**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

#### **FORM 10-Q**

 

**(Mark One)**

 
| **ý** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

 

 

**For the quarterly periodended September 29, 2001**

 

 

# **OR**

 
| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

 

**For the transition periodfrom  _______ to _______**

 

 

**Commission filenumber:               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)   |   |                                  |

 

 

| **10300 Ormsby Park Pl.  Ste. 600, Louisville, Kentucky** |   | **40223**  |
|-----------------------------------------------------------|--------|------------|
| (Address of Principal Executive Offices)                  |   | (Zip Code) |

 

 

Registrant’s telephone number, including area code     **(502)637-0011   **

 

 

| **Not applicable**                                                                 |
|------------------------------------------------------------------------------------|
| Former Name, Former  Address and Former Fiscal Year, if Changed Since Last Report. |

 

Indicate by check whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý No o

 

Indicate the number of shares outstanding of each of the issuer’sclasses 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 October 26, 2001.

 

 

INDEX

 

AAF-MCQUAY INC. ANDSUBSIDIARIES

 
| Part I -   | Financial Information                                                                                     |
|------------|-----------------------------------------------------------------------------------------------------------|
|       |                                                                                                      |
| Item 1.    | Financial Statements  (unaudited)                                                                         |
|       |                                                                                                      |
|       | Consolidated Balance Sheets  as of  - September 30, 2001 and June  30, 2001                          |
|       |                                                                                                      |
|       | Consolidated  Statements of Operations - Three Months Ended September 30, 2001 and 2000                   |
|       |                                                                                                      |
|       | Condensed  Consolidated Statements of Cash Flows - Three Months Ended September 30, 2001  and 2000        |
|       |                                                                                                      |
|       | Consolidated  Statements of Comprehensive Income (Loss) - Three Months Ended September 30,  2001 and 2000 |
|       |                                                                                                      |
|       | Notes  to the Consolidated Financial Statements                                                           |
|       |                                                                                                      |
| Item  2.   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations               |
|       |                                                                                                      |
| Item  3.   | Quantitative  and Qualitative Disclosures about Market Risk                                               |
|       |                                                                                                      |
| Part II -  | Other Information                                                                                         |
|       |                                                                                                      |
| Item 1.    | Legal Proceedings                                                                                         |
|       |                                                                                                      |
| Item 6(b). | Reports on Form 8-K                                                                                       |
|       |                                                                                                      |
|       | Signatures                                                                                                |

 

**PARTI:                 FINANCIAL INFORMATION**

 

**                Item 1.    FinancialStatements**

 

## **AAF-McQUAY INC. AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

(unaudited)

(dollars in thousands,except share data)

