10-K 1 ait-2019630x10k.htm 10-K Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[X]
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2019, 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
(I.R.S. Employer
incorporation or organization)
Identification No.)

1 Applied Plaza, Cleveland, Ohio 44115
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (216) 426-4000.
Securities registered pursuant to Section 12(b) of the Act:

Title of each class
Trading Symbol
Name of each exchange on which registered
Common Stock, without par value
AIT
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. x Yes ¨ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. ¨ Yes x No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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. x Yes ¨ 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). x Yes ¨ 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 x No

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter (December 31, 2018): $2,069,669,000.

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

Class
Outstanding at August 9, 2019
Common Stock, without par value
38,597,136


DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the annual meeting of shareholders of Applied Industrial Technologies, Inc., to be held October 29, 2019, are incorporated by reference into Parts II, III, and IV of this Form 10-K.





TABLE OF CONTENTS

 
 
Page
 
 
 
 
 
 
PART I
 
 
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
 
 
 
 
 
 
PART II
 
 
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management's Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures about Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
 
 
 
PART III
 
 
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accountant Fees and Services
 
 
 
PART IV
 
 
Exhibits and Financial Statement Schedules
Form 10-K Summary
 
 
 
 
 
 
 




CAUTIONARY STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT
This report, including the documents incorporated by reference, 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 our 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 Applied Industrial Technologies, Inc. ("Applied") and its management as to future occurrences and trends. Applied 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 forward-looking statements. All forward-looking statements are based on current expectations regarding important risk factors, many of which are outside Applied'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 Applied or another person that the results expressed in the statements will be achieved. In addition, Applied assumes no obligation publicly to update or revise forward-looking statements, whether because of new information or events, or otherwise, except as may be required by law.
Applied believes its primary risk factors include, but are not limited to, those identified in the following sections of this annual report on Form 10-K: “Risk Factors” in Item 1A; “Narrative Description of Business,” in Item 1, section (c); and “Management's Discussion and Analysis of Financial Condition and Results of Operations” in Item 7. PLEASE READ THOSE DISCLOSURES CAREFULLY.



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PART I
ITEM 1. BUSINESS.
In this annual report on Form 10-K, “Applied” refers to Applied Industrial Technologies, Inc., an Ohio corporation. References to “we,” “us,” “our,” and “the Company” refer to Applied and its subsidiaries.
We are a leading value-added distributor of bearings, power transmission products, engineered fluid power components and systems, specialty flow control solutions, and other industrial supplies, operating in North America, Australia, New Zealand, and Singapore. We serve MRO (maintenance, repair, and operations) and OEM (original equipment manufacturing) customers in virtually every industry. In addition, the Company 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.
We add value for our customers by providing product-related technical application support and solutions to help customers minimize their production downtime, improve machine performance, and reduce overall procurement and maintenance costs.
Applied and its predecessor companies have engaged in this business since 1923. Applied reincorporated in Ohio in 1988.
Our Internet address is www.applied.com. The following documents are available free of charge via hyperlink from the investor relations area of our website:
Applied's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, together with Section 16 insider beneficial stock ownership reports - these documents are posted as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission
Applied's Code of Business Ethics
Applied's Board of Directors Governance Principles and Practices
Applied's Director Independence Standards
Charters for the Audit, Corporate Governance, and Executive Organization & Compensation Committees of Applied's Board of Directors
The information available via hyperlink from our website is not incorporated into this annual report on Form 10-K.
General Development of Business.
Information regarding developments in our business can be found in Item 7 under the caption “Management's Discussion and Analysis of Financial Condition and Results of Operations.” This information is incorporated here by reference.
Narrative Description of Business.
Overview. Our field operating structure is built on two platforms: Service Center Based Distribution; and Fluid Power & Flow Control.
Service Center Based Distribution. We distribute a wide range of industrial products through service centers across North America, Australia, and New Zealand. Customers primarily purchase our products for scheduled maintenance of their machinery and equipment and for emergency repairs. The Service Center Based Distribution segment accounts for a majority of our field operations and 71% of our 2019 consolidated sales dollars.
The Service Center Based Distribution segment also includes: 1) the Applied Maintenance Supplies & Solutions (MSS) service offering, which provides customers C-Class MRO supplies (fasteners, cutting tools, paints and chemicals, fluid flow, safety and janitorial products) through a vendor managed inventory solution; 2) Applied U.S. Energy, which specializes in serving customers primarily in the upstream oil and gas industry; 3) regional fabricated rubber shops, which modify and repair conveyor belts and make hose assemblies in accordance with customer requirements, along with rubber service field crews, which install and repair conveyor belts and rubber linings at customer locations; and 4) our operations in Canada, Mexico, Australia, and New Zealand.
Fluid Power & Flow Control. Our Fluid Power & Flow Control segment businesses primarily market products and services to customers within the businesses' geographic regions. We serve customers purchasing for MRO needs as well as customers purchasing for OEM applications. In addition to distribution services, the businesses

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offer technical advice, broader system solutions, and other value-added services. The fluid power businesses design and assemble hydraulic and electro-hydraulic power units and control systems, electronic control systems, pneumatic and electro-pneumatic panels and sub-assemblies, fabricated aluminum assemblies, lubrication systems, hydraulic manifolds, and pump assemblies. They also perform equipment repairs. Flow control capabilities include the following: flow control system integration; valve, actuator, and pump repair; valve actuation; and process instrumentation and calibration.
Products. We are a leading distributor of products including bearings, power transmission products, engineered fluid power components and systems, specialty flow control solutions, industrial rubber products, linear motion components, tools, safety products, oilfield supplies, and other industrial and maintenance supplies.
These products are generally supplied to us by manufacturers whom we serve as a non-exclusive distributor. The suppliers also may provide us product training, as well as sales and marketing support. Authorizations to represent particular suppliers and product lines may vary by geographic region, particularly for our fluid power and flow control businesses. We believe our supplier relationships are generally good, and many have existed for decades. The disruption of relationships with certain suppliers, or the disruption of their operations, could adversely affect our business.
Our product suppliers typically confine their direct sales activities to large-volume transactions, mainly with large original equipment manufacturers. The suppliers generally do not sell maintenance and repair products directly to the customer, but instead refer the customer to us or another distributor.
Net sales by product category for the most recent fiscal year is detailed in note 2 to the consolidated financial statements, included in Item 8 under the caption “Financial Statements and Supplementary Data.” That information is incorporated here by reference.
Services. Our employees advise and assist customers in selecting and applying products, and in managing storeroom inventory. We consider this advice and assistance to be an integral part of our product sales efforts. Beyond logistical distribution services, we offer product and process solutions involving multiple technologies. These solutions help customers minimize production downtime, improve machine performance, and reduce overall procurement and maintenance costs. By providing high levels of service, product and industry expertise, and technical support, while at the same time offering product breadth and competitive pricing, we believe we develop stronger, longer-lasting, and more profitable customer relationships.
Our service center sales employees include customer sales and service representatives and account managers, as well as product and industry specialists. Customer sales and service representatives receive, process, and expedite customer orders, provide product information, and assist account managers in serving customers. Account managers make onsite calls to customers to provide product information, identify customer requirements, make recommendations, and assist in implementing equipment maintenance and storeroom management programs. Account managers also measure and document the value of the cost savings and increased productivity we help generate. Specialists assist with applications in their areas of expertise.
We maintain product inventory levels at each service center tailored to the local market. These inventories consist of standard items as well as other items specific to local customer demand. Distribution centers replenish service center inventories and also may ship products directly to customers. Having product in stock helps us satisfy customers' immediate needs.
Timely delivery of products is an integral part of our service, particularly when customers require products for emergency repairs. Service centers and distribution centers use the most effective method of transportation available to meet customer needs. These methods include our own delivery vehicles, dedicated third-party transportation providers, as well as surface and air common carrier and courier services. Customers can also pick up items at our service centers.
Our information systems enhance our customer service. Customers turn to our website at www.applied.com to search for products in a comprehensive electronic catalog, research product attributes, view prices, check inventory levels, place orders, and track order status. We also use electronic data interchange (EDI) and other electronic interfaces with customers' technology platforms and plant maintenance systems.
In addition to our electronic capabilities, we publish a printed catalog, a comprehensive purchasing tool and resource guide for industrial and maintenance products (also available in a mobile-friendly digital version).
The Applied Maintenance Supplies & Solutions service offering provides traditional vendor managed inventory (VMI) services, at customer sites, for industrial and maintenance supplies, including fasteners, cutting tools, paints and chemicals, fluid flow, safety, and janitorial products.

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In addition to distributing products, we offer shop services in select geographic areas. Our fabricated rubber shops modify and repair conveyor belts and provide hose assemblies (also available at select service centers and distribution centers and at our fluid power and flow control businesses) in accordance with customer requirements. Field crews install and repair conveyor belts and rubber lining, primarily at customer locations. Among the other services we offer, either performed by us directly or by third party providers, are the rebuilding or assembly of speed reducers, pumps, valves, cylinders, and electric and hydraulic motors, and custom machining.
Our specialized fluid power and flow control businesses generally operate independently of the service centers, but as product distributors, share the same focus on customer service. Product and application recommendations, inventory availability, and delivery speed are all important to the businesses' success.
Many of our fluid power and flow control businesses distinguish themselves from most component distributors by offering engineering, design, fabrication, installation, and repair services for equipment or systems in their fields of expertise. Our fluid power capabilities extend to the following specialties: fluid power system integration; manifold design, machining, and assembly; and the integration of hydraulic and pneumatic equipment with electronics for complete machine design. Flow control services include the following: flow control system integration; valve, actuator, and pump repair; valve actuation; and process instrumentation and calibration.
Each business has account managers with technical product and application knowledge, who handle sophisticated projects. The businesses also may provide technical support to our service centers and their customers.
Markets. We purchase from thousands of product manufacturers and resell the products to thousands of customers in a wide variety of industries, including agriculture and food processing, cement, chemicals and petrochemicals, fabricated metals, forest products, industrial machinery and equipment, mining, oil and gas, primary metals, transportation, and utilities, as well as to government entities. Customers range from very large businesses, with which we may have multiple-location relationships, to very small ones. We are not significantly dependent on a single customer or group of customers, the loss of which would have a material adverse effect on our business as a whole, and no single customer accounts for more than 4% of our net sales.
Competition. We consider our business to be highly competitive. In addition, our markets present few economic or technological barriers to entry, contributing to a high fragmentation of market share. Longstanding supplier and customer relationships, geographic coverage, name recognition, and our employees' knowledge and experience do, however, support our competitive position. Competition is based generally on breadth and quality of product and service offerings, product availability, price, ease of product selection and ordering, e-commerce capabilities, catalogs, and having a local presence. In the fluid power & flow control businesses, product manufacturer authorizations are often more selective and can be a more significant competitive factor, along with market reputation and product application knowledge.
Our principal competitors are specialist and general line distributors of bearings, power transmission products, fluid power components and systems, flow control solutions, industrial rubber products, linear motion components, tools, safety products, oilfield supplies, and other industrial and maintenance supplies. These competitors include local, regional, national, and multinational operations, and can include catalog and e-commerce companies. We also compete with original equipment manufacturers and their dealers in the sale of maintenance and replacement components. The identity and number of our competitors vary throughout the geographic, industry, and product markets we serve.
Although we may be one of the leading distributors in the geographic markets we serve for the primary product categories we provide there, our market share in a given market may be relatively small compared to the portion of the market served by original equipment manufacturers and other distributors.
Backlog Orders and Seasonality. Backlog orders are not material to our business as a whole, although they are a more important factor for our fluid power and flow control businesses. Our business has exhibited minor seasonality - in particular, sales per day during the first half of our fiscal year have historically been slightly lower than during the second half due, in part, to the impact of customer plant shutdowns, summer vacations and holidays.
Patents, Trademarks, Trade Names, and Licenses. Customer recognition of our service marks and trade names, including Applied Industrial Technologies®, Applied®, and AIT®, is an important contributing factor to our sales. Patents and licenses are not of material importance to our business.
Raw Materials and General Business Conditions. Our operations are dependent on general industrial and economic conditions. We would be adversely affected by the unavailability of raw materials to our suppliers, prolonged labor disputes experienced by suppliers or customers, or by events or conditions that have an adverse effect on industrial activity generally in the markets we serve or on key customer industries.

