Summary of PALL CORP - Yahoo! Finance

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

The following discussion should be read together with the accompanying consolidated financial statements and notes thereto and other financial information in this Form 10-K. The discussion under the subheading "Review of Operating Segments" below is in local currency (i.e., had exchange rates not changed year over year) unless otherwise indicated. Company management considers local currency change to be an important measure because by excluding the impact of volatility of exchange rates, underlying volume change is clearer. Dollar amounts discussed below are in thousands, unless otherwise indicated, except per share dollar amounts. In addition, per share dollar amounts are discussed on a diluted basis. The Company utilizes certain estimates and assumptions that affect the reported financial information as well as to quantify the impact of various significant factors that contribute to the changes in the Company's periodic results included in the discussion below. Forward-Looking Statements and Risk Factors The matters discussed in this Annual Report on Form 10-K contain "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that address activities, events or developments that the Company or management intends, expects, projects, believes or anticipates will or may occur in the future. All statements regarding future performance, earnings projections, earnings guidance, management's expectations about its future cash needs and effective tax rate, and other future events or developments are forward-looking statements. Forward-looking statements contained in this and other written and oral reports are based on management's assumptions and assessments in light of past experience and trends, current conditions, expected future developments and other relevant factors. They are subject to risks and uncertainties and are not guarantees of future performance, and actual results, developments and business decisions may differ materially from those envisaged by the Company's forward-looking statements. Such risks and uncertainties include, but are not limited to, those discussed in Part I-Item 1A.-Risk Factors in this Form 10-K. The Company makes these statements as of the date of this disclosure and undertakes no obligation to update them, whether as a result of new information, future developments or otherwise.
Critical Accounting Policies and Estimates The Company's accompanying consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). These accounting principles require the Company to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the accompanying consolidated financial statements, as well as the reported amounts of revenues and expenses during the periods presented. Although these estimates are based on management's knowledge of current events and actions the Company may undertake in the future, actual results may differ from estimates. The following discussion addresses the Company's critical accounting policies, which are those that are most important to the portrayal of the Company's financial condition and results, and that require judgment. See also the notes to the accompanying consolidated financial statements, which contain additional information regarding the Company's accounting policies. Income Taxes
Significant judgment is required in determining the worldwide provision for income taxes. In the ordinary course of a global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of revenue sharing and cost reimbursement arrangements among related entities, the process of identifying items of revenue and expense that qualify for preferential tax treatment and appropriate segregation of foreign and domestic income and expense to avoid double taxation. No assurance can be given that the final tax outcome of these matters will not be different than that which is reflected in the Company's historical income tax provisions and accruals. Such differences could have a material effect on the Company's income tax provision and net earnings in the period in which a final determination is made.
The Company records a valuation allowance to reduce deferred tax assets to the amount of the future tax benefit that is more likely than not to be realized. While Company management has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, there is no assurance that the valuation allowance would not need to be increased to cover additional deferred tax assets that may not be realizable. Any increase in the valuation allowance could have a material adverse impact on the Company's income tax provision and net earnings in the period in which such determination is made.

