You should read the following discussion together with Pall's condensed consolidated financial statements and notes thereto and other financial information included elsewhere in this Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended August 3, 2002. As used below, “½%” indicates that we have rounded the relevant data up or down to the nearest one-half percentage point. Dollar amounts discussed below are in thousands, except per share dollar amounts. In addition, per share dollar amounts are discussed on a diluted basis.
The matters discussed in this Form 10-Q may contain “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on current Company expectations and are subject to risks and uncertainties, which could cause actual results to differ materially. Such risks and uncertainties include, but are not limited to: fluctuations in foreign currency exchange rates; regulatory approval and market acceptance of new technologies; changes in product mix and product pricing and in interest rates and cost of raw materials; the Company’s success in enforcing its patents and protecting its proprietary products and manufacturing techniques and in integrating the operations of FSG into the Company’s existing business; global and regional economic conditions and legislative, regulatory and political developments; and domestic and international competition in the Company’s global markets.
On April 24, 2002, we acquired the Filtration and Separations Group (“FSG”) from United States Filter Corporation (“US Filter”) for $360,000 in cash, subject to a post closing adjustment of the purchase price based on the net assets acquired as of April 27, 2002. The adjustment to the purchase price was finalized in the first quarter resulting in additional consideration due to US Filter of $7,801. The operating results of FSG are reported in our results of operations from April 28, 2002.
The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, Business Combinations (“SFAS No. 141”). SFAS No. 141 requires that the total cost of the acquisition be allocated to the tangible and intangible assets acquired and liabilities assumed based upon their respective fair values at the date of acquisition. In the first quarter, we finalized the valuation of in-process research and development and patented and unpatented technology. Accordingly, the allocation of the purchase price and goodwill were updated for such items, and our net earnings for the nine months ended May 3, 2003 reflect the write-off of in-process research and development (refer to Note 4 in the notes accompanying the condensed consolidated financial statements for further discussion).
The fair value of in-process research and development was expensed because technological feasibility had not been established and no future alternative uses existed (refer to Note 3 in the notes accompanying the condensed consolidated financial statements). The fair value of the patented and unpatented technology, as well as the in-process research and development, was determined using the income approach, which discounts the expected future cash flows to present value. Failure to achieve expected levels of revenue and net income from these products will negatively impact the return on investment expected at the time the acquisition was completed and may result in impairment charges. We believe that the assumptions used in the valuation of these related items represented a reasonable estimate of the future benefits attributable to them at the time of the acquisition.
The discount rates used in the present value calculations were derived from a weighted average cost of capital analysis and, concerning in-process research and development, adjusted upward to reflect additional risks inherent in the development life cycle. The key assumptions specifically underlying the valuation for purchased in-process research and development consist of an expected completion date for the in-process projects, estimated costs to complete the projects, revenue and expense projections, and discount rates based on the risks associated with the development life cycle of the in-process technology acquired. The development of the in-process research and development technologies remains an uncertainty due to the remaining efforts to achieve technological feasibility, changing customer markets, and significant competitive threats from other companies. The nature of the efforts to develop these technologies into commercially viable products consists principally of planning, designing, experimenting, and testing activities necessary to determine that the technologies can meet market expectations, including functionality and technical requirements. Most of these projects were expected for commercialization within one to two years of the acquisition date. The valuation of in-process research and development at the acquisition date was related to forty-eight separate projects. At the date of acquisition, expenditures to complete these projects were not expected to exceed $6,000.
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Expenditures for these projects since the acquisition date, approximated $2,100 and it is estimated that expenditures to complete these projects will not exceed $1,800.
At the date of acquisition, management began formulating integration plans, which contemplated the closure of redundant facilities and the sale of certain businesses. In addition, the synergies created by joining the two organizations have resulted in employee terminations. The condensed consolidated balance sheets at May 3, 2003 and August 3, 2002 reflect liabilities for such items. We expect to finalize and announce other integration plans during the fourth quarter of fiscal 2003. Finalization of such integration plans will be reflected in earnings (refer to Note 4 for discussion of actions taken in the first nine months of fiscal 2003).
For more detail regarding the FSG acquisition and regarding restructuring actions taken, please refer to Notes 3 and 4 in the notes accompanying the condensed consolidated financial statements in this report and our Annual Report on Form 10-K for the fiscal year ended August 3, 2002.
Results of Operations
Review of Consolidated Results
Sales for the quarter increased 39½% to $421,491 from $302,377 for the same period last year. For the nine months, sales grew 32½% to $1,142,223. Exchange rates increased reported sales in the quarter and nine months by $36,598, or 12% and $68,131, or 8%, respectively, primarily due to the strengthening of the Euro and to a lesser extent the British Pound and Japanese Yen. For the nine months, the weakening of the Argentine Peso partly offset the increases in sales that resulted from the Euro, Pound and Yen. In local currency (i.e., had exchange rates not changed period over period), sales increased 27½% and 24½% for the quarter and nine months, respectively. Overall, pricing was flat for the quarter. For the nine months, pricing had a positive impact on sales, contributing 1% to our top line growth.