 
|                                                                                          |   | **September 30,** |    | **June 30,** |   |
|-----------------------------------------------------------------------------------------------|--------|-------------------|---------|--------------|--------|
|                                                                                          |   | **2001**          |    | **2001**     |   |
| **ASSETS**                                                                                    |   |              |    |         |   |
| Current assets:                                                                               |   |              |    |         |   |
| Cash and cash  equivalents                                                                    |   | $                 | 22,113  |         | $      | 14,254 |   |
| Accounts  receivable                                                                          |   | 191,253           |    | 191,942      |   |
| Inventories                                                                                   |   | 97,739            |    | 101,802      |   |
| Other current  assets                                                                         |   | 9,402             |    | 8,370        |   |
| Total current  assets                                                                         |   | 320,507           |    | 316,368      |   |
|                                                                                          |   |              |    |         |   |
| Property, plant  and equipment, net                                                           |   | 116,299           |    | 118,744      |   |
| Cost in excess  of net assets acquired and other identifiable intangibles, net                |   | 191,868           |    | 201,731      |   |
| Other assets and  deferred charges                                                            |   | 17,354            |    | 17,171       |   |
| Total assets                                                                                  |   | $                 | 646,028 |         | $      | 654,014 |   |
|                                                                                          |   |              |    |         |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                |   |              |    |         |   |
|                                                                                          |   |              |    |         |   |
| Current  liabilities:                                                                         |   |              |    |         |   |
| Short-term  borrowings                                                                        |   | $                 | 70,221  |         | $      | 63,938 |   |
| Current  maturities of long-term debt                                                         |   | 6,317             |    | 6,120        |   |
| Accounts  payable, trade                                                                      |   | 86,422            |    | 100,585      |   |
| Accrued warranty                                                                              |   | 19,518            |    | 19,567       |   |
| Accrued employee  compensation                                                                |   | 27,506            |    | 27,155       |   |
| Other accrued  liabilities                                                                    |   | 37,352            |    | 42,947       |   |
| Total current  liabilities                                                                    |   | 247,336           |    | 260,312      |   |
|                                                                                          |   |              |    |         |   |
| Long-term debt.                                                                               |   | 130,021           |    | 131,429      |   |
| Deferred income  taxes                                                                        |   | 26,180            |    | 26,029       |   |
| Other  liabilities                                                                            |   | 48,673            |    | 49,003       |   |
| Total  liabilities                                                                            |   | 452,210           |    | 466,773      |   |
|                                                                                          |   |              |    |         |   |
| Stockholders’  equity:                                                                   |   |              |    |         |   |
| Preferred stock  ($1 par value; 1,000 shares authorized, none issued)                         |   | ---               |    | ---          |   |
| Common stock  ($100 par value; 8,000 shares authorized, 2,497 shares issued and  outstanding) |   | 250               |    | 250          |   |
| Additional  paid-in capital                                                                   |   | 179,915           |    | 179,915      |   |
| Retained  earnings                                                                            |   | 33,059            |    | 29,607       |   |
| Accumulated other  comprehensive loss                                                         |   | (19,406           | )       | (22,531      | )      |
| Total  stockholders’ equity                                                              |   | 193,818           |    | 187,241      |   |
| Total  liabilities and stockholders’ equity                                              |   | $                 | 646,028 |         | $      | 654,014 |   |

 

See Notes to theConsolidated Financial Statements

 

**AAF-McQUAY INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(unaudited)

(dollars in thousands)

 

 
|                                 |   | **Three Months Ended** |    |
|--------------------------------------|--------|------------------------|---------|
|                                 |   | **September 30,**      |    |
|                                 |   | **2001**               |    | **2000** |   |
|                                 |   |                   |    |   |   |
| Net sales                            |   | $                      | 210,077 |   | $ | 215,009 |   |
| Cost of sales                        |   | 153,878                |    | 156,662 |   |
| Gross profit                         |   | 56,199                 |    | 58,347 |   |
| Operating  expenses:                 |   |                   |    |   |   |
| Selling, general  and administrative |   | 43,311                 |    | 44,723 |   |
| Restructuring                        |   | ---                    |    | 3,506 |   |
| Amortization of  intangible assets   |   | 2,757                  |    | 2,758 |   |
|                                 |   | 46,068                 |    | 50,987 |   |
| Income from  operations              |   | 10,131                 |    | 7,360 |   |
| Interest  expense, net               |   | 4,348                  |    | 5,223 |   |
| Other income,  net                   |   | (135                   | )       | (96 | ) |
| Income before  income taxes          |   | 5,918                  |    | 2,233 |   |
| Minority  interest (gain) loss       |   | (19                    | )       | 65 |   |
| Provision for  income taxes          |   | 2,485                  |    | 1,138 |   |
| Net income                           |   | $                      | 3,452   |   | $ | 1,030 |   |

 

 

See Notes to theConsolidated Financial Statements

 

**AAF-McQUAY INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

(unaudited)

(dollars in thousands)

 

