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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 APRIL 30, 2005 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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
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 - 17,280,123 shares as of April 30, 2005
CUNO INCORPORATED
PAGE
------
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Consolidated Statements of Income 1-2
Consolidated Balance Sheets 3
Consolidated Statements of Cash Flows 4
Notes to Unaudited Condensed Consolidated Financial Statements 5-12
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 13-26
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
Item 4. Controls and Procedures 27
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 6. Exhibits and Reports on Form 8-K 28
CUNO INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except share and per-share amounts)
THREE MONTHS ENDED
APRIL 30,
2005 2004
------------ ------------
Net sales $ 104,725 $ 82,745
Less costs and expenses:
Cost of products sold 59,970 43,676
Selling, general and administrative expenses 26,298 22,434
Research, development and engineering 5,157 4,036
Amortization expense 650 76
------------ ------------
92,075 70,222
------------ ------------
Operating income 12,650 12,523
Nonoperating income (expense):
Interest expense (561) (87)
Interest and other income, net 342 216
------------ ------------
(219) 129
------------ ------------
Income before income taxes 12,431 12,652
Provision for income taxes 4,003 4,208
------------ ------------
Net income $ 8,428 $ 8,444
============ ============
Basic earnings per common share $ 0.50 $ 0.51
Diluted earnings per common share $ 0.48 $ 0.49
Basic shares outstanding 16,958,565 16,694,466
Diluted shares outstanding 17,460,183 17,214,286
See accompanying notes.
-1-
CUNO INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except share and per-share amounts)
SIX MONTHS ENDED
APRIL 30,
2005 2004
------------ -------------
Net sales $ 204,101 $ 158,154
Less costs and expenses:
Cost of products sold 116,900 84,229
Selling, general and administrative expenses 50,962 42,604
Research, development and engineering 10,081 8,225
Amortization expense 1,303 144
------------ ------------
179,246 135,202
------------ ------------
Operating income 24,855 22,952
Nonoperating income (expense):
Interest expense (1,084) (170)
Interest and other income, net 565 366
------------ ------------
(519) 196
------------ ------------
Income before income taxes 24,336 23,148
Provision for income taxes 8,077 7,699
------------ ------------
Net income $ 16,259 $ 15,449
============ ============
Basic earnings per common share $ 0.96 $ 0.93
Diluted earnings per common share $ 0.93 $ 0.90
Basic shares outstanding 16,931,554 16,690,853
Diluted shares outstanding 17,459,076 17,211,187
See accompanying notes.
-2-
CUNO INCORPORATED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share amounts)
APRIL 30, OCTOBER 31,
2005 2004
--------- ---------
ASSETS
Current assets
Cash and cash equivalents $ 20,717 $ 23,359
Accounts receivable, less allowances for
doubtful accounts of $2,086 and $2,230, respectively 91,920 89,593
Inventories, net 50,516 47,275
Deferred income taxes 14,520 12,656
Prepaid expenses and other current assets 6,993 5,974
--------- ---------
Total current assets 184,666 178,857
Noncurrent assets
Deferred income taxes 761 892
Goodwill 104,566 103,977
Other intangible assets, net 31,876 32,894
Prepaid pension costs 9,786 9,785
Other noncurrent assets 5,574 4,832
Property, plant and equipment, net 112,067 103,321
--------- ---------
Total assets $ 449,296 $ 434,558
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Current portion of long-term debt $ 322 $ 276
Bank loans 10,476 11,048
Accounts payable 33,984 33,469
Accrued payroll and related taxes 16,094 20,329
Other accrued expenses 11,371 11,502
Accrued income taxes 3,916 4,539
--------- ---------
Total current liabilities 76,163 81,163
Noncurrent liabilities
Long-term debt, less current portion 68,494 75,569
Deferred income taxes 21,741 16,662
Retirement benefits 4,599 4,396
Other noncurrent liabilities 970 789
--------- ---------
Total noncurrent liabilities 95,804 97,416
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,
17,280,123 and 17,122,698 shares issued and outstanding 17 17
Treasury Stock, at cost (2,747 shares) (57) (57)
Additional paid-in-capital 68,195 63,413
Unearned compensation (4,597) (2,164)
Accumulated other comprehensive loss --
Foreign currency translation adjustments 10,754 7,966
Minimum pension liability (386) (386)
Change in fair value of derivative financial instruments (46) -
--------- ---------
10,322 7,580
Retained earnings 203,449 187,190
--------- ---------
Total stockholders' equity 277,329 255,979
--------- ---------
Total liabilities and stockholders' equity $ 449,296 $ 434,558
========= =========
See Accompanying Notes.
-3-
CUNO INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)
SIX MONTHS ENDED
APRIL 30,
2005 2004
--------- --------
OPERATING ACTIVITIES
Net income $ 16,259 $ 15,449
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 7,965 5,417
Noncash compensation recognized under employee stock plans 696 412
Losses (gains) on sales of property, plant and equipment (79) 30
Pension funding less than expense 117 171
Deferred income taxes 3,708 251
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable (1,507) (8,802)
Inventories (2,705) (5,506)
Prepaid expenses and other current assets (1,956) (1,207)
Accounts payable and accrued expenses (5,254) 239
Accrued income taxes (988) 2,424
-------- --------
Net cash provided by operating activities 16,256 8,878
INVESTING ACTIVITIES
Proceeds from sales of property, plant and equipment 100 -
Acquisition of companies, net of cash acquired - (554)
Capital expenditures (13,952) (8,543)
Other, net (692) (574)
-------- --------
Net cash used for investing activities (14,544) (9,671)
FINANCING ACTIVITIES
Principal payments on long-term debt (7,086) (784)
Principal payments on short-term debt (2,824) (612)
Proceeds from short-term debt 2,336 -
Net borrowings under short-term bank loans 1,673 2,964
Proceeds from stock options exercised 1,028 613
-------- --------
Net cash (used for) provided by financing activities (4,873) 2,181
Effect of exchange rate changes on cash and cash equivalents 519 746
-------- --------
Net change in cash and cash equivalents (2,642) 2,134
Cash and cash equivalents -- beginning of period 23,359 57,603
-------- --------
Cash and cash equivalents -- end of period $ 20,717 $ 59,737
======== ========
See accompanying notes.
-4-
CUNO INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per-share amounts)
APRIL 30, 2005
NOTE 1 - ORGANIZATION AND ACCOUNTING POLICIES
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 of America 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 of America for annual
financial statements. In the opinion of management, all adjustments which are of
a normal recurring nature considered necessary for a fair presentation of the
financial position and results of operations for the interim periods set forth
herein 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. These interim
unaudited financial statements should be read in conjunction with the Company's
Annual Report on Form 10-K for the year ended October 31, 2004.
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America 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. Actual results could differ from those estimates.
Certain prior year amounts have been reclassified to conform to current
year presentation.
INVENTORIES:
Inventories are stated at the lower of cost or market. Inventories in the
United States of America are primarily valued by the last-in, first-out (LIFO)
cost method. The methods used for all other inventories are first-in, first-out
(FIFO) and average cost. 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.
