Applied Industrial Technologies, Inc. — Form 10-Q Summary
Reporting period: The filing is for the quarter ended March 31, 2015, the third quarter of fiscal 2015, and compares the three- and nine-month periods with the same periods in 2014. This differs from the request metadata’s “2014 Q3.” Dollar amounts below are in millions unless stated otherwise. The interim financial statements were reviewed, not audited.
Business context
Applied is an industrial distributor and provider of engineering, design, integration, and shop services for MRO and OEM customers. It reported two segments: Service Center Based Distribution and Fluid Power Businesses, operating across 571 facilities in the United States, Canada, Mexico, Puerto Rico, Australia, and New Zealand.
Financial results
| Metric | Quarter ended March 31, 2015 | Quarter ended March 31, 2014 | Nine months ended March 31, 2015 | Nine months ended March 31, 2014 |
|---|---|---|---|---|
| Net sales | $680.0 | $618.0 | $2,074.0 | $1,805.3 |
| Gross profit | $187.4 | $171.2 | $578.0 | $504.4 |
| Operating income | $43.8 | $40.2 | $136.7 | $119.5 |
| Net income | $28.6 | $30.4 | $87.4 | $83.1 |
| Diluted EPS | $0.70 | $0.72 | $2.11 | $1.96 |
| Gross margin | 27.6% | 27.7% | 27.9% | 27.9% |
| Operating margin | 6.4% | 6.5% | 6.6% | 6.6% |
- Cash flow, nine months: Operating cash flow was $39.3, down from $44.3. Investing used $177.0, including $166.5 for acquisitions. Financing provided $127.7, principally reflecting borrowings, partly offset by $59.2 of share repurchases and $31.8 of dividends. Cash declined $16.0 to $55.2.
- Balance sheet and liquidity: At March 31, cash was $55.2, working capital was $617.0, and the current ratio was 3.3:1. Total debt was approximately $389.7, versus $170.7 at June 30, 2014; shareholders’ equity was $736.3, down from $800.3. The revolving facility had $23.0 of unused capacity net of letters of credit, and the Prudential shelf facility had $50.0 of additional availability.
- Capital returns: The company paid dividends of $0.27 per share in the quarter and repurchased 870,200 shares under its authorization for $37.3. At quarter-end, authorization remained for 512,300 shares.
Material changes and drivers
- Quarterly sales grew 10.0%; acquisitions added $65.4 (10.6 percentage points), while foreign currency translation reduced sales by $11.9 (1.9 points). Excluding currency, sales from businesses not acquired in the current year rose 1.3%.
- For the nine months, sales grew 14.9%; acquisitions added $237.6 (13.2 points), and currency reduced sales by $24.2 (1.3 points). Excluding currency, sales from businesses not acquired in the current year rose 3.0%.
- Growth was concentrated in Service Center Based Distribution. In the quarter, its sales increased 13.1%, while Fluid Power sales declined 1.9%, including weakness in western Canadian operations. Nine-month sales increased in both segments.
- Quarterly net income fell 5.9% despite higher sales and operating income. Management attributed the decline mainly to acquisition-related interest expense and the absence of prior-year tax-benefit reversals. Nine-month net income rose 5.2%; lower weighted-average shares from repurchases also supported EPS growth.
- Acquisitions included Knox Oil Field Supply, acquired for $132.5, and other businesses with combined consideration of approximately $54.9. These expanded oilfield and distribution operations and were funded with cash and debt. Acquisition-related amortization and expenses increased.
- Foreign-currency translation produced a $62.6 after-tax comprehensive loss for the nine months, primarily reflected in accumulated other comprehensive loss; this is separate from net income.
Outlook, risks, and notable items
- Management expected operating cash flow to improve during the remainder of fiscal 2015 and stated that cash, operating cash flow, and available borrowing capacity should cover normal working capital, dividends, acquisitions, capital investment, and repurchases.
- Management forecast a fourth-quarter fiscal 2015 effective tax rate of 33.8%–34.3% and a full-year rate of 33.5%–34.0%. These are tax-rate expectations, not earnings or revenue guidance.
- Management cited weaker industrial production and lower manufacturing capacity utilization in the March quarter, while the March PMI remained above 50. Performance remains exposed to customer activity, pricing and costs, supplier programs, competition, receivables, foreign exchange, and acquisition integration and execution.
- The company identified goodwill and intangible impairment as a risk; its impairment tests depend on judgmental forecasts and assumptions. The annual assessment found limited fair-value cushions at two reporting units, and future unfavorable results could require impairment charges.
- The multi-year SAP ERP implementation continued. Most U.S. financial and accounting systems had transitioned to SAP, but the consolidation system was expected to change at the start of fiscal 2016. Management noted implementation-related risks to internal controls; disclosure controls were considered effective.
- The company changed its U.S. inventory LIFO-index methodology effective July 1, 2014, using weighted-average costs; prior-period restatement was considered impracticable and the effects immaterial. New revenue-recognition guidance was under evaluation.
- Pending product-liability, commercial, and other legal matters were not expected by management to have a material adverse effect. The filing states the outcomes cannot be predicted.
Important facts for investors to verify
- How much future sales and earnings growth is organic versus acquisition-driven, particularly as oilfield and Canadian operations develop.
- Whether operating cash flow recovers and working-capital demands, including receivables and inventory, remain controlled.
- Debt levels, borrowing capacity, interest costs, and the company’s ability to fund acquisitions and shareholder returns while reducing leverage.
- Whether Fluid Power performance, foreign-exchange effects, and the limited fair-value cushions at certain reporting units create further downside or impairment risk.
- Progress on SAP deployment and the planned fiscal 2016 consolidation-system transition, including the adequacy of related financial controls.
- Actual results against the stated tax-rate expectations; the filing provides no specific sales, operating-income, or EPS guidance.