filings.toolsItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
A. O. Smith Corporation
We have audited the accompanying consolidated balance sheets of A. O. Smith Corporation as of December 31, 2014 and 2013, and the related consolidated statements of earnings, comprehensive earnings, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2014. Our audits also included the financial statement schedule listed in the index at Item 15(a). These financial statements and schedule are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of A. O. Smith Corporation at December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), A. O. Smith Corporation’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 17, 2015 expressed an unqualified opinion thereon.
Ernst & Young LLP
Milwaukee, Wisconsin
February 17, 2015
Table of Contents
CONSOLIDATED BALANCE SHEETS
| December 31 (dollars in millions) | ||||||||
| 2014 | 2013 | |||||||
| Assets | ||||||||
| Current Assets | ||||||||
| Cash and cash equivalents | $ | 319.4 | $ | 380.7 | ||||
| Marketable securities | 222.5 | 105.3 | ||||||
| Receivables | 475.4 | 458.7 | ||||||
| Inventories | 208.3 | 193.4 | ||||||
| Deferred income taxes | 40.5 | 40.1 | ||||||
| Other current assets | 52.9 | 27.4 | ||||||
| Total Current Assets | 1,319.0 | 1,205.6 | ||||||
| Net property, plant and equipment | 427.7 | 391.3 | ||||||
| Goodwill | 428.8 | 433.5 | ||||||
| Other intangibles | 308.5 | 324.8 | ||||||
| Other assets | 31.3 | 36.3 | ||||||
| Total Assets | $ | 2,515.3 | $ | 2,391.5 | ||||
| Liabilities | ||||||||
| Current Liabilities | ||||||||
| Trade payables | $ | 393.8 | $ | 387.1 | ||||
| Accrued payroll and benefits | 70.3 | 61.7 | ||||||
| Accrued liabilities | 85.1 | 81.2 | ||||||
| Product warranties | 42.3 | 46.7 | ||||||
| Long-term debt due within one year | 13.7 | 14.2 | ||||||
| Total Current Liabilities | 605.2 | 590.9 | ||||||
| Long-term debt | 210.1 | 177.7 | ||||||
| Deferred income taxes | 21.4 | 21.0 | ||||||
| Product warranties | 93.9 | 89.9 | ||||||
| Post-retirement benefit obligation | 9.6 | 10.0 | ||||||
| Pension liabilities | 133.1 | 110.7 | ||||||
| Other liabilities | 60.7 | 62.6 | ||||||
| Total Liabilities | 1,134.0 | 1,062.8 | ||||||
| Commitments and contingencies | — | — | ||||||
| Stockholders’ Equity | ||||||||
| Preferred Stock | — | — | ||||||
| Class A Common Stock (shares issued 13,220,470 and 13,288,516) | 66.1 | 66.4 | ||||||
| Common Stock (shares issued 82,133,326 and 82,065,280) | 82.1 | 82.1 | ||||||
| Capital in excess of par value | 600.1 | 589.7 | ||||||
| Retained earnings | 1,135.5 | 982.2 | ||||||
| Accumulated other comprehensive loss | (272.0 | ) | (259.1 | ) | ||||
| Treasury stock at cost | (230.5 | ) | (132.6 | ) | ||||
| Total Stockholders’ Equity | 1,381.3 | 1,328.7 | ||||||
| Total Liabilities and Stockholders’ Equity | $ | 2,515.3 | $ | 2,391.5 | ||||
See accompanying notes which are an integral part of these statements.
Table of Contents
CONSOLIDATED STATEMENT OF EARNINGS
| Years ended December 31 (dollars in millions, except per share amounts) | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Continuing Operations | ||||||||||||
| Net sales | $ | 2,356.0 | $ | 2,153.8 | $ | 1,939.3 | ||||||
| Cost of products sold | 1,496.7 | 1,380.0 | 1,287.3 | |||||||||
| Gross profit | 859.3 | 773.8 | 652.0 | |||||||||
| Selling, general and administrative expenses | 572.1 | 524.5 | 450.5 | |||||||||
| Restructuring, impairment and settlement expenses (income) - net | — | 11.0 | (3.9 | ) | ||||||||
| Contingent consideration adjustment | — | — | (3.3 | ) | ||||||||
| Interest expense | 5.7 | 5.7 | 9.2 | |||||||||
| Other income - net | (5.2 | ) | (3.8 | ) | (34.3 | ) | ||||||
| Earnings before provision for income taxes | 286.7 | 236.4 | 233.8 | |||||||||
| Provision for income taxes | 78.9 | 66.7 | 71.2 | |||||||||
| Earnings from Continuing Operations | 207.8 | 169.7 | 162.6 | |||||||||
| Discontinued Operations | ||||||||||||
| Loss on sale of discontinued EPC operations, including tax provision of $6.4 in 2012 | — | — | (3.9 | ) | ||||||||
| Net Earnings | $ | 207.8 | $ | 169.7 | $ | 158.7 | ||||||
| Net Earnings (Loss) Per Share of Common Stock | ||||||||||||
| Continuing operations | $ | 2.30 | $ | 1.84 | $ | 1.76 | ||||||
| Discontinued operations | — | — | (0.04 | ) | ||||||||
| Net Earnings | $ | 2.30 | $ | 1.84 | $ | 1.72 | ||||||
| Diluted Net Earnings (Loss) Per Share of Common Stock | ||||||||||||
| Continuing operations | $ | 2.28 | $ | 1.83 | $ | 1.75 | ||||||
| Discontinued operations | — | — | (0.04 | ) | ||||||||
| Net Earnings | $ | 2.28 | $ | 1.83 | $ | 1.71 | ||||||
CONSOLIDATED STATEMENT OF COMPREHENSIVE EARNINGS
| Years ended December 31 (dollars in millions) | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Net Earnings | $ | 207.8 | $ | 169.7 | $ | 158.7 | ||||||
| Other comprehensive (loss) earnings | ||||||||||||
| Foreign currency translation adjustments | (16.6 | ) | 0.4 | 3.0 | ||||||||
| Unrealized net (loss) gain on cash flow derivative instruments, less related income tax benefit (provision) of $0.1 in 2014, $(0.2) in 2013 and $(0.6) in 2012 | (0.1 | ) | 0.3 | 1.0 | ||||||||
| Change in pension liability less related income tax (provision) benefit of $(1.0) in 2014, $(39.7) in 2013 and $13.6 in 2012 | 3.8 | 60.7 | (22.4 | ) | ||||||||
| Unrealized loss on investments less related income tax benefit of $0.7 in 2012 | — | — | (1.2 | ) | ||||||||
| Comprehensive Earnings | $ | 194.9 | $ | 231.1 | $ | 139.1 | ||||||
See accompanying notes which are an integral part of these statements.
Table of Contents
CONSOLIDATED STATEMENT OF CASH FLOWS
| Years ended December 31 (dollars in millions) | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Operating Activities | ||||||||||||
| Net earnings | $ | 207.8 | $ | 169.7 | $ | 158.7 | ||||||
| Loss from discontinued operations | — | — | 3.9 | |||||||||
| Adjustments to reconcile earnings from continuing operations to cash provided by operating activities: | ||||||||||||
| Depreciation and amortization | 59.8 | 59.7 | 54.6 | |||||||||
| Pension expense | 28.6 | 27.9 | 13.8 | |||||||||
| Loss on disposal of assets | 0.1 | 0.2 | 1.1 | |||||||||
| Unrealized gain on investment | — | — | (27.2 | ) | ||||||||
| Net changes in operating assets and liabilities, net of acquisitions: | ||||||||||||
| Current assets and liabilities | (38.1 | ) | 20.5 | (36.6 | ) | |||||||
| Noncurrent assets and liabilities | 7.5 | 4.2 | 3.5 | |||||||||
| Cash Provided by Operating Activities - continuing operations | 265.7 | 282.2 | 171.8 | |||||||||
| Cash Used in Operating Activities - discontinued operations | (1.8 | ) | (2.6 | ) | (28.0 | ) | ||||||
| Cash Provided by Operating Activities | 263.9 | 279.6 | 143.8 | |||||||||
| Investing Activities | ||||||||||||
| Acquisitions of businesses | — | (4.0 | ) | (13.5 | ) | |||||||
| Investments in marketable securities | (321.9 | ) | (132.7 | ) | (311.4 | ) | ||||||
| Proceeds from sale of marketable securities | 202.0 | 226.2 | 308.0 | |||||||||
| Capital expenditures | (86.1 | ) | (97.7 | ) | (69.9 | ) | ||||||
| Cash Used in Investing Activities | (206.0 | ) | (8.2 | ) | (86.8 | ) | ||||||
| Financing Activities | ||||||||||||
| Long-term debt incurred | 34.2 | — | — | |||||||||
| Long-term debt repaid | — | (51.5 | ) | (218.8 | ) | |||||||
| Common stock repurchases | (103.8 | ) | (73.7 | ) | (22.0 | ) | ||||||
| Net proceeds from stock option activity | 4.8 | 10.2 | 20.5 | |||||||||
| Dividends paid | (54.4 | ) | (42.6 | ) | (33.2 | ) | ||||||
| Cash Used in Financing Activities | (119.2 | ) | (157.6 | ) | (253.5 | ) | ||||||
| Net (decrease) increase in cash and cash equivalents | (61.3 | ) | 113.8 | (196.5 | ) | |||||||
| Cash and cash equivalents-beginning of year | 380.7 | 266.9 | 463.4 | |||||||||
| Cash and Cash Equivalents-End of Year | $ | 319.4 | $ | 380.7 | $ | 266.9 | ||||||
See accompanying notes which are an integral part of these statements.
