Applied Industrial Technologies, Inc. — Form 10-Q Summary
Period clarification: The supplied filing is for the quarter and nine months ended March 31, 2016 (fiscal 2016 Q3), not 2015 Q3. Dollar amounts below are in millions unless noted.
Business context and reporting period
Applied distributes industrial and fluid power products and provides related engineering, systems integration, and service offerings. It operated 563 facilities across the U.S., Canada, Mexico, Puerto Rico, Australia, and New Zealand. Its segments are Service Center Based Distribution, primarily MRO markets, and Fluid Power Businesses, primarily OEM markets.
Financial performance and liquidity
| Metric | Q3 FY2016 | Q3 FY2015 | Nine months FY2016 | Nine months FY2015 |
|---|---|---|---|---|
| Net sales | $633.2 | $680.0 | $1,885.4 | $2,074.0 |
| Gross profit | $174.8 | $187.4 | $529.0 | $578.0 |
| Gross margin | 27.6% | 27.6% | 28.1% | 27.9% |
| Operating income (loss) | ($33.0) | $43.8 | $46.4 | $136.7 |
| Net income (loss) | ($44.7) | $28.6 | $3.5 | $87.4 |
| Diluted EPS | ($1.14) | $0.70 | $0.09 | $2.11 |
- Q3 sales fell 6.9%; excluding acquisitions and currency effects, sales declined 7.4%. Nine-month sales fell 9.1%, or 8.6% excluding acquisitions and currency effects.
- Q3 operating margin was negative 5.2%, including a $64.8 goodwill impairment. Excluding that charge, operating margin was 5.0%, versus 6.4% a year earlier. Q3 net loss also reflected $7.0 of restructuring charges.
- For nine months, operating margin was 2.5%; excluding goodwill impairment, it was 5.9%, versus 6.6% in the prior-year period. Restructuring charges totaled $8.0 over the nine months.
- Nine-month operating cash flow was $90.4, versus $39.3; investing cash flow was negative $65.2, versus negative $177.0; financing cash flow was negative $29.1, versus positive $127.7. Cash decreased $6.5 to $62.9. Management attributed improved operating cash flow mainly to lower working-capital needs as receivables and inventory declined.
- At March 31, cash was $62.9; current assets were $803.8 and current liabilities $252.5. Working capital was $551.4 and the current ratio was 3.2:1. Shareholders’ equity was $656.8, down from $741.3 at June 30, 2015.
- Total borrowings were approximately $371.2, up from $321.0 at June 30, 2015. The company had $171.3 available under its revolving credit facility, net of letters of credit, and $50.0 additional shelf financing available. The new five-year credit facility expires in December 2020.
- Quarterly dividends were $0.28 per share. The company repurchased 951,100 shares for $37.5 during the nine months and had authorization for 296,200 additional shares at March 31.
Material changes versus the prior comparable period
- Weak industrial demand, particularly in upstream oil and gas, contributed to lower sales. Q3 sales excluding acquisitions and currency fell 4.7% in upstream oil and gas-focused operations and 2.7% in traditional core operations. Canadian Q3 sales declined 24.3%, including an 8.3% currency impact.
- Service Center Based Distribution Q3 sales decreased 5.9%; Fluid Power Businesses sales decreased 11.2%. Excluding acquisitions and currency, the respective declines were 5.8% and 14.2%.
- Gross margin held at 27.6% in Q3. For nine months it increased to 28.1% from 27.9%, supported by freight management, lower scrap expense, and acquisitions, partly offset by inventory reserves.
- Goodwill fell to $199.2 from $254.4, primarily because of the $64.8 impairment, partly offset by goodwill from acquisitions and other changes. Debt increased as the company funded acquisitions and share repurchases.
- Cash dividends per share increased to $0.28 from $0.27 for Q3 and to $0.82 from $0.77 for nine months.
Outlook, commentary, risks, and unusual items
- The $64.8 non-cash goodwill impairment related to Canada ($56.0) and Australia/New Zealand ($8.8), reflecting weaker industrial, oil and gas, mining, and extraction markets and lower customer spending and revenue expectations. Management cautioned that further adverse conditions or forecast changes could require additional impairment.
- The quarter included $7.0 of restructuring charges: $3.6 for excess and obsolete inventory reserves and $3.4 for severance and facility consolidation. Management reported efforts to reduce costs and headcount; excluding acquisition effects, headcount was down nearly 400 year over year.
- Management expected operating cash flow to improve during the remainder of fiscal 2016 and said available cash, operating cash flow, and borrowing capacity should fund normal needs, dividends, acquisitions, investment, and potential repurchases. It expected the fiscal Q4 effective tax rate to be 34.3%–34.7%. No specific sales or earnings guidance was provided.
- The nine-month effective tax rate was 90.9%, heavily affected by the largely nondeductible goodwill impairment; the Q3 rate was negative 26.2%. Lower foreign earnings and discrete tax items also affected rates.
- Risks highlighted include customer operating levels and demand, energy-market weakness, receivable collectability, foreign currency and economic conditions, acquisition execution, debt and capital access, potential further impairment, and information-system and internal-control risks. Management said pending legal matters were not expected to have a material adverse effect, based on information then known.
- The independent accountant performed an interim review, not an audit, and reported no material modifications needed for GAAP conformity. Management concluded disclosure controls were effective; ongoing ERP/SAP implementation was identified as a control risk.
Important facts for investors to verify
- Whether demand and sales stabilize in upstream oil and gas, Canada, and Fluid Power markets, and how much future performance reflects underlying volume versus acquisitions and currency.
- Whether the assumptions behind the Canada and Australia/New Zealand goodwill valuations remain reasonable and whether additional impairment is possible.
- Whether restructuring and cost-control actions improve margins as sales remain weak, and whether receivable reserves remain adequate amid energy-sector stress.
- Debt levels, variable-rate exposure, facility availability, and cash needs for acquisitions, buybacks, and dividends.
- Progress and control implications of ERP/SAP implementation, particularly the planned Eastern Canada transition during fiscal 2017–2018.