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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 DECEMBER 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 January 31, 2004 19,392,190
------------------------------------------
(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 Six Months Ended
December 31, 2003 and 2002
Condensed Consolidated Balance Sheets - 3
December 31, 2003 and June 30, 2003
Condensed Statements of Consolidated Cash Flows - 4
Six Months Ended December 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 12-17
Financial Condition and Results of Operations
Item 3: Quantitative and Qualitative Disclosures About Market Risk 18
Item 4: Controls and Procedures 19
Part II: OTHER INFORMATION
Item 1: Legal Proceedings 20
Item 4: Submission of Matters to a Vote of Security Holders 20
Item 6: Exhibits and Reports on Form 8-K 20
Signatures 22
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 SIX MONTHS ENDED
DECEMBER 31 DECEMBER 31
2003 2002 2003 2002
---------------------------- ----------------------------
Net Sales $ 359,711 $ 355,707 $ 720,857 $ 723,726
Cost of sales 264,545 264,516 532,214 542,633
------------ ------------ ------------ ------------
Gross Profit 95,166 91,191 188,643 181,093
Selling, distribution and
administrative expenses 85,916 83,871 170,397 165,929
------------ ------------ ------------ ------------
Operating Income 9,250 7,320 18,246 15,164
Interest expense, net 1,405 1,342 2,723 2,603
Other, net (108) 38 58 326
------------ ------------ ------------ ------------
Income Before Income Taxes 7,953 5,940 15,465 12,235
Income Taxes 2,820 2,080 5,500 4,470
------------ ------------ ------------ ------------
Net Income (Loss) $ 5,133 $ 3,860 $ 9,965 $ 7,765
============ ============ ============ ============
Earnings Per Share - Basic $ 0.27 $ 0.20 $ 0.52 $ 0.41
============ ============ ============ ============
Earnings Per Share - Diluted $ 0.26 $ 0.20 $ 0.51 $ 0.40
============ ============ ============ ============
Cash dividends per common
share $ 0.12 $ 0.12 $ 0.24 $ 0.24
============ ============ ============ ============
Weighted average common shares
outstanding for basic computation 19,227 18,954 19,117 18,985
Dilutive effect of stock options
and awards 410 279 423 282
------------ ------------ ------------ ------------
Adjusted average common shares
outstanding for diluted computation 19,637 19,233 19,540 19,267
============ ============ ============ ============
See notes to condensed consolidated financial statements.
2
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Amounts in thousands)
DECEMBER 31 JUNE 30
2003 2003
----------- ---------
ASSETS
Current assets
Cash and temporary investments $ 24,401 $ 55,079
Accounts receivable, less allowances
of $6,200 and $6,100 170,074 173,915
Inventories (at LIFO) 191,249 159,798
Other current assets 13,536 11,702
----------- ---------
Total current assets 399,260 400,494
Property, less accumulated depreciation
of $92,746 and $85,836 81,207 77,942
Goodwill 50,433 49,687
Other assets 25,600 25,281
----------- ---------
TOTAL ASSETS $ 556,500 $ 553,404
=========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 74,040 $ 75,411
Other accrued liabilities 58,592 65,724
----------- ---------
Total current liabilities 132,632 141,135
Long-term debt 78,163 78,558
Other liabilities 26,684 25,855
----------- ---------
TOTAL LIABILITIES 237,479 245,548
----------- ---------
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 86,498 84,898
Income retained for use in the business 295,079 289,724
Treasury shares - at cost, 4,763 and 5,076 shares (74,418) (78,706)
Unearned restricted common stock compensation (31) (114)
Accumulated other comprehensive income 1,893 2,054
----------- ---------
TOTAL SHAREHOLDERS' EQUITY 319,021 307,856
----------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 556,500 $ 553,404
=========== =========
See notes to condensed consolidated financial statements.
