1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JULY 31, 2001 Commission file number 000-21109 CUNO INCORPORATED (Exact name of registrant as specified in its charter) Delaware 06-1159240 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 400 Research Parkway, Meriden, Connecticut 06450 (Address of principal executive offices) (Zip Code) (203) 237-5541 Registrant's telephone number, including area code Not Applicable Former name, former address and former fiscal year, if changed since last report. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common Stock, .001 Par Value -- 16,388,720 shares as of July 31, 2001 2 CUNO INCORPORATED Page ---- Part I. Financial Information Item 1. Condensed Consolidated Financial Statements (Unaudited) Consolidated Statements of Income - Three months ended July 31, 2001 and 2000 1 Consolidated Statements of Income - Nine months ended July 31, 2001 and 2000 2 Consolidated Balance Sheets - July 31, 2001 and October 31, 2000 3 Consolidated Statements of Cash Flows - Nine months ended July 31, 2001 and 2000 4 Notes to Unaudited Condensed Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Part II. Other Information Item 6. Exhibits and Reports on Form 8-K 16 Signatures 17 3 CUNO INCORPORATED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (dollars in thousands, except share amounts) THREE MONTHS ENDED JULY 31, 2001 2000 ------------ ------------ Net sales $ 63,441 $ 62,795 Less costs and expenses: Cost of products sold 35,154 35,680 Selling, general and administrative expenses 16,116 15,768 Research, development and engineering 3,545 3,184 ------------ ------------ 54,815 54,632 ------------ ------------ Operating income 8,626 8,163 Nonoperating income (expense): Interest expense (145) (128) Interest and other income, net 306 (63) ------------ ------------ 161 (191) ------------ ------------ Income before income taxes 8,787 7,972 Provision for income taxes 3,083 2,953 ------------ ------------ Net income $ 5,704 $ 5,019 ============ ============ Basic earnings per common share $ 0.35 $ 0.31 Diluted earnings per common share $ 0.34 $ 0.30 Basic shares outstanding 16,313,943 16,209,017 Diluted shares outstanding 16,722,906 16,672,653 See notes to unaudited condensed consolidated financial statements. -1- 4 CUNO INCORPORATED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (dollars in thousands, except share amounts) NINE MONTHS ENDED JULY 31, 2001 2000 ------------ ------------ Net sales $ 182,213 $ 179,439 Less costs and expenses: Cost of products sold 102,197 102,525 Selling, general and administrative expenses 48,266 47,291 Research, development and engineering 10,147 9,684 ------------ ------------ 160,610 159,500 ------------ ------------ Operating income 21,603 19,939 Nonoperating income (expense): Interest expense (414) (557) Interest and other income, net 683 53 ------------ ------------ 269 (504) ------------ ------------ Income before income taxes 21,872 19,435 Provision for income taxes 7,818 7,286 ------------ ------------ Net income $ 14,054 $ 12,149 ============ ============ Basic earnings per common share $ 0.86 $ 0.75 Diluted earnings per common share $ 0.84 $ 0.73 Basic shares outstanding 16,302,926 16,191,142 Diluted shares outstanding 16,686,552 16,610,598 See notes to unaudited condensed consolidated financial statements. -2- 5 CUNO INCORPORATED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (in thousands, except share amounts) JULY 31, OCTOBER 31, 2001 2000 --------- --------- ASSETS Current assets Cash and cash equivalents $ 20,251 $ 13,814 Accounts receivable, less allowances for doubtful accounts of $1,304 and $1,395, respectively 49,128 52,239 Inventories 24,544 24,087 Deferred income taxes 6,802 6,414 Prepaid expenses and other current assets 2,572 2,101 --------- --------- Total current assets 103,297 98,655 Noncurrent assets Deferred income taxes 1,328 1,168 Intangible assets, net 27,263 23,971 Other noncurrent assets 1,946 1,918 Property, plant and equipment, net 64,168 63,187 --------- --------- Total assets $ 198,002 $ 188,899 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Bank loans $ 12,574 $ 14,233 Accounts payable 15,904 17,978 Accrued payroll and related taxes 10,654 11,851 Other accrued expenses 8,613 7,675 Accrued income taxes 2,781 4,251 Current portion of long-term debt 729 746 --------- --------- Total current liabilities 51,255 56,734 