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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES AND EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2002 Commission file number 000-21109
---------
CUNO INCORPORATED
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-1159240
- ------------------------------------------ ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
400 Research Parkway, Meriden, Connecticut 06450
- ------------------------------------------ ------------------------------------
(Address of principal executive offices) (Zip Code)
(203) 237-5541
Registrant's telephone number, including area code
Not Applicable
- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last
report.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter periods that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $0.001 Par Value -- 16,570,986 shares as of July 31, 2002
CUNO INCORPORATED
Page
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Consolidated Statements of Income - Three months ended
July 31, 2002 and 2001 1
Consolidated Statements of Income - Nine months ended
July 31, 2002 and 2001 2
Consolidated Balance Sheets - July 31, 2002 and
October 31, 2001 3
Consolidated Statements of Cash Flows - Nine months
ended July 31, 2002 and 2001 4
Notes to Unaudited Condensed Consolidated Financial
Statements 5
Independent Accountants' Review Report 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
CUNO INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except share amounts)
THREE MONTHS ENDED
JULY 31,
2002 2001
------------ ------------
Net sales $ 68,932 $ 63,441
Less costs and expenses:
Cost of products sold 37,920 35,154
Selling, general and administrative 17,186 15,787
Goodwill amortization -- 329
Research, development and engineering 3,729 3,545
------------ ------------
58,835 54,815
------------ ------------
Operating income 10,097 8,626
Nonoperating income (expense):
Interest expense (94) (145)
Interest and other income, net 31 306
------------ ------------
(63) 161
------------ ------------
Income before income taxes 10,034 8,787
Income taxes 3,405 3,083
------------ ------------
Net income $ 6,629 $ 5,704
============ ============
Basic earnings per common share $ 0.40 $ 0.35
Diluted earnings per common share $ 0.39 $ 0.34
Basic shares outstanding 16,525,092 16,313,943
Diluted shares outstanding 16,958,674 16,722,906
See accompanying notes.
-1-
CUNO INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except share amounts)
NINE MONTHS ENDED
JULY 31,
2002 2001
------------ ------------
Net sales $ 190,685 $ 182,213
Less costs and expenses:
Cost of products sold 105,312 102,197
Selling, general and administrative expenses 49,224 47,279
Goodwill amortization -- 987
Research, development and engineering 10,850 10,147
------------ ------------
165,386 160,610
------------ ------------
Operating income 25,299 21,603
Nonoperating income (expense):
Interest expense (335) (414)
Interest and other income, net 229 683
------------ ------------
(106) 269
------------ ------------
Income before income taxes 25,193 21,872
Provision for income taxes 8,631 7,818
------------ ------------
Net income $ 16,562 $ 14,054
============ ============
Basic earnings per common share $ 1.01 $ 0.86
Diluted earnings per common share $ 0.98 $ 0.84
Basic shares outstanding 16,449,402 16,302,926
Diluted shares outstanding 16,877,245 16,686,552
See accompanying notes.
-2-
CUNO INCORPORATED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share amounts)
JULY 31, OCTOBER 31,
2002 2001
-------- ----------
ASSETS
Current assets
Cash and cash equivalents $ 34,595 $ 25,628
Accounts receivable, less allowances for doubtful
accounts of $1,542 and $1,336, respectively 51,830 48,546
Inventories 24,660 24,590
Deferred income taxes 7,348 5,971
Prepaid expenses and other current assets 6,182 4,329
-------- ----------
Total current assets 124,615 109,064
Noncurrent assets
Deferred income taxes 1,634 2,300
Intangible assets, net 27,727 27,725
Prepaid pension costs 3,909 --
Other noncurrent assets 1,666 1,941
Property, plant and equipment, net 71,909 65,595
-------- ----------
Total assets $231,460 $ 206,625
======== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Bank loans $ 13,535 $ 13,266
Accounts payable 20,663 16,606
Accrued payroll and related taxes 12,752 12,294
Other accrued expenses 8,699 7,265
Accrued income taxes 3,086 3,468
Current portion of long-term debt 714 728
-------- ----------
Total current liabilities 59,449 53,627
Noncurrent liabilities
Long-term debt, less current portion 2,021 2,893
Deferred income taxes 5,510 4,005
Retirement benefits 3,932 5,929
-------- ----------
Total noncurrent liabilities 11,463 12,827
STOCKHOLDERS' EQUITY
Preferred Stock, $.001 par value; 2,000,000 shares
authorized, no shares issued -- --
Common Stock, $.001 par value; 50,000,000 shares
authorized, 16,570,986 and 16,392,244 shares
issued and outstanding 17 16
Treasury Stock, at cost (2,747 shares) (57) (57)
Additional paid-in-capital 46,467 42,602
Unearned compensation (704) (957)
Accumulated other comprehensive income (loss) --
Foreign currency translation adjustments (5,712) (5,224)
Minimum pension liability (308) (670)
Change in fair value of derivative
financial instruments (84) 94
-------- ----------
(6,104) (5,800)
Retained earnings 120,929 104,367
-------- ----------
Total stockholders' equity 160,548 140,171
-------- ----------
Total liabilities and stockholders' equity $231,460 $ 206,625
======== ==========
See accompanying notes.