Purchase Accounting and Goodwill
Determining the fair value of assets acquired and liabilities assumed in a business combination is judgmental in nature and often involves the use of significant estimates and assumptions. There are various methods used to estimate the value of tangible and intangible assets acquired, such as discounted cash flow and market multiple approaches. Some of the more significant estimates and assumptions inherent in the two approaches include:
projected future cash flows (including timing); discount rates reflecting the risk inherent in the future cash flows; perpetual growth rate; determination of appropriate market comparables; and the determination of whether a premium or a discount should be applied to comparables. There are also judgments made to determine the expected useful lives assigned to each class of assets acquired and liabilities assumed.
The Company performs impairment testing for goodwill at least annually during the Company's fiscal third quarter, or more frequently if certain events or circumstances indicate impairment might have occurred. The Company evaluates the recoverability of goodwill using a two-step impairment test approach at the reporting unit level. The Company's two reportable operating segments, Life Sciences and Industrial, are also deemed to be its reporting units for purposes of testing goodwill for impairment. In the first step, the overall fair value for the reporting unit is compared to its book value including goodwill. In the event that the overall fair value of the reporting unit was determined to be less than the book value, a second step is performed which compares the implied fair value of the reporting unit's goodwill to the book value of the goodwill. The implied fair value for the goodwill is determined based on the difference between the overall fair value of the reporting unit and the fair value of the net identifiable assets. If the implied fair value of the goodwill is less than its book value, the difference is recognized as an impairment loss. The Company completed its annual goodwill impairment tests as of March 1, 2012 and March 1, 2011. The estimated fair values of both the Life Sciences and Industrial reporting units substantially exceeded the carrying values of these reporting units, and as such, step two was not performed.
When testing for impairment, the Company uses significant estimates and assumptions to estimate the fair values of its reporting units. Fair value of the Company's reporting units is determined using market multiples (derived from trailing-twelve-month revenue, earnings before interest and taxes ("EBIT") and earnings before interest, taxes, depreciation and amortization ("EBITDA")), of publicly traded companies with similar operating and investment characteristics as the Company's reporting units. These various market multiples are applied to the operating performance of the reporting unit being tested to determine a range of fair values for the reporting unit. The fair value of the reporting units for the purposes of the goodwill impairment test is then determined using the average of the fair values derived from the minimum and median market multiples.
The minimum and median market multiples used in the fiscal year 2012 impairment testing ranged from 1.2 to 2.4 times revenue, 6.9 to 12.1 times EBIT and 5.8 to 9.2 times EBITDA. The minimum and median market multiples used in the fiscal year 2011 impairment testing ranged from 1.4 to 2.6 times revenue, 7.0 to 14.8 times EBIT and 6.5 to 10.6 times EBITDA. To further substantiate the reasonableness of the fair value of its reporting units, the Company compares enterprise value (outstanding shares multiplied by the closing market price per share, plus debt, less cash and cash equivalents) to the aggregate fair value of its reporting units.
Revenue Recognition
Revenue is recognized when title and risk of loss have transferred to the customer and when contractual terms have been fulfilled, except for certain long-term contracts, whereby revenue is recognized under the percentage of completion method (see below). Transfer of title and risk of loss occurs when the product is delivered in accordance with the contractual shipping terms. In instances where contractual terms include a provision for customer acceptance, revenue is recognized when either (i) the Company has previously demonstrated that the product meets the specified criteria based on either seller or customer-specified objective criteria or (ii) upon formal acceptance received from the customer where the product has not been previously demonstrated to meet customer-specified objective criteria.
For contracts accounted for under the percentage of completion method, revenue recognition is based upon the ratio of costs incurred to date compared with estimated total costs to complete. The cumulative impact of revisions to total estimated costs is reflected in the period of the change, including anticipated losses.
Allowance for Doubtful Accounts
Company management evaluates its ability to collect outstanding receivables and provide allowances when collection becomes doubtful. In performing this evaluation, significant estimates are involved, including an analysis of specific risks on a customer-by-customer basis. Based upon this information, Company management records in earnings an amount believed to be uncollectible. If the factors used to estimate the allowance provided for doubtful accounts do not reflect the future ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed and the future results of operations could be materially affected.

