the Engine Products segment, total open order backlog increased 36.6 percent from the prior year. In the Industrial Products segment, total open order backlog increased 14.9 percent from the prior year. Because some of the change in backlog can be attributed to a change in the ordering patterns of the Company’s Customers and/or the impact of foreign exchange translation rates, it may not necessarily correspond to future sales.
Total debt outstanding increased $34.2 million during the year to $301.0 million outstanding at July 31, 2012. Short-term borrowings outstanding at the end of the year were $82.0 million more than the prior year, and long-term debt decreased $47.8 million (including current maturities) from the prior year.
The following table summarizes the Company’s cash obligations as of July 31, 2012, for the years indicated (thousands of dollars):
The Company’s general funding policy for its pension plans is to make at least the minimum contributions as required by applicable regulations. Additionally, the Company may elect to make additional contributions up to the maximum tax deductible contribution. As such, the Company made contributions of $25.5 million to its U.S. pension plans in Fiscal 2012. The minimum funding requirement for the Company’s U.S. pension plans for Fiscal 2013 is $13.5 million. Per the Pension Protection Act of 2006, this obligation could be met with existing credit balances. The Company is still considering whether a cash contribution will be made. The Company made contributions of $12.5 million to its non-U.S. pension plans in Fiscal 2012 and estimates that it will contribute approximately $7.0 million in Fiscal 2013 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 requirements.
The Company has a five-year, multi-currency revolving facility with a group of banks under which the Company may borrow up to $250 million. This facility 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 was $80.0 million outstanding
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at July 31, 2012 and nothing outstanding at July 31, 2011. At July 31, 2012 and 2011, $159.1 million and $238.6 million, respectively, were available for further borrowing under such facilities. The amount available for further borrowing reflects a reduction for issued standby letters of credit, as discussed below. The weighted average interest rate on short-term borrowings outstanding at July 31, 2012 was 0.4 percent. The Company’s multi-currency revolving facility contains debt covenants specifically related to maintaining a certain interest coverage ratio and a certain leverage ratio as well as other covenants that under certain circumstances can restrict the Company’s ability to incur additional indebtedness, make investments and other restricted payments, create liens, and sell assets. As of July 31, 2012, the Company was in compliance with all such covenants. The Company expects to remain in compliance with these covenants. The Company does anticipate refinancing this revolving credit facility during Fiscal 2013.
The Company has two uncommitted credit facilities in the United States, which provide unsecured borrowings for general corporate purposes. At July 31, 2012 and 2011, there was $41.3 million and $56.9 million available for use, respectively. There was $8.7 million outstanding at July 31, 2012 and $13.1 million outstanding at July 31, 2011.
The Company has a €100 million program for issuing treasury notes for raising short, medium, and long-term financing for its European operations. There was nothing outstanding on this program at July 31, 2012 or 2011. Additionally, the Company’s European operations have lines of credit with an available limit of €43.6 million. There was nothing outstanding on these lines of credit as of July 31, 2012 or 2011.
Other international subsidiaries may borrow under various credit facilities. There was $6.4 million outstanding under these credit facilities as of July 31, 2012 and nothing outstanding as of July 31, 2011.
Also, at July 31, 2012 and 2011, the Company had outstanding standby letters of credit totaling $10.9 million and $11.4 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 insurance contract terms as detailed in each letter of credit.
During Fiscal 2012, credit in the global credit markets was accessible and market interest rates remained low. The Company believes that its current financial resources, together with cash generated by operations, are sufficient to continue financing its operations for the next twelve months. There can be no assurance, however, that the cost or availability of future borrowings will not be impacted by future capital market disruptions.
Certain note agreements contain debt covenants related to working capital levels and limitations on indebtedness. As of July 31, 2012, the Company was in compliance with all such covenants. The Company expects to remain in compliance with these covenants.
Shareholders’ equity decreased $24.7 million in Fiscal 2012 to $910.0 million at July 31, 2012. The decrease was primarily due to the repurchase of treasury stock for $130.2 million, changes to foreign currency translation of $98.7 million, $49.7 million of dividend declarations, and $42.5 million (net of tax) of adjustments related to the pension liability. These decreases were partially offset by current year earnings of $264.3 million, $12.7 million of stock options exercised, $12.0 million in tax reductions related to employee plans, and $7.8 million of the equity impact of stock option expense.
The Company’s inventory balance was $256.1 million as of July 31, 2012, as compared to $271.5 million as of July 31, 2011. Excluding the impact of foreign exchange fluctuations, inventories increased $4.1 million. This increase was a result of our expansion of distribution capabilities in emerging regions as well as gas turbine projects that are being constructed but are not yet ready for shipment, resulting in increases in our inventory balances in local currencies.
The Company’s accounts receivable balance was $438.8 million as of July 31, 2012, as compared to $445.7 million as of July 31, 2011. Excluding the impact of foreign exchange fluctuations, accounts receivable increased $17.9 million. This increase was driven by the increase in the Company’s sales.
Cash FlowsDuring Fiscal 2012, $259.7 million of cash was generated from operating activities, compared with $246.1 million in Fiscal 2011. The increase in cash generated from operating activities of $13.6 million was primarily attributable to the Company’s net earnings increase of $39.0 million over the prior year, partially offset by changes in working capital needs resulting from purchases and inventory levels returning to normal and a larger discretionary pension contribution than the prior year. Cash flow generated by operations, cash on hand, and a $96.7 million increase in short-term borrowings were used to support $77.2 million of net capital expenditures, $130.2 million of stock repurchases, $47.7 million of dividend payments and $46.2 million of long-term debt repayments. In addition, $99.3 million of cash on hand was invested in short-term investments. Cash and cash equivalents decreased $47.7 million during Fiscal 2012.
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Nearly all of the Company’s cash and cash equivalents are held by its foreign subsidiaries as over half of the Company’s earnings occur outside the U.S. These funds are considered permanently reinvested outside the U.S., and will only be repatriated when it is tax effective to do so, as the cash generated from U.S. operations is sufficient for the U.S cash needs. If additional cash were required for the Company’s operations in the U.S., it may be subject to additional U.S. taxes if funds were repatriated from certain foreign subsidiaries.
Net capital expenditures for property, plant and equipment totaled $77.2 million in Fiscal 2012 and $59.9 million in Fiscal 2011. Net capital expenditures is comprised of purchases of property, plant, and equipment of $78.1 million and $60.6 million in Fiscal 2012 and 2011, respectively, partially offset by proceeds from the sale of property, plant and equipment of $1.0 million in Fiscal 2012 and $0.8 million in Fiscal 2011. Fiscal 2012 capital expenditures primarily related to plant capacity additions, information and lab technology, productivity enhancing investments at manufacturing sites, and tooling to manufacture new products.
Capital spending in Fiscal 2013 is planned to be approximately $125.0 million. The Company’s capital spending in Fiscal 2013 will be approximately 30 percent related to capacity expansion, 30 percent for technology initiatives, including a global ERP implementation, 20 percent for tooling for new products, and 20 percent will be in the form of automation or cost reduction projects related to the Company’s ongoing Continuous Improvement initiatives. It is anticipated that Fiscal 2013 capital expenditures will be financed primarily by cash on hand, cash generated from operations, and lines of credit.
The Company expects that cash generated by operating activities will be between $280 and $310 million in Fiscal 2013. At July 31, 2012, the Company had cash and cash equivalents of $225.8 million and short-term investments of $92.4 million. The Company also had $200.3 million available under existing credit facilities in the United States, €143.6 million or $176.8 million, available under existing credit facilities in Europe, and $56.2 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 will be adequate to meet cash requirements for Fiscal 2013, including debt repayment, issuance of anticipated dividends, possible share repurchase activity, and capital expenditures. The Company does anticipate refinancing its $250 million revolving credit facility during Fiscal 2013.
Shares and Stock Split At the Company’s Annual Meeting of Stockholders on November 18, 2011, the shareholders approved an increase in the number of authorized shares of common stock, par value $5.00, from 120,000,000 to 240,000,000 and the total number of shares of stock which the Company has the authority to issue from 121,000,000 to 241,000,000.
On January 27, 2012, the Company announced that its Board of Directors declared a two-for-one stock split effected in the form of a 100 percent stock dividend. The stock split was distributed March 23, 2012, to stockholders of record as of March 2, 2012. Earnings and dividends per share and weighted average shares outstanding are presented in this Form 10-K after the effect of the 100 percent stock dividend. The two-for-one stock split is reflected in the share amounts in all periods presented in this Form 10-K.
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 approximately 25 percent to 30 percent of the average earnings per share of the last three years. Including the Company’s declaration on July 27, 2012, of a $0.09 per share dividend to be paid, the dividend payout ratio was 27.9 percent of the average of the prior three years diluted earnings per share on July 31, 2012.
Share Repurchase PlanThe Board of Directors authorized the repurchase of 16.0 million shares of common stock under the stock repurchase plan dated March 26, 2010. In Fiscal 2012, the Company repurchased 4.5 million shares of common stock for $130.2 million, or 2.9 percent of its diluted outstanding shares, at an average price of $28.92 per share. The Company repurchased 3.9 million shares for $108.9 million in Fiscal 2011. The Company repurchased 3.3 million shares for $66.7 million in Fiscal 2010. As of July 31, 2012, the Company had remaining authorization to repurchase 5.6 million shares pursuant to the current authorization.
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. (AFSI), as further discussed in Note M of the Company’s Notes to Consolidated Financial Statements. As of July 31, 2012, the joint venture had $21.7 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 operations, liquidity, or capital resources.
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New Accounting Standards In June 2011, the Financial Accounting Standards Board (“FASB”) updated the disclosure requirements for comprehensive income. The updated guidance requires companies to disclose the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The updated guidance does not affect how earnings per share is calculated or presented. The updated guidance is effective for the Company beginning in the first quarter of Fiscal 2013. Since this standard impacts disclosure requirements only, its adoption will not have a material impact on the Company’s consolidated financial statements. In December 2011, the FASB issued updated guidance to delay the effective date of certain provisions that relate to reclassification items until such time as the FASB has time to re-deliberate the presentation of those items.
In May 2011, the FASB updated the accounting guidance related to fair value measurements. The updated guidance results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and International Financial Reporting Standards (IFRS). The updated guidance was effective for the Company beginning in the third quarter of Fiscal 2012. The adoption of this standard did not have a material impact on 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 and in Note F of the Notes to Consolidated Financial Statements.
Foreign CurrencyDuring Fiscal 2012, the U.S. dollar was generally stronger than in Fiscal 2011 compared 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 fewer U.S. dollars.
It is not possible to determine the true impact of foreign currency translation changes. However, the direct effect on reported net sales and net earnings can be estimated. For the year ended July 31, 2012, the impact of foreign currency translation resulted in an overall decrease in reported net sales of $38.7 million, a decrease in operating expenses of $9.8 million and a decrease in reported net earnings of $4.0 million. Foreign currency translation had a negative impact in many regions around the world. In Europe, the stronger U.S. dollar relative to the euro and British pound resulted in a total decrease of $29.9 million in reported net sales. The stronger U.S. dollar relative to the Mexican peso, South African rand, and the Indian rupee had a negative impact on foreign currency translation with a decrease in reported net sales of $9.4 million, $8.6 million, and 2.7 million, respectively and a decrease in reported net earnings of $1.2 million, $1.0 million, and $0.1 million, respectively. The weaker U.S. dollar relative to the Japanese yen and Chinese renminbi had a positive impact on foreign currency translation, with an increase in reported net sales of $8.2 million and $5.5 million, respectively, and an increase in reported net earnings of $0.4 million and $0.9 million, respectively.
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 the majority of their input costs and then sell to many of their Customers in 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.
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Some products made in the United States are sold 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 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, 2012, the estimated fair value of long-term debt with fixed interest rates was $223.5 million compared to its carrying value of $201.1 million. The fair value is estimated by discounting the projected cash flows using the rate of which similar amounts of debt could currently be borrowed. As of July 31, 2012, the Company’s financial liabilities with exposure to changes in interest rates consisted mainly of $88.7 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 million in Fiscal 2012.
Pensions The Company is exposed to market return fluctuations on its qualified defined benefit pension plans. In Fiscal 2012, we adjusted our long–term rate of return from 7.75 percent to 7.50 percent on our U.S. plans, and from a weighted average of 6.03 percent to 5.20 percent on our non-U.S. plans, to reflect our future expectation for returns. In addition, we adjusted our discount rate used to value our pension obligation for our U.S. plans from 4.91 percent to 3.59 percent and from 5.36 percent to 4.13 percent for the non-U.S plans. Our plans were underfunded by $73.9 million at July 31, 2012, since the projected benefit obligation exceeded the fair value of the plan assets.
Critical Accounting Policies
The Company’s consolidated financial statements are prepared in conformity with generally accepted accounting principles in the United States of America (U.S. GAAP). 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 U.S. GAAP 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, warranty, and allowance for doubtful accountsRevenue is recognized when both product ownership and the risk of loss have transferred to the Customer 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. Accruals for warranties on products sold are recorded based on historical return percentages and specific product campaigns. Allowances for doubtful accounts are estimated by management based on evaluation of potential losses related to Customer receivable balances. The Company determines the allowance based on historical write-off experience in the industry, regional economic data, and evaluation of specific Customer accounts for risk of loss. The Company reviews its allowance for doubtful accounts monthly. 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. 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 assessed for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company performs impairment assessments 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 assessment during the third quarter of Fiscal 2012 to satisfy its annual impairment requirement. The 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
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intangible assets with definite lives continue to be amortized over their estimated useful lives. Definite lived intangible assets are also subject to impairment assessments. A considerable amount of management judgment and assumptions are required in performing the impairment 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.
