PLL-10/31/2014-Q1FY2015


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
R
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended October 31, 2014
or
o
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: 001- 04311
PALL CORPORATION
(Exact name of registrant as specified in its charter)

New York
 
11-1541330
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
   
25 Harbor Park Drive, Port Washington, NY
11050
(Address of principal executive offices)
 
(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 the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ  No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ   No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 
Large accelerated filer þ
Accelerated filer o
 
 
 
 
 
Non-accelerated filer o
Smaller reporting company o
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The number of shares of the registrant’s common stock outstanding as of November 25, 2014 was 106,534,159.





Table of Contents
 
 
Page No.
 
 
 
 
 
 
 
 
 



2



PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
PALL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(Unaudited)

 
 
Oct 31, 2014
 
Jul 31, 2014
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
1,001,481

 
$
964,110

Accounts receivable
 
561,013

 
615,713

Inventory
 
401,524

 
404,878

Other current assets
 
156,855

 
152,522

Total current assets
 
2,120,873

 
2,137,223

Property, plant and equipment
 
773,373

 
805,327

Goodwill
 
485,548

 
491,462

Intangible assets
 
232,063

 
242,423

Other non-current assets
 
163,677

 
176,078

Total assets
 
$
3,775,534

 
$
3,852,513

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Notes payable
 
$
724,736

 
$
424,943

Accounts payable
 
149,596

 
165,373

Accrued liabilities
 
280,432

 
328,397

Income taxes payable
 
68,678

 
60,775

Current portion of long-term debt
 
82,784

 
87,955

Dividends payable
 
32,593

 
30,203

Total current liabilities
 
1,338,819

 
1,097,646

Long-term debt, net of current portion
 
375,593

 
375,826

Income taxes payable – non-current
 
149,333

 
150,484

Deferred taxes and other non-current liabilities
 
61,064

 
67,303

Other non-current liabilities
 
255,884

 
265,897

Total liabilities
 
2,180,693

 
1,957,156

Stockholders’ equity:
 
 
 
 
Common stock, par value $.10 per share
 
12,796

 
12,796

Capital in excess of par value
 
297,167

 
327,301

Retained earnings
 
2,567,609

 
2,512,961

Treasury stock, at cost
 
(1,191,017
)
 
(942,780
)
Accumulated other comprehensive income/(loss)
 
(91,714
)
 
(14,921
)
Total stockholders’ equity
 
1,594,841

 
1,895,357

Total liabilities and stockholders’ equity
 
$
3,775,534

 
$
3,852,513


See accompanying notes to condensed consolidated financial statements.



3



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

 
 
Three Months Ended
 
 
Oct 31, 2014
 
Oct 31, 2013
Net sales
 
$
696,492

 
$
629,779

Cost of sales
 
335,084

 
304,065

Gross profit
 
361,408

 
325,714

Selling, general and administrative expenses
 
202,656

 
194,884

Research and development
 
24,777

 
23,267

Restructuring and other charges, net
 
9,240

 
9,198

Interest expense, net
 
6,702

 
5,977

Earnings from operations before income taxes
 
118,033

 
92,388

Provision for income taxes
 
29,760

 
20,875

Net earnings
 
$
88,273

 
$
71,513

Earnings per share:
 
 
 
 
Basic
 
$
0.82

 
$
0.64

Diluted
 
$
0.81

 
$
0.63

Dividends declared per share
 
$
0.305

 
$
0.275

Average shares outstanding:
 
 
 
 
Basic
 
108,081

 
111,870

Diluted
 
109,219

 
113,135


See accompanying notes to condensed consolidated financial statements.



4



PALL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)

 
 
Three Months Ended
 
 
Oct 31, 2014
 
Oct 31, 2013
Net earnings
 
$
88,273

 
$
71,513

Other comprehensive income/(loss), net of income taxes:
 
 
 
 
Foreign currency translation
 
(81,297
)
 
43,227

Pension liability adjustment
 
6,352

 
(594
)
Unrealized investment losses
 
(632
)
 
(82
)
Unrealized gains/(losses) on derivatives
 
(1,216
)
 
2,455

Total other comprehensive income/(loss), net of income taxes
 
(76,793
)
 
45,006

Comprehensive income
 
$
11,480

 
$
116,519


See accompanying notes to condensed consolidated financial statements.



5



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

 
 
Three Months Ended
 
 
Oct 31, 2014
 
Oct 31, 2013
Operating Activities
 
 
 
 
Net cash provided by operating activities
 
$
114,537

 
$
85,897

Investing Activities
 
 
 
 
Capital expenditures
 
(10,408
)
 
(18,915
)
Acquisition of businesses, net of cash acquired
 

 
(1,460
)
Purchases of retirement benefit assets
 
(17,592
)
 
(4,693
)
Proceeds from retirement benefit assets
 
18,735

 
9,027

Proceeds from sale of assets
 
1,577

 
471

Other
 
(2,587
)
 
(1,685
)
Net cash used by investing activities
 
(10,275
)
 
(17,255
)
Financing Activities
 
 
 
 
Notes payable
 
299,793

 
90,007

Dividends paid
 
(30,202
)
 
(27,947
)
Repayments of short-term debt
 

 
(3,927
)
Repayments of long-term debt
 
(148
)
 
(195
)
Net proceeds from stock plans
 
1,138

 
15,251

Additions to deferred financing costs
 
(1,535
)
 

Purchase of treasury stock
 
(300,000
)
 
(125,000
)
Excess tax benefits from stock-based compensation arrangements
 
1,235

 
3,122

Net cash used by financing activities
 
(29,719
)
 
(48,689
)
Effect of exchange rate changes on cash and cash equivalents

 
(37,172
)
 
11,137

Net increase in cash and cash equivalents
 
37,371

 
31,090

Cash and cash equivalents at beginning of year
 
964,110

 
936,886

Cash and cash equivalents at end of period
 
$
1,001,481

 
$
967,976

Supplemental Disclosures
 
 
 
 
Interest paid
 
$
1,729

 
$
1,175

Income taxes paid (net of refunds)
 
18,806

 
22,826


See accompanying notes to condensed consolidated financial statements.



6


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

NOTE 1 – BASIS OF PRESENTATION
The condensed consolidated financial information of Pall Corporation and its subsidiaries (hereinafter collectively called the “Company”) included herein is unaudited. Such information reflects all adjustments of a normal recurring nature, which are, in the opinion of Company management, necessary to present fairly the Company’s consolidated financial position, results of operations and cash flows as of the dates and for the periods presented herein. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes set forth in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2014 (“2014 Form 10-K”).
NOTE 2 – BALANCE SHEET DETAILS
The following tables provide details of selected balance sheet items:
 
 
Oct 31, 2014
 
Jul 31, 2014
Accounts receivable:
 
 
 
 
Billed
 
$
497,724

 
$
556,928

Unbilled
 
76,182

 
72,681

Total
 
573,906

 
629,609

Less: Allowances for doubtful accounts
 
(12,893
)
 
(13,896
)
 
 
$
561,013

 
$
615,713

Unbilled receivables principally relate to revenues accrued for long-term contracts recorded under the percentage-of-completion method of accounting.
 
