-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TkKOO0H/Nw34bNclF0J7xS++5RzOXZE2mvGlwHG6pWON0pfUO4u2z6wgXf+QAJEs QaJQynTngk0g8TV0dPbSaA== 0000804212-99-000005.txt : 19990212 0000804212-99-000005.hdr.sgml : 19990212 ACCESSION NUMBER: 0000804212-99-000005 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990211 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AIRGAS INC CENTRAL INDEX KEY: 0000804212 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-CHEMICALS & ALLIED PRODUCTS [5160] IRS NUMBER: 560732648 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-09344 FILM NUMBER: 99531977 BUSINESS ADDRESS: STREET 1: 259 RADNOR-CHESETER ROAD STREET 2: SUITE 100 CITY: RADNOR STATE: PA ZIP: 19087 BUSINESS PHONE: 6106875253 MAIL ADDRESS: STREET 1: 259 RADNOR-CHESTER ROAD STREET 2: SUITE 100 CITY: RADNOR STATE: PA ZIP: 19087 10-Q 1 FORM 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: December 31, 1998 Commission file number: 1-9344 AIRGAS, INC. (Exact name of Registrant as specified in its charter) Delaware 56-0732648 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 259 North Radnor-Chester Road, Suite 100 Radnor, PA 19087-5283 (Address of principal executive offices) (ZIP code) (610) 687-5253 (Registrant's telephone number, including area code) 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 Common Stock outstanding at February 4, 1999: 71,032,380 shares 2 AIRGAS, INC. FORM 10-Q December 31, 1998 INDEX PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of December 31, 1998 (Unaudited) and March 31, 1998..........................................................3 Consolidated Statements of Earnings for the Three and Nine Months Ended December 31, 1998 and 1997 (Unaudited)..4 Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 1998 and 1997 (Unaudited)............5 Notes to Consolidated Financial Statements (Unaudited)......................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................13 PART II - OTHER INFORMATION Item 1. Legal Proceedings..................................................27 Item 5. Other Information..................................................27 Item 6. Exhibits and Reports on Form 8-K...................................28 SIGNATURES .................................................................29 3 PART I. FINANCIAL INFORMATION Item 1. Financial Statements AIRGAS, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts)
(Unaudited) December 31, March 31, 1998 1998 ASSETS Current Assets Trade receivables, less allowances for doubtful accounts of $5,955 at December 31,1998 and $5,676 at March 31, 1998 $ 192,129 $ 186,342 Inventories, net 164,471 154,937 Prepaid expenses and other current assets 31,185 25,555 Total current assets 387,785 366,834 Plant and equipment, at cost 981,993 923,635 Less accumulated depreciation, depletion and amortization (265,431) (236,331) Plant and equipment, net 716,562 687,304 Goodwill, net of accumulated amortization of $51,675 at December 31, 1998 and $42,147 at March 31, 1998 431,849 410,753 Other non-current assets 174,676 176,583 Total assets $1,710,872 $1,641,474 LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable, trade $ 74,395 $ 84,602 Accrued expenses and other current liabilities 133,608 128,806 Current portion of long-term debt 16,138 12,150 Total current liabilities 224,141 225,558 Long-term debt 861,554 830,845 Deferred income taxes 132,452 121,356 Other non-current liabilities 29,640 36,842 Stockholders' Equity Preferred stock, no par value, 20,000 shares authorized, no shares issued or outstanding at December 31, 1998 and March 31, 1998, respectively -- -- Common stock, par value $.01 per share, 200,000 shares authorized, 71,834 and 71,357 shares issued at December 31, 1998 and March 31, 1998, respectively 718 714 Capital in excess of par value 194,139 192,358 Retained earnings 281,009 237,166 Accumulated other comprehensive loss (965) (779) Treasury stock, 918 and 176 common shares at cost at December 31, 1998 and March 31, 1998, respectively (11,816) (2,586) Total stockholders' equity 463,085 426,873 Total liabilities and stockholders' equity $1,710,872 $1,641,474 See accompanying notes to consolidated financial statements.
4 AIRGAS, INC. CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited) (In thousands, except per share amounts)
Three Months Ended Nine Months Ended December 31, December 31, 1998 1997 1998 1997 Net sales: Distribution $ 279,669 $ 272,958 $ 860,628 $ 812,395 Direct Industrial 59,954 61,372 193,756 159,433 Manufacturing 40,700 33,480 123,304 87,750 Total net sales 380,323 367,810 1,177,688 1,059,578 Costs and expenses: Cost of products sold (excluding depreciation, depletion and amortization) Distribution 140,085 136,309 431,487 408,783 Direct Industrial 43,837 43,795 142,575 114,766 Manufacturing 15,755 15,847 49,963 41,537 Selling, distribution and administrative expenses 132,969 118,939 398,421 338,481 Depreciation, depletion and amortization 22,504 20,218 65,849 56,809 Special charges -- -- (1,000) (14,500) Total costs and expenses 355,150 335,108 1,087,295 945,876 Operating income: Distribution 20,282 26,902 73,081 82,778 Direct Industrial 352 2,463 2,165 4,911 Manufacturing 4,539 3,337 14,147 11,513 Special charges -- -- 1,000 14,500 Total operating income 25,173 32,702 90,393 113,702 Interest expense, net (15,701) (13,456) (46,227) (39,234) Other income, net 24,370 442 25,240 2,488 Equity in earnings of unconsolidated affiliates 2,862 943 4,838 1,262 Minority interest (12) (219) (51) (837) Earnings before income taxes 36,692 20,412 74,193 77,381 Income tax expense 14,604 8,586 30,350 31,654 Net earnings $ 22,088 $ 11,826 $ 43,843 $ 45,727 Basic earnings per share $ .32 $ .17 $ .63 $ .67 Diluted earnings per share $ .31 $ .17 $ .61 $ .65 Weighted average shares outstanding: Basic 69,700 69,600 70,000 68,200 Diluted 71,600 71,500 71,700 70,500 Comprehensive income $ 22,038 $ 11,641 $ 43,657 $ 45,443 See accompanying notes to consolidated financial statements.
5 AIRGAS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands) Nine Months Ended Nine Months Ended December 31, 1998 December 31, 1997 CASH FLOWS FROM OPERATING ACTIVITIES Net earnings $ 43,843 $ 45,727 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation, depletion and amortization 65,849 56,809 Deferred income taxes 7,478 13,778 Equity in earnings of unconsolidated affiliates (5,706) (2,372) Gain on sales of plant and equipment (397) (398) Minority interest in earnings 51 837 Gain on divestitures of non-core businesses (23,968) (1,452) Stock issued for employee stock purchase plan 4,270 4,483 Changes in assets and liabilities, excluding effects of business acquisitions and divestitures: Trade receivables, net (6,992) 3,287 Inventories, net (13,279) (12,693) Prepaid expenses and other current assets (1,502) (2,098) Accounts payable, trade (9,854) (21,218) Accrued expenses and other current liabilities 15,074 4,583 Other assets and liabilities, net (12,743) (1,248) Net cash provided by operating activities 62,124 88,025 CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (82,076) (93,579) Proceeds from sales of plant and equipment 1,655 2,056 Proceeds from divestitures of non-core businesses 48,816 4,000 Business acquisitions, net of cash acquired (43,969) (101,210) Business acquisitions, holdback settlements (3,619) (4,130) Investment in unconsolidated affiliates (140) (16,086) Dividends from unconsolidated affiliates 2,788 1,984 Other, net 4,409 2,732 Net cash used by investing activities (72,136) (204,233) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from borrowings 393,833 309,949 Repayment of debt (360,789) (172,011) Financing costs (21) (362) Repurchase of treasury stock (13,982) (31,905) Exercise of stock options 1,325 3,217 Cash overdraft (10,354) 7,320 Net cash provided by financing activities 10,012 116,208 CASH INCREASE (DECREASE) $ 0 $ 0 Cash - Beginning of period 0 0 Cash - End of period $ 0 $ 0 See accompanying notes to consolidated financial statements.
