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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________________ 
FORM 10-Q
 __________________________________________

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 2019
OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                 to                 
Commission File Number 1-2299
___________________________________________ 
APPLIED INDUSTRIAL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
___________________________________________ 
Ohio
34-0117420
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
 
One Applied Plaza, Cleveland, Ohio
44115
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (216) 426-4000
(Former name, former address and former fiscal year, if changed since last report)
__________________________________________ 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  [X]     No [ ]
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  [X]  No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
[X]
  
Accelerated filer
 
[ ]
 
 
 
 
Non-accelerated filer
 
[ ]  
  
Smaller reporting company
 
[ ]
 
 
 
 
 
 
 
Emerging growth company
 
[ ]
 
 
 
 


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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  
   Yes [ ]    No [X]

There were 38,593,360 (no par value) shares of common stock outstanding on April 19, 2019.


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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
INDEX
 
 
 
 
Page
No.
Part I:
 
 
 
 
 
 
 
 
Item 1:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2:
 
 
Item 3:
 
 
Item 4:
 
 
 
 
 
Part II:
 
 
 
 
 
 
 
 
Item 1:
 
 
Item 2:
 
 
Item 4:
 
 
Item 6:
 
 
 
 
 
 
 
 

1

Table of Contents

PART I:
FINANCIAL INFORMATION

ITEM I:
FINANCIAL STATEMENTS

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
(In thousands, except per share amounts)
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 31,
 
March 31,
 
 
2019
 
2018
 
2019
 
2018
Net sales
 
$
885,443

 
$
827,665

 
$
2,589,996

 
$
2,175,553

Cost of sales
 
629,884

 
588,141

 
1,839,724

 
1,555,245

Gross profit
 
255,559

 
239,524

 
750,272

 
620,308

Selling, distribution and administrative expense, including depreciation
 
189,456

 
183,080

 
556,865

 
465,312

Intangible impairment
 
31,594

 

 
31,594

 

Operating income
 
34,509

 
56,444

 
161,813

 
154,996

Interest expense, net
 
9,947

 
8,216

 
30,001

 
12,521

Other income, net
 
(1,256
)
 
(1,291
)
 
(549
)
 
(2,022
)
Income before income taxes
 
25,818

 
49,519

 
132,361

 
144,497

Income tax expense
 
9,283

 
12,927

 
28,171

 
43,234

Net income
 
$
16,535

 
$
36,592

 
$
104,190

 
$
101,263

Net income per share - basic
 
$
0.43

 
$
0.95

 
$
2.69

 
$
2.61

Net income per share - diluted
 
$
0.42

 
$
0.93

 
$
2.66

 
$
2.58

Weighted average common shares outstanding for basic computation
 
38,643

 
38,674

 
38,701

 
38,775

Dilutive effect of potential common shares
 
396

 
612

 
521

 
497

Weighted average common shares outstanding for diluted computation
 
39,039

 
39,286

 
39,222

 
39,272

See notes to condensed consolidated financial statements.


2

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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 31,
 
March 31,

 
2019
 
2018
 
2019
 
2018
Net income per the condensed statements of consolidated income
 
$
16,535

 
$
36,592

 
$
104,190

 
$
101,263

 
 
 
 
 
 
 
 
 
Other comprehensive (loss) income, before tax:
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
2,945

 
(353
)
 
(1,611
)
 
1,775

Post-employment benefits:
 
 
 
 
 
 
 
 
Reclassification of net actuarial gains and prior service cost into other income, net and included in net periodic pension costs
 
(77
)
 
(19
)
 
(230
)
 
(55
)
Unrealized (loss) gain on investment securities available for sale
 

 
(3
)
 

 
39

Cumulative effect of adopting accounting standard
 

 

 
(50
)


  Unrealized loss on cash flow hedge
 
(6,941
)
 

 
(6,941
)
 

  Reclassification of interest from cash flow hedge into interest expense
 
85

 

 
85

 

Total of other comprehensive (loss) income, before tax
 
(3,988
)
 
(375
)
 
(8,747
)
 
1,759

Income tax (benefit) expense related to items of other comprehensive (loss) income
 
(1,626
)
 
11

 
(1,976
)
 
57

Other comprehensive (loss) income, net of tax
 
(2,362
)
 
(386
)
 
(6,771
)
 
1,702

Comprehensive income, net of tax
 
$
14,173

 
$
36,206

 
$
97,419

 
$
102,965

See notes to condensed consolidated financial statements.
 


3

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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
 
 
March 31,
2019
 
June 30,
2018
ASSETS
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
47,367

 
$
54,150

Accounts receivable, less allowances of $13,055 and $13,566
 
574,468

 
548,811

Inventories
 
454,555

 
422,069

Other current assets
 
49,380

 
32,990

Total current assets
 
1,125,770

 
1,058,020

Property, less accumulated depreciation of $177,383 and $175,300
 
123,240

 
121,343

Identifiable intangibles, net
 
378,844

 
435,947

Goodwill
 
661,195

 
646,643

Other assets
 
33,761

 
23,788

TOTAL ASSETS
 
$
2,322,810

 
$
2,285,741

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
240,339

 
$
256,886

Current portion of long term debt
 
44,163

 
19,183

     Compensation and related benefits
 
69,324

 
73,370

Other current liabilities
 
62,731

 
83,112

Total current liabilities
 
416,557

 
432,551

Long-term debt
 
937,536

 
944,522

Post-employment benefits
 
8,372

 
11,985

Other liabilities
 
77,497

 
81,720

TOTAL LIABILITIES
 
1,439,962

 
1,470,778

Shareholders’ Equity
 
 
 
 
Preferred stock—no par value; 2,500 shares authorized; none issued or outstanding
 

 

Common stock—no par value; 80,000 shares authorized; 54,213 shares issued;
38,593 and 38,703 outstanding, respectively
 
10,000

 
10,000

Additional paid-in capital
 
171,734

 
169,383

Retained Earnings
 
1,213,314

 
1,129,678

Treasury shares—at cost (15,620 and 15,510 shares, respectively)
 
(415,206
)
 
(403,875
)
Accumulated other comprehensive loss
 
(96,994
)
 
(90,223
)
TOTAL SHAREHOLDERS’ EQUITY
 
882,848

 
814,963

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
2,322,810

 
$
2,285,741

See notes to condensed consolidated financial statements.


