EX-13 3 y44507ex13.txt EXHIBIT 13 1 Fluid Thinking SALES BY MARKET ($ Millions) [PIE CHART] 42% POTABLE WATER - $101.5 Sales in 2000 - Up 17% in local currency 26% HEALTHCARE - $ 62.8 Sales in 2000 - Up 7% in local currency 32% FLUID PROCESSING - $ 78.8 Sales in 2000 - Up 11% in local currency [PIE CHART] 19% NEW PRODUCTS (Shown as Percent of Sales) - Record new product sales of $45.8 in 2000 - Up from only 6% in 1996 MARKET DATA THE COMPANY'S COMMON STOCK IS QUOTED ON THE NASDAQ MARKET UNDER THE SYMBOL CUNO. THE FOLLOWING TABLE SHOWS THE QUARTERLY HIGH AND LOW PRICES FOR THE LAST TWO FISCAL YEARS ENDED OCTOBER 31:
QUARTER 2000 1999 HIGH LOW HIGH LOW FIRST $ 25.75 $ 19.50 $ 18.00 $ 13.00 SECOND 29.50 20.94 18.94 12.00 THIRD 30.25 22.06 20.50 16.25 FOURTH 31.00 22.06 21.50 18.88
AS OF OCTOBER 31, 2000 CUNO HAD APPROXIMATELY 2,370 SHAREHOLDERS OF RECORD. Visit Our Website at www.cuno.com 2 2 SUMMARY OF FINANCIAL DATA (in thousands, except per share data and ratios)
2000 1999 1998(1) 1997 1996(2) INCOME DATA Net sales $243,074 $220,584 $198,845 $187,478 $179,068 Gross profit 104,485 96,550 86,304 81,312 74,220 Operating income 27,927 23,653 11,923 20,231 11,906 Income before income taxes 27,595 22,774 11,249 18,593 11,011 Net income 17,447 14,831 6,355 12,085 5,593 Basic earnings per share 1.08 0.92 0.40 0.83 0.41 Diluted earnings per share 1.05 0.91 0.39 0.81 0.41 OTHER FINANCIAL DATA Total assets 188,899 184,342 171,566 146,325 139,274 Working capital 41,921 35,309 31,164 24,949 13,631 Net plant investment 63,187 60,352 56,072 48,529 48,201 Capital expenditures 12,143 11,695 11,860 7,589 6,472 Long-term debt 3,422 8,761 15,437 4,779 33,772 Stockholders' equity 119,518 104,574 90,301 81,890 43,148 RATIOS Gross profit to net sales 43.0% 43.8% 43.4% 43.4% 41.4% Net income to net sales 7.2% 6.7% 3.2% 6.4% 3.1% Effective income tax rate 36.8% 34.9% 43.5% 35.0% 49.2% Net income to average stockholders' equity 15.6% 15.2% 7.4% 19.3% 7.2% Ratio of current assets to current liabilities 1.7:1 1.6:1 1.5:1 1.5:1 1.3:1 Ratio of long-term debt to stockholders' equity plus long-term debt 2.8% 7.7% 14.7% 5.5% 43.9%
(1) Included in the 1998 results are an unusual charge for inventory write-down reducing gross profit by $2,245 and reorganization and other unusual charges of $7,439, reducing operating income by $9,684 and net income by $6,937 (net of income taxes of $2,747), or $0.43 per share. See Note 2. (2) In the Summary of Financial Data above, it was assumed that the common shares issued in conjunction with the spin-off of the Company on September 10, 1996 were outstanding for that entire year.Included in 1996 operating income and net income were distribution and other nonrecurring costs associated with the spin-off of the Company from its former parent, Commercial Intertech. These expenses totaled $4,858 (net of income taxes of $706). 13 3 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 2000 - 1998 YEAR ENDED OCTOBER 31, 2000 COMPARED TO YEAR ENDED OCTOBER 31, 1999 NET SALES Net sales of $243.1 million in fiscal year 2000 represented a 10.2 percent increase over net sales of $220.6 million in fiscal year 1999. The majority of this increase can be attributed to an increase in the volume (vs. price) of worldwide sales. The effects of foreign currency fluctuations reduced net sales in fiscal year 2000 by $4.5 million as compared to fiscal year 1999. Had currency values remained unchanged from fiscal year 1999, net sales in fiscal year 2000 would have been $247.6 million, or 12.2% greater than the prior year. CUNO's operations are affected by global and regional economic factors. However, the global diversity of the Company's business has helped limit the impact of any one industry or the economy of any single country on its consolidated results. The following table displays the Company's sales by geographic operating segment (dollars in thousands):
YEAR ENDED CURRENCY OCTOBER 31, OCTOBER 31, PERCENT ADJUSTED 2000 1999 CHANGE CHANGE ---------- ---------- ---------- -------- North America $135,494 $124,990 8.4% 8.4% Europe 31,501 32,985 (4.5%) 10.1% Japan 39,895 29,373 35.8% 25.0% Asia/Pacific 22,791 22,270 2.3% 7.0% Latin America 13,393 10,966 22.1% 30.9% -------- -------- ---- ---- Total Sales $243,074 $220,584 10.2% 12.2% ======== ======== ==== ====
Sales growth in the Company's North American operations was led by the Water Group (up 16.2 percent), a worldwide division of CUNO comprised of the potable water segment of the business. The Water Group continues to record strong sales with its series of new filters designed for OEM customers who serve various channels of distribution with final sales to U.S. consumers. Additionally, sales into the fluid processing market have continued to improve in the U.S. while sales into the healthcare market have declined year over year due mostly to a decline in sales to a large diagnostic customer. The Company's overseas sales increased $12.0 million or 12.5 percent in 2000 compared to 1999. Had the value of overseas currencies remained unchanged in fiscal 2000 as compared to fiscal 1999, sales for these operations would have increased $16.5 million or 17.2 percent. In Europe, sales increased 10.1 percent in local currency with this gain spread broadly across the three markets. Sales in Japan were 35.8 percent higher as compared to the same period last year, and 25.0 percent higher when expressed in local currency, reflecting strong double-digit sales growth in all three markets. Local currency sales growth in Asia/Pacific of 7.0 percent was due in large part to strong gains in the potable water market as well as a general recovery of the Southeast Asian economy. Local currency sales in Brazil increased 30.9 percent in fiscal 2000 reflecting strong, broad improvements across all markets. 14 4 The following table displays the Company's sales by market (dollars in thousands):
YEAR ENDED CURRENCY OCTOBER 31, OCTOBER 31, PERCENT ADJUSTED 2000 1999 CHANGE CHANGE ---------- ---------- ------- -------- Potable Water $101,483 $ 87,649 15.8% 17.1% Fluid Processing 78,781 72,269 9.0% 11.0% Healthcare 62,810 60,666 3.5% 6.7% -------- -------- ---- ---- Total Sales $243,074 $220,584 10.2% 12.2% ======== ======== ==== ====
On a currency-adjusted basis, all geographic operating segments experienced sales increases in the potable water segment. This dollar increase was driven by strong sales (up 16.2 percent) in North America associated with OEM customers, direct marketing companies, and appliance manufacturers, as well as increased foreign potable water sales (up 21.7 percent on a currency-adjusted basis). The increase in fluid processing sales primarily reflects the strengthening worldwide demand in the electronics and oil & gas markets. A decline in sales to a large diagnostic customer in North America was the primary reason for decreased North American healthcare sales in fiscal 2000 as compared to fiscal 1999. However, on a currency-adjusted basis, international healthcare sales increased $6.7 million or 17.8 percent over fiscal year 1999. GROSS PROFIT The Company's gross profit increased $7.9 million to $104.5 million in fiscal year 2000 from $96.6 million in 1999. Gross profit as a percentage of net sales was relatively flat - 43.8 percent in 1999 vs. 43.0 percent in 2000. The primary factor that contributed to the lower gross margin in 2000 was lower sales volume in the North American healthcare market which generally carries a higher margin than most products in the other markets. Also, the Company's gross profit was negatively impacted by a strong U.S. dollar prevailing throughout much of fiscal 2000. The strong U.S. dollar negatively impacts the cost of products and components manufactured in the US and shipped to overseas subsidiaries. OPERATING EXPENSES Selling, general and administrative expenses increased $2.5 million in fiscal year 2000 over fiscal year 1999, representing a 4.0 percent increase. Selling expenses accounted for $1.7 million of this growth, primarily reflecting the continued growth of programs that support the worldwide growth of the Water Group. Noncash compensation associated with employee stock plans decreased $0.5 million, reflecting a planned vesting of a significant program in fiscal year 1999. All other expense categories reflected minor increases consistent with normal incentive and inflation-based increases. Research, development and engineering expenses increased $1.2 million or 10.2 percent reflecting the Company's continued focus on the development of new products and technologies. OPERATING INCOME As a result of the above, operating income increased $4.3 million, or 18.1 percent, to $27.9 million or 11.5 percent of sales in fiscal year 2000 as compared to $23.7 million or 10.7 percent of sales in fiscal year 1999. NONOPERATING ACTIVITY Interest expense decreased by $0.5 million to $0.7 million in fiscal year 2000 reflecting the Company's continued reduction in the level of debt outstanding (see Liquidity and Capital Resources below). No other material nonoperating activity occurred in either of the two fiscal years. INCOME TAXES The Company's effective income tax rate for fiscal year 2000 was 36.8% as compared to 34.9% in fiscal year 1999. The tax rate in 1999 was favorably impacted by tax benefits related to 1996 spin-off expenses that were previously considered nondeductible. This one-time benefit served to reduce the 1999 effective tax rate by 1.8%. Most other factors were not significant and, on a net basis, were relatively consistent year over year. 15 5 YEAR ENDED OCTOBER 31, 1999 COMPARED TO YEAR ENDED OCTOBER 31, 1998 NET SALES Net sales of $220.6 million in fiscal year 1999 represented a 10.9 percent increase over net sales of $198.8 million in fiscal year 1998. The majority of this improvement can be attributed to an increase in the unit volume of worldwide sales. The effects of foreign currency fluctuations reduced net sales in fiscal year 1999 by $2.4 million as compared to fiscal year 1998. Had currency values remained unchanged from fiscal year 1998, net sales in fiscal year 1999 would have been $222.9 million, or 12.1% greater than the prior year. CUNO's operations are affected by global and regional economic factors. However, the global diversity of the Company's business has helped limit the impact of any one industry or the economy of any single country on the consolidated results. The following table displays the Company's sales by geographic operating segment (dollars in thousands):