 
|                                                        |   | **Three Months Ended** |   |
|-------------------------------------------------------------|--------|------------------------|--------|
|                                                        |   | **September 30,**      |   |
|                                                        |   | **2001**               |   | **2000** |   |
|                                                        |   |                   |   |   |   |
| Cash flows from operating activities:                       |   |                   |   |   |   |
| Net income                                                  |   | $                      | 3,452  |   | $ | 1,030 |   |
| Adjustments to reconcile to cash from operating activities: |   |                   |   |   |   |
| Depreciation and amortization                               |   | 7,228                  |   | 7,319 |   |
| Other non-cash items, net                                   |   | (97                    | )      | 23 |   |
| Changes in operating assets and liabilities                 |   | (18,709                | )      | (6,000 | ) |
| Net cash from operating activities                          |   | (8,126                 | )      | 2,372 |   |
|                                                        |   |                   |   |   |   |
| Cash flows from investing activities:                       |   |                   |   |   |   |
| Capital expenditures, net                                   |   | (1,630                 | )      | (4,392 | ) |
| Proceeds from sale of business                              |   | 13,308                 |   | --- |   |
| Net cash from investing activities                          |   | 11,678                 |   | (4,392 | ) |
|                                                        |   |                   |   |   |   |
| Cash flows from financing activities:                       |   |                   |   |   |   |
| Net borrowings under short-term borrowing arrangements      |   | 4,857                  |   | 8,363 |   |
| Proceeds from issuance of long-term debt                    |   | 2,393                  |   | --- |   |
| Payments on long-term debt                                  |   | (1,745                 | )      | (2,637 | ) |
| Repurchase of senior notes                                  |   | (1,990                 | )      | --- |   |
| Net cash from financing activities                          |   | 3,515                  |   | 5,726 |   |
|                                                        |   |                   |   |   |   |
| Effect of exchange rate changes on cash                     |   | 792                    |   | (328 | ) |
| Net increase in cash and cash equivalents                   |   | 7,859                  |   | 3,378 |   |
| Cash and cash equivalents at beginning of period            |   | 14,254                 |   | 11,522 |   |
|                                                        |   |                   |   |   |   |
| Cash and cash equivalents at end of period                  |   | $                      | 22,113 |   | $ | 14,900 |   |

 

See Notes to the ConsolidatedFinancial Statements

 

# **AAF-McQUAY INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME (LOSS)**

(unaudited)

(dollars inthousands)

** **
|                                                                                       |   | **Three Months Ended** |   |
|--------------------------------------------------------------------------------------------|--------|------------------------|--------|
|                                                                                       |   | **September 30,**      |   |
|                                                                                       |   | **2001**               |   | **2000** |   |
|                                                                                       |   |                   |   |   |   |
| Net income                                                                                 |   | $                      | 3,452  |   | $ | 1,030 |   |
| Other  comprehensive income (loss):                                                        |   |                   |   |   |   |
| Foreign currency  translation adjustments                                                  |   | 3,346                  |   | (2,141 | ) |
| Write off of  accumulated foreign currency translation adjustments due to sale of business |   | (221                   | )      | --- |   |
| Comprehensive  income (loss)                                                               |   | $                      | 6,577  |   | $ | (1,111 | ) |

 

See Notes to theConsolidated Financial Statements

 

**Notesto the Consolidated Financial Statements (unaudited)**

 

***1.  Basis of Presentation***

 

        Theconsolidated financial statements include the accounts of the Company and allof its wholly-owned subsidiaries.  Allinter-company transactions have been eliminated.  The accompanying unaudited consolidated financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States for interim reporting and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with accountingprinciples generally accepted in the United States have been omitted.  For further information, refer to theconsolidated financial statements and footnotes thereto included in theCompany’s Annual Report on Form 10-K (the “Annual Report”) for the year endedJune 30, 2001.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included.

 

        Theoperating results for the three months ended September 30, 2001 are notnecessarily indicative of the operating results that may be expected for thefull year ending June 30, 2002.  TheCompany’s period end is the Saturday closest to September 30. For clarity inpresentation all periods presented herein are shown to end on the last calendarday of the month.  Certainreclassifications of amounts in the consolidated financial statements have beenmade to reflect comparability.

 

### **Recent AccountingPronouncements**

 

    In June 2001,the Financial Standards Board issued Statements of Financial AccountingStandards (SFAS) No. 141, *Business Combinations*, and No. 142, *Goodwill andOther Intangibles Assets*, effective for fiscal years beginning afterDecember 15, 2001.  Under the new rules,goodwill and intangible assets deemed to have indefinite lives will no longerbe amortized, but will be subject to annual impairment tests in accordance withthe Statements.  Other intangible assetswill continue to be amortized over their useful lives.  The Company is required to apply the newrules on accounting for goodwill and other intangible assets beginning thefirst quarter of fiscal 2003.  TheCompany is currently assessing the financial impact that SFAS Nos. 141 and 142will have on its earnings and financial position.

