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 contains management’s discussion and analysis of our financial condition and results of operations and should be read together with “Item 6. Selected Financial Data” and our audited consolidated financial statements and related notes to our consolidated financial statements included elsewhere in this Form 10-K. This discussion contains forward-looking statements and involves numerous risks and uncertainties. Our actual results may differ materially from those anticipated in any forward-looking statements as a result of many factors, including those set forth under the “Special Note Regarding Forward-Looking Statements,” “Item 1A. Risk Factors” and elsewhere in this Form 10-K.
Executive Overview
Our Company
Ingersoll Rand is a global market leader with a broad range of innovative and mission-critical air, fluid, energy, specialty vehicle and medical technologies, providing services and solutions to increase industrial productivity and efficiency. We manufacture one of the broadest and most complete ranges of compressor, pump, vacuum and blower products in our markets, which, when combined with our global geographic footprint and application expertise, allows us to provide differentiated product and service offerings to our customers. Our products are sold under a collection of premier, market-leading brands, including Ingersoll Rand, Gardner Denver, Club Car, CompAir, Nash, Elmo Rietschle, Robuschi, Thomas, Milton Roy, ARO, Emco Wheaton and Runtech Systems, which we believe are globally recognized in their respective end-markets and known for product quality, reliability, efficiency and superior customer service.
These attributes, along with over 160 years of engineering heritage, generate strong brand loyalty for our products and foster long-standing customer relationships, which we believe have resulted in leading market positions within each of our operating segments. We have sales in more than 175 countries and our diverse customer base utilizes our products across a wide array of end-markets that have favorable near- and long-term growth prospects, including industrial manufacturing, energy (with particular exposure to the North American upstream land-based market), transportation, medical and laboratory sciences, food and beverage packaging and chemical processing.
Our products and services are critical to the processes and systems in which they are utilized, which are often complex and function in harsh conditions where the cost of failure or downtime is high. However, our products and services typically represent only a small portion of the costs of the overall systems or functions that they support. As a result, our customers place a high value on our application expertise, product reliability and the responsiveness of our service. To support our customers and
market presence, we maintain significant global scale with 65 key manufacturing facilities, approximately 50 complementary service and repair centers across six continents and approximately 15,900 employees worldwide as of December 31, 2020.
The process-critical nature of our product applications, coupled with the standard wear and tear replacement cycles associated with the usage of our products, generates opportunities to support customers with our broad portfolio of aftermarket parts, consumables and services. Customers place a high value on minimizing any time their operations are offline. As a result, the availability of replacement parts, consumables and our repair and support services are key components of our value proposition. Our large installed base of products provides a recurring revenue stream through our aftermarket parts, consumables and services offerings. As a result, our aftermarket revenue is significant, representing 36.1% of total Company revenue and approximately 42.8% of our combined Industrial Technologies and Services and High Pressure Solutions segments’ revenue in 2020.
Components of Our Revenue and Expenses
Revenues
We generate revenue from sales of original equipment and associated aftermarket parts, consumables and services. We sell our products and deliver services directly to end-users and through independent distribution channels, depending on the product line and geography. Revenue derived from short duration contracts is recognized at a single point in time when control is transferred to the customer, generally at shipment or when delivery has occurred or as services are performed. Certain contracts are highly-engineered and unique to customer specifications. Depending on the contractual terms, revenue is recognized either over the duration of the contract or at contract completion when control is transferred to the customer.
Expenses
Cost of Sales
Cost of sales includes purchased materials, labor and overhead related to manufactured products and aftermarket parts sold during a period. Depreciation of manufacturing equipment and facilities is included in cost of sales. Purchased materials represent the majority of costs of sales, with steel, aluminum, copper and partially finished castings representing our most significant materials inputs. Stock-based compensation expense for employees associated with the manufacture of products or delivery of services to customers is included in cost of sales. We have instituted a global sourcing strategy to take advantage of coordinated purchasing opportunities of key materials across our manufacturing plant locations.
Cost of sales for services includes direct labor, parts and other overhead costs including depreciation of equipment and facilities, to deliver repair, maintenance and other field services to our customers.
Selling and Administrative Expenses
Selling and administrative expenses consist of (i) salaries and other employee-related expenses for our selling and administrative functions and other activities not associated with the manufacture of products or delivery of services to customers; (ii) facility operating expenses for selling and administrative activities, including office rent, maintenance, depreciation and insurance; (iii) marketing and direct costs of selling products and services to customers including internal and external sales commissions; (iv) research and development expenditures; (v) professional and consultant fees; (vi) employee related stock-based compensation for our selling and administrative functions and (vii) other miscellaneous expenses. Certain corporate expenses, including those related to our shared service centers in the United States and Europe that directly benefit our businesses are allocated to our business segments. Certain corporate administrative expenses, including corporate executive compensation, treasury, certain information technology, internal audit and tax compliance, are not allocated to the business segments.
Amortization of Intangible Assets
Amortization of intangible assets represents the amortization of finite lived intangible assets recognized through accounting for acquisitions — including customer relationships, tradenames, and developed technology — as well as internal-use software.
Impairment of Other Intangible Assets
Impairment of other intangible assets represents the recognition of non-cash charges to reduce the carrying value of intangible assets other than goodwill to their fair value.
Other Operating Expense, Net
Other operating expense, net includes foreign currency gains and losses, restructuring charges, acquisition and integration costs, certain litigation and contract settlement losses, environmental remediation and other miscellaneous operating expenses.
Provision (Benefit) for Income Taxes
The provision or benefit for income taxes includes U.S. federal, state and local income taxes and all non-U.S. income taxes. We are subject to income tax in approximately 46 jurisdictions outside of the United States. Because we conduct operations on a global basis, our effective tax rate depends, and will continue to depend, on the geographic distribution of our pre-tax earnings among several different taxing jurisdictions. Our effective tax rate can also vary based on changes in the tax rates of the different jurisdictions, the availability of tax credits and non-deductible items.
Items Affecting our Reported Results
General Economic Conditions and Capital Spending in the Industries We Serve
Our financial results closely follow changes in the industries and end-markets we serve. Demand for most of our products depends on the level of new capital investment and planned and unplanned maintenance expenditures by our customers. The level of capital expenditures depends, in turn, on the general economic conditions as well as access to capital at reasonable cost. In particular, demand for our industrial products in our Industrial Technologies and Services and Precision and Science Technologies segment generally correlate with the rate of total industrial capacity utilization and the rate of change of industrial production. Capacity utilization rates above 80% have historically indicated a strong demand environment for industrial equipment. Demand for certain businesses in our Precision and Science Technologies segment are driven by favorable trends in healthcare spend due to an aging population requiring medical care and increased investment in health solutions and safety infrastructures in emerging economies. In our High Pressure Solutions segment, demand for our products that is influenced heavily by energy prices and the expectation as to future trends in those prices. Energy prices have historically been cyclical in nature and are affected by a wide range of factors. In addition to energy prices, demand for our upstream energy products are positively impacted by increasing global land rig count, drilled but uncompleted wells, the level of hydraulic fracturing intensity and activity measured by horsepower utilization and lateral lengths as well as drilling and completion capital expenditures. Over longer time periods, we believe that demand for all of our products also tends to follow economic growth patterns indicated by the rates of change in the GDP around the world, as augmented by secular trends in each segment. Our ability to grow and our financial performance will also be affected by our ability to address a variety of challenges and opportunities that are a consequence of our global operations, including efficiently utilizing our global sales, manufacturing and distribution capabilities and engineering innovative new product applications for end-users in a variety of geographic markets.
