PALL CORP - 10-K Annual Report

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

FORM 10-K

		Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
		For the fiscal year ended August 2, 2003 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 Number 1- 4311

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

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

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

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

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Name of exchange on which registered
Common Stock $.10 par value	New York Stock Exchange
Common Share Purchase Rights	New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

The aggregate market value of the voting stock held by non-affiliates of the registrant was $2,783,721,335, based on the closing price on October 1, 2003.

The number of common shares, $.10 par value, outstanding of the registrant was 124,975,414 shares on October 1, 2003.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the registrant’s Proxy Statement for the 2003 annual meeting of shareholders, previously filed (hereinafter referred to as the “Proxy Statement”), are incorporated by reference into Part III.

TABLE OF CONTENTS

		Page No.
PART I
Item 1.	Business.	3
Item 2.	Properties.	6
Item 3.	Legal Proceedings.	7
Item 4.	Submission of Matters to a Vote of Security Holders.	7
PART II
Item 5.	Market for the Registrant’s Common Stock and Related Stockholder Matters.	7
Item 6.	Selected Financial Data.	8
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	9
Item 7A.	Quantitative and Qualitative Disclosure About Market Risk.	21
Item 8.	Financial Statements and Supplementary Data.	23
Item 9.	Changes In and Disagreements With Accountants on Accounting and Financial Disclosures.	23
Item 9A.	Controls and Procedures.	23
PART III
Item 10.	Directors and Executive Officers of the Registrant.	24
Item 11.	Executive Compensation.	25
Item 12.	Security Ownership of Certain Beneficial Owners and Management.	25
Item 13.	Certain Relationships and Related Transactions.	25
Item 14.	Principal Accountant Fees and Services.	25
PART IV
Item 15.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K.	26

SIGNATURES		29
INDEPENDENT AUDITORS’ REPORT		30
VALUATION AND QUALIFYING ACCOUNTS		60

PART I

ITEM 1. BUSINESS.

(a) General development of business.

Pall Corporation, incorporated in July 1946, and its subsidiaries (hereinafter collectively called the “Company” or referred to as “we” or “our” unless the context requires otherwise) is a leading supplier of fine filters, principally made by the Company using its proprietary filter media, and other fluid clarification and separations equipment for the removal of solid, liquid and gaseous contaminants from a wide variety of liquids and gases.

We serve customers in two principal markets: Life Sciences and Industrial. The two principal markets are further divided into five segments: Medical and BioPharmaceuticals (which comprise the Life Sciences business) and General Industrial, Aerospace and Microelectronics (which comprise the Industrial business).

During the past five years, we have continued our development and sale of fluid clarification and separations products in a wide variety of markets. Additionally, in fiscal 2002, we acquired the Filtration and Separations Group (“FSG”) from United States Filter Corporation (“US Filter”), significantly expanding our presence in the Industrial market. For additional information, see Acquisition and Related Matters in Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Acquisitions note in the notes accompanying the consolidated financial statements.

Additional information about the Company is available on its website at www.pall.com. The Company’s periodic and current reports filed with the U.S. Securities and Exchange Commission (“SEC”) are also available on its website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.

(b) Financial information about market segments.

For financial information by market segment, please see the Segment Information and Geographies note in the notes accompanying the consolidated financial statements and in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

(c) Narrative description of business.

We are a specialty materials and engineering company with the broadest-based filtration, separations and purification capabilities in the world. Our proprietary products are used to discover, develop and produce pharmaceuticals, produce safe drinking water, protect hospital patients, remove white blood cells from blood, enhance the quality and efficiency of manufacturing processes, keep equipment running efficiently and protect the environment. Requirements for product quality, purity, environmental preservation, health and safety apply to a wide range of industries and across geographic borders. We have a 57-year history of commercializing successful products and continue to develop new materials and technologies for the Life Sciences and Industrial markets and their increasingly difficult fluid filtration, purification and separation challenges. We have an array of core materials and technologies that can be combined and manipulated in many ways to solve complex fluid separation challenges. These proprietary materials, coupled with our ability to engineer them into useful forms, are the cornerstones of our capabilities. Our proprietary materials enable us to provide customers with products that are well matched to their needs, to develop new products and to enter new markets. With the addition of FSG, we enhanced our library of proprietary materials and technologies with sophisticated offerings such as asymmetric membranes, selective adsorption, melt-blown media, nano ceramic membranes and metallic fiber media.