Inventories consist of the following:
APRIL 30, OCTOBER 31,
2005 2004
------- -------
(unaudited)
Raw materials $18,702 $18,805
Work-in-process 5,662 6,215
Finished goods 26,152 22,255
------- -------
$50,516 $47,275
======= =======
5
ACCOUNTS PAYABLE
At April 30, 2005 and October 31, 2004, approximately $4,094 and $2,478,
respectively, representing book overdrafts of cash accounts, were reclassified
to accounts payable.
INTEREST AND OTHER INCOME, NET:
Interest and other income (expense), net consisted of the following:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
2005 2004 2005 2004
---- ---- ---- ----
Interest income $ 157 $ 181 $ 329 $ 420
Exchange gains (losses) 93 11 104 (2)
Gains (losses) on sales of
property, plant, and
equipment 88 (38) 104 (30)
Other, net 4 62 28 (22)
----- ----- ----- -----
$ 342 $ 216 $ 565 $ 366
===== ===== ===== =====
EARNINGS PER SHARE:
Basic earnings per common share is based on net income divided by the
weighted average number of common shares outstanding during the period. Diluted
earnings per common share is based on net income divided by the weighted average
number of common shares outstanding during the period, including the effect of
stock equivalents, where such effect is dilutive. Earnings per share for the
three months ended April 30, 2005 and 2004 is calculated as follows:
APRIL 30, APRIL 30,
2005 2004
----------- -----------
NUMERATOR:
Net income $ 8,428 $ 8,444
=========== ===========
DENOMINATORS:
Weighted average shares outstanding 16,958,565 16,694,466
----------- -----------
DENOMINATOR FOR BASIC EARNINGS PER SHARE 16,958,565 16,694,466
=========== ===========
Weighted average shares outstanding 16,958,565 16,694,466
Effect of dilutive employee stock options 298,887 407,061
Effect of dilutive restricted shares 202,731 112,759
----------- -----------
DENOMINATOR FOR DILUTED EARNINGS PER SHARE 17,460,183 17,214,286
=========== ===========
Basic earnings per share $ 0.50 $ 0.51
Diluted earnings per share $ 0.48 $ 0.49
Approximately 104,618 and 216,000 shares (before the effects of the
treasury stock method) related to options to purchase common stock and unvested
restricted stock were excluded from the computations of diluted earnings per
share at April 30, 2005 and 2004, respectively, because the exercise price was
greater than the average market price of the common stock during the periods.
6
Earnings per share for the six months ended April 30, 2005 and 2004 is
calculated as follows:
APRIL 30, APRIL 30,
2005 2004
----------- -----------
NUMERATOR:
Net income $ 16,259 $ 15,449
=========== ===========
DENOMINATORS:
Weighted average shares outstanding 16,931,554 16,690,853
DENOMINATOR FOR BASIC EARNINGS PER SHARE 16,931,554 16,690,853
=========== ===========
Weighted average shares outstanding 16,931,554 16,690,853
Effect of dilutive employee stock options 315,132 407,491
Effect of dilutive restricted shares 212,390 112,843
----------- -----------
DENOMINATOR FOR DILUTED EARNINGS PER SHARE 17,459,076 17,211,187
=========== ===========
Basic earnings per share $ 0.96 $ 0.93
Diluted earnings per share $ 0.93 $ 0.90
Approximately 92,368 and 216,000 shares (before the effects of the
treasury stock method) related to options to purchase common stock and unvested
restricted stock were excluded from the computations of diluted earnings per
share for the six-months ended April 30, 2005 and 2004, respectively, because
the exercise price was greater than the average market price of the common stock
during the periods.
COMPREHENSIVE INCOME:
Total comprehensive income was comprised of the following:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
2005 2004 2005 2004
-------- -------- -------- --------
Net income $ 8,428 $ 8,444 $ 16,259 $ 15,449
Other comprehensive income (loss):
Change in fair value of derivative
financial instruments, net of deferred
income taxes of $10, $189, ($15) and $69 20 302 (23) 100
Losses related to derivative financial
instruments reclassified into earnings
from other comprehensive income,
net of $9, $30, $12 and $55 tax (16) (47) (23) (89)
benefit
Foreign currency translation adjustments 348 (2,577) 2,788 1,058
-------- -------- -------- --------
Total comprehensive income $ 8,780 $ 6,122 $ 19,001 $ 16,518
======== ======== ======== ========
7
EMPLOYEE STOCK OPTIONS:
The Company has stock option plans under which employees and directors
have options to purchase Common Stock. The Company applies APB 25, "Accounting
for Stock Issued to Employees" and related interpretations in accounting for its
stock option plans. The Company has adopted those provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (FAS 123) and Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure - an
amendment of Statement of Financial Accounting Standards No. 123", which require
the disclosure of pro forma effects on net income and earnings per share as if
compensation cost had been recognized based upon the fair value method at the
date of grant for options awarded.
Pro forma information regarding net income and earnings per share is
required by FAS 123, which requires that the information be determined as if we
had accounted for our employee stock options under the fair-value method of FAS
123. The fair value for the options granted during the following periods were
estimated at the date of grant using the Black-Scholes pricing model with the
following weighted average assumptions:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
2005 2004 2005 2004
---- ---- ------ ------
Volatility 35.44% N/A 34.87% 23.39%
Risk-free interest rate 4.16% N/A 3.75% 3.46%
Expected option life 5 years N/A 5 years 5 years
Dividend yield - N/A - -
N/A - There were no stock option grants during the quarter ended April 30,
2004
The following table illustrates the effect on net income and earnings per
share as if compensation cost had been recognized based on the fair value of the
options at the grant dates for awards under those plans consistent with FAS 123,
as amended, using the Black-Scholes fair value method for option pricing.
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
2005 2004 2005 2004
--------- --------- ---------- ----------
Net income, as reported $ 8,428 $ 8,444 $ 16,259 $ 15,449
Add: Stock-based compensation expense included in reported
net income, net of income taxes 295 147 466 276
Deduct: Total stock-based compensation expense determined
under fair value based method for all awards, net of
income taxes 706 616 1,346 1,236
--------- --------- ---------- ----------
Pro forma net income $ 8,017 $ 7,975 $ 15,379 $ 14,489
========= ========= ========== ==========
Earnings per share:
Basic - as reported $ 0.50 $ 0.51 $ 0.96 $ 0.93
Basic - pro forma $ 0.47 $ 0.48 $ 0.91 $ 0.87
Diluted - as reported $ 0.48 $ 0.49 $ 0.93 $ 0.90
Diluted - pro forma $ 0.46 $ 0.46 $ 0.88 $ 0.85
8
NEWLY ISSUED ACCOUNTING STANDARD
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment". This standard will require the Company to measure the
cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award. The cost will be
recognized over the period during which an employee is required to provide
service in exchange for the award. This Standard is effective as of the
beginning of the first annual reporting period that begins after June 15, 2005.
