-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VOgw1QQfEVAqgx8OQPLyJ7kCib6IeXDefCD6T5eJO52hIjAnaZDWnc59C8HviRNG mybABbQY+T7Fk/SbvbfibQ== 0000950152-06-007266.txt : 20060828 0000950152-06-007266.hdr.sgml : 20060828 20060828162219 ACCESSION NUMBER: 0000950152-06-007266 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20060630 FILED AS OF DATE: 20060828 DATE AS OF CHANGE: 20060828 FILER: COMPANY DATA: COMPANY CONFORMED NAME: APPLIED INDUSTRIAL TECHNOLOGIES INC CENTRAL INDEX KEY: 0000109563 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-MACHINERY, EQUIPMENT & SUPPLIES [5080] IRS NUMBER: 340117420 STATE OF INCORPORATION: OH FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-02299 FILM NUMBER: 061058964 BUSINESS ADDRESS: STREET 1: ONE APPLIED PLAZA CITY: CLEVELAND STATE: OH ZIP: 44115-5056 BUSINESS PHONE: 216-426-4753 MAIL ADDRESS: STREET 1: ONE APPLIED PLAZA CITY: CLEVELAND STATE: OH ZIP: 44115-5056 FORMER COMPANY: FORMER CONFORMED NAME: BEARINGS INC /OH/ DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: BROWN JIM STORES INC DATE OF NAME CHANGE: 19600201 10-K 1 l22078ae10vk.txt APPLIED INDUSTRIAL TECHNOLOGIES, INC. 10-K 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, 2006 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.)
One Applied Plaza, 3301 Euclid Avenue, 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 Preferred Stock Purchase Rights
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 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. ----- Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definitions of "accelerated filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filer X Accelerated filer Non-accelerated filer ----- ----- ----- 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, 2005): $972,335,951. 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, 2006 ----- ------------------------------ Common Stock, without par value 44,139,290
DOCUMENTS INCORPORATED BY REFERENCE Listed hereunder are the documents, portions of which are incorporated by reference, and the Parts of this Form 10-K into which such portions are incorporated: (1) Applied Industrial Technologies, Inc. Annual Report to shareholders for the fiscal year ended June 30, 2006, portions of which are incorporated by reference into Parts I, II and IV of this Form 10-K; and, (2) Applied's Proxy Statement relating to the annual meeting of shareholders to be held October 24, 2006, portions of which are incorporated by reference into Parts II, III, and IV of this Form 10-K. 1 TABLE OF CONTENTS
Page ---- CAUTIONARY STATEMENT UNDER PRIVATE SECURITIES 3 LITIGATION REFORM ACT PART I Item 1. Business 4 Item 1A. Risk Factors 10 Item 1B. Unresolved Staff Comments. 13 Item 2. Properties 13 Item 3. Legal Proceedings 15 Item 4. Submission of Matters to a Vote of Security Holders 15 EXECUTIVE OFFICERS OF THE REGISTRANT 15 PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 16 Item 6. Selected Financial Data 17 Item 7. Management's Discussion and Analysis 17 Item 7A. Quantitative and Qualitative Disclosures about Market Risk 17 Item 8. Financial Statements and Supplementary Data 18 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 19 Item 9A. Controls and Procedures 19 Item 9B. Other Information 19 PART III Item 10. Directors and Executive Officers of the Registrant 19 Item 11. Executive Compensation 20 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 20 Item 13. Certain Relationships and Related Transactions 20 Item 14. Principal Accountant Fees and Services 20 PART IV Item 15. Exhibits and Financial Statement Schedules 21 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 27 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS 28 SIGNATURES 29 EXHIBITS
2 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 "EXPECT," "BELIEVE," "PLAN," "INTEND," "WILL," "SHOULD," "COULD," "ANTICIPATE," "MAY," AND SIMILAR 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 ANY 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 ANY OTHER PERSON THAT THE RESULTS EXPRESSED IN THE STATEMENTS WILL BE ACHIEVED. IN ADDITION, APPLIED 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. APPLIED BELIEVES ITS PRIMARY RISK FACTORS INCLUDE, BUT ARE NOT LIMITED TO, THOSE IDENTIFIED IN "RISK FACTORS" AT PART I, ITEM 1A, AND IN "NARRATIVE DESCRIPTION OF BUSINESS," AT PART I, ITEM 1, SECTION (C), IN THIS ANNUAL REPORT ON FORM 10-K, AS WELL AS IN "MANAGEMENT'S DISCUSSION AND ANALYSIS" IN APPLIED'S 2006 ANNUAL REPORT TO SHAREHOLDERS. PLEASE READ THOSE DISCLOSURES CAREFULLY. 3 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. The company is one of North America's leading industrial product distributors. In addition, we provide fluid power, mechanical, and rubber shop services. We offer technical application support for our products and provide creative solutions to help customers minimize downtime and reduce overall procurement costs. Although we do not generally manufacture the products we sell, we do assemble and repair various products and systems. Our customers are primarily North American companies, who use our products to maintain and to repair their machinery and equipment. We also sell for original equipment manufacturing uses. Applied and its predecessor companies have engaged in this business since 1923, when The Ohio Ball Bearing Company was formed. Applied reincorporated in Ohio in 1988. Applied's Internet address is www.applied.com. The following documents are available free of charge at the investor relations area of our website: - Our 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, all as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission - Our Code of Business Ethics - Our Board of Directors Governance Principles and Practices - Charters for the Audit, Corporate Governance, and Executive Organization & Compensation Committees of our Board of Directors The information contained on our website is not incorporated into this annual report on Form 10-K. The documents referenced above are also available in print to any shareholder who sends a written request to our Vice President-Chief Financial Officer & Treasurer at One Applied Plaza, 3301 Euclid Avenue, Cleveland, Ohio 44115. (a) General Development of Business. In fiscal 2006, we continued to extend our geographic reach and product offerings. After making several acquisitions in recent years outside the United States, in September 2005 we acquired the assets of Spencer Industries, Inc., a fluid power distributor serving the western United States with annualized sales at the time of the acquisition of approximately $49 million. The business operates as Spencer Fluid Power. In March 2006, we acquired Minnesota Bearing Company, a distributor of bearings, power transmission components, and fluid power products with locations throughout the upper Midwest and with annualized sales at the time of the acquisition of 4 approximately $35 million. We also secured new or expanded distribution authorizations for various Parker Hannifin, Altra Industrial Motion, Rust-Oleum, 3M, and Sumitomo industrial product lines. Additional information regarding developments in our business can be found in our 2006 Annual Report to shareholders under the caption "Management's Discussion and Analysis" on pages 10 through 16, which is incorporated here by reference. (b) Financial Information about Segments. We have identified one reportable business segment, service center-based distribution. This business provides customers with a wide range of industrial products through a network of service centers stretching across North America. We also offer technical support and provide creative solutions to help customers minimize their production downtime and reduce overall procurement costs. In addition to service center-based distribution, we operate specialized fluid power companies that primarily sell products and services directly to customers rather than through the industrial product service centers. Segment financial information can be found in the 2006 Annual Report to shareholders in note 12 to the consolidated financial statements on pages 32 and 33, and that information is incorporated here by reference. (c) Narrative Description of Business. Overview. Our field operating structure is built on two primary platforms - industrial products, and fluid power products and systems: - Industrial Products. We distribute a wide range of products through our service centers in 48 states, Puerto Rico, five Canadian provinces, and six Mexican states. Customers primarily purchase our products for scheduled maintenance of their machinery and equipment and for emergency repairs. In addition, we operate regional fabricated rubber shops, which modify and repair conveyor belts and make hose assemblies in accordance with customer requirements, and rubber service field crews, which install and repair belts and rubber linings at customer locations. The industrial products business accounts for a substantial majority of our field operations and sales dollars. While the business operates in the U.S. using the Applied Industrial Technologies trade name, we also are known as Bearing & Transmission, B&T Rubber, Groupe GLM, and PV Hydraulique in Canada, Applied Mexico in Mexico, and Rafael Benitez Carrillo in Puerto Rico. 5 - Fluid Power. Our specialized fluid power businesses primarily market their products and services directly to customers, but also through the service center network. In addition to distributing fluid power components, the businesses operate shops that assemble fluid power systems and components, perform equipment repair, and offer technical advice to customers. Customers include businesses purchasing for maintenance, repair, and operations needs, as well as for original equipment manufacturing applications. Our fluid power businesses operate in various geographic areas of the U.S. and Canada under the following names: Air and Hydraulics Engineering (Southeast), Air Draulics Engineering (Mississippi Valley), Air-Hydraulic Systems (upper Midwest), Applied Engineered Systems (Midwest), Dees Fluid Power (Mid-Atlantic and Northeast), Elect-Air (West Coast), Engineered Sales (Midwest), ESI Power Hydraulics (Midwest), HyPower (western Canada), Kent Fluid Power (West Coast), and Spencer Fluid Power (Northwest and West). Products. We are one of North America's leading distributors of bearings, power transmission components, fluid power components and systems, industrial rubber products, linear components, tools, safety products, general maintenance products and a variety of mill supply products. 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 product 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. 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 own operations, could adversely affect our business. Our product suppliers generally confine their direct sales activities to large-volume transactions, mainly with 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. Of course, there is no assurance that this practice will continue, however, and its discontinuance could adversely affect our business. Net sales by product category for the most recent three fiscal years is detailed in the 2006 Annual Report to shareholders in note 12 to the consolidated financial statements on page 33, and that information is incorporated here by reference. Services. Our service center associates advise and assist customers with respect to product selection and application, and inventory management. We consider this advice and assistance to be an integral part of our sales efforts. Beyond traditional parts distribution services, we offer product and process solutions involving multiple technologies, helping to reduce production downtime, as well as overall procurement and maintenance costs for customers. By providing high levels of service, product and industry expertise, and technical support, while at the same time offering competitive pricing, we believe we develop stronger, longer-lasting, and more profitable customer relationships. 6 Our sales associates 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 and pricing information, and assist account managers in serving customers. Account managers make on-site calls to current and potential customers to provide product and price information, identify customer requirements, provide recommendations, and assist in implementing equipment maintenance and storeroom management programs, including our automated storeroom replenishment system, AppliedSTORE(R). Account managers also measure and document for customers the value of cost savings and increased productivity generated by our services and recommendations. Product and industry specialists assist with applications in their areas of technical 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 customers' immediate needs. Seven distribution centers replenish service center inventories and also may ship products directly to customers. The inventory maintained at our facilities allows us to satisfy our customers' just-in-time product needs. Timely delivery of products is an integral part of our service, particularly when customers require products for emergency repairs to their machinery or equipment. Service centers and distribution centers use the most effective method of transportation available to meet customer needs, including our own delivery vehicles, dedicated third-party transportation providers, as well as both surface and air common carrier and courier services. Customers can also pick up items at our service centers. Our information systems enhance our ability to serve customers. While we have long transacted with customers through electronic data interchange (EDI), customers can also turn to our website at www.applied.com to search for products in a comprehensive electronic database, research product attributes, view prices, check inventory levels, place orders, and track order status. We also interface with certain customers' technology platforms and plant maintenance systems. Along with our electronic capabilities, we support our service center network with paper catalogs. The Applied Maintenance America(SM) product catalog facilitates customers' purchases of general maintenance and safety products, and tools. Our Fluid Power Connection(R) catalog does the same for hydraulic and pneumatic components. Products from both specialty catalogs are also available at www.applied.com. We supplement the service center product offering with our MaintenancePro(R) 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. 7 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. We also provide field crews that install and repair 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 and 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 industrial service centers, but as product distributors, share the same focus on customer service. Product and application recommendations, inventory availability, and delivery speed are all key to the businesses' success. The fluid power businesses distinguish themselves from most component distributors by offering engineering, design, system fabrication, installation, and repair services. Each business has account managers with extensive technical knowledge, who handle sophisticated projects for customers primarily within the business's geographic region. The businesses also provide technical support to our service centers. Markets. We purchase from over 2,000 product manufacturers and resell the products to many thousands of customers in a wide variety of industries, including agriculture and food processing, automotive, chemical processing, forest products, industrial machinery and equipment, mining, primary metals, transportation, and utilities, as well as to government agencies. Customers range from the largest concerns in North America, with whom we may have multiple-location relationships, to the smallest. 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 4% 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 in our industry. Longstanding supplier and customer relationships, geographic coverage, name recognition, and our associates' experience and training 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, catalogs, online capability, and having a local presence. Our principal competitors are other bearing, power transmission, industrial rubber, fluid power, linear motion, and general maintenance and safety product distributors, and, to a lesser extent, mill supply 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. 8 Although we are one of the leading distributors in North America for the major product categories we carry, our market share for those products in any 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 our product resources and distribution network, we do not have a substantial backlog of orders, nor are backlog orders significant at any given time. Our business has exhibited minor seasonality - in particular, sales per day during the first half of our fiscal year have tended to be slightly lower compared with the second half due, in part, to the impact of customer plant shutdowns and holidays. Patents, Trademarks, and Licenses. Customer recognition of our service marks and trade names, including Applied Industrial Technologies(R), Applied(R), and AIT(R), 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 and would be adversely affected by the unavailability of raw materials to our suppliers, prolonged labor disputes experienced by suppliers or customers, or by any recession or depression that has an adverse effect on North American industrial activity generally or on key customer industries served by us. Number of Employees. On July 31, 2006, we had 4,683 employees. Working Capital. Our working capital position is discussed in "Management's Discussion and Analysis" in the 2006 Annual Report to shareholders on pages 12 through 14. We require substantial working capital related to accounts receivable and inventories. Significant amounts of inventory are carried to meet rapid delivery requirements of customers. 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. (d) Financial Information about Geographic Areas. We believe our U.S. operations' export sales during the fiscal year ended June 30, 2006, and prior fiscal years, were less than 2% of net sales, and were not concentrated in a specific geographic area. Additional information regarding our foreign operations, including information about revenues and long-lived assets, is included in the 2006 Annual Report to shareholders in note 12 to 9 the consolidated financial statements on page 33 and in "Quantitative and Qualitative Disclosures About Market Risk" on page 17 and 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. Additional risks not currently known to us, risks that could apply to any issuer, or risks that we currently deem immaterial, may also impact our business and operations. RISKS RELATED TO OUR BUSINESS LOSS OF KEY SUPPLIER AUTHORIZATIONS, LACK OF PRODUCT AVAILABILITY, OR CHANGES IN SUPPLIER DISTRIBUTION PROGRAMS COULD ADVERSELY AFFECT OUR SALES AND EARNINGS. Our business is dependent on maintaining an immediately available supply of a sufficient quantity of various products to meet customer demand. Of our overall dollar volume of product purchases in fiscal 2006, almost half was purchased from our top 10 suppliers. 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 products from these suppliers, could have a material adverse effect on our business. Supply interruptions could arise from shortages of raw materials, labor disputes or weather conditions affecting suppliers' production, transportation disruptions, or other reasons beyond our control. Furthermore, we cannot be certain that particular products will be available to us, or available in quantities sufficient to meet customer demand. Limitations on our access to products could put us at a competitive disadvantage. 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 our business. For example, key suppliers could change the prices we must pay for their products relative to other distributors or relative to competing products, geographic or product line breadth of distributor authorizations, purchase incentive programs, product purchase or stocking expectations, or other aspects of our relationships. AN INCREASE IN COMPETITION COULD DECREASE SALES OR EARNINGS. We operate in a highly competitive industry. We compete primarily with multinational, national, regional, and local 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 new market entrants may have, greater financial resources than we do. To the extent existing or future competitors seek to gain or retain market share by reducing prices, we may be required to lower our prices for products or services, thereby adversely affecting financial results. 10 INCREASES IN PRODUCT AND ENERGY COSTS COULD REDUCE OUR PROFITABILITY. Recent price increases in commodity materials, such as steel, have resulted in industrial product manufacturers increasing the prices of products we distribute. In addition, a portion of our distribution costs is comprised of fuel and freight costs, which have increased significantly in recent years. Our ability to pass on increases in our costs depends on market conditions. Raising our prices could result in decreased sales volume, which could significantly reduce our profitability. A DISRUPTION OF OUR INFORMATION SYSTEMS COULD INCREASE EXPENSES, DECREASE SALES, OR OTHERWISE REDUCE EARNINGS. Our ability to transact business has become increasingly reliant on our information systems. We depend on information systems to process customer orders, manage inventory and accounts receivable collections, purchase products, ship products to our customers on a timely basis, maintain cost-effective operations, and provide superior service to our customers. A serious, prolonged disruption of our information systems could materially impair fundamental business processes. OUR BUSINESS DEPENDS ON OUR ABILITY TO RETAIN AND ATTRACT QUALIFIED SALES AND CUSTOMER SERVICE PERSONNEL. There are significant costs associated with hiring and training sales and customer service professionals. We greatly benefit from having employees who are familiar with the products we sell and their applications, as well as our customer and supplier relationships. We could be adversely affected by a shortage of available skilled workers or the loss of a significant number of our sales or customer service professionals, including through retirement as the workforce ages. FUTURE ACQUISITIONS ARE A KEY COMPONENT OF OUR ANTICIPATED GROWTH. WE MAY NOT BE ABLE TO IDENTIFY OR COMPLETE FUTURE ACQUISITIONS, INTEGRATE THEM EFFECTIVELY INTO OUR OPERATIONS, OR REALIZE THEIR ANTICIPATED BENEFITS. Many industries we serve are mature. As a result, our growth in recent years has resulted in substantial part from the acquisition of other businesses. While we wish to continue to acquire businesses, we may not be able to identify and negotiate suitable acquisitions, obtain financing for them on satisfactory terms, or otherwise complete acquisitions in the future. In addition, existing or future competitors, including financial buyers, 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 technology, personnel, and operations in a timely and efficient manner. Further, even if we integrate successfully our operations with our acquisitions, we may not be able to realize the cost savings, sales increases, 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 reduce duplicative expenses and inventory effectively, and to consolidate facilities; the 11 incurrence of significant integration costs or charges in order to achieve those benefits; and our ability to retain key product supplier authorizations and customer relationships. In addition, future acquisitions could place significant demand on administrative, operational, and financial resources. AN INTERRUPTION OF OPERATIONS AT OUR HEADQUARTERS OR DISTRIBUTION CENTERS COULD ADVERSELY IMPACT OUR BUSINESS. Our business is highly dependent on maintaining operations at our headquarters and distribution centers. A serious, prolonged interruption of operations due to power outages, terrorist attack, earthquake, hurricane, fire, flood or other natural disaster, or other interruption could have a material adverse effect on our business and financial results. OUR GROWTH OUTSIDE THE UNITED STATES INCREASES OUR EXPOSURE TO GLOBAL ECONOMIC AND POLITICAL CONDITIONS. Our foreign operations contributed 11.3% of our sales in 2006. 