Compared to last year’s pro forma third quarter sales (which include FSG’s sales for the three months ended March 31, 2002), sales were up 6½% with all segments contributing to this gain. Growth was particularly strong in Microelectronics, Aerospace (which did not benefit from the FSG acquisition) and BioPharmaceuticals. For the nine-month period, sales compared to last year’s pro forma sales (which include FSG’s sales for the nine months ended March 31, 2002), increased 2%. The pro forma sales growth is provided to give an indication of what comparable sales growth would have been had the acquisition occurred at the beginning of each period presented. However, it is not necessarily indicative of what would have occurred if the acquisition had been consummated at those earlier dates due to many factors. These factors include different market approaches and routes to market (i.e., direct sales versus distribution), product rationalization and pricing.
For a detailed discussion of sales, refer to “Review of Market Segments and Geographies.”
On a sequential quarter basis, cost of sales, as a percentage of sales, declined 2.7%, reflecting increased factory throughput in the third quarter and the benefit of foreign exchange. Cost of sales for the quarter, as a percentage of sales, was 48.8% as compared to 48.1% last year. For the nine-month period, cost of sales, as a percentage of sales, increased 1.4% to 50.8% from 49.4% last year. Compared to last year, cost of sales for the quarter and nine months has increased primarily due to the effect of FSG products and product mix, including increased system sales, partly offset by the beneficial effect of foreign exchange. Over time, we expect FSG’s product margins to improve.
Selling, general and administrative expenses as a percentage of sales for the quarter declined 2.6% to 32.9% from 35.5% last year. For the nine-month period, selling, general and administrative expenses as a percentage of sales declined 1.9% to 33.7% from 35.6% last year. The percentage improvement in selling, general and administrative expenses reflects synergies achieved related to our FSG integration efforts, which are estimated at approximately $7,000 in the quarter and $15,000 for the nine months, and the effects of our cost reduction programs, offset by the impact of increased bonus, pension, medical, consulting and insurance costs (see next paragraph), foreign exchange (estimated to have increased selling, general and administrative expenses by about $12,500 in the quarter and $24,500 in the nine month period) and expenses related to the integration of FSG.
We have identified approximately $30,000 in annualized cost synergies that we expect to realize by the end of fiscal year 2004 as a result of our integration of FSG. In fiscal 2003, we expect an increase in pension costs of approximately $4,800 due to the downturn in the equities market and decreased interest rates. In addition, we expect an increase in insurance premiums of approximately $2,000. We will continue efforts to hold down controllable costs to offset the impact of these increases.
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Research and development (“R&D”) expenses in the quarter declined to 3.4% of sales from 4.4% last year, reflecting the elimination of shared research costs with V.I. Technologies (“VITEX”), partly offset by the impact of FSG’s R&D this quarter. For the nine-month period, R&D declined to 3.5% of sales from 4.5% last year reflecting the factors discussed above. As a result of the modification of our partnership agreement to eliminate shared research costs, the fourth quarter of fiscal 2002 included our final R&D payment to VITEX.
In the third quarter, we recorded restructuring and other charges of $5,036 (mainly related to the transfer of Medical manufacturing from Ireland) reflecting severance costs of $2,893, asset write-offs of $323 and other exit costs of $1,820. Restructuring and other charges for the nine-month period were $46,335, reflecting the write-off of in-process research and development acquired in the FSG acquisition of $37,600, severance costs of $6,320, asset write-offs of $528 and other exit costs of $1,887. The charges in the quarter and nine-month period were primarily related to the FSG acquisition and the realignment of our Life Sciences business (refer to Note 12 in the notes to the condensed consolidated financial statements for further discussion of the reorganization of our Life Sciences business) including the transfer of Medical manufacturing from Ireland (which is expected to be completed by the fourth quarter of t his calendar year).
The following table summarizes the activity for the quarter and nine months ended May 3, 2003 related to restructuring liabilities recorded in fiscal 2002 and fiscal 2003:
| | Fiscal 2003 | | Fiscal 2002 | |
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| | Severance | | Lease
Termination
Liabilities &
Other | | Total | | Severance | | Lease
Termination
Liabilities &
Other | | Total | |
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| |
|
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| Balance at Aug. 3, 2002 | $ | – | | $ | – | | $ | – | | $ | 8,937 | | $ | 1,487 | | $ | 10,424 | |
| Additions | 13,773 | | | 8,465 | | | 22,238 | | | – | | | – | | | – | |
| Utilized | (5,475 | ) | | (5,010 | ) | | (10,485 | ) | | (7,107 | ) | | (1,316 | ) | | (8,423 | ) |
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| |
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| |
|
| |
| Balance at May 3, 2003 | $ | 8,298 | | $ | 3 ,455 | | $ | 11,753 | | $ | 1,830 | | $ | 171 | | $ | 2,001 | |
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The details of the charges for the quarter and nine-months can be found in Note 4 in the notes accompanying the condensed consolidated financial statements. We expect to recover the costs of the restructuring-related charges within two years from the date of the charge.
