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

Forward-Looking Statements

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

Among other factors which may affect future performance are:

• increased cybersecurity threats and sophisticated computer crime;

• potential product liability risks;

• our leverage and future debt service obligations;

• potential impairment of goodwill;

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

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Overview

The Company is a leading worldwide diversified manufacturer of motion and control technologies and systems, providing precision engineered solutions for a wide variety of mobile, industrial and aerospace markets.

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

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

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

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

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

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

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

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

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We believe we can meet our strategic objectives by:

• Maintaining a decentralized division and sales company structure;

• Fostering a safety first and entrepreneurial culture;

• Acquiring strategic businesses;

• Organizing around targeted regions, technologies and markets;

• Driving efficiency by implementing lean enterprise principles; and

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

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

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

CONSOLIDATED STATEMENT OF INCOME

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

Gross profit margin 24.9 % 25.3 %

Selling, general and administrative expenses $ 1,657 $ 1,544

Other (income) expense, net (67 ) (61 )

(Gain) loss on disposal of assets (1 ) 11

Effective tax rate 20.2 % 21.7 %

Net income attributable to common shareholders $ 1,206 $ 1,512

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

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

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

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

Other (income) expense, net included the following:

(dollars in millions)

Income related to equity method investments $ (75 ) $ (93 )

Non-service components of retirement benefit cost 49 40

Interest income (31 ) (18 )

Other items, net (10 ) 10

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

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

BUSINESS SEGMENT INFORMATION

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

Diversified Industrial Segment

Sales

Operating income

Operating income as a percent of sales

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

Diversified Industrial North America – as reported (5.2 )%

Acquisitions 6.0 %

Currency (0.2 )%

Diversified Industrial International – as reported (9.9 )%

Acquisitions 4.1 %

Currency (3.1 )%

Total Diversified Industrial Segment – as reported (7.2 )%

Acquisitions 5.2 %

Currency (1.4 )%

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

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

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

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

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

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

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

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

Diversified Industrial North America $ 41 $ 13

Diversified Industrial International 32 15

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

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

Aerospace Systems Segment

Operating income as a percent of sales 17.4 % 19.4 %

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

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

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

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

Corporate general & administrative expenses

(dollars in millions)

Corporate general and administrative expense $ 171 $ 195

Corporate general and administrative expense, as a percent of sales 1.2 % 1.4 %

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

Other expense (in the Business Segment Information)

(dollars in millions)

Foreign currency transaction $ (10 ) $ 6

Stock-based compensation 52 52

Acquisition expenses 119 17

Divestitures and asset sales and writedowns, net (1 ) 11

Interest income (31 ) (18 )

Other items, net (13 ) 25

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

CONSOLIDATED BALANCE SHEET

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

Trade accounts receivable, net 1,854 2,131

Notes payable and long-term debt payable within one year 810 587

Current ratio 1.6 2.4

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

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

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

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

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

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

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

CONSOLIDATED STATEMENT OF CASH FLOWS

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

A summary of cash flows follows:

Cash provided by (used in):

Investing activities (5,024 ) (219 )

Effect of exchange rates (30 ) (16 )

Net (decrease) increase in cash and cash equivalents $ (2,534 ) $ 2,397

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

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

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

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

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

Fitch Ratings BBB+

Moody's Investor Services, Inc. Baa1

Standard & Poor's BBB+

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

During 2020, the Company amended and extended its existing multi-currency credit agreement, increasing its capacity to $2,500 million. As of June 30, 2020, the Company had $1,777 million available for borrowing under the credit agreement. The credit agreement expires in September 2024; however, the Company has the right to request a one-year extension of the expiration date on an annual basis, which request may result in changes to the current terms and conditions of the credit agreement. Advances from the credit agreement can be used for general corporate purposes, including acquisitions, and for the refinancing of existing indebtedness. The credit agreement requires the payment of an annual facility fee, the amount of which is dependent upon the Company’s credit ratings. Although a lowering of the Company’s credit ratings would increase the cost of future debt, it would not limit the Company’s ability to use the credit agreement nor would it accelerate the repayment of any outstanding borrowings. Refer to Note 9 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for further discussion.

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

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

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

(dollars in millions) Payments due by period

OFF-BALANCE SHEET ARRANGEMENTS

The Company does not have off-balance sheet arrangements.

CRITICAL ACCOUNTING POLICIES

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

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

For contracts where revenue is recognized over time, we use the cost-to-cost, efforts expended or units of delivery method depending on the nature of the contract, including length of production time. The estimation of these costs and efforts expended requires judgment on the part of management due to the duration of the contractual agreements as well as the technical nature of the products involved. Adjustments to these estimates are made on a consistent basis and a contract reserve is established when the estimated costs to complete a contract exceed the expected contract revenues.

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

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

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

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

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

Long-lived assets held for use, which primarily includes finite-lived intangible assets and plant and equipment, are evaluated for impairment whenever events or circumstances indicate that the undiscounted net cash flows to be generated by their use over their expected useful lives and eventual disposition are less than their carrying value. The long-term nature of these assets requires the estimation of their cash inflows and outflows several years into the future and only takes into consideration technological advances known at the time of the impairment test. During 2020, the Company did not record any material impairment related to long-lived assets.

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

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

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

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

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RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

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

ITEM 7A.Quantitative and Qualitative Disclosures About Market Risk.

The Company manages foreign currency transaction and translation risk by utilizing derivative and non-derivative financial instruments, including forward exchange contracts, costless collar contracts, cross-currency swap contracts and certain foreign denominated debt designated as net investment hedges. The derivative financial instrument contracts are with major investment grade financial institutions and we do not anticipate any material non-performance by any of the counterparties. The Company does not hold or issue derivative financial instruments for trading purposes.

Derivative financial instruments are recognized on the Consolidated Balance Sheet as either assets or liabilities and are measured at fair value. Further information on the fair value of these contracts is provided in Part II, Item 8 of this Annual Report on Form 10-K. Derivatives that are not designated as hedges are adjusted to fair value by recording gains and losses through the Consolidated Statement of Income. Derivatives that are designated as hedges are adjusted to fair value by recording gains and losses through accumulated other comprehensive income (loss) in the Consolidated Balance Sheet until the hedged item is recognized in earnings. For cross-currency swaps measured using the spot method, the periodic interest settlements are recognized directly in earnings through interest expense. The translation of the foreign denominated debt that has been designated as a net investment hedge is recorded in accumulated other comprehensive income (loss) and remains there until the underlying net investment is sold or substantially liquidated.

The Company's debt portfolio contains variable rate debt, inherently exposing the Company to interest rate risk. The Company's objective is to maintain a 60/40 mix between fixed rate and variable rate debt thereby limiting its exposure to changes in near-term interest rates. A 100 basis point increase in near-term interest rates would increase annual interest expense on variable rate debt existing at June 30, 2020 by approximately $24 million.

As discussed elsewhere in this report, the recent outbreak of COVID-19 has negatively impacted and we expect it to continue to negatively impact our business and results of operations. As we cannot predict the ultimate duration or scope of the COVID-19 pandemic, the ultimate negative financial impact to our results cannot be reasonably estimated, but could be material.

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ITEM 8. Financial Statements and Supplementary Data.