-3-
CUNO INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)
NINE MONTHS ENDED
JULY 31,
2002 2001
-------- --------
OPERATING ACTIVITIES
Net income $ 16,562 $ 14,054
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 5,984 6,827
Noncash compensation recognized under
employee stock plans 603 706
Gains on sales of property, plant and
equipment (16) (57)
Pension funding in excess of expense (4,290) (348)
Deferred income taxes 365 (272)
Changes in operating assets and liabilities,
net of acquisitions:
Accounts receivable (2,827) 1,998
Inventories (671) (1,617)
Prepaid expenses and other current
assets (1,579) (647)
Accounts payable and accrued expenses 6,269 249
Accrued income taxes 259 (1,434)
-------- --------
Net cash provided by operating activities 20,659 19,459
INVESTING ACTIVITIES
Proceeds from sales of property, plant and
equipment 80 74
Acquisition of companies, net of cash
acquired (503) (4,489)
Capital expenditures (12,236) (7,771)
-------- --------
Net cash used for investing activities (12,659) (12,186)
FINANCING ACTIVITIES
Principal payments on long-term debt (921) (862)
Net borrowings (repayments) under short-term
bank loans 122 (88)
Acquisition of Treasury Stock -- (57)
Proceeds from stock options exercised 1,564 497
-------- --------
Net cash provided by (used for) financing
activities 765 (510)
Effect of exchange rate changes on cash and cash
equivalents 202 (326)
-------- --------
Net change in cash and cash equivalents 8,967 6,437
Cash and cash equivalents -- beginning of period 25,628 13,814
-------- --------
Cash and cash equivalents -- end of period $ 34,595 $ 20,251
======== ========
See accompanying notes.
-4-
CUNO INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2002
NOTE 1 - BUSINESS AND BASIS OF PRESENTATION
CUNO Incorporated (the "Company", "CUNO", or "we") designs, manufactures
and markets a comprehensive line of filtration products for the separation,
clarification and purification of liquids and gases. Our products, which include
proprietary depth filters and semi-permeable membrane filters, are sold in the
potable water, healthcare and fluid processing markets throughout the world.
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally
accepted in the United States for annual financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. The accounts of the
Company and all of its subsidiaries are included in the consolidated financial
statements. All significant intercompany accounts and transactions are
eliminated in consolidation. Operating results for the interim periods are not
necessarily indicative of the results that may be expected for the full year.
For further information, refer to the consolidated financial statements and
footnotes thereto included in our Form 10-K for the year ended October 31, 2001.
NOTE 2 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per common share for the three months ended:
JULY 31, JULY 31,
2002 2001
------------ ------------
NUMERATOR:
Net income $ 6,629,000 $ 5,704,000
============ ============
DENOMINATORS:
Weighted average shares outstanding 16,556,206 16,386,821
Issued but unearned performance shares -- (609)
Issued but unearned restricted shares (31,114) (72,269)
------------ ------------
DENOMINATOR FOR BASIC EARNINGS PER SHARE 16,525,092 16,313,943
============ ============
Weighted average shares outstanding 16,556,206 16,386,821
Effect of dilutive employee stock options 402,468 336,085
------------ ------------
DENOMINATOR FOR DILUTED EARNINGS PER SHARE 16,958,674 16,722,906
============ ============
Basic earnings per share $ 0.40 $ 0.35
Diluted earnings per share $ 0.39 $ 0.34
5
The following table sets forth the computation of basic and diluted
earnings per common share for the nine months ended:
JULY 31, JULY 31,
2002 2001
------------ ------------
NUMERATOR:
Net income $ 16,562,000 $ 14,054,000
============ ============
DENOMINATORS:
Weighted average shares outstanding 16,490,222 16,361,037
Issued but unearned performance shares -- (914)
Issued but unearned restricted shares (40,820) (57,197)
------------ ------------
DENOMINATOR FOR BASIC EARNINGS PER SHARE 16,449,402 16,302,926
============ ============
Weighted average shares outstanding 16,490,222 16,361,037
Effect of dilutive employee stock options 387,023 325,515
------------ ------------
DENOMINATOR FOR DILUTED EARNINGS PER SHARE 16,877,245 16,686,552
============ ============
Basic earnings per share $ 1.01 $ 0.86
Diluted earnings per share $ 0.98 $ 0.84
During the first nine months of fiscal 2002, 133,088 stock options were
exercised (net of shares used to pay individual taxes) providing $1,564,000 in
net cash proceeds to the Company.
NOTE 3 - INVENTORIES
Inventories consist of the following (amounts in thousands):
JULY 31, OCTOBER 31,
2002 2001
-------- ----------
Raw materials $ 10,391 $ 10,692
Work-in-process 2,943 2,868
Finished goods 11,326 11,030
-------- ----------
$ 24,660 $ 24,590
======== ==========
Inventories are stated at the lower of cost or market. Inventories in the
United States are valued primarily by the last-in, first-out (LIFO) cost method.
The primary method used for all other inventories is first-in, first-out (FIFO).
An actual valuation of inventory under the LIFO method can be made only at the
end of each year based on the inventory levels and costs at that time.
