SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10 - Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 2003
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ____________
Commission File Number 1-2299
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APPLIED INDUSTRIAL TECHNOLOGIES, INC.
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(Exact name of registrant as specified in its charter)
Ohio 34-0117420
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
One Applied Plaza, Cleveland, Ohio 44115
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (216) 426-4000
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(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 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 12b-2 of the Exchange Act).
Yes X No
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Shares of common stock outstanding on April 30, 2003 18,960,802
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(No par value)
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
INDEX
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Page No.
Part I: FINANCIAL INFORMATION
Item 1: Financial Statements
Condensed Statements of Consolidated Income - 2
Three Months and Nine Months Ended
March 31, 2003 and 2002
Condensed Consolidated Balance Sheets - 3
March 31, 2003 and June 30, 2002
Condensed Statements of Consolidated Cash Flows - 4
Nine Months Ended March 31, 2003 and 2002
Notes to Condensed Consolidated Financial Statements 5-10
Review By Independent Public Accountants 11
Item 2: Management's Discussion and Analysis of 12-16
Financial Condition and Results of Operations
Item 3: Quantitative and Qualitative Disclosures About Market Risk 17
Item 4: Controls and Procedures 18
Part II: OTHER INFORMATION
Item 1: Legal Proceedings 19
Item 6: Exhibits and Reports on Form 8-K 19
Signatures 21
Certifications of Disclosure 22-24
Exhibit Index
Exhibits
PART I: FINANCIAL INFORMATION
ITEM I: Financial Statements
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
(Thousands, except per share amounts)
--------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
March 31 March 31
2003 2002 2003 2002
-------- -------- ---------- ----------
Net Sales $368,203 $361,542 $1,091,929 $1,077,082
Cost of sales 270,471 269,672 813,104 805,768
-------- -------- ---------- ----------
Gross Profit 97,732 91,870 278,825 271,314
Selling, distribution and
administrative expenses 87,578 86,037 253,507 249,337
-------- -------- ---------- ----------
Operating Income 10,154 5,833 25,318 21,977
Interest expense, net 1,295 1,378 3,898 5,025
Other, net 1,966 58 2,292 (142)
-------- -------- ---------- ----------
Income Before Income Taxes 6,893 4,397 19,128 17,094
Income tax expense 2,510 1,690 6,980 6,580
-------- -------- ---------- ----------
Income Before Cumulative Effect of
Accounting Change 4,383 2,707 12,148 10,514
Cumulative effect of accounting change (12,100)
-------- -------- ---------- ----------
Net Income (Loss) $ 4,383 $ 2,707 $ 12,148 $ (1,586)
======== ======== ========== ==========
Earnings (Loss) Per Share - Basic
Before cumulative effect of accounting change $ 0.23 $ 0.14 $ 0.64 $ 0.55
Cumulative effect of accounting change (0.63)
-------- -------- ---------- ----------
Net Income (Loss) $ 0.23 $ 0.14 $ 0.64 $ (0.08)
======== ======== ========== ==========
Earnings (Loss) Per Share - Diluted
Before cumulative effect of accounting change $ 0.23 $ 0.14 $ 0.63 $ 0.54
Cumulative effect of accounting change (0.63)
-------- -------- ---------- ----------
Net Income (Loss) $ 0.23 $ 0.14 $ 0.63 $ (0.09)
======== ======== ========== ==========
Cash dividends per common share $ 0.12 $ 0.12 $ 0.36 $ 0.36
======== ======== ========== ==========
Weighted average common shares
outstanding for basic computation 18,833 18,960 18,935 19,096
Dilutive effect of stock based options
and awards 257 303 287 329
-------- -------- ---------- ----------
Weighted average common shares
outstanding for diluted computation 19,090 19,263 19,222 19,425
======== ======== ========== ==========
See notes to condensed consolidated financial statements.
2
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Amounts in thousands)
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March 31 June 30
2003 2002
------------- -------------
ASSETS
Current assets
Cash and temporary investments $ 23,925 $ 23,060
Accounts receivable, less allowances
of $6,200 and $5,600 178,689 180,904
Inventories (at LIFO) 171,463 166,083
Other current assets 10,374 11,011
------------ -------------
Total current assets 384,451 381,058
Property, less accumulated depreciation
of $83,949 and $81,229 79,136 83,095
Goodwill 50,587 46,410
Other assets 21,954 24,003
------------ -------------
TOTAL ASSETS $ 536,128 $ 534,566
============ =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 79,560 $ 76,316
Other accrued liabilities 51,611 54,098
------------ -------------
Total current liabilities 131,171 130,414
Long-term debt 78,756 83,478
Other liabilities 26,262 22,527
------------ -------------
TOTAL LIABILITIES 236,189 236,419
------------ -------------
Shareholders' Equity
Preferred stock - no par value; 2,500
shares authorized; none issued or
outstanding
Common stock - no par value; 50,000
shares authorized; 24,096 shares issued 10,000 10,000
Additional paid-in capital 84,445 84,517
Income retained for use in the business 284,317 279,046
Treasury shares - at cost, 5,170 and 4,893 shares (80,153) (74,900)
Unearned restricted common stock compensation (259) (832)
Accumulated other comprehensive income 1,589 316
------------ -------------
TOTAL SHAREHOLDERS' EQUITY 299,939 298,147
------------ -------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 536,128 $ 534,566
============ =============
See notes to condensed consolidated financial statements.