YEAR ENDED CURRENCY OCTOBER 31, OCTOBER 31, PERCENT ADJUSTED 1999 1998 CHANGE CHANGE ---------- ---------- ------- -------- North America $124,990 $108,307 15.4% 15.4% Europe 32,985 30,878 6.8% 8.7% Japan 29,373 26,139 12.4% (1.0%) Asia/Pacific 22,270 19,959 11.6% 11.8% Latin America 10,966 13,562 (19.1%) 19.5% -------- -------- ---- ---- Total Sales $220,584 $198,845 10.9% 12.1% ======== ======== ==== ====
Sales growth in the Company's North American operations was led by the Water Group, a worldwide division of CUNO comprised of the potable water segment of the business. This group accounted for the majority of the increase in North America. The Group's recently introduced new appliance filters designed for the OEM market, as well as the purchase of Chemical Engineering Corporation, a manufacturer of water treatment equipment in March 1998, were significant contributors to the increase. Additionally, sales into most segments of the healthcare market have continued to improve in the US while sales into the fluid processing market have declined year-over-year due mostly to the sluggish oil and gas and microelectronics markets. The Company's overseas sales increased $5.1 million or 5.6 percent in 1999 compared to 1998. Had the value of overseas currencies remained unchanged in fiscal 1999 as compared to fiscal 1998, sales for these operations would have increased $7.5 million or 8.2 percent. Local currency sales in Latin America increased 19.5 percent in fiscal 1999 reflecting strong double-digit sales increases in both the fluid processing and healthcare markets. See "Brazilian Real Devaluation" below for further details. In Europe, sales increased 8.7 percent in local currency with the majority of the gain generated in the healthcare market. In addition, sales by the European Water Group, although embryonic, increased 53.1 percent due to increased marketing efforts associated with the establishment of a focused sales and marketing organization. In Japan, local currency sales declined 1.0 percent reflecting the overall depressed economic climate and general sluggishness in all three of the Company's markets. In Asia/Pacific, local currency sales increased 11.8% reflecting consistent double-digit sales growth in all markets. Much of the growth was related to a general recovery in Southeast Asian countries. The following table displays the Company's sales by market (dollars in thousands):
YEAR ENDED CURRENCY OCTOBER 31, OCTOBER 31, PERCENT ADJUSTED 1999 1998 CHANGE CHANGE ---------- ---------- ------- -------- Potable Water $ 87,649 $ 63,803 37.4% 39.8% Fluid Processing 72,269 73,829 (2.1%) (2.7%) Healthcare 60,666 61,213 (0.9%) 1.1% -------- -------- ---- ---- Total Sales $220,584 $198,845 10.9% 12.1% ======== ======== ==== ====
16 6 The large increase in potable water sales was primarily driven by continued strong sales in North America to OEM customers, direct marketing companies, and appliance manufacturers. The decrease in fluid processing sales primarily reflects the continued worldwide slowdown in petroleum exploration and production caused by depressed oil prices which prevailed early in 1999. A decline in sales of the Company's diagnostic membrane products was the primary reason for the flat healthcare sales in fiscal 1999 as compared to fiscal 1998. However, business conditions in this market remain sound and improvement is expected in fiscal 2000. GROSS PROFIT The Company's gross profit increased $10.2 million to $96.6 million in fiscal year 1999 from $86.3 million in 1998. Gross profit as a percentage of net sales increased from 43.4 percent in 1998 to 43.8 percent in 1999. After adjusting for an inventory write-down charge of $2.2 million recorded in the fourth quarter of 1998, the Company's gross profit increased $8.0 million, or 9.0 percent over the prior year. Similarly, after adjusting for the 1998 inventory write-down, gross profit as a percentage of sales declined from 44.5 percent in 1998 to 43.8 percent in 1999. This decrease is attributable to start-up costs incurred during the first quarter of 1999 associated with a new product in the Water Group, higher manufacturing costs in the U.S. membrane operation associated with the introduction of new manufacturing processes, and an unusually favorable mix of sales in the third quarter of 1998 which did not repeat in subsequent periods. Also, the Company's gross profit was negatively impacted by a strong US dollar prevailing throughout much of fiscal 1999. The strong US dollar negatively impacts the cost of products and components manufactured in the US and shipped to overseas subsidiaries. OPERATING EXPENSES Selling, general and administrative expenses increased $5.9 million in fiscal 1999 over fiscal 1998, representing a 10.6 percent increase. Selling expenses increased $3.8 million in 1999, or 11.9 percent, reflecting the continued expansion of programs supporting the worldwide growth of the Water Group, as well as increased expenses associated with businesses acquired during fiscal 1998. Administrative expenses increased $2.4 million or 12.2 percent reflecting increased expenses associated with businesses acquired during fiscal 1998 and other normal inflation-based increases. Research, development and engineering expenses were comparable at $11.7 million in 1999 vs. $11.6 million in 1998. OPERATING INCOME As a result of the above, excluding the 1998 Unusual Charges totaling $9.7 million for inventory write-down and reorganization and other unusual charges, operating income increased by 9.5 percent or $2.0 million in 1999 over 1998. NONOPERATING ACTIVITY Interest expense remained flat year-over-year at $1.2 million. Other income (expense) decreased by $0.2 million in fiscal 1999 over fiscal 1998. This decrease is primarily attributed to the Company's 1998 sale of a tract of land in Australia (which was unrelated to the business) for $0.4 million, resulting in a pre-tax gain of $0.3 million. No material gains on sales of property, plant, or equipment occurred in fiscal 1999. INCOME TAXES The Company's effective income tax rate for fiscal year 1999 was 34.9 percent as compared to 43.5 percent in fiscal year 1998. The unusually high tax rate in 1998 was primarily due to certain costs associated with the Company's 1998 reorganization which had no associated tax benefit and thereby increased the effective tax rate approximately seven percentage points. The tax rate in 1999 was favorably impacted by research and development tax credits and tax benefits related to certain 1996 expenses which were previously considered nondeductible. The mix of income attributed to various countries and their taxing authorities increased the 1999 tax rate 2.7 percentage points compared to 1998. Other factors were not significant and, on a net basis, were relatively consistent year over year. LIQUIDITY AND CAPITAL RESOURCES The Company assesses its liquidity in terms of its ability to generate cash to fund operating and investing activities. Of particular importance to the management of liquidity are cash flows generated from operating activities, capital expenditure levels and adequate external financing alternatives. 17 7 The Company manages its worldwide cash requirements with consideration of the cost effectiveness of the available funds from the many subsidiaries through which it conducts its business. Management believes that its existing cash position and other available sources of liquidity are sufficient to meet current and anticipated requirements for the foreseeable future. Set forth below is selected key cash flow data (amounts in thousands):
YEAR ENDED OCTOBER 31, SOURCE / (USE) OF CASH 2000 1999 -------- -------- OPERATING ACTIVITIES: Net cash provided by net income plus depreciation, amortization and non-cash compensation $ 27,203 $ 24,485 Inventory 3,511 (2,135) Accounts receivable (4,160) (4,940) Net cash provided by operating activities 34,523 24,394 INVESTING ACTIVITIES: Acquisitions of companies, net of cash acquired (2,885) (1,000) Proceeds from surrender of life insurance policies 569 -- Capital expenditures (12,143) (11,695) FINANCING ACTIVITIES: Net change in total debt (11,103) (10,060) Retirement of Common Stock (1,154) --
