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

NOTE REGARDING AMOUNTS AND FISCAL YEAR REFERENCES

In this annual report, all amounts related to United States dollars and foreign currency and to the number of Nordson Corporation’s common shares, except for per share earnings and dividend amounts, are expressed in thousands. Unless the context otherwise indicates, all references to “we,” “us,” “our,” or the “Company” mean Nordson Corporation.

Unless otherwise noted, all references to years relate to our fiscal year ending October 31.

Critical Accounting Policies and Estimates

Our Consolidated Financial Statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates, judgments and assumptions that affect reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate the accounting policies and estimates that are used to prepare financial statements. We base our estimates on historical experience and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates used by management.

Certain accounting policies that require significant management estimates and are deemed critical to our results of operations or financial position are discussed below. On a regular basis, critical accounting policies are reviewed with the Audit Committee of the board of directors.

Revenue recognition – Most of our revenues are recognized upon shipment, provided that persuasive evidence of an arrangement exists, the sales price is fixed or determinable, collectibility is reasonably assured, and title and risk of loss have passed to the customer. Certain arrangements may include installation, installation supervision, training, and spare parts, which tend to be completed in a short period of time, at an insignificant cost, and utilizing skills not unique to us, and, therefore, are typically regarded as inconsequential or perfunctory. Revenue for undelivered items is deferred and included within accrued liabilities in the Consolidated Balance Sheet. Revenues deferred in 2018, 2017 and 2016 were not material.

Business combinations – The acquisitions of our businesses are accounted for under the acquisition method of accounting. The amounts assigned to the identifiable assets acquired and liabilities assumed in connection with acquisitions are based on estimated fair values as of the date of the acquisition, with the remainder, if any, recorded as goodwill. The fair values are determined by management, taking into consideration information supplied by the management of the acquired entities, and other relevant information. Such information typically includes valuations obtained from independent appraisal experts, which management reviews and considers in its estimates of fair values. The valuations are generally based upon future cash flow projections for the acquired assets, discounted to present value. The determination of fair values requires significant judgment by management, particularly with respect to the value of identifiable intangible assets. This judgment could result in either a higher or lower value assigned to amortizable or depreciable assets. The impact could result in either higher or lower amortization and/or depreciation expense.

Goodwill – Goodwill is the excess of purchase price over the fair value of tangible and identifiable intangible net assets acquired in various business combinations. Goodwill is not amortized but is tested for impairment annually at the reporting unit level, or more often if indications of impairment exist. Our reporting units are the Adhesive Dispensing Systems segment, the Industrial Coating Systems segment and one level below the Advanced Technology Systems segment. 

We test goodwill in accordance with Accounting Standards Codification (ASC) 350. Goodwill impairment charge is recorded for the amount by which the carrying value of the reporting unit exceeds the fair value of the reporting unit, as calculated in the quantitative analysis described below. We did not record any goodwill impairment charges in 2018. We use an independent valuation specialist to assist with refining our assumptions and methods used to determine fair values using these methods. To test for goodwill impairment, we estimate the fair value of each of our reporting units using a combination of the Income Approach and the Market Approach.

The discounted cash flow method (Income Approach) uses assumptions for revenue growth, operating margin, and working capital turnover that are based on management’s strategic plans tempered by performance trends and reasonable expectations about those trends. Terminal value calculations employ a published formula known as the Gordon Growth Model Method that essentially captures the present value of perpetual cash flows beyond the last projected period assuming a constant Weighted Average Cost of Capital (WACC) methodology and growth rate. For each reporting unit, a sensitivity analysis is performed to vary the discount and terminal growth rates in order to provide a range of reasonableness for detecting impairment. Discount rates are developed using a WACC methodology. The WACC represents the blended average required rate of return for equity and debt capital based on observed market return data and company specific risk factors. For 2018, the discount rates used ranged from 9.5 percent to 12 percent depending upon the reporting unit's size, end market volatility, and projection risk.