This Standard will apply to all awards granted after the required effective date
and to awards modified, repurchased or canceled after that date. We are
currently evaluating the requirements and application of this standard and
expect the adoption to have an adverse effect on our consolidated statements of
income.
NOTE 2 - GOODWILL AND INTANGIBLE ASSETS
Goodwill amounted to $104,566 and $103,977 at April 30, 2005 and October
31, 2004, respectively. The increase in goodwill is attributable to changes in
foreign exchange rates.
Other intangible assets amounted to $31,876 and $32,894 at April 30, 2005
and October 31, 2004, respectively. The decrease in the balance of other
intangible assets is related primarily to amortization, which amounted to $650
and $1,303, respectively, for the three-month and six-month periods ended April
30, 2005, partially offset by the impact of fluctuations in foreign exchange
rates.
NOTE 3 - BENEFIT PLANS
Components of Net Periodic Benefit Cost are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
2005 2004 2005 2004
---- ---- ---- ----
Service cost $ 790 $ 683 $ 1,584 $ 1,366
Interest cost 688 633 1,377 1,266
Expected return on plan assets (880) (823) (1,762) (1,646)
Amortization of transition asset 1 20 2 40
Amortization of prior service cost 46 102 92 204
Amortization of net loss 237 141 474 282
------- ------- ------- -------
Net periodic benefit cost $ 882 $ 756 $ 1,767 $ 1,512
======= ======= ======= =======
During the three and six months ended April 30, 2005, employer
contributions of $816 and $1,650, respectively, were made to the pension plans.
We currently anticipate contributing an additional $1,640 to fund our pension
plans in fiscal 2005 for a total expected contribution of $3,290.
The pension assumptions used to determine our October 31, 2004 plan
liabilities and the fiscal 2005 pension expense are as follows:
US PLANS JAPAN PLANS
-------- -----------
Weighted-average discount rate 6.00% 2.25%
Rates of increases in compensation levels 4.00% 2.25%
Expected long-term rate of return on assets 8.75% 4.75%
9
We determine our assumptions based on current economic and market data, as
well as expectations of future economic and market data. Included in our
analysis are company-specific considerations, such as current and future
investment allocations, participant demographics, and employee compensation
strategies.
Pension expense for fiscal 2005 is determined at the beginning of the
fiscal year and expensed ratably throughout the year. Our estimate of pension
expense to be recognized in 2005 is $3,500 ($3,100 in fiscal 2004).
NOTE 4 - ACQUISITIONS
In the first quarter of 2004, we completed two acquisitions in Europe for
total consideration of $554. The amount of goodwill and other intangible assets
recorded in connection with these two acquisitions amounted to $340 and $480,
respectively. Neither of these acquisitions had a material impact on the
Company's historical financial statements or pro forma operating results.
On August 2, 2004 we acquired 100 percent of the outstanding common shares
of WTC Industries and subsidiary ("WTC"). The aggregate purchase price was
$115,193 (net of $569 of cash acquired). The results of operations of WTC are
included in our financial statements from August 2, 2004, the date of
acquisition, and thereafter.
NOTE 5 - SEGMENT DATA
Segment information has been prepared in accordance with Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information." CUNO is organized into five geographic
segments, as the Company's chief operating decision makers are responsible for
managing our global operations based on geographic regions. Our geographic
segments include: North America, Europe, Japan, Asia/Pacific and Latin America.
Each of these operations are led and managed by a local General Manager who is
responsible for the profitability of their respective geographic segment. Each
of these geographic operations in turn manufactures and sells products into our
three main filtrations markets; potable water, healthcare and fluid processing.
Each geographic segment manufactures and sells products in each of the three
markets. The geographic segment managers are responsible for managing their
respective resources with oversight and review by the CEO.
The Company does not present segment information by market as our
individual market focus is limited to worldwide sales, with assigned
responsibility for expanding worldwide sales within each respective market.
Financial information by geographic operating segments is summarized below:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
2005 2004 2005 2004
--------- --------- --------- ---------
NET SALES:
Europe $ 21,359 $ 20,424 $ 40,849 $ 37,058
Japan 13,464 11,393 25,826 21,214
Asia/Pacific 14,773 11,812 27,684 22,447
Latin America 4,240 3,482 7,804 6,969
--------- --------- --------- ---------
Subtotal - Foreign sales 53,836 47,111 102,163 87,688
North America 67,158 50,517 131,906 96,325
Intercompany sales (16,269) (14,883) (29,968) (25,859)
--------- --------- --------- ---------
Total net sales $ 104,725 $ 82,745 $ 204,101 $ 158,154
========= ========= ========= =========
10
Our sales by market are summarized below:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
2005 2004 2005 2004
-------- -------- -------- --------
NET SALES:
Potable Water $ 53,975 $ 37,940 $106,272 $ 72,793
Fluid Processing 24,332 21,143 47,571 41,413
Healthcare 26,418 23,662 50,258 43,948
-------- -------- -------- --------
Total net sales $104,725 $ 82,745 $204,101 $158,154
======== ======== ======== ========
Our operating income by segment is detailed below:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
2005 2004 2005 2004
-------- -------- -------- --------
OPERATING INCOME:
North America $ 5,791 $ 6,917 $ 12,126 $ 13,077
Europe 1,878 1,948 2,914 3,073
Japan 2,121 1,448 4,474 2,506
Asia/Pacific 2,403 1,879 4,564 3,612
Latin America 457 331 777 684
-------- -------- -------- --------
Total operating income 12,650 12,523 24,855 22,952
-------- -------- -------- --------
Interest expense (561) (87) (1,084) (170)
Other, net 342 216 565 366
-------- -------- -------- --------
Income before income taxes $ 12,431 $ 12,652 $ 24,336 $ 23,148
======== ======== ======== ========
Interest expense and other income (expense) have not been allocated to segments.
Our assets by segment are detailed below:
APRIL 30, OCTOBER 31,
2005 2004
--------- -----------
ASSETS:
North America $ 361,378 $ 345,359
Europe 70,729 59,605
Japan 42,292 37,100
Asia/Pacific 35,618 31,323
Latin America 14,512 14,047
General Corporate 20,690 23,359
Eliminations and other (95,923) (76,235)
--------- ---------
Total Assets $ 449,296 $ 434,558
========= =========
General corporate assets, consisting of cash, are not allocated to
segments.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
11
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.
Currently, we have self-insurance limits for workers' compensation,
product liability and employee medical claims. Our workers' compensation
policies have per-individual deductibles of $350, our product liability policy
has a $250 per claim deductible and our medical plan for employees has a
stop-loss of $200 per individual.
NOTE 7 - SUBSEQUENT EVENT
On May 11, 2005, CUNO entered into an Agreement and Plan of Merger with 3M
Company. On the terms and subject to the conditions of the Merger Agreement,
which has been approved by the Board of Directors of each of CUNO and 3M, at the
effective time of the Merger, each share of common stock, par value $0.001, of
CUNO will be converted into the right to receive $72.00 in cash.
