UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended APRIL 1, 2000 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: 33-80701 --------------------------- AAF-MCQUAY INC. - -------------------------------------------------------------------------------- (Exact name of Registrant as Specified in Its Charter) Delaware 41-0404230 - ------------------------------- ------------------------------------ (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 215 Central Avenue, Louisville, Kentucky 40208 - ---------------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code (502) 637-0011 ------------------- Not Applicable - -------------------------------------------------------------------------------- Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report. Indicate by check 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 2,497 shares of Common Stock, par value $100.00 per share, were outstanding as of May 11, 2000. 1 INDEX AAF-MCQUAY INC. AND SUBSIDIARIES PAGE ---- PART I - Financial Information...............................................3 Item 1. Financial Statements (unaudited)....................................3 Condensed Consolidated Balance Sheets as of - March 31, 2000 and June 30, 1999....................................3 Consolidated Statements of Operations - Three and Nine Months Ended March 31, 2000 and 1999.................4 Condensed Consolidated Statements of Cash Flows - Nine months ended March 31, 2000 and 1999...........................5 Consolidated Statements of Comprehensive Income - Three and Nine months ended March 31, 2000 and 1999.................6 Notes to the Consolidated Financial Statements......................7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................11 Item 3. Quantitative and Qualitative Disclosure About Market Risk..........14 PART II - Other Information..................................................15 Item 1. Legal Proceedings..................................................15 Item 6. Exhibits and Reports on Form 8-K...................................15 Signatures.........................................................16 2 PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AAF-MCQUAY INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (dollars in thousands, except share data) MARCH 31, JUNE 30, 2000 1999 --------- --------- ASSETS Current assets: Cash and cash equivalents .......................................... $ 15,236 $ 9,168 Accounts receivable ................................................ 192,989 227,844 Inventories ........................................................ 108,767 118,163 Other current assets ............................................... 5,463 6,754 --------- --------- Total current assets ........................................ 322,455 361,929 Property, plant and equipment, net .......................................... 128,671 145,086 Cost in excess of net assets acquired and other identifiable intangibles, net 217,486 228,906 Other assets and deferred charges ........................................... 18,839 19,274 --------- --------- Total assets ................................................ $ 687,451 $ 755,195 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings .............................................. $ 68,455 $ 87,602 Current maturities of long-term debt ............................... 7,929 14,495 Accounts payable, trade ............................................ 99,745 115,986 Accrued warranty ................................................... 18,572 18,604 Other accrued liabilities .......................................... 74,805 83,208 --------- --------- Total current liabilities ................................... 269,506 319,895 Long-term debt .............................................................. 158,532 164,322 Deferred income taxes ....................................................... 33,295 34,676 Other liabilities ........................................................... 45,286 49,874 --------- --------- Total liabilities ........................................... 506,619 568,767 Stockholders' equity: Preferred stock ($1 par value; 1,000 shares authorized, none issued) -- -- Common stock ($100 par value; 8,000 shares authorized, 2,497 shares issued and outstanding) .................................... 250 250 Additional paid-in capital ......................................... 179,915 179,915 Retained earnings .................................................. 13,127 17,762 Accumulated other comprehensive loss ............................... (12,460) (11,499) --------- --------- Total stockholders' equity .................................. 