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In the applicatio n of the guideline public company method (Market Approach), fair value is determined using transactional evidence for similar publicly traded equity. The comparable company guideline group is determined based on relative similarities to each reporting unit since exact correlations are not available. An indication of fair value for each reporting unit is based on the placement of each reporting unit within a range of multiples determined for its comparable guideline company group. Valuation multiples are de r ived by dividing latest twelve- month performance for revenues and EBITDA into total invested capital, which is the sum of traded equity plus interest bearing debt less cash. These multiples are applied against the revenue and EBITDA of each reporting unit. While the implied indications of fair value using the guideline public company method yield meaningful results, the discounted cash flow method of the income approach includes management’s thoughtful projections and insights as to what the reporting units will accomplish in the near future. Accordingly, the reasonable, implied fair value of each reporting unit is a blend based on the consideration of both the Income and Market approaches.

In 2018, 2017, and 2016, the results of our annual impairment tests indicated no impairment.

The excess of fair value (FV) over carrying value (CV) was compared to the carrying value for each reporting unit. Based on the results shown in the table below and based on our measurement date of August 1, 2018, our conclusion is that no goodwill was impaired in 2018. Potential events or circumstances, such as a sustained downturn in global economies, could have a negative effect on estimated fair values.

Pension plans and postretirement medical plans - The measurement of liabilities related to our pension plans and postretirement medical plans is based on management’s assumptions related to future factors, including interest rates, return on pension plan assets, compensation increases, mortality and turnover assumptions, and health care cost trend rates.

The weighted-average discount rate used to determine the present value of our domestic pension plan obligations was 4.53 percent at October 31, 2018 and 3.80 percent at October 31, 2017. The weighted-average discount rate used to determine the present value of our various international pension plan obligations was 2.14 percent at October 31, 2018, compared to 2.07 percent at October 31, 2017. The discount rates used for all plans were determined by using quality fixed income investments with a duration period approximately equal to the period over which pension obligations are expected to be settled.

In determining the expected return on plan assets, we consider both historical performance and an estimate of future long-term rates of return on assets similar to those in our plans. We consult with and consider the opinions of financial and actuarial experts in developing appropriate return assumptions. The expected rate of return (long-term investment rate) on domestic pension assets used to determine net benefit costs was 6.00 percent in 2018 and 6.25 percent in 2017. The average expected rate of return on international pension assets used to determine net benefit costs was 3.91 percent in 2018 and 3.51 percent in 2017.

The assumed rate of compensation increases used to determine the present value of our domestic pension plan obligations was 3.90 percent at October 31, 2018, compared to 3.61 percent at October 31, 2017. The assumed rate of compensation increases used to determine the present value of our international pension plan obligations was 3.12 percent at October 31, 2018, compared to 3.13 percent at October 31, 2017.

Annual expense amounts are determined based on the discount rate used at the end of the prior year. Differences between actual and assumed investment returns on pension plan assets result in actuarial gains or losses that are amortized into expense over a period of years.

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Economic assumptions have a significant effect on the amounts reported. The effect of a one percent change in the discount rate, expec ted return on assets and compensation increase is shown in the table below. Bracketed numbers represent decreases in expense and obligation amounts.

With respect to the domestic postretirement medical plan, the discount rate used to value the benefit plan was 4.56 percent at October 31, 2018 and 3.86 percent at October 31, 2017. The annual rate of increase in the per capita cost of covered benefits (the health care cost trend rate) is assumed to be 3.75 percent in 2019, decreasing gradually to 3.27 percent in 2026.

For the international postretirement plan, the discount rate used to value the benefit obligation was 3.88 percent at October 31, 2018 and 3.52 percent at October 31, 2017. The annual rate of increase in the per capita cost of covered benefits (the health care cost trend rate) is assumed to be 6.35 percent in 2019, decreasing gradually to 3.50 percent in 2037.

