DONALDSON COMPANY, INC.
ANNUAL REPORT ON FORM 10-K
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Management’s Discussion and Analysis of Financial Condition and Results of | 9 | |||
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Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 55 | |||
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Directors, | 56 | |||
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Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 56 | |||
Certain Relationships and Related Transactions, and Director Independence | 58 | |||
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Consent of Independent Registered Public Accounting Firm | 63 | |||
Certifications of Officers | 64 |
Donaldson Company, Inc. (“Donaldson” or the “Company”) was founded in 1915 and organized in its present corporate form under the laws of the State of Delaware in 1936.
The Company is a worldwide manufacturer of filtration systems and replacement parts. The Company’s product mix includes air and liquid filtersfiltration systems and exhaust and emission control products for mobile equipment; in-plant air cleaning systems; compressed air purification systems; air intake systems for industrial gas turbines and specialized filters for such diverse applications as computer disk drives and semi-conductor processing.products. Products are manufactured at more than 3040 plants around the world and through three of our joint ventures. The Company has two reporting segments engaged in the design, manufacture and sale of systems to filter air and liquid and other complementary products. The two segments aresegments: Engine Products and Industrial Products. Products in the Engine Products segment consist of air intakefiltration systems, exhaust and emissions systems, liquid filtration systems and replacement parts. The Engine Products segment sells to original equipment manufacturers (“OEM”OEMs”) in the construction, mining, agriculture, aerospace, defense, and transportationtruck markets and to independent distributors, OEM dealer networks, private label accounts and large equipment fleets. Products in the Industrial Products segment consist of dust, fume and mist collectors, compressed air purification systems, liquid filters and parts, static and pulse-cleanfiltration systems, air filter systems for gas turbines, and specialized air filtration systems for diverse applications including computer hard disk drives. The Industrial Products segment sells to various industrial end-users, OEMs of gas-fired turbines and OEMs and end-users requiring highly purifiedclean air.
The table below shows the percentage of total net sales contributed by the principal classes of similar products for each of the last three fiscal years:
| Year Ended July 31 | |||||||||||||||
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| 2006 | 2005 | 2004 | |||||||||||||
| Engine Products segment | |||||||||||||||
| Off-road equipment products (including defense products) | 18 | % | 18 | % | 17 | % | |||||||||
| Truck products | 11 | % | 11 | % | 11 | % | |||||||||
| Aftermarket products (including replacement part sales to our OEMs) | 29 | % | 29 | % | 29 | % | |||||||||
| Industrial Products segment | |||||||||||||||
| Industrial filtration solutions products | 26 | % | 27 | % | 26 | % | |||||||||
| Gas turbine systems products | 8 | % | 7 | % | 9 | % | |||||||||
| Special applications products | 8 | % | 8 | % | 8 | % | |||||||||
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| Year Ended July 31 |
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Engine Products segment |
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Off-Road Equipment Products (including Aerospace and Defense products) |
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| 20 | % |
| 20 | % |
| 18 | % |
On-Road Products |
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| 4 | % |
| 6 | % |
| 9 | % |
Aftermarket Products (including replacement part sales to the Company’s OEM’s) |
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| 30 | % |
| 29 | % |
| 30 | % |
Industrial Products segment |
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Industrial Filtration Solutions Products |
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| 27 | % |
| 27 | % |
| 27 | % |
Gas Turbine Systems Products |
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| 11 | % |
| 10 | % |
| 8 | % |
Special Applications Products |
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| 8 | % |
| 8 | % |
| 8 | % |
Financial information about segment operations appears in Note J in the Notes to Consolidated Financial Statements on page 44.51.
The Company makes its annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports, available free of charge through its website, at www.donaldson.com, as soon as reasonably practicable after it electronically files such material with (or furnishes such material to) the Securities and Exchange Commission. Also available on the Company’s website are various corporate governance documents, including the Company’s code of business conduct and ethics, corporate governance guidelines, Audit Committee charter, Human Resources Committee charter, and Corporate Governance Committee charter. These documents are available in print, free of charge to any shareholder who requests them. The information contained on the Company’s website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered to be part of this Form 10-K.
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TheIn general, the Company’s business in aggregate isEngine and Industrial Products segments are not considered to be seasonal. AHowever, a number of ourthe Company’s end markets are dependent on the construction, agricultural and agriculturalpower generation industries, which are generally stronger in the second half of ourthe Company’s fiscal year.
Principal methods of competition in both the Engine Products and Industrial Products segments are technology, price, geographic coverage, service and product performance. The Company competes in a number of highly competitive filtration markets in both the Engine Products and Industrial Products segments. The Company believes it is a market leader inwith many of its primary product lines. The Company believes within the Engine Products segment it is a market leader in its Off-Road Equipment and On-Road Products lines for OEMs and is a significant participant in the aftermarket for replacement filters. The Engine Products segment’s principal competitors include several large global competitors and regional competitors, especially in the Engine Aftermarket Products business. The Industrial Products segment’s principal competitors vary from country to country and include several large regional orand global competitors and a significant number of smallsmaller competitors who compete in a limitedspecific geographical region or in a limited number of product applications.
The principal raw materials that the Company uses are steel, filter media and plastics. The Company believes within the Engine Products segment it ispurchases a market leader in its off-road equipment and truck product lines for OEMs and is a significant participant in the aftermarket for replacement filters and hard parts. The Engine Products segment’s principal competitors vary from country to country and include several large regional or global competitors, and small regional competitors, especially in the engine aftermarket businesses.
Although the Company experienced an increase in commodityvariety of types of steel. Commodity prices were high during the first half of the year, but decreased during the Company responded through a combination of cost reductions and by recovering a portion of these price increases from customers.second half such that the full year was comparable with Fiscal 2008. The Company experienced no other significant or unusualsupply problems in the purchase of its raw materials or commodities.materials. The Company typically has more than one sourcemultiple sources of supply for the raw materials essential to its business. The Company is not required to carry significant amounts of raw material inventory to meet rapid delivery demands or secure supplier allotments. However, the Company does stock limited amounts offinished goods inventory at its regional distribution centers in order to meet anticipated customerCustomer demand.
The Company owns various patents and trademarks, which it considers in the aggregate to constitute a valuable asset.asset, including patents and trademarks for products sold under the Ultra-Web®, PowerCore®, and Donaldson® trademarks. However, it does not regard the validity of any one patent or trademark as being of material importance.
There were no Customers that accounted for over 10 percent of net sales in Fiscal 2009. Sales to Caterpillar Inc. and its subsidiaries (“Caterpillar”) accounted for 12 percent of net sales in 2006 and 2005, respectively, and 10 percent of net sales in 2004.Fiscal 2008 and Fiscal 2007. Caterpillar has been a customer of the Company for many years and it purchases many models and types of products for a variety of applications. Sales to the U.S. Government do not constitute a material portion of the Company’s business. There were no customersCustomers over 10 percent of gross accounts receivable in 2006Fiscal 2009 or 2005.2008.
At August 31, 2006,2009, the backlog of orders expected to be delivered within 90 days was $291,011,000.$259,181,000. All of this backlog is expected to be shipped during Fiscal 2010. The 90-day backlog at August 31, 20052008, was $227,243,000.$415,078,000. Backlog is one of many indicators of business conditions in our market.the Company’s markets. However, it is not always indicative of future results for a number of reasons, including short lead times in our aftermarketthe Company’s replacement parts business and the timing of receipt of orders in many of our original equipmentthe Company’s Engine OEM and industrialIndustrial markets.
During 2006,Fiscal 2009, the Company spent $33,887,000$40,643,000 on research and development activities relatingactivities. Research and development expenses include basic scientific research and the application of scientific advances to the development of new and improved products or improvements of existing products or manufacturing processes.and their uses. The Company spent $32,234,000$43,757,000 in 2005Fiscal 2008 and $30,487,000$36,458,000 in 2004Fiscal 2007 on research and development activities. EssentiallySubstantially all commercial research and development is Company-sponsored.
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Table of Contentsperformed in-house.
The Company does not anticipate any material effect on its capital expenditures, earnings or competitive position during fiscal 2007Fiscal 2010 due to compliance with government regulations involving environmental matters.regulating the discharge of materials into the environment or otherwise relating to the protection of the environment.
The Company employed approximately 11,500over 10,600 persons in worldwide operations as of August 31, 2006.2009.
Financial information about geographic areas appears in Note J of the Notes to Consolidated Financial Statements on page 44.51.
Item 1A. RISK FACTORSRisk Factors
There are inherent risks and uncertainties associated with our global operations that involve the design, manufacturing and sale of products for highly demanding customerCustomer applications throughout the world. TheThese risks and uncertainties associated with our business could adversely affect our operating performance orand financial condition. The following discussion, along with discussions elsewhere in this report, outlines the risks and uncertainties that we believe are the most material to our business. However, these are not the only risks or uncertainties that could affect our business. Therefore, the following is not intended to be a complete discussion of all potential risks or uncertainties.
Unfavorable fluctuations in foreign currency exchange rates could negatively impact our results of operations and financial position.
We have operations in many countries. Each of our subsidiaries reports its results of operations and financial position in its relevant foreign currency, which is then translated into United States dollars. The translated financial information is included in our consolidated financial statements. The strengtheningIn light of the United States dollarcurrent global economic slowdown, we want to further highlight the risks and uncertainties associated with: world economic factors; the reduction in comparisonsales volume and orders due to decreased global demand and Customers aggressively working to reduce their levels of inventory; increased governmental laws and regulations, including the foreign currenciesunprecedented financial actions being undertaken by governments around the world; a significant tightening of our subsidiaries could have a negative impact on our results of operationscredit availability; and potential global health outbreaks. We undertake no obligation to publicly update or financial position.revise any forward-looking statements.
Operating internationally carries risks which could negatively effectaffect our financial performance.
We have sales and manufacturing operations throughout the world, with the heaviest concentrations in North America, Europe and Asia. Our stability, growth and profitability are subject to a number of risks of doing business internationally that could harm our business, including:
• | political and military events, | |
• | legal and regulatory requirements, | |
• | tariffs and trade barriers, | |
• | potential difficulties in staffing and managing local operations, | |
• | credit risk of local | |
• | difficulties in protecting intellectual property, | |
• | local economic, political and social conditions, specifically in China and Thailand where we have significant investments, | |
• | potential global health outbreaks. |
Maintaining a competitive advantage requires continuing investment with uncertain returns.
We operate in highly competitive markets and have numerous competitors who may already be well established in those markets. We experience price pressures from these competitors in certain product lines and geographic markets. We expect our competitors to continue improving the design and performance of their products and to introduce new products that arecould be competitive in both price and performance. We believe that we have certain technological advantages over our competitors, but maintaining
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these advantages requires us to continually invest in research and development, sales and marketing and customerCustomer service and support. There is no guarantee that we will be successful in maintaining these advantages. We are currently makingmake investments in emissions technology development to meet the changingnew technologies that address increased performance and regulatory requirements worldwide.around the globe. There is no guarantee that we will be successful in completing development or achieving sales of these products or that the margins on such products will be acceptable. Our financial performance may be negatively impacted if a competitor’s successful product innovation reaches the market before ours or gains broader market acceptance before our product offerings.acceptance.
A numberSeveral of our major OEM customersCustomers also manufacture component products for their own use.filtration systems. Although these OEM customersCustomers rely on us and other suppliers for othersome of their component products,filtration systems, they couldsometimes choose to manufacture additional component productsfiltration systems for their own use. There is also a risk that one of our customers woulda Customer could acquire one or more of our competitors.
We may be adversely impacted by changes in technology that could reduce or eliminate the demand for our products. We are at risk with respect to:These risks include:
• | breakthroughs in technology which provide a viable alternative to diesel | |
• | reduced demand for disk drive products if |
AcquisitionsWe participate in highly competitive markets with pricing pressure. If we are not able to compete effectively our margins and results of operations could be adversely affected.
The businesses and product lines in which we participate are very competitive and we risk losing business based on a wide range of factors, including technology, price, delivery, product performance and Customer service. Large Customers continue to seek productivity gains and lower prices from their suppliers. We may not necessarilylose business or negatively impact our margins if we are unable to deliver the best value to our Customers.
Demand for our products relies on economic and industrial conditions worldwide.
Demand for our products tends to respond to varying levels of construction, agricultural, mining and industrial activity in the United States and in other industrialized nations.
Sales to Caterpillar accounted for slightly less than 10 percent of our net sales in Fiscal 2009 and 10 percent of our net sales in Fiscal 2008. An adverse change in Caterpillar’s financial performance or a material reduction in our sales to Caterpillar could negatively impact our operating results.
Changes in our product mix impacts our financial performance.
We sell products that have varying profit margins. Our financial performance can be impacted depending on the mix of products we sell during a given period.
Unavailable or higher cost materials could result in our Customers being dissatisfied.
We obtain raw material, including steel, filter media and plastics, and other components from third-party suppliers and tend to carry limited raw material inventories. An unanticipated delay in delivery by our suppliers could result in the inability to deliver on-time and meet the expectations of our Customers. This could negatively affect our financial performance. An increase in commodity prices during a recession or an otherwise challenging business and economic environment could result in lower operating margins.
Difficulties with the Company’s information technology systems could adversely affect the Company’s results.
The Company has many information technology systems that are important to the operation of its businesses. The Company could encounter difficulties in developing new systems or maintaining and upgrading existing systems. Such difficulties could lead to significant expenses due to disruption in business operations and could adversely affect the Company’s results.
Unfavorable fluctuations in foreign currency exchange rates could negatively impact our results and financial position.
We have operations in many countries. Each of our subsidiaries reports its results of operations and financial position in its relevant foreign currency, which is then translated into U.S. dollars. This translated financial information is included in our consolidated financial statements. The strengthening of the U.S. dollar in comparison to the foreign currencies of our subsidiaries could have a positivenegative impact on our results and financial position.
Acquisitions may have an impact on our results.
We have made and continue to pursue acquisitions of complementary product lines, technologies and businesses.acquisitions. We cannot guarantee that these acquisitions will have a positive impact on our results. These acquisitions could negatively impact our profitability due to dilutive issuances of equity securities,operating and integration inefficiencies, the incurrence of debt, and contingent liabilities and amortization expenses related to intangible assets. There are also a number of other risks involved in acquisitions. For example, weWe could lose key existing Customers, have difficulties in assimilating the acquired operations, assume unanticipated legal liabilities or lose key employees of the acquired company.employees.
Compliance with environmental laws and regulations can be costly.
We are subject to many environmental laws and regulations in the jurisdictions in which we operate. We routinely incur product development capital and operating costs in order to comply with these laws and regulations. We may be adversely impacted by new or changing environmental laws and regulations that affect both our operations and our ability to develop and sell products that meet our customers’ product and performanceCustomers’ requirements.
Demand for our products relies on economic and industrial conditions worldwide.
Demand for certain of our products tends to be cyclical and responds to varying levels of construction, agricultural, mining and industrial activity in the United States and in other industrialized nations.
Sales to Caterpillar, Inc. and its subsidiaries have accounted for greater than 10 percent of our net sales in the past three fiscal years. An adverse change in Caterpillar’s financial performance or a material reduction in our sales to it could negatively impact our operating results.
Unavailable or higher cost materials could result in our customers being dissatisfied.
We obtain raw material and certain manufactured components from third-party suppliers and tend to carry limited raw material inventories. Even a brief unanticipated delay in delivery or increases in prices by our suppliers could result in the inability to satisfy our customers on delivery and pricing. This could negatively affect our financial performance.
Changes in our product mix impacts our financial performance.
We sell products in various product lines that have varying profit margins. Our financial performance can be impacted positively or negatively depending on the mix of products we sell during a given period as compared to a previous period.
Item 1B. UNRESOLVED STAFF COMMENTSUnresolved Staff Comments
None.
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The Company’s principal office and research facilities are located in Bloomington, Minnesota, a suburb of Minneapolis, Minnesota. The principal European administrative and engineering offices are located in Leuven, Belgium. The Company also has extensive operations in Asia-Pacific.the Asia-Pacific region.
The Company’s principal plant activities are carried out in the United States and internationally. Following is a summary of the principal plants and other materially important physical properties owned or leased by the Company.
Americas |
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Auburn, Alabama (E) | Kadan, Czech Republic (I) | |
Riverbank, California (I)* | Klasterec, Czech Republic | |
Valencia, California (E)* | Domjean, France (E) | |
Dixon, Illinois | Paris, France (E) | |
Frankfort, Indiana | Dulmen, Germany (E) | |
Cresco, Iowa | Flensburg, Germany (I) | |
Grinnell, Iowa (E) | Haan, Germany (I) | |
Nicholasville, Kentucky | Ostiglia, Italy | |
Bloomington, Minnesota | Barcelona, Spain (I) | |
Chillicothe, Missouri (E) | Hull, United Kingdom | |
St. Charles, Missouri* (E) | Leicester, United Kingdom (I) | |
Philadelphia, Pennsylvania (I) | Cape Town, South Africa | |
Greeneville, Tennessee | Johannesburg, South Africa* | |
Baldwin, Wisconsin | ||
Stevens Point, Wisconsin | Australia | |
Sao Paulo, Brazil (E)* | Wyong, Australia | |
Athens, Canada (I) | ||
Aguascalientes, Mexico | Asia | |
Monterrey, Mexico | Hong Kong, China* | |
Wuxi, China | ||
Joint Venture Facilities | New Delhi, India | |
Most, Czech Republic (E) | Gunma, Japan | |
Champaign, Illinois (E) | Rayong, Thailand (I) | |
Jakarta, Indonesia | ||
Dammam, Saudi Arabia (I) | Third-Party Logistics Providers | |
Alsip, Illinois | ||
Distribution Centers | Plainfield, Indiana (I) | |
Brugge, Belgium | New Hampton, Iowa | |
Rensselaer, Indiana | Waterloo, Iowa (E) | |
Aguascalientes, Mexico | Greeneville, Tennessee (I) | |
Johannesburg, South | Singapore |
The Company’s properties are utilized for both the Engine and Industrial ProductProducts segments except as indicated with an (E) for Engine or (I) for Industrial. The Company also leases certain of its facilities, primarily under long-term leases, some of which provide for options to purchase theleases. The facilities at the end of the lease term. The denoted facilitieswith an asterisk (*) are leased facilities. In Wuxi, China, a portion of the operations are conducted in leased facilities. The Company’sCompany uses third-party logistics providers for some of its product distribution and neither leases nor owns the facilities. The Company considers its properties are considered to be suitable for their present purposes, well-maintained and in good operating condition.
Item 3. LEGAL PROCEEDINGSLegal Proceedings
In accordance with SFAS No. 5, “Accounting for Contingencies,” (SFAS No. 5), 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 isbelieves the recorded reserves in its consolidated financial statements are adequate in light of the probable and estimable outcomes. Any recorded liabilities were not currently subject to any pending litigation other than litigation which arises out of and is incidentalmaterial to the conductCompany’s financial position, results of the Company’s business. All such matters are subject to many uncertaintiesoperation and outcomes that are not predictable with assurance. Theliquidity and the Company does not considerbelieve that any of such proceedings that arethe currently pending to be likely to result in a material adverse effect on the Company’s consolidatedidentified claims or litigation will materially affect its financial position, or results of operation.operation and liquidity.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSSubmission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders of the Company during the quarter ended July 31, 2006.
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Table of Contents2009.
Executive Officers of the Registrant
Current information regarding executive officers is presented below. All terms of office are for one year. There are no arrangements or understandings between individual officers and any other person pursuant to which the officer was selected as an executive officer.
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| Name | Age | Positions and Offices Held | First Year Elected or Appointed as an Executive Officer |
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Tod E. Carpenter | Tod E. Carpenter |
| 50 |
| Vice President, Europe and Middle East |
| 2008 | ||||||
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| William M. Cook | 53 | Chairman, President and Chief Executive Officer | 1994 | William M. Cook |
| 56 |
| Chairman, President and Chief Executive Officer |
| 1994 | |||
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Sandra N. Joppa | Sandra N. Joppa |
| 44 |
| Vice President, Human Resources |
| 2005 | ||||||
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Norman C. Linnell | Norman C. Linnell |
| 50 |
| Vice President, General Counsel and Secretary |
| 1996 | ||||||
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Charles J. McMurray | Charles J. McMurray |
| 55 |
| Senior Vice President, Industrial Products |
| 2003 | ||||||
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Mary Lynne Perushek | Mary Lynne Perushek |
| 51 |
| Vice President and Chief Information Officer |
| 2006 | ||||||
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Lowell F. Schwab | Lowell F. Schwab |
| 61 |
| Senior Vice President, Global Operations |
| 1994 | ||||||
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David W. Timm | David W. Timm |
| 56 |
| Vice President, Asia-Pacific |
| 2007 | ||||||
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| Thomas R. VerHage | 53 | Vice President and Chief Financial Officer | 2004 | Thomas R. VerHage |
| 56 |
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| 2004 | |||
| Norman C. Linnell | 47 | Vice President, General Counsel and Secretary | 1996 | ||||||||||
| Charles J. McMurray | 52 | Senior Vice President, Industrial Products, Technology and South Africa | 2003 | ||||||||||
| Lowell F. Schwab | 58 | Senior Vice President, Engine Systems and Parts | 1994 | ||||||||||
| William I. Vann | 61 | Vice President, NAFTA Operations and Mexico | 2004 | ||||||||||
| Geert Henk Touw | 60 | Senior Vice President, Asia-Pacific | 2004 | ||||||||||
| Sandra N. Joppa | 41 | Vice President, Human Resources, Communications and Facilities | 2005 | ||||||||||
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Jay L. Ward | Jay L. Ward |
| 45 |
| Senior Vice President, Engine Products |
| 2006 | ||||||
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Debra L. Wilfong | Debra L. Wilfong |
| 54 |
| Vice President and Chief Technology Officer |
| 2007 | ||||||
Mr. Carpenter joined the Company in 1996 and has held various positions, including Gas Turbine Systems General Manager from 2002 to 2004; General Manager, Industrial Filtration Systems (IFS) Sales from 2004 to 2006; General Manager, IFS Americas in 2006; and Vice President, Global IFS from 2006 to 2008. Mr. Carpenter was appointed Vice President, Europe and Middle East in August 2008.
Mr. Cook joined the Company in 1980 and has held various positions, including CFO and Senior Vice President, International from 2001 to 2004 and President and CEO from 2004 to 2005. Mr. Cook was appointed Chairman, President and CEO in July 2005.
Ms. Joppa was appointed Vice President, Human Resources and Communications in November 2005. Prior to that time Ms. Joppa held various positions at General Mills, a consumer food products company, from 1989 to 2005, including service as Director of Human Resources for several different operating divisions from 1999 to 2005.
Mr. Linnell joined the Company in 1996 as General Counsel and Secretary and was appointed Vice President, General Counsel and Secretary in 2000.
Mr. McMurray joined the Company in 1980 and has held various positions, including Director, Global Information Technology from 2001 to 2003; Vice President, Human Resources from 2004 to 2005; and Vice President, Information Technology, Europe, South Africa and Mexico from 2005 to 2006. Mr. McMurray became Senior Vice President, Industrial Products, in September 2006.
Ms. Perushek was appointed Vice President and Chief Information Officer in November 2006. Prior to that time, Ms. Perushek was Vice President of Global Information Technology at H.B. Fuller Company, a worldwide manufacturer of adhesive products, from 2005 to 2006 and Chief Information Officer for Young America Corporation, a marketing company, from 1999 to 2004.
Mr. Schwab each has served as an officer ofjoined the Company duringin 1977 and has held various positions, including Senior Vice President, Operations from 1994 to 2004 and Senior Vice President, Engine Products from 2004 to 2008. Mr. Schwab was appointed Senior Vice President, Global Operations, in August 2008.
Mr. Timm joined the past five years.Company in 1983 and has held various positions, including General Manager, Disk Drive from 1995 to 2005 and General Manager, Gas Turbine Systems Products from 2005 to 2006. Mr. Timm was appointed Vice President, Asia-Pacific in December 2006.
Mr. VerHage was appointed Vice President and Chief Financial Officer in March 2004. Prior to that time, Mr. VerHage was a partner for Deloitte & Touche, LLP, an international accounting firm, from 2002 to 20042004.
Mr. Ward joined the Company in 1998 and prior to this a partner for Arthur Andersen, LLP, an international accounting firm, from 1987 to 2002. Mr. McMurray was appointed Vice President, Human Resources in September 2003 and was promoted to Vice President, Human Resources, Information Technology, Europe, South Africa and Mexico in August 2005. In September 2006, Mr. McMurray was promoted to Senior Vice President, Industrial Products, Technology, and South Africa. Mr. McMurray served ashas held various positions, including Director, of Information TechnologyOperations from 2001 to 2003. Mr. Vann was appointed2003; Director, Product and Business Development, IFS Group from 2003 to 2004; Managing Director, Europe from 2004 to 2006; and Vice President, Operations in May 2004Europe and priorMiddle East from 2006 to that served as General Manager of Industrial Air Filtration from 2000 to 2004.2008. Mr. TouwWard was appointed Senior Vice President, Asia-PacificEngine Products in November 2004 and prior to that served as Vice President and General Manager of Donaldson Europe, Middle East and South Africa from 2000 to 2004.August 2008.
Ms. JoppaWilfong was appointed Vice President Human Resources and CommunicationsChief Technology Officer in November 2005.May 2007. Prior to that time, Ms. Joppa was a Director of Human ResourcesWilfong held various director positions in research and development at General Mills, a3M Company, an international consumer food products company, from 19992000 to 2005. In September2007, most recently as Director, Research and Development for the 3M Automotive Division from 2006 James R. Giertz resigned his position as an executive officer of the Company to accept a position with Residential Capital Corporation.2007.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The common shares of the Company are traded on the New York Stock Exchange under the symbol DCI. The amount and frequency of all cash dividends declared on the Company’s common stock for 2006Fiscal 2009 and 20052008 appear in Note LN of the Notes to Consolidated Financial Statements on page 48. Also see Note D on page 33 for restrictions on payment of dividends.55. As of September 30, 2006,23, 2009, there were 1,9052,109 shareholders of record of common stock.
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The low and high sales prices for the Company’s common stock for each full quarterly period during 2006Fiscal 2009 and 20052008 were as follows:
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | |||||
Fiscal 2008 | $ | $ | $ | $ | ||||
Fiscal 2009 | $28.04 — 49.00 | $23.40 — 36.29 | $21.82 — 34.37 | $31.00 — 38.93 |
The following table sets forth information in connection with purchases made by, or on behalf of, the Company or any affiliated purchaser of the Company, of shares of the Company’s common stock during the quarterly period ended July 31, 2006.2009.
| Period | Total Number of Shares Purchased(1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs | ||||||||||||||
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| May 1-May 31, 2006 | — | — | — | 7,596,800 | ||||||||||||||
| June 1-June 30, 2006 | 868,000 | $ | 31.94 | 868,000 | 6,728,800 | |||||||||||||
| July 1-July 31, 2006 | 567,290 | $ | 31.94 | 566,800 | 6,162,000 | |||||||||||||
| Total | 1,435,290 | $ | 31.94 | 1,434,800 | 6,162,000 | |||||||||||||
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| Average Price |
| Total Number of |
| Maximum Number |
| |||||
May 1-May 31, 2009 |
|
| — |
|
| — |
|
| — |
|
| 930,210 |
| |
June 1-June 30, 2009 |
|
| 18,972 |
| $ | 36.12 |
|
| — |
|
| 930,210 |
| |
July 1-July 31, 2009 |
|
| — |
|
| — |
|
| — |
|
| 930,210 |
| |
Total |
|
| 18,972 |
| $ | 36.12 |
|
| — |
|
| 930,210 |
| |
(1) | On March 31, 2006, the Company announced that the Board of Directors authorized the repurchase of up to 8.0 million shares of common stock. This repurchase authorization, which is effective until terminated by the Board of Directors, replaced the existing authority that was authorized on January 17, 2003. There were no repurchases of common stock made outside of the Company’s current repurchase authorization during the quarter ended July 31, | |
The graph below compares the cumulative total stockholder return on the Company’s Common Stock for the last five fiscal years with the cumulative total return of the Standard & Poor’s 500 Stock Index and the Standard & Poor’s Index of Industrial Machinery Companies. The graph and table assume the investment of $100 in each of the Company’s Common Stock and the specified indexes at the beginning of the applicable period, and assume the reinvestment of all dividends.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Among Donaldson Company, Inc., The S&P 500 Index
And The S&P Industrial Machinery Index
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| Year ended July 31, |
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| 2009 |
| 2008 |
| 2007 |
| 2006 |
| 2005 |
| 2004 |
| ||||||
Donaldson Company, Inc. |
| $ | 150.18 |
| $ | 175.88 |
| $ | 140.46 |
| $ | 125.67 |
| $ | 123.27 |
| $ | 100.00 |
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S&P 500 |
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| 99.33 |
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| 124.10 |
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| 139.58 |
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| 120.19 |
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| 114.05 |
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| 100.00 |
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S&P Industrial Machinery |
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| 102.93 |
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| 133.98 |
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| 146.65 |
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| 113.48 |
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| 108.37 |
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| 100.00 |
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Item 6. SELECTED FINANCIAL DATASelected Financial Data
The informationfollowing table sets fourth selected financial data for the years 2002 through 2006 on page 8each of the 2006 Annual Report to Shareholders is incorporated herein by reference.fiscal years in the five-year period ended July 31, 2009 (in millions, except per share data):
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| Year ended July 31, |
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| 2009 |
| 2008 |
| 2007 |
| 2006 |
| 2005 |
| |||||
Net sales |
| $ | 1,868.6 |
| $ | 2,232.5 |
| $ | 1,918.8 |
| $ | 1,694.3 |
| $ | 1,595.7 |
|
Income from continuing operations |
|
| 131.9 |
|
| 172.0 |
|
| 150.7 |
|
| 132.3 |
|
| 110.6 |
|
Diluted earnings per share |
|
| 1.67 |
|
| 2.12 |
|
| 1.83 |
|
| 1.55 |
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| 1.27 |
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Total assets |
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| 1,334.0 |
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| 1,548.6 |
|
| 1,319.0 |
|
| 1,124.1 |
|
| 1,111.8 |
|
Long-term obligations |
|
| 253.7 |
|
| 176.5 |
|
| 129.0 |
|
| 100.5 |
|
| 103.3 |
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Cash dividends declared per share |
|
| 0.460 |
|
| 0.430 |
|
| 0.370 |
|
| 0.410 |
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| 0.180 |
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Cash dividends paid per share |
|
| 0.455 |
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| 0.420 |
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| 0.360 |
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| 0.320 |
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| 0.235 |
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Results of Operation
The following discussion of the Company’s financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto and other financial information included elsewhere in this report.
Overview
The Company manufactures and distributes filtration systems and replacement parts. The Company’s core strengths are leading filtration technology, strong customerCustomer relationships and global presence. The Company operates through two reporting segments, Engine Products and Industrial Products, and has a product mix including air and liquid filters and exhaust and emission control products. As a worldwide business, the Company’s results of operations are affected by conditions in the global industrial and economic factors. Theenvironment. Under normal economic conditions, the Company’s diversity between its original equipment and replacement parts customers,Customers, its diesel engine and industrial end markets, and its North American and international end markets has helped to limit the impact of these factorsweakness in any one product line, market or geography on the consolidated results of the Company. The continued strong demand in most ofHowever, the global recession had a dramatic negative impact on the Company’s end markets drove record earningsresults in fiscal 2006.Fiscal 2009 as nearly every product group and geographic area was impacted.
The Company reported record sales in 2006Fiscal 2009 of $1.694 billion, up 6.2$1,868.6 million, down 16.3 percent from $1.596 billion$2,233.5 million in the prior year. The Company’s results were negatively impacted by foreign currency translation for the year.translation. The impact of foreign currency translation during the year decreased sales by $25.3$76.8 million. Excluding the current year impact of foreign currency translation, worldwide sales increased 7.8decreased 12.9 percent during the year.
7
Although net sales excluding foreign currency translation is not a measure of financial performance under GAAP, the Company believes it is useful in understanding its financial results and provides a comparable measure for understanding the operating results of the Company’s foreign entitiesCompany between different fiscal periods excluding the impact of foreign currency translation. FollowingThe following is a reconciliation to the most comparable GAAP financial measure of this non-GAAP financial measure (in millions):
| July 31, 2006 | July 31, 2005 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Net sales, excluding foreign currency translation | $ | 1,719.6 | $ | 1,561.6 | ||||||
| Current year foreign currency translation impact | (25.3 | ) | 34.1 | |||||||
| Net sales | $ | 1,694.3 | $ | 1,595.7 | ||||||
Commodity prices continued to impact the Company during the year. These cost pressures were effectively offset by cost reduction programs, improved production efficiencies and selective price adjustments. Gross margin of 32.9 percent was up from the gross margin of 31.7 percent in the prior year.
Operating expenses as a percent of net sales in fiscal 2006 were 21.5 percent, down from 21.9 percent in the prior year. Operating expenses in fiscal 2006 included $2.8 million of stock option expense that was not included in fiscal 2005. However, operating expenses in fiscal 2005 included $6.4 million, or $.05 per share, related to the ruling of the Federal Circuit on the patent litigation between the Company and Engineered Products Company, Inc. (“EPC”).
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| July 31, |
| July 31, |
| ||
Net sales, excluding foreign currency translation |
| $ | 1,945.4 |
| $ | 2,110.0 |
|
Foreign currency translation impact |
|
| (76.8 | ) |
| 122.5 | |
Net sales |
| $ | 1,868.6 | $ | 2,232.5 | ||
Although not as significantlarge as the impact on net sales, the Company’s net earnings were also negatively impacted by foreign currency translation for the year.translation. The impact of foreign currency translation during the year decreased net earnings by $0.8$3.8 million. Excluding the current year impact of foreign currency translation, net earnings increased 20.4 percent during the year.decreased 21.1 percent.