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. WE ARE SUBJECT TO LITIGATION 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 business transactions. These may, for example, relate to product liability claims, commercial disputes, or employment matters. In addition, we could face claims over other matters, such as claims arising from our status as a government contractor or corporate or securities law matters. The defense and ultimate outcome of lawsuits or other legal proceedings may result in higher operating expenses, which could have a material adverse effect on our business, financial condition, or results of operations. RISKS RELATED TO OUR INDUSTRY OUR BUSINESS DEPENDS HEAVILY UPON THE OPERATING LEVELS OF OUR CUSTOMERS AND THE ECONOMIC FACTORS THAT AFFECT THEM. Some of the primary markets for the products and services we sell are subject to cyclical fluctuations that affect demand for goods that our customers produce. Consequently, the demand for our services and products has been and will continue to be influenced by most of the same economic factors that affect the demand for and production of customers' goods. When customers or prospective customers reduce their production levels in response to lower demand for their products, they have less need for our products and services. Also during periods of economic slowdown, our credit losses could increase. In addition, because some customers are moving portions of operations overseas in order to reduce manufacturing costs, our ability to continue to serve those customers may be impaired and the size of our overall market opportunity in North America may be diminished. THE CONSOLIDATION OCCURRING IN OUR CUSTOMERS' AND SUPPLIERS' INDUSTRIES COULD ADVERSELY AFFECT OUR BUSINESS AND FINANCIAL RESULTS. In recent years, we have witnessed increased consolidation among our product suppliers and customers. As customer industries consolidate, a greater proportion of our sales could be derived from larger, national contracts, which could 12 adversely impact the amount and volatility of our earnings. In addition, consolidation increases the risk of larger customers seeking to purchase industrial parts, equipment, and supplies directly from product manufacturers rather than through distributors. Similarly, continued consolidation among our product suppliers could reduce our ability to negotiate favorable pricing and other commercial terms for our inventory purchases. OTHER RISKS In addition to the risks identified above, other risks we face include, but are not limited to, the following: - changes in customer preferences for products and services of the nature and brands sold by Applied; - changes in the market prices for products and services relative to the cost of providing them; - changes in customer procurement policies and practices; - changes in product manufacturer sales policies and practices; - changes in operating expenses; - the variability and timing of new business opportunities including acquisitions, alliances, customer relationships, and supplier authorizations; - the incurrence of debt and contingent liabilities in connection with acquisitions; - our ability to access capital markets as needed; - volatility of our stock price and the resulting impact on our financial statements; - changes in accounting policies and practices; - organizational changes within the company; and, - adverse regulation and legislation. ITEM 1B. UNRESOLVED STAFF COMMENTS. Not applicable. ITEM 2. PROPERTIES. We believe that having a local presence is important to serving our customers, so we maintain service centers and other operations in local markets throughout North America. At June 30, 2006 we owned real properties at 149 locations and leased 278 locations. Certain properties house more than one company operation. Our principal owned real properties (each of which has more than 25,000 square feet of floor space) at June 30, 2006 were: 13 - the distribution center and service center in Atlanta, Georgia - the distribution center in Florence, Kentucky - the service center in Monroe, Louisiana - the service center and rubber shop in Omaha, Nebraska - the distribution center in Carlisle, Pennsylvania - the distribution center and rubber shop in Fort Worth, Texas Our principal leased real properties (each of which has more than 25,000 square feet of floor space) at June 30, 2006 were: - the corporate headquarters facility in Cleveland, Ohio - the distribution center, rubber shop, fluid power shop, and service center in Fontana, California - the rubber shop and fluid power shop in Tracy, California - the rubber shop and service center in Denver, Colorado - the service center, fluid power shop, and offices in Minneapolis, Minnesota - the fluid power shop in Billings, Montana - the distribution center in Portland, Oregon - the offices and fluid power shop in Kent, Washington - the service center in Longview, Washington - the rubber shop and the fluid power shop in Longview, Washington - the offices, service center, and rubber shop in Appleton, Wisconsin Except for those in Billings and Kent, all of the properties listed above are used in our service center-based distribution segment. The Fontana, Tracy, Minneapolis, and Longview (shops) properties are used in operations both inside and outside 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 of inventory the service center requires to meet customers' needs. We use all of our owned and leased properties except for 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. In recent years, when opening new operations, we have tended to lease rather than purchase real property. We do not consider any of our service center, distribution center, or shop properties to be material, because we believe that, if it becomes necessary or desirable to relocate an operation, other suitable property could be found. Additional information regarding our properties is included in the 2006 Annual Report to shareholders in note 11 to the consolidated financial statements on page 32, and that information is incorporated here by reference. 14 ITEM 3. LEGAL PROCEEDINGS. Applied and/or one of its subsidiaries is a party to various judicial and administrative proceedings. Based on circumstances currently known, we do not believe that any liabilities that may result from these proceedings are reasonably likely to have a material adverse effect on our consolidated financial position, results of operations, or cash flows. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of Applied's security holders during the last quarter of fiscal 2006. 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 12, 2005: David L. Pugh. Mr. Pugh is Chairman & Chief Executive Officer, and a member of our Board of Directors. He is 57 years of age. Bill L. Purser. Mr. Purser is President & Chief Operating Officer. He is 63 years of age. Todd A. Barlett. Mr. Barlett is Vice President-Acquisitions and Global Business Development (since July 2004). He had served as Vice President-Global Business Development (from 2000 to July 2004). He is 51 years of age. Fred D. Bauer. Mr. Bauer is Vice President-General Counsel (since April 2002) and Secretary (since October 2001). He had served as Vice President-Legal Services (from 2000 to April 2002) and Assistant Secretary (from 1994 to October 2001). He is 40 years of age. Michael L. Coticchia. Mr. Coticchia is Vice President-Chief Administrative Officer and Government Business (since July 2006). Prior to that, he served as Vice President-Human Resources and Administration (from April 2002 to July 2006), Vice President-Human Resources and Risk Management (from 1998 to April 2002) and Assistant Secretary (from 1990 to January 2002). He is 43 years of age. 15 Mark O. Eisele. Mr. Eisele is Vice President-Chief Financial Officer & Treasurer (since January 2004). Prior to that, he had been Vice President & Controller (from 1997 to December 2003). He is 49 years of age. James T. Hopper. Mr. Hopper is Vice President-Chief Information Officer. He is 62 years of age. Jeffrey A. Ramras. Mr. Ramras is Vice President-Marketing and Supply Chain Management (since September 2002). He had served as Vice President-Supply Chain Management (from 2000 to September 2002). He is 51 years of age. Richard C. Shaw. Mr. Shaw is Vice President-Communications and Learning. He is 57 years of age. 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 under the ticker symbol AIT. Information concerning the principal market for Applied's common stock, the quarterly stock prices and dividends for the fiscal years ended June 30, 2006, 2005, and 2004 and the number of shareholders of record as of August 15, 2006 is set forth in the 2006 Annual Report to shareholders on page 37, under the caption "Quarterly Operating Results and Market Data," and that information is incorporated here by reference. Information concerning securities authorized for issuance under Applied's equity compensation plans is incorporated by reference to Applied's proxy statement relating to the annual meeting of shareholders to be held October 24, 2006, under the caption "Equity Compensation Plan Information." The following table summarizes Applied's repurchases of its common stock in the quarter ended June 30, 2006. All of the share amounts and prices in the table and footnotes have been adjusted for the 3-for-2 stock split paid on June 15, 2006. 16
(c) Total Number of (d) Maximum Number of (a) Total (b) Average Shares Purchased as Part Shares that May Yet Be Number Price Paid of Publicly Announced Purchased Under the Plans Period of Shares per Share ($) Plans or Programs or Programs * - ------ --------- ------------- ------------------------ ------------------------- April 1, 2006 to April 30, 2006 0 -- 0 1,500,000 May 1, 2006 to May 31, 2006 226,800 25.28 226,800 1,273,200 June 1, 2006 to June 30, 2006 869,300 23.49 869,300 403,900 --------- ----- --------- --------- Total 1,096,100 23.86 1,096,100 403,900 ========= ===== ========= =========
* On January 18, 2006, the Board of Directors authorized the purchase of up to 1,500,000 shares of Applied common stock. The authorization was publicly announced that day. After 1,096,100 shares were repurchased, the Board of Directors replaced the existing authorization on July 18, 2006, again granting the company authorization to purchase up to 1,500,000 shares. The new authorization was publicly announced that day. The purchases may be made in the open market or in privately negotiated transactions. The new authorization is in effect until all shares are purchased or the authorization is revoked or amended by the Board of Directors. ITEM 6. SELECTED FINANCIAL DATA. The summary of selected financial data for the last five years is set forth in the 2006 Annual Report to shareholders in the table on pages 38 and 39 under the caption "10 Year Summary" and is incorporated here by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. "Management's Discussion and Analysis" is set forth in the 2006 Annual Report to shareholders on pages 10 through 16 and is incorporated here by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The disclosures about market risk required by this item are set forth in Applied's 2006 Annual Report to shareholders on page 17, which information is incorporated here by reference. For further information relating to borrowing and interest rates, see the Liquidity and Capital 17 Resources section of "Management's Discussion and Analysis" and Notes 6 and 7 to the consolidated financial statements in Applied's 2006 Annual Report to shareholders on pages 10-16, 26 and 27, respectively, which information is incorporated here by reference. In addition, please see "Risk Factors" at pages 10-13, above, for additional risk factors relating to our business. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The following consolidated financial statements and supplementary data of Applied and its subsidiaries and the reports of the independent registered public accounting firm listed below, which are included in the 2006 Annual Report to shareholders at the pages indicated, are incorporated here by reference and filed with this Report:
Caption Page No. - ------- -------- Financial Statements: Statements of Consolidated Income for the Years Ended June 30, 2006, 2005, and 2004 18 Consolidated Balance Sheets June 30, 2006 and 2005 19 Statements of Consolidated Cash Flows for the Years Ended June 30, 2006, 2005, and 2004 20 Statements of Consolidated Shareholders' Equity for the Years Ended June 30, 2006, 2005, and 2004 21 Notes to Consolidated Financial Statements for the Years Ended June 30, 2006, 2005, and 2004 22 - 33 Reports of Independent Registered Public Accounting Firm 34, 36 Supplementary Data: Quarterly Operating Results and Market Data 37
18 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. ITEM 9A. CONTROLS AND PROCEDURES. Management, under the supervision and with the participation of the chief executive officer and the chief financial officer, has evaluated Applied's disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the chief executive officer and chief financial officer have concluded that the disclosure controls and procedures are effective in timely alerting them to material information about Applied required to be included in our Exchange Act reports. Management's annual report on Applied's internal control over financial reporting and the attestation report of the independent registered public accounting firm are set forth in the 2006 Annual Report to shareholders on pages 35-36, and are incorporated here by reference. Management has not identified any change in internal control over financial reporting occurring during the fourth quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B. OTHER INFORMATION. Not applicable. PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by this Item as to Applied's directors is incorporated by reference to Applied's proxy statement relating to the annual meeting of shareholders to be held October 24, 2006, under the caption "Election of Directors." The information required by this Item as to Applied's executive officers has been furnished in this Report on pages 15 and 16 in Part I, after Item 4, under the caption "Executive Officers of the Registrant." The information required by this Item as to compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference to Applied's proxy statement relating to the annual meeting of shareholders to be held October 24, 2006, under the caption "Section 16(a) Beneficial Ownership Reporting Compliance." 19 Applied has a code of ethics, entitled the Code of Business Ethics, that applies to our employees, including our chief executive officer, chief operating officer, chief financial officer, and corporate controller. The Code of Business Ethics is posted at the investor relations area of our www.applied.com website. ITEM 11. EXECUTIVE COMPENSATION. The information required by this Item is incorporated by reference to Applied's proxy statement relating to the annual meeting of shareholders to be held October 24, 2006, under the captions "Compensation of Directors," "Deferred Compensation Plan for Non-Employee Directors," "Summary Compensation," "Option/SAR Grants in Last Fiscal Year," "Aggregated Option/SAR Exercises and Fiscal Year-End Option/SAR Values," "Long-Term Incentive Plans - Awards in Last Fiscal Year," "Estimated Retirement Benefits Under Supplemental Executive Retirement Benefits Plan," "Deferred Compensation Plan," and "Change in Control Agreements and Other Related Arrangements." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. Information concerning the security ownership of certain beneficial owners and management and related stockholder matters is incorporated by reference to Applied's proxy statement relating to the annual meeting of shareholders to be held October 24, 2006, under the captions "Beneficial Ownership of Certain Applied Shareholders and Management" and "Equity Compensation Plan Information." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Not applicable. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. The information required by this Item is incorporated by reference to Applied's proxy statement relating to the annual meeting of shareholders to be held October 24, 2006, under the caption "Item 2 - Ratification of Auditors." 20 PART IV. ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a)1. Financial Statements. The following consolidated financial statements, notes thereto, the reports of independent registered public accounting firm, and supplemental data are included in the 2006 Annual Report to shareholders on pages 18 - 34 and 36 - 37, and are incorporated by reference in Item 8 of this Report. Caption Statements of Consolidated Income for the Years Ended June 30, 2006, 2005, and 2004 Consolidated Balance Sheets at June 30, 2006 and 2005 Statements of Consolidated Cash Flows for the Years Ended June 30, 2006, 2005, and 2004 Statements of Consolidated Shareholders' Equity for the Years Ended June 30, 2006, 2005, and 2004 Notes to Consolidated Financial Statements for the Years Ended June 30, 2006, 2005, and 2004 Reports of Independent Registered Public Accounting Firm Supplementary Data: Quarterly Operating Results and Market Data (a)2. Financial Statement Schedule. The following report and schedule are included in this Part IV, and are found in this Report at the pages indicated:
Caption Page No. - ------- -------- Report of Independent Registered Public Accounting Firm 27 Schedule II - Valuation and Qualifying Accounts 28
21 All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission have been omitted because they are not required under the related instructions, are not applicable, or the required information is included in the consolidated financial statements and notes thereto. (a)3. Exhibits. * Asterisk indicates an executive compensation plan or arrangement.
Exhibit No. Description - ------- ----------- 3(a) Amended and Restated Articles of Incorporation of Applied Industrial Technologies, Inc., as amended on October 25, 2005 (filed as Exhibit 3(a) to the Company's Form 10-Q for the quarter ended December 31, 2005, SEC File No. 1-2299, and incorporated here by reference). 3(b) Code of Regulations of Applied Industrial Technologies, Inc., as amended on October 19, 1999 (filed as Exhibit 3(b) to Applied's Form 10-Q for the quarter ended September 30, 1999, SEC File No. 1-2299, and incorporated here by reference). 4(a) Certificate of Merger of Bearings, Inc. (Ohio) and Bearings, Inc. (Delaware) filed with the Ohio Secretary of State on October 18, 1988, including an Agreement and Plan of Reorganization dated September 6, 1988 (filed as Exhibit 4(a) to Applied's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). 4(b) Private Shelf Agreement dated as of November 27, 1996, as amended on January 30, 1998, between Applied and Prudential Investment Management, Inc. (assignee of The Prudential Insurance Company of America) (filed as Exhibit 4(f) to Applied's Form 10-Q for the quarter ended March 31, 1998, SEC File No. 1-2299, and incorporated here by reference). 4(c) Amendment dated October 24, 2000 to November 27, 1996 Private Shelf Agreement between Applied and Prudential Investment Management, Inc. (assignee of The Prudential Insurance Company of America) (filed as Exhibit 4(e) to Applied's Form 10-Q for the quarter ended September 30, 2000, SEC File No. 1-2299, and incorporated here by reference).
22 4(d) Amendment dated November 14, 2003 to 1996 Private Shelf Agreement between Applied and Prudential Investment Management, Inc. (assignee of The Prudential Insurance Company of America) (filed as Exhibit 4(d) to Applied's Form 10-Q for the quarter ended December 31, 2003, SEC File No. 1-2299, and incorporated here by reference). 4(e) Amendment dated February 25, 2004 to 1996 Private Shelf Agreement between Applied and Prudential Investment Management, Inc. (assignee of The Prudential Insurance Company of America) (filed as Exhibit 4(e) to Applied's Form 10-Q for the quarter ended March 31, 2004, SEC File No. 1-2299, and incorporated here by reference). 4(f) $100,000,000 Credit Agreement dated as of June 3, 2005, among Applied, KeyBank National Association as Agent, and various financial institutions (filed as Exhibit 4 to Applied's Form 8-K dated June 9, 2005, SEC File No. 1-2299, and incorporated here by reference). 4(g) Rights Agreement, dated as of February 2, 1998, between Applied and Computershare Investor Services LLP (successor to Harris Trust and Savings Bank), as Rights Agent, which includes as Exhibit B thereto the Form of Rights Certificate (filed as Exhibit No. 1 to Applied's Registration Statement on Form 8-A filed July 20, 1998, SEC File No. 1-2299, and incorporated here by reference). *10(a) Form of Change in Control Agreement (amended and restated as of August 8, 2001) between Applied and each of its executive officers (filed as Exhibit 10 to Applied's Form 10-Q for the quarter ended December 31, 2001, SEC File No. 1-2299, and incorporated here by reference). *10(b) A written description of Applied's director compensation program is incorporated by reference to Applied's proxy statement relating to the annual meeting of shareholders to be held October 24, 2006 under the caption, "Compensation of Directors."
