Applied Industrial Technologies, Inc. — Form 10-Q summary
Reporting period: The filing covers the quarter and nine months ended March 31, 2018 (fiscal 2018 Q3), not 2017 Q3 as stated in the request metadata. Amounts below are in millions of dollars unless noted; interim financial statements are unaudited and were reviewed, not audited, by Deloitte & Touche.
Business context and results
Applied is an industrial distributor and service provider operating across North America, Australia, New Zealand, and Singapore. On January 31, 2018, it acquired FCX Performance, a specialty flow-control distributor, for approximately $784.3 million. FCX became part of the Fluid Power & Flow Control segment.
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Net sales | $827.7; +21.8% | $2,175.6; +13.8% |
| Gross profit / margin | $239.5 / 28.9% (28.1% prior year) | $620.3 / 28.5% (28.3% prior year) |
| Operating income / margin | $56.4 / 6.8% (6.7% prior year) | $155.0 / 7.1% (6.6% prior year) |
| Net income | $36.6; +24.1% | $101.3; +25.1% |
| Diluted EPS | $0.93 vs. $0.75 | $2.58 vs. $2.06 |
| Interest expense, net | $8.2 vs. $2.2 | $12.5 vs. $6.4 |
Performance drivers and changes
- Quarterly sales growth included $103.9 million from acquisitions and $5.6 million from favorable currency translation; sales excluding acquisitions and currency grew $38.9 million, or 5.7%. For the nine months, acquisitions added $114.3 million, currency added $14.9 million, and sales excluding both grew $134.1 million, or 7.0%.
- FCX contributed $100.4 million of sales and $6.9 million of operating income from acquisition through quarter-end. Its higher-margin mix lifted gross margin by 56 basis points in the quarter and 22 basis points year to date.
- Quarterly SD&A rose 26.1% and reached 22.1% of sales, versus 21.4% a year earlier, reflecting acquisition costs, FCX amortization, and compensation. Year-to-date SD&A was 21.4% of sales, down from 21.7%.
- Management cited favorable operating leverage as sales increased. The Service Center Based Distribution segment’s operating margin improved to 8.0% in the quarter from 6.3%; Fluid Power & Flow Control was 11.7% in both periods.
Cash flow, balance sheet, and liquidity
- Nine-month operating cash flow was $47.9 million, down from $78.5 million, primarily because higher sales required more working capital. Investing cash outflow was $795.3 million, including $778.1 million for acquisitions. Financing provided $684.9 million, principally through new debt borrowings.
- Cash declined $61.5 million from fiscal year-end to $43.5 million. Capital expenditures were $17.9 million; dividends paid were $34.2 million and treasury-share purchases were $22.8 million.
- Total borrowings were approximately $1,039 million at March 31, 2018, versus $292 million at June 30, 2017. Cash was $43.5 million. The company entered a five-year credit facility with a $780 million term loan and $250 million revolver; $87.5 million was drawn on the revolver and $158.9 million remained available, net of letters of credit. Term-loan and revolver rates were 3.69% and 3.49%, respectively.
- Current assets were $1,051.2 million and current liabilities $370.0 million; working capital was $681.3 million and the current ratio 2.8, unchanged from June 30, 2017. The company reported compliance with debt covenants; indebtedness was below 3.5 times EBITDA against a maximum of 4.25 times.
- Accounts receivable days outstanding increased to 58.0 from 51.6 at June 30, partly because of FCX. Receivables more than 90 days past due were 2.1%, versus 1.7%. Inventory turnover was 3.9, compared with 3.7 at fiscal year-end.
Outlook, risks, and unusual items
- Management expected the fiscal 2018 full-year effective tax rate to be 30%–32%. The Tax Cuts and Jobs Act produced a $4.9 million net tax benefit for the nine months, including an $8.8 million benefit from the lower corporate rate and a $3.9 million provisional transition-tax liability. Tax accounting was not yet complete.
- Management believed cash, operating cash flow, and available credit facilities would be sufficient for normal working capital, dividends, capital investment, and share repurchases. It expected year-end inventory turnover to be similar to or slightly better than 3.9.
- Management noted that industrial production and capacity-utilization indicators had risen and the March PMI remained at 59.3, above the expansion threshold. Results for the first nine months are not necessarily indicative of the remainder of fiscal 2018.
- Key stated risks include customer and industrial demand, pricing and supplier programs, competition, receivable collectability, integration and expected benefits of acquisitions, increased debt and access to financing, foreign exchange, goodwill and intangible impairment, cybersecurity and systems reliance, tariffs and trade policy, and legal or extraordinary events. Pending legal matters were not expected by management to have a material adverse effect, though outcomes cannot be predicted.
- The FCX purchase-price allocation was preliminary and included $421.0 million of goodwill and $305.4 million of identifiable intangibles. The company recorded $5.7 million of FCX-related one-time costs in the quarter; the filing reports $6.1 million for the nine months. FCX’s internal controls were excluded from management’s period-end internal-control evaluation, with oversight and monitoring being extended to its operations.
Important facts for investors to verify
- Whether FCX integration, acquired sales, margins, and expected synergies support the purchase price and substantial goodwill/intangible balances.
- How quickly operating cash flow and working-capital efficiency recover, given lower year-to-date operating cash flow and increased receivable days.
- Debt repayment capacity, variable-rate exposure, available revolver capacity, and covenant headroom after the acquisition.
- The final effects of tax-law accounting and the company’s actual full-year tax rate.
- Whether organic growth and margins persist after separating acquisition, currency, and selling-day effects.