 
Oct 31, 2014
 
Jul 31, 2014
Inventory:
 
 
 
 
Raw materials and components
 
$
125,167

 
$
117,581

Work-in-process
 
106,758

 
112,824

Finished goods
 
169,599

 
174,473

 
 
$
401,524

 
$
404,878

 
 
Oct 31, 2014
 
Jul 31, 2014
Property, plant and equipment:
 
 
 
 
Property, plant and equipment
 
$
1,737,370

 
$
1,776,983

Less: Accumulated depreciation and amortization
 
(963,997
)
 
(971,656
)
 
 
$
773,373

 
$
805,327

NOTE 3 – GOODWILL AND INTANGIBLE ASSETS
The following table presents changes in the carrying value of goodwill, allocated by reportable segment.
 
 
Life Sciences
 
Industrial
 
Total
Balance at July 31, 2014
 
$
269,758

 
$
221,704

 
$
491,462

Acquisitions
 

 
2,617

 
2,617

Foreign currency translation
 
(6,987
)
 
(1,544
)
 
(8,531
)
Balance at October 31, 2014
 
$
262,771

 
$
222,777

 
$
485,548

Increase in acquisitions primarily related to working capital adjustment for acquisition of Filter Specialists, Inc.


7



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

Intangible assets consist of the following:
October 31, 2014
 
Gross
 
Accumulated
Amortization
 
Net
Patents and unpatented technology
 
$
163,125

 
$
67,618

 
$
95,507

Customer-related intangibles
 
162,679

 
36,506

 
126,173

Trademarks
 
16,763

 
7,379

 
9,384

Other
 
3,572

 
2,573

 
999

 
 
$
346,139

 
$
114,076

 
$
232,063

 
 
 
 
 
 
 
July 31, 2014
 
Gross
 
Accumulated
Amortization
 
Net
Patents and unpatented technology
 
$
165,727

 
$
66,126

 
$
99,601

Customer-related intangibles
 
165,759

 
33,845

 
131,914

Trademarks
 
16,971

 
7,130

 
9,841

Other
 
3,647

 
2,580

 
1,067

 
 
$
352,104

 
$
109,681

 
$
242,423

Amortization expense for intangible assets for the three months ended October 31, 2014 and October 31, 2013 was $6,217 and $4,724, respectively. Amortization expense is estimated to be approximately $17,189 for the remainder of fiscal year 2015, $22,087 in fiscal year 2016, $21,799 in fiscal year 2017, $21,660 in fiscal year 2018, $19,443 in fiscal year 2019, and $18,116 in fiscal year 2020.
NOTE 4 – TREASURY STOCK
The following table highlights the share repurchase authorizations in effect during fiscal year 2015:
 
 
Date of Authorization
 
 
 
 
Jan 17, 2013
 
Jul 17, 2014
 
Oct 9, 2014
 
Total
Amount available for repurchases as of July 31, 2014
 
$
81,873

 
$
600,000

 
$

 
$
681,873

New authorizations
 

 

 
200,000

 
200,000

Utilized
 
(81,873
)
 
(218,127
)
 

 
(300,000
)
Amount available for repurchases as of October 31, 2014
 
$

 
$
381,873

 
$
200,000

 
$
581,873

The Company’s shares may be purchased over time as market and business conditions warrant. There is no time restriction on these authorizations. In August 2014, the Company entered into an Accelerated Share Repurchase (“ASR”) agreement with a third-party financial institution to repurchase $300,000 of the Company’s common stock. Under the agreement, the Company paid $300,000 to the financial institution and received an initial delivery of approximately 3,056 shares at an aggregate cost of $255,000, with an average price per share of $83.43. These shares were included in treasury stock in the accompanying condensed balance sheet as of October 31, 2014. The remaining $45,000 was included in additional paid in capital in the accompanying condensed balance sheet as of October 31, 2014. The transaction was completed in the second quarter of fiscal year 2015, with the Company receiving approximately 405 additional shares, at which time the $45,000 initially included in additional paid in capital was reclassified to treasury stock. The final number of shares delivered upon settlement of the transaction was determined with reference to the average price of the Company's common stock over the term of the ASR agreement.
During the three months ended October 31, 2014, 132 shares were issued under the Company’s stock-based compensation plans. At October 31, 2014, the Company held 21,035 treasury shares.


8



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

NOTE 5 – CONTINGENCIES AND COMMITMENTS
With respect to the matters described in Note 14, Contingencies and Commitments, to the Company’s consolidated financial statements included in the Company’s 2014 Form 10-K and below, the Company has assessed the ultimate resolution of these matters and has reflected appropriate contingent liabilities in the condensed consolidated financial statements as of October 31, 2014 and July 31, 2014.
The Company and its subsidiaries are subject to certain other legal actions that arise in the normal course of business. Other than those legal proceedings and claims discussed in the 2014 Form 10-K and this Note, the Company is not facing any other legal proceedings and claims that would individually or in the aggregate have a reasonably possible material adverse effect on its financial condition or operating results. As such, any reasonably possible loss or range of loss, other than those legal proceedings discussed in the 2014 Form 10-K and this Note, is immaterial. However, the results of legal proceedings cannot be predicted with certainty. If the Company failed to prevail in several of these legal matters in the same reporting period, the operating results of a particular reporting period could be materially adversely affected.
Environmental Matters
The Company’s condensed consolidated balance sheet at October 31, 2014 includes liabilities for environmental matters of $18,896 which relate primarily to the environmental proceedings discussed in the 2014 Form 10-K and as updated in this Note. In the opinion of management, the Company is in substantial compliance with applicable environmental laws and its current accruals for environmental remediation are adequate. However, as regulatory standards under environmental laws are becoming increasingly stringent, there can be no assurance that future developments, additional information and experience gained will not cause the Company to incur material environmental liabilities or costs beyond those accrued in its condensed consolidated financial statements.
NOTE 6 – RESTRUCTURING AND OTHER CHARGES, NET
The following tables summarize the restructuring and other charges (“ROTC”) recorded in the three months ended October 31, 2014 and October 31, 2013:
 
 
Three Months Ended Oct 31, 2014
 
 
Restructuring (1)
 
Other Charges/(Gains) (2)
 
Total
Severance benefits and other employment contract obligations
 
$
8,750

 
$

 
$
8,750

Professional fees and other costs, net of receipt of insurance claim payments
 
552

 
48

 
600

Reversal of excess restructuring reserves
 
(110
)
 

 
(110
)
 
 
$
9,192

 
$
48

 
$
9,240

Cash
 
$
9,192

 
$
48

 
$
9,240

Non-cash
 

 

 

 
 
$
9,192

 
$
48

 
$
9,240

 
 
Three Months Ended Oct 31, 2013
 
 
Restructuring (1)
 
Other Charges/(Gains) (2)
 
