Item 7. . Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

Forward-looking statements contained in this and other written and oral reports are made based on known events and circumstances at the time of release, and as such, are subject in the future to unforeseen uncertainties and risks. All statements regarding future performance, earnings projections, events or developments are forward-looking statements. It is possible that the future performance and earnings projections of the Company, including its individual segments, may differ materially from current expectations, depending on economic conditions within its mobile, industrial and aerospace markets, and the Company's ability to maintain and achieve anticipated benefits associated with announced realignment activities, strategic initiatives to improve operating margins, actions taken to combat the effects of the current economic environment, and growth, innovation and global diversification initiatives. Additionally, the actual impact of changes in tax laws in the United States and foreign jurisdictions and any judicial or regulatory interpretations thereof on future performance and earnings projections may impact the Company's tax calculations. A change in the economic conditions in individual markets may have a particularly volatile effect on segment performance.

Among other factors which may affect future performance are:

•

global economic and political factors, including the impact of the global outbreak of COVID-19 and governmental and other actions taken in response, manufacturing activity, air travel trends, currency exchange rates and monetary policy, trade policy and tariffs, difficulties entering new markets and general economic conditions such as inflation, deflation, interest rates and credit availability, as well as uncertainties associated with the timing and conditions surrounding the return to service of the Boeing 737 MAX;

•

our ability to identify acceptable strategic acquisition targets; uncertainties surrounding timing, successful completion or integration of acquisitions and similar transactions, including the integrations of Clarcor, Lord and EMFCO Holdings Incorporated, parent company of Exotic; and our ability to successfully divest businesses planned for divestiture and realize the anticipated benefits of such divestitures;

•	our ability to effectively manage expanded operations from the acquisitions of Clarcor, Lord and Exotic;

•	the determination to undertake business realignment activities and the expected costs thereof and, if undertaken, the ability to complete such activities and realize the anticipated cost savings from such activities;

•	increased cybersecurity threats and sophisticated computer crime;

•	business relationships with and purchases by or from major customers, suppliers or distributors, including delays or cancellations in shipments;

•	the development of new products and technologies requiring substantial investment;

•	availability, limitations or cost increases of raw materials, component products and/or commodities that cannot be recovered in product pricing;

•	disputes regarding contract terms or significant changes in financial condition, changes in contract cost and revenue estimates for new development programs, and changes in product mix;

•	uncertainties surrounding the ultimate resolution of outstanding legal and regulatory proceedings, including the outcome of any appeals;

•	additional liabilities relating to changes in tax rates or exposure to additional income tax liabilities;

•	potential product liability risks;

•	our ability to enter into, own, renew and maintain intellectual property and know-how;

•	our leverage and future debt service obligations;

•	potential impairment of goodwill;

•	compliance costs associated with environmental laws and climate change regulations;

•	our ability to manage costs related to insurance and employee retirement and health care benefits;

•	compliance with federal rules, regulations, audits and investigations associated with being a provider of products to the United States government; and

•	our ability to implement successfully the Company's capital allocation initiatives, including timing, price and execution of share repurchases.

The Company makes these statements as of the date of the filing of its Annual Report on Form 10-K for the year ended June 30, 2020, and undertakes no obligation to update them unless otherwise required by law.

Overview

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.

Our order rates provide a near-term perspective of the Company's outlook particularly when viewed in the context of prior and future order rates. The Company publishes its order rates on a quarterly basis. The lead time between the time an order is received and revenue is realized generally ranges from one day to 12 weeks for mobile and industrial orders and from one day to 18 months for aerospace orders. We believe the leading economic indicators of these markets that have a correlation to the Company's future order rates are as follows:

•	Purchasing Managers Index ("PMI") on manufacturing activity specific to regions around the world with respect to most mobile and industrial markets;

•	Global aircraft miles flown and global revenue passenger miles for commercial aerospace markets and Department of Defense spending for military aerospace markets; and

•	Housing starts with respect to the North American residential air conditioning market and certain mobile construction markets.

