PALL CORP - 10-Q Quarterly Report

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

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED MAY 3, 2003

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

For the transition period from __________ to __________

Commission File Number 1-4311

PALL CORPORATION
(Exact name of registrant as specified in its charter)

NEW YORK (State or other jurisdiction of incorporation or organization)	11-1541330 (I.R.S. Employer Identification No.)

2200 Northern Boulevard, East Hills, NY (Address of principal executive offices)	11548 (Zip Code)

(516) 484-5400
(Registrant’s telephone number, including area code)

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 registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. Yes No

The number of shares of the registrant’s common stock outstanding as of June 6, 2003 was 124,112,960.

PALL CORPORATION
FORM 10-Q for the Quarter Ended May 3, 2003

INDEX

	Page No.


PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets at May 3, 2003 and August 3, 2002	3

Condensed Consolidated Statements of Earnings for the three and nine months ended
May 3, 2003 and April 27, 2002	4

Condensed Consolidated Statements of Cash Flows for the nine months ended
May 3, 2003 and April 27, 2002	5

Notes To Condensed Consolidated Financial Statements	6

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	16

ITEM 4. Controls and Procedures	24

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings	25

ITEM 6. Exhibits and Reports on Form 8-K	25

SIGNATURES	26

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

PALL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(Unaudited)

		May 3, 2003			Aug. 3, 2002

	ASSETS
Current assets:
Cash and cash equivalents		$	125,163		$	105,224
Short-term investments			23,600			40,200
Accounts receivable, net			394,166			415,853
Inventories			293,529			256,910
Other current assets			106,960			94,947

Total current assets			943,418			913,134
Property, plant and equipment, net			597,993			605,095
Goodwill, net			238,565			262,973
Intangible assets, net			54,135			39,948
Other assets			193,736			189,293

Total assets		$	2,027,847		$	2,010,443

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and other current liabilities		$	293,076		$	290,228
Income taxes payable			39,527			41,549
Current portion of long-term debt			39,415			61,344
Notes payable to banks			18,212			42,202

Total current liabilities			390,230			435,323
Long-term debt, net of current portion			606,139			619,705
Deferred taxes and other non-current liabilities			142,673			135,695

Total liabilities			1,139,042			1,190,723

Stockholders’ equity:
Common stock, par value $.10 per share			12,796			12,796
Capital in excess of par value			109,974			110,745
Retained earnings			844,638			832,308
Treasury stock, at cost			(95,536	)		(110,799	)
Stock option loans			(1,966	)		(3,259	)
Accumulated other comprehensive income (loss):
Foreign currency translation			25,225			(17,429	)
Minimum pension liability			(3,115	)		(3,079	)
Unrealized investment losses			(2,265	)		(236	)
Unrealized losses on derivatives			(946	)		(1,327	)

			18,899			(22,071	)

Total stockholders’ equity			888,805			819,720

Total liabilities and stockholders’ equity		$	2,027,847		$	2,010,443

See accompanying notes to condensed consolidated financial statements.

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PALL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands, except per share data)
(Unaudited)

	Three Months Ended				Nine Months Ended

		May 3, 2003		April 27, 2002		May 3, 2003		April 27, 2002

Net sales	$	421,491	$	302,377	$	1,142,223	$	861,931
Cost of sales		205,587		145,482		579,933		425,946

Gross profit		215,904		156,895		562,290		435,985

Selling, general and administrative expenses		138,664		107,245		384,361		306,471
Research and development		14,255		13,159		39,715		38,474
Restructuring and other charges		5,036		–		46,335		–
Interest expense, net		5,765		2,590		19,238		8,668

Earnings before income taxes		52,184		33,901		72,641		82,372
Income taxes		11,829		7,458		24,045		18,122

Net earnings	$	40,355	$	26,443	$	48,596	$	64,250

Earnings per share:
Basic	$	0.33	$	0.22	$	0.40	$	0.53
Diluted	$	0.33	$	0.21	$	0.39	$	0.52

Dividends declared per share	$	0.09	$	0.09	$	0.27	$	0.43

Average shares outstanding:
Basic		123,146		122,336		122,983		122,242
Diluted		123,891		123,512		123,745		123,478

See accompanying notes to condensed consolidated financial statements.