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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
(In thousands)
 
 
Nine Months Ended
 
 
March 31,
 
 
2019
 
2018
Cash Flows from Operating Activities
 
 
 
 
Net income
 
$
104,190

 
$
101,263

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization of property
 
15,045

 
12,721

Amortization of intangibles
 
31,823

 
21,326

Intangible impairment
 
31,594

 

Unrealized foreign exchange transactions gain
 
40

 
(440
)
Amortization of stock options and appreciation rights
 
1,831

 
1,479

Gain on sale of property
 
(258
)
 
(246
)
Other share-based compensation expense
 
3,716

 
3,481

Changes in operating assets and liabilities, net of acquisitions
 
(106,367
)
 
(91,642
)
Other, net
 
(4,448
)
 
(64
)
Net Cash provided by Operating Activities
 
77,166

 
47,878

Cash Flows from Investing Activities
 
 
 
 
Acquisition of businesses, net of cash acquired
 
(37,526
)
 
(778,149
)
Property purchases
 
(11,711
)
 
(17,898
)
Proceeds from property sales
 
649

 
714

Other
 
391

 

Net Cash used in Investing Activities
 
(48,197
)
 
(795,333
)
Cash Flows from Financing Activities
 
 
 
 
Net (repayments) borrowings under revolving credit facility
 
(500
)
 
87,500

Long-term debt borrowings
 
175,000

 
780,000

Long-term debt repayments
 
(156,803
)
 
(120,488
)
Payment of debt issuance costs
 
(775
)
 
(3,298
)
Purchases of treasury shares
 
(11,158
)
 
(22,778
)
Dividends paid
 
(35,254
)
 
(34,190
)
Acquisition holdback payments
 
(2,609
)
 
(318
)
Exercise of stock options and appreciation rights
 

 
5

Taxes paid for shares withheld for equity awards
 
(3,371
)
 
(1,498
)
Net Cash (used in) provided by Financing Activities
 
(35,470
)
 
684,935

Effect of Exchange Rate Changes on Cash
 
(282
)
 
986

Decrease in Cash and Cash Equivalents
 
(6,783
)
 
(61,534
)
Cash and Cash Equivalents at Beginning of Period
 
54,150

 
105,057

Cash and Cash Equivalents at End of Period
 
$
47,367

 
$
43,523

See notes to condensed consolidated financial statements.


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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
(In thousands)

For the Period Ended March 31, 2019
 
Shares of
Common
Stock
Outstanding
 
Common
Stock
 
Additional
Paid-In
Capital
 

Retained
Earnings
 
Treasury
Shares-
at Cost
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Shareholders'
Equity
Balance at July 1, 2018
 
38,703

 
$
10,000

 
$
169,383

 
$
1,129,678

 
$
(403,875
)
 
$
(90,223
)
 
$
814,963

Net income
 

 

 

 
48,938

 

 

 
48,938

Other comprehensive income (loss)
 

 

 

 

 

 
5,347

 
5,347

Cumulative effect of adopting accounting standards
 

 

 

 
3,056

 

 

 
3,056

Cash dividends — $0.30 per share
 

 

 

 
(13
)
 

 

 
(13
)
Exercise of stock appreciation rights and options
 
17

 

 
(855
)
 

 
(210
)
 

 
(1,065
)
Performance share awards
 
18

 

 
(844
)
 

 
(301
)
 

 
(1,145
)
Restricted stock units
 
16

 

 
(760
)
 

 
(198
)
 

 
(958
)
Compensation expense — stock appreciation rights and options
 

 

 
651

 

 

 

 
651

Other share-based compensation expense
 

 

 
1,043

 

 

 

 
1,043

Other
 

 

 

 
24

 
(35
)
 

 
(11
)
Balance at September 30, 2018
 
38,754

 
10,000

 
168,618

 
1,181,683

 
(404,619
)
 
(84,876
)
 
870,806

Net income
 

 

 

 
38,717

 

 

 
38,717

Other comprehensive income (loss)
 

 

 

 

 

 
(9,756
)
 
(9,756
)
Cash dividends — $0.30 per share
 

 

 

 
(11,651
)
 

 

 
(11,651
)
Exercise of stock appreciation rights and options
 

 

 
(7
)
 

 
1

 

 
(6
)
Restricted stock units
 
3

 

 
(140
)
 

 
31

 

 
(109
)
Compensation expense — stock appreciation rights and options
 

 

 
606

 

 

 

 
606

Other share-based compensation expense
 

 

 
1,308

 

 

 

 
1,308

Other
 

 

 

 
(1
)
 
1

 

 

Balance at December 31, 2018
 
38,757

 
10,000

 
170,385

 
1,208,748

 
(404,586
)
 
(94,632
)
 
889,915

Net income
 

 

 

 
16,535

 

 

 
16,535

Other comprehensive income (loss)
 

 

 

 

 

 
(2,362
)
 
(2,362
)
Cash dividends — $0.31 per share
 

 

 

 
(11,979
)
 

 

 
(11,979
)
Purchases of common stock for treasury
 
(192
)
 

 

 

 
(11,158
)
 

 
(11,158
)
Exercise of stock appreciation rights and options
 
13

 

 
(197
)
 

 
149

 

 
(48
)
Compensation expense — stock appreciation rights and options
 

 

 
574

 

 

 

 
574

Other share-based compensation expense
 

 

 
1,365

 

 

 

 
1,365

Other
 
15

 

 
(393
)
 
10

 
389

 

 
6

Balance at March 31, 2019
 
38,593

 
$
10,000

 
$
171,734

 
$
1,213,314

 
$
(415,206
)
 
$
(96,994
)
 
$
882,848








6

Table of Contents

APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
(In thousands)

For the Period Ended March 31, 2018
 
Shares of
Common
Stock
Outstanding
 
Common
Stock
 
Additional
Paid-In
Capital
 

Retained
Earnings
 
Treasury
Shares-
at Cost
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Shareholders'
Equity
Balance at July 1, 2017
 
39,041

 
$
10,000

 
$
164,655

 
$
1,033,751

 
$
(381,448
)
 
$
(81,702
)
 
$
745,256

Net income
 
  
 
  
 
  
 
33,721

 
  
 
  
 
33,721

Other comprehensive income (loss)
 
  
 
  
 

 
  
 
  
