Business context and reporting period
Applied Industrial Technologies, Inc. filed this Form 10-K for the fiscal year ended June 30, 2017. The filing reports annual results, not a standalone fiscal 2016 fourth quarter; its quarterly table identifies fiscal 2017 Q4 separately. Applied distributes industrial and fluid-power products and provides related engineering, repair, and inventory-management services. Its two reportable segments are Service Center-Based Distribution and Fluid Power Businesses.
Financial performance and liquidity
| Metric | FY2017 | FY2016 |
|---|---|---|
| Net sales | $2,593.7 million | $2,519.4 million |
| Gross margin | 28.4% | 28.1% |
| Operating income / margin | $174.6 million / 6.7% | $88.8 million / 3.5% |
| Net income | $133.9 million | $29.6 million |
| Diluted EPS | $3.40 | $0.75 |
| Cash from operations | $164.6 million | $162.0 million |
| Cash and cash equivalents at year-end | $105.1 million | $59.9 million |
| Total debt, including current portion | $292.0 million | $328.3 million |
| Working capital / current ratio | $572.8 million / 2.8 | $507.2 million / 2.8 |
Operating cash flow increased modestly despite working-capital investment. Investing activities used $16.9 million, including $17.0 million of capital expenditures and $2.8 million for acquisitions, partly offset by building-sale proceeds. Financing activities used $103.3 million, including $44.6 million of dividends, debt repayments, and $8.2 million of share repurchases. The company had $247.6 million of unused capacity under its revolving facility, net of letters of credit, and was in compliance with debt covenants.
Changes versus the prior comparable period
- Sales rose 2.9%; acquisitions contributed $31.1 million, while unfavorable currency translation reduced sales by $1.1 million. Excluding acquisitions and currency, sales increased 1.8%, with one fewer selling day a drag.
- Fluid Power Businesses sales increased 9.6% (7.1% excluding acquisitions and currency); Service Center-Based Distribution sales increased 1.6% (0.7% excluding acquisitions and currency).
- Operating income and net income rebounded from FY2016, which included a $64.8 million non-cash goodwill impairment and $8.8 million of restructuring charges. The comparison therefore overstates the improvement in underlying performance.
- FY2017 gross margin benefited from $9.4 million of LIFO liquidation, compared with $2.1 million in FY2016; a $4.8 million year-over-year increase in scrap expense partly offset this benefit.
- FY2017 net income included a $22.2 million tax benefit from a worthless-stock deduction, adding $0.56 to EPS. FY2016 EPS included a $1.62 negative impact from impairment and $0.16 from restructuring.
Outlook, commentary, risks and unusual items
- Management expected FY2018 capital expenditures of $18–20 million, mainly for information-technology equipment and infrastructure, and depreciation of $15.5–16.5 million. It expected the income-tax rate to be 34–35% and inventory turnover to be slightly better than FY2017.
- Management cited improving U.S. industrial indicators during FY2017. It stated that cash, operating cash flow, and available credit were expected to fund normal needs, dividends, acquisitions, and investment.
- On July 3, 2017, Applied acquired DICOFASA in Mexico for approximately $5.9 million, funded with available cash.
- Key risks include exposure to industrial and customer demand, competition and pricing pressure, supplier availability and incentives, working-capital and credit risks, foreign-exchange movements, acquisitions and integration, information-system disruption or cyberattack, and potential future goodwill or intangible impairment. Foreign operations generated 15.9% of FY2017 sales; the company did not hedge net investments in foreign operations.
- Other notable matters: DSO increased to 51.6 days from 49.4 as receivables grew faster than sales; 1.7% of receivables were more than 90 days past due, versus 2.7% a year earlier. The company reported an unqualified audit opinion and effective internal control over financial reporting.
Important facts for investors to verify
- How much of FY2017 earnings growth is sustainable after excluding the $22.2 million tax benefit and considering the FY2016 impairment and restructuring comparison.
- Whether organic sales growth and Fluid Power momentum continue, and how exposed results remain to energy, mining, and Canadian markets.
- Whether the favorable LIFO liquidation benefit recurs, and how scrap expense and inventory reserves develop.
- Whether receivables growth and higher DSO reverse, and whether operating cash flow continues to cover dividends, capital spending, and debt service.
- Future goodwill impairment sensitivity, particularly for reporting units affected by prior market weakness, and the tax or cash consequences of foreign earnings repatriation.