Applied Industrial Technologies, Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and six months ended December 31, 2019 (the second quarter and first half of fiscal 2020); comparisons are with the corresponding 2018 periods. Applied distributes industrial products and provides engineering, systems integration and related services through Service Center Based Distribution and Fluid Power & Flow Control segments.
Key financial metrics
Amounts are in millions of dollars except per-share data, percentages and ratios.
| Metric | Three months ended Dec. 31, 2019 | Six months ended Dec. 31, 2019 |
|---|---|---|
| Net sales | $833.4 | $1,689.8 |
| Gross profit / margin | $241.2 / 28.9% | $492.7 / 29.2% |
| Operating income / margin | $58.7 / 7.0% | $119.9 / 7.1% |
| Net income | $38.0 | $76.8 |
| Diluted EPS | $0.97 | $1.97 |
| Operating cash flow | $104.9 for the six-month period |
For the first half, cash used in investing was $48.0 million, including $36.4 million for acquisitions; cash used in financing was $36.3 million, including $24.0 million of dividends. Cash increased $19.9 million to $128.1 million. Working capital was $721.9 million and the current ratio was 2.7:1.
Total borrowings were approximately $950.0 million, versus $959.8 million at June 30, 2019. The company had $248.2 million of unused revolving-credit availability, net of specified letters of credit, and no revolver borrowings. It was in compliance with its financial covenants; net indebtedness was below 3.0 times covenant-defined EBITDA, against a maximum of 4.0 times.
Material changes versus prior comparable periods
- Second-quarter sales declined 0.8% year over year; excluding acquisitions, they fell 4.0%. Acquisitions contributed $26.5 million, more than offsetting some underlying weakness. First-half sales fell 0.9%; excluding acquisitions and currency, they were down 3.7%.
- Organic sales weakened in both segments: second-quarter Service Center Based Distribution sales excluding acquisitions declined 3.5%, and Fluid Power & Flow Control declined 4.9%. First-half declines were 2.6% and 6.2%, respectively, excluding acquisitions and currency.
- Second-quarter operating income fell 3.6% and net income fell 1.8%. First-half operating income fell 5.8%, net income fell 12.3%, and diluted EPS declined from $2.23 to $1.97. First-half effective tax rate increased to 23.5% from 17.7%, primarily because the prior-year period included a $3.5 million favorable tax adjustment.
- First-half operating cash flow increased to $104.9 million from $65.6 million, which management attributed to working-capital improvements. Receivables-loss provisions rose to $4.7 million from $2.1 million, principally due to customer bankruptcies.
- The company acquired Olympus Controls in August 2019 for $35.8 million, funded with cash. Lease accounting adoption on July 1, 2019 added $83.5 million of right-of-use assets and $89.8 million of lease liabilities, with a $3.3 million after-tax opening retained-earnings adjustment.
Outlook, management commentary and risks
- Management expects a fiscal 2020 full-year tax rate of 24.0%–25.0%. It stated that cash, operating cash flow and available borrowing capacity should be sufficient for expected working capital, dividends, acquisitions, capital spending, debt service and potential share purchases.
- Management described weaker demand across key end markets, slower manufacturing activity, customer spending discipline, slower flow-control demand and weaker industrial OEM activity. December’s ISM PMI was 47.2, below the 50 expansion threshold; industrial production and manufacturing capacity utilization had also declined from earlier 2019 readings.
- Management expected year-end inventory turnover to be similar to or slightly better than the December 31 level of 4.0. This is an expectation, not a quantified earnings or sales forecast.
- First-half severance expense was $1.5 million. The filing also identifies potential goodwill impairment if adverse market conditions, weaker demand or failure to achieve growth initiatives reduce estimated reporting-unit values; the latest cited annual assessment found fair value at least 20% above carrying value for each reporting unit.
- Other risks include customer credit deterioration, supplier or product availability, competition, acquisition integration, foreign exchange, interest rates, tariffs and trade policy, information-system security, and legal proceedings. Management said pending legal matters were not expected to have a material adverse effect, based on currently known circumstances.
Important facts for investors to verify
- Whether underlying demand stabilizes, given organic sales declines and the sub-50 PMI; monitor segment trends separately from acquisition contributions.
- Whether margins and earnings recover, and how much reported performance is affected by cost reductions, acquisition amortization, LIFO expense and tax-rate changes.
- Whether higher receivables-loss provisions persist: the six-month provision was 0.28% of sales versus 0.12% a year earlier, and 3.6% of receivables were more than 90 days past due.
- Debt and liquidity exposure, including variable-rate borrowings, the $175 million receivables securitization borrowing, scheduled note repayments and covenant headroom.
- Acquisition performance and integration, lease obligations, and the assumptions supporting goodwill valuations, particularly for the FCX reporting unit.