6 AIRGAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (1) BASIS OF PRESENTATION The consolidated financial statements include the accounts of Airgas, Inc. and its subsidiaries (the "Company"). Unconsolidated affiliates are accounted for on the equity method and generally consist of 20% - 50% owned operations where control does not exist or is considered temporary. The excess of the cost of these affiliates over the Company's share of their net assets at the acquisition date is being amortized over 40 years. Intercompany accounts and transactions are eliminated in consolidation. The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles. These statements do not include all disclosures required for annual financial statements. These financial statements should be read in conjunction with the more complete disclosures contained in the Company's audited consolidated financial statements for the year ended March 31, 1998. The Company adopted Statement of Financial Accounting Standard No. 130 "Reporting Comprehensive Income" in the quarter ended June 30, 1998, as required. The financial statements as of December 31, 1997 and March 31, 1998 have been restated to conform to the current presentation. The financial statements reflect, in the opinion of management, all adjustments necessary to present fairly the Company's financial position, results of operations and cash flows for the periods presented. Such adjustments are of a normal, recurring nature except for the impact of acquisitions, divestitures, and special charges which are discussed in the notes to the accompanying financial statements. The interim operating results are not necessarily indicative of the results to be expected for an entire year. (2) ACQUISITIONS AND DIVESTITURES From April 1, 1998 to December 31, 1998, the Company acquired 11 distributors of industrial gas and related equipment (Distribution segment) with aggregate annual sales of approximately $31 million and four manufacturers and distributors of dry ice (Manufacturing segment) with annual sales of approximately $20 million. The aggregate purchase price, including amounts related to non-competition agreements, totaled approximately $64 million ($48 million cash and $16 million assumed liabilities). Acquisitions have been recorded using the purchase method of accounting, and, accordingly, results of their operations are included in the Company's consolidated financial statements since the effective dates of the respective acquisitions. On December 31, 1998, the Company completed its previously announced divestiture of its calcium carbide and carbon products manufacturing operations to Elkem Metals Company L.P. ("Elkem"), a subsidiary of Elkem ASA. In conjunction with the sale, the Company and Elkem terminated the Elkem- American Carbide Company joint venture which marketed calcium carbide throughout the United States. The divestiture resulted in a non-recurring gain of $23.9 million ($14.1 million after-tax, or $.20 per diluted share) which is recognized in "other income, net." The calcium carbide and carbon products operations generated annual sales of approximately $30 million included in the Company's Manufacturing Segment ($7.8 million and $22.1 million in sales for the three and nine months ended December 31, 1998, respectively). Through a long-term contract, the Company will continue to purchase its calcium carbide requirements from Elkem. In January 1999, the Company announced the signing of a letter of intent with Linde AG ("Linde"), for the purchase by Linde of the Company's operations in Poland and Thailand for approximately $50 million. The transactions are subject to regulatory approvals, completion of due diligence and definitive documentation. 7 AIRGAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) As also discussed in Note (3), the Company divested two non-core businesses in the first quarter of fiscal 1999. The consideration for the sales of the businesses included cash proceeds of approximately $10.5 million and the assumption of certain liabilities. The businesses had combined annual net sales in 1998 and 1999 of approximately $17 million and $4.6 million, respectively. During the second quarter ended September 30, 1997, the Company recorded a gain, included in other income, of $1.5 million (approximately $980 thousand after-tax) related to the sale of a non-core business. (3) SPECIAL CHARGES During the fourth quarter of fiscal 1998, the Company announced its "Repositioning Airgas for Growth" restructuring plan (the "Repositioning Plan"). The Company recorded accruals of approximately $11 million in the fourth quarter of 1998 related to the pending divestiture of several non-core businesses, facility exit costs and severance. As discussed in Note (2), the Company completed the divestiture of two non-core businesses during the first quarter of 1999. As a result of these divestitures, accruals were reduced by $2.8 million, including $1 million ($570 thousand after-tax) which represented accruals which were no longer required. The Company estimated that facility exit costs and severance would require a use of cash of $4.2 million. Through December 31, 1998, the Company has paid amounts totaling $2.2 million related to facility exit costs and severance. At December 31, 1998, the Company believes its remaining accruals of $6 million ($4 million for divestitures and $2 million for facility exit costs and severance) are adequate. During the third quarter ended December 31, 1998, equity earnings of unconsolidated affiliates includes a $1.8 million non-recurring gain from insurance proceeds recorded by an equity affiliate. On July 28, 1997, the Company reported that it had negotiated a comprehensive settlement with all defendants in litigation related to the fraudulent breach of contract by a third-party supplier of refrigerant gas which was reported by the Company in December 1996. The Company recorded a non-recurring pre-tax charge during the fourth quarter of fiscal 1997 of $26.4 million (after-tax $17 million) for product losses and costs associated with the Company's investigation into the fraud and recovery of damages. As a result of the July 28, 1997 settlement, the Company recorded a gain of $14.5 million (after-tax $9.4 million) during the second quarter ended September 30, 1997. (4) EARNINGS PER SHARE Basic earnings per share is calculated by dividing net earnings by the weighted average number of shares of the Company's Common Stock outstanding during the period. Diluted earnings per share is calculated by adjusting the weighted average common shares outstanding for the dilutive effect of common stock equivalents related to stock options and contingently issuable shares. 8 AIRGAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) The table below reconciles basic weighted average common shares outstanding to diluted weighted average common shares outstanding for the three and nine month periods ended December 31, 1998 and 1997: (In thousands)
Three Months Ended Nine Months Ended December 31, December 31, 1998 1997 1998 1997 Weighted average common shares outstanding: Basic..................................... 69,700 69,600 70,000 68,200 Stock Options............................. 1,300 1,900 1,500 2,300 Contingently issuable shares.............. 600 -- 200 -- Diluted................................... 71,600 71,500 71,700 70,500
(5) INVENTORIES Net inventories consist of: (In thousands)
(Unaudited) December 31, March 31, 1998 1998 Finished goods $164,748 $154,003 Raw materials 1,178 2,380 165,926 156,383 Less reduction to LIFO cost (1,455) (1,446) $164,471 $154,937
9 AIRGAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) (6) PLANT AND EQUIPMENT The major classes of plant and equipment, at cost, are as follows: (In thousands)
(Unaudited) December 31, March 31, 1998 1998 Land and land improvements $ 24,283 $ 26,050 Buildings and leasehold improvements 90,382 88,130 Cylinders 419,996 404,198 Machinery and equipment, including bulk tanks 321,854 300,599 Computers and furniture and fixtures 62,751 52,051 Transportation equipment 51,336 48,720 Construction in progress 11,391 3,887 $981,993 $923,635
(7) OTHER NON-CURRENT ASSETS Other non-current assets include: (In thousands)
(Unaudited) December 31, March 31, 1998 1998 Investment in unconsolidated affiliates $ 96,863 $ 98,522 Non-compete agreements and other intangible assets, at cost, net of accumulated amortization of $83.1 million at December 31, 1998 and $73.2 million at March 31, 1998 59,258 63,205 Other assets 18,555 14,856 $174,676 $176,583
10 AIRGAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) (8) ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities include: (In thousands)
(Unaudited) December 31, March 31, 1998 1998 Cash overdraft $ 20,585 $ 31,621 Repositioning accruals 5,985 10,429 Accrued interest 14,142 8,918 Insurance and related reserves 10,130 7,248 Customer cylinder deposits 8,731 8,668 Accrued federal and state taxes 12,805 1,149 Other accrued expenses and current liabilities 61,230 60,773 $133,608 $128,806 The cash overdraft is attributable to the float of the Company's outstanding checks.