3
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
(Amounts in thousands)
Six Months Ended
December 31
2003 2002
-------- --------
Cash Flows from Operating Activities
Net income $ 9,965 $ 7,765
Adjustments to reconcile net income to cash provided by (used in)
operating activities:
Depreciation and amortization 8,491 7,953
Gain on sale of property (89) (2,577)
Treasury shares contributed to employee benefit and deferred
compensation plans 3,775 1,724
Changes in operating assets and liabilities, net of
effects from acquisition of businesses (35,053) 8,063
Other - net (395) (330)
-------- --------
Net Cash provided by (used in) Operating Activities (13,306) 22,598
-------- --------
Cash Flows from Investing Activities
Property purchases (10,317) (5,049)
Proceeds from property sales 373 5,151
Net cash paid for acquisition of businesses, net of cash (1,285) (10,255)
Deposits and other (149) 1,426
-------- --------
Net Cash used in Investing Activities (11,378) (8,727)
-------- --------
Cash Flows from Financing Activities
Borrowings and (repayments) - net (2,850)
Long-term debt repayments (5,714)
Proceeds from termination of interest rate swap 2,517
Dividends paid (4,610) (4,596)
Purchases of treasury shares (2,091) (3,934)
Exercise of stock options 3,557 275
-------- --------
Net Cash used in Financing Activities (5,994) (11,452)
-------- --------
Increase (decrease) in cash and temporary
investments (30,678) 2,419
Cash and temporary investments
at beginning of period 55,079 23,060
-------- --------
Cash and Temporary Investments
at End of Period $ 24,401 $ 25,479
======== ========
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 Applied Industrial
Technologies, Inc. (the Company) Annual Report on Form 10-K for the
year ended June 30, 2003.
The results of operations for the three and six month periods ended
December 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.
The Company recognizes shipping and handling fees billed when products
are shipped or delivered to a customer and includes such amounts in net
sales. Third party freight payments are recorded in cost of sales in
the accompanying consolidated statements of income.
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 9.0% of the
total net sales of Applied for the six months ended December 31, 2003
and therefore are not presented separately. In addition, approximately
31.1% 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 DECEMBER 31, 2003
Net sales $ 335,633 $ 24,078 $ 359,711
Operating income 10,844 1,299 12,143
Depreciation 3,707 167 3,874
Capital expenditures 1,552 23 1,575
-------------- ----------- -----------
THREE MONTHS ENDED DECEMBER 31, 2002
Net sales $ 333,964 $ 21,743 $ 355,707
Operating income 8,423 13 8,436
Depreciation 3,253 192 3,445
Capital expenditures 1,988 177 2,165
-------------- ----------- -----------
A reconciliation from the segment operating profit to the condensed consolidated
balances is as follows:
THREE MONTHS ENDED
DECEMBER 31
--------------------------
2003 2002
----------- -----------
Operating income for
reportable segment $ 10,844 $ 8,423
Other operating income 1,299 13
Adjustments for:
Other intangible amortization (188) (174)
Corporate and other income (expense),
net of allocations (a) (2,705) (942)
----------- -----------
Total operating income 9,250 7,320
Interest expense, net 1,405 1,342
Other expense, net (108) 38
----------- -----------
Income before income taxes $ 7,953 $ 5,940
=========== ===========
SEGMENT FINANCIAL INFORMATION:
SERVICE CENTER
BASED
DISTRIBUTION OTHER TOTAL
-------------- ----------- -----------
SIX MONTHS ENDED DECEMBER 31, 2003
Net sales $ 673,536 $ 47,321 $ 720,857
Operating income 20,647 2,011 22,658
Assets used in the business 532,514 23,986 556,500
Depreciation 7,008 337 7,345
Capital expenditures 10,254 63 10,317
-------------- ----------- -----------
6
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
SIX MONTHS ENDED DECEMBER 31, 2002
Net sales $ 678,934 $ 44,792 $ 723,726
Operating income 17,886 73 17,959
Assets used in the business 510,911 24,009 534,920
Depreciation 6,792 366 7,158
Capital expenditures 4,720 329 5,049
----------- ------------ -------------
A reconciliation from the segment operating profit to the condensed consolidated
balances is as follows:
SIX MONTHS ENDED
DECEMBER 31
--------------------------
2003 2002
----------- -----------
Operating income for
reportable segment $ 20,647 $ 17,886
Other operating income 2,011 73
Adjustments for:
Other intangible amortization (377) (417)
Corporate and other income (expense),
net of allocations (a) (4,035) (2,378)
----------- -----------
Total operating income 18,246 15,164
Interest expense, net 2,723 2,603
Other expense, net 58 326
----------- ------------
Income before income taxes $ 15,465 $ 12,235
=========== ===========
(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.
