10-K 1 ait-2014630x10k.htm 10-K AIT-2014.6.30-10K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[X]
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2014, or

[ ]
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     

Commission file number 1-2299

APPLIED INDUSTRIAL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)

Ohio
34-0117420
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)

1 Applied Plaza, Cleveland, Ohio 44115
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (216) 426-4000.
Securities registered pursuant to Section 12(b) of the Act:

Title of each class
Name of each exchange on which registered
Common Stock, without par value
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. x Yes ¨ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. ¨ Yes x No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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. x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No




Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer X
Accelerated filer __
Non-accelerated filer __
Smaller reporting company __

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
¨ Yes x No

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter (December 31, 2013): $2,032,869,000.

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

Class
Outstanding at August 15, 2014
Common Stock, without par value
41,507,647


DOCUMENTS INCORPORATED BY REFERENCE

Portions of Applied's proxy statement for the annual meeting of shareholders to be held October 28, 2014, are incorporated by reference into Parts II, III, and IV of this Form 10-K.





TABLE OF CONTENTS

 
 
Page
 
 
 
 
 
 
PART I
 
 
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
 
 
 
 
 
 
PART II
 
 
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management's Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures about Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
 
 
 
PART III
 
 
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accountant Fees and Services
 
 
 
PART IV
 
 
Exhibits and Financial Statement Schedules
 
 
 
 
 
 
 




CAUTIONARY STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT
This report, including the documents incorporated by reference, 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 “guidance,” “expect,” “believe,” “plan,” “intend,” “will,” “should,” “could,” “would,” “anticipate,” “estimate,” “forecast,” “may,” "optimistic" and derivative or similar words or expressions. Similarly, descriptions of our 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 Applied and its management as to future occurrences and trends. Applied 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 forward-looking statements. All forward-looking statements are based on current expectations regarding important risk factors, many of which are outside Applied'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 Applied or another person that the results expressed in the statements will be achieved. In addition, Applied assumes no obligation publicly to update or revise forward-looking statements, whether because of new information or events, or otherwise, except as may be required by law.
Applied believes its primary risk factors include, but are not limited to, those identified in the following sections of this annual report on Form 10-K: “Risk Factors” in Item 1A; “Narrative Description of Business,” in Item 1, section (c); and “Management's Discussion and Analysis of Financial Condition and Results of Operations” in Item 7. PLEASE READ THOSE DISCLOSURES CAREFULLY.



1


PART I
ITEM 1. BUSINESS.
In this annual report on Form 10-K, “Applied” refers to Applied Industrial Technologies, Inc., an Ohio corporation. References to “we,” “us,” “our,” and “the company” refer to Applied and its subsidiaries.
Applied is a leading industrial distributor in North America, Australia, and New Zealand, supplying customers in a wide range of industries with products including bearings, power transmission components, fluid power components and systems, industrial rubber products, linear motion components, tools, safety products, and other industrial and maintenance supplies. We provide engineering, design, and systems integration for industrial and fluid power applications, as well as customized mechanical, fabricated rubber, and fluid power shop services. We also offer maintenance training and inventory and storeroom management solutions.
We serve customers for both MRO (maintenance, repair, and operations) and OEM (original equipment manufacturing) product applications. We offer technical application support for our products and provide solutions to help customers minimize their production downtime, improve machine performance, and reduce overall procurement and maintenance costs.
Applied and its predecessor companies have engaged in this business since 1923. Applied reincorporated in Ohio
in 1988.
Our Internet address is www.applied.com. The following documents are available free of charge via hyperlink from the investor relations area of our website:
Applied's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, together with Section 16 insider beneficial stock ownership reports - these documents are posted as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission
Applied's Code of Business Ethics
Applied's Board of Directors Governance Principles and Practices
Applied's Director Independence Standards
Charters for the Audit, Corporate Governance, and Executive Organization & Compensation Committees of Applied's Board of Directors
The information available via hyperlink from our website is not incorporated into this annual report on Form 10-K.
(a) General Development of Business.
Information regarding developments in our business can be found below in Item 7 under the caption “Management's Discussion and Analysis of Financial Condition and Results of Operations.” This information is incorporated here by reference.
(b) Financial Information about Segments.
We have identified two reportable segments, service center-based distribution and fluid power businesses.
The service center-based distribution segment provides customers with a wide range of industrial products through a network of service centers. The fluid power businesses segment consists of specialized regional companies that distribute fluid power components and operate shops to assemble fluid power systems and perform equipment repair. The fluid power businesses primarily sell products and repair services directly to customers rather than through the service centers.
Segment financial information can be found in note 12 to the consolidated financial statements, included below
in Item 8 under the caption “Financial Statements and Supplementary Data.” That information is incorporated here
by reference.

2


(c) Narrative Description of Business.
Overview. Our field operating structure is built on two platforms - service center-based distribution and fluid power businesses:
Ÿ
Service Center-Based Distribution. We distribute a wide range of industrial products through service centers across North America, Australia, and New Zealand. Customers primarily purchase our products for scheduled maintenance of their machinery and equipment and for emergency repairs.
The service center network also includes:
Ÿ
Regional fabricated rubber shops, which modify and repair conveyor belts and make hose assemblies in accordance with customer requirements, and
Ÿ
Rubber service field crews, which install and repair conveyor belts and rubber linings at customer locations.
The service center-based distribution business accounts for a substantial majority of our field operations and 80.2% of our 2014 sales dollars. We operate in the United States, Canada, Australia, and New Zealand using the Applied Industrial Technologies and Applied Maintenance Supplies and Solutions trade names. We are known as Applied México and RODENSA (effective July 1, 2014) in Mexico and Rafael Benitez Carrillo in Puerto Rico. Reliance Industrial Products, Knox Oil Field Supply (effective July 1, 2014), and Texas Oilpatch Services operate under those trade names, serving the upstream oil and gas industry.
Ÿ
Fluid Power Businesses. Our specialized fluid power businesses primarily market products and services to customers within the businesses' geographic regions. In the United States, the businesses also market products and services through our service center network. In addition to distributing fluid power components, the businesses assemble fluid power systems and components, perform equipment repair, and offer technical advice to customers. Customers include firms purchasing for maintenance, repair, and operational needs, as well as for original equipment manufacturing applications. Our fluid power businesses include the following:
United States
International
Air Draulics Engineering
Engineered Sales
Atelier P.V. Hydraulique (Canada)
Air-Hydraulic Systems
FluidTech
HyPower (Canada)
Applied Engineered Systems
HydroAir
Pro-Hydraulique (Canada)
Bay Advanced Technologies
HyQuip
Vycmex (Mexico)
Carolina Fluid Components
Kent Fluid Power
 
DTS Fluid Power
Power Systems
 
ESI Power Hydraulics
Spencer Fluid Power
Elect-Air
 
Products. We are a leading distributor of products including bearings, power transmission components, fluid power components and systems, industrial rubber products, linear motion components, tools, safety products, and other industrial and maintenance supplies. Fluid power products include hydraulic, pneumatic, lubrication, and filtration components and systems.
These products are generally supplied to us by manufacturers whom we serve as a non-exclusive distributor. The suppliers also may provide us product training, as well as sales and marketing support. Authorizations to represent particular suppliers and product lines may vary by geographic region, particularly for our fluid power businesses. We believe our supplier relationships are generally good, and many have existed for decades. The disruption of relationships with certain suppliers, or the disruption of their operations, could adversely affect our business.
Our product suppliers typically confine their direct sales activities to large-volume transactions, mainly with large original equipment manufacturers. The suppliers generally do not sell maintenance and repair products directly to the customer, but instead refer the customer to us or another distributor.
Net sales by product category for the most recent three fiscal years is detailed in note 12 to the consolidated financial statements, included below in Item 8 under the caption “Financial Statements and Supplementary Data.”
That information is incorporated here by reference.

3


Services. Our employees advise and assist customers in selecting and applying products, and in managing inventory. We consider this advice and assistance to be an integral part of our sales efforts. Beyond logistical distribution services, we offer product and process solutions involving multiple technologies. These solutions help customers minimize production downtime, improve machine performance, and reduce overall procurement and maintenance costs. By providing high levels of service, product and industry expertise, and technical support, while at the same time offering product breadth and competitive pricing, we believe we develop stronger, longer-lasting, and more profitable customer relationships.
Our service center sales employees include customer sales and service representatives and account managers, as well as product and industry specialists. Customer sales and service representatives receive, process, and expedite customer orders, provide product information, and assist account managers in serving customers. Account managers make on-site calls to customers to provide product information, identify customer requirements, make recommendations, and assist in implementing equipment maintenance and storeroom management programs, as well as automated supplies dispensing systems. Account managers also measure and document the value of the cost savings and increased productivity we help generate. Product and industry specialists assist with applications in their areas of expertise.
We maintain product inventory levels at each service center tailored to the local market. These inventories consist of standard items as well as other items specific to local customer demand. Distribution centers replenish service center inventories and also may ship products directly to customers. Having product in stock helps us satisfy customers' immediate needs.
Timely delivery of products is an integral part of our service, particularly when customers require products for emergency repairs. Service centers and distribution centers use the most effective method of transportation available to meet customer needs. These methods include our own delivery vehicles, dedicated third-party transportation providers, as well as surface and air common carrier and courier services. Customers can also pick up items at our service centers.
Our information systems enhance our customer service. Customers turn to our website at www.applied.com to search for products in a comprehensive electronic catalog, research product attributes, view prices, check inventory levels, place orders, and track order status. We also transact with customers through electronic data interchange (EDI) and interface with customers' technology platforms and plant maintenance systems.
In addition to our electronic capabilities, we serve customers with our paper catalog, a comprehensive purchasing tool and resource guide for industrial and maintenance products.
We supplement the service center product offering with our MaintenancePro® fee-based technical training seminars. These courses provide customer personnel with information on maintenance, troubleshooting, component application, and failure analysis in the areas of hydraulics and pneumatics, lubrication, bearings, and power transmission.
The Maintenance Supplies & Solutions service offering provides inventory management services, at customer sites, for industrial and maintenance supplies, including fasteners, cutting tools, paints and chemicals, fluid flow, safety, and janitorial products.
Reliance Industrial Products and Texas Oilpatch Services specialize in supplying products and services to the
upstream oil and gas industry. At the beginning of fiscal 2015, we acquired another oilfield supply company, Knox Oil Field Supply.
In addition to distributing products, we offer shop services in select geographic areas. Our fabricated rubber shops modify and repair conveyor belts and provide hose assemblies (also available at select service centers and distribution centers) in accordance with customer requirements. Field crews install and repair conveyor belts and rubber lining, primarily at customer locations. Among the other services we offer, either performed by us directly or by third party providers, are the rebuilding or assembly of speed reducers, pumps, valves, cylinders, and electric and hydraulic motors, and custom machining.
Our specialized fluid power businesses generally operate independently of the service centers, but as product distributors, share the same focus on customer service. Product and application recommendations, inventory availability, and delivery speed are all important to the businesses' success.
The fluid power businesses distinguish themselves from most component distributors by offering engineering, design, system fabrication, installation, and repair services. Our capabilities extend to the following specialties: fluid power system integration; manifold design, machining, and assembly; and the integration of hydraulics with electronics for complete machine design.

