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

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

Results of Operations provides a discussion of the consolidated results of continuing operations for fiscal 2009 compared with fiscal 2008, and fiscal 2008 compared with fiscal 2007.

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

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

Overview

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

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

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

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

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

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

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

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

Significant Activity

(i) Net income increased by 79% in fiscal 2009 compared with fiscal 2008 despite sales growth of only 4%. We continue to benefit from having a broad portfolio of infection prevention and control products sold into diverse business segments and we have proactively developed our overall business to where approximately 75% of our consolidated net sales are consumable products and service. Our four largest business segments, which include Water Purification and Filtration, Healthcare Disposables, Dialysis and Endoscope Reprocessing each performed extremely well and contributed the vast majority of the increase to net income in fiscal 2009. The primary factors that contributed to this financial performance, as further described elsewhere in this MD&A, were as follows:

† improved gross margins as a result of numerous profit improvement and sales and marketing initiatives and the continued shift in sales mix to higher margin disposables,

† realization of price increases,

† reductions in manufacturing, raw material and distribution costs,
† †
† general company-wide efforts to control operating expenses while still investing in sales, marketing and research and development activities,
† †
† an increase in demand for healthcare disposables products principally in our fourth quarter as a result of the outbreak of the novel H1N1 flu (swine flu), and
† †
† favorable interest costs due to both reduced average interest rates as well as lower outstanding borrowings.
† † However, we cannot provide assurances that this level of growth can continue to be achieved, especially given the economic downturn, uncertainty surrounding the severity of the novel H1N1 flu outbreak and other potential risks or uncertainties. See "Risk Factors" elsewhere in this Form 10-K.

(ii) We sell our dialysis products to a concentrated number of customers. Sales in our Dialysis segment were adversely impacted by continued loss of some low margin dialysate concentrate business from domestic customers as a result of the highly competitive and price sensitive market for such product, as more fully described elsewhere in this MD&A. Additionally, although international concentrate sales were very strong in fiscal 2009, we cannot provide assurances that the current level of concentrate sales to international customers will be sustained.

(iii) The deterioration in the economy and credit markets adversely impacted our sales in fiscal 2009 compared with fiscal 2008 by causing some of our customers to delay spending on certain products, especially capital equipment in our Endoscope Reprocessing and Water Purification and Filtration segments, as more fully described elsewhere in this MD&A. Sales of capital equipment represent approximately 25% of our overall consolidated net sales and are included in our Water Purification and Filtration, Dialysis and Endoscope Reprocessing segments.

(iv) In June 2008, we announced and began executing our plan to restructure our Netherlands manufacturing operations as part of our continuing effort to reduce operating costs and leverage our existing United States infrastructure. As a result of this restructuring, approximately $345,000 and $365,000 of restructuring costs were recorded in fiscals 2009 and 2008, respectively, which decreased both basic and diluted earnings per share from continuing operations by $0.02 in each of fiscals 2009 and 2008, as more fully described in Note 18 to the Consolidated Financial Statements and elsewhere in this MD&A.

(v) Fluctuations in the rates of currency exchange had an overall favorable impact on our net income in fiscal 2009, compared with fiscal 2008, despite the adverse impact on net sales, as more fully described elsewhere in this MD&A.

(vi) In July 2009, we extended the life of certain "out-of-the-money" stock options previously awarded to certain executive officers. As a result, approximately $703,000 of additional stock-based compensation expense was recorded in fiscal 2009, which decreased both basic and diluted earnings per share from continuing operations by $0.03, as more fully described in Note 11 to the Consolidated Financial Statements and elsewhere in this MD&A.

(vii) Effective April 22, 2008, our former President and Chief Executive Officer resigned and our Chief Operating Officer and Executive Vice President was promoted to President. As a result of this resignation, a charge of approximately $720,000 primarily relating to separation benefits was recorded, which decreased both basic and diluted earnings per share from continuing operations by approximately $0.03 in fiscal 2008, as more fully described elsewhere in this MD&A.

(viii) Fiscal 2009 acquisition: We acquired the business of G.E.M. Water Systems Int'l, LLC ("G.E.M.") on July 31, 2009, as more fully described in "Business - Fiscal 2009 Acquisition" and Note 3 to the Consolidated Financial Statements.