 
8,152

 
8,152

Cash dividends — $0.29 per share
 
  
 
  
 
  
 
(2
)
 
  
 
  
 
(2
)
Purchases of common stock for treasury
 
(248
)
 
  
 
  
 
  
 
(13,761
)
 
  
 
(13,761
)
Exercise of stock appreciation rights and options
 
1

 
  
 
(80
)
 
  
 
14

 
  
 
(66
)
Performance share awards
 
5

 

 
(273
)
 

 
(24
)
 

 
(297
)
Restricted stock units
 
13

 

 
(616
)
 

 
(57
)
 

 
(673
)
Compensation expense — stock appreciation rights and options
 

 
  
 
577

 
  
 

 
  
 
577

Other share-based compensation expense
 
  
 
  
 
778

 
  
 
  
 
  
 
778

Other
 
2

 
  
 
(43
)
 
3

 
23

 
  
 
(17
)
Balance at September 30, 2017
 
38,814

 
10,000

 
164,998

 
1,067,473

 
(395,253
)
 
(73,550
)
 
773,668

Net income
 
  
 
  
 
  
 
30,950

 
  
 
  
 
30,950

Other comprehensive income (loss)
 
  
 
  
 
  
 
  
 
  
 
(6,064
)
 
(6,064
)
Cash dividends — $0.29 per share
 
  
 
  
 
  
 
(11,246
)
 
  
 
  
 
(11,246
)
Purchases of common stock for treasury
 
(145
)
 
  
 
  
 
  
 
(9,017
)
 
  
 
(9,017
)
Exercise of stock appreciation rights and options
 
3

 
  
 
(171
)
 
  
 
(26
)
 
  
 
(197
)
Restricted stock units
 
2

 

 
(54
)
 

 
8

 

 
(46
)
Compensation expense — stock appreciation rights and options
 
  
 
  
 
436

 
  
 
  
 
  
 
436

Other share-based compensation expense
 
  
 
  
 
799

 
  
 
  
 
  
 
799

Other
 

 
  
 

 
(21
)
 

 
  
 
(21
)
Balance at December 31, 2017
 
38,674

 
10,000

 
166,008

 
1,087,156

 
(404,288
)
 
(79,614
)
 
779,262

Net income
 
  
 
  
 
  
 
36,592

 
  
 
  
 
36,592

Other comprehensive income (loss)
 
  
 
  
 
  
 
  
 
  
 
(386
)
 
(386
)
Cash dividends — $0.30 per share
 
  
 
  
 
  
 
(11,637
)
 
  
 
  
 
(11,637
)
Exercise of stock appreciation rights and options
 
8

 
  
 
(169
)
 
  
 
(18
)
 
  
 
(187
)
Restricted stock units
 

 

 

 

 
(3
)
 

 
(3
)
Compensation expense — stock appreciation rights and options
 
  
 
  
 
466

 
  
 
  
 
  
 
466

Other share-based compensation expense
 
  
 
  
 
1,904

 
  
 
  
 
  
 
1,904

Other
 
14

 
  
 
(361
)
 
25

 
353

 
  
 
17

Balance at March 31, 2018
 
38,696

 
$
10,000

 
$
167,848

 
$
1,112,136

 
$
(403,956
)
 
$
(80,000
)
 
$
806,028




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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)



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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

1.    BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the financial position of Applied Industrial Technologies, Inc. (the “Company”, or “Applied”) as of March 31, 2019, and the results of its operations and its cash flows for the nine month periods ended March 31, 2019 and 2018, have been included. The condensed consolidated balance sheet as of June 30, 2018 has been derived from the audited consolidated financial statements at that date. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended June 30, 2018.
Operating results for the nine month period ended March 31, 2019 are not necessarily indicative of the results that may be expected for the remainder of the fiscal year ending June 30, 2019.

Inventory
The Company uses the LIFO method of valuing U.S. inventories. An actual valuation of inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs and are subject to the final year-end LIFO inventory determination.

Derivatives
The Company records all derivatives on the balance sheet at fair value.  The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting, and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.
In accordance with the FASB’s fair value measurement guidance, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

Recently Adopted Accounting Guidance
Revenue from Contracts with Customers
In May 2014, the FASB issued Accounting Standards Update ("ASU") 2014-09, "Revenue from Contracts with Customers (Topic 606)" ("ASC 606"). The standard outlines a single comprehensive model for entities to use in the accounting for revenue arising from contracts with customers. 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." Subsequent to the issuance of ASU 2014-09, the FASB issued ASU 2015-14, ASU 2016-08, ASU 2016-10, and ASU 2016-12, which clarify the guidance in ASU 2014-09 but do not change the core principle of the revenue recognition model, and have been collectively codified into ASC 606. The provisions of ASC 606 are effective for interim and annual periods beginning after December 15, 2017. On July 1, 2018, the Company adopted ASC 606 using the modified retrospective method. As a result, the Company applied ASC 606 only to contracts that were not completed as of July 1, 2018. The adoption of ASC 606 resulted in a net increase to opening retained earnings of approximately $3,429, net of tax, on July 1, 2018. See Note 2, Revenue Recognition, for further information on the impacts of these standard updates.


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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

Income Tax Consequences of Intra-entity Transfer of Assets other than Inventory
In October 2016, the FASB issued its final standard on the income tax consequences of intra-entity transfers of assets other than inventory. This standard, issued as ASU 2016-16, requires that an entity recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs and eliminates the exception for an intra-entity transfer of an asset other than inventory. This update is effective for annual and interim financial statement periods beginning after December 15, 2017. The Company adopted ASU 2016-16 during the first quarter of fiscal 2019 using the modified retrospective method, and recorded a cumulative-effect adjustment decreasing retained earnings by $424, recording a deferred tax asset of $587 and reversing a prepaid asset of $1,011 as of the beginning of the period. The deferred tax asset is included in other assets on the condensed consolidated balance sheet as of March 31, 2019.

Targeted Improvements to Accounting for Hedging Activities
In August 2017, the FASB issued its final standard on targeted improvements to accounting for hedging activities. This standard, issued as ASU 2017-12, expands and refines hedge accounting for both nonfinancial and financial risk components and aligns the recognition and presentation of the effects of the hedging instruments and the hedged item in the financial statements. This update is effective for annual and interim financial statement periods beginning after December 15, 2018. The Company early adopted ASU 2017-12 during the third quarter of fiscal 2019.

