Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
OVERVIEW
With approximately 6,500 associates across North America, Australia, New Zealand, and Singapore, Applied Industrial Technologies, Inc. ("Applied," the "Company," "we," "us," or "our") is a leading value-added distributor and technical solutions provider of industrial motion, fluid power, flow control, automation technologies, and related maintenance supplies. Our leading brands, specialized services, and comprehensive knowledge serve MRO (Maintenance, Repair & Operations) and OEM (Original Equipment Manufacturer) end users in virtually all industrial markets through our multi-channel capabilities that provide choice, convenience, and expertise. We have a long tradition of growth dating back to 1923, the year our business was founded in Cleveland, Ohio. At June 30, 2024, business was conducted in the United States, Puerto Rico, Canada, Mexico, Australia, New Zealand, Singapore, and Costa Rica from approximately 590 facilities.
The following is Management's Discussion and Analysis of significant factors that have affected our financial condition, results of operations and cash flows during the periods included in the accompanying consolidated balance sheets, statements of consolidated income, consolidated comprehensive income and consolidated cash flows in Item 8 under the caption "Financial Statements and Supplementary Data." When reviewing the discussion and analysis set forth below, please note that a significant number of SKUs (Stock Keeping Units) we sell in any given year were not sold in the comparable period of the prior year, resulting in the inability to quantify certain commonly used comparative metrics analyzing sales, such as changes in product mix and volume.
Our fiscal 2024 consolidated sales were $4.5 billion, an increase of $66.6 million or 1.5% compared to the prior year, with the acquisitions of Grupo Kopar (Kopar), Bearing Distributors, Inc. (BDI), Cangro Industries, Inc. (Cangro), Advanced Motion Systems Inc. (AMS), and Automation, Inc. increasing sales by $56.4 million or 1.3% and favorable foreign currency translation of $6.6 million increasing sales by 0.2%. Gross profit margin increased to 29.8% for fiscal 2024 from 29.2% for fiscal 2023. Operating margin increased to 11.1% in fiscal 2024 from 10.7% in fiscal 2023.
Our diluted earnings per share was $9.83 in fiscal 2024 versus $8.84 in fiscal 2023.
Shareholders’ equity was $1,688.8 million at June 30, 2024 compared to $1,458.4 million at June 30, 2023. Working capital increased $162.3 million from June 30, 2023 to $1,268.8 million at June 30, 2024. The current ratio was 3.5 to 1 and 3.0 to 1 at June 30, 2024 and at June 30, 2023, respectively.
Applied monitors several economic indices that have been key indicators for industrial economic activity in the United States. These include the Industrial Production (IP) and Manufacturing Capacity Utilization (MCU) indices published by the Federal Reserve Board and the Purchasing Managers Index (PMI) published by the Institute for Supply Management (ISM). Historically, our performance correlates well with the MCU, which measures productivity and calculates a ratio of actual manufacturing output versus potential full capacity output. When manufacturing plants are running at a high rate of capacity, they tend to wear out machinery and require replacement parts.
The MCU (total industry) and IP indices increased since June 2023. The ISM PMI registered 48.5 in June 2024, an increase from the June 2023 revised reading of 46.4. A reading above 50 generally indicates expansion. The index readings for the months during the most recent quarter, along with the revised indices for previous quarter ends, were as follows:
Index Reading
Month MCU PMI IP
June 2024 78.8 48.5 100.3
May 2024 78.3 48.7 99.9
April 2024 77.7 49.2 98.9
March 2024 77.8 50.3 99.4
December 2023 78.1 47.1 99.2
September 2023 78.9 48.6 99.6
June 2023 78.6 46.4 99.2
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RESULTS OF OPERATIONS
This discussion and analysis deals with comparisons of material changes in the consolidated financial statements for the years ended June 30, 2024 and 2023. For the comparison of the years ended June 30, 2023 and 2022, see the Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our 2023 Annual Report on Form 10-K.
The following table is included to aid in review of Applied’s statements of consolidated income.