Noncurrent liabilities Long-term debt, less current portion 2,954 3,422 Deferred income taxes 5,174 4,786 Retirement benefits 3,897 4,439 --------- --------- Total noncurrent liabilities 12,025 12,647 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, 16,388,720 and 16,279,198 shares issued and outstanding 16 16 Treasury Stock, at cost (2,747 and 747 shares) (57) - Additional paid-in-capital 42,424 39,814 Unearned compensation (1,122) (1,120) Accumulated other comprehensive income (loss) -- Foreign currency translation adjustments (5,026) (3,546) Change in fair value of derivative financial instruments 79 - --------- --------- (4,947) (3,546) Retained earnings 98,408 84,354 Total stockholders' equity 134,722 119,518 --------- --------- Total liabilities and stockholders' equity $ 198,002 $ 188,899 ========= ========= See notes to unaudited condensed consolidated financial statements. -3- 6 CUNO INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (dollars in thousands) NINE MONTHS ENDED JULY 31, 2001 2000 -------- -------- OPERATING ACTIVITIES Net income $ 14,054 $ 12,149 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 6,827 6,641 Noncash compensation recognized under employee stock plans 706 817 Gains on sales of property, plant and equipment (57) (25) Pension costs (less than) in excess of funding (348) 460 Deferred income taxes (272) 1,280 Changes in operating assets and liabilities, net of acquisitions: Accounts receivable 1,998 (37) Inventories (1,617) 2,805 Prepaid expenses and other current assets (647) (625) Accounts payable and accrued expenses 249 55 Accrued income taxes (1,434) (149) -------- -------- Net cash provided by operating activities 19,459 23,371 INVESTING ACTIVITIES Proceeds from sales of property, plant and equipment 74 44 Proceeds from surrender of life insurance policies - 569 Acquisitions of companies, net of cash acquired (4,489) (2,885) Capital expenditures (7,771) (8,754) -------- -------- Net cash used for investing activities (12,186) (11,026) FINANCING ACTIVITIES Proceeds from long-term debt - 3,800 Principal payments on long-term debt (862) (11,673) Net repayments under short-term bank loans (88) (411) Retirement of Common Stock - (1,154) Acquisition of Treasury Stock (57) - Proceeds from stock options exercised 497 203 -------- -------- Net cash used for financing activities (510) (9,235) Effect of exchange rate changes on cash and cash equivalents (326) (147) -------- -------- Net change in cash and cash equivalents 6,437 2,963 Cash and cash equivalents -- beginning of period 13,814 6,186 -------- -------- Cash and cash equivalents -- end of period $ 20,251 $ 9,149 ======== ======== See notes to unaudited condensed consolidated financial statements. -4- 7 CUNO INCORPORATED NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JULY 31, 2001 NOTE 1 - BUSINESS AND BASIS OF PRESENTATION 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 healthcare, fluid processing and potable water markets throughout the world. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for annual financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Form 10-K for the year ended October 31, 2000. NOTE 2 - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share for the three months ended: JULY 31, JULY 31, 2001 2000 ------------ ------------ NUMERATOR: Net income $ 5,704,000 $ 5,019,000 ============ ============ DENOMINATORS: Weighted average shares outstanding 16,386,821 16,333,841 Issued but unearned performance shares (609) (67,309) Issued but unearned restricted shares (72,269) (57,515) ------------ ------------ DENOMINATOR FOR BASIC EARNINGS PER SHARE 16,313,943 16,209,017 ============ ============ Weighted average shares outstanding 16,386,821 16,333,841 Effect of dilutive employee stock options 336,085 338,812 ------------ ------------ DENOMINATOR FOR DILUTED EARNINGS PER SHARE 16,722,906 16,672,653 ============ ============ Basic earnings per share $ 0.35 $ 0.31 Diluted earnings per share $ 0.34 $ 0.30 5 8 The following table sets forth the computation of basic and diluted earnings per share for the nine months ended: JULY 31, JULY 31, 2001 2000 ------------ ------------ NUMERATOR: Net income $ 14,054,000 $ 12,149,000 ============ ============ DENOMINATORS: Weighted average shares outstanding 16,361,037 16,326,762 Issued but unearned performance shares (914) (68,232) Issued but unearned restricted shares (57,197) (67,388) ------------ ------------ DENOMINATOR FOR BASIC EARNINGS PER SHARE 16,302,926 16,191,142 ============ ============ Weighted average shares outstanding 16,361,037 16,326,762 Effect of dilutive employee stock options 325,515 283,836 ------------ ------------ DENOMINATOR FOR DILUTED EARNINGS PER SHARE 16,686,552 16,610,598 ============ ============ Basic earnings per share $ 0.86 $ 0.75 Diluted earnings per share $ 0.84 $ 0.73 NOTE 3 - INVENTORIES Inventories consist of the following (amounts in thousands): JULY 31, OCTOBER 31, 2001 2000 -------- ----------- Raw materials $10,870 $10,814 Work-in-process 2,429 2,435 Finished goods 11,245 10,838 ------- ------- $24,544 $24,087 ======= ======= 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 primary method used for all other inventories is first-in, first-out (FIFO). An actual valuation of inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations must necessarily be based on management's estimates of expected year-end inventory levels and costs. Because these are subject to many factors beyond management's control, interim results are subject to the final year-end LIFO inventory valuation. 6 9 NOTE 4 - COMPREHENSIVE INCOME Total comprehensive income was comprised of the following (amounts in thousands): THREE MONTHS ENDED NINE MONTHS ENDED JULY 31, JULY 31, 2001 2000 2001 2000 -------- -------- -------- -------- Net income $ 5,704 $ 5,019 $ 14,054 $ 12,149 Other comprehensive income (loss): Change in fair value of derivative financial instruments, net of deferred income taxes of $6 and $58 (10) -- 79 -- Foreign currency translation adjustments (691) 120 (1,480) (1,983) -------- -------- -------- -------- Total comprehensive income $ 5,003 $ 5,139 $ 12,653 $ 10,166 ======== ======== ======== ======== NOTE 5 - SEGMENT 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 markets. Operating segment data includes the results of all subsidiaries, consistent with the management reporting of these operations. Financial information by geographic operating segments is summarized below (amounts in thousands): THREE MONTHS ENDED NINE MONTHS ENDED JULY 31, JULY 31, 2001 2000 2001 2000 --------- --------- --------- --------- NET SALES: Europe $ 11,096 $ 9,655 $ 31,469 $ 27,854 Japan 8,428 10,650 26,959 29,248 Asia/Pacific 6,536 6,474 19,234 19,128 Latin America 3,142 3,014 9,350 10,472 --------- --------- --------- --------- Subtotal - Foreign Sales 29,202 29,793 87,012 86,702 North America 42,590 40,930 119,579 116,695 Intercompany sales (8,351) (7,928) (24,378) (23,958) --------- --------- --------- --------- $ 63,441 $ 62,795 $ 182,213 $ 179,439 ========= ========= ========= ========= 7 10 THREE MONTHS ENDED NINE MONTHS ENDED JULY 31, JULY 31, 2001 2000 2001 2000 -------- -------- -------- -------- OPERATING INCOME: North America $ 5,379 $ 5,488 $ 12,848 $ 12,772 Europe 895 540 1,819 743 Japan 893 908 2,616 2,395 Asia/Pacific 928 887 2,807 2,706 Latin America 531 340 1,513 1,323 -------- -------- -------- -------- Segment total 8,626 8,163 21,603 19,939 -------- -------- -------- -------- Interest expense (145) (128) (414) (557) Other, net 306 (63) 683 53 -------- -------- -------- -------- Income before income taxes $ 8,787 $ 7,972 $ 21,872 $ 19,435 ======== ======== ======== ======== Interest expense and other income (expense) have not been allocated to segments. NOTE 6 - INTEREST AND OTHER INCOME (EXPENSE), NET Interest and other income (expense), net consisted of the following (amounts in thousands): THREE MONTHS ENDED NINE MONTHS ENDED JULY 31, JULY 31, 2001 2000 2001 2000 ------ ------ ------ ------ Interest income $ 271 $ 44 $ 658 $ 152 Exchange gains (losses) 22 (29) 56 (52) Gains on sales of property, plant, and equipment 17 7 57 25 Other, net (4) (85) (88) (72) ----- ----- ----- ----- $ 306 $ (63) $ 683 $ 53 ===== ===== ===== ===== NOTE 7 - NEWLY ISSUED ACCOUNTING STANDARDS FASB 133 As of November 1, 2000, the Company adopted Financial Accounting Standards Board Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (Statement 133). The adoption of Statement 133 did not effect the Company's financial statements since the accounting treatment for the financial instruments held at the time did not change. As a result of adoption of Statement 133, the Company recognizes all derivative financial instruments, such as interest rate swap contracts and foreign exchange contracts, in the consolidated financial statements at fair value regardless of the purpose or intent for holding the instrument. Changes in the fair value of derivative financial instruments are either recognized periodically in income or in shareholders' equity as a component of accumulated other comprehensive income depending on whether the derivative financial instrument qualifies for hedge accounting, and if so, whether it qualifies as a fair value hedge or cash flow hedge. Generally, changes in fair values of derivatives accounted for as fair value hedges are 8 11 recorded in income along with the portions of the changes in the fair values of the hedged items that relate to the hedged risk(s). Changes in fair values of derivatives accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in other comprehensive income net of deferred income taxes. Changes in fair values of derivatives not qualifying as hedges are reported in income. FASB 141 & 142 In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Under the new statements, goodwill (and other intangible assets deemed to have indefinite lives) will no longer be amortized but will be subject to annual impairment tests. Other intangible assets will be amortized over their useful lives. The Company will apply the new rules on accounting for existing goodwill and other intangible assets beginning November 1, 2001 (first quarter of fiscal 2002). The Company is in the process of determining the impact of applying these new Statements. NOTE 8 - CONTINGENCIES The Company is 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. 9 12 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THREE MONTH PERIOD ENDED JULY 31, 2001 VS. THREE MONTH PERIOD ENDED JULY 31, 2000 NET SALES The Company had net sales of $63.4 million in the third quarter of fiscal 2001 representing a 1.0 percent increase over 2000's third quarter sales of $62.8 million. This increase can generally be attributed to an increase in the unit volume of worldwide sales. Had currency values been unchanged from the second quarter of 2000, net sales in the second quarter of 2001 would have been $3.5 million higher, or 6.6 percent greater overall. The following table displays the Company's sales by geographic segment (amounts in thousands): THREE MONTHS ENDED CURRENCY JULY 31, PERCENT ADJUSTED 2001 2000 CHANGE CHANGE ------- ------- ------- -------- North America $37,394 $35,203 6.2% 6.2% Europe 9,034 8,429 7.2% 16.9% Japan 8,298 10,475 (20.8%) (9.1%) Asia/Pacific 5,768 5,731 0.6% 10.2% Latin America 2,947 2,957 (0.3%) 31.2% ------- ------- ---- ---- Total sales $63,441 $62,795 1.0% 6.6% ======= ======= ==== ==== North American sales increased 6.2 percent in the second quarter of 2001 as compared to the same quarter in 2000. The Healthcare and Potable Water markets were responsible for the majority of the growth in North America during this time period. Sales in Europe increased 7.2 percent as compared to the same period in 2000, and were up 16.9 percent when expressed in local currency. All three markets within Europe displayed sales gains. Sales in Japan were down 20.8 percent as compared to the same quarter last year, and were 9.1 percent lower when expressed in local currency. The unsettled economy in Japan is largely responsible for the softening sales demand. Asia/Pacific sales were relatively flat quarter over quarter, however sales increased 10.2 percent excluding changes in currency values. The majority of the increase in Asia/Pacific is due to sales growth throughout Australia and strong Fluid Processing sales throughout Asia/Pacific. Second quarter Latin American sales decreased 0.3 percent as compared to the same period in 2000, but were up 31.2 percent when expressed in local currency. The large increase in local currency sales was in part due to the timing of certain large shipments. 