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(Exact name of registrant as specified in its charter)
iOhio
i34-0117420
(State
or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
iOne Applied Plaza
iCleveland
iOhio
i44115
(Address
of principal executive offices)
(Zip Code)
(i216) i426-4000
Registrant's telephone number, including area code
Securities registered
pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
iCommon Stock, without par value
iAIT
iNew
York Stock Exchange
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. iYesx No o
Indicate
by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). iYesx No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
iLarge
accelerated filer
x
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
☐
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes i☐ No ☒
There were i38,759,994
(no par value) shares of common stock outstanding on October 16, 2020.
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
1. iBASIS
OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the financial position of Applied Industrial Technologies, Inc. (the “Company”, or “Applied”) as of September 30, 2020, and the results of its operations and its cash flows for the three month periods ended
September 30, 2020 and 2019, have been included. The condensed consolidated balance sheet as of June 30, 2020 has been derived from the audited consolidated financial statements at that date. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended June 30, 2020.
Operating results for the three month period ended September 30, 2020 are not necessarily indicative of the results that may be expected for the remainder of the fiscal year ending June 30, 2021.
i
Inventory
The
Company uses the LIFO method of valuing U.S. inventories. An actual valuation of inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs and are subject to the final year-end LIFO inventory determination.
i
Recently Adopted Accounting Guidance
Accounting
for current expected credit losses
In June 2016, the FASB issued its final standard on measurement of credit losses on financial instruments. This standard, issued as ASU 2016-13, requires that an entity measure impairment of certain financial instruments, including trade receivables, based on expected losses rather than incurred losses. This update is effective for annual and interim financial statement periods beginning after December 15, 2019, with early adoption permitted for financial statement periods beginning after December 15, 2018. In November 2018, April 2019, May 2019, November 2019, and February 2020, the FASB issued ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-11 and ASU 2020-02, respectively, which clarify the guidance in ASU 2016-13. The
Company adopted the new guidance in the first quarter of fiscal 2021. The adoption of this guidance did not have a material impact on the Company's financial statements or related disclosures.
i
Recently Issued Accounting Guidance
In December 2019, the FASB issued its final standard on simplifying the accounting for income taxes. This standard, issued as ASU 2019-12, makes a number of changes meant to add or clarify
guidance on accounting for income taxes. This update is effective for annual and interim financial statement periods beginning after December 15, 2020, with early adoption permitted in any interim period for which financial statements have not yet been filed. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures.
APPLIED
INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
2. iREVENUE RECOGNITION
Disaggregation of Revenues
i
The
following tables present the Company's net sales by reportable segment and by geographic areas based on the location of the facility shipping the product for the three months ended September 30, 2020 and 2019. Other countries consist of Mexico, Australia, New Zealand, and Singapore.
The
following tables present the Company’s percentage of revenue by reportable segment and major customer industry for the three months ended September 30, 2020 and 2019:
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
The following tables present the Company’s percentage of revenue by reportable segment and product line for the three months ended September 30, 2020 and 2019:
The Company’s contract assets consist of un-billed amounts resulting from contracts for which revenue is recognized over time using the cost-to-cost method, and for which revenue recognized exceeds the amount billed to the customer.
Activity related to contract assets, which are included in other current assets on the condensed consolidated balance sheet, is as follows:
The
difference between the opening and closing balances of the Company's contract assets primarily results from the timing difference between the Company's performance and when the customer is billed.
/
3. iBUSINESS
COMBINATIONS
The operating results of all acquired entities are included within the consolidated operating results of the Company from the date of each respective acquisition.
Fiscal 2020 Acquisition
On August 21, 2019, the Company acquired i100%
of the outstanding shares of Olympus Controls (Olympus), a Portland, Oregon automation solutions provider - including design, assembly, integration, and distribution - of motion control, machine vision, and robotic technologies. Olympus is included in the Fluid Power & Flow Control segment. The purchase price for the acquisition was $i36,642, net tangible assets acquired were $i9,540,
and intangible assets including goodwill was $i27,102 based upon estimated fair values at the acquisition date. The Company funded this acquisition using available cash. The acquisition price and the results of operations for the acquired entity are not material in relation to the Company's consolidated financial statements.
