filings.toolsItem 8. Financial Statements and Supplementary Data.
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Item 8. Financial Statements and Supplementary Data.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Parker-Hannifin Corporation
Cleveland, Ohio
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Parker-Hannifin Corporation and subsidiaries (the "Company") as of June 30, 2018 and 2017, the related consolidated statements of income, comprehensive income, equity, and cash flows, for each of the three years in the period ended June 30, 2018, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the “financial statements”). We also have audited the Company's internal control over financial reporting as of June 30, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of June 30, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2018, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
Basis for Opinions
The Company's management is responsible for these financial statements, 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 an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to fraud or error, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. 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.
Definition and Limitations of Internal Control over Financial Reporting
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 (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) 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 (3) 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 the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/S/ DELOITTE & TOUCHE, LLP
Cleveland, Ohio
August 24, 2018
We have served as the Company's auditor since 2008.
CONSOLIDATED STATEMENT OF INCOME
| For the years ended June 30, | ||||||||||||
| (Dollars in thousands, except per share amounts) | 2018 | 2017 | 2016 | |||||||||
| Net Sales | $ | 14,302,392 | $ | 12,029,312 | $ | 11,360,753 | ||||||
| Cost of sales | 10,762,841 | 9,188,962 | 8,823,384 | |||||||||
| Selling, general and administrative expenses | 1,657,152 | 1,453,935 | 1,359,360 | |||||||||
| Interest expense | 213,873 | 162,436 | 136,517 | |||||||||
| Other (income), net | (29,268 | ) | (61,401 | ) | (62,199 | ) | ||||||
| (Gain) on disposal of assets (Note 2) | (4,483 | ) | (43,261 | ) | (11,037 | ) | ||||||
| Income before income taxes | 1,702,277 | 1,328,641 | 1,114,728 | |||||||||
| Income taxes (Note 4) | 640,962 | 344,797 | 307,512 | |||||||||
| Net Income | 1,061,315 | 983,844 | 807,216 | |||||||||
| Less: Noncontrolling interest in subsidiaries' earnings | 514 | 432 | 376 | |||||||||
| Net Income Attributable to Common Shareholders | $ | 1,060,801 | $ | 983,412 | $ | 806,840 | ||||||
| Earnings per Share Attributable to Common Shareholders (Note 5) | ||||||||||||
| Basic earnings per share | $ | 7.98 | $ | 7.37 | $ | 5.96 | ||||||
| Diluted earnings per share | $ | 7.83 | $ | 7.25 | $ | 5.89 |
The accompanying notes are an integral part of the consolidated financial statements.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
| For the years ended June 30, | ||||||||||||
| (Dollars in thousands) | 2018 | 2017 | 2016 | |||||||||
| Net Income | $ | 1,061,315 | $ | 983,844 | $ | 807,216 | ||||||
| Less: Noncontrolling interests in subsidiaries' earnings | 514 | 432 | 376 | |||||||||
| Net income attributable to common shareholders | 1,060,801 | 983,412 | 806,840 | |||||||||
| Other comprehensive income (loss), net of tax | ||||||||||||
| Foreign currency translation adjustment and other (net of tax of $16,964, $40,935 and $(2,342) in 2018, 2017 and 2016) | (18,575 | ) | (80,865 | ) | (203,299 | ) | ||||||
| Retirement benefits plan activity (net of tax of $(82,506), $(218,590) and $152,203 in 2018, 2017 and 2016) | 179,253 | 384,784 | (286,044 | ) | ||||||||
| Other comprehensive income (loss) | 160,678 | 303,919 | (489,343 | ) | ||||||||
| Less: Other comprehensive income (loss) for noncontrolling interests | (440 | ) | 358 | (196 | ) | |||||||
| Other comprehensive income (loss) attributable to common shareholders | 161,118 | 303,561 | (489,147 | ) | ||||||||
| Total Comprehensive Income Attributable to Common Shareholders | $ | 1,221,919 | $ | 1,286,973 | $ | 317,693 |
The accompanying notes are an integral part of the consolidated financial statements.
BUSINESS SEGMENT INFORMATION
| (Dollars in thousands) | 2018 | 2017 | 2016 | |||||||||
| Net Sales: | ||||||||||||
| Diversified Industrial: | ||||||||||||
| North America | $ | 6,726,900 | $ | 5,366,809 | $ | 4,955,211 | ||||||
| International | 5,259,793 | 4,377,776 | 4,145,272 | |||||||||
| Aerospace Systems | 2,315,699 | 2,284,727 | 2,260,270 | |||||||||
| $ | 14,302,392 | $ | 12,029,312 | $ | 11,360,753 | |||||||
| Segment Operating Income: | ||||||||||||
| Diversified Industrial: | ||||||||||||
| North America | $ | 1,076,021 | $ | 873,552 | $ | 789,667 | ||||||
| International | 765,188 | 579,207 | 448,457 | |||||||||
| Aerospace Systems | 397,970 | 337,496 | 337,531 | |||||||||
| Total segment operating income | 2,239,179 | 1,790,255 | 1,575,655 | |||||||||
| Corporate administration | 200,901 | 172,632 | 173,203 | |||||||||
| Income before interest expense and other expense | 2,038,278 | 1,617,623 | 1,402,452 | |||||||||
| Interest expense | 213,873 | 162,436 | 136,517 | |||||||||
| Other expense | 122,128 | 126,546 | 151,207 | |||||||||
| Income before income taxes | $ | 1,702,277 | $ | 1,328,641 | $ | 1,114,728 | ||||||
| Assets: | ||||||||||||
| Diversified Industrial | $ | 13,368,619 | $ | 13,366,981 | $ | 8,728,671 | ||||||
| Aerospace Systems (a) | 1,446,745 | 1,412,707 | 1,430,577 | |||||||||
| Corporate | 504,723 | 710,216 | 1,874,894 | |||||||||
| $ | 15,320,087 | $ | 15,489,904 | $ | 12,034,142 | |||||||
| Property Additions: | ||||||||||||
| Diversified Industrial | $ | 196,469 | $ | 148,765 | $ | 134,618 | ||||||
| Aerospace Systems | 15,225 | 16,929 | 10,857 | |||||||||
| Corporate | 35,973 | 38,054 | 3,932 | |||||||||
| $ | 247,667 | $ | 203,748 | $ | 149,407 | |||||||
| Depreciation: | ||||||||||||
| Diversified Industrial | $ | 211,648 | $ | 176,823 | $ | 163,014 | ||||||
| Aerospace Systems | 16,737 | 17,484 | 18,469 | |||||||||
| Corporate | 9,421 | 8,561 | 8,825 | |||||||||
| $ | 237,806 | $ | 202,868 | $ | 190,308 |
| (Dollars in thousands) | 2018 | 2017 | 2016 | |||||||||
| By Geographic Area (b) | ||||||||||||
| Net Sales: | ||||||||||||
| North America | $ | 8,978,490 | $ | 7,585,689 | $ | 7,144,481 | ||||||
| International | 5,323,902 | 4,443,623 | 4,216,272 | |||||||||
| $ | 14,302,392 | $ | 12,029,312 | $ | 11,360,753 | |||||||
| Long-Lived Assets: | ||||||||||||
| North America | $ | 1,103,308 | $ | 1,145,127 | $ | 817,872 | ||||||
| International | 752,929 | 792,165 | 750,228 | |||||||||
| $ | 1,856,237 | $ | 1,937,292 | $ | 1,568,100 |
The accounting policies of the business segments are the same as those described in the Significant Accounting Policies footnote except that the business segment results are prepared on a basis that is consistent with the manner in which the Company’s management disaggregates financial information for internal review and decision-making.
| (a) | Includes an investment in a joint venture in which ownership is 50 percent or less and in which the Company does not have operating control (2018 - $235,665; 2017 - $240,182; 2016 - $241,728). |
| (b) | Net sales are attributed to countries based on the location of the selling unit. North America includes the United States, Canada and Mexico. No country other than the United States represents greater than 10 percent of consolidated sales. Long-lived assets are comprised of plant and equipment based on physical location. |
CONSOLIDATED BALANCE SHEET
| (Dollars in thousands) | ||||||||
| June 30, | 2018 | 2017 | ||||||
| Assets | ||||||||
| Current Assets | ||||||||
| Cash and cash equivalents (Note 1) | $ | 822,137 | $ | 884,886 | ||||
| Marketable securities and other investments (Note 1) | 32,995 | 39,318 | ||||||
| Trade accounts receivable, net (Note 1) | 2,145,517 | 1,930,751 | ||||||
| Non-trade and notes receivable (Note 1) | 328,399 | 254,987 | ||||||
| Inventories (Note 6) | 1,621,304 | 1,549,494 | ||||||
| Prepaid expenses | 134,886 | 120,282 | ||||||
| Total Current Assets | 5,085,238 | 4,779,718 | ||||||
| Plant and equipment (Note 1) | 5,215,253 | 5,186,748 | ||||||
| Less: Accumulated depreciation | 3,359,016 | 3,249,456 | ||||||
| Plant and equipment, net | 1,856,237 | 1,937,292 | ||||||
| Deferred income taxes (Notes 1 and 4) | 57,623 | 36,057 | ||||||
| Investments and other assets (Note 1) | 801,049 | 842,475 | ||||||
| Intangible assets, net (Notes 1 and 7) | 2,015,520 | 2,307,484 | ||||||
| Goodwill (Notes 1 and 7) | 5,504,420 | 5,586,878 | ||||||
| Total Assets | $ | 15,320,087 | $ | 15,489,904 | ||||
| Liabilities and Equity | ||||||||
| Current Liabilities | ||||||||
| Notes payable and long-term debt payable within one year (Notes 8 and 9) | $ | 638,466 | $ | 1,008,465 | ||||
| Accounts payable, trade | 1,430,306 | 1,300,496 | ||||||
| Accrued payrolls and other compensation | 427,500 | 435,911 | ||||||
| Accrued domestic and foreign taxes | 198,878 | 153,137 | ||||||
| Other accrued liabilities | 502,333 | 497,851 | ||||||
| Total Current Liabilities | 3,197,483 | 3,395,860 | ||||||
| Long-term debt (Note 9) | 4,318,559 | 4,861,895 | ||||||
| Pensions and other postretirement benefits (Note 10) | 1,177,605 | 1,406,082 | ||||||
| Deferred income taxes (Notes 1 and 4) | 234,858 | 221,790 | ||||||
| Other liabilities | 526,089 | 336,931 | ||||||
| Total Liabilities | 9,454,594 | 10,222,558 | ||||||
| Equity (Note 11) | ||||||||
| Shareholders' Equity | ||||||||
| Serial preferred stock, $.50 par value, authorized 3,000,000 shares; none issued | — | — | ||||||
| Common stock, $.50 par value, authorized 600,000,000 shares; issued 181,046,128 shares in 2018 and 2017 | 90,523 | 90,523 | ||||||
| Additional capital | 496,592 | 543,879 | ||||||
| Retained earnings | 11,625,975 | 10,930,348 | ||||||
| Accumulated other comprehensive (loss) | (1,763,086 | ) | (1,924,204 | ) | ||||
| Treasury shares at cost: 48,632,105 in 2018 and 47,854,475 in 2017 | (4,590,138 | ) | (4,378,897 | ) | ||||
| Total Shareholders' Equity | 5,859,866 | 5,261,649 | ||||||
| Noncontrolling interests | 5,627 | 5,697 | ||||||
| Total Equity | 5,865,493 | 5,267,346 | ||||||
| Total Liabilities and Equity | $ | 15,320,087 | $ | 15,489,904 |
The accompanying notes are an integral part of the consolidated financial statements.
