filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
51K characters. Original on sec.gov ·
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Cautionary Statement Under the Private Securities Litigation Reform Act
This management’s discussion and analysis, including, without limitations the section entitled “Historical Overview and Outlook” and other portions of this report contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934, as amended. These statements may relate to, among other things, capital expenditures, cost reductions, cash flow, and operating improvements and are indicated by words or phrases such as “anticipate,” “estimate,” “plans,” “expects,” “projects,” “should,” “will,” “management believes,” “the Company believes,” “we believe,” “the Company intends” and similar words or phrases. These statements are subject to inherent uncertainties and risks that could cause actual results to differ materially from those anticipated at the date of this filing. The risks and uncertainties include, but are not limited to, the following: economic and political consequences resulting from terrorist attacks and wars; levels of industrial activity and economic conditions in the U.S. and other countries around the world; pricing pressures and other competitive factors, and levels of capital spending in certain industries — all of which could have a material impact on our order rates and results, particularly in light of the low levels of order backlogs we typically maintain; our ability to make acquisitions and to integrate and operate acquired businesses on a profitable basis; the relationship of the U.S. dollar to other currencies and its impact on pricing and cost competitiveness; political and economic conditions in foreign countries in which we operate; interest rates; capacity utilization and the effect this has on costs; labor markets; market conditions and material costs; and developments with respect to contingencies, such as litigation and environmental matters. The forward-looking statements included here are only made as of the date of this report, and we undertake no obligation to publicly update them to reflect subsequent events or circumstances. Investors are cautioned not to rely unduly on forward-looking statements when evaluating the information presented here.
Historical Overview and Outlook
IDEX is an applied solutions company specializing in fluid and metering technologies, health and science technologies, dispensing equipment, and fire, safety and other diversified products built to its customers’ specifications. Our products are sold in niche markets to a wide range of industries throughout the world. Accordingly, our businesses are affected by levels of industrial activity and economic conditions in the U.S. and in other countries where we do business and by the relationship of the U.S. dollar to other currencies. Levels of capacity utilization and capital spending in certain industries and overall industrial activity are among the factors that influence the demand for our products.
The Company consists of four reportable segments: Fluid & Metering Technologies, Health & Science Technologies, Dispensing Equipment and Fire & Safety/Diversified Products.
The Fluid & Metering Technologies Segment designs, produces and distributes positive displacement pumps, flow meters, injectors, and other fluid-handling pump modules and systems and provides flow monitoring and other services for water and wastewater. The Health & Science Technologies Segment designs, produces and distributes a wide range of precision fluidics solutions, including very high precision, low-flow rate pumping solutions required in analytical instrumentation, clinical diagnostics and drug discovery, high performance molded and extruded, biocompatible medical devices and implantables, air compressors used in medical, dental and industrial applications, and precision gear and peristaltic pump technologies that meet exacting OEM specifications. The Dispensing Equipment Segment produces precision equipment for dispensing, metering and mixing colorants and paints used in a variety of retail and commercial businesses around the world. The Fire & Safety/Diversified Products Segment produces firefighting pumps and controls, rescue tools, lifting bags and other components and systems for the fire and rescue industry, and engineered stainless steel banding and clamping devices used in a variety of industrial and commercial applications.
Some of our key 2010 financial highlights are as follows:
| • | Sales of $1.51 billion rose 14%; organic sales — excluding acquisitions and foreign currency translation — were up 12%. | |
| • | Gross margins improved 160 basis points to 40.9% of sales |
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| • | Operating margins at 16.5% increased 260 basis points compared to 2009. | |
| • | Net income increased 39% to $157.1 million. | |
| • | Diluted EPS of $1.90 increased 50 cents compared to 2009. |
For 2011, the Company is expected to grow organically in the mid to high single digits with acquisition-related growth projected at approximately 4 percent for transactions completed in 2010 and two acquisitions to be completed in the first quarter of 2011. Based on the Company’s current outlook, for the full year 2011, we are forecasting fully diluted EPS of $2.23 to $2.33.
Results of Operations
The following is a discussion and analysis of our financial position and results of operations for each of the three years in the period ended December 31, 2010. For purposes of this discussion and analysis section, reference is made to the table on page 16 and the Consolidated Statements of Operations in Part II. Item 8. “Financial Statements and Supplementary Data” on page 26.
Performance in 2010 Compared with 2009
Sales in 2010 of $1,513.1 million were 14% higher than the $1,329.7 million recorded a year ago. This increase reflects a 12% increase in organic sales and 3% from four acquisitions (PPE — April 2010, OBL — July 2010, Periflo — September 2010 and Fitzpatrick — November 2010), partially offset by 1% unfavorable foreign currency translation. Organic sales increased in Fluid & Metering Technologies, Health & Science Technologies and Fire & Safety/Diversified Products segments, but were flat in the Dispensing Equipment segment. Domestic organic sales were up 9% versus the prior year, while international organic sales increased 15% in 2010. Organic sales to customers outside the U.S. represented 49% of total sales in 2010 and 46% in 2009.