We actively pursue only those applications in which Pall products can make a substantial difference to the customer and especially target projects that will result in real gains in performance and economics. The products sold are principally filters made with proprietary Pall filter media produced by chemical film casting, melt-blowing of polymer fibers, papermaking and metallurgical processes. Metal and plastic housings for our filters and a wide variety of appurtenant devices are also made. Competition is intense in all of our markets and includes many large and small companies in our global markets; however, no one company has a significant presence in all of our markets.

LIFE SCIENCES BUSINESS:

During the first quarter of fiscal 2003, we reorganized the Life Sciences business to improve profitability. As a result, the hospital and medical OEM sub-segments, which were previously part of the BioPharmaceuticals segment, were combined with the Blood segment to create a new segment called Medical. Life Sciences segment information for prior periods has been restated for these changes.

Our Life Sciences technologies facilitate the process of drug discovery and development and help ensure that drugs are produced to the highest standards. Many of the latest intravenous therapies require administration to patients through a Pall filter. Our capability in the life sciences industry is a unique competitive strength and an important element of our strategy going forward.

Sales in the Medical and BioPharmaceuticals markets are made through direct sales and through distribution. Backlog information is omitted for these markets, as it is not considered meaningful to an understanding of these portions of the Company’s business.

We feel that safety, efficacy, ease of use, technical support, as well as price, are the principal competitive factors in this business, although economy of use is important. Our principal competitors in the Medical segment include Baxter, Asahi Medical, MacoPharma, Terumo and Fresenius, and our principal competitors in the BioPharmaceuticals segment include Millipore, Sartorius and CUNO.

MEDICAL:

We sell disposable blood filtration and cardiovascular filtration products primarily to blood centers and hospitals. Our products are used to remove leukocytes (white blood cells) from blood used in transfusions and to filter out particulates, bacteria and viruses in the course of open-heart surgery, organ transplants, dialysis, intravenous feeding and breathing therapy. Leukocytes in donor blood can cause serious medical complications. Filtering out leukocytes reduces transfusion-related suppression of the immune system and helps protect against post-surgical infection. Based on medical risk and clinical benefits of filtration, hospitals and blood centers around the world have been converting to filtered blood. More than twenty countries either already are filtering all their donor blood or are moving toward this as a goal. In the United States, the Food and Drug Administration recommends blood filtration, and we believe that it is becoming the standard of care.

BIOPHARMACEUTICALS:

The BioPharmaceuticals segment includes sales of separation systems and disposable filters primarily to pharmaceutical, biotechnology and laboratory companies. We provide a broad range of advanced filtration solutions for each critical stage of drug development. Our product lines start in the laboratory with drug discovery, gene manipulation and proteomics applications. Our filtration systems and validation services allow drug manufacturers the quickest and surest path through the regulatory process and on to the market.

We believe that our established record of product performance and innovation is a particularly strong advantage among biopharmaceutical customers because of the high costs and safety risks associated with drug development and production.

INDUSTRIAL BUSINESS:

We provide enabling and process enhancing technologies throughout the industrial marketplace. This includes the machinery and equipment, aerospace, microelectronics, municipal and industrial water, fuels, chemicals, energy, and food and beverage industries. We have the capability to provide customers with integrated solutions for all of their process fluids.