10 13 The following table displays the Company's sales by market (amounts in thousands): THREE MONTHS ENDED CURRENCY JULY 31, PERCENT ADJUSTED 2001 2000 CHANGE CHANGE ------- ------- ------- -------- Potable Water $27,845 $26,065 6.8% 8.9% Fluid Processing 17,680 19,868 (11.0%) (3.7%) Healthcare 17,916 16,862 6.3% 15.2% ------- ------- ---- ---- Total sales $63,441 $62,795 1.0% 6.6% ======= ======= ==== ==== The slowing economies in the US and certain international markets (primarily Japan) have impacted all of the Company's markets to some extent; however, Fluid Processing is the Company's most cyclical market and is most impacted by the economic slowdown. The strength in the Potable Water market was broad geographically, driven largely by strong overseas sales (up 11.5 percent in local currency) and steady sales growth in North America (up 8.5 percent) associated with OEM customers, direct marketing companies, and appliance manufacturers. Healthcare sales continue to benefit from a continued focus by management on competitively favorable product lines and market niches. GROSS PROFIT The Company's gross profit increased $1.2 million to $28.3 million in the third quarter of 2001 from $27.1 million in the third quarter of 2000. Gross profit as a percentage of net sales (gross margin) increased during that same period from 43.2 percent in 2000 to 44.6 percent in 2001. The primary factor that contributed to the improved gross margin in 2001 was the market mix of sales (increased Healthcare sales which generally carry higher margins combined with decreased Fluid Processing sales which generally carry lower margins). OPERATING EXPENSES Selling, general and administrative expenses (SG&A) increased 2.2 percent reflecting the Company's focus on restraining discretionary spending. Expense categories within SG&A reflected nominal increases or decreases consistent with the Company's cost-management strategy. Research, development and engineering expenses increased 11.3 percent to $3.5 million in the third quarter of 2001, reflecting the Company's continued focus on the development of new products and technologies. As a percentage of sales, research, development and engineering expenses were 5.6 percent of sales in the third quarter of fiscal 2001 compared to 5.1 percent of sales in the third quarter of fiscal 2000. OPERATING INCOME As a result of the above, operating income increased $0.5 million, or 5.7 percent, to $8.6 million or 13.6 percent of sales in the third quarter of fiscal 2001 compared to $8.2 million or 13.0 percent of sales in the third quarter of 2000. NON-OPERATING ACTIVITY Interest income increased by $0.2 million in the third quarter of 2001 compared to the third quarter of 2000 as the Company maintained higher levels of invested cash. See "Financial Position and Liquidity" below. As disclosed in Note 6 to the condensed consolidated financial statements, other 11 14 income (expenses) was relatively minor in both periods as no material activity occurred in either of the two periods. INCOME TAXES The Company's effective income tax rate for the third quarter of 2001 was 35.1 percent compared to 37.0 percent in the third quarter of 2000. The decrease primarily reflects the recognition of incremental tax credits, certain tax planning initiatives, and a change in the mix of income attributed to the various countries in which the Company does business. NINE MONTH PERIOD ENDED JULY 31, 2001 VS. NINE MONTH PERIOD ENDED JULY 31, 2000 NET SALES The Company had net sales of $182.2 million in the first nine months of fiscal 2001 representing a 1.5 percent increase over 2000's comparable sales of $179.4 million. This increase can generally be attributed to an increase in the unit volume of worldwide sales. Had currency values been unchanged from the first nine months of 2000, net sales in the first nine months of 2001 would have been $9.2 million higher, or 6.6 percent greater overall. The following table displays the Company's sales by geographic segment (amounts in thousands): NINE MONTHS ENDED CURRENCY JULY 31, PERCENT ADJUSTED 2001 2000 CHANGE CHANGE -------- -------- ------- -------- North America $103,259 $ 99,579 3.7% 3.7% Europe 26,174 23,751 10.2% 20.3% Japan 26,623 28,691 (7.2%) 3.9% Asia/Pacific 17,211 17,231 (0.1%) 11.1% Latin America 8,946 10,187 (12.2%) 4.1% -------- -------- ---- ---- Total sales $182,213 $179,439 1.5% 6.6% ======== ======== ==== ==== North American sales increased 3.7 percent in the first nine months of 2001 as compared to the same period in 2000. Both the Potable Water and Healthcare markets were responsible for this growth. Sales in Europe increased 20.3 percent when expressed in local currency. All three markets displayed strong gains in sales. Sales in Japan were down 7.2 percent as compared to the same period last year, but were 3.9 percent higher when expressed in local currency. Local currency sales increased, albeit modestly, in all markets. Asia/Pacific sales were relatively flat as compared to the same period last year but, excluding changes in currency values over the period, increased 11.1 percent. The majority of the increase in Asia/Pacific is due to growing sales in both the Potable Water and Healthcare segments throughout the Asian and Pacific markets. Sales in Latin America decreased 12.2 percent but increased 4.1 percent in local currency driven predominantly by strong Potable Water sales. 