In 2010, Fluid & Metering Technologies contributed 48% of sales and 44% of operating income; Health & Science Technologies accounted for 26% of sales and 28% of operating income; Dispensing Equipment accounted for 8% of sales and 7% of operating income; and Fire & Safety/Diversified Products represented 18% of sales and 21% of operating income.
Fluid & Metering Technologies sales of $729.9 million in 2010 increased $88.8 million, or 14%, compared with 2009. This reflects a 13% increase in organic sales and 2% for acquisitions (OBL, Periflo and Fitzpatrick), partially offset by 1% unfavorable foreign currency translation. The increase in organic growth was driven by strong global growth across energy, chemical, food & pharma and water & wastewater markets. In 2010, organic sales increased approximately 13% domestically and 14% internationally. Organic sales to customers outside the U.S. were approximately 46% of total segment sales in 2010 and 41% in 2009.
Health & Science Technologies sales of $397.2 million increased $92.9 million, or 31%, in 2010 compared with last year. This change reflects a 21% increase in organic growth and a 10% increase from the acquisition of PPE. The increase in organic sales reflects market strength across all Health & Science Technologies products. In 2010, organic sales increased 14% domestically and 32% internationally. Organic sales to customers outside the U.S. were approximately 43% of total segment sales in 2010 and 40% in 2009.
Dispensing Equipment sales of $125.3 million decreased $2.0 million, or 2%, in 2010 compared with the prior year. This change reflects 2% unfavorable foreign currency translation, while organic growth was flat in 2010 compared to 2009. The Dispensing Equipment Segment experienced strength in Asia and parts of Eastern Europe, offset by softness in North America and Western Europe. Organic domestic sales decreased 9% compared with 2009, while organic international sales increased 5%. Organic sales to customers outside the U.S. were 67% of total segment sales in 2010 and 66% in 2009.
Fire & Safety/Diversified Products sales of $265.5 million increased $2.7 million, or 1%, in 2010 compared with 2009. Organic sales activity increased 2%, while foreign currency translation accounted for a 1% decrease. The increase in organic business growth was driven by higher demand for engineered band clamping systems, partially offset by weakness in fire suppression. In 2010, organic sales decreased 3% domestically and increased 7%
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internationally. Organic sales to customers outside the U.S. were 56% of total segment sales in 2010 and 55% in 2009.
Gross profit of $618.5 million in 2010 was $96.1 million, or 18%, higher than 2009. As a percent of sales, gross profit was 40.9% in 2010, which represented a 160 basis-point increase from 39.3% in 2009. The increase in gross margin primarily reflects higher sales volume, cost reductions due to our restructuring initiatives and change in product mix.
Selling, general and administrative (“SG&A”) expenses increased to $358.3 million in 2010 from $325.5 million in 2009. The $32.8 million increase reflects approximately $22.0 million for volume related expenses and $10.8 million for incremental costs associated with the acquisitions of PPE in April 2010, OBL in July 2010, Periflo in September 2010 and Fitzpatrick in November 2010. As a percent of net sales, SG&A expenses were 23.7% for 2010 and 24.5% in 2009.
In 2010, the Company recorded pre-tax restructuring expenses totaling $11.1 million, while $12.1 million was recorded in 2009. These restructuring expenses were mainly attributable to employee severance related to employee reductions across various functional areas and facility closures resulting from the Company’s cost savings initiatives. These initiatives included severance benefits for 215 employees in 2010 and 478 in 2009. The Company has completed these employee reductions in 2010 and expects severance payments to be fully paid by the end of 2011 using cash from operations.
Operating income increased $64.3 million, or 35%, to $249.1 million in 2010 from $184.9 million in 2009. This increase primarily reflects an increase in volume, changes in product mix and cost reductions due to our restructuring initiatives. Operating margins in 2010 were 16.5% of sales compared with 13.9% recorded in 2009.
In the Fluid & Metering Technologies Segment, operating income of $131.9 million and operating margins of 18.1% in 2010 were up from the $100.3 million and 15.6% recorded in 2009, principally due to higher sales and cost reduction initiatives. In the Health & Science Technologies Segment, operating income of $82.3 million and operating margins of 20.7% in 2010 were up from the $51.7 million and 17.0% recorded in 2009 due to higher volume and cost reduction initiatives. In the Dispensing Equipment Segment, operating income of $19.5 million and operating margins of 15.6% in 2010 were up from the $15.1 million and 11.9% recorded in 2009 due to cost reduction initiatives and improved productivity. Operating income and operating margins in the Fire & Safety/Diversified Products Segment of $62.8 million and 23.7%, respectively, were higher than the $59.9 million and 22.8% recorded in 2009, due to higher volume and favorable mix.
Other expense was $1.1 million in 2010 compared with a $1.2 million gain in 2009, due to unfavorable foreign currency translation.
Interest expense decreased to $16.2 million in 2010 from $17.2 million in 2009. The decrease was principally due to lower debt levels and a lower interest rate environment.
