NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements of Donaldson Company, Inc. and its subsidiaries (the Company) have been prepared in accordance with generally accepted accounting principles in the United States (GAAP) and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair statement of earnings, comprehensive income, financial position and cash flows have been included and are of a normal recurring nature. Operating results for the
three and nine
month periods ended
April 30, 2018
are not necessarily indicative of the results that may be expected for future periods. The year-end condensed consolidated balance sheet information was derived from the Company's audited financial statements but does not include all disclosures required by GAAP. For further information, refer to the Audited Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the year ended
July 31, 2017
.
New Accounting Standards Recently Adopted
In July 2015, the FASB issued Accounting Standards Update (ASU) 2015-11,
Inventory (Topic 330): Simplifying the Measurement of Inventory
(ASU 2015-11), which amended the guidance requiring companies not using the last-in, first-out (LIFO) method to measure inventory at the lower of cost and net realizable value rather than the lower of cost or market. This accounting guidance was effective for the Company beginning in the first quarter of
fiscal 2018
and did not have an impact on its Consolidated Financial Statements.
In March 2016, the FASB issued ASU 2016-09,
Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
(ASU 2016-09). This update simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. ASU 2016-09 was effective for the Company beginning in the first quarter of
fiscal 2018
and the guidance affecting the effective tax rate was adopted prospectively. The Condensed Consolidated Statements of Cash Flows is also presented retrospectively with the guidance of this new standard and, for the
nine months ended April 30, 2017
, resulted in an increase of
$6.7 million
to net cash provided by operating activities and a corresponding
$6.7 million
increase to net cash used in financing activities.
In August 2016, the FASB issued ASU 2016-15,
Statement of Cash Flows (Topic 230)
(ASU 2016-15). The new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for the Company beginning in the first quarter of fiscal 2019. Early adoption is permitted, provided that all of the amendments are adopted in the same period. The guidance requires application using a retrospective transition method. The Company adopted ASU 2016-15 in the first quarter of
fiscal 2018
and it did not have an impact on its Consolidated Financial Statements.
In October 2016, the FASB issued ASU No. 2016-16,
Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory
(ASU 2016-16), which is intended to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. This update removes the current exception in GAAP prohibiting entities from recognizing current and deferred income tax expenses or benefits related to transfer of assets, other than inventory, within the consolidated entity. The current exception to defer the recognition of any tax impact on the transfer of inventory within the consolidated entity until it is sold to a third party remains unaffected. ASU 2016-16 is effective for the Company beginning in the first quarter of
fiscal 2019
and early adoption is permitted. The Company adopted ASU 2016-16 in the first quarter of
fiscal 2018
and it did not have an impact on its Consolidated Financial Statements.
In May 2017, the FASB issued ASU 2017-09,
Compensation - Stock Compensation (Topic 718)
(ASU 2017-09). The amendments in ASU 2017-09 provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-09 is effective for the Company beginning in the first quarter of fiscal 2019 and early adoption is permitted. The Company adopted ASU 2017-09 in the first quarter of
fiscal 2018
and it did not have an impact on its Consolidated Financial Statements.
New Accounting Standards Not Yet Adopted
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers (Topic 606)
(ASU 2014-09), which amended revenue recognition guidance to clarify the principles for recognizing revenue from contracts with customers. The guidance requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. The guidance also requires expanded disclosures relating to the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments and assets recognized from the costs to obtain or fulfill a contract. In 2016, the FASB issued ASU 2016-08, ASU 2016-10, ASU 2016-11, ASU 2016-12 and ASU 2016-20 to clarify, among other things, the implementation guidance related to principal versus agent considerations, identifying performance obligations and accounting for licenses of intellectual property. This accounting guidance is effective for the Company beginning
in the first quarter of
fiscal 2019
. The amendments in this update are to be applied on a retrospective basis, either to each prior reporting period presented (full retrospective method) or by presenting the cumulative effect of applying the update recognized at the date of initial application (modified retrospective method). The Company is evaluating the impact of the adoption of the standard on its Consolidated Financial Statements. A project team has been established, has conducted surveys of the businesses, is performing revenue contract analyses to gather information and identify where potential differences could result in applying the requirements of the new standard and has begun assessing the financial impact of the new standard on its Consolidated Financial Statements. The results of this assessment have not yet been determined. During the quarter ended April 30, 2018, the Company made the decision that it anticipates adopting the standard using the modified retrospective method, applying the guidance to those contracts which were not completed as of August 1, 2018.
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842)
(ASU 2016-02), which amends the guidance requiring companies to recognize assets and liabilities for leases with lease terms of more than twelve months. The new guidance will require companies to record both capital and operating leases on the balance sheet. This accounting guidance is effective for the Company beginning in the first quarter of
fiscal 2020
on a modified retrospective basis, and early adoption is permitted. The Company is evaluating the impact of the adoption of ASU 2016-02 on its Consolidated Financial Statements.