Page Numberin Form 10-K

Financial Statements

Consolidated Statement of Income 32

Consolidated Statement of Comprehensive Income 33

Business Segment Information 34

Consolidated Balance Sheet 36

Consolidated Statement of Cash Flows 37

Consolidated Statement of Equity 38

Notes to Consolidated Financial Statements 39

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Parker-Hannifin Corporation

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Parker-Hannifin Corporation and subsidiaries (the "Company") as of June 30, 2020 and 2019, the related consolidated statements of income, comprehensive income, equity, and cash flows, for each of the three years in the period ended June 30, 2020, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of June 30, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of June 30, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2020, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.

As described in Management’s Report on Internal Control Over Financial Reporting, management excluded from its assessment the internal control over financial reporting at two entities which were acquired within the fiscal year, and whose financial statements constitute approximately 28% of total assets and 7% of net sales for the year ended June 30, 2020. Accordingly, our audit did not include the internal control over financial reporting over these acquired entities.

Basis for Opinions

The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

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

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Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Acquisitions - Valuation of intangible assets acquired via the acquisition of Exotic Metals Forming Co. & LORD Corporation - Refer to Note 3 to the financial statements

Critical Audit Matter Description

The Company completed the acquisitions of Exotic Metals Forming Company for $1.706 billion on September 16, 2019 and LORD Corporation for $3.455 billion on October 29, 2019. The Company accounted for the acquisitions under the acquisition method of accounting for business combinations. Accordingly, the purchase price was primarily allocated to the assets acquired and liabilities assumed based on their respective fair values, including customer-related and technology intangible assets. Management estimated the fair value of these intangible assets utilizing an income approach. The fair value determination of the customer-related and technology intangible assets required management to make significant assumptions related to the forecasted revenue growth rates and the selection of the discount rates.

We identified the customer-related and technology intangible assets for the Exotic and LORD acquisitions as a critical audit matter because of the significant assumptions management makes to fair value these assets. This required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists, when performing audit procedures to evaluate the reasonableness of management’s assumptions related to the revenue growth rates and the selection of the discount rates utilized to value these intangible assets.

How the Critical Audit Matter Was Addressed in the Audit

Our audit procedures related to the revenue growth rates and the selection of the assumptions for the intangible assets acquired included the following, among others:

/s/ DELOITTE & TOUCHE, LLP

Cleveland, Ohio

August 26, 2020

We have served as the Company's auditor since 2008.

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CONSOLIDATED STATEMENT OF INCOME

For the years ended June 30,

(Dollars in thousands, except per share amounts) 2020 2019 2018

Less: Noncontrolling interest in subsidiaries' earnings 362 567 514

Earnings per Share Attributable to Common Shareholders (Note 6)

The accompanying notes are an integral part of the consolidated financial statements.

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CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

For the years ended June 30,

Less: Noncontrolling interests in subsidiaries' earnings 362 567 514

Other comprehensive (loss) income, net of tax

The accompanying notes are an integral part of the consolidated financial statements.

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BUSINESS SEGMENT INFORMATION

Net Sales:

Diversified Industrial:

Segment Operating Income:

Diversified Industrial:

Assets:

Property Additions:

Depreciation:

Amortization:

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By Geographic Area(b)

Net Sales:

Long-Lived Assets:

The accounting policies of the business segments are the same as those described in the Significant Accounting Policies footnote except that the business segment results are prepared on a basis that is consistent with the manner in which the Company’s management disaggregates financial information for internal review and decision-making.

(a) Includes an investment in a joint venture in which ownership is 50 percent or less and in which the Company does not have operating control (2020 - $237,911; 2019 - $234,703; 2018 - $235,665).

(b) Net sales are attributed to countries based on the location of the selling unit. North America includes the United States, Canada and Mexico. No country other than the United States represents greater than 10 percent of consolidated sales. Long-lived assets are comprised of plant and equipment based on physical location.

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CONSOLIDATED BALANCE SHEET

(Dollars in thousands)

Assets

Current Assets

Marketable securities and other investments (Note 1) 70,805 150,931

Liabilities and Equity

Current Liabilities

Equity (Note 13)

Shareholders' Equity

The accompanying notes are an integral part of the consolidated financial statements.

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CONSOLIDATED STATEMENT OF CASH FLOWS

For the years ended June 30,

Cash Flows From Operating Activities

(Gain) loss on sale of plant and equipment (1,850 ) 5,091 (24,422 )

(Gain) loss on sale and impairment of investments (2,084 ) (16,749 ) 41,219

(Gain) loss on sale of marketable securities (587 ) 7,563 (2 )

Changes in assets and liabilities, net of effects from acquisitions:

Cash Flows From Investing Activities

Cash Flows From Financing Activities

Acquisition of noncontrolling interests (1,200 ) — —

Supplemental Data:

Cash paid during the year for:

The accompanying notes are an integral part of the consolidated financial statements.

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CONSOLIDATED STATEMENT OF EQUITY

Acquisition activity (30 ) (30 )

The accompanying notes are an integral part of the consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share amounts or as otherwise noted)

The term "year" and references to specific years refer to the applicable fiscal years.

1. Significant Accounting Policies

The significant accounting policies followed in the preparation of the accompanying consolidated financial statements are summarized below.

Nature of Operations- The Company is a leading worldwide diversified manufacturer of motion and control technologies and systems, providing precision engineered solutions for a wide variety of mobile, industrial and aerospace markets. We evaluate performance based on segment operating income before corporate administrative expenses, interest expense and income taxes.

The Diversified Industrial Segment is an aggregation of several business units, which manufacture motion-control and fluid power system components for builders and users of various types of manufacturing, packaging, processing, transportation, agricultural, construction, and military vehicles and equipment. Diversified Industrial Segment products are marketed primarily through field sales employees and independent distributors. The Diversified Industrial North American operations have manufacturing plants and distribution networks throughout the United States, Canada and Mexico and primarily service North America. The Diversified Industrial International operations provide Parker products and services to 46 countries throughout Europe, Asia Pacific, Latin America, the Middle East and Africa.

There are no individual customers to whom sales are more than three percent of the Company's consolidated sales. Due to our diverse group of customers throughout the world, we do not consider ourself exposed to any concentration of credit risks.

The Company manufactures and markets its products throughout the world. Although certain risks and uncertainties exist, the diversity and breadth of our products and geographic operations mitigate the risk that adverse changes with respect to any particular product and geographic operation would materially affect our operating results.

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

Basis of Consolidation - The consolidated financial statements include the accounts of all majority-owned domestic and foreign subsidiaries. All intercompany transactions and profits have been eliminated in the consolidated financial statements. The Company does not have off-balance sheet arrangements. Within the Business Segment Information, intersegment and interarea sales have been eliminated.

Revenue Recognition - Revenues are recognized when control of performance obligations, which are distinct goods or services within the contract, is transferred to the customer. Control is transferred when the customer has the ability to direct the use of and obtain the benefits from the goods or services. When revenue is recognized at a point in time, control generally transfers at time of shipment. Revenues are recognized over time if the customer simultaneously receives control as the Company performs work under a contract, if the customer controls the asset as it is being produced, or if the product produced for the customer has no alternative use and the Company has a contractual right to payment.

