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, mechanical and fabricated rubber services. As an
authorized distributor for more than 2,000 manufacturers, we offer access to
approximately 3 million stock keeping units ("SKUs"). A large portion of our
business is selling replacement parts to manufacturers and other industrial
concerns for repair or maintenance of machinery and equipment. We have a long
tradition of growth dating back to 1923, the year our business was founded in
Cleveland, Ohio. During the third quarter of fiscal 2009, business was conducted
in the United States, Canada, Mexico and Puerto Rico from 470 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. 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 March 31, 2009 decreased
$78.5 million or 14.8% compared to the prior year quarter as declines in
same-store business were only partially offset by net sales from businesses
acquired. Operating margin declined to 4.7% of net sales from 7.1% and net
income decreased $12.0 million or 51.0% compared to the prior year quarter.
Shareholders' equity at March 31, 2009 was $505.3 million. The current ratio
moved to 2.7-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 rebounded to 36.3 from December's low of 32.9 which is still at
a level which indicates contraction in the overall economy. The MCU continued to
decline. 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 four quarters as these indices have seen declines, we have experienced
same-store sales declines. For instance, our U.S. service center same-store
sales have reflected an increased decline during this time period. U.S. service
center same-store sales for each of the last four quarters compared to the prior
year quarters were down as follows: for the June 2008 quarter 2%, for the
September 2008 quarter 3%, for the December 2008 quarter 13% and for the
March 2009 quarter 23%. We believe we will continue to experience a softening in
sales until we see the MCU level-off or begin to rise. The PMI and MCU indices
indicate some further softening of sales can be expected. In our second 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 4,893 at March 31, 2009, 5,203 at
December 31, 2008, 4,831 at June 30, 2008, and 4,649 at March 31, 2008. Our
operating facilities totaled 470 at March 31, 2009, 474 at December 31, 2008,
459 as of June 30, 2008, and 451 at March 31, 2008. We have taken measures to
reduce associate costs including elimination of positions, reductions in
scheduled work hours and deferral of replacements for normal associate
attrition. The number of associates employed as adjusted to reflect an
equivalent full-time work status ("full-time equivalent") at March 31, 2009 is
about 9% lower than the same measure at December 31, 2008.
As of March 31, 2009, we had $96.9 million of goodwill ($60.5 million in the
Service Center Based Distribution segment and $36.4 million in the Fluid Power
Businesses segment) representing the costs of acquisitions in excess of fair
values assigned to the underlying net assets of acquired companies. Evaluating
for impairment requires significant judgment by management, including estimated
future operating results, estimated future cash flows, the long-term rate of
growth of our business, and determination of an appropriate discount rate. While
we use available information to prepare the estimates and evaluations, actual
results could differ significantly. For example, a worsening of economic
conditions beyond those assumed in an impairment analysis could impact the
estimates of future growth and result in an impairment charge in a future
period. Any resulting impairment charge could be viewed as having a material
adverse impact on our financial condition and results of operations. The annual
impairment testing was performed during the third quarter, at which time
management concluded there was no indication of goodwill impairment based on the
"Step One" test from SFAS 142. In conjunction with our impairment testing, we
determined that a hypothetical decrease of approximately 10% in the estimated
fair value of our Fluid Power Businesses segment would trigger the need to
perform the "Step Two" test under SFAS 142 to determine possible impairment. The
resulting impairment charge, if any, based on "Step Two" testing could be viewed
as material to our results of operations. We believe an impairment charge would
not significantly impact our cash flow or ability to borrow under our present
borrowing arrangements.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations
Three Months Ended March 31, 2009 and 2008
During the quarter ended March 31, 2009, net sales decreased $78.5 million or
14.8% 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 approximately $42.6 million. The number of selling days for the
quarters ended March 31, 2009 and 2008 were 63 and 63.5 days, respectively.
Net sales from our Service Center Based Distribution segment decreased
$101.8 million or 21.5% during the quarter ended March 31, 2009 from the same
period in the prior year. Net sales from businesses acquired since the prior
year period contributed $5.1 million, while our same-store business saw a net
decline of $106.9 million or 22.6%.
Net sales from our Fluid Power Businesses segment increased $23.3 million or
40.4% during the quarter from the same period in the prior year. Our recent
acquisitions added $37.5 million while our same-store business declined
$14.2 million or 24.6%.