The provision for income taxes increased to $74.8 million in 2010 from $55.4 million in 2009. The effective tax rate decreased to 32.2% in 2010 from 32.8% in 2009, due to changes in the mix of global pre-tax income among taxing jurisdictions.
Net income for 2010 was $157.1 million, 39% higher than the $113.4 million earned in 2009. Diluted earnings per share in 2010 of $1.90 increased $0.50, or 36%, compared with last year.
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Company and Business Segment Financial Information
| For the Years Ended December 31,(1) | ||||||||||||
| 2010 | 2009 | 2008 | ||||||||||
| (In thousands) | ||||||||||||
| Fluid & Metering Technologies | ||||||||||||
| Net sales(2) | $ | 729,945 | $ | 641,108 | $ | 697,702 | ||||||
| Operating income(3) | 131,944 | 100,289 | 123,801 | |||||||||
| Operating margin(3) | 18.1 | % | 15.6 | % | 17.7 | % | ||||||
| Identifiable assets | $ | 1,111,085 | $ | 1,043,082 | $ | 1,070,348 | ||||||
| Depreciation and amortization | 33,134 | 32,584 | 26,276 | |||||||||
| Capital expenditures | 17,308 | 12,867 | 13,859 | |||||||||
| Health & Science Technologies | ||||||||||||
| Net sales(2) | $ | 397,198 | $ | 304,329 | $ | 331,591 | ||||||
| Operating income(3) | 82,332 | 51,712 | 58,297 | |||||||||
| Operating margin(3) | 20.7 | % | 17.0 | % | 17.6 | % | ||||||
| Identifiable assets | $ | 648,400 | $ | 567,096 | $ | 594,459 | ||||||
| Depreciation and amortization | 16,012 | 14,293 | 11,806 | |||||||||
| Capital expenditures | 7,516 | 6,365 | 5,365 | |||||||||
| Dispensing Equipment | ||||||||||||
| Net sales(2) | $ | 125,320 | $ | 127,279 | $ | 163,861 | ||||||
| Operating income (loss)(3)(4) | 19,490 | 15,147 | (10,748 | ) | ||||||||
| Operating margin(3)(4) | 15.6 | % | 11.9 | % | (6.6 | )% | ||||||
| Identifiable assets | $ | 205,540 | $ | 164,979 | $ | 179,800 | ||||||
| Depreciation and amortization | 3,753 | 3,124 | 3,986 | |||||||||
| Capital expenditures | 1,129 | 864 | 2,528 | |||||||||
| Fire & Safety/Diversified Products | ||||||||||||
| Net sales(2) | $ | 265,501 | $ | 262,809 | $ | 300,462 | ||||||
| Operating income(3) | 62,844 | 59,884 | 74,310 | |||||||||
| Operating margin(3) | 23.7 | % | 22.8 | % | 24.7 | % | ||||||
| Identifiable assets | $ | 278,567 | $ | 285,893 | $ | 286,482 | ||||||
| Depreciation and amortization | 4,885 | 5,328 | 5,288 | |||||||||
| Capital expenditures | 3,513 | 3,686 | 4,743 | |||||||||
| Total IDEX | ||||||||||||
| Net sales | $ | 1,513,073 | $ | 1,329,661 | $ | 1,489,471 | ||||||
| Operating income | 249,116 | 184,854 | 205,956 | |||||||||
| Operating margin | 16.5 | % | 13.9 | % | 13.8 | % | ||||||
| Total assets | $ | 2,381,695 | $ | 2,098,157 | $ | 2,151,800 | ||||||
| Depreciation and amortization(5) | 58,108 | 56,346 | 48,599 | |||||||||
| Capital expenditures | 32,769 | 25,525 | 28,358 |
| (1) | Data includes acquisition of Fitzpatrick (November 2010), Periflo (September 2010), OBL (July 2010), IETG (October 2008), iPEK (October 2008), Richter (October 2008) and ADS (January 2008) in the Fluid & Metering Technologies Segment and PPE (April 2010), Innovadyne (November 2008) and Semrock (October 2008) in the Health & Science Technologies Segment from the date of acquisition. | |
| (2) | Segment net sales include intersegment sales. | |
| (3) | Segment operating income excludes unallocated corporate operating expenses. | |
| (4) | Segment operating income includes $30.1 million goodwill impairment charge in 2008 for Fluid Management. | |
| (5) | Excludes amortization of debt issuance expenses. |
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Performance in 2009 Compared with 2008
Sales in 2009 of $1,329.7 million were 11% lower than the $1,489.5 million recorded in 2008. This decrease reflects a 14% decrease in organic sales and 2% unfavorable foreign currency translation, partially offset by a 5% increase from five acquisitions (Richter — October 2008, iPEK — October 2008, IETG — October 2008, Semrock — October 2008 and Innovadyne — November 2008). Organic sales decreased in all four of the Company’s reportable segments. Domestic organic sales were down 13% versus the prior year, while international organic sales were down 15% in 2009. Sales to customers outside the U.S. represented 47% of total sales in both 2009 and 2008.