Accordingly, interim LIFO calculations must necessarily be based on our
estimates of expected year-end inventory levels and costs. Because these are
subject to many factors beyond management's control, interim results are subject
to the final year-end LIFO inventory valuation.
6
NOTE 4 - COMPREHENSIVE INCOME
Total comprehensive income was comprised of the following (amounts in
thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
2002 2001 2002 2001
-------- -------- -------- --------
Net income $ 6,629 $ 5,704 $ 16,562 $ 14,054
Other comprehensive income (loss):
Change in minimum pension
liability, net of deferred
income taxes of $195 -- -- 362 --
Change in fair value of
derivative financial
instruments, net of
deferred income taxes of
$61, $6, $2, and $58 (112) (10) 4 79
Gains related to derivative
financial instruments
reclassified into earnings
from other comprehensive
income, net of $56 and $80
tax benefit (103) -- (182) --
Foreign currency translation
adjustments (640) (691) (488) (1,480)
-------- -------- -------- --------
Total comprehensive income $ 5,774 $ 5,003 $ 16,258 $ 12,653
======== ======== ======== ========
NOTE 5 - SEGMENT DATA
For management reporting and control, the Company is divided into five
geographic operating segments as presented below. Each segment has general
operating autonomy over its markets.
Operating segment data includes the results of all subsidiaries,
consistent with the management reporting of these operations. Financial
information by geographic operating segments is summarized below (amounts in
thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
2002 2001 2002 2001
-------- -------- -------- --------
NET SALES:
Europe $ 14,112 $ 11,096 $ 37,049 $ 31,469
Japan 8,445 8,428 22,983 26,959
Asia/Pacific 7,680 6,536 20,842 19,234
Latin America 2,723 3,142 9,077 9,350
-------- -------- -------- --------
Subtotal - Foreign sales 32,960 29,202 89,951 87,012
North America 45,843 42,590 127,422 119,579
Intercompany sales (9,871) (8,351) (26,688) (24,378)
-------- -------- -------- --------
$ 68,932 $ 63,441 $190,685 $182,213
======== ======== ======== ========
7
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
2002 2001 2002 2001
-------- -------- -------- --------
OPERATING INCOME:
North America $ 6,663 $ 5,379 $ 16,683 $ 12,848
Europe 1,225 895 2,486 1,819
Japan 728 893 1,759 2,616
Asia/Pacific 1,114 928 2,909 2,807
Latin America 367 531 1,462 1,513
-------- -------- -------- --------
Segment total 10,097 8,626 25,299 21,603
-------- -------- -------- --------
Interest expense (94) (145) (335) (414)
Other, net 31 306 229 683
-------- -------- -------- --------
Income before income taxes $ 10,034 $ 8,787 $ 25,193 $ 21,872
======== ======== ======== ========
Interest expense and other income (expense) have not been allocated to segments.
NOTE 6 - INTEREST AND OTHER INCOME (EXPENSE), NET
Interest and other income (expense), net consisted of the following
(amounts in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
2002 2001 2002 2001
------ ------ ------ ------
Interest income $ 122 $ 271 $ 452 $ 658
Exchange gains (losses) (6) 22 (47) 56
Gains on sales of property,
plant, and equipment 1 17 16 57
Other, net (86) (4) (192) (88)
------ ------ ------ ------
$ 31 $ 306 $ 229 $ 683
====== ====== ====== ======
NOTE 7 - NEWLY ISSUED ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board issued Statements
of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.
Under the new statement, goodwill (and other intangible assets deemed to have
indefinite lives) is no longer amortized but is subject to annual impairment
tests. Other intangible assets continue to be amortized over their useful lives.
We began applying the new rules on accounting for existing goodwill and
other intangible assets on November 1, 2001. The following compares reported
results to adjusted results as if the new statement was adopted effective
November 1, 2000 (in thousands, except share amounts):
8
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
REPORTED ADJUSTED REPORTED ADJUSTED
2001 2001 2001 2001
-------- -------- -------- --------
Income before income taxes $ 8,787 $ 9,116 $ 21,872 $ 22,859
Net income $ 5,704 $ 6,019 $ 14,054 $ 14,999
Basic earnings per share $ 0.35 $ 0.37 $ 0.86 $ 0.92
Diluted earnings per share $ 0.34 $ 0.36 $ 0.84 $ 0.90
A reconciliation of reported net income to adjusted net income (amounts in
thousands) follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, 2001 JULY 31, 2001
Reported net income $ 5,704 $14,054
Goodwill amortization 329 987
Tax effect of deductible goodwill (14) (42)
------- -------
Adjusted net income $ 6,019 $14,999
======= =======
The net carrying amount of goodwill as of July 31, 2002 is $27.0 million.
In October 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" effective
for fiscal years beginning after December 15, 2001. SFAS No. 144 supersedes SFAS
No.121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" and provides a single accounting model for long-lived
assets to be disposed of. We will adopt the statement in fiscal year 2003, which
begins November 1, 2002. We are currently assessing the impact of this new
standard on our consolidated financial statements.
