Revenue

The Company recognizes revenue on a wide range of filtration solutions sold to customers in many industries around the globe. The vast majority of the Company’s performance obligations within customer sales contracts are for manufactured filtration systems and replacement parts. The Company does perform limited services, such as nonrecurring engineering (NRE) and installation. Customer contracts may include multiple performance obligations and the transaction price is allocated to each distinct performance obligation based on its relative standalone selling price.

Revenue Recognition Policy

Revenue is measured as the amount of consideration the Company expects to receive in exchange for the fulfillment of performance obligations. The transaction price of a contract could be reduced by variable consideration including product refunds, returns, volume rebates and discounts in the determination of net sales. The Company primarily relies on historical experience and anticipated future performance to estimate the variable consideration. Revenue is recognized to the extent that it is probable that a significant reversal of revenue will not occur when the contingency is resolved. The Company also accounts for amounts billed to customers for reimbursement of shipping and handling as fulfillment costs by recording these amounts as revenue and accruing the costs when the related revenue is recognized.

For most customer contracts, the Company recognizes revenue at a point in time when control of the goods or services is transferred to the customer. For product sales, control is typically deemed to have transferred in accordance with the shipping terms, either at the time of shipment from the plants or distribution centers or the time of delivery to the customers. Revenue is recognized for services upon completion of those services.

Due to the customized nature of some of the Company’s products, together with contractual provisions in certain customer contracts that provide the Company with an enforceable right to payment of the transaction price for performance completed to date, revenue is recognized for these contracts over time. For these contracts, the Company recognizes revenue on products by an output measure of production, which fairly depicts the amount of revenue the Company is entitled to. The timing of revenue recognized from these products is slightly accelerated compared to revenue recognized at the point in time of shipment or delivery. Revenue generated from NRE services is also satisfied over time and measured as contractual milestones are achieved, as this represents value transferred to the customer.

Incremental costs of obtaining a contract with a customer and other costs to fulfill a contract are required to be capitalized unless the Company elects to expense contract costs with periods less than a year. The Company has elected to expense these costs of obtaining a contract as incurred when the related contract period is less than one year. The Company does not pay upfront sales commissions on contracts when the related contract period is greater than one year, thus has not capitalized any amounts as of April 30, 2019.

Revenue Disaggregation

Net sales disaggregated by geography based on the location where the customer's order was placed (in millions):



	Three Months Ended April 30,				Nine Months Ended April 30,
	2019		2018		2019		2018
United States	$	301.5	$	280.3	$	896.0	$	827.0
Europe, Middle East and Africa	208.0		206.3		611.7		583.1
Asia Pacific	146.8		158.0		443.4		438.1
Latin America	56.5		55.4		166.8		161.3
Total net sales	$	712.8	$	700.0	$	2,117.9	$	2,009.5

Net sales disaggregated by product group (in millions):



	Three Months Ended April 30,				Nine Months Ended April 30,
	2019		2018		2019		2018
Engine Products segment
Off-Road	$	84.8	$	89.9	$	240.0	$	243.8
On-Road	46.9		42.2		135.6		110.7
Aftermarket	327.7		315.1		980.0		927.7
Aerospace and Defense	30.0		25.1		83.7		74.6
Engine Products segment net sales	489.4		472.3		1,439.3		1,356.8

Industrial Products segment
Industrial Filtration Solutions	155.2		152.2		469.2		431.8
Gas Turbine Systems	27.5		32.1		80.5		91.4
Special Applications	40.7		43.4		128.9		129.5
Industrial Products segment net sales	223.4		227.7		678.6		652.7
Total net sales	$	712.8	$	700.0	$	2,117.9	$	2,009.5

Contract Assets and Liabilities

The satisfaction of performance obligations and the resulting recognition of revenue typically corresponds with billing of the customer. In limited circumstances, the customer may be billed at a time later than when revenue is recognized, resulting in contract assets, which are reported in prepaid expenses and other current assets on the Condensed Consolidated Balance Sheets. Contract assets were $12.3 million as of April 30, 2019. In other limited circumstances, the Company will require a down payment from the customer prior to the satisfaction of performance obligations. This results in contract liabilities, or deferred revenue, which is reported in other current liabilities and other long-term liabilities on the Condensed Consolidated Balance Sheets, depending on when revenue is expected to be recognized. Contract liabilities were $15.1 million and $10.5 million as of April 30, 2019 and July 31, 2018, respectively.

The Company will recognize revenue in future periods related to remaining performance obligations for certain open contracts. Generally, these contracts have terms of one year or less. The amount of revenue related to unsatisfied performance obligations in which the original duration of the contract is greater than one year is not significant.

Adoption of ASC 606

Note 1 describes the requirements of the new revenue recognition standard, ASC 606. The cumulative effect of the adoption on the Company’s August 1, 2018 opening balance sheet is as follows (in millions):



	Balance at July 31, 2018		Adjustments for ASC 606			Balance at August 1, 2018
Assets
Inventories, net	$	334.1	$	(7.3	)	$	326.8
Prepaid expense and other current assets	52.3		14.0			66.3
Liabilities
Other current liabilities	86.6		0.3			86.9
Deferred income taxes	4.2		1.1			5.3
Equity
Retained earnings	1,122.1		5.3			1,127.4

These adjustments primarily related to certain contracts that qualify for revenue recognition over time under the new standard. This change does not have a material impact on revenue recognized during the nine months ended April 30, 2019.

In addition, the adoption of ASC 606 impacted one set of contracts within the Engine Products segment in which Donaldson is now deemed to be the principal under the new standard because the Company has control through the manufacturing of products prior to the sale of those products to the customer. For these contracts, the previous practice of recognizing revenue on a net basis, in which the amount of net sales recorded is the net amount retained after paying product costs to suppliers, has changed under ASC 606 to recognizing revenue on a gross basis, in which the amount of net sales recorded is the gross amount received from the customer, with corresponding product costs recorded as cost of sales. This change did not result in a cumulative effect adjustment under the modified retrospective method of adoption since there is no impact to the timing of revenue recognition but it has increased net sales and cost of sales on a prospective basis. The increase in net sales and cost of sales for this change was $3.6 million and $12.3 million for the three and nine months ended April 30, 2019, respectively.