UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
Commission File Number 1-13595
Delaware
13-3668641
(State or other jurisdiction of incorporationor organization)
(I.R.S. Employer Identification No.)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12 b-2 of the Exchange Act). Yes X No ____
The Registrant had 41,558,084 shares of Common Stock outstanding at September 30, 2005.
METTLER-TOLEDO INTERNATIONAL INC. INDEX TO QUARTERLY REPORT ON FORM 10-Q
PAGE
PART I. FINANCIAL INFORMATION
PART 2. OTHER INFORMATION
Table of Contents
Item 1. Financial Statements
METTLER-TOLEDO INTERNATIONAL INC.INTERIM CONSOLIDATED STATEMENTS OF OPERATIONSThree months ended September 30, 2005 and 2004(In thousands, except share data)
The accompanying notes are an integral part of these interim consolidated financial statements.
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METTLER-TOLEDO INTERNATIONAL INC.INTERIM CONSOLIDATED STATEMENTS OF OPERATIONSNine months ended September 30, 2005 and 2004(In thousands, except share data)
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$
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METTLER-TOLEDO INTERNATIONAL INC. INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWSNine months ended September 30, 2005 and 2004 (In thousands)
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METTLER-TOLEDO INTERNATIONAL INC. NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS AT SEPTEMBER 30, 2005 - Unaudited(In thousands except share data, unless otherwise stated)
1. BASIS OF PRESENTATION
Mettler-Toledo International Inc. ("Mettler-Toledo" or the "Company") is a global supplier of precision instruments and services. The Company manufactures weighing instruments for use in laboratory, industrial, packaging, logistics and food retailing applications. The Company also manufactures several related analytical instruments, and provides automated chemistry solutions used in drug and chemical compound discovery and development. In addition, the Company manufactures metal detection and other end-of-line inspection systems used in production and packaging, and provides solutions for use in certain process analytics applications. The Company's primary manufacturing facilities are located in Switzerland, the United States, Germany, the United Kingdom and China. The Company's principal executive offices are located in Greifensee, Switzerland.
The accompanying interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and include all entities in which the Company has control, which are its majority owned subsidiaries. The interim consolidated financial statements have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The interim consolidated financial statements as of September 30, 2005 and for the three and nine month periods ended September 30, 2005 and 2004 should be read in conjunction with the December 31, 2004 and 2003 consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2004.
The accompanying interim consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair statement of the results of the interim periods presented. Operating results for the three and nine months ended September 30, 2005 are not necessarily indicative of the results to be expected for the full year ending December 31, 2005.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, as well as disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates. A discussion of the Company's critical accounting policies is included in Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's Annual Report on Form 10-K for the year ended December 31, 2004.
Certain reclassifications have been made to prior year amounts to conform to the current year presentation.
Inventories
Inventories are valued at the lower of cost or net realizable value. Cost, which includes direct materials, labor and overhead, is generally determined using the first in, first out (FIFO) method. The estimated net realizable value is based on assumptions for future demand and related pricing. Reserves for excess and obsolete inventories are established based on forecast usage, orders and technological obsolescence.
Inventories consisted of the following at September 30, 2005 and December 31, 2004:
Other Intangible Assets
Other intangible assets include indefinite lived assets and assets subject to amortization. Where applicable, amortization is charged on a straight-line basis over the expected period to be benefited. The Company assesses the initial acquisition of intangible assets and the continued accounting for previously recognized intangible assets and goodwill in accordance with SFAS No. 142 "Goodwill and Other Intangible Assets."
Other intangible assets consisted of the following at September 30, 2005 and December 31, 2004.
Accumulated amortization
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19,905
The annual aggregate amortization expense based on the current balance of other intangible assets is estimated at $4.2 million for each of the next five years. The Company had amortization expense associated with the above intangible assets of $3.1 million and $2.7 million for the nine months ended September 30, 2005 and 2004, respectively.
As of December 31, 2004, the Company's intangible assets included a $19.9 million indefinite life intangible asset relating to an intellectual property license. This license was previously subject to litigation with the grantor and on June 6, 2005 the Company was ordered to pay $0.6 million in damages and the respective intellectual property license was terminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Other Intangible Assets (continued)
Due to the cancellation of the license, the Company has concluded that the intangible asset has no future benefit and as such during the second quarter has written-off the total value of the asset, $19.9 million ($12 million after tax). This charge has been included as a component of Other charges (income), net within the Statement of Operations. See further discussion within Note 8, Other Charges (Income), Net.