CONSOLIDATED STATEMENT OF CASH FLOWS
| For the years ended June 30, | ||||||||||||
| (Dollars in thousands) | 2018 | 2017 | 2016 | |||||||||
| Cash Flows From Operating Activities | ||||||||||||
| Net income | $ | 1,061,315 | $ | 983,844 | $ | 807,216 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Depreciation | 237,806 | 202,868 | 190,308 | |||||||||
| Amortization | 228,279 | 152,361 | 116,535 | |||||||||
| Stock incentive plan compensation | 118,831 | 80,339 | 71,293 | |||||||||
| Deferred income taxes | (41,412 | ) | 37,024 | (65,686 | ) | |||||||
| Foreign currency transaction loss | 7,284 | 8,060 | 22,750 | |||||||||
| (Gain) loss on sale of plant and equipment | (24,422 | ) | 1,494 | 414 | ||||||||
| Loss (gain) on sale of businesses | 19,666 | (41,285 | ) | (10,666 | ) | |||||||
| Loss on sale and impairment of investments | 41,219 | — | — | |||||||||
| (Gain) on sale of marketable securities | (2 | ) | (1,032 | ) | (723 | ) | ||||||
| Changes in assets and liabilities, net of effects from acquisitions: | ||||||||||||
| Accounts receivable | (301,978 | ) | (95,347 | ) | 17,549 | |||||||
| Inventories | (92,209 | ) | (73,673 | ) | 120,243 | |||||||
| Prepaid expenses | (16,206 | ) | 2,410 | 136,034 | ||||||||
| Other assets | (13,293 | ) | (3,887 | ) | (5,033 | ) | ||||||
| Accounts payable, trade | 125,907 | 174,761 | (52,378 | ) | ||||||||
| Accrued payrolls and other compensation | (4,614 | ) | 5,922 | (22,865 | ) | |||||||
| Accrued domestic and foreign taxes | 44,019 | 18,165 | (6,285 | ) | ||||||||
| Other accrued liabilities | (5,567 | ) | (59,738 | ) | (31,633 | ) | ||||||
| Pensions and other postretirement benefits | 31,239 | (103,866 | ) | (45,796 | ) | |||||||
| Other liabilities | 184,425 | 14,051 | (30,499 | ) | ||||||||
| Net cash provided by operating activities | 1,600,287 | 1,302,471 | 1,210,778 | |||||||||
| Cash Flows From Investing Activities | ||||||||||||
| Acquisitions (less cash acquired of $157,426 in 2017 and $3,814 in 2016) | — | (4,069,197 | ) | (67,552 | ) | |||||||
| Capital expenditures | (247,667 | ) | (203,748 | ) | (149,407 | ) | ||||||
| Proceeds from sale of plant and equipment | 81,881 | 14,648 | 18,821 | |||||||||
| Proceeds from sale of businesses | 177,741 | 85,610 | 24,325 | |||||||||
| Purchase of marketable securities and other investments | (80,607 | ) | (465,666 | ) | (1,351,464 | ) | ||||||
| Maturities and sales of marketable securities and other investments | 83,905 | 1,279,318 | 1,300,633 | |||||||||
| Other | 4,837 | (6,113 | ) | (39,995 | ) | |||||||
| Net cash provided by (used in) investing activities | 20,090 | (3,365,148 | ) | (264,639 | ) | |||||||
| Cash Flows From Financing Activities | ||||||||||||
| Proceeds from exercise of stock options | 3,682 | 2,202 | 126 | |||||||||
| Payments for common shares | (381,041 | ) | (338,078 | ) | (587,365 | ) | ||||||
| Proceeds from notes payable, net | 4,115 | 230,499 | 303,624 | |||||||||
| Proceeds from long-term borrowings | 1,189 | 2,614,463 | 2,287 | |||||||||
| Payments for long-term borrowings | (944,629 | ) | (381,078 | ) | (220,068 | ) | ||||||
| Dividends paid | (365,288 | ) | (345,380 | ) | (341,962 | ) | ||||||
| Net cash (used in) provided by financing activities | (1,681,972 | ) | 1,782,628 | (843,358 | ) | |||||||
| Effect of exchange rate changes on cash | (1,154 | ) | (56,718 | ) | (61,712 | ) | ||||||
| Net (decrease) increase in cash and cash equivalents | (62,749 | ) | (336,767 | ) | 41,069 | |||||||
| Cash and cash equivalents at beginning of year | 884,886 | 1,221,653 | 1,180,584 | |||||||||
| Cash and cash equivalents at end of year | $ | 822,137 | $ | 884,886 | $ | 1,221,653 | ||||||
| Supplemental Data: | ||||||||||||
| Cash paid during the year for: | ||||||||||||
| Interest | $ | 200,860 | $ | 131,937 | $ | 133,999 | ||||||
| Income taxes | 408,765 | 268,127 | 250,155 |
The accompanying notes are an integral part of the consolidated financial statements.
CONSOLIDATED STATEMENT OF EQUITY
| (Dollars in thousands) | Common Stock | Additional Capital | Retained Earnings | Accumulated Other Comprehensive (Loss) | Treasury Shares | Noncontrolling Interests | Total | |||||||||||||||||||||
| Balance June 30, 2015 | $ | 90,523 | $ | 622,729 | $ | 9,841,885 | $ | (1,738,618 | ) | $ | (3,712,232 | ) | $ | 3,282 | $ | 5,107,569 | ||||||||||||
| Net income | 806,840 | 376 | 807,216 | |||||||||||||||||||||||||
| Other comprehensive income (loss) | (489,147 | ) | (196 | ) | (489,343 | ) | ||||||||||||||||||||||
| Dividends paid | (341,923 | ) | (39 | ) | (341,962 | ) | ||||||||||||||||||||||
| Stock incentive plan activity | 5,722 | (3,936 | ) | 50,916 | 52,702 | |||||||||||||||||||||||
| Shares purchased at cost | (557,504 | ) | (557,504 | ) | ||||||||||||||||||||||||
| Balance June 30, 2016 | $ | 90,523 | $ | 628,451 | $ | 10,302,866 | $ | (2,227,765 | ) | $ | (4,218,820 | ) | $ | 3,423 | $ | 4,578,678 | ||||||||||||
| Net income | 983,412 | 432 | 983,844 | |||||||||||||||||||||||||
| Other comprehensive income (loss) | 303,561 | 358 | 303,919 | |||||||||||||||||||||||||
| Dividends paid | (345,042 | ) | (338 | ) | (345,380 | ) | ||||||||||||||||||||||
| Stock incentive plan activity | (84,572 | ) | (10,888 | ) | 104,615 | 9,155 | ||||||||||||||||||||||
| Acquisition activity | 1,822 | 1,822 | ||||||||||||||||||||||||||
| Shares purchased at cost | (264,692 | ) | (264,692 | ) | ||||||||||||||||||||||||
| Balance June 30, 2017 | $ | 90,523 | $ | 543,879 | $ | 10,930,348 | $ | (1,924,204 | ) | $ | (4,378,897 | ) | $ | 5,697 | $ | 5,267,346 | ||||||||||||
| Net income | 1,060,801 | 514 | 1,061,315 | |||||||||||||||||||||||||
| Other comprehensive income (loss) | 161,118 | (440 | ) | 160,678 | ||||||||||||||||||||||||
| Dividends paid | (365,174 | ) | (114 | ) | (365,288 | ) | ||||||||||||||||||||||
| Stock incentive plan activity | (47,287 | ) | 88,759 | 41,472 | ||||||||||||||||||||||||
| Acquisition activity | (30 | ) | (30 | ) | ||||||||||||||||||||||||
| Shares purchased at cost | (300,000 | ) | (300,000 | ) | ||||||||||||||||||||||||
| Balance June 30, 2018 | $ | 90,523 | $ | 496,592 | $ | 11,625,975 | $ | (1,763,086 | ) | $ | (4,590,138 | ) | $ | 5,627 | $ | 5,865,493 |
The accompanying notes are an integral part of the consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
The term "year" and references to specific years refer to the applicable fiscal years.
| 1. | Significant Accounting Policies |
The significant accounting policies followed in the preparation of the accompanying consolidated financial statements are summarized below.
Nature of Operations - The Company is a leading worldwide diversified manufacturer of motion and control technologies and systems, providing precision engineered solutions for a wide variety of mobile, industrial and aerospace markets. The Company evaluates performance based on segment operating income before corporate administrative expenses, interest expense and income taxes.
The Diversified Industrial Segment is an aggregation of several business units, which manufacture motion-control and fluid power system components for builders and users of various types of manufacturing, packaging, processing, transportation, agricultural, construction, and military vehicles and equipment. Diversified Industrial Segment products are marketed primarily through field sales employees and independent distributors. The Diversified Industrial North American operations have manufacturing plants and distribution networks throughout the United States, Canada and Mexico and primarily service North America. The Diversified Industrial International operations provide Parker products and services to 47 countries throughout Europe, Asia Pacific, Latin America, the Middle East and Africa.
The Aerospace Systems Segment produces hydraulic, fuel, pneumatic and electro-mechanical systems and components, which are utilized on virtually every domestic commercial, military and general aviation aircraft and also performs a vital role in naval vessels and land-based weapons systems. This segment serves original equipment and maintenance, repair and overhaul customers worldwide. Aerospace Systems Segment products are marketed by field sales employees and are sold directly to manufacturers and end users.
There are no individual customers to whom sales are more than three percent of the Company's consolidated sales. Due to the diverse group of customers throughout the world, the Company does not consider itself exposed to any concentration of credit risks.
The Company manufactures and markets its products throughout the world. Although certain risks and uncertainties exist, the diversity and breadth of the Company's products and geographic operations mitigate the risk that adverse changes with respect to any particular product and geographic operation would materially affect the Company's operating results.
Use of Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Basis of Consolidation - The consolidated financial statements include the accounts of all majority-owned domestic and foreign subsidiaries. All intercompany transactions and profits have been eliminated in the consolidated financial statements. The Company does not have off-balance sheet arrangements. Within the Business Segment Information, intersegment and interarea sales have been eliminated.
Revenue Recognition - Revenue is recognized when persuasive evidence of an arrangement exists, product has shipped and the risks and rewards of ownership have transferred or services have been rendered, the price to the customer is fixed and determinable and collectibility is reasonably assured, which is generally at the time the product is shipped. Shipping and handling costs billed to customers are included in net sales and the related costs in cost of sales. Taxes collected from customers and remitted to governmental authorities are excluded from revenue.
Long-term Contracts - The Company enters into long-term contracts primarily for the production of aerospace products. For financial statement purposes, revenues are primarily recognized using the percentage-of-completion method. The extent of progress toward completion is primarily measured using the units-of-delivery method. Unbilled costs on these contracts are included in inventory. Progress payments are netted against the inventory balances. The Company estimates costs to complete long-term contracts for purposes of evaluating and establishing contract reserves. Adjustments to cost estimates are made on a consistent basis and a contract reserve is established when the estimated costs to complete a contract exceed the expected contract revenues.
Cash - Cash equivalents consist of short-term highly liquid investments, with a three-month or less maturity, carried at cost plus accrued interest, which are readily convertible into cash.
Marketable Securities and Other Investments - Consist of short-term highly liquid investments, with stated maturities of greater than three months from the date of purchase, carried at cost plus accrued interest, and investments classified as available-for-sale, which are carried at fair value with unrealized gains and losses recorded in accumulated other comprehensive (loss). Gains and losses on available-for-sale investments are calculated based on the first-in, first-out method. The Company has the ability to liquidate the available-for-sale investments after giving appropriate notice to the issuer.
Trade Accounts Receivable, Net - Trade accounts receivable are initially recorded at their net collectible amount and are generally recorded at the time the revenue from the sales transaction is recorded. Receivables are written off to bad debt primarily when, in the judgment of the Company, the receivable is deemed to be uncollectible due to the insolvency of the debtor. Allowance for doubtful accounts was $9,672 and $14,336 at June 30, 2018 and 2017, respectively.
Non-Trade and Notes Receivable - The non-trade and notes receivable caption in the Consolidated Balance Sheet is comprised of the following components:
| June 30, | 2018 | 2017 | ||||||
| Notes receivable | $ | 149,254 | $ | 118,351 | ||||
| Accounts receivable, other | 179,145 | 136,636 | ||||||
| Total | $ | 328,399 | $ | 254,987 |
Plant, Equipment and Depreciation - Plant and equipment are recorded at cost and are depreciated principally using the straight-line method for financial reporting purposes. Depreciation rates are based on estimated useful lives of the assets, generally 40 years for buildings, 15 years for land improvements and building equipment, seven to 10 years for machinery and equipment, and three to eight years for vehicles and office equipment. Improvements, which extend the useful life of property, are capitalized, and maintenance and repairs are expensed. The Company reviews plant and equipment for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable. When plant and equipment are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the appropriate accounts and any gain or loss is included in current income.
The plant and equipment caption in the Consolidated Balance Sheet is comprised of the following components:
| June 30, | 2018 | 2017 | ||||||
| Land and land improvements | $ | 289,686 | $ | 321,331 | ||||
| Buildings and building equipment | 1,578,701 | 1,575,464 | ||||||
| Machinery and equipment | 3,218,639 | 3,167,885 | ||||||
| Construction in progress | 128,227 | 122,068 | ||||||
| Total | $ | 5,215,253 | $ | 5,186,748 |
Investments and Other Assets - Investments in joint-venture companies in which ownership is 50 percent or less and in which the Company does not have operating control are stated at cost plus the Company's equity in undistributed earnings and amounted to $304,389 and $341,869 at June 30, 2018 and 2017, respectively. A significant portion of the underlying net assets of the joint ventures are related to goodwill. The Company's share of earnings from investments in joint-venture companies were $50,473, $42,352 and $25,650 in 2018, 2017 and 2016, respectively.
