-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QO4sXdm3+TUJe3g/rkHEAzFBrB3CRrhqKYmVO/PAMDsfqOlFDUlWJcEouzcWijSX X1Idpmr4CPtIHlKARAHalg== 0000950123-03-013933.txt : 20031218 0000950123-03-013933.hdr.sgml : 20031218 20031218152136 ACCESSION NUMBER: 0000950123-03-013933 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20031031 FILED AS OF DATE: 20031218 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CUNO INC CENTRAL INDEX KEY: 0001019779 STANDARD INDUSTRIAL CLASSIFICATION: GENERAL INDUSTRIAL MACHINERY & EQUIPMENT, NEC [3569] IRS NUMBER: 061159240 STATE OF INCORPORATION: DE FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-21109 FILM NUMBER: 031062295 BUSINESS ADDRESS: STREET 1: 400 RESEARCH PARKWAY CITY: MERIDEN STATE: CT ZIP: 06450 BUSINESS PHONE: 2032375541 MAIL ADDRESS: STREET 1: 400 RESEARCH PARKWAY CITY: MERIDEN STATE: CT ZIP: 06450 10-K 1 y92549e10vk.txt FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 FOR THE FISCAL YEAR ENDED OCTOBER 31, 2003 COMMISSION FILE NUMBER 000-21109 CUNO INCORPORATED --------------------- (Exact name of registrant as specified in its charter) Delaware 06-1159240 - ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 400 Research Parkway, Meriden, Connecticut 06450 - ------------------------------------------ ---------- (Address of principal executive offices) (Zip Code) (203) 237-5541 -------------- (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, PAR VALUE $.001 PER SHARE (Title of class) 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 period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for at least the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate with a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] As of November 28, 2003, approximately 16,870,791 common shares were outstanding, and the aggregate market value of the common shares (based upon the last price on that date) was approximately $718.8 Million. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the 2004 Annual Meeting of Shareholders are incorporated by reference into Part II, Part III and Part IV of this report to the extent described herein. 1 Part I ITEM 1. BUSINESS (a) General development of business: CUNO Incorporated ("CUNO" the "Company", or "we") 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 balanced between domestic (approximately 55%) and international markets (approximately 45%). Our objective is to provide high value-added products and premium customer service. Our proprietary manufacturing processes result in products with features that lower customers' operating expenses and improve the quality of customers' end products. As part of our commitment to customer service, we designate our own scientists, each of whom possess particular industry expertise, to collaborate with customers on specific projects to insure satisfaction with its products and to create new products. Our success is partially dependent on the development and implementation of the following initiatives, which are key elements of our ongoing growth strategy: (i) develop new products for specific markets, (ii) decrease product development cycle times, (iii) develop pre/final filter systems, (iv) increase customer satisfaction, (v) improve operating efficiencies, and (vi) pursue selective acquisitions. (b) Financial information about industry segments: The Company is divided into five geographic operating segments, each of which has general operating autonomy over its products and local operations. These operating segments are as follows: North America, Europe, Japan, Asia/Pacific, and Latin America. See Note 9 - Segment Financial Data on pages 33-35 of the 2003 Annual Report to Stockholders which is incorporated herein by reference. (c) Narrative description of business: OVERVIEW: Filtration is the process of separating particles of various sizes from liquids or gases. The mechanics of filtration range from the removal of coarse contaminants, most often particulates, as large as 200 microns such as sand and sediment, to the elimination of bacteria and viruses at less than .01 micron (human hair is typically 20 microns in diameter). A filtration device consists of a plastic or metal housing and a filtration medium. Filtration media, which can be manufactured out of a variety of substances, act as the separator or barrier in the filtration process. Filtration media include microporous membranes, glass, synthetic and cellulosic fibers, porous metals and ceramics. Microporous membranes are thin, film-like materials with millions of uniform microscopic holes. Membranes are the most widely used filtration media because they remove specifically-sized particles and can be configured into a variety of shapes and sizes. Each of CUNO's five operating segments manufacture and sell products into the potable water, fluid processing, and healthcare markets. OPERATING SEGMENTS: We serve three primary markets through a geographical operating structure. Each of our five operating segments (North America, Europe, Japan, Asia/Pacific, and Latin America ) manufacture and sell products into the Potable Water, Fluid Processing, and Healthcare markets. These markets represent the end markets in which the customers reside. Since the nature and attributes of the markets vary widely by geographic region, to best address these markets we have established a management structure based upon geography. The management for each of the geographic regions operate independent sales and manufacturing organizations that function within an overall 2 corporate framework of strategic initiatives and performance targets. The majority of these initiatives and targets are established to best address the three major markets and to achieve the financial objectives of the business. Further detail on our three major markets follows: Potable Water: The potable water market includes residential, commercial, and food service customers. According to industry data, it is estimated that one billion people in the world do not have safe drinking water. Demand is driven both by consumers' desire to improve the taste and quality of their drinking water and by the expanded concern of regulatory agencies. North American sales have increased sharply since 1999 due primarily to exceptional growth in new appliance filters for the OEM market and, to a lessor extent, as a result of the successful assimilation of certain small acquisitions. Growth potential appears especially strong in Asia/Pacific and Latin American countries where the quality of drinking water has been found to be severely deficient in several regions. Water safety concerns have driven the growth of the consumer bottled water market to over $2 billion in the United States, as well as the growth in the water filtration market. The food service industry has an increasing need for consistent global product quality. Food service includes water used for fountain beverages, steam ovens, coffee and tea (i.e. "recipe quality water"). Specifically, restaurants have become increasingly aware of the need for water filtration to control the taste and quality of the water used in their businesses. Worldwide sales to the potable water market totaled $132,938,000, $119,456,000 and $107,263,000 during the years ended October 31, 2003, 2002, and 2001, respectively. Fluid Processing: Major customers in the fluid processing market include chemical, petrochemical and oil and gas processors, manufacturers of paints and resins, producers of electronics and semi-conductors, and power generation facilities. As sophisticated manufacturing processes increase and as the adoption of practices focused on quality increase, we believe the demand for filtration products will also increase. In part, this trend is driven by the enhanced ability to detect contaminants in process streams. As automation increases, focus on quality control increases, and as the ability to detect contaminants progresses, fluid filtration will play a greater role in the manufacturing process. A significant segment of our fluid processing market is electronics manufacturing. Ultra pure water is used to rinse the components during manufacturing in order to ensure that the product is particle free with no residual contamination. The industry uses corrosive, high purity chemicals and gases for the manufacture of computer chips, hard disks, video terminals and other components. All of the chemicals and gases used are processed through very fine filtration systems. The strengthening demand for electronic products and oil and gas products has helped recent sales growth, and certain new products are expected to stimulate growth in the future. Sales to the fluid processing market totaled $74,626,000, $68,714,000 and $71,898,000 during the years ended October 31 2003, 2002, and 2001, respectively. Healthcare: The healthcare market is experiencing rapid growth as a result of the intensive research efforts to find cures for diseases, the increasing use of rapid and simpler diagnostic tests to help reduce healthcare costs, the trend toward finer and more cost-efficient filtration and increased governmental regulation. When harmful elements are identified, they are often regulated or new medical standards of care are implemented to decrease or eliminate contact. In many cases, fluid filtration can play a key role in eliminating contact with many harmful elements. Price is not the primary factor in the customers' filtration decision process, but rather the performance and reliability of the product. Our healthcare market customers include pharmaceutical and biotechnology companies that require cost-efficient filtration and high levels of purity for production of sterile, contaminate free drugs, as well as producers of diagnostic test kits which require highly efficacious membranes. In addition, applications include the production of bacteria-free water and food and beverage products. Sales to the healthcare market totaled $80,667,000, $70,031,000 and $65,288,000 during the years ended October 31 2003, 2002, and 2001, respectively. 3 GROWTH STRATEGY: Our goals are to grow at a rate higher than the general filtration market, expand our market share and to increase our operating margins and profitability. Key elements of our growth strategy include: Develop New Products for Specific Markets. We have initiated a strategy to develop high value-added products for specific markets. Historically, we offered non-differentiated products and often competed solely on price. To gain a better understanding of specific markets and guide new product development, we introduced Scientific Application Support Services ("S.A.S.S."). S.A.S.S. uses scientists with post-graduate degrees who are experts in the specific industry they serve. They collaborate with customers who are developing and implementing new processes or products that have specific filtration requirements. Often these relationships lead to the development of new market-specific products. Decrease Product Development Cycle Times. We have decreased our product development cycle times to approximately 18 to 24 months. This improvement has occurred through increased market focus, collaboration with leading-edge customers through S.A.S.S. teams and the formation of cross-functional product launch teams. We believe we can continue to shorten product development cycle times through these same methods. Develop Pre/Final Filter Systems. Many filtration systems have one or more pre-filters to remove large contaminants from the liquid or gas before it passes through the final filter, prolonging the life of the more expensive final filter. When these filters are designed together in a system, the performance of the system is enhanced. We have a leading pre-filter market position and are expanding the number of final filters we offer. This allows the Company to provide its customers with a total filtration solution from one vendor. Increased Customer Focus. We have traditionally sold to distributors, who in turn sell to the end user. Our current goal is to provide unmatched customer service to our end-user customers, while providing resources to our distributors. In many cases the customer is unable to define its filtration needs accurately and seeks outside resources to identify and choose the best filtration alternative. Our S.A.S.S. professionals meet this need. Management has been training and focusing distributors on specific market segments and providing additional training, sales, and marketing support. This enables distributors to provide customers with superior industry expertise and company-specific product knowledge. Improve Operating Efficiencies. We believe we can improve operating efficiencies by offering higher margin new products and implementing cost controls, supply chain management, productivity gains, profit-based compensation programs and outsourcing production of certain processes. We have initiated a capital investment program designed to (i) integrate cell-based manufacturing, (ii) provide higher yields from raw materials, (iii) improve inventory management, (iv) lower labor costs, (v) reduce manufacturing cycle times, and (vi) reduce scrap rates. Pursue Selective Acquisitions. We review opportunities to acquire high-quality companies which will allow us to expand into new geographic markets, add new customers, provide new products, manufacturing and service capabilities or increase our penetration with existing customers. In fiscal 2002, we completed a product line acquisition in Australia and a distributor acquisition in Europe for total consideration of $700,000. The amount of goodwill and other intangibles recorded in connection with these acquisitions amounted to $250,000 and $244,000, respectively. In the second quarter of fiscal 2001, we completed two acquisitions - a product line in Australia and a distributor in Europe -- for a total cost of $4.5 million. These acquisitions did not have a material effect on the our historical financial statements or pro forma operating results PRODUCTS: We manufacture a full range of products by offering our customers solutions to a wide range of filtration requirements. Many of the products manufactured by us use electrokinetic adsorption, a proprietary chemical process we developed which alters both membrane and depth filter media surfaces. Electrokinetic adsorption uses molecular 4 charges on dissolved ions to bind finer contaminants to the filter surface. This attribute significantly enhances filtration efficiency by removing contaminants smaller than the micron rating of the filter. We typically group our products into the following categories: Membranes: The typical polymer and nylon membranes that we produce resembles plastic films except for the molecular size pores that are engineered into the surface and depth of the membrane. By varying pore size and altering the physical or chemical properties of the membrane, the quantity and type of substances which can pass through the membrane can be regulated with absolute certainty. We manufacture "absolute rated" products where no particle above a certain size can pass through the membrane. In many applications, these membranes can be integrity tested to ensure specific performance both at the beginning and end of a particular process. A membrane can be employed in a variety of configurations, including flat sheets, discs and cartridges that contain high surface area and pleated membrane media. Uses of membranes include water purification for electronics and applications in semiconductor manufacturing, pharmaceutical, biotechnology and other applications, as well as residential use for drinking water. Our products include those sold under the following labels: Zetapor(R), Microfluor(R), PolyPro(R), Zetabind(R), Electropor(R)II, BevASSURE(R), MaxMedia(TM), Synchro(TM), Acro(TM), AC/PH Lithowater(R), LifeASSURE(R), PhotoSHIELD(TM), OPTIMA(TM), SterASSURE(TM) and Novylon(R). Depth Filters: Our disposable depth filters are constructed from a matrix or formation