Net interest expense increased $3,175 and $10,570 for the quarter and nine months, respectively, reflecting increased borrowings to fund the FSG acquisition partly offset by the effect of our “receive fixed, pay variable interest rate swaps. Please refer to the Liquidity and Capital Resources section of the Management’s Discussion and Analysis as well as Note 9 in the notes to the condensed consolidated financial statements for discussion of our interest rate swaps. As a result of these swaps and reduced debt levels, net interest expense in the third quarter declined $442 and $1,501 as compared to the second and first quarters, respectively.
For the nine-month period, the tax rate was 33% due to the non-deductibility of the in-process research and development charge taken in the first quarter. The underlying effective tax rate for the quarter and nine months of each year was 22% and 24% for all of fiscal 2002. The improvement in the underlying effective rate as compared to all of fiscal 2002 was a result of fine-tuning our tax planning strategies in the first quarter of this year. We expect to sustain a rate of 22% for the remainder of fiscal 2003.
Net earnings for the quarter were $40,355, or 33 cents per share, compared with net earnings of $26,443, or 21 cents per share last year. For the nine months, net earnings were $48,596, or 39 cents per share, compared with net earnings of $64,250, or 52 cents per share last year. Net earnings in the quarter and nine months benefited from organic sales growth, the impact of the FSG acquisition, the controlling of expenses and the benefit of foreign exchange rates, partly offset by restructuring and other charges. Due to the difficulty in estimating the economic effect of foreign currency rates, particularly in periods of high volatility of such rates, the Company will no longer provide estimated effects but will report the translation effect to earnings per share. We estimate that foreign exchange translation added 4 cents to earnings per share in the quarter and 6 cents for the nine months.
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Review of Market Segments and Geographies
Market Segments:
The tables below compare sales by market segment for the three and nine months ended May 3, 2003 to sales for the comparable prior year periods restated to reflect the Life Sciences reorganization (as discussed in Note 12 in the notes to the accompanying condensed consolidated financial statements), including the effect of exchange rates.
Three Months Ended | May 3, 2003 (As reported) | | Apr. 27, 2002 (As reported) | | % Change | | | Exchange Rate Difference | | % Change in local currency | |
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| Medical | $ | 83,985 | | $ | 79,075 | | 6 | | $ | 5,092 | | – | |
| BioPharmaceuticals | | 93,295 | | | 73,093 | | 27 | ½ | | 8,030 | | 16 | ½ |
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| | | |
| Total Life Sciences | | 177,280 | | | 152,168 | | 16 | ½ | | 13,122 | | 8 | |
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| General Industrial | | 150,050 | | | 84,351 | | 78 | | 17,494 | | 57 | |
| Aerospace | | 51,060 | | | 38,454 | | 33 | | | 2,855 | | 25 | ½ |
| Microelectronics | | 43,101 | | | 27,404 | | 57 | ½ | | 3,127 | | 46 | |
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| Total Industrial | | 244,211 | | | 150,209 | | 62 | ½ | 23,476 | | 47 | |
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| Total | $ | 421,491 | | $ | 302,377 | | 39 | ½ | $ | 36,598 | | 27 | ½ |
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| | | | | | | | | | | | | | |
Nine Months Ended | May 3, 2003 (As reported) | | Apr. 27, 2002 (As reported) | | % Change | | | Exchange Rate Difference | | % Change in local currency | |
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| Medical | $ | 221,070 | | $ | 219,243 | | 1 | | $ | 9,602 | | (3 | ½) |
| BioPharmaceuticals | | 249,010 | | | 205,967 | | 21 | | 15,086 | | 13 | ½ |
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| Total Life Sciences | | 470,080 | | | 425,210 | | 10 | ½ | 24,688 | | 4 | ½ |
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| General Industrial | | 417,317 | | | 245,046 | | 70 | ½ | 31,628 | | 57 | ½ |
| Aerospace | | 134,032 | | | 114,836 | | 16 | ½ | | 5,901 | | 11 | ½ |
| Microelectronics | | 120,794 | | | 76,839 | | 57 | | | 5,914 | | 49 | ½ |
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| | | |
| Total Industrial | | 672,143 | | | 436,721 | | 54 | | 43,443 | | 44 | |
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|
| |
|
| | | |
|
| | | |
| Total | $ | 1,142,223 | | $ | 861,931 | | 32 | ½ | $ | 68,131 | | 24 | ½ |
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The tables below compare sales for the three and nine months ended May 3, 2003 to sales for the comparable prior year periods restated for the aforementioned Life Sciences reorganization presented on a pro forma basis to include FSG sales for the three and nine months ended March 31, 2002. The pro forma sales growth is provided to give an indication of what comparable sales growth would have been had the acquisition occurred at the beginning of each period presented. However, it is not necessarily indicative of what would have occurred if the acquisition had been consummated at those earlier dates due to many factors. These factors include different market approaches and routes to market (i.e., direct sales versus distribution), product rationalization and pricing.
