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, 2021 and 2020. A discussion of changes in the Company's results of operations and liquidity and capital resources for the year endedJuly 31, 2020 fromJuly 31, 2019 can be found in Part II, "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Company's Annual Report on Form 10-K for the year endedJuly 31, 2020 (the "2020 Annual Report"), which was filed with theSEC onSeptember 25, 2020 . 11 -------------------------------------------------------------------------------- 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 (GAAP) in theU.S. Excluding foreign currency translation from net sales and net earnings (i.e. constant currency) 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 global 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 and sold around the world. Products are sold to OEMs, distributors, dealers and directly to end users. The Company's operating segments are Engine Products and Industrial Products. The Engine Products segment consists 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. The Industrial Products segment consists 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, 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. Coronavirus (COVID-19) Pandemic The effects of the ongoing COVID-19 pandemic continue to impact global economic conditions. Management cannot predict with specificity the extent and duration of any future impact on the Company's business and financial results from the COVID-19 pandemic. Supply Chain Disruptions The Company's supply chain and manufacturing operations have experienced logistical and production constraints, and may continue to experience such constraints in the future. The supply chain disruptions the Company experienced due to a labor shortage, reduced freight transportation capacity and timing in receiving certain raw materials slowed the Company's production speed and increased lead times. The Company has undertaken steps to mitigate the supply chain disruptions, such as qualifying additional suppliers. These disruptions impeded the Company's ability to meet strengthening demand. This dynamic is expected to remain into fiscal 2022. Inflation In connection with the supply chain disruptions described above, the Company has experienced the effects of inflation related to raw materials and operating expenses. These inflationary pressures typically have an adverse impact on profit margins, particularly in the near term, because the Company is limited in its ability to pass cost increases onto certain of its customers due to fixed pricing under contracts that are not subject to adjustment until certain conditions are met or sometimes until the next renewal of the contract. In addition, there may be competitive pricing pressures in the markets in which the Company operates. These inflationary pressures impacted results in the second half of fiscal 2021 and are expected to continue in fiscal 2022. Consolidated Results of Operations Net sales for the year endedJuly 31, 2021 were$2,853.9 million , compared with$2,581.8 million for the year endedJuly 31, 2020 , an increase of$272.1 million , or 10.5%, including a positive impact from foreign currency translation of$78.0 million . On a constant currency basis, net sales for the year endedJuly 31, 2021 increased 7.5% from the prior year. Net earnings for the year endedJuly 31, 2021 were$286.9 million , compared with$257.0 million for the year endedJuly 31, 2020 , an increase of$29.9 million , or 11.6%. Diluted earnings per share were$2.24 for the year endedJuly 31, 2021 , compared with$2.00 for the year endedJuly 31, 2020 , an increase of 12.0%. 12 -------------------------------------------------------------------------------- Operating Results Operating results were as follows (in millions, except per share amounts): Year Ended July 31, 2021 % of net sales 2020 % of net sales Net sales$ 2,853.9 $ 2,581.8 Cost of sales 1,882.2 66.0 % 1,710.2 66.2 % Gross profit 971.7 34.0 871.6 33.8 Selling, general and administrative 519.2 18.2 470.3 18.2 Research and development 67.8 2.4 61.2 2.4 Operating expenses 587.0 20.6 531.5 20.6 Operating income 384.7 13.5 340.1 13.2 Interest expense 13.0 0.5 17.4 0.7 Other income, net (9.3) (0.3) (12.5) (0.5) Earnings before income taxes 381.0 13.3 335.2 13.0 Income taxes 94.1 3.3 78.2 3.0 Net earnings$ 286.9 10.1 %$ 257.0 10.0 % Net earnings per share - diluted$ 2.24 $ 2.00 Net Sales Net sales by operating segment were as follows (in millions): Year Ended July 31, 2021 % of net sales 2020 % of net sales Engine Products segment$ 1,957.7 68.6 %$ 1,727.5 66.9 % Industrial Products segment 896.2 31.4 854.3 33.1Total Company $ 2,853.9 100.0 %$ 2,581.8 100.0 %Net Sales by Origination Net sales, generally disaggregated by location where the customer's order was received, were as follows (in millions): Year Ended July 31, 2021 % of net sales 2020 % of net sales U.S. and Canada$ 1,084.2 38.0 %$ 1,059.9 41.1 % Europe, Middle East and Africa (EMEA) 865.7 30.3 760.2 29.4 Asia Pacific (APAC) 649.2 22.8 553.2 21.4 Latin America (LATAM) 254.8 8.9 208.5 8.1Total Company $ 2,853.9 100.0 %$ 2,581.8 100.0 %
