Applied Industrial Technologies, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended June 30, 2016. The filing also reports fourth-quarter results. Applied distributes industrial and fluid-power products and provides related engineering, systems integration, repair, and inventory services across North America, Australia, and New Zealand.
Financial results and liquidity
| Metric | FY2016 | FY2015 |
|---|---|---|
| Net sales | $2.519 billion | $2.752 billion |
| Gross profit margin | 28.1% | 28.0% |
| Operating income / margin | $88.8 million / 3.5% | $184.6 million / 6.7% |
| Net income | $29.6 million | $115.5 million |
| Diluted EPS | $0.75 | $2.80 |
| Operating cash flow | $161.0 million | $154.5 million |
| Capital expenditures | $13.1 million | $14.9 million |
| Debt outstanding | $328.3 million | $321.0 million |
- Cash and cash equivalents were $59.9 million at year-end, down from $69.5 million. Working capital was $507.2 million; the current ratio was 2.8.
- Cash used in investing activities was $75.0 million, including $62.5 million for acquisitions. Financing activities used $92.0 million, including dividends of $43.3 million and share repurchases of $37.5 million.
- The December 2015 five-year credit facility includes a $125 million term loan and a $250 million revolver. At year-end, $123.4 million and $33.0 million, respectively, were drawn; $214.3 million remained available under the facility, net of letters of credit. The company reported compliance with debt covenants.
Material changes and notable items
- Sales fell 8.4% year over year. Acquisitions added $57.1 million, while foreign currency translation reduced sales by $60.1 million. Excluding acquisitions and currency, sales declined 8.3%; upstream oil-and-gas-focused operations were particularly weak, with sales down 50.1%.
- Service Center Based Distribution sales decreased 7.4%; Fluid Power Businesses sales decreased 13.0%. Traditional core operations also declined, though less sharply than oil-and-gas-focused activity.
- Operating income included a $64.8 million non-cash goodwill impairment charge: $56.0 million for the Canadian service-center reporting unit and $8.8 million for Australia/New Zealand. The charge reduced net income by $63.8 million and diluted EPS by $1.62. Excluding the impairment, operating margin was 6.1%, versus 6.7% in FY2015.
- Restructuring charges totaled $8.8 million, including $3.6 million for inventory reserves and $5.2 million for severance and facility consolidation; the reported EPS impact was $0.16. The company also recorded a $2.1 million gross-profit benefit from LIFO layer liquidations.
- The effective tax rate rose to 62.6%, principally because $61.3 million of the goodwill impairment was not tax deductible. Management expected a FY2017 tax rate of 34%–35%.
- Fourth-quarter sales were $634.0 million, operating income $42.4 million, net income $26.1 million, and diluted EPS $0.66. Compared with the fourth quarter of FY2015, sales, operating income, net income, and EPS were lower.
Outlook, risks, and contingencies
- Management expected FY2017 capital expenditures of $17–19 million, primarily for information-technology equipment and infrastructure, and depreciation of $16–17 million. It expected inventory turnover to be slightly better than FY2016’s 3.6.
- Management said existing cash, operating cash flow, and available borrowing capacity should support normal working-capital needs, dividends, acquisitions, and investment. This is forward-looking and not a guarantee of results.
- Key risks include industrial and customer demand weakness, continued oil-and-gas and mining downturns, foreign-exchange movements, pricing and margin pressure, supplier availability and incentives, competition, acquisition integration, information-system and cybersecurity disruption, and potential further goodwill impairment. The Canadian reporting unit’s remaining goodwill was $31.2 million and was close to its estimated fair value after impairment.
- Foreign operations generated 16.0% of FY2016 sales; foreign-currency translation losses in other comprehensive income were $24.4 million. Foreign earnings of $141.5 million were considered permanently reinvested, with no U.S. tax provision recorded.
- Pending legal proceedings included product-liability, commercial, personal-injury, and other matters. Management considered a material adverse outcome remote based on information then known. The company also has self-insured exposures and $80.5 million of future operating-lease commitments.
- The company was continuing its SAP ERP rollout, including planned Eastern Canada deployment during FY2017–FY2018. Management and the auditor reported effective internal control over financial reporting at June 30, 2016; implementation-related control risks remain relevant.
Important facts for investors to verify
- Whether underlying sales and margins stabilize, particularly in Canada, Australia/New Zealand, and upstream oil and gas.
- Whether goodwill assumptions and reporting-unit performance support the remaining goodwill balance and avoid further impairment.
- Whether cash generation, working capital, and receivables quality remain sound amid the sales downturn; the allowance for doubtful accounts rose to 3.1% of gross receivables from 2.7%.
- Debt maturities, variable-rate exposure, covenant headroom, and the sustainability of dividends and share repurchases.
- Progress, costs, and internal-control implications of the SAP rollout, and the eventual impact of pending accounting standards.