In January 2017, the FASB issued ASU 2017-01,
Business Combinations: Clarifying the Definition of a Business
(ASU 2017-01). The new guidance provides a more robust framework to use in determining when a set of assets and activities is a business. The amendments provide more consistency in applying the guidance, reduce the costs of application and make the definition of a business more operable. ASU 2017-01 is effective for the Company beginning in the first quarter of
fiscal 2019
. The Company does not expect the application of ASU 2017-01 will have a material impact on its Consolidated Financial Statements.
In March 2017, the FASB issued ASU 2017-07,
Compensation - Retirement Benefits (Topic 715)
(ASU 2017-07). The new guidance requires employers to disaggregate and present separately the current service cost component from the other components of net benefit cost within the consolidated statement of earnings. ASU 2017-07 is effective for the Company beginning in the first quarter of
fiscal 2019
. The Company is evaluating the impact of the adoption of ASU 2017-07 on its Consolidated Statements of Earnings.
In August 2017, the FASB issued ASU 2017-12,
Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities
(ASU 2017-12), which improves the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements and make certain targeted improvements to simplify the application of the hedge accounting guidance. The guidance expands the ability to hedge non-financial and financial risk components, reduces complexity in fair value hedges of interest rate risk, eliminates the requirement to separately measure and report hedge ineffectiveness, as well as eases certain hedge effectiveness assessment requirements. ASU 2017-12 is effective for the Company beginning in the first quarter of
fiscal 2020
, and early adoption is permitted. The Company is evaluating the impact of the adoption of ASU 2017-12 on its Consolidated Financial Statements.
In February 2018, the FASB issued ASU 2018-02,
Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
(ASU 2018-02)
.
The guidance allows a company to elect to reclassify from accumulated other comprehensive income (AOCI) to retained earnings the stranded tax effects from the adoption of the newly enacted federal corporate tax rate as a result of the U.S. Tax Cuts and Jobs Act. The amount of the reclassification is calculated as the difference between the amount initially charged to other comprehensive income (OCI) at the time of the previously enacted tax rate that remains in AOCI and the amount that would have been charged using the newly enacted tax rate, excluding any valuation allowance previously charged to income. ASU 2018-02 is effective for the Company beginning in the first quarter of
fiscal 2020
, and early adoption is permitted. The Company is evaluating the impact of the adoption of ASU 2018-02 on its Consolidated Financial Statements.
Note 2. Acquisitions
On May 1, 2017, the Company acquired
100%
of the shares of Hy-Pro Corporation (Hy-Pro). Hy-Pro designs and manufactures filtration systems and replacement filters for stationary hydraulic and industrial lubrication applications. Hy-Pro has manufacturing locations in Anderson, Indiana and Vancouver, Washington. Total consideration for the transaction was
$21.9 million
after recording a working capital adjustment in accordance with the purchase agreement. The Company received cash of
$0.8 million
for this adjustment during the first quarter of fiscal 2018, which reduced the purchase price and goodwill by a corresponding amount.
On August 31, 2016, the Company acquired the net assets of Industrias Partmo S.A. (Partmo) in Colombia. Partmo is a leading manufacturer of replacement air, lube and fuel filters in Colombia for medium and heavy-duty engines. Total consideration for the transaction was
$12.1 million
.
For the
two
acquisitions that occurred during the year ended July 31, 2017, the Company acquired
$18.1 million
of net tangible assets,
$8.6 million
of intangible assets that had estimated useful lives ranging from
seven
to
twenty
years at the time of acquisition and
$7.3 million
of goodwill. Pro forma financial information for these acquisitions have not been presented because they are not material to the Company's consolidated results of operations.
Note 3. Supplemental Balance Sheet Information
The components of net inventories are as follows (in millions):
|
|
|
|
|
|
|
|
|
|
April 30,
2018
|
|
|
July 31,
2017
|
|
Raw materials
|
$
|
109.1
|
|
|
$
|
96.3
|
|
Work in process
|
27.5
|
|
|
19.7
|
|
Finished products
|
207.6
|
|
|
177.5
|
|
Inventories, net
|
$
|
344.2
|
|
|
$
|
293.5
|
|
The components of net property, plant and equipment are as follows (in millions):
|
|
|
|
|
|
|
|
|
|
April 30,
2018
|
|
|
July 31,
2017
|
|
Land
|
$
|
21.1
|
|
|
$
|
20.6
|
|
Buildings
|
310.6
|
|
|
292.5
|
|
Machinery and equipment
|
909.1
|
|
|
866.8
|
|
Construction in progress
|
67.2
|
|
|
48.9
|
|
Less: accumulated depreciation
|
(796.9
|
)
|
|
(744.2
|
)
|
Property, plant and equipment, net
|
$
|
511.1
|
|
|
$
|
484.6
|
|
Note 4. Earnings Per Share
The Company’s basic net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares. The Company’s diluted net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares and common share equivalents relating to stock options and stock incentive plans. Certain outstanding options were excluded from the diluted net earnings per share calculations because their exercise prices are greater than the average market price of the Company’s common stock during those periods. Options excluded from the diluted net earnings per share calculations were
0.1 million
for the three and
nine
months ended
April 30, 2018
. Options excluded from the diluted net earnings per share calculations were
zero
and
1.6 million
for the three and
nine
months ended
April 30, 2017
, respectively.
