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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JANUARY 2, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number: 33-80701
AAF-MCQUAY INC.
- --------------------------------------------------------------------------------
(Exact name of Registrant as Specified in Its Charter)
DELAWARE 41-0404230
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
111 SOUTH CALVERT STREET, BALTIMORE, MARYLAND 21202
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (410) 528-2755
----------------
NOT APPLICABLE
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Former Name, Former Address and Former Fiscal Year, if Changed Since Last
Report.
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
-- --
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 2,497 shares of Common Stock,
par value $100.00 per share, were outstanding as of February 8, 1999.
1
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INDEX
AAF-MCQUAY INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I - Financial Information.......................................... 3
- ------
Item 1. Financial Statements (unaudited)............................... 3
Consolidated Balance Sheets as of -
December 31, 1998 and June 30, 1998............................ 3
Consolidated Statements of Operations -
Three months ended December 31, 1998 and December 31,
1997; and the six months ended December 31, 1998 and
December 31, 1997.............................................. 4
Condensed Consolidated Statements of Cash Flows-
Six months ended December 31, 1998 and
December 31, 1997.............................................. 5
Notes to the Consolidated Financial Statements................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 10
PART II - Other Information.............................................. 15
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Item 1. Legal Proceedings.............................................. 15
Item 6. Exhibits and Reports on Form 8-K............................... 15
Signatures...................................................................... 16
</TABLE>
2
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PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AAF-MCQUAY INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
<TABLE>
<CAPTION>
December 31, June 30,
1998 1998
---------------- ----------------
(unaudited)
ASSETS:
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 9,220 $ 9,697
Accounts receivable 217,073 238,613
Inventories 137,058 124,793
Other current assets 8,911 8,423
---------------- ----------------
Total current assets 372,262 381,526
Property, plant and equipment, net 148,573 145,305
Cost in excess of net assets acquired and other identifiable intangibles, net 235,365 250,650
Other assets and deferred charges 20,084 19,397
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Total Assets $ 776,284 $ 796,878
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---------------- ----------------
LIABILITIES AND STOCKHOLDER'S EQUITY:
Current liabilities:
Short-term borrowings $ 71,301 $ 60,262
Current maturities of long-term debt 20,561 28,531
Accounts payable, trade 114,361 120,775
Accrued warranty 15,832 14,947
Other accrued liabilities 80,815 88,713
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Total current liabilities 302,870 313,228
Long-term debt 167,809 177,083
Other liabilities 93,682 100,727
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Total liabilities 564,361 591,038
Stockholder's equity:
Preferred stock ($1 par value; 1,000 shares authorized, none issued) Common
stock ($100 par value; 8,000 shares authorized, 2,497 shares
issued and outstanding) 250 250
Additional paid-in capital 179,915 179,915
Retained earnings 37,296 33,185
Accumulated other comprehensive income (6,168) (7,510)
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Total Stockholder's Equity 211,923 205,840
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Total Liabilities and Stockholder's Equity $ 776,284 $ 796,878
---------------- ----------------
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</TABLE>
See Notes To Consolidated Financial Statements
3
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AAF-MCQUAY INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(dollars in thousands)
<TABLE>
<CAPTION>
Three months ended Six months ended
--------------------------------- ---------------------------------
December 31, December 31, December 31, December 31,
1998 1997 1998 1997
---------------- ---------------- --------------- ----------------
<S> <C> <C> <C> <C>
Net Sales............................ $ 215,715 $ 233,380 $ 467,115 $ 478,506
Cost of Sales........................ 160,297 171,596 344,163 349,635
---------------- ---------------- --------------- ----------------
Gross Profit......................... 55,418 61,784 122,952 128,871
Operating Expenses:
Selling, general and
administrative................ 48,792 53,494 103,879 108,701
Restructuring................... --- --- 751 ---
Amortization of intangible
assets........................ 2,831 2,950 5,733 5,850
--------------- ---------------- ---------------- ----------------
51,623 56,444 110,363 114,551