3
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
(Amounts in thousands)
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Nine Months Ended
March 31
2003 2002
---------- ----------
Cash Flows from Operating Activities
Net income $ 12,148 $ (1,586)
Adjustments to reconcile net income to cash provided by
operating activities:
Cumulative effect of accounting change 12,100
Depreciation and amortization 11,371 13,452
Gain on sale of property (2,702) (466)
Changes in operating assets and liabilities, net of
effects from acquisition of businesses 7,765 21,077
Other - net 2,295 2,154
--------- ----------
Net Cash provided by Operating Activities 30,877 46,731
--------- ----------
Cash Flows from Investing Activities
Property purchases (9,348) (7,703)
Proceeds from property sales 5,947 1,829
Net cash paid for acquisition of businesses (10,255) (2,574)
Deposits and other 1,579 360
--------- ----------
Net Cash used in Investing Activities (12,077) (8,088)
--------- ----------
Cash Flows from Financing Activities
Borrowings and repayments under revolving credit
agreements - net (5,055)
Long-term debt repayments (5,714) (5,714)
Proceeds from termination of interest rate swap 2,517 2,038
Dividends paid (6,877) (6,966)
Purchases of treasury shares (9,872) (13,738)
Other 2,011 1,524
--------- ----------
Net Cash used in Financing Activities (17,935) (27,911)
--------- ----------
Increase in cash and temporary
investments 865 10,732
Cash and temporary investments
at beginning of period 23,060 13,981
--------- ----------
Cash and Temporary Investments
at End of Period $ 23,925 $ 24,713
========= ==========
See notes to condensed consolidated financial statements.
4
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts)
(Unaudited)
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1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the instructions to Form 10-Q and
therefore do not include all information and footnotes necessary for a
fair presentation of financial position, results of operations and cash
flows in conformity with generally accepted accounting principles.
However, in the opinion of management, all adjustments (consisting of
only normal recurring adjustments) necessary to a fair statement of
operations of the interim periods have been made. This Quarterly Report
on Form 10-Q should be read in conjunction with the Company's Annual
Report on Form 10-K for the year ended June 30, 2002.
The results of operations for the three and nine month periods ended
March 31, 2003 are not necessarily indicative of the results to be
expected for the fiscal year.
Cost of sales for interim financial statements are computed using
estimated gross profit percentages which are adjusted throughout the
year based upon available information. Adjustments to actual cost are
made based on periodic physical inventories and the effect of year-end
inventory quantities on LIFO costs.
Sales are recognized when products are shipped or delivered to a
customer, which is when title is transferred to the customer. Products
are billed at agreed upon prices. The Company's experience is that
collection of receivables recorded for all sales is reasonably assured.
2. SEGMENT INFORMATION
The accounting policies of the Company's reportable segment and its
other businesses are the same as those used to prepare the condensed
consolidated financial statements. Certain reclassifications have been
made to prior year amounts to be consistent with the presentation in
the current year. Sales between the service center based distribution
segment and the other businesses are not significant. Operating results
are in the United States, Canada, Mexico and Puerto Rico. Operations in
Canada, Mexico and Puerto Rico represent approximately 6.9% of the
total net sales of Applied for the nine months ended March 31, 2003 and
therefore are not presented separately. In addition, approximately
30.3% of these operations' net sales are included in the "Other" column
relating to the fluid power business. The long-lived assets located
outside of the United States are not material.