NOTE 8 - CONTINGENCIES
The Company is subject to various legal actions, governmental audits, and
proceedings relating to various matters incidental to its business including
product liability and environmental claims. While the outcome of such matters
cannot be predicted with certainty, in the opinion of management, after
reviewing such matters and consulting with our counsel and considering any
applicable insurance or indemnifications, any liability which may ultimately be
incurred is not expected to materially affect the consolidated financial
position, cash flows or results of operations of the Company.
9
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Stockholders and Board of Directors
CUNO Incorporated
We have reviewed the accompanying condensed consolidated balance sheet of CUNO
Incorporated as of July 31, 2002, and the related condensed consolidated
statements of income for the three-month and nine-month periods ended July 31,
2002 and 2001, and the condensed consolidated statements of cash flows for the
nine-month periods ended July 31, 2002 and 2001. These financial statements are
the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements referred
to above for them to be in conformity with accounting principles generally
accepted in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of CUNO
Incorporated as of October 31, 2001, and the related consolidated statements of
income, stockholders' equity, and cash flows for the year then ended (not
presented herewith) and in our report dated December 11, 2001, we expressed an
unqualified opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying condensed consolidated balance
sheet as of October 31, 2001, is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Hartford, Connecticut
August 16, 2002
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
THREE MONTH PERIOD ENDED JULY 31, 2002 VS. THREE MONTH PERIOD ENDED
JULY 31, 2001
NET SALES
Net sales were $68.9 million in the third quarter of fiscal 2002
representing an 8.7 percent increase over 2001's third quarter sales of $63.4
million. This increase can generally be attributed to an increase in the unit
volume of worldwide sales. Had currency values been unchanged from the third
quarter of 2001, net sales in the third quarter of 2002 would have been $1.1
million lower, or 6.8 percent greater overall.
The following table displays the Company's sales by geographic segment
(dollar amounts in thousands):
THREE MONTHS ENDED CURRENCY
JULY 31, PERCENT ADJUSTED
2002 2001 CHANGE CHANGE
-------- -------- -------- --------
North America $ 39,859 $ 37,394 6.6% 6.6%
Europe 11,242 9,034 24.4% 12.0%
Japan 8,354 8,298 0.7% 0.2%
Asia/Pacific 6,865 5,768 19.0% 12.9%
Latin America 2,612 2,947 (11.4%) 1.0%
-------- -------- -------- --------
Total sales $ 68,932 $ 63,441 8.7% 6.8%
======== ======== ======== ========
North American sales increased 6.6 percent in the third quarter of 2002 as
compared to the same quarter in 2001. Stronger Potable Water and Fluid
Processing market sales were responsible for the growth in North America during
this time period. The Water Group (which addresses the potable water market)
continues to record strong sales of its series of filters designed for customers
who serve various channels of distribution with final sales to US residential
consumers. European sales increased 24.4 percent as compared to the same period
in 2001, and was up 12.0 percent when expressed in local currency. Healthcare
sales were particularly strong in the quarter reflecting greater demand in the
pharmaceutical industry. Sales in Japan were relatively flat as compared to the
same quarter last year in both US dollars and local currency. The poor economy
in Japan is largely responsible for the sluggish sales demand. It is still
unclear when the overall Japanese economy, and more specifically certain
segments in which we compete, will significantly improve. Asia/Pacific sales
were up 19.0 percent and increased 12.9 percent excluding changes in currency
values. The increase in Asia/Pacific sales was due primarily to strong sales
growth in Potable Water throughout the region. Third quarter 2002 Latin American
sales were relatively flat when expressed in local currency despite the economic
troubles in Argentina and the Latin American region in general (see "Argentina
Peso Devaluation" in the "Other Matters" section below for a discussion of our
exposure to Argentina).
11
The following table displays the Company's sales by market (dollar amounts
in thousands):
THREE MONTHS ENDED CURRENCY
JULY 31, PERCENT ADJUSTED
2002 2001 CHANGE CHANGE
-------- -------- -------- --------
Potable Water $ 31,133 $ 27,845 11.8% 11.2%
Fluid Processing 18,979 17,680 7.3% 4.7%
Healthcare 18,820 17,916 5.0% 2.3%
-------- -------- -------- --------
Total sales $ 68,932 $ 63,441 8.7% 6.8%
======== ======== ======== ========
The weak economies in the US and certain international markets (primarily
Japan) have impacted all of our markets to some extent; however, Fluid
Processing is the Company's most cyclical market and has been most impacted by
the recent economic slowdown. Nevertheless, the Fluid Processing sales increase
of 7.3 percent reflects improved conditions in certain end markets. The strength
in the Potable Water market was broad geographically, driven largely by strong
overseas sales (up 15.9 percent in local currency) and strong sales growth in
North America (up 10.4 percent) associated with OEM customers, direct marketing
companies, and appliance manufacturers. Healthcare sales increased and continue
to benefit from a continued focus by management on competitively favorable
product lines and market niches.
GROSS PROFIT
Gross profit increased $2.7 million to $31.0 million in the third quarter
of 2002 from $28.3 million in the third quarter of 2001. Gross profit as a
percentage of net sales (gross margin) increased during that same period from
44.6 percent in 2001 to 45.0 percent in 2002. The primary factor that
contributed to the improved gross margin in 2002 was the market mix of sales
(increased aftermarket sales and higher Healthcare volume which generally carry
higher margins).
