Applied Industrial (AIT) 10-Q2024 Q1 Quarterly report

Applied monitors several economic indices that have been key indicators for industrial economic activity in the United States. These include the Industrial Production (IP) and Manufacturing Capacity Utilization (MCU) indices published by the Federal Reserve Board and the Purchasing Managers Index (PMI) published by the Institute for Supply Management (ISM). Historically, our performance correlates well with the MCU, which measures productivity and calculates a ratio of actual manufacturing output versus potential full capacity output. When manufacturing plants are running at a high rate of capacity, they tend to wear out machinery and require replacement parts.

The following table shows changes in sales by reportable segment (amounts in millions).

Sales from our Engineered Solutions segment increased $4.3 million or 1.2%. Acquisitions within this segment increased sales by $7.7 million or 2.2%. Excluding the impact of businesses acquired, sales decreased $3.4 million or 1.0%, driven by a 1.6% decrease due to one less sales day, offset by a 0.6% increase from operations reflecting positive underlying segment demand with support from engineering capabilities, backlog, and a diverse end-market mix despite reduced activity across the technology sector and ongoing supply chain constraints.

The following table shows changes in sales by geographic area. Other countries includes Mexico, Australia, New Zealand, and Singapore (amounts in millions).

Sales in our U.S. operations were up $37.9 million or 4.1%, as acquisitions added $11.6 million or 1.3%. Excluding the impact of businesses acquired, U.S. sales were up $26.3 million or 2.8%, driven by a 4.4% increase in operations, offset by 1.6% due to one less sales day. Sales from our Canadian operations decreased $4.5 million or 5.6%. Unfavorable foreign currency translation decreased Canadian sales by $2.2 million or 2.8%. Excluding the impact of foreign currency translation, Canadian sales were down $2.3 million or 2.8%, driven by a 1.6% decrease due to one less sales day and a 1.2% decrease from operations. Consolidated sales from our other country operations, which include Mexico, Australia, New Zealand, and Singapore, decreased $0.6 million or 1.0% from the prior year. Favorable foreign currency translation increased other country sales by $4.7 million or 7.6%. Excluding the impact of currency translation, other country sales were down $5.3 million, or 8.6% during the quarter.

The following table shows the changes in selling, distribution and administrative expense (SD&A) (amounts in millions).

Operating income increased $14.1 million or 13.3%, and as a percent of sales increased to 11.0% from 10.0% during the prior year quarter.

Operating income, as a percentage of sales for the Service Center Based Distribution segment increased to 13.0% in the current year quarter from 12.4% in the prior year quarter. Operating income as a percentage of sales for the Engineered Solutions segment increased to 14.2% in the current year quarter from 13.2% in the prior year quarter.

As a result of the factors addressed above, net income for the quarter ended September 30, 2023 increased $16.9 million or 22.0% compared to the prior year quarter. Diluted net income per share was $2.39 per share for the quarter ended September 30, 2023 compared to $1.97 per share in the prior year quarter, an increase of 21.3%.

Our primary source of capital is cash flow from operations, supplemented as necessary by bank borrowings or other sources of debt. We had total debt obligations outstanding of $622.2 million at September 30, 2023 and June 30, 2023. Management expects that our existing cash, cash equivalents, funds available under the revolving credit facility, and cash provided from operations will be sufficient to finance normal working capital needs in each of the countries in which we operate, payment of dividends, acquisitions, investments in properties, facilities and equipment, debt service, and the purchase of additional Company common stock. Management also believes that additional long-term debt and line of credit financing could be obtained based on the Company's credit standing and financial strength.

The Company's working capital at September 30, 2023 was $1,177.7 million, compared to $1,106.5 million at June 30, 2023. The current ratio was 3.5 to 1 at September 30, 2023 and 3.0 to 1 at June 30, 2023.

Net cash used in financing activities during the three months ended September 30, 2023 decreased from the prior period primarily due to a change in net debt activity, as there was $0.1 million of debt payments in the current year period compared to $40.1 million of debt payments in the prior year period.

The Company entered into an interest rate swap which mitigates variability in forecasted interest payments on $384.0 million of the Company’s U.S. dollar-denominated unsecured variable rate debt. For more information, see note 6, Derivatives, to the consolidated financial statements, included in Item 1 under the caption “Notes to Condensed Consolidated Financial Statements.”