The net cash provided by net income plus depreciation, amortization and non-cash compensation is an important measurement of cash generated from the earnings process before significant non-cash charges. Net income plus depreciation, amortization and non-cash compensation of $27.2 million increased 11.1 percent in fiscal 2000 as compared to fiscal 1999, reflecting the Company's increased sales volume, increased gross profit, and improved operating profit margin as discussed above. The improvement in cash provided by inventories reflects the Company's continued focus on improving the efficiency of inventory management despite rising sales volumes. The improvement in cash used by accounts receivable reflects the Company's strong management of worldwide receivables during a period of rising sales volume. These improvements helped generate cash flows of $34.5 million from operating activities (an increase of 41.5 percent) in 2000, as compared to $24.4 million in 1999. Capital expenditures amounted to $12.1 million in 2000 compared to $11.7 million in 1999. Expenditures in both periods were primarily comprised of building additions and purchases of machinery and equipment for the expansion of manufacturing capabilities. In the second quarter of fiscal 2000, the Company made a contingent consideration payment of $2.9 million related to the acquisition of Chemical Engineering Corporation (CEC). This payment was recorded as additional goodwill. There will be no future contingency payments related to the CEC acquisition. The acquisition of CEC included certain life insurance policies on key officers of CEC. In the second quarter of 2000, CUNO elected to surrender these policies for their cash surrender value. Due largely to the Company's continued strong cash flow from operating activities ($34.5 million) in 2000 and despite capital expenditures and contingent acquisition payments totaling $15.0 million, the Company was able to reduce its long-term debt and bank loans by $11.1 million. During the first quarter of 2000, a significant portion of the Company's outstanding performance shares vested. In connection therewith, the Company utilized $1.2 million in cash to pay applicable employee withholding taxes on the common shares earned in return for shares of the Company's Common Stock then retired. 18 8 Other selected financial data at October 31, follows (amounts in thousands):
2000 1999 -------- -------- Long term debt, less current portion $ 3,422 $ 8,761 Stockholders' equity 119,518 104,574 Ratio of long term debt to total capitalization 3% 8%
MARKET RISK DISCLOSURES FOREIGN CURRENCY RISK Approximately 50% of the Company's operations consist of sales and manufacturing activities in foreign countries. The Company manufactures a significant portion of its products in the U.S. and sells some of these products to affiliated companies overseas. As a result, the Company's financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company distributes its products. The Company's currency exposures vary, but are concentrated in the Japanese yen, Singapore dollar, Australian dollar, British pound, Brazilian real, and the Euro. The Company utilizes forward foreign exchange contracts to hedge specific exposures relating to intercompany payments (primarily parent company export sales to subsidiaries at pre-established U.S. dollar prices) and other specific and identified exposures. The terms of the forward foreign exchange contracts are matched to the underlying transaction being hedged, and are typically under 90 days. 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. The Company generally does not hedge overseas sales denominated in foreign currencies or translation exposures. The Company does not enter into financial instruments for speculation or trading purposes. The Company utilizes bank loans and other debt instruments throughout its worldwide operations. To mitigate foreign currency risk, such debt is generally denominated in the underlying local currency of the branch or subsidiary. In certain limited and specific instances, the Company will manage risk by denominating a portion of debt outstanding in a currency other than the local currency. INTEREST RATE RISK The Company's interest income and expense are most sensitive to changes in the general level of U.S. and Japanese interest rates. In this regard, changes in these interest rates may affect the interest paid on debt. To mitigate the impact of fluctuations in U.S. and Japanese interest rates, the Company periodically evaluates alternative interest rate arrangements. Below is a table detailing, by maturity date, the Company's debt portfolio and the associated interest rates for the fiscal years ended October 31, (dollars in thousands):
FAIR 2001 2002 2003 2004 2005 THEREAFTER TOTAL VALUE ------- ----- ----- ------ ----- ---------- ------- ------- Bank loans $14,233 -- -- -- -- -- $14,233 $14,233 Avg. Interest Rate 1.28% 1.28% Long-term Debt: Fixed Rate $ 746 $ 750 $ 706 $ 788 $ 74 $1,104 $ 4,168 $ 3,566 Avg. Interest Rate 5.89% 5.85% 5.90% 5.91% 5.00% 5.00% 5.64%
OTHER MATTERS IMPAIRMENT OF CAPITAL ASSETS AND GOODWILL The Company follows Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This Statement addresses the accounting for the impairment of long-lived assets and goodwill related to those assets and establishes guidance for recognizing and measuring impairment losses, and requires that the carrying amount of impaired assets be reduced to fair value. 19 9 In the fourth quarter of 1998, the Company implemented a plan to outsource the Company's manufacturing of metal housings. As part of this plan, the majority of equipment previously used in the production of metal housings would no longer be used to the extent previously anticipated or was disposed. The fair value of this equipment was generally immaterial. As a result of this plan, the Company recorded an equipment impairment charge of $737,000 and an associated goodwill impairment charge of $1,240,000. The amount of the loss recognized is the excess of the previous carrying amount of the equipment over the estimated fair value. This equipment was initially recorded in connection with a business acquisition. INFLATION Inflation had a negligible effect on the Company's operations during fiscal years 2000 and 1999. The Company estimates that inflationary effects, in the aggregate, were generally recovered or offset through increased pricing or cost reductions in both fiscal years. FORWARD LOOKING INFORMATION Because CUNO wants to provide shareholders with more meaningful and useful information, this annual report contains statements relating to future events and the predicted performance of CUNO which may constitute forward-looking statements, as defined under the Private Securities Litigation Act. CUNO has tried, wherever possible, to identify these "forward looking" statements by using words such as "anticipate," "believe," "estimate," "expect" and similar expressions. These statements reflect the Company's current beliefs and are based on information currently available to it. Accordingly, these statements are subject to risks and uncertainties which could cause the Company's actual results, performance or achievements to differ materially from those expressed in, or implied by, these statements. These risks and uncertainties include the following: limited history as a stand-alone company; economic and political conditions in the foreign countries in which the Company conducts a substantial part of its operations and other risks associated with international operations including taxation policies, exchange rate fluctuations and the risk of expropriation; the Company's ability to protect its technology, proprietary products and manufacturing techniques; volumes of shipments of the Company's products, changes in the Company's product mix and product pricing; costs of raw materials; the rate of economic and industry growth in the United States and the other countries in which the Company conducts its 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 the Company's global markets. CUNO undertakes no obligation to publicly release revisions to the forward-looking statements to reflect new events or circumstances. 20 10 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Stockholders and Board of Directors CUNO Incorporated We have audited the accompanying consolidated balance sheets of CUNO Incorporated as of October 31, 2000 and 1999, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended October 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of CUNO Incorporated at October 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended October 31, 2000 in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Hartford, Connecticut December 14, 2000 21 11 CONSOLIDATED STATEMENTS OF INCOME (in thousands, except share amounts)
YEAR ENDED OCTOBER 31, 2000 1999 1998 ------------ ------------ ------------ Net sales $ 243,074 $ 220,584 $ 198,845 Cost of sales: Before inventory write-down 138,589 124,034 110,296 Inventory write-down -- -- 2,245 ------------ ------------ ------------ Total cost of sales 138,589 124,034 112,541 ------------ ------------ ------------ Operating expenses: Selling, general and administrative 63,665 61,193 55,317 Research, development and engineering 12,893 11,704 11,625 Reorganization and other unusual charges -- -- 7,439 ------------ ------------ ------------ 76,558 72,897 74,381 ------------ ------------ ------------ Operating income 27,927 23,653 11,923 Nonoperating income: Interest expense (695) (1,202) (1,213) Other income 363 323 539 ------------ ------------ ------------ (332) (879) (674) ------------ ------------ ------------ Income before income taxes 27,595 22,774 11,249 Income tax provision (benefit): Current 7,490 7,632 7,000 Deferred 2,658 311 (2,106) ------------ ------------ ------------ 10,148 7,943 4,894 ------------ ------------ ------------ Net income $ 17,447 $ 14,831 $ 6,355 ------------ ------------ ------------ Basic earnings per common share $ 1.08 $ 0.92 $ 0.40 Diluted earnings per common share $ 1.05 $ 0.91 $ 0.39 Basic shares outstanding 16,195,843 16,064,159 15,923,255 Diluted shares outstanding 16,629,233 16,336,373 16,222,939 ============ ============ ============
