10-Q 1 l01006ae10vq.txt APPLIED INDUSTRIAL TECHNOLOGIES, INC. 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 --------------------------------------- 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 ---------- APPLIED INDUSTRIAL TECHNOLOGIES, INC. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 34-0117420 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) One Applied Plaza, Cleveland, Ohio 44115 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (216) 426-4000 --------------- -------------------------------------------------------------------------------- (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 ----- Shares of common stock outstanding on April 30, 2003 18,960,802 ------------------------------------- (No par value) APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES INDEX --------------------------------------------------------------------------
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) --------------------------------------------------------------------------------
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) --------------------------------------------------------------------------------
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) -------------------------------------------------------------------------------- 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) -------------------------------------------------------------------------------- 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