Foreign Currency Fluctuations
A significant portion of our revenues, approximately 49% for the year ended December 31, 2020, was recognized by subsidiaries with a functional currency other than the U.S. dollar. A significant portion of our costs are also denominated in currencies other than the U.S. dollar. Changes in foreign exchange rates can therefore impact our results of operations and are quantified when significant to our discussion.
Factors Affecting the Comparability of our Results of Operations
As a result of a number of factors, our historical results of operations are not comparable from period to period and may not be comparable to our financial results of operations in future periods. Key factors affecting the comparability of our results of operations are summarized below.
Acquisition of Ingersoll Rand Industrial
On February 29, 2020, we completed the acquisition of Ingersoll Rand Industrial. We reorganized our reportable segments in connection with this transaction and formed four new reportable segments.
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Industrial Technologies and Services – Ingersoll Rand Industrial’s Compression Technologies and Services (“CTS”) and Power Tools and Lift (“PTL”) businesses joined the legacy Gardner Denver Industrial segment (excluding the Specialty Pump businesses) and the midstream and downstream portions of the Gardner Denver Energy segment to form the new “Industrial Technologies and Services” segment.
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Precision and Science Technologies – Ingersoll Rand Industrial’s Precision Flow Systems (“PFS”) and ARO businesses joined the legacy Gardner Denver Medical segment and Specialty Pump businesses from the legacy Gardner Denver Industrial segment to form the new “Precision and Science Technologies” segment.
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Specialty Vehicle Technologies – Ingersoll Rand Industrial’s Club Car golf, utility and consumer low-speed vehicles business formed the new “Specialty Vehicle Technologies” segment.
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High Pressure Solutions – The upstream energy portion of the legacy Gardner Denver Energy segment was disaggregated to form the new “High Pressure Solutions” segment.
Ingersoll Rand Industrial is included in our results of operations beginning on the acquisition date (close of business February 29, 2020). Comparability between the years ended December 31, 2020 and 2019 will be affected by ten months of activity from Ingersoll Rand Industrial. Subsequent to the date of acquisition, in the year ended December 31, 2020, the Ingersoll Rand Industrial acquisition contributed $1,787.4 million, $406.1 million, and $741.4 million of revenue to the Industrial Technologies and Services, Precision and Science Technologies and Specialty Vehicle Technologies segments, respectively.
See Note 3 “Business Combinations” to our audited consolidated financial statements included elsewhere in this Form 10-K for further discussion of the acquisition of Ingersoll Rand Industrial.
Other acquisitions
Part of our strategy for growth is to acquire complementary flow control and compression equipment businesses, which provide access to new technologies or geographies or improve our aftermarket offerings. In addition to the Ingersoll Rand Industrial transaction discussed above, we have acquired several other businesses during the three year period ending December 31, 2020. While these acquisitions are not individually significant or significant in the aggregate, may be relevant when comparing our results from period to period.
See Note 3 “Business Combinations” to our audited consolidated financial statements included elsewhere in this Form 10-K for further discussion of these acquisitions.
Impact of Coronavirus (COVID-19)
We continue to assess and actively manage the impact of the ongoing COVID-19 pandemic on our global operations and also the operations of our suppliers and customers. Overall demand for our products has decreased as a result of the pandemic, which impacted our operating results for the year ended December 31, 2020. We are adhering to all state and country mandates and guidelines wherever we operate. Although certain of our facilities were closed for a period of time during the COVID-19 pandemic, currently all our major manufacturing locations are operational, in accordance with country mandates and guidelines. We are taking certain actions to reduce costs and preserve cash given the rapidly changing environment. The length of time the pandemic will impact our operations, and the operations of our customers and suppliers remains uncertain. See “The COVID-19 pandemic has adversely affected our business and results of operations, and could have a material and adverse effect on our business, results of operations and financial condition in the future” in Part II Item 1A. “Risk Factors” included elsewhere in this Form 10-K.
Variability within Upstream Energy Markets
We sell products and services to customers in upstream energy markets, primarily in the United States. Within our High Pressure Solutions segment, we manufacture pumps and associated aftermarket products and services used in drilling, hydraulic fracturing and well service applications.
Demand for upstream energy products has historically corresponded to the supply and demand dynamics related to oil and natural gas products, and has been influenced by oil and natural gas prices, the level and intensity of hydraulic fracturing activity rig count, drilling activity and other economic factors. These factors have caused the level of demand for certain of our High Pressure Solutions products to change at times (both positively and negatively) and we expect these trends to continue in the future.
Restructuring and Other Business Transformation Initiatives
We continue to implement business transformation initiatives. A key element of those business transformation initiatives was restructuring programs within our Industrial Technologies and Services, Precision and Science Technologies, Specialty Vehicle
Technologies and High Pressure Solutions segments as well as at the Corporate level. Restructuring charges, program related facility reorganization, relocation and other costs, and related capital expenditures were impacted most significantly.
Subsequent to the acquisition of Ingersoll Rand Industrial, the Company announced a restructuring program (“2020 Plan”) to create efficiencies and synergies, reduce the number of facilities and optimize operating margin within the merged Company. For the year ended December 31, 2020, $92.9 million was charged to expense related to this restructuring program.
We announced a restructuring program in the third quarter of 2018 that primarily involves workforce reductions and facility consolidations. For the year ended December 31, 2019, $17.1 million was charged to expense related to this restructuring program.
Stock-Based Compensation Expense
For the year ended December 31, 2020, we incurred stock-based compensation expense of approximately $51.3 million which was decreased by $0.5 million due to costs associated with employer taxes. The increase from 2019 was primarily due to increased awards as a result of the Ingersoll Rand Industrial acquisition as well as the $150 million equity grant to nearly 16,000 employees worldwide announced in the third quarter of 2020. See Note 17 “Stock-Based Compensation” to our audited consolidated financial statements included elsewhere in this Form 10-K for further discussion around our stock-based compensation expense.
For the year ended December 31, 2019, we incurred stock-based compensation expense of approximately $19.2 million which was increased by $1.5 million due to costs associated with employer taxes.
Outlook
Industrial Technologies and Services
The mission-critical nature of our Industrial Technologies and Services segment products across manufacturing processes drives a demand environment and outlook that are correlated with global and regional industrial production, capacity utilization and long-term GDP growth. Due to the uncertainty of current economic conditions associated with COVID-19, and its impact on end markets, our near-term visibility is limited. In the fourth quarter of 2020, we had $996.8 million of orders in our Industrial Technologies and Services segment, an increase of 154.8% over the fourth quarter of 2019. Approximately $601.9 million of these orders relate to the acquisition of Ingersoll Rand Industrial.
Precision and Science Technologies Segment
During the COVID-19 pandemic, the Precision and Science Technologies segment has seen increased demand for our vacuum pump and compressor solutions used in respirator and ventilator applications. Demand of other products and services have been curtailed as a result of the COVID-19 pandemic and near-term visibility is limited. In the fourth quarter of 2020 we booked $220.3 million of orders in our Precision and Science Technologies segment, an increase of 202.6% over the fourth quarter of 2019. Approximately $127.4 million of these orders relate to the acquisition of Ingersoll Rand Industrial.