See accompanying notes. 22 12 CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts)
OCTOBER 31, 2000 1999 --------- --------- ASSETS Current assets Cash and cash equivalents $ 13,814 $ 6,186 Accounts receivable (less allowances for doubtful accounts of $1,395 and $1,706, respectively) 52,239 50,777 Inventories 24,087 29,246 Deferred income taxes 6,414 8,606 Prepaid expenses and other current assets 2,101 2,434 --------- --------- Total current assets 98,655 97,249 Noncurrent assets Deferred income taxes 1,168 1,598 Intangible assets, net 23,971 22,567 Other noncurrent assets 1,918 2,576 Property, plant and equipment, net 63,187 60,352 --------- --------- Total assets $ 188,899 $ 184,342 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Bank loans $ 14,233 $ 19,189 Accounts payable 17,978 16,716 Accrued payroll and related taxes 11,851 11,790 Other accrued expenses 7,675 8,002 Accrued income taxes 4,251 3,750 Current portion of long-term debt 746 2,493 --------- --------- Total current liabilities 56,734 61,940 Noncurrent liabilities Long-term debt, less current portion 3,422 8,761 Deferred income taxes 4,786 4,750 Retirement benefits 4,439 4,317 --------- --------- Total noncurrent liabilities 12,647 17,828 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; 16,279,198 and 16,342,952 shares issued and outstanding (excluding 747 and 4,328 shares in treasury) 16 16 Additional paid-in-capital 39,814 39,779 Unearned compensation (1,120) (2,568) Accumulated other comprehensive(loss)income-- foreign currency translation adjustments (3,546) 440 Retained earnings 84,354 66,907 --------- --------- Total stockholders' equity 119,518 104,574 --------- --------- Total liabilities and stockholders' equity $ 188,899 $ 184,342 ========= =========
See accompanying notes. 23 13 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
ACCUMU- ADDITIONAL UNEARNED LATED OTHER TOTAL COMMON PAID-IN COMPEN- COMPREHEN- RETAINED STOCKHOLDERS' STOCK CAPITAL SATION SIVE INCOME EARNINGS EQUITY ------ ---------- -------- ----------- -------- ------------ BALANCE AT OCTOBER 31, 1997 $ 16 $34,930 $(2,646) $ 4,111 $45,721 $ 82,132 ----- ------- ------- ------- ------- -------- Net income 6,355 6,355 Other comprehensive income: Foreign currency translation adjustments (591) (591) Minimum pension liability adjustment, net of income taxes of $482 (349) (349) Comprehensive income 5,415 Amortization of unearned compensation 1,648 1,648 Shares awarded under employee stock plans 2,285 (1,744) 541 Shares issued to employee benefit plans 565 565 ----- ------- ------- ------- ------- -------- BALANCE AT OCTOBER 31, 1998 16 37,780 (2,742) 3,171 52,076 90,301 ----- ------- ------- ------- ------- -------- Net income 14,831 14,831 Other comprehensive income: Foreign currency translation adjustments (3,255) (3,255) Minimum pension liability adjustment, net of income taxes of $724 524 524 -------- Comprehensive income 12,100 Amortization of unearned compensation 1,184 1,184 Shares awarded under employee stock plans 2,501 (2,209) 292 Shares issued to employee benefit plans 599 599 Stock options exercised 118 118 Unearned compensation adjustments (1,081) 1,081 -- Other (138) 118 (20) ----- ------- ------- ------- ------- -------- BALANCE AT OCTOBER 31, 1999 16 39,779 (2,568) 440 66,907 104,574 ----- ------- ------- ------- ------- -------- Net income 17,447 17,447 Other comprehensive income-- foreign currency translation adjustments (3,986) (3,986) -------- Comprehensive income 13,461 Amortization of unearned compensation 610 610 Shares awarded under employee stock plans 816 (96) 720 Shares issued to employee benefit plans 650 650 Stock options exercised 254 254 Retirement of Common Stock (1,154) (1,154) Unearned compensation adjustments (934) 934 -- Tax benefit on stock-based compensation 403 403 ----- ------- ------- ------- ------- -------- BALANCE AT OCTOBER 31, 2000 $ 16 $39,814 $(1,120) $(3,546) $84,354 $119,518 ===== ======= ======= ======= ======= ========
See accompanying notes. 24 14 CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
YEAR ENDED OCTOBER 31, 2000 1999 1998 -------- -------- -------- OPERATING ACTIVITIES Net income $ 17,447 $ 14,831 $ 6,355 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 8,866 8,275 7,795 Noncash compensation recognized under employee stock plans 890 1,379 1,810 Reorganization and other unusual charges, and inventory write-down -- -- 9,163 Gain on sale of property, plant and equipment (17) (44) (486) Pension costs in excess of (less than) funding 304 (214) (33) Deferred income taxes 2,658 393 (2,106) Changes in operating assets and liabilities, net of acquisitions: Accounts receivable (4,160) (4,940) (1,220) Inventories 3,511 (2,135) (4,283) Accounts payable and accrued expenses 3,698 3,740 (579) Accrued income taxes 887 3,583 (2,850) Prepaid expenses and other 439 (474) (939) -------- -------- -------- Net cash provided by operating activities 34,523 24,394 12,627 INVESTING ACTIVITIES Proceeds from sales of property, plant and equipment 72 61 630 Proceeds from surrender of life insurance policies 569 -- -- Acquisition of companies, net of cash acquired (2,885) (1,000) (10,144) Capital expenditures (12,143) (11,695) (11,860) -------- -------- -------- Net cash used for investing activities (14,387) (12,634) (21,374) FINANCING ACTIVITIES Proceeds from long-term debt 5,200 6,100 20,892 Principal payments on long-term debt (12,159) (17,068) (10,501) Net borrowings under bank loans (4,144) 908 (372) Retirement of Common Stock (1,154) -- -- Proceeds from stock options exercised 254 118 -- -------- -------- -------- Net cash (used for) provided by financing activities (12,003) (9,942) 10,019 Effect of exchange rate changes on cash and cash equivalents (505) (65) (255) -------- -------- -------- Net change in cash and cash equivalents 7,628 1,753 1,017 Cash and cash equivalents at beginning of year 6,186 4,433 3,416 -------- -------- -------- Cash and cash equivalents at end of year $ 13,814 $ 6,186 $ 4,433 ======== ======== ======== SUPPLEMENTAL DISCLOSURES Cash paid for: Interest $ 760 $ 1,236 $ 1,122 Income taxes 6,286 2,523 9,603 ======== ======== ========
See accompanying notes. 25 15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CUNO INCORPORATED NOTE 1 - ORGANIZATION AND ACCOUNTING POLICIES ORGANIZATION: CUNO Incorporated (the "Company" or "CUNO") designs, manufactures and markets a comprehensive line of filtration products for the separation, clarification and purification of liquids and gases. The Company's 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. CONSOLIDATION: 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. CASH EQUIVALENTS: The Company considers all highly liquid investments with a maturity of three months or less, when purchased, to be cash equivalents. Cash equivalents consist of time deposits in financial institutions. INVENTORIES: Inventories are stated at the lower of cost or market. Inventories in the United States are primarily valued by the last-in, first-out (LIFO) cost method. The method used for all other inventories is first-in, first-out (FIFO). Approximately 42 percent of worldwide inventories, in both 2000 and 1999, are accounted for using the LIFO method. Inventories as of October 31 consisted of the following (in thousands):
2000 1999 ------- ------- Raw materials $10,814 $12,399 Work in process 2,435 3,197 Finished goods 10,838 13,650 ------- ------- $24,087 $29,246 ======= =======
If all inventories were valued by the FIFO method, which approximates replacement cost, inventories would have been $2,805,000 higher in 2000 and $2,651,000 higher in 1999. INTANGIBLES: Intangible assets as of October 31 follow (in thousands):
2000 1999 ------- ------- Goodwill, less accumulated amortization (2000 - $8,321; 1999 - $6,958) $23,222 $21,700 Other intangibles, less accumulated amortization (2000 - $24,770; 1999 - $24,652) 749 867 ------- ------- $23,971 $22,567 ======= =======
Goodwill, which is the excess of cost over the fair value of net assets acquired, generally is amortized on a straight-line basis over periods ranging from 10 to 40 years. Other intangibles, including patents, know-how and trademarks, are stated at their appraised value on the acquisition date less accumulated amortization, which is provided using the straight-line method over periods ranging from 10 to 25 years. 26 16 PROPERTIES AND DEPRECIATION: Property, plant and equipment are recorded at cost. Buildings and equipment are depreciated principally by the straight-line method over their useful lives, ranging from 10 to 40 years for buildings and 3 to 20 years for machinery and equipment. IMPAIRMENT OF LONG-LIVED ASSETS: In the event that facts and circumstances indicate that the carrying value of intangibles and long-lived assets or other assets may be impaired, an evaluation is performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset are compared to the asset's carrying amount to determine if a write-down is required. See Note 2. INCOME TAXES: The Company uses the liability method in measuring the provision for income taxes and recognizing deferred income tax assets and liabilities in the balance sheet. Deferred income tax assets and liabilities principally arise from differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements. Deferred income tax balances are determined using provisions of currently enacted tax laws; the effects of future changes in tax laws or rates are not anticipated. Provisions are made for income taxes on undistributed earnings of foreign subsidiaries which are expected to be remitted to the Company in the near term. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. Determination of the amount of any unrecognized deferred US income tax liability is not practicable because of the complexities associated with its hypothetical calculation. TRANSLATION OF FOREIGN CURRENCIES: Revenue and expense accounts are translated at the average exchange rate for the year while all assets and liability accounts are translated at the end of year exchange rate. Resulting translation adjustments are recorded as a separate component of accumulated other comprehensive income. REVENUE RECOGNITION: Revenue is recognized when the earning process is complete and the risks and rewards of ownership have transferred to the customer, which is considered to have occurred upon shipment of the finished product. RESEARCH AND DEVELOPMENT: Costs associated with the development of new products and improvements to existing products are charged to operations as incurred. Research and development costs were $6,508,000, $5,599,000, and $6,105,000 in 2000, 1999 and 1998, respectively. ADVERTISING: Advertising costs are expensed as incurred and included in "selling, general and administrative expenses." Advertising expenses were $3,203,000, $3,469,000, and $3,791,000 in 2000, 1999, and 1998, respectively. EMPLOYEE STOCK OPTIONS: The Company accounts for employee stock options under the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Accounting for the issuance of stock options under the provisions of APB Opinion No. 25 typically does not result in compensation expense for the Company since the exercise price of options is normally established at the market price of the Company's Common Stock on the date granted. 27 17 OTHER INCOME: Other income as reported in the accompanying Consolidated Statements of Income for the years ended October 31 consisted of the following (amounts in thousands):
2000 1999 1998 ----- ----- ----- Interest income $ 364 $ 199 $ 115 Exchange gains 5 120 179 Gains on sales of property, plant and equipment 17 44 486 Other expenses (23) (40) (241) ----- ----- ----- Total $ 363 $ 323 $ 539 ===== ===== =====
EARNINGS PER SHARE: The following table sets forth the computation of basic and diluted earnings per share for the years ended October 31:
2000 1999 1998 ------------ ------------ ------------ NUMERATOR: Net Income $ 17,447,000 $ 14,831,000 $ 6,355,000 ============ ============ ============ DENOMINATORS: Weighted average shares outstanding 16,326,697 16,233,591 16,132,099 Issued but unearned performance shares (67,636) (110,322) (165,002) Issued but unearned restricted shares (63,218) (59,110) (43,842) ------------ ------------ ------------ Denominator for basic earnings per share 16,195,843 16,064,159 15,923,255 ============ ============ ============ Weighted average shares outstanding 16,326,697 16,233,591 16,132,099 Effect of dilutive employee stock options 302,536 102,782 90,840 ------------ ------------ ------------ Denominator for diluted earnings per share 16,629,233 16,336,373 16,222,939 ============ ============ ============ Basic earnings per share $ 1.08 $ 0.92 $ 0.40 Diluted earnings per share $ 1.05 $ 0.91 $ 0.39
FOREIGN CURRENCY EXCHANGE CONTRACTS: The Company utilizes forward foreign exchange contracts to hedge specific exposures relating primarily to export sales with pre-established U.S. dollar amounts at specified dates. A forward foreign exchange contract obligates the Company to exchange predetermined amounts of specified foreign currencies at specified exchange rates on specified dates. Open, matured and terminated contracts are marked to market for changes in the spot exchange rate with resulting gains and losses recognized in the Consolidated Statements of Income (fair value method). See Note 12. USES OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. NEWLY ISSUED ACCOUNTING STANDARDS: In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires all derivatives to be recorded in the balance sheet at fair value and provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. 28 18 The adoption of this statement is not expected to change the Company's business practices nor is it expected to have a material impact on the consolidated results of operations, financial position or cash flows. As required, the Company plans to adopt this statement upon its applicable effective date in fiscal 2001. RECLASSIFICATIONS: Certain reclassifications have been made to the prior year amounts to conform to the current year presentation. NOTE 2 - UNUSUAL CHARGES During 1998, the Company took various actions to enhance its competitiveness including initiatives in its manufacturing operations to improve capabilities and efficiencies (the "Plan"). Under the Plan, the Company recognized charges of $9,684,000. After an income tax benefit of $2,747,000, these charges reduced fiscal year 1998 earnings by $6,937,000 or $0.43 per share on a diluted basis. Principal actions of the Plan included the outsourcing of the Company's metal housing manufacturing, streamlining of the Company's operations for membrane production in the U.S., reducing the salaried and hourly workforce, and consolidating certain distribution operations in the U.S. and Europe. The principal components of the Plan were approved in the latter part of fiscal 1998. Reorganization and other unusual charges include severance and employee benefit costs applicable to 59 terminated salaried and hourly employees ($1,715,000), undepreciated abandoned or impaired capital assets ($737,000) and associated unamortized acquisition goodwill ($1,240,000), reengineered operations ($785,000), and litigation related to consolidating certain worldwide distribution channels ($2,962,000). As part of the Plan, included in cost of goods sold is $2,245,000 relating to a non-cash write-down of obsolete inventory. Reorganization and other unusual charges of $7,439,000 include $5,462,000 which were ultimately paid in cash. Payments of $521,000 relating to this reorganization liability were made in fiscal 1998 - the remainder of this liability was substantially paid in fiscal 1999. As part of the Plan, the majority of equipment previously used in the production of metal housings was abandoned or disposed. The fair value of this equipment was generally immaterial. The amount of the loss recognized was the excess of the previous carrying amount of the equipment over the estimated fair value. The metal housing equipment was initially recorded in connection with a business acquisition. As such, the pro-rata unamortized goodwill associated with this equipment was also written off. 29 19 NOTE 3 - PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment as of October 31 is comprised of the following (in thousands):
2000 1999 -------- -------- Land and land improvements $ 6,335 $ 6,435 Buildings 29,691 27,234 Machinery and equipment 77,728 72,357 Construction in progress 11,844 11,554 -------- -------- 125,598 117,580 Less accumulated depreciation 62,411 57,228 -------- -------- $ 63,187 $ 60,352 ======== ========
Depreciation expense was $7,649,000 in 2000, $6,939,000 in 1999, and $5,870,000 in 1998. NOTE 4 - DEBT Long-term debt obligations as of October 31 follow (in thousands):
2000 1999 ------- ------- Revolving credit $ -- $ 6,000 Mortgages -- 1,239 Other 4,168 4,015 ------- ------- 11,254 Less current portion 746 2,493 ------- ------- $ 3,422 $ 8,761 ======= =======
The Company has a $60 million senior unsecured revolving credit facility which matures in 2001. The Company pays a variable per annum fee quarterly in arrears on the unused amount of the commitment. The rate was 0.1 percent at October 31, 2000. There were no outstanding borrowings at October 31, 2000. The facility has interest rate options determinable by the Company based upon prime or LIBOR rates plus an applicable margin. The credit facility includes covenants which require the Company to meet certain financial ratios. The Company continues to be in compliance with these covenants. Other debt primarily relates to debt instruments used to finance certain capital expenditures and acquisitions, including certain debt which has been discounted at 6.0 percent and is payable over five years. Principal payments due after October 31, 2000 are: 2001 - $746,000; 2002 - $750,000; 2003 - $706,000; 2004 - $788,000; 2005 - $74,000 and thereafter - $1,104,000. Outstanding bank loans at October 31, 2000 and 1999 had weighted average interest rates of 1.3 percent in both years. The bank loans and unused short-term lines of credit are payable upon demand and are unsecured. There are no significant commitment fees related to the bank loans or unused lines of credit. The Company had available uncommitted, unused short-term lines of credit in various countries totaling approximately $25.3 million at October 31, 2000. Borrowings under the unused short-term lines of credit are subject to the bank's approval. 