A PMI above 50 indicates that the manufacturing activity specific to a region of the world in the mobile and industrial markets is expanding. A PMI below 50 indicates the opposite. Recent PMI levels for some regions around the world were as follows:

	June 30, 2020			March 31, 2020			June 30, 2019
United States	52.6			49.1			50.6
Eurozone countries	47.4			44.5			47.6
China	51.2			50.1			49.4
Brazil	51.6			48.4			51.0

Global aircraft miles flown decreased by approximately 45 percent and global revenue passenger miles decreased by approximately 52 percent from their comparable 2019 levels. The Company anticipates that U.S. Department of Defense spending with regard to appropriations and operations and maintenance for the U.S. Government's fiscal year 2020 will increase by approximately two percent from its fiscal 2019 level.

Housing starts in June 2020 were approximately two percent lower than housing starts in March 2020 and approximately four percent lower than housing starts in June 2019.

During 2020, the World Health Organization declared the recent outbreak COVID-19 a pandemic. Given the unpredictable nature of COVID-19's impact on the global economy, the statistics included above may not be reflective of recent or future activity.

We are actively monitoring the impact of the COVID-19 outbreak, which has negatively impacted, and we expect will continue to negatively impact, our business and results of operations. Disruption within the aerospace industry, which is facing the consequences of travel restrictions and considerably lower demand, was significant and is expected to continue. The ultimate extent to which our business and results of operations will be impacted by the outbreak will depend largely on future developments, which are highly uncertain and cannot be accurately predicted at this time, including new information which may emerge concerning the severity of the outbreak and actions by government authorities to contain the outbreak or mitigate its economic, public health and other impacts.

We took immediate and aggressive action to minimize the spread of COVID-19 in our workplaces and are taking measures to preserve cash and reduce costs, including but not limited to, global salary reductions, reduced work schedules, elimination of discretionary spending, targeted restructuring and limiting capital expenditures to safety-related issues and strategic investments. At the same time, we are appropriately addressing the ongoing needs of our business so that we may continue to serve our customers.

In the long-term, we believe many opportunities for profitable growth are available. The Company intends to focus primarily on business opportunities in the areas of energy, water, food, environment, defense, life sciences, infrastructure and transportation.

We believe we can meet our strategic objectives by:

•	Serving the customer and continuously enhancing its experience with the Company;

•	Successfully executing The Win Strategy initiatives relating to engaged people, premier customer experience, profitable growth and financial performance;

•	Maintaining a decentralized division and sales company structure;

•	Fostering a safety first and entrepreneurial culture;

•	Engineering innovative systems and products to provide superior customer value through improved service, efficiency and productivity;

•	Delivering products, systems and services that have demonstrable savings to customers and are priced by the value they deliver;

•	Acquiring strategic businesses;

•	Organizing around targeted regions, technologies and markets;

•	Driving efficiency by implementing lean enterprise principles; and

•	Creating a culture of empowerment through our values, inclusion and diversity, accountability and teamwork.

Acquisitions will be considered from time to time to the extent there is a strong strategic fit, while at the same time maintaining the Company’s strong financial position. During 2020, the Company completed the Lord and Exotic acquisitions, which are further discussed in Note 3 to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.

We continue to assess our existing businesses and may initiate efforts to divest businesses that are not considered to be a good long-term strategic fit for the Company. Future business divestitures could have a negative effect on the Company’s results of operations.

The discussion below is structured to separately discuss the financial statements presented in Part II, Item 8 of this Annual Report on Form 10-K. The term "year" and references to specific years refer to the applicable fiscal year. Discussion of the 2018 financial statements is included in Part II, Item 7 of the Company's 2019 Annual Report on Form 10-K.

CONSOLIDATED STATEMENT OF INCOME

The Consolidated Statement of Income summarizes the Company's operating performance. The discussion below compares the operating performance in 2020 and 2019.