5
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts)
(Unaudited)
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SEGMENT FINANCIAL INFORMATION:
SERVICE CENTER
BASED DISTRIBUTION OTHER TOTAL
-------------------- ----------- ----------
THREE MONTHS ENDED MARCH 31, 2003
Net sales $347,719 $20,484 $368,203
Operating income (loss) 10,528 (699) 9,829
Depreciation 3,404 189 3,593
Capital expenditures 4,202 97 4,299
--------------- ----------- -----------
THREE MONTHS ENDED MARCH 31, 2002
Net sales $340,189 $21,353 $361,542
Operating income (loss) 7,829 (1,228) 6,601
Depreciation 3,585 131 3,716
Capital expenditures 1,812 19 1,831
--------------- ----------- -----------
A reconciliation from the segment operating profit to the condensed consolidated
balances is as follows:
THREE MONTHS ENDED
MARCH 31
----------------------------
2003 2002
------------ -----------
Operating income for
reportable segment $10,528 $ 7,829
Other operating income (loss) (699) (1,228)
Adjustments for:
Other intangible amortization (184) (351)
Corporate and other income (expense),
net of allocations (a) 509 (417)
----------- ----------
Total operating income 10,154 5,833
Interest expense, net 1,295 1,378
Other expense, net 1,966 58
----------- ----------
Income before income taxes $ 6,893 $ 4,397
=========== ==========
SERVICE CENTER
BASED DISTRIBUTION OTHER TOTAL
-------------------- ----------- ----------
NINE MONTHS ENDED MARCH 31, 2003
Net sales $1,025,912 $66,017 $1,091,929
Operating income (loss) 28,414 (626) 27,788
Assets used in the business 512,596 23,532 536,128
Depreciation 10,169 582 10,751
Capital expenditures 8,922 426 9,348
---------- ------ ----------
6
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts)
(Unaudited)
--------------------------------------------------------------------------------
SERVICE CENTER
BASED DISTRIBUTION OTHER TOTAL
-------------------- ----------- ----------
NINE MONTHS ENDED MARCH 31, 2002
Net sales $1,008,640 $68,442 $1,077,082
Operating income (loss) 18,057 (2,307) 15,750
Assets used in the business 524,696 28,867 553,563
Depreciation 11,263 424 11,687
Capital expenditures 7,535 168 7,703
---------- ----------- ----------
A reconciliation from the segment operating profit to the condensed consolidated
balances is as follows:
NINE MONTHS ENDED
MARCH 31
-----------------------
2003 2002
---------- -----------
Operating income for
reportable segment $28,414 $18,057
Other operating income (loss) (626) (2,307)
Adjustments for:
Other intangible amortization (601) (1,312)
Corporate and other income, net of
allocations (a) (1,869) 7,539
------ ------
Total operating income 25,318 21,977
Interest expense, net 3,898 5,025
Other expense (income), net 2,292 (142)
------ ------
Income before income taxes $19,128 $17,094
======= =======
(a) The change in corporate and other income (expense), net, is due to
various changes in the levels and amounts of expense being allocated to
the segments. The expenses being allocated include corporate charges
for working capital, logistics support and other items.
7
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
--------------------------------------------------------------------------------
3. DERIVATIVE INSTRUMENTS
In August 2002, the Company terminated a November 2001 interest rate
swap agreement for a favorable settlement of $2,517. This gain is being
amortized as a reduction in interest expense over the remaining life of
the Company's $50,000 6.6% senior unsecured term notes, which mature in
December 2007.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") 142, "Goodwill and Other
Intangible Assets." Effective July 1, 2001, the Company adopted this
standard. Under SFAS 142, goodwill is no longer amortized, but is
tested for impairment upon adoption and at least annually thereafter.
The Company's other intangible assets relate to non-competition
agreements and continue to be amortized over the lives of the
agreements which are primarily five years. Upon adoption of SFAS 142, a
non-cash charge totaling $17,600, $12,100 after tax, was retroactively
recorded as a change in accounting principle effective July 1, 2001 to
write-off the remaining goodwill relating to acquired fluid power
businesses. The Company has established January 1 as its annual
impairment testing date. The test as of January 1, 2003 resulted in no
additional impairment of goodwill required to be recorded at this time.
5. BUSINESS COMBINATION
In October 2002, the Company acquired assets from a Canadian
distributor of industrial products for approximately $12,000. The
results of the acquired business operations are included in our service
center based distribution segment from the acquisition date. Results of
operations for this acquisition are not material for all periods
presented. Goodwill and non-compete agreements, based on preliminary
allocations of fair values to assets and liabilities acquired, of
$4,300 were recognized in connection with the acquisition. The Company
has not yet completed its evaluation of other potential intangible
assets in accordance with SFAS 141.
6. NEW ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board issued SFAS
144, "Accounting for Impairment or Disposals of Long-Lived Assets". The
Company adopted SFAS 144 as of July 1, 2002. The adoption of SFAS 144
did not have a material impact on the consolidated financial
statements.
8
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
--------------------------------------------------------------------------------
In June 2002, the Financial Accounting Standards Board issued SFAS 146,
"Accounting for Costs Associated with Exit or Disposal Activities".
This statement is effective for exit or disposal activities that are
initiated after December 31, 2002, but earlier adoption is permitted.
The Company adopted SFAS 146 effective July 1, 2002. The adoption of
this statement did not have a material impact on the consolidated
statements.
In December 2002, the Financial Accounting Standards Board issued
Interpretation No. (FIN) 45, "Guarantor's Accounting and Disclosure
Requirements". FIN 45 requires the disclosure of any guarantees in
place at December 31, 2002 and the recognition of a liability for any
guarantees entered into or modified after that date. The Company is a
guarantor in three arrangements entered into prior to December 31, 2002
that require disclosure under FIN 45 as follows:
o The Company has a construction and lease facility under which a
distribution center and several service centers were constructed
by the lessor and leased to the Company under operating lease
arrangements. These leases expire in September 2003 and permit
the Company to purchase the facilities for $7,500. If the Company
does not exercise this option, residual value guarantee
provisions obligate the Company to compensate the lessor for up
to $6,000 at lease termination depending on the properties'
market values at that time. Due to the nature of the guarantee,
the Company has not recorded any liability on the financial
statements.
o In connection with the construction and lease of its corporate
headquarters facility, the Company has guaranteed repayment of a
total of $5,678 of taxable development revenue bonds issued by
Cuyahoga County and the Cleveland-Cuyahoga County Port Authority.