Year Ended June 30,
As a % of Net Sales Change in $'s Versus Prior Period
2024 2023 % Change
Net Sales 100.0 % 100.0 % 1.5 %
Gross Profit Margin 29.8 % 29.2 % 3.9 %
Selling, Distribution & Administrative Expense 18.8 % 18.4 % 3.3 %
Operating Income 11.1 % 10.7 % 4.8 %
Net Income 8.6 % 7.9 % 11.3 %
Sales in fiscal 2024 were $4.5 billion, which was $66.6 million or 1.5% above the prior year, with sales from acquisitions adding $56.4 million or 1.3% and favorable foreign currency translation accounting for an increase of $6.6 million or 0.2%. There were 251.5 selling days in fiscal 2024 and 252.5 selling days in 2023. Excluding the impact of businesses acquired and foreign currency translation, sales we re up $3.6 million durin g the year. The modest increase over the prior year was driven by our Service Center Based Distribution segment reflecting positive demand for technical MRO products and solutions, internal sales initiatives, and price increases. This was offset by normalizing end-market demand as the year progressed, sales declines across our Engineered Solutions segment, and a decrease due to the change in sales days.
The following table shows changes in sales by reportable segment.
Amounts in millions Amount of change due to
Year ended June 30, Sales Increase (Decrease) Acquisitions Foreign Currency Organic Change
Sales by Reportable Segment 2024 2023
Service Center Based Distribution 3,056.5 $ 2,966.8 $ 89.7 $ 36.4 $ 6.6 $ 46.7
Engineered Solutions 1,422.9 1,446.0 (23.1) 20.0 — (43.1)
Total $ 4,479.4 $ 4,412.8 $ 66.6 $ 56.4 $ 6.6 $ 3.6
Sales in our Service Center Based Distribution segment, which operates primarily in MRO markets, increased $89.7 million, or 3.0%. Acquisitions within this segment increased sales by $36.4 million or 1.2% and favorable foreign currency translation increased sales by $6.6 million or 0.2%. Excluding the impact of foreign currency tr anslation, sales increased $46.7 million or 1.6% during the year, driven by an increase of 2.0% from operations reflecting positive demand for technical MRO products and solutions, internal sales initiatives, price increases, cross-selling benefits, and new growth opportunities arising from our industry position. This was partially offset by a 0.4% decrease due to the change in sales days.
Sales in our Engineered Solutions segment decreased $23.1 million or 1.6%. Acquisitions within this segment increased sales $20.0 million or 1.4%. Excluding the impact of businesses acquired, sales decreased $43.1 million or 3.0%, driven by a 2.6% decline from operations primarily reflecting lower fluid power sales and, to a lesser extent, softer sales across our automation operations, as well as a decrease of 0.4% due to the change in sales days. The sales decline was partially offset by sales growth across our flow control operations.
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The following table shows changes in sales by geographical area. Other countries include Mexico, Australia, New Zealand, Singapore, and Costa Rica.
Amounts in millions Amount of change due to
Year ended June 30, Sales Increase (Decrease) Acquisitions Foreign Currency Organic Change
Sales by Geographic Area 2024 2023
United States $ 3,932.2 $ 3,860.4 $ 71.8 $ 50.0 $ — $ 21.8
Canada 310.2 315.5 (5.3) — (3.7) (1.6)
Other Countries 237.0 236.9 0.1 6.4 10.3 (16.6)
Total $ 4,479.4 $ 4,412.8 $ 66.6 $ 56.4 $ 6.6 $ 3.6
Sal es in our U.S. operations increased $71.8 million or 1.9%, with acquisitions adding $50.0 million or 1.3%. Excluding the impact of businesses acquired, U.S. sales were up $21.8 million or 0.6%, driven by an increase of 1.0% from operations offset by a 0.4% decrease due to the change in sales days. Sales from our Canadian operations decreased $5.3 million or 1.7%. Unfavorable foreign currency translation decreased Canadian sales by $3.7 million or 1.2%. Excluding the impact of foreign currency translation, Canadian sales were down $1.6 million or 0.5%, driven by a 0.4% decrease due to the change in sales days along with a decrease of 0.1% from operations. Consolidated sales from our other countries operations increased $0.1 million or 0.1%, with acquisitions adding $6.4 million or 2.7%. Favorable foreign currency translation increased other countries sales by $10.3 million or 4.4%. Exc luding the impact of businesses acquired and foreign currency translation, other countries sales were down $16.6 million or 7.0%, driven by a decrease from operations, primarily in Mexican sales due to decreased industrial activity.
