Exhibit 13
Applied Industrial Technologies, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
of Financial Condition and Results of Operations
YEAR ENDED JUNE 30, 2003 VS. 2002
Net sales in 2003 were $1.46 billion or slightly above (1%) the prior year's
sales. This increase was primarily due to the acquisition of Industrial
Equipment Co. Ltd. (IECO), and having one additional business day during the
year. The sales product mix for the year was 84.8% industrial products and 15.1%
fluid power products compared to 85.0% industrial and 14.8% fluid power in the
prior year. Same store sales were slightly above (.4%) the prior year. While
there was a reduction of 25 facilities in the U.S., Canada and Mexico, these
were offset by the acquisition of 16 IECO facilities in Western Canada. At June
30, 2003, the Company had a total of 440 operating facilities versus 449 at June
30, 2002. Industrial production in the United States continues to be depressed.
Our industry tends to lag slightly behind the manufacturing sector which
continues to perform at or below the prior year levels reflected in the
Manufacturing Capacity Utilization Index as published monthly by the Federal
Reserve Board. The Company does not expect inflation or deflation to have a
material impact on future revenues.
Despite relatively flat sales, the Company improved its gross profit
margins (net sales less cost of sales) to 25.9% from 25.3% in 2002. Improved
purchasing practices, improved pricing, training, systems and the growth of our
catalog business contributed to this increase. The Company expects fiscal 2004
gross margin levels to be in the 25.5% to 26% range as anticipated improvements
in pricing and shipping charges to customers are expected to offset a decline in
supplier purchasing allowances and rebates.
Selling, distribution and administrative expense ("SD&A") consists of
employee compensation, benefits and other expenses associated with purchasing,
warehousing, supply chain management and providing marketing and distribution of
the Company's products as well as costs associated with a variety of
administrative functions, such as legal, treasury, accounting, tax and facility
related expenses. SD&A increased 2.4% compared to the prior year, and increased
slightly as a percent of sales to 23.4% from 23.1% in 2002. The increase was
primarily due to the IECO acquisition, higher compensation and benefit costs and
related payroll taxes based on improved profitability. These additional costs
were partially offset by approximately $3.2 million of gains on sales of
unneeded real estate and a decrease in bad debt expense due to fewer customer
bankruptcies during fiscal 2003.
Operating income increased to $36.3 million in 2003 from $30.8 million in
2002. As a percent of sales, operating income increased to 2.5% in 2003 from
2.1% in 2002. The $5.4 million increase in operating income was due primarily to
the improved gross profit margin factors noted above.
Interest expense - net for 2003 decreased $1.4 million, or 21.4%, compared
with the prior year primarily from a decrease in average borrowings of $26.5
million related to strong cash flows from operations and lower interest rates.
Other, net represents certain non-operating items of income and expense.
During the year, the Company recorded a charge of $2.1 million to provide for
its share of net loss and other reserves associated with the Company's iSource
Performance Materials LLC ("iSource") affiliate. The Company owns 49% of
iSource, a certified minority-owned distributor of standard-use industrial
specialty and general maintenance items requiring special shipping and handling.
Offsetting the impact of this charge was the receipt of insurance proceeds of
$2.1 million for the settlement of a fiscal 2000 property casualty claim.
Income tax expense as a percentage of income before taxes was 35.9% for
the year ended June 30, 2003 and 37.9% for the year ended June 30, 2002. This
decrease related to a change in the tax law that reduces the Company's taxable
income beginning in fiscal 2003. Specifically, the Company can now take a tax
deduction for cash dividends paid on Company stock to participant 401(k) plan
accounts. Another factor that contributed to the rate decrease was a reduction
in effective state, local and foreign tax rates, primarily due to the
implementation of various tax planning initiatives. We expect our overall tax
rate for fiscal 2004 to be slightly below the fiscal 2003 rate based on current
tax laws and regulations.
Net income for the fiscal year ended June 30, 2003, increased $5.1 million
or 34.4% from prior years' income before the cumulative effect of accounting
change. Net income per share increased 35.5% to $1.03 in 2003 from $.76 in 2002
before the cumulative effect of the accounting change primarily due to the
factors described above and a decrease in the average shares attributable to
company repurchases.
The number of Company associates was 4,384 at June 30, 2003 and 4,508 at
June 30, 2002.
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 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.
Gross margin 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 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.
10
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 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
Standard ("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 Notes 1 and 4 to the Consolidated Financial Statements).
The number of associates was 4,508 at June 30, 2002 and 4,789 at June 30,
2001.
LIQUIDITY AND CAPITAL RESOURCES
The Company generated $67.3 million of cash from operating activities in 2003
and $68.9 million in 2002.
Cash flow from operations depends primarily upon generating operating
income, controlling investment in inventories and receivables, and managing the
timing of payments to suppliers. The Company has continued to monitor and
control its investments in inventories by taking advantage of various vendor
purchasing programs and through the use of system enhancements to improve
inventory tracking. The Company has continued to improve its collection of
accounts receivable through improved billing systems and collection efforts.
During the year ended June 30, 2003, inventories decreased approximately $10.4
million, exclusive of the additional $4.2 million of inventory acquired as part
of the acquisition of certain assets of IECO. Net of the IECO acquisition,
accounts receivable decreased $8.0 million due to improved collections and
systems. Accrued expenses increased $15.7 million due to increased personnel
compensation and benefit costs.
Cash used by investing activities of $16.3 million for the year ended June
30, 2003 consisted primarily of property purchases of approximately $12.8
million, and the expenditure for the purchase of IECO. The major components of
our property and equipment purchases related to our NetPC project which
converted all service center order entry equipment from old "green screen"
terminals to Internet capable workstations. Additional purchases were made to
enhance our AppliedACCESS(R) Web site and expand our electronic catalog content.
The Company also realized proceeds of approximately $7.5 million from property
sales, which generated gains of $3.2 million, primarily related to the disposal
of unneeded real estate.
For fiscal 2004, our property purchases are expected to be in the $14
million to $15 million range which includes a $7.5 million buy-out of properties
currently being leased. These include our Ft. Worth distribution center and 3
service centers, all of which were originally constructed for the company under
a lease facility 7 years ago (see discussion in Note 11). Depreciation for
fiscal 2004 is expected to be in the range of $13 to $15 million.
Cash used in financing activities was approximately $19.0 million in
fiscal 2003 and $51.1 million in fiscal 2002. During fiscal 2002, the Company
had net repayments under revolving credit agreements of $21.4 million.
Additionally, scheduled long-term debt repayments in fiscal 2002 were double the
amounts paid in fiscal 2003. The next scheduled principal repayment on our
long-term debt is in December 2007.
The following table shows the Company's approximate obligations and
commitments to make future payments under contractual obligations as of June 30,
2003 (in thousands):
Period Less Period Period Period
Total Than 1 yr 2-3 yrs. 4-5 yrs. Over 5 yrs.
----- --------- -------- -------- -----------
Operating Leases $ 75,246 $ 17,496 $ 21,365 $ 12,542 $ 23,843
Long-term Debt 75,000 50,000 25,000
-------- -------- -------- -------- --------
Total Contractual
Cash Obligations $150,246 $ 17,496 $ 21,365 $ 62,542 $ 48,843
======== ======== ======== ======== ========
The Company also used approximately $9.9 million to repurchase 581
thousand shares during the year for an average price of $17 per share compared
to $14.3 million for 817 thousand shares in fiscal 2002.
In July 2003, the Board of Directors increased the authorization to
purchase shares of the Company's common stock to 1.0 million shares. These
purchases are being made to fund employee benefit programs, equity award
programs, and future business acquisitions. These purchases are made in open
market and negotiated transactions, from time to time, depending upon market
conditions.
In fiscal 2003, the Company continued its practice of paying cash
dividends each quarter. As in the last four fiscal years, the Company's dividend
was 12 cents per share per quarter. The amount of the dividend paid is
recommended quarterly by management and approved by the Company's Board of
Directors based on financial
11
Applied Industrial Technologies, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS, Continued
performance, cash flow and payout guidelines consistent with other industrial
companies.
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 6 to the Consolidated Financial Statements for details regarding
the outstanding debt amounts as of June 30, 2003. The Company had no short-term
borrowings in fiscal 2003. The average long-term borrowings in fiscal 2003 were
$76.4 million compared to the average combined short-term and long-term
borrowings of $103.0 million in fiscal 2002. The weighted average interest rate
on short-term borrowings in the prior year was 3.7%. The weighted average
interest on borrowings under our long-term debt agreements, net of the benefits
from interest rate swaps was 5.9% in 2003 and 5.5% in 2002, respectively. The
increase in the weighted average interest rate was due to lower benefits from
interest rate swap agreements in fiscal 2003 versus fiscal 2002. The effect of
the swap agreements was to decrease interest expense by $880 thousand in 2003
and approximately $1.4 million in 2002. These settlement gains are being
amortized as a reduction in interest expense of approximately $800 thousand per
year over the remaining life of the notes through December 2007.
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. At June 30, 2003, the
Company has no variable rate debt or interest rate swaps outstanding. See Note 7
"Risk Management Activities" for additional discussion on the Company's
derivative activities.
The Company's working capital at June 30, 2003 was $259.4 million compared
to $250.6 million at June 30, 2002. The current ratio was 2.8 and 2.9 at June
30, 2003 and 2002, respectively. The increase in working capital is due to the
increase of cash generated from our operating results and from the reduction of
receivables and inventories.
The Company has a committed revolving credit agreement expiring in
November 2003 with a group of banks. This agreement provides for unsecured
borrowings of up to $150.0 million. The Company is currently exploring options
to replace this facility and expects to have a replacement facility in place
before the current facility expires. The Company had no borrowings outstanding
under this facility at June 30, 2003. The Company also has a $10.0 million
short-term uncommitted line of credit with a commercial bank that expires
October 2003. The Company had no borrowings outstanding under this facility at
June 30, 2003. Unused lines under these facilities, net of outstanding letters
of credit, totaling $153.0 million are available to fund future acquisitions or
other capital and operating requirements. An additional long-term financing
shelf facility is in place enabling the Company to borrow up to $100.0 million
at its discretion with terms up to twelve years. The Company has no outstanding
borrowings under this facility at June 30, 2003.
The aggregate annual maturities of long-term debt are $50.0 million in
fiscal 2008 and $25.0 million in fiscal 2011.
Management expects that cash provided from operations, available lines of
credit, long-term debt and the use of operating leases will be sufficient to
finance normal working capital needs, acquisitions, investments in properties,
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 based on the Company's credit standing and financial
strength.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States of America
requires management to make judgments, assumptions and estimates at a specific
point in time that affect the amounts reported in the Consolidated Financial
Statements and disclosed in the accompanying notes. Note 1 to the Consolidated
Financial Statements describes the significant accounting policies and methods
used in preparation of the Consolidated Financial Statements. Estimates are used
for, but not limited to, determining the net carrying value of trade
receivables, inventories, goodwill, other intangible assets and recording
self-insurance liabilities. Actual results could differ from these estimates.
The following critical accounting policies are impacted significantly by
judgments, assumptions and estimates used in the preparation of the Consolidated
Financial Statements.
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 majority of the Company's inventories are not
highly susceptible to obsolescence and 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 specific customer's inability to meet its financial
obligations (e.g., 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 diverse as to
12
industry and geography, a general economic downturn in any of the industry
segments in which the Company operates could result in higher than expected
customer defaults, and, therefore, the need to revise 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 for impairment. The Company has elected
to do annual tests for indications of goodwill impairment as of January 1 of
each year. 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 available
information to prepare its estimates and to perform impairment evaluations,
actual results could differ significantly, resulting in future impairment and
losses related to recorded goodwill balances.
SUPPLIER PURCHASING PROGRAMS
The Company enters into agreements with certain suppliers providing for
inventory purchase rebates. The Company's inventory purchase rebate arrangements
are unique to each supplier and are generally annual programs ending at either
the Company's June 30th year end or the supplier's year end. Rebates are
received in the form of cash or credits against future purchases upon attainment
of specified purchase volumes and are received monthly, quarterly or annually
based upon actual purchases for such period. The supplier rebates are a
specified percentage of the Company's net purchases based upon achieving
specific purchasing volume levels. These percentages can increase or decrease
based on changes in the volume of purchases.
The Company accrues for the receipt of these inventory purchase rebates
based upon actual cumulative purchases of inventory. The percentage level
utilized is based upon the estimated total volume of purchases we expect to
achieve during the life of the program. Each supplier program is analyzed,
reviewed and reconciled each quarter as information becomes available to
determine the appropriateness of the amount estimated to be received.
Differences between our estimates and actual rebates subsequently received have
not been material.
All rebates under these supplier purchasing programs are recognized under
the Company's LIFO inventory accounting method as a reduction of cost of sales
when the inventories representing these purchases are sold and recorded as cost
of sales. The Company's accounting for rebates is in accordance with guidance
issued by the FASB in EITF 02-16, "Accounting by a Customer (Including a
Reseller) for Certain Consideration Received from a Vendor." While management
believes the Company will continue to receive inventory purchase rebates, there
can be no assurance that suppliers will continue to provide comparable amounts
of rebates in the future.
SELF-INSURANCE LIABILITIES
The Company has insurance programs to cover workers' compensation, business,
automobile, general and product liability risks. The insurance programs have
self-insured retention to $350 thousand per claim. On an annual basis, an
independent actuarial firm is hired to determine the adequacy of estimated
liabilities. The Company accrues estimated losses based on actuarial models and
assumptions as well as the Company's historical loss experience. Although
management believes that the estimated liabilities for self insurance are
adequate, the estimates described above may not be indicative of current and
future losses. In addition, the actuarial calculations used to estimate self
insurance liabilities are based on numerous assumptions, some of which are
subjective. The Company will continue to adjust its estimated liabilities for
self insurance, as deemed necessary, in the event that future loss experience
differs from historical loss patterns.
GUARANTEES AND OTHER OFF-BALANCE SHEET ARRANGEMENTS
In December 2002, the Financial Accounting Standards Board issued Interpretation
No. (FIN) 45, "Guarantor's Accounting and Disclosure Requirements". FIN 45
requires the disclosure of any guarantees in place at December 31, 2002 and the
recognition of a liability for any guarantees entered into or modified after
that date. The Company is a guarantor in three arrangements entered into prior
to December 31, 2002 that require disclosure under FIN 45 as follows:
- - The Company has a construction and lease facility under which a
distribution center and several service centers were constructed by the
lessor and leased to the Company under operating lease arrangements. These
leases expire in September 2003 and permit the Company to purchase the
facilities for $7.5 million. If the Company did not exercise this option,
residual value guarantee provisions obligated the Company to compensate
the lessor for up to $6.0 million at lease termination depending on the
properties' market values at that time. Due to the nature of the
guarantee, the Company has not recorded any liability on the financial
statements. In July 2003, the Company exercised its option to purchase the
facilities effective September 2003.
- - In connection with the construction and lease of its corporate
headquarters facility, the Company has guaranteed repayment of a total of
approximately $5.7 million of taxable development revenue bonds issued by
Cuyahoga County and the Cleveland-Cuyahoga County Port Authority. These
bonds were issued with a 20-year term and are scheduled to mature in March
2016. Any
13
Applied Industrial Technologies, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS, Continued
default, as defined in the guarantee agreements, would obligate Applied
for the full amount of the outstanding bonds through maturity. Due to the
nature of the guarantee, the Company has not recorded any liability on the
financial statements.
- - The Company also has guaranteed, under an agreement scheduled to expire in
December 2003, a related entity's repayment of borrowings under a line of
credit. This guarantee was entered into to induce a financial institution
to provide a line of credit for a joint venture, iSource Performance
Materials L.L.C. (iSource), of which the Company is a minority owner.
iSource is a certified minority-owned distributor of standard-use
industrial specialty and general maintenance items requiring special
shipping and handling. Any default, as defined in the guarantee agreement,
will obligate the Company for any unpaid balance under the line of credit
up to a maximum of $3.0 million.
In the event of a default and subsequent payout under any or all of these
guarantees, the Company maintains the right to pursue all legal options
available to mitigate its exposure.
NEW ACCOUNTING PRONOUNCEMENTS
The Company adopted SFAS 144 "Accounting for Impairment or Disposals of
Long-Lived Assets" and SFAS 146, "Accounting for Costs Associated with Exit or
Disposal Activities" as of July 1, 2002. The adoption of these statements did
not have a material impact on the consolidated statements.
In December 2002, the Financial Accounting Standards Board issued SFAS
148, "Accounting for Stock-Based Compensation - Transition and Disclosure." The
impact of this statement on the Company's current accounting policies was to
amend the disclosure requirements of SFAS 123, "Accounting for Stock-Based
Compensation" and require additional disclosure in the Company's quarterly
financial statements. The Company adopted SFAS 148 effective January 1, 2003
(see Note 1).
In January 2003, the Financial Accounting Standards Board issued FIN 46,
"Consolidation of Variable Interest Entities." As disclosed above, the Company
is a minority owner in iSource and has guaranteed iSource's line of credit debt
up to $3.0 million. iSource maintains assets of approximately $3.7 million. The
Company's purchases currently account for more than 90% of iSource's sales and
the Company is considered the primary beneficiary of iSource's operations.
Accordingly, iSource's financial statements will be consolidated with the
Company's beginning in July 2003 in accordance with the effective date of FIN
46. It is expected that the effect on the Company's consolidated financial
statements will be immaterial.
OTHER MATTERS
In October 2002, the Company acquired certain assets of Industrial Equipment
Co., Ltd. (IECO), a Canadian distributor of industrial products, for
approximately $11.5 million. This acquisition was paid for from existing cash
balances. The results of the acquired business operations are not material for
periods represented. The acquired operations are reported in our service center
based distribution segment from the acquisition date. The business contributed
$12.2 million in sales from the date of acquisition through June 30, 2003. Sales
and operating results to date have met Company expectations.
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 our targeted geographic markets due to consolidation
in customer industries and 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 other business strategies; the incurrence of debt
and contingent liabilities in connection with acquisitions; changes in
accounting policies and practices; the effect of organizational changes within
the Company; the emergence of new competitors, including firms with greater
financial resources than the Company; risks and uncertainties associated with
the Company's expansion into foreign markets, including inflation rates,
recessions, and foreign currency exchange rates; adverse results in significant
litigation matters; adverse regulation and legislation; and the occurrence of
extraordinary events (including
14
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. There were no variable rate borrowings under its committed
revolving credit agreement and no interest rate swap agreements outstanding at
June 30, 2003. All the Company's outstanding debt is currently at fixed interest
rates at June 30, 2003.
The Company mitigates its foreign currency exposure from the Canadian
dollar through the use of cross currency swap agreements as well as
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 subsidiary are
not hedged, as 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.
15
Applied Industrial Technologies, Inc. and Subsidiaries
Statements of CONSOLIDATED INCOME
Year Ended June 30
---------------------------------------------
2003 2002 2001
----------- ----------- -----------
(In thousands, except per share amounts)
Net Sales $ 1,464,367 $ 1,446,569 $ 1,625,755
Cost of sales 1,085,072 1,080,879 1,216,456
----------- ----------- -----------
379,295 365,690 409,299
Selling, distribution and administrative 343,041 334,856 354,298
----------- ----------- -----------
Operating Income 36,254 30,834 55,001
----------- ----------- -----------
Interest Expense 5,677 7,078 9,386
Interest Income (379) (340) (281)
Other, net 24 341 548
----------- ----------- -----------
5,322 7,079 9,653
----------- ----------- -----------
Income Before Income Taxes 30,932 23,755 45,348
----------- ----------- -----------
Income Tax Expense 11,100 9,000 17,300
----------- ----------- -----------
Income Before Cumulative Effect of Accounting Change 19,832 14,755 28,048
Cumulative effect of accounting change (12,100)
----------- ----------- -----------
Net Income $ 19,832 $ 2,655 $ 28,048
=========== =========== ===========
Net Income Per Share - Basic
Before cumulative effect of accounting change $ 1.05 $ 0.77 $ 1.43
Cumulative effect of accounting change (0.63)
----------- ----------- -----------
Net Income Per Share - Basic $ 1.05 $ 0.14 $ 1.43
=========== =========== ===========
Net Income Per Share - Diluted
Before cumulative effect of accounting change $ 1.03 $ 0.76 $ 1.41
Cumulative effect of accounting change (0.63)
----------- ----------- -----------
Net Income Per Share - Diluted $ 1.03 $ 0.13 $ 1.41
=========== =========== ===========
See notes to consolidated financial statements.
16
Applied Industrial Technologies, Inc. and Subsidiaries
Consolidated BALANCE SHEETS
June 30
------------------------
2003 2002
--------- ---------
(In thousands)
Assets
Current assets
Cash and temporary investments $ 55,079 $ 23,060
Accounts receivable, less allowances of $6,100 and $5,600 173,915 180,904
Inventories 159,798 166,083
Other current assets 11,702 11,011
--------- ---------
Total current assets 400,494 381,058
--------- ---------
Property - at cost
Land 10,632 11,779
Buildings 62,179 69,131
Equipment 90,967 83,414
--------- ---------
163,778 164,324
Less accumulated depreciation 85,836 81,229
--------- ---------
Property - net 77,942 83,095
--------- ---------
Goodwill - net of accumulated amortization of $13,069 49,687 46,410
Other assets 25,281 24,003
--------- ---------
Total Assets $ 553,404 $ 534,566
========= =========
Liabilities
Current liabilities
Accounts payable $ 75,411 $ 76,316
Compensation and related benefits 39,359 27,277
Other current liabilities 26,365 26,821
--------- ---------
Total current liabilities 141,135 130,414
Long-term debt 78,558 83,478
Other liabilities 25,855 22,527
--------- ---------
Total Liabilities 245,548 236,419
--------- ---------
Shareholders' Equity
Preferred stock - no par value; 2,500 shares
authorized; none issued or outstanding
Common stock - no par value; 50,000 shares
authorized; 24,096 shares issued 10,000 10,000
Additional paid-in capital 84,898 84,517
Income retained for use in the business 289,724 279,046
Treasury shares - at cost (5,076 and 4,893 shares) (78,706) (74,900)
Unearned restricted common stock compensation (114) (832)
Accumulated other comprehensive income 2,054 316
--------- ---------
Total Shareholders' Equity 307,856 298,147
--------- ---------
Total Liabilities and Shareholders' Equity $ 553,404 $ 534,566
========= =========
See notes to consolidated financial statements.
17
Applied Industrial Technologies, Inc. and Subsidiaries
Statements of CONSOLIDATED CASH FLOWS
Year Ended June 30
------------------------------------
2003 2002 2001
-------- -------- --------
(In thousands)
Cash Flows from Operating Activities
Net income $ 19,832 $ 2,655 $ 28,048
Adjustments to reconcile net income to cash provided
by operating activities:
Cumulative effect of accounting change 12,100
Depreciation 14,458 15,294 16,364
Deferred income taxes (2,700) (5,000) (1,800)
Amortization of restricted common stock compensation,
goodwill and other intangible assets 1,499 2,499 6,145
Provision for losses on accounts receivable 2,510 4,488 6,995
Gain on sale of property (3,249) (1,327) (1,080)
Amortization of gain on interest rate swap terminations (752) (245)
Treasury shares contributed to employee benefit and deferred
compensation plans 3,156 2,977 6,529
Changes in current assets and liabilities, net of acquisitions:
Accounts receivable 8,004 7,237 15,869
Inventories 10,436 27,020 (8,522)
Other current assets (659) (688) (1,908)
Accounts payable (905) 420 (17,691)
Accrued expenses 15,661 1,518 (11,732)
-------- -------- --------
Net Cash provided by Operating Activities 67,291 68,948 37,217
-------- -------- --------
Cash Flows from Investing Activities
Property purchases (12,794) (10,050) (11,731)
Proceeds from property sales 7,456 3,610 4,251
Net cash paid for acquisition of businesses, net of cash
acquired of $812 in 2001 (10,255) (2,574) (5,491)
Deposits and other (689) 274 (310)
-------- -------- --------
Net Cash used in Investing Activities (16,282) (8,740) (13,281)
-------- -------- --------
Cash Flows from Financing Activities
Repayments under revolving credit agreements - net (21,350) (12,246)
Long-term debt borrowings 25,000
Long-term debt repayments (5,714) (11,429) (11,428)
Proceeds from termination of swap 2,517 2,038
Purchases of treasury shares (9,946) (14,318) (15,501)
Dividends paid (9,154) (9,270) (9,532)
Exercise of stock options 3,307 3,200 1,403
-------- -------- --------
Net Cash used in Financing Activities (18,990) (51,129) (22,304)
-------- -------- --------
Increase in cash and temporary investments 32,019 9,079 1,632
Cash and temporary investments at beginning of year 23,060 13,981 12,349
-------- -------- --------
Cash and Temporary Investments at End of Year $ 55,079 $ 23,060 $ 13,981
======== ======== ========
Supplemental Cash Flow Information
Cash paid during the year for:
Income taxes $ 8,161 $ 8,182 $ 22,080
Interest $ 4,995 $ 6,205 $ 8,595
See notes to consolidated financial statements.
18
Applied Industrial Technologies, Inc. and Subsidiaries
Statements of CONSOLIDATED SHAREHOLDERS' EQUITY
For the Years Ended June 30, 2003, 2002 and 2001
-------------------------------------------------------------------
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, 2000 20,078 $ 10,000 $ 83,312 $ 267,145 $ (57,419)
Net income 28,048
Minimum pension liability
Unrealized gain on cross currency swap
Foreign currency translation adjustment
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
Unrealized gain on cross currency swap
Foreign currency translation adjustment
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)
Net income 19,832
Unrealized loss on cross currency swap
Foreign currency translation adjustment
Total comprehensive income
Cash dividends - $.48 per share (9,154)
Purchases of common stock for treasury (581) (9,946)
Treasury shares issued for:
Retirement Savings Plan contributions 164 348 2,505
Exercise of stock options 217 (63) 3,370
Deferred compensation plans 17 38 265
Amortization of restricted
common stock compensation 30
Other 28
--------- --------- --------- --------- ---------
Balance at June 30, 2003 19,020 $ 10,000 $ 84,898 $ 289,724 $ (78,706)
========= ========= ========= ========= =========
For the Years Ended June 30, 2003, 2002 and 2001
------------------------------------------------
Unearned
Restricted Accumulated
Common Other Total
Stock Comprehensive Shareholders'
Compensation Income (loss) Equity
------------ ------------- ------
(In thousands, except per share amounts)
Balance at July 1, 2000 $ (3,707) $ 299,331
Net income 28,048
Minimum pension liability $ (285) (285)
Unrealized gain on cross currency swap 173 173
Foreign currency translation adjustment (70) (70)
---------
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
Unrealized gain on cross currency swap 297 297
Foreign currency translation adjustment (84) (84)
---------
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
Net income 19,832
Unrealized loss on cross currency swap (1,019) (1,019)
Foreign currency translation adjustment 2,757 2,757
---------
Total comprehensive income 21,570
---------
Cash dividends - $.48 per share (9,154)
Purchases of common stock for treasury (9,946)
Treasury shares issued for:
Retirement Savings Plan contributions 2,853
Exercise of stock options 3,307
Deferred compensation plans 303
Amortization of restricted
common stock compensation 718 748
Other 28
--------- --------- ---------
Balance at June 30, 2003 $ (114) $ 2,054 $ 307,856
========= ========= =========
See notes to consolidated financial statements.
19
Applied Industrial Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Years Ended June 30, 2003, 2002 and 2001
(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 and safety
products and tools. Fluid power includes hydraulic, pneumatic,
lubrication and filtration components and systems. The Company also
provides mechanical, electrical, rubber shop and fluid power services.
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. Outstanding checks of
$10,627 at June 30, 2003 and $7,256 at June 30, 2002 are classified as
a current liability in accounts payable.
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 has established January 1 as its annual impairment testing
date. The results of the Company's January 1, 2003 testing indicated no
impairment.
Inventories
U.S. 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.
Property and Depreciation
Property and equipment are initially stated at cost. 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. The carrying values of long-lived assets, including
property and equipment, are reviewed for impairment whenever events or
changes in circumstances indicate that the recorded value cannot be
recovered from undiscounted future cash flows.
Self-Insurance Liabilities
The Company maintains business insurance programs with significant
self-insured retention, relating to workers' compensation, business,
automobile and general products liability claims. The Company accrues
estimated losses using actuarial models and assumptions based on
historical loss experience The actuarial calculations used to estimate
business insurance reserves are based on numerous assumptions, some of
which are subjective. The Company utilizes an independent actuarial
firm to assist in determining the adequacy of our reserves.
The Company maintains a self-insured health benefits plan, which
provides medical benefits employees electing coverage under the plan.
The Company maintains a reserve for incurred but not reported medical
claims. The reserve is
20
actuarially determined by an independent actuarial firm and is an
estimate based on historical experience and other assumptions, some of
which are subjective.
Revenue Recognition
Sales are recognized when products are shipped or delivered to a
customer which is when title transferred to the customer. Products are
billed at agreed upon prices. The Company's experience is that
collection of receivables recorded for all sales is reasonably assured.
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 enacted tax laws.
Net Income Per Share
The following is a computation of the basic and diluted earnings per
share:
Year Ended June 30
2003 2002 2001
---------- ---------- ----------
Net Income
Income before cumulative effect of accounting change $ 19,832 $ 14,755 $ 28,048
Cumulative effect of accounting change (12,100)
---------- ---------- ----------
Net Income $ 19,832 $ 2,655 $ 28,048
========== ========== ==========
Average Shares Outstanding
Weighted average common shares outstanding
for basic computation 18,908 19,079 19,589
Dilutive effect of stock based options and awards 314 338 335
---------- ---------- ----------
Weighted average common shares outstanding
for dilutive computation 19,222 19,417 19,924
========== ========== ==========
Net Income Per Share - Basic
Before cumulative effect of accounting change $ 1.05 $ 0.77 $ 1.43
Cumulative effect of accounting change (0.63)
---------- ---------- ----------
Net Income Per Share - Basic $ 1.05 $ 0.14 $ 1.43
========== ========== ==========
Net Income Per Share - Diluted
Before cumulative effect of accounting change $ 1.03 $ 0.76 $ 1.41
Cumulative effect of accounting change (0.63)
---------- ---------- ----------
Net Income Per Share - Diluted $ 1.03 $ 0.13 $ 1.41
========== ========== ==========
Stock Based Compensation
At June 30, 2003, the Company had outstanding stock options (see Note
9). The Company applies APB Opinion No. 25 "Accounting for Stock Issued
to Employees" and related interpretations in accounting for options
granted and applies SFAS 123 "Accounting for Stock Issued to Employees"
for disclosure purposes only.
In December 2002, the Financial Accounting Standards Board issued
SFAS 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure." The impact of this statement on the Company's current
accounting policies was to amend the disclosure requirements of SFAS
123, "Accounting for Stock-Based Compensation" and require additional
disclosure in the Company's quarterly financial statements. The Company
adopted SFAS 148 effective January 1, 2003. The following table
discloses the compensation expense and net income had the Company
adopted fair value accounting under SFAS 123:
Year Ended June 30
2003 2002 2001
---------- ---------- ----------
Net income, as reported $ 19,832 $ 2,655 $ 28,048
Less: Total stock-based employee compensation
expense determined under fair value based method,
net of tax 1,250 1,321 1,166
---------- ---------- ----------
Pro forma net income $ 18,582 $ 1,334 $ 26,882
========== ========== ==========
Earnings per share:
Basic - as reported $ 1.05 $ .14 $ 1.43
========== ========== ==========
Basic - pro forma $ .98 $ .07 $ 1.37
========== ========== ==========
Diluted - as reported $ 1.03 $ .13 $ 1.41
========== ========== ==========
Diluted - pro forma $ .97 $ .07 $ 1.35
========== ========== ==========
21
Applied Industrial Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements, Continued
Disclosures under the fair value method are estimated using the
Black Scholes option pricing model. The assumptions used for grants
issued in 2003, 2002 and 2001 are:
2003 2002 2001
------- ------- -------
Expected life 7 years 7 years 7 years
Risk free interest rate 3.9% 4.9% 5.0%
Dividend yield 3.0% 3.0% 3.0%
Volatility 30.9% 29.1% 28.9%
New Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board issued SFAS
144, "Accounting for Impairment or Disposals of Long-Lived Assets." The
Company adopted SFAS 144 as of July 1, 2002. In June 2002, the
Financial Accounting Standards Board issued SFAS 146, "Accounting for
Costs Associated with Exit or Disposal Activities." The Company adopted
SFAS 146 effective July 1, 2002. The adoption of these statements did
not have a material impact on the consolidated financial statements.
In January 2003, the Financial Accounting Standards Board issued FIN
46, "Consolidation of Variable Interest Entities." As discussed in Note
11, the Company is a minority owner in iSource Performance Materials
L.L.C. (iSource), and has guaranteed iSource's line of credit debt up
to $3,000. iSource maintains assets of approximately $3,700. The
Company's purchases currently account for more than 90% of iSource's
sales and the Company is considered the primary beneficiary of
iSource's operations. Accordingly, iSource's financial statements will
be consolidated with the Company's beginning in July 2003 in accordance
with the effective date of FIN 46. It is expected that the effect on
the Company's consolidated financial statements will be immaterial.
NOTE 2 BUSINESS COMBINATIONS
During the year ended June 30, 2003, the Company acquired assets from a
Canadian distributor of industrial products for approximately $11,500.
The results of the acquired business operations are included in our
Service Center Based Distribution segment. Goodwill of $2,486 and other
intangible assets of $1,977, consisting of customer relationships,
trademark, exclusive supplier distribution agreements and a
non-competition agreement, were recognized in connection with this
combination.
For this acquisition, made during the year ended June 30, 2003,
the fair values of the acquired assets and liabilities assumed at the
date of acquisition are as follows:
Accounts receivable $ 2,600
Inventory 4,200
Property 700
Other assets 237
Goodwill 2,486
Other intangibles 1,977
--------
Total assets acquired 12,200
Current liabilities (700)
--------
Net assets acquired $ 11,500
========
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.
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
2003 2002
-------- --------
U.S. inventories at current cost $248,147 $259,145
Foreign inventories at average cost 26,228 18,527
-------- --------
274,375 277,672
Less: Excess of current cost over LIFO cost for U.S. inventories 114,577 111,589
-------- -------
Inventories on consolidated balance sheet $159,798 $166,083
======== ========
22
Reductions in inventories during the fiscal years ended June 30, 2003
and 2002 resulted in liquidation of LIFO inventory quantities carried
at lower costs prevailing in prior years. The effect of these
liquidations for the years ended June 30, 2003 and 2002 increased gross
profit by $741 and $915, net income by $453 and $546 and diluted net
income per share by $.02 and $.03 respectively.
NOTE 4 GOODWILL & OTHER INTANGIBLES
The changes in the carrying amount of goodwill for the years ended June
30, 2003 and 2002, are as follows:
Service Center Based Fluid Power
Distribution Segment Business Total
-------------------- ----------- --------
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 46,410
Goodwill of acquired businesses 2,486 2,486
Currency translation adjustment 791 791
------- -------- --------
Balance at June 30, 2003 $49,687 $ 0 $ 49,687
======= ======== ========
In accordance with SFAS 142, the Company discontinued the amortization
of goodwill effective July 1, 2001. Had goodwill amortization not been
recorded in the year ended June 30, 2001, operating income would have
been increased to $58,471; net income to $30,902; and net income per
share to $1.55.
For purposes of completing impairment testing upon adoption of
SFAS 142 at July 1, 2001, 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 was 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.
The Company's intangible assets acquired from business
combinations are amortized over their estimated useful lives and
consist of the following:
June 30, 2003 June 30,2002
------------------------------------- -------------------------------------
Accumulated Net Accumulated Net
Amount(a) Amortization Book Value Amount Amortization Book Value
--------- ------------ ---------- --------- ------------ ----------
Non-competition agreements $ 9,124 $7,704 $1,420 $8,918 $7,044 $1,874
Customer relationships 1,534 68 1,466
Exclusive supplier distribution
agreements 548 24 524
Trademarks 73 49 24
------- ------ ------ ------ ------ ------
$11,279 $7,845 $3,434 $8,918 $7,044 $1,874
======= ====== ====== ====== ====== ======
(a) Amounts include the impact of foreign currency
translation.
For the year ended June 30, 2003, the Company acquired the following
intangible assets through a business combination (See Note 2):
Amount Amortization Period
------ -------------------
Non-competition agreements $ 125 5 years
Customer relationships 1,318 15 years
Exclusive supplier distribution agreements 471 15 years
Trademarks 63 1 year
------
$1,977
======
Amortization expense for other intangible assets totaled $781 in 2003
and $1,651 in 2002. Estimated amortization expense is $663 for 2004;
$512 for 2005; $338 for 2006; $213 for 2007 and $1,708 after 2007.
23
Applied Industrial Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements, Continued
NOTE 5 OTHER BALANCE SHEET INFORMATION
Other assets consist of the following:
June 30
2003 2002
------- -------
Deferred tax assets - non-current $12,450 $13,032
Deposits and investments 4,459 3,634
Other intangibles 3,434 1,874
Other 4,938 5,463
------- -------
Total $25,281 $24,003
======= =======
Substantially all deposits and investments have fair values
approximately equal to their carrying values.
Other current liabilities consist of the following:
June 30
2003 2002
------- -------
Accrued income and other taxes $10,349 $ 9,689
Accrued self insurance liabilities 4,760 5,008
Deferred tax liabilities - current 1,950
Deferred lease liabilities 4,222 4,453
Other 7,034 5,721
------- -------
Total $26,365 $26,821
======= =======
NOTE 6 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, 2003. Fees on this facility range from
.12% to .40% per year on the average amount of the total revolving
credit commitments during the year. Unused lines under this facility,
net of outstanding letters of credit, totaling $142,964 are available
to fund future acquisitions or other capital and operating
requirements.
The Company also has a $10,000 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, 2003.
Long-term debt consists of:
June 30
2003 2002
------- -------
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(a)
6.6% Senior $50,000 unsecured term notes, due at maturity in
December 2007, including effects of interest rate swaps (See Note 7) 53,558 52,764
------- -------
Total $78,558 $83,478
======= =======
(a) This amount was included in long-term debt at June
30, 2002 due to the Company's ability to refinance
the debt under the revolving credit facility.
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,
2003, the most restrictive of these covenants required that the Company
maintain a minimum consolidated net worth of $270,455. 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, 2003 by approximately $5,051.
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, 2003, there were no borrowings under this agreement.
The aggregate annual maturities of long-term debt over the next
five years include $50,000 in fiscal 2008 and $25,000 in fiscal 2011.
24
NOTE 7 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.
During fiscal 2002, the Company entered into two interest rate
swap agreements with two domestic banks which effectively converted the
fixed interest rate on the 6.6% senior unsecured term notes to a
floating variable rate based on LIBOR. The July 2001 swap agreement was
for $47,000 of the $50,000 6.6% notes and the November 2001 swap
agreement was for all $50,000 of the 6.6% notes. Terms and settlement
dates for both swaps mirrored terms of the notes and the swaps were
designated as fair value hedges. The effect of the swap agreements was
to decrease interest expense by $880 in fiscal 2003 and $1,390 in
fiscal 2002. In October 2001 and August 2002, the Company terminated
the swap agreements for favorable settlements of $2,000 and $2,500,
respectively. These settlement gains are being amortized as a reduction
in interest expense of approximately $800 per year over the remaining
life of the notes through 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 a liability of $999 at
June 30, 2003 which is recorded in current liabilities and the related
unrealized loss 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
a liability of $250 at June 30, 2003 and an asset of $214 at June 30,
2002. Changes in the fair value of this derivative instrument are
recorded in earnings as a component of "other, net."
NOTE 8 INCOME TAXES
Provision
The provision (benefit) for income taxes consists of:
Year Ended June 30
2003 2002 2001
-------- -------- --------
Current
Federal $ 12,300 $ 12,350 $ 17,550
State 1,300 1,450 1,450
Foreign 200 200 100
-------- -------- --------
Total current 13,800 14,000 19,100
-------- -------- --------
Deferred
Federal (2,200) (4,500) (900)
State (500) (600) (200)
Foreign 100 (700)
-------- -------- --------
Total deferred (2,700) (5,000) (1,800)
-------- -------- --------
Total $ 11,100 $ 9,000 $ 17,300
======== ======== ========
The exercise of non-qualified stock options during fiscal 2003, 2002
and 2001 resulted in $466, $605 and $374, 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 2003 and 2001
resulted in $30 and $57, 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
2003 2002 2001
------ ------ ------
Statutory tax rate 35.0% 35.0% 35.0%
Effects of:
State and local income taxes 1.3 2.4 1.8
International income taxes (1.4) (.1) (.9)
Non-deductible expenses 1.4 1.4 2.6
Deductible dividend (2.2)
Income tax examinations 2.2 .8 .2
Other, net (.4) (1.6) (.6)
------ ------ ------
Effective tax rate 35.9% 37.9% 38.1%
====== ====== ======
25
Applied Industrial Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements, Continued
Balance Sheet
The significant components of the Company's deferred tax assets
(liabilities) are as follows:
June 30
2003 2002
-------- --------
Inventories $ (8,972) $(10,491)
Depreciation and differences in property bases (6,240) (5,966)
Compensation liabilities not currently deductible 11,705 10,682
Estimated liabilities and allowances not currently deductible 8,254 7,723
Goodwill 6,366 7,051
Canadian net operating loss carry forwards,
expiring 2010, 2009 and 2008 1,476 1,092
State and other net operating loss carry forwards 796 335
Other 939 656
-------- --------
Net deferred tax asset $ 14,324 $ 11,082
======== ========
NOTE 9 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, 2003 and
2002 were 142,000 and 253,000, respectively.
Under the 1997 Plan, the Executive Organization and Compensation
Committee 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.
At June 30, 2003, 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 "Accounting for Stock Issued to Employees" and related
interpretations in accounting for options granted under the 1997 Plan
and applies SFAS 123 "Accounting for Stock Issued to Employees" for
disclosure purposes only (see Note 1).
Information regarding these option plans is as follows:
2003 2002 2001
------------------- ------------------- -------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
(Share amounts in thousands) Shares Price Shares Price Shares Price
------------------------------ ------ --------- ------ --------- ------ ---------
Outstanding, beginning of year 2,199 $ 16.80 2,124 $ 16.10 1,870 $ 15.03
Granted 522 15.67 401 17.86 457 18.96
Exercised (219) 13.01 (226) 11.57 (110) 9.33
Expired/canceled (28) 17.94 (100) 17.82 (93) 16.72
------ --------- ------ --------- ------ ---------
Outstanding June 30 2,474 $ 16.89 2,199 $ 16.80 2,124 $ 16.10
====== ========= ====== ========= ====== =========
Options exercisable June 30 1,460 $ 16.92 1,322 $ 16.25 1,178 $ 15.05
Weighted-average fair value
of options granted
during the year $ 4.26 $ 4.65 $ 5.41
The following table summarizes information about stock options
outstanding at June 30, 2003:
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 25 0.1 $ 9.75 25 $ 9.75
13 - 17 1,304 6.7 1.46 697 15.18
17 - 21 1,112 6.3 8.43 705 18.44
21 - 28 33 4.4 26.93 33 26.93
--------------- ----------- --------------- --------- ----------- ---------
Total 2,474 1,460
=========== ===========
At June 30, 2003, exercise prices for outstanding options ranged from
$9.75 to $27.03 per share.
26
Shareholders' 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, 2003, 596,000 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 10 BENEFIT PLANS
Retirement Savings Plan
Substantially all associates of the Company's U.S. subsidiaries
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 (5% for 2003, 2002, and 2001). 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 (ranging from 25% to 100% of the first 6% of
compensation contributed to the plan).
The Company's expense for contributions to the above plan was
$3,990, $2,841, and $6,038 for the years ended June 30, 2003, 2002, and
2001, respectively.
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
--------------------- ---------------------
2003 2002 2003 2002
-------- -------- -------- --------
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of the year $ 18,514 $ 19,218 $ 4,244 $ 4,508
Service cost 712 628 63 57
Interest cost 1,123 1,732 287 306
Benefits paid (1,996) (2,236) (228) (281)
Amendments 148 252 150
Actuarial (gain) loss during year 2,329 (1,080) 859 (496)
-------- -------- -------- --------
Benefit obligation at June 30 $ 20,830 $ 18,514 $ 5,225 $ 4,244
======== ======== ======== ========
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of year $ 3,261 $ 2,166
Actual return on plan assets 113 (140)
Employer contribution 2,607 3,471 $ 228 $ 281
Benefits paid (1,996) (2,236) (228) (281)
-------- -------- -------- --------
Fair value of plan assets at June 30 $ 3,985 $ 3,261 $ 0 $ 0
======== ======== ======== ========
RECONCILIATION OF FUNDED STATUS:
Funded status $(16,845) $(15,253) $ (5,225) $ (4,244)
Unrecognized net (gain) loss 4,669 2,269 676 (189)
Unrecognized prior service cost 3,519 3,846 244 293
-------- -------- -------- --------
Accrued benefit cost at year end $ (8,657) $ (9,138) $ (4,305) $ (4,140)
======== ======== ======== ========
AMOUNTS RECOGNIZED IN THE BALANCE SHEET AT JUNE 30 CONSIST OF:
Prepaid benefit cost $ 2,027 $ 1,408
Accrued benefit liability (13,327) $(12,511) $ (4,305) $ (4,140)
Intangible asset 2,643 1,965
-------- -------- -------- --------
Net amount recognized $ (8,657) $ (9,138) $ (4,305) $ (4,140)
======== ======== ======== ========
WEIGHTED-AVERAGE ASSUMPTIONS AS OF JUNE 30:
Discount rate 6.0% 6.5% 6.0% 7.0%
Expected return on plan assets 8.0% 8.0% N/A N/A
Rate of compensation increase 5.5% 5.5% N/A N/A
27
Applied Industrial Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements, Continued
Pension Benefits Other Benefits
----------------------------- -----------------------------
2003 2002 2001 2003 2002 2001
------- ------- ------- ------- ------- -------
Components of net periodic benefit cost:
Service cost $ 712 $ 628 $ 482 $ 63 $ 57 $ 52
Interest cost 1,123 1,732 1,235 287 306 239
Expected return on plan assets (258) (172) (196)
Recognized net actuarial (gain) loss 74 17 71 (6) 13 (42)
Amortization of prior service cost 475 458 373 49 29 29
------- ------- ------- ------- ------- -------
Net periodic pension cost $ 2,126 $ 2,803 $ 1,965 $ 393 $ 405 $ 278
======= ======= ======= ======= ======= =======
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, 2003 and 2002 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, 2003
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 $ 613 $ (515)
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 5.5% at
June 30, 2003 and 2002.
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 11 COMMITMENTS, GUARANTEES, 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
non-cancelable operating leases are $17,496 in 2004; $12,454 in 2005;
$8,911 in 2006; $7,081 in 2007; $5,461 in 2008 and $23,843 after 2008.
Rental expenses incurred for operating leases, principally from leases
for real property, vehicles and computer equipment were $30,067 in
2003, $27,922 in 2002, and $26,122 in 2001.
The Company had outstanding letters of credit of $7,036 at June
30, 2003. These letters of credit secure certain insurance obligations.
In December 2002, the Financial Accounting Standards Board issued
Interpretation No. (FIN) 45, "Guarantor's Accounting and Disclosure
Requirements." FIN 45 requires the disclosure of any guarantees in
place at December 31, 2002 and the recognition of a liability for any
guarantees entered into or modified after that date. The Company is a
guarantor in three arrangements entered into prior to December 31, 2002
that require disclosure under FIN 45 as follows:
- The Company has a construction and lease facility under which a
distribution center and several service centers were constructed by
the lessor and leased to the Company under operating lease
arrangements. These leases expire in September 2003 and permit the
Company to purchase the facilities for $7,500. If the Company does
not exercise this option, residual value guarantee provisions
obligate the Company to compensate the lessor for up to $6,000 at
lease termination depending on the properties' market values at that
time. Due to the nature of the guarantee, the Company has not
recorded any liability on the financial statements. In July 2003 the
Company exercised its option to purchase the facilities for $7,500
when the leases expire in September 2003.
28
- In connection with the construction and lease of its corporate
headquarters facility, the Company has guaranteed repayment of a
total of $5,678 of taxable development revenue bonds issued by
Cuyahoga County and the Cleveland-Cuyahoga County Port Authority.
These bonds were issued with a 20-year term and are scheduled to
mature in March 2016. Any default, as defined in the guarantee
agreements, would obligate Applied for the full amount of the
outstanding bonds through maturity. Due to the nature of the
guarantee, the Company has not recorded any liability on the
financial statements.
- The Company also has guaranteed, under an agreement scheduled to
expire in December 2003, a related entity's repayment of borrowings
under a line of credit. This guarantee was entered into to induce a
financial institution to provide a line of credit for a joint
venture, iSource, of which the Company is a minority owner. iSource
is a certified minority-owned distributor of standard-use industrial
specialty and general maintenance items requiring special shipping
and handling. Any default, as defined in the guarantee agreement,
will obligate the Company for any unpaid balance under the line of
credit up to a maximum of $3,000.
In the event of a default and subsequent payout under any or all
of these guarantees, the Company maintains the right to pursue all
legal options available to mitigate its exposure.
NOTE 12 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 maintenance, repair 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, and
general maintenance items, safety products and tools. 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 Company's reportable segment and
its other businesses are the same as those described in Note 1. Certain
reclassifications have been made to prior year amounts to be consistent
with the presentation in the current year. Sales between the service
center based distribution segment and the other businesses are not
significant. Operating results are in the United States, Canada, Mexico
and Puerto Rico. Operations in Canada, Mexico and Puerto Rico represent
7.4% of the total net sales of Applied, and therefore, are not
presented separately. In addition, approximately 30% of these
operations' net sales are included in the "Other" column relating to
the fluid power business. The long-lived assets located outside of the
United States are not material.
Segment Financial Information:
Service
Center
Based
Distribution Other Total
------------ ---------- ----------
YEAR ENDED JUNE 30, 2003
Net sales $ 1,373,961 $ 90,406 $1,464,367
Operating income (loss) 43,358 (420) 42,938
Assets used in the business 530,540 22,864 553,404
Depreciation 13,693 765 14,458
Capital expenditures 12,273 521 12,794
------------ ---------- ----------
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 507,467 27,099 534,566
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 531,959 46,895 578,854
Depreciation 15,460 904 16,364
Capital expenditures 9,213 2,518 11,731
------------ ---------- ----------
29
Applied Industrial Technologies and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Concluded
A reconciliation from the segment operating profit to the consolidated
balance is as follows:
Year Ended June 30
2003 2002 2001
-------- -------- --------
Operating income for reportable segment $ 43,358 $ 29,015 $ 45,425
Other operating income (loss) (420) (2,049) (1,952)
Adjustments for:
Goodwill and other intangibles amortization (781) (1,651) (5,057)
Corporate and other income (expense), net (a) (5,903) 5,519 16,585
-------- -------- --------
Total operating income 36,254 30,834 55,001
Interest expense, net 5,298 6,738 9,105
Other expense, net 24 341 548
-------- -------- --------
Income before income taxes $ 30,932 $ 23,755 $ 45,348
======== ======== ========
(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
2003 2002 2001
---------- ---------- ----------
Industrial $1,242,339 $1,223,931 $1,396,170
Fluid power (b) 220,629 218,778 226,535
Other 1,399 3,860 3,050
Net sales $1,464,367 $1,446,569 $1,625,755
(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.
NOTE 13 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.
NOTE 14 OTHER EXPENSE
Other expense consists of the following:
Year Ended June 30
2003 2002 2001
------- ------- -------
Benefit from settlement of fiscal 2000 property
insurance claim $(2,133)
Loss on iSource 2,085
Unrealized (gain)/loss on deferred
compensation trusts (30) $ 417 $ 519
Unrealized (gain)/loss on cross currency swap 464 (88) (126)
Other (362) 12 155
------- ------- -------
Net sales $ 24 $ 341 $ 548
======= ======= =======
The loss on iSource for the year ended June 30, 2003, consists of a
$1,150 provision for potential losses on a guarantee of debt of
iSource, $550 for allowances on advances to iSource and $385 for the
Company's share of iSource's net losses.
30
INDEPENDENT AUDITORS'
Report
DELOITTE
& TOUCHE
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, 2003 and 2002, and the related statements of consolidated
income, shareholders' equity, and cash flows for each of the three
years in the period ended June 30, 2003. 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, 2003 and 2002, and the results of its operations and its
cash flows for each of the three years in the period ended June 30,
2003, in conformity with accounting principles generally accepted in
the United States of America.
As discussed in Notes 1 and 4 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."
Deloitte & Touche LLP
Cleveland, Ohio
August 8, 2003
31
Applied Industrial Technologies, Inc. and Subsidiaries
Quarterly Operating Results and Market Data (Unaudited)
Per Common Share (C)
-----------------------------------------------
Income Income
Before Net Before Net Price Range
Net Gross Operating Cumulative Income Cumulative Income - Cash --------------
Sales Profit Income Effect (loss) Effect Diluted Dividend High Low
(Dollars in thousands,
except per share amounts)
---------- -------- --------- ---------- -------- ---------- -------- -------- ------ ------
2003 (A)
First Quarter $ 368,019 $ 89,902 $ 7,844 $ 3,905 $ 3,905 $ 0.20 $ 0.20 $ 0.12 $19.75 $14.81
Second Quarter 355,707 91,191 7,320 3,860 3,860 0.20 0.20 0.12 19.23 14.70
Third Quarter 368,203 97,732 10,154 4,383 4,383 0.23 0.23 0.12 18.85 15.36
Fourth Quarter 372,438 100,470 10,936 7,684 7,684 0.40 0.40 0.12 21.10 16.60
---------- -------- --------- ---------- -------- ---------- -------- --------
$1,464,367 $379,295 $ 36,254 $ 19,832 $ 19,832 $ 1.03 $ 1.03 $ 0.48
========== ======== ========= ========== ======== ========== ======== ========
2002 (A)
First Quarter (B) $ 367,990 $ 92,431 $ 10,112 $ 4,889 $ (7,211) $ 0.25 $ (0.38) $ 0.12 $19.13 $16.50
Second Quarter 347,550 87,013 6,032 2,918 2,918 0.15 0.15 0.12 19.46 16.00
Third Quarter 361,542 91,870 5,833 2,707 2,707 0.14 0.14 0.12 20.91 17.28
Fourth Quarter 369,487 94,376 8,857 4,241 4,241 0.22 0.22 0.12 21.25 18.61
---------- -------- --------- ---------- -------- ---------- -------- --------
$1,446,569 $365,690 $ 30,834 $ 14,755 $ 2,655 $ 0.76 $ 0.13 $ 0.48
========== ======== ========= ========== ======== ========== ======== ========
2001 (A)
First Quarter $ 420,876 $104,454 $ 14,251 $ 7,231 $ 7,231 $ 0.36 $ 0.36 $ 0.12 $18.31 $15.69
Second Quarter 405,438 103,902 15,134 7,362 7,362 0.37 0.37 0.12 21.00 15.88
Third Quarter 408,839 102,037 13,236 6,956 6,956 0.35 0.35 0.12 20.69 16.25
Fourth Quarter 390,602 98,906 12,380 6,499 6,499 0.33 0.33 0.12 19.19 15.65
---------- -------- --------- ---------- -------- ---------- -------- --------
$1,625,755 $409,299 $ 55,001 $ 28,048 $ 28,048 $ 1.41 $ 1.41 $ 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. Fourth quarter adjustments in 2003, 2002 and 2001 increased gross
profit by $4,410, $3,171 and $2,850; net income by $2,682, $1,868 and $1,676 and
diluted net income per share by $.14, $.10, and $.08 respectively. Reductions in
year end inventories during the fiscal years ended June 30, 2003 and 2002
resulted in liquidations of LIFO inventory quantities carried at lower costs
prevailing in prior years. The effect of these liquidations for the years ended
June 30, 2003 and 2002 increased gross profit by $741 and $915, net income by
$453 and $546 and diluted net income per share by $.02 and $.03 respectively.
(B) Effective July 1, 2001, the Company adopted SFAS 142, "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 Notes 1 and 4 to the Consolidated Financial
Statements for additional information.
(C) On August 25, 2003 there were 6,168 shareholders of record, including 3,554
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 25, 2003 was $22.15 per share.
33
Applied Industrial Technologies, Inc. and Subsidiaries
10 Year Summary
2003 2002 2001 2000
(Dollars in thousands, except per share amounts and statistical data)
---------- ---------- ---------- ----------
Consolidated Operations-
Year Ended June 30
Net sales $1,464,367 $1,446,569 $1,625,755 $1,601,084
Operating income 36,254 30,834 55,001 57,779
Income before cumulative effect
of accounting change 19,832 14,755 28,048 31,048
Net income 19,832 2,655 28,048 31,048
Per share data
Income before cumulative effect
of accounting change
Basic 1.05 .77 1.43 1.52
Diluted 1.03 .76 1.41 1.50
Net Income
Basic 1.05 .14 1.43 1.52
Diluted 1.03 .13 1.41 1.50
Cash dividend .48 .48 .48 .48
Year End Position - June 30
Working capital $ 259,359 $ 250,644 $ 279,001 $ 255,132
Long-term debt 78,558 83,478 113,494 112,168
Total assets 553,404 534,566 578,854 594,667
Shareholders' equity 307,856 298,147 311,518 299,331
Year End Statistics - June 30
Current ratio 2.8 2.9 3.2 2.6
Operating facilities 440 449 469 478
Shareholders of record (A) 6,157 6,455 6,697 6,548
(A) Includes participant-shareholders in the Applied Industrial Technologies,
Inc. Retirement Savings Plan, and since 1998, shareholders in the
Automatic Dividend Reinvestment Plan.
34
1999 1998 1997 1996 1995 1994
- ---------- ---------- ---------- ---------- ---------- ----------
$1,555,424 $1,518,615 $1,182,152 $1,164,778 $1,073,875 $ 952,489
42,269 58,520 50,599 49,281 36,923 27,817
19,933 30,125 27,092 23,334 16,909 12,687
19,933 30,125 27,092 23,334 16,909 12,687
.93 1.40 1.47 1.26 .97 .75
.93 1.38 1.44 1.25 .96 .73
.93 1.40 1.47 1.26 .97 .75
.93 1.38 1.44 1.25 .96 .73
.48 .47 .41 .36 .31 .29
$ 258,730 $ 221,766 $ 164,723 $ 151,956 $ 153,555 $ 144,605
126,000 90,000 51,428 62,857 74,286 80,000
574,349 606,091 394,114 404,072 359,231 343,519
293,586 299,502 212,874 192,264 169,760 150,491
3.0 2.1 2.4 2.1 2.4 2.4
444 449 377 376 374 368
6,869 6,731 4,676 4,636 4,379 4,478
35