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. As of July 31, 2012, the liability for unrecognized tax benefits, accrued interest and penalties was $17.8 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 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 7.50 percent long-term rate of return on assets assumption as of July 31, 2012, for developing the Fiscal 2013 expense for the Company’s U.S. pension plans. In addition, the Company lowered the discount rate used to value the pension obligation for its U.S. plans from 4.91 percent to 3.59 percent. The Company also selected the long-term rate of return on assets for its non-U.S. plans of 5.20 percent and adjusted the discount rate used to 4.13 percent for developing the Fiscal 2013 expense. 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.
Reflecting the relatively long-term nature of the plans’ obligations, approximately 45 percent of the plans assets are invested in equity securities, 30 percent in alternative investments (funds of hedge funds), 10 percent in real assets (investments into funds containing commodities and real estate), 10 percent in fixed income, 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 U.S. plan assets, from 7.75 percent, would have changed the Fiscal 2012 annual pension expense by approximately $2.8 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 assessing the universe of bonds available on the measurement date with a quality rating of Aa or better. Similar appropriate benchmarks are used to determine the discount rate for the non-U.S. plans. As of the measurement date of July 31, 2012, the Company decreased its discount rate for the U.S. pension plans to 3.59 percent from 4.91 percent as of July 31, 2011. The decrease of 132 basis points is consistent with published bond indices. The change increased the Company’s U.S. projected benefit obligation as of July 31, 2012, by approximately $46.2 million and is expected to increase pension expense in fiscal year 2013 by approximately $3.4 million. The rates discussed above are weighted average rates as we have multiple plans both in the U.S. and internationally.
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The Company expects that global pension expenses will increase approximately $6.0 million in Fiscal 2013 as compared to Fiscal 2012, which is driven primarily by the changes in assumptions.
Safe Harbor Statement under the Securities Reform Act of 1995
The Company, through its management, may make forward-looking statements reflecting the Company’s current views with respect to future events and 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 on Form 10-K, including those contained in the “Outlook” section of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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. These factors include, but are not limited to risks associated with: world economic factors and the ongoing economic uncertainty, the reduced demand for hard disk drive products with the increased use of flash memory, the potential for some Customers to increase their reliance on their own filtration capabilities, currency fluctuations, commodity prices, political factors, the Company’s international operations, highly competitive markets, governmental laws and regulations, including the impact of the various economic stimulus and financial reform measures, the implementation of our new information technology systems, potential global events resulting in market instability including financial bailouts and defaults of sovereign nations, military and terrorist activities, health outbreaks, natural disasters, such as the recent flood in Thailand, and other factors included in Item 1A of this Report on Form 10-K. 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 Risk
Market risk disclosure appears in Management’s Discussion and Analysis on page 23 under “Market Risk.”
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Item 8. Financial 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 Framework issued 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, 2012. 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, 2012, as stated in this report which follows in Item 8 of this Form 10-K.
| |
/s/ William M. Cook | /s/ James F. Shaw |
| |
William M. Cook | James F. Shaw |
Chief Executive Officer | Chief Financial Officer |
September 28, 2012 | September 28, 2012 |
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Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of Donaldson Company, Inc.
In our opinion, the accompanying consolidated balance sheets and the related statements of earnings, shareholders’ equity and cash flows present fairly, in all material respects, the financial position of Donaldson Company, Inc. and its subsidiaries at July 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 2012, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion the financial statement schedule appearing under item 15(II) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of July 31, 2012, based on criteria established inInternal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible 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 in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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 opinions.
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.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
September 28, 2012
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Consolidated Statements of Earnings
Donaldson Company, Inc. and Subsidiaries
| | | | | | | | | | |
| | Year ended July 31, | |
| | 2012 | | 2011 | | 2010 | |
| | (thousands of dollars, except share and per share
amounts) | |
Net sales | | $ | 2,493,248 | | $ | 2,294,029 | | $ | 1,877,064 | |
Cost of sales | | | 1,619,485 | | | 1,480,233 | | | 1,218,316 | |
Gross margin | | | 873,763 | | | 813,796 | | | 658,748 | |
Selling, general and administrative | | | 451,158 | | | 443,227 | | | 376,018 | |
Research and development | | | 59,589 | | | 55,286 | | | 44,486 | |
Operating income | | | 363,016 | | | 315,283 | | | 238,244 | |
Interest expense | | | 11,489 | | | 12,525 | | | 11,975 | |
Other income, net | | | (19,253 | ) | | (9,505 | ) | | (3,907 | ) |
Earnings before income taxes | | | 370,780 | | | 312,263 | | | 230,176 | |
Income taxes | | | 106,479 | | | 86,972 | | | 64,013 | |
Net earnings | | $ | 264,301 | | $ | 225,291 | | $ | 166,163 | |
|
Weighted average shares - basic | | | 150,286,403 | | | 154,392,740 | | | 155,697,056 | |
Weighted average shares - diluted | | | 152,940,605 | | | 157,196,918 | | | 158,355,544 | |
Net earnings per share - basic | | $ | 1.76 | | $ | 1.46 | | $ | 1.07 | |
Net earnings per share - diluted | | $ | 1.73 | | $ | 1.43 | | $ | 1.05 | |
The accompanying notes are an integral part of these Consolidated Financial Statements.
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Consolidated Balance Sheets
Donaldson Company, Inc. and Subsidiaries
| | | | | | | |
| | At July 31, | |
| | 2012 | | 2011 | |
| | (thousands of dollars, except
share amounts) | |
Assets | | | | | | | |
Current assets | | | | | | | |
Cash and cash equivalents | | $ | 225,789 | | $ | 273,494 | |
Short-term investments | | | 92,362 | | | — | |
Accounts receivable, less allowance of $6,418 and $6,908 | | | 438,796 | | | 445,700 | |
Inventories, net | | | 256,116 | | | 271,476 | |
Deferred income taxes | | | 25,158 | | | 29,805 | |
Prepaids and other current assets | | | 47,441 | | | 46,107 | |
Total current assets | | $ | 1,085,662 | | $ | 1,066,582 | |
Property, plant and equipment, net | | | 384,909 | | | 391,502 | |
Goodwill | | | 162,949 | | | 171,741 | |
Intangible assets, net | | | 46,200 | | | 53,496 | |
Other assets | | | 50,362 | | | 42,772 | |
Total assets | | $ | 1,730,082 | | $ | 1,726,093 | |
| | | | | | | |
Liabilities and shareholders’ equity | | | | | | | |
Current liabilities | | | | | | | |
Short-term borrowings | | $ | 95,147 | | $ | 13,129 | |
Current maturities of long-term debt | | | 2,346 | | | 47,871 | |
Trade accounts payable | | | 199,182 | | | 215,918 | |
Accrued employee compensation and related taxes | | | 80,550 | | | 86,974 | |
Accrued liabilities | | | 49,242 | | | 64,008 | |
Other current liabilities | | | 72,056 | | | 68,344 | |
Total current liabilities | | | 498,523 | | | 496,244 | |
Long-term debt | | | 203,483 | | | 205,748 | |
Deferred income taxes | | | 4,611 | | | 11,196 | |
Other long-term liabilities | | | 113,451 | | | 78,194 | |
Total liabilities | | | 820,068 | | | 791,382 | |
Commitments and contingencies (Note O) | | | | | | | |
Shareholders’ equity | | | | | | | |
Preferred stock, $1.00 par value, 1,000,000 shares authorized, none issued | | | — | | | — | |
Common stock, $5.00 par value, 240,000,000 shares authorized, 151,643,194 shares and 88,643,194 shares issued in 2012 and 2011, respectively | | | 758,216 | | | 443,216 | |
Retained earnings | | | 366,788 | | | 925,542 | |
Stock compensation plans | | | 24,948 | | | 24,736 | |
Accumulated other comprehensive income (loss) | | | (101,888 | ) | | 40,027 | |
Treasury stock, 3,980,832 and 13,245,864 shares in 2012 and 2011, at cost | | | (138,050 | ) | | (498,810 | ) |
Total shareholders’ equity | | | 910,014 | | | 934,711 | |
Total liabilities and shareholders’ equity | | $ | 1,730,082 | | $ | 1,726,093 | |
The accompanying notes are an integral part of these Consolidated Financial Statements.
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Consolidated Statements of Cash Flows
Donaldson Company, Inc. and Subsidiaries
| | | | | | | | | | |
| | Year ended July 31, | |
| | 2012 | | 2011 | | 2010 | |
| | (thousands of dollars) | |
Operating Activities | | | | | | | | | | |
Net earnings | | $ | 264,301 | | $ | 225,291 | | $ | 166,163 | |
Adjustments to reconcile net earnings to net cash provided by operating activities | | | | | | | | | | |
Depreciation and amortization | | | 61,165 | | | 60,491 | | | 59,232 | |
Equity in losses (earnings) of affiliates, net of distributions | | | (2,380 | ) | | (2,585 | ) | | 183 | |
Deferred income taxes | | | 6,344 | | | 1,957 | | | 3,025 | |
Tax benefit of equity plans | | | (10,316 | ) | | (9,873 | ) | | (4,625 | ) |
Stock compensation plan expense | | | 10,553 | | | 9,234 | | | 8,253 | |
Other, net | | | (24,346 | ) | | (11,991 | ) | | (6,110 | ) |
Changes in operating assets and liabilities, net of acquired businesses | | | | | | | | | | |
Accounts receivable | | | (17,877 | ) | | (62,274 | ) | | (79,308 | ) |
Inventories | | | (4,149 | ) | | (52,999 | ) | | (25,826 | ) |
Prepaids and other current assets | | | (17,378 | ) | | 7,233 | | | (3,970 | ) |
Trade accounts payable and other accrued expenses | | | (6,205 | ) | | 81,571 | | | 85,988 | |
Net cash provided by operating activities | | | 259,712 | | | 246,055 | | | 203,005 | |
| | | | | | | | | | |
Investing Activities | | | | | | | | | | |
Purchases of property, plant and equipment | | | (78,139 | ) | | (60,633 | ) | | (43,149 | ) |
Proceeds from sale of property, plant and equipment | | | 969 | | | 782 | | | 490 | |
Purchases of short-term investments | | | (99,298 | ) | | — | | | — | |
Acquisitions and divestitures of affiliates | | | — | | | 3,493 | | | (250 | ) |
Net cash used in investing activities | | | (176,468 | ) | | (56,358 | ) | | (42,909 | ) |
| | | | | | | | | | |
Financing Activities | | | | | | | | | | |
Proceeds from long-term debt | | | — | | | 6,774 | | | 531 | |
Repayments of long-term debt | | | (46,205 | ) | | (13,353 | ) | | (5,508 | ) |
Change in short-term borrowings | | | 96,715 | | | (36,603 | ) | | 20,713 | |
Purchase of treasury stock | | | (130,233 | ) | | (108,929 | ) | | (66,696 | ) |
Dividends paid | | | (47,684 | ) | | (41,013 | ) | | (36,242 | ) |
Tax benefit of equity plans | | | 10,316 | | | 9,873 | | | 4,625 | |
Exercise of stock options | | | 13,691 | | | 15,899 | | | 13,053 | |
Net cash used in financing activities | | | (103,400 | ) | | (167,352 | ) | | (69,524 | ) |
Effect of exchange rate changes on cash | | | (27,549 | ) | | 19,149 | | | (2,259 | ) |
Increase (decrease)in cash and cash equivalents | | | (47,705 | ) | | 41,494 | | | 88,313 | |
Cash and cash equivalents, beginning of year | | | 273,494 | | | 232,000 | | | 143,687 | |
Cash and cash equivalents, end of year | | $ | 225,789 | | $ | 273,494 | | $ | 232,000 | |
| | | | | | | | | | |
Supplemental Cash Flow Information | | | | | | | | | | |
Cash paid during the year for: | | | | | | | | | | |
Income taxes | | $ | 91,915 | | $ | 57,688 | | $ | 40,032 | |
Interest | | | 13,410 | | | 12,852 | | | 11,446 | |
The accompanying notes are an integral part of these Consolidated Financial Statements.
