NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
NOTE 1: BUSINESS AND ACCOUNTING POLICIES
Business
Applied Industrial Technologies, Inc. and subsidiaries (the “Company” or “Applied”) is a leading industrial distributor serving Maintenance Repair & Operations (MRO) and Original Equipment Manufacturer (OEM) customers in virtually every industry. In addition, Applied provides engineering, design and systems integration for industrial and fluid power applications, as well as customized mechanical, fabricated rubber and fluid power shop services. Although the Company does not generally manufacture the products it sells, it does assemble and repair certain products and systems.
Consolidation
The consolidated financial statements include the accounts of Applied Industrial Technologies, Inc. and its subsidiaries. Intercompany transactions and balances have been eliminated in consolidation. For the year ended June 30, 2013 the financial results of the Company’s Canadian and Mexican subsidiaries were included in the consolidated financial statements for the twelve months ended May 31. During fiscal 2014, the Company eliminated the one month reporting lag for both the Canadian and Mexican subsidiaries in the first and third quarters respectively. See the "Change in Accounting Principle" section below for additional information related to the elimination of the reporting lag.
Foreign Currency
The financial statements of the Company’s Canadian, Mexican, Australian and New Zealand subsidiaries are measured using local currencies as their functional currencies. Assets and liabilities are translated into U.S. dollars at current exchange rates, while income and expenses are translated at average exchange rates. Translation gains and losses are reported in other comprehensive (loss) income in the statements of consolidated comprehensive income. Gains and losses resulting from transactions denominated in foreign currencies are included in the statements of consolidated income as a component of other expense (income), net.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the period. Actual results may differ from the estimates and assumptions used in preparing the consolidated financial statements.
Cash and Cash Equivalents
The Company considers all short-term, highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are carried at cost, which approximates fair value.
Marketable Securities
The primary marketable security investments of the Company include money market and mutual funds held in a rabbi trust for a non-qualified deferred compensation plan. These are included in other assets in the consolidated balance sheets, are classified as trading securities, and reported at fair value based on quoted market prices. Changes in the fair value of the investments during the period are recorded in other expense (income), net in the statements of consolidated income.
Concentration of Credit Risk
The Company has a broad customer base representing many diverse industries across North America, Australia and New Zealand. As such, the Company does not believe that a significant concentration of credit risk exists in its accounts receivable. The Company’s cash and cash equivalents consist of deposits with commercial banks and regulated non-bank subsidiaries. While Applied monitors the creditworthiness of these institutions, a crisis in the financial systems could limit access to funds and/or result in the loss of principal. The terms of these deposits and investments provide that all monies are available to the Company upon demand.
Allowances for Doubtful Accounts
The Company evaluates the collectibility of trade accounts receivable based on a combination of factors. Initially, the Company estimates an allowance for doubtful accounts as a percentage of net sales based on historical bad debt experience. This initial estimate is adjusted based on recent trends of customers and industries estimated to be greater credit risks, trends within the entire customer pool, and changes in the overall aging of accounts receivable. Accounts are written off against the allowance when it becomes evident collection will not occur. While the Company has a large customer base that is geographically dispersed, a general economic downturn in any of the industry segments in which the Company operates could result in higher than expected defaults, and therefore, the need to revise estimates for bad debts.
Inventories
Inventories are valued at the average cost method, using the last-in, first-out (LIFO) method for U.S. inventories and the average cost method for foreign inventories. The Company adopted the link chain dollar value LIFO method of accounting for U.S. inventories in fiscal 1974. At
June 30, 2016
, approximately
22.8%
of the Company’s domestic inventory dollars relate to LIFO layers added in the 1970s. The Company maintains five LIFO pools based on the following product groupings: bearings, power transmission products, rubber products, fluid power products and other products. LIFO layers and/or liquidations are determined consistently year-to-year.
The Company evaluates the recoverability of its slow moving or obsolete inventories at least quarterly. The Company estimates the recoverable cost of such inventory by product type while considering factors such as its age, historic and current demand trends, the physical condition of the inventory, as well as assumptions regarding future demand. The Company’s ability to recover its cost for slow moving or obsolete inventory can be affected by such factors as general market conditions, future customer demand, and relationships with suppliers. Historically, the Company’s inventories have demonstrated long shelf lives, are not highly susceptible to obsolescence, and, in certain instances, can be eligible for return under supplier return programs.
Supplier Purchasing Programs
The Company enters into agreements with certain suppliers providing inventory purchase incentives. The Company’s inventory purchase incentive arrangements are unique to each supplier and are generally annual programs ending at either the Company’s fiscal year end or the supplier’s year end; however, program length and ending dates can vary. Incentives are received in the form of cash or credits against purchases upon attainment of specified purchase volumes and are received either monthly, quarterly or annually. The incentives are generally a specified percentage of the Company’s net purchases based upon achieving specific purchasing volume levels. These percentages can increase or decrease based on changes in the volume of purchases. The Company accrues for the receipt of these inventory purchase incentives based upon cumulative purchases of inventory. The percentage level utilized is based upon the estimated total volume of purchases expected during the life of the program. Supplier programs are analyzed each quarter to determine the appropriateness of the amount of purchase incentives accrued. Upon program completion, differences between estimates and actual incentives subsequently received have not been material. Benefits under these supplier purchasing programs are recognized under the Company’s LIFO inventory accounting method as a reduction of cost of sales when the inventories representing these purchases are recorded as cost of sales. Accrued incentives expected to be settled as a credit against future purchases are reported on the consolidated balance sheet as an offset to amounts due to the related supplier.
Property and Related Depreciation and Amortization
Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets and is included in selling, distribution and administrative expenses in the accompanying statements of consolidated income. Buildings, building improvements and leasehold improvements are depreciated over ten to thirty years or the life of the lease if a shorter period, and equipment is depreciated over three to ten years. The Company capitalizes internal use software development costs in accordance with guidance on accounting for costs of computer software developed or obtained for internal use. Amortization of software begins when it is ready for its intended use, and is computed on a straight-line basis over the estimated useful life of the software, generally not to exceed twelve years. Capitalized software and hardware costs are classified as property on the consolidated balance sheets. The carrying values of property and equipment are reviewed for impairment when events or changes in circumstances indicate that the recorded value cannot be recovered from undiscounted future cash flows. Impairment losses, if any, would be measured based upon the difference between the carrying amount and the fair value of the assets.
Goodwill and Intangible Assets
Goodwill is recognized as the excess cost of an acquired entity over the net amount assigned to assets acquired and liabilities assumed. Goodwill is not amortized. Goodwill is reviewed for impairment annually as of
January 1
or whenever changes in conditions indicate an evaluation should be completed. These conditions could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. The Company utilizes discounted cash flow models and market multiples for comparable businesses to determine the fair value of reporting units. Evaluating impairment requires significant judgment by management, including estimated future operating results, estimated future cash flows, the long-term rate of growth of the business, and determination of an appropriate discount rate. While the Company uses available information to prepare the estimates and evaluations, actual results could differ significantly.
The Company recognizes acquired identifiable intangible assets such as customer relationships, trade names, vendor relationships, and non-competition agreements apart from goodwill. Customer relationship identifiable intangibles are amortized using the sum-of-the-years-digits method over estimated useful lives consistent with assumptions used in the determination of their value. Amortization of all other finite-lived identifiable intangible assets is computed using the straight-line method over the estimated period of benefit. Amortization of identifiable intangible assets is included in selling, distribution and administrative expenses in the accompanying statements of consolidated income. Identifiable intangible assets with finite lives are reviewed for impairment when changes in conditions indicate carrying value may not be recoverable. Identifiable intangible assets with indefinite lives are reviewed for impairment on an annual basis or whenever changes in conditions indicate an evaluation should be completed. The Company does not currently have any indefinite lived identifiable intangible assets.
Self-Insurance Liabilities
The Company maintains business insurance programs with significant self-insured retention covering workers’ compensation, business, automobile, general product liability and other claims. The Company accrues estimated losses including those incurred but not reported using actuarial calculations, models and assumptions based on historical loss experience. The Company also maintains a self-insured health benefits plan which provides medical benefits to U.S. based employees electing coverage under the plan. The Company estimates its reserve for all unpaid medical claims, including those incurred but not reported, based on historical experience, adjusted as necessary based upon management’s reasoned judgment.
Revenue Recognition
Sales are recognized when there is evidence of an arrangement, the sales price is fixed, collectibility is reasonably assured and the product’s title and risk of loss is transferred to the customer. Typically, these conditions are met when the product is shipped to the customer. The Company charges shipping and handling fees when products are shipped or delivered to a customer, and includes such amounts in net sales. The Company reports its sales net of actual sales returns and the amount of reserves established for anticipated sales returns based on historical rates. Sales tax collected from customers is excluded from net sales in the accompanying statements of consolidated income.
Shipping and Handling Costs
The Company records freight payments to third parties in cost of sales and internal delivery costs in selling, distribution and administrative expenses in the accompanying statements of consolidated income. Internal delivery costs in selling, distribution and administrative expenses were approximately
$21,480
,
$24,430
and
$16,230
for the fiscal years ended
June 30, 2016
,
2015
and
2014
, respectively.
Income Taxes
Income taxes are determined based upon income and expenses recorded for financial reporting purposes. 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. Uncertain tax positions meeting a more-likely-than-not recognition threshold are recognized in accordance with the Income Taxes topic of the ASC (Accounting Standards Codification). The Company recognizes accrued interest and penalties related to unrecognized income tax benefits in the provision for income taxes.
Share-Based Compensation
Share-based compensation represents the cost related to share-based awards granted to employees under the 2015 Long-Term Performance Plan, the 2011 Long-Term Performance Plan, or the 2007 Long-Term Performance Plan. The Company measures share-based compensation cost at the grant date, based on the estimated fair value of the award and recognizes the cost over the requisite service period. Non-qualified stock appreciation rights (SARs) and stock options are granted with an exercise price equal to the closing market price of the Company’s common stock at the date of grant and the fair values are determined using a Black-Scholes option pricing model, which incorporates assumptions regarding the expected volatility, the expected option life, the risk-free interest rate and the expected dividend yield. SARs and stock option awards generally vest over
four
years of continuous service and have
ten
-year contractual terms. The fair value of restricted stock awards, restricted stock units (RSUs), and performance shares are based on the closing market price of Company common stock on the grant date.
Treasury Shares
Shares of common stock repurchased by the Company are recorded at cost as treasury shares and result in a reduction of shareholders’ equity in the consolidated balance sheets. The Company uses the weighted-average cost method for determining the cost of shares reissued. The difference between the cost of the shares and the reissuance price is added to or deducted from additional paid-in capital.