---------------- ---------------- --------------- ----------------
Income from operations............... 3,795 5,340 12,589 14,320
Interest expense, net................ 5,738 6,618 12,244 13,176
Other (income) expense, net......... (661) (7,181) (4,721) (7,333)
---------------- ---------------- ---------------- ---------------
Income (loss) before income taxes.... (1,282) 5,903 5,066 8,477
Minority interest earnings (loss).... (50) (115) (40) (241)
Income taxes......................... (613) 2,656 915 3,814
---------------- ---------------- ---------------- ---------------
Net income (loss).................... $ (719) $ 3,132 $ 4,111 $ 4,422
---------------- ---------------- ---------------- ---------------
---------------- ---------------- ---------------- ---------------
</TABLE>
See Notes To Consolidated Financial Statements
4
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AAF-MCQUAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
<TABLE>
<CAPTION>
Six months ended
--------------------------------------
December 31, December 31,
1998 1997
--------------------------------------
<S> <C> <C>
Cash flows from operating activities
Net income $ 4,111 $ 4,422
Adjustments to reconcile to cash from
operating activities:
Depreciation and amortization 13,658 13,374
Foreign currency transaction (gains) losses (232) (24)
Restructuring spending (3,764) ----
Gain on sale of business ---- (6,626)
Changes in operating assets and liabilities 1,750 5,147
----------------- -----------------
Net cash from operating activities 15,523 16,293
Cash flows from investing activities:
Capital expenditures, net (9,931) (9,318)
Proceeds from sale of business ---- 17,133
----------------- -----------------
Net cash from investing activities (9,931) 7,815
Cash flows from financing activities:
Net borrowings (repayments) under short-term
borrowing arrangements 11,039 (6,015)
Payments on long-term debt (17,243) (17,198)
----------------- -----------------
Net cash from financing activities (6,204) (23,213)
Effect of exchange rate changes on cash 135 (178)
----------------- -----------------
Net increase (decrease) in cash and cash equivalents (477) 717
Cash and cash equivalents at beginning of period 9,697 10,827
----------------- -----------------
Cash and cash equivalents at end of period $ 9,220 $ 11,544
----------------- -----------------
----------------- -----------------
</TABLE>
See Notes To Consolidated Financial Statements
5
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. BASIS OF PRESENTATION:
The consolidated financial statements include the accounts of the Company
and all of its wholly-owned subsidiaries. All inter-company transactions have
been eliminated. The accompanying unaudited consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim reporting and with the instructions to Form 10-Q and Article 10 of
Regulation S-K. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been omitted. For further information, refer
to the consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K (the "Annual Report") for the year ended
June 30, 1998. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation have
been included. The accompanying financial statements reflect the statements of
operations for the three and six months ended December 31, 1998 and December 31,
1997, the balance sheets at December 31, 1998 and June 30, 1998, and the
consolidated statements of cash flows for the six months ended December 31, 1998
and December 31, 1997.
The operating results for the six months ended December 31, 1998 are not
necessarily indicative of the operating results that may be expected for the
full year ending June 30, 1999. The Company's period end is the Saturday closest
to December 31. For clarity in presentation all periods presented herein are
shown to end on the last calendar day of the month.
During the first quarter of fiscal year 1999, the Company made a change in
accounting estimate related to its warranty provision. The Company increased its
warranty provision by $2.5 million due to current activity related to new
product introductions and discontinued product lines.
NOTE 2. INVENTORIES:
Inventories consist of the following:
<TABLE>
<CAPTION>
December 31, June 30,
1998 1998
----------------- ---------------
(dollars in thousands)
<S> <C> <C>
FIFO Cost:
Raw Materials.................................. $ 52,439 $ 46,513
Work-in-process................................ 32,731 33,493
Finished goods................................. 48,197 40,961
----------------- ---------------
133,367 120,967
LIFO adjustment................................ 3,691 3,826
----------------- ---------------
$ 137,058 $ 124,793
----------------- ---------------
----------------- ---------------
</TABLE>
NOTE 3. COMPREHENSIVE INCOME:
In the first quarter of fiscal year 1999, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income."
SFAS 130 requires disclosure of total non-stockholder changes in equity in
interim periods and additional disclosures of the components of non-stockholder
changes in the equity on an annual basis. Total non-stockholder components in
equity includes all changes in equity during a period except those resulting
from investments by and distribution to stockholders.