The discount rate and the health care cost trend rate assumptions have a significant effect on the amounts reported. For example, a one-percentage point change in the discount rate and the assumed health care cost trend rate would have the following effects. Bracketed numbers represent decreases in expense and obligation amounts.

Employees hired after January 1, 2002, are not eligible to participate in the domestic postretirement medical plan.

In the fourth quarter of 2016, we adopted a change in the method to be used to estimate the service and interest cost components of net periodic benefit cost for defined benefit pension plans.  Historically, for the vast majority of our plans, the service and interest cost components were estimated using a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period.  Beginning in 2017, we used a spot rate approach by applying the specific spot rates along the yield curve to the relevant projected cash flows in the estimation of the service and interest components of benefit cost, resulting in a more precise measurement.  This change did not affect the measurement of total benefit obligations.  The change was accounted for as a change in estimate that is inseparable from a change in accounting principle and, accordingly, was accounted for prospectively starting in 2017. The reductions in service and interest costs for 2017 associated with this change were $1,200 and $3,100, respectively.

Pension and postretirement expenses in 2019 are expected to be approximately $990 lower than 2018.

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Income taxes – Income taxes are estimated based on income for financial reporting purposes. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabili ties for financial reporting purposes and the amounts used for income tax purposes and certain changes in valuation allowances. We provide valuation allowances against deferred tax assets if, based on available evidence, it is more likely than not that som e portion or all of the deferred tax assets will not be realized.

Management believes the valuation allowances are adequate after considering future taxable income, allowable carryforward periods and ongoing prudent and feasible tax planning strategies. In the event we were to determine that we would be able to realize the deferred tax assets in the future in excess of the net recorded amount (including the valuation allowance), an adjustment to the valuation allowance would increase income in the period such determination was made. Conversely, should we determine that we would not be able to realize all or part of the net deferred tax asset in the future, an adjustment to the valuation allowance would be expensed in the period such determination was made.

Further, at each interim reporting period, we estimate an effective income tax rate that is expected to be applicable for the full year. Judgment is involved regarding the application of global income tax laws and regulations and when projecting the jurisdictional mix of income. Additionally, interpretation of tax laws, court decisions or other guidance provided by taxing authorities influences our estimate of the effective income tax rates. As a result, our actual effective income tax rates and related income tax liabilities may differ materially from our estimated effective tax rates and related income tax liabilities. Any resulting differences are recorded in the period they become known.

2018 compared to 2017

Sales – Worldwide sales for 2018 were $2,254,668, an increase of 9.1 percent from 2017 sales of $2,066,982. Sales volume increased 7.1 percent and favorable currency translation effects increased sales by 2.0 percent. The volume increase consisted of 2.5 percent from organic growth and 4.6 percent from acquisitions. We had two acquisitions during 2018, Sonoscan, Inc. (“Sonoscan”), and Cladach Nua Teoranta (“Clada”), which are both included within the Advanced Technology Systems segment. We had four acquisitions during 2017, ACE Production Technologies, Inc. (“ACE”), Plas-Pak Industries, Inc. (“Plas-Pak), InterSelect GmbH (“InterSelect”), and Vention Medical’s Advanced Technologies business (“Vention”), which are also included within the Advanced Technology Systems segment. As used throughout this Form 10-K, geographic regions include the Americas (Canada, Mexico and Central and South America), Asia Pacific (excluding Japan), Europe, Japan, and the United States.

Sales of the Adhesive Dispensing Systems segment were $955,192 in 2018, an increase of $39,173, or 4.3 percent, from 2017 sales of $916,019. The increase was the result of a sales volume increase of 1.5 percent and favorable currency effects that increased sales by 2.8 percent. Within this segment, sales volume increased in all geographic regions with the exception of the United States. Growth in packaging and product assembly product lines was offset by softness in product lines serving polymer processing end markets.

