filings.toolsItem 7. . MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
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Item 7. . MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis contains forward-looking statements, including, without limitation, statements relating to our plans, strategies, objectives, expectations, intentions and resources. Such forward-looking statements should be read in conjunction with our disclosures under “Item 1A. Risk Factors” of this Form 10-K.
BUSINESS PRODUCTS GROUP
Effective June 30, 2020, the Company completed the divestiture of its Business Products Group by selling Supply Source Enterprises, Inc. ("SSE") and S.P. Richards Company ("SPR") in separate transactions. The Business Products Group was previously a reportable segment of the Company. The results of operations, financial position and cash flows for the Business Products Group are reported as discontinued operations for all periods presented. Further, as a result of the reclassification of the Business Products Group business to discontinued operations, the Company now has two segments: the Automotive Group and the Industrial Parts Group. Refer to the acquisitions, divestitures and discontinued operations footnote in the accompanying consolidated financial statements for more information.
COVID-19 PANDEMIC
The COVID-19 outbreak, which was declared a pandemic by the World Health Organization (“WHO”) on March 11, 2020, continues to evolve rapidly. Our deepest and sincere thoughts go out to all affected by COVID-19, as well as the dedicated healthcare workers and first responders who are on the front lines for all our citizens.
Overall, our business segments continue to face many uncertainties. The Company's operations are vulnerable to the reduced economic activity caused by the COVID-19 outbreak. Many governments put in place temporary social distancing and shelter-in-place mandates in late March and early April of 2020 and, as a result, our business segments experienced slowing sales trends as we entered the second quarter. Beginning in the second half of 2020, sales generally improved as markets reopened and governments eased restrictions.
The extent to which the COVID-19 pandemic impacts the Company will depend on numerous factors and future developments that we cannot predict, including the severity of the virus; the occurrence of additional waves or spikes in infection rates; the duration of the outbreak; governmental, business or other actions taken in response to the pandemic and the efficacy of these actions, including partial or complete shutdowns, travel restrictions, and stay-at-home orders among other actions; the effectiveness and distribution of COVID-19 vaccines; and impacts on our supply chain, our ability to keep operating locations open, and on customer demand. While the negative impact on our business operations cannot be reasonably estimated at this time, our teams are preparing for multiple scenarios to ensure we continue to protect our employees while also keeping our operations up and running to serve our customers.
During the first quarter of 2020 we created a dedicated COVID-19 taskforce and added enhanced protocols in response to COVID-19, including implementing many of the recommendations and requirements issued by the Centers for Disease Control and Prevention, WHO, and local, state and national health authorities, to protect our employees, customers, suppliers and communities.
As of December 31, 2020, substantially all operations are open for business. Our supply chain partners have been very supportive, despite strain on the supply chain with respect to labor shortages and certain inventory shortages, delays in order fulfillment and increased backlogs, and they continue to do their part to help our service levels to our customers remain strong. We remain in constant communication with our employees regarding changing conditions and protocol. Based on the length and severity of COVID-19, we may experience continued volatility in customer demand and supply chain disruption. We will continue to evaluate the nature and extent of these potential impacts to our business, consolidated results of operations, segment results, liquidity and capital resources.
KEY BUSINESS METRICS
We consider comparable sales to be a key business metric because management has evaluated its results of operations using this metric and we believe that this key indicator provides additional perspective and insights when analyzing the operating performance of the Company from period to period and trends in its historical operating results. This metric should not be considered superior to, as a substitute for or as an alternative to, and should be considered in conjunction with, the GAAP financial measures presented in this report.
Comparable Sales
Comparable sales refers to period-over-period comparisons of our net sales excluding the impact of acquisitions, divestitures and foreign currency. The Company considers this metric useful to investors because it provides greater transparency into management’s view and assessment of the Company’s core ongoing operations. This metric is widely used by analysts, investors and competitors in our industry, although our calculation of the metric may not be comparable to similar measures disclosed by other companies, because not all companies and analysts calculate this metric in the same manner.
OVERVIEW
Genuine Parts Company is a service organization engaged in the global distribution of automotive and industrial replacement parts. We have a long tradition of growth dating back to 1928, the year we were founded in Atlanta, Georgia. In 2020, the Company conducted business in North America, Europe and Australasia from approximately 10,000 locations.
The Company's Automotive Parts Group operated in the U.S., Canada, France, the UK, Germany, Poland, the Netherlands, Belgium, Australia and New Zealand in 2020, and accounted for 66% of total revenues for the year. The Industrial Parts Group operated in the U.S., Canada, Mexico, Australia, New Zealand, Indonesia and Singapore, and accounted for 34% of the Company's total revenues in 2020.
At Genuine Parts Company, our mission is to be a world-class service organization and the employer of choice, supplier of choice, valued customer, good corporate citizen and investment of choice. Our strategic financial objectives are intended to align with our mission and drive value for all our stakeholders. Our strategic financial objectives include: (1) top line revenue growth (2) improved operating margin, (3) strong balance sheet and cash flow and (4) effective capital allocation.
Top Line Revenue
The Company's strategy for top line revenue growth includes a combination of organic and acquisitive initiatives designed to outpace the industry, improve the market share in each of our business segments and position the Company for sustained long-term growth. In 2020, in response to the COVID-19 pandemic, our business segments faced tremendous challenges and uncertainties. Governments put in place temporary social distancing and shelter-in-place mandates in late March and early April of 2020 causing reduced economic activity globally. Additionally, we limited merger and acquisition activity to select “bolt-on” acquisitions to preserve financial flexibility. As markets reopened and governments eased restrictions sales results began to improve in the third and fourth quarter of 2020. Although, we still face many uncertainties, we are encouraged by the current economic outlook and believe our Company is well-positioned to drive positive sales growth in 2021.
Operating Margins
The Company targets continuous operating margin improvement each year. In October of 2019, the Company approved and began to implement certain restructuring actions across its subsidiaries primarily targeted at simplifying organizational structures and distribution networks (the "2019 Cost Savings Plan"). In accordance with our 2019 Cost Savings Plan, we recognized permanent expense reductions of $150 million driven by transformative reductions in payroll and facility costs for the year ended December 31, 2020. Additionally, we experienced lower costs in areas such as freight and delivery and legal and professional for the year. We also executed on a number of additional savings initiatives in response to the impact of COVID-19, which contributed approximately $300 million in incremental, temporary savings in 2020 related to furloughs, reduced travel and other initiatives. These efforts produced improved segment margins in 2020 and we believe created a path for a more efficient and productive cost structure in the years ahead.
Balance Sheet and Cash Flow
The Company is focused on maintaining a strong balance sheet and generating strong cash flows to support our growth initiatives. Our working capital was a source of operating cash flow. We also focused on having ample liquidity and we improved our debt position by entering into a new revolving credit facility and issuing $500 million of the Company's unsecured senior notes. Additionally, we entered into an accounts receivable sales agreement (the "A/R Sales Agreement"). We believe these measures further strengthen our liquidity position moving into 2021. The Company generated $2.0 billion in cash from operations and also benefited from cash proceeds associated with the sale of certain non-core businesses in 2020.