180,832 186,428 --------- --------- Total liabilities and stockholders' equity .................................. $ 687,451 $ 755,195 ========= ========= See Notes to Consolidated Financial Statements 3 AAF-MCQUAY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) (dollars in thousands) QUARTER ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, ----------------------- ------------------------- 2000 1999 2000 1999 --------- --------- --------- --------- Net Sales............................ $ 215,060 $ 221,634 $ 642,375 $ 688,748 Cost of Sales........................ 161,086 165,733 477,898 509,894 --------- --------- --------- --------- Gross Profit......................... 53,974 55,901 164,477 178,854 Operating Expenses: Selling, general and administrative................ 45,791 48,468 139,992 153,281 Restructuring................... 1,669 720 1,847 1,289 Amortization of intangible assets........................ 2,774 2,820 8,380 8,553 --------- --------- --------- --------- 50,234 52,008 150,219 163,123 --------- --------- --------- --------- Income from operations............... 3,740 3,893 14,258 15,731 Interest expense, net................ 5,421 5,731 16,840 17,975 Other (income) expense, net......... (23) 773 1,839 (4,700) --------- --------- --------- --------- Income (loss) before income taxes.... (1,658) (2,611) (4,421) 2,456 Minority interest income (loss)...... (99) 125 (235) (165) Provision for income taxes........... 710 681 (21) 1,597 --------- --------- --------- --------- Net income (loss).................... $ (2,467) $ (3,417) $ (4,635) $ 694 ========= ========= ========= ========= See Notes to Consolidated Financial Statements 4 AAF-MCQUAY INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (dollars in thousands) NINE MONTHS ENDED --------------------------------- MARCH 31, MARCH 31, 2000 1999 --------------------------------- Cash flows from operating activities: Net income $ (4,635) $ 694 Adjustments to reconcile to cash from operating activities: Depreciation and amortization 22,553 21,214 Foreign currency transaction (gains) losses 242 (421) Restructuring spending (1,847) (4,259) Loss on sale of business 1,331 -- Changes in operating assets and liabilities 14,880 (4,381) ------------ --------- Net cash from operating activities 32,524 12,847 Cash flows from investing activities: Capital expenditures, net (5,514) (14,610) Proceeds from sale of business 12,996 -- ------------ --------- Net cash from investing activities 7,482 (14,610) Cash flows from financing activities: Net borrowings (repayments) under short-term borrowing arrangements (19,147) 23,228 Payments on long-term debt (42,377) (21,217) Proceeds from issuance of long-term debt 30,000 -- Payment of debt issuance costs (1,387) -- ------------ --------- Net cash from financing activities (32,911) 2,011 Effect of exchange rate changes on cash (1,027) (99) ------------ --------- Net increase (decrease) in cash and cash equivalents 6,068 149 Cash and cash equivalents at beginning of period 9,168 9,697 ------------ --------- Cash and cash equivalents at end of period $ 15,236 $ 9,846 ========== ========== See Notes to Consolidated Financial Statements 5 AAF-MCQUAY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (unaudited) (dollars in thousands) QUARTER ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, -------------------------- ----------------------- 2000 1999 2000 1999 ---------- ---------- --------- -------- Net income (loss)................................ $ (2,467) $ (3,417) $ (4,635) $ 694 Other comprehensive income(loss):................ Foreign currency translation adjustments..... (1,811) (3,574) (1,790) (2,228) Write off of accumulated foreign currency translation adjustments due to sale of business.................................. -- -- 829 -- ---------- ---------- --------- -------- Comprehensive income(loss)....................... $ (4,278) $ (6,991) $ (5,596) $ (1,534) ========== ========== ========= ========= See Notes to Consolidated Financial Statements 6 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. BASIS OF PRESENTATION The consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. All inter-company transactions have been eliminated. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim reporting and with the instructions to Form 10-Q and Article 10 of Regulation S-K. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K (the "Annual Report") for the year ended June 30, 1999. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The accompanying financial statements reflect the statements of operations for the three and nine months ended March 31, 2000 and 1999, the balance sheets at March 31, 2000 and June 30, 1999, and the consolidated statements of cash flows for the nine months ended March 31, 2000 and 1999. The operating results for the nine months ended March 31, 2000 are not necessarily indicative of the operating results that may be expected for the full year ending June 30, 2000. The Company's period end is the Saturday closest to March 31. For clarity in presentation all periods presented herein are shown to end on the last calendar day of the month. Certain reclassifications of amounts in the consolidated financial statements have been made to reflect comparability. During the first quarter of fiscal year 1999, the Company made a change in accounting estimate related to its warranty provision. The Company increased its warranty provision by $2.5 million due to current activity related to new product introductions and discontinued product lines. 2. INVENTORIES Inventories consist of the following: MARCH 31, JUNE 30, 2000 1999 --------- --------- (DOLLARS IN THOUSANDS) FIFO Cost: Raw Materials ................. $ 39,072 $ 39,838 Work-in-process ............... 24,236 25,884 Finished goods ................ 44,741 51,063 -------- -------- 108,049 116,815 LIFO adjustment ............... 718 1,348 -------- -------- $108,767 $118,163 ======== ======== 3. NET OTHER (INCOME)EXPENSE During the third quarter of fiscal year 2000, the Company had net other income of $0.02 million compared to net other expense of $0.8 million in the third quarter of fiscal year 1999. Year-to-date the Company had net other expense of $1.8 million as compared to net other income of $4.7 million for the same period in fiscal year 1999. The year-to-date decrease is primarily related to events that occurred in the first quarters of fiscal years 2000 and 1999. In the first quarter of fiscal year 2000, the Company accrued a $1.3 million loss related to the sale of the commercial air conditioning and refrigeration operation in France in October 1999. Additionally, in conjunction with the Company's refinancing, discussed in Note 5, the Company wrote off certain unamortized income and debt issuance costs resulting in a charge of $0.3 million in the first quarter of fiscal year 2000. In the first quarter of fiscal year 1999 the Company recognized $2.9 million in other income as a result of favorable developments in the IRS audit and the tax indemnification settlement with former shareholders of the Company. The Company also recorded a $1.5 million gain related to the termination of a pension plan in Canada. The remaining components of other income and expenses resulted from foreign currency and equity affiliate transactions. 4. PROVISION FOR INCOME TAXES 7 The tax provisions for the third quarter and nine month periods ended March 31, 2000 and 1999 are based on the estimated effective tax rates applicable for the full years, and after giving effect to significant unusual items related specifically to the interim periods. In the third quarter of fiscal years 2000 and 1999, the Company changed its estimated effective tax rates for the full fiscal years. The difference between the Company's reported tax provision, for the third quarter and nine month periods ended March 31, 2000 and 1999, and the tax provision computed based on U.S. statutory rates is primarily attributable to nondeductible goodwill amortization and unbenefitted foreign losses. Additionally, the Company's effective tax rate for the third quarter and nine month period ended March 31, 2000 reflects the effect of the sale of a foreign subsidiary. Also, the effective tax rate for the nine months ended March 31, 1999 reflects the effect of the indemnification and the IRS Settlement. 5. DEBT AND FINANCIAL INSTRUMENTS On September 30, 1999, as further discussed in the Company's Form 10K, the Company entered into a new bank credit agreement. As a result of the bank credit agreement refinancing that took place, the Company wrote off certain unamortized debt issuance costs associated with the previous credit agreement. In addition, the balance of the unamortized income from early termination of the swap was eliminated. These actions resulted in net charge to other (income) expense of $0.3 million in the first quarter of fiscal year 2000. The Company secures pricing on a portion of its copper requirements through forward contracts executed with certain suppliers. At March 31, 2000, contracts for 2.5 million pounds of copper were in place. These contracts have various expiration dates through December 31, 2000. In January 2000, the Company entered into an interest rate swap transaction whereby the Company receives a fixed rate and pays a floating rate on the basis of 3-month LIBOR. The January 2000 swap has a three year term and a notional amount of $30 million and effectively converts a portion of the Company's fixed rate borrowings to a floating rate. 6. RESTRUCTURING In the third quarter of fiscal 2000, the Company commenced a restructuring of J&E Hall, a wholly-owned, U.K. based subsidiary of the Company engaged in manufacturing industrial refrigeration and freezer products and service. Approximately 50 positions were eliminated with corresponding severance costs of approximately $1.7 million recorded. As described in Note 10 of the Annual Report, the Company implemented several restructuring plans throughout fiscal year 1999 in both the Commercial Air Conditioning and Refrigeration and Filtration Products groups. Through March 31, 2000, the Company has spent $4.0 million of the $5.2 million restructuring reserve recorded in fiscal year 1999 primarily for severance arrangements. The Company continues to implement actions in accordance with the restructuring plan. 7. CONTINGENCIES ENVIRONMENTAL MATTERS - The Company is subject to potential liability under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended (CERCLA), and other federal, state and local statutes and regulations governing the discharge of pollutants into the environment and the handling and disposal of hazardous substances and waste. These statutes and regulations, among other things, impose potential liability on the Company for the cost of remediation of contamination arising from the Company's past and present operations and from former operations of other entities at sites later acquired and now owned by the Company. Many of the Company's facilities have operated for many years, and substances which are or might be considered hazardous were generated, used, and disposed of at some locations, both on- and off-site. Therefore, it is possible that environmental liabilities in addition to those described in note 14 of the Annual Report may arise in the future. The Company records liabilities if, in management's judgment, environmental assessments or remedial efforts are probable and the costs can be reasonably estimated. These accrued liabilities are not discounted. Such estimates are adjusted if necessary based upon the completion of a formal study or the Company's commitment to a formal plan of action. LITIGATION - The Company is involved in various lawsuits in the ordinary course of business. These lawsuits primarily involve claims for damages arising out of the use of the Company's products. The Company 8 is also involved in litigation and administrative proceedings involving employment matters and commercial disputes. Some of these lawsuits include claims for punitive as well as compensatory damages. The Company is insured for product liability claims for amounts in excess of established deductibles and accrues for the estimated liability on a case-by-case basis up to the limits of the deductibles. All other claims and lawsuits are also handled on a case-by-case basis. The Company does not believe that the potential liability from the ultimate outcome of environmental and litigation matters will have a material adverse effect on it. 8. BUSINESS SEGMENTS INFORMATION The Company serves the global commercial heating, ventilation, air conditioning and refrigeration ("HVAC&R") industry with two industry segments: Commercial Air Conditioning and Refrigeration, the manufacture, sale and distribution of heating, ventilating, air conditioning, industrial refrigeration and freezing equipment products, and Filtration Products, the manufacture and sale of air filtration products and systems. Information relating to operations in each industry segment is as follows as of and for the three and nine months ended March 31, 2000 and 1999: QUARTER ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, CLASSIFIED BY INDUSTRY 2000 1999 2000 1999 ---------------------- ---- ---- ---- ---- (DOLLARS IN THOUSANDS) Net Sales: Commercial Air Conditioning and Refrigeration $ 129,638 $ 144,270 $ 399,093 $ 446,103 Filtration Products ......................... 85,864 79,018 244,597 250,940 Eliminations ................................ (442) (1,654) (1,315) (8,295) --------- --------- --------- --------- Total ............................... $ 215,060 $ 221,634 $ 642,375 $ 688,748 ========= ========= ========= ========= Operating Income (Loss): Commercial Air Conditioning and Refrigeration $ (1,283) $ (3,523) $ (689) $ (837) Filtration Products ......................... 4,778 4,468 15,068 13,801 Corporate ................................... 245 2,948 (121) 2,767 --------- --------- --------- --------- Total ............................... $ 3,740 $ 3,893 $ 14,258 $ 15,731 ========= ========= ========= ========= Depreciation/Amortization: Commercial Air Conditioning and Refrigeration $ 4,982 $ 4,987 $ 15,136 $ 13,388 Filtration Products ......................... 2,444 2,543 7,388 7,745 Corporate ................................... 6 25 28 80 --------- --------- --------- --------- Total ............................... $ 7,432 $ 7,555 $ 22,552 $ 21,213 ========= ========= ========= ========= Capital Expenditures: Commercial Air Conditioning and Refrigeration $ 749 $ 3,804 $ 2,594 $ 12,696 Filtration Products ......................... 1,413 875 2,845 1,914 Corporate ................................... 75 -- 75 -- --------- --------- --------- --------- Total .......................... $ 2,237 $ 4,679 $ 5,514 $ 14,610 ========= ========= ========= ========= The Company estimates corporate expenses and determines fixed allocations of these expenses for each business segment at the beginning of the fiscal year. Any over or under allocation of actual expenses incurred results in income or expense reported at the corporate level. A reconciliation of segment profit to the Company's earnings before taxes is as follows: 9 QUARTER ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, 2000 1999 2000 1999 ---- ---- ---- ---- (DOLLARS IN THOUSANDS) Operating income from business segments ..... $ 3,495 $ 945 $ 14,379 $ 12,964 Over (under) allocation of corporate expenses 245 2,948 (121) 2,767 Interest expense, net ....................... 5,421 5,731 16,840 17,975 Other (income) expense ...................... (23) 773 1,839 (4,700) -------- -------- -------- -------- Income (loss) before income taxes ........... $ (1,658) $ (2,611) $ (4,421) $ 2,456 ======== ======== ======== ======== 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS NET SALES were $215 million in the three months ended March 31, 2000, which represents a decrease of $6.6 million, or 3.0%, as compared to the same period in the prior year. Net sales were $642.4 million for the nine months ended March 31, 2000, which represents a decrease of $46.4 million, or 6.7%, as compared to the same period in the prior year. The decrease is primarily attributable to the sale of the commercial air conditioning and refrigeration operation in France in October 1999, which contributed sales of $39.3 million in the first nine months of fiscal year 1999 as compared to $11.6 million in the first nine months of fiscal year 2000. The sale of this operation is in keeping with the Company's overall strategic plan to exit non-core businesses. This in conjunction with the restructuring that has occurred in the Chiller business unit discussed further below, and at J&E Hall discussed in footnote six (6) to the financial statements have resulted in an expected decrease in sales. Additionally, the Company estimates that approximately $17.3 million of the year-to-date decrease in sales is attributable to having one less week of sales in the first quarter of fiscal year 2000 as compared to fiscal year 1999. Excluding the impact of France and the additional week, the year-to-date decrease in net sales is less than 1.0%. COMMERCIAL AIR CONDITIONING AND REFRIGERATION GROUP net sales for the three months ended March 31, 2000 decreased $14.6 million, or 10.1%, to $129.6 million. This decrease is primarily attributable to the sale of the commercial air conditioning and refrigeration operation in France in October 1999. The France operation contributed $12.8 million of sales volume in the third quarter of fiscal year 1999 as compared to no sales in the third quarter of fiscal year 2000 due to the sale. Additional decreases were seen in the chiller products and terminal air conditioning systems business units. Chiller product net sales decreased 12.6% in the third quarter of fiscal year 2000 compared to the third quarter of fiscal year 1999. This decrease was expected primarily as a result of the restructuring of the chiller business unit in the prior year. Terminal air conditioning products net sales decreased 9.9% in the third quarter of fiscal 2000 as compared to the third quarter of fiscal year 1999 as a result of the product rationalization in North America and a related market reaction as a result of the changes in product offerings. The sales decreases noted were partially offset by increased sales in Applied Air Handling business unit as a result of strong demand for VisionTM air handlers, and increased sales from operations in the United Kingdom and Italy. Year-to-date sales decreased $47.0 million, or 10.5%, to $399.1 million. The Company estimates that approximately $11.4 million, or 24.3%, of the decrease is attributable to one less week of sales in the first quarter of fiscal 2000 as compared to the first quarter of fiscal 1999. The remaining decrease of $35.6 million is primarily attributable to the sale of the commercial air conditioning and refrigeration operation in France in October 1999, which contributed sales of $39.3 million in the first nine months of fiscal year 1999 as compared to $11.6 million in the first nine months of fiscal year 2000. Additional decreases were seen in the chiller products and terminal air conditioning systems business units. Chiller product year-to-date net sales decreased 14.5%. This decrease was expected primarily as a result of the restructuring of the chiller business unit in the prior year. Terminal air conditioning products year to date net sales decreased 11.3% as a result of the product rationalization in North America and a related market reaction as a result of the changes in product offerings. The sales decreases noted were partially offset by increased sales in the Applied Air Handling business unit as a result of strong demand for Vision-TM- air handlers, and increased sales from the operations in the United Kingdom and Italy. Backlog for the Commercial Air Conditioning and Refrigeration Group was $99.4 million at March 31, 2000 as compared to $133.7 and $124.4 million at June 30, 1999 and March 31, 1999, respectively. The decrease in backlog is attributable to a decrease in sales volume and the sale of the commercial air conditioning and refrigeration operation in France in October 1999. Excluding France backlog at June 30, 1999 and March 31, 1999, would have been $127.6 and $116.9 million, respectively. FILTRATION PRODUCTS GROUP net sales for the three months ended March 31, 2000 increased $6.8 million, or 8.7%, to $85.9 million. The increase is primarily attributable to increased sales in Latin America and Asia. Each of these regions had a large non-recurring project being completed in the third quarter of fiscal year 2000. There were no such projects in fiscal year 1999. Additionally, Clear Room product line sales increased as a result of the continued strong demand for semiconductors worldwide. Year-to-date sales decreased $6.3 million, or 2.5%, to $244.6 million. The decrease is attributable to the net impact of increased sales in the third quarter offset by continued slow MFAS sales in the United States due to soft market conditions and a decrease in air pollution control sales in Europe. Additionally, the Company 11 estimates that year-to-date sales are down by approximately $6.0 million due to one less week of sales in the first quarter of fiscal 2000 as compared to the first quarter of fiscal 1999. GROSS PROFIT decreased to $54.0 million, or 25.1%, of sales for the three months ended March 31, 2000, as compared to $55.9 million, or 25.2% of sales for the same period in the prior year. Year-to-date gross profit decreased to $164.5 million, or 25.6%, of sales. In the Commercial Air Conditioning and Refrigeration Group, year-to-date gross profit as a percentage of sales was 24.1% as compared to 24.6% for the same period in fiscal year 1999. This decrease in gross margin resulted primarily from unfavorable manufacturing performance. The Filtration Products Group's year-to-date gross profit as a percentage of sales increased from 28.3% in fiscal year 1999 to 28.6% for the same period in fiscal year 2000. This increase resulted from improved manufacturing performance and cost reduction programs. OPERATING EXPENSES were $50.2 million, or 23.4% of sales, for the third quarter of fiscal year 2000 versus $52.0 million, or 23.5% of sales, for the third quarter of fiscal year 1999. Excluding the restructuring charges operating expenses were 22.6% and 23.1% of sales in the third quarter of fiscal year 2000 and 1999, respectively. Year-to date operating expenses decreased $12.9 million to $150.2 million, or 23.4% of sales in fiscal year 2000 as compared to $163.1 million, or 23.7% of sales in fiscal year 1999. Excluding the restructuring charges operating expenses were 23.1% and 23.5% of sales in the first nine months of fiscal year 2000 and 1999, respectively. The Company estimates that approximately $4.1 million, or 33.8%, of the decrease is attributable to one less week of operating expenses in the first quarter of fiscal 2000 as compared to the first quarter of fiscal 1999. The remaining decrease of $8.0 million is primarily attributable to a reduction in commissions, selling and warranty expenses. INCOME FROM OPERATIONS for the third quarter and year-to-date decreased slightly as compared to the same periods in fiscal year 1999. For the third quarter income from operations decreased to $3.7 million, or 1.7% of sales, as compared to $3.9 million, or 1.8% of net sales, in the third quarter of fiscal 1999. Excluding the restructuring charges income from operations was 2.5% and 2.1% of sales in the third quarter of fiscal year 2000 and 1999, respectively. Year-to-date income from operations decreased to $14.3 million, or 2.2% of sales, as compared to $15.7 million, or 2.3% of sales, in fiscal year 2000 and 1999, respectively. Excluding the restructuring charges income from operations was flat at 2.5% of sales in the first nine months of fiscal years 1999 and 2000. The Commercial Air Conditioning and Refrigeration Group's income (loss) from operations decreased in the third quarter of fiscal year 2000 at $(1.3) million, or (1.0)% of sales, as compared to $(3.5) million, or (2.4)% of sales, in the third quarter of fiscal year 1999. Year-to-date income (loss) from operations decreased from $(0.8) million to $(0.7) million but remained flat at (0.2)% of sales, for the first nine months of fiscal year 2000 as compared to the first nine months of fiscal year 1999, respectively. The Filtration Products Group had an increase in income from operations in the third quarter of fiscal year 2000 from $4.5 million, or 5.7% of sales, to $4.8 million, or 5.6% of sales for the same period in fiscal year 1999. Year-to-date income from operations increased from $13.8 million, or 5.5% of sales, during the first nine months of fiscal year 1999 to $15.1 million, or 6.2% of sales, for the first nine months of fiscal year 2000. NET INTEREST EXPENSE decreased to $5.4 million and $16.8 million during the third quarter and nine months ended March 31, 2000 from $5.7 million and $18.0 million for the comparable periods ended March 31, 1999. This decrease is primarily attributable lower debt levels as well as having one less week of activity in the first nine months of fiscal year 2000 as compared to the first nine months of fiscal year 1999. NET OTHER (INCOME) EXPENSE for the third quarter of fiscal year 2000 was income of $0.02 million compared to net other expense of $0.8 million in the third quarter of fiscal year 1999. Year-to-date the Company had expense of $1.8 million as compared to income of $4.7 million for the same period in fiscal year 1999. See Note 3 to the unaudited condensed financial statements for further discussion. LIQUIDITY AND CAPITAL RESOURCES 12 The Company's liquidity needs are provided by cash generated from operating activities and supplemented when necessary by short-term credit facilities. During the first nine months of fiscal year 2000, funds generated by operating activities were $32.5 million as compared to $12.9 million of funds generated in the prior fiscal year for the comparable period. During the first nine months of fiscal year 2000, cash provided from investing activities was $7.5 million, which is comprised of proceeds from the sale of the Company's commercial air conditioning business in France for $13.0 million, reduced by capital expenditures of $5.5 million. Capital spending for the first nine months has been reduced from $14.6 million in the prior year to $5.5 million this year due to lower spending on the information technology project which was completed in September 1999. On September 30, 1999, the Company refinanced its Bank Credit Agreement with a New Term Loan of $30 million and a new Revolving Credit Facility of $90 million ("New Bank Credit Agreement"). The New Bank Credit Agreement has a three-year term, was used to retire all obligations under the previous Bank Agreement and is designed to provide added flexibility and borrowing availability. The New Bank Credit Agreement also provides favorable interest rates and other fees compared to the previous Bank Credit Agreement. At March 31, 2000, remaining borrowing availability under the new Revolving Credit portion of the New Bank Credit Agreement was $42 million. Total net payments on long term debt for the first nine months were $12.4 million which is a result of new borrowing under the New Term Loan of $30.0 million, repayment of the balance on the previous Bank Term Loan of $37.3 million and other long term debt payments of $5.1 million. Cash of $19.1 million was used to reduce borrowings under short term borrowing arrangements during the nine month period. Total debt of the Company was reduced from $266.4 million at June 30, 1999 to $234.9 million at March 31, 2000. A short-term credit facility provided to a subsidiary of the Company is supported by a letter of credit from O.Y.L. Industries Berhad (OYL) which expires on September 30, 2000. This support arrangement may be extended for additional time periods with the consent of OYL and the bank providing the facilities. Certain domestic letter of credit facilities totaling $13.5 million that were supported by a letter of credit from OYL expired on March 21, 2000. The related letter of credit requirements were transferred over to the New Bank Credit Agreement. On an ongoing basis the Company strives to evaluate its various businesses and product lines with the objective to enhance shareholder value. Consistent with this strategy, the Company intends to pursue global business opportunities that are synergistic with the Company's core businesses or exit low value added or non-synergistic operations. In October 1999, the Company sold the commercial air conditioning and refrigeration operation in France with the proceeds used to reduce debt. The Company does not believe that the sale of the commercial air conditioning and refrigeration operation in France will have a material effect on the Company's future financial results. Management believes, based upon current levels of operations and forecasted earnings, that cash flow from operations, together with borrowings under the New Bank Credit Agreement and other short-term credit facilities, will be adequate to make payments of principal and interest on debt, to permit anticipated capital expenditures and to fund working capital requirements and other cash needs. Nevertheless, the Company will remain leveraged to a significant extent and its debt service obligations will continue to be substantial. If the Company's sources of funds were to fail to satisfy the Company's requirements, the Company may need to refinance its existing debt or obtain additional financing. There is no assurance that any such new financing alternatives would be available, and, in any case, such new financing (if available) would be expected to be more costly and burdensome than the debt agreements currently in place. YEAR 2000 The Company experienced no significant disruptions in mission critical information technology and non-information technology systems related to the Year 2000 and believes it successfully responded to the Year 2000 date change. The Company incurred charges of approximately $27 million during the 1996 through 1999 time period in connection with remediating its systems. This spending was almost entirely for new ERP systems that resolved Y2K issues and increased the Company's system capabilities. The Company is not aware of any material problems resulting form Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly. 13 EURO CONVERSION Management has initiated an internal analysis of and planning for the effect the Euro will have on the operating and financial condition of the Company. The Euro is not expected to have a material effect on the Company's operating results or competitive position. The Company's financial systems are Euro compliant and opportunities will continue to be investigated for European-wide system infrastructure. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK There have been no material changes in the reported market risks since the end of the most recent fiscal year. See Note 5 to the Consolidated Financial Statements (unaudited) for disclosures of additional financial instruments that have been entered into by the Company since the end of the most recent fiscal year. FORWARD-LOOKING STATEMENTS When used in this report by management of the Company, from time to time, the words "believes," "anticipates," and "expects" and similar expressions are intended to identify forward-looking statements that involve certain risks and uncertainties. A variety of factors could cause actual results to differ materially from those anticipated in the Company's forward-looking statements, some of which include risk factors previously discussed in this and other SEC reports filed by the Company. These risk factors include, but are not limited to, general economic conditions, environmental laws and regulations, the weakening Asian markets, unforeseen competitive pressures, warranty expenses, market acceptance of new products, unseasonably cool spring or summer weather, a slow down in the chiller market, the inability to meet debt covenants, unforeseen difficulties in maintaining mutually beneficial relationships with strategic initiatives partners, the Year 2000 issue, and the results of restructuring activities. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date thereof. The Company undertakes no obligation to publicly release the results of any events or circumstances after the date hereof to reflect the occurrence of unanticipated events. 14 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS NUMBER DESCRIPTION ------ ----------- Exhibit 27 Financial Data Schedule (filed herewith) (b) REPORTS ON FORM 8-K There were no reports filed on Form 8-K during the period. 15 SIGNATURES - ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AAF-MCQUAY INC. DATE May 12, 2000 By: ---------------------- ----------------------------- Bruce D. Krueger Vice President of Finance Principal Accounting Officer and Principal Financial Officer 16 Exhibit Index NUMBER DESCRIPTION - ------ ----------- 27 Financial Data Schedule 17