Specialty Vehicle Technologies Segment
During 2020, the Specialty Vehicle Technologies segment is seeing consistent demand in golf end markets along with record demand for consumer vehicle and aftermarket parts offerings. This has helped to offset demand pressure in the commercial end markets as the COVID-19 pandemic continues to impact the hospitality and resort industries. In the fourth quarter of 2020, we had $274.2 million of orders in our Specialty Vehicle Technologies segment.
High Pressure Solutions Segment
The demand and outlook for the majority of our High Pressure Solutions products and services are influenced heavily by the supply and demand dynamics related to oil and natural gas products, and have been influenced by oil and natural gas prices, the level and intensity of hydraulic fracturing activity, global land rig count, the number of drilled but uncompleted wells and other economic factors. The COVID-19 pandemic and related economic repercussions have negatively impacted the global demand for oil and natural gas. The ultimate duration of these conditions is unknown. In the fourth quarter of 2020, we booked $38.8 million of orders in our High Pressure Solutions segment, a decrease of 50.9% over the fourth quarter of 2019.
How We Assess the Performance of Our Business
We manage operations through the four business segments described above. In addition to our consolidated GAAP financial measures, we review various non-GAAP financial measures, including Adjusted EBITDA, Adjusted Net Income and Free Cash Flow.
We believe Adjusted EBITDA and Adjusted Net Income are helpful supplemental measures to assist us and investors in evaluating our operating results as they exclude certain items whose fluctuation from period to period do not necessarily correspond to changes in the operations of our business. Adjusted EBITDA represents net income (loss) before interest, taxes, depreciation, amortization and certain non-cash, non-recurring and other adjustment items. We believe that the adjustments applied in presenting Adjusted EBITDA are appropriate to provide additional information to investors about certain material non-cash items and about non-recurring items that we do not expect to continue at the same level in the future. Adjusted Net Income is defined as net income (loss) including interest, depreciation and amortization of non-acquisition related intangible assets and excluding other items used to calculate Adjusted EBITDA and further adjusted for the tax effect of these exclusions.
We use Free Cash Flow to review the liquidity of our operations. We measure Free Cash Flow as cash flows from operating activities less capital expenditures. We believe Free Cash Flow is a useful supplemental financial measure for us and investors in assessing our ability to pursue business opportunities and investments and to service our debt. Free Cash Flow is not a measure of our liquidity under GAAP and should not be considered as an alternative to cash flows from operating activities.
Management and our board of directors regularly use these measures as tools in evaluating our operating and financial performance and in establishing discretionary annual compensation. Such measures are provided in addition to, and should not be considered to be a substitute for, or superior to, the comparable measures under GAAP. In addition, we believe that Adjusted EBITDA, Adjusted Net Income and Free Cash Flow are frequently used by investors and other interested parties in the evaluation of issuers, many of which also present Adjusted EBITDA, Adjusted Net Income and Free Cash Flow when reporting their results in an effort to facilitate an understanding of their operating and financial results and liquidity.
Adjusted EBITDA, Adjusted Net Income and Free Cash Flow should not be considered as alternatives to net income (loss) or any other performance measure derived in accordance with GAAP, or as alternatives to cash flow from operating activities as a measure of our liquidity. Adjusted EBITDA, Adjusted Net Income and Free Cash Flow have limitations as analytical tools, and you should not consider such measures either in isolation or as substitutes for analyzing our results as reported under GAAP.
Included in our discussion of our consolidated and segment results below are changes in revenues and Adjusted EBITDA on a Constant Currency basis. Constant Currency information compares results between periods as if exchange rates had remained constant period over period. We define Constant Currency revenues and Adjusted EBITDA as total revenues and Adjusted EBITDA excluding the impact of foreign exchange rate movements and use it to determine the Constant Currency revenue and Adjusted EBITDA growth on a year-over-year basis. Constant Currency revenues and Adjusted EBITDA are calculated by translating current period revenues and Adjusted EBITDA using corresponding prior period exchange rates. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a Constant Currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP.
For further information regarding these measures, see “Item 6. Selected Financial Data” and “Non-GAAP Financial Measures” below.
Results of Operations
Consolidated results should be read in conjunction with segment results and the Segment Information notes to our audited consolidated financial statements included elsewhere in this Form 10-K, which provide more detailed discussions concerning certain components of our consolidated statements of operations. All intercompany accounts and transactions have been eliminated within the consolidated results.
This section discusses our results of operations for the year ended December 31, 2020 as compared to the year ended December 31, 2019. For a discussion and analysis of the year ended December 31, 2019, compared to the same in 2018, please refer to the “Management’s Discussion and Analysis of Financial Condition” and “Results of Operations” sections included in Item 7 in Exhibit 99.2 of our Current Report on Form 8-K, filed with the SEC on June 5, 2020.
Consolidated Results of Operations for the Years Ended December 31, 2020 and 2019
| Year Ended December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Consolidated Statements of Operations | |||||||||||
| Revenues | $ | 4,910.2 | $ | 2,451.9 | |||||||
| Cost of sales | 3,296.8 | 1,540.2 | |||||||||
| Gross Profit | 1,613.4 | 911.7 | |||||||||
| Selling and administrative expenses | 894.8 | 436.4 | |||||||||
| Amortization of intangible assets | 395.8 | 124.3 | |||||||||
| Impairment of other intangible assets | 19.9 | — | |||||||||
| Other operating expense, net | 217.2 | 75.7 | |||||||||
| Operating Income | 85.7 | 275.3 | |||||||||
| Interest expense | 111.1 | 88.9 | |||||||||
| Loss on extinguishment of debt | 2.0 | 0.2 | |||||||||
| Other income, net | (8.0) | (4.7) | |||||||||
| Income (Loss) Before Income Taxes | (19.4) | 190.9 | |||||||||
| Provision for income taxes | 13.0 | 31.8 | |||||||||
| Net Income (Loss) | (32.4) | 159.1 | |||||||||
| Less: Net income attributable to noncontrolling interests | 0.9 | — | |||||||||
| Net Income (Loss) Attributable to Ingersoll Rand Inc. | $ | (33.3) | $ | 159.1 | |||||||
| Percentage of Revenues | |||||||||||
| Gross profit | 32.9 | % | 37.2 | % | |||||||
| Selling and administrative expenses | 18.2 | % | 17.8 | % | |||||||
| Operating income | 1.7 | % | 11.2 | % | |||||||
| Net income | (0.7) | % | 6.5 | % | |||||||
| Adjusted EBITDA(1) | 20.7 | % | 22.9 | % | |||||||
| Other Financial Data | |||||||||||
| Adjusted EBITDA(1) | $ | 1,017.6 | $ | 561.7 | |||||||
| Adjusted net income(1) | 599.0 | 329.3 | |||||||||
| Cash flows - operating activities | 914.3 | 343.3 | |||||||||
| Cash flows - investing activities | (37.9) | (54.3) | |||||||||
| Cash flows - financing activities | 328.7 | (11.5) | |||||||||
| Free cash flow(1) | 865.6 | 300.1 |
(1)See “Non-GAAP Financial Measures” below for a reconciliation to the most directly comparable GAAP measure.
Revenues
Revenues for 2020 were $4,910.2 million, an increase of $2,458.3 million, or 100.3%, compared to $2,451.9 million in 2019. The increase in revenues was primarily due to acquisitions, including Ingersoll Rand Industrial of $2,934.9 million partially offset by lower volumes due to the effects of COVID-19 in our Industrial Technologies and Services segment of $260.5 million and in our High Pressure Solutions segment of $220.5 million. The percentage of consolidated revenues derived from aftermarket parts and services was 36.1% in 2020 compared to 37.8% in 2019.