(9) STOCKHOLDERS' EQUITY Changes in stockholders' equity were as follows: (In thousands of shares) Shares of Common Treasury Stock $.01 Par Value Stock Balance--April 1, 1998 71,357 176 Common stock issuance (a) 477 -- Purchase of treasury stock -- 1,100 Reissuance of treasury stock -- (358) Balance--December 31, 1998 71,834 918 11 AIRGAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited)
(In thousands of dollars) Accumulated Capital in Other Common Excess of Retained Comprehensive Treasury Comprehensive Stock Par Value Earnings Loss Stock Income Balance--April 1, 1998 $714 $192,358 $237,166 $(779) $ (2,586) $ -- Net earnings -- -- 43,843 -- -- 43,843 Common stock issuance (a) 4 4,266 -- -- -- -- Foreign currency translation adjustments -- -- -- (186) -- (186) Purchase of treasury stock -- -- -- -- (13,982) -- Reissuance of treasury stock (b) -- (3,442) -- -- 4,752 -- Tax benefit from stock option exercises -- 957 -- -- -- -- Balance--December 31,1998 $718 $194,139 $281,009 $(965) $(11,816) $43,657 (a) Related to the issuance of common stock for the Company's Employee Stock Purchase Plan. (b) Treasury stock is reissued at average cost with the excess of the repurchase cost over the reissuance price treated as a charge to capital in excess of par value.
(10) COMMITMENTS AND CONTINGENCIES (a) Litigation In July 1996, Praxair, Inc. ("Praxair") filed suit against the Company in the Circuit Court of Mobile County, Alabama. The complaint alleged tortious interference with business or contractual relations with respect to Praxair's Right of First Refusal contract with the majority shareholders of National Welders by the Company in 12 AIRGAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (Unaudited) connection with the Company's formation of a joint venture with National Welders. Praxair sought compensatory damages in excess of $100 million and punitive damages. In June 1998, Praxair filed a motion to dismiss its own action in Alabama and commenced another action in the Superior Court of Mecklenburg County, North Carolina, alleging substantially the same tortious interference by the Company. The North Carolina action also alleges breach of contract against National Welders and certain shareholders of National Welders and unfair trade practices and conspiracy against all the defendants. In the North Carolina action Praxair seeks compensatory damages in excess of $10,000, punitive damages and other unspecified relief. The Company believes that all of Praxair's claims are without merit and intends to defend vigorously against such claims. On September 9, 1996, the Company filed suit against Praxair in the Court of Common Pleas of Philadelphia County, Pennsylvania. The complaint alleges breach of contract, fraud, conversion and misappropriation of trade secrets with respect to an agreement between Praxair and the Company, pursuant to which Praxair induced the Company to provide Praxair valuable information and conclusions developed by the Company concerning CBI Industries, Inc. ("CBI") in exchange for Praxair's promise not to acquire CBI without the Company's participation. The Company has alleged that it became entitled, pursuant to such agreement, to acquire certain of CBI's assets having a value in excess of $800 million. The Company is seeking compensatory and punitive damages. The Company is involved in various legal and regulatory proceedings which have arisen in the ordinary course of its business and have not been finally adjudicated. These actions, when ultimately concluded and determined, will not, in the opinion of management, have a material adverse effect upon the Company's consolidated financial position, results of operations or liquidity. (b) Insurance Coverage The Company has established insurance programs to cover workers' compensation, business automobile, general and products liability. These programs have self-insured retentions of $500,000 per occurrence for workers' compensation, business automobile, and general and products liability. Losses are accrued based upon the Company's estimates of the aggregate liability for claims incurred, claims incurred but not reported and based on Company experience. The Company has established insurance reserves that management believes to be adequate. 13 Item 2. AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL REVIEW OVERVIEW Net sales increased 3% to $380 million in the quarter ended December 31, 1998 ("current quarter"), from $368 million in the prior year. Net earnings in the current quarter were $22.1 million, or $.31 per diluted share compared to $11.8 million, or $.17 per share, a year ago. Excluding non-recurring gains, net earnings in the current quarter were $6.1 million or $.09 per diluted share. Net earnings in the current quarter were impacted by a general slowing in the manufacturing and industrial sectors and higher operating expenses, including expenses associated with the Company's "Repositioning Airgas for Growth" initiative (the "Repositioning Plan"). As more fully described in the Company's Form 10-K for the year ended March 31, 1998, the Repositioning Plan includes the consolidation of subsidiaries into larger regional companies, the conversion of information systems, the implementation of a national computer center and communications system, the build-out of regional distribution centers and the divestiture of several non-core businesses. Repositioning expenses were estimated to total $1.6 million in the current quarter and resulted from computer conversions, relocation and other personnel expenses and facility-related costs. Furthermore, the Company recognized additional operating expenses of $2.5 million during the quarter, which were directly related to the repositioning (ongoing costs of operating a national computer center and communications system, regional distribution centers, higher depreciation expense related to new capital equipment and additional salary expense related to new product line sales personnel). The Company believes that these repositioning expenses will be offset by savings associated with consolidating computer systems and back-office functions. In response to lower same-store sales growth, the Company has embarked on a Company-wide cost improvement program that the Company believes will yield in excess of $15 million in annual savings beginning in fiscal year 2000. The cost improvements are far reaching and are expected to impact all areas of the Company's expense structure including administrative cost reductions, consolidation of back offices, the closure of unprofitable branch locations, working capital improvements and reduced capital expenditures. On December 31, 1998, the Company completed its previously announced divestiture of its calcium carbide and carbon products manufacturing operations to Elkem Metals Company L.P. ("Elkem"), a subsidiary of Elkem ASA. In conjunction with the sale, the Company and Elkem terminated the Elkem-American Carbide Company joint venture which marketed calcium carbide throughout the United States. The divestiture resulted in a non- recurring gain of $23.9 million ($14.1 million after-tax, or $.20 per diluted share) which is recognized in "other income, net." The calcium carbide and carbon products operations generated annual sales of approximately $30 million included in the Company's Manufacturing Segment ($7.8 million and $22.1 million in sales for the three and nine months ended December 31, 1998, respectively). Through a long-term contract, the Company will continue to purchase its calcium carbide requirements from Elkem. From April 1, 1998 through December 31, 1998, the Company acquired 11 distributors of industrial gas and related equipment (Distribution segment) with aggregate annual sales of approximately $31 million and four manufacturers and distributors of dry ice (Manufacturing segment) with annual sales of approximately $20 million. 14 AIRGAS, INC. MANAGMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) In January 1999, the Company announced the signing of a letter of intent with Linde AG ("Linde"), for the purchase by Linde of the Company's operations in Poland and Thailand for approximately $50 million. The transactions are subject to regulatory approvals, completion of due diligence and definitive documentation. RESULTS OF OPERATIONS: THREE MONTHS ENDED DECEMBER 31, 1998 COMPARED TO THE THREE MONTHS ENDED DECEMBER 31, 1997 INCOME STATEMENT COMMENTARY Net sales increased 3% during the current quarter compared to the same quarter in the prior year. (in thousands)
Three months Ended December 31, Increase Net Sales: 1998 1997 (Decrease) Distribution $279,669 $272,958 $ 6,711 Direct Industrial 59,954 61,372 (1,418) Manufacturing 40,700 33,480 7,220 $380,323 $367,810 $12,513