Table of Contents
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
| Years ended December 31 (dollars in millions) | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Class A Common Stock | ||||||||||||
| Balance at the beginning of the year | $ | 66.4 | $ | 66.5 | $ | 72.5 | ||||||
| Conversion of Class A Common Stock | (0.3 | ) | (0.1 | ) | (6.0 | ) | ||||||
| Balance at the end of the year | $ | 66.1 | $ | 66.4 | $ | 66.5 | ||||||
| Common Stock | ||||||||||||
| Balance at the beginning of the year | $ | 82.1 | $ | 82.1 | $ | 80.9 | ||||||
| Conversion of Class A Common Stock | — | — | 1.2 | |||||||||
| Balance at the end of the year | $ | 82.1 | $ | 82.1 | $ | 82.1 | ||||||
| Capital in Excess of Par Value | ||||||||||||
| Balance at the beginning of the year | $ | 589.7 | $ | 580.5 | $ | 575.8 | ||||||
| Conversion of Class A Common Stock | 0.3 | 0.1 | 4.8 | |||||||||
| Issuance of share units | (5.1 | ) | (5.1 | ) | (3.9 | ) | ||||||
| Vesting of share units | (3.1 | ) | (3.0 | ) | (4.9 | ) | ||||||
| Stock based compensation expense | 10.3 | 9.8 | 6.8 | |||||||||
| Exercises of stock options | (0.3 | ) | (3.0 | ) | (11.4 | ) | ||||||
| Tax benefit from exercises of stock options and vesting of share units | 2.4 | 4.8 | 8.8 | |||||||||
| Stock incentives and directors’ compensation | 5.9 | 5.6 | 4.5 | |||||||||
| Balance at the end of the year | $ | 600.1 | $ | 589.7 | $ | 580.5 | ||||||
| Retained Earnings | ||||||||||||
| Balance at the beginning of the year | $ | 982.2 | $ | 855.1 | $ | 729.9 | ||||||
| Net earnings | 207.8 | 169.7 | 158.7 | |||||||||
| Cash dividends on stock | (54.5 | ) | (42.6 | ) | (33.5 | ) | ||||||
| Balance at the end of the year | $ | 1,135.5 | $ | 982.2 | $ | 855.1 | ||||||
| Accumulated Other Comprehensive Loss | ||||||||||||
| Balance at the beginning of the year | $ | (259.1 | ) | $ | (320.5 | ) | $ | (300.9 | ) | |||
| Foreign currency translation adjustments | (16.6 | ) | 0.4 | 3.0 | ||||||||
| Unrealized net (loss) gain on cash flow derivative instruments, less related income tax benefit (provision) of $0.1 in 2014, $(0.2) in 2013 and $(0.6) in 2012 | (0.1 | ) | 0.3 | 1.0 | ||||||||
| Change in pension liability less related income tax (provision) benefit of $(1.0) in 2014, $(39.7) in 2013 and $13.6 in 2012 | 3.8 | 60.7 | (22.4 | ) | ||||||||
| Unrealized loss on investments less related income tax provision of $0.7 in 2012 | — | — | (1.2 | ) | ||||||||
| Balance at the end of the year | $ | (272.0 | ) | $ | (259.1 | ) | $ | (320.5 | ) | |||
| Treasury Stock | ||||||||||||
| Balance at the beginning of the year | $ | (132.6 | ) | $ | (69.6 | ) | $ | (72.4 | ) | |||
| Exercise of stock options, net of 5,846, 29,126 and 334,516 shares surrendered as proceeds and to pay taxes in 2014, 2013 and 2012 | 2.6 | 7.5 | 19.7 | |||||||||
| Stock incentives and directors’ compensation | 0.2 | 0.2 | 0.2 | |||||||||
| Shares repurchased | (103.8 | ) | (73.7 | ) | (22.0 | ) | ||||||
| Vesting of share units | 3.1 | 3.0 | 4.9 | |||||||||
| Balance at the end of the year | $ | (230.5 | ) | $ | (132.6 | ) | $ | (69.6 | ) | |||
| Total Stockholders’ Equity | $ | 1,381.3 | $ | 1,328.7 | $ | 1,194.1 | ||||||
See accompanying notes which are an integral part of these statements
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 1. | Organization and Significant Accounting Policies |
|---|
Organization. A. O. Smith Corporation (A. O. Smith or the company) is comprised of two reporting segments: North America and Rest of World. The Rest of World segment is primarily comprised of China, Europe and India. Both segments manufacture and market comprehensive lines of residential gas, gas tankless and electric water heaters and commercial water heating equipment. Both segments primarily serve their respective regions of the world. The North America segment also manufactures and markets specialty commercial water heating equipment, condensing and non-condensing boilers and water system tanks. The Rest of World segment also manufactures and markets water treatment products, primarily in Asia.
On August 22, 2011, the company sold its Electrical Products business (EPC) to Regal Beloit Corporation (RBC) for approximately $760 million in cash and approximately 2.83 million shares of RBC common stock. Due to the sale, EPC has been reported separately as a discontinued operation. See Note 2 Discontinued Operations.
Consolidation. The consolidated financial statements include the accounts of the company and its wholly owned subsidiaries after elimination of intercompany transactions.
Except when otherwise indicated, amounts reflected in the financial statements or the notes thereto relate to the company’s continuing operations.
Use of estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States (U.S.) requires management to make estimates and assumptions that affect the amounts reported in the accompanying financial statements and notes. Actual results could differ from those estimates.
Fair value of financial instruments. The carrying amounts of cash, cash equivalents, marketable securities, receivables, floating rate debt and trade payables approximated fair value as of December 31, 2014 and 2013, due to the short maturities or frequent rate resets of these instruments. The fair value of term notes with insurance companies was approximately $44.3 million as of December 31, 2014 compared with the carrying amount of $43.3 million for the same date. The fair value of term notes with insurance companies was approximately $63.8 million as of December 31, 2013 compared with the carrying amount of $59.4 million for the same date. The fair value is estimated based on current rates offered for debt with similar maturities.
Foreign currency translation. For all subsidiaries outside the U.S., with the exception of its Mexican operation and its Dutch non-operating companies, the company uses the local currency as the functional currency. For those operations using a functional currency other than the U.S. dollar, assets and liabilities are translated into U.S. dollars at year-end exchange rates, and revenues and expenses are translated at weighted-average exchange rates. The resulting translation adjustments are recorded as a separate component of stockholders’ equity. The Mexican operation and the Dutch non-operating companies use the U.S. dollar as the functional currency. Gains and losses from foreign currency transactions are included in net earnings and were not significant in 2014, 2013 or 2012.
Cash and cash equivalents. The company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
Marketable securities. The company considers all highly liquid investments with maturities greater than 90 days when purchased to be marketable securities. At December 31, 2014, the company’s marketable securities consisted of bank time deposits with original maturities ranging from 180 days to 12 months and are primarily located at investment grade rated banks in China.
Inventory valuation. Inventories are carried at lower of cost or market. Cost is determined on the last-in, first-out (LIFO) method for a majority of the company’s domestic inventories, which comprise 63 percent and 62 percent of the company’s total inventory at December 31, 2014 and 2013, respectively. Inventories of foreign subsidiaries, the remaining domestic inventories and supplies are determined using the first-in, first-out (FIFO) method.
Property, plant and equipment. Property, plant and equipment are stated at cost. Depreciation is computed primarily by the straight-line method. The estimated service lives used to compute depreciation are generally 25 to 50 years for buildings, three to 20 years for equipment and three to 15 years for software. Maintenance and repair costs are expensed as incurred.
Table of Contents
| 1. | Organization and Significant Accounting Policies (continued) |
|---|
Goodwill and other intangibles. Goodwill and indefinite-lived intangible assets are not amortized but are reviewed for impairment on an annual basis. Separable intangible assets, primarily comprised of customer relationships, that are not deemed to have an indefinite life are amortized on a straight-line basis over their estimated useful lives which range from ten to 25 years.
Impairment of long-lived and amortizable intangible assets. Property, plant and equipment and intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the sum of the expected undiscounted cash flows is less than the carrying value of the related asset or group of assets, a loss is recognized for the difference between the fair value and carrying value of the asset or group of assets. Such analyses necessarily involve significant judgment.
Derivative instruments. Accounting Standards Codification (ASC) 815 Derivatives and Hedging, as amended, requires that all derivative instruments be recorded on the balance sheet at fair value and establishes criteria for designation and effectiveness of the hedging relationships. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as a part of a hedging relationship and, further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, the company must designate the hedging instrument, based upon the exposure hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation.
The company designates that all of its hedging instruments, with the exception of its steel futures contracts, are cash flow hedges. For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive loss, net of tax, and is reclassified into earnings in the same line item associated with the forecasted transaction and in the same period or periods during which the hedged transaction affects earnings. The amount by which the cumulative change in the value of the hedge more than offsets the cumulative change in the value of the hedged item (i.e., the ineffective portion) is recorded in earnings, net of tax, in the period the ineffectiveness occurs.
The company utilizes certain derivative instruments to enhance its ability to manage currency exposure as well as raw materials price risk. Derivative instruments are entered into for periods consistent with the related underlying exposures and do not constitute positions independent of those exposures. The company does not enter into contracts for speculative purposes. The contracts are executed with major financial institutions with no credit loss anticipated for failure of the counterparties to perform.
Foreign Currency Forward Contracts
The company is exposed to foreign currency exchange risk as a result of transactions in currencies other than the functional currency of certain subsidiaries. The company utilizes foreign currency forward purchase and sale contracts to manage the volatility associated with foreign currency purchases, sales and certain intercompany transactions in the normal course of business. Principal currencies for which the company utilizes foreign currency forward contracts include the British pound, Canadian dollar, Euro and Mexican peso.
Gains and losses on these instruments are recorded in accumulated other comprehensive loss, net of tax, until the underlying transaction is recorded in earnings. When the hedged item is realized, gains or losses are reclassified from accumulated other comprehensive loss to the statement of earnings. The assessment of effectiveness for forward contracts is based on changes in the forward rates. These hedges have been determined to be effective.
The majority of the amounts in accumulated other comprehensive loss for cash flow hedges is expected to be reclassified into earnings within one year.
Table of Contents
| 1. | Organization and Significant Accounting Policies (continued) |
|---|
The following table summarizes, by currency, the contractual amounts of the company’s foreign currency forward contracts:
| December 31 (dollars in millions) | 2014 | 2013 | ||||||||||||||
| Buy | Sell | Buy | Sell | |||||||||||||
| British pound | $ | — | $ | 0.9 | $ | — | $ | 1.4 | ||||||||
| Canadian dollar | — | 90.3 | — | 72.7 | ||||||||||||
| Euro | 32.1 | 1.0 | 9.1 | 1.7 | ||||||||||||
| Mexican peso | 17.3 | — | 14.6 | — | ||||||||||||
| Total | $ | 49.4 | $ | 92.2 | $ | 23.7 | $ | 75.8 | ||||||||
Commodity Futures Contracts
In addition to entering into supply arrangements in the normal course of business, the company also enters into futures contracts to fix the cost of certain raw material purchases, principally copper and hot rolled steel, with the objective of minimizing changes in cost due to market price fluctuations. The hedging strategy for achieving this objective is to purchase commodities futures contracts on the open market of the London Metals Exchange (LME) or over the counter contracts based on the LME for copper. Additionally steel futures contracts are purchased on the New York Metals Exchange (NYMEX).
With NYMEX, the company is required to make cash deposits on unrealized losses on steel derivative contracts.
The minimal after-tax loss of the effective portion of the copper contracts as of December 31, 2014 was recorded in accumulated other comprehensive loss and will be reclassified into cost of products sold in the periods in which the underlying transactions are recorded in earnings. The effective portion of the contracts will be reclassified within one year. The steel contracts do not qualify for hedge accounting and are adjusted to fair value on a quarterly basis through earnings. Commodity hedges outstanding at December 31, 2014 total approximately 1.5 million pounds of copper and 10,000 tons of steel.
The impact of derivative contracts on the company’s financial statements is as follows:
Fair value of derivative instruments designated as hedging instruments under ASC 815:
| Fair Value | ||||||||||
| December 31 (dollars in millions) | Balance Sheet Location | 2014 | 2013 | |||||||
| Foreign currency contracts | Other current assets | $ | 4.6 | $ | 1.9 | |||||
| Accrued liabilities | (3.0 | ) | (0.2 | ) | ||||||
| Commodities contracts | Accrued liabilities | (0.2 | ) | — | ||||||
| Total derivatives designated as hedging instruments | $ | 1.4 | $ | 1.7 | ||||||
Table of Contents
| 1. | Organization and Significant Accounting Policies (continued) |
|---|
The effect of derivative instruments on the statement of earnings is as follows.
| Year ended December 31 (dollars in millions) | ||||||||||||||||||||||||||||
| Derivatives in ASC 815 cash flow hedging relationships | Amount of gain (loss) recognized in other comprehensive loss on derivative (effective portion) | Location of gain (loss) reclassified from accumulated other comprehensive loss into earnings (effective portion) | Amount of gain (loss) reclassified from accumulated other comprehensive loss into earnings (effective portion) | Location of gain recognized in earnings on derivative (ineffective portion) | Amount of gain recognized in earnings on a derivative (ineffective portion) | |||||||||||||||||||||||
| 2014 | 2013 | 2014 | 2013 | 2014 | 2013 | |||||||||||||||||||||||
| Foreign currency contracts | $ | 3.6 | $ | 3.1 | Cost of products sold | $ | 3.6 | $ | 2.6 | N/A | $ | — | $ | — | ||||||||||||||
| Commodities contracts | (0.2 | ) | — | Cost of products sold | (0.2 | ) | (0.1 | ) | Cost of products sold | — | — | |||||||||||||||||
| $ | 3.4 | $ | 3.1 | $ | 3.4 | $ | 2.5 | $ | — | $ | — | |||||||||||||||||
Fair Value Measurements. ASC 820 Fair Value Measurements, among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring basis or nonrecurring basis. ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
Assets and liabilities measured at fair value are based on the market approach which are prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
Assets measured at fair value on a recurring basis are as follows (dollars in millions):
| Fair Value Measurement Using | December 31, 2014 | December 31, 2013 | ||||||
| Quoted prices in active markets for identical assets (Level 1) | $ | 224.1 | $ | 107.0 | ||||
| Significant other observable inputs (Level 2) | (0.2 | ) | — | |||||
| Total assets measured at fair value | $ | 223.9 | $ | 107.0 | ||||
There were no changes in the valuation techniques used to measure fair values on a recurring basis.
Table of Contents
| 1. | Organization and Significant Accounting Policies (continued) |
|---|
Revenue recognition. The company recognizes revenue upon transfer of title, which occurs upon shipment of the product to the customer except for certain export sales where transfer of title occurs when the product reaches the customer destination.
Contracts and customer purchase orders are used to determine the existence of a sales arrangement. Shipping documents are used to verify shipment. The company assesses whether the selling price is fixed or determinable based upon the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. The company assesses collectability based on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history. The allowance for doubtful accounts was $3.7 million and $2.8 million at December 31, 2014 and 2013, respectively.
Reserves for customer returns for defective product are based on historical experience with similar types of sales. Accruals for rebates and incentives are based on pricing agreements and are tied to sales volume. Changes in such accruals may be required if future returns differ from historical experience or if actual sales volume differs from estimated sales volume. Rebates and incentives are recognized as a reduction of sales.
Shipping and handling costs billed to customers are included in net sales and the related costs are included in cost of products sold.
Advertising. The majority of advertising costs are charged to operations as incurred and amounted to $94.0 million, $78.0 million and $69.2 million during 2014, 2013 and 2012, respectively. Included in total advertising costs are expenses associated with store displays for water heater and water treatment products in China that are amortized over 12 to 24 months which totaled $22.6 million, $17.9 million and $15.8 million during 2014, 2013 and 2012, respectively.
Research and development. Research and development costs are charged to operations as incurred and amounted to $67.9 million, $57.8 million and $51.7 million during 2014, 2013 and 2012, respectively.
Product warranties. The company’s products carry warranties that generally range from one to ten years and are based on terms that are generally accepted in the market. The company records a liability for the expected cost of warranty-related claims at the time of sale. The allocation of the warranty liability between current and long-term is based on expected warranty claims to be paid in the next year as determined by historical product failure rates.
The following table presents the company’s product warranty liability activity in 2014 and 2013:
| Years ended December 31 (dollars in millions) | 2014 | 2013 | ||||||
| Balance at beginning of year | $ | 136.6 | $ | 129.6 | ||||
| Expense | 62.2 | 68.0 | ||||||
| Claims settled | (62.6 | ) | (61.0 | ) | ||||
| Balance at end of year | $ | 136.2 | $ | 136.6 | ||||
Environmental costs. The company accrues for costs associated with environmental obligations when such costs are probable and reasonably estimable. Costs of estimated future expenditures are not discounted to their present value. Recoveries of environmental costs from other parties are recorded as assets when their receipt is considered probable. The accruals are adjusted as facts and circumstances change.
Stock-based compensation. The company follows ASC 718 Compensation – Stock Compensation. Compensation cost is recognized using the straight-line method over the vesting period of the award. ASC 718 also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow. Excess tax deductions of $2.4 million, $4.8 million and $8.8 million were recognized as cash flows provided by financing activities in 2014, 2013 and 2012, respectively.
Table of Contents
| 1. | Organization and Significant Accounting Policies (continued) |
|---|
Earnings per share of common stock. The company is not required to use the two-class method of calculating earnings per share since its Class A Common Stock and Common Stock have equal dividend rights. The numerator for the calculation of basic and diluted earnings per share is net earnings. The following table sets forth the computation of basic and diluted weighted-average shares used in the earnings per share calculations:
| 2014 | 2013 | 2012 | ||||||||||
| Denominator for basic earnings per share - weighted-average shares outstanding | 90,293,504 | 92,118,153 | 92,395,216 | |||||||||
| Effect of dilutive stock options, restricted stock and share units | 693,477 | 669,517 | 712,906 | |||||||||
| Denominator for diluted earnings per share | 90,986,981 | 92,787,670 | 93,108,122 | |||||||||
On April 15, 2013, the company’s stockholders approved a proposal to increase the company’s authorized shares of Common Stock and the company’s board of directors declared a two-for-one stock split of the company’s Class A Common Stock and Common Stock (including treasury shares) in the form of a 100 percent stock dividend to stockholders of record on April 30, 2013 and payable on May 15, 2013. All references in the financial statements and footnotes to the number of shares outstanding, price per share, per share amounts and stock based compensation data have been recast to reflect the split for all periods presented.
Reclassifications. Certain amounts from prior years have been reclassified to conform with current year presentation.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board issued 606-10, Revenue from Contracts with Customers (issued under Accounting Standards No. 2014-09). ASC 606-10 will replace all existing revenue recognition guidance when effective. ASC 606-10 is effective for the year beginning January 1, 2017. Either full retrospective adoption or modified retrospective adoption is allowed under ASC 606-10. The company is in the process of determining whether the adoption of ASC 606-10 will have an impact on the company’s consolidated financial condition, results of operations or cash flows.
| 2. | Discontinued Operations |
|---|
On August 22, 2011, the company completed the sale of EPC to RBC for $759.9 million in cash and approximately 2.83 million shares of RBC common stock. Included in the $759.9 million of cash is a final working capital adjustment of $7.4 million which was paid to the company by RBC in January 2012. The value of the RBC shares on the date of the closing of the sale was $140.6 million. See Note 13 for further discussion regarding the company’s investment in RBC stock. In 2012, the company paid $31.2 million in income taxes and $3.6 million of payments related to the sale of EPC.
In the fourth quarter of 2012, the company recorded expense of $3.9 million on the gain on sale of EPC which included $6.4 million of expense representing the correction of an error primarily due to the company’s calculation of taxes due upon repatriation of undistributed foreign earnings. The correction was not material to any previously reported financial period or to the year ended December 31, 2012 and as a result has been reported as the correction of the error in the year ended December 31, 2012. This correction was offset by a change in estimate related to other reserves associated with EPC of $2.5 million.
The results of EPC have been reported separately as discontinued operations.
The cash flows used in discontinued EPC operations is as follows:
| Years ended December 31 (dollars in millions) | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Operating Activities | ||||||||||||
| Loss | $ | — | $ | — | $ | (3.9 | ) | |||||
| Adjustments to reconcile earnings to net cash provided by discontinued operating activities: | ||||||||||||
| Net changes in operating assets and liabilities | ||||||||||||
| Current assets and liabilities | (0.4 | ) | (1.0 | ) | (22.6 | ) | ||||||
| Noncurrent assets and liabilities | (0.9 | ) | (0.5 | ) | (0.9 | ) | ||||||
| Cash Used in Discontinued Operating Activities | (1.3 | ) | (1.5 | ) | (27.4 | ) | ||||||
Table of Contents
| 3. | Acquisitions |
|---|
On February 14, 2013, the company acquired 100 percent of the shares of MiM Isitma Sogutma Havalandirma ve Aritma Sistemleri San. Tic. A.S. (MiM), a privately-held Turkish water treatment company. The addition of MiM expanded the company’s product offerings and gave the company access to Eastern Europe and the Black Sea region water treatment markets. MiM is included in the Rest of World segment.
The company paid an aggregate cash purchase price of $4.0 million, net of cash received of $1.9 million. In addition the company assumed debt of $1.7 million and recorded contingent consideration of $1.1 million the fair value of the contingent payment due to the former owners of MiM if certain targets are met for growth in sales, gross profits and operating profits through 2017.
The fair value of the purchase price resulted in an allocation to acquired intangible assets totaling $4.3 million of which $2.4 million was assigned to customer lists which are being amortized over ten years.
MiM’s results of operations have been included in the company’s financial statements from February 14, 2013, the date of acquisition. Revenues and pre-tax results associated with MiM included in results of operations for the year ended December 31, 2013 were not material to the company’s net sales or pre-tax earnings.
The company acquired Lochinvar Corporation in August 2011 for approximately $435 million, including an earn-out provision that resulted in a payment of $13.5 million in December 2012.
| 4. | Restructuring, Impairment and Settlement Income |
|---|
On March 28, 2013, the company announced the move of manufacturing operations from its Fergus, Ontario facility to other North American facilities. In 2013, the company recognized $22.0 million of pre-tax restructuring and impairment expenses, comprised of impairment charges related to long-lived assets totaling $9.2 million, severance costs of $7.5 million, equipment relocation costs of $2.9 million and inventory obsolescence costs totaling $2.4 million, as well as a corresponding $5.6 million income tax benefit related to the expenses related to this move. The majority of the consolidation of operations occurred in the second quarter of 2013.