Capital Allocation
The Company's priorities for disciplined and effective capital allocation remain consistent with prior years. In 2020, we used cash for key investments in the form of essential capital expenditures and small, bolt-on acquisitions, as well as the return of capital to our shareholders via cash dividends and opportunistic share repurchases. We plan to continue to support the dividend, which we have increased for 64 consecutive years through 2020.
RESULTS OF OPERATIONS
Our results of operations are summarized below for the years ended December 31, 2020, 2019 and 2018.
| Year Ended December 31, | ||||||||||||||||||||
| (In thousands, except per share data) | 2020 | 2019 | 2018 | |||||||||||||||||
| Net sales | $ | 16,537,433 | $ | 17,522,234 | $ | 16,831,605 | ||||||||||||||
| Gross margin | $ | 5,654,841 | $ | 5,859,683 | $ | 5,519,755 | ||||||||||||||
| Net income from continuing operations | $ | 163,395 | $ | 646,475 | $ | 749,534 | ||||||||||||||
| Diluted net income from continuing operations per common share | $ | 1.13 | $ | 4.42 | $ | 5.09 |
Net Sales
Consolidated net sales for the year ended December 31, 2020 totaled $16.5 billion, down 5.6% from 2019. The decline in net sales is due to a 5.6% comparable sales decrease attributable primarily to decreased demand caused by COVID-19 and a 3.3% negative impact from divestitures. These items were partially offset by a 3.0% positive impact from acquisitions. Additionally, the favorable impact of foreign currency and other partially offset the decline in total sales by 0.3%. Consolidated net sales for the year ended December 31, 2019 totaled $17.5 billion, up 4.1% from 2018. Net sales for 2019 included an approximate 5.1% contribution from acquisitions, net of store closures and an approximate 2.1% increase in core sales. The Company's sale of certain non-core businesses determined to be slower-growth and lower-margin operations partially offset total sales by 1.6%. Additionally, the unfavorable impact of foreign currency partially offset 2019 total sales by 1.5%.
The Company's comparable sales included both an increase in sales volume and product inflation. The impact of product inflation varied by business segment in 2020, with prices flat in the Automotive segment and up 0.7% in our Industrial segment. Due to the Company's global initiatives to grow revenues, we believe it is well positioned for sustainable long-term growth.
Automotive Group
Net sales for the Automotive Group (“Automotive”) were $10.9 billion in 2020, a 1.2% decrease from 2019. The decrease in sales consists of an approximate 4.4% decrease in comparable sales and a slight decrease related to divestitures. This decrease was partially offset by a 2.7% contribution from acquisitions, and a 0.6% favorable impact of currency translation and other. Foreign currency translation was positively impacted by our automotive businesses in Europe. In 2020, total Automotive revenues were down approximately 1.6% in the first quarter, down 10.1% in the second quarter, up 6.0% in the third quarter and up 0.7% in the fourth quarter. The positive growth in the second half of the year reflects a recovery from the decreased demand caused by COVID-19 in the first half of the year. We remain optimistic that our Automotive sales trends will continue to show positive growth, but we are still operating in an environment of significant uncertainty due to the COVID-19 pandemic. In our view, the underlying fundamentals in the automotive aftermarket, including trends related to the overall number and age of the vehicle population, as well as the continued increase in miles driven, remain supportive of sustained demand for automotive aftermarket maintenance and supply items across the markets we serve. We expect these fundamentals and our ongoing sales initiatives to drive sales growth for the Automotive Group in 2021.
Net sales for the Automotive Group were $11.0 billion in 2019, a 4.4% increase from 2018. The increase in sales consists of an approximate 5.0% contribution from acquisitions, a 2.3% comparable sales increase and a 2.3% negative impact of currency translation associated with our automotive businesses in Canada, Australasia, Europe and Mexico. In addition, the sale of Auto Todo in 2019, the Company's legacy automotive business in Mexico, slightly offset total sales for the Automotive Group. Automotive sales were positively impacted by product inflation of 2.4% in the U.S. operations.
Industrial Parts Group
Net sales for the Industrial Parts Group (“Industrial”) were $5.7 billion in 2020, down 13.0% from 2019. The decrease in sales reflects an 8.4% decrease in comparable sales and an approximate 8.5% decrease in net sales related to the sale of EIS, a non-core component of the industrial business due to its slower-growth and lower-margin profile. This decrease was slightly offset by an approximate 3.8% contribution from acquisitions. Total Industrial sales were positively impacted by product inflation of 0.7%, as a portion of this increase was passed through to customers and is included in the comparable sales impact. Industrial revenues were down approximately 7.7% in the first quarter of 2020, down 21.1% in the second quarter, down 18.6% in the third quarter and down 3.3% in the fourth quarter. These quarterly results reflect the impact of several factors, including reduced demand as a result of the COVID-19 pandemic. Beginning in the second half of 2020, however, the addition of three bolt-on acquisitions, among other initiatives, and strengthening industrial indicators such as the Purchasing Managers Index and Manufacturing Industrial Production led to improving conditions and sequentially stronger sales. We are confident in our growth plans for 2021, both in North America and Australasia, and expect to experience a continued, gradual recovery in the industrial economy amid the current COVID-19 environment.
Net sales for the Industrial Parts Group were $6.5 billion in 2019, up 3.6% from 2018. The increase in sales reflects an approximate 5.2% contribution from acquisitions and a 1.7% increase in comparable sales, offset by an approximate 3.1% decrease in net sales related to the sale of EIS. Total Industrial sales were positively impacted by product inflation of 2.4%, as a portion of this increase was passed through to customers and is included in the comparable sales increase. Industrial revenues were up approximately 5.7% in the first quarter of 2019, up 4.9% in the second quarter, up 9.9% in the third quarter and down 5.9% in the fourth quarter. These quarterly results reflect the impact of several factors, including the slowing trend in the industrial economy throughout the course of the year, as evidenced by weakening economic indicators such as Manufacturing Industrial Production and the Purchasing Managers Index, among others. In addition, the July 1, 2019 acquisition of Inenco (now referred to as Motion Asia Pacific), one of Australasia's leading industrial distributors, and the sale of EIS on September 30, 2019, impacted the quarterly sales comparisons for the Industrial Group in 2019.