These bonds were issued with a 20-year term and are scheduled to
mature in March 2016. Any default, as defined in the guaranty
agreements, would obligate Applied for the full amount of the
outstanding bonds through maturity. Due to the nature of the
guarantee, the Company has not recorded any liability on the
financial statements.
o The Company also has guaranteed, under an agreement scheduled to
expire in December 2003, a related entity's repayment of
borrowings under a line of credit. This guarantee was entered
into to induce a financial institution to provide a line of
credit for a joint venture, iSource Performance Materials L.L.C.
(iSource), of which the Company is a minority owner. iSource is a
certified minority-owned distributor of standard-use industrial
specialty and general maintenance items requiring special
shipping and handling. Any default, as defined in the guaranty
agreement, will obligate the Company for any unpaid balance under
the line of credit up to a maximum of $3,000.
9
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts)
(Unaudited)
--------------------------------------------------------------------------------
In the event of a default and subsequent payout under any or all of
these guarantees, the Company maintains the right to pursue all legal
options available to mitigate its exposure.
In December 2002, the Financial Accounting Standards Board issued SFAS
148, "Accounting for Stock-Based Compensation - Transition and
Disclosure". The impact of this statement on the Company's current
accounting policies was to amend the disclosure requirements of SFAS
123, "Accounting for Stock-Based Compensation" and require additional
disclosure in the Company's quarterly financial statements. The Company
adopted SFAS 148 effective January 1, 2003. The following table
discloses the compensation expense and net income had the Company
adopted SFAS 123:
Three Months Ended March 31 Nine Months Ended March 31
------------------------------- ------------------------------
2003 2002 2003 2002
----------- ------------- ---------- ------------
Net income (loss), as reported $4,383 $2,707 $12,148 $(1,586)
Less: Total stock-based employee compensation
expense determined under fair value based
method, net of tax 335 336 978 1,051
----------- ------------- ---------- ------------
Pro forma net income (loss) $4,048 $2,371 $11,170 $(2,637)
=========== ============= ========== ============
Earnings (loss) per share:
Basic - as reported $ 0.23 $ 0.14 $ 0.64 $ (0.08)
=========== ============= ========== ============
Basic - pro forma $ 0.21 $ 0.13 $ 0.59 $ (0.14)
=========== ============= ========== ============
Diluted - as reported $ 0.23 $ 0.14 $ 0.63 $ (0.09)
=========== ============= ========== ============
Diluted - pro forma $ 0.21 $ 0.12 $ 0.58 $ (0.14)
=========== ============= ========== ============
In January 2003, the Financial Accounting Standards Board issued FIN
46, "Consolidation of Variable Interest Entities". As disclosed above,
the Company is a minority owner in iSource and has guaranteed iSource's
line of credit debt up to $3,000. iSource maintains assets of
approximately $3,700. The Company's purchases currently account for
more than 90% of iSource's sales and the Company is considered the
primary beneficiary of iSource's operations. Accordingly, iSource's
financial statements will be consolidated with the Company's beginning
in July 2003 in accordance with the effective date of FIN 46. It is
expected that the effect on the Company's consolidated financial
statements will be immaterial.
7. OTHER
During the quarter, the Company recorded a liability of $1,700 to
provide for potential losses on investments and advances for iSource.
This estimate of losses will be revised based upon iSource's ability to
generate profitable operations in the future.
10
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
REVIEW BY INDEPENDENT PUBLIC ACCOUNTANTS
--------------------------------------------------------------------------------
The condensed consolidated balance sheet of the Company as of March 31, 2003,
and the related condensed statements of consolidated income and cash flows for
the three-month and nine-month periods ended March 31, 2003 and 2002, have been
reviewed by the Company's independent accountants, Deloitte & Touche LLP, whose
report covering their review of the financial statements follows.
INDEPENDENT ACCOUNTANTS' REPORT
Applied Industrial Technologies, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of
Applied Industrial Technologies, Inc. and subsidiaries (the "Company") as of
March 31, 2003, and the related condensed statements of consolidated income and
cash flows for the three-month and six-month periods ended March 31, 2003 and
2002. These financial statements are the responsibility of the Company's
management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and of making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Applied Industrial Technologies, Inc. and subsidiaries as of June 30, 2002, and
the related statements of consolidated income, shareholders' equity, and cash
flows for the year then ended (not presented herein); and in our report dated
August 6, 2002, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of June 30, 2002 is fairly
stated, in all material respects, in relation to the consolidated balance sheet
from which it has been derived.
/s/ Deloitte & Touche LLP
Cleveland, Ohio
May 9, 2003
11
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
The following is Management's Discussion and Analysis of certain significant
factors which have affected the Company's (1) financial condition at March 31,
2003 and June 30, 2002, and (2) results of operations and cash flows during the
periods included in the accompanying Condensed Statements of Consolidated Income
and Consolidated Cash Flows.