of very fine and micro-fine fibers such as polypropylene, cotton, polyester, glass fiber, acrylic, rayon, polymer, carbon and other materials. The fibre matrix is then processed into a rigid filter media using techniques such as thermal bonding, resin bonding, pleating or winding. Our technology has a strong emphasis on graded density attributes and electrokinetic adsorption. Graded density depth technology allows filter media to be manufactured with very open porous outer layers, progressively becoming smaller in the size of the pores or void volume through the depth of the filter media. Graded density construction extends filter life in many applications and reduces pressure loss across the filtration process thereby reducing energy costs. The structure of graded density filter media allows particles to be trapped throughout the depth of the cartridge which minimizes surface binding, allows for high contaminant capacity and lower pressure drops than solely trapping particles on the surface of the media. We manufacture depth filters in a wide variety of cartridge and pore sizes with "absolute" particulate ratings. The filter cartridges are used in filter housings that can be manufactured in a broad range of metals or plastics to suit particular customer specifications. Filter housings are designed for a wide range of temperatures and pressures. Our depth filter products include those sold under the following labels: Zeta Plus(R), Betafine(R), Micro-Klean(R) III, Beta-Klean(R), Betapure(R), PolyNet(R), BioCap(R), Micro-Wynd(R) II, Econo-Klean(R), Virosorb(R), Petro-Klean(R), Delipid(R), , Zetacarbon(R), and MPF(TM). Cleanable Filters and Systems: We design and manufacture an extensive range of self-cleaning disc filters, backwash strainers and recleanable metal filters. The self-cleaning disc filters and backwash strainers can be electrically or mechanically operated with automatic controls to provide for specific requirements in process applications. The recleanable metal filter elements are constructed of sintered porous stainless steel or metal screens in tubular and pleated construction. The recleanable elements can be cleaned in place in a filter housing or removed for mechanical, ultrasonic or chemical cleaning. Our cleanable filters and system products include those sold under the following labels: Poro-Klean(R), Micro-Screen(R), Auto-Klean(R), CTG-Klean(TM), and DuoFLO(TM). Housings and Systems: We design and manufacture a wide variety of filter housings to suit specific process and customer applications. The housings can be of plastic or metal construction utilizing a broad range of materials 5 including polypropylene, PVC, nylon, aluminum, copper, brass, steel, stainless steel and other specialized metals, such as titanium. Specialized designs include sanitary, electropolished and coated finishes for chemical resistance and ease of sterilization, sanitization or cleaning. We supply a broad range of standard housings manufactured from type 316 stainless steel in sanitary, polished and electropolished finishes for enhancing pharmaceutical and electronic applications. Finish specifications can be measured in terms of Roughness Average (Ra) with average variations in surface finish measured in microns down to 0.45 micron, the size of small bacteria. We design and manufacture proprietary housings and systems such as CTG-Klean(TM) with patented features and a totally enclosed disposable filter media pack for use in critical applications where housing cleanliness is essential or when physical separation of toxic or corrosive chemicals from the metal housing is desired. Our range of housings are designed and manufactured to regulatory pressure vessel codes, particularly for applications in the oil and gas, refinery and petrochemical industries. We design and market housings to meet the local regulatory requirements in most countries. BACKLOG: Our backlog on October 31, 2003 was $21.9 million as compared to $18.2 million as of the same date the previous year. Due to the relatively short manufacturing cycle and our use of wholesale distributors as well as general industry practice, backlog, which typically represents less than 30 days of shipments, is not deemed to be significant. A substantial portion of our revenues result from orders received and product sold in the same month. COMPETITION: The markets in which we compete are highly competitive. We compete with many domestic and international filtration companies in our global markets including some which are larger and which possess greater resources. No one company has a significant presence in all of our markets. The principal methods of competition are product specifications, performance, quality, knowledge, reputation, technology, distribution capabilities, service and price. Some of our other competitors are multi-line companies with other principal sources of income, some of which have substantially greater resources than the Company. Other competitors are local product assemblers or service companies that purchase components and supplies such as valves and tanks from more specialized manufacturers. Through our S.A.S.S. teams, we have developed many products by collaborating with our customers throughout the design and development process. We believe that these relationships provide us with a competitive advantage over other manufacturers. RESEARCH AND DEVELOPMENT: Our research, development, and engineering activities are conducted in our own laboratories, supplemented by on-site development and application of custom design and other technical skills. Our research, development and engineering expenditures, which consisted mainly of the development of new products, product applications and manufacturing processes for fiscal years 2003, 2002, and 2001 were approximately $15.0, $14.7 and $13.7, respectively, and 5.2 percent, 5.7 percent and 5.6 percent of net sales, respectively. We also incur additional internal costs relating to our sales and service personnel for product development. MANUFACTURING: Our manufacturing is largely vertically integrated, using unique, proprietary and patented processes, with many of the major components of our filtration units manufactured and assembled in our own plants. We have begun to outsource a limited amount of our manufacturing processes, such as segments of metal housing manufacturing. We believe that we generally have sufficient manufacturing capacity for the foreseeable future. We have developed a new, more efficient membrane manufacturing process that we believe provides a competitive advantage through the production of superior products at lower costs. Other than our facilities in Singapore and China, all of our manufacturing facilities are ISO 9002 certified. RAW MATERIAL SUPPLIERS: The primary raw materials used by the Company are cotton, nylon, acrylic, cellulose, resins, plastics and metals. We have not experienced a shortage of any of our raw materials in the past three years. We believe that there is an adequate supply of all of our raw materials at competitive prices from a variety of suppliers. 6 DISTRIBUTION AND SALES: We have approximately 150 independent distributors of our products in 65 countries. Distributors represent the primary channel in the marketing of our healthcare and fluid processing products. We have agreements with all of our major distributors in the United States. In certain markets outside the United States, we use dedicated sales people. Our potable water products are sold directly to wholesalers, such as plumbing suppliers, water quality dealers and major resellers, and through manufacturing representatives. Agreements with our United States distributors are usually for a period of two years. Such agreements usually assign an exclusive territory, prohibit distributors from carrying competing products, require that distributors share market and customer related information other than pricing with us, and require distributors to carry an adequate stock of our products. We do not believe that the loss of any one of our distributors would have a significant adverse effect on the Company. Our top ten customers accounted for approximately 28.8 percent of our total sales in fiscal year 2003. Whirlpool accounted for approximately 14.3 percent, 13.2 percent and 11.5 percent of sales during the fiscal years ended October 31, 2003, 2002 and 2001, respectively. We believe that no other customers account for more than ten percent of sales. As of October 31, 2003, the Company employed approximately 420 people as sales people. Of such employees, approximately 280 are located overseas. TRADEMARKS AND PATENTS: Trademarks and brand name recognition are important to the Company. We generally own the trademarks under which our products are marketed. We have registered our trademarks and will continue to do so as they are developed or acquired. We have approximately 400 registered trademarks throughout the world. We have approximately 290 active patents throughout the world and more than 200 patent applications pending worldwide. Additionally, we rely on proprietary, non-patented technologies to a certain extent. Certain of our employees sign non-disclosure and assignment of proprietary rights agreements. We protect our intellectual property and believe there is significant value associated with it. However, we believe that the loss of one or more of our trademarks and patents would not have a material adverse effect, as we are not heavily dependent on any one or few and we are continually expanding our intellectual estate through new additions. SEASONALITY: Our business is typically not seasonal. However, sales in the first quarter of each fiscal year tend to be lower than the other quarters due to the holiday season and year-end distributor inventory reductions. GOVERNMENT REGULATIONS: We believe that we are in substantial compliance with applicable regulations of Federal, state and local authorities regulating the handling of specified substances and the discharge of materials into the environment. We manufacture certain filtration products that are used as components in medical devices and we must use the Food and Drug Administration ("FDA") listed materials in the manufacture of these products. Additionally, we maintain Drug Master File ("DMF") files on certain products sold into the health care market. Certain medical devices marketed and manufactured by our customers are subject to extensive regulation by the FDA and, in some instances, by foreign governments. Noncompliance with FDA requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant pre-market clearance or pre-market approval for devices, withdrawal of marketing approvals and criminal prosecution. Before a new device can be introduced into the market, the manufacturer must generally obtain FDA clearance through either a 510(k) notification or pre-market approval application ("PMA"). A 510(k) clearance will be granted if the submitted information establishes that the proposed device is "substantially equivalent" to a legally marketed Class I or II medical device, or to a Class III medical device for which the FDA has not called for PMAs. The FDA recently has been requiring a more rigorous demonstration of 7 substantial equivalence than in the past. It generally takes from four to twelve months from submission to obtain a 510(k) clearance, but it may take longer. The FDA may determine that a proposed device is not substantially equivalent to a legally marketed device, or that additional information is needed before a substantial equivalence determination can be made. In many areas the sale and promotion of water treatment devices is regulated at the state level by product registration, advertising restrictions, water testing, product disclosure and other regulations specific to the water treatment industry. In some local areas certain types of water treatment products, including those manufactured by us, are restricted because of a concern with the amount and type of contaminants per volume of water they discharge as locally regulated. ENVIRONMENTAL MATTERS: Compliance with foreign, Federal, state and local laws and regulations enacted to regulate the handling of and the discharge of specified materials into the environment has not had, and is not expected to have, a material effect upon our business. EMPLOYEES: At October 31, 2003, we employed approximately 1,800 people worldwide (exclusive of employees of independent distributors), with approximately 980 employees in the United States and approximately 820 employees in other countries. (d) Financial information about foreign and domestic operations and export sales. See Note 9 to the financial statements on pages 33-35 of the 2003 Annual Report to Stockholders which is incorporated herein by reference. CAUTION CONCERNING FORWARD-LOOKING STATEMENTS: Because we want to provide shareholders with more meaningful and useful information, this annual report on Form 10-K contains statements relating to future events and the predicted performance of the Company 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 "anticipates," "believes," "estimates," "plans,", "expects," 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 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; cost 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 introduction 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. SECTION 16(A). AUDIT COMMITTEE FINANCIAL EXPERT Our Audit Committee consists of four Directors, Messrs. John M. Galvin, who is Chairman of the Committee, David L. Swift, C. Edward Migley, and Dr. Charles L. Cooney. All of these Directors are independent as defined in the rule of the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. The responsibilities of our Audit Committee, as more fully discussed in its Charter, are to assist the Board of Directors in fulfilling its oversight responsibilities for the financial reporting process, the system of internal control, the audit process, and the Company's process for monitoring compliance with laws and regulations. 8 The Board of Directors of the Company has determined that at least one member of the Audit Committee, Mr. John M. Galvin, is an audit committee financial expert. An audit committee financial expert is a person who has (i) and understanding of generally accepted accounting principles and financial statements, (ii) the ability to assess the general application of said principles in connection with the accounting for estimates, accruals and reserves, (iii) experience preparing, auditing, analyzing or evaluating financial statements of comparable breadth and complexity to the Company's or experience supervising others who do, (iv) an understanding of internal controls and procedures, and (v) an understanding of audit committee functions. SECTION 16(B). CODE OF ETHICS The Company has adopted a formal Code of Ethics including its Principal Executives and Senior Financial Officers that applies to its Chief Executive Officer, Chief Financial Officer and its Controller. The Company has posted this Code of Ethics to its website, www.cuno.com, and will provide a copy to any person without charge upon request. AVAILABLE INFORMATION The Company provides free of charge access to its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other SEC filings, through its website, www.cuno.com, as soon as reasonably practicable after such reports are electronically filed with the SEC. The Company will also provide free of charge a copy of its 2003 Annual Report to Shareholders upon written request to: John A. Tomich General Counsel and Secretary CUNO Incorporated 400 Research Parkway Meriden, CT 06450 Or by calling: 1-203-237-5541 9 ITEM 2. PROPERTIES Our world headquarters is located in Meriden, Connecticut. This facility also contains a manufacturing and assembly plant. The following table sets forth the location and approximate size of our principal properties and facilities, most of which are owned by the Company.