12 15 The following table displays the Company's sales by market (amounts in thousands): NINE MONTHS ENDED CURRENCY JULY 31, PERCENT ADJUSTED 2001 2000 CHANGE CHANGE -------- -------- ------- -------- Potable Water $ 78,952 $ 74,334 6.2% 8.3% Fluid Processing 54,635 58,562 (6.7%) (0.1%) Healthcare 48,626 46,543 4.5% 12.4% -------- -------- ---- ---- Total sales $182,213 $179,439 1.5% 6.6% ======== ======== ==== ==== The slowing economies in the US and certain international markets (primarily Japan) have impacted all of the Company's markets to some extent, however Fluid Processing is the Company's most cyclical market and is most impacted by the economic slowdown. The strength in the Potable Water market was broad geographically - all geographic segments had positive sales growth during the period. Growth in North America continues to benefit from existing OEM customers, direct marketing companies, and appliance manufacturers. Healthcare sales continue to benefit from a continued focus by management on competitively favorable niches. GROSS PROFIT The Company's gross profit increased $3.1 million to $80.0 million in the first nine months of 2001 from $76.9 million in the first nine months of 2000. Gross profit as a percentage of net sales (gross margin) increased during that same period from 42.9 percent in 2000 to 43.9 percent in 2001. The primary factors that contributed to the improved gross margin in 2001 were a large one-time contract completed and shipped in the first quarter of 2000 which carried a low margin and increased healthcare sales in 2001 which generally carry a higher margin. OPERATING EXPENSES Selling, general and administrative expenses (SG&A) increased 2.1 percent in the first nine months of 2001 compared to the prior period reflecting the Company's continued focus on restraining discretionary spending. Expense categories within SG&A reflected nominal increases or decreases consistent with the Company's cost-management strategy. Research, development and engineering expenses increased $0.5 million and were 5.6 percent of sales in the first nine months of fiscal 2001 compared to 5.4 percent of sales in the first nine months of fiscal 2000. This level of research and development reflects the Company's continued focus on the development of new products and technologies. OPERATING INCOME As a result of the above, operating income increased $1.7 million, or 8.3 percent, to $21.6 million or 11.9 percent of sales in the first nine months of fiscal 2001 compared to $19.9 million or 11.1 percent of sales in the first nine months of 2000. NON-OPERATING ACTIVITY Interest income increased by $0.5 million in the first nine months of 2001 compared to the first nine months of 2000 as the Company maintained higher levels of invested cash. See "Financial Position and Liquidity" below. As disclosed in Note 6 to the condensed consolidated financial statements, other 13 16 income (expenses) was relatively minor in both periods as no material activity occurred in either of the two periods. INCOME TAXES The Company's effective income tax rate for the first nine months of 2001 was 35.7 percent compared to 37.5 percent in the first nine months of 2000. The decrease primarily reflects the recognition of incremental tax credits, certain tax planning initiatives, and a change in the mix of income attributed to the various countries in which the Company does business. FINANCIAL POSITION AND LIQUIDITY 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 by operating activities, capital expenditure levels, and adequate bank financing alternatives. The Company manages its worldwide cash requirements considering the cost effectiveness of the funds available from the many subsidiaries through which it conducts its business. Management believes that its existing cash position and 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 (in thousands of dollars): Source/(Use) of