Inventories
Inventories are valued at the lower of cost (principally on the first-in, first-out method) or market. The Company records adjustments to the carrying value of inventory based upon assumptions about historic usage, future demand and market conditions. These adjustments are estimates which could vary significantly, either favorably or unfavorably, from actual requirements if future conditions, customer inventory levels or competitive conditions differ from the Company's expectations.
Recoverability of Available-for-Sale Investments Other than temporary losses relating to available-for-sale investments are recognized in earnings when Company management determines that the recoverability of the cost of the investment is unlikely. Such losses could result in a material adjustment in the period of the change. Company management considers numerous factors, on a case-by-case basis, in evaluating whether the decline in market value of an available-for-sale security below cost is other than temporary. Such factors include, but are not limited to, (i) the length of time and the extent to which the market value has been less than cost; (ii) the financial condition and the near-term prospects of the issuer of the investment; and (iii) whether Company management intends to retain the investment for a period of time that is sufficient to allow for any anticipated recovery in market value.
Defined Benefit Retirement Plans
The Company sponsors defined benefit retirement plans in various forms covering substantially all employees who meet eligibility requirements. Several statistical and other factors that attempt to anticipate future events are used in calculating the expense and liabilities related to those plans for which the benefit is actuarially determined. These factors include assumptions about the discount rate, expected return on plan assets and rate of future compensation increases as determined by the Company, within certain guidelines. In addition, the Company's actuarial consultants also use subjective factors, such as withdrawal and mortality rates, to calculate the liabilities and expense. The actuarial assumptions used by the Company are long-term assumptions and may differ materially from actual experience in the short-term due to changing market and economic conditions and changing participant demographics. These differences may have a significant effect on the amount of pension expense and pension assets/ (liabilities) recorded by the Company.
Pension expense associated with the Company's defined benefit plans was $35,188 in fiscal year 2012, which was based on a weighted average discount rate of 4.94% (calculated using the projected benefit obligation) and a weighted average expected long-term rate of return on plan assets of 6.25% (calculated using the fair value of plan assets).
The expected rates of return on the various defined benefit pension plans' assets are based on the asset allocation of each plan and the long-term projected return of those assets. If the expected long-term rate of return on plan assets was reduced by 50 basis points, pension expense in fiscal year 2012 would have increased approximately $2,000.
The objective of the discount rate assumption is to reflect the rate at which the pension benefits could be effectively settled. The Company's methodology for selecting the discount rate for the U.S. plans as of July 31, 2012 was to match the plan's cash flows to that of a yield curve that provides the equivalent yields on zero-coupon corporate bonds for each maturity. This is under the premise that cash flows for benefits due in a particular year can be theoretically "settled" by "investing" them in the zero-coupon bond that matures in the same year. The discount rate is the single rate that produces the same present value of cash flows. The discount rate assumption for non-U.S. plans reflects the market rate for high-quality, fixed-income debt instruments. Both discount rate assumptions are based on the expected duration of benefit payments for each of the Company's pension plans as of the annual measurement date and is subject to change each year. If the weighted average discount rate was reduced by 50 basis points, pension expense in fiscal year 2012 would have increased by approximately $2,900.
Accrued Expenses and Contingencies
Company management estimates certain material expenses in an effort to record those expenses in the period incurred. When no estimate in a given range is deemed to be better than any other, the low end of the range is accrued. Differences between estimates and assumptions and actual results could result in an accrual requirement materially different from the calculated accrual. Environmental accruals are recorded based upon historical costs incurred and estimates for future costs of remediation and on going legal expenses which have a high degree of uncertainty.
Self-insured workers' compensation insurance accruals are recorded based on insurance claims processed, including applied loss development factors as well as historical claims experience for claims incurred but not yet reported. Self-insured employee medical insurance accruals are recorded based on medical claims processed as well as historical medical claims experience for claims incurred but not yet reported.

