NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts or as otherwise noted)
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. We evaluate performance based on segment operating income before corporate administrative expenses, interest expense and income taxes.
There are no individual customers to whom sales are more than two percent of the Company's consolidated sales. Due to our diverse group of customers throughout the world, we do not consider ourself 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 our products and geographic operations mitigate the risk that adverse changes with respect to any particular product and geographic operation would materially affect our operating results.
Use of Estimates - The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
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, inter-segment and inter-area sales have been eliminated.
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. When revenue is recognized at a point in time, control generally transfers at time of shipment. Revenues are recognized over time if the customer simultaneously receives control as the Company performs work under a contract, if the customer controls the asset as it is being produced, or if the product produced for the customer has no alternative use and the Company has 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. We make adjustments to these estimates on a consistent basis and establish a contract reserve when the estimated costs to complete a contract exceed the expected contract revenues.
A contract’s transaction price is allocated to each distinct performance obligation. 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 of 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 primarily includes prompt pay discounts, rebates and volume discounts and 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.
Payment terms vary by customer and the geographic location of the customer. The time between when revenue is recognized and payment is due is not significant. Our contracts with customers generally do not include significant financing components or noncash consideration.
Taxes collected from customers and remitted to governmental authorities are excluded from revenue. Shipping and handling costs are treated as fulfillment costs and are included in cost of sales. The costs to obtain a contract where the amortization period for the related asset is one year or less are expensed as incurred.
There is generally no unilateral right to return products. The Company primarily offers an assurance-type standard warranty that the product will conform to certain specifications for a defined period of time or usage after delivery. This type of warranty does not represent a separate performance obligation.
Cash - Cash equivalents consist of short-term, highly liquid investments with a maturity of three months or less. These investments are carried at cost plus accrued interest and 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, which are carried at cost plus accrued interest. Marketable securities and other investments also include investments in equity securities which are carried at fair value. Changes in fair value related to equity securities are recorded in net income. We have the ability to liquidate these 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. We evaluate the collectibility of our receivables based on historical experience and current and forecasted economic conditions based on management's judgment. Additionally, receivables are written off to bad debt when management makes a final determination of uncollectibility. Allowance for credit losses was $10 million and $12 million at June 30, 2022 and 2021, 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, | | 2022 | | 2021 |
| Notes receivable | | $ | 103,558 | | | $ | 144,441 | |
| | | | |
Cash collateral receivable(a) | | 250,000 | | | — | |
| Accounts receivable, other | | 190,199 | | | 181,874 | |
| Total | | $ | 543,757 | | | $ | 326,315 | |
(a) The cash collateral receivable relates to the deal-contingent forward contracts. Refer to Note 16 for further discussion.
Property, Plant and Equipment and Depreciation - Property, 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. We review property, plant and equipment for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable. When property, 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 property, plant and equipment caption in the Consolidated Balance Sheet is comprised of the following components:
| | | | | | | | | | | | | | |
| June 30, | | 2022 | | 2021 |
| Land and land improvements | | $ | 322,024 | | | $ | 342,950 | |
| Buildings and building equipment | | 1,783,805 | | | 1,848,141 | |
| Machinery and equipment | | 3,588,106 | | | 3,653,566 | |
| Construction in progress | | 204,020 | | | 195,563 | |
| Total | | $ | 5,897,955 | | | $ | 6,040,220 | |
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 $314 million and $292 million at June 30, 2022 and 2021, 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 $76 million, $41 million and $75 million in 2022, 2021 and 2020, respectively.
Intangible Assets - Intangible assets primarily include patents and technology, trademarks and customer lists and contracts and are recorded at cost and amortized on a straight-line method. Patents and technology are amortized over the shorter of their remaining useful or legal life. Trademarks and customer contracts 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. Taxes related to Global Intangible Low-Taxed Income ("GILTI") are treated as a current period expense when incurred. Tax credits and similar tax incentives are applied to reduce the provision for income taxes in the year in which the credits arise. We recognize 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. Income tax effects resulting from adjusting temporary differences recorded in accumulated other comprehensive (loss) are released when the circumstances on which they are based cease to exist.
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 accumulated other comprehensive (loss). Such adjustments will affect net income only upon sale or liquidation of the underlying foreign investments. Exchange (gains) losses 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 $(40) million, $(11) million and $(10) million, in 2022, 2021 and 2020, respectively.
Subsequent Events - We 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, 2022. In July 2022, we issued $504 million of commercial paper and deposited this amount into the escrow account to finance a portion of the purchase of Meggitt. Additionally, in July 2022, we deposited a total of $250 million into escrow that was previously posted as collateral and recorded within non-trade and notes receivables at June 30, 2022. Refer to Note 16 for further discussion. In July 2022, after consideration of the escrow balance and funds available under the delayed-draw Term Loan Facility, we reduced the aggregate committed principal amount of the bridge credit agreement (the "Bridge Credit Agreement") to zero.
Recent Accounting Pronouncements - In November 2021, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2021-10, "Government Assistance (Topic 832), Disclosures by Business Entities about Government Assistance", which requires entities to provide disclosures on material government assistance transactions for annual reporting periods. The disclosures include information around the nature of the assistance, the related accounting policies used to account for government assistance, the effect of government assistance on the entity’s financial statements, and any significant terms and conditions of the agreements, including commitments and contingencies. The new guidance is effective for all entities for annual reporting periods beginning after December 15, 2021; however, early adoption is permitted. The guidance may be applied either prospectively to all in-scope transactions that are reflected in the financial statements at the date of initial application and to new transactions that are entered into after the date of initial application, or retrospectively. The Company is currently evaluating the impact this guidance will have on its consolidated financial statements and does not expect it to be material.
In October 2021, the FASB issued ASU 2021-08, "Business Combinations (Topic 805), Accounting for Contract Assets and Contract Liabilities from Contracts with Customers." ASU 2021-08 requires contract assets and contract liabilities acquired in a business combination to be recognized in accordance with Accounting Standards Codification (“ASC”) Topic 606 as if the acquirer had originated the contracts. The standard is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is permitted. The Company elected to early adopt this standard in the second quarter of fiscal 2022. The impact of the new standard on our consolidated financial statements and related disclosures will depend on the magnitude of future acquisitions.
2. Revenue recognition
Revenue is derived primarily from the sale of products in a variety of mobile, industrial and aerospace markets. A majority of the Company’s revenues are recognized at a point in time. However, a portion of the Company’s revenues are recognized over time.
Disaggregation of revenue
Revenue from contracts with customers is disaggregated by technology platforms for the Diversified Industrial Segment, by product platforms for the Aerospace Systems Segment and by geographic location for the total Company.
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. Contracts consist of individual purchase orders for standard product, blanket purchase orders and production contracts. Blanket purchase orders are often associated with individual purchase orders and have terms and conditions which are subject to a master supply or distributor agreement. Individual production contracts, some of which may include multiple performance obligations, are typically for products manufactured to the customer's specifications. Revenue in the Diversified Industrial Segment is typically recognized at the time of product shipment, but a portion of revenue may be recognized over time for installation services or in situations where the product has no alternative use and we have an enforceable right to payment.
Diversified Industrial Segment revenues by technology platform: | | | | | | | | | | | | | | |
| | 2022 | | 2021 |
| Motion Systems | | $ | 3,489,431 | | | $ | 3,081,366 | |
| Flow and Process Control | | 4,616,270 | | | 4,108,080 | |
| Filtration and Engineered Materials | | 5,236,345 | | | 4,770,713 | |
| Total | | $ | 13,342,046 | | | $ | 11,960,159 | |
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. Aerospace Systems Segment products also perform a vital role in naval vessels and land-based weapon systems. Contracts generally consist of blanket purchase orders and individual long-term production contracts. Blanket purchase orders, which have terms and conditions subject to long-term supply agreements, are typically associated with individual purchase orders. Revenue in the Aerospace Systems Segment is typically recognized at the time of product shipment, but a portion of revenue may be recognized over time in situations where the customer controls the asset as it is produced or the product has no alternative use and we have an enforceable right to payment.
Aerospace Systems Segment revenues by product platform: | | | | | | | | | | | | | | |
| | 2022 | | 2021 |
| Flight Control Actuation | | $ | 761,215 | | | $ | 698,877 | |
| Fuel and Inerting | | 535,292 | | | 509,687 | |
| Hydraulics | | 306,279 | | | 308,835 | |
| Engines | | 591,513 | | | 575,804 | |
| Fluid Conveyance | | 219,543 | | | 196,348 | |
| Other | | 105,720 | | | 97,930 | |
| Total | | $ | 2,519,562 | | | $ | 2,387,481 | |
Total revenues by geographic region based on the Company's selling operation's location: | | | | | | | | | | | | | | |
| | 2022 | | 2021 |
| North America | | $ | 10,216,292 | | | $ | 9,046,162 | |
| Europe | | 3,156,024 | | | 2,919,025 | |
| Asia Pacific | | 2,290,557 | | | 2,215,686 | |
| Latin America | | 198,735 | | | 166,767 | |
| Total | | $ | 15,861,608 | | | $ | 14,347,640 | |
The majority of revenues from the Aerospace Systems Segment is generated from sales to customers within North America.