23 *10(c) Applied Deferred Compensation Plan for Non-Employee Directors (September 1, 2003 Restatement) (filed as Exhibit 10(c) to Applied's Form 10-K for the year ended June 30, 2003, SEC File No. 1-2299, and incorporated here by reference). *10(d) A written description of Applied's Life and Accidental Death and Dismemberment Insurance for executive officers (filed as Exhibit 10(b) to Applied's Form 10-Q for the quarter ended December 31, 1997, SEC File No. 1-2299, and incorporated here by reference). *10(e) A written description of Applied's Long-Term Disability Insurance for executive officers (filed as Exhibit 10(c) to Applied's Form 10-Q for the quarter ended December 31, 1997, SEC File No. 1-2299, and incorporated here by reference). *10(f) Form of Director and Officer Indemnification Agreement entered into between Applied and each of its directors and executive officers (filed as Exhibit 10(g) to Applied's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). *10(g) Applied Supplemental Executive Retirement Benefits Plan (January 1, 2002 Restatement) in which current and certain former executive officers participate (filed as Exhibit 10 to Applied's Form 10-Q for the quarter ended March 31, 2002, SEC File No. 1-2299, and incorporated here by reference). *10(h) Applied Deferred Compensation Plan (September 1, 2003 Restatement) (filed as Exhibit 10(h) to Applied's Form 10-K for the year ended June 30, 2003, SEC File No. 1-2299, and incorporated here by reference). *10(i) First Amendment to the Company's Deferred Compensation Plan (September 1, 2003 Restatement) (filed as Exhibit 10 to Applied's Form 10-Q for the quarter ended December 31, 2003, SEC File No. 1-2299, and incorporated here by reference). *10(j) 1997 Long-Term Performance Plan re-adopted by Shareholders on October 22, 2002 (filed as Exhibit 10(a) to Applied's Form 10-Q for the quarter ended December 31, 1997, SEC File No. 1-2299, and incorporated here by reference). *10(k) Amendment No. 1 to 1997 Long-Term Performance Plan, effective as of August 8, 2003 (filed as Exhibit 10(j) to Applied's Form 10-K
24 for the year ended June 30, 2003, SEC File No. 1-2299, and incorporated here by reference). *10(l) Applied Supplemental Defined Contribution Plan (January 1, 1997 Restatement) (filed as Exhibit 10(m) to Applied's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). *10(m) First Amendment to Applied Supplemental Defined Contribution Plan effective as of October 1, 2000 (filed as Exhibit 10(a) to Applied's Form 10-Q for the quarter ended September 30, 2000, SEC File No. 1-2299, and incorporated here by reference). *10(n) Second Amendment to Applied Supplemental Defined Contribution Plan effective as of January 16, 2001 (filed as Exhibit 10(a) to Applied's Form 10-Q for the quarter ended March 31, 2001, SEC File No. 1-2299, and incorporated here by reference). *10(o) Form of Non-Statutory Stock Option Award Terms and Conditions (Directors) (filed as Exhibit 10 to Applied's Form 8-K dated November 30, 2005, SEC File No. 1-2299, and incorporated here by reference). *10(p) Stock Appreciation Rights Award Terms and Conditions (Officers) (filed as Exhibit 10(c) to Applied's Form 8-K dated August 9, 2005, SEC File No. 1-2299, and incorporated here by reference). *10(q) Performance Grant Terms and Conditions (filed as Exhibit 10(b) to Applied's Form 8-K dated August 8, 2006, SEC File No. 1-2299, and incorporated here by reference). *10(r) 2006 Management Incentive Plan General Terms (filed as Exhibit 10(a) to Applied's Form 8-K dated August 9, 2005, SEC File No. 1-2299, and incorporated here by reference). *10(s) 2007 Management Incentive Plan General Terms (re-filed to correct the version filed as Exhibit 10(a) to the Applied's Form 8-K dated August 8, 2006, SEC File No. 1-2299). *10(t) Non-qualified Deferred Compensation Agreement between Applied and J. Michael Moore effective as of December 31, 1997 (filed as Exhibit 10(a) to Applied's Form 10-Q for the quarter ended March 31, 1998, SEC File No. 1-2299, and incorporated here by reference).
25 10(u) Lease dated as of March 1, 1996 between Applied and the Cleveland-Cuyahoga County Port Authority (filed as Exhibit 10(n) to Applied's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). 13 Applied 2006 Annual Report to shareholders (not deemed "filed" as part of this Form 10-K except for those portions that are expressly incorporated by reference). 21 Applied's subsidiaries at June 30, 2006. 23 Consent of Independent Registered Public Accounting Firm. 24 Powers of attorney. 31 Rule 13a-14(a)/15d-14(a) certifications. 32 Section 1350 certifications.
Applied will furnish a copy of any exhibit described above and not contained herein upon payment of a specified reasonable fee which shall be limited to Applied's reasonable expenses in furnishing the exhibit. Certain instruments with respect to long-term debt have not been filed as exhibits because the total amount of securities authorized under any one of the instruments does not exceed 10 percent of the total assets of Applied and its subsidiaries on a consolidated basis. Applied agrees to furnish to the Securities and Exchange Commission, upon request, a copy of each such instrument. 26 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Applied Industrial Technologies, Inc. We have audited the consolidated financial statements of Applied Industrial Technologies, Inc. and subsidiaries (the "Company") as of June 30, 2006 and 2005, and for each of the three years in the period ended June 30, 2006, management's assessment of the effectiveness of the Company's internal control over financial reporting as of June 30, 2006, and the effectiveness of the Company's internal control over financial reporting as of June 30, 2006, and have issued our reports thereon dated August 18, 2006; such consolidated financial statements and reports are included in your 2006 Annual Report to Shareholders and are incorporated herein by reference. Our report relating to the consolidated financial statements of the Company includes an explanatory paragraph concerning the adoption of a new accounting standard effective July 1, 2005. Our audits also included the consolidated financial statement schedule of the Company listed in Item 15. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated 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. /s/ Deloitte & Touche LLP Cleveland, Ohio August 18, 2006 27 APPLIED INDUSTRIAL TECHNOLOGIES, INC. & SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED JUNE 30, 2006, 2005 AND 2004 (in thousands)
COLUMN C ------------------------- ADDITIONS COLUMN B ADDITIONS (DEDUCTIONS) COLUMN D COLUMN E BALANCE AT CHARGED TO CHARGED TO DEDUCTIONS BALANCE COLUMN A BEGINNING COSTS AND OTHER FROM AT END OF DESCRIPTION OF PERIOD EXPENSES ACCOUNTS RESERVE PERIOD ----------- ---------- ---------- ------------ ----------- --------- YEAR ENDED JUNE 30 2006: Reserve deducted from assets to which it applies - accounts receivable allowances $6,500 $1,953 ($510)(B) $1,943(A) $6,000 YEAR ENDED JUNE 30 2005: Reserve deducted from assets to which it applies - accounts receivable allowances $6,400 $1,958 $300(B) $2,158(A) $6,500 YEAR ENDED JUNE 30 2004: Reserve deducted from assets to which it applies - accounts receivable allowances $6,100 $2,525 $60(B) $2,285(A) $6,400
(A) Amounts represent uncollectible accounts charged off. (B) Amounts represent reserves for the return of merchandise by customers. SCHEDULE II SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. APPLIED INDUSTRIAL TECHNOLOGIES, INC. /s/ David L. Pugh /s/ Bill L. Purser - ------------------------------------- ---------------------------------------- David L. Pugh, Chairman & Bill L. Purser, President & Chief Executive Officer Chief Operating Officer /s/ Mark O. Eisele /s/ Daniel T. Brezovec - ------------------------------------- ---------------------------------------- Mark O. Eisele Daniel T. Brezovec Vice President-Chief Financial Corporate Controller Officer & Treasurer (Principal Accounting Officer) Date: August 28, 2006 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated. * * - ------------------------------------- ---------------------------------------- William G. Bares, Director Thomas A. Commes, Director * * - ------------------------------------- ---------------------------------------- Peter A. Dorsman, Director L. Thomas Hiltz, Director * * - ------------------------------------- ---------------------------------------- Edith Kelly-Green, Director John F. Meier, Director * /s/ David L. Pugh - ------------------------------------- ---------------------------------------- J. Michael Moore, Director David L. Pugh, Chairman & Chief Executive Officer and Director * * - ------------------------------------- ---------------------------------------- Dr. Jerry Sue Thornton, Director Peter C. Wallace, Director * - ------------------------------------- Stephen E. Yates, Director /s/ Fred D. Bauer - ------------------------------------- Fred D. Bauer, as attorney in fact for persons indicated by "*" Date: August 28, 2006 29 APPLIED INDUSTRIAL TECHNOLOGIES, INC. EXHIBIT INDEX TO FORM 10-K FOR THE YEAR ENDED JUNE 30, 2006
Exhibit No. Description - ------- ----------- 3(a) Amended and Restated Articles of Incorporation of Applied Industrial Technologies, Inc., as amended on October 25, 2005 (filed as Exhibit 3(a) to the Company's Form 10-Q for the quarter ended December 31, 2005, SEC File No. 1-2299, and incorporated here by reference). 3(b) Code of Regulations of Applied Industrial Technologies, Inc., as amended on October 19, 1999 (filed as Exhibit 3(b) to Applied's Form 10-Q for the quarter ended September 30, 1999, SEC File No. 1-2299, and incorporated here by reference). 4(a) Certificate of Merger of Bearings, Inc. (Ohio) and Bearings, Inc. (Delaware) filed with the Ohio Secretary of State on October 18, 1988, including an Agreement and Plan of Reorganization dated September 6, 1988 (filed as Exhibit 4(a) to Applied's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). 4(b) Private Shelf Agreement dated as of November 27, 1996, as amended on January 30, 1998, between Applied and The Prudential Insurance Company of America (filed as Exhibit 4(f) to Applied's Form 10-Q for the quarter ended March 31, 1998, SEC File No. 1-2299, and incorporated here by reference). 4(c) Amendment dated October 24, 2000 to November 27, 1996 Private Shelf Agreement between Applied and The Prudential Insurance Company of America (filed as Exhibit 4(e) to Applied's Form 10-Q for the quarter ended September 30, 2000, SEC File No. 1-2299, and incorporated here by reference). 4(d) Amendment dated November 14, 2003 to 1996 Private Shelf Agreement between Applied and The Prudential Insurance Company of America (filed as Exhibit 4(d) to Applied's Form 10-Q for the quarter ended December 31, 2003, SEC File No. 1-2299, and incorporated here by reference).
4(e) Amendment dated February 25, 2004 to 1996 Private Shelf Agreement between Applied and the Prudential Insurance Company of America (filed as Exhibit 4(e) to Applied's Form 10-Q for the quarter ended March 31, 2004, SEC File No. 1-2299, and incorporated here by reference). 4(f) $100,000,000 Credit Agreement dated as of June 3, 2005, among Applied, KeyBank National Association as Agent, and various financial institutions (filed as Exhibit 4 to Applied's Form 8-K dated June 9, 2005, SEC File No. 1-2299, and incorporated here by reference). 4(g) Rights Agreement, dated as of February 2, 1998, between Applied and Computershare Investor Services LLP (successor to Harris Trust and Savings Bank), as Rights Agent, which includes as Exhibit B thereto the Form of Rights Certificate (filed as Exhibit No. 1 to Applied's Registration Statement on Form 8-A filed July 20, 1998, SEC File No. 1-2299, and incorporated here by reference). *10(a) Form of Change in Control Agreement (amended and restated as of August 8, 2001) between Applied and each of its executive officers (filed as Exhibit 10 to Applied's Form 10-Q for the quarter ended December 31, 2001, SEC File No. 1-2299, and incorporated here by reference). *10(b) A written description of Applied's director compensation program is incorporated by reference to Applied's proxy statement relating to the annual meeting of shareholders to be held October 24, 2006, under the caption, "Compensation of Directors." *10(c) Applied Deferred Compensation Plan for Non-Employee Directors (September 1, 2003 Restatement) (filed as Exhibit 10(c) to Applied's Form 10-K for the year ended June 30, 2003, SEC File No. 1-2299, and incorporated here by reference). *10(d) A written description of Applied's Life and Accidental Death and Dismemberment Insurance for executive officers (filed as Exhibit 10(b) to Applied's Form 10-Q for the quarter ended December 31, 1997, SEC File No. 1-2299, and incorporated here by reference).
*10(e) A written description of Applied's Long-Term Disability Insurance for executive officers (filed as Exhibit 10(c) to Applied's Form 10-Q for the quarter ended December 31, 1997, SEC File No. 1-2299, and incorporated here by reference). *10(f) Form of Director and Officer Indemnification Agreement entered into between Applied and each of its directors and executive officers (filed as Exhibit 10(g) to Applied's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference). *10(g) Applied Supplemental Executive Retirement Benefits Plan (January 1, 2002 Restatement) in which current and certain former executive officers participate (filed as Exhibit 10 to Applied's Form 10-Q for the quarter ended March 31, 2002, SEC File No. 1-2299, and incorporated here by reference). *10(h) Applied Deferred Compensation Plan (September 1, 2003 Restatement) (filed as Exhibit 10(h) to Applied's Form 10-K for the year ended June 30, 2003, SEC File No. 1-2299, and incorporated here by reference). *10(i) First Amendment to the Company's Deferred Compensation Plan (September 1, 2003 Restatement) (filed as Exhibit 10 to Applied's Form 10-Q for the quarter ended December 31, 2003, SEC File No. 1-2299, and incorporated here by reference). *10(j) 1997 Long-Term Performance Plan re-adopted by Shareholders on October 22, 2002 (filed as Exhibit 10(a) to Applied's Form 10-Q for the quarter ended December 31, 1997, SEC File No. 1-2299, and incorporated here by reference). *10(k) Amendment No. 1 to 1997 Long-Term Performance Plan, effective as of August 8, 2003. (filed as Exhibit 10(j) to Applied's Form 10-K for the year ended June 30, 2003, SEC File No. 1-2299, and incorporated here by reference). *10(l) Applied Supplemental Defined Contribution Plan (January 1, 1997 Restatement) (filed as Exhibit 10(m) to Applied's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference).
*10(m) First Amendment to Applied Supplemental Defined Contribution Plan effective as of October 1, 2000 (filed as Exhibit 10(a) to Applied's Form 10-Q for the quarter ended September 30, 2000, SEC File No. 1-2299, and incorporated here by reference). *10(n) Second Amendment to Applied Supplemental Defined Contribution Plan effective as of January 16, 2001 (filed as Exhibit 10(a) to Applied's Form 10-Q for the quarter ended March 31, 2001, SEC File No. 1-2299, and incorporated here by reference). *10(o) Form of Non-Statutory Stock Option Award Terms and Conditions (Directors) (filed as Exhibit 10 to Applied's Form 8-K dated November 30, 2006, SEC File No. 1-2299, and incorporated here by reference). *10(p) Stock Appreciation Rights Award Terms and Conditions (Officers) (filed as Exhibit 10(c) to Applied's Form 8-K dated August 9, 2005, SEC File No. 1-2299, and incorporated here by reference). *10(q) Performance Grant Terms and Conditions (filed as Exhibit 10(b) to Applied's Form 8-K dated August 8, 2006, SEC File No. 1-2299, and incorporated here by reference). *10(r) 2006 Management Incentive Plan General Terms (filed as Exhibit 10(a) to Applied's Form 8-K dated August 9, 2005, SEC File No. 1-2299, and incorporated here by reference). *10(s) 2007 Management Incentive Plan General Terms (re-filed to correct the version filed as Exhibit 10(a) to the Applied's Form 8-K dated August 8, 2006, SEC File No. 1-2299). Attached *10(t) Non-qualified Deferred Compensation Agreement between Applied and J. Michael Moore effective as of December 31, 1997 (filed as Exhibit 10(a) to Applied's Form 10-Q for the quarter ended March 31, 1998, SEC File No. 1-2299, and incorporated here by reference). 10(u) Lease dated as of March 1, 1996 between Applied and the Cleveland-Cuyahoga County Port Authority (filed as Exhibit 10(n) to Applied's Registration Statement on Form S-4 filed May 23, 1997, Registration No. 333-27801, and incorporated here by reference).
