DONALDSON COMPANY, INC. The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) provides a comparison of the Company's results of operations, as well as liquidity and capital resources for the years endedJuly 31, 2020 and 2019. A discussion of changes in the Company's results of operations and liquidity and capital resources for the year endedJuly 31, 2019 fromJuly 31, 2018 can be found in Part II, "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the year endedJuly 31, 2019 (the "2019 Annual Report"), which was filed with theSEC onSeptember 27, 2019 . The MD&A should be read in conjunction with the Company's Consolidated Financial Statements and Notes included in Item 8 of this Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed elsewhere in this Annual Report, particularly Item 1A, "Risk Factors" and in the Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995, below. Throughout this MD&A, the Company refers to measures used by management to evaluate performance, including a number of financial measures that are not defined under generally accepted accounting principles inthe United States of America (GAAP). Excluding foreign currency translation from net sales and net earnings (i.e. constant currency) and excluding the impact of one-time transactions are not measures of financial performance under GAAP; however, the Company believes they are useful in understanding its financial results and provide comparable measures for understanding the operating results of the Company between different fiscal periods. Reconciliations within this MD&A provide more details on the use and derivation of these measures. Overview The Company is a worldwide manufacturer of filtration systems and replacement parts. The Company's core strengths include leading filtration technology, strong customer relationships and its global presence. Products are manufactured around the world. Products are sold to original equipment manufacturers (OEMs), distributors, dealers and directly to end users. The Company has two operating segments: Engine Products and Industrial Products. Products in the Engine Products segment consist of replacement filters for both air and liquid filtration applications, air filtration systems, liquid filtration systems for fuel, lube and hydraulic applications, exhaust and emissions systems and sensors, indicators and monitoring systems. The Engine Products segment sells to OEMs in the construction, mining, agriculture, aerospace, defense and transportation end markets and to independent distributors, OEM dealer networks, private label accounts and large fleets. Products in the Industrial Products segment consist of dust, fume and mist collectors, compressed air purification systems, gas and liquid filtration for food, beverage and industrial processes, air filtration systems for gas turbines, polytetrafluoroethylene (PTFE) membrane-based products and specialized air and gas filtration systems for applications including hard disk drives and semi-conductor manufacturing and sensors, indicators and monitoring systems. The Industrial Products segment sells to various dealers, distributors, OEMs and end users. 12 -------------------------------------------------------------------------------- The outbreak of the coronavirus (COVID-19), which was declared a pandemic by theWorld Health Organization (WHO ), is impacting worldwide economic activity. To navigate the pandemic, the Company is prioritizing the health and safety of its employees, fulfilling its customer commitments and implementing protocols to help lessen the spread of COVID-19. With respect to business operations and the protection of its employees, the Company implemented a variety of countermeasures to promote the health and safety of its employees and their families during this pandemic, including business travel restrictions, remote work capabilities, social distancing practices, increased cleaning frequency and thoroughness, temperature screenings and quarantine protocols. The Company's practices and policies are informed by recommendations from public health authorities, such as theCenters for Disease Control and Prevention ,European Centre for Disease Prevention and Control and theWHO , which are being closely monitored by the Company's crisis response team. Many of the Company's customer industries, including manufacturing, transportation, agriculture, defense and food and beverage, have been deemed "essential" or "critical" by governmental agencies. The Company, as well as some of its customers and suppliers, have experienced temporary closures in certain regions, reflecting its compliance with local mandates and support of its employees, but the Company has continued to operate during the pandemic and avoided meaningful operational disruption. The Company continually aligns its worldwide manufacturing resources as customer needs and market conditions change, and its region-to-support-region production footprint and supply chain strategy provide the Company with flexibility to adjust to local circumstances while mitigating the potential for global disruption. While the Company has experienced a material impact from the COVID-19 pandemic, the ultimate duration and future magnitude of the impact on the Company's financial performance remains unclear. Consolidated Results of Operations Net sales for the year endedJuly 31, 2020 were$2,581.8 million , compared with$2,844.9 million for the year endedJuly 31, 2019 , a decrease of$263.1 million , or 9.2%, including a negative impact from foreign currency translation of$38.1 million . On a constant currency basis, net sales for the year endedJuly 31, 2020 decreased 7.9% from the prior year. Net earnings for the year endedJuly 31, 2020 were$257.0 million , compared with$267.2 million for the year endedJuly 31, 2019 , a decrease of$10.2 million , or 3.8%. Diluted earnings per share were$2.00 for the year endedJuly 31, 2020 , compared with$2.05 for the year endedJuly 31, 2019 , a decrease of 2.4%. The following table summarizes consolidated results of operations for each of the years endedJuly 31, 2020 and 2019 (in millions, except per share data): Year Ended July 31, Percent of Net Sales 2020 2019 2020 2019 Net sales$ 2,581.8 $ 2,844.9 100.0 % 100.0 % Cost of sales 1,710.2 1,896.6 66.2 66.7 Gross profit 871.6 948.3 33.8 33.3 Selling, general and administrative 470.3 497.8 18.2 17.5 Research and development 61.2 62.3 2.4 2.2 Operating income 340.1 388.2 13.2 13.6 Interest expense 17.4 19.9 0.7 0.7 Other income, net (12.5) (6.9) (0.5) (0.2) Earnings before income taxes 335.2 375.2 13.0 13.2 Income taxes 78.2 108.0 3.0 3.8 Net earnings$ 257.0 $ 267.2 10.0 % 9.4 % Net earnings per share - diluted$ 2.00 $ 2.05 13
--------------------------------------------------------------------------------Net Sales Net sales by operating segment are as follows (in millions): Year Ended July 31, Percent of Net Sales 2020 2019 2020 2019 Engine Products$ 1,727.5 $ 1,926.0 66.9 % 67.7 % Industrial Products 854.3 918.9 33.1 32.3 Net sales$ 2,581.8 $ 2,844.9 100.0 % 100.0 %
Year Ended July 31 ,
Percent of
2020 2019 2020 2019
United States $ 1,059.9 $ 1,192.6 41.1 % 41.9 %
Europe, Middle East and Africa 760.2 826.8 29.4 29.1
Asia Pacific 553.2 597.9 21.4 21.0
Latin America 208.5 227.6 8.1 8.0
Net sales $ 2,581.8 $ 2,844.9 100.0 % 100.0 %
Net sales by origination is generally based on the country of the Company's
legal entity where the customer's order was placed.