GENERAL INDUSTRIAL:

Included in this diverse segment are sales of filters, coalescers and separation systems for hydraulic, fuel and lubrication systems on mechanical equipment across many industries as well as to producers of oil, gas, electricity, chemicals, food and beverages, municipal and industrial water and paper. Virtually all of the raw materials, process fluids and waste streams that course through industry are candidates for multiple stages of filtration, separations and purification.

We believe that technologies that purify water for use and reuse represent an important opportunity. Governments around the world are implementing stringent new regulations governing drinking water standards and we believe that our filters and systems provide a solution for these requirements. With the acquisition of FSG, we increased our presence in the stable and growing food and beverage sector and we have enhanced our ability to better serve our other industrial markets.

Backlog at August 2, 2003 was approximately $108,091,000. Our sales to General Industrial customers are made through our personnel, distributors and manufacturers’ representatives. We believe that product performance and quality, and service to the customer, as well as price, are the principal competitive factors in this market. Our principal competitors in the General Industrial segment include CUNO, US Filter, Sartorius and Parker Hannifin.

AEROSPACE:

The Aerospace segment includes sales of filtration and fluid monitoring equipment to the aerospace industry for use on commercial and military aircraft, including hydraulic, lubrication, and fuel filters, coalescers to remove water from fuel, filters to remove viruses from aircraft cabin air and filter monitoring systems. Our products and systems are also used in ships and land-based military vehicles. Commercial and Military sales represented 45% and 55%, respectively, of total Aerospace sales in fiscal 2003.

Our products are sold to customers in this segment through a combination of direct sales and through distribution. Backlog at August 2, 2003 was approximately $85,364,000. Competition varies by product, and no single competitor competes with us across all sub-segments of Aerospace; however, our principal competitors include Donaldson, ESCO Technologies Inc. and CLARCOR.

The Company believes that performance and quality of product and service, as well as price, are determinative in most sales.

MICROELECTRONICS:

Included in this segment are sales of disposable filtration products to producers of semiconductors, computer terminals, fiber optics, disk drives, thin film rigid discs and photographic film. The drive to shrink the size of computer components requires increasingly finer levels of filtration and purification, sometimes down to the level of parts per trillion. From the raw materials of silicon and water to the gases and chemicals of chip manufacture, we have extensive engineered solutions for the needs of this demanding industry.

Our products are sold to customers in this segment through our own personnel, distributors and manufacturers’ representatives. Backlog at August 2, 2003 was approximately $8,205,000. We believe that performance, quality of product and service, as well as price, are determinative in most sales. The principal competitors in the Microelectronics market include Mykrolis and Mott.

The following comments relate to the five segments discussed above:

RAW MATERIALS:

Most raw materials used by the Company are available from multiple sources. A limited number of materials are proprietary products of major chemical companies. The Company believes that it could find satisfactory substitutes for these materials should they become unavailable, as it has done several times in the past.

PATENTS:

The Company owns a broad range of patents covering its filter media, filter designs and other products, but it considers these to be mainly defensive, and relies on its proprietary manufacturing methods and engineering skills. However, it does act against infringers when it believes such action is economically justified.

The following comments relate to the Company’s business in general:


	1)	With few exceptions, research activities conducted by the Company are company sponsored. Such expenditures totaled $52,204,000 in 2003, $54,778,000 in 2002 and $56,041,000 in 2001.


	2)	No one customer provided 10% or more of the Company’s consolidated sales in fiscal 2003, 2002 or 2001.


	3)	The Company is in substantial compliance with federal, state and local laws regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. To date, compliance with environmental matters has not had a material effect upon the Company’s capital expenditures or competitive position.


	4)	For a further description of environmental issues see Item 3, Legal Proceedings and the Contingencies and Commitments note in the notes accompanying the consolidated financial statements.


	5)	At August 2, 2003, the Company employed approximately 10,500 persons.

(d) Financial information about geographic areas.

For financial information by geographic area, please see the Segment Information and Geographies note in the notes accompanying the consolidated financial statements.

ITEM 2. PROPERTIES.