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|
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, 2009 | | $ | 443,216 | | $ | — | | $ | 615,817 | | $ | 19,894 | | $ | (9,677 | ) | $ | (380,632 | ) | $ | 688,618 | |
Comprehensive income | | | | | | | | | | | | | | | | | | | | | | |
Net earnings | | | | | | | | | 166,163 | | | | | | | | | | | | 166,163 | |
Foreign currency translation | | | | | | | | | | | | | | | (15,961 | ) | | | | | (15,961 | ) |
Pension liability adjustment, net of deferred taxes | | | | | | | | | | | | | | | (14,780 | ) | | | | | (14,780 | ) |
Net loss on cash flow hedging derivatives | | | | | | | | | | | | | | | (68 | ) | | | | | (68 | ) |
Comprehensive income | | | | | | | | | | | | | | | | | | | | | 135,354 | |
Treasury stock acquired | | | | | | | | | | | | | | | | | | (66,696 | ) | | (66,696 | ) |
Stock options exercised | | | | | | (5,608 | ) | | (7,678 | ) | | 2,676 | | | | | | 22,951 | | | 12,341 | |
Deferred stock and other activity | | | | | | (704 | ) | | (30 | ) | | (244 | ) | | | | | 1,707 | | | 729 | |
Performance awards | | | | | | 7 | | | (7 | ) | | | | | | | | | | | — | |
Stock option expense | | | | | | | | | 6,891 | | | | | | | | | | | | 6,891 | |
Tax reduction - employee plans | | | | | | 6,305 | | | | | | | | | | | | | | | 6,305 | |
Dividends ($0.240 per share) | | | | | | | | | (36,909 | ) | | | | | | | | | | | (36,909 | ) |
Balance July 31, 2010 | | | 443,216 | | | — | | | 744,247 | | | 22,326 | | | (40,486 | ) | | (422,670 | ) | | 746,633 | |
Comprehensive income | | | | | | | | | | | | | | | | | | | | | | |
Net earnings | | | | | | | | | 225,291 | | | | | | | | | | | | 225,291 | |
Foreign currency translation | | | | | | | | | | | | | | | 72,505 | | | | | | 72,505 | |
Pension liability adjustment, net of deferred taxes | | | | | | | | | | | | | | | 7,166 | | | | | | 7,166 | |
Net gain on cash flow hedging derivatives | | | | | | | | | | | | | | | 842 | | | | | | 842 | |
Comprehensive income | | | | | | | | | | | | | | | | | | | | | 305,804 | |
Treasury stock acquired | | | | | | | | | | | | | | | | | | (108,929 | ) | | (108,929 | ) |
Stock options exercised | | | | | | (10,792 | ) | | (7,854 | ) | | 1,862 | | | | | | 30,604 | | | 13,820 | |
Deferred stock and other activity | | | | | | (1,418 | ) | | 174 | | | 548 | | | | | | 2,185 | | | 1,489 | |
Performance awards | | | | | | (7 | ) | | 7 | | | | | | | | | | | | — | |
Stock option expense | | | | | | | | | 6,462 | | | | | | | | | | | | 6,462 | |
Tax reduction - employee plans | | | | | | 12,217 | | | | | | | | | | | | | | | 12,217 | |
Dividends ($0.280 per share) | | | | | | | | | (42,785 | ) | | | | | | | | | | | (42,785 | ) |
Balance July 31, 2011 | | | 443,216 | | | — | | | 925,542 | | | 24,736 | | | 40,027 | | | (498,810 | ) | | 934,711 | |
Comprehensive income | | | | | | | | | | | | | | | | | | | | | | |
Net earnings | | | | | | | | | 264,301 | | | | | | | | | | | | 264,301 | |
Foreign currency translation | | | | | | | | | | | | | | | (98,723 | ) | | | | | (98,723 | ) |
Pension liability adjustment, net of deferred taxes | | | | | | | | | | | | | | | (42,520 | ) | | | | | (42,520 | ) |
Net loss on cash flow hedging derivatives | | | | | | | | | | | | | | | (672 | ) | | | | | (672 | ) |
Comprehensive income | | | | | | | | | | | | | | | | | | | | | 122,386 | |
Treasury stock acquired | | | | | | | | | | | | | | | | | | (130,233 | ) | | (130,233 | ) |
Stock options exercised | | | | | | (9,834 | ) | | (5,116 | ) | | | | | | | | 27,698 | | | 12,748 | |
Deferred stock and other activity | | | | | | (2,158 | ) | | 312 | | | 213 | | | | | | 1,926 | | | 293 | |
Performance awards | | | | | | | | | (9 | ) | | (1 | ) | | | | | | | | (10 | ) |
Stock option expense | | | | | | | | | 7,800 | | | | | | | | | | | | 7,800 | |
Tax reduction - employee plans | | | | | | 11,992 | | | | | | | | | | | | | | | 11,992 | |
Two-for-one Stock split | | | 315,000 | | | | | | (776,369 | ) | | | | | | | | 461,369 | | | — | |
Dividends ($0.335 per share) | | | | | | | | | (49,673 | ) | | | | | | | | | | | (49,673 | ) |
Balance July 31, 2012 | | $ | 758,216 | | $ | — | | $ | 366,788 | | $ | 24,948 | | $ | (101,888 | ) | $ | (138,050 | ) | $ | 910,014 | |
The accompanying notes are an integral part of these Consolidated Financial Statements.
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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 worldwide manufacturer of filtration systems and replacement parts. The Company’s product mix includes air and liquid filtration systems and exhaust and emission control products. Products are manufactured at 40 plants around the world and through three joint ventures. Products are sold to original equipment manufacturers (“OEMs”), distributors, 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, 2012. 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.
Use of EstimatesThe preparation of Financial Statements in conformity with U.S. GAAP 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 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 Accumulated other comprehensive income (loss) in the Consolidated Balance Sheets. Elements of the Consolidated Statements of Earnings 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 Statements of Earnings. A foreign currency transaction gain of $1.8 million and losses of $4.5 million, and $4.6 million are included in Other income, net in the Consolidated Statements of Earnings in Fiscal 2012, 2011, and 2010, 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.
Short-Term Investments Classification of the Company’s investments as current or non-current is dependent upon management’s intended holding period, the investment’s maturity date, and liquidity considerations based on market conditions. If management intends to hold the investments for longer than one year as of the balance sheet date, they are classified as non-current. See Note B for disclosures related to the Company’s short-term investments.
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 Customer 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 collectability. 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.
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InventoriesInventories are stated at the lower of cost or market. U.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 30 percent and 33 percent of total inventories at July 31, 2012 and 2011, respectively. For inventories valued under the LIFO method, the FIFO cost exceeded the LIFO carrying values by $37.4 million and $37.1 million at July 31, 2012 and 2011, respectively. Results of operations for all periods presented were not materially affected by the liquidation of LIFO inventory. The components of inventory are as follows (thousands of dollars):
| | | | | | | |
| | At July 31, | |
| | 2012 | | 2011 | |
Materials | | $ | 111,808 | | $ | 110,466 | |
Work in process | | | 30,767 | | | 33,917 | |
Finished products | | | 113,541 | | | 127,093 | |
Total inventories | | $ | 256,116 | | $ | 271,476 | |
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 expense as incurred. Depreciation is computed under the straight-line method. Depreciation expense was $55.3 million in Fiscal 2012, $54.5 million in Fiscal 2011, and $53.2 million in Fiscal 2010. 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):
| | | | | | | |
| | At July 31, | |
| | 2012 | | 2011 | |
Land | | $ | 21,062 | | $ | 22,578 | |
Buildings | | | 258,082 | | | 266,482 | |
Machinery and equipment | | | 643,199 | | | 625,439 | |
Construction in progress | | | 27,276 | | | 31,375 | |
Less accumulated depreciation | | | (564,710 | ) | | (554,372 | ) |
Total property, plant and equipment, net | | $ | 384,909 | | $ | 391,502 | |
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, Customer relationships and lists, are recorded at cost and are amortized on a straight-line basis over their estimated useful lives of 3 to 20 years. Goodwill is assessed for impairment annually or if an event occurs or circumstances change that would indicate the carrying amount may be impaired. The 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 assessment in the third quarters of Fiscal 2012 and 2011, 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.
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.
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Comprehensive Income (Loss)Comprehensive income (loss) consists of net income, foreign currency translation adjustments, net changes in the funded status of pension retirement 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):
| | | | | | | | | | |
| | At July 31, | |
| | 2012 | | 2011 | | 2010 | |
Foreign currency translation adjustment | | $ | 32,976 | | $ | 131,699 | | $ | 59,194 | |
Net gain (loss) on cash flow hedging derivatives, net of deferred taxes | | | (292 | ) | | 380 | | | (462 | ) |
Pension and postretirement liability adjustment, net of deferred taxes | | | (134,572 | ) | | (92,052 | ) | | (99,218 | ) |
Total accumulated other comprehensive income (loss) | | $ | (101,888 | ) | $ | 40,027 | | $ | (40,486 | ) |
Cumulative foreign translation is not adjusted for income taxes.
Earnings Per ShareThe Company’s basic net earnings per share are computed by dividing net earnings by the weighted average number of outstanding common shares. The Company’s diluted net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares and common equivalent shares relating to stock options and stock incentive plans. Certain outstanding options were excluded from the diluted net earnings per share calculations because their exercise prices were greater than the average market price of the Company’s common stock during those periods. There were 1,063,135 options, 988,698 options, and 1,691,654 options excluded from the diluted net earnings per share calculation for the fiscal year ended July 31, 2012, 2011, and 2010, respectively.
The following table presents information necessary to calculate basic and diluted earnings per share:
| | | | | | | | | | |
| | 2012 | | 2011 | | 2010 | |
| | (thousands of dollars, except per share amounts) | |
Weighted average shares - basic | | | 150,286 | | | 154,393 | | | 155,697 | |
Diluted share equivalents | | | 2,655 | | | 2,804 | | | 2,659 | |
Weighted average shares - diluted | | | 152,941 | | | 157,197 | | | 158,356 | |
Net earnings for basic and diluted earnings per share computation | | $ | 264,301 | | $ | 225,291 | | $ | 166,163 | |
Net earnings per share - basic | | $ | 1.76 | | $ | 1.46 | | $ | 1.07 | |
Net earnings per share - diluted | | $ | 1.73 | | $ | 1.43 | | $ | 1.05 | |
On January 27, 2012, the Company announced that its Board of Directors declared a two-for-one stock split effected in the form of a 100 percent stock dividend. The stock split was distributed March 23, 2012, to stockholders of record as of March 2, 2012. Earnings and dividends per share and weighted average shares outstanding are presented in this Form 10-K after the effect of the 100 percent stock dividend. The two-for-one stock split is reflected in the share amounts in all periods presented in the table above and elsewhere in this annual Form 10-K.
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 J. Stock-based employee compensation cost is recognized using the fair-value based method.
Revenue RecognitionRevenue is recognized when both product ownership and the risk of loss have transferred to the Customer 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 2012, 2011, and 2010 totaling $67.0 million, $61.9 million, and $49.8 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
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costs using standard quantitative measures based on historical warranty claim experience and evaluation of specific Customer warranty issues. For a warranty reserve reconciliation see Note N.
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.
Exit or Disposal ActivitiesThe Company accounts for costs relating to exit or disposal activities based on FASB guidance related to exit or disposal cost obligations. This guidance addresses recognition, measurement, and reporting of costs associated with exit and disposal activities including restructuring. See Note P 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 M for disclosures related to guarantees.
New Accounting Standards In June 2011, the the Financial Accounting Standards Board (“FASB”) FASB updated the disclosure requirements for comprehensive income. The updated guidance requires companies to disclose the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The updated guidance does not affect how earnings per share is calculated or presented. The updated guidance is effective for the Company beginning in the first quarter of Fiscal 2013. Since this standard impacts disclosure requirements only, its adoption will not have a material impact on the Company’s consolidated financial statements. In December 2011, the FASB issued updated guidance to delay the effective date of certain provisions that relate to reclassification items until such time as the FASB has time to re-deliberate the presentation of those items.
In May 2011, the FASB updated the accounting guidance related to fair value measurements. The updated guidance results ina consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and International Financial Reporting Standards (IFRS). The updated guidance was effective for the Company beginning in the third quarter of Fiscal 2012. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
NOTE B Short-Term Investments
All short-term investments are time deposits and have original maturities in excess of three months but not more than twelve months. The Company had $92.4 million in short-term investments as of July 31, 2012, and the Company did not have any short-term investments as of July 31, 2011.
NOTE C Goodwill and Other Intangible Assets
The Company has allocated goodwill to its Industrial Products and Engine Products segments. There was no acquisition or disposition activity during Fiscal 2012. Disposition of goodwill during Fiscal 2011 relates to the sale of the Company’s Ultracool chiller business, based in Terrassa, Spain, for $3.6 million, which resulted in a gain on sale of $0.4 million. The Ultracool chiller business manufactured industrial circulation chillers and was part of the Company’s Industrial Products segment. As of Fiscal 2011, as a result of an internal reorganization, the Company transferred Industrial Hydraulics, a component of its Industrial Filtration Solutions Products within the Industrial Products segment to Aftermarkets Products within the Engine Products segment, along with the goodwill associated with this component. The Company completed its annual impairment assessments in the third quarters of Fiscal 2012 and 2011. The results of this assessment showed that the fair values of the reporting units to which goodwill is assigned continue to exceed the book values of the respective reporting units, resulting in no goodwill impairment.
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Following is a reconciliation of goodwill for the years ended July 31, 2012 and 2011:
| | | | | | | | | | |
| | Engine
Products | | Industrial
Products | | Total Goodwill | |
| | (thousands of dollars) | |
Balance as of July 31, 2010 | | $ | 60,914 | | $ | 104,401 | | $ | 165,315 | |
Goodwill transferred | | | 11,258 | | | (11,258 | ) | | — | |
Disposition activity | | | — | | | (325 | ) | | (325 | ) |
Foreign exchange translation | | | 794 | | | 5,957 | | | 6,751 | |
Balance as of July 31, 2011 | | $ | 72,966 | | $ | 98,775 | | $ | 171,741 | |
Foreign exchange translation | | | (1,219 | ) | | (7,573 | ) | | (8,792 | ) |
Balance as of July 31, 2012 | | $ | 71,747 | | $ | 91,202 | | $ | 162,949 | |
Intangible assets are comprised of patents, trademarks, and Customer relationships and lists. Following is a reconciliation of intangible assets for the years ended July 31, 2012 and 2011:
| | | | | | | | | | |
| | Gross
Carrying
Amount | | Accumulated
Amortization | | Net
Intangible
Assets | |
| | (thousands of dollars) | |
Balance as of July 31, 2010 | | $ | 83,487 | | $ | (25,195 | ) | $ | 58,292 | |
Amortization expense | | | — | | | (5,917 | ) | | (5,917 | ) |
Foreign exchange translation | | | 1,952 | | | (831 | ) | | 1,121 | |
Balance as of July 31, 2011 | | $ | 85,439 | | $ | (31,943 | ) | $ | 53,496 | |
Amortization expense | | | — | | | (5,778 | ) | | (5,778 | ) |
Retirements | | | (1,530 | ) | | 1,530 | | | — | |
Foreign exchange translation | | | (3,834 | ) | | 2,316 | | | (1,518 | ) |
Balance as of July 31, 2012 | | $ | 80,075 | | $ | (33,875 | ) | $ | 46,200 | |
Net intangible assets consist of patents, trademarks, and trade names of $16.1 million and $20.0 million as of July 31, 2012 and 2011, respectively, and Customer related intangibles of $30.1 million and $33.5 million as of July 31, 2012 and 2011, respectively. As of July 31, 2012, patents, trademarks and trade names had a weighted average remaining life of 9.76 years and Customer related intangibles had a weighted average remaining life of 12.67 years. Expected amortization expense relating to existing intangible assets is as follows (in thousands):
| | | | | |
Fiscal Year | | | | | |
2013 | | | $ | 5,418 | |
2014 | | | $ | 5,045 | |
2015 | | | $ | 4,950 | |
2016 | | | $ | 4,948 | |
2017 | | | $ | 4,530 | |
NOTE D Credit Facilities
The Company has a five-year, multi-currency revolving facility with a group of banks under which the Company may borrow up to $250 million. This facility 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 was $80.0 million outstanding at July 31, 2012 and nothing outstanding at July 31, 2011. At July 31, 2012 and 2011, $159.1 million and $238.6 million, respectively, were available for further borrowing under such facilities. The amount available for further borrowing reflects a reduction for issued standby letters of credit, as discussed below. The weighted average interest rate on these short-term borrowings outstanding at July 31, 2012 was 0.4 percent. The Company’s multi-currency revolving facility contains debt covenants specifically related to maintaining a certain interest coverage ratio and a certain leverage ratio as well as other covenants that under certain circumstances can restrict the Company’s ability to incur additional indebtedness, make investments and other restricted payments, create liens, and sell assets. As of July
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31, 2012, the Company was in compliance with all such covenants. The Company does anticipate refinancing this revolving credit facility during Fiscal 2013.
