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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand our results of operations and financial condition for the three years ended December 31, 2015. The MD&A should be read in conjunction with our Consolidated Financial Statements and Notes included in Item 8 of this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed elsewhere in this Form 10-K, particularly in Item 1A. "Risk Factors" and in the "Special Note Regarding Forward-Looking Statements" preceding Part I of this Form 10-K.
Throughout this MD&A, we refer to measures used by management to evaluate performance, including a number of financial measures that are not defined under accounting principles generally accepted in the United States of America ("GAAP"). These include organic revenue, organic revenue growth, free cash flow and adjusted working capital. Organic revenue and organic growth refer to revenue and revenue growth excluding the impacts of foreign exchange, acquisitions and divestitures. Free cash flow is operating cash flow less capital spending, while adjusted working capital refers to accounts receivable, plus inventory, less accounts payable. We believe these measures provide investors with important information that is useful in understanding our business results and trends. Reconciliations within this MD&A provide more details on the use and derivation of these measures.
The MD&A is organized as follows:
| • | Overview and Outlook |
| • | Consolidated Results of Operations |
| • | Segment Results of Operations |
| • | Financial Condition |
| ◦ | Cash Flow Summary and Liquidity and Capital Resources |
| ◦ | Critical Accounting Policies and Recent Accounting Standards |
| ◦ | Non-GAAP Disclosures |
OVERVIEW AND OUTLOOK
Dover is a diversified global manufacturer delivering innovative equipment and components, specialty systems and support services through four major operating segments: Energy, Engineered Systems, Fluids, and Refrigeration & Food Equipment.
Full year 2015 consolidated revenue from continuing operations was $7.0 billion, a decrease of $796.4 million or 10.3%, as compared to the prior year. This decrease included a decline in organic revenue of 9.8%, an unfavorable impact of 3.9% from foreign currency, and 0.1% decline due to a disposed product line, partially offset by a 3.5% increase in acquisition-related revenue. Overall, customer pricing had a minimal unfavorable impact of 0.2% on revenue for the year.
Our Energy segment revenue decreased $533.6 million, or 26.4%, from the prior year. This decrease included a 34.3% decline in organic revenue and a 1.4% decrease due to foreign currency impacts, partially offset by 9.3% of acquisition related growth. The decline in organic revenue within our Energy segment was largely attributable to the significant deterioration within the oil and gas markets. Within our Engineered Systems segment, revenue decreased $43.1 million, or 1.8%, from the prior year. In spite of this overall decline, organic revenue grew 3.2% and acquisitions contributed 0.9% growth which was offset by 5.9% of the unfavorable impact of foreign currency rates. Our Fluids segment revenue decreased $31.3 million, or 2.2%, comprised of 0.8% organic revenue growth and 2.4% revenue growth attributable to acquisitions, offset by 5.4% unfavorability due to foreign currency. Within our Refrigeration & Food Equipment segment revenue declined $189.8 million, or 9.9%, from the prior year, including declines of 7.8% in organic revenue, 2.4% related to foreign currency, and 0.4% due to the disposition of a product line (See Note 3 Disposed and Discontinued Operations for additional information), partially offset by 0.7% of acquisition related growth.
Gross profit decreased $406.1 million, or 13.7%, to $2.6 billion, primarily as a result of the decline in sales partially offset by supply chain cost containment initiatives and the benefits of prior restructuring actions. For further discussion related to our
consolidated and segment results, see "Consolidated Results of Operations" and "Segment Results of Operations," respectively, within Management's Discussion and Analysis of Financial Condition and Results of Operations.
Bookings decreased 12.3% over the prior year to $6.8 billion, driven primarily by weakness within our Energy segment which declined 29.1%. The decrease in full company bookings included a decrease in organic bookings of 11.8%, 3.6% as a result of unfavorable foreign exchange rates, and a 0.1% decrease due to dispositions, partially offset by a 3.2% increase in acquisition-related bookings. Bookings across the Engineered Systems, Fluids, and Refrigeration & Food Equipment segments decreased by 5.7%, 5.8% and 7.8%, respectively. Overall, our book-to-bill was 0.98, a slight decrease from the prior year's book-to-bill of 1.00. Backlog as of December 31, 2015 was $994.6 million, down from $1.2 billion from the prior year.
From a geographic perspective, revenue declined in North America, Europe, Asia, and Latin America. The decrease in North America was primarily driven by the significant deterioration of oil and gas markets and the loss of share with a major food retail customer. The decrease in Europe and Latin America was primarily due to the unfavorable impact of foreign currency rates. Asia was down modestly due to weakness in industrial markets in China.
We acquired four businesses in 2015 for total net consideration of $567.8 million. These businesses were acquired primarily to complement and expand upon existing operations within our Fluids and Engineered Systems segments. In addition, in 2015, in conjunction with the regular review of our portfolio and the fit of our businesses, we completed the divestitures of the Sargent Aerospace and Datamax O'Neil businesses, which were previously classified as discontinued operations. We also completed the divestiture of a product line within our Refrigeration & Food Equipment segment during the fourth quarter of 2015. The operating results of this business remain within our consolidated results for 2015 as the disposal did not qualify to be classified as a discontinued operation.
During 2015, we continued our focus on operating efficiencies through our Dover Excellence Program. This program focuses on free cash flow generation, productivity to support the ongoing investment in product innovation and customer expansion activities, the continuous evaluation of operating efficiencies, and the continued consolidation of back office support. As a result of the Dover Excellence Program focus, we generated free cash flow of $794.8 million or 11.4% of revenue, an increase of $10.7 million and 13 basis points over the prior year. In addition the Dover Excellence Program's focus on supply chain initiatives generated approximately $40 million in cost savings during 2015. During the year we also took actions to right-size our businesses to reflect difficult market conditions, especially within our Energy segment. These actions resulted in full year 2015 restructuring charges of $55.2 million, of which $30.8 million was within the Energy segment. The 2016 cost savings expected to be realized as a result of the restructuring programs and other cost management actions initiated in 2015 is expected to be within the range of $40.0 million to $50.0 million. We expect additional programs may be implemented throughout 2016 with related restructuring charges in the range of $10 to $20 million.
During the year ended December 31, 2015, the Company purchased a total of approximately 8.2 million shares of its common stock in the open market at a total cost of $600.2 million, or approximately $72.94 per share. These share repurchases were made under the January 2015 share authorization through which the Board of Directors authorized total repurchases of 15 million shares of the Company's common stock. As of December 31, 2015, the approximate number of shares still available for repurchase under the January 2015 share repurchase authorization was 6.8 million. In 2015 we continued our history of increasing our annual dividend payments to shareholders and paid a total of $258.0 million in dividends to our shareholders.
LOOKING FORWARD
In 2016, we expect revenue growth in our Engineered Systems, Fluids and Refrigeration & Food Equipment segments. We also expect revenue to further decline in Energy, impacted by continuing deterioration within the oil and gas markets. In all, we expect 2016 revenue growth of 1% to 4%. This growth will be comprised of an organic revenue decline of 1% to 4%, growth from acquisitions of approximately 7%, and a negative impact from foreign currency of approximately 2%. We expect overall growth will be driven by acquisitions, primarily within the Fluids and Engineered Systems segments, and new product introduction, primarily within the Engineered Systems and Refrigeration & Food Equipment segments. Within the Energy segment, North American markets are expected to continue to decline due to reduced rig counts and capital spending resulting from lower oil prices. Our Energy business's international revenue, comprising approximately 24% of segment revenue, is expected to remain stable to modestly improving. Our estimate for Energy in 2016 is based on an average annual price per barrel of oil of approximately $40 versus the current market price around $30.
We expect to generate free cash flow in 2016 of approximately 11.0% of revenue. In total, we expect full year diluted earnings per share from continuing operations ("EPS") to be in the range of $3.85 to $4.05. Our 2016 guidance includes the impact of disposed product lines, the benefit of previously executed restructuring actions and share repurchases, and the impact of foreign currency translation.
If global or domestic economic conditions accelerate or deteriorate, especially energy markets, our operating results for 2016 could be materially different than currently projected.
CONSOLIDATED RESULTS OF OPERATIONS
As discussed in Note 3 Disposed and Discontinued Operations to the Consolidated Financial Statements in Item 8 of this Form 10-K, in the fourth quarter of 2014, we reclassified certain businesses in the Engineered Systems segment to discontinued operations based on our decision to divest these businesses. The results of operations of these businesses have been removed from the results of continuing operations and are presented within results of discontinued operations for all periods presented.
| Years Ended December 31, | % / Point Change | |||||||||||||||||
| (dollars in thousands, except per share figures) | 2015 | 2014 | 2013 | 2015 vs. 2014 | 2014 vs. 2013 | |||||||||||||
| Revenue | $ | 6,956,311 | $ | 7,752,728 | $ | 7,155,096 | (10.3 | )% | 8.4 | % | ||||||||
| Cost of goods and services | 4,388,167 | 4,778,479 | 4,376,505 | (8.2 | )% | 9.2 | % | |||||||||||
| Gross profit | 2,568,144 | 2,974,249 | 2,778,591 | (13.7 | )% | 7.0 | % | |||||||||||
| Gross profit margin | 36.9 | % | 38.4 | % | 38.8 | % | (1.5 | ) | (0.4 | ) | ||||||||
| Selling and administrative expenses | 1,647,382 | 1,758,765 | 1,616,921 | (6.3 | )% | 8.8 | % | |||||||||||
| Selling and administrative as a percent of revenue | 23.7 | % | 22.7 | % | 22.6 | % | 1.0 | 0.1 | ||||||||||
| Interest expense, net | 127,257 | 127,179 | 120,654 | 0.1 | % | 5.4 | % | |||||||||||
| Other income, net | (7,105 | ) | (5,902 | ) | (4,970 | ) | nm* | nm* | ||||||||||
| Provision for income taxes | 204,729 | 316,067 | 248,459 | (35.2 | )% | 27.2 | % | |||||||||||
| Effective tax rate | 25.6 | % | 28.9 | % | 23.8 | % | (3.3 | ) | 5.1 | |||||||||
| Earnings from continuing operations | 595,881 | 778,140 | 797,527 | (23.4 | )% | (2.4 | )% | |||||||||||
| Earnings (loss) from discontinued operations, net | 273,948 | (2,905 | ) | 205,602 | nm* | nm* | ||||||||||||
| Earnings from continuing operations per common share - diluted | $ | 3.74 | $ | 4.61 | $ | 4.60 | (18.9 | )% | 0.2 | % |
- nm: not meaningful
Revenue
Our 2015 consolidated revenue decreased $796.4 million, or 10.3% to $7.0 billion compared to 2014, reflecting an organic decline of 9.8%, an unfavorable impact of 3.9% from foreign currency translation, and 0.1% decline due to a disposed product line, offset by growth from acquisitions of 3.5%. Acquisition growth of 3.5% was largely driven by the recent acquisitions of JK Group, Gala Industries, and Reduction Engineering Scheer within our Engineered Systems and Fluids segments, respectively as well as the full-year benefit from the October 2014 acquisition of Accelerated within the Energy segment. Overall customer pricing was slightly unfavorable, impacting consolidated revenue 0.2%.
