APPLIED INDUSTRIAL TECHNOLOGIES, INC. OVERVIEW
With approximately 6,100 associates acrossNorth America ,Australia ,New Zealand , andSingapore ,Applied Industrial Technologies, Inc. ("Applied," the "Company," "We," "Us," or "Our") is a leading value-added distributor and technical solutions provider of industrial motion, fluid power, flow control, automation technologies, and related maintenance supplies. Our leading brands, specialized services, and comprehensive knowledge serve MRO (Maintenance, Repair & Operations) and OEM (Original Equipment Manufacturer) end users in virtually all industrial markets through our multi-channel capabilities that provide choice, convenience, and expertise. We have a long tradition of growth dating back to 1923, the year our business was founded inCleveland, Ohio . AtJune 30, 2022 , business was conducted inthe United States ,Puerto Rico ,Canada ,Mexico ,Australia ,New Zealand , andSingapore from approximately 568 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 a significant number 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 2022 consolidated sales were$3.8 billion , an increase of$574.8 million or 17.8% compared to the prior year, with the acquisitions of Advanced Control Solutions (ACS),Gibson Engineering (Gibson) andR.R. Floody Company (Floody) increasing sales by$34.1 million or 1.1% and favorable foreign currency translation of$2.4 million increasing sales by 0.1%. Gross profit margin increased to 29.0% for fiscal 2022 from 28.9% for fiscal 2021. Operating margin increased to 9.4% in fiscal 2022 from 6.3% in fiscal 2021.
Our earnings per share was
Fiscal 2021 results included a$49.5 million pre-tax non-cash charge related to the impairment of certain intangible, lease, and fixed assets, as well as non-routine costs of$7.8 million pre-tax, which were the result of weaker economic conditions and business alignment initiatives across a portion of the Service Center Based Distribution segment operations exposed to oil and gas end markets. Total non-routine costs of$7.8 million pre-tax included a$7.4 million inventory reserve charge recorded within cost of sales, and$0.4 million related to severance and facility consolidation recorded in selling, distribution and administrative expense. These charges were offset in the prior year by non-routine income of$2.6 million . On a net basis, the fiscal 2021 non-routine items unfavorably impacted operating income by$54.7 million , net income by$41.7 million , and earnings per share by$1.06 per share. Shareholders' equity was$1,149.4 million atJune 30, 2022 compared to$932.5 million atJune 30, 2021 . Working capital increased$91.0 million fromJune 30, 2021 to$859.9 million atJune 30, 2022 . The current ratio was 2.7 to 1 and 2.8 to 1 atJune 30, 2022 and atJune 30, 2021 , respectively. Applied monitors several economic indices that have been key indicators for industrial economic activity inthe United States . These include the Industrial Production (IP) and Manufacturing Capacity Utilization (MCU) indices published by theFederal Reserve Board and the Purchasing Managers Index (PMI) published by theInstitute 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. 17
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The MCU (total industry) and IP indices increased sinceJune 2021 correlating with an overall increase in the economy in the same period. The ISM PMI registered 53.0 inJune 2022 , a decrease from theJune 2021 revised reading of 60.9. A reading above 50 generally indicates expansion. The index readings for the months during the most recent quarter, along with the revised indices for previous quarter ends, were as follows: Index Reading Month MCU PMI IP June 2022 80.0 53.0 101.6 May 2022 80.3 56.1 102.2 April 2022 80.4 55.4 102.7 March 2022 79.9 57.1 102.1 December 2021 78.7 58.8 100.3 September 2021 77.4 60.5 98.2 June 2021 77.7 60.9 98.1
RESULTS OF OPERATIONS
This discussion and analysis deals with comparisons of material changes in the consolidated financial statements for the years endedJune 30, 2022 and 2021. For the comparison of the years endedJune 30, 2021 and 2020, see the Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our 2021 Annual Report on Form 10-K. The following table is included to aid in review of Applied's statements of consolidated income. Change in $'s Year Ended June 30, Versus Prior As a % of Net Sales Period 2022 2021 % Change Net Sales 100.0 % 100.0 % 17.8 % Gross Profit Margin 29.0 % 28.9 % 18.3 % Selling, Distribution & Administrative Expense 19.7 % 21.0 % 10.1 % Operating Income 9.4 % 6.3 % 74.2 % Net Income 6.8 % 4.5 % 77.8 % Sales in fiscal 2022 were$3.8 billion , which was$574.8 million or 17.8% above the prior year, with sales from acquisitions adding$34.1 million or 1.1% and favorable foreign currency translation accounting for an increase of$2.4 million or 0.1%. There were 252.5 selling days in both fiscal 2022 and 2021. Excluding the impact of businesses acquired and foreign currency translation, sales were up$538.3 million or 16.6% during the year, driven by an increase from operations reflecting positive growth across core end markets, including heavy industrial verticals, as well as ongoing pricing actions and our internal growth initiatives.
The following table shows changes in sales by reportable segment. Amounts in millions
Amount of change due to
Year ended June 30, Sales Foreign
Sales by Reportable Segment 2022 2021
Increase Acquisitions Currency Organic Change
Service Center Based Distribution
1,245.1 1,036.4 208.7 34.1 - 174.6
Total $ 3,810.7 $ 3,235.9 $ 574.8 $ 34.1 $ 2.4 $ 538.3
Sales in our Service Center Based Distribution segment, which operates primarily
in MRO markets, increased $366.1 million , or 16.6%. Favorable foreign currency
translation increased sales by $2.4 million or 0.1%. Excluding the impact of
businesses acquired and the impact of foreign currency translation, sales
increased $363.7 million or 16.5% during the year, driven by an increase from
operations due to benefits from break-fix MRO activity, sales process
initiatives, as well as incremental growth from heavy industry verticals, with
the strongest growth from the metals, machinery, aggregates, mining, pulp &
paper, rubber & plastics, energy, and lumber & wood end markets.
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Sales in ourFluid Power & Flow Control segment increased$208.7 million or 20.1%. Acquisitions within this segment, primarily Gibson and Floody, increased sales$34.1 million or 3.3%. Excluding the impact of businesses acquired, sales increased$174.6 million or 16.8%, driven by an increase from operations due to ongoing demand strength across technology verticals and automation, as well as end market growth across the metals, chemicals, refining, utilities, pulp & paper and mining end-markets, partially offset by supply chain bottlenecks. The following table shows changes in sales by geographical area. Other countries includeMexico ,Australia ,New Zealand , andSingapore . Amounts in millions Amount of change due to Year ended June 30, Sales Foreign Sales by Geographic Area 2022 2021
Increase Acquisitions Currency Organic Change United States$ 3,299.8 $ 2,782.9 $ 516.9 $ 34.1 $ -$ 482.8 Canada 291.5 255.4 36.2 - 2.8 33.4 Other Countries 219.4 197.7 21.7 - (0.4) 22.1 Total$ 3,810.7 $ 3,235.9 $ 574.8 $ 34.1 $ 2.4 $ 538.3 Sales in ourU.S. operations increased$516.9 million or 18.6%, with acquisitions adding$34.1 million or 1.2%. Excluding the impact of businesses acquired,U.S. sales were up$482.8 million or 17.4%, driven by an increase from operations. Sales from our Canadian operations increased$36.2 million or 14.2%, while favorable foreign currency translation increased Canadian sales by$2.8 million or 1.1%. Excluding the impact of foreign currency translation, Canadian sales were up$33.4 million or 13.1%. Consolidated sales from our other countries operations increased$21.7 million or 11.0% compared to the prior year. Unfavorable foreign currency translation decreased other countries sales by$0.4 million or 0.2%. Excluding the impact of foreign currency translation, other countries sales were up$22.1 million or 11.2% compared to the prior year, driven by an increase from operations, primarily a$13.9 million increase in Mexican sales due to increased industrial activity, primarily related to steel operations. Our gross profit margin increased to 29.0% in fiscal 2022 compared to 28.9% in fiscal 2021. Gross profit margin expanded year over year and sequentially primarily reflecting broad-based execution across the business and countermeasures in response to ongoing inflation and supply chain dynamics. This was offset by 72 basis points due to a$27.3 million increase in LIFO expense year over year. The following table shows the changes in selling, distribution, and administrative expense (SD&A). Amounts in millions Amount of change due to Year ended June 30, Foreign 2022 2021 SD&A Increase Acquisitions Currency Organic Change SD&A$ 749.1 $ 680.5 $ 68.5 $ 9.3$ 0.5 $ 58.7 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$68.5 million or 10.1% during fiscal 2022 compared to the prior year, and as a percentage of sales decreased to 19.7% in fiscal 2022 compared to 21.0% in fiscal 2021. Changes in foreign currency exchange rates had the effect of increasing SD&A by$0.5 million or 0.1% compared to the prior year. SD&A from businesses acquired added$9.3 million or 1.4%, including$0.8 million of intangibles amortization related to acquisitions. Excluding the impact of businesses acquired and the unfavorable impact from foreign currency translation, SD&A increased$58.7 million or 8.6% during fiscal 2022 compared to fiscal 2021. The Company incurred$0.4 million of non-routine expenses related to severance and closed facilities during fiscal 2021. Excluding the impact of acquisitions and severance, total compensation increased$50.3 million during fiscal 2022, primarily due to cost reduction actions taken by the Company in fiscal 2021 in response to the COVID-19 pandemic, including headcount reductions, temporary furloughs and pay reductions, and suspension of the 401(k) plan company match. Also, excluding the impact of acquisitions, travel & entertainment and fleet expenses increased$9.0 million during 2022, primarily due to reduced travel activity related to COVID-19 in the prior year. All other expenses within SD&A were down$0.2 million . During fiscal 2021, the Company determined that an impairment existed in two of its three asset groups within the Service Center Based Distribution segment that have significant exposure to oil and gas end markets as the asset 19
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groups' carrying values exceeded the sum of the undiscounted cash flows. The fair values of the long-lived assets were determined using the income approach, and the analyses resulted in the measurement of an intangible asset impairment loss of$45.0 million , as the fair value of the intangible assets was determined to be zero. The analyses of these asset groups also resulted in a fixed asset impairment loss and leased asset impairment loss of$2.0 million and$2.5 million , respectively, which were recorded in fiscal 2021. Combined, the non-cash impairment charges decreased net income by$37.8 million and earnings per share by$0.96 per share for fiscal 2021. Operating income increased$152.4 million , or 74.2%, to$357.9 million during fiscal 2022 from$205.5 million during fiscal 2021, and as a percentage of sales, increased to 9.4% from 6.3%, primarily due to gross profit margin expansion and control of SD&A expense in fiscal 2022, in addition to the$49.5 million non-cash impairment charges recorded in fiscal 2021. Operating income, before impairment charges, as a percentage of sales for the Service Center Based Distribution segment increased to 11.8% in fiscal 2022 from 10.2% in fiscal 2021. Operating income as a percentage of sales for theFluid Power & Flow Control segment increased to 12.6% in fiscal 2022 from 11.8% in fiscal 2021. 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 expense (income), net, represents certain non-operating items of income and expense, and was$1.8 million of expense in fiscal 2022 compared to$2.2 million of income in fiscal 2021. Current year expense primarily consists of unrealized loss on investments held by non-qualified deferred compensation trusts of$2.6 million and other expense of$0.6 million , offset by life insurance income of$1.4 million . Fiscal 2021 income consisted primarily of unrealized gains on investments held by non-qualified deferred compensation trusts of$4.0 million and other income of$0.3 million offset by foreign currency transaction losses of$2.1 million .
The effective income tax rate was 21.9% for fiscal 2022 compared to 18.2% for fiscal 2021. The increase in the effective tax rate is due to changes in compensation-related deductions and uncertain tax positions in fiscal 2022 compared to the prior year.
As a result of the factors discussed above, net income for fiscal 2022 increased$112.7 million from the prior year. Net income per share was$6.58 per share for fiscal 2022 compared to$3.68 per share for fiscal 2021.
We had a total of 568 operating facilities in
The approximate number of Company employees was 6,100 at
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. AtJune 30, 2022 we had total debt obligations outstanding of$689.5 million compared to$829.4 million atJune 30, 2021 . Management expects that our existing cash, cash equivalents, funds available under our debt facilities, 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 atJune 30, 2022 was$859.9 million compared to$768.9 million atJune 30, 2021 . The current ratio was 2.7 to 1 atJune 30, 2022 and 2.8 to 1 atJune 30, 2021 . 20
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Net Cash Flows
The following table is included to aid in review of Applied's statements of
consolidated cash flows.
Amounts in thousands Year Ended June 30,
2022 2021
Net Cash Provided by (Used in):
Operating Activities $ 187,570 $ 241,697
Investing Activities (35,658) (44,930)
Financing Activities (223,029) (213,037)
Exchange Rate Effect (2,154) 5,464
(Decrease) Increase in Cash and Cash Equivalents
The decrease in cash provided by operating activities during fiscal 2022 is driven by changes in working capital for the year offset by increased operating results. Changes in cash flows between years related to working capital were driven by (amounts in thousands): Accounts receivable$ (86,400) Inventory$ (133,743) Accounts payable$ 42,678 Net cash used in investing activities in fiscal 2022 included$7.0 million used for the acquisition of Floody,$14.8 million in cash payments for loans on company-owned life insurance and$18.1 million used for capital expenditures. Net cash used in investing activities in fiscal 2021 included$30.2 million used for the acquisitions of ACS and Gibson and$15.9 million for capital expenditures. Net cash used in financing activities increased from the prior year period primarily due to a change in net debt activity, as there was$139.9 million of net debt payments in fiscal 2022 compared to$105.9 million of net debt payments in 2021. Further uses of cash in 2022 were$51.8 million for dividend payments,$8.1 million used to pay taxes for shares withheld, and$13.8 million used to repurchase 148,658 shares of treasury stock. Further uses of cash in 2021 were$50.7 million for dividend payments,$10.1 million used to pay taxes for shares withheld, and$40.1 million used to repurchase 400,000 shares of treasury stock. The increase in dividends over the year is the result of regular increases in our dividend payout rates. We paid dividends of$1.34 and$1.30 per share in fiscal 2022 and 2021, respectively. Capital Expenditures We expect capital expenditures for fiscal 2023 to be in the$23.0 million to$25.0 million range, primarily consisting of capital associated with additional information technology equipment and infrastructure investments. 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. AtJune 30, 2022 , we had authorization to purchase an additional 315,960 shares. OnAugust 9, 2022 the Board of Directors authorized the repurchase of 1.5 million shares of the Company's stock. The Company repurchased 148,658 shares in fiscal 2022 at an average price per share of$92.72 . In fiscal 2021, we repurchased 400,000 shares of the Company's common stock at an average price per share of$100.22 and in fiscal 2020, no shares were repurchased. 21
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Borrowing Arrangements A summary of long-term debt, including the current portion, follows (amounts are in thousands): June 30, 2022 2021 Revolving credit facility$ 410,592 $ - Term Loan - 550,250 Trade receivable securitization facility 188,300 188,300 Series C Notes 40,000 40,000 Series D Notes 25,000 25,000 Series E Notes 25,000 25,000 Other 603 846 Total debt$ 689,495 $ 829,396 Less: unamortized debt issuance costs 171 1,016$ 689,324 $ 828,380 InDecember 2021 , the Company entered into a new five-year revolving credit facility with a group of banks to refinance the existing credit facility as well as provide funds for ongoing working capital and other general corporate purposes. This agreement provides a$900.0 million unsecured revolving credit facility and an uncommitted accordion feature which allows the Company to request an increase in the borrowing commitments, or