The following table presents the information necessary to calculate basic and diluted net earnings per share (in millions, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
April 30,
|
|
Nine Months Ended
April 30,
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Net earnings for basic and diluted earnings per share computation
|
$
|
69.9
|
|
|
$
|
60.1
|
|
|
$
|
77.9
|
|
|
$
|
164.6
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
|
Weighted average common shares – basic
|
130.1
|
|
|
132.5
|
|
|
130.5
|
|
|
133.0
|
|
Dilutive impact of share-based awards
|
1.8
|
|
|
1.6
|
|
|
2.0
|
|
|
1.4
|
|
Weighted average common shares – diluted
|
131.9
|
|
|
134.1
|
|
|
132.5
|
|
|
134.4
|
|
|
|
|
|
|
|
|
|
Net earnings per share – basic
|
$
|
0.54
|
|
|
$
|
0.45
|
|
|
$
|
0.60
|
|
|
$
|
1.24
|
|
Net earnings per share – diluted
|
$
|
0.53
|
|
|
$
|
0.45
|
|
|
$
|
0.59
|
|
|
$
|
1.23
|
|
Note 5. Goodwill and Other Intangible Assets
Goodwill is assessed for impairment annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired. The Company performed its annual impairment assessment during the third quarter of fiscal 2018 and did
no
t record any impairment as a result of this assessment.
The following is a reconciliation of goodwill by reportable segment for the
nine months ended April 30, 2018
(in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Engine
Products
|
|
Industrial
Products
|
|
Total
Goodwill
|
Balance as of July 31, 2017
|
$
|
84.3
|
|
|
$
|
153.8
|
|
|
$
|
238.1
|
|
Goodwill acquired
|
0.6
|
|
|
—
|
|
|
0.6
|
|
Foreign exchange translation
|
0.3
|
|
|
1.0
|
|
|
1.3
|
|
Balance as of April 30, 2018
|
$
|
85.2
|
|
|
$
|
154.8
|
|
|
$
|
240.0
|
|
The following is a reconciliation of net intangible assets for the
nine months ended April 30, 2018
(in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Net Intangible Assets
|
Balance as of July 31, 2017
|
$
|
106.6
|
|
|
$
|
(66.0
|
)
|
|
$
|
40.6
|
|
Amortization expense
|
—
|
|
|
(4.1
|
)
|
|
(4.1
|
)
|
Foreign exchange translation
|
1.1
|
|
|
(0.5
|
)
|
|
0.6
|
|
Balance as of April 30, 2018
|
$
|
107.7
|
|
|
$
|
(70.6
|
)
|
|
$
|
37.1
|
|
Note 6. Warranty
The Company estimates warranty expense on certain products at the time of sale. The following is a reconciliation of warranty reserves, included in other current liabilities and other long-term liabilities, for the
nine months ended April 30, 2018
and
2017
(in millions):
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
April 30,
|
|
2018
|
|
|
2017
|
|
Balance at beginning of period
|
$
|
14.6
|
|
|
$
|
11.9
|
|
Accruals for warranties issued during the reporting period
|
1.8
|
|
|
2.5
|
|
Accruals related to pre-existing warranties (including changes in estimates)
|
0.6
|
|
|
4.1
|
|
Less: settlements made during the period
|
(3.3
|
)
|
|
(3.0
|
)
|
Balance at end of period
|
$
|
13.7
|
|
|
$
|
15.5
|
|
There were no material specific warranty matters accrued for or significant settlements made in the
nine months ended April 30, 2018
or
2017
. The Company’s warranty matters are not expected to have a material impact on the Company's results of operations, liquidity or financial position.
