Applied Industrial Technologies, Inc. — Fiscal 2016 Second Quarter 10-Q
Reporting period: Three and six months ended December 31, 2015. The company distributes industrial products and provides engineering, systems integration, and related services to MRO and OEM customers. Its reportable segments are Service Center Based Distribution and Fluid Power Businesses.
Financial results and key metrics
| Metric | Three months ended Dec. 31, 2015 | Six months ended Dec. 31, 2015 |
|---|---|---|
| Net sales | $610.3 million; down 11.8% year over year | $1,252.3 million; down 10.2% |
| Gross profit / margin | $173.2 million / 28.4% (28.3% prior year) | $354.2 million / 28.3% (28.0%) |
| Operating income / margin | $38.4 million / 6.3% (6.8%) | $79.4 million / 6.3% (6.7%) |
| Net income | $23.9 million, down 19.4%; diluted EPS $0.61 versus $0.72 | $48.2 million, down 18.0%; diluted EPS $1.22 versus $1.41 |
| Operating cash flow | $32.9 million for six months, compared with $1.2 million in the prior-year period |
For the six months, cash used in investing was $28.8 million and cash used in financing was $13.4 million. Cash declined $13.8 million to $55.6 million. Capital expenditures were $5.7 million; acquisitions cost $23.3 million net of cash acquired. Dividends paid were $21.4 million and treasury-share purchases were $27.8 million.
At December 31, cash was $55.6 million, working capital $559.5 million, and the current ratio 3.5:1. Total borrowings were approximately $367.0 million, versus $321.0 million at June 30, 2015; shareholders’ equity was $707.6 million. The company had $176.3 million available under its revolving facility, net of letters of credit, and a further $50.0 million available under its Prudential shelf facility.
Material changes versus prior periods
- Sales fell amid weaker industrial activity, with reported declines also affected by unfavorable foreign exchange translation. For the quarter, currency reduced sales by $21.7 million and acquisitions added $12.6 million. Excluding acquisitions and currency, sales declined 10.5%; management attributed 6.7 percentage points to upstream oil and gas-focused businesses and 3.8 points to traditional core operations.
- For the quarter, Service Center Based Distribution sales fell 10.8% and Fluid Power Businesses sales fell 16.1%. Segment operating margins declined to 5.6% from 6.1% and 8.5% from 10.0%, respectively, primarily because lower sales were not matched by equivalent reductions in SD&A.
- Gross margin improved modestly, which management attributed to freight-management improvements and acquisitions. SD&A fell in dollars, helped by cost controls and lower headcount, but increased as a proportion of sales to 22.1% from 21.5% for the quarter.
- EPS declines were partly offset by the lower weighted-average share count following repurchases. The company repurchased 701,100 shares for $27.8 million during the six months; 546,200 shares remained authorized at December 31.
- Foreign currency translation losses were $34.3 million before tax for the six-month period, contributing to accumulated other comprehensive loss and lower reported equity.
Outlook, risks, and unusual items
- Management expects the fiscal 2016 full-year effective tax rate to be 34.4%–34.8%; the six-month rate was 34.8%. It expects operating cash flow to improve through the rest of fiscal 2016 and considers liquidity adequate for normal working capital, dividends, acquisitions, capital investment, and repurchases.
- Management described industrial economic indicators as generally trending lower. It cited weakness in upstream oil and gas markets, Canadian operations, and U.S. and Western Canadian fluid power businesses. Results for the first half are not necessarily indicative of the full fiscal year.
- Energy-market weakness may pressure receivable collections and create impairment risk for goodwill and acquired intangible assets, particularly those related to oil and gas businesses. The six-month provision for doubtful accounts was 0.20% of sales, above the company’s historical 0.10%–0.15% range, including $1.4 million of additional reserves for upstream oil and gas customers.
- In December, the company entered a new five-year unsecured credit facility: a $125 million term loan and a $250 million revolver, expiring in December 2020. Variable rates at period-end were 1.44% on the term loan and a weighted average 1.31% on revolver borrowings.
- Two acquisitions completed during the half had combined consideration of approximately $27 million. After quarter-end, the company acquired HUB Industrial Supply for $33 million, funded with revolver borrowings.
- The company early adopted ASU 2015-17, retrospectively classifying deferred tax assets and liabilities as non-current. It had not determined the impact of the forthcoming revenue-recognition standard. The ongoing SAP/ERP implementation and consolidation-system conversion require continued attention to internal controls; management reported disclosure controls effective.
- Pending product-liability, commercial, and other legal matters were considered unlikely to have a material adverse effect, based on information then available. The interim financial statements were reviewed by Deloitte & Touche, not audited.
Important facts for investors to verify
- Whether sales declines and margin pressure persist, especially in upstream oil and gas, Canadian markets, and fluid power.
- Whether operating cash flow improves as management expects, and whether working-capital and receivables trends remain sound.
- Debt and interest-rate exposure after the new credit facility, HUB acquisition, and other acquisition and repurchase spending.
- Potential impairment exposure for goodwill and acquired intangibles if energy-market weakness continues.
- Execution and control risks from the ongoing SAP/ERP changes, and the eventual effects of new accounting standards.