Contract balances
Contract assets and contract liabilities are reported on a contract-by-contract basis. Contract assets reflect revenue recognized and performance obligations satisfied in advance of customer billing. Contract liabilities relate to payments received in advance of the satisfaction of performance under the contract. Payments from customers are received based on the terms established in the contract with the customer.
Total contract assets and contract liabilities are as follows: | | | | | | | | | | | | | | |
| | 2022 | | 2021 |
| Contract assets, current (included within Prepaid expenses and other) | | $ | 28,546 | | | $ | 34,190 | |
| Contract assets, noncurrent (included within Investments and other assets) | | 794 | | | 1,884 | |
| Total contract assets | | 29,340 | | | 36,074 | |
| Contract liabilities, current (included within Other accrued liabilities) | | (60,472) | | | (51,211) | |
| Contract liabilities, noncurrent (included within Other liabilities) | | (2,225) | | | (3,080) | |
| Total contract liabilities | | (62,697) | | | (54,291) | |
| Net contract liabilities | | $ | (33,357) | | | $ | (18,217) | |
Net contract liabilities at June 30, 2022 increased from the prior year amount due to both an increase in contract liabilities related to the receipt of advance payments and a decrease in contract assets resulting from customer billings. During 2022, approximately $44 million of revenue was recognized that was included in the contract liabilities at June 30, 2021.
Remaining performance obligations
Our backlog represents 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 has been agreed to with the customer. We believe our backlog represents our unsatisfied or partially unsatisfied performance obligations. Backlog at June 30, 2022 was $7,850 million, of which approximately 88 percent is expected to be recognized as revenue within the next 12 months and the balance thereafter.
3. Acquisitions
Proposed Acquisition
On August 2, 2021, the Company announced that it reached an agreement on the terms of a recommended cash acquisition of the entire issued and to be issued ordinary share capital of Meggitt plc ("Meggitt") for 800 pence per share (the "Acquisition"), which is approximately £6,263 million based on issued share capital at July 31, 2022.
Meggitt is a leader in design, manufacturing and aftermarket support of technologically differentiated systems and equipment in aerospace, defense and selected energy markets with annual sales of approximately $2.1 billion for the year ended December 31, 2021. We intend to fund the proposed Acquisition with cash resources, borrowings under debt facilities and net proceeds of debt securities. Refer to Note 10 for further discussion. The proposed Acquisition received the European Commission's clearance on April 11, 2022, conditional on full compliance with commitments offered by the Company, including a commitment to divest its aircraft wheel and brake business within the Aerospace Systems Segment. The proposed Acquisition remains subject to customary closing conditions, including regulatory clearance. Acquisition-related transaction costs totaled $44 million in 2022. These costs are included in selling, general and administrative expenses in the Consolidated Statement of Income.
On May 23, 2022, the Company signed an agreement to divest its aircraft wheel and brake business, within the Aerospace Systems Segment. The aggregate carrying amount of the assets held for sale as of June 30, 2022 was $66 million. These assets primarily include goodwill and inventory and are recorded within prepaid expenses and other assets in the Consolidated Balance Sheet. Closing of this divestiture is subject to customary closing conditions, including regulatory clearance.
Restricted Cash
During 2022 we deposited funds, comprised of cash on hand and net proceeds from the issuance of commercial paper and the Senior Notes, into an escrow account. The escrow account is restricted to payments for the proposed Acquisition. At June 30, 2022, the balance was $6,112 million, which was recorded within prepaid expenses and other in the Consolidated Balance Sheet.
Acquisitions
On October 29, 2019, we completed the acquisition of a 100 percent equity interest in LORD Corporation ("Lord") for approximately $3,455 million in cash, including the assumption of debt. On September 16, 2019, we completed the acquisition of a 100 percent equity interest in EMFCO Holdings Incorporated, parent company of Exotic Metals Forming Company LLC ("Exotic") for approximately $1,706 million in cash.
Lord is a diversified technology and manufacturing company developing highly reliable adhesives and coatings, as well as vibration and motion control technologies, that significantly reduce risk and improve product performance. Lord’s products are used in mission-critical applications in the aerospace, automotive and industrial markets. Lord had annual sales of approximately $1,025 million for its fiscal 2018. For segment reporting purposes, approximately 95 percent of Lord's sales are included in the Diversified Industrial Segment, while the remaining five percent are included in the Aerospace Systems Segment. Lord’s unique and proprietary products, solutions and technologies for mission-critical applications are expected to increase the Company's overall engineered materials product and solutions offerings to enable a stronger value proposition for customers.
Exotic designs and manufactures innovative and technically demanding, high temperature, high pressure air and exhaust management solutions for aircraft and engines. Exotic had annual sales of approximately $409 million for its fiscal 2019.
For segment reporting purposes, Exotic is included in the Aerospace Systems Segment. We believe Exotic's products and proprietary manufacturing capabilities are complementary to our portfolio of flight control, fuel and inerting, hydraulics, fluid conveyance and engine components.
Assets acquired and liabilities assumed are 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. The following presents the estimated fair values of Lord's and Exotic's assets acquired and liabilities assumed on the respective acquisition dates. These estimates are based on available information and are revised during the measurement period, not to exceed 12 months from the acquisition date, as third-party 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 final purchase price allocations for acquisitions in 2020 is as follows:
| | | | | | | | | | | | | |
| Lord | | Exotic | | |
| October 29, 2019 | | September 16, 2019 | | |
| Assets: | | | | | |
| Cash and cash equivalents | $ | 74,013 | | | $ | 8,179 | | | |
| Accounts receivable | 153,765 | | | 81,336 | | | |
| Inventories | 248,600 | | | 114,661 | | | |
| Prepaid expenses | 24,230 | | | 1,343 | | | |
| Property, plant and equipment | 409,163 | | | 178,393 | | | |
| Deferred income taxes | — | | | 2,057 | | | |
| Other assets | 41,335 | | | 1,226 | | | |
| Intangible assets | 1,446,660 | | | 874,470 | | | |
| Goodwill | 1,970,603 | | | 503,725 | | | |
| Total assets acquired | 4,368,369 | | | 1,765,390 | | | |
| Liabilities: | | | | | |
| Notes payable and long-term debt payable within one year | 156 | | | — | | | |
| Accounts payable, trade | 56,186 | | | 23,176 | | | |
| Accrued payrolls and other compensation | 57,571 | | | 8,863 | | | |
| Accrued domestic and foreign taxes | 2,898 | | | 2,123 | | | |
| Other accrued liabilities | 88,394 | | | 25,662 | | | |
| Long-term debt | 221,161 | | | — | | | |
| Pensions and other postretirement benefits | 115,017 | | | — | | | |
| Deferred income taxes | 304,445 | | | — | | | |
| Other liabilities | 55,832 | | | — | | | |
| Noncontrolling interests | 11,266 | | | — | | | |
| Total liabilities and noncontrolling interests assumed | 912,926 | | | 59,824 | | | |
| Net assets acquired | $ | 3,455,443 | | | $ | 1,705,566 | | | |
Goodwill is calculated as the excess of the purchase price over the net assets acquired. With respect to the Lord and Exotic acquisitions, goodwill represents cost synergies and enhancements to our existing technologies. For tax purposes, Lord's goodwill is not deductible, and Exotic's goodwill is deductible. Based upon an acquisition valuation, intangibles acquired as part of the Exotic acquisition include $502 million of customer-related intangible assets, $281 million of patents and technology and $91 million of trademarks, with weighted average estimated useful lives of 18, 20 and 20 years, respectively. Similarly, the Lord acquisition includes $869 million of customer-related intangible assets, $458 million of patents and technology and $119 million of trademarks, with weighted average estimated useful lives of 13, 21 and 20 years, respectively. These intangible assets were valued using the income approach, which includes significant assumptions around future revenue growth and discount rates. Such assumptions are classified as level 3 inputs within the fair value hierarchy.
Our consolidated financial statements for 2020 include the results of operations of Lord and Exotic from their respective acquisition dates through June 30, 2020. Net sales and segment operating income attributable to these acquisitions during this period and included in our consolidated financial statements totaled $949 million and $22 million, respectively.
Acquisition-related transaction and integration costs totaled $119 million in 2020. These costs are included in selling, general, and administrative expenses in the Consolidated Statement of Income.
4. Business Realignment and Acquisition Integration Charges
The Company incurred business realignment and acquisition integration charges in 2022, 2021 and 2020. During 2021, business realignment charges primarily consisted of actions taken to address the impact of COVID-19 on our business. Such charges were also incurred in 2020, especially within the Aerospace Systems Segment. In 2022, 2021, and 2020 business realignment charges included severance costs related to actions taken under the Company's simplification initiative aimed at reducing organizational and process complexity as well as plant closures. In 2022 and 2021, a majority of the business realignment charges were incurred in Europe. In 2020, a majority of the business realignment charges were incurred in North America. We believe the realignment actions will positively impact future results of operations but will not have a material effect on liquidity and sources and uses of capital.