Although net earnings excluding foreign currency translation is not a measure of financial performance under GAAP, the Company believes it is useful in understanding its financial results and provides a comparable measure for understanding the operating results of the Company’s foreign entitiesCompany between different fiscal periods excluding the impact of foreign currency translation. FollowingThe following is a reconciliation to the most comparable GAAP financial measure of this non-GAAP financial measure (in millions):
| July 31, 2006 | July 31, 2005 |
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|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| July 31, |
| July 31, |
| |||||||||||||
| Net earnings, excluding foreign currency translation | $ | 133.1 | $ | 108.6 |
| $ | 135.7 |
| $ | 159.1 |
| ||||||
| Current year foreign currency translation impact, net of tax | (0.8 | ) | 2.0 | ||||||||||||||
Foreign currency translation impact, net of tax |
|
| (3.8 | ) |
| 12.9 | |||||||||||
| Net earnings | $ | 132.3 | $ | 110.6 |
| $ | 131.9 | $ | 172.0 | ||||||||
The Company reported record diluted earnings per share of $1.55,$1.67, a 22.121.2 percent increasedecrease from $1.27$2.12 in the prior year.
During fiscal 2006,Included in the Company’s Engine Products segment increased slightlyresults are pre-tax restructuring charges of $17.8 million resulting primarily from workforce reductions of 2,800 since the prior year as a percentbeginning of total net sales at 58.5the year. Gross margin and operating expenses include $10.1 million and $7.7 million of restructuring expenses, respectively. The Company also realized $43.0 million in cost savings from restructuring actions completed throughout the year.
The effective tax rate for Fiscal 2009 was 18.3 percent compared to 57.927.2 percent in Fiscal 2008. This decrease is attributable to a number of discrete tax items, partially offset by increased expense from the prior year. Forrepatriation of foreign earnings. Absent these items, the underlying tax rate for the Fiscal 2009 has decreased
from Fiscal 2008 by 1.2 points to 30.4 percent. The reinstatement of the U.S. Research and Experimentation credit, changes in current year unrecognized tax benefits, reduced statutory tax rates and the mix of earnings between foreign jurisdictions all contributed to the reduction in the underlying rate.
The Company continued to improve an already strong liquidity position which allowed for continued investment in business and debt reduction while increasing cash reserves and maintaining its dividend. While Fiscal 2009 was significantly impacted by the global recession, there are signs that some of the Company’s Industrial Products segment, percent of total net sales decreased slightlyend markets have begun to 41.5 percent from 42.1 percent instabilize. While the prior year. The comparable sales percentages reflectCompany’s future visibility remains limited and it’s too early to call a recovery, the strength inCompany believes that the conditions in the markets that both segments serve and the continued strong demand in mostworst of the global economic downturn is behind it in many of its early and mid-cycle end markets, in each segment.including the heavy truck, construction, special applications and replacement parts markets. This view is factored into the Fiscal 2010 outlook discussed below.
Following is financial information for the Company’s Engine Products and Industrial Products segments. Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments and interest income and expense, non-operating income and expense and expenses not allocated to the business segments in the same period. During the first quarter of 2006, the Company adjusted its basis of measurement for earnings before income taxes such that certain expenses, such as amortization of intangibles, which were previously considered to be Corporate and Unallocated, are now included in the Engine and Industrial Products segment results. The impact of the change in the basis of measurement resulted in approximately $16.0 million of Corporate and Unallocated expenses being charged to
8
the Engine and Industrial Products segments’ aggregate earnings before income taxes in fiscal 2006 as compared to fiscal 2005. This change resulted in approximately $8.0 million of additional expense to each of the Engine and Industrial Products segments during fiscal 2006. This adjustment to the basis of measurement of segment earnings did not change the business components included in each of the Company’s reportable segments.expense. See further discussion of segment information in Note J of the Company’s Notes to Consolidated Financial Statements.
| Engine Products | Industrial Products | Corporate & Unallocated | Total Company |
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|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Engine |
| Industrial |
| Corporate & |
| Total |
| ||||||||||||||||||||||||
| (thousands of dollars) |
| (thousands of dollars) |
| |||||||||||||||||||||||||||||
| 2006 | ||||||||||||||||||||||||||||||||
2009 |
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| |||||||||||||||||||||||
| Net sales | $ | 991,554 | $ | 702,773 | $ | — | $ | 1,694,327 |
| $ | 1,001,961 |
| $ | 866,668 |
| $ | — |
| $ | 1,868,629 |
| |||||||||||
| Earnings before income taxes | 135,994 | 65,550 | (12,377 | ) | 189,167 |
| 83,797 |
| 89,526 |
| (11,898 | ) |
| 161,425 |
| |||||||||||||||||
| 2005 | ||||||||||||||||||||||||||||||||
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2008 |
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| Net sales | $ | 923,840 | $ | 671,893 | $ | — | $ | 1,595,733 |
| $ | 1,229,171 |
| $ | 1,003,350 |
| $ | — |
| $ | 2,232,521 |
| |||||||||||
| Earnings before income taxes | 125,454 | 53,709 | (24,430 | ) | 154,733 |
| 158,931 |
| 102,420 |
| (25,188 | ) |
| 236,163 |
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| 2004 | ||||||||||||||||||||||||||||||||
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2007 |
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| Net sales | $ | 811,543 | $ | 603,437 | $ | — | $ | 1,414,980 |
| $ | 1,084,262 |
| $ | 834,566 |
| $ | — |
| $ | 1,918,828 |
| |||||||||||
| Earnings before income taxes | 114,662 | 42,985 | (15,811 | ) | 141,836 |
| 140,762 |
| 80,321 |
| (16,222 | ) |
| 204,861 |
| |||||||||||||||||
During Fiscal 2009, the Company’s Engine Products segment net sales decreased as a percent of total net sales to 53.6 percent compared to 55.1 percent in the prior year. For the Company’s Industrial Products segment, net sales as a percent of total net sales increased to 46.4 percent from 44.9 percent in the prior year.
Factors within the Company’s reporting segments that contributed to the Company’s results for fiscal 2006Fiscal 2009 included strong business conditions acrossa significant impact from the products withinCompany’s distributors and OEM customers aggressively working down their inventory levels. In the Engine Products segment, worldwide. North American heavy truck build rates remained at record levels. Strengththe Company experienced weak business conditions in newmost end markets and regions. Spending in the construction and mining equipment spurredend-markets in the United States, Europe and Asia was down, resulting in a decrease in off-road equipment related sales. This decrease was partially offset by an increase in Aerospace and Defense sales worldwide. Additionally,and the benefit of the acquisition of Western Filter Corporation in October 2008. On-road Products sales decreased in the United States, Europe and Asia due to a drop in demand for new trucks, which lowered new truck build rates. Aftermarket sales also decreased due to decreases in equipment utilization rates remained strongin most off-road end markets and decreased freight activity which impacted on-road markets, partially offset by increases in retrofit emissions sales of diesel emission retrofit equipment continued to ramp up throughoutin the year, driving aftermarket parts sales growth.United States. In the Industrial Products segment, improvement initiatives, higher volumes anddemand was also weak in all markets across all regions. Demand for Industrial Filtration Solutions Products was down as a focus on selling more replacement parts droveresult of the decline in general industrial activity. Also contributing to the decrease in Industrial Filtration Solutions Products sales growthwas the sale of the air dryer business in Maryville, Tennessee, in October 2008, partially offset by the Company’s industrial filtration solutions products.benefit from the acquisition of LMC West, Inc. in February of 2008. Worldwide sales in gas turbine productsGas Turbine Products weakened late in the year and full year sales were higher thanslightly lower as compared to the prior yearyear. Gas Turbine Products sales are typically large systems and, as business conditions in that market begana result, the Company’s shipments and revenues fluctuate from quarter to strengthen, specifically in the Middle East, Asia and parts of Africa.quarter. Sales of special application productsSpecial Applications Products were strong with continued strongweak due to decreased demand for computer hard drivessemiconductor fabrications and other consumer electronics impactingindustrial uses for PTFE membranes and a sudden contraction of the disk drive market that resulted in decreased demand for the Company’s special application products sales.hard disk drive filters.
Following are net sales by product within both the Engine Products segment and Industrial Products segment:segments:
| 2006 | 2005 | 2004 | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars) | |||||||||||||||
| Engine Products segment: | |||||||||||||||
| Off-road products | $ | 308,175 | $ | 286,230 | $ | 244,749 | |||||||||
| Truck products | 184,303 | 175,048 | 156,373 | ||||||||||||
| Aftermarket products* | 499,076 | 462,562 | 410,421 | ||||||||||||
| Total Engine Products segment | 991,554 | 923,840 | 811,543 | ||||||||||||
| Industrial Products segment: | |||||||||||||||
| Industrial filtration solutions | 440,230 | 424,727 | 370,095 | ||||||||||||
| Gas turbine products | 121,194 | 112,872 | 117,705 | ||||||||||||
| Special application products | 141,349 | 134,294 | 115,637 | ||||||||||||
| Total Industrial Products segment | 702,773 | 671,893 | 603,437 | ||||||||||||
| Total Company | $ | 1,694,327 | $ | 1,595,733 | $ | 1,414,980 | |||||||||
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|
| 2009 |
| 2008 |
| 2007 |
| |||
|
| (thousands of dollars) |
| |||||||
Engine Products segment: |
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|
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|
|
|
|
|
|
Off-Road Products* |
| $ | 362,785 |
| $ | 448,681 |
| $ | 352,065 |
|
On-Road Products |
|
| 71,958 |
|
| 123,146 |
|
| 166,370 |
|
Aftermarket Products** |
|
| 567,218 |
|
| 657,344 |
|
| 565,827 |
|
Total Engine Products segment |
|
| 1,001,961 |
|
| 1,229,171 |
|
| 1,084,262 |
|
Industrial Products segment: |
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|
|
|
|
|
|
|
|
|
Industrial Filtration Solutions Products |
|
| 503,611 |
|
| 600,526 |
|
| 515,022 |
|
Gas Turbine Products |
|
| 206,760 |
|
| 213,138 |
|
| 158,025 |
|
Special Applications Products |
|
| 156,297 |
|
| 189,686 |
|
| 161,519 |
|
Total Industrial Products segment |
| 866,668 | 1,003,350 | 834,566 | ||||||
Total Company |
| $ | 1,868,629 | $ | 2,232,521 | $ | 1,918,828 | |||
* | Includes Aerospace and Defense products. | |
** | Includes replacement part sales to | |
Outlook
While it appears that conditions may have stabilized at many of the Company’s Customers and in many of its end markets, the Company continues to have limited visibility into the future. Consequently, the Company remains cautious in the near-term about forecasting a return to growth.
• | The Company is planning its total Fiscal 2010 sales to be between $1.65 and $1.75 billion, or approximately the pace of the past two quarters. For the full year Fiscal 2010 versus Fiscal 2009, sales are projected to be down 6 to 12 percent. Foreign currency translation is expected to provide a small benefit based on the Company’s planned rates for the Euro of US$1.39 and 98 Yen to the US Dollar for Fiscal 2010. | |
• | The Company did not complete all of its planned restructuring actions by the end of the fourth quarter of Fiscal 2009 and anticipates there could be additional restructuring charges of up to $17 million in Fiscal 2010. Including these costs, the full year Fiscal 2010 operating margin is still expected to be between 9.5 to 10.5 percent. | |
• | The Company expects its full year Fiscal 2010 tax rate to be between 30 and 32 percent. The Company does not anticipate significant discrete tax benefits as occurred in Fiscal 2009. | |
• | The Company expects that cash generated by operating activities will exceed $150 million in Fiscal 2010. Capital spending in Fiscal 2010 is planned at $30.0 million to $40.0 million. The Company will continue to use its cash flow for dividends, potential acquisitions, capital projects and maintenance of its strong liquidity position. |
OutlookEngine Products– The Company expects mid single-digitfull year sales growth in fiscal 2007 for sales in its Engine Products segment. North American heavy-duty truck build rates are expected to remain at their current high levels through calendar 2006 as truck manufacturers are near capacity. Build rates are thendecrease 3 to 8 percent, inclusive of the impact of foreign currency translation.
• | In its On-Road Products businesses, the Company believes that global build rates for heavy- and medium-duty trucks are stabilizing at the current levels. | |
• | The Company is forecasting slightly lower sales for its Aerospace and Defense Products as the level of Customer demand for defense products is decreasing. | |
• | The Company expects activity in the global construction and mining end markets to remain at their current levels during the first half of Fiscal 2010, and anticipates Customer demand in the farm equipment market outside of North America to continue its current decline. | |
• | The Company’s Aftermarket sales are expected to improve slightly from their current levels as utilization rates for both heavy trucks and off-road equipment are stabilizing. The Company expects |
9
to benefit from the increasing amount of equipment in the field with PowerCore® technology as well as its other proprietary filtration systems. |
expectedIndustrial Products– The Company forecasts full year Fiscal 2010 sales to decrease resulting in a decrease in sales of approximately $30 million11 to $35 million in the second half of fiscal 2007 as compared to the second half of 2006 as a result16 percent, inclusive of the implementationimpact of the new diesel emissions standards. Strong worldwide conditions are expected to continue in the production of new construction and mining equipment. Aftermarket sales are expected to grow with continued strong equipment utilization, ongoing growth by our OEM customers of their replacement parts business and the increasing amount of equipment in the field with the Company’s PowerCore™ filtration systems. The Company expects sales growth in fiscal 2007 for its Industrial Products segment to be in the low double-digits. Industrial filtration solutions sales growth is expected to continue with healthy global industrial conditions. Globally, the Company expects full-year gas turbine sales to continue rebounding with sales increasing approximately 20 percent. Market conditions for special applications products are expected to remain strong.foreign currency translation.
• | Industrial Filtration Solutions sales are projected to decrease 10 to 15 percent for the year due to difficult comparable sales in the first half of Fiscal 2010. The Company expects general manufacturing activity to remain near its current level. | |
• | The Company expects full year sales of its Gas Turbine Products to decrease 21 to 26 percent due the slowdown in demand for large power generation projects. | |
• | Special Applications Products’ sales are projected to be flat to down 5 percent, as conditions appear to have stabilized in the hard disk drive market but may continue to weaken in the short-term in the Company’s membrane products’ industrial end-markets. |
Fiscal 20062009 Compared to Fiscal 20052008
Engine Products SegmentThe Engine Products segment sells to OEMs in the construction, mining, agriculture, aerospace, defense, and transportationtruck markets and to independent distributors, OEM dealer networks, private label accounts and large equipment fleets. Products include air intakefiltration systems, exhaust and emissions systems, liquid filtration systems and replacement filters.
Sales for the Engine Products segment were $991.6$1,002.0 million, an increasea decrease of 7.318.5 percent from $923.8$1,229.2 million in the prior year, reflecting increasedyear. International Engine Products sales across all products within this segment bothdecreased 24.3 percent and sales in the United States and internationally.
Withindecreased 12.4 percent from the prior year. The impact of foreign currency decreased sales by $38.9 million, or 3.2 percent. Earnings before income taxes as a percentage of Engine Products segment worldwide sales of off-road products8.4 percent decreased from 12.9 percent in the prior year. The Engine Products segment has been negatively impacted by lower absorption of fixed manufacturing costs due to the drop in sales volumes and increased costs related to restructuring, offset by cost savings as a result of workforce reductions already completed, improved distribution efficiencies as compared to the prior year and the impact of cost control measures including reductions in incentive compensation.
Worldwide sales of Off-Road Products were $308.2$362.8 million, an increasea decrease of 7.719.1 percent from $286.2$448.7 million in the prior year. Sales in the United States showed an increase of 5.8 percentdecreased 7.2 percent. Global mining activity started declining due to decreased commodity prices in the second quarter of Fiscal 2009, and remained weak throughout the remainder of the year. Spending in U.S. residential and non-residential construction markets was down more than 27 percent and 5 percent, respectively, over prior year, resulting in a decrease in the sales of the Company’s products into those markets. Domestic Aerospace and Defense sales benefited from the recent acquisition of Western Filter Corporation, which resulted in $15.4 million of incremental sales over the prior year, and continued improvements in new construction and mining equipment demand.strong demand for filters for military equipment. Internationally, sales of off-road productsOff-Road Products were up 9.9down 31.3 percent from the prior year, with sales increasingdecreasing in both Europe and Asia and Europe by 14.032.5 percent and 8.429.5 percent, respectively, reflecting the strengthrespectively. Sales in the off-roadEuropean construction equipment end market internationally.decreased due to a decline in construction activity related to the economic downturn. Sales to the European agricultural end market also decreased. In Asia, sales have declined significantly in Japan in the construction end markets.
Worldwide sales of truck productsOn-Road Products were $184.3$72.0 million, an increasea decrease of 5.341.6 percent from $175.0$123.1 million in the prior year. Truck productsOn-Road Products sales in the United States increased 6.9decreased 43.2 percent from the prior year, due to record heavy truck build rates and strong diesel emission sales. International truck products sales increased 0.9 percent from the prior year. Strong sales in Europe resulted in an increase of 10.4 percent from stronger build rates and increased market share. Offsetting Europe’s increase was a decrease in sales in Asia of 5.9 percent primarily as a result of a 29 percent decrease in Class 8 truck build rates, 40 percent decrease in medium duty truck build rates by the weaker Japanese Yen.Company’s Customers and a reduction in high value product mix over the prior year. International On-Road Products sales decreased 39.6 percent from the prior year, driven by decreased sales in Europe and Asia of 51.0 percent and 32.5 percent, respectively, reflecting the current economic downturn for freight activity and new truck build rates.
Worldwide aftermarket productEngine Aftermarket Products sales of $499.1$567.2 million increased 7.9decreased 13.7 percent from $462.6$657.3 million in the prior year as equipment utilization rates remained high spurring demand for replacement filters.year. Sales in the United States increased 9.1decreased 9.5 percent over the prior year, while internationaldriven
by inventory adjustments at the Company’s Customers and decreases in utilization rates in the mining, construction and transportation industries, partially offset by increases in retrofit emission sales increased 6.5of $5.2 million. International sales decreased 17.4 percent withfrom the prior year, primarily driven by sales increasingdecreases in Europe and Asia and Mexico by 6.1 percent, 5.4of 26.1 percent and 25.78.0 percent, respectively.respectively, due to weak economic conditions.
Industrial Products SegmentThe Industrial Products segment sells to various industrial end-users, OEMs of gas-fired turbines, and OEMs and end-users requiring highly purified air. Products include dust, fume and mist collectors, compressed air purification systems, liquid filters and parts, static and pulse-clean air filter systems, PTFE membrane and laminates, and specialized air filtration systems for diverse applications including computer hard disk drives and PTFE membrane and laminates.drives.
Sales for the Industrial Products segment were $702.8$866.7 million, an increasea decrease of 4.613.6 percent from $671.9$1,003.4 million in the prior year resultingyear. International Industrial Products sales decreased 14.2 percent and sales in the United States decreased 12.3 percent from strongerthe prior year. The impact of foreign currency decreased sales by $37.9 million, or 3.8 percent. Despite the 13.6 percent decrease in sales, earnings before income taxes as a percentage of industrial filtration solutions, gas turbine products and special application products.
Within the Industrial Products segment worldwide sales of industrial filtration solutions products10.3 percent increased from 10.2 percent in the prior year. The improvement in earnings as a percent of $440.2sales over the prior year was driven by better execution on large project shipments, cost savings from restructuring actions and the impact of cost control measures including reductions in incentive compensation expense. These were slightly offset by lower absorption of fixed costs and restructuring costs.
Worldwide sales of Industrial Filtration Solutions Products of $503.6 million increased 3.6decreased 16.1 percent from $424.7$600.5 million in the prior year. Sales in the United States Asia, South Africa and Mexico increased 5.8 percent, 2.7 percent, 33.6Europe decreased 18.3 percent and 45.121.0 percent, respectively. Sales in Asia remained relatively flat as compared to the prior year. The decline in Europe was due to reduced demand for industrial dust collectors and compressed air purification systems which fell with the downturn in general manufacturing activity during the year. Domestic sales decreased 0.9 percent from the prior year reflecting stabilityas a result of this same decline in general industrial activity. The results in the market despiteyear were also influenced by the negative impactsale of foreign currency translation.
10
Tablethe air dryer business in Maryville, Tennessee, on October 31, 2008 and the acquisition of ContentsLMC West, Inc. (LMC West) in February of Fiscal 2008. The sale of the air dryer business in Maryville, Tennessee, decreased sales $7.6 million over last year. The acquisition of LMC West contributed to $7.0 million of sales during the twelve months of Fiscal 2009 and $4.7 million during the latter six months of Fiscal 2008.
Worldwide sales of gas turbine productsGas Turbine Products were $121.2$206.8 million, an increasea decrease of 7.43.0 percent from $112.9 million in the prior year as business conditions strengthened primarily toward the end of fiscal 2006.
Worldwide sales of special application products were $141.3 million, a 5.3 percent increase from $134.3$213.1 million in the prior year. SalesGas Turbine Products sales are typically large systems and, as a result, the Company’s shipments and revenues fluctuate from quarter to quarter. Incoming orders declined 58 percent in Fiscal 2009 versus Fiscal 2008, a reflection of the reduced demand for power generation projects globally. This trend is expected to continue in Fiscal 2010.
Worldwide sales of Special Applications Products were $156.3 million, a 17.6 percent decrease from $189.7 million in the United Statesprior year. Domestic Special Application Products sales decreased 16.910.0 percent. International sales of Special Application Products decreased 18.7 percent fromover the prior yearyear. The primary decreases internationally were in Europe and Asia, which decreased 25.5 and 17.3 percent, respectively, due to a significant reduction in demand for hard disk drive filters, semiconductor filtration systems and PTFE membrane filtration products. The reduction in demand is primarily to softnessa result of a worldwide contraction in the end markets served by our membrane product line while sales in Europe and Asia increased 13.4 percent and 8.5 percent from the prior year, respectively, due to strong demand for computer hard drivescomputers, data storage devices and other consumer electronics.electronic products that began in the second quarter of Fiscal 2009.
Consolidated ResultsThe Company reported record net earnings for 2006Fiscal 2009 of $132.3$131.9 million compared to $110.6$172.0 million in 2005, an increaseFiscal 2008, a decrease of 19.723.3 percent. Diluted net earnings per share was a record $1.55, up 22.1$1.67, down 21.2 percent from $1.27$2.12 in the prior year. The Company’s operating income of $192.8$170.0 million increaseddecreased from prior year operating income of $156.5$245.8 million by 23.230.9 percent. Operating income in
The table below shows the Engine Products segment as a percentpercentage of total operating income decreased to 67.7 percent from 77.4 percent incontributed by each segment for each of the prior year. Operating income in the Industrial Products segment as a percent of total operating income of 33.6 percent decreased from the prior year of 34.2 percent. This change is primarily attributable to the Company’s decision to adjust its basis of measurement for earnings before income taxes such that certain expenses, such as amortization of intangibles, which were previously considered to belast three fiscal years. Corporate and Unallocated are now included inincludes corporate expenses determined to be non-allocable to the Enginesegments and Industrial Products segment results. This adjustment is discussed further in Note J.interest income and expense:
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|
|
|
|
|
|
| 2009 |
|
| 2008 |
|
| 2007 |
|
|
Engine Products |
| 44.5 | % |
| 61.1 | % |
| 62.9 | % |
|
Industrial Products |
| 51.8 | % |
| 42.1 | % |
| 37.8 | % |
|
Corporate and Unallocated |
| 3.7 | % |
| (3.2 | %) |
| (0.7 | %) |
|
Total Company |
| 100 | % |
| 100 | % |
| 100 | % |
|
International operating income, prior to corporate expense allocations, totaled 77.277.9 percent of consolidated operating income in 2006Fiscal 2009 as compared to 82.789.4 percent in 2005. Of the 2006 international operating income, prior to corporate expense allocations, Europe contributed 42.4 percent while Asia contributed 48.5 percent.Fiscal 2008. Total international operating income increased 15.0decreased 39.8 percent from the prior year. This increasedecrease is attributable to strong salesrestructuring charges internationally exceeding domestic restructuring costs, weaker foreign currencies and overall weak business conditions abroad. The table below shows the percentage of special application products and gas turbine systems.total operating income contributed by each major geographic region for each of the last three fiscal years:
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|
| 2009 |
|
| 2008 |
|
| 2007 |
|
|
United States |
| 22.1 | % |
| 10.6 | % |
| 22.3 | % |
|
Europe |
| 23.3 | % |
| 43.3 | % |
| 34.8 | % |
|
Asia |
| 43.5 | % |
| 37.9 | % |
| 38.6 | % |
|
Other |
| 11.1 | % | 8.2 | % |
| 4.3 | % |
| |
Total Company |
| 100 | % |
| 100 | % |
| 100 | % |
|
Gross margin for 2006Fiscal 2009 was 32.931.6 percent, an increasea decrease from 31.732.5 percent in the prior year. The Company had $10.1 million in restructuring costs which reduced gross margin benefitedin the year. In addition, lower absorption of fixed costs due to the drop in production volumes, net of savings from completed restructuring related activities, negatively impacted gross margin by approximately $23 million. Partially offsetting these factors were the Company’s focus on cost reduction efforts, productionpositive impacts of improved product mix, improved distribution efficiencies and some selective price increases.better execution on large project shipments. During Fiscal 2008, the Company began using a new warehouse management system at its main U.S. distribution center. The company encountered start-up problems during the transition to the new systems which, although now resolved, resulted in $7.6 million in unanticipated charges in Fiscal 2008 that did not recur in Fiscal 2009. The Company continuedalso incurred a charge of approximately $5.0 million to pretax income related to the use of the Last-In, First-Out (LIFO) accounting method for its effortsU.S. inventories, which charges increasing commodity costs to improve manufacturing infrastructure and reduce productincome immediately. As commodity costs through plant rationalization. Plant rationalization and start-up costs for new facilities were $5.4 millionrelatively flat in 2006, upFiscal 2009, the Company did not experience a similar impact from the $4.0 million in the prior year.rising commodity prices.
Operating expenses for 2006Fiscal 2009 were $363.8$419.8 million or 21.522.5 percent of sales, up from $349.1as compared to $480.1 million or 21.921.5 percent in the prior year. Operating expenses as a percent of sales increased due to sales volume declines and $7.7 million in fiscal 2006 included $2.8restructuring cost during the year, offset by $19.4 million in benefits from restructuring actions taken and $19.5 million of stock optionlower incentive compensation expense that was not included in fiscal 2005. Operating expenses in fiscal 2005 included a $6.4 million increaseas compared to the prior year. The Company’s legal reserve for the EPC patent infringement judgment. The Company continued to focus on operating expense controlsreduction programs remain in 2006.effect.
Interest expense of $9.9$17.0 million increased $0.5$0.4 million from $9.4$16.6 million in the prior year.year as a result of higher debt levels. Net other income totaled $6.3$8.5 million in 2006 compared to $7.7Fiscal 2009 up from $6.9 million in the prior year. Components of other income for 2006Fiscal 2009 were as follows: interest income of $1.7$1.6 million, earnings from non-consolidated joint ventures of $5.0$2.3 million, royalty income of $6.1 million, charitable donations of $2.1$0.6 million, foreign exchange gainslosses of $0.3$0.4 million and other miscellaneous income and expense items resulting in incomeexpenses of $1.4$0.5 million.
The effective income tax rate for fiscal 2006Fiscal 2009 was 30.1 percent. In18.3 percent compared to 27.2 percent in Fiscal 2008. The decrease in effective rate is primarily due to the fourth quartersettlements of fiscallong-standing court cases and examinations in various jurisdictions for tax years 2003 through 2006, the Company recognized a $3.6 millionreassessment of the corresponding unrecognized tax chargebenefits for the $80.0 millionsubsequent open years and a favorable resolution of a foreign earningstax matter. Partially offsetting these effects, the Company’s Fiscal 2009 tax rate was unfavorably impacted by an increased expense from the repatriation plan pursuant toof foreign earnings. Absent these items, the American Jobs Creation Act of 2004. The effective incomeunderlying tax rate for fiscal 2005 was 28.6 percentthe Fiscal
2009 has decreased from Fiscal 2008 by 1.2 points to 30.4 percent. The reinstatement of the U.S. Research and also included a $4.0 millionExperimentation credit, changes in current year unrecognized tax charge for a previous $80.0 million foreign earnings repatriation plan pursuant to the American Jobs Creation Act of 2004. Although the tax rate going forward is dependent upon the applicablebenefits, reduced statutory tax rates and the geographic mix of profits, the Company expects that it will be approximately 29 percent in fiscal 2007. The higher fiscal 2006 effective tax rate as compared to the prior year is primarily a result of the mix of earnings in our various jurisdictions. Higher taxbetween foreign jurisdictions such as Japan, Germany and the United Statesall contributed a higher proportion of our taxable earnings as compared to the prior year. The unfavorable timing of the phase-out/phase-in provisions of the United States export credit versus the manufacturing credit and the expiration of the research and development credit also adversely affected the rate for fiscal 2006. The Company undergoes examination by various taxing authoritiesreduction in the multiple jurisdictions in which it operates. Such
11
taxing authorities may require changes in the amount of tax expense to be recognized when their interpretations differ from those of management. The Company maintains reserves against such differences and the effect of such adjustments are recorded at the time of resolution of the applicable examination.underlying rate.
Total backlog at July 31, 20062009, was $516.7$528.0 million, up 25.4down 33.7 percent from the same period in the prior year. Backlog is one of many indicators of business conditions in our market.the Company’s markets. However, it is not always indicative of future results for a number of reasons, including short lead times in our aftermarketthe Company’s replacement parts businesses and the timing of receipt of orders in many of our original equipmentthe Company’s Engine OEM and industrialIndustrial markets. In the Engine Products segment, total open order backlog increased 20.3decreased 31.8 percent from the prior year. In the Industrial Products segment, total open order backlog increased 36.4decreased 36.8 percent from the prior year. Because some of the change in backlog can be attributed to a change in the ordering patterns of our customers,the Company’s Customers and/or the impact of foreign exchange translation rates, it may not necessarily correspond to higher future sales.
Fiscal 20052008 Compared to Fiscal 20042007
(Certain fiscal 2004 amounts have been reclassified between the segments to conform to the current structure for comparison between years.)
Engine Products SegmentSales for the Engine Products segment were $923.8 million,$1.229 billion, an increase of 13.813.4 percent from $811.5 million$1.084 billion in the prior year, reflecting increases in the Off-Road and Aftermarket Products businesses, partially offset by decreased On-Road Products sales in the NAFTA region. The impact of foreign currency increased sales across all products within this segment both in North America and internationally.
Within theby $60.6 million, or 5.6 percent. Earnings before income taxes as a percentage of Engine Products segment worldwide sales of off-road products12.9 percent decreased from 13.0 percent in the prior year. The Engine Products segment as a percent of sales was down slightly from last year due the impact of distribution inefficiencies and start-up costs related to the implementation of a new warehouse management system at our Rensselaer, Indiana distribution center, offset by stronger global volume across most business units.
Worldwide sales of Off-Road Products were $286.2$448.7 million, an increase of 16.927.4 percent from $244.7$352.1 million in the prior year. North American salesSales in the United States showed an increase of 12.427.1 percent, primarily driven by the impact of the acquisition of Aerospace Filtration Systems, Inc. in March of Fiscal 2007 and robust sales in the Company’s defense business due to continued improvementsthe combination of replacement parts sales growth, new vehicle programs (including the Mine Resistant Ambush Protected armored vehicles) and retrofit programs for the Abrams Tank and military helicopters including the Black Hawk. In addition, strong sales in newagriculture, mining and non-residential construction agriculture and mining equipment demand.markets more than offset a decrease in residential construction markets. Internationally, sales of off-road productsOff-Road Products were up 23.627.8 percent from the prior year, with sales increasing in both Europe and Asia and Europe by 22.824.4 percent and 23.436.3 percent, respectively, reflecting the strength in the off-roadheavy construction market and increased demand for mining and agricultural equipment market internationally.
Worldwide sales of truck productsOn-Road Products were $175.0$123.1 million, an increasea decrease of 11.926.0 percent from $156.4$166.4 million in the prior year. North American truckOn-Road Products sales increased 23.3in the United States decreased 43.3 percent from the prior year due to growingas a result of lower new truck build rates and strongat the Company’s Customers following the implementation of the 2007 Environmental Protection Agency diesel emission sales.regulations. International truckOn-Road Products sales decreased 10.7increased 14.9 percent from the prior year. StrongOn-Road Products sales in Europe resulted in an increase of 24.7 percentbenefited from stronger build rates and increased market share. Offsetting Europe’sresulting in a sales increase was a decrease in sales in Asia of 23.2 percent as emission sales spiked in Japan in the prior year ahead of new emissions regulations.28.1 percent.
Worldwide aftermarket productEngine Aftermarket Products sales of $462.6$657.3 million increased 12.716.2 percent from $410.4$565.8 million in the prior year as equipment utilization rates remained strong and sales of diesel emission retrofit equipment continued to ramp up throughout the year, driving aftermarket parts sales growth.year. Sales in North Americathe United States increased 13.14.6 percent over the prior year while internationalyear. International sales increased 13.028.4 percent with sales increasing in both Europe, Asia and AsiaMexico by 13.725.3 percent, 23.5 percent and 6.577.0 percent, respectively. The large percentage increase in Mexico is partially a result of transferring some Customer relationships to the Company’s Mexican subsidiary from the United States to better serve the Customers. Geographic expansion and high equipment utilization rates contributed to the overall increases. In addition, sales continue to benefit from the increasing amount of equipment in the field with the Company’s PowerCore™ filtration systems. Sales of PowerCore™ replacement filters increased 58.9 percent over the prior year.
Industrial Products SegmentSales for the Industrial Products segment were $671.9$1,003.4 million, an increase of 11.320.2 percent from $603.4$834.6 million in the prior year, resulting from strongstronger sales in Industrial Filtration Solutions Products, Special Application Products and Gas Turbine Systems Products across all regions. The impact of industrial filtration solutions and special application products, partially offsetforeign currency increased sales by $62.0 million, or 7.4 percent. Earnings before income taxes as a slight decrease in salespercentage of gas turbine products.
