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AIT > SEC Filings for AIT > Form 10-Q on 3-Feb-2014All Recent SEC Filings

Show all filings for APPLIED INDUSTRIAL TECHNOLOGIES INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for APPLIED INDUSTRIAL TECHNOLOGIES INC


3-Feb-2014

Quarterly Report


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

With more than 5,000 associates across North America, Australia and New Zealand, Applied Industrial Technologies ("Applied," the "Company," "We," "Us" or "Our") is a leading industrial distributor serving MRO (Maintenance, Repair & Operations) and OEM (Original Equipment Manufacturer) customers in virtually every industry. In addition, Applied provides engineering, design and systems integration for industrial and fluid power applications, as well as customized mechanical, fabricated rubber and fluid power shop services. Applied also offers maintenance training and inventory management solutions that provide added value to our customers. 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 2014, business was conducted in the United States, Canada, Mexico, Puerto Rico, Australia and New Zealand from 521 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
Sales for the quarter ended December 31, 2013 decreased $7.6 million or 1.3% compared to the prior year quarter, with acquisitions contributing $7.4 million or 1.2%, an unfavorable foreign currency translation of $6.2 million decreasing sales by 1.0% and decreases in sales from our businesses not acquired in the current year of $8.8 million or 1.5%. Operating margin decreased slightly to 6.8% of sales from 6.9% for the prior year quarter driven by an increase in SD&A as a percentage of sales. Net income of $25.9 million decreased 4.2% compared to the prior year quarter. Shareholders' equity was $773.5 million at December 31, 2013, up from the June 30, 2013 level of $759.6 million. The current ratio was 3.0 to 1 at both December 31, 2013 and June 30, 2013.

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.

In the December quarter, Industrial Production increased at an annual rate of 6.8%. The MCU for December was 77.2, up from the September 2013 revised reading of 76.2. The ISM PMI averaged 57.0 in the December quarter, an increase from 56.2 in the September quarter, and above 50 (its expansionary threshold).

The number of Company associates was 5,122 at December 31, 2013, 5,109 at June 30, 2013, and 5,160 at December 31, 2012. The number of operating facilities totaled 521 at December 31, 2013 and 522 at June 30, 2013 and 524 at December 31, 2012.


Table of Contents
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 December 31, 2013 and 2012

The following table is included to aid in review of Applied's condensed
statements of consolidated income.
                               Three Months Ended December 31,
                                  As a Percent of Net Sales        Change in $'s Versus Prior Period
                                   2013                2012                   - % Increase
Net Sales                           100.0 %              100.0 %                              (1.3 )%
Gross Profit                         28.1 %               27.6 %                               0.3  %
Selling, Distribution &
Administrative                       21.2 %               20.8 %                               1.0  %
Operating Income                      6.8 %                6.9 %                              (1.8 )%
Net Income                            4.5 %                4.6 %                              (4.2 )%

During the quarter ended December 31, 2013, sales decreased $7.6 million or 1.3% compared to the prior year quarter, with acquisitions adding $7.4 million or 1.2%, and foreign currency translation decreasing sales by $6.2 million or 1.0%, coupled with declines in sales in businesses not acquired in the current year, primarily in the Service Center Based Distribution segment. There were 62 selling days in the quarter ended December 31, 2013 and the quarter ended December 31, 2012 .

Sales from our Service Center Based Distribution segment, which operates primarily in MRO markets, decreased $14.5 million or 3.0% during the quarter from the same period in the prior year. Acquisitions within this segment increased sales by $6.6 million or 1.4%, unfavorable foreign currency translation losses decreased sales by $5.1 million or 1.1% with the remainder of the decline in sales related to businesses not acquired in the current year.

Sales from our Fluid Power Businesses segment, which operates primarily in OEM markets, increased $7.0 million or 6.4% during the quarter from the same period in the prior year. Acquisitions within this segment increased sales by $0.8 million or 0.7%, we also experienced strong sales growth at several of our Fluid Power Businesses, while unfavorable foreign currency translation losses decreased sales by $1.1 million or 1.0%.

Sales in our U.S. operations were up $1.17 million or 0.2%, with acquisitions adding $6.8 million or 1.4% . Sales from our Canadian operations decreased $6.4 million or 8.6%, with acquisitions adding $0.5 million or 0.7% and an unfavorable foreign currency translation decreasing Canadian sales by $4.1 million or 5.5%. Consolidated sales from our other country operations, which include Mexico, Australia and New Zealand, were $2.4 million or 6.4% below the prior year, with an unfavorable foreign currency translation impact of $2.1 million or 5.6%, contributing most of the decline.