(dollars in millions)		2020				2019
Net sales		$	13,696			$	14,320
Gross profit margin		24.9		%		25.3		%
Selling, general and administrative expenses		$	1,657			$	1,544
Selling, general and administrative expenses, as a percent of sales		12.1		%		10.8		%
Interest expense		$	308			$	190
Other (income) expense, net		(67		)		(61		)
(Gain) loss on disposal of assets		(1		)		11
Effective tax rate		20.2		%		21.7		%
Net income attributable to common shareholders		$	1,206			$	1,512

Net sales in 2020 decreased from the 2019 amount due to lower volume in all segments, partially offset by an increase in sales from acquisitions made within the last 12 months of $949 million. The effect of currency rate changes decreased net sales in 2020 by approximately $167 million, of which $152 million was attributable to the Diversified Industrial International operations.

Gross profit margin (calculated as net sales less cost of sales, divided by net sales) decreased slightly in 2020. Lower volume and current-year acquisition-related expenses of $69 million were partially offset by lower operating costs resulting from current and prior-year business realignment, acquisition integration and simplification activities, lower raw material costs and favorable product mix. Additionally, cost of sales included business realignment and acquisition integration charges of $60 million in 2020 compared to $15 million in 2019. Gross profit margin in 2020 benefited from a foreign currency transaction gain of $10 million compared to a loss of $6 million in 2019.

Selling, general and administrative expenses ("SG&A") increased seven percent in 2020 primarily due to acquisition-related transaction costs of $119 million in the current year compared to $17 million in 2019 and higher intangible asset amortization expense related to the Lord and Exotic acquisitions. SG&A also included business realignment and acquisition integration charges of $38 million and $13 million in 2020 and 2019, respectively. These expenses were partially offset by a net benefit associated with the Company's deferred compensation plan and related investments. Additionally, SG&A benefited from lower discretionary spending and wage and salary expense as a result of actions taken in response to the current business conditions resulting from the COVID-19 outbreak.

Interest expense in 2020 increased due to a higher average interest rate and higher average debt outstanding.

Other (income) expense, net included the following:

(dollars in millions)
Expense (income)		2020				2019
Income related to equity method investments		$	(75	)		$	(93	)
Non-service components of retirement benefit cost		49				40
Interest income		(31		)		(18		)
Other items, net		(10		)		10
		$	(67	)		$	(61	)

(Gain) loss on disposal of assets in 2020 and 2019 includes gains on the sale of real estate of $12 million and $11 million, respectively, with the remainder relating to net losses on divestitures and asset sales and writedowns.

Effective tax rate in 2020 was lower than 2019 primarily due to favorable one-time adjustments that were recorded in the current year as a result of a favorable foreign audit settlement.

BUSINESS SEGMENT INFORMATION

The Business Segment information presents sales and operating income on a basis that is consistent with the manner in which the Company's various businesses are managed for internal review and decision-making.

Diversified Industrial Segment

(dollars in millions)		2020				2019
Sales
North America		$	6,456			$	6,809
International		4,505				5,001
Operating income
North America		986				1,139
International		675				805
Operating income as a percent of sales
North America		15.3		%		16.7		%
International		15.0		%		16.1		%
Backlog		$	2,117			$	2,011

The Diversified Industrial Segment operations experienced the following percentage changes in net sales:

		2020
Diversified Industrial North America – as reported		(5.2	)%
Acquisitions		6.0	%
Currency		(0.2	)%
Diversified Industrial North America – without acquisitions and currency		(11.0	)%
Diversified Industrial International – as reported		(9.9	)%
Acquisitions		4.1	%
Currency		(3.1	)%
Diversified Industrial International – without acquisitions and currency		(10.9	)%
Total Diversified Industrial Segment – as reported		(7.2	)%
Acquisitions		5.2	%
Currency		(1.4	)%
Total Diversified Industrial Segment – without acquisitions and currency		(11.0	)%

The above presentation reconciles the percentage changes in net sales of the Diversified Industrial Segment reported in accordance with U.S. GAAP to percentage changes in net sales adjusted to remove the effects of acquisitions made within the prior four fiscal quarters as well as the effects of currency exchange rates (a non-GAAP measure). The effects of acquisitions and currency exchange rates are removed to allow investors and the Company to meaningfully evaluate the percentage changes in net sales on a comparable basis from period to period.