Introduction
The Company is one of North America's leading distributors of industrial and
fluid power products. Due to the struggling economy, sales and earnings for the
year ended June 30, 2002 were below that of the previous year. The industrial
economy remains weak, with no significant rebound expected during the fourth
quarter of fiscal 2003. Recent improvements from actions taken to improve
margins and reduce costs should, however, result in improved profitability
during the quarter and year ending June 30, 2003 compared with the same periods
last year.
Liquidity and Capital Resources
Cash provided by operating activities was $30.9 million in the nine months ended
March 31, 2003. This compares to $46.7 million provided by operating activities
in the same period a year ago.
Cash flow from operations depends primarily upon generating operating income,
controlling the investment in inventories and receivables, and managing the
timing of payments to suppliers. The Company has continued to monitor and
control its investments in inventories and receivables by taking advantage of
various vendor purchasing programs and through the use of system enhancements to
improve inventory tracking and collection efforts. During the nine month period
ended March 31, 2003, inventories increased approximately $5.4 million including
$4.3 million relative to the acquisition of certain assets of Industrial
Equipment Co. Ltd. (IECO) but has decreased $10.3 million from December 31,
2002. Inventory levels are expected to trend down during the last quarter of the
fiscal year to near June 30, 2002 levels. Net of the acquisition, accounts
receivable decreased $3.3 million due to improved collections, and accounts
payable increased $2.8 million due to timing of trade payments for the nine
months ended March 31, 2003. Capital expenditures, consisting primarily of
computer hardware and software, were $9.3 million for the nine months ended
March 31, 2003. For the entire year we expect our total capital expenditures to
be within a range of $11.0 million to $13.0 million. Our depreciation and
amortization for the entire year is expected to be approximately $15.0 million.
The Company has a committed revolving credit agreement expiring in November 2003
with a group of banks. This agreement provides for unsecured borrowings of up to
$150.0 million. The Company is currently exploring options to replace this
facility and expects to have a replacement facility in place before the current
facility expires. The Company had no borrowings outstanding under this facility
at March 31, 2003. The Company also has a $10.0 million short-term uncommitted
line of credit with a commercial bank that expires October 2003. The Company
12
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
had no borrowings outstanding under this facility at March 31, 2003. Unused
lines under these facilities, net of outstanding letters of credit, totaling
$154.8 million are available to fund future acquisitions or other capital and
operating requirements. Other long-term financing agreements are in place to
borrow up to $100.0 million at the Company's discretion.
During the quarter ended December 31, 2002, the Company made the final scheduled
long-term debt repayment of $5.7 million on 7.82% senior unsecured term notes.
No other long-term debt repayments are scheduled until December 2007.
In August 2002, the Company terminated an interest rate swap agreement for a
favorable settlement of $2.5 million. This gain is being amortized as a
reduction in interest expense over the remaining life of the Company's $50.0
million 6.6% senior unsecured term notes, which mature in full in December 2007.
At March 31, 2003, the Company had $25.0 million of private placement debt
outstanding that was entered into to refinance a portion of the debt incurred in
connection with its June 2000 Canadian acquisition. The full $25.0 million is
due at maturity in November 2010. The Company has mitigated the interest expense
associated with its debt as well as the foreign currency exposure though the use
of interest rate and cross currency swaps.
The Board of Directors has authorized the purchase of shares of the Company's
common stock to fund employee benefit programs, stock option and award programs,
and future business acquisitions. These purchases are made in open market and
negotiated transactions, from time to time, depending upon market conditions.
The Company acquired 577,000 shares of its common stock for $9.9 million during
the nine months ended March 31, 2003 compared to 786,000 shares for $13.7
million during the nine months ended March 31, 2002. At March 31, 2003, the
Company had remaining authorization to repurchase up to 338,000 additional
shares.
Other Matters
In October 2002, the Company acquired certain assets of Industrial Equipment Co.
Ltd. (IECO), a Canadian distributor of industrial products, for approximately
$12.0 million. This acquisition was paid for from existing cash balances. The
results of the acquired business operations are not material for all periods
presented. The acquired operations are reported in our service center based
distribution segment from the acquisition date. The business contributed $8.6
million in sales from the date of acquisition through March 31, 2003. Sales and
operating results to date have met Company expectations.
13
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
Net sales increased 1.8% compared to the prior year. This increase was primarily
attributed to the acquisition of IECO which added approximately $4.9 million, or
1.3% to sales during the quarter. Industrial product sales for the quarter
increased by 1.9% and fluid power and other sales increased by 1.2%. Same store
sales were comparable to those in the same quarter last year.
Gross profit as a percentage of sales increased to 26.5% from 25.4%. This
increase is primarily due to higher discounts and allowances from suppliers and
increased recovery of our shipping expenses.