Our 2014 consolidated revenue increased 8.4% to $7.8 billion compared with 2013, reflecting organic growth of 4.4%, acquisition- related growth of 4.4% and a slightly unfavorable impact from foreign currency translation. All four segments grew solidly year-over-year. Acquisition growth of 4.4% was largely driven by our Energy segment with the acquisitions of Accelerated and WellMark.
Gross Profit
Our gross profit decreased $406.1 million, or 13.7%, in 2015 compared with 2014, primarily due to the significant decline in sales volumes partially offset by supply chain cost containment initiatives and the benefits of prior restructuring actions. Gross profit margin declined 150 basis points due to an unfavorable product mix as those businesses with historically higher margin contributions experienced significant revenue declines.
Our gross profit increased $195.7 million or 7.0% in 2014 compared with 2013, reflecting the benefit of increased sales volumes. Gross profit margin declined 40 basis points due to the impact of higher restructuring costs of $14.4 million, higher acquisition- related depreciation and amortization of $15.4 million, and higher one-time labor costs as we completed the transition to new production sites.
Selling and Administrative Expenses
Selling and administrative expenses decreased $111.4 million, or 6.3%, in 2015 compared with 2014 reflecting the impact of cost savings realized as the result of restructuring programs and reduced discretionary spending. As a percentage of revenue, selling and administrative expenses increased 100 basis points in 2015 to 23.7%, reflecting deleveraging of fixed administrative costs, particularly within the Energy segment. Additionally, higher restructuring costs of $8.9 million as compared to 2014 also contributed to higher selling and administrative expenses relative to the revenue base.
Higher selling and administrative expenses in 2014 relative to 2013 reflect general increases across the segments in support of higher volumes. As a percentage of revenue, selling and administrative expenses increased 10 basis points in 2014 to 22.7% as compared to 22.6% for 2013. Results for 2014 include a $3.6 million one-time settlement charge for lump-sum payments made to participants in our U.S. defined benefit pension plan. Selling and administrative expenses for the 2013 period also include certain one-time gains of $6.8 million associated with the sale of land in Switzerland and pension curtailment gain of $4.4 million recognized in connection with the freeze of future service benefits for the U.S. benefit plans. Adjusting for these one-time items, selling and administrative expenses as a percentage of revenue improved 20 basis points in 2014 relative to 2013 as a result of leverage from higher revenue levels, which more than offset higher acquisition-related depreciation and amortization and increased restructuring charges.
Non-Operating Items
Interest expense, net, remained relatively flat at $127.3 million in 2015 due to higher interest rates on commercial paper year over year offset by lower interest on the Euro-denominated debt and on the $400.0 million notes issued during the fourth quarter. In 2014, our interest expense, net, increased 5.4% to $127.2 million due primarily to higher interest rates on the euro-denominated debt issued in the fourth quarter of 2013.
Other expense (income), net in 2015, 2014, and 2013 includes $1.6 million, $2.1 million, and $5.6 million, respectively, of net foreign exchange losses resulting from the re-measurement and settlement of foreign currency denominated balances. These foreign exchange losses were more than offset by other nonrecurring items including income due to insurance settlements for property damage of $3.6 million, $5.1 million and $7.4 million in 2015, 2014 and 2013, respectively. Other income for 2015 and 2014 also included $3.3 million and $1.7 million, respectively, for earnings on equity method investments during the year.
Income Taxes
Our businesses span the globe with 33.8%, 27.8%, and 31.7% of our pre-tax earnings in 2015, 2014, and 2013, respectively, generated in foreign jurisdictions. Foreign earnings are generally subject to local country tax rates that are below the 35.0% U.S. statutory rate. We also benefit from tax holidays and incentives in a number of the foreign jurisdictions. As a result, our effective non-U.S. tax rate is typically significantly lower than the U.S. statutory rate.
The 2015 effective tax rate on continuing operations was 25.6% compared to the 2014 rate of 28.9%. The 2015 and 2014 rates were impacted by $17.5 million and $11.3 million of favorable net discrete items, principally related to settlements of uncertain tax matters. After adjusting for discrete items, the effective tax rates were 27.8% for 2015 and 29.9% for 2014. Our 2015 tax rate was lower than the prior year due to the mix of earnings driven principally by reduced U.S. earnings within our Energy segment.
We believe it is reasonably possible during the next twelve months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. This decrease may result in an income tax benefit. Due to the potential for resolution of federal, state, and foreign examinations, and the expiration of various statutes of limitation, our gross unrecognized tax benefits balance may change within the next twelve months by a range of zero to $18.0 million. Some portion of such change may be reported as discontinued operations. We believe adequate provision has been made for all income tax uncertainties.
The 2013 effective tax rate on continuing operations was 23.8%. The effective tax rate in 2013 was impacted by favorable net discrete items totaling $75.5 million, principally related to the conclusion of certain U.S. federal, state and international tax audits, a favorable court opinion, certain cross-border tax consequences and the effect of the American Tax Relief Act of 2012 which was enacted on January 2, 2013. After adjusting for discrete and other items, the effective tax rate for 2013 was 31.0%.
Earnings from Continuing Operations
Earnings from continuing operations decreased 23.4% to $595.9 million, or $3.74 EPS in 2015, compared with earnings from continuing operations of $778.1 million, or $4.61 EPS, in 2014. These results include discrete tax benefits of $17.5 million, or $0.11 EPS, in 2015 and $11.3 million, or $0.07 EPS, in 2014. Excluding these tax benefits, earnings from continuing operations decreased 24.6% in 2015 primarily due to lower revenues and additional restructuring charges, partially offset by benefits from productivity and cost containment initiatives. EPS decreased in 2015 as a result of lower earnings, partially offset by lower weighted average shares outstanding relative to 2014 due to approximately eight million shares repurchased during the year.
Earnings from continuing operations decreased 2.4% in 2014, compared with earnings from continuing operations of $797.5 million, or $4.60 EPS, in 2013. These results include discrete tax benefits of $11.3 million in 2014 and $75.5 million, or $0.43 EPS, in 2013. Excluding these tax benefits, earnings from continuing operations increased 6.2% primarily due to higher revenues and benefits from productivity and cost containment initiatives, offset by higher restructuring and acquisition-related expenses. EPS increased in 2014, reflecting the impact of higher earnings and lower weighted average shares outstanding relative to 2013 due to over seven million shares repurchased during the year.
Discontinued Operations
The results of discontinued operations for the year ended December 31, 2015, primarily include the gain on sale of $265.6 million as a result of the sale of Datamax O'Neil and Sargent Aerospace and $6.3 million of earnings attributable to those businesses prior to their disposal. These businesses were previously included in the results of the Engineered Systems segment and were reclassified to discontinued operations in 2014.
The results of discontinued operations for the year ended December 31, 2014 totaled a net loss of $2.9 million. This amount includes a loss on the sale of DEK of $6.9 million and a gain of $3.2 million in connection with a working capital adjustment for ECT, which was sold in 2013. Also reflected within the net loss from discontinued operations is $32.3 million of after-tax earnings for those businesses classified as discontinued operations, including Datamax O'Neil and Sargent Aerospace, $27.1 million of spin-off costs and a pension settlement charge of $4.4 million, net of tax, attributable to lump sum payments made to Knowles participants in Dover's qualified defined benefit pension plan.
Earnings from discontinued operations for the year ended December 31, 2013 were $205.6 million, which primarily reflects after-tax earnings of the five businesses classified as discontinued operations as well as discrete tax benefits of $54.8 million, $30.1 million of spin-off costs, and $18.3 million of interest on tax obligations in foreign jurisdictions. Also reflected in discontinued operations is a net loss on the sale of ECT, including impairments, of $21.5 million and $14.0 million of impairment relating to DEK.
Refer to Note 3 Disposed and Discontinued Operations in the Consolidated Financial Statements in Item 8 of this Form 10-K for additional information on disposed and discontinued operations.
Restructuring Activities
2015 Restructuring Activities
The Company incurred $55.2 million of restructuring charges during 2015 including the programs described below.
| • | The Energy segment incurred restructuring charges of $30.8 million related to various programs across the segment focused on workforce reductions and field service consolidations. These programs were initiated to better align cost base with the significantly lower demand environment. |
| • | The Engineered Systems segment recorded $13.3 million of restructuring charges relating to headcount reductions across various businesses primarily related to optimization of administrative functions within the Printing & Identification platform and U.S. manufacturing consolidation within the Industrials platform. |
| • | The Fluids segment recorded $4.9 million of restructuring charges principally related to reduction in workforce for those businesses serving the Pumps markets. Additional restructuring was completed in the pumps businesses for facility consolidation. |
| • | The Refrigeration & Food Equipment segment recorded restructuring charges of $5.8 million, primarily related to asset impairments due to exit plans at targeted facilities and headcount reductions. |
We anticipate that much of the benefit of these 2015 programs will be realized in 2016 and into 2017. We also expect to fund the remainder of the 2015 programs currently underway over the next 12 to 18 months. In light of the economic uncertainty in certain of our end markets and our continued focus on improving our operating efficiency, it is possible that additional programs may be implemented throughout the remainder of 2016.
2014 Restructuring Activities
The Company incurred $44.8 million of restructuring charges during 2014 including the programs described below.
| • | The Energy segment incurred restructuring charges of $7.5 million, related principally to a facility consolidation in its businesses serving the compression markets and a reduction in workforce. |
| • | The Engineered Systems segment recorded $6.6 million of restructuring charges relating to facility consolidations within both the Printing & Identification and Industrials platforms, as well as actions taken to optimize costs related to engineering, sales, and administrative functions within the Printing & Identification platform. |
| • | The Fluids segment recorded $3.8 million of restructuring charges principally related to reduction in workforce for those businesses serving the Pumps markets. |
| • | The Refrigeration & Food Equipment segment recorded restructuring charges of $24.9 million, primarily related to headcount reductions and exit plans at targeted facilities, including approximately $17.5 million related to the closure of a European-based facility within Refrigeration. |
| • | Corporate recorded restructuring charges of approximately $2.0 million, primarily severance expense, resulting from the Company's decision to realign its businesses into a new segment structure in the first quarter of 2014 following the spin-off of Knowles. |
Restructuring initiatives in 2013 were limited to a few targeted facility consolidations and headcount reductions. We incurred restructuring charges of $9.1 million relating to such activities. See Note 8 Restructuring Activities in the Consolidated Financial Statements in Item 8 of this Form 10-K for additional details regarding our recent restructuring activities.