For contracts where revenue is recognized over time, we use the cost-to-cost, efforts expended or units of delivery method depending on the nature of the contract, including length of production time. The estimation of these costs and efforts expended requires judgment on the part of management due to the duration of the contractual agreements as well as the technical nature of the products involved. We make adjustments to these estimates on a consistent basis and establish a contract reserve when the estimated costs to complete a contract exceed the expected contract revenues.

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

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

Payment terms vary by customer and the geographic location of the customer. The time between when revenue is recognized and payment is due is not significant. Our contracts with customers generally do not include significant financing components or noncash consideration.

Taxes collected from customers and remitted to governmental authorities are excluded from revenue. Shipping and handling costs are treated as fulfillment costs and are included in cost of sales. The costs to obtain a contract where the amortization period for the related asset is one year or less are expensed as incurred.

There is generally no unilateral right to return products. The Company primarily offers an assurance-type standard warranty that the product will conform to certain specifications for a defined period of time or usage after delivery. This type of warranty does not represent a separate performance obligation.

Cash - Cash equivalents consist of short-term, highly liquid investments with a maturity of three months or less. These investments are carried at cost plus accrued interest and are readily convertible into cash.

Marketable Securities and Other Investments - Consist of short-term, highly liquid investments with stated maturities of greater than three months from the date of purchase, which are carried at cost plus accrued interest. Marketable securities and other investments also include investments in equity securities which are carried at fair value. Changes in fair value related to equity securities are recorded in net income. We have the ability to liquidate these investments after giving appropriate notice to the issuer.

Trade Accounts Receivable, Net - Trade accounts receivable are initially recorded at their net collectible amount and are generally recorded at the time the revenue from the sales transaction is recorded. Receivables are written off to bad debt primarily when, in the judgment of the Company, the receivable is deemed to be uncollectible due to the insolvency of the debtor. Allowance for doubtful accounts was $11,644 and $8,874 at June 30, 2020 and 2019, respectively.

Non-Trade and Notes Receivable - The non-trade and notes receivable caption in the Consolidated Balance Sheet is comprised of the following components:

Plant, Equipment and Depreciation - Plant and equipment are recorded at cost and are depreciated principally using the straight-line method for financial reporting purposes. Depreciation rates are based on estimated useful lives of the assets, generally 40 years for buildings, 15 years for land improvements and building equipment, seven to 10 years for machinery and equipment, and three to eight years for vehicles and office equipment. Improvements, which extend the useful life of property, are capitalized, and maintenance and repairs are expensed. We review plant and equipment for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable. When plant and equipment are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the appropriate accounts and any gain or loss is included in current income.

The plant and equipment caption in the Consolidated Balance Sheet is comprised of the following components:

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Investments and Other Assets -Investments in joint-venture companies in which ownership is 50 percent or less and in which the Company does not have operating control are stated at cost plus the Company's equity in undistributed earnings and amounted to $317,975 and $316,728 at June 30, 2020 and 2019, respectively. A significant portion of the underlying net assets of the joint ventures are related to goodwill. The Company's share of earnings from investments in joint-venture companies were $74,517, $93,239 and $50,473 in 2020, 2019 and 2018, respectively.

Intangible Assets- Intangible assets primarily include patents and technology, trademarks and customer lists and contracts and are recorded at cost and amortized on a straight-line method. Patents and technology are amortized over the shorter of their remaining useful or legal life. Trademarks and customer contracts are amortized over the estimated time period over which an economic benefit is expected to be received. Customer lists are amortized over a period based on anticipated customer attrition rates. The Company reviews intangible assets for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable.

Goodwill - The Company conducts a formal impairment test of goodwill on an annual basis and between annual tests if an event occurs or circumstances change that would, more likely than not, reduce the fair value of a reporting unit below its carrying value.

Income Taxes - Income taxes are provided based upon income for financial reporting purposes. Tax credits and similar tax incentives are applied to reduce the provision for income taxes in the year in which the credits arise. We recognize accrued interest related to unrecognized tax benefits in income tax expense. Penalties, if incurred, are recognized in income tax expense. Deferred income taxes arise from temporary differences in the recognition of income and expense for tax purposes. Income tax effects resulting from adjusting temporary differences recorded in accumulated other comprehensive (loss) are released when the circumstances on which they are based cease to exist.

Foreign Currency Translation - Assets and liabilities of foreign subsidiaries are translated at current exchange rates, and income and expenses are translated using weighted-average exchange rates. The effects of these translation adjustments, as well as gains and losses from certain intercompany transactions, are reported in accumulated other comprehensive (loss). Such adjustments will affect net income only upon sale or liquidation of the underlying foreign investments. Exchange (gains) losses from transactions in a currency other than the local currency of the entity involved are included within the cost of sales caption in the Consolidated Statement of Income and were $(10,018), $5,888 and $7,284, in 2020, 2019 and 2018, respectively.

Subsequent Events - We evaluated subsequent events that have occurred through the date of filing of this Annual Report on Form 10-K for the year ended June 30, 2020. No subsequent events occurred that required adjustment to or disclosure in these financial statements.

Recent Accounting Pronouncements - In June 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-13, "Measurement of Credit Losses on Financial Instruments." ASU 2016-13 requires a financial asset (or a group of financial assets) measured at amortized cost to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. ASU 2016-13 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. We adopted ASU 2016-13 on July 1, 2020. The adoption of this ASU will not materially impact the Company's financial statements or related disclosures.

In February 2016, the FASB issued ASU 2016-02, "Leases." ASU 2016-02 requires lessees to put most leases with terms greater than 12 months on their balance sheet by recognizing a liability to make lease payments and an asset representing their right to use the asset during the lease term. We adopted ASU 2016-02 on July 1, 2019 using the optional transition method and have not restated prior periods. We elected to use the package of practical expedients permitted under the transition guidance, which allows the carry forward of historical lease classification of existing leases. Upon adoption, we recorded a right-of-use asset and lease liability of approximately $126 million. The adoption of the ASU did not have a material impact on the Consolidated Statement of Income or Cash Flows.

2. Revenue recognition

Revenue is derived primarily from the sale of products in a variety of mobile, industrial and aerospace markets. A majority of the Company’s revenues are recognized at a point in time. However, a portion of the Company’s revenues are recognized over time.

Disaggregation of revenue

Revenue from contracts with customers is disaggregated by technology platforms for the Diversified Industrial Segment, by product platforms for the Aerospace Systems Segment and by geographic location for the total Company.

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The Diversified Industrial Segment is an aggregation of several business units, which manufacture motion-control and fluid power system components for builders and users of various types of manufacturing, packaging, processing, transportation, agricultural, construction, and military vehicles and equipment. Contracts consist of individual purchase orders for standard product, blanket purchase orders and production contracts. Blanket purchase orders are often associated with individual purchase orders and have terms and conditions which are subject to a master supply or distributor agreement. Individual production contracts, some of which may include multiple performance obligations, are typically for products manufactured to the customer's specifications. Revenue in the Diversified Industrial Segment is typically recognized at the time of product shipment, but a portion of revenue may be recognized over time for installation services or in situations where the product has no alternative use and we have an enforceable right to payment.

