10-Q 1 y09445e10vq.txt 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED APRIL 30, 2005 Commission file number 000-21109 CUNO INCORPORATED ------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 06-1159240 ------------------------------- ----------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 400 Research Parkway, Meriden, Connecticut 06450 ------------------------------------------ -------- (Address of principal executive offices) (Zip Code) (203) 237-5541 ------------------------------------------------------------------------------- Registrant's telephone number, including area code Not Applicable -------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No[ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $0.001 Par Value - 17,280,123 shares as of April 30, 2005 CUNO INCORPORATED

CUNO INCORPORATED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (dollars in thousands, except share and per-share amounts)

See accompanying notes. -1- CUNO INCORPORATED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (dollars in thousands, except share and per-share amounts)

See accompanying notes. -2- CUNO INCORPORATED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (in thousands, except share amounts)

-3- CUNO INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (dollars in thousands)

See accompanying notes. -4- CUNO INCORPORATED NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per-share amounts) APRIL 30, 2005 NOTE 1 - ORGANIZATION AND ACCOUNTING POLICIES CUNO Incorporated (the "Company", "CUNO", or "we") designs, manufactures and markets a comprehensive line of filtration products for the separation, clarification and purification of liquids and gases. Our products, which include proprietary depth filters and semi-permeable membrane filters, are sold in the potable water, healthcare and fluid processing markets throughout the world. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for annual financial statements. In the opinion of management, all adjustments which are of a normal recurring nature considered necessary for a fair presentation of the financial position and results of operations for the interim periods set forth herein have been included. The accounts of the Company and all of its subsidiaries are included in the consolidated financial statements. All significant intercompany accounts and transactions are eliminated in consolidation. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the full year. These interim unaudited financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended October 31, 2004. The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes to the financial statements. Actual results could differ from those estimates. Certain prior year amounts have been reclassified to conform to current year presentation. INVENTORIES: Inventories are stated at the lower of cost or market. Inventories in the United States of America are primarily valued by the last-in, first-out (LIFO) cost method. The methods used for all other inventories are first-in, first-out (FIFO) and average cost. An actual valuation of inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations must necessarily be based on our estimates of expected year-end inventory levels and costs. Because these are subject to many factors beyond management's control, interim results are subject to the final year-end LIFO inventory valuation. Inventories consist of the following:

5 ACCOUNTS PAYABLE At April 30, 2005 and October 31, 2004, approximately $4,094 and $2,478, respectively, representing book overdrafts of cash accounts, were reclassified to accounts payable. INTEREST AND OTHER INCOME, NET: Interest and other income (expense), net consisted of the following:

EARNINGS PER SHARE: Basic earnings per common share is based on net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is based on net income divided by the weighted average number of common shares outstanding during the period, including the effect of stock equivalents, where such effect is dilutive. Earnings per share for the three months ended April 30, 2005 and 2004 is calculated as follows:

Approximately 104,618 and 216,000 shares (before the effects of the treasury stock method) related to options to purchase common stock and unvested restricted stock were excluded from the computations of diluted earnings per share at April 30, 2005 and 2004, respectively, because the exercise price was greater than the average market price of the common stock during the periods. 6 Earnings per share for the six months ended April 30, 2005 and 2004 is calculated as follows:

Approximately 92,368 and 216,000 shares (before the effects of the treasury stock method) related to options to purchase common stock and unvested restricted stock were excluded from the computations of diluted earnings per share for the six-months ended April 30, 2005 and 2004, respectively, because the exercise price was greater than the average market price of the common stock during the periods. COMPREHENSIVE INCOME: Total comprehensive income was comprised of the following:

7 EMPLOYEE STOCK OPTIONS: The Company has stock option plans under which employees and directors have options to purchase Common Stock. The Company applies APB 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for its stock option plans. The Company has adopted those provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123) and Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of Statement of Financial Accounting Standards No. 123", which require the disclosure of pro forma effects on net income and earnings per share as if compensation cost had been recognized based upon the fair value method at the date of grant for options awarded. Pro forma information regarding net income and earnings per share is required by FAS 123, which requires that the information be determined as if we had accounted for our employee stock options under the fair-value method of FAS 123. The fair value for the options granted during the following periods were estimated at the date of grant using the Black-Scholes pricing model with the following weighted average assumptions:

N/A - There were no stock option grants during the quarter ended April 30, 2004 The following table illustrates the effect on net income and earnings per share as if compensation cost had been recognized based on the fair value of the options at the grant dates for awards under those plans consistent with FAS 123, as amended, using the Black-Scholes fair value method for option pricing.

8 NEWLY ISSUED ACCOUNTING STANDARD In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment". This standard will require the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost will be recognized over the period during which an employee is required to provide service in exchange for the award. This Standard is effective as of the beginning of the first annual reporting period that begins after June 15, 2005. This Standard will apply to all awards granted after the required effective date and to awards modified, repurchased or canceled after that date. We are currently evaluating the requirements and application of this standard and expect the adoption to have an adverse effect on our consolidated statements of income. NOTE 2 - GOODWILL AND INTANGIBLE ASSETS Goodwill amounted to $104,566 and $103,977 at April 30, 2005 and October 31, 2004, respectively. The increase in goodwill is attributable to changes in foreign exchange rates. Other intangible assets amounted to $31,876 and $32,894 at April 30, 2005 and October 31, 2004, respectively. The decrease in the balance of other intangible assets is related primarily to amortization, which amounted to $650 and $1,303, respectively, for the three-month and six-month periods ended April 30, 2005, partially offset by the impact of fluctuations in foreign exchange rates. NOTE 3 - BENEFIT PLANS Components of Net Periodic Benefit Cost are as follows:

