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 JANUARY 31, 2005 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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $0.001 Par Value - 17,199,923 shares as of January 31, 2005
CUNO INCORPORATED
PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Consolidated Statements of Income 1
Consolidated Balance Sheets 2
Consolidated Statements of Cash Flows 3
Notes to Unaudited Condensed Consolidated Financial Statements 4-10
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 11-21
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21-22
Item 4. Controls and Procedures 22
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 23-28
CUNO INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except share and per-share amounts)
THREE MONTHS ENDED
JANUARY 31,
2005 2004
---------------- ----------------
Net sales $ 99,376 $ 75,409
Less costs and expenses:
Cost of products sold 56,930 40,553
Selling, general and administrative expenses 24,664 20,174
Research, development and engineering 4,924 4,189
Amortization expense 653 64
---------------- ----------------
87,171 64,980
---------------- ----------------
Operating income 12,205 10,429
Nonoperating income (expense):
Interest expense (523) (83)
Interest and other income, net 223 150
---------------- ----------------
(300) 67
---------------- ----------------
Income before income taxes 11,905 10,496
Provision for income taxes 4,074 3,491
---------------- ----------------
Net income $ 7,831 $ 7,005
================ ================
Basic earnings per common share $ 0.46 $ 0.42
Diluted earnings per common share $ 0.45 $ 0.41
Basic shares outstanding 16,904,543 16,687,240
Diluted shares outstanding 17,380,874 17,215,135
See accompanying notes.
-1-
CUNO INCORPORATED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share amounts)
JANUARY 31, OCTOBER 31,
2005 2004
--------------- --------------
ASSETS
Current assets
Cash and cash equivalents $ 16,728 $ 23,359
Accounts receivable, less allowances for
doubtful accounts of $2,123 and $2,230, respectively 86,416 89,593
Inventories, net 49,177 47,275
Deferred income taxes 14,733 12,656
Prepaid expenses and other current assets 6,846 5,974
--------------- --------------
Total current assets 173,900 178,857
Noncurrent assets
Deferred income taxes 803 892
Goodwill, net 104,197 103,977
Other intangible assets 32,552 32,894
Prepaid pension costs 9,786 9,785
Other noncurrent assets 5,676 4,832
Property, plant and equipment, net 108,831 103,321
--------------- --------------
Total assets $ 435,745 $ 434,558
=============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Current portion of long-term debt $ 326 $ 276
Bank loans 13,371 11,048
Accounts payable 30,869 33,469
Accrued payroll and related taxes 13,414 20,329
Other accrued expenses 10,309 11,502
Accrued income taxes 3,715 4,539
--------------- --------------
Total current liabilities 72,004 81,163
Noncurrent liabilities
Long-term debt, less current portion 70,636 75,569
Deferred income taxes 20,199 16,662
Retirement benefits 4,537 4,396
Other noncurrent liabilities 955 789
--------------- --------------
Total noncurrent liabilities 96,327 97,416
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,
17,199,923 and 17,122,698 shares issued and outstanding 17 17
Treasury Stock, at cost (2,747 shares) (57) (57)
Additional paid-in-capital 66,174 63,413
Unearned compensation (3,711) (2,164)
Accumulated other comprehensive loss --
Foreign currency translation adjustments 10,406 7,966
Minimum pension liability (386) (386)
Change in fair value of derivative financial instruments (50) -
--------------- --------------
9,970 7,580
Retained earnings 195,021 187,190
--------------- --------------
Total stockholders' equity 267,414 255,979
--------------- --------------
Total liabilities and stockholders' equity $ 435,745 $ 434,558
=============== ==============
See accompanying notes.
-2-
CUNO INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)
THREE MONTHS ENDED
JANUARY 31,
2005 2004
--------------- ---------------
OPERATING ACTIVITIES
Net income $ 7,831 $ 7,005
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,891 2,656
Noncash compensation recognized under employee stock plans 260 193
Gains on sales of property, plant and equipment (16) (8)
Pension funding less than expense 51 111
Deferred income taxes 1,941 390
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable 4,272 275
Inventories (1,295) (1,161)
Prepaid expenses and other current assets (2,208) (851)
Accounts payable and accrued expenses (10,508) (3,783)
Accrued income taxes (1,175) 752
--------------- ---------------
Net cash provided by operating activities 3,044 5,579
INVESTING ACTIVITIES
Proceeds from sales of property, plant and equipment 26 -
Acquisition of companies, net of cash acquired - (554)
Capital expenditures (7,543) (3,718)
Other, net (308) (83)
--------------- ---------------
Net cash used for investing activities (7,825) (4,355)
FINANCING ACTIVITIES
Principal payments on long-term debt (5,039) -
Principal payments on short-term debt (160) (78)
Proceeds from short-term debt 2,336 -
Net (repayments) borrowings under short-term bank loans (204) 199
Proceeds from stock options exercised 846 392
--------------- ---------------
Net cash (used for) provided by financing activities (2,221) 513
Effect of exchange rate changes on cash and cash equivalents 371 1,514
--------------- ---------------
Net change in cash and cash equivalents (6,631) 3,251
Cash and cash equivalents -- beginning of period 23,359 57,603
--------------- ---------------
Cash and cash equivalents -- end of period $ 16,728 $ 60,854
=============== ===============
See accompanying notes.
-3-
CUNO INCORPORATED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per-share amounts)
JANUARY 31, 2005
NOTE 1 - ORGANIZATION AND ACCOUNTING POLICIES
CUNO Incorporated (the "Company", "CUNO", or "we") designs, manufactures
and markets a comprehensive line of filtration products for the separation,
clarification and purification of liquids and gases. Our 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.
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America 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 of America for annual
financial statements. In the opinion of management, all adjustments which are of
a normal recurring nature considered necessary for a fair presentation of the
financial position and results of operations for the interim periods set forth
herein have been included. 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. Operating results for the interim periods are not necessarily
indicative of the results that may be expected for the full year. These interim
unaudited financial statements should be read in conjunction with the Company's
Annual Report on Form 10-K for the year ended October 31, 2004.
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and disclosures made in the accompanying notes to the
financial statements. Actual results could differ from those estimates.