Consummation of the Merger is subject to customary conditions, including
(i) approval of the holders of CUNO Common Stock, (ii) absence of any law or
order prohibiting the consummation of the Merger and (iii) expiration or
termination of the Hart-Scott-Rodino waiting period and obtaining certain other
regulatory approvals.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
amounts in thousands, except share and per-share amounts)
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 provide an
understanding of our financial position, changes in our financial position and
results of our operations. Our MD&A is organized as follows:
- COMPANY OVERVIEW. This section provides a general description of
our business.
- COMPANY RISK FACTORS. This section describes the material risks
inherent in our business that investors should be aware of.
- 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.
- CRITICAL ACCOUNTING POLICIES. This section discusses those
accounting policies that are both considered important to our
financial statements and require significant judgment and
estimates on the part of management in their application.
- RESULTS OF OPERATIONS. This section provides an analysis of our
recent results of operations, including a brief description of
transactions and events that impact the comparability of these
results.
- FINANCIAL POSITION AND LIQUIDITY. This section provides an
analysis of our cash position and cash flows, as well as a
discussion of our financing arrangements.
Other information is presented in Items 3, 4 and elsewhere as follows:
- 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 the latest fiscal period
presented.
- 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 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 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 approximately balanced between
domestic and international markets. 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 filters.
13
COMPANY RISK FACTORS
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
Approximately 50% 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.
INFLATION
Inflation had a negligible effect on our operations. We estimate that
inflationary effects, in the aggregate, were generally recovered or offset
through increased pricing or cost reductions in all periods presented.
KEY CUSTOMERS AND SUPPLIERS
We have multi-year contracts and arrangements in place with several of
our major customers and suppliers. These contracts and arrangements help us
effectively plan and manage our operations. Since the markets for our products
are dynamic, these contracts and arrangements are continually evolving as we are
sensitive to the changing needs of our customers and the ongoing performance of
our suppliers. There is no assurance, however, that these
14
contracts and arrangements will be renewed, will not be terminated prematurely
or revised to take into consideration the evolving nature of our relationships
with our customers and suppliers.
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
Because we want to provide shareholders with more meaningful and useful
information, this quarterly report contains statements relating to future events
and the predicted performance of CUNO Incorporated (the "Company", "CUNO", or
"we") which may constitute forward-looking statements, as defined under the
Private Securities Litigation Act. We have tried, wherever possible, to identify
these "forward looking" statements by using words such as "anticipate,"
"believe," "estimate," "expect" and similar expressions. These statements
reflect our current beliefs and are based on information currently available to
us. Accordingly, these statements are subject to risks and uncertainties which
could cause our actual results performance or achievements to differ materially
from those expressed in, or implied by, these statements. These risks and
uncertainties include the following: economic and political conditions in the
foreign countries in which we conduct a substantial part of our operations and
other risks associated with international operations including taxation
policies, credit risk, exchange rate fluctuations and the risk of expropriation;
our ability to protect our technology, proprietary products and manufacturing
techniques; volumes of shipments of our products, changes in our product mix and
product pricing; continuing beneficial relationships with customers; costs of
raw materials; the rate of economic and industry growth in the United States and
the other countries in which we conduct our business; changes in technology,
changes in legislative, regulatory or industrial requirements and risks
generally associated with new product introductions and applications; and
domestic and international competition in our global markets. We assume no
obligation to publicly release revisions to the forward-looking statements to
reflect new events or circumstances.
CRITICAL ACCOUNTING POLICIES
The Securities and Exchange Commission ("SEC") defines 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: revenue recognition, accounting for depreciation and amortization,
employee benefits, contingencies, allowance for doubtful accounts, income taxes,
and stock based compensation. 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. There were no changes in
accounting policies or significant changes in accounting estimates during the
current period. All of our critical accounting policies and significant
estimates have been discussed with the Audit Committee of the Board of
Directors. We have not made any significant changes to our critical accounting
policies or estimates since year end.
Revenue Recognition -- We recognize revenue in accordance with SEC Staff
Accounting Bulletin No. 104 "Revenue Recognition" ("SAB 104"). SAB 104 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. Accordingly, revenue is recognized upon delivery to a common carrier when
terms are FOB shipping and upon receipt by customer when terms are FOB
destination.
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
15
We amortize our patents and other amortizable intangible assets over
their estimated useful lives. The straight line method of amortization is used
unless another method is more appropriate and reliable in reflecting the pattern
in which the asset provides economic benefits. These periods generally range
from 10 - 20 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 - We account for our pension plans in accordance with
SFAS No. 87, "Employer's Accounting for Pensions". In applying this accounting
practice, assumptions are made regarding the valuation of benefit obligations
and the performance of plan assets.
The primary assumptions are as follows:
- Weighted average discount rate - this rate is used to estimate the
current value of future benefits. This rate is adjusted based on
movements in long-term interest rates.
- Expected long-term rate of return on assets - this rate is used to
estimate future growth in investments and investment earnings. The
expected return is based upon a combination of historical market
performance and anticipated future returns for a portfolio
reflecting the mix of equity, debt and other investments indicative
of our plan assets.
- Rates of increase in compensation levels - this rate is used to
estimate projected annual pay increases, which are used to determine
the wage base used to project employees' pension benefits at
retirement.
We determine these assumptions based on consultations with our outside
actuaries and investment advisors. Any variance in the above assumptions could
have a significant impact on future recognized pension costs, assets and
obligations.
Business Acquisitions - Assets and liabilities acquired in a business
combination are recorded at their estimated fair values at the acquisition date.
In accordance with SFAS 142, goodwill and intangible assets deemed to have
indefinite lives are not amortized but are subject to annual impairment testing.
The assessment of goodwill involves the estimation of the fair value of
reporting units, as defined by SFAS 142. Management completed this annual
assessment during the fourth quarter of 2004 based on the best information
available as of the date of the assessment, which incorporated management's
assumptions about expected future cash flows. Based on this assessment, there
was no goodwill impairment in 2004. Future cash flows can be affected by changes
in the global economy and local economies, industries and markets in which the
Company sells products or services, and the execution of management's plans,
particularly with respect to integrating acquired companies. There can be no
assurance that future events will not result in impairment of goodwill or other
intangible assets.
Contingencies, Claims and 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 for specific contingencies, claims and assessments when both of the
following conditions are present: a loss is deemed probable and the amount of
the anticipated loss 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 Debts -- The allowance for doubtful accounts is
established to represent our best estimate of the net realizable value of the
outstanding accounts receivable balances. We estimate our allowance for doubtful
accounts based on past due amounts and historical write-off experience, as well
as trends and factors surrounding the credit risk of specific customers. In an
effort to identify adverse trends, we perform periodic credit
16
evaluations of our customers and ongoing account balance reviews and agings of
receivables. Amounts are considered past due when payment has not been received
within the time frame of the credit terms extended. Write-offs are charged
directly against the allowance for doubtful accounts and occur only after all
collection efforts have been exhausted. Actual write-offs and adjustments could
differ from the allowance estimates due to unanticipated changes in the business
environment as well as factors and risks surrounding specific customers.
