Applied Industrial Technologies, Inc. — Q2 FY2013 Form 10-Q
Reporting period: Three and six months ended December 31, 2012. Financial amounts below are in U.S. dollars; figures are converted from thousands to millions where appropriate. The interim statements are unaudited and were reviewed by Deloitte & Touche.
Business context and results
Applied distributes industrial products and provides related services to maintenance, repair and operations (MRO), original equipment manufacturer (OEM), and government markets. It reported two segments: Service Center Based Distribution and Fluid Power Businesses. In the quarter, it operated 524 facilities across the United States, Canada, Mexico, Puerto Rico, Australia and New Zealand.
| Metric | Three months ended Dec. 31, 2012 | Change vs. prior year | Six months ended Dec. 31, 2012 | Change vs. prior year |
|---|---|---|---|---|
| Net sales | $589.5 million | +3.4% | $1,200.0 million | +4.4% |
| Gross profit | $162.9 million | +4.8% | $327.5 million | +4.2% |
| Operating income | $40.6 million | +21.7% | $84.9 million | +10.8% |
| Net income | $27.0 million | +29.2% | $56.6 million | +19.6% |
| Diluted earnings per share | $0.64 | Prior year: $0.49 | $1.33 | Prior year: $1.11 |
Margins, cash flow and financial position
- Quarterly gross margin was 27.6%, versus 27.3% a year earlier; operating margin was 6.9%, versus 5.8%. For the six-month period, gross margin was 27.3% in both years, while operating margin improved to 7.1% from 6.7%.
- Quarterly sales growth included $25.3 million from acquisitions and $2.5 million from favorable currency translation; sales in businesses not acquired during the year declined slightly. For six months, acquisitions contributed $44.8 million, while currency translation reduced sales by $2.8 million.
- Six-month operating cash flow was $28.9 million, compared with $30.2 million. Investing cash outflow was $72.5 million, including $66.1 million for acquisitions and $6.8 million for property purchases. Financing provided $15.4 million, including $33.0 million of revolving-credit borrowings and $17.7 million of dividends paid.
- Cash declined by $26.6 million from June 30 to $51.8 million. At December 31, short-term debt was $33.0 million; the company reported $107.8 million of unused capacity on its $150 million revolving facility, net of letters of credit. A separate long-term financing shelf had no borrowings; it was extended and increased in February 2013.
- Working capital was $442.5 million, versus $435.6 million at June 30; the current ratio was 2.7, versus 2.9. Total liabilities were $315.5 million and shareholders’ equity was $722.1 million.
Material changes and management commentary
- The company acquired four distributors during the six months, including SKF’s company-owned distribution business in Australia and New Zealand. Acquisition results were not material individually for the periods presented. Goodwill increased to $105.0 million from $83.1 million, and net intangible assets rose to $100.9 million from $84.8 million; purchase-price allocations remained preliminary.
- Service Center Based Distribution sales rose 4.8% for the quarter and 6.1% for six months, primarily due to acquisitions. Fluid Power Businesses sales declined 2.7% in both comparisons, reflecting weakness in several businesses; its segment operating margin also fell.
- Management attributed improved consolidated operating margin mainly to sales growth without a comparable increase in selling, distribution and administrative expense (SD&A), including lower SD&A as a share of sales. Higher supplier support and acquisition mix also supported quarterly gross margin.
- Prior-year SD&A included approximately $4.4 million for the quarter and $4.5 million for six months in nonrecurring expenses, mainly a pension-plan curtailment and CEO-transition costs. The current six-month period also benefited from other income, including foreign-currency transaction gains and gains on deferred-compensation trust investments.
- Management expected a full-year effective tax rate of 34.0%–34.5%, and expected inventory turnover to improve through fiscal year-end, though not to fiscal 2012 levels. Management believed available cash, operating cash flow and credit capacity would fund ordinary needs, dividends, acquisitions and planned investment.
Risks, contingencies and other items
- The multi-year SAP ERP rollout was continuing, with deployments planned through calendar 2013. Management identified implementation and maintaining adequate internal controls during the transition as risks; disclosure controls were assessed as effective at quarter-end.
- Management cited risks including customer activity and economic conditions, supplier programs and product availability, competitive pressures, receivable collectability, acquisition integration, foreign-currency exposure, goodwill or intangible impairment, and access to capital.
- The company was party to product-liability, commercial and other legal proceedings. It said the likelihood of a material adverse effect from their resolution was remote based on currently known circumstances, while noting outcomes and possible loss ranges could not be predicted.
Important facts for investors to verify
- How much of future growth and margin performance comes from acquired businesses versus underlying demand, particularly in Fluid Power and the Canadian and other international operations.
- Whether operating cash generation improves as working-capital investment and inventory turnover evolve; inventory turns were 4.1 versus 4.6 at June 30, and DSO rose to 46.5 from 45.2.
- Integration costs, final purchase-price allocations, and the performance of the four acquisitions, alongside the increase in goodwill and intangible assets.
- Progress and costs of the SAP rollout, including whether internal controls remain effective as deployments continue.
- Availability and use of revolving-credit capacity, the February 2013 shelf-facility amendment, and the sustainability of dividends and acquisition spending.