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AIT > SEC Filings for AIT > Form 10-Q on 1-Nov-2012All Recent SEC Filings

Show all filings for APPLIED INDUSTRIAL TECHNOLOGIES INC

Form 10-Q for APPLIED INDUSTRIAL TECHNOLOGIES INC


1-Nov-2012

Quarterly Report


ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Applied Industrial Technologies ("Applied," the "Company," "We," "Us" or "Our") is a leading industrial distributor serving MRO, OEM and government markets. Applied is an authorized source for a diverse range of products, including bearings, power transmission components, fluid power components and systems, industrial rubber products, linear motion components, tools, safety products, and general maintenance and mill supply products. The Company also provides customized shop services for mechanical, fabricated rubber and fluid power products, as well as services to meet storeroom management and maintenance training needs. 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 2013, business was conducted in the United States, Canada, Mexico, Puerto Rico, Australia and New Zealand from 517 facilities.

The following is Management's Discussion and Analysis of significant factors which have affected our financial condition, results of operations and cash flows during the periods included in the accompanying condensed statements of consolidated income, consolidated comprehensive 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 necessarily sold in the comparable period of the prior year, resulting in the inability to quantify certain commonly used comparative metrics analyzing sales, such as changes in product mix and volume.

Overview
Consolidated sales for the quarter ended September 30, 2012 increased $30.9 million or 5.3% compared to the prior year quarter, with acquisitions contributing $19.5 million or 3.4% and an unfavorable foreign currency translation of $5.8 million reducing sales by 1.0%. Operating margin decreased to 7.3% of sales from 7.5% for the prior year quarter largely driven by a decrease in our gross margin. Net income of $29.5 million increased 11.9% compared to the prior year quarter. Shareholders' equity was $703.1 million at September 30, 2012, up from the June 30, 2012 level of $672.1 million. The current ratio was 2.8 to 1 at September 30, 2012 and 2.9 to 1 at June 30, 2012.

Applied monitors several economic indices that have been key indicators for industrial economic activity in the United States. These include the Industrial Production and Manufacturing Capacity Utilization (MCU) indices published by the Federal Reserve Board and the Purchasing Managers Index (PMI) published by the Institute for Supply Management (ISM). Historically, our performance correlates well with the MCU, which measures productivity and calculates a ratio of actual manufacturing output versus potential full capacity output. When manufacturing plants are running at a high rate of capacity, they tend to wear out machinery and require replacement parts. Our sales tend to lag the MCU by up to six months.

In the September quarter, Industrial Production declined at an annual rate of .4%. The MCU for September was 76.8, down from the June 2012 reading of 77.5. The ISM PMI averaged 51.5 in the September quarter, an improvement from 49.7 in the June quarter, and above 50 (its expansionary threshold).

The number of Company associates was 4,868 at September 30, 2012, 4,664 at June 30, 2012, and 4,686 at September 30, 2011. The number of operating facilities totaled 517 at September 30, 2012 and 476 at June 30, 2012.

Results of Operations

Three Months Ended September 30, 2012 and 2011

The following table is included to aid in review of Applied's condensed
statements of consolidated income.

                                    Three Months Ended September 30,               Change in $'s
                                                                                    Versus Prior
                                       As a Percent of Net Sales                      Period %
                                       2012                  2011                     Increase
Net Sales                                100.0 %                100.0 %                     5.3 %
Gross Profit                              26.9 %                 27.4 %                     3.7 %
Selling, Distribution &
Administrative                            19.7 %                 19.9 %                     4.1 %
Operating Income                           7.3 %                  7.5 %                     2.4 %
Net Income                                 4.8 %                  4.6 %                    11.9 %


Table of Contents
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

During the quarter ended September 30, 2012, sales increased $30.9 million or 5.3% compared to the prior year quarter, with acquisitions accounting for $19.5 million or 3.4%, and foreign currency translation decreasing sales by $5.8 million or 1.0%. There were 63 selling days in the quarter ended September 30, 2012 versus 64 selling days in the quarter ended September 30, 2011.