Gross Profit
Gross profit in 2020 was $1,613.4 million, an increase of $701.7 million, or 77.0%, compared to $911.7 million in 2019, and as a percentage of revenues was 32.9% in 2020 and 37.2% in 2019. The increase in gross profit is primarily due to acquisitions, including Ingersoll Rand Industrial, partially offset by the runoff of the fair valuation adjustments related to purchase price allocation from inventory into cost of sales, lower volumes due to the effects of COVID-19 in our Industrial Technologies and
Services segment and our High Pressure Solutions segment. The decrease in gross profit as a percentage of revenues is primarily due to the runoff of the fair valuation adjustments related to purchase price allocation from inventory into cost of sales and changes in segment mix.
Selling and Administrative Expenses
Selling and administrative expenses were $894.8 million in 2020, an increase of $458.4 million, or 105.0%, compared to $436.4 million in 2019. Selling and administrative expenses as a percentage of revenues increased to 18.2% in 2020 from 17.8% in 2019. This increase in selling and administrative expenses was primarily due to acquisitions, including Ingersoll Rand Industrial, increased professional and consultant fees and increased stock based compensation expense, partially offset by a decrease in advertising expenses and employee related expenses including salaries and wages, within our legacy business units.
Amortization of Intangible Assets
Amortization of intangible assets was $395.8 million in 2020, an increase of $271.5 million compared to $124.3 million in 2019. The increase was primarily due to the amortization of intangible assets related to the acquisition of Ingersoll Rand Industrial.
Impairment of Intangible Assets
Impairment of intangible assets was $19.9 million in 2020 due to the impairment of two tradenames in the Industrial Technologies and Services segment. See Note 8 “Goodwill and Other Intangible Assets” to our consolidated financial statements included elsewhere in this Form 10-K for further details.
Other Operating Expense, Net
Other operating expense, net was $217.2 million in 2020, an increase of $141.5 million compared to $75.7 million in 2019. The increase was primarily due to higher restructuring charges of $75.8 million, higher acquisition related expenses of $43.5 million, higher foreign currency transaction losses, net of $12.8 million and lower shareholder litigation recoveries of $6.0 million.
Interest Expense
Interest expense was $111.1 million in 2020, an increase of $22.2 million compared to $88.9 million in 2019. The increase was primarily due to the addition of a $1,900 million term loan entered into in conjunction with the acquisition of Ingersoll Rand Industrial and the addition of a $400 million term loan entered into in the second quarter of 2020, partially offset by a decrease in the weighted-average interest rate. The weighted-average interest rate was approximately 3.5% in 2020 and 5.4% in 2019.
Loss on Extinguishment of Debt
Loss on extinguishment of debt was $2.0 million in 2020, which was related to the refinancing of the senior secured term loan facility denominated in U.S. Dollars and the senior secured term loan facility denominated in Euros. See Note 10 “Debt” to our audited consolidated financial statements included elsewhere in this Form 10-K for further details.
Other Income, Net
Other income, net, was $8.0 million in 2020, an increase of $3.3 million compared to $4.7 million in 2019. The increase in other income, net was primarily due to increased gains on postretirement plan investments of $10.5 million due to the additional defined benefit plans from the acquisition of Ingersoll Rand Industrial, partially offset by increased costs in the other components of net periodic benefit cost of $6.1 million due to the additional defined benefit plans from the acquisition of Ingersoll Rand Industrial.
Provision for Income Taxes
The provision for income taxes was $13.0 million resulting in a (67.0)% effective tax rate in 2020 compared to a provision of $31.8 million resulting in a 16.7% effective tax provision rate in 2019. The decrease in the tax provision and the change in the effective tax rate is primarily due to a reduction in the pre-tax book income in jurisdictions with lower effective tax rates combined with significant earnings in jurisdictions with higher tax rates. The reduction in pre-tax book income is mainly from the COVID-19 global pandemic, the transaction costs associated with the acquisition of Ingersoll Rand Industrial, and additional amortization and depreciation expense associated with the purchase price step up adjustments.
Net Income (Loss)
Net loss was $32.4 million in 2020 compared to net income of $159.1 million in 2019. The decrease in net income was primarily due to higher selling and administrative expenses, higher amortization, increased other operating expenses, net, and higher interest expense, partially offset by higher gross profit on increased revenues.
Adjusted EBITDA
Adjusted EBITDA increased $455.9 million to $1,017.6 million in 2020 compared to $561.7 million in 2019. Adjusted EBITDA as a percentage of revenues decreased 220 basis points to 20.7% in 2020 from 22.9% in 2019. The increase in Adjusted EBITDA was primarily due to acquisitions, including Ingersoll Rand Industrial of $691.1 million, partially offset by lower organic sales volume of $179.0 million and increased corporate costs associated with Ingersoll Rand Industrial. The decrease in Adjusted EBITDA as a percentage of revenues is primarily attributable to end market challenges in the upstream oil and gas market in our High Pressure Solutions segment.
Adjusted Net Income
Adjusted Net Income increased $269.7 million to $599.0 million in 2020 compared to $329.3 million in 2019. The increase was primarily due to increased Adjusted EBITDA, partially offset by an increased income tax provision, as adjusted and higher depreciation and interest expenses.
Non-GAAP Financial Measures
Set forth below are reconciliations of net income (loss) to Adjusted EBITDA and Adjusted Net Income and cash flows from operating activities to Free Cash Flow. For additional information regarding Adjusted EBITDA and Adjusted Net Income, see “How We Assess the Performance of Our Business” above.
| Year Ended December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Net Income (Loss) | $ | (32.4) | $ | 159.1 | |||||||
| Plus: | |||||||||||
| Interest expense | 111.1 | 88.9 | |||||||||
| Provision for income taxes | 13.0 | 31.8 | |||||||||
| Depreciation expense(a) | 97.1 | 53.8 | |||||||||
| Amortization expense(b) | 395.8 | 124.3 | |||||||||
| Impairment of other intangible assets | 19.9 | — | |||||||||
| Restructuring and related business transformation costs(c) | 97.9 | 25.6 | |||||||||
| Acquisition related expenses and non-cash charges(d) | 233.2 | 54.6 | |||||||||
| Stock-based compensation(e) | 50.8 | 20.7 | |||||||||
| Foreign currency transaction losses (gains), net | 20.9 | 8.1 | |||||||||
| Loss on extinguishment of debt(f) | 2.0 | 0.2 | |||||||||
| Shareholder litigation settlement recoveries(g) | — | (6.0) | |||||||||
| Establish public company financial reporting compliance | — | 0.6 | |||||||||
| Other adjustments(h) | 8.3 | — | |||||||||
| Adjusted EBITDA | $ | 1,017.6 | $ | 561.7 | |||||||
| Minus: | |||||||||||
| Interest expense | $ | 111.1 | $ | 88.9 | |||||||
| Income tax provision, as adjusted(i) | 192.0 | 77.9 | |||||||||
| Depreciation expense | 97.1 | 53.8 | |||||||||
| Amortization of non-acquisition related intangible assets | 18.4 | 11.8 | |||||||||
| Adjusted Net Income | $ | 599.0 | $ | 329.3 | |||||||
| Free Cash Flow | |||||||||||
| Cash flows - operating activities | $ | 914.3 | $ | 343.3 | |||||||
| Minus: | |||||||||||
| Capital expenditures | 48.7 | 43.2 | |||||||||
| Free Cash Flow | $ | 865.6 | $ | 300.1 |
(a)Depreciation expense excludes $8.0 million of depreciation of rental equipment for the year ended December 31, 2020.