Impact of Foreign Currency Translation on Net Sales
Year Ended
2020 2019
Prior fiscal year net sales $ 2,844.9 $ 2,734.2
Change in net sales excluding translation (225.0) 184.7
Impact of foreign currency translation (1) (38.1) (74.0)
Current fiscal year net sales $ 2,581.8 $ 2,844.9
(1)The impact of foreign currency translation is calculated by translating current fiscal year foreign currency revenue intoU.S. dollars using the average foreign currency exchange rates for the prior fiscal year. The fiscal 2020 net sales decreased$263.1 million , or 9.2% from fiscal 2019, reflecting sales declines in the Engine Products segment of$198.5 million , or 10.3%, and the Industrial Products segment of$64.6 million , or 7.0%. Foreign currency translation decreased total sales by$38.1 million compared to the prior fiscal year, reflecting decreases in the Engine and Industrial Products segments of$29.4 million and$8.7 million , respectively. In fiscal 2020, the Company's net sales declined as slowing economic activity contributed to lower levels of heavy-duty equipment production and industrial activity in certain end markets. The slowdown was magnified by the negative economic impacts of the COVID-19 pandemic. Net sales were the weakest in businesses related to new equipment, while sales of replacement parts experienced a less significant decline as activity in certain markets continued during the pandemic. Gross Margin Cost of sales for the year endedJuly 31, 2020 was$1,710.2 million , compared with$1,896.6 million for the year endedJuly 31, 2019 , a decrease of$186.4 million , or 9.8%. Gross margin for the year endedJuly 31, 2020 was 33.8% compared to 33.3% for the year endedJuly 31, 2019 , an increase of 0.5%. The gross margin increase was driven by benefits from the Company's favorable mix of sales and lower raw materials costs combined with optimization initiatives. This increase was partially offset by a loss of leverage on lower sales, due in part to higher depreciation expense related to the Company's recently completed capacity expansion projects. 14 -------------------------------------------------------------------------------- Operating Expenses Operating expenses for the year endedJuly 31, 2020 were$531.5 million , or 20.6% of net sales, compared with$560.1 million , or 19.7% of net sales, for the year endedJuly 31, 2019 , a decrease of$28.6 million , or 5.1%. The decrease was primarily driven by expense reductions related to the COVID-19 pandemic and lower incentive compensation. As a rate of sales, operating expenses increased, reflecting a loss of leverage on lower sales. Non-Operating Items Interest expense for the year endedJuly 31, 2020 was$17.4 million , compared with$19.9 million , for the year endedJuly 31, 2019 , a decrease of$2.5 million , or 12.6%. The decrease in interest expense was primarily due to lower interest rates compared with the prior year. Other income, net for the year endedJuly 31, 2020 was$12.5 million , compared with$6.9 million , for the year endedJuly 31, 2019 , an increase of$5.6 million , or 81.4%. The increase was primarily due to improved joint venture performance. Income Taxes The effective tax rate was 23.3% and 28.8% for the years endedJuly 31, 2020 and 2019, respectively. The effective tax rate for the year endedJuly 31, 2019 included a net discrete tax expense of$18.7 million related to one-time adjustments for the enactment of theU.S. Tax Cuts and Jobs Act (TCJA). Excluding this expense, the effective tax rate for the year endedJuly 31, 2019 was 23.7%. The decrease in the adjusted effective tax rate was primarily due to a favorable shift in the mix of earnings between tax jurisdictions and tax benefits related to the release during the current fiscal year of certain treasury regulations governing foreign income and foreign tax credits. These decreases were partially offset by a nonrecurring discrete tax benefit recorded in the prior fiscal year related to the favorable settlement of tax audits, and a decrease in excess tax benefits on stock-based compensation. The effective tax rate is reconciled to the adjusted effective tax rate as follows: July 31, 2020 2019 Effective tax rate 23.3 % 28.8 % Impact of TCJA (1) - % (5.1) % Adjusted effective tax rate 23.3 % 23.7 % (1)TCJA-related matters resulted in charges of$18.7 million for the year endedJuly 31, 2019 . Net Earnings Net Earnings for the year endedJuly 31, 2020 was$257.0 million , compared with$267.2 million for the year endedJuly 31, 2019 , a decrease of$10.2 million , or 3.8%. Net earnings for the year endedJuly 31, 2019 included a net discrete tax expense of$18.7 million related to one-time adjustments for the enactment of the TCJA. Refer to Note 12 in the Notes to Consolidated Financial Statements included in Item 8 of this report for further discussion of TCJA. Diluted earnings per share were$2.00 for the year endedJuly 31, 2020 , compared with$2.05 for the year endedJuly 31, 2019 . The Company's net earnings are impacted by fluctuations in foreign currency exchange rates. The following table reflects the impact of these fluctuations on net earnings for the years endedJuly 31, 2020 and 2019 (in millions): Year Ended July
31,
2020 2019
Prior fiscal year net earnings$ 267.2 $
180.3
Change in net earnings excluding translation (7.2)
94.9
Impact of foreign currency translation (1) (3.0)
(8.0)
Current fiscal year net earnings$ 257.0 $
267.2
(1)The impact of foreign currency translation is calculated by translating
current fiscal year foreign currency net earnings into
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Segment Results of Operation
Net sales and earnings before income taxes by operating segment for the years
ended July 31, 2020 and 2019 are summarized as follows (in millions):
Year Ended July 31,
2020 2019 $ Change % Change
Net sales
Engine Products segment $ 1,727.5 $ 1,926.0 $ (198.5) (10.3) %
Industrial Products segment 854.3 918.9 (64.6) (7.0)
Total $ 2,581.8 $ 2,844.9 $ (263.1) (9.2) %
Earnings before income taxes
Engine Products segment $ 229.3 $ 254.6 $ (25.3) (9.9) %
Industrial Products segment 124.9 140.1 (15.2) (10.8)
Corporate and Unallocated (1) (19.0) (19.5) 0.5 (2.6)
Total $ 335.2 $ 375.2 $ (40.0) (10.7) %
(1)Corporate and Unallocated includes corporate expenses determined to be
non-allocable to the segments, such as interest expense.