In 2009, Fluid & Metering Technologies contributed 48% of sales and 44% of operating income; Health & Science Technologies accounted for 23% of both sales and operating income; Dispensing Equipment accounted for 9% of sales and 7% of operating income; and Fire & Safety/Diversified Products represented 20% of sales and 26% of operating income.
Fluid & Metering Technologies sales of $641.1 million in 2009 decreased $56.6 million, or 8%, compared with 2008. This reflects a 16% decline in organic sales and 1% of unfavorable foreign currency translation, partially offset by a 9% increase for acquisitions (Richter, iPEK and IETG). The decrease in organic growth was driven by weakness in chemical, energy, water and wastewater markets. In 2009, organic sales declined approximately 16% both domestically and internationally. Organic sales to customers outside the U.S. were approximately 41% of total segment sales in 2009 and 43% in 2008.
Health & Science Technologies sales of $304.3 million decreased $27.3 million, or 8%, in 2009 compared with 2008. This change represents a 12% decrease in organic volume and 1% unfavorable foreign currency translation, partially offset by a 5% increase from the acquisitions of Semrock and Innovadyne. The decrease in organic sales reflected market softness across the Health & Science Technologies businesses. In 2009, organic sales decreased 13% domestically and 10% internationally. Organic sales to customers outside the U.S. were approximately 40% of total segment sales in 2009 and 38% in 2008.
Dispensing Equipment sales of $127.3 million decreased $36.6 million, or 22%, in 2009 compared with the prior year. Organic sales decreased 18%, while foreign currency translation accounted for 4% of the decrease. The decrease in organic growth was due to continued deterioration in capital spending in the European and North American markets. Organic domestic sales increased 8% compared with 2008, while organic international sales decreased 27%. Organic sales to customers outside the U.S. were 66% of total segment sales in 2009, down from 73% in 2008.
Fire & Safety/Diversified Products sales of $262.8 million decreased $37.7 million, or 13%, in 2009 compared with 2008. Organic sales activity decreased 9%, while foreign currency translation accounted for 4% of the decrease. The decrease in organic business growth was driven by lower demand for engineered band clamping systems and lower levels of municipal spending. In 2009, organic sales decreased 12% domestically and 7% internationally. Organic sales to customers outside the U.S. were 55% of total segment sales in 2009 and 53% in 2008.
Gross profit of $522.4 million in 2009 was $75.0 million, or 13%, lower than 2008. As a percent of sales, gross profit was 39.3% in 2009, which represented an 80 basis-point decrease from 40.1% in 2008. The decrease in gross margin primarily reflects lower volume and product mix.
SG&A expenses decreased to $325.5 million in 2009 from $343.4 million in 2008. The $17.9 million decrease reflects approximately $40.7 million for restructuring related savings and volume related expenses, partially offset by a $22.8 million increase for incremental costs associated with recently acquired businesses. As a percent of net sales, SG&A expenses were 24.5% for 2009 and 23.1% in 2008.
In 2008, the Company recorded a goodwill impairment charge of $30.1 million. The Company concluded in accordance with ASC 350 that events had occurred and circumstances had changed which required the Company to perform an interim period goodwill impairment test at Fluid Management, a reporting unit in 2008 within the Company’s Dispensing Equipment Segment. Fluid Management had experienced a downturn in capital spending by its customer base and a loss of market share. The Company performed an impairment test and compared the fair
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value of the reporting unit to its carrying value. It was determined that the fair value of Fluid Management was less than the carrying value of the net assets. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. The Company’s analysis resulted in an implied fair value of goodwill of $21.2 million.
In 2009 and 2008, the Company recorded pre-tax restructuring expenses totaling $12.1 million and $18.0 million, respectively, for employee severance related to employee reductions across various functional areas and facility closures resulting from the Company’s cost savings initiatives. These initiatives included severance benefits for 478 employees in 2009 and 380 in 2008.
Operating income decreased $21.1 million, or 10%, to $184.9 million in 2009 from $206.0 million in 2008. This decrease primarily reflects a decrease in volume, partially offset by the goodwill impairment charge in 2008 and the impact from acquisitions. Operating margins in 2009 were 13.9% of sales compared with 13.8% recorded in 2008.
In the Fluid & Metering Technologies Segment, operating income of $100.3 million and operating margins of 15.6% in 2009 were down from the $123.8 million and 17.7% recorded in 2008 principally due to lower sales. In the Health & Science Technologies Segment, operating income of $51.7 million and operating margins of 17.0% in 2009 were down from the $58.3 million and 17.6% recorded in 2008 due to lower volume. In the Dispensing Equipment Segment, operating income of $15.1 million and operating margins of 11.9% in 2009 were up from the $10.7 million of operating loss recorded in 2008, due to a goodwill impairment charge in 2008, partially offset by continued deterioration in the North American and European markets. Operating income and operating margins in the Fire & Safety/Diversified Products Segment of $59.9 million and 22.8%, respectively, were lower than the $74.3 million and 24.7% recorded in 2008, due primarily to lower volume and unfavorable product mix.
Other income of $1.2 million in 2009 was $3.9 million lower than the $5.1 million in 2008, due to unfavorable foreign currency translation and lower interest income.