Impact of Foreign Currency Translation on
Year Ended July 31, 2021 2020 Prior year net sales$ 2,581.8 $ 2,844.9 Change in net sales excluding translation 194.1
(225.0)
Impact of foreign currency translation (1) 78.0
(38.1)
Current year net sales$ 2,853.9 $
2,581.8
(1)The impact of foreign currency translation was calculated by translating
current fiscal year foreign currency net sales into
13 --------------------------------------------------------------------------------Net Sales Net sales for the year endedJuly 31, 2021 , increased$272.1 million , or 10.5% from fiscal 2020, reflecting higher sales in the Engine Products segment of$230.2 million , or 13.3%, and the Industrial Products segment of$41.9 million , or 4.9%. Foreign currency translation increased total net sales by$78.0 million compared to the prior fiscal year, reflecting increases in the Engine and Industrial Products segments of$48.0 million and$30.0 million , respectively. In fiscal 2021, the Company's net sales increased as a result of the improved economic conditions, which increased demand most notably for the Engine Products segment, particularly in the second half of the fiscal year. Gross Margin Cost of sales for the year endedJuly 31, 2021 was$1,882.2 million , compared with$1,710.2 million for the year endedJuly 31, 2020 , an increase of$172.0 million , or 10.1%. Gross margin for the year endedJuly 31, 2021 was 34.0% compared with 33.8% for the year endedJuly 31, 2020 , an increase of 0.2%. Gross margin benefited from an increased leverage from higher sales and increased pricing, partially offset by increased raw material and freight costs, an unfavorable sales mix and restructuring charges of$5.8 million . Operating Expenses Operating expenses for the year endedJuly 31, 2021 were$587.0 million , or 20.6% of net sales, compared with$531.5 million , or 20.6% of net sales, for the year endedJuly 31, 2020 , an increase of$55.5 million , or 10.4%. Operating expenses as a percentage of net sales were flat, resulting from increased incentive compensation and restructuring charges of$9.0 million , offset by increased leverage from higher sales. Non-Operating Items Interest expense for the year endedJuly 31, 2021 was$13.0 million , compared with$17.4 million , for the year endedJuly 31, 2020 , a decrease of$4.4 million , or 25.0%. The decrease was primarily due to lower debt levels. Other income, net for the year endedJuly 31, 2021 was$9.3 million , compared with$12.5 million , for the year endedJuly 31, 2020 , a decrease of$3.2 million , or 25.7%. The decrease was related to costs associated with the Company's support of its communities. Income Taxes The effective tax rates were 24.7% and 23.3% for the years endedJuly 31, 2021 and 2020, respectively. The higher effective tax rate was primarily due to an overall decrease in discrete tax benefits. Net Earnings Net earnings for the year endedJuly 31, 2021 were$286.9 million , compared with$257.0 million for the year endedJuly 31, 2020 , an increase of$29.9 million , or 11.6%. Diluted earnings per share were$2.24 for the year endedJuly 31, 2021 , compared with$2.00 for the year endedJuly 31, 2020 . Net earnings were impacted by fluctuations in foreign currency exchange rates. The impact of these fluctuations on net earnings was as follows (in millions): Year Ended July 31, 2021 2020 Prior year net earnings$ 257.0 $ 267.2 Change in net earnings excluding translation 19.1
(7.2)
Impact of foreign currency translation (1) 10.8 (3.0) Current year net earnings$ 286.9 $ 257.0
(1)The impact of foreign currency translation was calculated by translating
current fiscal year foreign currency net earnings into
14 --------------------------------------------------------------------------------
Restructuring
In the second quarter of fiscal 2021, the Company initiated activities to further improve its operating and manufacturing cost structure, primarily in its EMEA region. These activities resulted in restructuring charges, primarily related to severance, of$14.8 million in the second quarter of fiscal 2021. Charges of$5.8 million were included in cost of sales and$9.0 million were included in operating expenses in the Consolidated Statement of Earnings for year endedJuly 31, 2021 . Charges of$2.5 million relate to the Engine Products segment,$6.5 million relate to the Industrial Products segment and$5.8 million were included in Corporate and unallocated. For the year endedJuly 31, 2021 ,$4.5 million of the restructuring charges were paid and$10.3 million were accrued as ofJuly 31, 2021 . The Company expects approximately$8 million in annualized savings from these restructuring activities once completed by the beginning of the third quarter of fiscal 2022. Segment Results of Operations Net sales and earnings before income taxes were as follows (in millions): Year Ended July 31, 2021 2020 $ Change % Change Net sales Engine Products segment$ 1,957.7 $ 1,727.5 $ 230.2 13.3 % Industrial Products segment 896.2 854.3 41.9 4.9Total Company $ 2,853.9 $ 2,581.8 $