Engine Products Segment
The following is a summary of net sales by product group within the Company's
Engine Products segment for the years ended July 31, 2020 and 2019 (in
millions):
Year Ended July 31,
2020 2019 $ Change % Change
Engine Products segment
Off-Road $ 256.5 $ 315.1 $ (58.6) (18.6) %
On-Road 124.4 179.8 (55.4) (30.8)
Aftermarket 1,228.9 1,315.3 (86.4) (6.6)
Aerospace and Defense 117.7 115.8 1.9 1.6
Engine Products segment net sales $ 1,727.5 $ 1,926.0 $ (198.5) (10.3) %
Engine Products segment earnings before
income taxes $ 229.3 $ 254.6 $ (25.3) (9.9) %
Net sales for the Engine Products segment for the year ended July 31, 2020 were
$1,727.5 million , compared with $1,926.0 million for the year ended July 31,
2019 , a decrease of $198.5 million , or 10.3%. Excluding the $29.4 million
decrease from foreign currency translation, fiscal 2020 sales decreased 8.8%.
Worldwide sales of Off-Road were $256.5 million , a decrease of 18.6% from fiscal
2019. In constant currency, sales decreased $54.7 million , or 17.3%. Off-Road
sales weakened in every major region due to lower levels of equipment production
as certain markets moved through their respective economic cycles. Additionally,
many of the Company's customers significantly reduced or temporarily halted
production in certain of their facilities in response to the COVID-19 pandemic,
compounding the impact from already weak end-market conditions. The Off-Road
decrease was partially offset by growth associated with program wins in emerging
markets.
Worldwide sales of On-Road were $124.4 million , a decrease of 30.8% from fiscal
2019. In constant currency, sales decreased $54.9 million , or 30.5%. On-Road
sales weakened in every major region due to lower levels of equipment production
as certain markets moved through their respective economic cycles, primarily due
to heavy-duty truck production in the U.S. market. Additionally, many of the
Company's customers significantly reduced or temporarily halted production in
certain of their facilities in response to the COVID-19 pandemic, compounding
the impact from already weak end-market conditions.
Worldwide sales of Aftermarket were $1,228.9 million , a decrease of 6.6% from
fiscal 2019. In constant currency, sales decreased $62.4 million , or 4.7%.
Aftermarket sales in both the distribution and OEM channels decreased due to
reduced end user demand associated with lower levels of equipment utilization in
certain markets, which was compounded by the COVID-19 pandemic. The independent
channel had the most significant decline, driven in part by the oil and gas
slowdown in the U.S. and economic pressure across Latin America , partially
offset by fiscal year-over-year growth in Europe and China related to market
share gains. Sales through the OEM channel reflected similar market-related
pressures that were partially offset by growing sales of the Company's
innovative products.
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Worldwide sales of Aerospace and Defense were $117.7 million , an increase of
1.6% from fiscal 2019. In constant currency, sales increased $2.9 million , or
2.5%. Aerospace and Defense sales performance reflected fiscal year-over-year
increases in products for military rotorcraft and ground defense vehicles.
Earnings before income taxes for the Engine Products segment for the year ended
July 31, 2020 were $229.3 million , or 13.3% of Engine Products' sales, an
increase from 13.2% of sales for the year ended July 31, 2019 . The increase was
driven by benefits from the Company's favorable mix of sales and lower raw
materials costs combined with optimization initiatives. This increase was
partially offset by a loss of leverage on lower sales and the impact from higher
depreciation expense related to the Company's capacity expansion projects.
Industrial Products Segment
The following is a summary of net sales by product group within the Company's
Industrial Products segment for the years ended July 31, 2020 and 2019 (in
millions):
Year Ended July 31,
2020 2019 $ Change % Change
Industrial Products segment:
Industrial Filtration Solutions $ 581.2 $ 641.8 $ (60.6) (9.4) %
Gas Turbine Systems 101.6 106.3 (4.7) (4.5)
Special Applications 171.5 170.8 0.7 0.4
Industrial Products segment net sales $ 854.3 $ 918.9 $ (64.6) (7.0) %
Industrial Products segment earnings
before income taxes $ 124.9 $ 140.1 $ (15.2) (10.8) %
Net sales for the Industrial Products segment for the year ended July 31, 2020
were $854.3 million , compared with $918.9 million for the year ended July 31,
2019 , a decrease of $64.6 million , or 7.0%. Excluding the $8.7 million decrease
from foreign currency translation, fiscal 2020 sales decreased 6.1%.
Worldwide sales of Industrial Filtration Solutions (IFS) were $581.2 million , a
decrease of 9.4% from fiscal 2019. In constant currency, sales decreased $52.2
million , or 8.1%. IFS sales decreased due to lower sales of new equipment and
replacement parts for dust collectors, due in part to the economic slowdown
created by the COVID-19 pandemic as many of the Company's customers
significantly reduced or temporarily halted production in certain of their
facilities in response to the COVID-19 pandemic. This decrease was partially
offset by sales of Process Filtration, which grew due to strong sales of
replacement parts for the Food and Beverage industry.
Worldwide sales of Gas Turbine Systems were $101.6 million , a decrease of 4.5%
from fiscal 2019. In constant currency, sales decreased $4.0 million , or 3.8%.