On March 11, 2013, the company entered into a settlement agreement with a former supplier of a North American subsidiary regarding previous overcharges and warranty costs. The terms of the settlement agreement resulted in an $11.0 million cash payment to the company, a pre-tax gain of $11.0 million and $4.2 million of income tax expense.
On November 15, 2012, the company entered into a settlement agreement with a supplier of the company’s Canadian operations. In 2012, the company recorded a pre-tax gain of $3.9 million relating to the settlement.
The restructuring, impairment and settlement income activities are included in the company’s North America segment.
The following table presents an analysis of the company’s restructuring, impairment and settlement reserves as of and for the years ended December 31, 2014 and 2013 (dollars in millions):
| Inventory Obsolescence | Severance Costs | Asset Impairment | Equipment Relocation | Settlement Income | Total | |||||||||||||||||||
| Balance at December 31, 2012 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
| Expense (income) recognized | 2.4 | 7.5 | 9.2 | 2.9 | (11.0 | ) | 11.0 | |||||||||||||||||
| Asset write-down | (0.7 | ) | — | (9.2 | ) | — | — | (9.9 | ) | |||||||||||||||
| Cash (payments) receipts | — | (6.0 | ) | — | (2.5 | ) | 11.0 | 2.5 | ||||||||||||||||
| Balance at December 31, 2013 | 1.7 | 1.5 | — | 0.4 | — | 3.6 | ||||||||||||||||||
| (Income) expense recognized | (0.4 | ) | 0.4 | — | — | — | — | |||||||||||||||||
| Cash payments | (1.2 | ) | (1.5 | ) | — | (0.4 | ) | — | (3.1 | ) | ||||||||||||||
| Balance at December 31, 2014 | $ | 0.1 | $ | 0.4 | $ | — | $ | — | $ | — | $ | 0.5 | ||||||||||||
Table of Contents
| 5. | Statement of Cash Flows |
|---|
Supplemental cash flow information is as follows:
| Years ended December 31 (dollars in millions) | 2014 | 2013 | 2012 | |||||||||
| Net change in current assets and liabilities, net of acquisitions: | ||||||||||||
| Receivables | $ | (16.8 | ) | $ | (32.3 | ) | $ | (57.0 | ) | |||
| Inventories | (14.9 | ) | (28.5 | ) | 5.0 | |||||||
| Other current assets | (7.7 | ) | (7.5 | ) | (0.8 | ) | ||||||
| Trade payables | 6.9 | 58.0 | 26.4 | |||||||||
| Accrued liabilities, including payroll and benefits | 2.1 | 29.4 | 3.1 | |||||||||
| Income taxes payable | (7.7 | ) | 1.4 | (13.3 | ) | |||||||
| $ | (38.1 | ) | $ | 20.5 | $ | (36.6 | ) | |||||
| 6. | Inventories |
|---|
| December 31 (dollars in millions) | 2014 | 2013 | ||||||
| Finished products | $ | 100.2 | $ | 88.8 | ||||
| Work in process | 10.7 | 12.3 | ||||||
| Raw materials | 121.3 | 113.6 | ||||||
| Inventories, at FIFO cost | 232.2 | 214.7 | ||||||
| LIFO reserve | (23.9 | ) | (21.3 | ) | ||||
| $ | 208.3 | $ | 193.4 | |||||
The company recognized after-tax LIFO (income) expense of $(0.1) million, $0.1 million and $(1.1) million in 2014, 2013 and 2012, respectively.
| 7. | Property, Plant and Equipment |
|---|
| December 31 (dollars in millions) | 2014 | 2013 | ||||||
| Land | $ | 11.2 | $ | 11.3 | ||||
| Buildings | 230.6 | 212.5 | ||||||
| Equipment | 504.5 | 497.8 | ||||||
| Software | 69.6 | 37.2 | ||||||
| 815.9 | 758.8 | |||||||
| Less accumulated depreciation and amortization | 388.2 | 367.5 | ||||||
| $ | 427.7 | $ | 391.3 | |||||
Table of Contents
| 8. | Goodwill and Other Intangible Assets |
|---|
Changes in the carrying amount of goodwill during the years ended December 31, 2014 and 2013 consisted of the following:
| (dollars in millions) | North America | Rest of World | Total | |||||||||
| Balance at December 31, 2012 | $ | 376.4 | $ | 59.0 | $ | 435.4 | ||||||
| Acquisition of business (see Note 3) | — | 1.9 | 1.9 | |||||||||
| Currency translation adjustment | (3.5 | ) | (0.3 | ) | (3.8 | ) | ||||||
| Balance at December 31, 2013 | 372.9 | 60.6 | 433.5 | |||||||||
| Currency translation adjustment | (4.4 | ) | (0.3 | ) | (4.7 | ) | ||||||
| Balance at December 31, 2014 | $ | 368.5 | $ | 60.3 | $ | 428.8 | ||||||
The carrying amount of other intangible assets consisted of the following:
| 2014 | 2013 | |||||||||||||||||||||||
| December 31 (dollars in millions) | Gross Carrying Amount | Accumulated Amortization | Net | Gross Carrying Amount | Accumulated Amortization | Net | ||||||||||||||||||
| Amortizable intangible assets | ||||||||||||||||||||||||
| Patents | $ | 6.7 | $ | (5.0 | ) | $ | 1.7 | $ | 6.8 | $ | (4.7 | ) | $ | 2.1 | ||||||||||
| Customer lists | 232.3 | (69.2 | ) | 163.1 | 232.7 | (55.2 | ) | 177.5 | ||||||||||||||||
| Total amortizable intangible assets | 239.0 | (74.2 | ) | 164.8 | 239.5 | (59.9 | ) | 179.6 | ||||||||||||||||
| Indefinite-lived intangible assets | ||||||||||||||||||||||||
| Trade names | 143.7 | — | 143.7 | 145.2 | — | 145.2 | ||||||||||||||||||
| Total intangible assets | $ | 382.7 | $ | (74.2 | ) | $ | 308.5 | $ | 384.7 | $ | (59.9 | ) | $ | 324.8 | ||||||||||
Amortization expenses of other intangible assets of $14.3 million, $14.4 million, and $14.6 million were recorded in 2014, 2013 and 2012, respectively. In the future, excluding the impact of any future acquisitions, the company expects amortization expense of approximately $14.3 million annually and the intangible assets will be amortized over a weighted average period of 14 years.
The company concluded that no goodwill impairment existed at the time of the annual impairment tests which were performed in the fourth quarters of 2014, 2013 and 2012. No impairments of other intangible assets were recorded in 2014, 2013 and 2012.
Table of Contents
| 9. | Debt and Lease Commitments |
|---|
| December 31 (dollars in millions) | 2014 | 2013 | ||||||
| Bank credit lines, average year-end interest rates of 2.7% for 2014 and 2.4% for 2013 | $ | 8.0 | $ | 3.6 | ||||
| Revolving credit agreement borrowings, average year-end interest rates of 1.3% for 2014 and 2013 | 130.0 | 80.0 | ||||||
| Commercial paper, average year-end interest rates of 1.1% for 2014 and 2013 | 42.5 | 48.9 | ||||||
| Term notes with insurance companies, expiring through 2018, average year-end interest rates of 6.1% for 2014 and 6.0% for 2013 | 22.6 | 31.2 | ||||||
| Canadian term notes with insurance companies, expiring through 2018, average year-end interest rates of 5.3% for 2014 and 2013 | 20.7 | 28.2 | ||||||
| 223.8 | 191.9 | |||||||
| Less long-term debt due within one year | 13.7 | 14.2 | ||||||
| Long-term debt | $ | 210.1 | $ | 177.7 | ||||
The company has a $400 million multi-year multi-currency revolving credit agreement with a group of eight banks, which expires on December 12, 2017. The facility has an accordion provision which allows it to be increased up to $500 million if certain conditions (including lender approval) are satisfied. Borrowings under the company’s bank credit lines and commercial paper borrowings are supported by the revolving credit agreement. As a result of the long-term nature of this facility, the commercial paper and credit line borrowings are classified as long-term debt at December 31, 2014 and 2013. At its option, the company either maintains cash balances or pays fees for bank credit and services.
Scheduled maturities of long-term debt within each of the five years subsequent to December 31, 2014 are as follows:
| Years ending December 31 (dollars in millions) | Amount | |||
| 2015 | $ | 13.7 | ||
| 2016 | 13.7 | |||
| 2017 | 188.4 | |||
| 2018 | 8.0 | |||
| 2019 | — |
Future minimum payments under non-cancelable operating leases relating mostly to office, manufacturing and warehouse facilities total $25.7 million and are due as follows:
| Years ending December 31 (dollars in millions) | Amount | |||
| 2015 | $ | 7.6 | ||
| 2016 | 5.5 | |||
| 2017 | 4.0 | |||
| 2018 | 3.5 | |||
| 2019 | 2.0 | |||
| Thereafter | 3.1 |
Rent expense, including payments under operating leases, was $24.3 million, $20.7 million and $18.3 million in 2014, 2013 and 2012, respectively.
Interest paid by the company was $5.8 million, $5.9 million and $9.4 million in 2014, 2013 and 2012, respectively. The company capitalized interest expense of $0.4 million and $0.8 million in 2014 and 2013, respectively.
Table of Contents
| 10. | Stockholders’ Equity |
|---|
The company’s authorized capital consists of three million shares of Preferred Stock $1 par value, 14 million shares of Class A Common Stock $5 par value, and 120 million shares of Common Stock $1 par value. The Common Stock has equal dividend rights with Class A Common Stock and is entitled, as a class, to elect one-third of the Board of Directors and has 1/10th vote per share on all other matters. Class A Common Stock is convertible to Common Stock on a one for one basis.
There were 272,184 shares during 2014, 85,792 shares during 2013 and 1,191,706 shares during 2012, of Class A Common Stock converted into Common Stock. Regular dividends paid on the A. O. Smith Corporation Class A Common Stock and Common Stock amounted to $0.60, $0.46 and $0.36 per share in 2014, 2013 and 2012, respectively.