Approximate Facility Size Location (Sq. Ft.) - ---------------------------------------------------- ------------- Meriden, Connecticut ............................... 189,000 Enfield, Connecticut ............................... 155,000 Stafford Springs, Connecticut ...................... 165,000 Kita-Ibaragi, Japan ................................ 40,000 Mairinque, Brazil .................................. 65,000 Calais, France ..................................... 50,000 Mazeres, France .................................... 40,000 Sydney, Australia * ................................ 265,000 Singapore** ........................................ 18,546 Churubusco, Indiana ................................ 47,000 Sucy en Brie, France ** ............................ 20,000 Nantes, France ** ................................. 4,600 Shanghai, China ** ................................ 4,700
* 10 percent of this facility is sublet to unrelated third parties. ** Leased facility. In addition to the properties listed above, we lease one facility in the United States and approximately 16 facilities outside the United States. These facilities are generally used as warehouses and/or sales offices. ITEM 3. LEGAL PROCEEDINGS As of the date hereof there is no pending litigation of a material nature, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or which may affect the income from, title, to, or possession of, any of their respective properties. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There were no matters submitted to a vote of stockholders during the fourth quarter of fiscal year 2003. 10 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The portion of the 2003 Annual Report to Stockholders appearing on page 1 under the heading "Market Data" is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The financial data on page 7 of the 2003 Annual Report to Stockholders, captioned "Summary of Financial Data" is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 2003-2001 The following portions of the 2003 Annual Report to Stockholders are incorporated herein by reference: (a) All of the material on pages 8-17 under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations". ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information appearing under the caption "Market Risk Disclosures" appearing on page 16 of the 2003 Annual Report to Stockholders is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements of the Company and report of independent auditors included on pages 18-22 of the Annual Report to Stockholders for the fiscal year ended October 31, 2003 are incorporated herein by reference. Quarterly Results of Operations on page 38 of the 2003 Annual Report to Stockholders is incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None ITEM 9A. CONTROLS AND PROCEDURES As of October 31, 2003, an evaluation of the effectiveness of the design and operation of the Company's disclosure control and procedures was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation, the Company's management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company's disclosure controls and procedures were effective as of October 31, 2003. No significant changes in the Company's internal controls or in other factors that have occurred that could significantly affect controls subsequent to October 31, 2003 through the date of the filing of this report. 11 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding the Directors of the Registrant required by Section 16 of the Exchange Act is incorporated by reference to the definitive Proxy Statement of the Registrant, required to be filed with the Commission within 120 days of October 31, 2003, in connection with the annual meeting of stockholders to be held on March 4, 2004. The principal executive officers of the Company and their recent business experience are as follows:
Name Office Held Age - ----------------------------- --------------------------------------------------- --- Mark G. Kachur............... Chairman of the Board of Directors, President and 60 Chief Executive Officer Frederick C. Flynn, Jr....... Senior Vice President - Finance and Administration, 53 Chief Financial Officer and Assistant Secretary Thomas J. Hamlin............. Senior Vice President, Research & Development 42 Timothy B. Carney............ Vice President, and General Manager and President - 51 North America Water Group Anthony C. Doina............. Vice President - Worldwide Fluid Processing 47 John A. Tomich............... General Counsel and Secretary 46
None of the officers are related and they are elected from year to year or until their successors are duly elected and qualified. Mark G. Kachur. Mr. Kachur is the Chairman of the Board of Directors, President and Chief Executive Officer of the Company. Mr. Kachur has been a director of the Company since July 1996. Since joining the Company in 1994, Mr. Kachur has been a Senior Vice President of Commercial Intertech and President and Chief Operating Officer of the Company. From 1992 until 1994, he was President and CEO of Biotage, Inc., from 1971 to 1991, he was with Pall Corporation, the last seven years as a Group Vice President. He holds a bachelor of science degree in Mechanical Engineering from Purdue University and a master's degree in Business Administration from the University of Hartford. Frederick C. Flynn, Jr. Mr. Flynn is the Senior Vice President - Finance and Administration, Chief Financial Officer, and Assistant Secretary of the Company. Prior to joining CUNO in January 1999, Mr. Flynn was Senior Vice President and Chief Financial Officer of GE Capital Information Technology Solutions. From 1989 to 1995 Mr. Flynn was Vice President and Treasurer of United Technologies Corporation. He holds a bachelor of science degree in Economics from Boston College and a master's degree in Business Administration from the University of Connecticut. 12 Thomas J. Hamlin. Mr. Hamlin is the Senior Vice President of Research and Development. Since joining the Company in 1983, Mr. Hamlin has held a variety of positions including managerial positions in manufacturing and plant operations as well as Vice President of Product Development. Mr. Hamlin holds a bachelor of science degree in Mechanical Engineering from Rensselaer Polytechnic Institute and a master's degree in Business Administration from RPI, Hartford Graduate Center. Timothy B. Carney. Mr. Carney is the Company's Vice President, and General Manager and President of the North American Water Group. Previous to this, Mr. Carney served as the Company's Controller and effective November 1999, became Senior Vice President - Finance and Administration of the Company's worldwide Water Group. From 1993 until joining the Company, he served Commercial Intertech as CUNO Inc. Group Controller and from 1989 until 1993 he served Commercial Intertech as General Manager and Controller of Water Factory Systems. He holds a bachelor of science degree in Economics and a master's degree in Business Administration from Youngstown State University. Anthony C. Doina. Mr. Doina is the Vice President -- Worldwide Fluid Processing. Since joining the Company in 1994, Mr. Doina has also served in the capacity of Vice President of Process Sales. From 1978 until 1994 he was employed by Pall Corporation, serving in a number of positions in Research and Development, Marketing, and Sales (Vice President of Sales). Prior to joining the Company, Mr. Doina had over 16 years of sales experience in the filtration industry. Mr. Doina holds a bachelor of science degree in Chemistry from the University of Stony Brook. John A. Tomich. Mr. Tomich is General Counsel and Secretary of the Company. Before joining CUNO Incorporated after the spin-off from Commercial Intertech he was Counsel and Assistant Secretary for Commercial Intertech, where he had been employed since January 1990 and had been involved extensively with the legal matters affecting CUNO. He holds a bachelor of Engineering degree in Mechanical Engineering from Youngstown State University and Juris Doctor degree from the University of Akron, School of Law. He is a licensed patent attorney. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference to the definitive Proxy Statement of the Registrant, which is required to be filed with the Commission within 120 days of October 31, 2003, in connection with the annual meeting of stockholders to be held on March 4, 2004. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference to the definitive Proxy Statement of the Registrant, which is required to be filed with the Commission within 120 days of October 31, 2003, in connection with the annual meeting of stockholders to be held on March 4, 2004. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference to the definitive Proxy Statement of the Registrant, which is required to be filed with the Commission within 120 days of October 31, 2003, in connection with the annual meeting of stockholders to be held on March 4, 2004. 13 PART IV ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this item is incorporated by reference to the definitive Proxy Statement of the Registrant, which is required to be filed with the Commission within 120 days of October 31, 2003, in connection with the annual meeting of stockholders to be held on March 4, 2004. ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) DOCUMENTS FILED AS PART OF THIS REPORT: (1) The following consolidated financial statements of CUNO Incorporated included in its 2003 Annual Report to Shareholders are incorporated by reference in Item 8:
Page Number In This Report -------------- Consolidated Statements of Income - Years ended October 31, 2003, 2002, and 2001...................................... 19 Consolidated Balance Sheets as of October 31, 2003 and 2002........................... 20 Consolidated Statements of Stockholders' Equity - Years ended October 31, 2003, 2002, and 2001................................ 21 Consolidated Statements of Cash Flows - Years ended October 31, 2003, 2002, and 2001........ 22 Notes to Consolidated Financial Statements............ 23-38 (2) The following financial statement schedule of CUNO Incorporated is included in Item 14 (d): Schedule II Valuation and Qualifying Accounts...................................... S-1
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (3) Exhibits (i) 3.1 -- Articles of Incorporation Filed as of April 17, 1992 Incorporated by reference to Exhibit 3.1 to the Company's Form 10 (as filed with Amendment No. 2 thereto dated August 20, 1996). 14 (10 ) -- Material Contracts (i) 10.9 Termination and Change of Control Agreement - Mark G. Kachur dated October 1, 1996 (iii) 10.12 Termination and Change of Control Agreement - Timothy B. Carney dated October 1, 1996, as amended October 31, 1997. (i) 10.13 Termination and Change of Control Agreement - John A. Tomich dated October 1, 1996 (ii) 10.15 CUNO Incorporated Executive Management Incentive Plan (ii) 10.16 CUNO Incorporated Management Incentive Plan (iii) 10.17 CUNO Incorporated Savings and Retirement Plan (iv) 10.20 CUNO Incorporated Nonqualified Deferred Compensation Plan for Mark G. Kachur (v) 10.21 Termination and Change of Control Agreement - Frederick C. Flynn, Jr. dated January 21, 1999 (vi) 10.23 Employment Agreement - Frederick C. Flynn, Jr. (vii) 10.24 Employment Agreement - Michael C. Croft (viii) 10.25 Employment Agreement - Mark G. Kachur (ix) 10.26 Employment Agreement - Frederick C. Flynn, Jr. (ix) 10.27 Employment Agreement - Thomas J. Hamlin (x) 10.28 Amended Employment Agreement - Mark G. Kachur (xi) 10.29 CUNO Incorporated Code of Ethics 10.30 Amended Employment Agreement - Mark G. Kachur 13 - Certain sections of the Annual Report to Shareholders for the year ended October 31, 2003. 21 - Subsidiaries of the Registrant 23 - Consent of Independent Auditors 31.1* Certification of Mark G. Kachur pursuant to Section 302 of the Sarbanes-Oxley Act of 2003 31.2* Certification of Frederick C. Flynn pursuant to Section 302 of the Sarbanes-Oxley Act of 2003 32.1* Certification of Chief Executive Officer pursuant to 18 U.S.C. sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2* Certification of Chief Financial Officer pursuant to 18 U.S.C. sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. - -------------------------- (i) Incorporated by reference to the registrant's Annual Report on Form 10-K, as amended, filed with the Securities and Exchange Commission on January 23, 1997. (ii) Incorporated by reference to the Registrant's Registration Statement on Form S-1, as amended, filed with the Securities and Exchange Commission on February 27, 1997. (iii) Incorporated by reference to the registrant's Annual Report on Form 10-K, filed with the Securities and Exchange Commission on January 28, 1998. (iv) Incorporated by reference to the registrant's Annual Report on Form 10-K, filed with the Securities and Exchange Commission on January 29, 1999. (v) Incorporated by reference to the registrant's Quarterly Report on Form 10-Q, filed with the Securities and Exchange Commission on April 4, 1999. (vi) Incorporated by reference to the registrant's Quarterly Report on Form 10-Q, filed with the Securities and Exchange Commission on June 4, 1999. (vii) Incorporated by reference to the registrant's Quarterly Report on Form 10-Q, filed with the Securities and Exchange Commission on September 11, 2000. (viii) Incorporated by reference to the registrant's Annual Report on Form 10-K, filed with the Securities and Exchange Commission on January 16, 2002. (ix) Incorporated by reference to the registrant's Quarterly Report on Form 10-Q, filed with the Securities and Exchange Commission on February 19, 2002. (x) Incorporated by reference to the registrant's Quarterly Report on Form 10-Q, filed with the Securities and Exchange Commission on August 21, 2002. 15 (xi) Incorporated by reference to the registrant's Annual Report on Form 10-K, filed with the Securities and Exchange Commission on December 13, 2002. (b) Reports on Form 8-K for the quarter ended October 31, 2003. We filed a Report on Form 8-K, dated August 20, 2003, under "Item 5. Other Events," reporting our financial results for the third quarter ended July 31, 2003 We filed a Report on Form 8-K, dated October 2, 2003, under "Item 4. Change in Registrant's Certifying Public Accountant," reporting the dismissal of Ernst & Young LLP as our independent accountants effective after the filing of the Annual Report on Form 10-K for the year ended October 31, 2003, and the appointment of PricewaterhouseCoopers LLP as our successor independent accountants. We filed a Report on Form 8-K, dated October 2, 2003, under "Item 4. Change in Registrant's Certifying Public Accountant," reporting the dismissal of Ernst & Young LLP as the independent accountants of the CUNO Incorporated Savings and Retirement Plan (the "Plan") and the appointment of PricewaterhouseCoopers LLP as the successor independent accountants of the Plan. Additional information relating to management contracts and renumerative plans is contained in Note 10 - Stock Options and Awards of the Notes to Consolidated Financial Statements on pages 35-36 of the 2003 Annual Report to Stockholders. 16 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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: December 18, 2003 /s/ Mark G. Kachur /s/ Frederick C. Flynn, Jr. - ---------------------------- ----------------------------- Mark G. Kachur Frederick C. Flynn, Jr. Chairman of the Board Senior Vice President -- of Directors, President, and Finance and Administration, Chief Executive Officer Chief Financial Officer, and Assistant Secretary Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated above.