SEGMENT RESULTS OF OPERATIONS
The summary that follows provides a discussion of the results of operations of each of our four reportable operating segments (Energy, Engineered Systems, Fluids, and Refrigeration & Food Equipment). Each of these segments is comprised of various product and service offerings that serve multiple end markets. See Note 16 Segment Information in the Consolidated Financial Statements in Item 8 of this Form 10-K for a reconciliation of segment revenue, earnings, and operating margin to our consolidated revenue, earnings from continuing operations, and operating margin. Segment EBITDA and segment EBITDA margin, which are presented in the segment discussion that follows, are non-GAAP measures and do not purport to be alternatives to operating income as a measure of operating performance. We believe that these measures are useful to investors and other users of our financial information in evaluating ongoing operating profitability as they exclude the depreciation and amortization expense related primarily to capital expenditures and acquisitions that occurred in prior years, as well as in evaluating operating performance in relation to our competitors. For further information, see the Non-GAAP Disclosures at the end of this Item 7.
Energy
Our Energy segment, serving the Drilling & Production, Bearings & Compression, and Automation end markets, is a provider of customer-driven solutions and services for safe and efficient production and processing of fuels worldwide and has a strong presence in the bearings and compression components and automation markets.
| Years Ended December 31, | % Change | |||||||||||||||||
| (dollars in thousands) | 2015 | 2014 | 2013 | 2015 vs. 2014 | 2014 vs. 2013 | |||||||||||||
| Revenue: | ||||||||||||||||||
| Drilling & Production | $ | 1,009,416 | $ | 1,459,514 | $ | 1,378,225 | (30.8 | )% | 5.9 | % | ||||||||
| Bearings & Compression | 306,387 | 347,470 | 341,628 | (11.8 | )% | 1.7 | % | |||||||||||
| Automation | 167,877 | 210,255 | 134,000 | (20.2 | )% | 56.9 | % | |||||||||||
| Total | $ | 1,483,680 | $ | 2,017,239 | $ | 1,853,853 | (26.4 | )% | 8.8 | % | ||||||||
| Segment earnings | $ | 173,190 | $ | 461,815 | $ | 459,649 | (62.5 | )% | 0.5 | % | ||||||||
| Operating margin | 11.7 | % | 22.9 | % | 24.8 | % | ||||||||||||
| Segment EBITDA | $ | 314,969 | $ | 573,771 | $ | 558,724 | (45.1 | )% | 2.7 | % | ||||||||
| Segment EBITDA margin | 21.2 | % | 28.4 | % | 30.1 | % | ||||||||||||
| Other measures: | ||||||||||||||||||
| Depreciation and amortization | $ | 141,779 | $ | 111,956 | $ | 99,075 | 26.6 | % | 13.0 | % | ||||||||
| Bookings | 1,429,260 | 2,016,411 | 1,853,562 | (29.1 | )% | 8.8 | % | |||||||||||
| Backlog | 155,586 | 233,347 | 206,790 | (33.3 | )% | 12.8 | % | |||||||||||
| Components of revenue growth: | 2015 vs. 2014 | 2014 vs. 2013 | ||||||||||||||||
| Organic (decline) growth | (34.3 | )% | 3.1 | % | ||||||||||||||
| Acquisitions | 9.3 | % | 6.6 | % | ||||||||||||||
| Foreign currency translation | (1.4 | )% | (0.9 | )% | ||||||||||||||
| (26.4 | )% | 8.8 | % |
2015 Versus 2014
Revenue generated by our Energy segment decreased $533.6 million, or 26.4%, as compared with 2014, composed of an organic revenue decline of 34.3% and an unfavorable impact from foreign currency translation of 1.4%, offset by 9.3% acquisition-related growth. This decline in revenue was the result of significantly lower demand from our customers as a result of the
dramatic decrease in the price of oil during 2015 and a decline of approximately 47% in the year over year average number of active drilling rigs in the U.S. The impact of strategic customer price reductions on revenue was approximately 1.7% in 2015.
| • | Drilling & Production end market revenue (representing 68.0% of segment revenue) decreased $450.1 million, or 30.8%, due to significantly reduced demand and customer inventory reductions in our North American markets caused by the decrease in the price of oil and reduced number of active drilling rigs. The decrease in revenue for Drilling & Production was partially offset by acquisition-related growth, mainly due to our acquisition of Accelerated in the fourth quarter of 2014. |
| • | Bearings & Compression end market revenue (representing 20.7% of segment revenue) decreased $41.1 million, or 11.8% due to ongoing declines in our Bearings end market, as slower OEM build rates continued, especially with oil and gas customers. |
| • | Automation end market revenue (representing approximately 11.3% of segment revenue) decreased $42.4 million, or 20.2%. The favorable impact of recent acquisitions was more than offset by customer project delays, as low oil prices and uncertainties resulted in reduced capital spending by service and exploration and production companies. |
Segment earnings decreased $288.6 million, or 62.5%, for our Energy segment, as compared to the prior year, primarily driven by lower volume for our businesses serving the Drilling & Production end market as well as higher acquisition-related depreciation and amortization of approximately $10.1 million over the prior year. In addition, restructuring charges increased $23.3 million over the prior year, as the segment continued targeted workforce reductions and field service consolidations.
Bookings for the year ended December 31, 2015 decreased 29.1% compared to 2014, reflecting ongoing market weakness. Backlog at December 31, 2015 decreased 33.3% compared to the prior year due to decreased demand in all three end markets primarily due to lower oil prices. Segment book-to-bill was 0.96.
2014 Versus 2013
Energy segment revenue for the year increased $163.4 million, an 8.8% increase over the prior year including organic growth of 3.1%, acquisition-related growth of 6.6%, slightly offset by an unfavorable impact from foreign currency translation of 0.9%. Customer pricing was neutral when comparing 2014 to the prior year.
| • | Drilling & Production revenue (representing 72.4% of 2014 segment revenue) increased $81.3 million, or 5.9%. Growth was driven by strong U.S. drilling and artificial lift activity and the impact of acquisitions, particularly Accelerated Companies LLC, purchased in October 2014. This growth was partially offset by expected lower project-related shipments in Australia and lower demand for winches in the military and infrastructure markets. |
| • | Bearings & Compression revenue (representing 17.2% of 2014 segment revenue) increased $5.8 million, or 1.7%. This growth resulted from increased demand in our Compression end market, partially offset by softness in our Bearings end market due to slower OEM build rates. |
| • | Automation revenue (representing 10.4% of 2014 segment revenue) increased $76.3 million, or 56.9%, primarily resulting from growth relating to the 2014 acquisitions of Wellmark Holdings, Inc. and Timberline Manufacturing as well as the full year impact of the 2013 acquisition of SPIRIT. Growth in 2014 was also driven by strong drilling activity and increased sensor replacement in the downhole pressure transducers business. |
Energy earnings in 2014 increased $2.2 million compared to 2013, or 0.5%, primarily due to higher Drilling and Automation revenue partially offset by higher acquisition-related depreciation and amortization of approximately $22.0 million, as well as higher restructuring costs of $8.4 million. The operating margin decrease of 190 basis points was also partially impacted by unfavorable material pricing in the artificial lift businesses.
Engineered Systems
Our Engineered Systems segment is comprised of two platforms, Printing & Identification and Industrials, and is focused on the design, manufacture and service of critical equipment and components serving the fast-moving consumer goods, digital textile printing, vehicle service, environmental solutions and industrials end markets.
| Years Ended December 31, | % Change | |||||||||||||||||
| (dollars in thousands) | 2015 | 2014 | 2013 | 2015 vs. 2014 | 2014 vs. 2013 | |||||||||||||
| Revenue: | ||||||||||||||||||
| Printing & Identification | $ | 943,670 | $ | 988,884 | $ | 877,875 | (4.6 | )% | 12.6 | % | ||||||||
| Industrials | 1,399,243 | 1,397,081 | 1,300,095 | 0.2 | % | 7.5 | % | |||||||||||
| $ | 2,342,913 | $ | 2,385,965 | $ | 2,177,970 | (1.8 | )% | 9.5 | % | |||||||||
| Segment earnings | $ | 376,961 | $ | 386,998 | $ | 347,497 | (2.6 | )% | 11.4 | % | ||||||||
| Operating margin | 16.1 | % | 16.2 | % | 16.0 | % | ||||||||||||
| Segment EBITDA | $ | 436,875 | $ | 448,944 | $ | 406,555 | (2.7 | )% | 10.4 | % | ||||||||
| Segment EBITDA margin | 18.6 | % | 18.8 | % | 18.7 | % | ||||||||||||
| Other measures: | ||||||||||||||||||
| Depreciation and amortization | $ | 59,914 | $ | 61,946 | $ | 59,058 | (3.3 | )% | 4.9 | % | ||||||||
| Bookings | ||||||||||||||||||
| Printing & Identification | $ | 937,215 | $ | 993,204 | $ | 879,531 | (5.6 | )% | 12.9 | % | ||||||||
| Industrials | 1,369,438 | 1,451,847 | 1,316,228 | (5.7 | )% | 10.3 | % | |||||||||||
| $ | 2,306,653 | $ | 2,445,051 | $ | 2,195,759 | (5.7 | )% | 11.4 | % | |||||||||
| Backlog | ||||||||||||||||||
| Printing & Identification | $ | 98,288 | $ | 110,359 | $ | 95,597 | (10.9 | )% | 15.4 | % | ||||||||
| Industrials | 250,725 | 282,598 | 231,748 | (11.3 | )% | 21.9 | % | |||||||||||
| $ | 349,013 | $ | 392,957 | $ | 327,345 | (11.2 | )% | 20.0 | % | |||||||||
| Components of revenue growth: | 2015 vs. 2014 | 2014 vs. 2013 | ||||||||||||||||
| Organic growth | 3.2 | % | 6.2 | % | ||||||||||||||
| Acquisitions | 0.9 | % | 4.1 | % | ||||||||||||||
| Foreign currency translation | (5.9 | )% | (0.8 | )% | ||||||||||||||
| (1.8 | )% | 9.5 | % |
2015 Versus 2014
Engineered Systems revenue for 2015 decreased $43.1 million, or 1.8% as compared to 2014 primarily driven by an unfavorable impact from foreign currency of 5.9%, partially offset by organic growth of 3.2% and acquisition-related growth of 0.9%. The Engineered Systems segment derived 45% of its revenues outside the U.S. in 2015, primarily within Europe. A significant portion of the segment's sales were impacted by the strengthening of the U.S. dollar against the Euro and other global currencies in 2015. Customer pricing did not have a significant impact on the segment in 2015.