During the third quarter, the Company has appealed the trial court decision. The Company believes that the consequences of the case will not have a material adverse effect on its consolidated financial condition or results of operations. In 2004, the Company had $13.9 million in sales of these third party-manufactured pipettes in the U.S. which had declined 28% since 2001. The Company expects to minimize any impact to its sales and profitability by increasing the sales of its own higher margin pipettes, including those the Company already manufactures and sells outside the United States.
Stock Based Compensation
The Company applies the intrinsic valuation methodology under Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock option plan.
Had compensation cost for the Company's stock option plan been determined based upon the fair value of such awards at the grant date, consistent with the methods of Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation," the Company's net earnings and basic and diluted net earnings per common share for the three and nine month periods ended September 30 would have been as follows:
Warranty
The Company generally offers one-year warranties on most of its products. Product warranties are recorded at the time revenue is recognized for certain product shipments. While the Company engages in extensive product quality programs and processes, our warranty obligation is affected by product failure rates, material usage and service costs incurred in correcting a product failure.
The Company's accrual for product warranties is included in accrued and other liabilities in the consolidated balance sheet. Changes to the Company's accrual for product warranties for the nine months ended September 30 are as follows:
Research and Development
Research and development costs primarily consist of salaries, consulting and other costs. The Company expenses these costs as incurred.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board ("FASB") issued FASB Statement No. 123R, "Share-Based Payment" ("SFAS 123R"). SFAS 123R replaces FASB Statement No. 123, "Accounting for Stock-Based Compensation", and supersedes Accounting Principles Board Opinion No. 25 ("APB25"), "Accounting for Stock Issued to Employees." SFAS 123R requires public companies to recognize the cost of employee services received in exchange for an award (with limited exceptions) over the period during which an employee is required to provide service in exchange for the award. Disclosure of the effect of expensing the fair value of equity compensation is currently required under SFAS 123 (see Stock Based Compensation within Footnote 2) by continuing to apply the guidance in APB25. On April 15, 2005, the Securities and Exchange Commission issued a release that delayed the implementation of SFAS 123R to annual periods beginning after June 15, 2005. The Company has assessed the impact of adopting SFAS 123R in 2006. Based upon existing information, the Company estimates its share based compensation arrangements will reduce 2006 net income between $5 million and $6 million or approximately $0.13 per share.
3. INCOME TAXES
In December 2004, the FASB issued FASB Staff Position No. 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" ("FSP 109-2"), which provides guidance under SFAS No. 109, "Accounting for Income Taxes" ("SFAS 109"), with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the "Jobs Act") on enterprises' income tax expense and deferred tax liability. The Jobs Act was enacted on October 22, 2004 and creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS 109.
As a result of the Jobs Act, the Company intends to repatriate approximately $400 million of cash by December 31, 2005 that has been generated over time by its foreign operations of which approximately $160 million was repatriated during the quarter ended September 30, 2005. As a result of this planned repatriation, the Company recorded additional income tax expense during the quarter ended September 30, 2005 of $13.1 million. This amount reflects the federal tax impact in the United States (including certain state taxes) of $12.3 million, foreign withholding taxes of $2.0 million and a net decrease of $1.2 million of deferred tax liabilities associated with the reassessment of pre-existing and future dividend repatriations.
In addition, during the quarter ended September 30, 2005 the Company recorded tax benefits of $7.7 million related to the favorable resolution of certain tax matters. The net impact of the items described above has increased the effective tax rate for the three months ended September 30, 2005 to 42.2%.
The Company currently benefits from tax holidays in certain jurisdictions. These holidays expire at various dates in the future, and may or may not be renewable. Management does not believe that potential changes in tax benefits from existing tax holidays will have a material adverse effect on the Company's financial condition or results of operations.
4. BUSINESS COMBINATIONS
The Company spent approximately $4 million during the nine months ended September 30, 2005 on acquisitions. Goodwill recognized in connection with these acquisition payments totaled $1.6 million. The Company accounted for the acquisition payments using the purchase method of accounting.
The terms of certain of our acquisitions provide for possible additional earn-out payments. The Company does not currently believe we will make any material payments relating to such earn-outs. However, any additional earn-out payments incurred will be treated as additional purchase price, accounted for using the purchase method of accounting and classified as additional goodwill.
