10-Q 1 ait12311810q.htm 10-Q Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________________ 
FORM 10-Q
 __________________________________________

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended DECEMBER 31, 2018
OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                 to                 
Commission File Number 1-2299
___________________________________________ 
APPLIED INDUSTRIAL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
___________________________________________ 
Ohio
34-0117420
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
 
One Applied Plaza, Cleveland, Ohio
44115
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (216) 426-4000
(Former name, former address and former fiscal year, if changed since last report)
__________________________________________ 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  [X]     No [ ]
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  [X]  No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
[X]
  
Accelerated filer
 
[ ]
 
 
 
 
Non-accelerated filer
 
[ ]  
  
Smaller reporting company
 
[ ]
 
 
 
 
 
 
 
Emerging growth company
 
[ ]
 
 
 
 






If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  
   Yes [ ]    No [X]

There were 38,759,724 (no par value) shares of common stock outstanding on January 11, 2019.



APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
INDEX
 
 
 
 
Page
No.
Part I:
 
 
 
 
 
 
 
 
Item 1:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2:
 
 
Item 3:
 
 
Item 4:
 
 
 
 
 
Part II:
 
 
 
 
 
 
 
 
Item 1:
 
 
Item 2:
 
 
Item 6:
 
 
 
 
 
 
 
 

1


PART I:
FINANCIAL INFORMATION

ITEM I:
FINANCIAL STATEMENTS

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
(In thousands, except per share amounts)
 
 
Three Months Ended
 
Six Months Ended
 
 
December 31,
 
December 31,
 
 
2018
 
2017
 
2018
 
2017
Net sales
 
$
840,038

 
$
667,187

 
$
1,704,553

 
$
1,347,888

Cost of sales
 
597,178

 
478,827

 
1,209,840

 
967,104

Gross profit
 
242,860

 
188,360

 
494,713

 
380,784

Selling, distribution and administrative expense, including depreciation
 
181,895

 
141,645

 
367,409

 
282,232

Operating income
 
60,965

 
46,715

 
127,304

 
98,552

Interest expense, net
 
9,578

 
2,139

 
20,054

 
4,305

Other expense (income), net
 
946

 
(20
)
 
707

 
(731
)
Income before income taxes
 
50,441

 
44,596

 
106,543

 
94,978

Income tax expense
 
11,724

 
13,646

 
18,888

 
30,307

Net income
 
$
38,717

 
$
30,950

 
$
87,655

 
$
64,671

Net income per share - basic
 
$
1.00

 
$
0.80

 
$
2.26

 
$
1.67

Net income per share - diluted
 
$
0.99

 
$
0.79

 
$
2.23

 
$
1.65

Cash dividends per common share
 
$
0.30

 
$
0.29

 
$
0.60

 
$
0.58

Weighted average common shares outstanding for basic computation
 
38,743

 
38,716

 
38,729

 
38,824

Dilutive effect of potential common shares
 
504

 
490

 
587

 
446

Weighted average common shares outstanding for diluted computation
 
39,247

 
39,206

 
39,316

 
39,270

See notes to condensed consolidated financial statements.


2


APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
 
 
Three Months Ended
 
Six Months Ended
 
 
December 31,
 
December 31,

 
2018
 
2017
 
2018
 
2017
Net income per the condensed statements of consolidated income
 
$
38,717

 
$
30,950

 
$
87,655

 
$
64,671

 
 
 
 
 
 
 
 
 
Other comprehensive (loss) income, before tax:
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
(10,270
)
 
(6,031
)
 
(4,556
)
 
2,128

Post-employment benefits:
 
 
 
 
 
 
 
 
Reclassification of net actuarial gains and prior service cost into other expense (income), net and included in net periodic pension costs
 
(78
)
 
(22
)
 
(153
)
 
(36
)
Unrealized loss on investment securities available for sale
 

 
46

 

 
42

Cumulative effect of adopting accounting standard
 

 

 
(50
)


Total of other comprehensive (loss) income, before tax
 
(10,348
)
 
(6,007
)
 
(4,759
)
 
2,134

Income tax (benefit) expense related to items of other comprehensive (loss) income
 
(592
)
 
57

 
(350
)
 
46

Other comprehensive (loss) income, net of tax
 
(9,756
)
 
(6,064
)
 
(4,409
)
 
2,088

Comprehensive income, net of tax
 
$
28,961

 
$
24,886

 
$
83,246

 
$
66,759

See notes to condensed consolidated financial statements.
 


3



APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
 
 
December 31,
2018
 
June 30,
2018
ASSETS
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
79,827

 
$
54,150

Accounts receivable, less allowances of $13,982 and $13,566
 
512,034

 
548,811

Inventories
 
445,881

 
422,069

Other current assets
 
44,041

 
32,990

Total current assets
 
1,081,783

 
1,058,020

Property, less accumulated depreciation of $182,812 and $175,300
 
122,005

 
121,343

Identifiable intangibles, net
 
413,093

 
435,947

Goodwill
 
651,206

 
646,643

Other assets
 
21,901

 
23,788

TOTAL ASSETS
 
$
2,289,988

 
$
2,285,741

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
232,558

 
$
256,886

Current portion of long term debt
 
44,184

 
19,183

     Compensation and related benefits
 
56,882

 
73,370

Other current liabilities
 
60,164

 
83,112

Total current liabilities
 
393,788

 
432,551

Long-term debt
 
923,410

 
944,522

Post-employment benefits
 
9,200

 
11,985

Other liabilities
 
73,675

 
81,720

TOTAL LIABILITIES
 
1,400,073

 
1,470,778

Shareholders’ Equity
 
 
 
 
Preferred stock—no par value; 2,500 shares authorized; none issued or outstanding
 

 

Common stock—no par value; 80,000 shares authorized; 54,213 shares issued;
38,758 and 38,703 outstanding, respectively
 
10,000

 
10,000

Additional paid-in capital
 
170,385

 
169,383

Retained Earnings
 
1,208,748

 
1,129,678

Treasury shares—at cost (15,455 and 15,510 shares, respectively)
 
(404,586
)
 
(403,875
)
Accumulated other comprehensive loss
 
(94,632
)
 
(90,223
)
TOTAL SHAREHOLDERS’ EQUITY
 
889,915

 
814,963

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
2,289,988

 
$
2,285,741

See notes to condensed consolidated financial statements.