| • | Revenue derived from our Printing & Identification platform (representing 40.3% of segment revenue) decreased $45.2 million, or 4.6%. The growth in organic revenue of 4.6% and acquisition-related growth of 2.2% was more than offset by the negative impact of foreign currency translation of 11.4%, as the Euro and several other currencies weakened against the U.S. dollar. |
| • | Revenue of our Industrials platform (representing 59.7% of segment revenue), increased $2.2 million, or 0.2%, as compared to the prior year. Organic growth of 2.3% was driven by continued strong results in our waste handling and auto-related businesses, partially offset by softness in other Industrials businesses. This increase was partially offset by a 2.1% unfavorable foreign currency translation impact. |
Engineered Systems segment earnings in 2015 decreased $10.0 million, or 2.6%, compared with 2014. Increased volume as a result of organic growth was more than offset by the significant, unfavorable impact from foreign currency and higher restructuring charges of $6.7 million. Operating margin remained flat with the prior year, reflecting productivity gains and the benefits from completed restructuring initiatives.
Bookings for our Industrials platform decreased 5.7% due to a decline in organic growth and foreign currency translation. Our Printing & Identification bookings decreased 5.6%, due to the impact of foreign currency translation offset by recent acquisitions and organic growth. Segment book-to-bill was 0.98.
2014 Versus 2013
Engineered Systems 2014 revenue increased $208.0 million, or 9.5%, including organic revenue growth of 6.2% and growth from recent acquisitions of 4.1%, partially offset by an unfavorable impact from foreign currency translation of 0.8%. Customer pricing did not have a significant impact on Engineered Systems revenue in 2014 as compared to 2013.
| • | Revenue within Printing & Identification (representing 41.4% of 2014 segment revenue) increased $111.0 million, or 12.6%, including organic growth of 4.8% and 9.7% acquisition-based growth, partially offset by a 1.9% unfavorable impact of foreign currency translation. Broad-based global growth in both our fast moving consumer goods and industrial businesses, especially in the U.S., drove organic revenue growth. Acquisition growth was primarily driven by MS Printing Solutions, acquired in February 2014, contributing revenue growth of approximately 8.0% as compared to 2013. |
| • | Revenue derived from Industrials (representing 58.6% of 2014 segment revenue) increased $97.0 million, or 7.5%, as compared to the prior year comprising organic growth of 7.1% resulting from broad-based growth led by our auto-related and waste equipment businesses. Acquisition-related revenue increased 0.2%, while foreign currency translation had a favorable impact of 0.1%. |
Engineered Systems segment earnings in 2014 increased $39.5 million, or 11.4%, compared with 2013, as a result of increased volume and productivity improvements and recent acquisitions. Operating margin increased 20 basis points compared to 2013, as productivity savings were partially offset by higher acquisition-related costs, including $6.5 million of depreciation and amortization, as well as higher restructuring costs of $3.0 million.
Fluids
Our Fluids segment, serving the Fluid Transfer and Pumps end markets, is focused on the safe handling of critical fluids across the retail fueling, chemical, hygienic, oil and gas and industrial end markets.
| Years Ended December 31, | % Change | |||||||||||||||||
| (dollars in thousands) | 2015 | 2014 | 2013 | 2015 vs. 2014 | 2014 vs. 2013 | |||||||||||||
| Revenue: | ||||||||||||||||||
| Fluid Transfer | $ | 792,971 | $ | 778,979 | $ | 665,559 | 1.8 | % | 17.0 | % | ||||||||
| Pumps | 606,302 | 651,587 | 571,279 | (6.9 | )% | 14.1 | % | |||||||||||
| Total | $ | 1,399,273 | $ | 1,430,566 | $ | 1,236,838 | (2.2 | )% | 15.7 | % | ||||||||
| Segment earnings | $ | 262,117 | $ | 251,639 | $ | 224,523 | 4.2 | % | 12.1 | % | ||||||||
| Operating margin | 18.7 | % | 17.6 | % | 18.2 | % | ||||||||||||
| Segment EBITDA | $ | 318,195 | $ | 312,542 | $ | 273,335 | 1.8 | % | 14.3 | % | ||||||||
| Segment EBITDA margin | 22.7 | % | 21.8 | % | 22.1 | % | ||||||||||||
| Other measures: | ||||||||||||||||||
| Depreciation and amortization | $ | 56,078 | $ | 60,903 | $ | 48,812 | (7.9 | )% | 24.8 | % | ||||||||
| Bookings | 1,351,191 | 1,434,358 | 1,261,922 | (5.8 | )% | 13.7 | % | |||||||||||
| Backlog | 243,459 | 277,834 | 310,330 | (12.4 | )% | (10.5 | )% | |||||||||||
| Components of revenue growth: | 2015 vs. 2014 | 2014 vs. 2013 | ||||||||||||||||
| Organic growth | 0.8 | % | 7.5 | % | ||||||||||||||
| Acquisitions | 2.4 | % | 8.3 | % | ||||||||||||||
| Foreign currency translation | (5.4 | )% | (0.1 | )% | ||||||||||||||
| (2.2 | )% | 15.7 | % |
2015 Versus 2014
Fluids segment revenue decreased $31.3 million, or 2.2%, compared to 2014, comprised of an unfavorable foreign currency impact of 5.4%, offset by organic growth of 0.8% and acquisition-related growth of 2.4%. Fluids segment revenue experienced some favorability in 2015 as a result of strategic customer pricing offset by pricing pressure in polymer pumps and pressures within the oil and gas markets.
| • | Fluid Transfer revenue (representing 56.7% of 2015 segment revenue) increased $14.0 million, or 1.8%, compared to the prior year. The Fluid Transfer businesses grew organically and continue to benefit from acquisition-related growth, which partially offset the unfavorable impact of foreign currency translation. |
| • | Pumps revenue (representing 43.3% of 2015 segment revenue) decreased $45.3 million, or 6.9%, as compared with the prior year, as solid results for our plastic and polymer pump business were offset by the impacts of foreign currency and slower activity in oil and gas-related pump end markets. |
Fluids segment earnings increased $10.5 million, or 4.2%, for the year ended December 31, 2015 compared to the prior year period, driven by the benefits of completed restructuring and productivity actions. Operating margin expanded 110 basis points, in spite of an increase in depreciation and amortization expense related to recent acquisitions, higher restructuring charges as compared to the prior year period, deal related expenses and the unfavorable impact of foreign currency.
Bookings for 2015 decreased 5.8% as compared to 2014, and backlog levels decreased 12.4% at December 31, 2015 compared to the prior year end, primarily reflecting the timing of project-related orders within Pumps. Book to bill was 0.97.
2014 Versus 2013
Fluids segment revenue increased $193.7 million, or 15.7%, compared to 2013, comprised of organic revenue growth of 7.5%, acquisition-related growth of 8.3%, partially offset by an unfavorable foreign currency impact of 0.1%. Customer pricing provided favorability due in 2014 as compared to 2013.
| • | Fluid Transfer revenue (representing 54.5% of 2014 segment revenue) increased $113.4 million, or 17.0%, compared to the prior year. Growth was driven by strong fuel transportation and global retail fueling environment markets, as well as from recent acquisitions. |
| • | Pumps revenue (representing 45.5% of 2014 segment revenue) increased $80.3 million, or 14.1%, as compared with the prior year. Growth was driven by solid global demand, growth from recent acquisitions and new product introductions. |
Fluids segment earnings increased $27.1 million, or 12.1%, in 2014 compared to 2013, as volume leverage, productivity initiatives and strategic pricing more than offset incremental costs associated with recent acquisitions, including approximately $10.7 million of depreciation and amortization. Operating margin decreased 60 basis points, primarily due to the aforementioned impact of recent acquisitions, as well as higher restructuring charges to better streamline businesses, particularly within the businesses serving the Pumps end market.
Refrigeration & Food Equipment
Our Refrigeration & Food Equipment segment is a provider of innovative and energy efficient equipment and systems serving the commercial refrigeration and food service end markets.
| Years Ended December 31, | % Change | |||||||||||||||||
| (dollars in thousands) | 2015 | 2014 | 2013 | 2015 vs. 2014 | 2014 vs. 2013 | |||||||||||||
| Revenue: | ||||||||||||||||||
| Refrigeration | $ | 1,336,829 | $ | 1,483,157 | $ | 1,449,857 | (9.9 | )% | 2.3 | % | ||||||||
| Food Equipment | 394,601 | 438,032 | 437,983 | (9.9 | )% | — | % | |||||||||||
| Total | $ | 1,731,430 | $ | 1,921,189 | $ | 1,887,840 | (9.9 | )% | 1.8 | % | ||||||||
| Segment earnings | $ | 221,299 | $ | 238,734 | $ | 267,307 | (7.3 | )% | (10.7 | )% | ||||||||
| Operating margin | 12.8 | % | 12.4 | % | 14.2 | % | ||||||||||||
| Segment EBITDA | $ | 287,373 | $ | 307,435 | $ | 334,535 | (6.5 | )% | (8.1 | )% | ||||||||
| Segment EBITDA margin | 16.6 | % | 16.0 | % | 17.7 | % | ||||||||||||
| Other measures: | ||||||||||||||||||
| Depreciation and amortization | $ | 66,074 | $ | 68,701 | $ | 67,228 | (3.8 | )% | 2.2 | % | ||||||||
| Bookings | 1,717,100 | 1,863,207 | 1,882,338 | (7.8 | )% | (1.0 | )% | |||||||||||
| Backlog | 247,352 | 282,507 | 347,004 | (12.4 | )% | (18.6 | )% | |||||||||||
| Components of revenue growth: | 2015 vs. 2014 | 2014 vs. 2013 | ||||||||||||||||
| Organic (decline) growth | (7.8 | )% | 1.7 | % | ||||||||||||||
| Acquisitions | 0.7 | % | 0.2 | % | ||||||||||||||
| Dispositions | (0.4 | )% | — | % | ||||||||||||||
| Foreign currency translation | (2.4 | )% | (0.1 | )% | ||||||||||||||
| (9.9 | )% | 1.8 | % |
2015 Versus 2014
Refrigeration & Food Equipment segment revenue decreased $189.8 million, or 9.9%, compared to 2014, comprised of an organic revenue decline of 7.8%, an unfavorable impact from foreign currency translation of 2.4%, and a 0.4% decline due to dispositions. The decline was slightly offset by acquisition-related growth of 0.7%. Customer pricing did not have a significant impact on the segments revenue in 2015.
