Applied Industrial Technologies, Inc. — Q1 FY2015 Form 10-Q
Reporting period: Three months ended September 30, 2014; comparison is the three months ended September 30, 2013, except balance-sheet comparisons, which are to June 30, 2014. Applied distributes industrial and fluid-power products and provides related services. The interim financial statements were reviewed by Deloitte & Touche, not audited.
Financial performance
| Metric | Q1 FY2015 | Prior-year quarter / change |
|---|---|---|
| Net sales | $702.3 million | $605.3 million; up 16.0% |
| Gross profit / margin | $194.9 million / 27.8% | $169.8 million / 28.1% |
| Operating income / margin | $46.2 million / 6.6% | $39.5 million / 6.5% |
| Net income | $29.1 million | $26.8 million; up 8.5% |
| Diluted earnings per share | $0.70 | $0.63 |
| Operating cash flow | -$18.1 million | +$17.0 million |
| Cash and cash equivalents | $52.0 million | $71.2 million at June 30, 2014 |
| Total borrowings | $324.3 million | $170.7 million at June 30, 2014 |
| Working capital / current ratio | $602.8 million / 3.2:1 | $545.2 million / 2.9:1 at June 30, 2014 |
Sales growth included $80.5 million from acquisitions (13.3 percentage points); businesses not acquired in the current year grew 3.2%, while unfavorable currency translation reduced sales by $3.3 million. Gross margin declined due to timing of volume-based supplier support and higher scrap and obsolescence expense, partly offset by stronger acquired-business margins. SD&A fell to 21.2% of sales from 21.5%. Interest expense rose to $1.7 million, primarily due to acquisition financing. The effective tax rate was 34.2%, versus 33.8%.
Cash, debt, acquisitions and other changes
- Operating cash use reflected a $58.9 million working-capital outflow. Investing cash use was $132.9 million, including $129.8 million for acquisitions. Financing provided $133.3 million, including $154.2 million of borrowings; the company also spent $10.4 million on share repurchases and paid $10.4 million in dividends.
- Acquisitions completed July 1 included Knox Oil Field Supply for $132.0 million and businesses in Mexico and Australia for approximately $12.6 million combined. Knox expands the company’s upstream oil-and-gas distribution business. Acquisition-related goodwill and identifiable intangibles increased materially; preliminary fair-value allocations remain subject to adjustment.
- Debt included $103.0 million drawn on the $150 million revolving facility, $98.8 million under a variable-rate term loan, and $120.0 million of fixed-rate Series C notes at 3.19%. Revolver availability, net of letters of credit, was $38.1 million.
- Comprehensive income was $10.0 million, substantially below net income because of a $19.1 million foreign-currency translation loss. This reduced accumulated other comprehensive income to -$20.7 million.
- Effective July 1, 2014, Applied changed its U.S. LIFO inventory-costing methodology to use weighted-average cost for current-year LIFO indices and new layers. Retrospective application was considered impracticable because prior data were unavailable; management says the historical effects would be immaterial.
Outlook, risks and subsequent events
Management expects the full-year FY2015 tax rate to be 34.0%–34.5% and expects operating cash flow to improve during the year as receivables collection, inventory turns and payable timing improve. It expects year-end inventory turnover to be similar to or slightly better than the September-quarter rate of 3.8. The company stated that cash, operating cash flow and available financing should support normal working capital, dividends, acquisitions, capital spending and repurchases. No specific revenue or earnings guidance was provided.
Key disclosed risks include customer and industrial demand, supplier incentives and product availability, pricing and cost pressures, receivable collectability, foreign currency and international operations, acquisition integration and debt, goodwill or intangible impairment, and successful ERP implementation. Management identified ongoing SAP implementation as a risk to maintaining adequate internal controls; it reported disclosure controls effective and no other material control changes during the quarter. Pending legal proceedings were not expected by management to have a material adverse effect.
After quarter-end, Applied acquired Ira Pump and Supply on November 3, 2014. On October 30, it issued $50 million of Series D notes at 3.21% to fund the acquisition and working-capital needs; the notes mature in 2023. The board also authorized up to 1.5 million additional share repurchases on October 27.
Most important facts for investors to verify
- How much future growth and profitability depend on acquisitions versus underlying sales growth, and whether preliminary acquisition valuations and expected benefits hold up.
- Whether working-capital cash use reverses as management expects, and whether liquidity remains adequate given higher debt and limited remaining revolver availability.
- Whether gross margins recover from supplier-support timing and elevated scrap and obsolescence costs.
- How currency movements affect reported results and equity, and whether the new inventory-costing methodology has any material ongoing effect.
- Whether ERP deployment and financial-system changes proceed without business disruption or weakening internal controls.