(ix) Fiscal 2008 acquisitions: We acquired the businesses of Dialysis Services, Inc. ("DSI") on August 1, 2007, Verimetrix, LLC ("Verimetrix") on September 17, 2007, and Strong Dental Products, Inc. ("Strong Dental") on September 26, 2007, as more fully described in Note 3 to the Consolidated Financial Statements.

(x) Fiscal 2007 acquisitions: We acquired GE Water & Process Technologies' water dialysis business (the "GE Water Acquisition" or "GE Water") on March 30, 2007 and the business of Twist 2 It Inc. ("Twist") on July 9, 2007, as more fully described in Note 3 to the Consolidated Financial Statements.

Results of Operations

The results of operations reflect the continuing operating results of Cantel and its wholly-owned subsidiaries, but exclude the operating results of Carsen Group Inc. ("Carsen"), which is reported as a discontinued operation for all years presented. The Olympus distribution agreements with Carsen, as well as Carsen's active business operations, terminated on July 31, 2006, as more fully described elsewhere in this MD&A and Note 19 to the Consolidated Financial Statements.

Since the GE Water and Twist acquisitions were completed on March 30, 2007 and July 9, 2007, respectively, their results of operations are included in our results of operations for fiscals 2009 and 2008 and the portion of fiscal 2007 subsequent to their respective acquisition dates.

Since the DSI, Verimetrix and Strong Dental acquisitions were completed on August 1, 2007, September 17, 2007 and September 26, 2007, respectively, their results of operations are included in our results of operations for fiscal 2009 and the portion of fiscal 2008 subsequent to their respective acquisition dates and are not reflected in our results of operations for fiscal 2007. The acquisitions of DSI, Verimetrix and Strong Dental had an overall insignificant effect on our results of operations for fiscal 2009 and the portion of fiscal 2008 subsequent to their respective acquisition dates due to the small size of these businesses.

Since the G.E.M. acquisition was completed on the last day of fiscal 2009, its results of operations are not reflected in our results of operations for any years presented.

For fiscal 2008 compared with fiscal 2007, discussion herein of our pre-existing business refers to all of our reporting segments with the exception of the operating results of the GE Water Acquisition included in our Water Purification and Filtration reporting segment.

The following table gives information as to the net sales from continuing operations and the percentage to the total net sales from continuing operations for each of our reporting segments.

                                                       Year Ended July 31,
                                          2009                2008                2007
                                                  (Dollar Amounts in thousands)
                                        $         %         $         %         $         %

Water Purification and Filtration   $  71,340    27.4   $  68,589    27.5   $  49,032    22.4
Healthcare Disposables                 64,085    24.7      58,657    23.5      57,610    26.3
Dialysis                               56,414    21.7      60,075    24.1      58,696    26.8
Endoscope Reprocessing                 52,333    20.1      46,924    18.8      38,941    17.8
All Other                              15,878     6.1      15,129     6.1      14,765     6.7
                                    $ 260,050   100.0   $ 249,374   100.0   $ 219,044   100.0

Fiscal 2009 compared with Fiscal 2008

Net sales

Net sales increased by $10,676,000, or 4.3%, to $260,050,000 in fiscal 2009 from $249,374,000 in fiscal 2008.

Net sales were adversely impacted in fiscal 2009 compared with fiscal 2008 by approximately $950,000 due to the translation of Canadian dollar net sales, primarily of our Water Purification and Filtration operating segment, using a weaker Canadian dollar against the United States dollar.

The increase in net sales in fiscal 2009 was principally attributable to increases in sales of healthcare disposables products, endoscope reprocessing products and services, water purification and filtration products and services and therapeutic filtration products (included in All Other), partially offset by a decrease in dialysis products.