During the quarter ended March 31, 2009, industrial products and fluid power
products accounted for 73.0% and 27.0%, respectively, of net sales as compared
to 79.8% and 20.2%, respectively, for the same period in the prior year.
Acquisitions since the prior year period have been primarily in our Fluid Power
Businesses segment, accounting for a majority of the shift in product mix.
From a geographical perspective, net sales from our U.S. operations were down
$73.0 million or 15.5% during the quarter ended March 31, 2009 from the same
period in the prior year. While acquisitions added $38.9 million or 8.3% to net
sales, they were unable to offset declines in the same-store U.S. business. Net
sales from our Canadian operations decreased $8.4 million or 16.4%. Unfavorable
foreign currency fluctuations drove net sales down $9.6 million, offsetting the
net sales increase of 2.4% in local currency which is down from a 7.3% increase
in local currency in the quarter ended December 31, 2008. Net sales from our
Mexican operations increased $2.9 million or 39.3%; driven primarily by sales
from businesses acquired since the prior year period.
Our gross profit margin decreased to 27.1% compared to the prior year's 27.3%.
This decline is primarily related to price competitiveness in the market place
and the on-going challenges of passing on supplier price increases to our large
contractual customers.
Selling, distribution and administrative expense ("SD&A") was 22.4% of net sales
in the quarter ended March 31, 2009 compared to 20.1% in the prior year quarter.
In dollars, SD&A decreased $5.6 million compared to the prior year quarter.
Acquisitions added $13.0 million of SD&A in the current quarter, including
additional amortization expense of $2.4 million. Associate compensation and
benefits including amounts tied to financial performance were approximately
$11.7 million lower in the current quarter as compared to the prior year
quarter. During the quarter, we reviewed our operations and reduced staff and
hours worked, resulting in a reduction of wage and benefit costs for the quarter
of $1.7 million. Foreign currency translation and reduced discretionary spending
account for the majority of the remaining decrease.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Interest expense, net for the current quarter increased $0.9 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 $0.5 million for the
quarter. Interest expense increased $0.4 million from the prior year quarter due
to higher average borrowings.
The effective income tax rate was 41.5% for the quarter ended March 31, 2009
compared to 36.7% for the quarter ended March 31, 2008. During the quarter, we
provided for U.S. income tax expense in the amount of $0.5 million (or 2.5%
impact on the effective income tax rate) on undistributed earnings no longer
considered permanently reinvested in our Canadian subsidiaries. Additionally,
current estimates for full year earnings have a higher proportion of
consolidated income derived from U.S. operations which bear a higher tax burden
than our foreign operations.
As a result of the above factors, net income decreased $12.0 million or 51.0%
compared to the prior year quarter. Net income per share was $0.27 per share for
the quarter ended March 31, 2009, compared to $0.55 in the prior year quarter.
Nine Months Ended March 31, 2009 and 2008
During the nine months ended March 31, 2009, net sales decreased $61.7 million
or 4.0% compared to the prior year. Net sales from companies acquired since the
prior year nine month period increased net sales by approximately $122.3 million
while same-store sales declined $184.0 million or 11.8%. The majority of the
decline in consolidated same-store sales was in the U.S. Sales in Canada and
Mexico as measured in local currency were up slightly over the prior year
period. Currency translation however lowered sales as measured in U.S. dollars
by $19.8 million. The number of selling days for the nine months ended March 31,
2009 and 2008 were 189 and 188.5 days, respectively.
Net sales from our Service Center Based Distribution segment decreased
$149.8 million or 10.7% during the nine months ended March 31, 2009 from the
same period in the prior year. Net sales increases from businesses acquired
since the prior year period contributed $16.4 million while our same-store
business saw a $166.2 million or 11.9% decline.
Net sales from our Fluid Power Businesses segment increased $88.1 million or
54.3% during the nine months ended March 31, 2009. The U.S. and Mexican fluid
power acquisitions added $105.9 million or 65.3% while our same-store business
saw a $17.8 million or 11.0% decline.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
During the nine months ended March 31, 2009, industrial products and fluid power
products accounted for 74.3% and 25.7%, respectively, of net sales as compared
to 80.3% and 19.7%, 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
down $72.8 million or 5.3% when compared to the same period in the prior year.
