Applied Industrial Technologies, Inc. — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2011, ended December 31, 2010. Unless stated otherwise, financial amounts below are in millions of dollars. Interim statements were reviewed, not audited; management cautions that results for the six-month period are not necessarily indicative of the full fiscal year.
Business context and key results
Applied distributes industrial and fluid-power products and provides related engineering and service capabilities. It operated 473 facilities in the U.S., Canada, Mexico and Puerto Rico. Growth reflected an improving industrial economy, acquisitions and favorable currency translation.
| Metric | Three months ended Dec. 31, 2010 | Six months ended Dec. 31, 2010 |
|---|---|---|
| Net sales | $529.5 million; up 18.7% | $1,057.0 million; up 19.6% |
| Gross margin | 27.2%, versus 26.2% | 27.2%, versus 26.3% |
| Operating income | $33.1 million; up 74.9%; 6.2% margin | $67.9 million; up 85.9%; 6.4% margin |
| Net income | $21.2 million; up 102.1% | $41.9 million; up 93.5% |
| Diluted EPS | $0.49, versus $0.24 | $0.97, versus $0.51 |
| Operating cash flow | Not separately provided | $20.0 million, versus $95.7 million |
Segment sales for the quarter were $426.2 million in Service Center Based Distribution and $103.4 million in Fluid Power Businesses. Segment operating margins improved year over year to 5.9% and 9.6%, respectively. Fluid Power growth was particularly strong, including demand from high-technology and construction-machinery customers.
Balance sheet, liquidity and cash flows
- At December 31, cash and cash equivalents were $53.9 million, total current assets $529.0 million, and total current liabilities $172.1 million. Management reported a 3.1-to-1 current ratio, compared with 2.3-to-1 at June 30, 2010.
- Total debt was zero at quarter-end after repayment of $50 million on the revolving facility and $25 million of private-placement debt. The $150 million revolver had no borrowings; $143.1 million was available net of letters of credit. The company also had an uncommitted shelf facility permitting up to $100 million of additional borrowing.
- Six-month operating cash flow was $20.0 million. Working-capital changes, including inventory increases, were a major factor in the decline from the prior-year period. Cash used in investing was $41.4 million, including $27.7 million for acquisitions and $13.8 million for property purchases. Cash used in financing was $101.1 million, including debt and swap repayments and $14.4 million of dividends.
- Cash declined by $121.9 million from June 30 to $53.9 million at December 31. Shareholders’ equity was $589.2 million.
Material changes and notable items
- Two acquisitions, UZ Engineered Products and SCS Supply Group, closed in July and August for an aggregate cash purchase price of $32 million. The acquired businesses contributed $11.4 million of quarterly sales and $16.9 million of six-month sales.
- Gross margin benefited from LIFO effects associated with supplier purchasing incentives: $1.7 million in the quarter and $4.4 million for the six months. Management said it did not expect this benefit to continue in the third or fourth quarters. Competitive pricing pressures were also noted.
- Quarterly tax rate was 35.8%, compared with 40.1%, including a reversal of a deferred-tax valuation allowance. The six-month rate was 37.5%, compared with 36.7%; U.S. tax provisions on certain undistributed Canadian earnings partly offset the benefit.
- The company settled its outstanding cross-currency and interest-rate swaps during the first half. A January 2011 insurance-policy benefit payment of $1.8 million was received after quarter-end; the company expected to recognize a $1.7 million gain in the quarter ending March 31, 2011.
Outlook, risks and contingencies
Management believed the U.S. industrial recovery would continue but expected slower growth for the remainder of fiscal 2011. It forecast fiscal-year capital expenditures of $26.0–$27.5 million, including approximately $18.5 million for the SAP ERP project, and about $5.0 million of related SD&A expense. Management expected cash, operating cash flow and available facilities to fund normal working capital, dividends, acquisitions and investment needs.
Risks identified include industrial demand and customer credit, competitive pricing and product availability, supplier disruptions, foreign-currency exposure, acquisition integration and returns, and timely, cost-effective ERP implementation. Other risks include potential goodwill or intangible impairment, legal proceedings, and changes in tax or LIFO-related regulation. The company said pending product-liability, commercial and other legal matters were not expected, based on currently known circumstances, to have a material adverse effect. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported for the quarter.
Important facts for investors to verify
- Whether sales and margins can be sustained as management expects slower industrial growth and the disclosed LIFO benefit is not expected to recur in the second half.
- How working-capital requirements, especially inventory, affect operating cash flow as activity grows.
- Whether the acquisitions and SAP ERP investment deliver expected benefits within stated cost and implementation expectations.
- The effect of competitive pricing, supplier availability, and tax treatment of foreign earnings on future margins and earnings.
- Whether the expected $1.7 million insurance-related gain was recognized in the March 2011 quarter as anticipated.