Within the Industrial Products segment worldwide sales of industrial filtration solutions products10.2 percent increased from 9.6 percent in the prior year. The improvement in earnings as a percent of $424.7sales over the prior year was driven by cost leverage across most business units due to strong global volumes offset slightly lower margins on a few large projects in both our Gas Turbine and Industrial Air Filtration business units.
Worldwide sales of Industrial Filtration Solutions Products of $600.5 million increased 14.816.6 percent from $370.1$515.0 million in the prior year. Sales in North Americathe United States, Europe, Asia and South Africa increased 9.9 percent, 22.0 percent, 16.5 percent and 25.0 percent, respectively. U.S. sales included the impact of the acquisition of LMC West, Inc. in February of Fiscal 2008. Demand was strong worldwide but specifically in Europe, where manufacturing investment conditions were favorable throughout the fiscal year.
Worldwide sales of Gas Turbine Products were $213.1 million, an increase of 34.9 percent from $158.0 million in the prior year. Growth globally has been strong in both the power generation and oil and gas markets. The Gas Turbine Products sales are typically large systems and, as a result, the Company’s shipments and revenues fluctuate from quarter to quarter.
Worldwide sales of Special Applications Products were $189.7 million, a 17.4 percent increase from $161.5 million in the prior year. Sales in the United States, Europe, and Asia increased 20.28.3 percent, 25.3 percent, and 17.317.8 percent, respectively, from the prior year reflecting strength in the manufacturing economy. Sales in Europe increased 10.0 percent from the prior year, reflecting stability in the market and the benefits of foreign currency translation.
Worldwideas sales of gas turbine products were $112.9 million, a decrease of 4.1 percent from $117.7 million in the prior year as business conditions in that marketdisk drive filters and PTFE membranes remained stable. North American sales decreased 6.5 percent from the prior year while sales in Asia increased 5.5 percent and sales in Europe decreased 5.9 percent.strong.
Worldwide sales of special application products were $134.3 million, a 16.1 percent increase from $115.6 million in the prior year. North American sales decreased 2.2 percent from the prior year while
12
sales in Europe and Asia increased 28.1 percent and 18.8 percent from the prior year, respectively. Continued strong demand for computer hard drives in Asia impacted the Company’s special application product sales. Worldwide sales of membrane products increased 13.6 percent from the prior year due to strong sales in that market in both Europe and Asia with increases of 32.0 percent and 29.4 percent, respectively.
Consolidated ResultsThe Company reported record net earnings for 2005Fiscal 2008 of $110.6$172.0 million compared to $106.3$150.7 million in 2004,Fiscal 2007, an increase of 4.014.1 percent. NetDiluted net earnings per share — diluted werewas a record $1.27,$2.12, up 7.615.8 percent from $1.18$1.83 in the prior year. The Company’s operating income of $156.5$245.8 million increased from prior year operating income of $141.6$211.1 million by 10.516.4 percent. Operating income in
The table below shows the Engine Products segment as a percentpercentage of total operating income was consistent withcontributed by each segment for each of the prior year at 77.4 percent of total operatinglast three fiscal years. Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments and interest income compared to 77.5 percent in the prior year. Operating income in the Industrial Products segment as a percent of total operating income of 34.2 percent increased from the prior year percent of 29.8 percent of total operating income.and expense:
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|
| 2008 |
|
| 2007 |
|
| 2006 |
|
|
Engine Products |
| 61.1 | % |
| 62.9 | % |
| 67.7 | % |
|
Industrial Products |
| 42.1 | % |
| 37.8 | % |
| 33.6 | % |
|
Corporate and Unallocated |
| (3.2 | %) |
| (0.7 | %) |
| (1.3 | %) |
|
Total Company |
| 100 | % |
| 100 | % |
| 100 | % |
|
International operating income, prior to corporate expense allocations, totaled 82.789.4 percent of consolidated operating income in 2005Fiscal 2008 as compared to 83.777.7 percent in 2004. Of the 2005 international operating income, prior to corporate expense allocations, Europe contributed 49.2 percent while Asia contributed 42.3 percent.Fiscal 2007. Total international operating income increased 9.234.0 percent from the prior year. This increase is attributable to stronger foreign currencies, the favorable impact of new plants globally and overall strong business conditions. The table below shows the percentage of total operating income contributed by each major geographic region for each of the last three fiscal years:
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|
|
|
|
|
|
|
| 2008 |
|
| 2007 |
|
| 2006 |
|
|
United States |
| 10.6 | % |
| 22.3 | % |
| 22.8 | % |
|
Europe |
| 43.3 | % |
| 34.8 | % |
| 32.7 | % |
|
Asia |
| 37.9 | % |
| 38.6 | % |
| 37.5 | % |
|
Other |
| 8.2 | % |
| 4.3 | % |
| 7.0 | % | |
Total Company |
| 100 | % |
| 100 | % |
| 100 | % |
|
Gross margin for 2005Fiscal 2008 was 31.732.5 percent, flat with 31.6an increase from 31.5 percent in the prior year. Commodity price increases related to steel and, to a lesser extent, petrochemicals later inThe primary drivers for the year, impactedimproved gross margin even though the Company worked to recover these increases through cost reduction programs and price adjustments. Somewhat offsetting the unrecovered portion of commodity price increases was operating leverage gained frominclude higher production volumes, throughouta favorable product mix, cost controls and productivity improvements. Partially offsetting the improvements was a charge of $5.0 million to pretax income related to the use of the Last-In, First-Out (LIFO) accounting method for its
U.S. inventories, which charges increasing commodity costs to income immediately. Also partially offsetting the improvements in gross margin were higher than expected distribution costs associated with implementing the investments made to increase the Company’s distribution capabilities and higher purchased commodity costs. During the second quarter, the Company began utilizing a new warehouse management system at its main U.S. distribution center. The Company encountered start-up problems during the transition to the new system. There were incremental expenses related to refining the system which resulted in $7.6 million in unanticipated charges for the year. The fiscal 2003 adjustment thatGross margin in Fiscal 2007 was identified in the fiscal 2004 closing processalso negatively impacted gross marginby a higher mix of systems sales versus replacement part sales and higher than expected distribution costs in 2004 by $2.3 million. The Company continued its efforts to improve manufacturing infrastructure and reduce product costs through plant rationalization.Europe from the integration of new distribution facilities while Customer demand ramped up beyond expectations. Plant rationalization and start-up costs for new facilities were $4.0$0.6 million in 2005, lower than the $6.2Fiscal 2008, down from $5.3 million in the prior year.
Operating expenses for 2005 were $349.1 million or 21.9 percent of sales, up from $311.8 million or 22.0 percent in the prior year. Operating expenses in fiscal 2005 included a $6.4for Fiscal 2008 were $480.1 million increase to the Company’s legal reserve for the EPC patent infringement judgment recordedor 21.5 percent of sales, up from $393.8 million or 20.5 percent in the fourth quarter. Also includedprior year. This increase was driven by the impact of foreign exchange as well as investments in 2005 operating costs were incremental costs associated with compliance withresearch and development to support essential product development initiatives and the Sarbanes-Oxley Actdevelopment of 2002 totaling approximately $3.0 million. Included in operating expenses for 2004 was the adjustment of $5.0 million to increase the Company’s reserve for the patent infringement judgment, a $3.0 million increase to the Company’s warranty reserve on a specific warranty-related matternext generation technologies and $1.3 million for the fiscal 2003 adjustment that was identified in the fiscal 2004 closing process.products across many product lines. The Company continuedalso increased its investment in information technology to focus on operating expense controls in 2005.improve Customer support capabilities and enhance its internal system infrastructure capabilities.
Interest expense of $9.4$16.6 million increased $4.4$2.0 million from $5.0$14.6 million in the prior year.year as a result of increased borrowing costs associated with the increases in working capital and the Aerospace Filtration Systems, Inc. acquisition in March of 2007. Net other income totaled $7.7$6.9 million in 2005Fiscal 2008 compared to $5.2$8.3 million in the prior year. Components of other income for 2005Fiscal 2008 were as follows: interest income of $2.7$1.5 million, earnings from non-consolidated joint ventures of $3.5$1.9 million, royalty income of $7.6 million, charitable donations of $0.9 million, foreign exchange gainslosses of $1.0$3.1 million and other miscellaneous income and expense items totaling $0.5resulting in expenses of $0.1 million.
The effective income tax rate for fiscal 2005Fiscal 2008 was 28.627.2 percent. During fiscal 2005, the Company filed an amended tax return related to a prior year, which resulted in additional research and development tax credits. This resulted in a $1.0 million reduction in the income tax provision during fiscal 2005. Additionally, at the end of fiscal 2005, the Company recognized a $4.0 million tax charge for the $80.0 million foreign earnings repatriation plan pursuant to the American Jobs Creation Act of 2004. The effective income tax rate for fiscal 2004Fiscal 2007 was 25.0 percent26.4 percent. The Company’s Fiscal 2008 tax rate benefited from the effect of changes in foreign statutory tax rates on outstanding deferred tax positions and includedreduced state tax expense due to lower U.S. earnings. U.S. earnings were also a $1.8 million reduction insignificantly lower percentage of total earnings, emphasizing the incomefact that the average tax provision as a resultrate continues to reflect the significant contribution from the Company’s international operations, the majority of which have statutory tax rates below those of the completionU.S. Offsetting these favorable effects, the Company’s Fiscal 2008 tax rate was also impacted by a reduced U.S. dividends received deduction, a reduced benefit from the repatriation of a researchforeign earnings, the expiration of some foreign tax incentives, and development tax credit study.the expiration of the U.S. Research and Experimentation credit.
Total backlog at July 31, 20052008, was $412.0$771.2 million, up 11.025.2 percent from the same period in the prior year. Backlog is one of many indicators of business conditions in the Company’s markets. However, it is not always indicative of future results for a number of reasons, including short lead times in the Company’s replacement parts businesses and the timing of receipt of orders in many of the Company’s Engine OEM and Industrial markets. In the Engine Products segment, total open order backlog increased 15.124.9 percent compared to the same period infrom the prior year. In the Industrial Products segment, total open order backlog increased 1.925.6 percent from the same periodprior year. Because some of the change in backlog can be attributed to a change in the prior year.
13
Tableordering patterns of Contentsthe Company’s Customers and/or the impact of foreign exchange translation rates, it may not necessarily correspond to higher future sales.
Liquidity and Capital Resources
Financial ConditionAt July 31, 2006,2009, the Company’s capital structure was comprised of $79.9$35.1 million of current debt, $100.5$253.7 million of long-term debt and $546.8$688.6 million of shareholders’ equity. The Company had cash and cash equivalents of $45.5$143.7 million at July 31, 2006.2009. The ratio of long-term debt to total capital was 15.526.9 percent and 16.519.3 percent at July 31, 20062009 and 2005,2008, respectively.
Total debt outstanding decreased $32.7$32.8 million forduring the year to $180.4$288.7 million outstanding at July 31, 2006. The decrease is a result of a decrease in short-term2009. Short-term borrowings outstanding at the end of the year of $28.6were $109.8 million lower as compared to the prior year, and a decrease in long-term debt of $4.0increased $77.0 million (including current maturities) from the prior year.
The decreaseincrease in long-term debt was comprised of a new note agreement. On November 14, 2008, the Company issued an addition$80 million senior unsecured note, due on November 14, 2013. The debt was issued at face value and bears interest payable semi-annually at a rate of a $4.1 million commercial property loan offset by payments made during6.59 percent. The proceeds from the year of $7.6 million, which includes a payment of a $7.1 million guaranteed note.note were used to refinance existing debt and for general corporate purposes.
The following table summarizes the Company’s fixed cash obligations as of July 31, 20062009, for the years indicated (thousands of dollars):
| Payments Due by Period | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Contractual Obligations | Total | Less than 1 year | 1 - 3 years | 3 - 5 years | More than 5 years | ||||||||||||||||||
| Long-term debt obligations | $ | 104,851 | $ | 5,819 | $ | 40,024 | $ | 10,786 | $ | 48,222 | |||||||||||||
| Capital lease obligations | 2,185 | 722 | 1,111 | 128 | 224 | ||||||||||||||||||
| Interest on long-term debt obligations | 23,329 | 5,618 | 8,102 | 4,925 | 4,684 | ||||||||||||||||||
| Operating lease obligations | 11,670 | 6,461 | 4,908 | 301 | — | ||||||||||||||||||
| Purchase obligations(1) | 115,966 | 115,247 | 719 | — | — | ||||||||||||||||||
| Deferred compensation and other(2) | 10,675 | 1,535 | 3,010 | 1,870 | 4,260 | ||||||||||||||||||
| Total | $ | 268,676 | $ | 135,402 | $ | 57,874 | $ | 18,010 | $ | 57,390 | |||||||||||||
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|
| Payments Due by Period |
| ||||||||||
Contractual Obligations |
| Total |
| Less than |
| 1 - 3 |
| 3 – 5 |
| More than |
| |||||
Long-term debt obligations |
| $ | 257,879 |
| $ | 4,982 |
| $ | 47,678 |
| $ | 97,434 |
| $ | 107,785 |
|
Capital lease obligations |
|
| 1,291 |
|
| 514 |
|
| 718 |
|
| 59 |
|
| — |
|
Interest on long-term debt obligations |
|
| 79,030 |
|
| 13,484 |
|
| 25,344 |
|
| 19,952 |
|
| 20,250 |
|
Operating lease obligations |
|
| 21,290 |
|
| 8,422 |
|
| 8,924 |
|
| 3,750 |
|
| 194 |
|
Purchase obligations(1) |
|
| 125,599 |
|
| 106,621 |
|
| 18,500 |
|
| 478 |
|
| — |
|
Pension and deferred compensation(2) |
|
| 78,643 |
|
| 6,416 |
|
| 10,100 |
|
| 9,725 |
|
| 52,402 | |
Total(3) |
| $ | 563,732 |
| $ | 140,439 |
| $ | 111,264 |
| $ | 131,398 |
| $ | 180,631 |
|
(1) | Purchase obligations consist primarily of inventory, tooling, contract employment services and capital expenditures. The Company’s purchase orders for inventory are based on expected |
(2) | Pension and deferred compensation |
(3) | In addition to the above contractual obligations, the Company may be obligated for additional cash outflows of $16.9 million of potential tax obligations. The payment and timing of any such payments is affected by the ultimate resolution of the tax years that are under audit or remain subject to examination by the relevant taxing authorities, and are therefore not currently capable of estimation by period. |
ForAs a result of its U.S. pension plans,past contribution practices, the Company does not have a minimum required contribution under the Pension Benefit Guarantee Corporation requirements for fiscal 2007. However, the Company may electits U.S. pension plans for Fiscal 2010. As such, there is no current intention to contribute up to its maximum deductiblemake a U.S. pension contribution of $28.6 million in fiscal 2007.Fiscal 2010. For its non-U.S. pension plans, the Company estimates that it will contribute approximately $8.1$5 million in fiscal 2007.Fiscal 2010 based upon the local government prescribed funding requirements. Future estimates of the Company’s pension plan contributions may change significantly depending on the actual rate of return on plan assets, discount rates and regulatory rules.requirements.
The Company has a three-yearfive-year, multi-currency revolving facility with a group of banks under which the Company may borrow up to $150.0$250 million. TheThis facility as amended in September 2004, expires in September 2009.matures on April 2, 2013. The agreement provides that loans may be made under a selection of currencies and rate formulas including Base Rate Advances or Off Shore Rate Advances. The interest rate on each advance is based on certain market interest rates and leverage ratios. Facility fees and other fees on the entire loan commitment are payable over the duration of this facility. There were no amounts outstanding at July 31, 2006 and $65.0was $20.0 million outstanding at July 31, 2005, leaving $150.02009, and $70.0 million outstanding at July 31, 2008. The amount available for further borrowing reflects a reduction for issued standby letters of credit, as discussed below. At July 31, 2009 and 2008, $210.0 million and $85.0$161.5 million, respectively, was available for further borrowing under such facilities. The weighted average interest rate on these short-term borrowings outstanding at July 31, 2009 and 2008, was 0.56 percent and 2.73 percent, respectively.
The Company also has three uncommitted credit facilities in the United States, which provide unsecured borrowings for general corporate purposes. At July 31, 2009 and 2008, there was $70.0 million available for use. There was $9.6 million and $28.0 million outstanding under these facilities at July 31, 20062009 and July 31, 2005,2008, respectively. The weighted average interest rate on these short-term borrowings outstanding at July 31, 20052009 and 2008, was 3.77 percent.
The Company also has three agreements under uncommitted credit facilities, which provide unsecured borrowings for general corporate purposes. At July 31, 20060.53 percent and 2005, there was $70.0 million and $60.0 million available for use under these facilities,2.79 percent, respectively. There were no amounts outstanding under these facilities at July 31, 2006 and $36.7 million outstanding under these facilities at July 31, 2005. The weighted average interest rate on these short-term borrowings outstanding at July 31, 2005 was 3.67 percent.
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The Company also has a 100€100 million euro program for issuing treasury notes for raising short-, medium-short, medium and long-term financing for its European operations. There was 35.3 million euro outstanding at July 31, 2006 andwere no amounts outstanding on this program at
July 31, 2005 under the program. The weighted average interest rate on these short-term issuances at July 31, 2006 was 3.13 percent.2009 and 2008. Additionally, the Company’s European operations have lines of credit in the amountwith an available limit of 50.2 million euro.€72.9 million. There were no amounts outstanding on these lines of credit as of July 31, 2009. As of July 31, 20062008, there was 20.1€23.5 million, euro outstanding. As of July 31, 2005 there were no amountsor $36.9 million outstanding. The weighted average interest rate onof these short-term borrowings outstanding at July 31, 20062008, was 3.385.60 percent.
Other international subsidiaries may borrow under various credit facilities. There were no amounts outstanding under these credit facilities as of July 31, 2009. As of July 31, 2006 and 2005,2008, borrowings under these facilities were $2.6 million and $0.3 million, respectively.$4.5 million. The weighted average interest rate on these international borrowings outstanding at July 31, 20062008, was 2.88 percent.
During the first quarter of Fiscal 2009, the global credit market began to experience a significant tightening of credit availability and 2005interest rate volatility. This crisis resulted in reduced funding available for commercial banks and corporate debt issuers. As a result, capital market financing became more expensive and less available. The Company has assessed the implications of these factors on its current business and believes that its current financial resources are sufficient to continue financing its operations. There can be no assurance, however, that the cost or availability of future borrowings will not be impacted by ongoing capital market disruptions.
The Company is exposed to changes in the fair value of its fixed-rate debt resulting from interest rate fluctuations. To hedge this exposure the Company entered into two fixed-to-variable interest rate swaps on August 3, 2009, subsequent to year end, for $80 million and $25 million, respectively, for approximately 5 and 8 years, respectively. These interest rate swaps will be accounted for as fair value hedges. Changes in the payment of interest resulting from the interest rate swaps will be recorded as an offset to interest expense.
Certain note agreements contain debt covenants related to working capital levels and limitations on indebtedness. As of July 31, 2009, the Company was 7.92 percent and 8.50 percent, respectively.in compliance with all such covenants. The Company currently expects to remain in compliance with these covenants.
Also, at July 31, 20062009 and 2005,2008, the Company had outstanding standby letters of credit totaling $18.7 million.$20.0 million and $18.5 million, respectively, upon which no amounts had been drawn. The letters of credit guarantee payment to beneficial third parties in the event the Company is in breach of a specified bond financing agreement and insurance contract terms as detailed in each letter of credit. At July 31, 2006 and 2005, there were no amounts drawn upon these letters of credit.
The Company repatriated $160.0 million of its accumulated foreign earnings in fiscal 2006 under the favorable provisions of the American Jobs Creation Act of 2004. Total U.S. income taxes of $3.6 million and $4.0 million have been provided on these repatriations in 2006 and 2005, respectively.
Shareholders’ equity increased $22.2decreased $51.4 million in 2006Fiscal 2009 to $546.8 million.$688.6 million at July 31, 2009. The increasedecrease was primarily due to current year earningschanges to foreign currency translation of $132.3$63.4 million, an increase in accumulated other comprehensive income$58.6 million (net of $23.6 million and $18.9 milliontax) of stock option and other stock activity offset by $118.9adjustments related to the pension liability, $32.8 million of treasury stock repurchases and $33.7$35.5 million of dividend declarations. The increase in accumulated other comprehensive income consisted primarilyThese decreases were partially offset by current year earnings of foreign currency translation adjustment of $15.3 million and a decrease in the Company’s additional minimum pension liability of $8.4$131.9 million.
Cash FlowsDuring fiscal 2006, $156.7Fiscal 2009, $276.9 million of cash was generated from operating activities, compared with $142.6$173.5 million in 2005Fiscal 2008 and $118.1$117.0 million in 2004.Fiscal 2007. Operating cash flows in 2006, whichFiscal 2009 increased by $14.1$103.4 million from the prior year, included paymentyear. Operating cash flows were positively impacted by the decreased level of sales as a result of the previously accrued EPC judgment of $14.2 million, the payment of $41.3 million toworldwide recession and the Company’s defined benefit plans, smaller increasescash flow improvement initiatives. This led to a decrease in accounts receivable and inventory levels of $12.1$146.8 million and the presentation of the tax benefit of equity plans of $10.9$115.5 million, respectively, and corresponding increase operating cash flows. These positive impacts were partially offset by larger increasesthe negative impacts of decreases in trade accounts payable and other accrued expensescompensation of $26.6 million. The tax benefit is required to be presented as a financing activity pursuant to new accounting standards. The tax benefit from equity plans was presented as an$82.3 million and $22.9 million, respectively, which reduced operating cash flow in the prior years and not shown separately as a financing activity.flows. In addition to cash generated from operating activities, the Company decreasedincreased its outstanding short-term debt by $31.7 million and net long-term debt by $3.2$72.7 million. Cash flow generated by operations, was$3.9 million of proceeds from the sale of the Maryville, TN air dryer business and $80.0 million of additional long-term debt were used primarily to support $81.3$45.6 million forof net capital expenditures, $118.9the acquisition of Western Filter Corporation for $78.5 million, $32.8 million for stock repurchases, and $26.4$35.2 million for dividend payments.payments and repayment of $103.7 million of short-term debt. Cash and cash equivalents increased $88.6$60.3 million during 2006.Fiscal 2009.
CapitalNet capital expenditures for property, plant and equipment totaled $81.3$45.6 million in 2006, $55.0Fiscal 2009, $70.8 million in 2005Fiscal 2008 and $47.7$76.6 million in 2004. CapitalFiscal 2007. Net capital expenditures is comprised of purchases of property, plant, and equipment of $46.1 million, $72.1 million, and $77.4 million in Fiscal 2009, 2008 and 2007, respectively, partially offset by proceeds from the sale of property, plant, and equipment of
$0.5 million, $1.3 million, and $0.8 million in Fiscal 2009, 2008 and 2007, respectively. Fiscal 2009 capital expenditures primarily related to new overseas facilitiesplant capacity additions and productivity enhancing investments at various plants worldwide.
Capital spending in 2007Fiscal 2010 is planned at $60.0$30.0 million to $70.0$40.0 million. Significant planned expenditures include the further upgrade of information systems and investment in manufacturing plants, equipment and tooling. It is anticipated that 2007Fiscal 2010 capital expenditures will be financed primarily by cash on hand, cash generated from operations and existing lines of credit.
The Company expects that cash generated by operating activities will exceed $100$150 million again in 2007.Fiscal 2010. At July 31, 2006,2009, the Company had $45.5cash of $143.7 million, cash, $220.0which primarily exists at subsidiaries outside of the United States. The Company also had $270.4 million available under existing credit facilities in the United States, and 94.8€172.9 million, euroor $245.3 million, available under existing credit facilities in Europe.Europe and $41.4 million available under various credit facilities and currencies in Asia and the rest of the world. The Company believes that the combination of existing cash, available credit under existing credit facilities and the expected cash generated by operating activities iswill be adequate to meet cash requirements for fiscal 2007,Fiscal 2010, including debt repayment, issuance of anticipated dividends, possible share repurchase activity
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Table of Contents and capital expenditures.
capital expenditures, and execution of the Company’s domestic reinvestment plan pursuant to the American Jobs Creation Act of 2004.
DividendsThe Company’s dividend policy is to maintain a payout ratio, which allows dividends to increase with the long-term growth of earnings per share. The Company’s dividend payout ratio target is 20.020 percent to 30.030 percent of the average earnings per share of the last three years. The current quarterly dividend of 0.09 cents per share equates to 27.0 percent of the average net earnings per share for 2004 through 2006.
Share Repurchase PlanIn fiscal 2006,Fiscal 2009, the Company repurchased 3.80.8 million shares of common stock for $118.9$32.8 million under the share repurchase plan authorized in March 2006 at an average price of $31.43$40.86 per share. The Company repurchased 3.82.2 million shares for $116.3$92.2 million in 2005.Fiscal 2008. The Company repurchased 1.12.2 million shares for $29.8$76.9 million in 2004.Fiscal 2007. As of July 31, 2009, the Company had remaining authorization to repurchase 0.9 million shares under this plan.
Off-Balance Sheet ArrangementsThe Company does not have any off-balance sheet arrangements, with the exception of the guarantee of 50 percent of certain debt of its joint venture, Advanced Filtration Systems, Inc. as further discussed in Note K of the Company’s Notes to Consolidated Financial Statements. As of July 31, 2009, the joint venture had $27.7 million of outstanding debt. The Company does not believe that this guarantee will have a current or future effect on its financial condition, results of operation, liquidity or capital resources.
Environmental Matters New Accounting Standards The CompanyIn May 2009, the Financial Accounting Standards Board (FASB) issued FAS No. 165, Subsequent Events (FAS 165), which establishes reserves as appropriategeneral standards of accounting and disclosure for potential environmental liabilitiesevents that occur after the balance sheet date but before the financial statements are issued. This new standard was effective for interim or annual financial periods ending after June 15, 2009, and will continue to accrue reserves in appropriate amounts. While uncertainties exist with respect to the amounts and timing of the Company’s ultimate environmental liabilities, management believes that such liabilities, individually and in the aggregate, willdid not have a material adverse effectan impact on the Company’sour consolidated financial conditionposition or results of operations.
In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1,NewInterim Disclosures about Fair Value of Financial Instruments, (FSP No. FAS-107-1 and APB-28-1), which amends FAS 107,Disclosures about Fair Value of Financial Instrumentsand Accounting StandardsPrinciples Board (APB) Opinion No. 28,Interim Financial Reporting, to require disclosures about fair value of financial instruments for interim periods. This FSP will be effective for the Company for the quarter ended October 31, 2009, and will expand the Company’s disclosures regarding the use of fair value in interim periods.
In December 2008, the FASB issued FSP No. FAS 132(R)-1,Employers’ Disclosures about Postretirement Benefit Plan Assets(FSP No. FAS 132(R)), which provides guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. This FSP is effective for fiscal years ending after December 15, 2009. The Company is currently evaluating the impact of adopting FSP No. FAS 132(R) on our defined benefit pension and other postretirement plan note disclosures.
In September 2006, the FASB issued SFAS No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“(SFAS 158”)158). ThisThe portion of the statement that requires recognition of the overfunded or underfunded status of defined benefit postretirement plans as an asset or liability in the statement of financial position and to recognize changeswas adopted in that funded status in comprehensive income in the year in which the changes occur.
Fiscal 2007 with minimal impact. SFAS 158 also requires measurement of the funded status of a plan as of the date of the statement of financial position. SFAS 158 is effective for recognitionThat provision required the Company to change its measurement date from April 30 to July 31 in Fiscal 2009. The adoption of the funded statusmeasurement date provision resulted in an after-tax decrease to Retained earnings of $0.9 million, a decrease to Other assets of $0.5 million increase to Other long-term liabilities of $0.8 million and an increase to Deferred income taxes of $0.5 million.
In September 2006, the benefit plansFASB issued SFAS No. 157,Fair Value Measurements(SFAS 157). This statement defines fair value, establishes a framework for fiscal years ending after December 15, 2006measuring fair value in U.S. generally accepted accounting principles and is effectiveexpands disclosures about fair value measurements. SFAS 157 applies whenever another standard requires (or permits) assets or liabilities to be measured at fair value, except for the measurement date provisions for fiscal years ending after December 15, 2008. The Company is currently evaluatingof share-based payments. SFAS 157 does not expand the effectuse of SFAS 158 on its consolidated financial statements.
In March 2005, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 47,Accounting for Conditional Asset Retirement Obligations, (“FIN 47”) which clarifies that the term “conditional asset retirement obligation” as used in SFAS No. 143,Accounting for Asset Retirement Obligations, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. However, the obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. FIN 47 requires that the uncertainty about the timing and/or method of settlement of a conditional asset retirement obligation be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47to any new circumstances, and was effective for the majority of the Company’s fiscal period ended July 31, 2006.assets and liabilities for its Fiscal 2009 year beginning August 1, 2008. The adoption of FIN 47this portion of SFAS 157 in the fourth quarter of fiscal 2006Fiscal 2009 did not have a material impact on the Company’s consolidated financial statements.
In December 2004, On February 12, 2008, the FASB issued FASB Staff Position No.(FSP) FAS 109-1,157-2,ApplicationEffective Date of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004157 (“(FSP 109-1”)FAS 157-2). FSP 109-1 concludes thatFAS 157-2 delays by one year the deduction should be accountedeffective date of SFAS 157 for ascertain non-financial assets and non-financial liabilities. The Company is currently evaluating the impact the FSP FAS 157-2 will have on the determination of fair value related to non-financial assets and non-financial liabilities in Fiscal 2010. The adoption of FSP FAS 157-2 is not expected to have a special deduction in accordance withmaterial impact on the Company’s financial statements.
In February 2007, the FASB issued SFAS No. 109. This deduction, which159,The Fair Value Option for Financial Assets and Financial Liabilities(“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007, and was available toeffective for the Company duringwith its 2009 fiscal 2006,year, beginning August 1, 2008. The adoption of SFAS 159 did not have a material impact on the Company’s consolidated financial statements.
16
Fiscal 2010. In June 2006,February 2009, the FASB issued FASB Interpretation No. 48,Staff Position 141(R)-a,Accounting for UncertaintyAssets Acquired and Liabilities Assumed in Income Taxes,a Business Combination That Arise from Contingencies(FSP FAS 141(R)-a), which will amend certain provisions of SFAS 141(R). The adoptions of SFAS 141(R) and FSP FAS 141(R)-a are not expected to have a material impact on the Company’s consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities, an interpretationamendment of FASB Statement No. 109133 (“FIN 48”)(SFAS 161). This pronouncement prescribes a recognition thresholdSFAS 161 requires enhanced disclosures about an entity’s derivative and measurement attributehedging activities, including (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for theunder SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, and (c) how derivative instruments and related hedged items affect an entity’s financial statement recognitionposition, financial performance and measurement of tax positions taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006.cash flows. The Company is currently evaluatingadopted the effectprovisions of FIN 48 on itsSFAS 161 effective February 1, 2009. The adoption of SFAS 161 only requires additional disclosures about the Company’s derivatives and thus did not affect the Company’s consolidated financial statements.
Market Risk
The Company’s market risk includes the potential loss arising from adverse changes in foreign currency exchange rates and interest rates. The Company manages foreign currency market risk from time to time through the use of a variety of financial and derivative instruments. The Company does not
enter into any of these instruments for trading purposes to generate revenue. Rather, the Company’s objective in managing these risks is to reduce fluctuations in earnings and cash flows associated with changes in foreign currency exchange rates. The Company uses forward exchange contracts and other hedging activities to hedge the U.S. dollar value resulting from existing recognized foreign currency denominated asset and liability balances and also for anticipated foreign currency transactions. The Company also naturally hedges foreign
currency through its production in the countries in which it sells its products. The Company’s market risk on interest rates is the potential decrease in fair value of long-term debt resulting from a potential increase in interest rates. See further discussion of these market risks below.
Foreign CurrencyDuring 2006,Fiscal 2009, the U.S. dollar was generally strongerstrong throughout the year relativecompared to many of the currencies of the foreign countries in which the Company operates. The overall strength of the dollar had a negative impact on the Company’s international net sales results because the foreign denominated revenues translated into lessfewer U.S. dollars.
It is not possible to determine the true impact of foreign currency translation changes; however,changes. However, the direct effect on reported net sales and net earnings can be estimated. For the year ended July 31, 2006,2009, the impact of foreign currency translation resulted in an overall decrease in reported net sales of $25.3$76.8 million, a decrease in operating expenses of $24.5 million and a decrease in reported net earnings of $0.8$3.8 million. Foreign currency translation had a negative impact in severalmost regions around the world. In Europe, the stronger U.S. dollar relative to the euro and British pound sterling resulted in a decrease of $17.9$66.2 million in reported net sales and aan insignificant decrease of $0.9 million in reported net earnings. In the Asia-Pacific region, theThe stronger U.S. dollar relative to the Japanese yenAustralian dollar, Korean won, Mexican peso and South African rand had a negative impact on foreign currency translation with a decrease in reported net sales of $9.9$10.7 million, $6.1 million, $12.3 million and $8.4 million, respectively, and a decrease in reported net earnings of $0.6 million.million, $0.6 million, $2.1 million and $0.4 million, respectively. Foreign currency losses were partially offset by gains relative to the Japanese yen and Chinese renminbi of $13.8 million and $4.4 million, respectively, in reported net sales and $0.3 million and $0.7 million, respectively, in reported net earnings.
The Company maintains significant assets and operations in Europe, Asia-Pacific, South Africa and Mexico, 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.
The foreign subsidiaries of the Company generally purchase productsthe majority of their input costs and partsthen sell to many of their Customers in various currencies. As a result, the same local currency.
The Company may be exposed to cost increases relative to local currencies in the markets to which it sells. To mitigate such adverse trends, the Company, from time to time, enters into forward exchange contracts and other hedging activities. Additionally, foreign currency positions are partially offsetting and are netted against one another to reduce exposure.
Some products made in the United States are sold abroad, primarily in Europe and Canada.abroad. As a result, sales of such products are affected by the value of the U.S. dollar relative to other currencies. Any long-term strengthening of the U.S. dollar could depress these sales. Also, competitive conditions in the Company’s markets may limit its ability to increase product pricing in the face of adverse currency movements.