Intangible Assets - Intangible assets primarily include patents, trademarks and customer lists and are recorded at cost and amortized on a straight-line method. Patents are amortized over the shorter of their remaining useful or legal life. Trademarks are amortized over the estimated time period over which an economic benefit is expected to be received. Customer lists are amortized over a period based on anticipated customer attrition rates. The Company reviews intangible assets for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable.
Goodwill - The Company conducts a formal impairment test of goodwill on an annual basis and between annual tests if an event occurs or circumstances change that would, more likely than not, reduce the fair value of a reporting unit below its carrying value.
Income Taxes - Income taxes are provided based upon income for financial reporting purposes. Tax credits and similar tax incentives are applied to reduce the provision for income taxes in the year in which the credits arise. The Company recognizes accrued interest related to unrecognized tax benefits in income tax expense. Penalties, if incurred, are recognized in income tax expense. Deferred income taxes arise from temporary differences in the recognition of income and expense for tax purposes.
Foreign Currency Translation - Assets and liabilities of foreign subsidiaries are translated at current exchange rates, and income and expenses are translated using weighted-average exchange rates. The effects of these translation adjustments, as well as gains and losses from certain intercompany transactions, are reported in the accumulated other comprehensive (loss) component of shareholders' equity. Such adjustments will affect net income only upon sale or liquidation of the underlying foreign investments. Exchange losses (gains) from transactions in a currency other than the local currency of the entity involved are included within the cost of sales caption in the Consolidated Statement of Income and were $7,284, $8,060 and $22,750, in 2018, 2017 and 2016, respectively.
Subsequent Events - The Company has evaluated subsequent events that have occurred through the date of filing of this Annual Report on Form 10-K for the year ended June 30, 2018. No subsequent events occurred that required adjustment to or disclosure in these financial statements.
Recent Accounting Pronouncements - In February 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2018-02, "Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." ASU 2018-02 allows for a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the TCJ Act reduction of the U.S. federal corporate income tax rate. The amendments also require certain disclosures about stranded tax effects. ASU 2018-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted in any period after the issuance of the update. The amendments in this update should be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the TCJ Act is recognized. The Company has not yet determined the effect that ASU 2018-02 will have on its financial statements.
In August 2017, the FASB issued ASU 2017-12, "Targeted Improvements to Accounting for Hedging Activities." ASU 2017-12 provides targeted improvements to Topic 815 accounting for hedging activities by expanding an entity’s ability to hedge non-financial and financial risk components and reduce complexity in fair value hedges of interest rate risk. The guidance eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. The guidance also eases certain documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness. ASU 2017-12 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early application is permitted in any interim period after issuance of the update. ASU 2017-12 should be applied using a modified retrospective approach for cash flow and net investment hedge relationships that exist on the date of adoption and prospectively for presentation and disclosure requirements. The Company has not yet determined the effect that ASU 2017-12 will have on its financial statements.
In May 2017, the FASB issued ASU 2017-09, "Scope of Modification Accounting." ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. An entity should account for the effects of a modification unless all of the following are met: (1) the fair value of the modified award is the same as fair value of the original award; (2) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; and (3) the classification of the award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. ASU 2017-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted. ASU 2017-09 should be applied prospectively to an award modified on or after the adoption date. During the first quarter of fiscal 2018, the Company adopted ASU 2017-09. The adoption of ASU 2017-09 did not affect the Company's financial statements as there were no modifications of any share-based awards during 2018.
In March 2017, the FASB issued ASU 2017-07, "Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost." ASU 2017-07 requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. ASU 2017-07 also provides that only the service cost component is eligible for capitalization, when applicable. ASU 2017-07 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. ASU 2017-07 should be applied retrospectively for the income statement presentation of net periodic pension cost and net periodic postretirement benefit cost and prospectively, on or after the effective date, for the capitalization of the service cost component of net periodic pension cost and net periodic postretirement benefit cost. The Company expects that adoption of this standard will result in a reclassification of expense from cost of sales and selling, general and administrative expenses to other (income) of approximately $25 million and $17 million, respectively, for 2018 and $70 million and $41 million, respectively, for 2017.
In January 2017, the FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment." ASU 2017-04 eliminates Step 2 from the goodwill impairment test. Under the amendments in this Update, an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 also eliminates the requirement for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. ASU 2017-04 is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted. During the first quarter of 2018, the Company adopted ASU 2017-04. The adoption of ASU 2017-04 did not affect the Company's financial statements as there were no instances of a reporting unit's carrying value exceeding its fair value for any goodwill impairment tests performed during 2018.
In October 2016, the FASB issued ASU 2016-16, "Intra-Entity Transfers of Assets Other Than Inventory." ASU 2016-16 provides that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Consequently, the amendments in ASU 2016-16 eliminate the exception for an intra-entity transfer of an asset other than inventory. ASU 2016-16 is effective for fiscal years, and interim periods within those years, beginning after December 31, 2017. Early adoption is permitted. The Company expects that the cumulative effect of the adoption of ASU 2016-16 will result in a reduction to retained earnings of approximately $18 million.
In August 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments." ASU 2016-15 provides specific guidance on several cash flow classification issues to reduce diversity in practice in how certain transactions are classified within the statement of cash flows. ASU 2016-15 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. After consideration of the current level of transactions within the scope of ASU 2016-15, the Company does not expect that the retrospective adoption of this standard at the beginning of the first quarter of 2019 will have a material impact on its financial statements.
In June 2016, the FASB issued ASU 2016-13, "Measurement of Credit Losses on Financial Instruments." ASU 2016-13 requires a financial asset (or a group of financial assets) measured at amortized cost to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. ASU 2016-13 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. Early adoption is permitted. The Company has not yet determined the effect that ASU 2016-13 will have on its financial statements.
In February 2016, the FASB issued ASU 2016-02, "Leases." ASU 2016-02 requires lessees to put most leases with terms greater than 12 months on their balance sheet by recognizing a liability to make lease payments and an asset representing their right to use the asset during the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election, by class of underlying asset, not to recognize the corresponding assets and lease liabilities. Lessee recognition, measurement, and presentation of expenses and cash flows will not change significantly from existing guidance and lessor accounting is largely unchanged. ASU 2016-02 also changes the definition of a lease and requires qualitative, and quantitative disclosures that provide information about the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. Adoption of this ASU is planned for the beginning of the first quarter of 2020. The Company has not yet determined the effect that ASU 2016-02 will have on its financial statements.
In January 2016, the FASB issued ASU 2016-01, "Recognition and Measurement of Financial Assets and Liabilities." ASU 2016-01 requires equity investments (excluding equity method investments and investments that are consolidated) to be measured at fair value with changes in fair value recognized in net income. Equity investments that do not have a readily determinable fair value may be measured at cost, adjusted for impairment and observable price changes. ASU 2016-01 also simplifies the impairment assessment of equity investments, eliminates the disclosure of the assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at cost on the balance sheet and requires the exit price to be used when measuring fair value of financial instruments for disclosure purposes. Under ASU 2016-01, changes in fair value (resulting from instrument-specific credit risk) will be presented separately in other comprehensive income for liabilities measured using the fair value option. Financial assets and liabilities will be presented separately by measurement category and type, either on the balance sheet or in the financial statement disclosures. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The Company does not expect that the retrospective adoption of ASU 2016-01 at the beginning of the first quarter of 2019 will have a material impact on its financial statements.
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers." ASU 2014-09 requires revenue recognition to depict the transfer of goods or services to customers in an amount that reflects the consideration that a company expects to be entitled to in exchange for the goods or services. To achieve this principle, a company must apply five steps including identifying the contract with a customer, identifying the performance obligations in the contract, determining the
transaction price, allocating the transaction price to the performance obligations, and recognizing revenue when (or as) the company satisfies the performance obligations. Additional quantitative and qualitative disclosure to enhance the understanding about the nature, amount, timing, and uncertainty of revenue and cash flows is also required. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. In April 2016, the FASB issued ASU 2016-10, "Identifying Performance Obligations and Licensing." ASU 2016-10 clarifies the following two aspects of ASU 2014-09: identifying performance obligations and licensing implementation guidance. The effective date of ASU 2016-10 is the same as the effective date of ASU 2014-09. The Company has elected to adopt ASU 2014-09 using the modified retrospective method. The Company does not expect that the cumulative effect of the adoption of ASU 2014-09 at the beginning of the first quarter of 2019 will have a material impact on retained earnings. We expect to provide the required additional disclosures in periods subsequent to the adoption.
| 2. | Acquisitions and Divestitures |
Acquisitions - During 2017, the Company completed three acquisitions, including Clarcor, whose aggregate sales for their most recent fiscal year prior to acquisition were approximately $1,522 million. Total purchase price for the three acquisitions was approximately $4,227 million in cash and $316 million in assumed debt.
During 2016, the Company completed two acquisitions whose aggregate sales for their most recent fiscal year prior to acquisition were approximately $48 million. Total purchase price for the two acquisitions was approximately $71 million in cash and $2 million in assumed debt.
The results of operations for all acquisitions were included as of the respective dates of acquisition. Assets acquired and liabilities assumed were recognized at their respective fair values as of the acquisition date. The process of estimating the fair values of certain tangible assets, identifiable intangible assets and assumed liabilities requires the use of judgment in determining the appropriate assumptions and estimates. Revisions occur as valuations are finalized, additional information becomes available and as additional analysis is performed. All measurement period adjustments were completed within a year from the acquisition date, and such adjustments did not have a material impact on the Company's results of operations and financial position. The initial purchase price allocation for acquisitions in 2017 and 2016 are as follows:
| 2017 | 2016 | |||||||
| Assets: | ||||||||
| Accounts receivable | $ | 263,616 | $ | 6,793 | ||||
| Inventories | 302,422 | 12,041 | ||||||
| Prepaid expenses | 18,342 | 1,350 | ||||||
| Deferred income taxes | 4,658 | — | ||||||
| Plant and equipment | 376,826 | 5,647 | ||||||
| Intangible and other assets | 1,526,909 | 26,849 | ||||||
| Goodwill | 2,677,489 | 31,134 | ||||||
| 5,170,262 | 83,814 | |||||||
| Liabilities: | ||||||||
| Notes payable | 20,162 | 720 | ||||||
| Accounts payable, trade | 84,753 | 2,536 | ||||||
| Accrued payrolls and other compensation | 45,942 | 1,310 | ||||||
| Accrued domestic and foreign taxes | 5,435 | 604 | ||||||
| Other accrued liabilities | 80,515 | 1,804 | ||||||
| Long-term debt | 296,240 | 1,743 | ||||||
| Pensions and other postretirement benefits | 33,929 | — | ||||||
| Deferred income taxes | 520,389 | 7,545 | ||||||
| Other liabilities | 11,878 | — | ||||||
| Noncontrolling interests | 1,822 | — | ||||||
| 1,101,065 | 16,262 | |||||||
| Net assets acquired | $ | 4,069,197 | $ | 67,552 |
Goodwill is calculated as the excess of the purchase price over the net assets acquired, primarily all of which is not deductible for tax purposes. With respect to the Clarcor acquisition, goodwill represents cost synergies and enhancements to the Company's existing filtration technologies.
The remaining disclosures in Note 2 pertain only to the Clarcor acquisition as the other two acquisitions completed during 2017 were immaterial.
Clarcor is a major manufacturer of filtration products under more than a dozen respected brands, including CLARCOR, Baldwin, Fuel Manager, PECOFacet, Airguard, Altair, BHA, Clearcurrent, Clark Filter, Hastings, United Air Specialists, Keddeg and Purolator. Clarcor had annual sales of approximately $1,400 million for its fiscal 2016. For segment reporting purposes, Clarcor is part of the Diversified Industrial Segment.
The Company believes that Clarcor is a highly complementary acquisition that provides the Company with additional proprietary media, industrial and process filtration products and technologies, as well as a broad portfolio of replacement filters. The acquisition of Clarcor also offers significant expected operating synergies.
The Company's results of operations for 2017 include Clarcor's results of operations from the date of acquisition, February 28, 2017, through June 30, 2017. Net sales and segment operating (loss) attributable to Clarcor during this period was $487,388 and $(16,164), respectively.
The following unaudited pro forma information gives effect to the Company's acquisition of Clarcor as if the acquisition had occurred on July 1, 2015, and Clarcor had been included in the Company's results of operations for 2017 and 2016.
| 2017 | 2016 | ||||||
| Net sales | $ | 12,935,834 | $ | 12,772,097 | |||
| Net income attributable to common shareholders | 1,027,693 | 748,634 | |||||
| Diluted earnings per share | 7.58 | 5.47 |
The unaudited pro forma financial information in the table above includes adjustments related to amortization expense, depreciation, interest expense and transaction costs incurred as well as adjustments to cost of sales for the step-up in inventory to estimated acquisition-date fair value and related income tax effects and was based on a preliminary purchase price allocation using information available at that time. Transaction costs incurred (which are reflected in the selling, general and administrative expenses caption in the Consolidated Statement of Income) and the adjustment to cost of sales for the step-up in inventory to estimated acquisition-date fair value are considered to be non-recurring. Adjustments for non-recurring items increased pro forma net income attributable to common shareholders by $108,078 for 2017 and decreased pro forma net income attributable to common shareholders by $39,121 for 2016. The unaudited pro forma financial information does not give effect to any synergies, operating efficiencies or cost savings that may result or have resulted from the Clarcor acquisition.