Sales of the Advanced Technology Systems segment were $1,039,366 in 2018, an increase of $141,743 or 15.8 percent, from 2017 sales of $897,623. The increase was the result of a sales volume increase of 14.5 percent and favorable currency effects that increased sales by 1.3 percent. The sales volume increase consisted of 3.8 percent from organic volume and 10.7 percent from the first-year effect of acquisitions. Within this segment, sales volume, inclusive of acquisitions, increased in all geographic regions with the exception of the Asia Pacific region. Organic volume was driven by demand in our fluid management product lines serving industrial and medical end markets.

Sales of the Industrial Coating Systems segment were $260,110 in 2018, an increase of $6,770, or 2.7 percent, from 2017 sales of $253,340. The increase was the result of a sales volume increase of 1.1 percent and favorable currency effects that increased sales by 1.6 percent. Within this segment, sales volume increased in Europe, Japan and the Asia Pacific regions. Growth in powder, liquid and container product lines serving industrial end markets was offset by softness in cold materials product lines serving automotive end markets .

Sales outside the United States accounted for 68.0 percent of our sales in 2018, as compared to 68.7 percent in 2017. On a geographic basis, sales in the United States were $720,832, an increase of 11.3 percent from 2017. The increase in sales volume consisted of 1.9 percent from organic volume and 9.4 percent from acquisitions. In the Americas region, sales were $158,837, an increase of 8.0 percent from 2017, with volume increasing 8.8 percent partially offset by unfavorable currency effects of 0.8 percent. The increase in sales volume consisted of 3.5 percent from organic volume and 5.3 percent from acquisitions. Sales in Europe were $622,108, an increase of 17.2 percent from 2017, with volume increasing 11.4 percent and favorable currency effects of 5.8 percent. The increase in sales volume consisted of 9.2 percent from organic volume and 2.2 percent from acquisitions. Sales in Japan were $161,771, an increase of 9.9 percent from 2017, with volume increasing 8.6 percent and favorable currency effects of 1.3 percent. The increase in sales volume consisted of 7.0 percent from organic volume and 1.6 percent from acquisitions. Sales in the Asia Pacific region were $591,120, a decrease of 0.5 percent from 2017, with volume decreasing 2.2 percent partially offset by favorable currency effects of 1.7 percent. The decrease in sales volume consisted of lower organic volume of 4.4 percent, offset by 2.2 percent growth from acquisitions.

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It is estimated that the effect of pricing on 2018 tot al sales was not material relative to 2017.

Operating profit – Cost of sales were $1,018,703 in 2018, up 9.8 percent from $927,981 in 2017. Gross profit, expressed as a percentage of sales, decreased to 54.8 percent in 2018 from 55.1 percent in 2017. Of the 0.3 percentage point decrease in gross margin, unfavorable product mix contributed 0.7 percentage points offset by 0.4 percentage points due to favorable currency translation effects.

Selling and administrative expenses were $734,856 in 2018, compared to $678,861 in 2017. The 8.2 percent increase includes 8.7 percent primarily in support of higher sales growth and 1.7 percent due to unfavorable currency translation effects, offset by 2.2 percent due to lower acquisition transaction costs in the current year.

Selling and administrative expenses as a percentage of sales decreased to 32.6 percent in 2018 from 32.8 percent in 2017. Of the 0.2 percentage point improvement, 0.7 percentage points is due to lower acquisition transaction costs, offset by 0.5 percentage points due to higher base business costs.

Severance and restructuring costs of $6,552 were recorded in 2018. Within the Adhesives Dispensing Systems segment, a restructuring initiative to consolidate certain polymer processing product line facilities in the U.S. resulted in severance and restructuring costs of $5,631. Within the Advanced Technology Systems segment, severance costs of $401 were recorded in Europe. Severance costs of $520 were recorded in the U.S. due to a Corporate restructuring initiative. No costs related to severance and restructuring were recorded in the Industrial Coating Systems segment in 2018. Additional costs related to these initiatives are not expected to be material in future periods. All severance and restructuring costs are included in selling and administrative expenses in the Consolidated Statements of Income.

Operating capacity for each of our segments can support fluctuations in order activity without significant changes in operating costs. Also, currency translation affects reported operating margins. Operating margins for each segment were favorably impacted by a weaker dollar primarily against the Euro during 2018 as compared to 2017.

Operating profit as a percentage of sales decreased to 21.9 percent in 2018 compared to 22.1 percent in 2017. Of the 0.2 percentage point decline in operating margin, unfavorable leverage of our selling and administrative expenses contributed 0.9 percentage points, higher severance and restructuring expenses contributed 0.2 percentage points, and unfavorable product mix contributed 0.7 percentage points. This decline was offset by 0.3 percentage points due to the first year effect of acquisitions, 0.7 percentage points due to lower acquisition transaction costs, and 0.6 percentage points due to favorable foreign currency translation effects.

For the Adhesive Dispensing Systems segment, operating profit as a percentage of sales decreased to 27.2 percent in 2018 compared to 27.7 percent in 2017. Of the 0.5 percentage point decline in operating margin, dilution in gross margin of 0.8 percentage points was due to the consolidation of certain facilities in the U.S., and higher severance and restructuring expenses contributed 0.3 percentage points, offset by favorable foreign currency translation effects of 0.6 percentage points.

For the Advanced Technology Systems segment, operating profit as a percentage of sales decreased to 23.4 percent in 2018 compared to 25.4 percent in 2017. Of the 2.0 percentage point decline in operating margin, unfavorable product mix contributed 1.2 percentage points, incremental amortization expense contributed 1.1 percentage points, and higher severance and restructuring expenses contributed 0.1 percentage points. This decline was partially offset by 0.4 percentage points due to favorable foreign currency translation effects.

For the Industrial Coating Systems segment, operating profit as a percentage of sales increased to 19.5 percent in 2018 compared to 17.4 percent in 2017. Of the 2.1 percentage point improvement in operating margin, 1.9 percentage points related to favorable product mix and 0.4 percentage points related to favorable foreign currency translation effects.  This improvement was partially offset by 0.2 percentage points due to un favorable leverage of our selling and administrative expenses .    

Interest and other income (expense) - Interest expense in 2018 was $49,576, an increase of $12,975, or 35.4 percent, from 2017. The increase was due to higher average borrowing levels between periods. Other income in 2018 was $2,154 compared to other expense of $1,934 in 2017. Included in the current year’s other income are foreign currency gains of $1,133 and a non-recurring gain of $2,512. Included in the prior year’s other expense were foreign currency losses of $686.

Income taxes –

Income tax expense in 2018 was $71,144, or 15.9 percent of pre-tax income, as compared to $124,489, or 29.6 percent of pre-tax income in 2017.

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On December 22, 2017, the U.S. Tax Cuts and Jobs Act ("the Act") was enacted.  It reduced the U.S. federal corporate income tax rate from 35 percent to 21 percent.  We hav e an October 31 fiscal year-end, therefore the lower corporate income tax rate will be phased in, resulting in a U.S. statutory federal rate of 23.34 percent for our fiscal year ended October 31, 2018, and 21 percent for subsequent fiscal years.  The statu tory tax rate of 23.34 percent was applied to earnings in the current year.  

