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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 January 31, 2003 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 -- 16,623,372 shares as of January 31, 2003
CUNO INCORPORATED
PAGE
----
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Consolidated Statements of Income - Three months ended January 31, 2003 and 2002 1
Consolidated Balance Sheets - January 31, 2003 and October 31, 2002 2
Consolidated Statements of Cash Flows - Three months ended January 31, 2003 and 2002 3
Notes to Unaudited Condensed Consolidated Financial Statements 4
Independent Accountants' Review Report 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk 14
Item 4. Controls and Procedures 15
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 18-24
CUNO INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except share amounts)
THREE MONTHS ENDED
JANUARY 31,
2003 2002
----------- -----------
Net sales $ 66,437 $ 58,637
Less costs and expenses:
Cost of products sold 36,683 32,467
Selling, general and administrative 17,789 15,888
Research, development and engineering 3,670 3,425
----------- -----------
58,142 51,780
----------- -----------
Operating income 8,295 6,857
Nonoperating income (expense):
Interest expense (147) (130)
Interest and other income, net 91 171
----------- -----------
(56) 41
----------- -----------
Income before income taxes 8,239 6,898
Income taxes 2,851 2,379
----------- -----------
Net income $ 5,388 $ 4,519
=========== ===========
Basic earnings per common share $ 0.33 $ 0.28
Diluted earnings per common share $ 0.32 $ 0.27
Basic shares outstanding 16,563,423 16,350,394
Diluted shares outstanding 16,941,155 16,795,713
See accompanying notes.
-1-
CUNO INCORPORATED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share amounts)
JANUARY 31, OCTOBER 31,
2003 2002
----------- -----------
ASSETS
Current assets
Cash and cash equivalents $ 34,762 $ 40,872
Accounts receivable, less allowances for
doubtful accounts of $1,403 and $1,406, respectively 52,029 50,862
Inventories 28,068 26,173
Deferred income taxes 7,870 7,998
Prepaid expenses and other current assets 5,260 4,233
--------- --------
Total current assets 127,989 130,138
Noncurrent assets
Deferred income taxes 1,515 1,482
Intangible assets, net 29,686 28,758
Prepaid pension costs 2,498 -
Other noncurrent assets 1,149 1,742
Property, plant and equipment, net 76,696 74,759
--------- --------
Total assets $ 239,533 $236,879
--------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Bank loans $ 14,897 $ 16,374
Accounts payable 16,362 16,256
Accrued payroll and related taxes 9,588 13,633
Other accrued expenses 10,771 10,093
Accrued income taxes 2,246 497
Current portion of long-term debt 715 714
--------- --------
Total current liabilities 54,579 57,567
Noncurrent liabilities
Long-term debt, less current portion 2,112 2,030
Deferred income taxes 5,848 5,924
Retirement benefits 5,533 8,945
--------- --------
Total noncurrent liabilities 13,493 16,899
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,
16,623,372 and 16,566,625 shares issued and outstanding 17 17
Treasury Stock, at cost (2,747 shares) (57) (57)
Additional paid-in-capital 48,036 46,375
Unearned compensation (702) (551)
Accumulated other comprehensive loss --
Foreign currency translation adjustments (3,314) (5,533)
Minimum pension liability (5,153) (5,153)
Change in fair value of derivative financial instruments (77) (8)
========= ========
(8,544) (10,694)
RETAINED EARNINGS 132,711 127,323
--------- --------
Total stockholders' equity 171,461 162,413
--------- --------
Total liabilities and stockholders' equity $ 239,533 $236,879
========= ========
See accompanying notes.
