**UNITEDSTATES**

**SECURITIES AND EXCHANGECOMMISSION**

**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****January 31, 2010.**                                                                                                      |
|                                                                                                                                                               |
| **or**                                                                                                                                                             |
|                                                                                                                                                               |                                                                                               |
| **o**                                                                                                                                                              | **Transition Report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|                                                                                                                                                               |                                                                                               |
| **For the transition  period from            to            .** |

 

**Commissionfile number:   001-31337**

 

**CANTEL MEDICAL CORP.**

(Exactname 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 allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.   Yes x   No o

 

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

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smaller reportingcompany” 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 (asdefined in Rule 12b-2 of the Exchange Act).   Yes o   No x

 

Number of shares of Common Stock outstanding as of February 28,2010: 16,825,792.

 

 

 

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PART I -FINANCIAL INFORMATION

ITEM 1. -FINANCIAL STATEMENTS

CANTEL MEDICALCORP.

CONDENSEDCONSOLIDATED BALANCE SHEETS

(Dollar Amounts inThousands, Except Share Data)

(Unaudited)

 
| ** **                                                                                                                                                                                                                       | ** ** | **January 31,** | ** ** | **July 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                       | ** ** | **2010**             | ** ** | **2009**          | ** ** |
| **Assets**                                                                                                                                                                                                                       |       |                 |       |              |       |
| Current assets:                                                                                                                                                                                                                  |       |                 |       |              |       |
| Cash and cash equivalents                                                                                                                                                                                                        |       | $                    | 18,131     |              | $          | 23,368 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $906 at January 31  and $1,080 at July 31                                                                                                              |       | 32,198               |       | 30,450            |       |
| Inventories:                                                                                                                                                                                                                     |       |                 |       |              |       |
| Raw materials                                                                                                                                                                                                                    |       | 12,963               |       | 10,980            |       |
| Work-in-process                                                                                                                                                                                                                  |       | 4,638                |       | 3,074             |       |
| Finished goods                                                                                                                                                                                                                   |       | 16,008               |       | 15,146            |       |
| Total inventories                                                                                                                                                                                                                |       | 33,609               |       | 29,200            |       |
| Deferred income taxes                                                                                                                                                                                                            |       | 1,919                |       | 1,898             |       |
| Prepaid expenses and other current assets                                                                                                                                                                                        |       | 4,161                |       | 3,994             |       |
| Total current assets                                                                                                                                                                                                             |       | 90,018               |       | 88,910            |       |
| Property and equipment, net                                                                                                                                                                                                      |       | 35,679               |       | 35,968            |       |
| Intangible assets, net                                                                                                                                                                                                           |       | 34,591               |       | 37,042            |       |
| Goodwill                                                                                                                                                                                                                         |       | 115,032              |       | 114,995           |       |
| Other assets                                                                                                                                                                                                                     |       | 1,259                |       | 956               |       |
|                                                                                                                                                                                                                             |       | $                    | 276,579    |              | $          | 277,871 |   |
| **Liabilities and stockholders’  equity**                                                                                                                                                                                   |       |                 |       |              |       |
| Current liabilities:                                                                                                                                                                                                             |       |                 |       |              |       |
| Current portion of long-term debt                                                                                                                                                                                                |       | $                    | 25,500     |              | $          | 10,000 |   |
| Accounts payable                                                                                                                                                                                                                 |       | 9,920                |       | 8,948             |       |
| Compensation payable                                                                                                                                                                                                             |       | 7,523                |       | 10,431            |       |
| Earnout payable                                                                                                                                                                                                                  |       | —               |       | 157               |       |
| Accrued expenses                                                                                                                                                                                                                 |       | 6,727                |       | 6,583             |       |
| Deferred revenue                                                                                                                                                                                                                 |       | 3,218                |       | 2,819             |       |
| Income taxes payable                                                                                                                                                                                                             |       | 184                  |       | 175               |       |
| Total current liabilities                                                                                                                                                                                                        |       | 53,072               |       | 39,113            |       |
|                                                                                                                                                                                                                             |       |                 |       |              |       |
| Long-term debt                                                                                                                                                                                                                   |       | 5,000                |       | 33,300            |       |
| Deferred income taxes                                                                                                                                                                                                            |       | 16,840               |       | 16,378            |       |
| Other long-term liabilities                                                                                                                                                                                                      |       | 1,767                |       | 1,964             |       |
|                                                                                                                                                                                                                             |       |                 |       |              |       |
| 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;  January 31 - 18,061,604 shares issued and 16,821,458 shares outstanding;  July 31 - 17,883,873 shares issued and 16,643,727 shares outstanding |       | 1,806                |       | 1,788             |       |
| Additional paid-in capital                                                                                                                                                                                                       |       | 89,680               |       | 87,169            |       |
| Retained earnings                                                                                                                                                                                                                |       | 112,308              |       | 102,103           |       |
| Accumulated other comprehensive income                                                                                                                                                                                           |       | 8,331                |       | 8,281             |       |
| Treasury Stock, at cost; January 31 and  July 31 - 1,240,146 shares                                                                                                                                                    |       | (12,225              | )          | (12,225           | )          |
| Total stockholders’ equity                                                                                                                                                                                                  |       | 199,900              |       | 187,116           |       |
|                                                                                                                                                                                                                             |       | $                    | 276,579    |              | $          | 277,871 |   |

 

See accompanying notes.

 

2

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CANTEL MEDICALCORP.

CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME

(Dollar Amounts inThousands, Except Per Share Data)

(Unaudited)

 
| ** **                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                              | ** ** | **January 31,**   | ** ** | **January 31,** | ** ** |
| ** **                              | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Net sales                               |       | $                      | 66,587     |                 | $          | 62,420 |   | $ | 137,582 |   | $ | 126,826 |   |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Cost of sales                           |       | 39,463                 |       | 38,809               |       | 81,000 |   | 79,592 |   |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Gross profit                            |       | 27,124                 |       | 23,611               |       | 56,582 |   | 47,234 |   |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Expenses:                               |       |                   |       |                 |       |   |   |   |   |
| Selling                                 |       | 8,711                  |       | 6,992                |       | 17,235 |   | 14,342 |   |
| General and administrative              |       | 9,272                  |       | 9,037                |       | 18,577 |   | 18,061 |   |
| Research and development                |       | 1,157                  |       | 983                  |       | 2,422 |   | 2,048 |   |
| Total operating expenses                |       | 19,140                 |       | 17,012               |       | 38,234 |   | 34,451 |   |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Income before interest and income taxes |       | 7,984                  |       | 6,599                |       | 18,348 |   | 12,783 |   |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Interest expense                        |       | 339                    |       | 674                  |       | 726 |   | 1,425 |   |
| Interest income                         |       | (8                     | )          | (38                  | )          | (16 | ) | (108 | ) |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Income before income taxes              |       | 7,653                  |       | 5,963                |       | 17,638 |   | 11,466 |   |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Income taxes                            |       | 2,777                  |       | 2,189                |       | 6,594 |   | 4,359 |   |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Net income                              |       | $                      | 4,876      |                 | $          | 3,774 |   | $ | 11,044 |   | $ | 7,107 |   |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Earnings per common share:              |       |                   |       |                 |       |   |   |   |   |
| Basic                                   |       | $                      | 0.29       |                 | $          | 0.23 |   | $ | 0.66 |   | $ | 0.43 |   |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Diluted                                 |       | $                      | 0.29       |                 | $          | 0.23 |   | $ | 0.65 |   | $ | 0.43 |   |
|                                    |       |                   |       |                 |       |   |   |   |   |
| Dividends per common share              |       | $                      | 0.05       |                 | $          | — |   | $ | 0.05 |   | $ | — |   |

 

See accompanyingnotes.

 

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CANTEL MEDICAL CORP.

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(Dollar Amounts inThousands)

(Unaudited)

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                         | ** ** | **January 31,** | ** ** |
| ** **                                                                         | ** ** | **2010**             | ** ** | **2009** | ** ** |
|                                                                               |       |                 |       |   |   |
| **Cash flows from operating  activities**                                          |       |                 |       |   |   |
| Net income                                                                         |       | $                    | 11,044     |   | $ | 7,107 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                 |       |   |   |
| Depreciation                                                                       |       | 3,138                |       | 3,075 |   |
| Amortization                                                                       |       | 2,572                |       | 2,606 |   |
| Stock-based compensation expense                                                   |       | 1,600                |       | 1,045 |   |
| Amortization of debt issuance costs                                                |       | 215                  |       | 197 |   |
| Loss on disposal of fixed assets                                                   |       | 227                  |       | 22 |   |
| Deferred income taxes                                                              |       | (588                 | )          | (965 | ) |
| Excess tax benefits from stock-based compensation                                  |       | (81                  | )          | (197 | ) |
| Changes in assets and liabilities:                                                 |       |                 |       |   |   |
| Accounts receivable                                                                |       | (1,743               | )          | 1,353 |   |
| Inventories                                                                        |       | (4,402               | )          | (1,705 | ) |
| Prepaid expenses and other current assets                                          |       | (345                 | )          | (793 | ) |
| Accounts payable, deferred revenue and accrued  expenses                           |       | (1,599               | )          | 332 |   |
| Income taxes payable                                                               |       | 277                  |       | 1,131 |   |
| Net cash provided by operating activities                                          |       | 10,315               |       | 13,208 |   |
|                                                                               |       |                 |       |   |   |
| **Cash flows from investing  activities**                                          |       |                 |       |   |   |
| Capital expenditures                                                               |       | (3,072               | )          | (2,062 | ) |
| Proceeds from disposal of fixed assets                                             |       | —               |       | 3 |   |
| Earnout paid to Crosstex sellers                                                   |       | —               |       | (3,666 | ) |
| Earnout paid to Twist seller                                                       |       | (157                 | )          | (629 | ) |
| Purchase of convertible note receivable                                            |       | (300                 | )          | — |   |
| Other, net                                                                         |       | (173                 | )          | 48 |   |
| Net cash used in investing activities                                              |       | (3,702               | )          | (6,306 | ) |
|                                                                               |       |                 |       |   |   |
| **Cash flows from financing  activities**                                          |       |                 |       |   |   |
| Borrowings under revolving credit facility                                         |       | —               |       | 3,500 |   |
| Repayments under term loan facility                                                |       | (5,000               | )          | (4,000 | ) |
| Repayments under revolving credit facility                                         |       | (7,800               | )          | (3,500 | ) |
| Proceeds from exercises of stock options                                           |       | 1,692                |       | 874 |   |
| Dividends paid                                                                     |       | (840                 | )          | — |   |
| Excess tax benefits from stock-based compensation                                  |       | 81                   |       | 197 |   |
| Purchases of treasury stock                                                        |       | —               |       | (404 | ) |
| Net cash used in financing activities                                              |       | (11,867              | )          | (3,333 | ) |
|                                                                               |       |                 |       |   |   |
| Effect  of exchange rate changes on cash and cash equivalents                      |       | 17                   |       | (1,835 | ) |
|                                                                               |       |                 |       |   |   |
| (Decrease) increase in cash and cash equivalents                                   |       | (5,237               | )          | 1,734 |   |
| Cash and cash equivalents at beginning of period                                   |       | 23,368               |       | 18,318 |   |
| Cash and cash equivalents at end of period                                         |       | $                    | 18,131     |   | $ | 20,052 |   |

 

See accompanying notes.

 

4

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

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

(Unaudited)

 

**Note 1.                   Basisof Presentation**

 

The unaudited Condensed Consolidated Financial Statements have beenprepared in accordance with United States generally accepted accountingprinciples for interim financial reporting and the requirements of Form 10-Qand Rule 10.01 of Regulation S-X. Accordingly, they do not include certaininformation and note disclosures required by generally accepted accountingprinciples for annual financial reporting and should be read in conjunctionwith the Consolidated Financial Statements and notes thereto included in theAnnual Report of Cantel Medical Corp. (“Cantel”) on Form 10-K for thefiscal year ended July 31, 2009 (the “2009 Form 10-K”), andManagement’s Discussion and Analysis of Financial Condition and Results ofOperations included elsewhere herein.

 

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

 

TheCondensed Consolidated Balance Sheet at July 31, 2009 was derived from theaudited Consolidated Balance Sheet of Cantel at that date.

 

In June 2008, the Financial Accounting Standards Board (“FASB”)issued Accounting Standards Codification (“ASC”) 260-10-45, “*Earnings Per Share — Other Presentation Matters,”*(“ASC 260-10-45”). ASC 260-10-45provides that unvested share-based payment awards that contain nonforfeitablerights to dividends or dividend equivalents (whether paid or unpaid) areparticipating securities and shall be included in the computation of earningsper share (“EPS”) pursuant to the two-class method. ASC 260-10-45 iseffective for fiscal years beginning after December 15, 2008 and thereforewas adopted on August 1, 2009 as further described in Note 10 to theCondensed Consolidated Financial Statements. All prior period EPS data havebeen adjusted retrospectively to conform to the provisions of ASC260-10-45. For the three and six months ended January 31, 2009, suchretrospective application caused an insignificant increase in the denominatorof our weighted average shares calculation, which decreased previously reportedbasic EPS for the six months ended January 31, 2009 from $0.44 to $0.43but had no impact on basic EPS for the three months ended January 31, 2009and previously reported diluted EPS.

 

Cantel had five principal operating companies at each of January 31,2010 and July 31, 2009, Minntech Corporation (“Minntech”), CrosstexInternational Inc. (“Crosstex”), Mar Cor Purification, Inc. (“Mar Cor”),Biolab Equipment Ltd. (“Biolab”) and Saf-T-Pak Inc. (“Saf-T-Pak”), all of whichare wholly-owned operating subsidiaries. In addition, Minntech has threeforeign subsidiaries, Minntech B.V., Minntech Asia/Pacific Ltd. and MinntechJapan K.K., which serve as Minntech’s bases in Europe, Asia/Pacific and Japan,respectively.

 

We currently operate our business through six operating segments: WaterPurification and Filtration (through Mar Cor, Biolab and Minntech), HealthcareDisposables (through Crosstex), Endoscope Reprocessing (through Minntech),Dialysis (through Minntech), Therapeutic Filtration (through Minntech) andSpecialty Packaging (through Saf-T-Pak). The Therapeutic Filtration andSpecialty Packaging operating segments are combined in the All 

 

5

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Otherreporting segment for financial reporting purposes.

 

On July 31, 2009, we acquired certain net assets of G.E.M. WaterSystems Int’l, LLC (“G.E.M.”), as more fully described in Note 3 to theCondensed Consolidated Financial Statements. The G.E.M. acquisition had an insignificant effect on ourresults of operations for the three and six months ended January 31, 2010due to the small size of this business and is not included in our results ofoperations for the three and six months ended January 31, 2009. G.E.M. isincluded in the Water Purification and Filtration segment.

 

Weperformed a review of events subsequent to January 31, 2010. Based uponthat review, no subsequent events occurred that required updating to ourCondensed Consolidated Financial Statements or disclosures.

 

Throughoutthis document, references to “Cantel,” “us,” “we,” “our,” and the “Company” arereferences to Cantel Medical Corp. and its subsidiaries, except where thecontext makes it clear the reference is to Cantel itself and not its subsidiaries.

 

**Note 2.                   Stock-BasedCompensation**

 

Thefollowing table shows the income statement components of stock-basedcompensation expense recognized in the Condensed Consolidated Statements ofIncome:

 
| ** **                                                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                              | ** ** | **January 31,**   | ** ** | **January 31,** | ** ** |
| ** **                                                              | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Cost of sales                                                           |       | $                      | 41,000     |                 | $          | 18,000 |   | $ | 59,000 |   | $ | 36,000 |   |
| Operating expenses:                                                     |       |                   |       |                 |       |   |   |   |   |
| Selling                                                                 |       | 110,000                |       | 53,000               |       | 179,000 |   | 106,000 |   |
| General and administrative                                              |       | 650,000                |       | 453,000              |       | 1,348,000 |   | 896,000 |   |
| Research and development                                                |       | 10,000                 |       | 1,000                |       | 14,000 |   | 7,000 |   |
| Total operating expenses                                                |       | 770,000                |       | 507,000              |       | 1,541,000 |   | 1,009,000 |   |
| Stock-based  compensation before income taxes                           |       | 811,000                |       | 525,000              |       | 1,600,000 |   | 1,045,000 |   |
| Income tax benefits                                                     |       | (293,000               | )          | (199,000             | )          | (583,000 | ) | (446,000 | ) |
| Total  stock-based compensation expense, net of tax                     |       | $                      | 518,000    |                 | $          | 326,000 |   | $ | 1,017,000 |   | $ | 599,000 |   |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Decrease in earnings per common share due to  stock-based compensation: |       |                   |       |                 |       |   |   |   |   |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                   |       | $                      | 0.03       |                 | $          | 0.02 |   | $ | 0.06 |   | $ | 0.04 |   |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Diluted                                                                 |       | $                      | 0.03       |                 | $          | 0.02 |   | $ | 0.06 |   | $ | 0.04 |   |

 

Forthe three and six months ended January 31, 2010 and 2009, the abovestock-based compensation expense before income taxes was recorded in theCondensed Consolidated Financial Statements as stock-based compensation expenseand an increase to additional paid-in capital. The related income tax benefits(which pertain only to stock awards and options that do not qualify asincentive stock options) were recorded as an increase to long-term deferredincome tax assets (which are netted with long-term deferred income taxliabilities) and a reduction to income tax expense.

 

6

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Mostof our stock options and stock awards (which consist only of restricted shares)are subject to graded vesting in which portions of the award vest at differenttimes during the vesting period, as opposed to awards that vest at the end ofthe vesting period. We recognize compensation expense for awards subject tograded vesting using the straight-line basis, reduced by estimated forfeitures.At January 31, 2010, total unrecognized stock-based compensation expensebefore income taxes related to total nonvested stock options and stock awardswas $4,603,000 with a remaining weighted average period of 23 months over whichsuch expense is expected to be recognized.

