MANAGEMENT'S DISCUSSION AND ANALYSIS
of Financial Condition
and Results of Operations
YEAR ENDED JUNE 30, 2002 VS. 2001
Net sales in 2002 decreased to $1.45 billion or 11% below the $1.63 billion
generated in 2001. This decrease was primarily due to the slowdown in U.S.
industrial activity. Sectors hardest hit by the slowdown include the industrial
machinery and equipment, durable goods and the electronic equipment industries,
all more than 20% below prior year sales levels. These sales decreases were
partially offset by stronger sales in the food products and automotive sectors.
The Company does not expect inflation to have a material impact on future
revenues.
Gross margin (net sales less cost of sales) for the year increased slightly
from 25.2% in 2001 to 25.3% in 2002. The 2002 margin was higher than in the
prior year due to improved buying practices and increased sales through catalog
channels which improved the profitability of our product mix.
Selling, distribution and administrative (SD&A) expenses were approximately
$19.4 million lower than in the prior year. The decreased amounts were due to
lower incentive and employee benefit expenses attributable to the lower sales
volumes, better overall expense management and additional operational
efficiencies. SD&A as a percentage of sales was 23.1% in 2002 versus 21.8% in
2001. The increase in SD&A as a percent of sales was due to the lower overall
sales noted above.
Operating income decreased to $30.8 million in 2002 from $55.0 million in
2001. As a percent of sales, operating income decreased to 2.1% in 2002 from
3.4% in 2001. The $24.2 million decline in operating income was due to the sales
decrease noted above.
Interest expense, net for 2002, decreased $2.4 million or 26.0% compared
with the prior year primarily as a result of a decrease in average borrowings
related to strong cash flows from operations and lower interest rates.
Income tax expense as a percentage of income before income taxes decreased
to 37.9% in 2002 from 38.1% in 2001. The decrease in the effective tax rate
resulted from a reduction in the impact of non-deductible items offset somewhat
by higher effective state and local income tax rates.
Net income before the cumulative effect of the accounting change for the
fiscal year ended June 30, 2002, decreased $13.3 million or 47.4% from the prior
year. Net income per share before the cumulative effect of the accounting change
decreased 46.1% to $.76 in 2002 from $1.41 in 2001 primarily due to the factors
described above.
In connection with the adoption of Statement of Financial Accounting
Standards ("SFAS") 142, "Goodwill and Other Intangible Assets", the Company
recorded a non-cash impairment charge totaling $12.1 million, after tax, or $.63
per share as a change in accounting principle effective July 1, 2001. This
charge wrote-off all of the remaining goodwill relating to the Company's fluid
power business. (See Note 1 to the Consolidated Financial Statements).
The number of associates was 4,508 at June 30, 2002 and 4,789 at June 30,
2001.
YEAR ENDED JUNE 30, 2001 VS. 2000
Net sales in 2001 increased to $1.63 billion or 1.5% over the $1.60 billion
generated in 2000. This increase was primarily due to the acquisition of the
operations of Dynavest to form Applied Industrial Technologies Ltd. of Canada,
and the acquisition of Air Draulics Engineering Co. (see Note 2 to Consolidated
Financial Statements). The increase in sales from these acquisitions offset the
decline in sales of the Company's existing U.S. operations during the year.
Gross margin for the year increased from 24.5% in 2000 to 25.2% in 2001
primarily due to improved buying practices as well as a better product mix.
Selling, distribution and administrative expenses increased in 2001 as a
percentage of sales to 21.8% from 20.8% in 2000. Total SD&A was approximately
$20.5 million higher than in the prior year. The increase was primarily due to
the operating expenses for our newly acquired operations and increased bad debt
expense due to the slowing industrial economy. This increase was partially
offset by lower incentive compensation costs.
Operating income decreased to $55.0 million in 2001 from $57.8 million in
2000. As a percent of sales, operating income decreased to 3.4% in 2001 from
3.6% in 2000. The $2.8 million reduction in operating income was primarily due
to the increase in SD&A expenses discussed previously.
Interest expense, net for 2001, increased $1.6 million or 21.2% compared
with the prior year primarily as a result of the increased average daily
borrowing to fund the Company's Canadian acquisition.
Income tax expense as a percentage of income before income taxes decreased
to 38.1% in 2001 from 38.6% in 2000. The decrease in the effective tax rate
resulted from lower effective state, local and Canadian tax rates.
Net income for the fiscal year ended June 30, 2001 decreased $3.0 million or
9.7% from the prior year. Net income per share decreased 6.0% to $1.41 in 2001
from $1.50 in 2000 primarily due to the factors described above.
The number of associates was 4,789 at June 30, 2001 and 4,847 at June 30,
2000.
10
LIQUIDITY AND CAPITAL RESOURCES
The Company generated $68.9 million of cash from operating activities in 2002
compared to $37.2 million in 2001. The primary reason for the increase relates
to the reduction of the Company's inventories and accounts receivable balances.
Cash used by investing activities decreased approximately $4.5 million in
2002 compared with 2001. The decrease is primarily due to a reduction in
acquisition activity from the previous year.
Cash used in financing activities was $51.1 million in 2002 compared to
$22.3 million in 2001. The primary reason for the increase was the additional
cash generated from operating activities used for debt reduction and stock
repurchases. During 2002, the Company repaid $30.7 million of long-term debt and
repurchased 0.8 million shares of its common stock for $14.3 million.
The Company is obligated for rental payments for operating leases on 261 of
its facilities. See Note 10 to the Consolidated Financial Statements for annual
rental commitments.
Working capital at June 30, 2002 was $250.6 million compared to $279.0
million at June 30, 2001. The current ratio was 2.9 and 3.2 at June 30, 2002 and
2001, respectively. These decreases are primarily due to reduction in year-end
inventory and accounts receivable balances.
Capital resources are obtained from income retained in the business,
borrowings under the Company's lines of credit, revolving credit agreement and
long-term debt facilities and from operating lease arrangements.
See Note 5 to the Consolidated Financial Statements for details regarding
the outstanding debt amounts as of June 30, 2002. Average combined short-term
and long-term borrowing was $103.0 million in 2002 and $117.5 million in 2001.
The weighted average interest rate on borrowings under revolving credit
facilities decreased to 3.7% in 2002 from an average rate of 6.2% in 2001. The
weighted average interest on borrowings under other long-term debt agreements,
net of the benefits received from interest rate swap agreements, was 5.5% in
2002 and 7.1% in 2001, respectively.
The Company has a committed revolving credit agreement expiring November
2003 with a group of lending institutions. This agreement provides for unsecured
borrowings of up to $150.0 million. The Company has no outstanding borrowings
under this facility at June 30, 2002. Unused capacity under this facility of
$144.8 million is available to fund future acquisitions or other capital and
operating requirements.
The Company also has an agreement with a commercial bank for an unsecured
$15.0 million uncommitted line of credit. The Company had no outstanding
borrowings under this facility at June 30, 2002.
In October 2000, the Company entered into an agreement with the Prudential
Insurance Company of America for an uncommitted shelf facility to borrow up to
$100.0 million in additional long-term financing, at the Company's sole
discretion, with terms of up to twelve years. The Company had no outstanding
borrowings under this facility at June 30, 2002.
The Board of Directors has authorized the repurchase of shares of the
Company's common stock to fund employee benefit programs, stock option and award
programs and for other corporate purposes. These purchases can be made in open
market or negotiated transactions. The Company acquired approximately 0.8
million shares of its common stock for $14.3 million during the year ended June
30, 2002. The Company has remaining authorization to repurchase 0.5 million
shares as of June 30, 2002.
Management expects that capital resources provided from operations,
available lines of credit, long-term debt and operating leases will be
sufficient to finance normal working capital needs, acquisitions, enhancement of
facilities and equipment and the purchase of additional Company common stock.
Management also believes that additional long-term debt and line of credit
financing could be obtained if desired.
CRITICAL ACCOUNTING POLICIES
ALLOWANCES FOR
SLOW-MOVING AND OBSOLETE INVENTORIES
The Company identifies slow moving or obsolete inventories and estimates
appropriate loss provisions related thereto. Historically, these loss provisions
have not been significant, as the vast majority of the Company's inventories are
eligible for credit under various supplier return programs. While the Company
has no reason to believe its inventory return privileges and programs will be
discontinued in the future, its risk of loss associated with obsolete or slow
moving inventories would increase if such were to occur.
ALLOWANCES FOR DOUBTFUL ACCOUNTS
The Company evaluates the collectibility of accounts receivable based on a
combination of factors. Initially, the Company estimates an allowance for
doubtful accounts as a percentage of net sales based on historical bad debt
experience. This initial estimate is periodically adjusted when the Company
becomes aware of a customer's inability to meet its financial obligations (e.g.,
11
bankruptcy filing) or as a result of changes in the overall aging of accounts
receivable. While the Company has a large customer base that is geographically
dispersed, a general economic downturn in any of the industry segments that the
Company serves could result in higher than expected defaults, and, therefore,
the need to increase estimates for bad debts.
GOODWILL ACCOUNTING
The Company adopted Statement of Financial Accounting Standard ("SFAS") No. 142,
"Goodwill and Other Intangible Assets", effective July 1, 2001. Goodwill is no
longer amortized but rather is evaluated at least annually for impairment. The
Company utilizes discounted cash flow models and relevant market multiples for
comparable businesses to determine fair value used in the goodwill impairment
evaluation. Management's estimates of fair value are based upon factors such as
projected future sales, price increases, and other uncertain elements requiring
significant judgments. While the Company uses the best available information to
prepare its estimates and perform impairment evaluations, actual results could
differ significantly, resulting in the future impairment of recorded goodwill
balances.
SUPPLIER PURCHASING PROGRAMS
The Company earns inventory purchase rebates under arrangements with certain
suppliers. The Company accrues for the receipt of inventory purchase rebates
based on cumulative purchases of inventory. While management believes the
Company will continue to receive such amounts, there can be no assurance that
suppliers will continue to provide comparable amounts of rebates in the future.
ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amount of revenues and expenses during
the period. Actual results may differ from the estimates and assumptions used in
preparing the consolidated financial statements.
OTHER MATTERS
In August 2001, the Financial Accounting Standards Board issued SFAS 144,
"Accounting for Impairment or Disposals of Long-Lived Assets". The Company will
adopt SFAS 144 as of July 1, 2002, but does not believe the statement will have
a material impact on the consolidated financial statements.
CAUTIONARY STATEMENT
UNDER PRIVATE SECURITIES LITIGATION REFORM ACT
This Annual Report to Shareholders, including Management's Discussion and
Analysis, contains 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", "intend", "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. 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 industry sectors; 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 products and labor; changes in operating
expenses; the effect of price increases or decreases; 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, including
electronic commerce and catalog initiatives; 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
12
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, natural events and
acts of God, fires, floods and accidents).
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
We have evaluated the Company's 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,
variable rate borrowings under its committed revolving credit agreement and
interest rate swaps. While there were no variable rate borrowings under its
committed revolving credit agreement at June 30, 2002, the Company effectively
converted its $50.0 million of 6.6% fixed rate debt to a variable rate based on
LIBOR through the use of an interest rate swap with a high credit quality major
commercial bank. Terms and settlement dates of the swap mirrored terms of the
6.6% senior unsecured term notes and the swap was designated as a fair value
hedge. The fair value changes in the swap were fully offset in interest expense
by the corresponding change in the notes. In August 2002, the Company terminated
this swap agreement for a favorable settlement of $2.8 million. This gain will
be amortized as a reduction in interest expense, over the remaining life of the
notes which mature in December 2007.
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 U.S. dollar denominated debt used to fund a
substantial portion of the 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 our
Mexican activity is not material at this time. The impact on the Company's
future earnings from exposure to changes in foreign currency exchange rates is
expected to be immaterial.
13
Applied Industrial Technologies, Inc. and Subsidiaries
STATEMENTS OF CONSOLIDATED INCOME
Year Ended June 30
2002 2001 2000
----------------------------------------------------
(In thousands, except per share amounts)
- -----------------------------------------------------------------------------------------------------------------------------------
NET SALES $ 1,446,569 $ 1,625,755 $ 1,601,084
Cost of sales 1,080,879 1,216,456 1,209,494
- -----------------------------------------------------------------------------------------------------------------------------------
365,690 409,299 391,590
Selling, distribution and administrative 334,856 354,298 333,811
- -----------------------------------------------------------------------------------------------------------------------------------
Operating Income 30,834 55,001 57,779
- -----------------------------------------------------------------------------------------------------------------------------------
Interest Expense 7,078 9,386 7,774
Interest Income (340) (281) (262)
Other, net 341 548 (281)
- -----------------------------------------------------------------------------------------------------------------------------------
7,079 9,653 7,231
- -----------------------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 23,755 45,348 50,548
- -----------------------------------------------------------------------------------------------------------------------------------
Income Tax Expense 9,000 17,300 19,500
- -----------------------------------------------------------------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 14,755 28,048 31,048
Cumulative effect of accounting change (12,100)
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 2,655 $ 28,048 $ 31,048
===================================================================================================================================
NET INCOME PER SHARE - BASIC
Before cumulative effect of accounting change $ 0.77 $ 1.43 $ 1.52
Cumulative effect of accounting change (0.63)
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME PER SHARE - BASIC $ 0.14 $ 1.43 $ 1.52
===================================================================================================================================
NET INCOME PER SHARE - DILUTED
Before cumulative effect of accounting change $ 0.76 $ 1.41 $ 1.50
Cumulative effect of accounting change (0.63)
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME PER SHARE - DILUTED $ 0.13 $ 1.41 $ 1.50
===================================================================================================================================
See notes to consolidated financial statements.
14
Applied Industrial Technologies, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
June 30
2002 2001
------------------------------------
(In thousands)
- -------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets
Cash and temporary investments $ 23,060 $ 13,981
Accounts receivable, less allowances of $5,600 and $5,400 180,904 190,935
Inventories 166,083 191,570
Other current assets 11,011 9,974
- -------------------------------------------------------------------------------------------------------------------------
Total current assets 381,058 406,460
- -------------------------------------------------------------------------------------------------------------------------
Property - at cost
Land 11,779 12,121
Buildings 69,131 68,840
Equipment 83,414 84,478
- -------------------------------------------------------------------------------------------------------------------------
164,324 165,439
Less accumulated depreciation 81,229 75,176
- -------------------------------------------------------------------------------------------------------------------------
Property - net 83,095 90,263
- -------------------------------------------------------------------------------------------------------------------------
Goodwill 46,410 62,021
Other assets 24,003 20,110
- -------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 534,566 $ 578,854
=======================================================================================================================
LIABILITIES
Current liabilities
Accounts payable $ 76,316 $ 75,896
Compensation and related benefits 27,277 23,749
Other current liabilities 26,821 27,814
- -------------------------------------------------------------------------------------------------------------------------
Total current liabilities 130,414 127,459
Long-term debt 83,478 113,494
Other liabilities 22,527 26,383
- -------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 236,419 267,336
- -------------------------------------------------------------------------------------------------------------------------
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 84,517 84,221
Income retained for use in the business 279,046 285,661
Treasury shares - at cost (4,893 and 4,449 shares) (74,900) (66,227)
Unearned restricted common stock compensation (832) (1,955)
Accumulated other comprehensive income (loss) 316 (182)
- -------------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 298,147 311,518
- -------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 534,566 $ 578,854
=======================================================================================================================
See notes to consolidated financial statements.
15
Applied Industrial Technologies, Inc. and Subsidiaries
STATEMENTS OF CONSOLIDATED CASH FLOWS
Year Ended June 30
2002 2001 2000
----------------------------------------------------
(In thousands)
- ----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,655 $ 28,048 $ 31,048
Adjustments to reconcile net income to cash provided
by operating activities:
Cumulative effect of accounting change 12,100
Depreciation 15,294 16,364 17,500
Deferred income taxes (5,000) (1,800) (2,886)
Amortization of restricted common stock compensation,
goodwill and other intangible assets 2,254 6,145 5,488
Provision for losses on accounts receivable 4,488 6,995 3,058
Gain on sale of property (1,327) (1,080) (460)
Treasury shares contributed to employee benefit and deferred
compensation plans 2,977 6,529 3,819
Changes in current assets and liabilities, net of acquisitions:
Accounts receivable 7,237 15,869 (7,606)
Inventories 27,020 (8,522) 1,138
Other current assets (688) (1,908) (944)
Accounts payable 420 (17,691) 14,751
Accrued expenses 1,518 (11,732) 11,538
- -----------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 68,948 37,217 76,444
- -----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Property purchases (10,050) (11,731) (9,510)
Proceeds from property sales 3,610 4,251 5,338
Net cash paid for acquisition of businesses, net of cash
acquired of $812 in 2001 (2,574) (5,491) (34,522)
Deposits and other 274 (310) (294)
- -----------------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (8,740) (13,281) (38,988)
- -----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments under revolving credit agreements - net (19,312) (12,246) (2,403)
Long-term debt borrowings 25,000
Long-term debt repayments (11,429) (11,428) (11,429)
Purchases of treasury shares (14,318) (15,501) (20,833)
Dividends paid (9,270) (9,532) (9,929)
Exercise of stock options 3,200 1,403 301
- -----------------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN FINANCING ACTIVITIES (51,129) (22,304) (44,293)
- -----------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and temporary investments 9,079 1,632 (6,837)
Cash and temporary investments at beginning of year 13,981 12,349 19,186
- -----------------------------------------------------------------------------------------------------------------------------------
CASH AND TEMPORARY INVESTMENTS AT END OF YEAR $ 23,060 $ 13,981 $ 12,349
===================================================================================================================================
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for:
Income taxes $ 8,182 $ 22,080 $ 21,359
Interest $ 6,205 $ 8,595 $ 7,247
See notes to consolidated financial statements.
16
Applied Industrial Technologies, Inc. and Subsidiaries
STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY
For the Years Ended June 30, 2002, 2001 and 2000
-----------------------------------------------------------------------------
Income
Shares of Additional Retained for Treasury
Common Stock Common Paid-in Use in the Shares-at
Outstanding Stock Capital Business Cost
(In thousands, except per share amounts)
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE AT JULY 1, 1999 21,101 $ 10,000 $ 82,599 $ 246,026 $ (40,140)
Net income 31,048
Cash dividends - $.48 per share (9,929)
Purchases of common stock for treasury (1,280) (20,833)
Treasury shares issued for:
Retirement Savings Plan contributions 210 493 2,921
Exercise of stock options 22 7 294
Deferred compensation plans 25 66 339
Amortization of restricted
common stock compensation 62
Other 85
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2000 20,078 10,000 83,312 267,145 (57,419)
Net income 28,048
Minimum pension liability
Cash flow hedge and other
TOTAL COMPREHENSIVE INCOME
Cash dividends - $.48 per share (9,532)
Purchases of common stock for treasury (891) (15,501)
Treasury shares issued for:
Retirement Savings Plan contributions 309 882 4,516
Exercise of stock options 110 (201) 1,604
Deferred compensation plans 67 180 951
Forfeiture of restricted common stock
compensation (26) (286) (378)
Amortization of restricted
common stock compensation 58
Other 276
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2001 19,647 10,000 84,221 285,661 (66,227)
Net income 2,655
Minimum pension liability
Cash flow hedge and other
TOTAL COMPREHENSIVE INCOME
Cash dividends - $.48 per share (9,270)
Purchases of common stock for treasury (817) (14,318)
Treasury shares issued for:
Retirement Savings Plan contributions 148 434 2,243
Exercise of stock options 226 (183) 3,383
Deferred compensation plans 14 52 248
Forfeiture of restricted common stock
compensation (15) (76) (229)
Amortization of restricted
common stock compensation (169)
Other 238
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2002 19,203 $ 10,000 $ 84,517 $ 279,046 $ (74,900)
===========================================================================================================================
For the Years Ended June 30, 2002, 2001 and 2000
---------------------------------------------------
Unearned
Restricted Accumulated
Common Other Total
Stock Comprehensive Shareholders'
Compensation Income (loss) Equity
(In thousands, except per share amounts)
- ------------------------------------------------------------------------------------------------
BALANCE AT JULY 1, 1999 $ (4,899) $ 293,586
Net income 31,048
Cash dividends - $.48 per share (9,929)
Purchases of common stock for treasury (20,833)
Treasury shares issued for:
Retirement Savings Plan contributions 3,414
Exercise of stock options 301
Deferred compensation plans 405
Amortization of restricted
common stock compensation 1,192 1,254
Other 85
- ---------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2000 (3,707) 299,331
Net income 28,048
Minimum pension liability $ (285) (285)
Cash flow hedge and other 103 103
------------
TOTAL COMPREHENSIVE INCOME 27,866
------------
Cash dividends - $.48 per share (9,532)
Purchases of common stock for treasury (15,501)
Treasury shares issued for:
Retirement Savings Plan contributions 5,398
Exercise of stock options 1,403
Deferred compensation plans 1,131
Forfeiture of restricted common stock
compensation 664
Amortization of restricted
common stock compensation 1,088 1,146
Other 276
- ---------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2001 (1,955) (182) 311,518
Net income 2,655
Minimum pension liability 285 285
Cash flow hedge and other 213 213
------------
TOTAL COMPREHENSIVE INCOME 3,153
------------
Cash dividends - $.48 per share (9,270)
Purchases of common stock for treasury (14,318)
Treasury shares issued for:
Retirement Savings Plan contributions 2,677
Exercise of stock options 3,200
Deferred compensation plans 300
Forfeiture of restricted common stock
compensation 305
Amortization of restricted
common stock compensation 818 649
Other 238
- ---------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2002 $ (832) $ 316 $ 298,147
=============================================================================================
See notes to consolidated financial statements.
17
Applied Industrial Technologies, Inc. and Subsidiaries
Notes to CONSOLIDATED FINANCIAL STATEMENTS
Years Ended June 30, 2002, 2001 and 2000
(Dollar amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
NOTE 1
BUSINESS AND ACCOUNTING POLICIES
Business
The Company is one of North America's leading distributors of industrial and
fluid power products and systems. Industrial products include bearings and
seals, linear motion products, power transmission products, industrial rubber
products, general maintenance products and related specialty items. Fluid power
includes hydraulic, pneumatic, lubrication and filtration components and
systems. The Company also provides mechanical, electrical, rubber shop and fluid
power services as well as material handling components and systems. The Company
offers technical application support for these products and provides creative
solutions to help customers minimize downtime and reduce overall procurement
costs. Although the Company does not generally manufacture the products it
sells, it does assemble and repair certain products and systems. Most of the
Company's sales are in the maintenance and replacement markets to customers in a
wide range of industries, principally in North America.
Consolidation
The consolidated financial statements include the accounts of Applied Industrial
Technologies, Inc. and its majority owned subsidiaries. All significant
intercompany transactions and balances have been eliminated in consolidation.
Investments in businesses in which the Company does not have control, but has
the ability to exercise significant influence over the operating and financial
policies, are accounted for using the equity method of accounting. The financial
statements of the Company's Canadian subsidiaries are included in the
consolidated financial statements based upon their fiscal year ended May 31.
Foreign Currency
The financial statements of the Company's Canadian and Mexican subsidiaries are
measured using local currencies as their functional currencies. Assets and
liabilities are translated into U.S. dollars at the exchange rates as of
year-end, while income statement amounts are translated at average monthly
exchange rates. Translation gains and losses are included as components of
accumulated other comprehensive income in shareholders' equity. Transaction
gains and losses are included in the statements of consolidated income and were
not material.
Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amount of revenues and expenses during
the period. Actual results may differ from the estimates and assumptions used in
preparing the consolidated financial statements.
Cash and Temporary Investments
The Company considers all temporary investments with maturities of three months
or less to be cash equivalents.
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 primarily are five years. The non-competition agreements are
included in other assets.
In accordance with SFAS 142, the Company discontinued the amortization of
goodwill effective July 1, 2001. Had goodwill amortization not been recorded in
the years ended June 30, 2001 and 2000, operating income would have increased to
$58,471 and $60,683; net income to $30,902 and $33,474; and net income per share
to $1.55 and $1.62, respectively.
For purposes of completing impairment testing upon adoption of SFAS 142, the
Company determined the fair value of its reporting units utilizing discounted
cash flows models and relative market multiples for comparable businesses. The
Company compared the fair value of each of its reporting units to its carrying
value. This evaluation indicated that goodwill associated with its fluid power
business was impaired. This impairment is primarily attributed to a downturn in
the industrial economy in the years following the Company's fluid power business
acquisitions. A non-cash charge totaling $17,600, $12,100 after tax, was
recorded as the cumulative effect of a change in accounting principle effective
July 1, 2001 to write-off the remaining goodwill relating to the fluid power
business.
18
The changes in the carrying amount of goodwill for the years ended June 30, 2002
and 2001, are as follows:
Service Center Based Fluid Power
Distribution Segment Business Total
---------------------------------------------
Balance at July 1, 2000 $ 47,552 $ 15,157 $ 62,709
Goodwill of acquired businesses 3,500 3,500
Adjustments of preliminary goodwill of prior year acquisition (524) (524)
Amortization (2,413) (1,057) (3,470)
Currency translation adjustment (194) (194)
----------------------------------------------------------------------------------------------------------------
Balance at June 30, 2001 44,421 17,600 62,021
Transitional impairment loss (17,600) (17,600)
Goodwill of acquired businesses 1,989 1,989
----------------------------------------------------------------------------------------------------------------
Balance at June 30, 2002 $ 46,410 $ 0 $ 46,410
================================================================================================================
As of June 30, 2001, prior to adoption of SFAS 142, accumulated goodwill
amortization totaled $13,069.
Inventories
Domestic inventories are valued at the lower of cost or market, using the
last-in, first-out (LIFO) method, and foreign inventories are valued using the
average cost method. See Note 3 for further information regarding inventories.
Depreciation
Depreciation of buildings and equipment is computed using the straight-line
method over the estimated useful lives of the assets. Buildings and related
improvements are depreciated over 10 to 30 years and equipment over 3 to 8
years.
Revenue Recognition
Sales are recognized when products are shipped or delivered to the customer.
Income Taxes
Income taxes are determined based upon income and expenses recorded for
financial reporting purposes. Deferred income taxes are recorded for estimated
future tax effects of differences between the bases of assets and liabilities
for financial reporting and income tax purposes giving consideration to enacted
tax laws.
Net Income Per Share
The following is a computation of the basic and diluted earnings per share:
Year Ended June 30
2002 2001 2000
------------------------------------------
NET INCOME
Income Before Cumulative Effect of Accounting Change $ 14,755 $ 28,048 $31,048
Cumulative effect of accounting change (12,100)
------------------------------------------------------------------------------------------------
Net Income $ 2,655 $ 28,048 $31,048
================================================================================================
AVERAGE SHARES OUTSTANDING
Weighted average common shares outstanding
for basic computation 19,079 19,589 20,439
Dilutive effect of stock based options and awards 338 335 248
------------------------------------------------------------------------------------------------
Weighted average common shares outstanding
for dilutive computation 19,417 19,924 20,687
================================================================================================
NET INCOME PER SHARE - BASIC
Before cumulative effect of accounting change $ 0.77 $ 1.43 $1.52
Cumulative effect of accounting change (0.63)
------------------------------------------------------------------------------------------------
Net Income Per Share - Basic $ 0.14 $ 1.43 $1.52
================================================================================================
Net Income Per Share - Diluted
Before cumulative effect of accounting change $ 0.76 $ 1.41 $1.50
Cumulative effect of accounting change (0.63)
------------------------------------------------------------------------------------------------
Net Income Per Share - Diluted $ 0.13 $ 1.41 $1.50
================================================================================================
New Accounting Standard
In August 2001, the Financial Accounting Standards Board issued SFAS 144,
"Accounting for Impairment or Disposals of Long-Lived Assets". The Company will
adopt SFAS 144 as of July 1, 2002, but does not believe the statement will have
a material impact on the consolidated financial statements.
NOTE 2
BUSINESS COMBINATIONS
During the year ended June 30, 2002, the Company acquired the stock of a Mexican
distributor of bearing and power transmission products for $3,200. Results of
the business operations are included in our Service Center Based Distribution
segment. Non-tax deductible goodwill of $1,989 and other intangible assets,
primarily non-competition agreements of $350, were recognized in connection with
this combination.
During the year ended June 30, 2001, the Company acquired the stock of Air
Draulics Engineering Company, a U.S. based distributor of fluid power products,
for $7,300. Goodwill, based on allocations of fair values to assets and
liabilities acquired, of $3,500 was recognized in connection with this
combination.
Effective June 1, 2000, the Company acquired certain assets of Dynavest
Corporation, a Canadian distributor of bearings, power transmission, fluid power
and industrial rubber products. In December 1999, the Company acquired certain
19
assets of a U.S. based distributor of bearings and power transmission
components. The total purchase price of these acquisitions was $37,803,
including notes payable to the sellers totaling $3,282. The Canadian
acquisition's operating results have been included in the Company's consolidated
income statement from the beginning of fiscal 2001. The Company recorded
goodwill totaling $6,800 from these acquisitions, representing the excess of the
purchase price over assets acquired.
Results of operations of all of the above acquisitions, which have all been
accounted for as purchases, are included in the accompanying consolidated
financial statements from their respective acquisition dates. The results of
operations for these acquisitions are not material for all years presented.
NOTE 3
INVENTORIES
Inventories consist of the following:
June 30
2002 2001
-------------------------
-----------------------------------------------------------------------------------------------
U.S. inventories at current cost $259,145 $283,215
Foreign inventories at average cost 18,527 17,250
-----------------------------------------------------------------------------------------------
277,672 300,465
Less: Excess of current cost over LIFO cost for U.S. inventories 111,589 108,895
-----------------------------------------------------------------------------------------------
Inventories on consolidated balance sheet $166,083 $191,570
===============================================================================================
Reductions in inventories during the fiscal year ended June 30, 2002 resulted in
liquidation of LIFO inventory quantities carried at lower costs prevailing in
prior years. The effect of these liquidations for the year ended June 30, 2002
increased gross profit by $915, net income by $546 and diluted net income per
share by $.03.
NOTE 4
OTHER BALANCE SHEET INFORMATION
Other assets consist of the following:
June 30
2002 2001
-------------------------
-----------------------------------------------------------------------------------------------
Deferred tax assets - non-current $ 13,032 $ 6,789
Deposits and investments 3,634 3,624
Non-competition agreements, net of accumulated
amortization of $7,044 and $5,393 1,874 3,092
Other 5,463 6,605
-----------------------------------------------------------------------------------------------
Total $ 24,003 $20,110
===============================================================================================
Substantially all investments have fair values approximately equal to their
carrying values. Amortization expense for the non-competition agreements totaled
$1,651 in 2002 and $1,587 in 2001. Estimated amortization expense is $640 for
2003; $480 for 2004; $370 for 2005 and $384 after 2005.
Other current liabilities consist of the following:
June 30
2002 2001
-------------------------
-----------------------------------------------------------------------------------------------
Accrued income and other taxes $ 9,689 $ 4,610
Accrued self insurance liabilities 5,008 4,907
Deferred tax liabilities - current 1,950 5,573
Other 10,174 12,724
-----------------------------------------------------------------------------------------------
Total $ 26,821 $27,814
===============================================================================================
NOTE 5
DEBT
The Company has a committed revolving credit agreement expiring November 2003
with a group of banks. This agreement provides for unsecured borrowings of up to
$150,000 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 June 30, 2002. Fees on this facility range
from .12% to .40% per year on the average amount of the total revolving credit
commitments during the year. This facility enables the Company to refinance
short-term debt on a long-term basis. Accordingly, the current portion of
long-term borrowings intended to be refinanced are classified as long-term debt.
Unused lines under this facility totaling $144,805 are available to fund future
acquisitions or other capital and operating requirements.
20
The Company also has a $15,000 short-term uncommitted line of credit with a
commercial bank. This agreement provides for payment of interest at various
interest rate options, none of which is in excess of the bank's prime rate at
interest determination dates. The Company had no borrowings outstanding under
this facility at June 30, 2002.
Long-term debt consists of:
June 30
2002 2001
-------------------------
--------------------------------------------------------------------------------------------------
Revolving credit facility, effective rate 4.3% $ 21,351
7.98% Private placement debt, due at maturity in November 2010 $ 25,000 25,000
7.82% Senior unsecured term notes, due in
semi-annual installments of $5,714 through December 2002 5,714 17,143
6.6% Senior $50,000 unsecured term notes, due at maturity in
December 2007, including effects of interest rate swaps (See Note 6) 52,764 50,000
--------------------------------------------------------------------------------------------------
Total $ 83,478 $113,494
==================================================================================================
The revolving credit facility, private placement debt and senior unsecured
term notes contain restrictive covenants regarding liquidity, tangible net
worth, financial ratios and other covenants. At June 30, 2002, the most
restrictive of these covenants required that the Company maintain a minimum
consolidated net worth of $264,505. Based upon current market rates for debt of
similar maturities, the Company estimates that the fair value of its debt is
greater than its carrying value at June 30, 2002 by approximately $1,510.
In November 2000, the Company refinanced $25,000 of its debt incurred in
connection with its Canadian acquisition, which debt was previously financed
under its revolving credit facility, through a private issuance of senior notes.
Fixed annual interest of 7.98% is paid quarterly and principal is due at
maturity in November 2010.
In October 2000, the Company entered into an agreement with the Prudential
Insurance Company of America for an uncommitted shelf facility to borrow up to
$100,000 in additional long-term financing, at the Company's sole discretion,
with terms of up to twelve years. At June 30, 2002, there were no borrowings
under this agreement.
NOTE 6
RISK MANAGEMENT ACTIVITIES
The Company is exposed to market risks, primarily resulting from changes in
interest rates and currency exchange rates. To manage these risks, the Company
may enter into derivative transactions pursuant to the Company's written policy.
These transactions are all accounted for in accordance with SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities". The Company does
not hold or issue derivative financial instruments for trading purposes.
In November 2001, the Company entered into an interest rate swap agreement
with a domestic bank. This agreement effectively converted the fixed interest
rate on the $50,000, 6.6% senior unsecured term notes to a floating variable
rate based on LIBOR. Terms and settlement dates mirrored terms of the 6.6%
senior unsecured term notes and the swap was designated as a fair value hedge.
The fair value changes in the notes were fully offset in interest expense by the
fair value changes in the swap. At June 30, 2002, the fair value of the interest
rate swap was recorded as an other current asset of $970 and the change in fair
value of the related underlying debt obligation was recorded as an increase in
long-term debt. In August 2002, the Company terminated its November 2001
interest rate swap agreement for a favorable settlement of $2,800. This gain
will be amortized as a reduction in interest expense over the remaining life of
the notes which mature in December 2007.
In July 2001, the Company entered into an interest rate swap agreement with a
domestic bank. This agreement effectively converted the fixed interest rate on
$47,000 of the $50,000, 6.6% senior unsecured term notes to a floating variable
rate based on LIBOR. Terms and settlement dates mirrored terms of the 6.6%
senior unsecured term note and the swap was designated as a fair value hedge. On
October 1, 2001, the Company terminated the swap agreement for a favorable
settlement of $2,100. This gain is being amortized as a reduction of interest
expense over the remaining life of the notes which mature in December 2007.
In November 2000, the Company entered into two 10 year cross-currency swap
agreements to manage its foreign currency risk exposure on private placement
borrowings related to its wholly owned Canadian subsidiary. The cross currency
swaps effectively convert $25,000 of debt, and the associated interest payments,
from 7.98% fixed rate U.S. dollar denominated debt to 7.75% fixed rate Canadian
dollar denominated debt. The terms of the two cross-currency swaps mirror the
terms of the private placement borrowings.
The Company has designated one of the cross-currency swaps, with a $20,000
U.S. notional amount, as a foreign currency cash flow hedge. The fair value of
the cross-currency swap was $854 at June 30, 2002 which is recorded in other
current assets and the related unrealized gain is recorded in accumulated other
comprehensive income (net of tax). The second cross-currency swap, however, has
not been designated as a hedging instrument under the hedge accounting
provisions of SFAS 133. The fair value of this cross-currency swap was $214 at
June 30, 2002 and $126 at June 30, 2001. Changes in the fair value of this
derivative instrument are recorded in earnings as a component of other income,
net.
21
NOTE 7
INCOME TAXES
Provision
The provision (benefit) for income taxes consists of:
Year Ended June 30
2002 2001 2000
------------------------------------------
-----------------------------------------------------------------------------------------------
Current
Federal $12,350 $ 17,550 $20,206
State 1,450 1,450 2,180
Foreign 200 100
-----------------------------------------------------------------------------------------------
Total current 14,000 19,100 22,386
===============================================================================================
Deferred
Federal (4,500) (900) (2,706)
State (600) (200) (180)
Foreign 100 (700)
-----------------------------------------------------------------------------------------------
Total deferred (5,000) (1,800) (2,886)
-----------------------------------------------------------------------------------------------
Total $ 9,000 $ 17,300 $19,500
===============================================================================================
The exercise of non-qualified stock options during fiscal 2002, 2001 and 2000
resulted in $605, $374 and $33, respectively, of income tax benefits to the
Company derived from the difference between the market price at the date of
exercise and the option price. The accelerated vesting of Performance
Accelerated Restricted Stock ("PARS") and other restricted stock awards in
fiscal 2002 resulted in incremental tax expense of $169 over the amounts
previously reported for financial reporting purposes. Accelerated vesting of
PARS in fiscal 2001 and 2000 resulted in $57 and $62, respectively, of
incremental income tax benefits over the amounts previously reported for
financial reporting purposes. These tax benefits and expense were recorded in
additional paid-in capital.
Effective Tax Rates
The following is a reconciliation between the federal statutory income tax rate
and the Company's effective tax rate:
Year Ended June 30
2002 2001 2000
---------------------------------------
-----------------------------------------------------------------------------------------------
Statutory tax rate 35.0% 35.0% 35.0%
Effects of:
State and local income taxes 2.4 1.8 2.6
Non-deductible expenses 1.4 2.6 1.8
International income taxes (.1) (.9)
Other, net (.8) (.4) (.8)
-----------------------------------------------------------------------------------------------
Effective tax rate 37.9% 38.1% 38.6%
===============================================================================================
Balance Sheet
The significant components of the Company's deferred tax assets (liabilities)
are as follows:
June 30
2002 2001
-------------------------
-----------------------------------------------------------------------------------------------
Inventories $(10,491) $(13,200)
Depreciation and differences in property bases (5,966) (5,625)
Compensation liabilities not currently deductible 10,682 10,960
Reserves not currently deductible 7,723 5,668
Goodwill 7,051 1,982
Net operating loss carry forward, expiring 2009 and 2008 1,427 821
Other 656 609
-----------------------------------------------------------------------------------------------
Net deferred tax asset $ 11,082 $ 1,215
===============================================================================================
NOTE 8
SHAREHOLDERS' EQUITY
Stock Incentive Plans
The 1997 Long-Term Performance Plan (the "1997 Plan") provides for granting of
stock options, stock awards, cash awards, and such other awards or combination
thereof as the Executive Organization and Compensation Committee of the Board of
Directors may determine. The number of shares of common stock which may be
awarded in each fiscal year under the 1997 Plan is two percent (2%) of the total
number of shares of common stock outstanding on the first day of each year for
which the plan is in effect. Common stock available for distribution under the
1997 Plan, but not distributed, may be carried over to the following year.
Shares available for future grants at June 30, 2002 and 2001 were 253,000 and
159,000, respectively.
Under the 1997 Plan, the Company has awarded PARS, restricted stock and/or
stock options to officers, other key associates and members of the Board of
Directors. PARS and restricted stock award recipients are entitled to receive
dividends on, and have voting rights with respect to their respective shares,
but are restricted from selling or transferring the shares prior to vesting. The
PARS vest after a period of six years, with accelerated vesting based upon
achievement of certain return on asset objectives or minimum stock price levels.
Restricted stock awards vest 25% each year. The aggregate fair market value of
the PARS and restricted stock is considered unearned compensation at the time of
grant and is amortized over the vesting period or until such time as
acceleration of vesting takes place.
22
At June 30, 2002, the Company had outstanding stock options granted under the
1997 Plan. In general, the stock options vest over a period of 4 years and
expire after 10 years. The Company applies APB Opinion No. 25 and related
interpretations in accounting for options granted under the 1997 Plan. Had the
Company accounted for options granted based on fair value at the grant dates for
awards under the 1997 Plan consistent with the method of SFAS 123, the Company's
net income and net income per share would have been reduced to $1,334 and $.07
in 2002, $26,882 and $1.35 in 2001 and $30,003 and $1.45 in 2000.
Disclosures under the fair value method are estimated using the Black Scholes
option pricing model. The assumptions used for grants issued in 2002, 2001 and
2000 are:
2002 2001 2000
------------------------------------------
-----------------------------------------------------------------------------------------------
Expected life 7 YEARS 7 years 7 years
Risk free interest rate 4.9% 5.0% 6.6%
Dividend yield 3.0% 3.0% 3.0%
Volatility 29.1% 28.9% 28.8%
Information regarding these option plans is as follows:
2002 2001 2000
-------------------------------------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
(Share amounts in thousands) Shares Price Shares Price Shares Price
-----------------------------------------------------------------------------------------------
Outstanding, beginning of year 2,124 $16.10 1,870 $15.03 1,464 $14.67
Granted 401 17.86 457 18.96 476 16.27
Exercised (226) 11.57 (110) 9.33 (21) 12.79
Expired/canceled (100) 17.82 (93) 16.72 (49) 17.27
-----------------------------------------------------------------------------------------------
Outstanding June 30 2,199 $16.80 2,124 $16.10 1,870 $15.03
===============================================================================================
Options exercisable June 30 1,322 $16.25 1,178 $15.05 928 $14.01
Weighted-average fair value
of options granted
during the year $ 4.65 $ 5.41 $ 5.15
The following table summarizes information about stock options outstanding at
June 30, 2002:
Options Outstanding Options Exercisable
------------------------------------------ ----------------------
Weighted- Weighted- Weighted-
Average Average Average
Ranges of Number Remaining Exercise Number Exercise
Exercise Prices Outstanding Life (in years) Price Exercisable Price
----------------------------------------------------------------------------------------------------------
$ 9 - $13 69 1.1 $ 9.75 69 $ 9.75
13 - 17 955 5.4 15.02 695 14.67
17 - 21 1,141 7.2 18.42 524 18.50
21 - 28 34 5.5 26.94 34 26.94
----------------------------------------------------------------------------------------------------------
Total 2,199 1,322
==========================================================================================================
At June 30, 2002, exercise prices for outstanding options ranged from $9.75 to
$27.50 per share.
Shareholder Rights
In 1998 the Company's Board of Directors adopted a Shareholder Rights Plan and
declared a dividend distribution of one preferred share purchase right for each
outstanding share of Company common stock. The rights become exercisable only if
a person or group acquires beneficial ownership or commences a tender or
exchange offer for 20% or more of the Company's common stock, unless the tender
or exchange offer is for all outstanding shares of the Company upon terms
determined by the Company's continuing directors to be in the best interests of
the Company and its shareholders. When exercisable, the rights would entitle the
holders (other than the acquirer) to buy shares of the Company's common stock
having a market value equal to two times the right's exercise price or, in
certain circumstances, to buy shares of the acquiring company having a market
value equal to two times the right's exercise price.
Treasury Shares
At June 30, 2002, 756,000 shares of the Company's common stock held as treasury
shares are restricted as collateral under escrow arrangements relating to
certain change in control and director and officer indemnification agreements.
NOTE 9
BENEFIT PLANS
Retirement Savings Plan
Substantially all associates of the Company's U.S. subsidiaries can participate
in the Applied Industrial Technologies, Inc. Retirement Savings Plan. The
Company makes a discretionary profit-sharing contribution to the Retirement
Savings Plan generally based upon a percentage of the Company's income before
income taxes and before the amount of the contribution. The Company also
partially matches 401(k) contributions by participants, who may elect to
contribute up to 50 percent of their compensation. The matching contribution is
made with the Company's common stock and is determined quarterly using rates
based on achieving certain quarterly earnings per share levels.
The Company's expense for contributions to the above plan was $2,841, $6,038,
and $4,837 for the years ended June 30, 2002, 2001, and 2000, respectively.
23
Deferred Compensation Plans
The Company has deferred compensation plans that enable certain associates of
the Company to defer receipt of a portion of their compensation and non-employee
directors to defer receipt of director fees. The Company funds these deferred
compensation liabilities by making contributions to rabbi trusts. Contributions
consist of Company common stock and investments in money market and mutual
funds.
Postemployment Benefit Plans
The following table provides summary disclosure of the Company's Supplemental
Executive Retirement Benefits Plan, qualified retirement plan, salary
continuation benefits and retiree medical benefits:
Pension Benefits Other Benefits
------------------ ----------------
2002 2001 2002 2001
------------------------------------------------------------------------------------------------
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of the year $ 19,218 $ 14,645 $ 4,508 $ 3,297
Service cost 628 482 57 52
Interest cost 1,732 1,235 306 239
Benefits paid (2,236) (1,996) (281) (196)
Amendments 252 2,262 150
Actuarial (gain) loss during year (1,080) 2,590 (496) 1,116
-----------------------------------------------------------------------------------------------
Benefit obligation at June 30 $ 18,514 $ 19,218 $ 4,244 $ 4,508
===============================================================================================
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning
of year $ 2,166 $ 1,943
Actual return on plan assets (140) 4
Employer contribution 3,471 2,215 $ 281 $ 196
Benefits paid (2,236) (1,996) (281) (196)
-----------------------------------------------------------------------------------------------
Fair value of plan assets at June 30 $ 3,261 $ 2,166 0 $ 0
===============================================================================================
RECONCILIATION OF FUNDED STATUS:
Funded status $(15,253) $(17,051) $(4,244) $(4,508)
Unrecognized net (gain) loss 2,269 3,194 (189) 322
Unrecognized prior service cost 3,846 4,051 293 171
-----------------------------------------------------------------------------------------------
Accrued pension cost at year end $ (9,138) $ (9,806) $(4,140) $(4,015)
===============================================================================================
AMOUNTS RECOGNIZED IN THE BALANCE SHEET
AT JUNE 30 CONSIST OF:
Prepaid benefit cost $ 1,408
Accrued benefit liability (12,511) $(13,708) $(4,140) $(4,015)
Intangible asset 1,965 3,437
Minimum pension liability 465
-----------------------------------------------------------------------------------------------
Net amount recognized $ (9,138) $ (9,806) $(4,140) $(4,015)
===============================================================================================
WEIGHTED-AVERAGE ASSUMPTIONS AS OF JUNE 30:
Discount rate 6.5% 7.0% 7.0% 7.0%
Expected return on plan assets 8.0% 9.0% N/A N/A
Rate of compensation increase 5.5% 5.5% N/A N/A
Pension Benefits Other Benefits
----------------------------- ---------------------------
2002 2001 2000 2002 2001 2000
----------------------------------------------------------------------------------------------------
COMPONENTS OF
NET PERIODIC BENEFIT COST:
Service cost $ 628 $ 482 $ 454 $ 57 $ 52 $ 71
Interest cost 1,732 1,235 1,096 306 239 254
Expected return on plan assets (172) (196) (166)
Recognized net actuarial (gain) loss 157 71 77 13 (42) (15)
Amortization of prior service cost 458 373 236 29 29 26
----------------------------------------------------------------------------------------------------
Net periodic pension cost $ 2,803 $ 1,965 $ 1,697 $ 405 $ 278 $ 336
====================================================================================================
The assumed health care cost trend rates used in measuring the accumulated
benefit obligation for post-retirement benefits other than pensions as of June
30, 2002 and 2001 were 9.5% decreasing to 5.5% by 2010. A one-percentage point
change in the assumed health care cost trend rates would have had the following
effects as of June 30, 2002 and for the year then ended:
One-Percentage One-Percentage
Point Increase Point Decrease
-------------- --------------
Effect on total service and interest cost
components of periodic expense $ 48 $ (40)
Effect on post-retirement benefit obligation $ 411 $ (322)
24
Supplemental Executive Retirement Benefits Plan
The Company has a non-qualified pension plan to provide supplemental retirement
benefits to certain officers. Benefits are payable at retirement based upon a
percentage of the participant's compensation. The plan specifies minimum annual
retirement benefits for certain participants.
Qualified Retirement Plan
The Company has a qualified defined benefit plan that provides benefits to
certain hourly employees at retirement. The benefits are based on length of
service and date of retirement.
Salary Continuation Benefits
The Company has agreements with certain retirees to pay monthly retirement
benefits for a period not in excess of 15 years. The discount rate used in
determining the benefit obligation was decreased to 5.5% at June 30, 2002 from
7.0% at June 30, 2001 to reflect current market rates.
Retiree Medical Benefits
The Company provides health care benefits to eligible retired associates who
elect to pay the Company a specified monthly premium. Premium payments are based
upon current insurance rates for the type of coverage provided and are adjusted
annually. Certain monthly health care premium payments are partially subsidized
by the Company. Additionally, in conjunction with a fiscal 1998 acquisition, the
Company assumed the obligation for a post-retirement medical benefit plan which
provides health care benefits to eligible retired associates at no cost to the
individual.
NOTE 10
COMMITMENTS, LEASE OBLIGATIONS AND RENT EXPENSES
The Company leases its corporate headquarters facility along with certain
service center and distribution center facilities, vehicles and equipment under
non-cancelable lease agreements accounted for as operating leases. The minimum
annual rental commitments under operating leases are $18,036 in 2003; $12,888 in
2004; $9,794 in 2005; $6,848 in 2006; $5,168 in 2007 and $26,113 after 2007. The
Company also has a construction and lease facility where properties were
constructed by the lessor and leased to the Company under operating lease
arrangements. Since the resulting leases are operating leases, no debt
obligation is recorded on the Company's balance sheet. 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, the leases contain residual value
guarantee provisions obligating the Company for up to $6,000 at lease
termination.
In connection with the construction and lease of the corporate headquarters
facility, the Company has guaranteed repayment of $5,678 of bonds issued by
Cuyahoga County and the Cleveland-Cuyahoga County Port Authority as lessor. The
Company also guarantees up to $3,000 of long-term debt related to a joint
venture.
Rental expenses incurred for operating leases, principally from leases for
real property, vehicles and computer equipment was $27,922 in 2002, $26,122 in
2001, and $20,327 in 2000.
The Company had outstanding letters of credit of $5,195 at June 30, 2002.
These letters of credit secure certain insurance obligations.
NOTE 11
SEGMENT INFORMATION
The Company has identified one reportable segment: Service Center Based
Distribution. The Service Center Based Distribution segment provides customers
with solutions to their immediate maintenance, repairs and original equipment
manufacturing needs through the distribution of industrial products including
bearings, power transmission components, fluid power components, industrial
rubber products, linear motion products, general maintenance and specialty
items. The "Other" column consists of the aggregation of all other non-service
center based distribution operations that sell directly to customers, including
fluid power and electrical shop businesses.
The accounting policies of the segments are the same as those described in
Note 1. Certain reclassifications have been made to prior year amounts to be
consistent with the current year presentation. Intersegment sales are not
significant. All current segment operating results are in the United States,
Canada, Mexico and Puerto Rico. Operations in Canada, Mexico and Puerto Rico
represent approximately 5.9% of the total net sales of Applied, and therefore,
are not presented separately. In addition, approximately 34% of these
operations' net sales are included in the "Other" segment related to the fluid
power business. The long-lived assets located outside of the United States are
not material.
25
Segment Financial Information:
Service Center
Based Distribution Other Total
-----------------------------------------------------------------------------------------
YEAR ENDED JUNE 30, 2002
Net sales $1,354,793 $91,776 $1,446,569
Operating income (loss) 29,015 (2,049) 26,966
Assets used in the business 508,283 26,283 534,566
Depreciation 14,749 545 15,294
Capital expenditures 9,773 277 10,050
---------------------------------------------------
YEAR ENDED JUNE 30, 2001
Net sales $1,527,936 $97,819 $1,625,755
Operating income (loss) 45,425 (1,952) 43,473
Assets used in the business 534,817 44,037 578,854
Depreciation 15,460 904 16,364
Capital expenditures 9,213 2,518 11,731
---------------------------------------------------
YEAR ENDED JUNE 30, 2000
Net sales $1,541,257 $59,827 $1,601,084
Operating income (loss) 68,116 (858) 67,258
Assets used in the business 552,954 41,713 594,667
Depreciation 16,989 511 17,500
Capital expenditures 6,970 2,540 9,510
---------------------------------------------------
A reconciliation from the segment operating profit to the consolidated balance
is as follows:
Year Ended June 30
2002 2001 2000
-----------------------------------------
------------------------------------------------------------------------------------------
Operating income for reportable segment $29,015 $45,425 $68,116
Other operating income (loss) (2,049) (1,952) (858)
Adjustments for:
Goodwill and other intangibles amortization (1,651) (5,057) (4,296)
Corporate and other income (expense), net (a) 5,519 16,585 (5,183)
------------------------------------------------------------------------------------------
Total operating income 30,834 55,001 57,779
Interest expense, net 6,738 9,105 7,512
Other income (expense) (341) (548) 281
-----------------------------------------------------------------------------------------
Income before income taxes $23,755 $45,348 $50,548
==========================================================================================
(a) The change in corporate and other income (expense), net is due to
various changes in the levels and amounts of expenses being
allocated to the segments. The expenses being allocated include
miscellaneous corporate charges for working capital, logistics
support and other items.
Net sales by product category are as follows:
Year Ended June 30
2002 2001 2000
---------------------------------------
-----------------------------------------------------------------------------------------
Industrial $1,223,931 $1,396,170 $1,412,006
Fluid power (b) 218,778 226,535 187,191
Other 3,860 3,050 1,887
-----------------------------------------------------------------------------------------
Net sales $1,446,569 $1,625,755 $1,601,084
=========================================================================================
(b) The fluid power product category includes sales of hydraulic,
pneumatic, lubrication and filtration components and systems and
repair services through the Company's service centers as well as the
fluid power businesses. Beginning in 2002, the net sales of
hydraulic hose and fittings were reclassed from the industrial
product category to the fluid power product category. Prior year
amounts have been restated to reflect the reclass.
NOTE 12
LITIGATION
The Company 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.
26
DELOITTE
& TOUCHE
INDEPENDENT AUDITORS' REPORT
Shareholders and Board of Directors
Applied Industrial Technologies, Inc.
We have audited the accompanying consolidated balance sheets of Applied
Industrial Technologies, Inc. and its subsidiaries (the "Company") as of June
30, 2002 and 2001, and the related statements of consolidated income,
shareholders' equity, and cash flows for each of the three years in the period
ended June 30, 2002. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company at June 30, 2002 and
2001, and the results of its operations and its cash flows for each of the three
years in the period ended June 30, 2002, in conformity with accounting
principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, effective
July 1, 2001, the Company changed its method of accounting for goodwill as a
result of the adoption of Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets."
/s/ Deloitte & Touche LLP
Cleveland, Ohio
August 6, 2002
27
Applied Industrial Technologies, Inc. and Subsidiaries
QUARTERLY OPERATING RESULTS AND MARKET DATA (UNAUDITED)
Per Common
Share (C)
-----------
Income Income
Before Net Before
Net Gross Operating Cumulative Income Cumulative
Sales Profit Income Effect (loss) Effect
(Dollars in thousands,
except per share amounts)
- ---------------------------------------------------------------------------------------------------
2002 (A)
First Quarter (B) $ 367,990 $ 92,431 $ 10,112 $ 4,889 $ (7,211) $ 0.25
Second Quarter 347,550 87,013 6,032 2,918 2,918 0.15
Third Quarter 361,542 91,870 5,833 2,707 2,707 0.14
Fourth Quarter 369,487 94,376 8,857 4,241 4,241 0.22
- ---------------------------------------------------------------------------------------------------
$1,446,569 $ 365,690 $ 30,834 $ 14,755 $ 2,655 $ 0.76
===================================================================================================
2001 (A)
First Quarter $ 420,876 $ 104,454 $ 14,251 $ 7,231 $ 7,231 $ 0.36
Second Quarter 405,438 103,902 15,134 7,362 7,362 0.37
Third Quarter 408,839 102,037 13,236 6,956 6,956 0.35
Fourth Quarter 390,602 98,906 12,380 6,499 6,499 0.33
- ---------------------------------------------------------------------------------------------------
$1,625,755 $ 409,299 $ 55,001 $ 28,048 $ 28,048 $ 1.41
===================================================================================================
2000 (A)
First Quarter $ 387,904 $ 93,765 $ 12,138 $ 5,862 $ 5,862 $ 0.28
Second Quarter 379,670 92,687 12,060 6,233 6,233 0.30
Third Quarter 420,897 103,022 15,531 8,304 8,304 0.40
Fourth Quarter 412,613 102,116 18,050 10,649 10,649 0.53
- ---------------------------------------------------------------------------------------------------
$1,601,084 $ 391,590 $ 57,779 $ 31,048 $ 31,048 $ 1.50
===================================================================================================
Per Common Share (C)
---------------------------------------------------
Net Price Range
Income - Cash
Diluted Dividend High Low
(Dollars in thousands,
except per share amounts)
- --------------------------------------------------------------------------------
2002 (A)
First Quarter (B) $ (0.38) $ 0.12 $ 19.13 $ 16.50
Second Quarter 0.15 0.12 19.46 16.00
Third Quarter 0.14 0.12 20.91 17.28
Fourth Quarter 0.22 0.12 21.25 18.61
- ----------------------------------------------
$ 0.13 $ 0.48
==============================================
2001 (A)
First Quarter $ 0.36 $ 0.12 $ 18.31 $ 15.69
Second Quarter 0.37 0.12 21.00 15.88
Third Quarter 0.35 0.12 20.69 16.25
Fourth Quarter 0.33 0.12 19.19 15.65
- ----------------------------------------------
$ 1.41 $ 0.48
==============================================
2000 (A)
First Quarter $ 0.28 $ 0.12 $ 19.06 $ 14.38
Second Quarter 0.30 0.12 17.88 15.06
Third Quarter 0.40 0.12 18.19 15.00
Fourth Quarter 0.53 0.12 18.13 14.31
- ----------------------------------------------
$ 1.50 $ 0.48
==============================================
(A) 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 primarily made based upon
the annual physical inventory and the effect of year-end inventory quantities on
LIFO costs. Adjustments in 2002, 2001 and 2000 increased gross profit by $3,171,
$2,850 and $2,924; net income by $1,868, $1,676 and $1,708 and diluted net
income per share by $.10, $.08 and $.08, respectively. Reductions in inventories
during the fiscal year ended June 30, 2002 resulted in liquidations of LIFO
inventory quantities carried at lower costs prevailing in prior years. The
effect of these liquidations for the year ended June 30, 2002 increased gross
profit by $915, net income by $546 and diluted net income per share by $.03.
(B) Effective July 2001, the Company adopted SFAS142, "Goodwill and Other
Intangible Assets." Upon adoption, the Company determined that goodwill
associated with its fluid power business was impaired. A non-cash charge
totaling $17,600, $12,100 after tax, has been recorded as a change in accounting
principle effective July 1, 2001 to write-off the remaining goodwill relating to
the fluid power business. See Note 1 to the Consolidated Financial Statements
for additional information.
(C) On August 16, 2002, there were 6,489 shareholders of record, including 3,760
shareholders in the Applied Industrial Technologies, Inc. Retirement Savings
Plan. The Company's common stock is listed on the New York Stock Exchange. The
closing price on August 16, 2002 was $16.49 per share.
Applied Industrial Technologies, Inc. and Subsidiaries
10 Year SUMMARY
<Table>
<Caption>
2002 2001 2000 1999 1998
(Dollars in thousands, except per share amounts
and statistical data)
- ----------------------------------------------------------------------------------------------------------------------
CONSOLIDATED OPERATIONS-
YEAR ENDED JUNE 30
Net Sales $1,446,569 $1,625,755 $1,601,084 $1,555,424 $1,518,615
Operating Income 30,834 55,001 57,779 42,269 58,520
Income before cumulative effect
of accounting change 14,755 28,048 31,048 19,933 30,125
Net income 2,655 28,048 31,048 19,933 30,125
Per share data
Income before cumulative effect
of accounting change
Basic 0.77 1.43 1.52 0.93 1.40
Diluted 0.76 1.41 1.50 0.93 1.38
Net Income
Basic 0.14 1.43 1.52 0.93 1.40
Diluted 0.13 1.41 1.50 0.93 1.38
Cash dividend 0.48 0.48 0.48 0.48 0.47
YEAR-END POSITION - JUNE 30
Working capital $250,644 $279,001 $255,132 $258,730 $221,766
Long-term debt 83,478 113,494 112,168 126,000 90,000
Total assets 534,566 578,854 594,667 574,349 606,091
Shareholders' equity 298,147 311,518 299,331 293,586 299,502
YEAR-END STATISTICS - JUNE 30
Current ratio 2.9 3.2 2.6 3.0 2.1
Operating facilities 449 469 478 444 449
Shareholders of record (A) 6,455 6,697 6,548 6,869 6,731
(A) Includes participant-shareholders in the Applied Industrial Technologies,
Inc. Retirement Savings Plan, and since 1998, shareholders in the Automatic
Dividend Reinvestment Plan.
29