Market Reorganization
Effective in the second quarter of fiscal year 2012, the Company reorganized its Industrial markets. The Machinery & Equipment submarket (previously part of the Aeropower market) and Energy & Water are now combined and are reported as the Process Technologies market. With the exclusion of Machinery & Equipment from Aeropower, Aerospace is now the stand-alone descriptor for that part of the business. Sales information by market for prior periods has been restated to reflect these changes. All discussions and amounts reported in this filing are based on the reorganized structure.
Discontinued Operations
On April 28, 2012, the Company entered into an asset purchase agreement ("APA") to sell certain assets of its blood collection, filtration and processing product line (the "Product Line") to Haemonetics Corporation ("Haemonetics") for approximately $550,000. The transaction involved the transfer of manufacturing facilities and equipment in Covina, California; Tijuana, Mexico; Ascoli, Italy and a portion of the Company's operations in Fajardo, Puerto Rico. The sale closed on August 1, 2012, and approximately 1,400 employees transitioned to Haemonetics at that time. In addition to the manufacturing facilities and related equipment, the Company transferred Product Line related inventory and intangible assets. Haemonetics also assumed certain employee related liabilities.
Separate from these manufacturing facilities, the Company also agreed to transfer related blood media manufacturing capabilities and assets to Haemonetics. The transfer of the related media manufacturing lines is expected to be completed by calendar year 2016. Until that time, the Company will provide these media products under a supply agreement. Under the terms of the APA, approximately $535,000 was paid upon closing, with the balance of the purchase price payable upon the Company's delivery of the aforementioned blood media manufacturing capability and related assets. Final determination of cash proceeds, gain on sale and tax impact are subject to working capital and certain other adjustments and final allocation of proceeds by jurisdiction. The Product Line, which was a component of the Company's Life Sciences segment, met the criteria for discontinued operations and held for sale presentation during the third quarter of fiscal year 2012. As such, it has been reported as a discontinued operation in the Company's consolidated financial statements. The Company did not allocate any portion of the Company's interest expense to discontinued operations. Furthermore, Life Sciences and Industrial segment profit have been restated to reflect a change in the allocation of certain shared expenses on a continuing operations basis. Results of Operations 2012 Compared with 2011 Review of Consolidated Results from Continuing Operations Sales in fiscal year 2012 increased 6.1% to $2.7 billion from $2.5 billion in fiscal year 2011. Exchange rates used to translate foreign subsidiary results into U.S. Dollars reduced reported sales by $26,718 primarily related to the strengthening of the U.S. Dollar against the Euro, partly offset by the weakening of the U.S. Dollar against the the Japanese Yen ("JPY") and the Chinese Renminbi. In local currency, sales increased 7.2%.
Life Sciences segment sales increased 7.3% (in local currency), while Industrial segment sales grew 7.1% (in local currency). For a detailed discussion of sales by segment, refer to the section "Review of Operating Segments Results From Continuing Operations" below.
Consumable filtration products sales (including appurtenant hardware) increased 6.2% (in local currency) reflecting growth of 7.0% in Life Sciences and 5.5% in Industrial. Increased pricing contributed $17,733, or about 80 basis points, to consumables sales growth in the year, reflecting increases in both segments. Systems sales increased 13.4% (in local currency) reflecting growth of 10.5% in Life Sciences and 14.8% in Industrial. Systems sales represented 14.2% of total sales in fiscal year 2012 compared to 13.6% in fiscal year 2011. Sales in emerging markets grew approximately 18% in fiscal year 2012, and represented approximately 20% of total sales. Emerging markets are defined as high growth and/or developing areas of the world in which the Company has focused growth resources. In the Americas, emerging markets include Latin America, primarily the countries of Brazil, Argentina and Mexico. In Europe, emerging markets include Eastern European countries, primarily Russia, Turkey and Poland, as well as various countries in the Middle East and Africa. In Asia, emerging markets primarily include the countries of China, India, Philippines, Indonesia and Vietnam.

Gross margin in fiscal year 2012 increased 70 basis points to 51.7% from 51.0% in fiscal year 2011. This reflects an increase in gross margin in the Life Sciences and Industrial segments of 130 basis points and 10 basis points, respectively. For a detailed discussion of the factors impacting gross margin by segment, refer to the section "Review of Operating Segments Results From Continuing Operations" below.
The Company has risks to gross margin from the fluctuation of the costs of products that are sourced in a currency different than the currency they are sold in (transactional impact). With the Company's current manufacturing footprint, a significant portion of products purchased by the Company in the Eurozone are sourced outside of the Eurozone. Sales in the Eurozone are approximately 25% of total Company sales. About 70% of the cost of goods on those sales are denominated in British Pounds or U.S. Dollars.The Company currently estimates that the transactional impact of a 5% fluctuation in the U.S. Dollar or the British Pound relationship to the Euro would impact the Company's consolidated gross margin by a range of approximately 40-60 basis points on an annualized basis. On average, in fiscal year 2012, the Euro was 1.32 against the U.S. Dollar and was 0.84 against the British Pound, which was a 5% and 4% depreciation, respectively, compared to the average rates in fiscal year 2011. The average Euro rate in the first half of fiscal year 2012 was stronger when compared to the first half of fiscal year 2011; however, this was more than offset by a weakening of the Euro in the second half of fiscal year 2012 when compared to the second half of fiscal year 2011.
Selling, general and administrative ("SG&A") expenses in fiscal year 2012 increased by $52,942, or 6.7% (approximately $62,000, or 8%, in local currency). These increases are reflected in both segments and in the Corporate Services Group. Selling expenses increased about 2%, while General and administrative ("G&A") expenses increased approximately 13%. In addition to inflationary increases in payroll and related costs affecting both selling and G&A expenses, the overall increase in SG&A (in local currency) year over year primarily reflects:
� project related costs in information technology, including incremental costs incurred as the Company concluded the last significant phase of its global ERP system implementation,

� increased expenses driven by resource deployment related to regional expansion in Latin America (including incremental costs related to an acquisition in Brazil (selling and G&A), impacting both segments), Middle East and Asia, impacting both segments,

� incremental costs related to the acquisition of ForteBio (selling and G&A), impacting Life Sciences, and

� costs related to bringing Industrial into the European and Asian hubs.

