The tables below present sales by market and geography within the Industrial segment for the three months ended October 31, 2009 and October 31, 2008, including the effect of exchange rates for comparative purposes.
Industrial segment sales decreased 15.5% in the first quarter of fiscal year 2010, reflecting declines of 12.3% in the EWPT market, 21.6% in the Aerospace & Transportation market and 19.2% in the Microelectronics market. This reflects a reduction in end market activity with a decrease in consumables sales of 17.6%. Industrial represented approximately 56% of the Company’s total sales in the first quarter of fiscal year 2010, compared to 62% in the first quarter of fiscal year 2009.
The EWPT market sells process related products to producers of municipal water, power generation, fuels & chemicals, foods & beverages as well as to the Industrial Manufacturing Submarkets which consists of a grouping of producers of pulp and paper, mining, automotive and metals. The sales results by the submarkets that comprise EWPT are discussed below:
The Aerospace & Transportation market is comprised of sales of air, water, lubrication, fuel and machinery/hydraulic protection products to OEM manufacturers and end-user customers in Military Aerospace, Commercial Aerospace and Transportation. The decrease in Aerospace and Transportation sales reflects declines in the Military Aerospace, Commercial Aerospace and Transportation submarket groupings of 29.8%, 8.5% and 21.5%, respectively, as discussed below.
Sales to the Military Aerospace submarket, which represented less than 10% of total Industrial sales, decreased in all geographies reflecting timing of shipments as well as projects in fiscal year 2009 that will not repeat this fiscal year.
Sales to the Commercial Aerospace submarket, which represented less than 10% of total Industrial sales, decreased reflecting a reduction in the Western Hemisphere related to weakness in the regional and private jet marketplace, partly offset by growth in Europe.
The decline in sales in the Transportation submarket, which represented less than 10% of total Industrial sales, primarily reflects weakness in the overall marketplace, particularly the mining vehicle market.
Microelectronics sales declined 19.2% reflecting decreases in all geographies. Overall, the sales decrease reflects the weakness in the semiconductor and consumer electronics markets related to the global economic environment. On a sequential quarter basis, the first quarter of fiscal year 2010 held steady with an improved fourth quarter of fiscal year 2009.
Industrial gross margins in the first quarter of fiscal year 2010 decreased 160 basis points to 44.5% from 46.1% in the first quarter of fiscal year 2009. The decrease in gross margin reflects unfavorable absorption of manufacturing overhead due to volume reduction that is estimated to have reduced gross margin by approximately 140 basis points. Gross margin was also negatively impacted by warranty costs and unfavorable mix changes. The change in mix principally relates to a shift in product mix to a higher percentage of systems sales (about 15.4% of total Industrial sales compared to about 13.3% in the first quarter of fiscal year 2009). These negative factors were partly offset by an improvement in margins on systems sales, improved pricing and the effects of cost reduction and lean manufacturing initiatives which offset inflationary increases in manufacturing costs.
SG&A expenses decreased by $2,302, or 2.3% (4% in local currency), compared to the first quarter of fiscal year 2009. The decrease in SG&A reflects the impact of cost reduction initiatives, including headcount reductions made in the last nine months of fiscal year 2009 related to the economic slowdown, a decrease in discretionary expenditures, partly offset by increases in other expenses, such as retirement benefit costs and facility costs related to the consolidation in to new facilities. SG&A expenses as a percentage of sales were 32.0% compared to 28.3% in the first quarter of fiscal year 2009 reflecting the decline in sales.
R&D expenses decreased 14.3% to $7,428 from $8,666 in the first quarter of fiscal year 2009 reflecting reductions in short-term spending due to the economic downturn. As a percentage of sales, R&D expenses were 2.4% on par with the first quarter of fiscal year 2009.
As a result of the above factors, operating profit dollars decreased 43.8% to $30,971. In local currency, operating profit decreased 42.9%. Operating margin decreased to 10.1% from 15.4% in the first quarter of fiscal year 2009.
Corporate:
Corporate expenses in the first quarter of fiscal year 2010 decreased by $4,575 or 26.9% to $12,447 from $17,022 in the first quarter of fiscal year 2009. The decrease in Corporate expenses primarily reflects a decrease in consulting fees and a decrease in foreign currency transaction losses.
Liquidity and Capital Resources
Non-cash working capital, which is defined as working capital excluding cash and cash equivalents, notes receivable, notes payable and the current portion of long-term debt, was approximately $641,600 at October 31, 2009 as compared with $577,900 at July 31, 2009. Excluding the effect of foreign exchange (discussed below), non-cash working capital increased approximately $53,200 compared to July 31, 2009.