Sales from our Service Center Based Distribution segment, which, operates primarily in MRO markets, increased $34.0 million or 7.3% during the quarter from the same period in the prior year, primarily attributed to expansion in the industrial economy. Acquisitions within this segment increased sales by $19.5 million or 4.2%.

Sales from our Fluid Power Businesses segment, which operates primarily in OEM markets, decreased $3.0 million or 2.6% during the quarter from the same period in the prior year, primarily attributed to weakness within one of our Fluid Power Businesses.

Sales in our U.S. operations were up $12.1 million or 2.5% with acquisitions adding $0.3 million or 0.1% . Sales from our Canadian operations increased $0.6 million or 0.9%, with acquisitions adding $4.7 million or 6.4% and an unfavorable foreign currency translation decreasing Canadian sales by $2.8 million or 3.9%. Consolidated sales from our other country operations, which include Mexico, Australia and New Zealand, were $18.2 million or 98.0% above the prior year. 20.0% of this increase, or $3.7 million relates to our Mexican operations. This increase consisted of a $6.7 million increase in local currency sales partially offset by an unfavorable foreign currency translation of $3.0 million .

During the quarter ended September 30, 2012, industrial products and fluid power products accounted for 72.1% and 27.9%, respectively, of sales as compared to 70.6% and 29.4%, respectively, for the same period in the prior year.

Our gross profit margin for the quarter was 26.9%, as compared to the prior year's quarter of 27.4%. The slight decrease can largely be attributed to small margin decreases from competitive pressures in the Service Center Based Distribution and Fluid Power businesses.

Selling, distribution and administrative expense (SD&A) consists of associate compensation, benefits and other expenses associated with selling, purchasing, warehousing, supply chain management and providing marketing and distribution of the Company's products, as well as costs associated with a variety of administrative functions such as human resources, information technology, treasury, accounting, legal, and facility related expenses. SD&A was 19.7% of sales in the quarter ended September 30, 2012 compared to 19.9% in the prior year quarter. On an absolute basis, SD&A increased $4.8 million or 4.1% compared to the prior year quarter. Acquisitions have contributed a $5.7 million increase in SD&A expenses. ERP project spending in 2013 is in line with our estimates.

Operating income increased 2.4% or $1.1 million, and as a percent of sales decreased to 7.3% from 7.5% during the prior year quarter. The quarterly increase in operating income primarily reflects higher sales levels. The decline in the operating margin percentage is driven by a lower gross margin percentage in the quarter offset somewhat by improved leverage of our SD&A expenses over a larger base, as we lowered our SD&A as a percent of sales to 19.7% versus 19.9% in the first quarter of fiscal 2012.

Operating income as a percentage of sales for the Service Center Based Distribution segment increased to 6.8% in the current year quarter, from 6.3% in the prior year quarter. This increase is primarily attributable to higher sales levels without a commensurate increase in SD&A. SD&A as a percentage of sales has decreased (representing a 0.4% decrease as a percentage of sales).

The Fluid Power Businesses operating margins decreased to 9.3% in the current year quarter from 9.7% in the prior year quarter. While the segment experienced a decline in sales from the prior year quarter, it also reduced its SD&A to a level commensurate with the lower sales level. The reduction in operating margin is attributable to a 0.4% gross profit margin decline as a percentage of sales.

Other income was $0.5 million in the quarter which included unrealized gains on investments held by non-qualified deferred compensation trusts of $0.4 million and net favorable foreign currency transaction gains of $0.1 million. During the prior year quarter other expense was $1.9 million which included unrealized losses on investments held by non-qualified deferred compensation trusts of $1.4 million and net unfavorable foreign currency transaction losses of $0.5 million.