Sales in 2020 for the Diversified Industrial North American operations decreased 5.2 percent from 2019. Acquisitions increased sales by $408 million, and the effect of currency exchange rates decreased sales by approximately $13 million. Excluding acquisitions and the effect of currency rate changes, sales in 2020 for the Diversified Industrial North American operations decreased 11.0 percent from prior-year levels reflecting lower demand from distributors and end users in virtually all markets, including the construction equipment, cars and light truck, heavy-duty truck, engines, refrigeration and general industrial machinery markets. This decrease was partially offset by an increase in end-user demand in the life sciences market.

Sales in the Diversified Industrial International operations decreased 9.9 percent in 2020. Acquisitions increased sales by approximately $203 million in 2020. The effect of currency rate changes decreased sales by $152 million, reflecting the strengthening of the U.S. dollar primarily against currencies in the Eurozone countries, China, Brazil, and South Korea. Excluding acquisitions and the effect of currency rate changes, sales in 2020 for the Diversified Industrial International operations decreased 10.9 percent from 2019 levels primarily due to lower demand from distributors and end users in both the mobile and industrial markets. During 2020, Europe, the Asia Pacific region, and Latin America accounted for approximately 68 percent, 28 percent, and four percent, respectively, of the decrease in sales.

Within Europe, the decrease in sales was primarily due to lower demand from distributors and end users in the construction equipment, general industrial machinery, machine tool, heavy-duty truck and cars and light truck markets.

Within the Asia Pacific region, the decrease in sales was primarily due to lower demand from distributors as well as end users in the construction equipment, railroad equipment, telecommunications and machine tool markets. This decrease was partially offset by an increase in end-user demand in the semiconductor, mining and engine markets.

The decrease in sales in Latin America was primarily due to lower demand from distributors and end users in the construction equipment, farm and agricultural equipment and cars and light truck markets, partially offset by an increase in end-user demand in the oil and gas market.

Operating margins in 2020 decreased in both the Diversified Industrial North American and International operations primarily due to lower sales volume, acquisition-related expenses, higher intangible asset amortization expense, and higher business realignment and acquisition integration costs. These costs were partially offset by lower discretionary spending, lower wage and salary expense, favorable product mix, lower raw material costs, benefits from current-year and prior-year business realignment and simplification actions, and prior-year pricing actions.

The following business realignment and acquisition integration charges are included in Diversified Industrial North America and Diversified Industrial International operating income:

(dollars in millions)		2020				2019
Diversified Industrial North America		$	41			$	13
Diversified Industrial International		32				15

The business realignment charges consist primarily of severance and plant closure costs related to actions taken under the Company's simplification initiative aimed at reducing organizational and process complexity, which is being implemented by its operating units throughout the world. Current-year acquisition integration charges relate to the Lord acquisition. Prior-year acquisition integration charges relate to the 2017 acquisition of Clarcor. During 2020, business realignment charges also include permanent workforce reductions to address the impact of COVID-19 on our business. The majority of the Diversified Industrial International business realignment and acquisition integration charges were incurred in Europe. We anticipate that cost savings realized from the workforce reduction measures taken during 2020 will increase operating income for 2021 by approximately five percent in the Diversified Industrial North American operations and by approximately two percent in the Diversified Industrial International operations. In 2021, we expect to continue to take actions necessary to structure appropriately the operations of the Diversified Industrial Segment. These actions are expected to result in approximately $53 million in business realignment charges in 2021. However, continually changing business conditions could impact the ultimate costs we incur.

The increase in Diversified Industrial Segment backlog in 2020 was primarily due to the current-year acquisition of Lord, partially offset by shipments exceeding orders in both the North American and International businesses. Within the International business, this decrease in backlog was primarily related to shipments exceeding orders in both Europe and Latin America, partially offset by orders exceeding shipments in the Asia Pacific region. Backlog consists of written firm orders from a customer to deliver products and, in the case of blanket purchase orders, only includes the portion of the order for which a schedule or release date has been agreed to with the customer. The dollar value of backlog is equal to the amount that is expected to be billed to the customer and reported as a sale.