Business realignment charges by business segment are as follows:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Diversified Industrial | $ | 13,787 | | | $ | 38,557 | | | $ | 52,288 | |
| Aerospace Systems | 967 | | | 6,680 | | | 22,101 | |
| Corporate administration | — | | | 1,399 | | | 1,175 | |
| Other expense | 3 | | | 1,226 | | | 50 | |
Workforce reductions in connection with such business realignment charges by business segment are as follows:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Diversified Industrial | 300 | | | 820 | | | 2,394 | |
| Aerospace Systems | 10 | | | 327 | | | 1,254 | |
| Corporate administration | — | | | 20 | | | 31 | |
| | | | | |
The business realignment charges are presented in the Consolidated Statement of Income as follows:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Cost of sales | $ | 7,821 | | | $ | 33,746 | | | $ | 58,791 | |
| Selling, general and administrative expenses | 6,933 | | | 12,890 | | | 16,773 | |
| Loss on disposal of assets | 3 | | | 1,226 | | | 50 | |
During 2022, approximately $21 million in payments were made relating to business realignment charges. Remaining payments related to current-year and prior-year business realignment actions of approximately $8 million, a majority of which are expected to be paid by March 31, 2023, 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.
In addition to the business realignment charges discussed above, in 2022, we also incurred $20 million of expense as a result of our exit of business operations in Russia. These charges primarily consist of write-downs of inventory and other working capital items and $8 million of foreign currency translation expense reclassified from accumulated other comprehensive income. Within the business segment information in Note 18, $7 million of expense was recorded in the other expense (income) caption, while the remainder of the charge was split evenly between the Aerospace Systems Segment and the Diversified Industrial International businesses.
We also incurred the following acquisition integration charges related to the Lord, Exotic and proposed Meggitt acquisitions: | | | | | | | | | | | | | | | | | |
| | | | | |
| | | | | |
| | 2022 | | 2021 | | 2020 |
| Diversified Industrial | $ | 3,589 | | | $ | 11,222 | | | $ | 20,669 | |
| Aerospace Systems | 1,177 | | | 719 | | | 1,908 | |
| | | | | |
| | | | | |
In 2022, acquisition integration planning charges within the Aerospace Systems segment relate to the proposed Meggitt acquisition. In both 2021 and 2020, acquisition integration charges relate to the acquisitions of Lord and Exotic. These charges were primarily included in selling, general and administrative expenses within the Consolidated Statement of Income.
5. Income Taxes
Income before income taxes was derived from the following sources:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| United States | $ | 646,364 | | | $ | 1,273,037 | | | $ | 828,160 | |
| Foreign | 967,862 | | | 973,920 | | | 678,694 | |
| $ | 1,614,226 | | | $ | 2,246,957 | | | $ | 1,506,854 | |
Income taxes include the following:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Federal | | | | | |
| Current | $ | 297,672 | | | $ | 247,094 | | | $ | 105,796 | |
| Deferred | (253,123) | | | (52,960) | | | 24,905 | |
| Foreign | | | | | |
| Current | 303,089 | | | 269,607 | | | 167,680 | |
| Deferred | (45,977) | | | 8,851 | | | (14,247) | |
| State and local | | | | | |
| Current | 48,479 | | | 34,895 | | | 18,756 | |
| Deferred | (52,100) | | | (7,391) | | | 1,632 | |
| $ | 298,040 | | | $ | 500,096 | | | $ | 304,522 | |
A reconciliation of the effective income tax rate to the statutory federal rate follows:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Statutory federal income tax rate | 21.0 | % | | 21.0 | % | | 21.0 | % |
| State and local income taxes | (0.2) | | | 1.0 | | | 1.4 | |
| | | | | |
| Tax related to international activities | 2.7 | | | 3.6 | | | 1.8 | |
| Transition tax related to the TCJ Act | — | | | — | | | (0.7) | |
| Cash surrender value of life insurance | 0.5 | | | (0.6) | | | (0.3) | |
| Foreign derived intangible income deduction | (3.7) | | | (1.0) | | | (1.5) | |
| Research tax credit | (0.8) | | | (0.4) | | | (0.6) | |
| Share-based compensation | (1.3) | | | (1.6) | | | (1.5) | |
| Other | 0.3 | | | 0.3 | | | 0.6 | |
| Effective income tax rate | 18.5 | % | | 22.3 | % | | 20.2 | % |
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:
| | | | | | | | | | | |
| 2022 | | 2021 |
| Retirement benefits | $ | 207,147 | | | $ | 322,931 | |
| Other liabilities and reserves | 180,624 | | | 136,710 | |
| Long-term contracts | 8,739 | | | 5,562 | |
| Stock-based compensation | 31,490 | | | 30,165 | |
| Loss carryforwards | 888,552 | | | 861,013 | |
| Unrealized currency exchange gains and losses | 254,334 | | | 18,841 | |
| Inventory | 14,649 | | | (11,753) | |
| Tax credit carryforwards | 17,326 | | | 19,709 | |
| Undistributed foreign earnings | (21,822) | | | (21,722) | |
| Depreciation and amortization | (875,623) | | | (945,422) | |
| Valuation allowance | (901,875) | | | (865,764) | |
| Net deferred tax (liability) | $ | (196,459) | | | $ | (449,730) | |
| | | |
| Change in net deferred tax (liability): | | | |
| Provision for deferred tax | $ | 351,201 | | | $ | 51,500 | |
| Items of other comprehensive (loss) income | (98,810) | | | (209,509) | |
| Acquisitions and other | 880 | | | 291 | |
| Total change in net deferred tax | $ | 253,271 | | | $ | (157,718) | |
As of June 30, 2022, we recorded deferred tax assets of $889 million resulting from $3,566 million in loss carryforwards. A valuation allowance of $876 million related to the loss carryforwards has been established due to the uncertainty of their realization. Of this valuation allowance, $853 million 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 $26 million related to other future deductible items has been established due to the uncertainty of their realization.
Although future distributions of foreign earnings to the United States should not be subject to U.S. federal income taxes, other U.S. or foreign taxes may be imposed on such earnings. We have analyzed existing factors and determined we will no longer permanently reinvest certain foreign earnings. On these undistributed foreign earnings of approximately $678 million that are no longer permanently reinvested outside of the United States, we have recorded a deferred tax liability of $13 million. The remaining undistributed foreign earnings of approximately $1,630 million remain permanently reinvested outside the United States at June 30, 2022. Of these undistributed earnings, we have recorded a deferred tax liability of $8 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:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Balance July 1 | $ | 100,759 | | | $ | 86,277 | | | $ | 140,662 | |
| Additions for tax positions related to current year | 7,039 | | | 10,145 | | | 4,955 | |
| Additions for tax positions of prior years | 1,415 | | | 10,320 | | | 798 | |
| Additions for acquisitions | — | | | 2,376 | | | 43,532 | |
| Reductions for tax positions of prior years | (140) | | | (1,996) | | | (41,726) | |
| Reductions for settlements | (3,127) | | | (7,165) | | | (53,520) | |
| Reductions for expiration of statute of limitations | (6,647) | | | (2,252) | | | (3,820) | |
| Effect of foreign currency translation | (8,630) | | | 3,054 | | | (4,604) | |
| Balance June 30 | $ | 90,669 | | | $ | 100,759 | | | $ | 86,277 | |
The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $91 million, $101 million and $86 million as of June 30, 2022, 2021 and 2020, respectively. The accrued interest related to the gross unrecognized tax benefits, excluded from the amounts above, was $18 million, $18 million and $14 million as of June 30, 2022, 2021 and 2020, 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 $30 million 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.
We file income tax returns in the United States and in various foreign jurisdictions. In the normal course of business, we are subject to examination by taxing authorities throughout the world. We are open to assessment of our U.S. federal income tax returns by the Internal Revenue Service for years after 2013, and our state and local income tax returns for years after 2016. We are open to assessment for significant foreign jurisdictions for years after 2011.
6. 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:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Numerator: | | | | | |
| Net income attributable to common shareholders | $ | 1,315,605 | | | $ | 1,746,100 | | | $ | 1,201,970 | |
| Denominator: | | | | | |
| Basic - weighted-average common shares | 128,539,387 | | | 128,999,879 | | | 128,418,495 | |
| Increase in weighted-average common shares from dilutive effect of equity-based awards | 1,816,556 | | | 1,834,599 | | | 1,386,539 | |
| Diluted - weighted-average common shares, assuming exercise of equity-based awards | 130,355,943 | | | 130,834,478 | | | 129,805,034 | |
| Basic earnings per share | $ | 10.24 | | | $ | 13.54 | | | $ | 9.36 | |
| Diluted earnings per share | $ | 10.09 | | | $ | 13.35 | | | $ | 9.26 | |
For 2022, 2021 and 2020, 0.4 million, 0.4 million and 0.6 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.
