Applied Industrial Technologies, Inc. — Form 10-Q Summary
Period clarification: The supplied filing is for the quarter ended March 31, 2017 (fiscal 2017 third quarter), not 2016 Q3. Figures below are in millions of dollars unless stated otherwise. Interim financial statements are unaudited; the independent accountant performed a review, not an audit.
Business context and reporting period
Applied distributes industrial and fluid power products and provides related engineering and service solutions. It operated 560 facilities across North America, Australia, and New Zealand. Its reportable segments are Service Center Based Distribution, primarily serving MRO markets, and Fluid Power Businesses, primarily serving OEM markets.
Key financial metrics
| Metric | Three months ended Mar. 31, 2017 | Three months ended Mar. 31, 2016 | Nine months ended Mar. 31, 2017 | Nine months ended Mar. 31, 2016 |
|---|---|---|---|---|
| Net sales | $679.3 | $633.2 | $1,912.3 | $1,885.4 |
| Gross profit | $190.8 | $174.8 | $541.6 | $529.0 |
| Operating income (loss) | $45.5 | $(33.0) | $126.3 | $46.4 |
| Net income (loss) | $29.5 | $(44.7) | $81.0 | $3.5 |
| Diluted EPS | $0.75 | $(1.14) | $2.06 | $0.09 |
- Quarterly gross margin was 28.1%, versus 27.6%; operating margin was 6.7%, versus negative 5.2%. Year-to-date gross margin was 28.3%, versus 28.1%, and operating margin was 6.6%, versus 2.5%.
- Quarterly sales rose 7.3%; management attributed 0.4 percentage points to acquisitions and 0.1 points to currency, with comparable sales excluding acquisitions and currency up 6.8%. Nine-month sales rose 1.4%, including a 1.4-point acquisition contribution and a 0.3-point currency drag.
- Quarterly segment sales were $554.9 for Service Center Based Distribution and $124.4 for Fluid Power Businesses. Nine-month segment sales were $1,569.2 and $343.1, respectively.
- Nine-month operating cash flow was $78.5, down from $91.3. Investing used $11.8, versus $65.2; financing used $58.8, versus $30.0. Cash increased $7.5 to $67.3.
- At March 31, cash was $67.3; working capital was $565.5 and the current ratio was 3.1:1. Total borrowings were approximately $321.8, compared with $328.3 at June 30, 2016. The company had $218.3 of unused capacity under its revolving facility, net of specified letters of credit, and $50.0 available under its shelf facility.
- Dividends paid in the first nine months were $33.2; treasury-share purchases were $8.2. The quarterly dividend per share was $0.29, versus $0.28.
Material changes versus comparable periods
- Reported earnings improved substantially, but comparisons are significantly affected by the prior-year $64.8 non-cash goodwill impairment and $8.0 of restructuring charges in the nine-month period (including $7.0 in the prior-year third quarter). These charges did not recur in fiscal 2017.
- Third-quarter comparable sales growth was broad-based: traditional core operations increased 4.3%, and upstream oil and gas-focused subsidiaries increased 51.1% year over year. For the first nine months, comparable sales excluding acquisitions and currency were up 0.3%; Service Center Based Distribution was down 0.7% on that basis while Fluid Power increased 5.3%.
- Quarterly gross margin benefited from the absence of $3.6 of prior-year inventory-reserve restructuring expense. Nine-month SD&A declined 0.6% despite acquisition-related expense; management cited cost controls, lower headcount excluding acquisitions, lower bad-debt expense, and a $1.6 gain on sales of five buildings.
- Operating cash flow fell as receivables and inventory rose with sales. Receivables increased 12.4% from June 30, 2016, while nine-month sales increased 1.4%; days sales outstanding rose to 51.8 from 49.4.
Outlook, risks, contingencies, and unusual items
- Management expected the fiscal 2017 effective tax rate to be 33%–34%, partly reflecting $2.0 of year-to-date excess tax benefits from share-based awards. No full-year sales or earnings guidance is stated in the supplied filing.
- Management expected existing cash, operating cash flow, and available borrowing capacity to fund normal working capital, dividends, acquisitions, capital spending, and share repurchases. It expected year-end inventory turnover to be similar to or slightly better than the March 31 rate of 3.7.
- Management noted that U.S. industrial production and capacity-utilization indices had been slowly increasing; the March 2017 PMI was 57.2, above the expansion threshold of 50. Results remain exposed to customer activity and economic conditions, pricing and costs, supplier relationships, competition, receivable collection, foreign exchange, acquisitions, and goodwill or intangible impairment.
- Reliance-related long-lived intangibles were tested amid continued softness in upstream oil and gas. The company recorded no impairment; the Canadian asset group had a narrower disclosed cushion than the U.S. group. Goodwill impairment depends on estimates and could arise if conditions or forecasts deteriorate.
- The company acquired Sentinel Fluid Controls on March 3, 2017, for a purchase price of $3.8; the acquisition was described as immaterial. Management reported covenant compliance, with indebtedness below two times EBITDA against a covenant limit of 3.25 times.
- Pending product-liability, commercial, and other legal matters were disclosed; management considered a material adverse effect on financial position, results, or cash flows remote. Foreign earnings were considered permanently reinvested; repatriation could result in U.S. tax, partly offset potentially by foreign tax credits.
Most important facts for investors to verify
- Confirm the intended reporting period: this filing covers fiscal 2017 Q3, not 2016 Q3.
- Separate underlying operating improvement from the prior-year impairment and restructuring comparison when assessing earnings growth.
- Track whether receivables and inventory growth converts to cash, including DSO and the disclosed expectation for receivable aging.
- Monitor upstream oil and gas demand and the assumptions supporting goodwill and intangible-asset valuations, particularly for Reliance-related assets.
- Verify the 33%–34% fiscal-year tax-rate outlook and the effect of share-based compensation tax benefits.
- Review debt maturities, variable-rate exposure, covenant headroom, foreign cash balances, and the company’s capital-allocation plans.