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Number of Employees. At June 30, 2019, we had approximately 6,650 employees.
Working Capital. Our working capital position is discussed in Item 7 under the caption “Management's Discussion and Analysis of Financial Condition and Results of Operations.” This information is incorporated here by reference.
We require substantial working capital related to accounts receivable and inventories. Significant amounts of inventory are carried to meet customers' delivery requirements. We generally require payments for sales on account within 30 days. Returns are not considered to have a material effect on our working capital requirements. We believe these practices are generally consistent among companies in our industry.
Environmental Laws. We believe that compliance with laws regulating the discharge of materials into the environment or otherwise relating to environmental protection will not have a material adverse effect on our capital expenditures, earnings, or competitive position.
ITEM 1A. RISK FACTORS.
In addition to other information set forth in this report, you should carefully consider the following factors that could materially affect our business, financial condition, or results of operations. The risks described below are not the only risks facing the Company. Certain risks are identified below in Item 7 under the caption “Management's Discussion and Analysis of Financial Condition and Results of Operations.” This information is incorporated here by reference. Additional risks not currently known to us, risks that could apply broadly to issuers, or risks that we currently deem immaterial, may also impact our business and operations. Risks can also change over time.
Our business depends heavily on the operating levels of our customers and the factors that affect them, including general economic conditions. The markets for our products and services are subject to conditions or events that affect demand for goods and materials that our customers produce. Consequently, demand for our products and services has been and will continue to be influenced by most of the same factors that affect demand for and production of customers' goods and materials.
When customers or prospective customers reduce production levels because of lower demand, increased supply, higher costs, tight credit conditions, unfavorable currency exchange rates, adverse trade policies, foreign competition, other competitive disadvantage, offshoring of production, or other reasons, their need for our products and services diminishes. Selling prices and terms of sale come under pressure, adversely affecting the profitability and the durability of customer relationships, and credit losses may increase. Inventory management becomes more difficult in times of economic uncertainty. Volatile economic and credit conditions also make it more difficult for us, as well as our customers and suppliers, to forecast and plan future business activities.
Our business could be adversely affected if we do not successfully execute our initiatives to grow sales and earnings. We have numerous initiatives underway to grow sales, enhance gross margins, manage costs, and otherwise improve our earnings and competitive position. If we do not implement these initiatives effectively, or if for other reasons they are unsuccessful, our business could be adversely affected.
Consolidation in our customers' and suppliers' industries could adversely affect our business and financial results. Consolidation continues among our product suppliers and customers. As customer industries consolidate or customers otherwise aggregate their purchasing power, a greater proportion of our sales could be derived from large volume contracts, which could adversely impact margins. Consolidation among customers can trigger changes in their purchasing strategies, potentially shifting blocks of business among competing distributors and contributing to volatility in our sales and pressure on prices. Similarly, continued consolidation among our suppliers could reduce our ability to negotiate favorable pricing and other commercial terms for our inventory purchases. There can be no assurance we will be able to take advantage of consolidation trends.
Loss of key supplier authorizations, lack of product availability, or changes in distribution programs could adversely affect our sales and earnings. Our business depends on maintaining an immediately available supply of various products to meet customer demand. Many of our relationships with key product suppliers are longstanding, but are terminable by either party. The loss of key supplier authorizations, or a substantial decrease in the availability of their products, could put us at a competitive disadvantage and have a material adverse effect on our business. Supply interruptions could arise from raw materials shortages, inadequate manufacturing capacity or utilization to meet demand, financial problems, trade issues, labor disputes, or weather conditions affecting suppliers' production, transportation disruptions, or other reasons beyond our control.
In addition, as a distributor, we face the risk of key product suppliers changing their relationships with distributors generally, or us in particular, in a manner that adversely impacts us. For example, key suppliers could change the following: the prices we must pay for their products relative to other distributors or relative to competing brands;

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the geographic or product line breadth of distributor authorizations; supplier purchasing incentive or other support programs; product purchase or stocking expectations; or the extent to which the suppliers seek to serve end-users directly.
An increase in competition could decrease sales or earnings. We operate in a highly competitive industry. The industry remains fragmented, but is consolidating. Our principal competitors are specialist and general line distributors of bearings, power transmission products, fluid power components and systems, flow control solutions, industrial rubber products, linear motion components, tools, safety products, oilfield supplies, and other industrial and maintenance supplies. These competitors include local, regional, national, and multinational operations, and can include catalog and e-commerce companies. Competition is largely focused in the local service area and is generally based on product line breadth, product availability, service capabilities, and price. Existing competitors have, and future competitors may have, greater financial or other resources than we do, broader or more appealing product or service offerings, greater market presence, stronger relationships with key suppliers or customers, or better name recognition. If existing or future competitors seek to gain or to retain market share by aggressive pricing strategies and sales methods, or otherwise through competitive advantage, our sales and profitability could be adversely affected. Our success will also be affected by our ability to continue to provide competitive offerings as customer preferences or demands evolve, for example with respect to our product and services portfolio or our e-commerce and inventory management solutions. Technological evolution or other factors can render product offerings obsolete, potentially impairing our competitive position and our inventory values.
The purchasing incentives we earn from product suppliers can be impacted if we reduce our purchases in response to declining customer demand. Certain of our product suppliers have historically offered to their distributors, including us, incentives for purchasing their products. In addition to market or customer account-specific incentives, certain suppliers pay incentives to the distributor for attaining specific purchase volumes during a program period. In some cases, to earn incentives, we must achieve year-over-year growth in purchases with the supplier. When demand for our products declines, we may be less inclined to add inventory to take advantage of certain incentive programs, thereby potentially adversely impacting our profitability.
Trade policies can have an adverse impact on industries we sell into, potentially negatively affecting our net sales and profits. Changes to trade policies can disrupt geographic and industry demand trends. While Applied primarily serves markets in the United States, a significant portion of our domestic customer base exports or serves exporters. U.S. government-imposed tariffs or taxes that penalize imports can be met with countermeasures by foreign governments, or can otherwise impact industrial production, and it becomes difficult to determine what the net effect of such actions is on Applied’s net sales and profits. It is possible that such changes could adversely affect our financial results.
Volatility in product, energy, and other costs can affect our profitability. Product manufacturers may adjust the prices of products we distribute for many reasons, including changes in their costs for raw materials, components, energy, labor, and tariffs and taxes on imports. In addition, a portion of our own distribution costs is composed of fuel for our sales and delivery vehicles, freight, and utility expenses for our facilities. Our ability to pass along increases in our product and distribution costs in a timely manner to our customers depends on execution, market conditions, and contractual limitations. Failing to pass along price increases timely in an inflationary environment, or not maintaining sales volume while increasing prices, could significantly reduce our profitability.
While increases in the cost of products or energy could be damaging to us, decreases in those costs, particularly if severe, could also adversely impact us by creating deflation in selling prices, which could cause our gross profit margin to deteriorate. Changes in energy or raw materials costs can also adversely affect customers; for example, declines in oil, gas, and coal prices may negatively impact customers operating in those industries and, consequently, our sales to those customers.
Changes in customer or product mix and downward pressure on sales prices could cause our gross profit percentage to fluctuate or decline. Because we serve thousands of customers in many end markets, and offer millions of products, with varying profitability levels, changes in our customer or product mix could cause our gross profit percentage to fluctuate or decline. Downward pressure on sales prices could also cause our gross profit percentage to fluctuate or decline. We can experience downward pressure on sales prices as a result of deflation, pressure from customers to reduce costs, or increased competition.
Our ability to transact business is highly reliant on information systems. A disruption or security breach could materially affect our business, financial condition, or results of operation. We depend on information systems to process customer orders, manage inventory and accounts receivable collections, purchase products, manage accounts payable processes, ship products to customers on a timely basis, maintain cost-effective operations, provide superior service to customers, and compile financial results. A serious, prolonged disruption of

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our information systems, due to manmade or natural causes, including power or telecommunications outage, or breach in security, could materially impair fundamental business processes and increase expenses, decrease sales, or otherwise reduce earnings.
Because of our reliance on information systems, we may be vulnerable to the growing threat of damage or intrusion from computer viruses or other cyber-attacks on our systems. Despite precautions taken to prevent or mitigate the risks of such incidents, an attack on our systems could not only cause business disruption, but could also result in the theft or disclosure of proprietary or confidential information, or a breach of customers, supplier, or employee information. Such an incident could negatively impact our sales, damage our reputation, and cause us to incur unanticipated legal liability and costs.
In recent years, we replaced multiple legacy information system applications with newer software platforms, to enhance our business information and transaction systems to support future growth. We continue with and consider additional enterprise resource planning system conversions, on a smaller scale, in discrete business operations. Despite extensive planning, we could experience disruptions related to the implementation because of the projects' complexity. The potential adverse consequences could include delays, loss of information, diminished management reporting capabilities, damage to our ability to process transactions timely, harm to our control environment, diminished employee productivity, and unanticipated increases in costs. Further, our ability to achieve anticipated operational benefits from new platforms is not assured.
Acquisitions are a key component of our anticipated growth. We may not be able to identify or to complete future acquisitions, to integrate them effectively into our operations, or to realize their anticipated benefits. Many industries we serve are mature. As a result, acquisitions of businesses have been important to our growth. While we wish to continue to acquire businesses, we may not be able to identify and to negotiate suitable acquisitions, to obtain financing for them on satisfactory terms, or otherwise to complete acquisitions. In addition, existing and future competitors, and private equity firms, increasingly compete with us for acquisitions, which can increase prices and reduce the number of suitable opportunities; the acquisitions they make can also adversely impact our market position.
We seek acquisition opportunities that complement and expand our operations. However, substantial costs, delays, or other difficulties related to integrating acquisitions could adversely affect our business or financial results. For example, we could face significant challenges in consolidating functions, integrating information systems, personnel, and operations, and implementing procedures and controls in a timely and efficient manner.
Further, even if we successfully integrate the acquisitions with our operations, we may not be able to realize cost savings, sales, profit levels, or other benefits that we anticipate from these acquisitions, either as to amount or in the time frame we expect. Our ability to realize anticipated benefits may be affected by a number of factors, including the following: our ability to achieve planned operating results, to reduce duplicative expenses and inventory effectively, and to consolidate facilities; economic and market factors; the incurrence of significant integration costs or charges in order to achieve those benefits; our ability to retain key product supplier authorizations, customer relationships, and employees; our ability to address competitive, distribution, and regulatory challenges arising from entering into new markets (geographic, product, service, end-industry, or otherwise), especially those in which we may have limited or no direct experience; and exposure to unknown or contingent liabilities of the acquired company. In addition, acquisitions could place significant demand on administrative, operational, and financial resources.
We incurred a substantial amount of debt to complete the acquisition of FCX Performance, Inc. To service our debt, we will require a significant amount of cash that may limit our ability to pay dividends, repurchase our shares, or complete other acquisitions or strategic initiatives.  On January 31, 2018, we acquired FCX Performance, Inc. (“FCX”), a distributor of specialty process flow control products and services, for an aggregate purchase price of $781.8 million. In connection with the FCX acquisition, we entered into a new credit facility pursuant to which we incurred approximately $780.0 million in term loan indebtedness and approximately $250.0 million in revolving indebtedness capacity. This indebtedness substantially increased our leverage and requires significant future principal and interest payments. As of June 30, 2019, we had total debt obligations outstanding of $959.8 million. Our ability to service our debt and fund our other liquidity needs will depend on our ability to generate cash in the future. The additional leverage may (i) require us to dedicate a substantial portion of our cash flows from operations to the payment of debt service, reducing the availability of our cash flow to fund planned capital expenditures, pay dividends, repurchase our shares, complete other acquisitions or strategic initiatives, and other general corporate purposes; (ii) limit our ability to obtain additional financing in the future (either at all or on satisfactory terms) to enable us to react to changes in our business or execute our growth strategies; and (iii) place us at a competitive disadvantage compared to businesses in our industry that have lower levels of indebtedness. Additionally, any failure to comply with covenants in the instruments governing our debt