Aerospace Systems Segment

(dollars in millions)		2020				2019
Sales		$	2,735			$	2,511
Operating income		477				488
Operating income as a percent of sales		17.4		%		19.4		%
Backlog		$	3,021			$	2,209

Sales in 2020 were higher than the 2019 level primarily due to $338 million of sales from current-year acquisitions and higher volume in the military OEM and aftermarket businesses, partially offset by lower volume in the commercial OEM and aftermarket businesses.

Operating margin decreased in 2020 primarily due to lower sales volume in the commercial OEM and aftermarket businesses, unfavorable product mix, acquisition-related expenses, higher intangible asset amortization expense and current-year business realignment and acquisition integration charges of $24 million. The halt in production of the Boeing 737 MAX also contributed to lower operating margin during 2020. These expenses were partially offset by lower engineering development expenses, lower discretionary spending and savings from the current-year business realignment and acquisition integration actions.

As a result of the disruption in the aerospace industry due to the COVID-19 pandemic, we expect to continue to take the actions necessary to structure appropriately the operations of the Aerospace Systems Segment. These actions are expected to result in approximately $12 million of business realignment charges in 2021. However, continually changing business conditions could impact the ultimate costs we incur. We anticipate that cost savings realized from the workforce reduction measures taken during 2020 will increase operating income for 2021 by approximately 13 percent.

The increase in backlog in 2020 was primarily due to the addition of Exotic backlog in the current year and orders exceeding shipments in the military OEM and aftermarket businesses, partially offset by shipments exceeding orders in the commercial OEM and aftermarket businesses. Backlog consists of written firm orders from a customer to deliver products and, in the case of blanket purchase orders, only includes the portion of the order for which a schedule or release date has been agreed to with the customer. The dollar value of backlog is equal to the amount that is expected to be billed to the customer and reported as a sale.

Corporate general & administrative expenses

(dollars in millions)
Expense (income)	2020				2019
Corporate general and administrative expense	$	171			$	195
Corporate general and administrative expense, as a percent of sales	1.2		%		1.4		%

Corporate general and administrative expenses decreased in 2020 primarily due to a net benefit related to the Company's deferred compensation plan and related investments. Additionally, corporate general and administrative expenses benefited from lower discretionary spending and wage and salary expense as a result of actions taken in response to the current business conditions resulting from the COVID-19 outbreak.

Other expense (in the Business Segment Information)

(dollars in millions)
Expense (income)	2020				2019
Foreign currency transaction	$	(10	)		$	6
Stock-based compensation	52				52
Pensions	30				20
Acquisition expenses	119				17
Divestitures and asset sales and writedowns, net	(1		)		11
Interest income	(31		)		(18		)
Other items, net	(13		)		25
	$	146			$	113

Foreign currency transaction primarily relates to the impact of changes in foreign exchange rates on cash, marketable securities and other investments and intercompany transactions. Acquisition expenses relate to the acquisitions of Lord and Exotic.

CONSOLIDATED BALANCE SHEET

The Consolidated Balance Sheet shows the Company's financial position at year end, compared with the previous year end. This discussion provides information to assist in assessing factors such as the Company's liquidity and financial resources.

(dollars in millions)		2020				2019
Cash		$	756			$	3,371
Trade accounts receivable, net		1,854				2,131
Inventories		1,815				1,678
Intangible assets, net		3,799				1,783
Goodwill		7,870				5,454
Notes payable and long-term debt payable within one year		810				587
Long-term debt		7,652				6,521
Shareholders' equity		6,114				5,962
Working capital		$	1,737			$	4,521
Current ratio		1.6				2.4

Cash (comprised of cash and cash equivalents and marketable securities and other investments) includes $726 million and $975 million held by the Company's foreign subsidiaries at June 30, 2020 and 2019, respectively. The Company has determined it will no longer permanently reinvest certain foreign earnings. The distribution of these earnings could result in non-federal U.S. or foreign taxes. All other undistributed foreign earnings remain permanently reinvested. Refer to Note 5 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion.

