DONALDSON Co INC - Annual Report: 2015 (Form 10-K)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission File Number: 1-7891

DONALDSON COMPANY, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (952) 887-3131

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
☒  Yes   ☐  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
☐  Yes   ☒  No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ☒  Yes   ☐  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ☒  Yes   ☐  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ☒

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).☐  Yes   ☒  No

As of January 31, 2015, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of voting and non-voting common stock held by non-affiliates of the registrant was $4,956,390,941 (based on the closing price of $36.56 as reported on the New York Stock Exchange as of that date).

As of October 30, 2015, there were approximately 132,636,175 shares of the registrant’s common stock outstanding.

Documents Incorporated by Reference

Portions of the registrant’s Proxy Statement for its 2015 annual meeting of stockholders (the “2015 Proxy Statement”) are incorporated by reference in Part III, as specifically set forth in Part III.

DONALDSON COMPANY, INC.

ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

PART I

Item 1. Business

General

Donaldson Company, Inc. (Donaldson or the Company) was founded in 1915 and organized in its present corporate form under the laws of the State of Delaware in 1936.

The Company is a worldwide manufacturer of filtration systems and replacement parts. The Company’s core strengths are leading filtration technology, strong Customer relationships, and its global presence. Products are manufactured at 41 plants around the world and through three joint ventures.

The Company has two reporting segments: Engine Products and Industrial Products. Products in the Engine Products segment consist of air filtration systems, exhaust and emissions systems, liquid filtration systems including hydraulics, fuel, and lube systems, and replacement filters. The Engine Products segment sells to original equipment manufacturers (OEMs) in the construction, mining, agriculture, aerospace, defense, and truck markets, and to independent distributors, OEM dealer networks, private label accounts, and large equipment fleets. Products in the Industrial Products segment consist of dust, fume, and mist collectors, compressed air purification systems, air filtration systems for gas turbines, PTFE membrane-based products, and specialized air and gas filtration systems for applications including computer hard disk drives and semi-conductor manufacturing. The Industrial Products segment sells to various industrial dealers, distributors, OEMs of gas-fired turbines, and OEMs and end-users requiring clean filtration solutions and replacement filters.

The discussion below should be read in conjunction with the risk factors discussed in this report in Part I, Item  1A, “Risk Factors.”

The table below shows the percentage of total net sales contributed by the principal classes of similar products for each of the last three fiscal years:

Total net sales contributed by the principal classes of similar products and financial information about segment operations and geographic regions appear in Note K in the Notes to Consolidated Financial Statements on page 54.

The Company makes its annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, and amendments to those reports, available free of charge through its website at www.donaldson.com, as soon as reasonably practicable after it electronically files such material with (or furnishes such material to) the Securities and Exchange Commission. Also available on the Company’s website are corporate governance documents, including the Company’s Code of Business Conduct and Ethics, Corporate Governance Guidelines, Audit Committee charter, Human Resources Committee charter, and Corporate Governance Committee charter. These documents are also available in print, free of charge to any person who requests them in writing to the attention of Investor Relations, MS 102, Donaldson Company, Inc., 1400 West 94^th Street, Minneapolis, Minnesota 55431. The information contained on the Company’s website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered to be part of this Form 10-K.

Seasonality

A number of the Company’s end markets are dependent on the construction, agricultural, and power generation industries, which are generally stronger in the second half of the Company’s fiscal year. The first two quarters of the fiscal year also contain the traditional summer and winter holiday periods, which are typically characterized by more Customer plant closures.

Competition

Principal methods of competition in both the Engine and Industrial Products segments are technology, innovation, price, geographic coverage, service, and product performance. The Company competes in a number of highly competitive filtration markets in both segments. The Company believes it is a market leader within many of its product lines, specifically within its Off-Road Equipment and On-Road Products lines for OEMs, and is a significant participant in the aftermarket for replacement filters. The Engine Products segment’s principal competitors include several large global competitors and many regional competitors, especially in the Engine Aftermarket Products business. The Industrial Products segment’s principal competitors vary from country to country and include several large regional and global competitors and a significant number of smaller competitors who compete in a specific geographical region or in a limited number of product applications.

Raw Materials

The principal raw materials that the Company uses are steel, filter media, and petroleum-based products including plastics, rubber, and chemicals. Purchased raw materials represent approximately 60 to 65 percent of the Company’s cost of goods sold. Of that amount, steel, including fabricated parts, represents approximately 25 percent. Filter media represents approximately 15 to 20 percent and the remainder is primarily made up of petroleum-based products and other components. The cost the Company paid for steel during Fiscal 2015 varied by grade, but in the aggregate, it slightly decreased during the fiscal year. The Company’s cost of filter media also varies by type and slightly increased during the fiscal year. The Company anticipates a moderately favorable impact from commodity prices in Fiscal 2016, as compared to Fiscal 2015, specifically for steel and petroleum-based products, based on recent market information for purchased commodities. The Company strives to recover or offset any material cost increases through selective price increases to its Customers and through the Company’s Continuous Improvement initiatives, which include material substitutions, process improvements, and product redesigns.

Patents and Trademarks

The Company owns various patents and trademarks, which it considers in the aggregate to constitute a valuable asset, including patents and trademarks for products sold under the Ultra-Web®, PowerCore®, and Donaldson® trademarks. However, it does not regard the validity of any one patent or trademark as being of material importance.

Major Customers

There were no Customers that accounted for over 10 percent of net sales in Fiscal 2015, 2014, or 2013. There were no Customers that accounted for over 10 percent of gross accounts receivable in Fiscal 2015 or Fiscal 2014.

Backlog

At August 31, 2015, the backlog of orders expected to be delivered within 90 days was $331.0 million. The 90-day backlog at August 31, 2014, was $375.1 million. Backlog is one of many indicators of business conditions in the Company’s markets. However, it is not always indicative of future results for a number of reasons, including short lead times in the Company’s replacement parts businesses and the timing of orders in many of the Company’s Engine OEM and Industrial markets.

Research and Development

During Fiscal 2015, the Company spent $60.2 million on research and development activities. Research and development expenses include basic scientific research and the application of scientific advances to the development of new and improved products and their uses. The Company spent $61.8 million and $62.6 million in Fiscal 2014 and Fiscal 2013, respectively, on research and development activities. Substantially all commercial research and development is performed in-house.

Environmental Matters

The Company does not anticipate any material effect on its capital expenditures, earnings, or competitive position during Fiscal 2016 due to compliance with government regulations regulating the discharge of materials into the environment or otherwise relating to the protection of the environment.

Employees

The Company employed over 12,500 persons in worldwide operations as of July 31, 2015.

Geographic Areas

Financial information about geographic areas appears in Note K of the Notes to Consolidated Financial Statements on page 54.

Item 1A. Risk Factors

There are inherent risks and uncertainties associated with our global operations that involve the manufacturing and sale of products for highly demanding Customer applications throughout the world. These risks and uncertainties could adversely affect our operating performance and financial condition. The following discussion, along with discussions elsewhere in this report, outlines the risks and uncertainties that we believe are the most material to our business at this time. We want to further highlight the risks and uncertainties associated with: world economic factors and ongoing global economic uncertainty, currency fluctuations, commodity prices, political factors, our international operations, the continued implementation of our global ERP information technology system and other new information technology systems, information security and data breaches, the reduced demand for hard disk drive products with the increased use of flash memory, highly competitive markets, governmental laws and regulations, including the impact of the various economic stimulus and financial reform measures, potential global events resulting in market instability including financial bailouts and defaults of sovereign nations, military and terrorist activities, including conditions where we do business, other political changes, health outbreaks, natural disasters, and other factors discussed below. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Operating internationally carries risks which could negatively affect our financial performance.

We have sales and manufacturing operations throughout the world, with the heaviest concentrations in the Americas, Europe, and Asia. Our stability, growth, and profitability are subject to a number of risks of doing business internationally that could harm our business, including:

Due to the international scope of our operations, we are subject to a complex system of import- and export-related laws and regulations. Any alleged or actual violations may subject us to government scrutiny, investigation, and civil and criminal penalties, and may limit our ability to import or export our products or to provide services outside the

United States (U.S.). In addition, the U.S. Foreign Corrupt Practices Act and similar foreign anti-corruption laws generally prohibit companies and their intermediaries from making improper payments or providing anything of value to improperly influence foreign government officials for the purpose of obtaining or retaining business, or obtaining an unfair advantage. Violations of these laws may result in severe criminal or civil sanctions, could disrupt our business, and result in an adverse effect on our reputation, business, and results of operations or financial condition.

Maintaining a competitive advantage requires continuing investment with uncertain returns.

We operate in highly competitive markets and have numerous competitors who may already be well-established in those markets. We expect our competitors to continue improving the design and performance of their products and to introduce new products that could be competitive in both price and performance. We believe that we have certain technological advantages over our competitors, but maintaining these advantages requires us to continually invest in research and development, sales and marketing, and Customer service and support. There is no guarantee that we will be successful in maintaining these advantages. We make investments in new technologies that address increased performance and regulatory requirements around the globe. There is no guarantee that we will be successful in completing development or achieving sales of these products or that the margins on such products will be acceptable. Our financial performance may be negatively impacted if a competitor’s successful product innovation reaches the market before ours or gains broader market acceptance.

We may be adversely impacted by changes in technology that could reduce or eliminate the demand for our products. These risks include:

Difficulties with our information technology systems and security could adversely affect our results.

We have many information technology systems that are important to the operation of our businesses, some of which are managed by third parties. These systems are used to process, transmit, and store electronic information, and to manage or support a variety of business processes and activities. We could encounter difficulties in developing new systems, maintaining and upgrading our existing systems, and preventing information security breaches. There may be other risks as we continue our multi-year implementation of an enterprise resource planning system (Global ERP Project) on a worldwide basis. Such difficulties could lead to significant additional expenses and/or disruption in business operations that could adversely affect our results. Additionally, information technology security threats are increasing in frequency and sophistication. These threats pose a risk to the security of our systems and networks and the confidentiality, availability, and integrity of our data. Should such an attack succeed, it could lead to the compromising of confidential information, manipulation and destruction of data, defective products, production downtimes, and operations disruptions. The occurrence of any of these events could adversely affect our reputation, and could result in litigation, regulatory action, potential liability, and increased costs and operational consequences of implementing further data protection matters.

Demand for our products relies on economic and industrial conditions worldwide.

Changes in economic or industrial conditions could impact our results or financial condition in any particular period as our business can be sensitive to varying conditions by region across the globe.

No Customer accounted for ten percent or more of our net sales in Fiscal 2015, 2014 and 2013. A number of our Customers are concentrated in similar cyclical industries (construction, agriculture, and mining), resulting in additional risk based on industrial conditions in those sectors.

We participate in highly competitive markets with pricing pressure. If we are not able to compete effectively our margins and results of operations could be adversely affected.

The businesses and product lines in which we participate are very competitive and we risk losing business based on a wide range of factors including technology, price, geographic coverage, product performance, and Customer

service. Large Customers continue to seek productivity gains and lower prices from us and their other suppliers. We may lose business or negatively impact our margins if we are unable to deliver the best value to our Customers.

Changes in our product mix impact our financial performance.

We sell products that have varying profit margins. Our financial performance can be impacted depending on the mix of products we sell during a given period. Our outlook assumes a certain geographic mix of sales as well as a product mix of sales. If actual results vary from this projected geographic and product mix of sales, our results could be negatively impacted.

Unavailable or higher cost materials could impact our financial performance.

We obtain raw materials including steel, filter media, petroleum-based products, and other components from third-party suppliers and tend to carry limited raw material inventories. An unanticipated delay in delivery by our suppliers could result in the inability to deliver on-time and meet the expectations of our Customers. This could negatively affect our financial performance. An increase in commodity prices could also result in lower operating margins.

An unfavorable fluctuation in foreign currency exchange rates could negatively impacts our results and financial position.