Certain note agreements contain debt covenants related to working capital levels and limitations on indebtedness. As of July 31, 2012, the Company was in compliance with all such covenants. The Company expects to remain in compliance with these covenants.
The Company has two uncommitted credit facilities in the United States, which provide unsecured borrowings for general corporate purposes. At July 31, 2012 and 2011, there was $41.3 million and $56.9 million available for use. There was $8.7 million outstanding at July 31, 2012 and $13.1 million outstanding at July 31, 2011. The weighted average interest rate on these short-term borrowings outstanding at July 31, 2012 and 2011 was 1.0 percent and 0.9 percent, respectively.
The Company has a €100 million, or $123.1 million, program for issuing treasury notes for raising short, medium, and long-term financing for its European operations. There was nothing outstanding on this program at July 31, 2012 or 2011. Additionally, the Company’s European operations have lines of credit with an available limit of €43.6 million or $53.7 million. There was nothing outstanding on these lines of credit as of July 31, 2012 or 2011.
Other international subsidiaries may borrow under various credit facilities. There was $6.4 million outstanding under these credit facilities as of July 31, 2012, and nothing outstanding as of July 31, 2011. The weighted average interest rate on these short-term borrowings outstanding at July 31, 2012, was 0.5 percent.
As discussed further in Note M, at July 31, 2012 and 2011, the Company had outstanding standby letters of credit totaling $10.9 million and $11.4 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 insurance contract terms as detailed in each letter of credit.
NOTE E Long-Term Debt
Long-term debt consists of the following:
| | | | | | | |
| | 2012 | | 2011 | |
| | (thousands of dollars) | |
4.85% Unsecured senior notes, interest payable semi-annually. This note was repaid on December 17, 2011. | | | — | | | 30,000 | |
6.59% Unsecured senior notes, interest payable semi-annually, principal payment of $80.0 million due November 14, 2013 | | | 80,000 | | | 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. This note was repaid on January 31, 2012. | | | — | | | 15,595 | |
2.019% Guaranteed senior note, interest payable semi-annually, principal payment of ¥ 1.65 billion due May 18, 2014 | | | 21,117 | | | 21,442 | |
Capitalized lease obligations and other, with various maturity dates and interest rates | | | 774 | | | 796 | |
Terminated interest rate swap contracts | | | 3,938 | | | 5,786 | |
Total | | | 205,829 | | | 253,619 | |
Less current maturities | | | 2,346 | | | 47,871 | |
Total long-term debt | | $ | 203,483 | | $ | 205,748 | |
Annual maturities of long-term debt are $0.5 million in 2013, $101.4 million in 2014, $50.0 million in 2017, and $50.0 million thereafter. There are no maturities in 2015 or 2016. As of July 31, 2012, the estimated fair value of long-term debt with fixed interest rates was $223.5 million compared to its carrying value of $201.1 million. On December
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17, 2011, the Company paid off its 4.85 percent Unsecured senior note for $30.0 million. On January 31, 2012, the Company paid off its 1.418 percent Guaranteed senior note for ¥1.2 billion, or $15.4 million.
Certain note agreements contain debt covenants related to working capital levels and limitations on indebtedness. As of July 31, 2012, the Company was in compliance with all such covenants. The Company expects to remain in compliance with these covenants.
NOTE F Financial Instruments
DerivativesThe Company uses forward exchange contracts to manage its exposure to fluctuations in foreign exchange rates. The Company also uses interest rate swaps to manage its exposure to changes in the fair value of its fixed-rate debt resulting from interest rate fluctuations. 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 counterparties with high credit ratings. 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.
The Company enters into forward exchange contracts of generally less than one year to hedge forecasted transactions between its subsidiaries and to reduce potential exposure related to fluctuations in foreign exchange rates for existing recognized assets and liabilities. 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 (loss) 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. The Company expects to record $0.4 million of net deferred losses from these forward exchange contracts during the next twelve months. 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 2012, 2011, and 2010, $0.4 million, $1.1 million, and $0.2 million of losses, respectively, were recorded due to the exclusion of forward points from the assessment of hedge effectiveness.
The impact on Accumulated other comprehensive income (loss) (OCI) and earnings from foreign exchange contracts that qualified as cash flow hedges for the twelve months ended July 31, 2012 and 2011, was as follows (thousands of dollars):
| | | | | | | |
| | July 31, | |
| | 2012 | | 2011 | |
Net carrying amount at beginning of year | | $ | 241 | | $ | (660 | ) |
Cash flow hedges deferred in OCI | | | 2,229 | | | (782 | ) |
Cash flow hedges reclassified to income (effective portion) | | | (2,960 | ) | | 1,963 | |
Change in deferred taxes | | | 117 | | | (280 | ) |
Net carrying amount at July 31 | | $ | (373 | ) | $ | 241 | |
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. The Company had no interest rate swaps outstanding at July 31, 2012 or 2011. 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 G Fair Value
Fair Value of Financial InstrumentsAt July 31, 2012 and 2011, 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, 2012, the estimated fair value of
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long-term debt with fixed interest rates was $223.5 million compared to its carrying value of $201.1 million. The fair value is estimated by discounting the projected cash flows using the rate that similar amounts of debt could currently be borrowed, classified as level 2 in the fair value hierarchy.
The following summarizes the Company’s fair value of outstanding derivatives at July 31, 2012, and 2011, on the Consolidated Balance Sheets (thousands of dollars):
| | | | | | | |
| | At July 31, | |
| | 2012 | | 2011 | |
Asset derivatives recorded under the caption Prepaids and other current assets
Foreign exchange contracts | | $ | 526 | | $ | 945 | |
| | | | | | | |
Liability derivatives recorded under the caption Other current liabilities
Foreign exchange contracts | | $ | 1,424 | | $ | 1,470 | |
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, 2012, failed to perform according to the terms of its agreement. At this time, the Company does not require collateral or any other form of securitization to be furnished by the counterparties to its derivative instruments.
The fair values of the Company’s financial assets and financial liabilities listed below reflect the amounts that would be received to sell the assets or paid to transfer the liabilities in an orderly transaction between market participants at the measurement date (exit price). The fair values are based on inputs other than quoted prices that are observable for the asset or liability. These inputs include foreign currency exchange rates and interest rates. The financial assets and financial liabilities are primarily valued using standard calculations and models that use as their basis readily observable market parameters. Industry standard data providers are the primary source for forward and spot rate information for both interest rates and currency rates.
| | | | | | | |
| | Significant Other Observable Inputs
(Level 2)*
(thousands of dollars) | |
| | At July 31, | |
| | 2012 | | 2011 | |
Forward exchange contracts – net liability position | | $ | (898 | ) | $ | (525 | ) |
*Inputs to the valuation methodology of level 2 assets include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
The Company holds equity method investments which are classified in other assets in the consolidated balance sheets. The aggregate carrying amount of these investments was $20.1 million and $19.2 million as of July 31, 2012 and 2011, respectively. These equity method investments are measured at fair value on a nonrecurring basis. The fair value of the Company’s equity method investments has not been estimated as there have been no identified events or changes in circumstance that would have had an adverse impact on the value of these investments. In the event that these investments were required to be measured, these investments would fall within Level 3 of the fair value hierarchy, due to the use of significant unobservable inputs to determine fair value, as the investments are privately-held entities without quoted market prices.
Goodwill and intangible assets are assessed for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company’s goodwill and intangible assets are not recorded at fair value as there have been no events or circumstances that would have an adverse impact on the value of these assets. In the event that an impairment was recognized, the fair value would be classified within Level 3 of the fair value hierarchy. Refer to Note C for further discussion of the annual goodwill impairment analysis and carrying values of goodwill and other intangible assets.
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The company assesses the impairment of property, plant, and equipment whenever events or changes in circumstances indicate that the carrying amount of property, plant, and equipment assets may not be recoverable. There were no impairment charges recorded in Fiscal 2012 or Fiscal 2011.
NOTE H Employee Benefit Plans
Pension PlansThe Company and certain of its international subsidiaries have defined benefit pension plans for many of their hourly and salaried employees. There are two types of U.S. plans. The first type of U.S. plan is a traditional defined benefit pension plan primarily for production employees. The second is 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.
Net periodic pension costs for the Company’s pension plans include the following components:
| | | | | | | | | | |
| | 2012 | | 2011 | | 2010 | |
| | (thousands of dollars) | |
Net periodic cost: | | | | | | | | | | |
Service cost | | $ | 15,464 | | $ | 16,148 | | $ | 13,184 | |
Interest cost | | | 19,436 | | | 19,440 | | | 19,445 | |
Expected return on assets | | | (28,114 | ) | | (27,538 | ) | | (28,390 | ) |
Transition amount amortization | | | 216 | | | 225 | | | 226 | |
Prior service cost amortization | | | 509 | | | 449 | | | 293 | |
Actuarial loss amortization | | | 5,696 | | | 3,962 | | | 2,864 | |
Net periodic benefit cost | | $ | 13,207 | | $ | 12,686 | | $ | 7,622 | |
The obligations and funded status of the Company’s pension plans as of 2012 and 2011, is as follows:
| | | | | | | |
| | 2012 | | 2011 | |
| | (thousands of dollars) | |
Change in benefit obligation: | | | | | | | |
Benefit obligation, beginning of year | | $ | 404,012 | | $ | 377,903 | |
Service cost | | | 15,464 | | | 16,148 | |
Interest cost | | | 19,436 | | | 19,440 | |
Plan amendments | | | (781 | ) | | 1,639 | |
Participant contributions | | | 1,130 | | | 1,058 | |
Actuarial loss | | | 51,914 | | | 1,034 | |
Currency exchange rates | | | (9,689 | ) | | 6,936 | |
Benefits paid | | | (19,994 | ) | | (20,146 | ) |
Benefit obligation, end of year | | $ | 461,492 | | $ | 404,012 | |
| | | | | | | |
Change in plan assets: | | | | | | | |
Fair value of plan assets, beginning of year | | $ | 373,555 | | $ | 319,734 | |
Actual return on plan assets | | | 4,442 | | | 38,758 | |
Company contributions | | | 37,915 | | | 27,655 | |
Participant contributions | | | 1,130 | | | 1,058 | |
Currency exchange rates | | | (9,472 | ) | | 6,496 | |
Benefits paid | | | (19,994 | ) | | (20,146 | ) |
Fair value of plan assets, end of year | | $ | 387,576 | | $ | 373,555 | |
| | | | | | | |
Funded status: | | | | | | | |
Underfunded status at July 31, 2012 and 2011 | | $ | (73,916 | ) | $ | (30,457 | ) |
The net underfunded status of $73.9 million at July 31, 2012 is recognized in the accompanying Consolidated Balance Sheet. Included in Accumulated other comprehensive income (loss) at July 31, 2012 are the following amounts that have not yet been recognized in net periodic pension expense: unrecognized actuarial losses of $202.6
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million, unrecognized prior service cost of $3.8 million, and unrecognized transition obligations of $2.4 million. The actuarial loss, prior service cost, and unrecognized transition obligation are included in Accumulated other comprehensive income (loss), net of tax. The amounts expected to be recognized in net periodic pension expense during Fiscal 2013 for actuarial loss, prior service cost, and unrecognized transition obligation are $10.3 million, $0.4 million, and $0.2 million, respectively. The accumulated benefit obligation for all defined benefit pension plans was $423.6 million and $365.2 million at July 31, 2012 and 2011, respectively.
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 $347.5 million, $335.1 million, and $277.5 million, respectively, as of July 31, 2012, and $294.2 million, $282.3 million, and $262.4 million, respectively, as of July 31, 2011.
For the years ended July 31, 2012 and 2011 the U.S. pension plans represented approximately 71 percent, of the Company’s total plan assets, and approximately 74 percent and 72 percent, respectively, of the Company’s total projected benefit obligation.