Total
Severance benefits and other employment contract obligations
 
$
3,115

 
$
442

 
$
3,557

Professional fees and other costs, net of receipt of insurance claim payments
 
1,243

 
142

 
1,385

Loss on sale and impairment of assets, net
 

 
160

 
160

Environmental matters
 

 
4,440

 
4,440

Reversal of excess restructuring reserves
 
(344
)
 

 
(344
)
 
 
$
4,014

 
$
5,184

 
$
9,198

Cash
 
$
4,014

 
$
5,024

 
$
9,038

Non-cash
 

 
160

 
160

 
 
$
4,014

 
$
5,184

 
$
9,198



9



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

(1) Restructuring:
In fiscal year 2012, the Company announced a multi-year strategic cost reduction initiative (“structural cost improvement initiative”). This initiative impacts both segments as well as the Corporate Services Group. The goal of this initiative is to properly position the Company’s cost structure globally to perform in the current economic environment without adversely impacting its growth or innovation potential.
Key components of the structural cost improvement initiative include:
the strategic alignment of manufacturing, sales and R&D facilities to cost-effectively deliver high-quality products and superior service to the Company’s customers worldwide,
creation of regional and global shared financial services centers for the handling of accounting transaction processing and other accounting functions,
reorganization of sales functions, to more cost-efficiently deliver superior service to the Company’s customers globally, and
reductions in headcount across all functional areas, enabled by efficiencies gained through the Company’s ERP systems, as well as in order to align to economic conditions.
Restructuring charges recorded in the three months ended October 31, 2014 and October 31, 2013 primarily reflect the expenses incurred in connection with the Company’s structural cost improvement initiative as discussed above.
(2) Other Charges/(Gains):
Severance benefits and other employment contract obligations: In the three months ended October 31, 2013, the Company recorded charges related to certain employment contract obligations.
Environmental matters: In the three months ended October 31, 2013, the Company increased its previously established environmental reserve related to a matter in Pinellas Park, Florida.
The following table summarizes the activity related to restructuring liabilities recorded for the Company’s structural cost improvement initiative which began in fiscal year 2012:
 
 
Severance
 
Other
 
Total
Original charge
 
$
61,852

 
$
3,448

 
$
65,300

Utilized
 
(27,365
)
 
(2,798
)
 
(30,163
)
Translation
 
(123
)
 
(47
)
 
(170
)
Balance at July 31, 2012
 
$
34,364

 
$
603

 
$
34,967

Additions
 
21,637

 
2,840

 
24,477

Utilized
 
(29,574
)
 
(1,936
)
 
(31,510
)
Reversal of excess reserves
 
(500
)
 
(57
)
 
(557
)
Translation
 
313

 
23

 
336

Balance at July 31, 2013
 
$
26,240

 
$
1,473

 
$
27,713

Additions
 
27,803

 
4,419

 
32,222

Utilized
 
(26,178
)
 
(4,596
)
 
(30,774
)
Reversal of excess reserves
 
(1,923
)
 
(107
)
 
(2,030
)
Translation
 
230

 
39

 
269

Balance at July 31, 2014
 
$
26,172

 
$
1,228

 
$
27,400

Additions
 
8,750

 
552

 
9,302

Utilized
 
(8,161
)
 
(513
)
 
(8,674
)
Reversal of excess reserves
 
(110
)
 

 
(110
)
Translation
 
(1,029
)
 
(43
)
 
(1,072
)
Balance at October 31, 2014
 
$
25,622

 
$
1,224

 
$
26,846



10



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

NOTE 7 – INCOME TAXES
The Company’s effective tax rates for the three months ended October 31, 2014 and October 31, 2013 were 25.2% and 22.6%, respectively. For the three months ended October 31, 2014 and October 31, 2013, the effective tax rate varied from the U.S. federal statutory rate primarily due to the benefits of foreign operations.
At October 31, 2014 and July 31, 2014, the Company had gross unrecognized income tax benefits of $197,611 and $202,564, respectively. During the three months ended October 31, 2014, the amount of gross unrecognized tax benefits decreased by $4,953, primarily due to the recognition of a tax position taken in a prior year and the impact of foreign currency translation partially offset by tax positions taken during the current period. As of October 31, 2014, the amount of net unrecognized income tax benefits that, if recognized, would impact the effective tax rate was $160,421.
At October 31, 2014 and July 31, 2014, the Company had liabilities of $15,546 and $14,556, respectively, for potential payment of interest and penalties.
Due to the potential resolution of tax examinations and the expiration of various statutes of limitation, the Company believes that it is reasonably possible that the gross amount of unrecognized tax benefits may decrease within the next twelve months by a range of zero to $44,850.
NOTE 8 – COMPONENTS OF NET PERIODIC PENSION COST
Net periodic pension benefit cost for the Company’s defined benefit pension plans includes the following components:
 
 
Three Months Ended
 
 
U.S. Plans
 
Foreign Plans
 
Total
 
 
Oct 31, 2014
 
Oct 31, 2013
 
Oct 31, 2014
 
Oct 31, 2013
 
Oct 31, 2014
 
Oct 31, 2013
Service cost
 
$
2,589

 
$
2,170

 
$
955

 
$
996

 
$
3,544

 
$
3,166

Interest cost
 
2,896

 
3,028

 
3,988

 
4,204

 
6,884

 
7,232

Expected return on plan assets
 
(2,483
)
 
(2,325
)
 
(3,844
)
 
(3,438
)
 
(6,327
)
 
(5,763
)
Amortization of prior service cost/(credit)
 
365

 
395

 
1

 
(11
)
 
366

 
384

Amortization of actuarial loss
 
1,019

 
1,344

 
1,374

 
1,386

 
2,393

 
2,730

Net periodic benefit cost
 
$
4,386

 
$
4,612

 
$
2,474

 
$
3,137

 
$
6,860

 
$
7,749

NOTE 9 – STOCK-BASED PAYMENT
The Company currently has three stock-based employee and director compensation plans — the Pall Corporation 2012 Stock Compensation Plan, under which the Company may grant stock options, restricted shares, restricted units, performance shares, and performance units; the Management Stock Purchase Plan (“MSPP”); and the Employee Stock Purchase Plan (“ESPP”). These three plans are more fully described in Note 15, Common Stock, to the consolidated financial statements included in the 2014 Form 10-K.
The detailed components of stock-based compensation expense recorded in the condensed consolidated statements of earnings for the three months ended October 31, 2014 and October 31, 2013 are reflected in the table below:
 
 
Three Months Ended
 
 
Oct 31, 2014
 
Oct 31, 2013
Restricted stock units
 
$
8,223

 
$
4,193

Stock options
 
1,954

 
1,521

MSPP
 
1,065

 
192

ESPP
 
274

 
225

 
 