4


APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
(In thousands)
 
 
Six Months Ended
 
 
December 31,
 
 
2018
 
2017
Cash Flows from Operating Activities
 
 
 
 
Net income
 
$
87,655

 
$
64,671

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization of property
 
10,019

 
8,008

Amortization of intangibles
 
21,912

 
11,526

Unrealized foreign exchange transactions gain
 
(155
)
 
(610
)
Amortization of stock options and appreciation rights
 
1,257

 
1,013

Gain on sale of property
 
(105
)
 
(333
)
Other share-based compensation expense
 
2,351

 
1,577

Changes in operating assets and liabilities, net of acquisition
 
(55,922
)
 
(65,007
)
Other, net
 
(1,432
)
 
339

Net Cash provided by Operating Activities
 
65,580

 
21,184

Cash Flows from Investing Activities
 
 
 
 
Acquisition of businesses, net of cash acquired
 
(6,900
)
 
(5,014
)
Property purchases
 
(7,096
)
 
(11,460
)
Proceeds from property sales
 
244

 
596

Other
 
391

 

Net Cash used in Investing Activities
 
(13,361
)
 
(15,878
)
Cash Flows from Financing Activities
 
 
 
 
Net (repayments) borrowings under revolving credit facility
 
(19,500
)
 
23,000

Long-term debt borrowings
 
175,000

 

Long-term debt repayments
 
(151,868
)
 
(1,679
)
Payment of debt issuance costs
 
(685
)
 

Purchases of treasury shares
 

 
(22,778
)
Dividends paid
 
(23,275
)
 
(22,571
)
Acquisition holdback payments
 
(2,275
)
 
(319
)
Taxes paid for shares withheld for equity awards
 
(3,318
)
 
(1,298
)
Net Cash used in Financing Activities
 
(25,921
)
 
(25,645
)
Effect of Exchange Rate Changes on Cash
 
(621
)
 
606

Increase (Decrease) in Cash and Cash Equivalents
 
25,677

 
(19,733
)
Cash and Cash Equivalents at Beginning of Period
 
54,150

 
105,057

Cash and Cash Equivalents at End of Period
 
$
79,827

 
$
85,324

See notes to condensed consolidated financial statements.


5

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

  
1.    BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the financial position of Applied Industrial Technologies, Inc. (the “Company”, or “Applied”) as of December 31, 2018, and the results of its operations and its cash flows for the six month periods ended December 31, 2018 and 2017, have been included. The condensed consolidated balance sheet as of June 30, 2018 has been derived from the audited consolidated financial statements at that date. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended June 30, 2018.
Operating results for the six month period ended December 31, 2018 are not necessarily indicative of the results that may be expected for the remainder of the fiscal year ending June 30, 2019.

Recently Adopted Accounting Guidance
Revenue from Contracts with Customers
In May 2014, the FASB issued Accounting Standards Update ("ASU") 2014-09, "Revenue from Contracts with Customers (Topic 606)" ("ASC 606"). The standard outlines a single comprehensive model for entities to use in the accounting for revenue arising from contracts with customers. The core principle of this model is that "an entity recognizes revenue to depict the transfer of promised goods or services to a customer in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services." Subsequent to the issuance of ASU 2014-09, the FASB issued ASU 2015-14, ASU 2016-08, ASU 2016-10, and ASU 2016-12, which clarify the guidance in ASU 2014-09 but do not change the core principle of the revenue recognition model, and have been collectively codified into ASC 606. The provisions of ASC 606 are effective for interim and annual periods beginning after December 15, 2017. On July 1, 2018, the Company adopted ASC 606 using the modified retrospective method. As a result, the Company applied ASC 606 only to contracts that were not completed as of July 1, 2018. The adoption of ASC 606 resulted in a net increase to opening retained earnings of approximately $3,429, net of tax, on July 1, 2018. See Note 2, Revenue Recognition, for further information on the impacts of these standard updates.
Income tax consequences of intra-entity transfer of assets other than inventory
In October 2016, the FASB issued its final standard on the income tax consequences of intra-entity transfers of assets other than inventory. This standard, issued as ASU 2016-16, requires that an entity recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs and eliminates the exception for an intra-entity transfer of an asset other than inventory. This update is effective for annual and interim financial statement periods beginning after December 15, 2017. The Company adopted ASU 2016-16 during the first quarter of fiscal 2019 using the modified retrospective method, and recorded a cumulative-effect adjustment decreasing retained earnings by $424, recording a deferred tax asset of $587 and reversing a prepaid asset of $1,011 as of the beginning of the period. The deferred tax asset is included in other assets on the condensed consolidated balance sheet as of December 31, 2018.

Inventory
The Company uses the LIFO method of valuing U.S. inventories. An actual valuation of inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs and are subject to the final year-end LIFO inventory determination.

Recently Issued Accounting Guidance
In February 2016, the FASB issued its final standard on accounting for leases. This standard, issued as ASU 2016-02, requires that an entity that is a lessee recognize lease assets and lease liabilities on the balance sheet for all leases and disclose key information about leasing arrangements. The core principle of this update is that a "lessee should recognize the assets and liabilities that arise from leases." This update is effective for financial statement periods beginning after December 15, 2018, with earlier application permitted. In July 2018, the FASB issued ASU 2018-10

6

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

which clarifies the guidance in ASU 2016-02, and ASU 2018-11 which provides entities with an additional transition method option for adopting the new standard. The company plans to use this new transition method option upon adoption and recognize a cumulative-effect adjustment to the opening balance of retained earnings. In December 2018, the FASB issued ASU 2018-20 which further clarifies the guidance. The Company has established a cross-functional team to evaluate the new standard and has begun implementing new lease administration software. The Company is still determining the financial impact that this standard update will have on its consolidated financial statements, but anticipates it will have a material impact on its assets and liabilities due to the addition of right-of-use assets and lease liabilities to the consolidated balance sheet. The Company will continue to evaluate the impacts of the adoption of the standard and these assessments are subject to change.
In June 2016, the FASB issued its final standard on measurement of credit losses on financial instruments. This standard, issued as ASU 2016-13, requires that an entity measure impairment of certain financial instruments, including trade receivables, based on expected losses rather than incurred losses. This update is effective for annual and interim financial statement periods beginning after December 15, 2019, with early adoption permitted for financial statement periods beginning after December 15, 2018. In November 2018, the FASB issued ASU 2018-19 which clarifies the guidance in ASU 2016-13. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures.
In August 2016, the FASB issued its final standard on the classification of certain cash receipts and cash payments within the statement of cash flows. This standard, issued as ASU 2016-15, makes a number of changes meant to add or clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows. This update is effective for annual and interim financial statement periods beginning after December 15, 2018, with early adoption permitted. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures.
In August 2018, the FASB issued its final standard on the accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. This standard, issued as ASU 2018-15, aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This update is effective for annual and interim periods beginning after December 15, 2019, with early adoption permitted. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures.

2.    REVENUE RECOGNITION

The Company adopted ASC 606 - Revenue from Contracts with Customers using the modified retrospective method effective July 1, 2018. The Company completed an analysis of revenue streams at each of its business units and evaluated the impact of adopting ASC 606 on revenue recognition. The Company primarily sells purchased products and the majority of its revenue is recognized at a point in time. The cumulative effect of initially applying ASC 606 resulted in a net increase to the opening retained earnings balance of $3,429, net of tax, at July 1, 2018. The transition adjustment is comprised of two components. The first component is recognition of revenue from bill and hold arrangements. The second component is recognition of revenue from contracts that meet the criteria to recognize revenue over time as the underlying products have no alternative use and the Company has a right to payment for performance completed to date. Revenue for periods prior to July 1, 2018 has not been adjusted and continues to be reported under ASC Topic 605 - Revenue Recognition.
Revenue Recognition
The Company primarily sells purchased products distributed through its network of service centers and recognizes revenue at a point in time when control of the product transfers to the customer, typically upon shipment from an Applied facility or directly from a supplier. For products that ship directly from suppliers to customers, Applied acts as the principal in the transaction and recognizes revenue on a gross basis. Revenue recognized over time is not significant. Revenue is measured as the amount of consideration expected to be received in exchange for the products and services provided, net of allowances for product returns, variable consideration, and any taxes collected from customers that will be remitted to governmental authorities. Shipping and handling costs are recognized in net sales when they are billed to the customer. The Company has elected to account for shipping and handling activities as fulfillment costs. There are no significant costs associated with obtaining customer contracts.
Payment terms with customers vary by the type and location of the customer and the products or services offered. The Company does not adjust the promised amount of consideration for the effects of significant financing components based on the expectation that the period between when the Company transfers a promised good or service to a