Note 7. Stock-Based Compensation
Stock-based compensation expense is recognized using the fair-value method for all awards. The Company determines the fair value of stock option awards using the Black-Scholes option pricing model. Options are granted whereby the option exercise price is equivalent to the market price of the Company's common stock at the date of grant. For the
three and nine
months ended
April 30, 2018
, the Company recorded pretax stock-based compensation expense associated with stock options of
$1.3 million
and $
6.8 million
, respectively, and recorded
$0.3 million
and $
1.6 million
, respectively, of related tax benefits. For the
three and nine
months ended
April 30, 2017
, the Company recorded pretax stock-based compensation expense associated with stock options of
$1.3 million
and $
6.2 million
, respectively, and recorded
$0.3 million
and $
1.9 million
, respectively, of related tax benefits. In addition, for the
three and nine
months ended
April 30, 2018
, the Company recorded expense associated with performance-based awards of
$2.0 million
and
$5.7 million
, respectively. For the
three and nine
months ended
April 30, 2017
, the Company recorded expense associated with performance-based awards of
$0.2 million
and
$0.7 million
, respectively.
The following table summarizes stock option activity during the
nine months ended April 30, 2018
:
|
|
|
|
|
|
|
|
|
Options
Outstanding
|
|
Weighted
Average
Exercise Price
|
Outstanding as of July 31, 2017
|
6,685,551
|
|
|
$
|
32.60
|
|
Granted
|
877,050
|
|
|
$
|
45.69
|
|
Exercised
|
(569,134
|
)
|
|
$
|
26.38
|
|
Canceled
|
(32,024
|
)
|
|
$
|
38.70
|
|
Outstanding as of April 30, 2018
|
6,961,443
|
|
|
$
|
34.73
|
|
The total intrinsic value of options exercised during the
nine months ended April 30, 2018
and
2017
was
$12.5 million
and
$13.8 million
, respectively. The weighted average fair value for options granted during the
nine
months ended
April 30, 2018
and
2017
was
$9.29
and $
10.09
per share, respectively.
The following table summarizes information concerning outstanding and exercisable options as of
April 30, 2018
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Range of Exercise Prices
|
|
Number Outstanding
|
|
Weighted
Average
Remaining
Contractual
Life (Years)
|
|
Weighted
Average
Exercise
Price of Outstanding Options
|
|
Number
Exercisable
|
|
Weighted
Average
Exercise
Price of Exercisable Options
|
$ 0.00 to $22.69
|
|
964,299
|
|
|
1.30
|
|
$
|
19.71
|
|
|
964,299
|
|
|
$
|
19.71
|
|
$22.70 to $28.69
|
|
854,652
|
|
|
7.62
|
|
$
|
28.06
|
|
|
562,043
|
|
|
$
|
28.05
|
|
$28.70 to $34.69
|
|
1,381,730
|
|
|
3.68
|
|
$
|
31.64
|
|
|
1,372,864
|
|
|
$
|
31.65
|
|
$34.70 to $40.69
|
|
1,374,716
|
|
|
5.40
|
|
$
|
37.02
|
|
|
1,369,717
|
|
|
$
|
37.03
|
|
$40.70 and above
|
|
2,386,046
|
|
|
8.10
|
|
$
|
43.65
|
|
|
941,242
|
|
|
$
|
42.39
|
|
|
|
6,961,443
|
|
|
5.69
|
|
$
|
34.73
|
|
|
5,210,165
|
|
|
$
|
32.40
|
|
As of
April 30, 2018
, the aggregate intrinsic value of options outstanding and exercisable was
$67.6 million
and
$61.8 million
, respectively.
As of
April 30, 2018
, there was
$8.5 million
of total unrecognized compensation expense related to non-vested stock options granted under the 2010 Master Stock Incentive Plan. This unvested expense is expected to be recognized during fiscal years
2018
,
2019
,
2020
and
2021
.
Note 8. Employee Benefit Plans
The Company and certain of its international subsidiaries have defined benefit pension plans. There are
two
types of U.S. plans. The first type of U.S. plan (Hourly Pension Plan) is a traditional defined benefit pension plan primarily for union employees. The second plan (Salaried Pension Plan) is for some salaried and non-union production employees and provides defined benefits pursuant to a cash balance feature whereby a participant accumulates a benefit comprised of a percentage of current salary that varies with years of service, interest credits and transition credits. The Company no longer allows entrants into the U.S. Salaried Pension Plan and the employees no longer accrue Company contribution credits under the plan. Employees are instead eligible for a
3%
annual Company retirement contribution to their 401(k) in addition to the Company’s normal 401(k) match. The non-U.S. plans generally provide pension benefits based on years of service and compensation level.