272.1 10.5 %
Earnings before income taxes Engine Products segment$ 289.0 $ 229.3 $ 59.7 26.0 % Industrial Products segment 133.3 124.9 8.4 6.7 Corporate and unallocated (1) (2) (41.3) (19.0) (22.3) 117.4Total Company $ 381.0 $ 335.2 $ 45.8 13.7 % (1)Corporate and unallocated includes corporate expenses determined to be non-allocable to the segments, such as interest expense, certain incentive compensation and restructuring charges. (2)The increase from fiscal 2020 to 2021 was driven by higher variable incentive compensation. Engine Products Segment Net sales were as follows (in millions): Year Ended July 31, 2021 2020 $ Change % Change Off-Road$ 328.1 $ 256.5 $ 71.6 27.9 % On-Road 138.8 124.4 14.4 11.5 Aftermarket 1,394.6 1,228.9 165.7 13.5 Aerospace and Defense 96.2 117.7 (21.5) (18.3) Total Engine Products segment$ 1,957.7 $ 1,727.5 $ 230.2 13.3 % Engine Products segment earnings before income taxes$ 289.0 $ 229.3 $ 59.7 26.0 % Net sales for the Engine Products segment for the year endedJuly 31, 2021 were$1,957.7 million , compared with$1,727.5 million for the year endedJuly 31, 2020 , an increase of$230.2 million , or 13.3%. Excluding a$48.0 million increase from foreign currency translation, net sales increased 10.5%. Net sales of Off-Road were$328.1 million , an increase of 27.9% compared with the year endedJuly 31, 2020 . In constant currency, net sales increased$59.8 million , or 23.3%. Off-Road net sales increased in every major region, with strong growth in EMEA and APAC, due to increased levels of equipment production as economic conditions improved compared to the prior year, which had experienced a greater impact from the COVID-19 pandemic. Net sales of On-Road were$138.8 million , an increase of 11.5% compared with the year endedJuly 31, 2020 . In constant currency, net sales increased$11.9 million , or 9.5%. On-Road sales reflected strong growth particularly in EMEA and APAC, with overall net sales higher in every major region due to increased levels of equipment production driven by greater new truck demand due to improved economic conditions. 15 -------------------------------------------------------------------------------- Net sales of Aftermarket were$1,394.6 million , an increase of 13.5% compared with the year endedJuly 31, 2020 . In constant currency, net sales increased$133.8 million , or 10.9%. Aftermarket net sales experienced broad growth across all regions as economic conditions improved. Net sales of Aerospace and Defense were$96.2 million , a decrease of 18.3% compared with the year endedJuly 31, 2020 . In constant currency, net sales decreased$23.2 million , or 19.7%. Aerospace and Defense net sales decreased primarily due to commercial aerospace experiencing significantly lower replacement part sales as a result of lower demand caused by the COVID-19 pandemic. Earnings before income taxes for the Engine Products segment for the year endedJuly 31, 2021 were$289.0 million , or 14.8% of Engine Products' net sales, an increase from 13.3% of net sales for the year endedJuly 31, 2020 . The increase was driven by greater leverage from higher sales and increased pricing, partially offset by higher incentive compensation, unfavorable sales mix and restructuring charges of$2.5 million incurred in the second quarter of fiscal 2021. Industrial Products Segment Net sales were as follows (in millions): Year Ended July
31,
2021 2020 $ Change % Change Industrial Filtration Solutions$ 621.9 $ 581.2 $ 40.7 7.0 % Gas Turbine Systems 96.2 101.6 (5.4) (5.3) Special Applications 178.1 171.5 6.6 3.8 Total Industrial Products$ 896.2 $ 854.3 $ 41.9 4.9 % Industrial Products segment earnings before income taxes$ 133.3 $ 124.9 $ 8.4 6.7 % Net sales for the Industrial Products segment for the year endedJuly 31, 2021 were$896.2 million , compared with$854.3 million for the year endedJuly 31, 2020 , an increase of$41.9 million , or 4.9%. Excluding a$30.0 million increase from foreign currency translation, fiscal 2021 net sales increased 1.4%. Net sales of Industrial Filtration Solutions (IFS) were$621.9 million , an increase of 7.0% compared with the year endedJuly 31, 2020 . In constant currency, net sales increased$17.5 million , or 3.0%. IFS sales increased across all business units and regions. Net sales of Gas Turbine Systems (GTS) were$96.2 million , a decrease of 5.3% compared with the year endedJuly 31, 2020 . In constant currency, net sales decreased$6.5 million , or 6.4%. The decrease in GTS net sales was driven by lower sales of small turbines in theU.S. , partially offset by growing replacement parts sales in theU.S. and LATAM. Net sales of Special Applications were$178.1 million , an increase of 3.8% compared with the year endedJuly 31, 2020 . In constant currency, net sales increased$0.9 million , or 0.5%. The increase in Special Applications net sales reflected higher sales of Integrated Venting Solutions 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 endedJuly 31, 2021 were$133.3 million , or 14.9% of Industrial Products' net sales, an increase from 14.6% of net sales for the year endedJuly 31, 2020 . The increase was driven by greater leverage from higher sales, partially offset by restructuring charges of$6.5 million incurred in the second quarter of fiscal 2021 and higher incentive compensation. 