APPLIED INDUSTRIAL TECHNOLOGIES, INC. OVERVIEW
With approximately 5,900 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, 2021 , 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 2021 consolidated sales were$3.2 billion , a decrease of$9.7 million or 0.3% compared to the prior year, with the acquisitions of Olympus Controls (Olympus), Advanced Control Solutions (ACS) and Gibson Engineering (Gibson) increasing sales by$44.1 million or 1.4% and favorable foreign currency of$16.5 million increasing sales by 0.5%. Gross profit margin was 28.9% for both fiscal 2021 and 2020. Operating margin increased to 6.3% in fiscal 2021 from 2.7% in fiscal 2020. Our earnings per share was$3.68 in fiscal 2021 versus$0.62 in fiscal year 2020. Fiscal 2021 results include 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. These items are 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 include 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 current year by other 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. The prior year included a$131.0 million non-cash goodwill impairment charge recorded during fiscal 2020 related to the goodwill associated with the Company'sFCX Performance, Inc. (FCX) operations within theFluid Power & Flow Control segment. The non-cash goodwill impairment charge decreased net income by$118.8 million and earnings per share by$3.04 per share for fiscal 2020. Fiscal 2021 ended on a positive note as underlying demand continued to strengthen across both segments during the fourth quarter reflecting sustained recovery in our core end-markets and momentum across our internal growth initiatives. We are managing inflation well and controlling costs, while benefiting from productivity enhancements. Fiscal 2022 is off to a positive start with organic sales through early August up by a high-teens percent over the prior year and customer indications signaling sustained demand momentum. Shareholders' equity was$932.5 million atJune 30, 2021 compared to$843.5 million atJune 30, 2020 . Working capital increased$35.2 million fromJune 30, 2020 to$768.9 million atJune 30, 2021 . The current ratio was 2.8 to 1 and 2.7 to 1 atJune 30, 2021 and atJune 30, 2020 , 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. The MCU (total industry) and IP indices increased sinceJune 2020 correlating with an overall increase in the economy in the same period. The ISM PMI registered 60.6 inJune 2021 , an increase from theJune 2020 revised 17 -------------------------------------------------------------------------------- Table of Contents reading of 52.2. 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 2021 75.4 60.6 97.9 May 2021 75.1 61.2 97.9 April 2021 74.6 60.7 97.1 March 2021 74.6 64.7 97.5 December 2020 74.1 60.5 96.8 September 2020 72.1 55.7 94.2 June 2020 68.7 52.2 89.1 RESULTS OF OPERATIONS This discussion and analysis deals with comparisons of material changes in the consolidated financial statements for the years endedJune 30, 2021 and 2020. For the comparison of the years endedJune 30, 2020 and 2019, see the Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our 2020 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 2021 2020 % Change Net Sales 100.0 % 100.0 % (0.3) % Gross Profit Margin 28.9 % 28.9 % (0.2) % Selling, Distribution & Administrative Expense 21.0 % 22.1 % (5.2) % Operating Income 6.3 % 2.7 % 130.9 % Net Income 4.5 % 0.7 % 502.1 % Sales in fiscal 2021 were$3.2 billion , which was$9.7 million or 0.3% below the prior year, with sales from acquisitions adding$44.1 million or 1.4% and favorable foreign currency translation accounting for an increase of$16.5 million or 0.5%. There were 252.5 selling days in fiscal 2021 and 253.5 selling days in fiscal 2020. Excluding the impact of businesses acquired and foreign currency translation, sales were down$70.3 million or 2.2% during the year, driven by a 1.8% decrease from operations and a 0.4% decrease due to one less sales day. The decrease from operations is due to weak demand across key end markets from the impact of the COVID-19 pandemic, although sales improved as the year progressed. The following table shows changes in sales by reportable segment. Amounts in millions Amount of change due to Year ended June 30, Sales (Decrease) Foreign Sales by Reportable Segment 2021 2020 Increase Acquisitions Currency Organic Change Service Center Based Distribution$ 2,199.5 $ 2,241.9 $ (42.4) $ -$ 16.5 $ (58.9) Fluid Power & Flow Control 1,036.4 1,003.7 32.7 44.1 - (11.4) Total$ 3,235.9 $ 3,245.7 $ (9.7) $ 44.1 $ 16.5 $ (70.3) Sales of our Service Center Based Distribution segment, which operates primarily in MRO markets, decreased$42.4 million , or 1.9%. Favorable foreign currency translation increased sales by$16.5 million or 0.7%. Excluding the impact of businesses acquired and the impact of foreign currency translation, sales decreased$58.9 million or 2.6% during the year, driven by a 2.2% decrease from operations and a decrease of 0.4% due to one less sales day. The decrease from operations reflects weaker industrial end-market demand from the impact of the COVID-19 pandemic, although sales improved as the year progressed. 