During the three and six months ended April 30, 2005, employer contributions of $816 and $1,650, respectively, were made to the pension plans. We currently anticipate contributing an additional $1,640 to fund our pension plans in fiscal 2005 for a total expected contribution of $3,290. The pension assumptions used to determine our October 31, 2004 plan liabilities and the fiscal 2005 pension expense are as follows:

9 We determine our assumptions based on current economic and market data, as well as expectations of future economic and market data. Included in our analysis are company-specific considerations, such as current and future investment allocations, participant demographics, and employee compensation strategies. Pension expense for fiscal 2005 is determined at the beginning of the fiscal year and expensed ratably throughout the year. Our estimate of pension expense to be recognized in 2005 is $3,500 ($3,100 in fiscal 2004). NOTE 4 - ACQUISITIONS In the first quarter of 2004, we completed two acquisitions in Europe for total consideration of $554. The amount of goodwill and other intangible assets recorded in connection with these two acquisitions amounted to $340 and $480, respectively. Neither of these acquisitions had a material impact on the Company's historical financial statements or pro forma operating results. On August 2, 2004 we acquired 100 percent of the outstanding common shares of WTC Industries and subsidiary ("WTC"). The aggregate purchase price was $115,193 (net of $569 of cash acquired). The results of operations of WTC are included in our financial statements from August 2, 2004, the date of acquisition, and thereafter. NOTE 5 - SEGMENT DATA Segment information has been prepared in accordance with Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information." CUNO is organized into five geographic segments, as the Company's chief operating decision makers are responsible for managing our global operations based on geographic regions. Our geographic segments include: North America, Europe, Japan, Asia/Pacific and Latin America. Each of these operations are led and managed by a local General Manager who is responsible for the profitability of their respective geographic segment. Each of these geographic operations in turn manufactures and sells products into our three main filtrations markets; potable water, healthcare and fluid processing. Each geographic segment manufactures and sells products in each of the three markets. The geographic segment managers are responsible for managing their respective resources with oversight and review by the CEO. The Company does not present segment information by market as our individual market focus is limited to worldwide sales, with assigned responsibility for expanding worldwide sales within each respective market. Financial information by geographic operating segments is summarized below:

10 Our sales by market are summarized below:

Our operating income by segment is detailed below:

Interest expense and other income (expense) have not been allocated to segments. Our assets by segment are detailed below:

General corporate assets, consisting of cash, are not allocated to segments. NOTE 6 - COMMITMENTS AND CONTINGENCIES 11 The Company is subject to various legal actions, governmental audits, and proceedings relating to various matters incidental to its business including product liability and environmental claims. While the outcome of such matters cannot be predicted with certainty, in the opinion of management, after reviewing such matters and consulting with our counsel and considering any applicable insurance or indemnifications, any liability which may ultimately be incurred is not expected to materially affect the consolidated financial position, cash flows or results of operations of the Company. Currently, we have self-insurance limits for workers' compensation, product liability and employee medical claims. Our workers' compensation policies have per-individual deductibles of $350, our product liability policy has a $250 per claim deductible and our medical plan for employees has a stop-loss of $200 per individual. NOTE 7 - SUBSEQUENT EVENT On May 11, 2005, CUNO entered into an Agreement and Plan of Merger with 3M Company. On the terms and subject to the conditions of the Merger Agreement, which has been approved by the Board of Directors of each of CUNO and 3M, at the effective time of the Merger, each share of common stock, par value $0.001, of CUNO will be converted into the right to receive $72.00 in cash. Consummation of the Merger is subject to customary conditions, including (i) approval of the holders of CUNO Common Stock, (ii) absence of any law or order prohibiting the consummation of the Merger and (iii) expiration or termination of the Hart-Scott-Rodino waiting period and obtaining certain other regulatory approvals. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS amounts in thousands, except share and per-share amounts) Management's discussion and analysis of financial condition and results of operations ("MD&A") is provided as a supplement to the accompanying unaudited interim condensed consolidated financial statements and footnotes to provide an understanding of our financial position, changes in our financial position and results of our operations. Our MD&A is organized as follows: - COMPANY OVERVIEW. This section provides a general description of our business. - COMPANY RISK FACTORS. This section describes the material risks inherent in our business that investors should be aware of. - CAUTION CONCERNING FORWARD-LOOKING STATEMENTS. This section discusses how certain forward-looking statements made by us throughout the MD&A and elsewhere in this report are based on management's present expectations about future events and are inherently susceptible to uncertainty and changes in circumstances. - CRITICAL ACCOUNTING POLICIES. This section discusses those accounting policies that are both considered important to our financial statements and require significant judgment and estimates on the part of management in their application. - RESULTS OF OPERATIONS. This section provides an analysis of our recent results of operations, including a brief description of transactions and events that impact the comparability of these results. - FINANCIAL POSITION AND LIQUIDITY. This section provides an analysis of our cash position and cash flows, as well as a discussion of our financing arrangements. Other information is presented in Items 3, 4 and elsewhere as follows: - QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK. This section discusses information about the various market risks we are exposed to as of the end of the latest fiscal period presented. - CONTROLS AND PROCEDURES. This section discusses the conclusions of our executive officer and principal financial officer about the effectiveness of our disclosure controls and procedures. - OTHER INFORMATION. This section describes material developments in the business or markets in which we compete, as well as any other information important to our stakeholders. COMPANY OVERVIEW CUNO is a world leader in the designing, manufacturing and marketing of a comprehensive line of filtration products for the separation, clarification and purification of liquids and gases. Our products, which include proprietary depth filters and semi-permeable membrane filters, are used in the potable water, fluid processing, and healthcare markets. These products, most of which are disposable, effectively remove contaminants that range in size from molecules to sand particles. Our sales are approximately balanced between domestic and international markets. Our objective is to provide high value-added products and premium customer service. Our proprietary manufacturing processes result in products that lower customers' operating expenses and improve the quality of customers' end products by providing longer lasting, higher quality and more efficient filters. 13 COMPANY RISK FACTORS RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS Approximately 50% of our net sales are derived from international operations. Consequently, our reported financial results may be adversely affected by significant fluctuations in the value of the US dollar in comparison to local currencies in the countries in which we operate outside the US. We manufacture products in Japan, China, Brazil, France, Singapore and Australia. Our international operations may be affected by economic, political and governmental conditions in some of the countries where we have manufacturing facilities or where our products are sold. In addition, changes in economic or political conditions in any of the countries in which we operate could result in unfavorable taxation policies, exchange rates, new or additional currency or exchange controls, governmental regulations, credit risks, or other restrictions being imposed on the operations of the Company or expropriation. PATENTS AND PROPRIETARY TECHNIQUES We have a broad patent portfolio as well as other proprietary information and manufacturing techniques and have applied, and will continue to apply, for patents to protect our technology. The Company's success depends in part upon our ability to protect our technology and proprietary products under US and foreign patent and other intellectual property laws. Trade secrets and confidential know-how which are not patented are protected through confidentiality agreements, contractual provisions and internal Company administrative procedures. There can be no assurance that such arrangements will provide meaningful protection for the Company in the event of any unauthorized use or disclosure. There can be no assurance that third parties will not assert infringement claims against the Company or that a license or similar agreement will be available on reasonable terms in the event of an unfavorable ruling on any such claim. In addition, any such claim may require the Company to incur litigation expenses or subject the Company to liabilities. TECHNOLOGICAL AND REGULATORY CHANGE The filtration and separations industry is characterized by changing technology, competitively imposed process standards and regulatory requirements, each of which influences the demand for our products and services. Changes in legislative, regulatory or industrial requirements or competitive technologies may render certain of our filtration and separations products and processes obsolete. Acceptance of new products may also be affected by the adoption of new government regulations requiring stricter standards. The Company's ability to anticipate changes in technology and regulatory standards and to develop and introduce new and enhanced products successfully on a timely basis are significant factors in our ability to grow and to remain competitive. Similar to all companies, we are also subject to the risks generally associated with new product introductions and applications, including lack of market acceptance, delays in product development and failure of products to operate properly. COMPETITION The filtration and separations markets in which we compete are highly competitive. We compete with many domestic and international companies in the global markets. The principal methods of competition in the markets in which we compete are product specifications, performance, quality, knowledge, reputation, technology, distribution capabilities, service and price. INFLATION Inflation had a negligible effect on our operations. We estimate that inflationary effects, in the aggregate, were generally recovered or offset through increased pricing or cost reductions in all periods presented. KEY CUSTOMERS AND SUPPLIERS We have multi-year contracts and arrangements in place with several of our major customers and suppliers. These contracts and arrangements help us effectively plan and manage our operations. Since the markets for our products are dynamic, these contracts and arrangements are continually evolving as we are sensitive to the changing needs of our customers and the ongoing performance of our suppliers. There is no assurance, however, that these 14 contracts and arrangements will be renewed, will not be terminated prematurely or revised to take into consideration the evolving nature of our relationships with our customers and suppliers. CAUTION CONCERNING FORWARD-LOOKING STATEMENTS Because we want to provide shareholders with more meaningful and useful information, this quarterly report contains statements relating to future events and the predicted performance of CUNO Incorporated (the "Company", "CUNO", or "we") which may constitute forward-looking statements, as defined under the Private Securities Litigation Act. We have tried, wherever possible, to identify these "forward looking" statements by using words such as "anticipate," "believe," "estimate," "expect" and similar expressions. These statements reflect our current beliefs and are based on information currently available to us. Accordingly, these statements are subject to risks and uncertainties which could cause our actual results performance or achievements to differ materially from those expressed in, or implied by, these statements. These risks and uncertainties include the following: economic and political conditions in the foreign countries in which we conduct a substantial part of our operations and other risks associated with international operations including taxation policies, credit risk, exchange rate fluctuations and the risk of expropriation; our ability to protect our technology, proprietary products and manufacturing techniques; volumes of shipments of our products, changes in our product mix and product pricing; continuing beneficial relationships with customers; costs of raw materials; the rate of economic and industry