4


Each business has account managers with technical knowledge, who handle sophisticated projects, including original equipment manufacturing applications. The businesses also provide technical support to our service centers and their customers.
Markets. We purchase from thousands of product manufacturers and resell the products to thousands of customers in a wide variety of industries, including agriculture and food processing, automotive, chemicals and petrochemicals, fabricated metals, forest products, industrial machinery and equipment, mining, oil and gas, primary metals, transportation, and utilities, as well as to government entities. Customers range from very large businesses, with which we may have multiple-location relationships, to very small ones. We are not significantly dependent on a single customer or group of customers, the loss of which would have a material adverse effect on our business as a whole, and no single customer accounts for more than 3% of our net sales.
Competition. We consider our business to be highly competitive. In addition, our markets present few economic or technological barriers to entry, contributing to a high fragmentation of market share. Longstanding supplier and customer relationships, geographic coverage, name recognition, and our employees' knowledge and experience do, however, support our competitive position. Competition is based generally on breadth and quality of product and service offerings, product availability, price, ease of product selection and ordering, online capability, catalogs, and having a local presence. In the fluid power businesses, product manufacturer authorizations are often more selective and can be a more significant competitive factor, along with market reputation and product application knowledge.
Our principal competitors are other bearing, power transmission, industrial rubber, fluid power, linear motion, tools, and safety product distributors, as well as specialized oilfield supply distributors and distributors of other industrial and maintenance supplies and catalog companies. These competitors include local, regional, national, and multinational operations. We also compete with original equipment manufacturers and their distributors in the sale of maintenance and replacement components. Some competitors have greater financial resources than we do.
The identity and number of our competitors vary throughout the geographic and product markets we serve.
Although we are one of the leading distributors in North America, Australia, and New Zealand for the primary categories of products we provide in those areas, our market share for those products in a given geographic area may be relatively small compared to the portion of the market served by original equipment manufacturers and other distributors.
Backlog Orders and Seasonality. Because of the type of industrial distribution we provide, backlog orders are not material to our business as a whole, although they are a more important factor for our fluid power businesses.
Our business has exhibited minor seasonality - in particular, sales per day during the first half of our fiscal year have tended in the past to be slightly lower compared with the second half due, in part, to the impact of customer plant shutdowns, summer vacations and holidays.
Patents, Trademarks, Trade Names, and Licenses. Customer recognition of our service marks and trade names, including Applied Industrial Technologies®, Applied®, and AIT®, is an important contributing factor to our sales. Patents and licenses are not of material importance to our business.
Raw Materials and General Business Conditions. Our operations are dependent on general industrial and economic conditions. We would be adversely affected by the unavailability of raw materials to our suppliers, prolonged labor disputes experienced by suppliers or customers, or by a recession or depression that has an adverse effect on industrial activity generally in the markets we serve or on key customer industries.
Number of Employees. At June 30, 2014, we had 5,472 employees.
Working Capital. Our working capital position is discussed below in Item 7 under the caption “Management's Discussion and Analysis of Financial Condition and Results of Operations.” This information is incorporated here by reference.
We require substantial working capital related to accounts receivable and inventories. Significant amounts of inventory are carried to meet customers' delivery requirements. We generally require payments for sales on account within 30 days. Returns are not considered to have a material effect on our working capital requirements.
We believe these practices are generally consistent among companies in our industry.
Environmental Laws. We believe that compliance with laws regulating the discharge of materials into the environment or otherwise relating to environmental protection will not have a material adverse effect on our capital expenditures, earnings, or competitive position.

5


(d) Financial Information about Geographic Areas.
Information regarding our foreign operations, including information about revenues and long-lived assets, is included in note 12 to the consolidated financial statements, included below in Item 8 under the caption “Financial Statements and Supplementary Data,” as well as in Item 7A below under the caption “Quantitative and Qualitative Disclosures about Market Risk.” That information is incorporated here by reference.
ITEM 1A. RISK FACTORS.
In addition to other information set forth in this report, you should carefully consider the following factors that could materially affect our business, financial condition, or results of operations. The risks described below are not the only risks facing our company. Certain risks are identified below in Item 7 under the caption “Management's Discussion and Analysis of Financial Condition and Results of Operations.” This information is incorporated here by reference. Additional risks not currently known to us, risks that could apply broadly to issuers, or risks that we currently deem immaterial, may also impact our business and operations.
Our business depends heavily on the operating levels of our customers and the economic factors that affect them. Many of the primary markets for the products and services we sell are subject to cyclical fluctuations that affect demand for goods and materials that our customers produce. Consequently, demand for our products and services has been and will continue to be influenced by most of the same economic factors that affect demand for and production of customers' goods and materials.
When customers or prospective customers reduce production levels because of lower demand or tight credit conditions, their need for our products and services diminishes. Selling prices and terms of sale come under pressure, adversely affecting the profitability and the durability of customer relationships, and credit losses increase too. Volatile economic and credit conditions also make it more difficult for distributors, as well as customers and suppliers, to forecast and plan future business activities.
Consolidation in our customers' and suppliers' industries could adversely affect our business and financial results. In recent years, we have witnessed consolidation among our product suppliers and customers. As customer industries consolidate, a greater proportion of our sales could be derived from higher volume contracts, which could adversely impact the amount and volatility of our earnings. Consolidation among customers can trigger changes in their purchasing strategies, potentially moving large blocks of business among competing industrial distributors and contributing to volatility in our sales and pressure on prices. Similarly, continued consolidation among our suppliers could reduce our ability to negotiate favorable pricing and other commercial terms for our inventory purchases.
Loss of key supplier authorizations, lack of product availability, or changes in supplier distribution programs
could adversely affect our sales and earnings. Our business depends on maintaining an immediately available supply of various products to meet customer demand. Many of our relationships with key product suppliers are longstanding, but are terminable by either party. The loss of key supplier authorizations, or a substantial decrease in the availability of their products, could put us at a competitive disadvantage and have a material adverse effect on our business. Supply interruptions could arise from raw materials shortages, inadequate manufacturing capacity or utilization to meet demand, financial problems, labor disputes or weather conditions affecting suppliers' production, transportation disruptions, or other reasons beyond our control.
In addition, as a distributor, we face the risk of key product suppliers changing their relationships with distributors generally, or Applied in particular, in a manner that adversely impacts us. For example, key suppliers could change the following: the prices we must pay for their products relative to other distributors or relative to competing products; the geographic or product line breadth of distributor authorizations; supplier purchasing incentive or other support programs; or product purchase or stocking expectations.
An increase in competition could decrease sales or earnings. We operate in a highly competitive industry. Our competitors include local, regional, national, and multinational distributors of industrial machinery parts, equipment, and supplies. Competition is largely focused in the local service area and is generally based on product line breadth, product availability, service capabilities, and price. Some existing competitors have, and potential market entrants may have, greater financial or other resources than we do, or broader product or service offerings. If existing or future competitors seek to gain or to retain market share by reducing prices, we may need to lower our prices for products or services, thereby adversely affecting financial results.
The purchasing incentives we earn from product suppliers can be impacted if we reduce our purchases in response to declining customer demand. Certain of our product suppliers have historically offered to their distributors, including us, incentives for purchasing their products. In addition to market or customer account-specific incentives, certain suppliers pay incentives to the distributor for attaining specific purchase volumes during the

6


program period. In some cases, in order to earn incentives, we must achieve year-over-year growth in purchases with the supplier. When demand for our products declines, we may be less willing to add inventory to take advantage of certain incentive programs, thereby potentially adversely impacting our profitability.
Our ability to transact business is highly reliant on our information systems. We face additional risks in this regard as we implement a new integrated information technology platform for our business. We depend on information systems to process customer orders, manage inventory and accounts receivable collections, purchase products, manage accounts payable processes, ship products to customers on a timely basis, maintain cost-effective operations, provide superior service to customers, and accumulate financial results. A serious, prolonged disruption of our information systems or breach in security could materially impair fundamental business processes and increase expenses, decrease sales, or otherwise reduce earnings.
We are completing the process of replacing multiple legacy applications with an SAP software platform, to enhance our business information and transaction systems to support future growth. The implementation has occurred over several years in planned phases, primarily based on geographic region; as of June 30, 2014, a substantial majority of our service center operations in the U.S. and Canada were using SAP. We have also begun the transformation of our financial and accounting systems including fixed assets, general ledger and consolidation systems. These implementations are expected to continue through fiscal 2015. Despite extensive planning, we could experience disruptions in our business operations related to the implementation because of the project's complexity.
The potential material adverse consequences could include delays, loss of information, diminished management reporting capabilities, damage to our ability to process transactions, harm to our control environment, diminished employee productivity, and unanticipated increases in costs. Further, our ability to achieve anticipated operational benefits from the new platform is not assured.
Volatility in product and energy costs can affect our profitability. Cost increases in commodity resources, such as steel and energy, can lead product manufacturers to increase the prices of products we distribute. In addition, a portion of our own distribution costs is comprised of fuel for our sales and delivery vehicles, freight, and utility expenses for our facilities. Our ability to pass along to customers the increases in our product and distribution costs depends on market conditions. Raising our prices could result in decreased sales volume, which could significantly reduce our profitability. When costs fall, market prices can fall too, again potentially affecting profitability.
Acquisitions are a key component of our anticipated growth. We may not be able to identify or to complete future acquisitions, to integrate them effectively into our operations, or to realize their anticipated benefits. Many industries we serve are mature. As a result, acquisitions of other businesses have been important to our growth in recent years. While we wish to continue to acquire businesses, we may not be able to identify and to negotiate suitable acquisitions, to obtain financing for them on satisfactory terms, or otherwise to complete acquisitions.
In addition, existing or future competitors may increasingly seek to compete with us for acquisitions, which could have the effect of increasing the price and reducing the number of suitable opportunities.
We seek acquisition opportunities that complement and expand our operations. However, substantial costs, delays, or other difficulties related to integrating acquisitions into our operations could adversely affect our business or financial results. We could face significant challenges in consolidating functions and integrating procedures, information systems, personnel, and operations in a timely and efficient manner.
Further, even if we successfully integrate the acquisitions with our operations, we may not be able to realize the cost savings, sales, profit levels, or other benefits that we anticipate from these acquisitions, either as to amount or in the time frame we expect. Our ability to realize anticipated benefits may be affected by a number of factors, including the following: our ability to achieve planned operating results, to reduce duplicative expenses and inventory effectively, and to consolidate facilities; the incurrence of significant integration costs or charges in order to achieve those benefits; and our ability to retain key product supplier authorizations, customer relationships, and employees. In addition, acquisitions could place significant demand on administrative, operational, and financial resources.
Tight credit markets could impact our ability to obtain financing on reasonable terms or increase the cost of future financing. Although the credit market turmoil of several years ago did not have a significant adverse impact on our liquidity or borrowing costs, the availability of funds tightened and credit spreads on corporate debt increased. If credit market volatility were to return, then obtaining additional or replacement financing could be more difficult and the cost of issuing new debt or replacing a credit facility could be higher than under our current facilities. Tight credit conditions could limit our ability to finance acquisitions on terms acceptable to us.

7


For more information relating to borrowing and interest rates, see the following sections below: “Liquidity and Capital Resources” in Item 7 under the caption “Management's Discussion and Analysis of Financial Condition and Results of Operations;” Item 7A under the caption “Quantitative and Qualitative Disclosures about Market Risk;” and note 5 to the consolidated financial statements, included below in Item 8 under the caption “Financial Statements and Supplementary Data.” That information is incorporated here by reference.
Our growth outside the United States increases our exposure to global economic and political conditions. Foreign operations contributed 17.4% of our sales in 2014. If we continue to grow outside the U.S., the risks associated with exposure to more volatile economic conditions, political instability, cultural and legal differences in conducting business, and currency fluctuations will increase.
Our business depends on our ability to attract, develop, motivate, and retain qualified sales and customer service personnel and other skilled managers and professionals. There are significant costs associated with recruiting, training, and developing skilled employees. With respect to sales and customer service positions, we greatly benefit from having employees who are familiar with the products we sell and their applications, as well as with our customer and supplier relationships. We could be adversely affected by a shortage of, or increased competition for, available skilled workers, or by the loss of a significant number of our sales and customer service personnel or other managers or professionals, including through retirement as the workforce ages.
An interruption of operations at our headquarters or distribution centers could adversely impact our business. Our business depends on maintaining operations at our headquarters and distribution centers. A serious, prolonged interruption due to power outage, telecommunications outage, terrorist attack, earthquake, extreme weather events, other natural disasters, fire, flood, or other interruption could have a material adverse effect on our business and financial results.
We are subject to litigation and regulatory risk due to the nature of our business, which may have a material adverse effect on our business. From time to time, we are involved in lawsuits or other legal proceedings that arise from our business. These may, for example, relate to product liability claims, commercial disputes, personal injuries, or employment-related matters. In addition, we could face claims over other matters, such as claims arising from our status as a public company or government contractor, or otherwise relating to our compliance with a wide array of laws and regulations to which we are subject. The defense and ultimate outcome of lawsuits or other legal proceedings or inquiries may result in higher operating expenses, which could have a material adverse effect on
our business, financial condition, or results of operations.
In addition to the risks identified above, other risks to our future performance include, but are not limited to,
the following:
Ÿ
changes in customer preferences for products and services of the nature, brands, quality,
or cost sold by Applied;
Ÿ
changes in customer procurement policies and practices;
Ÿ
changes in the market prices for products and services relative to the costs of providing them;
Ÿ
changes in operating expenses;
Ÿ
organizational changes within the company;
Ÿ
adverse regulation and legislation, both enacted and under consideration, including with respect to
federal tax policy (e.g., affecting the use of the LIFO inventory accounting method and the taxation of
foreign-sourced income);
Ÿ
the variability and timing of new business opportunities including acquisitions, alliances,
customer relationships, and supplier authorizations;
Ÿ
the incurrence of debt and contingent liabilities in connection with acquisitions;
Ÿ
volatility of our stock price and the resulting impact on our consolidated financial statements; and
Ÿ
changes in accounting policies and practices that could impact our financial reporting and increase
compliance costs.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable.

8


ITEM 2. PROPERTIES.
We believe having a local presence is important to serving our customers, so we maintain service centers and other operations in local markets throughout the countries in which we operate. At June 30, 2014, we owned real properties at 126 locations and leased 374 locations. Certain properties house more than one operation.
The following were our principal owned real properties (each of which has more than 30,000 square feet of floor space) at June 30, 2014.
Location of Principal Owned
Real Property
Type of Facility
Cleveland, Ohio
Corporate headquarters
Atlanta, Georgia
Distribution center and service center
Florence, Kentucky
Distribution center
Carlisle, Pennsylvania
Distribution center
Fort Worth, Texas
Distribution center and rubber shop
Clairmont, Alberta
Service center
Our principal leased real properties (each of which has more than 30,000 square feet of floor space) at June 30, 2014 were:
Location of Principal Leased
Real Property
Type of Facility
Fontana, California
Distribution center, rubber shop, fluid power shop and service center
Newark, California
Fluid power shop
Denver, Colorado
Rubber shop and service center
Lenexa, Kansas
Fluid power shop
Chanhassen, Minnesota
Fluid power shop
Billings, Montana
Fluid power shop
Cleveland, Ohio
Offices and warehouse
Elyria, Ohio
Product return center and service center
Portland, Oregon
Distribution center
Kent, Washington
Offices, fluid power shop, and service center
Longview, Washington
Service center, rubber shop, and fluid power shop
Appleton, Wisconsin
Offices, service center, and rubber shop
Edmonton, Alberta
Service center and shop
Winnipeg, Manitoba
Distribution center and service center
The properties in Newark, Lenexa, Chanhassen, and Billings are used in our fluid power businesses segment.
The Fontana, Kent, and Longview properties are used in both the service center-based distribution segment and the fluid power businesses segment. The remaining properties are used in the service center-based distribution segment.
We consider our properties generally sufficient to meet our requirements for office space and inventory stocking.
A service center's size is primarily influenced by the amount and types of inventory the service center requires to meet customers' needs.
In recent years, when opening new operations, we have tended to lease rather than purchase real property. We do not consider any service center, distribution center, or shop property to be material, because we believe that, if it becomes necessary or desirable to relocate an operation, other suitable property could be found.
In addition to operating locations, we own or lease certain properties which in the aggregate are not material and are either for sale, lease, or sublease to third parties due to a relocation or closing. We also may lease or sublease to others unused portions of buildings.
Additional information regarding our properties can be found in note 11 to the consolidated financial statements, included below in Item 8 under the caption “Financial Statements and Supplementary Data.” That information is incorporated here by reference.

9



ITEM 3. LEGAL PROCEEDINGS.
Applied and/or one of its subsidiaries is a party to pending legal proceedings with respect to product liability, commercial, personal injury, and other matters. Although it is not possible to predict the outcome of these proceedings or the range of reasonably possible loss, we believe, based on circumstances currently known, that the likelihood is remote that the ultimate resolution of any of these proceedings will have, either individually or in the aggregate, a material adverse effect on Applied's consolidated financial position, results of operations, or cash flows.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT.
Applied's executive officers are elected by the Board of Directors for a term of one year, or until their successors are chosen and qualified, at the Board's organizational meeting held following the annual meeting of shareholders.
The following is a list of the executive officers and a description of their business experience during the past five years. Except as otherwise stated, the positions and offices indicated are with Applied, and the persons were elected to their current positions on October 29, 2013:
Name
Positions and Experience
Age
Neil A. Schrimsher
President (since August 2013) and Chief Executive Officer (since October 2011). From February 2010 to August 2011, Mr. Schrimsher was Executive Vice President of Cooper Industries plc (formerly NYSE: CBE), a global electrical products manufacturer, where he led Cooper's Electrical Products Group and headed numerous domestic and international growth initiatives. He was also President of Cooper Lighting, Inc. throughout the period from 2006 to December 2010.
50
Thomas E. Armold
Vice President-Marketing and Strategic Accounts
59
Todd A. Barlett
Vice President-Acquisitions and Global Business Development
59
Fred D. Bauer
Vice President-General Counsel & Secretary
48
Mark O. Eisele
Vice President-Chief Financial Officer & Treasurer
57
Kurt W. Loring
Vice President-Chief Human Resources Officer since July 2014. From October 2011 to July 2014 he was Vice President, Human Resources for the Forged Products segment of Precision Castparts Corporation (NYSE: PCP). The $4.3 billion segment, with greater than 5,000 employees, is a world-leading producer of complex forgings and high-performance nickel-based alloys and super alloys for aerospace, power generation, and general industrial applications. Prior to that he served with Danaher Corporation (NYSE: DHR), most recently (from 2008 to September 2011) as the Vice President, Human Resources for its Fluke Corporation subsidiary, a leader in the manufacture, distribution, and service of electronic test tools and software worldwide.
45
Carl E. Will
Chief Commercial Officer since July 2013. From 2004 to January 2013, he served as an executive with Invacare Corporation (NYSE: IVC), which engages in the design, manufacture, and distribution of medical equipment and supplies worldwide. Most recently, he was Invacare's Senior Vice President-Global Commercial Operations from November 2010 to January 2013 and its Senior Vice President-North American Homecare from 2008 to November 2010.
44


10


PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Applied's common stock, without par value, is listed for trading on the New York Stock Exchange with the ticker symbol “AIT.” Information concerning the quarterly stock dividends for the fiscal years ended June 30, 2014, 2013, and 2012 and the number of shareholders of record as of August 15, 2014 are set forth in Item 8, “Financial Statements and Supplementary Data,” in the “Quarterly Operating Results” table. That information is incorporated here by reference.
Set forth below is market information on Applied's common stock.
 
 
 
 
 
 
      Price Range
 
 
Shares Traded

 
Average Daily Volume

 
High

 
Low

2014
 
 
 
 
 
 
 
 
First Quarter
 
9,157,400

 
143,100

 
$
53.57

 
$
47.21

Second Quarter
 
12,634,700

 
197,400

 
53.45

 
45.62

Third Quarter
 
10,107,300

 
165,700

 
52.27

 
45.74

Fourth Quarter
 
12,799,900

 
203,200

 
51.44

 
45.62

2013
 
 
 
 
 
 
 
 
First Quarter
 
12,149,000

 
196,000

 
$
44.86

 
$
34.67

Second Quarter
 
12,434,700

 
201,600

 
42.54

 
36.52

Third Quarter
 
11,238,700

 
187,300

 
45.67

 
42.02

Fourth Quarter
 
11,295,800

 
176,500

 
49.44

 
40.39

2012
 
 
 
 
 
 
 
 
First Quarter
 
26,284,500

 
410,700

 
$
36.77

 
$
24.50

Second Quarter
 
19,521,900

 
309,900

 
36.07

 
25.63

Third Quarter
 
15,756,700

 
254,100

 
42.01

 
34.78

Fourth Quarter
 
16,697,600

 
265,000

 
41.79

 
34.44

The following table summarizes Applied's repurchases of its common stock in the quarter ended June 30, 2014.
Period
(a) Total Number of Shares (1)

 
(b) Average Price Paid per Share ($)

 
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (2)
April 1, 2014 to April 30, 2014
86,235

 
48.32

 
86,100
 
560,400
May 1, 2014 to May 31, 2014
107,700

 
47.21

 
107,700
 
452,700
June 1, 2014 to June 30, 2014
71,100

 
49.15

 
71,100
 
381,600
Total
265,035

 
48.09

 
264,900
 
381,600
(1)
During the quarter ended June 30, 2014, Applied purchased 135 shares in connection with an employee deferred compensation program. This purchase is not counted in the authorization in note (2).
(2)
On October 25, 2011, the Board of Directors authorized the purchase of up to 1.5 million shares of Applied's common stock.
We publicly announced the authorization that day. Purchases can be made in the open market or in privately negotiated transactions. The authorization is in effect until all shares are purchased, or the Board revokes or amends the authorization.

11


ITEM 6. SELECTED FINANCIAL DATA.
Set forth below is selected financial data for each of the last five fiscal years.
(In thousands, except per share amounts and statistical data)
(UNAUDITED)
 
 
2014
 
2013
 
2012
 
2011
 
2010
Consolidated Operations — Year Ended June 30
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
2,459,878

 
$
2,462,171

 
$
2,375,445

 
$
2,212,849

 
$
1,893,208

Depreciation and amortization of property
 
13,977

 
12,501

 
11,236

 
11,234

 
11,465

Amortization:
 
 
 
 
 
 
 
 
 
 
Intangible assets
 
14,023

 
13,233

 
11,465

 
11,382

 
10,151

SARs and stock options
 
1,808

 
2,317

 
2,058

 
2,473

 
3,020

Operating income
 
164,358

 
176,399

 
168,395

 
150,763

 
110,050

Net income
 
112,821

 
118,149

 
108,779

 
96,759

 
65,903

Per share data:
 
 
 
 
 
 
 
 
 
 
Net income:
 
 
 
 
 
 
 
 
 
 
Basic
 
2.69

 
2.81

 
2.58

 
2.28

 
1.56

Diluted
 
2.67

 
2.78

 
2.54

 
2.24

 
1.54

Cash dividend
 
0.96

 
0.88

 
0.80

 
0.70

 
0.60

 
 
 
 
 
 
 
 
 
 
 
Year-End Position — June 30
 
 
 
 
 
 
 
 
 
 
Working capital
 
$
545,193

 
$
491,380

 
$
435,593

 
$
404,226

 
$
347,528

Long-term debt (including portion classified as current)
 
170,712

 

 

 

 
75,000

Total assets
 
1,334,169

 
1,058,706

 
962,183

 
914,931

 
891,520

Shareholders’ equity
 
800,308

 
759,615

 
672,131

 
633,563

 
555,039

 
 
 
 
 
 
 
 
 
 
 
Year-End Statistics — June 30
 
 
 
 
 
 
 
 
 
 
Current ratio
 
2.9

 
3.0

 
2.9

 
2.9

 
2.3

Operating facilities
 
538

 
522

 
476

 
474

 
455

Shareholders of record
 
6,330

 
6,319

 
6,225

 
6,208

 
5,884

Return on assets (a)
 
10.2
%
 
11.6
%
 
11.8
%
 
11.1
%
 
7.9
%
Return on equity (b)
 
14.5
%
 
16.5
%
 
16.7
%
 
16.3
%
 
12.4
%
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures (c)
 
$
20,190

 
$
12,214

 
$
26,021

 
$
20,431

 
$
7,216

 
 
 
 
 
 
 
 
 
 
 
Cash Returned to Shareholders During the Year
 
 
 
 
 
 
 
 
 
 
Dividends Paid
 
$
40,410

 
$
37,194

 
$
33,800

 
$
29,751

 
$
25,416

Purchases of Treasury Shares
 
36,732

 
53

 
31,032

 
6,085

 
3,929

Total
 
$
77,142

 
$
37,247

 
$
64,832

 
$
35,836

 
$
29,345

(a)
Return on assets is calculated as net income divided by monthly average assets.
(b)
Return on equity is calculated as net income divided by the average shareholders’ equity (beginning of the year and end of
the year divided by 2).
(c)
Capital expenditures for fiscal 2014 included the purchase of our headquarters facility which used $10.0 million of cash.
Capital expenditures for 2013, 2012 and 2011 include $5.6 million, $16.7 million and $12.5 million related to the ERP (SAP)
project, respectively. See Item 7 under the caption “Management's Discussion and Analysis of Financial Condition and Results
of Operations” for further description of the ERP (SAP) project.



12


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
OVERVIEW
With more than 5,000 employees 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. At June 30, 2014, business was conducted in the United States, Puerto Rico, Canada, Mexico, Australia and New Zealand from 538 facilities.
The following is Management's Discussion and Analysis of significant factors that have affected our financial condition, results of operations and cash flows during the periods included in the accompanying statements of consolidated income, consolidated comprehensive income and consolidated cash flows in Item 8 under the caption "Financial Statements and Supplementary Data". When reviewing the discussion and analysis set forth below, please note that the majority of SKUs (Stock Keeping Units) we sell in any given year were not 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.
Our fiscal 2014 consolidated sales were $2.46 billion, a decrease of $2.3 million or 0.1% compared to the prior year. We experienced overall declines in sales from our businesses not acquired in the current year of approximately $34.3 million or 1.4%. Currency translation decreased fiscal year sales by approximately $26.2 million or 1.1%. Incremental sales from companies acquired since the prior year period contributed $58.2 million or 2.4%. Gross margin was 27.9% compared to 27.7% in the prior year. Our operating margin decreased to 6.7% compared to the prior year’s 7.2%. Our earnings per share was $2.67 versus $2.78 in fiscal year 2013, a decrease of 4.0%.
Our consolidated balance sheet remains strong. Shareholders’ equity was $800.3 million, up from $759.6 million at June 30, 2013. Working capital increased $53.8 million from June 30, 2013 to $545.2 million at June 30, 2014. Our current ratio remains strong at 2.9 to 1, compared to 3.0 to 1 at 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.
Industrial production increased 0.2% in June and advanced at an annual rate of 5.5% for the second calendar quarter of 2014. In June, capacity utilization for manufacturing moved down 0.1% to 77.1% compared to May. The ISM PMI registered 55.3 in June, above 50 (its expansionary threshold). We enter fiscal 2015 optimistic about the U.S. industrial economy.
YEAR ENDED JUNE 30, 2014 vs. 2013
The following table is included to aid in review of Applied’s statements of consolidated income.
 
