ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
With more than 5,200 associates across North America, Applied Industrial
Technologies ("Applied", the "Company", "We", or "Our") is an industrial
distributor that offers parts critical to the operations of maintenance repair
operations and original equipment manufacturing customers in a wide range of
industries. In addition, Applied provides engineering, design and systems
integration for industrial and fluid power applications, as well as customized
fluid power shop, mechanical and fabricated rubber services. We have a long
tradition of growth dating back to 1923, the year our business was founded in
Cleveland, Ohio. During the first quarter of fiscal 2009, business was conducted
in the United States, Canada, Mexico and Puerto Rico from approximately 474
facilities.
The following is Management's Discussion and Analysis of certain significant
factors which have affected our financial condition and results of operations
and cash flows during the periods included in the accompanying condensed
statements of consolidated income and consolidated cash flows. Applied is an
authorized distributor for more than 2,000 manufacturers and offers access to
approximately 3 million stock keeping units ("SKUs"). A large portion of our
business is selling replacement parts to manufacturers for repair or maintenance
of machinery and equipment. When reviewing the discussion and analysis set forth
below, please note that the majority of SKUs we sell in any given period were
not sold in the comparable period of the prior year, resulting in the inability
to quantify commonly used comparative metrics such as changes in product mix and
volume.
Overview
On August 29, 2008, Applied completed the acquisition of substantially all of
the assets of Fluid Power Resource, LLC, including seven fluid power businesses
(collectively "FPR"). The results of FPR's operations have been included in the
condensed consolidated financial statements since that date.
Sales for the quarter ended September 30, 2008 increased $25.4 million or 4.9%
compared to the prior year quarter, driven by sales from businesses acquired of
$26.1 million. Net income decreased $1.9 million or 7.9% compared to the prior
year quarter. Our balance sheet remains strong, with shareholders' equity
increasing to $514.9 million. The current ratio moved to 2.4-to-one from
3.1-to-one at June 30, 2008, primarily reflecting the impact of the FPR
acquisition. Cash flow generated from operations increased $20.0 million to
$48.9 million for the quarter primarily due to changes in working capital.
Applied monitors the Purchasing Managers Index (PMI) published by the Institute
for Supply Management and the Manufacturers Capacity Utilization (MCU) index
published by the Federal Reserve Board and considers these indices key
indicators of potential Company business environment changes. During the quarter
the PMI and MCU both declined, signaling a weakening economy. Our performance
generally tracks these key indicators. When these indicators are increasing, our
sales performance generally lags them by up to 6 months. When these indicators
are decreasing, our performance more closely conforms to the downturns without
much of a lag. Consistent with the changes in these indices, over the last two
quarters we have experienced a decline in U.S. service center same store sales
and the rate of decline has increased during this time period.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The number of Company associates was 5,254 at September 30, 2008, 4,831 at
June 30, 2008, and 4,612 at September 30, 2007. Our operating facilities totaled
474 at September 30, 2008, 459 as of June 30, 2008, and 449 at September 30,
2007. Reflected in both the associate and facility counts from their respective
acquisition dates are the impact of our acquisitions.
Results of Operations
Three Months Ended September 30, 2008 and 2007
During the quarter ended September 30, 2008, sales increased $25.4 million or
4.9% compared to the prior year, reflecting increased sales in both our Service
Center Based Distribution segment and Fluid Power Businesses segment. Sales from
companies acquired since the prior year quarter accounted for sales increases of
$26.1 million. The number of selling days for the quarters ended September 30,
2008 and 2007 were 64 and 63 days, respectively.
Sales from our Service Center Based Distribution segment increased $4.7 million
or 1.0% during the quarter ended September 30, 2008 from the same period in the
prior year. Sales increases from businesses acquired since the prior year period
contributed $5.4 million, or 1.2%, to the overall increase. In addition, the
extra selling day was a positive impact of approximately 1.6% on sales. The
Canadian service center business grew by a little less than 1.0%, of which
approximately half related to favorable exchange rates. Offsetting these
increases were our U.S. based service centers which saw a same-store sales
decline of 2.7% driven by lower sales to smaller accounts.