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
4. iiGOODWILL
AND INTANGIBLES/
i
The changes in the carrying amount of goodwill for both the Service Center Based Distribution segment and the Fluid Power & Flow Control segment for the fiscal year ended June 30, 2020 and the three month period ended September 30, 2020 are as follows:
The
Company has eight (i8) reporting units for which an annual goodwill impairment assessment was performed as of January 1, 2020. The Company concluded that seven (i7)
of the reporting units’ fair value exceeded their carrying amounts by at least i10% as of January 1, 2020. Among these, the Canada reporting unit's fair value exceeded its carrying value by i12%,
and the Mexico reporting unit's fair value exceeded its carrying value by i14%. The Canada and Mexico reporting units have goodwill balances of $i27,770 and $i5,365,
respectively, as of September 30, 2020. As of January 1, 2020, the carrying value of the final reporting unit, which is comprised of the FCX Performance Inc. (FCX) operations, exceeded the fair value, resulting in goodwill impairment of $i131,000. The non-cash impairment charge is the result of the overall decline in the industrial economy, specifically slower demand in FCX's end markets. This has led to reduced spending by customers and reduced revenue expectations. The
remaining goodwill for the FCX reporting unit as of September 30, 2020 is $i309,012. Because the carrying value of the FCX reporting unit approximated fair value of the reporting unit after the impairment was recorded, a future decline in the estimated cash flows could result in an additional impairment loss. A future decline in the estimated cash flows could result from a significant or extended decline in various end markets.
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, earnings before interest, taxes, depreciation, and amortization (EBITDA), 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, EBITDA, and multiples that are applied to management’s forecasted revenues and EBITDA estimates.
The techniques used in the Company's impairment test have incorporated a number of assumptions that the
Company believes to be reasonable and to reflect known market conditions at the measurement date. Assumptions in estimating future cash flows are subject to a degree of judgment. The Company makes all efforts to forecast future cash flows as accurately as possible with the information available at the measurement date. The Company evaluates the appropriateness of its assumptions and overall forecasts by comparing projected results of upcoming years with actual results of preceding years. Key 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.
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. Certain events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impact the estimated fair
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
value of the Company’s reporting units may include such items as: (i) a decrease in expected future cash flows, specifically, a decrease in sales volume driven by a prolonged weakness in customer demand or other pressures adversely affecting our long-term sales trends; (ii) inability to achieve the sales from our strategic growth initiatives.
At September 30,
2020 and June 30, 2020, accumulated goodwill impairment losses subsequent to fiscal year 2002 totaled $i64,794 related to the Service Center Based Distribution segment. At September 30, 2020 and June 30, 2020, accumulated goodwill impairment losses subsequent to fiscal year 2002 totaled $i167,605
related to the Fluid Power & Flow Control segment.
i
The Company’s identifiable intangible assets resulting from business combinations are amortized over their estimated period of benefit and consist of the following:
Amounts
include the impact of foreign currency translation. Fully amortized amounts are written off.
/
Identifiable intangible assets with finite lives are reviewed for impairment when changes in conditions indicate carrying value may not be recoverable. Sustained significant softness in certain end market concentrations could result in impairment of certain intangible assets in future periods.
Estimated future amortization expense by fiscal year (based on the Company’s identifiable intangible assets as of September 30, 2020) for the next five years is as follows: $i28,600
for the remainder of 2021, $i36,200 for 2022, $i34,000
for 2023, $i29,800 for 2024, $i26,800 for 2025
and $i24,800 for 2026.
In January 2018, the Company refinanced its existing credit facility and entered into a new five-year credit facility with a group of banks expiring in January 2023. This agreement provides for a $i780,000 unsecured term loan and a $i250,000
unsecured revolving credit facility. Fees on this facility range from i0.10% to i0.20% 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 at September 30, 2020 or June 30, 2020. Unused lines under this facility, net of outstanding letters of credit of $i731
and $i1,873, respectively, to secure certain insurance obligations, totaled $i249,269 and $i248,127
at September 30, 2020 and June 30, 2020, respectively, and were available to fund future acquisitions or other capital and operating requirements. The interest rate on the term loan was i1.94% as of September 30, 2020 and June 30, 2020.
Additionally, the
Company had letters of credit outstanding with separate banks, not associated with the revolving credit agreement, in the amount of $i4,499 and $i4,475
as of September 30, 2020 and June 30, 2020, respectively, in order to secure certain insurance obligations.
Trade Receivable Securitization Facility
In August 2018, the Company established a trade receivable securitization facility (the “AR Securitization Facility”) with a termination date of August 31, 2021. The maximum availability under the AR Securitization Facility is $ii175,000/. Availability
is further subject to changes in the credit ratings of our customers, customer concentration levels or certain characteristics of the accounts receivable being transferred and, therefore, at certain times, we may not be able to fully access the $ii175,000/
of funding available under the AR Securitization Facility. The AR Securitization Facility effectively increases the Company’s borrowing capacity by collateralizing a portion of the amount of the Service Center Based Distribution reportable segment’s U.S. operations’ trade accounts receivable. The Company uses the proceeds from the AR Securitization Facility as an alternative to other forms of debt, effectively reducing borrowing costs. Borrowings under this facility carry variable interest rates tied to LIBOR and fees on the AR Securitization Facility are i0.90%
per year. The interest rate on the AR Securitization Facility was i1.07% as of September 30, 2020 and June 30, 2020. The Company classified the AR Securitization Facility as long-term debt as it has the ability and intent to extend or refinance this amount on a long-term basis.
Other Long-Term Borrowings
At
September 30, 2020 and June 30, 2020, the Company had borrowings outstanding under its unsecured shelf facility agreement with Prudential Investment Management of $i130,000 and $i170,000,
respectively. Fees on this facility range from i0.25% to i1.25% per year based on the Company's
leverage ratio at each quarter end. The "Series C" notes, which had an original principal amount of $i120,000, carry a fixed interest rate of i3.19%. A
$i40,000 principal payment was made on the "Series C" notes in July 2020, and the remaining principal balance of $i80,000 is due in equal payments in July 2021 and 2022. The "Series D" notes have a remaining
principal balance of $i25,000, carry a fixed interest rate of i3.21%, and are due in October 2023. The “Series E” notes have a principal amount of $i25,000,
carry a fixed interest rate of i3.08%, and are due in October 2024.
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)
In 2014, the Company assumed $i2,359 of debt as a part of the headquarters facility acquisition. The i1.50%
fixed interest rate note is held by the State of Ohio Development Services Agency, and matures in May 2024.
6. iDERIVATIVES
Risk Management Objective of Using Derivatives
The
Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined
by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s borrowings.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the
Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive loss and subsequently reclassified into interest expense in the same period(s) during which the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive loss related to derivatives will be reclassified to interest expense as interest payments are made on the
Company’s variable-rate debt.
In January 2019, the Company entered into an interest rate swap to mitigate variability in forecasted interest payments on $i463,000 of the Company’s U.S. dollar-denominated unsecured variable rate debt. The interest rate swap effectively converts a portion of the floating rate interest payment into a fixed rate interest
payment. The Company designated the interest rate swap as a pay-fixed, receive-floating interest rate swap instrument and is accounting for this derivative as a cash flow hedge. The interest rate swap converts $i431,000 of variable rate debt to a rate of i4.36%
as of September 30, 2020 and June 30, 2020, respectively. The fair value (Level 2 in the fair value hierarchy) of the interest rate cash flow hedge was $i23,505 and $i26,179
as of September 30, 2020 and June 30, 2020, respectively, which is included in other current liabilities and other liabilities in the condensed consolidated balance sheet. Realized losses related to the interest rate cash flow hedge were not material during the three months ended September 30, 2020 and 2019.
7. iFAIR
VALUE MEASUREMENTS
Marketable securities measured at fair value at September 30, 2020 and June 30, 2020 totaled $i13,533 and $i12,259,
respectively. The majority of these marketable securities are held in a rabbi trust for a non-qualified deferred compensation plan. The marketable securities are included in other assets on the accompanying condensed consolidated balance sheets and their fair values were determined using quoted market prices (Level 1 in the fair value hierarchy).
As of September 30, 2020 and June 30, 2020, the carrying values of the Company's fixed interest rate debt outstanding under its unsecured shelf facility agreement with Prudential Investment Management approximated fair value (Level 2 in the fair value hierarchy).
The revolving credit facility, the term loan and the AR Securitization Facility contain variable
interest rates and their carrying values approximate fair value (Level 2 in the fair value hierarchy).
Reclassification of net actuarial losses (gains) and prior service cost into other income, net and included in net periodic pension costs
i68
i17
i51
(i17)
(i4)
(i13)
Unrealized
loss on cash flow hedge
(i17)
(i4)
(i13)
(i2,180)
(i537)
(i1,643)
Reclassification
of interest from cash flow hedge into interest expense
i2,690
i658
i2,032
i427
i105
i322
Other
comprehensive income (loss)
$
i8,295
$
i786
$
i7,509
$
(i5,804)
$
(i557)
$
(i5,247)
/
Anti-dilutive
Common Stock Equivalents
In the three month periods ended September 30, 2020 and September 30, 2019, stock options and stock appreciation rights related to i578 and i740
shares of common stock, respectively, were not included in the computation of diluted earnings per share for the periods then ended as they were anti-dilutive.