3. GUARANTEES
The Company had a construction and lease facility under which a
distribution center and three service centers were constructed by the
lessor and leased to the Company under operating lease arrangements.
The Company purchased the properties for $7,500 at the end of the lease
term in September 2003. The residual value guarantee provisions of this
lease arrangement expired with the purchase of the properties.
In December 2003, the Company paid the $2,990 outstanding balance of
bank debt for iSource Performance Materials, L.L.C. (iSource) and
assumed the bank's rights under the loan agreement. Prior to assuming
the loan, the Company had guaranteed the bank debt of iSource.
7
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
4. STOCK OPTIONS
Effective July 1, 2003, the Company adopted the fair value recognition
provisions of SFAS 123, "Accounting for Stock-Based Compensation" as
amended by SFAS 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," using the modified prospective method for
the transition. Under the modified prospective method, stock-based
compensation cost recognized during this fiscal year is the same as
that which would have been recognized had the fair value recognition
provisions been applied to all awards granted after July 1, 1995.
Results for prior years have not been restated. The compensation
expense recorded during the quarter and six months ended December 31,
2003 was $327, $211 net of tax, or $0.01 per share and $686, $442 net
of tax, or $0.02 per share, respectively. The following table discloses
the compensation expense and net income as if the fair value based
method had been applied in each period:
Three Months Ended Six Months Ended
December 31 December 31
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net income, as reported $ 5,133 $ 3,860 $ 9,965 $ 7,765
Plus: Stock-based employee compensation
expense included in reported net income,
net of related tax effects 211 442
Less: Total stock-based employee
compensation expense determined under
fair value based method, net of tax (211) (336) (442) (644)
========= ========= ========= =========
Pro forma net income $ 5,133 $ 3,524 $ 9,965 $ 7,121
========= ========= ========= =========
Earnings per share:
Basic - as reported $ 0.27 $ 0.20 $ 0.52 $ 0.41
========= ========= ========= =========
Basic - pro forma $ 0.27 $ 0.19 $ 0.52 $ 0.38
========= ========= ========= =========
Diluted - as reported $ 0.26 $ 0.20 $ 0.51 $ 0.40
========= ========= ========= =========
Diluted - pro forma $ 0.26 $ 0.18 $ 0.51 $ 0.37
========= ========= ========= =========
Compensation expense has been determined using the Black-Scholes option-pricing
model. The assumptions used for grants issued during the six months ended
December 31, 2003 and 2002 are:
8
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
SIX MONTHS ENDED
DECEMBER 31
------------------
2003 2002
------- -------
Expected life 7 years 7 years
Risk free interest rate 3.8% 3.9%
Dividend yield 3.0% 3.0%
Volatility 31.7% 30.9%
5. CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In January 2003, the Financial Accounting Standards Board issued FIN
46, "Consolidation of Variable Interest Entities" which the Company
adopted as of July 1, 2003. The Company is a minority owner in iSource.
iSource has assets of $2,500 and accounts payable of $2,300. In
December 2003, the Company paid the outstanding amount of $2,990 of
bank debt and assumed the bank's rights under the loan agreement. 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. In accordance with FIN 46, iSource's financial
statements were consolidated with the Company's beginning in July 2003.