Net sales of healthcare disposables products increased by 9.3% in fiscal 2009 compared with fiscal 2008 despite negative growth in the overall dental market, primarily due to (i) increased sales volume of high margin face masks, disinfectants and other healthcare disposables products due to the outbreak of the novel H1N1 flu (swine flu) in April 2009, (ii) approximately $2,700,000 in higher net sales due to an increase in selling prices, which were implemented to offset corresponding supplier cost increases, (iii) the adverse impact on the first quarter of fiscal 2008 due to the consolidation of certain distributors of our dental products during 2007 resulting in the rationalization of duplicate inventories of the consolidated companies and (iv) approximately $194,000 in incremental net sales in the first quarter of fiscal 2009 due to the acquisition of Strong Dental during the first quarter of fiscal 2008. Although the outbreak of the novel H1N1 flu has resulted in strong sales volume during our fourth quarter of high margin face masks and other healthcare disposables products, we cannot provide assurances that such increased sales levels can be sustained throughout fiscal 2010 since such demand is highly dependent upon the severity and timing of the novel H1N1 flu, the ability of our Company to educate existing customers and potential new customers on the benefits of our face masks, disinfectants and other products and the level of urgency our customers and the general public develop and maintain with respect to epidemic and pandemic preparedness.

Net sales of endoscope reprocessing products and services increased by 11.5% in fiscal 2009 compared with fiscal 2008 primarily due to (i) the increase in demand in the United States for our disinfectants and product service due to the increased field population of equipment as well as our ability to gradually convert the sale of such items from our former equipment distributor (who continued to purchase high-level disinfectants, cleaners and consumables from us and provide product service to our customers) to our direct sales and service force at higher selling prices, (ii) higher selling prices, most of which relates to the direct sale of disinfectants, consumables and product service, which resulted in approximately $2,250,000 in incremental net sales in fiscal 2009 compared with fiscal 2008, and (iii) approximately $184,000 in incremental net sales in the first quarter of our fiscal 2009 due to the acquisition of Verimetrix during the first quarter of fiscal 2008. Partially offsetting these increases was a decrease in sales of endoscope reprocessing equipment in fiscal 2009 as a result of delayed spending on such investments due to the recent deterioration in the general economy and credit markets, which may continue to adversely affect future equipment sales.

Net sales of water purification and filtration products and services increased by 4.0% in fiscal 2009 compared with fiscal 2008, primarily due to (i) an increase in demand during fiscal 2009 for our sterilants and filters by pharmaceutical companies and within our installed equipment base of business, including one of our largest customers who standardized on our consumable products in their ordering system utilized by their dialysis clinics and
(ii) higher selling prices, which offset increased manufacturing costs and favorably impacted net sales in fiscal 2009 by approximately $2,150,000. Partially offsetting these increases were delayed investments during fiscal 2009 by customers of our water purification equipment used for dialysis as well as for commercial and industrial (large capital) applications as a result of the deterioration in the general economy and credit markets, which may continue to adversely affect capital equipment sales, and an $880,000 decrease in sales due to the translation of Canadian dollar net sales using a weaker Canadian dollar against the United States dollar.

Net sales contributed by the Therapeutic Filtration operating segment were $9,523,000, an increase of 14.8%, in fiscal 2009 compared with fiscal 2008. The increase in sales was primarily due to increases in both international and domestic demand for our hemoconcentrator products (filtration devices used to concentrate red blood cells and remove excess fluid from the bloodstream during open-heart surgery) and hemofilter products (filtration devices that perform a slow, continuous blood filtration therapy used to control fluid overload and acute renal failure in unstable, critically ill patients who cannot tolerate the rapid filtration rates of conventional hemodialysis). Increases in selling prices of our therapeutic filtration products did not have a significant effect on net sales in fiscal 2009 compared with fiscal 2008.

Net sales of dialysis products and services decreased by 6.1% in fiscal 2009 compared with fiscal 2008, primarily due to (i) the continuing adverse impact of previously losing some dialysate concentrate business (a concentrated acid or bicarbonate used to prepare dialysate, a chemical solution that draws waste products from a patient's blood through a dialyzer membrane during hemodialysis treatment) from domestic customers as a result of the highly competitive and price sensitive market for this low margin commodity product, and (ii) a decrease in net sales of low margin dialysis reuse supplies. Due to sales price decreases by some of our competitors, we expect a continued decrease in net sales of our low margin dialysate concentrate product in fiscal 2010 as we elect not to pursue unprofitable concentrate sales. Furthermore, Fresenius Medical Care ("Fresenius"), the largest dialysis provider chain in the United States, manufactures dialysate concentrate themselves and has been gradually decreasing their purchases of that product from us and may continue to do so in fiscal 2010. Additionally, we cannot provide assurances that the level of concentrate sales to international customers will be sustained. Partially offsetting these decreases were higher selling prices, which favorably impacted net sales in fiscal 2009 by approximately $950,000, to partially offset higher manufacturing and shipping costs, including freight invoiced to customers (related costs of a similar amount are included within cost of sales).