(b)Represents $377.4 million and $112.5 million of amortization of intangible assets arising from the acquisition of Ingersoll Rand Industrial and other acquisitions (customer relationships, technology, tradenames and backlog) and $18.4 million and $11.8 million of amortization of non-acquisition related intangible assets, in each case for the years ended December 31, 2020 and 2019, respectively.
(c)Restructuring and related business transformation costs consisted of the following.
| Year Ended December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Restructuring charges | $ | 92.9 | $ | 17.1 | |||||||
| Facility reorganization, relocation and other costs | 2.1 | 2.4 | |||||||||
| Other, net | 2.9 | 6.1 | |||||||||
| Total restructuring and related business transformation costs | $ | 97.9 | $ | 25.6 |
(d)Represents costs associated with successful and/or abandoned acquisitions, including third-party expenses, post-closure integration costs (including certain incentive and non-incentive cash compensation costs), and non-cash charges and credits arising from fair value purchase accounting adjustments.
(e)Represents stock-based compensation expense recognized for the year ended December 31, 2020 of $51.3 million decreased by $0.5 million due to costs associated with employer taxes. Represents stock-based compensation expense recognized for stock options outstanding for the year ended December 31, 2019 of $19.2 million increased by $1.5 million due to costs associated with employer taxes.
(f)Represents losses on the extinguishment of a portion of the U.S. term loan and the amendment of the revolving credit facility.
(g)Represents insurance recoveries of our shareholder litigation settlement in 2014.
(h)Includes (i) effects of the amortization of prior service costs and amortization of losses in pension and other postemployment (“OPEB”) expense, (ii) certain legal and compliance costs and (iii) other miscellaneous adjustments.
(i)Represents our income tax provision adjusted for the tax effect of pre-tax items excluded from Adjusted Net Income and the removal of applicable discrete tax items. The tax effect of pre-tax items excluded from Adjusted Net Income is computed using the statutory tax rate related to the jurisdiction that was impacted by the adjustment after taking into account the impact of permanent differences and valuation allowances. Discrete tax items include changes in tax laws or rates, changes in uncertain tax positions relating to prior years and changes in valuation allowances. All impacts relating to the Tax Cuts and Jobs Act of 2017 have been included as an adjustment on the “Tax law change” line of the table below.
The income tax provision, as adjusted for each of the periods presented below consists of the following.
| Year Ended December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Provision (benefit) for income taxes | $ | 13.0 | $ | 31.8 | |||||||
| Tax impact of pre-tax income adjustments | 184.0 | 45.6 | |||||||||
| Discrete tax items | (5.0) | 0.5 | |||||||||
| Income tax provision, as adjusted | $ | 192.0 | $ | 77.9 |
Segment Results
As discussed above, we reorganized our segments during the three month period ended March 31, 2020 and no longer report under the three reportable segments of Industrial, Energy and Medical. Discussed below are the results of operations for the three reorganized reportable segments of Industrial Technologies and Services, Precision and Science Technologies and High Pressure Solutions as well as our new Specialty Vehicles Technologies reportable segment. Our Corporate operations (as described below) are not discussed separately as any results that had a significant impact on operating results are included in the consolidated results discussion above.
We evaluate the performance of our segments based on Segment Revenues and Segment Adjusted EBITDA. Segment Adjusted EBITDA is indicative of operational performance and ongoing profitability. Our management closely monitors Segment Adjusted EBITDA to evaluate past performance and identify actions required to improve profitability.
The segment measurements provided to, and evaluated by, the Chief Operating Decision Maker (“CODM”) are described in Note 22 “Segment Information” to our audited consolidated financial statements included elsewhere in this Form 10-K.
Included in our discussion of our segment results below are changes in Segment Revenues and Segment Adjusted EBITDA on a Constant Currency basis. Constant Currency information compares results between periods as if exchange rates had remained constant period over period. We define Constant Currency as changes in Segment Revenues and Segment Adjusted EBITDA excluding the impact of foreign exchange rate movements. We use these measures to determine the Constant Currency Segment Revenues and Segment Adjusted EBITDA growth on a year-on-year basis. Constant Currency Segment Revenues and Segment Adjusted EBITDA are calculated by translating current period Segment Revenues and Segment Adjusted EBITDA using prior period exchange rates. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP.
Segment Results for Years Ended December 31, 2020 and 2019
The following tables display Segment Revenues, Segment Adjusted EBITDA and Segment Adjusted EBITDA Margin (Segment Adjusted EBITDA as a percentage of Segment Revenues) for each of our Segments and illustrates, on a percentage basis, the impact of foreign currency fluctuations on Segment Revenues and Segment Adjusted EBITDA growth.
Industrial Technologies and Services Segment Results
| Years Ended December 31, | Percent Change | ||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||
| Segment Revenues | $ | 3,248.2 | $ | 1,700.9 | 91.0 | % | |||||||||||
| Segment Adjusted EBITDA | $ | 759.8 | $ | 391.4 | 94.1 | % | |||||||||||
| Segment Margin | 23.4 | % | 23.0 | % | 40 bps |
2020 vs. 2019
Segment Revenues for 2020 were $3,248.2 million, an increase of $1,547.3 million, or 91.0%, compared to $1,700.9 million in 2019. The increase in Segment Revenues was primarily due to acquisitions, including Ingersoll Rand Industrial, of $1,787.4 million or 105.1% and improved pricing of $21.2 million or 1.2%, partially offset by lower volume of $260.5 million or 15.3%. The percentage of Segment Revenues derived from aftermarket parts and service was 40.2% in 2020 compared to 32.3% in 2019.
Segment Adjusted EBITDA in 2020 was $759.8 million, an increase of $368.4 million, or 94.1%, from $391.4 million in 2019. Segment Adjusted EBITDA Margin increased 40 bps to 23.4% from 23.0% in 2019. The increase in Segment Adjusted EBITDA was primarily due to acquisitions, including Ingersoll Rand Industrial, of $432.4 million or 110.5%, lower selling and administrative expenses of $35.4 million or 9.0%, and improved pricing of $21.2 million or 5.4%, partially offset by lower organic sales volumes of $104.0 million or 26.6% and unfavorable margin mix of $19.1 million or 4.9%.
Precision and Science Technologies Segment Results
| Years Ended December 31, | Percent Change | ||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||
| Segment Revenues | $ | 725.0 | $ | 316.6 | 129.0 | % | |||||||||||
| Segment Adjusted EBITDA | $ | 220.2 | $ | 95.8 | 129.9 | % | |||||||||||
| Segment Margin | 30.4 | % | 30.3 | % | 10 bps |
2020 vs. 2019
Segment Revenues for 2020 were $725.0 million, an increase of $408.4 million, or 129.0%, compared to $316.6 million in 2019. The increase in Segment Revenues was primarily due to acquisitions, including Ingersoll Rand Industrial, of $406.1 million or 128.3% and improved pricing of $4.7 million or 1.5%, partially offset by lower volume of $4.6 million or 1.5%. The percentage of Segment Revenues derived from aftermarket parts and service was 14.6% in 2020 compared to 4.2% in 2019.