Recently Issued Accounting Guidance
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 annual financial statement periods beginning after December 15, 2018, with earlier application permitted. In July 2018, the FASB issued ASU 2018-10 which clarifies the guidance in ASU 2016-02, and ASU 2018-11 which provides entities with an additional transition method option for adopting the new standard. The company plans to use this new transition method option upon adoption and recognize a cumulative-effect adjustment to the opening balance of retained earnings. In December 2018 and January 2019, the FASB issued ASU 2018-20 and ASU 2019-01, respectively, which further clarify the guidance. The Company has established a cross-functional team to evaluate the new standard and is in the process of implementing new lease administration software. The Company is still determining the financial impact that this standard update will have on its consolidated financial statements, but anticipates it will have a material impact on its assets and liabilities due to the addition of right-of-use assets and lease liabilities to the consolidated balance sheet. The Company will continue to evaluate the impacts of the adoption of the standard and these assessments are subject to change.
In June 2016, the FASB issued its final standard on measurement of credit losses on financial instruments. This standard, issued as ASU 2016-13, requires that an entity measure impairment of certain financial instruments, including trade receivables, based on expected losses rather than incurred losses. This update is effective for annual and interim financial statement periods beginning after December 15, 2019, with early adoption permitted for financial statement periods beginning after December 15, 2018. In November 2018, the FASB issued ASU 2018-19 which clarifies the guidance in ASU 2016-13. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures.
In August 2016, the FASB issued its final standard on the classification of certain cash receipts and cash payments within the statement of cash flows. This standard, issued as ASU 2016-15, makes a number of changes meant to add or clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows. This update is effective for annual and interim financial statement periods beginning after December 15, 2018, with early adoption permitted. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures.
In August 2018, the FASB issued its final standard on the accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. This standard, issued as ASU 2018-15, aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This update is effective for annual and interim periods beginning after December 15, 2019, with early adoption permitted. The Company has not yet determined the impact of this pronouncement on its financial statements and related disclosures.



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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

2.    REVENUE RECOGNITION

The Company adopted ASC 606 - Revenue from Contracts with Customers using the modified retrospective method effective July 1, 2018. The Company completed an analysis of revenue streams at each of its business units and evaluated the impact of adopting ASC 606 on revenue recognition. The Company primarily sells purchased products and the majority of its revenue is recognized at a point in time. The cumulative effect of initially applying ASC 606 resulted in a net increase to the opening retained earnings balance of $3,429, net of tax, at July 1, 2018. The transition adjustment is comprised of two components. The first component is recognition of revenue from bill and hold arrangements. The second component is recognition of revenue from contracts that meet the criteria to recognize revenue over time as the underlying products have no alternative use and the Company has a right to payment for performance completed to date. Revenue for periods prior to July 1, 2018 has not been adjusted and continues to be reported under ASC Topic 605 - Revenue Recognition.
Revenue Recognition
The Company primarily sells purchased products distributed through its network of service centers and recognizes revenue at a point in time when control of the product transfers to the customer, typically upon shipment from an Applied facility or directly from a supplier. For products that ship directly from suppliers to customers, Applied acts as the principal in the transaction and recognizes revenue on a gross basis. Revenue recognized over time is not significant. Revenue is measured as the amount of consideration expected to be received in exchange for the products and services provided, net of allowances for product returns, variable consideration, and any taxes collected from customers that will be remitted to governmental authorities. Shipping and handling costs are recognized in net sales when they are billed to the customer. The Company has elected to account for shipping and handling activities as fulfillment costs. There are no significant costs associated with obtaining customer contracts.
Payment terms with customers vary by the type and location of the customer and the products or services offered. The Company does not adjust the promised amount of consideration for the effects of significant financing components based on the expectation that the period between when the Company transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less. Arrangements with customers that include payment terms extending beyond one year are not significant.
Accounts Receivable
Accounts receivable are stated at their estimated net realizable value and consist of amounts billed or billable and currently due from customers. The Company maintains an allowance for doubtful accounts, which reflects management’s best estimate of probable losses based on an analysis of customer accounts, known troubled accounts, historical experience with write-offs, and other currently available evidence.
Variable Consideration
The Company’s products are generally sold with a right of return and may include variable consideration in the form of incentives, discounts, credits or rebates. Product returns are estimated based on historical return rates. The Company estimates and recognizes variable consideration based on historical experience to determine the expected amount to which the Company will be entitled in exchange for transferring the promised goods or services to a customer. The Company records variable consideration as an adjustment to the transaction price in the period it is incurred. The realization of variable consideration occurs within a short period of time from product delivery; therefore, the time value of money effect is not significant.
Contract Assets
The Company’s contract assets consist of un-billed amounts resulting from contracts for which revenue is recognized over time using the cost-to-cost method, and for which revenue recognized exceeds the amount billed to the customer. On July 1, 2018, $13,823 of contract assets were recognized as part of the cumulative effect adjustment resulting from the adoption of ASC 606.
Activity related to contract assets, which are included in other current assets on the condensed consolidated balance sheet, is as follows:
 
March 31, 2019
July 1, 2018
$ Change
% Change
Contract assets
$
8,732

$
13,823

$
(5,091
)
(36.8
)%

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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

The following tables summarize the impacts of ASC 606 on the Company's condensed consolidated financial statements:
 
 
Three Months Ended March 31, 2019
 
 
As Reported
 
Adjustments
 
Balances without adoption of ASC 606
Net sales
 
$
885,443

 
$
569

 
$
886,012

Cost of sales
 
629,884

 
369

 
630,253

Gross profit
 
255,559

 
200

 
255,759

Selling, distribution and administrative expense, including depreciation
 
189,456

 
57

 
189,513

Intangible Impairment
 
31,594

 

 
31,594

Operating income
 
34,509

 
143

 
34,652

Interest expense, net
 
9,947

 

 
9,947

Other income, net
 
(1,256
)
 

 
(1,256
)
Income before income taxes
 
25,818

 
143

 
25,961

Income tax expense
 
9,283

 
37

 
9,320

Net income
 
$
16,535

 
$
106

 
$
16,641

 
 