OPERATING EXPENSES
Selling, general and administrative expenses (SG&A) were up 8.9 percent.
SG&A expenses were 24.9 percent of sales in the third quarter of fiscal 2002
compared to 24.9 percent of sales in the third quarter of fiscal 2001. As
further described in Note 7, the 2002 results benefited from the elimination of
goodwill amortization ($0.3 million in the third quarter of 2001) required by
the adoption of SFAS 142. Expense categories within SG&A reflected nominal
increases or decreases consistent with our cost-management strategy.
Research, development and engineering expenses increased 5.2 percent to
$3.7 million in the third quarter of 2002, reflecting our continued focus on the
development of new products and technologies. As a percentage of sales,
research, development and engineering expenses were 5.4 percent of sales in the
third quarter of fiscal 2002 compared to 5.6 percent of sales in the third
quarter of fiscal 2001.
OPERATING INCOME
As a result of the above, operating income increased $1.5 million, or 17.1
percent, to $10.1 million or 14.6 percent of sales in the third quarter of
fiscal 2002 compared to $8.6 million or 13.6 percent of sales in the third
quarter of 2001.
12
NON-OPERATING ACTIVITY
Interest expense was relatively flat in the third quarter of 2002 compared
to the third quarter of 2001. See "Financial Position and Liquidity" below for
further discussion of the Company's cash and debt structure. Interest income was
down due to lower average interest rates in 2002, partially offset by higher
average net investment levels.
INCOME TAXES
The Company's effective income tax rate for the third quarter of 2002 was
33.9 percent compared to 35.1 percent in the third quarter of 2001. The decrease
primarily reflects the recognition of certain tax planning initiatives,
permanent tax benefits associated with the adoption of SFAS 142 (see Note 7),
and a change in the mix of income attributed to the various countries in which
the Company does business.
NINE MONTH PERIOD ENDED JULY 31, 2002 VS. NINE MONTH PERIOD ENDED JULY 31, 2001
NET SALES
Net sales were $190.7 million in the first nine months of fiscal 2002
representing a 4.6 percent increase over 2001's comparable sales of $182.2
million. This increase can generally be attributed to an increase in the unit
volume of worldwide sales. Had currency values been unchanged from the first
nine months of 2001, net sales in 2002 would have been $2.4 million higher, or
6.0 percent greater overall.
The following table displays the Company's sales by geographic segment
(dollar amounts in thousands):
NINE MONTHS ENDED CURRENCY
JULY 31, PERCENT ADJUSTED
2002 2001 CHANGE CHANGE
-------- -------- -------- --------
North America $110,895 $103,260 7.4% 7.4%
Europe 29,507 26,175 12.7% 10.3%
Japan 22,739 26,623 (14.6%) (8.7%)
Asia/Pacific 18,795 17,210 9.2% 9.0%
Latin America 8,749 8,945 (2.2%) 14.5%
-------- -------- -------- --------
Total sales $190,685 $182,213 4.6% 6.0%
======== ======== ======== ========
North American sales increased 7.4 percent in the first nine months of
2002 as compared to the same period in 2001. Strong Potable Water and Healthcare
market sales were responsible for the growth in North America during this time
period. The Water Group (which addresses the potable water market) continues to
record strong sales of its series of filters designed for customers who serve
various channels of distribution with final sales to US residential consumers.
Sales in Europe increased 12.7 percent as compared to the same period in 2001,
and were up 10.3 percent when expressed in local currency. Healthcare sales,
particularly to the pharmaceutical industry, and Potable Water sales, increased
during the period. Sales in Japan were down 14.6 percent as compared to the same
period last year, and were 8.7 percent lower when expressed in local currency.
The weak economy in Japan is largely responsible for the depressed sales demand.
Asia/Pacific sales were up 9.0 percent excluding changes in currency values. The
majority of the increase in Asia/Pacific is due to strong sales growth in
Potable Water
13
throughout the region. Despite the economic troubles in Argentina (see
"Argentina Peso Devaluation" in the "Other Matters" section below for a
discussion of our exposure to Argentina), Latin American sales increased 14.5
percent when expressed in local currency. The large increase in local currency
sales was supported by increased penetration of all markets, with particular
strength in the food and beverage industry which supports such products as beer,
wine, soft drinks, and bottled water.
The following table displays the Company's sales by market (dollar amounts
in thousands):
NINE MONTHS ENDED CURRENCY
JULY 31, PERCENT ADJUSTED
2002 2001 CHANGE CHANGE
-------- -------- -------- --------
Potable Water $ 87,794 $ 78,952 11.2% 11.6%
Fluid Processing 50,627 54,635 (7.3%) (5.4%)
Healthcare 52,264 48,626 7.5% 9.6%
-------- -------- -------- --------
Total sales $190,685 $182,213 4.6% 6.0%
======== ======== ======== ========
The weak economies in the US and certain international markets (primarily
Japan) have impacted all of our markets to some extent; however, Fluid
Processing is the Company's most cyclical market and has been most impacted by
the economic slowdown during the period. The strength in the Potable Water
market was broad geographically, driven largely by strong overseas sales (up
17.1 percent in local currency) and strong sales growth in North America (up
10.6 percent) associated with OEM customers, direct marketing companies, and
appliance manufacturers. Healthcare sales increased both domestically and
internationally and continue to benefit from the ongoing focus by management on
competitively favorable product lines and market niches.
