Applied Industrial Technologies - 10-Q quarterly report FY

 

 

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (216) 426-4000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Check One:

Large accelerated filer þ                    Accelerated filer o                    Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Shares of common stock outstanding on January 15, 2007   43,915,121

(No par value)

 

INDEX

PART I: FINANCIAL INFORMATION

ITEM I: Financial Statements

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
(In thousands, except per share amounts)

See notes to condensed consolidated financial statements.

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)

See notes to condensed consolidated financial statements.

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
(In thousands)

See notes to condensed consolidated financial statements.

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts) (Unaudited)

1.    BASIS OF PRESENTATION

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts) (Unaudited)

2.   NEW PRONOUNCEMENTS

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts) (Unaudited)

3.   SEGMENT INFORMATION

A reconciliation from the segment operating profit to the condensed consolidated balances is as follows:

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts) (Unaudited)

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts) (Unaudited)

4.   COMPREHENSIVE INCOME

     The components of comprehensive income are as follows:

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts) (Unaudited)

5.   BENEFIT PLANS

The following table provides summary disclosures of the net periodic benefit costs recognized for the Company’s postemployment benefit plans:

The Company contributed $368 to its pension benefit plans and $31 to its other benefit plans in the six months ended December 31, 2006. Expected contributions for the full fiscal year are $750 for the pension benefit plans and $300 for its other benefit plans.

6.   DEBT

The Company’s $50,000 in senior unsecured term notes mature in December 2007 and have been classified as a current liability as of December 31, 2006.

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The accompanying condensed consolidated financial statements of the Company have been reviewed by the Company’s independent registered public accounting firm, Deloitte & Touche LLP, whose report covering their review of the financial statements follows.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of
Applied Industrial Technologies, Inc.
Cleveland, Ohio

We have reviewed the accompanying condensed consolidated balance sheet of Applied Industrial Technologies, Inc. and subsidiaries (the “Company”) as of December 31, 2006, and the related condensed statements of consolidated income for the three-month and six-month periods ended December 31, 2006 and 2005, and of consolidated cash flows for the six-month periods ended December 31, 2006 and 2005. These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Applied Industrial Technologies, Inc. and subsidiaries as of June 30, 2006, and the related statements of consolidated income, shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated August 18, 2006, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of June 30, 2006 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Deloitte & Touche LLP

Cleveland, Ohio
January 24, 2007

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

The following is Management’s Discussion and Analysis of certain significant factors which have affected the Company’s (1) financial condition at December 31, 2006 and June 30, 2006, and (2) results of operations and cash flows during the periods included in the accompanying Condensed Statements of Consolidated Income and Consolidated Cash Flows.

The Company’s sales, operating income and earnings per share for the three months ended December 31, 2006 increased 3.5%, 14.7% and 25.2%, respectively, compared to the prior year quarter. Gross margin improved 100 basis points to 27.6% as a result of higher than expected supplier purchasing incentives and improved customer pricing.

The balance sheet continues to strengthen with shareholders equity increasing to $436.9 million. The current ratio declined to 2.6 from 3.0 driven largely by $50.8 million in interest bearing debt moving to current liabilities as it matures in December 2007.

The Company monitors the Purchasing Managers Index (PMI) as 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 both the MCU and the PMI index moderated downward. At December 31, 2006, they remain at levels which continue to indicate an expanding economy, albeit at a slower pace. The Company’s performance traditionally lags these key indicators by up to 6 months.

The Company expects sales for the full fiscal year to be in the range of $2.01 billion to $2.04 billion. The expected range for full fiscal year earnings is $1.80 to $1.85 per share.

The Company had 4,604 associates at December 31, 2006 and 4,573 associates at December 31, 2005. The Company had a total of 451 operating facilities at December 31, 2006 and 441 operating facilities at December 31, 2005. These increases are primarily attributable to a business acquired since the prior year period.

Sales during the three months ended December 31, 2006 increased $16.2 million or 3.5% compared to the prior year, reflecting increased sales in both our service center based distribution segment and other businesses. The number of selling days both during the three months ended December 31, 2006 and December 31, 2005 was 61 days.

Sales from our service center based distribution segment increased $10.6 million or 2.6% during the three months ended December 31, 2006 from the same period in the prior year. The increase in sales was driven by the impact of supplier price increases, sales generated by acquired

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

businesses that were not owned in the prior year period, sales mix and the impact of currency fluctuations.

Sales from our other businesses increased $5.6 million or 12.7% during the three months ended December 31, 2006 from the same period in the prior year. The increase between the two periods was due primarily to sales generated by a business acquired since the prior year and increased sales at existing operations.

During the three months ended December 31, 2006, industrial products and fluid power products accounted for 80.7% and 19.3%, respectively, of sales. In comparison, industrial products and fluid power products accounted for 81.4% and 18.6%, respectively, of sales for the same period in the prior year. The increase in the percentage of sales accounted for by fluid power products was primarily a result of the Company’s acquisition of Minnesota Bearings acquired on March 31, 2006.