Our gross profit margin increased to 29.8% in fiscal 2024 compared to 29.2% in fiscal 2023. The year over year increase primarily reflects benefits from ongoing margin initiatives, countermeasures in response to inflation dynamics, as well as a $21.2 million decrease in LIFO expense over the prior year, which positively impacted gross margins by 47 basis poi nts. This was partially offset by unfavorable mix tied to sales declines across our Engineered Solutions segment and local customer accounts.
The following table shows the changes in selling, distribution, and administrative expense (SD&A).
Amounts in millions Amount of change due to
Year ended June 30, SD&A Increase Acquisitions Foreign Currency Organic Change
2024 2023
SD&A $ 840.8 $ 813.8 $ 27.0 $ 16.7 $ 0.7 $ 9.6
SD&A consists of associate compensation, benefits and other expenses associated with selling, purchasing, warehousing, supply chain management, and marketing and distribution of the Company’s products, as well as costs associated with a variety of administrative functions such as human resources, information technology, treasury, accounting, insurance, legal, facility-related expenses and expenses incurred in acquiring businesses. SD&A increased $27.0 million or 3.3% during fiscal 2024 compared to the prior year, and as a percentage of sales increased to 18.8% in fiscal 2024 compared to 18.4% in fiscal 2023. Changes in foreign currency exchange rates had the effect of increasing SD&A by $0.7 million or 0.1% compared to the prior year. SD&A from businesses acquired added $16.7 million or 2.0%, including $1.8 million of intangibles amortization. Excluding the impact of businesses acquired and the unfavorable impact from foreign currency translation, SD&A increased $9.6 million or 1.2% during fiscal 2024 compared to fiscal 2023. Excluding the impact of acquisitions, total compensation increased $4.3 million during fiscal 2024 primarily due to annual calendar year merit increases and benefit costs partially offset by lower incentives and commission expense. All other expenses within SD&A were up $5.3 million.
Operating income increased $22.7 million, or 4.8% , to $495.8 million during fiscal 2024 from $473.2 million during fiscal 2023, and as a percentage of sales, increased to 11.1% from 10.7%, primarily due to gross profit margin expansion, inclusive of lower LIFO expense, volume leverage within our Service Center Based Distribution segment, and control of SD&A expense in f iscal 2024.
Operating income, as a percentage of sales for the Service Center Based Distribution segment increased to 13.1% in fiscal 2024 from 12.6% in fiscal 2023. Operating income as a percentage of sales for the Engineered Solutions segment increased to 14.5% in fiscal 2024 from 14.1% in fiscal 2023.
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Segment operating income is impacted by changes in the amounts and levels of certain supplier support benefits and expenses allocated to the segments. The expense allocations include corporate charges for working capital, logistics support, and other items and impact segment gross profit and operating expense.
Interest expense, net decreased $18.8 million during fiscal 2024 primarily due to reduced debt levels and greater interest income from higher cash balances and investment yields.
Other (income) expense, net, represents certain non-operating items of income and expense, and was $5.1 million of income in fiscal 2024 compared to $1.7 million of expense in fiscal 2023. Current year income primarily consists of unrealized gains on investments held by non-qualified deferred compensation trusts of $3.3 million, foreign currency transaction gains of $1.1 million and life insurance income of $0.9 million, offset by other periodic post-employment costs of $0.1 million and other expense of $0.1 million. Fiscal 2023 expense consisted primarily of foreign currency transaction loss of $3.3 million and other periodic post-employment costs of $1.5 million, offset by unrealized gains on investments held by non-qualified deferred compensation trusts of $2.2 million, life insurance income of $0.7 million and $0.2 million of other income.
The effective income tax rate was 22.6% for fiscal 2024 compared to 22.9% for fiscal 2023. The decrease in the effective tax rate is primarily due to changes in compensation-related deductions in fiscal 2024 compared to the prior year.
As a result o f the factors discussed above, net income for fiscal 2024 increased $39.0 million from the prior year. Diluted net income per share was $9.83 per share for fiscal 2024 compared to $8.84 per share for fiscal 2023.
At June 30, 2024, we had approximately 590 operating facilities in the United States, Puerto Rico, Canada, Mexico, Australia, New Zealand, Singapore, and Costa Rica, versus 580 at June 30, 2023.