Divestitures - During 2018, the Company divested its global Facet filtration business, which was part of the Diversified Industrial Segment. The operating results and net assets of the global Facet filtration business were immaterial to the Company's consolidated results of operations and financial position. The Company recorded a pre-tax loss in 2018 of approximately $20 million and tax expense of approximately $29 million resulting from a tax gain related to the divestiture. The pre-tax loss is reflected in the (gain) on disposal of assets caption in the Consolidated Statement of Income and the other expense caption in the Business Segment Information.
During 2017, the Company divested its Autoline product line, which was part of the Diversified Industrial Segment. The operating results and net assets of the Autoline product line were immaterial to the Company's consolidated results of operations and financial position. The Company recorded a net pre-tax gain in 2017 of approximately $45 million related to the divestiture. The gain is reflected in the (gain) on disposal of assets caption in the Consolidated Statement of Income and the other expense caption in the Business Segment Information.
| 3. | Charges Related to Business Realignment |
The Company incurred business realignment charges in 2018, 2017 and 2016. The Company also incurred acquisition integration costs in 2018 and 2017 related to the 2017 acquisition of Clarcor.
Business realignment charges and acquisition integration costs presented in the Business Segment Information are as follows:
| 2018 | 2017 | 2016 | |||||||||
| Diversified Industrial | $ | 78,558 | $ | 52,939 | $ | 91,404 | |||||
| Aerospace Systems | 3,428 | 2,674 | 3,629 | ||||||||
| Corporate administration | — | — | 2,215 | ||||||||
| Other expense | 1,009 | 784 | 116 |
Work force reductions in connection with such business realignment charges and acquisition integration costs in the Business Segment Information are as follows:
| 2018 | 2017 | 2016 | ||||||
| Diversified Industrial | 1,757 | 1,102 | 3,515 | |||||
| Aerospace Systems | 265 | 89 | 81 | |||||
| Corporate administration | — | — | 53 |
The business realignment charges primarily relate to actions taken under the Company's simplification initiative aimed at reducing organizational and process complexity. Business realignment charges and acquisition integration costs primarily consist of severance costs as well as plant closures, with the majority of charges incurred in Europe and North America. In connection with a plant closure during 2016, the Company recognized an expense associated with enhanced retirement benefits (refer to Note 10 for further discussion). The Company believes the realignment and acquisition integration actions taken will positively impact future results of operations but will not have a material effect on liquidity and sources and uses of capital.
The business realignment charges and acquisition integration costs are presented in the Consolidated Statement of Income as follows:
| 2018 | 2017 | 2016 | |||||||||
| Cost of sales | $ | 44,949 | $ | 35,932 | $ | 76,197 | |||||
| Selling, general and administrative expenses | 36,813 | 19,681 | 21,051 | ||||||||
| (Gain) on disposal of assets | 1,233 | 784 | 116 |
As of June 30, 2018, approximately $40 million in severance payments have been made relating to business realignment and acquisition integration charges incurred during 2018, the remainder of which are expected to be paid by June 30, 2019. Severance payments relating to prior-year actions are being made as required. Remaining severance payments related to current-year and prior-year business realignment and acquisition integration actions of approximately $26 million are primarily reflected within the other accrued liabilities caption in the Consolidated Balance Sheet. Additional charges may be recognized in future periods related to the business realignment and acquisition integration actions described above, the timing and amount of which are not known at this time.
| 4. | Income Taxes |
On December 22, 2017, the TCJ Act was enacted into law. The TCJ Act significantly reforms the Internal Revenue Code of 1986, as amended, by among other things, establishing a flat corporate income tax rate of 21 percent and creating a territorial tax system (with a one-time transition tax imposed on previously undistributed foreign earnings and profits).
The Securities and Exchange Commission staff issued SAB 118, which provides guidance on accounting for the tax effects of the TCJ Act. SAB 118 provides a measurement period that should not extend beyond one year from the TCJ Act's enactment date for companies to complete the applicable accounting under Topic 740. In accordance with SAB 118, and based on the information available as of June 30, 2018, the Company recorded a net provisional discrete income tax cost of $233 million as a result of the TCJ Act being enacted.
The reduction in the U.S. corporate tax rate under the TCJ Act required a one-time revaluation of certain tax-related assets and liabilities to reflect their value at the reduced corporate tax rate of 21 percent, which resulted in a decrease in income tax expense of approximately $80 million. The one-time transition tax on undistributed foreign earnings and profits resulted in an increase in income tax expense of $297 million. Incremental adjustments have been made to these estimates during the three months ended June 30, 2018, based on the availability of additional information. The Company has not yet completed the accounting for the one-time transition tax and continues to analyze undistributed foreign earnings and profits for purposes of filing the tax return for 2018. In addition, the Company continues to interpret the law and guidance issued as of the date of these financial statements. On August 1, 2018, the U.S. Treasury and Internal Revenue Service released proposed regulations relating to the one-time transition tax. The proposed regulations are subject to a 60-day comment period. Final regulations are expected to be issued after consideration of the comments. The Company is currently evaluating the impact of the proposed regulations. The Company intends to make the election to pay the one-time transition tax over eight years. The amount of cash payments will be less than the amount of the income tax expense due to the utilization of available credits.
Certain provisions of the TCJ Act will impact the Company starting in 2019. These provisions include, but are not limited to, the creation of the base erosion anti-abuse tax, a general limitation of U.S. federal income taxes on dividends from foreign subsidiaries, a new provision designed to tax global intangible low-taxed income and the repeal of the domestic production activities deduction. The Company continues to evaluate the future impacts of these provisions and, as of June 30, 2018, has not recorded any impact of any of these future provisions.
Income before income taxes was derived from the following sources:
| 2018 | 2017 | 2016 | |||||||||
| United States | $ | 963,843 | $ | 722,925 | $ | 672,907 | |||||
| Foreign | 738,434 | 605,716 | 441,821 | ||||||||
| $ | 1,702,277 | $ | 1,328,641 | $ | 1,114,728 |
Income taxes include the following:
| 2018 | 2017 | 2016 | |||||||||
| Federal | |||||||||||
| Current | $ | 453,821 | $ | 132,420 | $ | 235,557 | |||||
| Deferred | (23,876 | ) | 37,316 | (45,797 | ) | ||||||
| Foreign | |||||||||||
| Current | 210,385 | 157,518 | 113,146 | ||||||||
| Deferred | (17,454 | ) | (5,319 | ) | (7,006 | ) | |||||
| State and local | |||||||||||
| Current | 18,168 | 17,835 | 24,495 | ||||||||
| Deferred | (82 | ) | 5,027 | (12,883 | ) | ||||||
| $ | 640,962 | $ | 344,797 | $ | 307,512 |
A reconciliation of the Company's effective income tax rate to the statutory federal rate follows:
| 2018 | 2017 | 2016 | ||||||
| Statutory federal income tax rate | 28.1 | % | 35.0 | % | 35.0 | % | ||
| State and local income taxes | 1.2 | 1.7 | 0.6 | |||||
| Tax related to international activities | (1.0 | ) | (5.5 | ) | (5.2 | ) | ||
| Transition tax related to the TCJ Act | 17.5 | — | — | |||||
| Remeasurement of deferred tax assets and liabilities related to the TCJ Act | (4.8 | ) | — | — | ||||
| Cash surrender value of life insurance | (0.4 | ) | (0.9 | ) | 0.2 | |||
| Federal manufacturing deduction | (1.0 | ) | (0.9 | ) | (1.0 | ) | ||
| Research tax credit | (0.7 | ) | (0.8 | ) | (1.9 | ) | ||
| Share-based compensation | (2.2 | ) | (2.7 | ) | — | |||
| Other | 1.0 | 0.1 | (0.1 | ) | ||||
| Effective income tax rate | 37.7 | % | 26.0 | % | 27.6 | % |
Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of assets and liabilities. The differences comprising the net deferred taxes shown on the Consolidated Balance Sheet at June 30 were as follows:
| 2018 | 2017 | ||||||
| Retirement benefits | $ | 340,480 | $ | 571,022 | |||
| Other liabilities and reserves | 112,935 | 144,885 | |||||
| Long-term contracts | 17,496 | 61,375 | |||||
| Stock-based compensation | 38,535 | 59,725 | |||||
| Loss carryforwards | 679,880 | 678,486 | |||||
| Unrealized currency exchange gains and losses | 27,228 | 22,212 | |||||
| Inventory | (9,612 | ) | 17,809 | ||||
| Foreign tax credit carryforward | — | 23,050 | |||||
| Depreciation and amortization | (689,320 | ) | (1,080,218 | ) | |||
| Valuation allowance | (694,857 | ) | (684,079 | ) | |||
| Net deferred tax (liability) | $ | (177,235 | ) | $ | (185,733 | ) | |
| Change in net deferred tax asset (liability): | |||||||
| Provision for deferred tax | $ | 41,412 | $ | (37,024 | ) | ||
| Items of other comprehensive (loss) | (65,542 | ) | (177,655 | ) | |||
| Acquisitions and other | 32,628 | (521,814 | ) | ||||
| Total change in net deferred tax | $ | 8,498 | $ | (736,493 | ) |
As of June 30, 2018, the Company recorded deferred tax assets of $679,880 resulting from $2,633,218 in loss carryforwards. A valuation allowance of $675,045 related to the loss carryforwards has been established due to the uncertainty of their realization. Of this valuation allowance, $640,239 relates to non-operating entities whose loss carryforward utilization is considered to be remote. Some of the loss carryforwards can be carried forward indefinitely; others can be carried forward from three to 20 years. In addition, a valuation allowance of $19,812 related to future deductible items has been established due to the uncertainty of their realization. These future deductible items are recorded in the other liabilities and reserves line in the table above.
Historically, all foreign undistributed earnings were permanently reinvested in international operations. No tax was provided on such earnings as it was not practicable to estimate the additional tax that might be payable on the eventual distribution. The enactment of the TCJ Act created a territorial tax system significantly reducing the U.S. federal tax cost of future distributions. Although future distributions of foreign earnings to the U.S. should not be subject to U.S. federal income taxes, other U.S. or foreign taxes may be imposed on such earnings. The Company has analyzed existing factors and determined it will no longer permanently reinvest certain foreign earnings. On these undistributed foreign earnings of approximately $274 million that are no longer permanently reinvested outside of the U.S., the Company has recorded a deferred tax liability of $12 million. The remaining undistributed foreign earnings of approximately $2,700 million remain permanently reinvested outside the U.S. at June 30, 2018. Of these undistributed earnings, we have recorded a deferred tax liability of $4 million where certain foreign holding companies are not permanently reinvested in their subsidiaries. It is not practicable to estimate the additional taxes, including applicable foreign withholding taxes, that might be payable on the potential distribution of such permanently reinvested foreign earnings.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
| 2018 | 2017 | 2016 | |||||||||
| Balance July 1 | $ | 147,506 | $ | 139,907 | $ | 145,688 | |||||
| Additions for tax positions related to current year | 4,195 | 4,735 | 7,025 | ||||||||
| Additions for tax positions of prior years | 8,333 | 2,618 | 2,582 | ||||||||
| Additions for acquisitions | — | 3,939 | — | ||||||||
| Reductions for tax positions of prior years | (3,790 | ) | (1,175 | ) | (627 | ) | |||||
| Reductions for settlements | (315 | ) | (3,020 | ) | (10,284 | ) | |||||
| Reductions for expiration of statute of limitations | (4,480 | ) | (2,792 | ) | (4,142 | ) | |||||
| Effect of foreign currency translation | 1,642 | 3,294 | (335 | ) | |||||||
| Balance June 30 | $ | 153,091 | $ | 147,506 | $ | 139,907 |
The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $153,091, $95,460 and $80,722 as of June 30, 2018, 2017 and 2016, respectively. If recognized, a significant portion of the gross unrecognized tax benefits as of June 30, 2017, and 2016, would have been offset against an asset that had been recorded in the Consolidated Balance Sheet. The accrued interest related to the gross unrecognized tax benefits, excluded from the amounts above, was $21,737, $15,432 and $12,357 as of June 30, 2018, 2017 and 2016, respectively.
It is reasonably possible that, within the next 12 months, the amount of gross unrecognized tax benefits could be reduced by up to approximately $120,000 as a result of the revaluation of existing uncertain tax positions arising from developments in the examination process or the closure of tax statutes. Any increase in the amount of unrecognized tax benefits within the next 12 months is expected to be insignificant.
The Company and its subsidiaries file income tax returns in the United States and in various foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities throughout the world. The Company is open to assessment of its U.S. federal income tax returns by the Internal Revenue Service for years after 2011, and its state and local tax returns for years after 2011. The Company is open to assessment for significant foreign jurisdictions for years after 2009.
| 5. | Earnings Per Share |
Basic earnings per share are computed using the weighted-average number of common shares outstanding during the year. Diluted earnings per share are computed using the weighted-average number of common shares and common share equivalents outstanding during the year. Common share equivalents represent the dilutive effect of outstanding equity-based awards. The reconciliation of the numerator and denominator of basic and diluted earnings per share was as follows:
| 2018 | 2017 | 2016 | |||||||||
| Numerator: | |||||||||||
| Net income attributable to common shareholders | $ | 1,060,801 | $ | 983,412 | $ | 806,840 | |||||
| Denominator: | |||||||||||
| Basic - weighted-average common shares | 133,004,613 | 133,377,547 | 135,353,321 | ||||||||
| Increase in weighted-average common shares from dilutive effect of equity-based awards | 2,422,221 | 2,182,217 | 1,558,369 | ||||||||
| Diluted - weighted-average common shares, assuming exercise of equity-based awards | 135,426,834 | 135,559,764 | 136,911,690 | ||||||||
| Basic earnings per share | $ | 7.98 | $ | 7.37 | $ | 5.96 | |||||
| Diluted earnings per share | $ | 7.83 | $ | 7.25 | $ | 5.89 |
For 2018, 2017 and 2016, 0.5 million, 1.4 million and 3.1 million common shares, respectively, subject to equity-based awards were excluded from the computation of diluted earnings per share because the effect of their exercise would be anti-dilutive.
| 6. | Inventories |
The majority of domestic inventories are valued by the last-in, first-out (LIFO) cost method and the balance of the Company's inventories are valued by the first-in, first-out (FIFO) cost method. Inventories valued by the FIFO cost method are stated at the lower of cost or net realizable value. Inventories valued by the LIFO cost method are stated at lower of cost or market.
Inventories valued on the LIFO cost method were approximately 41 percent of total inventories in 2018 and 39 percent of total inventories in 2017. The current cost of these inventories exceeds their valuation determined on the LIFO basis by $203,192 in 2018 and $193,933 in 2017. Progress payments of $25,026 in 2018 and $44,231 in 2017 are netted against inventories.
The inventories caption in the Consolidated Balance Sheet is comprised of the following components:
| June 30, | 2018 | 2017 | ||||||
| Finished products | $ | 673,323 | $ | 642,788 | ||||
| Work in process | 765,835 | 723,133 | ||||||
| Raw materials | 182,146 | 183,573 | ||||||
| Total | $ | 1,621,304 | $ | 1,549,494 |
| 7. | Goodwill and Intangible Assets |
The changes in the carrying amount of goodwill are as follows:
| Diversified Industrial Segment | Aerospace Systems Segment | Total | |||||||||
| Balance June 30, 2016 | $ | 2,804,403 | $ | 98,634 | $ | 2,903,037 | |||||
| Acquisitions | 2,677,489 | — | 2,677,489 | ||||||||
| Divestitures | (22,618 | ) | — | (22,618 | ) | ||||||
| Foreign currency translation and other | 28,962 | 8 | 28,970 | ||||||||
| Balance June 30, 2017 | $ | 5,488,236 | $ | 98,642 | $ | 5,586,878 | |||||
| Acquisitions | 37,489 | — | 37,489 | ||||||||
| Divestitures | (138,541 | ) | — | (138,541 | ) | ||||||
| Foreign currency translation and other | 18,587 | 7 | 18,594 | ||||||||
| Balance June 30, 2018 | $ | 5,405,771 | $ | 98,649 | $ | 5,504,420 |
Acquisitions represent the original goodwill allocation, purchase price adjustments and final adjustments to the purchase price allocation for the acquisitions during the measurement period subsequent to the applicable acquisition dates. The impact of the purchase price adjustments and final adjustments to the purchase price allocation on the Company's results of operations and financial position were immaterial. Divestitures primarily represent goodwill associated with the sale of a business in 2018 and a product line in 2017 (see Note 2 for further discussion).
The Company's annual impairment tests performed in 2018, 2017 and 2016 resulted in no impairment loss being recognized.
Intangible assets are amortized on a straight-line method over their legal or estimated useful lives. The gross carrying value and accumulated amortization for each major category of intangible asset at June 30 are as follows:
| 2018 | 2017 | ||||||||||||||
| Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | ||||||||||||
| Patents | $ | 265,423 | $ | 117,440 | $ | 254,049 | $ | 100,860 | |||||||
| Trademarks | 546,905 | 227,580 | 553,691 | 200,413 | |||||||||||
| Customer lists and other | 2,482,079 | 933,867 | 2,566,983 | 765,966 | |||||||||||
| Total | $ | 3,294,407 | $ | 1,278,887 | $ | 3,374,723 | $ | 1,067,239 |
Total intangible asset amortization expense in 2018, 2017 and 2016 was $221,494, $145,128 and $108,019, respectively. Estimated intangible asset amortization expense for the five years ending June 30, 2019 through 2023 is $197,451, $187,040, $182,406, $176,495 and $168,961, respectively.
Intangible assets are evaluated for impairment whenever events or circumstances indicate that the undiscounted net cash flows to be generated by their use over their expected useful lives and eventual disposition may be less than their net carrying value. No such events or circumstances occurred in 2018, 2017 or 2016.
| 8. | Financing Arrangements |
The Company has a line of credit totaling $2,000,000 through a multi-currency revolving credit agreement with a group of banks, of which $1,466,200 was available at June 30, 2018. The credit agreement expires in October 2021; however, the Company has the right to request a one-year extension of the expiration date on an annual basis, which request may result in changes to the current terms and conditions of the credit agreement. Advances from the credit agreement can be used for general corporate purposes, including acquisitions, and for the refinancing of existing indebtedness. The credit agreement requires the payment of an annual facility fee, the amount of which may increase in the event the Company's credit ratings are lowered. Although a lowering of the Company's credit ratings would likely increase the cost of future debt, it would not limit the Company's ability to use the credit agreement nor would it accelerate the repayment of any outstanding borrowings.
The Company is currently authorized to sell up to $2,000,000 of short-term commercial paper notes. Commercial paper notes outstanding at June 30, 2018 and 2017 were $533,800 and $534,200, respectively.
In addition to commercial paper notes, notes payable includes short-term lines of credit and borrowings from foreign banks. At June 30, 2018 and 2017, the Company had $48,338 and $62,946, respectively, in lines of credit from various foreign banks, none of which were outstanding at June 30, 2018 and 2017. Most of these agreements are renewed annually. The Company had borrowings from foreign banks of $4,255 at June 30, 2018. The weighted-average interest rate on notes payable during 2018 and 2017 was 1.8 percent and 1.0 percent, respectively.
The Company's foreign locations in the ordinary course of business may enter into financial guarantees through financial institutions which enable customers to be reimbursed in the event of nonperformance by the Company.
The Company's credit agreements and indentures governing certain debt agreements contain various covenants, the violation of which would limit or preclude the use of the applicable agreements for future borrowings, or might accelerate the maturity of the related outstanding borrowings covered by the applicable agreements. Based on the Company's rating level at June 30, 2018, the most restrictive financial covenant provides that the ratio of debt to debt-shareholders' equity cannot exceed 0.60 to 1.0. As of June 30, 2018, the Company's debt to debt-shareholders' equity ratio was 0.46 to 1.0. The Company is in compliance with all covenants.
| 9. | Debt |
| June 30, | 2018 | 2017 | ||||||
| Domestic: | ||||||||
| Fixed rate medium-term notes, 3.30% to 6.55%, due 2019-2045 | $ | 2,225,000 | $ | 2,675,000 | ||||
| Senior Notes, 3.25% to 4.10%, due 2027 - 2047 | 1,300,000 | 1,300,000 | ||||||
| Term loan, Libor plus 100 bps, due 2020 | — | 493,750 | ||||||
| Foreign: | ||||||||
| Euro Senior Notes, 1.125%, due 2025 | 817,810 | 799,890 | ||||||
| Euro Term loan, Libor plus 150 bps, due 2022 | 116,830 | 114,270 | ||||||
| Other long-term debt | 762 | 433 | ||||||
| Deferred debt issuance costs | (41,432 | ) | (47,183 | ) | ||||
| Total long-term debt | 4,418,970 | 5,336,160 | ||||||
| Less: Long-term debt payable within one year | 100,411 | 474,265 | ||||||
| Long-term debt, net | $ | 4,318,559 | $ | 4,861,895 |
Principal amounts of long-term debt payable in the five years ending June 30, 2019 through 2023 are $100,411, $240, $32, $116,841 and $300,006, respectively. The principal amounts of long-term debt payable exclude the impact of the amortization of debt issuance costs.
Lease Commitments - Future minimum rental commitments as of June 30, 2018, under non-cancelable operating leases, which expire at various dates, are as follows: 2019-$78,812; 2020-$56,889; 2021-$35,102; 2022-$18,326; 2023-$9,172 and after 2023-$28,390.
Rental expense in 2018, 2017 and 2016 was $126,940, $118,723 and $119,004, respectively.
| 10. | Retirement Benefits |
Pensions - The Company has noncontributory defined benefit pension plans covering eligible employees, including certain employees in foreign countries. Plans for most salaried employees provide pay-related benefits based on years of service. Plans for hourly employees generally provide benefits based on flat-dollar amounts and years of service. The Company also has arrangements for certain key employees which provide for supplemental retirement benefits. In general, the Company's policy is to fund these plans based on legal requirements, tax considerations, local practices and investment opportunities. The Company also sponsors defined contribution plans and participates in government-sponsored programs in certain foreign countries.
A summary of the Company's defined benefit pension plans follows:
| 2018 | 2017 | 2016 | |||||||||
| Benefit cost | |||||||||||
| Service cost | $ | 82,993 | $ | 94,356 | $ | 94,650 | |||||
| Interest cost | 144,339 | 126,131 | 181,469 | ||||||||
| Special termination cost | — | — | 7,088 | ||||||||
| Settlement cost | — | — | 5,102 | ||||||||
| Expected return on plan assets | (258,490 | ) | (239,537 | ) | (221,629 | ) | |||||
| Amortization of prior service cost | 6,570 | 8,116 | 7,470 | ||||||||
| Amortization of unrecognized actuarial loss | 147,387 | 212,433 | 170,407 | ||||||||
| Amortization of initial net obligation | 18 | 18 | 17 | ||||||||
| Net periodic benefit cost | $ | 122,817 | $ | 201,517 | $ | 244,574 |
| 2018 | 2017 | ||||||
| Change in benefit obligation | |||||||
| Benefit obligation at beginning of year | $ | 5,217,857 | $ | 5,315,655 | |||
| Service cost | 82,993 | 94,356 | |||||
| Interest cost | 144,339 | 126,131 | |||||
| Acquisition | — | 201,283 | |||||
| Plan amendments | 2,932 | 3,265 | |||||
| Divestiture | (9,535 | ) | (851 | ) | |||
| Actuarial gain | (182,588 | ) | (268,370 | ) | |||
| Benefits paid | (216,169 | ) | (250,289 | ) | |||
| Foreign currency translation and other | (5,832 | ) | (3,323 | ) | |||
| Benefit obligation at end of year | $ | 5,033,997 | $ | 5,217,857 | |||
| Change in plan assets | |||||||
| Fair value of plan assets at beginning of year | $ | 3,896,001 | $ | 3,307,047 | |||
| Actual gain on plan assets | 174,951 | 341,344 | |||||
| Acquisition | — | 168,264 | |||||
| Divestiture | (12,231 | ) | — | ||||
| Employer contributions | 81,518 | 330,932 | |||||
| Benefits paid | (216,169 | ) | (250,289 | ) | |||
| Foreign currency translation and other | (8,181 | ) | (1,297 | ) | |||
| Fair value of plan assets at end of year | $ | 3,915,889 | $ | 3,896,001 | |||
| Funded status | $ | (1,118,108 | ) | $ | (1,321,856 | ) |
| Amounts recognized on the Consolidated Balance Sheet | |||||||
| Other accrued liabilities | $ | (11,333 | ) | $ | (12,793 | ) | |
| Pensions and other postretirement benefits | (1,106,775 | ) | (1,309,063 | ) | |||
| Net amount recognized | $ | (1,118,108 | ) | $ | (1,321,856 | ) | |
| Amounts recognized in Accumulated Other Comprehensive (Loss) | |||||||
| Net actuarial loss | $ | 1,216,612 | $ | 1,461,017 | |||
| Prior service cost | 18,900 | 22,761 | |||||
| Transition obligation | 61 | 77 | |||||
| Net amount recognized | $ | 1,235,573 | $ | 1,483,855 |
The presentation of the amounts recognized on the Consolidated Balance Sheet and in accumulated other comprehensive (loss) is on a debit (credit) basis and excludes the effect of income taxes.