-2-
CUNO INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)
THREE MONTHS ENDED
JANUARY 31,
2003 2002
---- ----
OPERATING ACTIVITIES
Net income $ 5,388 $ 4,519
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,371 1,912
Noncash compensation recognized under employee stock plans 143 201
Gains on sales of property, plant and equipment (3) (5)
Pension funding in excess of expense (6,000) (3,749)
Deferred income taxes 128 1,529
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable 38 588
Inventories (1,030) 603
Prepaid expenses and other current assets (670) (788)
Accounts payable and accrued expenses (3,549) (1,837)
Accrued income taxes 1,730 (1,478)
-------- --------
Net cash (used for) provided by operating activities (1,454) 1,495
INVESTING ACTIVITIES
Proceeds from sales of property, plant and equipment 19 20
Acquisition of companies, net of cash acquired (149) -
Capital expenditures (3,426) (3,217)
-------- --------
Net cash used for investing activities (3,556) (3,197)
FINANCING ACTIVITIES
Principal payments on long-term debt (25) (188)
Net repayments under short-term bank loans (1,758) (760)
Proceeds from stock options exercised 149 141
-------- --------
Net cash used for financing activities (1,634) (807)
Effect of exchange rate changes on cash and cash equivalents 534 43
-------- --------
Net change in cash and cash equivalents (6,110) (2,466)
Cash and cash equivalents -- beginning of period 40,872 25,628
-------- --------
Cash and cash equivalents -- end of period $ 34,762 $ 23,162
-------- --------
See accompanying notes.
-3-
CUNO INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 2003
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, 2002.
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and disclosures made in the accompanying notes to the financial
statements. These estimates include, among others: depreciation, amortization,
employee benefits, contingencies and asset valuation allowances (including those
for bad debts and for deferred income tax assets). Actual results could differ
from those estimates.
NOTE 2 - INVENTORIES
Inventories consist of the following (amounts in thousands):
JANUARY 31, OCTOBER 31,
2003 2002
--------- ---------
Raw materials $12,591 $11,701
Work-in-process 3,681 3,112
Finished goods 11,796 11,360
------- -------
$28,068 $26,173
======= =======
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.
4
NOTE 3 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per common share for the three months ended:
JANUARY 31, JANUARY 31,
2003 2002
---- ----
NUMERATOR:
Net income $ 5,388,000 $ 4,519,000
=========== ===========
DENOMINATORS:
Weighted average shares outstanding 16,588,552 16,393,840
Issued but unearned restricted shares (25,129) (43,446)
----------- -----------
DENOMINATOR FOR BASIC EARNINGS PER SHARE 16,563,423 16,350,394
=========== ===========
Weighted average shares outstanding 16,588,552 16,393,840
Effect of dilutive employee stock options 352,603 401,873
----------- -----------
DENOMINATOR FOR DILUTED EARNINGS PER SHARE 16,941,155 16,795,713
=========== ===========
Basic earnings per share $ 0.33 $ 0.28
Diluted earnings per share $ 0.32 $ 0.27
NOTE 4 - COMPREHENSIVE INCOME
Total comprehensive income was comprised of the following (amounts in
thousands):
THREE MONTHS ENDED
JANUARY 31,
2003 2002
---- ----
Net income $5,388 $4,519
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 $95 and $52 (131) 97
Losses (gains) related to derivative
financial instruments reclassified into
earnings from other comprehensive
income, net of $45 and $18 tax benefit 62 (33)
Foreign currency translation adjustments 2,219 (979)
------ ------
Total comprehensive income $7,538 $3,966
====== ======
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.