 

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

 

Asummary of nonvested stock award activity follows:

 
| ** **                                      | ** ** | ** **    | ** ** | **Weighted**   | ** ** |
|-------------------------------------------------|------------|---------------|------------|----------------|------------|
| ** **                                      | ** ** | **Number of** | ** ** | **Average**    | ** ** |
| ** **                                      | ** ** | **Shares**    | ** ** | **Fair Value** | ** ** |
|                                            |       |          |       |           |       |
| Nonvested stock awards at July 31, 2009    |       | 226,328       |       | $              | 13.38      |   |
| Granted                                         |       | 47,825        |       | 15.97          |       |
| Nonvested stock awards at January 31, 2010 |       | 274,153       |       | $              | 13.83      |   |

 

Thefair value of each option grant is estimated on the date of grant using theBlack-Scholes option valuation model with the following assumptions for optionsgranted during the three and six months ended January 31, 2010 and 2009:

 
| **Weighted-Average**          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------|------------|------------------------|------------|----------------------|------------|
| **Black-Scholes Option**      | ** ** | **January 31,**   | ** ** | **January 31,** | ** ** |
| **Valuation Assumptions**     | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                          |       |                   |       |                 |       |   |   |   |   |
| Dividend yield (1)            |       | 0.08                   | %          | 0.00                 | %          | 0.00 | % | 0.00 | % |
| Expected volatility (2)       |       | 0.437                  |       | 0.432                |       | 0.454 |   | 0.395 |   |
| Risk-free interest rate (3)   |       | 2.17                   | %          | 1.52                 | %          | 1.96 | % | 2.29 | % |
| Expected lives (in years) (4) |       | 4.75                   |       | 5.00                 |       | 3.58 |   | 4.80 |   |

 

----

(1) Expectedannual dividend yield of 0.50% for options granted after our dividendannouncement on December 17, 2009.

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

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

(4) Based on historical exercise behavior.

 

Additionally,all options were considered to be deductible for tax purposes in the valuationmodel, except for certain incentive options granted under the 1997 EmployeePlan and to employees residing outside of the United States. Such non-qualifiedoptions were tax-effected using the Company’s estimated U.S. effective tax rateat the time of grant. For the three and six months ended January 31, 2010,the weighted average fair value of all options granted was approximately $6.92and $5.67, respectively. For the three and six months ended January 31,2009, the weighted average fair value of all options granted was approximately$5.92 and $4.37, respectively.  Theaggregate intrinsic value (i.e. the excess market price over the exerciseprice) 

 

7

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ofall options exercised was approximately $706,000 and $807,000 for the three andsix months ended January 31, 2010, respectively, and $84,000 and $899,000for the three and six months ended January 31, 2009, respectively.

 

Asummary of stock option activity follows:

 
| ** **                           | ** ** | ** **    | ** ** | **Weighted**       | ** ** |
|--------------------------------------|------------|---------------|------------|--------------------|------------|
| ** **                           | ** ** | **Number of** | ** ** | **Average**        | ** ** |
| ** **                           | ** ** | **Shares**    | ** ** | **Exercise Price** | ** ** |
|                                 |       |          |       |               |       |
| Outstanding at July 31, 2009    |       | 1,505,722     |       | $                  | 16.32      |   |
| Granted                              |       | 414,750       |       | 15.95              |       |
| Canceled                             |       | (166,400      | )          | 21.21              |       |
| Exercised                            |       | (129,906      | )          | 13.02              |       |
| Outstanding at January 31, 2010 |       | 1,624,166     |       | $                  | 15.99      |   |
|                                 |       |          |       |               |       |
| Exercisable at July 31, 2009    |       | 1,049,657     |       | $                  | 17.86      |   |
|                                 |       |          |       |               |       |
| Exercisable at January 31, 2010 |       | 848,940       |       | $                  | 17.53      |   |

 

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

 

If certain criteria are met when options are exercised or restrictedstock becomes vested, the Company is allowed a deduction on its income taxreturn. Accordingly, we account for the income tax effect on such income taxdeductions as additional paid-in capital or a reduction of deferred income taxassets (which are netted with long-term deferred income tax liabilities) and asa reduction of income taxes payable. For the six months ended January 31,2010 and 2009, such income tax deductions reduced income taxes payable by$268,000 and $379,000, respectively.

 

We classify the cash flows resulting fromexcess tax benefits as financing cash flows on our Condensed ConsolidatedStatements of Cash Flows. Excess tax benefits arise when the ultimate taxeffect of the deduction for tax purposes is greater than the tax benefit onstock compensation expense (including tax benefits on stock compensationexpense that has only been reflected in past pro forma disclosures relating tofiscal years prior to August 1, 2005) which was determined based upon theaward’s fair value.

 

A summary of our stock award plans follows:

 

***2006 Equity Incentive Plan***

 

OnJanuary 10, 2007, the Company terminated its existing stock option plansand adopted the Cantel Medical Corp. 2006 Equity Incentive Plan (the “2006 Plan”).The 2006 Plan provides for the granting of stock options (including incentivestock options), restricted stock awards, stock appreciation rights andperformance-based awards (collectively “equity awards”) to our employees andnon-employee Directors. The 2006 Plan does not permit the granting ofdiscounted options or discounted stock appreciation rights. On December 17,2009, our stockholders approved an amendment to the 2006 Plan that increasedthe number of shares of Common Stock available for issuance under the 2006 Planby 385,000.  The maximum number of sharesas to which stock options and stock awards may be granted under the 2006 Planis 2,085,000 shares, of which 1,200,000 shares are authorized for issuancepursuant to stock options and stock appreciation rights and 885,000 shares areauthorized for issuance pursuant to 

 

8

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restrictedstock and other stock awards.  Stockoptions outstanding under this plan:

 
| · | were  granted at the closing market price on the day of the grant,                                                                                                                                                                                             |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                           |
| · | were  granted as options that do not qualify as incentive stock options,                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                           |
| · | as  to options granted to employees, are exercisable in three or four equal  annual installments commencing on the first anniversary of the grant date,                                                                                                        |
|   |                                                                                                                                                                                                                                                           |
| · | include  option grants of 750 shares on the last day of each of our fiscal quarters to  each non-employee director who attended that quarter’s regularly scheduled  Board of Directors meeting (exercisable on the first anniversary of the grant  date), |
|   |                                                                                                                                                                                                                                                           |
| · | include  option grants of 1,500 shares on the last day of our fiscal year to each  member of our Board of Directors (50% are exercisable on the first  anniversary of the grant date and 50% are exercisable on the second  anniversary of the grant date),    |
|   |                                                                                                                                                                                                                                                           |
| · | include  option grants of 15,000 shares to each newly appointed or elected director  (exercisable in three equal annual installments commencing on the first  anniversary of the grant date),                                                                  |
|   |                                                                                                                                                                                                                                                           |
| · | generally  terminate three months following termination of employment or service as a  non-employee director, and                                                                                                                                              |
|   |                                                                                                                                                                                                                                                           |
| · | expire  five years from the date of the grant.                                                                                                                                                                                                                 |

 

CommencingNovember 1, 2009, quarterly options are no longer granted to non-employeedirectors and, commencing July 31, 2010, the annual grants of 1,500options to non-employee directors will be changed to grants of 4,500 optionsthat are exercisable in full on the first anniversary of the grant date.

 

Restrictedstock shares outstanding under this plan are subject to risk of forfeituresolely due to an employment length-of-service restriction, with suchrestriction lapsing as to one-third of the shares on each of the first threeanniversaries of the grant date subject to being employed by the Companythrough such vesting date. At January 31, 2010, options to purchase901,915 shares of Common Stock were outstanding, and 274,153 unvestedrestricted stock shares were outstanding, under the 2006 Plan. At January 31,2010, 233,750 shares are available for issuance pursuant to stock options andstock appreciation rights and 462,096 shares are available for issuancepursuant to restricted stock and other stock awards. The 2006 Plan expires on November 13,2016.

 

***1997 Employee Plan***

 

Atotal of 3,750,000 shares of Common Stock was originally reserved for issuanceor available for grant under our 1997 Employee Stock Option Plan, as amended,which was terminated on January 10, 2007 in conjunction with the adoptionof the 2006 Plan. Options outstanding under this plan:

 
| · | were  granted at the closing market price on the day of the grant,                                                  |
|--------|---------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                |
| · | were  granted either as incentive stock options or stock options that do not  qualify as incentive stock options,   |
|   |                                                                                                                |
| · | are  exercisable in three or four equal annual installments commencing on the  first anniversary of the grant date, |
|   |                                                                                                                |
| · | generally  terminate three months following termination of employment, and                                          |
|   |                                                                                                                |
| · | expire  five years from the date of the grant.                                                                      |

 

At January 31, 2010, options to purchase 675,751 shares of CommonStock were 

 

9

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outstanding under the 1997 Employee Stock Option Plan. No additionaloptions will be granted under this plan.

 

***1998 Directors’ Plan***

 

Atotal of 450,000 shares of Common Stock was originally reserved for issuance oravailable for grant under our 1998 Directors’ Stock Option Plan, as amended,which was terminated on January 10, 2007 in conjunction with the adoptionof the 2006 Plan. Options outstanding under this plan:

 
| · | were  granted to directors at the closing market price on the day of grant,                                                                                                                                                                                 |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                        |
| · | include  option grants of 15,000 shares to each newly appointed or elected director  (exercisable in three equal annual installments commencing on the first  anniversary of the grant date),                                                               |
|   |                                                                                                                                                                                                                                                        |
| · | include  option grants of 750 shares on the last day of each of our fiscal quarters to  each non-employee director who attended that quarter’s regularly scheduled  Board of Directors meeting (exercisable on the grant date),                        |
|   |                                                                                                                                                                                                                                                        |
| · | include  option grants of 1,500 shares on the last day of our fiscal year to each  member of our Board of Directors (50% are exercisable on the first  anniversary of the grant date and 50% are exercisable on the second  anniversary of the grant date), |
|   |                                                                                                                                                                                                                                                        |
| · | have  a term of ten years if granted prior to July 31, 2000 or five years if  granted on or after July 31, 2000, and                                                                                                                              |
|   |                                                                                                                                                                                                                                                        |
| · | do  not qualify as incentive stock options.                                                                                                                                                                                                                 |

 

AtJanuary 31, 2010, options to purchase 46,500 shares of Common Stock were outstandingunder the 1998 Directors’ Stock Option Plan. No additional options will begranted under this plan.

 

**Note 3.                   Acquisitions**

 

***G.E.M. Water Systems Int’l, LLC***

 

OnJuly 31, 2009, we purchased substantially all of the assets, including the building housing itsoperations, of G.E.M., aprivate company with pre-acquisition annual revenues of approximately$3,500,000 based in Buena Park, California that designs, installs and services high quality water and bicarbonate systemsfor use in dialysis clinics, hospitals and other healthcare facilities. Thetotal consideration for the transaction, including transaction costs, was$4,468,000.

 

Thepurchase price was allocated to the assets acquired and assumed liabilitiesbased on estimated fair values as follows:

 
| ** **                                                            | ** ** | **Final**      | ** ** |
|-----------------------------------------------------------------------|------------|----------------|------------|
| **Net Assets**                                                        | ** ** | **Allocation** | ** ** |
| Current assets                                                        |       | $              | 681,000    |   |
| Property, plant and equipment                                         |       | 1,975,000      |       |
| Amortizable intangible assets - customer  relationships (9-year life) |       | 951,000        |       |
| Non-amortizable intangible assets - trade names  (indefinite life)    |       | 203,000        |       |
| Current liabilities                                                   |       | (808,000       | )          |
| Net assets acquired                                                   |       | $              | 3,002,000  |   |

 

Therewere no in-process research and development projects acquired in connectionwith the acquisition. The excess purchase price of $1,466,000 was assigned togoodwill. Such

 

10

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goodwill,all of which is deductible for income tax purposes, has been included in ourWater Purification and Filtration reporting segment.

 

Theprincipal reason for the acquisition was the strengthening of our sales and service presence and base of businessin California with a significant concentration of dialysis clinics andhealthcare institutions.

 

Theacquisition of G.E.M. is included in our results of operations for the threeand six months ended January 31, 2010. Since the acquisition of G.E.M. occurredon the last day of our fiscal 2009, its results of operations are excluded from the three and six months ended January 31,2009, but its net assets are included in our Condensed Consolidated BalanceSheet at July 31, 2009. Pro forma consolidated statements of incomedata have not been presented due to the insignificant impact of thisacquisition.

 

**Note 4.                   RecentAccounting Pronouncements**

 

In June 2009, the FASB issued Statement of FinancialAccounting Standards No. 168, “*The FASBAccounting Standards Codification and the Hierarchy of Generally AcceptedAccounting Principles, a replacement of FASB Statement No. 162,”*(codified as “ASC 105”). ASC 105 establishes the Accounting StandardsCodification as the source of authoritative accounting literature recognized bythe FASB to be applied by nongovernmental entities in addition to rules andinterpretive releases of the Securities and Exchange Commission (“SEC”), whichare sources of authoritative generally accepted accounting principles (“GAAP”)for SEC registrants. All other non-grandfathered, non-SEC accounting literaturenot included in the codification will become non-authoritative. ASC 105identifies the sources of accounting principles and the framework for selectingthe principles used in the preparation of the financialstatements. Following this statement, the FASB will issue new standards inthe form of Accounting Standards Updates (“ASU”). This standard becameeffective for financial statements for interim and annual reporting periodsending after September 15, 2009 and therefore was adopted by us on August 1,2009. As the codification was not intended to change or alter existing GAAP, itdid not have any impact on our Condensed Consolidated Financial Statements.

 

In February 2010, the FASB issued ASU 2010-09, *“Subsequent Events (Topic 855): Amendments to Certain Recognition andDisclosure Requirements,”* (“ASU 2010-09”). ASU 2010-09 addressespractical issues for SEC registrants with respect to management’s review ofsubsequent events by no longer requiring SEC registrants to disclose the datethrough which management evaluated subsequent events in financial statements.This change alleviates potential conflicts with SEC guidance. ASU 2010-09 iseffective immediately for all financial statements that have not been issued orhave not become available to be issued. As ASU 2010-09 was not intended tochange our subsequent events procedures, it did not have any impact on ourCondensed Consolidated Financial Statements other than excluding the disclosureof the date through which management evaluated subsequent events in thesefinancial statements.

 

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 assetsamong Levels 1 and 2, and a reconciliation of purchases, sales, issuance, andsettlements of activity valued with a Level 3 method, of the three-tier fairvalue hierarchy established by ASC 820, “*FairValue Measurements and Disclosures,”* (“ASC 820”). ASU 2010-06 also clarifies the existing guidanceto require fair value measurement disclosures for each class of assets and 

 

11

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liabilities. ASU 2010-06 is effective for interim and annual reportingperiods beginning after December 15, 2009 for Level 1 and 2 disclosurerequirements, which we will adopt in our third quarter of fiscal 2010, andafter December 15, 2010 for Level 3 disclosure requirements, which we willadopt in our third quarter of fiscal 2011. The adoption of ASU 2010-06 is notexpected to have any impact upon our financial position, results of operationsand financial statement disclosures due to the nature of our Level 1 assets andthe lack of any assets valued with a Level 2 or Level 3 method.

 

In October 2009, the FASB issued ASU 2009-13, *“RevenueRecognition (Topic 605): Multiple-Deliverable Arrangements, a consensus of theFASB Emerging Issues Task Force,”* (“ASU 2009-13”), which amends ASC605-25, “*RevenueRecognition-Multiple-Element Arrangements.” *ASU 2009-13provides principles for the allocation of consideration among multiple-elementarrangements, allowing more flexibility in identifying and accounting forseparate deliverables. ASU 2009-13 introduces an estimated selling pricemethod for allocating revenue to the elements of a bundled arrangement ifvendor-specific objective evidence or third-party evidence of selling price isnot available, and significantly expands related disclosurerequirements. This standard is effective on a prospective basis forrevenue arrangements entered into or materially modified in fiscal yearsbeginning on or after June 15, 2010. We are currently in the processof evaluating the impact of ASU 2009-13 on our financial position and resultsof operations.

 

In December 2007, the FASB issued ASC 805, “*Business Combinations,*” (“ASC 805”), whichestablishes principles and requirements for how an acquirer recognizes andmeasures in its financial statements the identifiable assets acquired, theliabilities assumed, any non-controlling interest in the acquiree and thegoodwill acquired. Some of the revised guidance of ASC 805 includes initialcapitalization of acquired in-process research and development, expensingtransaction and restructuring costs and recording contingent considerationpayments at fair value, with subsequent adjustments recorded to net earnings.It also provides disclosure requirements to enable users of the financialstatements to evaluate the nature and financial effects of the businesscombination. ASC 805 was effective for business combinations that occurduring or after fiscal years beginning after December 15, 2008 andtherefore was adopted by us on August 1, 2009. Any acquisitions we make infiscal 2010 and future periods will be subject to this new accounting guidance.

 

In September 2006, the FASB issued ASC 820.  ASC 820establishes a framework for measuring fair value, clarifies the definition offair value, and requires additional disclosures about fair value measurementsthat are already required or permitted by other accounting standards (exceptfor measurements of share-based payments) and is expected to increase theconsistency of those measurements. ASC 820, as issued, was effective forfiscal years beginning after November 15, 2007 and therefore was adoptedon August 1, 2008 with respect to recorded financial assets and financialliabilities. In February 2008, the effective date of ASC 820 was deferredfor certain nonfinancial assets and nonfinancial liabilities to fiscal yearsbeginning after November 15, 2008 and therefore this portion of ASC 820was adopted on August 1, 2009. The implementation of ASC 820 did not havea material impact on our financial position or results of operations at eitherdate.

 

In August 2009, the FASB issued ASU 2009-05, which amends ASC820. ASU 2009-05 provides amendments for fair value measurements ofliabilities. It provides clarification that in circumstances in which aquoted price in an active market for the identical liability is not available,a reporting entity is required to measure fair value using one or morealternate 

 

12

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techniques. ASU 2009-05 also clarifies that when estimating fairvalue of a liability, a reporting entity is not required to include a separateinput or adjustment to other inputs relating to the existence of a restrictionthat prevents the transfer of the liability. ASU 2009-05 was effective forthe first reporting period (including interim periods) beginning after issuanceand was adopted by us during our first quarter of fiscal 2010. Theadoption of ASU 2009-05 did not have a material impact on our financialposition or results of operations.

