**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.   20549**

 

**Form 10-Q**

 

**x****      QuarterlyReport pursuant to Section 13 or 15(d) of the Securities Exchange Act of1934**

 

**For thequarterly period ended October 31, 2010.**

 

**or**

 

**o****         TransitionReport pursuant to Section 13 or 15(d) of the Securities Exchange Act of1934**

 

**For thetransition period from           to          .**

 

**Commission file number: 001-31337**

 

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

 

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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of 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 markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o   No x

 

Number of shares of CommonStock outstanding as of November 30, 2010: 17,064,131.

 

 

 

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PART I- FINANCIAL INFORMATION

ITEM1. - FINANCIAL STATEMENTS

CANTELMEDICAL CORP.

CONDENSEDCONSOLIDATED BALANCE SHEETS

(DollarAmounts in Thousands, Except Share Data)

(Unaudited)

 
| ** **                                                                                                                                                                                                                       | ** ** | **October 31,** | ** ** | **July 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                       | ** ** | **2010**             | ** ** | **2010**          | ** ** |
| **Assets**                                                                                                                                                                                                                       |       |                 |       |              |       |
| Current  assets:                                                                                                                                                                                                                 |       |                 |       |              |       |
| Cash  and cash equivalents                                                                                                                                                                                                       |       | $                    | 15,954     |              | $          | 22,612 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $835 at October 31  and $870 at July 31                                                                                                                |       | 34,075               |       | 31,870            |       |
| Inventories:                                                                                                                                                                                                                     |       |                 |       |              |       |
| Raw  materials                                                                                                                                                                                                                   |       | 15,043               |       | 14,003            |       |
| Work-in-process                                                                                                                                                                                                                  |       | 4,668                |       | 5,153             |       |
| Finished  goods                                                                                                                                                                                                                  |       | 16,699               |       | 15,466            |       |
| Total  inventories                                                                                                                                                                                                               |       | 36,410               |       | 34,622            |       |
| Deferred  income taxes                                                                                                                                                                                                           |       | 2,436                |       | 2,420             |       |
| Prepaid  expenses and other current assets                                                                                                                                                                                       |       | 3,855                |       | 3,207             |       |
| Total  current assets                                                                                                                                                                                                            |       | 92,730               |       | 94,731            |       |
| Property  and equipment, net                                                                                                                                                                                                     |       | 34,814               |       | 35,243            |       |
| Intangible  assets, net                                                                                                                                                                                                          |       | 40,399               |       | 32,717            |       |
| Goodwill                                                                                                                                                                                                                         |       | 128,555              |       | 116,783           |       |
| Other  assets                                                                                                                                                                                                                    |       | 1,350                |       | 1,191             |       |
|                                                                                                                                                                                                                             |       | $                    | 297,848    |              | $          | 280,665 |   |
| **Liabilities and stockholders’ equity**                                                                                                                                                                                    |       |                 |       |              |       |
| Current  liabilities:                                                                                                                                                                                                            |       |                 |       |              |       |
| Current  portion of long-term debt                                                                                                                                                                                               |       | $                    | 33,000     |              | $          | 10,000 |   |
| Accounts  payable                                                                                                                                                                                                                |       | 10,822               |       | 9,640             |       |
| Compensation  payable                                                                                                                                                                                                            |       | 4,421                |       | 10,675            |       |
| Accrued  expenses                                                                                                                                                                                                                |       | 6,721                |       | 6,370             |       |
| Deferred  revenue                                                                                                                                                                                                                |       | 3,446                |       | 4,233             |       |
| Acquisition  payable                                                                                                                                                                                                             |       | 2,067                |       | —            |       |
| Dividends  payable                                                                                                                                                                                                               |       | 1,026                |       | —            |       |
| Income  taxes payable                                                                                                                                                                                                            |       | 2,329                |       | 66                |       |
| Total  current liabilities                                                                                                                                                                                                       |       | 63,832               |       | 40,984            |       |
|                                                                                                                                                                                                                             |       |                 |       |              |       |
| Long-term  debt                                                                                                                                                                                                                  |       | —               |       | 11,000            |       |
| Deferred  income taxes                                                                                                                                                                                                           |       | 17,440               |       | 17,868            |       |
| Long-term  acquisition payable                                                                                                                                                                                                   |       | 1,033                |       | —            |       |
| Other  long-term liabilities                                                                                                                                                                                                     |       | 1,334                |       | 1,408             |       |
|                                                                                                                                                                                                                             |       |                 |       |              |       |
| Stockholders’  equity:                                                                                                                                                                                                      |       |                 |       |              |       |
| Preferred  Stock, par value $1.00 per share; authorized 1,000,000 shares; none issued                                                                                                                                            |       | —               |       | —            |       |
| Common  Stock, par value $.10 per share; authorized 30,000,000 shares;  October 31 - 18,432,792 shares issued and 17,022,844 shares outstanding;  July 31 - 18,272,574 shares issued and 16,866,284 shares outstanding |       | 1,843                |       | 1,827             |       |
| Additional  paid-in capital                                                                                                                                                                                                      |       | 95,562               |       | 94,714            |       |
| Retained  earnings                                                                                                                                                                                                               |       | 124,312              |       | 120,363           |       |
| Accumulated  other comprehensive income                                                                                                                                                                                          |       | 8,103                |       | 8,045             |       |
| Treasury  Stock, at cost; October 31 - 1,409,948 shares; July 31 - 1,406,290  shares                                                                                                                                   |       | (15,611              | )          | (15,544           | )          |
| Total  stockholders’ equity                                                                                                                                                                                                 |       | 214,209              |       | 209,405           |       |
|                                                                                                                                                                                                                             |       | $                    | 297,848    |              | $          | 280,665 |   |

 

See accompanying notes.

 

2

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CANTELMEDICAL CORP.

CONDENSEDCONSOLIDATED STATEMENTS OF INCOME

(DollarAmounts in Thousands, Except Per Share Data)

(Unaudited)

 
| ** **                               | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **October 31,**             | ** ** |
| ** **                               | ** ** | **2010**                         | ** ** | **2009** | ** ** |
|                                     |       |                             |       |   |   |
| Net  sales                               |       | $                                | 71,993     |   | $ | 70,995 |   |
|                                     |       |                             |       |   |   |
| Cost  of sales                           |       | 43,801                           |       | 41,537 |   |
|                                     |       |                             |       |   |   |
| Gross  profit                            |       | 28,192                           |       | 29,458 |   |
|                                     |       |                             |       |   |   |
| Expenses:                                |       |                             |       |   |   |
| Selling                                  |       | 9,631                            |       | 8,524 |   |
| General  and administrative              |       | 9,118                            |       | 9,305 |   |
| Research  and development                |       | 1,629                            |       | 1,265 |   |
| Total  operating expenses                |       | 20,378                           |       | 19,094 |   |
|                                     |       |                             |       |   |   |
| Income  before interest and income taxes |       | 7,814                            |       | 10,364 |   |
|                                     |       |                             |       |   |   |
| Interest  expense                        |       | 241                              |       | 387 |   |
| Interest  income                         |       | (19                              | )          | (8 | ) |
|                                     |       |                             |       |   |   |
| Income  before income taxes              |       | 7,592                            |       | 9,985 |   |
|                                     |       |                             |       |   |   |
| Income  taxes                            |       | 2,617                            |       | 3,817 |   |
|                                     |       |                             |       |   |   |
| Net  income                              |       | $                                | 4,975      |   | $ | 6,168 |   |
|                                     |       |                             |       |   |   |
| Earnings  per common share:              |       |                             |       |   |   |
| Basic                                    |       | $                                | 0.29       |   | $ | 0.37 |   |
|                                     |       |                             |       |   |   |
| Diluted                                  |       | $                                | 0.29       |   | $ | 0.37 |   |
|                                     |       |                             |       |   |   |
| Dividends  per common share              |       | $                                | 0.06       |   | $ | — |   |

 

See accompanying notes.

 

3

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CANTELMEDICAL CORP.

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

(DollarAmounts in Thousands)

(Unaudited)

 
| ** **                                                                          | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                          | ** ** | **October 31,**             | ** ** |
| ** **                                                                          | ** ** | **2010**                         | ** ** | **2009** | ** ** |
|                                                                                |       |                             |       |   |   |
| **Cash flows from operating activities**                                            |       |                             |       |   |   |
| Net  income                                                                         |       | $                                | 4,975      |   | $ | 6,168 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities:  |       |                             |       |   |   |
| Depreciation                                                                        |       | 1,628                            |       | 1,564 |   |
| Amortization                                                                        |       | 1,319                            |       | 1,278 |   |
| Stock-based  compensation expense                                                   |       | 765                              |       | 789 |   |
| Amortization  of debt issuance costs                                                |       | 79                               |       | 103 |   |
| Gain  on disposal of fixed assets                                                   |       | (11                              | )          | — |   |
| Deferred  income taxes                                                              |       | (538                             | )          | (312 | ) |
| Excess  tax benefits from stock-based compensation                                  |       | (20                              | )          | (7 | ) |
| Changes  in assets and liabilities, net of assets acquired and liabilities assumed: |       |                             |       |   |   |
| Accounts  receivable                                                                |       | (2,177                           | )          | (1,415 | ) |
| Inventories                                                                         |       | 1,368                            |       | (2,187 | ) |
| Prepaid  expenses and other current assets                                          |       | (882                             | )          | (481 | ) |
| Accounts  payable and other current liabilities                                     |       | (5,655                           | )          | (2,556 | ) |
| Income  taxes payable                                                               |       | 2,369                            |       | 3,512 |   |
| Net  cash provided by operating activities                                          |       | 3,220                            |       | 6,456 |   |
|                                                                                |       |                             |       |   |   |
| **Cash flows from investing activities**                                            |       |                             |       |   |   |
| Capital  expenditures                                                               |       | (1,192                           | )          | (1,377 | ) |
| Proceeds  from disposal of fixed assets                                             |       | 29                               |       | — |   |
| Earnout  paid to Twist seller                                                       |       | —                           |       | (157 | ) |
| Acquisition  of Gambro Water                                                        |       | (20,600                          | )          | — |   |
| Other,  net                                                                         |       | (98                              | )          | (130 | ) |
| Net  cash used in investing activities                                              |       | (21,861                          | )          | (1,664 | ) |
|                                                                                |       |                             |       |   |   |
| **Cash flows from financing activities**                                            |       |                             |       |   |   |
| Borrowings  under revolving credit facility                                         |       | 20,500                           |       | — |   |
| Repayments  under term loan facility                                                |       | (2,500                           | )          | (2,500 | ) |
| Repayments  under revolving credit facility                                         |       | (6,000                           | )          | (2,800 | ) |
| Proceeds  from exercises of stock options                                           |       | 81                               |       | 240 |   |
| Excess  tax benefits from stock-based compensation                                  |       | 20                               |       | 7 |   |
| Purchases  of treasury stock                                                        |       | (67                              | )          | — |   |
| Net  cash provided by (used in) financing activities                                |       | 12,034                           |       | (5,053 | ) |
|                                                                                |       |                             |       |   |   |
| Effect  of exchange rate changes on cash and cash equivalents                       |       | (51                              | )          | (2 | ) |
|                                                                                |       |                             |       |   |   |
| Decrease  in cash and cash equivalents                                              |       | (6,658                           | )          | (263 | ) |
| Cash  and cash equivalents at beginning of period                                   |       | 22,612                           |       | 23,368 |   |
| Cash  and cash equivalents at end of period                                         |       | $                                | 15,954     |   | $ | 23,105 |   |

 

See accompanying notes.

 

4

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

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

(Unaudited)

 

**Note 1.****                                                         ****Basisof Presentation**

 

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

 

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

 

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

 

Cantel had five principaloperating companies at each of October 31, 2010 and July 31, 2010,Minntech Corporation (“Minntech”), Crosstex International Inc. (“Crosstex”),Mar Cor Purification, Inc. (“Mar Cor”), Biolab Equipment Ltd. (“Biolab”)and Saf-T-Pak Inc. (“Saf-T-Pak”), all of which are wholly-owned operatingsubsidiaries. In addition, Minntech has three foreign subsidiaries, MinntechB.V., Minntech Asia/Pacific Ltd. and Minntech Japan K.K., which serve asMinntech’s bases in Europe, Asia/Pacific and Japan, respectively.

 

During our fourth quarter offiscal 2010, we changed our internal reporting processes to include a newoperating segment called Chemistries to reflect the way the Company, throughits executive management, manages, allocates resources and measures theperformance of its businesses. This new operating segment is the combination ofa small portion of our existing sterilant business, comprised of products soldon an OEM basis and previously recorded in our Water Purification andFiltration segment, and a new business operation that was created to capitalizeon our chemistry expertise and expand our product offerings in existing and newmarkets within the infection prevention and control arena. As a result of thisinternal reorganization, certain research and development projects werereclassified among segments. All prior period segment results have beenrestated to reflect this change.

 

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

 

On October 6, 2010, ourMar Cor subsidiary acquired from Gambro Renal Products, Inc.

 

5

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(“GRP”) and a Swedish-basedaffiliate of GRP (collectively, “Gambro”) certain net assets and the exclusiverights in the United States and Puerto Rico to manufacture and sell Gambro’swater treatment products used in the production of water for hemodialysis (“GambroWater” or the “Gambro Acquisition”), as more fully described in Note 3 to theCondensed Consolidated Financial Statements. Gambro Water’s results of operations are included in our results ofoperations for the three months ended October 31, 2010 subsequent to itsacquisition date and are excluded from the three months ended October 31,2009.

 

On June 1, 2010, we acquiredall of the issued and outstanding stock of Purity Water Company of San Antonio, Inc. (“Purity”), as more fullydescribed in Note 3 to the Condensed Consolidated Financial Statements. Purity’sresults of operations are included in our results of operations for the threemonths ended October 31, 2010 and are excluded from the threemonths ended October 31, 2009.

 

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

 

***Subsequent Events***

 

We performed a review ofevents subsequent to October 31, 2010. Based upon that review, nosubsequent events occurred that required updating to our Condensed ConsolidatedFinancial Statements or disclosures.