$
11,516

 
$
6,131



11



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

NOTE 10 – EARNINGS PER SHARE
The condensed consolidated statements of earnings present basic and diluted earnings per share. Basic earnings per share is determined by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share considers the potential effect of dilution on basic earnings per share assuming potentially dilutive shares that meet certain criteria, such as those issuable upon exercise of stock options, were outstanding. The treasury stock method reduces the dilutive effect of potentially dilutive securities as it assumes that any cash proceeds (from the issuance of potentially dilutive securities) are used to buy back shares at the average share price during the period. Equity awards aggregating, 482 and 529 were not included in the computation of diluted shares for the three months ended October 31, 2014 and October 31, 2013, respectively, because their effect would have been antidilutive. The following is a reconciliation between basic shares outstanding and diluted shares outstanding:
 
 
Three Months Ended
 
 
Oct 31, 2014
 
Oct 31, 2013
Basic shares outstanding
 
108,081

 
111,870

Effect of stock plans
 
1,138

 
1,265

Diluted shares outstanding
 
109,219

 
113,135

NOTE 11 – FAIR VALUE MEASUREMENTS
The Company records certain of its financial assets and liabilities at fair value, which is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date.
The current authoritative guidance discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). Authoritative guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:
Level 1: Use of observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2: Use of inputs other than quoted prices included in Level 1, which are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3: Use of inputs that are unobservable.


12



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

The following table presents, for each of these hierarchy levels, the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as of October 31, 2014:
 
 
Fair Value Measurements
 
 
As of Oct 31, 2014
 
Level 1
 
Level 2
 
Level 3
Financial Assets Carried at Fair Value
 
 
 
 
 
 
 
 
Money market funds
 
$
4,507

 
$
4,507

 
$

 
$

Available-for-sale securities:
 
 
 
 
 
 
 
 
Equity securities
 
3,942

 
3,942

 

 

Debt securities:
 
 
 
 
 
 
 
 
Corporate
 
29,611

 

 
29,611

 

U.S. Treasury
 
9,689

 

 
9,689

 

Federal agency
 
12,719

 

 
12,719

 

Mortgage-backed
 
11,886

 

 
11,886

 

Trading securities
 
796

 
796

 

 

Derivative financial instruments:
 
 
 
 
 
 
 
 
Foreign exchange forward contracts
 
4,835

 

 
4,835

 

Financial Liabilities Carried at Fair Value
 
 
 
 
 
 
 
 
Derivative financial instruments:
 
 
 
 
 
 
 
 
Foreign exchange forward contracts
 
1,751

 

 
1,751

 

The following table presents, for each of these hierarchy levels, the Company’s financial assets and liabilities that are measured at fair value on a recurring basis as of July 31, 2014:
 
 
Fair Value Measurements
 
 
As of Jul 31, 2014
 
Level 1
 
Level 2
 
Level 3
Financial Assets Carried at Fair Value
 
 
 
 
 
 
 
 
Money market funds
 
$
4,860

 
$
4,860

 
$

 
$

Available-for-sale securities:
 
 
 
 
 
 
 
 
Equity securities
 
4,748

 
4,748

 

 

Debt securities:
 
 
 
 
 
 
 
 
Corporate
 
30,243

 

 
30,243

 

U.S. Treasury
 
9,724

 

 
9,724

 

Federal agency
 
13,719

 

 
13,719

 

Mortgage-backed
 
11,405

 

 
11,405

 

Trading securities
 
819

 
819

 

 

Derivative financial instruments:
 
 
 
 
 
 
 
 
Foreign exchange forward contracts
 
5,931

 

 
5,931

 

Financial Liabilities Carried at Fair Value
 
 
 
 
 
 
 
 
Derivative financial instruments:
 
 
 
 
 
 
 
 
Foreign exchange forward contracts
 
1,726

 

 
1,726

 

The Company’s money market funds and equity securities are valued using quoted market prices and, as such, are classified within Level 1 of the fair value hierarchy.
The fair value of the Company’s investments in debt securities are valued utilizing third party pricing services and verified by management. The pricing services use inputs to determine fair value which are derived from observable market sources including reportable trades, benchmark curves, credit spreads, broker/dealer quotes, bids, offers, and other industry and economic events. These investments are included in Level 2 of the fair value hierarchy.


13



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

The fair values of the Company’s foreign currency forward contracts are valued using pricing models, with all significant inputs derived from or corroborated by observable market data such as yield curves, currency spot and forward rates, and currency volatilities. These investments are included in Level 2 of the fair value hierarchy.
NOTE 12 – INVESTMENT SECURITIES
The following is a summary of the Company’s available-for-sale investment securities by category which are classified within other non-current assets in the Company’s condensed consolidated balance sheets. Contractual maturity dates of debt securities held by the benefits protection trusts at October 31, 2014 range from 2014 to 2046.
October 31, 2014
 
Cost/Amortized
Cost Basis
 
Fair Value
 
Gross Unrealized
Holding Gains
 
Gross Unrealized
Holding Losses
 
Net Unrealized
Holding
Gains/(Losses)
Equity securities
 
$
3,769

 
$
3,942

 
$
173

 
$

 
$
173

Debt securities:
 
 
 
 
 
 
 
 
 
 
Corporate
 
28,569

 
29,611

 
1,066

 
(24
)
 
1,042

U.S. Treasury
 
9,476

 
9,689

 
220

 
(7
)
 
213

Federal agency
 
11,896

 
12,719

 
823

 

 
823

Mortgage-backed
 
11,770

 
11,886

 
127

 
(11
)
 
116

 
 
$
65,480

 
$
67,847

 
$
2,409

 
$
(42
)
 
$
2,367

 
 
 
 
 
 
 
 
 
 
 
July 31, 2014
 
Cost/Amortized
Cost Basis
 
Fair Value
 
Gross Unrealized
Holding Gains
 
Gross Unrealized
Holding Losses
 
Net Unrealized
Holding
Gains/(Losses)
Equity securities
 
$
4,160

 
$
4,748

 
$
588

 
$

 
$
588

Debt securities:
 
 
 
 
 
 
 
 
 
 
Corporate
 
28,987

 
30,243

 
1,259

 
(3
)
 
1,256

U.S. Treasury
 
9,478

 
9,724

 
246

 

 
246

Federal agency
 
12,778

 
13,719

 
941

 

 
941

Mortgage-backed
 
11,219

 
11,405

 
190

 
(4
)
 
186

 
 
$
66,622

 
$
69,839

 
$
3,224

 
$
(7
)
 
$
3,217



14



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

The following table shows the gross unrealized losses and fair value of the Company’s available-for-sale investments with unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:
October 31, 2014
 
Less than 12 months
 
12 months or greater
 
Total
 
 
Fair Value
 
Gross Unrealized
Holding Losses
 
Fair Value
 
Gross Unrealized Holding Losses
 
Fair Value
 
Gross Unrealized Holding Losses
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
 
$
5,038

 
$
(24
)
 
$

 
$

 
$
5,038

 
$
(24
)
U.S. Treasury
 
3,026

 
(7
)
 

 

 
3,026

 
(7
)
Mortgage-backed
 
4,886

 
(11
)
 

 

 
4,886

 
(11
)
 