5. TREASURY STOCK
On February 5, 2004, the Company announced a share repurchase program, commencing with an initial buyback of up to $100 million over the two-year period ending December 31, 2005. In November 2004, in addition to the $100 million buyback amount the Company's Board of Directors approved an additional buyback of up to $200 million under its share repurchase program over the two-year period ending December 31, 2006. Our share repurchases are expected to be funded from cash generated from operating activities. Repurchases will be made through open market transactions, and the timing will depend on the level of acquisition activity, business and market conditions, the stock price, trading restrictions and other factors.
The Company spent $106.7 million and $60.1 million on the repurchase of 2,181,800 shares and 1,349,400 shares at an average price of $48.89 and $44.50 during the nine months ended September 30, 2005 and 2004, respectively, as well as an additional $1.4 million during the nine month period ended September 30, 2005 relating to the settlement of shares repurchased as of December 31, 2004. See Part II Item 2 regarding details of the share repurchase program for the nine months ended September 30, 2005. The Company reissued 367,945 shares and 282,891 shares held in treasury for the exercise of stock options for the nine months ended September 30, 2005 and 2004, respectively.
As of September 30, 2005, approximately 1.0 million stock options were outstanding that are scheduled to expire in October 2006, including 867,000 stock options held by the Company's Chairman and CEO. These options were granted before the Company's initial public offering in connection with the buy-out from Ciba-Geigy. The Company expects that these options will be exercised before their expiration date. Any purchases under the share repurchase program described above would offset the dilution from these future option exercises.
6. EARNINGS PER COMMON SHARE
In accordance with the treasury stock method, the Company has included the following common equivalent shares in the calculation of diluted weighted average common shares outstanding for the three and nine month periods ended September 30, relating to outstanding stock options.
Outstanding options to purchase 0 and 1,140,450 shares of common stock for the three month periods ended September 30, 2005 and 2004, respectively, and options to purchase 169,500 and 998,417 shares of common stock for the nine month periods ended September 30, 2005 and 2004, respectively, have been excluded from the calculation of diluted weighted average number of common shares on the grounds that such options would be anti-dilutive.
7. NET PERIODIC BENEFIT COST
Net periodic cost for the Company's defined benefit pension plans and U.S. post-retirement medical plan includes the following components for the three months ended September 30:
2004
Net periodic cost for the Company's defined benefit pension plans and U.S. post-retirement medical plan includes the following components for the nine months ended September 30:
As previously disclosed in the Company's annual report on Form 10-K for the year ended December 31, 2004, the Company expects to make normal employer pension contributions of approximately $11.9 million to its non-U.S. defined benefit pension plans and $2.8 million to its U.S. post-retirement medical plan during the year ended December 31, 2005.
8. OTHER CHARGES (INCOME), NET
Other charges (income), net consists primarily of charges related to interest income, (gains) losses from foreign currency transactions, (gains) losses from sales of assets and other items.
For the nine months ended September 30, 2005, other charges (income), net includes a $21.8 million charge related to pipette litigation. In June of 2005, the Company wrote-off a non-cash $19.9 million ($12 million after-tax) intangible asset relating to an intellectual property license that was subject to litigation with the grantor which is included as a component of Other and Deferred taxes in the interim consolidated statements of cash flows. This license enabled a wholly owned subsidiary of the Company exclusive rights to distribute certain third-party manufactured pipettes in the United States. A judgment entered on June 6, 2005 terminated the license agreement and awarded damages to the other party. The Company also incurred $1.9 million of related legal costs during the three months ended June 30, 2005, which includes damages of $0.6 million due to the grantor.
9. SEGMENT REPORTING
As disclosed in Note 16 to the Company's consolidated financial statements for the year ending December 31, 2004, operating segments are the individual reporting units within the Company. These units are managed separately, and it is at this level where the determination of resource allocation is made. The units have been aggregated based on operating segments in geographic regions that have similar economic characteristics and meet the aggregation criteria of SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). The Company has updated the geographic aggregation of its segments as of March 31, 2005 and has determined there are five reportable segments: U.S. Operations, Swiss Operations, Western European Operations, Chinese Operations and Other. Prior year segment information has been restated to conform with the current period presentation.
The Company evaluates segment performance based on Segment Profit (gross profit less research and development, selling, general and administrative expenses before amortization, interest expense and other charges).