30 20 NOTE 5 - CAPITAL STOCK The authorized capital stock of the Company consists of 50,000,000 shares of Common Stock, par value $.001 per share, and 2,000,000 shares of Preferred Stock, par value $.001 per share. COMMON STOCK Subject to preferences that may be applicable to any outstanding Preferred Stock, holders of Common Stock are entitled to receive ratably such dividends as may be declared by the Board of Directors out of funds legally available therefor. Holders of Common Stock are entitled to one vote per share in all matters to be voted upon by shareholders. In the event of a liquidation, dissolution or winding up of the Company, holders of Common Stock are entitled to share ratably in all assets remaining after payment of the Company's liabilities and the liquidation preferences of any outstanding Preferred Stock. Holders of Common Stock have no preemptive rights and no rights to convert their Common Stock into any other securities, and there are no redemption provisions with respect to such shares. All of the outstanding shares of Common Stock are subject to, and may be adversely affected by, the rights of the holders of shares of any series of Preferred Stock which the Company may issue in the future. PREFERRED STOCK The authorized class of Preferred Stock may be issued in series from time to time with such designations, relative rights, priorities, preferences, qualifications, limitations and restrictions thereof as the Board of Directors determines. The rights, priorities, preferences, qualifications, limitations and restrictions of different series of Preferred Stock may differ with respect to dividend rates, amounts payable on liquidation, voting rights, conversion rights, redemption provisions, sinking fund provisions and other matters. The Board of Directors may authorize the issuance of Preferred Stock which ranks senior to the Common Stock with respect to the payment of dividends and the distribution of assets upon liquidation. In addition, the Board is authorized to fix the limitations and restrictions, if any, upon the payment of dividends on Common Stock to be effective while any shares of Preferred Stock are outstanding. STOCKHOLDER RIGHTS PLAN The Company has a Stockholder Rights Plan, pursuant to which a preferred share purchase right (a "Right") is associated with, and trades with, each share of Common Stock outstanding. Each Right, when it becomes exercisable, entitles its holder to purchase from the Company one-hundredth of a share of Series A Junior Participating Preferred Stock ("Series A Preferred Stock"), par value $.001 per share, of the Company at a price of $60 per one-hundredth share, subject to adjustment. The Rights are not exercisable until the earlier of (i) the acquisition of 15% or more of the Company's Common Stock by a person or group of affiliated persons (an "Acquiring Person"); or (ii) 10 days following the commencement or announcement of an intention to make a tender or exchange offer which would result in a person or group becoming an Acquiring Person. Each holder of a Right will have the right to receive, upon exercise, the number of shares of Common Stock or one-hundredths of a share of Series A Preferred Stock having a value (immediately prior to such triggering event) equal to two times the exercise price of such Right. In the event that the Company is acquired in a merger or acquisition, as defined, each holder of a Right shall have the right to receive, upon exercise, common shares of the acquiring company having a value equal to two times the exercise price of the Right. The Rights expire on August 8, 2006. NOTE 6 - OPERATING LEASES The Company has certain lease agreements for various facilities and equipment. Rent expense under operating leases was approximately $2,694,000 in 2000, $2,812,000 in 1999, and $2,277,000 in 1998. Future minimum lease payments under noncancellable operating leases with an initial term of one year or more at October 31, 2000 were as follows: 2001 - $2,406,000; 2002 - $2,001,000; 2003 - $1,665,000; 2004 - $1,398,000; and 2005 - $1,292,000. NOTE 7 - BENEFIT PLANS The Company has noncontributory defined benefit plans for substantially all of its U.S. employees. Pension benefits for the hourly employees covered by these plans are expressed as a flat benefit rate times years of continuous service. Benefits for salaried employees are based upon a percentage of the employee's average compensation during the preceding ten years, reduced by 50 percent of the Social Security Retirement Benefit. The Company funds amounts at least sufficient to exceed the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, plus such additional amounts as may be deemed appropriate. The Company also has contributory defined benefit pension plans covering its employees in Japan. Benefits under these plans are based on years of service and compensation in the period immediately preceding 31 21 retirement. Funding is predicated on minimum contributions as required by local laws and regulations plus additional amounts, if any, as may be deemed appropriate. The following table sets forth the funded status and amounts recognized in the Consolidated Balance Sheets at October 31, 2000 and 1999 for the Company's U.S. and Japanese defined benefit pension plans (in thousands):
2000 1999 PLANS WHOSE PLANS WHOSE PLANS WHOSE PLANS WHOSE ASSETS EXCEED ACCUMULATED ASSETS EXCEED ACCUMULATED ACCUMULATED BENEFITS EXCEED ACCUMULATED BENEFITS EXCEED BENEFITS ASSETS BENEFITS ASSETS ------------- --------------- ------------- --------------- Projected benefit obligation $(21,162) $(13,051) $(20,587) $(13,056) -------- -------- -------- -------- Market value of plan assets $ 23,277 $ 6,908 $ 21,357 $ 7,084 -------- -------- -------- -------- Projected benefit obligation less than (in excess of) plan assets 2,115 (6,143) 770 (5,972) Unrecognized net (gain) loss (3,871) 1,592 (2,713) 1,467 Unrecognized prior service cost 1,349 201 1,488 233 Unrecognized transition obligation -- 318 -- 410 -------- -------- -------- -------- Net pension liability $ (407) $ (4,032) $ (455) $ (3,862) ======== ======== ======== ========
Plan assets at October 31, 2000 are invested in publicly traded and restricted mutual funds, various corporate and government bonds, guaranteed income contracts and listed stocks, including common stock of the Company having a market value of $2,537,500 (100,000 shares) at that date. A summary of the various components of net periodic pension cost for defined benefit plans and cost information for other plans for the three-year period is shown below (in thousands):
2000 1999 1998 ------- ------- ------- DEFINED BENEFIT PLANS: Service cost $ 1,915 $ 2,043 $ 1,868 Interest cost 1,908 1,702 1,649 Expected return on plan assets (2,000) (3,043) (1,501) Net amortization and deferral (60) 1,433 154 ------- ------- ------- Net pension expense $ 1,763 $ 2,135 $ 2,170 ======= ======= =======
32 22 A summary of the changes in the projected benefit obligation is shown below (amounts in thousands):
======================================================================================================= 2000 1999 ---- ---- Benefit obligation - beginning of year $ 33,643 $ 33,085 Service cost 1,915 2,043 Interest cost 1,908 1,702 Benefits and expenses paid (1,819) (1,811) Actuarial assumption changes (948) (2,658) Foreign currency exchange rate changes (486) 1,282 ------------------------------------------------------------------------------------------------------- Benefit obligation - end of year $ 34,213 $ 33,643 =======================================================================================================
A summary of the changes in the plan assets is shown below (amounts in thousands):
======================================================================================================= 2000 1999 ---- ---- Plan assets - beginning of year $ 28,441 $ 24,192 Actual return on assets 2,329 3,738 Employer contributions 1,561 1,592 Benefits and expenses paid (1,819) (1,811) Foreign currency exchange rate changes (327) 730 ------------------------------------------------------------------------------------------------------- Plan assets - end of year $ 30,185 $ 28,441 =======================================================================================================
Assumptions used in the accounting for the defined benefit plans as of October 31 were:
======================================================================================================== 2000 1999 ---- ---- DOMESTIC PLANS Weighted-average discount rate 7.75% 7.5% Rates of increase in compensation levels 5.0% 5.0% Expected long-term rate of return on assets 10.0% 10.0% FOREIGN PLAN (JAPAN) Weighted-average discount rate 2.75% 3.0% Rates of increase in compensation levels 3.0% 3.5% Expected long-term rate of return on assets 5.0% 5.0% ========================================================================================================
Due to assumptions inherent in the actuarial computations, it is reasonably possible that future actual expenses will differ from current actuarial estimates. The Company sponsors a defined contribution plan that provides all U.S. employees of the Company an opportunity to accumulate funds for their retirement. The Company currently matches 50% of employee contributions up to 6% of qualified wages. Company matching contributions charged to income amounted to $638,000, $567,000, and $570,000 in 2000, 1999, and 1998, respectively. Company matching contributions are made annually in shares of the Company's Common Stock subsequent to the Plan's calendar year end. 33 23 NOTE 8 - INCOME TAXES The components of income before income taxes and the provision for income taxes are summarized as follows (in thousands):