Cost of Goods Sold
The Company includes in cost of goods sold the actual cost of merchandise, which represents the vast majority of this line item. Other items in cost of goods sold include warranty costs and in-bound freight from the suppliers, net of any vendor allowances and incentives. Cost of goods sold was $10.9 billion in 2020, a 6.7% decrease from $11.7 billion in 2019. As a percentage of net sales, cost of goods sold was 65.8% in 2020, decreasing from 66.6% of net sales in 2019. The decrease in cost of goods sold in 2020 reflects the favorable impact of business unit sales and product mix shifts, strategic category management initiatives in areas such as pricing and global sourcing, and the benefit of acquisitions and divestitures. These items were slightly offset by reduced supplier incentives in 2020 compared to 2019. During the quarter ended December 31, 2020, the Company recorded a $40 million increase to cost of goods sold due to the correction of an immaterial error related to the accounting in prior years for consideration received from vendors. Refer to the quarterly financial data footnote within the notes to the consolidated financial statements for additional information.
Cost of goods sold was $11.7 billion in 2019, a 3.1% increase from $11.3 billion in 2018. The increase in cost of goods sold in 2019 compares to a 4.1% total sales increase and is a positive reflection of our global supply chain initiatives, the lower cost of goods sold models at certain acquired companies such as PartsPoint and Motion Asia Pacific, and the sale of the lower margin EIS business. These items were slightly offset by relatively unchanged levels of supplier incentives in 2019 compared to 2018. Cost of goods sold represented 67.2% of net sales in 2018.
Operating Expenses
The Company includes in selling, administrative and other expenses (“SG&A”) all personnel and personnel-related costs at its headquarters, distribution centers, stores and branches, which accounts for more than 60% of total SG&A. Additional costs in SG&A include our facilities, delivery, marketing, advertising, technology, digital, legal and professional costs.
SG&A of $4.4 billion in 2020 decreased by $0.2 billion or approximately 4.2% from 2019. This represents 26.5% of net sales in 2020 compared to 26.1% of net sales in 2019. The increase in SG&A expenses as a percent of net sales from the prior year reflects loss of leverage due to lower sales volume as a result of the COVID-19 pandemic, as well as the sale of EIS, which had a lower level of SG&A expenses relative to total sales. This increase was partially offset by our continued efforts to execute on our growth initiatives to better leverage our expenses. In addition, we are working towards a lower cost and highly effective infrastructure via steps to accelerate the integration of our acquisitions, investments to enhance our productivity and innovative strategies to unlock greater savings and efficiencies across our operations. In accordance with our $100 million cost savings plan announced in late 2019, we achieved permanent expense reductions of approximately $150 million for the year ended December 31, 2020 driven by transformative reductions in payroll and facility costs. Additionally, we have executed on a number of savings initiatives in response to the impact of COVID-19, which have contributed approximately $300 million in incremental, temporary savings related to furloughs, reduced travel and other initiatives for the year ended December 31, 2020.
SG&A of $4.6 billion in 2019 increased by $0.3 billion or approximately 7.9% from 2018. This represents 26.1% of net sales in 2019 compared to 25.2% of net sales in 2018. The increase in SG&A expenses from the prior year reflects a combination of factors, including the impact of increased sales for the year. In addition, our expenses reflect the impact of higher cost and higher gross margin models at certain acquired businesses, including PartsPoint and Motion Asia Pacific, as well as the sale of EIS, which had a lower level of SG&A expenses relative to total sales. We also experienced rising costs in areas such as labor, freight and delivery, insurance, legal and professional and technology for the year, although our labor and freight costs trended more favorably in the fourth quarter. Further, we incurred incremental costs associated with our acquisitions during the year. The increase in SG&A expenses as a percentage of net sales in 2019 relative to the prior year reflects the cost increases described above as well as the loss of leverage associated with the 2.1% comparable sales growth for the Company.
Depreciation and amortization expense was $272.8 million in 2020, an increase of approximately $15.6 million, or 6.1%, from 2019, due primarily to an increase in fixed assets acquired at the end of 2019 that began fully depreciating in 2020. The provision for doubtful accounts was $23.6 million in 2020, a $9.7 million increase from 2019, due primarily to higher collectability risks associated with the COVID-19 pandemic. We believe the Company is adequately reserved for bad debts and credit losses at December 31, 2020.
Depreciation and amortization expense was $257.3 million in 2019, an increase of approximately $29.7 million, or 13.0%, from 2018, due primarily to the impact of acquisitions and the increase in capital expenditures relative to the prior year. The provision for doubtful accounts was $13.9 million in 2019, a $2.1 million decrease from 2018.
Goodwill Impairment
Due to several factors that coalesced in the second quarter of 2020 we performed an interim impairment test as of May 31, 2020 for our European reporting unit and recorded a goodwill impairment charge of $506.7 million. These factors primarily resulted from the ongoing market volatility and uncertainty caused by the COVID-19 pandemic, which extended into the second quarter and impacted several critical impairment testing assumptions including weighted average cost of capital and market multiples, and near-term revenue and operating margin projections for the reporting unit. Refer to the goodwill and
other intangible assets footnote within the notes to the consolidated financial statements for additional information. If there are sustained declines in macroeconomic or business conditions in future periods, including as a result of the continued COVID-19 pandemic, affecting the projected earnings and cash flows at our reporting units, among other things, there can be no assurance that goodwill at one or more reporting units may not be impaired. As of December 31, 2020, we determined that there were no indicators that goodwill was impaired at any of our reporting units.
Non-Operating Expenses and Income
Non-operating expenses included interest expense of $93.7 million in 2020, $95.6 million in 2019 and $101.8 million in 2018. The decreases in interest expense of $1.9 million in 2020 and $6.2 million in 2019 reflect the combination of the repayment of debt and lower interest rates on certain variable interest debt instruments.
In 2019, the Company recorded $42.8 million in special termination costs related to benefits provided through the Company's defined benefit plans to employees that accepted the voluntary retirement program ("VRP") package as part of the Company's 2019 Cost Savings Plan. Refer to the restructuring footnote in the Notes to Consolidated Financial Statements for additional information.
In “Other”, the net benefit of interest income, equity method investment income, investment dividends, noncontrolling interests and pension income in 2020 was $58.1 million, an approximate $28.6 million decrease from the prior year primarily driven by an immaterial loss on investment and changes in retirement plan valuation. In 2019, the $25.3 million increase in income from 2018 was primarily driven by changes in retirement plan valuation.
Segment Profit
Segment profit is calculated as net sales less operating expenses excluding general corporate expenses, interest expense, equity in income from investees, intangible asset amortization, income attributable to noncontrolling interests and other unallocated amounts that are driven by corporate initiatives and adjusted in Non-GAAP Measures (as described further below). Refer to the segment data footnote in the Notes to Consolidated Financial Statements for additional information.
Automotive Group
Automotive's segment profit increased 4.3% in 2020 from 2019 and segment profit margin was 8.0% in 2020 as compared to 7.6% in 2019. The increase in segment profit margin reflects the strong operating results in North America and Australasia, driven by the positive impact of cost actions, which offset the 4.4% decrease in comparable sales for Automotive. The Company's European automotive operations were the most challenged in 2020, although this business made significant progress during the year, with improved margins in both the third and fourth quarters. To further improve Automotive's segment margin, this group will continue to execute on its growth plans and cost initiatives in 2021 and the years ahead.