GROSS PROFIT
Gross profit increased $5.4 million to $85.4 million in the first nine
months of 2002 from $80.0 million in the first nine months of 2001. Gross profit
as a percentage of net sales (gross margin) increased during that same period
from 43.9 percent in 2001 to 44.8 percent in 2002. The primary factor that
contributed to the improved gross margin in 2002 was the market mix of sales
(increased Healthcare sales which generally carry higher margins combined with
decreased Fluid Processing sales which generally carry lower margins).
OPERATING EXPENSES
Selling, general and administrative expenses (SG&A) increased moderately
(up 4.1%) reflecting our continued focus on restraining discretionary spending.
As a percentage of sales, SG&A expenses were 25.8 percent of sales in the first
nine months of fiscal 2002 compared to 25.9 percent of sales in the first nine
months of fiscal 2001. As further described in Note 7, the 2002 results
benefited by the elimination of goodwill amortization ($1.0 million in the first
nine months of 2001) required by the adoption of SFAS 142. Expense categories
within SG&A reflected nominal increases or decreases consistent with our
cost-management strategy.
Research, development and engineering expenses increased 6.9 percent to
$10.9 million in the first nine months of 2002, reflecting our continued focus
on the development of new products and technologies. As a percentage of sales,
research, development and engineering expenses were 5.7 percent of sales in the
first nine months of fiscal 2002 compared to 5.6 percent of sales in the first
nine months of fiscal 2001.
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OPERATING INCOME
As a result of the above, operating income increased $3.7 million, or 17.1
percent, to $25.3 million or 13.3 percent of sales in the first nine months of
fiscal 2002 compared to $21.6 million or 11.9 percent of sales in the first nine
months of 2001.
NON-OPERATING ACTIVITY
Interest expense was down $0.1 million in the first nine months of 2002
compared to the first nine months of 2001 due primarily to lower average
interest rates. See "Financial Position and Liquidity" below for further
discussion of the Company's cash and debt structure. Interest income was down
due to lower average interest rates in 2002, partially offset by higher average
net investment levels.
INCOME TAXES
The Company's effective income tax rate for the first nine months of 2002
was 34.3 percent compared to 35.7 percent in the first nine months of 2001. The
decrease primarily reflects the recognition of certain tax planning initiatives,
permanent tax benefits associated with the adoption of SFAS 142 (see Note 7),
and a change in the mix of income attributed to the various countries in which
the Company does business.
FINANCIAL POSITION AND LIQUIDITY
We assess liquidity in terms of the Company's ability to generate cash to
fund our operating and investing activities. Of particular importance to the
management of liquidity are cash flows generated by operating activities,
capital expenditure levels, and adequate bank financing alternatives.
We manage our worldwide cash requirements considering the cost
effectiveness of the funds available from the many subsidiaries through which we
conduct our business. We believe that our existing cash and cash equivalents
position ($34.6 million at July 31, 2002) and available sources of liquidity
(approximately $26.3 million of available, uncommitted, unused worldwide
short-term lines of credit) are sufficient to meet current and anticipated
requirements for the foreseeable future. We do not rely on commercial paper or
off-balance sheet financing arrangements for our liquidity needs nor do we have
any investments in special purpose entities (SPE's).
In addition, in March 2002, we closed on a $12 million unsecured credit
facility that renews annually. Borrowings under this facility are subject to
various financial covenants and bear interest at a floating interim rate based
upon LIBOR. There were no borrowings outstanding under this facility at July 31,
2002.
We continue to invest in R&D to provide future sources of revenue through
the development of new products, as well as through additional uses for existing
products. Our efforts are spread across the various markets in which we compete,
with particular emphasis on new products and technologies in Healthcare and the
improvement in design and function of products within Potable Water. We consider
R&D and the development of new products and technologies an integral part of our
growth strategy and a core competence of the Company.
Likewise, we continue to invest in capital expenditures in order to expand
and modernize manufacturing facilities around the globe. We are currently
expanding manufacturing lines in Brazil and
15
China in order to meet product demands around the globe. In addition, new
manufacturing lines and processes are being installed in the US to benefit the
Water Group, Fluid Processing, and Healthcare operations.
Set forth below is selected cash flow data (in thousands of dollars):
Source/(Use) of Cash NINE MONTHS ENDED
JULY 31,
2002 2001
-------- --------
OPERATING ACTIVITIES:
Net cash provided by net income plus depreciation,
amortization and non-cash compensation $ 23,149 $ 21,587
Pension funding in excess of expense (4,290) (348)
Accounts receivable (2,827) 1,998
Accounts payable and accrued expenses 6,269 249
Net cash provided by operating activities 20,659 19,459
INVESTING ACTIVITIES:
Capital expenditures (12,236) (7,771)
Acquisition of companies, net of cash acquired (503) (4,489)
FINANCING ACTIVITIES:
Net change in total debt (799) (950)
Proceeds from stock options exercised 1,564 497
The net cash provided by net income plus depreciation, amortization and
non-cash compensation is an important measurement of cash generated from the
earnings process. Net income plus depreciation, amortization and non-cash
compensation of $23.1 million increased 7.2 percent in the first nine months of
2002 as compared to the same period in 2001 reflecting our increased sales,
gross profit, improved operating profit margin, and improved tax rate. We made
an incremental $4.0 million contribution to our US pension plans in the first
quarter of 2002 to bolster the funding and earnings capabilities of the plans.
The use of cash for accounts receivable (accounts receivable up 6.8 percent) in
2002 reflects the increased level of sales during the period. The increase in
accounts payable and accrued expenses during the first nine months of 2002
primarily relates to the timing of inventory purchases and cash disbursements.
The increased rate of capital expenditures in 2002 primarily relates to
the continued focus on expanding and modernizing manufacturing facilities around
the globe. More specifically, we are currently expanding manufacturing lines in
Brazil and China. In addition, new manufacturing lines and processes are being
installed in the US to benefit the Water Group, Fluid Processing, and Healthcare
operations. In the second quarter of fiscal 2002, we completed a product line
acquisition in Australia for $0.5 million. In the second quarter of 2001, we
closed on two acquisitions - a product line in Australia and a distributor in
Europe for a total of $4.5 million. These acquisitions did not have a material
effect on the Company's historical financial statements or pro forma operating
results.
Due in part to our increased stock price, during the first nine months of
fiscal 2002, 133,088 stock options were exercised (net of shares used to pay
individual taxes) providing $1,564,000 in net cash proceeds.
16
OTHER MATTERS
ARGENTINE PESO DEVALUATION
A significant devaluation in the Argentine peso took place in our first
quarter of 2002. We have a branch located in Argentina that accounted for less
than 1% of consolidated net sales in 2001. Because this branch's operation is
not material to our consolidated results, it has only a minimal impact on our
overall results of operations. See "Market Risk Disclosures" below.
WAR ON TERRORISM AND ITS IMPACT ON CUNO
Other than the general economic downturn, the terrorist attacks on
September 11, 2001 did not materially impact our business. Going forward, our
exposure in the Middle East is very limited - fiscal 2001 sales were less than 2
percent of total worldwide sales and we have no fixed assets in the region.
Partly as a result of the terrorist attacks, the cost of insurance has
risen substantially and the availability of insurance has become more
restrictive. We maintain insurance coverage with such deductibles and
self-insurance as considered adequate for our needs. Such coverage reflects
market conditions (including cost and availability) existing at the time it is
written and the relationship of insurance coverage to self-insurance varies
accordingly. We consider the impact of these changes as we continually assess
the best way to provide for our insurance needs now and in the future.
ESTIMATES AND ASSUMPTIONS
In preparing financial information, we use estimates and assumptions that
may affect reported amounts and disclosures. Estimates are used when accounting
for depreciation, amortization, employee benefits, contingencies and asset
valuation allowances (including those for bad debts and for deferred income tax
assets). For example, in determining annual pension costs, we must estimate
future rates of return on plan assets and future compensation rates. We are also
subject to various risks and uncertainties that may cause actual results to
differ from estimated results, such as changes in the industry, overall economy,
competition, foreign exchange rates, litigation, and legislation.
MARKET RISK DISCLOSURES
The overall objective of our financial risk management program is to seek
a reduction in the potential negative earnings effects from changes in foreign
exchange and interest rates arising from business activities. We manage these
financial exposures through operational means and by utilizing available
financial instruments. Practices may change as economic conditions change.
Foreign Currency Risk
Our earnings and cash flows are subject to fluctuations due to changes in
foreign currency exchange rates. We utilize forward foreign exchange contracts
to hedge specific exposures relating to intercompany payments, certain firm
sales commitments and anticipated, but not yet committed, intercompany sales
(primarily parent company export sales to subsidiaries at pre-established US
dollar prices) and other specific and identified exposures. The terms of the
forward foreign exchange contracts are generally matched to the underlying
transaction being hedged, and are typically under one year.
17
Because such contracts are directly associated with identified
transactions, they are an effective hedge against fluctuations in the value of
the foreign currency underlying the transaction. All of our foreign exchange
contracts are accounted for at fair value based on readily available market
price quotations. We generally do not hedge overseas sales denominated in
foreign currencies or translation exposures. Further, we do not enter into
financial instruments for speculation or trading purposes.
We utilize bank loans and other debt instruments throughout our worldwide
operations. To mitigate foreign currency risk, such debt is generally
denominated in the underlying local currency of the affiliate. In certain
limited and specific circumstances, we will manage risk by denominating a
portion of debt outstanding in a currency other than the local currency.