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 | | 2012 | | 2011 | |
All U.S. plans: | | | | | | | |
Discount rate | | | 3.59 | % | | 4.91 | % |
Rate of compensation increase | | | 2.61 | % | | 4.50 | % |
Non - U.S. plans: | | | | | | | |
Discount rate | | | 4.13 | % | | 5.36 | % |
Rate of compensation increase | | | 2.86 | % | | 3.57 | % |
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 | | 2012 | | 2011 | | 2010 | |
All U.S. plans: | | | | | | | | | | |
Discount rate | | | 4.91 | % | | 5.25 | % | | 6.00 | % |
Expected return on plan assets | | | 7.75 | % | | 8.00 | % | | 8.50 | % |
Rate of compensation increase | | | 4.50 | % | | 5.00 | % | | 5.00 | % |
Non - U.S. plans: | | | | | | | | | | |
Discount rate | | | 5.36 | % | | 5.17 | % | | 5.90 | % |
Expected return on plan assets | | | 6.03 | % | | 6.17 | % | | 6.64 | % |
Rate of compensation increase | | | 3.57 | % | | 3.69 | % | | 3.87 | % |
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. As of our measurement date of July 31, 2012, the Company decreased its long-term rate of return for the U.S. pension plans to 7.50 percent from 7.75 percent as of July 31, 2011. The Company believes that based on the asset mix and the target asset allocation, the 7.50 percent rate is an appropriate rate. This is slightly below the Company’s twenty year average but above the five and ten year averages. Thus, the Company will use the 7.50 percent rate for the calculation of its Fiscal 2013 net periodic cost. 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.
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The discount rate 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.
Plan AssetsThe Company used the following definitions to classify pension assets into either Level 1, Level 2, or Level 3:
Level 1 – Quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 – Inputs other than quoted prices available in Level 1 that are observable either directly or indirectly.
Level 3 – Unobservable inputs for the asset or liability.
The fair values of the assets held by the U.S. pension plans by asset category are as follows (in millions):
| | | | | | | | | | | | | |
Asset Category | | Quoted Prices in
Active Markets
for Identical
Assets
(Level 1) | | Significant
Observable
Inputs
(Level 2) | | Significant
Unobservable
Inputs
(Level 3) | | Total | |
2012 | | | | | | | | | | | | | |
Cash | | $ | 0.9 | | $ | — | | $ | — | | $ | 0.9 | |
Global Equity Securities | | | 61.5 | | | 57.3 | | | 0.2 | | | 119.0 | |
Fixed Income Securities | | | 29.2 | | | — | | | — | | | 29.2 | |
Private Equity | | | — | | | — | | | 19.1 | | | 19.1 | |
Alternative | | | — | | | 19.5 | | | 56.1 | | | 75.6 | |
Real Assets | | | — | | | — | | | 30.4 | | | 30.4 | |
Total U.S. Assets at July 31, 2012 | | $ | 91.6 | | $ | 76.8 | | $ | 105.8 | | $ | 274.2 | |
2011 | | | | | | | | | | | | | |
Cash | | $ | 0.3 | | $ | — | | $ | — | | $ | 0.3 | |
Global Equity Securities | | | 64.8 | | | 56.2 | | | 0.3 | | | 121.3 | |
Fixed Income Securities | | | 36.6 | | | — | | | — | | | 36.6 | |
Private Equity | | | — | | | — | | | 17.6 | | | 17.6 | |
Alternative | | | — | | | 20.1 | | | 31.4 | | | 51.5 | |
Real Assets | | | — | | | — | | | 38.0 | | | 38.0 | |
Total U.S. Assets at July 31, 2011 | | $ | 101.7 | | $ | 76.3 | | $ | 87.3 | | $ | 265.3 | |
2010 | | | | | | | | | | | | | |
Cash | | $ | 0.9 | | $ | — | | $ | — | | $ | 0.9 | |
Global Equity Securities | | | 48.7 | | | 50.2 | | | 2.4 | | | 101.3 | |
Fixed Income Securities | | | 17.1 | | | — | | | — | | | 17.1 | |
Private Equity | | | — | | | — | | | 14.8 | | | 14.8 | |
Alternative | | | — | | | 39.4 | | | 33.1 | | | 72.5 | |
Real Assets | | | — | | | 9.6 | | | 16.3 | | | 25.9 | |
Total U.S. Assets at July 31, 2010 | | $ | 66.7 | | $ | 99.2 | | $ | 66.6 | | $ | 232.5 | |
Global equity consists of publicly traded U.S. and non-U.S. equities, Australasia, Far East (EAFE) index funds, equity private placement funds, and some cash and cash equivalents. Publicly traded equities are valued at the closing price reported in the active market in which the individual securities are traded. Index funds are valued at the net asset value (NAV) as determined by the custodian of the fund. The NAV is based on the fair value of the underlying assets owned by the fund, minus its liabilities then divided by the number of units outstanding.
Fixed income consists primarily of investment grade debt securities, but may include up to 10% in high yield securities rated B or higher by Moody’s or S&P. It may also include up to 20% in securities dominated in foreign currencies. Corporate and other bonds and notes are valued at either the yields currently available on comparable securities of issuers with similar credit ratings or valued under a discounted cash flows approach that maximizes
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observable inputs, such as current yields of similar instruments, but includes adjustments for certain risks that may not be observable such as credit and liquidity risks.
Private equity consists of interests in partnerships that invest in U.S. and non-U.S. debt and equity securities. The portfolio is a diversified mix of partnership interests including buyouts, distressed debt, growth equity, mezzanine, real estate, and venture capital investments. Partnership interests are valued using the most recent general partner statement of fair value, updated for any subsequent partnership interests’ cash flow.
Alternative consists primarily of private partnership interests in hedge funds of funds. Partnership interests are valued using the NAV as determined by the administrator or custodian of the fund.
Real Assets consist of commodity funds, Real Estate Investment Trusts (REITS), and interests in partnerships that invest in private real estate, commodity, and timber investments. Private investments are valued using the most recent partnership statement of fair value, updated for any subsequent partnership interests’ cash flows. Commodity funds and REITS are valued at the closing price reported in the active market in which they are traded.
The following table sets forth a summary of changes in the fair values of the U.S. pension plans’ Level 3 assets for the years ended July 31, 2012, 2011, and 2010 (in millions):
| | | | | | | | | | | | | | | | |
| | Global
Equity | | Private
Equity | | Alternative | | Real Assets | | Total | |
Beginning balance at August 1, 2009 | | $ | 2.7 | | $ | 11.4 | | $ | 41.4 | | $ | 15.5 | | $ | 71.0 | |
Unrealized gains | | | 0.1 | | | 1.8 | | | 2.8 | | | 0.1 | | | 4.8 | |
Realized gains | | | — | | | — | | | 0.7 | | | — | | | 0.7 | |
Purchases, sales, issuances and settlements, net | | | (0.4 | ) | | 1.6 | | | (11.8 | ) | | 0.7 | | | (9.9 | ) |
Ending balance at July 31, 2010 | | $ | 2.4 | | $ | 14.8 | | $ | 33.1 | | $ | 16.3 | | $ | 66.6 | |
Unrealized gains | | | — | | | 1.5 | | | 2.1 | | | 3.4 | | | 7.0 | |
Realized gains | | | — | | | 1.0 | | | — | | | — | | | 1.0 | |
Purchases, sales, issuances and settlements, net | | | (2.1 | ) | | 0.3 | | | (3.8 | ) | | 18.3 | | | 12.7 | |
Ending balance at July 31, 2011 | | $ | 0.3 | | $ | 17.6 | | $ | 31.4 | | $ | 38.0 | | $ | 87.3 | |
Unrealized gains | | | (0.1 | ) | | 0.2 | | | (0.3 | ) | | (1.2 | ) | | (1.4 | ) |
Realized gains | | | 0.1 | | | 1.4 | | | 0.4 | | | — | | | 1.9 | |
Purchases, sales, issuances and settlements, net | | | (0.1 | ) | | (0.1 | ) | | 17.3 | | | 0.9 | | | 18.0 | |
Net transfers into (out of) level 3 | | | — | | | — | | | 7.3 | | | (7.3 | ) | | — | |
Ending balance at July 31, 2012 | | $ | 0.2 | | $ | 19.1 | | $ | 56.1 | | $ | 30.4 | | $ | 105.8 | |
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Fair values of the assets held by the international pension plans by asset category are as follows (in millions):
| | | | | | | | | | | | | |
Asset Category | | Quoted Prices in
Active Markets
for Identical
Assets
(Level 1) | | Significant
Observable
Inputs
(Level 2) | | Significant
Unobservable
Inputs
(Level 3) | | Total | |
2012 | | | | | | | | | | | | | |
Global Equity Securities | | $ | 37.1 | | $ | — | | $ | — | | $ | 37.1 | |
Fixed Income Securities | | | 5.9 | | | 28.4 | | | — | | | 34.3 | |
Equity/Fixed Income | | | 13.3 | | | — | | | 21.8 | | | 35.1 | |
Real Assets | | | — | | | 6.8 | | | — | | | 6.8 | |
Total International Assets at July 31, 2012 | | $ | 56.3 | | $ | 35.2 | | $ | 21.8 | | $ | 113.3 | |
2011 | | | | | | | | | | | | | |
Global Equity Securities | | $ | 33.5 | | $ | — | | $ | — | | $ | 33.5 | |
Fixed Income Securities | | | — | | | 26.5 | | | — | | | 26.5 | |
Equity/Fixed Income | | | 15.4 | | | — | | | 26.3 | | | 41.7 | |
Real Assets | | | — | | | 6.5 | | | — | | | 6.5 | |
Total International Assets at July 31, 2011 | | $ | 48.9 | | $ | 33.0 | | $ | 26.3 | | $ | 108.2 | |
2010 | | | | | | | | | | | | | |
Global Equity Securities | | $ | 26.8 | | $ | — | | $ | — | | $ | 26.8 | |
Fixed Income Securities | | | — | | | 20.7 | | | — | | | 20.7 | |
Equity/Fixed Income | | | 12.5 | | | — | | | 21.7 | | | 34.2 | |
Real Assets | | | — | | | 5.5 | | | — | | | 5.5 | |
Total International Assets at July 31, 2010 | | $ | 39.3 | | $ | 26.2 | | $ | 21.7 | | $ | 87.2 | |
Global equity consists of a fixed weights index fund, used to maintain a fixed 50/50 distribution between UK and overseas assets. Publicly traded equities are valued at the closing price reported in the active market in which the individual securities are traded.
Fixed income consists primarily of investment grade debt securities. Corporate bonds and notes are valued at either the yields currently available on comparable securities of issuers with similar credit ratings or valued under a discounted cash flows approach that maximizes observable inputs, such as current yields of similar instruments, but includes adjustments for certain risks that may not be observable such as credit and liquidity risks.
Equity/Fixed Income consists of Level 1 assets that are part of a unit linked fund with a strategic asset allocation of 40% fixed income products and 60% equity type products. Assets are valued at either the closing price reported if traded on an active market or at yields currently available on comparable securities of issuers with similar credit ratings. Index funds are valued at the net asset value as determined by the custodian of the fund. The Level 3 assets are composed of mathematical reserves on individual contracts and the Company does not have any influence on the investment decisions as made by the insurer due to the specific minimum guaranteed return characteristics of this type of contract. European insurers in general, broadly have a strategic asset allocation with 80%-90% fixed income products and 20%-10% equity type products (including real estate).
Real Assets consists of property funds. Property funds are valued using the most recent partnership statement of fair value, updated for any subsequent partnership interests’ cash flows.
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The following table sets forth a summary of changes in the fair values of the International pension plans’ Level 3 assets for the years ended July 31, 2012, 2011, and 2010 (in millions):
| | | | |
| | Equity/Fixed
Income | |
Beginning balance at August 1, 2009 | | $ | 23.1 | |
Unrealized gains | | | 0.3 | |
Foreign currency exchange | | | (1.9 | ) |
Purchases, sales, issuances and settlements, net | | | 0.2 | |
Ending balance at July 31, 2010 | | $ | 21.7 | |
Unrealized gains | | | 0.9 | |
Foreign currency exchange | | | 2.5 | |
Purchases, sales, issuances and settlements, net | | | 1.2 | |
Ending balance at July 31, 2011 | | $ | 26.3 | |
Unrealized gains | | | 1.4 | |
Foreign currency exchange | | | (3.8 | ) |
Purchases, sales, issuances and settlements, net | | | (2.0 | ) |
Net transfers into (out of) Level 3 | | | (0.1 | ) |
Ending balance at July 31, 2012 | | $ | 21.8 | |
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 plans’ investments are diversified to assist in managing risk. The Company’s asset allocation guidelines target an allocation of 45 percent equity securities, 30 percent alternative investments (funds of hedge funds), 10 percent real assets (investments into funds containing commodities and real estate), 10 percent fixed income, and 5 percent private equity. Within equity securities, the Company will target an allocation of 15 percent international, 15 percent equity long/short, 10 percent small cap and 5 percent 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.
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. 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.
Estimated Contributions and Future PaymentsThe Company’s general funding policy for its pension plans is to make at least the minimum contributions as required by applicable regulations. Additionally, the Company may elect to make additional contributions up to the maximum tax deductible contribution. As such, the Company made contributions of $25.5 million to its U.S. pension plans in Fiscal 2012. The minimum funding requirement for the Company’s U.S. plans for Fiscal 2013 is $13.5 million. Per the Pension Protection Act of 2006, this obligation could be met with existing credit balances. The Company is still considering whether a cash contribution will be made. The Company made contributions of $12.5 million to its non-U.S. pension plans in Fiscal 2012 and estimates that it will contribute approximately $7.0 million in Fiscal 2013 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 requirements.
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Estimated future benefit payments for the Company’s U.S. and non-U.S. plans are as follows (thousands of dollars):
| | | | | |
Fiscal Year | | | | | |
2013 | | | $ | 19,516 | |
2014 | | | $ | 22,667 | |
2015 | | | $ | 20,875 | |
2016 | | | $ | 21,399 | |
2017 | | | $ | 28,955 | |
2018-2022 | | | $ | 142,611 | |
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 $1.5 million as of July 31, 2012 and July 31, 2011. The annual cost resulting from these benefits is not material. For measurement purposes, a 7.3 percent annual rate of increase in the per capita cost of covered health care benefits was assumed for Fiscal 2012. The Company has assumed that the long-term rate of increase will decrease gradually to an ultimate annual rate of 4.5 percent. A one-percentage point increase in the health care cost trend rate would increase the Fiscal 2012 and 2011 liability by $0.1 million.