InterestThe Company’s exposure to market risks for changes in interest rates relates primarily to its short-term investments, short-term borrowings and interest rate swap agreements as well as the potential increase in fair value of long-term debt resulting from a potential decrease in interest rates. The Company has no earnings or cash flow exposure due to market risks on its long-term debt obligations
17
as a result of the fixed-rate nature of the debt. However, interest rate changes would affect the fair market value of the debt. As of July 31, 2006,2009, the estimated fair value of long-term debt with fixed interest rates was $91.3$253.1 million compared to its carrying value of $92.5$250.1 million. The fair value is estimated by discounting the projected cash flows using the rate that similar amounts of debt could currently be borrowed. As of July 31, 2006, our2009, the Company’s financial liabilities with exposure to changes in interest rates consisted mainly of $73.4$29.6 million of short-term debt outstanding. Assuming a hypothetical increase of one-half percent in short-term interest rates, with all other variables remaining constant, interest expense would have increased $0.4$0.6 million in fiscal 2006.Fiscal 2009.
PensionsThe Company is exposed to market return fluctuations on its qualified defined benefit pension plans. During Fiscal 2009, the market value of these assets declined in conjunction with the global economic downturn. This decline in market value is the principle reason that pension expense is expected to increase by $1.1 million in Fiscal 2010. At July 31, 2009, the Company’s annual measurement date for its
pension plans, the plans were under funded by $40.7 million since the projected benefit obligation exceeded the fair value of plan assets.
Critical Accounting Policies
The Company’s consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial
statements requires the use of estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented. Management bases these 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 the recorded values of certain assets and liabilities. The Company believes its use of estimates and underlying accounting assumptions adheres to generally accepted accounting principles and is consistently applied. Valuations based on estimates and underlying accounting assumptions are reviewed for reasonableness on a consistent basis throughout the Company. Management believes the Company’s critical accounting policies that require more significant judgments and estimates used in the preparation of its consolidated financial statements and that are the most important to aid in fully understanding its financial results are the following:
Revenue recognition and allowance for doubtful accountsRevenue is recognized when both product ownership and the risk of loss hashave transferred to the customerCustomer and the Company has no remaining obligations. The Company records estimated discounts and rebates as a reduction of sales in the same period revenue is recognized. Allowances for doubtful accounts are estimated by management based on evaluation of potential losses related to customerCustomer receivable balances. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in its existing accounts receivable. The Company determines the allowance based on historical write-off experience in the industry, regional economic data and evaluation of specific customerCustomer accounts for risk of loss. The Company reviews its allowance for doubtful accounts monthly. Past due balances over 90 days and over a specified amount are reviewed individually for collectibility. All other balances are reviewed on a pooled basis by type of receivable. Account balances are charged off against the allowance when the Company feels it is probable the receivable will not be recovered. The Company does not have any off-balance-sheet credit exposure related to its customers.Customers. The establishment of this reserve requires the use of judgment and assumptions regarding the potential for losses on receivable balances. Though management considers these balances adequate and proper, changes in economic conditions in specific markets in which the Company operates could have an effect on reserve balances required.
Goodwill and other intangible assetsGoodwill is testedassessed for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company performs impairment reviewsassessments for its reporting units and uses a discounted cash flow model based on management’s judgments and assumptions to determine the estimated fair value. An impairment loss generally would be recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit. The Company performed an impairment testassessment during the third quarter of fiscal 2006Fiscal 2009 to satisfy its annual impairment requirement. Impairment testingThe impairment assessment in the third quarter indicated that the estimated fair value of each reporting unit exceeded its corresponding carrying amount, including recorded goodwill and, as such, no impairment existed at that time. Other intangible assets with definite lives continue to be amortized over their estimated useful lives. Definite lived intangible assets are also subject to impairment testing.assessments. A considerable amount of management judgment and assumptions are required in performing the impairment tests,assessments, principally in determining the fair value of each reporting unit. While the Company believes its judgments and assumptions are reasonable, different assumptions could change the estimated fair values and, therefore, impairment charges could be required.
18
Inventory The Company’s inventories are valued at the lower of cost or market. Domestic inventories are valued using the last-in first-out (“LIFO”) method, while the international subsidiaries use the first-in, first-out (“FIFO”) method. Reserves for shrink and obsolescence are estimated using standard quantitative measures based on historical losses, including issues related to specific inventory items. Though management considers these balances adequate and proper, changes in economic conditions in specific markets in which the Company operates could have an effect on reserve balances required.
Product warranty The Company estimates warranty costs using standard quantitative measures based on historical warranty claim experience and, in some cases, evaluating specific customer warranty issues. The establishment of reserves requires the use of judgment and assumptions regarding the
potential for losses relating to warranty issues. Though management considers these balances adequate and proper, changes in the future could impact these determinations.
Income taxesAs part of the process of preparing the Company’s Consolidated Financial Statements, management is required to estimate income taxes in each of the jurisdictions in which the Company operates. This process involves estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and book accounting purposes. These
differences result in deferred tax assets and liabilities, which are included within the Company’s Consolidated Balance Sheet. These assets and liabilities are evaluated by using estimates of future taxable income streams and the impact of tax planning strategies. Management assesses the likelihood that deferred tax assets will be recovered from future taxable income and to the extent management believes that recovery is not likely, a valuation allowance is established. To the extent that a valuation allowance is established or increased, an expense within the tax provision is included in the statement of operations. Reserves are also estimated for uncertain tax positions that are currently unresolved. The Company routinely monitors the potential impact of such situations and believes that it is properly reserved. Valuations related to tax accruals and assets can be impacted by changes to tax codes, changes in statutory tax rates and the Company’s future taxable income levels.
The Company’s accounting for income taxes in Fiscal 2008 was affected by the adoption of FIN No. 48,Accounting for Uncertainty in Income Taxes,which the Company was required to adopt on August 1, 2007. This pronouncement prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. As such, the standard required the Company to reassess all of the Company’s uncertain tax return positions in accordance with this new accounting principle. As of July 31, 2009, the liability for unrecognized tax benefits was $16.9 million.
Employee Benefit PlansThe Company incurs expenses relating to employee benefits such as non-contributory defined benefit pension plans and postretirement health care benefits. In accounting for these employment costs, management must make a variety of assumptions and estimates including mortality rates, discount rates, overall Company compensation increases, expected return on plan assets and health care cost trend rates. The Company considers historical data as well as current facts and circumstances and uses a third-party specialist to assist management in determining these estimates.
To develop the assumption regarding the expected long-term rate of return on assets assumption for its U.S. pension plans, the Company considered the historical returns and the future expectations for returns for each asset class, as well as the target asset allocation of the pension portfolio. This resulted in the selection of the 8.50 percent long-term rate of return on assets assumption for the Company’s U.S. pension plans. The expected long-term rate of return on assets assumption for the plans outside the U.S. reflects the investment allocation and expected total portfolio returns specific to each plan and country. The expected long-term rate of return on assets shown in the pension benefit disclosure for non-U.S. plans is an asset-based weighted average of all non-U.S. plans.
Reflecting the relatively long-term nature of the plans’ obligations, approximately 7045 percent of the plans’plans assets wereare invested in equities andequity securities, 30 percent of plans’ assets in alternative investments with the balance primarily invested(funds of hedge funds), 10 percent in real assets (investments into funds containing commodities and real estate), 10 percent in fixed income instruments.and 5 percent in private equity. Within equity securities, the Company targets an allocation of 15 percent international, 15 percent equity long / short, 10 percent small cap, and 5 percent large cap.
A one percent change in the expected long-term rate of return on plan assets would changehave changed the 2006Fiscal 2009 annual pension expense by approximately $2.3$3.6 million. The expected long-term rate of return on assets assumption for the plans outside the U.S. follows the same methodology as described above but reflects the investment allocation and expected total portfolio returns specific to each plan and country.
The Company’s objective in selecting a discount rate for its pension plans is to select the best estimate of the rate at which the benefit obligations could be effectively settled on the measurement date taking into account the nature and duration of the benefit obligations of the plan. In making this best estimate, the Company looks at 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 looking atassessing 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. As of ourthe measurement date of April 30, 2006,July 31, 2009, the Company increased itselected to maintain the 6.00 percent discount rate on U.S. plans to 6.25 percent from 5.5 percentelected as of April 30, 2005. The increase of 75 basis points wasJuly 31, 2009, for the U.S. pension plans. This is consistent with the changes in published bond indices. TheA 0.25 percent change decreasedin the Company’s U.S. projecteddiscount rate would have changed the benefit obligation as of April 30, 2006related to the U.S. plans by approximately $14.5$6.5 million at July 31, 2009, and is expected to decreasechanged Fiscal 2009 annual pension expense in fiscal year 2007 by approximately $0.9$0.3 million.
19
At April 30, 2006, the Company’s annual measurement date for its pension plans, the plans were over-funded by $18.8 million since the fair value of plan assets exceeded the projected benefit obligation. As of April 30, 2006, the Company has an unrecognized actuarial loss of $18.7 million which will be recognized as pension expense into the future over the average remaining service period of the employees in the plans in accordance with SFAS 87.
The Company, through its management, may make forward-looking statements reflecting the Company’s current views with respect to future events 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 Item 1A of this Form 10-K, 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,” “estimate,” “project,” “believe,” “expect,” “anticipate,” “forecast” 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 to Shareholders.annual report on Form 10-K.
Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date such statements are made. In addition, the Company wishes to advise readers that the factors listed in Item 1A of this Form 10-K, 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. The discussion of factors in Item 1A is not intended to be exhaustive, but rather to highlight important risk factors that impact results. General economic and political conditions and many other contingencies that may cause the Company’s actual results to differ from those currently anticipated are not separately discussed. 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.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKQuantitative and Qualitative Disclosures about Market Risk
Market risk disclosure appears in Management’s Discussion and Analysis on page 1722 under “Market Risk.”
20
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAFinancial Statements and Supplementary Data
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework inInternal Control – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of July 31, 2006.
Management’s assessment of2009. The Company’s independent registered public accounting firm, PricewaterhouseCoopers LLP, has audited the effectiveness of the Company’s internal control over financial reporting as of July 31, 2006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm,2009, as stated in itsthis report which is included herein.follows in Item 8 of this Form 10-K.
 |  | ||
|---|---|---|---|
|
| ||
William M. Cook | Thomas R. VerHage |
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
of Donaldson Company, Inc.
We have completed integrated audits of Donaldson Company, Inc.’s July 31, 2006 and 2005 consolidated financial statements and of its internal control over financial reporting as of July 31, 2006, and an audit of its 2004 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements and financial statement schedule
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, ofshareholders' equity and cash flows and of changes in shareholders’ equity present fairly, in all material respects, the financial position of Donaldson Company, Inc. and its subsidiaries (the “Company”) at July 31, 20062009 and 2005,July 31, 2008, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 2006,2009, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. TheseAlso in our opinion, the Company maintained, in all material respects, effective internal control over financial statements and financial statement schedule arereporting as of July 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the responsibilityCommittee of Sponsoring Organizations of the Company’s management. Our responsibilityTreadway Commission (COSO). The Company's management is to express an opinion onresponsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the auditaudits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An auditmisstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements includesincluded examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.opinions.
As discussed in Note A to the consolidated financial statements, the Company changed its method of accountingthe manner in which it accounts for share-based paymentsdefined benefit arrangements effective July 31, 2007. Also, as ofdiscussed in Note I to the consolidated financial statements, the Company changed the manner in which it accounts for unrecognized income tax positions effective August 1, 2005.
21
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 8, that the Company maintained effective internal control over financial reporting as of July 31, 2006, based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of July 31, 2006, based on criteria established inInternal Control – Integrated Framework issued by COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.2007.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
|
PricewaterhouseCoopers LLP |
PricewaterhouseCoopers LLP
Minneapolis, MinnesotaSeptember 30, 2006
22
Consolidated Statements of Earnings
Donaldson Company, Inc. and Subsidiaries
| Year ended July 31, | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2006 | 2005 | 2004 | |||||||||||||
| (thousands of dollars, except share and per share amounts) | |||||||||||||||
| Net sales | $ | 1,694,327 | $ | 1,595,733 | $ | 1,414,980 | |||||||||
| Cost of sales | 1,137,747 | 1,090,158 | 967,254 | ||||||||||||
| Gross margin | 556,580 | 505,575 | 447,726 | ||||||||||||
| Selling, general and administrative | 329,905 | 316,851 | 281,267 | ||||||||||||
| Research and development | 33,887 | 32,234 | 30,487 | ||||||||||||
| Gain on sale of Ome land and building | — | — | (5,616 | ) | |||||||||||
| Operating income | 192,788 | 156,490 | 141,588 | ||||||||||||
| Interest expense | 9,875 | 9,414 | 4,954 | ||||||||||||
| Other income, net | (6,254 | ) | (7,657 | ) | (5,202 | ) | |||||||||
| Earnings before income taxes | 189,167 | 154,733 | 141,836 | ||||||||||||
| Income taxes | 56,860 | 44,179 | 35,519 | ||||||||||||
| Net earnings | $ | 132,307 | $ | 110,554 | $ | 106,317 | |||||||||
| Weighted average shares — basic | 82,992,475 | 84,990,739 | 87,960,423 | ||||||||||||
| Weighted average shares — diluted | 85,139,250 | 86,883,408 | 90,429,956 | ||||||||||||
| Net earnings per share — basic | $ | 1.59 | $ | 1.30 | $ | 1.21 | |||||||||
| Net earnings per share — diluted | $ | 1.55 | $ | 1.27 | $ | 1.18 | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
| Year ended July 31, |
| |||||||
|
| 2009 |
| 2008 |
| 2007 |
| |||
|
| (thousands of dollars, except share |
| |||||||
Net sales |
| $ | 1,868,629 |
| $ | 2,232,521 |
| $ | 1,918,828 |
|
Cost of sales |
|
| 1,278,923 |
|
| 1,506,659 |
|
| 1,313,964 |
|
Gross margin |
|
| 589,706 |
|
| 725,862 |
|
| 604,864 |
|
Selling, general and administrative |
|
| 379,108 |
|
| 436,293 |
|
| 357,306 |
|
Research and development |
|
| 40,643 |
|
| 43,757 |
|
| 36,458 |
|
Operating income |
|
| 169,955 |
|
| 245,812 |
|
| 211,100 |
|
Interest expense |
|
| 17,018 |
|
| 16,550 |
|
| 14,559 |
|
Other income, net |
|
| (8,488 | ) |
| (6,901 | ) |
| (8,320 | ) |
Earnings before income taxes |
|
| 161,425 |
|
| 236,163 |
|
| 204,861 |
|
Income taxes |
|
| 29,518 |
|
| 64,210 |
|
| 54,144 |
|
Net earnings |
| $ | 131,907 |
| $ | 171,953 |
| $ | 150,717 |
|
Weighted average shares — basic |
|
| 77,879,036 |
|
| 79,207,604 |
|
| 80,454,861 |
|
Weighted average shares — diluted |
|
| 79,172,042 |
|
| 81,211,343 |
|
| 82,435,756 |
|
Net earnings per share — basic |
| $ | 1.69 |
| $ | 2.17 |
| $ | 1.87 |
|
Net earnings per share — diluted |
| $ | 1.67 |
| $ | 2.12 |
| $ | 1.83 |
|
The accompanying notes are an integral part of these Consolidated Financial Statements.
23
Consolidated Balance Sheets
Donaldson Company, Inc. and Subsidiaries
| At July 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2006 | 2005 | ||||||||||
| (thousands of dollars, except share amounts) | |||||||||||
| Assets | |||||||||||
| Current assets | |||||||||||
| Cash and cash equivalents | $ | 45,467 | $ | 134,066 | |||||||
| Accounts receivable, less allowance of $8,398 and $8,409 | 312,214 | 294,016 | |||||||||
| Inventories | 153,165 | 151,599 | |||||||||
| Deferred income taxes | 17,407 | 13,517 | |||||||||
| Prepaids and other current assets | 33,152 | 25,624 | |||||||||
| Total current assets | 561,405 | 618,822 | |||||||||
| Property, plant and equipment, net | 317,364 | 275,493 | |||||||||
| Goodwill | 110,609 | 105,304 | |||||||||
| Intangible assets | 22,129 | 23,166 | |||||||||
| Other assets | 112,560 | 88,988 | |||||||||
| Total assets | $ | 1,124,067 | $ | 1,111,773 | |||||||
| Liabilities and shareholders’ equity | |||||||||||
| Current liabilities | |||||||||||
| Short-term borrowings | $ | 73,368 | $ | 102,004 | |||||||
| Current maturities of long-term debt | 6,541 | 7,772 | |||||||||
| Trade accounts payable | 163,783 | 134,063 | |||||||||
| Accrued employee compensation and related taxes | 49,129 | 45,480 | |||||||||
| Accrued liabilities | 42,969 | 26,960 | |||||||||
| Other current liabilities | 24,079 | 37,923 | |||||||||
| Total current liabilities | 359,869 | 354,202 | |||||||||
| Long-term debt | 100,495 | 103,302 | |||||||||
| Deferred income taxes | 40,890 | 29,468 | |||||||||
| Other long-term liabilities | 76,011 | 100,185 | |||||||||
| Total liabilities | 577,265 | 587,157 | |||||||||
| Commitments and contingencies (Note K) | |||||||||||
| Shareholders’ equity | |||||||||||
| Preferred stock, $1.00 par value, 1,000,000 shares authorized, none issued | — | — | |||||||||
| Common stock, $5.00 par value, 120,000,000 shares authorized, 88,643,194 shares issued in 2006 and 2005 | 443,216 | 443,216 | |||||||||
| Retained earnings | 275,598 | 172,775 | |||||||||
| Stock compensation plans | 20,535 | 40,574 | |||||||||
| Accumulated other comprehensive income | 51,194 | 27,620 | |||||||||
| Treasury stock — 8,102,921 and 5,583,393 shares in 2006 and 2005, at cost | (243,741 | ) | (159,569 | ) | |||||||
| Total shareholders’ equity | 546,802 | 524,616 | |||||||||
| Total liabilities and shareholders’ equity | $ | 1,124,067 | $ | 1,111,773 | |||||||
|
|
|
|
|
|
|
|
|
| At July 31, |
| ||||
|
| 2009 |
| 2008 |
| ||
|
| (thousands of dollars, |
| ||||
Assets |
|
|
|
|
|
|
|
Current assets |
|
|
|
|
|
|
|
Cash and cash equivalents |
| $ | 143,687 |
| $ | 83,357 |
|
Accounts receivable, less allowance of $7,387 and $7,509 |
|
| 280,187 |
|
| 413,863 |
|
Inventories |
|
| 180,238 |
|
| 264,129 |
|
Deferred income taxes |
|
| 21,501 |
|
| 32,061 |
|
Prepaids and other current assets |
|
| 51,154 |
|
| 60,347 |
|
Total current assets |
|
| 676,767 |
|
| 853,757 |
|
Property, plant and equipment, net |
|
| 381,068 |
|
| 415,159 |
|
Goodwill |
|
| 169,027 |
|
| 134,162 |
|
Intangible assets |
|
| 65,386 |
|
| 46,317 |
|
Other assets |
|
| 41,748 |
|
| 99,227 |
|
Total assets |
| $ | 1,333,996 |
| $ | 1,548,622 |
|
Liabilities and shareholders’ equity |
|
|
|
|
|
|
|
Current liabilities |
|
|
|
|
|
|
|
Short-term borrowings |
| $ | 29,558 |
| $ | 139,404 |
|
Current maturities of long-term debt |
|
| 5,496 |
|
| 5,669 |
|
Trade accounts payable |
|
| 123,063 |
|
| 200,967 |
|
Accrued employee compensation and related taxes |
|
| 54,662 |
|
| 66,155 |
|
Accrued liabilities |
|
| 39,624 |
|
| 56,296 |
|
Other current liabilities |
|
| 47,681 |
|
| 48,216 |
|
Total current liabilities |
|
| 300,084 |
|
| 516,707 |
|
Long-term debt |
|
| 253,674 |
|
| 176,475 |
|
Deferred income taxes |
|
| 9,416 |
|
| 35,738 |
|
Other long-term liabilities |
|
| 82,204 |
|
| 79,667 |
|
Total liabilities |
|
| 645,378 |
|
| 808,587 |
|
Commitments and contingencies (Note K) |
|
|
|
|
|
|
|
Shareholders’ equity |
|
|
|
|
|
|
|
Preferred stock, $1.00 par value, 1,000,000 shares authorized, none issued |
|
| — |
|
| — |
|
Common stock, $5.00 par value, 120,000,000 shares authorized, 88,643,194 shares issued in 2009 and 2008 |
|
| 443,216 |
|
| 443,216 |
|
Retained earnings |
|
| 615,817 |
|
| 522,476 |
|
Stock compensation plans |
|
| 19,894 |
|
| 27,065 |
|
Accumulated other comprehensive income (loss) |
|
| (9,677 | ) |
| 112,883 |
|
Treasury stock-11,295,409 and 11,021,619 shares in 2009 and 2008, at cost |
|
| (380,632 | ) |
| (365,605 | ) |
Total shareholders’ equity |
|
| 688,618 |
|
| 740,035 |
|
Total liabilities and shareholders’ equity |
| $ | 1,333,996 |
| $ | 1,548,622 |
|
The accompanying notes are an integral part of these Consolidated Financial Statements.
24
Consolidated Statements of Cash Flows
Donaldson Company, Inc. and Subsidiaries
| Year ended July 31, | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2006 | 2005 | 2004 | |||||||||||||
| (thousands of dollars) | |||||||||||||||
| Operating Activities | |||||||||||||||
| Net earnings | $ | 132,307 | $ | 110,554 | $ | 106,317 | |||||||||
| Adjustments to reconcile net earnings to net cash provided by operating activities | |||||||||||||||
| Gain on sale of Ome land and building | — | — | (5,616 | ) | |||||||||||
| Depreciation and amortization | 44,700 | 44,284 | 41,555 | ||||||||||||
| Equity in (earnings) loss of affiliates | (664 | ) | 323 | (1,066 | ) | ||||||||||
| Deferred income taxes | 6,868 | 2,957 | (1,598 | ) | |||||||||||
| Tax benefit of equity plans | (10,943 | ) | — | — | |||||||||||
| Stock option expense | 2,832 | — | — | ||||||||||||
| Other, net | (13,551 | ) | 2,520 | 10,272 | |||||||||||
| Changes in operating assets and liabilities, net of acquired businesses | |||||||||||||||
| Accounts receivable | (12,147 | ) | (17,349 | ) | (37,270 | ) | |||||||||
| Inventories | 587 | (6,745 | ) | (20,734 | ) | ||||||||||
| Prepaids and other current assets | (5,794 | ) | 2,087 | 4,107 | |||||||||||
| Trade accounts payable and other accrued expenses | 26,649 | 3,957 | 22,085 | ||||||||||||
| Payment of litigation judgment | (14,170 | ) | — | — | |||||||||||
| Net cash provided by operating activities | 156,674 | 142,588 | 118,052 | ||||||||||||
| Investing Activities | |||||||||||||||
| Purchases of property, plant and equipment | (81,272 | ) | (54,979 | ) | (47,738 | ) | |||||||||
| Proceeds from sale of property, plant, and equipment | 3,688 | 4,781 | 4,708 | ||||||||||||
| Acquisitions and investments in affiliates, net of cash acquired | (4,560 | ) | (13,362 | ) | (4,397 | ) | |||||||||
| Net cash used in investing activities | (82,144 | ) | (63,560 | ) | (47,427 | ) | |||||||||
| Financing Activities | |||||||||||||||
| Proceeds from long-term debt | 4,400 | 30,000 | — | ||||||||||||
| Repayments of long-term debt | (7,613 | ) | (23,944 | ) | (1,873 | ) | |||||||||
| Change in short-term borrowings | (31,650 | ) | 81,917 | 5,195 | |||||||||||
| Purchase of treasury stock | (118,909 | ) | (116,268 | ) | (29,765 | ) | |||||||||
| Dividends paid | (26,443 | ) | (19,757 | ) | (17,779 | ) | |||||||||
| Tax benefit of equity plans | 10,943 | — | — | ||||||||||||
| Exercise of stock options | 4,774 | 2,703 | 3,298 | ||||||||||||
| Net cash used in financing activities | (164,498 | ) | (45,349 | ) | (40,924 | ) | |||||||||
| Effect of exchange rate changes on cash | 1,369 | 883 | 2,733 | ||||||||||||
| Increase (decrease) in cash and cash equivalents | (88,599 | ) | 34,562 | 32,434 | |||||||||||
| Cash and cash equivalents, beginning of year | 134,066 | 99,504 | 67,070 | ||||||||||||
| Cash and cash equivalents, end of year | $ | 45,467 | $ | 134,066 | $ | 99,504 | |||||||||
| Supplemental Cash Flow Information | |||||||||||||||
| Cash paid during the year for: | |||||||||||||||
| Income taxes | $ | 36,145 | $ | 33,087 | $ | 25,998 | |||||||||
| Interest | 9,287 | 8,453 | 4,629 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
| Year ended July 31, |
| |||||||
|
| 2009 |
| 2008 |
| 2007 |
| |||
|
| (thousands of dollars) |
| |||||||
Operating Activities |
|
|
|
|
|
|
|
|
|
|
Net earnings |
| $ | 131,907 |
| $ | 171,953 |
| $ | 150,717 |
|
Adjustments to reconcile net earnings to net cash provided by operating activities |
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
| 58,597 |
|
| 56,732 |
|
| 49,566 |
|
Equity in earnings of affiliates, net of distributions |
|
| (982 | ) |
| (1,558 | ) |
| (691 | ) |
Deferred income taxes |
|
| (4,726 | ) |
| (1,205 | ) |
| (4,401 | ) |
Tax benefit of equity plans |
|
| (2,663 | ) |
| (9,178 | ) |
| (5,898 | ) |
Stock compensation plan expense |
|
| 1,900 |
|
| 9,312 |
|
| 6,608 |
|
Other, net |
|
| (7 | ) |
| (2,528 | ) |
| (16,626 | ) |
Changes in operating assets and liabilities, net of acquired businesses |
|
|
|
|
|
|
|
|
|
|
Accounts receivable |
|
| 116,983 |
|
| (29,779 | ) |
| (31,418 | ) |
Inventories |
|
| 66,145 |
|
| (49,400 | ) |
| (36,469 | ) |
Prepaids and other current assets |
|
| (11,489 | ) |
| (4,755 | ) |
| 658 |
|
Trade accounts payable and other accrued expenses |
|
| (78,738 | ) |
| 33,940 |
|
| 4,999 |
|
Net cash provided by operating activities |
|
| 276,927 |
|
| 173,534 |
|
| 117,045 |
|
Investing Activities |
|
|
|
|
|
|
|
|
|
|
Purchases of property, plant and equipment |
|
| (46,080 | ) |
| (72,152 | ) |
| (77,440 | ) |
Proceeds from sale of property, plant, and equipment |
|
| 511 |
|
| 1,330 |
|
| 857 |
|
Acquisitions, investments, and divestitures of affiliates |
|
| (74,318 | ) |
| (2,377 | ) |
| (40,615 | ) |
Net cash used in investing activities |
|
| (119,887 | ) |
| (73,199 | ) |
| (117,198 | ) |
Financing Activities |
|
|
|
|
|
|
|
|
|
|
Proceeds from long-term debt |
|
| 80,471 |
|
| 50,297 |
|
| 64,903 |
|
Repayments of long-term debt |
|
| (7,745 | ) |
| (33,074 | ) |
| (9,507 | ) |
Change in short-term borrowings |
|
| (103,695 | ) |
| 12,478 |
|
| 44,904 |
|
Purchase of treasury stock |
|
| (32,773 | ) |
| (92,202 | ) |
| (76,898 | ) |
Dividends paid |
|
| (35,166 | ) |
| (33,003 | ) |
| (28,806 | ) |
Tax benefit of equity plans |
|
| 2,663 |
|
| 9,178 |
|
| 5,898 |
|
Exercise of stock options |
|
| 4,476 |
|
| 9,308 |
|
| 7,346 |
|
Net cash provided by (used in) financing activities |
|
| (91,769 | ) |
| (77,018 | ) |
| 7,840 |
|
Effect of exchange rate changes on cash |
|
| (4,941 | ) |
| 4,803 |
|
| 2,083 |
|
Increase in cash and cash equivalents |
|
| 60,330 |
|
| 28,120 |
|
| 9,770 |
|
Cash and cash equivalents, beginning of year |
|
| 83,357 |
|
| 55,237 |
|
| 45,467 |
|
Cash and cash equivalents, end of year |
| $ | 143,687 |
| $ | 83,357 |
| $ | 55,237 |
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental Cash Flow Information |
|
|
|
|
|
|
|
|
|
|
Cash paid during the year for: |
|
|
|
|
|
|
|
|
|
|
Income taxes |
| $ | 41,196 |
| $ | 50,629 |
| $ | 59,179 |
|
Interest |
|
| 14,861 |
|
| 14,589 |
|
| 12,630 |
|
The accompanying notes are an integral part of these Consolidated Financial Statements.