13 Applied 2006 Annual Report to shareholders (not deemed "filed" as part of this Form 10-K except for those portions that are expressly incorporated by reference). Attached 21 Applied's subsidiaries at June 30, 2006. Attached 23 Consent of Independent Registered Public Accounting Firm. Attached 24 Powers of attorney. Attached 31 Rule 13a-14(a)/15d-14(a) certifications. Attached 32 Section 1350 certifications. Attached
EX-10.S 2 l22078aexv10ws.txt EX-10(S) EXHIBIT 10(s) 2007 Management Incentive Plan General Terms Authority The Management Incentive Plan is established by the Board's Executive Organization & Compensation Committee (the "Committee") under the 1997 Long-Term Performance Plan. Objective The plan's objective is to reward eligible participants for their contributions toward the company's fiscal year business goals. Participation The plan's participants are those employees of Applied Industrial Technologies, Inc. designated as participants by the Committee. Eligibility for Awards To be eligible for an award under the plan, assuming plan goals are met, a participant must comply with the terms and conditions of the 1997 Long-Term Performance Plan. In addition, except as provided in the 1997 Long-Term Performance Plan, the participant must be actively employed by Applied on June 30, 2007, except, - Participants retiring at age 55 or older under an Applied retirement plan are eligible for a prorated award based on date of retirement (calculated using number of quarters' and partial quarters' participation). - Participants whose employment ceases due to death or permanent and total disability are eligible for a prorated award based on date of termination (calculated using number of quarters' and partial quarters' participation). Goals The Committee establishes the plan's goals. In the event of a stock split, then all goals based on per share measures shall be equitably adjusted to give proper effect to the split. Other The Committee has the authority, subject to the plan's express provisions, to construe the plan, to establish, amend, and rescind rules and regulations relating to the plan, and to make all other determinations in the Committee's judgment necessary or desirable for the plan's administration. The Committee may correct any defect or supply any omission or reconcile any inconsistency in the plan in the manner and to the extent it shall deem expedient to carry the plan into effect. All Committee action under these provisions shall be conclusive for all purposes. EX-13 3 l22078aexv13.txt EX-13 EXHIBIT 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW With more than 4,600 associates across North America, Applied Industrial Technologies ("Applied," the "Company," "We" or "Our") is an industrial distributor that offers more than two million parts critical to the operations of MRO and OEM customers in virtually every industry. In addition, Applied provides customized mechanical, fabricated rubber and fluid power shop services, as well as storeroom management and maintenance training. The Company has a long tradition of growth dating back to 1923, the year our business was founded in Cleveland, Ohio. During fiscal 2006, business was conducted in the United States, Canada and Mexico from 452 facilities. The Company's fiscal 2006 sales, operating income and earnings per share increased 10.7%, 31.4% and 30.8%, respectively, compared to the prior year. Significant factors that contributed to these increases included the growth and improved profitability of the service center based distribution business, particularly in the U.S. and Canada, and the impact of acquired businesses. Gross margin improved 50 basis points to 27.0% as a result of improvements in customer pricing, lower net freight costs and higher levels of supplier rebates. In addition, the rate of growth in selling, distribution and administrative expense for fiscal 2006 was held to less than the rate of increase in sales. Our balance sheet remains strong as shown by the increase in our working capital from the June 30, 2005 level. Cash provided from operations was $69.9 million and reflects the Company's increased profitability. The Company also has two $100 million credit/financing agreements available to fund future acquisitions or other capital and operating requirements. Applied monitors the Purchasing Managers Index (PMI) published by the Institute for Supply Management and the Manufacturers Capacity Utilization (MCU) index published by the Federal Reserve Board and considers these indices key indicators of potential Company business environment changes. Both the PMI and the MCU continued to show a solid economy through the second half of fiscal 2006. The Company's sales activity traditionally lags these key indicators by approximately six months. Given the trend of these indicators, we expect sales improvements to continue into fiscal 2007. We anticipate our next year sales to increase in the 7% to 10% range and our gross profit percentage to be consistent with fiscal 2006 levels. In fiscal 2007, the gross profit margin will be highly dependent on our ability to manage and recover supplier price increases. We anticipate that fiscal 2007 supplier purchasing incentives will be consistent with the fiscal 2006 levels. While we consider these purchasing incentives to be compensation for various sales, marketing and logistics services performed, when they are recognized in our income statement, they are accounted for as a reduction of cost of sales as required by the Financial Accounting Standards Board ("FASB") rules. Our aim is to hold our growth in selling, distribution and administrative expenses to a rate lower than our sales growth rate, although we do plan to invest in our infrastructure to support additional growth. Our June 30, 2006 balance sheet continued to be strong and reflects the impact of another record sales year as well as the inclusion of the acquisition of two businesses during the year. The receivable and inventory increases result directly from our sales increase, anticipated future demand for our products and the impact of the acquisitions. Our working capital improved again this year through the continued management of our inventory, receivable and payable balances. YEAR ENDED JUNE 30, 2006 VS. 2005 Net sales in fiscal 2006 were $1.9 billion or 10.7% above the prior year sales. This increase was primarily due to the 7.7% improvement in our service center based distribution sales and the impact of our acquisitions. The increase in service center based distribution sales was driven by sales mix, volume, the recovery of supplier price increases, the strengthening of the Canadian currency and sales generated by acquired businesses. The majority of the increase in sales at our other businesses was attributable to the sales generated by businesses acquired during the year. The remainder of the increase reflects sales mix, pricing and volume and the impact of the strengthening of the Canadian currency. The number of sales days was the same in both annual periods. The sales product mix for fiscal 2006 was 81.8% industrial products and 18.2% fluid power products compared to 84.0% industrial and 16.0% fluid power in the prior year. Business acquisitions accounted for most of the shift in sales product mix. At June 30, 2006, the Company had a total of 452 operating facilities in the U.S., Canada and Mexico versus 440 at June 30, 2005. The net increase of 12 facilities was primarily due to the acquisition of two businesses during fiscal 2006. Industrial production in the United States continued to improve throughout the year. Our industry continued to see improvement among manufacturing customers as reflected in the PMI and MCU indices. Should the current economic trends continue, the Company would anticipate our positive financial results to continue. Gross profit margin increased to 27.0% during fiscal 2006 from 26.5% during 2005. The increase in gross profit margin during fiscal 2006 primarily reflects improved customer pricing, lower net freight costs and higher levels of supplier purchasing incentives. This increase in supplier purchasing incentives reflects the recording of certain supplier purchasing incentives during the first quarter of fiscal 2006 related to inventory purchases made in the prior year. The criteria under U.S. generally accepted accounting principles necessary to permit us to 10/11 record these supplier purchasing incentives were not met until that time. The gross profit margin was also positively impacted by LIFO inventory layer liquidations during fiscal 2006, which increased gross profit by $1.6 million. There were no LIFO layer liquidations during fiscal 2005. Selling, distribution and administrative expense ("SD&A") consists of associate compensation, benefits and other expenses associated with selling, purchasing, warehousing, supply chain management and providing marketing and distribution of the Company's products, as well as costs associated with a variety of administrative functions such as legal, human resources, information technology, treasury, accounting and facility related expenses. SD&A increased 8.6% during fiscal 2006 compared to the prior year, but decreased as a percent of sales to 21.0% from 21.4% in 2005. Approximately 40% of the fiscal 2006 increase was attributable to SD&A amounts of businesses acquired. The remainder of the increase was primarily due to increases in associate compensation tied to improved financial performance. Operating income increased 31.4% to $115.6 million during fiscal 2006 from $88.0 million during 2005. As a percent of sales, operating income increased to 6.1% in fiscal 2006 from 5.1% in 2005. The $27.6 million increase in operating income during fiscal 2006 was primarily due to the increase in gross profit generated by the service center based distribution business, reflecting the improved gross profit margin noted above on higher sales levels. Operating income was also positively impacted by the acquisition of two businesses during the current year. These increases in operating income were only partially offset by the increases in SD&A noted above. Interest expense-net decreased by 32.1% or $1.5 million during fiscal 2006 compared with the prior year, primarily due to an increase in interest income associated with higher average balances of temporary investments and higher interest rates. Other income, net, represents certain non-operating items of income and expense. The decrease in other income, net in fiscal 2006 was due to $2.9 million of life insurance settlements received during 2005 which did not recur in 2006. Income tax expense as a percentage of income before taxes was 36.1% for fiscal 2006 and 35.9% for 2005. The increase in the effective income tax rate primarily reflects the benefit of tax-free life insurance proceeds recorded during the prior year that did not recur during fiscal 2006, partially offset by lower state and local income tax rates during the current year. We expect our overall tax rate for fiscal 2007 to rise to approximately 36.5%, as some of the benefits experienced in 2006 are not expected to recur. Net income for fiscal 2006 increased $17.0 million or 30.6% from the prior year, reflecting the increases in sales and margins. Net income per share increased 30.8% to $1.57 in fiscal 2006 from $1.20 in 2005. Effective July 1, 2005, the Company closed its Denver distribution center. This was the Company's smallest distribution center and the least efficient from a cost standpoint. The Company transferred a portion of the inventory to the area service centers to provide additional local inventory resources and availability for emergency shipment needs. The remainder of the inventory was transferred to our distribution centers in Texas, California and Oregon that now service the area previously serviced out of Denver. The number of Company associates was 4,684 at June 30, 2006 and 4,441 at June 30, 2005. This increase was primarily due to business acquisitions. YEAR ENDED JUNE 30, 2005 VS. 2004 Net sales in fiscal 2005 were $1.7 billion or 13.2% above 2004's sales. This increase was primarily due to the 11.1% improvement in our U.S. service center sales and increased sales from our Canadian operations which were up approximately 34.3%. The U.S. service center sales were driven by sales mix, volume and the recovery of supplier price increases. The Canadian sales increase was also attributable to sales mix, pricing and volume as well as the impact of the strength of the Canadian currency. Also contributing to the Canadian sales increase was the inclusion of five months of operations of the Canadian distribution business acquired during fiscal 2005 as well as overall Canadian economy improvements. The overall sales increase was partially offset by one less sales day in fiscal 2005 as compared to 2004. The sales product mix for fiscal 2005 was 84.0% industrial products and 16.0% fluid power products compared to 84.4% industrial and 15.6% fluid power during 2004. There was a net increase of six facilities in the U.S., Canada and Mexico, composed of ten new or acquired locations, one closed and three merged facilities. At June 30, 2005, the Company had a total of 440 operating facilities versus 434 at June 30, 2004. Industrial production in the United States continued to improve throughout the year. Our industry continued to see strength among manufacturing customers consistent with improvement as reflected in the PMI and MCU indices. Applied Industrial Technologies, Inc. and Subsidiaries MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTINUED Gross profit margin was consistent at 26.5% in both fiscal 2005 and 2004. The impact of lower freight costs and improved shop efficiencies offset the negative pressures on gross profit margins from supplier price increases experienced mid-year. In addition, the impact of supplier purchasing incentives on margin was consistent in both fiscal 2005 and 2004. There were no LIFO layer liquidations in fiscal 2005, while in 2004 LIFO layer liquidations increased gross profit by $0.7 million. SD&A increased 4.6% during fiscal 2005 compared to the prior year, but decreased as a percent of sales to 21.4% from 23.1% in 2004. The overall increase during fiscal 2005 was primarily due to higher associate compensation costs related to the record sales and operating results and, to a lesser extent, the acquisition of a Canadian distribution business. The fiscal 2005 increases were partially offset by lower provisions for bad debts, higher gains on sales of assets and lower rent expenses. Operating income increased to $88.0 million in fiscal 2005 from $51.4 million in 2004. As a percent of sales, operating income increased to 5.1% in fiscal 2005 from 3.4% in 2004. The $36.6 million increase in operating income during fiscal 2005 was due primarily to the increase in U.S. same store sales, the increased profitability of our U.S. fluid power businesses and the continued improvement from our Canadian operations. Interest expense-net decreased to $4.7 million, or 12.6% during fiscal 2005 compared with the prior year primarily due to an increase in interest income from higher balances of temporary investments, as well as higher rates. Other income, net, represents certain non-operating items of income and expense. The fiscal 2005 amount consists primarily of $2.9 million of life insurance settlements received during the year. Income tax expense as a percentage of income before taxes was 35.9% for fiscal 2005 and 32.3% for 2004. The fiscal 2004 rate was unusually low due to the recording of non-recurring tax benefits from a settlement with the Internal Revenue Service. Net income for fiscal 2005 increased $23.9 million or approximately 75.8% from prior years' income. Overall, net income per share increased 69.0% to $1.20 in fiscal 2005 from $0.71 in 2004. The Company had 4,441 associates at June 30, 2005 and 4,323 at June 30, 2004. LIQUIDITY AND CAPITAL RESOURCES Cash flows from operations depend primarily upon generating operating income, controlling investment in inventories and receivables, and managing the timing of payments to suppliers. The Company continues to monitor and control its investments in inventories and receivables by taking advantage of supplier purchasing programs, making internal information system enhancements and accelerating receivables collection through improvements in invoice delivery, customer communications and expanded external collection efforts. The Company generated $69.9 million of cash from operating activities during fiscal 2006, $81.0 million during 2005 and $40.9 million during 2004. Cash provided from operations in fiscal 2006 benefited from our strong operating results. Operating cash flow was also impacted in fiscal 2006 as increased sales resulted in higher receivables balances, although the increase was at a rate less than the sales increase - reflecting our improved DSO. The entire increase in inventory balances pertained to the acquisitions made during the year. Cash flows from operations were also impacted by the timing of certain income tax and service provider payments. Also impacting the current year operating cash flow was an accounting classification change as required under SFAS No. 123(R) related to tax benefits received from the exercise of stock awards (see Note 1 for a discussion). In fiscal 2006, these tax benefits were shown as a financing activity. In prior years, the benefit was included as an operating activity. The cash generated from operating activities in fiscal 2005 improved from 2004 due primarily to the improved operating results and the timing of payments to suppliers. Cash used by investing activities was $37.9 million during fiscal 2006, $12.5 million during 2005 and $15.9 million during 2004. Cash was primarily used for acquisitions and property purchases in each of these years. In fiscal 2006, the Company acquired two U.S. distributors for $27.7 million, net of cash acquired, compared to $5.9 million, net of cash acquired, in the prior year. Property purchases consisted primarily of computers and information technology equipment. For fiscal 2007, our property purchases are expected to be in the $10 million to $12 million range, consisting primarily of additional computers, information system technology and infrastructure investments. Depreciation for fiscal 2007 is expected to be in the range of $12.5 million to $13.5 million. Cash used in financing activities was $53.8 million during fiscal 2006, $11.7 million during 2005 and $10.1 million during 2004. The increased cash used in financing activities was primarily due to greater numbers of treasury shares purchased and increases in the 12/13 dividend rate. Over the last three fiscal years, the Company repurchased 2.4 million, 0.9 million and 0.7 million shares of the Company's common stock at an average price per share of $23.05, $16.04 and $9.70, respectively. The Company has also increased the quarterly dividend rate four times over the last two fiscal years to a quarterly rate of $0.12 per share. This represents a 125.0% increase compared to the quarterly dividend rate at the end of fiscal 2004. The amount of the dividend paid is recommended quarterly by management and approved by the Company's Board of Directors based on judgment, financial performance and cash flow and payout guidelines consistent with other industrial companies. Partially offsetting the current year use of cash for financing activities was the accounting change, noted above, related to the classification of tax benefits from share-based compensation as a source of cash in the financing area of the cash flow statement. In accordance with the accounting rules, these tax benefits were considered an operating cash flow in prior periods. The following table shows the Company's approximate obligations and commitments to make future payments under contractual obligations as of June 30, 2006 (in thousands):
Period Less Period Period Period Total Than 1 yr. 1-3 yrs. 4-5 yrs. over 5 yrs. -------- ----------- -------- -------- ----------- Operating leases $ 66,100 $17,900 $24,000 $11,100 $13,100 Interest payments on debt 14,000 5,300 5,700 3,000 Planned funding of postretirement obligations 35,700 1,600 9,800 16,400 7,900 Long-term debt 75,000 50,000 25,000 -------- ------- ------- ------- ------- Total Contractual Cash Obligations $190,800 $24,800 $89,500 $55,500 $21,000 ======== ======= ======= ======= =======
Purchase orders for inventory and other goods and services are not included in our estimates, as purchase orders generally represent authorizations to buy rather than binding agreements. The Board of Directors has authorized the repurchase of shares of the Company's common stock, at the Company's discretion, to fund benefit programs, equity award programs, and future business acquisitions. These purchases may be made in open market and negotiated transactions, from time-to-time, depending upon market conditions. At June 30, 2006, the Company had authorization to purchase an additional 403,900 shares. In July 2006, the Board of Directors replaced the existing authorization, granting the Company authorization to purchase up to 1.5 million shares of the Company's common stock. Capital resources are obtained from income retained in the business, borrowings under the Company's revolving credit agreement and long-term debt facilities, and from operating lease arrangements. See Note 6 to the consolidated financial statements for details regarding the outstanding debt amounts as of June 30, 2006 and 2005. The average long-term borrowings totaled $75.0 million during fiscal 2006, 2005 and 2004. One-third of the Company's outstanding debt has been converted from fixed rate U.S. dollar denominated debt to fixed rate Canadian dollar denominated debt through the use of a cross currency swap. As such, the consolidated interest expense is affected by changes in the exchange rates of U.S. and Canadian dollars (see Note 7 to the consolidated financial statements). The weighted average interest rate on borrowings under our long-term debt agreements, net of the benefits from interest rate swaps, was 6.7%, 6.5% and 6.3% in fiscal 2006, 2005 and 2004, respectively. The increase in the weighted average interest rate reflects the impact of the strengthening of the Canadian dollar during fiscal 2006 and 2005. The Company terminated its interest rate swap agreements for favorable settlements in prior years. The settlement gains are being amortized as a reduction in interest expense of $0.8 million per year over the remaining life of the notes through December 2007. The Company manages interest rate risk through the use of a combination of fixed rate long-term debt, variable rate borrowings under its committed revolving credit agreement and interest rate swaps. At June 30, 2006, the Company had no variable rate debt or interest rate swaps outstanding. See Note 7 to the consolidated financial statements "Risk Management Activities" for additional discussion on the Company's derivative activities. The Company's working capital at June 30, 2006 was $370.0 million compared to $345.8 million at June 30, 2005. The current ratio was 3.0 at June 30, 2006 and 2.9 at June 30, 2005. The increase in working capital at June 30, 2006 was primarily due to the increase in receivables and inventory associated with the expansion of our business and the timing of certain income tax and service provider payments. Applied Industrial Technologies, Inc. and Subsidiaries MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTINUED The Company has a five-year committed revolving credit agreement expiring in June 2010. This agreement provides for unsecured borrowings of up to $100.0 million. The Company had no borrowings outstanding under this facility at June 30, 2006. Unused lines under this facility, net of outstanding letters of credit, totaling $92.3 million are available to fund future acquisitions or other capital and operating requirements. The Company also has an uncommitted long-term financing shelf facility, expiring in February 2007, that enables the Company to borrow up to $100.0 million at its discretion with terms of up to twelve years. The Company had no outstanding borrowings under this facility at June 30, 2006. The aggregate annual maturities of long-term debt are $50.0 million in fiscal 2008 and $25.0 million in fiscal 2011. Management expects that cash provided from operations, available credit facilities and the use of operating leases will be sufficient to finance normal working capital needs, 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. 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. Note 1 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 receivables, inventories, supplier rebates receivable, goodwill, other long-lived assets, 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 U.S. inventories are valued at the lower of cost or market, using the last-in, first-out (LIFO) method, and foreign inventories are valued using the average cost method. The Company adopted the link chain dollar value LIFO method for accounting for U.S. inventories in fiscal 1974. Approximately half of our inventory dollars relate to LIFO layers added in the 1970s which results in a $137.6 million excess of current cost over LIFO cost as reflected on our consolidated balance sheet at June 30, 2006. 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 in a manner which is in accordance with the guidance in the 1984 AICPA LIFO Issues Paper, "Identification and Discussion of Certain Financial Accounting and Reporting Issues Concerning LIFO Inventories." See Note 3 to the consolidated financial statements for further information regarding inventories. ALLOWANCES FOR SLOW-MOVING AND OBSOLETE INVENTORIES 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, most of the Company's inventories have demonstrated long shelf lives, are not highly susceptible to obsolescence and are eligible for return under various supplier return programs. 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 certain customers and industries estimated to be a greater credit risk, trends within the entire customer pool and as a result of changes in the overall aging of accounts receivable. 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. IMPAIRMENT OF PROPERTY & EQUIPMENT, GOODWILL AND OTHER INTANGIBLE ASSETS The Company evaluates property and equipment, goodwill and other intangible assets for potential impairment indicators. The Company's judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operational performance. Future events could cause the Company to conclude that impairment indicators exist and that assets associated with a particular operation are impaired. Evaluating the impairment also requires the Company to estimate future operating results and cash flows which require judgment by management. Any resulting impairment loss could have a material adverse impact on the Company's financial condition and results of operations. The Company performs an annual test of impairment on its goodwill as of January 1 or whenever conditions would 14/15 indicate an evaluation should be completed. The Company also reviews its long-lived assets for impairment whenever conditions would indicate an evaluation should be completed. The Company utilizes discounted cash flow models and market multiples for comparable businesses to determine fair value used in the goodwill impairment evaluation. Management's estimates of fair value are based upon factors such as projected future sales, price increases, and other uncertain elements requiring significant judgments. While the Company uses available information to prepare its estimates and to perform impairment evaluations, actual results could differ significantly, resulting in future impairment and losses related to recorded balances. As of June 30, 2006 and 2005, the Company had $66.8 million and $55.0 million, respectively, of goodwill and other intangibles, representing the costs of acquisitions in excess of fair values assigned to the underlying net assets of acquired companies. The Company also had $70.8 million and $71.4 million in net property and equipment recorded as of June 30, 2006 and 2005, respectively. Based upon the Company's analysis, management believes these assets were not impaired as of June 30, 2006. SUPPLIER PURCHASING PROGRAMS The Company enters into agreements with certain suppliers that provide for inventory purchase incentives. Although these agreements are unique to each supplier, they are generally annual programs that provide for purchase incentives to be earned upon achieving specified purchase volumes. 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 actual cumulative purchases of inventory and expected total purchases through the life of the program. Each supplier program is analyzed at least quarterly to determine the appropriateness of the amount estimated to be received. Differences between our estimates and actual incentives subsequently received have not been material. All 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. The Company's accounting for inventory purchase incentives is in accordance with guidance issued by the FASB in EITF 02-16, "Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor." While management believes the Company will continue to receive inventory purchase incentives, there can be no assurance that suppliers will continue to provide comparable amounts of incentives in the future. SELF-INSURANCE LIABILITIES The Company maintains business insurance programs with significant self-insured retention, which cover workers' compensation, business automobile and general product liability claims. The Company accrues estimated losses using actuarial calculations, models and assumptions based on historical loss experience. The Company maintains a self-insured health benefits plan, which provides medical benefits to employees electing coverage under the plan. The Company maintains a reserve for incurred but not reported medical claims based on historical experience and other assumptions. The Company utilizes independent actuarial firms to assist in determining the adequacy of all self-insurance liability reserves. 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. The Company will continue to adjust its estimated liabilities for self-insurance, as deemed necessary, in the event that future loss experience differs from historical loss patterns. PENSION & OTHER POSTEMPLOYMENT 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, rate of compensation increases, and healthcare cost trend rates. The Company evaluates these assumptions and adjusts them as necessary. INCOME TAXES As of June 30, 2006, the Company had recognized $19.7 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. Applied Industrial Technologies, Inc. and Subsidiaries MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTINUED NEW ACCOUNTING PRONOUNCEMENTS In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"). FIN 48, which is an interpretation of SFAS No. 109, "Accounting for Income Taxes," provides guidance on the manner in which tax positions taken or to be taken on tax returns should be reflected in an entity's financial statements prior to their resolution with taxing authorities. The Company is required to adopt FIN 48 during the first quarter of fiscal 2008. The Company is currently evaluating the requirements of FIN 48 and has not yet determined the impact, if any, this interpretation will have on its consolidated financial statements. OTHER MATTERS In each of the past three fiscal years, the Company has acquired distributors thereby extending its business over a broader geographic area. In fiscal 2006, the Company acquired two U.S. based distributors of industrial and fluid power products for a combined purchase price of $28.6 million. In 2005, the Company acquired a Canadian distributor of industrial products for a purchase price of $6.6 million and in 2004 acquired a Mexican distributor of industrial products for a price of $2.8 million. Results of operations of all of the above acquisitions, which have all been accounted for as purchases, are included in the accompanying consolidated financial statements from their respective acquisition dates. The results of operations for these acquisitions are not material for all years presented. CAUTIONARY STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT This Annual Report to Shareholders, 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 "expect," "believe," "plan," "intend," "will," "should," "could," "anticipate" and similar expressions. 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. Accordingly, actual results may differ materially from those expressed in the forward-looking statements, and the making of such 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 undertakes no obligation publicly to update or revise any forward-looking statements, whether because of new information or events, or otherwise. 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; reduced demand for our products in targeted markets due to reasons including consolidation in customer industries and the transfer of manufacturing capacity to foreign countries; changes in customer preferences for products and services of the nature and brands sold by us; changes in customer procurement policies and practices; changes in the price for products and services relative to the cost of providing them; loss of key supplier authorizations, lack of product availability, or changes in supplier distribution programs; competitive pressures; the cost of products and energy and other operating costs; disruption of our information systems; our ability to retain and attract qualified sales and customer service personnel; our ability to identify and complete future acquisitions, integrate them effectively into our operations, and realize their anticipated benefits; disruption of operations at our headquarters or distribution centers; risks and uncertainties associated with our foreign operations, including more volatile economic conditions, political instability, cultural and legal differences, and currency exchange fluctuations; risks related to legal proceedings to which we are a party; the variability and timing of new business opportunities including acquisitions, alliances, customer relationships, and supplier authorizations; the incurrence of debt and contingent liabilities in connection with acquisitions; our ability to access capital markets as needed; changes in accounting policies and practices; organizational changes within the Company; the volatility of our stock price and the resulting impact on our financial statements; adverse regulation and legislation; and the occurrence of extraordinary events (including prolonged labor disputes, natural events and acts of god, terrorist acts, fires, floods, and accidents). Other factors and unanticipated events could also adversely affect our business, financial condition, or results of operations. We discuss certain of these matters more fully above in "Management's Discussion and Analysis" as well as other of our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended June 30, 2006. 16/17 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has evaluated its exposure to various market risk factors, including but not limited to, interest rate, foreign currency exchange and commodity price risks. The Company is primarily affected by market risk exposure through the effect of changes in interest rates and, to a lesser extent, through the change in exchange rates. The Company manages interest rate risk through the use of a combination of fixed rate long-term debt, variable rate borrowings under its committed revolving credit agreement and interest rate swaps. The Company had no variable rate borrowings under its committed revolving credit agreement and no interest rate swap agreements outstanding at June 30, 2006. All the Company's outstanding debt is currently at fixed interest rates at June 30, 2006 and scheduled for repayment in December 2007 and beyond. The Company mitigates its foreign currency exposure from the Canadian dollar through the use of cross currency swap agreements as well as foreign-currency denominated debt. Hedging of the U.S. dollar denominated debt, used to fund a substantial portion of the Company's net investment in its Canadian operations, is accomplished through the use of cross currency swaps. Any gain or loss on the hedging instrument offsets the gain or loss on the underlying debt. Translation exposures with regard to our Mexican business are not hedged, as our Mexican activity is not material. For the year ended June 30, 2006, a uniform 10% strengthening of the U.S. dollar relative to foreign currencies that affect the Company would have resulted in a $0.7 million decrease in net income. A uniform 10% weakening of the U.S. dollar would have resulted in a $0.7 million increase in net income. Applied Industrial Technologies, Inc. and Subsidiaries STATEMENTS OF CONSOLIDATED INCOME (In thousands, except per share amounts)
Year Ended June 30, 2006 2005 2004 - ------------------- ---------- ---------- ---------- NET SALES $1,900,780 $1,717,055 $1,517,004 COST OF SALES 1,386,895 1,262,206 1,114,861 ---------- ---------- ---------- 513,885 454,849 402,143 SELLING, DISTRIBUTION AND ADMINISTRATIVE 398,293 366,881 350,695 ---------- ---------- ---------- OPERATING INCOME 115,592 87,968 51,448 ---------- ---------- ---------- INTEREST EXPENSE 5,523 5,816 5,814 INTEREST INCOME (2,313) (1,086) (405) OTHER INCOME, NET (717) (3,101) (432) ---------- ---------- ---------- 2,493 1,629 4,977 ---------- ---------- ---------- INCOME BEFORE INCOME TAXES 113,099 86,339 46,471 ---------- ---------- ---------- INCOME TAX EXPENSE 40,800 31,000 15,000 ---------- ---------- ---------- NET INCOME $ 72,299 $ 55,339 $ 31,471 ========== ========== ========== NET INCOME PER SHARE - BASIC $ 1.62 $ 1.24 $ 0.73 ========== ========== ========== NET INCOME PER SHARE - DILUTED $ 1.57 $ 1.20 $ 0.71 ========== ========== ==========
See notes to consolidated financial statements. Applied Industrial Technologies, Inc. and Subsidiaries 18/19 CONSOLIDATED BALANCE SHEETS (In thousands)
June 30, 2006 2005 - -------- -------- -------- ASSETS Current assets Cash and cash equivalents $106,428 $127,136 Accounts receivable, less allowances of $ 6,000 and $6,500 231,524 202,226 Inventories 190,537 175,533 Other current assets 29,955 22,606 -------- -------- Total current assets 558,444 527,501 -------- -------- Property - at cost Land 10,916 10,939 Buildings 68,136 66,834 Equipment 107,230 100,287 -------- -------- 186,282 178,060 Less accumulated depreciation 115,488 106,619 -------- -------- Property - net 70,794 71,441 -------- -------- Goodwill 57,222 51,083 Other assets 44,211 40,145 -------- -------- TOTAL ASSETS $730,671 $690,170 ======== ======== LIABILITIES Current liabilities Accounts payable $109,440 $ 99,047 Compensation and related benefits 54,852 51,971 Other current liabilities 24,139 30,677 -------- -------- Total current liabilities 188,431 181,695 Long-term debt 76,186 76,977 Other liabilities 51,232 38,211 -------- -------- TOTAL LIABILITIES 315,849 296,883 -------- -------- 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 122,146 103,240 Income retained for use in the business 408,847 354,521 Treasury shares - at cost (10,146 and 9,211 shares) (130,967) (72,660) Unearned restricted common stock compensation (825) Accumulated other comprehensive income (loss) 4,796 (989) -------- -------- TOTAL SHAREHOLDERS' EQUITY 414,822 393,287 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $730,671 $690,170 ======== ========
See notes to consolidated financial statements. Applied Industrial Technologies, Inc. and Subsidiaries STATEMENTS OF CONSOLIDATED CASH FLOWS (In thousands)
Year Ended June 30, 2006 2005 2004 - ------------------- -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 72,299 $ 55,339 $ 31,471 Adjustments to reconcile net income to cash provided by operating activities: Depreciation 13,128 13,832 14,381 Deferred income taxes 1,000 (3,900) (5,700) Stock-based compensation and amortization of intangibles and other assets 4,158 3,429 2,483 Provision for losses on accounts receivable 1,953 1,958 2,527 (Gain) loss on sale of property (294) (1,427) 13 Amortization of gain on interest rate swap terminations (791) (790) (791) Treasury shares contributed to employee benefit and deferred compensation plans 8,937 9,506 6,497 Changes in current assets and liabilities, net of acquisitions: Accounts receivable (17,067) (9,594) (17,443) Inventories 2,103 (10,360) 4,208 Other current assets (8,514) (2,658) (11,114) Accounts payable 2,223 22,510 7,597 Accrued expenses (9,282) 3,189 6,734 -------- -------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES 69,853 81,034 40,863 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Property purchases (11,057) (9,208) (14,383) Proceeds from property sales 1,244 4,020 1,374 Net cash paid for acquisition of businesses, net of cash acquired of $968 in 2006 and $815 in 2004 (27,672) (5,914) (1,285) Deposits and other (429) (1,437) (1,575) -------- -------- -------- NET CASH USED IN INVESTING ACTIVITIES (37,914) (12,539) (15,869) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Repayments under revolving credit agreements - net (2,850) Purchases of treasury shares (54,778) (14,596) (6,336) Dividends paid (17,973) (12,740) (9,273) Excess tax benefits from share-based compensation 16,400 Exercise of stock options 2,569 15,590 8,336 -------- -------- -------- NET CASH USED IN FINANCING ACTIVITIES (53,782) (11,746) (10,123) -------- -------- -------- EFFECT OF EXCHANGE RATE CHANGES ON CASH 1,135 720 (283) -------- -------- -------- (Decrease) increase in cash and cash equivalents (20,708) 57,469 14,588 Cash and cash equivalents at beginning of year 127,136 69,667 55,079 -------- -------- -------- CASH AND CASH EQUIVALENTS AT END OF YEAR $106,428 $127,136 $ 69,667 ======== ======== ======== SUPPLEMENTAL CASH FLOW INFORMATION Cash paid during the year for: Income taxes $ 31,337 $ 29,624 $ 20,434 Interest $ 5,290 $ 5,343 $ 5,379
See notes to consolidated financial statements. Applied Industrial Technologies, Inc. and Subsidiaries 20/21 STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY (In thousands, except per share amounts)
Income Shares of Additional Retained for For the Years Ended June 30, 2006, 2005 and Common Stock Common Paid-in Use in the 2004 Outstanding Stock Capital Business - ------------------------------------------- ------------ -------- ---------- ------------ BALANCE AT JULY 1, 2003 42,795 $ 10,000 $ 84,898 $289,724 Net income 31,471 Unrealized loss on cash flow hedge, net of income tax of $(614) Foreign currency translation adjustment, net of income tax of $(46) TOTAL COMPREHENSIVE INCOME Cash dividends - $.21 per share (9,273) Purchases of common stock for treasury (653) Treasury shares issued for: Retirement Savings Plan contributions 515 1,713 Exercise of stock options 986 1,497 Deferred compensation plans 116 344 Restricted common stock awards 128 392 Compensation expense - stock options 1,586 Amortization of restricted common stock compensation 9 Other 81 ------ -------- -------- -------- BALANCE AT JUNE 30, 2004 43,886 10,000 90,520 311,922 Net income 55,339 Unrealized loss on cash flow hedge, net of income tax of $(634) Unrealized gain on investment securities available for sale, net of income tax of $42 Minimum pension liability, net of income tax of $(1,643) Foreign currency translation adjustment, net of income tax of $693 TOTAL COMPREHENSIVE INCOME Cash dividends - $.29 per share (12,740) Purchases of common stock for treasury (911) Treasury shares issued for: Retirement Savings Plan contributions 446 4,623 Exercise of stock options 1,467 4,934 Deferred compensation plans 114 728 Compensation expense - stock options and appreciation rights 2,111 Amortization of restricted common stock compensation 253 Other 71 ------ -------- -------- -------- BALANCE AT JUNE 30, 2005 45,002 10,000 103,240 354,521 Net income 72,299 Unrealized gain on cash flow hedge, net of income tax of $384 Unrealized gain on investment securities available for sale, net of income tax of $43 Reduction in minimum pension liability, net of income tax of $282 Foreign currency translation adjustment, net of income tax of $1,258 TOTAL COMPREHENSIVE INCOME Cash dividends - $.40 per share (17,973) Purchases of common stock for treasury (2,379) Treasury shares issued for: Retirement Savings Plan contributions 348 4,892 Exercise of stock options 1,088 11,279 Deferred compensation plans 21 269 Compensation expense - stock options and appreciation rights 2,658 Amortization of restricted common stock compensation 320 Reclassification of unearned restricted stock compensation due to the adoption of SFAS 123(R) (825) Other (13) 313 ------ -------- -------- -------- BALANCE AT JUNE 30, 2006 44,067 $ 10,000 $122,146 $408,847 ====== ======== ======== ======== Unearned Restricted Accumulated Treasury Common Other Total For the Years Ended June 30, 2006, 2005 and Shares Stock Comprehensive Shareholders' 2004 at Cost Compensation Income (Loss) Equity - ------------------------------------------- --------- ------------ ------------- ------------- BALANCE AT JULY 1, 2003 $ (78,706) $ (114) $2,054 $307,856 Net income 31,471 Unrealized loss on cash flow hedge, net of income tax of $(614) (776) (776) Foreign currency translation adjustment, net of income tax of $(46) (157) (157) -------- TOTAL COMPREHENSIVE INCOME 30,538 -------- Cash dividends - $.21 per share (9,273) Purchases of common stock for treasury (6,336) (6,336) Treasury shares issued for: Retirement Savings Plan contributions 3,609 5,322 Exercise of stock options 6,839 8,336 Deferred compensation plans 831 1,175 Restricted common stock awards 893 (1,285) Compensation expense - stock options 1,586 Amortization of restricted common stock compensation 241 250 Other 81 --------- -------- ------ -------- BALANCE AT JUNE 30, 2004 (72,870) (1,158) 1,121 339,535 Net income 55,339 Unrealized loss on cash flow hedge, net of income tax of $(634) (1,002) (1,002) Unrealized gain on investment securities available for sale, net of income tax of $42 74 74 Minimum pension liability, net of income tax of $(1,643) (2,858) (2,858) Foreign currency translation adjustment, net of income tax of $693 1,676 1,676 -------- TOTAL COMPREHENSIVE INCOME 53,229 -------- Cash dividends - $.29 per share (12,740) Purchases of common stock for treasury (14,596) (14,596) Treasury shares issued for: Retirement Savings Plan contributions 3,304 7,927 Exercise of stock options 10,656 15,590 Deferred compensation plans 851 1,579 Compensation expense - stock options and appreciation rights 2,111 Amortization of restricted common stock compensation 326 579 Other (5) 7 73 --------- -------- ------ -------- BALANCE AT JUNE 30, 2005 (72,660) (825) (989) 393,287 Net income 72,299 Unrealized gain on cash flow hedge, net of income tax of $384 598 598 Unrealized gain on investment securities available for sale, net of income tax of $43 72 72 Reduction in minimum pension liability, net of income tax of $282 542 542 Foreign currency translation adjustment, net of income tax of $1,258 4,573 4,573 -------- TOTAL COMPREHENSIVE INCOME 78,084 -------- Cash dividends - $.40 per share (17,973) Purchases of common stock for treasury (54,778) (54,778) Treasury shares issued for: Retirement Savings Plan contributions 3,583 8,475 Exercise of stock options (6,945) 4,334 Deferred compensation plans 193 462 Compensation expense - stock options and appreciation rights 2,658 Amortization of restricted common stock compensation 320 Reclassification of unearned restricted stock compensation due to the adoption of SFAS 123(R) 825 Other (360) (47) --------- -------- ------ -------- BALANCE AT JUNE 30, 2006 $(130,967) $ 0 $4,796 $414,822 ========= ======== ====== ========
See notes to consolidated financial statements. Applied Industrial Technologies, Inc. and Subsidiaries 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") is one of North America's leading distributors of industrial products. Industrial products include bearings, power transmission components, fluid power components and systems, industrial rubber products, linear components, tools, safety products, general maintenance and a variety of mill supply products. Fluid power products include hydraulic, pneumatic, lubrication and filtration components and systems. The Company also provides mechanical, rubber shop and fluid power services. The Company offers technical application support for these products and provides solutions to help customers minimize downtime and reduce overall procurement costs. Although the Company does not generally manufacture the products it sells, it does assemble and repair certain products and systems. Most of the Company's sales are in the maintenance and replacement markets to customers in a wide range of industries, principally in North America. CONSOLIDATION The consolidated financial statements include the accounts of Applied Industrial Technologies, Inc. and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. The financial results of the Company's Canadian subsidiary are included in the consolidated financial statements based upon their fiscal year ended May 31. Prior to June 30, 2006, the Company was considered the primary beneficiary for iSource Performance Materials, LLC (iSource) and included their accounts in the consolidated financial statements. Effective June 30, 2006, the Company ended its venture with iSource and is no longer the primary beneficiary. As of June 30, 2006, iSource's operating results and balances were no longer included in the Company's consolidated financial statements. FOREIGN CURRENCY The financial statements of the Company's Canadian and Mexican 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 monthly exchange rates. Translation gains and losses are included as components of accumulated other comprehensive income in shareholders' equity. Transaction gains and losses included in the statements of consolidated income were not material. 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 market value. CONCENTRATION OF CREDIT RISK The Company has a broad customer base representing many diverse industries doing business throughout North America. As such, the Company does not believe that a significant concentration of credit risk exists. The Company maintains its cash and cash equivalents with federally insured financial institutions. Deposits held with banks may exceed insurance limits. These deposits may be redeemed upon demand. ALLOWANCE 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 a greater credit risk, trends within the entire customer pool and changes in the overall aging of accounts receivable. 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. 22/23 INVENTORIES U.S. inventories are valued at the lower of cost or market, using the last-in, first-out (LIFO) method, and foreign inventories are valued using the average cost method. The Company adopted the link chain dollar value LIFO method of accounting for U.S. inventories in fiscal 1974. At June 30, 2006, approximately half of the Company's 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 in a manner which is in accordance with the guidance in the 1984 AICPA LIFO Issues Paper, "Identification and Discussion of Certain Financial Accounting and Reporting Issues Concerning LIFO Inventories." See Note 3 for further information regarding inventories. 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 are eligible for return under various supplier return programs. SUPPLIER PURCHASING PROGRAMS The Company enters into agreements with certain suppliers providing for 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. Incentives are received in the form of cash or credits against purchases upon attainment of specified purchase volumes and are received monthly, quarterly or annually based upon actual purchases for such period. The incentives are 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. Each supplier program is analyzed, reviewed and reconciled each quarter as information becomes available to determine the appropriateness of the amount estimated to be received. Differences between estimates and actual incentives subse-quently 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. The Company's accounting for inventory purchase incentives is in accordance with guidance issued by the Financial Accounting Standards Board ("FASB") in EITF 02-16, "Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor." PROPERTY AND DEPRECIATION Property and equipment are recorded at cost. Depreciation of buildings and equipment 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 and related improvements are depreciated over ten to thirty years and equipment is depreciated over three to eight years. The carrying values of property and equipment are reviewed for impairment on a quarterly basis or whenever events or changes in circumstances indicate that the recorded value cannot be recovered from undiscounted future cash flows. To analyze recov-erability, the Company considers market values, where available, or will project undiscounted net future cash flows over the remaining life of such assets. If these market values or projected cash flows are less than the carrying amount, an impairment would be recognized, resulting in a write-down of assets with a corresponding charge to earnings. Impairment losses, if any, are measured based upon the difference between the carrying amount and the fair value of the assets. GOODWILL AND OTHER 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. The Company recognizes acquired intangible assets such as noncompetition agreements, customer relationships, exclusive supplier distribution agreements and trademarks apart from goodwill. Amortization of intangible assets is computed using the straight-line method over the estimated period of benefit and is included in selling, distribution and administrative expenses in the accompanying statements of consolidated income. The weighted-average amortization period as of June 30, 2006 was 6 years for non-competition agreements, 14 years for customer relationships, 12 years for exclusive supplier distribution agreements and 10 years for trademarks. Applied Industrial Technologies, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED (In thousands, except per share amounts) Goodwill and other intangible assets are tested for impairment annually as of January 1 or whenever changes in conditions indicate carrying value may not be recoverable. Impairment exists when the carrying value of goodwill or other intangible assets exceed their fair value. The results of the Company's annual testing indicated no impairment. SELF-INSURANCE LIABILITY The Company maintains business insurance programs with significant self-insured retention, which cover workers' compensation, business automobile and general product liability claims. The Company accrues estimated losses using actuarial calculations, models and assumptions based on historical loss experience. The Company maintains a self-insured health benefits plan, which provides medical benefits to employees electing coverage under the plan. The Company maintains a reserve for incurred but not reported medical claims based on historical experience and other assumptions. The Company utilizes independent actuarial firms to assist in determining the adequacy of all self-insurance liability reserves. REVENUE RECOGNITION Sales are recognized when 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 recognizes 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 the amount of actual sales returns and the amount of reserves established for anticipated sales returns based on historical return rates. SHIPPING AND HANDLING COSTS The Company records third party freight payments in cost of sales and internal delivery costs in selling, distribution and administrative expenses in the accompanying statements of consolidated income. 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. NET INCOME PER SHARE The following is a computation of the basic and diluted earnings per share:
Year Ended June 30, 2006 2005 2004 - ------------------- ------- ------- ------- Net Income $72,299 $55,339 $31,471 ======= ======= ======= Average Shares Outstanding Weighted average common shares outstanding for basic computation 44,620 44,481 43,286 Dilutive effect of common stock equivalents 1,560 1,610 1,020 ------- ------- ------- Weighted average common shares outstanding for dilutive computation 46,180 46,091 44,306 ======= ======= ======= Net Income Per Share Net Income Per Share - Basic $ 1.62 $ 1.24 $ 0.73 ------- ------- ------- Net Income Per Share - Diluted $ 1.57 $ 1.20 $ 0.71 ======= ======= =======
Options to purchase 301, 516 and 860 shares of common stock were outstanding at June 30, 2006, 2005 and 2004, respectively, but were not included in the computation of diluted earnings per share for the fiscal years then ended as they were anti-dilutive. STOCK SPLITS All share and per share data have been restated to reflect a 3-for-2 stock split effective June 15, 2006 and a 3-for-2 stock split effective December 17, 2004. STOCK-BASED COMPENSATION The Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") effective July 1, 2003, utilizing the modified prospective method provided under SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." Effective July 1, 2005, the Company adopted SFAS No. 123(R), "Share-Based Payment" ("SFAS No. 123(R)"), which is a revision of SFAS No. 123. The adoption of SFAS No. 123(R) did not have a material impact on the determination of stock based compensation expense. The Company follows the transition guidance of SFAS No. 123(R) in determining the additional paid-in capital pool. Prior to the adoption of SFAS No. 123(R), all tax benefits resulting from the exercise of stock awards were reported as operating cash flows in the Company's statements of consolidated cash flows. In accordance with and effective upon the adoption of SFAS No. 123(R), excess tax benefits for fiscal 2006 were reported as financing cash flows in the Company's statements of consolidated cash flows. Excess tax benefits for fiscal years 2005 and 2004 resulting from the exercise of stock awards totaled $4,828 and $1,353, respectively, and are reported as operating cash flows in the accompanying statements of consolidated cash flows. 24/25 Also effective upon the adoption of SFAS No. 123(R), the amount of unearned restricted common stock compensation for non-vested awards, previously reported as a separate component of shareholder's equity, was eliminated against additional paid-in capital. 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. NEW ACCOUNTING PRONOUNCEMENTS In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"). FIN 48, which is an interpretation of SFAS No. 109, "Accounting for Income Taxes," provides guidance on the manner in which tax positions taken or to be taken on tax returns should be reflected in an entity's financial statements prior to their resolution with taxing authorities. The Company is required to adopt FIN 48 during the first quarter of fiscal 2008. The Company is currently evaluating the requirements of FIN 48 and has not yet determined the impact, if any, this interpretation may have on its consolidated financial statements. NOTE 2: BUSINESS COMBINATIONS In each of the past three fiscal years, the Company has acquired distributors to complement and extend its business over a broader geographic area. In fiscal 2006, the Company acquired two U.S. based distributors of industrial and fluid power products for a combined purchase price of $28,639. In 2005, the Company acquired a Canadian distributor of industrial products for a purchase price of $6,599 and in 2004 acquired a Mexican distributor of industrial products for a price of $2,800. Results of operations of all of the above acquisitions, which have all been accounted for as purchases, are included in the accompanying consolidated financial statements from their respective acquisition dates. The results of operations for these acquisitions are not material for all years presented. NOTE 3: INVENTORIES Inventories consist of the following:
June 30, 2006 2005 - -------- -------- -------- U.S. inventories at current cost $279,619 $271,140 Foreign inventories at average cost 48,547 40,694 -------- -------- 328,166 311,834 Less: Excess of current cost over LIFO cost for U.S. inventories 137,629 136,301 -------- -------- Inventories on consolidated balance sheet $190,537 $175,533 ======== ========
Reductions in certain U.S. inventories during fiscal 2006 and 2004 resulted in the liquidation of LIFO inventory quantities carried at lower costs prevailing in prior years. The effect of these liquidations increased gross profit by $1,647 and $672, net income by $1,013 and $420 and net income per share by $0.02 and $0.01 during fiscal 2006 and 2004, respectively. There were no LIFO layer liquidations during fiscal 2005. NOTE 4: GOODWILL & OTHER INTANGIBLES The changes in the carrying amount of goodwill for the years ended June 30, 2006 and 2005, are as follows:
Service Center Based Distribution Segment Other Total -------------------- ----- ------- Balance at July 1, 2004 $49,852 $49,852 Goodwill acquired during the year 734 734 Currency translation adjustment 497 497 ------- ------- Balance at June 30, 2005 51,083 51,083 Goodwill acquired during the year 4,801 $259 5,060 Currency translation adjustment 1,079 1,079 ------- ---- ------- Balance at June 30, 2006 $56,963 $259 $57,222 ======= ==== =======
The Company's intangible assets resulting from business combinations are included in other assets in the consolidated balance sheets and are amortized over their estimated useful lives and consist of the following:
Accumulated Net Book June 30, 2006 Amount (a) Amortization Value - ------------- ---------- ------------ -------- Non-competition agreements $ 750 $ 380 $ 370 Customer relationships 8,397 954 7,443 Exclusive supplier distribution agreements 1,127 305 822 Trademarks 1,163 174 989 ------- ------ ------ $11,437 $1,813 $9,624 ======= ====== ======
Accumulated Net Book June 30, 2005 Amount (a) Amortization Value - ------------- ---------- ------------ -------- Non-competition agreements $ 930 $ 513 $ 417 Customer relationships 3,050 454 2,596 Exclusive supplier distribution agreements 678 101 577 Trademarks 318 13 305 ------ ------ ------ $4,976 $1,081 $3,895 ====== ====== ======
(a) Amounts include the impact of foreign currency translation. Applied Industrial Technologies, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED (In thousands, except per share amounts) During fiscal 2006, the Company recorded intangible assets of $200 for non-competition agreements, $4,890 for customer relationships, $290 for exclusive supplier distribution agreements and $750 for trade names in connection with the acquisition of two U.S. distributors of industrial products (see Note 2). During fiscal 2005, the Company recorded intangible assets of $83 for non-competition agreements, $331 for trade names and $580 for customer relationships in connection with the acquisition of a Canadian distributor of industrial products (see Note 2). Amortization expense for other intangible assets totaled $732, $993 and $826 in fiscal 2006, 2005 and 2004, respectively. Amortization of other intangible assets at June 30, 2006 is expected to be $950 for 2007, $800 for 2008, $750 for 2009, $700 for 2010 and $700 for 2011. NOTE 5: OTHER LIABILITIES Other liabilities consist of the following:
June 30, 2006 2005 - -------- ------- ------- Accrued postemployment benefits $27,514 $26,314 Other 23,718 11,897 ------- ------- Total $51,232 $38,211 ======= =======
NOTE 6: DEBT Long-term debt consists of:
June 30, 2006 2005 - -------- ------- ------- 7.98% Private placement debt, due at maturity in November 2010 $25,000 $25,000 6.60% Senior $50,000 unsecured term notes, due at maturity in December 2007, including effects of interest rate swaps (see Note 7) 51,186 51,977 ------- ------- Total $76,186 $76,977 ======= =======
The aggregate annual maturities of long-term debt over the next five years as of June 30, 2006 include $50,000 in fiscal 2008 and $25,000 in 2011. Based upon current market rates for debt of similar maturities, the Company's long-term debt had an estimated fair value of $77,305 and $80,209 as of June 30, 2006 and 2005, respectively. In June 2005, the Company replaced its existing revolving credit facility with a new five year committed revolving credit facility with a group of banks. This agreement provides for unsecured borrowings of up to $100,000 at various interest rate options, none of which is in excess of the banks' prime rate at interest determination dates. Fees on this facility range from .10% to .20% per year on the average amount of the total revolving credit commitments during the year. Unused lines under this facility, net of outstanding letters of credit ($7,686 for securing certain insurance obligations), totaled $92,314 at June 30, 2006 and are available to fund future acquisitions or other capital and operating requirements. The Company had no borrowings outstanding under this facility at June 30, 2006. During February 2004, the Company entered into an agreement with Prudential Insurance Company, expiring in February 2007, for an uncommitted shelf facility that enables the Company to borrow up to $100,000 in additional long-term financing at the Company's sole discretion with terms of up to twelve years. At June 30, 2006, there was no borrowing under this agreement. The revolving credit facility, private placement debt and senior unsecured term notes contain restrictive covenants regarding liquidity, tangible net worth, financial ratios and other covenants. At June 30, 2006, the most restrictive of these covenants required that the Company have consolidated income before interest and taxes at least equal to 300% of net interest expense. At June 30, 2006, the Company was in compliance with all covenants. NOTE 7: RISK MANAGEMENT ACTIVITIES The Company is exposed to market risks, primarily resulting from changes in interest rates and currency exchange rates. To manage these risks, the Company may enter into derivative transactions pursuant to the Company's written policy. These transactions are accounted for in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." The Company does not hold or issue derivative financial instruments for trading purposes. During fiscal 2002, the Company entered into two interest rate swap agreements with two banks which effectively converted the fixed interest rate on the 6.60% senior unsecured term notes to a floating variable rate based on LIBOR. In October 2001 and August 2002, the Company terminated the swap agreements for favorable settlements of $2,000 and $2,500, respectively. These settlement gains are being amortized as a reduction in interest expense of approximately $790 per year over the remaining life of the notes through December 2007. The effect of the swap agreements was to decrease interest expense by $791 in fiscal 2006, $790 in 2005 and $791 in 2004. 26/27 In November 2000, the Company entered into two 10-year cross-currency swap agreements to manage its foreign currency risk exposure on private placement borrowings related to its wholly owned Canadian subsidiary. The cross-currency swaps effectively convert $25,000 of debt, and the associated interest payments, from 7.98% fixed rate U.S. dollar denominated debt to 7.75% fixed rate Canadian dollar denominated debt. The terms of the two cross-currency swaps mirror the terms of the private placement borrowings. The Company has designated one of the cross-currency swaps, with a $20,000 U.S. notional amount, as a foreign currency cash flow hedge. The fair value of the cross-currency swap was a liability of $8,401 and $6,022 at June 30, 2006 and 2005, respectively. These liabilities were recorded in other liabilities and the related unrealized losses are included in accumulated other comprehensive income (net of tax). The second cross-currency swap, however, has not been designated as a hedging instrument under the hedge accounting provisions of SFAS No. 133. The fair value of this cross-currency swap was a liability of $2,100 and $1,505 at June 30, 2006 and 2005, respectively. Changes in the fair value of this derivative instrument are recorded in earnings as a component of other income, net. NOTE 8: INCOME TAXES PROVISION The provision (benefit) for income taxes consists of:
Year Ended June 30, 2006 2005 2004 - ------------------- ------- ------- ------- CURRENT Federal $31,100 $28,200 $17,500 State 3,600 3,700 2,800 Foreign 5,100 3,000 400 ------- ------- ------- Total current 39,800 34,900 20,700 ------- ------- ------- DEFERRED Federal 900 (4,500) (5,900) State 400 (100) (600) Foreign (300) 700 800 ------- ------- ------- Total deferred 1,000 (3,900) (5,700) ------- ------- ------- Total $40,800 $31,000 $15,000 ======= ======= =======
The exercise of non-qualified stock options and stock appreciation rights during fiscal 2006, 2005, and 2004 resulted in $16,155, $4,575 and $1,353, respectively, of income tax benefits to the Company derived from the difference between the market price at the date of exercise and the option price. Vesting of stock awards in fiscal 2006 and 2005 resulted in $245 and $253, respectively, of incremental income tax benefits over the amounts previously reported for financial reporting purposes. These tax benefits were recorded in additional paid-in capital. EFFECTIVE TAX RATES The following is a reconciliation between the federal statutory income tax rate and the Company's effective tax rate:
Year Ended June 30, 2006 2005 2004 - ------------------- ---- ---- ---- Statutory tax rate 35.0% 35.0% 35.0% Effects of: State and local income taxes 2.4 2.8 3.1 Foreign income taxes (.7) (.7) (1.4) Non-deductible expenses .1 .3 .1 Deductible dividend (.6) (.5) (.6) Non-taxable life insurance settlement (1.2) Income tax examinations (.1) (2.8) Other, net .2 (1.1) ---- ---- ---- Effective tax rate 36.1% 35.9% 32.3% ==== ==== ====
BALANCE SHEET The significant components of the Company's deferred tax assets (liabilities) are as follows:
June 30, 2006 2005 - -------- ------- ------- Inventories $(5,471) $(5,121) Depreciation and differences in property bases (2,598) (3,840) Compensation liabilities not currently deductible 20,091 18,410 Reserves not currently deductible 7,998 9,650 Goodwill and other intangibles 1,296 4,480 Canadian net operating loss carryforwards, expiring 2015 151 47 State and other net operating loss carryforwards 271 339 Other (2,045) 136 ------- ------- Net deferred tax asset $19,693 $24,101 ======= =======
At June 30, 2006, $6,169 of the net deferred tax asset was included in other current assets and $13,524 was included in other assets in the accompanying consolidated balance sheet. Applied Industrial Technologies, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED (In thousands, except per share amounts) NOTE 9: SHAREHOLDERS' EQUITY STOCK-BASED INCENTIVE PLANS The 1997 Long-Term Performance Plan (the "1997 Plan"), which expires in 2012, provides for granting of stock options, stock appreciation rights ("SARs"), stock awards, cash awards, and such other awards or combination thereof as the Executive Organization and Compensation Committee of the Board of Directors (the "Committee") may determine to officers, other key associates and members of the Board of Directors. Grants are generally made by the Committee during regularly scheduled meetings. The number of shares of common stock which may be awarded in each fiscal year under the 1997 Plan is two percent (2%) of the total number of shares of common stock outstanding on the first day of each year for which the plan is in effect. Common stock available for distribution under the 1997 Plan, but not distributed, may be carried over to the following year. Shares available for future grants at June 30, 2006 and 2005 were 2,050 and 753, respectively. STOCK OPTION AND APPRECIATION RIGHTS SARs and non-qualified stock options are granted with an exercise price equal to the market price of the Company's common stock at the date of grant. SAR and stock option awards generally vest over four years of continuous service and have 10-year contractual terms. Compensation expense related to stock options and SARs recorded for the years ended June 30, 2006, 2005, and 2004 was $2,658, $2,111, and $1,586, respectively. Such amounts are included in selling, distribution and administrative expense in the accompanying statement of consolidated income. Compensation expense for stock options and SARs has been determined using the Black-Scholes option pricing model. Determining the appropriate fair value of stock-based awards requires management to select a fair value model and make certain estimates and assumptions. The weighted average assumptions used for SAR and stock option grants issued in fiscal 2006, 2005 and 2004 are:
2006 2005 2004 ---- ---- ---- Expected life, in years 7.2 8.0 7.3 Risk free interest rate 4.3% 3.9% 3.8% Dividend yield 1.4% 2.0% 2.9% Volatility 42.3% 31.5% 31.7%
The expected life is based upon historical exercise experience of the officers, other key associates and members of the Board of Directors currently awarded stock-based compensation. The risk free interest rate is based upon the U.S. Treasury zero-coupon bonds with remaining terms equal to the expected life of the stock options and SARs. The assumed dividend yield has been estimated based upon the Company's historical results and expectations for changes in dividends and stock prices. The volatility assumption is calculated based upon historical daily price observations of the Company's common stock for a period equal to the expected life. It has been the Company's practice to issue shares from Treasury to satisfy requirements of SAR and option exercises. SARs are redeemable solely in Company common stock. The exercise price of option awards may be settled by the holder with cash or by tendering Company common stock. A summary of stock option and SAR activity is presented below: 2006
Weighted Average Exercise (Share amounts in thousands) Shares Price ------ -------- Outstanding, beginning of year 4,302 $ 8.68 Granted 306 23.40 Exercised (2,103) 7.76 Expired/canceled (19) 14.04 ------ ------ Outstanding, end of year 2,486 11.23 ====== ====== Exercisable at end of year 1,381 $ 9.85 ====== ====== Weighted average fair value of SARs and options granted during year $10.29 ======
2005
Weighted Average Exercise (Share amounts in thousands) Shares Price ------ -------- Outstanding, beginning of year 5,253 $ 7.87 Granted 516 13.80 Exercised (1,455) 7.57 Expired/canceled (12) 7.76 ------ ------ Outstanding, end of year 4,302 8.68 ====== ====== Exercisable at end of year 2,763 $ 8.18 ====== ====== Weighted average fair value of SARs and options granted during year $ 4.67 ======
2004
Weighted Average Exercise (Share amounts in thousands) Shares Price ------ -------- Outstanding, beginning of year 5,567 $7.51 Granted 720 9.61 Exercised (981) 7.11 Expired/canceled (53) 8.23 ----- ----- Outstanding, end of year 5,253 7.87 ===== ===== Exercisable at end of year 3,419 $7.74 ===== ===== Weighted average fair value of SARs and options granted during year $2.76 =====
28/29 The weighted average remaining contractual term for SARs/options outstanding and exercisable at June 30, 2006 were 6.4 and 5.4 years, respectively. The aggregate intrinsic value of SARs/options outstanding and exercisable at June 30, 2006 were $32,292 and $19,846, respectively. The aggregate intrinsic value of the SARs/options exercised during fiscal 2006, 2005 and 2004 was $41,966, $12,891, and $3,241, respectively. A summary of the status of the Company's nonvested stock options and SARs at June 30, 2006 is presented below: 2006
Weighted Average Grant-Date (Share amounts in thousands) Shares Fair Value - ---------------------------- ------ ---------- Nonvested, beginning of year 1,539 $ 2.88 Granted 306 10.29 Vested (721) 3.31 Expired/canceled (19) 5.14 ----- ------ Nonvested, end of year 1,105 $ 4.61 ===== ======
As of June 30, 2006, unrecognized compensation cost related to stock options and SARs amounted to $2,497. That cost is expected to be recognized over a weighted average period of 2.7 years. The total fair value of shares vested during fiscal 2006, 2005, and 2004 was $2,388, $2,125, and $2,613, respectively. RESTRICTED STOCK Restricted stock award recipients are entitled to receive dividends on, and have voting rights with respect to their respective shares, but are restricted from selling or transferring the shares prior to vesting. Restricted stock awards generally vest 25% each year. The aggregate fair market value of the restricted stock is considered unearned compensation at the time of grant and is amortized over the vesting period. At June 30, 2006 and 2005, the Company had 63 and 96 shares of restricted stock outstanding at weighted average prices of $10.14 and $10.04 per share, respectively. During fiscal 2006, restricted stock was granted at an average grant price of $23.97 per share. Unamortized compensation related to unvested restricted stock awards aggregated $515 and $825 at June 30, 2006 and 2005, respectively. The unamortized compensation cost related to restricted stock is expected to be amortized over the remaining vesting period of 2.4 years. LONG TERM PERFORMANCE GRANTS The Committee also makes annual awards of three-year performance grants to key officers. A target payout is established at the beginning of each three-year performance period. The actual payout at the end of the period is calculated relative to the target level based upon the Company's achievement of objective sales growth, return on sales, and total shareholder return. Total shareholder return is generally calculated based upon the increase in the Company's common stock price, including dividend reinvestment, over the performance period as compared to the Company's peers, as defined. Payouts are made in cash, common stock, or a combination thereof, as determined by the Committee at the end of the performance period. During fiscal 2006, 2005 and 2004, the Company recorded $540, $784, and $690, respectively, of compensation expense for achievement relative to the total shareholder return-based goals of the Company's performance grants. At June 30, 2006 and 2005, the Company had accrued $1,308 and $1,500, respectively, for compensation relative to these goals. At June 30, 2006 and 2005, potential compensation expense related to the outstanding performance grants aggregated $1,234 and $853, respectively. This compensation expense is expected to be recognized over the remaining performance period of 1.7 years. SHAREHOLDERS' RIGHTS In 1998 the Company's Board of Directors adopted a Shareholder Rights Plan and declared a dividend distribution of one preferred share purchase right for each outstanding share of Company common stock. The rights become exercisable only if a person or group acquires beneficial ownership or commences a tender or exchange offer for 20% or more of the Company's common stock, unless the tender or exchange offer is for all outstanding shares of the Company upon terms determined by the Company's continuing directors to be in the best interests of the Company and its shareholders. When exercisable, the rights would entitle the holders (other than the acquirer) to buy shares of the Company's common stock having a market value equal to two times the right's exercise price or, in certain circumstances, to buy shares of the acquiring company having a market value equal to two times the right's exercise price. TREASURY SHARES At June 30, 2006, 596 shares of the Company's common stock held as treasury shares were restricted as collateral under escrow arrangements relating to change in control and director and officer indemnification agreements. Applied Industrial Technologies, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED (In thousands, except per share amounts) NOTE 10: BENEFIT PLANS RETIREMENT SAVINGS PLAN Substantially all U.S. associates participate in the Applied Industrial Technologies, Inc. Retirement Savings Plan. The Company makes a discretionary profit-sharing contribution to the Retirement Savings Plan generally based upon a percentage of the Company's U.S. income before income taxes and before the amount of the contribution (5% for fiscal 2006, 2005 and 2004). The Company also partially matches 401(k) contributions by participants, who may elect to contribute up to 50% of their compensation. The matching contribution is made with the Company's common stock and is determined quarterly using rates based on achieving pre-determined quarterly earnings per share levels (ranging from 25% to 100% of the first 6% of compensation contributed to the plan). The Company's expense for contributions to the above plan was $11,365, $9,947 and $6,808 during fiscal 2006, 2005 and 2004, respectively. DEFERRED COMPENSATION PLANS The Company has deferred compensation plans that enable certain associates of the Company to defer receipt of a portion of their compensation and non-employee directors to defer receipt of director fees. The Company funds these deferred compensation liabilities by making contributions to rabbi trusts. Contributions consist of Company common stock and investments in money market and mutual funds. POSTEMPLOYMENT BENEFIT PLANS The Company provides the following postemployment benefits: Supplemental Executive Retirement Benefit Plan The Company has a non-qualified pension plan to provide supplemental retirement benefits to certain officers. Benefits are payable at retirement based upon a percentage of the participant's compensation. Qualified Defined Benefit Retirement Plan The Company has a qualified defined benefit retirement plan that provides benefits to certain hourly associates at retirement. The benefits are based on length of service and date of retirement. These associates do not participate in the Retirement Savings Plan. Salary Continuation Benefits The Company has agreements with certain retirees to pay monthly retirement benefits for a period not in excess of 15 years. The discount rates used in determining the benefit obligation were 5.8% and 5.0% at June 30, 2006 and 2005, respectively. Retiree Medical Benefits The Company provides health care benefits to eligible retired associates who elect to pay the Company a specified monthly premium. Premium payments are based upon current insurance rates for the type of coverage provided and are adjusted annually. Certain monthly health care premium payments are partially subsidized by the Company. Additionally, in conjunction with a fiscal 1998 acquisition, the Company assumed the obligation for a post-retirement medical benefit plan which provides health care benefits to eligible retired associates at no cost to the individual. The changes in benefit obligations, plan assets and funded status for the plans described above were as follows:
Pension Benefits Other Benefits ------------------- ----------------- 2006 2005 2006 2005 -------- -------- ------- ------- CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of the year $ 32,035 $ 25,640 $ 5,209 $ 5,011 Service cost 1,450 1,274 55 48 Interest cost 1,601 1,638 253 292 Plan participants' contributions 28 24 Benefits paid (832) (1,174) (265) (354) Amendments 258 Actuarial loss (gain) during year 816 4,399 (1,299) 188 -------- -------- ------- ------- Benefit obligation at June 30 $ 35,070 $ 32,035 $ 3,981 $ 5,209 ======== ======== ======= ======= CHANGE IN PLAN ASSETS: Fair value of plan assets at beginning of year $ 4,831 $ 4,472 Actual return on plan assets 515 445 Employer contribution 740 1,088 $ 237 $ 330 Plan participants' contributions 28 24 Benefits paid (832) (1,174) (265) (354) -------- -------- ------- ------- Fair value of plan assets at June 30 $ 5,254 $ 4,831 $ 0 $ 0 ======== ======== ======= ======= RECONCILIATION OF FUNDED STATUS: Funded status $(29,817) $(27,204) $(3,981) $(5,209) Unrecognized net loss (gain) 11,011 10,929 (837) 490 Unrecognized prior service cost 3,970 4,597 98 146 -------- -------- ------- ------- Accrued benefit cost at June 30 $(14,836) $(11,678) $(4,720) $(4,573) ======== ======== ======= =======
30/31 The weighted-average actuarial assumptions at June 30 used to determine benefit obligations for the plans were as follows:
Pension Other Benefits Benefits ----------- ----------- 2006 2005 2006 2005 ---- ---- ---- ---- Discount rate 5.8% 5.0% 5.8% 5.0% Expected return on plan assets 8.0% 8.0% N/A N/A Rate of compensation increase 5.5% 5.5% N/A N/A
The amounts recognized on the balance sheet at June 30 were as follows:
Pension Other Benefits Benefits --------------------- ------------------- 2006 2005 2006 2005 -------- --------- -------- -------- Prepaid benefit cost $ 1,782 $ 1,883 Accrued benefit liability (23,697) (22,658) $(4,720) $(4,573) Intangible asset 3,403 4,597 Accumulated other comprehensive income 3,676 4,500 -------- -------- ------- ------- Net amount recognized $(14,836) $(11,678) $(4,720) $(4,573) ======== ======== ======= =======
The accumulated benefit obligations were $28,560 and $25,606 at June 30, 2006 and 2005, respectively. The following table provides information for pension plans with an accumulated benefit obligation and projected benefit obligation in excess of plan assets:
Pension Benefits ----------------- 2006 2005 ------- ------- Projected benefit obligations $35,070 $32,035 Accumulated benefit obligations 28,560 25,606 Fair value of plan assets at end of year 5,254 4,831
The net periodic pension costs are as follows:
Pension Benefits ------------------------ 2006 2005 2004 ------ ------ ------ Service cost $1,450 $1,274 $1,051 Interest cost 1,601 1,638 1,250 Expected return on plan assets (381) (353) (315) Recognized net actuarial loss 784 479 220 Amortization of prior service cost 627 627 590 ------ ------ ------ Net periodic pension cost $4,081 $3,665 $2,796 ====== ====== ======
Other Benefits ----------- 2006 2005 2004 ---- ---- ---- Service cost $ 55 $ 48 $ 57 Interest cost 253 292 304 Recognized net actuarial loss 28 14 19 Amortization of prior service cost 49 49 49 ---- ---- ---- Net periodic pension cost $385 $403 $429 ==== ==== ====
The assumed health care cost trend rates used in measuring the accumulated benefit obligation for post-retirement benefits other than pensions were 10% as of June 30, 2006 and 9% as of June 30, 2005, decreasing to 5% by 2012 and 2010, respectively. A one-percentage point change in the assumed health care cost trend rates would have had the following effects as of June 30, 2006 and for the year then ended:
One-Percentage One-Percentage Point Increase Point Decrease -------------- -------------- Effect on total service and interest cost components of periodic expense $ 51 $ (41) Effect on post-retirement benefit obligation $553 $(456) ==== =====
OBLIGATIONS AND FUNDED STATUS PLAN ASSETS Applied Industrial Technologies, Inc.'s Qualified Defined Benefit Retirement Plan weighted average asset allocation and target allocation are as follows:
Percentage of Pension Plan Target Assets At Fiscal Year End Allocation ---------------------------------- 2007 2006 2005 ---------- ---------- -------------- Asset Category: Equity Securities 60% 66% 62% Debt Securities 33% 34% 32% Other 7% 0% 6% --- --- --- Total 100% 100% 100% === === ===
Equity securities do not include any Applied Industrial Technologies, Inc. common stock. The Company has established an investment policy and regularly monitors the performance of the assets of the trust maintained in conjunction with the Qualified Defined Benefit Retirement Plan. The strategy implemented by the trustee of the Qualified Defined Benefit Retirement Plan is to achieve long-term objectives and invest the pension assets in accordance with ERISA and fiduciary standards. The long-term primary objectives are to provide for a reasonable amount of long-term capital, without undue exposure to risk; to protect the Qualified Defined Benefit Retirement Plan assets from erosion of purchasing power; and to provide investment results that meet or exceed the actuarially assumed long-term rate of return. The expected long-term rate of return on assets assumption was developed by considering the historical returns and the future expectations for returns of each asset class as well as the target asset allocation of the pension portfolio. Applied Industrial Technologies, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED (In thousands, except per share amounts) CASH FLOWS EMPLOYER CONTRIBUTIONS The Company expects to contribute $1,200 to its retirement benefit plans and $300 to its other benefit plans in 2007. ESTIMATED FUTURE BENEFIT PAYMENTS The Company expects to make the following benefit payments, which reflect expected future service:
During Fiscal Years Pension Benefits Other Benefits - ------------------- ---------------- -------------- 2007 $ 1,300 $ 300 2008 1,300 300 2009 7,900 300 2010 1,300 300 2011 14,500 300 2012 through 2016 6,600 1,300
NOTE 11 : LEASES The Company leases its corporate headquarters facility along with certain service center and distribution center facilities, vehicles and equipment under non-cancelable lease agreements accounted for as operating leases. The minimum annual rental commitments under non-cancelable operating leases as of June 30, 2006 are as follows: 2007 $17,900 2008 13,500 2009 10,500 2010 7,000 2011 4,100 Thereafter 13,100 ------- Total minimum lease payments $66,100 =======
Rental expenses incurred for operating leases, principally from leases for real property, vehicles and computer equipment were $26,700 in fiscal 2006, $25,500 in 2005 and $26,900 in 2004. NOTE 12: SEGMENT INFORMATION The Company has identified one reportable segment: Service Center Based Distribution. The Service Center Based Distribution segment provides customers with solutions to their maintenance, repair and original equipment manufacturing needs through the distribution of industrial products including bearings, power transmission components, fluid power components, industrial rubber products, linear motion products, safety products, general maintenance and a variety of mill supply products. The "Other" column consists of the aggregation of all other non-Service Center Based Distribution operations that sell directly to customers, including separate fluid power operations. The accounting policies of the Company's reportable segment and its other businesses are the same as those described in Note 1. Sales between the Service Center Based Distribution segment and the Company's other businesses have been eliminated. Segment Financial Information:
Service Center Based Distribution Other Total ------------------ -------- ---------- YEAR ENDED JUNE 30, 2006 Net sales $1,725,392 $175,388 $1,900,780 Operating income 111,774 11,849 123,623 Assets used in the business 670,619 60,052 730,671 Depreciation 12,019 1,109 13,128 Capital expenditures 10,310 747 11,057 ---------- -------- ---------- YEAR ENDED JUNE 30, 2005 Net sales $1,601,531 $115,524 $1,717,055 Operating income 83,059 7,183 90,242 Assets used in the business 660,616 29,554 690,170 Depreciation 13,135 697 13,832 Capital expenditures 8,789 419 9,208 ---------- -------- ---------- YEAR ENDED JUNE 30, 2004 Net sales $1,419,386 $ 97,618 $1,517,004 Operating income 55,737 4,127 59,864 Assets used in the business 572,617 24,224 596,841 Depreciation 13,704 677 14,381 Capital expenditures 14,098 285 14,383 ---------- -------- ----------
32/33 A reconciliation from the segment operating profit to the consolidated balance is as follows:
Year Ended June 30, 2006 2005 2004 - ------------------- -------- ------- ------- Operating income for reportable segment $111,774 $83,059 $55,737 Other operating income 11,849 7,183 4,127 Adjustments for: Amortization expense of intangibles 732 993 826 Corporate and other expense, net (a) 7,299 1,281 7,590 -------- ------- ------- Total operating income 115,592 87,968 51,448 Interest expense, net 3,210 4,730 5,409 Other income, net 717 3,101 432 -------- ------- ------- Income before income taxes $113,099 $86,339 $46,471 ======== ======= =======
(a) The change in corporate and other expense, net is due to various changes in the levels and amounts of expenses being allocated to the segments. The expenses being allocated include miscellaneous corporate charges for working capital, logistics support and other items. Net sales by product category are as follows:
Year Ended June 30, 2006 2005 2004 - ------------------- ---------- ---------- ---------- Industrial $1,554,589 $1,442,308 $1,281,037 Fluid power (b) 346,191 274,747 235,967 ---------- ---------- ---------- Net sales $1,900,780 $1,717,055 $1,517,004 ========== ========== ==========
(b) The fluid power product category includes sales of hydraulic, pneumatic, lubrication and filtration components, and systems and repair services through the Company's service centers as well as the fluid power businesses. Net sales are presented in the geographic area in which the Company's customers are located. Information by geographic area is as follows:
Year Ended June 30, 2006 2005 2004 - ------------------- ---------- ---------- ---------- NET SALES: United States $1,686,066 $1,539,143 $1,386,135 Canada 194,594 160,396 119,424 Other 20,120 17,516 11,445 ---------- ---------- ---------- Total $1,900,780 $1,717,055 $1,517,004 ========== ========== ========== LONG-LIVED ASSETS: United States $ 115,935 $ 106,346 $ 113,923 Canada 18,445 16,699 13,002 Other 3,260 3,374 3,481 ---------- ---------- ---------- Total $ 137,640 $ 126,419 $ 130,406 ========== ========== ==========
Long-lived assets are comprised of property and equipment, goodwill and other intangible assets. NOTE 13: COMMITMENTS AND CONTINGENCIES In connection with the construction and lease of its corporate headquarters facility, the Company has guaranteed repayment of a total of $5,678 of taxable development revenue bonds issued by Cuyahoga County and the Cleveland-Cuyahoga County Port Authority. These bonds were issued with a 20-year term and are scheduled to mature in March 2016. Any default, as defined in the guarantee agreements, would obligate the Company for the full amount of the outstanding bonds through maturity. Due to the nature of the guarantee, the Company has not recorded any liability on the financial statements. In the event of a default and subsequent payout under any or all guarantees, the Company maintains the right to pursue all legal options available to mitigate its exposure. The Company is a party to various pending judicial and administrative proceedings. Based on circumstances currently known, the Company does not believe that any liabilities that may result from these proceedings are reasonably likely to have a material adverse effect on the Company's consolidated financial position, results of operations, or cash flows. NOTE 14: OTHER INCOME, NET Other income, net consists of the following:
Year Ended June 30, 2006 2005 2004 - ------------------- ----- ------- ----- Unrealized loss on cross currency swap $ 595 $ 901 $ 355 Unrealized gain on deferred compensation trusts (869) (518) (781) Benefit from payouts on corporate-owned life insurance policies (2,945) Gain on sale of investments available for sale (166) Other (443) (373) (6) ----- ------- ----- Total other income, net $(717) $(3,101) $(432) ===== ======= =====
The Company is the owner and beneficiary under life insurance policies acquired in conjunction with a fiscal 1998 acquisition, with benefits in force of $13,910 and a net cash surrender value of $2,522 at June 30, 2006. Applied Industrial Technologies, Inc. and Subsidiaries DELOITTE. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF APPLIED INDUSTRIAL TECHNOLOGIES, INC. We have audited the accompanying consolidated balance sheets of Applied Industrial Technologies, Inc. and subsidiaries (the "Company") as of June 30, 2006 and 2005, and the related statements of consolidated income, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 2006. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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 Applied Industrial Technologies, Inc. and subsidiaries at June 30, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2006, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated financial statements, effective July 1, 2005, the Company changed its method of accounting for stock-based compensation to conform to Statement of Financial Accounting Standards No. 123(R), "Share-Based Payment." We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of June 30, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 18, 2006 expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting. Deloitte & Touche LLP Cleveland, Ohio August 18, 2006 34/35 MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The Management of Applied Industrial Technologies, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Chairman & Chief Executive Officer and the Vice President, Chief Financial Officer & Treasurer, and effected by the Company's Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. The Company's internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of the Company's Management and Board of Directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the consolidated financial statements. Because of inherent limitations, internal control over financial reporting can provide only reasonable, not absolute, assurance with respect to the preparation and presentation of the consolidated financial statements and may not prevent or detect misstatements. Further, because of changes in conditions, effectiveness of internal control over financial reporting may vary over time. Management conducted an evaluation of the effectiveness of the Company's internal control over financial reporting as of June 30, 2006. This evaluation was based on the criteria set forth in the Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, Management determined that the Company's internal control over financial reporting was effective as of June 30, 2006. Management's assessment of the effectiveness of the Company's internal control over financial reporting as of June 30, 2006 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which is included herein. August 18, 2006 /s/ David L. Pugh - ---------------------------------------- David L. Pugh Chairman & Chief Executive Officer /s/ Bill L. Purser - ---------------------------------------- Bill L. Purser President & Chief Operating Officer /s/ Mark O. Eisele - ---------------------------------------- Mark O. Eisele Vice President, Chief Financial Officer & Treasurer /s/ Daniel T. Brezovec - ---------------------------------------- Daniel T. Brezovec Corporate Controller Applied Industrial Technologies, Inc. and Subsidiaries REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF APPLIED INDUSTRIAL TECHNOLOGIES, INC. We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that Applied Industrial Technologies, Inc. and subsidiaries (the "Company") maintained effective internal control over financial reporting as of June 30, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of June 30, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet and the related statements of consolidated income, shareholders' equity and cash flows as of and for the year ended June 30, 2006 of the Company and our report dated August 18, 2006, expressed an unqualified opinion on those financial statements. Deloitte & Touche LLP Cleveland, Ohio August 18, 2006 36/37 QUARTERLY OPERATING RESULTS & MARKET DATA UNAUDITED (Dollars in thousands, except per share amounts)
Per Common Share (B) (C) ------------------------------------ Net Price Range Net Gross Operating Net Income- Cash --------------- Sales Profit Income Income Diluted Dividend High Low ---------- -------- --------- ------- ------- -------- ------ ------ 2006 (A) FIRST QUARTER $ 443,205 $122,304 $ 27,802 $16,850 $0.36 $ 0.08 $25.03 $21.33 SECOND QUARTER 456,180 121,397 25,214 15,294 0.33 0.10 24.54 20.41 THIRD QUARTER 497,198 136,815 32,085 19,990 0.43 0.10 31.15 22.50 FOURTH QUARTER 504,197 133,369 30,491 20,165 0.44 0.12 31.67 21.97 ---------- -------- -------- ------- ----- ------ $1,900,780 $513,885 $115,592 $72,299 $1.57 $ 0.40 ========== ======== ======== ======= ===== ====== 2005 (A) First Quarter $ 413,126 $109,522 $ 21,503 $13,040 $0.29 $ 0.06 $15.89 $11.73 Second Quarter 404,139 103,948 17,223 9,980 0.22 0.06 21.33 14.83 Third Quarter 446,470 119,293 24,080 16,336 0.35 0.08 20.01 15.19 Fourth Quarter 453,320 122,086 25,162 15,983 0.34 0.08 22.60 16.13 ---------- -------- -------- ------- ----- ------ $1,717,055 $454,849 $ 87,968 $55,339 $1.20 $ 0.29 ========== ======== ======== ======= ===== ====== 2004 (A) First Quarter $ 361,146 $ 93,477 $ 8,996 $ 4,832 $0.11 $0.053 $10.22 $ 8.78 Second Quarter 359,711 95,166 9,250 5,133 0.12 0.053 11.05 8.83 Third Quarter 391,053 104,423 14,880 10,611 0.24 0.053 11.63 8.75 Fourth Quarter 405,094 109,077 18,322 10,895 0.24 0.053 13.49 9.98 ---------- -------- -------- ------- ----- ------ $1,517,004 $402,143 $ 51,448 $31,471 $0.71 $0.213 ========== ======== ======== ======= ===== ======
(A) Cost of sales for interim financial statements are computed using estimated gross profit percentages which are adjusted throughout the year based upon available information. Adjustments to actual cost are primarily made based upon the annual physical inventory and the effect of year-end inventory quantities on LIFO costs. Reductions in year end inventories during the fiscal years ended June 30, 2006 and 2004 resulted in liquidations of LIFO inventory quantities carried at lower costs prevailing in prior years. The effect of these liquidations for the years ended June 30, 2006 and 2004 increased gross profit by $1,647 and $672, net income by $1,013 and $420 and diluted net income per share by $0.02 and $0.01, respectively. There were no LIFO layer liquidations in fiscal 2005. (B) On August 15, 2006 there were 6,249 shareholders of record including 3,938 shareholders in the Applied Industrial Technologies, Inc. Retirement Savings Plan. The Company's common stock is listed on the New York Stock Exchange. The closing price on August 15, 2006 was $22.56 per share. (C) All per share data have been restated to reflect three-for-two stock splits on June 15, 2006 and December 17, 2004 Applied Industrial Technologies, Inc. and Subsidiaries 10 YEAR SUMMARY (Dollars in thousands, except per share amounts and statistical data)
2006 2005 2004 2003 2002 ---------- ---------- ---------- ---------- ---------- CONSOLIDATED OPERATIONS - YEAR ENDED JUNE 30 Net sales $1,900,780 $1,717,005 $1,517,004 $1,464,367 $1,446,596 Operating income 115,592 87,968 51,448 36,254 30,834 Income before cumulative effect of accounting change 72,299 55,339 31,471 19,832 14,755 Net income 72,299 55,339 31,471 19,832 2,655 Per share data (B) Income before cumulative effect of accounting change Basic 1.62 1.24 0.73 0.47 0.34 Diluted 1.57 1.20 0.71 0.46 0.34 Net income Basic 1.62 1.24 0.73 0.47 0.06 Diluted 1.57 1.20 0.71 0.46 0.06 Cash dividend 0.40 0.29 0.21 0.21 0.21 YEAR-END POSITION - JUNE 30 Working capital $ 370,013 $ 345,806 $ 286,022 $ 259,359 $ 250,644 Long-term debt 76,186 76,977 77,767 78,558 83,478 Total assets 730,671 690,170 596,841 553,404 534,566 Shareholders' equity 414,822 393,287 339,535 307,856 298,147 YEAR-END STATISTICS - JUNE 30 Current ratio 3.0 2.9 2.9 2.8 2.9 Operating facilities 452 440 434 440 449 Shareholders of record (A) 6,192 6,079 6,154 6,157 6,455
(A) Includes participant-shareholders in the Applied Industrial Technologies, Inc. Retirement Savings Plan, and since 1998, shareholders in the Company's direct stock purchase program. (B) All per share data have been restated to reflect three-for-two stock splits effective June 15, 2006 and December 17, 2004. EX-21 4 l22078aexv21.txt EX-21 EXHIBIT 21 APPLIED INDUSTRIAL TECHNOLOGIES, INC. FORM 10-K FOR FISCAL YEAR ENDED JUNE 30, 2006 SUBSIDIARIES (as of June 30, 2006)
Jurisdiction of Name Incorporation or Organization ---- ----------------------------- * Air and Hydraulics Engineering, Incorporated Alabama * Air-Hydraulic Systems, Inc. Minnesota * Air Draulics Engineering Co. Tennessee AIT Limited Partnership Ontario, Canada Applied Industrial Technologies Ltd. Canada (Federal) Applied Industrial Technologies -- CA LLC Delaware Applied Industrial Technologies -- CAPITAL LLC Delaware Applied Industrial Technologies -- DBB, Inc. Ohio Applied Industrial Technologies -- Dixie, Inc. Tennessee Applied Industrial Technologies -- Indiana LLC Ohio Applied Industrial Technologies -- Mainline, Inc. Wisconsin Applied Industrial Technologies - MBC, Inc. Minnesota Applied Industrial Technologies -- PA LLC Pennsylvania Applied Industrial Technologies -- PACIFIC LLC Delaware Applied Industrial Technologies -- TX LP Delaware * Applied Mexico, S.A. de C.V. Mexico (97%-owned by subsidiaries of Applied Industrial Technologies, Inc.)
Applied Mexico Holdings, S.A. de C.V. Mexico Applied - Michigan, Ltd. Ohio Applied Nova Scotia Company Nova Scotia, Canada * Atelier PV Hydraulique 2004 Inc. Canada (Federal) BER International, Inc. Barbados Bearing Sales & Service, Inc. Washington Bearings Pan American, Inc. Ohio Dynavest Nova Scotia Company Nova Scotia, Canada * ESI Acquisition Corporation Ohio (d/b/a Engineered Sales, Inc., ESI Power Hydraulics, and Applied Engineered Systems) * International Supply Consortium, Inc. Delaware (33-1/3% owned by Applied Industrial Technologies, Inc.) Iowa Bearing Co. Iowa * Le Groupe GLM (2005) Inc. Canada (Federal) * Rafael Benitez Carrillo Inc. Puerto Rico * Spencer Fluid Power, Inc. Ohio The Ohio Ball Bearing Company Ohio
* Operating companies that do not conduct business under Applied Industrial Technologies trade name EX-23 5 l22078aexv23.txt EX-23 EXHIBIT 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statement Nos. 333-124574, 33-53361, 33-53401, 33-65509, 333-83809, and 333-69002 of Applied Industrial Technologies, Inc. (the "Company") on Forms S-8 of our reports dated August 18, 2006, relating to the financial statements and financial statement schedule of the Company and management's report on the effectiveness of internal control over financial reporting, appearing in and incorporated by reference in this Annual Report on Form 10-K of Applied Industrial Technologies, Inc. for the year ended June 30, 2006. Our report relating to the consolidated financial statements of the Company includes an explanatory paragraph concerning the adoption of the new accounting standard effective July 1, 2005. /s/ Deloitte & Touche LLP Cleveland, Ohio August 25, 2006 EX-24 6 l22078aexv24.txt EX-24 EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that the undersigned director and/or officer of Applied Industrial Technologies, Inc., an Ohio corporation, hereby constitutes and appoints Fred D. Bauer and Mark O. Eisele, and each of them, the true and lawful agents and attorneys-in-fact of the undersigned with full power and authority in said agents and the attorneys-in-fact, and in either or both of them, to sign for the undersigned and in his or her respective name as director and/or officer of the Corporation, the Corporation's Annual Report for the fiscal year ended June 30, 2006 on Form 10-K to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, and the rules and regulations issued thereunder, hereby ratifying and confirming all acts taken by such agents and attorneys-in-fact, or any one of them, as herein authorized. Date: 8/17/06 /s/ William G. Bares ---------------------------------------- EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that the undersigned director and/or officer of Applied Industrial Technologies, Inc., an Ohio corporation, hereby constitutes and appoints Fred D. Bauer and Mark O. Eisele, and each of them, the true and lawful agents and attorneys-in-fact of the undersigned with full power and authority in said agents and the attorneys-in-fact, and in either or both of them, to sign for the undersigned and in his or her respective name as director and/or officer of the Corporation, the Corporation's Annual Report for the fiscal year ended June 30, 2006 on Form 10-K to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, and the rules and regulations issued thereunder, hereby ratifying and confirming all acts taken by such agents and attorneys-in-fact, or any one of them, as herein authorized. Date: 8/17/06 /s/ T. A. Commes ---------------------------------------- EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that the undersigned director and/or officer of Applied Industrial Technologies, Inc., an Ohio corporation, hereby constitutes and appoints Fred D. Bauer and Mark O. Eisele, and each of them, the true and lawful agents and attorneys-in-fact of the undersigned with full power and authority in said agents and the attorneys-in-fact, and in either or both of them, to sign for the undersigned and in his or her respective name as director and/or officer of the Corporation, the Corporation's Annual Report for the fiscal year ended June 30, 2006 on Form 10-K to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, and the rules and regulations issued thereunder, hereby ratifying and confirming all acts taken by such agents and attorneys-in-fact, or any one of them, as herein authorized. Date: 8/18/06 /s/ Peter A. Dorsman ---------------------------------------- EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that the undersigned director and/or officer of Applied Industrial Technologies, Inc., an Ohio corporation, hereby constitutes and appoints Fred D. Bauer and Mark O. Eisele, and each of them, the true and lawful agents and attorneys-in-fact of the undersigned with full power and authority in said agents and the attorneys-in-fact, and in either or both of them, to sign for the undersigned and in his or her respective name as director and/or officer of the Corporation, the Corporation's Annual Report for the fiscal year ended June 30, 2006 on Form 10-K to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, and the rules and regulations issued thereunder, hereby ratifying and confirming all acts taken by such agents and attorneys-in-fact, or any one of them, as herein authorized. Date: August 17, 2006 /s/ L. Thomas Hiltz ---------------------------------------- EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that the undersigned director and/or officer of Applied Industrial Technologies, Inc., an Ohio corporation, hereby constitutes and appoints Fred D. Bauer and Mark O. Eisele, and each of them, the true and lawful agents and attorneys-in-fact of the undersigned with full power and authority in said agents and the attorneys-in-fact, and in either or both of them, to sign for the undersigned and in his or her respective name as director and/or officer of the Corporation, the Corporation's Annual Report for the fiscal year ended June 30, 2006 on Form 10-K to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, and the rules and regulations issued thereunder, hereby ratifying and confirming all acts taken by such agents and attorneys-in-fact, or any one of them, as herein authorized. Date: 8/21/2006 /s/ Edith Kelly-Green ---------------------------------------- EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that the undersigned director and/or officer of Applied Industrial Technologies, Inc., an Ohio corporation, hereby constitutes and appoints Fred D. Bauer and Mark O. Eisele, and each of them, the true and lawful agents and attorneys-in-fact of the undersigned with full power and authority in said agents and the attorneys-in-fact, and in either or both of them, to sign for the undersigned and in his or her respective name as director and/or officer of the Corporation, the Corporation's Annual Report for the fiscal year ended June 30, 2006 on Form 10-K to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, and the rules and regulations issued thereunder, hereby ratifying and confirming all acts taken by such agents and attorneys-in-fact, or any one of them, as herein authorized. Date: 8/17/06 /s/ John F. Meier ---------------------------------------- EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that the undersigned director and/or officer of Applied Industrial Technologies, Inc., an Ohio corporation, hereby constitutes and appoints Fred D. Bauer and Mark O. Eisele, and each of them, the true and lawful agents and attorneys-in-fact of the undersigned with full power and authority in said agents and the attorneys-in-fact, and in either or both of them, to sign for the undersigned and in his or her respective name as director and/or officer of the Corporation, the Corporation's Annual Report for the fiscal year ended June 30, 2006 on Form 10-K to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, and the rules and regulations issued thereunder, hereby ratifying and confirming all acts taken by such agents and attorneys-in-fact, or any one of them, as herein authorized. Date: 8/17/06 /s/ J. M. Moore ---------------------------------------- EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that the undersigned director and/or officer of Applied Industrial Technologies, Inc., an Ohio corporation, hereby constitutes and appoints Fred D. Bauer and Mark O. Eisele, and each of them, the true and lawful agents and attorneys-in-fact of the undersigned with full power and authority in said agents and the attorneys-in-fact, and in either or both of them, to sign for the undersigned and in his or her respective name as director and/or officer of the Corporation, the Corporation's Annual Report for the fiscal year ended June 30, 2006 on Form 10-K to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, and the rules and regulations issued thereunder, hereby ratifying and confirming all acts taken by such agents and attorneys-in-fact, or any one of them, as herein authorized. Date: 8/18/06 /s/ Jerry Sue Thornton ---------------------------------------- EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that the undersigned director and/or officer of Applied Industrial Technologies, Inc., an Ohio corporation, hereby constitutes and appoints Fred D. Bauer and Mark O. Eisele, and each of them, the true and lawful agents and attorneys-in-fact of the undersigned with full power and authority in said agents and the attorneys-in-fact, and in either or both of them, to sign for the undersigned and in his or her respective name as director and/or officer of the Corporation, the Corporation's Annual Report for the fiscal year ended June 30, 2006 on Form 10-K to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, and the rules and regulations issued thereunder, hereby ratifying and confirming all acts taken by such agents and attorneys-in-fact, or any one of them, as herein authorized. Date: August 23, 2006 /s/ Peter C. Wallace ---------------------------------------- EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that the undersigned director and/or officer of Applied Industrial Technologies, Inc., an Ohio corporation, hereby constitutes and appoints Fred D. Bauer and Mark O. Eisele, and each of them, the true and lawful agents and attorneys-in-fact of the undersigned with full power and authority in said agents and the attorneys-in-fact, and in either or both of them, to sign for the undersigned and in his or her respective name as director and/or officer of the Corporation, the Corporation's Annual Report for the fiscal year ended June 30, 2006 on Form 10-K to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, and the rules and regulations issued thereunder, hereby ratifying and confirming all acts taken by such agents and attorneys-in-fact, or any one of them, as herein authorized. Date: 8/17/06 /s/ Stephen E. Yates ---------------------------------------- EX-31 7 l22078aexv31.txt EX-31 EXHIBIT 31 APPLIED INDUSTRIAL TECHNOLOGIES, INC. FORM 10-K FOR FISCAL YEAR ENDED JUNE 30, 2006 CERTIFICATIONS I, David L. Pugh, Chairman & Chief Executive Officer, certify that: 1. I have reviewed this annual report on Form 10-K of Applied Industrial Technologies, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 28, 2006 /s/ David L. Pugh ---------------------------------------- David L. Pugh Chairman & Chief Executive Officer I, Mark O. Eisele, Vice President-Chief Financial Officer & Treasurer, certify that: 1. I have reviewed this annual report on Form 10-K of Applied Industrial Technologies, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 28, 2006 /s/ Mark O. Eisele ---------------------------------------- Mark O. Eisele Vice President-Chief Financial Officer & Treasurer EX-32 8 l22078aexv32.txt EX-32 EXHIBIT 32 APPLIED INDUSTRIAL TECHNOLOGIES, INC. FORM 10-K FOR FISCAL YEAR ENDED JUNE 30, 2006 [The following certification accompanies the Annual Report on Form 10-K for the year ended June 30, 2006, and is not filed, as provided in applicable SEC releases.] CERTIFICATIONS PURSUANT TO 18 U.S.C. 1350 In connection with the Form 10-K (the "Report") of Applied Industrial Technologies, Inc. (the "Company") for the period ending June 30, 2006, we, David L. Pugh, Chairman & Chief Executive Officer, and Mark O. Eisele, Vice President-Chief Financial Officer & Treasurer of the Company, certify that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ David L. Pugh /s/ Mark O. Eisele - ------------------------------------- ---------------------------------------- David L. Pugh Mark O. Eisele Chairman & Chief Executive Vice President-Chief Financial Officer Officer & Treasurer Dated: August 28, 2006 [A signed original of this written statement has been provided to Applied Industrial Technologies, Inc. and will be retained by Applied Industrial Technologies, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.] -----END PRIVACY-ENHANCED MESSAGE-----