The following represent the Company’s significant facilities:

Location	Type	Markets	Square Feet

OWNED:
Western Hemisphere
Cortland, NY	Plant & office	Life Sciences & Industrial	338,000
East Hills, NY	Office, plant & warehouse	Headquarters & all markets	326,000
DeLand, FL	Plant	Industrial	275,000
Fajardo, Puerto Rico	Plants, warehouse & laboratory	Life Sciences & Industrial	259,000
Pt. Washington, NY	Office, laboratory & training center	Life Sciences & Industrial	235,000
Ann Arbor, MI	Plant, office & warehouse	Life Sciences	180,000
New Port Richey, FL	Plant & office	Industrial	166,000
Timonium, MD	Plant & office	Industrial	160,000
Covina, CA	Plant, office & laboratory	Life Sciences	134,000
Ft. Myers, FL	Plant, office & warehouse	Industrial	111,000
Pensacola, FL	Plant	Life Sciences	77,000
Hauppauge, NY	Plant & office	Life Sciences	75,000
Putnam, CT	Plant	Life Sciences & Industrial	62,000
Europe
Bad Kreuznach, Germany	Plant & office	Life Sciences & Industrial	461,000
Waldstetten, Germany	Plant & office	Industrial	249,000
Portsmouth, U.K.	Plant, office, warehouse & laboratory	Life Sciences & Industrial	248,000
Crailsheim, Germany	Plant & office	Industrial	215,000
Tipperary, Ireland	Plant	Life Sciences & Industrial	178,000
Redruth, U.K.	Plant, office & warehouse	Industrial	163,000
Ilfracombe, U.K.	Plant & office	Life Sciences & Industrial	112,000
Bazet, France	Plant	Industrial	111,000
Newquay, U.K.	Plant & office	Life Sciences & Industrial	106,000
Frankfurt, Germany	Office & warehouse	Life Sciences & Industrial	72,000
Ascoli, Italy	Plant, office & warehouse	Life Sciences	71,000
Paris, France	Office & warehouse	Life Sciences & Industrial	65,000
Asia
Tsukuba, Japan	Plant, laboratory & warehouse	Life Sciences & Industrial	120,000
LEASED:
Western Hemisphere
Timonium, MD	Plant	Industrial	71,000
Covina, CA	Plant & warehouse	Life Sciences	66,000
Cortland, NY	Warehouse	Industrial	40,000
Tijuana, Mexico	Plant	Life Sciences	40,000
Europe
Frankfurt & Hamburg, Germany	Office & warehouse	Life Sciences & Industrial	100,000
Milan, Italy	Office & warehouses	Life Sciences & Industrial	54,000
Vienna, Austria	Office & warehouse	Life Sciences & Industrial	40,000
Madrid, Spain	Office & warehouse	Life Sciences & Industrial	28,000
Lyon, France	Plant	Industrial	26,000
Asia
Beijing, China	Plant, office & warehouse	Life Sciences & Industrial	160,000
Tokyo, Osaka, Nagoya, Japan	Offices	Life Sciences & Industrial	39,000

In the opinion of management, these premises are suitable and adequate to meet the Company’s requirements.

ITEM 3. LEGAL PROCEEDINGS.

