Applied Industrial Technologies, Inc. — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2023, ended December 31, 2022. Comparisons are with the corresponding periods ended December 31, 2021, except balance-sheet comparisons, which are with June 30, 2022. Amounts below are in millions unless stated otherwise.
Business context and performance
Applied is a value-added distributor and technical solutions provider serving industrial MRO and OEM customers. Its two reportable segments are Service Center Based Distribution and Engineered Solutions. The company reported broad-based sales growth, while noting that industrial activity indicators weakened during the quarter.
Key financial metrics
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $1,060.3, up 20.9% | $2,122.7, up 20.0% |
| Gross profit / margin | $308.5 / 29.1% (29.4% prior year) | $615.3 / 29.0% (unchanged) |
| Operating income / margin | $112.9 / 10.6% (8.9% prior year) | $219.4 / 10.3% (8.6% prior year) |
| Net income | $80.5, up 41.1% | $157.3, up 43.0% |
| Diluted EPS | $2.05 (versus $1.46) | $4.02 (versus $2.81) |
| Net interest expense | $6.2 (versus $7.0) | $12.7 (versus $14.4) |
For the quarter, organic sales growth excluding acquisitions and currency was 21.1%; six-month organic growth was 20.3%. Both segments grew. Quarterly sales were $705.4 million in Service Center Based Distribution and $354.9 million in Engineered Solutions.
For the first six months, operating cash flow was $88.8 million, compared with $81.3 million; investing cash outflow was $38.2 million and financing cash outflow was $69.1 million. Cash decreased $18.9 million to $165.5 million. Working-capital changes, including inventory, were a use of cash.
At December 31, cash was $165.5 million and total debt was $649.4 million, down from $689.5 million at June 30. Working capital was $975.0 million and the current ratio was 3.2, compared with 2.7 at June 30. The company had $489.2 million of unused revolving-credit capacity, net of specified letters of credit. Net indebtedness was 1.1 times defined EBITDA; the company reported compliance with its financial covenants.
Material changes and notable items
- Sales growth reflected underlying operations, pricing actions, MRO demand, growth initiatives, and automation demand; acquisitions added 0.5 percentage points to quarterly growth and foreign currency reduced it by 0.7 points.
- Quarterly gross margin declined 0.3 percentage points. Management attributed a 39-basis-point quarterly impact to higher LIFO expense amid inflation. Six-month gross margin was unchanged year over year, with a 46-basis-point LIFO impact offset by execution and countermeasures.
- SD&A fell as a share of sales to 18.4% from 20.5% for the quarter and to 18.6% from 20.4% year to date. However, bad-debt provisions rose sharply: $5.6 million in the quarter and $9.6 million for six months, reflecting customer credit deterioration and bankruptcies, primarily in Service Center Based Distribution.
- In November 2022, Applied acquired substantially all net assets of Automation, Inc. for $25.5 million, funded with cash; it was included in Engineered Solutions. The filing describes the acquisition as not material to consolidated results.
- The company recognized a $1.2 million loss related to termination of its qualified defined-benefit pension plan. Its $8.9 million settlement was paid from plan assets.
- Variable borrowing costs increased: the revolving facility rate was 5.35% at December 31 versus 2.81% at June 30; the receivables facility rate was 5.36% versus 2.60%. An interest-rate swap converted $384 million of variable-rate debt to a 2.54% rate at quarter end.
Outlook, risks, and contingencies
Management said existing cash, operating cash flow, and available credit were expected to support working capital, dividends, acquisitions, investment, debt service, and potential share repurchases. The filing provides no specific sales or earnings forecast. It states an expected full-year tax rate of 22%–24%, but labels this as fiscal 2022 despite the fiscal 2023 reporting period; the intended period is unclear and should be verified.
Management highlighted weakening industrial indicators: December PMI was 48.4, down from 50.9 in September, and manufacturing capacity utilization was 78.8, down from 80.1 in September. Risks discussed include customer operating conditions and credit collection, inflation and product costs, supplier and supply-chain disruption, interest rates, competition, staffing, foreign currency, acquisitions, cybersecurity and information systems, and potential goodwill or intangible impairment. Pending legal matters include product liability, commercial, personal injury, and employment proceedings; the company does not expect them to have a material adverse effect based on currently known circumstances.
Important facts for investors to verify
- Whether strong organic growth and margin improvement persist if industrial activity continues to weaken.
- Whether rising bad-debt expense, past-due receivables, and customer credit deterioration continue: receivables over 90 days past due were 4.1%, versus 3.4% at June 30.
- The effect of inflation and interim LIFO estimates on future gross margins; final LIFO valuation is determined at fiscal year-end.
- Exposure to higher variable interest rates and the availability and terms of receivables-backed borrowing, which is subject to eligibility conditions and is scheduled to terminate March 26, 2024.
- The intended fiscal year for the filing’s stated 22%–24% tax-rate expectation.