From a geographical perspective, sales from our Canadian operations increased $5.0 million or 10.6% during the three months ended December 31, 2006 from the same period in the prior year. Favorable currency translation accounted for approximately half of the increase between the two periods. The remaining net sales increase was due to a combination of sales mix and pricing.

Gross profit as a percentage of sales increased to 27.6% from 26.6%. We experienced higher than expected supplier purchasing incentives and some improved customer pricing. Overall the gross profit margin for this quarter is slightly higher than our forecast for the remainder of the year, which remains at approximately 27.0% as our expectations are for supplier purchasing incentives to decline from the levels experienced in the first half of the year.

During the quarter we increased our levels of certain U.S. inventories that are valued using the last-in, first-out (LIFO) method. These inventory increases restored temporary liquidations of LIFO inventory quantities from the first quarter. As required under generally accepted accounting principles, there was no impact on the income statement in either the first or second quarter, as the first quarter liquidation of LIFO inventory quantities was deemed temporary.

Selling, distribution and administrative expenses (“SD&A”) increased during the three months ended December 31, 2006 by $5.0 million or 5.2% over the prior year period and increased as a percentage of sales to 21.4% from 21.1% in the prior year period. The increase in SD&A is primarily attributable to a business acquired since the prior year period and increases in associate compensation and benefits.

Income tax expense as a percentage of income before taxes was 36.1% for the quarter ended December 31, 2006 compared to 37.7% for the quarter ended December 31, 2005. The lower tax rate for the quarter relates primarily to tax adjustments in the prior year and higher levels of tax-free interest income in the current year. The effective tax rate for the remainder of the year is expected to be in the range of 36.0% to 36.5%.

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

As a result of the above factors, net income increased by 21.4% compared to the same quarter of last year. Net income per share increased at a higher rate of 25.2% due to the lower number of shares outstanding.

Sales during the six months ended December 31, 2006 increased $65.6 million or 7.3% compared to the prior year, reflecting increased sales in both our service center based distribution segment and other businesses. The number of selling days during the six months ended December 31, 2006 and 2005 were 124 days and 125 days, respectively.

Sales from our service center based distribution segment increased $39.2 million or 4.8% during the six months ended December 31, 2006 from the same period in the prior year. The increase in sales was driven by the impact of supplier price increases, sales generated by acquired businesses that were not owned for the entire prior year period, sales mix and the impact of currency fluctuations.

Sales from our other businesses increased $26.3 million or 35.4% during the six months ended December 31, 2006 from the same period in the prior year. The majority of the increase between the two periods was due to sales generated by businesses acquired since the prior year period.

During the six months ended December 31, 2006, industrial products and fluid power products accounted for 80.8% and 19.2%, respectively, of sales. In comparison, industrial products and fluid power products accounted for 82.5% and 17.5%, respectively, of sales for the same period in the prior year. The increase in the percentage of sales accounted for by fluid power products was primarily a result of the Company’s acquisition of Spencer Fluid Power on September 30, 2005 and Minnesota Bearings on March 31, 2006.

From a geographical perspective, sales from our Canadian operations increased $11.8 million or 12.6% during the six months ended December 31, 2006 from the same period in the prior year. Favorable currency translation accounted for approximately half of the increase between the two periods. The remaining net sales increase was due to a combination of sales mix and pricing.

Gross profit as a percentage of sales increased to 27.5% for the six months ended December 31, 2006 compared to 27.1% for the comparable period in the prior year. The increase is a result of higher than expected supplier purchasing incentives, lower net freight costs and improved customer pricing. This was offset somewhat by the impact of lower margins of businesses acquired since the prior year. While these businesses continue to be accretive and have solid operating results, their gross margin percentages are lower than the Company average.

SD&A increased during the six months ended December 31, 2006 by $12.3 million or 6.4% over the prior year period, but declined slightly as a percentage of sales to 21.0% from 21.2% in the prior year period. The increase in SD&A is primarily attributable to businesses acquired since the prior year period and increases in associate compensation and benefits, some of which resulted from improved financial performance of the Company.

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

Income tax expense as a percentage of income before taxes was 35.8% for the six months ended December 31, 2006 compared to 37.5% for the six months ended December 31, 2005. The lower tax rate for the period relates primarily to tax adjustments in the prior year and higher levels of tax-free interest income in the current year. The effective tax rate for the remainder of the year is expected to be in the range of 36.0% to 36.5%.

As a result of the above factors, net income increased by 23.5% compared to the same period of last year. Net income per share increased at a higher rate of 27.8% due to the lower number of shares outstanding from the stock buyback program.