The decrease in Gas Turbine Systems sales was driven by a decline in sales of
products for new large turbines, reflecting the Company's continued execution of
its strategic shift toward more profitable opportunities.
Worldwide sales of Special Applications were $171.5 million , an increase of 0.4%
from fiscal 2019. In constant currency, sales increased $0.3 million , or 0.2%.
The increase in Special Applications sales was driven by higher sales of Disk
Drive filters and Semicon / Imaging products, partially offset by lower sales of
Membrane products.
Earnings before income taxes for the Industrial Products segment for the year
ended July 31, 2020 were $124.9 million , or 14.6% of Industrial Products' sales,
a decrease from 15.2% of sales for the year ended July 31, 2019 . The decrease
was driven by a loss of leverage on lower sales, due in part to continued
investments in the Company's strategic growth businesses, combined with the
impact from higher depreciation expense related to the Company's capacity
expansion projects. The decrease was partially offset by lower incentive
compensation expense and the Company's optimization initiatives combined with a
favorable mix of sales and lower raw materials costs.
Liquidity and Capital Resources
Liquidity Analysis
Liquidity is assessed in terms of the Company's ability to generate cash to fund
its operating, investing and financing activities. Significant factors affecting
liquidity are: cash flows generated from operating activities, capital
expenditures, acquisitions, dividends, repurchases of outstanding shares,
adequacy of available bank lines of credit and the ability to attract long-term
capital with satisfactory terms. The Company generates substantial cash from the
operation of its businesses as its primary source of liquidity, with sufficient
liquidity available to fund growth through reinvestment in existing businesses
and strategic acquisitions.
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Secondary sources of liquidity are existing cash and available credit
facilities. At July 31, 2020 , cash and cash equivalents were $236.6 million . A
significant portion of the Company's cash and cash equivalents are held by
subsidiaries throughout the world as over half of the Company's earnings occur
outside the U.S. Additionally, the Company has capacity of $625.1 million
available for further borrowing under existing credit facilities as of July 31,
2020 .
Short-term borrowing capacity at July 31, 2020 includes the following (in
millions):
European
U.S. Credit Commercial Paper European Operations Rest of the World
Facilities Program Credit Facilities Credit Facilities Total
Available short-term credit
facilities $ 190.0 $ 118.4 $ 55.4 $ 54.6 $ 418.4
Reductions to borrowing
capacity:
Outstanding borrowings - - - 3.8 3.8
Other non-borrowing reductions - - 20.9 21.1 42.0
Total reductions - - 20.9 24.9 45.8
Remaining short-term borrowing
capacity $ 190.0 $ 118.4 $ 34.5 $ 29.7 $ 372.6
Other non-borrowing reductions include financial instruments such as bank
guarantees and foreign exchange instruments. The weighted average interest rate
at July 31, 2020 for outstanding borrowings for the rest of the world credit
facilities was 1.48%.
As of July 31, 2020 , the Company's $500.0 million revolving credit facility is
with a group of lenders, in which it can borrow in multiple currencies, and
matures on July 21, 2022 . It is reported as long-term debt on the Company's
Consolidated Balance Sheet. Key items are as follows (in millions):
Revolving credit facility $ 500.0
Reductions to borrowing capacity:
Outstanding borrowings 240.0
Contingent liability for standby letters of credit 7.5
Total reductions 247.5
Remaining borrowing capacity $ 252.5
Weighted average interest rate at fiscal year end 1.29 %
The revolving credit facility includes an accordion feature in which the Company
can request to increase the revolving credit facility by up to $250.0 million ,
subject to terms of agreement including written notification and lender
acceptance. The remaining borrowing capacity reflects the issued standby letters
of credit, as discussed in Note 16 to the Consolidated Financial Statements
included in Item 8 of this Annual Report, as issued standby letters of credit
reduce the amounts available for borrowing.
Certain debt agreements contain financial covenants related to interest coverage
and leverage ratios, as well as other non-financial covenants. As of July 31,
2020 , the Company was in compliance with all such covenants.
The Company believes that the liquidity available from the combination of the
expected cash generated by operating activities, existing cash and available
credit under existing credit facilities will be sufficient to meet its cash
requirements for the next twelve months, including working capital needs, debt
service obligations, capital expenditures, payment of anticipated dividends,
share repurchase activity and potential acquisitions. For further discussion on
short-term borrowings and long-term debt, refer to Notes 7 and 8 in the Notes to
Consolidated Financial Statements included in Item 8 of this Annual Report.