====================================================================================================== 2000 1999 1998 ---- ---- ---- Income before income taxes Domestic $ 19,675 $ 16,887 $ 7,609 Foreign 7,920 5,887 3,640 ------------------------------------------------------------------------------------------------------ 27,595 22,774 11,249 Provision (benefit) for income taxes Current Domestic - Federal 3,108 4,290 4,778 - State and local 567 916 755 Foreign 3,815 2,629 1,781 Benefit of operating loss carryforwards -- (203) (314) ------------------------------------------------------------------------------------------------------ 7,490 7,632 7,000 Deferred Domestic - Federal 2,518 36 (1,862) - State and local 449 (1) (344) Foreign (309) 276 100 ------------------------------------------------------------------------------------------------------ 2,658 311 (2,106) ------------------------------------------------------------------------------------------------------ 10,148 7,943 4,894 ------------------------------------------------------------------------------------------------------ Net Income Domestic 13,033 11,646 4,282 Foreign 4,414 3,185 2,073 ------------------------------------------------------------------------------------------------------ $ 17,447 $ 14,831 $ 6,355 ======================================================================================================
A reconciliation of the statutory U.S. federal rate to the effective income tax rate follows:
====================================================================================================== 2000 1999 1998 ---- ---- ---- Statutory US federal income tax rate 35.0% 35.0% 35.0% State and local taxes on income, net of domestic Federal income tax benefit 2.4 2.5 2.7 Impact of foreign subsidiaries on effective rate 1.2 1.2 (1.5) Benefit of operating loss carryforwards -- (.3) (2.2) Unusual Charges with no tax benefit -- -- 6.9 Tax credits (2.7) (2.2) -- Prior year tax provision adjustments .4 (1.8) -- Goodwill amortization with no tax benefit 1.2 1.5 2.9 All other (.7) (1.0) (.3) ------------------------------------------------------------------------------------------------------ Effective income tax rate 36.8% 34.9% 43.5% ======================================================================================================
34 24 Significant components of the Company's deferred income tax liabilities and assets as of October 31 are as follows (in thousands):
================================================================================================== 2000 1999 ------ ------- Deferred income tax liabilities: Property, plant and equipment $5,135 $ 5,114 Other 34 37 -------------------------------------------------------------------------------------------------- Total deferred income tax liabilities 5,169 5,151 Deferred income tax assets: Pension liability 1,433 1,450 Employee benefits 2,492 4,751 Net operating loss carryforwards 350 189 Liability for Unusual Charges 495 821 Other accruals and reserves 1,064 1,223 Inventories 1,288 1,206 Other 1,193 1,154 -------------------------------------------------------------------------------------------------- Total deferred income tax assets 8,315 10,794 Less: valuation allowance for deferred income tax assets 350 189 -------------------------------------------------------------------------------------------------- Deferred income tax assets, after valuation allowance 7,965 10,605 -------------------------------------------------------------------------------------------------- Net deferred income tax assets $2,796 $ 5,454 ==================================================================================================
The valuation allowance for deferred income tax assets as of October 31, 1998 was $203,000. The increase in the valuation allowance for 2000 relates to provisions for net operating loss carryforwards in Italy and Germany. Although realization of the net deferred income tax asset of $7,965,000 is not assured, management believes it is more likely than not that all of such net deferred income tax assets will be realized. The amount of the net deferred income tax assets considered realizable, however, could be reduced if estimates of future taxable income are reduced. The net operating loss carryforwards in Germany are available indefinitely; the net operating loss carryforwards in Italy expire from 2001 through 2005. NOTE 9 - ACQUISITIONS On February 28, 1998, the Company acquired Chemical Engineering Corporation, a leading manufacturer of water treatment equipment and related systems. The transaction was accounted for as a purchase. The purchase price amounted to $8.6 million in cash (acquired assets included cash of $1.1 million), and was financed by the Company's revolving credit facility. The purchase price exceeded the fair value of net assets acquired by approximately $4.4 million. The excess of the purchase price over the fair value of the net assets acquired has been recorded as goodwill and is being amortized on a straight line basis over 25 years. The purchase agreement also provided for future contingent consideration payable over a two year period and is dependent on future sales levels and other performance criteria. During fiscal 2000 and 1999, contingent consideration payments of $2.9 million and $1 million, respectively, were recorded as additional goodwill. The results of operations of Chemical Engineering Corporation are included in the accompanying financial statements from the date of acquisition. This acquisition did not materially affect the financial statements of the Company in 1998 nor would it have materially effected the financial statements of prior periods had the results of its operations been included in them. During fiscal 1998, the Company completed the acquisition of certain distribution operations. In some cases, payments related to the acquisition have been scheduled for future periods, but are not contingent upon future events or performance criteria. These acquisitions have been accounted for as purchases and, accordingly, the results of their operations are included in the Company's consolidated statements of operations from the date of acquisition. These acquisitions did not materially affect the financial statements of the Company in 1998 nor would they have materially affected the financial statements of prior periods had the results of their operations been included in those financial statements. 35 25 NOTE 10 - SEGMENT FINANCIAL 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 products. Operating segment data include the results of all subsidiaries, consistent with the management reporting of these operations. Financial information by geographic operating segment as of and for each of the years ended October 31 is summarized below (amounts in thousands):
=============================================================================================================================== 2000 1999 1998 ---- ---- ---- NET SALES: Europe $ 36,724 $ 40,696 $ 39,695 Japan 40,593 30,143 26,712 Asia/Pacific 25,322 24,315 22,287 Latin America 13,788 11,287 13,738 ------------------------------------------------------------------------------------------------------------------------------- Subtotal - Foreign Sales 116,427 106,441 102,432 North America 157,846 146,248 126,720 Elimination of intercompany sales (31,199) (32,105) (30,307) ------------------------------------------------------------------------------------------------------------------------------- Consolidated $ 243,074 $ 220,584 $ 198,845 ===============================================================================================================================
- Each geographic operating segment primarily sells its products to external customers within its country of domicile.
=============================================================================================================================== 2000 1999 1998 ---- ---- ---- OPERATING INCOME: North America $ 17,503 $ 15,313 $ 6,308 Europe 1,330 2,384 817 Japan 3,504 1,083 497 Asia/Pacific 3,662 3,190 2,795 Latin America 1,928 1,683 1,506 ------------------------------------------------------------------------------------------------------------------------------- Segment total 27,927 23,653 11,923 ------------------------------------------------------------------------------------------------------------------------------- Interest expense (695) (1,202) (1,213) Other income, net 363 323 539 ------------------------------------------------------------------------------------------------------------------------------- Income before income taxes $ 27,595 $ 22,774 $ 11,249 ===============================================================================================================================
- Segment operating income consists of net sales less operating expenses. Interest expense and other income, net have not been allocated to segments. - Included in the 1998 segment operating income were Unusual Charges of $8,067,000, $1,521,000, $53,000, and $43,000 in North America, Europe, Japan, and Asia/Pacific, respectively. 36 26
================================================================================================================================ OCTOBER 31, 2000 1999 1998 ---- ---- ---- ASSETS: North America $ 153,830 $ 144,385 $ 135,200 Europe 18,972 24,028 25,735 Japan 31,824 31,558 29,864 Asia/Pacific 11,923 13,239 14,083 Latin America 6,345 5,763 7,219 General Corporate 13,814 6,186 4,433 Eliminations and other (47,809) (40,817) (44,968) -------------------------------------------------------------------------------------------------------------------------------- Consolidated $ 188,899 $ 184,342 $ 171,566 ================================================================================================================================
- General corporate assets (principally cash and investments) are not allocated to segments. - Eliminations and other is primarily comprised of intercompany receivables and investments in subsidiaries, both of which are eliminated in the Company's consolidated financial statements.