Year Ended June 30,
As a % of Net Sales
 
Change in $'s Versus Prior Period

 
2014

 
2013

 
% Increase

Net Sales
100.0
%
 
100.0
%
 
(0.1
)%
Gross Profit Margin
27.9
%
 
27.7
%
 
0.6
 %
Selling, Distribution & Administrative
21.2
%
 
20.6
%
 
3.2
 %
Operating Income
6.7
%
 
7.2
%
 
(6.8
)%
Net Income
4.6
%
 
4.8
%
 
(4.5
)%

13


Sales in fiscal 2014 were $2.46 billion, which was $2.3 million or 0.1% below the prior year. We experienced overall declines in sales from our businesses not acquired in the current year of approximately $34.3 million or 1.4%. There was one additional selling day in fiscal 2014 as compared to fiscal 2013. Currency translation decreased fiscal year sales by approximately $26.2 million or 1.1%. Incremental sales from companies acquired since the prior year period contributed $58.2 million or 2.4%.
Sales of our Service Center Based Distribution segment, which operates primarily in MRO markets, decreased $30.1 million, or 1.5%. This decline is due to decreases in sales from businesses not acquired in the current year of $62.5 million or 3.1% coupled with an unfavorable impact of foreign currency translation of $23.1 million or 1.2%. Offseting these decreases are acquisitions, which added $55.5 million or 2.8%.
Sales of our Fluid Power Businesses segment, which operates primarily in OEM markets, increased $27.8 million or 6.1%. We experienced sales growth at several of our Fluid Power businesses which added $29.9 million or 6.6% along with acquisitions within this segment which added $2.8 million or 0.6%, while unfavorable foreign currency translation losses decreased sales by $4.9 million or 1.1%.
Sales in our U.S. operations were up $14.0 million or 0.7% with acquisitions adding $32.8 million or 1.6% offsetting declines in sales from our businesses not acquired in the current year of $18.8 million or 0.9%. Sales from our Canadian operations decreased $7.2 million or 2.4%. Acquisitions added $19.3 million or 6.5%, offset by unfavorable foreign currency translation losses which reduced sales by $17.5 million or 5.9% coupled with declines in sales from our businesses not acquired in the current year of $9.0 million or 3.0%, mostly as a result of weakness within the Canadian mining sector. Consolidated sales from our other country operations, which include Mexico, Australia and New Zealand, were $9.1 million or 6.2% below the prior year. This decrease is primarily the result of unfavorable foreign currency translation losses of $8.7 million or 5.9%, coupled with declines in sales of $6.5 million or 4.4%, mostly within the mining sector, from our businesses not acquired in the current year, while acquisitions added $6.1 million or 4.2% in the current year.
The sales product mix for fiscal 2014 was 70.7% industrial products and 29.3% fluid power products compared to 72.1% industrial and 27.9% fluid power in the prior year. The change in our product mix in the current year is due to sales growth within our Fluid Power Businesses segment coupled with sales declines in our Service Center Based Distribution segment.
Our gross profit margin was 27.9% in fiscal 2014 versus 27.7% in fiscal 2013. The increased margins are attributable to the impact of relatively higher gross margins from acquired operations.
Selling, distribution and administrative expenses (SD&A) consist 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, facility related expenses and expenses incurred with acquiring businesses. SD&A increased $16.0 million or 3.2% during fiscal 2014 compared to the prior year, and as a percent of sales increased to 21.2% from 20.6% in fiscal 2013. The acquired businesses added $19.3 million of SD&A expenses, which includes an additional $2.5 million associated with acquired identifiable intangibles amortization. The increase in SD&A as a percentage of sales, was driven by relatively higher SD&A levels from businesses acquired in the current year.
Operating income decreased $12.0 million, or 6.8%, to $164.4 million during fiscal 2014 from $176.4 million during 2013. As a percent of sales, operating income decreased to 6.7% in the current year from 7.2% in 2013. The decrease in operating income is primarily attributable to relatively flat gross profit levels coupled with added levels of SD&A from businesses acquired in the current fiscal year. The decrease in operating margin percentage is driven by the negative leverage resulting from decreasing sales from businesses not acquired in the current year without a similar level of SD&A reductions which result in an increase in SD&A as a percentage of sales to 21.2% from 20.6% in the prior year, slightly offset by an increase in gross profit as a percentage of sales to 27.9% from 27.7%.
Operating income as a percentage of sales for the Service Center Based Distribution segment decreased to 6.0% in fiscal 2014 from 6.9% in fiscal 2013. This decrease is attributable to the negative leverage resulting from decreasing sales in businesses not acquired in the current year without a similar level of SD&A reductions which result in an increase in SD&A as a percentage of sales. In addition, SD&A for acquisitions in the current year operate at a relatively higher SD&A level. The SD&A impacts represent an approximate 1.0% reduction in operating income as a percentage of sales and are slightly offset by an increase in gross profit margins also due to acquisitions in the current year (representing an increase of approximately 0.1%) representing the total net change in operating income as a percentage of sales.

14


Operating income as a percentage of sales for the Fluid Power Businesses segment increased to 9.2% in fiscal 2014 from 9.0% in fiscal 2013. This increase is due to the positive leverage provided by an increase in sales without a commensurate increase in SD&A levels at several of our Fluid Power Businesses (representing a 0.5% increase in operating income as a percentage of sales), offset by a slight decrease in gross profit margins (representing a 0.3 decrease in operating income as a percentage of sales).
Segment operating income is impacted by changes in the amounts and levels of expenses allocated to the segments. The expense allocations include corporate charges for working capital, logistics support and other items and impact segment gross profit and operating expense.
Interest expense, net, remained relatively stable as compared to the prior fiscal year.
Other expense (income), net, represents certain non-operating items of income and expense. This was $2.2 million of income in fiscal 2014 compared to $1.4 million of income in fiscal 2013. Current year income primarily consists of unrealized gains on investments held by non-qualified deferred compensation trusts of $1.7 million as well as $1.3 million of income associated with the elimination of the one-month Canadian and Mexican reporting lags (see note 1 in Item 8 under the caption "Financial Statements and Supplementary Data"), offset by foreign currency transaction losses of $0.8 million. Fiscal 2013 consisted primarily of unrealized gains on investments held by non-qualified deferred compensation trusts of $1.3 million.
Income tax expense as a percent of income before taxes was 32.1% for fiscal 2014 and 33.5% for fiscal 2013. The impact of lower effective tax rates in foreign jurisdictions favorably reduced our rate when compared to the U.S. federal statutory rate by 2.6%. Further reducing our rate compared to the U.S. federal statutory rate by 1.6% was the reversal of a deferred tax liability recorded in the prior years on a portion of the undistributed earnings in Canada. All undistributed earnings of our foreign subsidiaries are considered to be permanently reinvested at June 30, 2014. The effective tax rate for fiscal 2014 was further reduced by 1.1% due to a favorable permanent dividend deduction along with other items. These reductions compared to the U.S. federal statutory rate were offset by the impact of state and local taxes which increased the rate by 2.4%.
We expect our income tax rate for fiscal 2015 to be in the range of 34.0% to 34.5%.
As a result of the factors addressed above, net income for fiscal 2014 decreased $5.3 million or 4.5% from the prior year. Net income per share decreased at a slightly lower rate of 4.0% due to lower weighted average shares outstanding in fiscal 2014.
At June 30, 2014, we had a total of 538 operating facilities in the United States, Puerto Rico, Canada, Mexico, Australia and New Zealand, versus 522 at June 30, 2013.
The number of Company employees was 5,472 at June 30, 2014 and 5,109 at June 30, 2013.
YEAR ENDED JUNE 30, 2013 vs. 2012
The following table is included to aid in review of Applied’s statements of consolidated income.
 
Year Ended June 30,
As a % of Net Sales
 
Change in $'s Versus Prior Period

 
2013

 
2012

 
% Increase

Net Sales
100.0
%
 
100.0
%
 
3.7
%
Gross Profit Margin
27.7
%
 
27.6
%
 
4.4
%
Selling, Distribution & Administrative
20.6
%
 
20.5
%
 
4.2
%
Operating Income
7.2
%
 
7.1
%
 
4.8
%
Net Income
4.8
%
 
4.6
%
 
8.6
%
Sales in fiscal 2013 were $2.5 billion, which was $86.7 million or 3.7% above the 2012 fiscal year. Incremental net sales from companies acquired since the 2012 fiscal year contributed $107.8 million or 4.5%. Currency translation decreased 2013 fiscal year sales by approximately $1.6 million or less than 1%. We experienced overall declines in sales from our businesses not acquired in fiscal year 2013 of approximately 0.8%. Approximately half of this decrease was due to there being 251.5 selling days in year ended June 30, 2013 versus 252.5 in the year ended June 30, 2012 which would approximate a 0.4% decrease in sales.

15


Sales of our Service Center Based Distribution segment in fiscal 2013 increased $98.9 million, or 5.2%, compared to fiscal year 2012, primarily attributed to acquisition related sales growth with acquisitions adding $102.8 million or 5.4%.
Sales of our Fluid Power Businesses segment in fiscal 2013 decreased $12.2 million or 2.6%, compared to fiscal year 2012, primarily attributed to weakness within a few of our larger Fluid Power businesses. Acquisitions within this segment added $5.0 million or 1.1%.
Sales in our U.S. operations in fiscal 2013 were up $7.9 million or 0.4%, compared to fiscal 2012, with acquisitions adding $21.7 million or 1.1%. Sales from our Canadian operations increased $5.4 million or 1.8%, compared to fiscal 2012. Acquisitions added $16.8 million or 5.7%, unfavorable foreign currency translation reduced sales by $1.7 million or 0.6%, compared to fiscal 2012, with the remaining difference relating to decreases in sales from businesses not acquired in the current year. Consolidated sales from our other country operations which include Mexico, Australia and New Zealand were $69.3 million or 94.7% above fiscal year 2012. Virtually all of this increase related to our Australian and New Zealand operations acquired in fiscal 2013.
The sales product mix for fiscal 2013 was 72.1% industrial products and 27.9% fluid power products compared to 70.8% industrial and 29.2% fluid power in fiscal year 2012.
Our gross profit margin was 27.7% in fiscal 2013 versus 27.6% in fiscal 2012. The increased margins were attributable to the impact of relatively higher gross margins from acquired operations.
SD&A increased $20.5 million or 4.2% during fiscal 2013 compared to fiscal 2012, and as a percent of sales increased slightly to 20.6% from 20.5% in fiscal 2012. The increase in SD&A, along with the increase in SD&A as a percentage of sales was entirely driven by the increased SD&A and relatively higher SD&A levels from businesses acquired since the prior year period. These acquired businesses added $37.8 million of SD&A expenses.
Operating income increased $8.0 million or 4.8% to $176.4 million during fiscal 2013 from $168.4 million during fiscal 2012. As a percent of sales, operating income increased to 7.2% in fiscal 2013 from 7.1% in fiscal 2012.
Operating income as a percentage of sales for the Service Center Based Distribution segment decreased to 6.9% in fiscal 2013 from 7.1% in fiscal 2012. This decrease was attributable to an increase in SD&A in select regions in which we do business (representing an approximate 0.7% reduction in operating income as a percentage of sales) slightly offset by a less than commensurate increase in gross profit mostly due to businesses acquired since fiscal 2012 (representing an increase of approximately 0.6%).
Operating income as a percentage of sales for the Fluid Power Businesses segment decreased to 9.0% in fiscal 2013 from 9.2% in fiscal 2012. This reduction was attributable to decreases in gross profit across many of our fluid power subsidiaries (representing a decrease of approximately 0.2%).
Segment operating income was impacted by changes in the amounts and levels of expenses allocated to the segments. The expense allocations included corporate charges for working capital, logistics support and other items and impact segment gross profit and operating expense.
Interest expense, net, in fiscal 2013 remained relatively stable as compared to the 2012 fiscal year.
Other expense (income), net, represented certain non-operating items of income and expense. This was $1.4 million of income in fiscal 2013 compared to $1.6 million of expense in fiscal 2012. The 2013 fiscal year income primarily consisted of unrealized gains on investments held by non-qualified deferred compensation trusts of $1.3 million. Fiscal 2012 primarily consisted of $1.6 million of foreign currency transaction losses.
Income tax expense as a percent of income before taxes was 33.5% for fiscal 2013 and 34.8% for fiscal 2012.
The impact of lower effective tax rates in foreign jurisdictions favorably reduced our rate when compared to the U.S. federal statutory rate by 2.3%. Further reducing our rate compared to the U.S. federal statutory rate was a permanent dividend deduction benefit of 0.5% along with other items which reduced our rate by 1.0%. These reductions compared to the U.S. federal rate were offset by the impact of state and local taxes which increased the rate by 2.3%.
As a result of the factors addressed above, net income for fiscal 2013 increased $9.4 million or 8.6% from fiscal year 2012. Net income per share increased at a slightly higher rate of 9.4% due to lower weighted average shares outstanding in fiscal 2013.
At June 30, 2013, we had a total of 522 operating facilities in the United States, Puerto Rico, Canada, Mexico, Australia and New Zealand, versus 476 in the U.S., Canada, Mexico and Puerto Rico at June 30, 2012.
The number of Company employees was 5,109 at June 30, 2013 and 4,664 at June 30, 2012.

