Applied Industrial Technologies, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2018, three months ended September 30, 2017. Applied distributes industrial and fluid-power products and related services through 554 facilities. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions where applicable.
Financial results
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Net sales | $680.7 million | $624.8 million | +8.9% |
| Gross profit | $192.4 million | $178.3 million | +7.9% |
| Gross margin | 28.3% | 28.5% | -0.2 percentage points |
| Operating income | $51.8 million | $43.4 million | +19.4% |
| Operating margin | 7.6% | 6.9% | +0.7 percentage points |
| Net income | $33.7 million | $27.4 million | +23.2% |
| Diluted EPS | $0.86 | $0.70 | +22.9% |
| Operating cash flow | $9.4 million | $41.9 million | Lower, primarily due to working capital needs |
- Sales growth included $4.7 million from acquisitions and $4.5 million from favorable currency translation. Excluding both, sales increased 7.4%, despite one fewer selling day.
- Service Center Based Distribution sales rose 7.5%; Fluid Power Businesses sales rose 16.9%. Segment operating margins improved to 5.9% and 11.9%, respectively.
- SD&A was 20.7% of sales versus 21.6% a year earlier. Gross margin was down slightly, partly reflecting a 14-basis-point unfavorable LIFO adjustment effect.
- Investing cash use was $11.1 million, including $5.0 million for an acquisition and $6.3 million for property purchases. Financing cash use was $27.3 million, including $13.8 million of share repurchases and $11.3 million of dividends. Cash declined $27.3 million to $77.8 million.
- At September 30, cash was $77.8 million; total borrowings were approximately $291.1 million, versus $292.0 million at June 30. No revolving-credit borrowings were outstanding. The company reported $247.5 million of unused capacity under its $250 million revolver, net of letters of credit, and $50 million available under its shelf facility.
- Working capital was $596.6 million, and the current ratio was 3.1:1, compared with 2.8:1 at June 30. Shareholders’ equity was $773.7 million.
Changes, outlook and other considerations
- Management attributed operating-margin improvement to sales leverage. EPS also benefited from a lower weighted-average share count following repurchases.
- The effective tax rate was 33.1%, versus 34.0% a year earlier, helped by a favorable discrete state tax item. Management expects a full-year FY2018 tax rate of 34.0%–35.0%; no specific sales or earnings guidance is provided in this filing.
- Management expects existing cash, operating cash flow and available borrowing capacity to cover normal working-capital needs, dividends, acquisitions, capital investment and share repurchases. The company was in compliance with debt covenants; indebtedness was less than two times EBITDA, versus a covenant limit of 3.25 times.
- The July 2017 DICOFASA acquisition in Mexico cost $5.9 million and was funded with cash; its results were not material to consolidated results. The company also cited the March 2017 Sentinel acquisition.
- The company early adopted ASU 2017-07, moving certain non-service pension and postretirement costs out of operating expenses into other income. This increased reported operating income for the prior-year quarter by $0.2 million, without changing pretax income, net income or EPS.
- Risks discussed include customer and industrial-market demand, pricing and supplier programs, competition, receivables collectability, acquisitions, foreign currency and international operations, information-system security, and potential goodwill or intangible-asset impairment. Pending product-liability, commercial and other legal proceedings were described as unlikely to have a material adverse effect, based on currently known circumstances.
- The interim financial statements were reviewed by the independent accounting firm, not audited. Management said disclosure controls were effective and reported no materially consequential change in internal control during the quarter.
Important facts for investors to verify
- Whether sales growth and improved segment margins continue, particularly excluding acquisitions and currency effects.
- Whether working-capital investment continues to constrain operating cash flow and how cash conversion develops.
- Whether gross-margin pressure, including LIFO effects, changes in subsequent quarters.
- Whether the expected full-year tax rate remains within the 34.0%–35.0% range.
- Progress on acquisitions, buybacks, dividend payments, debt levels and covenant headroom.
- Potential effects of the new revenue-recognition and lease accounting standards; management’s initial revenue-standard assessment was that a material financial-statement impact was not expected, but was still under evaluation.