Applied Industrial Technologies, Inc. — Form 10-Q
Reporting period: Three months ended September 30, 2016, the first quarter of fiscal 2017. The company distributes industrial and fluid-power products and provides related services across North America, Australia and New Zealand. Comparisons below are year over year unless noted. Amounts are in U.S. dollars.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $624.8 million | $641.9 million | Down 2.7% |
| Gross profit / margin | $178.3 million / 28.5% | $181.0 million / 28.2% | Profit down 1.5%; margin up 0.3 points |
| Operating income / margin | $43.2 million / 6.9% | $41.0 million / 6.4% | Up 5.3% |
| Net income | $27.4 million | $24.3 million | Up 12.7% |
| Diluted EPS | $0.70 | $0.61 | Up 14.8% |
| Operating cash flow | $41.9 million | $15.1 million | Up $26.8 million |
| Capital expenditures | $3.0 million | $3.1 million | Down $0.1 million |
Gross-margin improvement reflected approximately 20 basis points from acquisitions and 10 basis points from a LIFO benefit. SD&A was 21.6% of sales, down from 21.8%; excluding acquisitions and favorable currency effects, the company said SD&A fell 6.2%, citing expense controls and lower headcount. A $1.0 million gain on the sale of two buildings also benefited the quarter.
Segment sales: Service Center Based Distribution sales were $515.6 million, down 2.4%; reported operating income was $25.6 million, and segment operating margin fell to 5.0% from 5.7%. Fluid Power Businesses sales were $109.2 million, down 3.7%; reported operating income was $11.8 million, and segment margin rose to 10.8% from 9.1%.
Balance sheet, debt and liquidity
At September 30, 2016, cash was $58.0 million, total assets $1.30 billion, and shareholders’ equity $680.4 million. Total debt was approximately $305.0 million based on reported current and long-term debt balances; management reported borrowings of $305.5 million. Debt declined from approximately $327.8 million at June 30 based on balance-sheet balances (management reported $328.3 million). The current ratio was 2.9 to 1 and working capital was $513.1 million. The company had $236.3 million of unused revolving-credit capacity, net of specified letters of credit, and $50.0 million of additional shelf-facility financing available. It reported compliance with debt covenants; indebtedness was less than two times EBITDA versus a covenant ceiling of 3.25 times.
Cash decreased $1.8 million to $58.0 million. Operating cash flow improved chiefly because of lower working-capital requirements, including lower receivables and inventory associated with lower sales. Investing cash use was $1.3 million, with no acquisition spending in the quarter. Financing cash use was $42.2 million, including $22.8 million of debt repayments, $10.9 million of dividends, $3.0 million of treasury-share purchases and $4.4 million of acquisition holdback payments. Cash dividends were $0.28 per share versus $0.27.
Changes, outlook and risks
- Sales excluding acquisitions and currency effects declined 4.8%. Management attributed 2.8 percentage points of the decline to upstream oil-and-gas-focused subsidiaries and 2.0 points to traditional core operations. Fluid Power organic sales were particularly weak, down 9.0% excluding acquisitions and currency.
- Acquisitions added $15.4 million, or 2.4%, to consolidated sales; unfavorable currency translation reduced sales by $2.2 million, or 0.3%.
- The effective tax rate was 34.0%, versus 35.8%. Management expected a full-year FY2017 tax rate of 34.0%–35.0%. No consolidated sales or earnings guidance was provided in the supplied filing text.
- Management said existing cash, operating cash flow and available borrowing capacity should be sufficient for normal working capital, dividends, acquisitions, investment and share repurchases. It expected inventory turnover for the fiscal year to be similar to or slightly better than the 3.6 annualized rate reported at quarter-end.
- Economic indicators were mixed but generally stable: September manufacturing capacity utilization was 75.4, unchanged from June; the PMI was 51.5, below June’s 53.2 but above the 50 expansion threshold. Management cautioned that customer activity, particularly in energy markets, remains important to results.
- Goodwill was $205.5 million. An interim test of the Canada service-center reporting unit found estimated fair value about $8 million, or 5%, above carrying value. Reliance-related long-lived assets passed an undiscounted-cash-flow recoverability test with an 8% cushion; no impairment was recorded. Management warned that continued adverse markets or forecast shortfalls could lead to future impairment.
- The company early adopted ASU 2016-09 on share-based payments; $143,000 of excess tax benefits reduced income tax expense. Adoption changes also affected cash-flow classification. New revenue, lease and expected-credit-loss standards had not yet been assessed for their full financial-statement impact.
- Pending product-liability, commercial and other legal proceedings were not expected by management to have a material adverse effect, based on information then known. Forward-looking risks include industrial demand, energy-market exposure, pricing and supplier conditions, receivable collectability, acquisitions, foreign currency, systems and cybersecurity, and goodwill impairment.
Important facts for investors to verify
- Whether sales and margins recover in traditional operations and upstream oil-and-gas markets, and whether the reported organic sales contraction persists.
- How much of improved earnings reflects sustainable cost reductions versus the building-sale gain, LIFO benefit, tax items and other quarter-specific factors.
- Cash conversion and working-capital trends, particularly inventory, receivables and the allowance for doubtful accounts.
- Debt levels, variable-rate exposure, covenant headroom and the use of borrowing capacity for acquisitions or repurchases.
- Performance and impairment assumptions for the Canada reporting unit and Reliance asset group amid continued market softness.
- Management’s full-year tax-rate expectation and any subsequent sales, earnings or capital-allocation guidance.