We have operations in many countries, with more than one-half of our annual revenue coming from countries outside of the United States. Each of our subsidiaries reports its results of operations and financial position in its relevant functional currency, which is then translated into U.S. dollars. This translated financial information is included in our consolidated financial statements. Strengthening of the U.S. dollar in comparison to the foreign currencies of our subsidiaries has a negative impact on our results and financial position.

Acquisitions may have an impact on our results.

We have made and continue to pursue acquisitions, including our acquisitions of Northern Technical L.L.C. and IFIL USA L.L.C. in Fiscal 2015. These acquisitions could negatively impact our profitability due to operating and integration inefficiencies, the incurrence of debt, contingent liabilities, and amortization expenses related to intangible assets. There are also a number of other risks involved in acquisitions. We could lose key existing Customers, have difficulties in assimilating the acquired operations, assume unanticipated legal liabilities, or lose key Employees.

Costs associated with lawsuits or investigations may have an adverse effect on our results of operations.

We are subject to many laws and regulations in the jurisdictions in which we operate. We routinely incur costs in order to comply with these laws and regulations. We may be adversely impacted by new or changing laws and regulations that affect both our operations and our ability to develop and sell products that meet our Customers’ requirements. We are involved in various product liability, product warranty, intellectual property, environmental claims, and other legal proceedings that arise in and outside of the ordinary course of our business. It is not possible to predict the outcome of investigations and lawsuits, and we could incur judgments, fines, or penalties or enter into settlements of lawsuits and claims that could have an adverse effect on our business, results of operations, and financial condition in any particular period.

Additional tax expense or tax exposure could impact our financial performance.

We are subject to income taxes in various jurisdictions in which we operate. Our tax liabilities are dependent upon the location of earnings among these different jurisdictions. Our provision for income taxes and cash tax liability could be adversely affected by numerous factors, including income before taxes being lower than anticipated in countries with lower statutory tax rates and higher than anticipated in countries with higher statutory tax rates, changes in the valuation of deferred tax assets and liabilities, and changes in tax laws and regulations. We are also subject to the continuous examination of our income tax returns by tax authorities. The results of audits and examinations of previously filed tax returns and continuing assessments of our tax exposures may have an adverse effect on our provision for income taxes and cash tax liability.

Compliance with environmental and product laws and regulations can be costly.

We are subject to many environmental and product laws and regulations in the jurisdiction we operate. We routinely incur costs in order to comply with these laws and regulations. We may be adversely impacted by new or changing laws and regulations that affect both our operations and our ability to develop and sell products that meet our Customers’ requirements.

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results and prevent material fraud, which could adversely affect the value of our common stock. Failure to maintain an effective system of internal control over financial reporting resulted in a material weakness during fiscal 2015.

Effective internal control over financial reporting is necessary for us to provide reliable financial reports and effectively prevent and detect material fraud. If we cannot provide reliable financial reports or prevent or detect material fraud, our operating results could be misstated. In connection with reporting our results for fiscal 2015, we discovered that certain employees in our European Gas Turbine Products business falsified documents in a manner that caused revenue to be recorded in inappropriate periods during the fourth quarter of fiscal 2014 and the second and third quarters of fiscal 2015. Due to the inappropriate acceleration of revenue in the aforementioned periods, revenue was also misstated in the first and fourth quarters of 2015. The recording of revenue in inappropriate periods was the result of a control deficiency which constituted a material weakness in our internal control over financial reporting. There was also an indication that there may have been purposeful deferring of certain charges from suppliers to later time periods than appropriate, however, these allegations were not substantiated through the independent investigation performed. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. Management has determined that the misstatements in revenue were not material to the impacted periods. Although we are taking remedial actions in response to our discovery of these practices, including the termination of certain employees, there can be no assurances that we will be able to prevent future control deficiencies (including material weaknesses) from occurring and which could cause us to incur unforeseen costs, negatively impact our results of operations, cause the market price of our common stock to decline, or have other potential adverse consequences.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

The Company’s principal administrative office and research facilities are located in Bloomington, a suburb of Minneapolis, Minnesota. The Company’s principal European administrative and engineering offices are located in Leuven, Belgium. The Company also has extensive operations in the Asia-Pacific and Latin America regions.

The Company’s principal manufacturing and distribution activities are located throughout the world. The following is a summary of the principal plants and other materially important physical properties owned or leased by the Company.

The Company’s properties are utilized for both the Engine and Industrial Products segments except as indicated with an (E) for Engine or (I) for Industrial. The Company leases certain of its facilities, primarily under long-term leases. The facilities denoted with an asterisk (*) are leased facilities. In Wuxi, China, and Bloomington, Minnesota, a portion of the activities are conducted in leased facilities. The Company uses third-party logistics providers for some of its product distribution and neither leases nor owns the facilities. The Company considers its properties to be suitable for their present purposes, well-maintained, and in good operating condition.

Item 3. Legal Proceedings

The Company records provisions with respect to identified claims or lawsuits when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Claims and lawsuits are reviewed quarterly and provisions are taken or adjusted to reflect the status of a particular matter. The Company believes the recorded estimated liability in its consolidated financial statements is adequate in light of the probable and estimable outcomes. Any recorded liabilities were not material to the Company’s financial position, results of operations or liquidity, and the Company does not believe that any of the currently identified claims or litigation will materially affect its financial position, results of operations or liquidity.

Item 4. Mine Safety Disclosures

Not applicable.

Executive Officers of the Registrant

Current information as of October 30, 2015, regarding executive officers is presented below. All terms of office are for one year. There are no arrangements or understandings between individual officers and any other person pursuant to which the officer was selected as an executive officer.

Ms. Becker joined the Company in 1998 as Senior Counsel and Assistant Corporate Secretary and was appointed to Vice President, General Counsel and Secretary in August 2014. Prior to joining the Company, Ms. Becker was an attorney for Dorsey and Whitney, LLP from 1991 to 1995 and was a Project Manager and Corporate Counsel for Harmon, Ltd. from 1995 to 1998.

Mr. Carpenter joined the Company in 1996 and has held various positions, including Gas Turbine Systems General Manager from 2002 to 2004; General Manager, Industrial Filtration Systems (IFS) Sales from 2004 to 2006; General Manager, IFS Americas in 2006; Vice President, Global IFS from 2006 to 2008; Vice President, Europe and Middle East from 2008 to 2011; and Senior Vice President, Engine Products from 2011 to 2014. In April 2014, Mr. Carpenter was appointed Chief Operating Officer. On April 1, 2015, Mr. Carpenter was appointed President and Chief Executive Officer.

Mr. Cook joined the Company in 1980 and has held various positions, including CFO and Senior Vice President, International from 2001 to 2004. Mr. Cook was appointed President and CEO in 2004 and then Chairman, President, and CEO in 2005. On April 1, 2015, Mr. Cook transferred the positions of President and Chief Executive Officer to Tod Carpenter while remaining Chairman of the Board.

Ms. Kramer was appointed Vice President, Human Resources in October 2015. Prior to joining the Company, Ms. Kramer was Vice President, Human Resources for Taylor Corporation, a print and graphics media company, from 2013 until September 2015. From 1991 to 2013, Ms. Kramer was with Lifetouch, Inc., a photography company, where she held various human resources roles including Corporate Vice President, Human Resources from 2009 to 2013.

Ms. Perushek was appointed Vice President and Chief Information Officer in November 2006. Prior to that time, Ms. Perushek was Vice President of Global Information Technology at H.B. Fuller Company, a worldwide manufacturer of adhesive products, from 2005 to 2006, and Chief Information Officer for Young America Corporation, a marketing company, from 1999 to 2004.

Mr. Scalf joined the Company in 1989 and has held various positions, including Director of Global Operations from 2003 to 2006; General Manager of Exhaust & Emissions from 2006 to 2008; General Manager of Industrial Filtration Solutions from 2008 to 2012; and Vice President of Global Industrial Air Filtration from 2012 to 2014. Mr. Scalf was appointed Senior Vice President, Engine Products, in April 2014.

Mr. Shaw joined the Company in 2004 and has held various positions, including Director, Corporate Compliance/Internal Audit, and Corporate Controller and Principal Accounting Officer from 2004 to 2011. Mr. Shaw was appointed Vice President and Chief Financial Officer effective November 2011. Prior to joining Donaldson, Mr. Shaw held various positions at Deloitte & Touche, LLP and Arthur Andersen, LLP.

Mr. Vermeersch joined the Company in 1992 and has held various positions, including Director, Gas Turbine Systems, Asia Pacific from 2000 to 2005; Manager, Aftermarket and Service IFS, Belgium from 2005 to 2006; Manager, IFS, Belgium from 2006 to 2007; Director, Gas Turbine Systems, Europe, Middle East and North Africa, from 2007 to 2010; and Director, Engine, Europe, Middle East and North Africa from 2010 to 2011. Mr. Vermeersch was appointed Vice President, Europe and Middle East in January 2012.

Mr. Ward joined the Company in 1998 and has held various positions, including Director, Operations from 2001 to 2003; Director, Product and Business Development, IFS Group from 2003 to 2004; Managing Director, Europe from 2004 to 2006; and Vice President, Europe and Middle East from 2006 to 2008. Mr. Ward was appointed Senior Vice President, Engine Products in August 2008 and was appointed Senior Vice President, Industrial Products, in October 2011.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The common shares of the Company are traded on the New York Stock Exchange under the symbol DCI. The amount and frequency of all cash dividends declared on the Company’s common stock for Fiscal 2015 and 2014 appear in Note O of the Notes to Consolidated Financial Statements on page 58. The Company’s dividend payout ratio target is approximately 35 percent to 45 percent of the average earnings per share of the last three years. This guidance is expected to be used for future dividend payouts. As of October 30, 2015, there were 1,687 shareholders of record of common stock.

The low and high sales prices for the Company’s common stock for each full quarterly period during Fiscal 2015, 2014 and 2013 were as follows:

The following table sets forth information in connection with purchases made by, or on behalf of, the Company or any affiliated purchaser of the Company, of shares of the Company’s common stock during the quarterly period ended July 31, 2015.

The table set forth in Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters,” of this report is also incorporated herein by reference.

The graph below compares the cumulative total stockholder return on the Company’s common stock for the last five fiscal years with the cumulative total return of the Standard & Poor’s 500 Stock Index and the Standard & Poor’s Industrial Machinery Index. The graph and table assume the investment of $100 in each of the Company’s common stock and the specified indexes at the beginning of the applicable period, and assume the reinvestment of all dividends.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Among Donaldson Company, Inc., the S&P 500 Index and the S&P Industrial Machinery Index

Item 6. Selected Financial Data

The following table sets forth selected financial data for each of the fiscal years in the five-year period ended July 31, 2015 (in millions, except per share data):

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

Results of Operations

The following discussion of the Company’s financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto and other financial information included elsewhere in this report.

Overview

The Company is a worldwide manufacturer of filtration systems and replacement parts. The Company’s core strengths are leading filtration technology, strong Customer relationships, and its global presence. The Company operates through two reporting segments, Engine Products and Industrial Products, and has a product mix including air filtration systems, exhaust and emission systems, liquid filtration systems for hydraulics, fuel, lube applications, and replacement filters. As a worldwide business, the Company’s results of operations are affected by conditions in the global economic environment. Under most economic conditions, the Company’s market diversification between its OEM and replacement parts Customers, its diesel engine and industrial end markets, and its global end markets has helped to limit the impact of weakness in any one product line, market, or geography on the consolidated results of the Company.

The Company reported sales in Fiscal 2015 of $2,371.2 million down 4.1 percent from $2,473.5 million in the prior year. The Company’s results were negatively impacted by foreign currency translation, which decreased sales by $134.8 million. Excluding the current year impact of foreign currency translation, worldwide sales increased 1.3 percent.