7. Inventories
Inventories are stated at the lower of cost or net realizable value using the first-in, first-out ("FIFO") method.
The inventories caption in the Consolidated Balance Sheet is comprised of the following components: | | | | | | | | | | | | | | |
| June 30, | | 2022 | | 2021 |
| Finished products | | $ | 811,702 | | | $ | 733,744 | |
| Work in process | | 1,128,501 | | | 1,089,976 | |
| Raw materials | | 274,350 | | | 266,922 | |
| Total | | $ | 2,214,553 | | | $ | 2,090,642 | |
8. 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, 2020 | $ | 7,267,573 | | | $ | 602,362 | | | $ | 7,869,935 | |
| Acquisitions | 3,738 | | | — | | | 3,738 | |
| | | | | |
| | | | | |
| Foreign currency translation | 185,998 | | | 16 | | | 186,014 | |
| Balance June 30, 2021 | $ | 7,457,309 | | | $ | 602,378 | | | $ | 8,059,687 | |
| | | | | |
| Divestitures | (164) | | | — | | | (164) | |
| | | | | |
| Goodwill reclassified to held for sale | — | | | (48,242) | | | (48,242) | |
| Foreign currency translation | (271,164) | | | (35) | | | (271,199) | |
| Balance June 30, 2022 | $ | 7,185,981 | | | $ | 554,101 | | | $ | 7,740,082 | |
Acquisitions represent the goodwill allocation during the measurement period subsequent to the applicable acquisition dates. Refer to Note 3 for further discussion.
Divestitures represent goodwill associated with the sale of a business during 2022.
Goodwill reclassified to held for sale, which was allocated using the relative fair value method, relates to the aircraft wheel and brake business. Refer to Note 3 for further discussion.
We test goodwill for impairment at the reporting unit level on an annual basis and between annual tests whenever events or circumstances indicate that the carrying value of a reporting unit may exceed its fair value. Our annual impairment tests performed in 2022, 2021 and 2020 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:
| | | | | | | | | | | | | | | | | | | | | | | |
| 2022 | | 2021 |
| Gross Carrying Amount | | Accumulated Amortization | | Gross Carrying Amount | | Accumulated Amortization |
| Patents and technology | $ | 990,775 | | | $ | 259,587 | | | $ | 999,952 | | | $ | 216,314 | |
| Trademarks | 727,820 | | | 339,244 | | | 762,130 | | | 331,905 | |
| Customer lists and other | 3,735,042 | | | 1,718,989 | | | 3,869,772 | | | 1,563,838 | |
| Total | $ | 5,453,637 | | | $ | 2,317,820 | | | $ | 5,631,854 | | | $ | 2,112,057 | |
Total intangible asset amortization expense in 2022, 2021 and 2020 was $314 million, $325 million and $285 million, respectively. Estimated intangible asset amortization expense for the five years ending June 30, 2023 through 2027 is $300 million, $285 million, $278 million, $273 million and $267 million, 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 material intangible asset impairments occurred in 2022, 2021 or 2020.
9. Financing Arrangements
During 2022, the Company amended its existing multi-currency credit agreement, increasing its capacity to $3,000 million, by exercising the accordion feature. As of June 30, 2022, $1,578 million was 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 supports our commercial paper program, and issuances of commercial paper reduce the amount of credit available under the agreement. The credit agreement requires the payment of an annual facility fee, the amount of which may increase in the event our credit ratings are lowered. Although a lowering of our credit ratings would likely increase the cost of future debt, it would not limit our 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 $3,000 million of short-term commercial paper notes. There were $1,422 million commercial paper notes outstanding at June 30, 2022 and none were outstanding at June 30, 2021. The Company had no outstanding borrowings from foreign banks at June 30, 2022 and 2021. The weighted-average interest rate on notes payable during 2022 and 2021 was 0.7 percent and 0.2 percent, respectively.
In the ordinary course of business, some of our locations 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 our rating level at June 30, 2022, the most restrictive financial covenant provides that the ratio of debt to debt-shareholders' equity cannot exceed 0.65 to 1.0. As of June 30, 2022, our debt to debt-shareholders' equity ratio was 0.57 to 1.0. We are in compliance with all covenants.
10. Debt
| | | | | | | | | | | | | | |
| June 30, | | 2022 | | 2021 |
| Domestic: | | | | |
Fixed rate medium-term notes, 3.30% to 6.25%, due 2023 - 2045 | | $ | 2,125,000 | | | $ | 2,125,000 | |
Senior Notes, 2.70% to 4.50%, due 2024 - 2049 | | 7,275,000 | | | 3,675,000 | |
| | | | |
| Foreign: | | | | |
Euro Senior Notes, 1.125%, due 2025 | | 733,950 | | | 830,060 | |
| | | | |
| Other long-term debt | | 11,127 | | | 15,968 | |
| Deferred debt issuance costs | | (86,972) | | | (61,156) | |
| Total long-term debt | | 10,058,105 | | | 6,584,872 | |
Less: Long-term debt payable within one year | | 302,280 | | | 2,819 | |
| Long-term debt, net | | $ | 9,755,825 | | | $ | 6,582,053 | |
During 2022, the Company issued $1,400 million aggregate principal amount of 3.65 percent Senior Notes due June 15, 2024, $1,200 million aggregate principal amount of 4.25 percent Senior Notes due September 15, 2027, and $1,000 million aggregate principal amount of 4.50 percent Senior Notes due September 15, 2029 (collectively, the "Senior Notes"). Interest payments are due semi-annually. We intend to use the proceeds of the Senior Notes to finance a portion of the purchase of the proposed Acquisition. If the Company does not consummate its proposed acquisition of Meggitt on or prior to April 3, 2023 or, if prior to such date, the Company notifies the trustee in writing that the cooperation agreement between Parker and Meggitt is terminated, the Senior Notes will be subject to a special mandatory redemption at a price equal to 101 percent of the aggregate principal amount of such Senior Notes, plus accrued and unpaid interest on the Senior Notes to, but not including, the special mandatory redemption date. Debt issuance costs, including discounts, related to the Senior Notes totaled $33 million and will be amortized over the respective debt terms.
In connection with the proposed acquisition, the Company entered into a Bridge Credit Agreement on August 2, 2021. Under the Bridge Credit Agreement, lenders committed to provide senior, unsecured financing in the aggregate principal amount of £6,524 million at August 2, 2021. As permanent financing for the proposed Acquisition was secured, the principal amount of the Bridge Credit Agreement was reduced. At June 30, 2022, the available aggregate principal amount was £591 million. Any borrowings made under the Bridge Credit Agreement would mature 364 days from the initial funding date. The commitments are intended to be drawn to finance the proposed acquisition of Meggitt only to the extent that we do not arrange for alternative financing prior to closing. In 2022, we incurred $52 million in financing fees related to the Bridge Credit Agreement, all of which was included in other expense (income), net within the Consolidated Statement of Income.
Additionally, we entered into a senior, unsecured delayed-draw Term Loan Facility in an aggregate principal amount of $2,000 million on August 27, 2021. The proceeds of the Term Loan Facility, if drawn, will be used solely by the Company to finance a portion of the purchase of its proposed Acquisition.
Principal amounts of long-term debt payable in the five years ending June 30, 2023 through 2027 are $302 million, $1,976 million, $1,234 million, $0.4 million and $700 million, respectively. The principal amounts of long-term debt payable exclude the amortization of debt issuance costs.
11. Leases
We primarily enter into lease agreements for office space, distribution centers, certain manufacturing facilities and equipment. The majority of our leases are operating leases. Finance leases are immaterial to our financial statements. In addition, leases with an initial term of 12 months or less are not recorded on the Consolidated Balance Sheet. Certain leases contain options that provide us with the ability to extend the lease term. Such options are included in the lease term when it is reasonably certain that the option will be exercised. When accounting for leases, we combine payments for leased assets, related services and other components of a lease. Payments within certain lease agreements are adjusted periodically for changes in an index or rate.
The discount rate implicit within our leases is generally not determinable, and therefore we determine the discount rate based on our incremental borrowing rate. The incremental borrowing rate for our leases is determined based on lease term and the currency in which lease payments are made.
