CPAC INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2002

OR

[ ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File No. 0-9600

CPAC, INC.
(Exact name of registrant as specified in its charter)

New York
(State or other jurisdiction of
incorporation or organization)

16-0961040
(I.R.S. Employer Identification No.)

2364 Leicester Road
Leicester, New York 14481
(Address of principal executive offices and zip code)

(585) 382-3223
(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 period 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 [ ]

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

Class	Number of Shares Outstanding at December 31, 2002
Common Stock, $.01 par value	4,995,899

Options Outstanding & Not Exercised	Shares to cover the options will not be issued until they are exercised.
961,788

CPAC, INC. AND SUBSIDIARIES

INDEX

		Page No.
	PART I -- FINANCIAL INFORMATION
Item 1.	Financial Statements.
	CPAC, Inc. and Subsidiaries Consolidated Balance Sheets - December 31, 2002 (Unaudited), and March 31, 2002	3
	CPAC, Inc. and Subsidiaries Consolidated Statements of Operations and Comprehensive Income (Loss) -- Nine Months Ended December 31, 2002, and December 31, 2001 (Unaudited)	4
	CPAC, Inc. and Subsidiaries Consolidated Statements of Operations and Comprehensive Income (Loss) -- Three Months Ended December 31, 2002, and December 31, 2001 (Unaudited)	5
	CPAC, Inc. and Subsidiaries Consolidated Statements of Cash Flows -- Nine Months Ended December 31, 2002, and December 31, 2001 (Unaudited)	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations.	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	14
Item 4.	Controls and Procedures.	14

	PART II -- OTHER INFORMATION
Item 1.	Legal Proceedings.	15
Item 2.	Changes in Securities and Use of Proceeds.	15
Item 3.	Defaults Upon Senior Securities.	15
Item 4.	Submission of Matters to a Vote of Security Holders.	15
Item 5.	Other Information.	15
Item 6.	Exhibits and Reports on Form 8-K.	15
	SIGNATURE PAGE	17
	CERTIFICATIONS	18
	EXHIBIT INDEX	20

PART I -- FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS.

CPAC, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

		December 31, 2002 (Unaudited)		March 31, 2002 (Note)
ASSETS
Current assets:
	Cash and cash equivalents	$ 8,448,955		$ 7,991,834
	Accounts receivable (net of allowance for doubtful accounts of $1,338,000 and $868,000, respectively)	11,504,827		13,217,923
	Inventory, net	18,384,430		17,555,303
	Prepaid expenses and other current assets	1,476,776		1,208,274
	Deferred tax assets, current	1,057,790		1,251,000
	Total current assets	40,872,778		41,224,334
Property, plant and equipment, net		17,191,882		17,690,540
Goodwill		192,426		10,661,677
Other intangible assets (net of amortization of $1,591,292 and $1,299,166, respectively)		1,131,206		1,436,943
Deferred tax assets, long-term		2,649,691		190,000
Other assets		4,716,131		4,931,782
		$ 66,754,114		$ 76,135,276

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
	Current portion of long-term debt	$ 652,854		$ 1,061,175
	Accounts payable	4,467,322		4,758,153
	Accrued payroll and related expenses	1,611,411		1,679,952
	Accrued income taxes payable	24,708		621,575
	Other accrued expenses and liabilities	2,400,634		2,701,767
	Total current liabilities	9,156,929		10,822,622
Long-term debt, net of current portion		7,354,177		7,404,721
Other long-term liabilities		3,967,594		5,875,703
Shareholders' equity:
	Common stock, par value $0.01 per share; Authorized 30,000,000 shares; Issued 5,081,206 and 5,208,806 shares	50,812		52,088
	Additional paid-in capital	9,862,773		10,538,823
	Retained earnings	38,151,032		43,774,842
	Accumulated other comprehensive income	(1,199,015	)	(1,743,335	)
		46,865,602		52,622,418
Less: Treasury stock, at cost, 85,307 shares		(590,188	)	(590,188	)
	Total shareholders' equity	46,275,414		52,032,230
		$ 66,754,114		$ 76,135,276

Note: The balance sheet at March 31, 2002 has been taken from the audited financial statements as of that date.

The accompanying notes are an integral part of the financial statements.

CPAC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

FOR THE NINE MONTHS ENDED

DECEMBER 31, 2002 AND DECEMBER 31, 2001

UNAUDITED

		2002		2001
Net sales		$ 72,093,980		$ 73,680,202
Costs and expenses:
	Cost of sales	39,500,351		40,582,112
	Selling, administrative and engineering expenses	28,962,679		28,310,696
	Research and development expense	500,838		470,125
	Interest expense, net	399,412		399,520
		69,363,280		69,762,453
Income before income taxes and cumulative effect of change in accounting principle		2,730,700		3,917,749
Provision for income tax expense		997,000		1,407,000
Income before cumulative effect of change in accounting principle		1,733,700		2,510,749
Cumulative effect of change in accounting principle, net		(6,281,251	)
	Net income (loss)	$ (4,547,551	)	$ 2,510,749
Net income (loss) per common share:
	Basic:
	Before cumulative effect of change in accounting principle	$ 0.34		$ 0.48
	Cumulative effect of change in accounting principle, net	$ (1.23	)	$
	Basic net income (loss) per share	$ (0.89	)	$ 0.48
	Diluted:
	Before cumulative effect of change in accounting principle	$ 0.34		$ 0.48
	Cumulative effect of change in accounting principle, net	$ (1.23	)	$
	Diluted net income (loss) per share	$ (0.89	)	$ 0.48
Average common shares outstanding:
	Basic	5,100,718		5,226,228
	Diluted	5,111,726		5,238,901
Comprehensive income (loss):
	Net income (loss)	$ (4,547,551	)	$ 2,510,749
	Other comprehensive income (loss)	544,320		(273,633	)
	Comprehensive income (loss)	$ (4,003,231	)	$ 2,237,116

The accompanying notes are an integral part of the financial statements.

CPAC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

FOR THE THREE MONTHS ENDED

DECEMBER 31, 2002 AND DECEMBER 31, 2001

UNAUDITED

		2002		2001
Net sales		$ 23,685,856		$ 23,144,135
Costs and expenses:
	Cost of sales	12,989,219		12,448,030
	Selling, administrative and engineering expenses	9,646,860		9,304,377
	Research and development expense	148,878		164,209
	Interest expense, net	138,628		119,910
		22,923,585		22,036,526
Income before income taxes and cumulative effect of change in accounting principle		762,271		1,107,609
Provision for income tax expense		262,000		382,000
Income before cumulative effect of change in accounting principle		500,271		725,609
Cumulative effect of change in accounting principle, net
	Net income	$ 500,271		$ 725,609
Net income (loss) per common share:
	Basic:
	Before cumulative effect of change in accounting principle	$ 0.10		$ 0.14
	Cumulative effect of change in accounting principle, net	$		$
	Basic net income per share	$ 0.10		$ 0.14
	Diluted:
	Before cumulative effect of change in accounting principle	$ 0.10		$ 0.14
	Cumulative effect of change in accounting principle, net	$		$
	Diluted net income per share	$ 0.10		$ 0.14
Average common shares outstanding:
	Basic	5,057,297		5,139,722
	Diluted	5,059,045		5,152,800
Comprehensive income (loss):
	Net income	$ 500,271		$ 725,609
	Other comprehensive income (loss)	(117,419	)	351,278
	Comprehensive income (loss)	$ 382,852		$ 1,076,887

The accompanying notes are an integral part of the financial statements.

CPAC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED

DECEMBER 31, 2002 AND DECEMBER 31, 2001

UNAUDITED

		2002		2001
Cash flows from operating activities:
	Net income (loss)	$ (4,547,551	)	$ 2,510,749
	Adjustments to reconcile net income to net cash provided by operating activities:
	Depreciation	1,858,897		2,149,109
	Amortization of intangible assets	122,635		474,958
	Cumulative effect of accounting change	6,281,251
	Changes in assets and liabilities:
	Accounts receivable	1,791,647		2,470,608
	Inventory	(703,604	)	(1,766,596	)
	Accounts payable	(260,330	)	(432,258	)
	Accrued expenses and liabilities	(654,406	)	503,049
	Other changes, net	(91,074	)	(379,812	)
	Total adjustments	8,345,016		3,019,058
	Net cash provided by operating activities	3,797,465		5,529,807
Cash flows from investing activities:
	Purchase of property, plant, and equipment, net	(1,242,858	)	(897,605	)
	Net cash used in investing activities	(1,242,858	)	(897,605	)
Cash flows from financing activities:
	Common stock repurchase	(677,326	)	(1,836,267	)
	Repayment of long-term borrowings	(350,622	)	(541,484	)
	Payment of cash dividends	(1,076,259	)	(1,095,944	)
	Net cash used in financing activities	(2,104,207	)	(3,473,695	)
	Effect of exchange rate changes on cash	6,721		(2,311	)
	Net increase in cash and cash equivalents	457,121		1,156,196
Cash and cash equivalents -- beginning of period		7,991,834		8,859,885
Cash and cash equivalents -- end of period		$ 8,448,955		$ 10,016,081

The accompanying notes are an integral part of the financial statements.

1 -- CONSOLIDATED FINANCIAL STATEMENTS

The consolidated balance sheets, the consolidated statements of operations and comprehensive income (loss), and the consolidated statements of cash flows for the interim periods presented have been prepared by the Company without audit. In the opinion of management, all adjustments necessary to present fairly the financial position, results of operations, and changes in cash flows for the interim periods presented (which include only normal recurring adjustments), have been made.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested that these consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company's March 31, 2002, Annual Report to Shareholders. The results of operations for the interim periods presented are not necessarily indicative of the operating results for the full year.

2 -- INVENTORY

Inventory is summarized as follows:

	December 31, 2002	March 31, 2002
Raw materials and purchased parts	$ 7,577,299	$ 7,012,149
Work-in-process	1,075,589	905,305
Finished goods	9,731,542	9,637,849
	$ 18,384,430	$ 17,555,303

3 -- EARNINGS PER SHARE

Basic earnings per share are based upon the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted-average common shares outstanding during the period plus the dilutive effect of shares issuable through stock options and warrants. The shares used in calculating basic and diluted earnings per share are reconciled as follows:

	Three Months Ended December 31,		Nine Months Ended December 31,
	2002	2001	2002	2001
Basic weighted average number of shares outstanding	5,057,297	5,139,722	5,100,718	5,226,228
Effect of dilutive stock options	1,748	13,078	11,008	12,673
Dilutive shares outstanding	5,059,045	5,152,800	5,111,726	5,238,901

Unexercised stock options to purchase 916,417 and 1,005,311 shares of the Company's common stock as of December 31, 2002 and 2001, respectively, were not included in the computations of diluted earnings per share because the options' exercise prices were greater than the average market price of the Company's common stock during the respective periods. These options, issued at various dates from 1995 to 2002, are still outstanding at the end of the period.

4 -- COMPREHENSIVE INCOME

Other comprehensive income (loss) includes foreign currency translation adjustments.

5 -- SEGMENT INFORMATION

The Company operates in two industry segments: the Fuller Brands segment and the CPAC Global Imaging Group (Imaging) segment. Information concerning the Company's business segments' net sales and income before income taxes and cumulative effect of change in accounting principle for the quarters and nine months ended December 31, 2002 and 2001 are as follows:

	Three Months Ended December 31,				Nine Months Ended December 31,
	2002		2001		2002		2001
Net sales to customers:
Fuller Brands	$ 13,422,120		$ 12,951,874		$ 42,739,333		$ 43,146,430
Imaging	10,263,736		10,192,261		29,354,647		30,533,772
Total net sales to customers	$ 23,685,856		$ 23,144,135		$ 72,093,980		$ 73,680,202
Operating income:
Fuller Brands	$ 406,187		$ 751,901		$ 2,322,454		$ 2,656,304
Imaging	538,349		533,344		978,542		1,770,641
	944,536		1,285,245		3,300,996		4,426,945
Corporate income (loss)	(43,637	)	(57,726	)	(170,884	)	(109,676	)
Interest expense, net	(138,628	)	(119,910	)	(399,412	)	(399,520	)
Income before income taxes and cumulative effect of change in accounting principle	$ 762,271		$ 1,107,609		$ 2,730,700		$ 3,917,749

Sales between segments are not material.

Information concerning the Company's business segments' identifiable assets at December 31, 2002 and March 31, 2002 are as follows:

	December 31, 2002	March 31, 2002
Identifiable assets:
Fuller Brands	$ 39,515,174	$ 49,071,973
Imaging	14,885,858	18,356,404
Total identifiable assets of the segment	54,401,032	67,428,377
General Corporate assets	12,353,082	8,706,899
	$ 66,754,114	$ 76,135,276

General Corporate assets include short-term investments held for future use amounting to $6,671,425 and $4,974,251 at December 31, 2002 and March 31, 2002, respectively.

6 -- ADOPTION OF SFAS NO. 142

On April 1, 2002, the Company adopted the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets." The pronouncement required an annual impairment test (comparison of estimated fair value to carrying value) in lieu of monthly amortization for goodwill. In connection with adoption of SFAS No. 142, the Company completed in the first quarter of fiscal 2003 the impairment test for goodwill. To determine potential impairment, fair value of the applicable business units was determined by computing the present value of expected future cash flows. The effect was to reduce the carrying value of goodwill by approximately $6.3 million, net of income tax benefit of $4.2 million, or $1.23 per diluted share. The impairment adjustment was related to the Fuller Brand's Cleaning Technologies Group (CTG) operation, acquired in fiscal 1998, and was a result of a combination of factors, including operating performance, as well as new measurement techniques and methodologies as prescribed by SFAS No. 142. The adjustment is shown as a cumulative effect of change in accounting principle in the consolidated statements of operations and comprehensive income for the nine months ended December 31, 2002. The income tax benefit realized, netted with the previously recognized deferred tax credit, resulted in the recording of a long-term deferred tax asset upon adoption. This asset has been grouped with other long-term deferred tax assets on the Company's consolidated balance sheet.

7 -- GOODWILL AND AMORTIZABLE INTANGIBLES

A summary of changes in the Company's goodwill during the nine months ended December 31, 2002, by segment is as follows (in thousands):

	March 31, 2002	Impairment		December 31, 2002
Fuller Brands	$ 10,469	$ (10,469	) (a)	$
Imaging	193			193
Total	$ 10,662	$ (10,469	)	$ 193
(a) Actual impairment charge recorded was $6,281, net of tax benefit of $4,188.

The following table presents prior year earnings and earnings per share as if the non-amortization provisions of SFAS No. 142 had been applied in the prior year:

	Three Months Ended		Nine Months Ended
	December 31, 2002	December 31, 2001	December 31, 2002		December 31, 2001
Reported net income	$ 500,271	$ 725,609	$ (4,547,551	)	$ 2,510,749
Addback goodwill amortization, net of tax		56,000			180,000
Addback cumulative effect of change in accounting principle, net			6,281,251
Adjusted net income	$ 500,271	$ 781,609	$ 1,733,700		$ 2,690,749

Basic earnings per common share before cumulative effect of change in accounting principle:
Reported basic earnings per common share	$ 0.10	$ 0.14	$ (0.89	)	$ 0.48
Addback goodwill amortization, net of tax		0.01			0.03
Addback cumulative effect of change in accounting principle, net			1.23
Adjusted basic earnings per common share	$ 0.10	$ 0.15	$ 0.34		$ 0.51

Diluted earnings per common share before cumulative effect of change in accounting principle:
Reported diluted earnings per common share	$ 0.10	$ 0.14	$ (0.89	)	$ 0.48
Addback goodwill amortization, net of tax		0.01			0.03
Addback cumulative effect of change in accounting principle, net			1.23
Adjusted diluted earnings per common share	$ 0.10	$ 0.15	$ 0.34		$ 0.51

Reported comprehensive income (loss)	$ 382,852	$ 1,076,887	$ (4,003,231	)	$ 2,237,116
Addback goodwill amortization, net of tax		56,000			180,000
Addback cumulative effect of change in accounting principle, net			6,281,251
Adjusted comprehensive income (loss)	$ 382,852	$ 1,132,887	$ 2,278,020		$ 2,417,116

At December 31, 2002 and March 31, 2002, amortizable intangibles consisted primarily of a contractual license agreement allowing the Company to manufacture and distribute products through the use of the trademarks and formulas of Stanley Home Products. The license is being amortized over the contract period, which expires on March 31, 2010. The cost pertaining to this intangible at December 31, 2002 and March 31, 2002 was $2,250,000, while accumulated amortization at December 31, 2002 and March 31, 2002 were $1,162,500 and 1,050,000, respectively.

8 -- ACCOUNTING PRONOUNCEMENTS

On April 1, 2002, SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" was effective for the Company. The adoption of this pronouncement did not have any effect on the Company's financial position, results of operations, or cash flows.

In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, amendment of FASB Statement No. 13, and Technical Corrections," was issued. SFAS No. 145 rescinds SFAS No. 4 and SFAS No. 64 related to classification of gains and losses on debt extinguishment and amends SFAS No. 13 with respect to sales-leaseback transactions. The pronouncement was effective for the Company April 1, 2002 and had no impact on the Company's reported results of operations and financial position.

In June 2002, SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" was issued. SFAS No. 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity," and requires companies to recognize a liability for costs associated with an exit or disposal activity when the liability is incurred, as opposed to the date of an entity's commitment to an exit plan (as required under EITF No. 94-3). The pronouncement, effective for exit or disposal activities that are initiated after December 31, 2002, with earlier application allowed, did not impact the Company's reported results of operations and financial position for the nine months ended December 31, 2002. It is possible that future expense reduction efforts may be necessary, and if so, provisions of this pronouncement may apply to future results of operatio ns and financial position of the Company.

In December 2002, SFAS No. 148, "Accounting for Stock Based Compensation-Transition and Disclosure-an amendment of FASB No. 123" was issued. SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock based employee compensation. It also amends disclosure req