 

**Note 2.****                                                         ****Stock-BasedCompensation**

 

The following table showsthe income statement components of stock-based compensation expense recognizedin the Condensed Consolidated Statements of Income:

 
| ** **                                                              | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                              | ** ** | **October 31,**             | ** ** |
| ** **                                                              | ** ** | **2010**                         | ** ** | **2009** | ** ** |
|                                                                    |       |                             |       |   |   |
| Cost  of sales                                                          |       | $                                | 38,000     |   | $ | 18,000 |   |
| Operating  expenses:                                                    |       |                             |       |   |   |
| Selling                                                                 |       | 115,000                          |       | 69,000 |   |
| General  and administrative                                             |       | 604,000                          |       | 698,000 |   |
| Research  and development                                               |       | 8,000                            |       | 4,000 |   |
| Total  operating expenses                                               |       | 727,000                          |       | 771,000 |   |
| Stock-based  compensation before income taxes                           |       | 765,000                          |       | 789,000 |   |
| Income  tax benefits                                                    |       | (275,000                         | )          | (290,000 | ) |
| Total  stock-based compensation expense, net of tax                     |       | $                                | 490,000    |   | $ | 499,000 |   |
|                                                                    |       |                             |       |   |   |
| Decrease  in earnings per common share due to stock-based compensation: |       |                             |       |   |   |
|                                                                    |       |                             |       |   |   |
| Basic                                                                   |       | $                                | 0.03       |   | $ | 0.03 |   |
|                                                                    |       |                             |       |   |   |
| Diluted                                                                 |       | $                                | 0.03       |   | $ | 0.03 |   |

 

The above stock-basedcompensation expense before income taxes was recorded in the 

 

6

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Condensed ConsolidatedFinancial Statements as stock-based compensation expense and an increase toadditional paid-in capital. The related income tax benefits (which pertain onlyto stock awards and options that do not qualify as incentive stock options) wererecorded as an increase to long-term deferred income tax assets (which arenetted with long-term deferred income tax liabilities) and a reduction toincome tax expense.

 

All of our stock options andstock awards (which consist only of restricted stock) are subject to gradedvesting in which portions of the award vest at different times during thevesting period, as opposed to awards that vest at the end of the vestingperiod. We recognize compensation expense for awards subject to graded vestingusing the straight-line basis over the vesting period, reduced by estimatedforfeitures. At October 31, 2010, total unrecognized stock-basedcompensation expense before income taxes related to total nonvested stockoptions and stock awards was $5,655,000 with a remaining weighted averageperiod of 19 months over which such expense is expected to be recognized.

 

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

 

A summary of nonvested stockaward activity follows:

 
| ** **                                       | ** ** | ** **         | ** ** | **Weighted**        | ** ** |
|--------------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                       | ** ** | **Number of** | ** ** | **Average**         | ** ** |
| ** **                                       | ** ** | **Shares**         | ** ** | **Fair Value** | ** ** |
|                                             |       |               |       |                |       |
| Nonvested  stock awards at July 31, 2010    |       | 158,652            |       | $                   | 13.89      |   |
| Granted                                          |       | 152,550            |       | 18.19               |       |
| Vested                                           |       | (13,744            | )          | 15.79               |       |
| Nonvested  stock awards at October 31, 2010 |       | 297,458            |       | $                   | 16.01      |   |

 

There were no option grantsduring the three months ended October 31, 2010. The fair value of eachoption grant is estimated on the date of grant using the Black-Scholes optionvaluation model with the following assumptions for options granted during thethree months ended October 31, 2009:

 
| **Weighted-Average**           | ** ** | ** **                       | ** ** |
|--------------------------------|------------|----------------------------------|------------|
| **Black-Scholes Option**  | ** ** | **Three Months Ended** | ** ** |
| **Valuation Assumptions** | ** ** | **October 31, 2009**   | ** ** |
|                           |       |                             |       |
| Dividend  yield                |       | 0.00                             | %          |
| Expected  volatility (1)       |       | 0.455                            |       |
| Risk-free  interest rate (2)   |       | 1.95                             | %          |
| Expected  lives (in years) (3) |       | 3.52                             |       |

 

----

(1) Volatility wasbased on historical closing prices of our Common Stock.

(2) The U.S. Treasuryrate on the expected life at the date of grant.

(3) Based on historicalexercise behavior.

 

Additionally, all optionswere considered to be deductible for tax purposes in the valuation model,except for certain incentive options granted under the 1997 Employee Plan andto employees residing outside of the United States. Such non-qualified optionswere tax-effected using the Company’s estimated U.S. effective tax rate at thetime of grant. For the three months ended October 31, 2009, the weightedaverage fair value of all options granted was approximately

 

7

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$5.61.  The aggregate intrinsic value (i.e., theexcess market price over the exercise price) of all options exercised was$52,000 and $101,000 for the three months ended October 31, 2010 and 2009,respectively.

 

A summary of stock optionactivity follows:

 
| ** **                            | ** ** | ** **         | ** ** | **Weighted**            | ** ** |
|---------------------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **Number of** | ** ** | **Average**             | ** ** |
| ** **                            | ** ** | **Shares**         | ** ** | **Exercise Price** | ** ** |
|                                  |       |               |       |                    |       |
| Outstanding  at July 31, 2010    |       | 1,427,863          |       | $                       | 15.95      |   |
| Exercised                             |       | (7,668             | )          | 10.50                   |       |
| Expired                               |       | (3,750             | )          | 19.35                   |       |
| Outstanding  at October 31, 2010 |       | 1,416,445          |       | $                       | 15.97      |   |
|                                  |       |               |       |                    |       |
| Exercisable  at July 31, 2010    |       | 778,864            |       | $                       | 16.76      |   |
|                                  |       |               |       |                    |       |
| Exercisable  at October 31, 2010 |       | 904,801            |       | $                       | 16.66      |   |

 

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

 

If certain criteria are metwhen options are exercised or restricted stock becomes vested, the Company isallowed a deduction on its income tax return. Accordingly, we account for theincome tax effect on such income tax deductions as additional paid-in capitalor a reduction of deferred income tax assets (which are netted with long-termdeferred income tax liabilities) and as a reduction of income taxes payable.For the three months ended October 31, 2010 and 2009, such income taxdeductions reduced income taxes payable by $107,000 and $29,000, respectively.

 

Weclassify the cash flows resulting from excess tax benefits as financing cashflows on our Condensed Consolidated Statements of Cash Flows. Excess taxbenefits arise when the ultimate tax effect of the deduction for tax purposesis greater than the tax benefit on stock compensation expense (including taxbenefits on stock compensation expense that has only been reflected in past proforma disclosures relating to fiscal years prior to August 1, 2005) whichwas determined based upon the award’s fair value.

 

**Note 3.****                                                         ****Acquisitions**

 

***Gambro Water***

 

On October 6, 2010, ourMar Cor subsidiary acquired from Gambro certain net assets and the exclusiverights in the United States and Puerto Rico to manufacture and sell Gambro’swater treatment products used in the production of water for hemodialysis.Immediately following the acquisition, we commenced sales and service of allGambro water products, components, parts and consumables solely intended forthe United States and Puerto Rico markets. The manufacturing of these productsis being transitioned into our own manufacturing facility in Plymouth, Minnesota.With annual pre-acquisition revenues of approximately $14 million(approximately 75% of such revenues are from one customer), the GambroAcquisition expands our Water Purification and Filtration’s annual business interms of sales, particularly with respect to product and service sales volumesin both existing and new dialysis clinics across the United States and PuertoRico. Total consideration for the transaction, excluding acquisition-relatedcosts of approximately $205,000, was approximately $23,697,000, of which$3,100,000 will be paid in six equal quarterly payments

 

8

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ending April 2012. TheGambro Acquisition is included in our Water Purification and Filtrationoperating segment.

 

The purchase price waspreliminarily allocated to the assets acquired and assumed liabilities based onestimated fair values as follows:

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

 

There were no in-processresearch and development projects acquired in connection with the acquisition.The excess purchase price of $11,709,000 was assigned to goodwill. Suchgoodwill, all of which is deductible for income tax purposes, has been includedin our Water Purification and Filtration reporting segment.

 

The reasons for theacquisition were as follows: (i) the expansion of our water purificationproduct line, particularly in the area of cost effective heat sanitizable waterpurification equipment, (ii) the opportunity to add an installed equipmentbase of business into which we can (a) increase service revenue whileimproving the density and efficiency of the Mar Cor service network and (b) increaseconsumable sales per clinic; (iii) the potential revenue and cost savingssynergies and efficiencies that could be realized through optimizing andcombining the acquired assets (including Gambro employees) into Mar Cor; and (iv) theexpectation that the acquisition will be accretive to our future earnings pershare.

 

For the three months ended October 31,2010 subsequent to its acquisition, Gambro Water contributed approximately$940,000 to our net sales and $75,000 to our income before interest and incometaxes, excluding acquisition-related costs. Such operating performance may notnecessarily be indicative of future operating performance. The results ofoperations of Gambro Water are excluded from the three months ended October 31,2009. Pro forma consolidated statement of income data has not been presenteddue to the unavailability of pre-acquisition Gambro Water financial statements,since Gambro Water did not maintain separate financial statements related tothese purchased assets, and the expected insignificant impact of thisacquisition on our consolidated net income in fiscal 2011 subsequent to itsacquisition date.

 

***Purity WaterCompany of San Antonio, Inc.***

 

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

 

9

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The purchase price waspreliminarily allocated to the assets acquired and assumed liabilities based onestimated fair values as follows:

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

 

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

 

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

 

The acquisition of Purity isincluded in our results of operations for the three months ended October 31,2010 and is excluded from our resultsof operations for the three months ended October 31, 2009. Proforma consolidated statements of income data have not been presented due to theinsignificant impact of this acquisition.

 

**Note 4.****                                                         ****RecentAccounting Pronouncements**

 

InOctober 2009, the Financial Accounting Standards Board (“FASB”) issuedAccounting Standard Update (“ASU”) 2009-13, *“Revenue Recognition(Topic 605): Multiple-Deliverable Revenue Arrangements, a consensus of the FASBEmerging Issues Task Force,”* (“ASU 2009-13”), which amendsAccounting Standards Codification 605-25, “*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. Accordingly, we adopted ASU2009-13 on August 1, 2010. The adoption of ASU 2009-13 did not have amaterial effect on our financial position or results of operations.

 

InJanuary 2010, the FASB issued ASU 2010-06, “*Fair Value Measurements and Disclosures (Topic 820): ImprovingDisclosures 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, as more fully described in Note 6 to the CondensedConsolidated Financial Statements, established by ASC 820, “*Fair Value Measurements and Disclosures,”* (“ASC 820”). ASU 2010-06 alsoclarifies the existing

 

10

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guidanceto require fair value measurement disclosures for each class of assets andliabilities.  ASU 2010-06 is effectivefor interim and annual reporting periods beginning after December 15, 2009for Level 1 and 2 disclosure requirements, which was adopted in our thirdquarter of fiscal 2010, and after December 15, 2010 for Level 3 disclosurerequirements, which we will adopt in our third quarter of fiscal 2011 if wehave any assets valued with a Level 3 method. The adoption of ASU 2010-06 forLevel 1 and 2 disclosure requirements did not have any impact upon ourfinancial position, results of operations and financial statement disclosuresdue to the nature of our Level 1 assets and the lack of any assets valued witha Level 2 method.

 

**Note 5.****                                                         ****OtherComprehensive Income**

 

The Company’s comprehensiveincome for the three months ended October 31, 2010 and 2009 is set forthin the following table:

 
| ** **                          | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **October 31,**             | ** ** |
| ** **                          | ** ** | **2010**                         | ** ** | **2009** | ** ** |
|                                |       |                             |       |   |   |
| Net  income                         |       | $                                | 4,975,000  |   | $ | 6,168,000 |   |
| Other  comprehensive income (loss): |       |                             |       |   |   |
| Foreign  currency translation       |       | 58,000                           |       | (148,000 | ) |
| Comprehensive  income               |       | $                                | 5,033,000  |   | $ | 6,020,000 |   |

 

**Note 6.****                                                         ****FinancialInstruments**

 

We account for derivativeinstruments and hedging activities in accordance with ASC 815, *“Derivatives and Hedging,”* (“ASC 815”), which requires theCompany to recognize all derivatives on the balance sheet at fair value.Derivatives that are not designated as hedges must be adjusted to fair valuethrough earnings. If the derivative is designated as a hedge, depending on thenature of the hedge, changes in the fair value of the derivative will either beoffset against the change in the fair value of the hedged assets, liabilitiesor firm commitments through earnings or recognized in other comprehensiveincome until the hedged item is recognized in earnings. The ineffective portionof the change in fair value of a derivative that is designated as a hedge willbe recognized immediately in earnings. As of October 31, 2010, all of ourderivatives were designated as hedges.

 

Changes in the value of (i) theCanadian dollar against the United States dollar, (ii) the euro againstthe United States dollar and (iii) the British pound against the UnitedStates dollar affect our results of operations because a portion of the netassets of our Canadian subsidiaries (which are reported in our SpecialtyPackaging and Water Purification and Filtration segments)  are denominated and ultimately settled inUnited States dollars but must be converted into its functional Canadian dollarcurrency. Furthermore, certain cash bank accounts, accounts receivable, andliabilities of our United States subsidiaries, Minntech and Mar Cor, aredenominated and ultimately settled in euros or British pounds but must beconverted into our functional United States currency.

 

In order to hedge againstthe impact of fluctuations in the value of (i) the Canadian dollarrelative to the United States dollar, (ii) the euro relative to the UnitedStates dollar and (iii) the British pound relative to the United Statesdollar on the conversion of such net assets into the functional currencies, weenter into short-term contracts to purchase Canadian dollars, euros and Britishpounds forward, which contracts are generally one month in duration. Theseshort-term contracts are designated as fair value hedge instruments. There werethree foreign currency

 

11

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forward contracts with anaggregate value of $3,989,000 at October 31, 2010, which covered certainassets and liabilities that were denominated in currencies other than oursubsidiaries’ functional currencies. Such contracts expired on November 30,2010. These foreign currency forward contracts are continually replaced withnew one-month contracts as long as we have significant net assets at oursubsidiaries that are denominated and ultimately settled in currencies otherthan their functional currencies. Under our credit facilities, such contractsto purchase Canadian dollars, euros and British pounds may not exceed$12,000,000 in an aggregate notional amount at any time. For the three monthsended October 31, 2010, such forward contracts partially offset the impacton operations relating to certain assets and liabilities that were denominatedin currencies other than our subsidiaries’ functional currencies and resultedin a net currency conversion loss, net of tax, of $49,000 on the items hedged.Gains and losses related to the hedging contracts to buy Canadian dollars,euros and British pounds forward were immediately realized within general 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, weadopted ASC 820 for our financial assets and liabilities. ASC 820 defines fairvalue as the price that would be received to sell an asset or paid to transfera liability in an orderly transaction between market participants at themeasurement date. ASC 820 establishes a three level fair value hierarchy toprioritize the inputs used in valuations, as defined below:

 

Level 1: Observable inputsthat reflect unadjusted quoted prices for identical assets or liabilities inactive markets.

 

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

 

Level 3: Unobservable inputsfor the asset or liability.