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could result in an event of default. Any of the foregoing events or circumstances relating to our additional indebtedness may adversely affect our business, financial position, or results of operations and may cause our stock price to decline.
Goodwill, long-lived, and other intangible assets recorded as a result of our acquisitions could become impaired. We review goodwill, long-lived assets, including property, plant and equipment and identifiable amortizing intangible assets, for impairment whenever changes in circumstances or events may indicate that the carrying amounts are not recoverable. Factors which may cause an impairment of long-lived assets include significant changes in the manner of use of these assets, negative industry or market trends, significant underperformance relative to historical or projected future operating results, or a likely sale or disposal of the asset before the end of its estimated useful life. In 2019 we recorded a $31.6 million non-cash impairment charge for intangible assets associated with the Company's upstream oil and gas industry operations in Canada.
As of June 30, 2019, we had $662.0 million of goodwill and $368.9 million of other intangible assets, net. We assess all existing goodwill at least annually for impairment on a reporting unit basis. The techniques used in our qualitative assessment and goodwill impairment tests incorporate a number of estimates and assumptions that are subject to change. Although we believe these estimates and assumptions are reasonable and reflect market conditions forecasted at the assessment date, any changes to these assumptions and estimates due to market conditions or otherwise may lead to an outcome where impairment charges would be required in future periods.
Tight credit markets could impact our ability to obtain financing on reasonable terms or increase the cost of future financing. Although the credit market turmoil of a decade ago did not have a significant adverse impact on our liquidity or borrowing costs, the availability of funds tightened and credit spreads on corporate debt increased. If credit market volatility were to return, obtaining additional or replacement financing could be more difficult and the cost of issuing new debt or replacing a credit facility could be higher than under our current facilities. Tight credit conditions could limit our ability to finance acquisitions on terms acceptable to us.
For more information relating to borrowing and interest rates, see the following sections below: “Liquidity and Capital Resources” in Item 7 under the caption “Management's Discussion and Analysis of Financial Condition and Results of Operations;” Item 7A under the caption “Quantitative and Qualitative Disclosures about Market Risk;” and notes 6 and 7 to the consolidated financial statements, included below in Item 8 under the caption “Financial Statements and Supplementary Data.” That information is incorporated here by reference.
Our ability to maintain effective internal control over financial reporting may be insufficient to allow us to accurately report our financial results or prevent fraud, and this could cause our financial statements to become materially misleading and adversely affect the trading price of our common stock. We require effective internal control over financial reporting in order to provide reasonable assurance with respect to our financial reports and to effectively prevent fraud. Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Therefore, even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we cannot provide reasonable assurance with respect to our financial statements and effectively prevent fraud, our financial statements could be materially misstated, which could adversely affect the trading price of our common stock.
If we are not able to maintain the adequacy of our internal control over financial reporting, including any failure to implement required new or improved controls, or if we experience difficulties in their implementation, our business, financial condition and operating results could be harmed. Any material weakness could affect investor confidence in the accuracy and completeness of our financial statements. As a result, our ability to obtain any additional financing, or additional financing on favorable terms, could be materially and adversely affected. This, in turn, could materially and adversely affect our business, financial condition, and the market value of our stock and require us to incur additional costs to improve our internal control systems and procedures. In addition, perceptions of the Company among customers, suppliers, lenders, investors, securities analysts, and others could also be adversely affected.
We cannot assure that any material weaknesses will not arise in the future due to our failure to implement and maintain adequate internal control over financial reporting. In addition, although we have been successful historically in strengthening our controls and procedures, those controls and procedures may not be adequate to prevent or identify irregularities or ensure the fair presentation of our financial statements included in our periodic reports filed with the SEC.
Our business depends on our ability to attract, develop, motivate, and retain qualified employees. Our success depends on hiring, developing, motivating, and retaining key employees, including executive, managerial, sales, professional, and other personnel. We may have difficulty identifying and hiring qualified personnel. In

8


addition, we may have difficulty retaining such personnel once hired, and key people may leave and compete against us. With respect to sales and customer service positions in particular, we greatly benefit from having employees who are familiar with the products and services we sell, and their applications, as well as with our customer and supplier relationships. The loss of key employees or our failure to attract and retain other qualified workers could disrupt or adversely affect our business. In addition, our operating results could be adversely affected by increased competition for employees, shortages of qualified workers, higher employee turnover (including through retirement as the workforce ages), or increased employee compensation or benefit costs.
An interruption of operations at our headquarters or distribution centers, or in our means of transporting product, could adversely impact our business. Our business depends on maintaining operating activity at our headquarters and distribution centers, and being able to receive and deliver product in a timely manner. A serious, prolonged interruption due to power or telecommunications outage, terrorist attack, earthquake, extreme weather events, other natural disasters, fire, flood, or other interruption could have a material adverse effect on our business and financial results.
There is no assurance that we will continue to pay dividends on our common stock. The timing, declaration, amount, and payment of dividends to our shareholders fall within the discretion of our Board of Directors and depend on many factors, including our financial condition and results of operations, as well as applicable law and business considerations that our Board of Directors considers relevant. There can be no assurance that we will continue to pay a quarterly dividend.
Additionally, if we cannot generate sufficient cash flow from operations to meet our debt payment obligations, then our ability to pay dividends, if so determined by the Board of Directors, will be impaired and we may be required to attempt to restructure or refinance our debt, raise additional capital, or take other actions such as selling assets, reducing, or delaying capital expenditures, or reducing our dividend. There can be no assurance, however, that any such actions could be effected on satisfactory terms, if at all, or would be permitted by the terms of our debt or our other credit and contractual arrangements.
Our operations outside the United States increase our exposure to global economic and political conditions and currency exchange volatility. Foreign operations contributed 13% of our sales in 2019. This presence outside the U.S. increases risks associated with exposure to more volatile economic conditions, political instability, cultural and legal differences in conducting business (including corrupt practices), economic and trade policy actions, and currency exchange fluctuations.
Our foreign operations' results are reported in the local currency and then translated into U.S. dollars at applicable exchange rates for inclusion in our consolidated financial statements. Fluctuations in currency exchange rates affect our operating results and financial position, as well as the comparability of results between financial periods.
We may be adversely affected by changes in LIBOR reporting practices or the method by which LIBOR is determined. As of June 30, 2019, we had approximately $789 million of aggregate consolidated indebtedness that was indexed to the London Interbank Offered Rate (“LIBOR”).  In addition, as of June 30, 2019, approximately $463 million of this variable rate debt was converted to a fixed rate through an interest rate swap.  The swap agreement was entered into in January 2019 and is indexed to LIBOR. Central banks around the world, including the Federal Reserve, have commissioned working groups of market participants and official sector representatives with the goal of finding suitable replacements for LIBOR based on observable market transactions. It is expected that a transition away from the widespread use of LIBOR to alternative rates will occur over the course of the next few years. The U.K. Financial Conduct Authority (FCA), which regulates LIBOR, has announced that it has commitments from panel banks to continue to contribute to LIBOR through the end of 2021, but that it will not use its powers to compel contributions beyond such date. Accordingly, there is considerable uncertainty regarding the publication of such rates beyond 2021. The Federal Reserve Bank of New York and various other authorities have commenced the publication of reforms and actions relating to alternatives to U.S. dollar LIBOR. Although the full impact of such reforms and actions, together with any transition away from LIBOR, including the potential or actual discontinuance of LIBOR publication, remains unclear, these changes may have a material adverse impact on the availability of financing, including LIBOR-based loans, and on our financing costs.
We are subject to litigation and regulatory risk due to the nature of our business, which may have a material adverse effect on our business. From time to time, we are involved in lawsuits or other legal proceedings that arise from our business. These may, for example, relate to product liability claims, commercial disputes, personal injuries, or employment-related matters. In addition, we could face claims over other matters, such as claims arising from our status as a public company or government contractor, or otherwise relating to our compliance with a wide array of laws and regulations to which we are subject. The defense and ultimate outcome

9


of lawsuits or other legal proceedings or inquiries may result in higher operating expenses, which could have a material adverse effect on our business, financial condition, or results of operations.
Our business is subject to risks, some for which we maintain third-party insurance and some for which we self-insure. We may incur losses and be subject to liability claims that could have a material adverse effect on our financial condition, results of operations, or cash flows. We maintain insurance policies that provide limited coverage for some, but not all, of the potential risks and liabilities associated with our business. The policies are subject to deductibles and exclusions that result in our retention of a level of risk on a self-insured basis. For some risks, we may not obtain insurance if we believe the cost of available insurance is excessive relative to the risks presented. Because of market conditions, premiums and deductibles for certain insurance policies can increase substantially, and in some instances, certain insurance may become unavailable or available only for reduced amounts of coverage. As a result, we may not be able to renew existing insurance policies or procure other desirable insurance on commercially reasonable terms, if at all. Even where insurance coverage applies, insurers may contest their obligations to make payments. Our financial condition, results of operations, and cash flows could be materially and adversely affected by losses and liabilities from uninsured or underinsured events, as well as by delays in the payment of insurance proceeds, or the failure by insurers to make payments.
In addition to the risks identified above, other risks to our future performance include, but are not limited to, the following:
changes in customer preferences for products and services of the nature, brands, quality, or cost sold by us;
changes in customer procurement policies and practices;
changes in the market prices for products and services relative to the costs of providing them;
changes in operating expenses;
organizational changes in the Company;
government regulation, legislation, or policies, including with respect to federal tax policy and international trade;
the variability and timing of new business opportunities including acquisitions, customer relationships, and supplier authorizations;
the incurrence of debt and contingent liabilities in connection with acquisitions; and
changes in accounting policies and practices that could impact our financial reporting and increase compliance costs.




10


ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable.

ITEM 2. PROPERTIES.
We believe having a local presence is important to serving our customers, so we maintain service centers and other operations in local markets throughout the countries in which we operate. At June 30, 2019, we owned real properties at 119 locations and leased 451 locations. Certain properties house more than one operation.
The following were our principal owned real properties (each of which has more than 50,000 square feet of floor space) at June 30, 2019:
Location of Principal Owned
Real Property
Type of Facility
Cleveland, Ohio
Corporate headquarters
Atlanta, Georgia
Distribution center, service center, hose shop
Florence, Kentucky
Distribution center
Carlisle, Pennsylvania
Distribution center
Fort Worth, Texas
Distribution center and rubber shop
Our principal leased real properties (each of which has more than 50,000 square feet of floor space) at June 30, 2019 were:
Location of Principal Leased
Real Property
Type of Facility
Fontana, California
Distribution center, rubber shop, fluid power shop, and service center
Newark, California
Fluid power shop
Midland, Michigan
Flow control shop
Elyria, Ohio
Product return center and service center
Strongsville, Ohio
Offices and warehouse
Portland, Oregon
Distribution center
Stafford, Texas
Offices, warehouse, and flow control shop
Longview, Washington
Service center, rubber shop, and fluid power shop
Nisku, Alberta
Offices, service center, and shops
Winnipeg, Manitoba
Distribution center and service center
The properties in Newark, Midland, and Stafford are used in our Fluid Power & Flow Control segment. The Fontana and Longview properties are used in both the Service Center Based Distribution segment and the Fluid Power & Flow Control segment. The remaining properties are used in the Service Center Based Distribution segment.
We consider our properties generally sufficient to meet our requirements for office space and inventory stocking.
A service center's size is primarily influenced by the amount and types of inventory the service center requires to meet customers' needs.
When opening new operations, we have tended to lease rather than purchase real property. We do not consider any service center, distribution center, or shop property to be material, because we believe that, if it becomes necessary or desirable to relocate an operation, other suitable property could be found.
In addition to operating locations, we own or lease certain properties which in the aggregate are not material and are either for sale, lease, or sublease to third parties due to a relocation or closing. We also may lease or sublease to others unused portions of buildings.
Additional information regarding our properties can be found in note 13 to the consolidated financial statements, included below in Item 8 under the caption “Financial Statements and Supplementary Data.” That information is incorporated here by reference.

11


ITEM 3. LEGAL PROCEEDINGS.
Applied and/or one of its subsidiaries is a party to pending legal proceedings with respect to product liability, commercial, personal injury, employment, and other matters. Although it is not possible to predict the outcome of these proceedings or the range of reasonably possible loss, we believe, based on circumstances currently known, that the likelihood is remote that the ultimate resolution of any of these proceedings will have, either individually or in the aggregate, a material adverse effect on Applied's consolidated financial position, results of operations, or cash flows.
ITEM 4. MINE SAFETY DISCLOSURES.
Information concerning mine safety violations or other regulatory matters required by Section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act and Item 104 of SEC Regulation S-K is included in Exhibit 95 to this annual report on Form 10-K.
EXECUTIVE OFFICERS OF THE REGISTRANT.
Applied's executive officers are elected by the Board of Directors for a term of one year, or until their successors are chosen and qualified, at the Board's organization meeting held following the annual meeting of shareholders.
The following is a list of the executive officers and a description of their business experience during the past five years. Except as otherwise stated, the positions and offices indicated are with Applied, and the persons were most recently elected to their current positions on October 30, 2018:
:
Name
Positions and Experience
Age
Neil A. Schrimsher
President since 2013 and Chief Executive Officer since 2011.
55
Fred D. Bauer
Vice President-General Counsel & Secretary since 2002.
53
Warren E. Hoffner
Vice President, General Manager-Fluid Power & Flow Control since October 2018. He served as Vice President, General Manager-Fluid Power from 2003 to October 2018. The Board of Directors designated Mr. Hoffner an executive officer in October 2015.
59
Kurt W. Loring
Vice President-Chief Human Resources Officer since 2014.
50
David K. Wells
Vice President-Chief Financial Officer & Treasurer since September 2017. He served as Vice President-Finance from May 2017 through August 2017. Prior to joining Applied, from May 2015 to May 2017, Mr. Wells was Vice President & Chief Financial Officer of ESAB, a manufacturer of welding and material cutting products and a division of Colfax Corporation (NYSE: CFX).  Prior to then he was Vice President & Chief Financial Officer of Apex Tool Group, a manufacturer of hand and power tools.
56




12


PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Applied's common stock, without par value, is listed for trading on the New York Stock Exchange with the ticker symbol “AIT.” Information concerning the quarterly stock dividends for the fiscal years ended June 30, 2019, 2018, and 2017 and the number of shareholders of record as of August 9, 2019 are set forth in Item 8, “Financial Statements and Supplementary Data,” in the “Quarterly Operating Results” table. That information is incorporated here by reference.
The following table summarizes Applied's repurchases of its common stock in the quarter ended June 30, 2019.
Period
(a) Total Number of Shares (1)

 
(b) Average Price Paid per Share ($)

 
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs

 
(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (2)

April 1, 2019 to April 30, 2019
412

 
60.00

 

 
864,618

May 1, 2019 to May 31, 2019

 

 

 
864,618

June 1, 2019 to June 30, 2019
1,490

 
58.53

 

 
864,618

Total
1,902

 
58.85

 

 
864,618

(1)
During the quarter ended June 30, 2019, Applied purchased 1,902 shares in connection with an employee deferred compensation program. This purchase is not counted in the authorization in note (2).
(2)
On October 24, 2016, the Board of Directors authorized the repurchase of up to 1.5 million shares of the Company's common stock, replacing the prior authorization. We publicly announced the new authorization on October 26, 2016. Purchases can be made in the open market or in privately negotiated transactions. The authorization is in effect until all shares are purchased, or the Board revokes or amends the authorization.

13


ITEM 6. SELECTED FINANCIAL DATA.
This selected financial data should be read in conjunction with Applied's consolidated financial statements and related notes included elsewhere in this annual report as well as the section of the annual report titled Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
(In thousands, except per share amounts and statistical data)
 
 
2019
 
2018 (b)
 
2017
 
2016
 
2015
Consolidated Operations — Year Ended June 30
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
3,472,739

 
$
3,073,274

 
$
2,593,746

 
$
2,519,428

 
$
2,751,561

Depreciation and amortization of property
 
20,236

 
17,798

 
15,306

 
15,966

 
16,578

Amortization:
 
 
 
 
 
 
 
 
 
 
Intangible assets
 
41,883

 
32,065

 
24,371

 
25,580

 
25,797

SARs and stock options
 
2,437

 
1,961

 
1,891

 
1,543

 
1,610

Operating income (a) (d)
 
233,788

 
225,827

 
175,386

 
89,782

 
184,619

Net income (a) (c) (d)
 
143,993

 
141,625

 
133,910

 
29,577

 
115,484

Per share data:
 
 
 
 
 
 
 
 
 
 
Net income:
 
 
 
 
 
 
 
 
 
 
Basic
 
3.72

 
3.65

 
3.43

 
0.75

 
2.82

Diluted (a) (c) (d)
 
3.68

 
3.61

 
3.40

 
0.75

 
2.80

Cash dividend
 
1.22

 
1.18

 
1.14

 
1.10

 
1.04

 
 
 
 
 
 
 
 
 
 
 
Year-End Position — June 30
 
 
 
 
 
 
 
 
 
 
Working capital
 
$
724,344

 
$
625,469

 
$
572,789

 
$
507,238

 
$
535,938

Long-term debt (including portion classified as current)
 
959,829

 
966,063

 
291,982

 
328,334

 
320,995

Total assets
 
2,331,697

 
2,285,741

 
1,387,595

 
1,312,025

 
1,432,556

Shareholders’ equity
 
897,034

 
814,963

 
745,256

 
657,916

 
741,328

 
 
 
 
 
 
 
 
 
 
 
Year-End Statistics — June 30
 
 
 
 
 
 
 
 
 
 
Current ratio
 
2.7

 
2.4

 
2.8

 
2.8

 
2.7

Operating facilities
 
600

 
610

 
552

 
559

 
565

Shareholders of record (e)
 
4,165

 
4,323

 
4,687

 
5,372

 
6,016

Return on assets (a) (c) (d) (f)
 
6.3
%
 
8.0
%
 
10.2
%
 
2.2
%
 
7.9
%
Return on equity (a) (c) (d) (g)
 
16.8
%
 
18.2
%
 
19.1
%
 
4.2
%
 
15.0
%
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures
 
$
18,970

 
$
23,230

 
$
17,045

 
$
13,130

 
$
14,933

 
 
 
 
 
 
 
 
 
 
 
Cash Returned to Shareholders During the Year
 
 
 
 
 
 
 
 
 
 
Dividends paid
 
$
47,266

 
$
45,858

 
$
44,619

 
$
43,330

 
$
42,663

Purchases of treasury shares
 
11,158

 
22,778

 
8,242

 
37,465

 
76,515

Total
 
$
58,424

 
$
68,636

 
$
52,861

 
$
80,795

 
$
119,178

(a)
A long-lived intangible asset impairment charge in fiscal 2019 reduced operating income by $31.6 million, net income by $26.9 million, and diluted earnings per share by $0.69, which includes the impact of the $3.8 million valuation allowance on certain Canadian deferred tax assets. Excluding the long-lived intangible asset impairment charge, the fiscal 2019 return on assets would be 7.5% and return on equity would be 20.0%.
(b)
FY 2018 includes the acquisition of FCX Performance, Inc. from the acquisition date of 1/31/2018.
(c)
FY 2017 includes a tax benefit pertaining to a worthless stock tax deduction of $22.2 million, or $0.56 per share. Excluding the worthless stock tax deduction, the fiscal 2017 return on assets would be 8.5% and return on equity would be 16.2%.
(d)
A goodwill impairment charge in fiscal 2016 reduced operating income by $64.8 million, net income by $63.8 million, and diluted earnings per share by $1.62. Excluding the goodwill impairment charge, the fiscal 2016 return on assets would be 6.7% and return on equity would be 12.8%.
(e)
Includes participant-shareholders in the Applied Industrial Technologies, Inc. Retirement Savings Plan and shareholders in the Company's direct stock purchase program.
(f)
Return on assets is calculated as net income divided by monthly average assets.
(g)
Return on equity is calculated as net income divided by the average shareholders’ equity (beginning of the year plus end of
the year divided by 2).

14


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
OVERVIEW
With more than 6,600 employees across North America, Australia, New Zealand, and Singapore, Applied Industrial Technologies (“Applied,” the “Company,” “We,” “Us” or “Our”) is a leading value-added 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. At June 30, 2019, business was conducted in the United States, Puerto Rico, Canada, Mexico, Australia, New Zealand, and Singapore from 600 facilities.
The following is Management's Discussion and Analysis of significant factors that have affected our financial condition, results of operations and cash flows during the periods included in the accompanying consolidated balance sheets, statements of consolidated income, consolidated comprehensive income and consolidated cash flows in Item 8 under the caption "Financial Statements and Supplementary Data." When reviewing the discussion and analysis set forth below, please note that the majority of SKUs (Stock Keeping Units) we sell in any given year were not 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.
Our fiscal 2019 consolidated sales were $3.5 billion, an increase of $399.5 million or 13.0% compared to the prior year, with the acquisitions of FCX Performance Inc. (FCX), Fluid Power Sales Inc. (FPS), MilRoc Distribution (MilRoc), and Woodward Steel (Woodward), increasing sales by $360.0 million or 11.7% and unfavorable foreign currency translation of $19.2 million decreasing sales by 0.6%. Gross profit margin increased to 29.0% for fiscal 2019 from 28.8% for fiscal 2018 primarily due to the impact of the acquisitions, which favorably impacted the gross profit margin by 48 basis points in fiscal 2019, offset by an unfavorable impact of 26 basis points from the change in LIFO expense in fiscal 2019 compared to fiscal 2018. Operating margin decreased to 6.7% in fiscal 2019 from 7.3% in fiscal 2018. The reduction in operating margin is primarily due to a non-cash impairment charge recorded during fiscal 2019 totaling $31.6 million related to the long-lived intangible assets associated with the Company's upstream oil and gas operations in Canada within the Service Center Based Distribution segment. The non-cash impairment charge decreased net income by $23.1 million and earnings per share by $0.59 per share.
During the third quarter of fiscal 2019, the Company recorded charges of $2.3 million for restructuring activities within the Service Center Based Distribution segment to reduce headcount and consolidate locations, primarily related to the Company's oil and gas operations. Of the total, $0.7 million related to inventory reserves for excess and obsolete inventory recorded within cost of sales and $1.6 million related to severance and facility consolidation recorded within selling, distribution and administrative expense. Total restructuring charges reduced gross profit for the year by $0.7 million, operating income by $2.3 million, and earnings per share by $0.04 per share.
Our earnings per share was $3.68 in fiscal 2019 versus $3.61 in fiscal year 2018.
Shareholders’ equity was $897.0 million at June 30, 2019 compared to $815.0 million at June 30, 2018. Working capital increased $98.9 million from June 30, 2018 to $724.3 million at June 30, 2019. The current ratio was 2.7 to 1 at June 30, 2019 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.

15


The MCU (total industry) and IP indices have gradually decreased during the second half of fiscal 2019 correlating with an overall decline in the industrial economy in the same period. The ISM PMI registered 51.7 in June 2019, a decrease from the June 2018 revised reading of 60.0. A reading above 50 generally indicates expansion. The index readings for the months during the current quarter, along with the revised indices for previous quarter ends, were as follows:
 
Index Reading
Month
MCU
PMI
IP
June 2019
77.9
51.7
105.2
May 2019
78.1
52.1
104.8
April 2019
77.9
52.8
104.6
March 2019
78.4
55.3
105.2
December 2018
79.5
54.3
106.4
September 2018
79.3
59.5
105.7
June 2018
78.6
60.0
104.8
RESULTS OF OPERATIONS
This discussion and analysis deals with comparisons of material changes in the consolidated financial statements for the years ended June 30, 2019 and 2018. For the comparison of the years ended June 30, 2018 and 2017, see the Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our 2018 Annual Report on Form 10-K.
The following table is included to aid in review of Applied’s statements of consolidated income.
 
Year Ended June 30,
As a % of Net Sales
 
Change in $'s Versus Prior Period

 
2019

 
2018

 
% Change

Net Sales
100.0
%
 
100.0
%
 
13.0
%
Gross Profit Margin
29.0
%
 
28.8
%
 
14.0
%
Selling, Distribution & Administrative
21.4
%
 
21.4
%
 
12.8
%
Operating Income
6.7
%
 
7.3
%
 
3.5
%
Net Income
4.1
%
 
4.6
%
 
1.7
%
Sales in fiscal 2019 were $3.5 billion, which was $399.5 million or 13.0% above the prior year, with sales from acquisitions accounting for $360.0 million or 11.7% of the increase, and unfavorable foreign currency translation accounting for a decrease of $19.2 million or 0.6%. There were 251.5 selling days in both fiscal 2019 and fiscal 2018. Excluding the impact of businesses acquired and the impact of foreign currency translation, sales were up $58.7 million or 1.9% during the year, which is driven by growth of 3.5% from the Service Center Based Distribution segment, offset by a 1.6% decline from the Fluid Power & Flow Control segment.
The following table shows changes in sales by reportable segment.
Amounts in millions
 
 
 
Amount of change due to
 
Year ended June 30,
Sales Increase

Acquisitions

Foreign Currency

Organic Change

Sales by Reportable Segment
2019

2018

Service Center Based Distribution
$
2,452.9

$
2,346.4

$
106.5

$
17.6

$
(19.2
)
$
108.1

Fluid Power & Flow Control
1,019.8

726.8

293.0

342.4


(49.4
)
Total
$
3,472.7

$
3,073.2

$
399.5

$
360.0

$
(19.2
)
$
58.7

Sales of our Service Center Based Distribution segment, which operates primarily in MRO markets, increased $106.5 million, or 4.5%. Acquisitions within this segment increased sales by $17.6 million or 0.7%, and unfavorable foreign currency translation decreased sales by $19.2 million or 0.8%. Excluding the impact of businesses acquired and the impact of foreign currency translation, sales increased $108.1 million or 4.6% due to overall growth in the industrial economy.