The Company reported net earnings in Fiscal 2015 of $208.1 million, a decrease of 20.0 percent from $260.2 million in the prior year. The Company’s net earnings were negatively impacted by foreign currency translation, which decreased net earnings by $14.3 million. Excluding the current year impact of foreign currency translation, net earnings decreased 14.5 percent.

Although net sales and net earnings excluding foreign currency translation are not measures of financial performance under generally accepted accounting principles (GAAP) in the United States, the Company believes they are useful in understanding its financial results and provide comparable measures for understanding the operating results of the Company between different fiscal periods. Following are reconciliations to the most comparable U.S. GAAP financial measures of these non-GAAP financial measures (in millions):

The Company reported diluted earnings per share of $1.49, a 15.3% percent decrease from $1.76 in the prior year.

Following are net sales by product within the Company’s Engine and Industrial Products segments and a comparison of earnings before income taxes. Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments, such as interest income and interest expense. See further discussion of segment information in Note K of the Company’s Notes to Consolidated Financial Statements.

__________________

* Includes replacement part sales to the Company’s OEM Customers

The Company’s overall sales decreased compared to the prior year period. Many factors contributed to the Company’s results for each of its reportable segments for Fiscal 2015. The Company saw challenging conditions in most of the Off-Road OEM first-fit equipment end markets. However the first-fit On-Road OEM truck end-market experienced growth in new truck sales. The Company also saw continued strength in demand for replacement filters in both its Engine and Industrial end markets through the first half of the year, but then demand weakened during the second half of the fiscal year. In Industrial Products, the Company achieved a 19.2 percent increase in its Gas Turbine sales to $186.9. The Company’s sales increased in the Americas by $1.5 million, or 0.1% percent, offset by decreases in sales in both Europe and Asia, of $57.3 million or 7.9% and $46.6 million or 9.0 percent, respectively.

In the Engine Products segment, the Company experienced mixed results in its end-markets. Off-Road Product OEM first-fit sales decreased by 23.7 percent, driven by weakness in the mining and agricultural equipment markets, which was partially offset by an improving construction equipment market in North America. Aftermarket Products sales decreased 3.1 percent, primarily driven by the change in foreign currency exchange rates partially offset by increases in the utilization rates of equipment fleets, increased sales of the Company’s proprietary replacement filters, and expansion of the Company’s product portfolio and distribution capabilities. On-Road Products OEM first-fit sales increased by 6.4 percent, primarily due to an increase in Customer new truck build rates. Earnings before income taxes as a percentage of Engine Products segment sales were 12.6 percent, a decreased of 2.2 points from 14.8 percent in the prior year.

In the Industrial Products segment, sales decreased due to a 4.4 percent decrease in Industrial Filtration Solutions Products primarily driven by a 10.5 percent decrease in sales in Europe. Earnings before income taxes as a percentage of Industrial Products segment sales were 13.9, a decrease of 1.2 points from 15.1 percent in prior year. The decrease in earnings before income taxes is primarily due to a higher mix of Gas Turbine Products and Industrial Filtration Solutions Products large project sales which carry lower margins than replacement filters. Gas Turbine Products sales were up 19.2 percent as a result of increased shipments of large systems used in power generation and including the impact of Northern Technical. Industrial Filtration Solutions sales of new equipment sales were down due to a continued weak capital spending environment, particularly in Asia. Sales in Special Applications Products were down by 4.5 percent due to a decrease in industrial end-markets impacting the Company’s membrane product sales.

Outlook

Fiscal 2015 Compared to Fiscal 2014

Engine Products Segment The Engine Products segment sells to OEM Customers in the construction, mining, agriculture, aerospace, defense, and truck end-markets, and to independent distributors, OEM dealer networks, private label accounts, and large equipment fleets. Products include air filtration systems, exhaust and emissions systems, liquid filtration systems for hydraulics, fuel and lube application, and replacement filters.

Sales for the Engine Products segment were $1,484.1 million, a decrease of 6.3 percent from $1,584.0 million in the prior year. Fiscal 2015 Engine Products sales decreased by 13.7 percent in Europe, 10.2 percent in Asia, and 1.9 percent in the Americas compared to Fiscal 2014. The impact of the changes in foreign currency decreased sales by $82.0 million, or 5.5 percent.

Worldwide sales of Off-Road Products were $261.1 million, a decrease of 23.7 percent from $342.2 million in the prior year. Sales declined 24.8 percent in Europe, 24.4 percent in the Americas, and 22.6 percent in Asia. The sales decreases were driven by continued weakness in the mining and agricultural equipment markets. These decreases were partially offset by an improving construction equipment end-market, particularly in North America, and new program wins in Europe.

Worldwide sales of On-Road Products were $138.4 million, an increase of 6.4 percent from $130.0 million in the prior year. Sales increased 16.2 percent in the Americas offset by a decrease of 4.0 percent in Asia and a decrease of 7.9 percent in Europe. The increase overall is due to an increase in Customer new truck build rates in North America.

Worldwide sales of Aftermarket Products were $980.8 million, a decrease of 3.1 percent from $1,012.2 million in the prior year. Sales decreased 10.9 percent in Europe and 6.2 percent in Asia. The overall sales decreases were primarily driven by the impact of the change in foreign currency exchange rates partially offset by increases in the utilization rates of equipment fleets, increased sales of the Company’s proprietary replacement filters, and expansion of the Company’s product portfolio and distribution capabilities. Net of foreign currency fluctuations, Aftermarket sales increased 2.1 percent with sales in the Americas increasing by 1.6 percent, Europe by 3.1 percent and in Asia by 0.8 percent.

Worldwide sales of Aerospace and Defense Products were $103.9 million, an increase of 4.2 percent from $99.6 million in the prior year. Sales of Aerospace and Defense Products increased 12.7 percent in Europe and 1.8 percent in the Americas, partially offset by a sales decrease of 24.9 percent in Asia over the prior year.

Industrial Products Segment The Industrial Products segment sells to various industrial distributors, dealers, and end-users, OEM Customers of gas-fired turbines, and OEMs and end-users requiring clean air. Products include dust, fume, and mist collectors, compressed air purification systems, air filtration systems for gas turbines and compressors, PTFE membrane-based products, and specialized air and gas filtration systems for various applications including computer hard disk drives and other electronic equipment.

Sales for the Industrial Products segment were $887.1 million, a decrease of 0.3 percent from $889.4 million in the prior year. This result was driven by a 4.4 percent decline in Industrial Filtration Solutions Products and a 4.5 percent decline in Special Applications Products, offset by a 19.2 percent sales increase in Gas Turbine Products. Industrial Products sales decreased by 7.8 percent in Asia, which was partially offset by a 5.8 percent increase in sales in the Americas, compared to Fiscal 2014. The impact of foreign currency decreased total sales by $52.1 million, or 5.9 percent.

Worldwide sales of Industrial Filtration Solutions Products were $528.9 million, a 4.4 percent decrease from $553.4 million in the prior year. Sales decreased 10.5 and 6.6 percent in Europe and Asia, respectively, partially offset by a 3.1 percent increase in the Americas. The Company continued to experience soft new equipment sales due to a continued weak global capital investment environment, partially offset by strong replacement air filter sales due to improved utilization of the equipment already installed in the field.

Worldwide sales of Gas Turbine Products were $186.9 million, an increase of 19.2 percent from $156.9 million in the prior year. Sales of Gas Turbine Products systems were due to increased shipments of large filtration systems used in power generation as well as the benefit of the acquisition of Northern Technical, which generated sales of $16.3 million.

Worldwide sales of Special Applications Products were $171.2 million, a 4.5 percent decrease from $179.2 million in the prior year. Sales decreased 21.7 percent and 4.6 percent in the Americas and Asia, respectively, partially offset by an increase of 13.8 percent in Europe. The sales decline was the result of a decrease in demand for the Company’s membrane products.

Consolidated Results The Company reported net earnings for Fiscal 2015 of $208.1 million compared to $260.2 million in Fiscal 2014, a decrease of 20.0 percent. Diluted net earnings per share were $1.49, down 15.3 percent from $1.76 in the prior year. The Company’s operating income of $288.3 million decreased 19.0 percent from the prior year operating income of $355.7 million.

The table below shows the percentage of total operating income contributed by each segment for each of the last three fiscal years. Corporate and Unallocated includes corporate earnings and expenses determined to be non-allocable to the segments, such as interest income and interest expense:

International operating income, prior to corporate expense allocations, totaled 84.3 percent of consolidated operating income in Fiscal 2015 as compared to 79.7 percent in Fiscal 2014. Total international operating income decreased 14.3 percent from the prior year. The table below shows the percentage of total operating income contributed by each major geographic region for each of the last three fiscal years:

For more information regarding the Company’s net sales by geographic region, see Note K to the Consolidated Financial Statements.

Gross margin for Fiscal 2015 was 34.1 percent, or a 1.4 percent decrease from 35.5 percent in the prior year. The decreases were driven primarily by lower fixed cost absorption due to a decrease in sales and the negative mix impacts from more Gas Turbine Systems and Industrial Filtration Solutions project shipments. Restructuring and asset impairment charges of $8.4 million also negatively impacted gross margin in Fiscal 2015.

The principal raw materials that the Company uses are steel, filter media, and petroleum-based products including plastics, rubber, and chemicals. Purchased raw materials represents approximately 60 to 65 percent of the Company’s cost of goods sold. Of that amount, steel, including fabricated parts, represents approximately 25 percent. Filter media represents approximately 15 to 20 percent and the remainder is primarily made up of petroleum-based products and other components. The cost the Company paid for steel during Fiscal 2015 varied by grade, but in aggregate, it slightly decreased during the fiscal year. The Company’s cost of filter media also varies by type and slightly increased. The cost of petroleum-based products (plastics, rubber, and adhesives) slightly decreased. The Company anticipates a moderately favorable impact from commodity prices in Fiscal 2016, as compared to Fiscal 2015, specifically for steel and petroleum-based products, based on recent market information. On an ongoing basis, the Company strives to recover or offset any material cost increases through selective price increases to its Customers and through the Company’s Continuous Improvement initiatives, which include material substitutions, process improvements, and product redesigns.

Operating expenses for Fiscal 2015 were $520.3 million or 21.9 percent of sales, as compared to $522.1 million or 21.1 percent in the prior year. The decrease in operating expenses was primarily due to a reduction in incentive compensation expense accruals. Restructuring and asset impairment charges included in operating expenses were $8.5 million and included severance costs related to a reduction in workforce of $4.6 million, and the Company recorded a $3.9 million lump sum pension settlement.

Interest expense of $15.2 million increased $5.0 million from $10.2 million in the prior year. The increase was due to $150.0 million debt issued in the Fiscal 2015, as well as higher balances on the Company’s revolving line of credit. Other income, net totaled $15.4 million in Fiscal 2015, up from $15.2 million in the prior year.

The effective tax rate for Fiscal 2015 was 27.9 percent compared to 27.9 percent in Fiscal 2014. The effective tax rate in the current year was favorably impacted by the reinstatement of the Research and Experimentation Credit in the U.S. for calendar year 2014, non-recurring tax costs associated with foreign dividend distributions recorded during the prior year, and an increase in tax benefits from international operations. The effective tax rate in the prior year was favorably impacted by the settlement of a tax audit and the remeasurement of certain deferred tax assets due to a change in tax rates in certain foreign jurisdictions.

Total backlog at July 31, 2015, was $643.2 million, down 14.0 percent from the same period in the prior year. Backlog is one of many indicators of business conditions in the Company’s markets. However, it is not always indicative of future results for a number of reasons, including short lead times in the Company’s replacement parts businesses and the timing of the receipt of orders in many of the Company’s Engine OEM and Industrial markets. In the Engine Products segment, total open order backlog decreased 13.5 percent from the prior year. In the Industrial Products segment, total open order backlog decreased 15.2 percent from the prior year. Because some of the change in backlog can be attributed to a change in the ordering patterns of the Company’s Customers and/or the impact of foreign exchange translation rates, it may not necessarily correspond to future sales.