| • | Refrigeration revenue (representing 77.2% of segment revenue) decreased $146.3 million, or 9.9%, year over year, primarily driven by the anticipated decline in organic revenue due to reduced volume from a major food retail customer, as well as an unfavorable impact from foreign currency translation, primarily the Euro. |
| • | Food Equipment revenue (representing 22.8% of segment revenue) decreased $43.4 million, or 9.9%, compared with the prior year mainly due to market softness in our beverage can forming equipment and food packaging machinery businesses, as well as the unfavorable impact of foreign currency translation. |
Refrigeration & Food Equipment segment earnings decreased $17.4 million, or 7.3%, for the year ended December 31, 2015 compared to the prior year period, primarily due to volume declines, partially offset by the benefits of restructuring programs and productivity initiatives. Operating margin increased 40 basis points, reflecting the benefits of restructuring programs and reduced supply chain and manufacturing costs as well as lower restructuring charges in 2015 as compared to the prior year.
Results of operations for the Refrigeration & Food Equipment segment include a product line that was disposed in the fourth quarter of 2015. The disposal of this product line reduced segment revenue by 0.4% in 2015. The segment recognized a minimal gain on sale upon disposal of this product line.
Bookings for 2015 decreased 7.8% as compared to 2014, and backlog levels decreased 12.4% at December 31, 2015 compared to the prior year end, principally reflecting the reduction of orders from a major food retailer as well as the unfavorable impact of foreign currency translation. Book to bill was 0.99.
2014 Versus 2013
Revenue generated by our Refrigeration & Food Equipment segment in 2014 increased $33.3 million, or 1.8%, compared to 2013. The overall increase in revenue includes organic growth of 1.7%, and acquisition growth of 0.2%. Foreign currency translation had an unfavorable impact of 0.1%. Pricing was neutral in 2014 as compared to 2013.
| • | Revenue in our Refrigeration end market (representing 77.2% of 2014 segment revenue) increased $33.3 million, or 2.3%, resulting from solid activity with major food retailers. |
| • | Revenue derived from Food Equipment (representing 22.8% of 2014 segment revenue) was flat year over year, where growth in commercial kitchen and can-forming equipments was offset by soft food processing equipment activity. |
Refrigeration & Food Equipment segment earnings in 2014 decreased $28.6 million, or 10.7% compared with 2013, with a decrease in operating margin of 180 basis points. The earnings and margin decreases were driven by non-recurring restructuring of $24.9 million ($19.4 million higher as compared to 2013) primarily for the closure of a European-based facility, unfavorable product mix, as well as a $6.8 million land sale gain in the prior year that did not repeat.
FINANCIAL CONDITION
We assess our liquidity in terms of our ability to generate cash to fund our operating, investing, and financing activities. Significant factors affecting liquidity are: cash flows generated from operating activities, capital expenditures, acquisitions, dispositions, dividends, repurchase of outstanding shares, adequacy of available commercial paper and bank lines of credit, and the ability to attract long-term capital with satisfactory terms. We generate substantial cash from the operations of our businesses and remain in a strong financial position, with sufficient liquidity available for reinvestment in existing businesses and strategic acquisitions.
Cash Flow Summary
The following table is derived from our Consolidated Statement of Cash Flows:
| Years Ended December 31, | |||||||||||
| Cash Flows from Continuing Operations (in thousands) | 2015 | 2014 | 2013 | ||||||||
| Net Cash Flows Provided By (Used In): | |||||||||||
| Operating activities | $ | 949,059 | $ | 950,164 | $ | 979,612 | |||||
| Investing activities | (34,578 | ) | (782,557 | ) | (361,677 | ) | |||||
| Financing activities | (1,091,886 | ) | (255,489 | ) | (678,542 | ) |
Operating Activities
Cash provided by operating activities in 2015 decreased $1.1 million relative to 2014. This slight decline was driven primarily by lower continuing earnings excluding depreciation and amortization of $162.4 million and lower compensation and expense accruals of $114.1 million, offset by higher cash inflows from working capital of $234.7 million relative to the prior year primarily driven by improvements in inventory, accounts receivable, and accounts payable through active working capital management.
Cash provided by operating activities in 2014 decreased $29.4 million relative to 2013. This decline was driven by higher investments in working capital of $43.4 million in 2014 relative to the prior year primarily due to the impact of timing of inventory purchases and vendor payments. In addition, higher tax payments of approximately $54.0 million contributed to the decline in operating cash flow in 2014. These reductions were partially offset by higher continuing earnings before the impact of depreciation, amortization, and restructuring expenses and lower pension contributions of $16.0 million.
Pension and Post-Retirement Activity: Total contributions to defined benefit pension plans during 2015 were $21.9 million including contributions to our international pension plans and payments of benefits under our nonqualified supplemental pension plan.
The funded status of our qualified defined benefit pension plans is dependent upon many factors, including returns on invested assets, the level of market interest rates, and the level of funding. We contribute cash to our plans at our discretion, subject to applicable regulations and minimum contribution requirements. Cash contributions to the U.S. qualified benefit plans totaled $9.0 million in 2013. Due to the overfunded status of this plan, the Company made no contributions in 2015 and 2014 and expects to make minimal contributions in the near term.
Our significant international pension obligations are located in regions where it is not economically advantageous to pre-fund the plans due to local regulations. Total cash contributions to ongoing international defined benefit pension plans in 2015, 2014, and 2013 totaled $8.4 million, $9.5 million, and $9.8 million, respectively. In 2016, we expect to contribute approximately $6.3 million to our non-U.S. plans. Our non-qualified supplemental pension plan is funded through Company assets as benefits are paid. During 2015 a total of $12.8 million benefits were paid under this plan. See Note 14 Employee Benefit Plans in the Consolidated Financial Statements in Item 8 of this Form 10-K for further discussion regarding our post-retirement plans.
Adjusted Working Capital: In 2015, Adjusted Working Capital (a non-GAAP measure calculated as accounts receivable, plus inventory, less accounts payable) decreased from 2014 by $162.6 million, or 11.3%, to $1.3 billion, which reflected a decrease in receivables of $66.3 million, a decrease in net inventory of $60.8 million, and an increase in accounts payable of $35.5 million. Excluding acquisitions, dispositions, and the effects of foreign exchange translation, adjusted working capital decreased by $147.6 million, or 10.3%.
Investing Activities
Cash used in investing activities are derived from cash outflows for capital expenditures and acquisitions, partially offset by proceeds from sales of businesses, property, plant and equipment, and short-term investments. The majority of the activity in investing activities was comprised of the following:
| • | Acquisitions: In 2015, we deployed $567.8 million to acquire four businesses. In comparison, we acquired seven business in 2014 for an aggregate purchase price of approximately $802.3 million. Total acquisition spend in 2013 was nearly $322.8 million and was comprised of ten businesses. See Note 2 Acquisitions in the Consolidated Financial Statements in Item 8 of this Form 10-K for additional information with respect to recent acquisitions. |
| • | Capital spending: Capital expenditures, primarily to support productivity and new product launches were $154.3 million in 2015, $166.0 million in 2014, and $141.7 million in 2013. Our capital expenditures decreased $11.8 million in the 2015 period as compared to 2014, primarily within Energy. We expect 2016 capital expenditures to approximate 2.3% of revenue as compared to capital expenditures of 2.2% of revenue in 2015. |
| • | Proceeds from sale of businesses: In 2015, we generated cash proceeds of $689.3 million, primarily from the sale of Datamax O'Neil and Sargent Aerospace. In 2014, we generated cash proceeds of $191.3 million, primarily from the sale of DEK and $16.3 million from the collection of deferred sale proceeds on the 2013 sale of ECT. Cash proceeds of $76.5 million in 2013 were primarily the result of the sale of ECT. |
On January 7, 2016 we acquired the dispenser and system businesses of Tokheim Group S.A.S. ("Tokheim") for a purchase price of approximately €411.3 million , or $448.7 million. Of the total purchase price, €290.0 million, approximately $316.4 million, was funded through incremental borrowings of commercial paper with the remainder funded through available cash on hand.
We anticipate that capital expenditures and any additional acquisitions we make in 2016 will be funded from available cash and internally generated funds and, if necessary, through the issuance of commercial paper, the use of established lines of credit, or by accessing the public debt or equity markets.
Financing Activities
Our cash flow from financing activities generally relates to the use of cash for purchases of our common stock and payment of dividends, offset by net borrowing activity and proceeds from the exercise of stock options. The majority of financing activity was attributed to the following:
| • | Long-term debt and commercial paper and notes payable, net: During 2015, we decreased net borrowings from commercial paper by $327.0 million, we repaid the Company's $300.0 million of 4.875% notes, which matured October 15, 2015, and we issued $400.0 million, 3.150% notes realizing cash proceeds of $394.3 million, net of discounts and issuance costs. In 2014, we had cash inflow of $251.5 million from commercial paper issuances, principally to fund acquisitions during the period, including Accelerated Companies in the fourth quarter. In December 2013, the Company issued €300.0 million of 2.125% euro-denominated notes due in 2020. The proceeds of $403.8 million from this issuance , net of discounts and issuance costs, were primarily used to repay $381.0 million in commercial paper and fund business acquisitions. |
| • | Treasury purchases: In January 2015, Dover's Board of Directors approved a new standing share repurchase authorization, whereby the Company may repurchase up to 15 million shares of its common stock over the following three years. This share repurchase authorization replaced the previous November 2012 authorization. These share repurchases are opportunistic buybacks made as part of management's capital allocation strategy. These repurchases are also made to offset the dilutive impact of shares issued under our equity compensation plans. During 2015, we used $600.2 million to repurchase 8.2 million shares under this authorization. As of December 31, 2015, the number of shares still available for repurchase under the January 2015 share repurchase authorization was 6.8 million. During 2014, we completed the repurchase of 7.5 million shares at a total cost of $601.1 million under the May and November 2012 board-approved stock repurchase programs. We used $457.4 million in 2013 to repurchase 6.0 million shares under the November 2012 facility. In addition, in 2013 the Company repurchased 5,951 shares from employees for a total cost of $0.5 million. |
| • | Dividend payments: Total dividend payments to common shareholders were $258.0 million in 2015, $258.5 million in 2014 and $247.8 million in 2013. Our dividends paid per common share increased 6% to $1.64 per share in 2015 compared to $1.55 per share in 2014. This represents the 60th consecutive year that our dividend has increased. |
| • | Net Proceeds from the exercise of share-based awards: Proceeds from the exercise of share-based awards were $4.0 million, $20.3 million, and $38.9 million in 2015, 2014, and 2013, respectively. These proceeds have declined in recent periods due to the decline in the Company's stock price, the decrease in the number of stock options outstanding, and a larger number of cashless exercises of equity awards. Payments to settle tax obligations on these exercises were $5.0 million, $21.2 million, and $31.3 million in 2015, 2014, and 2013, respectively. These tax payments have been declining in relation to the declining number of exercises in recent years. |
| • | Cash received from Knowles, net of cash distributed: In connection with the separation of Knowles from Dover in 2014, Knowles made a cash payment of $400.0 million to Dover immediately prior to the distribution. Dover received net cash of $360.0 million million upon separation, which reflects the $400.0 million cash payment due net of cash held by Knowles at the time of distribution and retained by it in connection with its separation from Dover. Dover utilized the net proceeds from Knowles to pay down commercial paper and to repurchase shares of its common stock in the first quarter of 2014. |
Cash Flows from Discontinued Operations
Cash used in discontinued operations totaled $115.9 million in 2015 as compared to cash provided of $6.0 million in 2014. These cash flows reflect the operating results of Datamax O'Neil and Sargent Aerospace (prior to their sale in 2015), as well as the results of Knowles prior to its spin-off in the first quarter of 2014. Cash used in the 2015 period also includes $110.5 million of taxes paid relating to the gain on the sale of Sargent Aerospace. Cash used in the 2014 period includes costs incurred for the spin-off of Knowles of $27.1 million and capital expenditures of $20.6 million.
In 2013, cash provided by discontinued operations of $65.8 million included full year results for those business classified as discontinued operations, which include Knowles, DEK, ECT, Sargent Aerospace, and Datamax O'Neil. The cash generated from operations was offset by costs incurred for the spin-off of Knowles of $30.1 million and capital expenditures of $101.6 million.
Liquidity and Capital Resources
Free Cash Flow
In addition to measuring our cash flow generation and usage based upon the operating, investing, and financing classifications included in the Consolidated Statements of Cash Flows, we also measure free cash flow (a non-GAAP measure). We believe that free cash flow is an important measure of operating performance because it provides management and investors a measurement of cash generated from operations that is available to repay debt, pay dividends, fund acquisitions, and repurchase our common stock. For further information, see the Non-GAAP Disclosures at the end of this Item 7.
The following table reconciles our free cash flow to cash flow provided by operating activities:
| Years Ended December 31, | |||||||||||
| Free Cash Flow (dollars in thousands) | 2015 | 2014 | 2013 | ||||||||
| Cash flow provided by operating activities | $ | 949,059 | $ | 950,164 | $ | 979,612 | |||||
| Less: Capital expenditures | (154,251 | ) | (166,033 | ) | (141,694 | ) | |||||
| Free cash flow | $ | 794,808 | $ | 784,131 | $ | 837,918 | |||||
| Free cash flow as a percentage of revenue | 11.4 | % | 10.1 | % | 11.7 | % |
For 2015, we generated free cash flow of $794.8 million, representing 11.4% of revenue. Free cash flow in 2014 was $784.1 million or 10.1% of revenue, and $837.9 million, or 11.7% of revenue in 2013. The full year increase in 2015 free cash flow reflects our efforts around operating efficiencies and working capital management through our Dover Excellence program. We expect to generate free cash flow in 2016 of approximately 11.0% of revenue.
The 2014 decrease in free cash flow compared to 2013 reflects a higher investment in working capital and higher capital expenditures, partially offset by higher earnings from continuing operations before depreciation and amortization.
Net Debt to Net Capitalization
We utilize the net debt to net capitalization calculation (a non-GAAP measure) to assess our overall financial leverage and capacity and believe the calculation is useful to investors for the same reason. The following table provides a reconciliation of net debt to net capitalization to the most directly comparable GAAP measures:
| Net Debt to Net Capitalization Ratio (dollars in thousands) | December 31, 2015 | December 31, 2014 | December 31, 2013 | |||||||||
| Current maturities of long-term debt | $ | 122 | $ | 299,956 | $ | 2,778 | ||||||
| Commercial paper | 151,000 | 478,000 | 226,500 | |||||||||
| Long-term debt | 2,617,342 | 2,253,041 | 2,599,201 | |||||||||
| Total debt | 2,768,464 | 3,030,997 | 2,828,479 | |||||||||
| Less: Cash and cash equivalents | (362,185 | ) | (681,581 | ) | (803,882 | ) | ||||||
| Net debt | 2,406,279 | 2,349,416 | 2,024,597 | |||||||||
| Add: Stockholders' equity | 3,644,575 | 3,700,725 | 5,377,396 | |||||||||
| Net capitalization | $ | 6,050,854 | $ | 6,050,141 | $ | 7,401,993 | ||||||
| Net debt to net capitalization | 39.8 | % | 38.8 | % | 27.4 | % |
Our net debt to net capitalization ratio increased to 39.8% at December 31, 2015 compared to 38.8% at December 31, 2014. The increase in this ratio was driven by changes in net debt during the period. Net debt increased $56.9 million during the period primarily due to a reduction in cash levels as a result of debt repayments, stock repurchases, and acquisitions, and higher long-term debt outstanding due to the $400.0 million notes issued in the fourth quarter, offset by decreased commercial paper borrowings.
Our net debt to net capitalization ratio increased at December 31, 2014 compared to the prior year-end primarily due to the reduction in our net capitalization of $1.3 billion for the period primarily due to the $1.4 billion distribution of Knowles, $601.1 million in share repurchases, and $258.5 million of dividends, offset by $775.2 million of current earnings. As described above, we also received a cash payment of $360.0 million from Knowles, net of cash distributed, upon separation on February 28, 2014, which was used to fund share repurchases and reduce commercial paper balances. Net debt increased $324.8 million during the period primarily due to increases in commercial paper balances and a reduction in cash levels to fund acquisitions, dividend payments, and other general operating purposes.
We use commercial paper borrowings for general corporate purposes, including the funding of acquisitions and the repurchase of our common stock. On November 10, 2015, we entered into a $1.0 billion unsecured revolving credit facility with a syndicate of banks that replaced a facility with similar terms that was set to expire on November 16, 2016. The new facility will expire on November 10, 2020. This facility is used primarily as liquidity back-up for our commercial paper program. We have not drawn down any loans under this facility nor do we anticipate doing so. If we were to draw down a loan, at our election, the loan would bear interest at a Canadian Dollar, Eurodollar, Swedish Kroner, or Sterling rate based on CDOR, EURIBOR, LIBOR or STIBOR, plus an applicable margin ranging from 0.580% to 1.000% (subject to adjustment based on the rating accorded our senior unsecured debt by S&P and Moody’s) or at a base rate pursuant to a formula defined in the facility. Under this facility, we are required to maintain an interest coverage ratio of EBITDA to consolidated net interest expense of not less than 3.0 to 1. We were in compliance with this covenant and our other long-term debt covenants at December 31, 2015 and had a coverage ratio of 13.3 to 1.0. We are not aware of any potential impairment to our liquidity and expect to remain in compliance with all of our debt covenants.
We also have a current shelf registration statement filed with the SEC that allows for the issuance of additional debt securities that may be utilized in one or more offerings on terms to be determined at the time of the offering. Net proceeds of any offering would be used for general corporate purposes, including repayment of existing indebtedness, capital expenditures, and acquisitions.
At December 31, 2015, our cash and cash equivalents totaled $362.2 million, of which approximately $196.1 million was held outside the United States. Cash and cash equivalents are invested in highly liquid investment-grade money market instruments and bank deposits with maturities of three months or less. We regularly invest cash in excess of near-term requirements in money market instruments or short-term investments, which consist of investment grade time deposits with original maturity dates at the time of purchase of no greater than three months.
In 2014, we received a one-time cash dividend of approximately $235.0 million as a result of certain restructuring arising from the spin-off of Knowles. The U.S. tax consequences of this intercompany dividend, which were not significant, have been included in our total income tax expense. Cash held by our foreign subsidiaries is generally used to finance foreign operations and investments, including acquisitions. It is our intent to indefinitely reinvest those funds outside the U.S. It is not practicable to estimate the amount of tax payable if some or all of such funds were to be repatriated and the amount of foreign tax credits available to reduce or eliminate the resulting U.S. income tax liability. Management believes it has sufficient liquidity to satisfy its cash needs, including its cash needs in the U.S.
Our ability to obtain debt financing at comparable risk-based interest rates is partly a function of our existing cash-flow-to-debt and debt-to-capitalization levels as well as our current credit standing. Our credit ratings, which are independently developed by the respective rating agencies, were as follows as of December 31, 2015:
| Short Term Rating | Long Term Rating | Outlook | |||
| Moody's | P-1 | A2 | Stable | ||
| Standard & Poor's | A-1 | A | Negative | ||
| Fitch | F1 | A | Stable |
Short-term ratings of "P-1," "A-1" and "F1" are defined as a strong or superior ability to repay short-term debt obligations. A long-term rating of "A" or "A2" is defined as a strong capacity to meet financial commitments, but susceptible to adverse business or economic conditions.
We believe that existing sources of liquidity are adequate to meet anticipated funding needs at comparable risk-based interest rates for the foreseeable future. Acquisition spending and/or share repurchases could potentially increase our debt. Operating cash flow and access to capital markets are expected to satisfy our various cash flow requirements, including acquisitions and capital expenditures.
Off-Balance Sheet Arrangements and Contractual Obligations
As of December 31, 2015, we had approximately $116.2 million outstanding in letters of credit with financial institutions, which expire at various dates in 2016 through 2020. These letters of credit are primarily maintained as security for insurance, warranty and other performance obligations. In general, we would only be liable for the amount of these guarantees in the event of default in the performance of our obligations, the probability of which we believe is remote.