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 October 31, 2009 to those at July 31, 2009, the Euro and the Japanese Yen have strengthened against the U.S. Dollar, while the British Pound has weakened against the U.S. Dollar. The effect of foreign currency translation increased non-cash working capital by $10,543, including net inventory, net accounts receivable and other current assets by $3,680, $11,447 and $1,629, respectively, as compared to July 31, 2009. Additionally, foreign currency translation increased accounts payable and other current liabilities by $5,895 and current income taxes payable by $318.
Net cash provided by operating activities in the first quarter of fiscal year 2010 was $73,040 as compared to $50,854 in the first quarter of fiscal year 2009, an increase of $22,186, or 43.6%. The increase in net cash provided by operating activities primarily reflects an improvement in the Company’s cash conversion cycle as discussed below and reduced interest payments.
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The Company’s full cash conversion cycle, defined as days in inventory outstanding (“DIO”) plus days sales outstanding (“DSO”) less days payable outstanding, decreased to 161 days from 162 days in the quarter ended October 31, 2008. This improvement reflects a reduction in DIO partially offset by an increase in DSO.
Free cash flow, which is defined as net cash provided by operating activities less capital expenditures, was $35,959 in the first quarter of fiscal year 2010, as compared with $24,567 in the first quarter of fiscal year 2009. The increase in free cash flow reflects the increase in net cash provided by operating activities as discussed above, partly offset by an increase in capital expenditures. The Company utilizes free cash flow as one way to measure its current and future financial performance. Company management believes this measure is important because it is a key element of its planning. The following table reconciles net cash provided by operating activities to free cash flow.
| | | | Oct. 31, 2009 | | Oct. 31, 2008 |
| | Net cash provided by operating activities | | $ | 73,040 | | $ | 50,854 |
| Less capital expenditures | | | 37,081 | | | 26,287 |
| Free cash flow | | $ | 35,959 | | $ | 24,567 |
Overall, net debt (debt net of cash and cash equivalents) as a percentage of total capitalization (net debt plus equity) was 19.6% at October 31, 2009 as compared to 21.4% at July 31, 2009. Net debt decreased by approximately $11,800 compared with July 31, 2009, comprised of an increase in cash and cash equivalents of $11,900, partly offset by an increase in gross debt of $2,100. The impact of foreign exchange rates decreased net debt by about $2,000 (including the revaluation of the Yen loan described below). Significant uses of cash in the first quarter of fiscal year 2010 included the payment of dividends of $33,913 (see discussion below). The Company has a loan of Yen 9 billion ($99,981 at October 31, 2009) that is due on June 20, 2010.
The Company's five-year revolving credit facility contains financial covenants which provide that the Company may not have a consolidated net interest coverage ratio, based upon trailing four quarter results, that is less than 3.5 to 1.00, nor a consolidated leverage ratio, based upon trailing four quarter results, that is greater than 3.5 to 1.00. As of October 31, 2009, the Company was in compliance with all related financial and other restrictive covenants, including limitations on indebtedness.
The Company manages certain financial exposures through a risk management program that includes the use of foreign exchange and interest rate derivative financial instruments. Derivatives are executed with counterparties with a minimum credit rating of “A” by Standard and Poors and Moody’s Investor Services, in accordance with the Company’s policies. The Company does not utilize derivative instruments for trading or speculative purposes. The risk management objective of holding a floating-to-fixed interest rate swap is to lock in fixed interest cash outflows on a floating rate debt obligation. The associated risk is created by changes in market interest rates in Japan. The Company has an outstanding Yen loan with variable interest rates based on JPY-LIBOR-BBA. The Company meets the stated risk management objective by holding a floating-to-fixed interest rate swap resulting in a fixed interest cash flow for the Yen loan. The cash flow hedge consists of an interest rate swap with a notional value of Yen 9 billion. Including the impact of this floating-to-fixed interest rate swap, the Company’s ratio of fixed to variable rate debt is 55% to 45%.
The Company conducts transactions in currencies other than their functional currency. These transactions include non-functional intercompany and external sales as well as intercompany and external purchases. The Company uses foreign exchange forward contracts, matching the notional amounts and durations of the receivables and liabilities resulting from the aforementioned underlying foreign currency transactions, to mitigate the exposure to earnings and cash flows caused by changing foreign exchange rates. The risk management objective of holding foreign exchange derivatives is to mitigate volatility to earnings and cash flows due to changes in foreign exchange rates. The notional amount of foreign currency forward contracts entered into during the three months ended October 31, 2009 was $334,886. The notional amount of foreign currency forward contracts outstanding as of October 31, 2009 was $150,279. The Company’s foreign currency balance sheet exposures resulted in the recognition within SG&A of a gain of $1,845 in the three months ended October 31, 2009, before the impact of the measures described above. Including the impact of the Company’s foreign exchange derivative instruments, the net recognition within SG&A was a loss of $361 in the three months ended October 31, 2009.