 

 

***2. Inventories***

 
| Inventories consist of the following: |   | **September   30,**   |   | **June 30,** |   |
|---------------------------------------|--------|----------------------------|--------|--------------|--------|
|                                  |   | **2001**                   |   | **2001**     |   |
|                                  |   | **(dollars in thousands)** |   |
| FIFO cost:                            |   |                       |   |         |   |
| Raw materials                         |   | $                          | 37,432 |         | $      | 42,706 |   |
| Work-in-process                       |   | 19,602                     |   | 17,691       |   |
| Finished goods                        |   | 41,392                     |   | 41,851       |   |
|                                  |   | 98,426                     |   | 102,248      |   |
| LIFO adjustment                       |   | (687                       | )      | (446         | )      |
|                                  |   | $                          | 97,739 |         | $      | 101,802 |   |

 

***3. Provision for Income Taxes***

 

Thetax provisions for the quarters ended September 30, 2001 and 2000 are based onthe estimated effective tax rates applicable for the full years, and aftergiving effect to significant unusual items related specifically to the interimperiods.  The difference between theCompany’s reported tax provision, for the quarters ended September 30, 2001 and2000, and the tax provision computed based on U.S. statutory rates is primarilyattributable to nondeductible goodwill amortization and unbenefitted foreignlosses.

 

***4.  Debt and Financial Instruments***

 

        Inthe first quarter of fiscal 2002, the Company repurchased a total of $2 millionof its Senior Notes at a discount, resulting in a minimal loss after write offof associated debt issuance costs.  TheCompany plans to hold these repurchased notes until their maturity in February2003. The balance of Senior Notes held outside the Company after the repurchaseand included in the Company’s long-term debt at September 30, 2001 was $107million.

 

         In September 2000, the Company sold aninterest rate floor with a notional amount of $30 million, which requires theCompany to make payments if 3-month LIBOR falls below a certain level.  Measurement dates and the maturity datematch those contained in the January 2000 swap transaction describedbelow.  The Company received a paymentof $165,000 as selling price for the floor.  In January 2000, the Company entered into an interest rate swaptransaction whereby the Company receives a fixed rate and pays a floating rateon the basis of 3-month LIBOR.  TheJanuary 2000 swap has a three year term and a notional amount of $30 millionand effectively converts a portion of the Company's fixed rate borrowings to afloating rate.  Measurement dates andthe maturity date of the swap match interest payment dates and maturity date ofthe Company’s Senior Notes.  The Companyrecords its swap and floor in its balance sheet at fair market value.  There was no net gain or loss resulting fromthese positions for the quarter ended September 30, 2001.

 

***5. Restructuring Charges***

 

        Asdescribed in Note 9 of the Annual Report, the Company implemented severalrestructuring plans throughout fiscal 2001 in both the Commercial AirConditioning and Refrigeration and Filtration Products segments.  In the first quarter of fiscal 2002, theCompany spent $0.3 million related to its fiscal 2001 restructuringefforts.  Through September 30, 2001,the Company has spent $6.3 million of the $7.2 million restructuring reserverecorded in fiscal 2001 primarily for severance arrangements.

 

All the fiscal 2001 restructuring efforts are expectedto be completed by the end of fiscal 2002.

 

***6. Sale of Subsidiary***

 

In September 2001, the Company sold its Singapore subsidiary to asubsidiary of its parent, O.Y.L. Industries Berhad (“OYL”), for approximately$13.1 million, which resulted in an immaterial gain after write-off ofassociated goodwill and intangible assets. The Singapore subsidiary had sales of $3.6 million and $3.2 million, andnet income of $75,000 and $429,000, for the quarters ended September 30, 2001and 2000, respectively.  Proceeds fromthe sale will be used to pay down debt. In accordance with its bondindenture, the Company has offeredto repurchase up to $13.0 million of its outstanding Senior Notes on a pro ratabasis from its existing bondholders.