 
$
12,950

 
$
(42
)
 
$

 
$

 
$
12,950

 
$
(42
)
July 31, 2014
 
Less than 12 months
 
12 months or greater
 
Total
 
 
Fair Value
 
Gross Unrealized
Holding Losses
 
Fair Value
 
Gross Unrealized Holding Losses
 
Fair Value
 
Gross Unrealized Holding Losses
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
 
$
3,384

 
$
(3
)
 
$

 
$

 
$
3,384

 
$
(3
)
Mortgage-backed
 
1,919

 
(4
)
 

 

 
1,919

 
(4
)
 
 
$
5,303

 
$
(7
)
 
$

 
$

 
$
5,303

 
$
(7
)
The following table shows the proceeds and gross gains and losses from the sale of available-for-sale and trading investments primarily related to the Company's benefits protection trust for the three months ended October 31, 2014 and October 31, 2013:
 
 
Three Months Ended
 
 
Oct 31, 2014
 
Oct 31, 2013
Proceeds from sales
 
$
16,056

 
$
500

Realized gross gains on sales
 
58

 

Realized gross losses on sales
 
5

 
1

The following is a summary of the Company’s trading securities by category which are classified within other non-current assets in the Company’s condensed consolidated balance sheets.
 
 
Oct 31, 2014
 
Jul 31, 2014
Equity securities
 
$
796

 
$
819

Total trading securities
 
$
796

 
$
819

The following table shows the net gains and losses recognized on trading securities for the three months ended October 31, 2014 and October 31, 2013:
 
 
Three Months Ended
 
 
Oct 31, 2014
 
Oct 31, 2013
Gains/(losses), net recognized for securities held
 
$
(28
)
 
$
16

Gains/(losses), net recognized for securities sold
 
1

 

Total gains/(losses), net recognized
 
$
(27
)
 
$
16



15



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

NOTE 13 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company manages certain financial exposures through a risk management program that includes the use of foreign exchange derivative financial instruments. Derivatives are executed with counterparties with a minimum credit rating of “A” by Standard & Poors and “A2” by Moody’s Investor Services, in accordance with the Company’s policies. The Company does not utilize derivative instruments for trading or speculative purposes. As of October 31, 2014, the Company had foreign currency forward contracts outstanding with notional amounts aggregating $406,297, whose fair values were a net asset of $3,084.
Foreign Exchange Related
a. Derivatives Not Designated as Hedging Instruments
The risk management objective of holding foreign exchange derivatives is to mitigate volatility to earnings and cash flows due to changes in foreign exchange rates. The Company and its subsidiaries conduct transactions in currencies other than their functional currencies. These transactions include non-functional intercompany and external sales as well as intercompany and external purchases. The Company uses foreign exchange forward contracts, matching the notional amounts and durations of the receivables and payables resulting from the aforementioned underlying foreign currency transactions, to mitigate the exposure to earnings and cash flows caused by the changes in fair value of these receivables and payables from fluctuating foreign exchange rates. The notional amount of foreign currency forward contracts not designated as hedging instruments entered into during the three months ended October 31, 2014 was $821,771. The notional amount of foreign currency forward contracts outstanding that were not designated as hedging instruments as of October 31, 2014 was $315,289.
b. Cash Flow Hedges
The Company uses foreign exchange forward contracts for cash flow hedging on its future transactional exposure to the Euro due to changes in market rates to exchange Euros for British Pounds. The hedges cover a British subsidiary (British Pound functional) with Euro revenues and a Swiss subsidiary (Euro functional) with British Pound expenses. The probability of the occurrence of these transactions is high and the Company’s assessment is based on observable facts including the frequency and amounts of similar past transactions. The objective of the cash flow hedges is to lock a portion of the British Pound equivalent amount of Euro sales for the British subsidiary and a portion of the Euro equivalent amount of British Pound expenses for the Swiss subsidiary at the agreed upon exchange rates in the foreign exchange forward contracts. The notional amount of foreign currency forward contracts designated as hedging instruments entered into during the three months ended October 31, 2014 was $20,429. The notional amount of foreign currency forward contracts outstanding designated as hedging instruments as of October 31, 2014 was $91,008 and covers certain monthly transactional exposures through November 2015.
c. Net Investment Hedges
The risk management objective of designating the Company’s foreign currency loan as a hedge of a portion of its net investment in a wholly owned Japanese subsidiary is to mitigate the change in the fair value of the Company’s net investment due to changes in foreign exchange rates. The Company uses a JPY loan outstanding to hedge its equity of the same amount in the Japanese wholly owned subsidiary. The hedge of net investment consists of a JPY 9 billion loan.


16



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

The fair values of the Company’s derivative financial instruments included in the condensed consolidated balance sheets are presented as follows:
October 31, 2014
 
Asset Derivatives
 
Liability Derivatives
 
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
Foreign exchange forward contracts
 
Other current assets
 
$
3,626

 
Other current liabilities
 
$
86

Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
Foreign exchange forward contracts
 
Other current assets
 
$
1,209

 
Other current liabilities
 
$
1,665

Total derivatives
 
 
 
$
4,835

 
 
 
$
1,751

Nonderivative instruments designated as hedging instruments
 
 
 
 
 
 
 
 
Net investment hedge
 
 
 
 
 
Current portion of Long-term debt
 
$
82,422

July 31, 2014
 
Asset Derivatives
 
Liability Derivatives
 
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
Foreign exchange forward contracts
 
Other current assets
 
$
4,755

 
Other current liabilities
 
$
3

Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
Foreign exchange forward contracts
 
Other current assets
 
$
1,176

 
Other current liabilities
 
$
1,723

Total derivatives
 
 
 
$
5,931

 
 
 
$
1,726

Nonderivative instruments designated as hedging instruments
 
 
 
 
 
 
 
 
Net investment hedge
 
 
 
 
 
Current portion of Long-term debt
 
$
87,570

The amounts of the gains and losses related to the Company’s derivative financial instruments designated as hedging instruments for the three months ended October 31, 2014 and October 31, 2013 are presented as follows:
Derivatives in cash flow hedging relationships
 
Amount of Gain or (Loss) Recognized in OCI on Derivatives (Effective Portion)
 
Location of Gain or (Loss) Reclassified from Accumulated OCI into Earnings (Effective Portion)
 
Amount of Gain or (Loss) Reclassified from Accumulated OCI into Earnings (Effective Portion) (a)
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
Oct 31, 2014
 
Oct 31, 2013
 
 
 
Oct 31, 2014
 
Oct 31, 2013
Foreign exchange forward contracts
 
$
591

 
$
1,821

 
Net sales
 
$
560

 
$
(1
)
 
 
 
 
 
 
Cost of sales
 
1,091

 
(820
)
Total derivatives
 
$
591

 
$
1,821

 
 
