Applied Industrial Technologies, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended June 30, 2018, with comparisons to fiscal 2017. Although the request metadata says “2017 Q4,” this filing reports FY2018; it also provides fourth-quarter results.
Business context
Applied distributes industrial products and provides engineering, systems integration, repair, and inventory-management services to MRO and OEM customers. It operates through Service Center Based Distribution and Fluid Power & Flow Control segments. The January 31, 2018 acquisition of FCX Performance expanded the latter segment.
Financial performance and position
| Metric | FY2018 | FY2017 |
|---|---|---|
| Net sales | $3,073.3 million | $2,593.7 million |
| Gross profit margin | 28.8% | 28.4% |
| Operating income / margin | $225.8 million / 7.3% | $175.4 million / 6.8% |
| Net income | $141.6 million | $133.9 million |
| Diluted EPS | $3.61 | $3.40 |
| Operating cash flow | $147.3 million | $164.6 million |
| Capital expenditures | $23.2 million | $17.0 million |
| Total debt at year-end | $966.1 million | $292.0 million |
| Cash and cash equivalents | $54.2 million | $105.1 million |
| Working capital / current ratio | $625.5 million / 2.4 | $572.8 million / 2.8 |
Sales increased 18.5%; acquisitions contributed $264.7 million and favorable currency translation $16.0 million. Excluding acquisitions and currency, sales rose 7.7%. Service Center Based Distribution sales increased 7.6%; Fluid Power & Flow Control sales rose 75.8%, including substantial FCX acquisition contribution. FCX generated $249.8 million of sales and $16.8 million of operating income from acquisition through year-end.
Fourth-quarter FY2018 sales were $897.7 million, operating income $70.8 million, net income $40.4 million, and diluted EPS $1.03. FY2017 fourth-quarter net income included a $22.2 million tax benefit, making the year-over-year quarterly earnings comparison unusually affected by tax items.
Material changes and notable items
- FCX was acquired for approximately $781.8 million and largely financed through a new credit facility. FCX added $439.2 million of goodwill and $305.4 million of identifiable intangibles, subject to preliminary purchase accounting.
- Operating income increased 28.8%, supported by organic sales growth, improved operating leverage, and FCX. Gross margin rose 0.4 percentage points, primarily from FCX’s favorable mix.
- Net income rose 5.8%, less than operating income, as interest expense increased to $24.1 million from $8.8 million and the effective tax rate rose to 30.8% from 19.8%. FY2017 included the $22.2 million tax benefit; FY2018 included a net $5.8 million benefit from U.S. tax reform.
- Operating cash flow declined, principally due to higher working-capital needs, increased interest payments, and $7.1 million of FCX-related one-time costs. Investing cash outflow was $797.9 million, including $775.7 million for acquisitions.
- The new five-year credit facility included a $780 million term loan and $250 million revolver. At year-end, $775.1 million was outstanding on the term loan and $19.5 million on the revolver; $226.9 million of facility capacity remained available, net of letters of credit. The term-loan rate was 4.13%. The company reported covenant compliance.
- Dividends were $1.18 per share, up from $1.14. The company repurchased 393,300 shares for $22.8 million during FY2018.
Outlook, risks, and contingencies
- Management expected a FY2019 effective tax rate of 24%–26%, capital expenditures of $26–$28 million, and depreciation of $21–$22 million. It expected inventory turnover to be slightly better than FY2018. No sales or earnings guidance is provided in the supplied filing text.
- Management cited risks from industrial and customer demand, competitive pricing, supplier availability and authorizations, cost inflation and tariffs, foreign exchange, and the ability to integrate FCX and realize anticipated benefits. Higher variable-rate debt increases interest-rate exposure; management estimated a 1-percentage-point rate increase on average variable borrowings would add about $4.3 million of annual interest expense.
- Goodwill was $646.6 million and net intangible assets $435.9 million at year-end. Management’s January 2018 impairment assessment found reporting-unit fair values exceeded carrying values by at least 30%, but noted possible impairment risk for one unit with about $28 million of goodwill if forecast margin improvements are not achieved.
- Management and the auditor reported effective internal control over financial reporting, but FCX—representing 39.5% of assets and 8.1% of sales—was excluded from the FY2018 control assessment while oversight and monitoring processes were being extended to it.
- The company was party to various legal proceedings and stated that a material adverse outcome was remote based on information then known. It also disclosed self-insurance exposure and $111.4 million of operating-lease commitments.
Important facts for investors to verify
- FCX integration progress, realized synergies, acquisition-related costs, and final purchase-accounting adjustments.
- Debt repayment capacity, variable interest-rate exposure, covenant headroom, and the effect of leverage on dividends, repurchases, and future acquisitions.
- Whether organic growth and operating margins continue, and whether working-capital demands and cash conversion improve.
- FY2019 tax-rate and capital-spending expectations, including remaining accounting effects of U.S. tax reform.
- FCX’s inclusion in future internal-control assessments and any changes in goodwill impairment assumptions.