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Cash Flow Summary
Cash flows for the years ended July 31, 2020 , 2019 and 2018 are summarized as
follows (in millions):
July 31,
2020 2019 2018Net cash provided by (used in):
Operating activities $ 387.0 $ 345.8 $ 262.9
Investing activities (128.9) (246.4) (95.4)
Financing activities (199.5) (123.3) (268.8)
Effect of exchange rate changes on cash 0.2 (3.0) (2.4)
Increase (decrease) in cash and cash equivalents
Operating Activities Cash provided by operating activities for the year endedJuly 31, 2020 was$387.0 million , compared with$345.8 million for the year endedJuly 31, 2019 , an increase of$41.2 million . The increase in cash provided by operating activities was primarily driven by fiscal year-over-year improvements in net operating assets and liabilities. These changes are due to the Company's efforts to manage working capital as sales levels decreased. The increase also reflects a reduction in accounts receivable, resulting from lower revenues related to the COVID-19 pandemic. Investing Activities Cash used in investing activities for the year endedJuly 31, 2020 was$128.9 million , compared with$246.4 million for the year endedJuly 31, 2019 , a decrease of$117.5 million . Fiscal 2019 included$96.0 million of net cash used for theBOFA International LTD (BOFA) acquisition. In addition, fiscal 2020 had a decrease in net capital expenditures of$26.3 million . In fiscal 2020, capital expenditures included expanding production capacity as well as construction of a new facility designed for research and development. Financing Activities Cash used in financing activities generally relate to the use of cash for payment of dividends and repurchases of the Company's common stock, net borrowing activity and proceeds from the exercise of stock options. To determine the level of dividend and share repurchases, the Company considers recent and projected performance across key financial metrics, including earnings, cash flow from operations, and total debt. Dividends paid for the years endedJuly 31, 2020 and 2019 were$106.4 million and$99.7 million , respectively. Share repurchases for the years endedJuly 31, 2020 and 2019 were$94.3 million and$129.2 million , respectively. Cash used in financing activities for the year endedJuly 31, 2020 was$199.5 million , compared with$123.3 million for the year endedJuly 31, 2019 , an increase of$76.2 million . In fiscal 2020, proceeds from long-term debt were used to fund the Company's needs driven by expenditures on property, plant and equipment, dividends and share repurchases. In fiscal 2019, proceeds from long-term debt and short-term borrowings were used primarily to fund theBOFA acquisition and to fund the Company's needs driven by expenditures on property, plant and equipment, dividends and share repurchases. Financial Condition The Company's total capitalization components and debt-to-capitalization ratio atJuly 31, 2020 and 2019 was as follows (in millions): July
31,
2020 % 2019 %
Short-term borrowings $ 3.8 0.2 %
Current maturities of long-term debt 5.7 0.4
50.2 3.3
Long-term debt 617.4 38.1 584.4 38.2
Total debt 626.9 38.7 636.7 41.6
Shareholders' equity 992.9 61.3 892.7 58.4
Total capitalization $ 1,619.8 100.0 % $ 1,529.4 100.0 %
As of
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Long-term debt outstanding at July 31, 2020 was $617.4 million compared with
$584.4 million at July 31, 2019 , an increase of $33.0 million . The increase
reflects higher long-term debt primarily to refinance repayment of the current
portion of long-term debt.
Accounts receivable, net at July 31, 2020 was $455.3 million , compared with
$529.5 million at July 31, 2019 , a decrease of $74.2 million , primarily due to
lower revenue resulting from the COVID-19 pandemic. Days sales outstanding were
63 days as of July 31, 2020 , down from 65 days as of July 31, 2019 . Days sales
outstanding is calculated using the count back method, which calculates the
number of days of most recent revenue that is reflected in the net accounts
receivable balance.
Inventories, net at July 31, 2020 was $322.7 million , compared with
$332.8 million at July 31, 2019 , a decrease of $10.1 million . Inventory turns
were 4.9 times and 5.6 times per year as of July 31, 2020 and 2019,
respectively. Inventory turns are calculated by taking the annualized cost of
sales based on the trailing three month period divided by the average of the
beginning and ending net inventory values of the three month period.
Accounts payable at July 31, 2020 was $187.7 million , compared with
$237.5 million at July 31, 2019 , a decrease of $49.8 million , primarily due to
lower levels of purchasing associated with lower levels of sales.
Off-Balance Sheet Arrangements
Joint Venture Guarantee The Company guarantees 50% of certain debt and banking
services, including credit and debit cards, merchant processing and treasury
management services, of its joint venture with Caterpillar Inc., Advanced
Filtration Systems Inc. (AFSI). As of July 31, 2020 , the joint venture had
$40.0 million of outstanding debt, of which the Company guarantees half. The
Company does not believe this guarantee will have a current or future effect on
its financial condition, results of operations, liquidity or capital resources.
Contractual Obligations
The following table summarizes the Company's contractual obligations as of
July 31, 2020 , for the fiscal years indicated (in millions):
Payments Due by Period
Less than 1 - 3 3 - 5 More than
Total 1 year years years 5 years
Long-term debt obligations $ 623.1 $ 5.7
62.3 9.5 18.8 14.1 19.9
Operating lease obligations(1) 80.0 26.8 28.1 11.7 13.4
Purchase obligations (2) 156.8 145.5 9.7 1.6 -
Pension and deferred compensation (3) 55.3 8.1 7.9 7.6 31.7
Total (4) $ 977.5 $ 195.6 $ 303.2 $ 288.9 $ 189.8
(1)As described in Note 1 to our Consolidated Financial Statements, on August 1,
2019 , the Company adopted ASU 2016-02, Leases (Topic 842) under the modified
retrospective approach, and thus Consolidated Financial Statements prior to
fiscal 2020 were not restated for the adoption of this standard.
(2)Purchase obligations consist primarily of inventory, tooling and capital
expenditures. The Company's purchase orders for inventory are based on expected
customer demand and, as a result, quantities and dollar volumes are subject to
change.
(3)Pension and deferred compensation consist of long-term pension liabilities
and salary and bonus deferrals elected by certain executives under the Company's
deferred compensation plan. Deferred compensation balances earn interest based
on a treasury bond rate as defined by the plan (10-year treasury bond STRIP rate
plus 2% for deferrals prior to January 1, 2011 and 10 year treasury bond rates
for deferrals after December 31, 2010 ), are approved by the Human Resources
Committee of the Board of Directors and are payable at the election of the
participants.
(4)In addition to the above contractual obligations, the Company may be
obligated for additional cash outflows of $19.2 million for potential tax
obligations, including accrued interest and penalties. The payment and timing of
any such payments is affected by the ultimate resolution of the tax years,
current or future, that are under audit or dispute or remain subject to
examination by the relevant taxing authorities. Therefore, quantification of an
estimated range and timing of future payments cannot be made at this time.
Additionally, the transition tax on deemed repatriated earnings of non-U.S.
subsidiaries resulting from the TCJA is not included in contractual obligations.
See Note 12 to the Consolidated Financial Statements included in Item 8 of this
Annual Report for further information.