Certain prior year amounts have been reclassified to conform to current
year presentation.
INVENTORIES:
Inventories are stated at the lower of cost or market. Inventories in the
United States of America are primarily valued by the last-in, first-out (LIFO)
cost method. The methods used for all other inventories are first-in, first-out
(FIFO) and average cost. 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 our 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.
Inventories consist of the following:
JANUARY 31, OCTOBER 31,
2005 2004
------------ -----------
(unaudited)
Raw materials $ 18,435 $ 18,805
Work-in-process 6,415 6,215
Finished goods 24,327 22,255
---------- ---------
$ 49,177 $ 47,275
========== =========
4
ACCOUNTS PAYABLE
At January 31, 2005 and October 31, 2004, approximately $2,101 and $2,478,
respectively, representing book overdrafts of cash accounts, were reclassified
to accounts payable.
OTHER INCOME:
Interest and other income (expense), net consisted of the following:
THREE MONTHS ENDED
JANUARY 31,
2005 2004
----- -----
Interest income $ 172 $ 239
Exchange gains (losses) 11 (13)
Gains on sales of property,
plant, and equipment 16 8
Other, net 24 (84)
----- -----
$ 223 $ 150
===== =====
EARNINGS PER SHARE:
Basic earnings per common share is based on net income divided by the
weighted average number of common shares outstanding during the period. Diluted
earnings per common share is based on net income divided by the weighted average
number of common shares outstanding during the period, including the effect of
stock equivalents, where such effect is dilutive:
JANUARY 31, JANUARY 31,
2005 2004
----------- -----------
NUMERATOR:
Net income
$ 7,831 $ 7,005
=========== ===========
DENOMINATORS:
weighted average shares outstanding 16,904,543 16,687,240
----------- -----------
DENOMINATOR FOR BASIC EARNINGS PER SHARE 16,904,543 16,687,240
=========== ===========
Weighted average shares outstanding 16,904,543 16,687,240
Effect of dilutive employee stock options 331,697 413,234
Effect of dilutive restricted shares 144,634 114,661
----------- -----------
DENOMINATOR FOR DILUTED EARNINGS PER SHARE 17,380,874 17,215,135
=========== ===========
Basic earnings per share $ 0.46 $ 0.42
Diluted earnings per share $ 0.45 $ 0.41
Approximately 61,536 and 253,197 shares related to options to purchase
common stock and unvested restricted stock were excluded from the computations
of diluted earnings per share at January 31, 2005 and 2004, respectively,
because the exercise price was greater than the average market price of the
common stock during the periods.
5
COMPREHENSIVE INCOME:
Total comprehensive income was comprised of the following:
THREE MONTHS ENDED
JANUARY 31,
2005 2004
-------- --------
Net income $ 7,831 $ 7,005
Other comprehensive loss:
Change in fair value of derivative
financial instruments, net of deferred
income taxes of $25 and $120 (44) (202)
Losses related to derivative
financial instruments reclassified into
earnings from other comprehensive
income, net of $4 and $26 tax benefit (6) (42)
Foreign currency translation adjustments 2,440 3,635
-------- --------
Total comprehensive income $ 10,221 $ 10,396
======== ========
EMPLOYEE STOCK OPTIONS:
The Company has stock option plans under which employees and directors
have options to purchase Common Stock. The Company applies APB 25, "Accounting
for Stock Issued to Employees" and related interpretations in accounting for its
stock option plans. The Company has adopted those provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (FAS 123) and Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure - an
amendment of Statement of Financial Accounting Standards No. 123", which require
the disclosure of pro forma effects on net income and earnings per share as if
compensation cost had been recognized based upon the fair value method at the
date of grant for options awarded.
Pro forma information regarding net income and earnings per share is
required by Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (FAS 123), which requires that the information be determined as if
we had accounted for our employee stock options under the fair-value method of
FAS 123. The fair value for the options granted during the following periods
were estimated at the date of grant using the Black-Scholes pricing model with
the following weighted average assumptions:
THREE MONTHS ENDED
JANUARY 31,
2005 2004
-------- -------
Volatility 34.73% 23.39%
Risk-free interest rate 3.65% 3.46%
Expected option life 5 years 5 years
Dividend yield - -
6
The following table illustrates the effect on net income and earnings per
share as if compensation cost had been recognized based on the fair value of the
options at the grant dates for awards under those plans consistent with FAS 123,
as amended, using the Black-Scholes fair value method for option pricing.
THREE MONTHS ENDED
JANUARY 31,
2005 2004
--------- ---------
Net income, as reported $ 7,831 $ 7,005
Add: Stock-based compensation expense included in reported
net income, net of income taxes 171 129
Deduct: Total stock-based compensation expense determined
under fair value based method for all awards, net of
income taxes 640 620
--------- ---------
Pro forma net income $ 7,362 $ 6,514
========= =========
Earnings per share:
Basic - as reported $ 0.46 $ 0.42
Basic - pro forma $ 0.44 $ 0.39
Diluted - as reported $ 0.45 $ 0.41
Diluted - pro forma $ 0.42 $ 0.38
NEWLY ISSUED ACCOUNTING STANDARD
In December 2004, the FASB issued SFAS No. 123(revised 2004), "Share-Based
Payment". This standard will require the Company to measure the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value of the award. The cost will be recognized over the period
during which an employee is required to provide service in exchange for the
award. This Standard is effective as of the beginning of the first interim or
annual reporting period that begins after June 15, 2005. This Standard will
apply to all awards granted after the required effective date and to awards
modified, repurchased or canceled after that date. We are currently evaluating
the requirements and application of this standard and expect the adoption to
have an adverse effect on our consolidated statements of income.
NOTE 2 - GOODWILL AND INTANGIBLE ASSETS
Goodwill amounted to $104,197 and $103,977 at January 31, 2005 and October
31, 2004, respectively. The increase in goodwill is attributable to changes in
foreign exchange rates.
Other intangible assets amounted to $32,552 and $32,894 at January 31,
2005 and October 31, 2004, respectively. The decrease in the balance of other
intangible assets is related primarily to amortization, which amounted to $653
for the three-month period ended January 31, 2005, partially offset by the
impact of fluctuations in foreign exchange rates.