Trade accounts receivable, net are receivables due from customers for sales of product. Days sales outstanding relating to trade receivables for the Company was 54 days in 2020 and 53 days in 2019. We believe that our receivables are collectible and appropriate allowances for doubtful accounts have been recorded.

Inventories as of June 30, 2020 increased by $136 million (which includes an increase of $363 million from acquisitions and a decrease of $26 million from the effect of foreign currency translation). After consideration of the effects of acquisitions and foreign currency translation, inventories decreased primarily due to a decrease in the Diversified Industrial Segment, partially offset by an increase in the Aerospace Systems Segment. Days supply of inventory on hand was 89 days in 2020 and 69 days in 2019.

Intangible assets, net and Goodwill increased from 2019 primarily due to the current-year acquisitions of Lord and Exotic. Refer to Note 3 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion.

Notes payable and long-term debt payable within one year increased from 2019 primarily due to higher commercial paper notes outstanding of which a portion was used to finance the purchase of the Lord and Exotic acquisitions. Refer to Note 9 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion.

Long-term debt increased from 2019 primarily due to outstanding term loans related to the acquisition of Lord and Exotic. Refer to Note 10 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion.

Shareholders' equity activity during 2020 included a decrease of $147 million related to share repurchases, a decrease of $318 million related to pensions and postretirement benefits resulting from net actuarial losses due to a decrease in discount rates and a decrease of $182 million related to foreign currency translation adjustments.

CONSOLIDATED STATEMENT OF CASH FLOWS

The Consolidated Statement of Cash Flows reflects cash inflows and outflows from the Company's operating, investing and financing activities.

A summary of cash flows follows:

(dollars in millions)		2020				2019
Cash provided by (used in):
Operating activities		$	2,071			$	1,730
Investing activities		(5,024		)		(219		)
Financing activities		449				902
Effect of exchange rates		(30		)		(16		)
Net (decrease) increase in cash and cash equivalents		$	(2,534	)		$	2,397

Cash flows from operating activities in 2020 reflects a decrease in net income of $306 million and an increase of $327 million from cash provided by working capital items. The Company also made a discretionary cash contribution to the Company's domestic qualified defined benefit plan of $200 million in 2019.

Cash flows from investing activities in 2020 includes $5,076 million of acquisition-related activity for Lord and Exotic. It also includes $121 million of proceeds from the redemption of company-owned life insurance investments associated with the Company's deferred compensation programs as well proceeds of $44 million related to the settlement of a cross currency swap.

Cash flows from financing activities includes proceeds from the $925 million and $800 million term loans related to the acquisition of Exotic and Lord, respectively. It also includes repayment of long-term debt of approximately $740 million, of which approximately $221 million relates to acquired Lord debt. Refer to Note 10 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion. The Company repurchased 0.8 million common shares for $147 million during 2020 compared to the repurchase of 4.8 million common shares for $800 million in 2019.

Dividends have been paid for 280 consecutive quarters, including a yearly increase in dividends for the last 64 years. The current annual dividend rate is $3.52 per common share.

Our goal is to maintain a strong investment-grade credit profile. The rating agencies periodically update our credit ratings as events occur. At June 30, 2020, the long-term credit ratings assigned to the Company's senior debt securities by the credit rating agencies engaged by the Company were as follows:

Fitch Ratings		BBB+
Moody's Investor Services, Inc.		Baa1
Standard & Poor's		BBB+

During 2020, we have taken several meaningful measures to strengthen our liquidity position in light of the COVID-19 pandemic, including limiting capital expenditures to safety-related issues and strategic investments, the suspension of our share repurchase program and other cost reduction efforts. Although we cannot reasonably estimate the duration of the pandemic or its impact on our business, we believe these measures, as well as access to committed credit under our credit agreement, position the Company well to manage through the current economic uncertainty and capitalize on our position as the global leader in motion and control technologies as the economy recovers.