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Critical Accounting Policies
The Company's Consolidated Financial Statements are prepared in conformity with
GAAP. The preparation of these Consolidated Financial Statements requires the
use of estimates and judgments that affect the reported amounts of assets and
liabilities at the date of the Consolidated Financial Statements and the
reported amounts of revenue and expenses during the periods presented.
Management bases estimates on historical experience and various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about recorded amounts. The
Company believes its use of estimates and underlying accounting assumptions
adheres to GAAP and are reasonable and consistently applied. The Company's
Critical Accounting Policies are those which require more significant estimates
and judgments used in the preparation of its Consolidated Financial Statements
and are the most important to aid in fully understanding its financial results.
The Company's Critical Accounting Policies are the following:
Revenue recognition - variable consideration The transaction price of a contract
could be reduced by variable consideration including product refunds, returns,
volume purchase rebates and discounts in the determination of net sales. The
Company primarily relies on historical experience and anticipated future
performance to estimate the variable consideration. Revenue is recognized to the
extent that it is probable that a significant reversal of revenue will not occur
when the contingency is resolved.
At the time of sale to a customer, the Company records an estimate for product
refunds and returns, sales promotion and incentive costs that are classified as
a reduction from gross sales.
For product refunds and returns, estimates are based primarily on the estimated
number of products sold, the trend in the historical ratio of returns to sales,
and the historical length of time between the sale and resulting return. Actual
refunds and returns could be higher or lower than amounts estimated due to such
factors as performance of new products, or significant manufacturing or design
defects not discovered until after the product is delivered to customers.
For sales promotion and incentive costs, estimates are based on the terms of the
arrangements with customers, historical payment experience, field inventory
levels, volume in quantity or mix of purchases of product during a specified
time period and expectations for changes in relevant trends in the future.
Actual results may differ from estimates if competitive factors create the need
to enhance or reduce sales promotion and incentive accruals or if customer usage
and field inventory levels vary from historical trends. Adjustments to sales
promotions and incentive accruals are made from time to time as actual usage
becomes known in order to properly estimate the amounts necessary to generate
consumer demand based on market conditions as of the balance sheet date.
Goodwill Goodwill represents the excess of the purchase price over the fair
value of net assets acquired in business combinations under the purchase method
of accounting. The Company performed its annual impairment assessment during the
third quarter of fiscal 2020 and determined that there were no indicators of
impairment for any of the reporting units evaluated. The goodwill impairment
assessment is conducted at a reporting unit level, which is one level below the
operating segment level, and utilizes either a qualitative or quantitative
assessment.
The optional qualitative assessment evaluates general economic, industry and
entity-specific factors that could impact the reporting units' fair values. For
reporting units evaluated using a qualitative assessment, if it is determined
that the fair value more likely than not exceeds the carrying value, no further
assessment is necessary. The Company has elected this option for certain
reporting units. For reporting units evaluated using a quantitative assessment,
the fair values are determined using an income approach, a market approach or a
weighting of the two. The income approach determines fair value based on
discounted cash flow models derived from the reporting units' long-term
forecasts. The market approach determines fair value based on earnings multiples
derived from prices investors paid for the stocks of comparable, publicly traded
companies. An impairment loss would be recognized when the carrying amount of a
reporting unit's net assets exceeds the estimated fair value of the reporting
unit. Estimates and assumptions are utilized in the valuations, including
discounted projected cash flows, earnings before interest, taxes, depreciation
and amortization (EBITDA) margins, terminal value growth rates, revenue growth
rates, discount rates and the determination of comparable, publicly traded
companies. Changes in these estimates and assumptions could materially affect
the determination of fair value and goodwill impairment.
Income taxes Management is required to estimate income taxes in each of the
jurisdictions in which the Company operates. This process involves estimating
current tax exposure and assessing future tax consequences attributable to
temporary differences between the financial statement carrying amount of
existing assets and liabilities and their respective tax basis. These deferred
tax assets and liabilities are measured using the enacted tax rates expected to
apply to taxable income in the fiscal years in which those temporary differences
are anticipated to reverse based on future taxable income projections and the
impact of tax planning strategies. The Company intends to indefinitely reinvest
undistributed earnings for certain of its non-U.S. subsidiaries and thus has not
provided for income taxes on these earnings.
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Additionally, benefits of tax return positions are recognized in the
Consolidated Financial Statements when the position is more-likely-than-not to
be sustained by the taxing authorities based solely on the technical merits of
the position. If the recognition threshold is met, the tax benefit is measured
and recognized as the largest amount of tax benefit that in the Company's
judgment is greater than 50% likely to be realized. The Company maintains a
reserve for uncertain tax benefits that are currently unresolved and routinely
monitors the potential impact of such situations. The liability for unrecognized
tax benefits, accrued interest and penalties was $19.2 million and $17.1 million
as of July 31, 2020 and 2019, respectively.
The Company believes it is remote that any adjustment necessary to the reserve
for income taxes for the next 12 month period will be material. However, it is
possible the ultimate resolution of audits or disputes may result in a material
change to our reserve for income taxes, although the quantification of such
potential adjustments cannot be made at this time.
Defined benefit pension plans The Company incurs expenses for employee benefits
provided through defined benefit pension plans. In accounting for these defined
benefit pension plans, management must make a variety of estimates and
assumptions including mortality rates, discount rates, overall Company
compensation increases and expected return on plan assets. The Company considers
historical data as well as current facts and circumstances and uses a
third-party specialist to assist management in determining these estimates.
To develop the assumption for the expected long-term rate of return on assets
for its U.S. pension plans, the Company considered historical returns and future
expected returns for each asset class, as well as the target asset allocation of
the pension portfolio. The expected return on plan assets assumption for the
plans outside the U.S. reflects the investment allocation and expected total
portfolio returns specific to each plan and country. The Company utilized a
6.08% asset-based weighted average expected return on plan assets for its U.S.
plans as of the measurement dates July 31, 2020 and 2019. The Company utilized a
3.78% and 3.76% asset-based weighted average expected return on plan assets for
its non-U.S. plans for the years ended July 31, 2020 and 2019, respectively. The
expected returns on plan assets are used to develop the following fiscal years'
expense for the plans.
The Company's objective in selecting a discount rate for its pension plans is to
select the best estimate of the rate at which the benefit obligations could be
effectively settled on the measurement date, taking into account the nature and
duration of the benefit obligations of the plan. In making this best estimate,
the Company looks at the rates of return on high-quality, fixed-income
investments currently available, and expected to be available, during the period
to maturity of the benefits. This process includes assessing the universe of
bonds available on the measurement date with a quality rating of Aa or better.
Similar appropriate benchmarks are used to determine the discount rate for the
non-U.S. plans. The Company utilized a 2.37% and 3.54% weighted average discount
rate for its U.S. plans for the years ended July 31, 2020 and 2019,
respectively. The Company utilized a 1.48% and 1.79% weighted average discount
rate for its non-U.S. plans for the years ended July 31, 2020 and 2019,
respectively.
The Company utilizes a full yield curve approach to estimate service and
interest costs for pension benefits by applying specific spot rates along the
yield curve used to determine the benefit obligation of relevant projected cash
outflows. This method provides a precise measurement of service and interest
costs by aligning the timing of the plans' liability cash flows to the
corresponding spot rate on the yield curve.
If the Company were to use alternative assumptions for its pension plans at
July 31, 2020 , a 1% change would result in the following impact on 2020 pension
costs (in millions):
U.S. Pension Plans +1% (1)%
Rate of return $ (3.3) $ 3.3
Discount rate (38.7) 47.1
Non-U.S. Pension Plans +1% (1)%
Rate of return $ (1.6) $ 1.6
Discount rate (30.3) 36.0
The Company's net periodic benefit cost recognized in the Consolidated
Statements of Earnings was $7.2 million , $3.8 million and $5.1 million for the
years ended July 31, 2020 , 2019 and 2018, respectively. While changes to the
Company's pension plan assumptions would not be expected to impact its net
periodic benefit cost by a material amount, such changes could significantly
impact the Company's projected benefit obligation.
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Business Combinations The Company allocates the purchase price of acquired
businesses to the estimated fair values of the assets acquired and liabilities
assumed as of the date of acquisition. The fair values of the long-lived assets
acquired, primarily intangible assets, are determined using calculations which
can be complex and require significant judgment. Estimates include many factors
such as the nature of the acquired company's business, its historical financial
position and results, customer retention rates, discount rates and future
performance. Independent valuation specialists are used to assist in determining
certain fair value calculations.
The Company estimates the fair value of acquired customer relationships using
the multi-period excess earnings method. This approach is typically applied when
cash flows are not directly generated by the asset, but rather, by an operating
group which includes the particular asset. Value is estimated as the present
value of the benefits anticipated from ownership of the asset, in excess of the
returns required on the investment in contributory assets which are necessary to
realize those benefits. The intangible asset's estimated earnings are determined
as the residual earnings after quantifying estimated earnings from contributory
assets. Assumptions used in these calculations include same-customer revenue
growth rates, estimated earnings and customer attrition rates.
The Company estimates the fair value of trade names and/or trademarks using the
relief from royalty method, which calculates the cost savings associated with
owning rather than licensing the assets. Assumed royalty rates are applied to
projected revenue for the remaining useful lives of the assets to estimate the
royalty savings. Royalty rates are selected based on the attributes of the
asset, including reputation and recognition within the industry.
While the Company uses its best estimates and assumptions, fair value estimates
are inherently uncertain and subject to refinement. As a result, during the
measurement period, which may be up to one year from the acquisition date, the
Company may record adjustments to the assets acquired and liabilities assumed,
with the corresponding offset to goodwill. Any adjustments required after the
measurement period are recorded in the consolidated statement of earnings. The
judgments required in determining the estimated fair values and expected useful
lives assigned to each class of assets and liabilities acquired can
significantly affect net income.
New Accounting Standards Not Yet Adopted
For new accounting standards not yet adopted, refer to Note 1 in the Notes to
Consolidated Financial Statements included in Item 8 of this Annual Report.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
The Company, through its management, may make forward-looking statements
reflecting the Company's current views with respect to future events and
expectations, such as forecasts, plans, trends and projections relating to the
Company's business and financial performance. These forward-looking statements,
which may be included in reports filed under the Securities Exchange Act of
1934, as amended (the Exchange Act), in press releases and in other documents
and materials as well as in written or oral statements made by or on behalf of
the Company, are subject to certain risks and uncertainties, including those
discussed in Part I, Item 1A, "Risk Factors" of this Annual Report, which could
cause actual results to differ materially from historical results or those
anticipated. The words or phrases "will likely result," "are expected to," "will
continue," "will allow," "estimate," "project," "believe," "expect,"
"anticipate," "forecast," "plan" and similar expressions are intended to
identify forward-looking statements within the meaning of Section 21E of the
Exchange Act and Section 27A of the Securities Act of 1933, as amended, as
enacted by the Private Securities Litigation Reform Act of 1995 (PSLRA). In
particular, the Company desires to take advantage of the protections of the
PSLRA in connection with the forward-looking statements made in this Annual
Report. All statements other than statements of historical fact are
forward-looking statements. These statements do not guarantee future
performance.