7

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

customer and when the customer pays for that good or service will be one year or less. Arrangements with customers that include payment terms extending beyond one year are not significant.
Accounts Receivable
Accounts receivable are stated at their estimated net realizable value and consist of amounts billed or billable and currently due from customers. The Company maintains an allowance for doubtful accounts, which reflects management’s best estimate of probable losses based on an analysis of customer accounts, known troubled accounts, historical experience with write-offs, and other currently available evidence.
Variable Consideration
The Company’s products are generally sold with a right of return and may include variable consideration in the form of incentives, discounts, credits or rebates. Product returns are estimated based on historical return rates. The Company estimates and recognizes variable consideration based on historical experience to determine the expected amount to which the Company will be entitled in exchange for transferring the promised goods or services to a customer. The Company records variable consideration as an adjustment to the transaction price in the period it is incurred. The realization of variable consideration occurs within a short period of time from product delivery; therefore, the time value of money effect is not significant.
Contract Assets
The Company’s contract assets consist of un-billed amounts resulting from contracts for which revenue is recognized over time using the cost-to-cost method, and for which revenue recognized exceeds the amount billed to the customer. On July 1, 2018, $13,823 of contract assets were recognized as part of the cumulative effect adjustment resulting from the adoption of ASC 606.
Activity related to contract assets, which are included in other current assets on the condensed consolidated balance sheet, is as follows:
 
December 31, 2018
July 1, 2018
$ Change
% Change
Contract assets
$
9,324

$
13,823

$
(4,499
)
(32.5
)%
The following tables summarize the impacts of ASC 606 on the Company's condensed consolidated financial statements:
 
 
For the three months ended December 31, 2018
 
 
As Reported
 
Adjustments
 
Balances without adoption of ASC 606
Net sales
 
$
840,038

 
$
1,005

 
$
841,043

Cost of sales
 
597,178

 
699

 
597,877

Gross profit
 
242,860

 
306

 
243,166

Selling, distribution and administrative expense, including depreciation
 
181,895

 
55

 
181,950

Operating income
 
60,965

 
251

 
61,216

Interest expense, net
 
9,578

 

 
9,578

Other expense, net
 
946

 

 
946

Income before income taxes
 
50,441

 
251

 
50,692

Income tax expense
 
11,724

 
64

 
11,788

Net income
 
$
38,717

 
$
187

 
$
38,904


8

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

 
 
For the six months ended December 31, 2018
 
 
As Reported
 
Adjustments
 
Balances without adoption of ASC 606
Net sales
 
$
1,704,553

 
$
4,317

 
$
1,708,870

Cost of sales
 
1,209,840

 
3,103

 
1,212,943

Gross profit
 
494,713

 
1,214

 
495,927

Selling, distribution and administrative expense, including depreciation
 
367,409

 
274

 
367,683

Operating income
 
127,304

 
940

 
128,244

Interest expense, net
 
20,054

 

 
20,054

Other expense, net
 
707

 

 
707

Income before income taxes
 
106,543

 
940

 
107,483

Income tax expense
 
18,888

 
236

 
19,124

Net income
 
$
87,655

 
$
704

 
$
88,359

 
 
As of December 31, 2018
 
 
As Reported
 
Adjustments
 
Balances without adoption of ASC 606
Assets
 
 
 
 
 
 
Other current assets
 
$
44,041

 
$
(9,324
)
 
$
34,717

Inventories
 
445,881

 
11,830

 
457,711

Other assets
 
21,901

 
192

 
22,093

 
 
 
 
 
 
 
Liabilities
 


 
 
 
 
Other current liabilities
 
60,164

 
6,626

 
66,790

Compensation and related benefits
 
56,882

 
(456
)
 
56,426

Other liabilities
 
73,675

 
(747
)
 
72,928

 
 


 
 
 
 
Equity
 
 
 
 
 
 
Retained Earnings
 
$
889,915

 
$
(2,725
)
 
$
887,190

Disaggregation of Revenues
The following tables present the Company's net sales by reportable segment and by geographic areas based on the location of the facility shipping the product for the three and six months ended December 31, 2018. Other countries consist of Mexico, Australia, New Zealand, and Singapore.
 
Three Months Ended December 31,
 
2018
 
2017
 
Service Center Based Distribution
Fluid Power & Flow Control
Total
 
Service Center Based Distribution
Fluid Power & Flow Control
Total
Geographic Areas:
 
 
 
 
 
 
 
United States
$
479,335

$
247,862

727,197

 
$
448,819

$
108,212

$
557,031

Canada
68,569


68,569

 
67,479


$
67,479

Other countries
41,394

2,878

44,272

 
39,309

3,368

$
42,677

Total
$
589,298

$
250,740

$
840,038

 
$
555,607

$
111,580

$
667,187


9

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

 
Six Months Ended December 31,
 
2018
 
2017
 
Service Center Based Distribution
Fluid Power & Flow Control
Total
 
Service Center Based Distribution
Fluid Power & Flow Control
Total
Geographic Areas:
 
 
 
 
 
 
 
United States
$
970,109

$
504,511

1,474,620

 
$
907,815

$
216,761

$
1,124,576

Canada
137,676


137,676

 
134,296


$
134,296

Other countries
85,562

6,695

92,257

 
82,409

6,607

$
89,016

Total
$
1,193,347

$
511,206

$
1,704,553

 
$
1,124,520

$
223,368

$
1,347,888

The following tables present the Company’s percentage of revenue by reportable segment and major customer industry for the three and six months ended December 31, 2018:
 
For the three months ended December 31, 2018
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
General Industry
35.9
%
 
46.1
%
 
38.9
%
Industrial Machinery
9.7
%
 
20.3
%
 
12.9
%
Metals
13.6
%
 
8.5
%
 
12.1
%
Food
10.1
%
 
2.7
%
 
7.8
%
Oil & Gas
10.2
%
 
2.1
%
 
7.8
%
Chem/Petrochem
2.9
%
 
14.0
%
 
6.2
%
Forest Products
7.1
%
 
2.9
%
 
5.9
%
Cement & Aggregate
6.0
%
 
0.9
%
 
4.5
%
Transportation
4.5
%
 
2.5
%
 
3.9
%
Total
100.0
%
 
100.0
%
 
100.0
%
 
For the six months ended December 31, 2018
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
General Industry
35.8
%
 
44.9
%
 
38.4
%
Industrial Machinery
9.5
%
 
20.8
%
 
12.9
%
Metals
12.3
%
 
8.2
%
 
11.1
%
Food
10.4
%
 
2.6
%
 
8.1
%
Oil & Gas
9.9
%
 
2.1
%
 
7.6
%
Chem/Petrochem
3.2
%
 
14.8
%
 
6.7
%
Forest Products
8.0
%
 
2.8
%
 
6.4
%
Cement & Aggregate
6.4
%
 
1.0
%
 
4.8
%
Transportation
4.5
%
 
2.8
%
 
4.0
%
Total
100.0
%
 
100.0
%
 
100.0
%

10

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

The following tables present the Company’s percentage of revenue by reportable segment and product line for the three and six months ended December 31, 2018:
 
For the three months ended December 31, 2018
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
Power Transmission
34.3
%
 