growth in the United States and the other countries in which we conduct our business; changes in technology, changes in legislative, regulatory or industrial requirements and risks generally associated with new product introductions and applications; and domestic and international competition in our global markets. We assume no obligation to publicly release revisions to the forward-looking statements to reflect new events or circumstances. CRITICAL ACCOUNTING POLICIES The Securities and Exchange Commission ("SEC") defines the most critical accounting policies as the ones that are most important to the portrayal of a company's financial condition and operating results, and require management to make its most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Based on this definition, our most critical accounting policies include: revenue recognition, accounting for depreciation and amortization, employee benefits, contingencies, allowance for doubtful accounts, income taxes, and stock based compensation. The methods, estimates and judgments we use in applying these most critical accounting policies have a significant impact on the results we report in our financial statements. There were no changes in accounting policies or significant changes in accounting estimates during the current period. All of our critical accounting policies and significant estimates have been discussed with the Audit Committee of the Board of Directors. We have not made any significant changes to our critical accounting policies or estimates since year end. Revenue Recognition -- We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 104 "Revenue Recognition" ("SAB 104"). SAB 104 requires that four basic criteria be met before revenue can be recognized: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is reasonably assured. We recognize revenue upon determination that all criteria for revenue recognition have been met. Accordingly, revenue is recognized upon delivery to a common carrier when terms are FOB shipping and upon receipt by customer when terms are FOB destination. Depreciation and Amortization - We depreciate our property, plant and equipment using the straight-line method over the estimated useful life of the asset. These periods range as follows: Land improvements 10 - 20 years Buildings and additions 30 - 40 years Machinery and equipment 5 - 20 years Computers and related equipment 3 - 5 years 15 We amortize our patents and other amortizable intangible assets over their estimated useful lives. The straight line method of amortization is used unless another method is more appropriate and reliable in reflecting the pattern in which the asset provides economic benefits. These periods generally range from 10 - 20 years. We review the carrying values of intangibles and long-lived assets on an annual basis. In addition, in the event that facts and circumstances indicate that the carrying value of intangibles and long-lived assets or other assets may be impaired at any other time, an evaluation is performed. Our evaluations compare the estimated future undiscounted cash flows associated with the asset to the asset's carrying amount. Employee Benefits - We account for our pension plans in accordance with SFAS No. 87, "Employer's Accounting for Pensions". In applying this accounting practice, assumptions are made regarding the valuation of benefit obligations and the performance of plan assets. The primary assumptions are as follows: - Weighted average discount rate - this rate is used to estimate the current value of future benefits. This rate is adjusted based on movements in long-term interest rates. - Expected long-term rate of return on assets - this rate is used to estimate future growth in investments and investment earnings. The expected return is based upon a combination of historical market performance and anticipated future returns for a portfolio reflecting the mix of equity, debt and other investments indicative of our plan assets. - Rates of increase in compensation levels - this rate is used to estimate projected annual pay increases, which are used to determine the wage base used to project employees' pension benefits at retirement. We determine these assumptions based on consultations with our outside actuaries and investment advisors. Any variance in the above assumptions could have a significant impact on future recognized pension costs, assets and obligations. Business Acquisitions - Assets and liabilities acquired in a business combination are recorded at their estimated fair values at the acquisition date. In accordance with SFAS 142, goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to annual impairment testing. The assessment of goodwill involves the estimation of the fair value of reporting units, as defined by SFAS 142. Management completed this annual assessment during the fourth quarter of 2004 based on the best information available as of the date of the assessment, which incorporated management's assumptions about expected future cash flows. Based on this assessment, there was no goodwill impairment in 2004. Future cash flows can be affected by changes in the global economy and local economies, industries and markets in which the Company sells products or services, and the execution of management's plans, particularly with respect to integrating acquired companies. There can be no assurance that future events will not result in impairment of goodwill or other intangible assets. Contingencies, Claims and Assessments -- From time to time, we are involved with contingencies, claims, and assessments. We use both in-house and outside legal counsel to assess the probability of loss. The Company establishes an accrual for specific contingencies, claims and assessments when both of the following conditions are present: a loss is deemed probable and the amount of the anticipated loss can be reasonably estimated. There can be no assurance that the ultimate resolution of these contingencies, claims, and assessments will not differ materially from our estimates. Allowance for Bad Debts -- The allowance for doubtful accounts is established to represent our best estimate of the net realizable value of the outstanding accounts receivable balances. We estimate our allowance for doubtful accounts based on past due amounts and historical write-off experience, as well as trends and factors surrounding the credit risk of specific customers. In an effort to identify adverse trends, we perform periodic credit 16 evaluations of our customers and ongoing account balance reviews and agings of receivables. Amounts are considered past due when payment has not been received within the time frame of the credit terms extended. Write-offs are charged directly against the allowance for doubtful accounts and occur only after all collection efforts have been exhausted. Actual write-offs and adjustments could differ from the allowance estimates due to unanticipated changes in the business environment as well as factors and risks surrounding specific customers. Income Taxes - We estimate and use our expected annual effective income tax rate to accrue income taxes on an interim basis. We update these estimates quarterly. We record valuation allowances to reduce our deferred income tax assets to an amount that we believe is more likely than not to be realized. We consider estimated future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If we were to determine that we will not realize all or part of our deferred income tax assets in the future, we would make an adjustment to the carrying value of the deferred income tax asset, which would be reflected as an income tax expense. Conversely, if we were to determine that we will realize a deferred income tax asset, which currently has a valuation allowance, we would reverse the valuation allowance which would be reflected as an income tax benefit in our financial statements. We take tax positions in our worldwide corporate income tax filings based on careful interpretations of global statutes, rules, regulations and court decisions that may be applied and interpreted differently by various taxing jurisdictions. These taxing jurisdictions may or may not challenge our application and interpretation of a wide body of tax jurisprudence. However, we do not anticipate that any sustained challenge by any taxing jurisdiction will have a material adverse effect on our financial position or net income. Stock Based Compensation - We currently account for our stock option awards under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. No stock-based employee compensation cost pertaining to stock options is reflected in net income, as all options granted under our plans had exercise prices equal to the market value of the underlying common stock on the date of grant. Restricted and performance share grants awarded to employees are included in earnings as an expense over the vesting period of the award. The Company expects to adopt SFAS No. 123 (revised), "Share Based Payment" in the first quarter of 2006. SFAS No. 123(R) will require the recognition of compensation expense associated with the share-based payment in the Company's consolidated financial statements, and is expected to have a material impact on the Company's results of operations. 17 RESULTS OF OPERATIONS THREE MONTH PERIOD ENDED APRIL 30, 2005 VS. THREE MONTH PERIOD ENDED APRIL 30, 2004 OVERVIEW During the second quarter of fiscal 2005, CUNO's sales grew by 26.6 percent. Sales growth was particularly strong in North America, Japan and Asia/Pacific, and strong overall within the worldwide potable water market. U.S. Dollar organic sales growth was 14.9 percent and organic sales growth on a local currency basis was 12.4 percent. Although our sales increased significantly, our gross margin decreased due primarily to the impact of our recent acquisition of WTC Industries Inc. (WTC). Sales to retailers within the potable water market and sales attributable to WTC generally carry lower gross margins than we have historically reported. Net income was flat - we incurred approximately $0.5 million in operating costs associated with a new plant in Mexico and incurred approximately $0.8 million in costs associated with compliance efforts surrounding the Sarbanes-Oxley Act of 2002 which adversely affected profitability. Going forward, business and market uncertainties may affect results. See "Company Risk Factors" above and Management's Discussion and Analysis in our Annual Report on Form 10-K for the fiscal year ended October 31, 2004 for a full discussion of the key factors which affect our business and operating results. Below is a summary of selected consolidated earnings information:

BUSINESS ENVIRONMENT Our geographic and market diversity help limit the impact of any one market or the economy of any single country on our consolidated results. The uncertainty of the economic conditions in various markets and geographic regions in which we compete is likely to continue to present challenges to our business near term. The U.S. Dollar was significantly weaker compared to most of the currencies in countries we conduct business in during the second quarter of 2005 compared to the second quarter of 2004. We translate revenue and expense accounts at the average exchange rates during the periods presented. NET SALES Net sales were $104.7 million in the second quarter of fiscal 2005 representing a 26.6 percent increase over 2004's second quarter sales of $82.7 million. This increase can generally be attributed to an increase in the unit volume of worldwide sales. Had currency values been unchanged from the second quarter of 2004, net sales in the 18 second quarter of 2005 would have been $2.1 million lower than the reported sales of $104.7 million, or 24.1 percent greater overall. The following table displays the Company's sales by geographic segment:

North American sales increased 35.5 percent in the second quarter of 2005 as compared to the same quarter in 2004. Sales increased in all North American markets during the quarter, however stronger potable water market sales were largely responsible for this growth. Excluding sales from WTC which we acquired on August 2, 2004, sales in North America would have been up 12.6 percent quarter over quarter. North American fluid processing and healthcare sales increased 8.4 percent and 9.1 percent, respectively, reflecting the overall strength of the economy during this time period. European sales increased 4.9 percent in local currency as compared to the same period in 2004. Sales were generally strong in all European markets, however fluid processing sales were particularly strong in the quarter reflecting greater demand for our products serving the industrial and chemical markets. Sales in Japan were up broadly in all markets and were led by very strong sales of food and beverage filters used in the healthcare market primarily for the filtration of bottled drinks. Asia/Pacific sales were up 23.1 percent in local currency primarily reflecting strong growth of potable water sales within the Asia region. Second quarter 2005 Latin American sales were up 10.4 percent when expressed in local currency due primarily to increased sales within the potable water and fluid processing markets. The following table displays the Company's sales by market:

The strength in the potable water market continues to be broad geographically, driven largely by strong sales growth in North America (up 47.6 percent) associated with OEM customers, direct marketing companies and appliance manufacturers and strong overseas sales (up 19.7 percent in local currency). Excluding the impact of WTC, second quarter worldwide potable water sales were up 18.3 percent on a local currency basis. Fluid Processing sales were up 8.4 percent in North America and up 13.2 percent overseas on a local currency basis. Healthcare sales were up 9.1 percent in North America and up 7.6 percent overseas on a local currency basis. Much of this overseas growth was driven by continued strong sales of food and beverage filters in Japan used primarily for the filtration of bottled drinks. 19 GROSS PROFIT Gross profit increased $5.7 million to $44.8 million in the second quarter of 2005 from $39.1 million in the second quarter of 2004. Gross profit as a percentage of net sales (gross margin) decreased during that same period from 47.2 percent in 2004 to 42.7 percent in 2005. This decrease in gross margin is primarily attributable to a change in our sales mix in the potable water market, including sales of WTC (which we acquired on August 2, 2004 and are included in our 2005 results) and increasing sales to retailers, both of which carry comparatively lower gross margins. OPERATING EXPENSES Selling, general and administrative expenses (SG&A) were up 17.2 percent, less than the 26.6 percent sales growth rate for the quarter. Because of CUNO's international operations, the weaker US dollar served to increase the consolidated US dollar reported SG&A expense. SG&A expenses were 25.1 percent of sales in the second quarter of fiscal 2005 vs. 27.1 percent of sales in the second quarter of fiscal 2004. We continue to face rising structural costs such as Sarbanes/Oxley compliance, medical, pension and depreciation expense, as well as the addition of WTC's expenses included in 2005 results. Research, development and engineering expenses (incurred primarily in the US and to a lesser extent in Europe) increased 27.8 percent to $5.2 million in the second quarter of 2005, reflecting our continued focus on the development of new products and technologies. As a percentage of sales, research, development and engineering expenses were 4.9 percent of sales in both the second quarter of fiscal 2005 and 2004. OPERATING INCOME As a result of the above, operating income increased 1.0 percent, to $12.7 million or 12.1 percent of sales in the second quarter of fiscal 2005 compared to $12.5 million or 15.1 percent of sales in the second quarter of 2004. Our operating income by segment is detailed below:

Operating income in North America decreased by $1.1 million, or 16.3 percent. This decrease was due to many factors, including: operating costs of approximately $0.5 million associated with a new plant which is currently being built in Mexico to begin production of certain water products, compliance costs of approximately $0.8 million associated with the Sarbanes Oxley Act, amortization expense associated with WTC's definite lived amortizable intangible assets ($0.5 million), lower gross margins associated with the change in sales mix within the potable water market (as noted above) and other increased structural costs discussed above. The results of our foreign operations are heavily dependent on the relationship of their functional currency compared to the U.S. Dollar. We translate our foreign revenue and expense accounts into U.S. Dollars using the average exchange rate for the period. European sales increased 4.9 percent on a local currency basis, while the Euro 20 strengthened approximately 6 percent (average second quarter of 2005 versus average second quarter of 2004). Increased manufacturing and structural costs were responsible for the reduction in Europe's operating income. Sales in Japan were up 13.9 percent on a local currency basis (and up $1.8 million in U.S. dollars), and the Yen strengthened versus the U.S. Dollar approximately 2 percent quarter over quarter (allowing fixed costs to be spread over a larger sales base). Sales in 2005 were very strong for food and beverage filters used in the filtration of summer bottled drinks. These sales are dependent on consumer preferences and other external factors. Asia/Pacific sales were up 23.1 percent quarter over quarter, and the Australian Dollar strengthened approximately 3 percent in comparison (approximately 50 percent of our sales in the region are denominated in Australian Dollars). Local currency sales in Latin America increased 10.4 percent, contributing to the increase in operating income for the quarter. NONOPERATING INCOME (EXPENSE): Interest expense increased from $0.1 million in the second quarter of 2004 to $0.6 million in the second quarter of 2005. This primarily relates to interest expense associated with our variable rate, unsecured revolving credit facility. We had $68 million in outstanding borrowings under this facility at April 30, 2005 and capitalized approximately $0.2 million in interest costs during the second quarter of 2005 in accordance with the provisions of FAS 34, "Capitalization of Interest Cost". INCOME TAXES The Company's effective income tax rate for the second quarter of 2005 was 32.2 percent compared to 33.3 percent in the second quarter of 2004. Our tax rate is impacted by the change in the mix of income attributed to the various countries in which we do business and various one-time and recurring tax planning initiatives. As of April 30, 2005, the Company had a full valuation allowance against approximately $1.3 million of NOLs in China. Our China operations are start-up in nature with a history of losses (no profit has been earned since inception in 2001). The remaining countries in which we carry valuation allowances against NOLs are generally operations which are new to CUNO, have a history of losses, or are in volatile economic regions of the world. SIX MONTH PERIOD ENDED APRIL 30, 2005 VS. SIX MONTH PERIOD ENDED APRIL 30, 2004 OVERVIEW During the first six months of fiscal 2005, CUNO's sales were up 29.1 percent. This growth was favorably impacted by the overall weakness of the U.S. Dollar, strong sales in the North American potable water market (up 52.6 percent) and overseas sales in general (up 12.5 percent in local currency). U.S. Dollar organic sales growth was 17.3 percent and organic sales growth on a local currency basis was 14.6 percent. Although our sales increased significantly, our gross margin decreased due primarily to the impact of our recent acquisition of WTC Industries Inc. (WTC). Sales to retailers within the potable water market and sales attributable to WTC generally carry lower gross margins than we have historically reported. Net income increased modestly (up 5.2 percent) - we incurred approximately $0.7 million in operating costs associated with a new plant in Mexico and incurred approximately $0.9 million in costs associated with compliance efforts surrounding the Sarbanes-Oxley Act of 2002 which adversely affected profitability. Going forward, business and market uncertainties may affect results. See "Company Risk Factors" above and Management's Discussion and Analysis in our Annual Report on Form 10-K for the fiscal year ended October 31, 2004 for a full discussion of the key factors which affect our business and operating results. Below is a summary of selected consolidated earnings information: 21

BUSINESS ENVIRONMENT Our geographic and market diversity helps limit the impact of any one market or the economy of any single country on our consolidated results. The uncertainty of the economic conditions in various markets and geographic regions in which we compete is likely to continue to present challenges to our business near term. The U.S. Dollar was significantly weaker compared to most of the currencies in countries we conduct business in during the first six months of 2005 compared to the first six months of 2004. We translate revenue and expense accounts at the average exchange rates during the periods presented. NET SALES Net sales were $204.1 million in the first six months of fiscal 2005 representing a 29.1 percent increase over 2004's sales of $158.2 million. This increase can generally be attributed to an increase in the unit volume of worldwide sales. Had currency values been unchanged from the first six months of 2004, net sales in the first six months of 2004 would have been $4.2 million lower than the reported sales of $204.1 million, or 26.4 percent greater overall. The following table displays the Company's sales by geographic segment:

22 North American sales increased 39.6 percent in the first six months of 2005 as compared to the same period in 2004. Stronger potable water market sales were responsible for the growth in North America during this time period. Potable water continues to achieve strong sales of its series of filters designed for customers who serve various channels of distribution with final sales to US residential consumers. North American fluid processing and healthcare sales increased 10.8 percent and 9.4 percent, respectively. European sales increased 7.1 percent in local currency as compared to the same period in 2004. Fluid processing sales were particularly strong in the period reflecting greater demand for our products serving the industrial markets. Sales in Japan were up 17.2 percent in local currency led by a strong increase in sales to the healthcare market, and to a lesser extent the potable water market. Asia/Pacific sales were up 19.0 percent excluding changes in currency values. Sales were very strong throughout Asia, and particularly strong in the water markets in Asia. First half 2005 Latin American sales were up 3.1 percent when expressed in local currency. The following table displays the Company's sales by market:

The strength in the potable water market was broad geographically, driven largely by strong overseas sales (up 18.2 percent in local currency) and strong sales growth in North America (up 52.6 percent) associated with OEM customers, direct marketing companies, and appliance manufacturers. Fluid Processing sales were up 10.8 percent in the U.S. and up 11.4 percent overseas on a local currency basis. Healthcare sales were up 10.6 percent overseas on a local currency basis and up 9.4 percent in the U.S. despite a reduction in diagnostic sales. GROSS PROFIT Gross profit increased $13.3 million to $87.2 million in the first six months of 2005 from $73.9 million in the first six months of 2004. Gross profit as a percentage of net sales (gross margin) decreased during that same period from 46.7 percent in 2004 to 42.7 percent in 2005. This decrease in gross margin is primarily attributable to a change in our sales mix in the potable water market, including sales of WTC (which we acquired on August 2, 2004 and are included in our 2005 results) and increasing sales to retailers, both of which carry comparatively lower gross margins. OPERATING EXPENSES Selling, general and administrative expenses (SG&A) were up 19.6 percent, less than the 29.1 percent sales growth rate. Because of CUNO's international operations, the weaker U.S. dollar served to increase the consolidated U.S. dollar reported SG&A expense. SG&A expenses were 26.9 percent of sales in the first six months of 2004 compared to 25.0 percent of sales in the first six months of 2005. In addition, rising structural costs (such as Sarbanes/Oxley compliance, medical, pension, insurance and depreciation expenses) impacted overall SG&A expenses. Research, development and engineering expenses (incurred primarily in the US and to a lesser extent in Europe) increased 22.6 percent to $10.1 million in the first six months of 2005, reflecting our continued focus on the development of new products and technologies. As a percentage of sales, RD&E expenses were 4.9 percent of sales in the first six months of fiscal 2005 compared to 5.2 percent of sales in the first six months of fiscal 2004. 23 OPERATING INCOME As a result of the above, operating income increased $1.9 million, or 8.3 percent, to $24.9 million or 12.2 percent of sales in the first six months of fiscal 2005 compared to $23.0 million or 14.5 percent of sales in the first six months of 2004. Our operating income by segment is detailed below:

Operating income in North America decreased by $1.0 million, or 7.3 percent. This decrease was due to many factors, including: operating costs of approximately $0.7 million associated with a new plant which is currently being built in Mexico to begin production of certain water products, compliance costs of approximately $0.9 million associated with in Sarbanes/Oxley, amortization expense associated with WTC's definite lived amortizable intangible assets ($0.9 million), lower gross margins associated with the change in sales mix within the potable water market (as noted above) and other increased structural costs discussed above. The results of our foreign operations are heavily dependent on the relationship of their functional currency compared to the U.S. Dollar. We translate our foreign revenue and expense accounts into U.S. Dollars using the average exchange rate for the period. European sales increased 7.1 percent on a local currency basis, while the Euro strengthened approximately 7 percent (average first half of 2005 versus average first half of 2004) - these factors helped to offset increased manufacturing and structural costs in Europe. Sales in Japan were up 17.2 percent on a local currency basis, and the Yen strengthened versus the U.S. Dollar approximately 3 percent period over period. Asia/Pacific sales were up 19.0 percent on a local currency basis, and the Australian Dollar strengthened approximately 3 percent in comparison (approximately 50 percent of our sales in the region are denominated in Australian Dollars). Local currency sales in Latin America increased 3.1 percent, contributing to the modest increase in operating income. FINANCIAL POSITION AND LIQUIDITY We assess liquidity in terms of the Company's ability to generate cash to fund our operating and investing activities. Of particular importance to the management of liquidity are cash flows generated by operating activities, capital expenditure levels, and adequate bank financing alternatives. We manage our worldwide cash requirements considering the cost effectiveness of the funds available from the many subsidiaries through which we conduct our business. We believe that our existing cash and cash equivalents position ($20.7 million at April 30, 2005) and available sources of liquidity (approximately $25 million of available, uncommitted, unused worldwide short-term lines of credit) are sufficient to meet current and anticipated requirements for the foreseeable future. We do not rely on commercial paper or off-balance sheet financing arrangements for our liquidity needs nor do we have any investments in special purpose entities ("SPEs"), or variable interest entities ("VIEs"). 24 We continue to invest in R&D to provide future sources of revenue through the development of new products, as well as through additional uses for existing products. Our efforts are spread across the various markets in which we compete, with particular emphasis on new products and technologies in Healthcare and the improvement in design and function of products within Potable Water. We consider R&D and the development of new products and technologies an integral part of our growth strategy and a core competence of the Company. Likewise, we continue to invest in capital expenditures in order to expand and modernize manufacturing facilities around the globe. We are currently in the process of establishing a manufacturing operation in Mexico to meet product demands in the water market. In addition, new manufacturing lines and processes are being installed in the US to benefit the potable water, fluid processing, and healthcare markets. SUMMARY OF CASH FLOWS FOLLOWS:

Net cash provided by operating activities increased by $7,378 due primarily to: - Increase in deferred income taxes of $3,457 - Decrease in the use of cash for accounts receivable of $7,295 - Decrease in the use of cash for inventories of $2,801 - Increase in the use of cash for accounts payable and accrued expenses of $5,493 Net cash used for investing activities increased by $4,873 due primarily to: - Decrease in cash paid for acquisitions of $554 - Increase in capital expenditures of $5,409 Net cash used for financing activities increased by $7,054 due primarily to: - Increase of $6,302 in the paydown of long term debt in 2005 - Increase of $415 in proceeds from stock option exercises in 2005 The effect of exchange rate changes on cash and cash equivalents of $519 in 2005 reflects the continued weakening of the U.S. Dollar against the Japanese Yen, Euro and Australian Dollar. Contractual Obligations and Commercial Commitments Below is a table detailing, by maturity date, our Contractual Obligations and Commercial Commitments as of October 31, 2004: 25