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.
We take tax positions in our worldwide corporate income tax filings based
on careful interpretations of global statutes, rules, regulations and court
decisions that may be applied and interpreted differently by various taxing
jurisdictions. These taxing jurisdictions may or may not challenge our
application and interpretation of a wide body of tax jurisprudence. However, we
do not anticipate that any sustained challenge by any taxing jurisdiction will
have a material adverse effect on our financial position or net income.
Stock Based Compensation - We currently account for our stock option
awards under the recognition and measurement principles of APB Opinion No. 25,
"Accounting for Stock Issued to Employees", and related interpretations. No
stock-based employee compensation cost pertaining to stock options is reflected
in net income, as all options granted under our plans had exercise prices equal
to the market value of the underlying common stock on the date of grant.
Restricted and performance share grants awarded to employees are included in
earnings as an expense over the vesting period of the award. The Company expects
to adopt SFAS No. 123 (revised), "Share Based Payment" in the first quarter of
2006. SFAS No. 123(R) will require the recognition of compensation expense
associated with the share-based payment in the Company's consolidated financial
statements, and is expected to have a material impact on the Company's results
of operations.
17
RESULTS OF OPERATIONS
THREE MONTH PERIOD ENDED APRIL 30, 2005 VS. THREE MONTH PERIOD ENDED APRIL 30,
2004
OVERVIEW
During the second quarter of fiscal 2005, CUNO's sales grew by 26.6
percent. Sales growth was particularly strong in North America, Japan and
Asia/Pacific, and strong overall within the worldwide potable water market. U.S.
Dollar organic sales growth was 14.9 percent and organic sales growth on a local
currency basis was 12.4 percent. Although our sales increased significantly, our
gross margin decreased due primarily to the impact of our recent acquisition of
WTC Industries Inc. (WTC). Sales to retailers within the potable water market
and sales attributable to WTC generally carry lower gross margins than we have
historically reported. Net income was flat - we incurred approximately $0.5
million in operating costs associated with a new plant in Mexico and incurred
approximately $0.8 million in costs associated with compliance efforts
surrounding the Sarbanes-Oxley Act of 2002 which adversely affected
profitability.
Going forward, business and market uncertainties may affect results. See
"Company Risk Factors" above and Management's Discussion and Analysis in our
Annual Report on Form 10-K for the fiscal year ended October 31, 2004 for a full
discussion of the key factors which affect our business and operating results.
Below is a summary of selected consolidated earnings information:
THREE MONTHS ENDED
APRIL 30,
2005 2004 CHANGE
---- ---- ------
Net sales $104,725 $ 82,745 26.6%
Cost of products sold 59,970 43,676 37.3%
Gross profit 44,755 39,069 14.6%
Gross margin percent 42.7% 47.2% (450 bpt)
Selling, general and administrative 26,298 22,434 17.2%
SG&A as a percent of sales 25.1% 27.1% (200 bpt)
Operating income 12,650 12,523 1.0%
Operating margin 12.1% 15.1% (300 bpt)
Effective tax rate 32.2% 33.3% (110 bpt)
Net income $ 8,428 $ 8,444 (0.2%)
Diluted earnings per share $ 0.48 $ 0.49 (2.0%)
BUSINESS ENVIRONMENT
Our geographic and market diversity help limit the impact of any one
market or the economy of any single country on our consolidated results. The
uncertainty of the economic conditions in various markets and geographic regions
in which we compete is likely to continue to present challenges to our business
near term. The U.S. Dollar was significantly weaker compared to most of the
currencies in countries we conduct business in during the second quarter of 2005
compared to the second quarter of 2004. We translate revenue and expense
accounts at the average exchange rates during the periods presented.
NET SALES
Net sales were $104.7 million in the second quarter of fiscal 2005
representing a 26.6 percent increase over 2004's second quarter sales of $82.7
million. This increase can generally be attributed to an increase in the unit
volume of worldwide sales. Had currency values been unchanged from the second
quarter of 2004, net sales in the
18
second quarter of 2005 would have been $2.1 million lower than the reported
sales of $104.7 million, or 24.1 percent greater overall.
The following table displays the Company's sales by geographic segment:
THREE MONTHS ENDED CURRENCY
APRIL 30, PERCENT ADJUSTED
2005 2004 CHANGE CHANGE
-------- -------- ------ ------
North America $ 56,876 $ 41,989 35.5% 35.5%
Europe 17,950 16,100 11.5% 4.9%
Japan 12,894 11,135 15.8% 13.9%
Asia/Pacific 13,073 10,310 26.8% 23.1%
Latin America 3,932 3,211 22.5% 10.4%
-------- --------
Total sales $104,725 $ 82,745 26.6% 24.1%
======== ========
North American sales increased 35.5 percent in the second quarter of 2005
as compared to the same quarter in 2004. Sales increased in all North American
markets during the quarter, however stronger potable water market sales were
largely responsible for this growth. Excluding sales from WTC which we acquired
on August 2, 2004, sales in North America would have been up 12.6 percent
quarter over quarter. North American fluid processing and healthcare sales
increased 8.4 percent and 9.1 percent, respectively, reflecting the overall
strength of the economy during this time period. European sales increased 4.9
percent in local currency as compared to the same period in 2004. Sales were
generally strong in all European markets, however fluid processing sales were
particularly strong in the quarter reflecting greater demand for our products
serving the industrial and chemical markets. Sales in Japan were up broadly in
all markets and were led by very strong sales of food and beverage filters used
in the healthcare market primarily for the filtration of bottled drinks.
Asia/Pacific sales were up 23.1 percent in local currency primarily reflecting
strong growth of potable water sales within the Asia region. Second quarter 2005
Latin American sales were up 10.4 percent when expressed in local currency due
primarily to increased sales within the potable water and fluid processing
markets.
The following table displays the Company's sales by market:
THREE MONTHS ENDED CURRENCY
APRIL 30, PERCENT ADJUSTED
2005 2004 CHANGE CHANGE
-------- -------- ------ --------
Potable Water $ 53,975 $ 37,940 42.3% 40.9%
Healthcare 26,418 23,662 11.6% 8.0%
Fluid Processing 24,332 21,143 15.1% 11.7%
-------- --------
Total sales $104,725 $ 82,745 26.6% 24.1%
======== ========
The strength in the potable water market continues to be broad
geographically, driven largely by strong sales growth in North America (up 47.6
percent) associated with OEM customers, direct marketing companies and appliance
manufacturers and strong overseas sales (up 19.7 percent in local currency).
Excluding the impact of WTC, second quarter worldwide potable water sales were
up 18.3 percent on a local currency basis. Fluid Processing sales were up 8.4
percent in North America and up 13.2 percent overseas on a local currency basis.