In 2007, the company’s board of directors authorized the purchase of up to 3,000,000 shares (split adjusted) of the company’s common stock, and in 2010, the board of directors ratified that authorization. In 2013, the board of directors approved an incremental 2,000,000 shares to the existing discretionary share repurchase program. In 2014, the company’s board of directors authorized the purchase of an additional 3,500,000 shares of the company’s common stock. Under the share repurchase program, the company’s common stock may be purchased through a combination of a Rule 10b5-1 automatic trading plan and discretionary purchases in accordance with applicable securities laws. The number of shares purchased and the timing of the purchase will depend on a number of factors, including share price, trading volume and general market conditions, as well as on working capital requirements, general business conditions and other factors, including alternative investment opportunities. The stock repurchase authorizations remain effective until terminated by the board of directors which may occur at any time, subject to the parameters of any Rule 10b5-1 automatic trading plan that the company may then have in effect. In 2014, the company purchased 2,154,783 shares at a total cost of $103.8 million. As of December 31, 2014, there were 2,497,993 shares remaining on the existing repurchase authorization. In 2013, the company purchased 1,771,066 shares at a total cost of $73.7 million. In 2012, the company purchased 852,980 shares at a total cost of $22.0 million.
At December 31, 2014, a total of 65,190 and 5,889,073 shares of Class A Common Stock and Common Stock, respectively, were held as treasury stock. At December 31, 2013, a total of 65,190 and 4,049,408 shares of Class A Common Stock and Common Stock, respectively, were held as treasury stock.
Accumulated other comprehensive loss is as follows:
| December 31 (dollars in millions) | 2014 | 2013 | ||||||
| Cumulative foreign currency translation adjustments | $ | 3.3 | $ | 19.9 | ||||
| Unrealized net gain on cash flow derivative instruments less related income tax provision of $(0.5) in 2014 and $(0.6) in 2013 | 0.9 | 1.0 | ||||||
| Pension liability less related income tax benefit of $178.2 in 2014 and $179.2 in 2013 | (276.2 | ) | (280.0 | ) | ||||
| $ | (272.0 | ) | $ | (259.1 | ) | |||
Table of Contents
| 10. | Stockholders’ Equity (continued) |
|---|
Changes to accumulated other comprehensive loss by component are as follows:
| Year ended December 31, | ||||||||
| 2014 | 2013 | |||||||
| Cumulative foreign currency translation | ||||||||
| Balance at beginning of period | $ | 19.9 | $ | 19.5 | ||||
| Other comprehensive loss before reclassifications | (16.6 | ) | 0.4 | |||||
| Balance at end of period | 3.3 | 19.9 | ||||||
| Unrealized net gain on cash flow derivatives | ||||||||
| Balance at beginning of period | 1.0 | 0.7 | ||||||
| Other comprehensive earnings before reclassifications | 2.0 | 1.8 | ||||||
| Realized gains on derivatives reclassified to cost of products sold (net of tax provision of $1.3 and $1.0 in 2014 and 2013, respectively)(1) | (2.1 | ) | (1.5 | ) | ||||
| Balance at end of period | 0.9 | 1.0 | ||||||
| Pension liability | ||||||||
| Balance at beginning of period | (280.0 | ) | (340.7 | ) | ||||
| Other comprehensive loss before reclassifications | (17.0 | ) | 35.5 | |||||
| Amounts reclassified from accumulated other comprehensive loss:(1) | 20.8 | 25.2 | ||||||
| Balance at end of period | (276.2 | ) | (280.0 | ) | ||||
| Total accumulated other comprehensive loss, end of period | $ | (272.0 | ) | $ | (259.1 | ) | ||
| (1) | Amounts reclassified from accumulated other comprehensive loss: |
|---|
| Realized gains on derivatives reclassified to cost of products sold | (3.4 | ) | (2.5 | ) | ||||
| Tax provision | 1.3 | 1.0 | ||||||
| Reclassification net of tax | $ | (2.1 | ) | $ | (1.5 | ) | ||
| Amortization of pension items: | ||||||||
| Actuarial losses | $ | 34.8 | (2) | $ | 41.7 | (2) | ||
| Prior year service cost | (1.0 | )(2) | (0.9 | )(2) | ||||
| 33.8 | 40.8 | |||||||
| Tax benefit | (13.0 | ) | (15.6 | ) | ||||
| Reclassification net of tax | $ | 20.8 | $ | 25.2 | ||||
| (2) | These accumulated other comprehensive loss components are included in the computation of net periodic pension cost. See Note 12 – Pensions and Other Post-retirement Benefits for additional details |
|---|
Table of Contents
| 11. | Stock Based Compensation |
|---|
The company adopted the A. O. Smith Combined Incentive Compensation Plan (the “plan”) effective January 1, 2007. The plan was reapproved on April 16, 2012. The plan is a continuation of the A. O. Smith Combined Executive Incentive Compensation Plan which was originally approved by shareholders in 2002. The number of shares available for granting of options or share units at December 31, 2014, was 2,321,174.
Total stock based compensation expense recognized in 2014, 2013 and 2012 was $10.8 million, $10.5 million and $6.8 million, respectively.
Stock options
The stock options granted in 2014, 2013 and 2012 have three year pro rata vesting from the dates of grant. Stock options are issued at exercise prices equal to the fair value of Common Stock on the date of grant. For active employees, all options granted in 2014, 2013 and 2012 expire ten years after date of grant. Stock option compensation recognized in 2014, 2013 and 2012 was $4.9 million, $4.5 million and $3.2 million, respectively. Included in the stock option expense recognized in 2014, 2013 and 2012 is expense associated with the accelerated vesting of stock option awards for certain employees who either are retirement eligible or become retirement eligible during the vesting period.
Changes in option shares, all of which are Common Stock, were as follows:
| (dollars in millions) | ||||||||||||||||||||
| Weighted-Avg. | Aggregate | |||||||||||||||||||
| Per Share | Years Ended December 31 | Intrinsic Value | ||||||||||||||||||
| Exercise Price | 2014 | 2013 | 2012 | |||||||||||||||||
| Outstanding at beginning of year | $ | 22.37 | 1,440,623 | 1,530,734 | 2,843,734 | |||||||||||||||
| Granted | ||||||||||||||||||||
| 2014 - $46.47 to $50.67 per share | 298,750 | |||||||||||||||||||
| 2013 - $34.92 to $52.93 per share | 361,700 | |||||||||||||||||||
| 2012 - $22.08 to $22.99 per share | 382,000 | |||||||||||||||||||
| Exercised | ||||||||||||||||||||
| 2014 - $8.20 to $34.92 per share | (158,251 | ) | $ | 2.6 | ||||||||||||||||
| 2013 - $8.20 to $22.99 per share | (446,746 | ) | 6.0 | |||||||||||||||||
| 2012 - $8.21 to $21.56 per share | (1,686,834 | ) | 18.4 | |||||||||||||||||
| Forfeited | ||||||||||||||||||||
| 2014 - $34.92 to $46.47 per share | (4,119 | ) | ||||||||||||||||||
| 2013 - $22.99 to $34.92 per share | (5,065 | ) | ||||||||||||||||||
| 2012 - $13.97 to $22.99 per share | (8,166 | ) | ||||||||||||||||||
| Outstanding at end of year | ||||||||||||||||||||
| (2014 - $9.50 to $52.93 per share) | 27.50 | 1,577,003 | 1,440,623 | 1,530,734 | ||||||||||||||||
| Exercisable at end of year | 20.13 | 932,639 | 740,919 | 819,312 | ||||||||||||||||
The aggregate intrinsic value for the outstanding and exercisable options as of December 31, 2014 is $38.3 million and $31.4 million, respectively. The average remaining contractual life for outstanding and exercisable options is eight years and seven years, respectively.
Table of Contents
| 11. | Stock Based Compensation (continued) |
|---|
The following table summarizes weighted-average information by range of exercise prices for stock options outstanding and exercisable at December 31, 2014:
| Range of Exercise Prices | Options Outstanding at December 31, 2014 | Weighted- Average Exercise Price | Options Exercisable at December 31, 2014 | Weighted- Average Exercise Price | Weighted- Average Remaining Contractual Life | |||||||||||||
| $ 9.50 to $22.08 | 582,934 | $ | 15.93 | 582,756 | $ | 15.93 | 6 years | |||||||||||
| $22.99 to $34.92 | 688,389 | 28.86 | 345,950 | 26.88 | 8 years | |||||||||||||
| $36.27 to $52.93 | 305,680 | 46.50 | 3,933 | 47.73 | 10 years | |||||||||||||
| 1,577,003 | 932,639 | |||||||||||||||||
The weighted-average fair value per option at the date of grant during 2014, 2013 and 2012, using the Black-Scholes option-pricing model, was $16.55, $12.57 and $8.26, respectively. Assumptions were as follows:
| 2014 | 2013 | 2012 | ||||||||||
| Expected life (years) | 6.0 | 6.1 | 6.2 | |||||||||
| Risk-free interest rate | 2.7 | % | 2.0 | % | 2.0 | % | ||||||
| Dividend yield | 1.1 | % | 1.1 | % | 1.4 | % | ||||||
| Expected volatility | 36.6 | % | 38.4 | % | 39.4 | % |
The expected life is based on historical exercise behavior and the projected exercises of unexercised stock options. The risk free interest rate is based on the U.S. Treasury yield curve in effect on the date of grant for the respective expected life of the option. The expected dividend yield is based on the expected annual dividends divided by the grant date market value of the company’s common stock. The expected volatility is based on the historical volatility of the company’s common stock.
Restricted stock and share units
Participants may also be awarded shares of restricted stock or share units under the plan. The company granted 110,691, 144,696 and 167,860 share units under the plan in 2014, 2013 and 2012, respectively.
The share units were valued at $5.1 million, $5.0 million and $3.9 million at the date of issuance in 2014, 2013 and 2012, respectively, and will be recognized as compensation expense ratably over the three-year vesting period; however, included in share based compensation is expense associated with the accelerated vesting of share unit awards for certain employees who either are retirement eligible or become retirement eligible during the vesting period. Compensation expense of $5.9 million, $6.0 million and $3.6 million was recognized in 2014, 2013 and 2012, respectively.
A summary of share unit activity under the plan is as follows:
| Number of Units | Weighted-Average Grant Date Value | |||||||
| Outstanding at January 1, 2014 | 446,036 | $ | 26.14 | |||||
| Granted | 110,691 | 46.50 | ||||||
| Vested | (138,976 | ) | 21.63 | |||||
| Forfeited/cancelled | (1,462 | ) | 42.15 | |||||
| Outstanding at December 31, 2014 | 416,289 | 33.06 | ||||||
Total compensation expense for share units not yet recognized is $2.1 million at December 31, 2014. The weighted average period over which the expense is expected to be recognized is 14 months.
Table of Contents
| 12. | Pension and Other Post-retirement Benefits |
|---|
The company provides retirement benefits for all U.S. employees including benefits for employees of previously owned businesses which were earned up to the date of sale. The company also has two foreign pension plans, neither of which is material to the company’s financial position.
The company has a defined contribution plan which matches 100 percent of the first one percent of contributions made by participating employees and matches 50 percent of the next five percent of employee contributions. The company also has defined contribution plans for certain hourly employees which provide for matching company contributions.