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 credit facilities 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. 16 -------------------------------------------------------------------------------- Capital Resources Secondary sources of liquidity are existing cash and available credit facilities. As ofJuly 31, 2021 , cash and cash equivalents were$222.8 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 theU.S. Additionally, the Company has short-term and long-term borrowing capacity of$655.2 million available for further borrowing under existing credit facilities as ofJuly 31, 2021 . Short-term borrowing capacity as ofJuly 31, 2021 was as follows (in millions): European European Operations U.S. Credit Commercial Credit Rest of the World Facilities Paper Program Facilities Credit Facilities Total Available short-term credit facilities$ 100.0 $ 118.2 $ 54.3$ 64.1 $ 336.6 Reductions to borrowing capacity: Outstanding borrowings 48.5 - - - 48.5 Other non-borrowing reductions - - 30.6 19.6 50.2 Total reductions 48.5 - 30.6 19.6 98.7 Remaining borrowing capacity$ 51.5 $ 118.2 $ 23.7$ 44.5 $ 237.9 Weighted average interest rate as of July 31, 2021 0.96 % N/A N/A N/A N/A Other non-borrowing reductions include financial instruments such as bank guarantees and foreign exchange instruments. Long-term borrowing capacity is maintained through a$500.0 million revolving credit facility that is reported on the Consolidated Balance Sheets. Borrowing capacity as ofJuly 31, 2021 was as follows (in millions): July 31, 2021 Revolving credit facility$ 500.0 Reductions to borrowing capacity: Outstanding borrowings 75.0 Contingent liability for standby letters of credit 7.7 Total reductions 82.7 Remaining borrowing capacity$ 417.3 Weighted average interest rate as of July 31, 2021 1.10 % In the fourth quarter of fiscal 2021, the Company entered into a new credit agreement that maintained the borrowing availability of$500.0 million , which replaced the previous agreement. The revolving credit facility is with a group of lenders and allows for borrowings in multiple currencies. The facility matures onMay 21, 2026 , and bears interest payable monthly at a variable interest rate. The interest rate is calculated using the appropriate benchmark rate plus the applicable rate. The borrowing availability can be reduced or the agreement terminated early at the option of the Company. The Company can request to increase the revolving credit facility by up to$250.0 million , subject to terms of the credit facility agreement, including written notification and lender acceptance, through an accordion feature. Borrowings are automatically rolled over until the credit facility maturity date, unless the agreement is terminated early or the Company is found to be in default. The total facility includes a commitment fee of 0.08% to 0.25%, depending on the Company's leverage ratio. 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 ofJuly 31, 2021 , the Company was in compliance with all such covenants. In the fourth quarter of fiscal 2021, the Company entered into an agreement, in which the Company would issue and sell two tranches of unsecured senior notes. The first tranche is a$100.0 million ten year note due 2031 at a fixed interest rate of 2.50%, with proceeds received inAugust 2021 . The second tranche is a$50.0 million seven year note due 2028 at a fixed interest rate of 2.12%, with proceeds to be received inNovember 2021 . 17 -------------------------------------------------------------------------------- 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 12 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 Note 7 in the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report. Capital Expenditures In fiscal 2022, the Company expects its cash paid for capital expenditures to be within a range of$100.0 to$120.0 million , primarily associated with projects to enhance production capabilities. Cash Flow Summary Cash flows were as follows (in millions):
2021
2020 2019
Net cash provided by (used in)
Operating activities$ 401.9 $ 387.0 $ 345.8 Investing activities (58.3) (128.9) (246.4) Financing activities (363.3) (199.5) (123.3)
Effect of exchange rate changes on cash 5.9
0.2 (3.0)
(Decrease) increase in cash and cash equivalents