================================================================================================================================ 2000 1999 1998 ---- ---- ---- CAPITAL EXPENDITURES: North America $ 10,185 $ 10,127 $ 10,464 Europe 450 648 416 Japan 675 390 399 Asia/Pacific 511 429 398 Latin America 322 101 183 -------------------------------------------------------------------------------------------------------------------------------- Consolidated $ 12,143 $ 11,695 $ 11,860 ================================================================================================================================
================================================================================================================================ 2000 1999 1998 ---- ---- ---- DEPRECIATION AND AMORTIZATION: North America $ 6,996 $ 6,274 $ 5,826 Europe 668 804 956 Japan 540 524 416 Asia/Pacific 460 500 426 Latin America 202 173 171 -------------------------------------------------------------------------------------------------------------------------------- Consolidated $ 8,866 $ 8,275 $ 7,795 ================================================================================================================================
- Non-cash expenses associated with the 1998 Unusual Charges amounted to $1,977,000. CUNO sells its products into three principle markets. The potable water market includes applications designed for residential, commercial, and food service customers. The fluid processing market includes customers in industries as diverse as chemical, petrochemical, oil & gas, paints and resins, and electronics. The healthcare market customers include food & beverage providers which require absolute clarity and stability of their products and pharmaceutical and biotechnology companies which require cost-efficient filtration and high levels of purity for production of sterile, contaminate free drugs and diagnostic test kits. 37 27 The Company's sales by market are summarized for each of the years ended October 31 (amounts in thousands):
================================================================================ 2000 1999 1998 ---- ---- ---- NET SALES: Potable Water $ 101,483 $ 87,649 $ 63,803 Fluid Processing 78,781 72,269 73,829 Healthcare 62,810 60,666 61,213 -------------------------------------------------------------------------------- Consolidated $ 243,074 $ 220,584 $ 198,845 ================================================================================
NOTE 11 - STOCK OPTIONS AND AWARDS The Company has a stock option and award plan which allows for granting a number of stock incentive instruments, including nonqualified and incentive stock options, restricted stock, performance shares and stock appreciation rights which may be granted as part of a stock option or as a separate right to the holders of any rights previously granted. The plan permits the granting of such stock awards of up to 2,200,000 shares of Common Stock. Accordingly, such shares have been authorized and reserved. The options are exerciseable at various dates and have varying expiration dates. Approximately 800,000 shares of Common Stock are reserved for issuance to key employees and nonemployee directors under the provisions of these option and award plans as of October 31, 2000. Awards of performance shares totaled 6,333 in 1999 and 77,000 in 1998. No such awards were made in 2000. Awards of restricted shares totaled 5,500, 111,402, and 49,335 in 2000, 1999 and 1998, respectively. When rights or awards are granted, associated compensation expense is accrued from the date of the grant to the date such options or awards are exercisable. Shares earned under the plan are based on a formula which may be adjusted at the discretion of the Company's Compensation Committee. A summary of stock option activity follows:
================================================================================ OPTIONS EXERCISE PRICE ------- -------------- Outstanding at October 31, 1997 378,002 $ 5.96 - $ 16.63 -------------------------------------------------------------------------------- Options granted 125,000 14.13 - 21.50 Options forfeited (11,000) 15.13 -------------------------------------------------------------------------------- Outstanding at October 31, 1998 492,002 5.96 - 21.50 -------------------------------------------------------------------------------- Options granted 209,000 14.13 - 15.00 Options exercised (9,144) 5.96 - 15.13 Options forfeited (16,500) 14.13 - 15.13 -------------------------------------------------------------------------------- Outstanding at October 31, 1999 675,358 7.94 - 21.50 -------------------------------------------------------------------------------- Options granted 211,250 19.75 - 30.06 Options exercised (16,350) 15.13 - 15.25 Options forfeited (20,500) 14.13 - 27.50 -------------------------------------------------------------------------------- Outstanding at October 31, 2000 849,758 7.94 - 30.06 ================================================================================
38 28 The weighted-average grant-date fair value of options granted was $5.69, $8.86, and $7.25, in 2000, 1999, and 1998, respectively. The following table summarizes information concerning currently outstanding options:
==================================================================================================================== OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------------------ ------------------------------------ WEIGHTED- RANGE OF AVERAGE WEIGHTED- WEIGHTED- EXERCISE NUMBER REMAINING AVERAGE NUMBER AVERAGE PRICES OUTSTANDING LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE ------------------------------------------------------------ ------------------------------------ $ 5 - $10 26,438 3.50 $ 8.79 26,438 $ 8.79 10 - 15 241,598 7.16 13.22 74,098 11.18 15 - 20 552,472 7.39 17.23 286,828 15.72 20 - 25 8,500 7.73 21.30 3,500 21.50 25 - 30 20,000 9.55 28.42 -- -- 30 - 35 750 9.92 30.06 -- -- ------- ------- 849,758 390,864 ====================================================================================================================
Pro forma information regarding net income and earnings per share is required by Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), which also requires that the information be determined as if the Company had accounted for its employee stock options granted subsequent to October 31, 1995, under the fair-value method of SFAS 123. The fair value for these options was estimated at the date of grant using the Black-Scholes pricing model with the following assumptions: risk-free interest rates ranging from 5.7% to 6.5%, no dividend yield, expected volatility of the market price of Company Common Stock ranging from 14% to 69%, and an expected option life of five years. The risk-free interest rate is based on short-term treasury bill rates. For the purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information compared to as reported information follows (dollars in thousands):
================================================================================================================== 2000 1999 1998 ---- ---- ---- Net Income: As reported $ 17,447 $ 14,831 $ 6,355 Pro forma 16,602 13,968 5,758 Basic earnings per share: As reported 1.08 0.92 0.40 Pro forma 1.03 0.87 0.36 Diluted earnings per share: As reported 1.05 0.91 0.39 Pro forma 1.00 0.86 0.35 ==================================================================================================================
These pro forma effects may not be representative of the effects on future years because of the prospective application required by SFAS 123, and the fact that options vest over several years and new grants generally are made each year. 39 29 NOTE 12 - FAIR VALUES OF FINANCIAL INSTRUMENTS The following methods and assumptions were used by the Company in estimating its fair value disclosures of financial instruments: CASH AND CASH EQUIVALENTS: The carrying amounts reported for cash and cash equivalents approximate fair value. LONG AND SHORT-TERM DEBT: The carrying amounts of the Company's borrowings under its short-term credit agreements approximate their fair value. The fair values of the long-term debt are estimated using discounted cash flow analysis, based on the Company's incremental borrowing rates for similar types of borrowing arrangements. The fair value of the Company's long-term debt approximates its carrying value because of the variable interest rate of the majority of the debt. The carrying amounts and fair values of the Company's financial instruments follows:
================================================================================================= OCTOBER 31, ----------- 2000 1999 --------------------------------------------------------------------- CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE -------------- ---------- -------------- ---------- Cash and cash equivalents $13,814 $13,814 $ 6,186 $ 6,186 Bank loans 14,233 14,233 19,189 19,189 Long-term debt 4,168 3,566 11,254 11,263 =================================================================================================
The carrying amounts of accounts receivable and accounts payable and accrued expenses approximate fair value because of the short-term nature of those transactions. FOREIGN CURRENCY EXCHANGE CONTRACTS: At times, the Company utilizes foreign currency exchange contracts to minimize the impact of currency fluctuations on identified transactions. At October 31, 2000 and 1999, the Company held contracts for $3,140,000 and $3,041,000 respectively, with fair values of $3,181,000 and $2,989,000, respectively. The fair value of foreign currency exchange contracts is estimated based on quoted exchange rates at year end. The terms of the foreign currency exchange contracts are matched to the underlying transaction being hedged, and are typically under 90 days. The forward contracts are an effective hedge against fluctuations in the value of the foreign currency. Therefore, the contracts have no income statement impact. NOTE 13 - CONTINGENCIES The Company is, from time to time, 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 the Company's 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. 40 30 NOTE 14 - QUARTERLY DATA (UNAUDITED) A summary of the Company's quarterly data follows (in thousands, except per-share amounts):
================================================================================================================= 2000 FIRST SECOND THIRD FOURTH TOTAL ---- ----- ------ ----- ------ ----- Net sales $57,734 $58,910 $62,795 $63,635 $243,074 Gross profit 24,325 25,474 27,115 27,571 104,485 Net income 3,258 3,872 5,019 5,298 17,447 Basic earnings per share $ 0.20 $ 0.24 $ 0.31 $ 0.33 $ 1.08 Diluted earnings per share $ 0.20 $ 0.23 $ 0.30 $ 0.32 $ 1.05 1999 ---- Net sales $50,626 $54,027 $56,348 $59,583 $220,584 Gross profit 19,866 23,907 25,160 27,617 96,550 Net income 1,588 3,315 4,453 5,475 14,831 Basic earnings per share $ 0.10 $ 0.21 $ 0.28 $ 0.34 $ 0.92 Diluted earnings per share $ 0.10 $ 0.20 $ 0.27 $ 0.33 $ 0.91 =================================================================================================================
Earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share may not necessarily equal the total for the year. 41