5
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
JANUARY 31,
2003 2002
---- ----
NET SALES:
Europe $13,086 $10,831
Japan 8,086 6,922
Asia/Pacific 8,758 6,243
Latin America 2,364 3,264
------- -------
Subtotal - Foreign sales 32,294 27,260
North America 42,904 39,107
Intercompany sales (8,761) (7,730)
------- -------
$66,437 $58,637
======= =======
THREE MONTHS ENDED
JANUARY 31,
2003 2002
---- ----
OPERATING INCOME:
North America $5,230 $4,397
Europe 795 527
Japan 743 406
Asia/Pacific 1,192 906
Latin America 335 621
------ ------
Segment total 8,295 6,857
------ ------
Interest expense (147) (130)
Other, net 91 171
------ ------
Income before income taxes $8,239 $6,898
====== ======
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
JANUARY 31,
2003 2002
---- ----
Interest income $141 $198
Exchange gains (losses) (38) 47
Gains on sales of property,
Plant, and equipment 3 5
Other, net (15) (79)
---- ----
$ 91 $171
==== ====
6
NOTE 7 - NEWLY ISSUED ACCOUNTING STANDARDS
In June 2002, the Financial Accounting Standards Board (FASB) issued
SFAS 146, "Accounting for Costs Associated with Exit or Disposal Activities",
which addresses issues regarding the recognition, measurement and reporting of
costs associated with exit and disposal activities, including restructuring
activities. This statement requires that costs associated with exit or disposal
activities be recognized when they are incurred rather than at the date of a
commitment to an exit or disposal plan. SFAS 146 is effective for all exit or
disposal activities initiated after December 31, 2002. We will assess the impact
of this Statement when or if an exit plan for an activity exists.
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-
Based Compensation - Transition and Disclosure - an amendment of FASB Statement
No. 123" (FAS 148). This statement amends SFAS No. 123 "Accounting for Stock
Based Compensation" (FAS 123) to provide alternative methods of voluntarily
transitioning to the fair value based method of accounting for stock-based
employee compensation. FAS 148 also amends the disclosure requirements of FAS
123 to require disclosure of the method used to account for stock-based employee
compensation and the effect of the method on reported results in both annual and
interim financial statements. The disclosure provisions will be effective for
the Company beginning with the quarter ended April 30, 2003. The annual impact
of a change to a fair value model has been previously disclosed in the Company's
Annual Report on Form 10-K. We are currently studying this new accounting
standard.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (the Interpretation). The Interpretation
requires companies to recognize, at inception of the guarantee, a liability for
the fair value of the obligation undertaken in issuing the guarantee and also
requires a guarantor to make significant new disclosures, even when the
likelihood of making any payments under the guarantee is remote. The
Interpretation provides specific guidance identifying the characteristics of
contracts that are subject to its guidance in its entirety from those only
subject to the initial recognition and measurement provisions. The recognition
and measurement provisions of the Interpretation are effective on a prospective
basis for guarantees issued or modified after December 31, 2002. The disclosure
requirements of the Interpretation are effective for interim and annual period
financial statements ending after December 15, 2002. We do not believe any
additional disclosure is needed currently related to the Interpretation and will
apply the Interpretation prospectively if guarantees are entered into.
Effective November 1, 2002, the Company adopted Statement No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets". Statement No.
144 supersedes FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", however it
retains the fundamental provisions of that statement related to the recognition
and measurement of the impairment of long-lived assets to be "held and used." In
addition, Statement 144 provides more guidance on estimating cash flows when
performing a recoverability test, requires that a long-lived asset (group) to be
disposed of other than by sale (e.g. abandoned) be classified as "held and used"
until it is disposed of, and establishes more restrictive criteria to classify
an asset (group) as "held for sale." The adoption of Statement No. 144 did not
have an impact on the Company.
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.
7
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 January 31, 2003, and the related condensed consolidated
statements of income and the condensed consolidated statements of cash flows for
the three-month periods ended January 31, 2003 and 2002. 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, 2002, 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 5, 2002, 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, 2002, 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
February 18, 2003
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's discussion and analysis of financial condition and results
of operations ("MD&A") is provided as a supplement to the accompanying unaudited
interim condensed consolidated financial statements and footnotes to help
provide an understanding of our financial condition, changes in our financial
condition and results of our operations. Our MD&A is organized as follows:
- CAUTION CONCERNING FORWARD-LOOKING STATEMENTS. This section
discusses how certain forward-looking statements made by us
throughout the MD&A and elsewhere in this report are based on
management's present expectations about future events and are
inherently susceptible to uncertainty and changes in
circumstances.