Also, see fiscal 2005 changes in bank loans and long-term debt detailed on the Consolidated Statements of Cash Flows for the six months ended April 30, 2005. We had no material qualifying long-term purchase obligations at October 31, 2004 and through the interim period in 2005. Our U.S. pension plans require no minimum amount of funding in 2005, however we plan to contribute approximately $3.3 million to our U.S. and Japanese pension plan in fiscal 2005. OTHER INFORMATION Section 404 of the Sarbanes-Oxley Act of 2002 (the "Act") will require the Company to include an internal control report from management in its Annual Report on Form 10-K for the year ended October 31, 2005 and in subsequent reports. The internal control report must include the following: (1) a statement of management's responsibility for establishing and maintaining adequate internal control over financial reporting, (2) a statement identifying the framework used by management to conduct the required evaluation of the effectiveness of the Company's internal control over financial reporting, (3) management's assessment of the effectiveness of the Company's internal control over financial reporting as of October 31, 2005, including a statement as to whether or not internal control over financial reporting is effective, and (4) a statement that the Company's independent auditors have issued an attestation report on management's assessment of internal controls over financial reporting. Management acknowledges its responsibility for establishing and maintaining internal controls over financial reporting and seeks to continually improve those controls. In addition, in order to achieve compliance with Section 404 of the Act within the required time frame, the Company has been conducting a process to document and evaluate its internal controls over financial reporting. In this regard, the Company has dedicated internal resources, engaged outside consultants and adopted a detailed work plan to: (1) assess and document the adequacy of internal controls over financial reporting; (2) take steps to improve control processes where required; (3) validate through testing that controls are functioning as designed; and (4) implement a continuous reporting and improvement process for internal control over financial reporting. The Company believes its process for documenting, evaluating and monitoring its internal control over financial reporting is consistent with the objectives of Section 404 of the Act. Given the risks inherent in the design and operation of internal controls over financial reporting, the Company can provide no assurance as to its, or its independent auditor's, conclusions at October 31, 2005 with respect to the effectiveness of its internal controls over financial reporting. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The overall objective of our financial risk management program is to seek a reduction in the potential negative earnings effects from changes in foreign exchange and interest rates arising from business activities. We manage these financial exposures through operational means and by utilizing available financial instruments. Practices may change as economic conditions change. Foreign Currency Risk Our earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. We utilize forward foreign exchange contracts to hedge specific exposures relating to intercompany payments, certain firm sales commitments and anticipated, but not yet committed, intercompany sales (primarily parent 26 company export sales to subsidiaries at pre-established US dollar prices) and other specific and identified exposures. The terms of the forward foreign exchange contracts are generally matched to the underlying transaction being hedged, and are typically under one year. Because such contracts are directly associated with identified transactions, they are an effective hedge against fluctuations in the value of the foreign currency underlying the transaction. All of our foreign exchange contracts are accounted for at fair value based on readily available market price quotations. We generally do not hedge overseas sales denominated in foreign currencies or translation exposures. Further, we do not enter into financial instruments for speculation or trading purposes. We utilize bank loans and other debt instruments throughout our worldwide operations. To mitigate foreign currency risk, such debt is generally denominated in the underlying local currency of the affiliate. In certain limited and specific circumstances, we will manage risk by denominating a portion of debt outstanding in a currency other than the local currency. ITEM 4. CONTROLS AND PROCEDURES (a) Our Chief Executive Officer and Chief Financial Officer performed an evaluation of our disclosure controls and procedures as of April 30, 2005 (the "Evaluation Date"). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective and sufficient to ensure that the information required to be disclosed in the reports that we file under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms. (b) There have been no significant changes in our internal controls since the Evaluation Date. We are not aware of any significant change in any other factors that could significantly affect our internal controls subsequent to the Evaluation Date. 27 PART II ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) We held our annual meeting of Stockholders on March 3, 2005. (b) The following individuals were nominated and elected to serve a term of three years as Directors: Mr. C. Edward Midgley Mr. Frederick C. Flynn, Jr. (c) The stockholders voted on the following matters: 1. Election of Directors -- the voting results for each nominee, all of whom were reelected, are as follows:

2. A proposal for the reapproval of the performance goals in the Executive Management Incentive Plan was approved by a count of 14,957,019 votes for, 584,472 votes against, 40,684 votes abstaining, and 1,604,362 shares not voted. 3. A proposal for the appointment of PricewaterhouseCoopers LLP as independent auditors was approved by a count of 15,481,179 votes for, 85,472 votes against, 15,524 votes abstaining, 1,604,362 shares not voted. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Documents filed as part of this report. Exhibit 31.1 - Certification of Mark G. Kachur pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 31.2 - Certification of Frederick C. Flynn, Jr. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 32.1 - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 32.2 - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K We filed a Report on Form 8-K, dated February 23, 2005, under "Item 9.01 Financial Statements and Exhibits," reporting our financial results for the quarter ended January 31, 2005. 28 We filed a Report on Form 8-K dated March 28, 2005, under "Item 1.01 Entry into a material Definitive Agreement", disclosing a recent employment agreement with Mark G. Kachur and an amendment to Mark G. Kachur's Termination and Change in Control Agreement. We filed a report on Form 8-K dated May 11, 2005 under "Item 1.01 Entry into a Material Definitive Agreement" and "Item 3.03 Material Modification to Rights of Security Holders", disclosing an Agreement and Plan of Merger with 3M Company and an amendment to CUNO's Rights Agreement with the Compnay's transfer agent. 29 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CUNO INCORPORATED Date May 25, 2005 By /s/ Mark G. Kachur ------------------ Mark G. Kachur Chairman of the Board of Directors, President and Chief Executive Officer By /s/ Frederick C. Flynn, Jr. --------------------------- Frederick C. Flynn, Jr. Senior Vice President - Finance and Administration, Chief Financial Officer and Assistant Secretary 30

CUNO INC 10-Q