Interest expense decreased to $17.2 million in 2009 from $18.9 million in 2008. The decrease was due to a lower interest rate environment, the replacement of $150.0 million of debt with a lower interest rate borrowing in February 2008 and the conversion of $350.0 million floating-rate debt into fixed-rates.
The provision for income taxes decreased to $55.4 million in 2009 from $65.2 million in 2008. The effective tax rate decreased to 32.8% in 2009 from 33.9% in 2008, due to changes in the mix of global pre-tax income among taxing jurisdictions.
Net income for 2009 was $113.4 million, 11% lower than the $127.0 million in 2008. Diluted earnings per share in 2009 of $1.40 decreased $0.13, or 8%, compared with 2008.
Liquidity and Capital Resources
At December 31, 2010, working capital was $339.1 million and the Company’s current ratio was 2.0 to 1. Cash flows from operating activities decreased $28.1 million, or 13%, to $184.5 million in 2010, primarily due to the settlement of the forward starting interest rate contract entered into during 2010 in connection with the $300.0 million 4.5% Senior Notes issued in December 2010.
Cash flows from operations were more than adequate to fund capital expenditures of $32.8 million and $25.5 million in 2010 and 2009, respectively. Capital expenditures were generally for machinery and equipment that improved productivity and tooling to support the global sourcing initiatives, although a portion was for business system technology and replacement of equipment and facilities. Management believes that the Company has ample capacity in its plants and equipment to meet expected needs for future growth in the intermediate term.
The Company acquired PPE in April 2010 for cash consideration of $51.3 million and the assumption of approximately $2.7 million in debt related items, OBL in July 2010 for cash consideration of $15.4 million, Periflo in September 2010 for cash consideration of $4.3 million and Fitzpatrick in November 2010 for cash consideration of $20.3 million and the assumption of approximately $0.4 million in debt related items. The cash payment for PPE was financed with borrowings under the Company’s credit facility, while the other acquisitions were paid with cash from operations.
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The Company maintains a $600.0 million unsecured domestic, multi-currency bank revolving credit facility (“Credit Facility”), which expires on December 21, 2011. At December 31, 2010, there was $27.8 million outstanding under the Credit Facility. The net available borrowing under the Credit Facility as of December 31, 2010, was approximately $572.2 million. Interest is payable quarterly on the outstanding borrowings at the bank agent’s reference rate. Interest on borrowings based on LIBOR plus an applicable margin is payable on the maturity date of the borrowing, or quarterly from the effective date for borrowings exceeding three months. The applicable margin is based on the Company’s senior, unsecured, long-term debt rating and can range from 24 basis points to 50 basis points. Based on the Company’s credit rating at December 31, 2010, the applicable margin was 40 basis points. An annual Credit Facility fee, also based on the Company’s credit rating, is currently 10 basis points and is payable quarterly.
On April 18, 2008, the Company completed a $100.0 million unsecured senior bank term loan agreement (“Term Loan”), with covenants consistent with the existing Credit Facility and a maturity on December 21, 2011. At December 31, 2010, there was $90.0 million outstanding under the Term Loan included within short term borrowings. Interest under the Term Loan is based on the bank agent’s reference rate or LIBOR plus an applicable margin and is payable at the end of the selected interest period, but at least quarterly. The applicable margin is based on the Company’s senior, unsecured, long-term debt rating and can range from 45 to 100 basis points. Based on the Company’s current debt rating, the applicable margin is 80 basis points. The Term Loan requires a repayment of $7.5 million in April 2011, with the remaining balance due on December 21, 2011. The Company currently maintains an interest rate exchange agreement related to the Term Loan which expires in December 2011. This interest rate exchange agreement has a current notional amount of $90.0 million, the agreement effectively converted the $100.0 million of floating-rate debt into fixed-rate debt at an interest rate of 4.00%. The fixed rate is comprised of the fixed rate on the interest rate exchange agreement and the Company’s current margin of 80 basis points on the Term Loan.
On June 9, 2010, the Company completed a private placement of €81.0 million ($96.8 million) aggregate principal amount of 2.58% Series 2010 Senior Euro Notes due June 9, 2015 (“2.58% Senior Euro Notes”) pursuant to a Master Note Purchase Agreement, dated June 9, 2010 (the “Purchase Agreement”). The Purchase Agreement provides for the issuance of additional series of notes in the future. The 2.58% Senior Euro Notes bear interest at a rate of 2.58% per annum and will mature on June 9, 2015. The 2.58% Senior Euro Notes are unsecured obligations of the Company and rank pari passu in right of payment with all of the Company’s other senior debt. The Company may at any time prepay all or any portion of the 2.58% Senior Euro Notes; provided that such portion is greater than 5% of the aggregate principal amount of Notes then outstanding under the Purchase Agreement. In the event of a prepayment, the Company will pay an amount equal to par plus accrued interest plus a make-whole premium. The Purchase Agreement contains certain covenants that restrict the Company’s ability to, among other things, transfer or sell assets, create liens and engage in certain mergers or consolidations. In addition, the Company must comply with a leverage ratio and interest coverage ratio as set forth in the Purchase Agreement. The Purchase Agreement provides for customary events of default. In the case of an event of default arising from specified events of bankruptcy or insolvency, all outstanding 2.58% Senior Euro Notes will become due and payable immediately without further action or notice. In the case of payment events of defaults, any holder of the 2.58% Senior Euro Notes affected thereby may declare all the 2.58% Senior Euro Notes held by it due and payable immediately. In the case of any other event of default, a majority of the holders of the 2.58% Senior Euro Notes may declare all the 2.58% Senior Euro Notes to be due and payable immediately. The Company used a portion of the proceeds from the private placement to pay down existing debt outstanding under the Credit Facility that had previously been denominated in Euros, with the remainder being available for ongoing business activities.