Fiscal 2014 Compared to Fiscal 2013

Engine Products Segment The Engine Products segment sells to OEMs in the construction, mining, agriculture, aerospace, defense, and truck markets, and to independent distributors, OEM dealer networks, private label accounts, and large equipment fleets. Products include air filtration systems, exhaust and emissions systems, liquid filtration systems including hydraulics, fuel and lube, and replacement filters.

Sales for the Engine Products segment were $1,584.0 million, an increase of 5.3 percent from $1,504.2 million. Fiscal 2014 Engine Products sales increased by 11.6 percent in Europe, 5.3 percent in the Americas and decreased 0.5 percent in Asia, compared to Fiscal 2013. The impact of foreign currency decreased total sales by $13.7 million, or 0.9 percent.

Worldwide sales of Off-Road Products were $342.2 million, a decrease of 4.6 percent from $358.8 million in Fiscal 2013. Sales declined 13.6 percent in Asia and 6.4 percent in the Americas, partially offset by growth of 2.7 percent in Europe. The sales decreases were driven by continued weakness in mining equipment markets and a decline in the agricultural equipment market, driven by anticipated lower farm cash receipts in key grain producing regions moderating agricultural sales. These decreases were partially offset by an improving construction equipment market, particularly in North America, and new program wins in Europe.

Worldwide sales of On-Road Products were $130.0 million, an increase of 1.2 percent from $128.4 million in Fiscal 2013. Sales increased 37.5 percent in Europe, partially offset by sales decreases of 4.2 percent in the Americas and 2.7 percent in Asia. The increase in Europe was due primarily to growth after the Euro VI diesel emissions regulations went into effect January 1, 2014. Sales decreased in the Americas primarily due to lower emissions sales in that region for an OEM program the Company no longer supplies, totaling $6.3 million.

Worldwide sales of Aftermarket Products were $1,012.2 million, an increase of 10.9 percent from $912.7 million in Fiscal 2013. Sales increased 14.8 percent in Europe and 6.6 percent in Asia. The overall sales increases were primarily driven by increases in utilization rates of equipment fleets, increased sales of the Company’s proprietary replacement filters, and expansion of the Company’s product portfolio and distribution capabilities.

Worldwide sales of Aerospace and Defense Products were $99.6 million, a decrease of 4.4 percent from $104.2 million in Fiscal 2013. Sales of Aerospace and Defense Products decreased 10.2 percent in the Americas, partially offset by a sales increase of 16.6 percent in Europe. The sales decrease was due to the continued slowdown in U.S. military ground vehicle spending, which continued in Fiscal 2015, partially offset by higher helicopter air filter sales, which increased $2.9 million over Fiscal 2013.

Industrial Products Segment The Industrial Products segment sells to various industrial distributors, dealers, and end-users, OEM Customers of gas-fired turbines, and OEMs and end-users requiring clean air. Products include dust, fume, and mist collectors, compressed air purification systems, air filtration systems for gas turbines and compressors, PTFE membrane-based products, and specialized air and gas filtration systems for various applications including computer hard disk drives and other electronic equipment.

Sales for the Industrial Products segment were $889.4 million, a decrease of 4.6 percent from $932.8 million in Fiscal 2013. This result was driven by 32.7 percent sales decline in Gas Turbine Products, partially offset by sales increases in Special Applications Products and Industrial Filtration Solutions Products of 5.4 percent and 4.5 percent, respectively. Industrial Products sales decreased by 9.8 percent in Asia and 4.9 percent in the Americas, and grew by 2.0 percent in Europe compared to Fiscal 2013. The impact of foreign currency exchange rates decreased total sales by $2.3 million, or 0.3 percent.

Worldwide sales of Industrial Filtration Solutions Products were $553.4 million, a 4.5 percent increase from $529.8 million in the prior year. Sales increased 9.4 percent, 7.9 percent, and 1.7 percent in Asia, Europe, and the Americas, respectively. Strong replacement air filter sales, due to improved global manufacturing activity, were partially offset by continued soft new dust collector equipment sales, due to the continued weak global capital spending environment, particularly in the Americas.

Worldwide sales of Gas Turbine Products were $156.9 million, a decrease of 32.7 percent from $232.9 million in Fiscal 2013. Sales of Gas Turbine Products systems were down for the year, primarily due to fewer shipments of large systems used in power generation compared to Fiscal 2013. There was a large increase in the Company’s gas turbine shipments in Fiscal 2013, and the overall industry is now absorbing that new electrical generation capacity.

Worldwide sales of Special Applications Products were $179.2 million, a 5.4 percent increase from $170.1 million in Fiscal 2013. Sales increased 10.6 percent and 5.9 percent in Europe and Asia, respectively, from Fiscal 2013, partially offset by a sales decrease in the Americas of 1.5 percent. The sales increases were driven by a worldwide increase in demand for the Company’s disk drive, semiconductor, and venting products, partially offset by weakness in industrial end-markets impacting the Company’s membrane product sales.

Consolidated Results The Company reported net earnings for Fiscal 2014 of $260.2 million compared to $247.4 million in Fiscal 2013, an increase of 5.2 percent. Diluted net earnings per share were $1.76, up 7.3 percent from $1.64 in the prior year. The Company’s operating income of $355.7 million increased 3.6 percent from Fiscal 2013 operating income of $343.3 million.

The table below shows the percentage of total operating income contributed by each segment for each of the last three fiscal years. Corporate and Unallocated includes corporate earnings and expenses determined to be non-allocable to the segments, such as interest income and interest expense:

International operating income, prior to corporate expense allocations, totaled 79.7 percent of consolidated operating income in Fiscal 2014 as compared to 74.0 percent in Fiscal 2013. Total international operating income increased 11.6 percent from Fiscal 2013. The table below shows the percentage of total operating income contributed by each major geographic region for each of the last three fiscal years:

Gross margin for Fiscal 2014 was 35.5 percent, or a 0.7 percent increase from 34.8 percent in Fiscal 2013. The increase in gross margin is primarily attributable to the positive mix impacts from the reduction in shipments of large Gas Turbine projects, and a higher percentage of replacement filter sales. Overall, product mix had a positive 50 basis points impact on gross margin. In addition, the Company’s ongoing Continuous Improvement cost reduction initiatives, improved gross margin by 60 basis points. Offsetting these benefits was a 40 basis points reduction in margin from higher engineering costs and lower fixed cost absorption. Within gross profit, the Company incurred $1.7 million in restructuring charges related to workforce reductions compared to $1.6 million in Fiscal 2013.

The principal raw materials that the Company uses are steel, filter media, and petroleum-based products including plastics, rubber, and chemicals. Purchased raw materials represents approximately 60 to 65 percent of the Company’s cost of goods sold. Of that amount, steel, including fabricated parts, represents approximately 25 percent. Filter media represents approximately 15 to 20 percent and the remainder is primarily made up of petroleum-based products and other components. The cost the Company paid for steel during Fiscal 2014, varied by grade, but in aggregate, it slightly increased during the fiscal year. The Company’s cost of filter media also varies by type and slightly decreased during the fiscal year. The cost of petroleum-based products slightly decreased during the fiscal year. The Company anticipated a moderately unfavorable impact from commodity prices in Fiscal 2015, as compared to Fiscal 2014, specifically for steel and petroleum-based products, based on recent market information. The Company strives to recover or offset material cost increases through selective price increases to its Customers and through the Company’s Continuous Improvement initiatives, which include material substitutions, process improvements, and product redesigns.

Operating expenses for Fiscal 2014 were $522.1 million or 21.1 percent of sales, as compared to $503.8 million or 20.7 percent in Fiscal 2013. The increase in operating expenses as a percent of sales was primarily due to higher incentive compensation expenses, the incremental expenses related to the Company’s Global ERP Project, and increased travel expenses, which contributed 90 basis points in total. These increases were partially offset by improved fixed cost leverage and lower warranty expenses, which reduced the Company’s operating expenses as percent of sales by 50 basis points. Restructuring expenses included in operating expenses were $0.4 million for the year, which were employee severance costs related to a reduction in workforce.

Interest expense of $10.2 million decrease $0.7 million from $10.9 million in the prior year. Other income, net totaled $15.2 million in Fiscal 2014, down from $15.8 million in Fiscal 2013. The decrease of $0.6 million in other income was driven by $0.9 million of restructuring expenses related to the sale of a facility in Germany. In addition, Fiscal 2013 included the impact of a favorable insurance recovery. These decreases were partially offset by an increase in foreign exchange gains of $1.5 million and an increase of $1.4 million in income generated from the Company’s joint venture with Caterpillar.

The effective tax rate for Fiscal 2014 was 27.9 percent compared to 29.0 percent in Fiscal 2013. The decrease in the effective tax rate is primarily due to the favorable settlement of a tax audit, the remeasurement of certain deferred tax assets, and a favorable shift in the mix of earnings between tax jurisdictions. This was partially offset by tax costs associated with certain foreign dividend distributions and the expiration of the Research and Experimentation Credit in the U.S. in the current year.

Total backlog at July 31, 2014, was $748.2 million, up 4.5 percent from the same period in Fiscal 2013. Backlog is one of many indicators of business conditions in the Company’s markets. However, it is not always indicative of future results for a number of reasons, including short lead times in the Company’s replacement parts businesses and the timing of the receipt of orders in many of the Company’s Engine OEM and Industrial markets. In the Engine Products segment, total open order backlog decreased 1.1 percent from Fiscal 2013. In the Industrial Products segment, total open order backlog increased 18.4 percent from Fiscal 2013. Because some of the change in backlog can be attributed to a change in the ordering patterns of the Company’s Customers and the impact of foreign exchange translation rates, it may not necessarily correspond to future sales.

Liquidity and Capital Resources

Financial Condition At July 31, 2015, the Company’s capital structure was comprised of $189.2 million of current debt, $389.2 million of long-term debt, and $778.7 million of shareholders’ equity. The Company had cash and cash equivalents of $189.9 million and short-term investments of $27.5 million at July 31, 2015. The ratio of long-term debt to total capital was 33.3 percent and 19.6 percent at July 31, 2015 and 2014, respectively.

Total debt outstanding increased $147.6 million during the year to $578.4 million outstanding at July 31, 2015, as a result of increases in short-term and long-term borrowings, offset by a decrease in current maturities of long-term debt. Short-term borrowings outstanding at the end of the year increased $2.0 million driven by the Company drawing $160.0 million on the Company’s multi-currency revolving credit facility.

The following table summarizes the Company’s cash obligations as of July 31, 2015, for the years indicated (thousands of dollars):

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On July 31, 2015, the Company had a contingent liability for standard letters of credit totaling $7.8 million that have been issued and are outstanding. The letters of credit guarantee payment to third parties in the event the Company is in breach of insurance contract terms detailed in each letter of credit. As of July 31, 2015, there were no amounts drawn upon these letters of credit.

On October 28, 2014, the Company entered into a First Amendment (Amendment) to its five-year, multi-currency revolving credit facility with a group of banks under which the Company may borrow up to $250.0 million. The Amendment increased the borrowing availability up to $400.0 million. The credit facility provides that loans may be made under a selection of currencies and rate formulas including Base Rate Loans or LIBOR Rate Loans. The interest rate on each advance is based on certain market interest rates and leverage ratios. Facility fees and other fees on the entire loan commitment are payable over the duration of this facility. As of July 31, 2015, there was $160.0 million borrowed under this facility. The multi-currency revolving facility contains debt covenants specifically related to maintaining a certain interest coverage ratio, and a certain leverage ratio as well as other covenants that, under certain circumstances, can restrict the Company’s ability to incur additional indebtedness, make investments and other restricted payments, create liens, and sell assets. As of July 31, 2015, the Company was in compliance with all such covenants. Due to an investigation into revenue recognition in the Company’s Gas Turbine Systems business, the Company was unable to provide audited financial statements to the group of banks who are lenders in the credit facility in the 90 day time period required. On October 28, 2015, the Company obtained waivers for the covenant to provide audited statements within 90 days of year-end so long as they are provided by December 28, 2015. Upon providing the audited financial statements to the group of banks prior to December 28, 2015, the Company expects to remain in compliance with the above mentioned covenants.