Table of Contents
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The effective income tax rate was 34.0% for the quarter ended September 30, 2012 compared to 36.1% for the quarter ended September 30, 2011. The impact of lower effective tax rates in foreign jurisdictions favorably reduced our rate when compared to the U.S. federal statutory rate by approximately 2.3% in the quarter. We expect our full year tax rate to be in the 34.0% to 34.5% range.

As a result of the factors addressed above, net income increased $3.2 million or 11.9% compared to the prior year quarter. Net income per share was $0.70 per share for the quarter ended September 30, 2012, compared to $0.61 in the prior year quarter.

Liquidity and Capital Resources

Our primary source of capital is cash flow from operations, supplemented as necessary by bank borrowings or other sources of debt. At September 30, 2012 and at September 30, 2011, we had no outstanding 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 in each of the countries we operate in, 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.

The Company's working capital at September 30, 2012 was $445.1 million, compared to $435.6 million at June 30, 2012. The current ratio was 2.8 to 1 at September 30, 2012 and 2.9 to 1 at June 30, 2012.

In the first quarter, the Company acquired SKF's company-owned distribution businesses in Australia and New Zealand for cash consideration. The Company funded this acquisition from its available cash.

Net Cash Flows
The following table is included to aid in review of Applied's condensed
statements of consolidated cash flows; all amounts are in thousands.
                                           Three Months Ended September 30,
Net Cash Provided by (Used in):                2012                 2011
Operating Activities                    $        23,947       $        16,401
Investing Activities                            (39,058 )              (7,746 )
Financing Activities                             (8,423 )             (26,044 )
Exchange Rate Effect                              1,765                  (485 )
Decrease in Cash and Cash Equivalents   $       (21,769 )     $       (17,874 )

Net cash provided by operating activities was $23.9 million for the three months ended September 30, 2012 as compared to $16.4 million for the same period a year ago. Improved net income generated $3.2 million of operating cash flow with the remainder being generated by lower increases in working capital.

Net cash used in investing activities during the three months ended September 30, 2012 was $39.1 million; $3.9 million was used for capital expenditures (including capitalized costs associated with our ERP project) and $35.4 million for acquisitions. These uses of cash were partially offset by $0.2 million of proceeds from property sales. In the three months ended September 30, 2011, investing activities used $7.7 million including $1.2 million for acquisitions and $7.1 million for capital expenditures. These uses of cash were partially offset by $0.6 million of proceeds from property sales.

Net cash used in financing activities was $8.4 million for the three months ended September 30, 2012. Financing activities included $8.9 million used to pay dividends as well as $0.8 million for acquisition holdback payments, offset by $1.2 million from tax benefits from share based compensation. During the same period in the prior year, financing activities used $26.0 million of cash; repurchases of 640,000 shares of treasury stock were for $18.2 million and paid dividends used $8.1 million.


Table of Contents
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ERP Project
In the second quarter of fiscal 2011, Applied commenced its ERP (SAP) project to transform the Company's technology platforms and enhance its business information and transaction systems for future growth. We continue to expect spending in fiscal year 2013 to reach $19.0 million to $21.0 million ($4.0 million to $5.0 million capital and $15.0 million to $16.0 million expense). We have deployed our solution in a portion of our Canadian operations. U.S. deployments have started in the second quarter with further deployments planned for fiscal 2013 and 2014.

Share Repurchases
The Board of Directors has authorized the repurchase 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 any shares of treasury stock in the three months ended September 30, 2012. At September 30, 2012, we had authorization to repurchase an additional 1,142,800 shares. During the three months ended September 30, 2011, we acquired 640,000 shares of treasury stock for $18.2 million.

Borrowing Arrangements
We have a $150.0 million revolving credit facility with a group of banks expiring in May 2017. There are no borrowings outstanding under this facility at September 30, 2012. At September 30, 2012, unused capacity under this facility, net of outstanding letters of credit, was $140.9 million and is available to fund future acquisitions or other capital and operating requirements.

We also have an uncommitted long-term financing shelf facility which expires in February 2013 and enables us to borrow up to $100.0 million with terms of up to fifteen years. At September 30, 2012, there were no outstanding borrowings under this agreement.

Accounts Receivable Analysis
The following table is included to aid in analysis of accounts receivable and
the associated provision for losses on accounts receivable:
                                                     September 30,               June 30,
                                                          2012                     2012
Accounts receivable,
gross                                         $                 333,992    $           315,375
Allowance for doubtful accounts                                   8,239                  8,332
Accounts receivable, net                      $                 325,753    $           307,043
Allowance for doubtful accounts, % of gross
receivables                                                         2.5 %                  2.6 %

                                                   For the three months ended September 30,
                                                          2012                     2011
Provision for losses on accounts receivable   $                     224    $               819
Provision as a % of
net sales                                                          0.04 %                  0.1 %

Accounts receivable are reported at net realizable value and consist of trade receivables from customers. Management monitors accounts receivable by reviewing Days Sales Outstanding (DSO) and the aging of receivables for each of the Company's locations.

On a consolidated basis, DSO was 47.3 at September 30, 2012 versus 45.2 at June 30, 2012. Accounts receivable increased 6.1% this year, compared to a 5.3% increase in sales in the three months ended September 30, 2012. We primarily attribute the increase in DSO to higher sales to large contract accounts.

Less than 1.7% of our accounts receivable balances are more than 90 days past due. On an overall basis, our provision for losses from uncollected receivables represents 0.04% of our sales in the three months ended September 30, 2012. Historically, this percentage is around 0.15%. Management believes the overall receivables aging and provision for losses on uncollected receivables are at reasonable levels.


Table of Contents
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Inventory Analysis
Inventories are valued at the lower of cost or market, using the last-in, first-out (LIFO) method for U.S. inventories and the average cost method for foreign inventories. Management uses an inventory turnover ratio to monitor and evaluate inventory. Management calculates this ratio on an annual as well as a quarterly basis and uses inventory valued at current costs. The annualized inventory turnover for the period ended September 30, 2012 was 4.4 versus 4.6 at June 30, 2012. We believe our inventory turnover ratio in fiscal 2013 will remain similar to the fiscal 2012 levels.

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 "expect," "believe," "plan," "intend," "will," "should," "could," "would," "anticipate," "estimate," "forecast," "may," and derivative or similar words or 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 our customers and the economic factors that affect them; risks and uncertainties associated with executing our strategic business plan; changes in the prices for products and services relative to the cost of providing them; reduction in supplier inventory purchase incentives; loss of key supplier authorizations, lack of product availability, or changes in supplier distribution programs; the cost of products and energy and other operating costs; changes in customer preferences for products and services of the nature and brands sold by us; changes in customer procurement policies and practices; competitive pressures; our reliance on information systems; our ability to implement our ERP system in a timely, cost-effective, and competent manner, and to capture its planned benefits while maintaining an adequate internal control environment; the impact of economic conditions on the collectability 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; our ability to retain and attract qualified sales and customer service personnel and other skilled professionals; our ability to identify and complete acquisitions, integrate them effectively, and realize their anticipated benefits; 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; disruption of operations at our headquarters or distribution centers; risks and uncertainties associated with our foreign operations, including volatile economic conditions, political instability, cultural and legal differences, and currency exchange fluctuations; the potential for goodwill and intangible asset impairment; changes in accounting policies and practices; organizational changes within the Company; the volatility of our stock price and the resulting impact on our consolidated financial statements; risks related to legal proceedings to which we are a party; adverse regulation and legislation, including potential changes in tax regulations (e.g., those affecting the use of the LIFO inventory accounting method and the taxation of foreign-sourced income); 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 discuss certain of these matters more fully in our Annual Report on Form 10-K for the year ended June 30, 2012 .


APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES

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