Applied Industrial Technologies, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended March 31, 2019 (filed April 30, 2019). The request metadata says “2018 Q3,” but the filing is for fiscal 2019 Q3. Applied distributes industrial, fluid-power and flow-control products and provides related engineering and services. Its interim financial statements were reviewed by Deloitte, not audited.
Key financial results
| Metric | Quarter ended March 31, 2019 | Quarter prior year | Nine months 2019 | Nine months prior year |
|---|---|---|---|---|
| Net sales | $885.4 million | $827.7 million | $2,590.0 million | $2,175.6 million |
| Gross profit / margin | $255.6 million / 28.9% | $239.5 million / 28.9% | $750.3 million / 29.0% | $620.3 million / 28.5% |
| Operating income / margin | $34.5 million / 3.9% | $56.4 million / 6.8% | $161.8 million / 6.2% | $155.0 million / 7.1% |
| Net income | $16.5 million | $36.6 million | $104.2 million | $101.3 million |
| Diluted EPS | $0.42 | $0.93 | $2.66 | $2.58 |
| Net cash from operating activities | Not reported quarterly in this filing | $77.2 million | $47.9 million |
Quarterly sales rose 7.0%; acquisitions added $51.5 million and unfavorable currency reduced sales by $5.7 million. Organic sales, excluding acquisitions and currency, increased 1.5%. For the nine months, sales grew 19.1%, including $340.2 million from acquisitions; organic sales increased 4.3%. Nine-month gross margin improved, while operating margin declined, principally due to the Canadian intangible impairment.
Financial position and liquidity
- At March 31, 2019, cash was $47.4 million, working capital was $709.2 million and the current ratio was 2.7:1, versus 2.4:1 at June 30, 2018.
- Total borrowings were $983.8 million, compared with $966.1 million at June 30, 2018. Debt included $618.5 million under the term loan, $19.0 million on the revolver, $175.0 million under the receivables securitization facility and $170.0 million of private-placement notes, plus a small state note.
- Available capacity under the revolving facility, net of letters of credit, was $227.7 million. The $175 million receivables facility was fully drawn; actual availability can be affected by receivable and customer-credit characteristics.
- Management said cash, operating cash flow and available borrowing capacity should fund normal working capital, dividends, acquisitions, capital spending, debt service and share repurchases. The company was in compliance with debt covenants; its leverage was below 3.0x EBITDA against a maximum covenant of 4.25x.
- Nine-month investing cash outflow was $48.2 million, including $37.5 million for acquisitions and $11.7 million for property purchases. Financing cash outflow was $35.5 million; cash declined $6.8 million to $47.4 million.
Material changes, unusual items and management commentary
- A $31.6 million non-cash impairment charge fully impaired long-lived intangible assets in the Reliance asset group serving western Canada’s upstream oil and gas market. It reduced quarterly net income by $23.1 million and diluted EPS by $0.60; nine-month EPS impact was reported as $0.59.
- Quarterly restructuring charges were $2.3 million, primarily tied to headcount reductions and location consolidation in oil and gas operations. They reduced EPS by $0.04.
- Quarterly Fluid Power & Flow Control organic sales declined 8.5%, reflecting softness and project delays in technology-related fluid-power markets. Service Center Based Distribution organic sales increased 5.2%, supported by industrial demand.
- The quarterly effective tax rate was 36.0%, including a $3.8 million valuation allowance on certain Canadian deferred tax assets. The nine-month rate was 21.3%. Management expected a fiscal 2019 full-year tax rate of 22%–24%.
- The company adopted ASC 606 in fiscal 2019, increasing opening retained earnings by $3.4 million net of tax. Its effect on reported nine-month sales was modest; reported net income was $0.8 million lower than it would have been without adoption.
- Applied acquired MilRoc Distribution and Woodward Steel in March 2019 for $35.0 million and Fluid Power Sales in November 2018 for $8.1 million. These acquisitions were described as not material to consolidated results. FCX, acquired in January 2018, contributed $417.3 million in nine-month sales and $22.8 million in net income during the current period.
- For the quarter, operating income fell 38.9% and net income fell 54.8%, chiefly because of the impairment. For the nine months, net income increased 2.9% despite lower operating margin and the impairment.
Outlook and risks
Management cited improving U.S. industrial production and manufacturing-capacity indicators and expected fiscal 2019 tax expense to fall within the 22%–24% range. The filing does not provide a broader numerical sales or earnings forecast. Key risks include industrial and customer demand, oil-and-gas weakness, pricing and input costs, supplier relationships and product availability, acquisition integration, foreign currency and overseas conditions, receivable collection, floating-rate debt, potential future goodwill or intangible impairments, cybersecurity and information systems, tariffs and other trade policies, and legal or extraordinary events.
The company anticipated that adoption of the new lease accounting standard would materially increase reported assets and liabilities; the impact was still being evaluated. Management stated disclosure controls were effective and that no material change in internal control over financial reporting occurred during the nine months. Pending legal proceedings were not expected, based on currently known circumstances, to have a material adverse effect.
Investor verification priorities
- Assess underlying demand separately from acquisition-driven growth, especially the organic decline in Fluid Power & Flow Control.
- Track the Canadian oil-and-gas business, restructuring progress and whether further asset impairment is possible.
- Reconcile reported earnings and margins for the impairment, restructuring costs, Canadian tax valuation allowance and acquisition-related amortization.
- Monitor debt, interest-rate exposure, receivables-facility availability and covenant headroom; the new interest-rate swap hedged $463 million of variable-rate debt.
- Verify subsequent results against management’s 22%–24% fiscal-year tax-rate expectation and the stated expectation that liquidity would cover planned uses.
- Review the eventual balance-sheet effect of lease-standard adoption and the final purchase-price allocations for recent acquisitions.