Operating Activities Cash provided by operating activities for the year endedJuly 31, 2021 was$401.9 million , compared with$387.0 million for the year endedJuly 31, 2020 , an increase of$14.9 million . The increase in cash provided by operating activities was primarily driven by improved earnings for the Company compared to prior year, which was negatively impacted by the COVID-19 pandemic. Investing Activities Cash used in investing activities for the year endedJuly 31, 2021 was$58.3 million , compared with$128.9 million for the year endedJuly 31, 2020 , a decrease of$70.6 million . In fiscal 2021, the Company continued investing in its strategic priorities, though capital expenditures decreased in fiscal 2021 as the Company brought to completion many of its significant capital projects from the prior two fiscal years. Financing Activities Cash used in financing activities generally relates 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, 2021 and 2020 were$107.2 million and$106.4 million , respectively. Share repurchases for the years endedJuly 31, 2021 and 2020 were$142.2 million and$94.3 million , respectively. Cash used in financing activities for the year endedJuly 31, 2021 was$363.3 million , compared with$199.5 million for the year endedJuly 31, 2020 , an increase of$163.8 million . In fiscal 2021, cash was used to repay borrowings and to fund the Company's needs, driven by expenditures on property, plant and equipment, dividends, share repurchases and purchases of non-controlling interests. In fiscal 2020, proceeds from long-term debt were used to fund the Company's needs, driven by expenditures on property, plant and equipment, dividends and share repurchases. 18 -------------------------------------------------------------------------------- Financial Condition The Company's total capitalization components and debt-to-capitalization ratio were as follows (in millions): July 31, 2021 % 2020 % Short-term borrowings$ 48.5 2.9 %$ 3.8 0.2 %
Current maturities of long-term debt - -
5.7 0.4 Long-term debt 461.0 28.0 617.4 38.1 Total debt 509.5 30.9 626.9 38.7
Total stockholders' equity 1,137.1 69.1
992.9 61.3 Total capitalization$ 1,646.6 100.0 %$ 1,619.8 100.0 % As ofJuly 31, 2021 , total debt, including short-term borrowings and long-term debt, represented 30.9% of total capitalization, defined as total debt plus total stockholders' equity, compared with 38.7% as ofJuly 31, 2020 . Long-term debt outstanding as ofJuly 31, 2021 was$461.0 million compared with$617.4 million as ofJuly 31, 2020 , a decrease of$156.4 million . The Company used cash flows to pay down balances on its revolving credit facilities. Accounts receivable, net as ofJuly 31, 2021 was$552.7 million , compared with$455.3 million as ofJuly 31, 2020 , an increase of$97.4 million , primarily due to higher levels of sales. Days sales outstanding were 62 days as ofJuly 31, 2021 , down from 63 days as ofJuly 31, 2020 . 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 as ofJuly 31, 2021 was$384.5 million , compared with$322.7 million as ofJuly 31, 2020 , an increase of$61.8 million . Inventory turns were 5.5 times and 4.9 times per year as ofJuly 31, 2021 and 2020, 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 as ofJuly 31, 2021 was$293.9 million , compared with$187.7 million as ofJuly 31, 2020 , an increase of$106.2 million , primarily due to greater levels of purchasing associated with higher levels of sales. Off-Balance Sheet Arrangements Joint Venture Guarantee The Company and Caterpillar Inc. equally own the shares ofAdvanced Filtration Systems Inc. (AFSI), an unconsolidated joint venture, and guarantee certain debt and banking services, including credit and debit cards, merchant processing and treasury management services, of the joint venture. The Company accounts for AFSI as an equity method investment. As ofJuly 31, 2021 , the joint venture had$37.8 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. 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 as follows: Revenue Recognition - Variable Consideration The transaction price of a contract could be reduced by variable consideration including volume, purchase rebates and discounts, product refunds and returns. At the time of sale to a customer, the Company records an estimate of variable consideration as a reduction from gross 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. 19 -------------------------------------------------------------------------------- For volume, purchase rebates and discounts, management 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 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. For product refunds and returns, estimates are based primarily on the expected 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.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 2021 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. 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$20.3 million and$19.2 million as ofJuly 31, 2021 and 2020, respectively. The Company believes it is remote that any adjustment necessary to the reserve for income taxes for the next 12 months will be material. However, it is possible the ultimate resolution of audits or disputes may result in a material change to the Company's 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 discount rates, expected return on plan assets, mortality rates and overall employee compensation increases. The Company considers current and historical data and uses a third-party specialist to assist management in determining these estimates. 20 -------------------------------------------------------------------------------- Discount Rates The Company's objective in selecting a discount rate 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 2.55% and 2.37% weighted average discount rate for itsU.S. plans for the years endedJuly 31, 2021 and 2020, respectively. The Company used a 1.55% and 1.48% weighted average discount rate for its non-U.S. plans for the years endedJuly 31, 2021 and 2020, respectively. Expected Long-Term Rate of Return on AssetsThe Company considers historical returns and future expected returns for each asset class, as well as the target asset allocation to develop the assumption for each of itsU.S. pension plans. The assumption for the non-U.S. pension plans reflects the investment allocation and expected total portfolio returns specific to each plan and country. The Company utilized a 5.33% and 6.08% asset-based weighted average expected return on plan assets for itsU.S. plans as of the measurement dates ofJuly 31, 2021 and 2020, respectively. The Company utilized a 3.13% and 3.78% asset-based weighted average expected return on plan assets for its non-U.S. plans for the years endedJuly 31, 2021 and 2020, respectively. The expected returns on plan assets are used to develop the following fiscal years' expense for the plans. Mortality Rates The Company's actuary uses the Pri-2012 mortality table issued by theSociety of Actuaries in 2019, and the Scale MMP-2019 mortality improvement projection scale for itsU.S. pension plans. These assumptions were used for determining the benefit obligations as ofJuly 31, 2021 and for developing the annual expense for the fiscal year endingJuly 31, 2022 . For non-U.S. pension plans, the Company follows the local actuary's recommendation. Service and Interest Costs The Company uses 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. Alternative Assumptions If the Company were to use alternative assumptions for its pension plans as ofJuly 31, 2021 , a 1 percentage point change in the assumptions would impact fiscal 2021 net periodic benefit cost as follows (in millions): +1% (1)% Rate of return$ 5.5 $ (5.5) Discount rate$ (0.8) $ 2.0 The Company's net periodic benefit cost recognized in the Consolidated Statements of Earnings was$5.3 million ,$7.2 million and$3.8 million for the years endedJuly 31, 2021 , 2020 and 2019, 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. 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 expected 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. Fair value is estimated as the present value of the benefits anticipated from ownership of the asset, in excess of the economic 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 economic returns from contributory assets. Assumptions used in these calculations include same-customer revenue growth rates, estimated earnings and customer attrition rates. 21 -------------------------------------------------------------------------------- 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. 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, challenges in global operations; impacts of global economic, industrial and political conditions on product demand; impacts from unexpected events, including the COVID-19 pandemic; effects of unavailable raw materials or material cost inflation; inability to attract and retain qualified personnel; inability to meet customer demand; inability to maintain competitive advantages; threats from disruptive technologies; effects of highly competitive markets with pricing pressure; exposure to customer concentration in certain cyclical industries; impairment of intangible assets; inability to manage productivity improvements; inability to maintain an effective system of internal control over financial reporting; vulnerabilities associated with information technology systems and security; inability to protect and enforce intellectual property rights; costs associated with governmental laws and regulations; impacts of foreign currency fluctuations; effects of changes in capital and credit markets; changes in tax laws and tax rates, regulations and results of examinations; results of execution of any acquisition, divestiture and other strategic transactions strategy; 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 RiskThe 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 theU.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. 