Selling, distribution and administrative expenses increased $1.5 million
compared to the prior year. The increases were primarily due to the acquisition
of IECO. Additionally, increased costs relating to incentives and benefits,
hospitalization, casualty and general insurance costs were offset by lower
salaries and wages from lower headcount. Gains from the sales of unneeded real
estate and other property were immaterial for the quarter ended March 31, 2003.
Interest expense-net for the quarter decreased by 6.0% as compared to the prior
year. While average borrowings decreased 27.9%, the benefit from the interest
rate swap decreased by $0.3 million from the same quarter last year due to the
swap being terminated in August 2002. The termination of the interest rate swap
converted the variable short-term interest rates back into long-term fixed
interest rates.
Other expenses increased $1.9 million compared to the prior year. During the
quarter, the Company recorded a charge of $1.7 million to provide for losses of
the Company's iSource Performance Materials LLC affiliate and reserve against
outstanding advances. The Company owns 49% of iSource, a certified
minority-owned distributor of standard-use industrial specialty and general
maintenance items requiring special shipping and handling. It is anticipated
that any additional future charges related to iSource will not be significant.
Income tax expense as a percentage of income before taxes was 36.4% for the
quarter ended March 31, 2003 compared to 38.4% for the quarter ended March 31,
2002. This decrease related to a change in the tax law that reduces the
Company's taxable income beginning in fiscal 2003. Specifically, the Company can
now take a deduction for dividends on Company stock paid to participant accounts
in the Company's Section 401(k) plan.
As a result of the above factors, net income increased by 61.9% compared to the
same quarter of last year. Because the Company had fewer shares outstanding as a
result of repurchases, net income per share increased $.09 or 64.3% from the
same quarter last year.
14
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
NINE MONTHS ENDED MARCH 31, 2003 AND 2002
Net sales increased 1.4% compared to the prior year. This increase was primarily
attributed to the acquisition of IECO, and having one additional sales day in
the period compared to the prior year. The sales mix for the nine months ended
March 31, 2003, was 85.0% industrial and 15.0% fluid power compared to 85.1%
industrial and 14.9% fluid power in the prior year. While there was a reduction
of 12 facilities in the U.S. and Mexico, these were offset by the acquisition of
16 facilities in western Canada. At March 31, 2003, the Company had a total of
453 facilities versus 449 at June 30, 2002. Gross profit as a percentage of
sales was 25.5% versus 25.2% for the same period last year.
Selling, distribution and administrative expenses increased 1.7% compared to the
prior year, and increased slightly as a percent of sales to 23.2% from 23.1%.
This was primarily from the acquisition of IECO, medical costs due to higher
claims, general insurance costs due to higher premiums and personnel costs due
to larger accruals for incentives based on increased profitability. These
additional costs were partially offset by a benefit of approximately $2.7
million from gains on sales of unneeded real estate and other property including
a $1.5 million gain from the relocation and sale of a recently vacated facility
located in Portland, Oregon.
Interest expense-net for the period decreased by 22.4% as compared to the prior
year. While average borrowings decreased 27.9%, the benefit from the interest
rate swap decreased by $0.2 million from the same period last year due to the
swap being terminated in August 2002. The termination of the interest rate swap
converted the variable short-term interest rates back into long-term fixed
interest rates.
Other expenses increased $2.4 million compared to the prior year. During the
quarter, the Company recorded a charge of $1.7 million to provide for estimated
losses of the Company's iSource Performance Materials LLC affiliate and reserve
against outstanding advances. The Company owns 49% of iSource, a certified
minority-owned distributor of standard-use industrial specialty and general
maintenance items requiring special shipping and handling. It is anticipated
that any additional future charges related to iSource will not be significant.
Income tax expense as a percentage of income before taxes was 36.5% for the nine
months ended March 31, 2003 and 38.5% for the similar period ended March 31,
2002. This decrease related to a change in the tax law that reduces the
Company's taxable income beginning in fiscal 2003. Specifically, the Company can
now take a deduction for dividends on Company stock paid to participant accounts
in the Company's Section 401(k) plan. We expect our overall tax rate to be
around 36% for the entire year.
15
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
As a result of the above factors, net income before cumulative effect of change
in accounting increased by 15.5% compared to the same period of last year.
Because the Company had fewer shares outstanding as a result of repurchases, net
income per share increased $.09 or 16.7% from the same period last year.
CAUTIONARY STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT
Management's Discussion and Analysis and other sections of this Form 10-Q
contain statements that are forward-looking, based on management's current
expectations about the future. Forward-looking statements are often identified
by qualifiers such as "expect", "believe", "anticipate", "should", "project",
"forecast", "will", and similar expressions. The Company intends that the
forward-looking statements be subject to the safe harbors established in the
Private Securities Litigation Reform Act of 1995 and by the Securities and
Exchange Commission in its rules, regulations and releases.
Readers are cautioned not to place undue reliance on any forward-looking
statements. All forward-looking statements are based on current expectations
regarding important risk factors, many of which are outside the Company's
control. Accordingly, actual results may differ materially from those expressed
in the forward-looking statements, and the making of such statements should not
be regarded as a representation by the Company or any other person that the
results expressed in the statements will be achieved. In addition, the Company
undertakes no obligation publicly to update or revise any forward-looking
statements, whether because of new information or events, or otherwise.