25
Consolidated Statements of Changes in Shareholders’ Equity
Donaldson Company, Inc. and Subsidiaries
| Common Stock | Additional Paid-in Capital | Retained Earnings | Stock Compensation Plans | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Total | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars, except per share amounts) | |||||||||||||||||||||||||||||||
| Balance July 31, 2003 | $ | 248,280 | $ | — | $ | 337,952 | $ | 13,817 | $ | (6,888 | ) | $ | (145,768 | ) | $ | 447,393 | |||||||||||||||
| Comprehensive income | |||||||||||||||||||||||||||||||
| Net earnings | 106,317 | 106,317 | |||||||||||||||||||||||||||||
| Foreign currency translation | 23,675 | 23,675 | |||||||||||||||||||||||||||||
| Additional minimum pension liability | 14,356 | 14,356 | |||||||||||||||||||||||||||||
| Net gain on cash flow hedging derivatives | 415 | 415 | |||||||||||||||||||||||||||||
| Comprehensive income | 144,763 | ||||||||||||||||||||||||||||||
| Treasury stock acquired | (29,765 | ) | (29,765 | ) | |||||||||||||||||||||||||||
| Stock options exercised | (2,076 | ) | (6,687 | ) | 1,900 | 5,838 | (1,025 | ) | |||||||||||||||||||||||
| Deferred stock and other activity | (2,653 | ) | 4,872 | 1,202 | 3,421 | ||||||||||||||||||||||||||
| Performance awards | 117 | 92 | 209 | ||||||||||||||||||||||||||||
| Tax reduction — employee plans | 2,076 | 2,076 | |||||||||||||||||||||||||||||
| Two-for-one stock split | 194,936 | (303,996 | ) | 109,060 | — | ||||||||||||||||||||||||||
| Dividends ($.205 per share) | (17,779 | ) | (17,779 | ) | |||||||||||||||||||||||||||
| Balance July 31, 2004 | 443,216 | — | 113,271 | 20,589 | 31,558 | (59,341 | ) | 549,293 | |||||||||||||||||||||||
| Comprehensive income | |||||||||||||||||||||||||||||||
| Net earnings | 110,554 | 110,554 | |||||||||||||||||||||||||||||
| Foreign currency translation | 1,877 | 1,877 | |||||||||||||||||||||||||||||
| Additional minimum pension liability, net of tax | (5,499 | ) | (5,499 | ) | |||||||||||||||||||||||||||
| Net loss on cash flow hedging derivatives | (316 | ) | (316 | ) | |||||||||||||||||||||||||||
| Comprehensive income | 106,616 | ||||||||||||||||||||||||||||||
| Treasury stock acquired | (116,268 | ) | (116,268 | ) | |||||||||||||||||||||||||||
| Stock options exercised | (7,273 | ) | (30,080 | ) | 9,310 | 14,992 | (13,051 | ) | |||||||||||||||||||||||
| Deferred stock and other activity | (1,207 | ) | 10,675 | 428 | 9,896 | ||||||||||||||||||||||||||
| Performance awards | (6 | ) | 620 | 614 | |||||||||||||||||||||||||||
| Tax reduction — employee plans | 7,273 | 7,273 | |||||||||||||||||||||||||||||
| Dividends ($.235 per share) | (19,757 | ) | (19,757 | ) | |||||||||||||||||||||||||||
| Balance July 31, 2005 | 443,216 | — | 172,775 | 40,574 | 27,620 | (159,569 | ) | 524,616 | |||||||||||||||||||||||
| Comprehensive income | |||||||||||||||||||||||||||||||
| Net earnings | 132,307 | 132,307 | |||||||||||||||||||||||||||||
| Foreign currency translation | 15,287 | 15,287 | |||||||||||||||||||||||||||||
| Additional minimum pension liability, net of tax | 8,438 | 8,438 | |||||||||||||||||||||||||||||
| Net loss on cash flow hedging derivatives | (151 | ) | (151 | ) | |||||||||||||||||||||||||||
| Comprehensive income | 155,881 | ||||||||||||||||||||||||||||||
| Treasury stock acquired | (118,909 | ) | (118,909 | ) | |||||||||||||||||||||||||||
| Stock options exercised | (22,381 | ) | 12,358 | — | 11,934 | 1,911 | |||||||||||||||||||||||||
| Deferred stock and other activity | (11,310 | ) | (17,291 | ) | 20,893 | (7,708 | ) | ||||||||||||||||||||||||
| Performance awards | 320 | (2,748 | ) | 1,910 | (518 | ) | |||||||||||||||||||||||||
| Stock option expense | 2,832 | 2,832 | |||||||||||||||||||||||||||||
| Tax reduction — employee plans | 22,381 | 22,381 | |||||||||||||||||||||||||||||
| Dividends ($.041 per share) | (33,684 | ) | (33,684 | ) | |||||||||||||||||||||||||||
| Balance July 31, 2006 | $ | 443,216 | $ | — | $ | 275,598 | $ | 20,535 | $ | 51,194 | $ | (243,741 | ) | $ | 546,802 | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Common |
| Additional |
| Retained |
| Stock |
| Accumulated |
| Treasury |
| Total |
| |||||||
|
| (thousands of dollars, except per share amounts) |
| |||||||||||||||||||
Balance July 31, 2006 |
| $ | 443,216 |
| $ | — |
| $ | 275,598 |
| $ | 20,535 |
| $ | 51,194 |
| $ | (243,741 | ) | $ | 546,802 |
|
Comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
|
|
|
|
|
|
| 150,717 |
|
|
|
|
|
|
|
|
|
|
| 150,717 |
|
Foreign currency translation |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 28,615 |
|
|
|
|
| 28,615 |
|
Additional minimum pension liability, net of tax |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 312 |
|
|
|
|
| 312 |
|
Net loss on cash flow hedging derivatives |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 118 |
|
|
|
|
| 118 |
|
Comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 179,762 |
|
Treasury stock acquired |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (76,898 | ) |
| (76,898 | ) |
Stock options exercised |
|
|
|
|
| (7,700 | ) |
| (9,499 | ) |
| 1,513 |
|
|
|
|
| 19,133 |
|
| 3,447 |
|
Deferred stock and other activity |
|
|
|
|
|
|
|
| (2,273 | ) |
| 541 |
|
|
|
|
| 3,276 |
|
| 1,544 |
|
Performance awards |
|
|
|
|
|
|
|
| (1,163 | ) |
| (1,768 | ) |
|
|
|
| 1,626 |
|
| (1,305 | ) |
Stock option expense |
|
|
|
|
|
|
|
| 3,422 |
|
|
|
|
|
|
|
|
|
|
| 3,422 |
|
Tax reduction — employee plans |
|
|
|
|
| 7,700 |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 7,700 |
|
Adjustment to adopt SFAS 158, net of tax |
|
|
|
|
|
|
|
|
|
|
|
|
|
| (10,231 | ) |
|
|
|
| (10,231 | ) |
Dividends ($.370 per share) |
|
|
|
|
|
|
|
| (29,545 | ) |
|
|
|
|
|
|
|
|
|
| (29,545 | ) |
Balance July 31, 2007 |
|
| 443,216 |
|
| — |
|
| 387,257 |
|
| 20,821 |
|
| 70,008 |
|
| (296,604 | ) |
| 624,698 |
|
Comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
|
|
|
|
|
|
| 171,953 |
|
|
|
|
|
|
|
|
|
|
| 171,953 |
|
Foreign currency translation |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 57,151 |
|
|
|
|
| 57,151 |
|
Additional minimum pension liability, net of tax |
|
|
|
|
|
|
|
|
|
|
|
|
|
| (14,671 | ) |
|
|
|
| (14,671 | ) |
Net gain on cash flow hedging derivatives |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 395 |
|
|
|
|
| 395 |
|
Comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 214,828 |
|
Treasury stock acquired |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (92,202 | ) |
| (92,202 | ) |
Stock options exercised |
|
|
|
|
| (7,827 | ) |
| (9,810 | ) |
| 4,223 |
|
|
|
|
| 20,883 |
|
| 7,469 |
|
Deferred stock and other activity |
|
|
|
|
| (2,981 | ) |
| 2,564 |
|
| 3,474 |
|
|
|
|
| 1,363 |
|
| 4,420 |
|
Performance awards |
|
|
|
|
| (675 | ) |
| 279 |
|
| (1,453 | ) |
|
|
|
| 955 |
|
| (894 | ) |
Stock option expense |
|
|
|
|
|
|
|
| 4,214 |
|
|
|
|
|
|
|
|
|
|
| 4,214 |
|
Tax reduction — employee plans |
|
|
|
|
| 11,483 |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 11,483 |
|
Adjustment to adopt FIN 48 |
|
|
|
|
|
|
|
| (336 | ) |
|
|
|
|
|
|
|
|
|
| (336 | ) |
Dividends ($.430 per share) |
|
|
|
|
|
|
|
| (33,645 | ) |
|
|
|
|
|
|
|
|
|
| (33,645 | ) |
Balance July 31, 2008 |
|
| 443,216 |
|
| — |
|
| 522,476 |
|
| 27,065 |
|
| 112,883 |
|
| (365,605 | ) |
| 740,035 |
|
Comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
|
|
|
|
|
|
| 131,907 |
|
|
|
|
|
|
|
|
|
|
| 131,907 |
|
Foreign currency translation |
|
|
|
|
|
|
|
|
|
|
|
|
|
| (63,385 | ) |
|
|
|
| (63,385 | ) |
Pension liability adjustment, net of tax |
|
|
|
|
|
|
|
|
|
|
|
|
|
| (58,593 | ) |
|
|
|
| (58,593 | ) |
Net gain on cash flow hedging derivatives |
|
|
|
|
|
|
|
|
|
|
|
|
|
| (582 | ) |
|
|
|
| (582 | ) |
Comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 9,347 |
|
Treasury stock acquired |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (32,773 | ) |
| (32,773 | ) |
Stock options exercised |
|
|
|
|
| (2,998 | ) |
| (6,151 | ) |
|
|
|
|
|
|
| 12,104 |
|
| 2,955 |
|
Deferred stock and other activity |
|
|
|
|
| (529 | ) |
| (88 | ) |
| (4,344 | ) |
|
|
|
| 3,710 |
|
| (1,251 | ) |
Performance awards |
|
|
|
|
| (266 | ) |
| (60 | ) |
| (2,827 | ) |
|
|
|
| 1,932 |
|
| (1,221 | ) |
Stock option expense |
|
|
|
|
|
|
|
| 4,143 |
|
|
|
|
|
|
|
|
|
|
| 4,143 |
|
Tax reduction — employee plans |
|
|
|
|
| 3,793 |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 3,793 |
|
Adjustment to adopt FAS 158 measurement date provision, net of tax |
|
|
|
|
|
|
|
| (887 | ) |
|
|
|
|
|
|
|
|
|
| (887 | ) |
Dividends ($.460 per share) |
|
|
|
|
|
|
|
| (35,523 | ) |
|
|
|
|
|
|
|
|
|
| (35,523 | ) |
Balance July 31, 2009 |
| $ | 443,216 |
| $ | — |
| $ | 615,817 |
| $ | 19,894 |
| $ | (9,677 | ) | $ | (380,632 | ) | $ | 688,618 |
|
The accompanying notes are an integral part of these Consolidated Financial Statements.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Donaldson Company, Inc. and Subsidiaries
NOTE A
Summary of Significant Accounting Policies
Description of BusinessDonaldson Company, Inc. (“Donaldson” or the “Company”), is a leading worldwide provider of filtration systems and replacement parts. The Company’s product mix includes air and liquid filtersfiltration systems and exhaust and emission control products for mobile equipment; in-plant air cleaning systems; compressed air purification systems; air intake systems for industrial gas turbines and specialized filters and membranes for such diverse applications as computer disk drives, industrial bags and semi-conductor processing.products. Products are manufactured at more than 3040 plants around the world and through three joint ventures. Products are sold to original equipment manufacturers (“OEM”), distributors and dealers, and directly to end users.
Principles of ConsolidationThe Consolidated Financial Statements include the accounts of Donaldson Company, Inc. and all majority-owned subsidiaries. All intercompany accounts and transactions have been eliminated. The Company’s three joint ventures that are not majority-owned are accounted for under the equity method. The Company does not have any variable interests in variable interest entities as of July 31, 2006.2009. The company uses a fiscal period which ends on a calendar basis for international affiliates and on the Friday nearest to July 31 for U.S. purposes. Fiscal 2007 results included 53 weeks of U.S. sales and earnings.
Use of EstimatesThe preparation of Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Foreign Currency TranslationFor most foreign operations, local currencies are considered the functional currency. Assets and liabilities are translated to U.S. dollars at year-end exchange rates, and the resulting gains and losses arising from the translation of net assets located outside the United States are recorded as a cumulative translation adjustment, a component of accumulatedAccumulated other comprehensive income (loss) in the consolidated balance sheets.Consolidated Balance Sheets. Elements of the consolidated statementsConsolidated Statements of earningsEarnings are translated at average exchange rates in effect during the year. Realized and unrealized foreign currency transaction gains and losses are included in Other income, net in the consolidated statementsConsolidated Statements of earnings.Earnings. Foreign currency transaction gainslosses of $0.3$0.2 million, $3.1 million and $1.0 million and losses of $0.5$0.2 million are included in other income, net in the consolidated statementsConsolidated Statements of earningsEarnings in 2006, 2005Fiscal 2009, 2008, and 2004,2007, respectively.
Cash EquivalentsThe Company considers all highly liquid temporary investments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents are carried at cost that approximates market value.
Accounts Receivable and Allowance for Doubtful AccountsTrade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in its existing accounts receivable. The Company determines the allowance based on historical write-off experience in the industry, regional economic data and evaluation of specific customerCustomer accounts for risk of loss. The Company reviews its allowance for doubtful accounts monthly. Past due balances over 90 days and over a specified amount are reviewed individually for collectibility. All other balances are reviewed on a pooled basis by type of receivable. Account balances are charged off against the allowance when the Company feels it is probable the receivable will not be recovered. The Company does not have any off-balance-sheet credit exposure related to its customers.Customers.
InventoriesInventories are stated at the lower of cost or market. DomesticU.S. inventories are valued using the last-in, first-out (“LIFO”) method, while the international subsidiaries use the first-in, first-out (“FIFO”) method. Inventories valued at LIFO were approximately 3433 and 3635 percent of total inventories at July 31, 20062009 and 2005,2008, respectively. For inventories valued under the LIFO method, the FIFO cost exceeded the LIFO carrying values by $31.7$34.0 million and $30.4$37.7 million at July 31, 20062009 and 2005,2008, respectively. Results of
27
respectively. Results of operations for all periods presented were not materially affected by anythe liquidation of LIFO inventory. The components of inventory are as follows (thousands of dollars):
| July 31, 2006 | July 31, 2005 |
|
|
|
|
|
|
| |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| July 31, |
| July 31, |
| |||||||||||||
| Materials | $ | 56,194 | $ | 57,939 |
| $ | 71,518 |
| $ | 110,135 |
| ||||||
| Work in process | 20,304 | 19,897 |
| 20,022 |
| 23,728 |
| ||||||||||
| Finished products | 76,667 | 73,763 |
|
| 88,698 |
|
| 130,266 |
| ||||||||
| Total inventories | $ | 153,165 | $ | 151,599 |
| $ | 180,238 |
| $ | 264,129 | |||||||
Property, Plant and EquipmentProperty, plant and equipment are stated at cost. Additions, improvements or major renewals are capitalized, while expenditures that do not enhance or extend the asset’s useful life are charged to operating expense as incurred. Depreciation is computed under the straight-line method. Depreciation expense was $42.6$52.9 million in 2006, $42.6Fiscal 2009, $52.4 million in 2005,Fiscal 2008, and $40.1$46.6 million in 2004.Fiscal 2007. The estimated useful lives of property, plant and equipment are 10 to 40 years for buildings, including building improvements, and 3 to 10 years for machinery and equipment. The components of property, plant and equipment are as follows (thousands of dollars):
| July 31, 2006 | July 31, 2005 |
|
|
|
|
|
|
| |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| July 31, |
| July 31, |
| |||||||||||||
| Land | $ | 18,336 | $ | 16,654 |
| $ | 21,793 |
| $ | 21,561 |
| ||||||
| Buildings | 182,969 | 153,126 |
| 242,049 |
| 235,615 |
| ||||||||||
| Machinery and equipment | 473,483 | 436,951 |
| 600,198 |
| 586,937 |
| ||||||||||
| Construction in progress | 33,246 | 24,197 |
|
| 18,507 |
| 57,633 | ||||||||||
| Less accumulated depreciation | (390,670 | ) | (355,435 | ) |
|
| (501,479 | ) |
| (486,587 | ) | ||||||
| Total property, plant and equipment | $ | 317,364 | $ | 275,493 | |||||||||||||
Total property, plant and equipment, net |
| $ | 381,068 | $ | 415,159 | ||||||||||||
Internal-Use SoftwareThe Company capitalizes direct costs of materials and services used in the development and purchase of internal-use software. Amounts capitalized are amortized on a straight-line basis over a period of five years and are reported as a component of machinery and equipment within property, plant and equipment.
Goodwill and Other Intangible AssetsGoodwill represents the excess of the purchase price over the fair value of net assets acquired in business combinations under the purchase method of accounting. Other intangible assets, consisting primarily of patents, trademarks and customerCustomer relationships and lists, are recorded at cost and are amortized on a straight-line basis over their estimated useful lives of 53 to 1520 years. Goodwill is testedassessed for impairment annually or if an event occurs or circumstances change that would indicate the carrying amount may be impaired. Impairment testingThe impairment assessment for goodwill is done at a reporting unit level. Reporting units are one level below the business segment level, but can be combined when reporting units within the same segment have similar economic characteristics. An impairment loss generally would be recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit. The Company completed its annual impairment testsassessment in the third quarterquarters of fiscal 2006Fiscal 2009 and 2005,2008, which indicated no impairment.
Recoverability of Long-Lived AssetsThe Company reviews its long-lived assets, including identifiable intangibles, for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If impairment indicators are present and the estimated future undiscounted cash flows are less than the carrying value of the assets, the carrying value is reduced to the estimated fair value as measured by the undiscounted cash flows.reduced.
Income TaxesThe provision for income taxes is computed based on the pretax income included in the Consolidated Statements of Earnings. Deferred tax assets and liabilities are recognized for the expected future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.
28
Comprehensive Income (Loss)Comprehensive income (loss) consists of net income, foreign currency translation adjustments, additional minimumnet changes in the funded status of pension liabilityretirement obligations and net gain or loss on cash flow hedging derivatives, and is presented in the Consolidated Statements of Changes in Shareholders’ Equity. The components of the ending balances of accumulated other comprehensive income (loss) are as follows (thousands of dollars):
| July 31, 2006 | July 31, 2005 | July 31, 2004 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Foreign currency translation adjustment | $ | 52,774 | $ | 37,487 | $ | 35,610 | ||||||||
| Net gain (loss) on cash flow hedging derivatives, net of deferred taxes | (325 | ) | (174 | ) | 142 | |||||||||
| Additional minimum pension liability, net of deferred taxes | (1,255 | ) | (9,693 | ) | (4,194 | ) | ||||||||
| Total accumulated other comprehensive income | $ | 51,194 | $ | 27,620 | $ | 31,558 | ||||||||
The additional minimum pension liability adjustment is calculated on an annual basis. If the accumulated benefit obligation (“ABO”) exceeds the fair value of pension assets, the Company must recognize a liability that is at least equal to the unfunded ABO.
|
|
|
|
|
|
|
|
|
|
|
|
| July 31, |
| July 31, |
| July 31, |
| |||
Foreign currency translation adjustment |
| $ | 75,155 |
| $ | 138,540 |
| $ | 81,389 |
|
Net gain (loss) on cash flow hedging derivatives, net of deferred taxes |
|
| (394 | ) |
| 188 |
|
| (207 | ) |
Pension liability adjustment, net of deferred taxes |
|
| (84,438 | ) |
| (25,845 | ) |
| (11,174 | ) |
Total accumulated other comprehensive income (loss) |
| $ | (9,677 | ) | $ | 112,883 |
| $ | 70,008 |
|
Cumulative foreign translation is not adjusted for income taxes as substantially alltaxes. All translation relates to permanent investments in non-U.S. subsidiaries.
Earnings Per ShareThe 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 dilutive shares relating to stock options, restricted stock and stock incentive plans. Certain outstanding options were excluded from the diluted net earnings per share calculations because their exercise prices were greater than the average market price of the Company’s common stock during those periods. There were 443,7031,158,451 options, 245,344 options, and 540,09510,000 options excluded from the diluted net earnings per share calculation for the fiscal year ended July 31, 20062009, 2008, and 2005,2007, respectively. The following table presents information necessary to calculate basic and diluted earnings per share:
| 2006 | 2005 | 2004 |
|
|
|
|
|
|
|
|
|
| |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2009 |
| 2008 |
| 2007 |
| |||||||||||||||||||
| (thousands of dollars, except per share amounts) |
| (thousands of dollars, |
| ||||||||||||||||||||||
| Weighted average shares — basic | 82,992 | 84,991 | 87,960 |
| 77,879 |
| 79,208 |
| 80,455 |
| |||||||||||||||
| Dilutive shares | 2,147 | 1,892 | 2,470 |
| 1,293 |
| 2,003 |
| 1,981 |
| |||||||||||||||
| Weighted average shares — diluted | 85,139 | 86,883 | 90,430 |
| 79,172 |
| 81,211 |
| 82,436 |
| |||||||||||||||
| Net earnings for basic and diluted earnings per share computation | $ | 132,307 | $ | 110,554 | $ | 106,317 |
| $ | 131,907 |
| $ | 171,953 |
| $ | 150,717 |
| |||||||||
| Net earnings per share — basic | $ | 1.59 | $ | 1.30 | $ | 1.21 |
| $ | 1.69 |
| $ | 2.17 |
| $ | 1.87 |
| |||||||||
| Net earnings per share — diluted | $ | 1.55 | $ | 1.27 | $ | 1.18 |
| $ | 1.67 |
| $ | 2.12 |
| $ | 1.83 |
| |||||||||
Stock Split On January 16, 2004, the Company’s Board of Directors declared a two-for-one stock split effected in the form of a 100 percent dividend. The Company distributed 43.4 million shares of common stock on March 19, 2004, to shareholders of record as of March 5, 2004. All share and per share amounts have been retroactively adjusted to reflect the stock split.
Treasury StockRepurchased common stock is stated at cost and is presented as a separate reduction of shareholders’ equity.
Research and DevelopmentResearch and development costs are charged against earnings in the year incurred. Research and development expenses include basic scientific research and the application of scientific advances to the development of new and improved products and their uses.
Stock-Based CompensationThe Company offers stock-based employee compensation plans, which are more fully described in Note H. On August 1, 2005, the Company adopted the Statement of Financial Standards (“SFAS”) No. 123R,Share Based Payment – Revised 2004, using the modified prospective transition method. Under this method, stock-basedStock-based employee compensation cost is recognized using the
29
fair-value based method for all new awards granted after August 1, 2005. Compensation costs for unvested stock options and awards that arewere outstanding at August 1, 2005, will beare recognized over the requisite service period based on the grant-date fair value of those options and awards as previously calculated under the pro-forma disclosures under SFAS 123.disclosures.
Prior to the adoption of SFAS 123R, the Company accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Boards (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees, and related interpretations. If the fair value based method prescribed in SFAS 123 had been applied in fiscal 2005 and 2004 to all stock awards, the Company’s net income and basic and diluted net income per share would have been reduced as summarized below:
| 2005 | 2004 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars, except per share amounts) | |||||||||||
| Net earnings, as reported | $ | 110,554 | $ | 106,317 | |||||||
| Add total stock-based employee compensation expenses included in the determination of net income, net of tax | 3,784 | 2,364 | |||||||||
| Less total stock-based employee compensation expense under the fair value-based method, net of tax | (12,150 | ) | (8,182 | ) | |||||||
| Pro forma net earnings | $ | 102,188 | $ | 100,499 | |||||||
| Basic net earnings per share | |||||||||||
| As reported | $ | 1.30 | $ | 1.21 | |||||||
| Pro forma | $ | 1.20 | $ | 1.14 | |||||||
| Diluted net earnings per share | |||||||||||
| As reported | $ | 1.27 | $ | 1.18 | |||||||
| Pro forma | $ | 1.17 | $ | 1.11 | |||||||
Effective June 27, 2005, the Board of Directors of the Company authorized the acceleration of vesting of certain unvested and “out-of-the-money” stock options outstanding under the Plan. The accelerated options were granted in fiscal 2004 and fiscal 2005 with a three-year vesting period and had exercise prices per share ranging from $30.38 to $30.69. Options for the purchase of 511,242 shares of the common stock of the Company became exercisable immediately as a result of this action. No options held by any director or named executive officer were included in the acceleration action. As a result, the amount of pre-tax compensation expense amortized during fiscal 2006 was reduced by approximately $2.1 million from what it would have otherwise been.
Revenue RecognitionRevenue is recognized when both product ownership and the risk of loss hashave transferred to the customerCustomer, and the Company has no remaining obligations. The Company records estimated discounts and rebates as a reduction of sales in the same period revenue is recognized. Shipping and handling costs for fiscal 2006, 2005Fiscal 2009, 2008 and 20042007 totaling $35.3$50.4 million, $34.2$53.0 million and $31.8$34.8 million, respectively, are classified as a component of operating expenses.
Product WarrantiesThe Company provides for estimated warranty costs at the time of sale and accrues for specific items at the time their existence is known and the amounts are determinable. The Company estimates warranty costs using standard quantitative measures based on historical warranty claim experience and evaluation of specific customerCustomer warranty issues.
Derivative Instruments and Hedging ActivitiesThe Company recognizes all derivatives on the balance sheet at fair value. Derivatives that are not hedges are adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in shareholders’ equity through other comprehensive income until the hedged item is recognized. Gains or losses related to the ineffective portion of any hedge are recognized through earnings in the current period.
Asset Retirement Obligations The Company accounts for obligations under retirements of long-lived assets under SFAS No. 143,Accounting for Asset Retirement Obligations (“SFAS 143”). This statement addresses financial accounting and reporting for obligations associated with the retirement of
30
tangible long-lived assets and the associated asset retirement costs. In March 2005, the FASB issued Interpretation No. 47,Accounting for Conditional Asset Retirement Obligations, (“FIN 47”) which clarifies that the term “conditional asset retirement obligation” as used in SFAS 143 refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. However, the obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. FIN 47 requires that the uncertainty about the timing and/or method of settlement of a conditional asset retirement obligation be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 was effective for the Company’s fiscal period ended July 31, 2006. As of July 31, 2006 and 2005, the Company did not have any obligations associated with the retirement of long-lived assets.
Exit or Disposal ActivitiesThe Company accounts for costs relating to exit or disposal activities under SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities for exit and disposal activities initiated beginning in fiscal 2003.. SFAS No. 146 addresses recognition, measurement and reporting of costs associated with exit and disposal activities including restructuring. See Note L for disclosures related to restructuring.
GuaranteesUpon issuance of a guarantee, the Company recognizes a liability for the fair value of an obligation assumed under a guarantee. See Note K for disclosures related to guarantees.
New Accounting StandardsIn May 2009, the Financial Accounting Standards Board (FASB) issued FAS No. 165, Subsequent Events (FAS 165), which establishes general standards of accounting and disclosure for events that occur after the balance sheet date but before the financial statements are issued. This new standard was effective for interim or annual financial periods ending after June 15, 2009, and did not have an impact on our consolidated financial position or results of operations.
In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1,Interim Disclosures about Fair Value of Financial Instruments, (FSP No. FAS-107-1 and APB-28-1), which amends FAS 107,Disclosures about Fair Value of Financial Instrumentsand Accounting Principles Board (APB) Opinion No. 28,Interim Financial Reporting, to require disclosures about fair value of financial instruments for interim periods. This FSP will be effective for the Company for the quarter ended October 31, 2009, and will expand the Company’s disclosures regarding the use of fair value in interim periods.
In December 2008, the FASB issued FSP No. FAS 132(R)-1,Employers’ Disclosures about Postretirement Benefit Plan Assets(FSP No. FAS 132(R)), which provides guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. This FSP is effective for fiscal years ending after December 15, 2009. The Company is currently evaluating the impact of adopting FSP No. FAS 132(R) on our defined benefit pension and other postretirement plan note disclosures.
In September 2006, the FASB issued SFAS No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“(SFAS 158”)158). ThisThe portion of the statement that requires recognition of the overfunded or underfunded status of defined benefit postretirement plans as an asset or liability in the statement of financial position and to recognize changeswas adopted in that funded status in comprehensive income in the year in which the changes occur.Fiscal 2007 with minimal impact. SFAS 158 also requires measurement of the funded status of a plan as of the date of the statement of financial position. SFAS 158 is effective for recognitionThat provision required the Company to change its measurement date from April 30 to July 31 in Fiscal 2009. The adoption of the funded statusmeasurement date provision resulted in an after-tax decrease to Retained earnings of $0.9 million, a decrease to Other assets of $0.5 million increase to Other long-term liabilities of $0.8 million and an increase to Deferred income taxes of $0.5 million.
In September 2006, the benefit plansFASB issued SFAS No. 157,Fair Value Measurements(SFAS 157). This statement defines fair value, establishes a framework for fiscal years ending after December 15, 2006measuring fair value in U.S. generally accepted accounting principles and isexpands disclosures about fair value measurements. SFAS 157 applies whenever another standard requires (or permits) assets or liabilities to be measured at fair value, except for the measurement of share-based payments. SFAS 157 does not expand the use of fair value to any new circumstances, and was effective for the measurementmajority of the Company’s assets and liabilities for its Fiscal 2009 year beginning August 1, 2008. The adoption of this portion of SFAS 157 in Fiscal 2009 did not have a
material impact on the Company’s financial statements. On February 12, 2008, the FASB issued FASB Staff Position (FSP) FAS 157-2,Effective Date of FASB Statement No. 157(FSP FAS 157-2). FSP FAS 157-2 delays by one year the effective date provisionsof SFAS 157 for fiscal years ending after December 15, 2008.certain non-financial assets and non-financial liabilities. The Company is currently evaluating the effectimpact the FSP FAS 157-2 will have on the determination of SFAS 158fair value related to non-financial assets and non-financial liabilities in Fiscal 2010. The adoption of FSP FAS 157-2 is not expected to have a material impact on its consolidatedthe Company’s financial statements.
In June 2006,February 2007, the FASB issued FASB InterpretationSFAS No. 48,159,AccountingThe Fair Value Option for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109Financial Assets and Financial Liabilities (“FIN 48”(“SFAS 159”). This pronouncement prescribes a recognition thresholdSFAS 159 permits entities to choose to measure many financial instruments and measurement attribute for the financial statement recognition and measurement of tax positions taken or expectedcertain other items at fair value that are not currently required to be taken in a tax return. FIN 48measured at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007, and was effective for the Company with its 2009 fiscal year, beginning August 1, 2008. The adoption of SFAS 159 did not have a material impact on the Company’s financial statements.
In December 15, 2006.2007, the FASB issued SFAS No. 141(R),Business Combinations(SFAS 141(R)), which changes the accounting for business combinations and their effects on the financial statements. SFAS 141(R) will be effective for the Company at the beginning of Fiscal 2010. In February 2009, the FASB issued FASB Staff Position 141(R)-a,Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies(FSP FAS 141(R)-a), which will amend certain provisions of SFAS 141(R). The adoptions of SFAS 141(R) and FSP FAS 141(R)-a are not expected to have a material impact on the Company’s consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133(SFAS 161). SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities, including (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The Company is currently evaluatingadopted the effectprovisions of FIN 48 on itsSFAS 161 effective February 1, 2009. The adoption of SFAS 161 only requires additional disclosures about the Company’s derivatives and thus did not affect the Company’s consolidated financial statements.
NOTE B
Goodwill and Other Intangible Assets
The Company has allocated goodwill to its Industrial Products and Engine Products segments. Additions to goodwill and other intangible assets in fiscal 2005Fiscal 2009 relate to the acquisitionsacquisition of Triboguard Company Limited for a purchase price of $7.3 million on December 1, 2004 as a part100 percent of the Industrial Products segment and Le Bozec Filtration Systemsstock of Western Filter Corporation on October 15, 2008, for a purchase price of $9.3$78.5 million, on March 31, 2005 as a part of the Engine Products segment. The weighted average life of the intangibles acquired in this acquisition is 17.6 years and consists primarily of customer related intangibles. Goodwill associated with this acquisition is tax deductible. Dispositions of goodwill and other intangible assets in Fiscal 2006 additions2009 relate to the sale of the air dryer business in Maryville, Tennessee, on October 31, 2008, for $4.6 million, which resulted in a loss on sale of $0.6 million. This air dryer business was part of the Industrial Products segment were a result ofsegment. Additions to goodwill and other intangible assets in Fiscal 2008 relate to the acquisition of AirCel CorporationLMC West, Inc. on January 19, 2006 for $4.5 million. The current year addition to the Engine Products segment is a resultFebruary 4, 2008, as part of the final purchase price allocation for the Le Bozec acquisition.Industrial Products segment. Financial results for each of the above acquisitions are included in the Company’s consolidated results from the date of acquisition. Pro forma financial results are not presented as the acquisitions are not material, individually or in the aggregate. AsThe Company completed its annual impairment assessment in the third quarter of August 1, 2004, the Company transferred a component of its Engine Products segment to its Industrial Products segment along withFiscal 2009 and 2008, which indicated no impairment.
31
the goodwill associated with this component. At that time, the Company performed an impairment test of the reporting unit to which this goodwill is now assigned resulting in no impairment. Following is a reconciliation of goodwill for the years ended July 31, 20062009 and 2005:2008:
| Industrial Products | Engine Products | Total Goodwill | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars) | |||||||||||||||
| Balance as of August 1, 2004 | $ | 72,601 | $ | 23,973 | $ | 96,574 | |||||||||
| Transfer of goodwill between segments | 22,903 | (22,903 | ) | — | |||||||||||
| Acquisition activity | 4,310 | 5,135 | 9,445 | ||||||||||||
| Foreign exchange translation | (374 | ) | (341 | ) | (715 | ) | |||||||||
| Balance as of July 31, 2005 | $ | 99,440 | $ | 5,864 | $ | 105,304 | |||||||||
| Acquisition activity | 2,234 | — | 2,234 | ||||||||||||
| Final purchase price allocation | — | 1,394 | 1,394 | ||||||||||||
| Usage of pre-acquisition net operating losses | (1,166 | ) | — | (1,166 | ) | ||||||||||
| Foreign exchange translation | 2,419 | 424 | 2,843 | ||||||||||||
| Balance as of July 31, 2006 | $ | 102,927 | $ | 7,682 | $ | 110,609 | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
| Engine |
| Industrial |
| Total |
| |||
|
| (thousands of dollars) |
| |||||||
Balance as of July 31, 2007 |
| $ | 17,912 |
| $ | 106,695 |
| $ | 124,607 |
|
Acquisition activity |
|
| — |
|
| 625 |
|
| 625 |
|
Foreign exchange translation |
|
| 1,214 |
|
| 7,716 |
|
| 8,930 |
|
Balance as of July 31, 2008 |
| $ | 19,126 |
| $ | 115,036 |
| $ | 134,162 |
|
Acquisition activity |
|
| 43,646 |
|
| — |
|
| 43,646 |
|
Disposition activity |
|
| — |
|
| (1,089 | ) |
| (1,089 | ) |
Foreign exchange translation |
|
| (1,190 | ) |
| (6,502 | ) |
| (7,692 | ) |
Balance as of July 31, 2009 |
| $ | 61,582 |
| $ | 107,445 |
| $ | 169,027 |
|
Intangible assets are comprised of patents, trademarks and customerCustomer relationships and lists. Following is a reconciliation of intangible assets for the years ended July 31, 20062009 and 2005:2008:
| Gross Carrying Amount | Accumulated Amortization | Net Intangible Assets |
|
|
|
|
|
|
|
|
|
| |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Gross |
| Accumulated |
| Net Intangible |
| |||||||||||||||||||
| (thousands of dollars) |
| (thousands of dollars) |
| ||||||||||||||||||||||
| Balance as of August 1, 2004 | $ | 21,734 | $ | (2,607 | ) | $ | 19,127 | ||||||||||||||||||
Balance as of July 31, 2007 |
| $ | 57,203 |
| $ | (10,902 | ) | $ | 46,301 |
| |||||||||||||||
| Intangibles acquired | 5,864 | — | 5,864 |
| 1,868 |
| — |
| 1,868 |
| |||||||||||||||
| Amortization expense | — | (1,769 | ) | (1,769 | ) |
| — |
| (4,330 | ) |
| (4,330 | ) | ||||||||||||
| Foreign exchange translation | (109 | ) | 53 | (56 | ) |
|
| 3,171 |
|
| (693 | ) |
| 2,478 |
| ||||||||||
| Balance as of July 31, 2005 | $ | 27,489 | $ | (4,323 | ) | $ | 23,166 | ||||||||||||||||||
Balance as of July 31, 2008 |
| $ | 62,242 |
| $ | (15,925 | ) | $ | 46,317 |
| |||||||||||||||
| Intangibles acquired | 300 | (23 | ) | 277 |
| 26,710 |
| — |
| 26,710 |
| ||||||||||||||
Intangibles sold |
| (300 | ) |
| 114 |
| (186 | ) | |||||||||||||||||
| Amortization expense | — | (2,037 | ) | (2,037 | ) |
| — |
| (5,601 | ) |
| (5,601 | ) | ||||||||||||
| Foreign exchange translation | 994 | (271 | ) | 723 |
|
| (2,843 | ) |
| 989 |
|
| (1,854 | ) | |||||||||||
| Balance as of July 31, 2006 | $ | 28,783 | $ | (6,654 | ) | $ | 22,129 | ||||||||||||||||||
Balance as of July 31, 2009 |
| $ | 85,809 |
| $ | (20,423 | ) | $ | 65,386 |
| |||||||||||||||
Net intangible assets consist of patents, trademarks and tradenames of $15.9$23.9 million and $16.7$23.5 million as of July 31, 20062009 and 2005,2008, respectively, and customerCustomer related intangibles of $6.2$41.5 million and $6.4$22.8 million as of July 31, 20062009 and 2005,2008, respectively. Amortization expense relating to existing intangible assets is expected to be approximately $2.1$6.1 million for each of the yearsyear ending July 31, 2007, 2008, 20092010, $6.0 million for the year ending July 31, 2011, $5.9 million for the year ending July 31, 2012, $5.7 million for the year ending July 31, 2013 and 2010, respectively. For fiscal 2011,$5.3 million for the amortization is expected to be $2.0 million.year ending July 31, 2014.