6
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The components of comprehensive income for the second quarters and first half
year of fiscal years 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
------------------------------------------------------------
December 31, December 31, December 31, December 31,
1998 1997 1998 1997
--------------- ------------- ------------- ------------
<S> <C> <C> <C> <C>
Net income (loss) $ (719) $ 3,132 $ 4,111 $ 4,422
Foreign currency translation adjustment..... (1,772) (285) 1,342 (773)
--------------- ------------- ------------- ------------
Total comprehensive income (loss)........... $ (2,491) $ 2,847 $ 5,453 $ 3,649
--------------- ------------- ------------- ------------
--------------- ------------- ------------- ------------
</TABLE>
NOTE 4. INCOME TAXES:
The tax provisions for the second quarter and six month periods ended
December 31, 1998 and 1997 are based on the estimated effective tax rates
applicable for the full years, and after giving effect to significant unusual
items related specifically to the interim periods. The difference between the
Company's reported tax provision, for the second quarter and six months ended
December 31, 1998 and 1997, and the tax provision computed based on U.S.
statutory rates is primarily attributable to nondeductible goodwill amortization
and unbenefitted foreign losses. Additionally, the Company's effective tax rate
for the six months ended December 31, 1998 reflects the effect of the
indemnification settlement agreement and the IRS settlement which was recognized
as income for financial reporting purposes but is not taxable for income tax
purposes. The Company estimates that its effective income tax rate, excluding
the effects of the indemnification settlement agreement and the IRS settlement,
for the year ended June 30, 1999 will be 48%.
During the first quarter of fiscal year 1999, as a result of the
indemnification settlement agreement and the IRS settlement, the
Company realized certain deferred tax benefits related to periods prior to the
acquisition by OYL. The effect of realizing these tax benefits was to reduce net
deferred tax liabilities and goodwill by $9.7 million.
NOTE 5. FINANCIAL INSTRUMENTS:
During the second quarter of fiscal year 1999, the Company entered into an
interest rate swap with a $50 million notional amount which expires in October
of 2001 to protect against possible interest rate increases. Under the terms of
the swap, the Company pays a fixed rate of 4.58% and receives a floating rate (3
month LIBOR).
The Company secures pricing on a portion of its copper and aluminum
requirements through forward contracts executed with certain suppliers. At
December 31, 1998, contracts for 3.0 million pounds of copper at an average
price of $0.75 per pound and 1.8 million pounds of aluminum at an average price
of $0.65 per pound were in place. These contracts have various expiration dates
through June 30, 1999.
NOTE 6. RESTRUCTURING:
As described in Note 9 of the Annual Report, the Company commenced a
restructuring of its Filtration Products Group in the fourth quarter of fiscal
year 1998. Through December 31, 1998, the Company has spent $3.8 million of the
$7.3 million restructuring reserve primarily for severance charges and
professional fees. The remaining reserve relates to activities which will take
place in the second half of fiscal year 1999. The Company continues to implement
actions in accordance with the restructuring plan. In addition, the Company
restructured the German operations of the Filtration Products Group during the
first quarter of fiscal year 1999, recording a charge of $0.8 million which
primarily represents severance accruals.
7
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NOTE 7. CONTINGENCIES:
INDEMNIFICATION.
The purchase agreement between OYL and the former owners of the Company
contained certain indemnifications relating to specified contingencies that
existed as of the acquisition date relating to certain environmental, tax and
litigation matters. On July 8, 1998, the Company and the former owners entered
into a settlement agreement in resolution of certain disputes which were pending
before the American Arbitration Association in Dallas, Texas, concerning the
interpretation of the indemnification obligation. As a result of the settlement
agreement, the Company paid $10.5 million of the $11.5 million promissory note
due to the former shareholders, discussed in Note 7 of the Consolidated
Financial Statements, and the parties agreed to discharge claims and
entitlements under the indemnification provisions in the purchase agreement. The
residual balance of the promissory note has been reclassified to other
liabilities for specified contingencies that existed as of the acquisition date.
In addition, as a result of the indemnification settlement agreement and
the IRS settlement, the Company expects to receive payments from
certain former shareholders of approximately $5.0 million in fiscal year 1999 of
which $2.4 million has been received through December 31, 1998. Approximately
$2.1 million of the payments to be received from the former shareholders will be
utilized to fund obligations relating to the IRS settlement. In conjunction with
this settlement, the Company recognized $2.9 million in other income in the
first quarter of fiscal year 1999.