These increases were partly offset by savings realized from the Company's cost reduction programs.
As a percentage of sales, SG&A expenses were 31.6% compared to 31.4% in fiscal year 2011. The selling and G&A expense components of SG&A as a percentage of sales were as follows:
� selling expenses were 17.3% compared to 18.0% in fiscal year 2011, and

� G&A expenses were 14.2% compared to 13.4% in fiscal year 2011.

For a discussion of SG&A by business, refer to the section "Review of Operating Segments Results From Continuing Operations" below.
Research and development ("R&D") expenses were $82,932 in fiscal year 2012 compared to $80,506 in fiscal year 2011, an increase of $2,426, or 3.0% (approximately $3,000, or 4% in local currency). The increase in R&D expenses in local currency reflects increased spending in the Life Sciences segment partly offset by a decline in the Industrial segment. As a percentage of sales, R&D expenses were 3.1% compared to 3.2% in fiscal year 2011. For a discussion of R&D expenses by business, refer to the section "Review of Operating Segments Results From Continuing Operations" below.
In fiscal year 2012, the Company recorded restructuring and other charges ("ROTC") of $66,858 primarily comprised of severance, professional fees and other costs related to the Company's structural cost improvement initiatives, as well as charges related to certain employment contract obligations. Such costs were partly offset by the gain on sale of assets. The Company is targeting to achieve $100 million in structural cost improvements over the next three fiscal years, and expects to accomplish approximately 50% of this in fiscal year 2013. The cash outflow related to the costs to implement the structural cost improvements are estimated to be approximately $30-$40 million in fiscal year 2013.
In fiscal year 2011, the Company recorded ROTC of $26,505 primarily comprised of severance, professional fees and other costs related to the Company's cost reduction initiatives. Furthermore, ROTC includes costs related to certain employment contract obligations and an increase to previously established environmental reserves. These costs were partly offset by the receipt of insurance claim payments. The severance costs recorded in fiscal year 2011 relate to the closure of a manufacturing facility.

The details of ROTC for the years ended July 31, 2012 and July 31, 2011 as well as the activity related to restructuring liabilities that were recorded in those years can be found in Note 2, Restructuring and Other Charges, Net, to the accompanying consolidated financial statements.
Earnings before interest and income taxes ("EBIT") were $387,087 in fiscal year 2012, essentially flat compared to $387,622 in fiscal year 2011. The year over year comparison of EBIT was negatively impacted by the increase in ROTC as discussed above. The impact of foreign currency translation had an immaterial impact on EBIT in fiscal year 2012. As a percentage of sales, EBIT were 14.5% compared to 15.4% in fiscal year 2011.
Net interest expense in fiscal year 2012 was $20,177 compared to $18,903 in fiscal year 2011. Net interest expense in fiscal year 2012 reflects the reversal of $4,435 of accrued interest primarily related to the resolution of U.S. tax audits. Net interest expense in fiscal year 2011 reflects the net reversal of $6,184 of accrued interest primarily related to the resolution of U.S. tax audits, partially offset by an interest accrual related to foreign tax matters. Excluding these items, net interest expense decreased $475 compared to fiscal year 2011.
The Company's effective tax rate for fiscal years 2012 and 2011 was 23.4% and 24.3%, respectively. The effective tax rate for fiscal year 2011 reflects a tax benefit from the resolution of a U.S. tax audit partly offset by tax costs associated with the repatriation of foreign earnings and the establishment of the Company's Asian headquarters in Singapore. Excluding these impacts, as well as the impacts of ROTC and interest discussed above, the effective tax rate for fiscal years 2012 and 2011 would have been 23.2% and 26.5%, respectively. This decrease reflects tax benefits associated with the Company's Asian headquarters in Singapore and the expansion of the Company's European headquarters in Switzerland.
Net earnings from continuing operations in fiscal year 2012 were $280,947, or . . .