Automotive's segment profit decreased 2.8% in 2019 from 2018 and segment margin was 7.6% in 2019 as compared to 8.1% in 2018. The decrease in segment margin reflects the loss of expense leverage due to the 2.3% growth in comparable sales for Automotive. In addition, rising costs in several areas as described above negatively impacted Automotive's segment margin.
Industrial Group
Industrial’s segment profit decreased 7.7% in 2020 from 2019 and segment profit margin was 8.5%, an increase from 8.0% in 2019. The improvement in segment profit margin for this group primarily reflects the benefits of an improved gross margin, despite the reduced demand from the COVID-19 pandemic, and lower costs. The Company believes that strengthening economic indicators such as Manufacturing Industrial Production and the Purchasing Managers Index combined with effective growth initiatives and cost actions position the Industrial Group for further growth in 2021.
Industrial’s segment profit increased 7.1% in 2019 from 2018 and segment margin was 8.0%, an increase from 7.7% in 2018. The improvement in segment margin for this group primarily reflects the benefit of improved gross margins, despite the slowing sales trend during the year and 1.7% comparable sales growth. 2019 was a transformative year for Industrial, given the addition of Motion Asia Pacific in Australasia and sale of EIS.
Income Taxes
The effective income tax rate of 56.9% in 2020 increased from 24.8% in 2019. The increase in rate is primarily due to a non-deductible goodwill impairment charge and other one-time costs incurred during the year.
The effective income tax rate of 24.8% in 2019 increased from 24.6% in 2018. The increase in rate is primarily due to geographic income tax rate mix shifts and the impact of one-time transaction and other costs, as well as changes in the realizability of future tax benefit adjustments recorded in the comparable periods.
Net Income from Continuing Operations
Net income from continuing operations was $163.4 million in 2020, a decrease of 74.7% from $646.5 million in 2019. On a per share diluted basis, net income from continuing operations was $1.13 in 2020, down 74.4% compared to $4.42 in
- Net income from continuing operations was 1.0% of net sales in 2020 compared to 3.7% of net sales in 2019. Net income from continuing operations was $646.5 million in 2019, a decrease of 13.7% from $749.5 million in 2018. On a per share diluted basis, net income from continuing operations was $4.42 in 2019, down 13.2% compared to $5.09 in 2018. Net income from continuing operations was 3.7% of net sales in 2019 compared to 4.5% of net sales in 2018.
During the years ended December 31, 2020, 2019 and 2018, the Company incurred $634.5 million, $170.1 million and $34.9 million, respectively, of adjustments. In 2020, these adjustments include a goodwill impairment charge related to our European reporting unit, restructuring costs, an inventory adjustment, realized currency losses, and transaction and other costs and income. Transaction and other costs in 2020 primarily include incremental costs associated with certain divestitures and COVID-19, slightly offset by income from the SPR Fire insurance proceeds. In 2019 and 2018, these transaction and other costs primarily reflect costs related to acquisitions and divestitures. Refer to the acquisitions, divestitures and discontinued operations footnote, commitments and contingencies footnote, and quarterly financial data footnote in the notes to the consolidated financial statements for more information.
Adjusted net income from continuing operations was $765.0 million in 2020, down 1.5% from adjusted net income from continuing operations in 2019. On a per share diluted basis, adjusted net income from continuing operations was $5.27, a 0.8% decrease compared to adjusted net income per diluted share from continuing operations of $5.31 in 2019. Adjusted net income from continuing operations was $776.8 million in 2019, up 0.3% from adjusted net income from continuing operations in 2018. On a per share diluted basis, adjusted net income from continuing operations was $5.31 in 2019, a 1.0% increase compared to adjusted net income per diluted share from continuing operations of $5.26 in 2018. Adjusted net income from continuing operations and adjusted net income per diluted share from continuing operations, both Non-GAAP measures, in 2020, 2019 and 2018 exclude those items noted above (see table below for reconciliations to the most directly comparable GAAP measures).
Certain Information Regarding Non-GAAP Financial Measures
The following table sets forth a reconciliation of net income from continuing operations and diluted net income from continuing operations per common share to adjusted net income from continuing operations and adjusted diluted net income from continuing operations per common share to account for the impact of adjustments. The Company believes that the presentation of adjusted net income from continuing operations and adjusted diluted net income from continuing operations per common share, which are not calculated in accordance with GAAP, when considered together with the corresponding GAAP financial measures and the reconciliations to those measures, provide meaningful supplemental information to both management and investors that is indicative of the Company's core operations. The Company considers these metrics useful to investors because they provide greater transparency into management’s view and assessment of the Company’s ongoing operating performance by removing items management believes are not representative of our continuing operations and may distort our longer-term operating trends. We believe these measures to be useful to enhance the comparability of our results from period to period and with our competitors, as well as to show ongoing results from operations distinct from items that are infrequent or not associated with the Company’s core operations. The Company does not, nor does it suggest investors should, consider such non-GAAP financial measures in isolation from, or as a substitute for, GAAP financial information.