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. 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. Total contribution expense for these plans was $5.5 million, $9.1 million, and $4.5 million for the years ended July 31, 2012, 2011, and 2010, respectively. This plan also includes shares from an Employee Stock Ownership Plan (“ESOP”). As of July 31, 2012, all shares of the ESOP have been allocated to participants. 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 of their 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 the Internal Revenue Code. The Company has recorded a liability in the amount of $9.5 million and $9.2 million as of the year ended July 31, 2012 and July 31, 2011, respectively, related primarily to its deferred compensation plans.
NOTE I 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 2010 Master Stock Incentive Plan, as well as performance awards payable in common stock discussed further in Note J.
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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 up to 16.0 million shares of common stock under the stock repurchase plan dated March 26, 2010. As of July 31, 2012, the Company had remaining authorization to repurchase 5.6 million shares under this plan. Following is a summary of treasury stock share activity for Fiscal 2012 and 2011:
| | | | | | | |
| | 2012 | | 2011 | |
Balance at beginning of year | | | 13,245,864 | | | 12,222,381 | |
Stock repurchases | | | 4,503,587 | | | 1,956,648 | |
Net issuance upon exercise of stock options | | | (1,270,526 | ) | | (862,981 | ) |
Issuance under compensation plans | | | (89,528 | ) | | (62,304 | ) |
Stock split and other activity | | | (12,408,565 | ) | | (7,880 | ) |
Balance at end of year | | | 3,980,832 | | | 13,245,864 | |
NOTE J Stock Option Plans
Employee Incentive PlansIn November 2010 shareholders approved the 2010 Master Stock Incentive Plan (the “Plan”) that replaced the 2001 Plan that was scheduled to expire on December 31, 2010 and provided for similar awards. The Plan extends through September 2020 and allows for the granting of nonqualified stock options, incentive stock options, restricted stock, restricted stock units, stock appreciation rights (“SAR”), dividend equivalents, and other stock-based awards. Options under the Plan are granted to key employees at market price at the date of grant. Options are exercisable for up 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. Performance award expense under these plans totaled $1.9 million in Fiscal 2012 and $1.8 million in Fiscal 2011.
Stock options issued from Fiscal 2002 to Fiscal 2012 become exercisable for non-executives in equal increments over three years. Stock options issued in Fiscal 2012 and Fiscal 2011 become exercisable for executives in equal increments over three years. Stock options issued from Fiscal 2002 to Fiscal 2010 became exercisable for most executives immediately upon the date of grant. Certain other stock options issued to executives during Fiscal 2004, 2006, and 2007 became exercisable in equal increments over three years. For Fiscal 2012, the Company recorded pretax compensation expense associated with stock options of $7.8 million and recorded $2.5 million of related tax benefit. For Fiscal 2011 and 2010, the Company recorded pretax compensation expense associated with stock options of $6.5 million and $6.9 million, respectively, and $2.1 million and $2.4 million, respectively, of related tax benefit.
Stock-based employee compensation cost is recognized using the fair-value based method. The Company determined the fair value of these awards using the Black-Scholes option pricing model, with the following weighted average assumptions:
| | | | | | | | | | |
| | 2012 | | 2011 | | 2010 | |
Risk - free interest rate | | | <0.11 - 1.8 | % | | <0.12 - 3.1 | % | | < 0.01 - 3.9 | % |
Expected volatility | | | 25.8 - 31.9 | % | | 25.5 - 34.7 | % | | 24.4 - 32.3 | % |
Expected dividend yield | | | 1.0 | % | | 1.0 | % | | 1.0 | % |
| | | | | | | | | | |
Expected life | | | | | | | | | | |
Director original grants without reloads | | | 8 years | | | 8 years | | | 8 years | |
Non - officer original grants | | | 7 years | | | 8 years | | | 7 - 8 years | |
Officer original grants with reloads | | | — | | | — | | | 4 years | |
Reload grants | | | <8 years | | | <8 years | | | <8 years | |
Officer original grants without reloads | | | 8 years | | | 8 years | | | 8 years | |
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 2012, 2011, and 2010 is $9.37, $8.63, and $6.62 per share, respectively, using the Black-Scholes pricing model.
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 grant is for the
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number of shares equal to the shares used in payment of the purchase price and/or withheld for minimum tax withholding. Beginning in Fiscal 2011, options no longer have a reload provision for Officers and Directors.
The following table summarizes stock option activity:
| | | | | | | |
| | Options
Outstanding | | Weighted
Average Exercise
Price | |
Outstanding at July 31, 2009 | | | 9,996,250 | | $ | 13.47 | |
Granted | | | 1,287,948 | | | 21.21 | |
Exercised | | | (1,697,980 | ) | | 10.42 | |
Canceled | | | (42,594 | ) | | 20.97 | |
Outstanding at July 31, 2010 | | | 9,543,624 | | | 15.02 | |
Granted | | | 1,103,202 | | | 28.61 | |
Exercised | | | (2,243,502 | ) | | 11.55 | |
Canceled | | | (15,330 | ) | | 23.60 | |
Outstanding at July 31, 2011 | | | 8,387,994 | | | 17.72 | |
Granted | | | 1,082,979 | | | 34.76 | |
Exercised | | | (1,379,827 | ) | | 11.90 | |
Canceled | | | (34,819 | ) | | 27.45 | |
Outstanding at July 31, 2012 | | | 8,056,327 | | | 20.97 | |
The total intrinsic value of options exercised during Fiscal 2012, 2011, and 2010 was $29.5 million, $34.2 million, and $19.5 million, respectively.
Shares reserved at July 31, 2012 for outstanding options and future grants were 15,288,416. Shares reserved consist of shares available for grant plus all outstanding options. Upon shareholder approval of the 2010 Master Stock Incentive Plan, 9,200,000 shares were added to shares reserved.
The following table summarizes information concerning outstanding and exercisable options as of July 31, 2012:
| | | | | | | | | | | | | | | | |
Range of Exercise Prices | | Number
Outstanding | | Weighted
Average
Remaining
Contractual
Life (Years) | | Weighted
Average
Exercise
Price | | Number
Exercisable | | Weighted
Average
Exercise
Price | |
$8.89 to $12.89 | | | 559,800 | | | 0.75 | | $ | 9.99 | | | 559,800 | | $ | 9.99 | |
$12.90 to $16.89 | | | 2,430,944 | | | 2.34 | | | 15.53 | | | 2,430,944 | | | 15.53 | |
$16.90 to $20.89 | | | 1,476,801 | | | 5.32 | | | 17.84 | | | 1,465,291 | | | 17.85 | |
$20.90 to $24.89 | | | 1,541,740 | | | 6.67 | | | 21.78 | | | 1,371,437 | | | 21.86 | |
$24.90 and above | | | 2,047,042 | | | 8.61 | | | 32.08 | | | 423,458 | | | 30.07 | |
| | | 8,056,327 | | | 5.20 | | | 20.97 | | | 6,250,930 | | | 17.95 | |
At July 31, 2012, the aggregate intrinsic value of shares outstanding and exercisable was $116.7 million and $109.4 million, respectively.
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The following table summarizes the status of options which contain vesting provisions:
| | | | | | | |
| | Options | | Weighted
Average Grant
Date Fair
Value | |
Non - vested at July 31, 2011 | | | 1,385,750 | | $ | 8.45 | |
Granted | | | 1,004,500 | | | 9.63 | |
Vested | | | (550,868 | ) | | 8.06 | |
Canceled | | | (33,985 | ) | | 8.42 | |
Non - vested at July 31, 2012 | | | 1,805,397 | | | 9.22 | |
The total fair value of shares vested during Fiscal 2012, 2011, and 2010 was $19.5 million, $10.5 million, and $8.0 million, respectively.
As of July 31, 2012, there was $8.1 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 2013, Fiscal 2014, and Fiscal 2015.
NOTE K Income Taxes
The components of earnings before income taxes are as follows:
| | | | | | | | | | |
| | 2012 | | 2011 | | 2010 | |
| | (thousands of dollars) | |
Earnings before income taxes: | | | | | | | | | | |
United States | | $ | 171,101 | | $ | 117,562 | | $ | 85,987 | |
Foreign | | | 199,679 | | | 194,701 | | | 144,189 | |
Total | | $ | 370,780 | | $ | 312,263 | | $ | 230,176 | |
The components of the provision for income taxes are as follows:
| | | | | | | | | | |
| | 2012 | | 2011 | | 2010 | |
| | (thousands of dollars) | |
Income taxes: | | | | | | | | | | |
Current | | | | | | | | | | |
Federal | | $ | 45,468 | | $ | 26,675 | | $ | 25,455 | |
State | | | 4,012 | | | 3,555 | | | 2,206 | |
Foreign | | | 50,655 | | | 54,785 | | | 33,327 | |
| | | 100,135 | | | 85,015 | | | 60,988 | |
Deferred | | | | | | | | | | |
Federal | | | 7,391 | | | 8,556 | | | 3,860 | |
State | | | 722 | | | 191 | | | 20 | |
Foreign | | | (1,769 | ) | | (6,790 | ) | | (855 | ) |
| | | 6,344 | | | 1,957 | | | 3,025 | |
Total | | $ | 106,479 | | $ | 86,972 | | $ | 64,013 | |
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The following table reconciles the U.S. statutory income tax rate with the effective income tax rate:
| | | | | | | | | | |
| | 2012 | | 2011 | | 2010 | |
Statutory U.S. federal rate | | | 35.0 | % | | 35.0 | % | | 35.0 | % |
State income taxes | | | 1.2 | | | 1.0 | | | 0.8 | |
Foreign taxes at lower rates | | | (6.0 | ) | | (6.6 | ) | | (8.2 | ) |
Export, manufacturing and research credits | | | (1.0 | ) | | (1.6 | ) | | (0.9 | ) |
U.S. tax impact on repatriation of earnings | | | 0.8 | | | (0.3 | ) | | 0.1 | |
Change in unrecognized tax benefits | | | (1.0 | ) | | 0.1 | | | 1.2 | |
Other | | | (0.3 | ) | | 0.3 | | | (0.2 | ) |
| | | 28.7 | % | | 27.9 | % | | 27.8 | % |
The tax effects of temporary differences that give rise to deferred tax assets and liabilities are as follows:
| | | | | | | | | | |
| | 2012 | | 2011 | |
| | (thousands of dollars) | |
Deferred tax assets: | | | | | | | |
Accrued expenses | | $ | 10,666 | | $ | 12,243 | |
Compensation and retirement plans | | | 52,986 | | | 33,298 | |
Tax credit and NOL carryforwards | | | 723 | | | 1,173 | |
Inventory reserves | | | 7,482 | | | 9,545 | |
Other | | | 3,262 | | | 3,311 | |
Deferred tax assets: | | | 75,119 | | | 59,570 | |
Valuation allowance | | | (522 | ) | | (692 | ) |
Net deferred tax assets | | | 74,597 | | | 58,878 | |
Deferred tax liabilities: | | | | | | | |
Depreciation and amortization | | | (38,796 | ) | | (37,112 | ) |
Other | | | (394 | ) | | (1,119 | ) |
Deferred tax liabilities | | | (39,190 | ) | | (38,231 | ) |
Net deferred tax asset | | $ | 35,407 | | $ | 20,647 | |
The effective tax rate for Fiscal 2012 was 28.7 percent compared to 27.9 percent in Fiscal 2011. The increase in effective tax rate is primarily due to an unfavorable shift in the mix of earnings between tax jurisdictions, which increased the underlying average tax rate over the prior year to 30.8 percent from 29.7 percent. The increase in the underlying average tax rate was partially offset by incremental discrete benefits resulting in Fiscal 2012. Fiscal 2012 contained $7.7 million of discrete tax benefits from the favorable settlements of tax audits, the expiration of statutes in various jurisdictions, and other discrete items. Fiscal 2011 contained $5.8 million of discrete tax benefits primarily from the release of reserves after the favorable conclusions of foreign tax audits, the expiration of statutes in various jurisdictions, and the favorable impact of dividends from some foreign subsidiaries.
The Company has not provided for U.S. income taxes on additional undistributed earnings of non-U.S. subsidiaries of approximately $756.0 million. The Company currently intends to indefinitely reinvest these undistributed earnings overseas as there are significant investment opportunities there or to repatriate the earnings only when it is tax effective to do so. 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 Company has cumulative pre-tax loss carryforwards of $2.7 million, which exist in various international subsidiaries. If fully realized, the unexpired net operating losses may be carried forward to offset future local income tax payments of $0.7 million, at current rates of tax. Approximately 5 percent of these net operating losses expire within the next three years, while the majority of the remaining net operating loss carryforwards expire more than 5 years out or have no statutory expiration under current local laws. However, as it is more-likely-than-not that certain of these losses will not be realized, a valuation allowance of $0.5 million exists as of July 31, 2012.
The Company maintains a reserve for uncertain tax benefits. The accounting 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
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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. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits is as follows:
| | | | | | | | | | |
| | 2012 | | 2011 | | 2010 | |
| | (thousands of dollars) | |
Gross unrecognized tax benefits at beginning of fiscal year | | $ | 20,005 | | $ | 18,994 | | $ | 16,928 | |
Additions for tax positions of the current year | | | 3,323 | | | 7,406 | | | 3,122 | |
Additions for tax positions of prior years | | | 261 | | | 668 | | | 470 | |
Reductions for tax positions of prior years | | | (333 | ) | | (164 | ) | | (179 | ) |
Settlements | | | (4,129 | ) | | (3,895 | ) | | — | |
Reductions due to lapse of applicable statue of limitations | | | (2,613 | ) | | (3,004 | ) | | (1,347 | ) |
Gross unrecognized tax benefits at end of fiscal year | | $ | 16,514 | | $ | 20,005 | | $ | 18,994 | |
The Company recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. During the fiscal year ended July 31, 2012, the Company recognized interest expense, net of tax benefit, of approximately $0.3 million. At July 31, 2012 and July 31, 2011, accrued interest and penalties on a gross basis were $1.3 million and $1.5 million, respectively.