We have also provided typical indemnities in connection with sales of certain businesses and assets, including representations and warranties and related indemnities for environmental, health and safety, tax, and employment matters. We do not have any material liabilities recorded for these indemnifications and are not aware of any claims or other information that would give rise to material payments under such indemnities.
A summary of our consolidated contractual obligations and commitments as of December 31, 2015 and the years when these obligations are expected to be due is as follows:
| Payments Due by Period | ||||||||||||||||||||||||
| (in thousands) | Total | Less than 1 Year | 1-3 Years | 3-5 Years | More than 5 Years | Other | ||||||||||||||||||
| Long-term debt (1) | $ | 2,617,464 | $ | 122 | $ | 349,412 | $ | 328,592 | $ | 1,939,338 | $ | — | ||||||||||||
| Interest payments (2) | 1,666,518 | 122,755 | 235,972 | 207,360 | 1,100,431 | — | ||||||||||||||||||
| Rental commitments | 261,378 | 62,892 | 97,252 | 50,824 | 50,410 | — | ||||||||||||||||||
| Purchase obligations | 63,063 | 60,770 | 2,293 | — | — | — | ||||||||||||||||||
| Capital leases | 5,153 | 2,830 | 1,658 | 422 | 243 | — | ||||||||||||||||||
| Supplemental & post-retirement benefits (3) | 170,663 | 30,336 | 28,934 | 30,289 | 81,104 | — | ||||||||||||||||||
| Uncertain tax positions (4) | 79,992 | — | — | — | — | 79,992 | ||||||||||||||||||
| Total obligations | $ | 4,864,231 | $ | 279,705 | $ | 715,521 | $ | 617,487 | $ | 3,171,526 | $ | 79,992 |
| (1 | ) | See Note 9 to the Consolidated Financial Statements. Amounts represent principal payments for all long-term debt, including current maturities. |
| (2 | ) | Amounts represent estimate of future interest payments on long-term debt using the interest rates in effect at December 31, 2015. |
| (3 | ) | Amounts represent estimated benefit payments under our unfunded supplemental and post-retirement benefit plans and our unfunded non-U.S. qualified defined benefit plans. See Note 14 to the Consolidated Financial Statements. We also expect to contribute approximately $6.3 million to our non-U.S. qualified defined benefit plans in 2016, which amount is not reflected in the above table. |
| (4 | ) | Due to the uncertainty of the potential settlement of future uncertain tax positions, we are unable to estimate the timing of the related payments, if any, that will be made subsequent to 2015. These amounts do not include the potential indirect benefits resulting from deductions or credits for payments made to other jurisdictions. |
Financial Instruments and Risk Management
The diverse nature of our businesses’ activities necessitates the management of various financial and market risks, including those related to changes in interest rates, foreign currency exchange rates, and commodity prices. We periodically use derivative financial instruments to manage some of these risks. We do not hold or issue derivative instruments for trading or speculative purposes. We are exposed to credit loss in the event of nonperformance by counterparties to our financial instrument contracts; however, nonperformance by these counterparties is considered unlikely as our policy is to contract with highly-rated, diversified counterparties.
Interest Rate Exposure
As of December 31, 2015 and during the three year period then ended, we did not have any open interest rate swap contracts. However, we may in the future enter into interest rate swap agreements to manage our exposure to interest rate changes. We issue commercial paper, which exposes us to changes in variable interest rates; however, maturities are typically three months or less so a change in rates over this period would not have a material impact on our pre-tax earnings.
We consider our current risk related to market fluctuations in interest rates to be minimal since our debt is largely long-term and fixed-rate in nature. Generally, the fair market value of fixed-interest rate debt will increase as interest rates fall and decrease as interest rates rise. A 100 basis point increase in market interest rates would decrease the 2015 year-end fair value of our long-term debt by approximately $226.9 million. However, since we have no plans to repurchase our outstanding fixed-rate instruments before their maturities, the impact of market interest rate fluctuations on our long-term debt does not affect our results of operations or financial position.
Foreign Currency Exposure
We conduct business in various non-U.S. countries, primarily in Canada, Mexico, substantially all of the European countries, Brazil, Argentina, China, India, and other Asian countries. Therefore, we have foreign currency risk relating to receipts from customers, payments to suppliers, and intercompany transactions denominated in foreign currencies. We will occasionally use derivative financial instruments to offset such risks, when it is believed that the exposure will not be limited by our normal operating and financing activities. We have formal policies to mitigate risk in this area by using fair value and/or cash flow hedging programs.
Changes in the value of the currencies of the countries in which we operate affect our results of operations, financial position, and cash flows when translated into U.S. dollars, our reporting currency. The strengthening of the U.S. dollar could result in unfavorable translation effects as the results of foreign operations are translated into U.S. dollars. We have generally accepted the exposure to exchange rate movements relative to our investment in non-U.S. operations. We may, from time to time, for a specific exposure, enter into fair value hedges. Previously, we entered into a floating-to-floating cross currency swap agreement with a total notional amount of $50.0 million in exchange for CHF 65.1 million, which matured on October 15, 2015. This transaction hedged a portion of our net investment in non-U.S. operations. The agreement qualified as a net investment hedge and changes in the fair value were reported within the cumulative translation adjustment section of other comprehensive earnings, with any hedge ineffectiveness recognized in current earnings. The fair value of this hedge reflected cumulative losses of $15.6 million at December 31, 2014, reflecting the strengthening of the Swiss franc relative to the U.S. dollar over the term of this arrangement. At maturity on October 15, 2015, the Company settled the outstanding liability on this swap agreement for a total of $17.8 million.
Additionally, the Company has designated the €300.0 million of euro-denominated notes issued December 4, 2013 as a hedge of a portion of its net investment in euro-denominated operations. Due to the high degree of effectiveness between the hedging instruments and the exposure being hedged, fluctuations in the value of the euro-denominated debt due to exchange rate changes are offset by changes in the net investment. Accordingly, changes in the value of the euro-denominated debt are recognized in the cumulative translation adjustment section of other comprehensive income to offset changes in the value of the net investment in euro-denominated operations. Due to the devaluation of the euro relative to the U.S. dollar in the latter half of 2014 and through 2015, the U.S. dollar equivalent of this debt decreased, resulting in the recognition of a gain in other comprehensive income of $35.5 million and $47.6 million for the years ended December 31, 2015 and 2014, respectively.
Commodity Price Exposure
Certain of our businesses are exposed to volatility in the prices of certain commodities, such as aluminum, steel, copper, and various precious metals, among others. Our primary exposure to commodity pricing volatility relates to the use of these materials in purchased component parts or the purchase of raw materials. When possible, we maintain long-term fixed price contracts on raw materials and component parts; however, we are prone to exposure as these contracts expire. We may, from time to time, for a specific exposure, enter into cash flow hedges to mitigate our risk to commodity pricing; however, such contracts outstanding at December 31, 2015 were not significant.
Critical Accounting Policies
Our consolidated financial statements and related public financial information are based on the application of GAAP. GAAP requires the use of estimates, assumptions, judgments, and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenue, and expense amounts we report. These estimates can also affect supplemental information contained in our public disclosures, including information regarding contingencies, risk, and our financial condition. The significant accounting policies used in the preparation of our consolidated financial statements are discussed in Note 1 Description of Business and Summary of Significant Accounting Policies. The accounting assumptions and estimates discussed in the section below are those that we consider most critical to an understanding of our financial statements because they inherently involve significant judgments and estimates. We believe our use of estimates and underlying accounting assumptions conforms to GAAP and is consistently applied. We review valuations based on estimates for reasonableness on a consistent basis.
| • | Revenue is recognized when all of the following circumstances are satisfied: a) persuasive evidence of an arrangement exists, b) price is fixed or determinable, c) collectability is reasonably assured, and d) delivery has occurred or services have been rendered. The majority of our revenue is generated through the manufacture and sale of a broad range of specialized products and components, with revenue recognized upon transfer of title and risk of loss, which is generally |
upon shipment. Service revenue represents less than 5% of our total revenue and is recognized as the services are performed. In limited cases, our revenue arrangements with customers require delivery, installation, testing, certification, or other acceptance provisions to be satisfied before revenue is recognized. We do not have significant multiple deliverable arrangements.
| • | Inventories for the majority of our subsidiaries, including all international subsidiaries, are stated at the lower of cost, determined on the first-in, first-out (FIFO) basis, or market. Other domestic inventories are stated at cost, determined on the last-in, first-out (LIFO) basis, which is less than market value. Under certain market conditions, estimates and judgments regarding the valuation of inventories are employed by us to properly value inventories. Certain businesses tend to experience somewhat higher levels of inventory value fluctuations, particularly given the relatively high rate of product obsolescence over relatively short periods of time. |
| • | We have significant goodwill and intangible assets on our balance sheet as a result of current and past acquisitions. The valuation and classification of these assets and the assignment of useful lives involve significant judgments and the use of estimates. In addition, the testing of goodwill and intangibles for impairment requires significant use of judgment and assumptions, particularly as it relates to the determination of fair market value. Our intangible assets and reporting units are tested and reviewed for impairment on an annual basis during the fourth quarter, when indicators of impairment exist, or during an interim period when a significant portion of a reporting unit is to be reclassified to discontinued operations or assets held for sale. |
When performing an impairment test, we estimate fair value using the income approach. Under the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. We use our internal forecasts to estimate future cash flows and include an estimate of long-term future growth rate based on our most recent views of the long-term outlook for each reporting unit. Actual results may differ from these estimates. The discount rates used in these analyses vary by reporting unit and are based on a capital asset pricing model and published relevant industry rates. We use discount rates commensurate with the risks and uncertainties inherent to each reporting unit and in our internally developed forecasts. Discount rates used in our 2015 reporting unit valuations ranged from 9.5% to 11.0%.