ENVIRONMENTAL MATTERS:
The Company is subject to potential liability under the Comprehensive
Environmental Response, Compensation, and Liability Act of 1980, as amended
(CERCLA), and other federal, state and local statutes and regulations governing
the discharge of pollutants into the environment and the handling and disposal
of hazardous substances and waste. These statutes and regulations, among other
things, impose potential liability on the Company for the cost of remediation of
contamination arising from the Company's past and present operations and from
former operations of other entities at sites later acquired and now owned by the
Company. Many of the Company's facilities have operated for many years, and
substances which are or might be considered hazardous were generated, used, and
disposed of at some locations, both on- and off-site. Therefore, it is possible
that environmental liabilities in addition to those described in note 14 of the
Annual Report may arise in the future. The Company records liabilities if, in
management's judgment, environmental assessments or remedial efforts are
probable and the costs can be reasonably estimated. These accrued liabilities
are not discounted. Such estimates are adjusted if necessary based upon the
completion of a formal study or the Company's commitment to a formal plan of
action.
The Company is currently a plaintiff in several legal suits, assessing
insurance coverage, or pursuing other actions in an attempt to recover the cost
associated with above liabilities. No amounts have been recorded in the
accompanying Consolidated Balance Sheets relating to any such possible
recoveries.
INCOME TAX:
The Internal Revenue Service ("IRS") completed its examination of the
Company's tax returns for the years 1987 through 1994 and issued a final
executed closing agreement which was received by the Company in September of
1998.
LITIGATION:
The Company is involved in various lawsuits in the ordinary course of
business. These lawsuits primarily involve claims for damages arising out of the
use of the Company's products. The Company is also involved in litigation and
administrative proceedings involving employment matters and commercial disputes.
Some of these lawsuits include claims for punitive as well as compensatory
damages. The Company is insured for
8
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product liability claims for amounts in excess of established deductibles and
accrues for the estimated liability on a case-by-case basis up to the limits of
the deductibles. All other claims and lawsuits are also handled on a
case-by-case basis.
The Company does not believe that the potential liability from the ultimate
outcome of environmental, income tax and litigation matters will have a material
adverse effect on the Company.
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS:
NET SALES
Consolidated net sales were $215.7 million and $467.1 million for the
quarter and six months ended December 31, 1998. This represented decreases in
net sales of $17.7 million, or 7.6%, for the quarter and $11.4 million, or 2.4%
for the half year as compared to the comparable periods in the prior year. The
Commercial Air Conditioning and Refrigeration segment's net sales decreased $9.6
million, or 6.6%, for the quarter and were flat for the six month period ended
December 31, 1998 as compared to the comparable periods in the prior year. The
Filtration Products segment reported a decrease in net sales for the second
quarter of $8.5 million, or 9.3%, and for the half year period of $10.0 million,
or 5.5%, versus the comparable periods in the prior year. The following table
presents the Company's revenues by business segment.
<TABLE>
<CAPTION>
Quarter ended Six months ended
--------------------------------- -----------------------------------
December 31, December 31, December 31, December 31,
1998 1997 1998 1997
---------------- ---------------- ----------------- -----------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Net sales:
Commercial Air Conditioning
and Refrigeration.................... $ 135,077 $ 144,670 $ 301,834 $ 302,254
Filtration Products.................. 83,478 92,007 171,923 181,945
Eliminations/ other.................. (2,840) (3,297) (6,642) (5,693)
---------------- ---------------- ----------------- -----------------
Total............................ $ 215,715 $ 233,380 $ 467,115 $ 478,506
---------------- ---------------- ----------------- -----------------
---------------- ---------------- ----------------- -----------------
</TABLE>
Commercial Air Conditioning and Refrigeration net sales decreased $9.6
million or 6.6% to $135.1 million for the second quarter of fiscal year 1999 and
were relatively flat at $301.8 million for the six months ended December 31,
1998 versus the comparable periods ended December 31, 1997. North American net
sales decreased 8.3% for the second quarter and 3.0% for the first half of
fiscal year 1999 as compared to the comparable periods in the prior year.
Applied air handling products net sales increased 13.8% and 25.1% for the second
quarter and six month period ended December 31, 1998 versus the comparable
periods in the prior year. Strong market demand for the rooftop, self contained
and new air handling products continued from the first quarter of fiscal year
1999 to increase sales for the second quarter and first half of fiscal year 1999
versus the comparable periods in the prior year, respectively. The service
organization had net sales increases of $1.1 million and $2.2 million for the
second quarter and first half of fiscal year 1999 as compared to the prior year
comparable periods due to strong demand for replacement parts and retrofit
demand. Chiller net sales decreased 12.5% and 8.3% for the second quarter and
the first half of fiscal year 1999 versus the comparable periods in the prior
year primarily due to decreased centrifugal chiller sales to export markets,
especially the Asian market. The second quarter net sales decrease also resulted
from reduced absorption chiller sales as a result of the Company's decision in
the prior year to participate selectively in this market. Increased demand for
air cooled chiller products and increased compressor sales partially offset the
decrease in the centrifugal chiller market for the first half of fiscal year
1999 as compared to the prior year. Export sales to Asia are expected to remain
slow due to the weak Asian market conditions. Terminal product net sales
decreased 18.9% and 8.0% for the second quarter and first half of fiscal year
1999, respectively, as compared to the comparable periods in fiscal year 1998.
An overall decline in the unit ventilator and packaged terminal air conditioner
markets contributed to the decreases.
In the Commercial Air Conditioning and Refrigeration business segment,
international sales volume increased 4.5% for both the second quarter and first
half of fiscal year 1999 versus the comparable periods in fiscal year 1998.
Strong chiller sales in the European markets and increased market demand in the
Middle East combined to increase international sales. Additionally, the
establishment of a new sales office in Dubai contributed to the net sales
increase.
10
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Backlog for the Commercial Air Conditioning and Refrigeration segment was
$127.3 million at the end of the second quarter of fiscal year 1999 as compared
to $125.8 million and $138.5 million at the end of the second quarter and fiscal
year end 1998, respectively. The decrease from the end of fiscal year 1998
backlog is primarily seasonal yet is also attributable to the soft unit
ventilator market conditions and economic conditions in the Asian region.
Filtration Products net sales decreased $8.5 million, or 9.3%, for the
second quarter and $10.0 million, or 5.5%, for the first half of fiscal year
1999 as compared to the comparable periods in the fiscal year 1998. Compared to
the comparable periods in the prior year, domestic net sales decreased 14.5% and
6.8% for the second quarter and half year ended December 31, 1998. This decrease
resulted from the reorganization of the environmental products business focusing
on core product lines and a weakened clean room filter market as compared to the
prior year. During the same periods, international sales decreased 5.8% and
3.5%, respectively. Asian sales volume decreased $2.8 million for the second
quarter and $7.2 million for the first half of fiscal year 1999 as compared to
the comparable periods in fiscal year 1998 as a result of the continuing weak
market conditions being experienced in the Asian region and Asian clean room
markets. Management believes this trend will continue as the economic conditions
remain weak in the Asian market. Latin American net sales volume decreased due
to continuing soft market conditions. The decreases in the Asian and Latin
American markets were partially offset by increased net sales in the European
markets. European sales were flat for the second quarter and increased 6.9% for
the first half of fiscal year 1999 compared to the second quarter and first half
of fiscal year 1998. The increase in the first half of fiscal year 1999 results
from increased volume in air filtration products, air pollution control systems
in France and in machinery filtration systems in the European region.
GROSS PROFIT
Consolidated gross margin decreased for both the second quarter and
first half of fiscal year 1999 as compared to the prior year's comparable
periods at $55.4 million or 25.7% of sales and $123.0 million or 26.3% of sales,
respectively. In the Commercial Air Conditioning and Refrigeration segment,
gross profit as a percentage of sales remained flat for the second quarter and
first half of fiscal year 1999 versus the comparable periods of fiscal year
1998. Gross margin gains resulting from price increases and product mix in
applied air handling products and product mix in the European markets were
offset by unfavorable manufacturing variances and lower margin product sales of
chiller and terminal products. In the Filtration Products businesses, product
mix and competitive pricing aimed at gaining market share in both the air
filtration and environmental product lines contributed to decreases of 1.4
percentage points in the second quarter and 1.2 percentage points for the first
half of fiscal year 1999 versus the comparable periods in fiscal year 1998.
OPERATING EXPENSES
Operating expenses were $51.6 million or 23.9% of sales for the second
quarter of fiscal year 1999 versus $56.4 million or 24.2% of sales for the
second quarter of fiscal year 1998. For the first half of fiscal years 1999
and 1998, operating expenses were $110.4 or 23.6% of sales versus $114.6 or
23.9% of sales, respectively. The Commercial Air Conditioning and
Refrigeration segment operating expenses increased primarily as a result of
warranty expense increases related to new product introductions and a
discontinued product line in the chiller business. Increases in commission
expense as a result of changes in distribution pricing and increases in
logistics expenses in the chiller and terminal products businesses also
contributed to the increase in operating expenses for this segment. These
increased operating expenses as compared to sales volume by the Commercial
Air Conditioning and Refrigeration segment were partially offset by
improvements in operating expenses in the Filtration Products segment.
Expenses in the Filtration Products segment decreased for both the second
quarter and first half of the year as compared to the prior year as a result
of the reorganization of the environmental products business and reductions
in sales volume. Research and development costs remained consistent year over
year for both the second quarter and first half of fiscal year 1999.
11
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INCOME FROM OPERATIONS
Income from operations for the second quarter was $3.8 million, or 1.8%
of net sales, and $5.3 million, or 2.3% of net sales, for fiscal years 1999
and 1998, respectively. For the first half of fiscal years 1999 and 1998,
income from operations was $12.6 million, or 2.7% of net sales, and $14.3
million, or 3.0% of net sales, respectively. The Commercial Air Conditioning
and Refrigeration segment had decreases in income from operations to $(1.6)
million, or (1.2%) of net sales, and $2.7 million, or 0.9% of net sales, in
the second quarter and the first half year of fiscal year 1999 from $0.5
million, or 0.4% of net sales, and $5.8 million, or 1.9% of net sales, for
the comparable periods in fiscal year 1998. The Filtration Products segment
had a decrease in income from operations to $4.8 million, or 5.8% of net
sales, for the second quarter and an increase in income from operations to
$10.1 million, or 5.9% of net sales, for the first half of fiscal year 1999
from $5.3 million, or 5.8% of net sales, and $9.7 million, or 5.3% of net
sales, for the second quarter and first half of fiscal year 1998.
NET INTEREST EXPENSES AND OTHER (INCOME) EXPENSE
Net interest expense decreased to $5.7 million and $12.2 million during
the second quarter and six months ended December 31, 1998 from $6.6 million
and $13.2 million for the comparable periods ended December 31, 1997. This
decrease is primarily the result of reduced borrowing levels as the Company
reduced its borrowings with proceeds from the sale of the industrial fan
business in the first half of fiscal year 1998. Net other income was $0.7
million and $4.7 million for the quarter and six month period ended December
31, 1998 versus net other income of $7.2 million and $7.3 million for the
comparable periods ended December 31, 1997. In the first quarter of fiscal
year 1999, the Company recorded $2.9 million in other income as a result of
favorable developments in the IRS audit and the tax indemnification
settlement with former shareholders of the Company as described in Note 7.
The Company also recorded a $1.5 million gain related to the termination of a
pension plan in Canada during the first quarter of fiscal year 1999. During
fiscal year 1998, the Company recorded a $6.6 million gain on the sale of the
industrial fan business. The other components of other income include
currency gains and losses and income from equity affiliates during the period.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity needs are provided by cash generated from
operating activities and supplemented when necessary by short-term credit
facilities. During the first six months of fiscal year 1999, funds generated
by operating activities were $15.5 million as compared to $16.3 million in
the prior fiscal year for the comparable period. During the first six months
of fiscal year 1999, cash used in investing activities was $9.9 million,
reflecting increased capital spending on information technology enhancement
projects. As a result of a settlement agreement reached with the former
shareholders of the Company regarding certain indemnified matters, the
Company retired the $11.5 million promissory note due to the former
shareholders on July 8, 1998 by making a cash payment of $10.5 million, Total
payments on long term debt for the first six months were $17.3 million. Cash
of $11.0 million was provided by net borrowing under short term borrowing
arrangements for long term debt repayment and working capital requirements
during the period.
During the first quarter of fiscal year 1999, the Company amended its
bank credit facility, effective as of June 30, 1998, to restate certain
financial covenants. At the end of the second quarter of fiscal year 1999,
the Company had approximately $40 million in additional borrowing capacity
under the amended revolving credit facility.
In 1998, as a result of approaches received from interested parties, OYL
appointed BancAmerica Robertson Stephens as its financial advisor to pursue a
sale process. In January 1999, the formal sale process was terminated.
Deferred costs of $0.8 million associated with the transaction will be
recognized in the third quarter of fiscal year 1999.
A short-term credit facility provided to a subsidiary of the Company is
supported by a letter of credit from OYL which expires on April 30, 1999. In
addition, the Company has secured certain domestic letter of credit
facilities totaling $13.5 million that are supported by a letter of credit
from OYL which expires on March 21,
12
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1999. Each of these support arrangements may be extended for additional time
periods with the consent of OYL and the banks providing the facilities.
On an ongoing basis the Company strives to evaluate its various businesses
and product lines with the objective to enhance shareholder value. Consistent
with this strategy, the Company intends to pursue global business opportunities
that are synergistic with the Company's core businesses or exit low value added
or non-synergistic operations.
Management believes, based upon current levels of operations and
forecasted earnings, that cash flow from operations, together with borrowing
capacity available under the Amended Credit Facility, will be adequate to
make payments of principal and interest on debt, to permit anticipated
capital expenditures and to fund working capital requirements and other cash
needs for the foreseeable future. Nevertheless, the Company expects to remain
leveraged to a significant extent and expects its debt service obligations to
continue to be substantial. If the Company's sources of funds were to fail to
satisfy the Company's requirements, the Company may need to amend or
refinance its existing debt or obtain additional financing. There is no
assurance that any such new financing alternatives would be available, and,
in any case, such new financing (if available) would be expected to be more
costly and burdensome than the debt agreements currently in place.
YEAR 2000
The Company established a formal Year 2000 program during the fiscal year
ending June 30, 1998, which began with a worldwide assessment and development of
a central data base containing an inventory of the risk elements associated with
the Year 2000 issue for each of the Company's operations. The Company also
appointed an overall project coordinator and established an executive review
process. Prior to establishing a formal Year 2000 management process, the
Company had already decided to replace substantially all of its old systems with
new state-of-the-art Enterprise Resource Planning (ERP) systems. The Company
currently estimates expenditures for the new systems will aggregate
approximately $25.0 million (having incurred approximately $22.5 million as of
December 31, 1998). Expenditures for additional remedial actions beyond those
required to install new systems will be managed by the individual business units
and recognized in operating expenses. The Company's management believes that
modernizing its information systems is critical for the Company's stable and
efficient growth, and it is the basis of the Company's strategy for resolving
its Year 2000 issues.
During May 1998, the Company began its review of the products it
manufactures and sells, and though testing is not complete, the Company believes
that its products, including the control systems provided by the Company, will
be Year 2000 compliant by March 1999. The Company has also identified third
parties upon whom the Company is dependent for products or services, and
commenced actions during fiscal year ending June 30, 1998, to ensure those
products and services are compliant and will not be interrupted as a result of
Year 2000.
The scheduled Year 2000 activities and current status are summarized in the
chart below:
<TABLE>
<CAPTION>
------------------------------------ ------------------ ----------------- -----------------
------------------------------------ ------------------ ----------------- -----------------
ACTIVITY STATUS STARTING ENDING
------------------------------------ ------------------ ----------------- -----------------
------------------------------------ ------------------ ----------------- -----------------
<S> <C> <C> <C>
Assessment and inventory Complete September 1997 January 1998
------------------------------------ ------------------ ----------------- -----------------
Coordinator and Executive review Complete February 1998 May 1998
process
------------------------------------ ------------------ ----------------- -----------------
Industrial Refrigeration ERP Complete January 1997 April 1998
------------------------------------ ------------------ ----------------- -----------------
Filtration Products ERP In Process April 1997 April 1999
------------------------------------ ------------------ ----------------- -----------------
Commercial Air Conditioning ERP In Process September 1997 July 1999
------------------------------------ ------------------ ----------------- -----------------
Product compliance In Process May 1998 March 1999
------------------------------------ ------------------ ----------------- -----------------
Materials suppliers In Process June 1998 TBD
------------------------------------ ------------------ ----------------- -----------------
Other IT issues including third In Process September 1998 TBD
parties
------------------------------------ ------------------ ----------------- -----------------
Equipment and facilities In Process September 1998 TBD
------------------------------------ ------------------ ----------------- -----------------
</TABLE>
The Year 2000 activities are currently on schedule, and the Company anticipates
successful implementation of the scheduled ERP projects and systems upgrades.
The financial systems of the ERP project have been implemented and used during
the second quarter of fiscal year 1999 in the Commercial Air Conditioning
13
<PAGE>
businesses. The financial, bill of material and cost systems of the ERP project
have been implemented and used during the first and second quarters of fiscal
year 1999 in the Filtration Products businesses.
Failure by the Company to complete successfully the planned ERP projects and
systems upgrades or a failure by the Company's third party suppliers and/or
service providers to produce or deliver critical components or to transport
services could cause disruption in the Company's ability to manufacture and/or
deliver timely its products to its customers, which could result in increased
expenses, reduced billings and potential litigation. The precise costs
associated with such risks are difficult to predict at this time. The Company
currently does not have a contingency plan in place in the event it does not
complete all phases of the Year 2000 program. The Company plans to continue to
evaluate the status of completion of its Year 2000 program and determine whether
a contingency plan is necessary.
FORWARD-LOOKING STATEMENTS
When used in this report by management of the Company, from time to time,
the words "believes," "anticipates," and "expects" and similar expressions are
intended to identify forward-looking statements that involve certain risks and
uncertainties. A variety of factors could cause actual results to differ
materially from those anticipated in the Company's forward-looking statements,
some of which include risk factors previously discussed in this and other SEC
reports filed by the Company. These risk factors include, but are not limited
to, general economic conditions, environmental laws and regulations, the
weakening Asian markets, unforeseen competitive pressures, warranty expenses,
market acceptance of new products, unseasonably cool spring or summer weather, a
slow down in the chiller market, unforeseen difficulties in maintaining mutually
beneficial relationships with strategic initiatives partners, and the Year 2000
issue. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date thereof. The Company
undertakes no obligation to publicly release the results of any events or
circumstances after the date hereof to reflect the occurrence of unanticipated
events.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
There have been no material changes in the reported market risks since the
end of the most recent fiscal year. Note 5 of the Notes to the Consolidated
Financial Statements (unaudited) discloses additional financial instrument that
have been entered into by the Company since the end of the most recent fiscal
year.
14
<PAGE>
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
With respect to the Company's lawsuit against the excess insurance carrier
in connection with clean up expenses for the Scottsboro, Alabama, manufacturing
facility, the trial judge granted summary judgment on January 19, 1999, in favor
of the insurance carrier denying the Company's claim. The Company has until
February 18, 1999 to file an appeal of this decision.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
NUMBER DESCRIPTION
Exhibit 27 Financial Data Schedule (filed herewith)
(b) REPORTS ON FORM 8-K
There were no reports filed on Form 8-K during the period.
15
<PAGE>
SIGNATURES
- -------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AAF-MCQUAY INC.
DATE FEBRUARY 8, 1999 By: /S/ ANDREW R. MORRISON
------------------ --------------------------
Andrew R. Morrison
Chief Financial Officer
DATE FEBRUARY 8, 1999 /S/ BRUCE D. KRUEGER
------------------- ------------------------
Bruce D. Krueger
Controller
(Principal Accounting Officer)
16
<PAGE>
Exhibit Index
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
<S> <C>
27 Financial Data Schedule
</TABLE>
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS INCLUDED IN THE COMPANY'S FROM 10-Q
FOR THE YEAR-TO-DATE AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-27-1998
<PERIOD-END> JAN-02-1997
<CASH> 9220
<SECURITIES> 0
<RECEIVABLES> 224955
<ALLOWANCES> 7882
<INVENTORY> 137058
<CURRENT-ASSETS> 372262
<PP&E> 204793
<DEPRECIATION> 56220
<TOTAL-ASSETS> 776284
<CURRENT-LIABILITIES> 302870
<BONDS> 167809
0
0
<COMMON> 250
<OTHER-SE> 211674
<TOTAL-LIABILITY-AND-EQUITY> 776284
<SALES> 467115
<TOTAL-REVENUES> 467115
<CGS> 344163
<TOTAL-COSTS> 344163
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 12244
<INCOME-PRETAX> 5066
<INCOME-TAX> 915
<INCOME-CONTINUING> 4111
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4111
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