Diversified Industrial Segment revenues by technology platform:

The Aerospace Systems Segment produces hydraulic, fuel, pneumatic and electro-mechanical systems and components, which are utilized on virtually every domestic commercial, military and general aviation aircraft. Aerospace Systems Segment products also perform a vital role in naval vessels and land-based weapon systems. Contracts generally consist of blanket purchase orders and individual long-term production contracts. Blanket purchase orders, which have terms and conditions subject to long-term supply agreements, are typically associated with individual purchase orders. Revenue in the Aerospace Systems Segment is typically recognized at the time of product shipment, but a portion of revenue may be recognized over time in situations where the customer controls the asset as it is produced or the product has no alternative use and we have an enforceable right to payment.

Aerospace Systems Segment revenues by product platform:

Total revenues by geographic region based on the Company's selling operation's location:

The majority of revenues from the Aerospace Systems Segment is generated from sales to customers within North America.

Contract balances

Contract assets and contract liabilities are reported on a contract-by-contract basis. Contract assets reflect revenue recognized and performance obligations satisfied in advance of customer billing. Contract liabilities relate to payments received in advance of the satisfaction of performance under the contract. Payments from customers are received based on the terms established in the contract with the customer.

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Total contract assets and contract liabilities are as follows:

At June 30, 2020, the change in net contract liabilities was primarily due to timing differences between when revenue was recognized and the receipt of advance payments. During 2020, approximately $33 million of revenue was recognized that was included in the contract liabilities at June 30, 2019.

Remaining performance obligations

Our backlog represents written firm orders from a customer to deliver products and, in the case of blanket purchase orders, only includes the portion of the order for which a schedule or release has been agreed to with the customer. We believe our backlog represents our unsatisfied or partially unsatisfied performance obligations. Backlog at June 30, 2020 was $5,138 million, of which approximately 85 percent is expected to be recognized as revenue within the next 12 months and the balance thereafter.

3. Acquisitions and Divestitures

Acquisitions - On October 29, 2019, we completed the acquisition of a 100 percent equity interest in LORD Corporation ("Lord") for approximately $3,455 million in cash, including the assumption of debt. On September 16, 2019, we completed the acquisition of a 100 percent equity interest in EMFCO Holdings Incorporated, parent company of Exotic Metals Forming Company LLC ("Exotic") for approximately $1,706 million in cash.

Lord is a diversified technology and manufacturing company developing highly reliable adhesives and coatings, as well as vibration and motion control technologies, that significantly reduce risk and improve product performance. Lord’s products are used in mission-critical applications in the aerospace, automotive and industrial markets. Lord had annual sales of approximately $1,025 million for its fiscal 2018. For segment reporting purposes, approximately 95 percent of Lord's sales are included in the Diversified Industrial Segment, while the remaining five percent are included in the Aerospace Systems Segment. Lord’s unique and proprietary products, solutions and technologies for mission-critical applications are expected to increase the Company's overall engineered materials product and solutions offerings to enable a stronger value proposition for customers.

Exotic designs and manufactures innovative and technically demanding, high temperature, high pressure air and exhaust management solutions for aircraft and engines. Exotic had annual sales of approximately $409 million for its fiscal 2019.

For segment reporting purposes, Exotic is included in the Aerospace Systems Segment. We believe Exotic's products and proprietary manufacturing capabilities are complementary to our portfolio of flight control, fuel and inerting, hydraulics, fluid conveyance and engine components.

Assets acquired and liabilities assumed are recognized at their respective fair values as of the acquisition date. The process of estimating the fair values of certain tangible assets, identifiable intangible assets and assumed liabilities requires the use of judgment in determining the appropriate assumptions and estimates. The following presents the preliminary estimated fair values of Lord's and Exotic's assets acquired and liabilities assumed on the respective acquisition dates. These preliminary estimates are based on available information and will be revised during the measurement period, not to exceed 12 months from the acquisition date, as third-party valuations are finalized, additional information becomes available and as additional analysis is performed. Such revisions may have a material impact on our results of operations and financial position within the measurement period. During 2020, these revisions, which primarily impacted intangible assets, goodwill, deferred income taxes, other liabilities, and plant and equipment, did not have a material impact on our financial statements.

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The purchase price allocation for acquisitions in 2020 is as follows:

Lord Exotic

Assets:

Deferred income taxes — 2,057

Liabilities:

Notes payable and long-term debt payable within one year 404 —

Accrued payrolls and other compensation 57,571 8,863

Accrued domestic and foreign taxes 2,898 2,123

Pensions and other postretirement benefits 115,265 —

Deferred income taxes 303,958 —

Other liabilities 53,455 —

Noncontrolling interests 11,266 —

Total liabilities and noncontrolling interests assumed 909,974 59,824

Goodwill is calculated as the excess of the purchase price over the net assets acquired. With respect to the Lord and Exotic acquisitions, goodwill represents cost synergies and enhancements to our existing technologies. For tax purposes, Lord's goodwill is not deductible, and Exotic's goodwill is deductible. Based upon a preliminary acquisition valuation, intangibles acquired as part of the Exotic acquisition include $502,470 of customer-related intangible assets, $281,400 of patents and technology and $90,600 of trademarks, with weighted average estimated useful lives of 18, 20 and 20 years, respectively. Similarly, the Lord acquisition includes $869,190 of customer-related intangible assets, $458,030 of patents and technology and $119,440 of trademarks, with weighted average estimated useful lives of 13, 21 and 20 years, respectively. These intangible assets were valued using the income approach, which includes significant assumptions around future revenue growth and discount rates. Such assumptions are classified as level 3 inputs within the fair value hierarchy.

Our consolidated financial statements include the results of operations of Lord and Exotic from their respective acquisition dates through June 30, 2020. Net sales attributable to these acquisitions during this period and included in our consolidated financial statements totaled $949,066. Segment operating income attributable to these acquisitions during this period and included in our consolidated financial statements totaled $22,330.

Acquisition-related transaction and integration costs totaled $119,214 in 2020. These costs are included in selling, general, and administrative expenses in the Consolidated Statement of Income.

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Divestitures - During 2018, the Company divested its global Facet filtration business, which was part of the Diversified Industrial Segment. The operating results and net assets of the global Facet filtration business were immaterial to the Company's consolidated results of operations and financial position. The Company recorded a pre-tax loss in 2018 of approximately $20 million and tax expense of approximately $29 million resulting from a tax gain related to the divestiture. The pre-tax loss is reflected in the (gain) loss on disposal of assets caption in the Consolidated Statement of Income and the other expense caption in the Business Segment Information.

4. Charges Related to Business Realignment and Acquisition Integration

The Company incurred business realignment and acquisition integration charges in 2020, 2019 and 2018. The business realignment charges primarily consist of severance costs related to actions taken under the Company's simplification initiative aimed at reducing organizational and process complexity as well as plant closures. During 2020, business realignment charges also include actions taken to address the impact of COVID-19 on our business, especially within the Aerospace Systems Segment. The 2019 and 2018 acquisition integration charges relate to the 2017 acquisition of CLARCOR, Inc. ("Clarcor") and primarily consist of severance costs and expenses related to plant closures and relocations. A majority of the business realignment charges were incurred in North America and Europe. We believe the realignment actions will positively impact future results of operations but will not have a material effect on liquidity and sources and uses of capital.