 

**Note 5.                   AccumulatedOther Comprehensive Income**

 

The Company’s comprehensive income for the three and six months ended January 31,2010 and 2009 is set forth in the following table:

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                  | ** ** | **January 31,**   | ** ** | **January 31,** | ** ** |
| ** **                                  | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                        |       |                   |       |                 |       |   |   |   |   |
| Net income                                  |       | $                      | 4,876,000  |                 | $          | 3,774,000 |   | $ | 11,044,000 |   | $ | 7,107,000 |   |
| Other comprehensive income (loss):          |       |                   |       |                 |       |   |   |   |   |
| Unrealized loss on interest cap, net of tax |       | —                 |       | (27,000              | )          | — |   | (94,000 | ) |
| Foreign currency translation, net of tax    |       | 198,000                |       | (623,000             | )          | 50,000 |   | (5,729,000 | ) |
| Comprehensive income                        |       | $                      | 5,074,000  |                 | $          | 3,124,000 |   | $ | 11,094,000 |   | $ | 1,284,000 |   |

 

**Note 6.                   FinancialInstruments**

 

We account for derivative instruments and hedging activities inaccordance with ASC 815, *“Derivatives and Hedging,”*(“ASC 815”), which requires the Company to recognize all derivatives on thebalance sheet at fair value. Derivatives that are not designated as hedges mustbe adjusted to fair value through earnings. If the derivative is designated asa hedge, depending on the nature of the hedge, changes in the fair value of thederivative will either be offset against the change in the fair value of thehedged assets, liabilities or firm commitments through earnings or recognizedin other comprehensive income until the hedged item is recognized in earnings.The ineffective portion of the change in fair value of a derivative that isdesignated as a hedge will be recognized immediately in earnings. As of January 31,2010, all of our derivatives were designated as hedges.

 

Changesin the value of (i) the Canadian dollar against the United States dollar, (ii) theeuro against the United States dollar and (iii) the British pound againstthe United States dollar affect our results of operations because a portion ofthe net assets of our Canadian subsidiaries (which are reported in ourSpecialty Packaging and Water Purification and Filtration segments) andMinntech’s Netherlands subsidiary (which are reported in our Dialysis andEndoscope Reprocessing segments) are denominated and ultimately settled inUnited States dollars but must be converted into its functional Canadian dollaror euro currency. Furthermore, as part of the restructuring of our Netherlandssubsidiary, as further described in Note 15 to the Condensed ConsolidatedFinancial Statements, a portion of the net assets of our United Statessubsidiaries, Minntech and Mar Cor, are now denominated and ultimately settledin euros or British pounds but must be converted into our functional UnitedStates currency.

 

Inorder to hedge against the impact of fluctuations in the value of (i) theCanadian dollar relative to the United States dollar, (ii) the eurorelative to the United States dollar and (iii) the British pound relativeto the United States dollar on the conversion of such net assets into thefunctional currencies, we enter into short-term contracts to purchase Canadiandollars, euros and British pounds forward, which contracts are generally onemonth in duration. These short-term 

 

13

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contractsare designated as fair value hedge instruments. There were three foreigncurrency forward contracts with an aggregate value of $4,651,000 at January 31,2010, which covered certain assets and liabilities that were denominated incurrencies other than our subsidiaries’ functional currencies. Such contractsexpired on February 28, 2010. These foreign currency forward contracts arecontinually replaced with new one-month contracts as long as we havesignificant net assets at our subsidiaries that are denominated and ultimatelysettled in currencies other than their functional currencies. Under our creditfacilities, such contracts to purchase Canadian dollars, euros and Britishpounds may not exceed $12,000,000 in an aggregate notional amount at any time.For the three and six months ended January 31, 2010, such forwardcontracts partially offset the impact on operations relating to certain assetsand liabilities that were denominated in currencies other than our subsidiaries’functional currencies and resulted in a net currency conversion loss, net oftax, of $21,000 and $23,000, respectively, on the items hedged. Gains andlosses related to the hedging contracts to buy Canadian dollars, euros andBritish pounds forward were immediately realized within general andadministrative expenses due to the short-term nature of such contracts. We donot hold any derivative financial instruments for speculative or tradingpurposes.

 

On August 1, 2008, we adopted ASC 820 for our financial assets andliabilities. ASC 820 defines fair value as the price that would be received tosell an asset or paid to transfer a liability in an orderly transaction betweenmarket participants at the measurement date. ASC 820 establishes a three levelfair value hierarchy to prioritize the inputs used in valuations, as definedbelow:

 

Level1: Observable inputs that reflect unadjusted quoted prices for identical assetsor liabilities in active markets.

 

Level2: Inputs other than quoted prices included within Level 1 that are observablefor the asset or liability, either directly or indirectly.

 

Level3: Unobservable inputs for the asset or liability.

 

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

 
| ** **                                | ** ** | **January 31, 2010** | ** ** |
|-------------------------------------------|------------|---------------------------|------------|
| ** **                                | ** ** | **Level 1**               | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Cash and cash equilavents:                |       |                      |       |   |   |   |   |   |   |
| Bank deposits and certificates of deposit |       | $                         | 7,082,000  |   | $ | — |   | $ | — |   | $ | 7,082,000 |   |
| Money markets and treasury obligations    |       | 11,049,000                |       | — |   | — |   | 11,049,000 |   |
| Total cash and cash equilavents           |       | $                         | 18,131,000 |   | $ | — |   | $ | — |   | $ | 18,131,000 |   |

 
| ** **                                | ** ** | **July 31, 2009** | ** ** |
|-------------------------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **Level 1**            | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Cash and cash equilavents:                |       |                   |       |   |   |   |   |   |   |
| Bank deposits and certificates of deposit |       | $                      | 11,821,000 |   | $ | — |   | $ | — |   | $ | 11,821,000 |   |
| Money markets                             |       | 11,547,000             |       | — |   | — |   | 11,547,000 |   |
| Total cash and cash equilavents           |       | $                      | 23,368,000 |   | $ | — |   | $ | — |   | $ | 23,368,000 |   |

 

As of January 31, 2010 and July 31, 2009, the carryingamounts for cash and cash equivalents, accounts receivable and accounts payableapproximated fair value due to the short maturity of these instruments. Webelieve that as of January 31, 2010 and July 31, 2009, the fair 

 

14

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valueof our outstanding borrowings under our credit facilities approximated thecarrying value of those obligations since the borrowing rates were comparableto market interest rates.

 

**Note 7.                   IntangibleAssets and Goodwill**

 

Our intangible assets with definite lives consist primarily of customerrelationships, technology, brand names, non-compete agreements and patents.These intangible assets are being amortized using the straight-line method overthe estimated useful lives of the assets ranging from 3-20 years and have aweighted average amortization period of 10 years. Amortization expense relatedto intangible assets was $1,294,000 and $2,572,000 for the three and six monthsended January 31, 2010, respectively, and $1,268,000 and $2,606,000 forthe three and six months ended January 31, 2009, respectively. Ourintangible assets that have indefinite useful lives and therefore are notamortized consist of trademarks and trade names.

 

The Company’s intangible assets consist of the following:

 
| ** **                           | ** ** | **January 31, 2010** | ** ** |
|--------------------------------------|------------|---------------------------|------------|
| ** **                           | ** ** | ** **                | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Gross**                 | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| Intangible assets with finite lives: |       |                      |       |   |   |   |   |
| Customer relationships               |       | $                         | 25,953,000 |   | $ | (10,942,000 | ) | $ | 15,011,000 |   |
| Technology                           |       | 9,353,000                 |       | (5,765,000 | ) | 3,588,000 |   |
| Brand names                          |       | 9,546,000                 |       | (4,313,000 | ) | 5,233,000 |   |
| Non-compete agreements               |       | 1,863,000                 |       | (1,379,000 | ) | 484,000 |   |
| Patents and other registrations      |       | 1,224,000                 |       | (264,000 | ) | 960,000 |   |
|                                 |       | 47,939,000                |       | (22,663,000 | ) | 25,276,000 |   |
| Trademarks and tradenames            |       | 9,315,000                 |       | — |   | 9,315,000 |   |
| Total intangible assets              |       | $                         | 57,254,000 |   | $ | (22,663,000 | ) | $ | 34,591,000 |   |

 
| ** **                           | ** ** | **July 31, 2009** | ** ** |
|--------------------------------------|------------|------------------------|------------|
| ** **                           | ** ** | ** **             | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Gross**              | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| Intangible assets with finite lives: |       |                   |       |   |   |   |   |
| Customer relationships               |       | $                      | 26,977,000 |   | $ | (10,592,000 | ) | $ | 16,385,000 |   |
| Technology                           |       | 9,345,000              |       | (5,304,000 | ) | 4,041,000 |   |
| Brand names                          |       | 9,546,000              |       | (3,798,000 | ) | 5,748,000 |   |
| Non-compete agreements               |       | 1,863,000              |       | (1,223,000 | ) | 640,000 |   |
| Patents and other registrations      |       | 1,140,000              |       | (221,000 | ) | 919,000 |   |
|                                 |       | 48,871,000             |       | (21,138,000 | ) | 27,733,000 |   |
| Trademarks and tradenames            |       | 9,309,000              |       | — |   | 9,309,000 |   |
| Total intangible assets              |       | $                      | 58,180,000 |   | $ | (21,138,000 | ) | $ | 37,042,000 |   |

 

Estimated amortization expense of our intangible assets for theremainder of fiscal 2010 and the next five years is as follows:

 
| Six month period ending July 31, 2010 |   | $         | 2,505,000 |   |
|--------------------------------------------|--------|-----------|-----------|--------|
| Fiscal 2011                                |   | 4,745,000 |      |
| Fiscal 2012                                |   | 4,281,000 |      |
| Fiscal 2013                                |   | 4,207,000 |      |
| Fiscal 2014                                |   | 4,021,000 |      |
| Fiscal 2015                                |   | 3,855,000 |      |

 

15

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Goodwillchanged during fiscal 2009 and the six months ended January 31, 2010 asfollows:

 
| ** **                                                                    | ** ** | **Water**          | ** ** | ** **      | ** ** | ** **       | ** ** | ** **   | ** ** | ** **    | ** ** | ** **   | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------|------------|-----------------|------------|------------------|------------|--------------|------------|---------------|------------|--------------|------------|
| ** **                                                                    | ** ** | **Purification**   | ** ** | **Healthcare**  | ** ** | **Endoscope**    | ** ** | ** **   | ** ** | ** **    | ** ** | **Total**    | ** ** |
| ** **                                                                    | ** ** | **and Filtration** | ** ** | **Disposables** | ** ** | **Reprocessing** | ** ** | **Dialysis** | ** ** | **All Other** | ** ** | **Goodwill** | ** ** |
|                                                                          |       |               |       |            |       |             |       |         |       |          |       |         |       |
| Balance, July 31, 2008                                                   |       | $                  | 37,662,000 |            | $          | 50,473,000       |       | $            | 9,648,000  |          | $          | 8,133,000    |       | $ | 8,042,000 |   | $ | 113,958,000 |   |
| Acquisitions                                                                  |       | 1,466,000          |       | —          |       | —           |       | —       |       | —        |       | 1,466,000    |       |
| Earnout on acquisition                                                        |       | —             |       | 157,000         |       | —           |       | —       |       | —        |       | 157,000      |       |
| Adjustments  primarily relating to income tax exposure of acquired businesses |       | (38,000            | )          | —          |       | —           |       | —       |       | —        |       | (38,000      | )          |
| Foreign curreny translation                                                   |       | (244,000           | )          | —          |       | —           |       | —       |       | (304,000      | )          | (548,000     | )          |
| Balance, July 31, 2009                                                   |       | 38,846,000         |       | 50,630,000      |       | 9,648,000        |       | 8,133,000    |       | 7,738,000     |       | 114,995,000  |       |
| Foreign curreny translation                                                   |       | 17,000             |       | —          |       | —           |       | —       |       | 20,000        |       | 37,000       |       |
| Balance, January 31, 2010                                                |       | $                  | 38,863,000 |            | $          | 50,630,000       |       | $            | 9,648,000  |          | $          | 8,133,000    |       | $ | 7,758,000 |   | $ | 115,032,000 |   |

 

OnJuly 31, 2009, we performed impairment studies of the Company’s goodwilland trademarks and trade names and concluded that such assets were notimpaired.

 

**Note 8.                   Warranty**

 

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

 
| ** **                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                   | ** ** | **January 31,**   | ** ** | **January 31,** | ** ** |
| ** **                   | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                         |       |                   |       |                 |       |   |   |   |   |
| Beginning balance            |       | $                      | 975,000    |                 | $          | 882,000 |   | $ | 949,000 |   | $ | 916,000 |   |
| Provisions                   |       | 523,000                |       | 297,000              |       | 950,000 |   | 599,000 |   |
| Charges                      |       | (357,000               | )          | (267,000             | )          | (758,000 | ) | (555,000 | ) |
| Foreign currency translation |       | —                 |       | —               |       | — |   | (48,000 | ) |
| Ending balance               |       | $                      | 1,141,000  |                 | $          | 912,000 |   | $ | 1,141,000 |   | $ | 912,000 |   |

 

The warranty provisions and charges during the three and six monthsended January 31, 2010 and 2009 relate principally to the Company’sendoscope reprocessing and water purification products. Warranty reserves areincluded in accrued expenses in the Condensed Consolidated Balance Sheets.

 

**Note 9.                   FinancingArrangements**

 

In conjunction with theacquisition of Crosstex, we entered into amended and restated credit facilitiesdated as of August 1, 2005 (the “U.S. Credit Facilities”) with a consortiumof lenders to fund the cash consideration paid in the acquisition and costsassociated with the acquisition, as well as to modify our existing UnitedStates credit facilities. The U.S. Credit Facilities, as amended, include (i) asix-year $40.0 million senior secured amortizing term loan facility and (ii) afive-year $50.0 million senior secured revolving credit facility. Amounts werepay under the term loan facility may not be re-borrowed. Debt issuance costsrelating to the U.S. Credit Facilities were recorded in other assets and arebeing amortized over the life of the credit facilities. Such unamortized debtissuance costs amounted to approximately $426,000 at January 31, 2010.

 

At January 31, 2010, borrowings under the U.S. Credit Facilitiesbear interest at rates ranging from 0% to 0.50% above the lender’s base rate,or at rates ranging from 0.625% to 1.75% above the London Interbank OfferedRate (“LIBOR”), depending upon our consolidated ratio of debt to earningsbefore interest, taxes, depreciation and amortization, and as further 

 

16

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adjusted under the terms of the U.S. Credit Facilities (“EBITDA”). AtJanuary 31, 2010, the lender’s base rate was 3.25% and the LIBOR ratesranged from 1.41% to 2.09%. The margins applicable to our outstandingborrowings at January 31, 2010 were 0.00% above the lender’s base rate and0.625% above LIBOR. All of our outstanding borrowings were under LIBORcontracts at January 31, 2010. The majority of such contracts were twelvemonth LIBOR contracts; therefore, we are substantially protected for theremainder of fiscal 2010 from any exposure associated with increasing LIBORrates. The U.S. Credit Facilities also provide for fees on the unused portionof our facilities at rates ranging from 0.15% to 0.30%, depending upon ourconsolidated ratio of debt to EBITDA; such rate was 0.15% at January 31,2010.

 

The U.S. Credit Facilities require us to meet certain financialcovenants and are secured by (i) substantially all of our U.S.-basedassets (including assets of Cantel, Minntech, Mar Cor, Crosstex, and StrongDental Products, Inc.) and (ii) our pledge of all of the outstandingshares of Minntech, Mar Cor, Crosstex and Strong Dental Products, Inc. and65% of the outstanding shares of our foreign-based subsidiaries. Additionally,we are not permitted to pay cash dividends on our Common Stock without theconsent of our United States lenders. Such consent was obtained with respect toannual cash dividends of up to $1,800,000, commencing with the dividend paid onJanuary 29, 2010. As of January 31, 2010, we were in compliance withall financial and other covenants under the U.S. Credit Facilities.

 

OnJanuary 31, 2010, we had $30,500,000 of outstanding borrowings under the U.S.Credit Facilities, which consisted of $15,000,000 and $15,500,000 under theterm loan facility and the revolving credit facility, respectively. Thematurities of our credit facilities are described in Note 12 to the CondensedConsolidated Financial Statements.

 

The revolving portion of our credit facilities has a termination dateof August 1, 2010. Although we may repay a portion of our outstandingborrowings under the revolver throughout fiscal 2010, we do not presentlyanticipate paying off the revolver in full by its termination date. We arein discussions with our bank syndicate regarding modifications to suchfacility, including an extension of the termination date, and expect toformally modify the facility before the expiration date. However, since anymodification will not be completed until later in fiscal 2010, subsequent to July 31,2009 the entire outstanding balance of the revolver was reclassified fromlong-term to current.

 

**Note 10.                 Earnings Per Common Share**

 

BasicEPS is computed based upon the weighted average number of common sharesoutstanding during the period. Diluted EPS is computed based upon the weightedaverage number of common shares outstanding during the period plus the dilutiveeffect of Common Stock equivalents using the treasury stock method and theaverage market price of our Common Stock for the period.

 

In June 2008, the FASB issued ASC 260-10-45, which provides that unvested share-based paymentawards that contain nonforfeitable rights to dividends or dividend equivalents(whether paid or unpaid) are participating securities and shall be included inthe computation of EPS pursuant to the two-class method, a change that reducesboth basic and diluted EPS. Our participating securities consist solely ofunvested restricted 

 

17

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stock awards, which have contractual participation rights equivalent tothose of stockholders of unrestricted common stock. The two-class method ofcomputing earnings per share is an allocation method that calculates earningsper share for common stock and participating securities. Previously, weexcluded unvested restricted stock awards in the calculation of basic EPS andincluded such awards in diluted EPS under the treasury stock method. ASC260-10-45 was effective for fiscal years beginning after December 15, 2008and therefore was adopted on August 1, 2009. All prior period EPS datapresented have been adjusted retrospectively to conform to the provisions ofASC 260-10-45. For the three and six months ended January 31, 2009,such retrospective application caused an insignificant increase in thedenominator of our weighted average shares calculation, which decreasedpreviously reported basic EPS for the six months ended January 31, 2009from $0.44 to $0.43 but had no impact on basic EPS for the three months ended January 31,2009 and previously reported diluted EPS.