NOTE C
Credit Facilities
The Company has a three-yearfive-year, multi-currency revolving facility with a group of banks under which the Company may borrow up to $150.0$250 million. TheThis facility as amended in September 2004, expires in September 2009.matures on April 2, 2013. The agreement provides that loans may be made under a selection of currencies and rate formulas including Base Rate Advances or Off Shore Rate Advances. The interest rate on each advance is based on certain market interest rates and leverage ratios. Facility fees and other fees on the entire loan commitment are payable over the duration of this facility. There were no amounts outstanding at July 31, 2006 and $65.0was $20.0 million outstanding at July 31, 2005, leaving $150.02009, and $70.0 million outstanding at July 31, 2008. The amount available for further borrowing reflects a reduction for issued standby letters of credit, as discussed below. At July 31, 2009 and 2008, $210.0 million and $85.0$161.5 million, respectively, was available for further borrowing under such facilities. The weighted average interest rate on these short-term borrowings outstanding at July 31, 2009 and 2008, was 0.56 percent and 2.73 percent, respectively.
The Company also has three uncommitted credit facilities in the United States, which provide unsecured borrowings for general corporate purposes. At July 31, 2009 and 2008, there was $70.0 million available for use. There was $9.6 million and $28.0 million outstanding under these facilities at July 31, 20062009 and July 31, 2005, 2008,
respectively. The weighted average interest rate on these short-term borrowings outstanding at July 31, 20052009 and 2008, was 3.77 percent.
The Company also has three agreements under uncommitted credit facilities, which provide unsecured borrowings for general corporate purposes. At July 31, 20060.53 percent and 2005, there was $70.0 million and
32
$60.0 million available for use under these facilities,2.79 percent, respectively. There were no amounts outstanding at July 31, 2006 and $36.7 million outstanding at July 31, 2005 under these facilities. The weighted average interest rate on these short-term borrowings outstanding at July 31, 2005 was 3.67 percent.
The Company also has a 100€100 million euro program for issuing treasury notes for raising short, medium and long-term financing for its European operations. There was 35.3 million euronothing outstanding on this program at July 31, 20062009 and no amounts outstanding at July 31, 2005. The weighted average interest rate on these short-term issuances at July 31, 2006 was 3.13 percent.2008. Additionally, the Company’s European operations have lines of credit in the amountwith an available limit of 50.2 million euro.€72.9 million. There was nothing outstanding on these lines of credit as of July 31, 2009. As of July 31, 2006,2008, there was 20.1€23.5 million, euro outstanding. As of July 31, 2005 there were no amountsor $36.9 million outstanding. The weighted average interest rate of these short-term borrowings outstanding at July 31, 20062008, was 3.385.60 percent.
Other international subsidiaries may borrow under various credit facilities. There was nothing outstanding under these credit facilities as of July 31, 2009. As of July 31, 2006 and 2005,2008, borrowings under these facilities were $2.6 million and $0.3 million, respectively.$4.5 million. The weighted average interest rate on these international borrowings outstanding at July 31, 2006 and 20052008, was 7.92 percent and 8.50 percent, respectively.2.88 percent.
As discussed further in Note K, at July 31, 20062009 and 2005,2008, the Company had outstanding standby letters of credit totaling $18.7$20.0 million and $18.5 million, respectively, upon which no amounts had been drawn. The letters of credit guarantee payment to third parties in the event the Company is in breach of specified bond financing agreement and insurance contract terms as detailed in each letter of credit.
NOTE D
Long-Term Debt
Long-term debt consists of the following:
|
|
|
|
|
|
|
|
|
| 2009 |
| 2008 |
| ||
|
| (thousands of dollars) |
| ||||
6.39% Unsecured senior notes due August 15, 2010, interest payable semi-annually, principal payments of $5.0 million, to be paid annually commencing August 16, 2006 |
|
| 9,981 |
|
| 14,942 |
|
4.85% Unsecured senior notes, interest payable semi-annually, principal payment of $30.0 million due December 17, 2011. |
|
| 30,000 |
|
| 30,000 |
|
6.59% Unsecured senior notes, interest payable semi-annually, principal payment of $80.0 million due November 14, 2013 |
|
| 80,000 |
|
| — |
|
5.48% Unsecured senior notes, interest payable semi-annually, principal payment of $50.0 million due June 1, 2017 |
|
| 50,000 |
|
| 50,000 |
|
5.48% Unsecured senior notes, interest payable semi-annually, principal payment of $25.0 million due September 28, 2017 |
|
| 25,000 |
|
| 25,000 |
|
5.48% Unsecured senior notes, interest payable semi-annually, principal payment of $25.0 million due November 30, 2017 |
|
| 25,000 |
|
| 25,000 |
|
1.418% Guaranteed senior notes, interest payable semi-annually, principal payment of ¥1.2 billion due January 31, 2012 |
|
| 12,679 |
|
| 11,123 |
|
2.019% Guaranteed senior note, interest payable semi-annually, principal payment of ¥1.65 billion due May 18, 2014 |
|
| 17,434 |
|
| 15,295 |
|
Variable Rate Commercial Property Loan, to a maximum of R37 million, interest rate of 13.75% as of July 31, 2008, repaid in 2009 |
|
| — |
|
| 1,882 |
|
Variable Rate Industrial Development Revenue Bonds (“Low Floaters”) interest payable monthly, principal payment of $7.755 million due September 1, 2024, and an interest rate of 0.67% as of July 31, 2009 |
|
| 7,755 |
|
| 7,755 |
|
Capitalized lease obligations and other, with various maturity dates and Interest rates |
|
| 1,321 |
|
| 1,147 |
|
Total |
|
| 259,170 |
|
| 182,144 |
|
Less current maturities |
|
| 5,496 |
|
| 5,669 |
|
Total long-term debt |
| $ | 253,674 |
| $ | 176,475 |
|
| 2006 | 2005 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars) | |||||||||||
| 6.31% Unsecured senior notes, interest payable semi-annually, principal payment of $28.2 million due July 15, 2008 | $ | 27,771 | $ | 28,164 | |||||||
| 6.39% Unsecured senior notes due August 15, 2010, interest payable semi-annually, principal payments of $5.0 million, to be paid annually commencing August 16, 2006 | 24,775 | 24,624 | |||||||||
| 4.85% Unsecured senior notes, interest payable semi-annually, principal amount of $30.0 million due December 17, 2011 | 30,000 | 30,000 | |||||||||
| 1.418% Guaranteed senior notes, interest payable semi-annually, principal amount of 1.2 billion yen due January 31, 2012 | 10,468 | 10,668 | |||||||||
| 1.51% Guaranteed note repaid March 28, 2006 | — | 7,112 | |||||||||
| Variable Rate Industrial Development Revenue Bonds (“Lower Floaters”) due September 1, 2024, principal amount of $7.755 million, interest payable monthly, and an interest rate of 3.73% as of July 31, 2006 | 7,755 | 7,755 | |||||||||
| Variable Rate Commercial Property Loan, to a maximum of 37 million rand, final installment due September 2016, interest payable monthly, and an interest rate of 9.25% as of July 31, 2006 | 4,082 | — | |||||||||
| Capitalized lease obligations and other, with various maturity dates and Interest rates | 2,185 | 2,751 | |||||||||
| Total | 107,036 | 111,074 | |||||||||
| Less current maturities | 6,541 | 7,772 | |||||||||
| Total long-term debt | $ | 100,495 | $ | 103,302 | |||||||
Annual maturities of long-term debt are $6.5$5.5 million in 2007, $34.5 million in 2008, $6.6 million in 2009,2010, $5.4 million in 2010, $5.52011, $43.0 million in 20112012, $97.5 million in 2014 and $48.5$107.8 million thereafter. The Company estimates thatThere are no maturities in 2013. As of July 31, 2009, the carryingestimated fair value of long-term debt approximateswith fixed interest rates was $253.1 million compared to its carrying value of $250.1 million.
On November 14, 2008, the Company issued an $80 million senior unsecured note. The note is due on November 14, 2013. The debt was issued at face value and bears interest payable semi-annually at a rate of 6.59 percent. The proceeds from the note were used to refinance existing debt and for general corporate purposes.
On June 1, 2007, the Company issued $100 million of senior unsecured notes. The first $50 million was funded on June 1, 2007, and the remaining two $25 million tranches were funded on September 28, 2007, and November 30, 2007. The three tranches are due on June 1, 2017, September 28, 2017, and November 30, 2017, respectively. The debt was issued at face value and bears interest payable semi-annually at a rate of 5.48 percent. The proceeds from the notes were used to refinance existing debt and for general corporate purposes.
The Company is exposed to changes in the fair market value.value of its fixed-rate debt resulting from interest rate fluctuations. To hedge this exposure the Company entered into two fixed-to-variable interest rate swaps on August 3, 2009, subsequent to year end, for $80 million and $25 million, respectively, for approximately 5 and 8 years, respectively. These interest rate swaps will be accounted for as fair value hedges. Changes in the payment of interest resulting from the interest rate swaps will be recorded as an offset to interest expense.
Certain note agreements contain debt covenants related to working capital levels and limitations on indebtedness. Further, the Company is restricted from paying dividends or repurchasing common stock if its tangible net worth (as defined) does not exceed certain minimum levels. As of July 31, 2006,2009, the Company was in compliance with all such covenants.
33
Table of Contents The Company currently expects to remain in compliance with these covenants.
NOTE E
Derivatives and Other Financial Instruments
Derivatives The Company records all derivative instruments in the financial statements at fair value. The Company uses derivative instruments, primarily forward exchange contracts and interest rate swaps, to manage its exposure to fluctuations in foreign exchange rates and interest rates. It is the Company’s policy to enter into derivative transactions only to the extent true exposures exist; the Company does not enter into derivative transactions for speculative or trading purposes. The Company enters into derivative transactions only with highly rated counterparties. These transactions may expose the Company to credit risk to the extent that the instruments have a positive fair value, but the Company has not experienced any material losses, nor does the Company anticipate any material losses.
Each derivative transaction the Company enters into is designated at inception as a hedge and is expected to be highly effective. The Company evaluates hedge effectiveness at inception and on an ongoing basis. When a derivative is determined to be or is no longer expected to be highly effective, hedge accounting is discontinued. Hedge ineffectiveness, if any, is recorded in earnings on the same line as the underlying transaction risk.
The Company is exposed to changes in the fair value of its fixed-rate debt resulting from interest rate fluctuations. To hedge this exposure, the Company has from time to time entered into fixed to variable interest rate swaps that were accounted for as fair value hedges. The fair value of these swaps was recorded net of the underlying outstanding debt. Changes in the payment of interest resulting from the interest rate swaps are recorded as an offset to interest expense. Effectiveness is assessed based on changes in the fair value of the underlying debt using incremental borrowing rates currently available on loans with similar terms and maturities. The Company did not have any interest rate swaps outstanding as of July 31, 2006.
The Company enters into forward exchange contracts of generally less than one year to hedge forecasted transactions withamongst its foreign subsidiaries, and to reduce potential exposure related to fluctuations in foreign exchange rates for existing recognized assets and liabilities andliabilities. It also utilizes forward exchange contracts for anticipated intercompany and third-party transactions such as purchases, sales and dividend payments denominated in local currencies. Forward exchange contracts are designated as cash flow hedges as they are designed to hedge the variability of cash flows associated with the underlying existing recognized or anticipated transactions. Changes in the value of derivatives designated as cash flow hedges are recorded in other comprehensive income in shareholders’ equity until earnings are affected by the variability of the underlying cash flows. At that time, the applicable amount of gain or loss from the derivative instrument that is deferred in shareholders’ equity is reclassified to earnings and is included in other income or expense. For foreign currency forward contracts used as cash flow hedges, effectivenessearnings. Effectiveness is measured using spot rates to value both the hedge contract and the hedged item. The excluded forward points, as well as any ineffective portions of hedges, are recorded in earnings through the same line as the underlying transaction. During fiscal year 2006,Fiscal 2009, $0.4 million in gainsof losses were recorded in fiscal 2006 due to the exclusion of forward points from the assessment of hedge effectiveness.
Net unrealized losses of $0.7 million and $0.3 million from cash flow hedges were recorded in accumulated other comprehensive income as of July 31, 2006 and 2005, respectively. These unrealized losses and gains are reclassified, as appropriate, as earnings are affected by the variability of the underlying cash flows during the term of the hedges. For fiscal year 2006, $0.8The Company expects to record $0.6 million of net deferred gains were reclassifiedlosses from accumulated otherthese forward exchange contracts during the next twelve months.
The Company is exposed to changes in the fair value of its fixed-rate debt resulting from interest rate fluctuations. To hedge this exposure the Company entered into two fixed-to-variable interest rate swaps on August 3, 2009, subsequent to year end, for $80 million and $25 million, respectively, for approximately 5 and 8 years, respectively. These interest rate swaps will be accounted for as fair value hedges. Changes in the payment of interest resulting from the interest rate swaps will be recorded as an offset to interest expense.
The Company entered into and settled an interest rate lock in October 2008. The interest rate lock settlement resulted in a $0.5 million in gain, net of deferred taxes of $0.2 million, which will be amortized into income over the life of the related debt.
The following summarizes the Company’s fair value of outstanding derivatives at July 31, 2009, and 2008, on the Consolidated Balance Sheets (thousands of dollars):
|
|
|
|
|
|
|
|
|
| July 31, |
| July 31, |
| ||
Asset derivatives recorded under the caption Prepaids and other current assets |
|
|
|
|
|
|
|
Foreign exchange contracts |
| $ | 493 |
| $ | 952 |
|
|
|
|
|
|
|
|
|
Liability derivatives recorded under the caption Other current liabilities |
|
|
|
|
|
|
|
Foreign exchange contracts |
| $ | 2,366 |
| $ | 1,252 |
|
The impact on Other comprehensive income (OCI) and earnings from foreign exchange contracts that qualified as cash flow hedges for the twelve months ended July 31, 2009 and 2008, was as follows (thousands of dollars):
|
|
|
|
|
|
|
|
|
| July 31, |
| July 31, |
| ||
Net carrying amount at beginning of year |
| $ | 188 |
| $ | (206 | ) |
Cash flow hedges deferred in OCI |
|
| (1,826 | ) |
| 2,628 |
|
Cash flow hedges reclassified to income (effective portion) |
|
| 580 |
|
| (2,211 | ) |
Change in deferred taxes |
|
| 408 |
|
| (23 | ) |
Net carrying amount at July 31 |
| $ | (650 | ) | $ | 188 |
|
The Company’s derivative financial instruments present certain market and counterparty risks; however, concentration of counterparty risk is mitigated as the Company deals with a variety of major banks worldwide. In addition, only conventional derivative financial instruments are utilized. The Company would not be materially impacted if any of the counterparties to the derivative financial instruments outstanding at July 31, 2009, failed to perform according to the terms of its agreement. At this time, the Company does not require collateral or any other income.form of securitization to be furnished by the counterparties to its derivative instruments.
Fair Value of Financial InstrumentsAt July 31, 20062009 and 2005,2008, the Company’s financial instruments included cash and cash equivalents, accounts receivable, accounts payable, short-term borrowings, long-term debt and derivative contracts. The fair values of cash and cash equivalents, accounts receivable, accounts payable and short-term borrowings approximated carrying values because of the short-term nature of these instruments. Derivative contracts are reported at their fair values based on third-party quotes. As of July 31, 2006,2009, the estimated fair value of long-term debt with fixed interest rates was $91.3$253.1 million compared to its carrying value of $92.5$250.1 million. The fair value is estimated by discounting the projected cash flows using the rate that similar amounts of debt could currently be borrowed.
34
Credit RiskThe Company is exposed to credit loss in the event of nonperformance by counterparties in interest rate swaps and foreign exchange forward contracts. Collateral is generally not required of the counterparties or of the Company. In the unlikely event a counterparty fails to meet the contractual terms of an interest rate swap or foreign exchange forward contract, the Company’s risk is limited to the fair value of the instrument. There were no interest rate swaps outstanding at July 31, 2009 or 2008. The Company actively monitors its exposure to credit risk through the use of credit approvals and credit limits, and by
selecting major international banks and financial institutions as counterparties. The Company has not had any historical instances of non-performance by any counterparties, nor does it anticipate any future instances of non-performance.
NOTE F
Employee Benefit Plans
Pension PlansThe Company and certain of its subsidiaries have defined benefit pension plans for many of its hourly and salaried employees. The domesticU.S. plans include plans that provide defined benefits as well as a plan for salaried workers that 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 international plans generally provide pension benefits based on years of service and compensation level. TheDuring Fiscal 2009, the Company useschanged its measurement date to July 31, in accordance with the measurement date provisions of FAS 158, as discussed below. During Fiscal 2008, the Company used an April 30 measurement date for its pension plans.
Net periodic pension costs for the Company’s pension plans include the following components:
|
|
|
|
|
|
|
|
|
|
|
|
| 2009 |
| 2008 |
| 2007 |
| |||
|
| (thousands of dollars) |
| |||||||
Net periodic cost: |
|
|
|
|
|
|
|
|
|
|
Service cost |
| $ | 15,385 |
| $ | 15,996 |
| $ | 15,067 |
|
Interest cost |
|
| 18,481 |
|
| 17,702 |
|
| 17,014 |
|
Expected return on assets |
|
| (29,143 | ) |
| (28,275 | ) |
| (24,955 | ) |
Transition amount amortization |
|
| 193 |
|
| 164 |
|
| 523 |
|
Prior service cost amortization |
|
| 438 |
|
| 380 |
|
| 314 |
|
Actuarial (gain)/loss amortization |
|
| 1,088 |
|
| (58 | ) |
| 1,408 |
|
Curtailment loss |
|
| 910 |
|
| — |
|
| 408 |
|
Settlement gain |
|
| — |
|
| (35 | ) |
| (2,357 | ) |
Net periodic benefit cost |
| $ | 7,352 |
| $ | 5,874 |
| $ | 7,422 |
|
Negotiations with one of our unions resulted in a freeze in pension benefits at one of our U.S. plants. In exchange for the freezing of the plan, participants will be eligible for a company match in a defined contribution plan. The freeze in the plan resulted in a curtailment loss of $0.9 million during Fiscal 2009.
In anticipation of Japanese defined benefit plan law changes, the Company terminated the defined benefit plan offered to its employees in Japan on December 31, 2006, which resulted in a net settlement gain of $1.9 million in Fiscal 2007. This plan was replaced with a defined contribution plan as of January 1, 2007. The Company incurred the cost of initial contributions to the defined contribution plan as well as other costs of converting participants to the new defined contribution plan resulting in a net pretax gain for the net settlement and transition to the defined contribution plan of approximately $0.6 million during Fiscal 2007.
Effective July 31, 2007, the Company adopted SFAS No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R). This statement requires recognition of the overfunded or underfunded status of defined benefit postretirement plans as an asset or liability in the statement of financial position. This statement also requires that changes in the funded status are recognized in accumulated other comprehensive income in the year in which the adoption occurs and in other comprehensive income in the following years. SFAS 158’s provisions regarding the change in the measurement date of postretirement benefits plans required the Company to change its measurement date from April 30 to July 31 during Fiscal 2009. The adoption of the measurement date provisions resulted in an after-tax decrease to Retained earnings of $0.9 million, a decrease to Other assets of $0.5 million increase to Other long-term liabilities of $0.8 million and an increase to Deferred income taxes of $0.5 million.
| 2006 | 2005 | 2004 | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars) | |||||||||||||||
| Net periodic cost: | |||||||||||||||
| Service cost | $ | 14,851 | $ | 13,369 | $ | 12,302 | |||||||||
| Interest cost | 14,577 | 14,404 | 12,389 | ||||||||||||
| Expected return on assets | (20,060 | ) | (18,235 | ) | (16,365 | ) | |||||||||
| Transition amount amortization | 551 | 1,223 | 980 | ||||||||||||
| Prior service cost amortization | 208 | 214 | 152 | ||||||||||||
| Actuarial (gain) loss amortization | 1,898 | 455 | 1,605 | ||||||||||||
| Curtailment loss | 1,296 | — | 1 | ||||||||||||
| Settlement (gain)/loss | (356 | ) | 102 | — | |||||||||||
| Special termination benefit cost | — | 307 | — | ||||||||||||
| Net periodic benefit cost | $ | 12,965 | $ | 11,839 | $ | 11,064 | |||||||||
The obligations and funded status of the Company’s pension plans as of 20062009 and 2005,2008, is as follows:
| 2006 | 2005 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars) | |||||||||||
| Change in benefit obligation: | |||||||||||
| Benefit obligation, beginning of year | $ | 285,152 | $ | 233,867 | |||||||
| Addition of non-U.S. plans | — | 14,184 | |||||||||
| Service cost | 14,851 | 13,369 | |||||||||
| Interest cost | 14,577 | 14,404 | |||||||||
| Participant contributions | 1,220 | 1,068 | |||||||||
| Plan amendments | 1,508 | 488 | |||||||||
| Actuarial (gain) loss | (5,720 | ) | 22,594 | ||||||||
| Currency exchange rates | 3,787 | (900 | ) | ||||||||
| Settlement | (956 | ) | (1,459 | ) | |||||||
| Benefits paid | (15,418 | ) | (12,463 | ) | |||||||
| Benefit obligation, end of year | $ | 299,001 | $ | 285,152 | |||||||
|
|
|
|
|
|
|
|
|
| 2009 |
| 2008 |
| ||
|
| (thousands of dollars) |
| ||||
Change in benefit obligation: |
|
|
|
|
|
|
|
Benefit obligation, beginning of year |
| $ | 330,258 |
| $ | 312,514 |
|
Service cost |
|
| 18,730 |
|
| 15,996 |
|
Interest cost |
|
| 22,868 |
|
| 17,702 |
|
Participant contributions |
|
| 1,476 |
|
| 1,381 |
|
Plan amendments |
|
| — |
|
| 1,221 |
|
Actuarial gain |
|
| (1,077 | ) |
| (2,410 | ) |
Currency exchange rates |
|
| (13,338 | ) |
| 3,610 |
|
Settlement |
|
| — |
|
| (272 | ) |
Benefits paid |
|
| (20,763 | ) |
| (19,484 | ) |
Benefit obligation, end of year |
| $ | 338,154 |
| $ | 330,258 |
|
Change in plan assets: |
|
|
|
|
|
|
|
Fair value of plan assets, beginning of year |
| $ | 378,695 |
| $ | 377,461 |
|
Actual return on plan assets |
|
| (62,057 | ) |
| 5,389 |
|
Company contributions |
|
| 13,356 |
|
| 11,316 |
|
Participant contributions |
|
| 1,476 |
|
| 1,381 |
|
Currency exchange rates |
|
| (13,228 | ) |
| 2,904 |
|
Settlement |
|
| — |
|
| (272 | ) |
Benefits paid |
|
| (20,763 | ) |
| (19,484 | ) |
Fair value of plan assets, end of year |
| $ | 297,479 |
| $ | 378,695 |
|
Funded status: |
|
|
|
|
|
|
|
Over (under) funded status at July 31, 2009 and April 30, 2008 |
| $ | (40,675 | ) | $ | 48,437 |
|
Fourth quarter contributions |
|
| — |
|
| 808 |
|
Over (under) funded status after fourth quarter contributions |
| $ | (40,675 | ) | $ | 49,245 |
|
35
Table The net under funded status of Contents$40.7 million at July 31, 2009, is recognized in the accompanying Consolidated Balance Sheet as $4.3 million within Other assets for the Company’s over funded plans and $45.0 million within Other long-term liabilities for the Company’s under funded plans. Included in Accumulated other comprehensive income at July 31, 2009, are the following amounts that have not yet been recognized in net periodic pension expense: unrecognized actuarial losses of $123.0 million, unrecognized prior service cost of $4.2 million and unrecognized transition obligations of $3.4 million. The actuarial loss, prior service cost and unrecognized transition obligation are included in Accumulated other comprehensive income, net of tax. The amounts expected to be recognized in net periodic pension expense during Fiscal 2010 are $1.4 million, $0.3 million and $0.2 million, respectively. The accumulated benefit obligation for all defined benefit pension plans was $296.7 million and $282.7 million at July 31, 2009, and April 30, 2008, respectively.
| 2006 | 2005 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars) | |||||||||||
| Change in plan assets: | |||||||||||
| Fair value of plan assets, beginning of year | $ | 254,670 | $ | 220,200 | |||||||
| Addition of non-U.S. plans | — | 8,613 | |||||||||
| Actual return on plan assets | 50,941 | 12,870 | |||||||||
| Company contributions | 23,973 | 26,824 | |||||||||
| Participant contributions | 1,220 | 1,068 | |||||||||
| Currency exchange rates | 2,733 | (983 | ) | ||||||||
| Settlement | (368 | ) | (1,459 | ) | |||||||
| Benefits paid | (15,418 | ) | (12,463 | ) | |||||||
| Fair value of plan assets, end of year | $ | 317,751 | $ | 254,670 | |||||||
| Reconciliation of funded status: | |||||||||||
| Funded status | $ | 18,750 | $ | (30,482 | ) | ||||||
| Unrecognized actuarial loss | 18,715 | 57,143 | |||||||||
| Unrecognized prior service cost | 4,333 | 4,389 | |||||||||
| Unrecognized net transition obligation | 4,796 | 5,200 | |||||||||
| Fourth quarter contributions | 17,311 | 288 | |||||||||
| Net amount recognized in consolidated balance sheet | $ | 63,905 | $ | 36,538 | |||||||
| Amounts recognized in consolidated balance sheet consist of: | |||||||||||
| Prepaid benefit cost | $ | 81,939 | $ | 55,554 | |||||||
| Accrued benefit liability | (18,034 | ) | (19,016 | ) | |||||||
| Additional minimum liability | (2,815 | ) | (23,798 | ) | |||||||
| Intangible asset | 812 | 8,402 | |||||||||
| Accumulated other comprehensive income | 2,003 | 15,396 | |||||||||
| Net amount recognized in consolidated balance sheet | $ | 63,905 | $ | 36,538 | |||||||
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets were $45.5$246.7 million, $35.7$234.3 million and $14.6$213.3 million, respectively, as of July 31, 2009, and $16.4 million, $13.8 million and $0.0 million, respectively, as of April 30, 2006 and $86.8 million, $79.5 million and $54.1 million, respectively, as of April 30, 2005.2008.
For the years ended July 31, 20062009 and 2005,2008, the U.S. pension plans represented approximately 8272 percent and 8475 percent, respectively, of the Company’s total plan assets, and approximately 7172 percent and 7470 percent, respectively, of the Company’s total projected benefit obligation. Considering the significance
The weighted-average discount rates and rates of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation are as follows:
| Weighted average actuarial assumptions | 2006 | 2005 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| All U.S. plans: | ||||||||||
| Discount rate | 6.25 | % | 5.50 | % | ||||||
| Rate of compensation increase | 5.00 | % | 5.00 | % | ||||||
| Non-U.S. plans: | ||||||||||
| Discount rate | 4.64 | % | 4.43 | % | ||||||
| Rate of compensation increase | 3.62 | % | 3.29 | % | ||||||
36
|
|
|
|
|
|
|
|
Weighted average actuarial assumptions |
| 2009 |
| 2008 |
| ||
All U.S. plans: |
|
|
|
|
|
|
|
Discount rate |
|
| 6.00 | % |
| 6.00 | % |
Rate of compensation increase |
|
| 5.00 | % |
| 5.00 | % |
Non-U.S. plans: |
|
|
|
|
|
|
|
Discount rate |
|
| 5.90 | % |
| 6.30 | % |
Rate of compensation increase |
|
| 3.87 | % |
| 4.48 | % |
The weighted-average discount rates, expected returns on plan assets and rates of increase in future compensation levels used to determine the net periodic benefit cost are as follows:
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||
| Weighted average actuarial assumptions | Weighted average actuarial assumptions | 2006 | 2005 | 2004 |
| 2009 |
| 2008 |
| 2007 |
| |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| All U.S. plans: |
|
|
|
|
|
|
| |||||||||||||||||
| Discount rate | 5.50 | % | 6.25 | % | 6.25 | % |
| 6.00 | % |
| 6.00 | % |
| 6.25 | % | |||||||||
| Expected return on plan assets | 8.50 | % | 8.50 | % | 8.50 | % |
| 8.50 | % |
| 8.50 | % |
| 8.50 | % | |||||||||
| Rate of compensation increase | 5.00 | % | 5.00 | % | 5.00 | % |
| 5.00 | % |
| 5.00 | % |
| 5.00 | % | |||||||||
| Non-U.S. plans: |
|
|
|
|
|
|
| |||||||||||||||||
| Discount rate | 4.43 | % | 4.73 | % | 4.15 | % |
| 6.30 | % |
| 5.23 | % |
| 4.64 | % | |||||||||
| Expected return on plan assets | 6.08 | % | 6.71 | % | 6.88 | % |
| 7.14 | % |
| 7.49 | % |
| 6.60 | % | |||||||||
| Rate of compensation increase | 3.29 | % | 3.43 | % | 3.14 | % |
| 4.48 | % |
| 4.01 | % |
| 3.62 | % | |||||||||
Expected Long-Term Rate of ReturnTo develop the expected long-term rate of return on assets assumption, the Company considered the historical returns and the future expectations for returns for each asset class, as well as the target asset allocation of the pension portfolio. This resulted in the selection of the 8.50 percent long-term rate of return on assets assumption for the Company’s U.S. pension plans. The expected long-term rate of return on assets assumption for the plans outside the U.S. reflects the investment allocation and expected total portfolio returns specific to each plan and country. The expected long-term rate of return on assets shown in the pension benefit disclosure for non-U.S. plans is an asset-based weighted average of all non-U.S. plans.
Discount RateThe 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 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 looking at 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 discount rate for non-U.S. plans disclosed in the assumptions used to determine net periodic benefit cost and to determine benefit obligations is based upon a weighted average, using year-end projected benefit obligations, of all non-U.S. plans.
Plan AssetsThe Company’s pension plan weighted-average asset allocations by asset category are as follows:
|
|
|
|
|
|
|
|
|
| Plan Assets at |
| ||||
Asset Category |
| 2009 |
| 2008 |
| ||
All U.S. plans: |
|
|
|
|
|
|
|
Equity securities |
|
| 41 | % |
| 44 | % |
Alternative investments |
|
| 42 | % |
| 36 | % |
Real assets |
|
| 12 | % |
| 12 | % |
Fixed income |
|
| 5 | % |
| 8 | % |
Total U.S. plans |
|
| 100 | % |
| 100 | % |
Non U.S. plans: |
|
|
|
|
|
|
|
Equity securities |
|
| 44 | % |
| 64 | % |
Debt securities |
|
| 56 | % |
| 36 | % |
Total Non U.S. plans |
|
| 100 | % |
| 100 | % |
| Plan Assets at | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Asset Category | 2006 | 2005 | |||||||||
| All U.S. plans: | |||||||||||
| Equity securities | 62 | % | 63 | % | |||||||
| Alternative investments | 31 | % | 29 | % | |||||||
| Bonds | 7 | % | 7 | % | |||||||
| Cash and other | — | 1 | % | ||||||||
| Total U.S. plans | 100 | % | 100 | % | |||||||
| Non U.S. plans: | |||||||||||
| Equity securities | 64 | % | 64 | % | |||||||
| Debt securities | 33 | % | 34 | % | |||||||
| Cash and other | 3 | % | 2 | % | |||||||
| Total Non U.S. plans | 100 | % | 100 | % | |||||||
Investment Policies and Strategies.For the Company’s U.S. plans, the Company uses a total return investment approach to achieve a long-term return on plan assets, with a prudent level of risk for the purpose of meeting its retirement income commitments to employees. The plan’s investments are diversified to assist in managing risk. The Company’s asset allocation guidelines target an allocation of 6045 percent equity securities, 30 percent alternative investments (fund(funds of hedge funds) and, 10 percent bonds.real assets (investments into funds containing commodities and real estate), 10 percent fixed income and 5 percent private equity. Within equity securities, the Company targetswill target an allocation of 2515 percent international, 15 percent equity long / short, 10 percent small cap, 15 percent
37
large cap, 15 percent international and 5 percent private equity.large cap. These target allocation guidelines are determined in consultation with the Company’s investment consultant, and through the use of modeling the risk/return trade-offs among asset classes utilizing assumptions about expected annual return, expected volatility/standard deviation of returns and expected correlations with other asset classes. Investment policy and performance is measured and monitored on an ongoing basis by the Company’s investment committee through its use of an investment consultant and through quarterly investment portfolio reviews.
For the Company’s non-U.S. plans, the general investment objectives are to maintain a suitably diversified portfolio of secure assets of appropriate liquidity which will generate income and capital growth to meet, together with any new contributions from members and the Company, the cost of current and future benefits.
Estimated Contributions and Future Payments ForAs a result of its U.S. pension plans,past funding practices, the Company does not have a minimum required contribution under the Pension Benefit Guarantee Corporation requirements for fiscal 2007. However, the Company may electits U.S. pension plans for Fiscal 2010. As a result, there is no current intention to contribute up to its maximum deductiblemake a U.S. pension contribution of $28.6 million in fiscal 2007.Fiscal 2010. For its non-U.S. pension plans, the Company estimates that it will contribute approximately $8.1$5 million in fiscal 2007.Fiscal 2010, based upon the local government prescribed funding requirements.
Estimated future benefit payments for the Company’s U.S. and non-U.S. plans are as follows (thousands of dollars):
| Fiscal year 2007 | $ | 16,827 | ||||
| Fiscal year 2008 | $ | 16,532 | ||||
| Fiscal year 2009 | $ | 17,405 | ||||
| Fiscal year 2010 | $ | 19,841 | ||||
| Fiscal year 2011 | $ | 17,910 | ||||
| Fiscal years 2012-2016 | $ | 110,021 |
|
|
|
|
|
Fiscal year 2010 |
| $ | 18,528 |
|
Fiscal year 2011 |
| $ | 18,624 |
|
Fiscal year 2012 |
| $ | 22,469 |
|
Fiscal year 2013 |
| $ | 20,829 |
|
Fiscal year 2014 |
| $ | 23,313 |
|
Fiscal years 2015-2019 |
| $ | 125,346 |
|
Postemployment and Postretirement Benefit PlansThe Company provides certain postemployment and postretirement health care benefits for certain U.S. employees for a limited time after termination of employment. The Company has recorded a liability for its postretirement benefit plan in the amount of $3.6$1.7 million and $3.9$3.1 million as of July 31, 20062009 and July 31, 2005,2008, respectively. The annual cost resulting from these benefits is not material. Union negotiations have resulted in one U.S. plant freezing the plan. This change resulted in a curtailment gain of $1.4 million. For measurement purposes, a 10an 8 percent annual rate of increase in the per capita cost of covered health care benefits was assumed for 2006. We haveFiscal 2009. The Company has assumed that the long-term rate of increase will decrease gradually to an ultimate annual rate of 5 percent. A one-percentage point increase in the health care cost trend rate would increase the fiscal 2006Fiscal 2009 and 2005 costs2008 liability by $0.4 million.$0.1 million and $0.5 million, respectively.
401(k) Retirement Savings and Employee Stock Ownership PlanThe Company provides a contributory employee savings plan to U.S. employees that permits participants to make contributions by salary reduction pursuant to section 401(k) of the Internal Revenue Code. EmployeeThrough April 13, 2009, employee contributions of up to 25 percent of compensation are matched at a rate equaling 100 percent of the first 3 percent contributed and 50 percent of the next 2 percent contributed. The Company’s contributions under this plan are based on the level of employee contributions as well as a discretionary contribution based on performance of the Company. The Plan was amended effective April 13, 2009, to reduce Company fixed matching contributions to the Plan for salaried employees. After April 13, 2009, fixed matching contributions for salaried employees were calculated at 50 percent of up to 3 percent of compensation deferred by the participant and deposited into the Plan, and 25 percent of the next 2 percent of compensation deferred by
the participant and deposited to the Plan. In addition, the Company fixed matching contribution was eliminated for Company Executive Officers and Vice Presidents. Total contribution expense for these plans was $6.4$5.1 million, $5.8$8.3 million and $5.9$8.1 million for the years ended July 31, 2006, 20052009, 2008 and 2004,2007, respectively.
Employee Stock Ownership Plan The Company maintains This plan also includes shares from an Employee Stock Ownership Plan (“ESOP”) for eligible employees.. As of July 31, 2006,2009, all shares of the planESOP have been allocated to participants. The ESOP’s only assets are Company common stock. Total ESOP shares are considered to be shares outstanding for earnings per share calculations.
Deferred Compensation and Other Benefit PlansThe Company provides various deferred compensation and other benefit plans to certain executives. The deferred compensation plan allows these employees to defer the receipt of all or a portion of their salary, bonus and other stock related compensation and up to 75 percent of their salary to future periods. Other benefit plans are provided to supplement the benefits for a select group of highly compensated individuals which are reduced because of compensation limitations set by
38
the Internal Revenue Code. The Company has recorded a liability in the amount of $10.7$10.0 million and $10.6 million as of the year ended July 31, 20062009 and July 31, 2005,2008, respectively, related primarily to its deferred compensation plans.
NOTE G
Shareholders’ Equity
Stock RightsOn January 27, 2006, the Board of Directors of the Company approved the extension of the benefits afforded by the Company’s existing rights plan by adopting a new shareholder rights plan. Pursuant to the Rights Agreement, dated as of January 27, 2006, by and between the Company and Wells Fargo Bank, N.A., as Rights Agent, one right was issued on March 3, 2006, for each outstanding share of common stock of the Company upon the expiration of the Company’s existing rights. Each of the new rights entitles the registered holder to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock, without par value, at a price of $143.00 per one one-thousandth of a share. The rights, however, will not become exercisable unless and until, among other things, any person acquires 15 percent or more of the outstanding common stock of the Company. If a person acquires 15 percent or more of the outstanding common stock of the Company (subject to certain conditions and exceptions more fully described in the Rights Agreement), each right will entitle the holder (other than the person who acquired 15 percent or more of the outstanding common stock) to purchase common stock of the Company having a market value equal to twice the exercise price of a right. The rights are redeemable under certain circumstances at $.001 per right and will expire, unless earlier redeemed, on March 2, 2016.
Stock Compensation PlansThe Stock Compensation Plans in the Consolidated Statements of Changes in Shareholders’ Equity consist of the balance of amounts payable to eligible participants for stock compensation that was deferred to a Rabbi Trust pursuant to the provisions of the 2001 Master Stock Incentive Plan, as well as performance awards payable in common stock discussed further in Note H.
Treasury StockThe Company believes that the share repurchase program is a way of providing return to its shareholders. The Board of Directors authorized the repurchase, at the Company’s discretion, of 8.0 million shares of common stock under the stock repurchase plan dated March 31, 2006. As of July 31, 2006,2009, the Company had remaining authorization to repurchase 6.20.9 million shares under this plan. Following is a summary of treasury stock share activity for fiscal 2006Fiscal 2009 and 2005:2008:
|
|
|
|
|
|
|
|
|
| 2009 |
| 2008 |
| ||
Balance at beginning of year |
|
| 11,021,619 |
|
| 9,500,372 |
|
Stock repurchases |
|
| 802,000 |
|
| 2,245,790 |
|
Net issuance upon exercise of stock options |
|
| (355,491 | ) |
| (647,225 | ) |
Issuance under compensation plans |
|
| (99,612 | ) |
| (67,822 | ) |
Discretionary stock paid into 401(k) plan |
|
| (60,122 | ) |
| — |
|
Other activity |
|
| (12,985 | ) |
| (9,496 | ) |
Balance at end of year |
|
| 11,295,409 |
|
| 11,021,619 |
|
| 2006 | 2005 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Balance at beginning of year | 5,583,393 | 2,361,899 | ||||||||
| Stock repurchases | 3,783,000 | 3,763,700 | ||||||||
| Net issuance upon exercise of stock options | (399,612 | ) | (523,845 | ) | ||||||
| Issuance under compensation plans | (851,331 | ) | (6,549 | ) | ||||||
| Other activity | (12,529 | ) | (11,812 | ) | ||||||
| Balance at end of year | 8,102,921 | 5,583,393 | ||||||||
During fiscal 2005, the Company repurchased 3.0 million shares from BancTable of America Securities LLC under an overnight share repurchase program which was completed at a total cost of $91.9 million. The overnight share repurchase program permitted the Company to purchase the shares immediately, while Banc of America Securities purchased the shares in the market over six months.Contents
NOTE H
Stock Option Plans
Employee Incentive PlansIn November 2001, shareholders approved the 2001 Master Stock Incentive Plan (the “Plan”) that replaced the 1991 Plan that expired on December 31, 2001, and provided for similar awards. The Plan extends through December 2011 and allows for the granting of nonqualified stock options, incentive stock options, restricted stock, stock appreciation rights (“SAR”), dividend equivalents, dollar-denominated awards and other stock-based awards. Options under the Plan are granted to key employees at or above market price at the date of grant. Options are exercisable for up
39
to 10 years from the date of grant. The Plan also allows for the granting of performance awards to a limited number of key executives. As administered by the Human Resources Committee of the Company’s Board of Directors, these performance awards are payable in common stock and are based on a formula which measures performance of the Company over a three-year period. The Company recorded a net reversal of performance award expense in Fiscal 2009 of $3.1 million. The net benefit is due to the reversal of $3.6 million of Long-Term Compensation Plan expense recognized in prior periods. This reversal reflects an adjustment in the expected payouts for the three-year cycles ending July 31, 2009, and July 31, 2010, to zero based upon actual and forecasted results. Performance award expense under these plans totaled $5.2 million, $5.3$4.2 million and $2.9$2.7 million in 2006, 2005Fiscal 2008 and 2004,2007, respectively.
Stock Options Stock options issued during fiscal 2006from Fiscal 1999 to Fiscal 2009 become exercisable for non-executives in equal increments over three years and becomeyears. Stock options issued from Fiscal 1999 to Fiscal 2009 became exercisable for most executives immediately upon the date of grant. Certain other stock options issued to executives during fiscalFiscal 2004, 2006 and 2007 become exercisable in equal increments over three years. Stock options issued during fiscal 2005 become exercisable for non-executives in equal increments over three years and become exercisable for executives upon the date of grant. Stock options issued during fiscal 2004 become exercisable for non-executives in equal increments over three years and become exercisable for most executives immediately upon the date of grant. Certain stock options issued to executives during fiscal 2004 become exercisable in equal increments over three years. Stock options issued from fiscal 1999 through fiscal 2003 became exercisable for non-executives in equal increments over three years and became exercisable for executives immediately upon the date of grant. Stock options issued during fiscal 1997 and 1998 became exercisable in equal increments over three years for both executives and non-executives. Stock options issued prior to fiscal l997 for non-executives and during fiscal 1996 for executives became exercisable in equal increments over four years. Prior to fiscal 1996, stock options became exercisable immediately for executives.
Effective June 27, 2005, the Board of Directors of the Company authorized the acceleration of vesting of certain unvested and “out-of-the-money” stock options outstanding under the Plan. The accelerated options were granted in fiscal 2004 and fiscal 2005 with a three-year vesting period and had exercise prices per share ranging from $30.38 to $30.69. Options for the purchase of 511,242 shares of the common stock of the Company became exercisable immediately as a result of this action. No options held by any director or named executive officer were included in the acceleration action. As a result, the amount of pre-tax compensation expense amortized during fiscal 2006 was reduced by approximately $2.1 million from what it would have otherwise been. For fiscal 2006,Fiscal 2009, the Company recorded pretax compensation expense associated with stock options of $2.8$4.1 million and recorded $1.0$1.5 million of related tax benefit.
On August 1, 2005, the Company adopted SFAS No. 123R,Share Based Payment – Revised 2004, using the modified prospective transition method. Under this method, stock-basedStock-based employee compensation cost is recognized using the fair-value based method for all new awards granted after August 1, 2005. Compensation costs for unvested stock options and awards that were outstanding at August 1, 2005, are recognized over the requisite service period based on the grant-date fair value of those options and awards as previously calculated under the pro-forma disclosures under SFAS 123.disclosures. The Company determined the fair value of these awards using the Black-Scholes option pricing model with the following weighted average assumptions:
| 2006 | 2005 | 2004 |
|
|
|
|
|
|
|
|
|
| ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2009 |
| 2008 |
| 2007 |
| ||||||||||||||||||
| Risk-free interest rate | 4.3-5.0% | 3.74% | 3.55% |
| 1.4 – 4.0% |
| 2.1 - 4.2% |
| 4.4 - 4.9% |
| ||||||||||||||
| Expected volatility | 20.2-27.2% | 24.4% | 31.5% |
| 21.6 – 25.5% |
| 15.2 – 22.4% |
| 18.3 - 23.6% |
| ||||||||||||||
| Expected dividend yield | 1.0% | 0.8% | 1.0% |
| 1.0% |
| 1.0% |
| 1.0% |
| ||||||||||||||
| Expected life |
|
|
|
|
|
|
| |||||||||||||||||
| Director original grants without reloads | 7 years | — | — |
| 8 years |
| 8 years |
| 7 years |
| ||||||||||||||
| Director original grants with reloads | — | 3 years | 2 years | |||||||||||||||||||||
| Non-officer original grants | 6 years | 6 years | 6 years |
| 7 years |
| 7 years |
| 6 years |
| ||||||||||||||
| Officer original grants with reloads | 3 years | 3 years | 2 years |
| 4 years |
| 3 years |
| 3 years |
| ||||||||||||||
| Reload grants | — | 7 years | 7 years |
| <5 years |
| <3 years |
| <1 year |
| ||||||||||||||
| Officer original grants without reloads | 6 years | 6 years | 6 years |
| 7 years |
| 7 years |
| 6 years |
| ||||||||||||||
| Officer original grants with reloads and vesting | 3 years | — | 3 years |
| — |
| — |
| 5 years |
| ||||||||||||||
Reload grants are grants made to officers or directors who exercised a reloadable option during the fiscal year and made payment of the purchase price using shares of previously owned Company stock. The reload
40
grant is for the number of shares equal to the shares used in payment of the purchase price and/or withheld for minimum tax withholding. There were no reload grants made in fiscal 2006.
Black-Scholes is a widely accepted stock option pricing model; however, the ultimate value of stock options granted will be determined by the actual lives of options granted and the actual future price levels of the Company’s common stock. The weighted average fair value for options granted during fiscal 2006, 2005Fiscal 2009, 2008 and 20042007 is $9.36, $8.08$8.56, $10.60 and $9.46$7.89 per share, respectively, using the Black-Scholes pricing model.
The following table summarizes stock option activity:
| Options Outstanding | Weighted Average Exercise Price |
|
|
|
|
|
|
| |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Options |
| Weighted |
| |||||||||||||
| Outstanding at July 31, 2005 | 6,488,334 | $ | 19.74 | ||||||||||||||
Outstanding at July 31, 2008 |
| 5,181,778 |
| $ | 25.62 |
| |||||||||||
| Granted | 398,600 | 32.88 |
| 366,588 |
| 34.23 |
| ||||||||||
| Exercised | (591,299 | ) | 14.07 |
| (505,363 | ) |
| 17.64 |
| ||||||||
| Canceled | (14,331 | ) | 23.81 |
|
| (44,878 | ) |
| 39.04 |
| |||||||
| Outstanding at July 31, 2006 | 6,281,304 | 21.09 | |||||||||||||||
Outstanding at July 31, 2009 |
|
| 4,998,125 |
|
| 26.94 |
| ||||||||||
The total intrinsic value of options exercised during fiscal 2006, 2005Fiscal 2009, 2008 and 20042007 was $11.2$9.1 million, $38.7$26.2 million, and $15.5$20.6 million, respectively.
Shares reserved at July 31, 20062009 for outstanding options and future grants were 10,161,598.11,521,192. Shares reserved consist of shares available for grant plus all outstanding options. An amount is added to shares reserved each year based on shares outstanding adjusted for certain items as detailed in the Plan. The aggregate number of shares of common stock that may be issued under all awards under the Plan in any calendar year may not exceed 1.5 percent of the sum of the Company’s outstanding shares of common stock, the outstanding share equivalents, as determined by the Company in the calculation of earnings per share on a fully diluted basis, and shares held in treasury of the Company as reported for the Company’s most recent fiscal year that ends during such calendar year.
The following table summarizes information concerning outstanding and exercisable options as of July 31, 2006:2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||||
| Range of Exercise Prices | Range of Exercise Prices | Number Outstanding | Weighted Average Remaining Contractual Life (Years) | Weighted Average Exercise Price | Number Exercisable | Weighted Average Exercise Price |
| Number |
| Weighted |
| Weighted |
| Number |
| Weighted |
| |||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| $5 to $15 | 1,989,592 | 2.92 | $ | 11.22 | 1,989,592 | $ | 11.22 |
| 603,792 |
| 1.03 |
| $ | 12.41 |
| 603,792 |
| $ | 12.41 |
| ||||||||||||||||||
| $15 to $25 | 1,742,460 | 5.67 | 18.16 | 1,742,460 | 18.16 |
| 1,281,872 |
| 2.84 |
| 18.02 |
| 1,281,872 |
| 18.02 |
| ||||||||||||||||||||||
| $25 and above | 2,549,252 | 6.89 | 30.80 | 2,333,089 | 30.64 | |||||||||||||||||||||||||||||||||
$25 and $35 |
| 2,463,644 |
| 5.52 |
| 31.57 |
| 2,338,294 |
| 31.48 |
| |||||||||||||||||||||||||||
$35 and above |
|
| 648,817 |
| 7.94 |
| 40.47 |
|
| 481,390 |
| 40.61 |
| |||||||||||||||||||||||||
|
| 4,998,125 |
|
| 4.61 |
|
| 26.94 |
|
| 4,705,348 |
|
| 26.30 |
| |||||||||||||||||||||||
| 6,281,304 | 5.30 | 21.09 | 6,065,141 | 20.68 | ||||||||||||||||||||||||||||||||||
At July 31, 2006,2009, the aggregate intrinsic value of shares outstanding and exercisable was $72.2$57.5 million and $72.2$56.9 million, respectively.
The following table summarizes the status of options which contain vesting provisions:
| Options | Weighted Average Grant Date Fair Value | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Non-vested at July 31, 2005 | 201,236 | $ | 5.95 | |||||||
| Granted | 202,000 | 9.37 | ||||||||
| Vested | (182,574 | ) | 5.77 | |||||||
| Canceled | (4,499 | ) | 7.81 | |||||||
| Non-vested at July 31, 2006 | 216,163 | 9.26 | ||||||||
41
|
|
|
|
|
|
|
|
|
| Options |
| Weighted |
| ||
Non-vested at July 31, 2008 |
|
| 439,684 |
| $ | 10.43 |
|
Granted |
|
| 79,575 |
|
| 8.83 |
|
Vested |
|
| (207,390 | ) |
| 10.16 |
|
Canceled |
|
| (19,092 | ) |
| 10.14 |
|
Non-vested at July 31, 2009 |
|
| 292,777 |
|
| 10.21 |
|
The total fair value of shares vested during fiscal 2006, 2005Fiscal 2009, 2008 and 20042007 was $5.9$7.9 million, $33.2$6.3 million and $14.2$2.8 million, respectively.
As of July 31, 2006,2009 there was $1.4$1.6 million of total unrecognized compensation cost related to non-vested stock options granted under the Plan. This unvested cost is expected to be recognized during fiscal 2007, fiscal 2008Fiscal 2010, Fiscal 2011 and fiscal 2009.Fiscal 2012.
NOTE I
Income Taxes
The components of earnings before income taxes are as follows:
| 2006 | 2005 | 2004 |
|
|
|
|
|
|
|
|
|
| |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2009 |
| 2008 |
| 2007 |
| |||||||||||||||||||
| (thousands of dollars) |
| (thousands of dollars) |
| ||||||||||||||||||||||
| Earnings before income taxes: |
|
|
|
|
|
|
| ||||||||||||||||||
| United States | $ | 75,658 | $ | 59,973 | $ | 55,861 |
| $ | 69,863 |
| $ | 73,445 |
| $ | 88,157 |
| |||||||||
| Foreign | 113,509 | 94,760 | 85,975 |
|
| 91,562 |
|
| 162,718 |
|
| 116,704 |
| ||||||||||||
| Total | $ | 189,167 | $ | 154,733 | $ | 141,836 |
| $ | 161,425 |
| $ | 236,163 |
| $ | 204,861 |
| |||||||||
The components of the provision for income taxes are as follows:
| 2006 | 2005 | 2004 |
|
|
|
|
|
|
|
|
|
| |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2009 |
| 2008 |
| 2007 |
| |||||||||||||||||||
| (thousands of dollars) |
| (thousands of dollars) |
| ||||||||||||||||||||||
| Income taxes: |
|
|
|
|
|
|
| ||||||||||||||||||
| Current: |
|
|
|
|
|
|
| ||||||||||||||||||
| Federal | $ | 21,583 | $ | 18,451 | $ | 13,834 |
| $ | 18,624 |
| $ | 27,180 |
| $ | 27,430 |
| |||||||||
| State | 448 | 508 | 1,501 |
| 2,444 |
| 619 |
| 2,975 |
| |||||||||||||||
| Foreign | 27,961 | 22,263 | 21,782 |
|
| 13,176 |
|
| 37,616 |
|
| 28,140 |
| ||||||||||||
|
| 34,244 |
|
| 65,415 |
|
| 58,545 |
| ||||||||||||||||
| 49,992 | 41,222 | 37,117 | |||||||||||||||||||||||
| Deferred: |
|
|
|
|
|
|
| ||||||||||||||||||
| Federal | 4,860 | 2,026 | (55 | ) |
| (3,888 | ) |
| (4,712 | ) |
| (4,674 | ) | ||||||||||||
| State | 278 | 310 | (3 | ) |
| 90 |
| 2 |
| (332 | ) | ||||||||||||||
| Foreign | 1,730 | 621 | (1,540 | ) |
|
| (928 | ) |
| 3,505 |
|
| 605 |
| |||||||||||
|
| (4,726 | ) |
| (1,205 | ) |
| (4,401 | ) | ||||||||||||||||
| 6,868 | 2,957 | (1,598 | ) | ||||||||||||||||||||||
| Total | $ | 56,860 | $ | 44,179 | $ | 35,519 |
| $ | 29,518 |
| $ | 64,210 |
| $ | 54,144 |
| |||||||||
The following table reconciles the U.S. statutory income tax rate with the effective income tax rate:
| 2006 | 2005 | 2004 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Statutory U.S. federal rate | 35.0 | % | 35.0 | % | 35.0 | % | ||||||||
| State income taxes | 0.2 | 0.2 | 0.7 | |||||||||||
| Foreign taxes at lower rates | (5.1 | ) | (6.5 | ) | (7.1 | ) | ||||||||
| Export and research credits | (1.1 | ) | (1.5 | ) | (2.9 | ) | ||||||||
| Tax on repatriation of earnings | 1.9 | 2.6 | — | |||||||||||
| Other | (0.8 | ) | (1.2 | ) | (0.7 | ) | ||||||||
| 30.1 | % | 28.6 | % | 25.0 | % | |||||||||
42
|
|
|
|
|
|
|
|
|
|
|
|
| 2009 |
| 2008 |
| 2007 |
| |||
Statutory U.S. federal rate |
|
| 35.0 | % |
| 35.0 | % |
| 35.0 | % |
State income taxes |
|
| 1.3 |
|
| 0.3 |
|
| 0.8 |
|
Foreign taxes at lower rates |
|
| (7.5 | ) |
| (7.6 | ) |
| (5.9 | ) |
Export, manufacturing and research credits |
|
| (0.5 | ) |
| (0.6 | ) |
| (1.5 | ) |
Tax on repatriation of earnings |
|
| 0.7 |
|
| (0.6 | ) |
| (1.1 | ) |
Change in unrecognized tax benefits |
|
| (10.6 | ) |
| 0.5 |
|
| 0.1 |
|
Other |
|
| (0.1 | ) |
| 0.2 |
|
| (1.0 | ) |
|
|
| 18.3 | % |
| 27.2 | % |
| 26.4 | % |
The tax effects of temporary differences that give rise to deferred tax assets and liabilities are as follows:
|
|
|
|
|
|
|
|
|
| 2009 |
| 2008 |
| ||
|
| (thousands of dollars) |
| ||||
Deferred tax assets: |
|
|
|
|
|
|
|
Accrued expenses |
| $ | 8,438 |
| $ | 11,146 |
|
Compensation and retirement plans |
|
| 30,916 |
|
| 812 |
|
Tax credit and NOL carryforwards |
|
| 1,439 |
|
| 6,625 |
|
Inventory reserves |
|
| 10,183 |
|
| 8,588 |
|
Other |
|
| 2,232 |
|
| 4,370 |
|
Deferred tax assets |
|
| 53,208 |
|
| 31,541 |
|
Valuation allowance |
|
| (1,053 | ) |
| (2,472 | ) |
Net deferred tax assets |
|
| 52,155 |
|
| 29,069 |
|
Deferred tax liabilities: |
|
|
|
|
|
|
|
Depreciation and amortization |
|
| (31,593 | ) |
| (28,636 | ) |
Other |
|
| (2,923 | ) |
| (2,584 | ) |
Deferred tax liabilities |
|
| (34,516 | ) |
| (31,220 | ) |
Net deferred tax asset (liability) |
| $ | 17,639 |
| $ | (2,151 | ) |
| 2006 | 2005 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars) | |||||||||||
| Deferred tax assets: | |||||||||||
| Accrued expenses | $ | 10,465 | $ | 14,742 | |||||||
| Tax credit and NOL carryforwards | 2,554 | 5,361 | |||||||||
| LIFO inventory reserve | 628 | 689 | |||||||||
| Investment in joint venture | 82 | 117 | |||||||||
| Other | 2,283 | 3,243 | |||||||||
| Gross deferred tax assets | 16,012 | 24,152 | |||||||||
| Valuation allowance | (1,360 | ) | (3,722 | ) | |||||||
| Net deferred tax assets | 14,652 | 20,430 | |||||||||
| Deferred tax liabilities: | |||||||||||
| Depreciation and amortization | (25,810 | ) | (27,974 | ) | |||||||
| Compensation and retirement plans | (5,826 | ) | 62 | ||||||||
| Repatriation of foreign earnings | — | (4,000 | ) | ||||||||
| Other | (6,499 | ) | (4,469 | ) | |||||||
| Gross deferred tax liabilities | (38,135 | ) | (36,381 | ) | |||||||
| Net deferred tax liability | $ | (23,483 | ) | $ | (15,951 | ) | |||||
The effective tax rate for Fiscal 2009 was 18.3 percent compared 27.2 percent in Fiscal 2008. The decrease in effective rate is primarily due to the settlements of long-standing court cases and examinations in various jurisdictions for tax years 2003 through 2006, the reassessment of the corresponding unrecognized tax benefits for the subsequent open years and a favorable resolution of a foreign tax matter. Partially offsetting these effects, the Company’s Fiscal 2009 tax rate was unfavorably impacted by an increased expense from the repatriation of foreign earnings. Absent these items, the underlying tax rate for the Fiscal 2009 has decreased from Fiscal 2008 by 1.2 points to 30.4 percent. The reinstatement of the U.S. Research and Experimentation credit, changes in current year unrecognized tax benefits, reduced statutory tax rates and the mix of earnings between foreign jurisdictions all contributed to the reduction in the underlying rate.
The Company repatriated $160.0 million of its accumulated foreign earnings in fiscal 2006 under the favorable provisions of the American Jobs Creation Act of 2004. Totalhas not provided for U.S. income taxes of $3.6 million and $4.0 million have been provided on these repatriations in 2006 and 2005, respectively. U.S. income taxes have not been provided on additional undistributed earnings of non-U.S. subsidiaries of approximately $279.0$483.4 million. The Company currently plans to permanently reinvest these undistributed earnings.earnings in its non-U.S. subsidiaries. If any portion were to be distributed, the related U.S. tax liability may be reduced by foreign income taxes paid on those earnings plus any available foreign tax credit carryovers. Determination of the unrecognized deferred tax liability related to these undistributed earnings is not practicable.
The increase in the tax rate from 2005 primarily reflects the mix of earnings by jurisdiction. While the underlying rate continues to reflect the significant contribution from the Company’s international operations, the majority of which now have statutory tax rates below those of the United States, a higher percentage of the Company’s 2006 earnings were made in the United States or other countries with higher than average tax rates. Additionally, the Company recognized a smaller benefit from U.S. research and development credits in 2006 than in 2005 due primarily to the credit expiring in the middle of the fiscal year. In the first quarter of 2006 the Company recognized $0.9 million of benefit from a prior year amended research and development tax credit, consistent with the amount recognized in 2005.
While non-US operations have been profitable overall, the Company has cumulative pre-tax loss carryforwards of $8.6$6.7 million, which are carried as net operating losses in certain international subsidiaries. Approximately $3.1 million of these losses are attributable to pre-acquisition carryforwards. If fully realized, the unexpired net operating losses may be carried forward to offset future local income tax payments, at current rates of tax, of $2.6$1.4 million. Approximately 737 percent of these net operating losses expire within the next three years, while the majority of the remaining net operating loss carryforwards have no statutory expiration under current local laws. However, due to the uncertainty of being able to realizeas it is more likely than not that certain of these losses will not be realized, a valuation allowance of $1.4$1.1 million has been recorded atexists as of July 31, 2006.2009.
The Company adopted the provisions of FIN 48,Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109,on August 1, 2007. The standard defines the threshold for recognizing the benefits of tax return positions in the financial statements as “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 percent likely to be realized. As a result of the implementation of FIN 48, the Company recognized a $0.3 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the August 1, 2007, balance of retained earnings. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits is as follows (thousands of dollars):
|
|
|
|
|
|
|
|
|
| 2009 |
| 2008 |
| ||
|
| (thousands of dollars) |
| ||||
Gross unrecognized tax benefits at beginning of fiscal year |
| $ | 32,002 |
| $ | 28,209 |
|
Additions for tax positions of the current year |
|
| 3,527 |
|
| 8,221 |
|
Additions for tax positions of prior years |
|
| 772 |
|
| 2,322 |
|
Reductions for tax positions of prior years |
|
| (8,258 | ) |
| (540 | ) |
Settlements |
|
| (10,092 | ) |
| — |
|
Reductions due to lapse of applicable statute of limitations |
|
| (1,023 | ) |
| (6,210 | ) |
Gross unrecognized tax benefits at end of fiscal year |
| $ | 16,928 |
| $ | 32,002 |
|
The Company recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. During the fiscal year ended July 31, 2009, the Company recognized interest expense, net of tax benefit, of approximately $0.7 million. At July 31, 2009 and 2008, accrued interest and penalties on a gross basis were $1.8 million and $5.7 million respectively.
43
The Company’s uncertain tax positions are affected by the tax years that are under audit or remain subject to examination by the relevant taxing authorities. The following tax years, in addition to the current year, remain subject to examination, at least for certain issues, by the major tax jurisdictions indicated:
Major Jurisdictions | Open Tax Years | |
Belgium | 2005 through 2008 | |
China | 2000 through 2008 | |
France | 2006 through 2008 | |
Germany | 2004 through 2008 | |
Italy | 2003 through 2008 | |
Mexico | 2004 through 2008 | |
United Kingdom | 2007 through 2008 | |
United States | 2007 through 2008 |
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 about 5 years, up to $1.4 million of the unrecognized tax benefits could potentially be realized in the next 12 month period, unless extended by audit.
In accordance with SFAS No. 123R,Share Based Payment – Revised 2004, SFAS No. 109,Accounting for Income Taxesand EITF Topic D-32,Intra-period Tax Allocation of the Effect of Pretax Income from Continuing Operations, the Company has elected to use the “with-and-without” intra-period tax allocation rules. Under these rules, the windfall tax benefit is calculated based on the incremental tax benefit received from deductions related to stock-based compensation.
NOTE J
Segment Reporting
Consistent with SFAS No. 131,Disclosures about Segments of an Enterprise and Related Information, the Company identified two reportable segments: Engine Products and Industrial Products. Segment selection was based on the internal organizational structure, management of operations and performance evaluation by management and the Company’s Board of Directors.
The Engine Products segment sells to OEMs in the construction, mining, agriculture, aerospace, defense and transportationtruck markets and to independent distributors, OEM dealer networks, private label accounts and large equipment fleets. Products include air intakefiltration systems, exhaust and emissions systems, liquid filtration systems and replacement filters.
The Industrial Products segment sells to various industrial end-users, OEMs of gas-fired turbines, and OEMs and end-users requiring highly purified air. Products include dust, fume and mist collectors, compressed air purification systems, static and pulse-clean air filter systems for gas turbines and specialized air filtration systems for diverse applications including computer hard disk drives.
Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments and interest income and expense, non-operating income and expense, and expenses not allocated to the business segments in the same period. During the first quarter of 2006, the Company adjusted its basis of measurement for earnings before income taxes such that certain expenses, such as amortization of intangibles, which were previously considered to be Corporate and Unallocated, are now included in the Engine and Industrial Products segment results. The impact of the change in the basis of measurement resulted in approximately $16.0 million of Corporate and Unallocated expenses being charged to the Engine and Industrial Products segments’ aggregate earnings before income taxes in fiscal 2006 as compared to fiscal 2005. This change resulted in approximately $8.0 million of additional expense to each of the Engine and Industrial Products segments during fiscal 2006. This adjustment to the basis of measurement of segment earnings did not change the business components included in each of the Company’s reportable segments.expense. Assets included in Corporate and Unallocated principally are cash and cash equivalents, inventory reserves, certain prepaids, certain investments, other assets and assets allocated to intercompany transactions.general corporate purposes.
The Company has an internal measurement system to evaluate performance and allocate resources based on profit or loss from operations 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 is assignedrelate to intercompany activitygeneral corporate purposes and isare not assigned to either segment. Certain accounting policies applied to the reportable segments differ from those described in the summary of significant accounting policies. The reportable segments account for receivables on a gross basis and account for inventory on a standard cost basis.
Segment allocated assets are primarily accounts receivable, inventories, property, plant and equipment and goodwill. Reconciling items included in Corporate and Unallocated are created based on accounting
differences between segment reporting and the consolidated, external reporting as well as internal allocation methodologies. Certain prior year amounts have been reclassified between
The Company is an integrated enterprise, characterized by substantial intersegment cooperation, cost allocations and sharing of assets. Therefore, we do not represent that these segments, if operated independently, would report the segments to conform to the current structure. Amounts reclassified in net salesoperating profit and earnings before income taxes are not significant.other financial information shown below.
Segment detail is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Engine |
| Industrial |
| Corporate & |
| Total |
| ||||
|
| (thousands of dollars) |
| ||||||||||
2009 |
|
|
| ||||||||||
Net sales |
| $ | 1,001,961 |
| $ | 866,668 |
| $ | — |
| $ | 1,868,629 |
|
Depreciation and amortization |
|
| 31,517 |
|
| 21,156 |
|
| 5,924 |
|
| 58,597 |
|
Equity earnings in unconsolidated affiliates |
|
| 2,172 |
|
| 94 |
|
| — |
|
| 2,266 |
|
Earnings before income taxes |
|
| 83,797 |
|
| 89,526 |
|
| (11,898 | ) |
| 161,425 |
|
Assets |
|
| 610,341 |
|
| 495,228 |
|
| 228,427 |
|
| 1,333,996 |
|
Equity investments in unconsolidated affiliates |
|
| 15,474 |
|
| 517 |
|
| — |
|
| 15,991 |
|
Capital expenditures, net of acquired businesses |
|
| 24,785 |
|
| 16,637 |
|
| 4,658 |
|
| 46,080 |
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
| $ | 1,229,171 |
| $ | 1,003,350 |
| $ | — |
| $ | 2,232,521 |
|
Depreciation and amortization |
|
| 27,386 |
|
| 19,314 |
|
| 10,032 |
|
| 56,732 |
|
Equity earnings in unconsolidated affiliates |
|
| 1,876 |
|
| 34 |
|
| — |
|
| 1,910 |
|
Earnings before income taxes |
|
| 158,931 |
|
| 102,420 |
|
| (25,188 | ) |
| 236,163 |
|
Assets |
|
| 628,444 |
|
| 590,273 |
|
| 329,905 |
|
| 1,548,622 |
|
Equity investments in unconsolidated affiliates |
|
| 15,190 |
|
| 506 |
|
| — |
|
| 15,696 |
|
Capital expenditures, net of acquired businesses |
|
| 34,830 |
|
| 24,564 |
|
| 12,758 |
|
| 72,152 |
|
2007 |
|
|
|
|
|
|
|
|
| �� |
|
|
|
Net sales |
| $ | 1,084,262 |
| $ | 834,566 |
| $ | — |
| $ | 1,918,828 |
|
Depreciation and amortization |
|
| 23,735 |
|
| 16,512 |
|
| 9,319 |
|
| 49,566 |
|
Equity earnings in unconsolidated affiliates |
|
| 6,128 |
|
| (225 | ) |
| — |
|
| 5,903 |
|
Earnings before income taxes |
|
| 140,762 |
|
| 80,321 |
|
| (16,222 | ) |
| 204,861 |
|
Assets |
|
| 540,510 |
|
| 510,817 |
|
| 267,690 |
|
| 1,319,017 |
|
Equity investments in unconsolidated affiliates |
|
| 14,968 |
|
| 2,445 |
|
| — |
|
| 17,413 |
|
Capital expenditures, net of acquired businesses |
|
| 37,083 |
|
| 25,798 |
|
| 14,559 |
|
| 77,440 |
|
| Engine Products | Industrial Products | Corporate & Unallocated | Total Company | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars) | |||||||||||||||||||
| 2006 | |||||||||||||||||||
| Net sales | $ | 991,554 | $ | 702,773 | $ | — | $ | 1,694,327 | |||||||||||
| Depreciation and amortization | 21,679 | 15,248 | 7,773 | 44,700 | |||||||||||||||
| Equity earnings in unconsolidated affiliates | 4,896 | 58 | — | 4,954 | |||||||||||||||
| Earnings before income taxes | 135,994 | 65,550 | (12,377 | ) | 189,167 | ||||||||||||||
44
| Engine Products | Industrial Products | Corporate & Unallocated | Total Company | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars) | |||||||||||||||||||
| Assets | 435,285 | 444,242 | 244,540 | 1,124,067 | |||||||||||||||
| Equity investments in unconsolidated affiliates | 13,539 | 1,566 | — | 15,105 | |||||||||||||||
| Capital expenditures, net of acquired businesses | 39,416 | 27,723 | 14,133 | 81,272 | |||||||||||||||
| 2005 | |||||||||||||||||||
| Net sales | $ | 923,840 | $ | 671,893 | $ | — | $ | 1,595,733 | |||||||||||
| Depreciation and amortization | 23,072 | 16,157 | 5,055 | 44,284 | |||||||||||||||
| Equity earnings in unconsolidated affiliates | 3,368 | 90 | — | 3,458 | |||||||||||||||
| Earnings before income taxes | 125,454 | 53,709 | (24,430 | ) | 154,733 | ||||||||||||||
| Assets | 416,805 | 436,111 | 258,857 | 1,111,773 | |||||||||||||||
| Equity investments in unconsolidated affiliates | 12,898 | 1,345 | — | 14,243 | |||||||||||||||
| Capital expenditures, net of acquired businesses | 28,645 | 20,059 | 6,275 | 54,979 | |||||||||||||||
| 2004 | |||||||||||||||||||
| Net sales | $ | 811,543 | $ | 603,437 | $ | — | $ | 1,414,980 | |||||||||||
| Depreciation and amortization | 22,044 | 15,795 | 3,716 | 41,555 | |||||||||||||||
| Equity earnings in unconsolidated affiliates | 4,305 | 71 | — | 4,376 | |||||||||||||||
| Earnings before income taxes | 114,662 | 42,985 | (15,811 | ) | 141,836 | ||||||||||||||
| Assets | 371,661 | 399,916 | 230,032 | 1,001,609 | |||||||||||||||
| Equity investments in unconsolidated affiliates | 13,358 | 1,263 | — | 14,621 | |||||||||||||||
| Capital expenditures, net of acquired businesses | 25,324 | �� | 18,146 | 4,268 | 47,738 | ||||||||||||||
During fiscal 2004, an error was identified totaling $3.6 million (at 2004 exchange rates) relating to 2003 transactions between certain European subsidiaries and the United States in our Industrial Products segment. We assessed the materiality of these transactions on our reported results for both years and determined that they were not material. However, if the error had been identified and recorded in 2003, the Industrial Products segment would have reported $3.6 million more earnings before income taxes for 2004.
45
Following are net sales by product within the Engine Products segment and Industrial Products segment:
| 2006 | 2005 | 2004 | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (thousands of dollars) | |||||||||||||||
| Engine Products segment: | |||||||||||||||
| Off-road products | $ | 308,175 | $ | 286,230 | $ | 244,749 | |||||||||
| Truck products | 184,303 | 175,048 | 156,373 | ||||||||||||
| Aftermarket products* | 499,076 | 462,562 | 410,421 | ||||||||||||
| Total Engine Products segment | 991,554 | 923,840 | 811,543 | ||||||||||||
| Industrial Products segment: | |||||||||||||||
| Industrial filtration solutions | 440,230 | 424,727 | 370,095 | ||||||||||||
| Gas turbine products | 121,194 | 112,872 | 117,705 | ||||||||||||
| Special application products | 141,349 | 134,294 | 115,637 | ||||||||||||
| Total Industrial Products segment | 702,773 | 671,893 | 603,437 | ||||||||||||
| Total Company | $ | 1,694,327 | $ | 1,595,733 | $ | 1,414,980 | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
| 2009 |
| 2008 |
| 2007 |
| |||
|
| (thousands of dollars) |
| |||||||
Engine Products segment: |
|
|
|
|
|
|
|
|
|
|
Off-Road Products* |
| $ | 362,785 |
| $ | 448,681 |
| $ | 352,065 |
|
On-Road Products |
|
| 71,958 |
|
| 123,146 |
|
| 166,370 |
|
Aftermarket Products** |
|
| 567,218 |
|
| 657,344 |
|
| 565,827 |
|
Total Engine Products segment |
|
| 1,001,961 |
|
| 1,229,171 |
|
| 1,084,262 |
|
Industrial Products segment: |
|
|
|
|
|
|
|
|
|
|
Industrial Filtration Solutions Products |
|
| 503,611 |
|
| 600,526 |
|
| 515,022 |
|
Gas Turbine Products |
|
| 206,760 |
|
| 213,138 |
|
| 158,025 |
|
Special Applications Products |
|
| 156,297 |
|
| 189,686 |
|
| 161,519 |
|
Total Industrial Products segment |
|
| 866,668 |
|
| 1,003,350 |
|
| 834,566 |
|
Total Company |
| $ | 1,868,629 |
| $ | 2,232,521 |
| $ | 1,918,828 |
|
* | Includes Aerospace and Defense products. |
** | Includes replacement part sales to the Company’s OEM Customers. |
*Includes replacement part sales to the Company’s original equipment manufacturers.
Geographic sales by origination and property, plant and equipment:
| Net Sales | Property, Plant & Equipment — Net |
|
|
|
|
|
|
| ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net Sales |
| Property, Plant & |
| ||||||||||||||
| (thousands of dollars) |
| (thousands of dollars) |
| |||||||||||||||
| 2006 | ||||||||||||||||||
2009 |
|
|
|
|
| |||||||||||||
| United States | $ | 799,487 | $ | 134,817 |
| $ | 778,979 |
| $ | 141,052 |
| |||||||
| Europe | 491,665 | 104,343 |
| 567,117 |
| 138,350 |
| |||||||||||
| Asia-Pacific | 334,824 | 50,632 |
| 419,423 |
| 71,686 |
| |||||||||||
| Other | 68,351 | 27,572 |
|
| 103,110 |
|
| 29,980 |
| |||||||||
| Total | $ | 1,694,327 | $ | 317,364 |
| $ | 1,868,629 |
| $ | 381,068 |
| |||||||
| 2005 | ||||||||||||||||||
2008 |
|
|
|
|
| |||||||||||||
| United States | $ | 750,199 | $ | 128,866 |
| $ | 888,658 |
| $ | 144,429 |
| |||||||
| Europe | 474,084 | 88,775 |
| 766,797 |
| 166,195 |
| |||||||||||
| Asia-Pacific | 311,194 | 37,299 |
| 471,275 |
| 65,829 |
| |||||||||||
| Other | 60,256 | 20,553 |
|
| 105,791 |
|
| 38,706 |
| |||||||||
| Total | $ | 1,595,733 | $ | 275,493 |
| $ | 2,232,521 |
| $ | 415,159 |
| |||||||
| 2004 | ||||||||||||||||||
2007 |
|
|
|
|
| |||||||||||||
| United States | $ | 663,963 | $ | 131,245 |
| $ | 827,648 |
| $ | 142,511 |
| |||||||
| Europe | 423,267 | 84,659 |
| 615,049 |
| 129,564 |
| |||||||||||
| Asia-Pacific | 283,361 | 27,274 |
| 397,080 |
| 61,057 |
| |||||||||||
| Other | 44,389 | 18,351 |
|
| 79,051 |
|
| 31,301 |
| |||||||||
| Total | $ | 1,414,980 | $ | 261,529 |
| $ | 1,918,828 |
| $ | 364,433 |
| |||||||
ConcentrationsThere were no Customers over 10 percent of net sales during Fiscal 2009. Sales to one customerCustomer accounted for 1210 percent of net sales in 2006Fiscal 2008 and 2005.2007. There were no customersCustomers over 10 percent of gross accounts receivable in 2006Fiscal 2009 and 2005.2008.
NOTE K
Commitments and Contingencies
Guarantees to Related PartyThe Company and its partner, Caterpillar Inc., in an unconsolidated joint venture, Advanced Filtration Systems Inc., guarantee certain debt of the joint venture. As of July 31, 2006,2009, the joint venture did not have anyhad $27.7 million of outstanding debt.
46
Table In addition, during Fiscal 2009, 2008 and 2007, the Company recorded its equity in earnings of Contentsthis equity method investment of $1.0 million, $0.6 million and $5.0 million and royalty income of $5.1 million, $5.4 million and $0.4 million, respectively.
The Company provides for warranties on certain products. In addition, the Company may incur specific customerCustomer warranty issues. Following is a reconciliation of warranty reserves (in thousands of dollars):
| Balance at August 1, 2004 | $ | 9,529 | ||||
| Accruals for warranties (including changes in estimates) | 2,622 | |||||
| Less settlements made during the period | (4,310 | ) | ||||
| Balance at July 31, 2005 | $ | 7,841 | ||||
| Accruals for warranties (including changes in estimates) | 4,510 | |||||
| Less settlements made during the period | (3,562 | ) | ||||
| Balance at July 31, 2006 | $ | 8,789 | ||||
|
|
|
|
|
Balance at August 1, 2007 |
| $ | 8,545 |
|
Accruals for warranties issued during the reporting period |
|
| 3,634 |
|
Accruals related to pre-existing warranties (including changes in estimates) |
|
| 3,982 |
|
Less settlements made during the period |
|
| (4,638 | ) |
Balance at July 31, 2008 |
| $ | 11,523 |
|
Accruals for warranties issued during the reporting period |
|
| 2,942 |
|
Accruals related to pre-existing warranties (including changes in estimates) |
|
| (2,141 | ) |
Less settlements made during the period |
|
| (3,109 | ) |
Balance at July 31, 2009 |
| $ | 9,215 |
|
At July 31, 20062009 and 2005,2008, the Company had a contingent liability for standby letters of credit totaling $18.7$20.0 million and $18.5 million, respectively, which have been issued and are outstanding. The letters of credit guarantee payment to beneficial third parties in the event the Company is in breach of specified contract terms as detailed in each letter of credit. At July 31, 20062009 and 2005,2008, there were no amounts drawn upon these letters of credit.
Legal Proceedings The Company was a defendant in a patent infringement lawsuit filed in November 1998 in the United States District CourtIn accordance with SFAS No. 5, “Accounting for the Northern District of Iowa (Eastern Division)
by Engineered Products Co. (“EPC”). On August 31, 2005, the U.S. Court of Appeals for the Federal Circuit issued a ruling lowering the jury verdict againstContingencies,” (SFAS No. 5), the Company from $15,839,004records provisions with respect to $11,480,667. The court also directed the District Court to recalculate prejudgment interest (which had previouslyidentified claims or lawsuits when it is probable that a liability has been awarded inincurred and the amount of approximately $1.1 million), attorneys’ fees (which had previously been awardedthe 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 reserves in the amount of $1,844,933), costs (which had been awarded in the amount of $132,725) and post-judgment interest for EPCits consolidated financial statements are adequate in light of the Court’s revisionprobable and estimable outcomes. The recorded liabilities were not material to the damages.Company’s financial position, results of operation and liquidity and the Company does not believe that any of the currently identified claims or litigation will materially affect its financial position, results of operation and liquidity.
NOTE L
Restructuring
The following is a reconciliation of restructuring reserves (in thousands of dollars):
|
|
|
|
|
Balance at July 31, 2008 |
| $ | — |
|
Accruals for restructuring during the reporting period |
|
| 17,755 |
|
Less settlements made during the period |
|
| (13,915 | ) |
Balance at July 31, 2009 |
| $ | 3,840 |
|
The dramatic downturn in the worldwide economy made signification cost reduction actions necessary during Fiscal 2009. As a result, costs incurred and shown in the table above are primarily associated with workforce reductions of 2,800 since the beginning of the fiscal year. Gross margin and operating expenses include $10.1 million and $7.7 million of restructuring expenses, respectively. The Engine Products segment, Industrial Products segment, and Corporate and Unallocated incurred $7.2 million, $10.1 million and $0.5 million, respectively.
The Company increasedexpects to settle its reserves for the fourth quarterremaining liability during Fiscal 2010.
NOTE M
Subsequent Events
The Company is not currently subject to any pending litigation other than litigation which arises out ofhas evaluated and is incidental toreviewed for subsequent events that would impact the conductfinancial statements for the 12 months ended July 31, 2009, through the issuance date of the Company’s business. All such matters are subject to many uncertainties and outcomes that are not predictable with assurance. The Company does not consider any of such proceedings that are currently pending to be likely to result in a material adverse effect on the Company’s consolidated financial position or results of operations.financials, September 25, 2009.
Environmental Matters The Company establishes reserves as appropriate for potential environmental liabilities and will continue to accrue reserves in appropriate amounts. While uncertainties exist with respect to the amounts and timing of the Company’s ultimate environmental liabilities, management believes that such liabilities, individually and in the aggregate, will not have a material adverse effect on the Company’s financial condition or results of operations.
47
NOTE LN
Quarterly Financial Information (Unaudited)
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| First |
| Second |
| Third |
| Fourth |
| ||||||||||||||||||||||||
| (thousands of dollars, except per share amounts) |
| (thousands of dollars, except per share amounts) |
| |||||||||||||||||||||||||||||
| 2006 | ||||||||||||||||||||||||||||||||
2009 |
|
|
|
|
|
|
|
|
| |||||||||||||||||||||||
| Net sales | $ | 403,396 | $ | 392,915 | $ | 429,858 | $ | 468,158 |
| $ | 573,260 |
| $ | 460,601 |
| $ | 413,447 |
| $ | 421,321 |
| |||||||||||
| Gross margin | 131,532 | 124,782 | 144,074 | 156,192 |
| 186,703 |
| 134,012 |
| 130,782 |
| 138,209 |
| |||||||||||||||||||
| Net earnings | 32,198 | 26,909 | 37,012 | 36,188 |
| 47,962 |
| 33,793 |
| 26,598 |
| 23,554 |
| |||||||||||||||||||
| Basic earnings per share | .38 | .32 | .45 | .44 |
| .62 |
| .43 |
| .34 |
| .30 |
| |||||||||||||||||||
| Diluted earnings per share | .37 | .32 | .43 | .43 |
| .60 |
| .43 |
| .34 |
| .30 |
| |||||||||||||||||||
| Dividends declared per share | .080 | .160 | — | .170 |
| — |
| .230 |
| — |
| .230 |
| |||||||||||||||||||
| 2005 | ||||||||||||||||||||||||||||||||
Dividends paid per share |
| .110 |
| .115 |
| .115 |
| .115 |
| |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||||||
2008 |
|
|
|
|
|
|
|
|
| |||||||||||||||||||||||
| Net sales | $ | 372,906 | $ | 388,424 | $ | 411,664 | $ | 422,739 |
| $ | 525,576 |
| $ | 511,763 |
| $ | 587,760 |
| $ | 607,422 |
| |||||||||||
| Gross margin | 116,239 | 120,954 | 133,800 | 134,582 |
| 172,864 |
| 163,185 |
| 188,266 |
| 201,547 |
| |||||||||||||||||||
| Net earnings | 27,394 | 26,716 | 31,333 | 25,111 |
| 43,323 |
| 34,070 |
| 45,987 |
| 48,573 |
| |||||||||||||||||||
| Basic earnings per share | .32 | .31 | .37 | .30 |
| .54 |
| .43 |
| .58 |
| .62 |
| |||||||||||||||||||
| Diluted earnings per share | .31 | .31 | .36 | .29 |
| .53 |
| .42 |
| .57 |
| .60 |
| |||||||||||||||||||
| Dividends declared per share | — | .120 | — | .060 |
| — |
| .210 |
| — |
| .220 |
| |||||||||||||||||||
Dividends paid per share |
| .100 |
| .100 |
| .110 |
| .110 |
| |||||||||||||||||||||||
The quarters ended January 31, 2009, April 30, 2009, and July 31, 2009, include restructuring charges after-tax of $2.9 million or $0.04 per share, $4.7 million or $0.06 per share and $4.5 million or $0.05 per share, respectively.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
No additional disclosure is required regarding the recent change in independent registered public accounting firms for the Donaldson Company, Inc. Employee Stock Ownership and Retirement Savings Plan, as disclosed in the Company’s Form 8-K filed on January 18, 2006.None.
Item 9A. CONTROLS AND PROCEDURESControls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report (the “Evaluation Date”), the Company carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in applicable rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
No change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) identified in connection with such evaluation during the fiscal quarter ended July 31, 2006,2009, has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
See Management’s Report on Internal Control over Financial Reporting under Item 8 on page 21.27.
Report of Independent Registered Public Accounting Firm
See Report of Independent Registered Public Accounting Firm under Item 8 on page 21.28.
48
Item 9B. OTHER INFORMATIONOther Information
None.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTDirectors, Executive Officers and Corporate Governance
The information under the captions “Item 1: Election of Directors;” “Board Structure and Governance,Directors”; “Director Selection Process,” “Audit Committee,” “Audit Committee Expertise; Complaint-Handling Procedures,” and “Section 16(a) Beneficial Ownership Reporting Compliance” of the Company’s proxy statement for the 2006 annual shareholders meeting2009 Proxy Statement is incorporated herein by reference. Information on the Executive Officers of the Company is found under the caption “Executive Officers of the Registrant” on page 67 of this Annual Report on Form 10-K.
The Company has adopted a code of business conduct and ethics in compliance with applicable rules of the Securities and Exchange Commission that applies to its principal executive officer, its principal financial officer and its principal accounting officer or controller, or persons performing similar functions. A copy of the code of business conduct and ethics is posted on the Company’s website at www.donaldson.com. The code of business conduct and ethics is available in print, free of charge to any shareholder who requests it. The Company will disclose any amendments to, or waivers of, the code of business conduct and ethics for the Company’s principal executive officer, principal financial officer, and principal accounting officer on the Company’s website.
Item 11. EXECUTIVE COMPENSATIONExecutive Compensation
The information under the captions “Board Structure and Governance,” “Director Compensation;“Compensation Committee Report,” “Executive Compensation;” “Pension Benefits;”Compensation” and “Change-in-Control Arrangements”‘Director Compensation” of the Company’s proxy statement for the 20062009 annual shareholders meeting is incorporated herein by reference.
49
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
The information under the caption “Security Ownership” of the Company’s proxy statement for the 20062009 annual shareholders meeting is incorporated herein by reference.
The following table sets forth information as of July 31, 2006,2009, regarding the Company’s equity compensation plans:
|
|
|
|
|
|
|
|
|
|
|
Plan category |
| Number of securities |
| Weighted-average |
| Number of securities |
| |||
|
| (a) |
| (b) |
| (c) |
| |||
Equity compensation plans approved by security holders |
|
|
|
|
|
|
|
|
|
|
1980 Master Stock Compensation Plan: |
|
|
|
|
|
|
|
|
|
|
Stock Options |
|
| — |
|
| — |
|
| — |
|
Deferred Stock Gain Plan |
|
| 54,667 |
| $ | 13.2261 |
|
| — |
|
1991 Master Stock Compensation Plan: |
|
|
|
|
|
|
|
|
|
|
Stock Options |
|
| 1,350,821 |
| $ | 18.2605 |
|
| — |
|
Deferred Stock Option Gain Plan |
|
| 326,612 |
| $ | 30.6203 |
|
| — |
|
Deferred LTC/Restricted Stock |
|
| 156,304 |
| $ | 21.6543 |
|
| — |
|
2001 Master Stock Incentive Plan: |
|
|
|
|
|
|
|
|
|
|
Stock Options |
|
| 3,112,012 |
| $ | 30.3412 |
|
| See Note 1 |
|
Deferred LTC/Restricted Stock |
|
| 158,437 |
| $ | 30.7006 |
|
| See Note 1 |
|
Long Term Compensation |
|
| 12,334 |
| $ | 43.9300 |
|
| See Note 1 |
|
Subtotal for plans approved by security holders: |
|
| 5,171,187 |
| $ | 26.8030 |
|
|
|
|
Equity compensation plans not approved by security holders |
|
|
|
|
|
|
|
|
|
|
Nonqualified Stock Option Program for Non-Employee Directors |
|
| 535,292 |
| $ | 29.0432 |
|
| See Note 2 |
|
ESOP Restoration |
|
| 30,878 |
| $ | 12.2894 |
|
| See Note 3 |
|
Subtotal for plans not approved by security holders: |
|
| 556,170 |
| $ | 28.1294 |
|
|
|
|
Total: |
|
| 5,737,357 |
| $ | 26.9339 |
|
|
|
|
Note 1: Shares authorized for issuance during the 10-year term are limited in each plan year to 1.5% of the Company’s “outstanding shares” (as defined in the 2001 Master Stock Incentive Plan).
Note 2: The stock option program for non-employee directors (filed as exhibit 10-N to the Company’s 1998 Form 10-K report) provides for each non-employee director to receive annual option grants of 7,200 shares. The 2001 Master Stock Incentive Plan, which was approved by the Company’s stockholders on November 16, 2001, also provides for the issuance of stock options to non-employee directors.
Note 3: The Company has a non-qualified ESOP Restoration Plan established on August 1, 1990 (filed as exhibit 10-E to the Company’s Form 10-Q for the quarter ended January 31, 1998), to supplement the benefits for executive employees under the Company’s Employee Stock Ownership Plan that would otherwise be reduced because of the compensation limitations under the Internal Revenue Code. The ESOP’s 10-year term was completed on July 31, 1997, and the only ongoing benefits under the ESOP Restoration Plan are the accrual of dividend equivalent rights to the participants in the Plan.
| Plan category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (a) | (b) | (c) | ||||||||||||
| Equity compensation plans approved by security holders | ||||||||||||||
| 1980 Master Stock Compensation Plan: | ||||||||||||||
| Stock Options | — | — | — | |||||||||||
| Deferred Stock Gain Plan | 72,445 | $ | 12.3828 | — | ||||||||||
| 1991 Master Stock Compensation Plan: | ||||||||||||||
| Stock Options | 3,287,197 | $ | 16.8912 | — | ||||||||||
| Deferred Stock Option Gain Plan | 259,552 | $ | 21.4611 | — | ||||||||||
| Deferred LTC/Restricted Stock | 242,824 | $ | 19.6519 | — | ||||||||||
| 2001 Master Stock Incentive Plan: | ||||||||||||||
| Stock Options | 2,525,409 | $ | 26.7037 | See Note 1 | ||||||||||
| Deferred LTC/Restricted Stock | 52,130 | $ | 30.5468 | See Note 1 | ||||||||||
| Long Term Compensation | 259,805 | $ | 25.6039 | See Note 1 | ||||||||||
| Subtotal for plans approved by security holders: | 6,699,362 | $ | 21.2626 | |||||||||||
| Equity compensation plans not approved by security holders | ||||||||||||||
| Nonqualified Stock Option Program for Non-Employee Directors | 468,698 | $ | 20.3322 | See Note 2 | ||||||||||
| ESOP Restoration | 50,475 | $ | 11.4566 | See Note 3 | ||||||||||
| Subtotal for plans not approved by security holders: | 519,173 | $ | 19.4693 | |||||||||||
| Total: | 7,218,535 | $ | 21.1337 | |||||||||||
50
Certain Relationships and |
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information under “Audit Committee Reportthe caption “Policy and Appointment of Auditors — InformationProcedures Regarding the Independent Registered Public Accounting Firm”Transactions with Related Persons” of the Company’s proxy statement for the 20062009 annual shareholders meeting is incorporated here by reference.
Principal Accounting Fees and Services |
The information under “Audit Committee Report” of the Company’s proxy statement for the 2009 annual shareholders meeting is incorporated herein by reference.
Exhibits, Financial Statement Schedules |
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Documents filed with this report:
(1) | Financial Statements | |
Consolidated Statements of Earnings — years ended July 31, | ||
Consolidated Balance Sheets — July 31, | ||
Consolidated Statements of Cash Flows — years ended July 31, | ||
Consolidated Statements of Changes in Shareholders’ Equity — years ended July 31, | ||
Notes to Consolidated Financial Statements | ||
Report of Independent Registered Public Accounting Firm | ||
(2) | Financial Statement Schedules — | |
Schedule II Valuation and qualifying accounts | ||
All other schedules (Schedules I, III, IV and V) for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instruction, or are inapplicable, and therefore have been omitted. | ||
(3) | Exhibits | |
The exhibits listed in the accompanying index are filed as part of this report or incorporated by reference as indicated therein. |
51
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DONALDSON COMPANY, INC.
DONALDSON COMPANY, INC. | ||||
Date: | September | By: |
| |
William M. Cook | ||||
Chief Executive Officer | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on September 30, 2006.25, 2009.
President, Chief Executive Officer and Chairman | ||
(principal executive officer) | ||
| ||
William M. Cook | ||
Vice President and Chief Financial Officer | ||
(principal financial officer) | ||
| ||
Thomas R. VerHage | ||
Controller | ||
| ||
James F. Shaw | ||
* | Director | |
F. Guillaume Bastiaens | ||
* | Director | |
Janet M. Dolan | ||
* | Director | |
Jack W. Eugster | ||
* | Director | |
John F. Grundhofer | ||
* | Director | |
Michael J. Hoffman | ||
* | Director | |
Paul David Miller | ||
* | Director | |
Jeffrey Noddle | ||
* | Director | |
Willard D. Oberton | ||
* | Director | |
John P. Wiehoff | ||
*By: | ||
Norman C. Linnell | ||
As attorney-in-fact |
52
SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS
DONALDSON COMPANY, INC. AND SUBSIDIARIES
(thousands of dollars)
| Additions | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Description | Balance at Beginning of Period | Charged to Costs and Expenses | Charged to Other Accounts (A) | Deductions (B) & (C) | Balance at End of Period | ||||||||||||||||||
| Year ended July 31, 2006: | |||||||||||||||||||||||
| Allowance for doubtful accounts deducted from accounts receivable | $ | 8,409 | $ | 1,981 | $ | (399 | ) | $ | (1,593 | ) | $ | 8,398 | |||||||||||
| Year ended July 31, 2005: | |||||||||||||||||||||||
| Allowance for doubtful accounts deducted from accounts receivable | $ | 8,741 | $ | 2,832 | $ | 93 | $ | (3,257 | ) | $ | 8,409 | ||||||||||||
| Year ended July 31, 2004: | |||||||||||||||||||||||
| Allowance for doubtful accounts deducted from accounts receivable | $ | 5,836 | $ | 3,938 | $ | 176 | $ | (1,209 | ) | $ | 8,741 | ||||||||||||
| Restructuring reserves — Ultrafilter | $ | 82 | $ | (82 | ) | $ | 0 | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Additions |
|
|
|
|
|
|
| ||||
Description |
| Balance at |
| Charged to |
| Charged to |
| Deductions |
| Balance at |
| |||||
Year ended July 31, 2009: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts deducted from accounts receivable |
| $ | 7,509 |
| $ | 1,240 |
| $ | (534 | ) | $ | (828 | ) | $ | 7,387 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended July 31, 2008: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts deducted from accounts receivable |
| $ | 6,768 |
| $ | 1,126 |
| $ | 537 |
| $ | (922 | ) | $ | 7,509 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended July 31, 2007: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts deducted from accounts receivable |
| $ | 8,398 |
| $ | 914 |
| $ | 358 |
| $ | (2,902 | ) | $ | 6,768 |
|
Note B — Bad debts charged to allowance, net of reserves and changes in estimates.
53
EXHIBIT INDEX
ANNUAL REPORT ON FORM 10-K
* 3-A | — | Restated Certificate of Incorporation of Registrant as currently in effect (Filed as Exhibit 3-A to Form 10-Q Report for the | ||
* | — | Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock of Registrant, dated as of March 3, 2006 (Filed as Exhibit | ||
* 3-C | — | Amended and Restated Bylaws of Registrant (as of January 30, 2009) (Filed as Exhibit 3-C to Form 10-Q for the second quarter ended January 31, 2009) | ||
* 4 | — | ** | ||
* 4-A | — | Preferred Stock Amended and Restated Rights Agreement between Registrant and Wells Fargo Bank, N.A., as Rights Agent, dated as of January 27, 2006 (Filed as Exhibit 4.1 to Form 8-K Report filed February 1, 2006) | ||
*10-A | — | Officer Annual Cash Incentive Plan | ||
*10-B | — | 1980 Master Stock Compensation Plan as Amended (Filed as Exhibit | ||
*10-C | — | Form of Performance Award Agreement under 1991 Master Stock Compensation Plan (Filed as | ||
10-D | — | ESOP Restoration Plan (2003 Restatement) | ||
*10-E | — | Deferred Compensation Plan for Non-employee Directors as amended (Filed as Exhibit | ||
*10-F | — | Independent Director Retirement and Benefit Plan as amended (Filed as Exhibit | ||
10-G | — | Excess Pension Plan (2003 Restatement) | ||
10-H | — | Supplementary Executive Retirement Plan (2003 Restatement) | ||
*10-I | — | 1991 Master Stock Compensation Plan as amended (Filed as Exhibit | ||
*10-J | — | Form of Restricted Stock Award under 1991 Master Stock Compensation Plan (Filed as Exhibit | ||
*10-K | — | Form of Agreement to Defer Compensation for certain Executive Officers (Filed as Exhibit | ||
*10-L | — | Stock Option Program for Non-employee Directors (Filed as Exhibit | ||
* | — | Note Purchase Agreement among Donaldson Company, Inc. and certain listed Insurance Companies | ||
* | — | Second Supplement and First Amendment to Note Purchase Agreement among Donaldson Company, Inc. and certain listed Insurance Companies dated as of September 30, 2004 (Filed as Exhibit 10-A to Form 10-Q Report for the Second Quarter ended January 31, 2005) |
54
10-O | — | 2001 Master Stock Incentive Plan |
* | — | |||
Form of Officer Stock Option Award Agreement under the 2001 Master Stock Incentive Plan (Filed as Exhibit 10-A to Form 10-Q Report for the First Quarter ended October 31, 2004)*** | ||||
*10-Q | — | Form of Non-Employee Director Non-Qualified Stock Option Agreement under the 2001 Master Stock Incentive Plan (Filed as Exhibit 10-B to Form 10-Q Report for the First Quarter ended October 31, 2004)*** | ||
*10-R | — | Agreement dated August 29, 2005, by and between Donaldson Company, Inc. and William G. Van Dyke (Filed as Exhibit 99.1 to Form 8-K Report filed August 29, 2005)*** | ||
* | — | |||
Restated Compensation Plan for Non-Employee Directors dated July 28, 2006 (Filed as Exhibit 99.1 to Form 8-K Report filed August 4, 2006)*** | ||||
* | — | Restated Long-Term Compensation Plan dated May 23, 2006 (Filed as Exhibit 99.2 to Form 8-K Report filed August 4, 2006)*** | ||
*10-U | — | Qualified Performance-Based Compensation Plan (Filed as Exhibit 10-DD to 2006 Form 10-K Report)*** | ||
*10-V | — | Deferred Compensation and 401(k) Excess Plan (2005 Restatement) (Filed as Exhibit 10-EE to 2006 Form 10-K Report)*** | ||
*10-W | — | Deferred Stock Option Gain Plan (2005 Restatement) (Filed as Exhibit 10-FF to 2006 Form 10-K Report)*** | ||
*10-X | — | Excess Pension Plan (2005 Restatement) (Filed as Exhibit 10-GG to 2006 Form 10-K Report)*** | ||
*10-Y | — | Supplemental Executive Retirement Plan (2005 Restatement) (Filed as Exhibit 10-HH to 2006 Form 10-K Report)*** | ||
*10-Z | — | Form of Management Severance Agreement for Executive Officers (Filed as Exhibit 10-A to Form 10-Q Report for the Third Quarter ended April 30, 2008)*** | ||
11 | — | Computation of net earnings per share | ||
21 | — | Subsidiaries | ||
23 | — | Consent of PricewaterhouseCoopers LLP | ||
24 | — | Powers of Attorney | ||
31-A | — | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
31-B | — | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
32 | — | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
* | Exhibit has previously been filed with the Securities and Exchange Commission and is incorporated herein by reference as an exhibit. |
** | Pursuant to the provisions of Regulation S-K Item 601(b)(4)(iii)(A) copies of instruments defining the rights of holders of certain long-term debts of the Company and its subsidiaries are not filed and in lieu thereof the Company agrees to furnish a copy thereof to the Securities and Exchange Commission upon request. |
*** | Denotes compensatory plan or management contract. |
Note: Exhibits have been furnished only to the Securities and Exchange Commission. Copies will be furnished to individuals upon request. | |
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