While acquisitions added $107.7 million or 7.8% to net sales, they were only
partially able to offset the decline in the same-store U.S. business. Net sales
from our Canadian operations increased 4.1% in local currency, however, due to
the impact of unfavorable foreign currency exchange rates, reported an overall
net sales decline of 5.9%. Net sales from our Mexico operations increased
$20.6 million which can be primarily attributed to acquisitions.
Our gross profit margin decreased to 27.0% compared to the prior year's 27.3%.
This decline is primarily related to the on-going challenges of passing on
supplier price increases to our large contractual customers as well as the
increasing price competitiveness in the market place.
SD&A was 21.1% of net sales in the nine months ended March 31, 2009 compared to
20.0% in the prior year period. In dollars, SD&A increased $4.7 million compared
to the prior year period. Acquisitions added $32.6 million of SD&A in the
current period including additional amortization expense of $5.9 million.
Associate compensation and benefits including amounts tied to financial
performance were approximately $28.2 million lower in the current period as
compared to the prior year period, while wages and benefits including healthcare
costs and severance expenses rose approximately $7.9 million. Foreign currency
translation and reduced discretionary spending account for the majority of the
remaining decrease.
Interest expense, net for the nine months ended March 31, 2009 was up
$2.7 million. Lower cash balances and lower interest rates contributed to a
reduction in interest income of $2.3 million for the period. Interest expense
was up $0.4 million compared to the same period in the prior year due to higher
average borrowings.
Other expense, net for the nine months ended March 31, 2009 was $3.1 million and
included a $2.6 million decline in market values of investments held by
non-qualified deferred compensation trusts and $2.0 million of losses on foreign
currency transactions partially offset by a $1.5 million unrealized gain on the
cross-currency swap.
The effective income tax rate was 37.8% for the nine months ended March 31, 2009
compared to 37.2% for the nine months ended March 31, 2008. The increase in the
effective tax rate can be primarily attributed to provision for U.S. tax expense
of $0.5 million (or 0.6% impact on the effective income tax rate) on
undistributed earnings no longer considered permanently reinvested in our
Canadian subsidiaries and higher effective state tax rates compared to the prior
year.
As a result of the above factors, net income decreased $20.7 million or 29.2%
compared to the same period last year. Net income per share was $1.17 per share
for the nine months ended March 31, 2009, compared to $1.62 in the prior year.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
Net cash provided by operating activities for the nine months ended March 31,
2009 was $54.5 million. This compares to $62.0 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 lower net
income (exclusive of the impact of amortization) of $14.9 million, lower
accounts payable due to lower purchasing volume and increased inventory
investment. Partially offsetting these declines were lower accounts receivable
due primarily to lower sales volume.
Net cash used in investing activities during the current year of $177.1 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 $5.4 million, which is $0.7 million below
year-to-date fiscal 2008.
Net cash provided by financing activities was $79.2 million. Year-to-date in
fiscal 2009, we borrowed a net $100.0 million under our revolving credit
facility. Borrowings have been used to fund acquisitions and operations. In the
current year, we paid dividends of $19.0 million. We did not repurchase shares
of treasury stock in the current quarter, but year-to-date, we repurchased
$1.2 million in treasury shares. In the prior year, financing activities
utilized $98.0 million of cash, primarily including the repayment of
$50.0 million senior unsecured term notes, purchase of 1.1 million treasury
shares for $33.2 million, and dividend payments of $19.4 million.
We have a $150.0 million revolving credit facility with a group of banks
expiring in June 2012. We had $100.0 million of borrowings outstanding under
this facility at March 31, 2009. The weighted average interest rate on the
outstanding balance was 2.1% at March 31, 2009. In September 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 a
one-month LIBOR borrowing option. At March 31, 2009, unused lines under this
facility, net of outstanding letters of credit, total $44.9 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 March 31, 2009, 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.
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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 did not
acquire shares of common stock in the quarter ended March 31, 2009. At March 31,
2009, the Company had remaining authorization to repurchase 997,100 additional
shares.
Management expects to generate positive cash flow from operations over the next
quarter 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.
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", "would be", "believe" "will",
"should" 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; the impact of current economic conditions on the collectibility of
trade receivables; 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; 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 on reasonable terms; the potential for
goodwill impairment; changes in accounting policies and practices; risks related
to legal proceedings to which we are a party; 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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