Name Title Date - ------------------------- -------- ----------------- Joel B. Alvord* Director December 18, 2003 Charles L. Cooney, Ph.D.* Director December 18, 2003 Frederick C. Flynn, Jr.* Director December 18, 2003 John A. Galvin* Director December 18, 2003 Mark G. Kachur* Chairman December 18, 2003 C. Edward Midgley* Director December 18, 2003 David L. Swift* Director December 18, 2003
*By: /s/ John A. Tomich ------------------------------ John A. Tomich Attorney-in-Fact, Pursuant to Power of Attorney 17 SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS CUNO INCORPORATED YEARS ENDED OCTOBER 31, 2003, 2002, AND 2001
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E - ------------------------------------------------------------------------------------------------------------------------------------ ADDITIONS ------------------------------------ BALANCE AT BEGINNING CHARGED TO COSTS CHARGED TO OTHER BALANCE AT END DESCRIPTION OF PERIOD AND EXPENSES ACCOUNTS - DESCRIBE DEDUCTIONS OF PERIOD ==================================================================================================================================== Year ended October 31, 2003 Deducted from asset accounts: Allowance for doubtful accounts receivable $1,406,268 $ 355,615 $176,839(D) $233,192(A) $1,705,530 ========== ========== ======== ======== ========== Valuation allowance for deferred income tax assets $1,465,000 $ 211,000(B) $ 0 $ 0 $1,676,000 ========== ========== ======== ======== ========== Year ended October 31, 2002 Deducted from asset accounts: Allowance for doubtful accounts receivable $1,336,490 $ 279,134 $ 13,272(D) $222,629(A) $1,406,268 ========== ========== ======== ======== ========== Valuation allowance for deferred income tax assets $ 116,000 $1,349,000(B) $ 0 $ 0 $1,465,000 ========== ========== ======== ======== ========== Year ended October 31, 2001 Deducted from asset accounts: Allowance for doubtful accounts receivable $1,394,685 $ 133,384 $(87,204)(D) $104,375(A) $1,336,490 ========== ========== ======== ======== ========== Valuation allowance for deferred income tax assets $ 350,000 $ 0(B) $ 0 $234,000(C) $ 116,000 ========== ========== ======== ======== ==========
(A) Uncollectible accounts written off, net of recoveries. (B) Establishment of valuation allowance for operating loss carryforwards. (C) Net operating loss carryforwards utilized. (D) Changes in foreign currency. S-1 EX-10.30 3 y92549exv10w30.txt AMENDED EMPLOYMENT AGREEMENT EXHIBIT 10.30 SECOND AMENDMENT TO EMPLOYMENT AGREEMENT OF MARK G. KACHUR This Second Amendment to Employment Agreement of Mark G. Kachur, effective November 19, 2003, hereby amends the Employment Agreement, dated December 1, 2000, entered into by Mark G. Kachur and CUNO Incorporated, as follows: Paragraph 3(c), is deleted in its entirety and is replaced with new Paragraph 3(c), as follows: 3(c) Restricted Shares. Provided the Executive remains in the employ of the Company, the Company shall grant to Executive, restricted shares of the Company's Common Stock, as follows:
Date Award (# shares) Vesting Term - ---------------- ---------------- ------------ December 1, 2000 20,219 4 years April 17, 2002 1,000 4 years December 1, 2002 1,000 4 years December 1, 2003 23,000 5 years
Each award shall be made pursuant to the Company's 1996 Stock Incentive Plan, as amended, or any successor plan. Paragraph 3(d), is deleted in its entirety and is replaced with new Paragraph 3(d), as follows: 3(d) Options. Provided Executive remains in the employ of the Company, the Company shall grant to Executive options to purchase shares of the Company's Common Stock in the form of non-qualified stock options pursuant to the Company's 1996 Stock Incentive Plan, as amended, or any successor plan. The option awards shall be as follows:
Date NQSOs - ---------------- ------ December 1, 2000 30,330 December 1, 2001 29,708 April 17, 2002 6,000 December 1, 2002 36,000
Any option award may, prior to the date of the grant, be increased at the discretion of the Compensation Committee of the Board (the "Committee"). The Option Price for options granted pursuant to this paragraph 3(d) shall be the closing price of the Company's Common Stock on the day of the grant. If the grant date falls on Saturday, Sunday or any other day when the Company's Common Stock is not publicly traded, the Option Price for such grant shall be the closing price of the Company's Common Stock on the next day when the Stock is publicly traded. The remainder of the Employment Agreement, unaffected by this Second Amendment, shall remain in full force and effect. IN WITNESS WHEREOF, the parties have executed this Second Amendment to Employment Agreement of Mark G. Kachur, as of the date first written above. EXECUTIVE CUNO INCORPORATED /s/ Mark G. Kachur /s/ John A. Tomich - ------------------ ----------------------------- MARK G. KACHUR JOHN A. TOMICH General Counsel and Secretary EX-13 4 y92549exv13.txt CERTAIN SECTIONS OF THE ANNUAL REPORT EXHIBIT 13 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:
2003 2002 ---------------------- ----------------------- QUARTER High Low High Low - ------- -------- ------- ------- ------- First $ 35.06 $ 29.90 $ 35.71 $ 25.85 Second 37.14 32.06 38.35 33.40 Third 38.85 33.65 37.55 29.84 Fourth 42.35 34.51 33.43 28.99
AS OF OCTOBER 31, 2003 CUNO HAD APPROXIMATELY 5,500 SHAREHOLDERS OF RECORD. 1 SUMMARY OF FINANCIAL DATA(1) (In Thousands, Except Per Share Data and Ratios)
OCTOBER 31: 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- INCOME DATA Net Sales $288,231 $258,201 $244,449 $243,074 $220,584 Gross Profit 131,010 115,751 108,380 104,485 96,550 Operating Income 40,225 34,885 30,411 27,927 23,653 Income before Income Taxes 40,147 34,770 30,797 27,595 22,774 Net Income 26,796 22,956 20,013 17,447 14,831 Basic Earnings per Share 1.61 1.39 1.23 1.08 0.92 Diluted Earnings per Share 1.58 1.36 1.20 1.05 0.91 OTHER FINANCIAL DATA Total Assets 288,008 236,879 206,043 188,899 184,342 Working Capital 97,685 72,571 55,750 41,921 35,309 Net Plant Investment 85,060 74,759 65,595 63,187 60,352 Capital Expenditures 16,318 17,600 11,028 12,143 11,695 Long-Term Debt 401 2,030 2,893 3,422 8,761 Stockholders' Equity 208,328 162,413 140,171 119,518 104,574 RATIOS Gross Profit to Net Sales 45.5% 44.8% 44.3% 43.0% 43.8% Operating Income to Net Sales 14.0% 13.5% 12.4% 11.5% 10.7% Net Income to Net Sales 9.3% 8.9% 8.2% 7.2% 6.7% Effective Income Tax Rate 33.3% 34.0% 35.0% 36.8% 34.9% Net Income to Average Stockholders' Equity 14.5% 15.2% 15.4% 15.6% 15.2% Ratio of Current Assets to Current Liabilities 2.5:1 2.3:1 2.0:1 1.7:1 1.6:1
- ---------------- (1) We adopted FASB 142 in 2002, see Note 4. Goodwill amortization was $1,316, $1,140, and $840 in 2001, 2000, and 1999, respectively. 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 2003 - 2001 Management's discussion and analysis of financial condition and results of operations ("MD&A") of CUNO Incorporated (the "Company", "CUNO", or "we") is provided as a supplement to the accompanying consolidated financial statements and footnotes to help 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 of which investors should be aware. - 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 results of operations for the years ended October 31, 2003, 2002, and 2001. In addition, a brief description is provided 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. - 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. - 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 balanced between domestic (approximately 55 percent) and international markets (approximately 45 percent). Our objective is to provide high value-added products and premium customer service. Our proprietary manufacturing processes result in products with features that lower customers' operating expenses and improve the quality of customers' end products. COMPANY RISK FACTORS RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS Approximately 45 percent 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 of assets. 8 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 and on a timely basis are significant factors in our ability to grow and to remain competitive. Similar to all companies, we are also subject to the risks generally associated with new product introductions and applications, including lack of market acceptance, delays in product development and failure of products to operate properly. COMPETITION The filtration and separations markets in which we compete are highly competitive. We compete with many domestic and international companies in the global markets. The principal methods of competition in the markets in which we compete are product specifications, performance, quality, knowledge, reputation, technology, distribution capabilities, service and price. KEY CUSTOMERS AND SUPPLIERS We have multi-year contracts 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 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. INFLATION Inflation had a negligible effect on our operations during fiscal years 2003, 2002, and 2001. We estimate that inflationary effects, in the aggregate, were generally recovered or offset through increased pricing or cost reductions in all fiscal years. CAUTION CONCERNING FORWARD-LOOKING STATEMENTS Because we want 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. 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 9 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 Exchange Comission ("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 have been discussed with the Audit Committee of the Board of Directors. Revenue Recognition - We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 requires that four basic criteria be met before revenue can be recognized: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is reasonably assured. We recognize revenue upon determination that all criteria for revenue recognition have been met, which, based on our shipping terms, is considered to have occurred upon shipment of the finished product. Depreciation and amortization - We depreciate our property, plant and equipment using the straight-line method over the estimated useful life of the asset. These periods range as follows: Land improvements 10 - 20 years Buildings and additions 30 - 40 years Machinery and equipment 5 - 20 years Computers and related equipment 3 - 5 years
We amortize our patents and other amortizable intangible assets over their estimated useful lives. 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 intangible assets and long-lived assets for impairment 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 time other than during the annual impairment review, a specific evaluation of the assets or groups of assets is performed to determine whether any impairment exists. 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 liabilities. 10 Contingencies, claims, assessments - From time to time, we are involved with contingencies, claims, and assessments. We use both in-house and outside legal counsel to assess the probability of loss. The Company establishes an accrual 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 Doubtful Accounts - 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 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. 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 employee 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 share grants awarded to employees are included in earnings as an expense over the vesting period of the award. RESULTS OF OPERATIONS YEAR ENDED OCTOBER 31, 2003 COMPARED TO YEAR ENDED OCTOBER 31, 2002 BUSINESS ENVIRONMENT Our operations are affected by global economic and political factors. However, our geographic and market diversity helps limit the impact of any one market or the economy of any single country on our consolidated results. NET SALES Net sales of $288.2 million in fiscal 2003 represented an 11.6 percent increase over 2002 net sales of $258.2 million. This increase can generally be attributed to an increase in the unit volume of worldwide sales. Had currency values been unchanged from fiscal 2002, net sales in 2003 would have been $276.4 million ($11.8 million lower), or 7.1 percent greater overall. The following table displays our sales by geographic segment (dollar amounts in thousands):
YEAR ENDED CURRENCY OCTOBER 31, OCTOBER 31, PERCENT ADJUSTED 2003 2002 CHANGE CHANGE ----------- ----------- ------- -------- North America $156,294 $149,784 4.3% 4.3% Europe 52,291 40,369 29.5% 8.9% Japan 34,617 30,648 13.0% 6.1% Asia/Pacific 34,005 26,179 29.9% 17.6% Latin America 11,024 11,221 (1.8%) 15.2% ------------------------- Total sales $288,231 $258,201 11.6% 7.1% =========================
11 North American sales totaled $156.3 million in 2003, which represented a 4.3 percent increase over sales of $149.8 million in 2002. Moderately stronger Potable Water market sales were responsible for this growth in North America during this time period. Strong growth in sales to Original Equipment Manufacturer ("OEM") customers, direct marketing companies and appliance manufacturers were tempered by general weakness in the residential markets. Healthcare sales improved modestly year over year, while Fluid Processing sales were down slightly due to their more cyclical nature. Our international sales increased $23.5 million or 21.7 percent in 2003 (10.9 percent in local currency) compared to 2002. European sales increased 8.9 percent in local currency as compared to the same period in 2002. Healthcare sales were particularly strong during this period reflecting greater demand in the pharmaceutical industry, and sales in the Potable Water market were up significantly. Sales in Japan were up 6.1 percent in local currency despite an overall weak economy. Asia/Pacific sales were up 17.6 percent excluding changes in currency values. The increase in Asia/Pacific sales was due primarily to broad-based strength in sales among all markets throughout the region. Latin American sales increased 15.2 percent due to in large part to overall broad strength in all markets as well as new product sales within the Potable Water market in the latter half of 2003. The following table displays our sales by market (dollars in thousands):
YEAR ENDED CURRENCY OCTOBER 31, OCTOBER 31, PERCENT ADJUSTED 2003 2002 CHANGE CHANGE ----------- ----------- ------- -------- Potable Water $132,938 $119,456 11.3% 9.4% Fluid Processing 74,626 68,714 8.6% 2.1% Healthcare 80,667 70,031 15.2% 8.0% -------------------------- Total Sales $288,231 $258,201 11.6% 7.1% ==========================
The unsettled economies in the US and certain other countries (primarily Japan) throughout much of fiscal 2003 have impacted all of our markets to some extent. The strength in the Potable Water market was broad geographically, driven largely by strong overseas sales (up 23.6 percent in local currency). The Fluid Processing sales increase of 8.6 percent reflects incremental growth throughout the year, particularly in the international markets. Healthcare sales increased 15.2 percent (10.5 percent overseas on a local currency basis) and continue to benefit from an ongoing focus by management on competitively favorable product lines and market niches. GROSS PROFIT Gross profit increased $15.3 million to $131.0 million in 2003 from $115.8 million in 2002. Gross profit as a percentage of net sales (gross margin) increased during that same period from 44.8 percent in 2002 to 45.5 percent in 2003. The primary factors which contributed to the increased gross margin in 2003 were the overall increase in volume sales and higher mix of sales in Healthcare (which generally carry higher margins). Although we are under pressure to maintain competitive prices with our customers, we pursue various supply-chain management initiatives designed to lower our production costs. In addition, we have ongoing programs to modernize our manufacturing facilities to gain more efficiencies. OPERATING EXPENSES Selling, general and administrative expenses (SG&A) were up 14.5 percent in 2003 compared to fiscal 2002. SG&A expenses were 26.3 percent of sales in fiscal 2003 compared to 25.6 percent of sales in fiscal 2002. We continued to face rising insurance and other structural costs in fiscal 2003, and have taken active measures to curb these costs when prudent. Also, because of CUNO's international operations, the weaker US dollar served to increase the consolidated US dollar-reported SG&A expense in 2003. Research, development and engineering expenses ("RD&E"), which are incurred primarily in the US, increased 2.1% in 2003 compared to 2002. In 2003, we received approximately $0.5 million in RD&E cost reimbursements from various new customers. Adjusting for these one-time items, RD&E would have increased 5.6 percent - this reflects our continued focus on the development of new products and technologies. As a percentage of sales, RD&E expenses were 5.4 percent of sales (adjusted for reimbursements above) in fiscal 2003 compared to 5.7 percent of sales in fiscal 2002. OPERATING INCOME As a result of the above, operating income increased $5.3 million, or 15.3 percent, to $40.2 million or 14.0 percent of sales in fiscal 2003 compared to $34.9 million or 13.5 percent of sales in fiscal 2002. 12 NON-OPERATING ACTIVITY Interest expense was relatively flat in fiscal 2003 compared to fiscal 2002. See "Financial Position and Liquidity" below for further discussion of the Company's cash and debt structure. Interest income was flat due to lower average interest rates in 2003, partially offset by higher average investment levels. INCOME TAXES The Company's effective income tax rate for fiscal 2003 was 33.3 percent compared to 34.0 percent in 2002. Our tax rate is impacted by the change in the mix of income attributed to the various countries in which we do business, as well as ongoing , global tax planning initiatives. YEAR ENDED OCTOBER 31, 2002 COMPARED TO YEAR ENDED OCTOBER 31, 2001 NET SALES Net sales of $258.2 million in fiscal year 2002 represented a 5.6 percent increase over net sales of $244.4 million in fiscal year 2001. This increase can generally be attributed to an increase in the unit volume of worldwide sales. The effects of foreign currency fluctuations reduced net sales in fiscal year 2002 by $2.1 million as compared to fiscal year 2001. Had currency values remained unchanged from fiscal year 2001, net sales in fiscal year 2002 would have been $260.3 million, or 6.5 percent greater than the prior year. The following table displays our sales by geographic operating segment (dollars in thousands):
Year Ended Currency October 31, October 31, Percent Adjusted 2002 2001 Change Change ---- ---- ------ ------ North America $149,784 $139,745 7.2% 7.2% Europe 40,369 35,323 14.3% 10.2% Japan 30,648 34,390 (10.9%) (5.9%) Asia/Pacific 26,179 23,074 13.5% 12.2% Latin America 11,221 11,917 (5.8%) 12.2% ----------------------- Total sales $258,201 $244,449 5.6% 6.5% =======================
Sales growth of 7.2 percent in our North American operations was led by both Healthcare (up 9.2 percent) and Potable Water (up 9.9 percent). Potable Water continues to record strong sales with its series of new filters designed for customers who serve various channels of distribution with final sales primarily to U.S. residential consumers. Sales into the healthcare market improved year over year due mostly to broad-based volume increases. Our international sales increased $3.7 million or 3.5 percent in 2002 compared to 2001. Had the value of foreign currencies remained unchanged in fiscal 2002 as compared to fiscal 2001, sales for these operations would have increased $5.8 million or 5.6 percent. In Europe, sales increased 10.2 percent in local currency; this gain was spread broadly across our three markets. Strong Healthcare sales to the pharmaceutical market contributed to this growth. Sales by the European Potable Water group increased 27.5 percent due to increased marketing and sales efforts. Sales in Japan were down 5.9 percent on a local currency basis as compared to the same period last year. All markets have been impacted by the continued weakness in the Japanese economy. Local currency sales growth in Asia/Pacific of 12.2 percent was broad-based with a majority of the increase coming from strong sales growth in Potable Water throughout the region. Despite the economic troubles in Argentina (see "Argentine Peso Devaluation" in the "Other Matters" section below for a discussion of our exposure to Argentina), local currency sales in Latin America increased 12.2 percent in fiscal 2002. The sales increase reflects strong, broad improvements in all markets, led by a 21.5 percent increase in Healthcare sales in the region. 13 The following table displays our sales by market (dollars in thousands):
Year Ended Currency October 31, October 31, Percent Adjusted 2002 2001 Change Change ---- ---- ------ ------ Potable Water $119,456 $107,263 11.4% 11.6% Fluid Processing 68,714 71,898 (4.4%) (3.1%) Healthcare 70,031 65,288 7.3% 8.7% ----------------------- Total Sales $258,201 $244,449 5.6% 6.5% =======================
The weak economies in the U.S. and certain international markets (primarily Japan) impacted all of our markets to some extent; however, Fluid Processing is our most cyclical market and was most impacted by the recent economic slowdown. The strength in the Potable Water market was broad geographically, driven largely by strong international sales (up 21.3 percent in local currency) and strong sales growth in North America (up 9.9 percent) associated with OEM customers, direct marketing companies, and appliance manufacturers. Healthcare sales increased both domestically and internationally and continue to benefit from our ongoing focus on competitively favorable product lines, market niches, and new products. GROSS PROFIT Our gross profit increased $7.4 million to $115.8 million in fiscal year 2002 from $108.4 million in 2001. Gross profit as a percentage of net sales increased from 44.3 percent in 2001 to 44.8 percent in 2002. The primary factor that contributed to the improved gross margin in 2002 was the market mix of sales (increased Healthcare sales which generally carry higher margins combined with decreased Fluid Processing sales which generally carry lower margins). In addition, various supply chain management initiatives designed to lower our production costs and ongoing programs to modernize our manufacturing facilities to gain efficiencies contributed to our improved gross margin. OPERATING EXPENSES Selling, general and administrative (SG&A) expenses increased $3.3 million in fiscal year 2002 over fiscal 2001, representing a 5.2 percent increase. Generally, expense categories within SG&A reflected nominal changes consistent with our focus on restraining discretionary spending. The cost of obtaining insurance has risen sharply and we continually take steps to control these expenses by reviewing deductible levels, evaluating levels of self-insurance, and aggressively marketing our policies. As a percentage of sales, SG&A expenses were relatively flat year over year, representing 25.6 percent of sales in 2002 compared to 25.7 percent of sales in 2001. As further described in Note 1 to the Financial Statements, the 2002 results benefitted from the elimination of goodwill amortization ($1.3 million in 2001) required by the adoption of SFAS 142. Research, development and engineering (RD&E) expenses increased 6.8 percent to $14.7 million in fiscal year 2002, reflecting our continued emphasis on the development of new products and technologies. As a percentage of sales, research, development and engineering expenses were 5.7 percent of sales in fiscal year 2002 compared to 5.6 percent of sales in fiscal year 2001. Our plans are to continue to devote significant resources to research and development in order to develop new technologies, enhance existing products, and develop additional new products. OPERATING INCOME As a result of the above, our operating income increased $4.5 million, or 14.7 percent, to $34.9 million or 13.5 percent of sales in fiscal year 2002 as compared to $30.4 million or 12.4 percent of sales in fiscal year 2001. NON-OPERATING ACTIVITY Interest income decreased by $0.3 million to $0.6 million in fiscal year 2002 due primarily to lower average interest rates worldwide, partially offset by higher average net investment levels (see Liquidity and Capital Resources below). No other material nonoperating activity occurred in either of the two fiscal years. INCOME TAXES Our effective income tax rate for fiscal year 2002 was 34.0 percent as compared to 35.0 percent in fiscal year 2001. The tax rate in 2002 was favorably impacted by permanent tax benefits associated with the adoption of FAS 142 (see Note 1), certain tax planning initiatives, marginally lower worldwide tax rates, and a change in the mix of income attributed to the various countries in which we do business. 14 FINANCIAL POSITION AND LIQUIDITY We assess liquidity in terms of the Company's ability to generate cash to fund our continuing 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, and to, the many subsidiaries through which we conduct our business. We believe that our existing cash and cash equivalents position ($57.6 million at October 31, 2003) and available sources of liquidity (approximately $24.3 million of available, unused worldwide short-term lines of credit) are sufficient to meet current and anticipated requirements for the foreseeable future. We do not rely on commercial paper or off-balance sheet financing arrangements for our liquidity needs nor do we have any investments in special purpose entities ("SPE"), or variable interest entities ("VIE"). 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 world. We currently have plans to expand certain international manufacturing lines in order to meet product demands around the world. In addition, new manufacturing lines and processes are being installed in the US to benefit the Potable Water Group, Fluid Processing, and Healthcare operations. Summary of Cash Flows (in thousands of dollars) follows:
Year Ended October 31, 2003 2002 ---- ---- Cash provided by (used for): Operating activities $34,934 $29,120 Investing activities (16,892) (18,171) Financing activities (2,714) 4,006 Effect of exchange rate changes on cash and cash equivalents 1,403 289
Net cash provided by operating activities increased $5.8 million due primarily to: - Increased net income in 2003 of $3.8 million - Increased pension funding of approximately $1.8 million - Timing in collections of accounts receivable - Timing in payments of prepaid expenses and other current assets Net cash used for investing activities decreased by $1.3 million due primarily to: - Decrease in capital expenditures of $1.3 million Net cash used for financing activities increased by $6.7 million due primarily to: - Increase in net borrowing under short-term bank loans of $6.7 million due primarily to the timing of cash payments - Increase in proceeds from stock options of $1.2 million - Increase in payments on long term debt of $1.1 million The effect of exchange rate changes on cash and cash equivalents increased $1.1 million due primarily to the overall weakness of the US Dollar in 2003, particularly against the Japanese Yen, Euro and Australian Dollar. 15 QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK FOREIGN CURRENCY RISK Approximately 45 percent of our operations consist of sales and manufacturing activities in foreign countries. We manufacture a significant portion of our products in the U.S. and sell 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 we distribute and sell our products. Our currency exposures vary, but are concentrated in the Euro, Japanese yen, Singapore dollar, Australian dollar, British pound, Brazilian real, Argentine peso, and the Chinese Renminbi. We utilize 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 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. We do not hedge overseas sales denominated in foreign currencies or translation exposures. 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 branch or subsidiary. In certain limited and specific instances, we may manage risk by denominating a portion of debt outstanding in a currency other than the local currency. INTEREST RATE RISK Our 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, we periodically evaluate alternative interest rate arrangements. Below is a table detailing, by maturity date, the Company's debt portfolio and the estimated interest rates for the fiscal years ended October 31, (dollars in thousands):
Fair 2004 2005 2006 2007 2008 Thereafter Total Value ---- ---- ---- ---- ---- ---------- ----- ----- Bank loans $14,098 -- -- -- -- -- $14,098 $14,098 Avg. Interest Rate 0.80% 0.80% Long-term Debt: Fixed Rate $ 849 $ 143 $ 151 $ 76 $ 10 $ 21 $ 1,250 $ 1,220 Avg. Interest Rate 5.04% 5.07% 5.10% 4.29% 0.13% 0.13% 4.88%
16 OTHER INFORMATION ARGENTINE PESO DEVALUATION A significant devaluation in the Argentine peso took place in our first quarter of 2002. We have a branch located in Argentina that accounted for less than 1 percent of consolidated net sales in 2003. Because this branch's operation is not material to our consolidated results, it has only a minimal impact on our overall results of operations. See "Market Risk Disclosures" following. INSURANCE AND PENSION COSTS Due to market forces, the cost of insurance has risen substantially and the availability of insurance has become more restrictive. We maintain insurance coverage with such deductibles and self-insurance as considered adequate and appropriate for our needs. Such coverage reflects market conditions (including cost and availability) existing at the time it is written and the relationship of insurance coverage to self-insurance varies accordingly. We consider the impact of these changes as we continually assess the best way to provide for our insurance needs now and in the future. Due to the recent decline in interest rates and lower expectations of the long-term rate of return on our pension assets, the annual cost of our pension plans is likely to increase in the near term. Our current estimate of total pension expense for fiscal 2004 amounts to approximately $3.0 million (vs. $1.7 million in 2003). This change is primarily due to the decrease in discount rates in the US and Japan and the decrease in the expected long-term rate of return on assets in the US. See Note 6 in "Notes to Consolidated Financial Statements" for actuarial assumptions and additional information. MARKET RISK DISCLOSURES The overall objective of our financial risk management program is to seek a reduction in the potential negative earnings effects from changes in foreign exchange and interest rates arising from business activities. We manage these financial exposures through operational means and by utilizing available financial instruments. Practices may change as economic conditions change. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS Below is a table detailing, by maturity date, our contractual obligations and commercial commitments as of October 31, 2003 (amounts in thousands):
OBLIGATIONS AND COMMITMENTS 2004 2005 2006 2007 2008 Thereafter ---- ---- ---- ---- ---- ---------- Bank loans $14,098 $ -- $ -- $ -- $ -- $ -- Long-term debt 849 143 151 76 10 21 Operating leases 2,895 2,487 2,241 2,011 1,613 -- ----------------------------------------------------------- Total $17,842 $ 2,630 $ 2,392 $ 2,087 $ 1,623 $ 21 ===========================================================
17 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, 2003 and 2002, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended October 31, 2003. 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, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended October 31, 2003 in conformity with accounting principles generally accepted in the United States. As discussed in Note 1 to the financial statements, effective November 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." Hartford, Connecticut /s/ ERNST & YOUNG LLP December 11, 2003 18 CONSOLIDATED STATEMENTS OF INCOME (in thousands, except share and per-share amounts)
Year Ended October 31, 2003 2002 2001 ------------------------------------------------ Net sales $ 288,231 $ 258,201 $ 244,449 Operating expenses: Cost of products sold 157,221 142,450 136,069 Selling, general and administrative 75,808 66,204 62,924 Research, development and engineering 14,977 14,662 13,729 Goodwill amortization - - 1,316 - -------------------------------------------------------------------------------------------------- 248,006 223,316 214,038 - -------------------------------------------------------------------------------------------------- Operating income 40,225 34,885 30,411 Non-operating income (expense): Interest expense (540) (417) (545) Other income 462 302 931 - -------------------------------------------------------------------------------------------------- (78) (115) 386 - -------------------------------------------------------------------------------------------------- Income before income taxes 40,147 34,770 30,797 Income tax expense 13,351 11,814 10,784 - -------------------------------------------------------------------------------------------------- Net income $ 26,796 $ 22,956 $ 20,013 ================================================================================================== Basic earnings per common share $ 1.61 $ 1.39 $ 1.23 Diluted earnings per common share $ 1.58 $ 1.36 $ 1.20 Basic shares outstanding 16,661,101 16,477,637 16,308,563 Diluted shares outstanding 16,987,792 16,884,585 16,689,934 ==================================================================================================
See accompanying Notes. 19 CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts)
October 31, 2003 2002 ------------ ------------ ASSETS Current assets Cash and cash equivalents $ 57,603 $ 40,872 Accounts receivable (less allowances for doubtful accounts of $1,705 and $1,406, respectively) 59,658 50,862 Inventories 31,058 26,173 Deferred income taxes 9,020 7,998 Prepaid expenses and other current assets 4,306 4,233 - ------------------------------------------------------------------------------------------------ Total current assets 161,645 130,138 Noncurrent assets Deferred income taxes 1,340 1,482 Goodwill, net 28,489 26,995 Prepaid pension costs 7,923 - Other noncurrent assets 3,551 3,505 Property, plant and equipment, net 85,060 74,759 - ------------------------------------------------------------------------------------------------ Total assets $ 288,008 $ 236,879 - ------------------------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Current portion of long-term debt $ 849 $ 714 Short term bank loans 14,098 16,374 Accounts payable 18,556 16,256 Accrued payroll and related taxes 15,665 13,633 Other accrued expenses 12,234 10,093 Accrued income taxes 2,558 497 - ------------------------------------------------------------------------------------------------ Total current liabilities 63,960 57,567 Noncurrent liabilities Long-term debt, less current portion 401 2,030 Deferred income taxes 9,862 5,924 Accrued pension liability 5,457 8,945 - ------------------------------------------------------------------------------------------------ Total noncurrent liabilities 15,720 16,899 Commitments and contingencies (Note 12) 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; 16,863,482 and 16,566,625 shares issued and outstanding 17 17 Treasury Stock, at cost (2,747 shares) (57) (57) Additional paid-in-capital 53,787 46,375 Unearned compensation (784) (551) Accumulated other comprehensive income (loss): Foreign currency translation adjustments 3,282 (5,533) Fair value of derivative financial instruments, net 13 (8) Minimum pension liability, net (2,049) (5,153) - ------------------------------------------------------------------------------------------------ Total accumulated other comprehensive income (loss) 1,246 (10,694) Retained earnings 154,119 127,323 - ------------------------------------------------------------------------------------------------ Total stockholders' equity 208,328 162,413 - ------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $ 288,008 $ 236,879 ================================================================================================
See accompanying Notes. 20 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
Accumulated Additional Other Com- Total Stock- Common Treasury Paid-in Unearned prehensive Retained holders' Stock Stock Capital Compensation Income(Loss) Earnings Equity - ---------------------------------------------------------------------------------------------------------------------------------- Balance at October 31, 2000 $ 16 $ - $ 39,814 $ (1,120) $ (3,546) $ 54,354 $ 119,518 - ---------------------------------------------------------------------------------------------------------------------------------- Net income 20,013 20,013 Other comprehensive income- Foreign currency translation adjustments (1,678) (1,678) Change in fair value of derivative financial instruments, net of deferred income taxes of $50 94 94 Minimum pension liability adjustment, net of income taxes of $418 (670) (670) ----------- Comprehensive income 17,759 Amortization of unearned compensation 727 727 Shares awarded under employee stock plans 1,532 (564) 968 Shares issued to employee benefit plans 632 632 Stock options exercised 496 496 Purchase of Treasury Stock (57) (57) Tax benefit on stock-based compensation 128 128 - --------------------------------------------------------------------------------------------------------------------------------- Balance at October 31, 2001 16 (57) 42,602 (957) (5,800) 104,367 140,171 - --------------------------------------------------------------------------------------------------------------------------------- Net income 22,956 22,956 Other comprehensive income- Foreign currency translation adjustments (309) (309) Change in fair value of derivative financial instruments, net of deferred income taxes of $36 49 49 Loss related to derivative financial instruments reclassified into earnings from other comprehensive income, net of $109 tax benefit (151) (151) Minimum pension liability adjustment, net of income taxes of $2,761 Comprehensive income (4,483) (4,483) ----------- 18,062 Amortization of unearned compensation 648 648 Shares awarded under employee stock plans, net 519 (242) 277 Shares issued to employee benefit plans 717 717 Stock options exercised 1 1,664 1,665 Tax benefit on stock-based compensation 873 873 - --------------------------------------------------------------------------------------------------------------------------------- Balance at October 31, 2002 17 (57) 46,375 (551) (10,694) 127,323 162,413 - --------------------------------------------------------------------------------------------------------------------------------- Net income 26,796 26,796 Other comprehensive income- - Foreign currency translation adjustments 8,815 8,815 Change in fair value of derivative financial instruments, net of deferred income taxes of $56 77 77 Loss related to derivative financial instruments reclassified into earnings from other comprehensive income, net of deferred taxes of $40 (56) (56) Minimum pension liability adjustment, net of income taxes of $1,834 3,104 3,104 ----------- Comprehensive income 38,736 Amortization of unearned compensation 361 361 Shares awarded under employee stock plans, net 1,255 (594) 661 Shares issued to employee benefit plans 1,407 1,407 Stock options exercised 2,821 2,821 Tax benefit on stock-based compensation 1929 1,929 - --------------------------------------------------------------------------------------------------------------------------------- Balance at October 31, 2003 $ 17 $ (57) $ 53,787 $ (784) $ 1,246 $154,119 $ 208,328 =================================================================================================================================
See accompanying Notes. 21 CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Year Ended October 31, 2003 2002 2001 ---------- ---------- ---------- OPERATING ACTIVITIES Net income $ 26,796 $ 22,956 $ 20,013 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 9,769 8,266 9,052 Noncash compensation recognized under employee stock plans 554 840 921 Gain on sales of property, plant and equipment (13) (1) (59) Pension costs less than funding (6,252) (4,435) (347) Deferred income taxes 1,599 3,805 (792) Changes in Operating assets and liabilities, net of acquisitions: Accounts receivable (4,615) (2,031) 2,890 Inventories (1,845) (2,250) (1,654) Accounts payable and accrued expenses 287 546 90 Accrued income taxes 4,898 3,670 (474) Prepaid expenses and other 3,756 (2,246) (1,696) - ---------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 34,934 29,120 27,944 INVESTING ACTIVITIES Proceeds from sales of property, plant and equipment 41 129 104 Acquisition of companies, net of cash acquired (149) (700) (4,489) Capital expenditures (16,318) (17,600) (11,028) Other, net (466) - - - ---------------------------------------------------------------------------------------------------------------------------- Net cash used for investing activities (16,892) (18,171) (15,413) FINANCING ACTIVITIES Principal payments on long-term debt (2,069) (929) (969) Net borrowings (repayments) under short-term bank loans (3,466) 3,271 363 Acquisition of Treasury Stock - - (57) Proceeds from stock options exercised 2,821 1,664 496 - ---------------------------------------------------------------------------------------------------------------------------- Net cash (used for) provided by financing activities (2,714) 4,006 (167) Effect of exchange rate changes on cash and cash equivalents 1,403 289 (550) - ---------------------------------------------------------------------------------------------------------------------------- Net change in cash and cash equivalents 16,731 15,244 11,814 Cash and cash equivalents at beginning of year 40,872 25,628 13,814 - ---------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 57,603 $ 40,872 $ 25,628 - ---------------------------------------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURES Cash paid for: Interest $ 306 $ 403 $ 572 Income taxes $ 8,016 $ 10,371 $ 12,261 ============================================================================================================================
See accompanying Notes. 22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CUNO INCORPORATED (in thousands, except share and per-share amounts) NOTE I - ORGANIZATION AND ACCOUNTING POLICIES ORGANIZATION: 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. CONSOLIDATION: The accounts of CUNO and all of its subsidiaries are included in the consolidated financial statements. All significant intercompany accounts and transactions are eliminated in consolidation. We do not have any special purpose entities (SPE's), variable interest entities (VIE's) or joint venture arrangements. CASH AND CASH EQUIVALENTS: We consider 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. CONCENTRATIONS OF CREDIT RISK: Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents and trade accounts receivable. We invest our cash and cash equivalents in high-quality financial institutions and instruments. Concentrations of credit risk with respect to trade accounts receivable are limited by the large number of customers comprising our customer base and their distribution across many different industries and geographies. Foreign sales were approximately 45 percent of the Company's net sales in 2003, 47 percent in 2002 and 47 percent in 2001 and are concentrated primarily in Europe, Latin America, Japan, Australia, Asia, and China. For the year ended October 31, 2003, one customer accounted for 14.3 percent of total net sales and 15.4 percent of total net receivables. Our 2003 sales within Japan amounted to $34,617 and approximately 35 percent of those sales were derived from five distributors. We continually monitor the status of the receivable balances, including reviewing the financial condition of the ultimate end customer, as a means to help mitigate potential collection risk. As of October 31, 2003 we had no other significant concentrations of credit risk. RECOGNITION OF REVENUE AND ACCOUNTS RECEIVABLE: We recognize revenue and accounts receivable in accordance with SEC Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 requires that four basic criteria be met before revenue can be recognized: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is reasonably assured. We recognize revenue upon determination that all criteria for revenue recognition have been met, which, based on our shipping terms, is considered to have occurred upon shipment of the finished product. Shipping and handling costs associated with sales are charged to cost of sales. Credit is extended to customers based on an evaluation of each customer's financial condition; generally, collateral is not required. Revenues are presented in the consolidated financial statements net of sales allowances and discounts. Accounts receivable are presented in the consolidated financial statements net of the allowance for doubtful accounts. ALLOWANCE FOR DOUBTFUL ACCOUNTS: 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 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. 23 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) and average cost methods. Approximately 43 and 52 percent of worldwide inventories in 2003 and 2002, respectively, are accounted for using the LIFO method. Inventories as of October 31 consisted of the following:
2003 2002 ---- ---- Raw materials $ 13,112 $ 11,701 Work in process 3,992 3,112 Finished goods 13,954 11,360 - ------------------------------------------------- $ 31,058 $ 26,173 =================================================
If all inventories were valued by the FIFO method, inventories would have been $2,665 higher in 2003 and $2,699 higher in 2002. GOODWILL AND OTHER INTANGIBLE ASSETS: Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired companies. Goodwill was historically amortized on a straight-line basis over periods not exceeding 25 years. Effective November 1, 2001, we adopted the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," (FAS 142) which require that goodwill and certain other intangible assets with indefinite lives recorded as a result of business combinations completed after June 30, 2001 not be amortized. Effective July 1, 2001, additional provisions of FAS 142, which require that goodwill recorded from business combinations completed on or before June 30, 2001 and certain other intangible assets deemed to have indefinite lives no longer be amortized, were adopted by the Company. Goodwill and other intangible assets with indefinite lives are subject to annual impairment tests. Additionally, effective July 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards No. 141, "Business Combinations," which require purchase accounting for all business combinations completed after June 30, 2001. See Note 4 for additional information regarding goodwill and other intangible assets. PROPERTY, PLANT, AND EQUIPMENT: Property, plant and equipment are recorded at cost. Buildings and equipment are depreciated using the straight-line method over their estimated useful lives, ranging from 10 to 40 years for buildings and 3 to 20 years for machinery and equipment. All repair and maintenance costs are expensed as incurred. IMPAIRMENT OF AMORTIZABLE INTANGIBLE ASSETS AND LONG-LIVED ASSETS: We review the carrying values of amortizable intangible assets and long-lived assets on an annual basis. In addition, in the event that facts and circumstances indicate that the carrying value of such intangibles and long-lived assets or other assets may be impaired during 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. In 2003, we recorded diminimus losses on capitalized patent costs for patents we decided to no longer maintain. INCOME TAXES: We use 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 possible 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 U.S. in the near term. Upon distribution of those earnings in the form of dividends or otherwise, we 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. For those foreign locations where dividends are not planned or anticipated, determination of the amount of any unrecognized deferred U.S. income tax liability is not practicable because of the complexities associated with its hypothetical calculation. 24 TRANSLATION OF FOREIGN CURRENCIES: For most international operations, local currencies are considered their functional 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 exchange rate at the balance sheet date. Resulting translation adjustments are recorded as a separate component of accumulated other comprehensive income. DERIVATIVE INSTRUMENTS: We account for derivative instruments under Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," (FAS 133) as amended. FAS 133 established accounting and reporting standards for derivative instruments and hedging activities and requires the Company to recognize these instruments as either assets or liabilities on the balance sheet and measure them at fair value. 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 $7,254, $7,409, and $7,343 for the year ended October 31, 2003, 2002 and 2001, respectively. During the year ended October 31, 2003, we received approximately $500 in cost reimbursements from various customers, which were accounted for as a reduction of research and development expenses. ADVERTISING: Advertising costs are expensed as incurred and included in selling, general and administrative expenses. Advertising expenses were $3,528, $3,104, and $2,774, for the years ended October 31, 2003, 2002, and 2001, respectively. EMPLOYEE STOCK OPTIONS: 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 option-based employee compensation cost 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 share grants awarded to employees are included in earnings as an expense over the vesting period of the award. The following table illustrates the effect on net income and earnings per share had compensation cost been recognized based on the fair value of the options at the grant dates for awards under those plans consistent with Statement of Financial Accounting Standards No 123, "Accounting for Stock-Based Compensation," using the Black-Scholes fair value method for option pricing.