The Act requires us to revalue our existing U.S. deferred tax balance to reflect the lower statutory tax rate and pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously deferred from U.S. taxes.  As a result, during 2018, we recorded a provisional tax benefit of $49,082 to reflect the revaluation of our tax assets and liabilities at the reduced corporate tax rate. We also recorded a provisional tax expense of $27,618 to reflect the transition tax on previously deferred foreign earnings.  The net tax effect of these discrete items resulted in a decrease of $21,464 in income tax expense for 2018.  We intend to pay the transition tax in installments over the eight-year period allowable under the Act. The transition tax is primarily included in other long-term liabilities in the Consolidated Balance Sheet at October 31, 2018.  Incremental adjustments have been made to these estimates during the three months ended October 31, 2018 based on availability of additional information.  The amounts recorded are considered a provisional estimate under the U.S. Securities and Exchange Commission Staff Accounting Bulletin No. 118. The provisional calculations may change after various components of the computation are finalized. Furthermore, we are still analyzing certain aspects of the Act and related interpretive guidance and refining our calculations, which could potentially affect the measurement of these balances or give rise to new or additional deferred tax amounts. Certain provisions of the Act will impact the Company starting in 2019. These provisions include, but are not limited to, the creation of the base erosion anti-abuse tax, a general limitation of U.S. federal income taxes on dividends from foreign subsidiaries, a new provision designed to tax global intangible low-taxed income and the repeal of the domestic production activities deduction. We continue to evaluate the future impacts of these provisions and, as of October 31, 2018, have not recorded any impact of any of these future provisions.

In March 2016, the FASB issued a new standard which simplifies the accounting for share-based payment transactions, which we adopted in the first quarter of 2018. This guidance requires that excess tax benefits and tax deficiencies be recognized as income tax expense or benefit in the Consolidated Statements of Income rather than as additional paid-in capital.  Our income tax provision for 2018 also includes a favorable adjustment to unrecognized tax benefits of $1,120 related to the lapse of the statute of limitations.

Our income tax provision for 2017 includes a discrete tax expense of $1,070 related to nondeductible acquisition costs.

Net income – Net income was $377,375, or $6.40 per diluted share, in 2018, compared to net income of $295,802, or $5.08 per diluted share, in 2017. This represents a 27.6 percent increase in net income and a 26.0 percent increase in diluted earnings per share.

2017 compared to 2016

Sales – Worldwide sales for 2017 were $2,066,982, an increase of 14.3 percent from 2016 sales of $1,808,994. Sales volume increased 14.8 percent and unfavorable currency translation effects reduced sales by 0.5 percent. The volume increase consisted of 7.9 percent from organic growth and 6.9 percent from acquisitions. We had four acquisitions during 2017, ACE Production Technologies, Inc. (“ACE”), Plas-Pak Industries, Inc. (“Plas-Pak), InterSelect GmbH (“InterSelect”), and Vention Medical’s Advanced Technologies business (“Vention”), which are all included within the Advanced Technology Systems segment. We had one acquisition during 2016, LinkTech, which is also included within the Advanced Technology Systems segment. As used throughout this Form 10-K, geographic regions include the Americas (Canada, Mexico and Central and South America), Asia Pacific (excluding Japan), Europe, Japan, and the United States.

Sales of the Adhesive Dispensing Systems segment were $916,019 in 2017, an increase of $36,446, or 4.1 percent, from 2016 sales of $879,573. The increase was the net result of a sales volume increase of 4.3 percent partially offset by unfavorable currency effects that reduced sales by 0.2 percent. Within this segment, sales volume increased in all geographic regions with the exception of Europe. G rowth in product lines serving rigid packaging, consumer non-durable, disposable hygiene and general product assembly end markets, was offset by softness in product lines serving polymer processing end markets.

Sales of the Advanced Technology Systems segment were $897,623 in 2017, an increase of $221,294 or 32.7 percent, from 2016 sales of $676,329. The increase was the result of a sales volume increase of 33.4 percent partially offset by unfavorable currency effects that reduced sales by 0.7 percent. The sales volume increase consisted of 15.1 percent from organic volume and 18.3 percent from the first-year effect of acquisitions. Within the segment, sales volume, inclusive of acquisitions, increased in all geographic regions. Organic volume increased in most product lines, and was driven by demand in electronics and medical end markets.