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per
share amounts) (Unaudited)
9. iSEGMENT INFORMATION
The accounting policies of the Company’s reportable segments are generally the same as those used to prepare the condensed consolidated financial statements. LIFO expense of $i1,133
and $i358 in the three months ended September 30, 2020 and 2019, respectively, is recorded in cost of sales in the condensed statements of income, and is included in operating income for the Service Center Based Distribution segment. The Company allocates LIFO expense between the segments in the fourth quarter of its fiscal year. Intercompany sales, primarily from the Fluid Power & Flow Control segment
to the Service Center Based Distribution segment, of $i7,496 and $i7,313,
in the three months ended September 30, 2020 and 2019, respectively, have been eliminated in the Segment Financial Information tables below.
Intangible amortization—Service Center Based Distribution
i2,581
i3,054
Intangible
amortization—Fluid Power & Flow Control
i7,145
i7,320
Corporate
and other expense, net
i13,728
i15,677
Total
operating income
i52,308
i61,166
Interest
expense, net
i7,653
i10,059
Other
income, net
(i177)
i—
Income
before income taxes
$
i44,832
$
i51,107
/
The
change in corporate and other expense, net is due to changes in corporate expenses, as well as in the amounts and levels of certain expenses being allocated to the segments. The expenses being allocated include corporate charges for working capital, logistics support, and other items.
Unrealized
gain on assets held in rabbi trust for a non-qualified deferred compensation plan
$
(i819)
$
(i55)
Foreign
currency transactions loss (gain)
i416
(i222)
Net
other periodic post-employment benefits
i71
(i30)
Life
insurance expense, net
i177
i300
Other,
net
(i22)
i7
Total
other income, net
$
(i177)
$
i—
/
i
11. SUBSEQUENT
EVENTS
We have evaluated events and transactions occurring subsequent to September 30, 2019 through the date the financial statements were issued.
On October 5, 2020, the Company acquired substantially all of the net assets of Advanced Control Solutions, which operates four locations in Georgia, Tennessee and Alabama. As a provider of automation products, services, and engineered solutions focused on machine vision equipment and software, mobile and collaborative robotic solutions, intelligent sensors, logic controllers, and other related equipment, this business will be included in the Fluid Power & Flow Control segment.
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
With more than 6,100 employees across North America, Australia, New Zealand, and Singapore, Applied Industrial Technologies (“Applied,” the “Company,”“We,”“Us” or “Our”) is a leading value-added distributor 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 in Cleveland, Ohio. During the first quarter of fiscal 2021, business was conducted in the United States, Puerto Rico, Canada, Mexico, Australia, New Zealand, and Singapore from 583 facilities.
The following is Management's Discussion and Analysis of significant factors which have affected our financial condition, results of operations and cash flows during the periods included in the accompanying condensed consolidated balance sheets, statements of consolidated income, consolidated comprehensive income and consolidated cash flows.When reviewing the discussion and analysis set forth below, please note that the majority of SKUs (Stock Keeping
Units) we sell in any given period were not necessarily sold in the comparable period of the prior year, resulting in the inability to quantify certain commonly used comparative metrics analyzing sales, such as changes in product mix and volume.
Overview
Consolidated sales for the quarter ended September 30, 2020 decreased $108.6 million or 12.7% compared to the prior year quarter, with acquisitions increasing sales by $9.7 million or 1.1% and unfavorable foreign currency translation of $3.1 million decreasing sales by 0.4%. Operating margin was 7.0% of sales for the quarter ended September 30, 2020 compared to 7.1% of sales for the same quarter in the prior year. Net income of $34.8 million decreased 10.3% compared to the prior year quarter. The current ratio was 2.7 to 1 at September 30,
2020 and June 30, 2020.
We continued to face challenges during the quarter from the COVID-19 pandemic. We are classified as critical infrastructure and our facilities remain open and operational as they adhere to health and safety policies. We have experienced mid-teen year-over-year organic sales percentage declines month-to-date in October 2020. We are continuing to monitor the impact of the COVID-19 pandemic and continue to take appropriate cost actions. Cost measures implemented to date include reduced discretionary spend, staff realignments, temporary furloughs and pay reductions, suspension of 401(k) company match, and other expense reduction actions.