For the Year Ended October 31, 2003 2002 2001 ---- ---- ---- Net income, as reported $ 26,796 $ 22,956 $ 20,013 Add: Stock-based compensation expense included in reported net income, net of income taxes 360 546 599 Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of income taxes 2,168 2,208 1,790 -------- -------- -------- Pro forma net income $ 24,988 $ 21,294 $ 18,822 ============================== Earnings per share: Basic - as reported $ 1.61 $ 1.39 $ 1.23 Basic - pro forma $ 1.50 $ 1.29 $ 1.15 Diluted - as reported $ 1.58 $ 1.36 $ 1.20 Diluted - pro forma $ 1.47 $ 1.26 $ 1.13
25 OTHER INCOME: Other income as reported in the accompanying Consolidated Statements of Income for the years ended October 31 consisted of the following:
2003 2002 2001 ----- ----- ----- Interest income $ 603 $ 603 $ 944 Exchange (losses) gains (137) (123) 46 Gains on sales of property, plant and equipment 13 1 59 Other expenses (17) (179) (118) --------------------------- Total $ 462 $ 302 $ 931 ===========================
EARNINGS PER SHARE: The following table sets forth the computation of basic and diluted earnings per share for the years ended October 31:
2003 2002 2001 ---- ---- ---- NUMERATOR: Net income $ 26,796 $ 22,956 $ 20,013 ------------------------------------------------ DENOMINATORS: Weighted average shares outstanding 16,692,468 16,511,616 16,367,826 Issued but unearned performance shares -- -- (762) Issued but unearned restricted shares (31,367) (33,979) (58,501) ------------------------------------------------ Denominator for basic earnings per share 16,661,101 16,477,637 16,308,563 ------------------------------------------------ Weighted average shares outstanding 16,692,468 16,511,616 16,367,826 Effect of dilutive employee stock options 295,324 372,969 322,108 ------------------------------------------------ Denominator for diluted earnings per share 16,987,792 16,884,585 16,689,934 ------------------------------------------------ Basic earnings per share 1.61 $ 1.39 $ 1.23 Diluted earnings per share 1.58 $ 1.36 $ 1.20 ================================================
FOREIGN CURRENCY RISK AND DERIVATIVES: A significant portion of revenues, earnings and net investments in foreign affiliates are exposed to changes in foreign currency exchange rates. We seek to manage our foreign exchange risk in part through operational means, including managing expected local currency revenues in relation to local currency costs and local currency assets in relation to local currency liabilities. Foreign exchange risk is also managed through the use of derivative financial instruments and foreign currency denominated debt. These financial instruments serve to protect net income against the impact of the translation into U.S. dollars of certain foreign exchange denominated transactions. We utilize 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. We recognize all derivative financial instruments, such as foreign exchange contracts, in the consolidated financial statements, at fair value, regardless of the purpose or intent for holding the instrument. Changes in the fair value of derivative financial instruments are either recognized periodically in income or in shareholders' equity as a component of accumulated other comprehensive income depending on whether the derivative financial instrument qualifies for hedge accounting, and if so, whether it qualifies as a fair value hedge or cash flow hedge. Generally, changes in fair values of derivatives accounted for as fair value hedges are recorded in income along with the portions of the changes in the fair values of the hedged items that relate to the hedged risk(s). Changes in fair values of derivatives accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in other comprehensive income net of deferred income taxes. There were no ineffective hedges for any of the years presented. Changes in fair values of derivatives not qualifying as hedges are reported in income. 26 USES OF ESTIMATES: The preparation of the accompanying financial statements in conformity with accounting principles generally accepted in the United States requires us 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. Estimates are used when accounting for depreciation, amortization, employee benefits, contingencies, and asset valuation allowances. NEWLY ISSUED ACCOUNTING STANDARDS: In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123" (FAS 148). This statement amends SFAS No. 123 "Accounting for Stock Based Compensation" (FAS 123) to provide alternative methods of voluntarily transitioning to the fair value based method of accounting for stock-based employee compensation. FAS 148 also amends the disclosure requirements of FAS 123 to require disclosure of the method used to account for stock-based employee compensation and the effect of the method on reported results in both annual and interim financial statements. We adopted the disclosure provisions of this Statement beginning with the quarter ended April 30, 2003. RECLASSIFICATIONS: Certain reclassifications have been made to the prior year amounts to conform to the current year presentation. NOTE 2 - PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment as of October 31 is comprised of the following:
2003 2002 ---- ---- Land and land improvements $ 6,452 $ 6,056 Buildings 39,331 35,028 Machinery and equipment 111,774 92,744 Construction in progress 15,964 16,682 --------------------- 173,521 150,510 Less accumulated depreciation 88,461 75,751 --------------------- $ 85,060 $ 74,759 =====================
Depreciation expense was $9,591 in 2003, $7,945 in 2002, and $7,898 in 2001. NOTE 3 - DEBT Long-term debt amounted to $1,250 and $2,744 at October 31, 2003 and 2002, respectively, and 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, 2003 are: 2004 - $849; 2005 - $143; 2006 - $151; 2007 - $76; 2008 - $10 and thereafter - $21. Outstanding short-term bank loans at October 31, 2003 and 2002 of $14,098 and $16,374, respectively, had weighted average interest rates of 0.8 percent and 2.04 percent, respectively. The bank loans and 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. We had available uncommitted, unused short-term lines of credit in various countries totaling $24,287 at October 31, 2003. Because these lines of credit are uncommitted, borrowings under the unused short-term lines of credit are subject to the bank's approval. 27 NOTE 4 - GOODWILL AND INTANGIBLE ASSETS Effective November 1,2001, we discontinued the amortization of goodwill in accordance with FAS 142. The following table presents reported results adjusted to exclude amounts no longer amortized.
For the Years Ended October 31, 2003 2002 2001 ---- ---- ---- Net income - as reported $26,796 $22,956 $20,013 Goodwill amortization - - 1,316 Tax effect of deductible goodwill - - (56) Adjusted net income $26,796 $22,956 $21,273 ------------------------------- Basic earning per share: Net income, as reported $ 1.61 $ 1.39 $ 1.23 Goodwill amortization, net of tax - - 0.07 Adjusted net income $ 1.61 $ 1.39 $ 1.30 ------------------------------- Diluted earnings per share: Net income, as reported $ 1.58 $ 1.36 $ 1.20 Goodwill amortization, net of tax - - 0.07 Adjusted net income $ 1.58 $ 1.36 $ 1.27
Goodwill was $28,489 and $26,995 as of October 31, 2003 and 2002, respectively, net of accumulated amortization of $9,105 for both years. As of October 31, 2003 and 2002, goodwill was allocated to the reported operating segments as follows:
2003 2002 ---- ---- North America $18,018 $18,018 Europe 7,676 6,402 Japan 973 973 Asia/ Pacific 1,507 1,297 Latin America 315 305 --------------------- Total: $28,489 $26,995 =====================
The change in the goodwill balance at October 31, 2003 as compared to October 31, 2002 is due to $391 of additional goodwill in Europe as a result of the acquisition of a small distributor and $1,103 resulting from changes in foreign exchange rates. There were no impairments or dispositions of goodwill recorded during the years ended October 31, 2003 and 2002. Other intangible assets, which are included in "Other noncurrent assets" in the consolidated balance sheet, consist primarily of patents and trademarks, non-compete agreements and customer lists, and amounted to $2,075 and $1,763 at October 31, 2003 and 2002, respectively, net of accumulated amortization of $25,143 and $24,937, respectively. Amortization of intangible assets was insignificant for the years ended October 31, 2003, 2002, and 2001. The following table presents estimated amortization expense for each of the next five years, assuming current exchange rates:
2004 2005 2006 2007 2008 ---- ---- ---- ---- ---- Estimated amortization expense $227 $220 $208 $175 $155
28 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 we 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 We have 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 percent 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 - BENEFIT PLANS We have noncontributory defined benefit plans for most of our 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. We also have contributory defined benefit pension plans covering our employees in Japan. Benefits under these plans are based on years of service and compensation in the period immediately preceding retirement. Funding is predicated on minimum contributions as required by local laws and regulations plus additional amounts, if any, as may be deemed appropriate. 29 The following table sets forth the funded status and amounts recognized in the Consolidated Balance Sheets at October 31,2003 and 2002 for our U.S. and Japanese defined benefit pension plans:
2003 2002 ---- ---- Projected benefit obligation $(49,513) $(41,118) ----------------------------- Market value of plan assets $ 39,687 $ 27,776 ----------------------------- Projected benefit obligation in excess of plan assets $ (9,826) $(13,342) Unrecognized net loss 15,802 13,270 Unrecognized prior service cost 286 414 Unrecognized transition obligation 84 147 Additional minimum liability (3,880) (9,434) ----------------------------- Net pension asset /(liability) $ 2,466 $ (8,945) =============================
Amounts recognized in the Consolidated Balance Sheet consist of:
2003 2002 ---- ---- Prepaid pension costs $ 7,923 - Accrued pension liability (5,457) (8,945) -------- -------- Net pension asset / (liability) $ 2,466 $ (8,945) ======== ========
The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for the pension plans with accumulated benefit obligation in excess of plan assets and a minimum pension liability were $19,388, $18,231 and $14,835, respectively, as of October 31,2003, and $39,312, $35,098 and $27,776, respectively, as of October 31, 2002. Plan assets at October 31, 2003 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 $1,996 (50,000 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:
2003 2002 2001 ---- ---- ---- DEFINED BENEFIT PLANS: Service cost $ 2,174 $ 2,035 $1,794 Interest cost 2,342 2,124 1,947 Expected return on plan assets (3,539) (1,350) (1,750) Amortization of; Prior service costs 128 158 199 Net transition asset 72 68 71 Actuarial losses (gains) 560 (1,450) (917) ------------------------------------------------- Net pension expense $ 1,737 $ 1,585 $1,344 =================================================
30 A summary of the changes in the projected benefit obligation is shown below:
2003 2002 ---- ---- Benefit obligation - beginning of year $ 41,118 $ 38,806 Service cost 2,174 2,035 Interest cost 2,342 2,124 Benefits and expenses paid (2,038) (1,959) Actuarial assumption changes 4,566 78 Foreign currency exchange rate changes 1,351 34 --------------------------------- Benefit obligation - end of year $ 49,513 $ 41,118 =================================
A summary of the changes in Plan assets is shown below:
2003 2002 ---- ---- Plan assets - beginning of year $ 27,776 $ 27,009 Actual return on assets 5,575 (3,088) Employer contributions 7,609 5,839 Benefits and expenses paid (2,038) (1,959) Foreign currency exchange rate changes 765 (25) -------------------------------- Plan assets - end of year $ 39,687 $ 27,776 ================================
We made an incremental $6,000 contribution to our U.S. pension plans in the first quarter of 2003 to bolster the funding and earnings capabilities of the Plans. In addition, in November 2002 we made an incremental contribution of $4,000 to our pension Plans. 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. Our measurement date for determining the pension liability is September 30 of each fiscal year. Assumptions used in the accounting for the defined benefit plans during the fiscal years ended October 31,2003 and 2002 were;
2003 2002 ---- ---- DOMESTIC PLANS Weighted-average discount rate 6.20% 7.00% Rates of increase in compensation levels 4.00% 4.00% Expected long-term rate of return on assets 8.75% 9.25% FOREIGN PLAN (JAPAN) Weighted-average discount rate 2.00% 2.50% Rates of increase in compensation levels 2.25% 2.25% Expected long-term rate of return on assets 4.75% 4.75%
Due to assumptions inherent in the actuarial computations, it is reasonably possible that future actual expenses will differ from current actuarial estimates. We sponsor a defined contribution plan that provides all U.S. employees of the Company an opportunity to accumulate funds for their retirement. We currently match 50 percent of employee contributions up to 6 percent of qualified wages. Company matching contributions charged to income amounted to $887, $799 and $678 for the years ended October 31, 2003, 2002 and 2001, respectively. Company matching contributions are made quarterly in shares of the Company's Common Stock. 31 NOTE 7 - INCOME TAXES The components of income before income taxes and the provision for income taxes are summarized as follows:
2003 2002 2001 ---- ---- ---- Income before income taxes Domestic $ 28,848 $ 26,132 $ 22,109 Foreign 11,299 8,638 8,688 - -------------------------------------------------------------------- 40,147 34,770 30,797 Income taxes (benefit) Current Domestic - Federal 6,735 4,438 7,159 - State and local 592 197 915 Foreign 4,909 4,254 3,767 Operating loss carryforwards - - (265) - -------------------------------------------------------------------- 12,236 8,889 11,576 Deferred Domestic - Federal 1,238 3,338 (645) - State and local 47 344 (147) Foreign (170) (757) _ - -------------------------------------------------------------------- 1,115 2,925 (792) - -------------------------------------------------------------------- Income tax expense 13,351 11,814 10,784 - -------------------------------------------------------------------- Net Income Domestic 20,236 17,815 14,827 Foreign 6,560 5,141 5,186 - -------------------------------------------------------------------- $ 26,796 $ 22,956 $ 20,013 ====================================================================
A reconciliation of the statutory U.S. federal rate to the effective income tax rate follows:
2003 2002 2001 ---- ---- ---- Statutory U.S. federal income tax rate 35.00% 35.00% 35.00% State and local taxes on income, net of domestic federal income tax benefit 1.03 1.60 1.60 Impact of foreign subsidiaries on effective rate (0.16) (0.50) 1.00 Benefit of operating loss carryforwards - - (0.90) Tax credits (0.87) (0.80) (2.30) Prior year tax provision adjustments (1.39) (1.50) (0.20) Goodwill amortization with no tax benefit - - 1.00 Other (0.35) 0.20 (0.20) - ---------------------------------------------------------------------- Effective income tax rate 33.26% 34.00% 35.00% ======================================================================
32 Significant components of our deferred income tax liabilities and assets as of October 31 are as follows (in thousands):
2003 2002 ---- ---- Deferred income tax liabilities: Property, plant and equipment $ 7,958 $ 6,067 Pension liability 750 - ----------------- Total deferred income tax liabilities 8,708 6,067 Deferred income tax assets: Pension liability - 1,297 Employee benefits 3,504 2,983 Net operating loss carryforwards 1,676 1,465 Other accruals 3,127 2,886 Inventories 1,566 1,409 Other 1,009 1,048 - ------------------------------------------------------------------------- Total deferred income tax assets 10,882 11,088 Less: valuation allowance for deferred income tax assets 1,676 1,465 - ------------------------------------------------------------------------- Deferred income tax assets, after valuation allowance 9,206 9,623 - ------------------------------------------------------------------------- Net deferred income tax assets $ 498 $ 3,556 =========================================================================
The increase in the valuation allowance during fiscal 2003 relates to additional net operating loss carryforwards generated in China, Sweden, Germany, and Ireland. Although realization of the net deferred income tax asset of $9,206 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 valuation allowance for deferred income tax assets as of October 31, 2001 was $116. A summary of our net operating loss carryforwards, calculated using tax laws existing at October 31, 2003, follows:
AMOUNT COUNTRY EXPIRATION - ------ ------- ---------- $ 383 Germany Indefinite 707 China 2007-2008 414 Argentina 2007 93 United Kingdom Indefinite 5 Sweden Indefinite 74 Ireland Indefinite - ------ $1,676 - ------
NOTE 8-ACQUISITIONS In fiscal 2002, we completed a product line acquisition in Australia and a distributor acquisition in Europe for total consideration of $700. The amount of goodwill and other intangibles recorded in connection with these acquisitions amounted to $250 and $244, respectively. In the second quarter of fiscal 2001, we completed two acquisitions - a product line in Australia and a distributor in Europe - for a total cost of $4,500. The amount of goodwill recorded in connection with these acquisitions amounted to $4,300. None of these acquisitions had a material effect on the Company's historical financial statements or its pro forma operating results. NOTE 9 - SEGMENT FINANCIAL DATA For management reporting and control, the Company is divided into five geographic operating segments as presented below. Each segment has general autonomy over its business and local operations. 33 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:
2003 2002 2001 ---- ---- ---- NET SALES: Europe $ 62,267 $ 50,845 $ 42,337 Japan 35,102 30,950 34,807 Asia/Pacific 36,843 28,861 25,427 Latin America 11,496 11,629 12,406 ----------------------------------- Subtotal - Foreign Sales 145,708 122,285 114,977 North America 183,308 172,432 160,824 Elimination of intercompany sales (40,785) (36,516) (31,352) - ----------------------------------------------------------------------- Consolidated $ 288,231 $ 258,201 $ 244,449 =======================================================================
Each geographic operating segment primarily sells its products to external customers within its country of domicile. All of our operating segments sell the same types of products within our three principle markets. One of our customers accounted for approximately 14.3 percent of fiscal 2003 sales and 13.2 percent of fiscal 2002 sales. We believe that no other customer accounts for more than five percent of sales.