 

***7.  Commitments and Contingencies***

 

***        Purchase Commitments-***The Company secures pricing on a portion of itscopper requirements through forward contracts executed with certain suppliers.  At September 30, 2001, contracts for 2.3million pounds of copper were in place. These contracts have various expiration dates through March 31, 2002.

 

***        Environmental Matters -***The Company is subject to potential liabilityunder the Comprehensive Environmental Response, Compensation, and Liability Actof 1980, as amended (CERCLA), and other federal, state and local statutes andregulations governing the discharge of pollutants into the environment and thehandling and disposal of hazardous substances and waste. These statutes andregulations, among other things, impose potential liability on the Company forthe cost of remediation of contamination arising from the Company's past andpresent operations and from former operations of other entities at sites lateracquired and now owned by the Company. Many of the Company's facilities haveoperated for many years, and substances which are or might be consideredhazardous were generated, used, and disposed of at some locations, both on- andoff-site. Therefore, it is possible that environmental liabilities in additionto those described in Note 15 of the Annual Report may arise in the future. TheCompany records liabilities if, in management's judgment, environmentalassessments or remedial efforts are probable and the costs can be reasonablyestimated. These accrued liabilities are not discounted. Such estimates areadjusted if necessary based upon the completion of a formal study or theCompany's commitment to a formal plan of action.

 

        ***Litigation -***TheCompany is involved in various lawsuits in the ordinary course of business.These lawsuits primarily involve claims for damages arising out of the use ofthe Company's products. The Company is also involved in litigation andadministrative proceedings involving employment matters and commercialdisputes. Some of these lawsuits include claims for punitive as well ascompensatory damages. The Company is insured for product liability claims foramounts in excess of established deductibles and accrues for the estimatedliability on a case-by-case basis up to the limits of the deductibles. Allother claims and lawsuits are also provided for on a case-by-case basis.

 

The Company does not believethat the potential liability from the ultimate outcome of environmental andlitigation matters will have a material adverse effect on its financialstatements.

 

***8. BusinessSegments Information***

 

         TheCompany globally manufactures and markets commercial air conditioning and airfiltration products and systems within two principal segments: Commercial AirConditioning and Refrigeration, the manufacture, sale and distribution ofheating, ventilating, air conditioning, industrial refrigeration products, andFiltration Products, the manufacture and sale of air filtration products andsystems. Information relating to operations in each industry segment is asfollows as of and for the three months ended September 30, 2001 and 2000:

 
|                                           |   | **Three Months Ended ** |    |
|------------------------------------------------|--------|------------------------------|---------|
|                                           |   | **September 30,**            |    |
| **Classified  By Industry**                    |   | **2001**                     |    | **2000** |   |
|                                           |   | **(dollars in thousands)**   |    |
| Net Sales:                                     |   |                         |    |   |   |
| Commercial Air  Conditioning and Refrigeration |   | $                            | 129,807 |   | $ | 135,273 |   |
| Filtration  Products                           |   | 82,316                       |    | 80,110 |   |
| Eliminations                                   |   | (2,046                       | )       | (374 | ) |
| Total                                          |   | $                            | 210,077 |   | $ | 215,009 |   |
| Operating Income  (Loss):                      |   |                         |    |   |   |
| Commercial Air  Conditioning and Refrigeration |   | $                            | 6,852   |   | $ | 3,666 |   |
| Filtration  Products                           |   | 3,098                        |    | 4,199 |   |
| Corporate                                      |   | 181                          |    | (505 | ) |
| Total                                          |   | $                            | 10,131  |   | $ | 7,360 |   |
| Depreciation/Amortization:                     |   |                         |    |   |   |
| Commercial Air  Conditioning and Refrigeration |   | $                            | 4,806   |   | $ | 5,022 |   |
| Filtration  Products                           |   | 2,417                        |    | 2,291 |   |
| Corporate                                      |   | 5                            |    | 6 |   |
| Total                                          |   | $                            | 7,228   |   | $ | 7,319 |   |
| Capital  Expenditures:                         |   |                         |    |   |   |
| Commercial Air  Conditioning and Refrigeration |   | $                            | 1,035   |   | $ | 3,447 |   |
| Filtration  Products                           |   | 592                          |    | 945 |   |
| Corporate                                      |   | 3                            |    | --- |   |
| Total                                          |   | $                            | 1,630   |   | $ | 4,392 |   |