Sales of the Industrial Coating Systems segment were $253,340 in 2017, an increase of $248, or 0.1 percent, from 2016 sales of $253,092. The increase was the result of a sales volume increase of 0.8 percent partially offset by unfavorable currency effects that reduced sales by 0.7 percent. Within this segment, sales volume increased in Europe, Japan and the Americas regions. Sales volume increased in most product lines, and was driven by demand for liquid and UV curing, powder coating and container product lines serving industrial end markets.

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Sales outside the United States accounted for 68.7 percent of our sales in 2017, as co mpared to 70.6 percent in 2016. On a geographic basis, sales in the United States were $647,657, an increase of 21.9 percent from 2016. The increase in sales volume consisted of 5.3 percent from organic volume and 16.6 percent from acquisitions. In the Ame ricas region, sales were $147,026, an increase of 17.9 percent from 2016, with volume increasing 18.0 percent partially offset by unfavorable currency effects of 0.1 percent. The increase in sales volume consisted of 7.7 percent from organic volume and 10. 3 percent from acquisitions. Sales in Europe were $530,812, an increase of 5.3 percent from 2016, with volume increasing 5.5 percent partially offset by unfavorable currency effects of 0.2 percent. The increase in sales volume consisted of 2.2 percent from organic volume and 3.3 percent from acquisitions. Sales in Japan were $147,189, an increase of 20.6 percent from 2016, with volume increasing 24.5 percent partially offset by unfavorable currency effects of 3.9 percent. The increase in sales volume consis ted of 23.1 percent from organic volume and 1.4 percent from acquisitions. Sales in the Asia Pacific region were $594,298, an increase of 12.7 percent from the prior year, with volume increasing 13.2 percent partially offset by unfavorable currency effects of 0.5 percent. The increase in sales volume consisted of 12.3 percent from organic growth and 0.9 percent from acquisitions.

It is estimated that the effect of pricing on 2017 total sales was not material relative to 2016.

Operating profit – Cost of sales were $927,981 in 2017, up 13.8 percent from $815,495 in 2016. Gross profit, expressed as a percentage of sales, increased to 55.1 percent in 2017 from 54.9 percent in 2016. Of the 0.2 percentage point improvement in gross margin, favorable product mix added 0.3 percentage points primarily related to higher sales growth in our Adhesive Dispensing Systems and Advanced Technology Systems segments, which have higher margins than the Industrial Coating Systems segment.  The 0.1 percentage point offset is primarily due to unfavorable currency translation effects.

Selling and administrative expenses were $678,861 in 2017, compared to $594,293 in 2016. The 14.2 percentage point increase includes 6.1 percent primarily in support of higher sales growth, 6.1 percent related to the first year effect of acquisitions and 2.5 percent of corporate charges related to acquisition transaction costs, offset by 0.5 percentage points due to currency translation effects.

Selling and administrative expenses as a percentage of sales decreased to 32.8 percent in 2017 from 32.9 percent in 2016. Of the 0.1 percentage point improvement, 2.5 percentage points is due to leveraging higher sales growth in our Adhesive Dispensing Systems and Advanced Technology Systems segments. This improvement was partially offset by 1.7 percentage points due to the first year effect of acquisitions and 0.7 percentage points due to corporate charges related to acquisition transaction costs.

Severance and restructuring costs of $2,438 were recorded in 2017. Within the Adhesives Dispensing Systems segment, restructuring initiatives to optimize operations in the U.S. and Belgium and consolidate certain polymer processing product line facilities in the U.S. resulted in severance and restructuring costs of $2,618. Within the Advanced Technology Systems segment, costs of $180 were reversed during 2017 related to a 2015 restructuring initiative. No costs related to severance and restructuring were recorded in the Industrial Coating Systems segment in 2017. Additional costs related to these initiatives are not expected to be material in future periods. All severance and restructuring costs are included in selling and administrative expenses in the Consolidated Statements of Income.

Operating capacity for each of our segments can support fluctuations in order activity without significant changes in operating costs. Also, currency translation affects reported operating margins. Operating margins for each segment were unfavorably impacted by a stronger dollar primarily against the Euro during 2017 as compared to 2016.