The components of lease expense are as follows: | | | | | | | | | | | |
| 2022 | | 2021 |
| Operating lease expense | $ | 46,026 | | | $ | 48,171 | |
| Short-term lease cost | 7,041 | | | 7,674 | |
| Variable lease cost | 5,849 | | | 5,835 | |
| Total lease cost | $ | 58,916 | | | $ | 61,680 | |
Supplemental cash flow information related to operating leases is as follows: | | | | | | | | | | | |
| 2022 | | 2021 |
| Cash paid for amounts included in the measurement of operating lease liabilities | $ | 45,371 | | | $ | 47,080 | |
| Right-of-use assets obtained in exchange for operating lease obligations | 50,925 | | | 41,637 | |
Supplemental balance sheet information related to operating leases is as follows:
| | | | | | | | | | | |
| 2022 | | 2021 |
| Operating lease right-of-use assets (included within Investments and other assets) | $ | 133,412 | | | $ | 131,880 |
| | | |
| Current operating lease liabilities (included within Other accrued liabilities) | $ | 36,023 | | | $ | 40,193 | |
| Long-term operating lease liabilities (included within Other liabilities) | 100,337 | | | 93,904 | |
| Total operating lease liabilities | $ | 136,360 | | | $ | 134,097 | |
| | | |
| Weighted average remaining lease term | 5.6 years | | 5.5 years |
| Weighted average discount rate | 1.6 | % | | 1.8 | % |
Maturities of lease liabilities at June 30, 2022 are as follows: | | | | | |
| Operating Leases |
| 2023 | $ | 37,876 | |
| 2024 | 28,584 | |
| 2025 | 23,299 | |
| 2026 | 17,721 | |
| 2027 | 10,633 | |
| Thereafter | 25,483 | |
| Total operating lease payments | $ | 143,596 | |
| Less imputed interest | 7,236 | |
| Total operating lease liabilities | $ | 136,360 | |
12. 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. We also have 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. We also sponsor defined contribution plans and participate in government-sponsored programs in certain foreign countries.
A summary of the Company's defined benefit pension plans follows: | | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Benefit cost | | | | | |
| Service cost | $ | 76,638 | | | $ | 84,188 | | | $ | 82,743 | |
| Interest cost | 110,250 | | | 102,475 | | | 142,479 | |
| | | | | |
| | | | | |
| Expected return on plan assets | (267,888) | | | (267,579) | | | (266,674) | |
| Amortization of prior service cost | 4,103 | | | 5,325 | | | 5,633 | |
| Amortization of unrecognized actuarial loss | 157,288 | | | 207,897 | | | 165,815 | |
| Amortization of transition obligation | 8 | | | 18 | | | 18 | |
| Net periodic benefit cost | $ | 80,399 | | | $ | 132,324 | | | $ | 130,014 | |
Components of net pension benefit cost, other than service cost, are included in other expense (income), net in the Consolidated Statement of Income.
| | | | | | | | | | | |
| 2022 | | 2021 |
| Change in benefit obligation | | | |
| Benefit obligation at beginning of year | $ | 6,323,003 | | | $ | 6,405,623 | |
| Service cost | 76,638 | | | 84,188 | |
| Interest cost | 110,250 | | | 102,475 | |
| | | |
| | | |
| Plan amendments | (5,691) | | | 2,311 | |
| | | |
| Actuarial gain | (1,097,053) | | | (91,719) | |
| Benefits paid | (256,868) | | | (264,062) | |
| Foreign currency translation and other | (190,960) | | | 84,187 | |
| Benefit obligation at end of year | $ | 4,959,319 | | | $ | 6,323,003 | |
| | | |
| Change in plan assets | | | |
| Fair value of plan assets at beginning of year | $ | 5,305,577 | | | $ | 4,594,106 | |
| Actual (loss) gain on plan assets | (605,642) | | | 831,762 | |
| | | |
| | | |
| Employer contributions | 96,717 | | | 76,936 | |
| Benefits paid | (256,868) | | | (264,062) | |
| Foreign currency translation and other | (177,631) | | | 66,835 | |
| Fair value of plan assets at end of year | $ | 4,362,153 | | | $ | 5,305,577 | |
| Funded status | $ | (597,166) | | | $ | (1,017,426) | |
| | | | | | | | | | | |
| Amounts recognized on the Consolidated Balance Sheet | | | |
| Other accrued liabilities | $ | (19,307) | | | $ | (4,944) | |
| Pensions and other postretirement benefits | (577,859) | | | (1,012,482) | |
| Net amount recognized | $ | (597,166) | | | $ | (1,017,426) | |
| | | |
| Amounts recognized in Accumulated Other Comprehensive (Loss) | | | |
| Net actuarial loss | $ | 672,775 | | | $ | 1,090,343 | |
| Prior service cost | 4,901 | | | 15,006 | |
| Transition obligation | — | | | 8 | |
| Net amount recognized | $ | 677,676 | | | $ | 1,105,357 | |
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.
At June 30, 2022, the benefit obligation decreased primarily due to significantly higher discount rates. At June 30, 2021, the benefit obligation decreased primarily due to slightly higher discount rates, partially offset by updated census data and assumptions.
Investment (losses) gains are the primary contributing factor for the (decrease) increase in plan assets' fair value during 2022 and 2021, respectively.
The accumulated benefit obligation for all defined benefit plans was $4,785 million and $6,069 million at June 30, 2022 and 2021, respectively.
Information for pension plans with accumulated benefit obligations in excess of plan assets:
| | | | | | | | | | | |
| 2022 | | 2021 |
Accumulated benefit obligation | $ | 4,284,601 | | | $ | 5,358,817 | |
Fair value of plan assets | 3,742,513 | | | 4,546,301 | |
Information for pension plans with projected benefit obligations in excess of plan assets: | | | | | | | | | | | |
| 2022 | | 2021 |
Projected benefit obligation | $ | 4,483,486 | | | $ | 5,620,693 | |
Fair value of plan assets | 3,782,688 | | | 4,568,113 | |
We expect to make cash contributions of approximately $76 million to our defined benefit pension plans in 2023, the majority of which relates to our non-U.S. plans. Estimated future benefit payments in the five years ending June 30, 2023 through 2027 are $282 million, $319 million, $292 million, $294 million and $333 million, respectively, and $1,566 million in the aggregate for the five years ending June 30, 2028 through June 30, 2032.
The assumptions used to measure net periodic benefit cost for the Company's significant defined benefit plans are:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| U.S. defined benefit plan | | | | | |
| Discount rate | 2.55 | % | | 2.36 | % | | 3.28 | % |
| Average increase in compensation | 3.05 | % | | 2.98 | % | | 3.60 | % |
| Expected return on plan assets | 6.50 | % | | 6.75 | % | | 7.00 | % |
| Non-U.S. defined benefit plans | | | | | |
| Discount rate | 0.25 to 2.95% | | 0.2 to 3.03% | | 0.2 to 2.96% |
| Average increase in compensation | 1.75 to 4.50% | | 1.75 to 4.50% | | 1.75 to 3.90% |
| Expected return on plan assets | 1.0 to 4.50% | | 1.0 to 5.40% | | 1.0 to 5.75% |
The assumptions used to measure the benefit obligation for the Company's significant defined benefit plans are: | | | | | | | | | | | |
| 2022 | | 2021 |
| U.S. defined benefit plan | | | |
| Discount rate | 4.36 | % | | 2.55 | % |
| Average increase in compensation | 3.81 | % | | 3.05 | % |
| Non-U.S. defined benefit plans | | | |
| Discount rate | 0.60 to 5.06% | | 0.25 to 2.95% |
| Average increase in compensation | 1.75 to 4.00% | | 1.75 to 4.50% |
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:
| | | | | | | | | | | |
| 2022 | | 2021 |
| Equity securities | 31 | % | | 38 | % |
| Debt securities | 43 | % | | 41 | % |
| | | |
| Other investments | 26 | % | | 21 | % |
| 100 | % | | 100 | % |
The weighted-average target asset allocation as of June 30, 2022 is 40 percent equity securities, 43 percent debt securities and 17 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 plan account for approximately 77 percent of our total defined benefit plan assets. The overall investment strategy with respect to our U.S. defined benefit plan is to use a funding strategy more heavily weighted toward liability-hedging assets as the funded status improves. Over time, we will continue to add long duration fixed income investments to the portfolio. These securities are highly correlated with our pension liabilities and will be managed in a liability framework.
