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