Beginning in 2017, the Company changed the method used to estimate the service and interest cost components of net periodic pension and other postretirement benefit costs from the single-weighted average discount rate to the spot yield curve approach. The change does not affect the measurement of the Company's benefit obligations. The new method provides a more precise measure of these components by improving the correlation between projected benefit cash flows and the discrete spot yield curve rates and is accounted for as a change in estimate prospectively. As a result of the method change, net pension benefit cost for 2017 is lower than the net pension benefit cost for 2016 by $29,777.
During 2016, the Company provided enhanced retirement benefits in connection with a plant closure, which resulted in an increase in net pension benefit cost of $7,088.
The estimated amount of net actuarial loss, prior service cost and transition obligation that will be amortized from accumulated other comprehensive (loss) into net periodic benefit pension cost in 2019 is $114,825, $6,286 and $18, respectively.
The accumulated benefit obligation for all defined benefit plans was $4,751,111 and $4,890,058 at June 30, 2018 and 2017, 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 $4,933,863, $4,665,272 and $3,807,859, respectively, at June 30, 2018, and $5,120,268, $4,805,485 and $3,793,696, respectively, at June 30, 2017. The projected benefit obligation and fair value of plan assets for pension plans with projected benefit obligations in excess of plan assets were $4,970,120 and $3,842,539, respectively, at June 30, 2018, and $5,142,881 and $3,815,815, respectively, at June 30, 2017.
The Company expects to make cash contributions of approximately $70 million to its defined benefit pension plans in 2019, the majority of which relate to its non-U.S. defined benefit plans. Estimated future benefit payments in the five years ending June 30, 2019 through 2023 are $240,163, $242,051, $259,402, $305,553 and $267,258, respectively and $1,454,646 in the aggregate for the five years ending June 30, 2024 through June 30, 2028.
The assumptions used to measure net periodic benefit cost for the Company's significant defined benefit plans are:
| 2018 | 2017 | 2016 | ||||||
| U.S. defined benefit plans | ||||||||
| Discount rate | 3.64 | % | 3.33 | % | 4.19 | % | ||
| Average increase in compensation | 3.89 | % | 5.02 | % | 5.14 | % | ||
| Expected return on plan assets | 7.5 | % | 7.5 | % | 7.5 | % | ||
| Non-U.S. defined benefit plans | ||||||||
| Discount rate | 0.30 to 7.57% | 0.23 to 7.75% | 0.7 to 6.0% | |||||
| Average increase in compensation | 2.0 to 5.5% | 2.0 to 5.5% | 2.0 to 5.5% | |||||
| Expected return on plan assets | 1.0 to 5.75% | 1.0 to 5.75% | 1.0 to 5.75% |
The assumptions used to measure the benefit obligation for the Company's significant defined benefit plans are:
| 2018 | 2017 | ||||
| U.S. defined benefit plans | |||||
| Discount rate | 4.01 | % | 3.64 | % | |
| Average increase in compensation | 3.65 | % | 3.89 | % | |
| Non-U.S. defined benefit plans | |||||
| Discount rate | 0.30 to 3.37% | 0.30 to 7.57% | |||
| Average increase in compensation | 1.75 to 5.5% | 2.0 to 5.5% |
The discount rate assumption is based on current rates of high-quality, long-term corporate bonds over the same estimated time period that benefit payments will be required to be made. The expected return on plan assets assumption is based on the weighted-average expected return of the various asset classes in the plans' portfolio. The asset class return is developed using historical asset return performance as well as current market conditions such as inflation, interest rates and equity market performance.
The weighted-average allocation of the majority of the assets related to defined benefit plans is as follows:
| 2018 | 2017 | ||||
| Equity securities | 44 | % | 45 | % | |
| Debt securities | 49 | % | 47 | % | |
| Other investments | 7 | % | 8 | % | |
| 100 | % | 100 | % |
The weighted-average target asset allocation as of June 30, 2018 is 41 percent equity securities, 47 percent debt securities and 12 percent other investments. The investment strategy for the Company's worldwide defined benefit pension plan assets focuses on achieving prudent actuarial funding ratios while maintaining acceptable levels of risk in order to provide adequate liquidity to meet immediate and future benefit requirements. This strategy requires investment portfolios that are broadly diversified across various asset classes and external investment managers. Assets held in the U.S. defined benefit plans account for approximately 74 percent of the Company's total defined benefit plan assets. The Company's overall investment strategy with respect to the Company's U.S. defined benefit plans is to opportunistically migrate from its traditional mix between growth seeking assets (primarily consisting of global public equities in developed and emerging countries and hedge fund of fund strategies) and income generating assets (primarily consisting of high quality bonds, both domestic and global, emerging market bonds, high yield bonds and Treasury Inflation Protected Securities) to an allocation more heavily weighted toward income generating assets. Over time, long duration fixed income assets are being added to the portfolio. These securities are highly correlated with the Company's pension liabilities and will serve to hedge a portion of the Company's interest rate risk.
The fair values of pension plan assets at June 30, 2018 and at June 30, 2017, by asset class, are as follows:
| June 30, 2018 | Quoted Prices In Active Markets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Cash and cash equivalents | $ | 57,307 | $ | 54,322 | $ | 2,985 | $ | — | |||||||
| Equity securities | |||||||||||||||
| U.S. based companies | 447,553 | 447,553 | — | — | |||||||||||
| Non-U.S. based companies | 243,253 | 243,253 | — | — | |||||||||||
| Fixed income securities | |||||||||||||||
| Corporate bonds | 225,929 | 115,534 | 110,395 | — | |||||||||||
| Government issued securities | 272,604 | 184,636 | 87,968 | — | |||||||||||
| Mutual funds | |||||||||||||||
| Equity funds | 176,846 | 176,846 | — | — | |||||||||||
| Fixed income funds | 179,562 | 179,562 | — | — | |||||||||||
| Mutual funds measured at net asset value | 232,050 | ||||||||||||||
| Common/Collective trusts | |||||||||||||||
| Equity funds | 89,578 | 89,578 | — | — | |||||||||||
| Fixed income funds | 46,620 | 46,620 | — | — | |||||||||||
| Common/Collective trusts measured at net asset value | 1,737,543 | ||||||||||||||
| Limited Partnerships measured at net asset value | 243,536 | ||||||||||||||
| Miscellaneous | (36,492 | ) | — | (36,492 | ) | — | |||||||||
| Total at June 30, 2018 | $ | 3,915,889 | $ | 1,537,904 | $ | 164,856 | $ | — |
| June 30, 2017 | Quoted Prices In Active Markets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Cash and cash equivalents | $ | 76,057 | $ | 75,370 | $ | 687 | $ | — | |||||||
| Equity securities | |||||||||||||||
| U.S. based companies | 416,830 | 416,830 | — | — | |||||||||||
| Non-U.S. based companies | 236,134 | 236,134 | — | — | |||||||||||
| Fixed income securities | |||||||||||||||
| Corporate bonds | 176,135 | 91,982 | 84,153 | — | |||||||||||
| Government issued securities | 199,389 | 144,616 | 54,773 | — | |||||||||||
| Mutual funds | |||||||||||||||
| Equity funds | 306,168 | 306,168 | — | — | |||||||||||
| Fixed income funds | 204,628 | 204,628 | — | — | |||||||||||
| Mutual funds measured at net asset value | 233,234 | ||||||||||||||
| Common/Collective trusts | |||||||||||||||
| Equity funds | 70,389 | 70,389 | — | — | |||||||||||
| Fixed income funds | 46,003 | 46,003 | — | — | |||||||||||
| Common/Collective trusts measured at net asset value | 1,677,942 | ||||||||||||||
| Limited Partnerships measured at net asset value | 262,092 | ||||||||||||||
| Miscellaneous | (9,000 | ) | — | (9,000 | ) | — | |||||||||
| Total at June 30, 2017 | $ | 3,896,001 | $ | 1,592,120 | $ | 130,613 | $ | — |
Cash and cash equivalents, which include repurchase agreements and other short-term investments, are valued at cost, which approximates fair value.
Equity securities are valued at the closing price reported on the active market on which the individual securities are traded. U.S. based companies include Company stock with a fair value of $207,202 and $212,480 as of June 30, 2018 and 2017, respectively.
Fixed income securities are valued using both market observable inputs for similar assets that are traded on an active market and the closing price on the active market on which the individual securities are traded.
Mutual funds are valued using the closing market price reported on the active market on which the fund is traded or at net asset value per share and primarily consist of equity and fixed income funds. The equity funds primarily provide exposure to U.S. and international equities, real estate and commodities. The fixed income funds primarily provide exposure to high-yield securities and emerging market fixed income instruments. Mutual funds measured at fair value using the net asset value per share practical expedient have not been categorized in the fair value hierarchy and are being presented in the tables above to permit a reconciliation of the fair value hierarchy to the Consolidated Balance Sheet.
Common/Collective trusts primarily consist of equity and fixed income funds and are valued using the closing market price reported on the active market on which the fund is traded or at net asset value per share. Common/Collective trust investments can be redeemed without restriction after giving appropriate notice to the issuer. Generally, redemption of the entire investment balance requires a 60-day notice period. The equity funds provide exposure to large, mid and small cap U.S. equities, international large and small cap equities and emerging market equities. The fixed income funds provide exposure to U.S., international and emerging market debt securities. Common/Collective trusts measured at fair value using the net asset value per share practical expedient have not been categorized in the fair value hierarchy and are being presented in the tables above to permit a reconciliation of the fair value hierarchy to the Consolidated Balance Sheet.
Limited Partnerships primarily consist of hedge funds valued using a net asset value per share and provide exposure to a variety of hedging strategies including long/short equity, relative value, event driven and global macro. Limited Partnership investments can be redeemed either monthly or quarterly and without restriction after giving appropriate notice to the issuer. Redemption of the entire investment balance generally requires no more than a 95-day notice period. Limited Partnerships measured at fair value using the net asset value per share practical expedient have not been categorized in the fair value hierarchy and are being presented in the tables above to permit a reconciliation of the fair value hierarchy to the Consolidated Balance Sheet.
Miscellaneous primarily includes real estate funds, insurance contracts held in the asset portfolio of the Company's non-U.S. defined benefit pension plans, and net payables for securities purchased but not settled in the asset portfolio of the Company's U.S. defined benefit pension plans. Insurance contracts are valued at the present value of future cash flows promised under the terms of the insurance contracts.
The primary investment objective of equity securities and equity funds, within both the mutual fund and common/collective trust asset class, is to obtain capital appreciation in an amount that at least equals various market-based benchmarks. The primary investment objective of fixed income securities and fixed income funds, within both the mutual fund and common/collective trust asset class, is to provide for a constant stream of income while preserving capital. The primary investment objective of limited partnerships is to achieve capital appreciation through an investment program focused on specialized investment strategies. The primary investment objective of insurance contracts, included in the miscellaneous asset class, is to provide a stable rate of return over a specified period of time.
Employee Savings Plan - The Company sponsors an employee stock ownership plan (ESOP) as part of its existing savings and investment 401(k) plan. The ESOP is available to eligible domestic employees. Company matching contributions, up to a maximum of four percent of an employee's annual compensation, are recorded as compensation expense. Participants may direct company matching contributions to any investment option within the savings and investment 401(k) plan.
| 2018 | 2017 | 2016 | |||||||||
| Shares held by ESOP | 6,476,154 | 6,911,436 | 7,728,332 | ||||||||
| Company matching contributions | $ | 65,262 | $ | 57,766 | $ | 58,922 |
In addition to shares within the ESOP, as of June 30, 2018, employees have elected to invest in 1,870,286 shares of common stock within a company stock fund of the savings and investment 401(k) plan.
The Company has a retirement income account (RIA) within the employee savings plan. The Company makes a cash contribution to the participant's RIA each year, the amount of which is based on the participant's age and years of service. Participants do not contribute to the RIA. The Company recognized $29,023, $29,309 and $25,780 in expense related to the RIA in 2018, 2017 and 2016, respectively.
During 2017, the Company assumed various defined contribution plans previously sponsored by Clarcor. The Company recognized expense of $4,481 and $2,199 in 2018 and 2017, respectively, related to these defined contribution plans. In January 2018, the former employees of Clarcor became eligible to participate in the savings and investment 401(k) plan.