We performed the annual goodwill impairment testing of our nine identified reporting units in the fourth quarter of 2015. Based on the impairment tests performed, the fair value of our reporting units exceeded their carrying value, in most cases, by more than 100%. As such, no goodwill impairment was recognized. While all of our reporting units passed the goodwill impairment test, we noted a decrease in the amount of fair value in excess of carrying value for two of our reporting units within the Energy segment, which together have an aggregate goodwill balance of $957.0 million. These businesses and their estimated cash flows have been impacted by declining oil prices and the resulting economic pressures within the oil and gas industry. In spite of these declines these two reporting units had fair values in excess of their carrying values of 26% and 19%. Should market conditions worsen or persist for an extended period of time, an impairment may occur. We will continue to monitor the long-term outlook and forecasts, including estimated future cash flows, for these businesses in 2016.
| • | The valuation of our pension and other post-retirement plans requires the use of assumptions and estimates that are used to develop actuarial valuations of expenses and assets/liabilities. Inherent in these valuations are key assumptions, including discount rates, investment returns, projected salary increases and benefits, and mortality rates. Annually, we review the actuarial assumptions used in our pension reporting and compare them with external benchmarks to ensure that they accurately account for our future pension obligations. Changes in assumptions and future investment returns could potentially have a material impact on our pension expense and related funding requirements. Our expected long-term rate of return on plan assets is reviewed annually based on actual returns, economic trends and portfolio allocation. Our discount rate assumption is determined by developing a yield curve based on high quality corporate bonds with maturities matching the plans’ expected benefit payment streams. The plans’ expected cash flows are then discounted by the resulting year-by-year spot rates. As disclosed in Note 14 Employee Benefit Plans to the Consolidated Financial Statements, the 2015 weighted-average discount rates used to measure our qualified defined benefit, supplemental, and other post-retirement obligations ranged from 2.32% to 4.40%, an increase from the 2014 rates, which ranged from 2.31% to 4.05%. The slightly higher 2015 discount rates are reflective of the increase in global market interest rates over these periods. A 25 basis point decrease in the discount rates used for these plans would have increased the post retirement benefit obligations by approximately $34.2 million from the amount recorded in the financial statements at December 31, 2015. Our pension expense is also sensitive to changes in the expected long-term rate of return on plan |
assets. A decrease of 25 basis points in the expected long-term rate of return on assets would have increased our defined benefit pension expense by approximately $1.7 million.
| • | We have significant amounts of deferred tax assets that are reviewed for recoverability and valued accordingly. These assets are evaluated by using estimates of future taxable income streams and the impact of tax planning strategies. Reserves are also estimated, using more likely than not criteria, for ongoing audits regarding federal, state, and international issues that are currently unresolved. We routinely monitor the potential impact of these situations and believe that we have established the proper reserves. Reserves related to tax accruals and valuations related to deferred tax assets can be impacted by changes in tax codes and rulings, changes in statutory tax rates, and our future taxable income levels. The provision for uncertain tax positions provides a recognition threshold and measurement attribute for financial statement tax benefits taken or expected to be taken in a tax return and disclosure requirements regarding uncertainties in income tax positions. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. We record interest and penalties related to unrecognized tax benefits as a component of our provision for income taxes. |
| • | We have significant accruals and reserves related to the self-insured portion of our risk management program. These accruals require the use of estimates and judgment with regard to risk exposure and ultimate liability. We estimate losses under these programs using actuarial assumptions, our experience, and relevant industry data. We review these factors quarterly and consider the current level of accruals and reserves adequate relative to current market conditions and experience. |
| • | We have established liabilities for environmental and legal contingencies at both the business and corporate levels. A significant amount of judgment and the use of estimates are required to quantify our ultimate exposure in these matters. The valuation of liabilities for these contingencies is reviewed on a quarterly basis to ensure that we have accrued the proper level of expense. The liability balances are adjusted to account for changes in circumstances for ongoing issues and the establishment of additional liabilities for emerging issues. While we believe that the amount accrued to-date is adequate, future changes in circumstances could impact these determinations. |
| • | We establish liabilities for restructuring activities at an operation when management has committed to an exit or reorganization plan and when termination benefits are probable and can be reasonably estimated based on circumstances at the time the restructuring plan is approved by management. Exit costs include future minimum lease payments on vacated facilities and other contractual terminations. In addition, asset impairments may be recorded as a result of an approved restructuring plan. The accrual of both severance and exit costs requires the use of estimates. Though we believe that these estimates accurately reflect the anticipated costs, actual results may be different than the estimated amounts. |
| • | From time to time we sell or discontinue or dispose of certain operations for various reasons. Estimates are used to adjust, if necessary, the assets and liabilities of discontinued operations, including goodwill, to their estimated fair market value. These estimates include assumptions relating to the proceeds anticipated as a result of the sale. Fair value is established using internal valuation calculations along with market analysis of similar-type entities. The adjustments to fair market value of these operations provide the basis for the gain or loss when sold. Changes in business conditions or the inability to sell an operation could potentially require future adjustments to these estimates. We recognized total goodwill impairment charges of $63.8 million in 2013 for certain reporting units included in discontinued operations based on the reduction in fair value implied in the anticipated selling price. No impairment charges were recorded in 2015 or 2014. |
| • | We are required to recognize in our consolidated statements of earnings the expense associated with all share-based payment awards made to employees and directors, including stock options, stock appreciation rights ("SARs"), restricted stock, and performance share awards. We use the Black-Scholes valuation model to estimate the fair value of SARs and stock options granted to employees. The model requires that we estimate the expected life of the SAR or option, expected forfeitures and the volatility of our stock using historical data. We use the Monte Carlo simulation model to estimate fair value of performance share awards which also require us to estimate the volatility of our stock and the volatility of returns on the stock of our peer group as well as the correlation of the returns between the companies in the peer group. For additional information related to the assumptions used, see Note 12 Equity and Cash Incentive Program to the Consolidated Financial Statements in Item 8 of this Form 10-K. |
Recent Accounting Standards
Recently Issued Accounting Standards
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers, that introduces a new five-step revenue recognition model in which an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires disclosures sufficient to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, including qualitative and quantitative disclosures about contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. We are currently evaluating the new guidance to determine the impact it will have on our consolidated financial statements.
In May 2015, the FASB issued ASU 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), which addresses how certain investments measured at net asset value with redemption dates in the future are categorized within the fair value hierarchy. Topic 820, Fair Value Measurement, permits a reporting entity, as a practical expedient, to measure the fair value of certain investments using the net asset value per share of the investment. Under the new guidance, the requirement to categorize investments for which fair values are measured using the net asset value per share is removed. It also limits disclosures on investments for which the entity has elected to measure the fair value using the practical expedient. This ASU is effective for us January 1, 2016. The adoption of this standard will not have a significant impact on our consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30):Simplifying the Presentation of Debt Issuance Costs. Under this guidance, debt issuance costs related to a recognized debt liability are required to be presented in the balance sheet as a direct reduction from the carrying amount of such debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by this guidance. In adopting the ASU, we will be required to apply a full retrospective approach to all periods presented. This guidance is effective for us January 1, 2016 and, upon adoption, debt issuance costs of approximately $14 million included in other assets in the consolidated balance sheet as of December 31, 2015 will be reclassified and presented as a reduction to long-term debt.
In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 340): Simplifying the Measurement of Inventory. Under this guidance, entities utilizing the FIFO or average cost method should measure inventory at the lower of cost or net realizable value, whereas net realizable value is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This ASU should be applied prospectively and will be effective for us beginning January 1, 2017 with early adoption permitted. We are currently evaluating the new guidance; however, we do not anticipate that the impact to our consolidated financial statements will be significant.
In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. Under this guidance the cumulative impact of purchase accounting adjustments arising during the one year measurement period from the date of acquisition will be recognized, in full, in the period identified. This guidance is effective for fiscal years beginning after December 15, 2015 and will be applied prospectively to adjustments arising after that date. We do not anticipate that the impact of this standard will have a significant impact on our consolidated financial statements.
Recently Adopted Accounting Standards
In April 2014, the FASB issued ASU 2014-08, which includes amendments that change the requirements for reporting discontinued operations and require additional disclosures about discontinued operations. Under the new guidance, only disposals representing a strategic shift in operations - that is, a major effect on the organization's operations and financial results - should be presented as discontinued operations. Additionally, the ASU requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. We adopted this guidance in the first quarter of 2015. As a result of this guidance we anticipate future disposals of businesses which historically would have been classified as discontinued operations will no longer qualify for presentation as discontinued operations in our consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes, to simplify the presentation of deferred income taxes. The amendments in this update require that deferred tax assets and liabilities be entirely classified as noncurrent within the statement of financial position. We early adopted this guidance as of December 31, 2015 and applied its provisions retrospectively to all periods presented. Upon adoption, we reclassified $2.8 million of current deferred tax assets from "Deferred tax assets" to "Other assets and deferred charges," $60.5 million of current deferred tax assets from “Deferred tax assets” to “Deferred income taxes” and $0.9 million of current tax liabilities from “Federal and other income taxes” to “Deferred income taxes” as of December 31, 2014.
Non-GAAP Disclosures
In an effort to provide investors with additional information regarding our results as determined by GAAP, we also disclose non-GAAP information which we believe provides useful information to investors. Segment EBITDA, segment EBITDA margin, free cash flow, net debt, net capitalization, the net debt to net capitalization ratio, adjusted working capital, earnings adjusted for non-recurring items, effective tax rate adjusted for discrete and other items, revenue excluding the impact of changes in foreign currency exchange rates, and organic revenue growth are not financial measures under GAAP and should not be considered as a substitute for cash flows from operating activities, debt or equity, earnings, revenue, or working capital as determined in accordance with GAAP, and they may not be comparable to similarly titled measures reported by other companies. We believe that segment EBITDA and segment EBITDA margin are useful to investors and other users of our financial information in evaluating ongoing operating profitability as they exclude the depreciation and amortization expense related primarily to capital expenditures and acquisitions that occurred in prior years, as well as in evaluating operating performance in relation to our competitors. Segment EBITDA is calculated by adding back depreciation and amortization expense to segment earnings. Segment margin is calculated as segment EBITDA divided by segment revenue.
We believe the net debt to net capitalization ratio and free cash flow are important measures of liquidity. Net debt to net capitalization is helpful in evaluating our capital structure and the amount of leverage we employ. Free cash flow provides both management and investors a measurement of cash generated from operations that is available to fund acquisitions, pay dividends, repay debt, and repurchase our common stock. Reconciliations of free cash flow, total debt, and net debt can be found above in this Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation. We believe that reporting our effective tax rate adjusted for discrete and other items is useful to management and investors as it facilitates comparisons of our ongoing tax rate to prior and future periods and our peers. We believe that reporting adjusted working capital (also sometimes called "working capital"), which is calculated as accounts receivable, plus inventory, less accounts payable, provides a meaningful measure of our operational results by showing the changes caused solely by revenue. We believe that reporting adjusted working capital and revenues at constant currency, which excludes the positive or negative impact of fluctuations in foreign currency exchange rates, provides a meaningful measure of our operational changes, given the global nature of our businesses. We believe that reporting organic revenue and organic revenue growth, which exclude the impact of foreign currency exchange rates and the impact of acquisitions and divestitures, provides a useful comparison of our revenue performance and trends between periods.
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