Cash provided by operating activities for the six months ended December 31, 2006 was $3.9 million. This compares to approximately $19.1 million used in 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. This improvement in cash flow from operations relates to improved operating income, a decreased level of inventory purchases and reduction in our receivables balance compared to the prior period. In fiscal 2007 we changed how we fund the Company match to the 401(k) plan. We are now contributing cash (which is then used by the administrator to purchase Company stock in the open market) whereas previously we satisfied our obligation by contributing treasury shares. This reduced operating cash flow for the six months ended December 31, 2006 by approximately $3.5 million.

Capital expenditures were $5.4 million for the six months ended December 31, 2006 compared to $4.2 million in the prior year. For the entire year, the Company expects total capital expenditures to be in the range of $10.0 to $12.0 million. Depreciation expense for the entire year is expected to be within the range of $13.0 million to $14.0 million. Share-based compensation and amortization of intangibles and other assets as reported on the condensed statements of consolidated cash flows is expected to be in the range of $5.0 million to $5.5 million for the entire year.

The Company has a $100.0 million revolving credit facility with a group of banks expiring in June 2010. The Company had no borrowings outstanding under this facility at December 31, 2006. Unused lines under this facility, net of outstanding letters of credit, total $94.7 million, and are available to fund future acquisitions or other capital and operating requirements.

The Company has an agreement with Prudential Investment Management, Inc. expiring in February 2007, for an uncommitted shelf facility 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 twelve years. At December 31, 2006, there was no borrowing under this agreement. The Company is evaluating whether to extend or renew this agreement.

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

The Company’s long-term debt matures as follows: $50.0 million due in fiscal 2008 and $25.0 million due in fiscal 2011. The $50.0 million due in fiscal 2008 is due in December 2007 and as such was reclassified as a current liability effective December 31, 2006.

The Board of Directors has authorized the purchase of shares of the Company’s common stock for the purpose of funding benefit programs, stock option and award programs, and future business acquisitions. These purchases may be made in open market and negotiated transactions, from time to time, depending upon market conditions. The Company acquired 520,900 shares of its common stock for $12.4 million during the six months ended December 31, 2006. At December 31, 2006, the Company had remaining authorization to repurchase 979,100 additional shares.

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,” “expectation,” “forecast,” “believe,” “intend,” 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 the Company’s 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 the Company; changes in customer procurement policies and practices; changes in the price 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 the Company’s information systems;

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

the Company’s ability to retain and attract qualified sales and customer service personnel; the Company’s ability to identify and complete future acquisitions, integrate them effectively, and realize their anticipated benefits; disruption of operations at the Company’s headquarters or distribution centers; risks and uncertainties associated with the Company’s 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 the Company’s 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 the Company’s 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, 2006.

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company has evaluated its exposure to various market risk factors, including but not limited to, interest rate, foreign currency exchange and commodity price risks. The Company is primarily affected by market risk exposure through the effects of changes in interest rates and foreign exchange rates.

The Company manages interest rate risk through the use of a combination of fixed rate long-term debt and variable rate borrowings under its committed revolving credit agreement and interest rate swaps. The Company had no variable rate borrowings outstanding under its committed revolving credit agreement at December 31, 2006. The Company has no interest rate swap agreements outstanding. All of the Company’s outstanding debt is currently at fixed interest rates at December 31, 2006 and scheduled for repayment in December 2007 and beyond.

The Company mitigates its foreign currency exposure from the Canadian dollar through the use of cross currency swap agreements as well as foreign-currency denominated debt. Hedging of the U.S. dollar denominated debt, used to fund a substantial portion of the Company’s net investment in its Canadian operations, is accomplished through the use of cross currency swaps. Any gain or loss on the hedging instrument offsets the gain or loss on the underlying debt. Translation exposures with regard to our Mexican business are not hedged because the Mexican activity is not material. For the six months ended December 31, 2006, a uniform 10% strengthening of the U.S. dollar relative to foreign currencies that affect the Company would have resulted in a $0.5 million decrease in net income. A uniform 10% weakening of the U.S. dollar would have resulted in a $0.6 million increase in net income.

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 4: CONTROLS AND PROCEDURES

The Company maintains a set of disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, these officers have concluded that the Company’s disclosure controls and procedures are effective.

During the second quarter of fiscal 2007, there were no material changes in the Company’s internal controls or in other factors that materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.

ITEM 4. Submission of Matters to a Vote of Security Holders.

ITEM 6. Exhibits.

     Applied will furnish a copy of any exhibit described above and not contained herein upon payment of a specified reasonable fee which shall be limited to Applied’s reasonable expenses in furnishing the exhibit.

     Certain instruments with respect to long-term debt have not been filed as exhibits because the total amount of securities authorized under any one of the instruments does not exceed 10 percent of the total assets of Applied and its subsidiaries on a consolidated basis. Applied agrees to furnish to the Securities and Exchange Commission, upon request, a copy of each such instrument.

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

APPLIED INDUSTRIAL TECHNOLOGIES, INC.

EXHIBIT INDEX
TO FORM 10-Q FOR THE QUARTER ENDED DECEMBER 31, 2006