Net periodic benefit costs for the Company’s pension plans include the following components (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
April 30,
|
|
Nine Months Ended
April 30,
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Net periodic benefit costs:
|
|
|
|
|
|
|
|
|
|
|
|
Service cost
|
$
|
2.1
|
|
|
$
|
2.0
|
|
|
$
|
6.2
|
|
|
$
|
6.2
|
|
Interest cost
|
3.8
|
|
|
3.4
|
|
|
11.2
|
|
|
10.1
|
|
Expected return on assets
|
(6.6
|
)
|
|
(6.6
|
)
|
|
(19.7
|
)
|
|
(19.8
|
)
|
Prior service cost amortization
|
—
|
|
|
0.2
|
|
|
0.3
|
|
|
0.4
|
|
Actuarial loss amortization
|
1.2
|
|
|
1.8
|
|
|
3.5
|
|
|
5.4
|
|
Net periodic benefit costs
|
$
|
0.5
|
|
|
$
|
0.8
|
|
|
$
|
1.5
|
|
|
$
|
2.3
|
|
The Company’s funding policy is to fund the IRS minimum required contribution annually, plus any additional amounts that it determines to be appropriate. For the
nine months ended April 30, 2018
, the Company made required contributions of
$1.5 million
to its U.S. pension plans and
$1.1 million
to its non-U.S. pension plans. The estimated minimum funding requirement for the Company’s U.S. plans for the plan year ending July 31, 2018 is
$3.7 million
. In accordance with the Pension Protection Act of 2006, this contribution obligation may be met with existing credit balances that resulted from payments above the minimum obligation in prior years. The Company has sufficient credit balances to meet the minimum obligation for the plan year ended July 31, 2018. During the three months ended April 30, 2018, the Company made discretionary contributions of
$35.0 million
to the U.S. plans that were designated for the plan year ended July 31, 2017. The Company estimates it will contribute an additional
$0.2 million
to its non-U.S. pension plans during the remainder of fiscal 2018 based upon the local government prescribed funding requirements.
Note 9. Income Taxes
On December 22, 2017, the U.S. Tax Cuts and Jobs Act (TCJA) was enacted into law. The TCJA significantly reforms the Internal Revenue Code of 1986, including but not limited to reducing the U.S. federal corporate income tax rate from 35 percent to 21 percent and moving toward a territorial tax system with a one-time transition tax imposed on previously unremitted foreign earnings and profits.
On December 22, 2017, the SEC issued Staff Accounting Bulletin 118 (SAB 118) that includes additional guidance allowing companies to use a measurement period that should not extend beyond one year from the TCJA enactment date to account for the impacts of the law in their financial statements. The Company has accounted for certain income tax effects of the TCJA to the extent a reasonable estimate could be made during the periods ended April 30, 2018.
The most significant impacts of the enacted legislation for the Company’s current fiscal year include lowering of the U.S. federal corporate income tax rate, the re-measurement of the Company’s net deferred tax assets to reflect their value at the reduced tax rate and the one-time transition tax on the deemed repatriation of certain foreign earnings. The Company’s U.S. federal statutory tax rate will be a blended rate of
26.9
percent for fiscal 2018 and
21
percent for fiscal 2019. The Company recorded a discrete tax charge of
$1.4 million
during the second quarter ended January 31, 2018 for the re-measurement of its net deferred tax assets. The Company also recorded a discrete tax charge of
$108.3 million
during the second quarter ended January 31, 2018 for the one-time transition tax on deemed repatriated earnings of its non-U.S. subsidiaries. This charge is inclusive of U.S. state income tax on the portion of the earnings expected to be repatriated. The one-time transition tax is based on the Company’s post-1986 earnings and profits not previously subjected to U.S. taxation.
During the third quarter ended April 30, 2018, the Company made adjustments to its initial estimates. The Company recorded a net tax benefit of
$4.2 million
due to the filing of the Company's fiscal 2017 tax return, reflecting
$4.9 million
of tax benefits related to a further re-measurement of net deferred tax assets that was primarily driven by the
$35.0 million
pension plan contributions made in the quarter, partially offset by a reduction in manufacturing incentive credits. The Company also recorded an additional tax charge of
$4.6 million
during the third quarter ended April 30, 2018 for the transition tax, increasing the total estimated transition tax to
$112.9 million
. The transition tax is payable over an eight-year period, and the portion not due within 12 months of
$103.5 million
is classified within other long-term liabilities in the Condensed Consolidated Balance Sheet as of April 30, 2018. Although the Company made reasonable estimates in accounting for the impacts of the TCJA, these tax charges are provisional, as the Company is still analyzing certain aspects of the legislation and refining calculations as information becomes available during the measurement period as allowed by SAB 118.
The accounting for the income tax effects of the TCJA is expected to be completed at fiscal year-end and any future adjustments will be recognized as discrete income tax expense or benefit in the period the adjustments are determined.
The TCJA also adds many new provisions that do not apply to the Company until fiscal 2019, including the deduction for executive compensation and interest expense, a tax on global intangible low-taxed income, the base erosion anti-abuse tax and a deduction for foreign-derived intangible income. The Company has not made any adjustments in its financial statements related to these new provisions during the periods ended April 30, 2018 and continues to evaluate the future impact of these provisions.