Changes in Accounting Principle
Deferred Income Taxes
In November 2015, the FASB issued its final standard on the simplification of the presentation of deferred income taxes. The standard, issued as Accounting Standards Update ("ASU") 2015-17, requires that deferred tax liabilities and assets be classified as non-current in the consolidated balance sheet. This update is effective for financial statement periods beginning after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. The Company early adopted ASU 2015-17 in the second quarter of fiscal 2016. The Company applied the new standard retrospectively to the prior period presented in the consolidated balance sheets; the impact of this change in accounting principle on balances previously reported as of
June 30, 2015
was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Amount as of June 30, 2015
|
Balance Sheet Line Item
|
As Previously Reported
|
As Revised
|
Change
|
Other current assets
|
$
|
51,111
|
|
$
|
37,816
|
|
$
|
(13,295
|
)
|
Deferred tax assets
|
$
|
97
|
|
$
|
10,980
|
|
$
|
10,883
|
|
Other liabilities
|
$
|
46,295
|
|
$
|
43,883
|
|
$
|
(2,412
|
)
|
Alignment of Canadian Subsidiary Reporting
Effective July 1, 2013, the Company aligned the consolidation of the Company’s Canadian subsidiary in the consolidated financial statements, which previously included the results on a one month reporting lag. The Company believes that this change in accounting principle is preferable as it provides contemporaneous reporting within our consolidated financial statements. In accordance with applicable accounting literature, the elimination of a one month reporting lag of a subsidiary is treated as a change in accounting principle and requires retrospective application. The Company determined that the effect of this change is not material to the financial statements for all periods presented and therefore, the Company has not presented retrospective application of this change. The net impact of the lag elimination was
$1,200
of income for the month of June 2013 and has been included within other expense (income), net on the statement of consolidated income for the year ended June 30, 2014. The statement of consolidated income for the year ended June 30, 2014 reflects the same results, had the financial statements been retrospectively adjusted, with the exception of net income which would have decreased by $
1,200
.
Alignment of Mexican Subsidiary Reporting
Effective January 1, 2014, the Company aligned the consolidation of the Company’s Mexican subsidiary in the consolidated financial statements, which previously included the results on a one month reporting lag. The Company believes that this change in accounting principle is preferable as it provides contemporaneous reporting within our consolidated financial statements. In accordance with applicable accounting literature, the elimination of a one month reporting lag of a subsidiary is treated as a change in accounting principle and requires retrospective application. The Company determined that the effect of this change is not material to the financial statements for all periods presented and therefore, the Company has not presented retrospective application of this change. The net impact of the lag elimination was $
200
of income for the month of December 2013 and has been included within other expense (income), net on the statement of consolidated income for year ended June 30, 2014.
Net sales, operating income and net income for the year ended June 30, 2014 would have decreased by
$1,100
,
$100
and
$250
had the financial statements been retrospectively adjusted.
Other Recently Adopted Accounting Guidance
In June 2014, the FASB issued its final standard on accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The standard, issued as ASU 2014-12, clarifies that a performance target that affects vesting and that can be achieved after the requisite service period, should be treated as a performance condition. The update is effective for financial statement periods beginning after December 15, 2015, with early adoption permitted. The Company adopted ASU 2014-12 in the first quarter of fiscal 2016. The adoption of this update did not have an impact on the financial statements of the Company.
New Accounting Pronouncements
In May 2014, the FASB issued its final standard on the recognition of revenue from contracts with customers.
The standard, issued as ASU 2014-09, outlines a single comprehensive model for entities to use in the accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry specific guidance. The core principle of this model is that "an entity recognizes revenue to depict the transfer of promised goods or services to a customer in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services." In August 2015, the FASB issued ASU 2015-14 to delay the effective date of ASU 2014-09 by one year. In accordance with the delay, the update is effective for financial statement periods beginning after December 15, 2017. Early adoption is permitted, but not before financial statement periods beginning after December 15, 2016. In March 2016 the FASB issued ASU 2016-08 and ASU 2016-10, and in May 2016 the FASB issued ASU 2016-12, which clarify the guidance in ASU 2014-09 but do not change the core principle of the revenue recognition model. The Company has not determined the collective impact of these pronouncements on its financial statements and related disclosures or the method of adoption.
In April 2015, the FASB issued its final standard on simplifying the presentation of debt issue costs. This standard, issued as ASU 2015-03, requires that all costs incurred to issue debt be presented in the balance sheet as a direct reduction from the carrying value of the debt, similar to the presentation of debt discounts. This update is effective for financial statement periods beginning after December 15, 2015, and interim periods within those fiscal years, with early adoption permitted. The impact of the adoption of this guidance will result in the reclassification of the unamortized debt issuance costs on the consolidated balance sheets, which were
$504
and
$394
at June 30, 2016 and 2015, respectively, recorded in other current assets and other assets in the consolidated balance sheets.
In July 2015, the FASB issued its final standard on simplifying the measurement of inventory. This standard, issued as ASU 2015-11, specifies that an entity should measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The new standard does not apply to inventory that is measured using LIFO; therefore, it is not applicable to the Company's U.S. inventory values, but does apply to the Company's foreign inventories which are valued using the average cost method. The update is effective for financial statement periods beginning after December 15, 2016, with earlier application permitted. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures.
In September 2015, the FASB issued its final standard on simplifying the accounting for measurement-period adjustments for business combinations. This standard, issued as ASU 2015-16, requires that an entity that is the acquirer in a business combination that identifies adjustments to provisional amounts during the measurement period recognize those adjustments in the reporting period in which the amounts are determined. This update further requires that the acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The update is effective for financial statement periods beginning after December 15, 2015, and should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this update, with early adoption permitted. When adjustments to provisional amounts occur in the future, the Company will make the adjustments in the appropriate period and include the required disclosures.
In January 2016, the FASB issued its final standard on financial instruments. This standard, issued as ASU 2016-01, enhances the reporting model for financial instruments to provide users of financial statements with more decision-useful information and addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The update is effective for financial statement periods beginning after December 15, 2017, with earlier application permitted for only certain aspects of the standard; earlier application of the remaining
aspects is not permitted. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures.
In February 2016, the FASB issued its final standard on accounting for leases. This standard, issued as ASU 2016-02, requires that an entity that is a lessee recognize lease assets and lease liabilities on the balance sheet for all leases and disclose key information about leasing arrangements. The core principle of this update is that a "lessee should recognize the assets and liabilities that arise from leases." This update is effective for financial statement periods beginning after December 15, 2018, with earlier application permitted. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures.
In March 2016, the FASB issued its final standard on simplifying the accounting for share-based payment awards. This standard, issued as ASU 2016-09, simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification on the statement of cash flows, and accounting for forfeitures. This update is effective for financial statement periods beginning after December 15, 2016, with early adoption permitted. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures or the method of adoption.
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 financial statement periods beginning after December 15, 2019, with early adoption permitted for financial statement periods beginning after December 15, 2018. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures.
NOTE 2: BUSINESS COMBINATIONS
The operating results of all acquired entities are included within the consolidated operating results of the Company from the date of each respective acquisition.
Fiscal 2016 Acquisitions
On June 14, 2016, the Company acquired
100%
of the outstanding stock of Seals Unlimited ("Seals"), a distributor of sealing, fastener, and hose products located in Burlington, Ontario. On January 4, 2016, the Company acquired substantially all of the net assets of HUB Industrial Supply ("HUB"), a distributor of consumable industrial products operating from three locations - Lake City, FL, Indianapolis, IN, and Las Vegas, NV. On August 3, 2015, the Company acquired substantially all of the net assets of Atlantic Fasteners Co., Inc. ("Atlantic Fasteners"), a distributor of C-Class consumables including industrial fasteners and related industrial supplies located in Agawam, MA. Seals, HUB, and Atlantic Fasteners are all included in the Service Center Based Distribution segment. On October 1, 2015, the Company acquired substantially all of the net assets of S.G. Morris Co. ("SGM"). SGM, headquartered in Cleveland, OH, is a distributor of hydraulic components throughout Ohio, Western Pennsylvania and West Virginia and is included in the Fluid Power Businesses Segment. The total combined consideration for these acquisitions was approximately
$66,250
, net tangible assets acquired were
$22,650
, and intangibles including goodwill were
$43,600
based upon preliminary estimated fair values at the acquisition dates, which are subject to adjustment. The total combined consideration includes
$3,750
of acquisition holdback payments, included in other current liabilities and other liabilities on the condensed consolidated balance sheets, which will be paid plus interest at various times through October 2018. The Company funded the amounts paid for the acquisitions at closing using available cash and borrowings under the revolving credit facility at variable interest rates. The acquisition prices and the results of operations for the acquired entities are not material in relation to the Company's consolidated financial statements.
Knox Acquisition
On July 1, 2014, the Company acquired
100%
of the outstanding stock of Knox Oil Field Supply Inc. (“Knox”), headquartered in San Angelo, Texas, for total consideration of
$132,000
, including cash paid of
$118,000
at closing. The primary reason for the acquisition of Knox was to complement and expand the Company’s capabilities to serve the upstream oil and gas industry in the United States. As a distributor of oilfield supplies and related services, this business is included in the Service Center Based Distribution Segment. The Company funded the acquisition by drawing
$120,000
from the previously uncommitted shelf facility with Prudential Investment Management at a fixed interest rate of
3.19%
with an average seven year life. The remaining
$14,000
purchase price was to be paid as acquisition holdback payments on the first three anniversaries of the acquisition with interest at a fixed rate of
1.50%
per annum;
$7,100
was paid on the first anniversary in the first quarter of fiscal 2016.
The following table summarizes the consideration transferred, assets acquired, and liabilities assumed in connection with the acquisition of Knox based on their estimated fair values at the acquisition date:
|
|
|
|
|
|
Knox Acquisition
|
|
|
2015
|
|
Accounts receivable
|
$
|
19,100
|
|
Inventories
|
18,800
|
|
Property
|
3,900
|
|
Identifiable intangible assets
|
58,500
|
|
Goodwill
|
63,200
|
|
Total assets acquired
|
163,500
|
|
Accounts payable and accrued liabilities
|
7,200
|
|
Deferred income taxes
|
24,300
|
|
Net assets acquired
|
$
|
132,000
|
|
|
|
Purchase price
|
$
|
132,800
|
|
Reconciliation of fair value transferred:
|
|
Working Capital Adjustments
|
(800
|
)
|
Total Consideration
|
$
|
132,000
|
|
None of the goodwill acquired is expected to be deductible for income tax purposes. The goodwill recognized was attributable primarily to expected synergies and other benefits that the Company believed would result from the acquisition of Knox.
Reliance Acquisition
On May 1, 2014, the Company acquired
100%
of the outstanding stock of Reliance Industrial Products (“Reliance”), headquartered in Nisku, Alberta, Canada, with operations in Western Canada and the Western United States, for a total purchase price in the amount of
$188,500
. The primary reasons for the acquisition were to provide the Company enhanced capabilities to serve the upstream oil and gas industry in the United States and Canada. A distributor of fluid conveyance and oilfield supplies, this business is included in the Service Center Based Distribution Segment. The Company funded the acquisition by using available cash in Canada in the amount of
$31,900
, existing revolving credit facilities of
$36,600
and a new
$100,000
five-year term loan facility, with the remainder of
$20,000
to be paid in equal amounts as acquisition holdback payments on the first two anniversaries of the acquisition, plus interest at
2%
per annum;
$8,300
was paid during fiscal 2016.
The following table summarizes the consideration transferred, assets acquired, and liabilities assumed in connection with the acquisition of Reliance based on their estimated fair values at the acquisition date:
|
|
|
|
|
|
Reliance Acquisition
|
|
|
2014
|
|
Accounts receivable
|
$
|
20,600
|
|
Inventories
|
22,900
|
|
Other current assets
|
6,000
|
|
Property
|
12,900
|
|
Identifiable intangible assets
|
73,200
|
|
Goodwill
|
79,500
|
|
Total assets acquired
|
215,100
|
|
Accounts payable and accrued liabilities
|
15,800
|
|
Deferred income taxes
|
19,500
|
|
Net assets acquired
|
$
|
179,800
|
|
|
|
Purchase price
|
$
|
188,500
|
|
Reconciliation of fair value transferred:
|
|
Cash acquired
|
(1,400
|
)
|
Working capital adjustments
|
(8,200
|
)
|
Debt assumed
|
900
|
|
Total Consideration
|
$
|
179,800
|
|
None of the goodwill acquired is expected to be deductible for income tax purposes. The goodwill recognized was attributable primarily to expected synergies and other benefits that the Company believed would result from the acquisition of Reliance.
The Company incurred
$1,448
in third party costs during fiscal 2014 pertaining to the acquisition of Reliance. These expenses are included in selling, distribution and administration expense in the statement of consolidated income for the year ended June 30, 2014.
Knox and Reliance Pro Forma Results (Unaudited)
The following unaudited pro forma consolidated results of operations have been prepared as if the Reliance acquisition (including the related acquisition costs) had occurred at the beginning of fiscal 2013 and the Knox acquisition (including the related acquisition costs) had occurred at the beginning of fiscal 2014:
|
|
|
|
|
|
|
|
Pro forma, year ended June 30:
|
2014
|
|
2013
|
|
Sales
|
$
|
2,687,903
|
|
$
|
2,600,453
|
|
Operating income
|
$
|
184,164
|
|
$
|
187,419
|
|
Net income
|
$
|
121,158
|
|
$
|
128,779
|
|
Diluted net income per share
|
$
|
2.86
|
|
$
|
3.03
|
|
These pro forma amounts have been calculated after applying the Company’s accounting policies and adjusting the results to reflect additional depreciation and amortization that would have been charged assuming the fair value adjustments to property, plant, and equipment, and amortizable intangible assets had been applied as of July 1, 2013. In addition, pro forma adjustments have been made for the interest expense that would have been incurred as a result of the indebtedness used to finance the acquisitions. The pro forma net income amounts also incorporate an adjustment to the recorded income tax expense for the income tax effect of the pro forma adjustments described above. These pro forma results of operations do not include any anticipated synergies or other effects of the planned integration of Reliance and Knox; accordingly, such pro forma adjustments do not purport to be indicative of the results of operations that actually would have resulted had the acquisitions occurred as of the date indicated or that may result in the future.
Other Fiscal 2015 Acquisitions
Other acquisitions during fiscal 2015 included the acquisition of substantially all of the net assets of Rodamientos y Derivados del Norte S.A. de C.V., a Mexican distributor of bearings and power transmission products and related products, and Great Southern Bearings / Northam Bearings, a Western Australia distributor of bearings and power transmission products on July 1, 2014 as well as Ira Pump and Supply Inc., ("Ira Pump") a Texas distributor of oilfield pumps and supplies on November 3, 2014. These companies are included in the Service Center Based Distribution Segment. The total combined consideration for these acquisitions was approximately
$54,900
. Net tangible assets acquired were
$21,000
and intangibles including goodwill were
$33,900
, based upon estimated fair values at the acquisition date. The Company funded these acquisitions from borrowings under our existing debt facilities. Total acquisition holdback payments of
$6,900
are being paid at various times through July 2017. The results of operations for the Mexican, Australian, and Ira Pump acquisitions are not material for any period presented.
Other Fiscal 2014 Acquisitions
In December 2013, the Company acquired substantially all of the net assets of Texas Oilpatch Services Corporation, a Texas distributor of bearings, oil seals, power transmission products, and related replacement parts to the oilfield industry. The acquired business is included in the Service Center Based Distribution segment. The purchase price for this acquisition was
$17,000
, tangible assets acquired were
$3,863
and intangibles, including goodwill was
$13,137
. The purchase price included
$2,550
of acquisition holdback payments which were paid into an escrow account controlled by a third party. The acquisition price and the results of operations of the acquired entity are not material in relation to the Company’s consolidated financial statements.
Holdback Liabilities for Acquisitions
Acquisition holdback payments of approximately
$7,700
,
$3,800
and
$2,500
will be made in fiscal 2017, 2018 and 2019, respectively. The related liabilities for these payments are recorded in the consolidated balance sheets in other current liabilities for the amounts due in fiscal year 2017 and other liabilities for the amounts due in fiscal years 2018 through 2019.
NOTE 3: INVENTORIES
Inventories consist of the following:
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
2016
|
|
|
2015
|
|
U.S. inventories at average cost
|
|
$
|
380,000
|
|
|
$
|
397,524
|
|
Foreign inventories at average cost
|
|
105,465
|
|
|
116,674
|
|
|
|
485,465
|
|
|
514,198
|
|
Less: Excess of average cost over LIFO cost for U.S. inventories
|
|
147,244
|
|
|
151,779
|
|
Inventories on consolidated balance sheets
|
|
$
|
338,221
|
|
|
$
|
362,419
|
|
In fiscal
2016
, reductions in U.S. inventories, primarily in the bearings pool, resulted in liquidation of LIFO inventory quantities carried at lower costs prevailing in prior years. The overall impact of LIFO layer liquidations increased gross profit by
$2,100
in fiscal
2016
. There were no LIFO layer liquidations in fiscal
2015
or
2014
.
NOTE 4: GOODWILL AND INTANGIBLES
The changes in the carrying amount of goodwill for both the Service Center Based Distribution Segment and the Fluid Power Businesses segment for the years ended
June 30, 2016
and
2015
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service Center Based Distribution
|
|
|
Fluid Power Businesses
|
|
|
Total
|
|
Balance at July 1, 2014
|
$
|
192,565
|
|
|
$
|
929
|
|
|
$
|
193,494
|
|
Goodwill acquired during the year
|
77,728
|
|
|
—
|
|
|
77,728
|
|
Other, primarily currency translation
|
(16,816
|
)
|
|
—
|
|
|
(16,816
|
)
|
Balance at June 30, 2015
|
253,477
|
|
|
929
|
|
|
254,406
|
|
Goodwill acquired during the year
|
18,683
|
|
|
3,285
|
|
|
21,968
|
|
Impairment
|
(64,794
|
)
|
|
—
|
|
|
(64,794
|
)
|
Other, primarily currency translation
|
(8,880
|
)
|
|
—
|
|
|
(8,880
|
)
|
Balance at June 30, 2016
|
$
|
198,486
|
|
|
$
|
4,214
|
|
|
$
|
202,700
|
|
The Company has seven (
7
) reporting units for which an annual goodwill impairment assessment was performed as of January 1, 2016. The Company concluded that five (
5
) of the reporting units’ fair value substantially exceeded their carrying amounts. The carrying value for two (
2
) reporting units (Canada service center and Australia/New Zealand service center) exceeded the fair value, indicating there may be goodwill impairment. The fair values of the reporting units in accordance with step one of the goodwill impairment test were determined using the Income and Market approaches. The Income approach employs the discounted cash flow method reflecting projected cash flows expected to be generated by market participants and then adjusted for time value of money factors. The Market approach utilized an analysis of comparable publicly traded companies.
Step two of the goodwill impairment test compares the fair value of the reporting unit goodwill with the carrying amount of goodwill. The implied fair value of goodwill is determined in the same manner as in a business combination. The fair value of the reporting unit from step one is allocated to all of the assets and liabilities of the reporting unit, including unrecognized intangible assets, as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit.
Step two of the goodwill impairment test for the Canada service center reporting unit was completed in the third quarter of fiscal 2016. The analysis resulted in a goodwill impairment of
$56,022
for the Canada service center reporting unit. The non-cash impairment charge is the result of the overall decline in the industrial economy in Canada coupled with the substantial and sustained decline in the oil and gas sector during calendar year 2015. This has led to reduced spending by customers and reduced revenue expectations. The uncertainty regarding the oil and gas industries and overall industrial economy in Canada has also led the reporting unit to reduce expectations. The remaining goodwill for the Canada service center reporting unit at
June 30, 2016
is
$31,242
. Because the carrying value of the Canada service center 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 decline in capital spending by oil and gas producers and related businesses.
Step two of the goodwill impairment test for the Australia/New Zealand reporting unit was completed in the third quarter of fiscal 2016. The analysis concluded that all of the Australia/New Zealand reporting unit’s goodwill was impaired, and therefore the Company recorded a non-cash impairment expense of
$8,772
in the third quarter of fiscal 2016. The impairment charge is primarily the result of the decline in the mining and extraction industries in Australia, reduced spending by customers, and the effects of reduced revenue expectations.
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 Level 3 based assumptions relate to pricing trends, inventory costs, customer demand, and revenue growth. A number of benchmarks from independent industry and other economic publications were also used. Changes in future results, assumptions, and estimates after the measurement date may lead to an outcome where additional impairment charges would be required in future periods. Specifically, actual results may vary from the Company’s forecasts and such variations may be material and unfavorable, thereby triggering the need for future impairment tests where the conclusions may differ in reflection of prevailing market conditions. 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.
Accumulated goodwill impairment losses subsequent to fiscal year 2002 totaled
$36,605
related to the Fluid Power Businesses segment at
June 30, 2016
, 2015, and 2014, and totaled
$64,794
related to the Service Center Based Distribution segment at
June 30, 2016
.