| Year Ended December 31, | ||||||||||||||||||||
| (In thousands) | 2020 | 2019 | 2018 | |||||||||||||||||
| GAAP net income from continuing operations | $ | 163,395 | $ | 646,475 | $ | 749,534 | ||||||||||||||
| Adjustments: | ||||||||||||||||||||
| Goodwill impairment charge (1) | 506,721 | — | — | |||||||||||||||||
| Restructuring (2) | 50,019 | 142,780 | — | |||||||||||||||||
| Realized currency losses (3) | 11,356 | 34,701 | — | |||||||||||||||||
| Gain on insurance proceeds related to SPR Fire (4) | (13,448) | — | — | |||||||||||||||||
| Gain on equity investment (5) | — | (38,663) | — | |||||||||||||||||
| Inventory adjustment (6) | 40,000 | — | — | |||||||||||||||||
| Transaction and other costs (7) | 39,817 | 31,254 | 34,930 | |||||||||||||||||
| Total adjustments | 634,465 | 170,072 | 34,930 | |||||||||||||||||
| Tax impact of adjustments | (32,822) | (39,704) | (10,170) | |||||||||||||||||
| Adjusted net income from continuing operations | $ | 765,038 | $ | 776,843 | $ | 774,294 |
The table below represents amounts per common share assuming dilution:
| Year Ended December 31, | ||||||||||||||||||||
| (in thousands, except per share data) | 2020 | 2019 | 2018 | |||||||||||||||||
| GAAP net income from continuing operations | $ | 1.13 | $ | 4.42 | $ | 5.09 | ||||||||||||||
| Adjustments: | ||||||||||||||||||||
| Goodwill impairment charge (1) | 3.49 | — | — | |||||||||||||||||
| Restructuring (2) | 0.34 | 0.98 | — | |||||||||||||||||
| Realized currency losses (3) | 0.08 | 0.24 | — | |||||||||||||||||
| Gain on insurance proceeds related to SPR Fire (4) | (0.09) | — | — | |||||||||||||||||
| Gain on equity investment (5) | — | (0.26) | — | |||||||||||||||||
| Inventory adjustment (6) | 0.28 | — | — | |||||||||||||||||
| Transaction and other costs (7) | 0.27 | 0.20 | 0.24 | |||||||||||||||||
| Total adjustments | 4.37 | 1.16 | 0.24 | |||||||||||||||||
| Tax impact of adjustments | (0.23) | (0.27) | (0.07) | |||||||||||||||||
| Adjusted net income from continuing operations | $ | 5.27 | $ | 5.31 | $ | 5.26 | ||||||||||||||
| Weighted average common shares outstanding - assuming dilution | 145,115 | 146,417 | 147,241 |
The table below clarifies where the adjusted items are presented in the consolidated statement of income:
| Year Ended December 31, | ||||||||||||||||||||
| (in thousands) | 2020 | 2019 | 2018 | |||||||||||||||||
| Line item: | ||||||||||||||||||||
| Cost of goods sold | $ | 53,495 | $ | 9,608 | $ | 5,779 | ||||||||||||||
| Selling, administrative and other expenses | 10,094 | 23,768 | 29,151 | |||||||||||||||||
| Restructuring costs | 50,019 | 100,023 | — | |||||||||||||||||
| Goodwill impairment charge | 506,721 | — | — | |||||||||||||||||
| Non-operating expenses (income): Special termination costs | — | 42,757 | — | |||||||||||||||||
| Non-operating expenses (income): Other | 14,136 | (6,084) | — | |||||||||||||||||
| Total adjustments | $ | 634,465 | $ | 170,072 | $ | 34,930 |
(1) Adjustment reflects a second quarter goodwill impairment charge related to our European reporting unit.
(2) Adjustment reflects restructuring and special termination costs related to the 2019 Cost Savings Plan announced in the fourth quarter of 2019. The costs are primarily associated with severance and other employee costs, including a voluntary retirement program, and facility and closure costs related to the consolidation of operations.
(3) Adjustment reflects realized currency losses related to divestitures.
(4) Adjustment reflects insurance recoveries in excess of losses incurred on inventory, property, plant and equipment and other fire-related costs related to the S.P. Richards Headquarters and Distribution Center.
(5) Adjustment relates to the gain recognized upon remeasuring the Company's preexisting 35% equity investment to fair value upon acquiring the remaining equity of Motion Asia Pacific on July 1, 2019.
(6) Adjustment reflects a $40 million increase to cost of goods sold recorded during the quarter ended December 31, 2020 due to the correction of an immaterial error related to the accounting in prior years for consideration received from vendors.
(7) Adjustment includes a $17 million loss on investment, $10 million of incremental costs associated with COVID-19, and costs associated with certain divestitures. COVID-19 related costs include incremental costs incurred relating to fees to cancel marketing events and increased cleaning and sanitization materials, among other things. For the twelve months ended December 31, 2019 and December 31, 2018, adjustments reflect transaction and other costs related to acquisitions and divestitures.
FINANCIAL CONDITION
The Company’s cash balance of $990.2 million at December 31, 2020 compares to cash of $277.0 million at December 31, 2019, as discussed further below. For the year ended December 31, 2020, the Company used $895.0 million to pay down debt (net of proceeds). This was primarily used to pay down the term loan A facility. Additionally the Company used
$453.3 million for dividends paid to the Company’s shareholders, $153.5 million for investments in the Company via capital expenditures and $69.2 million for acquisitions and other investing activities. These items were offset by the Company’s earnings and net cash provided by operating activities.
Accounts receivable decreased $883.3 million, or 36.2%, from December 31, 2019 primarily due to entering into the A/R Sales Agreement. Inventory increased $62.4 million, or 1.8% from December 31, 2019, but was down 1.3% excluding the impact of foreign currency. Accounts payable increased $180.1 million, or 4.6% from December 31, 2019 partly due to extended payment terms with certain suppliers. Total debt of $2.7 billion at December 31, 2020 decreased $0.7 billion, or 21.9%, from December 31, 2019 primarily due to the extinguishment of the term loan A facility.
We continue to negotiate extended payment dates with our suppliers. Our current payment terms with the majority of our suppliers range from 30 to 360 days. Several global financial institutions offer voluntary supply chain finance ("SCF") programs which enable our suppliers (generally those that grant extended terms), at their sole discretion, to sell their receivables from the Company to these financial institutions on a non-recourse basis at a rate that takes advantage of our credit rating and may be beneficial to them. The SCF program is primarily available to suppliers of goods and services included in cost of goods sold in our consolidated statements of comprehensive income. The Company and our suppliers agree on commercial terms for the goods and services we procure, including prices, quantities and payment terms, regardless of whether the supplier elects to participate in the SCF program. The suppliers sell goods or services, as applicable, to the Company and they issue the associated invoices to the Company based on the agreed-upon contractual terms. Then, if they are participating in the SCF program, our suppliers, at their sole discretion, determine which invoices, if any, they want to sell to the financial institutions. In turn, we direct payment to the financial institutions, rather than the suppliers, for the invoices sold to the financial institutions. No guarantees are provided by the Company or any of our subsidiaries on third-party performance under the SCF program; however, the Company guarantees the payment by our subsidiaries to the financial institutions participating in the SCF program for the applicable invoices. We have no economic interest in a supplier’s decision to participate in the SCF program, and we have no direct financial relationship with the financial institutions, as it relates to the SCF program. Accordingly, amounts due to our suppliers that elected to participate in the SCF program are included in the line item accounts payable in our consolidated balance sheets. All activity related to amounts due to suppliers that elected to participate in the SCF program is reflected in cash flows from operating activities in our consolidated statement of cash flows. We have been informed by the financial institutions that as of December 31, 2020 and 2019, suppliers elected to sell $1.8 billion and $1.8 billion, respectively, of our outstanding payment obligations to the financial institutions. The amount settled through the SCF program was $2.6 billion for the year ended December 31, 2020.
LIQUIDITY AND CAPITAL RESOURCES
The Company’s sources of capital consist primarily of cash flows from operations, supplemented as necessary by private and public issuances of debt and bank borrowings. Currently, we believe that our cash on hand and available short-term and long-term sources of capital are sufficient to fund the Company’s operations in both the short and long term, including working capital requirements, scheduled debt payments, interest payments, capital expenditures, benefit plan contributions, income tax obligations, dividends, share repurchases and contemplated acquisitions.
The ratio of current assets to current liabilities was 1.21 to 1 at December 31, 2020 and 1.17 to 1 at 2019, and our liquidity position remains strong. The Company’s total debt outstanding at December 31, 2020 decreased by $749.0 million or 21.9% from December 31, 2019, primarily due to the extinguishment of our term loan A facility.