Net sales contributed by the Specialty Packaging operating segment were $6,355,000 in fiscal 2009, a decrease of 7.0% compared with fiscal 2008. This decrease in sales was primarily due to decreased customer demand in the United States for our specialty packaging products due to changes in regulatory requirements, increased competition and a decrease in clinical trials by our customers primarily due to the deterioration in the general economy. Increases in selling prices of our specialty packaging products did not have a significant effect on net sales in fiscal 2009 compared with fiscal 2008.

Gross profit

Gross profit increased by $11,853,000, or 13.5%, to $99,479,000 in fiscal 2009 from $87,626,000 in fiscal 2008. Gross profit as a percentage of net sales in fiscals 2009 and 2008 was 38.3% and 35.1%, respectively.

The gross profit percentage in fiscal 2009 increased compared with fiscal 2008 primarily due to (i) favorable sales mix due to the increased sales volume of certain high margin products such as disinfectants and consumables in our Endoscope Reprocessing segment, face masks and sterilization accessories in our Healthcare Disposables segment, and sterilants and filters in our Water Purification and Filtration segment, as well as decreased sales of our low margin dialysate concentrate product in our Dialysis segment, (ii) higher selling prices including those attributable to our ability to gradually convert the sale of high-level disinfectants, cleaners, and consumables in our Endoscope Reprocessing segment from our former equipment distributor to our direct sales and service force at higher selling prices, (iii) a decrease in raw material and distribution costs in all our segments due to the lower price of fuel and oil,
(iv) improved efficiencies in our manufacturing, distribution and service functions and (v) inefficiencies in our Water Purification and Filtration segment during the three months ended October 31, 2007 as a result of the integration of the acquired GE Water & Process Technologies' water dialysis business into our facilities. However, we cannot provide assurances that this gross profit percentage can be sustained, especially if raw materials and distribution costs increase and we are unable to implement price increases or we experience a significant change in sales mix away from higher margin products.

Operating expenses

Selling expenses increased by $1,762,000, or 6.2%, to $30,398,000 in fiscal 2009 from $28,636,000 in fiscal 2008, primarily due to (i) higher compensation expense relating to annual salary increases and incentive compensation in all of our reporting segments and additional sales personnel primarily in our Water Purification and Filtration and Healthcare Disposables segments and (ii) an increase of approximately $285,000 in advertising and marketing expense primarily related to our Healthcare Disposables segment. This increase was partially offset by a decrease of approximately $280,000 as a result of translating selling expenses of our international subsidiaries using a weaker Canadian dollar and euro against the United States dollar.

Selling expenses as a percentage of net sales were 11.7% in fiscal 2009 compared with 11.5% in fiscal 2008.

General and administrative expenses were $36,998,000 and $37,013,000 in fiscals 2009 and 2008, respectively. General and administrative expenses decreased principally due to (i) the prior year inclusion of approximately $720,000 in separation benefits and other costs related to the resignation of our former President and Chief Executive Officer on April 22, 2008, (ii) a decrease in overhead at our Netherlands operation due to the completion of restructuring activities, as more fully described elsewhere in this MD&A, (iii) a decrease of approximately $580,000 as a result of foreign exchange gains associated with translating certain foreign denominated assets into functional currencies and the translation of general and administrative expenses of our international subsidiaries using a significantly weaker Canadian dollar against the United States dollar, and (iv) a decrease of $522,000 in amortization expense of intangible assets. These decreases were offset by an increase in compensation expense primarily related to annual salary increases and incentive compensation in all of our locations and an increase of approximately $1,106,000 in stock-based compensation expense including a $703,000 charge in July 2009 to extend the life of certain "out-of-the-money" stock options previously awarded to certain executive officers, as more fully described elsewhere in this MD&A.