In February 1988, an action was filed in the Circuit Court for Washtenaw County, Michigan (“Court”) by the State of Michigan (“State”) against Gelman Sciences Inc. (“Gelman”), a subsidiary acquired by the Company in February 1997. The action sought to compel Gelman to investigate and remediate contamination near Gelman’s Ann Arbor facility and requested reimbursement of costs the State had expended in investigating the contamination, which the State alleged was caused by Gelman’s disposal of waste water from its manufacturing process. Pursuant to a consent judgment entered into by Gelman and the State in October 1992 (amended September 1996 and October 1999), which resolved that litigation, Gelman is remediating the contamination without admitting wrongdoing. In February 2000, the State Assistant Attorney General filed a Motion to Enforce Consent Judgment in the Court seeking approximately $4,900,000 in stipulated penalties for the alleged violations of the consent judgment and additional injunctive relief. Gelman disputed these assertions. Following an evidentiary hearing in July 2000, the Court took the matter of penalties “under advisement.” The Court issued a Remediation Enforcement Order requiring Gelman to submit and implement a detailed plan that will reduce the contamination to acceptable levels within five years. The Company’s plan has been submitted to, and approved by, both the Court and the State. In the opinion of management, to date the Court has expressed its satisfaction with the Company’s progress. In correspondence dated June 5, 2001, the State asserted that additional stipulated penalties in the amount of $141,500 were owed for a separate alleged violation of the consent judgment. The Court found that a “substantial basis” for Gelman’s position existed and again took the State’s request under advisement, pending the results of certain groundwater monitoring data. Those data have been submitted to the Court, but no ruling has been issued. Finally, on August 9, 2001, the State made a written demand for reimbursement of $227,462 it has allegedly incurred for groundwater monitoring. Gelman considers this claim barred by the consent judgment. The Company’s balance sheet at August 2, 2003 contains environmental reserves of $14,189,000, which relates mainly to the aforementioned cleanup. In the opinion of management, the Company is in substantial compliance with applicable environmental laws and its current accruals for environmental remediation are adequate.

Reference is also made to the Contingencies and Commitments note in the notes accompanying the consolidated financial statements.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

There were no matters submitted to a vote of shareholders during the fourth quarter of fiscal year 2003.

PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.

Pall Corporation’s Common Stock is listed on the New York Stock Exchange. The table below sets forth quarterly data relating to the Company’s Common Stock prices and cash dividends declared per share for the past two fiscal years.

	2003				2002				Cash Dividends Declared Per Share
Price per share	High		Low		High		Low		2003		2002

Quarter: First	$	18.40	$	14.68	$	24.74	$	17.50	$	0.09	$	0.17
Second		19.45		15.01		25.00		20.16		0.09		0.17
Third		21.50		15.16		23.40		16.75		0.09		0.09
Fourth		25.00		20.07		23.42		15.90		0.09		0.09

In April 2002, the Company reduced the quarterly dividend to $0.09 from the previous $0.17 level. Approximately $40 million in cash conserved annually may be used for future investments, debt reduction or other means of creating shareholder value.

There are approximately 4,950 holders of record of the Company’s Common Stock.

ITEM 6. SELECTED FINANCIAL DATA.

The following table sets forth selected financial data for the last five years. This selected financial data should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Form 10-K.

On April 24, 2002, the Company acquired FSG. The acquisition was accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141, Business Combinations (“SFAS No. 141”). The operating results of FSG are reported in the Company’s results of operations from April 28, 2002. Refer to the Acquisitions note in the notes accompanying the consolidated financial statements for a discussion of this transaction.

(In millions, except per share data)	2003			2002			2001		2000			1999

RESULTS FOR THE YEAR:
Net sales	$	1,613.6		$	1,290.8		$	1,235.4	$	1,224.1		$	1,147.1
Cost of sales		810.0			654.9			591.2		565.5			555.3
Selling, general and administrative expenses		536.2			440.0			404.0		396.1			398.7
Research and development		52.2			54.8			56.1		51.4			56.5
Restructuring and other charges, net		47.5	^(a)		26.8			17.2		8.6			64.7
Interest expense, net		24.5			14.3			16.6		14.1			13.0

Earnings before taxes		143.2			100.0	^(b)		150.3		188.4	^(c)		58.9	^(d)
Income taxes		40.0			26.8			32.3		41.8			7.4

Net earnings	$	103.2		$	73.2		$	118.0	$	146.6		$	51.5

Earnings per share:
Basic		0.84			0.60			0.96		1.18			0.41
Diluted		0.83			0.59			0.95		1.18			0.41
Dividends declared per share		0.36			0.52			0.68		0.66			0.64
Capital expenditures		62.2			69.9			77.8		66.5			71.2
Depreciation and amortization		83.9			74.0			71.5		72.0			74.8

