Applied Industrial Technologies, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended December 31, 2017 (fiscal 2018 second quarter). Amounts below are in U.S. dollars; financial-statement figures are rounded to millions unless stated otherwise. The interim financial statements were reviewed, not audited.
Business context and results
Applied distributes industrial and fluid-power products and provides related engineering, systems-integration, and inventory-management services. It reported two segments: Service Center Based Distribution, primarily MRO, and Fluid Power Businesses, primarily OEM. The company operated 552 facilities across North America, Australia, New Zealand, and Singapore.
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $667.2 million, up 9.7% | $1,347.9 million, up 9.3% |
| Gross profit / margin | $188.4 million / 28.2% (28.4% prior year) | $380.8 million / 28.3% (28.5% prior year) |
| Operating income / margin | $46.7 million / 7.0% (6.2% prior year) | $98.6 million / 7.3% (6.6% prior year) |
| Net income | $31.0 million, up 28.5% | $64.7 million, up 25.7% |
| Diluted EPS | $0.79 (prior year $0.61) | $1.65 (prior year $1.31) |
| Cash dividends per share | $0.29 (prior year $0.28) | $0.58 (prior year $0.56) |
Cash flow, liquidity, and debt
- Six-month operating cash flow was $21.2 million, down from $45.7 million a year earlier. Management attributed the reduction mainly to higher working-capital needs as sales increased.
- Investing cash outflow was $15.9 million, including $11.5 million of property purchases and $5.0 million for an acquisition. Financing cash outflow was $25.6 million; it included $22.8 million of share repurchases and $22.6 million of dividends, partly offset by $23.0 million of revolving-credit borrowings.
- Cash was $85.3 million at December 31, 2017, versus $105.1 million at June 30, 2017. Working capital was $631.9 million; the current ratio was 3.3:1, compared with 2.8:1 at June 30.
- Outstanding borrowings totaled $313.3 million, up from $292.0 million at June 30. The company had $224.5 million available under its revolving facility, net of specified letters of credit, and $50.0 million of additional shelf financing available. It reported compliance with debt covenants.
Material changes and management commentary
- Quarterly sales excluding acquisitions and currency effects increased 8.0%; six-month comparable sales increased 7.8%, despite one fewer selling day in the six-month period. Growth was broad-based, with particularly strong Fluid Power sales: up 19.0% in the quarter and 17.9% for six months, including acquisition contributions.
- Operating margins improved in both segments. Management cited positive operating leverage from sales growth. Gross margin nevertheless declined year over year, with LIFO accounting effects unfavorable by 28 basis points in the quarter and 21 basis points for six months.
- The Tax Cuts and Jobs Act produced a $2.0 million net tax benefit for the six-month period: a $5.9 million benefit from remeasuring for the lower corporate tax rate was partly offset by a $3.9 million provisional transition-tax expense. The company said its accounting for certain tax effects remained incomplete.
- The company early adopted an accounting update that reclassified certain pension and postretirement costs outside operating income; management said it did not affect pretax income, net income, or EPS.
- Management expects a 31.0%–32.0% effective tax rate for fiscal 2018 and expects year-end inventory turnover to be similar to or slightly better than the December level. The filing provides no clear full-year sales or earnings guidance.
Outlook, risks, and unusual items
- After quarter-end, Applied agreed to acquire FCX Performance for approximately $768 million, with closing anticipated January 31, 2018. The planned financing included a $780 million term loan and a $250 million revolver. The proposed transaction would substantially increase leverage and could constrain cash available for dividends, repurchases, other acquisitions, and investment.
- The company identified acquisition-closing, integration, synergy-realization, management-distraction, and potential debt-service risks. Other disclosed risks include industrial demand and customer activity, pricing and supplier programs, receivable collectability, foreign exchange, cybersecurity, and potential goodwill or intangible-asset impairment.
- Accounts receivable days sales outstanding rose to 53.1 from 51.6 at June 30. Receivables more than 90 days past due increased to 3.0% from 1.7%; management considered overall aging and reserves reasonable.
- Management said pending product-liability, commercial, and other legal proceedings were not expected to have a material adverse effect, based on information then available.
Important facts for investors to verify
- Whether the FCX acquisition closed on the anticipated terms and how its financing affected debt, interest expense, covenant headroom, and liquidity.
- Whether operating cash flow improves as working-capital investment normalizes, and whether receivable aging and DSO stabilize.
- Whether segment sales and operating margins sustain their gains, and how LIFO costs, compensation, and acquisition expenses affect profitability.
- Final tax accounting under the Tax Cuts and Jobs Act, including the provisional transition-tax and deferred-tax estimates.
- Progress on integrating FCX and realizing expected growth and cost benefits; the filing gives no quantified synergy target.