During the quarter ended December 31, 2013, industrial products and fluid power products accounted for 70.0% and 30.0%, respectively, of sales as compared to 72.3% and 27.7%, respectively, for the same period in the prior year.

Our gross profit margin for the quarter was 28.1%, as compared to the prior year's quarter of 27.6%. The increase can largely be attributed to the impact of higher supplier support for U.S. service centers, along with the impact of relatively higher margins from acquisitions.

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 21.2% of sales in the quarter ended December 31, 2013 compared to 20.8% in the prior year quarter. On an absolute basis, SD&A increased $1.2 million or 1.0% compared to the prior year quarter, with acquisitions adding $4.2 million or 3.4%. Net of the acquisition impact we experienced a decline in SD&A costs within our ongoing operations primarily resulting from ongoing cost containment actions to manage overall costs.


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

Operating income decreased 1.8% or $0.7 million, and as a percent of sales decreased to 6.8% from 6.9% during the prior year.

Operating income as a percentage of sales for the Service Center Based Distribution segment decreased to 5.5% in the current year quarter, from 5.9% in the prior year quarter. This decrease is primarily attributable to an increase in SD&A as a percentage of sales, representing a decrease of 1.2%, offset by an increase in gross profit as a percentage of sales, representing an increase of 0.8%.

Operating income as a percentage of sales for the Fluid Power Business segment increased to 8.9% in the current year quarter from 7.9% in the prior year quarter. This increase is primarily attributable to a decrease in SD&A as a percentage of sales, representing an increase of 1.3%, offset by a decrease in gross profit as a percentage of sales, representing a decrease of 0.3%.

Other income was $0.3 million in the quarter which included unrealized gains on investments held by non-qualified deferred compensation trusts of $0.6 million and net unfavorable foreign currency transaction losses of $0.3 million. During the prior year quarter other income was $0.4 million which included net favorable foreign currency transaction gains of $0.3 million, and unrealized gains on investments held by non-qualified deferred compensation trusts of $0.1 million.

The effective income tax rate was 35.6% for the quarter ended December 31, 2013 compared to 34.0% for the quarter ended December 31, 2012. Non-deductible items relating to compensation expense increased the rate by 0.8%, the impact of certain tax losses in our foreign operations increased the rate by 0.4%, and other items increased the rate by 0.4%. 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 decreased $1.1 million or 4.2% compared to the prior year quarter. Net income per share was $0.61 per share for the quarter ended December 31, 2013, compared to $0.64 in the prior year quarter.

Six months Ended December 31, 2013 and 2012

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

                                Six Months Ended December 31,
                                  As a Percent of Net Sales        Change in $'s Versus Prior Period
                                   2013                2012                   - % Increase
Net Sales                           100.0 %              100.0 %                              (1.1 )%
Gross Profit                         28.1 %               27.3 %                               1.7  %
Selling, Distribution &
Administrative                       21.4 %               20.2 %                               4.6  %
Operating Income                      6.7 %                7.1 %                              (6.5 )%
Net Income                            4.4 %                4.7 %                              (6.8 )%

During the six months ended December 31, 2013, sales decreased $12.8 million or 1.1% compared to the same period in the prior year, with acquisitions accounting for $25.1 million or 2.1% and foreign currency translation decreasing sales by $9.6 million or 0.8%, coupled with declines in sales in businesses not acquired in the current year, primarily in the Service Center Based Distribution segment. There were 126 selling days in the period ended December 31, 2013 as compared to 125 in the period ended December 31, 2012.

Sales from our Service Center Based Distribution segment, which operates primarily in MRO markets, decreased $20.3 million or 2.1% during the six months ended December 31, 2013 from the same period in the prior year. Acquisitions within this segment increased sales by $22.3 million or 2.3%, unfavorable foreign currency translation losses decreased sales by $8.4 million or 8.6% with the remainder of the decline in sales related to businesses not acquired in the current year.

Sales from our Fluid Power Businesses segment, which operates primarily in OEM markets, increased $7.5 million or 3.4% during the six months ended December 31, 2013 from the same period in the prior year. Acquisitions within this segment increased sales by $2.8 million or 1.2%, we also experienced strong sales growth at several of our Fluid Power Businesses, while unfavorable foreign currency translation losses decreased sales by $1.5 million or 0.7%.


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 six months ended December 31, 2013, sales in our U.S. operations were up $2.7 million or 0.3% with acquisitions adding $16.6 million or 1.7%. Sales from our Canadian operations decreased $10.8 million or 7.3%, with acquisitions adding $2.3 million or 1.6% and an unfavorable foreign currency translation decreasing Canadian sales by $5.9 million or 4.0%. Consolidated sales from our other country operations, which include Mexico, Australia and New Zealand, were $4.6 million or 6.3% below the prior year with an unfavorable foreign currency translation impact of $3.7 million or 5.0%.

During the six months ended December 31, 2013, industrial products and fluid power products accounted for 70.3% and 29.7%, respectively, of sales as compared to 72.2% and 27.8%, respectively, for the same period in the prior year.

Our gross profit margin for the period was 28.1%, as compared to the prior year quarter of 27.3%. The increase can largely be attributed to the impact of higher supplier support for U.S. service centers, along with the impact of relatively higher margins from acquisitions.

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 21.4% of sales for the six months ended December 31, 2013 compared to 20.2% in the prior year period. On an absolute basis, SD&A increased $11.2 million or 4.6% compared to the prior year period, with acquisitions adding $11.1 million or 4.6%, accounting for almost the entire increase.

Operating income decreased 6.5% or $5.5 million, and as a percent of sales decreased to 6.7% from 7.1% during the prior year period. The period decrease in operating margin primarily reflects higher SD&A levels which increased as a percent of sales to 21.4% versus 20.2% in the same period of fiscal 2013, offset by increases in gross profit margin to 28.1% versus 27.3% in the same period in fiscal 2013.

Operating income as a percentage of sales for the Service Center Based Distribution segment decreased to 5.6% in the current year period, from 6.3% in the prior year period. This decrease is primarily attributable to an increase in SD&A as a percentage of sales, representing a decrease of 1.3%, offset by an increase in gross profit as a percentage of sales, representing an increase of 0.6%.

Operating income as a percentage of sales for the Fluid Power Business segment remained stable at 8.6% in the current year period and in the prior year period.

Other income was $1.4 million in the period which included unrealized gains on investments held by non-qualified deferred compensation trusts of $1.2 million and net unfavorable foreign currency transaction losses of $0.9 million as well as $1.2 million in income from the elimination of the one-month Canadian reporting lag. During the prior year period other income was $0.9 million which included unrealized gains on investments held by non-qualified deferred compensation trusts of $0.6 million and net favorable foreign currency transaction gains of $0.4 million.

The effective income tax rate was 34.7% for the six month period ended December 31, 2013 compared to 34.0% for the six month period ended December 31, 2012. Non-deductible executive compensation increased the rate by 0.5%, the impact of certain tax losses in our foreign operations increased the rate by 0.3%. 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 decreased $3.8 million or 6.8% compared to the prior year period. Net income per share was $1.24 per share for the six month period ended December 31, 2013, compared to $1.33 in the prior year 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

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 December 31, 2013, we had $15.0 million in outstanding borrowings. At December 31, 2012, we had $33.0 million in 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 holds, from time to time, relatively significant cash and cash equivalent balances outside of the United States. The following table shows the Company's total cash as of December 31, 2013 by geographic location.

    Country        Amount
United States     $ 10,451
Canada              50,092
Other countries      6,041
          Total   $ 66,584

To the extent cash in foreign countries is distributed to the U.S., it could become subject to U.S. income taxes. Foreign tax credits may be available to offset all or a portion of such taxes. For financial reporting purposes, the Company has provided for $2.8 million of U.S. income taxes on approximately $11.0 million of undistributed earnings from Canada.

The Company's working capital at December 31, 2013 was $499.6 million, compared to $491.4 million at June 30, 2013. The current ratio was 3.0 to 1 at both December 31, 2013 and June 30, 2013.

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.
                                            Six Months Ended December 31,
Net Cash Provided by (Used in):               2013                2012
Operating Activities                    $      32,663       $        28,886
Investing Activities                          (20,802 )             (72,469 )
Financing Activities                          (17,187 )              15,376
Exchange Rate Effect                           (1,254 )               1,610
Decrease in Cash and Cash Equivalents   $      (6,580 )     $       (26,597 )

Net cash provided by operating activities was $32.7 million for the six months ended December 31, 2013 as compared to $28.9 million for the same period a year ago. The improvement in operating cash was due to a smaller amount of cash being invested in working capital compared to the prior period.