 

        The Company estimates corporate expensesand determines fixed allocations of these expenses for each business segment atthe beginning of the fiscal year.  Anyover or under allocation of actual expenses incurred results in income orexpense reported at the corporate level. A reconciliation of segment profit to the Company’s earnings beforetaxes for each period is as follows:

 
|                                           |   | **Three Months Ended**     |   |
|------------------------------------------------|--------|----------------------------|--------|
|                                           |   | **September 30,**          |   |
|                                           |   | **2001**                   |   | **2000** |   |
|                                           |   | **(dollars in thousands)** |   |
| Operating income  from business segments       |   | $                          | 9,950  |   | $ | 7,865 |   |
| Over (under)  allocation of corporate expenses |   | 181                        |   | (505 | ) |
| Interest  expense, net                         |   | 4,348                      |   | 5,223 |   |
| Other income,  net                             |   | (135                       | )      | (96 | ) |
| Income before  income taxes                    |   | $                          | 5,918  |   | $ | 2,233 |   |

 

**Item2.   Management’s Discussion and Analysis of Financial Condition**and Results of Operations

 

**Results of Operations**

 

***Net Sales***were $210.0 million in thethree months ended September 30, 2001, which represents a decrease of $5.0million, or 2.3%, as compared to $215.0 million for the same period in theprior year.  However, sales have decreasedby approximately $1.3 million for the three months ended September 30, 2001 dueto the impact of unfavorable currency trends in translating Europeansales.  Excluding the currency impact,net sales for the three months ended September 30, 2001 decreased $3.7 millionor 1.7% as compared to the corresponding period of the prior year.

 

**         Commercial AirConditioning and Refrigeration**net sales for the three monthsended September 30, 2001 decreased $5.5 million, or 4.0%, to $129.8 million ascompared to $135.3 million for the three months ended September 30, 2000.  However, sales have decreased byapproximately $0.3 million for the three months ended September 30, 2001 due tothe impact of unfavorable currency trends in translating European sales.  Excluding the currency impact, net sales forthe three months ended September 30, 2001 decreased $5.1 million or 3.8% ascompared to the prior year.   Thisdecrease is the result of a 3.2% decrease in domestic sales and a 6.0% decreasein international sales.  The decrease indomestic sales is primarily due to a 4.6% decrease in applied air handlingvolume and a 7.8% decrease in applied terminal systems (“ATS”).  The decrease in applied air handling volumeis principally due to a decrease in sales of self-contained units as a resultof current economic conditions.   ATSsales decreased primarily due to a slowdown in the market for packaged terminalair conditioners and water source heat pumps. The decrease in international sales is primarily due to the fiscal 2001restructuring activities in the Company’s industrial refrigeration business inthe United Kingdom.

 

Backlog for theCommercial Air Conditioning and Refrigeration segment was $94 million atSeptember 30, 2001 as compared to $111 million and $130 million at June 30,2001 and September 30, 2000, respectively. The decrease in backlog is primarily due to the softness in the rooftopself-contained market.

 

**Filtration Products**net sales for the threemonths ended September 30, 2001 increased $2.2 million, or 2.8%, to $82.3million as compared to $80.1 million for the three months ended September 30,2000.  Additionally, sales havedecreased by approximately $1.0 million due to the impact of unfavorablecurrency trends in translating European sales. Excluding the currency impact, net sales for the three months endedSeptember 30, 2001 increased by approximately $3.2 million or 4.0%.  This increase is primarily attributable toincreased machinery filtration and acoustical systems (“MFAS”) volume in theU.S. and U.K., offset by the decreases in several large air pollution controlsystems (“APCS”) projects primarily in Latin America.  Sales of replacement air filtration products were flat with theprior year.