Important risk factors include, but are not limited to, the following: changes
in the economy or in specific customer industries; reduction in manufacturing
capacity in the Company's targeted geographic markets due to consolidation in
customer industries or the transfer of manufacturing capacity to foreign
countries; changes in interest rates; changes in customer procurement policies
and practices; changes in product manufacturer sales policies and practices; the
availability of product and labor; changes in operating expenses; the effect of
price increases or decreases in both procuring and selling products and
services; the variability and timing of business opportunities including
acquisitions, alliances, customer agreements and supplier authorizations; the
Company's ability to realize the anticipated benefits of acquisitions and
marketing and other business strategies; the incurrence of additional debt and
contingent liabilities in connection with acquisitions; changes in accounting
policies and practices; the effect of organizational changes within the Company;
the emergence of new competitors, including firms with greater financial
resources than the Company; risks and uncertainties associated with the
Company's expansion into foreign markets, including inflation rates, recessions,
and foreign currency exchange rates; adverse results in significant litigation
matters; adverse regulation and legislation; and the occurrence of extraordinary
events (including prolonged labor disputes, war, natural events and acts of God,
fires, floods and accidents).
16
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
--------------------------------------------------------------------------------
The Company has evaluated its exposure to various market risk factors, including
but not limited to, interest rate, foreign currency exchange and commodity price
risks. The Company is primarily affected by market risk exposure through the
effect of changes in interest rates. The Company manages interest rate risk
through the use of a combination of fixed rate long-term debt and variable rate
borrowings under its committed revolving credit agreement and interest rate
swaps. The Company had no variable rate borrowings outstanding under its
committed revolving credit agreement at March 31, 2003. In August 2002, the
Company terminated a November 2001 interest rate swap agreement. The Company has
no other interest rate swap agreements outstanding, therefore, all of the
Company's outstanding debt is currently at fixed interest rates at March 31,
2003 and scheduled for repayment in December 2007 and beyond.
The Company mitigates its foreign currency exposure from the Canadian dollar
through the use of cross currency swap agreements as well as of foreign-currency
denominated debt. Hedging of the US dollar denominated debt used to fund a
substantial portion of Company's net investment in its Canadian operations is
accomplished through the use of cross currency swaps. Any gain or loss on the
hedging instrument offsets the gain or loss on the underlying debt. Translation
exposures with regard to our Mexican business are not hedged because the Mexican
activity is not material. The impact on the Company's future earnings from
exposure to changes in foreign currency exchange rates is expected to be
immaterial.
17
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 4: CONTROLS AND PROCEDURES
--------------------------------------------------------------------------------
Management, under the supervision and with the participation of the Chief
Executive Officer (CEO) and the Chief Financial Officer (CFO), has evaluated the
Company's disclosure controls and procedures within 90 days prior to the filing
date of this report. Based upon that evaluation, the CEO and the CFO have
concluded as of the evaluation date, that such disclosure controls and
procedures are effective in timely alerting them to material information about
the Company required to be included in the Company's Exchange Act reports.
There have not been any significant changes in the Company's internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of management's evaluation of those controls.
18
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings.
Applied Industrial Technologies, Inc. and/or one of its subsidiaries is a
party to various pending judicial and administrative proceedings. Based on
circumstances currently known, the Company does not believe that any
liabilities that may result from these proceedings are reasonably likely to
have a material adverse effect on the Company's consolidated financial
position, results of operations, or cash flows.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit No. Description
----------- -----------
3(a) Amended and Restated Articles of Incorporation of
Applied Industrial Technologies, Inc., as amended
on October 8, 1998 (filed as Exhibit 3(a) to the
Company's Form 10-Q for the quarter ended
September 30, 1998, SEC File No. 1-2299, and
incorporated here by reference).
3(b) Code of Regulations of Applied Industrial
Technologies, Inc., as amended on October 19, 1999
(filed as Exhibit 3(b) to the Company's Form 10-Q
for the quarter ended September 30, 1999, SEC File
No. 1-2299, and incorporated here by reference).
4(a) Certificate of Merger of Bearings, Inc. (Ohio) and
Bearings, Inc. (Delaware) filed with the Ohio
Secretary of State on October 18, 1988, including
an Agreement and Plan of Reorganization dated
September 6, 1988 (filed as Exhibit 4(a) to the
Company's Registration Statement on Form S-4 filed
May 23, 1997, Registration No. 333-27801, and
incorporated here by reference).
4(b) Private Shelf Agreement dated as of November 27,
1996, as amended on January 30, 1998, between the
Company and The Prudential Insurance Company of
America (filed as Exhibit 4(f) to the Company's
Form 10-Q for the quarter ended March 31, 1998,
SEC File No. 1-2299, and incorporated here by
reference).