The following tables show the operations of the Company's operating segments:
For the three months ended September 30, 2005
For the nine months ended September 30, 2005
Footnotes on the following page
9. SEGMENT REPORTING (Continued)
For the three months ended September 30, 2004
For the nine months ended September 30, 2004
A reconciliation of Adjusted Operating Income, or Segment Profit, to net earnings for the three and nine months ended September 30 follows:
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10. RELATED PARTY TRANSACTIONS
As part of the Rainin acquisition, the Company entered into an agreement to lease certain property from the former owner and current General Manager of Rainin. During the three and nine months ended September 30, 2005 and 2004, the Company made lease payments in respect of this agreement of $0.6 million and $0.5 million, respectively, and $1.9 million and $1.6 million, respectively. In addition, Rainin purchased certain products from its former owner. During both the three and nine months ended September 30, 2004, the volume of these purchases was $0.2 million. The agreement to purchase these products was terminated during the third quarter of 2004. This termination did not have a material impact on the Company's consolidated financial statements. All of the Company's transactions with the former owner of Rainin were in the normal course of business.
11. CONTINGENCIES
The company is party to various legal proceedings, including certain environmental matters, incidental to the normal course of business. Management does not expect that any of such proceedings will have a material adverse effect on the Company's financial condition, results of operations or cash flows.
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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Unaudited Interim Consolidated Financial Statements included herein.
General
Our interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America on a basis which reflects the interim consolidated financial statements of Mettler-Toledo International Inc. Operating results for the three and nine months ended September 30, 2005 are not necessarily indicative of the results to be expected for the full year ending December 31, 2005.
Results of Operations - Consolidated
The following table sets forth certain items from our interim consolidated statements of operations for the three and nine month periods ended September 30, 2005 and 2004 (amounts in thousands).
Note:
Net sales
Net sales were $365.4 million and $1,071.2 million, respectively, for the three and nine months ended September 30, 2005, compared to $342.0 million and $1,005.2 million for the corresponding periods in 2004. This represents an increase in U.S. dollars of 7% for both the three and nine months ended September 30, 2005, of which 0% and 2% was due to currency exchange rate fluctuations for the three and nine month periods then ended.
During the three and nine months ended September 30, 2005, our net sales by geographic destination excluding the effect of currency exchange rate fluctuations, or in local currencies, increased by 5% in the Americas, by 7% and 3% in Europe and by 11% and 10% in Asia/Rest of World. A discussion of sales by operating segment is included below.
As described in Note 16 to our consolidated financial statements for the year ending December 31, 2004, our net sales comprise product sales of precision instruments and related services. Service revenues are primarily derived from regulatory compliance qualification, calibration, certification and repair services, much of which is provided under separately priced contracts, as well as sales of spare parts.
Net sales of products increased in U.S. dollars by 7% and 6% during the three and nine months ended September 30, 2005 compared to the corresponding periods in 2004, of which 1% was due to currency exchange rate fluctuations for the nine month period then ended. Service revenue (including spare parts) increased in U.S. dollars by 6% and 7% during the three and nine months ended September 30, 2005 compared to the corresponding periods in 2004, of which 1% and 2% were due to currency exchange rate fluctuations for the three and nine month periods then ended, respectively.
Net sales for our laboratory-related products increased 3% in local currencies during the three and nine months ended September 30, 2005, principally driven by continued growth in our drug discovery instruments. We also experienced growth in process analytics and analytical instruments during the three months ended September 30, 2005. Our sales growth of laboratory-related products was also reduced by approximately 1% for the three and nine months ended September 30, 2005 due to the exit of our third party electronic component sales.
Net sales of our industrial-related products increased 9% and 7% in local currencies, respectively, for the three and nine months ended September 30, 2005. We experienced increased transportation and logistics project activity, as well as continued sales growth in our core industrial and product inspection products.
In our food retailing markets, net sales increased 14% and 3% in local currencies, respectively, during the three months and nine months ended September 30, 2005. The increase for the three months ended September 30, 2005 is due to increased sales across all geographic regions particularly in the U.S. and Europe related to strong project activity. Retail sales also continue to experience improved sales growth of our in-store retail item management software solutions.
Gross profit
Gross profit as a percentage of net sales was 49.0% and 48.8% for the three and nine months ended September 30, 2005, compared to 48.5% and 48.1% for the corresponding periods in 2004.
Gross profit as a percentage of net sales for products was 52.9% for both the three and nine months ended September 30, 2005, compared to 52.3% and 52.0% for the corresponding period in 2004.
Gross profit as a percentage of net sales for services (including spare parts) was 35.9% and 35.2% for the three and nine months ended September 30, 2005, compared to 36.0% and 35.3% for the corresponding period in 2004.