7
NOTE 3 - BENEFIT PLANS
Components of Net Periodic Benefit Cost are as follows:
THREE MONTHS ENDED
JANUARY 31,
2005 2004
------ ------
Service cost $ 794 $ 683
Interest cost 689 633
Expected return on plan assets (882) (823)
Amortization of transition asset 1 20
Amortization of prior service cost 46 102
Amortization of net loss 237 141
------ ------
Net periodic benefit cost $ 885 $ 756
====== ======
During the quarter ended January 31, 2005, employer contributions of $834
were made to the pension plans. We currently anticipate contributing an
additional $2,456 to fund our pension plans in fiscal 2005 for a total expected
contribution of $3,290.
The pension assumptions used to determine our October 31, 2004 plan
liabilities and the fiscal 2005 pension expense are as follows:
US PLANS JAPAN PLANS
-------- -----------
Weighted-average discount rate 6.00% 2.25%
Rates of increases in compensation levels 4.00% 2.25%
Expected long-term rate of return on assets 8.75% 4.75%
We determine our assumptions based on current economic and market data, as
well as expectations of future economic and market data. Included in our
analysis are company-specific considerations, such as current and future
investment allocations, participant demographics, and employee compensation
strategies.
Pension expense for fiscal 2005 is determined at the beginning of the
fiscal year and expensed ratably throughout the year. Our estimate of pension
expense to be recognized in 2005 is $3.5 million ($3.1 million in fiscal 2004).
NOTE 4 - ACQUISITIONS
In the first quarter of 2004, we completed two acquisitions in Europe for
total consideration of $554. The amount of goodwill and other intangible assets
recorded in connection with these two acquisitions amounted to $340 and $480,
respectively. Neither of these acquisitions had a material impact on the
Company's historical financial statements or pro forma operating results.
NOTE 5 - SEGMENT DATA
Segment information has been prepared in accordance with Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information." CUNO is organized into five geographic
segments, as the Company's chief operating decision makers are responsible for
managing our global operations based on geographic regions. Our geographic
segments include: North America, Europe, Japan, Asia/Pacific and Latin America.
Each of these operations are led and managed by a local General Manager who is
responsible for the profitability of their respective geographic segment. Each
of these geographic operations in turn
8
manufactures and sells products into our three main filtrations markets; potable
water, healthcare and fluid processing. Each geographic segment manufactures and
sells products in each of the three markets. The geographic segment managers are
responsible for managing their respective resources with oversight and review by
the CEO.
The Company does not present segment information by market as our
individual market focus is limited to worldwide sales, with assigned
responsibility for expanding worldwide sales within each respective market.
Financial information by geographic operating segments is summarized below:
THREE MONTHS ENDED
JANUARY 31,
2005 2004
-------- --------
NET SALES:
Europe $ 19,490 $ 16,633
Japan 12,362 9,821
Asia/Pacific 12,911 10,635
Latin America 3,564 3,487
-------- --------
Subtotal - Foreign sales 48,327 40,576
North America 64,748 45,808
Intercompany sales (13,699) (10,975)
-------- --------
Total net sales $ 99,376 $ 75,409
======== ========
Our sales by market are summarized below:
THREE MONTHS ENDED
JANUARY 31,
2005 2004
------- -------
NET SALES:
Potable Water $52,297 $34,853
Fluid Processing 23,239 20,270
Healthcare 23,840 20,286
------- -------
Total net sales $99,376 $75,409
======= =======
Our operating income by segment is detailed below:
THREE MONTHS ENDED
JANUARY 31,
2005 2004
-------- --------
OPERATING INCOME:
North America $ 6,335 $ 6,159
Europe 1,036 1,126
Japan 2,353 1,058
Asia/Pacific 2,161
1,733
Latin America 320 353
-------- --------
Total operating income 12,205 10,429
-------- --------
Interest expense (523) (83)
Other, net 223 150
-------- --------
Income before income taxes $ 11,905 $ 10,496
======== ========
Interest expense and other income (expense) have not been allocated to
segments.
9
Our assets by segment are detailed below:
JANUARY 31, OCTOBER 31,
2005 2004
----------- -----------
ASSETS:
North America $ 347,382 $ 345,359
Europe 60,069 59,605
Japan 38,706 37,100
Asia/Pacific 34,469 31,323
Latin America 14,385 14,047
General Corporate 16,728 23,359
Eliminations and other (75,994) (76,235)
--------- ---------
Total Assets $ 435,745 $ 434,558
========= =========
General corporate assets, consisting of cash, are not allocated to
segments.
NOTE 6 - COMMITMENTS AND 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 our 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.
Currently, we have self-insurance limits for workers' compensation,
product liability and employee medical claims. Our workers' compensation
policies have per-individual deductibles of $350, our product liability policy
has a $250 per claim deductible and our medical plan for employees has a
stop-loss of $200 per individual.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(amounts in thousands, except share and per-share amounts)
Management's discussion and analysis of financial condition and results of
operations ("MD&A") is provided as a supplement to the accompanying unaudited
interim condensed consolidated financial statements and footnotes to provide an
understanding of our financial position, changes in our financial position and
results of our operations. Our MD&A is organized as follows:
- COMPANY OVERVIEW. This section provides a general description of our
business.
- COMPANY RISK FACTORS. This section describes the material risks
inherent in our business that investors should be aware of.
- CAUTION CONCERNING FORWARD-LOOKING STATEMENTS. This section
discusses how certain forward-looking statements made by us
throughout the MD&A and elsewhere in this report are based on
management's present expectations about future events and are
inherently susceptible to uncertainty and changes in circumstances.
- CRITICAL ACCOUNTING POLICIES. This section discusses those
accounting policies that are both considered important to our
financial statements and require significant judgment and estimates
on the part of management in their application.
- RESULTS OF OPERATIONS. This section provides an analysis of our
results of operations for the three months ended January 31, 2005
and 2004, including a brief description of transactions and events
that impact the comparability of these results.
- FINANCIAL POSITION AND LIQUIDITY. This section provides an analysis
of our cash position and cash flows, as well as a discussion of our
financing arrangements.
Other information is presented in Items 3, 4 and elsewhere as follows:
- QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK. This
section discusses information about the various market risks we are
exposed to as of the end of the latest fiscal period presented.
- CONTROLS AND PROCEDURES. This section discusses the conclusions of
our executive officer and principal financial officer about the
effectiveness of our disclosure controls and procedures.
- OTHER INFORMATION. This section describes material developments in
the business or markets in which we compete, as well as any other
information important to our stakeholders.
COMPANY OVERVIEW
CUNO is a world leader in the designing, manufacturing and marketing of a
comprehensive line of filtration products for the separation, clarification and
purification of liquids and gases. Our products, which include proprietary depth
filters and semi-permeable membrane filters, are used in the potable water,
fluid processing, and healthcare markets. These products, most of which are
disposable, effectively remove contaminants that range in size from molecules to
sand particles. Our sales are approximately balanced between domestic and
international markets. Our objective is to provide high value-added products and
premium customer service. Our proprietary manufacturing processes result in
products that lower customers' operating expenses and improve the quality of
customers' end products by providing longer lasting, higher quality and more
efficient filters.
11
COMPANY RISK FACTORS
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
Approximately 44% of our net sales are derived from international
operations. Consequently, our reported financial results may be adversely
affected by significant fluctuations in the value of the US dollar in comparison
to local currencies in the countries in which we operate outside the US. We
manufacture products in Japan, China, Brazil, France, Singapore and Australia.
Our international operations may be affected by economic, political and
governmental conditions in some of the countries where we have manufacturing
facilities or where our products are sold. In addition, changes in economic or
political conditions in any of the countries in which we operate could result in
unfavorable taxation policies, exchange rates, new or additional currency or
exchange controls, governmental regulations, credit risks, or other restrictions
being imposed on the operations of the Company or expropriation.
PATENTS AND PROPRIETARY TECHNIQUES
We have a broad patent portfolio as well as other proprietary information
and manufacturing techniques and have applied, and will continue to apply, for
patents to protect our technology. The Company's success depends in part upon
our ability to protect our technology and proprietary products under US and
foreign patent and other intellectual property laws. Trade secrets and
confidential know-how which are not patented are protected through
confidentiality agreements, contractual provisions and internal Company
administrative procedures. There can be no assurance that such arrangements will
provide meaningful protection for the Company in the event of any unauthorized
use or disclosure. There can be no assurance that third parties will not assert
infringement claims against the Company or that a license or similar agreement
will be available on reasonable terms in the event of an unfavorable ruling on
any such claim. In addition, any such claim may require the Company to incur
litigation expenses or subject the Company to liabilities.
TECHNOLOGICAL AND REGULATORY CHANGE
The filtration and separations industry is characterized by changing
technology, competitively imposed process standards and regulatory requirements,
each of which influences the demand for our products and services. Changes in
legislative, regulatory or industrial requirements or competitive technologies
may render certain of our filtration and separations products and processes
obsolete. Acceptance of new products may also be affected by the adoption of new
government regulations requiring stricter standards. The Company's ability to
anticipate changes in technology and regulatory standards and to develop and
introduce new and enhanced products successfully on a timely basis are
significant factors in our ability to grow and to remain competitive. Similar to
all companies, we are also subject to the risks generally associated with new
product introductions and applications, including lack of market acceptance,
delays in product development and failure of products to operate properly.
COMPETITION
The filtration and separations markets in which we compete are highly
competitive. We compete with many domestic and international companies in the
global markets. The principal methods of competition in the markets in which we
compete are product specifications, performance, quality, knowledge, reputation,
technology, distribution capabilities, service and price.
INFLATION
Inflation had a negligible effect on our operations. We estimate that
inflationary effects, in the aggregate, were generally recovered or offset
through increased pricing or cost reductions in all periods presented.
KEY CUSTOMERS AND SUPPLIERS
We have multi-year contracts and arrangements in place with several of our
major customers and suppliers. These contracts and arrangements help us
effectively plan and manage our operations. Since the markets for our products
are dynamic, these contracts and arrangements are continually evolving as we are
sensitive to the changing needs of our customers and the ongoing performance of
our suppliers. There is no assurance, however, that these
12
contracts and arrangements will be renewed, will not be terminated prematurely
or revised to take into consideration the evolving nature of our relationships
with our customers and suppliers.
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
Because we want to provide shareholders with more meaningful and useful
information, this quarterly report contains statements relating to future events
and the predicted performance of CUNO Incorporated (the "Company", "CUNO", or
"we") which may constitute forward-looking statements, as defined under the
Private Securities Litigation Act. We have tried, wherever possible, to identify
these "forward looking" statements by using words such as "anticipate,"
"believe," "estimate," "expect" and similar expressions. These statements
reflect our current beliefs and are based on information currently available to
us. Accordingly, these statements are subject to risks and uncertainties which
could cause our actual results performance or achievements to differ materially
from those expressed in, or implied by, these statements. These risks and
uncertainties include the following: economic and political conditions in the
foreign countries in which we conduct a substantial part of our operations and
other risks associated with international operations including taxation
policies, credit risk, exchange rate fluctuations and the risk of expropriation;
our ability to protect our technology, proprietary products and manufacturing
techniques; volumes of shipments of our products, changes in our product mix and
product pricing; continuing beneficial relationships with customers; costs of
raw materials; the rate of economic and industry growth in the United States and
the other countries in which we conduct our 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 our global markets. We assume no
obligation to publicly release revisions to the forward-looking statements to
reflect new events or circumstances.
CRITICAL ACCOUNTING POLICIES
The Securities and Exchange Commission ("SEC") defines the most critical
accounting policies as the ones that are most important to the portrayal of a
company's financial condition and operating results, and require management to
make its most difficult, subjective or complex judgments, often as a result of
the need to make estimates about the effect of matters that are inherently
uncertain. Based on this definition, our most critical accounting policies
include: revenue recognition, accounting for depreciation and amortization,
employee benefits, contingencies, allowance for doubtful accounts, income taxes,
and stock based compensation. The methods, estimates and judgments we use in
applying these most critical accounting policies have a significant impact on
the results we report in our financial statements. There were no changes in
accounting policies or significant changes in accounting estimates during the
current period. All of our critical accounting policies and significant
estimates have been discussed with the Audit Committee of the Board of
Directors. We have not made any significant changes to our critical accounting
policies or estimates since year end.
