General

Young Innovations, Inc. and its subsidiaries ("the Company") develops, manufactures and markets supplies and equipment used by dentists, dental hygienists, dental assistants and consumers. The Company's product offering includes disposable and metal prophylaxis ("prophy") angles, prophy cups and brushes, dental micro-applicators, panoramic X-ray machines, moisture control products, infection control products, dental handpieces (drills) and related components, endodontic systems, orthodontic toothbrushes, flavored examination gloves, children's toothbrushes, and children's toothpastes.

The Company's manufacturing and distribution facilities are located in Missouri, Illinois, California, Indiana, Texas, Wisconsin and Ireland.

The Company operates in one reporting segment, which is the development and manufacture of a broad line of products marketed to dental professionals. The Company markets its products primarily in the U.S. The Company also markets its products in several international markets, including Canada, Europe, South America, Central America, and the Pacific Rim. International sales represented approximately 18% and 16% of the Company's total net sales in 2008 and 2007, respectively and less than 10% of the Company's total net sales in 2006.

Some of the risk factors that affect the Company's business and financial results are discussed in "Item 1A: Risk Factors." We wish to caution the reader that the risk factors discussed in "Item 1A: Risk Factors", and those described elsewhere in this report or our other Securities and Exchange Commission filings, could cause our actual results to differ materially from those stated in the forward-looking statements.

Critical Accounting Policies

The SEC has requested that all registrants include in their MD&A a description of their most critical accounting policies, the judgments and uncertainties affecting the application of those policies, and the likelihood that materially different amounts would be reported under different conditions using different assumptions. The SEC indicated that a "critical accounting policy" is one which is both important to the portrayal of the company's financial condition and results and requires management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company believes that the following accounting policies fit this definition:

Allowance for doubtful accounts - The Company has 36% of its December 31, 2008 accounts receivable balance with two large customers (see footnote 5 of the notes to consolidated financial statements set forth in Item 8) with the remaining balance comprised of amounts due from numerous customers, some of which are international. Accounts receivable balances are subject to credit risk. Management has reserved for expected credit losses, sales returns and allowances, and discounts based upon past experience, as well as knowledge of current customer information. The Company believes that its reserves are adequate. It is possible, however, that the accuracy of our estimation process could be impacted by unforeseen circumstances. The Company continuously reviews its reserve balance and refines the estimates to reflect any changes in circumstances.

Inventory - The Company values inventory at the lower of cost or market on a first-in, first-out (FIFO) basis. Inventory values are based upon standard costs, which approximate actual costs. Management regularly reviews inventory quantities on hand and records a write-down for excess or obsolete inventory based primarily on estimated product demand and other information related to the inventory including planned introduction of new products and changes in technology. If demand for the Company's products is significantly different than management's expectations, the value of inventory could be materially impacted. Inventory write-downs are included in cost of goods sold.

Goodwill and other intangible assets - In accordance with the Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Intangible Assets," goodwill and other intangible assets with indefinite useful lives are reviewed by management for impairment at least annually, or whenever events or changes in circumstances indicate the carrying amount may not be recoverable. If indicators of impairment are present, the determination of the amount of impairment would be based on management's judgment as to the future operating cash flows to be generated from the assets. SFAS

Revenue Recognition - Revenue from the sale of products is recorded at the time title passes, generally when the products are shipped, as the Company's shipping terms are customarily FOB shipping point. Revenue from the rental of equipment to others is recognized on a month-to-month basis as the revenue is earned. The Company generally requires payment within 30 days from the date of invoice and offers cash discounts for early payment. For certain acquired businesses that offer different terms, the Company migrates these customers to the terms referred above within a 2-5 year period.

The Company offers discounts to its distributors if certain conditions are met. Customer allowances, volume discounts and rebates, and other short-term incentive programs are recorded as a reduction in reported revenues at the time of sale. The Company reduces product revenue for the estimated redemption of annual rebates on certain current product sales. Customer allowances and rebates are estimated based on historical experience and known trends.

The policy with respect to sales returns generally provides that a customer may not return inventory except at the Company's option, with the exception of X-ray machines, which have a 90-day return policy. Historically, the level of product returns has not been significant. The Company generally warrants its products against defects, and its most generous policy provides a two-year parts and labor warranty on X-ray machines. The Company owns X-ray equipment rented on a month-to-month basis to customers. A liability for the removal costs of the rented X-ray machines is capitalized and amortized over four years.

Stock compensation - Effective January 1, 2006, the Company adopted SFAS No.
123(R). The Company elected the modified prospective transition method as permitted by SFAS No. 123(R); accordingly, results from prior periods have not been restated. Under this transition method, compensation cost must be recognized in the financial statements for all awards granted after the date of adoption as well as for existing stock awards for which the requisite service had not been rendered as of the date of adoption. Under the provisions of SFAS
123(R), share-based compensation cost is estimated at the grant date based on the award's fair-value as calculated by an option pricing model, and is recognized as expense ratably over the requisite service period. The option pricing models require judgmental assumptions including volatility, forfeiture rates, and expected option life. If any of the assumptions used in the model change significantly, share-based compensation expense may differ in the future from that recorded in the current period.

Assets and Liabilities Acquired in Business Combinations - The Company periodically acquires businesses. All business acquisitions completed subsequent to 2002 were accounted for under the provisions of SFAS No. 141, "Business Combinations," which requires the use of the purchase method. The purchase method requires the Company to allocate the cost of an acquired business to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The allocation of acquisition cost to assets acquired includes the consideration of identifiable intangible assets. The excess of the cost of an acquired business over the fair value of the assets acquired and liabilities assumed is recognized as goodwill. The Company's measurement of fair values and certain preacquisition contingencies may impact the Company's cost allocation to assets acquired and liabilities assumed for a period of up to one year following the date of an acquisition. The Company utilizes a variety of information sources to determine the value of acquired assets and liabilities. For larger acquisitions, third-party appraisers are utilized to assist the Company in determining the fair value and useful lives of identifiable intangibles, including the determination of intangible assets that have an indefinite life. The valuation of the acquired assets and liabilities and the useful lives assigned by the Company will impact the determination of future operating performance of the Company.

The following table sets forth, for the periods indicated, certain items from the Company's statements of income expressed as a percentage of net sales.

                                              Years Ended December 31
                                               2008     2007     2006
Net sales                                      100.0%   100.0%   100.0%
Cost of goods sold                             47.3      46.8    45.9
Gross profit                                   52.7      53.2    54.1
Selling, general and administrative expenses   32.8      31.8    28.2
Income from operations                         19.9      21.4    25.9
Interest expense (income) and other, net        0.9       1.2     (.0)
Income from operations before provision
for income taxes                               19.0      20.2    25.9
Provision for income taxes                      6.7       6.9     9.6
Net income                                      12.3%    13.3%    16.3%

Net Sales - Net sales for the year ended December 31, 2008 were $99,143, up 1.8% or $1,741 from $97,402 in the prior year. The sales increase reflects strong demand for the Company's consumable products, which were offset by weak performance in its diagnostic product line. The Company's preventive, infection control, micro-applicators and home care product lines, which are included in the Company's consumable products, posted solid growth in 2008. In addition, a weaker U.S. dollar provided a benefit to sales of approximately $474. The Company's diagnostic product line posted disappointing results. On a full year basis, the diagnostic product line sales were approximately $2,300 below the 2007 results. The Company believes this product line continues to be negatively effected by on-going economic uncertainty, as the Company witnessed a significant increase in purchase deferrals at the end of the year.

Gross Profit - Gross profit increased $517, or 1.0%, from $51,779 in 2007 to $52,296 in 2008. The additional gross profit was primarily a result of the increased net sales. Gross margin decreased to 52.7% in 2008 from 53.2% in 2007 as a result of changes in product mix and a $130 reallocation of selling, general and administrative expense into cost of goods sold. This was offset by reduction in staffing levels and the benefits of facility consolidations the Company has implemented over the past two years.

Selling, General and Administrative Expenses (SG&A) - SG&A expenses increased by $1,524, or 4.9%, to $32,543 in 2008 from $31,019 in 2007. Share-based compensation cost totaled $1,442 in 2008 compared to $1,071 in 2007. SG&A increased primarily due to the full year impact of headcount additions in 2007 in addition to increased equity compensation, incentive compensation and facility expenses in accordance with the Company's previously disclosed plans. This was offset by a $130 reallocation of SG&A expenses to cost of goods sold. As a percentage of net sales, SG&A expenses increased to 32.8% in 2008 from 31.8% in 2007 as a result of the factors explained above.

Income from Operations - Income from operations in 2008 was $19,753 compared to $20,760 in 2007, a decrease of 4.9%. The change was a result of the factors described above.

Interest Expense, net - Interest expense, net increased to $1,332 versus $1,109 in 2007. The increase was attributable to higher levels of debt partially offset by lower interest rates in 2008 compared to 2007. The increase in debt levels was primarily related to the settlement of the earnout payment for the Microbrush acquisition and repurchases of the Company's stock.

Other (Income) Expense, net - Other (income) expense, net increased to $(465) versus $41 in 2007. This increase was primarily attributable to a foreign exchange impact on debt repaid from the Company's Irish subsidiary of approximately $300.

Provision for Income Taxes - During the year ended 2008, the Company's provision for income taxes increased to $6,705 versus $6,677 in 2007 as a result of an increase in the effective tax rate. The effective tax rate in 2008 was 35.5% compared to 34.1% in 2007. The higher effective tax rate in 2008 is primarily attributable to recognition of a tax benefit in 2007 associated with the lower tax rate on earnings at the Company's operations in Ireland due to lower local tax rates and certain earnings being permanently reinvested there in 2007.

Year Ended December 31, 2007, Compared to Year Ended December 31, 2006

Net Sales - Net sales for the year ended December 31, 2007 were $97,402, up 7.3% or $6,597 from $90,805 in the prior year. Sales for the year were positively impacted by the acquisition of Microbrush, which contributed approximately $14,500 in net sales in 2007, an increase of $9,500 over $5,000 in 2006. Microbrush was acquired in the third quarter of 2006. In addition, while the Company believes end-user demand for preventive and infection control products sold through distributors increased in total, sales of these products to distributors decreased in 2007. Distributor purchases continued to be impacted by further distributor consolidation activity and improved inventory management systems, which reduced inventory holding levels at certain distributors.

Gross Profit - Gross profit increased $2,668, or 5.4%, from $49,111 in 2006 to $51,779 in 2007. The additional gross profit was primarily a result of the increased net sales resulting from the Microbrush acquisition. Gross margin decreased to 53.2% in 2007 from 54.1% in 2006 as a result of lower sales of certain products to distributors and reduced production levels. In preparation for future consolidations, the Company maintained staffing levels in manufacturing, which negatively impacted profitability. Gross margin continued to have volatility related to distributor purchase patterns,

Selling, General and Administrative Expenses (SG&A) - SG&A expenses increased by $5,391, or 21.0%, to $31,019 in 2007 from $25,628 in 2006. SG&A costs increased approximately $1,500 as a result of the acquisition of Microbrush. Share-based compensation cost totaled $1,071 in 2007 compared to $294 in 2006. In 2007 the Company made considerable investments in personnel and physical infrastructure to support its long-term growth objectives. The Company substantially enhanced its sales and marketing team and product development efforts across its product offerings, adding approximately 30 people in these areas. The Company also opened a new warehouse and distribution facility to support both its growth and consolidation activities. As a percentage of net sales, SG&A expenses increased to 31.8% in 2007 from 28.2% in 2006 as a result of the factors explained above.

Income from Operations - Income from operations in 2007 was $20,760 compared to $23,483 in 2006, a decrease of 11.6%. The change was a result of the factors described above.

Interest Expense, net - Interest expense, net increased to $1,109 versus $28 in 2006. This increase was primarily attributable to additional interest expense resulting from borrowings on the Company's credit facility to finance the Microbrush acquisition and the buyback of 1,000 shares of the Company's Common Stock from trusts controlled by George E. Richmond, its Vice Chairman and principal stockholder.

Other (Income) Expense, net - Other (income) expense, net decreased to $41 versus $(56) in 2006. This decrease was due to lower levels of miscellaneous income.

Provision for Income Taxes - During the year ended 2007, the Company's provision for income taxes decreased to $6,677 versus $8,732 in 2006 as a result of lower pre-tax income as well as a decrease in the effective tax rate. The effective tax rate in 2007 was 34.1% compared to 37.1% in 2006. The lower effective tax rate in 2007 is primarily attributable to recognition of a tax benefit associated with the lower tax rate on earnings at the Company's operations in Ireland due to lower local tax rates and certain earnings being permanently reinvested there.

Liquidity and Capital Resources

Sources of Cash

Historically, the Company has financed its operations primarily through cash flow from operating activities and, to a lesser extent, through borrowings under its credit facility. Net cash flow from operating activities was $22,465, $20,440, and $13,711, for 2008, 2007 and 2006, respectively. The increase in operating cash flow in 2008 is attributable to a decrease in accounts receivable due to a change in payment timing by one of the Company's largest customers and a decrease in notes receivable due to a decrease in in-house financing. These were offset by a build in inventory related to inventory planning, consolidation activities and new product introductions as well as lower net income.

On January 16, 2008, the Company transferred a majority of its X-ray equipment loans to a third party for a cash payment of $3,519. The Company transferred $4,154 of the notes receivable portfolio for a purchase price of $4,140. Of the purchase price, $621 is subject to a recourse holdback pool that has been established with respect to the limited recourse the third party has on the loans. On May 5, 2008, the Company transferred additional X-ray equipment loans to a third party for a cash payment of $235. There is an additional $42 subject to a recourse holdback pool. As the transactions do not qualify as sales of assets under SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," the transactions have been treated as financing and the loans remain on the Company's balance sheet. As the third party receives payments on the transferred notes, the Company reduces the corresponding notes receivable and secured borrowing balances. As of December 31, 2008, the residual amount of notes receivable transferred to a third party was $2,815, of which $1,126 is classified as a short-term notes receivable and $1,689 as a long-term notes receivable. A corresponding long-term and short-term liability have been recorded, net of the recourse holdback pool of $663, on the Company's balance sheet.

The Company maintains a credit agreement with a borrowing capacity of $75,000, which expires in April 2010. Borrowings under the agreement bear interest at rates ranging from LIBOR + .75% to LIBOR + 1.50%, or Prime, depending on the Company's level of indebtedness. Commitment fees for this agreement range from .125% to .15% of the unused balance. The agreement is unsecured and contains various financial and other covenants. As of December 31, 2008, the Company was in compliance with all of these covenants. During 2008, the Company borrowed under the credit

Uses of Cash

Consistent with historical spending, the Company's uses of cash primarily relate to acquisition activity, capital expenditures, dividend distributions to shareholders, and stock repurchases. Specific significant uses of cash over the three years are as follows:

2008

Net capital expenditures for property, plant and equipment were $3,214 in 2008. Significant capital expenditures included facility expansion and improvements, production machinery and new equipment purchases. Future capital expenditures are expected to include facility improvements, production machinery and information systems. In May 2008, the Company paid $2,735 as an earnout payment for certain performance targets achieved in the purchase of Microbrush Inc. and Microbrush International, Ltd. The Company also repurchased 505 shares of its Common Stock for $9,406. Quarterly dividends of $0.04 per share were paid March 14, June 16, September 15, and December 15, 2008, for a total payment of $1,281.

2007

Net capital expenditures for property, plant and equipment were $7,279 in 2007. Significant capital expenditures included the construction of a distribution and manufacturing facility in Illinois, facility improvements, and new equipment purchases. The Company also repurchased 1,000 shares of its Common Stock from trusts controlled by George E. Richmond, the Company's Vice Chairman and principal stockholder, for an aggregate purchase price of $26,000. In addition, the Company repurchased 53 shares of its Common Stock for $1,285. Quarterly dividends of $0.04 per share were paid March 15, June 15, September 14, and December 14, 2007, for a total payment of $1,391.

2006

Net capital expenditures for property, plant and equipment were $7,189 in 2006. Significant capital expenditures included land, facility improvements, panoramic X-ray machines and new equipment purchases. In January 2006, YI Ventures LLC (a wholly owned subsidiary) acquired D&N Microproducts, Inc., a contract manufacturer of the Company's diagnostic product line. The Company paid approximately $2,800 in cash. On July 31, 2006, the Company acquired substantially all of the assets of Microbrush, Inc. and Microbrush International, Ltd. for approximately $32,000 in cash. The purchase price was principally financed with borrowings on the Company's credit facility and cash generated from operations. In addition, the Company repurchased 51 shares of its Common Stock for $1,669. Quarterly dividends of $0.04 per share were paid March 15, June 15, September 15, and December 15, 2006, for a total payment of $1,457.

                                                  Payments due by period

Contractual Obligations                   Less than                          Beyond 5 years
                                 Total      1 Year    1-3 years   4-5 years

Operating Leases (including    $ 1,534    $ 440      $ 869       $ 225       $ --
buildings)
Long-Term Debt                 $ 29,349   $ --       $ 29,349    $ ---       $ --
Liability for uncertain tax    $ 101      $ 101      $ --        $ ---       $ --
positions
Total                          $ 30,984   $ 541      $ 30,218    $ 225       $ --

As of December 31, 2008 and 2007, management was aware of no relationships with any other unconsolidated entities, financial partnerships, structured finance entities, or special purpose entities that were established for the purpose of facilitating off-balance-sheet arrangements or for other contractually narrow or limited purposes.

Recent Financial Accounting Standards Board Statements

See footnote 23 to the Company's audited consolidated financial statements set forth in Item 8.