Healthcare sales were up 9.1 percent in North America and up 7.6 percent
overseas on a local currency basis. Much of this overseas growth was driven by
continued strong sales of food and beverage filters in Japan used primarily for
the filtration of bottled drinks.
19
GROSS PROFIT
Gross profit increased $5.7 million to $44.8 million in the second quarter
of 2005 from $39.1 million in the second quarter of 2004. Gross profit as a
percentage of net sales (gross margin) decreased during that same period from
47.2 percent in 2004 to 42.7 percent in 2005. This decrease in gross margin is
primarily attributable to a change in our sales mix in the potable water market,
including sales of WTC (which we acquired on August 2, 2004 and are included in
our 2005 results) and increasing sales to retailers, both of which carry
comparatively lower gross margins.
OPERATING EXPENSES
Selling, general and administrative expenses (SG&A) were up 17.2 percent,
less than the 26.6 percent sales growth rate for the quarter. Because of CUNO's
international operations, the weaker US dollar served to increase the
consolidated US dollar reported SG&A expense. SG&A expenses were 25.1 percent of
sales in the second quarter of fiscal 2005 vs. 27.1 percent of sales in the
second quarter of fiscal 2004. We continue to face rising structural costs such
as Sarbanes/Oxley compliance, medical, pension and depreciation expense, as well
as the addition of WTC's expenses included in 2005 results.
Research, development and engineering expenses (incurred primarily in the
US and to a lesser extent in Europe) increased 27.8 percent to $5.2 million in
the second quarter of 2005, reflecting our continued focus on the development of
new products and technologies. As a percentage of sales, research, development
and engineering expenses were 4.9 percent of sales in both the second quarter of
fiscal 2005 and 2004.
OPERATING INCOME
As a result of the above, operating income increased 1.0 percent, to $12.7
million or 12.1 percent of sales in the second quarter of fiscal 2005 compared
to $12.5 million or 15.1 percent of sales in the second quarter of 2004.
Our operating income by segment is detailed below:
THREE MONTHS ENDED
APRIL 30, DOLLAR PERCENT
2005 2004 CHANGE CHANGE
------- ------- ------ ---------
OPERATING INCOME:
North America $ 5,791 $ 6,917 ($1,126) (16.3%)
Europe 1,878 1,948 (70) (3.6%)
Japan 2,121 1,448 673 46.5%
Asia/Pacific 2,403 1,879 524 27.9%
Latin America 457 331 126 38.1%
------- ------- -------
Total $12,650 $12,523 127 1.0%
======= ======= =======
Operating income in North America decreased by $1.1 million, or 16.3
percent. This decrease was due to many factors, including: operating costs of
approximately $0.5 million associated with a new plant which is currently being
built in Mexico to begin production of certain water products, compliance costs
of approximately $0.8 million associated with the Sarbanes Oxley Act,
amortization expense associated with WTC's definite lived amortizable intangible
assets ($0.5 million), lower gross margins associated with the change in sales
mix within the potable water market (as noted above) and other increased
structural costs discussed above.
The results of our foreign operations are heavily dependent on the
relationship of their functional currency compared to the U.S. Dollar. We
translate our foreign revenue and expense accounts into U.S. Dollars using the
average exchange rate for the period. European sales increased 4.9 percent on a
local currency basis, while the Euro
20
strengthened approximately 6 percent (average second quarter of 2005 versus
average second quarter of 2004). Increased manufacturing and structural costs
were responsible for the reduction in Europe's operating income. Sales in Japan
were up 13.9 percent on a local currency basis (and up $1.8 million in U.S.
dollars), and the Yen strengthened versus the U.S. Dollar approximately 2
percent quarter over quarter (allowing fixed costs to be spread over a larger
sales base). Sales in 2005 were very strong for food and beverage filters used
in the filtration of summer bottled drinks. These sales are dependent on
consumer preferences and other external factors. Asia/Pacific sales were up 23.1
percent quarter over quarter, and the Australian Dollar strengthened
approximately 3 percent in comparison (approximately 50 percent of our sales in
the region are denominated in Australian Dollars). Local currency sales in Latin
America increased 10.4 percent, contributing to the increase in operating income
for the quarter.
NONOPERATING INCOME (EXPENSE):
Interest expense increased from $0.1 million in the second quarter of 2004
to $0.6 million in the second quarter of 2005. This primarily relates to
interest expense associated with our variable rate, unsecured revolving credit
facility. We had $68 million in outstanding borrowings under this facility at
April 30, 2005 and capitalized approximately $0.2 million in interest costs
during the second quarter of 2005 in accordance with the provisions of FAS 34,
"Capitalization of Interest Cost".
INCOME TAXES
The Company's effective income tax rate for the second quarter of 2005 was
32.2 percent compared to 33.3 percent in the second quarter of 2004. Our tax
rate is impacted by the change in the mix of income attributed to the various
countries in which we do business and various one-time and recurring tax
planning initiatives.
As of April 30, 2005, the Company had a full valuation allowance against
approximately $1.3 million of NOLs in China. Our China operations are start-up
in nature with a history of losses (no profit has been earned since inception in
2001). The remaining countries in which we carry valuation allowances against
NOLs are generally operations which are new to CUNO, have a history of losses,
or are in volatile economic regions of the world.
SIX MONTH PERIOD ENDED APRIL 30, 2005 VS. SIX MONTH PERIOD ENDED APRIL 30, 2004
OVERVIEW
During the first six months of fiscal 2005, CUNO's sales were up 29.1
percent. This growth was favorably impacted by the overall weakness of the U.S.
Dollar, strong sales in the North American potable water market (up 52.6
percent) and overseas sales in general (up 12.5 percent in local currency). U.S.
Dollar organic sales growth was 17.3 percent and organic sales growth on a local
currency basis was 14.6 percent. Although our sales increased significantly, our
gross margin decreased due primarily to the impact of our recent acquisition of
WTC Industries Inc. (WTC). Sales to retailers within the potable water market
and sales attributable to WTC generally carry lower gross margins than we have
historically reported. Net income increased modestly (up 5.2 percent) - we
incurred approximately $0.7 million in operating costs associated with a new
plant in Mexico and incurred approximately $0.9 million in costs associated with
compliance efforts surrounding the Sarbanes-Oxley Act of 2002 which adversely
affected profitability.
Going forward, business and market uncertainties may affect results. See
"Company Risk Factors" above and Management's Discussion and Analysis in our
Annual Report on Form 10-K for the fiscal year ended October 31, 2004 for a full
discussion of the key factors which affect our business and operating results.