16


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 June 30, 2014 we had total debt obligations outstanding of $170.7 million. At June 30, 2013, we had no outstanding borrowings. Management expects that our existing cash, cash equivalents, funds available under the revolving credit and uncommitted shelf facilities, 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 of America. The following table shows the Company's total cash as of June 30, 2014 by geographic location; all amounts are in thousands.
Country
Amount

United Sates
$
14,472

Canada
33,566

Other Countries
23,151

Total
$
71,189

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. At June 30, 2014, all foreign earnings are considered permanently reinvested.
The Company’s working capital at June 30, 2014 was $545.2 million compared to $491.4 million at June 30, 2013. The current ratio was 2.9 to 1 at June 30, 2014 and 3.0 to 1 at June 30, 2013.
Net Cash Flows
The following table is included to aid in review of Applied’s statements of consolidated cash flows; all amounts
are in thousands.
 
Year Ended June 30,
 
2014

 
2013

 
2012

Net Cash Provided by (Used in):
 
 
 
 
 
Operating Activities
$
110,110

 
$
111,397

 
$
90,422

Investing Activities
(203,637
)
 
(78,825
)
 
(39,434
)
Financing Activities
92,142

 
(38,025
)
 
(60,816
)
Exchange Rate Effect
(590
)
 
175

 
(2,822
)
(Decrease) in Cash and Cash Equivalents
$
(1,975
)
 
$
(5,278
)
 
$
(12,650
)
In the last three fiscal years, and typically, a portion of cash generated from operations was invested in working capital, particularly receivables and inventory.
Net cash used in investing activities in fiscal 2014 included $20.2 million for capital expenditures, $10.0 million of which of which was used for the purchase of our headquarters facility, and $184.3 million for acquisitions. Capital expenditures included an insignificant amount related to the ERP project. Fiscal 2013 investing cash activities included the use of $12.2 million for capital expenditures, and $67.6 million for acquisitions. Capital expenditures included $5.6 million related to the ERP project. In fiscal 2012, net cash used in investing activities included $14.7 million for acquisitions and $26.0 million for capital expenditures.
Net cash provided by financing activities in fiscal 2014 included $100.0 million from borrowings under long term debt facilities as well as $69.0 million in borrowings under our revolving credit facility, both of which were utilized for the financing of acquisitions. These sources of cash were offset by $40.4 million for dividend payments and $36.7 million used to repurchase 759,900 shares of treasury stock. Net cash used in financing activities in fiscal 2013 included $37.2 million for dividend payments and $3.8 million related to acquisition holdback payments, partially offset by $2.6 million of excess tax benefits from share-based compensation.

17


Net cash used in financing activities in fiscal 2012 included $33.8 million for dividend payments and $31.0 million to repurchase 997,200 shares of treasury stock. These uses were partially offset by $3.7 million of excess tax benefits from share-based compensation.
The increase in dividends over the last three fiscal years is the result of regular increases in our dividend payout rates. We paid dividends of $0.96, $0.88 and $0.80 per share in fiscal 2014, 2013 and 2012, respectively.
Capital Expenditures
We expect capital expenditures for fiscal 2015 to be in the $14.5 million to $15.5 million range, primarily consisting of capital associated with additional information technology equipment and infrastructure investments. Depreciation for fiscal 2015 is expected to be in the range of $17.0 million to $18.0 million.
ERP Project
In fiscal 2011 Applied commenced its ERP (SAP) project to transform the Company's technology platforms
and enhance its business information and technology systems for future growth. We have deployed our solution
in a majority of our Canadian and all of our U.S. operations. During fiscal 2015 the Company will evaluate and determine a deployment schedule for our remaining Canadian businesses as well as refine our current business and system processes. The Company is continuing to work on the transformation of its financial and accounting systems including fixed assets, general ledger and consolidation systems and expects to complete these implementations in
fiscal year 2015.
Share Repurchases
The Board of Directors has authorized the repurchase of shares of the Company’s stock. These purchases may
be made in open market and negotiated transactions, from time to time, depending upon market conditions.
At
June 30, 2014, we had authorization to purchase an additional 381,600 shares.
In fiscal 2014, 2013 and 2012, we repurchased 759,900, 1,300 and 997,200 shares of the Company’s common stock, respectively, at an average price per share of $48.34, $40.96 and $31.12, respectively.
Borrowing Arrangements
The Company has a five-year committed revolving credit agreement with a group of banks that expires in May 2017. This agreement provides for unsecured borrowings of up to $150.0 million. We had $69.0 million in borrowings outstanding under our revolving credit agreements at June 30, 2014. No borrowings were outstanding under this agreement at June 30, 2013. Unused lines under this facility, net of outstanding letters of credit, totaled $72.3 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.
Additionally, the Company had letters of credit outstanding with a separate bank, in the amount of $1.8 million,
in order to secure certain insurance obligations.
In April 2014 the Company entered into a new $100.0 million unsecured five-year term loan with a group of banks with a final maturity date in March 2019. We have $99.4 million outstanding under this term loan at June 30, 2014.
Also in April 2014 the Company assumed $2.4 million of debt as a part of the acquisition of our headquarters facility. The 1.5% fixed interest note held by the State of Ohio Development Services Agency has a remaining term of ten years, maturing in May 2024. We had $2.3 million outstanding under this note at June 30, 2014.
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. We had no outstanding borrowings under this facility at June 30, 2014 or June 30, 2013. Subsequent to the year end, the Company borrowed $120.0 million on the uncommitted long-term financing shelf facility in order to finance acquisitions which were completed on July 1, 2014.
The revolving credit facility and uncommitted shelf facility contain restrictive covenants regarding liquidity, net worth, financial ratios, and other covenants. At June 30, 2014, the most restrictive of these covenants required that the Company have net indebtedness less than three times consolidated income before interest, taxes, depreciation and amortization. At June 30, 2014, the Company's indebtedness was less than one times consolidated income before interest, taxes, depreciation and amortization. The Company was in compliance with all covenants at June 30, 2014 and expects to remain in compliance during the terms of the agreements.

18


Accounts Receivable Analysis
The following table is included to aid in analysis of accounts receivable and the associated provision for losses on accounts receivable (all dollar amounts are in thousands):
June 30,
2014

 
2013

Accounts receivable, gross
$
386,117

 
$
337,617

Allowance for doubtful accounts
10,385

 
7,737

Accounts receivable, net
$
375,732

 
$
329,880

Allowance for doubtful accounts, % of gross receivables
2.7
%
 
2.3
%
 
 
 
 
Year Ended June 30,
2014

 
2013

Provision for losses on accounts receivable
$
3,970

 
$
2,267

Provision as a % of net sales
0.16
%
 
0.09
%
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.
We experienced higher DSO levels as well as elevated past due balances in our U.S. Service Center Based Distribution Businesses attributed to our phased deployment of SAP throughout fiscal 2014. Now that all U.S. Service Center Based Distribution Businesses are fully operational on SAP, we expect DSO and past due balances to return to more traditional levels.
On a consolidated basis, DSO was 51.4 at June 30, 2014 versus 46.4 at June 30, 2013. Accounts receivable increased 13.9% this year, compared to a 0.1% decrease in sales in the twelve months ended June 30, 2014.
We primarily attribute the increase in DSO to the timing of collections in connection with our ERP conversion.
We have increased our reserve levels consistent with this trend.
Approximately 5.7% of our accounts receivable balances are more than 90 days past due. On an overall basis, our provision for losses from uncollected receivables represents 0.16% of our sales in the year ended June 30, 2014. Historically, this percentage is around 0.15%. Our experience with accounts which have uncollected receivables was better than our historical averages in fiscal 2014. Management believes the overall receivables aging and provision for losses on uncollected receivables are at reasonable levels, and that past due balances will begin to return to levels consistent with prior years.
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 (using current costs) for the period ended June 30, 2014
was 3.8 versus 4.1 at
June 30, 2013. This decrease is due to the impact of recent acquisitions which historically have had lower inventory turnover rates, coupled with strategic inventory investments that we believe will assist with future sales growth. We believe our inventory turnover ratio in fiscal 2015 will be similar to or slightly better than our fiscal 2014 levels.

19


CONTRACTUAL OBLIGATIONS
The following table shows the approximate value of the Company’s contractual obligations and other commitments to make future payments as of June 30, 2014 (in thousands):
 
Total

 
Period Less
Than 1 yr

 
Period
2-3 yrs

 
Period
4-5 yrs

 
Period
Over 5 yrs

 
Other

Operating leases
$
83,700

 
$
27,100

 
$
32,400

 
$
15,800

 
$
8,400

 
 
Planned funding of post-retirement obligations
32,900

 
6,600

 
7,100

 
5,700

 
13,500

 
 
Unrecognized income tax benefit liabilities, including interest and penalties
2,800

 
 
 
 
 
 
 
 
 
2,800

Long term debt obligations
170,700

 
2,700

 
8,600

 
89,200

 
1,200

 
69,000

Acquisition holdback payments
21,900

 
11,600

 
10,300

 
 
 
 
 
 
Total Contractual Cash Obligations
$
312,000

 
$
48,000

 
$
58,400

 
$
110,700

 
$
23,100

 
$
71,800

Purchase orders for inventory and other goods and services are not included in our estimates as we are unable to aggregate the amount of such purchase orders that represent enforceable and legally binding agreements specifying all significant terms. The previous table includes the gross liability for unrecognized income tax benefits including interest and penalties as well as the balance outstanding under our revolving credit facility in the “Other” column as the Company is unable to make a reasonable estimate regarding the timing of cash settlements, if any, with the respective taxing authorities or lenders.
SUBSEQUENT EVENTS
On July 1, 2014, the Company acquired 100% of the outstanding stock of Knox Oil Field Supply Inc. (“Knox”), headquartered in San Angelo, Texas, for a total purchase price of $132.8 million. The Company funded the acquisition by using a $120.0 million draw on the uncommitted shelf facility with Prudential Insurance Company at a fixed interest rate of 3.19% with an average seven year life, as well as cash on hand. The financial results of the operations acquired will be included in the Service Center Based Distribution Segment from July 1, 2014.
Also on July 1, 2014, the Company acquired substantially all of the net assets of Rodamientos y Derivados del Norte S.A. de C.V., a Mexican distributor of bearings and power transmission products and related products, and Great Southern Bearings / Northam Bearings, a Western Australia distributor of bearings and power transmission products for a combined purchase price of approximate $12.8 million. The Company funded these acquisitions from borrowings under the revolving credit facility at a variable interest rate. The acquired businesses will be included in the Service Center Based Distribution Segment from July 1, 2014.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates at a specific point in time that affect the amounts reported in the consolidated financial statements and disclosed in the accompanying notes. The Business and Accounting Policies note to the consolidated financial statements describes the significant accounting policies and methods used in preparation of the consolidated financial statements. Estimates are used for, but not limited to, determining the net carrying value of trade accounts receivable, inventories, recording self-insurance liabilities and other accrued liabilities. Actual results could differ from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the consolidated financial statements.
LIFO Inventory Valuation and Methodology
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. We adopted the link chain dollar value LIFO method for accounting for U.S. inventories in fiscal 1974. Approximately 26% of our domestic inventory dollars relate to LIFO layers added in the 1970s. The excess of current cost over LIFO cost is $151.4 million as reflected in our consolidated balance sheet at June 30, 2014. The Company maintains five LIFO pools based on the following product groupings: bearings, power transmission products, rubber products, fluid power products and other products.
LIFO layers and/or liquidations are determined consistently year-to-year. See the Inventories note to the
consolidated financial statements in Item 8 under the caption "Financial Statements and Supplementary Data,
for further information.