        

***Gross Profit***decreased to $56.2million, or 26.8% of sales, for the three months ended September 30, 2001 ascompared to $58.3 million, or 27.1% of sales, for the three months endedSeptember 30, 2000.  In the CommercialAir Conditioning and Refrigeration segment, gross profit as a percentage ofsales was 27.2% as compared to 26.5% for the same period in fiscal 2001.  The increase in gross margin is primarilyattributable to improved manufacturing efficiency in the applied air handlingproduct line resulting from the closure of the Scottsboro, Alabama facility andimproved margins on aftermarket parts and service.  These margin increases were partially offset by pricing pressureresulting in lower chiller and applied terminal systems margins.  The Filtration Products segment’s grossprofit as a percentage of sales decreased from 28.1% in fiscal 2001 to 25.4%for the same period in fiscal 2002. This decrease is primarily the result ofcontinued competitive pricing pressures in the replacement filter business inNorth America and Asia and adverse sales mix.

 

***        Operating Expenses***were$46.1 million, or 21.9% of sales, for the first quarter of fiscal 2002 versus$51.0 million, or 23.7% of sales, for the first quarter of fiscal 2001.  Excluding amortization and restructuringcharges, first quarter fiscal 2002 operating expenses were $43.2 million, or20.5% of sales, versus $44.7 million, or 20.8% of sales for the first quarterof fiscal 2001.  The decrease for thefirst quarter of fiscal 2002 compared to the first quarter of fiscal 2001 isprimarily attributable to favorable warranty experience and continued focus oncontrol of general and administrative costs, partially offset by an increase inselling expense.

 

***Income from Operations***for the firstquarter of fiscal 2002 increased to $10.1 million, or 4.8% of sales, ascompared to $7.4 million, or 3.4% of sales, in the first quarter of fiscal2001.  Excluding amortization andrestructuring charges, first quarter income from operations decreased to $13.0million, or 6.2% of sales, compared to $13.6 million, or 6.3% of sales in thecorresponding period of the prior year.

 

The Commercial Air Conditioning and Refrigerationsegment’s income from operations improved in the first quarter of fiscal 2002to $8.5 million, or 6.6% of sales, as compared to $8.2 million, or 6.1% ofsales, in the first quarter of fiscal 2001, excluding amortization andrestructuring charges.

 

The Filtration Products segment’s income fromoperations, excluding amortization and restructuring charges, for the firstquarter of fiscal 2002 decreased from $5.9 million, or 7.4% of sales, in fiscal2001 to $4.3 million, or 5.2% of sales.

 

        ***Net Interest Expense***decreasedto $4.3 million during the quarter ended September 30, 2001 from $5.2 millionfor the comparable period ended September 30, 2000.  The decrease in interest expense is primarily attributable tolower debt levels and declining interest rates.

 

 

**Liquidityand Capital Resources**

 

        TheCompany's liquidity needs are provided by cash generated from operatingactivities and supplemented when necessary by short-term credit facilities.During the first three months of fiscal 2002, funds used by operatingactivities were $8.1 million as compared to $2.4 million of funds generated inthe prior fiscal year for the comparable period.  The decrease in net cash provided by operating activities isprimarily due to a decrease in accounts payable.  During the first three months of fiscal 2002, net cash frominvesting activities was comprised of $13.3 million in cash proceeds from thesale of businesses, partially offset by $1.6 million in capitalexpenditures.  In September 2001, theCompany sold its Singapore business for $13.1 million (see Note 6 to theConsolidated Financial Statements (unaudited) for further information) and willuse these proceeds to pay down debt. Capital spending for the first threemonths decreased from $4.3 million in the prior year to $1.6 million this yeardue to higher than normal spending in first quarter fiscal 2001 related to theconsolidation of the Company’s applied air handling operations in Minnesota.

 

        OnSeptember 30, 1999, the Company refinanced its U.S. bank credit facilities witha Term Loan of $30 million and a Revolving Credit Facility of $90 million(" Bank Credit Agreement"). The Bank Credit Agreement has a three-year term, was used to retire all obligationsunder the previous bank agreement and is designed to provide added flexibilityand borrowing availability.  AtSeptember 30, 2001, remaining borrowing availability under the Revolving Creditportion of the Bank Credit Agreement was $30.7 million. Payments on long-termdebt for the first three months of fiscal 2002 were $1.7 million, while $2.4million in long-term debt was issued. In addition, as more fully discussed inNote 4 to the Consolidated Financial Statements (unaudited), the Company usedcash of $2.0 million to repurchase its Senior Notes.   Short-term borrowings increased by $4.9 million during thethree-month period.