The approximate number of Company employees was 6,500 at June 30, 2024 and 6,200 at June 30, 2023.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of capital is cash flow from operations, supplemented as necessary by bank borrowings or other sources of debt. At June 30, 2024 we had total debt obligations outstanding of $597.4 million compared to $622.2 million at June 30, 2023. Management expects that our existing cash, cash equivalents, funds available under the revolving credit facility, and cash provided from operations, will be sufficient to finance normal working capital needs in each of the countries in which we operate, payment of dividends, acquisitions, investments in properties, facilities and equipment, debt service, and the purchase of additional Company common stock. Management also believes that additional long-term debt and line of credit financing could be obtained on commercially acceptable terms if necessary based on the Company’s credit standing and financial strength.
The Company’s working capital at June 30, 2024 was $1,268.8 million compared to $1,106.5 million at June 30, 2023. The current ratio was 3.5 to 1 at June 30, 2024 and 3.0 to 1 at June 30, 2023.
Net Cash Flows
The following table is included to aid in review of Applied’s statements of consolidated cash flows.
Amounts in thousands Year Ended June 30,
2024 2023
Net Cash Provided by (Used in):
Operating Activities $ 371,393 $ 343,966
Investing Activities (95,407) (60,833)
Financing Activities (156,468) (126,888)
Exchange Rate Effect (2,937) 3,317
Increase in Cash and Cash Equivalents $ 116,581 $ 159,562
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The increase in cash provided by operating activities during fiscal 2024 is driven by changes in working capital for the year and by improved operating results. Changes in cash flows between years related to working capital were driven by (amounts in thousands):
Accounts receivable $ 49,134
Inventory $ 61,364
Accounts payable $ (76,954)
Net cash used in investing activities in fiscal 2024 included $72.1 million used for the acquisitions of Kopar, BDI and Cangro and $24.9 million used for capital expenditures. Net cash used in investing activities in fiscal 2023 included $35.8 million used for the acquisitions of Automation, Inc. and AMS, and $26.5 million used for capital expenditures.
N et cash used in financing activities increased from the prior year period primarily due to an increase in treasury purchases as $73.4 million was used to repurchase 398,000 shares of common stock which were taken into treasury in 2024 compared to $0.7 million used to repurchase 8,000 shares of common stock which were taken into treasury in 2023. This was offset by the change in net debt activity, as there was $24.8 million of net debt payments in fiscal 2024 compared to $67.2 million of net debt payments in 2023. Further uses of cash in 2024 were $55.9 million for dividend payments and $16.3 million used to pay taxes for shares withheld. Further uses of cash in 2023 were $53.4 million for dividend payments and $12.9 million used to pay taxes for shares withheld.
The increase in dividends over the year is the result of regular increases in our dividend payout rates. We paid aggregate dividends of $1.44 and $1.38 per share in fiscal 2024 and 2023, respectively.
Capital Expenditures
We expect capital expenditures for fiscal 2025 to be in the $28.0 million to $30.0 million range, primarily consisting of capital associated with focused investments for growth and information technology equipment maintenance.
Share Repurchases
The Board of Directors has authorized the repurchase of shares of the Company’s common stock. These purchases may be made in open market or through negotiated transactions, from time to time, depending upon market conditions. At June 30, 2024, we had remaining authorization to purchase an additional 1,102,000 shares.
In fiscal 2024, we purchased 398,000 shares of the Company's common stock at an average price per share of $184.39. In fiscal 2023, we repurchased 8,000 shares of the Company's common stock at an average price per share of $89.46. In fiscal 2022,we repurchased 148,658 shares of the Company's common stock at an average price per share of $92.72.
Borrowing Arrangements
A summary of long-term debt, including the current portion, follows (amounts are in thousands):
June 30, 2024 2023
Revolving credit facility $ 384,000 $ 383,592
Trade receivable securitization facility 188,300 188,300
Series D Notes — 25,000
Series E Notes 25,000 25,000
Other 105 356
Total debt $ 597,405 $ 622,248
Less: unamortized debt issuance costs 71 152
$ 597,334 $ 622,096
In December 2021, the Company entered into a five-year revolving credit facility with a group of banks to refinance the existing credit facility as well as provide funds for ongoing working capital and other general corporate purposes. The revolving credit facility provides a $900.0 million unsecured revolving credit facility and an uncommitted accordion feature which allows the Company to request an increase in the borrowing commitments, or incremental term loans, under the credit facility in aggregate principal amounts of up to $500.0 million. In May 2023, the Company and the administrative agent entered into an amendment to the credit facility to replace LIBOR with SOFR as a reference rate available for use in the computation of interest. Borrowings under this agreement bear interest, at the Company's election, at either the base rate plus a margin that ranges from 0 to 55 basis points based on the net leverage ratio or SOFR plus a margin that ranges from 80 to 155 basis points based on the net leverage ratio.
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Available borrowing under this facility, without exercising the accordion feature and net of outstanding letters of credit of $0.2 million to secure certain insurance obligations, totaled $515.8 million and $516.2 million at June 30, 2024 and June 30, 2023, respectively, and were available to fund future acquisitions or other capital and operating requirements. The interest rate on the revolving credit facility was 6.24% and 6.11% as of June 30, 2024 and June 30, 2023, respectively.
Additionally, the Company had letters of credit outstanding with separate banks, not associated with the revolving credit agreement, in the amount of $4.0 million as of June 30, 2024 and June 30, 2023 in order to secure certain insurance obligations.
In August 2018, the Company established a trade receivable securitization facility (the “AR Securitization Facility”). On March 26, 2021, the Company amended the AR Securitization Facility to expand the eligible receivables, which increased the maximum availability to $250.0 million and increased the fees on the AR Securitization Facility to 0.98% per year. On August 4, 2023, the Company amended the AR Securitization Facility, extended the term to August 4, 2026, and reduced drawn fees to 0.90% per year. Availability is further subject to changes in the credit ratings of our customers, customer concentration levels or certain characteristics of the accounts receivable being transferred and, therefore, at certain times, we may not be able to fully access the $250.0 million of funding available under the AR Securitization Facility. The AR Securitization Facility effectively increases the Company’s borrowing capacity by collateralizing a portion of the amount of the U.S. operations’ trade accounts receivable. The Company uses the proceeds from the AR Securitization Facility as an alternative to other forms of debt, effectively reducing borrowing costs. In May 2023, the Company entered into an amendment to the AR Securitization facility to replace LIBOR with SOFR as a reference rate available for use in the computation of interest, therefore borrowings under this facility carry variable interest rates tied to SOFR. The interest rate on the AR Securitization Facility as of June 30, 2024 and June 30, 2023 was 6.35% and 6.16%, respectively.
At June 30, 2024 and June 30, 2023, the Company had borrowings outstanding under its unsecured shelf facility agreement with Prudential Investment Management of $25.0 million and $50.0 million, respectively. Fees on this facility range from 0.25% to 1.25% per year based on the Company's leverage ratio at each quarter end. The "Series D" notes carried a fixed interest rate of 3.21%, and the remaining principal balance of $25.0 million was paid in October 2023. The "Series E" notes have a principal amount of $25.0 million, carry a fixed interest rate of 3.08%, and are due in October 2024.
In 2014, the Company assumed $2.4 million of debt as a part of the headquarters facility acquisition. The 1.50% fixed interest rate note is held by the State of Ohio Development Services Agency and matures in November 2024.
In 2019, the Company entered into an interest rate swap which mitigates variability in forecasted interest payments on $384.0 million of the Company’s U.S. dollar-denominated unsecured variable rate debt. For more information, see note 7, Derivatives, to the consolidated financial statements, included in Item 8 under the caption “Financial Statements and Supplementary Data.”
The credit facility and the unsecured shelf facility contain restrictive covenants regarding liquidity, net worth, financial ratios, and other covenants. At June 30, 2024, the most restrictive of these covenants required that the Company have net indebtedness less than 3.75 times consolidated income before interest, taxes, depreciation and amortization (as defined). At June 30, 2024, the Company's net indebtedness was less than 0.3 times consolidated income before interest, taxes, depreciation and amortization (as defined). T he Company was in compliance with all financial covenants at June 30, 2024.
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Accounts Receivable Analysis
The following table is included to aid in analysis of accounts receivable and the associated provision for losses on accounts receivable (all dollar amounts are in thousands):
June 30, 2024 2023
Accounts receivable, gross
$ 737,941 $ 730,729
Allowance for doubtful accounts
13,063 22,334
Accounts receivable, net $ 724,878 $ 708,395
Allowance for doubtful accounts, % of gross receivables
1.8 % 3.1 %
Year Ended June 30, 2024 2023
(Recoveries of) provision for losses on accounts receivable $ (205) $ 5,619
Provision as a % of net sales
— % 0.13 %
Accounts receivable are reported at net realizable value and consist of trade receivables from customers. Management monitors accounts receivable by reviewing Days Sales Outstanding (DSO) and the aging of receivables for each of the Company's locations.
On a consolidated basis, DSO was 56.2 at June 30, 2024 versus 55.1 at June 30, 2023. Approximately 1.5% of our accounts receivable balances are more than 90 days past due at June 30, 2024 compared to 2.5% at June 30, 2023. On an overall basis, our provision for losses from uncollected receivables represents 0.00% of our sales for the year ended June 30, 2024, compared to 0.13% of sales for the year ended June 30, 2023. The decrease primarily relates to provisions recorded in the prior year for customer credit deterioration and bankruptcies primarily in the U.S. operations of the Service Center Based Distribution segment, as well as improved collections performance. Historically, this percentage is around 0.10% to 0.15%. Management believes the overall receivables aging and provision for losses on uncollected receivables are at reasonable levels.
Inventory Analysis
Inventories are valued using the last-in, first-out (LIFO) method for U.S. inventories and the average cost method for foreign inventories. Management uses an inventory turnover ratio to monitor and evaluate inventory. Management calculates this ratio on an annual as well as a quarterly basis and uses inventory valued at average costs. The annualized inventory turnover (using average costs) for the year ended June 30, 2024 was 4.3 versus 4.4 for the year ended June 30, 2023.
CONTRACTUAL OBLIGATIONS
The following table shows the approximate value of the Company’s contractual obligations and other commitments to make future payments as of June 30, 2024 (in thousands):
Total Period Less
Than 1 yr Period
2-3 yrs Period
4-5 yrs Period
Over 5 yrs Other
Operating leases
$ 155,947 $ 38,617 $ 60,200 $ 33,674 $ 23,456 $ —
Planned funding of post-retirement obligations
4,900 1,340 1,570 400 1,590 —
Unrecognized income tax benefit liabilities, including interest and penalties 4,500 — — — — 4,500
Long-term debt obligations 597,405 25,105 572,300 — — —
Interest on long-term debt obligations (1)
62,200 21,700 40,500 — — —
Acquisition holdback payments
2,855 1,273 1,582 — — —
Total Contractual Cash Obligations
$ 827,807 $ 88,035 $ 676,152 $ 34,074 $ 25,046 $ 4,500
(1) Amounts represent estimated contractual interest payments on outstanding long-term debt obligations net of receipts under the terms of the interest rate swap. Rates in effect as of June 30, 2024 are used for variable rate debt.
Purchase orders for inventory and other goods and services are not included in our estimates as we are unable to aggregate the amount of such purchase orders that represent enforceable and legally binding agreements specifying all significant terms. The previous table includes the gross liability for unrecognized income tax benefits including
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interest and penalties in the “Other” column as the Company is unable to make a reasonable estimate regarding the timing of cash settlements, if any, with the respective taxing authorities.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates at a specific point in time that affect the amounts reported in the consolidated financial statements and disclosed in the accompanying notes. The Business and Accounting Policies note to the consolidated financial statements describes the significant accounting policies and methods used in preparation of the consolidated financial statements. Estimates are used for, but are not limited to, determining the net carrying value of trade accounts receivable, inventories, recording self-insurance liabilities and other accrued liabilities. Estimates are also used in establishing opening balances in relation to purchase accounting. Actual results could differ from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions, and estimates used in the preparation of the consolidated financial statements.
LIFO Inventory Valuation and Methodology
Inventories are valued at the average cost method, using the last-in, first-out (LIFO) method for U.S. inventories, and the average cost method for foreign inventories. We adopted the link chain dollar value LIFO method for accounting for U.S. inventories in fiscal 1974. Approximately 14.9% of our domestic inventory dollars relate to LIFO layers added in the 1970s. The excess of average cost over LIFO cost is $225.9 million as reflected in our consolidated balance sheet at June 30, 2024. The Company maintains five LIFO pools based on the following product groupings: bearings, power transmission products, rubber products, fluid power products, and other products.
LIFO layers and/or liquidations are determined consistently year-to-year. See the Inventories note to the
consolidated financial statements in Item 8 under the caption "Financial Statements and Supplementary Data,"
for further information.
Allowances for Slow-Moving and Obsolete Inventories
We evaluate the recoverability of our slow-moving and inactive inventories at least quarterly. We estimate the recoverable cost of such inventory by product type while considering factors such as its age, historic and current demand trends, and the physical condition of the inventory, as well as assumptions regarding future demand. Our ability to recover our cost for slow moving or obsolete inventory can be affected by such factors as general market conditions, future customer demand and relationships with suppliers. A significant portion of the products we hold in inventory have long shelf lives and are not highly susceptible to obsolescence.
As of June 30, 2024 and 2023, the Company's reserve for slow-moving or obsolete inventories was $41.2 million and $42.6 million, respectively, recorded in inventories in the consolidated balance sheets.
Allowances for Doubtful Accounts
We evaluate the collectability of trade accounts receivable based on a combination of factors. Initially, we estimate an allowance for doubtful accounts as a percentage of net sales based on historical bad debt experience. This initial estimate is adjusted based on recent trends of certain customers and industries estimated to be a greater credit risk, trends within the entire customer pool and changes in the overall aging of accounts receivable. While we have a large customer base that is geographically dispersed, a general economic downturn in any of the industry segments in which we operate could result in higher than expected defaults, and therefore, the need to revise estimates for bad debts. Accounts are written off against the allowance when it becomes evident that collection will not occur.
As of June 30, 2024 and 2023, our allowance for doubtful accounts was 1.8% and 3.1% of gross receivables, respectively. Our (recoveries of) provision for losses on accounts receivable was $(0.2) million, $5.6 million, and $3.2 million in fiscal 2024, 2023, and 2022, respectively.
Goodwill and Intangibles
The purchase price of an acquired company is allocated between intangible assets and the net tangible assets of the acquired business with the residual of the purchase price recorded as goodwill. Goodwill for acquired businesses is accounted for using the acquisition method of accounting which requires that the assets acquired and liabilities assumed be recorded at the date of the acquisition at their respective estimated fair values. The determination of the value of the intangible assets acquired involves certain judgments and estimates. These judgments can include, but are not limited to, the cash flows that an asset is expected to generate in the future and the appropriate weighted average cost of capital. The judgments made in determining the estimated fair value assigned to each class of assets acquired, as well as the estimated life of each asset, can materially impact the net income of the
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periods subsequent to the acquisition through depreciation and amortization, and in certain instances through impairment charges, if the asset becomes impaired in the future. As part of acquisition accounting, we recognize acquired identifiable intangible assets such as customer relationships, vendor relationships, trade names, and non-competition agreements apart from goodwill. Finite-lived identifiable intangibles are evaluated for impairment when changes in conditions indicate carrying value may not be recoverable. If circumstances require a finite-lived intangible asset be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by the asset to the carrying value of the asset. If the carrying value of the finite-lived intangible asset is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value determined through a discounted cash flow model.
We evaluate goodwill for impairment at the reporting unit level annually as of January 1, and whenever an event occurs or circumstances change that would indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Events or circumstances that may result in an impairment review include changes in macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, other relevant entity-specific events, specific events affecting the reporting unit or sustained decrease in share price. Each year, the Company may elect to perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If impairment is indicated in the qualitative assessment, or, if management elects to initially perform a quantitative assessment of goodwill, the impairment test uses a one-step approach. The fair value of a reporting unit is compared with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired. If the carrying amount of a reporting unit exceeds its fair value, an impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to that reporting unit.
Goodwill on our consolidated financial statements relates to both the Service Center Based Distribution segment and the Engineered Solutions segment. The Company has eight (8) reporting units for which an annual goodwill impairment assessment was performed as of January 1, 2024. Based on the assessment performed, the Company concluded that the fair value of all of the reporting units exceeded their carrying amount as of January 1, 2024, therefore no impairment exists.
The fair values of the reporting units in accordance with the goodwill impairment test were determined using the income and market approaches. The income approach employs the discounted cash flow method reflecting projected cash flows expected to be generated by market participants and then adjusted for time value of money factors, and requires management to make significant estimates and assumptions related to forecasts of future revenues, operating margins, and discount rates. The market approach utilizes an analysis of comparable publicly traded companies and requires management to make significant estimates and assumptions related to the forecasts of future revenues, earnings before interest, taxes, depreciation, and amortization (EBITDA) and multiples that are applied to management’s forecasted revenues and EBITDA estimates.
Changes in future results, assumptions, and estimates after the measurement date may lead to an outcome where additional impairment charges would be required in future periods. Specifically, actual results may vary from the Company’s forecasts and such variations may be material and unfavorable, thereby triggering the need for future impairment tests where the conclusions may differ in reflection of prevailing market conditions. Further, continued adverse market conditions could result in the recognition of additional impairment if the Company determines that the fair values of its reporting units have fallen below their carrying values.
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CAUTIONARY STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT
This Form 10-K, including Management’s Discussion and Analysis, contains statements that are forward-looking based on management’s current expectations about the future. Forward-looking statements are often identified by qualifiers, such as “guidance”, “expect”, “believe”, “plan”, “intend”, “will”, “should”, “could”, “would”, “anticipate”, “estimate”, “forecast”, “may”, "optimistic" and derivative or similar words or expressions. Similarly, descriptions of objectives, strategies, plans, or goals are also forward-looking statements. These statements may discuss, among other things, expected growth, future sales, future cash flows, future capital expenditures, future performance, and the anticipation and expectations of the Company and its management as to future occurrences and trends. The Company intends that the forward-looking statements be subject to the safe harbors established in the Private Securities Litigation Reform Act of 1995 and by the Securities and Exchange Commission in its rules, regulations, and releases.
Readers are cautioned not to place undue reliance on any forward-looking statements. All forward-looking statements are based on current expectations regarding important risk factors, many of which are outside the Company’s control. Accordingly, actual results may differ materially from those expressed in the forward-looking statements, and the making of those statements should not be regarded as a representation by the Company or any other person that the results expressed in the statements will be achieved. In addition, the Company assumes no obligation publicly to update or revise any forward-looking statements, whether because of new information or events, or otherwise, except as may be required by law.
Important risk factors include, but are not limited to, the following: risks relating to the operations levels of our customers and the economic factors that affect them; continuing risks relating to the effects of the COVID-19 pandemic; inflationary or deflationary trends in the cost of products, energy, labor and other operating costs, and changes in the prices for products and services relative to the cost of providing them; reduction in supplier inventory purchase incentives; loss of key supplier authorizations, lack of product availability (such as due to supply chain strains), changes in supplier distribution programs, inability of suppliers to perform, and transportation disruptions; changes in customer preferences for products and services of the nature and brands sold by us; changes in customer procurement policies and practices; competitive pressures; our reliance on information systems and risks relating to their proper functioning, the security of those systems, and the data stored in or transmitted through them; the impact of economic conditions on the collectability of trade receivables; reduced demand for our products in targeted markets due to reasons including consolidation in customer industries; our ability to retain and attract qualified sales and customer service personnel and other skilled executives, managers and professionals; our ability to identify and complete acquisitions, integrate them effectively, and realize their anticipated benefits; the variability, timing and nature of new business opportunities including acquisitions, alliances, customer relationships, and supplier authorizations; the incurrence of debt and contingent liabilities in connection with acquisitions; our ability to access capital markets as needed on reasonable terms; disruption of operations at our headquarters or distribution centers; risks and uncertainties associated with our foreign operations, including volatile economic conditions, political instability, cultural and legal differences, and currency exchange fluctuations; the potential for goodwill and intangible asset impairment; changes in accounting policies and practices; our ability to maintain effective internal control over financial reporting; organizational changes within the Company; risks related to legal proceedings to which we are a party; potentially adverse government regulation, legislation, or policies, both enacted and under consideration, including with respect to federal tax policy, international trade, data privacy and security, and government contracting; and the occurrence of extraordinary events (including prolonged labor disputes, power outages, telecommunication outages, terrorist acts, war, public health emergency, earthquakes, extreme weather events, other natural disasters, fires, floods, and accidents). Other factors and unanticipated events could also adversely affect our business, financial condition, or results of operations. Risks can also change over time. Further, the disclosure of a risk should not be interpreted to imply that the risk has not already materialized.
We discuss certain of these matters and other risk factors more fully throughout our Form 10-K, as well as other of our filings with the Securities and Exchange Commission.
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