Applied Industrial Technologies, Inc. — FY2014 Form 10-K
Reporting period: Fiscal year ended June 30, 2014. The filing also reports fourth-quarter results; this is not a calendar-year 2013 filing. Unless noted, financial amounts below are in millions of dollars.
Business context
Applied distributes industrial and fluid-power products and provides related engineering, repair, systems-integration, training, and inventory-management services to MRO and OEM customers. It reports two segments: Service Center-Based Distribution and Fluid Power Businesses. Operations spanned the U.S., Puerto Rico, Canada, Mexico, Australia, and New Zealand, with 538 facilities at year-end. No customer represented more than 3% of sales.
Financial performance and liquidity
| Metric | FY2014 | FY2013 |
|---|---|---|
| Net sales | $2,459.9 | $2,462.2 |
| Gross profit / gross margin | $686.9 / 27.9% | $683.0 / 27.7% |
| Operating income / margin | $164.4 / 6.7% | $176.4 / 7.2% |
| Net income | $112.8 | $118.1 |
| Diluted EPS | $2.67 | $2.78 |
| Cash from operations | $110.1 | $111.4 |
| Capital expenditures | $20.2 | $12.2 |
| Cash and cash equivalents at year-end | $71.2 | $73.2 |
| Total debt at year-end | $170.7 | None outstanding |
| Working capital / current ratio | $545.2 / 2.9 | $491.4 / 3.0 |
Net cash used in investing activities was $203.6 million, including $184.3 million for acquisitions. Financing activities provided $92.1 million, including $169.0 million of borrowings; the company paid $40.4 million in dividends and repurchased $36.7 million of shares. The annual dividend was $0.96 per share, up from $0.88.
Service Center-Based Distribution sales declined 1.5% to $1,973.4 million; Fluid Power Businesses sales increased 6.1% to $486.5 million. Foreign operations generated 17.4% of sales. The effective tax rate was 32.1%, versus 33.5% in FY2013.
In the fourth quarter, sales were $654.6 million versus $640.5 million; operating income was $44.8 million versus $48.0 million; net income was $29.7 million versus $32.3 million; and diluted EPS was $0.71 versus $0.76.
Material changes and notable items
- Consolidated sales were essentially flat year over year. Acquisitions contributed $58.2 million, while currency translation reduced sales by $26.2 million and sales from businesses not acquired in the year declined approximately $34.3 million.
- Gross margin improved 0.2 percentage points, but SD&A rose to 21.2% of sales from 20.6%. Management attributed the lower operating income and margin primarily to acquisition-related expenses and reduced sales at existing businesses without equivalent expense reductions.
- Receivables grew 13.9% while sales decreased 0.1%; days sales outstanding increased to 51.4 from 46.4. Management cited SAP conversion and collection timing, increased the doubtful-account allowance, and expected collection metrics to normalize. Inventory turnover fell to 3.8 from 4.1.
- The company acquired Reliance Industrial Products for approximately $188.5 million in May 2014. On July 1, 2014, it acquired Knox Oil Field Supply for $132.8 million and two other distributors for approximately $12.8 million combined. Knox was funded in part with a $120 million, fixed-rate 3.19% shelf-facility borrowing.
- FY2014 included $1.3 million of income from eliminating Canadian and Mexican reporting lags. A $2.8 million reversal of tax reserves in the third quarter increased EPS by $0.07. There were no LIFO layer liquidations in FY2014; FY2013 benefited from $6.3 million of LIFO liquidations.
- The company continued its multi-year SAP implementation. Most U.S. and Canadian service-center operations were using SAP; remaining Canadian deployments and financial-system implementations were expected to continue into FY2015. Management and the auditor reported effective internal control over financial reporting, although Reliance was excluded from the assessment.
Outlook, risks, and contingencies
Management said it entered FY2015 optimistic about the U.S. industrial economy. It expected an FY2015 tax rate of 34.0%–34.5%, capital expenditures of $14.5–$15.5 million, and depreciation of $17–$18 million. Management stated that cash, operating cash flow, and available credit were expected to support normal working capital, dividends, acquisitions, investment, and share repurchases.
Key risks include cyclical customer demand, competitive pricing, supplier availability and authorizations, foreign-exchange exposure, acquisition integration and financing, receivable collection, commodity and energy costs, and disruption or control risks from SAP implementation. Debt facilities carry restrictive covenants; the company reported compliance at year-end and debt below one times EBITDA against a covenant limit of less than three times. Pending legal proceedings were considered unlikely to have a material adverse effect. The filing reports $83.7 million of operating-lease commitments and $21.9 million of acquisition holdback payments.
Investor verification priorities
- Track organic sales, segment margins, and whether SD&A leverage improves as acquired businesses are integrated.
- Verify that receivable aging, DSO, and the allowance for doubtful accounts normalize after the SAP conversion.
- Assess acquisition performance, integration costs, goodwill and intangible balances, and the added debt used to fund acquisitions.
- Monitor SAP deployment progress, related operating disruptions, and maintenance of effective financial controls.
- Review the quality and sustainability of earnings, including the $2.8 million tax-reserve reversal and reporting-lag income; compare cash from operations with net income.