| Three Months Ended | May 3, 2003 (As reported) | | Apr. 27, 2002 (Pro Forma) | | % Change | | | Exchange Rate Difference | | % Change in local currency | |
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| Medical | $ | 83,985 | | $ | 79,076 | | 6 | | $ | 5,092 | | – | |
| BioPharmaceuticals | | 93,295 | | | 77,674 | | 20 | | | 8,030 | | 10 | |
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| | | |
| Total Life Sciences | | 177,280 | | | 156,750 | | 13 | | 13,122 | | 4 | ½ |
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|
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| General Industrial | | 150,050 | | | 131,214 | | 14 | ½ | 17,494 | | 1 | |
| Aerospace | | 51,060 | | | 38,454 | | 33 | | | 2,855 | | 25 | ½ |
| Microelectronics | | 43,101 | | | 34,532 | | 25 | | | 3,127 | | 16 | |
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| Total Industrial | | 244,211 | | | 204,200 | | 19 | ½ | 23,476 | | 8 | |
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| Total | $ | 421,491 | | $ | 360,950 | | 17 | | $ | 36,598 | | 6 | ½ |
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Nine Months Ended | May 3, 2003 (As reported) | | Apr. 27, 2002 (Pro Forma) | | % Change | | | Exchange Rate Difference | | % Change in local currency | |
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| Medical | $ | 221,070 | | $ | 219,263 | | 1 | | $ | 9,602 | | (3 | ½) |
| BioPharmaceuticals | | 249,010 | | | 220,537 | | 13 | | 15,086 | | 6 | |
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|
| | | |
| Total Life Sciences | | 470,080 | | | 439,800 | | 7 | | 24,688 | | 1 | ½ |
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| General Industrial | | 417,317 | | | 400,299 | | 4 | ½ | 31,628 | | (3 | ½) |
| Aerospace | | 134,032 | | | 114,836 | | 16 | ½ | | 5,901 | | 11 | ½ |
| Microelectronics | | 120,794 | | | 100,331 | | 20 | ½ | | 5,914 | | 14 | ½ |
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| Total Industrial | | 672,143 | | | 615,466 | | 9 | | 43,443 | | 2 | |
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| Total | $ | 1,142,223 | | $ | 1,055,266 | | 8 | | $ | 68,131 | | 2 | |
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The discussions of sales growth below are in local currency unless indicated otherwise.
Life Sciences sales increased 8% and 4½% for the quarter and nine months, respectively, as compared with the same periods last year. On a pro forma basis to include FSG, sales grew 4½% and 1½% for the quarter and nine months, respectively. Life Sciences represented approximately 42% of our total sales for the quarter and nine months as compared to approximately 50% for the same periods last year.
Within Life Sciences, Medical segment sales were flat as compared to the third quarter of fiscal 2002 as a 3% increase in Critical Care was offset by a 1½% decline in Blood sales. On a sequential quarter basis, Medical sales grew 6%. For the nine-month period, Medical sales declined 3½% reflecting a decline in Blood sales of 7½% partly offset by an increase in Critical Care of 7%. The decline in Blood sales for the nine-month period was primarily due to a decrease in the level of blood donations as compared to last year. By geography, the Western Hemisphere and Asia reported low single-digit growth in Medical sales in the quarter, while Europe was down. For the nine months, the Western Hemisphere and Europe reported declines in Medical sales compared to the same period last year, while sales in Asia were flat.
BioPharmaceuticals segment sales grew 16½% and 13½% in the quarter and nine-months, respectively, as compared to the same periods last year. Sales on a pro-forma basis grew 10% and 6% for the quarter and nine months, respectively. Growth in BioPharmaceuticals was attributable to our Pharmaceutical sub-market where sales increased 28½% in the quarter and 21½% for the nine-months. This sub-market has benefited from the biotechnology industry, which is driving growth. All geographies reported strong growth in the Pharmaceuticals sub-market. In BioSciences, the other sub-market in our BioPharmaceuticals segment, sales were down 6½% in the quarter and 2½% for the nine-month period reflecting a softening of our lab business due to customer consolidations and budget cuts. In addition, sales were down in the Specialty Materials part of our BioSciences business. By geography, the decline in BioSciences for the quarter and nine months reflects shortfalls in Europe and the Western Hemisphere. In Asia, BioSciences sales were flat in the quarter, however, on a year-to-date basis, sales were up.
Our Industrial business, where the majority of FSG’s sales are reported, accounted for approximately 58% of total sales for the quarter and nine-month period, as compared to 50% for the same periods last year. Industrial sales grew 47% and 44% in the quarter and nine-month period, respectively, due to the inclusion of FSG in the periods. Sales on a pro forma basis increased 8% in the quarter and 2% for the nine months reflecting strong growth in Aerospace and Microelectronics.
General Industrial segment sales, which are the largest portion of our Industrial business, grew 57% in the quarter and 57½% for the nine-month period, with all geographies contributing to this gain. All sub-markets within General Industrial reported strong sales growth for the quarter and nine months. On a pro forma basis, General Industrial sales grew 1% in the quarter; however, the segment’s sales were down 3½% for the nine-month period. Within General Industrial, sales in our Water Processing sub-market increased 19% and 49% for the quarter and nine months, respectively. The growth in Water Processing reflects our continued successful pilot testing at prospective municipal sites and our market penetration in Eastern Europe and Asia. Sales in our Food & Beverage sub-market grew 151½% and 154% in the quarter and nine months, respectively, as the integration of FSG technologies and exper tise has significantly broadened our breadth and reach. All geographies contributed to this gain, however, sales were particularly strong in Europe and Asia, especially in the emerging beer markets in Eastern Europe and China. Sales in our Fuels & Chemicals sub-market grew 89½% and 70% for the quarter and nine months, respectively. Strategic partnerships are creating excellent growth opportunities and a key growth driver
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continues to be clean fuels and synthetic fuels initiatives based on environmental driven regulations. Sales in our Power Generation sub-market increased 6½% and 13% for the quarter and nine months, respectively. Power Generation sales growth was strong in Europe and Asia, although we have seen some weakening in the Western Hemisphere and European OEM turbine market.
Aerospace sales grew 25½% in the quarter and 11½% for the nine months, reflecting strong Military sales. Military sales, which were boosted by the Middle East conflict, grew 55% and 22½% in the quarter and nine months, respectively. Growth in Military sales was driven by Europe and to a lesser extent the Western Hemisphere. We expect strong military sales to continue for the balance of the year. Commercial sales were flat in the quarter and nine months as growth in the Western Hemisphere was offset by a decline in Europe. Excluding the Marine water portion of our Commercial Aerospace business, sales were up 6% in the quarter and 2½% in the nine-month period. In the quarter, Military sales comprised approximately 58% of total Aerospace sales as compared to 47% in the third quarter of last year.
Microelectronics sales grew 46% and 49½% in the quarter and nine months, respectively, as compared with last year. On a pro-forma basis, sales increased 16% and 14½% for the quarter and nine months, respectively. This is the fourth consecutive quarter of double-digit sales growth, despite the fact that the semiconductor OEM market remains weak globally and its near term outlook is uncertain. All geographies reported double-digit sales growth in the quarter and nine-month periods. We are achieving growth in the photolithography materials and data storage markets and we have been executing our strategy of providing integrated solutions for all of the filtration, purification and waste minimization applications affecting wafer production.
The Company’s consolidated operating profit as a percentage of sales for the quarter increased to 19.8% from 16.9% last year. For the nine-month period operating profit was 16.6% as compared to 15.7% for the same period last year.
In Life Sciences, overall operating profit margins for the quarter increased to 22.4% from 20.1% last year reflecting an improvement in Medical operating profit margins. For the nine-month period, Life Sciences’ overall operating profit margin of 18.7% was similar to last year, while operating profit dollars increased 10%.
Within Life Sciences, Medical operating profit margins for the quarter improved to 19.5% from 15.6% in the third quarter of last year. Medical operating profit margins also improved on a sequential quarter basis from 16% in the second quarter and 7.8% in the first quarter. Medical operating profit margins for the nine-months improved to 15.2% from 13% last year and in dollars the increase was 17½%. The improvements in operating profit margins reflect manufacturing based cost reduction programs, synergies realized as a result of the reorganization of the critical care and blood businesses (refer to Note 4 for discussion of actions taken in the first nine months of fiscal 2003) and the elimination of our R&D cost sharing with VITEX. Additionally, the elimination of most distributor commission payments, which is expected to result in an annual savings of $3,000, positively impacted operating profit margins. Operating profit margins in BioPharmaceuticals of 24.9% were similar to last year. For the nine-month period, operating profit margins declined to 21.9% as compared to 25% last year. The decrease in margin for the nine months was primarily related to a change in product mix. FSG’s sales, which carry a lower gross margin, also contributed to the decline. Overall we expect BioPharmaceuticals margins to fluctuate within a range of 20% – 25% based on the sales mix.
Overall operating profit margins in Industrial improved to 17.9% in the quarter from 13.6% last year. For the nine months, operating profit margins improved to 15.2% from 12.7%. General Industrial operating profit margins in the quarter improved to 13.1% from 10.7% last year. For the nine months, General Industrial operating profit margins increased to 10.7% from 10.3%. The improvement in operating profit margin for the quarter and nine months reflects a change in product mix and cost reductions partly offset by the addition of FSG products, which carry lower margins. Aerospace operating profit margins improved to 32% from 23.3% in the quarter and to 28% from 24.1% for the nine months, primarily attributable to strong Military sales. Microelectronics operating profit margins improved to 18% in the quarter and 16.4% for the nine-month period from 8.8% and 3.3% in the same periods last year, driven by strong sales grow th. Looking at the dollar increases in operating profits for the nine months compared to last year, the increases in General Industrial, Aerospace and Microelectronics were 76%, 36% and 674% respectively.
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Geographies:
The tables below compare sales to unaffiliated customers by geography for the three and nine months ended May 3, 2003 to sales for the comparable prior year periods, including the effect of exchange rates. The discussions of sales growth below are in local currency unless indicated otherwise.
| | | | | | | | | | | | | | % | |
| Three Months Ended | May 3, 2003 | | Apr. 27, 2002 | | % Change | | | | Exchange Rate Difference | | Change in local currency | |
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| Western Hemisphere | $ | 164,410 | | $ | 141,829 | | 16 | | | $ | 1,122 | | 15 | |
| Europe | | 178,536 | | | 107,328 | | 66 | ½ | | | 29,602 | | 39 | |
| Asia | | 78,545 | | | 53,220 | | 47 | ½ | | | 5,874 | | 36 | ½ |
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| Total | $ | 421,491 | | $ | 302,377 | | 39 | ½ | | $ | 36,598 | | 27 | ½ |
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Nine Months Ended | May 3, 2003 | | Apr. 27, 2002 | | | | | | Exchange Rate Difference | | %
Change in local currency | |
% Change |
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| |
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| | | | | | | | | | | | | | | |
| Western Hemisphere | $ | 453,569 | | $ | 393,841 | | 15 | | | $ | (3,173 | ) | 16 | |
| Europe | | 479,556 | | | 307,348 | | 56 | | | | 61,377 | | 36 | |
| Asia | | 209,098 | | | 160,742 | | 30 | | | | 9,927 | | 24 | |
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| Total | $ | 1,142,223 | | $ | 861,931 | | 32 | ½ | | $ | 68,131 | | 24 | ½ |
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By geography, sales in the Western Hemisphere increased 15% in the quarter and 16% for the nine-month period. Exchange rates added $1,122 to sales in the quarter. For the nine-month period, exchange rates, primarily related to the weakening of the Argentine Peso, negatively impacted sales by $3,173. Operating profit margins in the quarter improved to 15.4% from 11.6% last year. For the nine-month period, operating profit margins increased to 13.3% from 10.8% last year. The 48½% increase in operating profit dollars in the Western Hemisphere reflects the improvements in margins achieved in our various business segments as noted above.
In Europe, sales increased 39% and 36% for the quarter and nine months, respectively, compared to last year. The strengthening of European currencies added $29,602 and $61,377 in sales, resulting in reported sales growth of 66½% and 56% in the quarter and nine months, respectively. Operating profit margins in the quarter declined to 18.3% from 18.5% last year and for the nine-month period declined to 15.5% from 16.5%, reflecting the lower rate of profit on FSG products. However, operating profit dollars in the quarter and the nine months increased 61% and 45½%, respectively.
Sales in Asia increased 36½% and 24% in the quarter and nine months, respectively. The strengthening of Asian currencies added $5,874 and $9,927 in sales, resulting in reported sales growth of 47½% and 30% in the quarter and nine months, respectively. Operating profit margins improved to 17.4% from 16.1% last year primarily due to strong sales growth and the effect of foreign exchange partly offset by the impact of lower FSG margins. For the nine-month period, operating profit margins declined to 14.9% from 16.1% reflecting a change in product mix and the impact of lower FSG margins. Operating profit dollars in Asia increased 61% and 20½% for the three months and nine months, respectively.
General corporate expenses were up $5,806 in the quarter and $7,250 for the nine-month period reflecting increased bonus, pension, consulting and insurance costs.
Liquidity and Capital Resources
The Company’s balance sheet is affected by spot exchange rates used to translate local currency amounts into U.S. dollars. In comparing spot exchange rates at May 3, 2003 to those at the end of fiscal 2002, the European currencies and the Yen have strengthened against the U.S. dollar.
The acquisition of FSG in the third quarter of fiscal 2002 was initially funded via a $360,000 364-day variable rate credit facility. On August 6, 2002, we issued $280,000 of 10-year bonds at an annual interest rate of 6%. The proceeds were utilized to repay a portion of the interim acquisition credit facility. Additionally, on October 18, 2002,we refinanced the remainder of the acquisition credit facility with a $100,000 term loan bearing interest based on LIBOR.
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We received $8,568 representing $7,533 of fair value for “receive fixed, pay variable” interest rate swaps with an aggregate notional value of $100,000, terminated on November 26, 2002, and $1,035 of accrued interest receivable through the termination date. The terminated swaps related to our $100,000 private placement of 7.83% unsecured senior notes due in 2010. Simultaneously, we entered into new interest rate swaps with a notional amount of $230,000 involving the $280,000, 6% notes due on August 1, 2012. The new swaps require that we make payments at a variable rate based on LIBOR and receive payments at a fixed rate of 6%. On May 30, 2003, we received $16,134 representing $13,467 of fair value for the new “receive fixed, pay variable” interest rate swaps, terminated on May 28, 2003, and $2,667 of accrued interest receivable through the termination date and simultaneously entered into substantially the same “receive fixed, pay variable” interest rate swaps except for an increase in the spread above LIBOR. The $21,000 of fair value received to terminate the interest rate swaps will be amortized as a reduction of interest expense over the remaining lives of the underlying notes.
We have received a commitment from a financial institution to refinance our Yen 3 billion loan (approximately $25,000), which is due on June 18, 2003, until June 18, 2005. The terms of the commitment will require us to make interest payments at a floating rate based upon Yen LIBOR. As such, the Yen loan is classified as long-term debt in our May 3, 2003 condensed consolidated balance sheet. On March 7, 2003, we entered into a forward dated “receive variable, pay fixed” interest rate swap related to this loan, whereby we would receive payments at a variable rate based upon Yen LIBOR and make payments at a fixed rate of .95% on a notional amount of Yen 3 billion. The swap expires on June 18, 2005. As it is our intent to enter into this loan, this swap will be accounted for as a hedge of a forecasted transaction until June 18, 2003. Accordingly, changes in the fair value of the swap will be reflected in other comprehensive income.
In April 2003, we amended the terms of the “receive variable, pay fixed” interest rate swap related to certain borrowings under the senior credit facility. The Company receives payments at a variable rate based on LIBOR and makes payments at an effective fixed rate of 4.3% on a notional amount of $25,000. The swap expires in February 2006.
Net cash provided by operating activities for the first nine months of fiscal 2003 was $127,940, an increase of $23,248 compared to the same period of fiscal 2002. The increase in cash flow from operations was generated by increased earnings as well as by accounts receivable, partly offset by increased inventory levels and lower levels of accounts payable. Additionally, the first quarter of fiscal 2002 included a rebate payment to a major blood customer. The increase in inventory reflects increased work-in-process and replenishment of stock for anticipated fourth quarter shipments, as well as, the effect of exchange rates.
Working capital was approximately $553,000, a ratio of 2.4 at May 3, 2003 as compared to $478,000, a ratio of 2.1 at August 3, 2002. Accounts receivable days sales outstanding was 84 days, as compared to 94 at August 3, 2002, while inventory turns have improved to 2.9 from 2.8. The effect of foreign exchange increased inventory, accounts receivable and other current assets by $11,730, $22,449 and $2,376, respectively, as compared to August 3, 2002. Additionally, foreign exchange increased accounts payable and other current liabilities by $15,190 and income taxes payable by $899.
When operating the business day-to-day, excluding acquisitions but including funding capital expenditures and buying back common stock, our current intention is to keep net debt (debt net of cash, cash equivalents and short-term investments) at 25% to 30% of total capitalization (net debt plus equity). Net debt decreased by approximately $62,800 compared with year-end fiscal 2002. The impact of foreign exchange rates accounted for $9,600 of the reduction, while the fair value adjustment on our fixed to variable interest rate swaps carried as part of debt increased debt by approximately $5,800. As such, the actual cash reduction in our net debt was $59,000 for the first nine months of fiscal 2003. Overall, net debt, as a percentage of total capitalization, was 36.7% as compared to 41.3% at year-end fiscal 2002. Our goal for fiscal 2003 is to aggressively reduce net debt by $75,000 to facilitate our return to the debt levels that existed prior to the acquisition. Therefore, we did not purchase treasury stock during the first nine months of fiscal 2003. Capital expenditures were $39,303 of which $11,068 was spent in the third quarter. Depreciation expense was $18,643 and $56,615 in the quarter and nine months, respectively. Amortization expense was $2,108 and $6,111 for the quarter and nine months, respectively. We expect capital expenditures to be at or below $65,000 in fiscal 2003.
As mentioned previously, we modified our partnership agreement with VITEX to eliminate shared research costs. On June 4, 2003, we purchased 4,147 VITEX shares for $4,230, including the final milestone payment of $4,000 as per our agreement with VITEX and concurrently, VITEX repaid the $5,000 borrowed under the one-year line of credit that we had extended them. In a recent press release, VITEX management indicated that the cash
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received from their recent rights offering, wherein they raised $14,351 (including $230 purchased by the Company), represents approximately seven months of cash flow.
We consider our existing lines of credit, along with the cash generated from operations, to be sufficient for future growth. It is management’s intention to refinance any unpaid amounts under the unsecured senior revolving credit facility when it expires in 2005.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days prior to the filing date of this Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-14 and 15d-14 under the Securities Exchange Act of 1934. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.
There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the Company’s internal controls subsequent to the date the Company carried out its evaluation.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
In February 1988, an action was filed in the Circuit Court for Washtenaw County, Michigan (“Court”) by the State of Michigan (“State”) against Gelman Sciences Inc. (“Gelman”), a subsidiary acquired by the Company in February 1997. The action sought to compel Gelman to investigate and remediate contamination near Gelman’s Ann Arbor facility and requested reimbursement of costs the State had expended in investigating the contamination, which the State alleged was caused by Gelman’s disposal of waste water from its manufacturing process. Pursuant to a consent judgment entered into by Gelman and the State in October 1992 (amended September 1996 and October 1999), which resolved that litigation, Gelman is remediating the contamination without admitting wrongdoing. In February 2000, the State Assistant Attorney General filed a Motion to Enforce Consent Judgment in the Court seeking ap proximately $4,900,000 in stipulated penalties for the alleged violations of the consent judgment and additional injunctive relief. Gelman disputed these assertions. In July 2000, the Court took the matter of penalties “under advisement.” The Court issued a Remediation Enforcement Order requiring Gelman to submit and implement a detailed plan that will reduce the contamination to acceptable levels within five years. The Company’s plan has been submitted to, and approved by, both the Court and the State. In the opinion of management, to date the Court has expressed its satisfaction with the Company’s progress. Subsequently, the State asserted in correspondence dated June 5, 2001 that additional stipulated penalties in the amount of $141,500 were owed for a separate alleged violation of the consent judgment. The Court found that a “substantial basis” for Gelman’s position existed and again took the State’s request under advisement, pending the results of certain groundwa ter monitoring data. On August 9, 2001, the State made a written demand for reimbursement of $227,462 plus interest it has allegedly incurred for groundwater monitoring. Gelman considers this claim barred by the consent judgment. The Company’s balance sheet at May 3, 2003 contains reserves of approximately $14,900,000, which relates mainly to the aforementioned cleanup. In the opinion of management, the Company is in substantial compliance with applicable environmental laws and its current accruals for environmental remediation are adequate.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
| | (a) | Exhibits |
| | | |
| | | See the index to exhibits for a list of exhibits filed herewith. |
| | | |
| | (b) | Reports on Form 8-K. |
| | | |
| | | On June 5, 2003, the Company filed Form 8-K under Item 9. Information provided under Item 12 (Results of Operations and Financial Condition). On June 6, 2003 a Form 8-K/A was filed to correct a typographical error in the Form 8-K filed on June 5, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | Pall Corporation |
| | | |
| June 17, 2003 | /s/ | JOHN ADAMOVICH, JR. |
| | | John Adamovich, Jr.
Chief Financial Officer
and Treasurer |
| | | |
| June 17, 2003 | /s/ | LISA KOBARG
Lisa Kobarg
Chief Accountant |
| | | |
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CHIEF EXECUTIVE OFFICER CERTIFICATION
I, Eric Krasnoff, certify that:
| | 1. | I have reviewed this quarterly report on Form 10-Q of Pall Corporation; |
| | | | |
| | 2.
| Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; |
| | | | |
| | 3.
| Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of Pall Corporation as of, and for, the periods presented in this quarterly 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-14 and 15d-14) for the registrant and we have: |
| | | | |
| | | a) | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; |
| | | | |
| | | b) | evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and |
| | | | |
| | | c) | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
| | | | |
| | 5. | The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function): |
| | | | |
| | | a) | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and |
| | | | |
| | | b) | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and |
| | | | |
| | 6.
| The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. |
June 17, 2003
| | /s/ | ERIC KRASNOFF
Eric Krasnoff
Chief Executive Officer |
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CHIEF FINANCIAL OFFICER CERTIFICATION
I, John Adamovich, Jr., certify that:
| | 1. | I have reviewed this quarterly report on Form 10-Q of Pall Corporation; |
| | | |
| | 2. | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; |
| | | |
| | 3. | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of Pall Corporation as of, and for, the periods presented in this quarterly 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-14 and 15d-14) for the registrant and we have: |
| | | | |
| | | a. | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; |
| | | | |
| | | b. | evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and |
| | | | |
| | | c. | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
| | | |
| | 5. | The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function): |
| | | | |
| | | a. | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and |
| | | | |
| | | b. | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and |
| | | |
| | 6. | The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. |
June 17, 2003
| | /s/ | JOHN ADAMOVICH, JR. |
| | | John Adamovich, Jr.
Chief Financial Officer |
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EXHIBIT INDEX
| Exhibit | |
Number | Description of Exhibit |
| | |
| 2(i)* | Stock Purchase Agreement dated February 14, 2002, by and between the Registrant and United States Filter Corporation, filed as Exhibit 2 to the Registrant’s Quarterly Report on Form 10-Q forthe quarterly period ended January 26, 2002. |
| | |
| 2(ii)* | Amendment dated April 24, 2002, to Stock Purchase Agreement dated February 14, 2002, by and between the Registrant and United States Filter Corporation, filed as Exhibit 2.2 to theRegistrant’s Current Report on Form 8-K bearing cover date of April 24, 2002. |
| | |
| 3(i)* | Restated Certificate of Incorporation of the Registrant as amended through November 23, 1993, filed as Exhibit 3(i) to the Registrant's Annual Report on Form 10-K for the fiscal year ended July30, 1994. |
| | |
| 3(ii)* | By-Laws of the Registrant as amended on October 3, 2002, filed as exhibits 3(ii) and 3(iii) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended August 3, 2002. |
| | |
| 4(i)* | Credit Agreement dated as of August 30, 2000 by and among the Registrant and Fleet Bank, National Association as Administrative Agent, The Chase Manhattan Bank as Syndication Agent, Wachovia Bank, N.A. as Documentation Agent and The Lenders Party Thereto, filed as Exhibit 4 to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended October 28,2000. |
| | |
| 4(ii)* | Indenture dated as of August 1, 2002, by and among Pall Corporation as Issuer, the Guarantors named therein, as Guarantors, and The Bank of New York, as Trustee, filed as Exhibit 4(iii) to theRegistrant’s Annual Report on Form 10-K for the fiscal year ended August 3, 2002. |
| | |
| | The exhibits filed herewith do not include other instruments with respect to long-term debt of the Registrant and its subsidiaries, inasmuch as the total amount of debt authorized under any such instrument does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. The Registrant agrees, pursuant to Item 601(b) (4) (iii) of Regulation S-K, that it will furnish a copy of any such instrument to the Securities and Exchange Commission upon request. |
| | |
| 99.1† | Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
| 99.2† | Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002. |
| * | Incorporated herein by reference. |
| | |
| † | Exhibits filed herewith |
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