Sales from our Fluid Power Businesses increased $20.6 million or 39.0% during
the quarter from the same period in the prior year. Our recent acquisitions
accounted for an increase of $20.7 million. Favorable foreign currency
translation of the Canadian businesses accounted for $0.5 million of the
increase between periods. Offsetting these increases were slightly lower sales
in our existing U.S. locations.
During the quarter ended September 30, 2008, industrial products and fluid power
products accounted for 77.4% and 22.6%, respectively, of sales as compared to
80.4% and 19.6%, respectively, for the same period in the prior year. Recent
acquisitions within the fluid power businesses segment account for the shift in
product mix.
From a geographical perspective, sales from our U.S. operations were up
$13.3 million or 2.9% during the quarter ended September 30, 2008 from the same
period in the prior year. Acquisitions drove this increase by adding
$18.0 million to sales, offsetting a decline in the core U.S. business. Sales
from our Canadian operations increased $3.1 million or 5.8% of which
approximately half related to favorable exchange rates. Sales from our Mexico
operations increased $8.9 million which can be primarily attributed to recent
acquisitions.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Gross profit as a percentage of sales decreased to 26.9% compared to the prior
year's 27.4%. We experienced gross profit margin pressures reflecting the
on-going challenges of passing on supplier price increases to our large
contractual customers as well as the price competitiveness in the market place.
Selling, distribution and administrative expense ("SD&A") was 20.0% of sales in
the quarter ended September 30, 2008 compared to 19.8% in the prior year
quarter. In dollars, SD&A increased $5.8 million compared to the prior year
quarter. Acquisitions added $6.0 million of SD&A in the current quarter which
includes $1.1 million in new intangibles amortization expense.
Interest expense, net for the current quarter increased $0.4 million from the
same period in the prior year. Borrowings to fund the acquisition of FPR
increased interest expense by $0.3 million in the current quarter. Lower cash
balances and lower effective interest rates contributed to a reduction in
interest income of $0.7 million for the quarter. In addition, in the prior year
quarter, we had interest expense of $0.8 million associated with $50.0 million
unsecured term notes which were paid off in December 2007.
Other expense, net for the quarter ended September 30, 2008 increased
$0.6 million largely due to declines in market values in investments held by
non-qualified deferred compensation trusts.
The income tax rate was 37.2% for the quarter ended September 30, 2008 compared
to 36.8% for the quarter ended September 30, 2007. The higher tax rate relates
primarily to higher effective state tax rates and less tax exempt interest
income during the quarter, partially offset by lower effective rates in foreign
jurisdictions.
As a result of the above factors, net income decreased $1.9 million or 7.9%
compared to the prior year quarter. Earnings per share were $0.52 per share for
the quarter ended September 30, 2008, compared to $0.56 in the prior year
quarter.
Liquidity and Capital Resources
Cash provided by operating activities for the three months ended September 30,
2008 was $48.9 million. This compares to approximately $28.9 million provided by
operating activities in the same period a year ago. Cash flows from operations
depend primarily upon generating operating income, controlling the investment in
inventories and receivables and managing the timing of payments to suppliers.
The improvement in cash flow from operations primarily resulted from the
following: (1) standard inventory replenishments made nearer to quarter end than
normal which temporarily increased accounts payable at September 30, 2008,
(2) improved timing on collections of supplier purchasing incentives, and
(3) improved collection of accounts receivable.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Cash used in investing activities during the current year of $168.5 million
included $166.0 million paid to acquire FPR in August 2008. Capital expenditures
accounted for an additional $1.7 million, which is consistent with the first
quarter of fiscal 2008.
Cash provided by financing activities was $77.1 million. In the prior year,
financing activities utilized $4.3 million of cash. In the current quarter, we
borrowed a net $83.0 million associated with the acquisition of FPR. This was
partially offset by payment of $6.3 million in dividends. We did not repurchase
any treasury shares in the first quarter of fiscal 2009 or 2008.