The credit facility and the unsecured shelf facility contain restrictive covenants regarding liquidity, net worth, financial ratios, and other covenants. At September 30, 2023, the most restrictive of these covenants required that the Company have net indebtedness less than 3.75 times consolidated income before interest, taxes, depreciation and amortization (as defined). At September 30, 2023, the Company's net indebtedness was less than 0.6 times consolidated income before interest, taxes, depreciation and amortization (as defined). The Company was in compliance with all financial covenants at September 30, 2023.

Management’s Discussion and Analysis contains statements that are forward-looking based on management’s current expectations about the future. Forward-looking statements are often identified by qualifiers, such as “guidance”, “expect”, “believe”, “plan”, “intend”, “will”, “should”, “could”, “would”, “anticipate”, “estimate”, “forecast”, “may”, "optimistic" and derivative or similar words or expressions. Similarly, descriptions of objectives, strategies, plans, or goals are also forward-looking statements. These statements may discuss, among other things, expected growth, future sales, future cash flows, future capital expenditures, future performance, and the anticipation and expectations of the Company and its management as to future occurrences and trends. The Company intends that the forward-looking statements be subject to the safe harbors established in the Private Securities Litigation Reform Act of 1995 and by the Securities and Exchange Commission in its rules, regulations and releases.

Readers are cautioned not to place undue reliance on any forward-looking statements. All forward-looking statements are based on current expectations regarding important risk factors, many of which are outside the Company’s control. Accordingly, actual results may differ materially from those expressed in the forward-looking statements, and the making of those statements should not be regarded as a representation by the Company or any other person that the results expressed in the statements will be achieved. In addition, the Company assumes no obligation publicly to update or revise any forward-looking statements, whether because of new information or events, or otherwise, except as may be required by law.

Important risk factors include, but are not limited to, the following: risks relating to the operations levels of our customers and the economic factors that affect them; continuing risks relating to the effects of the COVID-19 pandemic; inflationary or deflationary trends in the cost of products, energy, labor and other operating costs, and changes in the prices for products and services relative to the cost of providing them; reduction in supplier inventory purchase incentives; loss of key supplier authorizations, lack of product availability (such as due to supply chain strains), changes in supplier distribution programs, inability of suppliers to perform, and transportation disruptions; changes in customer preferences for products and services of the nature and brands sold by us; changes in customer procurement policies and practices; competitive pressures; our reliance on information systems and risks relating to their proper functioning, the security of those systems, and the data stored in or transmitted through them; the impact of economic conditions on the collectability of trade receivables; reduced demand for our products in targeted markets due to reasons including consolidation in customer industries; our ability to retain and attract qualified sales and customer service personnel and other skilled executives, managers and professionals; our ability to identify and complete acquisitions, integrate them effectively, and realize their anticipated benefits; the variability, timing and nature of new business opportunities including acquisitions, alliances, customer relationships, and supplier authorizations; the incurrence of debt and contingent liabilities in connection with acquisitions; our ability to access capital markets as needed on reasonable terms; disruption of operations at our headquarters or distribution centers; risks and uncertainties associated with our foreign operations, including volatile economic conditions, political instability, cultural and legal differences, and currency exchange fluctuations; the potential for goodwill and intangible asset impairment; changes in accounting policies and practices; our ability to maintain effective internal control over financial reporting; organizational changes within the Company; risks related to legal proceedings to which we are a party; potentially adverse government regulation, legislation, or policies, both enacted and under consideration, including with respect to federal tax policy, international trade, data privacy and security, and government contracting; and the occurrence of extraordinary events (including prolonged labor disputes, power outages, telecommunication outages, terrorist acts, war, public health emergency, earthquakes, extreme weather events, other natural disasters, fires, floods, and accidents). Other factors and unanticipated events could also adversely affect our business, financial condition, or results of operations. Risks can also change over time. Further, the disclosure of a risk should not be interpreted to imply that the risk has not already materialized.

We discuss certain of these matters and other risk factors more fully throughout this Form 10-Q as well as other of our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended June 30, 2023.