Sources and Uses of Cash
A summary of the Company’s consolidated statements of cash flows is as follows:
| Year Ended December 31, | ||||||||||||||||||||||||||
| (In thousands) | 2020 | 2019 | $ Change | % Change | ||||||||||||||||||||||
| Operating activities | $ | 2,014,522 | $ | 832,519 | $ | 1,182,003 | 142.0 | % | ||||||||||||||||||
| Investing activities | $ | 182,768 | $ | (543,595) | $ | 726,363 | (133.6) | % | ||||||||||||||||||
| Financing activities | $ | (1,513,765) | $ | (385,962) | $ | (1,127,803) | 292.2 | % |
| Year Ended December 31, | ||||||||||||||||||||||||||
| (In thousands) | 2019 | 2018 | $ Change | % Change | ||||||||||||||||||||||
| Operating activities | $ | 832,519 | $ | 1,056,722 | $ | (224,203) | (21.2) | % | ||||||||||||||||||
| Investing activities | $ | (543,595) | $ | (469,938) | $ | (73,657) | 15.7 | % | ||||||||||||||||||
| Financing activities | $ | (385,962) | $ | (608,830) | $ | 222,868 | (36.6) | % |
Operating Activities
The Company continues to generate cash, and in 2020 net cash provided by operating activities totaled $2.0 billion, a $1.2 billion, or 142.0%, increase from 2019. The increase in cash provided by operating activities was primarily driven by the effective management of working capital, including the entry into an A/R Sales Agreement to sell receivables that provided an $800 million benefit to operating cash flows.
In 2019 net cash provided by operating activities totaled $0.8 billion, a $0.2 billion, or 21.2%, decrease from 2018. The decrease in cash provided by operating activities was primarily due to the change in working capital in 2019 as compared to 2018, as the Company's increase in accounts payable was less than in the prior year.
Investing Activities
Net cash provided by investing activities was $182.8 million in 2020 compared to net cash used of $543.6 million in 2019, a $726.4 million, or 133.6%, decrease. In 2020, net cash provided by investing activities included $387.4 million in proceeds from the divestiture of the Business Products Group and $18.1 million in proceeds from the sale of property, plant and equipment. These proceeds were partially offset by capital expenditures of $153.5 million, a decrease of $124.4 million, or 44.8%, from the prior year, and $69.2 million used for acquisitions of businesses and other investing activities, a decrease of $655.5 million, or 90.5%, from 2019. As part of our actions to preserve liquidity as a result of the COVID-19 pandemic, we significantly reduced our planned capital expenditures during 2020 from our original estimate of $300 million for the year. We estimate that cash used for capital expenditures in 2021 will be in the range of $275 million to $325 million.
Net cash used in investing activities was $543.6 million in 2019 compared to $469.9 million in 2018, a $73.7 million, or 15.7%, increase. In 2019, net cash used in investing activities included $724.7 million used for acquisitions of businesses and other investing activities, an increase of $466.9 million, or 181.1%, from 2018, and capital expenditures of $277.9 million, an increase of $51.4 million, or 22.7%, from the prior year. This increase was mostly offset by $434.6 million in proceeds for the divestiture of businesses during the year and $24.4 million in proceeds from the sale of property, plant and equipment.
Financing Activities
Net cash used in financing activities in 2020 totaled $1.5 billion, an increase of $1.1 billion, or 292.2%, from the $386.0 million in cash used in financing activities in 2019. The increase is primarily driven by the extinguishment of the term loan A facility in 2020. For the years presented, the Company's financing activities also included the use of cash for dividends paid to shareholders and repurchases of the Company’s common stock. The Company paid dividends to shareholders of $453.3 million during 2020. During 2020, the Company repurchased $96.2 million, of the Company’s common stock. The Company expects this trend of increasing dividends to continue in the foreseeable future. We also expect to remain active in our share repurchase program, but the amount and value of shares repurchased will vary and is at the discretion of the Company's board of directors.
Net cash used in financing activities in 2019 totaled $386.0 million, a decrease of $222.9 million, or 36.6%, from the $608.8 million in cash used in financing activities in 2018. Primarily, the decrease reflects the net proceeds from debt issued in 2019 as compared to the net payments on debt in 2018. For the years presented, the Company's financing activities also included the use of cash for dividends paid to shareholders and repurchases of the Company’s common stock. The Company paid dividends to shareholders of $438.9 million and $416.0 million during 2019 and 2018, respectively. During 2019 and 2018, the Company repurchased $74.2 million and $92.0 million, respectively, of the Company’s common stock.
Notes and Other Borrowings
We have taken actions and will continue to take actions, as necessary, intended to preserve financial flexibility in light of current uncertainty in the global markets resulting from COVID-19. These actions have included the previously negotiated covenant amendments to our credit arrangements due to macro uncertainty and evaluating alternative forms of liquidity to enhance credit capacity, reducing our capital expenditures (specifically deferring our growth related capital spending) and limiting merger and acquisition activity to select “bolt-on” acquisitions. Additionally, we took precautionary measures in 2020 to conserve liquidity including, but not limited to, reducing our inventory levels and managing replenishment volumes to adjust to the changing levels of market demand. To the extent available, we are also delaying tax payments as allowed by governmental authorities. We have a low level of capital expenditures related to maintenance items, which provides the flexibility to modify spending as needed to further preserve funds.
We believe that we have sufficient liquidity to manage through the current market conditions caused by COVID-19. We ended the year with $2.9 billion of total liquidity (comprising $1.9 billion availability on the revolving credit facility and $1.0 billion of cash and cash equivalents). From time to time, the Company may enter into other credit facilities or financing arrangements to provide additional liquidity and to manage against foreign currency risk. The Company currently believes that the existing lines of credit and cash generated from operations will be sufficient to fund anticipated operations for the foreseeable future.
On May 1, 2020, the Company entered into an amendment to each of the Amended and Restated Syndicated Credit Facility Agreement (the "October 30, 2017 Syndicated Facility") and the Notes Purchase Agreement, each dated as of October
30, 2017, to provide additional covenant flexibility on account of the COVID-19 pandemic. In consideration of the increased covenant flexibility, the Company agreed to certain interest rate increases under these facilities which expire on March 31, 2021.
On May 29, 2020, we entered into the A/R Sales Agreement to sell approximately $500 million of short-term receivables from certain customer trade accounts to an unaffiliated financial institution. The A/R Sales Agreement has a one year term, which the Company intends to renew each year. On October 29, 2020, the Company transferred ownership and control of an additional $300 million in receivables under the A/R Sales Agreement bringing the total to $800 million. The terms of the A/R Sales Agreement limit the balance of receivables sold to approximately $800 million at any point in time.