Distribution sales include three product groups: gases, hardgoods and rent. Distribution sales increased $6.7 million as a result of approximately $12.2 million from the acquisition of 18 distributors since October 1, 1997. Offsetting the increase in sales due to acquisitions were a $1.1 million decline in same-store sales and the divestitures of two businesses in the first quarter of 1999 which had sales of approximately $4.4 million in the prior period. Distribution same-store sales decreased approximately .4% as a result of a 4% increase in same-store gas and rent revenue, offset by a decline of approximately 5% in hardgoods sales. The increases in gas and rent sales were helped by the Company's continued focus on strategic products, growth of national accounts, expansion of its rental welder fleet and small bulk gas sales. Selected price increases also helped improve gas and rent revenues in the current quarter. Sales were negatively impacted by a general slowing in several manufacturing and industrial sectors including: oil and gas exploration and production, agriculture, steel, pulp and paper products, mining and shipbuilding. The Company believes that these factors contributed to the decline in its Distribution same-store sales growth rate from 3% in the prior year quarter. Additionally, although difficult to quantify, the Company believes that the indirect effects of the Repositioning have impacted sales. The Company estimates same-store sales based on a comparison of current period sales to the prior period's sales, adjusted for acquisitions and divestitures. Future same-store sales growth is dependent on the economy, price increases and the Company's ability to sell additional products and services to existing customers. The Company continues to focus on internal sales growth through the addition of new products and product-line extensions, including certain specialty gases, carbon dioxide, refrigerant gases in returnable containers, rental welders and tool and safety hardgoods items. 15 AIRGAS, INC. MANAGMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) Airgas Direct Industrial ("ADI") sales include safety products and equipment, metalworking tools and supplies and other Maintenance, Repair and Operations ("MRO") hardgoods items. ADI's sales decreased $1.4 million primarily from a same-store sales decline. The same-store sales decrease compared to the prior year was approximately 5% as a result of a 17% decline in tool products sales, offset by an increase of approximately 3% in sales of safety-related products. Sales increases of safety-related products were helped by growth in national accounts business, however, sales growth slowed compared to the first and second quarters of fiscal 1999 due to the general slowing in the manufacturing and industrial sectors. Sales of tool products were more significantly impacted by the slowing economy, particularly on the West coast. Tool sales also continue to be impacted by system conversions and warehousing consolidations which occurred late in fiscal 1998. The Company believes the release of a new tool catalog will help tool sales during the fourth quarter ending March 31, 1999. The Manufacturing segment's sales primarily include six product groups: liquid carbon dioxide, dry ice, specialty gases, nitrous oxide, carbon products and calcium carbide. Sales increased $7.2 million primarily from seven liquid carbon dioxide and dry ice acquisitions completed since October 1, 1997. Liquid carbon dioxide sales declined in both volume (3.6%) and price (7%) compared to the same quarter a year ago. Pipeline sales of carbon dioxide increased 23%, partially offsetting the decline in liquid carbon dioxide sales. Liquid carbon dioxide pricing has been impacted by market production levels which exceed the growth in demand. Dry ice sales volumes increased in the quarter as a result of acquisitions, partially offset by a seasonal slow-down. Sales of nitrous oxide were down slightly compared to last year due to the general slowing in the manufacturing and industrial sectors. Sales of carbon products and calcium carbide decreased 9% compared to the prior year due to a general decline in metals prices and a downturn in the steel industry. Gross profits increased 5% during the current quarter compared to the same quarter in the prior year. (in thousands)
Three Months Ended December 31, Increase Gross Profits: 1998 1997 (Decrease) Distribution $139,584 $136,649 $ 2,935 Direct Industrial 16,117 17,577 (1,460) Manufacturing 24,945 17,633 7,312 $180,646 $171,859 $ 8,787
16 AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) The increase in Distribution gross profits of $2.9 million resulted from acquisitions which contributed approximately $5.6 million. Offsetting the increase in gross profits from acquisitions was a same-store gross profit decline of approximately $.6 million, or .4%, and the divestiture of two businesses in the first quarter of 1999 which had gross profits of approximately $2.1 million during the same period in the prior year. Same-store gross profits for gas and rent increased 3% in the current quarter as a result of higher gas volumes and increased rental business. Gas and rent gains were offset by a decrease in hardgoods same-store gross profits of approximately 9%. The slowing economy impacted pricing in certain areas, particularly related to hardgoods sales. The decrease in ADI gross profits of $1.5 million resulted from a same-store gross profit decline of 8.3%. The same-store gross profit decline resulted primarily from inventory adjustments recognized in relation to warehousing consolidations, lower vendor rebates due to lower purchase volumes and product discounting in certain regions to regain customers. ADI gross margins were 26.9% for the current quarter and declined 170 basis points compared to 28.6% in the prior year. The increase in Manufacturing gross profits of $7.3 million resulted primarily from higher gross margins of carbon dioxide and dry ice acquisitions, a favorable product mix and increased volume in pipeline carbon dioxide sales. Selling, distribution and administrative expenses consist of personnel and related costs, distribution and warehousing costs, occupancy expenses and other selling and general administrative expenses. Selling, distribution and administrative expenses increased $14 million in the current quarter compared to the prior year primarily as a result of acquisitions, higher operating expenses and repositioning expenses. Repositioning expenses were estimated to total $1.6 million in the current quarter and resulted from computer conversions, relocation and other personnel expenses and facility-related costs. Furthermore, the Company recognized additional operating expenses of $2.1 million during the quarter, which were directly related to the repositioning (ongoing costs of operating a national computer center and communication system, regional distribution centers and additional salary expense related to new product line sales personnel). The Company believes that these repositioning expenses will be offset by savings associated with consolidating computer systems and back-office functions. As a percentage of net sales, selling, distribution and administrative expenses increased to 35% in the current quarter compared to 32% in the prior year. Depreciation, depletion and amortization totaled $22.5 million in the current quarter and increased $2.3 million compared to the prior year primarily as a result of acquisitions and capital projects completed during the previous 12 months. Compared to the prior year, depreciation, depletion and amortization as a percentage of sales increased 40 basis points to 5.9%. For the Distribution, ADI and Manufacturing segments, depreciation, depletion and amortization expense in the current quarter, relative to net sales, was 6.2%, 3.3% and 7.9%, respectively. Operating income decreased $7.5 million or 23% in the current quarter compared to the prior year. The decrease in operating income was primarily due to higher operating expenses, repositioning expenses and lower gross profits from reduced hardgoods sales. 17 AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) (in thousands)
Three Months Ended December 31, Increase Operating Income: 1998 1997 (Decrease) Distribution $20,282 $26,902 $(6,620) Direct Industrial 352 2,463 (2,111) Manufacturing 4,539 3,337 1,202 $25,173 $32,702 $(7,529)