Below is a summary of selected consolidated earnings information:
21
SIX MONTHS ENDED
APRIL 30,
2005 2004 CHANGE
---- ---- ------
Net sales $204,101 $158,154 29.1%
Cost of products sold 116,900 84,229 38.8%
Gross profit 87,201 73,925 18.0%
Gross margin percent 42.7% 46.7% (400 bpt)
Selling, general and administrative 50,962 42,604 19.6%
SG&A as a percent of sales 25.0% 26.9% (190 bpt)
Operating income 24,855 22,952 8.3%
Operating margin 12.2% 14.5% (230 bpt)
Effective tax rate 33.2% 33.3% (10 bpt)
Net income $ 16,259 $ 15,449 5.2%
Diluted earnings per share $ 0.93 $ 0.90 3.3%
BUSINESS ENVIRONMENT
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 of the economic conditions in various markets and geographic regions
in which we compete is likely to continue to present challenges to our business
near term. The U.S. Dollar was significantly weaker compared to most of the
currencies in countries we conduct business in during the first six months of
2005 compared to the first six months of 2004. We translate revenue and expense
accounts at the average exchange rates during the periods presented.
NET SALES
Net sales were $204.1 million in the first six months of fiscal 2005
representing a 29.1 percent increase over 2004's sales of $158.2 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 six months of
2004, net sales in the first six months of 2004 would have been $4.2 million
lower than the reported sales of $204.1 million, or 26.4 percent greater
overall.
The following table displays the Company's sales by geographic segment:
SIX MONTHS ENDED CURRENCY
APRIL 30, PERCENT ADJUSTED
2005 2004 CHANGE CHANGE
-------- -------- ------- -------
North America $112,938 $ 80,925 39.6% 39.6%
Europe 34,282 29,957 14.4% 7.1%
Japan 24,934 20,729 20.3% 17.2%
Asia/Pacific 24,732 20,091 23.1% 19.0%
Latin America 7,215 6,452 11.8% 3.1%
-------- --------
Total sales $204,101 $158,154 29.1% 26.4%
======== ========
22
North American sales increased 39.6 percent in the first six months of
2005 as compared to the same period in 2004. Stronger potable water market sales
were responsible for the growth in North America during this time period.
Potable water continues to achieve strong sales of its series of filters
designed for customers who serve various channels of distribution with final
sales to US residential consumers. North American fluid processing and
healthcare sales increased 10.8 percent and 9.4 percent, respectively. European
sales increased 7.1 percent in local currency as compared to the same period in
2004. Fluid processing sales were particularly strong in the period reflecting
greater demand for our products serving the industrial markets. Sales in Japan
were up 17.2 percent in local currency led by a strong increase in sales to the
healthcare market, and to a lesser extent the potable water market. Asia/Pacific
sales were up 19.0 percent excluding changes in currency values. Sales were very
strong throughout Asia, and particularly strong in the water markets in Asia.
First half 2005 Latin American sales were up 3.1 percent when expressed in local
currency.
The following table displays the Company's sales by market:
SIX MONTHS ENDED CURRENCY
APRIL 30, PERCENT ADJUSTED
2005 2004 CHANGE CHANGE
-------- -------- ------ ------
Potable Water $106,272 $ 72,793 46.0% 44.7%
Healthcare 50,258 43,948 14.4% 10.3%
Fluid Processing 47,571 41,413 14.9% 11.2%
-------- --------
Total sales $204,101 $158,154 29.1% 26.4%
======== ========
The strength in the potable water market was broad geographically, driven
largely by strong overseas sales (up 18.2 percent in local currency) and strong
sales growth in North America (up 52.6 percent) associated with OEM customers,
direct marketing companies, and appliance manufacturers. Fluid Processing sales
were up 10.8 percent in the U.S. and up 11.4 percent overseas on a local
currency basis. Healthcare sales were up 10.6 percent overseas on a local
currency basis and up 9.4 percent in the U.S. despite a reduction in diagnostic
sales.
GROSS PROFIT
Gross profit increased $13.3 million to $87.2 million in the first six
months of 2005 from $73.9 million in the first six months of 2004. Gross profit
as a percentage of net sales (gross margin) decreased during that same period
from 46.7 percent in 2004 to 42.7 percent in 2005. This decrease in gross margin
is primarily attributable to a change in our sales mix in the potable water
market, including sales of WTC (which we acquired on August 2, 2004 and are
included in our 2005 results) and increasing sales to retailers, both of which
carry comparatively lower gross margins.
OPERATING EXPENSES
Selling, general and administrative expenses (SG&A) were up 19.6 percent,
less than the 29.1 percent sales growth rate. Because of CUNO's international
operations, the weaker U.S. dollar served to increase the consolidated U.S.
dollar reported SG&A expense. SG&A expenses were 26.9 percent of sales in the
first six months of 2004 compared to 25.0 percent of sales in the first six
months of 2005. In addition, rising structural costs (such as Sarbanes/Oxley
compliance, medical, pension, insurance and depreciation expenses) impacted
overall SG&A expenses.
Research, development and engineering expenses (incurred primarily in the
US and to a lesser extent in Europe) increased 22.6 percent to $10.1 million in
the first six months of 2005, reflecting our continued focus on the development
of new products and technologies. As a percentage of sales, RD&E expenses were
4.9 percent of sales in the first six months of fiscal 2005 compared to 5.2
percent of sales in the first six months of fiscal 2004.
23
OPERATING INCOME
As a result of the above, operating income increased $1.9 million, or 8.3
percent, to $24.9 million or 12.2 percent of sales in the first six months of
fiscal 2005 compared to $23.0 million or 14.5 percent of sales in the first six
months of 2004.
Our operating income by segment is detailed below:
SIX MONTHS ENDED
APRIL 30, DOLLAR PERCENT
2005 2004 CHANGE CHANGE
------- ------- ------- -------
OPERATING INCOME:
North America $12,126 $13,077 ($ 951) (7.3%)
Europe 2,914 3,073 (159) (5.2%)
Japan 4,474 2,506 1,968 78.5%
Asia/Pacific 4,564 3,612 952 26.4%
Latin America 777 684 93 13.6%
------- ------- -------
Total $24,855 $22,952 $1,903 8.3%
======= ======= =======
Operating income in North America decreased by $1.0 million, or 7.3
percent. This decrease was due to many factors, including: operating costs of
approximately $0.7 million associated with a new plant which is currently being
built in Mexico to begin production of certain water products, compliance costs
of approximately $0.9 million associated with in Sarbanes/Oxley, amortization
expense associated with WTC's definite lived amortizable intangible assets ($0.9
million), lower gross margins associated with the change in sales mix within the
potable water market (as noted above) and other increased structural costs
discussed above.
The results of our foreign operations are heavily dependent on the
relationship of their functional currency compared to the U.S. Dollar. We
translate our foreign revenue and expense accounts into U.S. Dollars using the
average exchange rate for the period. European sales increased 7.1 percent on a
local currency basis, while the Euro strengthened approximately 7 percent
(average first half of 2005 versus average first half of 2004) - these factors
helped to offset increased manufacturing and structural costs in Europe. Sales
in Japan were up 17.2 percent on a local currency basis, and the Yen
strengthened versus the U.S. Dollar approximately 3 percent period over period.
Asia/Pacific sales were up 19.0 percent on a local currency basis, and the
Australian Dollar strengthened approximately 3 percent in comparison
(approximately 50 percent of our sales in the region are denominated in
Australian Dollars). Local currency sales in Latin America increased 3.1
percent, contributing to the modest increase in operating income.