Other Postretirement Benefits - The Company provides postretirement medical and life insurance benefits to certain retirees and eligible dependents. Most plans are contributory, with retiree contributions adjusted annually. The plans are unfunded and pay stated percentages of covered medically necessary expenses incurred by retirees, after subtracting payments by Medicare or other providers and after stated deductibles have been met. For most plans, the Company has established cost maximums to more effectively control future medical costs. The Company has reserved the right to change these benefit plans.
The Company recognized $2,755, $4,357 and $8,754 in expense related to other postretirement benefits in 2018, 2017 and 2016, respectively. During 2016, the Company provided enhanced retirement benefits in connection with a plant closure, which resulted in an increase in expense related to other postretirement benefits of $4,521.
| 2018 | 2017 | ||||||
| Change in benefit obligation | |||||||
| Benefit obligation at beginning of year | $ | 79,933 | $ | 89,785 | |||
| Service cost | 320 | 469 | |||||
| Interest cost | 2,003 | 1,922 | |||||
| Acquisition | — | 291 | |||||
| Actuarial gain | (11,259 | ) | (8,235 | ) | |||
| Benefits paid | (4,476 | ) | (4,299 | ) | |||
| Benefit obligation at end of year | $ | 66,521 | $ | 79,933 | |||
| Funded status | $ | (66,521 | ) | $ | (79,933 | ) |
| Amounts recognized on the Consolidated Balance Sheet | |||||||
| Other accrued liabilities | $ | (6,180 | ) | $ | (6,532 | ) | |
| Pensions and other postretirement benefits | (60,341 | ) | (73,401 | ) | |||
| Net amount recognized | $ | (66,521 | ) | $ | (79,933 | ) | |
| Amounts recognized in Accumulated Other Comprehensive (Loss) | |||||||
| Net actuarial loss | $ | 1,232 | $ | 12,828 | |||
| Prior service credit | (314 | ) | (435 | ) | |||
| Net amount recognized | $ | 918 | $ | 12,393 |
The presentation of the amounts recognized on the Consolidated Balance Sheet and in accumulated other comprehensive (loss) is on a debit (credit) basis and is before the effect of income taxes. The amount of net actuarial loss and prior service credit that will be amortized from accumulated other comprehensive (loss) into net periodic postretirement cost in 2019 is $14 and $(121), respectively.
The assumptions used to measure the net periodic benefit cost for postretirement benefit obligations are:
| 2018 | 2017 | 2016 | ||||||
| Discount rate | 3.46 | % | 3.15 | % | 3.96 | % | ||
| Current medical cost trend rate (Pre-65 participants) | 8.19 | % | 7.35 | % | 7.61 | % | ||
| Current medical cost trend rate (Post-65 participants) | 9.79 | % | 8.68 | % | 9.00 | % | ||
| Ultimate medical cost trend rate | 4.50 | % | 4.50 | % | 4.50 | % | ||
| Medical cost trend rate decreases to ultimate in year | 2025 | 2025 | 2025 |
The discount rate assumption used to measure the benefit obligation was 3.92 percent in 2018 and 3.46 percent in 2017.
Estimated future benefit payments for other postretirement benefits in the five years ending June 30, 2019 through 2023 are $6,463, $6,358, $5,967, $5,804 and $5,564, respectively, and $24,842 in the aggregate for the five years ending June 30, 2024 through June 30, 2028.
A one percentage point change in assumed health care cost trend rates would not have a material effect on the benefit cost or benefit obligation.
Other - The Company has established nonqualified deferred compensation programs, which permit officers, directors and certain management employees annually to elect to defer a portion of their compensation, on a pre-tax basis, until their retirement. The retirement benefit to be provided is based on the amount of compensation deferred, Company matching contributions and earnings on the deferrals. In addition, the Company maintains a defined contribution nonqualified supplemental executive pension plan in which the Company is the only contributor. During 2018, 2017 and 2016, the Company recorded expense (income) relating to these programs of $13,420, $20,400 and $(2,917), respectively.
The Company has invested in corporate-owned life insurance policies to assist in meeting the obligation under these programs. The policies are held in a rabbi trust and are recorded as assets of the Company.
| 11. | Equity |
Changes in accumulated other comprehensive (loss) in shareholders' equity by component:
| Foreign Currency Translation Adjustment and Other | Retirement Benefit Plans | Total | |||||||||
| Balance June 30, 2016 | $ | (844,121 | ) | $ | (1,383,644 | ) | $ | (2,227,765 | ) | ||
| Other comprehensive income (loss) before reclassifications | (80,189 | ) | 242,414 | 162,225 | |||||||
| Amounts reclassified from accumulated other comprehensive (loss) | (1,032 | ) | 142,368 | 141,336 | |||||||
| Balance June 30, 2017 | $ | (925,342 | ) | $ | (998,862 | ) | $ | (1,924,204 | ) | ||
| Other comprehensive income (loss) before reclassifications | (10,141 | ) | 76,417 | 66,276 | |||||||
| Amounts reclassified from accumulated other comprehensive (loss) | (7,994 | ) | 102,836 | 94,842 | |||||||
| Balance June 30, 2018 | $ | (943,477 | ) | $ | (819,609 | ) | $ | (1,763,086 | ) |
Significant reclassifications out of accumulated other comprehensive (loss) in shareholders' equity during 2018:
| Details about Accumulated Other Comprehensive (Loss) Components | Income (Expense) Reclassified from Accumulated Other Comprehensive (Loss) | Consolidated Statement of Income Classification | ||||
| Retirement benefit plans | ||||||
| Amortization of prior service cost and initial net obligation | $ | (6,467 | ) | See Note 10 | ||
| Recognized actuarial loss | (147,611 | ) | See Note 10 | |||
| Total before tax | (154,078 | ) | ||||
| Tax benefit | 51,242 | Income taxes | ||||
| Net of tax | $ | (102,836 | ) |
Significant reclassifications out of accumulated other comprehensive (loss) in shareholders' equity during 2017:
| Details about Accumulated Other Comprehensive (Loss) Components | Income (Expense) Reclassified from Accumulated Other Comprehensive (Loss) | Consolidated Statement of Income Classification | ||||
| Retirement benefit plans | ||||||
| Amortization of prior service cost and initial net obligation | $ | (8,014 | ) | See Note 10 | ||
| Recognized actuarial loss | (214,284 | ) | See Note 10 | |||
| Total before tax | (222,298 | ) | ||||
| Tax benefit | 79,930 | Income taxes | ||||
| Net of tax | $ | (142,368 | ) |
Share Repurchases - The Company has a program to repurchase its common shares. On October 22, 2014, the Board of Directors of the Company approved an increase in the overall number of shares authorized to repurchase under the program so that, beginning on such date, the aggregate number of shares authorized for repurchase was 35 million. There is no limitation on the number of shares that can be repurchased in a year. Repurchases may be funded primarily from operating cash flows and commercial paper borrowings and the shares are initially held as treasury shares. The number of common shares repurchased at the average purchase price follows:
| 2018 | 2017 | 2016 | |||||||||
| Shares repurchased | 1,738,234 | 1,976,778 | 5,121,051 | ||||||||
| Average price per share including commissions | $ | 172.59 | $ | 133.90 | $ | 108.87 |
| 12. | Stock Incentive Plans |
The Company's 2016 Omnibus Stock Incentive Plan provides for the granting of share-based incentive awards in the form of nonqualified stock options, stock appreciation rights (SARs), restricted stock units (RSUs) and restricted and unrestricted stock to officers and key employees of the Company. The aggregate number of shares authorized for issuance under the 2016 Omnibus Stock Incentive Plan is 16 million. At June 30, 2018, 11.6 million common shares were available for future issuance.
The Company satisfies share-based incentive award obligations by issuing shares of common stock out of treasury, which have been repurchased pursuant to the Company's share repurchase program described in Note 11, or through the issuance of previously unissued common stock.
SARs - Upon exercise, SARs entitle the participant to receive shares of common stock equal to the increase in value of the award between the grant date and the exercise date. SARs are exercisable from one to three years after the date of grant and expire no more than 10 years after grant.
The fair value of each SAR award granted in 2018, 2017 and 2016 was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
| 2018 | 2017 | 2016 | |||||||||
| Risk-free interest rate | 1.9 | % | 1.4 | % | 1.9 | % | |||||
| Expected life of award | 5.2 years | 5.3 years | 5.4 years | ||||||||
| Expected dividend yield of stock | 2.0 | % | 2.0 | % | 1.9 | % | |||||
| Expected volatility of stock | 23.4 | % | 28.5 | % | 28.7 | % | |||||
| Weighted-average fair value | $ | 29.71 | $ | 27.39 | $ | 26.88 |
The risk-free interest rate was based on U.S. Treasury yields with a term similar to the expected life of the award. The expected life of the award was derived by referring to actual exercise and post-vesting employment termination experience. The expected dividend yield was based on the Company's historical dividend rate and stock price over a period similar to the expected life of the award. The expected volatility of stock was derived by referring to changes in the Company's historical common stock prices over a time-frame similar to the expected life of the award.
SAR activity during 2018 is as follows (aggregate intrinsic value in millions):
| Number of Shares | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||||||
| Outstanding June 30, 2017 | 6,533,406 | $ | 94.18 | |||||||||
| Granted | 907,626 | $ | 158.79 | |||||||||
| Exercised | (1,351,120 | ) | $ | 78.61 | ||||||||
| Canceled | (43,031 | ) | $ | 146.84 | ||||||||
| Outstanding June 30, 2018 | 6,046,881 | $ | 106.98 | 5.8 years | $ | 298.1 | ||||||
| Exercisable June 30, 2018 | 4,168,672 | $ | 92.74 | 4.6 years | $ | 263.1 |
A summary of the status and changes of shares subject to SAR awards and the related average price per share follows:
| Number of Shares | Weighted-Average Grant Date Fair Value | |||||
| Nonvested June 30, 2017 | 1,947,569 | $ | 27.80 | |||
| Granted | 907,626 | $ | 29.71 | |||
| Vested | (933,955 | ) | $ | 28.33 | ||
| Canceled | (43,031 | ) | $ | 28.34 | ||
| Nonvested June 30, 2018 | 1,878,209 | $ | 28.44 |
At June 30, 2018, $13,458 of expense with respect to nonvested SAR awards has yet to be recognized and will be amortized into expense over a weighted-average period of approximately 17 months. The total fair value of shares vested during 2018, 2017 and 2016 was $26,461, $33,094 and $34,706, respectively.
Information related to SAR awards exercised during 2018, 2017 and 2016 is as follows:
| 2018 | 2017 | 2016 | |||||||||
| Net cash proceeds | $ | 3,682 | $ | 2,202 | $ | 126 | |||||
| Intrinsic value | 136,000 | 153,908 | 40,612 | ||||||||
| Income tax benefit | 28,701 | 31,193 | 7,188 |
During 2018, 2017 and 2016, the Company recognized stock-based compensation expense of $27,422, $28,535 and $28,129, respectively, relating to SAR awards. The Company derives a tax deduction measured by the excess of the market value over the grant price at the date stock-based awards are exercised. The related income tax benefit was credited to income tax expense in 2018 and 2017 and to additional capital in 2016.
Shares surrendered upon exercise of SARs: 2018 - 269,670; 2017 - 371,246; 2016 - 158,808.
RSUs - RSUs constitute an agreement to deliver shares of common stock to the participant at the end of a vesting period. Generally, the RSUs granted to employees vest and the underlying stock is issued ratably over a three-year graded vesting period. Nonvested RSUs may not be transferred and do not have dividend or voting rights. For each nonvested RSU, recipients are entitled to receive a dividend equivalent, payable in cash or common shares, equal to the cash dividend per share paid to common shareholders.
The fair value of each RSU award granted in 2018, 2017 and 2016 was based on the fair market value of the Company's common stock on the date of grant. A summary of the status and changes of shares subject to RSU awards for employees and the related average price per share follows:
| Number of Shares | Weighted-Average Grant Date Fair Value | |||||
| Nonvested June 30, 2017 | 394,329 | $ | 120.92 | |||
| Granted | 157,086 | $ | 159.26 | |||
| Vested | (176,855 | ) | $ | 116.94 | ||
| Canceled | (13,949 | ) | $ | 139.61 | ||
| Nonvested June 30, 2018 | 360,611 | $ | 138.85 |
During 2018, 2017 and 2016, the Company recognized stock-based compensation expense of $24,073, $23,025 and $21,190 respectively, relating to RSU awards for employees. At June 30, 2018, $18,627 of expense with respect to nonvested RSU awards has yet to be recognized and will be amortized into expense over a weighted-average period of approximately 21 months. The total fair value of RSU awards vested during 2018, 2017 and 2016 was $20,681, $21,576 and $21,173, respectively. The Company recognized an income tax benefit of $2,451, $939 and $870 relating to the issuance of common stock for RSU awards that vested during 2018, 2017 and 2016, respectively.