Operating profit as a percentage of sales increased to 22.1 percent in 2017 compared to 21.5 percent in 2016. Of the 0.6 percentage point improvement in operating margin, favorable leverage of our selling and administrative expenses contributed 2.4 percentage points, lower severance and restructuring expenses added 0.5 percentage points, and favorable product mix added 0.2 percentage points primarily related to higher sales growth in our Adhesives Dispensing Systems and Advanced Technology Systems segments. This improvement was offset by 1.7 percentage points due to the first year effect of acquisitions, 0.7 percentage points due to corporate charges related to acquisition transaction costs, and 0.1 percentage points due to short term purchase price accounting charges for acquired inventory.

For the Adhesive Dispensing Systems segment, operating profit as a percentage of sales increased to 27.7 percent in 2017 compared to 26.1 percent in 2016. Of the 1.6 percentage point improvement in operating margin, favorable product mix added 0.7 percentage points due to increased sales to consumer non-durable, disposable hygiene and rigid packaging end markets, lower severance and restructuring expenses added 0.6 percentage points, favorable foreign currency translation effects added 0.2 percentage points and favorable leverage of selling and administrative expenses added 0.1 percentage points.

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For the Advanced Tech nology Systems segment, operating profit as a percentage of sales increased to 25.4 percent in 2017 compared to 23.6 percent in 2016. Of the 1.8 percentage point improvement in operating margin, favorable leverage of our selling and administrative expenses due to higher sales contributed 5.6 percentage points, favorable product mix added 0.4 percentage points, and lower severance and restructuring expenses contributed 0.2 percentage points. These increases were partially offset by 4 .0 percentage points due to the first year effect of acquisitions, 0.3 percentage points due to unfavorable currency translation effects, and 0.1 percentage points due to short term purchase price accounting charges for acquired inventory.

For the Industrial Coating Systems segment, operating profit as a percentage of sales increased to 17.4 percent in 2017 compared to 17.2 percent in 2016. Of the 0.2 percentage point improvement in operating margin, lower severance and restructuring expenses added 0.8 percentage points and favorable leverage of our selling and administrative expenses added 0.4 percentage points.  These increases were offset by 0.7 percentage points related to unfavorable product mix and 0.3 percentage points related to unfavorable foreign currency translation effects.

Interest and other income (expense) - Interest expense in 2017 was $36,601, an increase of $15,279, or 71.7 percent, from 2016. The increase was due to higher average borrowing levels between periods. Other expense in 2017 was $1,934 compared to other income of $657 in 2016. Included in the current year’s other expense are foreign currency losses of $686. Included in the prior year’s other income were a litigation settlement of $800 and foreign currency gains of $2,004. These gains were partially offset by $1,530 of net unfavorable adjustments primarily related to the reversal of an indemnification asset resulting from the effective settlement of a tax exam.

Income taxes – Income tax expense in 2017 was $124,489, or 29.6 percent of pre-tax income, as compared to $96,651, or 26.2 percent of pre-tax income in 2016.

Our income tax provision for 2017 includes a discrete tax expense of $1,070 related to nondeductible acquisition costs.

On December 18, 2015, the Protecting Americans from Tax Hikes Act of 2015 was enacted which retroactively reinstated the Federal Research and Development Tax Credit (Federal R&D Tax Credit) as of January 1, 2015, and made it permanent. As a result, our income tax provision for 2016 includes a discrete tax benefit of $2,200 related to 2015.  The tax rate for 2016 also includes a discrete tax benefit of $6,154 related to dividends paid from previously taxed foreign earnings generated prior to 2015, and a benefit of $2,682 related to the effective settlement of a tax exam.

Net income – Net income was $295,802, or $5.08 per diluted share, in 2017, compared to net income of $271,843, or $4.73 per diluted share, in 2016. This represents an 8.8 percent increase in net income and a 7.4 percent increase in diluted earnings per share.