Revenue Recognition -- We recognize revenue in accordance with SEC Staff
Accounting Bulletin No. 104 "Revenue Recognition" ("SAB 104"). SAB 104 requires
that four basic criteria be met before revenue can be recognized: 1) there is
evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is
fixed or determinable; and 4) collectibility is reasonably assured. We recognize
revenue upon determination that all criteria for revenue recognition have been
met. Accordingly, revenue is recognized upon delivery to a common carrier when
terms are FOB shipping and upon receipt by customer when terms are FOB
destination.
Depreciation and Amortization - We depreciate our property, plant and
equipment using the straight-line method over the estimated useful life of the
asset. These periods range as follows:
Land improvements 10 - 20 years
Buildings and additions 30 - 40 years
Machinery and equipment 5 - 20 years
Computers and related equipment 3 - 5 years
13
We amortize our patents and other amortizable intangible assets over their
estimated useful lives. The straight line method of amortization is used unless
another method is more appropriate and reliable in reflecting the pattern in
which the asset provides economic benefits. These periods generally range from
10 - 20 years.
We review the carrying values of intangibles and long-lived assets on an
annual basis. In addition, in the event that facts and circumstances indicate
that the carrying value of intangibles and long-lived assets or other assets may
be impaired at any other time, an evaluation is performed. Our evaluations
compare the estimated future undiscounted cash flows associated with the asset
to the asset's carrying amount.
Employee Benefits - We account for our pension plans in accordance with
SFAS No. 87, "Employer's Accounting for Pensions". In applying this accounting
practice, assumptions are made regarding the valuation of benefit obligations
and the performance of plan assets.
The primary assumptions are as follows:
- Weighted average discount rate - this rate is used to estimate the
current value of future benefits. This rate is adjusted based on
movements in long-term interest rates.
- Expected long-term rate of return on assets - this rate is used to
estimate future growth in investments and investment earnings. The
expected return is based upon a combination of historical market
performance and anticipated future returns for a portfolio reflecting the
mix of equity, debt and other investments indicative of our plan assets.
- Rates of increase in compensation levels - this rate is used to estimate
projected annual pay increases, which are used to determine the wage base
used to project employees' pension benefits at retirement.
We determine these assumptions based on consultations with our outside
actuaries and investment advisors. Any variance in the above assumptions could
have a significant impact on future recognized pension costs, assets and
obligations.
Business Acquisitions - Assets and liabilities acquired in a business
combination are recorded at their estimated fair values at the acquisition date.
In accordance with SFAS 142, goodwill and intangible assets deemed to have
indefinite lives are not amortized but are subject to annual impairment testing.
The assessment of goodwill involves the estimation of the fair value of
reporting units, as defined by SFAS 142. Management completed this annual
assessment during the fourth quarter of 2004 based on the best information
available as of the date of the assessment, which incorporated management's
assumptions about expected future cash flows. Based on this assessment, there
was no goodwill impairment in 2004. Future cash flows can be affected by changes
in the global economy and local economies, industries and markets in which the
Company sells products or services, and the execution of management's plans,
particularly with respect to integrating acquired companies. There can be no
assurance that future events will not result in impairment of goodwill or other
intangible assets.
Contingencies, Claims and Assessments -- From time to time, we are
involved with contingencies, claims, and assessments. We use both in-house and
outside legal counsel to assess the probability of loss. The Company establishes
an accrual for specific contingencies, claims and assessments when both of the
following conditions are present: a loss is deemed probable and the amount of
the anticipated loss can be reasonably estimated. There can be no assurance that
the ultimate resolution of these contingencies, claims, and assessments will not
differ materially from our estimates.
Allowance for Bad Debts -- The allowance for doubtful accounts is
established to represent our best estimate of the net realizable value of the
outstanding accounts receivable balances. We estimate our allowance for doubtful
accounts based on past due amounts and historical write-off experience, as well
as trends and factors surrounding the credit risk of specific customers. In an
effort to identify adverse trends, we perform periodic credit
14
evaluations of our customers and ongoing account balance reviews and agings of
receivables. Amounts are considered past due when payment has not been received
within the time frame of the credit terms extended. Write-offs are charged
directly against the allowance for doubtful accounts and occur only after all
collection efforts have been exhausted. Actual write-offs and adjustments could
differ from the allowance estimates due to unanticipated changes in the business
environment as well as factors and risks surrounding specific customers.
Income Taxes - We estimate and use our expected annual effective income
tax rate to accrue income taxes on an interim basis. We update these estimates
quarterly. We record valuation allowances to reduce our deferred income tax
assets to an amount that we believe is more likely than not to be realized. We
consider estimated future taxable income and ongoing prudent and feasible tax
planning strategies in assessing the need for a valuation allowance. If we were
to determine that we will not realize all or part of our deferred income tax
assets in the future, we would make an adjustment to the carrying value of the
deferred income tax asset, which would be reflected as an income tax expense.
Conversely, if we were to determine that we will realize a deferred income tax
asset, which currently has a valuation allowance, we would reverse the valuation
allowance which would be reflected as an income tax benefit in our financial
statements.
We take tax positions in our worldwide corporate income tax filings based
on careful interpretations of global statutes, rules, regulations and court
decisions that may be applied and interpreted differently by various taxing
jurisdictions. These taxing jurisdictions may or may not challenge our
application and interpretation of a wide body of tax jurisprudence. However, we
do not anticipate that any sustained challenge by any taxing jurisdiction will
have a material adverse effect on our financial position or net income.
Stock Based Compensation - We currently account for our stock option
awards under the recognition and measurement principles of APB Opinion No. 25,
"Accounting for Stock Issued to Employees", and related interpretations. No
stock-based employee compensation cost pertaining to stock options is reflected
in net income, as all options granted under our plans had exercise prices equal
to the market value of the underlying common stock on the date of grant.
Restricted share grants awarded to employees are included in earnings as an
expense over the vesting period of the award.