On April 16, 2015, the Company entered into a First Supplement to Note Purchase Agreement (First Supplement), dated April 16, 2015, with a group of instructional investors, which supplements a Note Purchase Agreement, dated March 27, 2014. Pursuant to the First Supplement, the Company issued $25.0 million of senior unsecured notes due April 16, 2025, and $125.0 million of senior unsecured notes due June 17, 2030. The debt was issued at face value and bears interest payable semi-annually at an annual rate of interest of 2.93 percent and 3.18 percent, respectively. The proceeds from the notes were primarily used to refinance existing debt, and were also used for general corporate purposes. The notes contain debt covenants specifically related to maintaining a certain leverage ratio as well as other covenants that, under certain circumstances, can restrict the Company’s ability to incur additional indebtedness, make investments and other restricted payments, create liens, and sell assets. As of July 31, 2015, the Company was in compliance with all such covenants.

The Company has two uncommitted credit facilities in the U.S., which provide unsecured borrowings for general corporate purposes. At July 31, 2015 and 2014, there was $49.7 million and $45.7 million available for use, respectively, under these two facilities. There was $15.3 million outstanding at July 31, 2015 and $4.3 million outstanding at July 31, 2014. The weighted average interest rate on the short-term borrowings outstanding at July 31, 2015, was 1.00 percent.

The Company has a €100.0 million, or $109.9 million, program for issuing treasury notes for raising short, medium, and long-term financing for its European operations. There were no outstanding amounts on this program at July 31, 2015 or 2014. Additionally, the Company’s European operations have lines of credit with an available limit of €34.0 million or $37.4 million. There was €9.5 million, or $10.4 million, outstanding as of July 31, 2015, and there was no amount outstanding on these lines of credit as of July 31, 2014. The weighted average interest rate on the short-term borrowings outstanding at July 31, 2015, was 0.83 percent.

Other international subsidiaries may borrow under various credit facilities. There was $1.6 million outstanding under these credit facilities as of July 31, 2015, and $1.0 million outstanding as of July 31, 2014. At July 31, 2015 and 2014, there was $47.2 million and $57.5 million available for use, respectively, under these facilities. The weighted average interest rate on these short-term borrowings outstanding at July 31, 2015, and July 31, 2014, was 0.41 percent and 0.75 percent, respectively.

The amount of unused lines of credit as of July 31, 2015, was approximately $474.8 million. Long-term debt of $389.2 million as of July 31, 2015, increased from $243.7 million at July 31, 2014. Long-term debt represented 33.3 percent of total long-term capital, defined as long-term debt plus total shareholders’ equity, compared to 19.6 percent at July 31, 2014.

During Fiscal 2015, credit in the global credit markets was accessible and market interest rates remained low. The Company believes that its current financial resources, together with cash generated by operations, are sufficient to continue financing its operations for the next twelve months. There can be no assurance, however, that the cost or availability of future borrowings will not be impacted by future capital market disruptions.

Certain note agreements contain debt covenants related to working capital levels and limitations on indebtedness. As of July 31, 2015, the Company was in compliance with all such covenants.

Shareholders’ equity decreased by $223.8 million from $1,002.5 million at July 31, 2014, to $778.7 million at July 31, 2015. The decrease was primarily due to the repurchase of treasury stock for $256.3 million, foreign currency translation of $119.1 million, and $90.9 million of dividends declared. These decreases were partially offset by current year earnings of $208.1 million, $11.4 million of stock options exercised, $7.7 million in tax reductions related to employee plans, and $9.5 million of the equity impact of stock option expense.

The Company’s inventory balance was $265.0 million as of July 31, 2015, compared to $253.4 million as of July 31, 2014. Excluding the impact of foreign exchange fluctuations, inventories increased $36.1 million. Current year inventory levels increased over the prior year as the Company increased its distribution capacity, added the acquisitions of Northern Technical and IFIL USA, along with additional parts to support its independent Aftermarket Customers. The Company’s accounts receivable balance was $460.0 million as of July 31, 2015, compared to $474.2 million as of July 31, 2014. Excluding the impact of foreign exchange fluctuations, accounts receivable increased $23.3 million driven primarily by the large number of GTS projects sales in the fourth quarter Fiscal 2015 compared to the prior year.

Cash Flows During Fiscal 2015, $212.8 million of cash was generated from operating activities, compared with $317.8 million in Fiscal 2014. The decrease in cash generated from operating activities of $105.0 million is primarily attributable to a decrease in net income of $52.1 million, a decrease in accrued compensation along with a decrease in accounts payable, partially offset by a smaller increase in accounts receivable compared to the prior year. Operating cash flows, cash on hand, and short-term debt facilities were used to support the acquisitions of Northern Technical and IFIL for $105.6 million, $93.6 million of net capital expenditures, $256.3 million of stock repurchases, and $91.2 million of dividend payments. Cash and cash equivalents decreased $106.5 million during Fiscal 2015.

At the end of the year, the Company held $189.9 million in cash and cash equivalents, down from $296.4 million at July 31, 2014. Short-term investments were $27.5 million compared to $127.2 million at July 31, 2014. Short-term investments may change year to year based on maturity dates of existing investments, the Company’s outlook for cash needs, and available access to other sources of liquidity. The amount of unused lines of credit as of July 31, 2015, was approximately $474.8 million. Current maturities of long-term debt of $1.8 million at year-end increased slightly from $1.7 million at July 31, 2014. Long-term debt of $389.2 million at July 31, 2015, increased from $243.7 million at July 31, 2014, due to the issuance of $150.0 million of senior unsecured notes during Fiscal 2015. Long-term debt represented 33.3 percent of total long-term capital, defined as long-term debt plus total shareholders’ equity, compared to 19.6 percent at July 31, 2014.

The majority of the Company’s cash and cash equivalents are held by its foreign subsidiaries as over half of the Company’s earnings occur outside the U.S. Most of these funds are considered permanently reinvested outside the U.S., and will only be repatriated when it is tax effective to do so, as the cash generated from U.S. operations plus the Company’s short-term debt facilities are anticipated to be sufficient for our U.S operation’s cash needs. If additional cash was required for the Company’s operations in the U.S., it may be subject to additional U.S. taxes if funds were repatriated from certain foreign subsidiaries.

Net capital expenditures for property, plant, and equipment totaled $93.6 million in Fiscal 2015, $96.8 million in Fiscal 2014, and $94.3 million in Fiscal 2013. Fiscal 2015 capital expenditures primarily related to the Company’s Global ERP Project, plant capacity additions, information and lab technology equipment, productivity-enhancing investments at manufacturing sites, and tooling to manufacture new products.

Capital spending in Fiscal 2016 is estimated to be between $80 and $90 million. The Company’s capital spending in Fiscal 2016 will be approximately 25 percent for technology initiatives, including the Global ERP Project and research and development labs, 30 percent for tooling for new products, 30 percent will be in the form of automation or cost reduction projects related to the Company’s ongoing Continuous Improvement initiatives, and 15 percent related to capacity expansion. It is anticipated that Fiscal 2016 capital expenditures will be financed primarily by cash on hand, cash generated from operations, and lines of credit.

The Company expects that cash generated by operating activities will be between $300 and $350 million in Fiscal 2016. At July 31, 2015, the Company had cash and cash equivalents of $189.9 million and short-term investments of $27.5 million. The Company also had $281.9 million available under existing credit facilities in the U.S., €134.0 million, or $147.3 million, available under existing credit facilities in Europe, and $47.2 million available under various credit facilities and currencies in Asia and the rest of the world. The Company believes that the combination of existing cash, available credit under existing credit facilities, and the expected cash generated by operating activities will be adequate to meet cash requirements for Fiscal 2016, including debt repayment, issuance of anticipated dividends, possible share repurchase activity, potential acquisitions, and capital expenditures.

Dividends The Company’s dividend policy is to maintain a payout ratio, which allows dividends to increase with the long-term growth of earnings per share. The Company’s dividend payout ratio target is 35 percent to 45 percent of the prior three years average earnings per share. Including the Company’s declaration on July 31, 2015, of a $0.17 per share dividend to be paid on September 3, 2015, the dividend payout ratio was 41.7 percent of the prior three years average diluted earnings per share on July 31, 2015.

Share Repurchase Plan The Board of Directors authorized the repurchase of 14.0 million shares of common stock under the stock repurchase plan dated May 29, 2015. In Fiscal 2015, the Company repurchased 6.7 million shares of common stock for $256.3 million, or 4.8 percent of its diluted outstanding shares, at an average price of $38.39 per share. Of the 6.7 million shares repurchased in Fiscal 2015, 5.7 million shares were repurchased under the stock repurchase plan dated September 27, 2013, which authorized the repurchase of 15.0 million shares, and 1.0 million shares were purchased under the current stock repurchase plan. Under prior stock repurchase plans, the Company repurchased 6.8 million shares for $279.4 million in Fiscal 2014 and 3.0 million shares for $102.6 million in Fiscal 2013. As of July 31, 2015, the Company had remaining authorization to repurchase 13.0 million shares pursuant to the current authorization.

Off-Balance Sheet Arrangements The Company does not have any off-balance sheet arrangements, with the exception of the guarantee of 50 percent of certain debt of its joint venture with Caterpillar, Advanced Filtration Systems Inc. (AFSI), as further discussed in Note L of the Company’s Notes to consolidated financial statements. As of July 31, 2015, the joint venture had $26.1 million of outstanding debt. The Company does not believe that this guarantee will have a current or future effect on its financial condition, results of operations, liquidity, or capital resources.

Standards adopted and note yet adopted by the Company are referenced in Note A Summary of Significant Accounting Policies.

Market Risk

The Company’s market risk includes the potential loss arising from adverse changes in foreign currency exchange rates and interest rates. The Company manages foreign currency market risk from time to time through the use of a variety of financial and derivative instruments. The Company does not enter into any of these instruments for trading purposes to generate revenue. Rather, the Company’s objective in managing these risks is to reduce fluctuations in earnings and cash flows associated with changes in foreign currency exchange rates. The Company uses forward exchange contracts and other hedging activities to hedge the U.S. dollar value resulting from existing recognized foreign currency denominated asset and liability balances, and also for anticipated foreign currency transactions. The Company also naturally hedges foreign currency through its production in the countries in which it sells its products. The Company’s market risk on interest rates is the potential decrease in fair value of long-term debt resulting from a potential increase in interest rates. See further discussion of these market risks below.

Foreign Currency During Fiscal 2015, the U.S. dollar was generally stronger than in Fiscal 2014 compared to many of the currencies of the foreign countries in which the Company operates. The overall strength of the dollar had a negative impact on the Company’s international net sales results because the foreign denominated revenues translated into fewer U.S. dollars.

It is not possible to determine the exact impact of foreign currency translation changes. However, the direct effect on reported net sales and net earnings can be estimated. For the year ended July 31, 2015, the impact of foreign currency translation resulted in an overall decrease in reported net sales of $134.8 million and a decrease in reported net earnings of $14.3 million. Foreign currency translation had a negative impact in many regions around the world. The stronger U.S. dollar relative to the Japanese yen resulted in a total decrease of $16.3 million in reported net sales. The stronger U.S. dollar relative to the Australian Dollar, the South African rand, the Brazilian real, and the Indian rupee had a negative impact on foreign currency translation with a decrease in reported net sales of $7.9 million, $4.9 million, $7.0 million, and $0.4 million, respectively. In Europe, the stronger U.S. dollar relative to the euro and British pound resulted in a total decrease of $94.1 million in reported net sales.