 

The fair values of theCompany’s financial instruments measured on a recurring basis were categorizedas follows:

 
| ** **                                 | ** ** | **October 31, 2010** | ** ** |
|--------------------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **Level 1**               | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Cash  and cash equilavents:                |       |                           |       |   |   |   |   |   |   |
| Bank  deposits and certificates of deposit |       | $                              | 11,038,000 |   | $ | — |   | $ | — |   | $ | 11,038,000 |   |
| Money  markets                             |       | 4,916,000                      |       | — |   | — |   | 4,916,000 |   |
| Total  cash and cash equilavents           |       | $                              | 15,954,000 |   | $ | — |   | $ | — |   | $ | 15,954,000 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| ** **                                 | ** ** | **July 31, 2010**    | ** ** |
| ** **                                 | ** ** | **Level 1**               | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Cash  and cash equilavents:                |       |                           |       |   |   |   |   |   |   |
| Bank  deposits and certificates of deposit |       | $                              | 17,696,000 |   | $ | — |   | $ | — |   | $ | 17,696,000 |   |
| Money  markets                             |       | 4,916,000                      |       | — |   | — |   | 4,916,000 |   |
| Total  cash and cash equilavents           |       | $                              | 22,612,000 |   | $ | — |   | $ | — |   | $ | 22,612,000 |   |

 

As of October 31, 2010and July 31, 2010, the carrying amounts for cash and cash equivalents,accounts receivable and accounts payable approximated fair value due to theshort maturity of these instruments. We believe that as of October 31,2010 and July 31, 2010, the fair value of our outstanding borrowings underour credit facilities approximated the carrying value of those obligationssince the borrowing rates were at prevailing market interest rates, principallyunder LIBOR contracts ranging from one to twelve months.

 

12

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**Note 7.****                                                         ****IntangibleAssets and Goodwill**

 

Our intangible assets withdefinite lives consist primarily of customer relationships, technology, brandnames, non-compete agreements and patents. These intangible assets are beingamortized using the straight-line method over the estimated useful lives of theassets ranging from 3-20 years and have a weighted average amortization periodof 10 years. Amortization expense related to definite life intangible assetswas $1,319,000 and $1,278,000 for the three months ended October 31, 2010and 2009, respectively. Our intangible assets that have indefinite useful livesand therefore are not amortized consist of trademarks and trade names.

 

The Company’s intangibleassets consist of the following:

 
| ** **                            | ** ** | **October 31, 2010** | ** ** |
|---------------------------------------|------------|--------------------------------|------------|
| ** **                            | ** ** | ** **                     | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Gross**                      | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| Intangible  assets with finite lives: |       |                           |       |   |   |   |   |
| Customer  relationships               |       | $                              | 32,850,000 |   | $ | (12,834,000 | ) | $ | 20,016,000 |   |
| Technology                            |       | 9,585,000                      |       | (5,344,000 | ) | 4,241,000 |   |
| Brand  names                          |       | 9,275,000                      |       | (4,799,000 | ) | 4,476,000 |   |
| Non-compete  agreements               |       | 2,951,000                      |       | (1,621,000 | ) | 1,330,000 |   |
| Patents  and other registrations      |       | 1,260,000                      |       | (330,000 | ) | 930,000 |   |
|                                  |       | 55,921,000                     |       | (24,928,000 | ) | 30,993,000 |   |
| Trademarks  and trade names           |       | 9,406,000                      |       | — |   | 9,406,000 |   |
| Total  intangible assets              |       | $                              | 65,327,000 |   | $ | (24,928,000 | ) | $ | 40,399,000 |   |
|                                  |       |                           |       |   |   |   |   |
| ** **                            | ** ** | **July 31, 2010**         | ** ** |
| ** **                            | ** ** | ** **                     | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Gross**                      | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| Intangible  assets with finite lives: |       |                           |       |   |   |   |   |
| Customer  relationships               |       | $                              | 26,205,000 |   | $ | (12,102,000 | ) | $ | 14,103,000 |   |
| Technology                            |       | 9,267,000                      |       | (6,085,000 | ) | 3,182,000 |   |
| Brand  names                          |       | 9,556,000                      |       | (4,829,000 | ) | 4,727,000 |   |
| Non-compete  agreements               |       | 1,901,000                      |       | (1,536,000 | ) | 365,000 |   |
| Patents  and other registrations      |       | 1,251,000                      |       | (307,000 | ) | 944,000 |   |
|                                  |       | 48,180,000                     |       | (24,859,000 | ) | 23,321,000 |   |
| Trademarks  and trade names           |       | 9,396,000                      |       | — |   | 9,396,000 |   |
| Total  intangible assets              |       | $                              | 57,576,000 |   | $ | (24,859,000 | ) | $ | 32,717,000 |   |

 

Estimated amortizationexpense of our intangible assets for the remainder of fiscal 2011 and the nextfive years is as follows:

 
| Nine  month period ending July 31, 2011 |   | $         | 4,199,000 |   |
|----------------------------------------------|--------|-----------|-----------|--------|
| Fiscal  2012                                 |   | 5,172,000 |      |
| Fiscal  2013                                 |   | 5,098,000 |      |
| Fiscal  2014                                 |   | 4,903,000 |      |
| Fiscal  2015                                 |   | 4,727,000 |      |
| Fiscal  2016                                 |   | 1,569,000 |      |

 

13

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Goodwill changed duringfiscal 2010 and the three months ended October 31, 2010 as follows:

 
| ** **                      | ** ** | **Water**               | ** ** | ** **       | ** ** | ** **      | ** ** | ** **   | ** ** | ** **         | ** ** | ** **   | ** ** |
|---------------------------------|------------|-------------------------|------------|------------------|------------|-----------------|------------|--------------|------------|--------------------|------------|--------------|------------|
| ** **                      | ** ** | **Purification**        | ** ** | **Endoscope**    | ** ** | **Healthcare**  | ** ** | ** **   | ** ** | ** **         | ** ** | **Total**    | ** ** |
| ** **                      | ** ** | **and Filtration** | ** ** | **Reprocessing** | ** ** | **Disposables** | ** ** | **Dialysis** | ** ** | **All Other** | ** ** | **Goodwill** | ** ** |
|                            |       |                    |       |             |       |            |       |         |       |               |       |         |       |
| Balance,  July 31, 2009    |       | $                       | 38,375,000 |             | $          | 9,648,000       |       | $            | 50,630,000 |               | $          | 8,133,000    |       | $ | 8,209,000 |   | $ | 114,995,000 |   |
| Acquisition                     |       | 1,217,000               |       | —           |       | —          |       | —       |       | —             |       | 1,217,000    |       |
| Foreign  currency translation   |       | 255,000                 |       | —           |       | —          |       | —       |       | 316,000            |       | 571,000      |       |
| Balance,  July 31, 2010    |       | 39,847,000              |       | 9,648,000        |       | 50,630,000      |       | 8,133,000    |       | 8,525,000          |       | 116,783,000  |       |
| Acquisition                     |       | 11,709,000              |       | —           |       | —          |       | —       |       | —             |       | 11,709,000   |       |
| Foreign  currency translation   |       | 27,000                  |       | —           |       | —          |       | —       |       | 36,000             |       | 63,000       |       |
| Balance,  October 31, 2010 |       | $                       | 51,583,000 |             | $          | 9,648,000       |       | $            | 50,630,000 |               | $          | 8,133,000    |       | $ | 8,561,000 |   | $ | 128,555,000 |   |

 

On July 31, 2010, weperformed impairment studies of the Company’s goodwill and trademarks and tradenames and concluded that such assets were not impaired.

 

**Note 8.****                                                         ****Warranty**

 

A summary of activity in theCompany’s warranty reserves follows:

 
| ** **         | ** ** | **Three Months Ended** | ** ** |
|--------------------|------------|----------------------------------|------------|
| ** **         | ** ** | **October 31,**             | ** ** |
| ** **         | ** ** | **2010**                         | ** ** | **2009** | ** ** |
|               |       |                             |       |   |   |
| Beginning  balance |       | $                                | 1,181,000  |   | $ | 949,000 |   |
| Acquisitions       |       | 10,000                           |       | — |   |
| Provisions         |       | 611,000                          |       | 427,000 |   |
| Charges            |       | (515,000                         | )          | (401,000 | ) |
| Ending  balance    |       | $                                | 1,287,000  |   | $ | 975,000 |   |

 

The warranty provisions andcharges during the three months ended October 31, 2010 and 2009 relateprincipally to the Company’s endoscope reprocessing and water purificationproducts. Warranty reserves are included in accrued expenses in the CondensedConsolidated Balance Sheets.

 

**Note 9.****                                                         ****FinancingArrangements**

 

OurUnited States credit facilities, as amended, include (i) a six-year $40.0million senior secured amortizing term loan facility and (ii) a five-year$50.0 million senior secured revolving credit facility, which both expire on August 1,2011 (the “U.S. Credit Facilities”). Amounts we repay under the term loanfacility may not be re-borrowed. Debt issuance costs relating to the U.S CreditFacilities were recorded in other assets and are being amortized over the lifeof the credit facilities. Such unamortized debt issuance costs amounted toapproximately $224,000 at October 31, 2010.

 

AtOctober 31, 2010, borrowings under the U.S. Credit Facilities bearinterest at rates ranging from 0.50% to 1.50% above the lender’s base rate, orat rates ranging from 1.50% to 2.50% above the London Interbank Offered Rate (“LIBOR”),depending upon our consolidated ratio of debt to earnings before interest,taxes, depreciation and amortization, and as further adjusted under the termsof the facilities (“EBITDA”). At October 31, 2010, the lender’s baserate was 3.25% and the LIBOR rates ranged from 0.26% to 1.21%. The marginsapplicable to our outstanding borrowings at October 31, 2010 were 0.50%above the lender’s base rate and 1.50% above LIBOR. All of our outstanding borrowingswere under LIBOR contracts at October 31,

 

14

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2010.The revolving credit facility also provides for fees on the unused portion atrates ranging from 0.20% to 0.40%, depending upon our consolidated ratio ofdebt to EBITDA; such rate was 0.20% at October 31, 2010.

 

TheU.S Credit Facilities require us to meet certain financial covenants and aresecured by (i) substantially all of our U.S.-based assets (includingassets of Cantel, Minntech, Mar Cor, Crosstex and Strong Dental) and(ii) our pledge of all of the outstanding shares of Minntech, Mar Cor,Crosstex and Strong Dental and 65% of the outstanding shares of ourforeign-based subsidiaries. Additionally, we are not permitted to pay annual cashdividends on our Common Stock in excess of $3,000,000 without the consent ofour United States lenders. As of October 31, 2010, we were in compliancewith all financial and other covenants under the credit facilities.

 

On October 31, 2010, wehad $33,000,000 of outstanding borrowings under the U.S Credit Facilities,which consisted of $7,500,000 and $25,500,000 under the term loan facility andthe revolving credit facility, respectively, and $24,500,000 was available tobe borrowed under our revolving credit facility.

 

The U.S. Credit Facilitieshave a termination date of August 1, 2011. Although we may repay aportion of our outstanding borrowings under the revolver throughout fiscal2011, we do not presently anticipate paying off the revolver in full by its terminationdate. We are in discussions with our bank syndicate regardingmodifications to our credit facilities, including an extension of thetermination date of our revolving facility, and expect to formally modify therevolving credit facility before the expiration date. However, since anymodification will not be completed until later in fiscal 2011, subsequent to July 31,2010 the entire outstanding balance of the revolver was reclassified fromlong-term to current.

 

**Note10.****                                                  ****EarningsPer Common Share**

 

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

 

Weinclude participating securities (unvested share-based payment awards thatcontain nonforfeitable rights to dividends or dividend equivalents) in thecomputation of EPS pursuant to the two-class method. Our participatingsecurities consist solely of unvested restricted stock awards, which havecontractual participation rights equivalent to those of stockholders ofunrestricted common stock. The two-class method of computing earnings per shareis an allocation method that calculates earnings per share for common stock andparticipating securities.

 

15

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

 
| ** **                                                                                                                                 | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                                 | ** ** | **October 31,**             | ** ** |
| ** **                                                                                                                                 | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| Numerator  for basic and diluted earnings per share:                                                                                       |       |                             |       |   |   |
| Net  income                                                                                                                                |       | $                                | 4,975,000  |   | $ | 6,168,000 |   |
| Less  income allocated to participating securities                                                                                         |       | (57,000                          | )          | (87,000 | ) |
| Net  income available to common shareholders                                                                                               |       | $                                | 4,918,000  |   | $ | 6,081,000 |   |
|                                                                                                                                       |       |                             |       |   |   |
| Denominator  for basic and diluted earnings per share, as adjusted for participating  securities:                                          |       |                             |       |   |   |
| Denominator  for basic earnings per share - weighted average number of shares outstanding attributable  to common stock                    |       | 16,712,353                       |       | 16,423,016 |   |
|                                                                                                                                       |       |                             |       |   |   |
| Dilutive  effect of stock options using the treasury stock method and the average  market price for the period                             |       | 107,553                          |       | 108,274 |   |
|                                                                                                                                       |       |                             |       |   |   |
| Denominator  for diluted earnings per share - weighted average number of shares and common  stock equivalents attributable to common stock |       | 16,819,906                       |       | 16,531,290 |   |
|                                                                                                                                       |       |                             |       |   |   |
| Earnings  per share attributable to common stock:                                                                                          |       |                             |       |   |   |
| Basic  earnings per share                                                                                                                  |       | $                                | 0.29       |   | $ | 0.37 |   |
|                                                                                                                                       |       |                             |       |   |   |
| Diluted  earnings per share                                                                                                                |       | $                                | 0.29       |   | $ | 0.37 |   |
|                                                                                                                                       |       |                             |       |   |   |
| Stock  options excluded from weighted average dilutive common shares outstanding  because their inclusion would have been antidilutive     |       | 906,251                          |       | 1,247,251 |   |

 

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

 
| ** **                                                                                                                                 | ** ** | **Three  Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                 | ** ** | **October 31,**    | ** ** |
| ** **                                                                                                                                 | ** ** | **2010**                | ** ** | **2009** | ** ** |
| Denominator  for diluted earnings per share - weighted average number of shares and common  stock equivalents attributable to common stock |       | 16,819,906              |       | 16,531,290 |   |
|                                                                                                                                       |       |                    |       |   |   |
| Participating  securities                                                                                                                  |       | 173,218                 |       | 237,347 |   |
|                                                                                                                                       |       |                    |       |   |   |
| Total  weighted average number of shares and common stock equivalents attributable  to both common stock and participating securities      |       | 16,993,124              |       | 16,768,637 |   |

 

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**Note11.****                                                  ****IncomeTaxes**

 

The consolidated effectivetax rate was 34.5% and 38.2% for the three months ended October 31, 2010and 2009, respectively. The decrease in the consolidated effective tax rate wasprincipally due to the geographic mix of pre-tax income and an increase to aUnited States Federal income tax deduction, as described below.