YEAR-END POSITION:
Working capital	$	516.9		$	477.8		$	465.1	$	329.7		$	199.3
Property, plant and equipment, net		600.2			605.1			503.0		503.8			507.0
Total assets		2,016.7			2,010.4			1,548.5		1,507.3			1,488.3
Long-term debt, net of current portion		489.9			619.7			359.1		223.9			116.8
Total liabilities		1,082.2			1,190.7			778.5		746.0			757.6
Stockholders’ equity		934.5			819.7			770.0		761.3			730.7

(a)	Includes $37.6 million of acquired in-process research and development and $9.9 million of restructuring costs.

(b)

Includes Restructuring and other charges, net, of $32.8 million (including a $6.0 million one-time purchase accounting adjustment contained in cost of sales, considered to be non-recurring in nature because, although the Company acquired the manufacturing operations of FSG, this adjustment was required by SFAS No. 141 as an elimination of the manufacturing profit of inventory acquired from FSG and sold in the period).

(c)	Includes Restructuring and other charges, net, of $12.0 million (including $3.4 million contained in cost of sales).

(d)	Includes Restructuring and other charges, net, of $89.4 million (including $24.7 million contained in cost of sales).

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

You should read the following discussion together with Pall’s consolidated financial statements and Notes thereto and other financial information included elsewhere in this Form 10-K report. The discussions under the subheadings “Review of Market Segment and Geographies” below are in local currency unless indicated otherwise. As used below, “½%” indicates that we have rounded the relevant data up or down to the nearest one-half percentage point. Dollar amounts discussed below are in thousands, except per share dollar amounts. In addition, per share dollar amounts are discussed on a diluted basis.

Acquisition and Related Matters

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 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. The methodology for allocating the purchase price to the estimated fair value of in-process research and development, as well as patented and unpatented technology was determined with the assistance of the Mentor Group, a third party valuation firm. 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 the Restructuring and Other Charges note accompanying the consolidated financial statements 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 with 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 Consolidated Balance Sheets at August 2, 2003 and August 3, 2002 reflect liabilities for such items (refer to the Restructuring and Other Charges note accompanying the consolidated financial statements for discussion of these items). We expect to continue to finalize and announce other integration plans during fiscal 2004. Finalization of such integration plans will be reflected in earnings.

For more detail regarding the FSG acquisition, please refer to the Acquisitions note accompanying the consolidated financial statements.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. These accounting principles require us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the periods presented. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may differ from estimates. The following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results, and that require judgment. See also the notes accompanying the consolidated financial statements, which contain additional information regarding our accounting policies.

Purchase Accounting and Goodwill

Determining the fair value of certain assets and liabilities acquired in a business combination in accordance with SFAS No. 141 is judgmental in nature and often involves the use of significant estimates and assumptions. There are various methods used to estimate the value of tangible and intangible assets acquired, such as discounted cash flow and market multiple approaches. Some of the more significant estimates and assumptions inherent in the two approaches include: projected future cash flows (including timing); discount rate reflecting the risk inherent in the future cash flows; perpetual growth rate; determination of appropriate market comparables; and the determination of whether a premium or a discount should be applied to comparables. There are also judgments made to determine the expected useful lives assigned to each class of assets and liabilities acquired.

Goodwill is measured as the excess of the cost of acquisition over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed. The Company performs goodwill impairment tests on an annual basis. In response to changes in industry and market conditions, the Company could be required to strategically realign its resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of goodwill. Based on impairment tests performed, there was no impairment of goodwill in fiscal 2003 and 2002.

Revenue Recognition

Revenue is recognized when title and risk of loss have transferred to the customer and when contractual terms have been fulfilled. Long-term contracts are accounted for under the percentage of completion method based upon the ratio of costs incurred to date compared with estimated total costs to complete them. The cumulative impact of revisions to total estimated costs is reflected in the per