- COMPANY OVERVIEW. This section provides a general description
of our business.
- CRITICAL ACCOUNTING POLICIES. This section discusses those
accounting policies that are both considered important to our
financial condition and operating results and require
significant judgment and estimates on the part of management
in their application.
- RESULTS OF OPERATIONS. This section provides an analysis of
our results of operations for the three months ended January
31, 2003 and 2002. In addition, a brief description is
provided of transactions and events that impact the
comparability of the results being analyzed.
- FINANCIAL CONDITION AND LIQUIDITY. This section provides an
analysis of our cash position and cash flows, as well as a
discussion of our financing arrangements.
- QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
This section discusses information about the various market
risks we are exposed to as of the end of our latest fiscal
year.
- CONTROLS AND PROCEDURES. This section discusses the
conclusions of our executive officer and principal financial
officer about the effectiveness of our disclosure controls and
procedures.
- OTHER INFORMATION. This section describes material
developments in the business or markets in which we compete,
as well as any other information important to our
stakeholders.
- COMPANY RISK FACTORS. This section describes the material
risks inherent in our business that investors should be aware
of.
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
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, 2002, 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.
COMPANY OVERVIEW
CUNO is a world leader in the designing, manufacturing and marketing of
a comprehensive line of filtration products for the separation, clarification
and purification of liquids and gases. Our products, which include
9
proprietary depth filters and semi-permeable membrane filters, are used in the
potable water, fluid processing, and healthcare markets. These products, most of
which are disposable, effectively remove contaminants that range in size from
molecules to sand particles. Our sales are balanced between domestic
(approximately 55%) and international markets (approximately 45%). Our objective
is to provide high value-added products and premium customer service. Our
proprietary manufacturing processes result in products that lower customers'
operating expenses and improve the quality of customers' end products by
providing longer lasting, higher quality and more efficient filtration products.
CRITICAL ACCOUNTING POLICIES
In December 2001 the U.S. Securities and Exchange Commission ("SEC")
issued Financial Reporting Release No. 60, "Cautionary Advice Regarding
Disclosure About Critical Accounting Policies" ("FRR 60"), encouraging companies
to provide additional disclosure and commentary on their most critical
accounting policies. In FRR 60, the SEC defined the most critical accounting
policies as the ones that are most important to the portrayal of a company's
financial condition and operating results, and require management to make its
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.
Based on this definition, our most critical accounting policies include:
accounting for depreciation, amortization, employee benefits, income taxes,
contingencies and asset valuation allowances (including those for bad debts and
for deferred income tax assets). We also have other key accounting policies,
such as our policy for revenue recognition. The methods, estimates and judgments
we use in applying these most critical accounting policies have a significant
impact on the results we report in our financial statements.
Depreciation and amortization - We depreciate our property, plant
and equipment using the straight-line method over the estimated useful life of
the asset. These periods range as follows:
Land improvements 10 - 20 years
Buildings and additions 30 - 40 years
Machinery and equipment 5 - 20 years
Computers and related equipment 3 - 5 years
We amortize our patents and other amortizable intangible assets over
their estimated useful lives. These periods generally range from 10 - 25 years.
We review the carrying values of intangibles and long-lived assets on
an annual basis. In addition, in the event that facts and circumstances indicate
that the carrying value of intangibles and long-lived assets or other assets may
be impaired at any other time, an evaluation is performed. Our evaluations
compare the estimated future undiscounted cash flows associated with the asset
to the asset's carrying amount.
Employee benefits - Under the provisions of SFAS No.87, "Employer's
Accounting for Pensions" measurement of the obligations under employee benefits
plans are subject to a number of assumptions. These include the future rate of
return on plan assets, future rates of increase in compensation levels, and
future interest rates. Each of these assumptions reflects our best estimate of
future conditions.
Contingencies, claims, assessments - From time to time, we are
involved with contingencies, claims, and assessments. We use both in-house and
outside legal counsel to assess the probability of loss. The Company establishes
an accrual when the claims and litigation represent a probable loss and the cost
can be reasonably estimated. There can be no assurance that the ultimate
resolution of these contingencies, claims, and assessments will not differ
materially from our estimates.
Allowance for Bad Debt - We maintain an allowance for doubtful
accounts for estimated losses resulting from the inability of our customers to
make required payments. Our allowance for doubtful accounts is based on our
assessment of the collectibility of specific customer accounts, the aging of
accounts receivable, our history of bad debts, and the general condition of the
industry and geographic locations we operate in. If a major customer's credit
10
worthiness deteriorates, or our customers' actual defaults exceed our historical
experience, our estimates could change and impact our reported results.
Income Taxes - We estimate and use our expected annual effective income
tax rate to accrue income taxes on an interim basis. We update these estimates
quarterly. We record valuation allowances to reduce our deferred income tax
assets to an amount that we believe is more likely than not to be realized. We
consider estimated future taxable income and ongoing prudent and feasible tax
planning strategies in assessing the need for a valuation allowance. If we were
to determine that we will not realize all or part of our deferred income tax
assets in the future, we would make an adjustment to the carrying value of the
deferred income tax asset, which would be reflected as an income tax expense.
Conversely, if we were to determine that we will realize a deferred income tax
asset, which currently has a valuation allowance, we would reverse the valuation
allowance which would be reflected as an income tax benefit in our financial
statements.
Revenue Recognition - We recognize revenue in accordance with SEC
Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements"
("SAB 101"). SAB 101 requires that four basic criteria be met before revenue can
be recognized: 1) there is evidence that an arrangement exists; 2) delivery has
occurred; 3) the fee is fixed or determinable; and 4) collectibility is
reasonably assured. We recognize revenue upon determination that all criteria
for revenue recognition have been met, which is considered to have occurred upon
shipment of the finished product.
RESULTS OF OPERATIONS
THREE MONTH PERIOD ENDED JANUARY 31, 2003 VS. THREE MONTH PERIOD ENDED JANUARY
31, 2002
BUSINESS ENVIRONMENT
Our operations are affected by global economic and political factors.
However, our geographic and market diversity helps limit the impact of any one
market or the economy of any single country on our consolidated results. The
uncertainty in the North American economy, including conditions in certain
markets in which we compete, impacted our consolidated results and is likely to
continue to present challenges to our business near term.
NET SALES
Net sales were $66.4 million in the first quarter of fiscal 2003
representing a 13.3 percent increase over 2002 first quarter sales of $58.6
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
quarter of 2002, net sales in the first quarter of 2003 would have been $1.5
million lower, or 10.7 percent greater overall.
The following table displays the Company's sales by geographic segment
(dollar amounts in thousands):
THREE MONTHS ENDED CURRENCY
JANUARY 31, PERCENT ADJUSTED
2003 2002 CHANGE CHANGE
---- ---- ------ ------
North America $36,895 $34,179 7.9% 7.9%
Europe 11,120 8,661 28.4% 10.3%
Japan 7,979 6,847 16.5% 10.6%
Asia/Pacific 8,232 5,741 43.4% 33.2%
Latin America 2,211 3,209 (31.1%) 0.8%
------- ------- ----- ----
Total sales $66,437 $58,637 13.3% 10.7%
======= ======= ===== ====
North American sales increased 7.9 percent in the first quarter of 2003
as compared to the same quarter in 2002. Stronger Potable Water and Fluid
Processing market sales were responsible for the growth in North America
11
during this time period. European sales increased 10.3 percent in local currency
as compared to the same period in 2002. Healthcare sales were particularly
strong in the quarter reflecting greater demand in the pharmaceutical industry.