Business realignment and Clarcor acquisition integration charges presented in the Business Segment Information are as follows:

Corporate administration 1,175 — —

Workforce reductions in connection with such business realignment and Clarcor acquisition integration charges in the Business Segment Information are as follows:

Corporate administration 31 — —

The business realignment and Clarcor acquisition integration charges are presented in the Consolidated Statement of Income as follows:

(Gain) loss on disposal of assets 50 305 1,233

As of June 30, 2020, approximately $63 million in severance payments were made relating to business realignment and Clarcor acquisition integration charges. Remaining payments related to current-year and prior-year business realignment and Clarcor acquisition integration actions of $23 million, a majority of which are expected to be paid by June 30, 2021, are primarily reflected within the other accrued liabilities caption in the Consolidated Balance Sheet. Additional charges may be recognized in future periods related to the business realignment and acquisition integration actions described above, the timing and amount of which are not known at this time.

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We also incurred the following acquisition integration charges related to the Lord and Exotic acquisitions:

Diversified Industrial $ 20,669

Aerospace Systems 1,908

These charges are primarily included in selling, general and administrative expenses within the Consolidated Statement of Income.

5. Income Taxes

Income before income taxes was derived from the following sources:

Income taxes include the following:

Federal

Foreign

State and local

A reconciliation of the effective income tax rate to the statutory federal rate follows:

Statutory federal income tax rate 21.0 % 21.0 % 28.1 %

State and local income taxes 1.4 1.7 1.2

Tax related to international activities 1.8 2.9 (1.0 )

Transition tax related to the TCJ Act (0.7 ) 0.8 17.5

Cash surrender value of life insurance (0.3 ) (0.1 ) (0.4 )

Federal manufacturing deduction — 0.1 (1.0 )

Foreign derived intangible income deduction (1.5 ) (1.0 ) —

Research tax credit (0.6 ) (0.5 ) (0.7 )

Share-based compensation (1.5 ) (1.7 ) (2.2 )

Effective income tax rate 20.2 % 21.7 % 37.7 %

We made the accounting policy election to treat taxes related to Global Intangible Low-Taxed Income ("GILTI") as a current period expense when incurred. The tax rate impact of GILTI is included with tax related to international activities in the table above.

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On March 27, 2020, the President of the United States signed into law the Coronavirus Aid, Relief, and Economic Security ("CARES") Act, a significant tax-and-spending package intended to provide economic stimulus to address the impact of the COVID-19 pandemic. We continue to monitor the impact from the CARES Act; however, no income tax effects have been recorded in the current year, and we do not expect it to materially impact the Company.

Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of assets and liabilities. The differences comprising the net deferred taxes shown on the Consolidated Balance Sheet at June 30 were as follows:

Unrealized currency exchange gains and losses 39,256 27,034

Change in net deferred tax (liability):

As of June 30, 2020, we recorded deferred tax assets of $754,655 resulting from $3,048,453 in loss carryforwards. A valuation allowance of $741,171 related to the loss carryforwards has been established due to the uncertainty of their realization. Of this valuation allowance, $710,439 relates to non-operating entities whose loss carryforward utilization is considered to be remote. Some of the loss carryforwards can be carried forward indefinitely; others can be carried forward from three to 20 years. In addition, a valuation allowance of $30,259 related to future deductible items has been established due to the uncertainty of their realization. These future deductible items are recorded in the other liabilities and reserves and tax credit carryforward lines in the table above.

Although future distributions of foreign earnings to the U.S. should not be subject to U.S. federal income taxes, other U.S. or foreign taxes may be imposed on such earnings. We have analyzed existing factors and determined we will no longer permanently reinvest certain foreign earnings. On these undistributed foreign earnings of approximately $717 million that are no longer permanently reinvested outside of the U.S., we have recorded a deferred tax liability of $10 million. The remaining undistributed foreign earnings of approximately $2,122 million remain permanently reinvested outside the U.S. at June 30, 2020. Of these undistributed earnings, we have recorded a deferred tax liability of $5 million where certain foreign holding companies are not permanently reinvested in their subsidiaries. It is not practicable to estimate the additional taxes, including applicable foreign withholding taxes, that might be payable on the potential distribution of such permanently reinvested foreign earnings.

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A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

Additions for tax positions related to current year 4,955 2,272 4,195

Additions for tax positions of prior years 798 45 8,333

Additions for acquisitions 43,532 — —

Reductions for tax positions of prior years (41,726 ) (927 ) (3,790 )

Reductions for expiration of statute of limitations (3,820 ) (9,388 ) (4,480 )

Effect of foreign currency translation (4,604 ) (3,599 ) 1,642

The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $86,277, $140,662 and $153,091 as of June 30, 2020, 2019 and 2018, respectively. The accrued interest related to the gross unrecognized tax benefits, excluded from the amounts above, was $14,247, $25,214 and $21,737 as of June 30, 2020, 2019 and 2018, respectively. In the current year, we recorded the resolution of an examination with a foreign jurisdiction that resulted in a significant decrease to the unrecognized tax benefit recorded on our balance sheet. This is included in reductions for tax positions of prior years and reductions for settlements in the table above.

It is reasonably possible that, within the next 12 months, the amount of gross unrecognized tax benefits could be reduced by up to approximately $40,000 as a result of the revaluation of existing uncertain tax positions arising from developments in the examination process or the closure of tax statutes. Any increase in the amount of unrecognized tax benefits within the next 12 months is expected to be insignificant.

We file income tax returns in the United States and in various foreign jurisdictions. In the normal course of business, we are subject to examination by taxing authorities throughout the world. We are open to assessment of our U.S. federal income tax returns by the Internal Revenue Service for years after 2013, and our state and local income tax returns for years after 2013. We are open to assessment for significant foreign jurisdictions for years after 2008.

6. Earnings Per Share

Basic earnings per share are computed using the weighted-average number of common shares outstanding during the year. Diluted earnings per share are computed using the weighted-average number of common shares and common share equivalents outstanding during the year. Common share equivalents represent the dilutive effect of outstanding equity-based awards. The reconciliation of the numerator and denominator of basic and diluted earnings per share was as follows:

Numerator:

Denominator:

For 2020, 2019 and 2018, 0.6 million, 0.9 million and 0.5 million common shares, respectively, subject to equity-based awards were excluded from the computation of diluted earnings per share because the effect of their exercise would be anti-dilutive.

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7. Inventories

The majority of domestic inventories are valued by the last-in, first-out ("LIFO") cost method and the balance of the Company's inventories are valued by the first-in, first-out ("FIFO") cost method. Inventories valued by the FIFO cost method are stated at the lower of cost or net realizable value. Inventories valued by the LIFO cost method are stated at lower of cost or market.

Inventories valued on the LIFO cost method were approximately 33 percent of total inventories in 2020 and 41 percent in 2019. The current cost of these inventories exceeds their valuation determined on the LIFO basis by $219,854 and $222,715 in 2020 and 2019, respectively.

The inventories caption in the Consolidated Balance Sheet is comprised of the following components:

8. Goodwill and Intangible Assets

The changes in the carrying amount of goodwill are as follows:

Diversified Industrial Segment Aerospace Systems Segment Total

Foreign currency translation and other (53,546 ) (9 ) (53,555 )

Foreign currency translation and other (54,457 ) (3 ) (54,460 )

Acquisitions represent the goodwill allocation during the measurement period subsequent to the applicable acquisition dates. Refer to Note 3 for further discussion.

