Applied Industrial Technologies, Inc. — Form 10-Q Summary
Business context and reporting period. The filing covers the fiscal second quarter and six months ended December 31, 2013. Applied is an industrial distributor serving MRO and OEM customers, with engineering, systems integration, and related services. It operated 521 facilities across North America, Australia, and New Zealand. Unless stated otherwise, amounts below are in millions.
Financial performance
| Metric | Three months ended Dec. 31, 2013 | Year-over-year change | Six months ended Dec. 31, 2013 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $581.9 | Down 1.3% | $1,187.3 | Down 1.1% |
| Gross profit / margin | $163.4 / 28.1% | Margin up from 27.6% | $333.2 / 28.1% | Margin up from 27.3% |
| Operating income / margin | $39.8 / 6.8% | Down 1.8%; margin was 6.9% | $79.4 / 6.7% | Down 6.5%; margin was 7.1% |
| Net income | $25.9 | Down 4.2% | $52.8 | Down 6.8% |
| Diluted EPS | $0.61 | Prior year $0.64 | $1.24 | Prior year $1.33 |
Quarterly and year-to-date sales declines reflected lower sales from businesses not acquired in the current year and unfavorable currency translation, partly offset by acquisitions. For the quarter, acquisitions added $7.4 million and currency reduced sales by $6.2 million. Gross margin improved, primarily due to higher supplier support at U.S. service centers and relatively higher acquisition margins; higher SD&A as a share of sales weighed on operating margin. The Service Center Based Distribution segment had lower sales and margin, while Fluid Power sales grew and quarterly segment margin improved.
Cash flow, balance sheet, and liquidity
- Six-month operating cash flow was $32.7 million, versus $28.9 million a year earlier. Investing cash outflow was $20.8 million, including $17.0 million for acquisitions and $4.1 million for capital expenditures. Financing cash outflow was $17.2 million, including $19.5 million in dividends and $13.8 million in share repurchases.
- Cash was $66.6 million at December 31, 2013, down $6.6 million from June 30. Cash included $50.1 million in Canada. The company stated that repatriating foreign cash could result in U.S. taxes; it had provided $2.8 million for taxes on approximately $11.0 million of undistributed Canadian earnings.
- Short-term revolving-credit borrowings were $15.0 million, compared with none at June 30, 2013. The $150 million committed facility had $126.4 million available, net of letters of credit. No borrowings were outstanding under the separate $125 million shelf facility.
- Working capital was $499.6 million, up from $491.4 million; the current ratio remained 3.0 to 1. Total liabilities were $300.7 million and shareholders’ equity was $773.5 million.
- Inventory was $323.3 million, up from $281.4 million at June 30. Annualized inventory turnover was 3.7 versus 4.1 at fiscal year-end; management said inventory had been temporarily increased to help avoid customer-service disruptions during ERP deployment.
Material changes, outlook, and risks
- Management expected the full-year effective tax rate to be 34.0%–34.5%; the six-month rate was 34.7%. The filing provides no specific sales or earnings guidance.
- The company acquired substantially all net assets of Texas Oilpatch Services Corporation in December 2013. The acquisition was included in the Service Center Based Distribution segment; its results were not material for the periods presented.
- Effective July 1, 2013, Applied eliminated the one-month reporting lag for its Canadian subsidiary. The change was deemed preferable and immaterial overall, but $1.2 million of June 2013 income was included in the six-month 2014 results. Management said six-month 2013 net income would have been $1.2 million lower under retrospective adjustment.
- ERP (SAP) deployment continued in U.S. and Canadian operations. Management expected U.S. deployments to be completed in fiscal 2014, with location implementation continuing through fiscal 2014 and into fiscal 2015. The filing identifies implementation disruption and maintaining adequate internal controls as risks; management said disclosure controls were effective.
- Management cited customer activity and economic conditions, supplier programs and product availability, competition, receivable collectability, foreign exchange, acquisitions, and ERP execution among the risks that could affect results. Legal proceedings were pending, but the company considered a material adverse effect remote based on currently known circumstances.
- Other notable items: unfavorable foreign-currency translation reduced quarterly and year-to-date sales; six-month results included $1.2 million of income from eliminating the Canadian reporting lag. Foreign currency translation also reduced six-month comprehensive income, which was $46.1 million versus $65.3 million a year earlier.
Important facts for investors to verify
- Whether underlying demand and sales in the core Service Center Based Distribution business recover, and how much reported growth depends on acquisitions, currency, or selling-day differences.
- Whether improved gross margin can offset higher SD&A and restore operating margins, particularly in the Service Center Based Distribution segment.
- Whether ERP deployment proceeds on schedule without customer-service disruption or material internal-control issues; monitor the elevated inventory and receivables measures.
- How foreign-cash deployment, currency movements, and the $15 million revolving borrowing affect liquidity and future financing needs.
- The tax-rate outlook and the treatment of the Canadian reporting-lag change when comparing periods. Interim financial statements were reviewed by Deloitte, not audited.