The Distribution segment's operating income margin decreased 260 basis points to 7.3% of sales in the current quarter compared with the prior year. The lower margin was primarily the result of higher operating expenses, including expenses associated with the Company's Repositioning Plan and higher selling expenses related to the expanded distribution of safety products, specialty gases and welder rentals. In the current quarter, the Distribution segment incurred approximately $1.5 million of repositioning expenses which were primarily related to computer conversions and $1.8 million of ongoing operating expenses related to a national computer center and communications system and additional salary expense related to new product line sales personnel. The operating income margin for ADI decreased to .6% of sales in the current quarter compared to 4% in the prior year. A decline in same-store sales and related gross profits coupled with ongoing operating expenses related to the new regional distribution centers of approximately $800 thousand resulted in operating margin degradation. The Manufacturing segment's operating margin increased 120 basis points to 11.2% of sales in the current quarter compared to the prior year primarily from improved operations of specialty gases and pipeline carbon dioxide sales. Interest expense, net, totaled $15.7 million in the current quarter and increased $2.2 million compared to the prior year. The increase in interest expense was primarily attributable to an increase in debt associated with completing 25 acquisitions since October 1, 1997. Interest costs were also impacted by capital expenditures and an increase in working capital. As discussed in "Liquidity and Capital Resources" below, the Company has hedged interest rates under certain borrowings with interest rate swap agreements. Equity in earnings of unconsolidated affiliates of $2.9 million increased $1.9 million compared to the prior year as a result of a non- recurring insurance gain of $1.8 million and higher joint venture earnings from National Welders Supply. Excluding the impact of non-recurring gains in fiscal 1999, the effective income tax rate increased slightly compared to the prior year. 18 AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) Net earnings in the current quarter (excluding non-recurring gains) were $6.1 million, or $.09 per diluted share, compared to $11.8 million, or $.17 per diluted share in the prior year. Including the non-recurring after-tax gain of $14.1 million from the divestiture of the Company's calcium carbide and carbon products operations and the $1.8 million non- recurring gain recognized by an equity affiliate, net earnings in the current quarter were $22.1 million, or $.31 per diluted share. RESULTS OF OPERATIONS: NINE MONTHS ENDED DECEMBER 31, 1998 COMPARED TO THE NINE MONTHS ENDED DECEMBER 31, 1997 INCOME STATEMENT COMMENTARY Net sales increased 11% during the nine months ended December 31, 1998 ("current period") compared to the same period in the prior year. (in thousands)
Nine Months Ended December 31, Net Sales: 1998 1997 Increase Distribution $ 860,628 $ 812,395 $ 48,233 Direct Industrial 193,756 159,433 34,323 Manufacturing 123,304 87,750 35,554 $1,177,688 $1,059,578 $118,110
Distribution sales increased $48.2 million as a result of approximately $49.4 million from the acquisition of 30 distributors since April 1, 1997 and $9.9 million from same-store sales growth. Offsetting the increase in sales were the divestitures of two businesses in the first quarter of 1999 which had sales of $11.1 million in the prior period. Distribution same-store sales increased approximately 1.2% as a result of a 4.4% same-store increase in gas and rent, partially offset by a 1.7% decline in hardgoods sales. The increases in gas and rent sales were due to gas sales from the Company's two air separation plants, the expansion of its rental welder fleet and other sales initiatives. The Company believes its hardgoods sales were adversely affected by a general slowing in the manufacturing and industrial sectors which was more significantly highlighted in the quarter ended December 31, 1998. The slowing in the economy impacted customers in the following industries: oil and gas exploration and production, agriculture, steel, pulp and paper products, mining and shipbuilding. The Company believes that these factors contributed to the decline in its Distribution same-store sales growth rate from 4% in the prior year. Additionally, although difficult to quantify, the Company believes the indirect effects of the Repositioning have impacted sales. 19 AIRGAS, INC. MANAGMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) ADI's sales increased $34.3 million primarily as a result of approximately $30 million from the acquisition of two distributors since April 1, 1997 and approximately $4.3 million from same-store sales growth. The same-store sales growth rate for ADI was 2.3% and resulted from an 8.4% increase in sales of safety-related products helped by growth in national account business and by an expanded telemarketing force, largely offset by an 8.6% decline in tool products. The slowing in the manufacturing and industrial sectors has impacted ADI's sales growth. The Manufacturing segment's sales increased $35.6 million primarily from nine liquid carbon dioxide and dry ice acquisitions completed since April 1, 1997. Liquid carbon dioxide and dry ice sales volumes increased during the current period, although volumes declined in the third quarter. Lower pricing partially offset liquid volume growth. The Company believes that liquid carbon dioxide prices were impacted by market production which has exceeded growth in demand. Gross profits increased approximately 12% in the current period compared to the same period in the prior year. (in thousands)
Nine Months Ended December 31, Gross Profits: 1998 1997 Increase Distribution $429,141 $403,612 $25,529 Direct Industrial 51,181 44,667 6,514 Manufacturing 73,341 46,213 27,128 $553,663 $494,492 $59,171
The increase in Distribution gross profits of $25.5 million resulted from acquisitions which contributed approximately $24.6 million and from same-store gross profit growth of approximately $6.7 million, or 1.6%. Offsetting the increase in gross profits was the divestiture of two businesses in the first quarter of 1999 which had contributed gross profits of $5.8 million in the same period of the prior year. Same-store gross profits were helped by higher gas volumes and increased rental revenues of 4%, partially offset by a 4% decrease in hardgoods same-store gross profits. The increase in ADI gross profits of $6.5 million resulted primarily from acquisitions. Same-store gross profits were essentially flat compared to the prior year. ADI's gross margin of 26.4% for the current period was down 160 basis points compared to the prior year as a result of an acquisition with lower margins not included in the prior period for the full nine months, certain inventory adjustments, lower vendor rebates and product discounting in certain regions to regain customers. The increase in Manufacturing gross profits of $27.1 million resulted primarily from gross profits of liquid carbon dioxide and dry ice acquisitions. The Manufacturing gross margin increased to 59.5% in the current period from 52.7% in the same period last year. 20 AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) Selling, distribution, and administrative expenses increased $59.9 million in the current period compared to the prior period primarily as a result of acquisitions, higher operating expenses and repositioning expenses. Repositioning expenses were estimated to total $4.7 million in the current period and resulted from computer conversions, relocation and other personnel expenses and facility-related costs. Furthermore, the Company recognized additional operating expenses of $6.9 million during the current period, which were directly related to the repositioning (ongoing costs of operating a national computer center and communication system, regional distribution centers and additional salary expense related to new product line sales personnel). The Company believes that these repositioning expenses will be offset by savings associated with consolidating computer systems and back-office functions. As a percentage of net sales, selling, distribution and administrative expenses increased to 34% for the current period compared to 32% in the same period of the prior year. Depreciation, depletion and amortization totaled $65.8 million in the current period and increased approximately $9 million compared to the prior year primarily as a result of acquisitions and capital projects completed during previous periods. Compared to the prior year, depreciation, depletion and amortization as a percentage of sales increased 20 basis points to 5.6%. For the Distribution, ADI and Manufacturing segments, depreciation, depletion and amortization relative to net sales was 5.9%, 2.9% and 7.8%, respectively, for the current period. Operating income decreased $9.8 million or 10% compared to the prior period, excluding special charges in both periods. The decrease in operating income was primarily due to higher operating expenses, repositioning, expenses and lower gross profits on hardgoods. (in thousands)
Nine Months Ended Operating Income December 31, Increase (excluding special charges): 1998 1997 (Decrease) Distribution $73,081 $82,778 $ (9,697) Direct Industrial 2,165 4,911 (2,746) Manufacturing 14,147 11,513 2,634 $89,393 $99,202 $ (9,809)
The Distribution segment's operating income margin decreased 170 basis points to 8.5% for the current period compared to the prior year. The decrease resulted primarily from higher operating expenses related to the Company's Repositioning Plan, higher selling expenses related to expanded product offerings and from acquisitions which had lower operating margins. The Distribution segment incurred $4.2 million of repositioning expenses during the nine months ended December 31, 1998, primarily related to computer conversions and personnel-related costs and $4.8 million of ongoing operating expenses primarily related to a national computer center and communications system and additional salary expense related to new product line sales personnel. 21 AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) The operating income margin for ADI decreased 200 basis points to 1.1% in the current period compared to the prior year. Slightly higher same-store sales and gross profits were offset by repositioning expenses totaling $560 thousand and ongoing additional operating expenses of approximately $3 million associated with new regional distribution facilities in Southern California and Georgia. The Manufacturing segment's operating margin decreased to 11.5% in the current period from 13.1% in the prior year primarily as a result of acquisitions and integration expenses. Interest expense, net, totaled $46.2 million in the current period and increased $7 million compared to the prior year. The increase in interest expense was primarily attributable to an increase in debt associated with completing 41 acquisitions since April 1, 1997. Interest costs were also impacted by capital expenditures, an increase in working capital and the repurchase of the Company's Common Stock. As discussed in "Liquidity and Capital Resources" below, the Company has hedged interest rates under certain borrowings with interest rate swap agreements. Equity in earnings of unconsolidated affiliates of $4.8 million increased $3.5 million compared to the prior year as a result of a non- recurring insurance gain of $1.8 million, an increase in earnings from the Company's liquid carbon dioxide joint venture which was acquired in connection with the June 1997 acquisition of Carbonic Industries Corporation and higher joint venture earnings of National Welders Supply. Earnings have been helped at the Company's liquid carbon dioxide joint venture because of expanded production capacity which came on-line in September 1997. Excluding the impact of special charges and non-recurring gains, the effective income tax rate of 42.2% declined slightly compared to the prior year. Net earnings, excluding special charges and non-recurring gains, in the current period were $27.3 million, or $.38 per diluted share, compared to $35.3 million, or $.50 per diluted share, in the prior year. Net earnings, including an after-tax non-recurring gain of $14.1 million from the divestiture of a non-core business, a $1.8 million non-recurring gain recognized by an equity affiliate and the $570 thousand after-tax effect of the reversal of accruals no longer required related to the divestiture of two non-core businesses, were $43.8 million, or $.61 per diluted share. Net earnings in the prior period, including the after-tax gain of $980 thousand related to a divestiture of a non-core business and the after-tax gain of $9.4 million related to a partial recovery of refrigerant losses, were $45.7 million, or $.65 per diluted share. 22 AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) LIQUIDITY AND CAPITAL RESOURCES The Company has primarily financed its operations, capital expenditures, stock repurchases and acquisitions with borrowings and funds provided by operating activities. The divestiture of certain non-core businesses has also provided the Company with a source of funds. Cash flows from operating activities totaled $62.1 million for the nine months ended December 31, 1998. Depreciation, depletion and amortization represented $65.8 million of cash flows from operating activities. Cash flows from working capital components decreased $16.6 million as a result of an increase in accounts receivable; an increase in inventory levels in order to improve customer order fulfillment rates; a decrease in accounts payable; and an increase in accrued expenses and other current liabilities primarily due to taxes payable on the divestiture of a business. Accounts receivable days' sales outstanding increased from 44 to 48 and hardgoods days' supply of inventory levels also increased from 74 to 90 compared to March 31, 1998 levels. After-tax cash flow (net earnings plus depreciation, depletion and amortization and deferred income taxes), increased 2.4% to $101.6 million in the nine-month period ended December 31, 1998, compared to $99.2 million in the prior year (before special charges and non-recurring gains in both periods). Cash used by investing activities totaled $72.1 million. Activities which used cash during the period primarily included capital expenditures of $82.1 million and acquisitions totaling $47.6 million. The divestiture of three non-core businesses provided cash of $48.8 million. Capital expenditures associated with the purchase of cylinders, bulk tanks and machinery and equipment totaled $46.5 million and have helped facilitate strategic product sales growth. Such purchases account for approximately 57% of the total capital expenditures during the nine-month period ended December 31, 1998. Computer capital expenditures related to the Company's Repositioning Plan totaled approximately $8 million. Financing activities provided cash of $10 million for the nine months ended December 31, 1998, with total bank debt increasing by $34.7 million since March 31, 1998. Cash overdraft, the float of the Company's outstanding checks, decreased by $10.4 million since March 31, 1998. Funds provided by financing activities were used primarily for acquisitions, capital expenditures, working capital needs and the repurchase of the Company's Common Stock. The Company has unsecured revolving credit facilities totaling US$725 million and C$100 million (US$65 million) with a final maturity date of December 5, 2002. The agreement contains covenants which include the maintenance of certain financial ratios, restrictions on additional borrowings and limitations on dividends. At December 31, 1998, the Company had borrowings under the agreement of US$533 million, C$43 million (US$28 million), and commitments under letters of credit supported by the agreement of US$76 million. Availability under the credit facilities was $153 million at December 31, 1998. At December 31, 1998, the effective interest rate on borrowings under the credit line was 5.76% (U.S. borrowings) and 5.10% (Canadian borrowings). 23 AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) In August 1998, the Company filed an amendment to its shelf registration pursuant to Rule 462 (b) under the Securities Act of 1933, as amended, which increased the remaining capacity under the shelf registration to approximately $175 million. At December 31, 1998, the Company had the following long-term debt outstanding under medium-term notes issued under the shelf registration: $100 million of unsecured notes due September 2006 bearing interest at a fixed rate of 7.75%; $50 million of unsecured notes due September 2001 bearing interest at a fixed rate of 7.15%; and $75 million of unsecured notes due March 2004 at a fixed rate of 7.14%. The proceeds from the medium-term note issuances were used to repay bank debt. Additionally, at December 31, 1998, long-term debt of the Company included acquisition notes and other long-term debt instruments. In managing interest rate exposure, principally under the Company's floating rate revolving credit facilities, the Company participates in 25 interest rate swap agreements. The swap agreements are with major financial institutions and aggregate $497 million in notional principal amount at December 31, 1998. Seventeen swap agreements with approximately $252 million in notional principal amount require fixed interest payments based on an average effective rate of 6.55% for remaining periods ranging between 1 and 8 years. Eight swap agreements require floating rates ($245 million notional amount at 5.71% at December 31, 1998). The Company continually monitors its positions and the credit ratings of its counterparties, and does not anticipate non-performance by the counterparties. The Company will continue to look for appropriate acquisitions and expects to fund such acquisitions, future capital expenditure requirements and costs related to its Repositioning Plan primarily through the use of cash flow from operations, debt, common stock for certain acquisition candidates, funds from the divestiture of certain businesses and other available sources. The Company believes that its sources of financing are adequate for its anticipated needs and that it could arrange additional sources of financing for any unanticipated requirement. The cost and terms of any future financing arrangement will depend on the market conditions and the Company's financial position at that time. The Board of Directors has authorized the repurchase of up to 4.6 million shares of Company Common Stock (the "repurchase plan") from time-to-time to offset share issuances for stock options, the Company's Employee Stock Purchase Plan and acquisitions. During the second quarter of fiscal 1999, the Company purchased 1.1 million shares of Airgas Common Stock at an average cost of $12.71 per share. No shares were repurchased during the third quarter of fiscal 1999. The impact of the repurchased shares on earnings per share was immaterial for both the three and nine month periods ended December 31, 1998. During fiscal 1999, the Company reissued 358 thousand shares in connection with stock option exercises. From inception through December 31, 1998, the Company repurchased approximately 4.1 million shares under the repurchase plan at an average cost of $15.15 per share. The remaining shares authorized for repurchase under the repurchase program total approximately 500 thousand shares. The Company does not currently pay dividends. 