Applied Industrial Technologies, Inc. — Q2 FY2012 Form 10-Q
Reporting period: Fiscal quarter and six months ended December 31, 2011; comparisons are with the corresponding 2010 periods. Amounts below are in U.S. dollars unless noted. The interim financial statements were reviewed by Deloitte & Touche, not audited.
Business context and performance
Applied is a North American industrial distributor serving MRO, OEM and government markets, with service-center distribution and fluid-power businesses. It operated 475 facilities in the U.S., Canada, Mexico and Puerto Rico. Management attributed sales growth primarily to improvement in the industrial economy.
Key financial metrics
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $570.4 million, up 7.7% | $1,150.0 million, up 8.8% |
| Gross profit / margin | $155.5 million / 27.3% | $314.2 million / 27.3% |
| Operating income / margin | $33.3 million / 5.8% | $76.6 million / 6.7% |
| Net income | $20.9 million, down 1.2% | $47.3 million, up 12.8% |
| Diluted EPS | $0.49, unchanged | $1.11, versus $0.97 |
| Operating cash flow | Not presented for the quarter | $30.2 million, versus $20.0 million |
- Quarterly sales increased in both segments: Service Center Based Distribution rose 7.5% and Fluid Power Businesses rose 8.4%. Six-month increases were 8.5% and 10.1%, respectively.
- Six-month cash used in investing was $14.3 million, including $14.0 million in property purchases and $1.2 million net acquisition spending. Cash used in financing was $34.3 million, including $19.0 million in share repurchases and $16.1 million in dividends.
- Cash and cash equivalents were $70.5 million at December 31, down $20.6 million from June 30. Working capital was $411.0 million; the current ratio was 3.1:1.
- Total assets were $898.0 million and shareholders’ equity was $646.2 million at December 31. The company reported no outstanding borrowings; $143.1 million was available under its revolving facility after letters of credit.
Material changes and unusual items
- Quarterly operating margin fell to 5.8% from 6.2%, despite a small increase in operating income. SD&A rose 9.8% and to 21.4% of sales, reflecting higher operating costs, ERP expense, a $3.1 million SERP curtailment charge and $1.3 million in one-time CEO-transition costs.
- For the six months, operating margin improved to 6.7% from 6.4%; net income rose 12.8%. Gross margin increased to 27.3% from 27.2%. The prior-year period included LIFO benefits that did not recur.
- Effective December 31, the company froze benefit accruals and new entry into its Supplemental Executive Retirement Benefits Plan. The action reduced the plan liability by $8.9 million and generated a $3.1 million income-statement curtailment charge.
- Foreign-currency transaction losses and investment remeasurement also affected other expense: $0.8 million in the quarter and $2.7 million for six months.
Outlook, liquidity, and risks
- Management said the U.S. industrial economy had settled into moderate growth and expected that pace to continue through fiscal 2012. This is management’s outlook, not quantified sales or earnings guidance.
- Management expected cash, operating cash flow, available credit and operating leases to fund normal working capital, dividends, acquisitions and capital investment. The $150 million revolving facility expires in June 2012, and the company intended to renew it.
- The ERP project was expected to cost $70–$75 million over three to four years, at the upper end of the previously stated range. Fiscal 2012 spending was estimated at $36.0–$40.5 million; Canadian deployments were underway, with U.S. deployments planned for fiscal 2013–2014.
- Risks highlighted include economic and customer-demand changes, pricing and supplier incentives, product availability, ERP execution and internal controls, foreign-exchange exposure, acquisitions, receivable collectability, competition, and potential goodwill or intangible impairment. Management said pending legal proceedings were not expected to have a material adverse effect, based on currently known circumstances.
Important facts for investors to verify
- Whether moderate industrial growth continues and supports sales across both segments and geographies.
- Progress, costs and business benefits of ERP implementation, including the planned rollout and effect on controls.
- Underlying quarterly profitability after the SERP charge, CEO-transition costs and elevated ERP spending.
- Renewal terms and continued availability of the revolving credit facility ahead of its June 2012 expiration.
- Cash conversion and working-capital trends, including the effect of inventory and receivables on operating cash flow.
- Execution of the 1.5 million-share repurchase authorization and the sustainability of dividends and capital spending.