During 2018, 2017 and 2016, 9,900, 12,430 and 14,404 RSU awards, respectively, with a one-year vesting period were granted to non-employee members of the Board of Directors. Although nonvested shares do not have dividend or voting rights, recipients receive a dividend equivalent payable in common shares, equal to the cash dividend per share paid to common shareholders. In 2018, 2017 and 2016, the Company recognized stock-based compensation expense of $1,697, $1,560, and $824, respectively, relating to these awards. At June 30, 2018, $596 of expense with respect to 9,845 nonvested RSU awards granted to the Board of Directors has yet to be recognized and will be amortized into expense over a weighted-average period of approximately four months. During 2018 and 2017, the Company recognized an income tax benefit of $270 and $105, respectively, related to the vesting of 12,639 and 13,740 RSU awards, respectively, issued to the Board of Directors.
LTIP - The Company's Long Term Incentive Plans (LTIP) provide for the issuance of unrestricted stock to certain officers and key employees based on the attainment of certain goals relating to the Company's revenue growth, earnings per share growth and return on invested capital during the three-year performance period. No dividends or dividend equivalents are paid on unearned shares.
| Stock issued for LTIP | 2018 | 2017 | 2016 | |||||||||
| LTIP three-year plan | 2015-16-17 | 2014-15-16 | 2013-14-15 | |||||||||
| Number of shares issued | 308,278 | 227,707 | 175,291 | |||||||||
| Share value on date of issuance | $ | 176.39 | $ | 157.07 | $ | 113.91 | ||||||
| Total value | $ | 54,377 | $ | 35,766 | $ | 19,967 |
Under the Company's 2016-17-18 LTIP, a payout of unrestricted stock will be issued in April 2019.
The fair value of each LTIP award granted in 2018, 2017 and 2016 was based on the fair market value of the Company's common stock on the date of grant. A summary of the status and changes of shares relating to the LTIP and the related average price per share follows:
| Number of Shares | Weighted-Average Grant Date Fair Value | |||||
| Nonvested June 30, 2017 | 734,744 | $ | 119.56 | |||
| Granted | 191,986 | $ | 206.99 | |||
| Vested | (256,071 | ) | $ | 122.11 | ||
| Canceled | (12,388 | ) | $ | 128.63 | ||
| Nonvested June 30, 2018 | 658,271 | $ | 143.90 |
During 2018, 2017 and 2016, the Company recorded stock-based compensation expense of $65,640, $27,219 and $21,150, respectively, relating to the LTIP. During 2018, 2017 and 2016, the Company recognized an income tax benefit of $3,893, $1,701 and $3,119, respectively, relating to the LTIP.
Shares surrendered in connection with the LTIP: 2018 - 139,918; 2017 - 113,074; 2016 - 78,173.
Restricted Shares - Prior to 2016, the Company issued restricted shares to non-employee members of the Board of Directors. The fair value of the restricted shares was based on the fair market value of the Company's common stock on the date of grant. During 2016, the Company recognized expense of $468 and tax cost of $(32) related to restricted shares.
| 13. | Research and Development |
Research and development costs amounted to $327,877 in 2018, $336,675 in 2017 and $359,796 in 2016. These amounts include both costs incurred by the Company related to independent research and development initiatives as well as costs incurred in connection with research and development contracts. Costs incurred in connection with research and development contracts amounted to $40,823 in 2018, $65,292 in 2017 and $57,999 in 2016. These costs are included in the total research and development cost for each of the respective years.
| 14. | Financial Instruments |
The Company’s financial instruments consist primarily of cash and cash equivalents, marketable securities and other investments, accounts receivable and long-term investments as well as obligations under accounts payable, trade, notes payable and long-term debt. Due to their short-term nature, the carrying values for cash and cash equivalents, accounts receivable, accounts payable, trade and notes payable approximate fair value.
Marketable securities and other investments include deposits, which are recorded at cost, and investments classified as available-for-sale, which are recorded at fair value with unrealized gains and losses recorded in accumulated other comprehensive (loss). Gross unrealized gains and losses were not material as of June 30, 2018 and 2017. There were no facts or circumstances that indicated the unrealized losses were other than temporary.
The contractual maturities of available-for-sale investments were predominantly one to three years at June 30, 2018 and 2017. Actual maturities of available-for-sale investments may differ from their contractual maturities as the Company has the ability to liquidate the available-for-sale investments after giving appropriate notice to the issuer.
The carrying value of long-term debt and estimated fair value of long-term debt at June 30 are as follows:
| 2018 | 2017 | |||||||
| Carrying value of long-term debt | $ | 4,460,402 | $ | 5,383,343 | ||||
| Estimated fair value of long-term debt | 4,548,796 | 5,645,529 |
The fair value of long-term debt was determined based on observable market prices in the active market in which the security is traded and is classified within level 2 of the fair value hierarchy.
The Company utilizes derivative and non-derivative financial instruments, including forward exchange contracts, costless collar contracts, cross-currency swap contracts and certain foreign denominated debt designated as net investment hedges, to manage foreign currency transaction and translation risk. The derivative financial instrument contracts are with major investment grade financial institutions and the Company does not anticipate any material non-performance by any of the counterparties. The Company does not hold or issue derivative financial instruments for trading purposes.
The Company’s €700 million aggregate principal amount of Senior Notes due 2025 have been designated as a hedge of the Company’s net investment in certain foreign subsidiaries. The translation of the Senior Notes due 2025 into U.S. dollars is recorded in accumulated other comprehensive (loss) and remains there until the underlying net investment is sold or substantially liquidated.
Derivative financial instruments are recognized on the Consolidated Balance Sheet as either assets or liabilities and are measured at fair value.
The location and fair value of derivative financial instruments reported in the Consolidated Balance Sheet are as follows:
| Balance Sheet Caption | 2018 | 2017 | |||||||
| Net investment hedges | |||||||||
| Cross-currency swap contracts | Other assets | $ | 7,614 | $ | 15,135 | ||||
| Cash flow hedges | |||||||||
| Costless collar contracts | Non-trade and notes receivable | 932 | 430 | ||||||
| Costless collar contracts | Other accrued liabilities | 236 | 2,027 |
The cross-currency swap and costless collar contracts are reflected on a gross basis in the Consolidated Balance Sheet. The Company has not entered into any master netting arrangements.
Gains or losses on derivatives that are not hedges are adjusted to fair value through the cost of sales caption in the Consolidated Statement of Income. Gains or losses on derivatives that are hedges are adjusted to fair value through accumulated other comprehensive (loss) in the Consolidated Balance Sheet until the hedged item is recognized in earnings.
The cross-currency swap contracts have been designated as hedging instruments. The costless collar contracts have not been designated as hedging instruments and are considered to be economic hedges of forecasted transactions.
Gains or losses on derivative financial instruments that were recorded in the Consolidated Statement of Income during 2018, 2017 and 2016 were not material.
(Losses) on derivative and non-derivative financial instruments that were recorded in accumulated other comprehensive (loss) in the Consolidated Balance Sheet are as follows:
| 2018 | 2017 | ||||||
| Cross-currency swap contracts | $ | (9,209 | ) | $ | (6,003 | ) | |
| Foreign denominated debt | (9,543 | ) | (16,175 | ) |
There was no ineffectiveness of the cross-currency swap contracts or foreign denominated debt, nor were any portion of these financial instruments excluded from the effectiveness testing during 2018, 2017 and 2016.
A summary of financial assets and liabilities that were measured at fair value on a recurring basis at June 30, 2018 and 2017 are as follows:
| June 30, 2018 | Quoted Prices In Active Markets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
| Assets: | ||||||||||||||||
| Equity securities | $ | 2,956 | $ | 2,956 | $ | — | $ | — | ||||||||
| Corporate bonds | 5,331 | 5,331 | — | — | ||||||||||||
| Asset-backed and mortgage-backed securities | 3,911 | — | 3,911 | — | ||||||||||||
| Derivatives | 14,110 | — | 14,110 | — | ||||||||||||
| Investments measured at net asset value | 7,208 | |||||||||||||||
| Liabilities: | ||||||||||||||||
| Derivatives | 5,315 | — | 5,315 | — |
| June 30, 2017 | Quoted Prices In Active Markets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
| Assets: | ||||||||||||||||
| Equity securities | $ | 3,008 | $ | 3,008 | $ | — | $ | — | ||||||||
| Corporate bonds | 5,968 | 5,968 | — | — | ||||||||||||
| Asset-backed and mortgage-backed securities | 4,762 | — | 4,762 | — | ||||||||||||
| Derivatives | 16,496 | — | 16,496 | — | ||||||||||||
| Investments measured at net asset value | 7,073 | |||||||||||||||
| Liabilities: | ||||||||||||||||
| Derivatives | 16,064 | — | 16,064 | — |
The fair values of the equity securities, corporate bonds and asset-backed and mortgage-backed securities are determined using the closing market price reported in the active market in which the fund is traded or the market price for similar assets that are traded in an active market.
Derivatives consist of forward exchange, costless collar and cross-currency swap contracts, the fair values of which are calculated using market observable inputs including both spot and forward prices for the same underlying currencies. The calculation of fair value of the cross-currency swap contracts also utilizes a present value cash flow model that has been adjusted to reflect the credit risk of either the Company or the counterparty.
Investments measured at net asset value primarily consist of investments in fixed income mutual funds, which are measured at fair value using the net asset value per share practical expedient. These investments have not been categorized in the fair value hierarchy. The Company has the ability to liquidate these investments after giving appropriate notice to the issuer.
The primary investment objective for all investments is the preservation of principal and liquidity while earning income.
There are no other financial assets or financial liabilities that are marked to market on a recurring basis. Fair values are transferred between levels of the fair value hierarchy when facts and circumstances indicate that a change in the method of estimating the fair value of a financial asset or financial liability is warranted.
| 15. | Contingencies |
The Company is involved in various litigation matters arising in the normal course of business, including proceedings based on product liability claims, workers' compensation claims and alleged violations of various environmental laws. The Company is self-insured in the United States for health care, workers' compensation, general liability and product liability up to predetermined amounts, above which third party insurance applies. Management regularly reviews the probable outcome of these proceedings, the expenses expected to be incurred, the availability and limits of the insurance coverage and the established accruals for liabilities. While the outcome of pending proceedings cannot be predicted with certainty, management believes that any liabilities that may result from these proceedings will not have a material adverse effect on the Company's liquidity, financial condition or results of operations.
Environmental - The Company is currently responsible for environmental remediation at various manufacturing facilities presently or formerly operated by the Company and has been named as a “potentially responsible party,” along with other companies, at off-site waste disposal facilities and regional sites.
As of June 30, 2018, the Company had an accrual of $18,024 for environmental matters, which are probable and reasonably estimable. The accrual is recorded based upon the best estimate of costs to be incurred in light of the progress made in determining the magnitude of remediation costs, the timing and extent of remedial actions required by governmental authorities and the amount of the Company's liability in proportion to other responsible parties.
The Company's estimated total liability for environmental matters ranges from a minimum of $18.0 million to a maximum of $81.0 million. The largest range for any one site is approximately $9.5 million. The actual costs to be incurred by the Company will be dependent on final determination of contamination and required remedial action, negotiations with governmental authorities with respect to cleanup levels, changes in regulatory requirements, innovations in investigatory and remedial technologies, effectiveness of remedial technologies employed, the ability of other responsible parties to pay, and any insurance or other third-party recoveries.
| 16. | Quarterly Information (Unaudited) |
| 2018 | 1st | 2nd | 3rd | 4th | Total | |||||||||||||||
| Net sales | $ | 3,364,651 | $ | 3,370,673 | $ | 3,749,591 | $ | 3,817,477 | $ | 14,302,392 | ||||||||||
| Net income attributable to common shareholders | 285,397 | 56,159 | 365,989 | 353,256 | 1,060,801 | |||||||||||||||
| Diluted earnings per share | 2.10 | 0.41 | 2.70 | 2.62 | 7.83 |
| 2017 | 1st | 2nd | 3rd | 4th | Total | |||||||||||||||
| Net sales | $ | 2,743,131 | $ | 2,670,804 | $ | 3,119,139 | $ | 3,496,238 | $ | 12,029,312 | ||||||||||
| Net income attributable to common shareholders | 210,129 | 241,305 | 238,673 | 293,305 | 983,412 | |||||||||||||||
| Diluted earnings per share | 1.55 | 1.78 | 1.75 | 2.15 | 7.25 |
Earnings per share amounts are computed independently for each of the quarters presented, therefore, the sum of the quarterly earnings per share amounts may not equal the total computed for the year.
Previous: Item 7A. Quantitative and Qualitative Disclosures About Market Risk. · Next: Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None.