The Company utilizes cash flow generated from operations and its revolving credit facility to meet its short-term liquidity needs. Company management considers its existing lines of credit, along with the cash typically generated from operations, to be sufficient to meet its short-term liquidity needs.
Capital expenditures were $37,081 in the first quarter of fiscal year 2010. Depreciation expense was $20,530 and amortization expense was $2,698 in the first quarter of fiscal year 2010. Depreciation and amortization expense in the first quarter of fiscal year 2009 were $20,665 and $2,330, respectively.
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On November 15, 2006, the board of directors authorized an expenditure of $250,000 to repurchase shares of the Company’s common stock. On October 16, 2008, the board authorized an additional expenditure of $350,000 to repurchase shares. At July 31, 2009 there was $452,943 remaining under the current stock repurchase programs. The Company did not repurchase stock in the first quarter of fiscal year 2010, and as such there was $452,943 remaining under the current stock repurchase programs. Net proceeds from stock plans were $8,162 in the first quarter of fiscal year 2010.
In the first quarter of fiscal year 2010, the Company paid dividends of $33,913 compared to $15,501 in the first quarter of fiscal year 2009. The increase in dividends paid reflects the timing of dividend payments compared to last year, representing an additional quarter of dividends. Furthermore, the Company increased its quarterly dividend by 11.5% from 13 cents to 14.5 cents per share, effective with the dividend declared on January 22, 2009.
Recently Issued Accounting Pronouncements
In December 2008, the Financial Accounting Standards Board (“FASB”)issued authoritative guidance to require employers to provide additional disclosures about plan assets of a defined benefit pension or other post-retirement plan. These disclosures should principally include information detailing investment policies and strategies, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets and an understanding of significant concentrations of risk within plan assets. The Company will provide this guidance beginning with its Annual Report on Form 10-K for fiscal year 2010. Upon initial application, the provisions of this authoritative guidance are not required for earlier periods that are presented for comparative purposes.
In October 2009, the FASB issued updated guidance that amends existing revenue recognition accounting pronouncements that have multiple element arrangements, which requires companies to allocate revenue in arrangements involving multiple deliverables based on the estimated selling price of each deliverable, even though such deliverables are not sold separately either by the company or other vendors. This guidance eliminates the requirement that all undelivered elements must have objective and reliable evidence of fair value before a company can recognize the portion of the overall arrangement fee that is attributable to items that already have been delivered. As a result, the new guidance may allow some companies to recognize revenue on transactions that involve multiple deliverables earlier than under current requirements. This new guidance is effective for the Company beginning with fiscal year 2011. The Company is in the process of assessing the effect this updated guidance may have on its consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
There is no material change in the market risk information disclosed in Item 7A of the 2009 Form 10-K.
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ITEM 4. CONTROLS AND PROCEDURES.
There are a number of significant business improvement initiatives designed to improve processes and enhance customer and supplier relationships and opportunities. These include information systems upgrades and integrations that are in various phases of planning or implementation and contemplate enhancements of ongoing activities to support the growth of the Company’s financial shared service capabilities and standardization of its financial systems. When taken together, these changes, which have and will occur over a multi year period, are expected to have a favorable impact on the Company’s internal control over financial reporting. The Company is employing a project management and phased implementation approach that will provide continued monitoring and assessment in order to maintain the effectiveness of internal control over financial reporting during and subsequent to implementation of these initiatives.
There have been no changes in, including in connection with the above described initiatives, the Company’s internal control over financial reporting during the first quarter of fiscal year 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
As of the end of the period covered by this report, 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-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based on this evaluation, the chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures are effective.
Any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
(In thousands)
As previously disclosed in the 2009 Form 10-K, the Company is subject to various regulatory proceedings and litigation relating to various environmental matters and to the tax matters described in Note 2, Audit Committee Inquiry and Restatement, to the consolidated financial statements included in the Company’s 2007 Form 10-K. The information provided below updates and should be read in conjunction with the discussion of these proceedings in Part I — Item 3 — Legal Proceedings in the 2009 Form 10-K. Reference is also made to Note 6, Contingencies and Commitments, to the accompanying condensed consolidated financial statements.
Federal Securities Class Actions:
As previously disclosed in Part 1 – Item 3 – Legal Proceedings in the 2009 Form 10-K, the U.S. District Court for the Eastern District of New York consolidated four putative class action lawsuits filed against the Company and certain members of its management team alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Exchange Act Rule 10b-5 relating to the Company’s understatement of certain U.S. federal income tax payments and its provision for income taxes in certain prior periods (as described in Note 2, Audit Committee Inquiry and Restatement to the consolidated financial statements included in the 2007 Form 10-K). On September 21, 2009, the Court denied the Company’s motion to dismiss the consolidated amended complaint. On October 9, 2009, the Company moved for certification for interlocutory appeal, and the Court denied the motion by Memorandum and Order entered November 25, 2009.