The TCJA moves toward a territorial tax system through the provision of a 100% dividends received deduction for the foreign-source portions of dividends received from controlled foreign subsidiaries. As a result, the Company is in the process of evaluating its indefinite reinvestment assertions with regard to unremitted earnings for certain of its foreign subsidiaries. As part of this evaluation, the Company will consider estimated global working capital levels, capital investment requirements and the potential tax liabilities that would be incurred if the foreign subsidiaries distribute cash to the U.S. parent and make a determination in the SAB 118 measurement period as to whether earnings of these subsidiaries remain permanently invested or not. If the Company determines that a subsidiary should no longer remain subject to the indefinite reinvestment assertion, additional tax charges will be accrued, including but not limited to state income taxes, withholding taxes and other relevant foreign taxes in the period the conclusion is determined. As of April 30, 2018, the Company has determined that the earnings of certain subsidiaries are no longer subject to the indefinite reinvestment assertion and recorded an immaterial provisional estimate of the withholding taxes due on the repatriation of those earnings. The Company will continue to evaluate its global cash needs and opportunities to repatriate cash as part of an effort to more precisely compute this tax impact.
The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. With few exceptions, the Company is no longer subject to state and foreign income tax examinations by tax authorities for years before 2008. The United States Internal Revenue Service (IRS) has completed examinations of the Company’s U.S. federal income tax returns through 2013. Currently, the Company is under examination by the IRS for fiscal years 2015 and 2016, and on May 29, 2018, the IRS proposed an adjustment related to the Company’s foreign legal entity restructuring which was completed in fiscal 2015. The Company disagrees with the IRS proposal and believes their claims to be without merit. The Company will vigorously defend its position, beginning with an attempt to resolve these matters at the IRS Appellate level and through litigation if necessary.
As of
April 30, 2018
, the gross unrecognized tax benefits were
$19.7 million
and accrued interest and penalties on these unrecognized tax benefits were
$2.8 million
. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. If the Company were to prevail on all unrecognized tax benefits recorded, substantially all of the unrecognized tax benefits would benefit the effective tax rate. With an average statute of limitations of approximately five years, up to
$2.4 million
of the unrecognized tax benefits could potentially expire in the next 12-month period, unless extended by an audit.
The Company believes that it is remote that any adjustment necessary to our reserve for income taxes over 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.
Note 10. Fair Value Measurements
As of
April 30, 2018
, the carrying values of cash and cash equivalents, accounts receivables, short-term borrowings and trade accounts payable approximate fair value because of the short-term nature of these instruments. As of
April 30, 2018
, the estimated fair value of long-term debt with fixed interest rates was
$263.3 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. Long-term debt would be classified as Level 2 in the fair value hierarchy. The carrying values of long-term debt with variable interest rates approximate fair value.
Note 11. Shareholders' Equity
The Company’s Board of Directors authorized the repurchase of up to
14.0 million
shares of common stock under the Company's stock repurchase plan. This repurchase authorization is effective until terminated by the Board of Directors. During the
nine months ended April 30, 2018
, the Company repurchased
2.3 million
shares for
$107.7 million
. As of
April 30, 2018
, the Company had remaining authorization to repurchase
4.8 million
shares under this plan.
On May 23, 2018, the Company's Board of Directors declared a cash dividend in the amount of
19.0 cents
per common share, payable June 28, 2018, to shareholders of record as of June 11, 2018.
Note 12. Accumulated Other Comprehensive Income