Sales in Japan were up 10.6 percent in local currency primarily reflecting an
increase in sales to the fluid processing market. Asia/Pacific sales were up
33.2 percent excluding changes in currency values. The increase in Asia/Pacific
sales was due primarily to the timing of some shipments as well as strong sales
to the Australian wine industry. First quarter 2003 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).
The following table displays the Company's sales by market (dollar
amounts in thousands):
THREE MONTHS ENDED CURRENCY
JANUARY 31, PERCENT ADJUSTED
2003 2002 CHANGE CHANGE
---- ---- ------ ------
Potable Water $30,381 $27,120 12.0% 11.2%
Fluid Processing 17,628 15,149 16.4% 11.6%
Healthcare 18,428 16,368 12.6% 8.9%
------- ------- ---- ----
Total sales $66,437 $58,637 13.3% 10.7%
======= ======= ==== ====
The weak economies in the US and certain international markets
(primarily Japan) have impacted all of our markets to some extent. The Fluid
Processing sales increase of 11.6 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 20.4 percent in
local currency) and strong sales growth in North America (up 9.4 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 $3.6 million to $29.8 million in the first
quarter of 2003 from $26.2 million in the first quarter of 2002. Gross profit as
a percentage of net sales (gross margin) increased during that same period from
44.6 percent in 2002 to 44.8 percent in 2003. Although we are under pressure to
maintain competitive prices with our customers, we pursue various supply-chain
management initiatives designed to lower our production costs. In addition, we
have ongoing programs to modernize our manufacturing facilities to gain more
efficiencies.
OPERATING EXPENSES
Selling, general and administrative expenses (SG&A) were up 12.0
percent. However, SG&A expenses were 26.8 percent of sales in the first quarter
of fiscal 2003 compared to 27.1 percent of sales in the first quarter of fiscal
2002. Because of CUNO's international operations, the weaker US dollar served to
increase the consolidated US dollar-reported SG&A expense.
Research, development and engineering expenses (incurred primarily in
the US) increased 7.2 percent to $3.7 million in the first quarter of 2003,
reflecting our continued focus on the development of new products and
technologies. As a percentage of sales, research, development and engineering
expenses were 5.5 percent of sales in the first quarter of fiscal 2003 compared
to 5.8 percent of sales in the first quarter of fiscal 2002.
12
OPERATING INCOME
As a result of the above, operating income increased $1.4 million, or
21.0 percent, to $8.3 million or 12.5 percent of sales in the first quarter of
fiscal 2003 compared to $6.9 million or 11.7 percent of sales in the first
quarter of 2002.
NON-OPERATING ACTIVITY
Interest expense was relatively flat in the first quarter of 2003
compared to the first quarter of 2002. 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 the first quarter of
2003, partially offset by higher average net investment levels.
INCOME TAXES
The Company's effective income tax rate for the first quarter of 2003
was 34.6 percent compared to 34.5 percent in the first quarter of 2002. Our tax
rate is impacted by the change in the mix of income attributed to the various
countries in which we do 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 ($34.8 million at January 31, 2003) and available sources of liquidity
(approximately $29.8 million of available, 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 (SPEs).
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 currently
have plans to expand manufacturing lines in Brazil, China, and France 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.
13
Set forth below is selected cash flow data (in thousands of dollars):
Source/(Use) of Cash THREE MONTHS ENDED
JANUARY 31,
2003 2002
---- ----
OPERATING ACTIVITIES:
Pension funding in excess of expense $(6,000) $ (3,749)
Accrued income taxes 1,730 (1,478)
Accounts payable and accrued expenses (3,549) (1,837)
Net cash (used for) provided by operating activities (1,454) 1,495
INVESTING ACTIVITIES:
Capital expenditures (3,426) (3,217)
Acquisition of companies, net of cash acquired (149) --
FINANCING ACTIVITIES:
Net change in total debt (1,783) (948)
The funded status of our pension plans is dependent upon many factors,
including returns on invested assets and the level of market interest rates.