24 AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) YEAR 2000 READINESS DISCLOSURE Year 2000 Issues The Company is aware of the issues associated with the Year 2000 problem. The "Year 2000" matter relates to whether computer hardware and software and equipment will properly recognize date sensitive information referring to the Year 2000. Potential computer system and equipment failures arising from years beginning with "20" rather than "19" are a known risk. The Company's exposure to Year 2000 issues rests primarily in three main areas: information systems hardware and application software, embedded chip technology which may be found in a wide variety of operating equipment and third party Year 2000 readiness. Information Systems Hardware and Application Software With respect to information systems and application software, the Company's businesses generally do not utilize "home grown" programs or systems that require programming to become Year 2000 compliant. The Company typically uses "out of the box" or "shrink wrap" software for its business needs. Standardized software and computer systems are being implemented across the Company in connection with the Company's Repositioning Plan. Although vendors for such software have advised the Company that their software is Year 2000 compliant, the Company has undertaken and expects to complete time dimensional testing of critical systems and software by June 1999. Although execution of the Repositioning Plan addresses certain significant Year 2000 issues, it was not initiated primarily as a remediation initiative. The Company believes that standardized operating platforms will help provide for an effective multi- channel distribution network. The Company estimates expenditures related to the system conversion and standardization project will total approximately $20-$25 million over the duration of the project, of which approximately $15 million is expected to be capitalized. On a project-to- date basis, the Company has incurred approximately $13 million in costs and expenses to standardize systems, of which approximately $8.5 million represents new capital equipment and software. The Company believes that it is on target for completion of the project by June 1999. However, if such standardization is not completed prior to the Year 2000, the Year 2000 matter could have a material impact on the business, results of operations and financial condition of the Company as well as on customers of the Company. The Company has not determined the extent to which its business and customers might be affected in that event. In conjunction with the Repositioning Plan, the Company has established a national data center equipped with systems hardware and software which its vendors have indicated are Year 2000 compliant. Time dimensional testing of data center hardware and software is expected to be completed by June 1999. In addition, the Company has substantially completed testing of its desktop personal computers with very few failures noted. 25 AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) Embedded Chips The Company's Year 2000 project team includes designated subsidiary- company managers responsible for directing Year 2000 remediation efforts at the business unit level. These managers, in cooperation with the Company's national information services personnel, have completed the inventories and risk assessments of critical processes and equipment containing embedded chips. Testing has been substantially completed with regard to certain critical processes and equipment of the Company's manufacturing operations. No significant instances of non-compliance were identified. Additionally, the Company has completed its assessment of its phone systems and anticipates completing the necessary repairs and replacements by June 1999. The Year 2000 project team is also in the process of contacting suppliers to obtain Year 2000 readiness product information for less significant equipment containing embedded chips. The Company is in the process of assessing the potential costs for remediation of non-compliant embedded chip equipment, which costs are not expected to be material. Although the Company believes it is on target for completing remediation efforts with regard to embedded chip equipment and processes, if repair, replacement or contingency plans are not completed before the Year 2000, the Year 2000 problem could have a material impact on the business, results of operations and financial condition of the Company. Third Parties The Company's Year 2000 issues relate not only to its own business systems and equipment but also to those of its customers, vendors and suppliers. To mitigate the risk to the Company arising from third parties, the Company is contacting significant suppliers, customers and other critical business partners to determine if they have effective Year 2000 plans in place. The Company anticipates that this evaluation will be ongoing through calendar 1999. Responses from approximately 55% of key national suppliers and 30% of other suppliers have been received and evaluated by the Company, with the majority indicating that they have active Year 2000 compliance programs. In addition, audits of certain key suppliers have been initiated to confirm Year 2000 readiness. As a result of the supplier contact and audit programs, alternative suppliers will be identified as deemed necessary. However, there can be no assurance that the Company's customers, vendors, suppliers and other third parties will successfully resolve their own Year 2000 issues in a timely manner sufficient to prevent impact to the Company. Contingency Plans A contingency plan has not been developed for dealing with the most reasonably likely worst case scenario, and such scenario has not yet been clearly identified. The Company currently plans to complete such analysis and contingency planning during the latter part of calendar year 1999. Resources The Company is funding the computer conversion and standardization project as well as non-compliant equipment repairs and replacements from cash flow generated by operations and other available financing sources. Substantially all of the effort to accomplish the remediation objectives with regard to the computer conversion and standardization project, embedded chip equipment, and evaluating third party readiness has been performed by internal Company personnel. 26 AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) OTHER New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company will adopt SFAS No. 131 during its fourth quarter ending March 31, 1999, as required. Adoption of this accounting standard will not impact earnings, financial condition or liquidity. In April 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 98-5, "Reporting on the Costs of Start-up Activities." This statement requires that costs of start-up activities, including organization costs, be expensed as incurred. The statement is effective for fiscal years beginning after December 15, 1998. The adoption of this standard will not materially impact earnings, financial condition or liquidity of the Company. In June 1998, the FASB unanimously approved for issuance SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 standardizes the accounting for derivative instruments, including derivative instruments embedded in other contracts, by requiring that an entity recognize those items as assets or liabilities in the statement of financial position and measure them at fair value. The statement is effective for fiscal years beginning after June 15, 1999. Management is currently evaluating the impact that the adoption of this statement may have on earnings, financial condition or liquidity of the Company. 