The Company maintains significant assets and operations in Europe, Asia-Pacific, Latin America, and South Africa, resulting in exposure to foreign currency gains and losses. A portion of the Company’s foreign currency exposure is naturally hedged by incurring liabilities, including bank debt, denominated in the local currency in which the Company’s foreign subsidiaries are located.

The foreign subsidiaries of the Company generally purchase the majority of their input costs and then sell to many of their Customers in the same local currency.

The Company may be exposed to cost increases relative to local currencies in the markets to which it sells. To mitigate such adverse trends, the Company, from time to time, enters into forward exchange contracts and other hedging activities. Additionally, foreign currency positions are partially offsetting and are netted against one another to reduce exposure.

Some products made by the Company in the U.S. are sold internationally. As a result, sales of such products are affected by the value of the U.S. dollar relative to other currencies. Any long-term strengthening of the U.S. dollar could depress these sales. Also, competitive conditions in the Company’s markets may limit its ability to increase product pricing in the face of adverse currency movements.

Interest The Company’s exposure to market risks for changes in interest rates relates primarily to its short-term investments, short-term borrowings, and interest rate swap agreements, as well as the potential increase in fair value of long-term debt resulting from a potential decrease in interest rates. The Company has limited earnings or cash flow exposure due to market risks on its long-term debt obligations as a result of the majority of the debt being fixed-rate. However, interest rate changes would affect the fair market value of the debt. As of July 31, 2015, the estimated fair value of long-term debt with fixed interest rates was $383.3 million compared to its carrying value of $375.0 million. The fair value is estimated by discounting the projected cash flows using the rate of which similar amounts of debt could currently be borrowed. As of July 31, 2015, the Company’s financial liabilities with exposure to changes in interest rates consisted mainly of $187.3 million of short-term debt outstanding and ¥ 1.65 billion, or $13.3 million, of variable rate long-term debt. Assuming a hypothetical increase of one-half percent in short-term interest rates, with all other variables remaining constant, interest expense would have increased $1.5 million and interest income would have increased $1.3 million in Fiscal 2015.

Pensions The Company is exposed to market return fluctuations on its qualified defined benefit pension plans. In Fiscal 2015, the Company reduced its long-term rate of return from 7.14 percent to 6.99 percent on its U.S. plans and increased its rate from 5.48 percent to 5.41 percent on its non-U.S. plans, to reflect its future expectation for returns. Consistent with published bond indices, the Company held its discount rate flat for the U.S. pension plans at 4.33 percent versus the prior year and decreased the discount rate used for its non-US plans from 4.04 percent to 3.64 percent. The plans were underfunded by $20.2 million at July 31, 2015, since the projected benefit obligation exceeded the fair value of the plan assets.

Critical Accounting Policies

The Company’s consolidated financial statements are prepared in conformity with U.S. GAAP. The preparation of these financial statements requires the use of estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented. Management bases these estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the recorded values of certain assets and liabilities. The Company believes its use of estimates and underlying accounting assumptions adheres to U.S. GAAP and is consistently applied. Valuations based on estimates and underlying accounting assumptions are reviewed for reasonableness on a consistent basis throughout the Company. The Company’s Critical Accounting Policies are those that require more significant judgments and estimates used in the preparation of its consolidated financial statements and that are the most important to aid in fully understanding its financial results are the following:

Revenue recognition Revenue is recognized when both product ownership and the risk of loss have transferred to the Customer, the Company has no remaining obligations, the selling price is fixed and determinable, and collectability is reasonably assured. Although the majority of the Company’s sales agreements contain standard terms and conditions, there are also agreements that contain multiple elements or non-standard terms and conditions. For the Company’s Gas Turbine Systems (GTS) sales, which typically consists of multiple shipments of components that will comprise the entire GTS project, it must carefully monitor the transfer of title related to each portion of a system sale and may defer recognition of revenue until all terms specified in the contract are met. The Company records estimated discounts and rebates as a reduction of sales in the same period revenue is recognized.

Goodwill and other intangible assets Goodwill is assessed for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company performs impairment assessments for its reporting units and uses a discounted cash flow model based on management’s judgments and assumptions to determine the estimated fair value. An impairment loss generally would be recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit. The Company performed an impairment assessment during the third quarter of Fiscal 2015 to satisfy its annual impairment assessment requirement. This impairment assessment indicated that the estimated fair values of the reporting units to which goodwill is assigned, continued to significantly exceed the corresponding carrying values of the respective reporting units, including recorded goodwill and, as such, no impairment existed at that time. Other intangible assets with definite lives continue to be amortized over their estimated useful lives. Definite lived intangible assets are subject to impairment assessments as triggering events occur which could indicate that the asset might be impaired. A considerable amount of management judgment and assumptions are required in performing the impairment assessments, principally in determining the fair value of each reporting unit. The important assumptions utilized in these assessments include the (i) discount rate; (ii) projected revenue, gross margin, operating income; and (iii) terminal value. While the Company believes its judgments and assumptions are reasonable, different assumptions could change the estimated fair values and, therefore, impairment charges could be required.

Income taxes As part of the process of preparing the Company’s Consolidated Financial Statements, management is required to estimate income taxes in each of the jurisdictions in which the Company operates. This process involves estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and book accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the Company’s Consolidated Balance Sheet. These assets and liabilities are evaluated by using estimates of future taxable income streams and the impact of tax planning strategies. Reserves are also estimated for uncertain tax positions that are currently unresolved. The Company routinely monitors the potential impact of such situations and believes that it was properly reserved at July 31, 2015. As of July 31, 2015, the liability for unrecognized tax benefits, accrued interest, and penalties was $20.0 million.

Defined Benefit Pension Plans The Company incurs expenses relating to employee benefits such as non-contributory defined benefit pension plans. In accounting for these defined benefit pension plans, management must make a variety of assumptions and estimates including mortality rates, discount rates, overall Company compensation increases, expected return on plan assets, and health care cost trend rates. The Company considers historical data as well as current facts and circumstances and uses a third-party specialist to assist management in determining these estimates.

To develop the assumption regarding the expected long-term rate of return on assets for its U.S. pension plans, the Company considered the historical returns and the future expectations for returns for each asset class, as well as the target asset allocation of the pension portfolio. This resulted in the selection of 6.99 percent long-term rate of return on assets as of July 31, 2015, and was used to develop the Fiscal 2016 expense for the Company’s U.S. pension plans. The discount rate used by the Company to value the pension obligation for its U.S. plans remained constant at 4.33 percent. The Company also selected a long-term rate of return on assets for its non-U.S. plans of 5.47 percent and decreased the discount rate used for its non-U.S. plans from 3.64 percent to 3.14 percent. The expected long-term rate of return on assets assumption for the plans outside the U.S. reflects the investment allocation and expected total portfolio returns specific to each plan and country. The rates discussed above are weighted average rates as the Company has multiple plans both in the U.S. and internationally. A one percent change in the expected long-term rate of return on plan assets would have changed the Fiscal 2015 annual pension expense by approximately $4.5 million.

Reflecting the relatively long-term nature of the plans’ obligations, approximately 65 percent of the plans assets are invested in equity securities, 30 percent in fixed income, and 5 percent in real assets (investments into funds containing commodities and real estate). In Fiscal 2016, the Company plans to begin investing in liability-driven investment funds, which will change the asset allocations.

The Company’s objective in selecting a discount rate for its pension plans is to select the best estimate of the rate at which the benefit obligations could be effectively settled on the measurement date, taking into account the nature and duration of the benefit obligations of the plan. In making this best estimate, the Company looks at the rates of return on high-quality fixed-income investments currently available and expected to be available during the period to maturity of the benefits. This process includes assessing the universe of bonds available on the measurement date with a quality rating of Aa or better. Similar appropriate benchmarks are used to determine the discount rate for the non-U.S. plans.

In Fiscal 2015, the Company’s global pension expense was $21.6 million and included a settlement charge of $3.9 million. The Company expects that global pension expenses to decrease approximately $4.2 million in Fiscal 2016 as compared to Fiscal 2015, which is driven primarily by the settlement charges of $3.9 million incurred during Fiscal 2015. While changes to the Company’s pension assumptions would not be expected to impact pension expense by a material amount, such changes could significantly impact the Company’s pension liability.

Effective August 1, 2013, the salaried plan in the U.S. was frozen to any Employees hired on or after August 1, 2013. These Employees are eligible for a 3.0 percent annual Company retirement contribution in addition to the Company’s 401(k) match. Effective August 1, 2016, Employees hired prior to August 1, 2013, will no longer continue to accrue Company contribution credits under the plan but will be eligible for a 3.0 percent annual Company retirement contribution in addition to the Company’s 401(k) match.

For new accounting standards not yet adopted refer to Note A Summary of Significant Accounting Policies.

Safe Harbor Statement under the Securities Reform Act of 1995

The Company, through its management, may make forward-looking statements reflecting the Company’s current views with respect to future events and financial performance. These forward-looking statements, which may be included in reports filed under the Securities Exchange Act of 1934, as amended (the Exchange Act), in press releases and in other documents and materials as well as in written or oral statements made by or on behalf of the Company, are subject to certain risks and uncertainties, including those discussed in Item 1A of this Form 10-K, which could cause actual results to differ materially from historical results or those anticipated. The words or phrases “will likely result,” “are expected to,” “will continue,” “will allow,” “estimate,” “project,” “believe,” “expect,” “anticipate,” “forecast,” and similar expressions are intended to identify forward-looking statements within the meaning of Section 21e of the Exchange Act and Section 27A of the Securities Act of 1933, as amended, as enacted by the Private Securities Litigation Reform Act of 1995 (PSLRA). In particular, the Company desires to take advantage of the protections of the PSLRA in connection with the forward-looking statements made in this Annual Report on Form 10-K, including those contained in the “Outlook” section of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. All statements other than statements of historical fact are forward-looking statements. These statements do not guarantee future performance.

Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date such statements are made. In addition, the Company wishes to advise readers that the factors listed in Item 1A of this Form 10-K, as well as other factors, could affect the Company’s performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed. These factors include, but are not limited to, world economic factors and the ongoing economic uncertainty, currency fluctuations, commodity prices, political factors, the Company’s international operations, the continued implementation of our global ERP information technology system and other new information technology systems, information security and data breaches, the reduced demand for hard disk drive products with the increased use of flash memory, highly competitive markets, governmental laws and regulations, including the impact of the various economic stimulus and financial reform measures, potential global events resulting in market instability including financial bailouts and defaults of sovereign nations, military and terrorist activities, including political conditions where we do business, health outbreaks, natural disasters, and other factors included in Item 1A of this Report on Form 10-K. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Market risk disclosure appears in Management’s Discussion and Analysis on page 21 under “Market Risk.”

Item 8. Financial Statements and Supplementary Data

Management’s Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Management conducted an evaluation of the effectiveness of internal control over financial reporting as of July 31, 2015 based on the framework in Internal Control – Integrated Framework – version 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management concluded that the Company’s internal control over financial reporting was not effective as of July 31, 2015 due to the material weakness described below. The Company’s independent registered public accounting firm, PricewaterhouseCoopers LLP, has audited the effectiveness of the Company’s internal control over financial reporting as of July 31, 2015, as stated in its report which follows in Item 8 of this Form 10-K.

Management has defined the material weakness that existed at July 31, 2015 as follows:

The Company did not maintain effective controls over recognition of revenue in its European Gas Turbine Products business. Specifically, transactions were not recorded in the proper period because the design of the controls did not contemplate effective review of delivery terms associated with Gas Turbine Products business projects revenue and the fulfillment of certain contractual terms by the Company was not sufficiently verified by reference to independent third party documentation.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

The financial statement errors that arose because of the identified material weakness resulted in the revision of previously reported interim financial statements for the quarters ended January 31, 2015 and April 30, 2015. Management concludes that the material weakness described above existed as of July 31, 2015 and could result in a material misstatement to the annual or interim financial statements that would not be prevented or detected on a timely basis.