Net cash used in investing activities during the six months ended December 31, 2013 was $20.8 million; $4.1 million was used for capital expenditures and $17.0 million for acquisitions. These uses of cash were partially offset by $0.3 million of proceeds from property sales. In the six months ended December 31, 2012, investing activities used $72.5 million including $66.1 million for acquisitions and $6.8 million for capital expenditures. These uses of cash were partially offset by $0.4 million of proceeds from property sales.

Net cash used in financing activities was $17.2 million for the six months ended December 31, 2013. Financing activities included $19.5 million used to pay dividends, $1.0 million used to make acquisition holdback payments and $13.8 million used for the purchase of treasury shares, offset by $15.0 million borrowed under the revolving credit facility, and $2.1 million from tax benefits from share based compensation. During the same period in the prior year, financing activities provided $15.4 million of cash; $33.0 million borrowed under the revolving credit facility, $1.5 million from tax benefits from share based compensation offset by dividends paid of $17.7 million, and acquisition holdback payments of $1.8 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 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 have deployed our solution in a portion of our Canadian and U.S. operations. U.S. deployments have continued in the first and second quarter with further deployments planned for the remainder of fiscal 2014, we expect to complete our U.S. deployments in fiscal 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 acquired 226,100 shares of treasury stock in the three months ended December 31, 2013 for $10.8 million. Through the six months ended December 31, 2013 we acquired 286,800 shares of treasury stock for $13.8 million. At December 31, 2013, we had authorization to repurchase an additional 854,700 shares. During the six months ended December 31, 2012, we did not acquire any shares of treasury stock.

Borrowing Arrangements
The Company has a five-year committed revolving credit agreement that expires in May 2017. This agreement provides for unsecured borrowings of up to $150.0 million. We had borrowings outstanding under our revolving credit agreements of $15 million at December 31, 2013 and $33.0 million at December 31, 2012. At December 31, 2013 unused lines under this facility, net of outstanding letters of credit, totaled $126.4 million and were available to fund future acquisitions or other capital and operating requirements. Borrowings under this agreement are at variable interest rates tied to either LIBOR, prime, or the bank's cost of funds.

We also have an uncommitted long-term financing shelf facility which expires in February 2016 and enables us to borrow up to $125.0 million with terms of up to fifteen years. At December 31, 2013 we had no outstanding borrowings under this facility.

Accounts Receivable Analysis
The following table is included to aid in analysis of accounts receivable and
the associated provision for losses on accounts receivable:
                                                     December 31,              June 30,
                                                         2013                    2013
Accounts receivable, gross                     $              313,271    $          337,617
Allowance for doubtful accounts                                 7,335                 7,737
Accounts receivable, net                       $              305,936    $          329,880
Allowance for doubtful accounts, % of gross
receivables                                                       2.3 %                 2.3 %

                                                   For the six months ended December 31,
                                                         2013                    2012
Provision for losses on accounts receivable    $                  357    $              604
Provision as a % of net sales                                    0.03 %                0.05 %

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 December 31, 2013 versus 46.4 at June 30, 2013. Accounts receivable decreased 7.3% this year, compared to a 1.1% decrease in sales in the six months ended December 31, 2013. We primarily attribute the increase in DSO to higher sales to large contract accounts as well as locations undergoing the ERP transformation. We expect increases at locations converted to our new ERP system to return to a normal state as the ERP transformation matures.


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

Less than 3.6% of our accounts receivable balances are more than 90 days past due. On an overall basis, our provision for losses from uncollected receivables represents 0.03% of our sales in the six months ended December 31, 2013. Historically, this percentage is around 0.15%. Our loss experience continues to be favorable in fiscal 2014. Management believes the overall receivables aging and provision for losses on uncollected receivables are at reasonable levels.

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. We have temporarily increased inventory levels within our U.S. Service Center network to ensure that we have no customer service disruptions due to our ERP transformation. The annualized inventory turnover for the period ended December 31, 2013 was 3.7 versus 4.1 at June 30, 2013. We believe our inventory turnover ratio at the end of the year, will be slightly lower than the fiscal 2013 levels.


Table of Contents
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, contains statements that are forward-looking, based on management's current expectations about the future. Forward-looking statements are often identified by qualifiers, such as . . .

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