15
RESULTS OF OPERATIONS
THREE MONTH PERIOD ENDED JANUARY 31, 2005 VS. THREE MONTH PERIOD ENDED JANUARY
31, 2004
OVERVIEW
During the first three months of fiscal 2005, CUNO's sales and net
income grew by 31.8 percent and 11.8 percent, respectively. U. S. Dollar organic
sales growth was 19.9 percent and organic sales growth on a local currency basis
was 17.0 percent. Sales growth was particularly strong in North America and
Japan, and strong overall within the worldwide potable water market. Although
our sales increased significantly, our gross margin decreased due primarily to
the impact of our recent acquisition of WTC Industries Inc. (WTC). Sales to
retailers within the potable water market and sales attributable to WTC
generally carry lower gross margins than we have historically reported.
Going forward, business and market uncertainties may affect results. See
"Company Risk Factors" above and Management's Discussion and Analysis in our
Annual Report on Form 10-K for the fiscal year ended October 31, 2004 for a full
discussion of the key factors which affect our business and operating results.
We anticipate increased expenditures associated with compliance efforts
surrounding the Sarbanes-Oxley Act of 2002 during the remainder of fiscal 2005.
Below is a summary of selected consolidated earnings information:
THREE MONTHS ENDED
JANUARY 31,
2005 2004 CHANGE
-------- -------- --------
Net sales $ 99,376 $ 75,409 31.8%
Cost of products sold 56,930 40,553 40.4%
Gross profit 42,446 34,856 21.8%
Gross margin percent 42.7% 46.2% 350 bpt
Selling, general and administrative 24,664 20,174 22.3%
SG&A as a percent of sales 24.8% 26.8% 200 bpt
Operating income 12,205 10,429 17.0%
Operating margin 12.3% 13.8% 150 bpt
Effective tax rate 34.2% 33.3% 90 bpt
Net income 7,831 7,005 11.8%
Diluted earnings per share $ 0.45 $ 0.41 9.8%
BUSINESS ENVIRONMENT
Our geographic and market diversity helps limit the impact of any one
market or the economy of any single country on our consolidated results. The
uncertainty of the economic conditions in various markets and geographic regions
in which we compete is likely to continue to present challenges to our business
near term. The U.S. Dollar was weaker compared to most of the currencies in
countries we conduct business in during the first quarter of 2005 compared to
the first quarter of 2004. We translate revenue and expense accounts at the
average exchange rates during the periods presented.
NET SALES
Net sales were $99.4 million in the first quarter of fiscal 2005
representing a 31.8 percent increase over 2004's first quarter sales of $75.4
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
quarter of 2004, net sales in the first
16
quarter of 2005 would have been $2.2 million lower than the reported sales of
$99.4 million, or 28.9 percent greater overall.
The following table displays the Company's sales by geographic segment:
THREE MONTHS ENDED CURRENCY
JANUARY 31, PERCENT ADJUSTED
2005 2004 CHANGE CHANGE
-------- -------- -------- --------
North America $ 56,062 $ 38,938 44.0% 44.0%
Europe 16,332 13,857 17.9% 9.8%
Japan 12,040 9,594 25.5% 20.9%
Asia/Pacific 11,659 9,779 19.2% 14.8%
Latin America 3,283 3,241 1.3% (4.3%)
-------- --------
Total sales $ 99,376 $ 75,409 31.8% 28.9%
======== ========
North American sales increased 44.0 percent in the first quarter of 2005
as compared to the same quarter in 2004. Sales increased in all North American
markets during the quarter, however stronger potable water market sales were
largely responsible for this growth. Excluding sales from WTC which we acquired
on August 2, 2004, sales in North America would have been up 20.9 percent
quarter over quarter. North American fluid processing and healthcare sales
increased 13.4 percent and 9.8 percent, respectively, reflecting the overall
strength of the economy during this time period. European sales increased 9.8
percent in local currency as compared to the same period in 2004. Sales were
generally strong in all European markets, however potable water sales were
particularly strong in the quarter reflecting greater demand for our products
serving the OEM and appliance markets. Sales in Japan were up broadly in all
markets and were led by very strong sales of food and beverage filters used in
the healthcare market primarily for the filtration of bottled drinks.
Asia/Pacific sales were up 14.8 percent in local currency primarily reflecting
strong growth of potable water sales within the Asia region. First quarter 2005
Latin American sales were down 4.3 percent when expressed in local currency due
primarily to lower sales within the potable water market.
The following table displays the Company's sales by market:
THREE MONTHS ENDED CURRENCY
JANUARY 31, PERCENT ADJUSTED
2005 2004 CHANGE CHANGE
-------- -------- -------- --------
Potable Water $ 52,297 $ 34,853 50.1% 48.8%
Fluid Processing 23,239 20,270 14.6% 10.6%
Healthcare 23,840 20,286 17.5% 12.9%
-------- --------
Total sales $ 99,376 $ 75,409 31.8% 28.9%
======== ========
The strength in the potable water market continues to be broad
geographically, driven largely by strong overseas sales (up 16.5 percent in
local currency) and strong sales growth in North America (up 57.8 percent)
associated with OEM customers, direct marketing companies, and appliance
manufacturers. Excluding the impact of WTC, first quarter worldwide water sales
were up 23.1 percent on a local currency basis. Fluid Processing sales were up
13.4 percent in North America and up 9.5 percent overseas on a local currency
basis. Healthcare sales were up 9.8 percent in North America and up 14.2 percent
overseas on a local currency basis. Much of this overseas growth was driven by
continued strong sales of food and beverage filters in Japan used primarily for
the filtration of bottled drinks.
17
GROSS PROFIT
Gross profit increased $7.6 million to $42.4 million in the first quarter
of 2005 from $34.9 million in the first quarter of 2004. Gross profit as a
percentage of net sales (gross margin) decreased during that same period from
46.2 percent in 2004 to 42.7 percent in 2005. This decrease in gross margin is
primarily attributable to a change in our sales mix in the potable water market,
including sales of WTC (which we acquired on August 2, 2004 and are included in
our 2005 results) and increasing sales to retailers, both of which carry
comparatively lower gross margins.
OPERATING EXPENSES
Selling, general and administrative expenses (SG&A) were up 22.3 percent,
less than the 31.8 percent sales growth rate for the quarter. Because of CUNO's
international operations, the weaker US dollar served to increase the
consolidated US dollar reported SG&A expense. SG&A expenses were 24.8 percent of
sales in the first quarter of fiscal 2005 vs. 26.8 percent of sales in the first
quarter of fiscal 2004. We continue to face rising structural costs such as
medical, pension and depreciation expense, as well as the addition of WTC's
expenses included in 2005 results.
Research, development and engineering expenses (incurred primarily in the
US and to a lesser extent in Europe) increased 17.5 percent to $4.9 million in
the first quarter of 2005, reflecting our continued focus on the development of
new products and technologies. As a percentage of sales, research, development
and engineering expenses were 5.0 percent of sales in the first quarter of
fiscal 2005 compared to 5.6 percent of sales in the first quarter of fiscal
2004.
OPERATING INCOME
As a result of the above, operating income increased $1.8 million, or 17.0
percent, to $12.2 million or 12.3 percent of sales in the first quarter of
fiscal 2005 compared to $10.4 million or 13.8 percent of sales in the first
quarter of 2004.
Our operating income by segment is detailed below:
THREE MONTHS ENDED
JANUARY 31, DOLLAR PERCENT
2005 2004 CHANGE CHANGE
-------- -------- -------- --------
OPERATING INCOME:
North America $ 6,335 $ 6,159 $ 176 2.9%
Europe 1,036 1,126 (90) (8.0%)
Japan 2,353 1,058 1,295 122.4%
Asia/Pacific 2,161 1,733 428 24.7%
Latin America 320 353 (33) (9.3%)
-------- -------- --------
Total $ 12,205 $ 10,429 $ 1,776 17.0%
-------- -------- --------
Operating income in North America increased only modestly compared to the
$17.1 million increase in sales. This increase was due to many factors,
including: start-up costs of associated with a new plant which is currently
being built in Mexico to begin production of certain water products,
amortization expense associated with WTC's definite lived amortizable intangible
assets, lower gross margins associated with the change in sales mix within the
potable water market (as noted above) and other increased structural costs
discussed above.
18
The results of our foreign operations are heavily dependent on the
relationship of their functional currency compared to the U.S. Dollar. We
translate our foreign revenue and expense accounts into U.S. Dollars using the
average exchange rate for the period. European sales increased 9.8 percent on a
local currency basis, while the Euro strengthened approximately 8 percent
(average first quarter of 2005 versus average first quarter of 2004). Increased
manufacturing and structural costs were responsible for the reduction in
Europe's operating income. Sales in Japan were up 20.9 percent on a local
currency basis, and the Yen strengthened versus the U.S. Dollar approximately 4
percent quarter over quarter (allowing fixed costs to be spread over a larger
sales base). Sales in 2005 were very strong for food and beverage filters used
in the filtration of summer bottled drinks. These sales are dependent on
consumer preferences and other external factors. Asia/Pacific sales were up 14.8
percent quarter over quarter, and the Australian Dollar strengthened
approximately 4 percent in comparison (approximately 50 percent of our sales in
the region are denominated in Australian Dollars). Local currency sales in Latin
America decreased 4.3 percent, contributing to the modest decrease in operating
income for the quarter.
NONOPERATING INCOME (EXPENSE):
Interest expense increased from $0.1 million in the first quarter of 2004
to $0.5 million in the first quarter of 2005. This primarily relates to interest
expense associated with our variable rate, unsecured revolving credit facility.
We had $70 million in outstanding borrowings under this facility at January 31,
2005 and capitalized approximately $0.2 million in interest costs during the
first quarter of 2005 in accordance with the provisions of FAS 34,
"Capitalization of Interest Cost".
INCOME TAXES
The Company's effective income tax rate for the first quarter of 2005 was
34.2 percent compared to 33.3 percent in the first quarter of 2004. In 2004, our
rate was benefited by a one-time expanded availability and utilization of
certain state credits in the U.S. Also, our tax rate is impacted by the change
in the mix of income attributed to the various countries in which we do business
and various one-time and recurring tax planning initiatives.
As of January 31, 2005, the Company had a full valuation allowance against
approximately $1.3 million of NOLs in China. Our China operations are start-up
in nature with a history of losses (no profit has been earned since inception in
2001). The remaining countries in which we carry valuation allowances against
NOLs are generally operations which are new to CUNO, have a history of losses,
or are in volatile economic regions of the world.
FINANCIAL POSITION AND LIQUIDITY
We assess liquidity in terms of the Company's ability to generate cash to
fund our 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.
We manage our worldwide cash requirements considering the cost
effectiveness of the funds available from the many subsidiaries through which we
conduct our business. We believe that our existing cash and cash equivalents
position ($16.7 million at January 31, 2005) and available sources of liquidity
(approximately $25 million of available, uncommitted, unused worldwide
short-term lines of credit) are sufficient to meet current and anticipated
requirements for the foreseeable future. We do not rely on commercial paper or
off-balance sheet financing arrangements for our liquidity needs nor do we have
any investments in special purpose entities ("SPEs"), or variable interest
entities ("VIEs") .
We continue to invest in R&D to provide future sources of revenue through
the development of new products, as well as through additional uses for existing
products. Our efforts are spread across the various markets in which we compete,
with particular emphasis on new products and technologies in Healthcare and the
19
improvement in design and function of products within Potable Water. We consider
R&D and the development of new products and technologies an integral part of our
growth strategy and a core competence of the Company.
Likewise, we continue to invest in capital expenditures in order to expand
and modernize manufacturing facilities around the globe. We are currently in the
process of establishing a manufacturing operation in Mexico to meet product
demands in the water market. In addition, new manufacturing lines and processes
are being installed in the US to benefit the potable water, fluid processing,
and healthcare markets.