Remediation Plan

Management is engaged in the implementation of remedial actions to address the material weakness identified above. Specifically, management is in the process of implementing changes, including enhancement of existing controls, to ensure European Gas Turbine Products revenue is recognized in the appropriate period, and taking multiple disciplinary actions, including termination of certain employees. In addition, a training program will be implemented to provide clarity on the Company’s policies and procedures for proper revenue recognition. Improvements to the control activities associated with our European Gas Turbine Products business projects revenue will include:

We are committed to maintaining a strong internal control environment and believe that these actions will be effective in remediating the material weakness described above. While we believe that enhancing existing controls remediate the identified material weakness, the material weakness in internal control will not be considered fully addressed until the new procedures have been in place for a sufficient period of time and tested to allow management to conclude that the controls are effective.

Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors of Donaldson Company, Inc.

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, comprehensive income, changes in shareholders’ equity and cash flows present fairly, in all material respects, the financial position of Donaldson Company, Inc. and its subsidiaries at July 31, 2015 and July 31, 2014, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 2015 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of July 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) because a material weakness in internal control over financial reporting related to recognition of revenue in its European Gas Turbine Products business existed as of that date. Specifically, transactions were not recorded in the proper period because the design of the controls did not contemplate effective review of delivery terms associated with Gas Turbine Products business projects revenue and the fulfillment of certain contractual terms by the Company was not sufficiently verified by reference to independent third party documentation.  A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness referred to above is described in the accompanying Management’s Report on Internal Control over Financial Reporting. We considered this material weakness in determining the nature, timing, and extent of audit tests applied in our audit of the July 31, 2015 consolidated financial statements and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements. The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in management’s report referred to above. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP
Minneapolis, Minnesota
November 09, 2015

Consolidated Statements of Earnings
Donaldson Company, Inc. and Subsidiaries

The accompanying notes are an integral part of these Consolidated Financial Statements.

Consolidated Statements of Comprehensive Income
Donaldson Company, Inc. and Subsidiaries

The accompanying notes are an integral part of these Consolidated Financial Statements.

Consolidated Balance Sheets
Donaldson Company, Inc. and Subsidiaries

The accompanying notes are an integral part of these Consolidated Financial Statements.

Consolidated Statements of Cash Flows
Donaldson Company, Inc. and Subsidiaries

The accompanying notes are an integral part of these Consolidated Financial Statements.

Consolidated Statements of Changes in Shareholders’ Equity
Donaldson Company, Inc. and Subsidiaries

The accompanying notes are an integral part of these Consolidated Financial Statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Donaldson Company, Inc. and Subsidiaries

NOTE A Summary of Significant Accounting Policies

Description of Business Donaldson Company, Inc. (Donaldson or the Company), is a worldwide manufacturer of filtration systems and replacement parts. The Company’s core strengths are leading filtration technology, strong Customer relationships, and its global presence. Products are manufactured at 41 plants around the world and through three joint ventures. Products are sold to original equipment manufacturers (OEMs), distributors, dealers, and directly to end-users.

Principles of Consolidation The Consolidated Financial Statements include the accounts of Donaldson Company, Inc., all majority-owned subsidiaries, along with the majority stake in IFIL USA. All intercompany accounts and transactions have been eliminated. The Company’s three joint ventures that are not majority-owned are accounted for under the equity method.

Use of Estimates The preparation of Financial Statements in conformity with generally accepted accounting principles in the United States of America (U.S.) (U.S. GAAP) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Foreign Currency Translation For substantially all foreign operations, local currencies are considered the functional currency. Assets and liabilities of non-U.S. dollar functional currency entities are translated to U.S. dollars at year-end exchange rates and the resulting gains and losses arising from the translation of net assets located outside the U.S. are recorded as a cumulative translation adjustment, a component of Accumulated other comprehensive income (loss) (AOCI) in the Consolidated Balance Sheets. Elements of the Consolidated Statements of Earnings are translated at average exchange rates in effect during the year. Realized and unrealized foreign currency transaction gains and losses are included in Other income, net in the Consolidated Statements of Earnings. Foreign currency transaction gains of $2.1 million, $1.7 million, and $0.2 million are included in Other income, net in the Consolidated Statements of Earnings in Fiscal 2015, 2014, and 2013, respectively.

Cash Equivalents The Company considers all highly liquid temporary investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost that approximates market value.

Short-Term Investments As of July 31, 2015 and 2014, the Company’s short-term investments consisted exclusively of time deposits with durations longer than 3 months, but less than 1 year. These investments are carried at cost, which approximates their estimated fair value. Classification of the Company’s investments as current or non-current is dependent upon management’s intended holding period, the investment’s maturity date, and liquidity considerations based on market conditions. If management intends to hold the investments for longer than one year as of the balance sheet date, they are classified as non-current.

Accounts Receivable and Allowance for Doubtful Accounts Trade accounts receivables are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of credit losses in its existing accounts receivable. The Company determines the allowance based on historical write-off experience in the industry, regional economic data, and evaluation of specific Customer accounts for risk of loss. The Company reviews its allowance for doubtful accounts monthly. Past due balances over 90 days and over a specified amount are reviewed individually for collectability. All other balances are reviewed on a pooled basis by type of receivable. Account balances are charged off against the allowance when the Company feels it is probable the receivable will not be recovered. The Company does not have any off-balance-sheet credit exposure related to its Customers.

Inventories Inventories are stated at the lower of cost or market. U.S. inventories are valued using the last-in, first-out (LIFO) method, while the non-U.S. inventories are valued using the first-in, first-out (FIFO) method. Inventories valued at LIFO were approximately 34.2 percent of total inventories at July 31, 2015 and 2014. For inventories valued under the LIFO method, the FIFO cost exceeded the LIFO carrying values by $41.6 million and $37.9 million at July 31, 2015 and 2014, respectively. Results of operations for all periods presented were not materially affected by the liquidation of LIFO inventory. The components of inventory are as follows (thousands of dollars):

Property, Plant, and Equipment Property, plant, and equipment are stated at cost. Additions, improvements, or major renewals are capitalized, while expenditures that do not enhance or extend the asset’s useful life are charged to expense as incurred. Depreciation is computed under the straight-line method. Depreciation expense was $66.9 million in Fiscal 2015, $62.0 million in Fiscal 2014, and $58.8 million in Fiscal 2013. The estimated useful lives of property, plant, and equipment are 10 to 40 years for buildings, including building improvements, and three to ten years for machinery and equipment. The components of property, plant, and equipment are as follows (thousands of dollars):

Internal-Use Software The Company capitalizes direct costs of materials and services used in the development and purchase of internal-use software. Amounts capitalized are amortized on a straight-line basis over a period of five to seven years and are reported as a component of machinery and equipment within property, plant, and equipment.

Goodwill and Other Intangible Assets Goodwill represents the excess of the purchase price over the fair value of net assets acquired in business combinations under the purchase method of accounting. Other intangible assets, consisting primarily of patents, trademarks, and Customer relationships and lists, are recorded at cost and are amortized on a straight-line basis over their estimated useful lives of 3 to 20 years. Goodwill is assessed for impairment annually or if an event occurs or circumstances change that would indicate the carrying amount may be impaired. The impairment assessment for goodwill is done at a reporting unit level. Reporting units are one level below the operating segment level, but can be combined when reporting units within the same operating segment have similar economic characteristics. An impairment loss generally would be recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit.

Recoverability of Long-Lived Assets The Company reviews its long-lived assets, including identifiable intangibles, for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If impairment indicators are present and the estimated future undiscounted cash flows are less than the carrying value of the assets, the carrying value is reduced. The Company recorded an impairment charge of $2.9 million in Fiscal 2015 for a partially completed facility in Xuzhou, China and there were no significant impairment charges recorded in Fiscal 2014, or Fiscal 2013.

Income Taxes The provision for income taxes is computed based on the pre-tax income reported for financial statement purposes. Deferred tax assets and liabilities are recognized for the expected future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets when it is more-likely-than-not that a tax benefit will not be realized.

Earnings Per Share The Company’s basic net earnings per share are computed by dividing net earnings by the weighted average number of outstanding common shares. The Company’s diluted net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares and common equivalent shares relating to stock options and stock incentive plans. Certain outstanding options were excluded from the diluted net earnings per share calculations because their exercise prices were greater than the average market price of the Company’s common stock during those periods. There were 977,824 options, 884,138 options, and 22,619 options excluded from the diluted net earnings per share calculation for the fiscal year ended July 31, 2015, 2014, and 2013, respectively.

The following table presents information necessary to calculate basic and diluted earnings per share:

Treasury Stock Repurchased common stock is stated at cost (determined on an average cost basis) and is presented as a reduction of shareholders’ equity.

Research and Development Research and development costs are charged against earnings in the year incurred. Research and development expenses include basic scientific research and the application of scientific advances to the development of new and improved products and their uses.

Stock-Based Compensation The Company offers stock-based employee compensation plans, which are more fully described in Note I. Stock-based employee compensation cost is recognized using the fair-value based method.

Revenue Recognition Revenue is recognized when both product ownership and the risk of loss have transferred to the Customer, the Company has no remaining obligations, the selling price is fixed and determinable, and collectability is reasonably assured. Although the majority of the Company’s sales agreements contain standard terms and conditions, there are also agreements that contain multiple elements or non-standard terms and conditions. For the Company’s Gas Turbine Systems (GTS) sales, which typically consists of multiple shipments of components that will comprise the entire GTS project, it must carefully monitor the transfer of title related to each portion of a system sale and may defer recognition of revenue until all terms specified in the contract are met. The Company records estimated discounts and rebates as a reduction of sales in the same period revenue is recognized. Shipping and handling costs for Fiscal 2015, 2014, and 2013 totaled $63.2 million, $64.2 million, and $66.2 million, respectively, and are classified as a component of selling, general, and administrative expenses.

Product Warranties The Company provides for estimated warranty costs at the time of sale and accrues for specific items at the time their existence is known and the amounts are determinable. The Company estimates warranty costs using standard quantitative measures based on historical warranty claim experience and evaluation of specific Customer warranty issues. For a warranty reserve reconciliation see Note M.

Derivative Instruments and Hedging Activities The Company recognizes all derivatives on the balance sheet at fair value. Derivatives that are not designated as hedges are adjusted to fair value through income. If the derivative is designated as a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings, or recognized in shareholders’ equity through other comprehensive income until the hedged item is recognized. Gains or losses related to the ineffective portion of any hedge are recognized through earnings in the current period.

New Accounting Standards Recently Adopted In February 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2013-04, Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date (“ASU 2013-04”), which amended guidance related to obligations resulting from joint and several liability arrangements for which the total amount of the obligations is fixed at the reporting date. The guidance was effective for the Company beginning the first quarter of Fiscal 2015. The adoption of ASU 2013-04 did not have a material impact on the Company’s consolidated financial statements. For additional information, refer to Note L.

New Accounting Standards Not Yet Adopted In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), which amended revenue recognition guidance to clarify the principles for recognizing revenue from contracts with Customers. The guidance requires an entity to recognize revenue to depict the transfer of goods or services to Customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. The guidance also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with Customers. Additionally, qualitative and quantitative disclosures are required about Customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This accounting guidance is effective for the Company beginning in the first quarter of Fiscal 2019 using one of two prescribed retrospective methods. Early adoption is permitted. The Company is evaluating the impact that ASU 2014-09 will have on the Company’s consolidated financial statements.