Contractual Obligations and Commercial Commitments
Below is a table detailing, by maturity date, our Contractual Obligations
and Commercial Commitments as of October 31, 2001 (amounts in millions):
OBLIGATIONS AND
COMMITMENTS 2002 2003 2004 2005 2006 THEREAFTER
- ---------------- ------ ------ ------ ------ ------ ----------
Bank loans $ 13.3 $ -- $ -- $ -- $ -- $ --
Long-term debt 0.7 0.8 0.8 0.2 0.2 0.9
Operating leases 2.1 1.8 1.5 1.5 1.5 --
Total $ 16.1 $ 2.6 $ 2.3 $ 1.7 $ 1.7 $ 0.9
There have been no material changes in the information reported in the
Company's Form 10-K for the year ended October 31, 2001 under the "Market Risk
Disclosures" section of Management's Discussion and Analysis of Financial
Condition and Results of Operations.
COMPANY RISK FACTORS
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
Approximately 45% of our net sales are derived from international operations.
Consequently, our reported financial results may be adversely affected by
significant fluctuations in the value of the U.S. dollar in comparison to local
currencies in the countries in which we operate outside the US. We manufacture
products in Japan, China, Brazil, France, Singapore and Australia. Our
international operations may be affected by economic, political and governmental
conditions in some of the countries where we have manufacturing facilities or
where our products are sold. In addition, changes in economic or political
conditions in any of the countries in which we operate could result in
unfavorable taxation policies, exchange rates, new or additional currency or
exchange controls, governmental regulations, credit risks, or other restrictions
being imposed on the operations of the Company or expropriation.
PATENTS AND PROPRIETARY TECHNIQUES
We have a broad patent portfolio as well as other proprietary information and
manufacturing techniques and have applied, and will continue to apply, for
patents to protect our technology. The Company's success depends in part upon
our ability to protect our technology and proprietary products under U.S. and
foreign patent and other intellectual property laws. Trade secrets and
confidential know-how which are not patented are protected through
confidentiality agreements, contractual provisions and internal Company
administrative procedures. There can be no assurance that such arrangements will
provide meaningful protection for the Company in the event of any unauthorized
use or disclosure. There can be no assurance that third parties will not assert
infringement claims against the Company or that a license
18
or similar agreement will be available on reasonable terms in the event of an
unfavorable ruling on any such claim. In addition, any such claim may require
the Company to incur litigation expenses or subject the Company to liabilities.
TECHNOLOGICAL AND REGULATORY CHANGE
The filtration and separations industry is characterized by changing technology,
competitively imposed process standards and regulatory requirements, each of
which influences the demand for our products and services. Changes in
legislative, regulatory or industrial requirements or competitive technologies
may render certain of our filtration and separations products and processes
obsolete. Acceptance of new products may also be affected by the adoption of new
government regulations requiring stricter standards. The Company's ability to
anticipate changes in technology and regulatory standards and to develop and
introduce new and enhanced products successfully on a timely basis are
significant factors in our ability to grow and to remain competitive. Similar to
all companies, we are also subject to the risks generally associated with new
product introductions and applications, including lack of market acceptance,
delays in product development and failure of products to operate properly.
COMPETITION
The filtration and separations markets in which we compete are highly
competitive. We compete with many domestic and international companies in the
global markets. The principal methods of competition in the markets in which we
compete are product specifications, performance, quality, knowledge, reputation,
technology, distribution capabilities, service and price.
KEY CUSTOMERS AND SUPPLIERS
We have multi-year contracts in place with several of our major customers and
suppliers. Such contracts help us effectively plan and manage our operations. We
are sensitive to the changing needs of our customers and the ongoing performance
of our suppliers. When appropriate, we will negotiate contracts to insure the
continuation of beneficial, long-term relationships. However, there is no
assurance that such contracts will not be terminated prematurely or will be
renewed by such third parties.
FORWARD LOOKING INFORMATION
The Securities and Exchange Commission encourages companies to disclose
forward-looking information so that investors can better understand a company's
future prospects and make informed investment decisions. Also, we want to
provide stockholders and investors with more meaningful and useful information
and therefore, this quarterly report describes our beliefs regarding business
conditions and the outlook for the Company, which reflects currently available
information. These forward looking statements are subject to risks and
uncertainties which, as described in Management's Discussion and Analysis in the
Company's Annual Report on Form 10-K for the year ended October 31, 2001, could
cause the Company's actual results or performance to differ materially from
those expressed herein. We assume no obligation to update the information
contained in this quarterly report.
19
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Documents filed as part of this report.
Exhibit 10. Material Contracts
10.26 Amended Employment Agreement - Mark G. Kachur
Exhibit 15 -- Acknowledgement of Ernst & Young LLP
Exhibit 99.1 - Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on From 8-K
No reports were filed on Form 8-K during the quarter for which this 10-Q is
filed.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CUNO INCORPORATED
Date August 21, 2002
By /s/Mark G. Kachur
Mark G. Kachur
Chairman of the Board of Directors,
President and Chief Executive Officer
By /s/ Frederick C. Flynn, Jr.
------------------------------------
Frederick C. Flynn, Jr.
Senior Vice President -
Finance and Administration,
Chief Financial Officer,
Controller, and Assistant Secretary
By /s/ William J. DeFrances, CPA
------------------------------------
William J. DeFrances, CPA
Treasurer, Assistant Controller,
and Assistant Secretary
21