 

The majority of our incomebefore income taxes was generated from our United States operations, which hadan overall effective tax rate of 36.7% and 38.1% for the three months ended October 31,2010 and 2009, respectively. The lower overall effective tax rate for the threemonths ended October 31, 2010 was principally caused by Federal taxlegislation that is now fully phased in, which enabled us to claim a largerincome tax deduction offered to United States manufacturers. Approximately 85%of our income before income taxes was generated from our United Statesoperations during the three months ended October 31, 2010. For the threemonths ended October 31, 2009, virtually all of our income before incometaxes related to our United States operations.

 

Approximately 8.8% of ourincome before income taxes was generated from our Canadian operations for thethree months ended October 31, 2010 compared with an insignificant amountin the prior year period. Our Canadian operations had an overall effective taxrate of 29.0% for the three months ended October 31, 2010.

 

For the three months ended October 31,2010 and 2009, approximately 3.4% and 1.2%, respectively, of our income beforeincome taxes was generated from our operations in Singapore, a country with alow corporate tax structure. The overall effective tax rate for our Singaporeoperation was 16.4% and 8.2% for the three months ended October 31, 2010and 2009, respectively.

 

Approximately 1.9% of ourincome before income taxes was generated from our subsidiary in Japan for thethree months ended October 31, 2010 compared with a small loss in theprior year period. Due to the uncertainty of our Japan subsidiary utilizing taxbenefits in the future, a tax benefit was not recorded on the losses fromoperations at our Japan subsidiary during the three months ended October 31,2009, thereby adversely affecting our overall consolidated effective tax ratein the prior year period. For the three months ended October 31, 2010, ourJapan operation was slightly profitable and we recorded no income taxes due tothe existence of net operating loss carryforwards.

 

The results of operationsfor our Netherlands subsidiary did not have a significant impact on our overalleffective tax rate for the three months ended October 31, 2010 and 2009due to the size of income before income taxes generated from this operation.

 

We record liabilities for anunrecognized tax benefit when a tax benefit for an uncertain tax position istaken or expected to be taken on a tax return, but is not recognized in ourCondensed Consolidated Financial Statements because it does not meet themore-likely-than-not recognition threshold that the uncertain tax positionwould be sustained upon examination by the applicable taxing authority. The taxbenefits recognized in the financial statements from such a position aremeasured based on the largest benefit that has a greater than fifty percentlikelihood of being realized upon settlement with the tax authorities. Themajority of our unrecognized tax benefits originated from acquisitions. Anyadjustments upon resolution of income tax uncertainties that predate or resultfrom acquisitions are recognized in our results of operations. 

 

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However, if our unrecognizedtax benefits are recognized in our financial statements in future periods,there would not be a significant impact to our overall effective tax rate dueto the size of the unrecognized tax benefits in relation to our income beforeincome taxes. Except for decreases due to the lapse of applicable statutes oflimitation, we do not expect such unrecognized tax benefits to significantlydecrease or increase in the next twelve months.

 

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

 
| ** **                                                    | ** ** | **Unrecognized**      | ** ** |
|---------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                    | ** ** | **Tax Benefits** | ** ** |
|                                                          |       |                  |       |
| Unrecognized  tax benefits on July 31, 2009              |       | $                     | 380,000    |   |
| Lapse  of statute of limitations                              |       | (172,000              | )          |
| Unrecognized  tax benefits on July 31, 2010              |       | 208,000               |       |
| Activity  during the three months ended October 31, 2010 |       | —                |       |
| Unrecognized  tax benefits on October 31, 2010           |       | $                     | 208,000    |   |

 

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

 

Ourpolicy is to record potential interest and penalties related to income taxpositions in interest expense and general and administrative expense,respectively, in our Condensed Consolidated Financial Statements. However, suchamounts have been relatively insignificant due to the amount of ourunrecognized tax benefits relating to uncertain tax positions.

 

**Note 12. Commitments and Contingencies**

 

***Long-term contractualobligations***

 

As of October 31, 2010,aggregate annual required payments over the remaining fiscal year, the nextfour years and thereafter under our contractual obligations that have long-termcomponents were as follows:

 
| ** **                                                  | ** ** | **Nine Months**                 | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|
| ** **                                                  | ** ** | **Ending**                           | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                                                  | ** ** | **July 31,**                    | ** ** | **Year Ending July 31,** | ** ** | ** ** | ** ** |
| ** **                                                  | ** ** | **2011**                             | ** ** | **2012**                                | ** ** | **2013**   | ** ** | **2014**   | ** ** | **2015**   | ** ** | **Thereafter** | ** ** | **Total**  | ** ** |
| ** **                                                  | ** ** | **(Amounts in thousands)** | ** ** |
| Maturities  of the credit facilities                        |       | $                                    | 7,500      |                                    | $          | 25,500     |       | $          | —     |       | $          | —         |       | $          | —     |   | $ | — |   | $ | 33,000 |   |
| Expected  interest payments under the credit facilities (1) |       | 456                                  |       | —                                  |       | —     |       | —     |       | —     |       | —         |       | 456        |       |
| Minimum  commitments under noncancelable operating leases   |       | 2,360                                |       | 2,546                                   |       | 1,861      |       | 1,519      |       | 1,150      |       | 5,695          |       | 15,131     |       |
| Minimum  commitments under noncancelable capital leases     |       | 6                                    |       | —                                  |       | —     |       | —     |       | —     |       | —         |       | 6          |       |
| Deferred  compensation and other                            |       | 304                                  |       | 307                                     |       | 37         |       | 33         |       | 33         |       | 132            |       | 846        |       |
| Acquisition  payable                                        |       | 1,550                                |       | 1,550                                   |       | —     |       | —     |       | —     |       | —         |       | 3,100      |       |
| Employment  agreements                                      |       | 1,886                                |       | 943                                     |       | —     |       | —     |       | —     |       | —         |       | 2,829      |       |
| Total  contractual obligations                              |       | $                                    | 14,062     |                                    | $          | 30,846     |       | $          | 1,898      |       | $          | 1,552          |       | $          | 1,183      |   | $ | 5,827 |   | $ | 55,368 |   |

 

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(1) The expectedinterest payments under the term and revolving credit facilities reflectinterest rates of 2.48% and 1.98%, respectively, which were our weightedaverage interest rates on outstanding borrowings at October 31, 2010.

 

***Operating leases***

 

Minimum commitments underoperating leases include minimum rental commitments for our leasedmanufacturing facilities, warehouses, office space and equipment.

 

***Deferred compensation***

 

Included in other long-term liabilitiesare deferred compensation arrangements for certain former Minntech directorsand officers.

 

***Acquisition payable***

 

In connection with theGambro Water acquisition, as more fully described in Note 3 to the CondensedConsolidated Financial Statements, a portion of the purchase price amounting to$3,100,000 will be paid in six equal quarterly payments beginning January 2011and ending April 2012.

 

***Employment agreements***

 

We had previously enteredinto various employment agreements with executives of the Company, includingour Corporate executive officers and our subsidiary Chief Executive Officers.All of such contracts expired and most were replaced effective January 1,2010 with severance contracts that defined certain compensation arrangementsrelating to various employment termination scenarios.

 

**Note13.****                                                  ****OperatingSegments**

 

We are a leading provider ofinfection prevention and control products and services in the healthcaremarket. Our products include specialized medical device reprocessing systemsfor renal dialysis and endoscopy, dialysate concentrates and other dialysissupplies, water purification equipment, sterilants, disinfectants and cleaners,hollow fiber membrane filtration and separation products for medical andnon-medical applications, and specialty packaging for infectious and biologicalspecimens. We also provide technical maintenance for our products and offercompliance training services for the transport of infectious and biologicalspecimens.

 

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

 

During our fourth quarter offiscal 2010, we changed our internal reporting processes to include a newoperating segment called Chemistries to reflect the way the Company, throughits executive management, manages, allocates resources and measures theperformance of its businesses. This new operating segment is the combination ofa small portion of our existing sterilant business, comprised of products soldon an OEM basis and previously recorded in our Water Purification andFiltration segment, and a new business operation that was created to

 

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capitalize on our chemistryexpertise and expand our product offerings in existing and new markets within theinfection prevention and control arena. As a result of this internalreorganization, certain research and development projects were reclassifiedamong segments. All prior period segment results have been restated to reflectthese changes.

 

The Company’s segments areas follows:

 

**Water Purification and Filtration**, whichincludes water purification equipment design and manufacturing, projectmanagement, installation, maintenance, deionization and mixing systems, as wellas hollow fiber 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.

 

One customer accounted forapproximately 20% of our Water Purification and Filtration segment net salesand approximately 6% of our consolidated net sales during the three months endedOctober 31, 2010.

 

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

 

**Healthcare Disposables**, whichincludes single-use infection prevention and control products used principallyin the dental market such as face masks, sterilization pouches, patient towelsand bibs, self-sealing sterilization pouches, tray covers, surface barriersincluding eyewear, aprons and gowns, disinfectants, germicidal wipes, hand careproducts, gloves, sponges, cotton products, cups, needles and syringes,scalpels and blades, and saliva evacuators and ejectors.

 

Four customers collectivelyaccounted for approximately 59% of our Healthcare Disposables segment net salesand approximately 14% of our consolidated net sales during the three monthsended October 31, 2010.

 

**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.

 

One customer accounted forapproximately 36% of our Dialysis segment net sales and approximately 8% of ourconsolidated net sales during the three months ended October 31, 2010.

 

**All Other**

 

In accordance withquantitative thresholds established by ASC 280, we have combined theTherapeutic Filtration, Specialty Packaging and Chemistries operating segmentsinto the All Other reporting segment.

 

**Therapeutic Filtration**, whichincludes hollow fiber filter devices and ancillary products for use in medicalapplications that are sold to biotech manufacturers and third-partydistributors.

 

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**SpecialtyPackaging**, which includes specialty packaging and thermalcontrol products, as well as related compliance training, for the safetransport of infectious and biological specimens and thermally sensitivepharmaceutical, medical and other products.

 

**Chemistries,**which includessterilants, disinfectants, detergents and decontamination services used invarious applications for infection prevention and control.

 

Noneof our customers accounted for 10% or more of our consolidated net sales duringthe three months ended October 31, 2010 and 2009. However, as a result ofthe Gambro Acquisition, DaVita (the largest customer of Gambro Water) wouldhave likely accounted for approximately 10% of our consolidated net sales forthe three months ended October 31, 2010 had the acquisition occurred atthe beginning of the fiscal year.

 

The operating segmentsfollow the same accounting policies used for our Condensed ConsolidatedFinancial Statements as described in Note 2 to the 2010 Form 10-K.

 

Information as to operatingsegments is summarized below:

 
| ** **                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|
| ** **                         | ** ** | **October 31,**             | ** ** |
| ** **                         | ** ** | **2010**                         | ** ** | **2009** | ** ** |
|                               |       |                             |       |   |   |
| Net  sales:                        |       |                             |       |   |   |
| Water  Purification and Filtration |       | $                                | 20,606,000 |   | $ | 18,114,000 |   |
| Endoscope  Reprocessing            |       | 19,700,000                       |       | 14,790,000 |   |
| Healthcare  Disposables            |       | 17,321,000                       |       | 20,582,000 |   |
| Dialysis                           |       | 9,820,000                        |       | 12,829,000 |   |
| All  Other                         |       | 4,546,000                        |       | 4,680,000 |   |
| Total                              |       | $                                | 71,993,000 |   | $ | 70,995,000 |   |
|                               |       |                             |       |   |   |
| Operating  income:                 |       |                             |       |   |   |
| Water  Purification and Filtration |       | $                                | 1,712,000  |   | $ | 2,027,000 |   |
| Endoscope  Reprocessing            |       | 2,035,000                        |       | 1,728,000 |   |
| Healthcare  Disposables            |       | 2,870,000                        |       | 4,848,000 |   |
| Dialysis                           |       | 2,573,000                        |       | 2,988,000 |   |
| All  Other                         |       | 580,000                          |       | 1,121,000 |   |
|                               |       | 9,770,000                        |       | 12,712,000 |   |
| General  corporate expenses        |       | (1,956,000                       | )          | (2,348,000 | ) |
| Interest  expense, net             |       | (222,000                         | )          | (379,000 | ) |
|                               |       |                             |       |   |   |
| Income  before income taxes        |       | $                                | 7,592,000  |   | $ | 9,985,000 |   |

 

**Note 14.****             ****LegalProceedings**

 

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

 

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**Note 15.****             ****ConvertibleNote Receivable**

 

In February 2009, weinvested an initial $200,000 in a senior subordinated convertible promissorynote issued by BIOSAFE, Inc. (“BIOSAFE”), in connection with BIOSAFE’sgrant to us of certain exclusive and non-exclusive license rights to BIOSAFE’santimicrobial additive. BIOSAFE is the owner of a patented and proprietaryantimicrobial agent that is built into the manufacturing of end-products toachieve long-lasting microbial protection on such end-products’ surface. As aresult of BIOSAFE’s successful raising of a minimum incremental amount of cashfollowing our investment, we invested an additional $300,000 in notes ofBIOSAFE in January 2010 bringing the aggregate investment in BIOSAFE notesto $500,000, as obligated under our agreement with BIOSAFE. We are notobligated to invest any additional funds.

 

The notes are convertibleinto a newly-created series of preferred stock of BIOSAFE. Interest is payablein shares of BIOSAFE stock or in cash. The notes accrue interest at a per annumrate of 8% until the maturity date of June 30, 2011 or earlier exercise.If not paid by the maturity date, interest will accrue thereafter at a rate of12% per annum. In connection with our investment, we entered into a licenseagreement with BIOSAFE under which we will pay BIOSAFE a fixed royaltypercentage of sales of our products containing BIOSAFE’s antimicrobialformulation. This investment, together with the accrued interest, is includedwithin other assets in our Condensed Consolidated Balance Sheets at October 31,2010 and July 31, 2010. The carrying value of this investment approximatesfair value due to the short maturity of the notes and the relative consistentunderlying value of BIOSAFE.

 

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

 

The following Management’s Discussion andAnalysis of Financial Condition and Results of Operations (“MD&A”) isintended to help you understand Cantel Medical Corp. (“Cantel”). The MD&Ais provided as a supplement to and should be read in conjunction with ourfinancial statements and the accompanying notes. Our MD&A includes thefollowing 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.

 

**Results of Operations** provides adiscussion of the consolidated results of operations for the three months endedOctober 31, 2010 compared with the three months ended October 31,2009.

 

**Liquidity and Capital Resources** provides anoverview of our working capital, cash flows, contractual obligations, financingand foreign currency activities.

 

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

 

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

 

**Overview**

 

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

 

·      WaterPurification and Filtration: Water purificationequipment and services, filtration and separation products, and disinfectantsfor the medical, pharmaceutical, biotech, beverage and commercial industrialmarkets.

 

·      EndoscopeReprocessing: Medical device reprocessing systems,disinfectants, detergents and other supplies used to high-level disinfectflexible endoscopes.

 

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

 

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

 

·      TherapeuticFiltration: Hollow fiber membrane filtration and separationtechnologies for medical applications. (Included in the All Other reportingsegment.)

 

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

 

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

 

Most of our equipment,consumables and supplies are used to help prevent the occurrence 

 

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or spread of infections.

 

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

 

***Significant Activity***

 

(i)           Despite slightgrowth in net sales of 1.4% to $71,993,000 for the three months ended October 31,2010 compared with the three months ended October 31, 2009, whichrepresents a new quarterly record for our business, net income decreased by19.3% in the current year quarter. The primary factors that contributed to thisreduction in net income, as further described elsewhere in this MD&A, wereas follows:

 

·            a decrease ingross profit percentage to 39.2% for the three months ended October 31,2010 from 41.5% in the comparative quarter due principally to unfavorable salesmix attributable to,

 

(i)            atypical demandin the prior year period for higher margin face masks and other healthcaredisposables products as a result of the elevated level of reported cases of thenovel H1N1 flu (swine flu), which contributed approximately $2,600,000 and$1,640,000 in incremental gross profit and net income, respectively, or $0.10in earnings per share, and

 

(ii)           an increase insales volume of lower margin capital equipment in our Endoscope Reprocessingand Water Purification and Filtration segments including sales associated withour recent acquisitions.

 

·            decreases innet sales and profitability in our Dialysis segment, and

 

·            increasedinvestment in sales, marketing and research and development activities.

 

Theabove factors were partially offset by:

 

·            significantincreases in net sales of capital equipment, service, disinfectants andequipment accessories in our Endoscope Reprocessing segment resulting inincreased profitability for this segment,

 

·            favorableinterest costs due to lower average outstanding borrowings, and

 

·            a decrease inthe consolidated effective tax rate primarily due to the geographic mix ofpre-tax income.

 

Wecontinue to benefit from having a broad portfolio of infection prevention andcontrol products sold into diverse business segments and we have proactivelydeveloped our overall business to where approximately 70% of our net sales areattributable to consumable products and service.

 

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(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 international customersas a result of the highly competitive and price sensitive market for suchproduct, as well as the decrease in demand for our Renatron® reprocessing equipment, sterilants andreprocessing supplies, as more fully described elsewhere in this MD&A. Thisreduction in dialysis sales has reduced overall profitability in this segment.Our market for dialysis reprocessing products is limited to dialysis centersthat reuse dialyzers, which market has been decreasing in the United Statesdespite the environmental advantages and our belief that the per-procedure costof reuse dialyzers is more economical than single-use dialyzers. A furtherdecrease in the market for dialysis reprocessing products is likely to resultin continued loss of net sales and a lower level of profitability in thissegment in the future. See “Risk Factors” in our 2010 Form 10-K for adiscussion of our Dialysis segment.

 

(iii)         We acquired theUnited States water purification business of Gambro Renal Products, Inc. (“GRP”)and a Swedish-based affiliate of GRP (“Gambro Water” or the “Gambro Acquisition”)on October 6, 2010, as more fully describedin Note 3 to the Condensed Consolidated Financial Statements.

 

(iv)        While overallsales have increased in our Water Purification and Filtration segment for thethree months ended October 31, 2010 compared with the three months ended October 31,2009, this segment’s profitability was adversely impacted by a decrease in netsales of capital equipment used for dialysis due to the slow growth of theeconomy, the timing of orders in the prior year period from our largestcustomer in this segment, lower gross margins on capital equipment due to salesmix and one-time charges related to acquiring Gambro Water, as more fullydescribed elsewhere in this MD&A.

 

(v)         In fiscal 2010,we declared our first semiannual cash dividend of $0.05 per share ofoutstanding common stock, which was paid on each of January 29, 2010 and July 30,2010. On October 21, 2010, we announced an increase in the semiannual cashdividend to $0.06 per share of outstanding common stock and declared the nextdividend to be paid on January 28, 2011 to shareholders of record at theclose of business on January 14, 2011, as more fully described elsewherein this MD&A.

 

(vi)        We created anew operating segment named Chemistries, as more fully described elsewhere inthis MD&A.

 

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

 

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

 

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**Results of Operations**

 

The results of operationsdescribed below reflect the operating results of Cantel and its wholly-ownedsubsidiaries. Since the Gambro Acquisition was completed on October 6,2010, its results of operations are included in our results of operations forthe portion of the three months ended October 31, 2010 subsequent to itsacquisition date, but are not reflected in our results of operations for thethree months ended October 31, 2009. Since the acquisition of Purity wascompleted on June 1, 2010, its results of operations are included in ourresults of operations for the three months ended October 31, 2010, but arenot reflected in our results of operations for the three months ended October 31,2009.

 

During our fourth quarter offiscal 2010, we changed our internal reporting processes to include a newoperating segment called Chemistries to reflect the way the Company, throughits executive management, manages, allocates resources and measures theperformance of its businesses. This new operating segment is the combination ofa small portion of our existing sterilant business, comprised of products soldon an OEM basis and previously recorded in our Water Purification andFiltration segment, and a new business operation that was created to capitalizeon our chemistry expertise and expand our product offerings in existing and newmarkets within the infection prevention and control arena. As a result of thisinternal reorganization, certain research and development projects werereclassified among segments. All prior period segment results have beenrestated to reflect these changes.

 

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

 

The following table givesinformation as to the net sales and the percentage to the total net sales foreach of our reporting segments:

 
| ** **                         | ** ** | **Three Months Ended**                 | ** ** |
|------------------------------------|------------|--------------------------------------------------|------------|
| ** **                         | ** ** | **October 31,**                             | ** ** |
| ** **                         | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| ** **                         | ** ** | **(Dollar amounts in thousands)** | ** ** |
| ** **                         | ** ** | **$**                                            | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
|                               |       |                                             |       |   |   |   |   |   |   |
| Water  Purification and Filtration |       | $                                                | 20,606     |   | 28.6 |   | $ | 18,114 |   | 25.5 |   |
| Endoscope  Reprocessing            |       | 19,700                                           |       | 27.4 |   | 14,790 |   | 20.8 |   |
| Healthcare  Disposables            |       | 17,321                                           |       | 24.1 |   | 20,582 |   | 29.0 |   |
| Dialysis                           |       | 9,820                                            |       | 13.6 |   | 12,829 |   | 18.1 |   |
| All  Other                         |       | 4,546                                            |       | 6.3 |   | 4,680 |   | 6.6 |   |
|                               |       | $                                                | 71,993     |   | 100.0 |   | $ | 70,995 |   | 100.0 |   |

 

***Net Sales***

 

Net sales increased by$998,000, or 1.4%, to $71,993,000 for the three months ended October 31,2010 from $70,995,000 for the three months ended October 31, 2009.

 

The increase in net salesfor the three months ended October 31, 2010 was principally attributableto increases in sales of endoscope reprocessing products and services and waterpurification and filtration products and services, partially offset bydecreases in sales of healthcare disposables products and dialysis products.

 

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Net sales of endoscopereprocessing products and services increased by 33.2% for the three monthsended October 31, 2010, compared with the three months ended October 31,2009, primarily due to increases in both domestic and international demand for (i) ourendoscope reprocessing equipment and (ii) our service, disinfectants andequipment accessories due to the increased field population of equipment. Weattribute the increased demand in our endoscope reprocessing equipment to ourinvestments in new product offerings and sales and marketing programs.Partially offsetting these increases were slightly lower net sales as a resultof decreases in selling prices of our endoscope reprocessing equipment.

 

Net sales of waterpurification and filtration products and services increased by 13.8% for thethree months ended October 31, 2010, compared with the three months ended October 31,2009, primarily due to (i) an increase in demand for capital equipmentused for commercial and industrial applications, (ii) approximately$940,000 of net sales due to the Gambro Acquisition on October 6, 2010 and(iii) an increase in demand for our sterilants and filters within ourinstalled equipment base of business. Partially offsetting these increases wasa decrease in demand for our water purification equipment used for dialysisprimarily as a result of the slow growth of the overall economy and the timingof orders in the prior year period from our largest customer in this segment.Increases in selling prices of our water purification products and services didnot have a significant effect on net sales for the three months ended October 31,2010, compared with the three months ended October 31, 2009.

 

Net sales of healthcaredisposables products decreased by 15.8% for the three months ended October 31,2010, compared with the three months ended October 31, 2009, primarily dueto decreased sales volume of higher margin face masks, disinfectants and otherhealthcare disposables products that were in strong demand during the prior yearoutbreak of the novel H1N1 flu (swine flu). Although the outbreak of the novelH1N1 flu resulted in strong sales volume of higher margin face masks and otherhealthcare disposables products during the first four months of fiscal 2010,such sales volume has returned to a sales level that is similar to that whichexisted prior to the outbreak of the novel H1N1 flu, with the exception ofsales to certain distributors who are overstocked with face masks, given thatthe elevated level of reported cases of influenza viruses has subsided and anew outbreak has not occurred. Atypical demand for face masks is highlydependent upon the severity and timing of any pandemic flu outbreak such as therecent novel H1N1 flu, the ability of our Company to educate existing customersand potential new customers on the benefits of our face masks, disinfectantsand other products and the level of urgency our customers, government agenciesand the general public develop and maintain with respect to epidemic andpandemic preparedness. Partially offsetting this decrease in sales volume were (i) increaseddemand for our sterilization accessories as a result of favorable sales andmarketing initiatives and (ii) approximately $330,000 in higher net salesas a result of increases in selling prices that were implemented to offsetcorresponding supplier cost increases.

 

Net sales of dialysisproducts and services decreased by 23.5% for the three months ended October 31,2010, compared with the three months ended October 31, 2009, primarily dueto (i) the expected adverse impact of losing some dialysate concentratebusiness (a concentrated acid or bicarbonate used to prepare dialysate, achemical solution that draws waste products from a patient’s blood through adialyzer membrane during hemodialysis treatment) from domestic andinternational customers as a result of the highly competitive and pricesensitive market for this lower margin commodity product, as well as variousglobal economic factors with respect to international demand, and (ii) adecrease in demand in the United States (including a decrease from our largestdialysis customer) for our Renatron dialyzer reprocessing equipment, sterilants

 

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and reprocessing supplies.Due to sales price decreases by some of our competitors, we expect a continueddecrease in net sales of our lower margin dialysate concentrate product in thefuture as we elect not to pursue unprofitable concentrate sales. Furthermore,Fresenius Medical Care (“Fresenius”), the largest dialysis provider chain inthe United States, manufactures dialysate concentrate themselves and has beendecreasing their purchases of that product from us and may continue to do so inthe future. Our market for dialysis reprocessing products is limited todialysis centers that reuse dialyzers, which market has been decreasing in theUnited States despite the environmental advantages and our belief that the perprocedure cost of reuse dialyzers is more economical than single-use dialyzers.A further decrease in the market for dialysis reprocessing products is likelyto result in continued loss of net sales and a lower level of profitability inthis segment in the future. Increases in selling prices of our dialysisproducts did not have a significant effect on net sales for the three monthsended October 31, 2010, compared with the three months ended October 31,2009.

 

***Gross profit***

 

Gross profit decreased by$1,266,000, or 4.3%, to $28,192,000 for the three months ended October 31,2010 from $29,458,000 for the three months ended October 31 2009. Grossprofit as a percentage of net sales for the three months ended October 31,2010 and 2009 was 39.2% and 41.5%, respectively.

 

The gross profit percentagefor the three months ended October 31, 2010 decreased compared with thethree months ended October 31, 2009 primarily due to (i) a lessfavorable sales mix due to a decrease in sales volume of high margin facemasks, disinfectants and other healthcare disposables products that were instrong demand during the prior year outbreak of the novel H1N1 flu (swine flu)and increases in sales volume of certain lower margin products such as capitalequipment sales in our Endoscope Reprocessing and Water Purification andFiltration segments, (ii) lower overhead absorption in our WaterPurification and Filtration segment as a result of the decrease in sales ofcapital equipment used for dialysis, (iii) the inclusion of sales withlower gross margin as a result of acquiring Gambro Water and (iv) anincrease in raw materials and distribution costs primarily due to the higherprice of oil.

 

We cannot provide assurancesthat our gross profit percentage will not be further adversely affected in thefuture (i) by price competition in certain of our segments such asHealthcare Disposables, Endoscope Reprocessing and Dialysis, (ii) byuncertainties associated with our product mix or (iii) if raw materialsand distribution costs increase and we are unable to implement price increases.Additionally, despite expensiveshipping costs, some of our competitors manufacture certain healthcaredisposable products in China and Southeast Asia due to lower overall costs incertain parts of that region of the world. Although we believe the quality ofour healthcare disposable products, which are generally produced in the UnitedStates, are superior to similar products produced in China and Southeast Asia,we expect to experience significant pricing pressure that will adversely affectour gross profit for the remainder of fiscal 2011 in our Healthcare Disposablessegment as a result of low cost competition in China and Southeast Asia.

 

***Operating Expenses***

 

Selling expenses increasedby $1,107,000, or 13.0%, to $9,631,000 for the three months ended October 31,2010 from $8,524,000 for the three months ended October 31, 2009,primarily due to (i) an increase of approximately $920,000 relating toadditional sales personnel and higher 

 

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incentive compensation inorder to expand into new markets and gain market share principally in ourEndoscope Reprocessing and Water Purification and Filtration segments, and to alesser extent in our new Chemistries segment, and (ii) an increase ofapproximately $120,000 in advertising and marketing expense primarily relatedto our Healthcare Disposables segment.

 

Sellingexpenses as a percentage of net sales were 13.4% and 12.0% for the three monthsended October 31, 2010 and 2009, respectively. The increase in our sellingexpense as a percentage of net sales was due to our strategic decision toinvest in selling initiatives designed to gain or maintain market share as wellas to expand into new markets.

 

Generaland administrative expenses decreased by $187,000 to $9,118,000 for the threemonths ended October 31, 2010, from $9,305,000 for the three months ended October 31,2009, primarily due to a decrease of approximately $485,000 in incentivecompensation in all of our locations and a $94,000 decrease in stock-basedcompensation expense, partially offset by increases of approximately $220,000in administrative personnel, including temporary employees, and approximately$205,000 in acquisition-related costs related to the Gambro Acquisition.

 

Generaland administrative expenses as a percentage of net sales were 12.7% and 13.1%for the three months ended October 31, 2010 and 2009, respectively.

 

Researchand development expenses (which include continuing engineering costs) increasedby $364,000 to $1,629,000 for the three months ended October 31, 2010, from$1,265,000 for the three months ended October 31, 2009. This increase isprimarily due to development work on certain new products in our newly createdChemistries operating segment. For the remainder of fiscal 2011, we intend toaccelerate investments in research and development to leverage our newChemistry group across various infection prevention and control opportunities.

 

***Interest***

 

Interest expense decreasedby $146,000 to $241,000 for the three months ended October 31, 2010, from$387,000 for the three months ended October 31, 2009, primarily due todecreases in average outstanding borrowings.

 

Interest income increased by$11,000 to $19,000 for the three months ended October 31, 2010, from$8,000 for the three months ended October 31, 2009, due to increasing ourinvestment in a senior subordinated convertible promissory note issued byBIOSAFE, Inc. (“BIOSAFE”), as more fully described elsewhere in thisMD&A.

 

***Income taxes***

 

The consolidated effectivetax rate was 34.5% and 38.2% for the three months ended October 31, 2010and 2009, respectively. The decrease in the consolidated effective tax rate wasprincipally due to the geographic mix of pre-tax income and an increase to aUnited States Federal income tax deduction, as described below.

 

The majority of our incomebefore income taxes was generated from our United States operations, which hadan overall effective tax rate of 36.7% and 38.1% for the three months ended October 31,2010 and 2009, respectively. The lower overall effective tax rate for the threemonths ended October 31, 2010 was principally caused by Federal taxlegislation that is now fully phased in, which enabled us to claim a largerincome tax deduction offered to United States 

 

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manufacturers. Approximately85% of our income before income taxes was generated from our United Statesoperations during the three months ended October 31, 2010. For the threemonths ended October 31, 2009, virtually all of our income before incometaxes related to our United States operations.

 

Approximately 8.8% of ourincome before income taxes was generated from our Canadian operations for thethree months ended October 31, 2010 compared with an insignificant amountin the prior year period. Our Canadian operations had an overall effective taxrate of 29.0% for the three months ended October 31, 2010.

 

For the three months ended October 31,2010 and 2009, approximately 3.4% and 1.2%, respectively, of our income beforeincome taxes was generated from our operations in Singapore, a country with alow corporate tax structure. The overall effective tax rate for our Singaporeoperation was 16.4% and 8.2% for the three months ended October 31, 2010and 2009, respectively.

 

Approximately 1.9% of ourincome before income taxes was generated from our subsidiary in Japan for thethree months ended October 31, 2010 compared with a small loss in theprior year period. Due to the uncertainty of our Japan subsidiary utilizing taxbenefits in the future, a tax benefit was not recorded on the losses fromoperations at our Japan subsidiary during the three months ended October 31,2009, thereby adversely affecting our overall consolidated effective tax ratein the prior year period. For the three months ended October 31, 2010, ourJapan operation was slightly profitable and we recorded no income taxes due tothe existence of net operating loss carryforwards.

 

The results of operationsfor our Netherlands subsidiary did not have a significant impact on our overalleffective tax rate for the three months ended October 31, 2010 and 2009due to the size of income before income taxes generated from this operation.

 

We record liabilities for anunrecognized tax benefit when a tax benefit for an uncertain tax position istaken or expected to be taken on a tax return, but is not recognized in ourCondensed Consolidated Financial Statements because it does not meet themore-likely-than-not recognition threshold that the uncertain tax positionwould be sustained upon examination by the applicable taxing authority. The taxbenefits recognized in the financial statements from such a position aremeasured based on the largest benefit that has a greater than fifty percentlikelihood of being realized upon settlement with the tax authorities. Themajority of our unrecognized tax benefits originated from acquisitions. Anyadjustments upon resolution of income tax uncertainties that predate or resultfrom acquisitions are recognized in our results of operations. However, if ourunrecognized tax benefits are recognized in our financial statements in futureperiods, there would not be a significant impact to our overall effective taxrate due to the size of the unrecognized tax benefits in relation to our incomebefore income taxes. Except for decreases due to the lapse of applicablestatutes of limitation, we do not expect such unrecognized tax benefits tosignificantly decrease or increase in the next twelve months.

 

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

 
| ** **                                                    | ** ** | **Unrecognized**      | ** ** |
|---------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                    | ** ** | **Tax Benefits** | ** ** |
|                                                          |       |                  |       |
| Unrecognized  tax benefits on July 31, 2009              |       | $                     | 380,000    |   |
| Lapse  of statute of limitations                              |       | (172,000              | )          |
| Unrecognized  tax benefits on July 31, 2010              |       | 208,000               |       |
| Activity  during the three months ended October 31, 2010 |       | —                |       |
| Unrecognized  tax benefits on October 31, 2010           |       | $                     | 208,000    |   |

 

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

 

Ourpolicy is to record potential interest and penalties related to income taxpositions in interest expense and general and administrative expense,respectively, in our Condensed Consolidated Financial Statements. However, suchamounts have been relatively insignificant due to the amount of ourunrecognized tax benefits relating to uncertain tax positions.

 

***Stock-Based Compensation***

 

The following table showsthe income statement components of stock-based compensation expense recognizedin the Condensed Consolidated Statements of Income:

 
| ** **                                                              | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                              | ** ** | **October 31,**             | ** ** |
| ** **                                                              | ** ** | **2010**                         | ** ** | **2009** | ** ** |
|                                                                    |       |                             |       |   |   |
| Cost  of sales                                                          |       | $                                | 38,000     |   | $ | 18,000 |   |
| Operating  expenses:                                                    |       |                             |       |   |   |
| Selling                                                                 |       | 115,000                          |       | 69,000 |   |
| General  and administrative                                             |       | 604,000                          |       | 698,000 |   |
| Research  and development                                               |       | 8,000                            |       | 4,000 |   |
| Total  operating expenses                                               |       | 727,000                          |       | 771,000 |   |
| Stock-based  compensation before income taxes                           |       | 765,000                          |       | 789,000 |   |
| Income  tax benefits                                                    |       | (275,000                         | )          | (290,000 | ) |
| Total  stock-based compensation expense, net of tax                     |       | $                                | 490,000    |   | $ | 499,000 |   |
|                                                                    |       |                             |       |   |   |
| Decrease  in earnings per common share due to stock-based compensation: |       |                             |       |   |   |
|                                                                    |       |                             |       |   |   |
| Basic                                                                   |       | $                                | 0.03       |   | $ | 0.03 |   |
|                                                                    |       |                             |       |   |   |
| Diluted                                                                 |       | $                                | 0.03       |   | $ | 0.03 |   |

 

The above stock-basedcompensation expense before income taxes was recorded in the Condensed ConsolidatedFinancial Statements as stock-based compensation expense and an increase toadditional paid-in capital. The related income tax benefits (which pertain onlyto stock awards and options that do not qualify as incentive stock options)were recorded as an increase to long-term 

 

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deferred income tax assets(which are netted with long-term deferred income tax liabilities) and areduction to income tax expense.

 

The stock-based compensationexpense recorded in the Condensed Consolidated Financial Statements may not berepresentative of the effect of stock-based compensation expense in futureperiods due to the level of awards issued in past years (which level may not besimilar in the future), modifications of existing awards and assumptions usedin determining fair value, expected lives and estimated forfeitures. Wedetermine the fair value of each stock award using the closing market price ofour Common Stock on the date of grant. We estimate the fair value of eachoption grant on the date of grant using the Black-Scholes option valuationmodel. The determination of fair value using an option-pricing model isaffected by our stock price as well as assumptions regarding a number ofsubjective variables. These variables include, but are not limited to, theexpected stock price volatility over the term of the expected option life(which is determined by using the historical closing prices of our CommonStock), the expected dividend yield (which historically was 0% and is nowapproximately 0.6% 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.

 

All of our stock options andstock awards (which consist only of restricted stock) are subject to gradedvesting in which portions of the award vest at different times during thevesting period, as opposed to awards that vest at the end of the vestingperiod. We recognize compensation expense for awards subject to graded vestingusing the straight-line basis over the vesting period, reduced by estimatedforfeitures. At October 31, 2010, total unrecognized stock-basedcompensation expense before income taxes, related to total nonvested stockoptions and stock awards which are expected to vest was $5,655,000 with aremaining weighted average period of 19 months over which such expense isexpected to be recognized.

 

Ifcertain criteria are met when options are exercised or restricted stock becomesvested, the Company is allowed a deduction on its income tax return.Accordingly, we account for the income tax effect on such income tax deductionsas additional paid-in capital or a reduction of deferred income tax assets(which are netted with long-term deferred income tax liabilities) and as areduction of income taxes payable. For the three months ended October 31,2010 and 2009, such income tax deductions reduced income taxes payable by$107,000 and $29,000, respectively.

 

We classify the cash flows resulting from excess taxbenefits as financing cash flows on our Condensed Consolidated Statements ofCash Flows. Excess tax benefits arise when the ultimate tax effect of thededuction for tax purposes is greater than the tax benefit on stockcompensation expense (including tax benefits on stock compensation expense thathas only been reflected in past pro forma disclosures relating to fiscal yearsprior to August 1, 2005) which was determined based upon the award’s fairvalue.

 

**Liquidity and Capital Resources**

 

***Working capital***

 

AtOctober 31, 2010, the Company’s working capital was $28,898,000, comparedwith $53,747,000 at July 31, 2010. The decrease in working capital wasprimarily due to borrowing

 

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$20,500,000 under ourrevolving credit facility to acquire Gambro Water and reclassifying the entireoutstanding balance of our revolving credit facility from long-term to currentas a result of its expiration occurring in less than one year on August 1,2011.

 

***Cash flows from operating activities***

 

Netcash provided by operating activities was $3,220,000 and $6,456,000 for thethree months ended October 31, 2010 and 2009, respectively. For the threemonths ended October 31, 2010, the net cash provided by operatingactivities was primarily due to net income (after adjusting for depreciation,amortization, stock-based compensation expense and deferred taxes), an increasein income taxes payable (due to the timing associated with tax payments) and adecrease in inventories, partially offset by a decrease in accounts payable andother current liabilities (due primarily to the timing associated withincentive compensation payments) and an increase in accounts receivables. Theincrease in accounts receivable and the decrease in inventories were primarilydue to strong sales of capital equipment for commercial and industrialapplications in our Water Purification and Filtration segment.

 

Forthe three months ended October 31, 2009, the net cash provided byoperating activities was primarily due to net income (after adjusting fordepreciation, amortization, stock-based compensation expense and deferredtaxes) and an increase in taxes payable (due to the timing associated with taxpayments), partially offset by increases in inventories (due to plannedincreases in stock levels of certain products primarily in our HealthcareDisposables and Endoscope Reprocessing segments) and accounts receivable (dueto strong October sales primarily in our Healthcare Disposables segment)and a decrease in accounts payable and other current liabilities (due primarilyto the timing associated with incentive compensation payments).

 

***Cash flows from investing activities***

 

Netcash used in investing activities was $21,861,000 and $1,664,000 for the threemonths ended October 31, 2010 and 2009, respectively. For the three monthsended October 31, 2010, the net cash used in investing activities wasprimarily for the acquisition of Gambro Water as well as capital expenditures.For the three months ended October 31, 2009, the net cash used ininvesting activities was primarily for capital expenditures.

 

***Cash flows from financing activities***

 

Netcash provided by financing activities was $12,034,000 for the three monthsended October 31, 2010, compared with net cash used in financingactivities of $5,053,000 for the three months ended October 31, 2009. Forthe three months ended October 31, 2010, the net cash provided byfinancing activities was due primarily to a borrowing under our revolvingcredit facility relating to the Gambro Acquisition, partially offset byrepayments under our credit facilities. For the three months ended October 31,2009, the net cash used in financing activities was primarily attributable torepayments under our credit facilities, partially offset by proceeds from theexercises of stock options.

 

***Dividends***

 

Infiscal 2010, we declared our first semiannual cash dividends of $0.05 per shareof outstanding common stock, which were paid on each of January 29, 2010and July 30, 2010, which totaled $1,683,000. On October 21, 2010, weannounced an increase in the semiannual cash 

 

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dividend to $0.06 per shareof outstanding common stock and declared the next dividend to be paid on January 28,2011 to shareholders of record at the close of business on January 14,2011. Future declaration of dividends and the establishment of future recordand payment dates are subject to the final determination of the Company’s Boardof Directors.

 

***Long-term contractualobligations***

 

As of October 31, 2010,aggregate annual required payments over the remaining fiscal year, the nextfour years and thereafter under our contractual obligations that have long-termcomponents were as follows:

 
| ** **                                                  | ** ** | **Nine Months**                 | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|------------|------------|
| ** **                                                  | ** ** | **Ending**                           | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                                                  | ** ** | **July 31,**                    | ** ** | **Year Ending July 31,** | ** ** | ** ** | ** ** |
| ** **                                                  | ** ** | **2011**                             | ** ** | **2012**                                | ** ** | **2013**   | ** ** | **2014**   | ** ** | **2015**   | ** ** | **Thereafter** | ** ** | **Total**  | ** ** |
| ** **                                                  | ** ** | **(Amounts in thousands)** | ** ** |
| Maturities  of the credit facilities                        |       | $                                    | 7,500      |                                    | $          | 25,500     |       | $          | —     |       | $          | —         |       | $          | —     |   | $ | — |   | $ | 33,000 |   |
| Expected  interest payments under the credit facilities (1) |       | 456                                  |       | —                                  |       | —     |       | —     |       | —     |       | —         |       | 456        |       |
| Minimum  commitments under noncancelable operating leases   |       | 2,360                                |       | 2,546                                   |       | 1,861      |       | 1,519      |       | 1,150      |       | 5,695          |       | 15,131     |       |
| Minimum  commitments under noncancelable capital leases     |       | 6                                    |       | —                                  |       | —     |       | —     |       | —     |       | —         |       | 6          |       |
| Deferred  compensation and other                            |       | 304                                  |       | 307                                     |       | 37         |       | 33         |       | 33         |       | 132            |       | 846        |       |
| Acquisition  payable                                        |       | 1,550                                |       | 1,550                                   |       | —     |       | —     |       | —     |       | —         |       | 3,100      |       |
| Employment  agreements                                      |       | 1,886                                |       | 943                                     |       | —     |       | —     |       | —     |       | —         |       | 2,829      |       |
| Total  contractual obligations                              |       | $                                    | 14,062     |                                    | $          | 30,846     |       | $          | 1,898      |       | $          | 1,552          |       | $          | 1,183      |   | $ | 5,827 |   | $ | 55,368 |   |

 

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(1) Theexpected interest payments under the term and revolving credit facilitiesreflect interest rates of 2.48% and 1.98%, respectively, which were our weightedaverage interest rates on outstanding borrowings at October 31, 2010.

 

***Credit facilities***

 

Our United States credit facilities, as amended, include (i) asix-year $40.0 million senior secured amortizing term loan facility and(ii) a five-year $50.0 million senior secured revolving credit facility,which both expire on August 1, 2011 (the “U.S. Credit Facilities”).Amounts we repay under the term loan facility may not be re-borrowed. Debtissuance costs relating to the U.S Credit Facilities were recorded in otherassets and are being amortized over the life of the credit facilities. Suchunamortized debt issuance costs amounted to approximately $224,000 at October 31,2010.

 

AtNovember 30, 2010, borrowings under our U.S. Credit Facilities bearinterest at rates ranging from 0.50% to 1.50% above the lender’s base rate, orat rates ranging from 1.50% to 2.50% above the London Interbank Offered Rate (“LIBOR”),depending upon our consolidated ratio of debt to earnings before interest,taxes, depreciation and amortization, and as further adjusted under the termsof the facilities (“EBITDA”). At November 30, 2010, the lender’s baserate was 3.25% and the LIBOR rates ranged from 0.25% to 1.21%. The marginsapplicable to our outstanding borrowings at November 30, 2010 were 0.50%above the lender’s base rate and 1.50% above LIBOR. All of our outstandingborrowings were under LIBOR contracts at November 30, 2010. The revolvingcredit facility also provides for fees on the unused portion at

 

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ratesranging from 0.20% to 0.40%, depending upon our consolidated ratio of debt toEBITDA; such rate was 0.20% at November 30, 2010.

 

TheU.S. Credit Facilities require us to meet certain financial covenants and aresecured by (i) substantially all of our U.S.-based assets (includingassets of Cantel, Minntech, Mar Cor, Crosstex and Strong Dental Products, Inc.)and (ii) our pledge of all of the outstanding shares of Minntech, Mar Cor,Crosstex and Strong Dental Products, Inc. and 65% of the outstanding sharesof our foreign-based subsidiaries. Additionally, we are not permitted to payannual cash dividends on our Common Stock in excess of $3,000,000 without theconsent of our United States lenders. As of October 31, 2010, we were incompliance with all financial and other covenants under the credit facilities.

 

On October 31, 2010, wehad $33,000,000 of outstanding borrowings under the U.S. Credit Facilities,which consisted of $7,500,000 and $25,500,000 under the term loan facility andthe revolving credit facility, respectively, and $24,500,000 was available tobe borrowed under our revolving credit facility. Subsequent to October 31,2010, we repaid $1,000,000 under the revolving credit facility reducing ourtotal outstanding borrowings to $32,000,000.

 

The U.S. Credit Facilitieshave a termination date of August 1, 2011. Although we may repay aportion of our outstanding borrowings under the revolver throughout fiscal2011, we do not presently anticipate paying off the revolver in full by itstermination date. We are in discussions with our bank syndicate regardingmodifications to our credit facilities, including an extension of thetermination date of the revolving credit facility, and expect to formallymodify the revolving credit facility before the expiration date. However, sinceany modification will not be completed until later in fiscal 2011, subsequentto July 31, 2010 the entire outstanding balance of the revolver wasreclassified from long-term to current.

 

***Operating leases***

 

Minimum commitments underoperating leases include minimum rental commitments for our leasedmanufacturing facilities, warehouses, office space and equipment.

 

***Deferred compensation***

 

Included in other long-termliabilities are deferred compensation arrangements for certain former Minntechdirectors and officers.

 

***Acquisition payable***

 

In connection with theGambro Water acquisition, as more fully described in Note 3 to the CondensedConsolidated Financial Statements, a portion of the purchase price amounting to$3,100,000 will be paid in six equal quarterly payments beginning January 2011and ending April 2012.

 

***Employment agreements***

 

We had previously enteredinto various employment agreements with executives of the Company, includingour Corporate executive officers and our subsidiary Chief Executive Officers.All of such contracts expired and most were replaced effective January 1,2010 with severance contracts that defined certain compensation arrangementsrelating to various

 

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employment terminationscenarios.

 

***Convertible NoteReceivable***

 

In February 2009, weinvested an initial $200,000 in a senior subordinated convertible promissorynote issued by BIOSAFE, Inc., in connection with BIOSAFE’s grant to us ofcertain exclusive and non-exclusive license rights to BIOSAFE’s antimicrobialadditive. BIOSAFE is the owner of a patented and proprietary antimicrobialagent that is built into the manufacturing of end-products to achievelong-lasting microbial protection on such end-products’ surface. As a result ofBIOSAFE’s successful raising of a minimum incremental amount of cash followingour investment, we invested an additional $300,000 in notes of BIOSAFE in January 2010bringing the aggregate investment in BIOSAFE notes to $500,000, as obligatedunder our agreement with BIOSAFE. We are not obligated to invest any additionalfunds.

 

The notes are convertibleinto a newly-created series of preferred stock of BIOSAFE. Interest is payablein shares of BIOSAFE stock or in cash. The notes accrue interest at a per annumrate of 8% until the maturity date of June 30, 2011 or earlier exercise.If not paid by the maturity date, interest will accrue thereafter at a rate of12% per annum. In connection with our investment, we entered into a licenseagreement with BIOSAFE under which we will pay BIOSAFE a fixed royaltypercentage of sales of our products containing BIOSAFE’s antimicrobialformulation. This investment, together with the accrued interest, is includedwithin other assets in our Condensed Consolidated Balance Sheets at October 31,2010 and July 31, 2010. The carrying value of this investment approximatesfair value due to the short maturity of the notes and the relative consistentunderlying value of BIOSAFE.

 

***Financing needs***

 

Althoughall of our operating segments generate significant cash from operations, ourHealthcare Disposables, Dialysis, Water Purification and Filtration andEndoscope Reprocessing segments are the largest generators of cash. At October 31,2010, we had a cash balance of $15,954,000, of which $2,907,000 was held byforeign subsidiaries. On September 28, 2010, we repatriated $5,500,000 inearnings from one of the foreign subsidiaries.

 

Webelieve that our current cash position, anticipated cash flows from operationsand the funds available under our revolving credit facility will be sufficientto satisfy our cash operating requirements for the foreseeable future basedupon our existing operations, particularly given that we historically have notneeded to borrow for working capital purposes. At November 30, 2010,$25,500,000 was available under our revolving credit facility, which expires onAugust 1, 2011.

 

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

 

***Foreign currency***

 

Duringthe three months ended October 31, 2010, compared with the three monthsended October 31, 2009, the average value of the Canadian dollar increasedby approximately 4.0%

 

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relative to the value of theUnited States dollar. Additionally, at October 31, 2010 compared with July 31,2010, the value of the Canadian dollar relative to the value of the UnitedStates dollar increased by approximately 0.5%. The financial statements of ourCanadian subsidiaries are translated using the accounting policies described inNote 2 to the 2010 Form 10-K and therefore are impacted by changes in theCanadian dollar exchange rate. Additionally, changes in the value of theCanadian dollar against the United States dollar affect our results ofoperations because a portion of our Canadian subsidiaries’ inventories andoperating costs (which are reported in the Water Purification and Filtrationand Specialty Packaging segments) are purchased in the United States and asignificant amount of their sales are to customers in the United States.

 

For the three months ended October 31,2010, compared with the three months ended October 31, 2009, the averagevalue of the euro and British pound decreased by approximately 8.8% and 4.0%,respectively, relative to the value of the United States dollar. Additionally,at October 31, 2010 compared with July 31, 2010, the value of theeuro and British pound relative to the United States dollar increased byapproximately 6.2% and 2.6%, respectively. Changes in the value of the euro andBritish pound against the United States dollar affect our results of operationsbecause certain cash bank accounts, accounts receivable and liabilities of ourUnited States subsidiaries, Minntech and Mar Cor, are denominated andultimately settled in euros or British pounds but must be converted into ourfunctional United States currency. Furthermore, the financial statements of ourNetherlands subsidiary are translated using the accounting policies describedin Note 2 of the 2010 Form 10-K and therefore are impacted by changes inthe euro exchange rate relative to the United States dollar.

 

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 contracts are designated as fair valuehedges. There were three foreign currency forward contracts with an aggregatevalue of $4,312,000 at November 30, 2010, which cover certain assets andliabilities that were denominated in currencies other than our subsidiaries’functional currencies. Such contracts expire on December 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 U.S. Credit Facilities, such contracts topurchase Canadian dollars, euros and British pounds may not exceed $12,000,000in an aggregate 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 contracts to buy Canadian dollars, euros and British pounds forward areimmediately realized within general and administrative expenses due to theshort-term nature of such contracts. For the three months ended October 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.

 

Changesin the value of the Japanese yen relative to the United States dollar duringthe three months ended October 31, 2010, compared with the three monthsended October 31, 2009, did not have a significant impact upon either ourresults of operations or the translation of our balance sheet, primarily due tothe fact that our Japanese subsidiary accounts for a relatively small portionof consolidated net sales, net income and net assets.

 

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Overall,fluctuations in the rates of currency exchange had an insignificant impact uponour net income for the three months ended October 31, 2010 compared withthe three months ended October 31, 2009.

 

Forpurposes of translating the balance sheet at October 31, 2010 comparedwith July 31, 2010, the total of the foreign currency movements resultedin a foreign currency translation gain of $58,000, net of tax, for the threemonths ended October 31, 2010, thereby increasing stockholders’ equity.

 

**Critical Accounting Policies**

 

Ourdiscussion and analysis of our financial condition and results of operationsare based upon our Condensed Consolidated Financial Statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosures of contingentassets and liabilities. On an ongoing basis, we continually evaluate ourestimates. We base our estimates on historical experience and on various otherassumptions that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates.

 

Webelieve the following critical accounting policies affect our more significantjudgments and estimates used in the preparation of our Condensed ConsolidatedFinancial Statements.

 

***RevenueRecognition***

 

Revenueon product sales is recognized as products are shipped to customers and titlepasses. The passing of title is determined based upon the FOB terms specifiedfor each shipment. With respect to dialysis, therapeutic, specialty packaging,chemistries and endoscope reprocessing products, shipment terms are generallyFOB origin for common carrier and FOB destination when our distribution fleetis utilized (except for one large customer in dialysis whereby all products areshipped FOB destination). With respect to water purification and filtration andhealthcare disposable products, shipment terms may be either FOB origin ordestination. Customer acceptance for the majority of our product sales occursat the time of delivery. With respect to a portion of water purification andfiltration product sales, equipment is sold as part of a system for which theequipment is functionally interdependent or the customer’s purchase orderspecifies “ship-complete” as a condition of delivery; revenue recognition onsuch sales is deferred until all equipment has been delivered, or post-deliveryobligations such as installation has been substantially fulfilled such that theproducts are deemed functional by the end-user.

 

Aportion of our endoscope reprocessing, water purification and filtration anddialysis sales are recognized as multiple element arrangements, whereby revenueis allocated to the equipment, installation and service components based uponvendor specific objective evidence, which includes comparable historicaltransactions of similar equipment and installation sold as stand-alonecomponents. If vendor-specific objective evidence of selling price is notavailable, we allocate revenue to the elements of the bundled arrangement usingthe estimated selling price method in order to qualify the components asseparate units of accounting. Revenue on the equipment component is recognizedas the equipment is shipped to customers and title passes. Revenue on theinstallation component is recognized when the installation is complete.

 

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

 

None of our sales containright-of-return provisions. Customer claims for credit or return due to damage,defect, shortage or other reason must be pre-approved by us before credit isissued or such product is accepted for return. No cash discounts for earlypayment are offered except with respect to a small portion of our sales ofdialysis, healthcare disposable and water purification and filtration productsand certain prepaid packaging products. We do not offer price protection,although advance pricing contracts or required notice periods prior toimplementation of price increases exist for certain customers with respect tomany of our products. With respect to certain of our dialysis, dental, waterpurification and filtration and endoscope reprocessing customers, volumerebates are provided; such volume rebates are provided for as a reduction ofsales at the time of revenue recognition and amounted to $735,000 and $764,000for the three months ended October 31, 2010 and 2009, respectively. Suchallowances are determined based on estimated projections of sales volume forthe entire rebate periods. If it becomes known that sales volume to customerswill deviate from original projections, the volume rebate provisions originallyestablished would be adjusted accordingly.

 

The majority of our dialysisproducts are sold to end-users; the majority of therapeutic filtration productsand healthcare disposable products are sold to third party distributors; waterpurification and filtration products and services are sold directly and throughthird-party distributors to hospitals, dialysis clinics, pharmaceutical andbiotechnology companies and other end-users; our endoscope reprocessingproducts and services are sold primarily to distributors internationally anddirectly to hospitals and other end-users in the United States; specialtypackaging products are sold to third-party distributors, medical researchcompanies, laboratories, pharmaceutical companies, hospitals, governmentagencies and other end-users; and chemistries products and services are sold tomedical products and service companies, laboratories, pharmaceutical companies,hospitals and other end-users. Sales to all of these customers follow ourrevenue recognition policies.

 

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

 

Accountsreceivable consist of amounts due to us from normal business activities.Allowances for doubtful accounts are reserves for the estimated loss from theinability of customers to make required payments. We use historical experienceas well as current market information in determining the estimate. While actuallosses have historically been within management’s expectations and provisionsestablished, if the financial condition of our customers were to deteriorate,resulting in an impairment of their ability to make payments, additionalallowances may be required. Alternatively, if certain customers paid theirdelinquent receivables, reductions in allowances may be required.

 

***Inventories***

 

Inventoriesconsist of raw materials, work-in-process and finished products which are sold 

 

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in the ordinary course ofour business and are stated at the lower of cost (first-in, first-out) ormarket. In assessing the value of inventories, we must make estimates andjudgments regarding reserves required for product obsolescence, aging ofinventories and other issues potentially affecting the saleable condition ofproducts. In performing such evaluations, we use historical experience as wellas current market information. With few exceptions, the saleable value of ourinventories has historically been within management’s expectation andprovisions established, however, rapid changes in the market due tocompetition, technology and various other factors could have an adverse effecton the saleable value of our inventories, resulting in the need for additionalreserves.

 

***Goodwill and Intangible Assets***

 

Certainof our identifiable intangible assets, including customer relationships,technology, brand names, non-compete agreements and patents, are amortizedusing the straight-line method over their estimated useful lives which rangefrom 3 to 20 years. Additionally, we have recorded goodwill and trademarks andtrade names, all of which have indefinite useful lives and are therefore notamortized. All of our intangible assets and goodwill are reviewed forimpairment 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 average fair value results of the market multiple anddiscounted cash flow methodologies, as well as the comparable transactionmethodology when applicable. 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 31,2010, management concluded that none of our intangible assets or goodwill wasimpaired. On October 31, 2010, management concluded that no events orchanges in circumstances have occurred during the three months ended October 31,2010 that would indicate that the carrying amount of our intangible assets andgoodwill may not be recoverable.