1.3
%
 
24.4
%
Fluid Power
13.7
%
 
38.1
%
 
21.0
%
General Maintenance; Hose Products
25.4
%
 
5.8
%
 
19.6
%
Bearings, Linear & Seals
26.6
%
 
0.4
%
 
18.8
%
Specialty Flow Control
%
 
54.4
%
 
16.2
%
Total
100.0
%
 
100.0
%
 
100.0
%
 
For the six months ended December 31, 2018
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
Power Transmission
33.5
%
 
1.4
%
 
23.9
%
Fluid Power
13.8
%
 
37.9
%
 
21.0
%
General Maintenance; Hose Products
26.6
%
 
5.2
%
 
20.2
%
Bearings, Linear & Seals
26.1
%
 
0.2
%
 
18.3
%
Specialty Flow Control
%
 
55.3
%
 
16.6
%
Total
100.0
%
 
100.0
%
 
100.0
%

3.
BUSINESS COMBINATIONS

The operating results of all acquired entities are included within the consolidated operating results of the Company from the date of each respective acquisition.
Fiscal 2019 Acquisition
On November 2, 2018, the Company acquired substantially all of the net assets of Fluid Power Sales, Inc. (FPS), a Baldwinsville, New York based manufacturer and distributor of fluid power components, specializing in the engineering and fabrication of manifolds and power units. FPS is included in the Fluid Power & Flow Control segment. The purchase price for the acquisition was $8,100, net tangible assets acquired were $4,104, and goodwill was $3,996 based upon estimated fair values at the acquisition date. The purchase price includes acquisition holdback payments of $1,200, which is included in other current liabilities and other liabilities on the condensed consolidated balance sheet as of December 31, 2018, and which will be paid on the first and second anniversaries of the acquisition date with interest at a fixed rate of 1.5% per annum. The Company funded this acquisition using available cash. The acquisition price and the results of operations for the acquired entity are not material in relation to the Company's consolidated financial statements.
FCX Acquisition
On January 31, 2018, the Company completed the acquisition of 100% of the outstanding shares of FCX Performance, Inc. (FCX), a Columbus, Ohio based distributor of specialty process flow control products and services. The total consideration transferred for the acquisition was $781,781, which was financed by cash-on-hand and a new credit facility comprised of a $780,000 Term Loan A and a $250,000 revolver, effective with the transaction closing. See Note 5 - Debt. As a distributor of engineered valves, instruments, pumps and lifecycle services to MRO (Maintenance, Repair & Operations) and OEM (Original Equipment Manufacturer) customers across diverse industrial and process end markets, this business is included in the Fluid Power & Flow Control Segment.


11

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

The following table summarizes the consideration transferred, assets acquired, and liabilities assumed in connection with the acquisition of FCX based on their preliminary estimated fair values at the acquisition date, which are subject to adjustment. The purchase accounting will be finalized within one year from the acquisition date.
Cash
$
11,141

Accounts receivable
80,836

Inventories
44,669

Other current assets
1,657

Property
8,282

Identifiable intangible assets
305,420

Goodwill
440,143

Other assets
775

Total assets acquired
$
892,923

Accounts payable and accrued liabilities
54,012

Other liabilities
2,677

Deferred tax liabilities
54,453

Net assets acquired
$
781,781

 
 
Purchase price
$
784,281

Reconciliation of fair value transferred:
 
Working Capital Adjustments
(2,500
)
Total Consideration
$
781,781


Goodwill acquired of $161,452 is expected to be deductible for income tax purposes.

Net sales, operating income and net income from the FCX acquisition included in the Company’s three and six months ended December 31, 2018 are as follows:
 
Three Months Ended December 31, 2018
Six Months Ended December 31, 2018
Net sales
$
138,254

$
284,740

Operating income
10,906

22,458

Net income
8,463

17,683


The following unaudited pro forma consolidated results of operations have been prepared as if the FCX acquisition (including the related acquisition costs) had occurred at the beginning of fiscal 2018:
 
Three Months Ended December 31,
Six Months Ended December 31,
Pro forma
2017
2017
Net sales
$
789,407

$
1,565,890

Operating income
46,640

102,045

Net income
26,287

58,127

Diluted net income per share
$
0.67

$
1.48


These pro forma amounts have been calculated after applying the Company’s accounting policies and adjusting the results to reflect additional amortization that would have been recorded assuming the fair value adjustments to identified intangible assets had been applied as of July 1, 2017. In addition, pro forma adjustments have been made for the interest expense that would have been incurred as a result of the indebtedness used to finance the acquisitions. The pro forma net income amounts also incorporate an adjustment to the recorded income tax expense for the income

12

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

tax effect of the pro forma adjustments described above. These pro forma results of operations do not include any anticipated synergies or other effects of the planned integration of FCX; accordingly, such pro forma adjustments do not purport to be indicative of the results of operations that actually would have resulted had the acquisitions occurred as of the date indicated or that may result in the future.
Other Fiscal 2018 Acquisition
On July 3, 2017, the Company acquired 100% of the outstanding stock of Diseño, Construcciones y Fabricaciones Hispanoamericanas, S.A. (DICOFASA), a distributor of accessories and components for hydraulic systems and lubrication, located in Puebla, Mexico. DICOFASA is included in the Service Center Based Distribution segment. The purchase price for the acquisition was $5,920, net tangible assets acquired were $3,395, and goodwill was $2,525 based upon estimated fair values at the acquisition date. The purchase price includes $906 of acquisition holdback payments, of which $219 was paid during the six months ended December 31, 2018. Due to changes in foreign currency exchange rates, the remaining balance is $634, which is included in other current liabilities and other liabilities on the condensed consolidated balance sheet as of December 31, 2018, and which will be paid on the second and third anniversaries of the acquisition date with interest at a fixed rate of 1.5% per annum. The Company funded this acquisition using available cash. The acquisition price and the results of operations for the acquired entity are not material in relation to the Company's consolidated financial statements.

4.    GOODWILL AND INTANGIBLES

The changes in the carrying amount of goodwill for both the Service Center Based Distribution segment and the Fluid Power & Flow Control segment for the fiscal year ended June 30, 2018 and the six month period ended December 31, 2018 are as follows:
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
Balance at July 1, 2017
$
201,740

 
$
4,395

 
$
206,135

Goodwill acquired during the period
2,525

 
439,164

 
441,689

Other, primarily currency translation
(1,181
)
 

 
(1,181
)
Balance at June 30, 2018
$
203,084

 
$
443,559

 
$
646,643

Goodwill acquired/adjusted during the period

 
4,975

 
4,975

Other, primarily currency translation
(412
)
 

 
(412
)
Balance at December 31, 2018
$
202,672

 
$
448,534

 
$
651,206


The Company has six (6) reporting units for which an annual goodwill impairment assessment was performed as of January 1, 2018.  The Company concluded that all of the reporting units’ fair value exceeded their carrying amounts by at least 30% as of January 1, 2018. The fair values of the reporting units in accordance with the goodwill impairment test were determined using the Income and Market approaches.  The Income approach employs the discounted cash flow method reflecting projected cash flows expected to be generated by market participants and then adjusted for time value of money factors. The Market approach utilizes an analysis of comparable publicly traded companies. 

The techniques used in the Company's impairment tests have incorporated a number of assumptions that the Company believes to be reasonable and to reflect known market conditions at the measurement dates. Assumptions in estimating future cash flows are subject to a degree of judgment. The Company makes all efforts to forecast future cash flows as accurately as possible with the information available at the measurement date.  The Company evaluates the appropriateness of its assumptions and overall forecasts by comparing projected results of upcoming years with actual results of preceding years.  Key Level 3 based assumptions relate to pricing trends, inventory costs, customer demand, and revenue growth.  A number of benchmarks from independent industry and other economic publications were also used.  Changes in future results, assumptions, and estimates after the measurement date may lead to an outcome where additional impairment charges would be required in future periods.  Specifically, actual results may vary from the Company’s forecasts and such variations may be material and unfavorable, thereby triggering the need for future impairment tests where the conclusions may differ in reflection of prevailing market conditions. 


13

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

At December 31, 2018 and June 30, 2018, accumulated goodwill impairment losses subsequent to fiscal year 2002 totaled $64,794 related to the Service Center Based Distribution segment and $36,605 related to the Fluid Power & Flow Control segment.

The Company’s identifiable intangible assets resulting from business combinations are amortized over their estimated period of benefit and consist of the following:
December 31, 2018
 
Amount
 
Accumulated
Amortization
 
Net Book
Value
Finite-Lived Identifiable Intangibles:
 
 
 
 
 
 
Customer relationships
 
$
463,998

 
$
141,565

 
$
322,433

Trade names
 
112,757

 
26,179

 
86,578

Vendor relationships
 
11,376

 
7,758

 
3,618

Non-competition agreements
 
2,762

 
2,298

 
464

Total Identifiable Intangibles
 
$
590,893

 
$
177,800

 
$
413,093


June 30, 2018
 
Amount
 
Accumulated
Amortization
 
Net Book
Value
Finite-Lived Identifiable Intangibles:
 
 
 
 
 
 
Customer relationships
 
$
465,691

 
$
125,009

 
$
340,682

Trade names
 
112,939

 
22,454

 
90,485

Vendor relationships
 
11,425

 
7,382

 
4,043

Non-competition agreements
 
2,761

 
2,024

 
737

Total Identifiable Intangibles
 
$
592,816

 
$
156,869

 
$
435,947


Amounts include the impact of foreign currency translation. Fully amortized amounts are written off.

Estimated future amortization expense by fiscal year (based on the Company’s identifiable intangible assets as of December 31, 2018) for the next five years is as follows: $22,200 for the remainder of 2019, $42,600 for 2020, $40,200 for 2021, $37,800 for 2022, $35,400 for 2023 and $31,000 for 2024.

5.     DEBT

Revolving Credit Facility & Term Loan
In January 2018, in conjunction with the acquisition of FCX, the Company refinanced its existing credit facility and entered into a new five-year credit facility with a group of banks expiring in January 2023. This agreement provides for a $780,000 unsecured term loan and a $250,000 unsecured revolving credit facility. Fees on this facility range from 0.10% to 0.20% per year based upon the Company's leverage ratio at each quarter end. Borrowings under this agreement carry variable interest rates tied to either LIBOR or prime at the Company's discretion. At December 31, 2018 and June 30, 2018, the Company had $623,375 and $775,125, respectively, outstanding under the term loan. The interest rate on the term loan as of December 31, 2018 and June 30, 2018 was 4.31% and 4.13%, respectively. The Company had no amount outstanding under the revolver at December 31, 2018, and $19,500 was outstanding under the revolver at June 30, 2018. Unused lines under this facility, net of outstanding letters of credit of $4,674 and $3,625, respectively, to secure certain insurance obligations, totaled $245,326 and $226,875 at December 31, 2018 and June 30, 2018, respectively, and were available to fund future acquisitions or other capital and operating requirements. The weighted average interest rate on the amount outstanding under the revolving credit facility as of June 30, 2018 was 3.93%.
Additionally, the Company had letters of credit outstanding with a separate bank, not associated with the revolving credit agreement, in the amount of $2,698 as of December 31, 2018 and June 30, 2018, in order to secure certain insurance obligations.

14

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

Trade Receivable Securitization Facility
In August 2018, the Company established a trade receivable securitization facility (the “AR Securitization Facility”) with a termination date of August 31, 2021. The maximum availability under the AR Securitization Facility is $175,000. Availability is further subject to changes in the credit ratings of our customers, customer concentration levels or certain characteristics of the accounts receivable being transferred and, therefore, at certain times, we may not be able to fully access the $175,000 of funding available under the AR Securitization Facility. The AR Securitization Facility effectively increases the Company’s borrowing capacity by collateralizing a portion of the amount of the Service Center Based Distribution reportable segment’s U.S. operations’ trade accounts receivable. The collateralized trade accounts receivable is equal to the borrowed amount outstanding under the AR Securitization Facility and there are no restrictions on cash or other assets. The Company uses the proceeds from the AR Securitization Facility as an alternative to other forms of debt, effectively reducing borrowing costs. Borrowings under this facility carry variable interest rates tied to LIBOR and fees on the AR Securitization Facility are 0.90% per year. As of December 31, 2018, the Company borrowed $175,000 under the AR Securitization Facility, and the interest rate was 3.22%.
Other Long-Term Borrowings
At December 31, 2018 and June 30, 2018, the Company had borrowings outstanding under its unsecured shelf facility agreement with Prudential Investment Management of $170,000. The "Series C" notes have a principal amount of $120,000 and carry a fixed interest rate of 3.19%, and are due in equal principal payments in July 2020, 2021, and 2022. The "Series D" notes have a principal amount of $50,000 and carry a fixed interest rate of 3.21%, and are due in equal principal payments in October 2019 and 2023. As of December 31, 2018, $50,000 in additional financing was available under this facility.
In April 2014 the Company assumed $2,359 of debt as a part of the headquarters facility acquisition. The 1.5% fixed interest rate note is held by the State of Ohio Development Services Agency, maturing in May 2024. At December 31, 2018 and June 30, 2018, $1,322 and $1,438 was outstanding, respectively.
Unamortized debt issue costs of $551 are included as a reduction of current portion of long-term debt on the condensed consolidated balance sheets as of December 31, 2018 and June 30, 2018, respectively. Unamortized debt issue costs of $1,552 and $1,807 are included as a reduction of long-term debt on the condensed consolidated balance sheets as of December 31, 2018 and June 30, 2018, respectively.

6.    FAIR VALUE MEASUREMENTS

Marketable securities measured at fair value at December 31, 2018 and June 30, 2018 totaled $9,730 and $10,318, respectively. The majority of these marketable securities are held in a rabbi trust for a non-qualified deferred compensation plan. The marketable securities are included in other assets on the accompanying condensed consolidated balance sheets and their fair values were determined using quoted market prices (Level 1 in the fair value hierarchy).
As of December 31, 2018 and June 30, 2018, the carrying values of the Company's fixed interest rate debt outstanding under its unsecured shelf facility agreement with Prudential Investment Management approximated fair value (Level 2 in the fair value hierarchy).
The revolving credit facility, the term loan and the AR Securitization Facility contain variable interest rates and their carrying values approximate fair value (Level 2 in the fair value hierarchy).

7.    INCOME TAXES

On December 22, 2017, the Tax Cuts and Jobs Act (the "Act") was enacted in the U.S., making significant changes to U.S. tax law. The Act reduced the U.S. federal corporate income tax rate from 35% to 21%, required companies to pay a one-time transition tax on certain un-remitted earnings of foreign subsidiaries that were previously tax deferred, generally eliminated U.S. federal income tax on dividends from foreign subsidiaries, and created new taxes on certain foreign-sourced earnings. During the six months ended December 31, 2018, the Company's estimated annual effective tax rate reflects the change in the federal statutory rate from 35% to 21%. The corporate income tax rate change had a favorable impact to the Company of $5,780 and $13,634 for the three and six months ended December 31, 2018, respectively.

15

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

As of December 31, 2018, we have completed our accounting for the tax effects of the Act. In fiscal 2018, we recognized a provisional tax liability of $3,877 related to the one-time transition tax on certain un-remitted earnings of foreign subsidiaries, which is payable over eight years. During fiscal 2019, the Company recorded adjustments totaling $3,497 to reduce the tax liability related to the one-time transition tax. We also recorded a net tax benefit of $577 to increase the foreign tax credit related to the transition tax. The new taxes and deductions related to certain foreign-sourced earnings recognized in fiscal 2019 resulted in a net tax benefit of $375.
Overall, considering the decrease in the corporate income tax rate, the tax benefit related to the transition tax adjustment, and the new taxes and deductions related to certain foreign earnings, the Act resulted in a tax benefit of $5,977 and $18,083 for the three and six months ended December 31, 2018, respectively, which is included as a component of income tax expense in the condensed statements of consolidated income.

8.    SHAREHOLDERS' EQUITY

Accumulated Other Comprehensive Loss
Changes in the accumulated other comprehensive loss are comprised of the following amounts, shown net of taxes:
 
 
Three Months Ended December 31, 2018
 
 
Foreign currency translation adjustment

 
Post-employment benefits

 
Total Accumulated other comprehensive (loss) income

Balance at October 1, 2018
 
$
(82,521
)
 
$
(2,355
)
 
$
(84,876
)
Other comprehensive loss
 
(9,699
)
 

 
(9,699
)
Amounts reclassified from accumulated other comprehensive (loss) income
 

 
(57
)
 
(57
)
Net current-period other comprehensive loss
 
(9,699
)
 
(57
)
 
(9,756
)
Balance at December 31, 2018
 
$
(92,220
)
 
$
(2,412
)
 
$
(94,632
)

 
 
Three Months Ended December 31, 2017
 
 
Foreign currency translation adjustment

 
Unrealized gain (loss) on securities available for sale

 
Post-employment benefits

 
Total Accumulated other comprehensive (loss) income

Balance at October 1, 2017
 
$
(71,288
)
 
$
18

 
$
(2,280
)
 
$
(73,550
)
Other comprehensive (loss) income
 
(6,067
)
 
17

 

 
(6,050
)
Amounts reclassified from accumulated other comprehensive (loss) income
 

 

 
(14
)
 
(14
)
Net current-period other comprehensive (loss) income
 
(6,067
)
 
17

 
(14
)
 
(6,064
)
Balance at December 31, 2017
 
$
(77,355
)
 
$
35

 
$
(2,294
)
 
$
(79,614
)


16

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

 
 
Six Months Ended December 31, 2018
 
 
Foreign currency translation adjustment

 
Unrealized gain (loss) on securities available for sale

 
Post-employment benefits

 
Total Accumulated other comprehensive (loss) income

Balance at July 1, 2018
 
$
(87,974
)
 
$
50

 
$
(2,299
)
 
$
(90,223
)
Other comprehensive loss
 
(4,246
)
 

 

 
(4,246
)
Amounts reclassified from accumulated other comprehensive (loss) income
 

 

 
(113
)
 
(113
)
Cumulative effect of adopting accounting standard
 

 
(50
)
 

 
(50
)
Net current-period other comprehensive loss
 
(4,246
)
 
(50
)
 
(113
)
 
(4,409
)
Balance at December 31, 2018
 
$
(92,220
)
 
$

 
$
(2,412
)
 
$
(94,632
)

 
 
Six Months Ended December 31, 2017
 
 
Foreign currency translation adjustment

 
Unrealized gain (loss) on securities available for sale

 
Post-employment benefits

 
Total Accumulated other comprehensive (loss) income

Balance at July 1, 2017
 
$
(79,447
)
 
$
21

 
$
(2,276
)
 
$
(81,702
)
Other comprehensive income (loss)
 
2,092

 
14

 

 
2,106

Amounts reclassified from accumulated other comprehensive (loss) income
 

 

 
(18
)
 
(18
)
Net current-period other comprehensive income (loss)
 
2,092

 
14

 
(18
)
 
2,088

Balance at December 31, 2017
 
$
(77,355
)
 
$
35

 
$
(2,294
)
 
$
(79,614
)

Other Comprehensive (Loss) Income
Details of other comprehensive (loss) income are as follows:
 
Three Months Ended December 31,
 
2018
 
2017
 
Pre-Tax Amount
 
Tax Benefit
 
Net Amount
 
Pre-Tax Amount
 
Tax Expense (Benefit)
 
Net Amount
Foreign currency translation adjustments
$
(10,270
)
 
$
(571
)
 
$
(9,699
)
 
$
(6,031
)
 
$
36

 
$
(6,067
)
Post-employment benefits:
 
 
 
 
 
 
 
 
 
 
 
Reclassification of net actuarial gains and prior service cost into other expense (income), net and included in net periodic pension costs
(78
)
 
(21
)
 
(57
)
 
(22
)
 
(8
)
 
(14
)
Unrealized gain on investment securities available for sale

 

 

 
46

 
29

 
17

Other comprehensive (loss) income
$
(10,348
)
 
$
(592
)
 
$
(9,756
)
 
$
(6,007
)
 
$
57

 
$
(6,064
)

17

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

 
Six Months Ended December 31,
 
2018
 
2017
 
Pre-Tax Amount
 
Tax Benefit
 
Net Amount
 
Pre-Tax Amount
 
Tax Expense (Benefit)
 
Net Amount
Foreign currency translation adjustments
$
(4,556
)
 
$
(310
)
 
$
(4,246
)
 
$
2,128

 
$
36

 
$
2,092

Post-employment benefits:
 
 
 
 
 
 
 
 
 
 
 
Reclassification of net actuarial gains and prior service cost into other expense (income), net and included in net periodic pension costs
(153
)
 
(40
)
 
(113
)
 
(36
)
 
(18
)
 
(18
)
Unrealized (loss) gain on investment securities available for sale

 

 

 
42

 
28

 
14

Cumulative effect of adopting accounting standard
(50
)
 

 
(50
)
 

 

 

Other comprehensive income
$
(4,759
)
 
$
(350
)
 
$
(4,409
)
 
$
2,134

 
$
46

 
$
2,088

 
Anti-dilutive Common Stock Equivalents
In the three month periods ended December 31, 2018 and 2017, respectively, stock options and stock appreciation rights related to 242 and 234 shares of common stock, were not included in the computation of diluted earnings per share for the periods then ended as they were anti-dilutive. In the six month periods ended December 31, 2018 and 2017, respectively, stock options and stock appreciation rights related to 242 and 274 shares of common stock, were not included in the computation of diluted earnings per share for the periods then ended as they were anti-dilutive.

9.    BENEFIT PLANS

The following table provides summary disclosures of the net periodic post-employment costs recognized for the Company’s post-employment benefit plans:
 
 
Pension Benefits
 
Retiree Health Care
Benefits
Three Months Ended December 31,
 
2018
 
2017
 
2018
 
2017
Components of net periodic cost:
 
 
 
 
 
 
 
 
Service cost
 
$
11

 
$
31

 
$
4

 
$
4

Interest cost
 
174

 
184

 
13

 
13

Expected return on plan assets
 
(133
)
 
(119
)
 

 

Recognized net actuarial loss (gain)
 
46

 
106

 
(30
)
 
(38
)
Amortization of prior service cost
 

 
7

 
(92
)
 
(92
)
Net periodic cost (benefit)
 
$
98

 
$
209

 
$
(105
)
 
$
(113
)
 
 
Pension Benefits
 
Retiree Health Care
Benefits
Six Months Ended December 31,
 
2018
 
2017
 
2018
 
2017
Components of net periodic cost:
 
 
 
 
 
 
 
 
Service cost
 
$
22

 
$
62

 
$
8

 
$
9

Interest cost
 
348

 
367

 
26

 
26

Expected return on plan assets
 
(266
)
 
(237
)
 

 

Recognized net actuarial loss (gain)
 
92

 
212

 
(60
)
 
(77
)
Amortization of prior service cost
 

 
14

 
(184
)
 
(184
)
Net periodic cost (benefit)
 
$
196

 
$
418

 
$
(210
)
 
$
(226
)
    

18

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

The Company contributed $3,100 to its pension benefit plans and $110 to its retiree health care plans in the six months ended December 31, 2018. Expected contributions for the remainder of fiscal 2019 are $200 for the pension benefit plans to fund scheduled retirement payments and $110 for retiree health care plans.

10.    SEGMENT INFORMATION

In the first quarter of fiscal 2019, the Company performed a review of its management reporting structure and implemented changes to align with how the Company measures performance. As a result, the Company has revised its reportable segments to reflect how management currently reviews financial information and makes operating decisions. Certain supplier support benefits are now included within the Service Center Based Distribution segment operating income. Previously, these benefits were included in Corporate and other expense, net. All prior-period amounts have been adjusted to reflect the reportable segment change.
The accounting policies of the Company’s reportable segments are generally the same as those used to prepare the condensed consolidated financial statements. Intercompany sales, primarily from the Fluid Power & Flow Control segment to the Service Center Based Distribution segment, of $6,769 and $5,664, in the three months ended December 31, 2018 and 2017, respectively, and $13,685 and $11,755 in the six months ended December 31, 2018 and 2017, respectively, have been eliminated in the Segment Financial Information tables below.
Three Months Ended
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
December 31, 2018
 
 
 
 
 
 
Net sales
 
$
589,298

 
$
250,740

 
$
840,038

Operating income for reportable segments
 
58,317

 
29,243

 
87,560

Depreciation and amortization of property
 
3,911

 
1,127

 
5,038

Capital expenditures
 
3,256

 
667

 
3,923

 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
Net sales
 
$
555,607

 
$
111,580

 
$
667,187

Operating income for reportable segments
 
52,642

 
13,766

 
66,408

Depreciation and amortization of property
 
3,802

 
279

 
4,081

Capital expenditures
 
4,822

 
302

 
5,124

 
Six Months Ended
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
December 31, 2018
 
 
 
 
 
 
Net sales
 
$
1,193,347

 
$
511,206

 
$
1,704,553

Operating income for reportable segments
 
121,126

 
60,123

 
181,249

Assets used in business
 
1,223,926

 
1,066,062

 
2,289,988

Depreciation and amortization of property
 
7,822

 
2,197

 
10,019

Capital expenditures
 
5,700

 
1,396

 
7,096

 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
Net sales
 
$
1,124,520

 
$
223,368

 
$
1,347,888

Operating income for reportable segments
 
111,889

 
26,968

 
138,857

Assets used in business
 
1,199,704

 
206,178

 
1,405,882

Depreciation and amortization of property
 
7,471

 
537

 
8,008

Capital expenditures
 
10,370

 
1,090

 
11,460




19

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

A reconciliation of operating income for reportable segments to the condensed consolidated income before income taxes is as follows:
 
 
 
Three Months Ended
 
Six Months Ended
 
 
December 31,
 
December 31,
 
 
2018
 
2017
 
2018
 
2017
Operating income for reportable segments
 
$
87,560

 
$
66,408

 
$
181,249

 
$
138,857

Adjustment for:
 
 
 
 
 
 
 
 
Intangible amortization—Service Center Based Distribution
 
3,973

 
4,425

 
7,991

 
8,937

Intangible amortization—Fluid Power & Flow Control
 
7,018

 
1,270

 
13,921

 
2,589

Corporate and other expense, net
 
15,604

 
13,998

 
32,033

 
28,779

Total operating income
 
60,965

 
46,715

 
127,304

 
98,552

Interest expense, net
 
9,578

 
2,139

 
20,054

 
4,305

Other expense (income), net
 
946

 
(20
)
 
707

 
(731
)
Income before income taxes
 
$
50,441

 
$
44,596

 
$
106,543

 
$
94,978


The change in corporate and other expense, net is due to changes in corporate expenses, as well as in the amounts and levels of certain expenses being allocated to the segments. The expenses being allocated include corporate charges for working capital, logistics support and other items.

11.    OTHER EXPENSE (INCOME), NET

Other expense (income), net consists of the following:
 
 
Three Months Ended
 
Six Months Ended
 
 
December 31,
 
December 31,
 
 
2018
 
2017
 
2018
 
2017
Unrealized loss (gain) on assets held in rabbi trust for a non-qualified deferred compensation plan
 
$
1,179

 
$
(417
)
 
$
837

 
$
(784
)
Foreign currency transactions loss (gain)
 
7

 
260

 
34

 
(51
)
Net other periodic post-employment (benefits) costs
 
(22
)
 
61

 
(44
)
 
121

Other, net
 
(218
)
 
76

 
(120
)
 
(17
)
Total other expense (income), net
 
$
946

 
$
(20
)
 
$
707

 
$
(731
)




20



APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


The accompanying condensed consolidated financial statements of the Company have been reviewed by the Company’s independent registered public accounting firm, Deloitte & Touche LLP, whose report covering their reviews of the condensed consolidated financial statements follows.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of
Applied Industrial Technologies, Inc.
Cleveland, Ohio

Results of Review of Interim Financial Information

We have reviewed the accompanying condensed consolidated balance sheet of Applied Industrial Technologies, Inc. and subsidiaries (the “Company”) as of December 31, 2018, the related condensed consolidated statements of income and comprehensive income for the three-month and six-month periods ended December 31, 2018 and 2017, and of consolidated cash flows for the six-month periods ended December 31, 2018 and 2017, and the related notes (collectively referred to as the "interim financial information"). Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of June 30, 2018, and the related statements of consolidated income, comprehensive income, shareholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated August 17, 2018, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of June 30, 2018, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results

This interim financial information is the responsibility of the Company's management. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our reviews in accordance with standards of the PCAOB. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
 
/s/ Deloitte & Touche LLP         

Cleveland, Ohio
January 25, 2019



21

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS


With approximately 6,700 employees across North America, Australia, New Zealand, and Singapore, Applied Industrial Technologies (“Applied,” the “Company,” “We,” “Us” or “Our”) is a leading distributor of bearings, power transmission products, engineered fluid power components and systems, specialty flow control solutions, and other industrial supplies, serving MRO (Maintenance, Repair & Operations) and OEM (Original Equipment Manufacturer) customers in virtually every industry. In addition, Applied provides engineering, design and systems integration for industrial, fluid power, and flow control applications, as well as customized mechanical, fabricated rubber, fluid power, and flow control shop services. Applied also offers storeroom services and inventory management solutions that provide added value to its customers. We have a long tradition of growth dating back to 1923, the year our business was founded in Cleveland, Ohio. During the second quarter of fiscal 2019, business was conducted in the United States, Puerto Rico, Canada, Mexico, Australia, New Zealand, and Singapore from 606 facilities.