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 ($20.7 million at April 30, 2005) and available sources of liquidity
(approximately $25 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 ("SPEs"), or variable interest
entities ("VIEs").
24
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 in the
process of establishing a manufacturing operation in Mexico to meet product
demands in the water market. In addition, new manufacturing lines and processes
are being installed in the US to benefit the potable water, fluid processing,
and healthcare markets.
SUMMARY OF CASH FLOWS FOLLOWS:
SIX MONTHS ENDED
APRIL 30,
2005 2004
---- ----
CASH PROVIDED BY (USED FOR):
Operating activities $ 16,256 $ 8,878
Investing activities (14,544) (9,671)
Financing activities (4,873) 2,181
Effect of exchange rate changes on cash and cash
equivalents 519 746
Net cash provided by operating activities increased by $7,378 due primarily to:
- Increase in deferred income taxes of $3,457
- Decrease in the use of cash for accounts receivable of $7,295
- Decrease in the use of cash for inventories of $2,801
- Increase in the use of cash for accounts payable and accrued
expenses of $5,493
Net cash used for investing activities increased by $4,873 due primarily to:
- Decrease in cash paid for acquisitions of $554
- Increase in capital expenditures of $5,409
Net cash used for financing activities increased by $7,054 due primarily to:
- Increase of $6,302 in the paydown of long term debt in 2005
- Increase of $415 in proceeds from stock option exercises in 2005
The effect of exchange rate changes on cash and cash equivalents of $519 in 2005
reflects the continued weakening of the U.S. Dollar against the Japanese Yen,
Euro and Australian Dollar.
Contractual Obligations and Commercial Commitments
Below is a table detailing, by maturity date, our Contractual Obligations
and Commercial Commitments as of October 31, 2004:
25
OBLIGATIONS AND
COMMITMENTS 2005 2006 2007 2008 2009 THEREAFTER
- --------------- ------- ------- ------- ------- ------- ----------
Bank loans $11,048 $ -- $ -- $ -- $ -- $ --
Long-term debt 276 242 119 28 75,011 169
Operating leases 3,436 2,904 2,479 1,852 1,700 253
------- ------- ------- ------- ------- -------
Total $14,760 $ 3,146 $ 2,598 $ 1,880 $76,711 $ 422
======= ======= ======= ======= ======= =======
Also, see fiscal 2005 changes in bank loans and long-term debt detailed on
the Consolidated Statements of Cash Flows for the six months ended April 30,
2005. We had no material qualifying long-term purchase obligations at October
31, 2004 and through the interim period in 2005. Our U.S. pension plans require
no minimum amount of funding in 2005, however we plan to contribute
approximately $3.3 million to our U.S. and Japanese pension plan in fiscal 2005.
OTHER INFORMATION
Section 404 of the Sarbanes-Oxley Act of 2002 (the "Act") will
require the Company to include an internal control report from management in its
Annual Report on Form 10-K for the year ended October 31, 2005 and in subsequent
reports. The internal control report must include the following: (1) a statement
of management's responsibility for establishing and maintaining adequate
internal control over financial reporting, (2) a statement identifying the
framework used by management to conduct the required evaluation of the
effectiveness of the Company's internal control over financial reporting, (3)
management's assessment of the effectiveness of the Company's internal control
over financial reporting as of October 31, 2005, including a statement as to
whether or not internal control over financial reporting is effective, and (4) a
statement that the Company's independent auditors have issued an attestation
report on management's assessment of internal controls over financial reporting.
Management acknowledges its responsibility for establishing and
maintaining internal controls over financial reporting and seeks to continually
improve those controls. In addition, in order to achieve compliance with Section
404 of the Act within the required time frame, the Company has been conducting a
process to document and evaluate its internal controls over financial reporting.
In this regard, the Company has dedicated internal resources, engaged outside
consultants and adopted a detailed work plan to: (1) assess and document the
adequacy of internal controls over financial reporting; (2) take steps to
improve control processes where required; (3) validate through testing that
controls are functioning as designed; and (4) implement a continuous reporting
and improvement process for internal control over financial reporting. The
Company believes its process for documenting, evaluating and monitoring its
internal control over financial reporting is consistent with the objectives of
Section 404 of the Act.
Given the risks inherent in the design and operation of internal
controls over financial reporting, the Company can provide no assurance as to
its, or its independent auditor's, conclusions at October 31, 2005 with respect
to the effectiveness of its internal controls over financial reporting.
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
26
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.
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.
ITEM 4. CONTROLS AND PROCEDURES
(a) Our Chief Executive Officer and Chief Financial Officer performed an
evaluation of our disclosure controls and procedures as of April 30, 2005 (the
"Evaluation Date"). Based on that evaluation, our Chief Executive Officer and
Chief Financial Officer concluded that our disclosure controls and procedures
were effective and sufficient 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.
(b) 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.
27
PART II
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) We held our annual meeting of Stockholders on March 3, 2005.
(b) The following individuals were nominated and elected to serve a term of
three years as Directors:
Mr. C. Edward Midgley
Mr. Frederick C. Flynn, Jr.
(c) The stockholders voted on the following matters:
1. Election of Directors -- the voting results for each nominee, all of
whom were reelected, are as follows:
Name Votes For Votes Withheld Not Voted
---- --------- -------------- ---------
Mr. C. Edward Midgley 15,400,602 181,573 1,604,362
Mr. Frederick C. Flynn, Jr. 14,440,700 1,141,475 1,604,362
2. A proposal for the reapproval of the performance goals in the
Executive Management Incentive Plan was approved by a count of
14,957,019 votes for, 584,472 votes against, 40,684 votes
abstaining, and 1,604,362 shares not voted.
3. A proposal for the appointment of PricewaterhouseCoopers LLP as
independent auditors was approved by a count of 15,481,179 votes
for, 85,472 votes against, 15,524 votes abstaining, 1,604,362 shares
not voted.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report.
Exhibit 31.1 - Certification of Mark G. Kachur pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
Exhibit 31.2 - Certification of Frederick C. Flynn, Jr. pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 - Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 - 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 Form 8-K
We filed a Report on Form 8-K, dated February 23, 2005, under "Item 9.01
Financial Statements and Exhibits," reporting our financial results for the
quarter ended January 31, 2005.
28
We filed a Report on Form 8-K dated March 28, 2005, under "Item 1.01
Entry into a material Definitive Agreement", disclosing a recent employment
agreement with Mark G. Kachur and an amendment to Mark G. Kachur's
Termination and Change in Control Agreement.
We filed a report on Form 8-K dated May 11, 2005 under "Item 1.01 Entry
into a Material Definitive Agreement" and "Item 3.03 Material Modification
to Rights of Security Holders", disclosing an Agreement and Plan of Merger
with 3M Company and an amendment to CUNO's Rights Agreement with the
Compnay's transfer agent.
29
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 May 25, 2005
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 and Assistant Secretary
30