19
4(c) Amendment dated October 24, 2000 to November 27,
1996 Private Shelf Agreement between the Company
and The Prudential Insurance Company of America
(filed as Exhibit 4(e) to the Company's Form 10-Q
for the quarter ended September 30, 2000, SEC File
No. 1-2299, and incorporated here by reference).
4(d) $150,000,000 Credit Agreement dated as of November
5, 1998 among the Company, KeyBank National
Association as Agent, and various financial
institutions (filed as Exhibit 4(e) to the
Company's Form 10-Q for the quarter ended
September 30, 1998, SEC File No. 1-2299, and
incorporated here by reference).
4(e) Rights Agreement, dated as of February 2, 1998,
between the Company and Computershare Investor
Services LLP (successor to Harris Trust and
Savings Bank), as Rights Agent, which includes as
Exhibit B thereto the Form of Rights Certificate
(filed as Exhibit No. 1 to the Company's
Registration Statement on Form 8-A filed July 20,
1998, SEC File No. 1-2299, and incorporated here
by reference).
15 Letter from independent accountants regarding
unaudited interim financial information.
99 Certification under Section 906 of the
Sarbanes-Oxley Act.
(b) The Company did not file, nor was it required to file, a Report on Form 8-K
with the Securities and Exchange Commission during the quarter ended March
31, 2003.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
APPLIED INDUSTRIAL TECHNOLOGIES, INC.
(Company)
Date: May 14, 2003 By: /s/ David L. Pugh
----------------------------------------
David L. Pugh
Chairman & Chief Executive Officer
Date: May 14, 2003 By: /s/ John R. Whitten
-----------------------------------------
John R. Whitten
Vice President-Chief Financial Officer
& Treasurer
21
Certifications of Disclosure in Quarterly Report on Form 10-Q
I, David L. Pugh, Chairman & Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Applied Industrial
Technologies, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the period presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a. All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
22
b. Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 14, 2003
/s/ David L. Pugh
----------------------------------
David L. Pugh
Chairman & Chief Executive Officer
I, John R. Whitten, Vice President-Chief Financial Officer & Treasurer, certify
that:
1. I have reviewed this quarterly report on Form 10-Q of Applied Industrial
Technologies, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the period presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
23
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a. All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 14, 2003
/s/ John R. Whitten
----------------------------------------
John R. Whitten
Vice President-Chief Financial Officer &
Treasurer
24
APPLIED INDUSTRIAL TECHNOLOGIES, INC.
EXHIBIT INDEX
TO FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2003
EXHIBIT NO. DESCRIPTION PAGE
----------- ----------- ----
3(a) Amended and Restated Articles of Incorporation
of Applied Industrial Technologies, Inc., as amended
on October 8, 1998 (filed as Exhibit 3(a) to the Company's Form
10-Q for the quarter ended September 30, 1998, SEC File No.
1-2299, and incorporated here by reference).
3(b) Code of Regulations of Applied Industrial Technologies,
Inc., as amended on October 19, 1999 (filed as Exhibit 3(b) to the
Company's Form 10-Q for the quarter ended September 30, 1999, SEC
File No. 1-2299, and incorporated here by reference).
4(a) Certificate of Merger of Bearings, Inc. (Ohio) and
Bearings, Inc. (Delaware) filed with the Ohio Secretary of State
on October 18, 1988, including an Agreement and Plan of
Reorganization dated September 6, 1988 (filed as Exhibit 4(a) to
the Company's Registration Statement on Form S-4 filed May 23,
1997, Registration No. 333-27801, and incorporated here by
reference).
4(b) Private Shelf Agreement dated as of November 27, 1996, as
amended on January 30, 1998, between the Company and The
Prudential Insurance Company of America (filed as Exhibit 4(f)
to the Company's Form 10-Q for the quarter ended March 31,
1998, SEC File No. 1-2299, and incorporated here by
reference).
4(c) Amendment dated October 24, 2000 to November 27, 1996 Private
Shelf Agreement between the Company and The Prudential
Insurance Company of America (filed as Exhibit 4(e) to the
Company's Form 10-Q for the quarter ended September 30, 2000,
SEC File No. 1-2299, and incorporated here by reference).
EXHIBIT NO. DESCRIPTION PAGE
----------- ----------- ----
4(d) $150,000,000 Credit Agreement dated as of November 5, 1998
among the Company, KeyBank National Association as Agent, and
various financial institutions (filed as Exhibit 4(e) to the
Company's Form 10-Q for the quarter ended September 30, 1998,
SEC File No. 1-2299, and incorporated here by reference).
4(e) Rights Agreement, dated as of February 2, 1998, between the
Company and Computershare Investor Services LLP (successor to
Harris Trust and Savings Bank), as Rights Agent, which
includes as Exhibit B thereto the Form of Rights Certificate
(filed as Exhibit No. 1 to the Company's Registration
Statement on Form 8-A filed July 20, 1998, SEC File No.
1-2299, and incorporated here by reference).
15 Letter from independent accountants regarding unaudited interim Attached
financial information.
99 Certification under Section 906 of the Sarbanes-Oxley Act. Attached