The increase in gross profit reflects benefits from our sales volume, leveraging our fixed production costs, as well as the impact of increased pricing. These trends were offset in part by unfavorable product mix.
Research and development and selling, general and administrative expenses
Research and development expenses decreased 4% and 2%, in local currencies, during the three and nine months ended September 30, 2005, compared to the corresponding periods in 2004. The decrease reflects the timing of projects in the prior year comparable period, as well as our desire to reallocate research and development resources to marketing.
Selling, general and administrative expenses increased 4% and 5%, in local currencies during the three and nine months ended September 30, 2005, compared to the corresponding periods in 2004. This is due in part to sales and marketing investments in China as well as other promotional activities. The three and nine months ended September 30, 2004 also includes $2.7 million ($1.9 million after-tax) and $3.9 million ($2.7 million after-tax) of costs related to an investigation into allegations made by an employee with respect to the Company and various company processes.
Interest expense, other charges (income) net, taxes and net earnings
Interest expense was $4.0 million and $11.3 million for the three and nine months ended September 30, 2005 and $2.9 million and $9.6 million for the corresponding periods in 2004. The increase is due to higher interest rates in 2005 over the comparable period in 2004 combined with an increase in the Company's borrowings.
Other charges (income), net consists primarily of charges related to interest income, (gains) losses from foreign currency transactions, (gains) losses from sales of assets and other items. For the nine months ended September 30, 2005, other charges (income), net also includes a $21.8 million charge related to pipette litigation. The Company wrote-off a $19.9 million intangible asset relating to an intellectual property license that was subject to litigation with the grantor in June 2005. This license enabled a wholly owned subsidiary of the Company exclusive rights to distribute certain third-party manufactured pipettes in the United States. A judgment entered on June 6, 2005 terminated the license agreement and awarded damages to the other party. The Company also incurred $1.9 million of related legal costs during the three months ended June 30, 2005, which includes damages of $0.6 million. During the third quarter, the Company has appealed the trial court decision. The Company believes that the consequences of the case will not have a material adverse effect on its consolidated financial condition or results of operations. In 2004, the Company had $13.9 million in sales of these third party-manufactured pipettes in the U.S. which had declined 28% since 2001. The Company expects to minimize any impact to its sales and profitability by increasing the sales of its own higher margin pipettes, including those the Company already manufactures and sells outside the United States.
The provision for taxes is based upon our projected annual effective tax rate for the related periods. During the three months ended September 30, 2005 the Company recorded two tax items discrete to the quarter consisting of a charge of approximately $13.1 million relating to the impact of earnings repatriation associated with the American Jobs Creation Act of 2004 (net of certain benefits associated with the reduction of previously established deferred liabilities on remitted earnings), and a tax benefit of approximately $7.7 million relating to the favorable resolution of certain tax matters. Our tax rate for the nine months ended September 30, 2005 also includes a tax benefit associated with the previously described pipette litigation. Excluding the tax effects of the previously described earnings repatriation, tax audit settlements and pipette litigation, the Company's annual effective tax rate is currently expected to be approximately 30% for 2005. Including these items, the Company's annual effective tax rate is currently estimated at 32.1%.
Net earnings were $25.6 million and $64.7 million during the three and nine months ended September 30, 2005. The three months ended September 30, 2005 included a net $5.4 million expense related to the two tax items described above. The nine months ended September 30, 2005 also included a one-time $13.1 million charge related to the pipette litigation described above. Net earnings of $24.6 million and $71.7 million during the three and nine months ended September 30, 2004 included $1.9 million and $2.7 million, respectively, related to the investigation costs described above. The increase in net earnings excluding these items reflects improved sales volume in 2005 and the benefits from our cost rationalization initiatives.
Non-GAAP Financial Measures
We supplement our U.S. GAAP results with non-GAAP financial measures. The principal non-GAAP financial measure we use is Adjusted Operating Income which we define as gross profit less research and development, selling, general and administrative expenses and restructuring charges, before amortization, interest, other charges and taxes. The most directly comparable U.S. GAAP financial measure is net earnings.
We believe that Adjusted Operating Income is important supplemental information for investors. Adjusted Operating Income is used internally as the principal profit measurement by our segments in their reporting to management. We use this measure because it excludes amortization, interest, other charges and taxes, which are not allocated to the segments.