The company also has a defined benefit plan for salaried employees and its non-union hourly workforce. In 2009, the company announced U.S. employees hired after January 1, 2010, would not participate in the defined benefit plan, and benefit accruals for the majority of current salaried and hourly employees sunset on December 31, 2014. Beginning in 2015, an additional company contribution will be made to the defined contribution plan in lieu of benefits earned in a defined benefit plan. The company also has defined benefit and contribution plans for certain union hourly employees.
The company has unfunded defined-benefit post-retirement plans covering certain hourly and salaried employees that provide medical and life insurance benefits from retirement to age 65. Certain hourly employees retiring after January 1, 1996, are subject to a maximum annual benefit and salaried employees hired after December 31, 1993, are not eligible for post-retirement medical benefits.
The company amended its pension plan in 2014 to offer a one-time opportunity to pay pension benefits to former employees in a lump sum. These amendments did not have a significant impact on the plan. Former employees eligible for the voluntary lump sum payment option are generally those who are vested participants of the pension plan who terminated employment prior to January 1, 2014 and who have not yet started receiving monthly payments of their pension benefits. Eligible participants had until October 31, 2014 to make their election. For the approximately 2,700 former employees who made the election, the company made payments of approximately $50 million in December 2014 and funded the payments from existing pension plan assets. The company did not incur any non-cash charges related to settling this liability as the payments did not exceed settlement thresholds.
Table of Contents
| 12. | Pension and Other Post-retirement Benefits (continued) |
|---|
Obligations and Funded Status
Pension and Post-Retirement Disclosure Information Under ASC 715
The following tables present the changes in benefit obligations, plan assets and funded status for domestic pension and post-retirement plans and the components of net periodic benefit costs.
| Pension Benefits | Post-retirement Benefits | |||||||||||||||
| Years ended December 31 (dollars in millions) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
| Accumulated benefit obligation (ABO) at December 31 | $ | 948.4 | $ | 929.1 | N/A | N/A | ||||||||||
| Change in projected benefit obligations (PBO) | ||||||||||||||||
| PBO at beginning of year | $ | (937.0 | ) | $ | (987.7 | ) | $ | (10.9 | ) | $ | (11.4 | ) | ||||
| Service cost | (7.9 | ) | (9.0 | ) | (0.1 | ) | (0.1 | ) | ||||||||
| Interest cost | (44.7 | ) | (39.5 | ) | (0.5 | ) | (0.5 | ) | ||||||||
| Participant contributions | — | — | (0.2 | ) | (0.3 | ) | ||||||||||
| Actuarial (loss) gain including assumption changes | (83.2 | ) | 39.6 | — | (0.3 | ) | ||||||||||
| Benefits paid | 116.1 | 59.6 | 1.3 | 1.7 | ||||||||||||
| PBO at end of year | $ | (956.7 | ) | $ | (937.0 | ) | $ | (10.4 | ) | $ | (10.9 | ) | ||||
| Change in fair value of plan assets | ||||||||||||||||
| Plan assets at beginning of year | $ | 822.3 | $ | 800.5 | $ | — | $ | — | ||||||||
| Actual return on plan assets | 110.1 | 80.8 | — | — | ||||||||||||
| Contribution by the company | 7.6 | 0.6 | 1.1 | 1.4 | ||||||||||||
| Participant contributions | — | — | 0.2 | 0.3 | ||||||||||||
| Benefits paid | (116.1 | ) | (59.6 | ) | (1.3 | ) | (1.7 | ) | ||||||||
| Plan assets at end of year | $ | 823.9 | $ | 822.3 | $ | — | $ | — | ||||||||
| Funded status | $ | (132.8 | ) | $ | (114.7 | ) | $ | (10.4 | ) | $ | (10.9 | ) | ||||
| Amount recognized in the balance sheet | ||||||||||||||||
| Current liabilities | $ | (0.5 | ) | $ | (7.1 | ) | $ | (0.8 | ) | $ | (0.9 | ) | ||||
| Non-current liabilities | (132.3 | ) | (107.6 | ) | (9.6 | ) | (10.0 | ) | ||||||||
| Net pension liability at end of year | $ | (132.8 | )* | $ | (114.7 | )* | $ | (10.4 | ) | $ | (10.9 | ) | ||||
| Amounts recognized in accumulated other comprehensive loss before tax | ||||||||||||||||
| Net actuarial loss (gain) | $ | 463.2 | $ | 467.1 | $ | (2.6 | ) | $ | (2.9 | ) | ||||||
| Prior service cost | (6.1 | ) | (7.2 | ) | — | — | ||||||||||
| Total recognized in accumulated other comprehensive loss | $ | 457.1 | $ | 459.9 | $ | (2.6 | ) | $ | (2.9 | ) | ||||||
| * | In addition, the company has a liability for a foreign pension plan of $0.3 million and $3.1 million at December 31, 2014 and 2013, respectively, and an accumulated other comprehensive loss of $2.2 million at December 31, 2013. |
|---|
Table of Contents
| 12. | Pension and Other Post-retirement Benefits (continued) |
|---|
| Pension Benefits | Post-retirement Benefits | |||||||||||||||||||||||
| Years ended December 31 (dollars in millions) | 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | ||||||||||||||||||
| Net periodic benefit cost | ||||||||||||||||||||||||
| Service cost | $ | 7.9 | $ | 9.0 | $ | 7.8 | $ | 0.1 | $ | 0.1 | $ | 0.1 | ||||||||||||
| Interest cost | 44.7 | 39.5 | 43.6 | 0.5 | 0.5 | 0.5 | ||||||||||||||||||
| Expected return on plan assets | (60.3 | ) | (61.7 | ) | (68.9 | ) | — | — | — | |||||||||||||||
| Amortization of unrecognized: | ||||||||||||||||||||||||
| Net actuarial loss (gain) | 35.1 | 42.0 | 32.1 | (0.4 | ) | (0.3 | ) | (0.4 | ) | |||||||||||||||
| Prior service cost | (1.0 | ) | (0.9 | ) | (0.8 | ) | — | — | — | |||||||||||||||
| Curtailment and other one-time charges | 2.2 | — | — | — | — | — | ||||||||||||||||||
| Defined-benefit plan cost | 28.6 | 27.9 | 13.8 | $ | 0.2 | $ | 0.3 | $ | 0.2 | |||||||||||||||
| Various U.S. defined contribution plans cost | 6.1 | 5.4 | 5.0 | |||||||||||||||||||||
| $ | 34.7 | $ | 33.3 | $ | 18.8 | |||||||||||||||||||
| Other changes in plan assets and projected benefit obligation recognized in other comprehensive loss | ||||||||||||||||||||||||
| Net actuarial loss (gain) | $ | 33.4 | $ | (58.7 | ) | $ | 68.0 | $ | — | $ | 0.3 | $ | (1.1 | ) | ||||||||||
| Amortization of net actuarial (loss) gain | (37.3 | ) | (42.0 | ) | (32.1 | ) | 0.3 | 0.3 | 0.4 | |||||||||||||||
| Amortization of prior service cost | 1.0 | 0.9 | 0.8 | — | — | — | ||||||||||||||||||
| Total recognized in other comprehensive loss | (2.9 | ) | (99.8 | ) | 36.7 | 0.3 | 0.6 | (0.7 | ) | |||||||||||||||
| Total recognized in net periodic cost (benefit) and other comprehensive loss | $ | 25.7 | $ | (71.9 | ) | $ | 50.5 | $ | 0.5 | $ | 0.9 | $ | (0.5 | ) | ||||||||||
The estimated net actuarial loss and prior service cost for the pension plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost during 2015 are $18.6 million and $(1.1) million, respectively. The estimated net actuarial gain and prior year service cost for the post-retirement benefit plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost during 2015 are each less than $0.2 million. As permitted under ASC 715, the amortization of any prior service cost was previously determined using a straight-line amortization of the cost over the average remaining service period of employees expected to receive benefits under the plan. Beginning in 2015 the amortization will occur over the average remaining life expectancy of participants expected to receive benefits under the plan as permitted under ASC 715.
The 2014 and 2013 after tax adjustments for additional minimum pension liability resulted in other comprehensive gain of $1.6 million and $60.7 million, respectively.
Actuarial assumptions used to determine benefit obligations at December 31 are as follows:
| Pension Benefits | Post-retirement Benefits | |||||||||||||||
| 2014 | 2013 | 2014 | 2013 | |||||||||||||
| Discount rate | 4.05 | % | 4.85 | % | 4.00 | % | 4.70 | % | ||||||||
| Average salary increases | 4.00 | % | 4.00 | % | 4.00 | % | 4.00 | % |
Actuarial assumptions used to determine net periodic benefit cost for the year ended December 31 are as follows:
| Pension Benefits | Post-retirement Benefits | |||||||||||||||||||||||
| Years ended December 31 | 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | ||||||||||||||||||
| Discount rate | 4.85 | % | 4.05 | % | 4.90 | % | 4.70 | % | 4.05 | % | 4.90 | % | ||||||||||||
| Expected long-term return on plan assets | 7.75 | % | 8.00 | % | 8.50 | % | n/a | n/a | n/a | |||||||||||||||
| Rate of compensation increase | 4.00 | % | 4.00 | % | 4.00 | % | 4.00 | % | 4.00 | % | 4.00 | % |
Table of Contents
| 12. | Pension and Other Post-retirement Benefits (continued) |
|---|
Assumptions
In developing the expected long-term rate of return on plan assets assumption, the company evaluated its pension plan’s target and actual asset allocation and expected long-term rates of return of equity and bond indices. The company also considered its pension plan’s historical ten-year and 25-year compounded annualized returns of 6.9 percent and 9.6 percent, respectively.
Assumed health care cost trend rates
Assumed health care cost trend rates as of December 31 are as follows:
| 2014 | 2013 | |||||||
| Health care cost trend rate assumed for next year | 7.25 | % | 10.00 | % | ||||
| Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) | 5.00 | % | 5.00 | % | ||||
| Year that the rate reaches the ultimate trend rate | 2021 | 2018 |
A one-percentage-point change in the assumed health care cost trend rates would not result in a material impact on the company’s consolidated financial statements.