The fair values of pension plan assets at June 30, 2022 and at June 30, 2021, by asset class, are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2022 | | Quoted Prices In
Active Markets
(Level 1) | | Significant Other
Observable Inputs
(Level 2) | | Significant
Unobservable
Inputs
(Level 3) |
| Cash and cash equivalents | $ | 201,053 | | | $ | 190,616 | | | $ | 10,437 | | | $ | — | |
| Equity securities | | | | | | | |
| U.S. based companies | 327,122 | | | 327,122 | | | — | | | — | |
| Non-U.S. based companies | 8,700 | | | 8,700 | | | — | | | — | |
| Fixed income securities | | | | | | | |
| Corporate debt securities | 380,694 | | | 1,309 | | | 379,385 | | | — | |
| Government issued securities | 87,650 | | | 55,201 | | | 32,449 | | | — | |
| Mutual funds | | | | | | | |
| Equity funds | 9,085 | | | 9,085 | | | — | | | — | |
| Fixed income funds | 9,679 | | | 9,679 | | | — | | | — | |
| Mutual funds measured at net asset value | 279,849 | | | | | | | |
| | | | | | | |
| Common/Collective trusts measured at net asset value | 2,718,445 | | | | | | | |
| Limited Partnerships measured at net asset value | 133,026 | | | | | | | |
| Miscellaneous | 206,850 | | | — | | | 206,850 | | | — | |
| Total at June 30, 2022 | $ | 4,362,153 | | | $ | 601,712 | | | $ | 629,121 | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2021 | | Quoted Prices In
Active Markets
(Level 1) | | Significant Other
Observable Inputs
(Level 2) | | Significant
Unobservable
Inputs
(Level 3) |
| Cash and cash equivalents | $ | 248,525 | | | $ | 241,421 | | | $ | 7,104 | | | $ | — | |
| Equity securities | | | | | | | |
| U.S. based companies | 408,301 | | | 408,301 | | | — | | | — | |
| Non-U.S. based companies | 12,834 | | | 12,834 | | | — | | | — | |
| Fixed income securities | | | | | | | |
| Corporate debt securities | 531,497 | | | 1,440 | | | 530,057 | | | — | |
| Government issued securities | 151,458 | | | 105,167 | | | 46,291 | | | — | |
| Mutual funds | | | | | | | |
| Equity funds | 6,768 | | | 6,768 | | | — | | | — | |
| Fixed income funds | 6,506 | | | 6,506 | | | — | | | — | |
| Mutual funds measured at net asset value | 368,340 | | | | | | | |
| Common/Collective trusts | | | | | | | |
| | | | | | | |
| | | | | | | |
| Common/Collective trusts measured at net asset value | 3,161,683 | | | | | | | |
| | | | | | | |
| Limited Partnerships measured at net asset value | 126,606 | | | | | | | |
| Miscellaneous | 283,059 | | | — | | | 283,059 | | | — | |
| Total at June 30, 2021 | $ | 5,305,577 | | | $ | 782,437 | | | $ | 866,511 | | | $ | — | |
Cash and cash equivalents are valued at cost, which approximates fair value. During 2021, the U.S. defined benefit plan implemented a new liability-hedging initiative that requires the plan to maintain a certain cash balance. At June 30, 2022, this required cash balance totaled approximately $33 million.
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 Parker stock with a fair value of $327 million and $408 million as of June 30, 2022 and 2021, 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 presented in the tables above to permit reconciliation of the fair value hierarchy to total pension plan assets. Redemption of a certain mutual fund is subject to a lock-up period, lasting throughout its duration, scheduled to terminate July 2026. However, this mutual fund may extend its duration up to an additional two years under certain conditions.
Common/Collective trusts primarily consist of equity, fixed income and real estate 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 of all common/collective trusts requires no more than a 90-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 presented in the tables above to permit reconciliation of the fair value hierarchy to total pension plan assets.
Limited Partnerships' interest in venture capital investments are measured at fair value based on net asset value as determined by the respective fund investment. A certain limited partnership investment, for which the lock-up period expired June 30, 2022, is restricted to a maximum redemption of 20 percent of its account balance every six months upon a 90-day notification 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 presented in the tables above to permit reconciliation of the fair value hierarchy to total pension plan assets.
Miscellaneous primarily includes 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 plan. 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 the investments in the miscellaneous category is to provide a stable rate of return over a specified period of time.
Employee Savings Plan - We sponsor an employee stock ownership plan ("ESOP") as part of our legacy savings and investment 401(k) plan. The ESOP is available to eligible domestic employees. Effective January 1, 2022, the Company matching contributions were increased, up to a maximum of five percent of eligible compensation from the previous maximum of four percent of eligible compensation. These contributions are recorded as compensation expense. Participants may direct company matching contributions to any investment option within the savings and investment 401(k) plan.
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Shares held by ESOP | 4,125,214 | | | 4,497,902 | | | 5,306,643 | |
| Company matching contributions | $ | 87,554 | | | $ | 66,249 | | | $ | 69,434 | |
In addition to shares within the ESOP, as of June 30, 2022, employees have elected to invest in 1,223,103 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 our legacy savings and investment 401(k) plan. We make a cash contribution to the participant's RIA each year and participants do not contribute to the RIA. Prior to January 1, 2021, the amount of the annual contribution was based on the participant's age and years of service. Beginning January 1, 2021, we amended the RIA ensuring most participants receive a flat three percent annual contribution of eligible compensation with some grandfathered participants receiving annual contributions calculated at a higher percent of eligible compensation. Under the amended RIA, no participant will receive less than the flat three percent contribution. The Company recognized $57 million, $42 million and $38 million in expense related to the RIA in 2022, 2021 and 2020, respectively.
During 2020, we acquired several defined contribution plans comprised of similar company matching contributions and RIA features as our legacy plan. In 2021 and 2020, we recorded additional company matching expense of $5 million and $4 million, respectively, and additional RIA expense of $5 million and $7 million, respectively, for these acquired plans. During 2021, these acquired plans were merged into our legacy 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. We have reserved the right to change these benefit plans.
The Company recognized $1 million, $1 million and $2 million in expense related to other postretirement benefits in 2022, 2021 and 2020, respectively. Components of net other postretirement benefit cost, other than service cost, are included in other expense (income), net in the Consolidated Statement of Income.
| | | | | | | | | | | |
| 2022 | | 2021 |
| Change in benefit obligation | | | |
| Benefit obligation at beginning of year | $ | 63,739 | | | $ | 72,130 | |
| Service cost | 206 | | | 328 | |
| Interest cost | 982 | | | 983 | |
| | | |
| | | |
| Actuarial gain | (11,220) | | | (4,139) | |
| Benefits paid | (4,831) | | | (5,563) | |
| Benefit obligation at end of year | $ | 48,876 | | | $ | 63,739 | |
| Funded status | $ | (48,876) | | | $ | (63,739) | |
| | | | | | | | | | | |
| Amounts recognized on the Consolidated Balance Sheet | | | |
| Other accrued liabilities | $ | (4,971) | | | $ | (5,634) | |
| Pensions and other postretirement benefits | (43,905) | | | (58,105) | |
| Net amount recognized | $ | (48,876) | | | $ | (63,739) | |
| | | |
| Amounts recognized in Accumulated Other Comprehensive (Loss) | | | |
| Net actuarial gain | $ | (15,154) | | | $ | (4,311) | |
| | | |
| | | |
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 decrease in the benefit obligation is due to significantly higher discount rates in 2022 and slightly higher discount rates in 2021. Updated census data and actuarial assumptions also contributed to the decrease in both fiscal years.
The assumptions used to measure the net periodic benefit cost for postretirement benefit obligations are:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Discount rate | 2.36 | % | | 2.14 | % | | 3.15 | % |
| Current medical cost trend rate (Pre-65 participants) | 6.45 | % | | 6.73 | % | | 7.09 | % |
| Current medical cost trend rate (Post-65 participants) | 6.72 | % | | 7.03 | % | | 7.43 | % |
| Ultimate medical cost trend rate | 4.50 | % | | 4.50 | % | | 4.50 | % |
| Medical cost trend rate decreases to ultimate in year | 2029 | | 2028 | | 2028 |
The discount rate assumption used to measure the benefit obligation was 4.26 percent and 2.36 percent in 2022 and 2021, respectively.
Estimated future benefit payments for other postretirement benefits in the five years ending June 30, 2023 through 2027 are $5 million, $5 million, $4 million, $4 million and $4 million, respectively, and $17 million in the aggregate for the five years ending June 30, 2028 through June 30, 2032.
Other - The Company has established nonqualified deferred compensation programs, which permit officers, directors and certain management employees to annually 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, we maintain a defined contribution nonqualified supplemental executive pension plan in which the Company is the only contributor. During 2022, 2021 and 2020, we recorded (income) expense relating to these programs of $(21) million, $45 million and $6 million, respectively.
The Company has invested in corporate-owned life insurance policies to assist in meeting the obligations under these programs. The policies are held in a rabbi trust and are recorded as assets of the Company.
