Applied Industrial Technologies, Inc. — Q2 FY2015 Form 10-Q
Reporting period: Three and six months ended December 31, 2014. Unaudited interim financial statements; fiscal year ends June 30.
Business context
Applied is an industrial distributor serving MRO and OEM customers, with engineering, systems integration, and related services. It operates through Service Center Based Distribution and Fluid Power Businesses, across 570 facilities in North America, Australia, and New Zealand. Results include acquisitions from their respective closing dates.
Financial performance
| Metric | Q2 FY2015 | Q2 FY2014 | Six months FY2015 | Six months FY2014 |
|---|---|---|---|---|
| Net sales | $691.7m | $581.9m | $1,394.0m | $1,187.3m |
| Gross profit | $195.7m | $163.4m | $390.6m | $333.2m |
| Operating income | $46.8m | $39.8m | $93.0m | $79.4m |
| Net income | $29.7m | $25.9m | $58.8m | $52.8m |
| Diluted EPS | $0.72 | $0.61 | $1.41 | $1.24 |
| Operating margin | 6.8% | 6.8% | 6.7% | 6.7% |
| Gross margin | 28.3% | 28.1% | 28.0% | 28.1% |
Q2 sales increased 18.9%; acquisitions contributed $91.7m (15.8 percentage points), while currency translation reduced sales by $8.1m (1.4 points). Excluding currency, sales from businesses not acquired in the current year grew 4.5%. For the six-month period, sales grew 17.4%; acquisitions contributed $172.2m and currency reduced sales by $11.7m. Net income rose 14.7% in Q2 and 11.5% for six months. Lower average share counts from repurchases also benefited EPS.
Q2 segment sales were $569.5m for Service Center Based Distribution and $122.2m for Fluid Power Businesses. Segment operating margins were 6.1% and 10.0%, respectively; both improved year over year. Acquisitions, especially in service-center distribution, materially contributed to growth.
Cash, balance sheet, and capital
- Operating cash flow: $1.2m for the six months, versus $32.7m a year earlier, primarily due to working-capital investment including large inventory purchases. Management expected cash from operations to improve during the rest of FY2015.
- Investing and financing: Investing cash outflow was $173.3m, including $165.6m for acquisitions. Financing provided $136.8m, including $180.0m of borrowings; cash uses included $21.8m of treasury-share purchases and $20.7m of dividends. Cash declined $38.0m to $33.2m.
- Debt: Total borrowings were $349.4m at December 31, 2014, versus $170.7m at June 30, 2014. This includes $79.0m drawn on the $150m revolving facility, $98.1m on the term loan, and $170.0m under the Prudential shelf facility. Revolver availability, net of letters of credit, was $62.3m; another $50.0m was available under the shelf facility.
- Liquidity: Current assets were $877.8m and current liabilities $271.7m; working capital was $606.1m and the current ratio 3.2:1, compared with 2.9:1 at June 30. Cash was $33.2m. Inventories rose to $401.5m from $335.7m.
- Equity and distributions: Shareholders’ equity was $781.7m, down from $800.3m at June 30. The company paid $0.25 per share in Q2 dividends and repurchased 463,900 shares for $21.9m during the six months; 1,382,500 shares remained authorized for repurchase at quarter-end.
Material changes and unusual items
- Fiscal 2015 acquisitions included Knox Oil Field Supply for $132.0m and several other businesses for combined consideration of approximately $54.5m. The company funded acquisitions with cash and debt; acquired goodwill and intangible values were preliminary. Management cited oil-and-gas market capabilities as a strategic rationale.
- Interest expense increased due to acquisition-related borrowing. Q2 effective tax rate fell to 33.2% from 35.6%; the six-month rate was 33.7% versus 34.7%, reflecting higher Canadian earnings and discrete tax items, including reinstatement of the U.S. R&D tax credit.
- Foreign-currency translation reduced sales and produced a $36.7m six-month other comprehensive loss before tax, contributing to accumulated other comprehensive loss of $38.2m.
- Effective July 1, 2014, the company changed its U.S. inventory-costing methodology in connection with SAP implementation, using weighted average costs to determine current-year LIFO indices and new layers. Retrospective application was deemed impracticable; management stated prior-period effects were immaterial.
Outlook, risks, and contingencies
Management expected a 34.0%–34.5% effective tax rate for the remaining two quarters of FY2015, operating cash flow to improve through the remainder of the year, and year-end inventory turnover to be similar to or slightly better than the December 31 rate. Management said existing cash, operating cash flow, and available borrowing capacity should support normal working capital, dividends, acquisitions, capital investment, and share repurchases. These are expectations, not guarantees; the filing states interim results are not necessarily indicative of full-year results.
Disclosed risks include customer demand and economic conditions, pricing and supplier programs, competition, receivable collectability, foreign-exchange movements, acquisition integration and debt, access to capital, goodwill or intangible impairment, and successful SAP deployment while maintaining effective internal controls. Management reported disclosure controls were effective, while noting ongoing SAP implementation creates risks to internal control over financial reporting. Pending product-liability, commercial, and other legal matters were considered unlikely to have a material adverse effect, based on information then known.
Important facts for investors to verify
- How much future sales and earnings growth depends on acquisitions versus organic demand, and whether acquired businesses meet integration and return expectations.
- Whether working-capital needs—particularly inventory—normalize and operating cash flow improves as management anticipated.
- Debt levels, interest-rate exposure on variable-rate borrowings, and remaining financing capacity as acquisition funding and capital returns continue.
- Progress on SAP deployment, related costs, and maintenance of effective financial reporting controls.
- Effects of currency movements and oil-and-gas market conditions on reported sales, margins, and acquired business performance.