 
$
1,651

 
$
(821
)
(a)
There were no gains or losses recognized in earnings related to the ineffective portion of the hedging relationship or related to the amount excluded from the assessment of hedge effectiveness for the three months ended October 31, 2014 and October 31, 2013.
The amounts of the gains and losses related to the Company’s derivative financial instruments not designated as hedging instruments for the three months ended October 31, 2014 and October 31, 2013 are presented as follows:
Derivatives not designated as hedging relationships
 
Location of Gain or (Loss) Recognized in Earnings on Derivatives
 
Amount of Gain or (Loss) Recognized in
Earnings on Derivatives
 
 
 
 
Three Months Ended
 
 

 
Oct 31, 2014
 
Oct 31, 2013
Foreign exchange forward contracts
 
Selling, general and administrative expenses
 
$
(4,510
)
 
$
450



17



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

The amounts of the gains and losses related to the Company’s nonderivative financial instruments designated as hedging instruments for the three months ended October 31, 2014 and October 31, 2013 are presented as follows:
Nonderivatives designated as hedging relationships
 
Amount of Gain or (Loss) Recognized in OCI on Derivatives (Effective Portion)
 
Location of Gain or (Loss) Reclassified from Accumulated OCI into Earnings (Effective Portion)
 
Amount of Gain or (Loss) Reclassified from Accumulated OCI into Earnings (Effective Portion) (b)
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
Oct 31, 2014
 
Oct 31, 2013
 
 
 
Oct 31, 2014
 
Oct 31, 2013
Net investment hedge
 
$
3,295

 
$
(441
)
 
N/A
 
$

 
$

(b)
There were no gains or losses recognized in earnings related to the ineffective portion of the hedging relationship or related to the amount excluded from the assessment of hedge effectiveness for the three months ended October 31, 2014 and October 31, 2013.
NOTE 14 – ACCUMULATED OTHER COMPREHENSIVE INCOME/(LOSS)
Changes in accumulated other comprehensive income by component are presented below:
 
 
Foreign Currency Translation
 
Defined Benefit Pension Plan
 
Unrealized Investment Gains/(Losses)
 
Unrealized Gains/(Losses) on Derivatives
 
Accumulated Other Comprehensive Income/(Loss)
Balance at July 31, 2014
 
$
98,689

 
$
(121,280
)
 
$
2,880

 
$
4,790

 
$
(14,921
)
Other comprehensive income/(loss) before reclassifications
 
(81,297
)
 

 
(621
)
 
288

 
(81,630
)
Amounts reclassified from accumulated other comprehensive income (loss)
 

 
1,892

 
(11
)
 
(1,504
)
 
377

Foreign exchange adjustments and other
 

 
4,460

 

 

 
4,460

Balance at October 31, 2014
 
$
17,392

 
$
(114,928
)
 
$
2,248

 
$
3,574

 
$
(91,714
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign Currency Translation
 
Defined Benefit Pension Plan
 
Unrealized Investment Gains/(Losses)
 
Unrealized Gains/(Losses) on Derivatives
 
Accumulated Other Comprehensive Income/(Loss)
Balance at July 31, 2013
 
$
84,598

 
$
(125,211
)
 
$
2,123

 
$
(2,302
)
 
$
(40,792
)
Other comprehensive income/(loss) before reclassifications
 
43,227

 

 
(119
)
 
1,648

 
44,756

Amounts reclassified from accumulated other comprehensive income (loss)
 

 
2,149

 
37

 
807

 
2,993

Foreign exchange adjustments and other
 

 
(2,743
)
 

 

 
(2,743
)
Balance at October 31, 2013
 
$
127,825

 
$
(125,805
)
 
$
2,041

 
$
153

 
$
4,214



18



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

Reclassifications out of accumulated other comprehensive income are presented below:
 
 
Three Months Ended
 
Affected Line Item in the Condensed Consolidated Statement of Earnings
 
 
Oct 31, 2014
 
Oct 31, 2013
 
Defined benefit pension plan:
 
 
 
 
 
 
Amortization of prior service cost
 
$
(366
)
 
$
(384
)
 
Note (a)
Recognized actuarial gain/(loss)
 
(2,393
)
 
(2,730
)
 
Note (a)
Total before tax
 
(2,759
)
 
(3,114
)
 
 
Tax (expense)/benefit
 
867

 
965

 
 
Net of tax
 
$
(1,892
)
 
$
(2,149
)
 
 
Unrealized investment gains/(losses):
 
 
 
 
 
 
Realized investment gain/(losses)
 
$
17

 
$
(57
)
 
Selling, general and administrative
Tax (expense)/benefit
 
(6
)
 
20

 
 
Net of tax
 
$
11

 
$
(37
)
 
 
Unrealized gains/(losses) on derivatives:
 
 
 
 
 
 
Foreign exchange forward contracts
 
$
560

 
$
(1
)
 
Sales
Foreign exchange forward contracts
 
1,091

 
(820
)
 
Cost of sales
Total before tax
 
1,651

 
(821
)
 
 
Tax (expense)/benefit
 
(147
)
 
14

 
 
Net of tax
 
$
1,504

 
$
(807
)
 
 
(a)
These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see Note 8, Components of Net Periodic Pension Cost, for additional details).
NOTE 15 – SEGMENT INFORMATION
The Company’s reportable segments, which are also its operating segments, consist of the Company’s Life Sciences and Industrial businesses.
The following table presents sales and segment profit by business segment reconciled to earnings before income taxes for the three months ended October 31, 2014 and October 31, 2013.
 
 
Three Months Ended
 
 
Oct 31, 2014
 
Oct 31, 2013
Sales:
 
 
 
 
Life Sciences
 
$
352,464

 
$
318,946

Industrial
 
344,028

 
310,833

Total
 
$
696,492

 
$
629,779

Segment Profit:
 
 
 
 
Life Sciences
 
$
86,480

 
$
73,045

Industrial
 
64,232

 
50,482

Total segment profit
 
150,712

 
123,527

Corporate Services Group
 
16,737

 
15,964

ROTC
 
9,240

 
9,198

Interest expense, net
 
6,702

 
5,977

Earnings before income taxes
 
$
118,033

 
$
92,388



19



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

NOTE 16 – ACQUISITIONS
2014 Acquisitions
During fiscal year 2014, the Company completed four acquisitions – in the first quarter, Medistad Holding BV (“Medistad”), a European manufacturing entity; in the second quarter, SoloHill Engineering, Inc. (“SoloHill”), a U.S. technology company; in the third quarter, the Life Sciences business of ATMI, Inc. (“ATMI LifeSciences”), a technology leader in the field of single-use bioprocess equipment and consumables for the biopharmaceutical and biotechnology industries; and in the fourth quarter, Filter Specialists, Inc. (“FSI”), a U.S. based worldwide supplier of filtration products and solutions.
The above transactions (the “2014 acquisitions”) were funded with available cash and borrowings under the Company's commercial paper program. Tangible and intangible assets acquired and liabilities assumed were recognized based upon their estimated fair values at the respective closing dates. The Company is currently in the process of finalizing the valuations of acquired tangible and intangible assets and liabilities for the SoloHill, ATMI LifeSciences, and FSI acquisitions, and will make appropriate adjustments to the purchase price allocation prior to completion of the measurement period, as required.
The results of operations for the 2014 acquisitions since their respective acquisition dates are included in the accompanying condensed consolidated financial statements. The results of operations for FSI are reported in the Industrial Segment, and the results of operations for ATMI LifeSciences, Medistad, and SoloHill are reported in the Life Sciences segment. The impact of the 2014 acquisitions was not material, individually or in the aggregate, to the company's condensed consolidated financial position or results from operations. Additionally, assuming these transactions had occurred at the beginning of the respective fiscal years, the consolidated pro forma results would not be materially different from reported results for the three months ended October 31, 2014 and October 31, 2013.