 

        Ashort-term credit facility provided to a subsidiary of the Company is supportedby a letter of credit from OYL, which expires on May 31, 2002. This supportarrangement may be extended for additional time periods with the consent of OYLand the bank providing the facilities.

 

        Managementbelieves, based upon current levels of operations and forecasted earnings, thatcash flows from operations, together with borrowings under the Bank CreditAgreement and other short-term credit facilities, will be adequate to makepayments of principal and interest on debt, to permit anticipated capitalexpenditures and to fund working capital requirements and other cash needs.Nevertheless, the Company will remain leveraged to a significant extent and itsdebt service obligations will continue to be substantial. If the Company'ssources of funds were to fail to satisfy the Company's requirements, theCompany may need to refinance its existing debt or obtain additionalfinancing.  There is no assurance thatany such new financing alternatives would be available, and, in any case, suchnew financing (if available) would be expected to be more costly and burdensomethan the debt agreements currently in place.

###  

### **Recent AccountingPronouncements**

 

                In June 2001, theFinancial Standards Board issued Statements of Financial Accounting Standards(SFAS) No. 141, *Business Combinations*, and No. 142, *Goodwill and Other Intangibles Assets*,effective for fiscal years beginning after December 15, 2001.  Under the new rules, goodwill and intangibleassets deemed to have indefinite lives will no longer be amortized, but will besubject to annual impairment tests in accordance with the Statements.  Other intangible assets will continue to beamortized over their useful lives.  TheCompany is required to apply the new rules on accounting for goodwill and otherintangible assets beginning the first quarter of fiscal 2003.  The Company is currently assessing thefinancial impact that SFAS Nos. 141 and 142 will have on its earnings andfinancial position.

 

**Item3. Quantitative and Qualitative Disclosure about Market Risk**

 

        Therehave been no material changes in the reported market risks since the end of themost recent fiscal year.

 

**Forward-Looking Statements**

 

          Whenused in this report the words “believes,” anticipates, “estimates”, “plans” and“expects” and similar expressions are intended to identify forward-lookingstatements.  These forward-lookingstatements are intended to provide management's current expectations or plansfor the future operating and financial performance of the Company, based onassumptions currently believed to be valid. A variety of factors could causeactual results to differ materially from those anticipated in the Company’sforward-looking statements, some of which include risk factors previouslydiscussed in this and other SEC reports filed by the Company.  These risk factors include, but are notlimited to, economic conditions in the United States, changes in worldfinancial markets, environmental laws and regulations, risks associated withcurrency fluctuations, a weakening in Latin America markets, unforeseencompetitive pressures, warranty expenses, market acceptance of new products,unfavorable weather conditions, unforeseen difficulties in maintaining mutuallybeneficial relationships with strategic partnerships and alliances, and theresults of restructuring activities. Readers are cautioned not to place unduereliance on these forward-looking statements, which speak only as of the dateon which those statements are made.  TheCompany undertakes no obligation to update any forward-looking statements toreflect unanticipated events or circumstances occurring after that date.

 

**PART II:                OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

        Notapplicable.

 

 

**Item 6(b).  Reports on Form 8-K**

 

        Therewere no reports filed on Form 8-K during the period.

 

 

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 theundersigned thereunto duly authorized.

 

 

 
|   |             |   |   | AAF-MCQUAY INC.                                    |
|--------|------------------|--------|--------|----------------------------------------------------|
|   |             |   |   |                                               |
|   |             |   |   |                                               |
|   |             |   |   |                                               |
|   |             |   |   |                                               |
|   |             |   |   |                                               |
| DATE   | November 9, 2001 |   | By:    | /S/ BRUCE D. KRUEGER                               |   |
|   |             |   |   | Bruce D. Krueger                                   |
|   |             |   |   | Vice President of Finance and CFO                  |
|   |             |   |   | (Principal Financial and Chief Accounting Officer) |