16


Sales of our Fluid Power & Flow Control segment increased $293.0 million or 40.3%. Acquisitions within this segment, primarily FCX, increased sales $342.4 million or 47.1%. Excluding the impact of businesses acquired, sales decreased $49.4 million or 6.8%. The decrease from operations is primarily due to softness and project delays in our fluid power businesses tied to technology markets, specifically electronic equipment and component manufacturers, as well as slower demand in our flow control operations.
The following table shows changes in sales by geographical area. Other countries includes Mexico, Australia, New Zealand, and Singapore.
Amounts in millions
 
 
 
Amount of change due to
 
Year ended June 30,
Sales Increase

Acquisitions

Foreign Currency

Organic Change

Sales by Geographic Area
2019

2018

United States
$
3,016.7

$
2,615.0

$
401.7

$
360.0

$

$
41.7

Canada
271.3

273.6

(2.3
)

(11.5
)
9.2

Other countries
184.7

184.6

0.1


(7.7
)
7.8

Total
$
3,472.7

$
3,073.2

$
399.5

$
360.0

$
(19.2
)
$
58.7

Sales in our U.S. operations increased $401.7 million or 15.4%, with acquisitions adding $360.0 million or 13.8%. Excluding the impact of businesses acquired, U.S. sales were up $41.7 million or 1.6%. Sales from our Canadian operations decreased $2.3 million or 0.8%, and unfavorable foreign currency translation decreased Canadian sales by $11.5 million or 4.2%. Excluding the impact of foreign currency translation, Canadian sales were up $9.2 million or 3.4%, of which 4.2% is growth from operations, offset by a 0.8% decrease due to two less sales days. Consolidated sales from our other country operations increased $0.1 million compared to the prior year. Unfavorable foreign currency translation decreased other country sales by $7.7 million or 4.2%. Excluding the impact of foreign currency translation, other country sales were up $7.8 million or 4.2% compared to the prior year.
Our gross profit margin increased to 29.0% in fiscal 2019 compared to 28.8% in fiscal 2018 primarily due to the impact of acquisitions, which favorably impacted the gross profit margin by 48 basis points in fiscal 2019, offset by an unfavorable impact of 26 basis points from the change in LIFO expense in fiscal 2019 compared to fiscal 2018.
The following table shows the changes in selling, distribution, and administrative expense (SD&A).
Amounts in millions
 
 
 
Amount of change due to
 
Year ended June 30,
SD&A Increase

Acquisitions

Foreign Currency

Organic Change

 
2019

2018

SD&A
$
742.2

$
658.2

$
84.1

$
86.9

$
(5.6
)
$
2.8

SD&A consists of associate compensation, benefits and other expenses associated with selling, purchasing, warehousing, supply chain management, and marketing and distribution of the Company’s products, as well as costs associated with a variety of administrative functions such as human resources, information technology, treasury, accounting, insurance, legal, facility related expenses and expenses incurred in acquiring businesses. SD&A increased $84.1 million or 12.8% during fiscal 2019 compared to the prior year, and as a percentage of sales remained stable at 21.4% in fiscal 2019 and 2018. Changes in foreign currency exchange rates had the effect of decreasing SD&A by $5.6 million or 0.9% compared to the prior year. SD&A from businesses acquired added $86.9 million or 13.2%, including $13.7 million of intangibles amortization related to acquisitions, and net of $6.1 million of one-time acquisition costs related to the acquisition of FCX in the prior year that did not reoccur in the current year. Excluding the impact of businesses acquired and the favorable impact from foreign currency translation, SD&A increased $2.8 million or 0.5% during fiscal 2019 compared to fiscal 2018. The Company incurred $1.6 million of restructuring expenses related to severance and facility consolidation during fiscal 2019. All other expenses within SD&A were up $1.2 million.
As a result of the continued decline in the oil and gas industry in western Canada, the Company performed an impairment analysis for certain long-lived intangible assets related to the Company's upstream oil and gas operations in Canada during the third quarter of fiscal 2019. As a result of this test, the Company determined that the net book values of these long-lived intangible assets were impaired and recognized a non-cash impairment charge of $31.6 million for intangible assets in fiscal 2019, which decreased net income by $23.1 million and earnings per share by $0.59 per share.

17


Operating income increased $8.0 million, or 3.5%, to $233.8 million during fiscal 2019 from $225.8 million during fiscal 2018, and as a percentage of sales, decreased to 6.7% from 7.3%, primarily as a result of the impairment expense recorded during the current year.
Operating income as a percentage of sales for the Service Center Based Distribution segment increased to 10.4% in fiscal 2019 from 10.2% in fiscal 2018. Operating income as a percentage of sales for the Fluid Power & Flow Control segment decreased to 11.0% in fiscal 2019 from 11.4% in fiscal 2018.
Segment operating income is impacted by changes in the amounts and levels of certain supplier support benefits and expenses allocated to the segments. The expense allocations include corporate charges for working capital, logistics support and other items and impact segment gross profit and operating expense.
Other income, net, represents certain non-operating items of income and expense. This was $0.9 million of income in fiscal 2019 compared to $2.4 million of income in fiscal 2018. Current year income primarily consists of unrealized gains on investments held by non-qualified deferred compensation trusts of $0.7 million and life insurance income of $0.5 million, offset by foreign currency transaction losses of $0.3 million. Fiscal 2018 income consisted primarily of life insurance income of $1.6 million and unrealized gains on investments held by non-qualified deferred compensation trusts of $0.8 million.
The effective income tax rate was 26.0% for fiscal 2019 compared to 30.8% for fiscal 2018. The decrease in the effective tax rate is primarily due to the enactment of the Tax Cuts and Jobs Act (the "Act") in December 2017, which reduced the U.S. federal corporate income tax rate from 35.0% to 21.0% effective January 1, 2018. The Act resulted in a statutory rate of 21.0% for fiscal 2019 and a blended statutory rate of 28.1% for fiscal 2018. In the third quarter of fiscal 2019, the Company recorded a valuation allowance of $3.8 million related to certain deferred tax assets in Canada due to the uncertainty in realizing these net deferred tax assets, which was increased by $1.8 million in the fourth quarter of fiscal 2019, and in total increased the effective tax rate by 2.9% for fiscal 2019. Also in the fourth quarter of fiscal 2019, final regulations were released by the Internal Revenue Service that impacted the transition tax. As a result of these regulations, the net transition tax paid by the Company was $1.4 million.
We expect our income tax rate for fiscal 2020 to be in the range of 25.0% to 27.0%.
As a result of the factors discussed above, net income for fiscal 2019 increased $2.4 million from the prior year. Net income per share was $3.68 per share for fiscal 2019 compared to $3.61 per share for fiscal 2018. Current year results were favorably impacted by $0.48 per share for acquisitions, $0.37 per share for tax reform, and improved Company performance, offset by a $0.69 per share unfavorable impact from the intangible impairment, which includes the impact of recording the $3.8 million valuation allowance in the third quarter of fiscal 2019, and a $0.04 per share unfavorable impact from restructuring charges during fiscal 2019. The prior year results include positive impacts on earnings per share of $0.15 per share related to tax reform and $0.05 per share related to the results of FCX, offset by a negative impact of $0.13 per share for one-time costs related to the acquisition of FCX.
At June 30, 2019, we had a total of 600 operating facilities in the United States, Puerto Rico, Canada, Mexico, Australia, New Zealand, and Singapore, versus 610 at June 30, 2018.
The approximate number of Company employees was 6,650 at June 30, 2019 and 6,634 at June 30, 2018.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of capital is cash flow from operations, supplemented as necessary by bank borrowings or other sources of debt. At June 30, 2019 we had total debt obligations outstanding of $959.8 million compared to $966.1 million at June 30, 2018. 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 we operate in, 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 June 30, 2019 was $724.3 million compared to $625.5 million at June 30, 2018. The current ratio was 2.7 to 1 at June 30, 2019 and 2.4 to 1 at June 30, 2018. The increase is primarily driven by a higher cash balance at June 30, 2019.

18


Net Cash Flows
The following table is included to aid in review of Applied’s statements of consolidated cash flows; all amounts
are in thousands.
 
Year Ended June 30,
 
2019

 
2018

Net Cash Provided by (Used in):
 
 
 
Operating Activities
$
180,601

 
$
147,304

Investing Activities
(55,102
)
 
(797,906
)
Financing Activities
(71,539
)
 
600,284

Exchange Rate Effect
109

 
(589
)
Increase (Decrease) in Cash and Cash Equivalents
$
54,069

 
$
(50,907
)
The increase in cash provided by operating activities during fiscal 2019 is primarily due to the impact of acquisitions along with improved operating results, offset by changes in working capital.
Net cash used in investing activities in fiscal 2019 included $37.5 million used for the acquisitions of FPS, MilRoc and Woodward, and $19.0 million used for capital expenditures. Net cash used in investing activities in fiscal 2018 included $775.7 million used for acquisitions, primarily FCX, and $23.2 million for capital expenditures.
Net cash used in financing activities in fiscal 2019 included $175.0 million of cash from borrowings under the new trade receivable securitization facility, offset by $19.5 million of net payments under the revolving credit facility, and $161.7 million of long-term debt repayments. Further uses of cash were $47.3 million for dividend payments, $11.2 million used to repurchase 192,082 shares of treasury stock, $3.5 million used to pay taxes for shares withheld, and $2.6 million used for acquisition holdback payments.
Net cash provided by financing activities in fiscal 2018 included $780.0 million of cash borrowings under the new credit facility and $19.5 million of net borrowings under the revolving credit facility, offset by $125.4 million of long-term debt repayments. Further uses of cash were $45.9 million for dividend payments, $22.8 million used to repurchase 393,300 shares of treasury stock, and $3.3 million used for the payment of debt issuance costs.
The increase in dividends over the year is the result of regular increases in our dividend payout rates. We paid dividends of $1.22 and $1.18 per share in fiscal 2019 and 2018, respectively.
Capital Expenditures
We expect capital expenditures for fiscal 2020 to be in the $20.0 million to $25.0 million range, primarily consisting of capital associated with additional information technology equipment and infrastructure investments. Depreciation for fiscal 2020 is expected to be in the range of $21.0 million to $22.0 million.
Share Repurchases
The Board of Directors has authorized the repurchase of shares of the Company’s stock. These purchases may
be made in open market and negotiated transactions, from time to time, depending upon market conditions.
At
June 30, 2019, we had authorization to purchase an additional 864,618 shares.
In fiscal 2019, 2018 and 2017, we repurchased 192,082, 393,300, and 162,500 shares of the Company’s common stock, respectively, at an average price per share of $58.10, $57.92, and $50.72, respectively.
Borrowing Arrangements
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 $780.0 million unsecured term loan and a $250.0 million 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 June 30, 2019 and June 30, 2018, the Company had $613.6 million and $775.1 million outstanding under the term loan, respectively. The Company had no amount outstanding under the revolver as of June 30, 2019 and $19.5 million was outstanding under the revolver as of June 30, 2018. Unused lines under this facility, net of outstanding letters of credit of $3.2 million and $3.6 million, respectively, to secure certain insurance obligations, totaled $246.8 million and $226.9 million at June 30, 2019 and June 30, 2018, respectively, and were available to fund future acquisitions or other capital and operating requirements. In January 2019, the Company entered into an interest rate swap on $463.0 million of unsecured variable debt to mitigate variability in forecasted interest payments.

19


The interest rate on the term loan was 4.19% and 4.13% as of June 30, 2019 and June 30, 2018, respectively. 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 $2.7 million as of June 30, 2019 and June 30, 2018, in order to secure certain insurance obligations.
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 $175.0 million. 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 $175.0 million 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 June 30, 2019, the Company borrowed $175.0 million under the AR Securitization Facility, and the interest rate was 3.33%.
At June 30, 2019 and June 30, 2018, the Company had borrowings outstanding under its unsecured shelf facility agreement with Prudential Investment Management of $170.0 million. Fees on this facility range from 0.25% to 1.25% per year based on the Company's leverage ratio at each quarter end. The "Series C" notes have a principal amount of $120.0 million 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 $50.0 million, carry a fixed interest rate of 3.21%, and are due in equal principal payments in October 2019 and 2023.
In 2014, the Company assumed $2.4 million of debt as a part of the headquarters facility acquisition. The 1.50% fixed interest rate note is held by the State of Ohio Development Services Agency, maturing in May 2024. At June 30, 2019 and 2018, $1.2 million and $1.4 million was outstanding, respectively.
The credit facility and the unsecured shelf facility contain restrictive covenants regarding liquidity, net worth, financial ratios, and other covenants. At June 30, 2019, the most restrictive of these covenants required that the Company have net indebtedness less than 4.0 times consolidated income before interest, taxes, depreciation and amortization (as defined). At June 30, 2019, the Company's net indebtedness was less than 3.0 times consolidated income before interest, taxes, depreciation and amortization (as defined). The Company was in compliance with all financial covenants at June 30, 2019.
Accounts Receivable Analysis
The following table is included to aid in analysis of accounts receivable and the associated provision for losses on accounts receivable (all dollar amounts are in thousands):
June 30,
2019

 
2018

Accounts receivable, gross
$
551,400

 
$
559,775

Allowance for doubtful accounts
10,498

 
10,964

Accounts receivable, net
$
540,902

 
$
548,811

Allowance for doubtful accounts, % of gross receivables
1.9
%
 
2.0
%
 
 
 
 
Year Ended June 30,
2019

 
2018

Provision for losses on accounts receivable
$
4,058

 
$
2,803

Provision as a % of net sales
0.12
%
 
0.09
%
Accounts receivable are reported at net realizable value and consist of trade receivables from customers. Management monitors accounts receivable by reviewing Days Sales Outstanding (DSO) and the aging of receivables for each of the Company's locations.
On a consolidated basis, DSO was 55.2 at June 30, 2019 versus 55.0 at June 30, 2018.
Approximately 3.0% of our accounts receivable balances are more than 90 days past due at June 30, 2019 compared to 4.0% at June 30, 2018. This decrease primarily relates to our U.S. Service Center Based Distribution

20


businesses. On an overall basis, our provision for losses from uncollected receivables represents 0.12% of our sales in the year ended June 30, 2019. Historically, this percentage is around 0.10% to 0.15%. Management believes the overall receivables aging and provision for losses on uncollected receivables are at reasonable levels.
Inventory Analysis
Inventories are valued using the last-in, first-out (LIFO) method for U.S. inventories and the average cost method for foreign inventories. Management uses an inventory turnover ratio to monitor and evaluate inventory. Management calculates this ratio on an annual as well as a quarterly basis and uses inventory valued at average costs. The annualized inventory turnover (using average costs) for the period ended June 30, 2019 was 4.2 versus 4.0 at June 30, 2018. We believe our inventory turnover ratio in fiscal 2020 will be slightly better than our fiscal 2019 levels.
CONTRACTUAL OBLIGATIONS
The following table shows the approximate value of the Company’s contractual obligations and other commitments to make future payments as of June 30, 2019 (in thousands):
 
Total

 
Period Less
Than 1 yr

 
Period
2-3 yrs

 
Period
4-5 yrs

 
Period
Over 5 yrs

 
Other

Operating leases
$
104,160

 
$
33,707

 
$
39,827

 
$
18,491

 
$
12,135

 

Planned funding of post-retirement obligations
12,900

 
3,500

 
1,800

 
1,200

 
6,400

 

Unrecognized income tax benefit liabilities, including interest and penalties
5,800

 

 

 

 

 
5,800

Long-term debt obligations
959,829

 
49,613

 
338,361

 
571,855

 

 

Interest on long-term debt obligations (1)
105,400

 
35,800

 
58,400

 
11,200

 

 

Acquisition holdback payments
6,371

 
2,640

 
3,656

 
75

 

 

Total Contractual Cash Obligations
$
1,194,460

 
$
125,260

 
$
442,044

 
$
602,821

 
$
18,535

 
$
5,800

(1) Amounts represent estimated contractual interest payments on outstanding long-term debt obligations. Rates in effect as of June 30, 2019 are used for variable rate debt.
Purchase orders for inventory and other goods and services are not included in our estimates as we are unable to aggregate the amount of such purchase orders that represent enforceable and legally binding agreements specifying all significant terms. The previous table includes the gross liability for unrecognized income tax benefits including interest and penalties in the “Other” column as the Company is unable to make a reasonable estimate regarding the timing of cash settlements, if any, with the respective taxing authorities.
SUBSEQUENT EVENTS
We have evaluated events and transactions occurring subsequent to June 30, 2019 through the date the financial statements were issued.
During the first quarter of fiscal 2020, the Company reached a definitive agreement to acquire 100% of the outstanding stock of Olympus Controls Corp., located in Tualatin, Oregon. The Company intends to fund this acquisition using funds available through the Company's revolving credit facility. As a full-service provider of innovative technologies and complete engineered solutions for OEMs, machine builders, integrators, and end users, this business will be included in the Fluid Power & Flow Control segment.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates at a specific point in time that affect the amounts reported in the consolidated financial statements and disclosed in the accompanying notes. The Business and Accounting Policies note to the consolidated financial statements describes the significant accounting policies and methods used in preparation of the consolidated financial statements. Estimates are used for, but not limited to, determining the net carrying value of trade accounts receivable, inventories, recording self-insurance liabilities and other accrued liabilities. Estimates are also used in establishing opening balances in relation to purchase accounting. Actual results could differ from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the consolidated financial statements.

21


LIFO Inventory Valuation and Methodology
Inventories are valued at the average cost method, using the last-in, first-out (LIFO) method for U.S. inventories, and the average cost method for foreign inventories. We adopted the link chain dollar value LIFO method for accounting for U.S. inventories in fiscal 1974. Approximately 15.9% of our domestic inventory dollars relate to LIFO layers added in the 1970s. The excess of average cost over LIFO cost is $151.7 million as reflected in our consolidated balance sheet at June 30, 2019. The Company maintains five LIFO pools based on the following product groupings: bearings, power transmission products, rubber products, fluid power products and other products.
LIFO layers and/or liquidations are determined consistently year-to-year. See the Inventories note to the
consolidated financial statements in Item 8 under the caption "Financial Statements and Supplementary Data,"
for further information.
Allowances for Slow-Moving and Obsolete Inventories
We evaluate the recoverability of our slow-moving and inactive inventories at least quarterly. We estimate the recoverable cost of such inventory by product type while considering factors such as its age, historic and current demand trends, the physical condition of the inventory, as well as assumptions regarding future demand. Our ability to recover our cost for slow moving or obsolete inventory can be affected by such factors as general market conditions, future customer demand and relationships with suppliers. A significant portion of the products we hold in inventory have long shelf lives, are not highly susceptible to obsolescence and are eligible for return under various supplier return programs.
As of June 30, 2019 and 2018, the Company's reserve for slow-moving or obsolete inventories was $41.1 million and $38.1 million, respectively, recorded in inventories in the consolidated balance sheets.
Allowances for Doubtful Accounts
We evaluate the collectibility of trade accounts receivable based on a combination of factors. Initially, we estimate an allowance for doubtful accounts as a percentage of net sales based on historical bad debt experience. This initial estimate is adjusted based on recent trends of certain customers and industries estimated to be a greater credit risk, trends within the entire customer pool and changes in the overall aging of accounts receivable. While we have a large customer base that is geographically dispersed, a general economic downturn in any of the industry segments in which we operate could result in higher than expected defaults, and therefore, the need to revise estimates for bad debts. Accounts are written off against the allowance when it becomes evident that collection will not occur.
As of June 30, 2019 and 2018, our allowance for doubtful accounts was 1.9% and 2.0% of gross receivables, respectively. Our provision for losses on accounts receivable was $4.1 million, $2.8 million and $2.1 million in fiscal 2019, 2018 and 2017, respectively.
Goodwill and Intangibles
The purchase price of an acquired company is allocated between intangible assets and the net tangible assets of the acquired business with the residual of the purchase price recorded as goodwill. Goodwill for acquired businesses is accounted for using the acquisition method of accounting which requires that the assets acquired and liabilities assumed be recorded at the date of the acquisition at their respective estimated fair values. The determination of the value of the intangible assets acquired involves certain judgments and estimates. These judgments can include, but are not limited to, the cash flows that an asset is expected to generate in the future and the appropriate weighted average cost of capital. The judgments made in determining the estimated fair value assigned to each class of assets acquired, as well as the estimated life of each asset, can materially impact the net income of the periods subsequent to the acquisition through depreciation and amortization, and in certain instances through impairment charges, if the asset becomes impaired in the future. As part of acquisition accounting, we recognize acquired identifiable intangible assets such as customer relationships, vendor relationships, trade names, and non-competition agreements apart from goodwill. Finite-lived identifiable intangibles are evaluated for impairment when changes in conditions indicate carrying value may not be recoverable.
We evaluate goodwill for impairment at the reporting unit level annually as of January 1, and whenever an event occurs or circumstances change that would indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Events or circumstances that may result in an impairment review include changes in macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, other relevant entity-specific events, specific events affecting the reporting unit or sustained decrease in share price. Each year, the Company may elect to perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If impairment is indicated in the qualitative assessment, or, if management elects to initially perform a quantitative assessment of goodwill, the impairment test uses a one-step approach. The fair value of a reporting unit is compared with its carrying amount,

22


including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired. If the carrying amount of a reporting unit exceeds its fair value, an impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to that reporting unit.
Goodwill on our consolidated financial statements relates to both the Service Center Based Distribution segment and the Fluid Power & Flow Control segment. The Company has seven reporting units for which an annual goodwill impairment assessment was performed as of January 1, 2019.  The Company concluded that all of the reporting units’ fair value exceeded their carrying amounts by at least 20% as of January 1, 2019. As of June 30, 2019, the Company's goodwill balance was $662.0 million, of which $28.3 million relates to the Canada reporting unit. As of January 1, 2019, the fair value of the Canada reporting unit exceeded the carrying value by 25.0%. If the Company does not achieve the forecasted sales growth and margin improvements goodwill could be impaired.
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, and requires management to make significant estimates and assumptions related to forecasts of future revenues, operating margins, and discount rates. The market approach utilizes an analysis of comparable publicly traded companies and requires management to make significant estimates and assumptions related to the forecasts of future revenues, earnings before interest, taxes, depreciation, and amortization (EBITDA) and multiples that are applied to management’s forecasted revenues and EBITDA estimates.
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.  Further, continued adverse market conditions could result in the recognition of additional impairment if the Company determines that the fair values of its reporting units have fallen below their carrying values.
Income Taxes
Deferred income taxes are recorded for estimated future tax effects of differences between the bases of assets and liabilities for financial reporting and income tax purposes, giving consideration to enacted tax laws. As of June 30, 2019, the Company had recognized $54.5 million of net deferred tax liabilities. Valuation allowances are provided against deferred tax assets where it is considered more-likely-than-not that the Company will not realize the benefit of such assets on a jurisdiction by jurisdiction basis. The remaining net deferred tax asset is the amount management believes is more-likely-than-not of being realized. The realization of these deferred tax assets can be impacted by changes to tax laws, statutory rates and future taxable income levels.

23


CAUTIONARY STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT
This Form 10-K, including 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; 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, or changes in supplier distribution programs; the cost of products and energy and other operating costs; 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, and international trade, such as recent tariffs and proposed tariffs on imports; and the occurrence of extraordinary events (including prolonged labor disputes, power outages, telecommunication outages, terrorist acts, 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.
We discuss certain of these matters and other risk factors more fully throughout our Form 10-K, as well as other of our filings with the Securities and Exchange Commission.


24


ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our market risk is impacted by changes in foreign currency exchange rates as well as changes in interest rates.
We occasionally utilize derivative instruments as part of our overall financial risk management policy, but do not use derivative instruments for speculative or trading purposes.
Foreign Currency Exchange Rate Risk
Because we operate throughout North America, Australia and New Zealand and approximately 13.1% of our fiscal year 2019 net sales were generated outside the United States, foreign currency exchange rates can impact our financial position, results of operations and competitive position. The financial statements of foreign subsidiaries are translated into their U.S. dollar equivalents at end-of-period exchange rates for assets and liabilities, while income and expenses are translated at average monthly exchange rates. Translation gains and losses are components of other comprehensive income (loss) as reported in the statements of consolidated comprehensive income. Transaction gains and losses arising from fluctuations in currency exchange rates on transactions denominated in currencies other than the functional currency are recognized in the statements of consolidated income as a component of other (income) expense, net. Applied does not currently hedge the net investments in our foreign operations.
During the course of the fiscal year, the Canadian and Mexican currency exchange rates increased in relation to the U.S. dollar by 1.4% and 3.6%, respectively, while the Australian and New Zealand currency exchange rates decreased in relation to the U.S. dollar by 4.8% and 1.1%, respectively. In the twelve months ended June 30, 2019, we experienced net foreign currency translation gains totaling $2.0 million, which were included in other comprehensive (loss) income. We utilize a sensitivity analysis to measure the potential impact on earnings based on a hypothetical 10% change in foreign currency rates. Excluding the non-cash intangible asset impairment charge recorded in fiscal 2019, a 10% strengthening of the U.S. dollar relative to foreign currencies that affect the Company from the levels experienced during the year ended June 30, 2019 would have resulted in a $1.4 million decrease in net income for the year ended June 30, 2019. Excluding the non-cash intangible asset impairment charge recorded in fiscal 2019, a 10% weakening of the U.S. dollar relative to foreign currencies that affect the Company from the levels experienced during the year ended June 30, 2019 would have resulted in a $1.4 million increase in net income for the year ended June 30, 2019.
Interest Rate Risk
Our primary exposure to interest rate risk results from our outstanding debt obligations with variable interest rates. The levels of fees and interest charged on our various debt facilities are based upon leverage levels and market interest rates. The Company uses interest rate swap instruments to mitigate variability in forcasted interest rates.
Our variable interest rate debt facilities outstanding include our five-year credit facility, which provides for a revolving credit facility with a capacity of up to $250.0 million in borrowings with no balance outstanding at June 30, 2019, a $780.0 million term loan, of which $613.6 million was outstanding at June 30, 2019, and a $175.0 million trade receivable securitization facility, all of which was outstanding at June 30, 2019. In January 2019, the Company entered into an interest rate swap on $463.0 million of the Company’s U.S. dollar-denominated unsecured variable rate debt. The interest rate swap effectively converts a portion of the floating rate interest payment into a fixed rate interest payment. The Company designated the interest rate swap as a pay-fixed, receive-floating interest rate swap instrument and is accounting for this derivative as a cash flow hedge. Fixed interest rate debt facilities include $170.0 million outstanding under our unsecured shelf facility agreement, as well as $1.2 million of assumed debt from the purchase of our headquarters facility. We had total average variable interest rate bank borrowings of $810.9 million during fiscal 2019. The impact of a hypothetical 1.0% increase in the interest rates on our average variable interest rate bank borrowings (not considering the impact of our interest rate swap) would have resulted in a $8.1 million increase in interest expense. Due to the interest rate swap, the impact of a hypothetical 1.0% increase in the variable interest rate would have reduced net cash interest paid by $1.9 million. Changes in market interest rates would also impact interest rates on these facilities.
For more information relating to borrowing and interest rates, see the “Liquidity and Capital Resources” section of “Management's Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and notes 6 and 7 to the consolidated financial statements in Item 8. That information is also incorporated here by reference. In addition, see Item 1A, “Risk Factors,” for additional risk factors relating to our business.


25


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Applied Industrial Technologies, Inc.

Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Applied Industrial Technologies, Inc. and subsidiaries (the “Company”) as of June 30, 2019 and 2018, the related statements of consolidated income, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 2019, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2019, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2019, based on the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 16, 2019, expressed an unqualified opinion on the Company's internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. 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 audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
 
 
 
 
 
Goodwill - Canada Reporting Unit - Refer to Note 5 to the financial statements
 
 
 
 
 
Critical Audit Matter Description
The Company’s evaluation of goodwill for impairment involves the comparison of the fair value of each reporting unit to its carrying value. The Company determines the fair value of its reporting units using the income and market approaches. The determination of the fair value using the income approach requires management to make significant estimates and assumptions related to forecasts of future revenues, operating margins, and discount rates. The determination of the fair value using the market approach requires management to make significant estimates and assumptions related to forecasts of future revenues, earnings before interest, taxes, depreciation, and amortization (EBITDA) and multiples that are applied to management’s forecasted revenues and EBITDA estimates. The goodwill balance was $662.0 million as of June 30, 2019, of which $28.3 million related to the Canada reporting unit. The fair value of the Canada reporting unit exceeded its carrying value by 25% as of the measurement date and, therefore, no impairment was recognized.

26


Given the nature of the Canada reporting unit's operations, the sensitivity of the business to changes in the Canadian economy, the reporting unit’s historical performance as compared to projections, and the difference between its fair value and the carrying value, auditing management’s judgments regarding forecasts of future revenues, operating margins, and EBITDA, as well as selection of the discount rate and selection of multiples applied to management’s forecasted revenues and EBITDA estimates for the Canada reporting unit, required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists.
 
 
 
 
 
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the forecasts of future revenues, operating margins, and EBITDA (“forecasts”), and the selection of the discount rate and selection of multiples applied to management’s forecasted revenues and EBITDA estimates (“market multiples”) for the Canada reporting unit included the following, among others:
We tested the effectiveness of controls over management’s goodwill impairment evaluation, including those over the determination of the fair value of the Canada reporting unit, such as controls related to management’s forecasts and the selection of the discount rate and market multiples used.
We evaluated management’s ability to accurately forecast by comparing actual results to management’s historical forecasts.
We evaluated the reasonableness of management’s forecasts by comparing the forecasts to (1) historical results, (2) internal communications to management and the Board of Directors, and (3) forecasted information included in industry reports for the various industries the Canada reporting unit operates within.
With the assistance of our fair value specialists, we evaluated the discount rate, including testing the underlying source information and the mathematical accuracy of the calculations, and developing a range of independent estimates and comparing those to the discount rate selected by management.
With the assistance of our fair value specialists, we evaluated the market multiples by evaluating the selected comparable publicly traded companies and the adjustments made for differences in growth prospects and risk profiles between the reporting unit and the comparable publicly traded companies. We tested the underlying source information and mathematical accuracy of the calculations.
 
 
 
 
 

/s/ Deloitte & Touche LLP
Cleveland, Ohio

August 16, 2019

We have served as the Company's auditor since 1966.

27


STATEMENTS OF CONSOLIDATED INCOME
(In thousands, except per share amounts)

Year Ended June 30,
 
2019

 
2018

 
2017

Net Sales
 
$
3,472,739

 
$
3,073,274

 
$
2,593,746

Cost of Sales
 
2,465,116

 
2,189,279

 
1,856,051

Gross Profit
 
1,007,623

 
883,995

 
737,695

Selling, Distribution and Administrative, including depreciation
 
742,241

 
658,168

 
562,309

Intangible Impairment
 
31,594

 

 

Operating Income
 
233,788

 
225,827

 
175,386

Interest Expense
 
40,788

 
24,142

 
8,831

Interest Income
 
(600
)
 
(657
)
 
(290
)
Other Income, net
 
(881
)
 
(2,376
)
 
(121
)
Income Before Income Taxes
 
194,481

 
204,718

 
166,966

Income Tax Expense
 
50,488

 
63,093

 
33,056

Net Income
 
$
143,993

 
$
141,625

 
$
133,910

Net Income Per Share — Basic
 
$
3.72

 
$
3.65

 
$
3.43

Net Income Per Share — Diluted
 
$
3.68

 
$
3.61

 
$
3.40


See notes to consolidated financial statements.


28


STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(In thousands)

Year Ended June 30,
 
2019

 
2018

 
2017

Net income per the statements of consolidated income
 
$
143,993

 
$
141,625

 
$
133,910

 
 
 
 
 
 
 
Other comprehensive (loss) income, before tax:
 
 
 
 
 
 
Foreign currency translation adjustments
 
2,021

 
(8,875
)
 
2,238

Post-employment benefits:
 
 
 
 
 
 
  Actuarial (loss) gain on re-measurement
 
(372
)
 
709

 
2,038

  Reclassification of actuarial (gains) losses and prior service cost into other income, net and included in net periodic pension costs
 
(306
)
 
(73
)
 
506

Unrealized gain on investment securities available for sale
 

 
37

 
91

Cumulative effect of adopting accounting standard
 
(50
)
 

 

Unrealized loss on cash flow hedge
 
(14,446
)
 

 

Reclassification of interest from cash flow hedge into interest expense
 
244

 

 

Total other comprehensive (loss) income, before tax
 
(12,909
)
 
(8,202
)
 
4,873

Income tax (benefit) expense related to items of other comprehensive income (loss)
 
(3,246
)
 
319

 
1,029

Other comprehensive (loss) income, net of tax
 
(9,663
)
 
(8,521
)
 
3,844

Comprehensive income
 
$
134,330

 
$
133,104

 
$
137,754


See notes to consolidated financial statements.

29


CONSOLIDATED BALANCE SHEETS
(In thousands)

June 30,
 
2019

 
2018

Assets
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
108,219

 
$
54,150

Accounts receivable, net
 
540,902

 
548,811

Inventories
 
447,555

 
422,069

Other current assets
 
51,462

 
32,990

Total current assets
 
1,148,138

 
1,058,020

Property — at cost
 
 
 
 
Land
 
14,452

 
14,411

Buildings
 
101,338

 
104,419

Equipment, including computers and software
 
189,579

 
177,813

Total property — at cost
 
305,369

 
296,643

Less accumulated depreciation
 
181,066

 
175,300

Property — net
 
124,303

 
121,343

Identifiable intangibles, net
 
368,866

 
435,947

Goodwill
 
661,991

 
646,643

Other assets
 
28,399

 
23,788

Total Assets
 
$
2,331,697

 
$
2,285,741

Liabilities
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
237,289

 
$
256,886

Current portion of long-term debt
 
49,036

 
19,183

Compensation and related benefits
 
67,978

 
73,370

Other current liabilities
 
69,491

 
83,112

Total current liabilities
 
423,794

 
432,551

Long-term debt
 
908,850

 
944,522

Other liabilities
 
102,019

 
93,705

Total Liabilities
 
1,434,663

 
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;
38,597 and 38,703 shares outstanding, respectively
 
10,000

 
10,000

Additional paid-in capital
 
172,931

 
169,383

Retained earnings
 
1,229,148

 
1,129,678

Treasury shares — at cost (15,616 and 15,510 shares), respectively
 
(415,159
)
 
(403,875
)
Accumulated other comprehensive loss
 
(99,886
)
 
(90,223
)
Total Shareholders’ Equity
 
897,034

 
814,963

Total Liabilities and Shareholders’ Equity
 
$
2,331,697

 
$
2,285,741


See notes to consolidated financial statements.

30


STATEMENTS OF CONSOLIDATED CASH FLOWS
(In thousands)
Year Ended June 30,
 
2019

 
2018

 
2017

Cash Flows from Operating Activities
 
 
 
 
 
 
Net income
 
$
143,993

 
$
141,625

 
$
133,910

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
Intangible impairment
 
31,594

 

 

Depreciation and amortization of property
 
20,236

 
17,798

 
15,306

Amortization of intangibles
 
41,883

 
32,065

 
24,371

Amortization of stock appreciation rights and options
 
2,437

 
1,961

 
1,891

Deferred income taxes
 
2,368

 
1,615

 
(2,852
)
Provision for losses on accounts receivable
 
4,058

 
2,803

 
2,071

Unrealized foreign exchange transaction losses (gains)
 
238

 
(667
)
 
(333
)
Other share-based compensation expense
 
4,474

 
4,666

 
3,629

Gain on sale of property
 
(459
)
 
(335
)
 
(1,541
)
Other
 

 

 
103

Changes in operating assets and liabilities, net of acquisitions:
 
 
 
 
 
 
Accounts receivable
 
8,465

 
(83,103
)
 
(42,267
)
Inventories
 
(16,590
)
 
(33,436
)
 
(3,624
)
Other operating assets
 
(7,738
)
 
6,947

 
(6,162
)
Accounts payable
 
(29,788
)
 
50,345

 
32,076

Other operating liabilities
 
(24,570
)
 
5,020

 
8,041

Cash provided by Operating Activities
 
180,601

 
147,304

 
164,619

Cash Flows from Investing Activities
 
 
 
 
 
 
Capital expenditures
 
(18,970
)
 
(23,230
)
 
(17,045
)
Proceeds from property sales
 
1,003

 
978

 
2,924

Cash paid for acquisition of businesses, net of cash acquired
 
(37,526
)
 
(775,654
)
 
(2,773
)
Other
 
391

 

 

Cash used in Investing Activities
 
(55,102
)
 
(797,906
)
 
(16,894
)
Cash Flows from Financing Activities
 
 
 
 
 
 
Net (repayments) borrowings under revolving credit facility
 
(19,500
)
 
19,500

 
(33,000
)
Borrowings under long-term debt facilities
 
175,000

 
780,000

 

Long-term debt repayments
 
(161,738
)
 
(125,420
)
 
(3,353
)
Payment of debt issuance costs
 
(775
)
 
(3,298
)
 

Purchases of treasury shares
 
(11,158
)
 
(22,778
)
 
(8,242
)
Dividends paid
 
(47,266
)
 
(45,858
)
 
(44,619
)
Acquisition holdback payments
 
(2,610
)
 
(319
)
 
(11,307
)
Exercise of stock appreciation rights and options
 

 
102

 
656

Taxes paid for shares withheld
 
(3,492
)
 
(1,645
)
 
(3,484
)
Cash (used in) provided by Financing Activities
 
(71,539
)
 
600,284

 
(103,349
)
Effect of exchange rate changes on cash
 
109

 
(589
)
 
820

Increase (decrease) in cash and cash equivalents
 
54,069

 
(50,907
)
 
45,196

Cash and cash equivalents at beginning of year
 
54,150

 
105,057

 
59,861

Cash and Cash Equivalents at End of Year
 
$
108,219

 
$
54,150

 
$
105,057

 
 
 
 
 
 
 
Supplemental Cash Flow Information
 
 
 
 
 
 
Cash paid during the year for:
 
 
 
 
 
 
Income taxes
 
54,294

 
41,724

 
38,772

Interest
 
40,142

 
25,560

 
8,561

See notes to consolidated financial statements.

31


STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY
(In thousands)

For the Years Ended June 30, 2019, 2018 and 2017
 
Shares of
Common
Stock
Outstanding

 
Common
Stock

 
Additional
Paid-In
Capital

 

Retained
Earnings

 
Treasury
Shares-
at Cost

 
Accumulated
Other
Comprehensive
Income (Loss)

 
Total
Shareholders'
Equity

Balance at July 1, 2016
 
39,057

 
$
10,000

 
$
162,529

 
$
944,821

 
$
(373,888
)
 
$
(85,546
)
 
$
657,916

Net income
 
 
 
 
 
 
 
133,910

 
 
 
 
 
133,910

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
 
 
 
3,844

 
3,844

Cash dividends — $1.14 per share
 
 
 
 
 
 
 
(45,005
)
 
 
 
 
 
(45,005
)
Purchases of common stock for treasury
 
(163
)
 
 
 
 
 
 
 
(8,242
)
 
 
 
(8,242
)
Treasury shares issued for:
 
 
 
 
 
 
 
 
 
 
 
 
 

Exercise of stock appreciation rights and options
 
111

 
 
 
(2,218
)
 
 
 
105

 
 
 
(2,113
)
Performance share awards
 
10

 

 
(360
)
 

 
126

 

 
(234
)
Restricted stock units
 
15

 
 
 
(624
)
 
 
 
227

 
 
 
(397
)
Compensation expense — stock appreciation rights and options
 

 
 
 
1,891

 
 
 

 
 
 
1,891

Other share-based compensation expense
 
 
 
 
 
3,629

 
 
 
 
 
 
 
3,629

Other
 
11

 
 
 
(192
)
 
25

 
224

 
 
 
57

Balance at June 30, 2017
 
39,041

 
10,000

 
164,655

 
1,033,751

 
(381,448
)
 
(81,702
)
 
745,256

Net income
 
 
 
 
 
 
 
141,625

 
 
 
 
 
141,625

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
 
 
 
(8,050
)
 
(8,050
)
Reclassifications of certain income tax effects from accumulated other comprehensive loss
 
 
 
 
 
 
 
471

 
 
 
(471
)
 

Cash dividends — $1.18 per share
 
 
 
 
 
 
 
(46,162
)
 
 
 
 
 
(46,162
)
Purchases of common stock for treasury
 
(393
)
 
 
 
 
 
 
 
(22,778
)
 
 
 
(22,778
)
Treasury shares issued for:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of stock appreciation rights and options
 
19

 
 
 
(482
)
 
 
 
84

 
 
 
(398
)
Performance share awards
 
5

 
 
 
(273
)
 
 
 
(24
)
 
 
 
(297
)
Restricted stock units
 
15

 
 
 
(740
)
 
 
 
(56
)
 
 
 
(796
)
Compensation expense — stock appreciation rights and options
 
 
 
 
 
1,961

 
 
 
 
 
 
 
1,961

Other share-based compensation expense
 
 
 
 
 
4,666

 
 
 
 
 
 
 
4,666

Other
 
16

 
 
 
(404
)
 
(7
)
 
347

 
 
 
(64
)
Balance at June 30, 2018
 
38,703

 
10,000

 
169,383

 
1,129,678

 
(403,875
)
 
(90,223
)
 
814,963

Net income
 
 
 
 
 
 
 
143,993

 
 
 
 
 
143,993

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
 
 
 
(9,663
)
 
(9,663
)
Cumulative effect of adopting accounting standards
 
 
 
 
 
 
 
3,056

 
 
 

 
3,056

Cash dividends — $1.22 per share
 

 
 
 
 
 
(47,621
)
 
 
 
 
 
(47,621
)
Purchases of common stock for treasury
 
(192
)
 
 
 

 
 
 
(11,158
)
 
 
 
(11,158
)
Treasury shares issued for:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of stock appreciation rights and options
 
30

 
 
 
(1,069
)
 
 
 
(59
)
 
 
 
(1,128
)
Performance share awards
 
18

 
 
 
(844
)
 
 
 
(301
)
 
 
 
(1,145
)
Restricted stock units
 
23

 
 
 
(1,057
)
 
 
 
(120
)
 
 
 
(1,177
)
Compensation expense — stock appreciation rights and options
 
 
 
 
 
2,437

 
 
 
 
 
 
 
2,437

Other share-based compensation expense
 
 
 
 
 
4,474

 
 
 
 
 
 
 
4,474

Other
 
15

 
 
 
(393
)
 
42

 
354

 
 
 
3

Balance at June 30, 2019
 
38,597

 
$
10,000

 
$
172,931

 
$
1,229,148

 
$
(415,159
)
 
$
(99,886
)
 
$
897,034


See notes to consolidated financial statements.

32


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)

NOTE 1: BUSINESS AND ACCOUNTING POLICIES
Business
Applied Industrial Technologies, Inc. and subsidiaries (the “Company” or “Applied”) is a leading value-added distributor of bearings, power transmission products, engineered fluid power components and systems, specialty flow control solutions, and other industrial supplies, serving Maintenance Repair & Operations (MRO) and Original Equipment Manufacturer (OEM) 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. Although the Company does not generally manufacture the products it sells, it does assemble and repair certain products and systems.
Consolidation
The consolidated financial statements include the accounts of Applied Industrial Technologies, Inc. and its subsidiaries. Intercompany transactions and balances have been eliminated in consolidation.
Foreign Currency
The financial statements of the Company’s Canadian, Mexican, Australian and New Zealand subsidiaries are measured using local currencies as their functional currencies. Assets and liabilities are translated into U.S. dollars at current exchange rates, while income and expenses are translated at average exchange rates. Translation gains and losses are reported in other comprehensive (loss) income in the statements of consolidated comprehensive income. Gains and losses resulting from transactions denominated in foreign currencies are included in the statements of consolidated income as a component of other income, net.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the period. Actual results may differ from the estimates and assumptions used in preparing the consolidated financial statements.
Cash and Cash Equivalents
The Company considers all short-term, highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are carried at cost, which approximates fair value.
Marketable Securities
The primary marketable security investments of the Company include money market and mutual funds held in a rabbi trust for a non-qualified deferred compensation plan. These are included in other assets in the consolidated balance sheets, are classified as trading securities, and are reported at fair value based on quoted market prices. Changes in the fair value of the investments during the period are recorded in other income, net in the statements of consolidated income.
Concentration of Credit Risk
The Company has a broad customer base representing many diverse industries across North America, Australia, New Zealand, and Singapore. As such, the Company does not believe that a significant concentration of credit risk exists in its accounts receivable. The Company’s cash and cash equivalents consist of deposits with commercial banks and regulated non-bank subsidiaries. While the Company monitors the creditworthiness of these institutions, a crisis in the financial systems could limit access to funds and/or result in the loss of principal. The terms of these deposits and investments provide that all monies are available to the Company upon demand.
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.

33


Allowances for Doubtful Accounts
The Company evaluates the collectibility of trade accounts receivable based on a combination of factors. Initially, the Company estimates an allowance for doubtful accounts as a percentage of net sales based on historical bad debt experience. This initial estimate is adjusted based on recent trends of customers and industries estimated to be greater credit risks, trends within the entire customer pool, and changes in the overall aging of accounts receivable. Accounts are written off against the allowance when it becomes evident collection will not occur. While the Company has a large customer base that is geographically dispersed, a general economic downturn in any of the industry segments in which the Company operates could result in higher than expected defaults, and therefore, the need to revise estimates for bad debts. The allowance for doubtful accounts was $10,498 and $10,964 at June 30, 2019 and June 30, 2018, respectively.
Inventories
Inventories are valued at average cost, using the last-in, first-out (LIFO) method for U.S. inventories and the average cost method for foreign inventories. The Company adopted the link chain dollar value LIFO method of accounting for U.S. inventories in fiscal 1974. At June 30, 2019, approximately 15.9% of the Company’s domestic inventory dollars relate to LIFO layers added in the 1970s. The Company maintains five LIFO pools based on the following product groupings: bearings, power transmission products, rubber products, fluid power products and other products. LIFO layers and/or liquidations are determined consistently year-to-year.
The Company evaluates the recoverability of its slow moving and inactive inventories at least quarterly. The Company estimates the recoverable cost of such inventory by product type while considering factors such as its age, historic and current demand trends, the physical condition of the inventory, as well as assumptions regarding future demand. The Company’s ability to recover its cost for slow moving or obsolete inventory can be affected by such factors as general market conditions, future customer demand, and relationships with suppliers. Historically, the Company’s inventories have demonstrated long shelf lives, are not highly susceptible to obsolescence, and, in certain instances, can be eligible for return under supplier return programs.
Supplier Purchasing Programs
The Company enters into agreements with certain suppliers providing inventory purchase incentives. The Company’s inventory purchase incentive arrangements are unique to each supplier and are generally annual programs ending at either the Company’s fiscal year end or the supplier’s year end; however, program length and ending dates can vary. Incentives are received in the form of cash or credits against purchases upon attainment of specified purchase volumes and are received either monthly, quarterly or annually. The incentives are generally a specified percentage of the Company’s net purchases based upon achieving specific purchasing volume levels. These percentages can increase or decrease based on changes in the volume of purchases. The Company accrues for the receipt of these inventory purchase incentives based upon cumulative purchases of inventory. The percentage level utilized is based upon the estimated total volume of purchases expected during the life of the program. Supplier programs are analyzed each quarter to determine the appropriateness of the amount of purchase incentives accrued. Upon program completion, differences between estimates and actual incentives subsequently received have not been material. Benefits under these supplier purchasing programs are recognized under the Company’s inventory accounting methods as a reduction of cost of sales when the inventories representing these purchases are recorded as cost of sales. Accrued incentives expected to be settled as a credit against future purchases are reported on the consolidated balance sheets as an offset to amounts due to the related supplier.
Property and Related Depreciation and Amortization
Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets and is included in selling, distribution and administrative expenses in the accompanying statements of consolidated income. Buildings, building improvements and leasehold improvements are depreciated over ten to thirty years or the life of the lease if a shorter period, and equipment is depreciated over three to ten years. The Company capitalizes internal use software development costs in accordance with guidance on accounting for costs of computer software developed or obtained for internal use. Amortization of software begins when it is ready for its intended use, and is computed on a straight-line basis over the estimated useful life of the software, generally not to exceed twelve years. Capitalized software and hardware costs are classified as property on the consolidated balance sheets. The carrying values of property and equipment are reviewed for impairment when events or changes in circumstances indicate that the recorded value cannot be recovered from undiscounted future cash flows. Impairment losses, if any, would be measured based upon the difference between the carrying amount and the fair value of the assets.

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Goodwill and Intangible Assets
Goodwill is recognized as the excess cost of an acquired entity over the net amount assigned to assets acquired and liabilities assumed. Goodwill is not amortized. Goodwill is reviewed for impairment annually as of January 1 or whenever changes in conditions indicate an evaluation should be completed. These conditions could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. The Company utilizes the income and market approaches to determine the fair value of reporting units. Evaluating impairment requires significant judgment by management, including estimated future operating results, estimated future cash flows, the long-term rate of growth of the business, and determination of an appropriate discount rate. While the Company uses available information to prepare the estimates and evaluations, actual results could differ significantly.
The Company recognizes acquired identifiable intangible assets such as customer relationships, trade names, vendor relationships, and non-competition agreements apart from goodwill. Customer relationship identifiable intangibles are amortized using the sum-of-the-years-digits method or the expected cash flow method over estimated useful lives consistent with assumptions used in the determination of their value. Amortization of all other finite-lived identifiable intangible assets is computed using the straight-line method over the estimated period of benefit. Amortization of identifiable intangible assets is included in selling, distribution and administrative expense in the accompanying statements of consolidated income. Identifiable intangible assets with finite lives are reviewed for impairment when changes in conditions indicate carrying value may not be recoverable. Identifiable intangible assets with indefinite lives are reviewed for impairment on an annual basis or whenever changes in conditions indicate an evaluation should be completed. The Company does not currently have any indefinite-lived identifiable intangible assets.
Self-Insurance Liabilities
The Company maintains business insurance programs with significant self-insured retention covering workers’ compensation, business, automobile, general product liability and other claims. The Company accrues estimated losses including those incurred but not reported using actuarial calculations, models and assumptions based on historical loss experience. The Company also maintains a self-insured health benefits plan which provides medical benefits to U.S. based employees electing coverage under the plan. The Company estimates its reserve for all unpaid medical claims, including those incurred but not reported, based on historical experience, adjusted as necessary based upon management’s reasoned judgment.
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 s