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PALL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

	Nine Months Ended

		May 3, 2003		April 27, 2002

Net cash provided by operating activities,
net of effect of acquisitions	$	127,940		$	104,692
Investing activities:
Acquisitions of businesses, net of cash acquired		(14,095	)		(345,490	)
Capital expenditures		(39,303	)		(47,791	)
Disposals of fixed assets		4,110			4,164
Short-term investments		16,600			93,600
Benefits protection trust		(67	)		(1,562	)

Net cash used by investing activities		(32,755	)		(297,079	)

Financing activities:
Notes payable		(375,883	)		325,034
Long-term borrowings		445,191			1,485
Repayments of long-term debt		(137,386	)		(53,921	)
Net proceeds from stock plans		8,423			12,139
Proceeds representing the fair value of terminated interest rate swaps		7,533			–
Purchase of treasury stock		–			(9,999	)
Dividends paid		(33,175	)		(62,337	)

Net cash (used) provided by financing activities		(85,297	)		212,401

Cash flow for period		9,888			20,014
Cash and cash equivalents at beginning of year		105,224			54,927
Effect of exchange rate changes on cash		10,051			240

Cash and cash equivalents at end of period	$	125,163		$	75,181

Supplemental disclosures:
Interest paid	$	19,932		$	14,048
Income taxes paid (net of refunds)		24,195			30,435

Non-cash transactions:
During the third quarter of fiscal 2003, the Company funded certain pension obligations of $4,288 by issuing treasury stock.

See accompanying notes to condensed consolidated financial statements.

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PALL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)

(Unaudited)

NOTE 1 – BASIS OF PRESENTATION

The financial information included herein is unaudited. However, such information reflects all adjustments which are, in the opinion of management, necessary to present fairly the Company’s financial position, results of operations and cash flows as of the dates and for the periods presented herein. These financial statements should be read in conjunction with the financial statements and notes set forth in the Company’s Annual Report on Form 10-K for the fiscal year ended August 3, 2002.

Certain prior year amounts have been reclassified to conform to the current year presentation.

NOTE 2 – RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In May 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“SFAS No. 150”). SFAS No. 150 establishes standards on the classification and measurement of financial instruments with characteristics of both liabilities and equity. SFAS No. 150 will become effective for financial instruments entered into or modified after May 31, 2003. The Company is in the process of assessing the effect of SFAS No. 150 and does not expect its adoption to have a material effect on the Company’s results of operations, cash flows or financial position.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (“SFAS No. 149”). This statement amends Statement 133 to provide clarification on the financial accounting and reporting of derivative instruments and hedging activities and requires contracts with similar characteristics to be accounted for on a comparable basis. The Company is in the process of assessing the effect of SFAS No. 149 and does not expect the adoption of the statement, which will be effective for contracts entered into or modified after June 30, 2003, to have a material effect on its results of operations, cash flows or financial position.

In February 2003, the Company adopted the provisions of SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure (“SFAS No. 148”), which amends SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”). SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects on reported results of operations of an entity's accounting policy decisions with respect to stock-based employee compensation, and requires disclosure about those effects in both annual and interim financial statements. See Note 5 for the disclosures required under SFAS 148.

In January 2003, the Company adopted the provisions of SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS No. 146”). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The adoption of this accounting pronouncement did not have a material effect on the Company's results of operations, cash flows or financial position.

In December 2002, the Company adopted the provisions of FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN No. 45”). The adoption of FIN No. 45 did not have a material effect on the Company's results of operations, cash flows or financial position.

NOTE 3 – ACQUISITIONS

On April 24, 2002, the Company acquired the Filtration and Separations Group (“FSG”) from United States Filter Corporation (“US Filter”) for $360,000 in cash, subject to a post closing adjustment of the purchase price based on the net assets acquired as of April 27, 2002. The adjustment to the purchase price was finalized in the first quarter of fiscal 2003, resulting in additional consideration due to US Filter of $7,801. The operating results of FSG are reported in the Company’s results of operations from April 28, 2002.