SUMMARY OF CASH FLOWS FOLLOWS:
THREE MONTHS ENDED
JANUARY 31,
2005 2004
------- -------
CASH PROVIDED BY (USED FOR):
Operating activities $ 3,044 $ 5,579
Investing activities (7,825) (4,355)
Financing activities (2,221) 513
Effect of exchange rate changes on cash and cash
equivalents 371 1,514
Net cash provided by operating activities decreased by $2,535 due primarily to:
- Increase in deferred income taxes of $1,551 in the first quarter of 2005
- Timing in the payments of accounts payable and accrued expenses
- Timing in the collection of accounts receivable (increased sales in the
first quarter of 2005 contributed to a source of cash of $4,272 in
accounts receivable)
- Timing in the payment of income taxes
Net cash used for investing activities increased by $3,470 due primarily to:
- Decrease in cash paid for acquisitions of $554
- Increase in capital expenditures of $3,825
Net cash used for financing activities increased by $2,734 due primarily to:
- Change in net borrowings under short-term bank debt of $2,254 due
primarily to the timing of certain cash payments
- Paydown of long term debt in 2005 of $5,039
The effect of exchange rate changes on cash and cash equivalents of $371
reflects the continued weakening of the U.S. Dollar in 2005 against the Japanese
Yen, Euro and Australian Dollar.
20
Contractual Obligations and Commercial Commitments
Below is a table detailing, by maturity date, our Contractual
Obligations and Commercial Commitments as of October 31, 2004:
OBLIGATIONS AND
COMMITMENTS 2005 2006 2007 2008 2009 THEREAFTER
- ---------------- ---------- ---------- ---------- ---------- ---------- ----------
Bank loans $ 11,048 $ -- $ -- $ -- $ -- $ --
Long-term debt 276 242 119 28 75,011 169
Operating leases 3,436 2,904 2,479 1,852 1,700 253
---------- ---------- ---------- ---------- ---------- ----------
Total $ 14,760 $ 3,146 $ 2,598 $ 1,880 $ 76,711 $ 422
========== ========== ========== ========== ========== ==========
Also, see fiscal 2005 changes in bank loans and long-term debt detailed on
the Consolidated Statements of Cash Flows for the three months ended January 31,
2005. We had no material qualifying long-term purchase obligations at October
31, 2004 and through the interim period in 2005. Our U.S. pension plans require
no minimum amount of funding in 2005, however we plan to contribute
approximately $3.3 million to our U.S. and Japanese pension plan in fiscal 2005.
OTHER INFORMATION
Section 404 of the Sarbanes-Oxley Act of 2002 (the "Act") will require the
Company to include an internal control report from management in its Annual
Report on Form 10-K for the year ended October 31, 2005 and in subsequent
reports. The internal control report must include the following: (1) a statement
of management's responsibility for establishing and maintaining adequate
internal control over financial reporting, (2) a statement identifying the
framework used by management to conduct the required evaluation of the
effectiveness of the Company's internal control over financial reporting, (3)
management's assessment of the effectiveness of the Company's internal control
over financial reporting as of October 31, 2005, including a statement as to
whether or not internal control over financial reporting is effective, and (4) a
statement that the Company's independent auditors have issued an attestation
report on management's assessment of internal controls over financial reporting.
Management acknowledges its responsibility for establishing and
maintaining internal controls over financial reporting and seeks to continually
improve those controls. In addition, in order to achieve compliance with Section
404 of the Act within the required time frame, the Company has been conducting a
process to document and evaluate its internal controls over financial reporting.
In this regard, the Company has dedicated internal resources, engaged outside
consultants and adopted a detailed work plan to: (1) assess and document the
adequacy of internal controls over financial reporting; (2) take steps to
improve control processes where required; (3) validate through testing that
controls are functioning as designed; and (4) implement a continuous reporting
and improvement process for internal control over financial reporting. The
Company believes its process for documenting, evaluating and monitoring its
internal control over financial reporting is consistent with the objectives of
Section 404 of the Act.
Given the risks inherent in the design and operation of internal controls
over financial reporting, the Company can provide no assurance as to its, or its
independent auditor's, conclusions at October 31, 2005 with respect to the
effectiveness of its internal controls over financial reporting.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The overall objective of our financial risk management program is to seek
a reduction in the potential negative earnings effects from changes in foreign
exchange and interest rates arising from business activities. We
21
manage these financial exposures through operational means and by utilizing
available financial instruments. Practices may change as economic conditions
change.
Foreign Currency Risk
Our earnings and cash flows are subject to fluctuations due to changes in
foreign currency exchange rates. We utilize forward foreign exchange contracts
to hedge specific exposures relating to intercompany payments, 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 one year.
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. All of our foreign exchange
contracts are accounted for at fair value based on readily available market
price quotations. We generally do not hedge overseas sales denominated in
foreign currencies or translation exposures. Further, we do not enter into
financial instruments for speculation or trading purposes.
We utilize bank loans and other debt instruments throughout our worldwide
operations. To mitigate foreign currency risk, such debt is generally
denominated in the underlying local currency of the affiliate. In certain
limited and specific circumstances, we will manage risk by denominating a
portion of debt outstanding in a currency other than the local currency.
ITEM 4. CONTROLS AND PROCEDURES
(a) Our chief executive officer and chief financial officer performed an
evaluation of our disclosure controls and procedures as of January 31, 2005 (the
"Evaluation Date"). Based on that evaluation, our chief executive officer and
chief financial officer concluded that our disclosure controls and procedures
were effective and sufficient to ensure that the information required to be
disclosed in the reports that we file under the Securities Exchange Act of 1934
is recorded, processed, summarized, and reported within the time periods
specified in the SEC's rules and forms.
(b) There have been no significant changes in our internal controls since the
Evaluation Date. We are not aware of any significant change in any other factors
that could significantly affect our internal controls subsequent to the
Evaluation Date.
22
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report.
Exhibit 31.1 - Certification of Mark G. Kachur pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
Exhibit 31.2 - Certification of Frederick C. Flynn, Jr. pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 - Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 - Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
We filed a Report on Form 8-K dated January 18, 2005, under "Item 1.01
Entry into a material Definitive Agreement", disclosing recent employments
agreements with Timothy B. Carney and Mark G. Kachur.
23
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 February 23, 2005
By /s/Mark G. Kachur
-----------------
Mark G. Kachur
Chairman of the Board of Directors,
President and Chief Executive Officer
By /s/ Frederick C. Flynn, Jr.
---------------------------
Frederick C. Flynn, Jr.
Senior Vice President -
Finance and Administration,
Chief Financial Officer and Assistant Secretary
24