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 | | 2010 through 2011 |
China | | 2002 through 2011 |
France | | 2009 through 2011 |
Germany | | 2009 through 2011 |
Italy | | 2003 through 2011 |
Japan | | 2009 through 2011 |
Mexico | | 2006 through 2011 |
Thailand | | 2005 through 2011 |
United Kingdom | | 2011 |
United States | | 2011 |
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 $2.1 million of the unrecognized tax benefits could potentially expire in the next 12 month period, unless extended by audit. It is possible that quicker than expected settlement of either current or future audits and disputes would cause additional reversals of previously recorded reserves in the next 12 month period. Currently, the Company has approximately $0.2 million of unrecognized tax benefits that are in formal dispute with various taxing authorities related to transfer pricing and deductibility of expenses. Quantification of an estimated range and timing of future audit settlements cannot be made at this time.
NOTE L Segment Reporting
Consistent with FASB guidance related to segment reporting, 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 truck markets and to independent distributors, OEM dealer networks, private label accounts, and large equipment fleets. Products include air filtration systems, exhaust and emissions systems, liquid filtration systems including hydraulics, fuel and lube, and replacement filters.
The Industrial Products segment sells to various industrial end-users, OEMs of gas-fired turbines, and OEMs and end-users requiring clean air. Products include dust, fume, and mist collectors, compressed air purification systems, air filtration systems for gas turbines, PTFE membrane-based products, and specialized air and gas filtration systems for applications including computer hard disk drives, and other electronic equipment.
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Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments, interest income, and interest 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 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 relate to general corporate purposes and are 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.
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 operating profit and other financial information shown below.
Segment detail is summarized as follows:
| | | | | | | | | | | | | |
| | Engine
Products | | Industrial
Products | | Corporate &
Unallocated | | Total
Company | |
| | (thousands of dollars) | |
2012 | | | | | | | | | | | | | |
Net sales | | $ | 1,570,140 | | $ | 923,108 | | $ | — | | $ | 2,493,248 | |
Depreciation and amortization | | | 36,646 | | | 18,852 | | | 5,667 | | | 61,165 | |
Equity earnings in unconsolidated affiliates | | | 3,966 | | | 769 | | | — | | | 4,735 | |
Earnings before income taxes | | | 227,941 | | | 149,249 | | | (6,410 | ) | | 370,780 | |
Assets | | | 845,176 | | | 520,739 | | | 364,167 | | | 1,730,082 | |
Equity investments in unconsolidated affiliates | | | 17,304 | | | 2,822 | | | — | | | 20,126 | |
Capital expenditures, net of acquired businesses | | | 46,816 | | | 24,083 | | | 7,240 | | | 78,139 | |
2011 | | | | | | | | | | | | | |
Net sales | | $ | 1,440,495 | | $ | 853,534 | | $ | — | | $ | 2,294,029 | |
Depreciation and amortization | | | 36,338 | | | 19,396 | | | 4,757 | | | 60,491 | |
Equity earnings in unconsolidated affiliates | | | 3,302 | | | 803 | | | — | | | 4,105 | |
Earnings before income taxes | | | 211,255 | | | 123,871 | | | (22,863 | ) | | 312,263 | |
Assets | | | 888,080 | | | 519,730 | | | 318,283 | | | 1,726,093 | |
Equity investments in unconsolidated affiliates | | | 16,619 | | | 2,558 | | | — | | | 19,177 | |
Capital expenditures, net of acquired businesses | | | 36,423 | | | 19,442 | | | 4,768 | | | 60,633 | |
2010 | | | | | | | | | | | | | |
Net sales | | $ | 1,126,007 | | $ | 751,057 | | $ | — | | $ | 1,877,064 | |
Depreciation and amortization | | | 33,433 | | | 20,935 | | | 4,864 | | | 59,232 | |
Equity earnings in unconsolidated affiliates | | | 1,859 | | | 160 | | | — | | | 2,019 | |
Earnings before income taxes | | | 155,833 | | | 91,084 | | | (16,741 | ) | | 230,176 | |
Assets | | | 702,300 | | | 477,154 | | | 320,052 | | | 1,499,506 | |
Equity investments in unconsolidated affiliates | | | 14,860 | | | 625 | | | — | | | 15,485 | |
Capital expenditures, net of acquired businesses | | | 24,355 | | | 15,250 | | | 3,544 | | | 43,149 | |
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Following are net sales by product within the Engine Products segment and Industrial Products segment:
| | | | | | | | | | |
| | 2012 | | 2011 | | 2010 | |
| | (thousands of dollars) | |
Engine Products segment: | | | | | | | | | | |
Off-Road Products | | $ | 376,870 | | $ | 327,557 | | $ | 222,329 | |
On-Road Products | | | 163,934 | | | 127,107 | | | 81,874 | |
Aftermarket Products* | | | 907,306 | | | 861,393 | | | 691,899 | |
Retrofit Emissions Products | | | 15,354 | | | 19,555 | | | 17,928 | |
Aerospace and Defense Products | | | 106,676 | | | 104,883 | | | 111,977 | |
Total Engine Products segment | | | 1,570,140 | | | 1,440,495 | | | 1,126,007 | |
Industrial Products segment: | | | | | | | | | | |
Industrial Filtration Solutions Products | | | 553,453 | | | 507,646 | | | 423,050 | |
Gas Turbine Products | | | 180,669 | | | 154,726 | | | 150,131 | |
Special Applications Products | | | 188,986 | | | 191,162 | | | 177,876 | |
Total Industrial Products segment | | | 923,108 | | | 853,534 | | | 751,057 | |
Total Company | | $ | 2,493,248 | | $ | 2,294,029 | | $ | 1,877,064 | |
| |
* | Includes replacement part sales to the Company’s OEM Customers. |
Geographic sales by origination and property, plant and equipment:
| | | | | | | |
| | Net Sales | | Property, Plant &
Equipment - Net | |
| | (thousands of dollars) | |
2012 | | | | | | | |
United States | | $ | 1,064,474 | | $ | 146,328 | |
Europe | | | 678,619 | | | 114,266 | |
Asia - Pacific | | | 572,163 | | | 80,200 | |
Other | | | 177,992 | | | 44,115 | |
Total | | $ | 2,493,248 | | $ | 384,909 | |
| | | | | | | |
2011 | | | | | | | |
United States | | $ | 941,218 | | $ | 141,584 | |
Europe | | | 653,275 | | | 131,739 | |
Asia - Pacific | | | 540,874 | | | 81,035 | |
Other | | | 158,662 | | | 37,144 | |
Total | | $ | 2,294,029 | | $ | 391,502 | |
| | | | | | | |
2010 | | | | | | | |
United States | | $ | 745,400 | | $ | 139,717 | |
Europe | | | 545,803 | | | 122,646 | |
Asia - Pacific | | | 460,470 | | | 72,950 | |
Other | | | 125,391 | | | 30,579 | |
Total | | $ | 1,877,064 | | $ | 365,892 | |
ConcentrationsThere were no Customers over 10 percent of net sales during Fiscal 2012, 2011, and 2010. There was one Customer over 10 percent of gross accounts receivable in Fiscal 2012 and no customers over 10 percent of gross accounts receivable in Fiscal 2011.
NOTE M Guarantees
The Company and Caterpillar Inc. equally own the shares of Advanced Filtration Systems Inc. (AFSI), an unconsolidated joint venture, and guarantee certain debt of the joint venture. As of July 31, 2012, the joint venture had
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$21.7 million of outstanding debt, of which the Company guarantees half. In addition, during Fiscal 2012, 2011, and 2010, the Company recorded its equity in earnings of this equity method investment of $2.0 million, $1.6 million, and $0.4 million and royalty income of $6.2 million, $6.2 million, and $5.4 million, respectively, related to AFSI.
At July 31, 2012 and 2011, the Company had a contingent liability for standby letters of credit totaling $10.9 million and $11.4 million, respectively, which have been issued and are outstanding. The letters of credit guarantee payment to 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, 2012 and 2011, there were no amounts drawn upon these letters of credit.
NOTE N Warranty
The Company provides for warranties on certain products. In addition, the Company may incur specific Customer warranty issues. Following is a reconciliation of warranty reserves (in thousands of dollars):
| | | | |
Balance at July 31, 2010 | | $ | 15,707 | |
Accruals for warranties issued during the reporting period | | | 8,406 | |
Accruals related to pre-existing warranties (including changes in estimates) | | | 7,735 | |
Less settlements made during the period | | | (12,128 | ) |
Balance at July 31, 2011 | | $ | 19,720 | |
Accruals for warranties issued during the reporting period | | | 5,002 | |
Accruals related to pre-existing warranties (including changes in estimates) | | | (2,956 | ) |
Less settlements made during the period | | | (10,861 | ) |
Balance at July 31, 2012 | | $ | 10,905 | |
During Fiscal 2011, the increase in warranty accruals was primarily due to three specific warranty matters: one in the Company’s Retrofit Emissions Product group for $3.6 million, one in the Company’s Off-Road Products group for $1.8 million, and one in the On-Road Product group for $4.1 million. These warranty accruals were partially offset by supplier and insurance recoveries of $4.2 million. These warranty matters are not expected to have a material impact on our results of operations, liquidity, or financial position. There were no significant specific warranty matters accrued for in Fiscal 2012. The settlements made during Fiscal 2012 were primarily in relation to the three above mentioned matters.
NOTE O Commitments and Contingencies
Operating Leases The Company enters into operating leases primarily for office and warehouse facilities, production and non-production equipment, automobiles, and computer equipment. Total expense recorded under operating leases for the periods ended July 31, 2012 and 2011 were $26.8 million and $24.3 million, respectively. Future commitments under operating leases are: $11.8 million in Fiscal 2013, $7.7 million in Fiscal 2014, $4.1 million in Fiscal 2015, $1.7 million in Fiscal 2016, $0.8 million in Fiscal 2017, and $0.4 million thereafter.
LitigationThe Company records provisions with respect to identified claims or lawsuits when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Claims and lawsuits are reviewed quarterly and provisions are taken or adjusted to reflect the status of a particular matter. The Company believes the recorded reserves in its consolidated financial statements are adequate in light of the probable and estimable outcomes. The recorded liabilities were not material to the Company’s financial position, results of operations, or liquidity and the Company does not believe that any of the currently identified claims or litigation will materially affect its financial position, results of operations, or liquidity.
The Company has reached a preliminary agreement to settle the class action lawsuits filed in 2008 alleging that 12 filter manufacturers, including the Company, engaged in a conspiracy to fix prices, rig bids, and allocate U.S. Customers for aftermarket automotive filters. The U.S. cases have been consolidated into a single multi-district litigation in the Northern District of Illinois. The Company denies any liability and has vigorously defended the claims raised in these lawsuits. The settlement will fully resolve all claims brought against the Company in the lawsuits and the Company does not admit any liability or wrongdoing. The settlement is still subject to Court approval and will not have a material impact on the Company’s financial position, results of operations, or liquidity.
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NOTE P 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 | |
Accruals for restructuring during the reporting period | | | 8,023 | |
Less settlements made during the period | | | (7,724 | ) |
Balance at July 31, 2010 | | $ | 4,139 | |
Accruals for restructuring during the reporting period | | | 759 | |
Less settlements made during the period | | | (4,898 | ) |
Balance at July 31, 2011 | | $ | — | |
Certain restructuring actions commenced in Fiscal 2009 in response to the dramatic downturn in the worldwide economy and these actions and related costs carried over into Fiscal 2010 and Fiscal 2011. In Fiscal 2011, the Engine Products segment incurred minimal restructuring expenses and Industrial Products segment incurred $0.7 million in restructuring expenses. The restructuring expenses in Fiscal 2011 include employee severance costs for approximately five employees related to the completion of the Company’s planned restructuring activities. There was no restructuring activity during Fiscal 2012.
The fiscal 2010 costs were employee severance costs related to the reduction in workforce of approximately 550 employees. In addition to these restructuring costs, the Company recorded $2.1 million in asset impairment costs related to the downsizing of a plant in Germany. Fiscal 2009 included $17.3 million in employee severance costs related to the reduction in workforce of approximately 2,800 employees. In addition, $0.5 million was incurred primarily for distribution center consolidation and production line transfers.
Restructuring and asset impairment expense detail is summarized as follows (in thousands):
| | | | | | | | | | |
| | Fiscal Year | |
| | 2012 | | 2011 | | 2010 | |
Gross Margin | | $ | — | | $ | 20 | | $ | 7,488 | |
Operating expenses | | | — | | | 739 | | | 2,677 | |
Total restructuring and asset impairment expenses | | $ | — | | $ | 759 | | $ | 10,165 | |
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NOTE Q Quarterly Financial Information (Unaudited)
| | | | | | | | | | | | | |
| | First
Quarter | | | Second
Quarter | | | Third
Quarter | | | Fourth
Quarter | |
| | (In thousands) | |
2012 | | | | | | | | | | | | | |
Net sales | | $ | 608,295 | | $ | 580,883 | | $ | 647,237 | | $ | 656,833 | |
Gross margin | | | 214,934 | | | 200,817 | | | 228,229 | | | 229,783 | |
Net earnings | | | 68,553 | | | 53,821 | | | 70,946 | | | 70,981 | |
Basic earnings per share | | | 0.46 | | | 0.36 | | | 0.47 | | | 0.47 | |
Diluted earnings per share | | | 0.45 | | | 0.35 | | | 0.46 | | | 0.47 | |
Dividends declared per share | | | 0.075 | | | 0.080 | | | 0.090 | | | 0.090 | |
Dividends paid per share | | | 0.075 | | | 0.075 | | | 0.080 | | | 0.090 | |
| | | | | | | | | | | | | |
2011 | | | | | | | | | | | | | |
Net sales | | $ | 536,909 | | $ | 537,105 | | $ | 594,565 | | $ | 625,450 | |
Gross margin | | | 188,090 | | | 189,543 | | | 209,158 | | | 227,005 | |
Net earnings | | | 53,134 | | | 44,579 | | | 61,811 | | | 65,767 | |
Basic earnings per share | | | 0.34 | | | 0.29 | | | 0.40 | | | 0.43 | |
Diluted earnings per share | | | 0.34 | | | 0.28 | | | 0.39 | | | 0.42 | |
Dividends declared per share | | | — | | | 0.130 | | | — | | | 0.150 | |
Dividends paid per share | | | 0.063 | | | 0.065 | | | 0.065 | | | 0.075 | |
Note: the above table reflects the impact of the two-for-one stock split that occurred on March 23, 2012.