The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, Business Combinations (“SFAS No. 141”). SFAS No. 141 requires that the total cost of the acquisition be allocated

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PALL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands, except per share data)

(Unaudited)

to the tangible and intangible assets acquired and liabilities assumed based upon their respective fair values at the date of acquisition. The allocation of the purchase price was dependent upon certain valuations and other studies. In the first quarter of fiscal 2003, the valuation of in-process research and development and certain amortizable intangible assets, patented and unpatented technology, was finalized. As a result, the Company wrote-off $37,600 of preliminary goodwill as in-process research and development (refer to Note 4 for further discussion) and reallocated $16,800 of preliminary goodwill to write up the aforementioned amortizable intangible assets from their book value to their fair value of $20,100.

The amount of in-process research and development was determined by identifying research projects for which technological feasibility had not been established and for which no alternative future uses existed. As of the acquisition date, there were various projects that met the above criteria. The majority of the projects identified are targeted for the General Industrial segment. The value of the research projects identified to be in process was determined by estimating the future cash flows from the projects once commercially feasible, discounting the net cash flows back to their present value and then applying a percentage of completion to the calculated value. The key assumptions specifically underlying the valuation for purchased in-process research and development consist of an expected completion date for the in-process projects, estimated costs to complete the projects, revenue and expense projections, and discount rates based on the risks associated with the development life cycle of the in-process technology acquired. The weighted average discount rate used was approximately 24% (ranging from 18% to 67%). The percentage of completion for the projects was determined using milestones representing estimates of effort, value added and degree of difficulty of the portion of the projects completed as of April 27, 2002, as compared to the total research and development to be completed to bring the projects to technological feasibility. As of May 3, 2003, the Company estimates the projects were approximately 67% complete on a weighted average basis (ranging from 23% to 99%). The development of these technologies remains an uncertainty due to the remaining efforts to achieve technological feasibility, changing customer markets, and significant competitive threats from other companies.

At the date of acquisition, management began formulating integration plans which contemplated the closure of redundant facilities and the sale of certain businesses. In addition, the synergies created by joining the two organizations have resulted in employee terminations. The condensed consolidated balance sheets at May 3, 2003 and August 3, 2002 reflect liabilities for such items. We expect to continue to finalize and announce other integration plans during the fourth quarter of fiscal 2003. Finalization of such integration plans will be reflected in earnings (refer to Note 4 for discussion of actions taken in the first nine months of fiscal 2003).

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PALL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands, except per share data)

(Unaudited)

The May 3, 2003 condensed consolidated balance sheet reflects the final allocation of the purchase price and non-deductible goodwill of $176,802. The following table summarizes the final allocation of the purchase price to the assets and in-process research and development acquired and liabilities assumed:

Purchase price	$	367,801
Transaction costs		7,179

Total cost		374,980
Cash acquired		19,671

Total purchase price, net of cash acquired		355,309

Current assets		168,038
Property, plant and equipment		90,169
Intangible assets		23,617
Other non-current assets		3,870
In-process research and development		37,600

Total assets and in-process research and development acquired		323,294

Current liabilities		109,501
Non-current liabilities		35,286

Total liabilities assumed		144,787

Goodwill	$	176,802

Goodwill has been allocated to the Company’s reportable segments as follows:

BioPharmaceuticals	$	13,419
General Industrial		141,477
Microelectronics		21,906

Total	$	176,802

On March 4, 2003, we acquired the assets, primarily manufacturing equipment and intellectual property, of Whatman Hemasure Inc., a wholly owned subsidiary of Whatman plc (“the seller”) for a purchase price of $5,950. The agreement contains a non-compete agreement for a period of 7½ years, which precludes the seller from engaging in the blood filter business during that time. The May 3, 2003 condensed consolidated balance sheet reflects the preliminary allocation of the purchase price (which is subject to the completion of a valuation of the assets acquired) to intangible assets and goodwill of $2,500 and $3,450, respectively. The preliminary goodwill has been allocated to the Company’s Medical segment.

