ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 second quarter of fiscal 2009, business
was conducted in the United States, Canada, Mexico and Puerto Rico from 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 certain of the assets
of Fluid Power Resource, LLC, ("FPR"); the results of FPR's operations have been
included in the condensed consolidated financial statements since that date.
Consolidated net sales for the quarter ended December 31, 2008 decreased
$8.6 million or 1.7% compared to the prior year quarter as declines in
same-store business were only partially offset by net sales from businesses
acquired. Operating income declined to 5.7% from 7.3% and net income decreased
$6.8 million or 29.5% compared to the prior year quarter. Shareholders' equity
was $504.9 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.
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. Historically our performance generally
tracks to these key indicators. When these indicators are increasing, our sales
performance has generally lagged them by up to 6 months. We believe when these
indicators are decreasing, our performance more closely conforms to the
downturns without much of a lag. Over the last three quarters we have
experienced sales declines, as these indices have seen declines. For instance,
our U.S. service center same-store sales have declined and the rate of decline
has increased during this time period. U.S. service center same-store sales for
each of the last three quarters compared to the prior year quarters were down as
follows: for the June quarter 2%, for the September quarter 3% and for the
December quarter 13%. The PMI and MCU indices indicate some further softening of
sales can be expected. In the current quarter, the National Bureau of Economic
Research declared the economy has been in a recession since December 2007. The
effects of this recession are being felt by the industries we serve.
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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 5,203 at December 31, 2008, 4,831 at
June 30, 2008, and 4,661 at December 31, 2007. Our operating facilities totaled
474 at December 31, 2008, 459 as of June 30, 2008, and 452 at December 31, 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 December 31, 2008 and 2007
During the quarter ended December 31, 2008, net sales decreased $8.6 million or
1.7% compared to the prior year, reflecting decreased net sales in same-store
business which were partially offset by net sales attributed to acquisitions.
Net sales from companies acquired since the prior year quarter accounted for
increases of $53.3 million. The number of selling days for both of the quarters
ended December 31, 2008 and 2007 were 62 days.
Net sales from our Service Center Based Distribution segment decreased
$52.8 million or 11.5% during the quarter ended December 31, 2008 from the same
period in the prior year. Net sales from businesses acquired since the prior
year period contributed $5.5 million, while our same-store business saw a net
decline of $58.3 million.
Within the Service Center Based Distribution segment, net sales for our U.S.
based service centers experienced a same-store sales decline of $55.6 million or
13.4%. The Canadian service center net sales in local currency increased by
5.8%, however, unfavorable foreign currency translation to U.S. dollars drove
net sales down by $5.7 million to an overall decrease of $3.4 million compared
to the prior year quarter. Our Mexican service center locations experienced a
net sales increase of $6.2 million of which approximately 90% is attributable to
acquisitions.
Net sales from our Fluid Power Businesses increased $44.2 million or 85.7%
during the quarter from the same period in the prior year. Our recent
acquisitions added $47.7 million while our same-store business declined
$3.5 million. Unfavorable foreign currency translation of the Canadian fluid
power businesses accounted for $2.7 million of this decline which saw a 10.7%
increase in local currency. Our net same-store sales at U.S. fluid power
locations declined 7.9%.
During the quarter ended December 31, 2008, industrial products and fluid power
products accounted for 72.1% and 27.9%, respectively, of net sales as compared
to 80.6% and 19.4%, respectively, for the same period in the prior year.
Acquisitions since the prior year period have concentrated primarily in our
fluid power businesses segment, accounting for a majority of the shift in
product mix.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
From a geographical perspective, net sales from our U.S. operations were down
$13.1 million or 2.9% during the quarter ended December 31, 2008 from the same
period in the prior year. While acquisitions added $45.6 million to net sales,
they were unable to offset declines in the same-store U.S. business. Net sales
from our Canadian operations decreased $4.3 million or 7.4%. Unfavorable foreign
currency fluctuations drove net sales down $8.4 million, offsetting the net
sales increase of 7.3% in local currency. Net sales from our Mexican operations
increased $8.7 million; primarily due to sales from businesses acquired since
the prior year period.
Our gross profit margin decreased to 27.0% compared to the prior year's 27.3%.
This decline is primarily related to lower purchasing volume which led to lower
supplier purchasing incentives. Additionally, we continue to experience 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 21.2% of net sales
in the quarter ended December 31, 2008 compared to 20.0% in the prior year
quarter. In dollars, SD&A increased $4.4 million compared to the prior year
quarter. Acquisitions added $13.7 million of SD&A in the current quarter which
includes $2.4 million in new intangibles amortization expense. Associate
compensation and benefits including amounts tied to financial performance were
approximately $12.0 million lower in the current quarter as compared to the
prior year quarter, while wages and benefits including healthcare costs rose
approximately $6.0 million. Favorable foreign currency translation and reduced
discretionary spending account for the majority of the remaining decrease.
Interest expense, net for the current quarter increased $1.3 million from the
same period in the prior year. Lower invested cash balances and lower interest
rates contributed to a reduction in interest income of $1.1 million for the
quarter. Interest expense increased slightly from the prior year quarter due to
higher average borrowings.
Other expense, net for the quarter ended December 31, 2008 increased
$2.1 million. Expenses of $1.4 million due to declines in market values of
investments held by non-qualified deferred compensation trusts and $1.6 million
representing losses on foreign currency transactions were partially offset by a
$0.9 million unrealized gain on the cross-currency swap.
The effective income tax rate was 35.9% for the quarter ended December 31, 2008
compared to 38.1% for the quarter ended December 31, 2007. The lower effective
tax rate relates primarily to lower effective rates in foreign jurisdictions.
As a result of the above factors, net income decreased $6.8 million or 29.5%
compared to the prior year quarter. Earnings per share were $0.38 per share for
the quarter ended December 31, 2008, compared to $0.52 in the prior year
quarter.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Six Months Ended December 31, 2008 and 2007
During the six months ended December 31, 2008, net sales increased $16.8 million
or 1.6% compared to the prior year, reflecting increased net sales in our Fluid
Power Businesses segment largely offset by declines in our Service Center Based
Distribution segment. Net sales from companies acquired since the prior year six
month period increased net sales by $79.8 million. The number of selling days
for the six months ended December 31, 2008 and 2007 were 126 and 125 days,
respectively.
Net sales from our Service Center Based Distribution segment decreased
$48.1 million or 5.2% during the six months ended December 31, 2008 from the
same period in the prior year. Net sales increases from businesses acquired
since the prior year period contributed $11.4 million while our same-store
business saw a $59.5 million decline.
Within the Service Center Based Distribution segment, net sales for our U.S.
based service centers experienced a same-store sales decline of 7.9%. The
Canadian service center business experienced a decline of 1.1%. Unfavorable
foreign currency exchange rates drove net sales down $4.5 million, offsetting a
4.7% increase in local currency. Our Mexican service centers experienced a $12.5
million increase, largely driven by the impact of an acquisition.
Net sales from our Fluid Power Businesses increased $64.8 million or 62.0%
during the six months ended December 31, 2008. The U.S. and Mexican Fluid Power
acquisitions added $68.4 million. On a year-to-date basis, unfavorable foreign
currency translation of the Canadian fluid power businesses offset net sales
increases in local currency of 5.6%. Our same-store U.S. fluid power locations
had slightly lower net sales compared to prior year-to-date.
During the six months ended December 31, 2008, industrial products and fluid
power products accounted for 74.8% and 25.2%, respectively, of net sales as
compared to 80.5% and 19.5%, respectively, for the same period in the prior
year. Acquisitions since the prior year period have concentrated primarily in
the fluid power businesses segment accounting for the majority of the shift in
product mix.
From a geographical perspective, overall net sales from our U.S. operations were
comparable to the same period in the prior year. The $63.6 million of net sales
from our acquisitions offset the decline in the same-store U.S. business. Net
sales from our Canadian operations increased 4.9% in local currency, however,
due to the impact of unfavorable foreign currency exchange rates, reported an
overall net sales decline of 1.0%. Net sales from our Mexico operations
increased $17.7 million which can be primarily attributed to acquisitions.
Our gross profit margin decreased to 26.9% compared to the prior year's 27.3%.
This decline is primarily related to lower purchasing volume which led to lower
supplier purchasing incentives. We continue to experience 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.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
SD&A was 20.6% of net sales in the six months ended December 31, 2008 compared
to 19.9% in the prior year period. In dollars, SD&A increased $10.3 million
compared to the prior year period. Acquisitions added $19.6 million of SD&A in
the current period which includes $3.5 million in new intangibles amortization
expense. Associate compensation and benefits including amounts tied to financial
performance were approximately $16.5 million lower in the current period as
compared to the prior year period, while wages and benefits including healthcare
costs rose approximately $8.5 million.
Interest expense, net for the current period was up $1.7 million. Lower cash
balances and lower interest rates contributed to a reduction in interest income
of $1.8 million for the period. Interest expense was nearly flat compared to the
same period in the prior year.
Other expense, net for the six months ended December 31, 2008 increased
$2.6 million due to a $2.4 million decline in market values of investments held
by non-qualified deferred compensation trusts and $1.6 million of losses on
foreign currency transactions partially offset by a $1.2 million unrealized gain
on the cross-currency swap.
The effective income tax rate was 36.7% for the six months ended December 31,
2008 compared to 37.5% for the six months ended December 31, 2007. The lower
effective tax rate relates primarily to lower effective rates in foreign
jurisdictions.
As a result of the above factors, net income decreased $8.7 million or 18.3%
compared to the same period last year. Earnings per share were $0.90 per share
for the six months ended December 31, 2008, compared to $1.08 in the prior year.
Liquidity and Capital Resources
Cash provided by operating activities for the six months ended December 31, 2008
was $32.5 million. This compares to approximately $50.7 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 decline in cash flow from operations primarily resulted from increased
inventory investment and lower net income (exclusive of the impact of
amortization) of $5.2 million. Partially offsetting these declines were lower
accounts receivable due primarily to lower sales volume.
Cash used in investing activities during the current year of $176.0 million
included $166.0 million paid to acquire FPR in August 2008 and $4.7 million to
acquire Cincinnati Transmission Company in December 2008. Capital expenditures
accounted for an additional $4.3 million, which is $0.5 million below the first
half of fiscal 2008.
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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 provided by financing activities was $97.6 million. In the first half of
fiscal 2009, we borrowed a net $111.0 million under our revolving credit
facility. Borrowings have been used to fund acquisitions and operations. In the
current year, we paid dividends of $12.7 million. Additionally, we repurchased
68,000 shares of treasury stock in the current quarter for $1.2 million. In the
prior year, financing activities utilized $80.3 million of cash, primarily
reflecting (1) repayment of the $50.0 million senior unsecured term notes,
(2) purchases of 710,000 treasury shares for $21.0 million and (3) dividend
payments of $13.0 million.
We have a $150.0 million revolving credit facility with a group of banks
expiring in June 2012. We had $111.0 million of borrowings outstanding under
this facility at December 31, 2008. The average weighted interest rate on the
outstanding balance was 2.2% at December 31, 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 from a variable 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 December 31, 2008, unused lines under this facility, net of
outstanding letters of credit, total $33.9 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 December 31, 2008, there were no outstanding
borrowings under this agreement. In the current borrowing environment, funds
drawn down under this facility would carry interest rates significantly higher
than our current borrowing rates.
Debt classified as long-term includes $50.0 million borrowed under our revolving
credit facility as discussed above. 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 acquired
68,000 shares of common stock in the quarter ended December 31, 2008. At
December 31, 2008, the Company had remaining authorization to repurchase 997,100
additional shares.
Management expects to generate positive cash flow from operations over the next
two quarters which is expected to be used to pay down short-term borrowings.
Management expects that our existing cash, cash equivalents, funds available
under the revolving credit facility, cash provided from operations, and the use
of operating leases will be sufficient to finance normal working capital needs,
payment of dividends, acquisitions, investments in properties, facilities and
equipment, and the purchase of additional Company common stock. Management also
believes that additional long-term debt and line of credit financing could be
obtained based on the Company's credit standing and financial strength, however
at rates significantly higher than the Company is currently paying.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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", "estimated", "expected", "could be" 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.
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 and
elsewhere in this report.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
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