On a consolidated basis, we also believe Adjusted Operating Income is an important supplemental method of measuring profitability. It is used internally by senior management for measuring profitability, setting performance targets for managers and has historically been used as one of the means of publicly providing guidance on possible future results. We also believe that Adjusted Operating Income is an important performance measure because it provides a measure of comparability to other companies with different capital or legal structures, which accordingly may be subject to disparate interest rates and effective tax rates, and to companies which may incur different amortization expenses or impairment charges related to intangible assets.
Adjusted Operating Income is used in addition to and in conjunction with results presented in accordance with U.S. GAAP. Adjusted Operating Income is not intended to represent operating income under U.S. GAAP and should not be considered as an alternative to net earnings as an indicator of our performance because of the following limitations.
Limitations of our non-GAAP measure, Adjusted Operating Income
Our non-GAAP measure, Adjusted Operating Income, has certain material limitations as follows:
Adjusted Operating Income should not be relied upon to the exclusion of U.S. GAAP financial measures, but reflects an additional measure of comparability and means of viewing aspects of our operations that, when viewed together with our U.S. GAAP results and the accompanying reconciliation to net earnings, provides a more complete understanding of factors and trends affecting our business.
Because Adjusted Operating Income is not standardized, it may not be possible to compare with other companies' non-GAAP financial measures having the same or a similar name. We strongly encourage investors to review our financial statements and publicly filed reports in their entirety and not to rely on any single financial measure.
Our Adjusted Operating Income increased 17% and 11% during the three and nine months ended September 30, 2005 compared to the corresponding periods in 2004 excluding the previous year investigation related costs. These increases reflect improved sales volume in 2005 and the benefits from our cost rationalization initiatives. This performance was achieved while we continued to invest in sales and marketing and our field service infrastructure.
Results of Operations - by Operating Segment
U.S. Operations
The increase in total net sales reflects improved sales to external customers across most product lines for the nine months ended September 30, 2005. Net sales growth to external customers for the three months ended September 30, 2005 also included particularly strong results in our retail products due to significant project activity as well as continued growth of our in-store retail item management software.
Segment profit or Adjusted Operating Income increased 4% for the three and nine months ended September 30, 2005 compared to the corresponding periods in 2004. The increase was primarily due to increased sales volume offset in part by unfavorable product mix. We also continue to experience losses in our drug discovery business.
Swiss Operations
Total net sales in local currency increased 1% and 0% for the three and nine month periods ended September 30, 2005, respectively. Net sales to external customers in local currency decreased 2% and 6% for the same periods versus the prior year comparable period. The exit of our third party electronic component product line reduced total net sales by approximately 2% for both the three and nine months ended September 30, 2005. The decrease in sales to external customers relates primarily to a reduction in laboratory-related sales due to significant project activity during the prior year comparable periods. This decrease was partially offset by an increase in our food retailing products due to significant project activity during the three months ended September 30, 2005.
The increase in segment profit or Adjusted Operating Income primarily reflects benefits from our cost rationalization initiatives as well as favorable changes in foreign currency translation fluctuations.
Western European Operations
Total net sales increased 10% and 5% in local currency for the three and nine months ended September 30, 2005. Net sales in local currency to external customers increased 7% and 3% for the three and nine month periods compared to the corresponding periods in 2004 primarily due to improved market conditions in the major European economies. Sales growth was particularly strong in our industrial-related and food retailing products. We also experienced improved growth in our laboratory-related products during the three months ended September 30, 2005.
The increase in segment profit or Adjusted Operating Income is principally a result of increased net sales, benefits from our cost rationalization initiatives and favorable currency translation fluctuations.
Chinese Operations
Total net sales in local currency increased 13% and 9% for the three and nine months ended September 30, 2005. This reflects a 13% and 12% increase in local currency net sales to external customers for the three and nine months ended September 30, 2005 as compared to the corresponding periods in 2004. These increases were due to continued sales growth for all product lines, in particular industrial-related products. However, we note the Chinese government has stated it is seeking to slow their economy.
The increase in segment profit or Adjusted Operating Income is primarily due to the continued improvement in sales volume and leveraging our fixed production costs.
Other
Total net sales and net sales to external customers increased 7% and 9% in local currency for the three and nine months ended September 30, 2005 compared to the previous year comparable period. This performance reflects increased sales in our Other Asian Pacific, Eastern European and Other North American markets.
Segment profit or Adjusted Operating Income increased during the three months ended September 30, 2005 primarily due to the continued improvement in sales volume and our cost rationalization initiatives.