Recent declines in the value of securities traded in equity markets coupled with
declines in long-term interest rates have had a negative impact on the funded
status of our plans. We made an incremental $6.0 million contribution to our US
pension plans in the first quarter of 2003 and 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 source of cash of $1,730,000 for income taxes payable primarily
relates to the timing of Federal and other worldwide taxes on income paid. The
increased use of cash for accounts payable and accrued expenses relates
primarily to the timing of disbursements and larger bonus and incentive payments
related to fiscal 2002 that were paid in fiscal 2003.
Capital expenditures in 2003 primarily relate to the continued focus on
expanding and modernizing manufacturing facilities around the globe. More
specifically, these expenditures primarily relate to new manufacturing lines in
Brazil and the US. The new manufacturing lines and processes being installed in
the US will benefit the Water Group, Fluid Processing, and Healthcare
operations. In the first quarter of fiscal 2003, we completed the acquisition of
a distributor in Europe for total consideration of $448,000 ($149,000 in cash
and $299,000 in other consideration). This acquisition did not have a material
effect on the Company's historical financial statements or pro forma operating
results.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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.
14
The terms of the forward foreign exchange contracts are generally matched to the
underlying transaction being hedged, and are typically under one year.
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.
There have been no material changes in the information reported in the
Company's Form 10-K for the year ended October 31, 2002 under the "Market Risk
Disclosures" section of Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Contractual Obligations and Commercial Commitments
Below is a table detailing, by maturity date, our Contractual
Obligations and Commercial Commitments as of October 31, 2002 (amounts in
thousands):
OBLIGATIONS AND
COMMITMENTS 2003 2004 2005 2006 2007 THEREAFTER
- ----------- ---- ---- ---- ---- ------------------
Bank loans $16,374 $ -- $ -- $ -- $ -- $ --
Long-term debt 714 862 139 135 131 763
Operating leases 2,151 1,917 1,470 1,310 1,394 --
--------------------------------------------------------
Total $19,239 $2,779 $1,609 $1,445 $1,525 $763
ITEM 4. CONTROLS AND PROCEDURES
Our chief executive officer and chief financial officer performed an
evaluation of our disclosure controls and procedures as of January 31, 2003 (the
"Evaluation Date"). Based on that evaluation, our chief executive officer and
chief financial officer concluded that our disclosure controls and procedures
were effective to ensure that the information required to be disclosed in the
reports that we file under the Securities Exchange Act of 1934 is recorded,
processed, summarized, and reported within the time periods specified in the
SEC's rules and forms.
There have been no significant changes in our internal controls since
the Evaluation Date. We are not aware of any significant change in any other
factors that could significantly affect our internal controls subsequent to the
Evaluation Date.
OTHER INFORMATION
ARGENTINE PESO DEVALUATION
A significant devaluation in the Argentine peso took place in the first
quarter of 2002. We have a branch located in Argentina that accounted for less
than 1% of consolidated net sales in 2002. 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" above.
15
COST OF INSURANCE
Partly as a result of the September 11, 2001 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.
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 US 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
US 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 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.
16
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.
17
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report.
Exhibit 15 - Acknowledgement of Ernst & Young LLP
Exhibit 99.1 - Certification Pursuant to18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 99.2 - Certification Pursuant to18 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.
18
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 February 18, 2003
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
19
CERTIFICATIONS
I, Mark G. Kachur, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CUNO Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls;
and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: February 18, 2003
/s/ Mark G. Kachur
------------------
Mark G. Kachur
Chairman, President and
Chief Executive Officer
(Principal Executive Officer)
20
CERTIFICATIONS
I, Frederick C. Flynn, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CUNO Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls;
and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: February 18, 2003
/s/ Frederick C. Flynn, Jr.
---------------------------
Frederick C. Flynn, Jr.
Senior Vice President, Chief Financial
Officer
(Principal Financial Officer)
21