22 -------------------------------------------------------------------------------- During fiscal 2021, theU.S. dollar was generally weaker than in fiscal 2020 compared with many of the currencies of the foreign countries in which the Company operates. The overall weaker dollar had a positive impact on the Company's international net sales results because the foreign denominated revenues translated into moreU.S. dollars. Foreign currency translation had a positive impact to net sales and net earnings in many regions around the world. The estimated impact of foreign currency translation for the year endedJuly 31, 2021 , resulted in an overall increase in reported net sales of$78.0 million and an increase in reported net earnings of approximately$10.8 million . Derivative Fair Value Measurements The Company enters into derivative instrument agreements, including forward foreign currency exchange contracts, net investment hedges and interest rate swaps, to manage risk in connection with changes in foreign currency and interest rates. The Company only enters into derivative instrument agreements with counterparties who have highly rated credit. The Company does not enter into derivative instrument agreements for trading or speculative purposes (see Note 15 to the Notes to the Consolidated Financial Statements in Item 8. of this Annual Report). Forward Foreign Currency Exchange Contracts The Company buys materials from foreign suppliers. Those transactions can be denominated in those suppliers' local currency. The Company also sells to customers in foreign countries. Those transactions can be denominated in those customers' local currency. Both of these transaction types can create volatility in the Company's financial statements. The Company uses forward currency exchange contracts to manage those exposures and fluctuations. These contracts generally mature in 12 months or less, which is consistent with the forecasts of the related purchases and sales. Certain contracts are designated as cash flow hedges, whereas the remaining contracts, most of which are related to certain intercompany transactions, are not designated. 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 inEurope . This contract terminates inJuly 2029 . The Company has elected the spot method for designating these contracts as net investment hedges. Based on the net investment hedge outstanding as ofJuly 31, 2021 , a 10% appreciation of theU.S. dollar compared to the Euro, would result in a net gain of$6.1 million in the fair value of these contracts. Interest Rates The Company's exposure to market risk for changes in interest rates primarily relates to debt obligations that are at variable rates, as well as the potential increase in the fair value of long-term debt resulting from a potential decrease in interest rates. As ofJuly 31, 2021 , the Company's financial liabilities with exposure to changes in interest rates consisted mainly of$75.0 million outstanding on the Company's revolving credit facility, €80.0 million, or$95.1 million of a variable rate term loan, and ¥2.0 billion, or$18.2 million , of variable rate senior notes. As ofJuly 31, 2021 , additional short-term borrowings outstanding consisted of$48.5 million . Assuming a hypothetical 0.5 percentage point increase in short-term interest rates, with all other variables remaining constant, interest expense would have increased approximately$0.8 million and interest income would have increased approximately$0.3 million in fiscal 2021. Interest rate changes would also affect the fair market value of fixed-rate debt. As ofJuly 31, 2021 , the estimated fair value of long-term debt with fixed interest rates was$297.4 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. 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 2021 the Company increased its weighted average discount rate from 2.37% to 2.55% on itsU.S. plans and increased its weighted average discount rate from 1.48% to 1.55% for its non-U.S. plans. To protect against declines in interest rates, the pension plans hold high-quality, long-duration bonds. The rates impact both the projected benefit obligation and the fair value of the plan assets and hence, the funded status of the plans. The plans were overfunded by$11.4 million as ofJuly 31, 2021 , since the fair value of the plan assets exceeded the projected benefit obligation. Commodity Prices The Company is exposed to market risk from fluctuating prices of 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 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 gross profit. 23 -------------------------------------------------------------------------------- Chinese Notes Consistent with common business practice inChina , 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 180 days from the date of the Company's receipt of such draft. As ofJuly 31, 2021 and 2020, the Company owned$14.1 million and$12.1 million , respectively, of these bankers' acceptance notes, and includes them in Accounts Receivable on the Consolidated Balance Sheets. 24
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