NOTE 4 – RESTRUCTURING AND OTHER CHARGES

The following tables summarize the restructuring related items and other charges recorded for the quarter and nine months ended May 3, 2003:

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PALL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands, except per share data)

(Unaudited)

Three Months Ended May 3, 2003		Restructuring		Other Charges and Adjustments		Total Charged To Earnings		Adjustments To Goodwill (a)		Total

Severance (c)	$	2,893	$	–	$	2,893	$	4,014	$	6,907
Asset write-offs/
impairment (c)		323		–		323		2,962		3,285
Lease termination
liabilities and other (c)		1,820		–		1,820		4,199		6,019

Total	$	5,036	$	–	$	5,036	$	11,175	$	16,211


Cash	$	4,713	$	–	$	4,713	$	8,213	$	12,926
Non-cash		323		–		323		2,962		3,285

Total	$	5,036	$	–	$	5,036	$	11,175	$	16,211

Nine Months Ended May 3, 2003		Restructuring		Other Charges and Adjustments		Total Charged To Earnings		Adjustments To Goodwill (a)		Total

In-process research and development (b)	$	–	$	37,600	$	37,600	$	–	$	37,600
Severance (c)		6,320		–		6,320		7,453		13,773
Asset write-offs/				–
impairment (c)		528				528		5,453		5,981
Lease termination
liabilities and other (c)		1,887		–		1,887		6,578		8,465

Total	$	8,735	$	37,600	$	46,335	$	19,484	$	65,819


Cash	$	8,207	$	–	$	8,207	$	14,031	$	22,238
Non-cash		528		37,600		38,128		5,453		43,581

Total	$	8,735	$	37,600	$	46,335	$	19,484	$	65,819

(a)	Reflects restructuring activities related to FSG employees and facilities (refer to Note 3 for discussion of the purchase accounting).

(b)	In the first quarter of fiscal 2003, the Company recorded a charge of $37,600 to write-off in-process research and development acquired in the acquisition of FSG (refer to Note 3 for further discussion of the purchase accounting).

(c)	At the date of the FSG acquisition, management began formulating integration plans and identifying synergistic opportunities. During the fourth quarter of fiscal 2002 and in the first nine months of fiscal 2003, the Company announced and implemented plans to eliminate redundant employees and facilities and to consolidate certain manufacturing lines with other Pall facilities. The Company also consolidated its United States, European and Asian sales routes to market. As a result of the consolidation of routes to market, the Company terminated certain sales employees worldwide and in Asia, made payments to certain distributors to terminate these relationships. In addition, in the third quarter of fiscal 2003, the Company announced and implemented plans to reorganize and streamline its German operations. The plans include the elimination of some functional overlap, changes in routes to market and the rationalization of product lines.

	Furthermore, during the first quarter of fiscal 2003, the Company reorganized its Life Sciences business such that the Company’s hospital and medical OEM sub-segments were combined with the former Blood segment to form a new segment called Pall Medical (refer to Note 12 for further discussion). Additionally, in the third quarter of fiscal 2003, the Company announced plans to move certain Medical manufacturing from Tipperary, Ireland to Puerto Rico and Tijuana, Mexico. This reorganization, which is expected to reduce manufacturing and selling costs, included employee terminations. Restructuring costs related to the Life Sciences business totaled approximately $4,200 and $6,700 for the three months and nine months ended May 3, 2003, respectively.

	The integration and restructuring activities described above resulted in the recording of approximately $13,773 for the nine months ended May 3, 2003 in severance related liabilities for an estimated workforce reduction of 490 people, of which approximately 239 employees had been terminated as of May 3, 2003. In addition, liabilities of approximately $8,465 were recorded for lease termination, distributor cancellation payments and other office closure costs, while asset write-offs and impairments amounted to approximately $5,981.

	Cash requirements of these actions are expected to be $22,238 of which $10,485 has been expended, leaving $11,753 in accruals reflected on the balance sheet as of May 3, 2003. The expected cash outlays comprise $13,773 in employee termination benefits and $8,465 principally related to lease termination liabilities, distributor cancellation costs and other office closure costs.

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PALL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands, except per share data)

(Unaudited)

The following table summarizes activity for the nine months ended May 3, 2003 related to restructuring liabilities recorded in fiscal 2002 and fiscal 2003: