1 FORM 10 - Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended MARCH 31, 1998 ----------------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ____________ Commission File Number 1-2299 ---------- APPLIED INDUSTRIAL TECHNOLOGIES, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 34-0117420 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) One Applied Plaza, Cleveland, Ohio 44115 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (216) 426-4000 - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------- ------- Shares of common stock outstanding on April 30, 1998 22,067,009 --------------------------------------- (No par value)
2 APPLIED INDUSTRIAL TECHNOLOGIES, INC. ------------------------------------- INDEX <TABLE> <CAPTION> - -------------------------------------------------------------------------------------------------------------------- Page No. <S> <C> Part I: FINANCIAL INFORMATION Item 1: Financial Statements Statements of Consolidated Income - 2 Three Months and Nine Months Ended March 31, 1998 and 1997 Consolidated Balance Sheets - 3 March 31, 1998 and June 30, 1997 Statements of Consolidated Cash Flows 4 Nine Months Ended March 31, 1998 and 1997 Statements of Consolidated Shareholders' Equity - 5 Nine Months Ended March 31, 1998 and Year Ended June 30, 1997 Notes to Consolidated Financial Statements 6 - 9 Item 2: Management's Discussion and Analysis of 10 - 15 Financial Condition and Results of Operations Part II: OTHER INFORMATION 16 Item 1: Legal Proceedings 16 Item 6: Exhibits and Reports on Form 8-K 16 Signatures 18 </TABLE>
3 PART I: FINANCIAL INFORMATION ITEM I: Financial Statements APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED INCOME (Unaudited) (Thousands, except per share amounts) <TABLE> <CAPTION> - ------------------------------------------------------------------------------------------------------------------------- Three Months Ended Nine Months Ended March 31 March 31 1998 1997 1998 1997 ---------------------- ---------------------------- <S> <C> <C> <C> <C> Net Sales $393,871 $297,190 $1,107,220 $854,431 -------- -------- ---------- --------- Cost and Expenses Cost of sales 291,380 221,991 821,379 630,791 Selling, distribution and administrative 85,088 62,752 244,365 188,766 -------- -------- ---------- --------- 376,468 284,743 1,065,744 819,557 -------- -------- ---------- --------- Operating Income 17,403 12,447 41,476 34,874 -------- -------- ---------- --------- Interest Interest expense 2,408 1,673 7,238 4,829 Interest income (182) (124) (660) (695) -------- -------- ---------- --------- 2,226 1,549 6,578 4,134 -------- -------- ---------- --------- Income Before Income Taxes 15,177 10,898 34,898 30,740 -------- -------- ---------- --------- Income Taxes Federal 5,601 3,379 12,098 10,338 State and local 461 764 1,474 2,239 -------- -------- ---------- --------- 6,062 4,143 13,572 12,577 --------- --------- ----------- --------- Net Income $ 9,115 $ 6,755 $ 21,326 $ 18,163 ======== ======== ========== ========= Net Income per share - Basic $ 0.42 $ 0.37 $ 1.00 $ 0.98 ======== ======== ========== ========= Net Income per share - Diluted $ 0.41 $ 0.36 $ 0.98 $ 0.97 ======== ======== ========== ========= Cash dividends per common share $ 0.12 $ 0.11 $ 0.35 $ 0.31 ======== ======== ========== ========= </TABLE> See notes to consolidated financial statements. 2
4 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ CONSOLIDATED BALANCE SHEETS (Amounts in thousands) <TABLE> <CAPTION> March 31 June 30 1998 1997 --------- --------- (Unaudited) Assets <S> <C> <C> Current assets Cash and temporary investments $ 17,698 $ 22,405 Accounts receivable, less allowance of $3,299 and $2,400 195,363 153,080 Inventories (at LIFO) 190,195 103,069 Other current assets 5,666 6,905 --------- --------- Total current assets 408,922 285,459 --------- --------- Property - at cost Land 12,685 12,281 Buildings 73,577 66,157 Equipment 87,575 81,132 --------- --------- 173,837 159,570 Less accumulated depreciation 63,329 68,809 --------- --------- Property - net 110,508 90,761 --------- --------- Goodwill 54,932 5,604 Other assets 17,185 12,290 --------- --------- TOTAL ASSETS $ 591,547 $ 394,114 ========= ========= Liabilities and Shareholders' Equity Current liabilities Notes payable $ 21,132 $ 25,415 Current portion of long-term debt 19,429 11,429 Accounts payable 96,840 49,469 Compensation and related benefits 22,854 19,025 Other accrued liabilities 22,276 15,398 --------- --------- Total current liabilities 182,531 120,736 Long-term debt 95,714 51,428 Other liabilities 28,427 14,366 --------- --------- TOTAL LIABILITIES 306,672 186,530 --------- --------- Shareholders' Equity Preferred Stock - no par value; 2,500 shares authorized; none issued or outstanding Common stock - no par value; 50,000 shares authorized; 24,095 and 20,931 shares issued 10,000 10,000 Additional paid-in capital 81,412 10,311 Income retained for use in the business 230,340 216,642 Less 2,051 and 2,310 treasury shares - at cost (25,036) (22,983) Less shares held in trust for deferred compensation plans (6,853) (5,436) Less unearned restricted common stock compensation (4,988) (950) --------- --------- TOTAL SHAREHOLDERS' EQUITY 284,875 207,584 --------- --------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 591,547 $ 394,114 ========= ========= </TABLE> See notes to consolidated financial statements. 3
5 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ STATEMENTS OF CONSOLIDATED CASH FLOWS (Unaudited) (Amounts in thousands) <TABLE> <CAPTION> Nine Months Ended March 31 ---------------------- 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> Cash Flows from Operating Activities Net income $ 21,326 $ 18,163 Adjustments to reconcile net income to cash provided by (used in) operating activities: Depreciation 11,798 10,178 Amortization of goodwill and restricted common stock compensation 3,345 606 Provision for losses on accounts receivable 1,465 599 Gain on sale of property (574) (399) Treasury shares contributed to employee benefit plans 3,261 2,502 Changes in current assets and liabilities, net of effects from acquisition and disposal of businesses: Accounts receivable 20 (426) Inventories (32,686) 3,765 Other current assets 4,815 (4,792) Accounts payable and accrued expenses (1,067) (3,637) Other - net 650 938 - ------------------------------------------------------------------------------------------------------------------------------ Net Cash provided by Operating Activities 12,353 27,497 - ------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Investing Activities Property purchases (26,126) (10,855) Proceeds from property sales 6,536 3,068 Net cash paid for acquisition of businesses (31,328) Proceeds from sale of Aircraft Division 9,090 Deposits and other 9,193 1,976 - ------------------------------------------------------------------------------------------------------------------------------ Net Cash (used in) provided by Investing Activities (41,725) 3,279 - ------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Financing Activities Net repayments under Line-of-credit agreements (4,283) (9,159) Long-term debt borrowings 50,000 Long-term debt repayments (6,361) (5,714) Exercise of stock options 938 510 Dividends paid (7,628) (5,701) Purchase of treasury shares (8,001) (4,434) - ------------------------------------------------------------------------------------------------------------------------------ Net Cash provided by (used in) Financing Activities 24,665 (24,498) - ------------------------------------------------------------------------------------------------------------------------------ Increase (decrease ) in cash and temporary investments (4,707) 6,278 Cash and temporary investments at beginning of period 22,405 9,243 - ------------------------------------------------------------------------------------------------------------------------------ Cash and Temporary Investments at End of Period $ 17,698 $ 15,521 ============================================================================================================================== Supplemental Cash Flow Information Cash paid during the period for: Income taxes $ 10,997 $ 16,740 Interest $ 7,171 $ 5,161 Significant noncash investing activity: Issuance of common stock for the acquisition of Invetech Company $ 63,374 </TABLE> See notes to consolidated financial statements. 4
6 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY For the Nine Months Ended March 31, 1998 (Unaudited) and Year Ended June 30, 1997 (Thousands, except per share amounts ) <TABLE> <CAPTION> Income Shares of Additional Retained Treasury Common Stock Common Paid-in for Use in Shares Outstanding Stock Capital the Business -at Cost - ------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> Balance at July 1, 1996 18,566 $ 10,000 $ 7,528 $ 197,232 $ (21,260) Net income 27,092 Cash dividends - $.41 per share (7,682) Purchase of common stock for treasury (249) (4,568) Treasury shares issued for: Retirement Savings Plan contributions 164 1,809 1,568 Exercise of stock options 78 342 747 Deferred compensation plans 53 532 463 Restricted common stock awards 9 68 67 Amortization of restricted common stock compensation 32 Increase in fair value of shares held in trust - ------------------------------------------------------------------------------------------------------------------------------ Balance at June 30, 1997 18,621 10,000 10,311 216,642 (22,983) Net income 21,326 Cash dividends - $.35 per share (7,628) Purchase of common stock for treasury (284) (8,001) Issuance of common stock for the acquisition of Invetech Company 3,165 63,374 Treasury shares issued for: Retirement Savings Plan contributions 113 1,970 1,291 Exercise of stock options 81 22 916 Deferred compensation plans 24 405 245 Restricted common stock awards 201 3,560 2,005 Acquisition of Associated Bearings 123 1,770 1,491 Amortization of restricted common stock compensation Increase in fair value of shares held in trust - ----------------------------------------------------------------------------------------------------------------------------- Balance at March 31, 1998 22,044 $ 10,000 $ 81,412 $ 230,340 $ (25,036) ============================================================================================================================= </TABLE> <TABLE> <CAPTION> Shares Held in Unearned Trust for Restricted Total Deferred Common Stock Shareholders' Compensation Plans Compensation Equity - ------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> Balance at July 1, 1996 $ (3,008) $ (1,200) $ 189,292 Net income 27,092 Cash dividends - $.41 per share (7,682) Purchase of common stock for treasury (4,568) Treasury shares issued for: Retirement Savings Plan contributions 3,377 Exercise of stock options 1,089 Deferred compensation plans (995) Restricted common stock awards (135) Amortization of restricted common stock compensation 385 417 Increase in fair value of shares held in trust (1,433) (1,433) - ------------------------------------------------------------------------------------------------------------------------ Balance at June 30, 1997 (5,436) (950) 207,584 Net income 21,326 Cash dividends - $.35 per share (7,628) Purchase of common stock for treasury (8,001) Issuance of common stock for the acquisition of Invetech Company 63,374 Treasury shares issued for: Retirement Savings Plan contributions 3,261 Exercise of stock options 938 Deferred compensation plans (650) Restricted common stock awards (5,565) Acquisition of Associated Bearings 3,261 Amortization of restricted common stock compensation 1,527 1,527 Increase in fair value of shares held in trust (767) (767) - ------------------------------------------------------------------------------------------------------------------------ Balance at March 31, 1998 $ (6,853) $ (4,988) $ 284,875 ======================================================================================================================== </TABLE> See notes to consolidated financial statements. 5
7 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands) (Unaudited) - -------------------------------------------------------------------------------- 1. BASIS OF PRESENTATION In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position as of March 31, 1998 and June 30, 1997, and the results of operations for the three months and nine months ended March 31, 1998 and 1997, and cash flows for the nine months ended March 31, 1998 and 1997. The results of operations for the three and nine month periods ended March 31, 1998 are not necessarily indicative of the results to be expected for the fiscal year. Cost of sales for interim financial statements are computed using estimated gross profit percentages which are adjusted throughout the year based upon available information. Adjustments to actual cost are made based on the annual physical inventory and the effect of year-end inventory quantities on LIFO costs. 2. NET INCOME PER SHARE Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards No. 128, Earnings per Share. All prior amounts have been restated to conform to the basic and diluted presentation. The impact to previously reported earnings per share amounts is not significant. All share and per share data have also been restated to reflect a three for two stock split effective September 15, 1997. 6
8 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except per share amounts) (Unaudited) - -------------------------------------------------------------------------------- The following is a computation of the basic and diluted earnings per share: <TABLE> <CAPTION> Three Months Ended Nine Months Ended March 31 March 31 1998 1997 1998 1997 ----------------------------------------------------- <S> <C> <C> <C> <C> Net Income - ---------- Net income as reported in statements of consolidated income $9,115 $6,755 $21,326 $18,163 ===================================================== Average Shares Outstanding - -------------------------- Weighted average common shares outstanding for basic computation 21,776 18,412 21,343 18,467 Dilutive effect of: Stock options 297 251 325 227 Performance Accelerated Restricted Stock (PARS) 41 53 54 53 ----------------------------------------------------- Adjusted average common shares outstanding for diluted computation 22,114 18,716 21,722 18,747 ===================================================== Net Income Per Share - -------------------- Net income per common share - basic $0.42 $0.37 $1.00 $0.98 ===================================================== Net income per common share - diluted $0.41 $0.36 $0.98 $0.97 ===================================================== </TABLE> 7
9 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands, except per share amounts) (Unaudited) - -------------------------------------------------------------------------------- 3. BUSINESS COMBINATIONS Effective August 1, 1997, the Company completed the acquisition of Invetech Company (Invetech), a distributor of bearings, mechanical and electrical drive system products, industrial rubber products and specialty maintenance and repair products. The aggregate purchase price including the issuance of 2,110 shares of Company common stock, was $93,900. The cash portion of the purchase price of $23,400 was financed through available short-term lines of credit. The Company accounted for the acquisition as a purchase and has included Invetech's results of operations from the effective date of the acquisition. The Company incurred a pre-tax nonrecurring charge of $4,000 in the quarter ending September 30, 1997 for consolidation expenses and costs associated with disposal of duplicative property and other assets. The purchase price was allocated based on estimated fair values at the date of acquisition. Goodwill representing the excess of the purchase price over assets acquired of $35,840 is being amortized on a straight-line basis over 30 years. The following table summarizes the unaudited consolidated pro forma results of operations, as if the acquisition had occurred at the beginning of the following periods: <TABLE> <CAPTION> Nine Months Ended March 31 1998 1997 ---- ---- (Unaudited) <S> <C> <C> Net sales $1,132,359 $1,092,405 Income before income taxes 33,983 32,968 Net income 20,777 19,904 Net income per share-basic .96 .92 Net income per share-diluted .94 .90 </TABLE> The unaudited pro forma amounts include the pre-tax nonrecurring charge of $4,000 for the nine months ended March 31, 1998. This pro forma information is not necessarily indicative of the results that actually would have been attained if the operations had been combined during the periods presented and is not intended to be a projection of future results. 8
10 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands) (Unaudited) - -------------------------------------------------------------------------------- During the nine months ended March 31, 1998 the Company acquired certain assets of a rubber fabrication and repair shop, the stock of two distributors of fluid power products, and a distributor of bearings, power transmission products and industrial supplies for a total of 123 shares of Company stock and $12,278 in cash. The acquisitions of these businesses were accounted for as purchases and their results of operations are included in the accompanying consolidated financial statements from their respective acquisition dates. Results of operations for these acquisitions are not material for all periods presented. Goodwill recognized in connection with these combinations is being amortized over 15 years. 4. LONG-TERM DEBT In connection with the Invetech acquisition, the Company assumed an $8,000 bank term loan, at an interest rate of 5.97%, payable in December 1998. In January 1998 the Company borrowed $50,000 of long-term debt under a shelf facility agreement with The Prudential Insurance Company of America. Proceeds from these 6.6% Senior Unsecured Term Notes were used to repay short-term debt. Interest is payable quarterly. The principal amount is to be paid in December 2007. 5. SHAREHOLDER RIGHTS PLAN On January 15, 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 held of record as of February 2, 1998. The rights become exercisable only if a person or group acquires beneficial ownership of 20% or more of the Company's common stock 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. 9
11 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- The following is Management's discussion and analysis of certain significant factors which have affected the Company's: (1) financial condition at March 31, 1998 and June 30, 1997, and (2) results of operations and cash flows during the periods included in the accompanying statements of Consolidated Income and Consolidated Cash Flows. FINANCIAL CONDITION Liquidity and Working Capital - ----------------------------- Cash provided by operating activities was $12.3 million in the nine months ended March 31, 1998. This compares to $27.5 million provided by operating activities in the same period a year ago. Cash flow from operations depends primarily upon generating operating income, controlling the investment in inventories and receivables, and managing the timing of payments to suppliers. The Company has continuing programs to monitor and control these investments. During the six month period ended December 31, 1997 inventories (excluding inventories purchased in the Invetech transaction and other acquisitions) increased approximately $35.5 million due to timing of purchases relating to the calendar year end. Inventories declined approximately $3.0 million from December 1997 through March 1998 and are expected to continue to decline through the remainder of the fiscal year. Accounts receivable, exclusive of receivables acquired in the Invetech transaction and other acquisitions, remained constant. Investments in property totaled $26.1 million and $10.9 million in the nine months ended March 31, 1998 and 1997 respectively. The increases in capital expenditures were primarily made for integrating and improving facilities, data processing equipment and vehicles related to Invetech and other acquisitions. The Company entered into an agreement to build a new 160,000 square foot distribution center in the city of Corona, California, in the greater Los Angeles area. Construction is expected to begin in the fourth quarter and be completed by the third quarter of fiscal 1999. This build-to-suit facility will be leased by the Company under a 10 year lease which is expected to be accounted for as an operating lease. The Company is planning to move out of its current Corona Distribution Center and into the new facility upon expiration of its current lease. Working capital at March 31, 1998 was $226.4 million compared to $164.7 million at June 30, 1997. This increase is primarily due to the acquisition of Invetech and other companies, the increase in inventories and the refinancing of short term borrowings to long term debt. 10
12 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Capital Resources - ----------------- Capital resources are obtained from income retained in the business, indebtedness under the Company's lines of credit and long-term debt agreements, and operating lease arrangements. Average combined short-term and long-term borrowing was $121.2 and $90.7 million for the nine months ended March 31, 1998 and 1997, respectively. The average effective interest rate on the short-term borrowings for the nine months ended March 31, 1998 decreased to 6.0% from an average rate of 6.5% for the nine months ended March 31, 1997 due to lower interest rates on short-term debt. The Company has $160 million of short-term lines of credit with commercial banks that provide for payment of interest at various interest rate options, none of which are in excess of the banks' prime rate. The Company had $21.1 million of borrowings outstanding under short-term bank lines of credit on March 31, 1998. Unused lines of credit totaling $138.9 million are available for future short-term financing needs. In January 1998 the Company borrowed $50 million at a 6.6% interest rate with a ten-year term under a previously unused $50 million shelf facility agreement in place with The Prudential Insurance Company of America. Proceeds from these notes were used to repay short term debt. The Board of Directors has authorized an ongoing program to purchase shares of the Company's common stock to fund employee benefit programs and stock option and award programs. These purchases are made in open market and negotiated transactions, from time to time, depending upon market conditions. The Company acquired 284,000 shares of its common stock for $8.0 million during the nine months ended March 31, 1998. Management expects that capital resources provided from operations, available lines of credit and long-term debt and operating leases will be sufficient to finance normal working capital needs, business acquisitions, enhancement of facilities and equipment and the purchase of additional Company common stock. Management also believes that additional long-term debt and line of credit financing could be obtained if desired. 11
13 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Year 2000 Issue - --------------- The Company's plan for assessment, remediation and replacement of those of its internal computer systems affected by the Year 2000 issue is on schedule. The Company expects all internal systems to be fully tested and compliant by the end of calendar year 1999. In addition, the Company is seeking assurances from its product and service suppliers and major customers as to their Year 2000 compliance plans. The Company's progress in completing its Year 2000 activities is overseen by an executive task force made up of representatives from all key management areas. Additionally, the Company has retained an outside Year 2000 consultant to provide an independent assessment of the Company's Year 2000 efforts. The Company expects that the actions described above will significantly reduce the likelihood that Year 2000 issues would have a material adverse effect on the Company's business, financial condition or results of operations. Based on currently available information, the total cost of the Company's Year 2000 activities is not expected to be material to its financial condition or results of operations. If the requisite changes to the Company's systems are not made or are not completed in a timely manner, or if the Company's suppliers and customers fail to achieve Year 2000 compliance in a timely manner, then the Year 2000 issue could have a material adverse effect on the Company. 12
14 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- RESULTS OF OPERATIONS - --------------------- A summary of the period-to-period changes in principal items included in the statements of consolidated income follows: <TABLE> <CAPTION> Increase (Decrease) (Dollars in Thousands Except per Share Amounts) Three Months Ended Nine Months Ended March 31 March 31 1998 and 1997 1998 and 1997 Amount Change Amount Change ------ ------ ------ ------ <S> <C> <C> <C> <C> Net sales $96,681 32.5% $252,789 29.6% Cost of sales 69,389 31.3% 190,588 30.2% Selling,distribution and administrative expenses 22,336 35.6% 55,599 29.5% Operating income 4,956 39.8% 6,602 18.9% Interest expense - net 677 43.7% 2,444 59.1% Income before income taxes 4,279 39.3% 4,158 13.5% Income taxes 1,919 46.3% 995 7.9% Net income 2,360 34.9% 3,163 17.4% Net income per share - diluted .05 13.9% .01 1.0% </TABLE> 13
15 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Three Months Ended March 31, 1998 and 1997 - ------------------------------------------ The increase in net sales, cost of sales and selling, distribution and administrative expenses from the prior year relate primarily to the operations of Invetech. Gross profit as a percentage of sales increased to 26.0% from 25.3%. This increase primarily relates to a reduction in estimated year to date costs used to determine cost of sales offset by higher freight costs and changes in the product mix due to the Invetech acquisition. Selling, distribution and administrative expenses as a percent of sales, increased to 21.6% from 21.1%. The increase was primarily from higher goodwill amortization, hospitalization and temporary employment expenses as a percent of sales. Interest expense-net for the quarter increased by 43.7% as compared to the prior year primarily as a result of an increase in average borrowings related to Invetech and other acquisitions. Income tax expense as a percentage of income before taxes was 39.9% in the quarter ended March 31, 1998 and 38.0% in the quarter ended March 31, 1997. Prior year amounts were lowered due to a year to date adjustment recorded in the quarter ended March 31, 1997, which lowered the effective state and local income tax rates in the prior year. As a result of the above factors, net income increased by 34.9% compared to the same quarter of last year. Net income per share - diluted increased by 13.9% due to the impact of increased net income partly offset by an increase in the number of shares outstanding primarily in connection with the acquisition of Invetech in August 1997. Nine Months Ended March 31, 1998 and 1997 - ----------------------------------------- The Company acquired Invetech effective August 1, 1997. Invetech's operations were consolidated with those of the Company beginning as of the acquisition date. The increases in net sales, cost of sales and selling, distribution and administrative expenses from the prior year relate primarily to the operations of Invetech. During the period ended March 31, 1998, the Company incurred a pre-tax nonrecurring charge of $4,000 included in selling, distribution and administrative expenses for consolidation expenses and costs associated with disposal of duplicative property and other assets related to the Invetech acquisition. Gross profit as a percent of sales was 25.8% compared to 26.2%. This decrease primarily relates to higher freight costs, lower purchase allowances and changes in the product mix due to the Invetech acquisition. 14
16 APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES ------------------------------------------------------ ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Selling, distribution and administrative expenses, as a percent of sales, remained constant at 22.1%. Increases in selling, distribution and administrative expenses resulted primarily from the $4.0 million nonrecurring charge as well as other nonrecurring expenses and were offset primarily from the benefits of the consolidation of certain Invetech administrative functions. Interest expense-net for the period increased by 59.1% as compared to the prior year primarily as a result of an increase in average borrowings related to the Invetech acquisition. Income tax expense as a percentage of income before taxes was 38.9% in the nine months ended March 31, 1998 and 40.9% in the nine months ended March 31, 1997. The decrease is primarily attributed to tax savings from lower effective state and local income tax rates and adjustments to the tax liability accounts from a change in estimate. As a result of the above factors, net income increased by 17.4% compared to the same period last year. Net income per share - diluted increased by 1.0% due to the impact of the increase in net income partly offset by the issuance of 3.2 million shares for the acquisition of Invetech in August 1997. CAUTIONARY STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT - ------------------------------------------------------------------- Management's discussion and analysis contains statements that are forward-looking, as that term is defined by the Private Securities Litigation Reform Act of 1995 or by the Securities and Exchange Commission in its rules, regulations and releases. The Company intends that such forward-looking statements be subject to the safe harbors created thereby. 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 therein will be achieved. Important risk factors include, but are not limited to, the following: changes in the economy or in specific customer industry sectors; changes in customer procurement policies and practices; changes in product manufacturer sales policies and practices; the availability of product; changes in operating expenses; the effect of price increases; the variability and timing of business opportunities including acquisitions, customer agreements, supplier authorizations and other business strategies; the Company's ability to realize the anticipated benefits of acquisitions and other business opportunities; the Company's ability to complete, in a timely manner and within cost estimates, its Year 2000 project; changes in accounting policies and practices; the effect of organizational changes within the Company; adverse results in significant litigation matters; adverse state and federal regulation and legislation; and the occurrence of extraordinary events (including prolonged labor disputes, natural events and acts of God, fires, floods and accidents). 15
17 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings. (a) The Company incorporates by reference herein the description of the case captioned KING BEARING, INC. V. CARYL EDMUND ORANGES, ET AL., Superior Court of the State of California, County of Orange, Case No. 53-42-31 found in Item 3 "Pending Legal Proceedings" contained in the Company's Form 10-K for the fiscal year ended June 30, 1997. The Company believes that this case will have no material adverse effect on its business or financial condition. (b) Applied Industrial Technologies, Inc. and/or one of its subsidiaries is a defendant in several product-related lawsuits. Based on circumstances presently known, the Company believes that these cases are not material to its business or financial condition. ITEM 6. Exhibits and Reports on Form 8-K. --------------------------------- (a) Exhibits. --------- Exhibit No. Description ----------- ----------- 4(a) Amended and Restated Articles of Incorporation of Applied Industrial Technologies, Inc., as amended on November 5, 1997 (filed as Exhibit 4(a) to the Company's Form 10-Q for the quarter ending December 31, 1997, SEC File No. 1-2299, and incorporated here by reference). 4(b) Code of Regulations of Applied Industrial Technologies, Inc. adopted September 6, 1988 (filed as Exhibit 3(b) to the Company's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). 4(c) Certificate of Merger of the Company and Bearings, Inc. (Delaware) filed with the Ohio Secretary of State on October 18, 1988, including an Agreement and Plan of Reorganization dated September 6, 1988 (filed as Exhibit 4(a) to the Company's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). 16
18 4(d) $80,000,000 Maximum Aggregate Principal Amount Note Purchase and Private Shelf Facility dated October 31, 1992 between the Company and The Prudential Insurance Company of America (filed as Exhibit 4(b) to the Company's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). 4(e) Amendment to $80,000,000 Maximum Aggregate Principal Amount Note Purchase and Private Shelf Facility dated October 31, 1992 between the Company and The Prudential Insurance Company of America (filed as Exhibit 4(g) to the Company's Form 10-Q for the quarter ended March 31, 1996, SEC File No. 1-2299, and incorporated here by reference). 4(f) $50,000,000 Private Shelf Agreement dated as of November 27, 1996, as amended on January 30, 1998, between the Company and The Prudential Insurance Company of America. 10(a) Non-Qualified Deferred Compensation Agreement between the Company and J. Michael Moore. 10(b) Amended and Restated Change in Control Agreements between the Company and each of its executive officers. 27 Financial Data Schedule. (b) The Company did not file, nor was it required to file, a Report on Form 8-K with the Securities and Exchange Commission during the quarter ended March 31, 1998. 17
19 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. APPLIED INDUSTRIAL TECHNOLOGIES, INC. (Company) Date: May 15, 1998 By: /s/ Mark O. Eisele ----------------------------------------------- Mark O. Eisele Vice President & Controller Date: May 15, 1998 By: /s/ Robert C. Stinson ----------------------------------------------- Robert C. Stinson Vice President 18
20 APPLIED INDUSTRIAL TECHNOLOGIES, INC. EXHIBIT INDEX TO FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 1998 <TABLE> <CAPTION> EXHIBIT NO. DESCRIPTION PAGE <S> <C> <C> 4(a) Amended and Restated Articles of Incorporation of Applied Industrial Technologies, Inc., as amended on November 5, 1997 (filed as Exhibit 4(a) to the Company's Form 10-Q for the quarter ending December 31, 1997, SEC File No. 1-2299, and incorporated here by reference). 4(b) Code of Regulations of Applied Industrial Technologies, Inc., adopted September 6, 1988 (filed as Exhibit 3(b) to the Company's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). 4(c) Certificate of Merger of the Company and Bearings, Inc. (Delaware) filed with the Ohio Secretary of State on October 18, 1988, including an Agreement and Plan of Reorganization dated September 6, 1988 (filed as Exhibit 4(a) to the Company's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). 4(d) $80,000,000 Maximum Aggregate Principal Amount Note Purchase and Private Shelf Facility dated October 31, 1992 between the Company and The Prudential Insurance Company of America (filed as Exhibit 4(b) to the Company's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). 4(e) Amendment to $80,000,000 Maximum Aggregate Principal Amount Note Purchase </TABLE>
21 <TABLE> <CAPTION> <S> <C> <C> and Private Shelf Facility dated October 31, 1992 between the Company and The Prudential Insurance Company of America (filed as Exhibit 4(g) to the Company's Form 10-Q for the quarter ended March 31, 1996, SEC File No. 1-2299, and incorporated here by reference). 4(f) $50,000,000 Private Shelf Agreement dated as Attached Attached of November 27, 1996, as amended on January 30, 1998, between the Company and The Prudential Insurance Company of America. 10(a) Non-Qualified Deferred Compensation Attached Agreement between the Company and J. Michael Moore. 10(b) Amended and Restated Change in Control Attached Agreements between the Company and each of its executive officers. 27 Financial Data Schedule. Attached </TABLE>