Segment Adjusted EBITDA in 2020 was $220.2 million, an increase of $124.4 million, or 129.9%, from $95.8 million in 2019. Segment Adjusted EBITDA Margin increased 10 bps to 30.4% from 30.3% in 2019. The increase in Segment Adjusted EBITDA was due primarily to acquisitions, including Ingersoll Rand Industrial, of $120.1 million or 125.4%, improved pricing of $4.7 million or 4.9% and lower selling and administrative expenses of $2.1 million or 2.2%, partially offset by lower volume of $1.8 million or 1.9%.
Specialty Vehicle Technologies Segment Results
The Specialty Vehicle Technologies segment is entirely composed of businesses acquired as part of the Ingersoll Rand Industrial transaction. Therefore, comparative prior period information was not part of our consolidated results.
Segment Revenues for 2020 were $741.4 million. The percentage of Segment Revenues derived from aftermarket parts and service was 26.0% in 2020.
Segment Adjusted EBITDA in 2020 was $138.6 million. Segment Adjusted EBITDA Margin was 18.7% in 2020.
High Pressure Solutions Segment Results
| Years Ended December 31, | Percent Change | ||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||
| Segment Revenues | $ | 195.6 | $ | 434.4 | (55.0) | % | |||||||||||
| Segment Adjusted EBITDA | $ | 12.1 | $ | 117.0 | (89.7) | % | |||||||||||
| Segment Margin | 6.2 | % | 26.9 | % | (2,070) bps |
2020 vs. 2019
Segment Revenues for 2020 were $195.6 million, a decrease of $238.8 million, or 55.0%, compared to $434.4 million in 2019. The decrease in Segment Revenues was primarily due to lower volume of $220.5 million or 50.8% and lower pricing $17.3 million or 4.0%. The percentage of Segment Revenues derived from aftermarket parts and service was 86.7% in 2020 compared to 83.9% in 2019.
Segment Adjusted EBITDA in 2020 was $12.1 million, a decrease of $104.9 million, or 89.7%, from $117.0 million in 2019. Segment Adjusted EBITDA Margin decreased 2,070 bps to 6.2% from 26.9% in 2019. The decrease in Segment Adjusted EBITDA was due primarily to lower volume of $73.2 million or 62.6%, lower pricing of $17.3 million or 14.8%, unfavorable margin mix of $10.6 million or 9.1% and higher selling and administrative expenses of $5.0 million or 4.3%.
Unaudited Quarterly Results of Operations
| (in millions, except per share amounts) | Year Ended December 31, 2020**(1)** | Year Ended December 31, 2019 | |||||||||||||||||||||||||||||||||||||||||||||
| Q1 | Q2 | Q3 | Q4 | Q1 | Q2 | Q3 | Q4 | ||||||||||||||||||||||||||||||||||||||||
| Revenues | $ | 799.9 | $ | 1,264.4 | $ | 1,335.2 | $ | 1,510.7 | $ | 620.3 | $ | 629.1 | $ | 596.7 | $ | 605.8 | |||||||||||||||||||||||||||||||
| Gross profit | $ | 244.5 | $ | 360.0 | $ | 482.0 | $ | 526.9 | $ | 230.5 | $ | 234.4 | $ | 221.5 | $ | 225.3 | |||||||||||||||||||||||||||||||
| Operating income (loss) | $ | (66.8) | $ | (52.2) | $ | 74.3 | $ | 130.4 | $ | 80.2 | $ | 74.6 | $ | 72.9 | $ | 47.6 | |||||||||||||||||||||||||||||||
| Net income (loss) | $ | (36.8) | $ | (176.6) | $ | 29.9 | $ | 151.1 | $ | 47.1 | $ | 44.9 | $ | 41.3 | $ | 25.8 | |||||||||||||||||||||||||||||||
| Net income (loss) attributable to Ingersoll Rand Inc. | $ | (36.8) | $ | (177.6) | $ | 29.5 | $ | 151.6 | $ | 47.1 | $ | 44.9 | $ | 41.3 | $ | 25.8 | |||||||||||||||||||||||||||||||
| Weighted average shares, basic | 277.3 | 417.0 | 417.6 | 418.4 | 201.6 | 203.4 | 204.2 | 204.8 | |||||||||||||||||||||||||||||||||||||||
| Weighted average shares, diluted | 277.3 | 417.0 | 422.0 | 424.5 | 207.7 | 208.9 | 209.0 | 209.4 | |||||||||||||||||||||||||||||||||||||||
| Basic earnings (loss) per share | $ | (0.13) | $ | (0.43) | $ | 0.07 | $ | 0.36 | $ | 0.23 | $ | 0.22 | $ | 0.20 | $ | 0.13 | |||||||||||||||||||||||||||||||
| Diluted earnings (loss) per share | $ | (0.13) | $ | (0.43) | $ | 0.07 | $ | 0.36 | $ | 0.23 | $ | 0.21 | $ | 0.20 | $ | 0.12 | |||||||||||||||||||||||||||||||
| Adjusted EBITDA(2) | $ | 147.8 | $ | 241.2 | $ | 284.2 | $ | 344.4 | $ | 139.0 | $ | 146.3 | $ | 141.8 | $ | 134.6 |
(1)See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Factors Affecting the Comparability of our Results of Operations.”
(2)Set forth below are the reconciliations of Net Income to Adjusted EBITDA
| Year Ended December 31, 2020 | Year Ended December 31, 2019 | ||||||||||||||||||||||||||||||||||||||||||||||
| Q1 | Q2 | Q3 | Q4 | Q1 | Q2 | Q3 | Q4 | ||||||||||||||||||||||||||||||||||||||||
| Net Income (Loss) | $ | (36.8) | $ | (176.6) | $ | 29.9 | $ | 151.1 | $ | 47.1 | $ | 44.9 | $ | 41.3 | $ | 25.8 | |||||||||||||||||||||||||||||||
| Plus: | |||||||||||||||||||||||||||||||||||||||||||||||
| Interest expense | 27.1 | 30.8 | 28.8 | 24.4 | 22.4 | 22.4 | 23.2 | 20.9 | |||||||||||||||||||||||||||||||||||||||
| Provision (benefit) for income taxes | (58.9) | 95.9 | 18.2 | (42.2) | 12.0 | 8.3 | 9.0 | 2.5 | |||||||||||||||||||||||||||||||||||||||
| Depreciation expense | 15.9 | 28.4 | 25.9 | 26.9 | 14.1 | 13.5 | 12.7 | 13.5 | |||||||||||||||||||||||||||||||||||||||
| Amortization expense | 55.2 | 114.6 | 114.2 | 111.8 | 31.4 | 30.9 | 30.4 | 31.6 | |||||||||||||||||||||||||||||||||||||||
| Impairment of other intangible assets | — | — | 19.9 | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Restructuring and related business transformation costs (a) | 42.2 | 32.2 | 12.3 | 11.2 | 4.1 | 2.0 | 9.9 | 9.6 | |||||||||||||||||||||||||||||||||||||||
| Acquisition related expenses and non-cash charges (b) | 96.1 | 96.0 | 15.3 | 25.8 | 1.6 | 17.1 | 15.9 | 20.0 | |||||||||||||||||||||||||||||||||||||||
| Environmental remediation loss reserve (c) | — | — | — | — | — | — | — | 0.1 | |||||||||||||||||||||||||||||||||||||||
| Establish public company financial reporting compliance(d) | — | — | — | — | 0.6 | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Stock-based compensation(e) | 3.0 | 12.7 | 12.8 | 22.3 | 8.7 | 6.2 | — | 5.8 | |||||||||||||||||||||||||||||||||||||||
| Loss on extinguishment of debt(f) | 2.0 | — | — | — | — | 0.2 | — | — | |||||||||||||||||||||||||||||||||||||||
| Foreign currency transaction losses (gains), net | 2.6 | 5.2 | 6.2 | 6.9 | 3.1 | 0.6 | (0.6) | 5.0 | |||||||||||||||||||||||||||||||||||||||
| Shareholder litigation settlement recoveries(g) | — | — | — | — | (6.0) | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Other adjustments(h) | (0.6) | 2.0 | 0.7 | 6.2 | (0.1) | 0.2 | — | (0.2) | |||||||||||||||||||||||||||||||||||||||
| Adjusted EBITDA | $ | 147.8 | $ | 241.2 | $ | 284.2 | $ | 344.4 | $ | 139.0 | $ | 146.3 | $ | 141.8 | $ | 134.6 |
(a)Restructuring and related business transformation costs consist of (i) restructuring charges, (ii) severance, sign-on, relocation and executive search costs, (iii) facility reorganization, relocation and other costs, (iv) information technology infrastructure transformation, (v) gains and losses on asset disposals, (vi) consultant and other advisor fees and (vii) other miscellaneous costs.