The first quarter of Fiscal 2011 included restructuring charges after-tax of $0.6 million or $0.01 per share.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls 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, 2012, 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 27.
Report of Independent Registered Public Accounting Firm
See Report of Independent Registered Public Accounting Firm under Item 8 on page 28.
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Item 9B. Other Information
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information under the captions “Item 1: Election of Directors”; “Director Selection Process,” “Audit Committee,” “Audit Committee Expertise; Complaint-Handling Procedures,” and “Section 16(a) Beneficial Ownership Reporting Compliance” of the 2012 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 7 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 Compensation
The information under the captions “Executive Compensation” and “Director Compensation” of the 2012 Proxy Statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information under the caption “Security Ownership” of the 2012 Proxy Statement is incorporated herein by reference.
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The following table sets forth information as of July 31, 2012 regarding the Company’s equity compensation plans:
| | | | | | | | | | |
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 | | | 71,020 | | $ | 7.2621 | | | — | |
| | | | | | | | | | |
1991 Master Stock Compensation Plan: | | | | | | | | | | |
Stock Options | | | — | | | — | | | | |
Deferred Stock Option Gain Plan | | | 640,103 | | $ | 17.8227 | | | — | |
Deferred LTC/Restricted Stock | | | 245,687 | | $ | 11.7362 | | | — | |
| | | | | | | | | | |
2001 Master Stock Incentive Plan: | | | | | | | | | | |
Stock Options | | | 5,321,679 | | $ | 17.3283 | | | — | |
Deferred Stock Option Gain Plan | | | 3,470 | | $ | 28.9411 | | | — | |
Deferred LTC/Restricted Stock | | | 293,942 | | $ | 16.8754 | | | — | |
Long-Term Compensation | | | 181,193 | | $ | 20.9766 | | | — | |
| | | | | | | | | | |
2010 Master Stock Incentive Plan: | | | | | | | | | | |
Stock Options | | | 1,642,497 | | $ | 32.0838 | | | See Note 1 | |
Deferred LTC/Restricted Stock | | | — | | $ | — | | | — | |
Long-Term Compensation | | | 35,096 | | $ | 28.0992 | | | — | |
Subtotal for plans approved by security holders | | | 8,434,687 | | $ | 20.1037 | | | | |
| | | | | | | | | | |
Equity compensation plans not approved by security holders: | | | | | | | | | | |
Non-qualified Stock Option Program for Non - Employee Directors | | | 1,092,151 | | $ | 21.9863 | | | See Note 2 | |
ESOP Restoration | | | 43,258 | | $ | 6.7700 | | | See Note 3 | |
Subtotal for plans not approved by security holders | | | 1,135,409 | | | 21.4066 | | | | |
Total | | | 9,570,096 | | | 20.2583 | | | | |
Note 1: The 2010 Master Stock Incentive Plan limits the number of shares authorized for issuance to 9,200,000 during the 10-year term of the plan in addition to any shares forfeited under the 2001 plan. The Plan allows for the granting of nonqualified stock options, incentive stock options, restricted stock, restricted stock units, stock appreciation rights (“SAR”), dividend equivalents, and other stock-based awards. There are currently 7,232,089 shares of the authorization remaining.
Note 2: The stock option program for non-employee directors (filed as exhibit 10-H to Form 10-Q report filed for the first quarter ended October 31, 2008) provides for each non-employee director to receive annual option grants of 14,400 shares. The 2010 Master Stock Incentive Plan, which was approved by the Company’s stockholders on November 19, 2010 provides for the issuance of stock options to non-employee directors, and the stock option program for non-employee directors has been adopted as a sub-plan under the 2010 Master Stock Incentive Plan and shares issued to directors after December 10, 2010 will be issued under the 2010 Master Stock Incentive Plan.
Note 3: The Company has a non-qualified ESOP Restoration Plan established on August 1, 1990 (filed as exhibit 10-D to the Company’s 2009 Form 10-K report), 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.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information under the captions “Policy and Procedures Regarding Transactions with Related Persons” and “Board Oversight and Director Independence” of the 2012 Proxy Statement is incorporated herein by reference.
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Item 14. Principal Accounting Fees and Services
The information under the captions “Independent Auditor Fees” and “Audit Committee Pre-Approval Policies and Procedures” of the 2012 Proxy Statement is incorporated herein by reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules
Documents filed with this report:
| | |
| (1) | Financial Statements |
| | |
| | Report of Independent Registered Public Accounting Firm |
| | |
| | Consolidated Statements of Earnings — years ended July 31, 2012, 2011 and 2010 |
| | |
| | Consolidated Balance Sheets — July 31, 2012 and 2011 |
| | |
| | Consolidated Statements of Cash Flows — years ended July 31, 2012, 2011 and 2010 |
| | |
| | Consolidated Statements of Changes in Shareholders’ Equity — years ended July 31, 2012, 2011 and 2010 |
| | |
| | Notes to Consolidated Financial Statements |
| | |
| (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. |
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SIGNATURES
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. | |
| | |
Date:September 28, 2012 | By: /s/ William M. Cook | |
| | |
| 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 28, 2012.
| | |
/s/ William M. Cook | | President, Chief Executive Officer and Chairman |
William M. Cook | | (Principal Executive Officer) |
| | |
/s/ James F. Shaw | | Vice President and Chief Financial Officer |
James F. Shaw | | (Principal Financial Officer) |
| | |
/s/ Melissa A. Osland | | Controller |
Melissa A. Osland | | (Principal Accounting Officer) |
| | |
* | | 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 |
Ajita G. Rajendra | | |
| | |
* | | Director |
John P. Wiehoff | | |
| | |
| | |
*By: /s/ Norman C. Linnell | | |
Norman C. Linnell | | |
As attorney-in-fact | | |
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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) | | Balance at
End of Period | |
Year ended July 31, 2012: | | | | | | | | | | | | | | | | |
Allowance for doubtful accounts deducted from accounts receivable | | $ | 6,908 | | $ | 1,151 | | $ | (676 | ) | $ | (965 | ) | $ | 6,418 | |
| | | | | | | | | | | | | | | | |
Year ended July 31, 2011: | | | | | | | | | | | | | | | | |
Allowance for doubtful accounts deducted from accounts receivable | | $ | 6,315 | | $ | 482 | | $ | 481 | | $ | (370 | ) | $ | 6,908 | |
| | | | | | | | | | | | | | | | |
Year ended July 31, 2010: | | | | | | | | | | | | | | | | |
Allowance for doubtful accounts deducted from accounts receivable | | $ | 7,387 | | $ | 1,063 | | $ | (293 | ) | $ | (1,842 | ) | $ | 6,315 | |
| | | | | | | | | | | | | | | | |
Note A - Allowance for doubtful accounts foreign currency translation losses (gains) recorded directly to equity.
Note B - Bad debts charged to allowance, net of reserves and changes in estimates.
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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 Second Quarter ended January 31, 2012) |
| | |
*3-B | — | 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-B to 2011 Form 10-K Report) |
| | |
* 3-C | — | Amended and Restated Bylaws of Registrant (as of January 30, 2009) (Filed as Exhibit 3-C to Form 10-Q Report 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-A to 2011 Form 10-K Report) |
| | |
*10-A | — | Officer Annual Cash Incentive Plan (Filed as Exhibit 10-A to 2011 Form 10-K Report)*** |
| | |
*10-B | — | 1980 Master Stock Compensation Plan as Amended (Filed as Exhibit 10-A to Form 10-Q Report filed for the first quarter ended October 31, 2008)*** |
| | |
*10-C | — | Form of Performance Award Agreement under 1991 Master Stock Compensation Plan (Filed as Exhibit 10-B to Form 10-Q Report filed for the first quarter ended October 31, 2008)*** |
| | |
*10-D | — | ESOP Restoration Plan (2003 Restatement) (Filed as Exhibit 10-D to 2009 Form 10-K Report)*** |
| | |
*10-E | — | Deferred Compensation Plan for Non-employee Directors as amended (Filed as Exhibit 10-C to Form 10-Q Report filed for the first quarter ended October 31, 2008)*** |
| | |
*10-F | — | Independent Director Retirement and Benefit Plan as amended (Filed as Exhibit 10-D to Form 10-Q Report filed for the first quarter ended October 31, 2008)*** |
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*10-G | — | Supplemental Executive Retirement Plan (2008 Restatement) (Filed as Exhibit 10-G to 2011 Form 10-K Report)*** |
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*10-H | — | 1991 Master Stock Compensation Plan as amended (Filed as Exhibit 10-E to Form 10-Q Report filed for the first quarter ended October 31, 2008)*** |
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*10-I | — | Form of Restricted Stock Award under 1991 Master Stock Compensation Plan (Filed as Exhibit 10-F to Form 10-Q Report filed for the first quarter ended October 31, 2008)*** |
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*10-J | — | Form of Agreement to Defer Compensation for certain Executive Officers (Filed as Exhibit 10-G to Form 10-Q Report filed for the first quarter ended October 31, 2008)*** |
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*10-K | — | Stock Option Program for Non-employee Directors (Filed as Exhibit 10-H to Form 10-Q Report filed for the first quarter ended October 31, 2008)*** |
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*10-L | — | Note Purchase Agreement among Donaldson Company, Inc. and certain listed Insurance Companies Dated as of July 15, 1998 (Filed as Exhibit 10-I to Form 10-Q Report filed for the first quarter ended October 31, 2008) |
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*10-M | — | 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-N to 2010 Form 10-K Report) |
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*10-N | — | 2001 Master Stock Incentive Plan (Filed as Exhibit 10-O to 2009 Form 10-K Report)*** |
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*10-O | — | Form of Officer Stock Option Award Agreement under the 2001 Master Stock Incentive Plan (Filed as Exhibit 10-P to 2010 Form 10-K Report)*** |
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*10-P | — | Form of Non-Employee Director Non-Qualified Stock Option Agreement under the 2001 Master Stock Incentive Plan (Filed as Exhibit 10-Q to 2010 Form 10-K Report)*** |
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*10-Q | — | Restated Compensation Plan for Non-Employee Directors dated July 28, 2006 (Filed as Exhibit 10-Q to 2011 Form 10-K Report)*** |
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*10-R | — | Restated Long-Term Compensation Plan dated May 23, 2006 (Filed as Exhibit 10-R to 2011 Form 10-K Report)*** |
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*10-S | — | Qualified Performance-Based Compensation Plan (Filed as Exhibit 10-S to 2011 Form 10-K Report)*** |
*10-T | — | Deferred Compensation and 401(k) Excess Plan (2008 Restatement) (Filed as Exhibit 10-T to 2011 form 10-K Report)*** |
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*10-U | — | Deferred Stock Option Gain Plan (2008 Restatement) (Filed as Exhibit 10-U to 2011 Form 10-K Report) *** |
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*10-V | — | Excess Pension Plan (2008 Restatement) (Filed as Exhibit 10-V to 2011 Form 10-K Report) *** |
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*10-W | — | 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)*** |
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*10-X | — | 2010 Master Stock Incentive Plan (Filed as Exhibit 4.5 to Registration Statement on Form S-* (File No. 333-170729) filed on November 19, 2010)*** |
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Table of Contents
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*10-Y | — | Form of Officer Stock Option Award Agreement under the 2010 Master Stock Incentive Plan (Filed as Exhibit 10.1 to Form 8-K Report filed on December 16, 2010) *** |
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*10-Z | — | Form of Restricted Stock Award Agreement under the 2010 Master Stock Incentive Plan (Filed as Exhibit 10.2 to Form 8-K Report filed on December 16, 2010) *** |
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*10-AA | — | Non-Employee Director Automatic Stock Option Grant Program (Filed as Exhibit 10-AA to 2011 Form 10-K Report)*** |
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*10-BB | — | Form of Indemnification Agreement for Directors (Filed as Exhibit 10.1 to Form 8-K Report filed on April 2, 2012)*** |
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10-CC | — | Form of Non-Employee Director Non-Qualified Stock Option Agreement under the 2010 Master Stock Incentive Plan*** |
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11 | — | Computation of net earnings per share (See “Earnings Per Share” in “Summary of Significant Accounting Policies” in Note A in the Notes to Consolidated Financial Statements on page 33) |
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21 | — | Subsidiaries |
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23 | — | Consent of PricewaterhouseCoopers LLP |
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24 | — | Powers of Attorney |
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31-A | — | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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31-B | — | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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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 |
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101 | — | The following financial information from the Donaldson Company, Inc. Annual Report on Form 10-K for the fiscal year ended July 31, 2012 as filed with the Securities and Exchange Commission, formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Statements of Earnings, (ii) the Consolidated Balance Sheets, (iii) the Consolidated Statements of Cash Flows (iv) the Consolidated Statement of Changes in Shareholders’ Equity and (v) the Notes to Consolidated Financial Statements. |
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* | Exhibit has previously been filed with the Securities and Exchange Commission and is incorporated herein by reference as an exhibit. |
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** | 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. |
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*** | 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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