Applied monitors several economic indices that have been key indicators for industrial economic activity in the United States. These include the Industrial Production
(IP) and Manufacturing Capacity Utilization (MCU) indices published by the Federal Reserve Board and the Purchasing Managers Index (PMI) published by the Institute for Supply Management (ISM). Historically, our performance correlates well with the MCU, which measures productivity and calculates a ratio of actual manufacturing output versus potential full capacity output. When manufacturing plants are running at a high rate of capacity, they tend to wear out machinery and require replacement parts.
The MCU (total industry) and IP indices have increased since June 2020. The MCU for September 2020 was 71.5, which is up from the June 2020 revised readings of 68.7. The ISM PMI registered 55.4 in September, up from the June 2020 reading of 52.6. The indices for the months during the current quarter were as follows:
The following table is included to aid in review of Applied's condensed statements of consolidated income.
Three
Months Ended September 30,
Change in $'s Versus Prior Period - % Decrease
As a Percent of Net Sales
2020
2019
Net sales
100.0
%
100.0
%
(12.7)
%
Gross
profit
28.9
%
29.4
%
(14.2)
%
Selling, distribution & administrative expense
21.9
%
22.2
%
(14.1)
%
Operating
income
7.0
%
7.1
%
(14.5)
%
Net income
4.7
%
4.5
%
(10.3)
%
During the quarter ended September 30,
2020, sales decreased $108.6 million or 12.7% compared to the prior year quarter, with sales from acquisitions adding $9.7 million or 1.1% and unfavorable foreign currency translation accounting for a decrease of $3.1 million or 0.4%. There were 64 selling days in both the quarter ended September 30, 2020 and September 30, 2019. Excluding the impact of businesses acquired, sales were down $115.2 million or 13.4% during the quarter, due to weak demand across key end markets.
The following table shows changes in sales by reportable segment.
Sales
by Reportable Segment
Three Months Ended September 30,
Sales Decrease
Amount of change due to
Foreign Currency
Organic Change
2020
2019
Acquisitions
Service Center Based Distribution
$
513.3
$
603.2
$
(89.9)
$
—
$
(3.1)
$
(86.8)
Fluid
Power & Flow Control
234.5
253.2
(18.7)
9.7
—
(28.4)
Total
$
747.8
$
856.4
$
(108.6)
$
9.7
$
(3.1)
$
(115.2)
Sales
from our Service Center Based Distribution segment, which operates primarily in MRO markets, decreased $89.9 million or 14.9%. Unfavorable foreign currency translation decreased sales by $3.1 million or 0.5%. Excluding the impact of foreign currency translation, sales decreased $86.8 million or 14.4%, reflecting weaker industrial end-market demand from the impact of the COVID-19 pandemic, although sales improved as the quarter progressed. Weakness remains the greatest within heavy industries but is stabilizing, with positive momentum across the food and beverage, pulp and paper, aggregates, and forestry end markets.
Sales from our Fluid Power & Flow Control segment decreased $18.7 million or 7.4%. The acquisition within this segment increased sales by $9.7 million or 3.8%. Excluding the impact of businesses acquired, sales decreased $28.4 million or 11.2%, driven by a decrease from operations due to ongoing soft demand
across industrial, off-highway mobile, and process-related end markets; partially offset by growth within technology, life sciences, and food and beverage end markets, as well as internal growth initiatives and automation-related sales.
The following table shows changes in sales by geographic area. Other countries includes Mexico, Australia, New Zealand, and Singapore.
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Sales in our U.S. operations were down $98.9 million or 13.3%, as acquisitions added $9.7 million or 1.3%. Excluding the impact of businesses acquired, U.S. sales were down $108.6 million or 14.6%. Sales from our Canadian operations decreased $9.0 million or 13.7%. Unfavorable foreign currency translation decreased Canadian sales by $0.6 million or 1.0%. Excluding the impact of foreign currency translation, Canadian sales were down $8.4 million or 12.7%. Consolidated sales from our other country operations,
which include Mexico, Australia, New Zealand, and Singapore, decreased $0.7 million or 1.3% from the prior year. Unfavorable foreign currency translation decreased other country sales by $2.5 million or 5.2%. Excluding the impact of currency translation, other country sales were up $1.8 million, or 3.9% during the quarter.
Our gross profit margin was 28.9% in the quarter ended September 30, 2020 compared to 29.4% in the prior period. The gross profit margin for the current quarter was negatively impacted by 10 basis points due to a $0.7 million increase in LIFO expense between quarters. The remaining change is attributable to a lower mix of local account business and the organic sales decline coupled with subdued pricing opportunities given the softer demand environment.
The following table shows the changes in selling, distribution and
administrative expense (SD&A).