During 2020, the Company amended and extended its existing multi-currency credit agreement, increasing its capacity to $2,500 million. As of June 30, 2020, the Company had $1,777 million available for borrowing under the credit agreement. The credit agreement expires in September 2024; 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 is dependent upon the Company’s credit ratings. Although a lowering of the Company’s credit ratings would 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. Refer to Note 9 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion.

The Company is currently authorized to sell up to $2,500 million of short-term commercial paper notes. There were $724 million outstanding commercial paper notes as of June 30, 2020, and the largest amount of commercial paper notes outstanding during the last quarter of 2020 was $1,089 million.

The Company’s credit agreements and indentures governing certain debt securities contain various covenants, the violation of which would limit or preclude the use of the credit agreements for future borrowings, or might accelerate the maturity of the related outstanding borrowings covered by the indentures. Based on the Company’s rating level at June 30, 2020, the most restrictive financial covenant provides that the ratio of debt to debt-shareholders' equity cannot exceed 0.65 to 1.0. At June 30, 2020, the Company's debt to debt-shareholders' equity ratio was 0.58 to 1.0. We are in compliance and expect to remain in compliance with all covenants set forth in the credit agreement and indentures.

Contractual Obligations - The total amount of gross unrecognized tax benefits, including interest, for uncertain tax positions was $101 million at June 30, 2020. Payment of these obligations would result from settlements with worldwide taxing authorities. Due to the difficulty in determining the timing of the settlements, these obligations are not included in the following summary of the Company's fixed contractual obligations. References to Notes are to the Notes to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.

(dollars in millions)		Payments due by period
Contractual obligations		Total				Less than 1 year				1-3 years				3-5 years				More than 5 years
Transition tax payments related to U.S. Tax Cuts and Jobs Act ("TCJ Act") (Note 5)		$	176			$	—			$	12			$	96			$	68
Long-term debt (Note 10)		7,814				87				675				2,615				4,437
Interest on long-term debt		3,527				258				498				411				2,360
Operating leases (Note 11)		149				46				55				24				24
Retirement benefits (Note 12)		118				77				11				10				20
Total		$	11,784			$	468			$	1,251			$	3,156			$	6,909

OFF-BALANCE SHEET ARRANGEMENTS

The Company does not have off-balance sheet arrangements.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The policies discussed below are considered by management to be more critical than other policies because their application places the most significant demands on management's judgment.

Revenue Recognition - Revenues are recognized when control of performance obligations, which are distinct goods or services within the contract, is transferred to the customer. Control is transferred when the customer has the ability to direct the use of and obtain the benefits from the goods or services. A majority of our revenues are recognized at a point in time when control is transferred to the customer, which is generally at the time of shipment. However, a portion of our revenues are recognized over time if the customer simultaneously receives control as we perform work under a contract, if the customer controls the asset as it is being produced, or if the product has no alternative use and we have a contractual right to payment.

For contracts where revenue is recognized over time, we use the cost-to-cost, efforts expended or units of delivery method depending on the nature of the contract, including length of production time. The estimation of these costs and efforts expended requires judgment on the part of management due to the duration of the contractual agreements as well as the technical nature of the products involved. Adjustments to these 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.

When there are multiple performance obligations within a contract, the transaction price is allocated to each performance obligation based on its standalone selling price. The primary method used to estimate a standalone selling price is the price observed in standalone sales to customers for the same product or service. Revenue is recognized when control of the individual performance obligations is transferred to the customer.

We consider the contractual consideration payable by the customer and assesses variable consideration that may affect the total transaction price. Variable consideration is included in the estimated transaction price when there is a basis to reasonably estimate the amount, including whether the estimate should be constrained in order to avoid a significant reversal of revenue in a future period. These estimates are based on historical experience, anticipated performance under the terms of the contract and our best judgment at the time.