20



ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion should be read together with the accompanying condensed consolidated financial statements and notes thereto and other financial information in this Form 10-Q and in the Pall Corporation and its subsidiaries (hereinafter collectively referred to as the “Company”, “we” and “our”) Annual Report on Form 10-K for the fiscal year ended July 31, 2014 (“2014 Form 10-K”). Certain information is presented below excluding the impact of foreign exchange translation (“translational FX”) (i.e., had exchange rates not changed year over year). We consider year over year change excluding translational FX to be an important measure because by excluding the impact of volatility of exchange rates, underlying impact of volume and rate changes are evident. United States (“U.S.”) Dollar amounts discussed below are in thousands, unless otherwise indicated, except per share dollar amounts. In addition, per share dollar amounts are discussed on a diluted basis. Our gross margin is impacted by the fluctuation of the costs of products that are sourced in a currency different from the currency they are sold in (“transactional FX”) and our discussion of gross margin below may include references to this. We utilize certain estimates and assumptions that affect the reported financial information as well as to quantify the impact of various significant factors that contribute to the changes in our periodic results included in the discussion below.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
The matters discussed in this Quarterly Report contain “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that address activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future. All statements regarding future performance, earnings projections, earnings guidance, management’s expectations about our future cash needs and effective tax rate, and other future events or developments are forward-looking statements. Forward-looking statements are those that use terms such as “may,” “will,” “expect,” “believe,” “intend,” “should,” “could,” “anticipate,” “estimate,” “forecast,” “project,” “plan,” “predict,” “potential,” and similar expressions. Forward-looking statements contained in this and other written and oral reports are based on management’s assumptions and assessments in light of past experience and trends, current conditions, expected future developments and other relevant factors.
Our forward-looking statements are subject to risks and uncertainties and are not guarantees of future performance, and actual results, developments and business decisions may differ materially from those envisaged by our forward-looking statements. Such risks and uncertainties include, but are not limited to, those discussed in Part I-Item 1A.-Risk Factors in the 2014 Form 10-K, and other reports we file with the Securities and Exchange Commission, including: the impact of disruptions in the supply of raw materials and key components for our products from suppliers, including limited or single source suppliers; the impact of terrorist acts, conflicts and wars or natural disasters; the extent to which special U.S. and foreign government laws and regulations, such as the Foreign Corrupt Practices Act and the U.K. Bribery Act, and regulations and procurement policies and practices, including regulations on import-export control, may expose us to liability or impair our ability to compete in international markets; the impact of a significant disruption in, or breach in security of, our information technology systems or we fail to implement, manage or integrate new systems, software and technologies successfully; the impact of economic, political, social and regulatory instability in emerging markets, and other risks characteristic of doing business in emerging markets; fluctuations in foreign currency exchange rates and interest rates; our ability to successfully complete or integrate acquisitions; product defects and unanticipated use or inadequate disclosure with respect to our products; our ability to develop innovative and competitive new products; the impact of global and regional economic conditions and legislative and political developments; our ability to comply with a broad array of regulatory requirements; the loss of one or more members of our senior management team and our ability to recruit and retain qualified management personnel; changes in the demand for our products and business relationships with key customers and suppliers; changes in product mix and product pricing, particularly with systems products and associated hardware and devices for our consumable filtration products; our ability to deliver our backlog on time; increases in manufacturing and operating costs and/or our ability to achieve the savings anticipated from our structural cost improvement initiative; the impact of environmental, health and safety laws and regulations, and violations; our ability to enforce patents or protect proprietary products and manufacturing techniques; costs and outcomes of pending or future litigation and the availability of insurance or indemnification rights; changes in our effective tax rate; the impact of certain risks associated with potential labor disruptions; our ability to compete effectively in domestic and global markets; and the effect of the restrictive covenants in our debt facilities. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We make these statements as of the date of this disclosure and undertake no obligation to update them, whether as a result of new information, future developments or otherwise.
OVERVIEW
We are a leading supplier of filtration, separation and purification technologies. Our products are used to remove solid, liquid and gaseous contaminants from a variety of liquids and gases, and are principally made by us, using our engineering capability, fluid management expertise, proprietary filter media and manufacturing expertise. Our products primarily consist of consumable filtration products and filtration systems.
We serve customers through two businesses globally: Life Sciences and Industrial. The Life Sciences business group serves customers in the BioPharmaceutical, Food & Beverage and Medical markets. The Industrial business group serves customers in the Process Technologies, Aerospace and Microelectronics markets. We operate globally in three geographic regions: the Americas; Europe (in which we include the Middle East and Africa); and Asia.


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Our reporting currency is the U.S. Dollar. Because we operate through subsidiaries or branches that transact in over thirty foreign currencies around the world, our earnings are exposed to translation risk when the financial statements of the subsidiaries or branches, as stated in their functional currencies, are translated into the U.S. Dollar. We estimate that translational FX decreased sales by approximately $18,000 and earnings per share by approximately 5 cents in the three months ended October 31, 2014 when compared to the three months ended October 31, 2013.
During fiscal year 2014, we completed four acquisitions – in the first quarter, Medistad Holding BV (“Medistad”), a European manufacturing entity; in the second quarter, SoloHill Engineering, Inc. (“SoloHill”), a U.S. technology company; in the third quarter, the Life Sciences business of ATMI, Inc. (“ATMI LifeSciences”), a technology leader in the field of single-use bioprocess equipment and consumables for the biopharmaceutical and biotechnology industries; and in the fourth quarter, Filter Specialists, Inc. (“FSI”), a U.S. based worldwide supplier of filtration products and solutions.
These acquisitions did not have a material impact on our results from operations or financial position. See Note 16, Acquisitions, to the accompanying condensed consolidated financial statements for further detail.
In the U.S., some of our workforce at our Cortland, New York facility are represented by the United Auto Workers (“UAW”). The employees covered under this collective bargaining agreement represent approximately 7% of our global consumables production capacity. Our contract with the UAW expired in April 2014 and we continue to operate during our negotiations. On November 19, 2014, we declared an impasse in negotiations and have implemented our last, best and final offer to the UAW. Depending on the course of implementation of our last, best and final offer, we could incur additional costs and/or experience work stoppages which could adversely affect our business operations through a loss of revenue and strained relationships with customers.
RESULTS FROM OPERATIONS
Net Sales
 