 

Thefollowing table sets forth the computation of basic and diluted EPS availableto shareholders of common stock:

 
| ** **                                                                                                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                                             | ** ** | **January 31,**   | ** ** | **January 31,** | ** ** |
| ** **                                                                                                                             | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| Numerator for basic and diluted earnings per share:                                                                                    |       |                   |       |                 |       |   |   |   |   |
| Net income                                                                                                                             |       | $                      | 4,876,000  |                 | $          | 3,774,000 |   | $ | 11,044,000 |   | $ | 7,107,000 |   |
| Less income allocated to participating securities                                                                                      |       | (78,000                | )          | (47,000              | )          | (167,000 | ) | (90,000 | ) |
| Net income available to common shareholders                                                                                            |       | $                      | 4,798,000  |                 | $          | 3,727,000 |   | $ | 10,877,000 |   | $ | 7,017,000 |   |
|                                                                                                                                   |       |                   |       |                 |       |   |   |   |   |
| 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                                              |       | 16,486,818             |       | 16,263,703           |       | 16,454,918 |   | 16,227,013 |   |
|                                                                                                                                   |       |                   |       |                 |       |   |   |   |   |
| Dilutive  effect of stock options using the treasury stock method and the average  market price for the period                         |       | 222,240                |       | 32,378               |       | 174,429 |   | 44,139 |   |
|                                                                                                                                   |       |                   |       |                 |       |   |   |   |   |
| Denominator  for diluted earnings per share - weighted average number of shares and common  stock equivalents                          |       | 16,709,058             |       | 16,296,081           |       | 16,629,347 |   | 16,271,152 |   |
|                                                                                                                                   |       |                   |       |                 |       |   |   |   |   |
| Earnings per share attributable to common stock:                                                                                       |       |                   |       |                 |       |   |   |   |   |
| Basic earnings per share                                                                                                               |       | $                      | 0.29       |                 | $          | 0.23 |   | $ | 0.66 |   | $ | 0.43 |   |
|                                                                                                                                   |       |                   |       |                 |       |   |   |   |   |
| Diluted earnings per share                                                                                                             |       | $                      | 0.29       |                 | $          | 0.23 |   | $ | 0.65 |   | $ | 0.43 |   |
|                                                                                                                                   |       |                   |       |                 |       |   |   |   |   |
| Stock  options excluded from weighted average dilutive common shares outstanding  because their inclusion would have been antidulitive |       | 601,401                |       | 1,183,651            |       | 708,276 |   | 1,499,601 |   |

 

18

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TheCompany’s total weighted average number of shares, including participatingsecurities, for the three and six months ended January 31, 2010 and 2009are set forth in the following table:

 
| ** **                                                                                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                     | ** ** | **January 31,**   | ** ** | **January 31,** | ** ** |
| ** **                                                                                                     | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| Weighted average number of shares outstanding  attributable to:                                                |       |                   |       |                 |       |   |   |   |   |
| Common stock                                                                                                   |       | 16,486,818             |       | 16,263,703           |       | 16,454,918 |   | 16,227,013 |   |
| Participating securities                                                                                       |       | 273,866                |       | 207,165              |       | 255,606 |   | 207,165 |   |
| Total weighted average number of shares outstanding                                                            |       | 16,760,684             |       | 16,470,868           |       | 16,710,524 |   | 16,434,178 |   |
|                                                                                                           |       |                   |       |                 |       |   |   |   |   |
| Dilutive  effect of stock options using the treasury stock method and the average  market price for the period |       | 222,240                |       | 32,378               |       | 174,429 |   | 44,139 |   |
|                                                                                                           |       |                   |       |                 |       |   |   |   |   |
| Total  weighted average number of shares and common stock equivalents                                          |       | 16,982,924             |       | 16,503,246           |       | 16,884,953 |   | 16,478,317 |   |

 

**Note11.                 IncomeTaxes**

 

Theconsolidated effective tax rate was 37.4% and 38.0% for the six months ended January 31,2010 and 2009, respectively. The decrease in the consolidated effective taxrate was principally due to the geographic mix of pre-tax income, as describedbelow, as well as additional United States taxes in the prior year periodrelated to the repatriation of earnings from our Netherlands subsidiary.

 

Themajority of our income before income taxes was generated from our United Statesoperations, which had an overall effective tax rate of 37.9% and 38.5% for thesix months ended January 31, 2010 and 2009, respectively.

 

Dueto the uncertainty of our Netherlands subsidiary utilizing tax benefits in thefuture, a tax benefit was not recorded on the losses from operations at ourNetherlands subsidiary for the six months ended January 31, 2009, therebyadversely affecting our overall consolidated effective tax rate in the prioryear period. For the six months ended January 31, 2010, our Netherlandsoperation became slightly profitable as a result of the prior yearrestructuring of its operations, as more fully described elsewhere in thisMD&A and Note 15 to the Condensed Consolidated Financial Statements.

 

Approximately2% of our income before income taxes was generated from our operations inSingapore, a country with a low corporate tax structure. The overall effectivetax rate for our Singapore operation was 11.4% for the six months ended January 31,2010. For the prior year period, our Singapore operation was slightlyprofitable and did not have a significant impact on our overall effective taxrate.

 

Partiallyoffsetting the favorable impact of our United States, Netherlands and Singaporeoperations on our overall effective tax rate for the six months ended January 31,2010, compared with our overall effective tax rate for the six months ended January 31,2009, was our Canadian operations, which had an overall effective tax rate of27.6% and 10.5% for the six months ended January 31, 2010 and 2009,respectively. The low overall effective tax rate in the prior year period wasattributable to the impact of a lower overall effective tax rate in ourSpecialty 

 

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Packagingsegment as applied to existing deferred income tax liabilities. Approximately3% and 5% of our income before income taxes was generated from our Canadianoperations for the six months ended January 31, 2010 and 2009,respectively.

 

Theresults of operations for our subsidiary in Japan did not have a significantimpact on our overall effective tax rate for the six months ended January 31,2010 and 2009 due to the size of income before income taxes generated from thisoperation.

 

Werecord liabilities for an unrecognized tax benefit when a tax benefit for anuncertain tax position is taken or expected to be taken on a tax return, but isnot recognized in our Condensed Consolidated Financial Statements because itdoes not meet the more-likely-than-not recognition threshold that the uncertaintax position would be sustained upon examination by the applicable taxingauthority. The tax benefits recognized in the financial statements from such aposition are measured based on the largest benefit that has a greater thanfifty percent likelihood of being realized upon settlement with the taxauthorities.The majority ofour unrecognized tax benefits originated from acquisitions. Accordingly, anyadjustments upon resolution of income tax uncertainties that predate or resultfrom acquisitions were recorded as an increase or decrease to goodwill. On August 1,2009, we adopted ASC 805, which requires the resolution of income taxuncertainties that predate or result from acquisitions to be recognized in ourresults of operations beginning with fiscal 2010. However, if our unrecognizedtax benefits are recognized in our financial statements in future periods,there would not be a significant impact to our effective tax rate due to thesize of the unrecognized tax benefits in relation to our income before incometaxes. We do not expect such unrecognized tax benefits to significantlydecrease or increase in the next twelve months.

 

Areconciliation of the beginning and ending amounts of gross unrecognized taxbenefits is as follows:

 
| ** **                                                  | ** ** | **Unrecognized** | ** ** |
|-------------------------------------------------------------|------------|------------------|------------|
| ** **                                                  | ** ** | **Tax Benefits** | ** ** |
|                                                        |       |             |       |
| Unrecognized tax benefits on July 31, 2008             |       | $                | 427,000    |   |
| Lapse of statute of limitations                             |       | (47,000          | )          |
| Unrecognized tax benefits on July 31, 2009             |       | 380,000          |       |
| Activity during the six months ended  January 31, 2010 |       | —           |       |
| Unrecognized tax benefits on January 31, 2010          |       | $                | 380,000    |   |

 

Generally, the Company is no longersubject to federal, state or foreign income tax examinations for fiscal yearsended prior to July 31, 2003.

 

Our policy is to record potentialinterest and penalties related to income tax positions in interest expense andgeneral and administrative expense, respectively, in our Condensed ConsolidatedFinancial Statements. However, such amounts have been relatively insignificantdue to the amount of our unrecognized tax benefits relating to uncertain tax positions.

 

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**12.          Commitmentsand Contingencies**

 

***Long-term contractual obligations***

 

As of January 31, 2010, aggregate annual required payments overthe remaining fiscal year, the next four years and thereafter under ourcontractual obligations that have long-term components were as follows:

 
| ** **                                                  | ** ** | **Six Months**             | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** |
|-------------------------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|
| ** **                                                  | ** ** | **Ending**                 | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                                                  | ** ** | **July 31,**          | ** ** | **Year Ending July 31,** | ** ** | ** ** | ** ** |
| ** **                                                  | ** ** | **2010**                   | ** ** | **2011**                      | ** ** | **2012**   | ** ** | **2013**   | ** ** | **2014**   | ** ** | **Thereafter** | ** ** | **Total**  | ** ** |
| ** **                                                  | ** ** | **(Amounts in thousands)** | ** ** |
| Maturities  of the credit facilities                        |       | $                          | 5,000      |                          | $          | 25,500     |       | $          | —     |       | $          | —         |       | $          | —     |   | $ | — |   | $ | 30,500 |   |
| Expected  interest payments under the credit facilities (1) |       | 344                        |       | 120                           |       | —     |       | —     |       | —     |       | —         |       | 464        |       |
| Minimum  commitments under noncancelable operating leases   |       | 1,591                      |       | 2,480                         |       | 1,583      |       | 1,071      |       | 895        |       | 3,086          |       | 10,706     |       |
| Minimum  commitments under noncancelable capital leases     |       | 26                         |       | 14                            |       | —     |       | —     |       | —     |       | —         |       | 40         |       |
| Deferred compensation and other                             |       | 203                        |       | 408                           |       | 253        |       | 32         |       | 33         |       | 166            |       | 1,095      |       |
| Employment agreements                                       |       | 1,613                      |       | 1,541                         |       | 131        |       | —     |       | —     |       | —         |       | 3,285      |       |
| Total contractual obligations                               |       | $                          | 8,777      |                          | $          | 30,063     |       | $          | 1,967      |       | $          | 1,103          |       | $          | 928        |   | $ | 3,252 |   | $ | 46,090 |   |

 

----

(1) The expected interest payments under the term and revolvingcredit facilities reflect interest rates of 2.19% and 2.62%, respectively,which were our weighted average interest rates on outstanding borrowings at January 31,2010.

 

***Operating leases***

 

Minimumcommitments under operating leases include minimum rental commitments for ourleased manufacturing facilities, warehouses, office space and equipment.

 

***Deferred compensation***

 

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

 

***Employment agreements***

 

Wehave previously entered into various employment agreements with executives ofthe Company, including our Corporate executive officers and our subsidiaryChief Executive Officers. The majority of such contracts expired and werereplaced effective January 1, 2010 with severance contracts that definedcertain compensation arrangements relating to various employment terminationscenarios.

 

**Note13.                 OperatingSegments**

 

We are a leading provider of infection prevention and control productsin the healthcare market. Our products include specialized medical devicereprocessing systems for renal dialysis and endoscopy, dialysate concentratesand other dialysis supplies, water purification equipment, 

 

21

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sterilants,disinfectants and cleaners, hollow fiber membrane filtration and separationproducts for medical and non-medical applications, and specialty packaging forinfectious and biological specimens. We also provide technical maintenance forour products and offer compliance training services for the transport ofinfectious and biological specimens.

 

Inaccordance with FASB ASC Topic 280, “*SegmentReporting”* (“ASC 280”),we have determined our reportable business segments based upon an assessment ofproduct types, organizational structure, customers and internally preparedfinancial statements. The primary factors used by us in analyzing segmentperformance are net sales and operating income.

 

TheCompany’s segments are as follows:

 

**WaterPurification and Filtration**, which includes waterpurification equipment design and manufacturing, project management,installation, maintenance, deionization and mixing systems, as well as hollowfiber filter devices and ancillary products for high-purity fluid andseparation applications for healthcare (with a large concentration indialysis), pharmaceutical, biotechnology, research, beverage, semiconductor andother commercial industries. Additionally, this segment includes cold sterilantproducts used to disinfect high-purity water systems.

 

Onecustomer accounted for approximately 24% of our Water Purification andFiltration segment net sales and approximately 8% of our consolidated net salesduring the six months ended January 31, 2010.

 

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

 

Fourcustomers collectively accounted for approximately 53% of our HealthcareDisposables segment net sales and approximately 14% of our consolidated netsales during the six months ended January 31, 2010.

 

**EndoscopeReprocessing**, which includes endoscope disinfection equipmentand related accessories, disinfectants and supplies that are sold to hospitals,clinics and physicians. Additionally, this segment includes technicalmaintenance service on its products.

 

**Dialysis**, whichincludes disinfection/sterilization reprocessing equipment, sterilants,supplies and concentrates related to hemodialysis treatment of patients withacute kidney failure or chronic kidney failure associated with end-stage renaldisease. Additionally, this segment includes technical maintenance service onits products.

 

Threecustomers collectively accounted for approximately 43% of our Dialysis segmentnet sales and approximately 16% of our consolidated net sales, including onecustomer that accounted for approximately 32% of our Dialysis segment net salesand approximately 8% of our consolidated net sales, during the six months endedJanuary 31, 2010.

 

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**All Other**

 

In accordance with quantitative thresholds established by ASC 280, wehave combined the Therapeutic Filtration and Specialty Packaging operatingsegments into the All Other reporting segment.

 

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

 

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

 

Theoperating segments follow the same accounting policies used for our CondensedConsolidated Financial Statements as described in Note 2 to the 2009 Form 10-K.

 

Informationas to operating segments is summarized below:

 
| ** **                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                        | ** ** | **January 31,**   | ** ** | **January 31,** | ** ** |
| ** **                        | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                              |       |                   |       |                 |       |   |   |   |   |
| Net sales:                        |       |                   |       |                 |       |   |   |   |   |
| Water Purification and Filtration |       | $                      | 18,870,000 |                 | $          | 16,799,000 |   | $ | 37,702,000 |   | $ | 35,269,000 |   |
| Healthcare Disposables            |       | 16,160,000             |       | 14,371,000           |       | 36,742,000 |   | 30,120,000 |   |
| Endoscope Reprocessing            |       | 15,987,000             |       | 11,941,000           |       | 30,777,000 |   | 24,364,000 |   |
| Dialysis                          |       | 11,465,000             |       | 15,250,000           |       | 24,294,000 |   | 29,480,000 |   |
| All Other                         |       | 4,105,000              |       | 4,059,000            |       | 8,067,000 |   | 7,593,000 |   |
| Total                             |       | $                      | 66,587,000 |                 | $          | 62,420,000 |   | $ | 137,582,000 |   | $ | 126,826,000 |   |
|                              |       |                   |       |                 |       |   |   |   |   |
| Operating Income:                 |       |                   |       |                 |       |   |   |   |   |
| Water Purification and Filtration |       | $                      | 1,918,000  |                 | $          | 1,448,000 |   | $ | 4,076,000 |   | $ | 3,200,000 |   |
| Healthcare Disposables            |       | 2,439,000              |       | 1,546,000            |       | 7,287,000 |   | 3,523,000 |   |
| Endoscope Reprocessing            |       | 1,933,000              |       | 1,568,000            |       | 3,650,000 |   | 3,103,000 |   |
| Dialysis                          |       | 2,748,000              |       | 2,896,000            |       | 5,692,000 |   | 5,135,000 |   |
| All Other                         |       | 1,180,000              |       | 1,021,000            |       | 2,225,000 |   | 1,686,000 |   |
|                              |       | 10,218,000             |       | 8,479,000            |       | 22,930,000 |   | 16,647,000 |   |
| General corporate expenses        |       | (2,234,000             | )          | (1,880,000           | )          | (4,582,000 | ) | (3,864,000 | ) |
| Interest expense, net             |       | (331,000               | )          | (636,000             | )          | (710,000 | ) | (1,317,000 | ) |
|                              |       |                   |       |                 |       |   |   |   |   |
| Income before income taxes        |       | $                      | 7,653,000  |                 | $          | 5,963,000 |   | $ | 17,638,000 |   | $ | 11,466,000 |   |

 

**Note 14.                 LegalProceedings**

 

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

 

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**Note 15.*****               *****RestructuringActivities**

 

During the fourth quarter of fiscal 2008, our management approved andinitiated plans to restructure our Netherlands subsidiary by relocating all ofour manufacturing operations from the Netherlands to the United States. Thisaction is part of our continuing effort to reduce operating costs and improveefficiencies by leveraging the existing infrastructure of our Minntechoperations in Minnesota. The elimination of manufacturing operations in theNetherlands has led to the end of onsite material management, qualityassurance, finance and accounting, human resources and some customer servicefunctions. However, we continue to maintain a strong marketing, sales, serviceand technical support presence based in the Netherlands to serve customersthroughout Europe, the Middle East and Africa.

 

For the three months ended January 31, 2009, we recorded $74,000in restructuring costs, of which $37,000 was recorded in each of cost of salesand general and administrative expenses. For the six months ended January 31,2009, we recorded $345,000 in restructuring costs, of which $176,000 wasrecorded in cost of sales and $169,000 was recorded in general andadministrative expenses. The total cost of the restructuring plan was $710,000and was recorded beginning in our fourth quarter of fiscal 2008 until therestructuring plan completion date of July 31, 2009. We do not expect toincur any additional restructuring costs. The majority of the restructuringcosts were included in our Endoscope Reprocessing segment.  Since the above costs were recorded in ourNetherlands subsidiary, which had been experiencing losses from its operations,tax benefits on the above costs were not recorded.

 

As part of the restructuring plan, we sold our Netherlands building andland on May 19, 2009 and entered into a lease for 2.5 years with the newowner so we can continue to use the facility as our European sales and serviceheadquarters as well as for warehouse and distribution activity. The sale ofthe building and land resulted in a gain of $146,000, which is being amortizedover the life of the lease and is recorded in deferred revenue and otherlong-term liabilities. The rent for the full 2.5 year lease of $325,000 waspaid from the sale proceeds and recorded in prepaid expenses and other assets.

 

**Note16.                 ConvertibleNote Receivable**

 

InFebruary 2009, we invested an initial $200,000 in a senior subordinatedconvertible promissory note issued by BIOSAFE, Inc. (“BIOSAFE”), inconnection with BIOSAFE’s grant to us of certain exclusive and non-exclusivelicense rights to BIOSAFE’s antimicrobial additive. BIOSAFE is the owner of apatented and proprietary antimicrobial agent that is built into themanufacturing of end-products to achieve long-lasting microbial protection onsuch end-products’ surface. As a result of BIOSAFE’s successful raising of aminimum incremental amount of cash following our investment, we invested anadditional $300,000 in notes of BIOSAFE during the three months ending January 31,2010 bringing the aggregate investment in BIOSAFE notes to $500,000, asobligated under our agreement with BIOSAFE. We are not obligated to invest anyadditional funds.

 

Thenotes are convertible into a newly-created series of preferred stock of BIOSAFE.The notes accrue interest at a per annum rate of 8% until the maturity date of June 30,2011 or earlier exercise. Interest is payable in shares of BIOSAFE stock or incash. If not paid by the maturity date, interest will accrue thereafter at arate of 12% per annum. In connection with our investment, we entered into alicense agreement with BIOSAFE under which we will pay BIOSAFE a fixed royaltypercentage of sales of our products containing BIOSAFE’s 

 

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antimicrobialformulation. This investment, together with the accrued interest of $16,000, isincluded within other assets in our Condensed Consolidated Balance Sheets. Thecarrying value of this investment approximates fair value due to the shortmaturity of the notes and the relatively consistent underlying value ofBIOSAFE.

 

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

 

# **The followingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations (“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 inconjunction with our financial statements and the accompanying notes. OurMD&A includes the following sections:**

# ** **

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

 

**Resultsof Operations** provides a discussion of the consolidated resultsof operations for the three and six months ended January 31, 2010 comparedwith the three and six months ended January 31, 2009.

 

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

 

**CriticalAccounting Policies** provides a discussion of our accounting policiesthat require critical judgments, assumptions and estimates.

 

**Forward-LookingStatements** provides a discussion of cautionary factors thatmay affect future results.

 

**Overview**

 

# **Cantel is aleading provider of infection prevention and control products in the healthcaremarket, specializing in the following operating segments:**

# ** **

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

 

·                  Healthcare Disposables: Single-use,infection prevention and control products used principally inthe dental market including face masks, towels and bibs, tray covers, salivaejectors, germicidal wipes, plastic cups, sterilization pouches anddisinfectants.

 

·                  Endoscope Reprocessing: Medicaldevice reprocessing systems, disinfectants, enzymatic detergents and othersupplies used to high-level disinfect flexible endoscopes.

 

·                  Dialysis: Medicaldevice reprocessing systems, sterilants/disinfectants, dialysate concentratesand other supplies for renal dialysis.

 

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

 

·                  Specialty Packaging: Specialtypackaging and thermal control products, as well as related compliance training,for the transport of infectious and biological specimens and thermallysensitive pharmaceutical, medical and other products. (Included in All Otherreporting segment.)

 

Mostof our equipment, consumables and supplies are used to help prevent theoccurrence or spread of infections.

 

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Seeour Annual Report on Form 10-K for the fiscal year ended July 31,2009 (the “2009 Form 10-K”) and our Condensed Consolidated FinancialStatements for additional financial information regarding our reportingsegments.

 

# ***SignificantActivity***

# ** **

(i)                                                        Net incomeincreased by 29% and 55% for the three and six months ended January 31,2010, respectively, compared with the three and six months ended January 31,2009. We continue to benefit from having a broad portfolio of infectionprevention and control products sold into diverse business segments and we haveproactively developed our overall business to where approximately 75% of ournet sales are attributable to consumable products and service. While all of ourbusiness segments performed well, the Healthcare Disposables segmentcontributed a significant portion of the increase to net income for the threeand six months ended January 31, 2010. The primary factors thatcontributed to this financial performance, as further described elsewhere inthis MD&A, were as follows:

 

·                  an increase in demand duringthe first four months of the six months ended January 31, 2010 forhealthcare disposables products as a result of the outbreak of the novel H1N1(swine flu),

 

·                  improved gross margins as aresult of numerous profit improvement and sales and marketing initiatives andthe continued shift in sales mix to higher margin disposables,

 

·                  higher selling pricesincluding those attributable to converting the sale of high-level disinfectantsin our Endoscope Reprocessing segment from our former equipment distributor toour direct sales and service force at higher selling prices,

 

·                  reductions in manufacturing,raw material and distribution costs,

 

·                  general company-wide effortsto control operating expenses while still investing in sales, marketing andresearch and development activities, and

 

·                  favorable interest costs dueto both reduced average interest rates as well as lower outstanding borrowings.

 

However, we do not expect this level of growth will continue to beachieved, especially given the economic conditions, the decrease in theseverity of the novel H1N1 flu outbreak and other potential risks oruncertainties. See “Risk Factors” in our 2009 Form 10-K for a discussionof the Company’s risk factors.

 

(ii)                                                     We sell ourdialysis products to a concentrated number of customers. Sales in our Dialysissegment were adversely impacted by the continued loss of some lower margindialysate concentrate business from both domestic and 

 

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international customers as a result of the highly competitive and pricesensitive market for such product, as more fully described elsewhere in thisMD&A. Although operating income has not been significantly affected by theloss of such sales, a further loss in sales is likely to result in a lowerlevel of operating income in this segment.

 

(iii)                                               While overallsales and operating income have increased in our Water Purification andFiltration segment for the three and six months ended January 31, 2010compared with the three and six months ended January 31, 2009, thedeterioration in the economy and credit markets adversely impacted our sales ofcapital equipment used for dialysis by causing some of our customers to delayspending on such products, as more fully described elsewhere in this MD&A.

 

(iv)                                               We declared ourfirst cash semiannual dividend of $0.05 per share of outstanding common stock,which was paid on January 29, 2010, as more fully described elsewhere inthis MD&A.

 

(v)                                                    In June 2008,we announced and began executing our plan to restructure our Netherlandsmanufacturing operations as part of our continuing effort to reduce operatingcosts and leverage our existing United States infrastructure. As a result ofthis restructuring, approximately $74,000 and $345,000 of restructuring costswere recorded in the three and six months ended January 31, 2009,respectively, which decreased both basic and diluted earnings per share by$0.02 during the six months ended January 31, 2009, as more fullydescribed in Note 15 to the Condensed Consolidated Financial Statements andelsewhere in this MD&A.

 

(vi)                                                 Fluctuations inthe rates of currency exchange had an overall adverse impact on our net incomefor the three and six months ended January 31, 2010, compared with thethree and six months ended January 31, 2009, as more fully describedelsewhere in this MD&A.

 

(vii)                                              We acquired thebusiness of G.E.M. Water Systems Int’l, LLC (“G.E.M.”) on July 31, 2009,as more fully described in Note 3 to the Condensed Consolidated FinancialStatements.

 

**Resultsof Operations**

 

Theresults of operations described below reflect the operating results of Canteland its wholly-owned subsidiaries. Since the G.E.M. acquisition was completedon July 31, 2009, its results of operations are included in our results ofoperations for the three and six months ended January 31, 2010, but arenot reflected in our results of operations for the three and six months ended January 31,2009.

 

Thefollowing discussion should also be read in conjunction with our 2009 Form 10-K.

 

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Thefollowing table gives information as to the net sales and the percentage to thetotal net sales for each of our reporting segments:

 
| ** **                        | ** ** | **Three Months Ended**            | ** ** | **Six Months Ended**              | ** ** |
|-----------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                        | ** ** | **January 31,**              | ** ** | **January 31,**              | ** ** |
| ** **                        | ** ** | **2010**                          | ** ** | **2009**                          | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                        | ** ** | **(Dollar amounts in thousands)** | ** ** | **(Dollar amounts in thousands)** | ** ** |
| ** **                        | ** ** | **$**                             | ** ** | **%**                             | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
|                              |       |                              |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Water Purification and Filtration |       | $                                 | 18,870     |                              | 28.3       |   | $ | 16,799 |   | 26.9 |   | $ | 37,702 |   | 27.4 |   | $ | 35,269 |   | 27.8 |   |
| Healthcare Disposables            |       | 16,160                            |       | 24.3                              |       | 14,371 |   | 23.0 |   | 36,742 |   | 26.7 |   | 30,120 |   | 23.7 |   |
| Endoscope Reprocessing            |       | 15,987                            |       | 24.0                              |       | 11,941 |   | 19.1 |   | 30,777 |   | 22.4 |   | 24,364 |   | 19.2 |   |
| Dialysis                          |       | 11,465                            |       | 17.2                              |       | 15,250 |   | 24.5 |   | 24,294 |   | 17.7 |   | 29,480 |   | 23.3 |   |
| All Other                         |       | 4,105                             |       | 6.2                               |       | 4,059 |   | 6.5 |   | 8,067 |   | 5.8 |   | 7,593 |   | 6.0 |   |
|                              |       | $                                 | 66,587     |                              | 100.0      |   | $ | 62,420 |   | 100.0 |   | $ | 137,582 |   | 100.0 |   | $ | 126,826 |   | 100.0 |   |

 

***Net Sales***

 

Netsales increased by $4,167,000, or 6.7%, to $66,587,000 for the three monthsended January 31, 2010 from $62,420,000 for the three months ended January 31,2009.

 

Netsales increased by $10,756,000, or 8.5%, to $137,582,000 for the six monthsended January 31, 2010 from $126,826,000 for the six months ended January 31,2009.

 

Theincrease in net sales for the three and six months ended January 31, 2010was principally attributable to increases in sales of endoscope reprocessingproducts and services, healthcare disposables products and water purificationand filtration products and services, partially offset by a decrease indialysis products.

 

Netsales of endoscope reprocessing products and services increased by 33.9% and26.3% for the three and six months ended January 31, 2010, respectively,compared with the three and six months ended January 31, 2009, primarilydue to increases in both domestic and international demand for (i) ourendoscope reprocessing equipment and (ii) our disinfectants, equipmentaccessories and product service due to the increased field population ofequipment. Additionally, the increase was due to higher selling prices of ourdisinfectants in the United States as a result of converting such prior periodsales from our former equipment distributor to our direct sales and serviceforce.

 

Netsales of healthcare disposables products increased by 12.4% and 22.0% for thethree and six months ended January 31, 2010, respectively, compared withthe three and six months ended January 31, 2009, despite nominal growth inthe overall dental market, primarily due to (i) increased sales volume ofhigh margin face masks, disinfectants and other healthcare disposables productsdue to the outbreak of the novel H1N1 flu (swine flu) in April 2009, whichresulted in increased demand during the first four months of the six monthsended January 31, 2010, (ii) approximately $400,000 in higher netsales in the first half of the six months ended January 31, 2010 due to aprior year increase in selling prices, which were implemented to offsetcorresponding supplier cost increases, and (iii) favorable results fromsales and marketing initiatives. Although the outbreak of the novel H1N1 fluresulted in strong sales volume of high margin face masks and other healthcaredisposables products during the first four months of the six months ended January 31,2010, such increased sales levels will not be sustained throughout the lasthalf of fiscal 2010 due to the low level of reported cases of influenza virusesin recent 

 

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monthswhich has already decreased demand. Overall demand for face masks is highlydependent upon the severity and timing of the novel H1N1 flu, the ability ofour Company to educate existing customers and potential new customers on thebenefits of our face masks, disinfectants and other products and the level ofurgency our customers and the general public develop and maintain with respectto epidemic and pandemic preparedness.

 

Netsales of water purification and filtration products and services increased by12.3% and 6.9% for the three and six months ended January 31, 2010, respectively,compared with the three and six months ended January 31, 2009, primarilydue to (i) approximately $715,000 and $1,490,000, respectively, of netsales due to the acquisition of G.E.M. on July 31, 2009, (ii) anincrease in demand for our sterilants and filters within our installedequipment base of business and (iii) higher selling prices, whichfavorably impacted net sales for the three and six months ended January 31,2010 by approximately $185,000 and $465,000, respectively. Partially offsettingthese increases were delayed investments by customers of our water purificationequipment used for dialysis primarily as a result of the deterioration in thegeneral economy and credit markets, which may continue to adversely affectcapital equipment sales.

 

Netsales of dialysis products and services decreased by 24.8% and 17.6% for thethree and six months ended January 31, 2010, respectively, compared withthe three and six months ended January 31, 2009, primarily due to thecontinuing adverse impact of losing some dialysate concentrate business (aconcentrated acid or bicarbonate used to prepare dialysate, a chemical solutionthat draws waste products from a patient’s blood through a dialyzer membraneduring hemodialysis treatment) from domestic and international customers as aresult of the highly competitive and price sensitive market for this lowermargin commodity product, as well as various global economic factors withrespect to international demand. Due to sales price decreases by some of ourcompetitors, we expect a continued decrease in net sales of our lower margindialysate concentrate product during the remainder of fiscal 2010 as we electnot to pursue unprofitable concentrate sales. Furthermore, Fresenius MedicalCare (“Fresenius”), the largest dialysis provider chain in the United States,manufactures dialysate concentrate themselves and has been gradually decreasingtheir purchases of that product from us and may continue to do so in thefuture. Partially offsetting these decreases were higher selling prices, whichfavorably impacted net sales for the three and six months ended January 31,2010 by approximately $225,000 and $475,000, respectively. Although operatingincome has not been significantly affected by the loss of sales of dialysateconcentrate, a further loss in sales is likely to result in a lower level ofoperating income in this segment.

 

***Gross profit***

 

Grossprofit increased by $3,513,000, or 14.9%, to $27,124,000 for the three monthsended January 31, 2010 from $23,611,000 for the three months ended January 31,2009. Gross profit as a percentage of net sales for the three months ended January 31,2010 and 2009 was 40.7% and 37.8%, respectively.

 

Grossprofit increased by $9,348,000, or 19.8%, to $56,582,000 for the six monthsended January 31, 2010 from $47,234,000 for the six months ended January 31,2009. Gross profit as a percentage of net sales for the six months ended January 31,2010 and 2009 was 41.1% and 37.2%, respectively.

 

Thegross profit percentage for the three and six months ended January 31,2010 increased compared with the three and six months ended January 31,2009 primarily due to (i)

 

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favorablesales mix due to the increased sales volume of certain higher margin productssuch as face masks and disinfectants in our Healthcare Disposables segment,disinfectants and equipment accessories in our Endoscope Reprocessing segment,and sterilants and filters in our Water Purification and Filtration segment, aswell as decreased sales of our lower margin dialysate concentrate product inour Dialysis segment, (ii) higher selling prices including thoseattributable to converting the sale of high-level disinfectants in ourEndoscope Reprocessing segment from our former equipment distributor to ourdirect sales and service force at higher selling prices, (iii) a decreasein raw material costs due to the lower price of oil, (iv) improvedefficiencies in our manufacturing, distribution and service functions and (v) approximately$37,000 and $176,000 in restructuring charges recorded primarily in ourEndoscope Reprocessing segment during the three and six months ended January 31,2009 relating to the relocation of our Netherlands manufacturing operations, asmore fully described elsewhere in this MD&A. However, we cannot provideassurances that this gross profit percentage will be sustained, particularlysince we anticipate a reduction in sales of our higher margin HealthcareDisposables products due to the low level of reported cases of the novel H1N1flu in recent months which has already decreased demand. Additionally, wecannot provide assurances that our gross profit percentage will not beadversely affected if raw materials and distribution costs increase and we areunable to implement price increases.

 

***Operating Expenses***

 

Sellingexpenses increased by $1,719,000, or 24.6%, to $8,711,000 for the three monthsended January 31, 2010, from $6,992,000 for the three months ended January 31,2009. For the six months ended January 31, 2010, selling expensesincreased by $2,893,000, or 20.2%, to $17,235,000 from $14,342,000 for the sixmonths ended January 31, 2009. These increases are primarily due to (i) additionalsales personnel and higher compensation expense principally in our EndoscopeReprocessing segment relating to incentive compensation, including commissionsexpense from a more aggressive commission plan designed to gain market share, (ii) anincrease in advertising and marketing expense primarily related to ourHealthcare Disposables segment and (iii) increased sales support servicesprincipally in our Water Purification and Filtration and Endoscope Reprocessingsegments.

 

Selling expenses as a percentage of net sales were 13.1% and 11.2% forthe three months ended January 31, 2010 and 2009, respectively, and 12.5%and 11.3% for the six months ended January 31, 2010 and 2009,respectively.

 

General and administrative expenses increased by $235,000, or 2.6%, to$9,272,000 for the three months ended January 31, 2010, from $9,037,000for the three months ended January 31, 2009, primarily due to (i) highercompensation expense of approximately $205,000 relating to additional personnelprimarily in our Water Purification and Filtration segment and incentivecompensation and (ii) an increase of $197,000 in stock-based compensationexpense, partially offset by a decrease of approximately $175,000 in outsideprofessional fees.

 

General and administrative expenses increased by $516,000, or 2.9%, to$18,577,000 for the six months ended January 31, 2010, from $18,061,000for the six months ended January 31, 2009, primarily due to (i) anincrease of $452,000 in stock-based compensation expense, (ii) highercompensation expense of approximately $380,000 relating to incentivecompensation and (iii) an increase of approximately $210,000 relating toforeign currency primarily as a result of the inclusion of foreign exchangegains during the prior year period associated with translating certain foreigndenominated assets into functional currencies. These increases were partially

 

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offsetby a decrease in overhead and restructuring costs at our Netherlands operationdue to the completion of restructuring activities, as more fully describedelsewhere in this MD&A, and approximately $172,000 in lower bad debtexpense primarily in our Water Purification and Filtration segment.

 

General and administrative expenses as a percentage of net sales were13.9% and 14.5% for the three months ended January 31, 2010 and 2009,respectively, and 13.5% and 14.2% for the six months ended January 31,2010 and 2009, respectively.

 

Research and development expenses (which include continuing engineeringcosts) increased by $174,000 to $1,157,000 for the three months ended January 31,2010, from $983,000 for the three months ended January 31, 2009.  For the six months ended January 31,2010, research and development expenses increased by $374,000 to $2,422,000,from $2,048,000 for the six months ended January 31, 2009. These increasesare primarily due to increased development work on certain new products as wellas continuing engineering on existing products primarily in our WaterPurification and Filtration, Endoscope Reprocessing and Therapeutic Filtrationsegments.