2003 2002 2001 ---- ---- ---- OPERATING INCOME: North America $25,206 $23,032 $19,032 Europe 5,335 3,523 2,465 Japan 3,354 2,365 3,380 Asia/Pacific 5,289 4,053 3,543 Latin America 1,041 1,912 1,991 - ------------------------------------------------------------------------------------------------ Segment total 40,225 34,885 30,411 - ------------------------------------------------------------------------------------------------ Interest expense (540) (417) (545) Other income, net 462 302 931 - ------------------------------------------------------------------------------------------------ Income before income taxes $40,147 $34,770 $30,797 ================================================================================================
Segment operating income consists of net sales less operating expenses. Interest expense and other income, net have not been allocated to segments.
2003 2002 2001 ---- ---- ---- ASSETS: North America $ 197,374 $ 154,132 $ 143,902 Europe 46,643 35,226 30,236 Japan 30,788 28,043 27,868 Asia/Pacific 20,531 15,368 12,601 Latin America 11,702 7,679 6,441 General Corporate 57,604 40,872 25,628 Eliminations and other (76,634) (44,441) (40,633) - ------------------------------------------------------------ Consolidated $ 288,008 $ 236,879 $ 206,043 ============================================================
General corporate assets (principally cash) are not allocated to segments. 34 Eliminations and other is primarily comprised of intercompany receivables and investments in subsidiaries, both of which are eliminated in our consolidated financial statements.
2003 2002 2001 ---- ---- ---- CAPITAL EXPENDITURES: North America $10,999 $12,752 $ 7,842 Europe 2,311 840 754 Japan 264 576 812 Asia/Pacific 933 864 975 Latin America 1,811 2,568 645 - --------------------------------------------------- Consolidated $l6,318 $17,600 $11,028 ===================================================
2003 2002 2001 ---- ---- ---- DEPRECIATION AND AMORTIZATION: North America $7,120 $6,337 $6,878 Europe 976 690 894 Japan 605 521 541 Asia/Pacific 731 543 428 Latin America 337 175 311 - --------------------------------------------------------- Consolidated $9,769 $8,266 $9,052 =========================================================
We sell our products in 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. Our sales by market are summarized for each of the years ended October 31:
2003 2002 2001 ---- ---- ---- NET SALES: Potable Water $132,938 $119,456 $107,263 Fluid Processing 74,626 68,714 71,898 Healthcare 80,667 70,031 65,288 - --------------------------------------------------------------- Consolidated $288,231 $258,201 $244,449 ===============================================================
NOTE 10 - STOCK OPTIONS AND AWARDS We have a stock option and award plan which allows for granting a number of stock incentive instruments, including non-qualified 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, as amended, permits the granting of such stock awards of up to 3,200,000 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 990,000 shares of Common Stock are reserved for issuance to employees and non-employee directors under the provisions of these option and award plans as of October 31,2003. Awards of restricted shares totaled 16,250, 7,250, and 20,219 in the years ended October 31, 2003, 2002, and 2001, respectively. The weighted average price of the awards was $36.56, $33.36, and $17.88 for the years ended October 31, 2003, 2002, and 2001, 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. 35 A summary of stock option activity follows:
OPTIONS EXERCISE PRICE ------- -------------- Outstanding at October 31, 2000 849,758 7.94 - 30.06 - -------------------------------------------------------------- OPTIONS GRANTED 204,410 25.05 - 30.00 OPTIONS EXERCISED (34,722) 14.13 - 21.50 OPTIONS FORFEITED (11,250) 14.13 - 27.88 - -------------------------------------------------------------- Outstanding at October 31, 2001 1,008,196 7.94 - 30.06 - -------------------------------------------------------------- OPTIONS GRANTED 221,253 29.15 - 37.19 OPTIONS EXERCISED (162,725) 14.13 - 21.50 OPTIONS FORFEITED (13,750) 14.13 - 29.15 - -------------------------------------------------------------- Outstanding at October 31, 2002 1,052,974 7.94 - 37.19 - -------------------------------------------------------------- OPTIONS GRANTED 225,750 33.00 - 37.90 OPTIONS EXERCISED (221,411) 7.94 - 27.88 OPTIONS FORFEITED (500) 20.38 - -------------------------------------------------------------- Outstanding at October 31, 2003 1,056,813 14.13 - 37.90 ==============================================================
The weighted-average grant-date fair value of options granted was S11.07, $14.60 and $ 12.93 in the years ended October 31, 2003, 2002, and 2001, 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 - $15 74,450 4.90 $ 14.19 74,450 $ 14.19 15 - 20 317,950 5.80 18.30 317,950 18.30 20 - 25 5,000 4.40 21.50 5,000 21.50 25 - 30 390,413 7.50 28.44 119,580 27.87 30 - 35 209,500 9.00 33.06 750 30.06 35 - 40 59,500 9.20 37.05 10,000 37.19 --------- ------- 1,056,813 527,730
Pro forma information regarding net income and earnings per share is required by SFAS 123 (sec Note 1), which requires that the information be determined as if we had accounted for our employee stock options 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 weighted average assumptions:
2003 2002 2001 ---- ---- ---- Volatility 29.51% 49.99% 56.22% Risk-free interest rates 3.57% 4.24% 3.75% Expected option life 5 years 5 years 5 years Divided yield - - -
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. 36 NOTE 11 - FAIR VALUES OF FINANCIAL INSTRUMENTS We used the following methods and assumptions in estimating our 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 our borrowings under our 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 our incremental borrowing rates for similar types of borrowing arrangements. The fair value of our 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 our financial instruments follows (dollars in thousands):
OCTOBER 31, ------------ 2003 2002 ------------------------------------------------------ CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE -------------- ---------- -------------- ---------- Cash and cash equivalents $57,603 $57,603 $40,872 $40,872 Bank loans 14,098 14,098 16,374 16,374 Long-term debt 1,250 1,220 2,744 3,155
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: We utilize forward foreign exchange contracts to hedge specific or anticipated 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 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. At October 31,2003, we held forward foreign exchange contracts with notional amounts totaling $21,368 (of which $14,285 settled in November 2003 and related to planned intercompany transactions) and forward foreign exchange contracts designated as cash flow hedges with notional amounts totaling $6,600. The fair market value (gain or loss) on these contracts was not significant as of October 31, 2003. At October 31, 2002, we held forward foreign exchange contracts with notional amounts totaling $6,210 and forward foreign exchange contracts designated as cash flow hedges with notional amounts totaling $4,950. The fair market value (gain or loss) on these contracts was not significant as of October 31, 2002. At October 31, 2001, we held forward foreign exchange contracts with notional amounts totaling $6,081 and forward foreign exchange contracts designated as cash flow hedges with notional amounts totaling $4,050. The fair market value (gain or loss) on these contracts was not significant as of October 31, 2001. NOTE 12-CONTINGENCIES We are, from time to time, subject to various legal actions, governmental audits, and proceedings relating to various matters incidental to our 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 our consolidated financial position, cash flows or results of operations. We have certain lease agreements for various facilities and equipment. Rent expense under operating leases was approximately $1,729 in 2003, $2,220 in 2002, and $2,430 in 2001. Future minimum lease payments under noncancellable operating leases with an initial term of one year or more at October 31, 2003 were as follows: 2004 - $2,895; 2005 - $2,487; 2006 - $2,241; 2007 - $2,011; and 2008 -$1,613. 37 We maintain insurance coverage with such deductibles and self insurance as we believe adequate for our needs. Such coverage reflects market conditions (including cost and availability) existing at the time it is written and the relationship of insurance coverage to self insurance varies accordingly. As a result of recent external events, the cost of insurance has risen substantially and the availability of insurance has become more restrictive. We consider the impact of these changes as we continually assess the best way to provide for our insurance needs in the future. NOTE 13 - PRODUCT WARRANTY We warrant our products against defects in design, materials, and workmanship, generally for periods ranging from one to three years. A provision for estimated future costs related to these warranties is recorded on a monthly basis and is included in cost of goods sold. Activity related to the product warranty liability was as follows:
YEAR ENDED OCTOBER 31, 2003 2002 ---- ---- Balance at beginning of year $ 785 $ 612 Provision for warranty obligations 818 1,092 Settlements made (816) (921) Changes in foreign exchange rates 30 2 ---------------------- Balance at end of year $ 817 $ 785 ======================
NOTE 14 - QUARTERLY DATA (UNAUDITED) A summary of our quarterly data follows:
FIRST SECOND THIRD FOURTH TOTAL ----- ------ ----- ------ ----- 2003 Net sales $ 66,437 $ 69,305 $ 74,965 $ 77,524 $288,231 Gross profit 29,754 31,278 33,877 36,101 131,010 Net income 5,388 6,304 7,467 7,637 26,796 Basic earnings per share $ 0.33 $ 0.38 $ 0.45 $ 0.46 $ 1.61 Diluted earnings per shire $ 0.32 $ 0.37 $ 0.44 $ 0.44 $ 1.58 2002 Net sales $ 58,637 $ 63,116 $ 68,932 $ 67,516 $258,201 Gross profit 26,170 28,191 31,012 30,378 115,751 Net income 4,519 5,414 6,629 6,394 22,956 Basic earnings per share $ 0.28 $ 0.33 $ 0.40 $ 0.39 $ 1.39 Diluted earnings per share $ 0.27 $ 0.32 $ 0.39 $ 0.38 $ 1.36
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. 38 EX-21 5 y92549exv21.txt SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT Listed below, as of October 31, 2003, are the significant subsidiaries of the Company and their jurisdictions of organization. All of such subsidiaries are either directly or indirectly wholly owned by the Company. Other subsidiaries of the Company have been omitted because, considered in the aggregate, they would not constitute a significant subsidiary.
Jurisdiction of Name of Subsidiary Organization - ------------------ ------------ 100% Owned CUNO Europe S.A. France CUNO Pacific, Pty. Ltd. Australia CUNO Filtration Asia Pte. Ltd. Singapore CUNO K.K. Japan CUNO Latina Ltda Brazil CUNO SarL Italy CUNO GmbH Germany CUNO Ltd. United Kingdom CUNO Filtration System Shanghai Company China
EX-23 6 y92549exv23.txt CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of CUNO Incorporated ("CUNO") of our report dated December 11, 2003, included in the 2003 Annual Report to Shareholders of CUNO. Our audits also included the financial statement schedule of CUNO listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-39763) pertaining to the CUNO Incorporated 1996 Stock Incentive Plan, the CUNO Incorporated Non-Employee Directors' Stock Option Plan, and the CUNO Incorporated Savings and Retirement Plan and the registration statement (Form S-8 No. 333-54388) pertaining to the CUNO Incorporated 1996 Stock Incentive Plan and the CUNO Incorporated Non-employee Directors' Stock Option Plan of our report dated December 11, 2003, with respect to the consolidated financial statements incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedule included in this Annual Report (Form 10-K) of CUNO. /s/ Ernst & Young LLP Hartford, Connecticut December 17, 2003 EX-31.1 7 y92549exv31w1.txt SECTION 302 CERTIFICATION OF CEO EXHIBIT 31.1 CERTIFICATIONS I, Mark G. Kachur, certify that: 1. I have reviewed this annual report on Form 10-K of CUNO Incorporated; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) [Paragraph omitted in accordance with SEC transition instructions contained in SEC Release 31-47986] c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: December 18, 2003 /s/ Mark G. Kachur ----------------------------------- Mark G. Kachur Chairman, Chief Executive Officer (Principal Executive Officer) EX-31.2 8 y92549exv31w2.txt 302 CERTIFICATION OF CFO EXHIBIT 31.2 CERTIFICATIONS I, Frederick C. Flynn, certify that: 1. I have reviewed this annual report on Form 10-K of CUNO Incorporated; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) [Paragraph omitted in accordance with SEC transition instructions contained in SEC Release 31-47986] c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: December 18, 2003 /s/ Frederick C. Flynn, Jr. --------------------------- Frederick C. Flynn, Jr. Senior Vice President, Chief Financial Officer (Principal Executive Officer) EX-32.1 9 y92549exv32w1.txt 906 CERTIFICATION OF CEO EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SEC.1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of CUNO, Incorporated (the "Company") on Form 10-K for the period ended October 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Mark G. Kachur, Chairman and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. sec.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ MARK G. KACHUR - --------------------------------- Mark G. Kachur Chairman, Chief Executive Officer (Principal Executive Officer) Date: December 18, 2003 EX-32.2 10 y92549exv32w2.txt 906 CERTIFICATION OF CFO EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SEC.1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of CUNO, Incorporated (the "Company") on Form 10-K for the period ended October 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Frederick C. Flynn, Jr., Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. sec.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ FREDERICK C. FLYNN, JR - --------------------------- Frederick C. Flynn, Jr. Senior Vice President and Chief Financial Officer (Principal Accounting Officer) Date: December 18, 2003 -----END PRIVACY-ENHANCED MESSAGE-----