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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, 2009, or
     
[  ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from                            to                           
Commission file number 1-2299
APPLIED INDUSTRIAL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
     
                 Ohio                    34-0117420
     
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
1 Applied Plaza, Cleveland, Ohio 44115
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (216) 426-4000.
Securities registered pursuant to Section 12(b) of the Act:
     
Title of each class   Name of each exchange on which registered
     
Common Stock, without par value   New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
X Yes __ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. __ Yes X No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X Yes __ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). __ 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. X
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
     
Large accelerated filer X
  Accelerated filer __
Non-accelerated filer __
  Smaller reporting company __
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). __ Yes X No
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter (December 31, 2008): $775,276,950.
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 11, 2009
     
Common Stock, without par value   42,318,184
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, 2009, portions of which are incorporated by reference into Parts I, II and IV of this Form 10-K, and
  (2)   Applied’s proxy statement for the annual meeting of shareholders to be held October 20, 2009, portions of which are incorporated by reference into Parts II, III, and IV of this Form 10-K.

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TABLE OF CONTENTS
         
        Page
         
CAUTIONARY STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT
  3
   
 
   
PART  
 
   
Item 1.     4
Item 1A.     10
Item 1B.     14
Item 2.     14
Item 3.     15
Item 4.     16
   
 
   
EXECUTIVE OFFICERS OF THE REGISTRANT   16
   
 
   
PART II  
 
   
Item 5.     17
Item 6.     17
Item 7.     18
Item 7A.     18
Item 8.     18
Item 9.     19
Item 9A.     19
Item 9B.     19
   
 
   
PART III  
 
   
Item 10.     20
Item 11.     20
Item 12.     20
Item 13.     21
Item 14.     21
   
 
   
PART IV  
 
   
Item 15.     22
   
 
   
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   29
   
 
   
SCHEDULE II – VALUATION AND QUALIFYING ACCOUNTS   30
   
 
   
SIGNATURES  
 
  31
EXHIBITS  
 
   
 EX-13
 EX-21
 EX-23
 EX-24
 EX-31
 EX-32

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CAUTIONARY STATEMENT
UNDER PRIVATE SECURITIES LITIGATION REFORM ACT
          This report, including the documents incorporated by reference, contains statements that are forward-looking, based on management’s current expectations about the future. Forward-looking statements are often identified by qualifiers such as “guidance,” “expect,” “believe,” “plan,” “intend,” “will,” “should,” “could,” “would,” “anticipate,” “estimate,” “forecast,” “may,” and derivative or similar words or expressions. Similarly, descriptions of our objectives, strategies, plans, or goals are also forward-looking statements. These statements may discuss, among other things, expected growth, future sales, future cash flows, future capital expenditures, future performance, and the anticipation and expectations of Applied and its management as to future occurrences and trends. Applied intends that the forward-looking statements be subject to the safe harbors established in the Private Securities Litigation Reform Act of 1995 and by the Securities and Exchange Commission in its rules, regulations, and releases.
          Readers are cautioned not to place undue reliance on 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. 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 2009 annual report to shareholders. PLEASE READ THOSE DISCLOSURES CAREFULLY.

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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 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.
          Our Internet address is www.applied.com. The following documents are available free of charge at the investor relations area of our website:
    Applied’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, together with Section 16 insider beneficial stock ownership reports, all as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission
 
    Applied’s Code of Business Ethics
 
    Applied’s Board of Directors Governance Principles and Practices
 
    Applied’s Director Independence Standards
 
    Charters for the Audit, Corporate Governance, and Executive Organization & Compensation Committees of Applied’s Board of Directors
          The information 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 Applied’s Vice President-Chief Financial Officer & Treasurer at 1 Applied Plaza, Cleveland, Ohio 44115.
          (a)     General Development of Business.
          Information regarding developments in our business can be found in Applied’s 2009 annual report to shareholders under the caption “Management’s Discussion and Analysis” on pages 5 - 11. This information is incorporated here by reference.

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          (b)     Financial Information about Segments.
          We have identified two reportable segments, service center-based distribution and fluid power businesses.
          The service center-based distribution segment provides customers with a wide range of industrial products through a network of service centers stretching across North America. The fluid power businesses segment consists of specialized regional companies that distribute fluid power components and operate shops to assemble fluid power systems and perform equipment repair. The fluid power businesses primarily sell products and services directly to customers rather than through the service centers. Both segments offer technical support and provide solutions to help customers minimize their production downtime, improve machine performance, and reduce overall procurement and maintenance costs.
          Segment financial information can be found in the 2009 annual report to shareholders in note 12 to the consolidated financial statements on page 32. That information is incorporated here by reference.
          (c)     Narrative Description of Business.
          Overview. Our field operating structure is built on two platforms – service center-based distribution and fluid power businesses:
    Service Center-Based Distribution. We distribute a wide range of industrial products through service centers across the United States, Puerto Rico, Canada, and Mexico. 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 service center-based distribution business accounts for a substantial majority of our field operations and 83% of our 2009 sales dollars. The business operates in the United States using the Applied Industrial Technologies trade name. We also are known as Bearing & Transmission and Groupe GLM in Canada, Applied México in Mexico, and Rafael Benitez Carrillo in Puerto Rico.
 
    Fluid Power Businesses. Our specialized fluid power businesses primarily market products and services to customers within the businesses’ geographic regions. In the United States, the businesses also market products and services through our service center network. In addition to distributing fluid power components, the businesses assemble fluid power systems, perform equipment repair, and offer technical advice to customers. Customers include firms purchasing for maintenance, repair, and operations needs, as well as for original equipment manufacturing applications. Our fluid power businesses include the following:

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  United States    
International
 
             
 
A&H Fluid Technologies
    ESI Power Hydraulics     Atelier P.V. Hydraulique (Canada)  
 
Air Draulics Engineering
    Elect-Air     HyPower (Canada)  
 
Air-Hydraulic Systems
    Engineered Sales     Pro-Hydraulique (Canada)  
 
Applied Engineered Systems
    FluidTech*     Vycmex (Mexico)  
 
Bay Advanced Technologies*
    HydroAir Hughes*        
 
Carolina Fluid Components*
    Kent Fluid Power        
 
DTS Fluid Power*
    Power Systems*        
 
Dees Fluid Power
    Spencer Fluid Power        
 
 
    * Business added through August 2008 Fluid Power Resource, LLC acquisition.
          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 suppliers also may provide us product training, as well as sales and marketing support. Authorizations to represent particular suppliers and product lines may vary by geographic region, particularly for our fluid power businesses. We believe our supplier relationships are generally good, and many have existed for decades. The disruption of relationships with certain suppliers, or the disruption of their operations, could adversely affect our business.
          Our product suppliers 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. There is no assurance this practice will continue and its discontinuance could adversely affect our business.
          Net sales by product category for the most recent three fiscal years is detailed in the 2009 annual report to shareholders in note 12 to the consolidated financial statements on page 33. That information is incorporated here by reference.
          Services. Our associates advise and assist customers in selecting and applying products, and in managing inventory. We consider this advice and assistance to be an integral part of our sales efforts. Beyond traditional parts distribution services, we offer product and process solutions involving multiple technologies. These solutions help customers minimize production downtime, improve machine performance, and reduce overall procurement and maintenance costs. By providing high levels of service, product and industry expertise, and technical support, while at the same time offering product breadth and competitive pricing, we believe we develop stronger, longer-lasting, and more profitable customer relationships.

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          Our service center 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 information, and assist account managers in serving customers. Account managers make on-site calls to current and potential customers to provide product information, identify customer requirements, make recommendations, and assist in implementing equipment maintenance and storeroom management programs, including our automated storeroom replenishment system, AppliedSTORE®. Account managers also measure and document the value of the cost savings and increased productivity we help generate. Product and industry specialists assist with applications in their areas of expertise.
          We maintain product inventory levels at each service center tailored to the local market. These inventories consist of standard items as well as other items specific to local customer demand. Seven distribution centers replenish service center inventories and also may ship products directly to customers. Having product in stock helps us satisfy customers’ immediate needs.
          Timely delivery of products is an integral part of our service, particularly when customers require products for emergency repairs. Service centers and distribution centers use the most effective method of transportation available to meet customer needs. These methods include our own delivery vehicles, dedicated third-party transportation providers, as well as surface and air common carrier and courier services. Customers can also pick up items at our service centers.
          Our information systems enhance our customer service. 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 catalog, research product attributes, view prices, check inventory levels, place orders, and track order status. We also interface with customers’ technology platforms and plant maintenance systems.
          In addition to our electronic capabilities, we serve customers with our paper catalog, a comprehensive resource for nearly 42,000 products, including more than 20,000 bearing and power transmission parts and 9,000 fluid power products. Products from the catalog are also available for purchase at www.applied.com.
          We supplement the service center product offering with our MaintenancePro® fee-based technical training seminars. These courses provide customer personnel with information on maintenance, troubleshooting, component application, and failure analysis in the areas of hydraulics and pneumatics, lubrication, bearings, and power transmission.
          In addition to distributing products, we offer shop services in select geographic areas. Our fabricated rubber shops modify and repair conveyor belts and provide hose assemblies (also available at select service centers and distribution centers) in accordance with customer requirements. Field crews install and repair 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

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the rebuilding or assembly of speed reducers, pumps, valves, cylinders, and electric and hydraulic motors, and custom machining.
          Our specialized fluid power businesses generally operate independently of the service centers, but as product distributors, share the same focus on customer service. Product and application recommendations, inventory availability, and delivery speed are all critical to the businesses’ success.
          The fluid power businesses distinguish themselves from most component distributors by offering engineering, design, system fabrication, installation, and repair services. These services can represent a significant portion of the overall value provided to customers. Each business has account managers with extensive technical knowledge, who handle sophisticated projects, including original equipment manufacturing applications. The businesses also provide technical support to our service centers and their customers.
          With the businesses acquired from Fluid Power Resource in August 2008, we expanded our capabilities in providing the following value-added services: fluid power system integration; manifold design, machining, and assembly; and the integration of hydraulics with electronics for complete machine design.
          Markets. We purchase from over 2,000 product manufacturers and resell the products to 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’ knowledge and experience do, however, support our competitive position. Competition is based generally on breadth and quality of product and service offerings, product availability, price, ease of product selection and ordering, catalogs, online capability, and having a local presence. In the fluid power businesses, product manufacturer authorizations are often more selective and can be a more significant competitive factor.
          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

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greater financial resources than we do. The identity and number of our competitors vary throughout the geographic and product markets we serve.
          Although we are one of the leading distributors in North America 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 material at any given time to our business as a whole, although they are a more important factor for our fluid power businesses. Our business has exhibited minor seasonality – in particular, sales per day during the first half of our fiscal year have tended, at least in past years, to be slightly lower compared with the second half due, in part, to the impact of customer plant shutdowns and holidays.
          Patents, Trademarks, Trade Names, and Licenses. Customer recognition of our service marks and trade names, including Applied Industrial Technologies®, Applied®, and AIT®, is an important contributing factor to our sales. Patents and licenses are not of material importance to our business.
          Raw Materials and General Business Conditions. Our operations are dependent on general industrial and economic conditions. We would be adversely affected by the unavailability of raw materials to our suppliers, prolonged labor disputes experienced by suppliers or customers, or by any recession or depression that has an adverse effect on North American industrial activity generally or on key customer industries.
          Number of Employees. At July 31, 2009, we had 4,673 employees.
          Working Capital. Our working capital position is discussed in “Management’s Discussion and Analysis” in the 2009 annual report to shareholders on pages 7 – 8.
          We require substantial working capital related to accounts receivable and inventories. Significant amounts of inventory are carried to meet customers’ delivery requirements. We generally require payments for sales on account within 30 days. Returns are not considered to have a material effect on our working capital requirements. We believe these practices are generally consistent among companies in our industry.
          Environmental Laws. We believe that compliance with laws regulating the discharge of materials into the environment or otherwise relating to environmental protection will not have a material adverse effect on our capital expenditures, earnings, or competitive position.

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          (d)     Financial Information about Geographic Areas.
          Information regarding our foreign operations, including information about revenues and long-lived assets, is included in the 2009 annual report to shareholders in note 12 to the consolidated financial statements on page 33 and in “Quantitative and Qualitative Disclosures About Market Risk” on page 11. 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 broadly to issuers, or risks that we currently deem immaterial, may also impact our business and operations.
          Our business depends heavily on the operating levels of our customers and the economic factors that affect them. Many of the primary markets for the products and services we sell are subject to cyclical fluctuations that affect demand for goods and materials that our customers produce. Consequently, the demand for our products and services 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 and materials.
          When, as has occurred in this economic downturn, customers or prospective customers reduce production levels because of lower demand or tight credit conditions, they have less need for our products and services. Selling prices and terms of sale come under pressure, adversely affecting profitability and the durability of customer relationships. Credit losses increase too. Recent volatile economic and credit conditions have also made it more difficult for distributors, as well as customers and suppliers, to forecast and plan future business activities.
          In addition, our industry confronts the longer-term secular trend of manufacturing customers moving operations overseas in order to reduce costs. Our ability to continue to serve such customers may be impaired and the size of our overall market opportunity in North America may be diminished.
          The purchasing incentives we earn from product suppliers could be impacted if we reduce our purchases in response to declining customer demand. Certain of our product suppliers have historically offered to their distributors, including us, incentives associated with purchasing their products. The programs often pay incentives to the distributor for attaining specific purchase volumes during the program period. In some cases, in order to earn incentives, we must achieve year-over-year growth in purchases with the supplier. Because of existing inventory levels and reduced customer demand under current conditions, we may be less willing to take advantage of certain incentive programs, thereby adversely impacting our profitability.

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          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 adversely impact the amount and volatility of our earnings. In addition, consolidation increases the risk of larger customers seeking to purchase industrial products directly from manufacturers rather than through distributors. Similarly, continued consolidation among our suppliers could reduce our ability to negotiate favorable pricing and other commercial terms for our inventory purchases.
          Loss of key supplier authorizations, lack of product availability, or changes in supplier distribution programs could adversely affect our sales and earnings. Our business depends on maintaining an immediately available supply of various products to meet customer demand. Of our overall dollar volume of product purchases in fiscal 2009, 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 their products, could have a material adverse effect on our business. Supply interruptions could arise from raw materials shortages, financial problems, 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 us. For example, key suppliers could change any of the following: the prices we must pay for their products relative to other distributors or relative to competing products; the geographic or product line breadth of distributor authorizations; supplier support programs; or product purchase or stocking expectations.
          An increase in competition could decrease sales or earnings. We operate in a highly competitive industry. Our competitors include local, regional, national, and multinational distributors of industrial machinery parts, equipment, and supplies. Competition is largely focused in the local service area and is generally based on product line breadth, product availability, service capabilities, and price. Some existing competitors have, and potential market entrants may have, greater financial or other resources than we do. If existing or future competitors seek to gain or to retain market share by reducing prices, we may need to lower our prices for products or services, thereby adversely affecting financial results.
          Volatility in product and energy costs can affect our profitability. In recent years, cost increases in commodity materials, such as steel, and energy led product manufacturers to increase the prices of products we distribute. In addition, a portion of our own distribution costs is comprised of fuel for our sales and delivery vehicles, freight, and utility expenses for our

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facilities. All of these costs have fluctuated 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. When costs fall, market prices can fall too, again potentially affecting profitability.
          Future acquisitions are a key component of our anticipated growth. We may not be able to identify or to complete future acquisitions, to integrate them effectively into our operations, or to realize their anticipated benefits. Many industries we serve are mature. As a result, our growth in recent years has resulted substantially from the acquisition of other businesses. While we wish to continue to acquire businesses, we may not be able to identify and to negotiate suitable acquisitions, to obtain financing for them on satisfactory terms, or otherwise to complete acquisitions. In addition, existing or future competitors may increasingly seek to compete with us for acquisitions, which could have the effect of increasing the price and reducing the number of suitable opportunities.
          We seek acquisition opportunities that complement and expand our operations. However, substantial costs, delays, or other difficulties related to integrating acquisitions into our operations could adversely affect our business or financial results. We could face significant challenges in consolidating functions and integrating procedures, information technology, personnel, and operations in a timely and efficient manner.
          Further, even if we successfully integrate the acquisitions with our operations, we may not be able to realize the cost savings, sales 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 incurrence of significant integration costs or charges in order to achieve those benefits; and our ability to retain key product supplier authorizations, customer relationships, and managers and employees. In addition, future acquisitions could place significant demand on administrative, operational, and financial resources.
          Tight credit markets could impact our ability to obtain financing on reasonable terms or increase the cost of future financing. Although recent credit market turmoil has not had a significant adverse impact on our liquidity or borrowing costs, the availability of funds has tightened and credit spreads on corporate debt have increased. Obtaining additional or replacement financing may be more difficult and the cost of issuing new debt or replacing a credit facility would likely be higher than under our current facilities. Tight credit conditions could limit our ability to finance acquisitions on terms acceptable to us. For more information relating to borrowing and interest rates, see the following sections of Applied’s 2009 annual report to shareholders: “Liquidity and Capital Resources” on pages 7 – 8, “Quantitative and Qualitative Disclosures About Market Risk” on page 11, and notes 5 and 6 to the consolidated financial statements on pages 21 - 22.

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          Our growth outside the United States increases our exposure to global economic and political conditions. Foreign operations contributed 12.9% of our sales in 2009. 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. In particular, our results are affected by fluctuations in currency exchange rates for the Canadian dollar and the Mexican peso.
          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 customers on a timely basis, maintain cost-effective operations, and provide superior service to customers. A serious, prolonged disruption of our information systems could materially impair fundamental business processes.
          Our business depends on our ability to retain and to 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 with 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.
          An interruption of operations at our headquarters or distribution centers could adversely impact our business. Our business depends on maintaining operations at our headquarters and distribution centers. A serious, prolonged interruption due to power outage, telecommunications outage, terrorist attack, earthquake, hurricane, fire, flood or other natural disaster, or other interruption could have a material adverse effect on our business and financial results.
          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.
          In addition to the risks identified above, other risks to our future performance include, but are not limited to, the following:
    changes in customer preferences for products and services of the nature, brands, quality, or cost sold by Applied;
 
    changes in customer procurement policies and practices;

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    changes in the market prices for products and services relative to the costs of providing them;
 
    changes in operating expenses;
 
    adverse regulation and legislation, including in areas currently under active consideration, such as federal tax policy and health care;
 
    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;
 
    volatility of our stock price and the resulting impact on our consolidated financial statements;
 
    changes in accounting policies and practices; and
 
    organizational changes within the company.
ITEM 1B.  UNRESOLVED STAFF COMMENTS.
Not applicable.
ITEM 2.  PROPERTIES.
          We believe having a local presence is important to serving our customers, so we maintain service centers and other operations in local markets throughout North America. At June 30, 2009, we owned real properties at 138 locations and leased 310 locations. Certain properties house more than one operation.
          The following were our principal owned real properties (each of which has more than 30,000 square feet of floor space) at June 30, 2009:
           
 
  Location of Principal Owned     Type of Facility  
  Real Property        
 
 
       
 
Atlanta, Georgia
    Distribution center and service center  
 
Florence, Kentucky
    Distribution center  
 
Carlisle, Pennsylvania
    Distribution center  
 
Fort Worth, Texas
    Distribution center and rubber shop  
 

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          Our principal leased real properties (each of which has more than 30,000 square feet of floor space) at June 30, 2009 were:
           
 
  Location of Principal Leased     Type of Facility  
  Real Property        
 
 
       
 
Cleveland, Ohio
    Corporate headquarters  
 
Fontana, California
    Distribution center, rubber shop, fluid power shop, and service center  
 
Newark, California
    Fluid power shop  
 
Denver, Colorado
    Rubber shop and service center  
 
Lenexa, Kansas
    Fluid power shop  
 
Chanhassen, Minnesota
    Fluid power shop  
 
Billings, Montana
    Fluid power shop  
 
Portland, Oregon
    Distribution center  
 
Kent, Washington
    Offices and fluid power shop  
 
Longview, Washington
    Rubber shop and the fluid power shop  
 
Appleton, Wisconsin
    Offices, service center, and rubber shop  
 
Winnipeg, Manitoba
    Distribution center and service center  
 
          The properties in Newark, Lenexa, Chanhassen, Billings, and Kent are used in our fluid power businesses segment. The Fontana and Longview properties are used in operations both in the service center-based distribution segment and the fluid power businesses segment. The remaining properties are used in the service center-based distribution segment.
          We consider our properties generally sufficient to meet our requirements for office space and inventory stocking. A service center’s size is primarily influenced by the amount 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 2009 annual report to shareholders in note 11 to the consolidated financial statements on page 31. That information is incorporated here by reference.
ITEM 3.  LEGAL PROCEEDINGS.
          Applied and/or one of its subsidiaries is a party to pending legal proceedings with respect to product liability, commercial, and other matters. Although it is not possible to predict the outcome of these proceedings or the range of possible loss, we believe, based on circumstances

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currently known, that the likelihood is remote that the ultimate resolution of any of these proceedings will have, either individually or in the aggregate, a material adverse effect on Applied’s consolidated financial position, results of operations, or cash flows.
ITEM 4.  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 2009.
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 21, 2008:
                     
 
  Name

    Positions and Experience

    Age

 
 
David L. Pugh
    Chairman & Chief Executive Officer, and a member of Board of Directors       60    
 
Benjamin J. Mondics
    President & Chief Operating Officer (since January 2008); previously served as Executive Vice President & Chief Operating Officer (from February 2007 – December 2007) and Vice President-Midwest Area (prior to February 2007)       51    
 
Thomas E. Armold
    Vice President-Marketing and Strategic Accounts (since January 2008); previously served as Vice President-Product Management and Marketing       54    
 
Todd A. Barlett
    Vice President-Acquisitions and Global Business Development       54    
 
Fred D. Bauer
    Vice President-General Counsel & Secretary       43    
 
Michael L. Coticchia
    Vice President-Chief Administrative Officer and Government Business (since July 2006); previously served as Vice President-Human Resources and Administration       46    
 
Mark O. Eisele
    Vice President-Chief Financial Officer & Treasurer       52    
 
Jeffrey A. Ramras
    Vice President-Supply Chain Management (since January 2008); previously served as Vice President-Marketing and Supply Chain Management       54    
 
Richard C. Shaw
    Vice President-Communications and Learning       60    
 

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PART II.
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
          Applied’s common stock, without par value, is listed for trading on the New York Stock Exchange with the ticker symbol “AIT.” Information concerning the principal market for Applied’s common stock, the quarterly stock prices and dividends for the fiscal years ended June 30, 2009, 2008, and 2007 and the number of shareholders of record as of August 11, 2009 is set forth in the 2009 annual report to shareholders on page 37, under the caption “Quarterly Operating Results and Market Data,” and that information is incorporated here by reference.
          The following table summarizes Applied’s repurchases of its common stock in the quarter ended June 30, 2009.
                                             
 
                            (c) Total Number of     (d) Maximum Number  
                            Shares Purchased as     of Shares that May  
        (a) Total     (b) Average     Part of Publicly     Yet Be Purchased  
        Number of     Price Paid per     Announced Plans or     Under the Plans or  
  Period     Shares (1)     Share ($)     Programs     Programs (2)  
  April 1, 2009 to
April 30, 2009
      0         --         0         997,100    
                                     
  May 1, 2009 to
May 31, 2009
      0         --         0         997,100    
                                     
  June 1, 2009 to
June 30, 2009
      0         --         0         997,100    
                                     
  Total       0         --         0         997,100    
                                     
 
 
(1)   During the quarter ended June 30, 2009, Applied purchased 63 shares in connection with an employee deferred compensation program. This purchase is not counted in the Board of Directors authorization in note (2).
 
(2)   On January 23, 2008, the Board of Directors authorized the purchase of up to 1.5 million shares of Applied’s common stock. We publicly announced the authorization that day. Purchases may be made in the open market or in privately negotiated transactions. This authorization is in effect until all shares are purchased, or the Board revokes or amends the authorization.
ITEM 6.  SELECTED FINANCIAL DATA.
          The summary of selected financial data for the last five years is set forth in the 2009 annual report to shareholders in the table on pages 38 - 39 under the caption “10 Year Summary.” That information is incorporated here by reference.

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ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
          “Management’s Discussion and Analysis” is set forth in the 2009 annual report to shareholders on pages 5 - 11 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 2009 annual report to shareholders on page 11, which information is incorporated here by reference. For more information relating to borrowing and interest rates, see the “Liquidity and Capital Resources” section of “Management’s Discussion and Analysis” and notes 5 and 6 to the consolidated financial statements in Applied’s 2009 annual report to shareholders on pages 7 - 8, and 21 - 22. That information is also incorporated here by reference. In addition, see “Risk Factors” at pages 10 - 14, 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 2009 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
    12  
for the Years Ended
June 30, 2009, 2008, and 2007
       
 
       
Consolidated Balance Sheets
    13  
June 30, 2009 and 2008
       
 
       
Statements of Consolidated Cash Flows
    14  
for the Years Ended
June 30, 2009, 2008, and 2007
       
 
       
Statements of Consolidated Shareholders’
    15  
Equity for the Years Ended
June 30, 2009, 2008, and 2007
       

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Notes to Consolidated Financial Statements
    16 - 33  
for the Years Ended
June 30, 2009, 2008, and 2007
       
 
       
Reports of Independent Registered Public Accounting Firm
    34, 36  
 
       
Supplementary Data:
       
 
       
Quarterly Operating Results & Market Data
    37  
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
ITEM 9A.  CONTROLS AND PROCEDURES.
          Applied’s management, under the supervision and with the participation of the chief executive officer and the chief financial officer, has evaluated the effectiveness of Applied’s disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act, as of the end of the period covered by this report. Based on that evaluation, management has concluded that the disclosure controls and procedures are effective.
          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 2009 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.

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PART III.
ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
          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 20, 2009, under the caption “Item 1 – Election of Directors.” The information required by this Item as to Applied’s executive officers has been furnished in this Report on page 16 in Part I, after Item 4, under the caption “Executive Officers of the Registrant.”
          The information required by this Item regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference to Applied’s proxy statement, under the caption “Section 16(a) Beneficial Ownership Reporting Compliance.”
          Applied has a code of ethics, named 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.
          Information regarding the composition of Applied’s audit committee and the identification of audit committee financial expert(s) serving on the audit committee is incorporated by reference to Applied’s proxy statement, under the caption “Corporate Governance.”
ITEM 11.  EXECUTIVE COMPENSATION.
          The information required by this Item is incorporated by reference to Applied’s proxy statement for the annual meeting of shareholders to be held October 20, 2009, under the captions “Executive Compensation” and “Compensation Committee Report.”
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
            MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
          Applied’s shareholders have approved the following equity compensation plans: the 1997 Long-Term Performance Plan, the 2007 Long-Term Performance Plan, the Deferred Compensation Plan, and the Deferred Compensation Plan for Non-Employee Directors. All of these plans are currently in effect.
          The following table shows information regarding the number of shares of Applied common stock that may be issued pursuant to equity compensation plans or arrangements of Applied as of June 30, 2009.

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        Number of     Weighted-        
        Securities     Average        
        to be     Exercise     Number of  
        Issued upon     Price of     Securities  
        Exercise of     Outstanding     Remaining  
        Outstanding     Options,     Available for Future  
        Options,     Warrants     Issuance Under  
        Warrants and     and     Equity  
  Plan Category     Rights     Rights     Compensation Plans  
 
 
Equity compensation plans approved by security holders
      2,446,405       $ 17.06         *    
                       
 
 
Equity compensation plans not approved by security holders
      0         --         0    
                       
 
 
Total
      2,446,405       $ 17.06         *    
                       
 
 
*     The 2007 Long-Term Performance Plan was adopted to replace the 1997 Long-Term Performance Plan, under which previously awarded stock options and stock appreciation rights remain outstanding. The aggregate number of shares that remained available for awards under the 2007 Long-Term Performance Plan at June 30, 2009, was 1,585,200. The number of shares issuable under the Deferred Compensation Plan for Non-Employee Directors and the Deferred Compensation Plan depends on the dollar amount of participant contributions deemed invested in Applied common stock.
          Information concerning the security ownership of certain beneficial owners and management is incorporated by reference to Applied’s proxy statement for the annual meeting of shareholders to be held October 20, 2009, under the caption “Beneficial Ownership of Certain Applied Shareholders and Management.”
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,
AND DIRECTOR INDEPENDENCE.
          The information required by this Item is incorporated by reference to Applied’s proxy statement for the annual meeting of shareholders to be held October 20, 2009, under the caption “Corporate Governance.”
ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES.
          The information required by this Item is incorporated by reference to Applied’s proxy statement for the annual meeting of shareholders to be held October 20, 2009, under the caption “Item 2 – Ratification of Auditors.”

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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 2009 annual report to shareholders on pages 12 - 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, 2009, 2008, and 2007
Consolidated Balance Sheets
June 30, 2009 and 2008
Statements of Consolidated Cash Flows for
the Years Ended June 30, 2009, 2008, and 2007
Statements of Consolidated Shareholders’
Equity for the Years Ended June 30, 2009,
2008, and 2007
Notes to Consolidated Financial Statements
for the Years Ended June 30, 2009, 2008, and 2007
Reports of Independent Registered Public Accounting Firm
Supplementary Data:
Quarterly Operating Results & 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
    29  
 
       
Schedule II - Valuation and Qualifying Accounts
    30  

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          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
 
       
 
  3.1   Amended and Restated Articles of Incorporation of Applied Industrial Technologies, Inc., as amended on October 25, 2005 (filed as Exhibit 3(a) to Applied’s Form 10-Q for the quarter ended December 31, 2005, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  3.2   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).
 
       
 
  4.1   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).
 
       
 
  4.2   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).
 
       
 
  4.3   Amendment dated October 24, 2000 to 1996 Private Shelf Agreement between Applied and Prudential Investment Management, Inc. (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).

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  4.4   Amendment dated November 14, 2003 to 1996 Private Shelf Agreement between Applied and Prudential Investment Management, Inc. (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).
 
       
 
  4.5   Amendment dated February 25, 2004 to 1996 Private Shelf Agreement between Applied and Prudential Investment Management, Inc. (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).
 
       
 
  4.6   Amendment dated March 30, 2007 to 1996 Private Shelf Agreement between Applied and Prudential Investment Management, Inc. (filed as Exhibit 4(f) to Applied’s Form 10-Q for the quarter ended March 31, 2007, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  4.7   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).
 
       
 
  4.8   First Amendment Agreement dated as of June 6, 2007, among Applied, KeyBank National Association as Agent, and various financial institutions, amending June 3, 2005 Credit Agreement (filed as Exhibit 4 to Applied’s Form 8-K dated June 11, 2007, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.1   Form of Change in Control Agreement between Applied and each of its executive officers (filed as Exhibit 99.1 to Applied’s Form 8-K dated April 25, 2008, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.2   A written description of Applied’s director compensation program is incorporated by reference to Applied’s proxy statement for the annual meeting of shareholders to be held October 20, 2009 under the caption “Director Compensation.”
 
       
 
  *10.3   Deferred Compensation Plan for Non-Employee Directors (September 1, 2003 Restatement), the terms of which govern benefits vested as of December 31, 2004, for certain directors (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).

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  *10.4   Deferred Compensation Plan for Non-Employee Directors (Post-2004 Terms) (filed as Exhibit 10.2 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.5   A written description of Applied’s Life and Accidental Death and Dismemberment Insurance for executive officers (filed as Exhibit 10(d) to Applied’s Form 10-K for the year ended June 30, 2007, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.6   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).
 
       
 
  *10.7   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).
 
       
 
  *10.8   Supplemental Executive Retirement Benefits Plan (January 1, 2002 Restatement), the terms of which govern benefits vested as of December 31, 2004, for one executive officer, R. C. Shaw (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).
 
       
 
  *10.9   First Amendment to Supplemental Executive Retirement Benefits Plan (January 1, 2002 Restatement) (filed as Exhibit 10 to Applied’s Form 10-Q for the quarter ended September 30, 2004, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.10   Supplemental Executive Retirement Benefits Plan (Restated Post-2004 Terms) (filed as Exhibit 10.1 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.11   Deferred Compensation Plan (September 1, 2003 Restatement), the terms of which govern benefits vested as of December 31, 2004, for certain executive officers (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).

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  *10.12   First Amendment to 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).
 
       
 
  *10.13   Deferred Compensation Plan (Post-2004 Terms) (filed as Exhibit 10.3 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.14   1997 Long-Term Performance Plan, as amended April 19, 2007 (filed as Exhibit 10(k) to Applied’s Form 10-K for the year ended June 30, 2007, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.15   Section 409A Amendment to the 1997 Long-Term Performance Plan (filed as Exhibit 10.4 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.16   2007 Long-Term Performance Plan (filed as Exhibit 10 to Applied’s Form 8-K dated October 23, 2007, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.17   Section 409A Amendment to the 2007 Long-Term Performance Plan (filed as Exhibit 10.5 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.18   Supplemental Defined Contribution Plan (January 1, 1997 Restatement) the terms of which govern benefits vested as of December 31, 2004, for certain executive officers (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).
 
       
 
  *10.19   First Amendment to 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).
 
       
 
  *10.20   Second Amendment to 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).

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  *10.21   Supplemental Defined Contribution Plan (Post-2004 Terms) (filed as Exhibit 10.6 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.22   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).
 
       
 
  *10.23   Restricted Stock Award Terms (Directors) (filed as Exhibit 10(b) to Applied’s Form 10-Q for the quarter ended March 31, 2007, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.24   Stock Appreciation Rights Award Terms and Conditions (Officers) (filed as Exhibit 10.1 to Applied’s Form 10-Q for the quarter ended September 30, 2008, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.25   Performance Grant Terms and Conditions (filed as Exhibit 10.3 to Applied’s Form 10-Q for the quarter ended September 30, 2008, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.26   Management Incentive Plan General Terms (filed as Exhibit 10.2 to Applied’s Form 10-Q for the quarter ended September 30, 2008, SEC File No. 1-2299, and incorporated here by reference).
 
       
 
  *10.27   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).
 
       
 
  10.28   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).
 
       
 
  10.29   Asset Purchase Agreement made as of July 14, 2008, among Applied, Fluid Power Resource, LLC (“FPR”), and certain FPR subsidiaries (filed as Exhibit 2.1 to Applied’s Form 8-K dated July 16, 2008, SEC File No. 1-2299, and incorporated here by reference).

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  13   Applied’s 2009 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, 2009.
 
       
 
  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 long-term debt instruments 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.

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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, 2009 and 2008, and for each of the three years in the period ended June 30, 2009, and the Company’s internal control over financial reporting as of June 30, 2009, and have issued our reports thereon dated August 19, 2009; such consolidated financial statements and reports are included in your 2009 Annual Report to Shareholders and are incorporated herein by reference. 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 19, 2009

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APPLIED INDUSTRIAL TECHNOLOGIES, INC. & SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JUNE 30, 2009, 2008 AND 2007

(in thousands)
 
                                         
COLUMN A   COLUMN B   COLUMN C   COLUMN D   COLUMN E
                    ADDITIONS        
            ADDITIONS   (DEDUCTIONS)        
    BALANCE AT   CHARGED TO   CHARGED TO   DEDUCTIONS   BALANCE
    BEGINNING   COSTS AND   OTHER   FROM   AT END OF
DESCRIPTION   OF PERIOD   EXPENSES   ACCOUNTS   RESERVE   PERIOD
 
 
                                       
YEAR ENDED JUNE 30 2009
                                       
Reserve deducted from assets to which it applies - accounts receivable allowances
  $ 6,119     $ 4,540     $18  (B)   $ 4,213  (A)   $ 6,464  
 
                                       
YEAR ENDED JUNE 30 2008:
                                       
Reserve deducted from assets to which it applies - accounts receivable allowances
  $ 6,134     $ 2,595     $80  (B)   $ 2,690  (A)   $ 6,119  
 
                                       
YEAR ENDED JUNE 30 2007:
                                       
Reserve deducted from assets to which it applies - accounts receivable allowances
  $ 6,000     $ 1,462       ($30)  (B)   $ 1,298  (A)   $ 6,134  
 
(A)   Amounts represent uncollectible accounts charged off.
 
(B)   Amounts represent reserves for the return of merchandise by customers.
 
SCHEDULE II

 


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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/ Benjamin J. Mondics    
 
David L. Pugh, Chairman &
 
 
Benjamin J. Mondics, 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 Officer
  Corporate Controller    
& Treasurer
  (Principal Accounting Officer)    
Date: August 19, 2009
          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 19, 2009

 


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APPLIED INDUSTRIAL TECHNOLOGIES, INC.
EXHIBIT INDEX
TO FORM 10-K FOR THE YEAR ENDED JUNE 30, 2009
         
Exhibit        
No.   Description    
 
       
3.1
  Amended and Restated Articles of Incorporation of Applied Industrial Technologies, Inc., as amended on October 25, 2005 (filed as Exhibit 3(a) to Applied’s Form 10-Q for the quarter ended December 31, 2005, SEC File No. 1-2299, and incorporated here by reference).    
 
       
3.2
  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).    
 
       
4.1
  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).    
 
       
4.2
  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).    
 
       
4.3
  Amendment dated October 24, 2000 to 1996 Private Shelf Agreement between Applied and Prudential Investment Management, Inc. (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).    
 
       
4.4
  Amendment dated November 14, 2003 to 1996 Private Shelf Agreement between Applied and Prudential Investment Management, Inc. (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).    

 


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4.5
  Amendment dated February 25, 2004 to 1996 Private Shelf Agreement between Applied and Prudential Investment Management, Inc. (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).    
 
       
4.6
  Amendment dated March 30, 2007 to 1996 Private Shelf Agreement between Applied and Prudential Investment Management, Inc. (filed as Exhibit 4(f) to Applied’s Form 10-Q for the quarter ended March 31, 2007, SEC File No. 1-2299, and incorporated here by reference).    
 
       
4.7
  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).    
 
       
4.8
  First Amendment Agreement dated as of June 6, 2007, among Applied, KeyBank National Association as Agent, and various financial institutions, amending June 3, 2005 Credit Agreement (filed as Exhibit 4 to Applied’s Form 8-K dated June 11, 2007, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.1
  Form of Change in Control Agreement between Applied and each of its executive officers (filed as Exhibit 99.1 to Applied’s Form 8-K dated April 25, 2008, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.2
  A written description of Applied’s director compensation program is incorporated by reference to Applied’s proxy statement for the annual meeting of shareholders to be held October 20, 2009, under the caption “Director Compensation.”    
 
       
*10.3
  Deferred Compensation Plan for Non-Employee Directors (September 1, 2003 Restatement) the terms of which govern benefits vested as of December 31, 2004, for certain directors (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).    
 
       
*10.4
  Deferred Compensation Plan for Non-Employee Directors (Post-2004 Terms) (filed as Exhibit 10.2 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.5
  A written description of Applied’s Life and Accidental Death and Dismemberment Insurance for executive officers (filed as Exhibit 10(d) to Applied’s Form 10-K for the year ended June 30, 2007, SEC File No. 1-2299, and incorporated here by reference).    

 


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*10.6
  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).    
 
       
*10.7
  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).    
 
       
*10.8
  Supplemental Executive Retirement Benefits Plan (January 1, 2002 Restatement), the terms of which govern benefits vested as of December 31, 2004, for one executive officer, R. C. Shaw (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).    
 
       
*10.9
  First Amendment to Supplemental Executive Retirement Benefits Plan (January 1, 2002 Restatement) (filed as Exhibit 10 to Applied’s Form 10-Q for the quarter ended September 30, 2004, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.10
  Supplemental Executive Retirement Benefits Plan (Restated Post-2004 Terms) (filed as Exhibit 10.1 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.11
  Deferred Compensation Plan (September 1, 2003 Restatement), the terms of which govern benefits vested as of December 31, 2004, for certain executive officers (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).    
 
       
*10.12
  First Amendment to 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).    
 
       
*10.13
  Deferred Compensation Plan (Post-2004 Terms) (filed as Exhibit 10.3 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.14
  1997 Long-Term Performance Plan, as amended April 19, 2007 (filed as Exhibit 10(k) to Applied’s Form 10-K for the year ended June 30, 2007, SEC File No. 1-2299, and incorporated here by reference).    

 


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*10.15
  Section 409A Amendment to the 1997 Long-Term Performance Plan (filed as Exhibit 10.4 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.16
  2007 Long-Term Performance Plan (filed as Exhibit 10 to the Applied’s Form 8-K dated October 23, 2007, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.17
  Section 409A Amendment to the 2007 Long-Term Performance Plan (filed as Exhibit 10.5 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.18
  Supplemental Defined Contribution Plan (January 1, 1997 Restatement) the terms of which govern benefits vested as of December 31, 2004, for certain executive officers (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).    
 
       
*10.19
  First Amendment to 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).    
 
       
*10.20
  Second Amendment to 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).    
 
       
*10.21
  Supplemental Defined Contribution Plan (Post-2004 Terms) (filed as Exhibit 10.6 to Applied’s Form 10-Q for the quarter ended December 31, 2008, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.22
  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).    
 
       
*10.23
  Restricted Stock Award Terms (Directors) (filed as Exhibit 10(b) to Applied’s Form 10-Q for the quarter ended March 31, 2007, SEC File No. 1-2299, and incorporated here by reference).    

 


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*10.24
  Stock Appreciation Rights Award Terms and Conditions (Officers) (filed as Exhibit 10.1 to Applied’s Form 10-Q for the quarter ended September 30, 2008, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.25
  Performance Grant Terms and Conditions (filed as Exhibit 10.3 to Applied’s Form 10-Q for the quarter ended September 30, 2008, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.26
  Management Incentive Plan General Terms (filed as Exhibit 10.2 to Applied’s Form 10-Q for the quarter ended September 30, 2008, SEC File No. 1-2299, and incorporated here by reference).    
 
       
*10.27
  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).    
 
       
10.28
  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).    
 
       
10.29
  Asset Purchase Agreement made as of July 14, 2008, among Applied, Fluid Power Resource, LLC (“FPR”), and certain FPR subsidiaries (filed as Exhibit 2.1 to Applied’s Form 8-K dated July 16, 2008, SEC File No. 1-2299, and incorporated here by reference).    
 
       
13
  Applied’s 2009 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, 2009.   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

 

EXHIBIT 13
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

OVERVIEW
With more than 4,700 associates across North America, Applied Industrial Technologies (“Applied,” the “Company,” “We,” “Us” or “Our”) is an industrial distributor that offers parts critical to the operations of MRO and OEM customers in a wide range of industries. In addition, Applied provides engineering, design and systems integration for industrial and fluid power applications, as well as customized fluid power shop, mechanical and fabricated rubber services. As an authorized distributor for more than 2,000 manufacturers, we offer access to approximately 3 million stock keeping units (“SKUs”). A large portion of our business is selling replacement parts to manufacturers and other industrial concerns for repair or maintenance of machinery and equipment. We have a long tradition of growth dating back to 1923, the year our business was founded in Cleveland, Ohio. At June 30, 2009, business was conducted in the United States, Canada, Mexico and Puerto Rico from 464 facilities.
When reviewing the discussion and analysis set forth below, please note that the majority of SKUs we sell in any given year were not sold in the prior year, resulting in the inability to quantify certain commonly used comparative metrics analyzing sales, such as changes in product mix and volume.
On August 29, 2008, Applied completed the acquisition of certain assets of Fluid Power Resource, LLC, (“FPR”). The results of FPR’s operations have been included in the consolidated financial statements since that date.
Our fiscal 2009 sales came in at $1.9 billion, a decrease of $166.3 million or 8.0% compared to the prior year. The effects of the worldwide recession are being felt in the industries we serve. Declines in same-store business of 14.6% were only partially offset by net sales from acquired businesses which added $160.6 million. Our operating margin declined to 3.8% compared to the prior year’s 7.3%. The current year includes the impact of a goodwill impairment charge of $36.6 million related to our Fluid Power Businesses segment, which decreased operating margins by 1.9% and earnings per share by $0.54. Gross margin declined slightly to 27.0% from 27.2% in the prior year. Our earnings per share was $0.99 versus $2.19 in fiscal year 2008, a decline of 54.8%. Goodwill impairment accounted for approximately half of this decline, whereas the remaining decline represents the impact of lower sales and higher net interest costs partially offset by reductions in operating expenses.
During the fourth quarter of fiscal 2009, the Company performed an interim goodwill impairment test based on current and expected market conditions, including reduced operating results and a worsening economic outlook. As a result of this test, the Company determined that all of the goodwill associated with the Fluid Power Businesses segment was impaired as of June 30, 2009. Accordingly, the Company recognized an impairment charge of $36.6 million for goodwill in the fourth quarter of fiscal 2009, which decreased net income by $23.0 million and earnings per share by $0.54.
Our consolidated balance sheet remains strong. Shareholders’ equity is $508.1 million, up slightly from the June 30, 2008 level of $502.1 million. Working capital decreased $40.1 million from June 30, 2008 to $369.0 million at June 30, 2009, primarily reflecting the impact of the FPR acquisition. Our current ratio remains strong at 3.4 to 1 versus 3.1 to 1 in fiscal year 2008.
Applied monitors several economic indices that have proven to be key indicators for industrial economic activity. These include the Manufacturing Index published by the Institute for Supply Management (“ISM”), and the
Manufacturing Capacity Utilization (“MCU”) published by the Federal Reserve Board.
Historically our performance correlates well with the MCU, which measures productivity and calculates a ratio of actual manufacturing output versus potential full capacity output. When manufacturing plants are running at a high rate of capacity, they tend to wear out machinery and require replacement parts. Our sales tend to lag the MCU on the upswing and move with the decline.
Over the last five quarters, both of these indices have been signifying a severe recessionary economy for the United States, which has heavily impacted the industries we serve. Our U.S. same-store sales have declined steadily during this same period. For instance, our U.S. service center same-store sales fell compared to the same quarter of the prior year as follows:
         
Quarter Ended   Sales Decline
 
June 2008
    2 %
 
September 2008
    3 %
 
December 2008
    13 %
 
March 2009
    23 %
 
June 2009
    27 %
Although there has been some improvement in the ISM Manufacturing Index through the first two calendar quarters of 2009, it (along with the MCU) is still showing an economy in recession. Hence, we believe our sales will be sluggish through most, if not all, of fiscal 2010, barring any sudden and dramatic increase in capacity utilization.
YEAR ENDED JUNE 30, 2009 vs. 2008
Net sales in fiscal 2009 were $1.9 billion or 8.0% below the prior year. Net sales from companies acquired since the prior year contributed approximately $160.6 million. Our same-store sales declined 14.6% due to the slowing industrial economy. Currency translation accounted for approximately $32.4 million of the decline or 1.5%. In local currency, our Canadian business was up 0.5% from fiscal 2008 levels. Net sales from our Mexican operations more than doubled to $50.6 million, driven primarily by newly acquired businesses. The number of selling days in fiscal 2009 was the same as in fiscal 2008.
Within the Service Center Based Distribution segment, net sales decreased $268.7 million or 14.4% compared to fiscal year 2008. Net sales from acquired businesses contributed $21.1 million, while our same-store sales saw a net decline of $289.8 million or 15.5%. Within the Fluid Power Businesses segment, net sales increased $102.4 million or 45.7%. This increase was primarily due to our U.S. and Mexican acquisitions in this segment which added $139.5 million to net sales. Same-store sales declined in our Fluid Power Businesses segment by 16.6%.
The sales product mix for fiscal 2009 was 74.0% industrial products and 26.0% fluid power products compared to 80.0% industrial and 20.0% fluid power in the prior year. Acquisitions since the prior year have been primarily in our Fluid Power Businesses segment, accounting for the shift in product mix.
At June 30, 2009, we had a total of 464 operating facilities in the U.S., Canada and Mexico versus 459 at June 30, 2008. The net increase in facilities reflects 20 new facilities from acquisitions and 2 newly opened locations, offset by 17 mergers/closures of locations in the current year.
Our gross profit margin declined to 27.0% in fiscal 2009 from 27.2% in fiscal 2008. LIFO inventory layer liquidations resulted in a $4.4 million


 
Applied Industrial Technologies, Inc. and Subsidiaries     5

 


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATION (Continued)
 

positive impact during fiscal 2009, which helped offset a reduction in U.S. point-of-sale margin.
SD&A consists of associate compensation, benefits and other expenses associated with selling, purchasing, warehousing, supply chain management and providing marketing and distribution of the Company’s products, as well as costs associated with a variety of administrative functions such as human resources, information technology, treasury, accounting, legal, and facility related expenses. SD&A decreased $5.5 million or 1.3% during fiscal 2009 compared to the prior year, and increased as a percent of sales to 21.4% in 2009 from 19.9% in 2008. Acquisitions added $44.0 million of SD&A compared to the prior year, including additional amortization expense of $8.1 million. Healthcare costs and severance expense increased $5.8 million. Associate compensation and benefits, including amounts tied to financial performance, were $38.5 million lower in the current fiscal year. During the latter half of the year, we reviewed our operations and reduced staff and hours worked, resulting in an additional reduction of wage and benefit costs for the year of $4.4 million. Foreign currency translation and reduced discretionary spending account for the majority of the remaining decrease.
During the fourth quarter of fiscal 2009, the Company performed an interim goodwill impairment test based on current and expected market conditions, including reduced operating results and a worsening economic outlook. As a result of this test, the Company determined that all of the goodwill associated with the Fluid Power Businesses segment was impaired as of June 30, 2009. Accordingly, the Company recognized an impairment charge of $36.6 million for goodwill in the fourth quarter of fiscal 2009, which decreased net income by $23.0 million and earnings per share by $0.54.
Operating income decreased 52.6% to $72.5 million during fiscal 2009 from $152.8 million during 2008. As a percent of sales, operating income decreased to 3.8% in fiscal 2009 from 7.3% in 2008. The $80.3 million decrease in operating income during fiscal 2009 primarily reflects the impact of sales declining at a greater rate than SD&A expenses and the goodwill impairment charge of $36.6 million.
Operating income of both of our segments declined. Operating income as a percentage of sales for the Service Center Based Distribution segment declined from 6.7% in fiscal 2008 to 4.7% in fiscal 2009 and for the Fluid Power Businesses segment from 7.7% to 5.8%. Again, these changes reflect the impact of a sales decline at a greater rate than SD&A expenses.
Interest expense, net, increased $3.5 million during fiscal 2009 compared with the prior year. Lower invested cash balances and lower interest rates on invested cash led to a reduction in interest income of approximately $2.9 million. Interest expense increased $0.6 million due to higher average borrowings.
Other expense (income), net, represents certain non-operating items of income and expense. This line increased $2.0 million due primarily to $1.9 million in foreign currency transaction losses and $1.4 million of a loss in market value in investments held by deferred compensation trusts. These losses were partially offset by $1.2 million of foreign currency gains on our cross-currency swap.
Income tax expense as a percentage of income before taxes was 35.8% for fiscal 2009 and 37.1% for 2008. The decrease in the effective tax rate was primarily due to the reversal of a valuation allowance as the related deferred tax asset is now expected to be utilized. This reduction was partially offset by higher effective state and local tax rates and foreign income taxes. We
expect our overall tax rate for fiscal 2010 to be in the range of 37.0% to 37.5%, since the valuation allowance reversal will not recur and state and local taxes are expected to increase.
As a result of the factors addressed above, net income for fiscal 2009 decreased $53.2 million or 55.7% from the prior year. Net income per share decreased 54.8% to $0.99 in fiscal 2009 from $2.19 in 2008.
The number of Company associates was 4,729 at June 30, 2009 and 4,831 at June 30, 2008. The acquisition of FPR added more than 400 associates in August 2008; the net decline year-over-year represents the impact of these additions offset by company-wide reductions in workforce. Additionally, during the latter half of the year, we took measures to further reduce compensation costs including reducing scheduled work hours. The number of associates adjusted to reflect an equivalent full-time work status (“full-time equivalent”) at June 30, 2009 was about 10% lower than the same measure at December 31, 2008.
YEAR ENDED JUNE 30, 2008 vs. 2007
Net sales in fiscal 2008 were $2.1 billion or 3.7% above the prior year sales. This increase was due to improvements in our Service Center Based Distribution segment sales of 3.3% and in our Fluid Power Businesses segment sales of 7.7%. The increase in Service Center Based Distribution segment sales was primarily driven by an increase in national contract business and the recovery of supplier price increases. Within the Service Center Based Distribution segment, the impact of the strengthening Canadian currency was largely offset by a 9.3% volume decline in our Canadian market. The increase in sales of our Fluid Power Businesses segment was approximately 45% attributable to favorable currency fluctuations at the Canadian locations and approximately 25% related to the VYCMEX S.A. de C.V. (“VYCMEX”) acquisition. Also contributing to these increases was an additional sales day in fiscal 2008 compared to fiscal 2007.
The sales product mix for fiscal 2008 was 80.0% industrial products and 20.0% fluid power products compared to 80.2% industrial and 19.8% fluid power in the prior year.
At June 30, 2008, we had a total of 459 operating facilities in the U.S., Canada and Mexico versus 445 at June 30, 2007. The increase in facilities was largely attributed to 5 facilities from the acquisition of VYCMEX midway through the fiscal year and 10 facilities from the acquisition of Suministros Industriales Enol, S.A. de C.V. (“Enol”) at the end of fiscal 2008.
Our gross profit margin maintained the 27.2% achieved in fiscal 2007. Slightly higher levels of supplier purchasing incentives were largely offset by continued pressures in gross profit margin with national contracts. LIFO inventory layer liquidations resulted in a $0.6 million positive impact during fiscal 2008.
SD&A increased 0.8% during fiscal 2008 compared to the prior year, but decreased as a percent of sales to 19.9% from 20.5% in 2007. Approximately one-third of the fiscal 2008 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 13.2% to $152.8 million during fiscal 2008 from $135.0 million during 2007. As a percent of sales, operating income increased to 7.3% in fiscal 2008 from 6.7% in 2007. The $17.8 million increase in operating income during fiscal 2008 primarily reflects the impact


 
6      Applied Industrial Technologies, Inc. and Subsidiaries

 


 

 

of higher sales at a stable gross profit percentage with only modest increases in SD&A expenses.
Interest expense, net decreased by 62.6% or $1.5 million during fiscal 2008 compared with the prior year, primarily due to repayment of $50.0 million of long-term debt in December 2007.
Other expense (income), net, represents certain non-operating items of income and expense. This line decreased $1.4 million due primarily to the loss in market value in investments held by deferred compensation trusts.
Income tax expense as a percentage of income before taxes was 37.1% for fiscal 2008 and 35.7% for 2007. The increase in the effective tax rate was due to higher effective state tax rates and U.S. federal tax law changes that eliminated the deductibility of certain expenses.
As a result of the factors addressed above, net income for fiscal 2008 increased $9.4 million or 11.0% from the prior year. Net income per share increased 13.5% to $2.19 in fiscal 2008 from $1.93 in 2007. During fiscal 2008 and 2007, we repurchased 1.1 million and 1.4 million shares, respectively, which resulted in fewer shares outstanding for the year compared to the prior year. The buybacks in fiscal 2008 contributed approximately $0.03 cents per share.
The number of Company associates was 4,831 at June 30, 2008 and 4,649 at June 30, 2007.
LIQUIDITY AND CAPITAL RESOURCES
Net cash flows from operations depend primarily upon generating operating income, controlling investment in inventories and receivables and managing the timing of payments to suppliers. We continue to monitor and control our 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.
We generated $81.3 million of cash from operating activities during fiscal 2009, $110.3 million during 2008 and $70.9 million during 2007. Cash provided by operating activities of $81.3 million decreased $29.0 million in fiscal 2009 compared with 2008. The slowing of sales in 2009 resulted in a reduction in income and in cash provided. Cash generated by declines in receivables was offset by cash used for declines in accounts payable and compensation related liabilities. Inventories increased despite the slowdown in sales as we fulfilled purchase commitments in place before the downturn in the economy. We expect to reduce these inventory levels over the coming year which will generate cash inflows. Cash provided from operations in fiscal 2008 benefited from our strong operating results. Cash flows from operations in fiscal 2007 were also impacted by the timing of certain income tax payments and the timing of receipts from certain supplier purchasing programs.
Net cash used by investing activities was $178.4 million during fiscal 2009, $26.8 million during fiscal 2008 and $10.2 million during 2007. Cash was primarily used for acquisitions in fiscal 2009 and fiscal 2008, whereas it was primarily used for capital expenditures in fiscal 2007. In fiscal 2009, net cash paid for acquisitions of $172.2 million was primarily due to the FPR acquisition in August 2008 ($166.0 million paid at closing) and a Service Center Based Distributor acquisition in December 2008 ($4.7 million paid at closing). In fiscal 2008, we acquired two distributors based in Mexico for $28.7 million, of which $22.1 million was paid at closing. Capital
expenditures for all years presented consist primarily of information technology equipment, and buildings and improvements.
For fiscal 2010, our capital expenditures are expected to be in the $8.0 million to $9.5 million range, consisting primarily of additional information system technology equipment and infrastructure investments. Depreciation for fiscal 2010 is expected to be in the range of $12.0 million to $13.0 million.
Cash provided by (used in) financing activities was $28.5 million during fiscal 2009, ($103.5) million during fiscal 2008 and ($48.4) million during 2007. Cash provided by financing activities in fiscal 2009 was primarily due to net borrowings of $55.0 million on our revolving credit facility, which were primarily used to fund acquisitions. Partially offsetting these borrowings was the payment of $25.4 million in dividends in fiscal 2009.
In fiscal 2008, we utilized cash in financing activities to repay $50.0 million of long-term debt, repurchase $33.2 million worth of shares for our treasury and pay $25.7 million in dividends which included the effect of an increase in our quarterly dividend to $0.15 per share. The amount of the dividend paid is based on judgment, financial performance and payout guidelines consistent with other industrial companies.
In fiscal 2009, 2008 and 2007, we repurchased 68,000, 1.1 million and 1.4 million shares of the Company’s common stock, respectively, at an average price per share of $17.80, $29.02, and $24.26, respectively.
The following table shows the approximate value of the Company’s contractual obligations and other commitments to make future payments as of June 30, 2009 (in thousands):
                                               
          Period Less     Period     Period     Period        
    Total   Than 1 yr     1-3 yrs     4-5 yrs     Over 5 yrs     Other  
   
Operating leases
  78,400   $ 21,800     $ 28,200     $ 15,300     $ 13,100          
Interest payments
on long-term debt
    5,100     3,700       1,400                          
Planned funding of postretirement obligations
    54,000     1,900       3,000       3,300       45,800          
FIN 48 liabilities, including interest and penalties
    2,400                                   $ 2,400  
Long-term debt
    75,000             75,000                          
   
Total Contractual Cash Obligations
  214,900   $ 27,400     $ 107,600     $ 18,600     $ 58,900     $ 2,400  
   
Purchase orders for inventory and other goods and services are not included in our estimates as we are unable to aggregate the amount of such purchase orders that represent enforceable and legally binding agreements specifying all significant terms. The table above includes the gross liability for unrecognized income tax benefits (“FIN 48 liabilities, including interest and penalties”) in the “Other” column as the Company is unable to make a reasonable estimate regarding the timing of cash settlements with the respective taxing authorities. See Note 8 to the consolidated financial statements, for further information on income taxes and the FIN 48 liability.
The Board of Directors has authorized the repurchase of shares of the Company’s stock. These purchases may be made in open market and negotiated transactions, from time to time, depending upon market conditions. At June 30, 2009, we had authorization to purchase an additional 997,100 shares.


 
Applied Industrial Technologies, Inc. and Subsidiaries     7

 


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATION (Continued)
 

Capital resources are obtained from income retained in the business, borrowings under the Company’s credit facilities, and operating lease arrangements.
See Note 5 to the consolidated financial statements for details regarding outstanding debt as of June 30, 2009 and 2008. The average borrowings totaled $105.0 million during fiscal 2009 and $47.1 million during fiscal 2008. The Company has a five-year committed revolving credit agreement which expires in June 2012. This agreement provides for unsecured borrowings of up to $150.0 million. In fiscal 2009, we drew down on our revolving credit facility; borrowings have primarily been used to fund acquisitions. We had $55.0 million of borrowings outstanding under this facility at June 30, 2009, of which $5.0 million is classified as current and $50.0 million is classified as long-term. It is the Company’s intention to maintain a balance of at least $50.0 million outstanding on the revolving credit facility, utilizing the one-month LIBOR borrowing option through September 19, 2010 per the terms of the interest rate swap agreement described in Note 6 to the consolidated financial statements, “Risk Management Activities.” Unused lines under this facility, net of outstanding letters of credit, total $88.9 million and are available to fund future acquisitions or other capital and operating requirements. Borrowings under this agreement carry variable interest rates tied to either LIBOR, prime, or the bank’s cost of funds at the Company’s discretion. We also have an uncommitted long-term financing shelf facility which expires in March 2010, which enables us to borrow up to $100.0 million at our discretion with terms of up to fifteen years. We had no outstanding borrowings under this facility at June 30, 2009.
The weighted average interest rate on borrowings under our debt agreements, including the effects of interest rate swaps, was 4.4%, 8.4%, and 6.8% in fiscal 2009, 2008 and 2007, respectively. The decrease in the weighted average interest rate primarily reflects the impact of borrowings under the revolver at lower interest rates.
We manage interest rate risk through the use of a combination of fixed-rate long-term debt, variable rate borrowings under a committed revolving credit agreement and interest rate swaps. At June 30, 2009, we had $55.0 million of variable rate debt outstanding of which $50.0 million was effectively converted to fixed-rate debt under the terms of an interest rate swap agreement. The Company’s private placement 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, consolidated interest expense was affected by changes in the exchange rates of U.S. and Canadian dollars. See Note 6 to the consolidated financial statements for additional discussion on our derivative activities.
In fiscal 2008, we paid off $50.0 million of debt that matured in December 2007. We terminated certain interest rate swap agreements for favorable settlements in prior years. The settlement gains were amortized as a reduction in interest expense of $0.8 million per year through December 2007.
The Company’s working capital at June 30, 2009 was $369.0 million compared to $409.2 million at June 30, 2008. The current ratio was 3.4 to 1 at June 30, 2009 and 3.1 to 1 at June 30, 2008. The decrease in working capital at June 30, 2009 was primarily due to utilization of cash to purchase FPR.
Debt classified as long-term includes $50.0 million borrowed under our revolving credit facility as discussed above. The remaining $25.0 million of long-term debt matures in November 2010.
The revolving credit facility, private placement debt and uncommitted shelf facility contain restrictive covenants regarding liquidity, net worth, financial ratios, and other covenants. At June 30, 2009, the most restrictive of these covenants required that the Company have consolidated income before interest, taxes, depreciation and amortization at least equal to 300% of net interest expense. At June 30, 2009, the Company was in compliance with all covenants and expects to remain in compliance during the terms of the agreements.
Management expects that our existing cash, cash equivalents, funds available under the revolving credit facility, cash provided from operations, and the use of operating leases will be sufficient to finance normal working capital needs, payment of dividends, acquisitions, investments in properties, facilities and equipment, and the purchase of additional Company common stock. Management also believes that additional long-term debt and line of credit financing could be obtained based on the Company’s credit standing and financial strength, however at higher rates than the Company is currently paying.
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 accounts receivable, inventories, recording self-insurance liabilities and other accrued liabilities. Actual results could differ from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the consolidated financial statements.
LIFO Inventory Valuation and Methodology
Inventories are valued at the lower of cost or market, using the last-in, first-out (“LIFO”) method for U.S. inventories, and the average cost method for foreign inventories. We adopted the link chain dollar value LIFO method for accounting for U.S. inventories in fiscal 1974. Approximately one-third of our domestic inventory dollars relate to LIFO layers added in the 1970s. The excess of current cost over LIFO cost is $166.9 million as reflected in our consolidated balance sheet at June 30, 2009. 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.


 
8     Applied Industrial Technologies, Inc. and Subsidiaries

 


 

 

Allowances for Slow-Moving and
Obsolete Inventories
We evaluate the recoverability of our slow-moving or obsolete inventories at least quarterly. We estimate the recoverable cost of such inventory by product type while considering factors such as its age, historic and current demand trends, the physical condition of the inventory, as well as assumptions regarding future demand. Our ability to recover our cost for slow moving or obsolete inventory can be affected by such factors as general market conditions, future customer demand and relationships with suppliers. Most of the products we hold in inventory have long shelf lives, are not highly susceptible to obsolescence and are eligible for return under various supplier return programs.
Allowances for Doubtful Accounts
We evaluate the collectibility of trade accounts receivable based on a combination of factors. Initially, we estimate an allowance for doubtful accounts as a percentage of net sales based on historical bad debt experience. This initial estimate is adjusted based on recent trends of certain customers and industries estimated to be a greater credit risk, trends within the entire customer pool and changes in the overall aging of accounts receivable. While we have a large customer base that is geographically dispersed, a general economic downturn in any of the industry segments in which we operate could result in higher than expected defaults, and therefore, the need to revise estimates for bad debts.
Reflecting the current economic slowdown, as of June 30, 2009 and 2008, our allowance for doubtful accounts was 3.1% and 2.4% of gross receivables, respectively. Our provision for losses on accounts receivable was $4.5 million and $2.6 million in fiscal 2009 and 2008, respectively.
Goodwill and Intangibles
Goodwill is recognized as the amount by which the cost of an acquired entity exceeds the net amount assigned to assets acquired and liabilities assumed. As part of purchase accounting, we also recognize acquired intangible assets such as customer relationships, vendor relationships, trade names, and non-competition agreements apart from goodwill. Intangibles are evaluated for impairment when changes in conditions indicate carrying value may not be recoverable. We evaluate goodwill for impairment at least annually. This evaluation requires significant judgment by management, including estimated future operating results, estimated future cash flows, the long-term rate of growth of our business, and determination of an appropriate discount rate. While we use available information to prepare the estimates and evaluations, actual results could differ significantly. For example, a worsening of economic conditions beyond those assumed in an impairment analysis could impact the estimates of future growth and result in an impairment charge in a future period. Any resulting impairment charge could be viewed as having a material adverse impact on our financial condition and results of operations.
During the fourth quarter of fiscal 2009, the Company performed an interim goodwill impairment test based on current and expected market conditions, including reduced operating results and a worsening economic outlook. As a result of this test, the Company determined that all of the goodwill associated with the Fluid Power Businesses segment was impaired as of June 30, 2009. Accordingly, the Company recognized an impairment charge of $36.6 million for goodwill in the fourth quarter of fiscal 2009, which decreased net income by $23.0 million and earnings per share by $0.54. In addition, the Company performed an impairment analysis of its intangible
assets and noted no further impairment. As of June 30, 2009, we had $63.1 million of goodwill remaining on our consolidated financial statements, all of which is related to the Service Center Based Distribution segment. We believe the fair value of this segment is well in excess of its carrying value.
Self-Insurance Liabilities
We maintain business insurance programs with significant self-insured retention covering workers’ compensation, business, automobile, general product liability and other claims. We accrue estimated losses using actuarial calculations, models and assumptions based on historical loss experience. We maintain a self-insured health benefits plan, which provides medical benefits to employees electing coverage. We maintain a reserve for all unpaid medical claims including those incurred but not reported based on historical experience and other assumptions. Although management believes that the estimated liabilities for self-insurance are adequate, the estimates described above may not be indicative of current and future losses. In addition, the actuarial calculations used to estimate self-insurance liabilities are based on numerous assumptions, some of which are subjective. We will continue to adjust our estimated liabilities for self-insurance, as deemed necessary, in the event that future loss experience differs from historical loss patterns.
Pension and 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. We evaluate these assumptions and adjust them as necessary. Changes to these assumptions could result in a material change to the Company’s pension obligation causing a related increase or decrease in reported net operating results in the period of change in the estimate. A 1% decrease in the discount rate would result in an additional liability of $3.2 million and additional expense of $0.2 million. A 1% increase in the discount rate would result in a decrease in the liability of $2.8 million and a decrease in expense of $0.2 million. A 1% decrease in the salary scale would result in a decrease in the liability and expense of $1.4 million and $0.3 million, respectively. A 1% increase in the salary scale would increase the liability and expense by $1.5 million and $0.3 million, respectively. A 1% change in the return on assets is not material since most of the plans are non-qualified and unfunded.
In fiscal 2007, we adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS 158”). As a result of our adoption of SFAS 158 in fiscal 2007, we recorded a decrease in other non-current assets of $0.2 million, an increase in postemployment benefits of $7.7 million, and a decrease in accumulated other comprehensive income (loss) of $7.9 million.
Income Taxes
As of June 30, 2009, the Company had recognized $55.4 million of net deferred tax assets, including a $0.1 million valuation allowance. Management believes that sufficient income will be earned in the future to realize its deferred income tax assets, except for the minor amount for which a valuation allowance is recorded. 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     9

 


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATION (Continued)
 

Effective July 1, 2007, the Company adopted 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. In accordance with FIN 48, the Company recognized an immaterial cumulative effect adjustment decreasing its liability for unrecognized tax benefits, interest, and penalties and increasing the July 1, 2007 balance of retained earnings. See Note 8 to the consolidated financial statements for more information on income taxes.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS 141. SFAS 141(R) requires most assets acquired and liabilities assumed in a business combination, contingent consideration, and certain acquired contingencies to be measured at their fair values as of the date of acquisition. SFAS 141(R) also requires that acquisition related costs and restructuring costs be recognized separately from the business combination. SFAS 141(R) is effective for the Company for business combinations entered into after July 1, 2009.
In December 2008, the FASB issued FASB Staff Position (“FSP”) FAS 132(R)-1 “Employers’ Disclosures about Postretirement Benefit Plan Assets,” which amends SFAS 132(R) “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” FSP FAS 132(R)-1 requires additional detailed disclosures about employers’ plan assets, including employers’ investment strategies, major categories of plan assets, concentrations of risk within plan assets, and valuation techniques used to measure the fair value of plan assets. FSP FAS 132(R)-1 is effective for the Company in fiscal 2010.
In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles.” This standard replaces SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” and establishes only two levels of U.S. generally accepted accounting principles (“GAAP”), authoritative and non-authoritative. The FASB Accounting Standards Codification™ (the “Codification”) will become the source of authoritative, non-governmental GAAP, except for rules and interpretive releases of the Securities and Exchange Commission (“SEC”), which are sources of authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literature not included in the Codification will become non-authoritative. The Company will begin to use the new guidelines and numbering system prescribed by the Codification when referring to GAAP in the first quarter of fiscal 2010. As the Codification was not intended to change or alter existing GAAP, the Company does not believe it will have any impact on the consolidated financial statements.
OTHER MATTERS
We have made acquisitions of other distributors in two of the past three fiscal years. On August 29, 2008, Applied completed the acquisition of certain of the assets of FPR for a purchase price of $166.9 million. Also in fiscal 2009, we acquired an industrial distributor for $5.5 million. In fiscal 2008, we acquired two distributors of industrial and fluid power products based in Mexico for a combined purchase price of $28.7 million.
Results of operations of all of the above acquisitions, which have been accounted for as purchases, are included in the accompanying consolidated financial statements from their respective acquisition dates. Pro-forma
disclosures are included in Note 2 to the consolidated financial statements related to the FPR acquisition. The results of operations for the other 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 “guidance,” “expect,” “expected,” “expectation,” “believe,” “plan,” “intend,” “will,” “should,” “could,” “anticipate,” “intention,” “estimated,” “would be,” and similar expressions. Similarly, descriptions of objectives, strategies, plans, or goals are also forward-looking statements. These statements may discuss, among other things, expected growth, future sales, future cash flows, future capital expenditures, future performance, and the anticipation and expectations of the Company and its management as to future occurrences and trends. The Company intends that the forward-looking statements be subject to the safe harbors established in the Private Securities Litigation Reform Act of 1995 and by the Securities and Exchange Commission in its rules, regulations and releases.
Readers are cautioned not to place undue reliance on any forward-looking statements. All forward-looking statements are based on current expectations regarding important risk factors, many of which are outside the Company’s control. Accordingly, actual results may differ materially from those expressed in the forward-looking statements, and the making of those statements should not be regarded as a representation by the Company or any other person that the results expressed in the statements will be achieved. In addition, the Company assumes no obligation publicly to update or revise any forward-looking statements, whether because of new information or events, or otherwise, except as may be required by law.
Important risk factors include, but are not limited to, the following: risks relating to the operations levels of our customers and the economic factors that affect them; the impact of current economic conditions on the collectibility of trade receivables; reduced demand for our products in targeted markets due to reasons including consolidation in customer industries and the transfer of manufacturing capacity to foreign countries; 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 prices 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 acquisitions, integrate them effectively, 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 on reasonable terms; the potential for


 
10     Applied Industrial Technologies, Inc. and Subsidiaries

 


 

 

goodwill and intangible asset impairment; changes in accounting policies and practices; organizational changes within the Company; the volatility of our stock price and the resulting impact on our consolidated financial statements; adverse regulation and legislation, including potential changes in tax regulations (i.e., utilization of LIFO inventory accounting method and taxation of foreign-sourced income); and the occurrence of extraordinary events (including prolonged labor disputes, natural events and acts of God, terrorist acts, fires, floods, and accidents). Other factors and unanticipated events could also adversely affect our business, financial condition or results of operations. We discuss certain of these matters more fully throughout our “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, 2009.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has evaluated its exposure to various market risk factors, including its primary market risk exposures through the effects of changes in exchange rates and changes in interest rates. We occasionally utilize derivative instruments as part of our overall financial risk management policy, but do not use derivative instruments for speculative or trading purposes. We utilize a sensitivity analysis to measure the potential impact on earnings based on a hypothetical 1% increase in interest rates and a 10% change in foreign currency rates. A summary of our primary market risk exposures follows.
Interest Rate Risk
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, 2009, the Company had $55.0 million outstanding in variable rate borrowings under its committed revolving credit agreement. In conjunction with this facility, on September 19, 2008, the Company entered into a two-year agreement for a $50.0 million interest rate swap to effectively convert a portion of this variable-rate debt to fixed-rate debt at a fixed rate of 3.33%. The impact of a 1% increase in the interest rate on the remaining $5.0 million of outstanding variable rate debt would be immaterial to interest expense. In the current borrowing environment, borrowings beyond the amounts available under the revolving credit agreement would carry interest rates higher than our current borrowing rates.
The Company also had $25.0 million of outstanding long-term debt at fixed interest rates at June 30, 2009, which is scheduled for repayment in November 2010.
Foreign Currency Rate Risk
The financial statements of foreign subsidiaries are translated into their U.S. dollar equivalents at end-of-period exchange rates for assets and liabilities, while income and expenses are translated at average monthly exchange rates. Translation gains and losses are included as components of accumulated other comprehensive (loss) income in consolidated shareholders’ equity. Transaction gains and losses arising from fluctuations in currency exchange rates on transactions denominated in currencies other than the functional currency are recognized in the consolidated statements of income as a component of other expense (income), net. Since we operate internationally and approximately 12.9% of our fiscal 2009 net sales were generated outside the Unites States, foreign currency exchange rates can impact our financial position, results of operations and competitive position.
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 businesses are not hedged.
In the twelve months ended June 30, 2009, we experienced foreign currency translation losses, totaling $13.0 million, net of tax, which were included in accumulated other comprehensive (loss) income. The Canadian and Mexican foreign exchange rates to the U.S. dollar dropped by approximately 10% and 22%, respectively, since the beginning of the fiscal year. A 10% strengthening from the levels at June 30, 2009 of the U.S. dollar relative to foreign currencies that affect the Company would have resulted in a $1.1 million decrease in net income for the year ended June 30, 2009. A 10% weakening from the levels at June 30, 2009 of the U.S. dollar would have resulted in a $0.6 million increase in net income for the year ended June 30, 2009.


 
Applied Industrial Technologies, Inc. and Subsidiaries     11

 


 

STATEMENTS OF CONSOLIDATED INCOME
 
(In thousands, except per share amounts)
                         
Year Ended June 30,
  2009     2008     2007  
                         
Net Sales
  $ 1,923,148     $ 2,089,456     $ 2,014,109  
                       
Cost of Sales
    1,403,138       1,520,173       1,466,057  
                       
                         
 
    520,010       569,283       548,052  
                       
Selling, Distribution and Administrative, including depreciation
    410,912       416,459       413,041  
                       
Goodwill Impairment
    36,605                  
                       
                         
Operating Income
    72,493       152,824       135,011  
                       
                         
Interest Expense
    5,523       4,939       5,798  
                       
Interest Income
    (1,099 )     (4,057 )     (3,438 )
                       
Other Expense (Income), net
    2,255       227       (1,179 )
                       
                         
 
    6,679       1,109       1,181  
                         
Income Before Income Taxes
    65,814       151,715       133,830  
                         
Income Tax Expense
    23,554       56,259       47,808  
                         
Net Income
  $ 42,260     $ 95,456     $ 86,022  
                         
Net Income Per Share - Basic
  $ 1.00     $ 2.23     $ 1.97  
                         
Net Income Per Share - Diluted
  $ 0.99     $ 2.19     $ 1.93  
 
     See notes to consolidated financial statements.
 
12     Applied Industrial Technologies, Inc. and Subsidiaries

 


 

CONSOLIDATED BALANCE SHEETS
 
(In thousands)
                 
June 30,   2009     2008  
                 
Assets
               
                 
Current assets
               
                 
Cash and cash equivalents
  $ 27,642     $ 101,830  
                 
Accounts receivable, less allowances of $6,464 and $6,119
    198,792       245,119  
                 
Inventories
    254,690       210,723  
                 
Other current assets
    44,470       48,525  
                 
                 
Total current assets
    525,594       606,197  
                 
                 
Property - at cost
               
                 
Land
    10,577       10,639  
                 
Buildings
    72,481       71,142  
                 
Equipment
    110,951       108,162  
                 
                 
Total Property - at cost
    194,009       189,943  
                 
Less accumulated depreciation
    131,274       124,946  
                 
                 
Property - net
    62,735       64,997  
                 
                 
Goodwill
    63,108       64,685  
                 
Intangibles, net
    95,832       19,164  
                 
Other assets
    62,059       43,728  
                 
                 
Total Assets
  $ 809,328     $ 798,771  
                 
Liabilities
               
                 
Current liabilities
               
                 
Accounts payable
  $ 80,655     $ 109,822  
                 
Short-term debt
    5,000          
                 
Compensation and related benefits
    34,695       56,172  
                 
Other current liabilities
    36,206       31,017  
                 
                 
Total current liabilities
    156,556       197,011  
                 
Long-term debt
    75,000       25,000  
                 
Postemployment benefits
    43,186       37,746  
                 
Other liabilities
    26,484       36,939  
                 
                 
Total Liabilities
    301,226       296,696  
                 
                 
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
    136,895       133,078  
                 
Income retained for use in the business
    560,574       543,692  
                 
Treasury shares - at cost (11,929 and 11,923 shares)
    (191,518 )     (190,944 )
                 
Accumulated other comprehensive (loss) income
    (7,849 )     6,249  
                 
                 
Total Shareholders’ Equity
    508,102       502,075  
                 
                 
Total Liabilities and Shareholders’ Equity
  $ 809,328     $ 798,771  
                 
 
See notes to consolidated financial statements.
 
Applied Industrial Technologies, Inc. and Subsidiaries     13

 


 

STATEMENTS OF CONSOLIDATED CASH FLOWS
 
(In thousands)
                         
Year Ended June 30,   2009     2008     2007  
                         
Cash Flows from Operating Activities
                       
                 
Net income
  $ 42,260     $ 95,456     $ 86,022  
                 
Adjustments to reconcile net income to net cash provided by operating activities:
                       
                 
Goodwill impairment
    36,605                  
                 
Deferred income taxes
    (16,648 )     (5,809 )     (6,424 )
                 
Depreciation
    12,736       12,776       13,489  
                 
Amortization of intangibles
    9,655       1,663       1,045  
                 
Provision for losses on accounts receivable
    4,540       2,595       1,462  
                 
Share-based compensation
    4,092       3,376       2,927  
                 
Unrealized foreign exchange transaction losses
    806                  
                 
Treasury shares contributed to employee benefit and deferred compensation plans
    410       812       1,921  
                 
Gain on sale of property
    (320 )     (1,214 )     (334 )
                 
Amortization of gain on interest rate swap terminations
            (395 )     (791 )
                 
Changes in assets and liabilities, net of acquisitions:
                       
                 
Accounts receivable
    63,929       8,306       (17,415 )
                 
Inventories
    (20,581 )     (1,484 )     (7,934 )
                 
Other operating assets
    6,858       (13,950 )     (1,369 )
                 
Accounts payable
    (38,124 )     11,881       (12,220 )
                 
Other operating liabilities
    (24,918 )     (3,710 )     10,546  
                 
                         
Net Cash provided by Operating Activities
    81,300       110,303       70,925  
                 
                         
Cash Flows from Investing Activities
                       
                 
Property purchases
    (6,988 )     (8,410 )     (11,192 )
                 
Proceeds from property sales
    757       1,372       1,275  
                 
Net cash paid for acquisition of businesses, net of cash acquired of $185 and $2,355 in 2009 and 2008, respectively
    (172,199 )     (22,105 )        
                 
Other
            2,304       (302 )
                         
Net Cash used in Investing Activities
    (178,430 )     (26,839 )     (10,219 )
                 
                         
Cash Flows from Financing Activities
                       
                 
Net short-term borrowings under revolving credit facility
    5,000                  
                 
Borrowings under revolving credit facility classified as long-term
    50,000                  
                 
Long-term debt repayment
            (50,000 )        
                 
Purchases of treasury shares
    (1,210 )     (33,224 )     (33,988 )
                 
Dividends paid
    (25,378 )     (25,728 )     (20,970 )
                 
Excess tax benefits from share-based compensation
    802       3,761       3,885  
                 
Exercise of stock options and appreciation rights
    408       1,664       2,663  
                 
Other
    (1,120 )                
                         
                 
Net Cash provided by (used in) Financing Activities
    28,502       (103,527 )     (48,410 )
                 
                         
Effect of Exchange Rate Changes on Cash
    (5,560 )     2,228       941  
                 
                         
(Decrease) increase in cash and cash equivalents
    (74,188 )     (17,835 )     13,237  
                 
Cash and cash equivalents at beginning of year
    101,830       119,665       106,428  
                 
                         
Cash and Cash Equivalents at End of Year
  $ 27,642     $ 101,830     $ 119,665  
                 
                         
 
                       
Supplemental Cash Flow Information
                       
                 
Cash paid during the year for:
                       
                 
Income taxes
  $ 43,081     $ 60,049     $ 42,857  
                 
Interest
  $ 5,265     $ 4,763     $ 5,488  
See notes to consolidated financial statements.
 
14     Applied Industrial Technologies, Inc. and Subsidiaries

 


 

STATEMENTS OF CONSOLIDATED SHAREHOLDERS’ EQUITY
 
(In thousands, except per share amounts)
                                                         
    Shares of                     Income             Accumulated        
    Common             Additional     Retained     Treasury     Other     Total  
    Stock     Common     Paid-in     for Use in     Shares-     Comprehensive     Shareholders'  
For the Years Ended June 30, 2009, 2008 and 2007   Outstanding     Stock     Capital     the Business     at Cost     Income (Loss)     Equity  
 
Balance at July 1, 2006
    44,067     $ 10,000     $ 122,146     $ 408,847     $ (130,967 )   $ 4,796     $ 414,822  
Net income
                            86,022                       86,022  
Unrealized loss on cash flow hedge, net of income tax of $(59)
                                            (93 )     (93 )
Unrealized gain on investment securities available for sale, net of income tax of $68
                                            110       110  
Increase in minimum pension liability, net of income tax of $(185)
                                            (301 )     (301 )
Foreign currency translation adjustment, net of income tax of $194
                                            2,703       2,703  
 
                                                     
Total comprehensive income
                                                    88,441  
 
                                                     
Cash dividends - $0.48 per share
                            (20,970 )                     (20,970 )
Purchases of common stock for treasury
    (1,401 )                             (33,988 )             (33,988 )
Treasury shares issued for:
                                                       
Retirement Savings Plan contributions
    5               47               65               112  
Exercise of stock options and appreciation rights
    366               796               4,157               4,953  
Deferred compensation plans
    78               1,613               1,046               2,659  
Compensation expense - stock options and appreciation rights
                    2,494                               2,494  
Amortization of restricted common stock compensation
                    433                               433  
Adjustment to initially apply SFAS 158, net of income tax of $(4,899)
                                            (7,897 )     (7,897 )
Other
    1               40               (116 )             (76 )
 
Balance at June 30, 2007
    43,116       10,000       127,569       473,899       (159,803 )     (682 )     450,983  
Net income
                            95,456                       95,456  
Unrealized gain on cash flow hedge, net of income tax of $414
                                            645       645  
Unrealized gain on investment securities available for sale, net of income tax of $50
                                            82       82  
Reclassification of pension and postemployment expense into income, net of income tax of $611
                                            998       998  
Pension and postemployment adjustment, net of income tax of $(318)
                                            (520 )     (520 )
Foreign currency translation adjustment, net of income tax of $912
                                            5,726       5,726  
 
                                                     
Total comprehensive income
                                                    102,387  
 
                                                     
Cash dividends - $0.60 per share
                            (25,728 )                     (25,728 )
Purchases of common stock for treasury
    (1,145 )                             (33,224 )             (33,224 )
Treasury shares issued for:
                                                       
Exercise of stock options and appreciation rights
    315               1,800               2,330               4,130  
Deferred compensation plans
    26               410               402               812  
Compensation expense - stock options and appreciation rights
                    2,999                               2,999  
Amortization of restricted common stock compensation
                    377                               377  
Other
    (22 )             (77 )     65       (649 )             (661 )
 
Balance at June 30, 2008
    42,290       10,000       133,078       543,692       (190,944 )     6,249       502,075  
Net income
                            42,260                       42,260  
Unrealized loss on cash flow hedges, net of income tax of $(457)
                                            (569 )     (569 )
Reclassification of interest expense on cash flow hedge, net of income tax of $264
                                            437       437  
Unrealized loss on investment securities available for sale, net of income tax of $(105)
                                            (177 )     (177 )
Reclassification of pension and postemployment expense into income, net of income tax of $691
                                            1,127       1,127  
Pension and postemployment adjustment, net of income tax of $(1,154)
                                            (1,883 )     (1,883 )
Foreign currency translation adjustment, net of income tax of ($3,793)
                                            (13,033 )     (13,033 )
 
                                                     
Total comprehensive income
                                                    28,162  
 
                                                     
Cash dividends - $0.60 per share
                            (25,378 )                     (25,378 )
Purchases of common stock for treasury
    (68 )                             (1,210 )             (1,210 )
Treasury shares issued for:
                                                       
Exercise of stock options and appreciation rights
    73               47               1,007               1,054  
Deferred compensation plans
    18               110               300               410  
Compensation expense - stock options and appreciation rights
                    3,701                               3,701  
Amortization of restricted common stock compensation
                    391                               391  
Other
    (29 )             (432 )             (671 )             (1,103 )
 
Balance at June 30, 2009
    42,284     $ 10,000     $ 136,895     $ 560,574     $ (191,518 )   $ (7,849 )   $ 508,102  
 
See notes to consolidated financial statements.
 
Applied Industrial Technologies, Inc. and Subsidiaries    15


 

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,” “Applied”) 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 shop services for mechanical, rubber and fluid power products. 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 and Mexican subsidiaries are included in the consolidated financial statements for the twelve months ended May 31.
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 exchange rates. Translation gains and losses are included as components of accumulated other comprehensive (loss) income in consolidated shareholders’ equity. Gains and losses resulting from transactions denominated in foreign currencies are included in the statements of consolidated income as a component of other expense (income), net.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the period. Actual results may differ from the estimates and assumptions used in preparing the consolidated financial statements.
Cash and Cash Equivalents
The Company considers all short-term, highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are carried at cost, which approximates market value.
Marketable Securities
The primary marketable security investments of the Company include money market and mutual funds. These are included in other assets, are classified as trading securities and reported at fair value, based on quoted market prices. Unrealized gains and losses are recorded in other expense (income), net in the statements of consolidated income and reflect changes in the fair value of the investment during the period.
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.
Allowances for Doubtful Accounts
The Company evaluates the collectibility of trade accounts receivable based on a combination of factors. Initially, the Company estimates an allowance for doubtful accounts as a percentage of net sales based on historical bad debt experience. This initial estimate is adjusted based on recent trends of customers and industries estimated to be 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.
Inventories
Inventories are valued at the lower of cost or market, using the last-in, first-out (“LIFO”) method for U.S. inventories and the average cost method for foreign inventories. The Company adopted the link chain dollar value LIFO method of accounting for U.S. inventories in fiscal 1974. At June 30, 2009, approximately one-third of the Company’s domestic inventory dollars relate to LIFO layers added in the 1970s. The Company maintains five LIFO pools based on the following product groupings: bearings, power transmission products, rubber products, fluid power products and other products. LIFO layers and/or liquidations are determined consistently year-to-year 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.”
 
16   Applied Industrial Technologies, Inc. and Subsidiaries


 

 
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. The incentives are generally a specified percentage of the Company’s net purchases based upon achieving specific purchasing volume levels. These percentages can increase or decrease based on changes in the volume of purchases. The Company accrues for the receipt of these inventory purchase incentives based upon cumulative purchases of inventory. The percentage level utilized is based upon the estimated total volume of purchases expected during the life of the program. 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. Upon program completion, differences between estimates and actual incentives subsequently received have not been material. Benefits under these supplier purchasing programs are recognized under the Company’s LIFO inventory accounting method as a reduction of cost of sales when the inventories representing these purchases are recorded as cost of sales. 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.” Accrued incentives expected to be settled as a credit against purchases are reported on the consolidated balance sheet as an offset to amounts due to the related supplier.
Property and Depreciation
Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets and is included in selling, distribution and administrative expenses in the accompanying statements of consolidated income. Buildings, building improvements and leasehold improvements are depreciated over ten to thirty years or the life of the lease if a shorter period, and equipment is depreciated over three to eight years. The carrying values of property and equipment are reviewed for impairment when events or changes in circumstances indicate that the recorded value cannot be recovered from undiscounted future cash flows. Impairment losses, if any, are measured based upon the difference between the carrying amount and the fair value of the assets.
Goodwill and Intangible Assets
Goodwill is recognized as the excess cost of an acquired entity over the net amount assigned to assets acquired and liabilities assumed. Goodwill is not amortized. Goodwill is reviewed for impairment annually as of January 1 or whenever changes in conditions indicate an evaluation should be completed. These conditions could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. The Company utilizes discounted cash flow models and market multiples for comparable businesses to determine the fair value of reporting units. Evaluating impairment requires significant judgment by management, including estimated future operating results, estimated future cash flows, the long-term rate of growth of the business, and determination of an appropriate discount rate. While the Company uses available information to prepare the estimates and evaluations, actual results could differ significantly.
During the fourth quarter of fiscal 2009, the Company performed an interim goodwill impairment test based on current and expected market conditions, including reduced operating results and a worsening economic outlook. As a result of this test, the Company determined that all of the goodwill associated with the Fluid Power Businesses segment was impaired as of June 30, 2009. Accordingly, the Company recognized an impairment charge of $36,605 for goodwill in the fourth quarter of fiscal 2009, which decreased net income by $23,000 and earnings per share by $0.54.
The Company recognizes acquired intangible assets such as customer relationships, trade names, vendor relationships, and non-competition agreements apart from goodwill. Customer relationship intangibles are amortized using the sum-of-the years digits method over estimated useful lives consistent with assumptions used in the determination of their value. Amortization of all other intangible assets is computed using the straight-line method over the estimated period of benefit. Amortization of intangible assets is included in selling, distribution and administrative expenses in the accompanying statements of consolidated income. The weighted-average amortization period for intangible assets with an unamortized balance as of June 30, 2009 was 18 years for customer relationships, 14 years for vendor relationships, 14 years for trade names, and 7 years for non-competition agreements. Intangible assets are reviewed for impairment when changes in conditions indicate carrying value may not be recoverable. As a result of the goodwill impairment recorded on the Fluid Power Businesses segment, the Company performed impairment tests on its long-lived assets (including intangible assets subject to amortization) as of June 30, 2009. No impairment loss was recognized on intangible assets subject to amortization.
Self-Insurance Liabilities
The Company maintains business insurance programs with significant self-insured retention covering workers’ compensation, business, automobile, general product liability and other claims. The Company accrues estimated losses including those incurred but not reported using actuarial calculations, models and assumptions based on historical loss experience. The Company maintains a self-insured health benefits plan, which provides medical benefits to employees electing coverage under the plan. The Company estimates its reserve for all unpaid medical claims including those incurred but not reported based on historical experience, adjusted as necessary based upon management’s reasoned judgment.
 
Applied Industrial Technologies, Inc. and Subsidiaries   17


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(In thousands, except per share amounts)
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 charges shipping and handling fees when products are shipped or delivered to a customer, and includes such amounts in net sales. The Company reports its sales net of actual sales returns and the amount of reserves established for anticipated sales returns based on historical rates. Sales tax collected from customers is excluded from net sales in the accompanying statements of consolidated income.
Shipping and Handling Costs
The Company records freight payments to third parties in cost of sales and internal delivery costs in selling, distribution and administrative expenses in the accompanying statements of consolidated income. Internal delivery costs in selling, distribution and administrative expenses were approximately $15,400, $17,000 and $16,000 for the fiscal years ended June 30, 2009, 2008 and 2007, respectively.
Income Taxes
Income taxes are determined based upon income and expenses recorded for financial reporting purposes. Deferred income taxes are recorded for estimated future tax effects of differences between the bases of assets and liabilities for financial reporting and income tax purposes, giving consideration to enacted tax laws. Uncertain tax positions are provided for in accordance with the requirements of FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of Statement of Financial Accounting Standards (“SFAS”) No. 109 “Accounting for Income Taxes.” The Company records interest and penalties related to uncertain tax positions as a component of income tax expense. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized under FIN 48.
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 December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS 141. SFAS 141(R) requires most assets acquired and liabilities assumed in a business combination, contingent consideration, and certain acquired contingencies to be measured at their fair values as of the date of acquisition. SFAS 141(R) also requires that acquisition related costs and restructuring costs be recognized separately from the business combination. SFAS 141(R) is effective for the Company for business combinations entered into after July 1, 2009.
In December 2008, the FASB issued FASB Staff Position (“FSP”) FAS 132(R)-1 “Employers’ Disclosures about Postretirement Benefit Plan Assets,” which amends SFAS 132(R) “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” FSP FAS 132(R)-1 requires additional detailed disclosures about employers’ plan assets, including employers’ investment strategies, major categories of plan assets, concentrations of risk within plan assets, and valuation techniques used to measure the fair value of plan assets. FSP FAS 132(R)-1 is effective for the Company in fiscal 2010.
In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles.” This standard replaces SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” and establishes only two levels of U.S. generally accepted accounting principles (“GAAP”), authoritative and non-authoritative. The FASB Accounting Standards Codification™ (the “Codification”) will become the source of authoritative, non-governmental GAAP, except for rules and interpretive releases of the Securities and Exchange Commission (“SEC”), which are sources of authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literature not included in the Codification will become non-authoritative. The Company will begin to use the new guidelines and numbering system prescribed by the Codification when referring to GAAP in the first quarter of fiscal 2010. As the Codification was not intended to change or alter existing GAAP, the Company does not believe it will have any impact on the consolidated financial statements.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current year presentation.
Subsequent Events
Subsequent events have been evaluated through August 19, 2009; the date the financial statements were issued.
NOTE 2: BUSINESS COMBINATIONS
Results of operations of acquired businesses, which have been accounted for as purchases, are included in the accompanying consolidated financial statements from their respective acquisition dates based on the Company’s consolidation policy.
Fluid Power Resource Acquisition
On August 29, 2008, Applied completed the acquisition of certain of the assets of Fluid Power Resource, LLC and the following fluid power distribution businesses: Bay Advanced Technologies, Carolina Fluid Components, DTS Fluid Power, Fluid Tech, Hughes HiTech, Hydro Air, and Power Systems
 
18   Applied Industrial Technologies, Inc. and Subsidiaries


 

 
(collectively “FPR”). Applied acquired certain assets and assumed certain specified liabilities of FPR for an aggregate cash purchase price of $166,000 (originally funded with existing cash balances and $104,000 of borrowings through the Company’s committed revolving credit facility).
The acquired businesses included 19 locations and the associated assembled workforce. This acquisition is part of the Fluid Power Businesses segment whose base business is distributing fluid power components, assembling fluid power systems, performing equipment repair, and offering technical advice to customers. This acquisition increased the Company’s capabilities in the following areas: fluid power system integration; manifold design, machining, and assembly; and the integration of hydraulics with electronics.
The excess of the purchase price over the estimated fair values is assigned to goodwill and is expected to be deductible for tax purposes. Adjustments to goodwill and initial asset valuations were recorded in the second, third and fourth quarters of fiscal 2009 to reflect updated asset valuation information.
The following table summarizes the fair values of assets acquired and liabilities assumed at the date of acquisition:
         
Cash and cash equivalents
  $ 100  
Accounts receivable
    26,500  
Inventories
    28,700  
Other current assets
    300  
Property, plant and equipment
    4,900  
Intangibles
    86,000  
Goodwill (subsequently written off as part of impairment charge in fourth quarter 2009)
    34,000  
Other assets
    200  
 
Total assets acquired
    180,700  
Accounts payable
    10,600  
Other accrued liabilities
    3,200  
 
Net assets acquired
  $ 166,900  
 
 
Purchase price
  $ 166,000  
Direct acquisition costs
    900  
 
Acquisition cost
  $ 166,900  
 
Total intangible assets have a weighted-average useful life of 17 years and include customer relationships of $51,900 (19-year weighted-average useful life), trade names of $22,000 (15-year weighted-average useful life), vendor relationships of $9,600 (15-year weighted-average useful life) and non-competition agreements of $2,500 (5-year weighted-average useful life).
The table below presents summarized unaudited pro forma results of operations as if FPR had been acquired effective at the beginning of the fiscal years ended June 30, 2009 and 2008, respectively.
                 
(unaudited)
  2009     2008  
     
Net sales
  $  1,962,882     $ 2,336,336  
Income before income taxes
    66,357       155,857  
Net income
    42,601       98,049  
Net income per share - diluted
  $ 1.00     $ 2.25  
     
Other Acquisitions
On December 5, 2008, the Company acquired certain assets of Cincinnati Transmission Company, an industrial distributor, for $5,535 (of which $4,700 was paid during the second quarter of fiscal 2009). Tangible assets acquired totaled $900 and intangibles, including goodwill, totaled $4,635 as of June 30, 2009 and are considered part of our Service Center Based Distribution segment.
In fiscal 2008, the Company acquired two distributors based in Mexico for a combined purchase price of $28,703. VYCMEX S.A. de C.V., a distributor of fluid power products, was acquired in December 2007 (included in our Fluid Power Businesses segment) and Suministros Industriales Enol, S.A. de C.V., an industrial products distributor, was acquired in May 2008 (included in our Service Center Based Distribution segment).
The Company acquired these distributors to complement and extend its business over a broader geographic area. The results of operations for these acquisitions are not material for all years presented.
 
Applied Industrial Technologies, Inc. and Subsidiaries   19


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(In thousands, except per share amounts)
NOTE 3: INVENTORIES
Inventories consist of the following:
                 
June 30,
  2009     2008  
     
U.S. inventories at current cost
  $ 367,836     $ 305,377  
Foreign inventories at average cost
    53,742       55,441  
     
 
    421,578       360,818  
Less: Excess of current cost over LIFO cost for U.S. inventories
    166,888       150,095  
     
Inventories on consolidated balance sheets
  $ 254,690     $ 210,723  
 
Reductions in certain U.S. inventories during fiscal 2009 and 2008 resulted in the liquidation of LIFO inventory quantities carried at lower costs prevailing in prior years. The effect of the liquidations increased gross profit by $4,419 and $626, net income by $2,693 and $383, and diluted net income per share by $0.06 and $0.01, respectively. There were no LIFO layer liquidations during fiscal 2007.
NOTE 4: GOODWILL AND INTANGIBLES
During the fourth quarter of fiscal 2009, the Company performed an interim goodwill impairment test based on current and expected market conditions, including reduced operating results and a worsening economic outlook. As a result of this test, the Company determined that all of the goodwill associated with the Fluid Power Businesses segment was impaired as of June 30, 2009. Accordingly, the Company recognized an impairment charge of $36,605 for goodwill in the fourth quarter of fiscal 2009, which decreased net income by $23,000 and earnings per share by $0.54. In addition, the Company performed an impairment analysis of its intangible assets and noted no further impairment.
The changes in the carrying amount of goodwill by reportable segment for the years ended June 30, 2009 and 2008 are as follows:
                           
    Service Center Based         Fluid Power          
    Distribution Segment         Businesses Segment         Total  
 
Balance at July 1, 2007
  $ 57,304     $ 246     $ 57,550  
Goodwill acquired during the year
    3,486       2,692       6,178  
Other, including currency translation
    657       300       957  
 
Balance at June 30, 2008
    61,447       3,238       64,685  
 
Goodwill acquired during the year
    2,382       34,000       36,382  
Other, including currency translation
    (721 )     (633 )     (1,354 )
Goodwill impairment
            (36,605 )     (36,605 )
 
Balance at June 30, 2009
  $ 63,108     $ 0     $ 63,108  
 
The Company’s intangible assets resulting from business combinations are amortized over their estimated period of benefit and consist of the following:
                         
            Accumulated      Net  
June 30, 2009
  Amount     Amortization      Book Value   
 
Customer relationships
  $ 65,077     $ 8,693     $ 56,384  
Trade names
    25,576       1,879       23,697  
Vendor relationships
    13,750       1,442       12,308  
Non-competition agreements
    4,425       982       3,443  
 
Total Intangibles
  $ 108,828     $ 12,996     $ 95,832  
 
            Accumulated     Net  
June 30, 2008   Amount     Amortization     Book Value  
 
Customer relationships
  $ 11,824     $ 2,716     $ 9,108  
Trade names
       4,240          278       3,962  
Vendor relationships
    4,731       575       4,156  
Non-competition agreements
    2,441       503       1,938  
 
Total Intangibles
  $ 23,236     $ 4,072     $ 19,164  
 
Amounts include the impact of foreign currency translation. Fully amortized amounts are written off.
 
20   Applied Industrial Technologies, Inc. and Subsidiaries


 

 
During fiscal 2009, the Company recorded intangible assets of $53,600 for customer relationships, $22,080 for trade names, $10,015 for vendor relationships, and $2,576 for non-competition agreements.
During fiscal 2008, the Company recorded intangible assets of $3,210 for customer relationships, $3,200 for trade names, $3,440 for vendor relationships, and $1,740 for non-competition agreements.
Amortization expense for intangible assets totaled $9,655, $1,663 and $1,045 in fiscal 2009, 2008 and 2007, respectively, and is included in selling, distribution and administrative expenses in the statements of consolidated income. Amortization of intangible assets at June 30, 2009 is estimated to be $10,400 for 2010, $9,900 for 2011, $9,400 for 2012, $8,800 for 2013 and $7,700 for 2014.
NOTE 5: DEBT
The Company’s outstanding borrowings consist of:
                 
June 30,
  2009     2008  
     
7.98% Private placement debt, due at maturity in November 2010
  $ 25,000     $ 25,000  
Revolving credit agreement
    55,000          
     
Total outstanding debt
    80,000       25,000  
Less: Payable within one year
    5,000          
     
Long-term portion of outstanding debt
  $ 75,000     $ 25,000  
 
Based upon current market rates for debt of similar maturities, the Company’s outstanding debt had an estimated fair value of $74,000 and $26,336 as of June 30, 2009 and 2008, respectively.
The Company has a revolving credit facility with a group of banks expiring in June 2012. This agreement provides for unsecured borrowings of up to $150,000. Fees on this facility range from 0.07% to 0.15% per year on the average amount of the total revolving credit commitments during the year. As of June 30, 2009, the Company had $55,000 outstanding on this revolving credit facility, of which $5,000 is classified as current and $50,000 is classified as long-term. Borrowings under this agreement carry variable interest rates tied to either LIBOR, prime, or the bank’s cost of funds at the Company’s discretion. At June 30, 2009, the weighted-average interest rate for the outstanding borrowings under this agreement along with the interest rate swap agreement was 3.08%. It is the Company’s intention to maintain a balance of at least $50,000 outstanding utilizing the one-month LIBOR borrowing option through September 19, 2010, the date on which the related cash flow hedge ends (described in Note 6, “Risk Management Activities”). Unused lines under this facility, net of outstanding letters of credit of $6,104 to secure certain insurance obligations, totaled $88,896 at June 30, 2009 and are available to fund future acquisitions or other capital and operating requirements.
The Company has an agreement with Prudential Insurance Company 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 fifteen years. The agreement expires in March 2010. There were no borrowings at June 30, 2009.
The revolving credit facility, private placement debt and uncommitted shelf facility contain restrictive covenants regarding liquidity, net worth, financial ratios, and other covenants. At June 30, 2009, the most restrictive of these covenants required that the Company have consolidated income before interest, taxes, depreciation and amortization at least equal to 300% of net interest expense. At June 30, 2009, the Company was in compliance with all covenants.
NOTE 6: RISK MANAGEMENT ACTIVITIES
On January 1, 2009, Applied adopted FASB Statement No. 161 “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133” (“SFAS 161”). The adoption of SFAS 161 required additional financial statement disclosures. The Company has applied the requirements of SFAS 161 on a prospective basis. Accordingly, disclosures related to prior periods have not been presented.
The Company is exposed to market risks, primarily resulting from changes in currency exchange rates and interest 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” (“SFAS 133”). This standard, as amended, requires that all derivative instruments be recorded on the balance sheet at their fair value and that changes in fair value be recorded each period in current earnings or comprehensive income. The Company does not hold or issue derivative financial instruments for trading purposes. The criteria for designating a derivative as a hedge include the assessment of the instrument’s effectiveness in risk reduction, matching of the derivative instrument to its underlying transaction, and the probability that the underlying transaction will occur.
 
Applied Industrial Technologies, Inc. and Subsidiaries   21


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(In thousands, except per share amounts)
Foreign Currency Exchange Rate Risk
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. One of the cross-currency swaps is designated as a cash flow hedge. There was no ineffectiveness of this cross-currency swap during fiscal 2009. The unrealized losses on this swap are included in accumulated other comprehensive (loss) income and the corresponding fair value is included in other liabilities in the consolidated balance sheets.
The other cross-currency swap is not designated as a hedging instrument under the hedge accounting provisions of SFAS 133. Accordingly, the Company records the fair value of this contract as of the end of its reporting period to its consolidated balance sheet with changes in fair value recorded in the Company’s statements of consolidated income. The balance sheet classification for the fair value of this contract is to other assets for unrealized gains or other liabilities for unrealized losses. The income statement classification for the fair value of this swap is to other expense (income), net for both unrealized gains and losses.
Interest Rate Risk
Effective September 19, 2008, the Company entered into a two-year agreement for a $50,000 interest rate swap to effectively convert $50,000 of its variable-rate debt to fixed-rate debt at a fixed rate of 3.33%. This instrument has been designated as a cash flow hedge, the objective of which is to eliminate the variability of cash flows in interest payments attributable to changes in the benchmark one-month LIBOR interest rates. There was no ineffectiveness of this interest rate swap contract during fiscal 2009. The unrealized loss on this interest rate swap is included in accumulated other comprehensive (loss) income and the corresponding fair value is included in other liabilities in the consolidated balance sheet. Based upon market valuations at June 30, 2009, approximately $700 is expected to be reclassified into the statement of consolidated income over the next twelve months, as cash flow payments are made in accordance with the interest rate swap agreements.
The following table summarizes the fair value of derivative instruments as recorded in the consolidated balance sheet as of June 30:
                 
    Consolidated Balance   Fair Value  
    Sheet Classification   2009  
     
Derivatives designated as hedging instruments:
               
Cross-currency swap
  Other liabilities   $ 6,689  
Interest rate swap
  Other liabilities     1,381  
     
Total derivatives designated as hedging instruments
            8,070  
     
Derivative not designated as a hedging instrument - cross-currency swap
  Other liabilities     1,672  
     
Total Derivatives
          $ 9,742  
 
The following table summarizes the effects of derivative instruments on income and other comprehensive income (“OCI”) for the year ended June 30, 2009 (amounts presented exclude any income tax effects):
                       
Derivatives in Cash Flow Hedging
  Amount of Gain (Loss) Recognized in OCI     Amount of Loss Reclassified from Accumulated OCI into Income  
Relationships   on Derivatives (Effective Portion)     (Effective Portion), Included in Interest Expense  
 
Cross-currency swap
  $ 3,790          
Interest rate swap
  (1,381 )   $ (701 )
 
Total
  $ 2,409     $ (701 )
 
 
    Amount of Gain (Loss) Recognized in          
Derivative Not Designated   Income on Derivative, Included in Other          
as Hedging Instrument   Expense (Income), net          
         
Cross-currency swap
  $ 947          
         
NOTE 7: FAIR VALUE MEASUREMENTS
Fair value as defined by SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), is the price that would be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS 157 classifies the inputs to measure fair value into three tiers. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
 
22   Applied Industrial Technologies, Inc. and Subsidiaries


 

 
In February, 2008, the FASB finalized FASB Staff Position 157-2, “Effective Date of FASB Statement No. 157.” This Staff Position delays the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The effective date for Applied for items within the scope of this FASB Staff Position is July 1, 2009.
Financial assets and liabilities measured at fair value on a recurring basis are as follows at June 30, 2009:
                                 
            Fair Value Measurements  
            Quoted Prices in Active              
            Markets for Identical     Significant Other     Significant  
            Instruments     Observable Inputs     Unobservable Inputs  
               
    Recorded Value     Level 1     Level 2     Level 3  
     
Assets:
                               
Marketable securities
    $ 8,211       $ 8,211                  
     
 
                               
Liabilities:
                               
Cross-currency swaps
    $ 8,361               $ 8,361          
Interest rate swap
    1,381               1,381          
     
Total Liabilities
    $ 9,742               $ 9,742          
 
Marketable securities in the above table are held in a rabbi trust for a non-qualified deferred compensation plan. The marketable securities are included in other assets in the consolidated balance sheets. The fair values were derived using quoted market prices. Marketable securities totaled $10,527 at June 30, 2008.
Fair values for cross-currency and interest rate swaps shown in the above table are derived using foreign currency exchange rates and inputs readily available in the public swap markets for similar instruments adjusted for terms specific to these instruments. Since the inputs used to value these instruments are observable and the counterparty is credit worthy, the Company has classified them as Level 2 inputs. These liabilities are included in other liabilities in the consolidated balance sheets.
NOTE 8: INCOME TAXES
Income Before Income Taxes
The components of income before income taxes are as follows:
                         
Year Ended June 30,   2009     2008     2007  
     
U.S.
  $ 54,916     $ 136,179     $ 119,275  
Foreign
    10,898       15,536       14,555  
     
Total income before income taxes
  $  65,814     $ 151,715     $ 133,830  
 
Provision
The provision (benefit) for income taxes consists of:
   
Year Ended June 30,   2009     2008     2007  
     
Current:
                       
Federal
  $ 30,142     $ 49,532     $ 43,325  
State and local
    4,235       7,025       5,341  
Foreign
    5,825       5,511       5,566  
     
Total current
    40,202       62,068       54,232  
     
Deferred:
                       
Federal
    (14,492 )     (5,028 )     (5,914 )
State and local
    (769 )     (346 )     (342 )
Foreign
    (1,387 )     (435 )     (168 )
     
Total deferred
    (16,648 )     (5,809 )     (6,424 )
     
Total
  $ 23,554     $ 56,259     $ 47,808  
 
The exercise of non-qualified stock options and stock appreciation rights during fiscal 2009, 2008 and 2007 resulted in $452, $3,140 and $2,860, 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.
 
Applied Industrial Technologies, Inc. and Subsidiaries   23


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(In thousands, except per share amounts)
Vesting of stock awards and other stock compensation in fiscal 2009, 2008 and 2007 resulted in $422, $577 and $1,025, 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 reconciles the federal statutory income tax rate and the Company’s effective income tax rate:
                                   
Year Ended June 30,   2009     2008     2007  
     
Statutory income tax rate
    35.0 %     35.0 %     35.0 %
Effects of:
                       
State and local taxes
    3.2       2.8       2.3  
U.S. tax on foreign income, net
    6.4       .1          
Foreign tax credit carryforwards
    (6.0 )                
Valuation allowance
    (1.5 )     .7          
Foreign income taxes
    (.4 )     (.9 )     (.8 )
Deductible dividend
    (1.2 )     (.5 )     (.5 )
Other, net
    .3       (.1 )     (.3 )
     
Effective income tax rate
    35.8 %     37.1 %     35.7 %
 
Consolidated Balance Sheets
Significant components of the Company’s net deferred tax assets are as follows:
                      
June 30,   2009     2008  
     
Deferred tax assets:
               
Compensation liabilities not currently deductible
  $ 33,751     $ 33,248  
Expenses and reserves not currently deductible
    7,220       7,523  
Goodwill and intangibles
    12,588          
Net operating loss carryforwards (expiring in years 2014-2024)
    370       451  
Foreign tax credits
    3,954          
Other
    1,452       880  
     
Total deferred tax assets
    59,335       42,102  
Less: Valuation allowance
    (105 )     (1,019 )
     
Deferred tax assets, net of valuation allowance
    59,230       41,083  
     
Deferred tax liabilities:
               
Currency translation
    (232 )     (4,024 )
Inventories
    (2,403 )     (1,813 )
Depreciation and differences in property bases
    (1,229 )     (124 )
Other
            (52 )
     
Total deferred tax liabilities
    (3,864 )     (6,013 )
     
Net deferred tax assets
  $ 55,366     $ 35,070  
 
Net deferred tax assets are reflected in the accompanying consolidated balance sheets as follows:
                      
June 30,   2009     2008  
     
Deferred tax assets:
               
Other current assets
  $ 9,930     $ 9,288  
Other assets
    46,650       25,782  
Deferred tax liabilities:
               
Other current liabilities
    (926 )        
Other liabilities
    (288 )        
     
Net deferred tax assets
  $ 55,366     $ 35,070  
 
 
24   Applied Industrial Technologies, Inc. and Subsidiaries


 

 
Valuation allowances are provided against deferred tax assets where it is considered more-likely-than-not that the Company will not realize the benefit of such assets. In fiscal 2008, changes in U.S. tax regulations resulted in limitations to the deductibility of certain expenses and management believed it was not likely the Company would be able to utilize certain expenses, so a valuation allowance was established against them. In fiscal 2009, the Company determined it would be able to utilize these deferred tax assets and the related valuation allowance was reversed. The remaining net deferred tax asset is the amount management believes is more-likely-than-not of being realized. The realization of these deferred tax assets can be impacted by changes to tax laws, statutory rates and future income levels.
No provision has been made for income taxes on undistributed earnings of non-U.S. subsidiaries of approximately $29.7 million at June 30, 2009, since it is the Company’s intention to indefinitely reinvest undistributed earnings of its foreign subsidiaries. Determination of the net amount of the unrecognized tax liability with respect to these earnings is not practicable; however, foreign tax credits would be available to partially reduce U.S. income taxes in the event of a distribution. In fiscal 2009, the Company declared and received a dividend of $30.8 million from a Canadian subsidiary. Net U.S. tax expense of $1.1 million (or a 1.7% impact on the effective income tax rate) was recorded related to this transaction.
Unrecognized Income Tax Benefits
The Company and its subsidiaries file income tax returns in the U.S. federal, various state and local and foreign jurisdictions. Effective July 1, 2007, the Company adopted FIN 48. The following is a reconciliation of the Company’s total gross unrecognized tax benefits for the years ended June 30, 2009 and 2008:
                 
    2009     2008  
     
Unrecognized Tax Benefits at July 1, 2008 and 2007, respectively
  $ 2,004     $ 1,903  
Current year tax positions
    183       369  
Prior year tax positions
    (51 )     (31 )
Expirations of statutes of limitations
    (167 )     (216 )
Settlements
    (109 )     (21 )
     
Unrecognized Tax Benefits at June 30, 2009 and 2008, respectively
  $ 1,860     $ 2,004  
 
Included in the balance of unrecognized tax benefits at June 30, 2009 and 2008, are $984 and $1,124, respectively, of tax benefits that, if recognized, would affect the effective income tax rate.
The Company recognizes accrued interest and penalties related to unrecognized income tax benefits in the provision for income taxes. During 2009 and 2008, the Company recognized $32 and $97, respectively, for interest and penalties related to unrecognized benefits in its statements of consolidated income. The Company had a liability for penalties and interest of $526 and $494, as of June 30, 2009 and 2008, respectively. The Company does not anticipate a significant change to the total amount of unrecognized income tax benefits within the next twelve months.
The Company is subject to U.S. federal jurisdiction income tax examinations for the tax years 2006 through 2009. In addition, the Company is subject to foreign, state and local income tax examinations for the tax years 2005 through 2009.
The Company’s unrecognized tax benefits are classified as non-current liabilities since payment of cash is not expected within one year.
NOTE 9: SHAREHOLDERS’ EQUITY
Net Income Per Share
The following is a computation of basic and diluted earnings per share:
                                   
Year Ended June 30,   2009     2008     2007  
     
Net Income
  $ 42,260     $ 95,456     $ 86,022  
     
Average Shares Outstanding:
                       
Weighted-average common shares outstanding for basic computation
    42,287       42,797       43,630  
Dilutive effect of potential common shares
    507       755       865  
     
Weighted-average common shares outstanding for dilutive computation
    42,794       43,552       44,495  
     
Net Income Per Share – Basic
  $ 1.00     $ 2.23     $ 1.97  
     
Net Income Per Share – Diluted
  $ 0.99     $ 2.19     $ 1.93  
 
Stock options and stock appreciation rights relating to the acquisition of 1,208, 255 and 460 shares of common stock were outstanding at June 30, 2009, 2008 and 2007, respectively, but were not included in the computation of diluted earnings per share for the fiscal years then ended as they were anti-dilutive.
 
Applied Industrial Technologies, Inc. and Subsidiaries   25


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(In thousands, except per share amounts)
Share-Based Incentive Plans
The 2007 Long-Term Performance Plan (the “2007 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 or the Corporate Governance Committee of the Board of Directors may determine to officers, other key associates and members of the Board of Directors. Grants are generally made by the two committees at regularly scheduled meetings. The aggregate number of shares of common stock which may be awarded under the 2007 Plan is 2,000. Shares available for future grants at June 30, 2009 were 1,585.
Stock Option and Stock 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. SARs 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, 2009, 2008 and 2007 was $3,702, $2,999 and $2,494, respectively. Such amounts are included in selling, distribution and administrative expense in the accompanying statements 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 share-based awards requires management to select a fair value model and make certain estimates and assumptions.
The weighted-average assumptions used for SARs and stock option grants issued in fiscal 2009, 2008 and 2007 are:
                         
    2009     2008     2007  
     
Expected life, in years
    5.5       5.3       5.1  
Risk free interest rate
    2.9 %     4.4 %     4.8 %
Dividend yield
    2.2 %     2.2 %     2.2 %
Volatility
    48.4 %     45.9 %     46.7 %
 
The expected life is based upon historical exercise experience of the officers, other key associates and members of the Board of Directors. 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 SARs and stock option exercises. SARs are redeemable solely in Company common stock. The exercise price of stock option awards may be settled by the holder with cash or by tendering Company common stock.
A summary of stock option and SARs activity is presented below:
                      
2009           Weighted-Average  
(Share amounts in thousands)   Shares     Exercise Price  
 
               
 
Outstanding, beginning of year
    2,195       $ 15.17  
Granted
    349       26.51  
Exercised
    (97 )     8.26  
Forfeited
    (1 )     20.99  
 
Outstanding, end of year
    2,446       $ 17.06  
 
Exercisable at end of year
    1,823       $ 14.08  
 
Weighted-average fair value of SARs and options granted during year
            $ 10.31  
 
                      
2008           Weighted-Average  
(Share amounts in thousands)   Shares     Exercise Price  
 
Outstanding, beginning of year
    2,384       $ 13.15  
Granted
    263       25.32  
Exercised
    (452 )     10.43  
 
Outstanding, end of year
    2,195       $ 15.17  
 
Exercisable at end of year
    1,596       $ 12.61  
 
Weighted-average fair value of SARs and options granted during year
            $   9.79  
 
 
26   Applied Industrial Technologies, Inc. and Subsidiaries


 

 

                 
2007           Weighted-Average  
(Share amounts in thousands)   Shares     Exercise Price  
 
Outstanding, beginning of year
    2,486       $ 11.23  
Granted
    319       22.11  
Exercised
    (421 )     8.61  
 
Outstanding, end of year
    2,384       $ 13.15  
 
Exercisable at end of year
    1,533       $ 10.63  
 
Weighted-average fair value of SARs and options granted during year
            $   8.74  
 
The weighted-average remaining contractual terms for SARs/stock options outstanding and exercisable at June 30, 2009 were 5.32 and 4.33 years, respectively. The aggregate intrinsic values of SARs/stock options outstanding and exercisable at June 30, 2009 were $12,156. The aggregate intrinsic value of the SARs/stock options exercised during fiscal 2009, 2008 and 2007 was $1,453, $9,356, and $7,887, respectively.
A summary of the status of the Company’s nonvested stock options and SARs at June 30, 2009, all of which are expected to vest, is presented below:
                 
            Weighted-Average  
2009           Grant-Date  
(Share amounts in thousands)   Shares     Fair Value  
 
               
 
Nonvested, beginning of year
    599       $   8.64  
Granted
    349       10.31  
Vested
    (325 )     7.61  
 
Nonvested, end of year
    623       $ 10.12  
 
As of June 30, 2009, unrecognized compensation cost related to stock options and SARs amounted to $2,231. 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 2009, 2008 and 2007 was $2,495, $3,190 and $2,116, 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 vest over a period of one to four years. 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, 2009 and 2008, the Company had 31 and 14 shares of unvested restricted stock outstanding at weighted-average prices of $17.19 and $23.94, respectively. During fiscal 2009, 29 shares of restricted stock were granted at an average grant price of $16.68 per share. Unamortized compensation related to unvested restricted stock awards aggregated $273 and $375 at June 30, 2009 and 2008, respectively. The unamortized compensation cost related to restricted stock is expected to be amortized over the weighted-average remaining vesting period of 0.7 years.
Long-Term Performance Grants
The Executive Organization and Compensation 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 based upon the Company’s achievement of sales growth, return on sales, and total shareholder return targets. Total shareholder return is 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 in the plan. 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 2009, 2008 and 2007, the Company recorded $7, $493 and $549, respectively, of compensation expense for achievement relative to the total shareholder return-based goals of the Company’s performance grants. At June 30, 2009, and 2008, the Company had accrued $769 and $762, respectively, for compensation expense relative to these goals. At June 30, 2009, the maximum potential compensation expense related to the outstanding performance grants was $3,115. Any amounts estimated to be earned up to the related potential would be recognized during the remaining performance period of two years.
Treasury Shares
At June 30, 2009, 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   27


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(In thousands, except per share amounts)
Accumulated Other Comprehensive (Loss) Income
Accumulated other comprehensive (loss) income is comprised of the following:
                 
June 30,
  2009     2008  
     
Unrealized losses on cash flow hedges, net of taxes
  $ (151 )   $ (19 )
Unrealized gains on investment securities available for sale, net of taxes
    161       338  
Foreign currency translation, net of taxes
    2,933       15,966  
Pension liability, net of taxes
    (10,792 )     (10,036 )
     
Total accumulated other comprehensive (loss) income
  $ (7,849 )   $ 6,249  
 
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 (2.5% for fiscal 2009 and 5% for fiscal 2008 and 2007). The Company also partially matched 401(k) contributions by participants through December 31, 2008. Participants may elect to contribute up to 50% of their compensation, subject to Internal Revenue Code maximums. Effective January 1, 2009, the Company suspended the 401(k) match indefinitely. The Company’s expense for contributions to the above plan was $3,086, $12,442 and $11,548 during fiscal 2009, 2008 and 2007, 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 which, except for the Qualified Defined Benefit Retirement Plan, are unfunded:
Supplemental Executive Retirement Benefits Plan
The Company has a non-qualified pension plan to provide supplemental retirement benefits to certain officers. Benefits are payable beginning at retirement and determinable at retirement based upon a percentage of the participant’s historical compensation.
Qualified Defined Benefit Retirement Plan
The Company has a qualified defined benefit retirement plan that provides benefits to certain hourly associates at retirement. These associates do not participate in the Retirement Savings Plan. The benefits are based on length of service and date of retirement.
Salary Continuation Benefits
The Company has agreements with certain retirees of acquired companies to pay monthly retirement benefits for a period not in excess of 15 years. The discount rate used in determining the benefit obligation was 6.0% at June 30, 2009 and 2008.
Retiree Health Care Benefits
The Company provides health care benefits to eligible retired associates who 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 Company uses a June 30 measurement date for all plans.
 
28   Applied Industrial Technologies, Inc. and Subsidiaries


 

 
The changes in benefit obligations, plan assets and funded status for the postemployment plans described above were as follows:
                                 
         Pension Benefits     Retiree Health Care Benefits    
    2009     2008     2009     2008  
         
Change in benefit obligation:
                               
Benefit obligation at beginning of the year
  $ 42,576     $ 42,210     $ 3,924     $ 4,173  
Service cost
    2,139       2,090       41       49  
Interest cost
    2,518       2,413       228       271  
Plan participants’ contributions
                    35       31  
Benefits paid
    (3,061 )     (4,655 )     (232 )     (207 )
Amendments
    1,749       249       190       419  
Actuarial (gain) loss during year
    (455 )     269       167       (812 )
         
Benefit obligation at end of year
  $ 45,466     $ 42,576     $ 4,353     $ 3,924  
         
Change in plan assets:
                               
Fair value of plan assets at beginning of year
  $ 5,530     $ 5,893                  
Actual loss on plan assets
    (949 )     (249 )                
Employer contributions
    3,237       4,541     $ 197     $ 176  
Plan participants’ contributions
                    35       31  
Benefits paid
    (3,061 )     (4,655 )     (232 )     (207 )
         
Fair value of plan assets at end of year
  $ 4,757     $ 5,530     0     0  
         
Funded status at end of year
  $ (40,709 )   $ (37,046 )   $ (4,353 )   $ (3,924 )
         
Amounts recognized in the consolidated balance sheets:
                               
Prepaid benefit cost
                               
Current liabilities
  $ (1,656 )   $ (2,953 )   $ (220 )   $ (270 )
Noncurrent liabilities
    (39,053 )     (34,093 )     (4,133 )     (3,654 )
         
Net amount recognized
  $ (40,709 )   $ (37,046 )   $ (4,353 )   $ (3,924 )
         
Amounts recognized in accumulated other comprehensive loss (income):
                               
Net actuarial loss (gain)
  $ 12,854     $ 12,834     $ (1,171 )   $ (1,465 )
Prior service cost
    5,165       4,330       560       490  
         
Total amounts recognized in accumulated
                               
other comprehensive loss (income)
  $ 18,019     $ 17,164     $ (611 )   $ (975 )
 
The following table provides information for pension plans with an accumulated benefit obligation and projected benefit obligation in excess of plan assets:
                 
              Pension Benefits  
    2009     2008  
     
Projected benefit obligations
  $ 45,466     $ 42,576  
Accumulated benefit obligations
    38,229       35,385  
Fair value of plan assets
    4,757       5,530  
 
 
Applied Industrial Technologies, Inc. and Subsidiaries   29


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(In thousands, except per share amounts)
   
The net postemployment benefit costs are as follows:
                         
    Pension Benefits          
    2009     2008     2007  
           
Service cost
  $2,139     $2,090     $1,685  
Interest cost
    2,518       2,413       2,032  
Expected return on plan assets
    (436 )     (466 )     (415 )
Recognized net actuarial loss
    911       962       804  
Amortization of prior service cost
    920       635       658  
           
Net periodic pension cost
  $6,052     $5,634     $4,764  
 
                         
    Retiree Health Care Benefits          
    2009     2008     2007  
           
Service cost
  $    41     $    49     $    56  
Interest cost
    228       271       222  
Recognized net actuarial (gain)
    (125 )     (107 )     (109 )
Amortization of prior service cost
    119       119       49  
           
Net periodic postemployment benefit cost
  $  263     $  332     $  218  
           
   
The estimated net loss and prior service cost for the pension plans that will be amortized from accumulated other comprehensive (loss) income into net periodic benefit cost over the next fiscal year are $924 and $797, respectively. The estimated net gain and prior service cost for the retiree health care benefits that will be amortized from accumulated other comprehensive (loss) income into net periodic benefit cost over the next fiscal year are $87 and $147, respectively.
Assumptions
   
The discount rate is used to determine the present value of future payments. In general, the Company’s liability increases as the discount rate decreases and decreases as the discount rate increases. The Company computes a weighted-average discount rate taking into account anticipated plan payments and the associated interest rates from the Citigroup Pension Discount Yield Curve.
   
The weighted-average actuarial assumptions at June 30 used to determine benefit obligations for the plans were as follows:
                                 
    Pension Benefits     Retiree Health Care Benefits  
    2009     2008     2009     2008  
                         
Discount rate
    6.0 %     6.0 %     6.0 %     6.0 %
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 assumed health care cost trend rates used in measuring the accumulated benefit obligation for post-retirement benefits other than pensions were 9% and 8% as of June 30, 2009 and 2008, respectively, decreasing to 5% by 2018 and 2015, respectively. A one-percentage point change in the assumed health care cost trend rates would have had the following effects as of June 30, 2009 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
  $   44     $   (36 )
Effect on post-retirement benefit obligation
    650       (539 )
 
 
30     Applied Industrial Technologies, Inc. and Subsidiaries

 


 

 

Plan Assets
   
The Company’s Qualified Defined Benefit Retirement Plan weighted-average asset allocation and target allocation are as follows:
                         
    Target     Percentage of Pension Plan  
    Allocation     Assets At Fiscal Year End  
    2010     2009     2008  
                     
Asset Category:
                       
Equity securities
    40 – 70 %     48 %     57 %
Debt securities
    20 – 50 %     47 %     39 %
Other
    0 – 20 %     5 %     4 %
                     
Total
    100 %     100 %     100 %
 
   
Equity securities do not include any Company 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.
Cash Flows
   
Employer Contributions
 
   
The Company expects to contribute $1,700 to its pension benefit plans and $200 to its retiree health care benefit plans in 2010.
 
   
Estimated Future Benefit Payments
   
The following benefit payments, which reflect expected future service, as applicable, are expected to be paid in each of the next five years and in the aggregate for the subsequent five years:
                 
During Fiscal Years
  Pension Benefits     Retiree Health Care Benefits  
 
2010
  $   1,800     $   200  
2011
    1,900       300  
2012
    900       300  
2013
    1,000       300  
2014
    2,300       300  
2015 through 2019
    31,000       1,400  
 
NOTE 11: LEASES
   
The Company leases its corporate headquarters facility along with many service center and distribution center facilities, vehicles and equipment under non-cancelable lease agreements accounted for as operating leases. Future minimum rental commitments under operating leases having initial or remaining non-cancelable terms exceeding one year as of June 30, 2009 are as follows:
         
During Fiscal Years
       
 
2010
  $21,800  
2011
    15,700  
2012
    12,500  
2013
    8,800  
2014
    6,500  
Thereafter
    13,100  
 
Total minimum lease payments
  $78,400  
 
   
Rental expenses incurred for operating leases, principally from leases for real property, vehicles and computer equipment were $30,900 in 2009, $29,000 in 2008, and $28,300 in 2007.
 
Applied Industrial Technologies, Inc. and Subsidiaries     31

 


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
(In thousands, except per share amounts)
NOTE 12: SEGMENT AND GEOGRAPHIC INFORMATION
   
The Company has identified two reportable segments: Service Center Based Distribution and Fluid Power Businesses. 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 Fluid Power Businesses segment distributes fluid power components and operates shops that assemble fluid power systems and components, performs equipment repair, and offers technical advice to customers.
   
The accounting policies of the Company’s reportable segments are the same as those described in Note 1. Sales between the Service Center Based Distribution segment and the Fluid Power Businesses segment have been eliminated.
Segment Financial Information
                         
    Service Center     Fluid Power        
    Based Distribution     Businesses     Total  
 
Year Ended June 30, 2009
                       
 
Net sales
  $1,596,998     $326,150     $1,923,148  
Operating income for reportable segments
    75,411       18,942       94,353  
Assets used in the business
    611,255       198,073       809,328  
Depreciation
    10,876       1,860       12,736  
Capital expenditures
    5,537       1,451       6,988  
 
Year Ended June 30, 2008
                       
 
Net sales
  $1,865,663     $223,793     $2,089,456  
Operating income for reportable segments
    124,271       17,320       141,591  
Assets used in the business
    712,546       86,225       798,771  
Depreciation
    11,441       1,335       12,776  
Capital expenditures
    7,550       860       8,410  
 
Year Ended June 30, 2007
                       
 
Net sales
  $1,806,284     $207,825     $2,014,109  
Operating income for reportable segments
    122,684       14,427       137,111  
Assets used in the business
    715,864       61,505       777,369  
Depreciation
    12,166       1,323       13,489  
Capital expenditures
    10,074       1,118       11,192  
 
   
A reconciliation of operating income for reportable segments to the consolidated income before income taxes is as follows:
                         
  Year Ended June 30,   2009     2008     2007  
           
Operating income for reportable segments
  $94,353     $141,591     $137,111  
Adjustments for:
                       
Goodwill impairment
    36,605                  
Corporate and other (income) expense, net
    (14,745 )     (11,233 )     2,100  
           
Total operating income
    72,493       152,824       135,011  
Interest expense, net
    4,424       882       2,360  
Other expense (income), net
    2,255       227       (1,179 )
           
Income before income taxes
  $65,814     $151,715     $133,830  
 
   
The change in corporate and other (income) 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.
   
Amortization expense is not included in the operating income for reportable segments; amortization expense for Fluid Power Businesses was $7,390, $418 and $137 for fiscal 2009, 2008 and 2007, respectively and $2,265, $1,245 and $908 for the Service Center Based Distribution segment, respectively.
 
32   Applied Industrial Technologies, Inc. and Subsidiaries

 


 

 


Product Category
   
Net sales by product category are as follows:
                         
Year Ended June 30,
  2009     2008     2007  
           
Industrial
  $1,422,518     $1,670,464     $1,614,515  
Fluid power
    500,630       418,992       399,594  
           
Net sales
  $1,923,148     $2,089,456     $2,014,109  
 
   
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 segment.
Geographic Information
   
Net sales are presented in geographic areas based on the location of the subsidiary making the sale. Long-lived assets are based on physical locations and are comprised of the net book value of property, goodwill and intangible assets. Information by geographic area is as follows:
                         
Year Ended June 30,
  2009     2008     2007  
           
Net Sales:
                       
United States
  $1,674,769     $1,839,410     $1,778,993  
Canada
    197,795       222,121       211,446  
Mexico
    50,584       27,925       23,670  
           
Total
  $1,923,148     $2,089,456     $2,014,109  
 
 
June 30,
  2009     2008  
             
Long-Lived Assets:
               
United States
  $189,720     $107,384  
Canada
    16,481       19,455  
Mexico
    15,474       22,007  
             
Total
  $221,675     $148,846  
 
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 consolidated 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 believes the likelihood is remote that the ultimate resolution of any of these matters will have, either individually or in the aggregate, a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.
NOTE 14: OTHER EXPENSE (INCOME), NET
   
Other expense (income), net consists of the following:
                         
Year Ended June 30,
  2009     2008     2007  
           
Unrealized loss (gain) on assets held in rabbi trust for a nonqualified
deferred compensation plan
  $1,741     $  327     $(1,397 )
Foreign currency transaction losses (gains)
    1,466       (384 )     (27 )
Unrealized (gain) loss on cross-currency swap
    (947 )     277       243  
Other, net
    (5 )     7       2  
           
Total other expense (income), net
  $2,255     $  227     $(1,179 )
 
   
The Company is the owner and beneficiary under life insurance policies acquired in conjunction with a fiscal 1998 acquisition, with benefits in force of $14,000 and a net cash surrender value of $3,000 at June 30, 2009.
 
Applied Industrial Technologies, Inc. and Subsidiaries   33

 


 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
     
 
To the Board of Directors and Shareholders of Applied Industrial Technologies, Inc.
Cleveland, Ohio
  (LOGO)
We have audited the accompanying consolidated balance sheets of Applied Industrial Technologies, Inc. and subsidiaries (the “Company”) as of June 30, 2009 and 2008, and the related statements of consolidated income, shareholders’ equity, and cash flows for each of the three years in the period ended June 30, 2009. 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 the Company at June 30, 2009 and 2008, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2009, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of June 30, 2009, 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 19, 2009 expressed an unqualified opinion on the Company’s internal control over financial reporting.
(DELIOTTE & TOUCH LLP)
Cleveland, Ohio
August 19, 2009
 
34   Applied Industrial Technologies, Inc. and Subsidiaries

 


 

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 accounting principles generally accepted in the United States of America.
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 accounting principles generally accepted in the United States of America 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, 2009. This evaluation was based on the criteria set forth in the framework Internal Control—Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, Management determined that the Company’s internal control over financial reporting was effective as of June 30, 2009.
The effectiveness of the Company’s internal control over financial reporting has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which is included herein.
     
-s- David L. Pugh
  -s- Mark O. Eisele
David L. Pugh
  Mark O. Eisele
Chairman & Chief Executive Officer
  Vice President – Chief Financial Officer & Treasurer
-s- Benjamin J. Mondics
  -s- Daniel T. Brezovec
Benjamin J. Mondics
  Daniel T. Brezovec
President & Chief Operating Officer
  Corporate Controller
 
   
August 19, 2009
   
 
Applied Industrial Technologies, Inc. and Subsidiaries   35

 


 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
     
To the Board of Directors and Shareholders of Applied Industrial Technologies, Inc.
Cleveland, Ohio
  (LOGO)
We have audited the internal control over financial reporting of Applied Industrial Technologies, Inc. and subsidiaries (the “Company”) as of June 30, 2009, 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, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
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, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2009, 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, 2009 of the Company and our report dated August 19, 2009 expressed an unqualified opinion on those consolidated financial statements.
(IMAGE)
Cleveland, Ohio
August 19, 2009
 
36   Applied Industrial Technologies, Inc. and Subsidiaries

 


 

QUARTERLY OPERATING RESULTS AND MARKET DATA
 
 
(In thousands, except per share amounts)                                   Per Common Share (A)  
 
(UNAUDITED)                                   Net Income        
                    Operating Income     Net Income     (Loss)-     Cash  
    Net Sales     Gross Profit     (Loss)     (Loss)     Diluted (B)     Dividend  
 
2009
                                               
First Quarter
  $ 543,906     $ 146,058     $ 37,375     $ 22,536     $ 0.52     $ 0.15  
Second Quarter
    502,412       135,469       28,807       16,194       0.38       0.15  
Third Quarter
    451,647       122,246       21,019       11,560       0.27       0.15  
Fourth Quarter
    425,183       116,237       (14,708 )     (8,030 )     (0.19 )     0.15  
 
 
  $ 1,923,148     $ 520,010     $ 72,493     $ 42,260     $ 0.99     $ 0.60  
 
2008
                                               
First Quarter
  $ 518,547     $ 142,056     $ 39,216     $ 24,457     $ 0.56     $ 0.15  
Second Quarter
    511,008       139,491       37,268       22,967       0.52       0.15  
Third Quarter
    530,156       144,500       37,685       23,595       0.55       0.15  
Fourth Quarter
    529,745       143,236       38,655       24,437       0.57       0.15  
 
 
  $ 2,089,456     $ 569,283     $ 152,824     $ 95,456     $ 2.19     $ 0.60  
 
2007
                                               
First Quarter
  $ 492,590     $ 135,134     $ 33,377     $ 21,117     $ 0.47     $ 0.12  
Second Quarter
    472,365       130,151       28,929       18,568       0.42       0.12  
Third Quarter
    521,129       140,572       34,105       21,697       0.49       0.12  
Fourth Quarter
    528,025       142,195       38,600       24,640       0.56       0.12  
 
 
  $ 2,014,109     $ 548,052     $ 135,011     $ 86,022     $ 1.93     $ 0.48  
 
(A)
On August 11, 2009 there were 6,198 shareholders of record including 4,048 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 11, 2009 was $22.00 per share.
 
(B)
The sum of the quarterly per share amounts may not equal per share amounts reported for year to date. This is due to changes in the number of weighted shares outstanding and the effects of rounding for each period.
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 on periodic physical inventory and the effect of year end inventory quantities on LIFO costs. Reductions in year end inventories in certain LIFO inventory pools during the fiscal years ended June 30, 2009 and 2008 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, 2009 and 2008 increased gross profit by $4,419 and $626, respectively, net income by $2,693 and $383, respectively and net income per share by $0.06 and $0.01, respectively. There were no LIFO layer liquidations for fiscal 2007.
The fiscal 2009 fourth quarter includes a goodwill impairment charge of $36.6 million, which decreased net income by $23.0 million and earnings per share by $0.54.
Additionally, SD&A was reduced by $3.5 million relating to the reversal of prior years’ long-term incentive accruals and other items not expected to re-occur, and income tax expense was reduced by $1.3 million due to tax benefits not expected to re-occur. These items combined to increase net income per share by $0.08.
 
QUARTERLY VOLUME, PRICE AND DIVIDEND INFORMATION
 
                                 
                    Price Range
    Shares Traded     Average Daily Volume     High     Low  
 
2009
                               
First Quarter
    23,839,000       372,500     $ 31.29     $ 22.92  
Second Quarter
    25,940,700       405,300       26.78       14.12  
Third Quarter
    27,478,700       450,500       20.49       14.63  
Fourth Quarter
    22,937,700       364,100       23.95       16.25  
 
2008
                               
First Quarter
    21,416,800       339,900     $ 33.26     $ 22.90  
Second Quarter
    19,630,600       306,700       35.68       28.01  
Third Quarter
    26,431,600       433,300       30.68       22.05  
Fourth Quarter
    26,215,300       409,600       32.20       23.81  
 
2007
                               
First Quarter
    20,528,900       325,900     $ 25.50     $ 20.75  
Second Quarter
    16,447,500       261,100       30.00       23.61  
Third Quarter
    17,787,400       291,600       26.95       22.72  
Fourth Quarter
    18,389,300       291,900       30.73       24.26  
 
 

Applied Industrial Technologies, Inc. and Subsidiaries   37

 


 

5 YEAR SUMMARY
 
(In thousands, except per share amounts and statistical data)
                                         
    2009 (a)     2008     2007     2006     2005  
     
Consolidated Operations – Year Ended June 30
                                       
Net sales
  $ 1,923,148     $ 2,089,456     $ 2,014,109     $ 1,900,780     $ 1,717,055  
Operating income
    72,493       152,824       135,011       115,592       87,968  
Income before cumulative effect of accounting change
    42,260       95,456       86,022       72,299       55,339  
Net income
    42,260       95,456       86,022       72,299       55,339  
Per share data
                                       
Income before cumulative effect of accounting change
                                       
Basic
    1.00       2.23       1.97       1.62       1.24  
Diluted
    0.99       2.19       1.93       1.57       1.20  
Net income
                                       
Basic
    1.00       2.23       1.97       1.62       1.24  
Diluted
    0.99       2.19       1.93       1.57       1.20  
Cash dividend
    0.60       0.60       0.48       0.40       0.29  
 
                                       
Year-End Position – June 30
                                       
Working capital
  $ 369,038     $ 409,186     $ 365,523     $ 370,013     $ 345,806  
Long-term debt (including long-term debt classified as current)
    75,000       25,000       75,395       76,186       76,977  
Total assets
    809,328       798,771       777,369       730,671       690,170  
Shareholders’ equity
    508,102       502,075       450,983       414,822       393,287  
 
                                       
Year-End Statistics – June 30
                                       
Current ratio
    3.4       3.1       2.6       3.0       2.9  
Operating facilities
    464       459       445       452       440  
Shareholders of record
    6,329       6,305       6,242       6,192       6,079  
 
(a) The goodwill impairment charge in fiscal 2009 reduced operating income by $36.6 million, net income by $23.0 million and net income per share by $0.54.
 

38   Applied Industrial Technologies, Inc. and Subsidiaries

 

EXHIBIT 21
APPLIED INDUSTRIAL TECHNOLOGIES, INC. FORM 10-K FOR
FISCAL YEAR ENDED JUNE 30, 2009
SUBSIDIARIES
(as of June 30, 2009)
     
  Jurisdiction of
                    Name Incorporation or Organization
 
   
* A&H Fluid Technologies, Inc.
  Alabama
 
   
* Air-Hydraulic Systems, Inc.
  Minnesota
 
   
* Air Draulics Engineering Co.
  Tennessee
 
   
AIT Limited Partnership
  Ontario, Canada
 
   
* Applied Fluid Power Holdings, LLC
  Ohio
 
   
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 México, S.A. de C.V.
(99%-owned by subsidiaries of Applied Industrial
Technologies, Inc.)
  Mexico
 
   
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
 
   
* Bay Advanced Technologies, LLC
  Ohio
 
   
Bearing Sales & Service, Inc.
  Washington
 
   
Bearings Pan American, Inc.
  Ohio
 
   
* Carolina Fluid Components, LLC
  Ohio
 
   
* DTS Fluid Power, LLC
  Ohio
 
   
Dynavest Nova Scotia Company
  Nova Scotia, Canada
 
   
* ESI Acquisition Corporation
(d/b/a Engineered Sales, Inc., ESI Power Hydraulics,
and Applied Engineered Systems)
  Ohio
 
   
* FluidTech, LLC
  Ohio
 
   
* HydroAir Hughes, LLC
  Ohio
 
   
Iowa Bearing Co.
  Iowa
 
   
* Le Groupe GLM (2005) Inc.
  Canada (Federal)
 
   
* Power Systems, LLC
  Ohio
 
   
* Rafael Benitez Carrillo Inc.
  Puerto Rico
 
   
* Servicios Enol, S.A. de C. V.
  Mexico
 
   
* Spencer Fluid Power, Inc.
  Ohio
 
   
The Ohio Ball Bearing Company
  Ohio
 
   
* VYCMEX Mexico, S.A. de C.V.
  Mexico
 
*        Operating companies that do not conduct business under Applied Industrial Technologies trade name

 

EXHIBIT 23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statement Nos. 333-149183, 333-138054, 333-138053, 333-124574, 333-69002, 333-83809, 33-65509, 33-53401, and 33-53361 on Form S-8 of our reports dated August 19, 2009, relating to the financial statements and financial statement schedule of Applied Industrial Technologies, Inc. (the “Company”), and the effectiveness of the Company’s internal control over financial reporting, appearing in and incorporated by reference in this Annual Report on Form 10-K of the Company for the year ended June 30, 2009.
/s/ Deloitte & Touche LLP
Cleveland, Ohio
August 19, 2009

 

EXHIBIT 24
POWER OF ATTORNEY
               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, 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, 2009 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:
  8/7/2009       /s/ William G. Bares
 
           

 


 

EXHIBIT 24
POWER OF ATTORNEY
               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, 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, 2009 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:
  8/7/09       /s/ T. A. Commes
 
           

 


 

EXHIBIT 24
POWER OF ATTORNEY
               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, 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, 2009 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:
  8/11/09       /s/ Peter A. Dorsman
 
           

 


 

EXHIBIT 24
POWER OF ATTORNEY
               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, 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, 2009 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 11, 2009       /s/ L. Thomas Hiltz
 
           

 


 

EXHIBIT 24
POWER OF ATTORNEY
               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, 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, 2009 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:
  8/10/2009       /s/ Edith Kelly-Green
 
           

 


 

EXHIBIT 24
POWER OF ATTORNEY
               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, 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, 2009 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:
  8/7/09       /s/ John F. Meier
 
           

 


 

EXHIBIT 24
POWER OF ATTORNEY
               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, 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, 2009 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 7, 2009       /s/ J. M. Moore
 
           

 


 

EXHIBIT 24
POWER OF ATTORNEY
               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, 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, 2009 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 7, 2009       /s/ Jerry Sue Thornton
 
           

 


 

EXHIBIT 24
POWER OF ATTORNEY
               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, 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, 2009 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:
  8/7/2009       /s/ Peter C. Wallace
 
           

 


 

EXHIBIT 24
POWER OF ATTORNEY
               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, 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, 2009 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:
  8/7/09       /s/ Stephen E. Yates
 
           

 

EXHIBIT 31
APPLIED INDUSTRIAL TECHNOLOGIES, INC. FORM 10-K FOR
FISCAL YEAR ENDED JUNE 30, 2009
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 19, 2009
         
  /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 19, 2009
         
  /s/ Mark O. Eisele    
  Mark O. Eisele   
  Vice President-Chief Financial Officer & Treasurer   
 

 

EXHIBIT 32
APPLIED INDUSTRIAL TECHNOLOGIES, INC. FORM 10-K FOR
FISCAL YEAR ENDED JUNE 30, 2009
[The following certification accompanies the Annual Report on Form 10-K for the year
ended June 30, 2009, 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, 2009, 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
 
David L. Pugh
      /s/ Mark O. Eisele
 
Mark O. Eisele
   
Chairman & Chief Executive
Officer
      Vice President-Chief Financial Officer
& Treasurer
   
Dated: August 19, 2009
[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.]

 


 

August 19, 2009
     
Securities and Exchange Commission   VIA EDGAR                 
Washington, D.C. 20549    
          Re:        Applied Industrial Technologies, Inc.
     Form 10-K – SEC File No. 1-2299
Dear Sir or Madam:
Transmitted herewith for filing under the Securities and Exchange Act of 1934, as amended, is Applied’s Form 10-K Annual Report for the fiscal year ended June 30, 2009, together with the exhibits thereto.
The financial statements in the Report do not reflect any changes from the preceding year in accounting principles or practices, or in the method of applying any such principles or practices, except for the following:
    Effective July 1, 2008, Applied adopted SFAS No. 157, “Fair Value Measurements.”
    Effective January 1, 2009, Applied adopted SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133.” Applied has applied the requirements of SFAS No. 161 on a prospective basis.
Cordially,
/s/ Fred D. Bauer
Fred D. Bauer
Vice President-General Counsel & Secretary