The Company's identifiable intangible assets resulting from business combinations are amortized over their estimated period of benefit and consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2016
|
Amount
|
|
|
Accumulated
Amortization
|
|
|
Net
Book Value
|
|
Finite-Lived Intangibles:
|
|
|
|
|
|
Customer relationships
|
$
|
239,132
|
|
|
$
|
84,566
|
|
|
$
|
154,566
|
|
Trade names
|
44,430
|
|
|
16,099
|
|
|
28,331
|
|
Vendor relationships
|
14,042
|
|
|
8,003
|
|
|
6,039
|
|
Non-competition agreements
|
4,700
|
|
|
2,396
|
|
|
2,304
|
|
Total Intangibles
|
$
|
302,304
|
|
|
$
|
111,064
|
|
|
$
|
191,240
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2015
|
Amount
|
|
|
Accumulated
Amortization
|
|
|
Net
Book Value
|
|
Finite-Lived Intangibles:
|
|
|
|
|
|
Customer relationships
|
$
|
225,332
|
|
|
$
|
65,789
|
|
|
$
|
159,543
|
|
Trade names
|
42,689
|
|
|
13,187
|
|
|
29,502
|
|
Vendor relationships
|
14,465
|
|
|
7,258
|
|
|
7,207
|
|
Non-competition agreements
|
4,578
|
|
|
2,002
|
|
|
2,576
|
|
Total Intangibles
|
$
|
287,064
|
|
|
$
|
88,236
|
|
|
$
|
198,828
|
|
Amounts include the impact of foreign currency translation. Fully amortized amounts are written off.
During
2016
, the Company acquired identifiable intangible assets with an acquisition cost allocation and weighted-average life as follows:
|
|
|
|
|
|
|
|
Acquisition Cost Allocation
|
|
|
Weighted-Average Life
|
Customer relationships
|
$
|
17,996
|
|
|
15.0 years
|
Trade names
|
2,889
|
|
|
15.0 years
|
Non-competition agreements
|
765
|
|
|
5.0 years
|
Total Intangibles Acquired
|
$
|
21,650
|
|
|
14.7 years
|
Amortization of identifiable intangibles totaled
$25,580
,
$25,797
and $
14,023
in fiscal
2016
,
2015
and
2014
, respectively, and is included in selling, distribution and administrative expenses in the statements of consolidated income. Future amortization expense based on the Company’s identifiable intangible assets as of
June 30, 2016
is estimated to be
$25,000
for
2017
,
$22,700
for
2018
,
$21,000
for
2019
,
$19,200
for
2020
and
$17,600
for
2021
.
NOTE 5: DEBT
Revolving Credit Facility & Term Loan
In December 2015, the Company entered into a new five-year credit facility with a group of banks expiring in
December 2020
. This agreement provides for a
$125,000
unsecured term loan and a
$250,000
unsecured revolving credit facility. Fees on this facility range from
0.09%
to
0.175%
per year based upon the Company's leverage ratio at each quarter end. Borrowings under this agreement carry variable interest rates tied to either LIBOR or prime at the Company’s discretion. At
June 30, 2016
, the Company had
$123,438
outstanding under the term loan and
$33,000
outstanding under the revolver. Unused lines under this facility, net of outstanding letters of credit of
$2,707
to secure certain insurance obligations, totaled
$214,293
at
June 30, 2016
and are available to fund future acquisitions or other capital and operating requirements. The interest rate on the term loan as of
June 30, 2016
was
1.50%
. The weighted-average interest rate on the revolving credit facility outstanding as of
June 30, 2016
was
1.44%
.
The new credit facility replaced the Company's previous term loan and revolving credit facility agreements. The Company had
$96,875
outstanding at
June 30, 2015
under the previous term loan agreement, which carried a variable interest rate tied to LIBOR and was
1.19%
at
June 30, 2015
. At
June 30, 2015
, the Company had
$52,000
outstanding under the previous revolving credit facility. Unused lines under this facility, net of outstanding letters of credit of
$3,764
to secure certain insurance obligations, totaled
$94,236
at
June 30, 2015
and were available to
fund future acquisitions or other capital and operating requirements. The weighted-average interest rate on the revolving credit facility outstanding as of
June 30, 2015
was
1.15%
.
Additionally, the Company had letters of credit outstanding with a separate bank, not associated with the revolving credit agreement, in the amount of
$2,698
as of
June 30, 2016
and
$1,841
as of
June 30, 2015
, in order to secure certain insurance obligations.
Other Long-Term Borrowings
In April 2014 the Company assumed
$2,359
of debt as a part of the headquarters facility acquisition. The
1.5%
fixed interest rate note is held by the State of Ohio Development Services Agency, maturing in May 2024. At
June 30, 2016
and
2015
,
$1,896
and
$2,120
was outstanding, respectively.
At
June 30, 2016
and
June 30, 2015
, the Company had borrowings outstanding under its unsecured shelf facility agreement with Prudential Investment Management of
$170,000
. The "Series C" notes have a principal amount of
$120,000
and carry a fixed interest rate of
3.19%
, and are due in equal principal payments in July 2020, 2021, and 2022. The "Series D" notes have a principal amount of
$50,000
and carry a fixed interest rate of
3.21%
, and are due in equal principal payments in October 2019 and 2023. As of
June 30, 2016
,
$50,000
in additional financing was available under this facility.
The table below summarizes the aggregate maturities of amounts outstanding under long-term borrowing arrangements for each of the next five years:
|
|
|
|
|
Fiscal Year
|
Aggregate Maturity
|
|
2017
|
$
|
3,352
|
|
2018
|
4,918
|
|
2019
|
6,484
|
|
2020
|
33,050
|
|
2021
|
174,804
|
|
Thereafter
|
105,726
|
|
Covenants
The revolving credit facility, the term loan agreement, and the unsecured shelf facility contain restrictive covenants regarding liquidity, net worth, financial ratios, and other covenants. At
June 30, 2016
, the most restrictive of these covenants required that the Company have net indebtedness less than 3.25 times consolidated income before, interest, taxes, depreciation and amortization. The Company was in compliance with all covenants at
June 30, 2016
.
NOTE 6: FAIR VALUE MEASUREMENTS
Marketable securities measured at fair value at
June 30, 2016
and
June 30, 2015
totaled
$9,097
and
$9,330
, 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 consolidated balance sheets and their fair values were valued using quoted market prices (Level 1 in the fair value hierarchy).
As of
June 30, 2016
, the carrying value of the Company's fixed interest rate debt outstanding under its unsecured shelf facility agreement with Prudential Investment Management approximates fair value (Level 2 in the fair value hierarchy).
The revolving credit facility and the term loan contain variable interest rates and their carrying values approximate fair value (Level 2 in the fair value hierarchy).
NOTE 7: INCOME TAXES
Income Before Income Taxes
The components of income before income taxes are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
U.S.
|
$
|
139,960
|
|
|
$
|
152,618
|
|
|
$
|
147,980
|
|
Foreign
|
(60,982
|
)
|
|
23,253
|
|
|
18,282
|
|
Income before income taxes
|
$
|
78,978
|
|
|
$
|
175,871
|
|
|
$
|
166,262
|
|
Provision
The provision (benefit) for income taxes consists of:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
Current:
|
|
|
|
|
|
Federal
|
$
|
45,226
|
|
|
$
|
52,861
|
|
|
$
|
50,455
|
|
State and local
|
6,349
|
|
|
6,884
|
|
|
6,576
|
|
Foreign
|
4,407
|
|
|
5,603
|
|
|
4,619
|
|
Total current
|
55,982
|
|
|
65,348
|
|
|
61,650
|
|
Deferred:
|
|
|
|
|
|
Federal
|
397
|
|
|
(3,799
|
)
|
|
(5,328
|
)
|
State and local
|
(30
|
)
|
|
(153
|
)
|
|
(267
|
)
|
Foreign
|
(6,948
|
)
|
|
(1,009
|
)
|
|
(2,614
|
)
|
Total deferred
|
(6,581
|
)
|
|
(4,961
|
)
|
|
(8,209
|
)
|
Total
|
$
|
49,401
|
|
|
$
|
60,387
|
|
|
$
|
53,441
|
|
The exercise of non-qualified stock appreciation rights and options during fiscal
2016
,
2015
and
2014
resulted in
$212
,
$352
and
$1,462
, respectively, of income tax benefits to the Company derived from the difference between the market and option price of the shares at the date of exercise and the fair value of the options on the grant date. Vesting of stock awards and other stock compensation in fiscal
2016
,
2015
and
2014
resulted in
$(4)
,
$690
and
$1,211
, respectively, of incremental income tax (expense), benefits over the amounts previously reported for financial reporting purposes. These tax (expenses) benefits were recorded in additional paid-in capital.
Effective Tax Rates
The following reconciles the U.S. federal statutory income tax rate to the Company’s effective income tax rate:
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
Statutory income tax rate
|
35.0
|
%
|
|
35.0
|
%
|
|
35.0
|
%
|
Effects of:
|
|
|
|
|
|
State and local taxes
|
5.2
|
%
|
|
2.5
|
%
|
|
2.4
|
%
|
Goodwill impairment
|
27.1
|
%
|
|
—
|
%
|
|
—
|
%
|
U.S. tax on foreign income, net
|
—
|
%
|
|
—
|
%
|
|
(1.6
|
)%
|
Foreign income taxes
|
(3.0
|
)%
|
|
(2.5
|
)%
|
|
(2.6
|
)%
|
Deductible dividend
|
(0.9
|
)%
|
|
(0.5
|
)%
|
|
(0.5
|
)%
|
Valuation allowance
|
0.5
|
%
|
|
0.5
|
%
|
|
—
|
%
|
Other, net
|
(1.3
|
)%
|
|
(0.7
|
)%
|
|
(0.6
|
)%
|
Effective income tax rate
|
62.6
|
%
|
|
34.3
|
%
|
|
32.1
|
%
|
Consolidated Balance Sheets
Significant components of the Company’s deferred tax assets and liabilities are as follows:
|
|
|
|
|
|
|
|
|
June 30,
|
2016
|
|
|
2015
|
|
Deferred tax assets:
|
|
|
|
Compensation liabilities not currently deductible
|
$
|
25,992
|
|
|
$
|
28,902
|
|
Other expenses and reserves not currently deductible
|
11,650
|
|
|
9,115
|
|
Goodwill and intangibles
|
6,366
|
|
|
7,363
|
|
Foreign tax credit (expiring in years 2025-2026)
|
849
|
|
|
1,155
|
|
Net operating loss carryforwards (expiring in years 2017-2036)
|
4,960
|
|
|
860
|
|
Other
|
83
|
|
|
289
|
|
Total deferred tax assets
|
49,900
|
|
|
47,684
|
|
Less: Valuation allowance
|
(1,347
|
)
|
|
(917
|
)
|
Deferred tax assets, net of valuation allowance
|
48,553
|
|
|
46,767
|
|
Deferred tax liabilities:
|
|
|
|
Inventories
|
(4,785
|
)
|
|
(5,499
|
)
|
Goodwill and intangibles
|
(33,353
|
)
|
|
(38,707
|
)
|
Depreciation and differences in property bases
|
(9,892
|
)
|
|
(9,328
|
)
|
Total deferred tax liabilities
|
(48,030
|
)
|
|
(53,534
|
)
|
Net deferred tax assets (liabilities)
|
$
|
523
|
|
|
$
|
(6,767
|
)
|
Net deferred tax assets (liabilities) are classified as follows:
|
|
|
|
Deferred tax assets
|
$
|
12,277
|
|
|
$
|
10,980
|
|
Other liabilities
|
(11,754
|
)
|
|
(17,747
|
)
|
Net deferred tax assets (liabilities)
|
$
|
523
|
|
|
$
|
(6,767
|
)
|
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. 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 income levels.
U.S. federal income taxes are provided on the portion of non-U.S. subsidiaries' income that is not considered to be permanently reinvested outside the U.S. and may be remitted to the U.S. At
June 30, 2016
, all undistributed earnings of non-U.S. subsidiaries are considered to be permanently reinvested and totaled approximately
$141,482
, for which no U.S. tax has been provided. Determination of the net amount of the unrecognized tax liability with respect to the distribution of these earnings is not practicable; however, foreign tax credits would be available to partially reduce U.S. income taxes in the event of a distribution.
In 2014, the Company recognized a tax benefit of
$2,804
related to U.S. tax on foreign income which reduced the Company's effective tax rate by approximately
1.6%
. This tax benefit was due to the reversal of taxes previously accrued on a portion of the undistributed earnings of non-US subsidiaries applicable to a change in the permanent reinvestment assertion. In 2015,
$17,793
of cash was distributed by one of the Company's non-U.S. subsidiaries as a non-taxable return of capital.
Unrecognized Income Tax Benefits
The Company and its subsidiaries file income tax returns in U.S. federal, various state, local and foreign jurisdictions. The following table sets forth the changes in the amount of unrecognized tax benefits for the years ended June 30, 2016, 2015 and 2014:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
Unrecognized Income Tax Benefits at beginning of the year
|
$
|
2,604
|
|
|
$
|
2,364
|
|
|
$
|
2,655
|
|
Current year tax positions
|
539
|
|
|
472
|
|
|
730
|
|
Expirations of statutes of limitations
|
(132
|
)
|
|
(160
|
)
|
|
(1,007
|
)
|
Settlements
|
(96
|
)
|
|
(72
|
)
|
|
(14
|
)
|
Unrecognized Income Tax Benefits at end of year
|
$
|
2,915
|
|
|
$
|
2,604
|
|
|
$
|
2,364
|
|
Included in the balance of unrecognized income tax benefits at
June 30, 2016
,
2015
and
2014
are
$2,691
,
$2,377
and
$2,104
, respectively, of income tax benefits that, if recognized, would affect the effective income tax rate.
During
2016
,
2015
and
2014
, the Company recognized
$127
and
$49
and
$16
of expense, respectively, for interest and penalties related to unrecognized income tax benefits in its statements of consolidated income. The Company had a liability for penalties and interest of
$625
and
$497
as of
June 30, 2016
and
2015
, respectively. The Company does not anticipate a significant change to the total amount of unrecognized income tax benefits within the next twelve months.
The Company is subject to U.S. federal income tax examinations for the tax years 2014 through 2016 and to state and local income tax examinations for the tax years 2010 through 2016. In addition, the Company is subject to foreign income tax examinations for the tax years 2009 through 2016.
The Company’s unrecognized income tax benefits are included in other liabilities in the consolidated balance sheets since payment of cash is not expected within one year.
NOTE 8: SHAREHOLDERS’ EQUITY
Treasury Shares
At
June 30, 2016
,
596
shares of the Company’s common stock held as treasury shares were restricted as collateral under escrow arrangements relating to change in control and director and officer indemnification agreements.
Accumulated Other Comprehensive Income (Loss)
Changes in the accumulated other comprehensive income (loss) for the years ended June 30, 2016 and 2015, is comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment
|
|
|
Unrealized gain (loss) on securities available for sale
|
|
|
Postemployment benefits
|
|
|
Total accumulated other comprehensive income (loss)
|
|
Balance at July 1, 2013
|
$
|
360
|
|
|
$
|
(52
|
)
|
|
$
|
(3,729
|
)
|
|
$
|
(3,421
|
)
|
Other comprehensive income (loss)
|
629
|
|
|
73
|
|
|
871
|
|
|
1,573
|
|
Amounts reclassified from accumulated other comprehensive income (loss)
|
—
|
|
|
—
|
|
|
233
|
|
|
233
|
|
Net current-period other comprehensive income (loss), net of taxes
|
629
|
|
|
73
|
|
|
1,104
|
|
|
1,806
|
|
Balance at June 30, 2014
|
$
|
989
|
|
|
$
|
21
|
|
|
$
|
(2,625
|
)
|
|
$
|
(1,615
|
)
|
Other comprehensive income (loss)
|
(58,233
|
)
|
|
(25
|
)
|
|
(472
|
)
|
|
(58,730
|
)
|
Amounts reclassified from accumulated other comprehensive income (loss)
|
—
|
|
|
—
|
|
|
174
|
|
|
174
|
|
Net current-period other comprehensive income (loss), net of taxes
|
(58,233
|
)
|
|
(25
|
)
|
|
(298
|
)
|
|
(58,556
|
)
|
Balance at June 30, 2015
|
$
|
(57,244
|
)
|
|
$
|
(4
|
)
|
|
$
|
(2,923
|
)
|
|
$
|
(60,171
|
)
|
Other comprehensive income (loss)
|
(24,441
|
)
|
|
(34
|
)
|
|
(1,215
|
)
|
|
(25,690
|
)
|
Amounts reclassified from accumulated other comprehensive income (loss)
|
—
|
|
|
—
|
|
|
315
|
|
|
315
|
|
Net current-period other comprehensive income (loss), net of taxes
|
(24,441
|
)
|
|
(34
|
)
|
|
(900
|
)
|
|
(25,375
|
)
|
Balance at June 30, 2016
|
$
|
(81,685
|
)
|
|
$
|
(38
|
)
|
|
$
|
(3,823
|
)
|
|
$
|
(85,546
|
)
|
Other Comprehensive (Loss) Income
Details of other comprehensive (loss) income are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
2016
|
|
2015
|
|
2014
|
|
Pre-Tax Amount
|
|
|
Tax (Benefit) Expense
|
|
|
Net Amount
|
|
|
Pre-Tax Amount
|
|
|
Tax (Benefit) Expense
|
|
|
Net Amount
|
|
|
Pre-Tax Amount
|
|
|
Tax Expense
|
|
|
Net Amount
|
|
Foreign currency translation adjustments
|
$
|
(24,441
|
)
|
|
$
|
—
|
|
|
$
|
(24,441
|
)
|
|
$
|
(58,233
|
)
|
|
$
|
—
|
|
|
$
|
(58,233
|
)
|
|
$
|
629
|
|
|
$
|
—
|
|
|
$
|
629
|
|
Postemployment benefits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Actuarial (loss) gain on remeasurement
|
(1,998
|
)
|
|
(783
|
)
|
|
(1,215
|
)
|
|
(776
|
)
|
|
(304
|
)
|
|
(472
|
)
|
|
1,402
|
|
|
531
|
|
|
871
|
|
Reclassification of actuarial losses and prior service cost into SD&A expense and included in net periodic pension costs
|
518
|
|
|
203
|
|
|
315
|
|
|
286
|
|
|
112
|
|
|
174
|
|
|
382
|
|
|
149
|
|
|
233
|
|
Unrealized (loss) gain on investment securities available for sale
|
(52
|
)
|
|
(18
|
)
|
|
(34
|
)
|
|
(38
|
)
|
|
(13
|
)
|
|
(25
|
)
|
|
112
|
|
|
39
|
|
|
73
|
|
Other comprehensive (loss) income
|
$
|
(25,973
|
)
|
|
$
|
(598
|
)
|
|
$
|
(25,375
|
)
|
|
$
|
(58,761
|
)
|
|
$
|
(205
|
)
|
|
$
|
(58,556
|
)
|
|
$
|
2,525
|
|
|
$
|
719
|
|
|
$
|
1,806
|
|
Net Income Per Share
Basic net income per share is based on the weighted-average number of common shares outstanding. Diluted net income per share includes the dilutive effect of potential common shares outstanding. Under the two-class method of computing net income per share, non-vested share-based payment awards that contain rights to receive non-forfeitable dividends are considered participating securities. The Company’s participating securities include RSUs and restricted stock awards. The Company calculated basic and diluted net income per share under both the treasury stock method and the two-class method. For the years presented there were no material differences in the net income per share amounts calculated using the two methods. Accordingly, the treasury stock method is disclosed below.
The following table presents amounts used in computing net income per share and the effect on the weighted-average number of shares of dilutive potential common shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
Net Income
|
$
|
29,577
|
|
|
$
|
115,484
|
|
|
$
|
112,821
|
|
Average Shares Outstanding:
|
|
|
|
|
|
Weighted-average common shares outstanding for basic computation
|
39,254
|
|
|
40,892
|
|
|
41,942
|
|
Dilutive effect of potential common shares
|
212
|
|
|
295
|
|
|
389
|
|
Weighted-average common shares outstanding for dilutive computation
|
39,466
|
|
|
41,187
|
|
|
42,331
|
|
Net Income Per Share — Basic
|
$
|
0.75
|
|
|
$
|
2.82
|
|
|
$
|
2.69
|
|
Net Income Per Share — Diluted
|
$
|
0.75
|
|
|
$
|
2.80
|
|
|
$
|
2.67
|
|
Stock appreciation rights and options relating to
775
,
435
and
289
shares of common stock were outstanding at
June 30, 2016
,
2015
and
2014
, respectively, but were not included in the computation of diluted earnings per share for the fiscal years then ended as they were anti-dilutive.
NOTE 9: SHARE-BASED COMPENSATION
Share-Based Incentive Plans
Following approval by the Company's shareholders in October 2015, the 2015 Long-Term Performance Plan (the "2015 Plan") replaced the 2011 Long-Term Performance Plan. The 2015 Plan, which expires in 2020, provides for granting of SARs, stock options, stock awards, cash awards, and such other awards or combination thereof as the Executive Organization and Compensation Committee or, in the case of director awards, the Corporate Governance Committee of the Board of Directors (together referred to as the Committee) may determine to officers, other key employees and members of the Board of Directors. Grants are generally made at regularly scheduled committee
meetings. Compensation costs charged to expense under award programs paid (or to be paid) with shares (including SARs, stock options, performance shares, restricted stock, and RSUs) are summarized in the table below:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
SARs and options
|
$
|
1,543
|
|
|
$
|
1,610
|
|
|
$
|
1,808
|
|
Performance shares
|
446
|
|
|
836
|
|
|
309
|
|
Restricted stock and RSUs
|
2,078
|
|
|
2,015
|
|
|
2,394
|
|
Total compensation costs under award programs
|
$
|
4,067
|
|
|
$
|
4,461
|
|
|
$
|
4,511
|
|
Such amounts are included in selling, distribution and administrative expense in the accompanying statements of consolidated income. The total income tax benefit recognized in the statements of consolidated income for share-based compensation plans was
$1,595
,
$1,749
and
$1,768
for fiscal years
2016
,
2015
and
2014
, respectively. It has been the practice of the Company to issue shares from treasury to satisfy requirements of awards paid with shares.
The aggregate unrecognized compensation cost for share-based award programs with the potential to be paid at
June 30, 2016
are summarized in the table below:
|
|
|
|
|
|
|
June 30,
(Shares in thousands)
|
2016
|
|
|
Average Expected Period of Expected Recognition (Years)
|
SARs and options
|
$
|
2,193
|
|
|
2.6
|
Performance shares
|
3,933
|
|
|
1.7
|
Restricted stock and RSUs
|
2,133
|
|
|
2.0
|
Total unrecognized compensation costs under award programs
|
$
|
8,259
|
|
|
2.0
|
Cost of these programs will be recognized as expense over the weighted-average remaining vesting period of
2.0
years. The aggregate number of shares of common stock which may be awarded under the 2015 Plan is
2,500
; shares available for future grants at
June 30, 2016
were
2,449
.
Stock Appreciation Rights and Stock Options
The weighted-average assumptions used for SARs and stock option grants issued in fiscal
2016
,
2015
and
2014
are:
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
Expected life, in years
|
4.4
|
|
|
4.7
|
|
|
4.6
|
|
Risk free interest rate
|
1.3
|
%
|
|
1.4
|
%
|
|
1.3
|
%
|
Dividend yield
|
2.5
|
%
|
|
2.5
|
%
|
|
2.5
|
%
|
Volatility
|
26.0
|
%
|
|
29.0
|
%
|
|
31.8
|
%
|
Per share fair value of SARs and stock options granted during the year
|
$6.79
|
|
$9.53
|
|
$11.02
|
The expected life is based upon historical exercise experience of the officers, other key employees and members of the Board of Directors. The risk free interest rate is based upon U.S. Treasury zero-coupon bonds with remaining terms equal to the expected life of the SARs and stock options. The assumed dividend yield has been estimated based upon the Company’s historical results and expectations for changes in dividends and stock prices. The volatility assumption is calculated based upon historical daily price observations of the Company’s common stock for a period equal to the expected life.
SARs are redeemable solely in Company common stock. The exercise price of stock option awards may be settled by the holder with cash or by tendering Company common stock.
A summary of SARs and stock options activity is presented below
:
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Weighted-Average
Exercise Price
|
|
Year Ended June 30, 2016
|
|
(Shares in thousands)
|
|
Outstanding, beginning of year
|
1,116
|
|
|
$
|
35.86
|
|
Granted
|
297
|
|
|
39.08
|
|
Exercised
|
(171
|
)
|
|
27.95
|
|
Forfeited
|
(6
|
)
|
|
44.15
|
|
Outstanding, end of year
|
1,236
|
|
|
$
|
37.69
|
|
Exercisable at end of year
|
728
|
|
|
$
|
34.09
|
|
Expected to vest at end of year
|
480
|
|
|
$
|
42.87
|
|
The weighted-average remaining contractual terms for SARs and stock options outstanding, exercisable, and expected to vest at
June 30, 2016
were
6.3
,
4.8
, and
8.5
years, respectively. The aggregate intrinsic values of SARs and stock options outstanding, exercisable, and expected to vest at
June 30, 2016
were
$10,491
$8,546
, and
$1,827
, respectively. The aggregate intrinsic value of the SARs and stock options exercised during fiscal
2016
,
2015
, and
2014
was
$2,422
,
$1,601
, and
$5,241
, respectively.
The total fair value of shares vested during fiscal
2016
,
2015
, and
2014
was
$1,291
,
$2,187
, and
$2,080
, respectively.
Performance Shares
Performance shares are paid in shares of Applied stock at the end of a
three
-year period provided the Company achieves goals established by the committee. The number of Applied shares payable will vary depending on the level of the goals achieved.
A summary of nonvested performance shares activity at
June 30, 2016
is presented below:
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Weighted-Average
Grant-Date
Fair Value
|
|
Year Ended June 30, 2016
|
|
(Shares in thousands)
|
|
Nonvested, beginning of year
|
38
|
|
|
$
|
46.66
|
|
Awarded
|
12
|
|
|
38.34
|
|
Vested
|
(13
|
)
|
|
40.75
|
|
Nonvested, end of year
|
37
|
|
|
$
|
46.01
|
|
The Committee set
three
one
-year goals for each of the 2016, 2015 and 2014 grants. Each fiscal year during the three-year term has its own separate goals, tied to the Company’s earnings before interest, tax, depreciation, and amortization (EBITDA) and after-tax return on assets (ROA). Achievement during any particular fiscal year is awarded and “banked” for payout at the end of the three-year term. Based upon the outstanding grants as of
June 30, 2016
, the maximum number of shares which could be earned in future periods was
96
.
Restricted Stock and Restricted Stock Units
Restricted stock award recipients are entitled to receive dividends on, and have voting rights with respect to their respective shares, but are restricted from selling or transferring the shares prior to vesting. Restricted stock awards vest over periods of
one
to
four
years. RSUs are grants valued in shares of Applied stock, but shares are not issued until the grants vest
one
to
four
years from the award date, assuming continued employment with Applied. Applied primarily pays dividend equivalents on RSUs on a current basis.
A summary of the status of the Company’s non-vested restricted stock and RSUs at
June 30, 2016
is
presented below:
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Weighted-Average
Grant-Date
Fair Value
|
|
Year Ended June 30, 2016
|
|
(Share amounts in thousands)
|
|
Nonvested, beginning of year
|
90
|
|
|
$
|
46.18
|
|
Granted
|
62
|
|
|
38.68
|
|
Forfeitures
|
(1
|
)
|
|
46.36
|
|
Vested
|
(33
|
)
|
|
41.47
|
|
Nonvested, end of year
|
118
|
|
|
$
|
43.56
|
|
NOTE 10: BENEFIT PLANS
Retirement Savings Plan
Substantially all U.S. employees participate in the Applied Industrial Technologies, Inc. Retirement Savings Plan. Participants may elect 401(k) contributions of up to
50%
of their compensation, subject to Internal Revenue Code maximums. The Company partially matches 401(k) contributions by participants. The Company’s expense for matching of employees’ 401(k) contributions was
$2,535
,
$3,156
and
$2,788
during fiscal
2016
,
2015
and
2014
, respectively.
Deferred Compensation Plans
The Company has deferred compensation plans that enable certain employees of the Company to defer receipt of a portion of their compensation. Non-employee directors were able to defer receipt of director fees until January 1, 2015. The Company funds these deferred compensation liabilities by making contributions to rabbi trusts. Assets held in these rabbi trusts consist of investments in money market and mutual funds and Company common stock.
Post-employment Benefit Plans
The Company provides the following post-employment benefits which, except for the Qualified Defined Benefit Retirement Plan, are unfunded:
Supplemental Executive Retirement Benefits Plan
The Company has a non-qualified pension plan to provide supplemental retirement benefits to certain officers. Benefits are payable and determinable at retirement based upon a percentage of the participant’s historical compensation. The Executive Organization and Compensation Committee of the Board of Directors froze participant benefits (credited service and final average earnings) and entry into the Supplemental Executive Retirement Benefits Plan (SERP) effective December 31, 2011.
Key Executive Restoration Plan
In fiscal 2012, the Company adopted the Key Executive Restoration Plan (KERP), an unfunded, non-qualified deferred compensation plan, to replace the SERP. The Company recorded
$268
,
$300
, and
$234
of expense associated with this plan in fiscal 2016, 2015, and 2014, respectively.
Qualified Defined Benefit Retirement Plan
The Company has a qualified defined benefit retirement plan that provides benefits to certain hourly employees at retirement. These employees do not participate in the Retirement Savings Plan. The benefits are based on length of service and date of retirement.
Salary Continuation Benefits
The Company has agreements with certain retirees of acquired companies to pay monthly retirement benefits through fiscal 2020.
Retiree Health Care Benefits
The Company provides health care benefits, through third-party policies, to eligible retired employees who pay a specified monthly premium. Premium payments are based upon current insurance rates for the type of coverage provided and are adjusted annually. Certain monthly health care premium payments are partially
subsidized by the Company. Additionally, in conjunction with a fiscal 1998 acquisition, the Company assumed the obligation for a post-retirement medical benefit plan which provides health care benefits to eligible retired employees at no cost to the individual.
The Company uses a June 30 measurement date for all plans.
The following table sets forth the changes in benefit obligations and plan assets during the year and the funded status for the post-employment plans at June 30:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
Retiree Health Care Benefits
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Change in benefit obligation:
|
|
|
|
|
|
|
|
Benefit obligation at beginning of the year
|
$
|
29,994
|
|
|
$
|
34,558
|
|
|
$
|
2,144
|
|
|
$
|
2,790
|
|
Service cost
|
91
|
|
|
97
|
|
|
22
|
|
|
53
|
|
Interest cost
|
879
|
|
|
896
|
|
|
75
|
|
|
95
|
|
Plan participants’ contributions
|
—
|
|
|
—
|
|
|
60
|
|
|
64
|
|
Benefits paid
|
(5,555
|
)
|
|
(6,697
|
)
|
|
(229
|
)
|
|
(238
|
)
|
Amendments
|
—
|
|
|
(8
|
)
|
|
—
|
|
|
—
|
|
Actuarial loss (gain) during year
|
1,196
|
|
|
1,148
|
|
|
163
|
|
|
(620
|
)
|
Benefit obligation at end of year
|
$
|
26,605
|
|
|
$
|
29,994
|
|
|
$
|
2,235
|
|
|
$
|
2,144
|
|
Change in plan assets:
|
|
|
|
|
|
|
|
Fair value of plan assets at beginning of year
|
$
|
7,185
|
|
|
$
|
7,245
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Actual (loss) gain on plan assets
|
(149
|
)
|
|
247
|
|
|
—
|
|
|
—
|
|
Employer contributions
|
5,256
|
|
|
6,390
|
|
|
169
|
|
|
174
|
|
Plan participants’ contributions
|
—
|
|
|
—
|
|
|
60
|
|
|
64
|
|
Benefits paid
|
(5,555
|
)
|
|
(6,697
|
)
|
|
(229
|
)
|
|
(238
|
)
|
Fair value of plan assets at end of year
|
$
|
6,737
|
|
|
$
|
7,185
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Funded status at end of year
|
$
|
(19,868
|
)
|
|
$
|
(22,809
|
)
|
|
$
|
(2,235
|
)
|
|
$
|
(2,144
|
)
|
The amounts recognized in the consolidated balance sheets and in accumulated other comprehensive loss for the post-employment plans were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
Retiree Health Care Benefits
|
June 30,
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Amounts recognized in the consolidated balance sheets:
|
|
|
|
|
|
|
|
Other current liabilities
|
$
|
741
|
|
|
$
|
5,256
|
|
|
$
|
220
|
|
|
$
|
220
|
|
Post-employment benefits
|
19,127
|
|
|
17,553
|
|
|
2,015
|
|
|
1,924
|
|
Net amount recognized
|
$
|
19,868
|
|
|
$
|
22,809
|
|
|
$
|
2,235
|
|
|
$
|
2,144
|
|
Amounts recognized in accumulated other comprehensive loss:
|
|
|
|
|
|
|
|
Net actuarial (loss) gain
|
$
|
(8,234
|
)
|
|
$
|
(7,311
|
)
|
|
$
|
1,119
|
|
|
$
|
1,492
|
|
Prior service cost
|
(121
|
)
|
|
(208
|
)
|
|
948
|
|
|
1,219
|
|
Total amounts recognized in accumulated other comprehensive loss
|
$
|
(8,355
|
)
|
|
$
|
(7,519
|
)
|
|
$
|
2,067
|
|
|
$
|
2,711
|
|
The following table provides information for pension plans with projected benefit obligations and accumulated benefit obligations in excess of plan assets:
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
June 30,
|
2016
|
|
|
2015
|
|
Projected benefit obligations
|
$
|
26,605
|
|
|
$
|
29,994
|
|
Accumulated benefit obligations
|
26,605
|
|
|
29,994
|
|
Fair value of plan assets
|
6,737
|
|
|
7,185
|
|
The net periodic costs (benefits) are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
Retiree Health Care Benefits
|
Year Ended June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
Service cost
|
$
|
91
|
|
|
$
|
97
|
|
|
$
|
77
|
|
|
$
|
22
|
|
|
$
|
53
|
|
|
$
|
48
|
|
Interest cost
|
879
|
|
|
896
|
|
|
1,180
|
|
|
75
|
|
|
95
|
|
|
139
|
|
Expected return on plan assets
|
(491
|
)
|
|
(495
|
)
|
|
(416
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
Recognized net actuarial loss (gain)
|
913
|
|
|
559
|
|
|
611
|
|
|
(210
|
)
|
|
(87
|
)
|
|
(38
|
)
|
Amortization of prior service cost
|
86
|
|
|
86
|
|
|
78
|
|
|
(271
|
)
|
|
(272
|
)
|
|
(271
|
)
|
Net periodic cost (benefits)
|
$
|
1,478
|
|
|
$
|
1,143
|
|
|
$
|
1,530
|
|
|
$
|
(384
|
)
|
|
$
|
(211
|
)
|
|
$
|
(122
|
)
|
The estimated net actuarial loss and prior service cost for the pension plans that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost over the next fiscal year are
$872
and
$86
, respectively. The estimated net actuarial gain and income from prior service cost for the retiree health care benefits that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost over the next fiscal year are
$181
and
$271
, respectively.
Assumptions
A discount rate is used to determine the present value of future payments. In general, the Company’s liability increases as the discount rate decreases and decreases as the discount rate increases. The Company computes a weighted-average discount rate taking into account anticipated plan payments and the associated interest rates from the Citigroup Pension Discount Yield Curve. During fiscal 2015, the Society of Actuaries released a series of updated mortality tables resulting from recent studies measuring mortality rates for various groups of individuals. As of June 30, 2015, the Company adopted these mortality tables, which reflect improved trends in longevity and have the effect of increasing the estimate of benefits to be received by plan participants.
The weighted-average actuarial assumptions used to determine benefit obligations and net periodic benefit cost for the plans were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
Retiree Health Care Benefits
|
June 30,
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Assumptions used to determine benefit obligations at year end:
|
|
|
|
|
|
|
|
Discount rate
|
2.3
|
%
|
|
3.0
|
%
|
|
3.3
|
%
|
|
4.0
|
%
|
Assumptions used to determine net periodic benefit cost:
|
|
|
|
|
|
|
|
Discount rate
|
3.0
|
%
|
|
2.8
|
%
|
|
4.0
|
%
|
|
3.8
|
%
|
Expected return on plan assets
|
7.0
|
%
|
|
7.0
|
%
|
|
N/A
|
|
|
N/A
|
|
The assumed health care cost trend rates used in measuring the accumulated benefit obligation for retiree health care benefits were
7.0%
and
6.8%
as of
June 30, 2016
and
2015
, respectively, decreasing to
5.0%
by 2027.
A one-percentage point change in the assumed health care cost trend rates would have had the following effects as of
June 30, 2016
and for the year then ended:
|
|
|
|
|
|
|
|
|
|
One-Percentage Point
|
|
|
Increase
|
|
Decrease
|
Effect on total service and interest cost components of periodic expense
|
$
|
13
|
|
|
$
|
(11
|
)
|
Effect on post-retirement benefit obligation
|
255
|
|
|
(214
|
)
|
Plan Assets
The fair value of each major class of plan assets for the Company’s Qualified Benefit Retirement Plan is valued using either quoted market prices in active markets for identical instruments; Level 1 in the fair value hierarchy, or other inputs that are observable, either directly or indirectly; Level 2 in the fair value hierarchy. Following are the fair values and target allocation as of June 30:
|
|
|
|
|
|
|
|
|
|
|
|
Target Allocation
|
|
Fair Value
|
|
|
|
2016
|
|
|
2015
|
|
Asset Class:
|
|
|
|
|
|
Equity* securities (Level 1)
|
40 – 70%
|
|
$
|
3,843
|
|
|
$
|
4,022
|
|
Debt securities (Level 2)
|
20 – 50%
|
|
2,759
|
|
|
2,930
|
|
Other (Level 1)
|
0 – 20%
|
|
135
|
|
|
233
|
|
Total
|
100%
|
|
$
|
6,737
|
|
|
$
|
7,185
|
|
*
Equity securities do not include any Company common stock.
The Company has established an investment policy and regularly monitors the performance of the assets of the trust maintained in conjunction with the Qualified Defined Benefit Retirement Plan. The strategy implemented by the trustee of the Qualified Defined Benefit Retirement Plan is to achieve long-term objectives and invest the pension assets in accordance with ERISA and fiduciary standards. The long-term primary objectives are to provide for a reasonable amount of long-term capital, without undue exposure to risk; to protect the Qualified Defined Benefit Retirement Plan assets from erosion of purchasing power; and to provide investment results that meet or exceed the actuarially assumed long-term rate of return. The expected long-term rate of return on assets assumption was developed by considering the historical returns and the future expectations for returns of each asset class as well as the target asset allocation of the pension portfolio.
Cash Flows
Employer Contributions
The Company expects to contribute
$750
to its pension benefit plans and
$180
to its retiree health care benefit plans in fiscal 2017. Contributions do not equal estimated future benefit payments as certain payments are made from plan assets
.
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service, as applicable, are expected to be paid in each of the next five years and in the aggregate for the subsequent five years:
|
|
|
|
|
|
|
|
|
During Fiscal Years
|
Pension Benefits
|
|
|
Retiree Health
Care Benefits
|
|
2017
|
$
|
1,100
|
|
|
$
|
180
|
|
2018
|
1,700
|
|
|
190
|
|
2019
|
2,200
|
|
|
180
|
|
2020
|
3,800
|
|
|
170
|
|
2021
|
3,000
|
|
|
160
|
|
2022 through 2026
|
7,200
|
|
|
550
|
|
NOTE 11: LEASES
The Company leases many service center and distribution center facilities, vehicles and equipment under non-cancelable lease agreements accounted for as operating leases. The Company leased its corporate headquarters facility until purchasing it in April 2014. The minimum annual rental commitments under non-cancelable operating leases as of
June 30, 2016
are as follows:
|
|
|
|
|
During Fiscal Years
|
|
2017
|
$
|
27,500
|
|
2018
|
19,900
|
|
2019
|
15,600
|
|
2020
|
9,100
|
|
2021
|
3,100
|
|
Thereafter
|
5,300
|
|
Total minimum lease payments
|
$
|
80,500
|
|
Rental expense incurred for operating leases, principally from leases for real property, vehicles and computer equipment was
$37,300
in
2016
,
$39,300
in
2015
and
$36,900
in
2014
, and was classified within selling, distribution and administrative expenses on the statements of consolidated income.
The Company maintains lease agreements for many of the operating facilities of businesses it acquires from previous owners. In many cases, the previous owners of the business acquired, become employees of Applied and occupy management positions within those businesses. The payments under lease agreements of this nature totaled
$3,800
,
$3,100
and
$2,500
in fiscal 2016, 2015 and 2014, respectively.
NOTE 12: SEGMENT AND GEOGRAPHIC INFORMATION
The Company's reportable segments are: Service Center Based Distribution and Fluid Power Businesses. These reportable segments contain the Company's various operating segments which have been aggregated based upon similar economic and operating characteristics. The Service Center Based Distribution segment provides customers with solutions to their maintenance, repair and original equipment manufacturing needs through the distribution of industrial products including bearings, power transmission components, fluid power components and systems, industrial rubber products, linear motion products, tools, safety products, and other industrial and maintenance supplies. The Fluid Power Businesses segment distributes fluid power components and operates shops that assemble fluid power systems and components, performs equipment repair, and offers technical advice to customers.
The accounting policies of the Company’s reportable segments are generally the same as those described in note 1. Intercompany sales, primarily from the Fluid Power Businesses segment to the Service Center Based Distribution segment of
$21,485
,
$24,087
, and
$21,809
, in fiscal
2016
,
2015
, and
2014
, respectively, have been eliminated in the following table.
Segment Financial Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service Center
Based Distribution
|
|
|
Fluid Power
Businesses
|
|
|
Total
|
|
Year Ended June 30, 2016
|
|
|
|
|
|
Net sales
|
$
|
2,087,041
|
|
|
$
|
432,387
|
|
|
$
|
2,519,428
|
|
Operating income for reportable segments
|
109,491
|
|
|
40,794
|
|
|
150,285
|
|
Assets used in the business
|
1,124,101
|
|
|
188,428
|
|
|
1,312,529
|
|
Depreciation and amortization of property
|
14,595
|
|
|
1,371
|
|
|
15,966
|
|
Capital expenditures
|
12,227
|
|
|
903
|
|
|
13,130
|
|
Year Ended June 30, 2015
|
|
|
|
|
|
Net sales
|
$
|
2,254,768
|
|
|
$
|
496,793
|
|
|
$
|
2,751,561
|
|
Operating income for reportable segments
|
140,421
|
|
|
48,535
|
|
|
188,956
|
|
Assets used in the business
|
1,228,131
|
|
|
204,425
|
|
|
1,432,556
|
|
Depreciation and amortization of property
|
15,196
|
|
|
1,382
|
|
|
16,578
|
|
Capital expenditures
|
13,531
|
|
|
1,402
|
|
|
14,933
|
|
Year Ended June 30, 2014
|
|
|
|
|
|
Net sales
|
$
|
1,973,359
|
|
|
$
|
486,519
|
|
|
$
|
2,459,878
|
|
Operating income for reportable segments
|
118,857
|
|
|
44,621
|
|
|
163,478
|
|
Assets used in the business
|
1,116,311
|
|
|
217,858
|
|
|
1,334,169
|
|
Depreciation and amortization of property
|
12,399
|
|
|
1,578
|
|
|
13,977
|
|
Capital expenditures
|
18,744
|
|
|
1,446
|
|
|
20,190
|
|
ERP related assets are included in assets used in the business and capital expenditures within the Service Center Based Distribution segment. Within the geographic disclosures, these assets are included in the United States. Expenses associated with the ERP are included in the Corporate and other income, net, line in the reconciliation of operating income for reportable segments to the consolidated income before income taxes table below.
A reconciliation of operating income for reportable segments to the consolidated income before income
taxes
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
Operating income for reportable segments
|
$
|
150,285
|
|
|
$
|
188,956
|
|
|
$
|
163,478
|
|
Adjustments for:
|
|
|
|
|
|
Intangible amortization — Service Center Based Distribution
|
19,595
|
|
|
19,561
|
|
|
7,336
|
|
Intangible amortization — Fluid Power Businesses
|
5,985
|
|
|
6,236
|
|
|
6,687
|
|
Goodwill Impairment — Service Center Based Distribution
|
64,794
|
|
|
—
|
|
|
—
|
|
Corporate and other income, net
|
(28,890
|
)
|
|
(21,460
|
)
|
|
(14,903
|
)
|
Total operating income
|
88,801
|
|
|
184,619
|
|
|
164,358
|
|
Interest expense, net
|
8,763
|
|
|
7,869
|
|
|
249
|
|
Other expense (income), net
|
1,060
|
|
|
879
|
|
|
(2,153
|
)
|
Income before income taxes
|
$
|
78,978
|
|
|
$
|
175,871
|
|
|
$
|
166,262
|
|
Fluctuations in corporate and other income, net, are due to changes in the levels and amounts of expenses being allocated to the segments. The expenses being allocated include corporate charges for working capital, logistics support and other items.
Product Category
Net sales by product category are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
Industrial
|
$
|
1,836,484
|
|
|
$
|
2,013,447
|
|
|
$
|
1,739,496
|
|
Fluid power
|
682,944
|
|
|
738,114
|
|
|
720,382
|
|
Net sales
|
$
|
2,519,428
|
|
|
$
|
2,751,561
|
|
|
$
|
2,459,878
|
|
The fluid power product category includes sales of hydraulic, pneumatic, lubrication and filtration components and systems, and repair services through the Company’s Fluid Power Businesses segment as well as the Service Center Based Distribution segment.
Geographic Information
Net sales are presented in geographic areas based on the location of the facility shipping the product. Long-lived assets are based on physical locations and are comprised of the net book value of property and intangible assets. Information by geographic area is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
Net Sales:
|
|
|
|
|
|
United States
|
$
|
2,117,485
|
|
|
$
|
2,238,263
|
|
|
$
|
2,031,142
|
|
Canada
|
257,797
|
|
|
358,580
|
|
|
291,117
|
|
Other Countries
|
144,146
|
|
|
154,718
|
|
|
137,619
|
|
Total
|
$
|
2,519,428
|
|
|
$
|
2,751,561
|
|
|
$
|
2,459,878
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
Long-Lived Assets:
|
|
|
|
|
|
United States
|
$
|
225,538
|
|
|
$
|
217,597
|
|
|
$
|
153,945
|
|
Canada
|
66,304
|
|
|
76,565
|
|
|
99,161
|
|
Other Countries
|
7,163
|
|
|
9,113
|
|
|
9,998
|
|
Total
|
$
|
299,005
|
|
|
$
|
303,275
|
|
|
$
|
263,104
|
|
Other countries consist of Mexico, Australia and New Zealand.
NOTE 13: COMMITMENTS AND CONTINGENCIES
The Company is a party to various pending judicial and administrative proceedings. Based on circumstances currently known, the Company believes the likelihood is remote that the ultimate resolution of any of these matters 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.
NOTE 14: OTHER EXPENSE (INCOME), NET
Other expense (income), net, consists of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended June 30,
|
2016
|
|
|
2015
|
|
|
2014
|
|
Unrealized gain on assets held in rabbi trust for a non-qualified deferred compensation plan
|
$
|
(87
|
)
|
|
$
|
(442
|
)
|
|
$
|
(1,683
|
)
|
Elimination of one-month Canadian and Mexican reporting lag, effective July 1, 2013 and January 1, 2014, respectively
|
—
|
|
|
—
|
|
|
(1,342
|
)
|
Foreign currency transaction losses
|
1,039
|
|
|
1,251
|
|
|
801
|
|
Other, net
|
108
|
|
|
70
|
|
|
71
|
|
Total other expense (income), net
|
$
|
1,060
|
|
|
$
|
879
|
|
|
$
|
(2,153
|
)
|
NOTE 15: SUBSEQUENT EVENTS
We have evaluated events and transactions occurring subsequent to
June 30, 2016
through the date the financial statements were issued.
QUARTERLY OPERATING RESULTS
(In thousands, except per share amounts)
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per Common Share
|
|
Net Sales
|
|
|
Gross Profit
|
|
|
Operating Income
|
|
|
Net Income
|
|
|
Net Income
|
|
|
Cash Dividend
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
$
|
641,904
|
|
|
$
|
181,012
|
|
|
$
|
41,026
|
|
|
$
|
24,291
|
|
|
$
|
0.61
|
|
|
$
|
0.27
|
|
Second Quarter
|
610,346
|
|
|
173,167
|
|
|
38,362
|
|
|
23,947
|
|
|
0.61
|
|
|
0.27
|
|
Third Quarter
|
633,172
|
|
|
174,793
|
|
|
(33,032
|
)
|
|
(44,728
|
)
|
|
(1.14
|
)
|
|
0.28
|
|
Fourth Quarter
|
634,006
|
|
|
178,450
|
|
|
42,445
|
|
|
26,067
|
|
|
0.66
|
|
|
0.28
|
|
|
$
|
2,519,428
|
|
|
$
|
707,422
|
|
|
$
|
88,801
|
|
|
$
|
29,577
|
|
|
$
|
0.75
|
|
|
$
|
1.10
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
$
|
702,325
|
|
|
$
|
194,932
|
|
|
$
|
46,165
|
|
|
$
|
29,122
|
|
|
$
|
0.70
|
|
|
$
|
0.25
|
|
Second Quarter
|
691,702
|
|
|
195,713
|
|
|
46,807
|
|
|
29,707
|
|
|
0.72
|
|
|
0.25
|
|
Third Quarter
|
679,994
|
|
|
187,363
|
|
|
43,772
|
|
|
28,610
|
|
|
0.70
|
|
|
0.27
|
|
Fourth Quarter
|
677,540
|
|
|
191,806
|
|
|
47,875
|
|
|
28,045
|
|
|
0.70
|
|
|
0.27
|
|
|
$
|
2,751,561
|
|
|
$
|
769,814
|
|
|
$
|
184,619
|
|
|
$
|
115,484
|
|
|
$
|
2.80
|
|
|
$
|
1.04
|
|
2014
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
$
|
605,305
|
|
|
$
|
169,795
|
|
|
$
|
39,539
|
|
|
$
|
26,844
|
|
|
$
|
0.63
|
|
|
$
|
0.23
|
|
Second Quarter
|
581,949
|
|
|
163,383
|
|
|
39,837
|
|
|
25,909
|
|
|
0.61
|
|
|
0.23
|
|
Third Quarter
|
618,006
|
|
|
171,220
|
|
|
40,173
|
|
|
30,394
|
|
|
0.72
|
|
|
0.25
|
|
Fourth Quarter
|
654,618
|
|
|
182,528
|
|
|
44,809
|
|
|
29,674
|
|
|
0.71
|
|
|
0.25
|
|
|
$
|
2,459,878
|
|
|
$
|
686,926
|
|
|
$
|
164,358
|
|
|
$
|
112,821
|
|
|
$
|
2.67
|
|
|
$
|
0.96
|
|
On
August 5, 2016
, there were 5,559 shareholders of record including 4,048 shareholders in the Applied Industrial Technologies, Inc. Retirement Savings Plan. The Company’s common stock is listed on the New York Stock Exchange. The closing price on
August 5, 2016
was $47.85 per share.
The sum of the quarterly per share amounts may not equal per share amounts reported for year-to-date. This is due to changes in the number of weighted shares outstanding and the effects of rounding for each period.
Cost of sales for interim financial statements are computed using estimated gross profit percentages which are adjusted throughout the year based upon available information. Adjustments to actual cost are primarily made based on periodic physical inventory and the effect of year-end inventory quantities on LIFO costs.
Fiscal 2016
During the third quarter of fiscal 2016, the Company recorded goodwill impairment of $64.8 million related to the Canada and Australia/New Zealand service center reporting units within the Service Center Based Distribution reportable segment. After taxes, the impairment had a negative impact on earnings of $63.8 million and reduced earnings per share by $1.62 per share.
During fiscal 2016, the Company incurred certain restructuring charges. During the third quarter, a reserve of $3.6 million was recorded within cost of sales for potential non-salable, non-returnable and excess inventory due to declining demand, primarily for Canada oil and gas operations. SD&A included expenses of $5.2 million during the fiscal year related to severance and facility consolidations, primarily for oil and gas operations. Total restructuring charges reduced gross profit for the year by $3.6 million, operating income by $8.8 million, net income by $6.2 million and earnings per share by $0.16.
During the fourth quarter of fiscal 2016, the Company realized LIFO layer liquidation benefits of $2.1 million from certain inventory quantity levels decreasing.
Fiscal 2015
During the fourth quarter of fiscal 2015, the Company recorded severance of $1.8 million. Also, we sold a building recognizing a gain of $1.5 million.
During the fourth quarter of fiscal 2015, income tax expense increased due to recording a valuation allowance against certain deferred tax assets for foreign jurisdictions of $1.0 million. Also, an increase of tax rates in certain foreign jurisdictions at the end of the fiscal period increased tax expense by $1.2 million during the quarter.
No LIFO layer liquidations took place during the year ended June 30, 2015.
Fiscal 2014
During the first quarter of fiscal 2014, the Company aligned the consolidation of the Company's Canadian subsidiary which previously included results on a month reporting lag. The elimination of this lag resulted in the recognition of $1.2 million of additional income which was included within "Other income, net" on the Condensed Statements of Consolidated Income.
During the third quarter of fiscal 2014, the Company aligned the consolidation of the Company's Mexican subsidiary which previously included results on a month reporting lag. The elimination of this lag resulted in the recognition of $0.2 million of additional income which was included within "Other income, net" on the Condensed Statements of Consolidated Income.
During the third quarter of fiscal 2014, $2.8 million of tax reserves were reversed. The impact of this reversal was a reduction in income tax expense of $2.8 million and a $0.07 increase in earnings per share.
No LIFO layer liquidations took place during the year ended June 30, 2014.