The inevitability of change is the nature of business. Cycles come

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1 Executive Summary by Brian Beaulieu SOARING ON THE WINDS OF CHANGE Brian Beaulieu CEO, ITR Economics Leading Indicator and Economic Sector Input The leading indicators that cover a broad cross-section of the US economy continue to tell us that there is no recession ahead. Our ITR Leading Indicator has moved lower from the January 213 peak but sits ensconced in positive territory with no collapse in view. Ongoing improvement in the economy is also visible in the Purchasing Managers (PMI), albeit at a slower rate of rise than we experienced in 213. The April PMI, at 4.9, is rising above the benchmark., indicating that expansion in the manufacturing sector is probable through late 214. (continued on next page) The inevitability of change is the nature of business. Cycles come and go, with business leaders navigating the changing winds of regulations, currency fluctuations, taxes, inflation, and not to mention weather. A change that is almost always welcome is improvement in the US economy. US Industrial Production, our benchmark for the general economy, increased 3.1% over the last 12 months. In spite of a harsh winter, growth in the first three months of 214 rose 3.7% over the year earlier. All three segments of Industrial Production (Mining, Manufacturing, and Utilities) are in positive territory with additional rise probable through the near term based on our rate-of-change analysis and leading indicators. Upward Revised Data and Forecast The Federal Reserve published an upward revision to the Industrial Production data last month. We altered our forecast based on that revision of the trend through March 214. Our expectation that economic growth will moderate late this year remains intact. At the end of 214 we see Industrial Production growth slowing from its current 3.1% rate to 2.7% (moved higher from our previous expectation of 1.9%). We will reach the bottom of the cycle in the third quarter of 21 (unchanged from the previous forecast), with the annual rate-of-change diminishing to 1.4% (previously.8%). This change to our outlook is fairly linear (see chart). ROC Industrial Production Forecasts Nov 213 Mar /12 '6 '7 '8 '9 '1 '11 '12 '13 '14 '1 '16 '17 '18 ROC MAY 214

2 The labor market is gaining momentum. In April the economy added 288, jobs to Non-Farm Payrolls (seasonally adjusted), the strongest one-month gain since January 212. Non-Farm payrolls are now just.1% below their pre-recession peak in January 28. The Unemployment Rate fell to a five-and-a-half year low of 6.3%. A stronger job market is certainly good news for the consumer who is facing headwinds in the form of higher shelter and food prices (more on those later) as well as more expensive gasoline. Be aware though with the pool of skilled workers shrinking, we are seeing wage gains begin to accelerate. With benign inflation this could impact your margins. Nonresidential Construction is recovering from the overbuilding of prior years, but the gains are spotty. Education and Hospital Construction, two large sectors, are creating a drag on total dollars. Commercial and Office Building Construction are improving at a faster pace, but the dollars spent remain well below pre-recession peaks. Interest Rates remain very low by historical standards, and we see the Fed staying on the sideline through the remainder of this year. This should provide you ample opportunity to invest in the capital equipment and software that you will need in order to take advantage of the growth we expect through 217. Consider investing in used equipment get the machinery you need to grow, but at a discount. Potential Headwinds Despite the plethora of good news, we are not blind to the troubles that the economy faces. The rise in the Housing Starts ended a year ago, and the rate of ascent has markedly slowed. Weather may not have helped, but the easing in Starts, which ITR Economics has been forecasting, began prior to the winter weather. The Mortgage Bankers Association reported that mortgage application activity (refinancing and home purchase demand) dropped to its lowest level since December 2 (seasonally adjusted). Higher mortgage rates, tighter regulations (Dodd-Frank), and tight inventory in some markets resulted in a weak start to the spring selling season. In addition, higher home prices have put affordability at a three-year low. Annual total Retail Sales (inflation adjusted) rose 4.% over the last year to a record $2.7 trillion in spending. The rates-of-change are indicating that spending growth will slow through the near term. Retail Sales of Automobiles as well as Online Sales, General Merchandise, and Building Material Sales which together account for nearly half of all Sales, appear to be on the cusp of slowing. Rising Food Prices, especially meat and dairy, more expensive healthcare, and higher costs for housing are negatively impacting discretionary spending. Ratio We don t see these events as breaking the back of the 1.2 Ratio of Durable Goods New Orders Ratio 1.2 consumer, but merely unanticipated costs which will stall the to Inventories rise in spending over the next 12 months '6 '7 '8 '9 '1 '11 '12 '13 ' Annual Nondefense Capital Goods New Orders (business-tobusiness activity) rose a healthy.% in the year to March, but there has been a noticeable decline in the quarterly trends, signaling slower growth in the near term. Note the declining trend in the Durable Goods New Orders to Inventory Ratio. This tells us that inventories are outpacing the New Orders trend and companies may need to start cutting stock. Expect a slowdown in Production to follow. Remember over the next 12 months that competition will always be in pursuit. Innovation of existing products and improved services will be key to retaining customers and increasing market share. Add top-notch sales people to help you penetrate new markets. Be prepared though for wages, inflation, and health care costs to press against cash flow. 6 MAY 214

3 ITR Trends 1 ITRCurrentData Consumer Prices Soft Landing Production Wholesale Trade Foreign Nonresidential Construction New Orders Medical Retail Housing Financial Hard Landing About ITR Trends 1 The ITR Trends 1 compares the current cyclical status of 1 major benchmarks of macroeconomic activity as they move through this business cycle and into the next. Think of the Trends 1 as a train with 1 cars. The majority of the cars have gone through a soft landing for the cycle. Please note that not all of the remaining cars will go down into a hard landing. Many are likely to pass through a low between Phase C and Phase B without going into Phases D and A. This is the essence of the soft landing we are projecting for this business cycle. Summary Financial, Housing, Retail Sales, and New Orders are leading the economy in Phase C, Slower Growth, of the business cycle. Production is approacing the top of the business cycle with an expected third quarter peak. The Foreign, Medical, and Wholesale Trade benchmarks are in Phase B, Accelerating Growth, of the business cycle. Inflation is benign. Consumer Prices are in Phase C, Slower Growth. Nonresidential Construction is approaching a transition to Phase B, Accelerating Growth. Phase A: Recovery RECOV 12/12 is rising and the data trend is either heading toward a low or is in the early stages of recovery. This is the first positive phase of the business cycle. Phase B: Accelerating Growth CCELERATINB 12/12 is rising above, data trend is accelerating in its ascent, and growth is occurring above year-ago levels. This is the second positive phase of the business cycle. Phase C: Slower Growth SLOWER G 12/12 decline is in place, data trend is decelerating in its ascent or has stopped its rise, but it is still above last year. This is the first negative phase of the business cycle. Phase D: Recession RECESSD 12/12 is below, data trend is in recession at levels below the yearearlier level. This is the final phase and the second negative phase of the business cycle. 8 MAY 214

4 ITR Leading Indicator and Economic Forecast ITR Leading Indicator Flat it April ITRCurrentData 1 ITR Leading Indicator 1 The ITR Leading Indicator was virtually unchanged in April, and the trend remains one of general decline. The downward trajectory in the ITR Leading Indicator suggests that US Industrial Production, our benchmark for the US economy, will slow in its pace of growth in late 214 and into 21. Bolstered by a stronger-than-normal month-to-month increase, Industrial Production in March registered 4.1% above March USIP 12/12 ITR LI Raw 7 '8 '9 '1 '11 '12 '13 '14 US Total Industrial Production The strength in monthly activity, combined with the data revision earlier this year and positive leading indicator signals, have led us to revise our outlook for US Industrial Production. The forecast for 214 has been pushed higher. We were previously anticipating 1.9% growth throughout the year, and we are now looking at a 2.7% gain. Growth in 21 is expected to be mildly higher, up to 1.9% from the previous 1.6%. We are still anticipating a slowdown in economic activity, but the timing of the slowdown has been extended further into the second half of the year. The deceleration will persist into the third quarter of MMA Forecast Range 12MMA Actual Forecast Period 12MMA Forecast Result Dec Mar Jun Sep Dec Mar Jun Sep Dec MAY 214

5 ITRCurrentData US Total Industrial Production, 27=1, N.S.A. 1 1 Rate-of-Change MMA Forecast 12MMA 3MMA Data Trend /12 Forecast Range 12/12 3/12 '1 '11 '12 '13 '14 '1 ' '1 '11 '12 '13 '14 '1 ' US Industrial Production strengthened through early spring after a rough winter dampened activity. Quarterly and annual Industrial Production are up 3.7% and 3.1% from their respective year-earlier levels. The Federal Reserve Board s data revision affecting data through February, compounded with a positive showing in March, has led to a mildly upward adjustment to the outlook. Look for Industrial Production to accelerate into the third quarter of the year before growth moderates into the latter half of 21. It s important to note we are looking at a slowdown and not a breakdown ahead. Mining, Manufacturing, and Electric & Gas Utilities Production, are all positively contributing to Industrial Production, increasing.8%, 2.8%, and 2.7%, respectively over the last 12 months. All three subcategories are showing signs of further improvement moving forward. High Tech Industries Production, which measures output of computers, communication equipment, and semiconductors, is also showing impressive activity, increasing 8.2% in the last year. The Total Industry Capacity Utilization Rate increased to 79.2% in March. Although Utilization rates are on the rise, they remain below the historical average of 8.6%, indicating Production has room to move upward without inflationary pressures building. ITRManagementNote Lead and support continuous improvement and innovation efforts to gain market share and retain customers. ITREconomicSnapshot Current Phase B ACCELERATING GROWTH Forecast % % Highlights Industrial Production outlook adjusted mildly upward Mining, Manufacturing, and Utilities contributing to the gains Data Link Ask An Analyst MAY

6 TrendsReport MANUFACTURING ITRCurrentData Metalworking Machinery New Orders Billions of Dollars, N.S.A. 4 3 Rate-of-Change 4 3 Bils $ 11 1 Data Trend 12MMT Forecast 12MMT 3MMT 37.7 Bils $ /12 Forecast Range 12/12 3/12 '1 '11 '12 '13 '14 '1 ' '1 '11 '12 '13 '14 '1 ' Metalworking Machinery New Orders saw a robust 1.6% increase from February to March, but internal trend dynamics are still suggesting a slowdown will take shape in the near term. Expect New Orders to subsequently soften late this year and into 21 before rise resumes in the latter half of next year. Metalworking Machine Tool Exports are contracting and have been since May 213. Annual Exports currently stand at $7. billion and 4.4% below the year-earlier level. Quarterly Exports are deteriorating at a faster rate, with the most recent three months registering a 1.8% decline from one year ago. The ongoing softness in both quarterly and annual Exports indicates that we will likely continue to see additional weakness in Exports during the coming months. The fact that the Metalworking Machinery New Orders trend is still robust while global demand is deteriorating indicates that domestic demand is doing the majority of the heavy lifting in this industry. However, as the US economy begins to cool late this year, domestic demand will not be enough to keep the market growing at an accelerating rate. The negativity in global demand for these products coupled with slower domestic demand will begin to weigh on the New Orders trend in the coming months, resulting in a transition into Phase C, Slower Growth, of the business cycle and a subsequent contraction in New Orders. ITRManagementNote Be careful ramping up costs and overhead during the current phase of the business cycle as activity is anticipated to slow imminently. ITREconomicSnapshot Current Phase B ACCELERATING GROWTH Forecast % % Highlights New Orders to slow imminently Metalworking Machine Tool Exports deteriorating at an accelerating pace Data Link Ask An Analyst 6 MAY 214