The effect of the consolidation was not material to the Company's
consolidated financial statements.
6. BUSINESS COMBINATION
In November 2003, the Company acquired the stock of a Mexican
distributor of industrial products for approximately $2,800. The
results of the acquired 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. Other intangibles of $880, consisting of customer
relationships and non-competition agreements were recognized in
connection with this combination and will be amortized over a period of
seven to ten years.
The preliminary fair value of the acquired assets and liabilities
assumed at the date of acquisition are as follows:
Cash $ 815
Accounts receivable 2,313
Inventory 1,815
Other current assets 90
Property 238
Other assets 7
Goodwill 398
Other intangibles 880
---------
Total assets acquired 6,556
Liabilities assumed 3,756
---------
Net assets acquired $ 2,800
=========
9
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
7. DEBT
During the quarter ended December 31, 2003, the Company replaced its
existing revolving credit facility with a new, five year revolving
credit facility with a group of banks. This agreement provides for
unsecured borrowings of up to $100,000 at various interest rate
options, none of which is in excess of the banks' prime rate at
interest determination dates. The Company had no borrowings outstanding
under this facility at December 31, 2003. Fees on this facility range
from .15% to .30% per year on the average amount of the total revolving
credit commitments during the year. Unused lines under this facility,
net of outstanding letters of credit, totaling $92,114, are available
to fund future acquisitions or other capital and operating
requirements.
8. NEW ACCOUNTING STANDARD
During December 2003, the FASB issued a revision to Statement of
Financial Accounting Standards No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits, an amendment of FASB
Statements No. 87, 88, and 106," which expands the disclosure
requirements regarding plan assets and benefit obligations for the
Company's benefit and pension plans. Certain provisions of this
statement are effective for the third quarter of fiscal 2004, while the
remaining provisions relating to the annual financial statement
disclosures, are effective for the fiscal year ending June 30, 2004.
10
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
REVIEW BY INDEPENDENT PUBLIC ACCOUNTANTS
The accompanying condensed consolidated financial statements of the Company 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
December 31, 2003, and the related condensed statements of consolidated income
for the three-month and six-month periods ended December 31, 2003 and 2002, and
of consolidated cash flows for the six-month periods ended December 31, 2003 and
2002. These interim 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 and
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 interim 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, 2003, 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 8, 2003, 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, 2003 is fairly
stated, in all material respects, in relation to the consolidated balance sheet
from which it has been derived.
As discussed in Note 4 to the condensed consolidated interim financial
statements, effective July 1, 2003, the Company changed its method of accounting
for stock-based compensation and adopted the fair value recognition provisions
of SFAS 123 "Accounting for Stock-Based Compensation," as amended by SFAS 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure."
/s/ Deloitte & Touche LLP
Cleveland, Ohio
February 6, 2004
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 December
31, 2003 and June 30, 2003, and (2) results of operations and cash flows during
the periods included in the accompanying Condensed Statements of Consolidated
Income and Consolidated Cash Flows.
Overview
During the quarter, income increased 33.0% compared to the same quarter in the
prior year. Sales increased 1.1% primarily due to our Canadian operations. Gross
margin performance was improved as our initiatives in the areas of product
pricing, freight recovery, cost controls and asset management continue to show
progress. The balance sheet remains solid. Inventories increased $27.2 million
from September balances primarily due to special calendar year-end buying
opportunities. These inventories of standard product are expected to be sold off
in the normal course of business. We expect the total inventory dollars to
return to the June 30, 2003 levels by the end of fiscal 2004.
The Company monitors the ISM Purchasing Managers Index (ISM) and the
government's Manufacturers Capacity Utilization (MCU) index and considers these
indexes key indicators of potential Company business environment changes. The
ISM has increased recently and the MCU had increased for the 4th consecutive
month. The Company's performance traditionally lags these key indicators by
approximately 6 months. Therefore, the Company expects relatively flat sales on
a sales per day basis for the fiscal third quarter with improvement possible in
the 4th quarter of fiscal 2004.
