Applied Industrial Technologies, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2014, the three months ended September 30, 2013; comparisons are with the three months ended September 30, 2012 unless otherwise noted. The interim financial statements are unaudited and were reviewed by the independent accounting firm.
Business context
Applied is an industrial distributor serving maintenance, repair and operations (MRO) and original equipment manufacturer (OEM) customers, with engineering and related services. It reported two segments: Service Center Based Distribution and Fluid Power Businesses. At quarter-end it operated 521 facilities and had 5,132 associates.
Key financial metrics
| Metric | Q1 FY2014 | Q1 FY2013 |
|---|---|---|
| Net sales | $605.3 million | $610.5 million |
| Gross profit / margin | $169.8 million / 28.1% | $164.5 million / 26.9% |
| Operating income / margin | $39.5 million / 6.5% | $44.3 million / 7.3% |
| Net income | $26.8 million | $29.5 million |
| Diluted earnings per share | $0.63 | $0.70 |
| Operating cash flow | $17.0 million | $23.9 million |
- Cash and liquidity: Cash was $76.9 million at September 30, 2013, versus $73.2 million at June 30, 2013. Working capital was $508.2 million and the current ratio was 3.3, up from 3.0 at fiscal year-end.
- Debt and borrowing capacity: No borrowings were outstanding. The $150 million revolving credit facility had $141.3 million available after letters of credit; an additional uncommitted shelf facility permits borrowing up to $125 million.
- Cash uses: Investing activities used $1.4 million, including $1.6 million of capital expenditures. Financing activities used $11.8 million, including $9.7 million in dividends and $3.0 million to repurchase shares. Cash increased $3.7 million during the quarter.
- Dividends and repurchases: Quarterly dividends were $0.23 per share, versus $0.21 a year earlier. The company repurchased 60,700 shares for $3.0 million; authorization for another 1,080,800 shares remained.
Changes versus the prior-year quarter
- Sales fell $5.2 million, or 0.9%, despite one additional selling day. Acquisitions added $18.3 million (3.0%); foreign currency translation reduced sales by $2.6 million (0.4%).
- Gross margin improved 1.2 percentage points, which management attributed primarily to acquisitions with higher gross margins. SD&A rose 8.4% to $130.3 million; acquisitions and the additional selling day accounted for most of the increase, while core SD&A increased 0.8%.
- Operating income declined 10.8% and net income declined 9.1%. Management cited lower sales and higher SD&A as key reasons for the operating-income decline.
- Service Center Based Distribution sales declined 1.2%; management cited slowdowns in some industrial sectors, particularly mining. Fluid Power Businesses sales increased 0.5%, primarily on improved sales in one customer group.
- Operating cash flow decreased $7.0 million, mainly due to lower net income and greater working-capital use. Investing cash use was much lower than a year earlier, when $35.4 million was spent on acquisitions.
Outlook, commentary and risks
- Management expected the full-year fiscal 2014 effective tax rate to be 34.0%–34.5%. The filing provides no specific sales or earnings guidance.
- Management believed existing cash, operating cash flow and available credit were sufficient for normal working capital, dividends, acquisitions, investments and share repurchases. It expected inventory turnover in fiscal 2014 to remain similar to fiscal 2013 levels.
- The company continued its SAP ERP rollout, with further deployments planned during fiscal 2014 and U.S. deployment expected to be completed in fiscal 2014. Management identified transitional risks to internal controls as the system is implemented; disclosure controls were reported effective.
- DSO increased to 47.6 from 46.4 at June 30, 2013; management attributed the increase primarily to slower payments from large contract accounts. Approximately 3.3% of receivables were more than 90 days past due.
- Cash held outside the U.S. totaled $49.1 million, principally in Canada. Repatriation could trigger U.S. income taxes; the company had provided $2.8 million of U.S. taxes on approximately $11.0 million of undistributed Canadian earnings.
- Key disclosed risks include industrial demand and customer activity, supplier and competitive pressures, receivable collection, foreign currency and other foreign-operation risks, acquisition integration, ERP implementation, and potential goodwill or intangible-asset impairment. Pending legal proceedings were not expected by management to have a material adverse effect, based on circumstances then known.
Unusual items and accounting
Effective July 1, 2013, the company eliminated a one-month reporting lag for its Canadian subsidiary. The quarter’s other income included $1.2 million of income from this change. Management said the change was not material to the periods presented and did not retrospectively restate them; without retrospective adjustment, Q1 FY2014 net income would have been $1.2 million lower. Interim U.S. LIFO inventory valuations rely on management estimates and are subject to year-end determination.
Important facts for investors to verify
- Whether sales trends recover, particularly in mining and other slower industrial markets, and whether acquisition contributions continue.
- Whether higher SD&A relative to sales persists and pressures operating margins despite improved gross margin.
- Receivables collection, rising DSO and the aging of balances, including the level of accounts more than 90 days past due.
- ERP deployment progress, costs, business disruption and maintenance of effective internal controls.
- The effects of the Canadian reporting-lag change and other one-time or non-operating items on earnings comparisons.
- Available liquidity and the tax consequences of potential foreign cash repatriation.