18 -------------------------------------------------------------------------------- Table of Contents Sales of ourFluid Power & Flow Control segment increased$32.7 million or 3.3%. Acquisitions within this segment, primarily ACS and Gibson, increased sales$44.1 million or 4.4%. Excluding the impact of businesses acquired, sales decreased$11.4 million or 1.1%, driven by a 0.7% decrease from operations and by a decrease of 0.4% due to one less sales day. The decrease from operations is primarily due to ongoing soft demand across process-related end markets, offset by stronger demand across technology, off-highway mobile, life sciences, and chemical end markets, as well as automation-related sales. The following table shows changes in sales by geographical area. Other countries includesMexico ,Australia ,New Zealand , andSingapore . Amounts in millions Amount of change due to Year ended June 30, Sales (Decrease) Foreign Sales by Geographic Area 2021 2020
Increase Acquisitions Currency Organic Change
United States $ 2,782.9 $ 2,819.4 $ (36.5) $ 44.1 $ - $ (80.6)
Canada 255.4 248.6 6.8 - 11.6 (4.8)
Other countries 197.7 177.7 20.0 - 4.9 15.1
Total $ 3,235.9 $ 3,245.7 $ (9.7) $ 44.1 $ 16.5 $ (70.3)
Sales in our U.S. operations decreased $36.5 million or 1.3%, with acquisitions
adding $44.1 million or 1.6%. Excluding the impact of businesses acquired, U.S.
sales were down $80.6 million or 2.9%, driven by a decrease of 2.5% from
operations and by a decrease of 0.4% due to one less sales days. Sales from our
Canadian operations increased $6.8 million or 2.7%, while favorable foreign
currency translation increased Canadian sales by $11.6 million or 4.7%.
Excluding the impact of foreign currency translation, Canadian sales were down
$4.8 million or 2.0%, driven by a decrease of 1.6% from operations and by a
decrease of 0.4% due to one less sales days. Consolidated sales from our other
country operations increased $20.0 million or 11.3% compared to the prior year.
Favorable foreign currency translation increased other country sales by $4.9
million or 2.7%. Excluding the impact of foreign currency translation, other
country sales were up $15.1 million or 8.6% compared to the prior year, driven
by an increase of 9.2% from operations, primarily a $10.9 million increase in
Australian sales due to increased demand in the mining industry, offset by a
decrease of 0.6% due to less sales days.
The gross profit margin was 28.9% in both fiscal 2021 and 2020.
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 Foreign
2021 2020 Decrease Acquisitions Currency Organic Change
SD&A $ 680.5 $ 717.7 $ (37.2) $ 11.9 $ 4.9 $ (54.0)
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 decreased $37.2 million or
5.2% during fiscal 2021 compared to the prior year, and as a percentage of sales
decreased to 21.0% in fiscal 2021 compared to 22.1% in fiscal 2020. Changes in
foreign currency exchange rates had the effect of increasing SD&A by $4.9
million or 0.7% compared to the prior year. SD&A from businesses acquired added
$11.9 million or 1.7%, including $1.1 million of intangibles amortization
related to acquisitions. Excluding the impact of businesses acquired and the
favorable impact from foreign currency translation, SD&A decreased $54.0 million
or 7.6% during fiscal 2021 compared to fiscal 2020. The Company incurred $0.4
million of non-routine expenses related to severance and closed facilities
during fiscal 2021 compared to $5.1 million non-routine expenses related to
severance and facility consolidation during fiscal 2020. Excluding the impact of
acquisitions and severance, total compensation decreased $14.1 million during
fiscal 2021, primarily due to cost reduction actions taken by the Company in
response to the COVID-19 pandemic, including headcount reductions, temporary
furloughs and pay reductions, and suspension of the 401(k) company match. All of
the temporary cost reductions have been reinstated in the second half of fiscal
2021. Also, excluding the impact of acquisitions, travel & entertainment and
fleet expenses decreased $12.2 million during 2021, primarily due to continued
reduced travel activity related to COVID-19. In addition, bad debt expense
decreased $7.5 million , primarily due to provisions recorded in the prior year
for customer credit deterioration and bankruptcies primarily in the Service
Center Based Distribution segment, offset by strong cash collections and an
improvement in the overall credit profile of the
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accounts receivable portfolio in fiscal 2021. Further, excluding the impact of
acquisitions, intangible amortization expense decreased $8.3 million during
fiscal 2021 primarily due to the intangible impairment recorded during the year.
All other expenses within SD&A were down $7.2 million .
During the second quarter of 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 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.
As a result of the Company's annual goodwill impairment test in fiscal 2020, the
Company recorded a $131.0 million non-cash goodwill impairment charge related to
the Company's FCX operations in the Fluid Power & Flow Control segment,
primarily due to the overall decline in the industrial economy, specifically
slower demand in FCX's end markets. The non-cash goodwill impairment charge
decreased net income by $118.8 million and earnings per share by $3.04 per share
for fiscal 2020.
Operating income increased $116.5 million , or 130.9%, to $205.5 million during
fiscal 2021 from $89.0 million during fiscal 2020, and as a percentage of sales,
increased to 6.3% from 2.7%, primarily as a result of the goodwill impairment
expense recorded during fiscal 2020 offset by the intangible impairment recorded
in fiscal 2021.
Operating income, before impairment charges, as a percentage of sales for the
Service Center Based Distribution segment increased to 10.2% in fiscal 2021 from
9.4% in fiscal 2020. Operating income, before impairment charges, as a
percentage of sales for the Fluid Power & Flow Control segment increased to
11.8% in fiscal 2021 from 10.9% in fiscal 2020.
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,
and was $2.2 million of income in fiscal 2021 compared to $2.8 million of income
in fiscal 2020. Current year income primarily consists 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 . Fiscal 2020 income consisted primarily of unrealized gains on
investments held by non-qualified deferred compensation trusts of $0.5 million
and foreign currency transaction gains of $2.5 million offset by other expenses
of $0.2 million .
The effective income tax rate was 18.2% for fiscal 2021 compared to 56.5% for
fiscal 2020. The decrease in the effective tax rate is primarily due to the FCX
goodwill impairment charge in the prior year, which increased the effective tax
rate by 31.4% in fiscal 2020.
We expect our income tax rate for fiscal 2022 to be in the range of 22.0% to
23.0%.
As a result of the factors discussed above, net income for fiscal 2021 increased
$120.7 million from the prior year. Net income per share was $3.68 per share for
fiscal 2021 compared to $0.62 per share for fiscal 2020.
At June 30, 2021 , we had a total of 568 operating facilities in the United
States , Puerto Rico , Canada , Mexico , Australia , New Zealand , and Singapore ,
versus 580 at June 30, 2020 .
The approximate number of Company employees was 5,900 at June 30, 2021 and 6,200
at June 30, 2020 .
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, 2021 we had
total debt obligations outstanding of $829.4 million compared to $935.3 million
at June 30, 2020 . 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.
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The Company's working capital at June 30, 2021 was $768.9 million compared to
$733.7 million at June 30, 2020 . The current ratio was 2.8 to 1 at June 30, 2021
and 2.7 to 1 at June 30, 2020 .
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,
2021 2020
Net Cash Provided by:
Operating Activities $ 241,697 $ 296,714
Investing Activities (44,930) (55,404)
Financing Activities (213,037) (78,238)
Exchange Rate Effect 5,464 (2,740)
(Decrease) Increase in Cash and Cash Equivalents
The decrease in cash provided by operating activities during fiscal 2021 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: Accounts receivable$ (133,556) Inventory$ (15,710) Accounts payable$ 64,775 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 used for capital expenditures. Net cash used in investing activities in fiscal 2020 included$37.2 million used for the acquisitions of Olympus and$20.1 million for capital expenditures. Net cash used in financing activities included$131.9 million and$49.6 million of long-term debt repayments in 2021 and 2020, respectively, offset by$26.0 million of cash borrowings from the trade receivable securitization facility in 2021 and$25.0 million of cash borrowings under a unsecured shelf facility agreement withPrudential Investment Management in 2020. 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. Further uses of cash in 2020 were$48.9 million for dividend payments and$2.6 million used to pay taxes for shares withheld. The increase in dividends over the year is the result of regular increases in our dividend payout rates. We paid dividends of$1.30 and$1.26 per share in fiscal 2021 and 2020, respectively. Capital Expenditures We expect capital expenditures for fiscal 2022 to be in the$18.0 million to$20.0 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, 2021 , we had authorization to purchase an additional 464,618 shares. The Company repurchased 400,000 shares in fiscal 2021 at an average price per share of$100.22 . In fiscal 2020 no shares were repurchased and in 2019, we repurchased 192,082 shares of the Company's common stock at an average price per share of$58.10 . 21 -------------------------------------------------------------------------------- Table of Contents Borrowing Arrangements A summary of long-term debt, including the current portion, follows; all amounts are in thousands: June 30, 2021 2020 Unsecured credit facility$ 550,250 $ 589,250 Trade receivable securitization facility 188,300 175,000 Series C notes 40,000 120,000 Series D Notes 25,000 25,000 Series E Notes 25,000 25,000 Other 846 1,026 Total debt$ 829,396 $ 935,276 Less: unamortized debt issuance costs 1,016 1,487$ 828,380 $ 933,789 InJanuary 2018 , the Company refinanced its existing credit facility and entered into a new five-year credit facility with a group of banks expiring inJanuary 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. The Company had no amount outstanding under the revolver as ofJune 30, 2021 andJune 30, 2020 . Unused lines under this facility, net of outstanding letters of credit of$0.2 million and$1.9 million , respectively, to secure certain insurance obligations, totaled$249.8 million and$248.1 million atJune 30, 2021 andJune 30, 2020 , respectively, and were available to fund future acquisitions or other capital and operating requirements. The interest rate on the term loan was 1.88% and 1.94% as ofJune 30, 2021 andJune 30, 2020 , respectively. InAugust 2018 , the Company established a trade receivable securitization facility (the "AR Securitization Facility") with a termination date ofAugust 31, 2021 . InMarch 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. The interest rate on the AR Securitization Facility as ofJune 30, 2021 andJune 30, 2020 was 1.20% and 1.07%, respectively. The termination date of the AR Securitization is now inMarch 2024 . AtJune 30, 2021 andJune 30, 2020 , the Company had borrowings outstanding under its unsecured shelf facility agreement withPrudential Investment Management of$90.0 million and$170.0 million , respectively. 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, which had an original principal amount of$120.0 million , carry a fixed interest rate of 3.19%. During fiscal 2021, two principal payments of$40.0 million each were made on the "Series C" notes and the remaining balance of$40.0 million is due 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 . The Company entered into an interest rate swap which mitigates variability in forecasted interest payments on$420.0 million of the Company'sU.S. dollar-denominated unsecured variable rate debt. For more information, see note 7, Derivatives, to the consolidated financial statements, included in Item 8 under the caption "Financial Statements and Supplementary Data." The credit facility and the unsecured shelf facility contain restrictive covenants regarding liquidity, net worth, financial ratios, and other covenants. AtJune 30, 2021 , the most restrictive of these covenants required that the Company have net indebtedness less than 3.75 times consolidated income before interest, taxes, depreciation and amortization (as defined). AtJune 30, 2021 , the Company's net indebtedness was less than 2.5 times consolidated income before interest, taxes, depreciation and amortization (as defined). The Company was in compliance with all financial covenants atJune 30, 2021 . 22 -------------------------------------------------------------------------------- Table of Contents Accounts Receivable Analysis The following table is included to aid in analysis of accounts receivable and the associated provision for losses on accounts receivable (all dollar amounts are in thousands): June 30, 2021 2020 Accounts receivable, gross$ 532,777 $ 463,659 Allowance for doubtful accounts 16,455
13,661
Accounts receivable, net$ 516,322 $ 449,998 Allowance for doubtful accounts, % of gross receivables 3.1 %
2.9 %
Year EndedJune 30, 2021
2020
Provision for losses on accounts receivable$ 6,540 $ 14,055 Provision as a % of net sales 0.20 % 0.43 % 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 51.9 atJune 30, 2021 versus 55.9 atJune 30, 2020 . Approximately 3.0% of our accounts receivable balances are more than 90 days past due atJune 30, 2021 compared to 4.6% atJune 30, 2020 . On an overall basis, our provision for losses from uncollected receivables represents 0.20% of our sales for the year endedJune 30, 2021 , compared to 0.43% of sales for the year endedJune 30, 2020 . The decrease primarily relates to strong cash collections and an improvement in the overall credit profile of the accounts receivable portfolio in the current year, compared 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. 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, 2021 was 4.3 versus 3.8 for the year endedJune 30, 2020 . We believe our inventory turnover ratio in fiscal 2022 will be slightly better than our fiscal 2021 levels. 23 -------------------------------------------------------------------------------- Table of Contents 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, 2021 (in thousands): Period Less Period Period Period Total Than 1 yr 2-3 yrs 4-5 yrs Over 5 yrs Other Operating leases$ 99,150 $ 29,853 $ 40,878 $ 17,009 $ 11,410 - Planned funding of post-retirement obligations 9,400 900 1,100 500 6,900 - Unrecognized income tax benefit liabilities, including interest and penalties 6,500 - - - - 6,500 Long-term debt obligations 829,396 44,118 760,173 25,105 - - Interest on long-term debt obligations (1) 39,500 17,800 16,900 4,800 - - Acquisition holdback payments 3,538 2,569 969 - - -
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, 2021 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 19.8% of our domestic inventory dollars relate to LIFO layers added in the 1970s. The excess of average cost over LIFO cost is$151.9 million as reflected in our consolidated balance sheet atJune 30, 2021 . 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 ofJune 30, 2021 and 2020, the Company's reserve for slow-moving or obsolete inventories was$43.5 million and$42.9 million , respectively, recorded in inventories in the consolidated balance sheets. 24 -------------------------------------------------------------------------------- Table of Contents 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, 2021 and 2020, our allowance for doubtful accounts was 3.1% and 2.9% of gross receivables, respectively. Our provision for losses on accounts receivable was$6.5 million ,$14.1 million and$4.1 million in fiscal 2021, 2020 and 2019, 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 prolonged economic downturn in these end markets, 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 -------------------------------------------------------------------------------- Table of Contents 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, 2021 . The Company concluded that seven (7) of the reporting units' fair values exceeded their carrying amounts by at least 25% as ofJanuary 1, 2021 . The fair value of the final reporting unit, which is comprised of theFCX Performance Inc. (FCX) operations, exceeded its carrying value by 14%. The FCX reporting unit has a goodwill balance of$309.0 million as ofJune 30, 2021 . The Company had eight (8) reporting units for which an annual goodwill impairment assessment was performed as ofJanuary 1, 2020 . The Company concluded that seven (7) of the reporting units' fair values exceeded their carrying amounts by at least 10% as ofJanuary 1, 2020 . Specifically, theCanada reporting unit's fair value exceeded its carrying value by 12%, and theMexico reporting unit's fair value exceeded its carrying value by 14%. The carrying value of the final reporting unit, which is comprised of the FCX operations, exceeded the fair value, resulting in goodwill impairment of$131.0 million . The non-cash impairment charge was the result of the overall decline in the industrial economy, specifically slower demand in FCX's end markets, which led to reduced spending by customers and reduced revenue expectations. If the Company does not achieve forecasted sales growth and margin improvements goodwill could be further 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 ofJune 30, 2021 , the Company recognized$12.9 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. 26 -------------------------------------------------------------------------------- Table of Contents 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; risks relating to the effects of the COVID-19 pandemic; 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, changes in supplier distribution programs, inability of suppliers to perform, and transportation disruptions; 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, 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, 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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