The Company expects to sustain our improvements in profitability. We anticipate
fiscal third quarter gross profit levels to be in the range of 26.0% to 26.5%.
We anticipate that a decline in rebates during the remainder of the year will
continue to be offset by improvements in freight recovery, pricing and asset
management. We expect selling, distribution and administrative expenses for the
third quarter to be relatively flat compared to the prior year.
Liquidity and Capital Resources
Cash used in operating activities was $13.3 million in the six months ended
December 31, 2003. This compares to $22.6 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. In the area of inventory, the Company has
attempted to secure cost advantages by buying product through special vendor
purchasing programs. In addition, the Company has made system enhancements in
recent quarters to improve inventory tracking and receivables collection
efforts. During the six month period ended December 31, 2003, inventories
increased approximately $31.5 million primarily due to purchases made under
special calendar year-end programs offered by certain of our suppliers. These
inventories of standard product are expected to be sold in the normal course of
business. The inventory increase also includes $2.3 million from the
12
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
consolidation of iSource resulting from the adoption of FIN 46 and $1.8 million
from the acquisition of a Mexican distributor (see notes to the condensed
consolidated financial statements). Accounts receivable decreased $3.8 million
during the six months ended December 31, 2003 due to improved collections and
accounts payable and other accrued liabilities decreased $12.0 million due to
the payment during the period of fiscal year-end accrued compensation benefits.
Capital expenditures were $10.3 million for the period ended December 31, 2003
compared to $5.0 million in the prior year. In September 2003, the Company
purchased, for $7.5 million, four operating facilities which had previously been
leased (see notes to the condensed consolidated financial statements). For the
entire year we expect our total capital expenditures to be approximately $15.0
million. Our depreciation and amortization for the entire year is expected to be
within the range of $16.0 million to $17.0 million.
During the quarter ended December 31, 2003, the Company replaced its existing
revolving credit facility with a new $100 million revolving credit facility with
a group of banks expiring in November 2008. The Company had no borrowings
outstanding under this facility at December 31, 2003. Unused lines under this
facility, net of outstanding letters of credit, totaling $92.1 million are
available to fund future acquisitions or other capital and operating
requirements. Additionally, the Company is currently negotiating with Prudential
Insurance Company for an uncommitted shelf facility that would enable the
Company to borrow up to $100 million in additional long-term financing at the
Company's sole discretion. This shelf agreement will replace a previously unused
facility that expired on October 31, 2003. The new facility is expected to be
completed by the end of February, 2004.
At December 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 2000 Canadian acquisition. The full $25.0 million is due at
maturity in November 2010. The Company has mitigated the foreign currency
exposure though the use of cross currency swaps on the $25.0 million of debt.
The aggregate annual maturities of long-term debt include $50.0 million in
fiscal 2008 and $25.0 million in fiscal 2011.
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 96,000 shares of its common stock for $2.1 million during
the six months ended December 31, 2003 compared to 232,000 shares for $3.9
million during the six months ended December 31, 2002. At December 31, 2003, the
Company had remaining authorization to repurchase up to 1 million additional
shares.
13
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Other Matters
In November 2003, the Company acquired the stock of a Mexican distributor of
industrial products for approximately $2.8 million. The acquisition was paid for
from our cash balances. The results of the acquired operations are not material
for all periods presented. The acquired operations are reported in our service
center based distribution segment from the acquisition date.
In January 2003, the Financial Accounting Standards Board issued FIN 46,
"Consolidation of Variable Interest Entities." The Company is a minority owner
in iSource Performance Materials L.L.C. (iSource). iSource has assets of $2.5
million and accounts payable of $2.3 million. In December 2003, the Company paid
the outstanding amount of $3.0 million of bank debt and assumed the bank's
rights under the loan agreement. 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. In accordance with FIN 46, iSource's
financial statements were consolidated with the Company's beginning in July
2003. The effect of the consolidation was not material to the Company's
consolidated financial statements.
Effective July 1, 2003, the Company adopted the fair value recognition
provisions of SFAS 123, "Accounting for Stock-Based Compensation," using the
modified prospective method for the transition. Under the modified prospective
method, stock-based compensation cost recognized during this fiscal year for
stock options is the same as that which would have been recognized had the fair
value recognition provisions been applied to all stock option awards granted
after July 1, 1995. The compensation expense recorded during the quarter and six
months ended December 31, 2003 related to stock options was $.3 million, or $.01
per share after tax and $.7 million or $.02 per share after tax, respectively.
RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 2003 AND 2002
Net sales increased 1.1% compared to the prior year primarily due to the
strength of performance of our Canadian operations. Service center based same
store sales in the U.S. decreased 1.5% compared to those in the same quarter
last year. The U.S. fluid power sales also declined 5.1% during the quarter.
Gross profit as a percentage of sales increased to 26.5% from 25.6%. This
increase is primarily due to higher recovery of our shipping expenses, lower
freight costs and improvements from product pricing initiatives. The increase
was also due to recording cost adjustments during the quarter related to
inventory cycle counting programs and interim inventory reconciliations. In the
prior year, these factors were incorporated to a greater extent in the 4th
quarter annual physical inventory results. These factors were offset somewhat by
lower purchase rebates from our product suppliers.
14
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Selling, distribution and administrative expenses increased 2.4% compared to the
prior year. The difference primarily relates to a relatively high level of gains
on the sales of unneeded real estate and other property in the prior year. These
gains are recorded as a reduction in selling, distribution and administrative
expense. Health care and other benefit expenses increased versus last year and
the Company also began to expense stock options during the quarter ended
September 30, 2003.
Interest expense-net for the quarter increased by 4.7% as compared to the prior
year as a result of the consolidation of iSource (see notes to the condensed
consolidated financial statements).
Income tax expense as a percentage of income before taxes was 35.5% for the
quarter ended December 31, 2003 compared to 35.0% for the quarter ended December
31, 2002 and 35.9% for all of fiscal 2003.
As a result of the above factors, net income increased by 33.0% compared to the
same quarter of last year and earnings per share increased 30.0%.
SIX MONTHS ENDED DECEMBER 31, 2003 AND 2002
Net sales decreased slightly compared to the prior year. Same store sales for
our U.S. service centers decreased 3.3% compared to those in the same period
last year. The U.S. fluid power sales also declined 7.1% during the period.
Offsetting the decrease was an increase in Canadian sales. While a portion of
this increase was due to the strengthening of the Canadian dollar, the majority
relates to actual year over year volume increases.
Gross profit as a percentage of sales increased to 26.2% from 25.0%. This
increase is primarily due to higher recovery of our shipping expenses, lower
freight costs and improvements from product pricing initiatives. The increase
was also due to recording throughout the year, cost adjustments related to
inventory cycle counting programs and interim inventory reconciliations. In the
prior year, these factors were incorporated to a greater extent in the 4th
quarter annual physical inventory results. These factors were offset somewhat by
lower purchase rebates from our product suppliers.
Selling, distribution and administrative expenses increased 2.7% compared to the
prior year. The difference primarily relates to a relatively high level of gains
on the sales of unneeded real estate and other property in the prior year.
Health care and other benefit expenses increased versus last year and the
Company also began to expense stock options during the quarter ended September
30, 2003.
15
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Interest expense-net for the quarter increased by 4.6% as compared to the prior
year as a result of lower interest income and the consolidation of iSource (see
notes to the condensed consolidated financial statements).
Income tax expense as a percentage of income before taxes was 35.6% for the
period ended December 31, 2003 compared to 36.5% for the period ended December
31, 2002. This decrease is due to a lower proportion of non-deductible expenses
and lower effective state, local and Canadian tax rates.
As a result of the above factors, net income increased by 28.3% compared to the
same period of last year and earnings per share increased 27.5%.
16
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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).
17
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 December 31, 2003. The Company has no
interest rate swap agreements outstanding, therefore, all of the Company's
outstanding long-term debt is currently at fixed interest rates at December 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.
18
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 as of the end of the period covered
by this report. Based upon that evaluation, the CEO and the CFO have concluded
that the 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.
Management has not identified any change in internal control over financial
reporting occurring during the quarter ended December 31, 2003 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
19
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 4. Submission of Matters to a Vote of Security Holders.
At the Company's Annual Meeting of Shareholders held on October 21,
2003, the Shareholders (i) elected Thomas A. Commes, Peter A. Dorsman,
J. Michael Moore, and Dr. Jerry Sue Thornton as Directors for terms
expiring in 2006, (ii) ratified the appointment of Deloitte & Touche
LLP as the Company's independent auditors for the fiscal year ending
June 30, 2004, (iii) approved the Deferred Compensation Plan for
Non-Employee Directors, and (iv) approved the Deferred Compensation
Plan. Substantially the same information was previously reported in
Part II, Item 5 "Other Information" of the Company's Form 10-Q for the
quarter ended September 30, 2003.
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
20
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 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) Amendment dated November 14, 2003 to 1996
Private Shelf Agreement between the Company
and The Prudential Insurance Company of
America.
4(e) $100,000,000 Credit Agreement dated as of
October 31, 2003 among the Company, KeyBank
National Association as Agent, and various
financial institutions.
4(f) 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).
10 First Amendment to the Company's Deferred
Compensation Plan (September 1, 2003
Restatement).
15 Letter from independent accountants
regarding unaudited interim financial
information.
31 Rule 13a-14(a)/15d-14(a) certifications.
21
32 Section 1350 certifications.
Applied will furnish a copy of any exhibit described above and not
contained herein upon payment of a specified reasonable fee which shall be
limited to Applied's reasonable expenses in furnishing the exhibit.
Certain instruments with respect to long-term debt have not been filed
as exhibits because the total amount of securities authorized under any one of
the instruments does not exceed 10 percent of the total assets of Applied and
its subsidiaries on a consolidated basis. Applied agrees to furnish to the
Securities and Exchange Commission, upon request, a copy of each such
instrument.
(b) Reports on Form 8-K.
The Company filed the following Report on Form 8-K with the Securities
and Exchange Commission during the quarter ended December 31, 2003:
1. Filing on October 14, 2003 - the Company attached its press
release of October 13, 2003, regarding first quarter earnings.
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: February 9, 2004 By: /s/ David L. Pugh
----------------------------------
David L. Pugh
Chairman & Chief Executive Officer
Date: February 9, 2004 By: /s/ Mark O. Eisele
----------------------------------
Mark O. Eisele
Vice President-Chief Financial Officer
& Treasurer
22
APPLIED INDUSTRIAL TECHNOLOGIES, INC.
EXHIBIT INDEX
TO FORM 10-Q FOR THE QUARTER ENDED DECEMBER 31, 2003
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).
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) Amendment dated November 14, 2003 to 1996 Attached
Private Shelf Agreement between the Company and The
Prudential Insurance Company of America.
4(e) $100,000,000 Credit Agreement dated as of Attached
October 31, 2003 among the Company, KeyBank National
Association as Agent, and various financial
institutions.
4(f) 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).
10 First Amendment to the Company's Deferred Attached
Compensation Plan (September 1, 2003 Restatement).
15 Letter from independent accountants regarding Attached
unaudited interim financial information.
31 Rule 13a-14(a)/15d-14(a) certifications. Attached
32 Section 1350 certifications. Attached