Three Months Ended September 30,
SD&A Decrease
Amount of change due to
Foreign Currency
Organic
Change
2020
2019
Acquisitions
SD&A
$
163.5
$
190.3
$
(26.8)
$
2.2
$
(0.4)
$
(28.6)
SD&A
consists of associate compensation, benefits and other expenses associated with selling, purchasing, warehousing, supply chain management and providing 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, and facility related expenses. SD&A was 21.9% of sales in the quarter ended September 30, 2020 compared to 22.2% in the prior year quarter. SD&A decreased $26.8 million or 14.1% compared to the prior year quarter. Changes in foreign currency exchange rates had the effect of decreasing SD&A during the quarter ended September 30, 2020 by $0.4 million or 0.2% compared to the prior year quarter. SD&A from businesses
acquired added $2.2 million or 1.1% of SD&A expenses, including $0.2 million of intangibles amortization related to acquisitions. Excluding the impact of businesses acquired and the favorable currency translation impact, SD&A decreased $28.6 million or 15.0% during the quarter ended September 30, 2020 compared to the prior year quarter. The Company incurred $1.5 million of non-routine expenses related to severance during the quarter
ended September 30, 2019. Excluding the impact of acquisitions and severance, total compensation decreased $22.3 million during the quarter ended September 30, 2020, 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. Further, travel & entertainment expense decreased $3.5 million during the quarter ended September 30, 2020 primarily due to reduced travel activity related to COVID-19. All other expenses within SD&A were down $1.3 million.
Operating income decreased $8.9 million or 14.5%, and as a percent of sales decreased to 7.0% from 7.1% during the prior year quarter.
Operating income, as a percentage of sales for the Service Center Based Distribution segment decreased to 9.7% in the current year quarter from 10.0% in the prior year quarter. Operating income as a percentage of sales for the Fluid Power & Flow Control segment increased to 11.0% in the current year
quarter from 10.6% in the prior year quarter.
Other income, net was income of $0.2 million for the quarter, which included unrealized gains on investments held by non-qualified deferred compensation trusts of $0.8 million, offset by net unfavorable foreign currency transaction losses of $0.4 million and $0.2 million of expense from other items. During the prior year quarter, other income, net consisted of net favorable foreign currency transaction gains of $0.2 million and unrealized gains on investments held by non-qualified deferred compensation trusts of $0.1 million, offset by life insurance expense of $0.3 million.
The effective income tax rate was 22.4% for the quarter ended September 30, 2020 compared to 24.1% for the quarter ended September 30, 2019. The decrease in the
effective tax rate over the prior year is due to changes in discrete items and a reduction in non-deductible expenses associated with travel due to the COVID-19 pandemic during the quarter ended September 30, 2020 compared to the prior year quarter. We expect our full year tax rate for fiscal 2021 to be in the 23.0% to
25.0% range.
As a result of the factors addressed above, net income for the quarter ended September 30, 2020 decreased $4.0 million or 10.3% compared to the prior year quarter. Net income was $0.89 per share for the quarter ended September 30, 2020 compared to $1.00 per share in the prior year quarter, a decrease of 11.0%.
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 September 30, 2020, we had total debt obligations outstanding of $872.8 million compared to $935.3 million at June 30, 2020. Management expects that our existing cash, cash equivalents, funds available
under the revolving credit facility, and cash provided from operations will be sufficient to finance normal working capital needs in each of the countries in which we operate, 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 following table is included to aid in review of Applied's condensed statements of consolidated cash flows; all amounts are in thousands.
Three Months Ended September 30,
Net Cash Provided by (Used in):
2020
2019
Operating
Activities
$
81,842
$
50,018
Investing Activities
(3,404)
(40,561)
Financing Activities
(77,183)
(18,874)
Exchange Rate Effect
1,254
(598)
Increase
in Cash and Cash Equivalents
$
2,509
$
(10,015)
Net cash provided by operating activities was $81.8 million for the three months ended September 30, 2020 compared to $50.0 million provided by operating activities in the prior period. The increase in cash provided by operating activities during the three months ended September 30, 2020 is related to working capital improvements.
Net cash used in investing activities during the three months ended September 30,
2020 decreased from the prior period primarily due to $35.7 million used for the acquisition of Olympus Controls in the prior year period.
Net cash used in financing activities during the three months ended September 30, 2020 increased from the prior period primarily due to a change in net debt activity, as there was $62.5 million of debt payments in the current year period compared to $4.9 million of debt payments in the prior year period.
Share Repurchases
The Board of Directors has authorized the repurchase of shares of the Company's common stock. These purchases may be made in open market and negotiated transactions, from time to time, depending upon market conditions. During the three months
ended September 30, 2020 and 2019, the Company did not acquire any shares of treasury stock on the open market. At September 30, 2020, we had authorization to repurchase 864,618 shares.
In January 2018, the Company refinanced its existing credit facility and entered into a new five-year credit facility with a group of banks expiring in January 2023. This agreement provides for a $780.0 million unsecured term loan and a $250.0 million unsecured revolving credit facility. Fees on this facility range from 0.10% to 0.20% per year based upon the Company's leverage ratio at each quarter end. Borrowings under this agreement carry variable interest rates tied to either LIBOR or prime at the Company's discretion. The Company had no amount outstanding under
the revolver at September 30, 2020 or June 30, 2020. Unused lines under this facility, net of outstanding letters of credit of $0.7 million and $1.9 million, respectively, to secure certain insurance obligations, totaled $249.3 million and $248.1 million at September 30, 2020 and June 30, 2020, respectively, and were available to fund future acquisitions or other capital and operating requirements. The interest rate on the term loan was 1.94% as of September 30, 2020 and June 30, 2020.
Additionally, the Company had letters of credit outstanding
with separate banks, not associated with the revolving credit agreement, in the amount of $4.5 million as of September 30, 2020 and June 30, 2020, in order to secure certain insurance obligations.
Trade Receivable Securitization Facility
In August 2018, the Company established a trade receivable securitization facility (the “AR Securitization Facility”) with a termination date of August 31, 2021. The maximum availability under the AR Securitization Facility is $175.0 million. Availability is further subject to changes in the credit ratings of our customers, customer concentration levels or certain characteristics of the accounts receivable being transferred
and, therefore, at certain times, we may not be able to fully access the $175.0 million of funding available under the AR Securitization Facility. The AR Securitization Facility effectively increases the Company’s borrowing capacity by collateralizing a portion of the amount of the Service Center Based Distribution reportable segment’s U.S. operations’ trade accounts receivable. The Company uses the proceeds from the AR Securitization Facility as an alternative to other forms of debt, effectively reducing borrowing costs. Borrowings under this facility carry variable interest rates tied to LIBOR and fees on the AR Securitization Facility are 0.90% per year. The interest rate on the AR Securitization Facility was 1.07% as of September 30, 2020 and
June 30, 2020. The Company classified the AR Securitization Facility as long-term debt as it has the ability and intent to extend or refinance this amount on a long-term basis.
Other Long-Term Borrowings
At September 30, 2020 and June 30, 2020, the Company had borrowings outstanding under its unsecured shelf facility agreement with Prudential Investment Management of $130.0 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%. A $40.0 million principal payment was made on the "Series C" notes in July 2020, and the remaining principal balance of $80.0 million is due in equal payments in July 2021 and 2022. The "Series D" notes have a remaining principal balance of $25.0 million, carry a fixed interest rate of 3.21%, and are due in October 2023. The “Series E” notes have a principal amount of $25.0 million, carry a fixed interest rate of 3.08%, and are due in October 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 the State of Ohio Development Services Agency, and matures in
May 2024.
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company entered into an interest rate swap which mitigates variability in forecasted interest payments on $431.0 million of the
Company’s U.S. dollar-denominated unsecured variable rate debt. For more information, see note 6, Derivatives, to the consolidated financial statements, included in Item 1 under the caption “Notes to Condensed Consolidated Financial Statements.”
The credit facility and the unsecured shelf facility contain restrictive covenants regarding liquidity, net worth, financial ratios, and other covenants. At September 30, 2020, 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). At September 30, 2020, the Company's
net indebtedness was less than 3.0 times consolidated income before interest, taxes, depreciation and amortization (as defined). The Company was in compliance with all financial covenants at September 30, 2020.
Accounts Receivable Analysis
The following table is included to aid in analysis of accounts receivable and the associated provision for losses on accounts receivable:
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.
As of September 30, 2020, approximately 3.6% of our accounts receivable balances are more than 90 days past due, compared to 4.6% at June 30, 2020. On an overall basis, our provision for losses from uncollected receivables represents 0.68% of our sales in the three months ended September 30,
2020, compared to 0.25% of sales for the three months ended September 30, 2019. The increase primarily relates to provisions recorded in the current year for customer credit deterioration and bankruptcies primarily in the U.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 for U.S. inventories and the average cost method for foreign inventories. Management uses an inventory turnover ratio to monitor and evaluate inventory. Management calculates this ratio on an annual as well as a quarterly basis,
and believes that using average costs to determine the inventory turnover ratio instead of LIFO costs provides a more useful analysis. The annualized inventory turnover based on average costs was 3.8 for the periods ended September 30, 2020 and June 30, 2020, respectively. We believe our inventory turnover ratio at the end of the year will be similar or slightly better than the ratio at September 30, 2020.
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM
2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Cautionary Statement Under Private Securities Litigation Reform Act
Management’s Discussion and Analysis contains statements that are forward-looking based on management’s current expectations about the future. Forward-looking statements are often identified by qualifiers, such as “guidance”, “expect”, “believe”, “plan”, “intend”, “will”, “should”, “could”, “would”, “anticipate”, “estimate”, “forecast”, “may”, "optimistic" and derivative or similar words or expressions. Similarly, descriptions of objectives, strategies, plans, or goals are also forward-looking statements. These statements may discuss,
among other things, expected growth, future sales, future cash flows, future capital expenditures, future performance, and the anticipation and expectations of the Company and its management as to future occurrences and trends. The Company intends that the forward-looking statements be subject to the safe harbors established in the Private Securities Litigation Reform Act of 1995 and by the Securities and Exchange Commission in its rules, regulations and releases.
Readers are cautioned not to place undue reliance on any forward-looking statements. All forward-looking statements are based on current expectations regarding important risk factors, many of which are outside the
Company’s control. Accordingly, actual results may differ materially from those expressed in the forward-looking statements, and the making of those statements should not be regarded as a representation by the Company or any other person that the results expressed in the statements will be achieved. In addition, the Company assumes no obligation publicly to update or revise any forward-looking statements, whether because of new information or events, or otherwise, except as may be required by law.
Important risk factors include, but are not limited to, the following: risks relating to the operations levels of our customers and the economic factors that affect them; 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.
We discuss certain of these matters and other risk factors more fully throughout this Form 10-Q as well as other of our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended June 30,
2020.
24
APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For quantitative and qualitative disclosures about market risk, see Item 7A "Quantitative and Qualitative Disclosures About Market Risk" in our Annual Report on Form 10-K for the year ended June 30, 2020.
25
APPLIED
INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 4: CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company's management, under the supervision and with the participation of the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), evaluated the effectiveness of the Company's disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e), as of the end of the period covered by this report. Based on that evaluation, the CEO and CFO have concluded that the
Company's disclosure controls and procedures are effective.
Changes in Internal Control Over Financial Reporting
There have not been any changes in internal control over financial reporting during the quarter ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. While a significant portion of our workforce began working remotely in March 2020 due to COVID-19, most have returned to working in the office during the first quarter of fiscal 2021. These changes to the working environment did not have a material effect on our internal controls over financial reporting during the most recent quarter. We are continually monitoring and assessing
the COVID-19 pandemic on our internal controls to minimize the impact on their design and operating effectiveness.
The
Company is a party to pending legal proceedings with respect to various product liability, commercial, personal injury, employment, and other matters. Although it is not possible to predict the outcome of these proceedings or the range of reasonably possible loss, the Company does not expect, based on circumstances currently known, that the ultimate resolution of any of these proceedings will have, either individually or in the aggregate, a material adverse effect on the Company's consolidated financial position, results of operations, or cash flows.
ITEM
2. Unregistered Sales of Equity Securities and Use of Proceeds
Repurchases of common stock in the quarter ended September 30, 2020 were as follows:
Period
(a) Total Number of Shares
(b) Average Price Paid per Share ($)
(c) Total Number of Shares Purchased as Part of Publicly
Announced Plans or Programs
(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (1)
(1)During the quarter the Company purchased 502 shares in connection with the Deferred Compensation Plan.
(2)On
October 24, 2016, the Board of Directors authorized the repurchase of up to 1.5 million shares of the Company's common stock, replacing the prior authorization. We publicly announced the new authorization on October 26, 2016. Purchases can be made in the open market or in privately negotiated transactions.
The authorization is in effect until all shares are purchased, or the Board revokes or amends the authorization.
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline
XBRL document
The Company will furnish a copy of any exhibit described above and not contained herein upon payment of a specified reasonable fee which shall be limited to the Company’s reasonable expenses in furnishing the exhibit.
Certain instruments with respect to long-term debt have not been filed as exhibits because the total amount of securities authorized
under any one of the instruments does not exceed 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis. The Company agrees to furnish to the Securities and Exchange Commission, upon request, a copy of each such instrument.
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.