(b)Represents costs associated with successful and/or abandoned acquisitions, including third-party expenses, post-closure integration costs (including certain incentive and non-incentive cash compensation costs) and non-cash charges and credits arising from fair value purchase accounting adjustments.
(c)Represents estimated environmental remediation costs and losses related to a former production facility.
(d)Represents third party expenses to comply with the requirements of Sarbanes-Oxley and the accelerated adoption of the new accounting standard (ASC 842 – Leases) in the first quarter of 2019, one year ahead of the required adoption dates for a private company.
(e)Represents stock-based compensation expense recognized for stock options outstanding for the year ended December 31, 2020 of $51.3 million, decreased by $0.5 million due to costs associated with employer taxes.
Represents stock-based compensation expense recognized for the year ended December 31, 2019 of $19.2 million, increased by $1.5 million due to costs associated with employer taxes.
(f)Represents losses on extinguishment of portions of the U.S. Term Loan, the amendment of the revolving credit facility and losses reclassified from AOCI into income related to the amendment of the interest rate swaps in conjunction with the debt repayment.
(g)Represents insurance recoveries of the Company’s shareholder litigation settlement in 2014.
(h)Includes (i) non-cash impact of net LIFO reserve adjustments, (ii) effects of amortization of prior service costs and amortization of losses in pension and other postemployment (“OPEB”) expense, (iii) certain legal and compliance costs and (iv) other miscellaneous adjustments.
Liquidity and Capital Resources
Our investment resources include cash on hand, cash generated from operations and borrowings under our Revolving Credit Facility. We also have the ability to seek additional secured and unsecured borrowings, subject to Credit Agreement restrictions.
For a description of our material indebtedness, see Note 10 “Debt” to our audited consolidated financial statements included elsewhere in this Form 10-K.
As of December 31, 2020, we had no outstanding borrowings, $101.9 million of outstanding letters of credit under the New Revolving Credit Facility and unused availability of $998.1 million.
As of December 31, 2020 and 2019 we were in compliance with all of our debt covenants and no event of default had occurred or was ongoing.
Liquidity
A substantial portion of our liquidity needs arise from debt service requirements, and from the ongoing cost of operations, working capital and capital expenditures.
| Year Ended December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Cash and cash equivalents | $ | 1,750.9 | $ | 505.5 | |||||||
| Short-term borrowings and current maturities of long-term debt | $ | 40.4 | $ | 7.6 | |||||||
| Long-term debt | 3,859.1 | 1,603.8 | |||||||||
| Total debt | $ | 3,899.5 | $ | 1,611.4 |
We can increase the borrowing availability under the Senior Secured Credit Facilities by up to $1,600.0 million in the form of additional commitments under the Revolving Credit Facility and/or incremental term loans plus an additional amount so long as we do not exceed a specified senior secured leverage ratio. We can incur additional secured indebtedness under the Senior Secured Credit Facilities if certain specified conditions are met under the credit agreement governing the Senior Secured Credit Facilities. Our liquidity requirements are significant primarily due to debt service requirements. See Note 10 “Debt” to our audited consolidated financial statements included elsewhere in this Form 10-K for further details.
Our principal sources of liquidity have been existing cash and cash equivalents, cash generated from operations and borrowings under the Senior Secured Credit Facilities and, prior to its termination, the Receivables Financing Agreement. Our principal uses of cash will be to provide working capital, meet debt service requirements, fund capital expenditures and finance strategic plans, including possible acquisitions. We may also seek to finance capital expenditures under capital leases or other debt arrangements that provide liquidity or favorable borrowing terms. We continue to consider acquisition opportunities, but the size and timing of any future acquisitions and the related potential capital requirements cannot be predicted. In the event that suitable businesses are available for acquisition upon acceptable terms, we may obtain all or a portion of the necessary financing through the incurrence of additional long-term borrowings. We may from time to time, seek to repay loans that we have borrowed, including the borrowings under the Senior Secured Credit Facilities. Based on our current level of operations and available cash, we believe our cash flow from operations, together with availability under the Revolving Credit Facility, will provide sufficient liquidity to fund our current obligations, projected working capital requirements, debt service requirements and capital spending requirements for the foreseeable future. Our business may not generate sufficient cash flows from operations or future borrowings may not be available to us under our Revolving Credit Facility in an amount sufficient to enable us to pay our indebtedness, or to fund our other liquidity needs. Our ability to do so depends on, among other factors, prevailing economic conditions, many of which are beyond our control. In addition, upon the occurrence of certain events, such as a change in control, we could be required to repay or refinance our indebtedness. We may not be able to refinance any of our indebtedness, including the Senior Secured Credit Facilities, on commercially reasonable terms or at all. Any future acquisitions, joint ventures, or other similar transactions may require additional capital and there can be no assurance that any such capital will be available to us on acceptable terms or at all.
A substantial portion of our cash is in jurisdictions outside the United States. We do not assert ASC 740-30 (formerly APB 23) indefinite reinvestment of our historical non-U.S. earnings or future non-U.S. earnings. The Company records a deferred foreign tax liability to cover all estimated withholding, state income tax and foreign income tax associated with repatriating all non-U.S. earnings back to the United States. Our deferred income tax liability as of December 31, 2020 is $32.5 million which consists mainly of withholding taxes.
