APPLIED INDUSTRIAL TECHNOLOGIES INC quarterly report, Q1 FY2011

Applied Industrial Technologies, Inc. — Form 10-Q Summary

Business context and reporting period. Applied distributes industrial and fluid-power products and provides related engineering and services. This filing covers the three months ended September 30, 2010—the first quarter of fiscal 2011—and compares results with the three months ended September 30, 2009. The interim financial statements are unaudited; Deloitte & Touche conducted a review, not an audit.

Financial performance

Metric	Quarter ended Sep. 30, 2010	Prior-year quarter
Net sales	$527.5 million	$437.7 million
Gross profit / gross margin	$143.1 million / 27.1%	$115.4 million / 26.4%
Operating income / operating margin	$34.9 million / 6.6%	$17.6 million / 4.0%
Net income	$20.8 million	$11.2 million
Diluted earnings per share	$0.48	$0.26
Net cash from operating activities	$4.5 million	$50.2 million

Sales increased 20.5%; acquisitions contributed 1.3 percentage points of the increase, with the balance attributed to same-store business. Operating income rose 97.8% and net income rose 85.5%.
Sales grew in both reportable segments: Service Center Based Distribution increased 16.7%, and Fluid Power Businesses increased 39.1%. Fluid-power products rose to 28.5% of sales from 26.5%.
Gross margin benefited from a $2.7 million LIFO benefit in the current quarter. The prior-year quarter included a $4.35 million gross-profit benefit from LIFO layer liquidations, making the comparison subject to differing LIFO effects.
SD&A was 20.5% of sales versus 22.3% a year earlier. Expense increased 10.7% in dollars, including acquisition costs and higher wages and benefits, partly tied to improved performance.
The effective tax rate rose to 39.2% from 33.1%, reflecting U.S. tax provision on some undistributed Canadian earnings and the absence of $0.5 million in prior-year foreign and state tax benefits.

Cash, liquidity, and capital

Cash and cash equivalents were $94.6 million at September 30, down from $175.8 million at June 30, 2010. Operating cash flow was $4.5 million; the filing attributes the year-over-year decline primarily to inventory changes, as inventory increased slightly in the current quarter while it was being reduced a year earlier.
Cash used in investing was $28.5 million, including $27.7 million net cash paid for acquisitions and $0.9 million of property purchases. Cash used in financing was $56.7 million, including $50.0 million of revolving-credit repayments and $7.2 million of dividends.
Current assets were $571.2 million and current liabilities $235.6 million; management reported a current ratio of 2.4 to 1, versus 2.3 to 1 at June 30. Total liabilities were $303.6 million and shareholders’ equity was $569.1 million.
Debt included $25.0 million of private-placement debt due in November 2010. The company had no revolving-credit borrowings and reported $143.2 million of unused facility capacity, net of letters of credit. It also had no borrowings under its $100 million Prudential shelf facility.
The quarterly dividend was $0.17 per common share, compared with $0.15 a year earlier. No company share repurchases were made during the quarter.

Outlook, developments, and risks

Management believed the U.S. industrial recovery would continue but expected slower growth for the rest of fiscal 2011. It noted moderating industry indicators and a sales-per-day run rate consistent with the June 2010 quarter. No specific revenue or earnings guidance is stated.
In July and August, the company acquired UZ Engineered Products and SCS Supply Group for an aggregate cash purchase price of $32 million. Their projected annual sales run rate is approximately $45 million; results are included from closing dates.
The company selected SAP for a multi-year replacement of legacy information systems. Fiscal 2011 ERP-related capital expenditures were expected to be about $16 million, in addition to the previously disclosed $8.0–$9.5 million capital expenditure outlook; $10 million was included in the September quarter. Related fiscal 2011 SD&A expense was expected to be about $3.5 million. Management identified implementation delays, disruption, data loss, transaction-processing issues, control impacts, and cost overruns as risks.
Management said available cash, operating cash flow, and credit facilities should be sufficient for normal needs, debt repayment, dividends, acquisitions, and investment. Other stated risks include economic and customer-demand conditions, competition and supplier availability, receivable collectability, acquisition integration, foreign-currency exposure, and potential goodwill or intangible impairment.
Cross-currency swap liabilities had a reported fair value of $11.9 million; the related $25 million private-placement borrowing and swaps were expected to be settled in November 2010. Management reported no material change in market-risk exposure during the quarter.
Pending product-liability, commercial, and other legal proceedings were described as unlikely, based on currently known circumstances, to have a material adverse effect. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.

Important facts for investors to verify

Whether sales and margin improvement persists, particularly given the company’s expectation of slower economic growth and the quarter’s LIFO benefit.
How much operating cash flow improves as inventory and other working-capital needs develop; quarterly operating cash flow was substantially below the prior-year amount.
Repayment or refinancing of the $25 million debt maturing in November 2010 and the settlement of associated cross-currency swaps.
Actual cost, timing, and operational effects of the multi-year SAP implementation versus the announced investment and expense expectations.
Whether the acquisitions deliver their projected sales and can be integrated effectively.
Tax-rate developments, foreign-currency movements, and the potential effects of competition and supplier price increases on margins.