We test goodwill for impairment at the reporting unit level on an annual basis and between annual tests whenever events or circumstances indicate that the carrying value of a reporting unit may exceed its fair value. Our annual impairment tests performed in 2020, 2019 and 2018 resulted in no impairment loss being recognized. We did not identify any events or circumstances during 2020 that required performance of an interim impairment test. However, the effects of COVID-19 on the global economy, including further market disruption, lack of economic recovery or lower than anticipated customer demand, may require the performance of additional impairment tests in future periods.

Intangible assets are amortized on a straight-line method over their legal or estimated useful lives. The gross carrying value and accumulated amortization for each major category of intangible asset at June 30 are as follows:

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Total intangible asset amortization expense in 2020, 2019 and 2018 was $284,632, $205,164 and $221,494, respectively. Estimated intangible asset amortization expense for the five years ending June 30, 2021 through 2025 is $321,200, $303,504, $293,603, $284,418 and $270,409, respectively.

Intangible assets are evaluated for impairment whenever events or circumstances indicate that the undiscounted net cash flows to be generated by their use over their expected useful lives and eventual disposition may be less than their net carrying value. No material intangible asset impairments occurred in 2020, 2019 or 2018.

9. Financing Arrangements

During 2020, the Company amended and extended its existing multi-currency credit agreement, increasing its capacity to $2,500,000. As of June 30, 2020, $1,776,500 was available for borrowing under the credit agreement. The credit agreement expires in September 2024; however, the Company has the right to request a one-year extension of the expiration date on an annual basis, which request may result in changes to the current terms and conditions of the credit agreement. Advances from the credit agreement can be used for general corporate purposes, including acquisitions, and for the refinancing of existing indebtedness. The credit agreement requires the payment of an annual facility fee, the amount of which may increase in the event our credit ratings are lowered. Although a lowering of our credit ratings would likely increase the cost of future debt, it would not limit our ability to use the credit agreement nor would it accelerate the repayment of any outstanding borrowings.

The Company is currently authorized to sell up to $2,500,000 of short-term commercial paper notes. Commercial paper notes outstanding at June 30, 2020 and 2019 were $723,500 and $586,000, respectively. The Company had no outstanding borrowings from foreign banks at June 30, 2020 and had borrowings of $786 at June 30, 2019. The weighted-average interest rate on notes payable during 2020 and 2019 was 2.2 percent and 2.8 percent, respectively.

In the ordinary course of business, our foreign locations may enter into financial guarantees through financial institutions which enable customers to be reimbursed in the event of nonperformance by the Company.

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

Domestic:

Foreign:

Less: Long-term debt payable within one year 86,029 228

During 2020, the Company entered into and drew against a term loan with an aggregate principal amount of $925,000, which will mature in its entirety in September 2023. We used the proceeds to finance a portion of the purchase of the Exotic acquisition. In addition, we drew against the $800,000 term loan, which will mature in its entirety in October 2022. We used the proceeds to finance a portion of the purchase of the Lord acquisition. Interest payments were made quarterly in 2020. The agreements permit interest rate re-set periods ranging from one to six months at our election, and interest is due at the conclusion of the re-set period chosen.

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Principal amounts of long-term debt payable in the five years ending June 30, 2021 through 2025 are $87,218, $87,998, $587,458, $1,327,376 and $1,287,303, respectively. The principal amounts of long-term debt payable exclude the amortization of debt issuance costs.

11. Leases

We primarily enter into lease agreements for office space, distribution centers, certain manufacturing facilities and equipment. The majority of our leases are operating leases. Finance leases are immaterial to our financial statements. In addition, leases with an initial term of twelve months or less are not recorded on the Consolidated Balance Sheet. Certain leases contain options that provide us with the ability to extend the lease term. Such options are included in the lease term when it is reasonably certain that the option will be exercised. When accounting for leases, we combine payments for leased assets, related services and other components of a lease. Payments within certain lease agreements are adjusted periodically for changes in an index or rate.

The discount rate implicit within our leases is generally not determinable and therefore we determine the discount rate based on our incremental borrowing rate. The incremental borrowing rate for our leases is determined based on lease term and the currency in which lease payments are made.

The components of lease expense are as follows:

Operating lease expense $ 50,267

Short-term lease cost 8,566

Variable lease cost 5,108

Supplemental cash flow information related to operating leases are as follows:

Right-of-use assets obtained in exchange for operating lease obligations 41,069

Supplemental balance sheet information related to operating leases is as follows:

Long-term operating lease liabilities (included within Other liabilities) 96,446

Total operating lease liabilities $ 139,773

Weighted average remaining lease term 5.2 years

Weighted average discount rate 2.1 %

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Maturities of lease liabilities at June 30, 2020 are as follows:

Operating Leases

Total operating lease payments $ 148,250

Less imputed interest 8,477

Total operating lease liabilities $ 139,773

Future minimum rental commitments as of June 30, 2019, under non-cancelable operating leases, which expire at various dates, are as follows: 2020-$45,920; 2021-$31,115; 2022-$21,625; 2023-$13,228; 2024-$7,591 and after 2024-$22,723.

Rental expense in 2019 and 2018 was $126,752 and $126,940, respectively.

12. Retirement Benefits

Pensions - The Company has noncontributory defined benefit pension plans covering eligible employees, including certain employees in foreign countries. Plans for most salaried employees provide pay-related benefits based on years of service. Plans for hourly employees generally provide benefits based on flat-dollar amounts and years of service. We also have arrangements for certain key employees, which provide for supplemental retirement benefits. In general, the Company's policy is to fund these plans based on legal requirements, tax considerations, local practices and investment opportunities. We also sponsor defined contribution plans and participate in government-sponsored programs in certain foreign countries.

A summary of the Company's defined benefit pension plans follows:

Benefit cost

Amortization of transition obligation 18 18 18

Components of net pension benefit cost, other than service cost, are included in other (income) expense, net in the Consolidated Statement of Income.

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Change in benefit obligation

Foreign currency translation and other (27,954 ) (46,043 )

Change in plan assets

Foreign currency translation and other (25,355 ) (37,614 )

Amounts recognized on the Consolidated Balance Sheet

Other accrued liabilities $ (1,423 ) $ (8,396 )

Amounts recognized in Accumulated Other Comprehensive (Loss)

Transition obligation 26 44

The presentation of the amounts recognized on the Consolidated Balance Sheet and in accumulated other comprehensive (loss) is on a debit (credit) basis and excludes the effect of income taxes.

The benefit obligation increased in 2020 upon acquisition of the Lord pension plans. Significant reductions in the discount rates also contributed to the increase in the benefit obligation, which was partially offset by a reduced salary scale and updated mortality assumptions for the domestic qualified defined benefit plan.

The increase in the benefit obligation in 2019, largely reflected in the net actuarial loss component, is primarily due to the decrease in the discount rate used to measure the obligation across all pension plans. Additionally, the benefit obligation increased slightly as a result of updated census data for the domestic qualified defined benefit plan due to delayed retirements and higher than anticipated compensation increases.