incremental term loans, under the credit facility in aggregate principal amounts of up to$500.0 million . Borrowings under this agreement bear interest, at the Company's election, at either the base rate plus a margin that ranges from 0 to 55 basis points based on net leverage ratio or LIBOR plus a margin that ranges from 80 to 155 basis points based on the net leverage ratio. Unused lines under this facility, net of outstanding letters of credit of$0.2 million to secure certain insurance obligations, totaled$489.2 million atJune 30, 2022 , and were available to fund future acquisitions or other capital and operating requirements. The interest rate on the revolving credit facility was 2.81% as ofJune 30, 2022 . The new credit facility replaced the Company's previous credit facility agreement. The Company used its initial borrowings on the new revolving credit facility along with cash on hand of$98.2 million to extinguish the term loan balance outstanding under the previous credit facility of$540.5 million . The Company had no amount outstanding under the revolver atJune 30, 2021 . Unused lines under the previous facility, net of outstanding letters of credit of$0.2 million to secure certain insurance obligations, totaled$249.8 million atJune 30, 2021 . The interest rate on the term loan was 1.88% as ofJune 30, 2021 . The Company paid$2.0 million of debt issuance costs related to the new revolving credit facility in the year endedJune 30, 2022 , which are included in other current assets and other assets on the consolidated balance sheet as ofJune 30, 2022 and will be amortized over the five-year term of the new credit facility. The Company analyzed the unamortized debt issuance costs related to the previous credit facility under Accounting Standards Codification (ASC) Topic 470 - Debt. As a result of this analysis,$0.1 million of unamortized debt issuance costs were expensed and included within interest expense on the statements of consolidated income for the year endedJune 30, 2022 , and$0.5 million of unamortized debt issuance costs were rolled forward into the new credit facility and were reclassified from the current portion of long-term debt and long-term debt into other current assets and other assets on the consolidated balance sheet as ofJune 30, 2022 , and will be amortized over the five-year term of the new credit facility. Additionally, the Company had letters of credit outstanding not associated with the revolving credit agreement, in the amount of$4.7 million and$4.5 million as ofJune 30, 2022 andJune 30, 2021 , respectively, in order to secure certain insurance obligations. InAugust 2018 , the Company established a trade receivable securitization facility (the "AR Securitization Facility") with a termination date ofAugust 31, 2021 . OnMarch 26, 2021 , the Company amended the AR Securitization Facility to expand the eligible receivables, which increased the maximum availability to$250.0 million and increased the drawn fees on the AR Securitization Facility to 0.98% per year. 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$250.0 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 theU.S. operations' trade accounts receivable. 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. 22
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The interest rate on the AR Securitization Facility as of
AtJune 30, 2022 andJune 30, 2021 , the Company had borrowings outstanding under its unsecured shelf facility agreement withPrudential Investment Management of$90.0 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 carried a fixed interest rate of 3.19%, and the remaining balance of$40.0 million was paid inJuly 2022 . The "Series D" notes have a remaining principal amount of$25.0 million , carry a fixed interest rate of 3.21%, and are due inOctober 2023 . The "Series E" notes have a principal amount of$25.0 million , carry a fixed interest rate of 3.08%, and are due inOctober 2024 . 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 theState of Ohio Development Services Agency and matures inNovember 2024 . In 2019, the Company entered into an interest rate swap which mitigates variability in forecasted interest payments on$409.0 million of the Company'sU.S. dollar-denominated unsecured variable rate debt. For more information, see note 7, Derivatives, to the consolidated financial statements, included in Item 8 under the caption "Financial Statements and Supplementary Data." The credit facility and the unsecured shelf facility contain restrictive covenants regarding liquidity, net worth, financial ratios, and other covenants. AtJune 30, 2022 , the most restrictive of these covenants required that the Company have net indebtedness less than 3.75 times consolidated income before interest, taxes, depreciation and amortization (as defined). AtJune 30, 2022 , the Company's net indebtedness was less than 1.3 times consolidated income before interest, taxes, depreciation and amortization (as defined). The Company was in compliance with all financial covenants atJune 30, 2022 . Accounts Receivable Analysis The following table is included to aid in analysis of accounts receivable and the associated provision for losses on accounts receivable (all dollar amounts are in thousands): June 30, 2022 2021 Accounts receivable, gross$ 673,951 $ 532,777 Allowance for doubtful accounts 17,522
16,455
Accounts receivable, net$ 656,429 $ 516,322 Allowance for doubtful accounts, % of gross receivables 2.6 %
3.1 %
Year EndedJune 30, 2022
2021
Provision for losses on accounts receivable$ 3,193 $ 6,540 Provision as a % of net sales 0.08 % 0.20 % 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. The Company experienced a significant increase in accounts receivable during fiscal 2022 commensurate with the increase in sales. On a consolidated basis, DSO was 55.7 atJune 30, 2022 versus 51.9 atJune 30, 2021 . Approximately 3.4% of our accounts receivable balances are more than 90 days past due atJune 30, 2022 compared to 3.0% atJune 30, 2021 . On an overall basis, our provision for losses from uncollected receivables represents 0.08% of our sales for the year endedJune 30, 2022 , compared to 0.20% of sales for the year endedJune 30, 2021 . The decrease primarily relates to provisions recorded in the prior year for customer credit deterioration and bankruptcies primarily in theU.S. and Mexican operations of the Service Center Based Distribution segment. 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 forU.S. inventories and the average cost method for foreign inventories. Inventory increased throughout fiscal 2022 to meet increasing customer demand. 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 year endedJune 30, 2022 was 4.7 versus 4.3 for the year endedJune 30, 2021 . 23
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CONTRACTUAL OBLIGATIONS
The following table shows the approximate value of the Company's contractual obligations and other commitments to make future payments as ofJune 30, 2022 (in thousands): Period Less Period Period Period Total Than 1 yr 2-3 yrs 4-5 yrs Over 5 yrs Other Operating leases$ 119,834 $ 32,759 $ 46,514 $ 23,807 $ 16,754 - Planned funding of post-retirement obligations 8,830 900 500 530 6,900 - Unrecognized income tax benefit liabilities, including interest and penalties 5,800 - - - - 5,800 Long-term debt obligations 689,495 40,247 238,656 410,592 - - Interest on long-term debt obligations (1) 74,300 19,700 32,800 21,800 - - Acquisition holdback payments 1,969 1,469 500 - - -
Total Contractual Cash Obligations
(1) Amounts represent estimated contractual interest payments on outstanding long-term debt obligations and net payments under the terms of the interest rate swap. Rates in effect as ofJune 30, 2022 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.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted inthe 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. LIFO Inventory Valuation and Methodology Inventories are valued at the average cost method, using the last-in, first-out (LIFO) method forU.S. inventories, and the average cost method for foreign inventories. We adopted the link chain dollar value LIFO method for accounting forU.S. inventories in fiscal 1974. Approximately 15.7% of our domestic inventory dollars relate to LIFO layers added in the 1970s. The excess of average cost over LIFO cost is$178.9 million as reflected in our consolidated balance sheet atJune 30, 2022 . 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 and are not highly susceptible to obsolescence.
As of
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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 ofJune 30, 2022 and 2021, our allowance for doubtful accounts was 2.6% and 3.1% of gross receivables, respectively. Our provision for losses on accounts receivable was$3.2 million ,$6.5 million , and$14.1 million in fiscal 2022, 2021, and 2020, 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. If circumstances require a finite-lived intangible asset be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by the asset to the carrying value of the asset. If the carrying value of the finite-lived intangible asset is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value determined through a discounted cash flow model. The Company has three asset groups that have significant exposure to oil and gas end markets. Due to the economic downturn in these end markets in the prior year, the Company determined during the second quarter of fiscal 2021 that certain carrying values may not be recoverable. The Company determined that an impairment existed in two of the three asset groups as the asset groups' carrying values exceeded the sum of the undiscounted cash flows. The fair values of the long-lived assets were then determined using the income approach, and the analyses resulted in the measurement of an intangible asset impairment loss of$45.0 million , which was recorded in the second quarter of fiscal 2021, as the fair value of the intangible assets was determined to be zero. 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, earnings before interest, taxes, depreciation, and amortization (EBITDA), and discount rates. Key assumptions (Level 3 in the fair value hierarchy) relate to pricing trends, inventory costs, customer demand, and revenue growth. A number of benchmarks from independent industry and other economic publications were also used. The analyses of these asset groups also resulted in a fixed asset impairment loss and leased asset impairment loss of$2.0 million and$2.5 million , respectively, which were recorded in the second quarter of fiscal 2021. Sustained significant softness in certain end market concentrations could result in impairment of certain intangible assets in future periods. We evaluate goodwill for impairment at the reporting unit level annually as ofJanuary 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, 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 25
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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 theFluid Power & Flow Control segment. The Company has eight (8) reporting units for which an annual goodwill impairment assessment was performed as ofJanuary 1, 2022 . The Company concluded that all of the reporting units' fair values exceeded their carrying amounts by at least 25% as ofJanuary 1, 2022 . 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 ofJune 30, 2022 , the Company recognized$38.3 million of net deferred tax liabilities. Valuation allowances are provided against net deferred tax assets, determined on a jurisdiction by jurisdiction basis, where it is considered more-likely-than-not that the Company will not realize the benefit of such assets. 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. 26
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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 theSecurities and Exchange Commission in its rules, regulations, and releases. Readers are cautioned not to place undue reliance on any forward-looking statements. All forward-looking statements are based on current expectations regarding important risk factors, many of which are outside the Company's control. Accordingly, actual results may differ materially from those expressed in the forward-looking statements, and the making of those statements should not be regarded as a representation by the Company or any other person that the results expressed in the statements will be achieved. In addition, the Company assumes no obligation publicly to update or revise any forward-looking statements, whether because of new information or events, or otherwise, except as may be required by law. Important risk factors include, but are not limited to, the following: risks relating to the operations levels of our customers and the economic factors that affect them; continuing risks relating to the effects of the COVID-19 pandemic; inflationary or deflationary trends in the cost of products, energy, labor and other operating costs, and changes in the prices for products and services relative to the cost of providing them; reduction in supplier inventory purchase incentives; loss of key supplier authorizations, lack of product availability (such as due to supply chain strains), changes in supplier distribution programs, inability of suppliers to perform, and transportation disruptions; changes in customer preferences for products and services of the nature and brands sold by us; changes in customer procurement policies and practices; competitive pressures; our reliance on information systems and risks relating to their proper functioning, the security of those systems, and the data stored in or transmitted through them; the impact of economic conditions on the collectability of trade receivables; reduced demand for our products in targeted markets due to reasons including consolidation in customer industries; our ability to retain and attract qualified sales and customer service personnel and other skilled executives, managers and professionals; our ability to identify and complete acquisitions, integrate them effectively, and realize their anticipated benefits; the variability, timing and nature of new business opportunities including acquisitions, alliances, customer relationships, and supplier authorizations; the incurrence of debt and contingent liabilities in connection with acquisitions; our ability to access capital markets as needed on reasonable terms; disruption of operations at our headquarters or distribution centers; risks and uncertainties associated with our foreign operations, including volatile economic conditions, political instability, cultural and legal differences, and currency exchange fluctuations; the potential for goodwill and intangible asset impairment; changes in accounting policies and practices; our ability to maintain effective internal control over financial reporting; organizational changes within the Company; risks related to legal proceedings to which we are a party; potentially adverse government regulation, legislation, or policies, both enacted and under consideration, including with respect to federal tax policy, international trade, data privacy and security, and government contracting; and the occurrence of extraordinary events (including prolonged labor disputes, power outages, telecommunication outages, terrorist acts, war, public health emergency, earthquakes, extreme weather events, other natural disasters, fires, floods, and accidents). Other factors and unanticipated events could also adversely affect our business, financial condition, or results of operations. Risks can also change over time. Further, the disclosure of a risk should not be interpreted to imply that the risk has not already materialized. We discuss certain of these matters and other risk factors more fully throughout our Form 10-K, as well as other of our filings with theSecurities and Exchange Commission . 27
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