20


Allowances for Slow-Moving and Obsolete Inventories
We evaluate the recoverability of our slow-moving or obsolete inventories at least quarterly. We estimate the recoverable cost of such inventory by product type while considering factors such as its age, historic and current demand trends, the physical condition of the inventory, as well as assumptions regarding future demand. Our ability to recover our cost for slow moving or obsolete inventory can be affected by such factors as general market conditions, future customer demand and relationships with suppliers.
Most of the products we hold in inventory have long shelf lives, are not highly susceptible to obsolescence and are eligible for return under various supplier return programs.
Allowances for Doubtful Accounts
We evaluate the collectibility of trade accounts receivable based on a combination of factors. Initially, we estimate an allowance for doubtful accounts as a percentage of net sales based on historical bad debt experience. This initial estimate is adjusted based on recent trends of certain customers and industries estimated to be a greater credit risk, trends within the entire customer pool and changes in the overall aging of accounts receivable. While we have a large customer base that is geographically dispersed, a general economic downturn in any of the industry segments in which we operate could result in higher than expected defaults, and therefore, the need to revise estimates for bad debts. Accounts are written off against the allowance when it becomes evident that collection will not occur.
As of June 30, 2014 and 2013, our allowance for doubtful accounts was 2.7% and 2.3% of gross receivables, respectively. Our provision for losses on accounts receivable was $4.0 million, $2.3 million and $3.9 million in fiscal 2014, 2013 and 2012, respectively.
Goodwill and Intangibles
Goodwill is recognized as the amount by which the cost of an acquired entity exceeds the net amount assigned to assets acquired and liabilities assumed. Goodwill for acquired businesses is accounted for using the acquisition method of accounting which requires that the assets acquired and liabilities assumed be recorded at the date of the acquisition at their respective estimated fair values. The judgments made in determining the estimated fair value assigned to each class of assets acquired, as well as the estimated life of each asset, can materially impact the net income of the periods subsequent to the acquisition through depreciation and amortization, and in certain instances through impairment charges, if the asset becomes impaired in the future. As part of acquisition accounting, we also recognize acquired identifiable intangible assets such as customer relationships, vendor relationships, trade names, and non-competition agreements apart from goodwill. Finite-lived identifiable intangibles are evaluated for impairment when changes in conditions indicate carrying value may not be recoverable. We evaluate goodwill and indefinite-lived identifiable intangibles for impairment at least annually. This evaluation 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.
Goodwill on our consolidated financial statements is related to both the Service Center Based Distribution segment and the Fluid Power Businesses segment. We believe the fair value of the reporting units within these segments are in excess of their carrying value.
Self-Insurance Liabilities
We maintain business insurance programs with significant self-insured retention covering workers’ compensation, business, automobile, general product liability and other claims. We accrue estimated losses using actuarial calculations, models and assumptions based on historical loss experience. We also maintain a self-insured health benefits plan, which provides medical benefits to U.S. based employees electing coverage. We maintain a reserve for all unpaid medical claims including those incurred but not reported based on historical experience and other assumptions. Although management believes that the estimated liabilities for self-insurance are adequate, the estimates described above may not be indicative of current and future losses. In addition, the actuarial calculations used to estimate self-insurance liabilities are based on numerous assumptions, some of which are subjective. We will continue to adjust our estimated liabilities for self-insurance, as deemed necessary, in the event that future loss experience differs from historical loss patterns.

21


Pension and Other Post-employment Benefit Plans
The measurement of liabilities related to pension plans and other post-employment benefit plans is based on management’s assumptions related to future events including interest rates, return on pension plan assets, and health care cost trend rates. We evaluate these assumptions and adjust them as necessary. Changes to these assumptions could result in a material change to the Company’s pension obligation causing a related increase or decrease in reported net operating results in the period of change in the estimate. At June 30, 2014, a 1% point change would have the following effects (in thousands):
 
One-Percentage Point
Effect of change in:
Increase

 
Decrease

Discount rate on liability
$
(1,863
)
 
$
2,211

Discount rate on net periodic benefit cost
(150
)
 
170

A 1% change in the return on assets is not material as most of the plans are non-qualified and unfunded.
Income Taxes
Deferred income taxes are recorded for estimated future tax effects of differences between the bases of assets and liabilities for financial reporting and income tax purposes, giving consideration to enacted tax laws. As of June 30, 2014, the Company had recognized $8.0 million of net deferred tax assets. Management believes that sufficient income will be earned in the future to realize its deferred income tax assets.
The realization of these deferred tax assets can be impacted by changes to tax laws, statutory tax rates and future taxable income levels.
Income taxes on undistributed earnings of non-U.S. subsidiaries are not accrued for the portion of such earnings that management considers to be permanently reinvested. At June 30, 2014, management considered all undistributed earnings of non-U.S. subsidiaries to be permanently reinvested. Undistributed earnings of non-U.S. subsidiaries totaled $134.0 million for which no provision for U.S. income tax had been made.


22


CAUTIONARY STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT
This Form 10-K, including 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 “guidance”, “expect”, “believe”, “plan”, “intend”, “will”, “should”, “could”, “would”, “anticipate”, “estimate”, “forecast”, “may”, "optimistic" 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; 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, limiting disruption to our business, 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; our ability to retain and attract qualified sales and customer service personnel and other skilled managers and professionals; our ability to identify and complete acquisitions, integrate them effectively, and realize their anticipated benefits; the variability, timing and nature 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, both enacted and under consideration, including with respect to health care and federal tax policy (e.g., 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, power outages,telecommunication outages, terrorist acts, earthquakes, extreme weather events, other natural disasters, 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 throughout our Form 10-K, as well as other of our filings with the Securities and Exchange Commission.


23


ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our market risk is impacted by changes in foreign currency exchange rates as well as changes in interest rates.
We occasionally utilize derivative instruments as part of our overall financial risk management policy, but do not use derivative instruments for speculative or trading purposes. We do not currently have any outstanding derivative instruments.
Foreign Currency Exchange Rate Risk
Because we operate throughout North America, Australia and New Zealand and approximately 17.4% of our fiscal year 2014 net sales were generated outside the United States, foreign currency exchange rates can impact our financial position, results of operations and competitive position. The financial statements of foreign subsidiaries are translated into their U.S. dollar equivalents at end-of-period exchange rates for assets and liabilities, while income and expenses are translated at average monthly exchange rates. Translation gains and losses are components of other comprehensive income (loss) as reported in the statements of consolidated comprehensive income. Transaction gains and losses arising from fluctuations in currency exchange rates on transactions denominated in currencies other than the functional currency are recognized in the statements of consolidated income as a component of other expense (income), net. Applied does not currently hedge the net investments in our foreign operations.
During the course of the fiscal year, the Canadian, Australian and New Zealand foreign exchange rates decreased in relation to the U.S. dollar by 1.9%, 1.5% and 12.7%, respectively, while the Mexican exchange rates increased in relation to the U.S. dollar by 0.2%. In the twelve months ended June 30, 2014, we experienced net foreign currency translation gains totaling $0.6 million, which were included in other comprehensive income (loss). We utilize a sensitivity analysis to measure the potential impact on earnings based on a hypothetical 10% change in foreign currency rates. A 10% strengthening from the levels experienced during the year ended June 30, 2014 of the U.S. dollar relative to foreign currencies that affect the Company would have resulted in a $1.8 million decrease in net income for the year ended June 30, 2014. A 10% weakening from the levels experienced during the year ended June 30, 2014 of the U.S. dollar relative to foreign currencies that affect the Company would have resulted in a $1.8 million increase in net income for the year ended June 30, 2014.
Interest Rate Risk
Our primary exposure to interest rate risk results from our outstanding debt obligations. The levels of fees and interest charged on our various debt facilities are based upon leverage levels and market interest rates.
Our debt facilities outstanding include our revolving credit facility, with a capacity of up to $150.0 million in borrowings and $69.0 million outstanding at June 30, 2014, our $100.0 million five year term loan facility, $99.4 million of which was outstanding at June 30, 2014, as well as $2.3 million of assumed debt from the purchase of our headquarters facility. We had total average bank borrowings of $70.5 million during fiscal 2014. The impact of a hypothetical 1.0% increase in the interest rates on our average bank borrowings would have resulted in a $0.7 million increase in interest expense. Changes in market interest rates would also impact interest rates on these facilities.
We monitor depository institutions that hold our cash and cash equivalents, primarily for safety of principal and secondarily for maximizing yield on those funds. We diversify our cash and cash equivalents among counterparties to minimize exposure to any of these entities.
For more information relating to borrowing and interest rates, see the “Liquidity and Capital Resources” section of “Management's Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and note 5 to the consolidated financial statements in Item 8. That information is also incorporated here by reference. In addition, see Item 1A, “Risk Factors,” for additional risk factors relating to our business.


24


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Report of Independent Registered Public Accounting Firm

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

We have audited the accompanying consolidated balance sheets of Applied Industrial Technologies, Inc. and subsidiaries (the "Company") as of June 30, 2014 and 2013, and the related statements of consolidated income, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 2014. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on
our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at June 30, 2014 and 2013, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2014, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of June 30, 2014, based on the criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated August 22, 2014 expressed an unqualified opinion on the Company's internal control over financial reporting.

/s/ Deloitte & Touche LLP
Cleveland, Ohio

August 22, 2014

25


STATEMENTS OF CONSOLIDATED INCOME
(In thousands, except per share amounts)

Year Ended June 30,
 
2014

 
2013

 
2012

Net Sales
 
$
2,459,878

 
$
2,462,171

 
$
2,375,445

Cost of Sales
 
1,772,952

 
1,779,209

 
1,720,973

Gross Profit
 
686,926

 
682,962

 
654,472

Selling, Distribution and Administrative, including depreciation
 
522,568

 
506,563

 
486,077

Operating Income
 
164,358

 
176,399

 
168,395

Interest Expense
 
900

 
621

 
457

Interest Income
 
(651
)
 
(456
)
 
(466
)
Other Expense (Income), net
 
(2,153
)
 
(1,431
)
 
1,578

Income Before Income Taxes
 
166,262

 
177,665

 
166,826

Income Tax Expense
 
53,441

 
59,516

 
58,047

Net Income
 
$
112,821

 
$
118,149

 
$
108,779

Net Income Per Share — Basic
 
$
2.69

 
$
2.81

 
$
2.58

Net Income Per Share — Diluted
 
$
2.67

 
$
2.78

 
$
2.54


See notes to consolidated financial statements.


26


STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(In thousands)

Year Ended June 30,
 
2014

 
2013

 
2012

Net income per the statements of consolidated income
 
$
112,821

 
$
118,149

 
$
108,779

 
 
 
 
 
 
 
Other comprehensive income (loss), before tax:
 
 
 
 
 
 
Foreign currency translation adjustments
 
629

 
(1,358
)
 
(14,471
)
Postemployment benefits:
 
 
 
 
 
 
  Actuarial gain (loss) on remeasurement
 
1,402

 
3,153

 
(5,028
)
  Reclassification of actuarial losses and prior service cost into SD&A expense and included in net periodic pension costs
 
382

 
872

 
1,123

Impact of reduction in postemployment benefit liability (as forecasted salary increases will not be realized) due to plan curtailment
 

 

 
8,860

Reclassification of prior service cost into SD&A expense upon plan curtailment
 

 

 
3,117

Unrealized gain (loss) on investment securities available for sale
 
112

 
10

 
(220
)
Total other comprehensive income (loss), before tax
 
2,525

 
2,677

 
(6,619
)
Income tax expense related to items of other comprehensive income (loss)
 
719

 
1,529

 
3,009

Other comprehensive income (loss), net of tax
 
1,806

 
1,148

 
(9,628
)
Comprehensive income
 
$
114,627

 
$
119,297

 
$
99,151


See notes to consolidated financial statements.

27


CONSOLIDATED BALANCE SHEETS
(In thousands)

June 30,
 
2014

 
2013

Assets
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
71,189

 
$
73,164

Accounts receivable, less allowances of $10,385 and $7,737
 
375,732

 
329,880

Inventories
 
335,747

 
281,417

Other current assets
 
53,480

 
52,819

Total current assets
 
836,148

 
737,280

Property — at cost
 
 
 
 
Land
 
13,212

 
10,125

Buildings
 
89,886

 
75,463

Equipment, including computers and software
 
157,370

 
155,161

Total property — at cost
 
260,468

 
240,749

Less accumulated depreciation
 
156,872

 
157,506

Property — net
 
103,596

 
83,243

Identifiable intangibles, net
 
159,508

 
91,267

Goodwill
 
193,494

 
106,849

Deferred tax assets
 
21,166

 
21,026

Other assets
 
20,257

 
19,041

Total Assets
 
$
1,334,169

 
$
1,058,706

Liabilities
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
172,401

 
$
136,575

Current portion of long term debt
 
2,720

 

Compensation and related benefits
 
55,760

 
63,899

Other current liabilities
 
60,074

 
45,426

Total current liabilities
 
290,955

 
245,900

Long-term debt
 
167,992

 

Post-employment benefits
 
23,611

 
30,919

Other liabilities
 
51,303

 
22,272

Total Liabilities
 
533,861

 
299,091

Shareholders’ Equity
 
 
 
 
Preferred stock — no par value; 2,500 shares authorized; none issued or outstanding
 

 

Common stock — no par value; 80,000 shares authorized; 54,213 shares issued
 
10,000

 
10,000

Additional paid-in capital
 
156,999

 
153,893

Retained earnings
 
896,776

 
824,362

Treasury shares — at cost (12,650 and 12,044 shares)
 
(261,852
)
 
(225,219
)
Accumulated other comprehensive income (loss)
 
(1,615
)
 
(3,421
)
Total Shareholders’ Equity
 
800,308

 
759,615

Total Liabilities and Shareholders’ Equity
 
$
1,334,169

 
$
1,058,706


See notes to consolidated financial statements.

28


STATEMENTS OF CONSOLIDATED CASH FLOWS
(In thousands)

Year Ended June 30,
 
2014

 
2013

 
2012

Cash Flows from Operating Activities
 
 
 
 
 
 
Net income
 
$
112,821

 
$
118,149

 
$
108,779

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
Depreciation and amortization of property
 
13,977

 
12,501

 
11,236

Amortization of intangibles
 
14,023

 
13,233

 
11,465

Amortization of stock appreciation rights and options
 
1,808

 
2,317

 
2,058

Deferred income taxes
 
(8,209
)
 
10,179

 
8,641

Provision for losses on accounts receivable
 
3,970

 
2,267

 
3,915

Unrealized foreign exchange transaction losses (gains)
 
204

 
(1,410
)
 
1,298

Other share-based compensation expense
 
2,703

 
3,444

 
4,308

Shares issued for deferred compensation plans
 
161

 
241

 
284

Gain on sale of property
 
(53
)
 
(321
)
 
(627
)
Changes in operating assets and liabilities, net of acquisitions:
 
 
 
 
 
 
Accounts receivable
 
(29,089
)
 
(15,721
)
 
(22,748
)
Inventories
 
(29,171
)
 
(26,745
)
 
(28,511
)
Other operating assets
 
17,966

 
(7,857
)
 
(14,735
)
Accounts payable
 
21,369

 
12,206

 
14,157

Other operating liabilities
 
(12,370
)
 
(11,086
)
 
(9,098
)
Cash provided by Operating Activities
 
110,110

 
111,397

 
90,422

Cash Flows from Investing Activities
 
 
 
 
 
 
Property purchases
 
(20,190
)
 
(12,214
)
 
(26,021
)
Proceeds from property sales
 
877

 
979

 
1,258

Net cash paid for acquisition of businesses, net of cash acquired of $1,369, $0 and $38 in 2014, 2013 and 2012, respectively
 
(184,324
)
 
(67,590
)
 
(14,671
)
Cash (used in) Investing Activities
 
(203,637
)
 
(78,825
)
 
(39,434
)
Cash Flows from Financing Activities
 
 
 
 
 
 
Net borrowings under revolving credit facility classified as long term
 
69,000

 

 

Borrowings under long term debt facilities
 
100,000

 

 

Long term debt repayment
 
(647
)
 

 

Purchases of treasury shares
 
(36,732
)
 
(53
)
 
(31,032
)
Dividends paid
 
(40,410
)
 
(37,194
)
 
(33,800
)
Excess tax benefits from share-based compensation
 
2,674

 
2,566

 
3,695

Acquisition holdback payments
 
(1,839
)
 
(3,843
)
 

Exercise of stock appreciation rights and options
 
96

 
499

 
321

Cash provided by (used in) Financing Activities
 
92,142

 
(38,025
)
 
(60,816
)
Effect of exchange rate changes on cash
 
(590
)
 
175

 
(2,822
)
(Decrease) in cash and cash equivalents
 
(1,975
)
 
(5,278
)
 
(12,650
)
Cash and cash equivalents at beginning of year
 
73,164

 
78,442

 
91,092

Cash and Cash Equivalents at End of Year
 
$
71,189

 
$
73,164

 
$
78,442

 
 
 
 
 
 
 
Supplemental Cash Flow Information
 
 
 
 
 
 
Cash paid during the year for:
 
 
 
 
 
 
Income taxes
 
$
51,548

 
$
51,816

 
$
53,463

Interest
 
1,026

 
501

 
672

See notes to consolidated financial statements.


29


STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY
(In thousands)

For the Years Ended June 30, 2014, 2013 and 2012
 
Shares of
Common
Stock
Outstanding

 
Common
Stock

 
Additional
Paid-In
Capital

 

Retained
Earnings

 
Treasury
Shares-
at Cost

 
Accumulated
Other
Comprehensive
Income (Loss)

 
Total
Shareholders'
Equity

Balance at July 1, 2011
 
42,602

 
$
10,000

 
$
148,307

 
$
668,421

 
$
(198,224
)
 
$
5,059

 
$
633,563

Net income
 
 
 
 
 
 
 
108,779

 
 
 
 
 
108,779

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
 
 
 
(9,628
)
 
(9,628
)
Cash dividends — $0.80 per share
 
 
 
 
 
 
 
(33,800
)
 
 
 
 
 
(33,800
)
Purchases of common stock for treasury
 
(997
)
 
 
 
 
 
 
 
(31,032
)
 
 
 
(31,032
)
Treasury shares issued for:
 
 
 
 
 
 
 
 
 
 
 
 
 

Exercise of stock appreciation rights and options
 
250

 
 
 
(1,853
)
 
 
 
1,448

 
 
 
(405
)
Performance share awards
 
91




(2,664
)



714




(1,950
)
Deferred compensation plans
 
9

 
 
 
128

 
 
 
156

 
 
 
284

Compensation expense — stock appreciation rights and options
 
 
 
 
 
2,058

 
 
 
 
 
 
 
2,058

Other share-based compensation expense
 
 
 
 
 
4,308

 
 
 
 
 
 
 
4,308

Other
 
12

 
 
 
(214
)
 
(40
)
 
208

 
 
 
(46
)
Balance at June 30, 2012
 
41,967

 
10,000

 
150,070

 
743,360

 
(226,730
)
 
(4,569
)
 
672,131

Net income
 
 
 
 
 
 
 
118,149

 
 
 
 
 
118,149

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
 
 
 
1,148

 
1,148

Cash dividends — $0.88 per share
 
 
 
 
 
 
 
(37,194
)
 
 
 
 
 
(37,194
)
Purchases of common stock for treasury
 
(1
)
 
 
 
 
 
 
 
(53
)
 
 
 
(53
)
Treasury shares issued for:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of stock appreciation rights and options
 
129

 
 
 
(175
)
 
 
 
1,086

 
 
 
911

Performance share awards
 
53

 
 
 
(1,675
)
 
 
 
74

 
 
 
(1,601
)
Deferred compensation plans
 
5

 
 
 
131

 
 
 
110

 
 
 
241

Compensation expense — stock appreciation rights and options
 
 
 
 
 
2,317

 
 
 
 
 
 
 
2,317

Other share-based compensation expense
 
 
 
 
 
3,444

 
 
 
 
 
 
 
3,444

Other
 
16

 
 
 
(219
)
 
47

 
294

 
 
 
122

Balance at June 30, 2013
 
42,169

 
10,000

 
153,893

 
824,362

 
(225,219
)
 
(3,421
)
 
759,615

Net income
 
 
 
 
 
 
 
112,821

 
 
 
 
 
112,821

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
 
 
 
1,806

 
1,806

Cash dividends — $0.96 per share
 
 
 
 
 
 
 
(40,410
)
 
 
 
 
 
(40,410
)
Purchases of common stock for treasury
 
(760
)
 
 
 
 
 
 
 
(36,732
)
 
 
 
(36,732
)
Treasury shares issued for:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of stock appreciation rights and options
 
76

 
 
 
849

 
 
 
324

 
 
 
1,173

Performance share awards
 
36

 
 
 
(1,062
)
 
 
 
(21
)
 
 
 
(1,083
)
Restricted stock units
 
31

 
 
 
(1,110
)
 
 
 
(247
)
 
 
 
(1,357
)
Deferred compensation plans
 
3

 
 
 
98

 
 
 
63

 
 
 
161

Compensation expense — stock appreciation rights and options
 
 
 
 
 
1,808

 
 
 
 
 
 
 
1,808

Other share-based compensation expense
 
 
 
 
 
2,703

 
 
 
 
 
 
 
2,703

Other
 
8

 
 
 
(180
)
 
3

 
(20
)
 
 
 
(197
)
Balance at June 30, 2014
 
41,563

 
$
10,000

 
$
156,999

 
$
896,776

 
$
(261,852
)
 
$
(1,615
)
 
$
800,308


See notes to consolidated financial statements.


30


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)

NOTE 1: BUSINESS AND ACCOUNTING POLICIES
Business
Applied Industrial Technologies, Inc. and subsidiaries (the “Company” or “Applied”) is a leading industrial distributor serving Maintenance Repair & Operations (MRO) and Original Equipment Manufacturer (OEM) 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 its customers. Although the Company does not generally manufacture the products it sells, it does assemble and repair certain products and systems.
Consolidation
The consolidated financial statements include the accounts of Applied Industrial Technologies, Inc. and its subsidiaries. Intercompany transactions and balances have been eliminated in consolidation. For the years ended June 30, 2013 and 2012 the financial results of the Company’s Canadian and Mexican subsidiaries were included in the consolidated financial statements for the twelve months ended May 31. During fiscal 2014, the Company eliminated the one month reporting lag for both the Canadian and Mexican subsidiaries in the first and third quarters respectively. See the "Change in Accounting Principle" section below for additional information related to the elimination of the reporting lag.
Foreign Currency
The financial statements of the Company’s Canadian, Mexican, Australian and New Zealand subsidiaries are measured using local currencies as their functional currencies. Assets and liabilities are translated into U.S. dollars at current exchange rates, while income and expenses are translated at average exchange rates. Translation gains and losses are reported in other comprehensive income (loss) in the statements of consolidated comprehensive income. Gains and losses resulting from transactions denominated in foreign currencies are included in the statements of consolidated income as a component of other expense (income), net.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the period. Actual results may differ from the estimates and assumptions used in preparing the consolidated financial statements.
Cash and Cash Equivalents
The Company considers all short-term, highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are carried at cost, which approximates fair value.
Marketable Securities
The primary marketable security investments of the Company include money market and mutual funds held in a rabbi trust for a non-qualified deferred compensation plan. These are included in other assets in the consolidated balance sheets, are classified as trading securities, and reported at fair value based on quoted market prices. Changes in the fair value of the investments during the period are recorded in other expense (income), net in the statements of consolidated income.
Concentration of Credit Risk
The Company has a broad customer base representing many diverse industries across North America, Australia and New Zealand. As such, the Company does not believe that a significant concentration of credit risk exists in its accounts receivable. The Company’s cash and cash equivalents consist of deposits with commercial banks and regulated non-bank subsidiaries. While Applied monitors the creditworthiness of these institutions, a crisis in the financial systems could limit access to funds and/or result in the loss of principal. The terms of these deposits and investments provide that all monies are available to the Company upon demand.

31


Allowances for Doubtful Accounts
The Company evaluates the collectibility of trade accounts receivable based on a combination of factors. Initially, the Company estimates an allowance for doubtful accounts as a percentage of net sales based on historical bad debt experience. This initial estimate is adjusted based on recent trends of customers and industries estimated to be greater credit risks, trends within the entire customer pool, and changes in the overall aging of accounts receivable. Accounts are written off against the allowance when it becomes evident collection will not occur. While the Company has a large customer base that is geographically dispersed, a general economic downturn in any of the industry segments in which the Company operates could result in higher than expected defaults, and therefore, the need to revise estimates for bad debts.
Inventories
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. The Company adopted the link chain dollar value LIFO method of accounting for U.S. inventories in fiscal 1974. At June 30, 2014, approximately 26% of the Company’s domestic inventory dollars relate to LIFO layers added in the 1970s. The Company maintains five LIFO pools based on the following product groupings: bearings, power transmission products, rubber products, fluid power products and other products. LIFO layers and/or liquidations are determined consistently year-to-year.
The Company evaluates the recoverability of its slow moving or obsolete inventories at least quarterly. The Company estimates the recoverable cost of such inventory by product type while considering factors such as its age, historic and current demand trends, the physical condition of the inventory, as well as assumptions regarding future demand. The Company’s ability to recover its cost for slow moving or obsolete inventory can be affected by such factors as general market conditions, future customer demand, and relationships with suppliers. Historically, the Company’s inventories have demonstrated long shelf lives, are not highly susceptible to obsolescence, and, in certain instances, can be eligible for return under supplier return programs.
Supplier Purchasing Programs
The Company enters into agreements with certain suppliers providing inventory purchase incentives. The Company’s inventory purchase incentive arrangements are unique to each supplier and are generally annual programs ending at either the Company’s fiscal year end or the supplier’s year end; however, program length and ending dates can vary. Incentives are received in the form of cash or credits against purchases upon attainment of specified purchase volumes and are received either monthly, quarterly or annually. The incentives are generally a specified percentage of the Company’s net purchases based upon achieving specific purchasing volume levels. These percentages can increase or decrease based on changes in the volume of purchases. The Company accrues for the receipt of these inventory purchase incentives based upon cumulative purchases of inventory. The percentage level utilized is based upon the estimated total volume of purchases expected during the life of the program. Supplier programs are analyzed each quarter to determine the appropriateness of the amount of purchase incentives accrued. Upon program completion, differences between estimates and actual incentives subsequently received have not been material. Benefits under these supplier purchasing programs are recognized under the Company’s LIFO inventory accounting method as a reduction of cost of sales when the inventories representing these purchases are recorded as cost of sales. Accrued incentives expected to be settled as a credit against future purchases are reported on the consolidated balance sheet as an offset to amounts due to the related supplier.
Property and Related Depreciation and Amortization
Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets and is included in selling, distribution and administrative expenses in the accompanying statements of consolidated income. Buildings, building improvements and leasehold improvements are depreciated over ten to thirty years or the life of the lease if a shorter period, and equipment is depreciated over three to ten years. The Company capitalizes internal use software development costs in accordance with guidance on accounting for costs of computer software developed or obtained for internal use. Amortization of software begins when it is ready for its intended use, and is computed on a straight-line basis over the estimated useful life of the software, generally not to exceed twelve years. Capitalized software and hardware costs are classified as property on the consolidated balance sheets. The carrying values of property and equipment are reviewed for impairment when events or changes in circumstances indicate that the recorded value cannot be recovered from undiscounted future cash flows. Impairment losses, if any, would be measured based upon the difference between the carrying amount and the fair value of the assets.

32


Goodwill and Intangible Assets
Goodwill is recognized as the excess cost of an acquired entity over the net amount assigned to assets acquired and liabilities assumed. Goodwill is not amortized. Goodwill is reviewed for impairment annually as of January 1 or whenever changes in conditions indicate an evaluation should be completed. These conditions could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. The Company utilizes discounted cash flow models and market multiples for comparable businesses to determine the fair value of reporting units. Evaluating impairment requires significant judgment by management, including estimated future operating results, estimated future cash flows, the long-term rate of growth of the business, and determination of an appropriate discount rate. While the Company uses available information to prepare the estimates and evaluations, actual results could differ significantly.
The Company recognizes acquired identifiable intangible assets such as customer relationships, trade names, vendor relationships, and non-competition agreements apart from goodwill. Customer relationship identifiable intangibles are amortized using the sum-of-the-years-digits method over estimated useful lives consistent with assumptions used in the determination of their value. Amortization of all other finite-lived identifiable intangible assets is computed using the straight-line method over the estimated period of benefit. Amortization of identifiable intangible assets is included in selling, distribution and administrative expenses in the accompanying statements of consolidated income. Identifiable intangible assets with finite lives are reviewed for impairment when changes in conditions indicate carrying value may not be recoverable. Identifiable intangible assets with indefinite lives are reviewed for impairment on an annual basis or whenever changes in conditions indicate an evaluation should be completed. The Company does not currently have any indefinite lived identifiable intangible assets.
Self-Insurance Liabilities
The Company maintains business insurance programs with significant self-insured retention covering workers’ compensation, business, automobile, general product liability and other claims. The Company accrues estimated losses including those incurred but not reported using actuarial calculations, models and assumptions based on historical loss experience. The Company, also maintains a self-insured health benefits plan, which provides medical benefits to U.S. based employees electing coverage under the plan. The Company estimates its reserve for all unpaid medical claims, including those incurred but not reported, based on historical experience, adjusted as necessary based upon management’s reasoned judgment.
Revenue Recognition
Sales are recognized when there is evidence of an arrangement, the sales price is fixed, collectibility is reasonably assured and the product’s title and risk of loss is transferred to the customer. Typically, these conditions are met when the product is shipped to the customer. The Company charges shipping and handling fees when products are shipped or delivered to a customer, and includes such amounts in net sales. The Company reports its sales net of actual sales returns and the amount of reserves established for anticipated sales returns based on historical rates. Sales tax collected from customers is excluded from net sales in the accompanying statements of consolidated income.
Shipping and Handling Costs
The Company records freight payments to third parties in cost of sales and internal delivery costs in selling, distribution and administrative expenses in the accompanying statements of consolidated income. Internal delivery costs in selling, distribution and administrative expenses were approximately $16,230, $15,560 and $15,500 for the fiscal years ended June 30, 2014, 2013 and 2012, respectively.
Income Taxes
Income taxes are determined based upon income and expenses recorded for financial reporting purposes. Deferred income taxes are recorded for estimated future tax effects of differences between the bases of assets and liabilities for financial reporting and income tax purposes, giving consideration to enacted tax laws. Uncertain tax positions meeting a more-likely-than-not recognition threshold are recognized in accordance with the Income Taxes topic of the ASC (Accounting Standards Codification). The Company recognizes accrued interest and penalties related to unrecognized income tax benefits in the provision for income taxes.

33


Share-Based Compensation
Share-based compensation represents the cost related to share-based awards granted to employees under either the 2011 Long-Term Performance Plan or the 2007 Long-Term Performance Plan. The Company measures share-based compensation cost at the grant date, based on the estimated fair value of the award and recognizes the cost over the requisite service period. Non-qualified stock appreciation rights (SARs) and stock options are granted with an exercise price equal to the closing market price of the Company’s common stock at the date of grant and the fair values are determined using a Black-Scholes option pricing model, which incorporates assumptions regarding the expected volatility, the expected option life, the risk-free interest rate and the expected dividend yield. SARs and stock option awards generally vest over four years of continuous service and have ten-year contractual terms. The fair value of restricted stock awards, restricted stock units (RSUs), and performance shares are based on the closing market price of Company common stock on the grant date.
Treasury Shares
Shares of common stock repurchased by the Company are recorded at cost as treasury shares and result in a reduction of shareholders’ equity in the consolidated balance sheets. The Company uses the weighted-average cost method for determining the cost of shares reissued. The difference between the cost of the shares and the reissuance price is added to or deducted from additional paid-in capital.
Change in Accounting Principle
Alignment of Canadian Subsidiary Reporting
Effective July 1, 2013, the Company aligned the consolidation of the Company’s Canadian subsidiary in the consolidated financial statements, which previously included the results on a one month reporting lag. The Company believes that this change in accounting principle is preferable as it provides contemporaneous reporting within our consolidated financial statements. In accordance with applicable accounting literature, the elimination of a one month reporting lag of a subsidiary is treated as a change in accounting principle and requires retrospective application. The Company has determined that the effect of this change is not material to the financial statements for all periods presented and therefore, the Company has not presented retrospective application of this change. The net impact of the lag elimination was $1,200 of income for the month of June 2013 and has been included within “Other (Income) Expense, net” on the statement of consolidated income for the year ended June 30, 2014. The statement of consolidated income for the year ended June 30, 2014 reflects the same results, had the financial statements been retrospectively adjusted, with the exception of net income which would have decreased by $1,200. Net sales, operating income and net income for the year ended June 30, 2013 would have decreased by $1,050, $600 and $500 had the financial statements been retrospectively adjusted. Net sales would have remained the same, operating income would have decreased by $250, and net income would have increased by $100 for the year ended June 30, 2012, had the financial statements been retrospectively adjusted.
Alignment of Mexican Subsidiary Reporting
Effective January 1, 2014, the Company aligned the consolidation of the Company’s Mexican subsidiary in the consolidated financial statements, which previously included the results on a one month reporting lag. The Company believes that this change in accounting principle is preferable as it provides contemporaneous reporting within our consolidated financial statements. In accordance with applicable accounting literature, the elimination of a one month reporting lag of a subsidiary is treated as a change in accounting principle and requires retrospective application. The Company has determined that the effect of this change is not material to the financial statements for all periods presented and therefore, the Company has not presented retrospective application of this change. The net impact of the lag elimination was $200 of income for the month of December 2013 and has been included within “Other (Income) Expense, net” on the statement of consolidated income for year ended June 30, 2014. Net sales, operating income and net income for the year ended June 30, 2014 would have decreased by $1,100, $100 and $250 had the financial statements been retrospectively adjusted. Net sales, operating income and net income for the year ended June 30, 2013 would have decreased by $900, $400 and $250 had the financial statements been retrospectively adjusted. Net sales would have decreased by $250, operating income would have remained the same, and net income would have increased by $100 for the year ended June 30, 2012 had the financial statements been retrospectively adjusted.
New Accounting Pronouncements
In May 2014, the FASB issued its final standard on the recognition of revenue from contracts with customers.
The standard, issued as Accounting Standards Update (ASU) 2014-09, outlines a single comprehensive model for entities to use in the accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry specific guidance. The core principle of this model is that "an entity recognizes revenue to depict the transfer of promised goods or services to a customer in an amount that

34


reflects the consideration to which the entity expects to be entitled in exchange for those goods and services." The update is effective for financial statement periods beginning after December 15, 2016, with early adoption prohibited. The Company has not determined the impact of this pronouncement on its financial statements and related disclosures.
In June 2014, the FASB issued its final standard on accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The standard, issued as (ASU) 2014-12, clarifies that a performance target that affects vesting and that can be achieved after the requisite period service period, should be treated as a performance condition. The update is effective for financial statement periods beginning after December 15, 2015, with early adoption permitted. The Company has not determined the impact of this pronouncement on its financial statements and related disclosures.
NOTE 2: BUSINESS COMBINATIONS
The operating results of all acquired entities are included within the consolidated operating results of the Company from the date of each respective acquisition.
Fiscal 2014 Acquisitions
On May 1, 2014, the Company acquired 100% of the outstanding stock of Reliance Industrial Products (“Reliance”), headquartered in Nisku, Alberta, Canada, with operations in Western Canada and the Western United States, for a total purchase price in the amount of $188,500. The primary reasons for the acquisition are to provide the Company enhanced capabilities to serve the upstream oil and gas industry in the United States and Canada. A distributor of fluid conveyance and oilfield supplies, this business is included in the Service Center Based Distribution Segment. The Company funded the acquisition by using available cash in Canada in the amount of $31,900, existing revolving credit facilities of $36,600 and a new $100,000 five year term loan facility, with the remainder of $20,000 to be paid in equal amounts as acquisition holdback payments on the first two anniversaries of the acquisition, plus interest at 2% per annum.
The following table summarizes the consideration transferred, assets acquired, and liabilities assumed in connection with the acquisition of Reliance based on their preliminary estimated fair values at the acquisition date, which are subject to adjustment:
 
Reliance Acquisition

 
2014

Accounts receivable
$
20,573

Inventories
22,932

Other current assets
6,731

Property
13,294

Identifiable intangible assets
73,211

Goodwill
79,074

Total assets acquired
215,815

Accounts payable and accrued liabilities
16,099

Deferred income taxes
19,906

Net assets acquired
$
179,810

 
 
Purchase price
$
188,477

Reconciliation of fair value transferred:
 
Cash acquired
(1,369
)
Working capital adjustments
(8,173
)
 Debt assumed
875

Total Consideration
$
179,810

None of the goodwill acquired is expected to be deductible for income tax purposes. The goodwill recognized is attributable primarily to expected synergies and other benefits that the Company believes will result from the acquisition of Reliance.

35


The Company incurred