The increase in the plan assets' fair value in 2020 is attributable the acquisition of the Lord pension plans and investment gains. The increase in the plan assets' fair value in 2019 is attributable to a $200 million discretionary contribution to the domestic qualified defined benefit plan and investment gains.

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The accumulated benefit obligation for all defined benefit plans was $6,102,038 and $5,184,637 at June 30, 2020 and 2019, respectively.

Information for pension plans with accumulated benefit obligations in excess of plan assets:

Information for pension plans with projected benefit obligations in excess of plan assets:

We expect to make cash contributions of approximately $71 million to our defined benefit pension plans in 2021, the majority of which relates to our unfunded non-U.S. plans. Estimated future benefit payments in the five years ending June 30,2021 through 2025 are $266,011, $326,214, $284,379, $290,707 and $302,169, respectively, and $1,606,648 in the aggregate for the five years ending June 30, 2026 through June 30, 2030.

The assumptions used to measure net periodic benefit cost for the Company's significant defined benefit plans are:

U.S. defined benefit plan

Average increase in compensation 3.60 % 3.65 % 3.89 %

Expected return on plan assets 7.00 % 7.00 % 7.50 %

Non-U.S. defined benefit plans

The assumptions used to measure the benefit obligation for the Company's significant defined benefit plans are:

U.S. defined benefit plan

Average increase in compensation 2.98 % 3.60 %

Non-U.S. defined benefit plans

The discount rate assumption is based on current rates of high-quality, long-term corporate bonds over the same estimated time period that benefit payments will be required to be made. The expected return on plan assets assumption is based on the weighted-average expected return of the various asset classes in the plans' portfolio. The asset class return is developed using historical asset return performance as well as current market conditions such as inflation, interest rates and equity market performance.

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The weighted-average allocation of the majority of the assets related to defined benefit plans is as follows:

Equity securities 41 % 43 %

Debt securities 49 % 54 %

Other investments 10 % 3 %

The weighted-average target asset allocation as of June 30, 2020 is 39 percent equity securities, 43 percent debt securities and 18 percent other investments. The investment strategy for the Company's worldwide defined benefit pension plan assets focuses on achieving prudent actuarial funding ratios while maintaining acceptable levels of risk in order to provide adequate liquidity to meet immediate and future benefit requirements. This strategy requires investment portfolios that are broadly diversified across various asset classes and external investment managers. Assets held in the U.S. defined benefit plan account for approximately 75 percent of our total defined benefit plan assets. The overall investment strategy with respect to our U.S. defined benefit plan is to use a funding strategy more heavily weighted toward liability-hedging assets as the funded status improves. Over time, we will continue to add long duration fixed income investments to the portfolio. These securities are highly correlated with our pension liabilities and will be managed in a liability framework.

The fair values of pension plan assets at June 30, 2020 and at June 30, 2019, by asset class, are as follows:

Equity securities

Fixed income securities

Mutual funds

Mutual funds measured at net asset value 259,776

Common/Collective trusts measured at net asset value 2,711,736

Limited Partnerships measured at net asset value 104,760

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Equity securities

Fixed income securities

Mutual funds

Mutual funds measured at net asset value 304,504

Common/Collective trusts

Common/Collective trusts measured at net asset value 1,872,473

Limited Partnerships measured at net asset value 240,803

Cash and cash equivalents, including short-term investments, are valued at cost, which approximates fair value.

Equity securities are valued at the closing price reported on the active market on which the individual securities are traded. U.S. based companies include Parker stock with a fair value of $243,656 and $226,027 as of June 30, 2020 and 2019, respectively.

Fixed income securities are valued using both market observable inputs for similar assets that are traded on an active market and the closing price on the active market on which the individual securities are traded.

Mutual funds are valued using the closing market price reported on the active market on which the fund is traded or at net asset value per share and primarily consist of equity and fixed income funds. The equity funds primarily provide exposure to U.S. and international equities, real estate and commodities. The fixed income funds primarily provide exposure to high-yield securities and emerging market fixed income instruments. Mutual funds measured at fair value using the net asset value per share practical expedient have not been categorized in the fair value hierarchy and are presented in the tables above to permit reconciliation of the fair value hierarchy to total pension plan assets.

Common/Collective trusts primarily consist of equity, fixed income and real estate funds and are valued using the closing market price reported on the active market on which the fund is traded or at net asset value per share. Common/Collective trust investments can be redeemed without restriction after giving appropriate notice to the issuer. Generally, redemption of the entire investment balance of all common/collective trusts requires no more than a 90-day notice period. However, a certain real estate common/collective trust has a lock-up period expiring December 2020. The equity funds provide exposure to large, mid and small cap U.S. equities, international large and small cap equities and emerging market equities. The fixed income funds provide exposure to U.S., international and emerging market debt securities. Common/Collective trusts measured at fair value using the net asset value per share practical expedient have not been categorized in the fair value hierarchy and are presented in the tables above to permit reconciliation of the fair value hierarchy to total pension plan assets.

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Limited Partnerships' interest in venture capital investments are measured at fair value based on net asset value as determined by the respective fund investment. Hedge funds are also included in this category. The hedge funds provide exposure to a variety of hedging strategies, including long/short equity, relative value, event driven and global macro and are also measured at fair value using the net asset value per share. As of June 30, 2020, the only limited partnership investment, subject to a lock-up period of two years, is restricted to a maximum redemption of 20 percent of its account balance every six months upon a 90-day notification period. Hedge fund investments can be redeemed either monthly or quarterly and without restriction after giving appropriate notice to the issuer. Redemption of the entire hedge fund investment balance generally requires no more than a 95-day notice period. Limited Partnerships measured at fair value using the net asset value per share practical expedient have not been categorized in the fair value hierarchy and are presented in the tables above to permit reconciliation of the fair value hierarchy to total pension plan assets.

Miscellaneous primarily includes insurance contracts held in the asset portfolio of the Company's non-U.S. defined benefit pension plans and net payables for securities purchased but not settled in the asset portfolio of the Company's U.S. defined benefit pension plan. Insurance contracts are valued at the present value of future cash flows promised under the terms of the insurance contracts.

The primary investment objective of equity securities and equity funds, within both the mutual fund and common/collective trust asset class, is to obtain capital appreciation in an amount that at least equals various market-based benchmarks. The primary investment objective of fixed income securities and fixed income funds, within both the mutual fund and common/collective trust asset class, is to provide for a constant stream of income while preserving capital. The primary investment objective of limited partnerships is to achieve capital appreciation through an investment program focused on specialized investment strategies. The primary investment objective of the investments in the miscellaneous category is to provide a stable rate of return over a specified period of time.

Employee Savings Plan - We sponsor an employee stock ownership plan ("ESOP") as part of our legacy savings and investment 401(k) plan. The ESOP is available to eligible domestic employees. Company matching contributions, up to a maximum of four percent of an employee's annual compensation, are recorded as compensation expense. Participants may direct company matching contributions to any investment option within the savings and investment 401(k) plan.

In addition to shares within the ESOP, as of June 30, 2020, employees have elected to invest in 1,573,247 shares of common stock within a company stock fund of the savings and investment 401(k) plan.