Cash NINE MONTHS ENDED JULY 31, 2001 2000 --------- -------- OPERATING ACTIVITIES: Net cash provided by net income plus depreciation, amortization and non-cash compensation $ 21,587 $ 19,607 Accounts receivable 1,998 (37) Inventories (1,617) 2,805 Accrued income taxes (1,434) (149) Net cash provided by operating activities 19,459 23,371 INVESTING ACTIVITIES: Proceeds from surrender of life insurance policies -- 569 Acquisitions of companies, net of cash acquired (4,489) (2,885) Capital expenditures (7,771) (8,754) FINANCING ACTIVITIES: Net change in total debt (950) (8,284) 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. Net income plus depreciation, amortization and non-cash compensation of $21.6 million increased 10.1 percent in the first nine months of 2001 as compared to the same period in 2000 reflecting the Company's increased gross profit, improved operating profit margin, and improved non-operating performance as discussed above. Accounts receivable continue to provide positive cash from operating activities despite the Company's rising sales volume. This results from a continued focus by the Company on improving the efficiency of 14 17 international accounts receivable management. The increase in inventories over the nine months ended July 31, 2001 primarily relates to the timing of certain sales shipments. The use of cash of $1,434 related to accrued income taxes payable relates to increased profitability of the Company and the timing of Federal income taxes paid in the US. In the second quarter of fiscal 2001, CUNO closed on two acquisitions - a product line in Australia and a distributor in Europe for a total of $4.5 million. These acquisitions do not have a material effect on the Company's historical financial statements or pro forma operating results. 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 upon settlement. The reduced rate of capital expenditures in 2001 primarily relates to the timing of certain capital projects. The Company paid all outstanding borrowings under its revolving credit facility in fiscal 2000. No amounts have been outstanding under the revolving credit facility in fiscal 2001. 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. OTHER MATTERS MARKET RISK DISCLOSURES The Company's earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. The Company utilizes forward foreign exchange contracts to hedge certain firm sales commitments and anticipated, but not yet committed, intercompany sales (primarily parent company export sales to subsidiaries at pre-established US dollar prices) and other specific and identified exposures. The terms of the forward foreign exchange contracts are generally 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. Further, the Company does not enter into financial instruments for speculation or trading purposes. There have been no material changes in the information reported in the Company's Form 10-K for the year ended October 31, 2000 under the "Market Risk Disclosures" section of Management's Discussion and Analysis of Financial Condition and Results of Operations. FORWARD LOOKING INFORMATION The Company wants to provide stockholders and investors with more meaningful and useful information and therefore, this quarterly report describes the Company's belief regarding business conditions and the outlook for the Company, which reflects currently available information. These forward looking statements are subject to risks and uncertainties which, as described in Management's Discussion and Analysis in the Company's Annual Report on Form 10-K for the year ended October 31, 2000, could cause the Company's actual results or performance to differ materially from those expressed herein. The Company assumes no obligation to update the information contained in this quarterly report. 15 18 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K No reports were filed on Form 8-K during the quarter for which this 10-Q is filed. 16 19 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. CUNO INCORPORATED Date August 21, 2001 --------------------------- By /s/ Frederick C. Flynn, Jr. --------------------------- Frederick C. Flynn, Jr. Senior Vice President - Finance and Administration, Chief Financial Officer, and Assistant Secretary By /s/ William J. DeFrances --------------------------- William J. DeFrances Treasurer, Assistant Controller, and Assistant Secretary 17