In June 2014, the FASB issued ASU 2014-12, Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could be Achieved after the Requisite Service Period (ASU 2014-12), which amended guidance related to share-based payments where terms of the award provide that a performance target could be achieved after the requisite service period. This guidance is effective for the Company beginning the first quarter of Fiscal 2018. The Company is evaluating the impact that ASU 2014-12 will have on the Company’s consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (ASU 2015-03), which amended guidance requiring the issuance of debt costs related to a recognized debt liability be presented on the balance sheet as a direct deduction from the amount of the debt liability, consistent with debt discounts and premiums. This accounting guidance is effective for the Company beginning in the first quarter of Fiscal 2017, with early adoption permitted. The Company is evaluating the impact that ASU 2015-03 will have on the Company’s consolidated financial statements.

In May 2015, FASB issued ASU 2015-07, Fair Value Measurement (Topic 850): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (ASU 2015-07), which amended guidance requiring a Company to categorize investments for which fair values are measured using the net asset value (NAV) per share practical expedient. ASU 2015-07 also limits the disclosures to investments for which the entity has elected to measure the fair value using the practical expedient. This accounting guidance is effective for the Company beginning in the first quarter of Fiscal 2017, with early adoption permitted. The Company is evaluating the impact that ASU 2015-07 will have on the Company’s consolidated financial statements.

In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (ASU 2015-11), which amended the guidance requiring Company’s not using the last-in, first-out (LIFO) method to measure inventory at the lower of cost and net realizable rather than the lower of cost or market. This accounting guidance is effective for the Company beginning in the first quarter of Fiscal 2017, with early adoption permitted. The Company is evaluating the impact that ASU 2015-11 will have on the Company’s consolidated financial statements.

NOTE B Goodwill and Other Intangible Assets

The Company has allocated goodwill to its Engine Products and Industrial Products segments. During Fiscal 2015 the Company acquired Northern Technical L.L.C. (Northern Technical) as of September 30, 2014, and IFIL USA L.L.C. (IFIL), as of June 30, 2015. There were no acquisitions during Fiscal 2014. There was no disposition activity during Fiscal 2015 or 2014. The Company completed its annual impairment assessments in the third quarters of Fiscal 2015 and 2014. The results of this assessment showed that the estimated fair values of the reporting units to

which goodwill is assigned continued to exceed the corresponding carrying values of the respective reporting units, resulting in no goodwill impairment.

Following is a reconciliation of goodwill for the years ended July 31, 2015 and 2014:

Intangible assets are comprised of patents, trademarks, and Customer relationships and lists. Following is a reconciliation of intangible assets for the years ended July 31, 2015 and 2014:

Net intangible assets consist of patents, trademarks, and trade names of $8.8 million and $11.5 million as of July 31, 2015 and 2014, respectively, and Customer related intangibles of $29.1 million and $24.5 million as of July 31, 2015 and 2014, respectively. As of July 31, 2015, patents, trademarks, and trade names had a weighted average remaining life of 7.0 years and Customer related intangibles had a weighted average remaining life of 9.9 years. Expected amortization expense relating to existing intangible assets is as follows (in thousands):

NOTE C Credit Facilities

On October 28, 2014, the Company entered into a First Amendment (Amendment) to its five-year, multi-currency revolving credit facility with a group of banks under which the Company may borrow up to $250.0 million. The Amendment increased the borrowings availability up to $400.0 million. The agreement provides that loans may be made under a selection of currencies and rate formulas including Base Rate Loans or LIBOR Rate Loans. The interest rate on each advance is based on certain market interest rates and leverage ratios. Facility fees and other fees on the entire loan commitment are payable over the duration of this facility. There was $160.00 million outstanding at July 31, 2015, and $180.0 million outstanding at July 31, 2014. At July 31, 2015 and 2014, $232.2 million and $62.2 million, respectively, were available for further borrowing under such facilities. The amount available for further borrowing reflects a reduction for issued standby letters of credit, as discussed in Note L. The Company’s multi-currency  

revolving facility contains financial covenants specifically related to maintaining a certain interest coverage ratio and a certain leverage ratio as well as other covenants that, under certain circumstances, can restrict the Company’s ability to incur additional indebtedness, make investments and other restricted payments, create liens, and sell assets. As of July 31, 2015, the Company was in compliance with all such covenants. Due to an investigation into revenue recognition in the Company’s Gas Turbine Systems business, the Company was unable to provide audited financial statements to the group of banks who are lenders in the credit facility in the 90 day time period required. On October 28, 2015, the Company obtained waivers for the covenant to provide audited statements within 90 days of year-end so long as they are provided by December 28, 2015. Upon providing the audited financial statements to the group of banks prior to December 28, 2015, the Company expects to remain in compliance with the above mentioned covenants.

The Company has two uncommitted credit facilities in the U.S., which provide unsecured borrowings for general corporate purposes. At July 31, 2015 and 2014, there was $49.7 million and $45.7 million available for use, respectively, under these two facilities. There was $15.3 million outstanding at July 31, 2015, and $4.3 million outstanding at July 31, 2014. The weighted average interest rate on the short-term borrowings outstanding at July 31, 2015, was 1.00 percent.

The Company has a €100.0 million, or $109.9 million, program for issuing treasury notes for raising short-, medium-, and long-term financing for its European operations. There were no amounts outstanding on this program at July 31, 2015 or 2014. Additionally, the Company’s European operations have lines of credit with an available limit of €34.0 million or $37.4 million. There was €9.5 million or $10.4 million outstanding at July 31, 2015, and there was no amount outstanding on these lines of July 31, 2014. The weighted average interest rate on the short-term borrowings outstanding at July 31, 2015, was 0.83 percent.

Other international subsidiaries may borrow under various credit facilities. There was $1.6 million outstanding under these credit facilities as of July 31, 2015, and $1.0 million as of July 31, 2014. At July 31, 2015 and 2014, there was $47.2 million and $57.5 million available for use, respectively, under these facilities. The weighted average interest rate on these short-term borrowings outstanding at July 31, 2015 and July 31, 2014, was 0.41 percent and 0.75 percent, respectively.

NOTE D Long-Term Debt

Long-term debt consists of the following:

Annual maturities of long-term debt are $1.8 million in Fiscal 2016, $50.8 million in Fiscal 2017, $50.1 million in Fiscal 2018, $13.3 million in Fiscal 2019, no maturities in Fiscal 2020, and $275.0 million thereafter. Certain note agreements contain debt covenants related to working capital levels and limitations on indebtedness. As of July 31, 2015, the Company was in compliance with all such covenants.

On April 16, 2015, the Company entered into a First Supplement to Note Purchase Agreement (First Supplement), dated April 16, 2015, with a group of institutional investors, which supplements a Note Purchase Agreement, dated March 27, 2014. Pursuant to the First Supplement, the Company issued $25.0 million of senior unsecured notes due April 16, 2025, and $125.0 million of senior unsecured notes due June 17, 2030. The debt was issued at face value and bears interest payable semi-annually at an annual rate of interest of 2.93 percent and 3.18 percent respectively. The proceeds from the notes primarily were used to refinance existing debt, and were also used for general corporate purposes. The notes contain debt covenants specifically related to maintaining a certain leverage ratio as well as other covenants that, under certain circumstances, can restrict the Company’s ability to incur additional indebtedness, make investments and other restricted payments, create liens, and sell assets. As of July 31, 2015, the Company was in compliance with all such covenants. The Company expects to remain in compliance with these covenants.

On March 27, 2014, the Company issued $125.0 million of senior unsecured notes due March 27, 2024. The debt was issued at face value and bears interest payable semi-annually at an annual rate of interest of 3.72 percent. The proceeds from the notes were used to refinance existing debt and for general corporate purposes. The notes contain debt covenants specifically related to maintaining a certain leverage ratio as well as other covenants that, under certain circumstances, can restrict the Company’s ability to incur additional indebtedness, make investments and other restricted payments, create liens, and sell assets. As of July 31, 2015, the Company was in compliance with all such covenants.

On May 19, 2014, the Company refinanced its 1.65 billion yen guaranteed note that matured on May 18, 2014. The debt that was issued at face value, or approximately $13.3 million as of July 31, 2015, is due May 19, 2019, and bears interest payable quarterly at a variable interest rate. The interest rate was 0.52 percent as of July 31, 2015.

NOTE E Fair Value

Fair Value of Financial Instruments The Company used the following definitions to classify pension assets into either Level 1, Level 2, or Level 3:

Level 1 – Quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 – Inputs other than quoted prices available in Level 1 that are observable either directly or indirectly.

Level 3 – Unobservable inputs for the asset or liability.

At July 31, 2015 and 2014, the Company’s financial instruments included cash and cash equivalents, accounts receivable, accounts payable, short-term borrowings, long-term debt, and derivative contracts. The fair values of cash and cash equivalents, accounts receivable, accounts payable, and short-term borrowings approximated carrying values because of the short-term nature of these instruments and are classified as Level 1 in the fair value hierarchy. As of July 31, 2015, the estimated fair value of long-term debt with fixed interest rates was $383.3 million compared to its carrying value of $375 million. The fair value is estimated by discounting the projected cash flows using the rate that similar amounts of debt could currently be borrowed, which is classified as Level 2 in the fair value hierarchy.

Derivative contracts are reported at their fair values based on third-party quotes. The fair values of the Company’s financial assets and liabilities listed below reflect the amounts that would be received to sell the assets or paid to transfer the liabilities in an orderly transaction between market participants at the measurement date (exit price). The fair values are based on inputs other than quoted prices that are observable for the asset or liability. These inputs include foreign currency exchange rates and interest rates. The financial assets and liabilities are primarily valued using standard calculations and models that use as their basis readily observable market parameters. Industry standard data providers are the primary source for forward and spot rate information for both interest rates and currency rates.

The following summarizes the Company’s fair value of outstanding derivatives at July 31, 2015 and 2014, on the Consolidated Balance Sheets:

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The Company holds equity method investments which are classified in other long-term assets in the consolidated balance sheets. The aggregate carrying amount of these investments was $18.3 million and $21.4 million as of July 31, 2015 and 2014, respectively. These equity method investments are measured at fair value on a nonrecurring basis. The fair value of the Company’s equity method investments has not been estimated as there have been no identified events or changes in circumstance that would have had an adverse impact on the value of these investments. In the event that these investments were required to be measured, these investments would fall within Level 3 of the fair value hierarchy, due to the use of significant unobservable inputs to determine fair value, as the investments are in privately-held entities or divisions of public companies without quoted market prices.

Goodwill is assessed for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company’s goodwill and intangible assets are not recorded at fair value as there have been no events or circumstances that would have an adverse impact on the value of these assets. In the event that an impairment was recognized, the fair value would be classified within Level 3 of the fair value hierarchy. Definite lived intangible assets are subject to impairment assessments as triggering events occur which could indicate that the asset might be impaired. Refer to Note B for further discussion of the annual goodwill impairment analysis and carrying values of goodwill and other intangible assets.

The Company assesses the impairment of property, plant, and equipment whenever events or changes in circumstances indicate that the carrying amount of property, plant, and equipment assets may not be recoverable. There were no significant impairment charges recorded in Fiscal 2015, Fiscal 2014, or Fiscal 2013.

NOTE F Employee Benefit Plans

Plans The Company and certain of its international subsidiaries have defined benefit pension plans for many of their hourly and salaried employees. There are two types of U.S. plans. The first type of U.S. plan (Hourly Pension Plan) is a traditional defined benefit pension plan for union production employees. The second is a plan (Salaried Pension Plan) for some salaried and non-union production employees that provides defined benefits pursuant to a cash balance feature whereby a participant accumulates a benefit comprised of a percentage of current salary that varies with years of service, interest credits and transition credits. The non-U.S. plans generally provide pension benefits based on years of service and compensation level.

On July 31, 2013, the Company adopted a sunset freeze on its U.S. Salaried Pension Plan. Effective August 1, 2013, there are no longer any new entrants into the plan. Then effective, August 1, 2016, Employees hired prior to August 1, 2013, will no longer continue to accrue Company contribution credits under the plan.

Net periodic pension costs for the Company’s pension plans include the following components:

The obligations and funded status of the Company’s pension plans as of 2015 and 2014, is as follows: