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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended July 2, 2005 or
¨ | Transition report pursuant to Section 13 or 15(d) of the Securities Act of 1934 |
For the transition period from to
Commission File Number 001-09781 (0-1052)
MILLIPORE CORPORATION
(Exact name of registrant as specified in its charter)
Massachusetts | 04-2170233 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) |
290 Concord Road, Billerica, MA | 01821 | |
(Address of principal executive offices) | (Zip Code) |
(978) 715-4321
(Registrant’s telephone number, including area code)
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 such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yesx No¨
As of July 22, 2005, there were 51,560,123 shares of the registrant’s Common Stock outstanding.
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INDEX TO FORM 10-Q
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In this Form 10-Q, unless the context otherwise requires, the terms “Millipore”, the “Company”, “we” or “us” shall mean Millipore Corporation and its subsidiaries.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
July 2, 2005 | December 31, 2004 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 167,080 | $ | 152,144 | ||||
Accounts receivable, net | 188,140 | 181,911 | ||||||
Inventories | 135,174 | 143,714 | ||||||
Deferred income taxes | 45,520 | 54,247 | ||||||
Other current assets | 10,511 | 8,840 | ||||||
Total current assets | 546,425 | 540,856 | ||||||
Property, plant and equipment, net | 342,417 | 351,004 | ||||||
Deferred income taxes | 96,521 | 85,197 | ||||||
Intangible assets, net | 18,218 | 19,584 | ||||||
Goodwill | 9,433 | 9,433 | ||||||
Other assets | 6,661 | 7,745 | ||||||
Total assets | $ | 1,019,675 | $ | 1,013,819 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 62,443 | $ | 66,970 | ||||
Accrued expenses | 94,030 | 88,407 | ||||||
Accrued income taxes payable | 9,038 | 7,633 | ||||||
Total current liabilities | 165,511 | 163,010 | ||||||
Deferred income taxes | 1,774 | 7,495 | ||||||
Long-term debt | 105,000 | 147,000 | ||||||
Other liabilities | 58,090 | 57,464 | ||||||
Total liabilities | 330,375 | 374,969 | ||||||
Commitments and contingencies (Note 9) | — | — | ||||||
Shareholders’ equity: | ||||||||
Common stock, par value $1.00 per share, 120,000 shares authorized; 50,641 shares issued and outstanding as of July 2, 2005; 49,816 shares issued and outstanding as of December 31, 2004 | 50,641 | 49,816 | ||||||
Additional paid-in capital | 50,258 | 10,654 | ||||||
Retained earnings | 585,811 | 529,534 | ||||||
Unearned compensation | (338 | ) | (4 | ) | ||||
Accumulated other comprehensive income | 2,928 | 48,850 | ||||||
Total shareholders’ equity | 689,300 | 638,850 | ||||||
Total liabilities and shareholders’ equity | $ | 1,019,675 | $ | 1,013,819 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
Three Months Ended | Six Months Ended | |||||||||||||||
July 2, 2005 | July 3, 2004 | July 2, 2005 | July 3, 2004 | |||||||||||||
Net sales | $ | 244,964 | $ | 224,668 | $ | 495,142 | $ | 447,137 | ||||||||
Cost of sales | 116,125 | 103,241 | 230,228 | 204,151 | ||||||||||||
Gross profit | 128,839 | 121,427 | 264,914 | 242,986 | ||||||||||||
Selling, general and administrative expenses | 80,550 | 66,976 | 157,983 | 134,758 | ||||||||||||
Research and development expenses | 17,341 | 16,037 | 33,414 | 32,034 | ||||||||||||
Operating income | 30,948 | 38,414 | 73,517 | 76,194 | ||||||||||||
Interest income | 633 | 225 | 1,308 | 641 | ||||||||||||
Interest expense | (1,755 | ) | (2,101 | ) | (3,589 | ) | (4,979 | ) | ||||||||
Income before income taxes | 29,826 | 36,538 | 71,236 | 71,856 | ||||||||||||
Provision for income taxes | 5,849 | 8,044 | 14,959 | 16,167 | ||||||||||||
Net income | $ | 23,977 | $ | 28,494 | $ | 56,277 | $ | 55,689 | ||||||||
Basic income per share | $ | 0.48 | $ | 0.58 | $ | 1.13 | $ | 1.13 | ||||||||
Diluted income per share | $ | 0.47 | $ | 0.57 | $ | 1.11 | $ | 1.11 | ||||||||
Weighted average shares outstanding: | ||||||||||||||||
Basic | 50,143 | 49,424 | 50,000 | 49,251 | ||||||||||||
Diluted | 50,707 | 50,305 | 50,525 | 50,092 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six months ended | ||||||||
July 2, 2005 | July 3, 2004 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 56,277 | $ | 55,689 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 24,020 | 21,114 | ||||||
Tax benefit from stock plan activities | 2,329 | 4,886 | ||||||
Non-cash stock based compensation | 5,509 | 909 | ||||||
Change in operating assets and liabilities: | ||||||||
Increase in accounts receivable | (20,946 | ) | (14,890 | ) | ||||
Increase in inventories | (2,258 | ) | (2,177 | ) | ||||
Increase in other current assets | (2,185 | ) | (3,794 | ) | ||||
Decrease in other assets | 535 | 300 | ||||||
Increase (decrease) in accounts payable | 746 | (3,941 | ) | |||||
Increase (decrease) in accrued expenses | 4,682 | (3,357 | ) | |||||
Increase (decrease) in accrued income taxes payable | 6,456 | (2,098 | ) | |||||
Increase in other liabilities | 2,374 | 951 | ||||||
Net cash provided by operating activities | 77,539 | 53,592 | ||||||
Cash flows from investing activities: | ||||||||
Additions to property, plant and equipment | (32,952 | ) | (25,549 | ) | ||||
Net cash used in investing activities | (32,952 | ) | (25,549 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from issuance of common stock under stock plans | 32,257 | 22,404 | ||||||
Repayment of debt | — | (75,000 | ) | |||||
Net repayments of revolver borrowings | (42,000 | ) | (26,000 | ) | ||||
Net cash used in financing activities | (9,743 | ) | (78,596 | ) | ||||
Effect of foreign exchange rates on cash and cash equivalents | (19,908 | ) | (2,357 | ) | ||||
Net increase (decrease) in cash and cash equivalents | 14,936 | (52,910 | ) | |||||
Cash and cash equivalents at beginning of period | 152,144 | 147,027 | ||||||
Cash and cash equivalents at end of period | $ | 167,080 | $ | 94,117 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
1. General
Millipore Corporation is a multinational life science company that provides innovative tools, technologies, and services to optimize the development and manufacturing of biopharmaceuticals and to improve laboratory productivity. We offer a broad range of high-performance products and services based on membrane, chromatographic and other enabling technologies.
Our interim fiscal quarters end on the thirteenth Saturday of each quarter. Since our fiscal year-end is December 31, the first and fourth fiscal quarters may not consist of precisely thirteen weeks. The second fiscal quarter of 2005 and 2004 ended on July 2, 2005 and July 3, 2004, respectively.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, accordingly, these footnotes condense or omit information and disclosures which substantially duplicate information provided in our latest audited financial statements. These financial statements should be read in conjunction with the financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2004.
Certain reclassifications have been made to prior year’s financial statements to conform to the 2005 presentation.
In the opinion of our management, these financial statements reflect all adjustments necessary for a fair statement of the results for the interim periods presented. The accompanying unaudited condensed consolidated financial statements are not necessarily indicative of future trends or our operations for the entire year.
2. Stock-Based Compensation
We grant stock options and award restricted stock as part of our stock-based employee compensation plans. We also grant stock options from our non-employee director stock option plan. As permitted under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” we apply the recognition and measurement provisions of Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees”, and related interpretations in accounting for these plans. No stock-based employee compensation expense has been recorded in connection with the issuance of employee and director stock options as all options granted under these plans were fixed awards and had an exercise price equal to the market value of our common stock at the date of grant. Stock-based employee compensation expense in relation to the separation agreements for the former Chief Executive Officer and several executive officers and the vesting of restricted stock, granted at no cost to certain employees, is reflected in net income.
SFAS No. 123, as amended by SFAS No. 148,“Accounting for Stock-Based Compensation-Transition and Disclosure, an Amendment of FASB Statement No. 123”, requires the presentation of certain pro forma information as if we had accounted for our stock-based employee compensation under the fair value method. For purpose of this disclosure, the fair value of the fixed option grants was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions for option grants:
Three Months Ended | Six Months Ended | |||||||||||
July 2, 2005 | July 3, 2004 | July 2, 2005 | July 3, 2004 | |||||||||
Risk-free interest rate | 3.9 | % | 3.0 | % | 3.7 | % | 3.0 | % | ||||
Volatility factor | 35.0 | % | 40.0 | % | 35.0 | % | 40.0 | % | ||||
Weighted average expected life (in years) | 5 | 5 | 5 | 5 | ||||||||
Dividend rate | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % |
The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, the model requires the use of highly subjective assumptions, including the expected stock price volatility and average expected life of the options. Although our employee stock options have characteristics significantly different from those of traded options, we believe that the Black-Scholes model provides a reasonable estimate for the fair value of these options.
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MILLIPORE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(In thousands, except per share data)
2. Stock-Based Compensation (continued)
The table below illustrates the effect on net income and net income per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.
Three Months Ended | Six months ended | |||||||||||||||
July 2, 2005 | July 3, 2004 | July 2, 2005 | July 3, 2004 | |||||||||||||
Net income, as reported | $ | 23,977 | $ | 28,494 | $ | 56,277 | $ | 55,689 | ||||||||
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects | 1,818 | 622 | 3,581 | 782 | ||||||||||||
Deduct: Stock-based employee compensation expense determined under fair value based method, net of related tax effects, pro forma | (3,190 | ) | (5,471 | ) | (7,096 | ) | (10,143 | ) | ||||||||
Pro forma net income | $ | 22,605 | $ | 23,645 | $ | 52,762 | $ | 46,328 | ||||||||
Net income per share: | ||||||||||||||||
Basic, as reported | $ | 0.48 | $ | 0.58 | $ | 1.13 | $ | 1.13 | ||||||||
Basic, pro forma | $ | 0.45 | $ | 0.48 | $ | 1.06 | $ | 0.94 | ||||||||
Diluted, as reported | $ | 0.47 | $ | 0.57 | $ | 1.11 | $ | 1.11 | ||||||||
Diluted, pro forma | $ | 0.44 | $ | 0.47 | $ | 1.04 | $ | 0.92 | ||||||||
3. Inventories
Inventories at July 2, 2005 and December 31, 2004, stated at the lower of first-in, first-out (“FIFO”) cost or market, consisted of the following:
July 2, 2005 | December 31, 2004 | |||||
Raw materials | $ | 24,860 | $ | 29,880 | ||
Work in process | 48,011 | 46,351 | ||||
Finished goods | 62,303 | 67,483 | ||||
$ | 135,174 | $ | 143,714 | |||
4. Property, Plant and Equipment
Accumulated depreciation on property, plant and equipment was $241,063 at July 2, 2005 and $257,249 at December 31, 2004.
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MILLIPORE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(In thousands, except per share data)
5. Intangible Assets
Net intangible assets consisted of the following at July 2, 2005 and December 31, 2004:
Gross Intangible Assets | Accumulated Amortization | Net Intangible Assets | Estimated Useful Life | |||||||||
July 2, 2005 | ||||||||||||
Patented and unpatented technology | $ | 19,329 | $ | (13,749 | ) | $ | 5,580 | 5 – 20 years | ||||
Trade names | 19,206 | (8,138 | ) | 11,068 | 10 –20 years | |||||||
Licenses and other | 5,137 | (3,567 | ) | 1,570 | 5 – 10 years | |||||||
Total | $ | 43,672 | $ | (25,454 | ) | $ | 18,218 | |||||
December 31, 2004 | ||||||||||||
Patented and unpatented technology | $ | 19,329 | $ | (13,118 | ) | $ | 6,211 | 5 – 20 years | ||||
Trade names | 19,206 | (7,568 | ) | 11,638 | 10 – 20 years | |||||||
Licenses and other | 4,995 | (3,260 | ) | 1,735 | 5 – 10 years | |||||||
Total | $ | 43,530 | $ | (23,946 | ) | $ | 19,584 | |||||
Amortization expense for the six months ended July 2, 2005 and July 3, 2004 was $1,506 and $1,647, respectively.
The estimated aggregate amortization expense for intangible assets owned as of July 2, 2005 for each of the five succeeding years is as follows:
Remainder of 2005 | $ | 1,502 | |
2006 | 2,730 | ||
2007 | 1,829 | ||
2008 | 1,604 | ||
2009 | 1,467 | ||
Thereafter | 9,086 | ||
$ | 18,218 | ||
6. Employee Retirement Plans
The following tables summarize the components of net periodic benefit cost for our various defined benefit employee pension and postretirement benefit plans in accordance with SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits.”
U.S. Pension Benefits | ||||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||
July 2, 2005 | July 3, 2004 | July 2, 2005 | July 3, 2004 | |||||||||||||
Components of net periodic benefit cost: | ||||||||||||||||
Service benefit | $ | (75 | ) | $ | (106 | ) | $ | (150 | ) | $ | (212 | ) | ||||
Interest cost | 285 | 320 | 570 | 640 | ||||||||||||
Expected return on plan assets | (271 | ) | (283 | ) | (542 | ) | (566 | ) | ||||||||
Amortization of prior service cost | 2 | 2 | 4 | 4 | ||||||||||||
Amortization of net loss | 184 | 192 | 368 | 384 | ||||||||||||
Net periodic benefit cost | $ | 125 | $ | 125 | $ | 250 | $ | 250 | ||||||||
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MILLIPORE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(In thousands, except per share data)
6. Employee Retirement Plans (continued)
Foreign Pension Benefits | ||||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||
July 2, 2005 | July 3, 2004 | July 2, 2005 | July 3, 2004 | |||||||||||||
Components of net periodic benefit cost: | ||||||||||||||||
Service cost | $ | 607 | $ | 476 | $ | 1,220 | $ | 952 | ||||||||
Interest cost | 307 | 284 | 627 | 568 | ||||||||||||
Expected return on plan assets | (226 | ) | (192 | ) | (463 | ) | (384 | ) | ||||||||
Amortization of net transition obligation | — | 18 | — | 36 | ||||||||||||
Amortization of net loss | 32 | 38 | 66 | 76 | ||||||||||||
Net periodic benefit cost | $ | 720 | $ | 624 | $ | 1,450 | $ | 1,248 | ||||||||
Other Postretirement Benefits | ||||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||
July 2, 2005 | July 3, 2004 | July 2, 2005 | July 3, 2004 | |||||||||||||
Components of net periodic benefit cost: | ||||||||||||||||
Service cost | $ | 103 | $ | 138 | $ | 206 | $ | 276 | ||||||||
Interest cost | 134 | 187 | 268 | 374 | ||||||||||||
Amortization of net gain | (28 | ) | — | (56 | ) | — | ||||||||||
Net periodic benefit cost | $ | 209 | $ | 325 | $ | 418 | $ | 650 | ||||||||
We expect to contribute $1,513 to our U.S. pension plan, $901 to our foreign pension plans, and $582 to our other postretirement benefit plans for 2005. As of July 2, 2005, we have made $506, $592, and $421 of contributions to the U.S. pension plan, the foreign pension plans and the other postretirement benefit plans, respectively.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) introduced a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of retiree healthcare benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In May 2004, the Financial Accounting Standards Board (the “FASB”) issued FASB Staff Position (“FSP”) No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”. As permitted under FSP No. 106-2, we elected to defer the accounting for the Act until the issuance of authoritative guidance on the determination of actuarial equivalence for purposes of receiving the federal subsidy. On January 21, 2005, the Center for Medicare and Medicaid Services released the final regulations implementing the Act. Based on these final regulations, we determined that most benefits provided by the plan are at least actuarially equivalent to Medicare Part D. The effect of the federal subsidy to which we are entitled has been accounted for as an actuarial gain of $1,308. The subsidy will reduce postretirement benefit expense for 2005 by $203. In addition to accounting for the federal subsidy as a result of Medicare Part D, the plan’s actuarial assumptions were changed to reflect an expected future reduction in our HMO plan cost as a result of the Act. This change in assumptions resulted in an actuarial gain of $872 and a reduction in benefit expense for 2005 of $100.
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MILLIPORE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(In thousands, except per share data)
7. Basic and Diluted Net Income per Share
The following table presents share information used to calculate net income per share (“EPS”):
Three Months Ended | Six Months Ended | |||||||
July 2, 2005 | July 3, 2004 | July 2, 2005 | July 3, 2004 | |||||
Weighted average common shares outstanding for basic EPS | 50,143 | 49,424 | 50,000 | 49,251 | ||||
Dilutive effect of stock options and restricted stock | 564 | 881 | 525 | 841 | ||||
Weighted average common shares outstanding for diluted EPS | 50,707 | 50,305 | 50,525 | 50,092 | ||||
For the three months ended July 2, 2005 and July 3, 2004, outstanding stock options of 2,932 and 1,751, respectively, with exercise prices in excess of the average fair market value of our common stock for the related period, were excluded from the calculation of diluted net income per share because their inclusion would have been antidilutive. For the six months ended July 2, 2005 and July 3, 2004, outstanding stock options of 4,008 and 2,690, respectively, with exercise prices in excess of the average fair value of our common stock for the related period, were excluded from the calculation of diluted net income per share because their inclusion would have been antidilutive. Antidilutive options could become dilutive in the future.
8. Comprehensive Income
The following table presents the components of comprehensive income, net of taxes:
Three Months Ended | Six Months Ended | |||||||||||||||
July 2, 2005 | July 3, 2004 | July 2, 2005 | July 3, 2004 | |||||||||||||
Net unrealized (loss) gain on securities available for sale | $ | — | $ | (10 | ) | $ | (203 | ) | $ | 11 | ||||||
Change in additional minimum pension liability adjustments | 56 | — | 79 | — | ||||||||||||
Foreign currency translation adjustments | (27,483 | ) | 4,065 | (45,798 | ) | (5,662 | ) | |||||||||
Other comprehensive (loss) income | (27,427 | ) | 4,055 | (45,922 | ) | (5,651 | ) | |||||||||
Net income | 23,977 | 28,494 | 56,277 | 55,689 | ||||||||||||
Total comprehensive (loss) income | $ | (3,450 | ) | $ | 32,549 | $ | 10,355 | $ | 50,038 | |||||||
9. Commitments and Contingencies
During the first quarter of 2004, an issue arose under our tax sharing agreement with our former subsidiary, Mykrolis Corporation (“Mykrolis”), relating to the inclusion of Mykrolis in our consolidated tax return for portions of 2001 and 2002. The tax sharing agreement provides that if Millipore receives a tax benefit (as defined in the agreement) due to the inclusion of Mykrolis in our consolidated tax return, Millipore is required to pay Mykrolis the amount of that benefit. During the first quarter of 2004, we made a payment to Mykrolis in the amount of $1,255 pursuant to the tax sharing agreement. Mykrolis has questioned the methodologies underlying the calculation of the tax benefit. We believe that we have properly calculated and recorded amounts owed to Mykrolis.
10. Investments in Unconsolidated Companies
We have equity investments in two companies which are accounted for using the equity method. During the three and six months ended July 2, 2005, we recorded $243 and $716 of income and received $274 and $411 of dividends from these unconsolidated companies. During the three and six months ended July 3, 2004, we recorded $23 and $3 of loss and received $132 and $385 of dividends from these unconsolidated companies.
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MILLIPORE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(In thousands, except per share data)
11. Officer Compensation Agreements
During the three and six months ended July 2, 2005, we recorded charges related to separation agreements with certain of our executive officers in the amounts of $2,960 and $6,219, respectively. In the three months ended July 2, 2005, we recorded $1,278 for severance, bonus and other related benefits and $1,682 related to stock options as a result of modification of certain options pursuant to these agreements. In the six months ended July 2, 2005, we recorded $4,004 for severance, bonus and other related benefits and $2,215 related to stock options.
On April 28, 2004, Francis J. Lunger announced that he would step down as CEO and President of Millipore. Mr. Lunger stepped down as CEO and President as of December 31, 2004, and as Director and Chairman of Millipore’s Board of Directors as of March 1, 2005. In connection with Mr. Lunger’s separation agreement, we recorded an aggregate of $7,520 in compensation expense, including $2,501 for severance, bonus and related benefits and $5,019 related to stock options. In the six months ended July 2, 2005, we recorded $519 for severance, bonus and related benefits, and $3,242 for stock options.
On January 1, 2005, Dr. Martin D. Madaus joined Millipore as CEO and President, and as a director. Dr. Madaus became Chairman of Millipore’s Board of Directors on March 1, 2005. In 2005, we reimbursed Dr. Madaus $1,819 for certain compensation from his former employer forfeited by his acceptance of Millipore’s employment offer. The compensation is a combination of $1,433 cash and 8 shares of restricted stock with a fair market value of $386. The fair value of the restricted stock was recorded as unearned compensation and will be amortized over the four year restriction period. We also paid $94 for his relocation costs.
12. New Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends the guidance in Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight and handling costs, and wasted material (spoilage). SFAS No. 151 requires that those items be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overheads to the conversion costs be based on the normal capacity of production facilities. SFAS No. 151 will be effective for us for the first quarter of 2006. We are in the process of evaluating the impact of SFAS No. 151 on our consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),“Share-Based Payment” (“SFAS No. 123R”), which replaces SFAS No. 123,“Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. The pro forma footnote disclosure alternative is no longer allowable under SFAS No. 123R. On March 29, 2005, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 107 to express the SEC staff’s views regarding the interaction between SFAS No. 123R and certain SEC rules and regulations and provide the staff’s views regarding the valuation of share-based payment arrangements. SFAS No. 123R will be effective for us for the first quarter of 2006. We are in the process of assessing the impact of expensing stock options on our consolidated financial statements.
The American Jobs Creation Act of 2004 (the “AJCA”) contains a number of provisions which will affect us in the future. One provision of the AJCA establishes a special deduction for “Qualified Domestic Production Activities” for U.S. manufacturers. The special deduction starts at 3% of “Qualified Production Income (“QPI”)” as defined in the AJCA in 2005 and will be 9% of QPI when fully phased in after 2009. In December 2004, the FASB issued FSP No. 109-1, “Application of FASB Statement No. 109, ‘Accounting for Income Taxes,’ to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004”. FSP No. 109-1 requires that qualified domestic production activities deductions should be accounted for as a special deduction in accordance with SFAS No. 109 and that the related impact of this deduction should be reported in the period in which the deduction is claimed on tax returns. We are currently projecting a tax loss on our 2005 U.S. tax return. Therefore, we do not currently believe there is a benefit to us from the qualified domestic production activities deduction.
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MILLIPORE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(In thousands, except per share data)
12. New Accounting Pronouncements (continued)
A second provision of the AJCA provides a temporary incentive for a U.S. company to repatriate funds deemed to be permanently reinvested outside the U.S., at a reduced effective tax rate of approximately 5.25%. In December 2004, the FASB issued FSP No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004,” to address the appropriate point at which a company should reflect in its financial statements the effects of the one-time tax benefit on the repatriation of foreign earnings. The FASB provided companies with additional time beyond the financial reporting period to evaluate the effect of the AJCA on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. While we have not made a decision to repatriate earnings under the AJCA, we are studying the AJCA and recent IRS guidance to determine whether it would be beneficial for us to make use of the temporary incentive in 2005. If we decide to repatriate under the provisions of the AJCA, a tax provision for the related taxes will be recorded in the fiscal quarter in which the repatriation plan is approved. We will make a final determination by the end of 2005. The amount of income tax we would incur, should we repatriate some level of earnings, cannot be reasonably estimated at this time.
In March 2005, the FASB issued Interpretation No. 47 (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations – an interpretation of FASB Statement No. 143.” FIN 47 clarifies that the term “conditional asset retirement obligation” refers to a legal obligation to perform an asset retirement activity in which the timing and/(or) method of settlement are conditional on a future event that may or may not be within the control of an entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/(or) method of settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The fair value of a liability for the conditional asset retirement should be recognized when incurred – generally upon acquisition, construction, or development and/(or) through the normal operation of the asset. FIN 47 will be effective for us as of the end of 2005. Retrospective application of this standard to interim financial statements is not required. We are in the process of assessing the impact of FIN 47 on our consolidated financial statements.
13. Subsequent Events
On July 4, 2005, we completed the acquisition of MicroSafe, B.V., a European contract laboratory that develops assays and provides testing services to help biotechnology and pharmaceutical customers monitor quality and compliance in the drug manufacturing process. The total purchase price was approximately $9 million. The acquisition was funded with our available cash.
On August 9, 2005, we completed the acquisition of approximately 90% of the outstanding shares of NovAseptic A.B. stock from its majority shareholders for $86 million in cash, subject to certain post-closing adjustments. We are in the process of acquiring the remaining shares from the minority shareholders. NovAseptic A.B. is a company that provides innovative solutions for aseptic processing applications in biotechnology and pharmaceutical manufacturing operations. The total purchase price will be approximately $95 million, subject to certain post-closing adjustments.
On July 21, 2005, we announced that our worldwide bioprocess systems hardware manufacturing operations will be consolidated in order to improve our competitive position by helping us streamline production and manage costs more effectively. As a result of this decision, we will cease systems production in our Billerica, Massachusetts facility and close our Stonehouse, England manufacturing plant in 2006. All custom systems manufacturing will be transferred to Molsheim, France and the manufacturing of standard systems products will be outsourced.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Basis of Presentation
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Condensed Consolidated Financial Statements and related notes thereto and other financial information included elsewhere in this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2004. Throughout this discussion, references will be made to “constant currencies”. Constant currency is a non-GAAP measure whereby foreign currency balances are translated, for all periods presented, at Millipore’s predetermined budgeted exchange rates for 2005, thus excluding the impact of fluctuations in the actual foreign currency exchange rates. In addition to analyzing U.S. GAAP financial results, we also analyze our results in constant currencies as we believe these measures may allow for a better understanding of the underlying business trends. The U.S. dollar results represent the foreign currency balances translated at actual exchange rates. Our interim fiscal quarters end on the thirteenth Saturday of each quarter. Since our fiscal year-end is December 31, the first and fourth fiscal quarters may not consist of precisely thirteen weeks. The second fiscal quarter for 2005 and 2004 ended on July 2, 2005 and July 3, 2004, respectively.
During the second quarter of 2005, as part of our strategic reorganization, we announced the formation of two divisions, Bioprocess and Bioscience. The Bioprocess division offers our customers solutions to optimize development and manufacturing of biopharmaceuticals. The Bioscience division, which consisted of our former Laboratory Water and Life Science operating segments, provides products and application insights that improve laboratory productivity.
Executive Summary
During the three months ended July 2, 2005 (the “second quarter of 2005”) as compared with the three months ended July 3, 2004 (the “second quarter of 2004”), our sales growth was 9%, comprised of a 6% growth in constant currencies and a 3% foreign currency impact. Sales of the Bioprocess division increased 11%, comprised of an 8% growth in constant currencies and a 3% foreign currency impact. Sales of the Bioscience division increased 6%, comprising of a 3% growth in constant currencies and a 3% foreign currency impact. Both divisions experienced strong growth in sales of consumables and services while the Bioprocess division experienced a decline in sales of systems hardware primarily due to our customers’ timing for capacity expansion.
During the six months ended July 2, 2005 as compared with the six months ended July 3, 2004, our sales growth was 11%, comprised of an 8% growth in constant currencies and a 3% foreign currency impact. Sales of the Bioprocess division increased 14%, comprised of an 11% growth in constant currencies and a 3% foreign currency impact. Sales of the Bioscience division increased 7%, comprised of a 4% growth in constant currencies primarily due to our biotechnology customers and a 3% foreign currency impact. Geographically, the Americas have experienced the strongest constant currency growth at 10% in the first six months of 2005 as compared to the first six months of 2004, primarily due to strong sales to pharmaceutical customers. Both divisions experienced strong growth in sales of consumables and services while systems hardware sales growth was flat.
Operating income as a percent of sales for the three and six months ended July 2, 2005 declined as compared to the same periods in 2004. The decrease was due to expenses related to three discrete items: our manufacturing consolidation strategy, expenses in connection with executive compensation agreements and costs associated with the reorganization of our divisions.
Our strategic manufacturing plan, which began in the fourth quarter of 2004 with the closing of our Japan manufacturing plant, will result over five years in the consolidation of the majority of our manufacturing activities into three major plants in New Hampshire, Ireland and France and, to a lesser extent, the outsourcing of some of our manufacturing processes. As part of this five-year plan, we will cease bioprocess systems hardware production in our Billerica, Massachusetts facility in 2006, close our Bedford, Massachusetts device plant and our Stonehouse, England plant in 2006, and close our Puerto Rico plant in 2008. Approximately 350 employees will be affected. The total cost of this program over the five-year period is expected to be approximately $55 million, of which approximately $9 to $11 million is expected in 2005 with the remainder to be incurred in 2006 through 2008. We project that annual savings from this program will be approximately $40 million by 2009.
On July 4, 2005, we completed the acquisition of Microsafe, B.V. (“Microsafe”). MicroSafe develops assays and provides testing services to help biotechnology and pharmaceutical customers monitor quality and compliance in the drug manufacturing process. The acquisition of MicroSafe enhances growth in our process monitoring tools business and enables us to participate in the outsourcing trend in the biotechnology industry.
On August 9, 2005, we completed the acquisition of approximately 90% of the outstanding shares of NovAseptic A.B. (“NovAseptic”) stock from its majority shareholders. We are in the process of acquiring the remaining shares from the minority shareholders. NovAseptic provides innovative solutions for aseptic processing applications in biotechnology and pharmaceutical manufacturing operations and is an excellent strategic fit for our Bioprocess division’s process monitoring tools business as well as the systems and components businesses.
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For the second half of 2005, we are expecting strong sales growth in the biotechnology market. In the second quarter of 2005, we received a large, one-time stocking order from one of our major biotechnology customers that we believe will add approximately $10 to $12 million revenue in the second half of 2005 and over $20 million revenue in 2006 over and above the previously forecasted sales to this customer. Notwithstanding this order, it is possible that, at some time in the future, this customer may choose to draw down this inventory, in which case the incremental revenue to our forecast will not be realized or will be less than what is currently anticipated. As a result of the increase in forecasted revenue, combined with the impact of the two acquisitions discussed above, we now expect a constant currency revenue growth of between 9% and 11% for 2005 with foreign currency resulting in an additional 1% in U.S. dollar growth rate (based on current rates of exchange).
Critical Accounting Policies and Estimates
This discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Our most critical accounting policies had a significant impact on the preparation of these condensed consolidated financial statements. These policies include estimates and significant judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continue to have the same critical accounting policies and estimates as we described under Item 7, on page 13, in our Annual Report on Form 10-K for the year ended December 31, 2004. Those policies and estimates were identified as those relating to revenue recognition, allowance for doubtful accounts, inventory valuation analysis, valuation of long-lived assets, income tax provision, employee pension and postretirement medical plans and our intention to refinance short-term debt on a long-term basis. We continue to evaluate our estimates and judgments on an on-going basis. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. We base our estimates and judgments on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions.
Results of Operations
Three Months Ended July 2, 2005 Compared to Three Months Ended July 3, 2004
Net Sales
The following discussion of net sales summarizes sales growth by division and by the geographies in which our products were sold.
Net Sales by Division
Net sales growth by division, for the second quarter of 2005 as compared with the second quarter of 2004, is summarized in the table below.
U.S. Dollars (in thousands) | U.S. Dollar Growth | Constant Currency Growth | ||||||||
2005 | 2004 | |||||||||
Bioprocess | $ | 147,953 | $ | 133,387 | 11% | 8% | ||||
Bioscience | 97,011 | 91,281 | 6% | 3% | ||||||
Total net sales | $ | 244,964 | $ | 224,668 | 9% | 6% | ||||
In the Bioprocess division, constant currency sales increased 8% during the second quarter of 2005 as compared with the second quarter of 2004, consisting of a 10% growth in consumables sales, an 11% decline in hardware sales and a 53% increase in services. The increase in sales of consumables reflected strong increases in sales of process scale filtration devices and process monitoring tools, partially offset by a decline in sales of chromatography media. The strong sales growth in filtration consumables reflected the timing of our customers’ manufacturing cycles and activities related to their qualification and validation of new production facilities. The decline in chromatography media sales was principally due to the timing of large shipments to customers in the second quarter of 2004. The decrease in hardware sales was the result of several large system sales in the second quarter of 2004. Hardware sales can fluctuate significantly as they are driven by our customers’ timing for capacity expansion. Although services represent a small portion of Bioprocess division sales, our services revenue experienced strong growth as our installed base of hardware and validation support continued to grow and as a result of the strategic emphasis being placed on this segment of the business.
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In the Bioscience division, constant currency sales grew 3% during the second quarter of 2005 as compared with the second quarter of 2004. Strong demand for consumable products used in laboratory water purification, drug discovery and other general filtration applications was partially offset by declining sales of products used in OEM devices and genomics applications by life science laboratories. In addition, services provided to customers for our water purification equipment grew 11% as the installed base of equipment continued to grow.
Net Sales by Geography
Net sales growth by geography, for the second quarter of 2005 as compared with the second quarter of 2004, is summarized in the table below.
U.S. Dollars (in thousands) | U.S. Dollar Growth | Constant Currency Growth | ||||||||
2005 | 2004 | |||||||||
Americas | $ | 103,452 | $ | 97,000 | 7% | 5% | ||||
Europe | 98,488 | 87,334 | 13% | 8% | ||||||
Asia/Pacific | 43,024 | 40,334 | 7% | 4% | ||||||
Total net sales | $ | 244,964 | $ | 224,668 | 9% | 6% | ||||
The Americas achieved constant currency sales growth of 5%, primarily driven by the Bioprocess division which experienced strong sales of consumable process scale filtration devices. In addition, U.S. sales of laboratory water purification and life science research consumables benefited as favorable economic conditions continued to stimulate growth in both privately and publicly funded laboratories. Further, our customers increased spending for drug discovery projects, thereby supporting demand for our consumable offerings. In Europe, sales grew 8% in constant currencies due to strong sales of consumable process scale devices and process monitoring tools, partially offset by lower sales of chromatography media and systems hardware. Both the media and systems hardware businesses were impacted by the timing of large customer orders. In the Asia/Pacific region, constant currency sales growth of 4% reflected strong shipments of process scale filtration devices as well as strong growth in consumables used in water purification. This was offset by a significant decrease in systems hardware sales as a result of the timing of large system sales in the second quarter of 2004.
During the second quarter of 2005, the U.S. dollar remained weaker on average as compared to the second quarter of the prior year. A weaker U.S. dollar positively impacts U.S. dollar sales growth because approximately 60% of our sales are outside the U.S. Since we have a higher percentage of our sales in Europe than in Asia, the impact of translating sales denominated in European currencies will have a greater impact on our U.S. dollar sales than the impact of translating sales denominated in Asian currencies. On average, the U.S. dollar weakened against the Euro by approximately 4% and against the Japanese Yen by approximately 2% during the second quarter of 2005 as compared with the second quarter of 2004.
Gross Profit Margins
Gross profit margin percentage was 52.6% in the second quarter of 2005 as compared with 54.0% in the second quarter of 2004. The decrease in our gross profit margin percentage for the second quarter of 2005 as compared with the second quarter of 2004 was primarily due to costs associated with our strategic manufacturing plan and an unfavorable shift in our mix of product sales, offset by favorable foreign exchange. During the second quarter of 2005, we recorded $2.6 million of expenses related to our strategic manufacturing plan, including $1.3 million of inventory write-offs related to our decision to outsource certain manufacturing processes, $0.5 million for accelerated depreciation and $0.8 million for severance costs.
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Operating Expenses
Selling, general and administrative (“SG&A”) expenses increased $13.6 million, or 20%, in the second quarter of 2005 as compared with the second quarter of 2004. Our results for the second quarter of 2005 included $7.2 million of expenses related to officer and other employee terminations as compared to $1.7 million for CEO transition costs recorded in the second quarter of 2004. In addition, higher SG&A expenses for the second quarter of 2005 included a $4.3 million increase related to incentive compensation and salaries and a $3.8 million increase in other costs, primarily for outside services, sales training and demolition costs for our Bedford campus. The officer and other employee severance costs included $4.0 million costs associated with termination agreements for certain executive officers and $3.2 million severance for other employees in connection with our decision in the first quarter of 2005 to combine our Laboratory Water and Life Science operating segments into one division. The demolition costs for our Bedford campus are for site preparation costs for our new R&D facility which will be completed in 2006.
Research and development (“R&D”) expenses increased $1.3 million, or 8%, in the second quarter of 2005 as compared with the second quarter of 2004. The increase during the second quarter of 2005 was due to continued investment in the level of R&D programs aimed at introducing new products to our markets and $0.5 million for employee severance in connection with our decision in the first quarter of 2005 to combine Laboratory Water and Life Sciences divisions. R&D expenses were 7.1% of sales for the second quarter of both 2005 and 2004.
Net Interest Expense
Net interest expense decreased $0.8 million in the second quarter of 2005 as compared with the second quarter of 2004. The lower net interest expense was principally a result of lower average debt outstanding and higher average cash balance. During the second quarter of 2005, the weighted average interest rate on our revolving credit agreement was approximately 4.2%.
Provision for Income Taxes
Our effective tax rate for the second quarter of 2005 was 19.6% as compared with 22.0% during the second quarter of 2004. The effective annual tax rate for 2005 is now expected to be 21.0%, which is lower than the 22.0% effective annual tax rate projected in the first quarter of 2005. The decline in the estimated effective annual tax rate is due to a decrease in the expected profits from higher tax rate jurisdictions as a result of certain unusual charges as compared to the first quarter of 2005.
Six Months Ended July 2, 2005 Compared to Six Months Ended July 3, 2004
Net Sales
The following discussion of net sales summarizes sales growth by division and by the geographies in which our products were sold.
Net Sales by Division
Net sales growth by division, for the first six months of 2005 as compared with the first six months of 2004, is summarized in the table below.
U.S. Dollars (in thousands) | U.S. Dollar Growth | Constant currency growth | ||||||||
2005 | 2004 | |||||||||
Bioprocess | $ | 298,182 | $ | 262,226 | 14% | 11% | ||||
Bioscience | 196,960 | 184,911 | 7% | 4% | ||||||
Total net sales | $ | 495,142 | $ | 447,137 | 11% | 8% | ||||
In the Bioprocess division, constant currency sales increased 11% during the first six months of 2005 as compared with the first six months of 2004, consisting of a 12% growth in consumables sales, a 1% decline in hardware sales and a 49% increase in services. The increase in sales of consumables reflected strong increases in sales of process scale filtration devices. The decline in hardware sales was primarily due to the timing of large systems sold to customers in 2004. Hardware sales can fluctuate significantly as they are driven by our customers’ timing for capacity expansion. Although services represent a small portion of Bioprocess division sales, our services revenue experienced strong growth as our installed base of hardware and validation support continued to grow and as a result of the strategic emphasis being placed on this segment of the business.
In the Bioscience division, constant currency sales grew 4% during the first six months of 2005 as compared with the first six months of 2004. Strong demand for consumable products used in laboratory water purification, drug discovery and other general filtration applications was partially offset by declining sales of products used in OEM devices and genomics applications by life science laboratories. In addition, services provided to customers for water purification equipment grew 10% as the installed base of equipment continued to grow.
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Net Sales by Geography
Net sales growth by geography, for the first six months of 2005 as compared with the first six months of 2004, is summarized in the table below.
U.S. Dollars (in thousands) | U.S. Dollar Growth | Constant Currency Growth | ||||||||
2005 | 2004 | |||||||||
Americas | $ | 206,824 | $ | 186,009 | 11% | 10% | ||||
Europe | 200,903 | 177,728 | 13% | 7% | ||||||
Asia/Pacific | 87,415 | 83,400 | 5% | 3% | ||||||
Total net sales | $ | 495,142 | $ | 447,137 | 11% | 8% | ||||
The Americas achieved constant currency sales growth of 10%, primarily driven by the Bioprocess division which experienced strong sales of consumable process scale filtration devices. Further, customers increased spending for drug discovery projects, thereby supporting demand for our consumable offerings. In Europe, the 7% constant currency sales growth was primarily due to a 23% growth in sales of chromatography and filtration consumables. The growth in the Asia/Pacific region remained modest, despite shipment of a large filtration system.
During the first six months of 2005, the U.S. dollar remained weaker on average as compared to the first six months of the prior year. A weaker U.S. dollar positively impacts U.S. dollar sales growth because approximately 60% of our sales is outside the U.S. Since we have a higher percentage of our sales in Europe than in Asia, the impact of translating sales denominated in European currencies will have a greater impact on our U.S. dollar sales than the impact of translating sales denominated in Asian currencies. On average, the U.S. dollar weakened against the Euro by approximately 4% and against the Japanese Yen by approximately 1% during the first six months of 2005 as compared with the first six months of 2004.
Gross Profit Margins
Our gross profit margin percentage was 53.5% in the first six months of 2005 as compared with 54.3% in the first six months of 2004. The decrease in our gross profit margin percentage for the first six months of 2005 as compared with the first six months of 2004 was primarily due to costs associated with our strategic manufacturing plan and an unfavorable shift in our mix of product sales, offset by favorable foreign exchange. During the second quarter of 2005, we recorded $2.6 million expenses related to our strategic manufacturing plan, including $1.3 million of inventory write-offs related to our decision to outsource certain manufacturing processes, $0.5 million for accelerated depreciation and $0.8 million for severance costs.
Operating Expenses
Selling, general and administrative (“SG&A”) expenses increased $23.2 million, or 17%, in the first six months of 2005 as compared with the first six months of 2004. Our results for the first six months of 2005 included $15.2 million expenses related to officer compensation and other employee terminations as compared with $1.7 million charge recorded for CEO transition costs in the first six months of 2004. In addition, higher SG&A expenses for the first six months of 2005 included a $7.3 million increase related to incentive compensation and salary and a $2.4 increase in other costs, primarily for outside services, sales training and demolition costs for our Bedford campus. The officer compensation and other employee severance costs included costs associated with CEO transition and termination agreements for certain executive officers and severance for other employees in connection with our decision in the first quarter of 2005 to combine our Laboratory Water and Life Science operating segments into one division. The demolition costs for our Bedford campus are for site preparation costs for our new R&D facility which will be completed in 2006.
Research and development (“R&D”) expenses increased $1.4 million, or 4%, in the first six months of 2005 as compared with the first six months of 2004. As a percentage of sales, R&D expenses decreased from 7.2% to 6.7%. The increased spending during the first six months of 2005 was due to $0.5 million employee severance in connection with our decision in the first quarter of 2005 to combine our Laboratory Water and Life Science divisions with the remainder due to our continued investment in the level of research and development programs aimed at introducing new products to our markets.
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Net Interest Expense
Net interest expense decreased $2.1 million in the first six months of 2005 as compared with the first six months of 2004. The lower net interest expense was principally a result of lower average debt outstanding and higher average cash balance. During the first six months of 2005, the weighted average interest rate on the revolving credit agreement was approximately 3.8%.
Provision for Income Taxes
Our effective tax rate on net income for the first six months of 2005 was 21.0% as compared with 22.5% for the first six months of 2004. The decline in the effective tax rate is due to a decrease in the expected profits from higher tax rate jurisdictions primarily as a result of certain unusual charges in the first six months of 2005 as compared to the first six months of 2004.
Market Risk
We are exposed to market risks, which include changes in foreign currency exchange rates and credit risk. We manage these market risks through our normal financing and operating activities and, when appropriate, through the use of derivative financial instruments.
Foreign Currency Exchange Rate Risk
We are exposed to foreign currency exchange rate risk inherent in sales, net income and assets and liabilities denominated in currencies other than the U.S. dollar. The potential change in foreign currency exchange rates offers a substantial risk to us, as approximately 60% of our business is conducted outside of the United States, generally in foreign currencies. Our risk management strategy currently uses forward contracts to mitigate certain foreign currency exposures. The intent is to offset gains and losses that occur on the underlying exposures, with gains and losses resulting from the forward contracts that hedge these exposures. Principal hedged currencies include the Euro, Japanese Yen and British Pound. The periods of these forward contracts typically span less than three months. We held forward foreign exchange contracts with U.S. equivalent notional amounts totaling $90.2 million at July 2, 2005. The fair value of these contracts was a loss of $0.5 million at July 2, 2005. Additionally, we are able to partially mitigate the impact that fluctuations in currencies have on our net income as a result of our manufacturing facilities located in Europe, material sourcing and other spending which occur in countries outside the U.S. We do not enter into derivatives for trading or other speculative purposes, nor do we use leveraged financial instruments.
Although we attempt to manage our foreign currency exchange risk through the above activities, when the U.S. dollar weakens against other currencies in which we transact business, generally sales and net income will be positively but not proportionately impacted.
Credit Risk
We are exposed to concentrations of credit risk in cash and cash equivalents and trade receivables. Cash and cash equivalents are placed with major financial institutions with high quality credit ratings. The amount placed with any one institution is limited by policy. Trade receivables credit risk exposure is limited due to the large number of established customers and their dispersion across different geographies.
Capital Resources and Liquidity
Cash flow provided from operations was $77.5 million in the first six months of 2005 as compared with $53.6 million in the first six months of 2004. The increase in cash flow from operations in the first six months of 2005 compared with the first six months of 2004 was primarily the result of increased net income, higher non-cash stock based compensation expense included in net income, and increases in current and other liabilities partially offset by increases in accounts receivable.
During the first six months of 2005, we invested $33.0 million in property, plant and equipment and we expect to spend an additional $47.0 to $57.0 million during the remainder of 2005. Our largest projects for 2005 include the start of construction of our new research and development center in Bedford, Massachusetts and the buildout of a new membrane production line in Cork, Ireland. As a result of our decision to close our manufacturing plant in Cidra, Puerto Rico, we have also decided to accelerate the buildout of our existing building shell in our Ireland facility in 2006 which had previously been postponed.
Cash flows used in financing activities during the first six months of 2005 were principally the result of our repaying $42.0 million of our revolver borrowings offset by proceeds from exercises of employee stock options. We believe the increased cash from employees exercising stock options was largely related to the increase in our stock price. In general, as our stock price increases, we expect the volume of our employees’ exercise of their vested stock options to increase.
We expect to continue using cash flows from operations to invest in capital projects, fund acquisitions and/or to reduce debt. We believe that our existing cash and cash equivalents, cash flows expected to be generated from future operating activities, our ready access to capital markets for competitively priced instruments and funds available under our revolving credit agreement will be sufficient to meet our cash requirements over the next twelve to twenty-four months. We are in compliance with all of our debt covenants.
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Legal Proceedings
We currently are not a party to any material legal proceeding.
New Accounting Pronouncement
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight and handling costs, and wasted material (spoilage). SFAS No. 151 requires that those items be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overheads to conversion costs be based on the normal capacity of production facilities. SFAS No. 151 will be effective for us for the first quarter of 2006. We are in the process of evaluating the impact of SFAS No. 151 on our consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),“Share-Based Payment” (“SFAS No. 123R”), which replaces SFAS No. 123,“Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. The pro forma footnote disclosure alternative is no longer allowable under SFAS No. 123R. On March 29, 2005, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 107 to express the SEC staff’s views regarding the interaction between FAS No. 123R and certain SEC rules and regulations and provide the staff’s views regarding the valuation of share-based payment arrangements. SFAS No. 123R will be effective for us for the first quarter of 2006. We are in the process of assessing the impact of expensing stock options on our consolidated financial statements.
The American Jobs Creation Act of 2004 (the “AJCA”) contains a number of provisions which will affect us in the future. One provision of the AJCA establishes a special deduction for “Qualified Domestic Production Activities” for U.S. manufacturers. The special deduction starts at 3% of “Qualified Production Income (“QPI”)” as defined in the AJCA in 2005 and will be 9% of QPI when fully phased in after 2009. In December 2004, the FASB issued FSP No. 109-1, “Application of FASB Statement No. 109, ‘Accounting for Income Taxes,’ to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004”. FSP No. 109-1 requires that qualified domestic production activities deductions should be accounted for as a special deduction in accordance with SFAS No. 109 and that the related impact of this deduction should be reported in the period in which the deduction is claimed on tax returns. We are currently projecting a tax loss on our 2005 U.S. tax return. Therefore, we do not currently believe there is a benefit to us from the qualified domestic production activities deduction.
A second provision of the AJCA provides a temporary incentive for a U.S. company to repatriate funds deemed to be permanently reinvested outside the U.S., at a reduced effective tax rate of approximately 5.25%. In December 2004, the FASB issued FSP No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004,” to address the appropriate point at which a company should reflect in its financial statements the effects of the one-time tax benefit on the repatriation of foreign earnings. The FASB provided companies with additional time beyond the financial reporting period to evaluate the effect of the AJCA on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. While we have not made a decision to repatriate earnings under the AJCA, we are studying the AJCA and recent IRS guidance to determine whether it would be beneficial for us to make use of the temporary incentive in 2005. If we decide to repatriate under the provisions of the AJCA, a tax provision for the related taxes will be recorded in the fiscal quarter in which the repatriation plan is approved. We will make a final determination by the end of 2005. The amount of income tax we would incur, should we repatriate some level of earnings, cannot be reasonably estimated at this time.
In March 2005, the FASB issued Interpretation No. 47 (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations – an interpretation of FASB Statement No. 143.” FIN 47 clarifies that the term “conditional asset retirement obligation” refers to a legal obligation to perform an asset retirement activity in which the timing and/(or) method of settlement are conditional on a future event that may or may not be within the control of an entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/(or) method of settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The fair value of a liability for the conditional asset retirement should be recognized when incurred – generally upon acquisition, construction, or development and/(or) through the normal operation of the asset. FIN 47 will be effective for us as of the end of 2005. Retrospective application of this standard to interim financial statements is not required. We are in the process of assessing the impact of FIN 47 on our consolidated financial statements.
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Forward-Looking Statements
The matters discussed in this Form 10-Q, as well as in future oral and written statements by our management, that are forward-looking statements are based on our current management expectations. These expectations involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. These risks and uncertainties include without limitation the risk factors and uncertainties described in our Form 10-K for the year ended December 31, 2004.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
The information called for by this item is set forth under the heading “Market Risk” in Management’s Discussion and Analysis contained in this Form 10-Q which information is hereby incorporated by reference.
Item 4. Controls and Procedures.
An evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the fiscal quarter covered by this report. Based upon that evaluation, our CEO and CFO have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported in accordance with and within the time periods specified in Securities and Exchange Commission rules and forms. There has been no change in our internal control over financial reporting during the quarter ended July 2, 2005 that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders of Millipore Corporation was held on April 27, 2005. The following matters were voted on:
1. | The election of three Class III Directors for a three-year term (expiring in 2008). The following votes were tabulated with respect to the election: |
Votes “For” | “Withhold” | |||
Melvin D. Booth | 42,006,261 | 3,405,041 | ||
Maureen A. Hendricks | 35,296,817 | 10,114,431 | ||
Martin D. Madaus | 41,962,966 | 3,448,281 |
2. | A proposal to adopt amendments to the Millipore Corporation 1999 Stock Incentive Plan to increase the number of shares available for grant under such plan by 1,650,000 and to make certain other amendments thereto. The following votes were tabulated with respect to this proposal: |
Votes “For” | Votes “Against” | “Abstain” | ||
27,130,053 | 14,211,367 | 295,820 |
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a. | Exhibits Filed or Furnished Herewith. |
Exhibits Filed Herewith
10.1 | Amended and Restated 1999 Stock Incentive Plan | |
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13(a) (17 CFR 240.13a-14(a)) or Rule 15d-14(a) (17 CRF 240.15d-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13(a) (17 CFR 240.13a-14(a)) or Rule 15d-14(a) (17 CRF 240.15d-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
Exhibits Furnished Herewith
32.1 | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
MILLIPORE CORPORATION
Signature | Title | Date | ||||
By: | /s/ KATHLEEN B. ALLEN Kathleen B. Allen | Vice President and Chief Financial Officer | August 9, 2005 | |||
By: | /s/ DONALD B. MELSON Donald B. Melson | Corporate Controller (Chief Accounting Officer) | August 9, 2005 | |||
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Exhibit Number | Exhibit Title | |
10.1 | Amended and Restated 1999 Stock Incentive Plan | |
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) (17 CFR 240.13a-14(a)) or Rule 15d-14(a) (17 CFR 240.15d-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) (17 CFR 240.13a-14(a)) or Rule 15d-14(a) (17 CFR 240.15d-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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