Plan Assets
The company’s pension plan weighted asset allocations as of December 31 by asset category are as follows:
| Asset Category | 2014 | 2013 | ||||||
| Equity securities | 50 | % | 53 | % | ||||
| Debt securities | 37 | 34 | ||||||
| Private equity | 4 | 5 | ||||||
| Real estate | 8 | 7 | ||||||
| Other | 1 | 1 | ||||||
| 100 | % | 100 | % | |||||
Table of Contents
| 12. | Pension and Other Post-retirement Benefits (continued) |
|---|
The following tables present the fair value measurement of the company’s plan assets as of December 31, 2014 and 2013 (dollars in millions):
| December 31, 2014 | ||||||||||||||||
| Asset Category | Total | Quoted Prices in Active Markets for Identical Contracts (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Non- observable Inputs (Level 3) | ||||||||||||
| Short-term investments | $ | 23.1 | $ | 2.4 | $ | — | $ | 20.7 | ||||||||
| Equity securities | ||||||||||||||||
| Common stocks | 264.4 | 264.4 | — | — | ||||||||||||
| Commingled equity funds | 134.7 | — | 134.7 | — | ||||||||||||
| Fixed income securities | ||||||||||||||||
| U.S. treasury securities | 122.9 | 122.9 | — | — | ||||||||||||
| Other fixed income securities | 93.2 | — | 93.2 | — | ||||||||||||
| Commingled fixed income funds | 83.8 | — | 83.8 | — | ||||||||||||
| Other types of investments | ||||||||||||||||
| Real estate funds | 64.1 | — | — | 64.1 | ||||||||||||
| Private equity | 34.8 | — | — | 34.8 | ||||||||||||
| Total fair value of plan asset investments | $ | 821.0 | $ | 389.7 | $ | 311.7 | $ | 119.6 | ||||||||
| Non-investment plan assets | 2.9 | |||||||||||||||
| Total plan assets | $ | 823.9 | ||||||||||||||
| December 31, 2013 | ||||||||||||||||
| Asset Category | Total | Quoted Prices in Active Markets for Identical Contracts (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Non- observable Inputs (Level 3) | ||||||||||||
| Short-term investments | $ | 15.4 | $ | 1.4 | $ | — | $ | 14.0 | ||||||||
| Equity securities | ||||||||||||||||
| Common stocks | 272.9 | 272.9 | — | — | ||||||||||||
| Commingled equity funds | 147.5 | — | 147.5 | — | ||||||||||||
| Fixed income securities | ||||||||||||||||
| U.S. treasury securities | 136.2 | 136.2 | — | — | ||||||||||||
| Other fixed income securities | 75.3 | — | 75.0 | 0.3 | ||||||||||||
| Commingled fixed income funds | 71.8 | — | 71.8 | — | ||||||||||||
| Other types of investments | ||||||||||||||||
| Real estate funds | 57.2 | — | — | 57.2 | ||||||||||||
| Private equity | 37.7 | — | — | 37.7 | ||||||||||||
| Total fair value of plan asset investments | $ | 814.0 | $ | 410.5 | $ | 294.3 | $ | 109.2 | ||||||||
| Non-investment plan assets | 8.3 | |||||||||||||||
| Total plan assets | $ | 822.3 | ||||||||||||||
Table of Contents
| 12. | Pension and Other Post-retirement Benefits (continued) |
|---|
The following table presents a reconciliation of the fair value measurements using significant unobservable inputs (Level 3) as of December 31, 2014 and 2013 (dollars in millions):
| Short term investments | Other fixed income securities | Real estate funds | Private equity | Total | ||||||||||||||||
| Balance at December 31, 2012 | $ | 23.3 | $ | 0.3 | $ | — | $ | 34.4 | $ | 58.0 | ||||||||||
| Actual return (loss) on plan assets: | ||||||||||||||||||||
| Relating to assets still held at the reporting date | — | — | 1.6 | 2.4 | 4.0 | |||||||||||||||
| Relating to assets sold during the period | — | — | — | 0.8 | 0.8 | |||||||||||||||
| Purchases, sales and settlements | (9.3 | ) | — | 55.6 | 0.1 | 46.4 | ||||||||||||||
| Balance at December 31, 2013 | 14.0 | 0.3 | 57.2 | 37.7 | 109.2 | |||||||||||||||
| Actual return (loss) on plan assets: | ||||||||||||||||||||
| Relating to assets still held at the reporting date | — | — | 6.2 | 1.6 | 7.8 | |||||||||||||||
| Relating to assets sold during the period | — | (0.3 | ) | — | 3.4 | 3.1 | ||||||||||||||
| Purchases, sales and settlements | 6.7 | — | 0.7 | (7.9 | ) | (0.5 | ) | |||||||||||||
| Balance at December 31, 2014 | $ | 20.7 | $ | — | $ | 64.1 | $ | 34.8 | $ | 119.6 | ||||||||||
The company’s investment policies employ an approach whereby a diversified blend of equity and bond investments is used to maximize the long-term return of plan assets for a prudent level of risk. Equity investments are diversified across domestic and non-domestic stocks, as well as growth, value, and small to large capitalizations. Bond investments include corporate and government issues, with short-, mid- and long-term maturities, with a focus on investment grade when purchased. The company’s target allocation to equity managers is between 45 to 55 percent with the remainder allocated primarily to bonds and a small allocation to real estate, private equity managers and cash. Investment and market risks are measured and monitored on an ongoing basis through regular investment portfolio reviews, annual liability measurements and periodic asset/liability studies.
The company’s actual asset allocations are in line with target allocations. The company regularly reviews its actual asset allocation and periodically rebalances its investments to the targeted allocation when considered appropriate.
There was no company stock included in plan assets at December 31, 2014.
Cash Flows
The company was not required to and did not make any contributions in 2014 and is not required to make a contribution in 2015.
Estimated Future Payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
| Years ending December 31 (dollars in millions) | Pension Benefits | Post-retirement Benefits | ||||||
| 2015 | $ | 59.7 | $ | 0.8 | ||||
| 2016 | 60.6 | 0.8 | ||||||
| 2017 | 59.3 | 0.7 | ||||||
| 2018 | 65.4 | 0.7 | ||||||
| 2019 | 59.2 | 0.7 | ||||||
| 2020 - 2024 | 294.9 | 3.4 |
Table of Contents
| 13. | Investment in Shares of RBC Common Stock |
|---|
As discussed in Note 2, the company received approximately 2.83 million shares of RBC common stock as part of the proceeds of its sale of EPC to RBC. One half of the company’s shares of RBC common stock were classified as available for sale securities and were recorded at fair value with an unrealized after-tax gain of $1.2 million included in other comprehensive loss as of December 31, 2011. The company entered into an equity collar contract for the remaining half of its shares of RBC common stock which were classified as trading securities. Those shares were also recorded at fair value. During 2012, the company sold all of its shares of RBC common stock for net proceeds of $187.6 million or an average price of $66.19 per share. Net pre-tax gains of $27.2 million were recorded in other income-net in the consolidated statement of earnings in 2012. The net pre-tax $27.2 million gain was comprised of $43.2 million of gains on the sale of the shares of RBC common stock, the recognition of a $1.9 million gain previously recognized in other comprehensive loss at December 31, 2011 and the write off of $17.9 million, the value of the collar at December 31, 2011. The $187.6 million of net proceeds received in 2012 were used to pay down debt.
| 14. | Income Taxes |
|---|
The components of the provision (benefit) for income taxes consisted of the following:
| Years ended December 31 (dollars in millions) | 2014 | 2013 | 2012 | |||||||||
| Current: | ||||||||||||
| Federal | $ | 48.7 | $ | 53.9 | $ | 51.5 | ||||||
| State | 10.4 | 9.6 | 7.2 | |||||||||
| International | 22.4 | 19.1 | 17.0 | |||||||||
| Deferred: | ||||||||||||
| Federal | (5.2 | ) | (8.4 | ) | (3.8 | ) | ||||||
| State | (0.2 | ) | (0.5 | ) | 4.6 | |||||||
| International | 2.8 | (7.0 | ) | (5.3 | ) | |||||||
| $ | 78.9 | $ | 66.7 | $ | 71.2 | |||||||
The provision for income taxes differs from the U.S. federal statutory rate due to the following items:
| Years ended December 31 | 2014 | 2013 | 2012 | |||||||||
| Provision at U.S. federal statutory rate | 35.0 | % | 35.0 | % | 35.0 | % | ||||||
| State income and franchise taxes, net of federal benefit | 2.3 | 2.5 | 3.3 | |||||||||
| International income tax rate differential - China | (8.2 | ) | (8.1 | ) | (5.8 | ) | ||||||
| International income tax rate differential - other | 0.4 | 0.7 | 0.2 | |||||||||
| U.S. manufacturing credit | (2.1 | ) | (1.9 | ) | (2.1 | ) | ||||||
| Research tax credits | (0.4 | ) | (0.8 | ) | — | |||||||
| Other | 0.5 | 0.8 | (0.2 | ) | ||||||||
| 27.5 | % | 28.2 | % | 30.4 | % | |||||||
Components of earnings before income taxes were as follows:
| Years ended December 31 (dollars in millions) | 2014 | 2013 | 2012 | |||||||||
| U.S. | $ | 150.6 | $ | 151.9 | $ | 158.6 | ||||||
| International | 136.1 | 84.5 | 75.2 | |||||||||
| $ | 286.7 | $ | 236.4 | $ | 233.8 | |||||||
Total income taxes paid by the company including discontinued operations amounted to $88.9 million, $70.2 million, and $103.0 million in 2014, 2013 and 2012, respectively.
In the fourth quarter of 2012, the company recorded discontinued operations expense of $6.4 million representing the correction of an error primarily due to its calculation of taxes due upon repatriation of undistributed foreign earnings. The correction was not material to any previously reported financial period or to the year ended December 31, 2012 and as a result has been reported as the correction of an error in the year ended December 31, 2012.
Table of Contents
| 14. | Income Taxes (continued) |
|---|
As of December 31, 2014, the company has $50.7 million accrued for its estimate of the tax costs due upon repatriation of undistributed foreign earnings it considers to be not permanently reinvested. At December 31, 2014, the company had undistributed foreign earnings of $717.7 million, of which $501.5 million are considered permanently reinvested. No. U.S. income tax provision or foreign withholding tax provisions have been made on foreign earnings that remain permanently reinvested. Determination of the amount of unrecognized deferred tax liability on the undistributed earnings considered permanently reinvested is not practicable. In addition, no provision or benefit for U.S. income taxes has been made on foreign currency translation gains or losses. As of December 31, 2014, $541.9 million of cash and cash equivalents and marketable securities were held by our foreign subsidiaries.