On December 6, 2010, the Company completed a public offering of $300.0 million 4.5% Notes due December 15, 2020 (“4.5% Senior Notes”). The net proceeds from the offering of approximately $295.7 million, after deducting the $1.6 million issuance discount, the $1.9 million underwriting commission and estimated offering expenses of approximately $0.8 million, was used to repay $250.0 million of outstanding indebtedness under the Credit Facility. The balance of the net proceeds will be used for general corporate purposes. The 4.5% Senior Notes will bear interest at a rate of 4.5% per annum, which is payable semi-annually in arrears each June 15 and December 15, beginning June 15, 2011. The Company may redeem all or part of the 4.5% Senior Notes at any time prior to maturity at the redemption prices set forth in the Note Indenture (“Indenture”) governing the
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4.5% Senior Notes. The Company may issue additional debt from time to time pursuant to the Indenture. The Indenture and 4.5% Senior Notes contain covenants that limit the Company’s ability to, among other things, incur certain liens securing indebtedness, engage in certain sale-leaseback transactions, and enter into certain consolidations, mergers, conveyances, transfers or leases of all or substantially all the Company’s assets. The terms of the 4.5% Senior Notes also require the Company to make an offer to repurchase 4.5% Senior Notes upon a change of control triggering event (as defined in the Indenture) at a price equal to 101% of their principal amount plus accrued and unpaid interest if any.
On April 15, 2010, the Company entered into a forward starting interest rate contract with a notional amount of $300.0 million with a settlement date in December 2010. This contract was entered into in anticipation of the issuance of the $300.0 million 4.5% Senior Notes and was designed to lock in the market interest rate as of April 15, 2010. The Company settled this interest rate contract in December 2010, resulting in a $31.0 million payment. The $31.0 million will be amortized into interest expense over the 10 year term of the 4.5% Senior Notes yielding an effective interest rate of 5.8%.
There are two key financial covenants that the Company is required to maintain in connection with the Credit Facility, Term Loan, and 2.58% Senior Euro Notes. There are no financial covenants relating to the 4.5% Senior Notes. The most restrictive financial covenants under these debt instruments require a minimum interest coverage ratio (operating cash flow to interest) of 3.0 to 1 and a maximum leverage ratio (outstanding debt to operating cash flow) of 3.25 to 1. At December 31, 2010, the Company was in compliance with both of these financial covenants. The Company expects to be in compliance with both of these key financial covenants throughout 2011.
On April 21, 2008, the Company’s Board of Directors authorized the repurchase of up to $125.0 million of its outstanding common shares. Repurchases under the new program will be funded with cash flow generation, and made from time to time in either the open market or through private transactions. The timing, volume, and nature of share repurchases will be at the discretion of management, dependent on market conditions, other priorities for cash investment, applicable securities laws, and other factors, and may be suspended or discontinued at any time. No shares were purchased in 2010 or 2009.
We expect our current cash and cash that will be generated from operations during 2011 will be sufficient to meet our operating cash requirements, planned capital expenditures, interest on all borrowings, required debt repayments, pension and postretirement funding requirements and annual dividend payments to holders of the Company’s stock during the next twelve months. Additionally, in the event that suitable businesses are available for acquisition upon acceptable terms, we may obtain all or a portion of the financing for these acquisitions through the incurrence of additional borrowings. Our current intention, if the available terms and conditions are acceptable, is to enter into a new revolving credit facility agreement during 2011 since the existing Credit Facility matures on December 21, 2011. As of December 31, 2010, $27.8 million is outstanding under the existing Credit Facility and $90.0 million is outstanding under the Term Loan and both are classified as short term borrowings on the Balance Sheet. We expect our cash and cash from operations to be adequate to repay these balances during 2011.
Contractual Obligations, Commitments and Off-Balance Sheet Arrangements
Our contractual obligations and commercial commitments include pension and postretirement medical benefit plans, rental payments under operating leases, payments under capital leases, and other long-term obligations arising in the ordinary course of business. There are no identifiable events or uncertainties, including the lowering of our credit rating that would accelerate payment or maturity of any of these commitments or obligations.
The following table summarizes our significant contractual obligations and commercial commitments at December 31, 2010, and the future periods in which such obligations are expected to be settled in cash. In addition, the table reflects the timing of principal and interest payments on outstanding borrowings. Additional detail
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regarding these obligations is provided in the Notes to Consolidated Financial Statements in Part II. Item 8. “Financial Statements and Supplementary Data”, as referenced in the table:
| **Less ** | **More ** | |||||||||||||||||||
| **Than ** | **1-3 ** | **3-5 ** | **Than ** | |||||||||||||||||
| Payments Due by Period | Total | 1 Year | Years | Years | 5 Years | |||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Borrowings(1) | $ | 677,156 | $ | 139,347 | $ | 32,538 | $ | 138,333 | $ | 366,938 | ||||||||||
| Interest rate exchange agreements | 2,365 | 2,365 | — | — | — | |||||||||||||||
| Operating lease commitments | 35,321 | 9,679 | 12,668 | 6,057 | 6,917 | |||||||||||||||
| Capital lease obligations(2) | 3,808 | 793 | 981 | 718 | 1,316 | |||||||||||||||
| Purchase obligations(3) | 76,629 | 63,084 | 2,514 | 11,031 | — | |||||||||||||||
| Pension and post-retirement obligations | 96,100 | 8,600 | 17,600 | 19,500 | 50,400 | |||||||||||||||
| Income tax obligations(4) | 6,440 | 1,319 | 4,201 | 204 | 716 | |||||||||||||||
| Total contractual obligations(5) | $ | 897,819 | $ | 225,187 | $ | 70,502 | $ | 175,843 | $ | 426,287 | ||||||||||
| (1) | Includes interest payments based on contractual terms and current interest rates for variable debt. | |
| (2) | Consists primarily of property leases. | |
| (3) | Consists primarily of inventory commitments. | |
| (4) | Excludes interest and penalties. | |
| (5) | Comprises liabilities recorded on the balance sheet of $492,878, and obligations not recorded on the balance sheet of $404,941. |
Critical Accounting Policies
We believe that the application of the following accounting policies, which are important to our financial position and results of operations, requires significant judgments and estimates on the part of management. For a summary of all of our accounting policies, including the accounting policies discussed below, see Note 1 of the Notes to Consolidated Financial Statements in Part II. Item 8. “Financial Statements and Supplementary Data”.
Revenue recognition — The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collectibility of the sales price is reasonably assured. For product sales, delivery does not occur until the products have been shipped and risk of loss has been transferred to the customer. Revenue from services is recognized when the services are provided or ratably over the contract term. Some arrangements with customers may include multiple deliverables, including the combination of products and services. In such cases, the Company has identified these as separate elements in accordance with ASC 985-65-25 “Revenue Recognition-Multiple-Element Arrangements-Recognition” and recognizes revenue consistent with the policy for each separate element based on the fair value of each accounting unit. Revenues from certain long-term contracts are recognized on the percentage-of-completion method. Percentage-of-completion is measured principally by the percentage of costs incurred to date for each contract to the estimated total costs for such contract at completion. Provisions for estimated losses on uncompleted long-term contracts are made in the period in which such losses are determined. Due to uncertainties inherent in the estimation process, it is reasonably possible that completion costs, including those arising from contract penalty provisions and final contract settlements, will be revised in the near-term. Such revisions to costs and income are recognized in the period in which the revisions are determined.
The Company records allowances for discounts, product returns and customer incentives at the time of sale as a reduction of revenue as such allowances can be reliably estimated based on historical experience and known trends. The Company also offers product warranties and accrues its estimated exposure for warranty claims at the time of sale based upon the length of the warranty period, warranty costs incurred and any other related information known to the Company.
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Share-based compensation — The Company accounts for stock-based employee compensation under the fair value recognition and measurement provisions of ASC Topic 718 “Compensation — Stock Compensation” and applies the Binomial lattice option-pricing model to determine the fair value of options. The Binomial lattice option-pricing model incorporates certain assumptions, such as the expected volatility, risk-free interest rate, expected dividend yield, expected forfeiture rate and expected life of options, in order to arrive at a fair value estimate. As a result, share-based compensation expense, as calculated and recorded under ASC 718 could have been impacted if other assumptions were used. Furthermore, if the Company used different assumptions in future periods, share-based compensation expense could be impacted in future periods. See Note 13 of the Notes to Consolidated Financial Statements in Part II. Item 8. “Financial Statements and Supplementary Data” for additional information.
Inventory — The Company states inventories at the lower of cost or market. Cost, which includes material, labor, and factory overhead, is determined on a FIFO basis. We make adjustments to reduce the cost of inventory to its net realizable value, if required, for estimated excess, obsolescence or impaired balances. Factors influencing these adjustments include changes in market demand, product life cycle and engineering changes.
Goodwill, long-lived and intangible assets — The Company evaluates the recoverability of certain noncurrent assets utilizing various estimation processes. An impairment of a long-lived asset exists when the asset’s carrying amount exceeds its fair value, and is recorded when the carrying amount is not recoverable through future operations. An intangible asset or goodwill impairment exists when the carrying amount of intangible assets and goodwill exceeds its fair value. Assessments of possible impairments of goodwill, long-lived or intangible assets are made when events or changes in circumstances indicate that the carrying value of the asset may not be recoverable through future operations. Additionally, testing for possible impairment of recorded goodwill and indefinite-lived intangible asset balances is performed annually. The amount and timing of impairment charges for these assets require the estimation of future cash flows and the fair value of the related assets.