Liquidity and Capital Resources
Liquidity is our ability to generate sufficient cash flows from operating activities to meet our obligations and commitments. In addition, liquidity includes the ability to obtain appropriate financing. Currently, our liquidity needs arise primarily from working capital requirements, capital expenditures, share repurchases and acquisitions. In 2005, we have also increased our debt balance in Europe and our cash balance in the United States as a result of our foreign earnings repatriation associated with the American Jobs Creation Act of 2004.
Cash provided by operating activities totaled $117.6 million in the nine months ended September 30, 2005, compared to $121.9 million in the corresponding period in 2004. The decrease in 2005 resulted principally from approximately $15 million of higher payments relating to 2004 performance related compensation incentives (bonus payments) in the nine months ended September 30, 2005 compared to the corresponding period in 2004. This decrease was partially offset by the improved operating results during the nine months ended September 30, 2005 compared to the corresponding period in 2004.
The Company spent approximately $4 million on acquisitions during the nine months ended September 30, 2005. We continue to explore other potential acquisitions. In connection with any acquisition, we may incur additional indebtedness. In addition, the terms of certain of our acquisitions provide for possible additional earn-out payments. However, we do not currently believe we will make any material payments relating to such earn-outs.
Capital expenditures are a significant use of funds and are made primarily for investments in information systems and technology, machinery, equipment and the purchase and expansion of facilities. Our capital expenditures totaled $21.0 million for the nine months ended September 30, 2005 compared to $17.5 million in the corresponding period in 2004. The increase is due primarily to timing. However, we expect capital expenditures to increase as our business grows, and to fluctuate as currency exchange rates change.
Senior Notes and Credit Facility Agreement
Our short-term borrowings and long-term debt consisted of the following at September 30, 2005.
As of September 30, 2005, we had $217.0 million of availability remaining under our credit facility. Changes in exchange rates between the currencies in which we generate cash flows and the currencies in which our borrowings are denominated affect our liquidity. In addition, because we borrow in a variety of currencies, our debt balances fluctuate due to changes in exchange rates.
We currently believe that cash flow from operating activities, together with liquidity available under our credit facility and local working capital facilities, will be sufficient to fund currently anticipated working capital needs and capital spending requirements. However, the Company is currently in negotiation to refinance and amend the existing revolving credit agreement in order to provide greater flexibility. This agreement would increase the borrowing capacity from $300 million to $450 million while the other terms of the facility are not expected to change significantly. The Company expects to enter into the amended agreement during the fourth quarter of 2005.
Share repurchase program
On February 5, 2004, the Company announced a share repurchase program, commencing with an initial buyback of up to $100 million over the two-year period ending December 31, 2005. In November 2004, in addition to the $100 million buyback amount, the Company's Board of Directors approved an additional buyback of up to $200 million under its share repurchase program over the two-year period ending December 31, 2006. Our share repurchases are expected to be funded from cash generated from operating activities. Repurchases will be made through open market transactions, and the timing will depend on the level of acquisition activity, business and market conditions, the stock price, trading restrictions and other factors.
As of September 30, 2005, approximately 1.0 million stock options were outstanding that are scheduled to expire in October 2006, including 867,000 stock options held by the Company's Chairman and CEO. These options were granted before the Company's initial public offering in connection with the buy-out from Ciba-Geigy. The Company expects that these options will be exercised before their expiration date. Any purchases under the share repurchase program described above would operate to offset the dilution from these option exercises.
Effect of Currency on Results of Operations
Because we conduct operations in many countries, our operating income can be significantly affected by fluctuations in currency exchange rates. Swiss franc-denominated expenses represent a much greater percentage of our operating expenses than Swiss franc-denominated sales represent of our net sales. In part, this is because most of our manufacturing costs in Switzerland relate to products that are sold outside Switzerland. Moreover, a substantial percentage of our research and development expenses and general and administrative expenses are incurred in Switzerland. Therefore, if the Swiss franc strengthens against all or most of our major trading currencies (e.g., the U.S. dollar, the euro, other major European currencies and the Japanese yen), our operating profit is reduced. We also have significantly more sales in European currencies (other than the Swiss franc) than we have expenses in those currencies. Therefore, when European currencies weaken against the U.S. dollar and the Swiss franc, it also decreases our operating profits. Accordingly, the Swiss franc exchange rate to the euro is an important cross-rate monitored by the Company. We estimate that a 1% strengthening of the Swiss franc against the euro would result in a decrease in our earnings before tax of approximately $1 million on an annual basis. In addition to the effects of exchange rate movements on operating profits, our debt levels can fluctuate due to changes in exchange rates, particularly between the U.S. dollar and the Swiss franc. Based on our outstanding debt at September 30, 2005, we estimate that a 10% weakening of the U.S. dollar against the currencies in which our debt is denominated would result in an increase of approximately $8.7 million in the reported U.S. dollar value of the debt.