13. 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, 2020 | $ | (1,193,937) | | | $ | (1,364,938) | | | $ | (2,558,875) | |
| | | | | |
| Other comprehensive income before reclassifications | 328,072 | | | 502,853 | | | 830,925 | |
| Amounts reclassified from accumulated other comprehensive (loss) | — | | | 161,223 | | | 161,223 | |
| Balance June 30, 2021 | $ | (865,865) | | | $ | (700,862) | | | $ | (1,566,727) | |
| | | | | |
| Other comprehensive (loss) income before reclassifications | (290,853) | | | 185,101 | | | (105,752) | |
| Amounts reclassified from accumulated other comprehensive (loss) | 7,647 | | | 121,634 | | | 129,281 | |
| Balance June 30, 2022 | $ | (1,149,071) | | | $ | (394,127) | | | $ | (1,543,198) | |
Significant reclassifications out of accumulated other comprehensive (loss) in shareholders' equity during 2022:
| | | | | | | | | | | | | | |
| 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 | | $ | (4,111) | | | Other expense (income), net |
| Recognized actuarial loss | | (156,912) | | | Other expense (income), net |
| Total before tax | | (161,023) | | | |
| Tax benefit | | 39,389 | | | |
| Net of tax | | $ | (121,634) | | | |
Significant reclassifications out of accumulated other comprehensive (loss) in shareholders' equity during 2021:
| | | | | | | | | | | | | | |
| 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 | | $ | (5,270) | | | Other expense (income), net |
| Recognized actuarial loss | | (207,896) | | | Other expense (income), net |
| Total before tax | | (213,166) | | | |
| Tax benefit | | 51,943 | | | |
| Net of tax | | $ | (161,223) | | | |
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:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Shares repurchased | 1,281,818 | | | 331,259 | | | 818,581 | |
| Average price per share, including commissions | $ | 296.71 | | | $ | 301.88 | | | $ | 179.29 | |
14. Stock Incentive Plans
The Company's 2016 Omnibus Stock Incentive Plan ("2016 SIP") 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. On October 23, 2019, the number of shares of common stock authorized for issuance under the 2016 SIP increased to 23.8 million shares. At June 30, 2022, 8.4 million common stock shares were available for future issuance.
We satisfy share-based incentive award obligations by issuing shares of common stock out of treasury, which have been repurchased pursuant to our share repurchase program described in Note 13, 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 2022, 2021 and 2020 was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Risk-free interest rate | 0.8 | % | | 0.4 | % | | 1.5 | % |
| Expected life of award | 5.6 years | | 5.4 years | | 5.1 years |
| Expected dividend yield of stock | 1.9 | % | | 2.0 | % | | 2.0 | % |
| Expected volatility of stock | 35.7 | % | | 35.2 | % | | 25.9 | % |
| Weighted-average fair value | $ | 81.71 | | | $ | 53.92 | | | $ | 31.68 | |
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 our 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 our historical common stock prices over a time-frame similar to the expected life of the award.
SAR activity during 2022 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, 2021 | 4,148,586 | | | $ | 152.44 | | | | | |
| Granted | 499,386 | | | $ | 296.00 | | | | | |
| Exercised | (520,602) | | | $ | 129.32 | | | | | |
| Canceled | (28,226) | | | $ | 239.22 | | | | | |
| Outstanding June 30, 2022 | 4,099,144 | | | $ | 172.27 | | | 6.0 years | | $ | 326.8 | |
| Exercisable June 30, 2022 | 2,886,647 | | | $ | 146.49 | | | 5.0 years | | $ | 287.4 | |
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, 2021 | 1,470,829 | | | $ | 43.19 | |
| Granted | 499,386 | | | $ | 81.71 | |
| Vested | (729,492) | | | $ | 40.16 | |
| Canceled | (28,226) | | | $ | 61.81 | |
| Nonvested June 30, 2022 | 1,212,497 | | | $ | 60.44 | |
During 2022, 2021 and 2020, we recognized stock-based compensation expense of $37 million, $35 million and $26 million, 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.
At June 30, 2022, $15 million 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 13 months. The total fair value of shares vested during 2022, 2021 and 2020 was $29 million, $25 million and $27 million, respectively.
Information related to SAR awards exercised during 2022, 2021 and 2020 is as follows: | | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
| Net cash proceeds | $ | 2,831 | | | $ | 4,684 | | | $ | 2,623 | |
| Intrinsic value | 97,002 | | | 225,025 | | | 133,641 | |
| Income tax benefit | $ | 15,845 | | | $ | 37,437 | | | $ | 21,132 | |
| Number of shares surrendered | 98,673 | | | 316,330 | | | 228,986 | |
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 2022, 2021 and 2020 was based on the fair market value of our 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, 2021 | 349,586 | | | $ | 182.22 | |
| Granted | 89,579 | | | $ | 293.56 | |
| Vested | (153,950) | | | $ | 168.21 | |
| Canceled | (7,313) | | | $ | 238.03 | |
| Nonvested June 30, 2022 | 277,902 | | | $ | 224.40 | |
During 2022, 2021 and 2020, we recognized stock-based compensation expense of $26 million, $26 million and $26 million, respectively, relating to RSU awards for employees. At June 30, 2022, $19 million 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 22 months. The total fair value of RSU awards vested during 2022, 2021 and 2020 was $26 million, $21 million and $23 million, respectively. We recognized an income tax benefit of $4 million, $1 million and $1 million relating to the issuance of common stock for RSU awards that vested during 2022, 2021 and 2020, respectively.
Additionally, we granted RSUs with a one-year vesting period to non-employee members of the Board of Directors. Recipients receive a dividend equivalent payable in common shares, equal to the cash dividend per share paid to common shareholders. A summary of the status and changes of shares subject to Board of Directors RSU awards and the related average price per share follows: | | | | | | | | | | | |
| Number of Shares | | Weighted-Average Grant Date Fair Value |
| Nonvested June 30, 2021 | 7,476 | | | $ | 215.51 | |
| Granted | 5,648 | | | $ | 297.57 | |
| Vested | (7,504) | | | $ | 215.57 | |
| | | |
| Nonvested June 30, 2022 | 5,620 | | | $ | 297.89 | |
The fair value of each RSU award granted to the Board of Directors in 2022, 2021 and 2020 was based on the fair market value of our common stock on the date of grant. In 2022, 2021 and 2020, we recognized stock-based compensation expense of $1.8 million, $1.5 million, and $1.4 million, respectively, relating to these awards. During 2022, 2021 and 2020, we recognized an income tax benefit of $0.2 million, $2.1 million and $0.1 million, respectively, related to the vesting of Board of Directors RSU awards. At June 30, 2022, $0.6 million of expense with respect to 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.
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 our revenue growth, earnings per share growth and return on invested capital during the three-year performance period.
| | | | | | | | | | | | | | | | | | | | |
| Stock issued and surrendered for LTIP | | 2022 | | 2021 | | 2020 |
| LTIP three-year plan | | 2019-20-21 | | 2018-19-20 | | 2017-18-19 |
| Number of shares issued | | 251,783 | | | 210,864 | | | 279,469 | |
| Number of shares surrendered | | 124,007 | | | 105,402 | | | 132,449 | |
| Share value on date of issuance | | $ | 271.38 | | | $ | 317.60 | | | $ | 134.95 | |
| Total value of shares issued | | $ | 68,329 | | | $ | 66,970 | | | $ | 37,714 | |
Under the Company's 2020-21-22 LTIP, a payout of unrestricted stock will be issued in April 2023.
The fair value of each LTIP award granted in 2022, 2021 and 2020 was based on the fair market value of our common stock on the date of grant. These nonvested LTIP awards entitle participants to earn a dividend equivalent unit, payable in common shares, equal to the cash dividend per share paid to common shareholders. These dividend equivalent units do not have dividend or voting rights and are subject to the same performance goals as the initial award granted. 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, 2021 | 495,051 | | | $ | 194.68 | |
| Granted | 135,433 | | | $ | 302.29 | |
| Vested | (201,340) | | | $ | 156.81 | |
| Canceled | (11,355) | | | $ | 237.86 | |
| Nonvested June 30, 2022 | 417,789 | | | $ | 246.63 | |
During 2022, 2021 and 2020, we recorded stock-based compensation expense of $72 million, $59 million and $58 million, respectively, relating to the LTIP. During 2022, 2021 and 2020, we recognized an income tax benefit (cost) of $5 million, $2 million and $(1) million, respectively, relating to the LTIP.
15. Research and Development
Independent research and development costs amounted to $191 million in 2022, $205 million in 2021 and $237 million in 2020. Pre-production expense incurred in connection with development contracts amounted to $74 million in 2022, $54 million in 2021 and $57 million in 2020.
16. 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 and equity investments. Deposits are recorded at cost, and equity investments are recorded at fair value. Changes in fair value of equity investments are recognized in net income.
The carrying value of long-term debt, which excludes the impact of net unamortized debt issuance costs, and estimated fair value of long-term debt at June 30 are as follows:
| | | | | | | | | | | | | | |
| | 2022 | | 2021 |
| Carrying value of long-term debt | | $ | 10,145,077 | | | $ | 6,646,029 | |
| Estimated fair value of long-term debt | | 9,709,407 | | | 7,527,268 | |
The fair value of long-term debt 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 currency 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.
In connection with the proposed Acquisition, the Company entered into deal-contingent forward contracts during October 2021 to mitigate the risk of appreciation in the GBP-denominated purchase price. The deal-contingent forward contracts have an aggregate notional amount of £6,415 million, and settlement is contingent upon closing the proposed Acquisition. In June 2022, we amended the agreement to include a credit support annex ("CSA") which obligated Parker to post $250 million of cash collateral recorded within non-trade and notes receivables on the Consolidated Balance Sheet and cash flows from investing activities on the Consolidated Statement of Cash Flows.