The tax effects of temporary differences of assets and liabilities between income tax and financial reporting are as follows:
| December 31 (dollars in millions) | ||||||||||||||||
| 2014 | 2013 | |||||||||||||||
| Assets | Liabilities | Assets | Liabilities | |||||||||||||
| Employee benefits | $ | 77.0 | $ | — | $ | 66.8 | $ | — | ||||||||
| Product liability and warranties | 65.8 | — | 64.5 | — | ||||||||||||
| Inventories | — | 4.2 | — | 4.7 | ||||||||||||
| Accounts receivable | 11.7 | — | 11.1 | — | ||||||||||||
| Property, plant and equipment | — | 39.4 | — | 33.0 | ||||||||||||
| Intangibles | — | 52.1 | — | 40.0 | ||||||||||||
| Environmental liabilities | 3.1 | — | 3.2 | — | ||||||||||||
| Undistributed foreign earnings | — | 50.7 | — | 56.4 | ||||||||||||
| Tax loss and credit carryovers | 14.9 | — | 17.7 | — | ||||||||||||
| All other | 4.7 | — | 2.4 | — | ||||||||||||
| Valuation allowance | (9.8 | ) | — | (9.6 | ) | — | ||||||||||
| $ | 167.4 | $ | 146.4 | $ | 156.1 | $ | 134.1 | |||||||||
| Net asset | $ | 21.0 | $ | 22.0 | ||||||||||||
These deferred tax assets and liabilities are classified in the balance sheet as current or long-term based on the balance sheet classification of the related assets and liabilities as follows:
| December 31 (dollars in millions) | 2014 | 2013 | ||||||
| Current deferred income tax assets | $ | 40.5 | $ | 40.1 | ||||
| Long-term deferred income tax assets | 1.9 | 2.9 | ||||||
| Long-term deferred income tax liabilities | (21.4 | ) | (21.0 | ) | ||||
| Net asset | $ | 21.0 | $ | 22.0 | ||||
A reconciliation of the beginning and ending amounts of tax loss carryovers, credit carryovers and valuation allowances is as follows:
| December 31 (dollars in millions) | ||||||||||||||||
| Net Operating Losses and Tax Credits | Valuation Allowances | |||||||||||||||
| 2014 | 2013 | 2014 | 2013 | |||||||||||||
| Beginning balance | $ | 17.7 | $ | 15.3 | $ | 9.6 | $ | 7.4 | ||||||||
| Additions | 0.6 | 4.1 | 1.0 | 2.2 | ||||||||||||
| Reductions | (3.4 | ) | (1.7 | ) | (0.8 | ) | — | |||||||||
| Ending balance | $ | 14.9 | $ | 17.7 | $ | 9.8 | $ | 9.6 | ||||||||
Table of Contents
| 14. | Income Taxes (continued) |
|---|
The company has foreign net operating loss carryovers that expire in 2015 through 2022, a foreign tax credit carryover that expires in 2021, and state and local net operating loss carryovers that expire between 2015 and 2031.
A reconciliation of the beginning and ending amount of unrecognized benefits is as follows:
| (Dollars in millions) | 2014 | 2013 | ||||||
| Balance at January 1 | $ | 1.3 | $ | 1.3 | ||||
| Reductions for tax positions of prior years | (0.1 | ) | — | |||||
| Balance at December 31 | $ | 1.2 | $ | 1.3 | ||||
The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is $0.8 million. The company recognizes potential interest and penalties related to unrecognized tax benefits as a component of income tax expense. At December 31, 2014 there was an immaterial amount of interest and penalties accrued. It is anticipated there will be no decrease in the total amount of unrecognized tax benefits in 2015. The company’s U.S. federal income tax returns for 2011-2014 are subject to audit. The company is subject to state and local income tax audits for tax years 2000-2014. The company is subject to non-U.S. income tax examinations for years 2006-2014.
| 15. | Commitments and Contingencies |
|---|
The company is a potentially responsible party in judicial and administrative proceedings seeking to clean up sites which have been environmentally impacted. In each case the company has established reserves, insurance proceeds and/or a potential recovery from third parties. The company believes any environmental claims will not have a material effect on its financial position or results of operations.
The company is subject to various claims and pending lawsuits for product liability and other matters arising out of the conduct of the company’s business. With respect to product liability claims, the company has self-insured a portion of its product liability loss exposure for many years. The company has established reserves and has insurance coverage which it believes are adequate to cover incurred claims. For the years ended December 31, 2014 and 2013, the company had $125 million of product liability insurance for individual losses in excess of $7.5 million. The company periodically reevaluates its exposure on claims and lawsuits and makes adjustments to its reserves as appropriate. The company believes, based on current knowledge, consultation with counsel, adequate reserves and insurance coverage that the outcome of such claims and lawsuits will not have a material adverse effect on the company’s financial position, results of operations or cash flows.
| 16. | Operations by Segment |
|---|
The company is comprised of two reporting segments: North America and Rest of World. The Rest of World segment is primarily comprised of China, Europe and India. Both segments manufacture and market comprehensive lines of residential gas, gas tankless and electric water heaters and commercial water heating equipment. Both segments primarily serve in their respective regions of the world. The North America segment also manufactures and markets specialty commercial water heating equipment, condensing and non-condensing boilers and water system tanks. The Rest of World segment also manufactures and markets water treatment products, primarily in Asia.
Table of Contents
| 16. | Operations by Segment (continued) |
|---|
The accounting policies of the reportable segments are the same as those described in the “Summary of Significant Accounting Policies” outlined in Note 1. Operating earnings, defined by the company as earnings before interest, taxes, general corporate and corporate research and development expenses, were used to measure the performance of the segments.
| Net Sales | Earnings | |||||||||||||||||||||||
| Years ended December 31 (dollars in millions) | 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | ||||||||||||||||||
| North America | $ | 1,621.7 | $ | 1,520.0 | $ | 1,430.8 | $ | 238.7 | $ | 211.9 | $ | 199.8 | ||||||||||||
| Rest of World | 768.3 | 668.0 | 542.5 | 106.7 | 88.0 | 59.6 | ||||||||||||||||||
| Inter-segment | (34.0 | ) | (34.2 | ) | (34.0 | ) | (0.1 | ) | — | — | ||||||||||||||
| Total segments - sales, operating earnings | $ | 2,356.0 | $ | 2,153.8 | $ | 1,939.3 | $ | 345.3 | $ | 299.9 | $ | 259.4 | ||||||||||||
| Corporate expenses | (52.9 | ) | (57.8 | ) | (16.4 | ) | ||||||||||||||||||
| Interest expense | (5.7 | ) | (5.7 | ) | (9.2 | ) | ||||||||||||||||||
| Earnings before income taxes | 286.7 | 236.4 | 233.8 | |||||||||||||||||||||
| Provision for income taxes | (78.9 | ) | (66.7 | ) | (71.2 | ) | ||||||||||||||||||
| Earnings from continuing operations | $ | 207.8 | $ | 169.7 | $ | 162.6 | ||||||||||||||||||
In 2014, sales to the North America segment’s two largest customers were $296.5 million and $237.2 million which represented 13 percent and ten percent of the company’s net sales, respectively. In 2013, sales to the North America segment’s two largest customers were $310.3 million and $240.6 million which represented 14 percent and 11 percent of the company’s net sales, respectively. In 2012, sales to the North America segment’s two largest customers were $284.0 million and $194.8 million which represented 15 percent and ten percent of the company’s net sales, respectively.
Assets, depreciation and capital expenditures by segment
| Total Assets (December 31) | Depreciation and Amortization (Years Ended December 31) | Capital Expenditures (Years Ended December 31) | ||||||||||||||||||||||||||||||||||
| (dollars in millions) | 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | |||||||||||||||||||||||||||
| North America | $ | 1,358.5 | $ | 1,298.6 | $ | 1,306.2 | $ | 37.8 | $ | 40.5 | $ | 39.3 | $ | 59.4 | $ | 38.0 | $ | 24.7 | ||||||||||||||||||
| Rest of World | 523.8 | 525.2 | 420.2 | 20.0 | 16.8 | 14.3 | 26.5 | 59.0 | 40.3 | |||||||||||||||||||||||||||
| Corporate | 633.0 | 567.7 | 552.4 | 2.0 | 2.4 | 1.0 | 0.2 | 0.7 | 4.9 | |||||||||||||||||||||||||||
| Total | $ | 2,515.3 | $ | 2,391.5 | $ | 2,278.8 | $ | 59.8 | $ | 59.7 | $ | 54.6 | $ | 86.1 | $ | 97.7 | $ | 69.9 | ||||||||||||||||||
The majority of corporate assets consist of cash, cash equivalents, marketable securities and deferred income taxes.
Net sales and long-lived assets by geographic location
The following data by geographic area includes net sales based on product shipment destination and long-lived assets based on physical location. Long-lived assets include net property, plant and equipment and other long-term assets.
| Long-lived Assets (December 31) | Net Sales (Years Ended December 31) | |||||||||||||||||||||||||
| (dollars in millions) | 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | ||||||||||||||||||||
| United States | $ | 262.1 | $ | 238.6 | $ | 219.1 | United States | $ | 1,447.9 | $ | 1,335.4 | $ | 1,241.0 | |||||||||||||
| China | 131.9 | 134.9 | 99.6 | China | 691.8 | 581.0 | 461.2 | |||||||||||||||||||
| Canada | 3.6 | 4.7 | 20.4 | Canada | 128.8 | 142.5 | 150.1 | |||||||||||||||||||
| Other Foreign | 58.3 | 46.4 | 35.9 | Other Foreign | 87.5 | 94.9 | 87.0 | |||||||||||||||||||
| Total | $ | 455.9 | $ | 424.6 | $ | 375.0 | Total | $ | 2,356.0 | $ | 2,153.8 | $ | 1,939.3 | |||||||||||||
Table of Contents
| 17. | Quarterly Results of Operations (Unaudited) |
|---|
| (dollars in millions, except per share amounts) | ||||||||||||||||||||||||||||||||
| 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||||||||||||||||||||||||
| 2014 | 2013 | 2014 | 2013 | 2014 | 2013 | 2014 | 2013 | |||||||||||||||||||||||||
| Net sales | $ | 552.2 | $ | 509.6 | $ | 595.4 | $ | 549.1 | $ | 581.6 | $ | 536.2 | $ | 626.8 | $ | 558.9 | ||||||||||||||||
| Gross profit | 195.9 | 179.3 | 216.2 | 198.0 | 215.3 | 196.6 | 231.9 | 199.9 | ||||||||||||||||||||||||
| Net earnings | 46.7 | 39.0 | 57.3 | 42.1 | 50.6 | 46.2 | 53.2 | 42.4 | ||||||||||||||||||||||||
| Basic earnings per share | 0.51 | 0.42 | 0.63 | 0.45 | 0.56 | 0.50 | 0.59 | 0.46 | ||||||||||||||||||||||||
| Diluted earnings per share | 0.51 | 0.42 | 0.63 | 0.45 | 0.56 | 0.50 | 0.59 | 0.46 | ||||||||||||||||||||||||
| Common dividends declared | 0.15 | 0.10 | 0.15 | 0.12 | 0.15 | 0.12 | 0.15 | 0.12 |
Net earnings per share are computed separately for each period, and therefore, the sum of such quarterly per share amounts may differ from the total for the year.
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