27 AIRGAS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) Forward-looking Statements This report contains statements that are forward-looking, as that term is defined by Private Securities Litigation Reform Act of 1995 or by the Securities and Exchange Commission in rules, regulations and releases. Airgas 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, and the making of such statements should not be regarded as a representation by Airgas or any other person that the results expressed therein will be achieved. Important factors that could cause actual results to differ materially from those contained in any forward-looking statement include, but are not limited to, underlying market conditions, growth in same-store sales, costs and potential disruptive effects of the Repositioning, the success of the Repositioning Plan, the Company's ability to reduce costs, implementation and standardization of information systems projects, any potential problems relating to Year 2000 matters (including without limitation, those relating to Airgas' ability to identify and timely remediate Year 2000 problems, unanticipated remediation costs, timely resolution of Year 2000 problems by significant vendors, suppliers, customers and other similar third parties, and Airgas' ability to develop and implement contingency plans, if necessary), the success and timing of intended divestitures, the effects of competition from independent distributors and vertically integrated gas producers on products and pricing, growth and acceptance of new product lines through the Company's sales and marketing programs, changes in product prices from gas producers and name-brand manufacturers and suppliers of hardgoods, uncertainties regarding accidents or litigation which may arise in the ordinary course of business and the effects of, and changes in the economy, monetary and fiscal policies, laws and regulations, inflation and monetary fluctuations and fluctuations in interest rates, both on a national and international basis. The Company does not undertake to update any forward-looking statement made herein or that may be made from time to time by or on behalf of the Company. PART II - OTHER INFORMATION Item 1. Legal Proceedings For information regarding certain pending litigation, reference is made to the Company's Form 10-Q for the quarter ended June 30, 1998, which is incorporated herein by reference. Item 5. Other Information Divestiture of Calcium Carbide and Carbon Products Manufacturing Operations On December 31, 1998, the Company completed its previously announced divestiture of its calcium carbide and carbon products manufacturing operations to Elkem Metals Company L.P. ("Elkem"), a subsidiary of Elkem ASA. In conjunction with the sale, the Company and Elkem terminated the Elkem-American Carbide Company joint venture which marketed calcium carbide throughout the United States. The divestiture resulted in a non- recurring gain of $23.9 million ($14.1 million after-tax, or $.20 per diluted share) which is recognized in "other income, net." The calcium carbide and carbon products operations generated annual sales of approximately $30 million included in the Company's Manufacturing Segment ($7.8 million and $22.1 million in sales for the three and nine months ended December 31, 1998, respectively). Through a long-term contract, the Company will continue to purchase its calcium carbide requirements from Elkem. 28 Letter of Intent for the Sale of Certain Foreign Operations In January 1999, the Company announced the signing of a letter of intent with Linde AG ("Linde"), for the purchase by Linde of the Company's investments in Poland and Thailand for approximately $50 million. The transactions are subject to regulatory approvals, completion of due diligence and definitive documentation. Item 6. Exhibits and Reports on Form 8-K a. Exhibits The following exhibits are being filed as part of this Form 10-Q Report: Exhibit No. Description 4 First Amendment to the 1997 Rights Agreement 27 Financial Data Schedule as of December 31, 1998 b. Reports on Form 8-K On October 29, 1998, the Company filed a Form 8-K pursuant to Item 5, reporting its earnings for the second quarter ended September 30, 1998. On December 18, 1998, the Company filed a Form 8-K pursuant to Item 5, reporting its earnings outlook for the third quarter ending December 31, 1998. 29 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. Airgas, Inc. (Registrant) Date: February 11, 1999 /s/ Scott M. Melman Scott M. Melman Senior Vice President and Chief Financial Officer EX-4 2 FIRST AMENDMENT TO THE 1997 RIGHTS AGREEMENT EX-1 FIRST AMENDMENT TO THE 1997 RIGHTS AGREEMENT This First Amendment (this "Amendment") is made as of November 12, 1998 between Airgas, Inc., a Delaware corporation (the "Company"), and The Bank of New York, a New York banking corporation, as Rights Agent (the "Rights Agent"). The Company and the Rights Agent entered into a Rights Agreement, dated as of April 1, 1997 (the "Rights Agreement"). Pursuant to Section 26 of the Rights Agreement, the Board of Directors of the Company has authorized this amendment to the Rights Agreement. Accordingly, in consideration of the premises and mutual agreements herein set forth, and intending to be legally bound hereby, the parties hereby agree as follows: Section 1. Amendments to Rights Agreement. The Rights Agreement shall be amended as follows: (a) The first sentence of Section 3(a) of the Rights Agreement is hereby amended by deleting the words ", provided that if such determination occurs on or after the date of an Adverse Change in Control, then such date may be extended only if there are Continuing Directors in office and such extension is authorized by a majority of such Continuing Directors". (b) Section 23(a) is hereby deleted in its entirety and replaced with the following: "The Board of Directors of the Company may, at its option, at any time prior to the earlier of (i) any Person becoming an Acquiring Person or (ii) the Close of Business on the Final Expiration Date, redeem all, but not less than all, of the then outstanding Rights at a redemption price of $.001 per Right, appropriately adjusted to reflect any stock split, stock dividend or similar transaction occurring after the date hereof (such redemption price being hereinafter referred to as the "Redemption Price"). Notwithstanding the foregoing, in the event payment of the Redemption Price to a holder of Rights would result in the payment of an amount not equal to $.01 or an integral multiple of $.01, the amount to be paid shall be rounded upward to the next $.01. The Company may, at its option, pay the Redemption Price in cash, shares of Common Stock (based on the current market price per share at the time of redemption) or any other form of consideration deemed appropriate by the Board of Directors." (c) The first and second sentences of Section 27 are hereby deleted in their entirety and replaced with the following: EX-2 "Prior to the earliest of (i) the Distribution Date or (ii) a Triggering Event, the Company may and the Rights Agent shall, if the Company so directs, supplement or amend any provision of this Agreement (including supplements or amendments that may be deemed to affect the interests of the holders of Right Certificates adversely) without the approval of any holders of certificates representing shares of Common Stock and associated Rights. From and after the earliest of (i) the Distribution Date or (ii) a Triggering Event, the Company may and the Rights Agent shall, if the Company so directs, supplement or amend this Agreement without the approval of any holders of Right Certificates (i) to cure any ambiguity or to correct or supplement any provision contained herein which may be defective or inconsistent with any other provisions herein or (ii) to make any other changes or provisions in regard to matters or questions arising hereunder which the Company may deem necessary or desirable; provided, however, that no such supplement or amendment shall adversely affect the interests of the holders of Rights as such (other than an Acquiring Person or an Affiliate or Associate of any such Acquiring Person), and no such supplement or amendment may cause the Rights again to become redeemable at such time as the Rights are not then redeemable or cause this Agreement again to become amendable other than in accordance with this sentence." (d) The third sentence of Section 27 is hereby amended by deleting the words "or, so long as any Person is an Acquiring Person hereunder, the Continuing Directors". (e) Section 29 is hereby amended by (i) deleting in each instance where they appear the words "(with, where specifically provided for herein, the concurrence of the Continuing Directors)", and (ii) deleting from the last sentence thereof the words "or the Continuing Directors". Section 2. One Agreement. Except as otherwise expressly provided in this Amendment, all of the terms, conditions and provisions of the Rights Agreement shall remain the same, and the Rights Agreement, as amended hereby, shall continue in full force and effect and this Amendment and the Rights Agreement shall be read and construed as one instrument. Section 3. Governing Law. This Amendment shall be governed by and construed in accordance with the laws of the State of Delaware applicable to contracts to be made and performed entirely within such State. Section 4. Counterparts. This Amendment may be executed in one or more counterparts, each of which when so executed shall be deemed an original and all of which when taken together shall constitute one and the same instrument. EX-3 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed, all as of the date and year first written above. AIRGAS, INC. By: /s/ G.L. Keen Jr. Name: G.L. Keen Jr. Title: Sr. V.P. Law & Corp. Dev. THE BANK OF NEW YORK, As Rights Agent By: /s/ Ralph Chianese Name: Ralph Chianese Title: Vice President EX-27 3 ART. 5 FDS FOR 3RD QUARTER 10-Q ENDED DECEMBER 31, 1998
5 1000 9-MOS MAR-31-1999 DEC-31-1998 0 0 198,084 5,955 164,471 387,785 981,993 265,431 1,710,872 224,141 861,554 718 0 0 462,367 1,710,872 1,177,688 1,177,688 624,025 1,087,295 0 3,782 46,227 74,193 30,350 43,843 0 0 0 43,843 .63 .61
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