 

***Interest***

 

Interestexpense decreased by $335,000 to $339,000 for the three months ended January 31,2010, from $674,000 for the three months ended January 31, 2009.  For the six months ended January 31,2010, interest expense decreased by $699,000 to $726,000, from $1,425,000 forthe six months ended January 31, 2009, primarily due to decreases inaverage outstanding borrowings and average interest rates.

 

Interestincome decreased by $30,000 to $8,000 for the three months ended January 31,2010, from $38,000 for the three months ended January 31, 2009.  For the six months ended January 31,2010, interest income decreased by $92,000 to $16,000, from $108,000 for thesix months ended January 31, 2009, primarily due to a decrease in averageinterest rates and a more conservative investment philosophy.

 

***Income taxes***

 

Theconsolidated effective tax rate was 37.4% and 38.0% for the six months ended January 31,2010 and 2009, respectively. The decrease in the consolidated effective taxrate was principally due to the geographic mix of pre-tax income, as describedbelow, as well as additional United States taxes in the prior year periodrelated to the repatriation of earnings from our Netherlands subsidiary.

 

Themajority of our income before income taxes was generated from our United Statesoperations, which had an overall effective tax rate of 37.9% and 38.5% for thesix months ended January 31, 2010 and 2009, respectively.

 

Dueto the uncertainty of our Netherlands subsidiary utilizing tax benefits in thefuture, a tax benefit was not recorded on the losses from operations at ourNetherlands subsidiary for the six months ended January 31, 2009, therebyadversely affecting our overall consolidated effective tax rate in the prioryear period. For the six months ended January 31, 2010, our Netherlandsoperation became slightly profitable as a result of the prior yearrestructuring of its operations, as more fully described elsewhere in thisMD&A and Note 15 to the Condensed Consolidated Financial Statements.

 

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Approximately2% of our income before income taxes was generated from our operations inSingapore, a country with a low corporate tax structure. The overall effectivetax rate for our Singapore operation was 11.4% for the six months ended January 31,2010. For the prior year period, our Singapore operation was slightlyprofitable and did not have a significant impact on our overall effective taxrate.

 

Partiallyoffsetting the favorable impact of our United States, Netherlands and Singaporeoperations on our overall effective tax rate for the six months ended January 31,2010, compared with our overall effective tax rate for the six months ended January 31,2009, was our Canadian operations, which had an overall effective tax rate of27.6% and 10.5% for the six months ended January 31, 2010 and 2009,respectively. The low overall effective tax rate in the prior year period wasattributable to the impact of a lower overall effective tax rate in ourSpecialty Packaging segment as applied to existing deferred income taxliabilities. Approximately 3% and 5% of our income before income taxes wasgenerated from our Canadian operations for the six months ended January 31,2010 and 2009, respectively.

 

Theresults of operations for our subsidiary in Japan did not have a significantimpact on our overall effective tax rate for the six months ended January 31,2010 and 2009 due to the size of income before income taxes generated from thisoperation.

 

Werecord liabilities for an unrecognized tax benefit when a tax benefit for anuncertain tax position is taken or expected to be taken on a tax return, but isnot recognized in our Condensed Consolidated Financial Statements because itdoes not meet the more-likely-than-not recognition threshold that the uncertaintax position would be sustained upon examination by the applicable taxingauthority. The tax benefits recognized in the financial statements from such aposition are measured based on the largest benefit that has a greater thanfifty percent likelihood of being realized upon settlement with the taxauthorities.The majority ofour unrecognized tax benefits originated from acquisitions. Accordingly, anyadjustments upon resolution of income tax uncertainties that predate or resultfrom acquisitions were recorded as an increase or decrease to goodwill. On August 1,2009, we adopted Accounting Standards Codification (“ASC”) 805, “*Business Combinations*” (“ASC 805”), whichrequires the resolution of income tax uncertainties that predate or result fromacquisitions to be recognized in our results of operations beginning withfiscal 2010. However, if our unrecognized tax benefits are recognized in ourfinancial statements in future periods, there would not be a significant impactto our effective tax rate due to the size of the unrecognized tax benefits inrelation to our income before income taxes. We do not expect such unrecognizedtax benefits to significantly decrease or increase in the next twelve months.

 

Areconciliation of the beginning and ending amounts of gross unrecognized taxbenefits is as follows:

 
| ** **                                                  | ** ** | **Unrecognized** | ** ** |
|-------------------------------------------------------------|------------|------------------|------------|
| ** **                                                  | ** ** | **Tax Benefits** | ** ** |
|                                                        |       |             |       |
| Unrecognized tax benefits on July 31, 2008             |       | $                | 427,000    |   |
| Lapse of statute of limitations                             |       | (47,000          | )          |
| Unrecognized tax benefits on July 31, 2009             |       | 380,000          |       |
| Activity during the six months ended  January 31, 2010 |       | —           |       |
| Unrecognized tax benefits on January 31, 2010          |       | $                | 380,000    |   |

 

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Generally, the Company is no longersubject to federal, state or foreign income tax examinations for fiscal yearsended prior to July 31, 2003.

 

Our policy is to record potentialinterest and penalties related to income tax positions in interest expense andgeneral and administrative expense, respectively, in our Condensed ConsolidatedFinancial Statements. However, such amounts have been relatively insignificantdue to the amount of our unrecognized tax benefits relating to uncertain taxpositions.

 

***Stock-Based Compensation***

 

Thefollowing table shows the income statement components of stock-basedcompensation expense recognized in the Condensed Consolidated Statements ofIncome:

 
| ** **                                                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                              | ** ** | **January 31,**   | ** ** | **January 31,** | ** ** |
| ** **                                                              | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Cost of sales                                                           |       | $                      | 41,000     |                 | $          | 18,000 |   | $ | 59,000 |   | $ | 36,000 |   |
| Operating expenses:                                                     |       |                   |       |                 |       |   |   |   |   |
| Selling                                                                 |       | 110,000                |       | 53,000               |       | 179,000 |   | 106,000 |   |
| General and administrative                                              |       | 650,000                |       | 453,000              |       | 1,348,000 |   | 896,000 |   |
| Research and development                                                |       | 10,000                 |       | 1,000                |       | 14,000 |   | 7,000 |   |
| Total operating expenses                                                |       | 770,000                |       | 507,000              |       | 1,541,000 |   | 1,009,000 |   |
| Stock-based compensation before income taxes                            |       | 811,000                |       | 525,000              |       | 1,600,000 |   | 1,045,000 |   |
| Income tax benefits                                                     |       | (293,000               | )          | (199,000             | )          | (583,000 | ) | (446,000 | ) |
| Total stock-based compensation expense, net of tax                      |       | $                      | 518,000    |                 | $          | 326,000 |   | $ | 1,017,000 |   | $ | 599,000 |   |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Decrease in earnings per common share due to  stock-based compensation: |       |                   |       |                 |       |   |   |   |   |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                   |       | $                      | 0.03       |                 | $          | 0.02 |   | $ | 0.06 |   | $ | 0.04 |   |
|                                                                    |       |                   |       |                 |       |   |   |   |   |
| Diluted                                                                 |       | $                      | 0.03       |                 | $          | 0.02 |   | $ | 0.06 |   | $ | 0.04 |   |

 

Forthe three and six months ended January 31, 2010 and 2009, the abovestock-based compensation expense before income taxes was recorded in theCondensed Consolidated Financial Statements as stock-based compensation expenseand an increase to additional paid-in capital. The related income tax benefits(which pertain only to stock awards and options that do not qualify asincentive stock options) were recorded as an increase to long-term deferredincome tax assets (which are netted with long-term deferred income taxliabilities) and a reduction to income tax expense.

 

Thestock-based compensation expense recorded in the Condensed ConsolidatedFinancial Statements may not be representative of the effect of stock-based compensationexpense in future periods due to the level of awards issued in past years(which level may not be similar in the future), modifications of existingawards and assumptions used in determining fair value, expected lives andestimated forfeitures. We determine the fair value of each stock award usingthe closing market price of our Common Stock on the date of grant. We estimatethe fair value of each option grant on the date of grant using theBlack-Scholes option valuation model. The determination of fair value using anoption-pricing model is affected by our stock price as well as assumptionsregarding a number of subjective variables. These variables include, but arenot

 

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limitedto, the expected stock price volatility over the term of the expected optionlife (which is determined by using the historical closing prices of our CommonStock), the expected dividend yield (which historically was 0% and is nowexpected to be 0.5% as we began paying dividends in January 2010), and theexpected option life (which is based on historical exercise behavior). Iffactors change and we employ different assumptions in the application of ASCTopic 718, *“Compensation — Stock Compensation,”* (“ASC718”), in future periods, the compensation expense that we would record maydiffer significantly from what we have recorded in the current period.

 

Mostof 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 differenttimes during the vesting period, as opposed to awards that vest at the end ofthe vesting period. We recognize compensation expense for awards subject tograded vesting using the straight-line basis, reduced by estimated forfeitures.At January 31, 2010, total unrecognized stock-based compensation expensebefore income taxes related to total nonvested stock options and stock awardswas $4,603,000 with a remaining weighted average period of 23 months over whichsuch expense is expected to be recognized.

 

If certain criteria are met when options are exercised or restrictedstock becomes vested, the Company is allowed a deduction on its income taxreturn. Accordingly, we account for the income tax effect on such income taxdeductions as additional paid-in capital or a reduction of deferred income taxassets (which are netted with long-term deferred income tax liabilities) and asa reduction of income taxes payable. For the six months ended January 31,2010 and 2009, such income tax deductions reduced income taxes payable by$268,000 and $379,000, respectively.

 

We classify the cash flows resulting fromexcess tax benefits as financing cash flows on our Condensed ConsolidatedStatements of Cash Flows. Excess tax benefits arise when the ultimate taxeffect of the deduction for tax purposes is greater than the tax benefit onstock compensation expense (including tax benefits on stock compensationexpense that has only been reflected in past pro forma disclosures relating tofiscal years prior to August 1, 2005) which was determined based upon theaward’s fair value.

 

**Liquidity and Capital Resources**

 

***Working capital***

 

At January 31, 2010, the Company’s working capital was$36,946,000, compared with $49,797,000 at July 31, 2009. This decrease inworking capital was primarily due to reclassifying the entire outstandingbalance of our revolving credit facility from long-term to current as a resultof the revolving credit facility’s expiration occurring in less than one yearon August 1, 2010.

 

***Cash flows from operating activities***

 

Net cash provided by operating activities was $10,315,000 and$13,208,000 for the six months ended January 31, 2010 and 2009,respectively. For the six months ended January 31, 2010, the net cashprovided by operating activities was primarily due to net income (afteradjusting for depreciation, amortization, stock-based compensation expense anddeferred taxes), partially offset by increases in inventories (due to plannedstrategic increases in stock levels of certain products primarily in ourHealthcare Disposables and Endoscope Reprocessing segments) and accountsreceivable (due to strong sales primarily in our Water Purification andFiltration and Endoscope

 

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Reprocessingsegments) and a decrease in accounts payable, deferred revenue and accruedexpenses (due primarily to the timing associated with incentive compensationpayments).

 

For the six months ended January 31, 2009, the net cash providedby operating activities was primarily due to net income (after adjusting fordepreciation, amortization, stock-based compensation expense and deferredincome taxes), a decrease in accounts receivable (due to improved collections)and an increase in income taxes payable (due to the timing associated with taxpayments). These items were partially offset by increases in inventories (dueto planned increases in stock levels of certain products primarily in ourHealthcare Disposables segment) and prepaid expenses (due to the prepayment ofcertain operating expenses).

 

***Cash flows from investing activities***

 

Net cash used in investing activities was $3,702,000 and $6,306,000 forthe six months ended January 31, 2010 and 2009, respectively. For the sixmonths ended January 31, 2010, the net cash used in investing activitieswas primarily for capital expenditures and the purchase of a convertible note.For the six months ended January 31, 2009, the net cash used in investingactivities was primarily for acquisition earnout payments to the former ownersof Crosstex and Twist 2 It Inc. and capital expenditures.

 

***Cash flows from financing activities***

 

Net cash used in financing activities was $11,867,000 and $3,333,000for the six months ended January 31, 2010 and 2009, respectively. For thesix months ended January 31, 2010, the net cash used in financingactivities was primarily attributable to repayments under our credit facilitiesand the payment of a dividend to our shareholders, partially offset by proceedsfrom the exercises of stock options. For the six months ended January 31,2009, the net cash used in financing activities was primarily attributable torepayments under our credit facilities and purchases of treasury stock,partially offset by a borrowing under our revolving credit facility andproceeds from the exercises of stock options.

 

***Dividends***

 

In December 2009, we announced that we intend to pay, for thefirst time, a semiannual cash dividend of $0.05 per outstanding share, or $0.10per share annually, of the Company’s Common Stock. The first cash dividend of$0.05 per share of outstanding Common Stock, which totaled $840,000, was paidon January 29, 2010 to shareholders of record at the close of business on January 15,2010. Future declaration of semiannual dividends and the establishment offuture record and payment dates are subject to the final determination of theCompany’s Board of Directors.

 

***Restructuring activities***

 

During the fourth quarter of fiscal 2008, our management approved andinitiated plans to restructure our Netherlands subsidiary by relocating all ofour manufacturing operations from the Netherlands to the United States. Thisaction is part of our continuing effort to reduce operating costs and improveefficiencies by leveraging the existing infrastructure of our Minntechoperations in Minnesota. The elimination of manufacturing operations in theNetherlands has led to the end of onsite material management, qualityassurance, finance and accounting, human resources and some customer servicefunctions. However, we continue to maintain a strong

 

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marketing,sales, service and technical support presence based in the Netherlands to servecustomers throughout Europe, the Middle East and Africa.

 

For the three months ended January 31, 2009, we recorded $74,000in restructuring costs, of which $37,000 was recorded in each of cost of salesand general and administrative expenses. For the six months ended January 31,2009, we recorded $345,000 in restructuring costs, of which $176,000 wasrecorded in cost of sales and $169,000 was recorded in general andadministrative expenses. The total cost of the restructuring plan was $710,000and was recorded beginning in our fourth quarter of fiscal 2008 until therestructuring plan completion date of July 31, 2009. We do not expect toincur any additional restructuring costs. The majority of the restructuringcosts were included in our Endoscope Reprocessing segment.  Since the above costs were recorded in ourNetherlands subsidiary, which had been experiencing losses from its operations,tax benefits on the above costs were not recorded.

 

As part of the restructuring plan, we sold our Netherlands building andland on May 19, 2009 and entered into a lease for 2.5 years with the newowner so we can continue to use the facility as our European sales and serviceheadquarters as well as for warehouse and distribution activity. The sale ofthe building and land resulted in a gain of $146,000, which is being amortizedover the life of the lease and is recorded in deferred revenue and otherlong-term liabilities. The rent for the full 2.5 year lease of $325,000 waspaid from the sale proceeds and recorded in prepaid expenses and other assets.

 

***Long-term contractual obligations***

 

Asof January 31, 2010, aggregate annual required payments over the remainingfiscal year, the next four years and thereafter under our contractualobligations that have long-term components were as follows:

 
| ** **                                                  | ** ** | **Six Months  Ending  July 31,** | ** ** | **Year Ending July 31,** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------|------------|------------|------------|
| ** **                                                  | ** ** | **2010**                              | ** ** | **2011**                      | ** ** | **2012**   | ** ** | **2013** | ** ** | **2014** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| ** **                                                  | ** ** | **(Amounts in thousands)**            | ** ** |
| Maturities of the credit facilities                         |       | $                                     | 5,000      |                          | $          | 25,500     |       | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 30,500 |   |
| Expected interest payments under the credit  facilities (1) |       | 344                                   |       | 120                           |       | —     |       | — |   | — |   | — |   | 464 |   |
| Minimum commitments under noncancelable operating  leases   |       | 1,591                                 |       | 2,480                         |       | 1,583      |       | 1,071 |   | 895 |   | 3,086 |   | 10,706 |   |
| Minimum commitments under noncancelable capital  leases     |       | 26                                    |       | 14                            |       | —     |       | — |   | — |   | — |   | 40 |   |
| Deferred compensation and other                             |       | 203                                   |       | 408                           |       | 253        |       | 32 |   | 33 |   | 166 |   | 1,095 |   |
| Employment agreements                                       |       | 1,613                                 |       | 1,541                         |       | 131        |       | — |   | — |   | — |   | 3,285 |   |
| Total contractual obligations                               |       | $                                     | 8,777      |                          | $          | 30,063     |       | $ | 1,967 |   | $ | 1,103 |   | $ | 928 |   | $ | 3,252 |   | $ | 46,090 |   |

 

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(1) The expected interest payments under the term and revolvingcredit facilities reflect interest rates of 2.19% and 2.62%, respectively,which were our weighted average interest rates on outstanding borrowings at January 31,2010.

 

***Credit facilities***

 

In conjunction with theacquisition of Crosstex, we entered into amended and restated credit facilitiesdated as of August 1, 2005 (the “U.S. Credit Facilities”) with aconsortium of

 

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lenders to fund the cash consideration paid in the acquisition andcosts associated with the acquisition, as well as to modify our existing UnitedStates credit facilities. The U.S. Credit Facilities, as amended, include (i) asix-year $40.0 million senior secured amortizing term loan facility and (ii) afive-year $50.0 million senior secured revolving credit facility. Amounts werepay under the term loan facility may not be re-borrowed. Debt issuance costsrelating to the U.S. Credit Facilities were recorded in other assets and arebeing amortized over the life of the credit facilities. Such unamortized debtissuance costs amounted to approximately $426,000 at January 31, 2010.

