended April 30, 2011, atypical demand in the first four months of fiscal 2010 for higher margin face masks and other healthcare disposables products as a result of the elevated level of reported cases of the novel H1N1 flu (swine flu), which contributed approximately $3,400,000 and $2,135,000 in incremental gross profit and net income, respectively, or $0.13 in earnings per share, during the first four months of fiscal 2010,

 

·                                    decreases in net sales and profitability in our Dialysis and Therapeutic Filtration operating segments, and

 

·                                    increased investment in sales, marketing and research and development activities.

 

(ii)         We sell our dialysis products to a concentrated number of customers. Sales in our Dialysis segment were adversely impacted by the continued loss of some lower margin dialysate concentrate business from both domestic and international customers as a result of the highly competitive and price sensitive market for such product, as well as the decrease in demand for our Renatron® reprocessing equipment, sterilants and reprocessing supplies, as more fully described elsewhere in this MD&A. This reduction in dialysis sales has reduced overall profitability in this segment. Our market for dialysis reprocessing products is limited to dialysis centers that reuse dialyzers, which market has been decreasing in the United States despite the environmental advantages and our belief that the per-procedure cost of reuse dialyzers is more economical than single-use dialyzers. A further decrease in the market for dialysis reprocessing products is likely to result in continued loss of net sales and a lower level of profitability in this segment in the future. See “Risk Factors” in our 2010 Form 10-K for a discussion of our Dialysis segment.

 

(iii)        We acquired the business of ConFirm Monitoring Systems, Inc. (“ConFirm”) on February 11, 2011, as more fully described in Note 3 to the Condensed Consolidated Financial Statements.

 

(iv)        We acquired the United States water purification business of Gambro Water on October 6, 2010, as more fully described in Note 3 to the Condensed Consolidated Financial Statements.

 

(v)         In fiscal 2010, we declared our first semiannual cash dividend of $0.05 per share of outstanding common stock, which was paid on each of January 29, 2010 and July 30, 2010. On October 21, 2010, we announced an increase in the semiannual cash dividend to $0.06 per share of outstanding common stock, which was paid on January 28, 2011 to shareholders of record at the close of business on January 14,

 

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2011, as more fully described elsewhere in this MD&A.

 

(vi)        We created a new operating segment named Chemistries, as more fully described elsewhere in this MD&A.

 

(vii)       We acquired the business of Purity Water Company of San Antonio, Inc. (“Purity”) on June 1, 2010, as more fully described in Note 3 to the Condensed Consolidated Financial Statements.

 

(viii)      We amended our credit facilities on May 28, 2010 primarily to extend the termination date of the revolving credit facility from its August 1, 2010 expiration date to August 1, 2011, as well as to expand our acquisition financing capabilities, as more fully described elsewhere in this MD&A.

 

**Results of Operations**

 

The results of operations described below reflect the operating results of Cantel and its wholly-owned subsidiaries. Since the acquisition of ConFirm was consummated on February 11, 2011, its results of operations are included in our results of operations for the portion of the three and nine months ended April 30, 2011 subsequent to its acquisition date, but are not reflected in our results of operations for the three and nine months ended April 30, 2010. Since the Gambro Acquisition was completed on October 6, 2010, its results of operations are included in our results of operations for the three months ended April 30, 2011 and the portion of the nine months ended April 30, 2011 subsequent to its acquisition date, but are not reflected in our results of operations for the three and nine months ended April 30, 2010. Since the acquisition of Purity was completed on June 1, 2010, its results of operations are included in our results of operations for the three and nine months ended April 30, 2011, but are not reflected in our results of operations for the three and nine months ended April 30, 2010.

 

During our fourth quarter of fiscal 2010, we changed our internal reporting processes to include a new operating segment called Chemistries to reflect the way the Company, through its executive management, manages, allocates resources and measures the performance of its businesses. This new operating segment is the combination of a small portion of our existing sterilant business, comprised of products sold on an OEM basis and previously recorded in our Water Purification and Filtration segment, and a new business operation that was created to capitalize on our chemistry expertise and expand our product offerings in existing and new markets within the infection prevention and control arena. As a result of this internal reorganization, certain research and development projects were reclassified among segments. All prior period segment results have been restated to reflect these changes.

 

The following discussion should also be read in conjunction with our 2010 Form 10-K.

 

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The following table gives information as to the net sales and the percentage to the total net sales for each of our reporting segments:

 

 
| ** **                          | ** ** | **Three Months Ended**                 | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **April 30,**                               | ** ** | **April 30,**              | ** ** |
| ** **                          | ** ** | **2011**                                         | ** ** | **2010**                        | ** ** | **2011** | ** ** | **2010** | ** ** |
| ** **                          | ** ** | **(Dollar amounts in thousands)** | ** ** |
| ** **                          | ** ** | **$**                                            | ** ** | **%**                           | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
|                                |       |                                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Water   Purification and Filtration |       | $                                                | 23,298     |                            | 28.2       |   | $ | 18,446 |   | 27.7 |   | $ | 67,973 |   | 28.9 |   | $ | 54,556 |   | 26.7 |   |
| Endoscope   Reprocessing            |       | 27,311                                           |       | 33.0                            |       | 16,310 |   | 24.5 |   | 74,119 |   | 31.5 |   | 47,087 |   | 23.1 |   |
| Healthcare   Disposables            |       | 18,237                                           |       | 22.1                            |       | 16,305 |   | 24.5 |   | 50,903 |   | 21.6 |   | 53,047 |   | 26.0 |   |
| Dialysis                            |       | 9,318                                            |       | 11.3                            |       | 10,558 |   | 15.9 |   | 29,326 |   | 12.4 |   | 34,852 |   | 17.1 |   |
| All   Other                         |       | 4,455                                            |       | 5.4                             |       | 4,940 |   | 7.4 |   | 13,312 |   | 5.6 |   | 14,599 |   | 7.1 |   |
|                                |       | $                                                | 82,619     |                            | 100.0      |   | $ | 66,559 |   | 100.0 |   | $ | 235,633 |   | 100.0 |   | $ | 204,141 |   | 100.0 |   |

 

***Net Sales***

 

Net sales increased by $16,060,000, or 24.1%, to $82,619,000 for the three months ended April 30, 2011 from $66,559,000 for the three months ended April 30, 2010.

 

Net sales increased by $31,492,000, or 15.4%, to $235,633,000 for the nine months ended April 30, 2011 from $204,141,000 for the nine months ended April 30, 2010.

 

The increase in net sales for the three and nine months ended April 30, 2011 was principally attributable to increases in sales of endoscope reprocessing products and services and water purification and filtration products and services, partially offset by decreases in sales of dialysis and therapeutic filtration products, and with respect to the first four months of the nine months ended April 30, 2011, healthcare disposables products.

 

Net sales of endoscope reprocessing products and services increased by 67.4% and 57.4% for the three and nine months ended April 30, 2011, respectively, compared with the three and nine months ended April 30, 2010, primarily due to an increase in worldwide demand, especially in the United States, for (i) our endoscope reprocessing equipment and (ii) our equipment accessories, disinfectants, consumables and service due to the increased field population of equipment. We attribute the increased demand in our endoscope reprocessing equipment to (i) our investments in new product offerings and sales and marketing programs, (ii) regulatory issues experienced by a major competitor, (iii) successfully participating in a major initiative by the Veterans Administration to upgrade their hospitals’ endoscope reprocessing equipment throughout their system, which system-wide upgrade will be substantially completed over the next few months, and (iv) improved economic conditions relating to capital equipment purchases. We believe that at least half of the increase in Endoscope Reprocessing sales for the three and nine months ended April 30, 2011 was due to our competitors’ regulatory issues and our participation in this Veterans Administration initiative. In fiscal 2012 we expect this elevated level of capital equipment sales to return to a level that existed in prior periods.  However, in the future we expect disinfectants, consumables and service sales to benefit from the increased field population of equipment. Partially offsetting these increases were lower selling prices, which adversely impacted net sales for the three and nine months ended April 30, 2011 by approximately $435,000 and $1,895,000, respectively, and primarily related to the significant

 

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volume of sales to government entities, such as Veterans Administration hospitals, which typically receive discounted pricing.

 

Net sales of water purification and filtration products and services increased by approximately $4,852,000 and $13,417,000 for the three and nine months ended April 30, 2011, respectively, compared with the three and nine months ended April 30, 2010, primarily due to (i) incremental net sales attributable to the Gambro Acquisition of approximately $3,656,000 and $8,608,000 for the three and nine months ended April 30, 2011, respectively, (ii) an increase in demand for our sterilants and filters within our installed equipment base of business, and (iii) an increase in demand during the first half of the nine months ended April 30, 2011 for capital equipment used for commercial and industrial applications. Increases in selling prices of our water purification products and services did not have a significant effect on net sales for the three and nine months ended April 30, 2011, compared with the three and nine months ended April 30, 2010.

 

Net sales of dialysis products and services decreased by 11.7% and 15.9% for the three and nine months ended April 30, 2011, respectively, compared with the three and nine months ended April 30, 2010, primarily due to (i) the expected adverse impact of losing some dialysate concentrate business (a concentrated acid or bicarbonate used to prepare dialysate, a chemical solution that draws waste products from a patient’s blood through a dialyzer membrane during hemodialysis treatment) from domestic and international customers as a result of the highly competitive and price sensitive market for this lower margin commodity product, as well as various global economic factors with respect to international demand, and (ii) a decrease in demand in the United States (including a decrease from our largest dialysis customer, DaVita, Inc. (“DaVita”)) for our Renatron dialyzer reprocessing equipment, sterilants and reprocessing supplies. Due to sales price decreases by some of our competitors, we expect a continued decrease in net sales of our lower margin dialysate concentrate product in the future as we elect not to pursue unprofitable concentrate sales. Furthermore, Fresenius Medical Care (“Fresenius”), the largest dialysis provider chain in the United States, manufactures dialysate concentrate themselves and no longer purchases that product from us. Our market for dialysis reprocessing products is limited to dialysis centers that reuse dialyzers, which market has been decreasing in the United States despite the environmental advantages and our belief that the per-procedure cost of reuse dialyzers is more economical than single-use dialyzers. A further decrease in the market for dialysis reprocessing products is likely to result in continued loss of net sales and a lower level of profitability in this segment in the future. Additionally, our Dialysis segment is highly dependent upon DaVita as a customer and any shift by this customer away from reuse would have a material adverse effect on our Dialysis segment net sales. Changes in selling prices of our dialysis products did not have a significant effect on net sales for the three and nine months ended April 30, 2011, compared with the three and nine months ended April 30, 2010.

 

Net sales of healthcare disposables products increased by 11.8% for the three months ended April 30, 2011 and decreased by 4.0% for the nine months ended April 30, 2011, compared with the three and nine months ended April 30, 2010. The decrease in net sales for the nine months ended April 30, 2011 was principally due to a decline in net sales of approximately $5,600,000 during the first four months of the current year period as a result of reduced sales volume of higher margin face masks and other healthcare disposables products that were in strong demand during the prior year outbreak of the novel H1N1 flu (swine flu). Although the outbreak of the novel H1N1 flu resulted in strong sales volume of higher margin face masks and other healthcare disposables products during the first four months of fiscal 2010, such sales volume has returned to a sales level that is similar to that which existed prior to the outbreak of the novel

 

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H1N1 flu, with the exception of sales to certain distributors who are overstocked with face masks, given that the elevated level of reported cases of influenza viruses has subsided and a new outbreak has not occurred. Atypical demand for face masks is highly dependent upon the severity and timing of any pandemic flu outbreak such as the recent novel H1N1 flu, the ability of our Company to educate existing customers and potential new customers on the benefits of our face masks, disinfectants and other products and the level of urgency our customers, government agencies and the general public develop and maintain with respect to epidemic and pandemic preparedness. Partially offsetting this decrease in sales volume for the nine months ended April 30, 2011 was an increase in net sales primarily during the second half of the nine months ended April 30, 2011 due to (i) higher selling prices, which favorably impacted net sales for the three and nine months ended April 30, 2011 by approximately $670,000 and $1,610,000, respectively, and were implemented to offset the rising cost of raw materials, (ii) increased demand for our sterilization accessories as a result of favorable sales and marketing initiatives, (iii) incremental net sales of approximately $667,000 attributable to the acquisition of ConFirm on February 11, 2011, and (iv) elevated customer demand during our third quarter of fiscal 2011 in advance of known price increases to be implemented in our fourth quarter of fiscal 2011.

 

For the three and nine months ended April 30, 2011, net sales contributed by the Therapeutic Filtration operating segment (included in the All Other reporting segment) was $1,984,000 and $5,938,000, respectively, which was a decrease of 21.1% and 18.1% for the three and nine months ended April 30, 2011, compared with the three and nine months ended April 30, 2010, respectively. This decrease in net sales was primarily due to (i) a reduction in higher margin sales in the United States of filters manufactured by us on an OEM basis for a single customer’s hydration system as a result of our customer phasing out the model that uses our filters, and (ii) a decrease in demand for our hemoconcentrator products (a device used to concentrate red blood cells and remove excess fluid from the bloodstream during open-heart surgery), both in the United States and internationally.

 

***Gross profit***

 

Gross profit increased by $4,609,000, or 17.3%, to $31,302,000 for the three months ended April 30, 2011 from $26,693,000 for the three months ended April 30, 2010. Gross profit as a percentage of net sales for the three months ended April 30, 2011 and 2010 was 37.9% and 40.1%, respectively.

 

Gross profit increased by $7,611,000, or 9.1%, to $90,886,000 for the nine months ended April 30, 2011 from $83,275,000 for the nine months ended April 30, 2010. Gross profit as a percentage of net sales for the nine months ended April 30, 2011 and 2010 was 38.6% and 40.8%, respectively.

 

The gross profit as a percentage of net sales for the three and nine months ended April 30, 2011 decreased compared with the three and nine months ended April 30, 2010 primarily due to (i) a less favorable sales mix due to increases in sales volume of certain lower margin products, such as the significant increase in capital equipment sales in our Endoscope Reprocessing segment, and with respect to the first four months of fiscal 2010, a decrease in sales volume of high margin face masks, disinfectants and other healthcare disposables products that were in strong demand during the prior year outbreak of the novel H1N1 flu (swine flu), (ii) the inclusion of sales with lower gross margin as a result of acquiring Gambro Water and (iii) an increase in raw materials and distribution costs primarily due to the higher price of oil.

 

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We cannot provide assurances that our gross profit percentage will not be further adversely affected in the future (i) by price competition in certain of our segments such as Healthcare Disposables, Endoscope Reprocessing and Dialysis, (ii) by uncertainties associated with our product mix or (iii) if raw materials and distribution costs increase and we are unable to implement price increases. Additionally, despite expensive shipping costs, some of our competitors manufacture certain healthcare disposable products in China and Southeast Asia due to lower overall costs. Although we believe the quality of our healthcare disposable products, which are generally produced in the United States, are superior to similar products produced in China and Southeast Asia, we expect to experience significant pricing pressure that will adversely affect our gross profit in the future in our Healthcare Disposables segment as a result of low cost competition from products produced in China and Southeast Asia.

 

***Operating Expenses***

 

Selling expenses increased by $2,157,000, or 23.1%, to $11,505,000 for the three months ended April 30, 2011 from $9,348,000 for the three months ended April 30, 2010. For the nine months ended April 30, 2011, selling expenses increased by $5,345,000, or 20.1%, to $31,928,000 from $26,583,000 for the nine months ended April 30, 2010. These increases were primarily due to commissions on increased sales by our endoscope reprocessing direct sales force and to a lesser extent, additional sales personnel principally in our Endoscope Reprocessing and Water Purification and Filtration segments.

 

Selling expenses as a percentage of net sales were 13.9% and 14.0% for the three months ended April 30, 2011 and 2010, respectively, and 13.5% and 13.0% for the nine months ended April 30, 2011 and 2010, respectively. The increase in our selling expense as a percentage of net sales for the nine months ended April 30, 2011 was due to our strategic decision to invest in selling initiatives designed to gain or maintain market share as well as to expand into new markets.

 

General and administrative expenses increased by $1,290,000, or 14.1%, to $10,439,000 for the three months ended April 30, 2011, from $9,149,000 for the three months ended April 30, 2010, primarily due to increases of (i) approximately $615,000 in compensation expense relating to annual salary raises, additional administrative personnel, employee benefit costs and stock-based compensation expense, (ii) approximately $150,000 in outside professional fees and (iii) $195,000 in amortization expense of intangible assets primarily relating to our acquisitions of ConFirm, Gambro Water and Purity.

 

General and administrative expenses increased by $2,137,000, or 7.7%, to $29,863,000 for the nine months ended April 30, 2011, from $27,726,000 for the nine months ended April 30, 2010, primarily due to increases of (i) approximately $895,000 in compensation expense relating to annual salary raises, additional administrative personnel, employee benefit costs and stock-based compensation expense, (ii) approximately $420,000 in outside professional fees which primarily related to acquisitions and (iii) $348,000 in amortization expense of intangible assets primarily related to our acquisitions of ConFirm, Gambro Water and Purity.

 

General and administrative expenses as a percentage of net sales were 12.6% and 13.7% for the three months ended April 30, 2011 and 2010, respectively, and 12.7% and 13.6% for the nine months ended April 30, 2011 and 2010, respectively.

 

Research and development expenses (which include continuing engineering costs) increased

 

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by $373,000 to $1,715,000 for the three months ended April 30, 2011, from $1,342,000 for the three months ended April 30, 2010. For the nine months ended April 30, 2011, research and development expenses increased by $1,015,000 to $4,779,000, from $3,764,000 for the nine months ended April 30, 2010. These increases were primarily due to development work on certain new products in our newly created Chemistries operating segment. For fiscal 2012 and the remainder of fiscal 2011, we intend to continue our acceleration of investments in research and development to leverage our new Chemistries group across various infection prevention and control opportunities.

 

***Interest***

 

Interest expense decreased by $38,000 to $195,000 for the three months ended April 30, 2011, from $233,000 for the three months ended April 30, 2010, primarily due to a decrease in average interest rates.  For the nine months ended April 30, 2011, interest expense decreased by $261,000 to $698,000, from $959,000 for the nine months ended April 30, 2010, primarily due to decreases in average outstanding borrowings and average interest rates.

 

Interest income increased by $5,000 to $24,000 for the three months ended April 30, 2011, from $19,000 for the three months ended April 30, 2010.  For the nine months ended April 30, 2011, interest income increased by $27,000 to $62,000, from $35,000 for the nine months ended April 30, 2010. These increases were due to increasing our investment in a senior subordinated convertible promissory note issued by BIOSAFE, Inc. (“BIOSAFE”) during the prior year, as more fully described elsewhere in this MD&A.

 

***Income taxes***

 

The consolidated effective tax rate was 33.5% and 36.9% for the nine months ended April 30, 2011 and 2010, respectively. The decrease in the consolidated effective tax rate was principally due to the geographic mix of pre-tax income and the impact of various Federal tax legislation changes, as described below.

 

The majority of our income before income taxes was generated from our United States operations, which had an overall effective tax rate of 35.6% and 37.8% for the nine months ended April 30, 2011 and 2010, respectively. The lower overall effective tax rate for the nine months ended April 30, 2011 was principally caused by (i) Federal tax legislation enacted in December 2010 that enabled us to claim the research and experimentation tax credit and (ii) Federal tax legislation that is now fully phased in, which enabled us to claim a larger income tax deduction offered to United States manufacturers. Approximately 90% of our income before income taxes was generated from our United States operations during the nine months ended April 30, 2011. For the nine months ended April 30, 2010, approximately 95% of our income before income taxes related to our United States operations.

 

Approximately 6% of our income before income taxes was generated from our Canadian operations for the nine months ended April 30, 2011 compared with approximately 3% of our income before income taxes in the prior year period. Our Canadian operations had an overall effective tax rate of 17.1% and 15.5% for the nine months ended April 30, 2011 and 2010, respectively. The low overall effective tax rates for both periods was due to the low corporate tax structure in Canada as well as the recognition of tax benefits upon resolution of income tax uncertainties, as more fully described below.

 

For the nine months ended April 30, 2011 and 2010, approximately 3% and 2%,

 

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respectively, of our income before income taxes was generated from our operations in Singapore, a country with a low corporate tax structure. The overall effective tax rate for our Singapore operation was 14.3% and 13.5% for the nine months ended April 30, 2011 and 2010, respectively.

 

Approximately 1% of our income before income taxes was generated from our subsidiary in Japan for the nine months ended April 30, 2011 compared with a small loss in the prior year period. Due to the uncertainty of our Japan subsidiary utilizing tax benefits in the future, a tax benefit was not recorded on the losses from operations at our Japan subsidiary during the nine months ended April 30, 2010, thereby adversely affecting our overall consolidated effective tax rate in the prior year period. For the nine months ended April 30, 2011, our Japan operation was slightly profitable and we recorded no income taxes due to the existence of net operating loss carryforwards.

 

The results of operations for our Netherlands subsidiary did not have a significant impact on our overall effective tax rate for the nine months ended April 30, 2011 and 2010 due to the size of income before income taxes generated from this operation.

 

We record liabilities for an unrecognized tax benefit when a tax benefit for an uncertain tax position is taken or expected to be taken on a tax return, but is not recognized in our Condensed Consolidated Financial Statements because it does not meet the more-likely-than-not recognition threshold that the uncertain tax position would be sustained upon examination by the applicable taxing authority. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon settlement with the tax authorities. The majority of our unrecognized tax benefits originated from acquisitions. Any adjustments upon resolution of income tax uncertainties that predate or result from acquisitions are recognized in our results of operations. However, if our unrecognized tax benefits are recognized in our financial statements in future periods, there would not be a significant impact to our overall effective tax rate due to the size of the unrecognized tax benefits in relation to our income before income taxes. Except for decreases due to the lapse of applicable statutes of limitation, we do not expect such unrecognized tax benefits to significantly decrease or increase in the next twelve months.

 

A reconciliation of the beginning and ending amounts of gross unrecognized tax benefits is as follows:

 
| ** **                                         | ** ** | **Unrecognized**      | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **Tax Benefits** | ** ** |
|                                               |       |                  |       |
| Unrecognized   tax benefits on July 31, 2009  |       | $                     | 380,000    |   |
| Lapse   of statute of limitations                  |       | (172,000              | )          |
| Unrecognized   tax benefits on July 31, 2010  |       | 208,000               |       |
| Lapse   of statute of limitations                  |       | (141,000              | )          |
| Unrecognized   tax benefits on April 30, 2011 |       | $                     | 67,000     |   |

 

Generally, the Company is no longer subject to federal, state or foreign income tax examinations for fiscal years ended prior to July 31, 2004.

 

Our policy is to record potential interest and penalties related to income tax positions in interest expense and general and administrative expense, respectively, in our Condensed

 

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Consolidated Financial Statements. However, such amounts have been relatively insignificant due to the amount of our unrecognized tax benefits relating to uncertain tax positions.

 

***Stock-Based Compensation***

 

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

 
| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                               | ** ** | **April 30,**               | ** ** | **April 30,**              | ** ** |
| ** **                                                               | ** ** | **2011**                         | ** ** | **2010**                        | ** ** | **2011** | ** ** | **2010** | ** ** |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Cost   of sales                                                          |       | $                                | 31,000     |                            | $          | 36,000 |   | $ | 101,000 |   | $ | 95,000 |   |
| Operating   expenses:                                                    |       |                             |       |                            |       |   |   |   |   |
| Selling                                                                  |       | 100,000                          |       | 115,000                         |       | 316,000 |   | 294,000 |   |
| General   and administrative                                             |       | 733,000                          |       | 511,000                         |       | 2,114,000 |   | 1,859,000 |   |
| Research   and development                                               |       | 7,000                            |       | 8,000                           |       | 22,000 |   | 22,000 |   |
| Total   operating expenses                                               |       | 840,000                          |       | 634,000                         |       | 2,452,000 |   | 2,175,000 |   |
| Stock-based   compensation before income taxes                           |       | 871,000                          |       | 670,000                         |       | 2,553,000 |   | 2,270,000 |   |
| Income   tax benefits                                                    |       | (319,000                         | )          | (239,000                        | )          | (927,000 | ) | (822,000 | ) |
| Total   stock-based compensation expense, net of tax                     |       | $                                | 552,000    |                            | $          | 431,000 |   | $ | 1,626,000 |   | $ | 1,448,000 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Decrease   in earnings per common share due to stock-based compensation: |       |                             |       |                            |       |   |   |   |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                    |       | $                                | 0.03       |                            | $          | 0.03 |   | $ | 0.10 |   | $ | 0.09 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Diluted                                                                  |       | $                                | 0.03       |                            | $          | 0.03 |   | $ | 0.09 |   | $ | 0.09 |   |

 

The above stock-based compensation expense before income taxes was recorded in the Condensed Consolidated Financial Statements as stock-based compensation expense and an increase to additional paid-in capital. The related income tax benefits were recorded as an increase to long-term deferred income tax assets (which are netted with long-term deferred income tax liabilities) and a reduction to income tax expense.

 

The stock-based compensation expense recorded in the Condensed Consolidated Financial Statements may not be representative of the effect of stock-based compensation expense in future periods due to the level of awards issued in past years (which level may not be similar in the future), modifications of existing awards and assumptions used in determining fair value, expected lives and estimated forfeitures. We determine the fair value of each stock award using the closing market price of our Common Stock on the date of grant. We estimate the fair value of each option grant on the date of grant using the Black-Scholes option valuation model. The determination of fair value using an option-pricing model is affected by our stock price as well as assumptions regarding a number of subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the expected option life (which is determined by using the historical closing prices of our Common Stock), the expected dividend yield (which historically was 0% and is now approximately 0.6% as we began paying dividends in January 2010), and the expected option life (which is based on historical exercise behavior). If factors change and we employ different assumptions in the application of Accounting Standards Codification (“ASC”) Topic 718, *“Compensation — Stock Compensation,”* (“ASC 718”), in future periods, the compensation expense that we would record may differ significantly from what we

 

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have recorded in the current period.

 

All of our stock options and stock awards (which consist only of restricted stock) are subject to graded vesting in which portions of the award vest at different times during the vesting period, as opposed to awards that vest at the end of the vesting period. We recognize compensation expense for awards subject to graded vesting using the straight-line basis over the vesting period, reduced by estimated forfeitures. At April 30, 2011, total unrecognized stock-based compensation expense before income taxes related to total nonvested stock options and stock awards was $4,213,000 with a remaining weighted average period of 15 months over which such expense is expected to be recognized.

 

If certain criteria are met when options are exercised or restricted stock becomes vested, the Company is allowed a deduction on its United States income tax return. Accordingly, we account for the income tax effect on such income tax deductions as a reduction of deferred income tax assets (which are netted with long-term deferred income tax liabilities) and as a reduction of income taxes payable. For the nine months ended April 30, 2011 and 2010, such income tax deductions reduced income taxes payable by $1,458,000 and $976,000, respectively.

 

We classify the cash flows resulting from excess tax benefits as financing cash flows on our Condensed Consolidated Statements of Cash Flows. Excess tax benefits arise when the ultimate tax effect of the deduction for tax purposes is greater than the tax benefit on stock compensation expense which was determined based upon the award’s fair value.

 

**Liquidity and Capital Resources**

 

***Working capital***

 

At April 30, 2011, the Company’s working capital was $36,840,000, compared with $53,747,000 at July 31, 2010. The decrease in working capital was primarily due to borrowing $28,000,000 under our revolving credit facility to acquire Gambro Water and ConFirm and reclassifying the entire outstanding balance of our revolving credit facility from long-term to current as a result of its expiration occurring in less than one year on August 1, 2011.

 

***Cash flows from operating activities***

 

Net cash provided by operating activities was $17,528,000 and $17,451,000 for the nine months ended April 30, 2011 and 2010, respectively. For the nine months ended April 30, 2011, the net cash provided by operating activities was primarily due to net income (after adjusting for depreciation, amortization, stock-based compensation expense and deferred taxes) and an increase in accounts payable and other current liabilities (due primarily to the timing associated with vendor payments), partially offset by an increase in accounts receivable (primarily due to strong sales of Endoscope Reprocessing products and services and Healthcare Disposables products in the three months ended April 30, 2011).

 

For the nine months ended April 30, 2010, the net cash provided by operating activities was primarily due to net income (after adjusting for depreciation, amortization, stock-based compensation expense and deferred taxes), partially offset by increases in inventories (due to planned strategic increases in stock levels of certain products primarily in our Healthcare Disposables and Endoscope Reprocessing segments) and a decrease in accounts payable and other current liabilities (due primarily to the timing associated with incentive compensation payments).

 

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***Cash flows from investing activities***

 

Net cash used in investing activities was $34,007,000 and $4,852,000 for the nine months ended April 30, 2011 and 2010, respectively. For the nine months ended April 30, 2011, the net cash used in investing activities was primarily for the acquisitions of Gambro Water and ConFirm as well as capital expenditures. For the nine months ended April 30, 2010, the net cash used in investing activities was primarily for capital expenditures.

 

***Cash flows from financing activities***

 

Net cash provided by financing activities was $9,555,000 for the nine months ended April 30, 2011, compared with net cash used in financing activities of $17,140,000 for the nine months ended April 30, 2010. For the nine months ended April 30, 2011, the net cash provided by financing activities was due primarily to borrowings under our revolving credit facility relating to the Gambro Water and ConFirm acquisitions and proceeds from the exercises of stock options, partially offset by repayments under our credit facilities, the payment of a dividend to our shareholders and the purchase of treasury shares. For the nine months ended April 30, 2010, the net cash used in financing activities was primarily attributable to repayments under our credit facilities and the payment of a dividend to our shareholders, partially offset by proceeds from the exercises of stock options.

 

***Dividends***

 

In fiscal 2010, we declared our first semiannual cash dividends of $0.05 per share of outstanding common stock, which were paid on each of January 29, 2010 and July 30, 2010, which totaled $1,683,000. On October 21, 2010, we announced an increase in the semiannual cash dividend to $0.06 per share of outstanding common stock, which was paid on January 28, 2011 to shareholders of record at the close of business on January 14, 2011. Future declaration of dividends and the establishment of future record and payment dates are subject to the final determination of the Company’s Board of Directors.

 

***Long-term contractual obligations***

 

As of April 30, 2011, aggregate annual required payments over the remaining fiscal year, the next four years and thereafter under our contractual obligations that have long-term components were as follows:

 
| ** **                                                   | ** ** | **Three Months**                | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|
| ** **                                                   | ** ** | **Ending**                           | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **July 31,**                    | ** ** | **Year Ending July 31,** | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **2011**                             | ** ** | **2012**                                | ** ** | **2013**   | ** ** | **2014**   | ** ** | **2015**   | ** ** | **Thereafter** | ** ** | **Total**  | ** ** |
| ** **                                                   | ** ** | **(Amounts in thousands)** | ** ** |
| Maturities   of the credit facilities                        |       | $                                    | 2,500      |                                    | $          | 27,500     |       | $          | —     |       | $          | —         |       | $          | —     |   | $ | — |   | $ | 30,000 |   |
| Expected   interest payments under the credit facilities (1) |       | 142                                  |       | —                                  |       | —     |       | —     |       | —     |       | —         |       | 142        |       |
| Minimum   commitments under noncancelable operating leases   |       | 865                                  |       | 3,064                                   |       | 2,314      |       | 1,940      |       | 1,489      |       | 6,222          |       | 15,894     |       |
| Deferred   compensation and other                            |       | 102                                  |       | 253                                     |       | 38         |       | 33         |       | 34         |       | 132            |       | 592        |       |
| Acquisitions   payable                                       |       | 516                                  |       | 2,207                                   |       | —     |       | —     |       | —     |       | —         |       | 2,723      |       |
| Employment   agreements                                      |       | 709                                  |       | 2,375                                   |       | 121        |       | —     |       | —     |       | —         |       | 3,205      |       |
| Total   contractual obligations                              |       | $                                    | 4,834      |                                    | $          | 35,399     |       | $          | 2,473      |       | $          | 1,973          |       | $          | 1,523      |   | $ | 6,354 |   | $ | 52,556 |   |

 

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(1) The expected interest payments under the term and revolving credit facilities reflect interest rates of 2.71% and 1.96%, respectively, which were our weighted average interest rates on outstanding borrowings at April 30, 2011.

 

***Credit facilities***

 

Our United States credit facilities, as amended, include (i) a six-year $40.0 million senior secured amortizing term loan facility and (ii) a five-year $50.0 million senior secured revolving credit facility, which both expire on August 1, 2011 (the “U.S. Credit Facilities”). Amounts we repay under the term loan facility may not be re-borrowed. Debt issuance costs relating to the U.S. Credit Facilities were recorded in other assets and are being amortized over the life of the credit facilities. Such unamortized debt issuance costs amounted to approximately $75,000 at April 30, 2011.

 

At May 31, 2011, borrowings under our U.S. Credit Facilities bear interest at rates ranging from 0.50% to 1.50% above the lender’s base rate, or at rates ranging from 1.50% to 2.50% above the London Interbank Offered Rate (“LIBOR”), depending upon our consolidated ratio of debt to earnings before interest, taxes, depreciation and amortization, and as further adjusted under the terms of the facilities (“EBITDA”). At May 31, 2011, the lender’s base rate was 3.25% and the LIBOR rates ranged from 0.19% to 1.21%. The margins applicable to our outstanding borrowings at May 31, 2011 were 0.50% above the lender’s base rate and 1.50% above LIBOR. All of our outstanding borrowings were under LIBOR contracts at May 31, 2011. The revolving credit facility also provides for fees on the unused portion at rates ranging from 0.20% to 0.40%, depending upon our consolidated ratio of debt to EBITDA; such rate was 0.20% at May 31, 2011.

 

The U.S. Credit Facilities require us to meet certain financial covenants and are secured by (i) substantially all of our U.S.-based assets (including assets of Cantel, Minntech, Mar Cor, Crosstex and Strong Dental Products, Inc.) and (ii) our pledge of all of the outstanding shares of Minntech, Mar Cor, Crosstex and Strong Dental Products, Inc. and 65% of the outstanding shares of our foreign-based subsidiaries. Additionally, we are not permitted to pay annual cash dividends on our Common Stock in excess of $3,000,000 without the consent of our United States lenders. As of April 30, 2011, we were in compliance with all financial and other covenants under the credit facilities.

 

On April 30, 2011, we had $30,000,000 of outstanding borrowings under the U.S. Credit Facilities, which consisted of $2,500,000 and $27,500,000 under the term loan facility and the revolving credit facility, respectively, and $22,500,000 was available to be borrowed under our revolving credit facility. On June 9, 2011, we repaid the remaining $2,500,000 under the term credit facility decreasing our total outstanding borrowings to $27,500,000.

 

The U.S. Credit Facilities have a termination date of August 1, 2011. Although we may repay a portion of our outstanding borrowings under the revolver throughout the remainder of fiscal 2011, we do not presently anticipate paying off the revolver in full by its termination date. We are in discussions with our bank syndicate regarding modifications to our credit facilities, including an extension of the termination date of the revolving credit facility, and expect to formally modify the revolving credit facility before the expiration date. However, since any modification will not be completed until later in fiscal 2011, the entire outstanding balance of the revolver was reclassified from long-term to current subsequent to July 31, 2010.

 

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***Operating leases***

 

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

 

***Deferred compensation***

 

Included in other long-term liabilities are deferred compensation arrangements for certain former Minntech directors and officers.

 

***Acquisitions payable***

 

In connection with the Gambro Water acquisition, as more fully described in Note 3 to the Condensed Consolidated Financial Statements, a portion of the purchase price amounting to $3,100,000 is payable in six equal quarterly payments beginning January 2011 and ending April 2012. As of April 30, 2011, $2,067,000 of the $3,100,000 remains payable. In addition, we have estimated $656,000 as the fair value of contingent consideration relating to the acquisition of ConFirm, as further described in Notes 3 and 7 to the Condensed Consolidated Financial Statements, which will be payable after the one year period ending January 31, 2012 assuming the achievement of a contractually specified sales level for such period.

 

***Employment agreements***

 

We had previously entered into various employment agreements with executives of the Company, including our Corporate executive officers and our subsidiaries’ Chief Executive Officers. All of such contracts expired and most were replaced effective January 1, 2010 with severance contracts that defined certain compensation arrangements relating to various employment termination scenarios.

 

***Convertible Note Receivable***

 

In February 2009, we invested an initial $200,000 in a senior subordinated convertible promissory note issued by BIOSAFE, Inc. (“BIOSAFE”), in connection with BIOSAFE’s grant to us of certain exclusive and non-exclusive license rights to BIOSAFE’s antimicrobial additive. BIOSAFE is the owner of a patented and proprietary antimicrobial agent that is built into the manufacturing of end-products to achieve long-lasting microbial protection on such end-products’ surface. As a result of BIOSAFE’s successful raising of a minimum incremental amount of cash following our investment, we invested an additional $300,000 in notes of BIOSAFE in January 2010 bringing the aggregate investment in BIOSAFE notes to $500,000, as obligated under our agreement with BIOSAFE. We are not obligated to invest any additional funds.

 

The notes mature and are due and payable on June 30, 2011 (“Maturity Date”). The notes accrue interest at a per annum rate of 8% until the Maturity Date or earlier exercise. The entire principal amount and accrued interest are automatically payable in a newly-created series of preferred stock issued upon the closing of BIOSAFE’s next round financing on or before the Maturity Date (“Next Round Financing”) based on a conversion formula.

 

If the Next Round Financing fails to occur by the Maturity Date, the notes, both principal and interest, will be payable in cash and the automatic conversion will no longer apply. If

 

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BIOSAFE defaults on such payment, interest will accrue thereafter at a rate of 12% per annum. Additionally, during the 30-day period following the Maturity Date, we may elect to convert the principal and all accrued interest into shares of common stock of BIOSAFE at a price per share equal to 70% of the fair market value (the “Discount Rate”). No further interest will accrue if we make such election. As of June 9, 2011, the Next Round Financing has not occurred.

 

On June 3, 2011 BIOSAFE requested that the Company and other note holders agree to amend the notes to extend the Maturity Date to December 31, 2011 in consideration for (i) an increase in the interest rate of the notes to 12% per annum (commencing from the effective date of the amendment), (ii) decreasing the Discount Rate to 60% and (iii) certain other benefits to the note holders. Such amendment requires approval of holders representing a majority of the aggregate outstanding principal amount of the notes.

 

In connection with our investment, we entered into a license agreement with BIOSAFE under which we will pay BIOSAFE a fixed royalty percentage of sales of our products containing BIOSAFE’s antimicrobial formulation. This investment, together with the accrued interest, is included within other assets in our Condensed Consolidated Balance Sheets at April 30, 2011 and July 31, 2010. At April 30, 2011, we evaluated this investment for potential impairment and determined that no impairment exists at such date since the carrying value of this investment approximates fair value. However, based upon the evidence evaluated, we will need to conduct another impairment assessment at the end of our fourth quarter.

 

***Financing needs***

 

Although all of our reporting segments generate significant cash from operations, our Endoscope Reprocessing, Healthcare Disposables, Dialysis and Water Purification and Filtration segments are the largest generators of cash. At April 30, 2011, we had a cash balance of $16,039,000, of which $4,222,000 was held by foreign subsidiaries. On September 28, 2010, we repatriated $5,500,000 in earnings from one of the foreign subsidiaries.

 

We believe that our current cash position, anticipated cash flows from operations and the funds available under our revolving credit facility will be sufficient to satisfy our cash operating requirements for the foreseeable future based upon our existing operations, particularly given that we historically have not needed to borrow for working capital purposes. At May 31, 2011, $22,500,000 was available under our revolving credit facility, which expires on August 1, 2011. We are in discussions with our bank syndicate regarding modifications to our credit facilities, including an extension of the termination date of the revolving credit facility, and expect to formally modify the revolving credit facility before the expiration date.

 

Under the terms of our U.S. Credit Facilities we are limited to the amount of aggregate purchase price we pay for acquisitions during the duration of the credit agreement without obtaining prior bank approval. The aggregate purchase price permitted for acquisitions subsequent to May 28, 2010, the date of the latest bank amendment, without obtaining prior bank approval was $50,000,000, of which $2,014,000, $23,697,000 and $7,500,000 was used for the acquisitions of Purity, Gambro Water and ConFirm, respectively.

 

***Foreign currency***

 

During the three and nine months ended April 30, 2011, compared with the three and nine months ended April 30, 2010, the average value of the Canadian dollar increased by approximately 6.5% and 5.1%, respectively, relative to the value of the United States dollar. Additionally, at April 30, 2011 compared with July 31, 2010, the value of the Canadian dollar relative to the value of the United States dollar increased by approximately 7.8%. The financial statements of our Canadian subsidiaries are translated using the accounting policies described in Note 2 to the 2010 Form 10-K and therefore are impacted by changes in the Canadian dollar exchange rate. Additionally, changes in the value of the Canadian dollar against the United States dollar affect our results of operations because a portion of our Canadian subsidiaries’ inventories

 

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and operating costs (which are reported in the Water Purification and Filtration and Specialty Packaging segments) are purchased in the United States and a significant amount of their sales are to customers in the United States.

 

For the three and nine months ended April 30, 2011, compared with the three and nine months ended April 30, 2010, the average value of the euro relative to the value of the United States dollar increased by approximately 3.6% and decreased by approximately 4.6%, respectively, and the average value of the British pound relative to the value of the United States dollar increased by approximately 5.8% and decreased by approximately 0.7%, respectively. Additionally, at April 30, 2011 compared with July 31, 2010, the value of the euro and British pound relative to the United States dollar increased by approximately 13.5% and 6.5%, respectively. Changes in the value of the euro and British pound against the United States dollar affect our results of operations because certain cash bank accounts, accounts receivable and liabilities of our United States subsidiaries, Minntech and Mar Cor, are denominated and ultimately settled in euros or British pounds but must be converted into their functional United States currency. Furthermore, the financial statements of our Netherlands subsidiary are translated using the accounting policies described in Note 2 of the 2010 Form 10-K and therefore are impacted by changes in the euro exchange rate relative to the United States dollar.

 

In order to hedge against the impact of fluctuations in the value of (i) the Canadian dollar relative to the United States dollar, (ii) the euro relative to the United States dollar and (iii) the British pound relative to the United States dollar on the conversion of such net assets into the functional currencies, we enter into short-term contracts to purchase Canadian dollars, euros and British pounds forward, which contracts are generally one month in duration. These short-term contracts are designated as fair value hedges. There were three foreign currency forward contracts with an aggregate value of $3,629,000 at May 31, 2011, which cover certain assets and liabilities that were denominated in currencies other than our subsidiaries’ functional currencies. Such contracts expire on June 30, 2011. These foreign currency forward contracts are continually replaced with new one-month contracts as long as we have significant net assets at our subsidiaries that are denominated and ultimately settled in currencies other than their functional currencies. Under our U.S. Credit Facilities, such contracts to purchase Canadian dollars, euros and British pounds may not exceed $12,000,000 in an aggregate notional amount at any time. In accordance with ASC 815, *“Derivatives and Hedging”* (“ASC 815”), such foreign currency forward contracts are designated as hedges. Gains and losses related to these hedging contracts to buy Canadian dollars, euros and British pounds forward are immediately realized within general and administrative expenses due to the short-term nature of such contracts. For the three and nine months ended April 30, 2011, such forward contracts partially offset the impact on operations related to certain assets and liabilities that are denominated in currencies other than our subsidiaries’ functional currencies.

 

Changes in the value of the Japanese yen relative to the United States dollar during the three and nine months ended April 30, 2011, compared with the three and nine months ended April 30, 2010, did not have a significant impact upon either our results of operations or the translation of our balance sheet, primarily due to the fact that our Japanese subsidiary accounts for a relatively small portion of consolidated net sales, net income and net assets.

 

Overall, fluctuations in the rates of currency exchange had an insignificant impact upon our net income for the three and nine months ended April 30, 2011 compared with the three and nine months ended April 30, 2010.

 

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For purposes of translating the balance sheet at April 30, 2011 compared with July 31, 2010, the total of the foreign currency movements resulted in a foreign currency translation gain of $1,342,000, net of tax, for the nine months ended April 30, 2011, thereby increasing stockholders’ equity.

 

**Critical Accounting Policies**

 

Our discussion and analysis of our financial condition and results of operations are based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, we continually evaluate our estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

 

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our Condensed Consolidated Financial Statements.

 

***Revenue Recognition***

 

Revenue on product sales is recognized as products are shipped to customers and title passes. The passing of title is determined based upon the FOB terms specified for each shipment. With respect to dialysis, therapeutic, specialty packaging, chemistries and endoscope reprocessing products, shipment terms are generally FOB origin for common carrier and FOB destination when our distribution fleet is utilized (except for one large customer in dialysis whereby all products are shipped FOB destination). With respect to water purification and filtration and healthcare disposable products, shipment terms may be either FOB origin or destination. Customer acceptance for the majority of our product sales occurs at the time of delivery. With respect to a portion of water purification and filtration product sales, equipment is sold as part of a system for which the equipment is functionally interdependent or the customer’s purchase order specifies “ship-complete” as a condition of delivery; revenue recognition on such sales is deferred until all equipment has been delivered, or post-delivery obligations such as installation has been substantially fulfilled such that the products are deemed functional by the end-user.

 

A portion of our endoscope reprocessing, water purification and filtration and dialysis sales are recognized as multiple element arrangements, whereby revenue is allocated to the equipment and installation components based upon vendor specific objective evidence, which includes comparable historical transactions of similar equipment and installation sold as stand-alone components. If vendor-specific objective evidence of selling price is not available, we allocate revenue to the elements of the bundled arrangement using the estimated selling price method in order to qualify the components as separate units of accounting. Revenue on the equipment component is recognized as the equipment is shipped to customers and title passes. Revenue on the installation component is recognized when the installation is complete.

 

As a result of our acquisition of ConFirm, as more fully described in Note 3 to the Condensed Consolidated Financial Statements, a portion of our healthcare disposables sales

 

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relating to the mail-in spore test kit is recorded as deferred revenue when initially sold. We recognized the revenue on these test kits using an estimate based on historical experience of the amount of time that elapses from the point of sale to when the kit is returned to us and we communicate to the customer the results of the required laboratory test.

 

Revenue on service sales is recognized when repairs are completed at the customer’s location or when repairs are completed at our facilities and the products are shipped to customers. With respect to certain service contracts in our Endoscope Reprocessing and Water Purification and Filtration operating segments, service revenue is recognized on a straight-line basis over the contractual term of the arrangement. All shipping and handling fees invoiced to customers, such as freight, are recorded as revenue (and related costs are included within cost of sales) at the time the sale is recognized.

 

None of our sales contain right-of-return provisions. Customer claims for credit or return due to damage, defect, shortage or other reason must be pre-approved by us before credit is issued or such product is accepted for return. No cash discounts for early payment are offered except with respect to a small portion of our sales of dialysis, healthcare disposable and water purification and filtration products and certain prepaid packaging products. We do not offer price protection, although advance pricing contracts or required notice periods prior to implementation of price increases exist for certain customers with respect to many of our products. With respect to certain of our dialysis, dental, water purification and filtration and endoscope reprocessing customers, volume rebates are provided; such volume rebates are provided for as a reduction of sales at the time of revenue recognition and amounted to $866,000 and $2,191,000 for the three and nine months ended April 30, 2011, respectively, and $712,000 and $2,269,000 for the three and nine months ended April 30, 2010, respectively. Such allowances are determined based on estimated projections of sales volume for the entire rebate periods. If it becomes known that sales volume to customers will deviate from original projections, the volume rebate provisions originally established would be adjusted accordingly.

 

The majority of our dialysis products are sold to end-users; the majority of therapeutic filtration products and healthcare disposable products are sold to third party distributors; water purification and filtration products and services are sold directly and through third-party distributors to hospitals, dialysis clinics, pharmaceutical and biotechnology companies and other end-users; our endoscope reprocessing products and services are sold primarily to distributors internationally and directly to hospitals and other end-users in the United States; specialty packaging products are sold to third-party distributors, medical research companies, laboratories, pharmaceutical companies, hospitals, government agencies and other end-users; and chemistries products and services are sold to medical products and service companies, laboratories, pharmaceutical companies, hospitals and other end-users. Sales to all of these customers follow our revenue recognition policies.

 

***Accounts Receivable and Allowance for Doubtful Accounts***

 

Accounts receivable consist of amounts due to us from normal business activities. Allowances for doubtful accounts are reserves for the estimated loss from the inability of customers to make required payments. We use historical experience as well as current market information in determining the estimate. While actual losses have historically been within management’s expectations and provisions established, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Alternatively, if certain customers paid their delinquent receivables,

 

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reductions in allowances may be required.

 

***Inventories***

 

Inventories consist of raw materials, work-in-process and finished products which are sold in the ordinary course of our business and are stated at the lower of cost (first-in, first-out) or market. In assessing the value of inventories, we must make estimates and judgments regarding reserves required for product obsolescence, aging of inventories and other issues potentially affecting the saleable condition of products. In performing such evaluations, we use historical experience as well as current market information. With few exceptions, the saleable value of our inventories has historically been within management’s expectation and provisions established, however, rapid changes in the market due to competition, technology and various other factors could have an adverse effect on the saleable value of our inventories, resulting in the need for additional reserves.

 

***Goodwill and Intangible Assets***

 

Certain of our identifiable intangible assets, including customer relationships, technology, brand names, non-compete agreements and patents, are amortized using the straight-line method over their estimated useful lives which range from 3 to 20 years. Additionally, we have recorded goodwill and trademarks and trade names, all of which have indefinite useful lives and are therefore not amortized. All of our intangible assets and goodwill are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, and goodwill and intangible assets with indefinite lives are reviewed for impairment at least annually*.*Our management is primarily responsible for determining if impairment exists and considers a number of factors, including third-party valuations, when making these determinations. In performing a review for goodwill impairment, management uses a two-step process that begins with an estimation of the fair value of the related operating segments by using average fair value results of the market multiple and discounted cash flow methodologies, as well as the comparable transaction methodology when applicable. The first step is a review for potential impairment, and the second step measures the amount of impairment, if any. In performing our annual review for indefinite lived intangibles, management compares the current fair value of such assets to their carrying values. With respect to amortizable intangible assets when impairment indicators are present, management would determine whether expected future non-discounted cash flows would be sufficient to recover the carrying value of the assets; if not, the carrying value of the assets would be adjusted to their fair value. On July 31, 2010, management concluded that none of our intangible assets or goodwill was impaired. On April 30, 2011, management concluded that no events or changes in circumstances have occurred during the nine months ended April 30, 2011 that would indicate that the carrying amount of our intangible assets and goodwill may not be recoverable.

 

While the results of these annual reviews have historically not indicated impairment, impairment reviews are highly dependent on management’s projections of our future operating results and cash flows (which management believes to be reasonable), discount rates based on the Company’s weighted average cost of capital and appropriate benchmark peer companies. Assumptions used in determining future operating results and cash flows include current and expected market conditions and future sales forecasts. Subsequent changes in these assumptions and estimates could result in future impairment. Although we consistently use the same methods in developing the assumptions and estimates underlying the fair value calculations, such estimates are uncertain by nature and can vary from actual results. At July 31, 2010, the average fair value

 

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of all of our reporting units exceeded book value by substantial amounts, except our Specialty Packaging segment, which had an average fair value that exceeded book value by approximately 16%.

 

***Long-Lived Assets***

 

We evaluate the carrying value of long-lived assets including property, equipment and other assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. An assessment is made to determine if the sum of the expected future non-discounted cash flows from the use of the assets and eventual disposition is less than the carrying value. If the sum of the expected non-discounted cash flows is less than the carrying value, an impairment loss is recognized based on fair value. Our historical assessments of our long-lived assets have not differed significantly from the actual amounts realized. However, the determination of fair value requires us to make certain assumptions and estimates and is highly subjective. On April 30, 2011, management concluded that no events or changes in circumstances have occurred that would indicate that the carrying amount of our long-lived assets may not be recoverable.

 

***Warranties***

 

We provide for estimated costs that may be incurred to remedy deficiencies of quality or performance of our products at the time of revenue recognition. Most of our products have a one year warranty, although a majority of our endoscope reprocessing equipment in the United States carries a warranty period of up to fifteen months. We record provisions for product warranties as a component of cost of sales based upon an estimate of the amounts necessary to settle existing and future claims on products sold. The historical relationship of warranty costs to products sold is the primary basis for the estimate. A significant increase in third party service repair rates, the cost and availability of parts or the frequency of claims could have a material adverse impact on our results for the period or periods in which such claims or additional costs materialize. Management reviews its warranty exposure periodically and believes that the warranty reserves are adequate; however, actual claims incurred could differ from original estimates, requiring adjustments to the reserves.

 

***Stock-Based Compensation***

 

We account for stock options and stock awards in which stock compensation expense is recognized for any option or stock award grant based upon the award’s fair value. All of our stock options and stock awards (which consist only of restricted stock) are subject to graded vesting in which portions of the award vest at different times during the vesting period, as opposed to awards that vest at the end of the vesting period. We recognize compensation expense for awards subject to graded vesting using the straight-line basis, reduced by estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience.

 

The stock-based compensation expense recorded in our Condensed Consolidated Financial Statements may not be representative of the effect of stock-based compensation expense in future periods due to the level of awards issued in past years (which level may not be similar in the future), modifications to existing awards and assumptions used in determining fair value, expected lives and estimated forfeitures. We determine the fair value of each stock award using the closing market price of our Common Stock on the date of grant. We estimate the fair value of

 

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each option grant on the date of grant using the Black-Scholes option valuation model. The determination of fair value using an option-pricing model is affected by our stock price as well as assumptions regarding a number of subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the expected option life (which is determined by using the historical closing prices of our Common Stock), the expected dividend yield (which historically has been 0% and is now approximately 0.6% as we began paying dividends in January 2010), and the expected option life (which is based on historical exercise behavior). If factors change and we employ different assumptions in future periods, the compensation expense that we would record may differ significantly from what we have recorded in the current period.

 

***Legal Proceedings***

 

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

 

***Income******Taxes***

 

We recognize deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. Deferred tax assets and liabilities also include items recorded in conjunction with the purchase accounting for business acquisitions. We regularly review our deferred tax assets for recoverability and establish a valuation allowance, if necessary, based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. Although realization is not assured, management believes it is more likely than not that the recorded deferred tax assets, as adjusted for valuation allowances, will be realized. Additionally, deferred tax liabilities are regularly reviewed to confirm that such amounts are appropriately stated. A review of our deferred tax items considers known future changes in various income tax rates, principally in the United States. If the income tax rate were to change in the future, particularly in the United States and to a lesser extent Canada, our items of deferred tax could be materially affected. All of such evaluations require significant management judgments.

 

We record liabilities for an unrecognized tax benefit when a tax benefit for an uncertain tax position is taken or expected to be taken on a tax return, but is not recognized in our Condensed Consolidated Financial Statements because it does not meet the more-likely-than-not recognition threshold that the uncertain tax position would be sustained upon examination by the applicable taxing authority. The majority of such unrecognized tax benefits originated from acquisitions and are based primarily upon management’s assessment of exposure associated with acquired companies. Any adjustments upon resolution of income tax uncertainties that predate or result from acquisitions are recognized in our results of operations. Unrecognized tax benefits are analyzed periodically and adjustments are made as events occur to warrant adjustment to the related liability.

 

***Business Combinations***

 

Acquisitions require significant estimates and judgments related to the fair value of assets acquired and liabilities assumed. We determine fair value based on the estimated price that would

 

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be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

 

Certain liabilities and reserves are subjective in nature. We reflect such liabilities and reserves based upon the most recent information available. In conjunction with our acquisitions, such subjective liabilities and reserves principally include contingent consideration, certain income tax and sales and use tax exposures, including tax liabilities related to our foreign subsidiaries, as well as reserves for accounts receivable, inventories and warranties. We account for contingent consideration relating to business combinations that occurred subsequent to July 31, 2009 in accordance with ASC 805, *“Business Combinations,”* which requires us to record the fair value of contingent consideration as a liability and a reduction of goodwill at the date of the acquisition and continually re-measure the liability at each balance sheet date by recording changes in the fair value through our Condensed Consolidated Statements of Income.  The ultimate settlement of liabilities relating to business combinations may be for amounts which are different from the amounts initially recorded.

 

***Costs Associated with Exit or Disposal Activities***

 

We recognize costs associated with exit or disposal activities, such as costs to terminate a contract, the exit or disposal of a business, or the early termination of a leased property, by recognizing the liability at fair value when incurred, except for certain one-time termination benefits, such as severance costs, for which the period of recognition begins when a severance plan is communicated to employees.

 

Inherent in the calculation of liabilities relating to exit and disposal activities are significant management judgments and estimates, including estimates of termination costs, employee attrition and the interest rate used to discount certain expected net cash payments. Such judgments and estimates are reviewed by us on a regular basis. The cumulative effect of a change to a liability resulting from a revision to either timing or the amount of estimated cash flows is recognized by us as an adjustment to the liability in the period of the change.

 

***Other Matters***

 

We do not have any off balance sheet financial arrangements, other than future commitments under operating leases and employment and license agreements.

 

**Forward Looking Statements**

 

This quarterly report on Form 10-Q contains “forward-looking statements” as that term is defined under the Private Securities Litigation Reform Act of 1995 and releases issued by the Securities and Exchange Commission (the “SEC”) and within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements are based on current expectations, estimates, or forecasts about our businesses, the industries in which we operate, and the beliefs and assumptions of management; they do not relate strictly to historical or current facts. We have tried, wherever possible, to identify such statements by using words such as “expect,” “anticipate,” “goal,” “project,” “intend,” “plan,” “believe,” “seek,”  “may,” “could,” and variations of such words and similar expressions. In addition, any statements that refer to predictions or projections of our future financial performance, anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions

 

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about future events, activities or developments and are subject to numerous risks, uncertainties, and assumptions that are difficult to predict including, among other things, the following:

 

·                  the increasing market share of single-use dialyzers relative to reuse dialyzers in the United States

 

·                  our continuing loss of dialysate concentrate business

 

·                  our dependence on a concentrated number of customers in three of our largest segments

 

·                  severity of flu outbreaks and level of urgency developed by customers with respect to pandemic preparedness

 

·                  the volatility of fuel and oil prices on our raw materials and distribution costs

 

·                  the acquisition of new businesses and successfully integrating and operating such businesses

 

·                  the adverse impact of increased competition on selling prices and our ability to compete effectively

 

·                  foreign currency exchange rate fluctuations and trade barriers

 

·                  the impact of significant government regulation on our businesses

 

You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the foregoing items to be a complete list of all potential risks or uncertainties. See “Risk Factors” in our 2010 Form 10-K for a discussion of the above risk factors and certain additional risk factors that you should consider before investing in the shares of our Common Stock.

 

All forward-looking statements herein speak only as of the date of this report. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

 

For these statements, we claim the protection of the safe harbor for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Exchange Act.

 

**ITEM 3.                  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

**Foreign Currency and Market Risk**

 

A portion of our products in all of our business segments are exported to and imported from a variety of geographic locations, and our business could be materially and adversely affected by the imposition of trade barriers, fluctuations in the rates of exchange of various currencies, tariff increases and import and export restrictions, affecting all of such geographies including but not limited to the United States, Canada, the European Union, the United Kingdom and the Far East.

 

A portion of our Canadian subsidiaries’ inventories and operating costs (which are reported in the Water Purification and Filtration and Specialty Packaging segments) are purchased in the United States and a significant amount of their sales are to customers in the United States. The businesses of our Canadian subsidiaries could be materially and adversely affected by the imposition of trade barriers, fluctuations in the rate of currency exchange, tariff increases and

 

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import and export restrictions between the United States and Canada. Changes in the value of the Canadian dollar against the United States dollar also affect our results of operations because certain net assets of our Canadian subsidiaries are denominated and ultimately settled in United States dollars but must be converted into their functional currency. Additionally, the financial statements of our Canadian subsidiaries are translated using the accounting policies described in Note 2 to the 2010 Form 10-K. Fluctuations in the rates of currency exchange between the United States dollar and the Canadian dollar had an insignificant impact for the three and nine months ended April 30, 2011, compared with the three and nine months ended April 30, 2010, upon our net income and had a favorable impact upon stockholders’ equity, as described in our MD&A.

 

Changes in the value of the euro and British pound against the United States dollar affect our results of operations because certain cash bank accounts, accounts receivable and liabilities of our United States subsidiaries, Minntech and Mar Cor, are denominated and ultimately settled in euros or British pounds but must be converted into their functional United States currency. Furthermore, the financial statements of our Netherlands subsidiary are translated using the accounting policies described in Note 2 of the 2010 Form 10-K and therefore are impacted by changes in the euro exchange rate relative to the United States dollar. Fluctuations in the rates of currency exchange between the United States dollar and the euro or British pound did not have a significant overall impact for the three and nine months ended April 30, 2011, compared with the three and nine months ended April 30, 2010, upon our net income and stockholders’ equity.

 

In order to hedge against the impact of fluctuations in the value of (i) the Canadian dollar relative to the United States dollar, (ii) the euro relative to the United States dollar and (iii) the British pound relative to the United States dollar on the conversion of such net assets into the functional currencies, we enter into short-term contracts to purchase Canadian dollars, euros and British pounds forward, which contracts are generally one month in duration. These short-term contracts are designated as fair value hedge instruments. There were three foreign currency forward contracts with an aggregate value of $4,379,000 at April 30, 2011, which covered certain assets and liabilities that were denominated in currencies other than our subsidiaries’ functional currencies. Such contracts expired on May 31, 2011. These foreign currency forward contracts are continually replaced with new one-month contracts as long as we have significant net assets at our subsidiaries that are denominated and ultimately settled in currencies other than their functional currencies. Under our U.S. Credit Facilities, such contracts to purchase Canadian dollars, euros and British pounds may not exceed $12,000,000 in an aggregate notional amount at any time. For the three and nine months ended April 30, 2011, such forward contracts partially offset the impact on operations relating to certain assets and liabilities that were denominated in currencies other than our subsidiaries’ functional currencies.

 

The functional currency of Minntech’s Japan subsidiary is the Japanese yen. Changes in the value of the Japanese yen relative to the United States dollar during the three and nine months ended April 30, 2011, compared with the three and nine months ended April 30, 2010, did not have a significant impact upon either our results of operations or the translation of the balance sheet, primarily due to the fact that our Japanese subsidiary accounts for a relatively small portion of consolidated net sales, net income and net assets.

 

Overall, fluctuations in the rates of currency exchange had an insignificant impact on our net income for the three and nine months ended April 30, 2011, compared with the three and nine months ended April 30, 2010, and a favorable impact upon stockholders’ equity primarily due to the increase in the value of the Canadian dollar relative to the United States dollar.

 

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**Interest Rate Market Risk**

 

We have United States credit facilities for which the interest rate on outstanding borrowings is variable. Substantially all of our outstanding borrowings are under LIBOR contracts. Therefore, interest expense is affected by the general level of interest rates in the United States as well as LIBOR interest rates.

 

Additionally, we expect to amend our U.S. Credit Facilities prior to August 1, 2011. Due to current market conditions, the modification of our credit facilities may result in an increase of our margins above the lender’s base rate and LIBOR, which would adversely affect our results of operations in the future if levels of outstanding borrowings increase significantly.

 

**Market Risk Sensitive Transactions**

 

Additional information related to market risk sensitive transactions is contained in Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our 2010 Form 10-K.

 

**ITEM 4.****                                                    ****CONTROLS AND PROCEDURES.**

 

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

 

Under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer each concluded that the design and operation of these disclosure controls and procedures were effective and designed to ensure that material information relating to the Company, including our consolidated subsidiaries, required to be disclosed in our SEC reports is (i) recorded, processed, summarized and reported within the time periods specified by the SEC and (ii) accumulated and communicated by the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.

 

We have evaluated our internal controls over financial reporting and determined that no changes occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting, except as described below.

 

On February 11, 2011, we acquired ConFirm, as more fully described in Note 3 to the Condensed Consolidated Financial Statements. During the initial transition period following the acquisition, we enhanced our internal control process at our Crosstex subsidiary to ensure that all financial information related to this acquisition was properly reflected in our Condensed Consolidated Financial Statements. We expect that all aspects of the ConFirm acquisition will be fully integrated into Crosstex’ existing internal control structure by July 31, 2011.

 

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**PART II - OTHER INFORMATION**

 

**ITEM 1.****                                                    ****LEGAL PROCEEDINGS**

 

None.

 

**ITEM 1A.****                                           ****RISK FACTORS**

 

There have been no material changes in our risk factors from those disclosed in Part I, Item 1A to our 2010 Form 10-K. The risk factors disclosed in Part I, Item 1A to our 2010 Form 10-K, in addition to the other information set forth in this report, could materially affect our business, financial condition, or results of operations.

 

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

 

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

 
| ** **   | ** ** | ** **                    | ** ** | ** **          | ** ** | **Total number of shares** | ** ** | **Maximum number of**        | ** ** |
|--------------|------------|-------------------------------|------------|---------------------|------------|-------------------------------------------|------------|----------------------------------------|------------|
| **Month**    | ** ** | ** **                    | ** ** | **Average**         | ** ** | **purchased as part of**   | ** ** | **shares that may yet** | ** ** |
| **of**       | ** ** | **Total number of** | ** ** | **price paid** | ** ** | **publicly announced**               | ** ** | **be purchased under**       | ** ** |
| **Purchase** | ** ** | **shares purchased**     | ** ** | **per share**  | ** ** | **plans or programs**           | ** ** | **the program**                   | ** ** |
|         |       |                          |       |                |       |                                      |       |                                   |       |
| February     |       | 14,088                        |       | $                   | 21.45      |                                      | —     |                                   | —     |   |
| March        |       | 39,719                        |       | 25.77               |       | —                                    |       | —                                 |       |
| April        |       | 754                           |       | 27.10               |       | —                                    |       | —                                 |       |
| Total        |       | 54,561                        |       | $                   | 24.68      |                                      | —     |                                   | —     |   |

 

The Company does not currently have a repurchase program. All of the shares purchased during the current quarter represent shares surrendered to the Company to pay employee withholding taxes due upon the vesting of restricted stock or the exercise of stock options that do not qualify as incentive stock options.

 

**ITEM 3.****                                                    ****DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 4.****                                                    ****RESERVED**

 

**ITEM 5.****                                                    ****OTHER INFORMATION**

 

None.

 

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**ITEM 6.****                                                    ****EXHIBITS**

** **

31.1   - Certification of Principal Executive Officer.

** **

31.2   - Certification of Principal Financial Officer.

** **

32      - Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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**SIGNATURES**

 

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

 

 
|                    | CANTEL MEDICAL CORP. |
|-------------------------|----------------------|
|                    |                 |
| Date: June 9, 2011 |                 |
|                    |                 |
|                    |                 |
|                    | By:                  | /s/ Andrew A. Krakauer |
|                    |                 | Andrew A. Krakauer, |
|                    |                 | President and Chief Executive Officer |
|                    |                 | (Principal Executive Officer) |
|                    |                 |
|                    |                 |
|                    | By:                  | /s/ Craig A. Sheldon |
|                    |                 | Craig A. Sheldon, |
|                    |                 | Senior Vice President, Chief Financial   Officer   and Treasurer (Principal Financial and Accounting   Officer) |
|                    |                 |
|                    |                 |
|                    | By:                  | /s/ Steven C. Anaya |
|                    |                 | Steven C. Anaya, |
|                    |                 | Vice President and Controller |

 

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