Nine Months Ended March 31, 2019
 
 
As Reported
 
Adjustments
 
Balances without adoption of ASC 606
Net sales
 
$
2,589,996

 
$
4,886

 
$
2,594,882

Cost of sales
 
1,839,724

 
3,472

 
1,843,196

Gross profit
 
750,272

 
1,414

 
751,686

Selling, distribution and administrative expense, including depreciation
 
556,865

 
331

 
557,196

Intangible Impairment
 
31,594

 

 
31,594

Operating income
 
161,813

 
1,083

 
162,896

Interest expense, net
 
30,001

 

 
30,001

Other income, net
 
(549
)
 

 
(549
)
Income before income taxes
 
132,361

 
1,083

 
133,444

Income tax expense
 
28,171

 
273

 
28,444

Net income
 
$
104,190

 
$
810

 
$
105,000


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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

 
 
As of March 31, 2019
 
 
As Reported
 
Adjustments
 
Balances without adoption of ASC 606
Assets
 
 
 
 
 
 
Other current assets
 
$
49,380

 
$
(8,732
)
 
$
40,648

Inventories
 
454,555

 
11,461

 
466,016

Other assets
 
33,761

 
209

 
33,970

 
 
 
 
 
 
 
Liabilities
 


 
 
 
 
Other current liabilities
 
62,731

 
6,649

 
69,380

Compensation and related benefits
 
69,324

 
(402
)
 
68,922

Other liabilities
 
77,497

 
(692
)
 
76,805

 
 


 
 
 
 
Equity
 
 
 
 
 
 
Retained Earnings
 
$
882,848

 
$
(2,619
)
 
$
880,229

Disaggregation of Revenues
The following tables present the Company's net sales by reportable segment and by geographic areas based on the location of the facility shipping the product for the three and nine months ended March 31, 2019. Other countries consist of Mexico, Australia, New Zealand, and Singapore.
 
Three Months Ended March 31,
 
2019
 
2018
 
Service Center Based Distribution
Fluid Power & Flow Control
Total
 
Service Center Based Distribution
Fluid Power & Flow Control
Total
Geographic Areas:
 
 
 
 
 
 
 
United States
$
520,180

$
251,922

772,102

 
$
491,698

$
222,197

$
713,895

Canada
66,725


66,725

 
68,112


$
68,112

Other countries
43,533

3,083

46,616

 
41,404

4,254

$
45,658

Total
$
630,438

$
255,005

$
885,443

 
$
601,214

$
226,451

$
827,665

 
Nine Months Ended March 31,
 
2019
 
2018
 
Service Center Based Distribution
Fluid Power & Flow Control
Total
 
Service Center Based Distribution
Fluid Power & Flow Control
Total
Geographic Areas:
 
 
 
 
 
 
 
United States
$
1,490,289

$
756,433

2,246,722

 
$
1,399,513

$
438,958

$
1,838,471

Canada
204,401


204,401

 
202,408


$
202,408

Other countries
129,095

9,778

138,873

 
123,813

10,861

$
134,674

Total
$
1,823,785

$
766,211

$
2,589,996

 
$
1,725,734

$
449,819

$
2,175,553


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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

The following tables present the Company’s percentage of revenue by reportable segment and major customer industry for the three and nine months ended March 31, 2019:
 
Three Months Ended March 31, 2019
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
General Industry
35.8
%
 
41.7
%
 
37.5
%
Industrial Machinery
10.2
%
 
24.2
%
 
14.2
%
Metals
12.0
%
 
8.6
%
 
11.0
%
Food
10.5
%
 
2.5
%
 
8.2
%
Oil & Gas
10.1
%
 
2.3
%
 
7.9
%
Chem/Petrochem
2.8
%
 
12.8
%
 
5.7
%
Forest Products
7.0
%
 
3.6
%
 
6.0
%
Cement & Aggregate
6.9
%
 
1.0
%
 
5.2
%
Transportation
4.7
%
 
3.3
%
 
4.3
%
Total
100.0
%
 
100.0
%
 
100.0
%
 
Nine Months Ended March 31, 2019
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
General Industry
35.9
%
 
44.0
%
 
38.2
%
Industrial Machinery
9.7
%
 
22.0
%
 
13.3
%
Metals
12.2
%
 
8.3
%
 
11.1
%
Food
10.4
%
 
2.5
%
 
8.1
%
Oil & Gas
10.0
%
 
2.2
%
 
7.7
%
Chem/Petrochem
3.1
%
 
14.1
%
 
6.3
%
Forest Products
7.6
%
 
3.0
%
 
6.3
%
Cement & Aggregate
6.5
%
 
1.0
%
 
4.9
%
Transportation
4.6
%
 
2.9
%
 
4.1
%
Total
100.0
%
 
100.0
%
 
100.0
%

14

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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

The following tables present the Company’s percentage of revenue by reportable segment and product line for the three and nine months ended March 31, 2019:
 
Three Months Ended March 31, 2019
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
Power Transmission
34.5
%
 
2.3
%
 
25.2
%
Fluid Power
13.5
%
 
41.3
%
 
21.5
%
General Maintenance; Hose Products
24.7
%
 
4.7
%
 
18.9
%
Bearings, Linear & Seals
27.3
%
 
0.4
%
 
19.6
%
Specialty Flow Control
%
 
51.3
%
 
14.8
%
Total
100.0
%
 
100.0
%
 
100.0
%
 
Nine Months Ended March 31, 2019
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
Power Transmission
33.8
%
 
1.7
%
 
24.3
%
Fluid Power
13.7
%
 
39.0
%
 
21.2
%
General Maintenance; Hose Products
26.0
%
 
5.0
%
 
19.7
%
Bearings, Linear & Seals
26.5
%
 
0.3
%
 
18.8
%
Specialty Flow Control
%
 
54.0
%
 
16.0
%
Total
100.0
%
 
100.0
%
 
100.0
%

3.
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 2019 Acquisitions
On March 4, 2019, the Company acquired substantially all of the net assets of MilRoc Distribution and Woodward Steel. MilRoc Distribution is an Oklahoma based distributor of oilfield specific products, namely pumps and valves, as well as equipment repair services and industrial parts to the oil & gas industry. Woodward Steel is an Oklahoma based steel supplier to the oil & gas and agriculture industries. MilRoc Distribution and Woodward Steel are both included in the Service Center Based Distribution segment. The purchase price for the acquisition was $35,000, net tangible assets acquired were $17,981, and intangible assets including goodwill was $17,019 based upon preliminary estimated fair values at the acquisition date, which are subject to adjustment. The purchase price includes acquisition holdback payments of $4,375, which are included in other current liabilities and other liabilities on the condensed consolidated balance sheet as of March 31, 2019, and which will be paid on the first, second, and third anniversaries of the acquisition date with interest at a fixed rate of 2.0% per annum. The Company funded this acquisition using available cash. The acquisition price and the results of operations for the acquired entity are not material in relation to the Company's consolidated financial statements.
On November 2, 2018, the Company acquired substantially all of the net assets of Fluid Power Sales, Inc. (FPS), a Baldwinsville, New York based manufacturer and distributor of fluid power components, specializing in the engineering and fabrication of manifolds and power units. FPS is included in the Fluid Power & Flow Control segment. The purchase price for the acquisition was $8,100, net tangible assets acquired were $4,156, and goodwill was $3,944 based upon preliminary estimated fair values at the acquisition date, which are subject to adjustment. The purchase price includes acquisition holdback payments of $1,200, which is included in other current liabilities and other liabilities on the condensed consolidated balance sheet as of March 31, 2019, and which will be paid on the first and second anniversaries of the acquisition date with interest at a fixed rate of 1.5% per annum. The Company funded

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

this acquisition using available cash. The acquisition price and the results of operations for the acquired entity are not material in relation to the Company's consolidated financial statements.
FCX Acquisition
On January 31, 2018, the Company completed the acquisition of 100% of the outstanding shares of FCX Performance, Inc. (FCX), a Columbus, Ohio based distributor of specialty process flow control products and services. The total consideration transferred for the acquisition was $781,781, which was financed by cash-on-hand and a new credit facility comprised of a $780,000 Term Loan A and a $250,000 revolver, effective with the transaction closing. See Note 5 - Debt. As a distributor of engineered valves, instruments, pumps and lifecycle services to MRO (Maintenance, Repair & Operations) and OEM (Original Equipment Manufacturer) customers across diverse industrial and process end markets, this business is included in the Fluid Power & Flow Control segment.

The following table summarizes the consideration transferred, assets acquired, and liabilities assumed in connection with the acquisition of FCX based on their estimated fair values at the acquisition date.
Cash
$
11,141

Accounts receivable
80,836

Inventories
44,669

Other current assets
1,753

Property
8,282

Identifiable intangible assets
305,420

Goodwill
440,012

Other assets
775

Total assets acquired
$
892,888

Accounts payable and accrued liabilities
54,035

Other liabilities
2,677

Deferred tax liabilities
54,395

Net assets acquired
$
781,781

 
 
Purchase price
$
784,281

Reconciliation of fair value transferred:
 
Working Capital Adjustments
(2,500
)
Total Consideration
$
781,781


Goodwill acquired of $161,452 is expected to be deductible for income tax purposes.

Net sales, operating income, and net income from the FCX acquisition included in the Company’s three and nine months ended March 31, 2019 are as follows:
 
Three Months Ended March 31, 2019
Nine Months Ended March 31, 2019
Net sales
$
132,595

$
417,336

Operating income
6,659

29,117

Net income
5,115

22,798



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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

The following unaudited pro forma consolidated results of operations have been prepared as if the FCX acquisition (including the related acquisition costs) had occurred at the beginning of fiscal 2018:
 
Three Months Ended March 31,
Nine Months Ended March 31,
Pro forma
2018
2018
Net sales
$
866,818

$
2,432,709

Operating income
62,360

164,302

Net income
40,546

98,391

Diluted net income per share
$
1.03

$
2.51


These pro forma amounts have been calculated after applying the Company’s accounting policies and adjusting the results to reflect additional amortization that would have been recorded assuming the fair value adjustments to identified intangible assets had been applied as of July 1, 2017. 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 FCX; 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 2018 Acquisition
On July 3, 2017, the Company acquired 100% of the outstanding stock of Diseño, Construcciones y Fabricaciones Hispanoamericanas, S.A. (DICOFASA), a distributor of accessories and components for hydraulic systems and lubrication, located in Puebla, Mexico. DICOFASA is included in the Service Center Based Distribution segment. The purchase price for the acquisition was $5,920, net tangible assets acquired were $3,395, and goodwill was $2,525 based upon estimated fair values at the acquisition date. The purchase price includes $906 of acquisition holdback payments, of which $219 was paid during the nine months ended March 31, 2019. Due to changes in foreign currency exchange rates, the remaining balance is $645, which is included in other current liabilities and other liabilities on the condensed consolidated balance sheet as of March 31, 2019, and which will be paid on the second and third anniversaries of the acquisition date with interest at a fixed rate of 1.5% per annum. The Company funded this acquisition using available cash. The acquisition price and the results of operations for the acquired entity are not material in relation to the Company's consolidated financial statements.

4.    GOODWILL AND INTANGIBLES

The changes in the carrying amount of goodwill for both the Service Center Based Distribution segment and the Fluid Power & Flow Control segment for the fiscal year ended June 30, 2018 and the nine month period ended March 31, 2019 are as follows:
 
Service Center Based Distribution
 
Fluid Power & Flow Control
 
Total
Balance at July 1, 2017
$
201,740

 
$
4,395

 
$
206,135

Goodwill acquired during the period
2,525

 
439,164

 
441,689

Other, primarily currency translation
(1,181
)
 

 
(1,181
)
Balance at June 30, 2018
$
203,084

 
$
443,559

 
$
646,643

Goodwill acquired/adjusted during the period
9,872

 
4,791

 
14,663

Other, primarily currency translation
(111
)
 

 
(111
)
Balance at March 31, 2019
$
212,845

 
$
448,350

 
$
661,195


The Company has seven (7) reporting units for which an annual goodwill impairment assessment was performed as of January 1, 2019.  The Company concluded that all of the reporting units’ fair value exceeded their carrying amounts by at least 20% as of January 1, 2019. The fair values of the reporting units in accordance with the goodwill

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

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 utilizes an analysis of comparable publicly traded companies. 

The techniques used in the Company's impairment tests have incorporated a number of assumptions that the Company believes to be reasonable and to reflect known market conditions at the measurement dates. 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. 

At March 31, 2019 and June 30, 2018, accumulated goodwill impairment losses subsequent to fiscal year 2002 totaled $64,794 related to the Service Center Based Distribution segment and $36,605 related to the Fluid Power & Flow Control segment.

The Company’s identifiable intangible assets resulting from business combinations are amortized over their estimated period of benefit and consist of the following:
March 31, 2019
 
Amount
 
Accumulated
Amortization
 
Net Book
Value
Finite-Lived Identifiable Intangibles:
 
 
 
 
 
 
Customer relationships
 
$
422,077

 
$
127,758

 
$
294,319

Trade names
 
105,933

 
25,417

 
80,516

Vendor relationships
 
11,387

 
7,968

 
3,419

Non-competition agreements
 
2,702

 
2,112

 
590

Total Identifiable Intangibles
 
$
542,099

 
$
163,255

 
$
378,844


June 30, 2018
 
Amount
 
Accumulated
Amortization
 
Net Book
Value
Finite-Lived Identifiable Intangibles:
 
 
 
 
 
 
Customer relationships
 
$
465,691

 
$
125,009

 
$
340,682

Trade names
 
112,939

 
22,454

 
90,485

Vendor relationships
 
11,425

 
7,382

 
4,043

Non-competition agreements
 
2,761

 
2,024

 
737

Total Identifiable Intangibles
 
$
592,816

 
$
156,869

 
$
435,947


Amounts include the impact of foreign currency translation. Fully amortized amounts are written off.

During the nine month period ended March 31, 2019, the Company acquired identifiable intangible assets with a preliminary acquisition cost allocation and weighted-average life as follows:
 
 
Acquisition Cost Allocation
 
Weighted-Average Life
Customer relationships
 
$
5,956

 
20
Trade names
 
941

 
5
Non-competition agreements
 
250

 
5
Total Intangibles Acquired
 
$
7,147

 
17.5

18

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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)


Due to a sustained decline in economic conditions in the upstream oil and gas industry in western Canada, management also assessed the long-lived intangible assets related to the Reliance asset group in Canada for impairment during the third quarter of fiscal 2019. The Reliance asset group is located in western Canada and primarily serves customers in the upstream oil and gas industry. The asset group carrying value exceeded the sum of the undiscounted cash flows, indicating impairment. The fair value of the asset group was then determined using the Income approach, and the analysis resulted in the measurement of a full impairment loss of $31,594, which was recorded in the three months ended March 31, 2019.

Estimated future amortization expense by fiscal year (based on the Company’s identifiable intangible assets as of March 31, 2019) for the next five years is as follows: $10,200 for the remainder of 2019, $39,000 for 2020, $36,900 for 2021, $34,800 for 2022, $32,700 for 2023 and $28,500 for 2024.

5.     DEBT

Revolving Credit Facility & Term Loan
In January 2018, in conjunction with the acquisition of FCX, the Company refinanced its existing credit facility and entered into a new five-year credit facility with a group of banks expiring in January 2023. This agreement provides for a $780,000 unsecured term loan and a $250,000 unsecured revolving credit facility. Fees on this facility range from 0.10% to 0.20% per year based upon the Company's leverage ratio at each quarter end. Borrowings under this agreement carry variable interest rates tied to either LIBOR or prime at the Company's discretion. At March 31, 2019 and June 30, 2018, the Company had $618,500 and $775,125, respectively, outstanding under the term loan. The interest rate on the term loan as of March 31, 2019 and June 30, 2018 was 4.25% and 4.13%, respectively. The Company had $19,000 and $19,500 outstanding under the revolver at March 31, 2019 and June 30, 2018, respectively. Unused lines under this facility, net of outstanding letters of credit of $3,290 and $3,625, respectively, to secure certain insurance obligations, totaled $227,710 and $226,875 at March 31, 2019 and June 30, 2018, respectively, and were available to fund future acquisitions or other capital and operating requirements. The weighted average interest rate on the amount outstanding under the revolving credit facility was 4.39% and 3.93% as of March 31, 2019 and June 30, 2018, respectively.
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 March 31, 2019 and June 30, 2018, in order to secure certain insurance obligations.
Trade Receivable Securitization Facility
In August 2018, the Company established a trade receivable securitization facility (the “AR Securitization Facility”) with a termination date of August 31, 2021. The maximum availability under the AR Securitization Facility is $175,000. Availability is further subject to changes in the credit ratings of our customers, customer concentration levels or certain characteristics of the accounts receivable being transferred and, therefore, at certain times, we may not be able to fully access the $175,000 of funding available under the AR Securitization Facility. The AR Securitization Facility effectively increases the Company’s borrowing capacity by collateralizing a portion of the amount of the Service Center Based Distribution reportable segment’s U.S. operations’ trade accounts receivable. The collateralized trade accounts receivable is equal to the borrowed amount outstanding under the AR Securitization Facility and there are no restrictions on cash or other assets. The Company uses the proceeds from the AR Securitization Facility as an alternative to other forms of debt, effectively reducing borrowing costs. Borrowings under this facility carry variable interest rates tied to LIBOR and fees on the AR Securitization Facility are 0.90% per year. As of March 31, 2019, the Company borrowed $175,000 under the AR Securitization Facility, and the interest rate was 3.39%.
Other Long-Term Borrowings
At March 31, 2019 and June 30, 2018, 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.
In 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 March 31, 2019 and June 30, 2018, $1,263 and $1,438 was outstanding, respectively.

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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

Unamortized debt issue costs of $574 and $551 are included as a reduction of current portion of long-term debt on the condensed consolidated balance sheets as of March 31, 2019 and June 30, 2018, respectively. Unamortized debt issue costs of $1,490 and $1,807 are included as a reduction of long-term debt on the condensed consolidated balance sheets as of March 31, 2019 and June 30, 2018, respectively.

6.     DERIVATIVES
Risk Management Objective of Using Derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s borrowings.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive loss and subsequently reclassified into interest expense in the same period(s) during which the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive loss related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt.
In January 2019, the Company entered into an interest rate swap to mitigate variability in forecasted interest payments on $463,000 of the Company’s U.S. dollar-denominated unsecured variable rate debt. The interest rate swap effectively converts a portion of the floating rate interest payment into a fixed rate interest payment. The Company designated the interest rate swap as a pay-fixed, receive-floating interest rate swap instrument and is accounting for this derivative as a cash flow hedge. The fair value of the interest rate cash flow hedge was $6,856 as of March 31, 2019 (Level 2 in the fair value hierarchy), which is included in other current liabilities and other liabilities in the condensed consolidated balance sheet. Losses related to the interest rate cash flow hedge were not material during the three or nine months ended March 31, 2019.

7.    FAIR VALUE MEASUREMENTS

Marketable securities measured at fair value at March 31, 2019 and June 30, 2018 totaled $10,818 and $10,318, respectively. The majority of these marketable securities are held in a rabbi trust for a non-qualified deferred compensation plan. The marketable securities are included in other assets on the accompanying condensed consolidated balance sheets and their fair values were determined using quoted market prices (Level 1 in the fair value hierarchy).
As of March 31, 2019 and June 30, 2018, the carrying values of the Company's fixed interest rate debt outstanding under its unsecured shelf facility agreement with Prudential Investment Management approximated fair value (Level 2 in the fair value hierarchy).
The revolving credit facility, the term loan and the AR Securitization Facility contain variable interest rates and their carrying values approximate fair value (Level 2 in the fair value hierarchy).



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

8.    INCOME TAXES

On December 22, 2017, the Tax Cuts and Jobs Act (the "Act") was enacted in the U.S., making significant changes to U.S. tax law. The Act reduced the U.S. federal corporate income tax rate from 35% to 21%, required companies to pay a one-time transition tax on certain un-remitted earnings of foreign subsidiaries that were previously tax deferred, generally eliminated U.S. federal income tax on dividends from foreign subsidiaries, and created new taxes on certain foreign-sourced earnings. During the nine months ended March 31, 2019, the Company's estimated annual effective tax rate reflects the change in the federal statutory rate from 35% to 21%.
As of March 31, 2019, we have completed our accounting for the tax effects of the Act. In fiscal 2018, we recognized a provisional tax liability of $3,877 related to the one-time transition tax on certain un-remitted earnings of foreign subsidiaries, which is payable over eight years, if elected. The Company has paid the liability in full and no election was made on the Company's federal tax return to defer the payments over eight years. During fiscal 2019, the Company recorded adjustments totaling $3,448 to reduce the tax liability related to the one-time transition tax. We also recorded a net tax benefit of $619 to increase the foreign tax credit related to the transition tax. The new taxes and deductions related to certain foreign-sourced earnings recognized in fiscal 2019 resulted in a net tax benefit of $576. These adjustments were included as components of income tax expense in the condensed statements of consolidated income.
During the three months ended March 31, 2019, the Company recorded a valuation allowance of $3,785 related to certain deferred tax assets in Canada due to the uncertainty in realizing these net deferred tax assets.

9.    SHAREHOLDERS' EQUITY

Accumulated Other Comprehensive Loss
Changes in the accumulated other comprehensive loss are comprised of the following amounts, shown net of taxes:
 
 
Three Months Ended March 31, 2019
 
 
Foreign currency translation adjustment

 
Post-employment benefits

 
Cash flow hedge

 
Total Accumulated other comprehensive (loss) income

Balance at January 1, 2019
 
$
(92,220
)
 
$
(2,412
)
 
$

 
$
(94,632
)
Other comprehensive income (loss)
 
2,767

 

 
(5,136
)
 
(2,369
)
Amounts reclassified from accumulated other comprehensive (loss) income
 

 
(56
)
 
63

 
7

Net current-period other comprehensive income (loss)
 
2,767

 
(56
)
 
(5,073
)
 
(2,362
)
Balance at March 31, 2019
 
$
(89,453
)
 
$
(2,468
)
 
$
(5,073
)
 
$
(96,994
)

 
 
Three Months Ended March 31, 2018
 
 
Foreign currency translation adjustment

 
Unrealized gain on securities available for sale

 
Post-employment benefits

 
Total Accumulated other comprehensive (loss) income

Balance at January 1, 2018
 
$
(77,355
)
 
$
35

 
$
(2,294
)
 
$
(79,614
)
Other comprehensive (loss) income
 
(378
)
 
6

 

 
(372
)
Amounts reclassified from accumulated other comprehensive (loss) income
 

 

 
(14
)
 
(14
)
Net current-period other comprehensive (loss) income
 
(378
)
 
6

 
(14
)
 
(386
)
Balance at March 31, 2018
 
$
(77,733
)
 
$
41

 
$
(2,308
)
 
$
(80,000
)


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APPLIED INDUSTRIAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts) (Unaudited)

 
 
Nine Months Ended March 31, 2019
 
 
Foreign currency translation adjustment

 
Unrealized gain (loss) on securities available for sale

 
Post-employment benefits

 
Cash flow hedge

 
Total Accumulated other comprehensive (loss) income

Balance at July 1, 2018
 
$
(87,974
)
 
$
50

 
$
(2,299
)
 
$

 
$
(90,223
)
Other comprehensive loss
 
(1,479
)
 

 

 
(5,136
)
 
(6,615
)
Amounts reclassified from accumulated other comprehensive (loss) income
 

 

 
(169
)
 
63

 
(106
)
Cumulative effect of adopting accounting standard
 

 
(50
)
 

 

 
(50
)
Net current-period other comprehensive loss
 
(1,479
)
 
(50
)
 
(169
)
 
(5,073
)
 
(6,771
)
Balance at March 31, 2019
 
$
(89,453
)
 
$

 
$
(2,468
)
 
$
(5,073
)
 
$
(96,994
)

 
 
Nine Months Ended March 31, 2018
 
 
Foreign currency translation adjustment

 
Unrealized gain on securities available for sale

 
Post-employment benefits

 
Total Accumulated other comprehensive (loss) income

Balance at July 1, 2017
 
$
(79,447
)
 
$
21

 
$
(2,276
)
 
$
(81,702
)
Other comprehensive income
 
1,714

 
20

 

 
1,734

Amounts reclassified from accumulated other comprehensive (loss) income
 

 

 
(32
)
 
(32
)
Net current-period other comprehensive income (loss)
 
1,714

 
20

 
(32
)
 
1,702

Balance at March 31, 2018
 
$
(77,733
)
 
$
41

 
$
(2,308
)
 
$
(80,000
)

Other Comprehensive (Loss) Income
Details of other comprehensive (loss) income are as follows:
 
Three Months Ended March 31,
 
2019
 
2018