 

At February 28, 2010, borrowings under the U.S. Credit Facilitiesbear interest at rates ranging from 0% to 0.50% above the lender’s base rate,or at rates ranging from 0.625% to 1.75% above the London Interbank OfferedRate (“LIBOR”), depending upon our consolidated ratio of debt to earningsbefore interest, taxes, depreciation and amortization, and as further adjustedunder the terms of the U.S. Credit Facilities (“EBITDA”). At February 28,2010, the lender’s base rate was 3.25% and the LIBOR rates ranged from 0.23% to1.97%. The margins applicable to our outstanding borrowings at February 28,2010 were 0.00% above the lender’s base rate and 0.625% above LIBOR. All of ouroutstanding borrowings were under LIBOR contracts at February 28, 2010.The majority of such contracts were twelve month LIBOR contracts; therefore, weare substantially protected for the remainder of fiscal 2010 from any exposureassociated with increasing LIBOR rates. The U.S. Credit Facilities also providefor fees on the unused portion of our facilities at rates ranging from 0.15% to0.30%, depending upon our consolidated ratio of debt to EBITDA; such rate was0.15% at February 28, 2010.

 

The U.S. Credit Facilities require us to meet certain financialcovenants and are secured by (i) substantially all of our U.S.-basedassets (including assets of Cantel, Minntech, Mar Cor, Crosstex and StrongDental Products, Inc.) and (ii) our pledge of all of the outstandingshares of Minntech, Mar Cor, Crosstex and Strong Dental Products, Inc. and65% of the outstanding shares of our foreign-based subsidiaries. Additionally,we are not permitted to pay cash dividends on our Common Stock without theconsent of our United States lenders. Such consent was obtained with respect toannual cash dividends of up to $1,800,000, commencing with the dividend paid onJanuary 29, 2010. As of January 31, 2010, we were in compliance withall financial and other covenants under the U.S. Credit Facilities.

 

Onboth January 31, 2010 and February 28, 2010, we had $30,500,000 ofoutstanding borrowings under the U.S. Credit Facilities, which consisted of$15,000,000 and $15,500,000 under the term loan facility and the revolvingcredit facility, respectively.

 

The revolving portion of our credit facilities has a termination dateof August 1, 2010. Although we may repay a portion of our outstandingborrowings under the revolver throughout fiscal 2010, we do not presentlyanticipate paying off the revolver in full by its termination date. We arein discussions with our bank syndicate regarding modifications to suchfacility, including an extension of the termination date, and expect toformally modify the facility before the expiration date. However, since anymodification will not be completed until later in fiscal 2010, subsequent to July 31,2009 the entire outstanding balance of the revolver was reclassified fromlong-term to current.

 

***Operating leases***

 

Minimumcommitments under operating leases include minimum rental commitments for ourleased manufacturing facilities, warehouses, office space and equipment.

 

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***Deferred compensation***

 

Includedin other long-term liabilities are deferred compensation arrangements forcertain former Minntech directors and officers.

 

***Employment agreements***

 

Wehave previously entered into various employment agreements with executives ofthe Company, including our Corporate executive officers and our subsidiaryChief Executive Officers. The majority of such contracts expired and werereplaced effective January 1, 2010 with severance contracts that definedcertain compensation arrangements relating to various employment terminationscenarios.

 

***Convertible Note Receivable***

 

InFebruary 2009, we invested an initial $200,000 in a senior subordinatedconvertible promissory note issued by BIOSAFE, Inc. (“BIOSAFE”), inconnection with BIOSAFE’s grant to us of certain exclusive and non-exclusivelicense rights to BIOSAFE’s antimicrobial additive. BIOSAFE is the owner of apatented and proprietary antimicrobial agent that is built into themanufacturing of end-products to achieve long-lasting microbial protection onsuch end-products’ surface. As a result of BIOSAFE’s successful raising of aminimum incremental amount of cash following our investment, we invested anadditional $300,000 in notes of BIOSAFE during the three months ending January 31,2010 bringing the aggregate investment in BIOSAFE notes to $500,000, asobligated under our agreement with BIOSAFE. We are not obligated to invest anyadditional funds.

 

Thenotes are convertible into a newly-created series of preferred stock ofBIOSAFE. Interest is payable in shares of BIOSAFE stock or in cash. The notesaccrue interest at a per annum rate of 8% until the maturity date of June 30,2011 or earlier exercise. If not paid by the maturity date, interest willaccrue thereafter at a rate of 12% per annum. In connection with ourinvestment, we entered into a license agreement with BIOSAFE under which wewill pay BIOSAFE a fixed royalty percentage of sales of our products containingBIOSAFE’s antimicrobial formulation. This investment, together with the accruedinterest of $16,000, is included within other assets in our CondensedConsolidated Balance Sheets. The carrying value of this investment approximatesfair value due to the short maturity of the notes and the relatively consistentunderlying value of BIOSAFE.

 

***Financing needs***

 

At January 31, 2010, we had a cash balance of $18,131,000, ofwhich $8,431,000 was held by foreign subsidiaries. We believe that our currentcash position, anticipated cash flows from operations and the funds availableunder our revolving credit facility will be sufficient to satisfy our cashoperating requirements for the foreseeable future based upon our existingoperations, particularly given that we historically have not needed to borrowfor working capital purposes. At February 28, 2010, $34,500,000 wasavailable under our United States revolving credit facility, which expires on August 1,2010.

 

Notwithstanding our cash position and revolving credit borrowingavailability, under the terms of our credit facilities we are limited to theamount of aggregate purchase price we pay for

 

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acquisitionsduring the duration of the credit agreement without obtaining prior bankapproval. As of February 28, 2010, the remaining purchase price availablefor future acquisitions without obtaining prior bank approval is approximately$2,500,000.

 

***Foreign currency***

 

During the three and six months ended January 31, 2010, comparedwith the three and six months ended January 31, 2009, the average value ofthe Canadian dollar increased by approximately 15.5% and 7.1%, respectively,relative to the value of the United States dollar. Additionally, at January 31,2010 compared with July 31, 2009, the value of the Canadian dollarrelative to the value of the United States dollar increased by approximately0.3%. The financial statements of our Canadian subsidiaries are translatedusing the accounting policies described in Note 2 to the 2009 Form 10-Kand therefore are impacted by changes in the Canadian dollar exchange rate.Additionally, changes in the value of the Canadian dollar against the UnitedStates dollar affect our results of operations because a portion of ourCanadian subsidiaries’ inventories and operating costs (which are reported inthe Water Purification and Filtration and Specialty Packaging segments) arepurchased in the United States and a significant amount of their sales are tocustomers in the United States.

 

For the three and six months ended January 31, 2010, compared withthe three and six months ended January 31, 2009, the average value of theeuro increased by approximately 11.1% and 6.5%, respectively, relative to thevalue of the United States dollar. Additionally, at January 31, 2010compared with July 31, 2009, the value of the euro relative to the UnitedStates dollar decreased by approximately 1.9%. The financial statements of our Netherlandssubsidiary are translated using the accounting policies described in Note 2 tothe 2009 Form 10-K and therefore are impacted by changes in the euroexchange rate relative to the United States dollar. Additionally, changes inthe value of the euro against the United States dollar affect our results ofoperations because a portion of the net assets of our Netherlands subsidiary(which are reported in our Dialysis and Endoscope Reprocessing segments) aredenominated and ultimately settled in United States dollars but must beconverted into its functional euro currency. Furthermore, as part of therestructuring of our Netherlands subsidiary, as described in Note 15 to theCondensed Consolidated Financials and elsewhere in this MD&A, a portion ofthe net assets of our United States subsidiaries, Minntech and Mar Cor, are nowdenominated and ultimately settled in euros or British pounds but must beconverted into our functional United States currency.

 

In order to hedge against the impact of fluctuations in the value of (i) theCanadian dollar relative to the United States dollar, (ii) the eurorelative to the United States dollar and (iii) the British pound relativeto the United States dollar on the conversion of such net assets into thefunctional currencies, we enter into short-term contracts to purchase Canadiandollars, euros and British pounds forward, which contracts are generally onemonth in duration. These short-term contracts are designated as fair valuehedges. There were three foreign currency forward contracts with an aggregatevalue of $3,922,000 at February 28, 2010, which cover certain assets andliabilities that were denominated in currencies other than our subsidiaries’functional currencies. Such contracts expire on March 31, 2010. Theseforeign currency forward contracts are continually replaced with new one-monthcontracts as long as we have significant net assets at our subsidiaries thatare denominated and ultimately settled in currencies other than theirfunctional currencies. Under our credit facilities, such contracts to purchaseCanadian dollars, euros and British pounds may not exceed $12,000,000 in anaggregate notional amount at any time. In accordance with ASC 815, *“Derivatives and Hedging”* (“ASC 815”), such foreign currencyforward contracts are designated as hedges. Gains and losses related to thesehedging

 

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contractsto buy Canadian dollars, euros and British pounds forward are immediatelyrealized within general and administrative expenses due to the short-termnature of such contracts. For the three and six months ended January 31,2010, such forward contracts partially offset the impact on operations relatedto certain assets and liabilities that are denominated in currencies other thanour subsidiaries’ functional currencies.

 

Changes in the value of the Japanese yen relative to the United Statesdollar during the three and six months ended January 31, 2010, comparedwith the three and six months ended January 31, 2009, did not have asignificant impact upon either our results of operations or the translation ofour balance sheet, primarily due to the fact that our Japanese subsidiaryaccounts for a relatively small portion of consolidated net sales, net incomeand net assets.

 

Overall, fluctuations in the rates of currency exchange had an adverseimpact for the three and six months ended January 31, 2010, compared withthe three and six months ended January 31, 2009, upon our net income ofapproximately $90,000 and $200,000 primarily due to the decrease in the valueof the Canadian dollar relative to the United States dollar.

 

For purposes of translating the balance sheet at January 31, 2010compared with July 31, 2009, the total of the foreign currency movementsresulted in a foreign currency translation gain of $50,000 for the six monthsended January 31, 2010, thereby increasing stockholders’ equity.

 

# **Critical AccountingPolicies**

 

Our discussion and analysis of our financial condition and results ofoperations are based upon our Condensed Consolidated Financial Statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. On an ongoing basis, we continually evaluateour estimates. We base our estimates on historical experience and on variousother assumptions that are believed to be reasonable under the circumstances,the results of which form the basis for making judgments about the carryingvalues of assets and liabilities that are not readily apparent from othersources. Actual results may differ from these estimates.

 

We believe the following critical accounting policies affect our moresignificant judgments and estimates used in the preparation of our CondensedConsolidated Financial Statements.

 

# ***Revenue Recognition***

 

Revenue on product sales is recognized as products are shipped tocustomers and title passes. The passing of title is determined based upon theFOB terms specified for each shipment. With respect to dialysis, therapeutic,specialty packaging and endoscope reprocessing products, shipment terms aregenerally FOB origin for common carrier and FOB destination when ourdistribution fleet is utilized (except for one large customer in dialysiswhereby all products are shipped FOB destination). With respect to waterpurification and filtration and healthcare disposable products, shipment termsmay be either FOB origin or destination. Customer acceptance for the majorityof our product sales occurs at the time of delivery. In certain instances,primarily with respect to some of our water purification and filtrationequipment, endoscope reprocessing equipment and an insignificant amount of oursales of dialysis

 

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equipment,post-delivery obligations such as installation, in-servicing or training arecontractually specified; in such instances, revenue recognition is deferreduntil all of such conditions have been substantially fulfilled such that theproducts are deemed functional by the end-user. With respect to a portion ofwater purification and filtration product sales, equipment is sold as part of asystem for which the equipment is functionally interdependent or the customer’spurchase order specifies “ship-complete” as a condition of delivery; revenuerecognition on such sales is deferred until all equipment has been delivered.

 

A portion of our water purification and filtration and endoscopereprocessing sales are recognized as multiple element arrangements, wherebyrevenue is allocated to the equipment, installation and service componentsbased upon vendor specific objective evidence, which principally includescomparable historical transactions of similar equipment and installation soldas stand alone components, as well as an evaluation of unrelated third partycompetitor pricing of similar installation.

 

Revenueon service sales is recognized when repairs are completed at the customer’slocation or when repairs are completed at our facilities and the products areshipped to customers. With respect to certain service contracts in ourEndoscope Reprocessing and Water Purification and Filtration operatingsegments, service revenue is recognized on a straight-line basis over thecontractual term of the arrangement. All shipping and handling fees invoiced tocustomers, such as freight, are recorded as revenue (and related costs areincluded within cost of sales) at the time the sale is recognized.

 

Noneof our sales contains right-of-return provisions. Customer claims for credit orreturn due to damage, defect, shortage or other reason must be pre-approved byus before credit is issued or such product is accepted for return. No cashdiscounts for early payment are offered except with respect to a small portionof our sales of dialysis, healthcare disposable and water purification andfiltration products and certain prepaid packaging products. We do not offerprice protection, although advance pricing contracts or required notice periodsprior to implementation of price increases exist for certain customers withrespect 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 areduction of sales at the time of revenue recognition and amounted to $793,000and $1,557,000 for the three and six months ended January 31, 2010,respectively, and $441,000 and $1,166,000 for the three and six months ended January 31,2009, respectively. The increase in volume rebates for the three and six monthsended January 31, 2010, compared with the three and six months ended January 31,2009, is primarily due to increased sales volume primarily in our HealthcareDisposables and Endoscope Reprocessing segments. Such allowances are determinedbased on estimated projections of sales volume for the entire rebate agreementperiods. If it becomes known that sales volume to customers will deviate fromoriginal projections, the volume rebate provisions originally established wouldbe adjusted accordingly.

 

Themajority of our dialysis products are sold to end-users; the majority oftherapeutic filtration products and healthcare disposable products are sold tothird party distributors; water purification and filtration products andservices are sold directly and through third-party distributors to hospitals,dialysis clinics, pharmaceutical and biotechnology companies and otherend-users; our endoscope reprocessing products and services are sold primarilyto distributors internationally and directly to hospitals and other end-usersin the United States; and specialty packaging products are sold to third-partydistributors, medical research companies, laboratories, pharmaceuticalcompanies, hospitals, government agencies and other end-users. Sales to all of

 

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thesecustomers follow our revenue recognition policies.

 

***Accounts Receivable and Allowance for DoubtfulAccounts***

 

Accounts receivable consist of amounts due to us from normal businessactivities. Allowances for doubtful accounts are reserves for the estimatedloss from the inability of customers to make required payments. We usehistorical experience as well as current market information in determining theestimate. While actual losses have historically been within management’sexpectations and provisions established, if the financial condition of ourcustomers were to deteriorate, resulting in an impairment of their ability tomake payments, additional allowances may be required. Alternatively, if certaincustomers paid their delinquent receivables, reductions in allowances may berequired.

 

# ***Inventories***

# ** **

Inventories consist of raw materials and finished products which aresold 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 mustmake estimates and judgments regarding reserves required for product obsolescence,aging of inventories and other issues potentially affecting the saleablecondition of products. In performing such evaluations, we use historicalexperience as well as current market information. With few exceptions, thesaleable value of our inventories has historically been within management’sexpectation and provisions established, however, rapid changes in the marketdue to competition, technology and various other factors could have an adverseeffect on the saleable value of our inventories, resulting in the need foradditional reserves.

 

***Goodwill and Intangible Assets***

 

Certain of our identifiable intangible assets, including customerrelationships, technology, brand names, non-compete agreements and patents, areamortized using the straight-line method over their estimated useful liveswhich range from 3 to 20 years. Additionally, we have recorded goodwill andtrademarks and trade names, all of which have indefinite useful lives and aretherefore not amortized. All of our intangible assets and goodwill are reviewedfor impairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable, and goodwill and intangibleassets with indefinite lives are reviewed for impairment at least annually*.*Our management is primarily responsiblefor determining if impairment exists and considers a number of factors,including third-party valuations, when making these determinations. Inperforming a review for goodwill impairment, management uses a two-step processthat begins with an estimation of the fair value of the related operatingsegments by using the average fair value results of the market multiple anddiscounted cash flow methodologies. The first step is a review for potentialimpairment, and the second step measures the amount of impairment, if any. Inperforming our annual review for indefinite lived intangibles, managementcompares the current fair value of such assets to their carrying values. Withrespect to amortizable intangible assets when impairment indicators arepresent, management would determine whether expected future non-discounted cashflows 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 31,2009, management concluded that none of our intangible assets or goodwill wasimpaired. On January 31, 2010, management concluded that no events orchanges in circumstances have occurred during the six months ended January 31,2010 that would indicate that the carrying amount of our intangible assets andgoodwill may not be

 

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recoverable.

 

While the results of these annual reviews have historically notindicated impairment, impairment reviews are highly dependent on management’sprojections of our future operating results and cash flows (which managementbelieves to be reasonable), discount rates based on the Company’sweighted-average cost of capital and appropriate benchmark peer companies.Assumptions used in determining future operating results and cash flows includecurrent and expected market conditions and future sales forecasts. Subsequentchanges in these assumptions and estimates could result in future impairment.Although we consistently use the same methods in developing the assumptions andestimates underlying the fair value calculations, such estimates are uncertainby nature and can vary from actual results. At July 31, 2009, ourreporting units that were potentially at risk for impairment were HealthcareDisposables and Specialty Packaging, which had average fair values thatexceeded book value by approximately 6% and 11%, respectively. With respect toHealthcare Disposables, such average fair value was determined using futureoperating and cash flow assumptions that management believes to beconservative, especially in light of more recent market conditions such as the outbreak of the novel H1N1 flu (swine flu),which has had a positive impact on operating results of this segment.For all of our remaining reporting units, average fair value exceeded bookvalue by substantial amounts.

 

***Long-Lived Assets***

 

Weevaluate the carrying value of long-lived assets including property, equipmentand other assets whenever events or changes in circumstances indicate that thecarrying value may not be recoverable. An assessment is made to determine ifthe sum of the expected future non-discounted cash flows from the use of theassets and eventual disposition is less than the carrying value. If the sum ofthe expected non-discounted cash flows is less than the carrying value, animpairment loss is recognized based on fair value. With few exceptions, ourhistorical assessments of our long-lived assets have not differed significantlyfrom the actual amounts realized. However, the determination of fair valuerequires us to make certain assumptions and estimates and is highly subjective,and accordingly, actual amounts realized may differ significantly from ourestimates.

