Applied Industrial Technologies, Inc. — Form 10-Q summary
Period: The filing covers the third quarter and first nine months of fiscal 2014, ended March 31, 2014. The request metadata says “2013 Q3,” but that does not match the filing period. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless otherwise noted.
Business context and financial performance
Applied distributes industrial products to maintenance, repair and operations (MRO) and original equipment manufacturer (OEM) customers, and provides engineering, systems integration and related services. It reports Service Center Based Distribution and Fluid Power Businesses segments.
| Metric | Quarter ended March 31, 2014 | Nine months ended March 31, 2014 |
|---|---|---|
| Net sales | $618.0 million; down 0.6% | $1,805.3 million; down 0.9% |
| Gross profit / margin | $171.2 million / 27.7% | $504.4 million / 27.9% |
| Operating income / margin | $40.2 million / 6.5% | $119.5 million / 6.6% |
| Net income | $30.4 million; up 3.7% | $83.1 million; down 3.2% |
| Diluted EPS | $0.72, versus $0.69 | $1.96, versus $2.02 |
| Operating cash flow | Not separately reported for the quarter | $44.3 million, versus $69.1 million |
Quarterly sales included a $3.4 million acquisition contribution and a $9.9 million adverse foreign-exchange impact. Service Center Based Distribution sales declined 2.8%, while Fluid Power sales increased 9.1%. For the nine-month period, Service Center sales fell 2.3% and Fluid Power sales rose 5.3%.
Margins, balance sheet, cash flow and liquidity
Quarterly gross margin declined from 28.1% to 27.7%, primarily due to lower margins in non-U.S. Service Center businesses. Operating margin fell from 7.0% to 6.5%. Nine-month gross margin improved from 27.5% to 27.9%, but higher selling, distribution and administrative expense as a share of sales (21.3%, versus 20.5%) contributed to lower operating margin.
At March 31, 2014, cash was $69.1 million, current assets were $774.5 million and current liabilities were $268.2 million; the current ratio was 2.9, compared with 3.0 at June 30, 2013. Working capital was $506.3 million. Total liabilities were $315.6 million and shareholders’ equity was $781.1 million. Debt included $30.0 million drawn on the revolving credit facility; $111.3 million of facility capacity remained available after letters of credit. The filing reports no borrowings under its separate $125 million uncommitted shelf facility.
Nine-month operating cash flow was $44.3 million, down from $69.1 million, primarily due to lower net income and increased working-capital needs. Investing cash use was $23.1 million, including $17.0 million for acquisitions and $6.5 million for property purchases. Financing cash use was $23.2 million, including $24.0 million of share repurchases and $30.0 million of revolving-credit borrowings; dividends paid were $30.0 million. Cash declined $4.1 million to $69.1 million. Inventory rose to $320.0 million from $281.4 million at June 30, 2013; management said it temporarily increased U.S. Service Center inventory to avoid customer-service disruptions during ERP conversion.
Material changes, outlook and risks
- Quarterly net income increased despite lower operating income, mainly because the effective tax rate fell to 25.1% from 34.0%. The quarter included a $2.8 million reversal of a Canadian deferred tax liability and a $1.1 million reversal of U.S. tax reserves. Excluding those items, the quarter’s effective tax rate would have been 34.7%.
- Management expected a 34.5%–35.0% tax rate for fiscal Q4 and a 32.0%–32.5% rate for fiscal 2014 overall. It did not provide specific sales or earnings guidance.
- The SAP ERP rollout was expected to continue through fiscal Q4 and into fiscal 2015. Management identified implementation disruption and maintaining adequate internal controls as risks. Receivables days sales outstanding increased to 50.1 from 46.4 at June 30, 2013; management attributed the increase primarily to collection timing related to ERP conversion.
- On May 1, 2014, after quarter-end, the company acquired Reliance Industrial Products for $189.8 million. Funding included $31.9 million of Canadian cash, $36.6 million from revolving facilities and a new $100 million five-year term loan; the remainder was payable to sellers over several years. Reliance’s results were to be included from May 1.
- Management expected to purchase its headquarters facility for approximately $12.5 million in fiscal Q4. The filing identifies risks including economic and customer demand conditions, pricing and supplier programs, foreign currency, receivables collection, acquisitions and ERP execution. Pending legal proceedings were not expected by management to have a material adverse effect, although outcomes cannot be predicted.
Important facts for investors to verify
- Confirm the reporting-period mismatch in the request metadata: this is a quarter ended March 31, 2014, not a 2013 Q3 filing.
- Assess whether the lower quarterly operating margin and weaker Service Center performance persist, and whether Fluid Power growth continues.
- Monitor working capital, receivables collection and inventory levels as ERP deployment proceeds.
- Review the financing, integration and expected contribution of the $189.8 million Reliance acquisition, including the new term loan and deferred seller payments.
- Separate underlying earnings and tax performance from the one-time tax-reserve and deferred-tax reversals. The interim financial statements were reviewed, not audited; the auditor stated it was not aware of material modifications needed for GAAP conformity.