Impairment of Goodwill and Long-Lived Assets - We test goodwill for impairment at the reporting unit level on an annual basis and between annual tests whenever events or circumstances indicate the carrying value of a reporting unit may exceed its fair value. Our six reporting units are equivalent to our operating segments. As quoted market prices are not available for our reporting units, determining whether an impairment occurred requires the valuation of the respective reporting unit, which is

estimated using both income-based and market-based valuation methods. The income-based valuation method utilizes a discounted cash flow model which requires several assumptions, including future sales growth and operating margin levels as well as assumptions regarding future industry-specific market conditions. Each reporting unit regularly prepares discrete operating forecasts and uses these forecasts as the basis for the assumptions in the discounted cash flow analysis. Within the discounted cash flow models, the Company uses a discount rate, commensurate with its cost of capital but adjusted for inherent business risks, and an appropriate terminal growth factor. The market-based valuation performed for each reporting unit includes an analysis consisting of market-adjusted multiples based on key data points for guideline public companies. We also reconcile the estimated aggregate fair value of our reporting units resulting from these procedures to our overall market capitalization.

At December 31, 2019, the Company performed its annual goodwill impairment test for each of its six reporting units. The results of this test indicated the fair value substantially exceeded carrying value for all reporting units. We continually monitor our reporting units for impairment indicators and update assumptions used in the most recent calculation of the fair value of a reporting unit as appropriate. We did not identify any events or circumstances during 2020 that required performance of an interim impairment test. However, the effects of COVID-19 on the global economy, including further market disruption, lack of economic recovery or lower than anticipated customer demand, may require the performance of additional goodwill impairment tests, and the estimated fair value of certain reporting units could fall below their carrying value.

Long-lived assets held for use, which primarily includes finite-lived intangible assets and plant and equipment, 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 are less than their carrying value. The long-term nature of these assets requires the estimation of their cash inflows and outflows several years into the future and only takes into consideration technological advances known at the time of the impairment test. During 2020, the Company did not record any material impairment related to long-lived assets.

Pensions - The annual net periodic expense and benefit obligations related to the Company's defined benefit plans are determined on an actuarial basis. This determination requires critical assumptions regarding the discount rate, long-term rate of return on plan assets, increases in compensation levels and amortization periods for actuarial gains and losses. Assumptions are determined based on Company data and appropriate market indicators and are evaluated each year as of the plans' measurement date. Changes in the assumptions to reflect actual experience as well as the amortization of actuarial gains and losses could result in a material change in the annual net periodic expense and benefit obligations reported in the financial statements.

For the Company's domestic qualified defined benefit plan, a 50 basis point change in the assumed long-term rate of return on plan assets is estimated to have a $17 million effect on annual pension expense and a 50 basis point decrease in the discount rate is estimated to increase annual pension expense by $28 million. As of June 30, 2020, $1,456 million of past years' net actuarial losses related to the Company's domestic qualified defined benefit plan are subject to amortization in the future. These losses will generally be amortized over approximately seven years and will negatively affect earnings in the future. Any actuarial gains experienced in future years will help reduce the effect of the net actuarial loss amortization. Further information on pensions is provided in Note 12 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.

Income Taxes - Significant judgment is required in determining the Company's income tax expense and in evaluating tax positions. Deferred income tax assets and liabilities have been recorded for the differences between the financial accounting and income tax basis of assets and liabilities. Factors considered by the Company in determining the probability of realizing deferred income tax assets include forecasted operating earnings, available tax planning strategies and the time period over which the temporary differences will reverse. The Company reviews its tax positions on a regular basis and adjusts the balances as new information becomes available. For those tax positions where it is more likely than not that a tax benefit will be sustained, the largest amount of tax benefit with a greater than 50 percent likelihood of being realized upon examination by a taxing authority that has full knowledge of all relevant information will be recorded. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the Consolidated Financial Statements. Further information on income taxes is provided in Note 5 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.

Loss Contingencies - The Company has a number of loss exposures incurred in the ordinary course of business such as environmental claims, product liability and litigation reserves. Establishing loss accruals for these matters requires management's estimate and judgment with regards to risk exposure and ultimate liability or realization. We review these loss accruals periodically and make adjustments to reflect the most recent facts and circumstances.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Recently issued accounting pronouncements are described in Note 1 to the Consolidated Financial Statements, included in Part II, Item 8 of this Annual Report on Form 10-K.