The Company’s business acquisitions result in recording goodwill and other intangible assets, which affect the amount of amortization expense and possible impairment expense that the Company will incur in future periods. The Company follows the guidance prescribed in ASC 350, “Goodwill and Other Intangible Assets” to test goodwill and intangible assets for impairment. Annually, on October 31 or more frequently if triggering events occur, the Company compares the fair value of their reporting units to the carrying value of each reporting unit to determine if a goodwill impairment exists.
The Company determines the fair value of each reporting unit utilizing an income approach (discounted cash flows) weighted 50% and a market approach consisting of a comparable public company EBITDA multiples methodology weighted 50%. To determine the reasonableness of the calculated fair values, the Company reviews the assumptions to ensure that neither the income approach nor the market approach yielded significantly different valuations.
The key assumptions are updated each year for each reporting unit for the income and market methodology used to determine fair value. Various assumptions are utilized including forecasted operating results, annual operating plans, strategic plans, economic projections, anticipated future cash flows, the weighted average cost of capital, comparable transactions, market data and EBITDA multiples. The assumptions that have the most significant effect on the fair value calculation are the weighted average cost of capital, the EBITDA multiples and terminal growth rates. The 2010 and 2009 ranges for these three assumptions utilized by the Company are as follows:
| Assumptions: | 2010 Range | 2009 Range | ||
| Weighted average cost of capital | 12.1% to 13.9% | 11.0% to 13.7% | ||
| EBITDA multiples | 9.0x to 12.0x | 9.0x to 11.0x | ||
| Terminal growth rates | 3.0% to 3.5% | 3.0% to 3.5% |
The Company concluded that the fair value of each of its reporting units was substantially in excess of its carrying value as of October 31, 2010, and thus no goodwill impairment was identified.
Income taxes — The Company accounts for income taxes in accordance with ASC 740 — “Income Taxes”. Under ASC 740, deferred income tax assets and liabilities are determined based on the estimated future tax effects
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of differences between the financial statement and tax bases of assets and liabilities based on currently enacted tax laws. The Company’s tax balances are based on management’s interpretation of the tax regulations and rulings in numerous taxing jurisdictions. Future tax authority rulings and changes in tax laws and future tax planning strategies could affect the actual effective tax rate and tax balances recorded by the Company.
Contingencies and litigation — We are currently involved in certain legal and regulatory proceedings and, as required and where it is reasonably possible to do so, we accrue estimates of the probable costs for the resolution of these matters. These estimates are developed in consultation with outside counsel and are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. It is possible, however, that future operating results for any particular quarterly or annual period could be materially affected by changes in our assumptions or the effectiveness of our strategies related to these proceedings.
Defined benefit retirement plans — The plan obligations and related assets of the defined benefit retirement plans are presented in Note 14 of the Notes to Consolidated Financial Statements in Part II. Item 8. “Financial Statements and Supplementary Data”. Level 1 assets are valued using unadjusted quoted prices for identical assets in active markets. Level 2 assets are valued using quoted prices or other observable inputs for similar assets. Level 3 assets are valued using unobservable inputs, but reflect the assumptions market participants would use in pricing the assets. Plan obligations and the annual pension expense are determined by consulting with actuaries using a number of assumptions provided by the Company. Key assumptions in the determination of the annual pension expense include the discount rate, the rate of salary increases, and the estimated future return on plan assets. To the extent actual amounts differ from these assumptions and estimated amounts, results could be adversely affected.
Recently Adopted Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (“FASB”) issued ASU 2010-06, “Fair Value Measurements and Disclosures (Topic 820).” This Update provides amendments to Subtopic 820-10 and related guidance within U.S. Generally Accepted Accounting Principles (“GAAP”) to require disclosure of the transfers in and out of Levels 1 and 2 and a schedule for Level 3 that separately identifies purchases, sales, issuances and settlements and requires more detailed disclosures regarding valuation techniques and inputs. The new disclosures and clarifications of existing disclosures were effective for the Company’s fiscal year 2010, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, which will be effective for the Company’s fiscal year 2011. See Note 7 of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report for disclosures associated with the adoption of this standard that were effective in 2010.
New Accounting Pronouncements
In October 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition (Topic 605) — Multiple-Deliverable Revenue Arrangements.” ASU No. 2009-13 addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. This guidance establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (a) vendor-specific objective evidence; (b) third-party evidence; or (c) estimates. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. In addition, this guidance significantly expands required disclosures related to a vendor’s multiple-deliverable revenue arrangements. ASU No. 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and early adoption is permitted. A company may elect, but will not be required, to adopt the amendments in ASU No. 2009-13 retrospectively for all prior periods. Management is currently evaluating the requirements of ASU No. 2009-13 and has not yet determined the impact on the Company’s consolidated financial statements.
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