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 on the Consolidated Balance Sheet are as follows:
| | | | | | | | | | | | | | | | | |
| Balance Sheet Caption | | 2022 | | 2021 |
| Net investment hedges | | | | | |
| | | | | |
Cross-currency swap contracts | Investments and other assets | | $ | 21,444 | | | $ | — | |
Cross-currency swap contracts | Other liabilities | | — | | | 71,798 | |
| Other derivative contracts | | | | | |
| Forward exchange contracts | Non-trade and notes receivable | | 20,976 | | | 5,376 | |
| Forward exchange contracts | Other accrued liabilities | | 5,651 | | | 9,435 | |
| Deal-contingent forward contracts | Other accrued liabilities | | 1,015,426 | | | — | |
Costless collar contracts | Non-trade and notes receivable | | 351 | | | 110 | |
Costless collar contracts | Other accrued liabilities | | 1,578 | | | 901 | |
The cross-currency swap, forward exchange, deal-contingent forward 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.
The cross-currency swap contracts have been designated as hedging instruments. The forward exchange, deal-contingent forward and costless collar contracts have not been designated as hedging instruments and are considered to be economic hedges of forecasted transactions.
The forward exchange and costless collar contracts are adjusted to fair value by recording gains and losses through the cost of sales caption in the Consolidated Statement of Income. The deal-contingent forward contracts are adjusted to fair value by recording gains and losses through the other expense (income), net caption in the Consolidated Statement of Income.
Derivatives designated as hedges are adjusted to fair value by recording gains and losses through accumulated other comprehensive (loss) on the Consolidated Balance Sheet until the hedged item is recognized in earnings. We assess the effectiveness of the €69 million, €290 million and ¥2,149 million cross-currency swap hedging instruments using the spot method. Under this method, the periodic interest settlements are recognized directly in earnings through interest expense.
Net gains (losses) of $56 million, $16 million and $(27) million relating to forward exchange contracts were recorded within cost of sales on the Consolidated Statement of Income for the year ended June 30, 2022, 2021 and 2020, respectively. Net (losses) of $(1,015) million related to the deal-contingent forward contracts were recorded during 2022. All other gains or losses on derivative financial instruments that were recorded in the Consolidated Statement of Income during 2022, 2021 and 2020 were not material.
Gains (losses) on derivative and non-derivative financial instruments that were recorded in accumulated other comprehensive (loss) in the Consolidated Balance Sheet are as follows: | | | | | | | | | | | |
| 2022 | | 2021 |
| Cross-currency swap contracts | $ | 69,992 | | | $ | (31,988) | |
| Foreign currency denominated debt | 72,670 | | | (32,882) | |
During 2022, 2021, and 2020 the periodic interest settlements related to the cross-currency swaps were not material.
A summary of financial assets and liabilities that were measured at fair value on a recurring basis at June 30, 2022 and 2021 are as follows: | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2022 | | Quoted Prices In
Active Markets
(Level 1) | | Significant Other
Observable Inputs
(Level 2) | | Significant
Unobservable
Inputs
(Level 3) |
| Assets: | | | | | | | | |
| Equity securities | | $ | 13,038 | | | $ | 13,038 | | | $ | — | | | $ | — | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| Derivatives | | 42,771 | | | — | | | 42,771 | | | — | |
| | | | | | | | |
| Liabilities: | | | | | | | | |
| Derivatives | | 1,022,655 | | | — | | | 1,022,655 | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2021 | | Quoted Prices In
Active Markets
(Level 1) | | Significant Other
Observable Inputs
(Level 2) | | Significant
Unobservable
Inputs
(Level 3) |
| Assets: | | | | | | | | |
| Equity securities | | $ | 20,517 | | | $ | 20,517 | | | $ | — | | | $ | — | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| Derivatives | | 5,486 | | | — | | | 5,486 | | | — | |
| | | | | | | | |
| Liabilities: | | | | | | | | |
| Derivatives | | 82,134 | | | — | | | 82,134 | | | — | |
The fair values of the equity securities are determined using the closing market price reported in the active market in which the fund is traded.
Derivatives consist of forward exchange, deal-contingent forward, 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.
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.
17. 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, employee claims, class action lawsuits, and alleged violations of various environmental laws. We are 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 our 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, 2022, we had an accrual of $16.4 million 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 our liability in proportion to other responsible parties.
Our estimated total liability for environmental matters ranges from a minimum of $16.4 million to a maximum of $64.9 million. The largest range for any one site is approximately $13.4 million. The actual costs we will incur are 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.
18. Business Segment Information
The Company operates in two reportable business segments: Diversified Industrial and Aerospace Systems. Both segments utilize eight core technologies, including hydraulics, pneumatics, electromechanical, filtration, fluid and gas handling, process control, engineered materials and climate control, to drive superior customer problem solving and value creation.
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 42 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.
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.
| | | | | | | | | | | | | | | | | | | | |
| | 2022 | | 2021 | | 2020 |
| Net Sales: | | | | | | |
| Diversified Industrial: | | | | | | |
| North America | | $ | 7,703,150 | | | $ | 6,676,449 | | | $ | 6,456,298 | |
| International | | 5,638,896 | | | 5,283,710 | | | 4,504,587 | |
| Aerospace Systems | | 2,519,562 | | | 2,387,481 | | | 2,734,635 | |
| | $ | 15,861,608 | | | $ | 14,347,640 | | | $ | 13,695,520 | |
| | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | 2022 | | 2021 | | 2020 |
| Segment Operating Income: | | | | | | |
| Diversified Industrial: | | | | | | |
| North America | | $ | 1,515,259 | | | $ | 1,247,419 | | | $ | 985,944 | |
| International | | 1,178,044 | | | 988,054 | | | 674,763 | |
| Aerospace Systems | | 501,431 | | | 402,895 | | | 476,900 | |
| Total segment operating income | | 3,194,734 | | | 2,638,368 | | | 2,137,607 | |
| Corporate administration | | 219,699 | | | 178,427 | | | 170,903 | |
| Income before interest expense and other expense | | 2,975,035 | | | 2,459,941 | | | 1,966,704 | |
| Interest expense | | 255,252 | | | 250,036 | | | 308,161 | |
| Other expense (income) | | 1,105,557 | | | (37,052) | | | 151,689 | |
| Income before income taxes | | $ | 1,614,226 | | | $ | 2,246,957 | | | $ | 1,506,854 | |
| | | | | | |
| Assets: | | | | | | |
| Diversified Industrial | | $ | 15,838,512 | | | $ | 16,518,688 | | | $ | 15,973,576 | |
Aerospace Systems(a) | | 3,020,606 | | | 3,077,395 | | | 3,251,522 | |
| Corporate | | 7,084,825 | | | 745,117 | | | 662,655 | |
| | $ | 25,943,943 | | | $ | 20,341,200 | | | $ | 19,887,753 | |
| | | | | | |
| Property Additions: | | | | | | |
| Diversified Industrial | | $ | 197,675 | | | $ | 186,233 | | | $ | 183,981 | |
| Aerospace Systems | | 27,452 | | | 20,705 | | | 44,546 | |
| Corporate | | 4,917 | | | 3,019 | | | 4,064 | |
| | $ | 230,044 | | | $ | 209,957 | | | $ | 232,591 | |
| | | | | | |
| Depreciation: | | | | | | |
| Diversified Industrial | | $ | 219,206 | | | $ | 229,891 | | | $ | 218,092 | |
| Aerospace Systems | | 29,576 | | | 32,151 | | | 27,749 | |
| Corporate | | 8,532 | | | 7,901 | | | 7,058 | |
| | $ | 257,314 | | | $ | 269,943 | | | $ | 252,899 | |
| | | | | | |
| Amortization: | | | | | | |
| Diversified Industrial | | $ | 263,430 | | | $ | 274,368 | | | $ | 243,714 | |
| Aerospace Systems | | 51,020 | | | 51,079 | | | 40,918 | |
| | $ | 314,450 | | | $ | 325,447 | | | $ | 284,632 | |
| | | | | | |
By Geographic Area(b) | | | | | | |
| Net Sales: | | | | | | |
| North America | | $ | 10,216,292 | | | $ | 9,046,162 | | | $ | 9,166,773 | |
| International | | 5,645,316 | | | 5,301,478 | | | 4,528,747 | |
| | $ | 15,861,608 | | | $ | 14,347,640 | | | $ | 13,695,520 | |
| Long-Lived Assets: | | | | | | |
| North America | | $ | 1,398,966 | | | $ | 1,448,109 | | | $ | 1,494,858 | |
| International | | 723,792 | | | 818,367 | | | 797,877 | |
| | $ | 2,122,758 | | | $ | 2,266,476 | | | $ | 2,292,735 | |
(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 (2022 - $211 million; 2021 - $219 million; 2020 - $238 million) and assets held for sale (2022 - $66 million).
(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 property, plant and equipment based on physical location.