We have a $150.0 million revolving credit facility with a group of banks
expiring in June 2012. We had $83.0 million of borrowings outstanding under this
facility at September 30, 2008. The average weighted interest rate on the
outstanding balance was 3.78% at September 30, 2008. We entered into a two year
interest rate swap agreement to effectively convert $50.0 million of the
outstanding balance to a fixed rate. This portion of the debt was classified as
long-term as it is our intention to maintain this balance in conjunction with
the interest rate swap, utilizing the one-month LIBOR borrowing option. At
September 30, 2008, unused lines under this facility, net of outstanding letters
of credit, total $61.9 million and are available to fund future acquisitions or
other capital and operating requirements.
We have an uncommitted shelf facility with Prudential Insurance Company that
enables the Company to borrow up to $100.0 million in additional long-term
financing at the Company's discretion with terms of up to fifteen years. This
agreement expires in March 2010. At September 30, 2008, there were no
outstanding borrowings under this agreement.
Debt classified as long-term includes $50.0 million borrowed under our revolving
credit facility which we intend to maintain outstanding until expiration of a
related interest rate swap agreement in September 2010. The remaining
$25.0 million of long-term debt matures in November 2010.
The Board of Directors has authorized the purchase of shares of the Company's
common stock. These purchases may be made in open market and negotiated
transactions, from time to time, depending upon market conditions. We did not
acquire shares of common stock in the quarter ended September 30, 2008. At
quarter-end, the Company had remaining authorization to repurchase 1,065,100
additional shares.
Cautionary Statement Under Private Securities Litigation Reform Act
Management's Discussion and Analysis and other sections of this report,
including documents incorporated by reference, contain statements that are
forward-looking, based on management's current expectations about the future.
Forward-looking statements are often identified by qualifiers such as
"intention", "expected," and similar expressions. Similarly, descriptions of
objectives, strategies, plans, or goals are also forward-looking statements.
These statements may discuss, among other things, expected growth, future sales,
future cash flows, future capital expenditures, future performance, and the
anticipation and expectations of the Company and its management as to future
occurrences and trends. The Company intends that the forward-looking statements
be subject to the safe harbors established in the Private Securities Litigation
Reform Act of 1995 and by the Securities and Exchange Commission in its rules,
regulations, and releases.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Readers are cautioned not to place undue reliance on any forward-looking
statements. All forward-looking statements are based on current expectations
regarding important risk factors, many of which are outside the Company's
control. Accordingly, actual results may differ materially from those expressed
in the forward-looking statements, and the making of those statements should not
be regarded as a representation by the Company or any other person that the
results expressed in the statements will be achieved. In addition, the Company
assumes no obligation publicly to update or revise any forward-looking
statements, whether because of new information or events, or otherwise, except
as may be required by law.
Important risk factors include, but are not limited to, the following: risks
relating to the operations levels of customers and the economic factors that
affect them; reduced demand for our products in targeted markets due to reasons
including consolidation in customer industries and the transfer of manufacturing
capacity to foreign countries; changes in customer preferences for products and
services of the nature and brands sold by us; changes in customer procurement
policies and practices; changes in the prices for products and services relative
to the cost of providing them; loss of key supplier authorizations, lack of
product availability, or changes in supplier distribution programs; competitive
pressures; the cost of products and energy and other operating costs; disruption
of our information systems; our ability to retain and attract qualified sales
and customer service personnel; our ability to identify and complete
acquisitions, integrate them effectively, and realize their anticipated
benefits; disruption of operations at our headquarters or distribution centers;
risks and uncertainties associated with our foreign operations, including more
volatile economic conditions, political instability, cultural and legal
differences, and currency exchange fluctuations; risks related to legal
proceedings to which we are a party; the variability and timing of new business
opportunities including acquisitions, alliances, customer relationships, and
supplier authorizations; the incurrence of debt and contingent liabilities in
connection with acquisitions; our ability to access capital markets as needed;
changes in accounting policies and practices; organizational changes within the
Company; the volatility of our stock price and the resulting impact on our
financial statements; adverse regulation and legislation; and the occurrence of
extraordinary events (including prolonged labor disputes, natural events and
acts of god, terrorist acts, fires, floods, and accidents). Other factors and
unanticipated events could also adversely affect our business, financial
condition or results of operations. We discussed certain of these matters more
fully in our Annual Report on Form 10-K for the year ended June 30, 2008.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
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