Environmental Matters:
With respect to the environmental matters at the Company’s Glen Cove, New York site, previously disclosed in Part I — Item 3 — Legal Proceedings in the Company’s 2009 Form 10-K, the Company and the New York State Department of Environmental Conservation executed on September 23, 2009 a Consent Decree settling liability for the shallow and intermediate groundwater zones, termed OU-1. On October 23, 2009, the Consent Decree was entered by the clerk of the federal District Court for the Eastern District of New York and became effective. Pursuant to the Consent Decree, the Company agreed to pay $2 million (which was previously accrued) in exchange for a broad release of OU-1 claims and liability. The settlement payment of $2 million, which was due by November 23, 2009, was paid by the Company on November 19, 2009. Claims and losses arising out of or in connection with the deep groundwater zone, termed OU-2, and any damages to the State’s natural resource are not covered by the Consent Decree and are thus excluded from the settlement. As previously disclosed in Part I — Item 3 — Legal Proceedings in the Company’s 2009 Form 10-K, the New York State Department of Environmental Conservation’s OU-2 investigation continues to be ongoing.
The Company’s condensed consolidated balance sheet at October 31, 2009 includes liabilities for environmental matters of approximately $11,953, which relate primarily to the previously reported environmental proceedings involving a Company subsidiary, Gelman Sciences Inc., pertaining to groundwater contamination. In the opinion of management, the Company is in substantial compliance with applicable environmental laws and its current accruals for environmental remediation are adequate. However, as regulatory standards under environmental laws are becoming increasingly stringent, there can be no assurance that future developments, additional information and experience gained will not cause the Company to incur material environmental liabilities or costs beyond those accrued in its condensed consolidated financial statements. The Company is currently in negotiations with the Michigan Department of Environmental Quality regarding its Comprehensive Proposal to Modify Cleanup Program (the “Proposal”) that was submitted to the State of Michigan on May 4, 2009. It is reasonably possible that the results of these negotiations may result in a material increase to the Company’s environmental reserves beyond those accrued in its condensed consolidated balance sheet at October 31, 2009, however, the impact is not currently estimable.
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ITEM 1A. RISK FACTORS.
There is no material change in the risk factors reported in Item 1A of the 2009 Form 10-K. This report contains certain forward-looking statements that reflect management’s expectations regarding future events and operating performance and speak only as of the date hereof. These statements are subject to risks and uncertainties, which could cause actual results to differ materially. For a description of these risks see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Forward-Looking Statements and Risk Factors.”
ITEM 6. EXHIBITS.
See the Exhibit Index for a list of exhibits filed herewith or incorporated by reference herein.
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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 |
| |
| |
| |
| |
| December 10, 2009 | /s/ | LISA MCDERMOTT |
| | | Lisa McDermott |
| | | Chief Financial Officer |
| | | and Treasurer |
| |
| | /s/ | FRANCIS MOSCHELLA |
| | | Francis Moschella |
| | | Vice President – Corporate Controller |
| | | Chief Accounting Officer |
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EXHIBIT INDEX
| Exhibit | | |
| Number | | Description of Exhibit |
| 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 July 30, 1994. |
| |
| 3(ii)* | | By-Laws of the Registrant as amended through November 18, 2009, filed as Exhibit 3(ii) to the Registrant’s Current Report on Form 8-K filed on November 23, 2009. |
| |
| 10.1* | | Employment Agreement dated October 1, 2009 between the Company and Lisa McDermott, filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on October 7, 2009. |
| |
| 10.2* | | Employment Agreement dated October 1, 2009 between the Company and Sandra Marino, filed as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on October 7, 2009. |
| |
| 10.3* | | Pall Corporation Employee Stock Purchase Plan, as amended effective November 18, 2009, filed as Appendix B to the Registrant’s Proxy Statement filed on October 9, 2009. |
| |
| 10.4* | | Pall Corporation Management Stock Purchase Plan, as amended effective November 18, 2009, filed as Appendix C to the Registrant’s Proxy Statement filed on October 9, 2009. |
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| 10.5* | | Pall Corporation 2005 Stock Compensation Plan, as amended effective November 18, 2009, filed as Appendix D to the Registrant’s Proxy Statement filed on October 9, 2009. |
| |
| 31.1† | | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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| 31.2† | | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
| 32.1† | | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. |
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| 32.2† | | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. |
* Incorporated herein by reference.
† Exhibit filed herewith.
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