On October 27, 2020, the Company issued $500,000 aggregate principal amount of unsecured 1.875% Senior Notes due 2030 at a price to the public of 99.069% of their face value with U.S. Bank National Association as trustee. Interest on the 1.875% Senior Notes due 2030 is payable semi-annually on May 1 and November 1 of each year, which begins on May 1, 2021, and is computed on the basis of a 360-day year. On October 30, 2020, the term loan A was extinguished in connection with the issuance of these senior notes.
On October 30, 2020, the Company entered into a new $1.5 billion Syndicated Facility Agreement (the "October 30, 2020 Syndicated Facility"). Borrowings under the October 30, 2020 Syndicated Facility bear interest at a rate of London Inter-bank Offered Rate ("LIBOR") (or a similar index for foreign currency borrowings) plus a margin, which is based on the Company’s debt rating, with a LIBOR floor of 0.50%. The Company also has the option to increase the borrowing capacity up to an additional $750 million, as well as an option to decrease the borrowing capacity or terminate the facility with appropriate notice. The October 30, 2020 Syndicated Facility matures in October 2025. Simultaneously with the entry into the October 30, 2020 Syndicated Facility, the Company terminated and paid in full all outstanding indebtedness under the October 30, 2017 Syndicated Facility and repaid the existing term loan A facility.
At December 31, 2020, approximately $1.5 billion was available under this line of credit. Due to the workers’ compensation and insurance reserve requirements in certain states, the Company also had unused letters of credit of approximately $69.9 million outstanding at December 31, 2020. Our unused letters of credit expire within one year, but have automatic renewal clauses.
At December 31, 2020, the Company had unsecured Senior Notes outstanding of $2.1 billion. These borrowings contain covenants related to a maximum debt to EBITDA ratio and certain limitations on additional borrowings. The weighted average interest rate on the Company’s total outstanding borrowings was approximately 2.65% at December 31, 2020 and 2.18% at December 31, 2019. Total interest expense, net of interest income, for all borrowings was $91.0 million, $91.4 million and $93.3 million in 2020, 2019 and 2018, respectively. Refer to the credit facilities footnote the Consolidated Financial Statements for more information.
At December 31, 2020, the Company was in compliance with the covenants under its October 30, 2020 Syndicated Facility and its outstanding unsecured Senior Notes. Any failure to comply with our debt covenants or restrictions could result in a default under our financing arrangements or could require us to obtain waivers from our lenders for failure to comply with these restrictions. The occurrence of a default that remains uncured or the inability to secure a necessary consent or waiver could create cross defaults under other debt arrangements and have a material adverse effect on our business, financial condition, results of operations and cash flows.
Contractual and Other Obligations
The following table summarizes our material cash requirements at December 31, 2020 that we expect to be paid in cash. The table does not include amounts that are contingent on events or other factors that are uncertain or unknown at this time, including legal contingencies and uncertain tax positions. The amounts presented are based on various estimates and actual results may vary from the amounts presented.
| Payment Due by Period | ||||||||||||||||||||||||||||||||
| (In thousands) | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | Over 5 Years | |||||||||||||||||||||||||||
| Credit facilities | $ | 2,690,863 | $ | 162,429 | $ | 251,573 | $ | 395,906 | $ | 1,880,955 | ||||||||||||||||||||||
| Operating leases | 1,132,539 | 295,841 | 440,660 | 209,903 | 186,135 | |||||||||||||||||||||||||||
| Total material cash requirements | $ | 3,823,402 | $ | 458,270 | $ | 692,233 | $ | 605,809 | $ | 2,067,090 |
Purchase orders or contracts for the purchase of inventory and other goods and services are not included in our estimates. We are not able to determine the aggregate amount of such purchase orders that represent contractual cash requirement, as purchase orders may represent authorizations to purchase rather than binding agreements. Our purchase orders are based on our current distribution needs and are fulfilled by our vendors within short time horizons. The Company does not have significant agreements for the purchase of inventory or other goods specifying minimum quantities or set prices that exceed our expected requirements.
Additionally, the Company guarantees the borrowings of certain independently owned automotive parts stores (independents) and certain other affiliates in which the Company has a noncontrolling equity ownership interest (affiliates). The Company’s maximum exposure to loss as a result of its involvement with these independents and affiliates is generally equal to the total borrowings subject to the Company’s guarantee. At December 31, 2020, the total borrowings of the independents and affiliates subject to guarantee by the Company were approximately $884.7 million. These loans generally mature over periods from one to six years. Our amount of commitment expiring in 2021 is approximately $420.7 million. To date, the Company has had no significant losses in connection with guarantees of independents’ and affiliates’ borrowings.
Share Repurchases
In 2020, the Company repurchased approximately 1.1 million shares of its common stock and the Company had remaining authority to purchase approximately 14.5 million shares of its common stock at December 31, 2020. There were no other repurchase plans announced as of December 31, 2020.
CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of our consolidated financial statements requires management to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, net sales and expenses and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We describe in this section certain critical accounting policies that require us to make significant estimates, assumptions and judgments. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are uncertain at the time the estimate is made and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. Management believes the following critical accounting policies reflect its most significant estimates and assumptions used in the preparation of the consolidated financial statements. For further information on the critical accounting policies, see the summary of significant accounting policies footnote in the Notes to Consolidated Financial Statements.
Inventories — Provisions for Slow Moving and Obsolescence
The Company identifies slow moving or obsolete inventories and estimates appropriate provisions related thereto. Historically, these losses have not been significant as the vast majority of the Company’s inventories are not highly susceptible to obsolescence and a majority are eligible for return under various vendor return programs. While the Company has no reason to believe its inventory return privileges will be discontinued in the future, its risk of loss associated with obsolete or slow moving inventories would increase if such were to occur.
Allowance for Doubtful Accounts — Methodology
The Company evaluates the collectability of trade accounts receivable based on a combination of factors. The Company estimates an allowance for doubtful accounts as a percentage of net sales based on various factors, including historical experience, current economic conditions and expected future credit losses and collectability trends. The Company periodically adjusts this estimate when the Company becomes aware of a specific customer’s inability to meet its financial obligations (e.g., bankruptcy filing) or as a result of changes in the overall aging of accounts receivable. While the Company has a large customer base that is geographically dispersed, a general economic downturn in any of the industry segments in which the Company operates could result in higher than expected defaults and, therefore, the need to revise estimates for bad debts. For the years ended December 31, 2020, 2019 and 2018, the Company recorded provisions for doubtful accounts of approximately $23.6 million, $13.9 million, and $15.9 million, respectively.
Consideration Received from Vendors
The Company may enter into agreements at the beginning of each year with many of its vendors that provide for inventory purchase incentives. Generally, the Company earns inventory purchase incentives upon achieving specified volume purchasing levels or other criteria. The Company accrues for the receipt of these incentives as part of its inventory cost based on cumulative purchases of inventory to date and projected inventory purchases through the end of the year. While management believes the Company will continue to receive consideration from vendors in 2021 and beyond, there can be no assurance that vendors will continue to provide comparable amounts of incentives in the future or that we will be able to achieve the specified volumes necessary to take advantage of such incentives.
Impairment of Property, Plant and Equipment and Goodwill and Other Intangible Assets
At least annually, the Company evaluates property, plant and equipment, goodwill and other intangible assets for potential impairment indicators. The Company’s judgments regarding the existence of impairment indicators are based on market conditions and operational performance, among other factors. Future events could cause the Company to conclude that impairment indicators exist and that assets associated with a particular operation are impaired. Evaluating for impairment also requires the Company to estimate future operating results and cash flows which requires judgment by management. Any resulting impairment loss could have a material adverse impact on the Company’s financial condition and results of operations. Refer to the goodwill and other intangible assets footnote of the Notes to Consolidated Financial Statements for further information on the results of the Company's annual goodwill impairment testing.
Employee Benefit Plans
The Company’s benefit plan committees in the U.S. and Canada establish investment policies and strategies and regularly monitor the performance of the Company’s pension plan assets. The plans in Europe are unfunded and therefore there are no plan assets. The pension plan investment strategy implemented by the Company’s management is to achieve long-term objectives and invest the pension assets in accordance with the applicable pension legislation in the U.S. and Canada, as well as fiduciary standards. The long-term primary objectives for the pension plan funds are to provide for a reasonable amount of long-term growth of capital without undue exposure to risk, protect the assets from erosion of purchasing power and provide investment results that meet or exceed the pension plans’ actuarially assumed long-term rates of return. The Company’s investment strategy with respect to pension plan assets is to generate a return in excess of the passive portfolio benchmark (47% S&P 500 Index, 5% Russell Mid Cap Index, 7% Russell 2000 Index, 5% MSCI EAFE Index, 5% DJ Global Moderate Index, 3% MSCI Emerging Market Net, and 28% Barclays U.S. Long Govt/Credit).
We make several critical assumptions in determining our pension plan assets and liabilities and related pension income. We believe the most critical of these assumptions are the expected rate of return on plan assets and the discount rate. Other assumptions we make relate to employee demographic factors such as rate of compensation increases, mortality rates, retirement patterns and turnover rates. Refer to the employee benefit plans footnote of the Notes to Consolidated Financial Statements for more information regarding these assumptions.
Based on the investment policy for the pension plans, as well as an asset study that was performed based on the Company’s asset allocations and future expectations, the Company’s expected rate of return on plan assets for measuring 2021 pension income is 6.88% for the plans. The asset study forecasted expected rates of return for the approximate duration of the Company’s benefit obligations, using capital market data and historical relationships.
The discount rate is chosen as the rate at which pension obligations could be effectively settled and is based on capital market conditions as of the measurement date. We have matched the timing and duration of the expected cash flows of our pension obligations to a yield curve generated from a broad portfolio of high-quality fixed income debt instruments to select our discount rate. Based upon this cash flow matching analysis, we selected a weighted average discount rate for the plans of 2.7% at December 31, 2020.
Effective December 31, 2013, our defined benefit pension plans was amended to freeze benefit plan accruals for participants and provide for immediate vesting of accrued benefits. Net periodic benefit income for our defined benefit pension plans was $18.0 million, $16.2 million, and $15.8 million for the years ended December 31, 2020, 2019 and 2018, respectively. The income associated with the pension plans in 2020, 2019 and 2018 reflects the impact of the freeze. Refer to the employee benefit plans footnote of the Notes to Consolidated Financial Statements for more information regarding employee benefit plans.
Business Combinations
When the Company acquires businesses, it applies the acquisition method of accounting and recognizes the identifiable assets acquired, the liabilities assumed, and any noncontrolling interests in an acquiree at their fair values on the acquisition date, which requires significant estimates and assumptions. Goodwill is measured as the excess of the fair value of the consideration transferred over the net of the acquisition date fair values of the identifiable assets acquired and liabilities assumed. The acquisition method requires the Company to record provisional amounts for any items for which the accounting is not complete at the end of a reporting period. The Company must complete the accounting during the measurement period, which cannot exceed one year. Adjustments made during the measurement period could have a material impact on the Company's financial condition and results of operations.
The Company typically measures customer relationship and other intangible assets using an income approach. Significant estimates and assumptions used in this approach include discount rates and certain assumptions that form the basis of the forecasted cash flows expected to be generated from the asset (e.g., future revenue growth rates, operating margins and attrition rates). If the subsequent actual results and updated projections of the underlying business activity change compared with the assumptions and projections used to develop these values, the Company could record impairment charges. In addition, the Company has estimated the economic lives of certain acquired tangible and intangible assets and these lives are used to
calculate depreciation and amortization expense. If the Company's estimates of the economic lives change, depreciation or amortization expenses could be increased or decreased, or the acquired asset could be impaired.
Legal and Product Liabilities
The Company accrues for potential losses related to legal disputes, litigation, product liabilities, and regulatory matters when it is probable (the future event or events are likely to occur) that the Company will incur a loss and the amount of the loss can be reasonably estimated.
To calculate product liabilities, the Company estimates potential losses relating to pending claims and also estimates the likelihood of additional, similar claims being filed against the Company in the future. To estimate potential losses on claims that could be filed in the future, the Company considers claims pending against the Company, claim filing rates, the number of codefendants and the extent to which they share in settlements, and the amount of loss by claim type. The estimated losses for pending and potential future claims are calculated on a discounted basis using risk-free interest rates derived from market data about monetary assets with maturities comparable to those of the projected product liabilities. The Company uses an actuarial specialist to assist with measuring its product liabilities. Refer to the commitments and contingencies footnote of the Notes to Consolidated Financial Statements for additional information regarding product liabilities.
Self Insurance
The Company is self-insured for the majority of its group health insurance costs. A reserve for claims incurred but not reported is developed by analyzing historical claims data provided by the Company’s claims administrators. These reserves are included in accrued expenses in the accompanying consolidated balance sheets as the expenses are expected to be paid within one year.
Long-term insurance liabilities consist primarily of reserves for the Company's workers’ compensation program. In addition, the Company carries various large risk deductible workers’ compensation policies for the majority of workers’ compensation liabilities. The Company records the workers’ compensation reserves based on an analysis performed by an independent actuary. The analysis calculates development factors, which are applied to total reserves as provided by the various insurance companies who underwrite the program. While the Company believes that the assumptions used to calculate these liabilities are appropriate, significant differences in actual experience or significant changes in these assumptions may materially affect workers’ compensation costs.
Income Taxes
The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amount and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets and liabilities are recorded net as noncurrent deferred income taxes. In addition, valuation allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. In making this determination, the Company considers all available positive and negative evidence including projected future taxable income, future reversals of existing temporary differences, recent financial operations and tax planning strategies.
The Company recognizes a tax benefit from uncertain tax positions when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Refer to the summary of significant accounting policies footnote in the Notes to Consolidated Financial Statements for information on recent accounting pronouncements.
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