General and administrative expenses as a percentage of net sales were 14.2% in fiscal 2009 compared with 14.8% in fiscal 2008.

Research and development expenses (which include continuing engineering costs) were $4,632,000 and $4,010,000 in fiscals 2009 and 2008, respectively. The increase in research and development expenses in fiscal 2009, compared with fiscal 2008, is primarily due to increased development work on certain new products as well as continuing engineering on existing products primarily in our Water Purification and Filtration, Endoscope Reprocessing and Therapeutic Filtration segments.

Interest

Interest expense decreased by $1,992,000 to $2,639,000 in fiscal 2009, from $4,631,000 in fiscal 2008, primarily due to decreases in average outstanding borrowings and average interest rates, partially offset by a $148,000 charge relating to the ineffective portion of the change in fair value of an interest rate cap agreement, as more fully described elsewhere in this MD&A and Note 5 to the Consolidated Financial Statements.

Interest income decreased by $371,000 to $144,000 in fiscal 2009, from $515,000 in fiscal 2008, primarily due to a decrease in average interest rates.

Income from continuing operations before taxes

Income from continuing operations before income taxes increased by $11,105,000 to $24,956,000 in fiscal 2009 from $13,851,000 in fiscal 2008. The increase was primarily attributable to the improved gross profit percentage on increased sales as well as lower interest expense, as further explained above.

Income taxes

The consolidated effective tax rate was 37.6% and 37.2% in fiscals 2009 and 2008, respectively. The consolidated effective tax rate for fiscal 2009 was affected principally by the geographic mix of pre-tax income, repatriation of cash from our foreign subsidiaries and the impact of various tax rate changes, as described below.

The majority of our income from continuing operations before income taxes was generated from our United States operations, which had an overall effective tax rate of 38.6% and 34.4% in fiscals 2009 and 2008, respectively. The increase in our United States effective tax rate in fiscal 2009, compared with fiscal 2008, was due to an increase in our Federal tax rate to 35.0% and additional taxes relating to the repatriation of approximately $11,400,000 in earnings from our subsidiaries in Canada and the Netherlands, partially offset by recently enacted Federal tax legislation that enabled us to claim the research and experimentation tax credit as well as New York state tax rate reductions enacted in 2008, which primarily relate to our Healthcare Disposables segment. Such New York state tax rate reductions had a significant favorable effect on our fiscal 2008 effective tax rate in the year of enactment.

Approximately 5% of our fiscal 2009 income from continuing operations before income taxes was generated from our Canadian operations, which had an overall effective tax rate in fiscals 2009 and 2008 of 16.8% and 22.5%, respectively. Overall statutory tax rates in Canada are significantly below comparable rates in the United States. Additionally, the low overall effective tax rate in fiscal 2009 was attributable to the impact of a lower overall effective rate in our Specialty Packaging segment due to recently enacted rate reductions as applied to existing deferred income tax liabilities.

Due to the uncertainty of our Netherlands subsidiary utilizing tax benefits in the future, a tax benefit was not recorded on the losses from operations at our Netherlands subsidiary in fiscals 2009 and 2008, thereby adversely affecting our overall consolidated effective tax rate. The overall loss from our Netherlands operation in fiscal 2009 decreased compared with fiscal 2008 as a result of the restructuring of its operations, as more fully described elsewhere in this MD&A and Note 18 to the Consolidated Financial Statements.

The results of operations for our subsidiaries in Japan and Singapore did not have a significant impact on our overall effective tax rate in fiscals 2009 and 2008 due to the size of these operations relative to our United States, Canada and Netherlands operations. However, during fiscal 2008, we decided to place a full valuation allowance against the NOLs of our Japanese subsidiary, which resulted in the recording of tax expense on the past losses of our subsidiary in Japan.

We record liabilities for an unrecognized tax benefit when a tax benefit for an uncertain tax position is taken or expected to be taken on a tax return, but is not recognized in our Consolidated Financial Statements because it does not meet the more-likely-than-not recognition threshold that the uncertain tax position . . .