The 2020 Mid-Year Economic Update_long

Applied Making Right Cost-Control Moves, but Tough Environment Lingers

Market conditions weren’t favorable for Applied Industrial Technologies Inc. in the fiscal fourth quarter, but the distributor navigated the COVID-plagued business landscape as well as possible thanks to cost-reduction measures it will extend into 2021.
Applied Industrial Technologies

As the demand environment further softened during Applied Industrial Technology Inc.’s fiscal fourth quarter (April to June), the company enacted some critical cost-reduction measures that kept revenue losses under control.

Yes, the Cleveland, Ohio-based industrial, fluid power and automation distributor posted revenue of just $725.1 million, a 17.9% loss compared with the same quarter a year ago and shy of analysts’ estimates by $14.4 million.

But Applied notched positive net income ($30 million, down from $39.8 million in the fourth quarter of fiscal 2019) and its GAAP EPS of 77 cents beat expectations by 5 cents, showing the company was able to navigate the quarter with the discipline needed in a tough, coronavirus-choked marketplace.

“Our operating discipline and prompt cost actions have allowed us to quickly align expenses and manage working capital within the slower environment, driving mid-teen decremental margins, record cash generation and improved liquidity during our fiscal fourth quarter,” Applied’s president and CEO, Neil Schrimsher, told analysts on Wednesday morning’s earnings call. “We are encouraged by the execution across our team in recent months, which provides solid footing entering fiscal 2021.”

Indeed, that disciple resulted in selling, distribution and administrative (SD&A) expense, including depreciation, declining 14 percent year over the year. That excluded $1.5 million of non-routine costs in the quarter, $1 million of which was recorded in Applied’s service center segment and $0.5 million in its fluid power and flow control segment, according to the company’s CFO, David Wells.

“These costs include severance and facility exit costs related to actions implemented in response to the weaker demand environment,” Wells said on the earnings call. “As highlighted last quarter, we implemented various actions to align expenses with slower demand. These include restricting T&E, over time, temporary labor and consulting spend. as well as staffing alignments, implementation of furloughs and pay reductions and the temporary suspension of the company’s 401(k) match. While materially difficult, our team displayed great discipline and swiftly executed these requirements across the organization.”

Difficult Conditions Remain on Horizon

That weaker demand environment has taken its toll on Applied, which said it will continue cost-reduction measures into 2021.

The company’s revenue loss included a 1.5% increase from acquisitions, partially offset by an approximate 1% negative impact from foreign currency translation. Excluding these factors, sales decreased 18.4% on an organic basis reflecting a 21.1% decline in the service center segment and an 11.8% decline in the fluid power and flow control segment.

“Lower industrial production activity and customer facility closures from COVID-19 precautions drove reduced MRO needs across the majority of our service center customer base during the quarter,” Wells said. “Weakness was particularly acute within metals, mining, oil and gas, machinery and transportation end markets, partially offset by more resilient demand within food and beverage, pulp and paper, forestry, electronics and chemical industries, as well as growth in our Australian operations.”

Baird analyst Dave Manthey, in his note to clients, said the firm wasn’t changing its outlook on Applied, even with the tough conditions, in part because of the leadership team’s discipline to keep spending under control.

“With this backdrop, management has extended the previously announced cost actions into F2021,” Manthey wrote. “Net, AIT is doing well controlling SD&A and keeping gross margins relatively flattish, but the external environment remains very challenging.”

There were some bright spots in Applied’s 4Q, according to Schrimsher. He noted the company’s ability to expand its offerings to customers during this crisis, especially in fluid power and flow control, as well as finding traction with the company’s most recent addition, Olympus Controls, which it acquired last year.

“We are also gaining traction with our cross-selling opportunity, focused on further penetrating our fluid power, flow control, automation and consumable solutions across our legacy service and our customer base,” he said. “Of note, we are experiencing greater quoting activity and sales of flow control products and solutions across our service center network over the past several quarters. We’re also encouraged by initial progress in identifying and developing opportunities aimed at connecting Olympus Controls’ automation capabilities across traditional industries.”

The full-year revenue picture wasn’t quite as bleak thanks to a solid first three quarters of fiscal 2020. Applied reported that fiscal-year sales of $3.2 billion, down 6.5% compared to a year ago. However, net income for the year was $24 million compared with $144 million in fiscal-year 2019.

Shares of Applied Industrial Technologies (NYSE: AIT) were down $1.25, or 1.8 percent, to $67.80 at market close Wednesday. The company’s stock is just about back to pre-COVID levels ($70) after dipping to about $32 per share in mid-March.

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