Changes in accumulated other comprehensive loss by component for the
three months ended April 30, 2018
and
2017
are as follows (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
Currency
Translation
Adjustment
|
|
Pension
Benefits
|
|
Derivative
Financial
Instruments
|
|
Total
|
Balance as of January 31, 2018, net of tax
|
$
|
(8.4
|
)
|
|
$
|
(94.1
|
)
|
|
$
|
(1.4
|
)
|
|
$
|
(103.9
|
)
|
Other comprehensive loss before reclassifications and tax
|
(23.2
|
)
|
|
—
|
|
|
(0.2
|
)
|
|
(23.4
|
)
|
Tax expense
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Other comprehensive loss before reclassifications, net of tax
|
(23.2
|
)
|
|
—
|
|
|
(0.2
|
)
|
|
(23.4
|
)
|
Reclassifications, before tax
|
—
|
|
|
2.2
|
|
|
1.9
|
|
|
4.1
|
|
Tax expense
|
—
|
|
|
(0.6
|
)
|
|
(0.6
|
)
|
|
(1.2
|
)
|
Reclassifications, net of tax
|
—
|
|
|
1.6
|
|
(1)
|
1.3
|
|
(2)
|
2.9
|
|
Other comprehensive (loss) income, net of tax
|
(23.2
|
)
|
|
1.6
|
|
|
1.1
|
|
|
(20.5
|
)
|
Balance as of April 30, 2018, net of tax
|
$
|
(31.6
|
)
|
|
$
|
(92.5
|
)
|
|
$
|
(0.3
|
)
|
|
$
|
(124.4
|
)
|
|
|
|
|
|
|
|
|
Balance as of January 31, 2017, net of tax
|
$
|
(110.1
|
)
|
|
$
|
(112.1
|
)
|
|
$
|
0.2
|
|
|
$
|
(222.0
|
)
|
Other comprehensive income before reclassifications and tax
|
10.7
|
|
|
—
|
|
|
0.6
|
|
|
11.3
|
|
Tax expense
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Other comprehensive income before reclassifications, net of tax
|
10.7
|
|
|
—
|
|
|
0.6
|
|
|
11.3
|
|
Reclassifications, before tax
|
—
|
|
|
1.0
|
|
|
(0.5
|
)
|
|
0.5
|
|
Tax (expense) benefit
|
—
|
|
|
(0.5
|
)
|
|
0.1
|
|
|
(0.4
|
)
|
Reclassifications, net of tax
|
—
|
|
|
0.5
|
|
(1)
|
(0.4
|
)
|
(2)
|
0.1
|
|
Other comprehensive income, net of tax
|
10.7
|
|
|
0.5
|
|
|
0.2
|
|
|
11.4
|
|
Balance as of April 30, 2017, net of tax
|
$
|
(99.4
|
)
|
|
$
|
(111.6
|
)
|
|
$
|
0.4
|
|
|
$
|
(210.6
|
)
|
|
|
(1)
|
Primarily includes net amortization of prior service costs and actuarial losses included in net periodic benefit cost (see Note 8) that were reclassified from accumulated other comprehensive loss to operating expenses or cost of sales.
|
|
|
(2)
|
Relates to foreign currency cash flow hedges that were reclassified from accumulated other comprehensive loss to other income, net.
|
Changes in accumulated other comprehensive loss by component for the
nine months ended April 30, 2018
and
2017
are as follows (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
Currency
Translation
Adjustment
|
|
Pension
Benefits
|
|
Derivative
Financial
Instruments
|
|
Total
|
Balance as of July 31, 2017, net of tax
|
$
|
(58.8
|
)
|
|
$
|
(95.1
|
)
|
|
$
|
(3.1
|
)
|
|
$
|
(157.0
|
)
|
Other comprehensive income before reclassifications and tax
|
27.2
|
|
|
—
|
|
|
1.8
|
|
|
29.0
|
|
Tax expense
|
—
|
|
|
—
|
|
|
(0.7
|
)
|
|
(0.7
|
)
|
Other comprehensive income before reclassifications, net of tax
|
27.2
|
|
|
—
|
|
|
1.1
|
|
|
28.3
|
|
Reclassifications, before tax
|
—
|
|
|
4.1
|
|
|
2.5
|
|
|
6.6
|
|
Tax expense
|
—
|
|
|
(1.5
|
)
|
|
(0.8
|
)
|
|
(2.3
|
)
|
Reclassifications, net of tax
|
—
|
|
|
2.6
|
|
(1)
|
1.7
|
|
(2)
|
4.3
|
|
Other comprehensive income, net of tax
|
27.2
|
|
|
2.6
|
|
|
2.8
|
|
|
32.6
|
|
Balance as of April 30, 2018, net of tax
|
$
|
(31.6
|
)
|
|
$
|
(92.5
|
)
|
|
$
|
(0.3
|
)
|
|
$
|
(124.4
|
)
|
|
|
|
|
|
|
|
|
Balance as of July 31, 2016, net of tax
|
$
|
(89.3
|
)
|
|
$
|
(115.8
|
)
|
|
$
|
(0.5
|
)
|
|
$
|
(205.6
|
)
|
Other comprehensive (loss) income before reclassifications and tax
|
(10.1
|
)
|
|
—
|
|
|
2.5
|
|
|
(7.6
|
)
|
Tax expense
|
—
|
|
|
—
|
|
|
(0.6
|
)
|
|
(0.6
|
)
|
Other comprehensive (loss) income before reclassifications, net of tax
|
(10.1
|
)
|
|
—
|
|
|
1.9
|
|
|
(8.2
|
)
|
Reclassifications, before tax
|
—
|
|
|
6.5
|
|
|
(1.3
|
)
|
|
5.2
|
|
Tax (expense) benefit
|
—
|
|
|
(2.3
|
)
|
|
0.3
|
|
|
(2.0
|
)
|
Reclassifications, net of tax
|
—
|
|
|
4.2
|
|
(1)
|
(1.0
|
)
|
(2)
|
3.2
|
|
Other comprehensive (loss) income, net of tax
|
(10.1
|
)
|
|
4.2
|
|
|
0.9
|
|
|
(5.0
|
)
|
Balance as of April 30, 2017, net of tax
|
$
|
(99.4
|
)
|
|
$
|
(111.6
|
)
|
|
$
|
0.4
|
|
|
$
|
(210.6
|
)
|
|
|
(1)
|
Primarily includes net amortization of prior service costs and actuarial losses included in net periodic benefit cost (see Note 8) that were reclassified from accumulated other comprehensive loss to operating expenses or cost of sales.