 

# ***WarrantyReserve***

 

We provide for estimated costs that may be incurred to remedydeficiencies of quality or performance of our products at the time of revenuerecognition. Most of our products have a one year warranty, although a majorityof our endoscope reprocessing equipment in the United States carries a warrantyperiod of up to fifteen months. We record provisions for product warranties asa component of cost of sales based upon an estimate of the amounts necessary tosettle existing and future claims on products sold. The historical relationshipof warranty costs to products sold is the primary basis for the estimate. Asignificant increase in third party service repair rates, the cost andavailability of parts or the frequency of claims could have a material adverseimpact on our results for the period or periods in which such claims oradditional costs materialize. Management reviews its warranty exposureperiodically and believes that the warranty reserves are adequate; however,actual claims incurred could differ from original estimates, requiringadjustments to the reserves.

 

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***Stock-Based Compensation***

 

Forfiscal 2005 and earlier periods, we accounted for stock options using theintrinsic value method under which stock compensation expense was notrecognized because we granted stock options with exercise prices equal to themarket value of the shares at the date of grant. Beginning August 1, 2005,we accounted for stock options under ASC 718 using the modified prospectivemethod for the transition. Under the modified prospective method, stockcompensation expense is recognized for any option grant or stock award grantedon or after August 1, 2005, as well as the unvested portion of stockoptions granted prior to August 1, 2005, based upon the award’s fairvalue.

 

Most of our stock option and stock awards (which consist only ofrestricted stock) are subject to graded vesting in which portions of the awardvest at different times during the vesting period, as opposed to awards thatvest at the end of the vesting period. We recognize compensation expense forawards subject to graded vesting using the straight-line basis, reduced byestimated forfeitures. Forfeitures are estimated at the time of grant andrevised, if necessary, in subsequent periods if actual forfeitures differ fromthose estimates. Forfeitures are estimated based on historical experience.

 

Thestock-based compensation expense recorded in our Condensed ConsolidatedFinancial Statements may not be representative of the effect of stock-basedcompensation expense in future periods due to the level of awards issued inpast years (which level may not be similar in the future), modifications toexisting awards and assumptions used in determining fair value, expected livesand estimated forfeitures. We determine the fair value of each stock awardusing the closing market price of our Common Stock on the date of grant. Weestimate the fair value of each option grant on the date of grant using theBlack-Scholes option valuation model. The determination of fair value using anoption-pricing model is affected by our stock price as well as assumptionsregarding a number of subjective variables. These variables include, but arenot limited to, the expected stock price volatility over the term of theexpected option life (which is determined by using the historical closingprices of our Common Stock), the expected dividend yield (which historicallyhas been 0% and is now expected to be 0.5% 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, thecompensation expense that we would record may differ significantly from what wehave recorded in the current period.

 

***Legal Proceedings***

 

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

 

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

 

We recognize deferred tax assets and liabilities based on differencesbetween the financial statement carrying amounts and the tax basis of assetsand liabilities. Deferred tax assets and liabilities also include itemsrecorded in conjunction with the purchase accounting for business acquisitions.We regularly review our deferred tax assets for recoverability and establish

 

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avaluation allowance, if necessary, based on historical taxable income,projected future taxable income, and the expected timing of the reversals ofexisting temporary differences. Although realization is not assured, managementbelieves it is more likely than not that the recorded deferred tax assets, asadjusted for valuation allowances, will be realized. Additionally, deferred taxliabilities are regularly reviewed to confirm that such amounts areappropriately stated. A review of our deferred tax items considers known futurechanges in various effective tax rates, principally in the United States. Ifthe effective tax rate were to change in the future, particularly in the UnitedStates and to a lesser extent Canada, our items of deferred tax could bematerially affected. All of such evaluations require significant managementjudgments.

 

We record liabilities for an unrecognized tax benefit when a taxbenefit for an uncertain tax position is taken or expected to be taken on a taxreturn, but is not recognized in our Condensed Consolidated FinancialStatements because it does not meet the more-likely-than-not recognitionthreshold that the uncertain tax position would be sustained upon examinationby the applicable taxing authority. The majority of such unrecognized taxbenefits originated from acquisitions and are based primarily upon management’sassessment of exposure associated with acquired companies. Accordingly, anyadjustments upon resolution of income tax uncertainties that predate or resultfrom acquisitions were recorded as an increase or decrease to goodwill. On August 1,2009, we adopted ASC 805, which requires the resolution of income taxuncertainties that predate or result from acquisitions to be recognized in ourresults of operations beginning with fiscal 2010. Unrecognized tax benefits areanalyzed periodically and adjustments are made as events occur to warrantadjustment to the related liability.

 

# ***Business Combinations***

 

Acquisitions require significant estimates and judgments related to thefair value of assets acquired and liabilities assumed.

 

Certain liabilities and reserves are subjective in nature. We reflectsuch liabilities and reserves based upon the most recent information available.In conjunction with our acquisitions, such subjective liabilities and reservesprincipally include certain income tax and sales and use tax exposures,including tax liabilities related to our foreign subsidiaries, as well asreserves for accounts receivable, inventories and warranties. The ultimatesettlement of such liabilities may be for amounts which are different from theamounts recorded.

 

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

 

Werecognize costs associated with exit or disposal activities, such as costs toterminate a contract, the exit or disposal of a business, or the earlytermination of a leased property, by recognizing the liability at fair valuewhen incurred, except for certain one-time termination benefits, such asseverance costs, for which the period of recognition begins when a severanceplan is communicated to employees.

 

Inherentin the calculation of liabilities relating to exit and disposal activities aresignificant management judgments and estimates, including estimates oftermination costs, employee attrition and the interest rate used to discountcertain expected net cash payments. Such judgments and estimates are reviewedby us on a regular basis. The cumulative effect of a change to a liabilityresulting from a revision to either timing or the amount of estimated cashflows is recognized by us as an adjustment to the liability in the period ofthe change.

 

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Althoughwe have historically recorded minimal charges associated with exit or disposalactivities, we recorded charges associated with exit or disposal activities infiscals 2009 and 2008 relating to our restructuring plan for our Netherlandsmanufacturing operations, as further described in our MD&A and Note 15 tothe Condensed Consolidated Financial Statements.

 

# ***Other Matters***

 

Wedo not have any off balance sheet financial arrangements, other than futurecommitments under operating leases and employment agreements.

 

**ForwardLooking Statements**

 

Thisquarterly report on Form 10-Q contains “forward-looking statements” asthat term is defined under the Private Securities Litigation Reform Act of 1995and releases issued by the Securities and Exchange Commission (the “SEC”) andwithin the meaning of Section 27Aof the Securities Act of 1933, as amended (the “Securities Act”) and Section 21Eof the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements are based on currentexpectations, estimates, or forecasts about our businesses, the industries inwhich we operate, and the beliefs and assumptions of management; they do notrelate strictly to historical or current facts. We have tried, whereverpossible, to identify such statements by using words such as “expect,” “anticipate,”“goal,” “project,” “intend,” “plan,” “believe,” “seek,”  “may,” “could,” and variations of such wordsand similar expressions. In addition, any statements that refer to predictionsor projections of our future financial performance, anticipated growth andtrends in our businesses, and other characterizations of future events orcircumstances are forward-looking statements. Readers are cautioned that theseforward-looking statements are only predictions about future events, activitiesor developments and are subject to numerous risks, uncertainties, andassumptions that are difficult to predict including, among other things, thefollowing:

 

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

 

·                  further industry consolidation resulting in greater buying power bysome of our customers

 

·                  our dependenceon a concentrated number of customers in three of our largest segments

 

·                  novel H1N1 flu severity and level of urgency developed by customerswith respect to pandemic preparedness

 

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

 

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

 

·                  the adverseimpact of increased competition on selling prices and our ability to competeeffectively

 

·                  foreign currency exchange rate fluctuations and trade barriers

 

·                  the impact of significant government regulation on our businesses

 

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Youshould understand that it is not possible to predict or identify all suchfactors. Consequently, you should not consider the foregoing items to be a completelist of all potential risks or uncertainties. See “Risk Factors” in our 2009 Form 10-Kfor a discussion of the above risk factors and certain additional risk factorsthat you should consider before investing in the shares of our Common Stock.

 

Allforward-looking statements herein speak only as of the date of this Report. Weexpressly disclaim any obligation or undertaking to release publicly anyupdates or revisions to any forward-looking statements contained herein toreflect any change in our expectations with regard thereto or any change inevents, conditions or circumstances on which any such statement is based.

 

Forthese statements, we claim the protection of the safe harbor forforward-looking statements contained in Section 27A of the Securities Actand Section 21E of the Exchange Act.

 

**ITEM 3.          QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

**Foreign Currency and Market Risk**

 

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

 

A portion of our Canadian subsidiaries’ inventories and operating costs(which are reported in the Water Purification and Filtration and SpecialtyPackaging segments) are purchased in the United States and a significant amountof their sales are to customers in the United States. The businesses of ourCanadian subsidiaries could be materially and adversely affected by theimposition of trade barriers, fluctuations in the rate of currency exchange,tariff increases and import and export restrictions between the United Statesand Canada. Changes in the value of the Canadian dollar against the UnitedStates dollar also affect our results of operations because certain net assetsof our Canadian subsidiaries are denominated and ultimately settled in UnitedStates dollars but must be converted into their functional currency.Additionally, the financial statements of our Canadian subsidiaries are translatedusing the accounting policies described in Note 2 to the 2009 Form 10-K.Fluctuations in the rates of currency exchange between the United States andCanada had an overall adverse impact for the three and six months ended January 31,2010, compared with the three and six months ended January 31, 2009, uponour net income and did not have a material impact upon stockholders’ equity, asdescribed in our MD&A.

 

Changes in the value of the euro against the United States dollaraffect our results of operations because a portion of the net assets of ourNetherlands subsidiary (which are reported in our Dialysis and EndoscopeReprocessing segments) are denominated and ultimately settled in United Statesdollars but must be converted into its functional euro currency. Furthermore,as part of the restructuring of our Netherlands subsidiary, as described inNote 15 to the Condensed Consolidated Financials and elsewhere in thisMD&A, a portion of the net assets of our United States subsidiaries,Minntech and Mar Cor, are now denominated and ultimately settled in euros

 

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orBritish pounds but must be converted into our functional United Statescurrency. Additionally, the financial statements of our Netherlands subsidiaryare translated using the accounting policies described in Note 2 to the 2009 Form 10-K.Fluctuations in the rates of currency exchange between the United States dollarand the euro or British pound had an overall favorable impact for the three andsix months ended January 31, 2010, compared with the three and six months endedJanuary 31, 2009, upon our net income, and did not have a material impactupon stockholders’ equity, as described in our MD&A.

 

Inorder to hedge against the impact of fluctuations in the value of (i) theCanadian dollar relative to the United States dollar, (ii) the eurorelative to the United States dollar and (iii) the British pound relativeto the United States dollar on the conversion of such net assets intofunctional currencies, we enter into short-term contracts to purchase Canadiandollars, euros and British pounds forward, which contracts are generally onemonth in duration. These short-term contracts are designated as fair valuehedges. There were three foreign currency forward contracts with an aggregatevalue of $4,651,000 at January 31, 2010, which covered certain assets andliabilities that were denominated in currencies other than our subsidiaries’functional currencies. Such contracts expired on February 28, 2010. Theseforeign currency forward contracts are continually replaced with new one-monthcontracts as long as we have significant net assets at our subsidiaries thatare denominated and ultimately settled in currencies other than theirfunctional currencies. Under our credit facilities, such contracts to purchaseCanadian dollars, euros and British pounds may not exceed $12,000,000 in anaggregate notional amount at any time. For the three and six months ended January 31,2010, such forward contracts partially offset the impact on operations relatedto certain assets and liabilities that are denominated in currencies other thanour subsidiaries’ functional currencies.

 

The functional currency of Minntech’s Japan subsidiary is the Japaneseyen. Changes in the value of the Japanese yen relative to the United Statesdollar during the three and six months ended January 31, 2010, comparedwith the three and six months ended January 31, 2009, did not have asignificant impact upon either our results of operations or the translation ofthe balance sheet, primarily due to the fact that our Japanese subsidiaryaccounts for a relatively small portion of consolidated net sales, net incomeand net assets.

 

Overall, fluctuations in the rates of currency exchange had an adverseimpact on our net income for the three and six months ended January 31,2010, compared with the three and six months ended January 31, 2009,primarily due to the decrease in the value of the Canadian dollar relative tothe United States dollar, and did not have a material impact upon stockholders’equity.

 

**Interest Rate Market Risk**

 

Wehave a United States credit facility for which the interest rate on outstandingborrowings is variable. Substantially all of our outstanding borrowings areunder LIBOR contracts. Therefore, interest expense is affected by the generallevel of interest rates in the United States as well as LIBOR interest rates.

 

Additionally,we are in discussions with our bank syndicate regarding modifications to ourrevolving credit facility, including an extension of the termination date, andexpect to formally modify the facility before its August 1, 2010expiration. Due to current market conditions, a modification of our creditfacilities will likely result in an increase of our margins above the lender’sbase rate and LIBOR, which may adversely affect our results of operations. In addition, depending upon the structure ofthe modification, we may be required to write-off

 

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certain deferred financing costs that are recordedin other assets and are currently being amortized over the life of the creditfacilities.

 

**Market Risk Sensitive Transactions**

 

Additional information related to market risk sensitive transactions iscontained in Part II, Item 7A, Quantitative and Qualitative DisclosuresAbout Market Risk, in our 2009 Form 10-K.

 

**ITEM 4.          CONTROLS AND PROCEDURES.**

 

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act) designed to ensure that informationrequired to be disclosed in our Exchange Act reports is recorded, processed,summarized and reported within the time periods specified by the SEC and thatsuch information is accumulated and communicated to our management, includingour Chief Executive Officer and our Chief Financial Officer, as appropriate, toallow timely decisions regarding required disclosures.

 

Under the supervision and with the participation of our Chief ExecutiveOfficer and our Chief Financial Officer, we conducted an evaluation of theeffectiveness of the design and operation of our disclosure controls andprocedures 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 Officereach concluded that the design and operation of these disclosure controls andprocedures were effective and designed to ensure that material informationrelating to the Company, including our consolidated subsidiaries, required tobe disclosed in our SEC reports is (i) recorded, processed, summarized andreported within the time periods specified by the SEC and (ii) accumulatedand communicated by the Company’s management, including the Chief ExecutiveOfficer and Chief Financial Officer, as appropriate to allow timely decisionsregarding disclosure.

 

We have evaluated our internal controls over financial reporting anddetermined that no changes occurred during the period covered by this reportthat have materially affected, or are reasonably likely to materially affect,our internal controls over financial reporting.

 

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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 thosedisclosed in Part I, Item 1A to our 2009 Form 10-K. The riskfactors disclosed in Part I, Item 1A to our 2009 Form 10-K, inaddition to the other information set forth in this report, could materiallyaffect our business, financial condition, or results of operations.

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

 

None.

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

 

None.

 
| **ITEM 4.** | **RESERVED** |
|-------------|--------------|

 
| **ITEM 5.** | **OTHER  INFORMATION** |
|-------------|------------------------|

 

On December 17, 2009, the Company held its Annual Meeting ofStockholders for the fiscal year ended July 31, 2009. At the meeting,stockholders voted for (i) the election of nine members of the Company’sBoard of Directors to serve until the next annual meeting and until theirsuccessors are duly elected and qualified, (ii) the approval of anamendment to the Company’s 2006 Equity Incentive Plan that increased by 385,000the number of shares of Common stock available for issuance under the Plan and (iii) theratification of Ernst & Young LLP to serve as the Company’sindependent registered public accounting firm for the fiscal year ending July 31,2010.

 

A tabulation of the number of votescast for, against and withheld, as well as the number of abstentions as to eachmatter voted on, as applicable, is set forth below. There were no brokernon-votes.

 
| **1.** | **Election  of Directors** | ** ** | **Votes  For** | ** ** | **Votes  Withheld** | ** ** |
|--------|----------------------------|------------|----------------|------------|---------------------|------------|
|   |                       |       |           |       |                |       |
|   | Robert L. Barbanell        |       | 15,632,598     |       | 336,404             |       |
|   | Alan R. Batkin             |       | 15,592,928     |       | 376,074             |       |
|   | Joseph M. Cohen            |       | 15,592,278     |       | 376,724             |       |
|   | Charles M. Diker           |       | 15,639,539     |       | 329,463             |       |
|   | Mark N. Diker              |       | 15,636,585     |       | 332,417             |       |
|   | George L. Fotiades         |       | 15,665,894     |       | 303,108             |       |
|   | Alan J. Hirschfield        |       | 15,584,159     |       | 384,843             |       |
|   | Andrew A. Krakauer         |       | 15,653,257     |       | 315,745             |       |
|   | Bruce Slovin               |       | 15,644,624     |       | 324,378             |       |

 

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| **2.** | ** ** | **Approval  of the 2006 Equity  Incentive Plan Amendment** | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker  Non-votes** | ** ** |
|--------|------------|------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|-----------------------|------------|
|   |       |                                                       |       |       |       |        |       |        |       |                  |       |
|   |       |                                                       |       | 12,652,985 |       | 774,731     |       | 18,514      |       | 2,522,722             |       |

 
| **3.**     | ** ** | **Ratification  of Independent   Registered Public Accounting  Firm** | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker  Non-votes** | ** ** |
|------------|------------|-----------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|-----------------------|------------|
| ** ** | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** **  | ** ** | ** **  | ** ** | ** **            | ** ** |
|       |       |                                                                  |       | 15,849,960 |       | 38,529      |       | 80,513      |       | 0                     |       |

 
| **ITEM 6.** | **EXHIBITS** |
|-------------|--------------|

 

10(a) - Fifth Amendment to Credit Agreement and Consent dated December 17,2009 among Registrant, Bank of America N.A., PNC Bank, National Association,and Wells Fargo Bank, National Association (and Banc of America Securities LLC,as sole lead arranger and sole book manager.)

 

31.1   - Certification ofPrincipal Executive Officer.

 

31.2   - Certification of Principal FinancialOfficer.

 

32      - Certification of ChiefExecutive 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 theundersigned, thereunto duly authorized.

 

 
|                       |   | CANTEL  MEDICAL CORP. |
|----------------------------|--------|-----------------------|
|                       |   |                  |
|                       |   |                  |
| Date:  March 10, 2010 |   |                  |
|                       |   |                  |
|                       |   |                  |
|                       |   | 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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