Business Context and Reporting Period
Company: Applied Industrial Technologies, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2007 (Third Quarter of Fiscal Year 2007)
Business Overview: An industrial distributor offering over two million parts for Maintenance, Repair, and Operations (MRO) and Original Equipment Manufacturing (OEM) customers. Operations span the United States, Canada, and Mexico through approximately 451 facilities.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Mar 31, 2007 |
Three Months Ended Mar 31, 2006 |
Nine Months Ended Mar 31, 2007 |
Nine Months Ended Mar 31, 2006 |
|---|---|---|---|---|
| Net Sales | $521,129 | $497,198 | $1,486,084 | $1,396,583 |
| Gross Profit | $140,572 | $136,815 | $405,857 | $380,516 |
| Gross Margin % | 27.0% | 27.5% | 27.3% | 27.2% |
| Operating Income | $34,105 | $32,085 | $96,411 | $85,101 |
| Net Income | $21,697 | $19,990 | $61,382 | $52,134 |
| Diluted EPS | $0.49 | $0.43 | $1.37 | $1.13 |
| Cash from Operations (9mo) | $31,655 (2007) vs $11,416 (2006) | |||
| Cash & Equivalents | $85,018 (Mar 31, 2007) | |||
| Total Debt | $75,593 ($50.6M Current / $25.0M Long-term) |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 4.8% in the quarter and 6.4% for the nine-month period. Growth was driven by acquisitions completed in the prior fiscal year, supplier price increases, and favorable currency fluctuations (for the nine-month period).
- Profitability: Net income rose 8.5% in the quarter and 17.7% for the nine months. Diluted EPS grew faster (14.0% and 21.2% respectively) due to share repurchases reducing the share count.
- Margins: Gross margin decreased 50 basis points to 27.0% in the quarter due to lower supplier purchasing incentives and less favorable customer pricing. For the nine months, gross margin improved slightly to 27.3%.
- Balance Sheet: Shareholders' equity increased to $431.7 million. The current ratio declined from 3.0 to 2.5, primarily because $50 million of term notes maturing in December 2007 were reclassified as current liabilities.
- Cash Flow: Operating cash flow for the nine months improved significantly to $31.7 million from $11.4 million, aided by higher operating income and lower tax payments. This was partially offset by a change in 401(k) funding methods (cash vs. treasury shares).
Guidance, Outlook, and Risks
- Fiscal 2007 Guidance: Management forecasts full-year sales in the range of $2.01 billion to $2.04 billion. Expected earnings per share are $1.80 to $1.85.
- Outlook: Gross profit for the fourth quarter is expected to range between 26.6% and 27.0%. The effective tax rate for the remainder of the year is projected at 36.0% to 36.5%.
- Liquidity: The company has a $100 million revolving credit facility with $94.7 million available. A $50 million term note matures in December 2007, which management intends to retire with cash.
- Risks: Key risks include economic factors affecting customer operations, consolidation in customer industries, transfer of manufacturing capacity overseas, supplier authorization changes, and foreign currency fluctuations. The company is also evaluating the impact of new accounting standards (FIN 48, SFAS 157, SFAS 158).
- Restatement: The cash flow statement for the nine months ended March 31, 2006, was restated to reclassify excess tax benefits from operating to financing activities.
Investor Verification Checklist
- Debt Maturity: Verify the company's ability to refinance or repay the $50 million term note maturing in December 2007.
- Margin Pressure: Monitor the trend in gross margins, specifically the impact of supplier purchasing incentives and customer pricing power.
- Acquisition Integration: Assess the contribution of acquisitions made in fiscal 2006 to current sales growth and operating income.
- Share Repurchases: Track the impact of the stock buyback program (1.4 million shares repurchased in nine months) on EPS versus cash burn.
- Accounting Changes: Review the eventual impact of adopting FIN 48 (Accounting for Uncertainty in Income Taxes) in fiscal 2008.