The following is Management's Discussion and Analysis of significant factors which have affected our financial condition, results of operations and cash flows during the periods included in the accompanying condensed consolidated balance sheets, statements of consolidated income, consolidated comprehensive income and consolidated cash flows. When reviewing the discussion and analysis set forth below, please note that the majority of SKUs (Stock Keeping Units) we sell in any given period were not necessarily sold in the comparable period of the prior year, resulting in the inability to quantify certain commonly used comparative metrics analyzing sales, such as changes in product mix and volume.

Overview
Consolidated sales for the quarter ended December 31, 2018 increased $172.9 million or 25.9% compared to the prior year quarter, with acquisitions increasing sales by $142.2 million or 21.3% and unfavorable foreign currency translation of $4.7 million decreasing sales by 0.7%. Operating margin of 7.3% of sales, was up from 7.0% for the prior year quarter. Net income of $38.7 million increased 25.1% compared to the prior year quarter. Shareholders' equity was $889.9 million at December 31, 2018, up from the June 30, 2018 level of $815.0 million. The current ratio was 2.7 to 1 at December 31, 2018 and 2.4 to 1 at June 30, 2018.

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 MCU (total industry) and IP indices have increased since June and September 2018. The MCU for December 2018 was 78.7, which is increased from both the June 2018 and September 2018 revised readings of 77.8 and 78.4, respectively. The ISM PMI registered 54.1 in December, down from the September 2018 reading of 59.8, but remained above 50 (its expansionary threshold). The indices for the months during the current quarter were as follows:
 
Index Reading
Month
MCU
PMI
IP
December 2018
78.7
54.1
106.2
November 2018
78.6
59.3
105.0
October 2018
78.4
57.7
105.0

The number of Company employees was 6,664 at December 31, 2018, 6,634 at June 30, 2018, and 5,546 at December 31, 2017. The number of operating facilities totaled 606 at December 31, 2018, 610 at June 30, 2018 and 552 at December 31, 2017.

22

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS


Results of Operations

Three months Ended December 31, 2018 and 2017

The following table is included to aid in review of Applied's condensed statements of consolidated income.
 
 
Three Months Ended December 31,
 
Change in $'s Versus Prior Period - % Increase
 
 
As a Percent of Net Sales
 
 
 
2018
 
2017
 
Net Sales
 
100.0
%
 
100.0
%
 
25.9
%
Gross Profit
 
28.9
%
 
28.2
%
 
28.9
%
Selling, Distribution & Administrative
 
21.7
%
 
21.2
%
 
28.4
%
Operating Income
 
7.3
%
 
7.0
%
 
30.5
%
Net Income
 
4.6
%
 
4.6
%
 
25.1
%

During the quarter ended December 31, 2018, sales increased $172.9 million or 25.9% compared to the prior year quarter, with sales from acquisitions adding $142.2 million or 21.3% and unfavorable foreign currency translation accounting for a decrease of $4.7 million or 0.7%. There were 62 selling days in the quarter ended December 31, 2018 and 61 selling days in the quarter ended December 31, 2017. Excluding the impact of businesses acquired and currency translation, sales were up $35.4 million or 5.3% during the quarter, driven by an increase of 3.7% organic growth from operations, primarily the Service Center Based Distribution segment, in addition to an increase of 1.6% due to one additional sales day.

The following table shows changes in sales by reportable segment.
 
 
 
 
Amount of change due to
Sales by Reportable Segment
Three Months Ended December 31,
Sales Increase
 
Foreign Currency
Organic Change
2018
2017
Acquisitions
Service Center Based Distribution
$
589.3

$
555.6

$
33.7

$

$
(4.7
)
$
38.4

Fluid Power & Flow Control
250.7

111.5

139.2

142.2


(3.0
)
Total
$
840.0

$
667.1

$
172.9

$
142.2

$
(4.7
)
$
35.4


Sales from our Service Center Based Distribution segment, which operates primarily in MRO markets, increased $33.7 million or 6.1%. Unfavorable foreign currency translation decreased sales by $4.7 million or 0.8%. Excluding the impact of foreign currency translation, sales increased $38.4 million or 6.9%, driven by an increase of 5.3% organic growth from operations which reflects the improvement in the industrial economy and correlates with the increases in the MCU and IP indices, despite a deceleration of sales in the last week of the calendar year, in addition to an increase of 1.6% due to one additional sales day.

Sales from our Fluid Power & Flow Control segment increased $139.2 million or 124.7%. The acquisitions within this segment increased sales by $142.2 million or 127.4%. Excluding the impact of businesses acquired, sales decreased $3.0 million or 2.7%, due to a 4.4% decrease from operations offset by an increase of 1.7% due to one additional sales day. The decrease from operations is due to softness and project delays in our fluid power businesses tied to technology markets, specifically electronic equipment and component manufacturers.


23

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS


The following table shows changes in sales by geographic area. Other countries includes Mexico, Australia, New Zealand, and Singapore.
 
 
 
 
Amount of change due to
 
Three Months Ended December 31,
Sales Increase
 
Foreign Currency
Organic Change
Sales by Geographic Area
2018
2017
Acquisitions
United States
$
727.2

$
557.0

$
170.2

$
142.2

$

$
28.0

Canada
68.5

67.4

1.1


(2.5
)
3.6

Other countries
44.3

42.7

1.6


(2.2
)
3.8

Total
$
840.0

$
667.1

$
172.9

$
142.2

$
(4.7
)
$
35.4


Sales in our U.S. operations were up $170.2 million or 30.5%, as acquisitions added $142.2 million or 25.5%. Excluding the impact of businesses acquired, U.S. sales were up $28.0 million or 5.0%, driven by an increase of 3.4% organic growth from operations in addition to an increase of 1.6% due to one additional sales day. Sales from our Canadian operations increased $1.1 million or 1.6%, and unfavorable foreign currency translation decreased Canadian sales by $2.5 million or 3.8%. Excluding the impact of foreign currency translation, Canadian sales were up $3.6 million or 5.4%, of which 3.8% is organic growth from operations in addition to an increase of 1.6% due to one additional sales day. Consolidated sales from our other country operations, which include Mexico, Australia, New Zealand, and Singapore, increased $1.6 million or 3.7% from the prior year. Unfavorable foreign currency translation decreased other country sales by $2.2 million or 5.1%. Excluding the impact of currency translation, other country sales were up $3.8 million, or 8.8% during the quarter, driven by an increase of 7.2% organic growth from operations in addition to an increase of 1.6% due to one additional sales day.

Our gross profit margin for the quarter was 28.9% compared to the prior year's quarter of 28.2%. The acquisitions favorably impacted the gross profit margin by 93 basis points during the three months ended December 31, 2018, which was offset by 16 basis points of unfavorable impact from the change in LIFO expense in the current quarter compared to the prior year quarter.

The following table shows the changes in selling, distribution and administrative expense (SD&A).
 
 
 
 
Amount of change due to
 
Three Months Ended December 31,
SD&A Increase
 
Foreign Currency
Organic Change