See Note 2 to the interim consolidated financial statements.
Forward-Looking Statements and Associated Risks
Some of the statements in this quarterly report constitute "forward-looking statements" within the meaning of Section 27A of the U.S. Securities Act of 1933 and Section 21E of the U.S. Securities Exchange Act of 1934. These statements relate to future events or our future financial performance, including, but not limited to, strategic plans, annual amortization expense, outcome of litigation, effect of potential loss of licensed rights, potential growth opportunities in both developed markets and emerging markets, planned research and development efforts, product introductions and innovation, manufacturing capacity, expected customer demand, meeting customer expectations, planned operational changes and productivity improvements, research and development expenditures, competitors' product development, expected capital expenditures, source of funding, method and timing of share repurchases, timing and effect of potential exercises of options, future cash sources and requirements, liquidity, impact of taxes, impact of changes in tax laws, expected compliance with laws, impact of environmental costs and environmental proceedings, expected pension contribution, expected cost savings and benefits of completed or future acquisitions, which involve known and unknown risks, impact of currency fluctuations, uncertainties and other factors that may cause our or our businesses' actual results, levels of activity, performance or achievements to be materially different from those expressed or implied by any forward-looking statements.
In some cases, you can identify forward-looking statements by terminology such as "may," "will," "could," "would," "should," "expect," "plan," "anticipate," "intend," "believe," "estimate," "predict," "potential" or "continue" or the negative of those terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially because of market conditions in our industries or other factors. Moreover, we do not, nor does any other person, assume responsibility for the accuracy and completeness of those statements. Unless otherwise required by applicable laws, we disclaim any intention or obligation to publicly update or revise any of the forward-looking statements after the date of this quarterly report to conform them to actual results, whether as a result of new information, future events, or otherwise. All of the forward-looking statements are qualified in their entirety by reference to the factors discussed under the caption, "Factors affecting our future operating results" in Part I, Item 1 of our Annual Report on Form 10-K for the year ended December 31, 2004, which describes risks and factors that could cause results to differ materially from those projected in those forward-looking statements.
We caution the reader that the above list of risks and factors that may affect results addressed in the forward-looking statements may not be exhaustive. Other sections of this quarterly report and other documents incorporated by reference may describe additional risks or factors that could adversely impact our business and financial performance. We operate in a continually changing business environment, and new risk factors emerge from time to time. Management cannot predict these new risk factors, nor can it assess the impact, if any, of these new risk factors on our businesses or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those projected in any forward-looking statements. Accordingly, forward-looking statements should not be relied upon as a prediction of actual results.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As of September 30, 2005, there was no material change in the information provided under Item 7A in the Company's Annual Report on Form 10-K for the year ended December 31, 2004.
Item 4. Controls and Procedures
Our management carried out an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report under the supervision and with the participation of our disclosure committee, our CFO and CEO. Based upon that evaluation, our CFO and CEO concluded that our disclosure controls and procedures are effective in permitting us to comply with our disclosure obligations and ensure that the material information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. There were no changes in our internal controls over financial reporting during the nine months ended September 30, 2005 that have materially affected, or are reasonably likely to materially affect, our controls over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. None
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.
Issuer Purchases of Equity Securities
The Company has only one share repurchase program. Under this program, announced on February 5, 2004 and November 4, 2004, the Company is authorized to buy back up to $100 million of equity shares over the two-year period ending December 31, 2005, and an additional $200 million of equity shares over the two-year period ending December 31, 2006.
The Company spent $106.7 million and $60.1 million on the repurchase of 2,181,800 shares and 1,349,400 shares at an average price of $48.89 and $44.50 during the nine months ended September 30, 2005 and 2004, respectively, as well as an additional $1.4 million during the nine month period ended September 30, 2005, relating to the settlement of shares repurchased as of December 31, 2004. The Company reissued 367,945 shares and 282,891 shares held in treasury for the exercise of stock options for the nine months ended September 30, 2005 and 2004, respectively.
Item 3. Defaults Upon Senior Securities. None
Item 4. Submission of Matters to a Vote of Security Holders. None
Item 5. Other Information. None
Item 6. Exhibits and Reports on Form 8-K
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