The Company has a retirement income account ("RIA") within our legacy savings and investment 401(k) plan. We make a cash contribution to the participant's RIA each year, the amount of which is based on the participant's age and years of service. Participants do not contribute to the RIA. The Company recognized $38,387, $30,603 and $29,023 in expense related to the RIA in 2020, 2019 and 2018, respectively.

During 2020, we acquired several defined contribution plans comprising similar company matching contributions and RIA features as our legacy plan. We recorded additional expense of $4,190 and $7,439 forcompany matching contributions and RIA, respectively, for these acquired plans in 2020. These acquired plans will be merged into our legacy savings and investment 401(k) plan as soon as administratively possible. We recorded additional expense of $4,481 for company matching contributions related to the acquired Clarcor defined contribution plans in 2018. The former employees of Clarcor became eligible to participate in our legacy savings and investment 401(k) plan during 2018.

Other Postretirement Benefits - The Company provides postretirement medical and life insurance benefits to certain retirees and eligible dependents. Most plans are contributory, with retiree contributions adjusted annually. The plans are unfunded and pay stated percentages of covered medically necessary expenses incurred by retirees after subtracting payments by Medicare or other providers and after stated deductibles have been met. For most plans, the Company has established cost maximums to more effectively control future medical costs. We have reserved the right to change these benefit plans.

The Company recognized $1,551, $1,838 and $2,755 in expense related to other postretirement benefits in 2020, 2019 and 2018, respectively. Components of net other postretirement benefit cost, other than service cost, are included in other (income) expense, net in the Consolidated Statement of Income.

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Change in benefit obligation

Benefit obligation at beginning of year $ 60,998 $ 66,521

Benefit obligation at end of year $ 72,130 $ 60,998

Amounts recognized on the Consolidated Balance Sheet

Other accrued liabilities $ (6,374 ) $ (5,308 )

Pensions and other postretirement benefits (65,756 ) (55,690 )

Amounts recognized in Accumulated Other Comprehensive (Loss)

Net actuarial gain $ (173 ) $ (1,713 )

Prior service credit (73 ) (194 )

Net amount recognized $ (246 ) $ (1,907 )

The presentation of the amounts recognized on the Consolidated Balance Sheet and in accumulated other comprehensive (loss) is on a debit (credit) basis and is before the effect of income taxes.

The benefit obligation increased in 2020, primarily reflected in the acquisition component, is a result of assuming the Lord postretirement plans. The decrease in the benefit obligation in 2019, largely reflected in the net actuarial gain component, is primarily due to updated census data resulting from a different mix of benefit selections and actuarial assumptions reflecting lower benefit claims offset by decreases in the discount rates.

The assumptions used to measure the net periodic benefit cost for postretirement benefit obligations are:

Current medical cost trend rate (Pre-65 participants) 7.09 % 7.47 % 8.19 %

Current medical cost trend rate (Post-65 participants) 7.43 % 7.87 % 9.79 %

Ultimate medical cost trend rate 4.50 % 4.50 % 4.50 %

Medical cost trend rate decreases to ultimate in year 2028 2026 2025

The discount rate assumption used to measure the benefit obligation was 2.14 percent in 2020 and 3.15 percent in 2019.

Estimated future benefit payments for other postretirement benefits in the five years ending June 30,2021 through 2025 are $6,373, $5,772, $5,256, $4,938 and $4,622, respectively, and $20,172 in the aggregate for the five years ending June 30, 2026 through June 30, 2030.

Other - The Company has established nonqualified deferred compensation programs, which permit officers, directors and certain management employees to annually elect to defer a portion of their compensation, on a pre-tax basis, until their retirement. The retirement benefit to be provided is based on the amount of compensation deferred, company matching contributions and earnings on the deferrals. In addition, we maintain a defined contribution nonqualified supplemental executive pension plan in which the Company is the only contributor. During 2020, 2019 and 2018, we recorded expense relating to these programs of $5,863, $5,916 and $13,420, respectively.

The Company has invested in corporate-owned life insurance policies to assist in meeting the obligations under these programs. The policies are held in a rabbi trust and are recorded as assets of the Company.

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Changes in accumulated other comprehensive (loss) in shareholders' equity by component:

Foreign Currency Translation Adjustment and Other Retirement Benefit Plans Total

Significant reclassifications out of accumulated other comprehensive (loss) in shareholders' equity during 2020:

Retirement benefit plans

Recognized actuarial loss (165,550 ) Other (income) expense, net

Significant reclassifications out of accumulated other comprehensive (loss) in shareholders' equity during 2019:

Retirement benefit plans

Recognized actuarial loss (121,534 ) Other (income) expense, net

Share Repurchases- The Company has a program to repurchase its common shares. On October 22, 2014, the Board of Directors of the Company approved an increase in the overall number of shares authorized to repurchase under the program so that, beginning on such date, the aggregate number of shares authorized for repurchase was 35 million. There is no limitation on the number of shares that can be repurchased in a year. Repurchases may be funded primarily from operating cash flows and commercial paper borrowings and the shares are initially held as treasury shares. In March 2020, the Company suspended the share repurchase program in response to business uncertainty resulting from the COVID-19 pandemic.

The number of common shares repurchased at the average purchase price follows:

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14. Stock Incentive Plans

The Company's 2016 Omnibus Stock Incentive Plan ("2016 SIP") provides for the granting of share-based incentive awards in the form of nonqualified stock options, stock appreciation rights ("SARs"), restricted stock units ("RSUs") and restricted and unrestricted stock to officers and key employees of the Company. On October 23, 2019, our shareholders approved the Board of Directors' recommendation to increase the number of shares of common stock authorized for issuance under the 2016 SIP by 7.8 million shares. The amended aggregate number of shares of common stock authorized for total issuance under the 2016 SIP is 23.8 million. At June 30, 2020, 13.5 million common stock shares were available for future issuance.

We satisfy share-based incentive award obligations by issuing shares of common stock out of treasury, which have been repurchased pursuant to our share repurchase program described in Note 13, or through the issuance of previously unissued common stock.

SARs - Upon exercise, SARs entitle the participant to receive shares of common stock equal to the increase in value of the award between the grant date and the exercise date. SARs are exercisable from one to three years after the date of grant and expire no more than 10 years after grant.

The fair value of each SAR award granted in 2020, 2019 and 2018 was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:

Risk-free interest rate 1.5 % 2.8 % 1.9 %

Expected life of award 5.1 years 5.1 years 5.2 years

Expected dividend yield of stock 2.0 % 1.9 % 2.0 %

Expected volatility of stock 25.9 % 24.2 % 23.4 %

The risk-free interest rate was based on U.S. Treasury yields with a term similar to the expected life of the award. The expected life of the award was derived by referring to actual exercise and post-vesting employment termination experience. The expected dividend yield was based on our historical dividend rate and stock price over a period similar to the expected life of the award. The expected volatility of stock was derived by referring to changes in our historical common stock prices over a time-frame similar to the expected life of the award.

PH US Equity

PH · 10-K · period ended 2020-06-30

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

ITEM 7A.Quantitative and Qualitative Disclosures About Market Risk.

ITEM 8. Financial Statements and Supplementary Data.

PH US Equity☆

PH · 10-K · period ended 2020-06-30

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

ITEM 7A.Quantitative and Qualitative Disclosures About Market Risk.

ITEM 8. Financial Statements and Supplementary Data.

PH US Equity