7 TrendsReport FINANCIAL Consumer Price (Consumer Inflation), = 1, N.S.A. ITRCurrentData 4 2 Rate-of-Change MMA Forecast 12MMA 3MMA Data Trend /12 Forecast Range 12/12 3/12 '1 '11 '12 '13 '14 '1 ' '1 '11 '12 '13 '14 '1 ' Inflation trends in the US are for the most part benign. There are however pockets of inflation developing, mainly in food prices. For the 12 months ending in March, the Consumer Price (CPI) is up 1.4% from last year. We expect the rate of inflation to move in a horizontal fashion through the end of 21. Prices will end % higher, with a further 1.% growth expected next year. The CPI for Food At Home increased 1.4% from March 213 to March 214; however that figure masks some of the inflationary trends developing in foodstuffs. Supply issues have pushed Pork (+.3%) and Beef (+7.4%) prices up substantially since March 213. In addition, rising demand from China, the world s largest dairy consumer, has pushed Milk prices up 6.9% year-over-year. So far, Vegetable prices (-4.6%) are unscathed. Severe drought in California, which grows the vast majority of many fruits and vegetables consumed in the US, will in all likelihood place upward pressure on prices in the months to come. Higher food prices are yet another headwind that consumers face heading into the second half of 214. ITREconomicSnapshot Current Phase C SLOWER GROWTH Forecast % % ITRManagementNote Use cash to improve efficiencies during this period of stable inflation. Highlights Consumer Price up 1.4% from last year Food prices escalating Data Link Ask An Analyst 12 MAY 214

8 Data Methodology ITR Economics Moving Total/Moving Average Moving totals/averages are used to smooth out the volatility inherent to monthly data. Monthly Moving Total (MMT) vs Monthly Moving Average (MMA): Totals are used for things where is makes sense to add the data together. For example, units sold, or total dollars spent. There are times when it is desirable to calculate a monthly moving average instead of a total. Averages are used when the data cannot be compounded such as an index, percent, price level, or interest rates. 3MMT or 3MMA: A three-month moving total (3MMT) or average (3MMA) is the total (or average) of the monthly data for the most recent three months. Three-month moving totals (3MMT) or averages (3MMA) illustrate the seasonal changes inherent to the data series. 12MMT or 12MMA: A twelve-month moving total (12MMT) or average (12MMA) is the total (or average) of the monthly data for the past 12 months. The 12MMT (A) removes seasonal variation in order to derive the underlying cyclical trend. It is also referred to as the annual total or average. Rate-of-Change A rate-of-change figure is the ratio comparing a data series during a specified time period to the same time period one year ago. Rates-of-change are expressed in terms of the annual percent change in an MMT or MMA. Rates-of-change reveal whether activity levels are getting progressively better or worse compared to last year. Consecutive rate-of-change illustrates and measures cyclical change and trends. ITR Economics three commonly used rates-of-change are the 1/12, 3/12, and 12/12, which represent the year-overyear percent change of a single month, 3MMT, and 12MMT (respectively). A rate-of-change above indicates a rise in the data relative to one year prior, while a rate-of-change below indicates decline. Definition of an An index is a statistical measure of percent change from a base value in a dataset. The base value is equal to 1. Any reading above 1 indicates a percentage gain above the base value and any reading below 1 indicates a percentage decline from the base value. For example: an with the base year 27 means that the year 27 is 1. A reading of 17 indicates a 7% gain over the base year. A reading of 94 means activity is 6% below the base year level. 2 MAY 214

9 Four Phases of a Business Cycle ITR Economics Phase RECOVA A: Recovery 12/12 is rising but remains below zero, and the data trend is either heading toward a low or is in the early stages of recovery. This is the first positive phase of the business cycle. CCELERATINB Phase B: Accelerating Growth 12/12 is rising above zero, data trend is accelerating in its ascent, and growth is occurring above year-ago levels. This is the second positive phase of the business cycle. Phase A Management Objectives Phase Late A - Recovery: 1. Positive leadership modeling (culture turns to behavior) 2. Establish goals: tactical goals which lead to strategic achievement 3. Develop a system for measurement and accountability re:#2 4. Align compensation plans with #2 and #3. Be keenly aware of the BE (Break Even) point and check it regularly 6. Judiciously expand credit 7. Ensure distribution systems are ready to accommodate more activity 8. Review and uncover competitive advantages 9. Invest in customer market research (know what they value) 1. Improve efficiencies with investment in technology and software 11. Start to phase out marginal opportunities 12. Add sales staff 13. Build inventories (consider lead time and turn rate) 14. Introduce new product lines 1. Determine capital equipment needs and place orders 16. Begin advertising and sales promotions 17. Hire top people 18. Implement plans for facilities expansion 19. Implement training programs Phase B Management Objectives Phase Early B - Growth: 1. Accelerate training 2. Check the process flow for possible future bottlenecks 3. Continue to build inventory 4. Increase prices. Consider outside manufacturing sources if internal pressures becoming tight 6. Find the answer to What next? 7. Open distribution centers 8. Use improved cash flow to improve corporate governance 9. Use cash to create new competitive advantages 1. Watch your debt-to-equity ratio and ROI 11. Maintain/pursue quality: don t let complacency set in Phase Late B Early C - Prosperity: 1. Stay in stock on A items, be careful with C items 2. Consider selling the business in a climate of maximum goodwill 3. Penetrate new selected accounts 4. Develop plan for lower activity in traditional, mature markets. Freeze all expansion plans (unless related to what is next ) 6. Spin off undesirable operations 7. Consider taking on subcontract work if the backside of the cycle looks recessionary 8. Stay realistic beware of linear budgets 9. Begin missionary efforts into new markets 1. Communicate competitive advantages to maintain margins MAY

10 Four Phases of a Business Cycle ITR Economics Phase SLOWER C: Slower GRCGrowth 12/12 decline is in place but remains above zero, data trend is decelerating in its ascent or has stopped its rise, but it is still above last year. This is the first negative phase of the business cycle. Phase C Management Objectives Phase Late C - Warning: 1. Begin work force reductions 2. Set budget reduction goals by department 3. Avoid long-term purchase commitments late in the price cycle 4. Concentrate on cash and balance sheet. Reduce advertising & inventories 6. De-emphasize commodity/services in anticipation of diminishing margins 7. Weed out inferior products (lose the losers) 8. Encourage distributors to decrease inventory 9. Identify and overcome any competitive disadvantages 1. Make sure you and the management team are not in denial 11. Cross train key people 12. Watch Accounts Receivable aging 13. Increase the requirements for justification of capital expenditures 14. Evaluate vendors for strength 1. Manage backlog through pricing and delivery, try to fill the funnel Phase D: Recession RECESSD 12/12 is below zero and declining, data trend is declining to levels below the year-earlier level. This is the second negative phase of the business cycle. Phase D Management Objectives Phase Early D - Recession: 1. Continue force reduction 2. Reduce advertising be very selective 3. Continue to avoid long-term purchase commitments 4. Review all lease agreements. Increase the requirements for justification of capital equipment 6. Eliminate all overtime 7. Reduce overhead labor 8. Combine departments with like capabilities and reduce management 9. Select targets of opportunity where price will get the business 1.Tighten credit policies increase scrutiny 11. Look for opportunistic purchases 12. Grab market share as your competitor dies Phase Late D - Recession / Early A - Early Recovery 1. Prepare training programs 2. Negotiate union contracts if possible 3. Develop advertising & marketing programs 4. Enter or renegotiate long-term leases. Look for additional vendors 6. Capital expenditures & acquisitions considered in light of market-by-market potential 7. Make acquisitions use pessimism to your advantage 8. People will be scared lead with optimism and can do attitude 22 MAY 214

11 Checking Points ITR Economics '8 '9 '1 '11 '12 '13 3/12 12/ Positive Checking Points 1. 3/12 reaches a low 2. 3/12 passes above the 12/12 The rate-of-change is making the transition from the previous cycle s decline to rise in the current business cycle. Checking points #1 and #2 reflect this activity /12 reaches a low The onset of business cycle rise is observed. 4. 3/12 crosses about the % line. 12/12 crosses above the % line The entry of the cycle into its steepest part of the rise is with checking points #4 and #. Negative Checking Points 6. 3/12 reaches a high 7. 3/12 passes below the 12/12 Checking points #6 and #7 indicate that the business cycle is making the transition from rise to decline 8. 12/12 reaches a high Business cycle decline begins with checking point # /12 crosses below the % line 1. 12/12 crosses below the % line The entry of the cycle into its steepest part of the decline is with checking points #9 and #1. MAY