 

Whilethe results of these annual reviews have historically not indicated impairment,impairment reviews are highly dependent on management’s projections of ourfuture operating results and cash flows (which management believes to bereasonable), discount rates based on the Company’s weighted-average cost ofcapital and appropriate benchmark peer companies. Assumptions used indetermining future operating results and cash flows include current andexpected market conditions and future sales forecasts. Subsequent changes inthese assumptions and estimates could result in future impairment. Although weconsistently use the same methods in developing the assumptions and estimatesunderlying the fair value calculations, such estimates are uncertain by natureand can vary from actual results. At July 31, 2010, the average fair valueof all of our reporting units exceeded book value by substantial amounts, exceptour Specialty Packaging segment, which had an average fair value that exceededbook value by approximately 16%.

 

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***Long-Lived Assets***

 

We evaluate the carryingvalue of long-lived assets including property, equipment and other assetswhenever events or changes in circumstances indicate that the carrying valuemay not be recoverable. An assessment is made to determine if the sum of theexpected future non-discounted cash flows from the use of the assets andeventual disposition is less than the carrying value. If the sum of theexpected non-discounted cash flows is less than the carrying value, animpairment loss is recognized based on fair value. Our historical assessmentsof our long-lived assets have not differed significantly from the actualamounts realized. However, the determination of fair value requires us to makecertain assumptions and estimates and is highly subjective.

 

***Warranties***

 

Weprovide for estimated costs that may be incurred to remedy deficiencies ofquality or performance of our products at the time of revenue recognition. Mostof our products have a one year warranty, although a majority of our endoscopereprocessing equipment in the United States carries a warranty period of up tofifteen months. We record provisions for product warranties as a component ofcost of sales based upon an estimate of the amounts necessary to settleexisting and future claims on products sold. The historical relationship ofwarranty 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.

 

***Stock-Based Compensation***

 

We account for stock optionsand stock awards  under ASC 718 in whichstock compensation expense is recognized for any option or stock award grantbased upon the award’s fair value. Most of our stock options and stock awards(which consist only of restricted stock) are subject to graded vesting in whichportions of the award vest at different times during the vesting period, asopposed to awards that vest at the end of the vesting period. We recognizecompensation expense for awards subject to graded vesting using thestraight-line basis, reduced by estimated forfeitures. Forfeitures areestimated at the time of grant and revised, if necessary, in subsequent periodsif actual forfeitures differ from those estimates. Forfeitures are estimatedbased on historical experience.

 

The stock-based compensationexpense recorded in our Condensed Consolidated Financial Statements may not berepresentative of the effect of stock-based compensation expense in futureperiods due to the level of awards issued in past years (which level may not besimilar in the future), modifications to existing awards and assumptions usedin determining fair value, expected lives and estimated forfeitures. Wedetermine the fair value of each stock award using the closing market price ofour Common Stock on the date of grant. We estimate the fair value of eachoption grant on the date of grant using the Black-Scholes option valuationmodel. The determination of fair value using an option-pricing model isaffected by our stock price as well as assumptions regarding a number ofsubjective variables. These variables include, but are not limited to, theexpected stock price volatility over the term of the expected option life(which is determined by using the historical closing prices of our CommonStock), the expected dividend yield (which historically has been 0% and is nowapproximately 0.6% as we began paying 

 

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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***

 

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 ofanticipated exposure can be reasonably estimated. We do not believe that any ofthese pending claims or legal actions will have a material adverse effect onour business, financial condition, results of operations or cash flows.

 

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

 

Werecognize deferred tax assets and liabilities based on differences between thefinancial statement carrying amounts and the tax basis of assets andliabilities. Deferred tax assets and liabilities also include items recorded inconjunction with the purchase accounting for business acquisitions. Weregularly review our deferred tax assets for recoverability and establish 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 income tax rates, principally in the United States. If theincome tax rate were to change in the future, particularly in the United Statesand to a lesser extent Canada, our items of deferred tax could be materiallyaffected. All of such evaluations require significant management judgments.

 

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 majority of such unrecognized tax benefits originated fromacquisitions and are based primarily upon management’s assessment of exposureassociated with acquired companies. Any adjustments upon resolution of incometax uncertainties that predate or result from acquisitions are recognized inour results of operations. Unrecognized tax benefits are analyzed periodicallyand adjustments are made as events occur to warrant adjustment to the related liability.

 

***BusinessCombinations***

 

Acquisitionsrequire significant estimates and judgments related to the fair value of assetsacquired and liabilities assumed. We determine fair value based on theestimated price that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants at themeasurement date.

 

Certainliabilities and reserves are subjective in nature. We reflect such liabilitiesand reserves based upon the most recent information available. In conjunctionwith our acquisitions, such subjective liabilities and reserves principallyinclude certain income tax and sales and use tax 

 

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exposures, including taxliabilities related to our foreign subsidiaries, as well as reserves foraccounts receivable, inventories and warranties. The ultimate settlement ofsuch liabilities may be for amounts which are different from the amountsrecorded.

 

***Costs Associated with Exitor Disposal Activities***

 

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

 

Inherent in the calculationof liabilities relating to exit and disposal activities are significant managementjudgments and estimates, including estimates of termination costs, employeeattrition and the interest rate used to discount certain expected net cashpayments. Such judgments and estimates are reviewed by us on a regular basis.The cumulative effect of a change to a liability resulting from a revision toeither timing or the amount of estimated cash flows is recognized by us as anadjustment to the liability in the period of the change.

 

***Other Matters***

 

We do not have any offbalance sheet financial arrangements, other than future commitments underoperating leases and employment and license agreements.

 

**Forward Looking Statements**

 

This quarterly report on Form 10-Q contains “forward-lookingstatements” as that term is defined under the Private Securities LitigationReform Act of 1995 and releases issued by the Securities and ExchangeCommission (the “SEC”) and within the meaning of Section 27A of theSecurities 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:

 

·                  theincreasing market share of single-use dialyzers relative to reuse dialyzers inthe United States

·                  ourcontinuing loss of dialysate concentrate business

·                  our dependence on aconcentrated number of customers in three of our largest segments

·                  severityof flu outbreaks and level of urgency developed by customers with respect topandemic preparedness

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

·                  theacquisition of new businesses and successfully integrating and operating such 

 

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businesses

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

·                  foreigncurrency exchange rate fluctuations and trade barriers

·                  theimpact of significant government regulation on our businesses

 

Youshould understand that it is not possible to predict or identify all suchfactors. Consequently, you should not consider the foregoing items to be acomplete list of all potential risks or uncertainties. See “RiskFactors” in our 2010 Form 10-K for a discussion of the above risk factorsand certain additional risk factors that you should consider before investingin 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.                  QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

**Foreign Currency and Market Risk**

 

Aportion of our products in all of our business segments are exported to andimported from a variety of geographic locations, and our business could bematerially 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.

 

Aportion of our Canadian subsidiaries’ inventories and operating costs (whichare reported in the Water Purification and Filtration and Specialty Packagingsegments) are purchased in the United States and a significant amount of theirsales are to customers in the United States. The businesses of our Canadiansubsidiaries could be materially and adversely affected by the imposition oftrade barriers, fluctuations in the rate of currency exchange, tariff increasesand import and export restrictions between the United States and Canada.Changes in the value of the Canadian dollar against the United States dollaralso affect our results of operations because certain net assets of ourCanadian subsidiaries are denominated and ultimately settled in United Statesdollars but must be converted into their functional currency. Additionally, thefinancial statements of our Canadian subsidiaries are translated using theaccounting policies described in Note 2 to the 2010 Form 10-K.Fluctuations in the rates of currency exchange between the United States dollarand the Canadian dollar had an insignificant impact for the three months ended October 31,2010, compared with the three months ended October 31, 2009, upon our netincome and had a favorable impact upon stockholders’ equity, as described inour MD&A.

 

Changesin the value of the euro and British pound against the United States dollaraffect our results of operations because certain cash bank accounts, accountsreceivable and liabilities of 

 

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our United Statessubsidiaries, Minntech and Mar Cor, are denominated and ultimately settled ineuros or British pounds but must be converted into our functional United Statescurrency. Furthermore, the financial statements of our Netherlands subsidiary aretranslated using the accounting policies described in Note 2 of the 2010 Form 10-Kand therefore are impacted by changes in the euro exchange rate relative to theUnited States dollar. Fluctuations in the rates of currency exchange betweenthe United States dollar and the euro or British pound did not have asignificant overall impact for the three months ended October 31, 2010,compared with the three months ended October 31, 2009, upon our net incomeand stockholders’ equity.

 

In order to hedge againstthe impact of fluctuations in the value of (i) the Canadian dollarrelative to the United States dollar, (ii) the euro relative to the UnitedStates dollar and (iii) the British pound relative to the United Statesdollar on the conversion of such net assets into the functional currencies, weenter into short-term contracts to purchase Canadian dollars, euros and Britishpounds forward, which contracts are generally one month in duration. Theseshort-term contracts are designated as fair value hedge instruments. There werethree foreign currency forward contracts with an aggregate value of $3,989,000at October 31, 2010, which covered certain assets and liabilities thatwere denominated in currencies other than our subsidiaries’ functionalcurrencies. Such contracts expired on November 30, 2010. These foreigncurrency 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 U.S. Credit Facilities, such contracts topurchase Canadian dollars, euros and British pounds may not exceed $12,000,000in an aggregate notional amount at any time. For the three months ended October 31,2010, such forward contracts partially offset the impact on operations relatingto certain assets and liabilities that were denominated in currencies otherthan our subsidiaries’ functional currencies.

 

Thefunctional currency of Minntech’s Japan subsidiary is the Japanese yen. Changesin the value of the Japanese yen relative to the United States dollar duringthe three months ended October 31, 2010, compared with the three monthsended October 31, 2009, did not have a significant impact upon either ourresults of operations or the translation of the balance sheet, primarily due tothe fact that our Japanese subsidiary accounts for a relatively small portionof consolidated net sales, net income and net assets.

 

Overall,fluctuations in the rates of currency exchange had an insignificant impact onour net income for the three months ended October 31, 2010, compared withthe three months ended October 31, 2009, and a favorable impact uponstockholders’ equity primarily due to the increase in the value of the Canadiandollar relative to the United States dollar.

 

**Interest Rate Market Risk**

 

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

 

Additionally, we amended ourU.S. Credit Facilities on May 28, 2010. Due to current market conditions,the modification of our credit facilities resulted in an increase of ourmargins above the lender’s base rate and LIBOR, which would adversely affectour results of operations in the future if levels of outstanding borrowingsincrease significantly.

 

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**Market Risk SensitiveTransactions**

 

Additionalinformation related to market risk sensitive transactions is contained in Part II, Item7A, Quantitative and Qualitative Disclosures About Market Risk, in our 2010 Form 10-K.

 

**ITEM 4.                  CONTROLSAND PROCEDURES.**

 

Wemaintain 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.

 

Underthe supervision and with the participation of our Chief Executive Officer andour Chief Financial Officer, we conducted an evaluation of the effectiveness ofthe design and operation of our disclosure controls and procedures as of theend of the period covered by this report on Form 10-Q. Based on thisevaluation, our Chief Executive Officer and Chief Financial Officer eachconcluded 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.

 

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

 

On October 6, 2010 and June 1,2010, we acquired Gambro Water and Purity, respectively, as more fullydescribed in Note 3 to the Condensed Consolidated Financial Statements. Duringthe initial transition period following these acquisitions, we enhanced ourinternal control process at our Mar Cor Purification subsidiary to ensure thatall financial information related to these acquisitions were properly reflectedin our Consolidated Financial Statements. As of October 31, 2010, allaspects of the Purity acquisition were fully integrated into Mar Cor’s existinginternal control structure and we expect that all aspects of the Gambro Wateracquisition will be fully integrated into Mar Cor’s existing internal controlstructure during the second quarter of fiscal 2011.

 

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**PART II - OTHER INFORMATION**

 

**ITEM 1.****                 ****LEGALPROCEEDINGS**

 

None.

 

**ITEM 1A.****              ****RISKFACTORS**

 

Therehave been no material changes in our risk factors from those disclosed inPart I, Item 1A to our 2010 Form 10-K. The risk factorsdisclosed in Part I, Item 1A to our 2010 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.****                                                    ****UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

Thefollowing table represents information with respect to purchases of CommonStock made by the Company during the current quarter:

 
| ** **   | ** ** | ** **                    | ** ** | ** **                   | ** ** | **Total number of shares** | ** ** | **Maximum number of**        | ** ** |
|--------------|------------|-------------------------------|------------|------------------------------|------------|-------------------------------------------|------------|----------------------------------------|------------|
| **Month**    | ** ** | ** **                    | ** ** | ** **                   | ** ** | **purchased as part of**   | ** ** | **shares that may yet** | ** ** |
| **of**       | ** ** | **Total number of** | ** ** | **Average price**       | ** ** | **publicly announced**               | ** ** | **be purchased under**       | ** ** |
| **Purchase** | ** ** | **shares purchased**     | ** ** | **paid per share** | ** ** | **plans or programs**           | ** ** | **the program**                   | ** ** |
|         |       |                          |       |                         |       |                                      |       |                                   |       |
| August       |       | —                        |       | —                       |       | —                                    |       | —                                 |       |
| September    |       | —                        |       | —                       |       | —                                    |       | —                                 |       |
| October      |       | 3,658                         |       | $                            | 18.52      |                                      | —     |                                   | —     |   |
| Total        |       | 3,658                         |       | $                            | 18.52      |                                      | —     |                                   | —     |   |

 

TheCompany does not currently have a repurchase program. All of the sharespurchased during the current quarter represent shares surrendered to theCompany to pay employee withholding taxes due upon the vesting of restrictedstock.

 

**ITEM 3.****                 ****DEFAULTSUPON SENIOR SECURITIES**

 

None.

 

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

 

 

**ITEM 5.****                 ****OTHERINFORMATION**

 

None.

 

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

 
| 10(a)  | —  | Cantel Medical Corp. Long  Term Incentive Compensation Plan, as amended.                                                                                                                    |
|--------|---------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |    |                                                                                                                                                                                        |
| 10(b)  | —  | Cantel Medical Corp.  Annual Incentive Compensation Plan, as amended.                                                                                                                       |
|   |    |                                                                                                                                                                                        |
| 31.1   |  - | Certification of Principal  Executive Officer.                                                                                                                                              |
|   |    |                                                                                                                                                                                        |
| 31.2   |  - | Certification of Principal  Financial Officer.                                                                                                                                              |
|   |    |                                                                                                                                                                                        |
| 32     |  - | Certification of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                          | CANTEL MEDICAL CORP. |
|-------------------------------|----------------------|
|                          |                 |
| Date: December 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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