|
|
|
(2)
|
Relates to foreign currency cash flow hedges that were reclassified from accumulated other comprehensive loss to other income, net.
|
Note 13. Guarantees
The Company and Caterpillar Inc. equally own the shares of Advanced Filtration Systems Inc. (AFSI), an unconsolidated joint venture, and guarantee certain debt of the joint venture. As of
April 30, 2018
, AFSI had
$33.5 million
of outstanding debt, of which the Company guarantees half. In addition, during the three months ended
April 30, 2018
and
2017
, the Company recorded earnings from this equity method investment of
$0.6 million
and
$0.7 million
, respectively. The Company recorded
$1.1 million
and
$1.6 million
of earnings from this equity method investment during the
nine
months ended
April 30, 2018
and
2017
, respectively. During the three months ended
April 30, 2018
and
2017
, the Company recorded royalty income related to AFSI of
$1.7 million
and
$1.6 million
, respectively, in other income, net. During the
nine
months ended
April 30, 2018
and
2017
, the Company recorded royalty income related to AFSI of
$5.3 million
and
$4.3 million
, respectively, in other income, net.
As of
April 30, 2018
and
July 31, 2017
, the Company had a contingent liability for standby letters of credit totaling
$8.2 million
and
$10.5 million
, respectively, that have been issued and are outstanding. The letters of credit guarantee payment to third parties in the event the Company is in breach of contract terms as detailed in each letter of credit. As of
April 30, 2018
and
July 31, 2017
, there were
no
amounts drawn upon these letters of credit.
Note 14. Commitments and Contingencies
The Company records provisions with respect to identified claims or lawsuits when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Claims and lawsuits are reviewed quarterly and provisions are
taken or adjusted to reflect the status of a particular matter. The Company believes the recorded estimated liability in its Condensed Consolidated Financial Statements is adequate in light of the probable and estimable outcomes. The recorded liabilities were not material to the Company’s results of operations, liquidity or financial position and the Company believes it is remote that the settlement of any of the currently identified claims or litigation will be materially in excess of what is accrued.
Note 15. Segment Reporting
The Company has identified
two
reportable segments: Engine Products and Industrial Products. Segment determination is based on the internal organization structure, management of operations and performance evaluation by management and the Company’s Board of Directors. Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments, such as interest income and interest expense.
The Company has an internal measurement system to evaluate performance and allocate resources based on earnings before income taxes. The Company’s manufacturing facilities serve both reporting segments. Therefore, the Company uses an allocation methodology to assign costs and assets to the segments. A certain amount of costs and assets relate to general corporate purposes and are not assigned to either segment.
The Company is an integrated enterprise, characterized by substantial intersegment cooperation, cost allocations and sharing of assets. Therefore, the Company does not represent that these segments, if operated independently, would report the earnings before income taxes and other financial information shown below.
Segment detail is summarized as follows (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
April 30,
|
|
Nine Months Ended
April 30,
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Net sales
|
|
|
|
|
|
|
|
Engine Products segment
|
$
|
472.3
|
|
|
$
|
405.6
|
|
|
$
|
1,356.8
|
|
|
$
|
1,121.4
|
|
Industrial Products segment
|
227.7
|
|
|
202.6
|
|
|
652.7
|
|
|
590.4
|
|
Total
|
$
|
700.0
|
|
|
$
|
608.2
|
|
|
$
|
2,009.5
|
|
|
$
|
1,711.8
|
|
|
|
|
|
|
|
|
|
|
|
Earnings before income taxes
|
|
|
|
|
|
|
|
Engine Products segment
|
$
|
67.8
|
|
|
$
|
63.1
|
|
|
$
|
185.9
|
|
|
$
|
157.2
|
|
Industrial Products segment
|
34.8
|
|
|
31.9
|
|
|
97.0
|
|
|
94.5
|
|
Corporate and Unallocated
|
(3.6
|
)
|
|
(10.7
|
)
|
|
(22.8
|
)
|
|
(21.4
|
)
|
Total
|
$
|
99.0
|
|
|
$
|
84.3
|
|
|
$
|
260.1
|
|
|
$
|
230.3
|
|
There were
no
customers that accounted for over 10% of net sales for the
three
or
nine
months ended
April 30, 2018
or
2017
. There were
no
customers that accounted for over 10% of gross accounts receivable as of
April 30, 2018
or
July 31, 2017
.