 
Three Months Ended
By Segment (dollars in thousands)
 
Oct 31, 2014
 
Oct 31, 2013
Life Sciences
 
$
352,464

 
$
318,946

Industrial
 
344,028

 
310,833

Total Sales
 
$
696,492

 
$
629,779

 
 
Three Months Ended
By Product (dollars in thousands)
 
Oct 31, 2014
 
Oct 31, 2013
Consumables
 
$
605,122

 
$
550,669

Systems
 
91,370

 
79,110

Total Sales
 
$
696,492

 
$
629,779

The percentage change in sales for the three months ended October 31, 2014 compared to the three months ended October 31, 2013 by segment, with and without the impact of translational FX, are presented below:
 
 
Three Months
By Segment
 
% Change Excluding Translational FX

Translational FX %
 
Total
% Change
Life Sciences
 
13.6
 
(3.1
)
 
10.5
Industrial
 
13.3
 
(2.6
)
 
10.7
Total
 
13.4
 
(2.8
)
 
10.6


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The percentage change in sales for the three months ended October 31, 2014 compared to the three months ended October 31, 2013 by product, with and without the impact of translational FX, are presented below:
 
 
Three Months
By Product
 
% Change Excluding Translational FX

Translational FX %
 
Total
% Change
Consumables
 
12.6
 
(2.7
)
 
9.9
Systems
 
19.4
 
(3.9
)
 
15.5
Total
 
13.4
 
(2.8
)
 
10.6
Total sales increased approximately 13% (excluding translational FX) reflecting growth in the BioPharmaceuticals and Food & Beverage markets in the Life Sciences segment and in all markets in the Industrial segment, partly offset by a decline in the Medical market in the Life Sciences segment. Acquisitions contributed approximately 470 basis points to total sales growth compared to last year. More details regarding sales by segment can be found in the discussions under the section “Segment Review.”
The approximate 13% increase in consumables sales (excluding translational FX) reflects the same trend as total sales discussed above. Increased pricing contributed approximately $2,900, or about 50 basis points, to consumables sales growth, reflecting increases in both segments.
The 19% increase in system sales (excluding translational FX) reflects timing of capital projects in both the Life Sciences and Industrial segments.
Gross Margin
 
 
Three Months Ended
(dollars in thousands)
 
Oct 31, 2014
 
Oct 31, 2013
Gross Profit
 
$
361,408

 
$
325,714

% of sales
 
51.9

 
51.7

% change
 
11.0

 
 
The increase in overall gross margin of 20 basis points primarily reflects the impact of the following factors:
improved fixed cost leverage in our manufacturing facilities, and
improved pricing.
These factors were partly offset by the impact of lower gross margin rates from acquisitions and unfavorable transactional FX (particularly the Pound/Euro relationship).
More details regarding gross margin can be found in the discussions under the section “Segment Review.”


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Selling, General and Administrative
 
 
Three Months Ended
(dollars in thousands)
 
Oct 31, 2014
 
Oct 31, 2013
Selling, general and administrative
 
$
202,656

 
$
194,884

% of sales
 
29.1

 
30.9

% change
 
4.0

 
 
The decrease in selling, general and administrative expenses (“SG&A”) as a percent of sales of 180 basis points reflects savings generated by our structural cost improvement initiative and better fixed cost leverage, partly offset by inflationary increases in payroll and other costs.
Research & Development
 
 
Three Months Ended
(dollars in thousands)
 
Oct 31, 2014
 
Oct 31, 2013
Research and development
 
$
24,777

 
$
23,267

% of sales
 
3.6

 
3.7

% change
 
6.5

 
 
The increase in research and development expenses (“R&D”), was primarily driven by spend related to our recent acquisitions.
Restructuring and Other Charges, Net
 
 
Three Months Ended
(dollars in thousands)
 
Oct 31, 2014
 
Oct 31, 2013
Restructuring and other charges, net
 
$
9,240

 
$
9,198

In fiscal year 2012, we announced a multi-year strategic cost reduction initiative (“structural cost improvement initiative”). This initiative impacts both segments as well as the Corporate Services Group. Our goal is to properly position our cost structure globally to perform in the current economic environment without adversely impacting our growth or innovation potential.
Key components of the structural cost improvement initiative include:
the strategic alignment of our manufacturing, sales and R&D facilities to cost-effectively deliver high-quality products and superior service to our customers worldwide,
creation of regional and global shared financial services centers for the handling of accounting transaction processing and other accounting functions,
reorganization of sales functions, to more cost- efficiently deliver superior service to our customers globally, and
reductions in headcount across all functional areas, enabled by efficiencies gained through our ERP systems, as well as in order to align to economic conditions.
The structural cost improvement initiative is now expected to generate $125,000 in annualized cost savings (“targeted savings”) over a four year period, which will allow us to invest in resources where needed. Previously, the savings target was $100,000 in annualized cost savings over a three year period. We achieved over 40% of the targeted savings by the end of fiscal year 2013 and about 30% in fiscal year 2014. We expect to achieve more than 20% of the targeted savings in fiscal year 2015 and the balance in fiscal year 2016. We expect to fund these restructuring activities with cash flows generated from operating activities.
Restructuring and other charges (“ROTC”) in the three months ended October 31, 2014 and October 31, 2013 primarily reflect the expenses incurred in connection with our structural cost improvement initiative, as discussed above, including severance costs of $8,750 and $3,115 in the three months ended October 31, 2014 and October 31, 2013, respectively. In addition, the three months ended October 31, 2013 includes an increase of $4,440 to our previously established environmental reserves related to a matter in Pinellas Park, Florida.
The details of ROTC, as well as the activity related to restructuring liabilities that were recorded related to our structural cost improvement initiative, can be found in Note 6, Restructuring and Other Charges, Net, to the accompanying condensed consolidated financial statements.


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Interest Expense, Net
 
 
Three Months Ended
(dollars in thousands)
 
Oct 31, 2014
 
Oct 31, 2013
Interest expense, net
 
$
6,702

 
$
5,977

The increase in net interest expense of $725 was primarily driven by an increase in income tax related interest expense.
Income Taxes
 
 
Three Months Ended
(dollars in thousands)
 
Oct 31, 2014
 
Oct 31, 2013
Income taxes
 
$
29,760

 
$
20,875

Effective tax rate (%)
 
25.2

 
22.6

Excluding the impact of ROTC discussed above, the effective tax rate for the three months ended October 31, 2014 and October 31, 2013 would have been 23.8% and 22.2%, respectively. The effective tax rate for the three months ended October 31, 2014 was impacted by the expiration of certain tax extenders and unfavorable jurisdictional mix. We expect our effective tax rate for the full fiscal year 2015 to be approximately 23.0%, exclusive of the impact of ROTC and discrete items. The actual effective tax rate for the full fiscal year 2015 may differ materially based on several factors, including the geographical mix of earnings in tax jurisdictions, enacted tax laws, the resolution of tax audits, the ti