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These forward-looking statements, speak only as of the date such statements are
made and are subject to risks and uncertainties. In addition, the factors listed
in Part I, Item 1A, "Risk Factors" of this Annual Report, as well as other
factors, could affect the Company's performance and could cause the Company's
actual results for future periods to differ materially from any opinions or
statements expressed. These factors include, but are not limited to, pandemics
and unexpected events, including the Coronavirus (COVID-19) pandemic; economic
and industrial conditions worldwide; the Company's ability to maintain
competitive advantages; threats from disruptive innovation; highly competitive
markets with pricing pressure; the Company's ability to protect and enforce its
intellectual property; the difficulties in operating globally; customer
concentration in certain cyclical industries; significant demand fluctuations;
unavailable raw materials or material cost inflation; inability of operations to
meet customer demand; difficulties with information technology systems and
security; foreign currency fluctuations; governmental laws and regulations;
litigation; changes in tax laws and tax rates, regulations and results of
examinations; the Company's ability to attract and retain qualified personnel;
changes in capital and credit markets; execution of the Company's acquisition,
divestiture and other strategic transactions strategy; the possibility of
intangible asset impairment; the Company's ability to manage productivity
improvements; unexpected events and business disruptions; the Company's ability
to maintain an effective system of internal control over financial reporting;
the United Kingdom's decision to end its membership in the European Union
(BREXIT) and other factors included in Part I, Item 1A, "Risk Factors" of this
Annual Report. The Company undertakes no obligation to publicly update or revise
any forward-looking statements, whether as a result of new information, future
events or otherwise, unless required by law.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company's market risk includes the potential loss arising from adverse
changes in foreign currency exchange rates, interest rates and commodity prices.
In an attempt to manage these risks, the Company employs certain strategies to
mitigate the effect of these fluctuations. The Company does not enter into any
of these instruments for speculative trading purposes.
The Company maintains significant assets and operations outside the U.S. ,
resulting in exposure to foreign currency gains and losses. A portion of the
Company's foreign currency exposure is naturally hedged by incurring
liabilities, including bank debt, denominated in the local currency in which the
Company's foreign subsidiaries are located.
During fiscal 2020, the U.S. dollar was generally stronger than in fiscal 2019
compared with many of the currencies of the foreign countries in which the
Company operates. The overall stronger dollar had a negative impact on the
Company's international net sales results because the foreign denominated
revenues translated into less U.S. dollars. Foreign currency translation had a
negative impact to net sales and net earnings in many regions around the world.
The estimated impact of foreign currency translation for the year ended July 31,
2020 , resulted in an overall decrease in reported net sales of $38.1 million and
a decrease in reported net earnings of approximately $3.0 million .
Forward Foreign Currency Exchange Contracts The Company uses forward currency
exchange contracts to manage exposure to fluctuations in foreign currency. The
Company enters into certain purchase commitments with foreign suppliers based on
the value of its purchasing subsidiaries' local currency relative to the
currency requirement of the supplier on the date of the commitment. The Company
also sells into foreign countries based on the value of purchaser's local
currency. The Company mitigates risk through using forward currency contracts
that generally mature in 12 months or less, which is consistent with the related
purchases and sales. Contracts that qualify for hedge accounting are designated
as cash flow hedges.
Net investment hedges The Company uses fixed-to-fixed cross currency swap
agreements to hedge its exposure to adverse foreign currency exchange rate
movements for its operations in Europe through July 2029 . The Company has
elected the spot method for assessing effectiveness of these contracts.
Based on the net investment hedge outstanding as of July 31, 2020 , a 10%
appreciation of the U.S. dollar compared to the Euro, would result in a net gain
of $6.2 million in the fair value of these contracts.
Interest rates The Company's exposure to market risk for changes in interest
rates relates primarily to debt obligations that are at variable rates, as well
as the potential increase in fair value of long-term debt resulting from a
potential decrease in interest rates. As of July 31, 2020 , the Company's
financial liabilities with exposure to changes in interest rates consisted
mainly of $240.0 million outstanding on the Company's revolving credit facility,
€80.0 million, or $94.7 million of a variable rate term loan, and ¥1.6 billion,
or $15.3 million , of variable rate senior notes. Assuming a hypothetical
increase of 0.5% in short-term interest rates, with all other variables
remaining constant, interest expense would have increased approximately $1.9
million and interest income would have increased approximately $1.2 million in
fiscal 2020. Interest rate changes would also affect the fair market value of
fixed-rate debt. As of July 31, 2020 , the estimated fair value of long-term debt
with fixed interest rates was $297.3 million compared to its carrying value of
$275.0 million . The fair value is estimated by discounting the projected cash
flows using the rate at which similar amounts of debt could currently be
borrowed.
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In addition, the Company is exposed to market risk for changes in interest rates
for the impact to its qualified defined benefit pension plans. The plans'
projected benefit obligation is inversely related to changes in interest rates.
Consistent with published bond indices, in fiscal 2020 the Company decreased its
discount rate from 3.54% to 2.37% on its U.S. plans and decreased its rates from
1.79% to 1.48% for its non-U.S. plans. To protect against declines in interest
rates, the pension plans hold high-quality, long-duration bonds. The plans were
underfunded by $35.0 million at July 31, 2020 , since the projected benefit
obligation exceeded the fair value of the plan assets.
Commodity prices The Company is exposed to market risk from fluctuating market
prices of certain purchased commodity raw materials, including steel, filter
media and petrochemical-based products including plastics, rubber and adhesives.
On an ongoing basis, the Company enters into selective supply arrangements with
certain of its suppliers that allow the Company to reduce volatility in its
costs. The Company strives to recover or offset all material cost increases
through selective price increases to its customers and the Company's cost
reduction initiatives, which include material substitution, process improvement
and product redesigns. However, an increase in commodity prices could result in
lower operating margins.
Chinese notes Consistent with common business practice in China , the Company's
Chinese subsidiaries accept bankers' acceptance notes from Chinese customers in
settlement of certain customer billed accounts receivable. Bankers' acceptance
notes represent a commitment by the issuing financial institution to pay a
certain amount of money at a specified future maturity date to the legal owner
of the bankers' acceptance note as of the maturity date. The maturity date of
bankers' acceptance notes varies, but it is the Company's policy to only accept
bankers' acceptance notes with maturity dates no more than 270 days from the
date of the Company's receipt of such draft. As of July 31, 2020 , the Company
owned $12.1 million of these bankers' acceptance notes, and includes them in
Accounts Receivable on the Consolidated Balance Sheets.
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