Applied Industrial Technologies, Inc. — Form 10-Q Summary
Reporting period: Second quarter and six months ended December 31, 2016 (fiscal 2017). The interim financial statements are unaudited and were reviewed by Deloitte & Touche LLP. Applied distributes industrial and fluid power products and provides related engineering and services across 554 facilities.
Financial performance
| Metric | Three months ended Dec. 31, 2016 | Six months ended Dec. 31, 2016 |
|---|---|---|
| Net sales | $608.1 million; down 0.4% year over year | $1,233.0 million; down 1.5% |
| Gross profit / margin | $172.5 million / 28.4% | $350.8 million / 28.5%, versus 28.3% |
| Operating income / margin | $37.7 million / 6.2%, versus 6.3% | $80.9 million / 6.6%, versus 6.3% |
| Net income | $24.1 million, up 0.6% | $51.5 million, up 6.7% |
| Diluted EPS | $0.61, unchanged | $1.31, versus $1.22 |
| Cash dividends per share | $0.28, versus $0.27 | $0.56, versus $0.54 |
For the six-month period, operating cash flow was $45.7 million, compared with $33.8 million. Investing used $4.1 million, versus $28.8 million, mainly reflecting no acquisitions in the current period. Financing used $37.0 million, including $21.9 million of dividends, $5.5 million of share repurchases and $7.1 million of acquisition holdback payments. Cash increased $3.0 million to $62.9 million.
At December 31, cash was $62.9 million, working capital $545.2 million and the current ratio 3.3, up from 2.8 at June 30, 2016. Total borrowings were $327.6 million, compared with $328.3 million at June 30. The company had $213.3 million of unused capacity under its revolving facility, net of letters of credit, and $50.0 million available under its shelf facility. It reported compliance with debt covenants.
Changes versus comparable periods
- Second-quarter sales fell $2.2 million. Acquisitions contributed $7.8 million, while foreign currency translation reduced sales by $3.3 million. Excluding acquisitions and currency, sales declined 1.2%; one fewer selling day reduced sales by 1.6%.
- Six-month sales declined $19.3 million. Acquisitions added $23.2 million and currency reduced sales by $5.5 million; excluding both, sales decreased 3.0%, including softness in upstream oil and gas markets and one fewer selling day.
- Segment results diverged: second-quarter Service Center Based Distribution sales fell 1.2% and its operating margin declined to 4.2% from 5.6%; Fluid Power sales rose 3.6% and margin improved to 10.0% from 8.5%. For six months, the respective margins were 4.6% versus 5.5% and 10.4% versus 9.0%.
- Six-month net income and EPS improved despite lower sales, supported by lower expenses, improved gross margin, lower tax expense and reduced weighted-average shares. The company cited expense controls and headcount reductions; excluding acquisitions, headcount was down about 264 year over year.
Outlook, risks and notable items
- Management expects the fiscal 2017 effective tax rate to be 33.5%–34.5%, reflecting the early adoption of share-based payment accounting guidance. Excess tax benefits reduced income tax expense by $0.7 million for the six months.
- No specific full-year sales or earnings guidance is provided. Management says existing cash, operating cash flow and available borrowing capacity should fund normal working capital, dividends, acquisitions, capital investment and share repurchases.
- Management described U.S. industrial production and capacity utilization as generally stable; the December PMI reading of 54.7 was above the 50 expansion threshold. It cautioned that interim results are not necessarily indicative of the remainder of the fiscal year.
- Goodwill testing for the Canada service center reporting unit found fair value about $8 million, or 5%, above carrying value. No goodwill impairment was recorded. A long-lived asset review for the Reliance group also found no impairment, with estimated undiscounted cash flows 8% above the $100.7 million carrying value. Further deterioration could lead to impairment charges.
- The company recorded $1.6 million in gains from building sales during the six months. It also adopted new share-based payment and debt-issuance-cost accounting standards; the share-based payment change affected income taxes and cash-flow classification.
- Pending product liability, commercial and other legal matters were described as unlikely, based on currently known circumstances, to have a material adverse effect. Principal disclosed risks include customer demand and economic conditions, energy-market weakness, supplier and competitive pressures, receivable collection, foreign currency, acquisitions, information systems and potential goodwill or intangible impairment.
Important facts for investors to verify
- Whether sales and margins stabilize, particularly in Service Center Based Distribution, Canada and upstream oil and gas-focused operations.
- Whether operating cash flow remains strong as working capital changes, and how the company allocates cash among dividends, repurchases, acquisitions and debt.
- Whether the Canada reporting unit’s relatively narrow 5% goodwill valuation cushion and Reliance asset group’s 8% cash-flow cushion withstand changing forecasts and market conditions.
- How much of the reported earnings improvement reflects ongoing operations versus tax benefits, share-count reductions and building-sale gains.
- The potential effects of forthcoming accounting standards; the filing says impacts of several new standards had not yet been determined.