Working Capital
| For the Years Ended December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Net Working Capital | |||||||||||
| Current assets | $ | 3,862.1 | $ | 1,543.9 | |||||||
| Less: Current liabilities | 1,498.6 | 574.6 | |||||||||
| Net working capital | $ | 2,363.5 | $ | 969.3 | |||||||
| Operating Working Capital | |||||||||||
| Accounts receivable and contract assets | $ | 1,027.1 | $ | 488.1 | |||||||
| Plus: Inventories (excluding LIFO) | 934.8 | 489.5 | |||||||||
| Less: Accounts payable | 671.1 | 322.9 | |||||||||
| Less: Contract liabilities | 172.8 | 51.7 | |||||||||
| Operating working capital | $ | 1,118.0 | $ | 603.0 |
Net working capital increased $1,394.2 million to $2,363.5 million as of December 31, 2020 from $969.3 million as of December 31, 2019. Operating working capital increased $515.0 million to $1,118.0 million as of December 31, 2020 from $603.0 million as of December 31, 2019. Operating working capital as of December 31, 2020 was 22.8% of 2020 revenues as compared to 24.6% as of December 31, 2019 as a percentage of 2019 revenues. The increase in operating working capital was primarily due to higher accounts receivable, higher inventories and higher contract assets, partially offset by higher accounts payable and higher contract liabilities. The increase in accounts receivable was primarily due to the acquisition of Ingersoll Rand Industrial, which accounts for $599.9 million of accounts receivable and $18.2 million of contract assets as of December 31, 2020. The increase in inventory was primarily attributable to the acquisition of Ingersoll Rand Industrial of which $447.4 million is included in the December 31, 2020 balance. The increase in accounts payable was primarily due to the acquisition of Ingersoll Rand Industrial of which $410.8 million is included in the December 31, 2020 balance and the timing of vendor cash disbursements. The increase in contract liabilities was due to the acquisition of Ingersoll Rand Industrial of which $113.9 million is included in the December 31, 2020 balance.
Cash Flows
The following table reflects the major categories of cash flows for the years ended December 31, 2020 and 2019, respectively.
| Year Ended December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Cash flows - operating activities | $ | 914.3 | $ | 343.3 | |||||||
| Cash flows - investing activities | (37.9) | (54.3) | |||||||||
| Cash flows - financing activities | 328.7 | (11.5) | |||||||||
| Free cash flow (1) | 865.6 | 300.1 |
(1)See “Non-GAAP Financial Measures” for a reconciliation to the most directly comparable GAAP measure.
Operating activities
Cash provided by operating activities increased $571.0 million to $914.3 million in 2020 from $343.3 million in 2019, due to higher net income adjusted for non-cash items and from cash generated from operating working capital.
Operating working capital generated cash of $263.3 million in 2020 compared to generating cash of $38.7 million in 2019. Changes in account receivables generated cash of $100.3 million in 2020 compared to generating cash of $54.7 million in 2019. Changes in contract assets used cash of $12.6 million in 2020 compared to using cash of $9.1 million in 2019. Changes in inventory generated cash of $170.8 million in 2020 compared to generating cash of $18.7 million in 2019. Changes in accounts payable used cash of $13.3 million in 2020 compared to using cash of $9.2 million in 2019. Changes in contract liabilities generated cash of $18.1 million in 2020 compared to using cash of $16.4 million in 2019.
Investing activities
Cash flows used by investing activities included capital expenditures of $48.7 million (1.0% of consolidated revenues) and $43.2 million (1.8% of consolidated revenues) in 2020 and 2019, respectively. We expect capital expenditures will be in the range of 1.5% to 2.0% of consolidated revenues in 2021. Cash acquired (paid) in business combinations was $9.0 million in 2020 and $(12.0) million in 2019. Net proceeds from the disposal of property, plant and equipment were $1.8 million and $0.9 million in 2020 and 2019, respectively.
Financing activities
Cash provided by financing activities of $328.7 million in 2020 is primarily due to proceeds from long-term debt of $1,980.1 million, offset by repayments of long term debt of $1,619.1 million and payments of debt issuance costs of $47.8 million. Also included are proceeds from stock option exercises of $22.7 million and a net usage of cash of $3.0 million related to the purchase and sale of noncontrolling interests of our India subsidiary. See Note 12 “Stockholders' Equity and Noncontrolling Interests” to our audited consolidated financial statements included elsewhere in this Form 10-K for further details.
Cash used in financing activities of $11.5 million in 2019 reflects repayments of long-term debt of $32.8 million, purchases of treasury stock of $18.6 million, payments of $2.3 million for contingent consideration and payment of $0.5 million of debt issuance costs, partially offset by proceeds from stock option exercises of $42.7 million.
Free cash flow
Free cash flow increased $565.5 million to $865.6 million in 2020 from $300.1 million in 2019 primarily due to increased cash provided by operating activities, mainly driven by the acquisition of Ingersoll Rand Industrial.
Off-Balance Sheet
We have no off-balance sheet arrangements that have or are materially likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Contractual Obligations
The following table summarizes our future minimum payments as of December 31, 2020 for all contractual obligations for years subsequent to the year ended December 31, 2020.
| Payments Due by Period | |||||||||||||||||||||||||||||
| Contractual Obligations | Total | 2021 | 2022-2023 | 2024-2025 | More than 5 years | ||||||||||||||||||||||||
| Debt(1) | $ | 3,933.1 | $ | 39.6 | $ | 79.3 | $ | 79.2 | $ | 3,735.0 | |||||||||||||||||||
| Estimated interest payments(2) | 586.1 | 80.4 | 169.6 | 206.1 | 130.0 | ||||||||||||||||||||||||
| Finance leases | 17.2 | 0.8 | 1.8 | 2.2 | 12.4 | ||||||||||||||||||||||||
| Operating leases | 159.2 | 57.4 | 66.2 | 23.5 | 12.1 | ||||||||||||||||||||||||
| Purchase obligations(3) | 394.4 | 343.9 | 46.6 | 3.7 | 0.2 | ||||||||||||||||||||||||
| Total | $ | 5,090.0 | $ | 522.1 | $ | 363.5 | $ | 314.7 | $ | 3,889.7 |
(1)As of February 28, 2020, we entered into an additional $1,900.0 million term loan in connection with the acquisition of Ingersoll Rand Industrial and as of June 29, 2020, we entered into a $400.0 million term loan. See Note 10 “Debt” to our audited consolidated financial statements included elsewhere in this Form 10-K for further details.
(2)Estimated interest payments for long-term debt were calculated as follows: for fixed-rate debt and term debt, interest was calculated based on applicable rates and payment dates; for variable-rate debt and/or non-term debt, interest rates and payment dates were estimated based on management’s determination of the most likely scenarios for each relevant debt instrument. The increase of estimated interest payments since our previously disclosed contractual obligations on Form 10-K for the fiscal year ended December 31, 2019 was due to the $1,900.0 million term loan and $400.0 million term loan as discussed above, partially offset by lower interest rate.
(3)Purchase obligations consist primarily of agreements to purchase inventory or services made in the normal course of business to meet operational requirements. The purchase obligation amounts do not represent the entire anticipated purchases in the future, but represent only those items for which we are contractually obligated as of December 31, 2020. For this reason, these amounts will not provide a complete and reliable indicator of our expected future cash outflows. The increase in purchase obligations since our
previously disclosed contractual obligations on Form 10-K for the fiscal year ended December 31, 2019 was due to the acquisition of Ingersoll Rand Industrial.
Total pension and other postretirement benefit liabilities recognized on our consolidated balance sheet as of December 31, 2020 were $287.0 million. The total pension and other postretirement benefit liabilities are included in our consolidated balance sheet line items “Accrued liabilities” and “Pensions and other postretirement benefits.” Because these liabilities are impacted by, among other items, plan funding levels, changes in plan demographics and assumptions and investment return on plan assets, these liabilities do not represent expected liquidity needs. Accordingly, we did not include these liabilities in the “Contractual Obligations” table above.
We fund our U.S. qualified pension plans in accordance with the Employee Retirement Income Security Act of 1974 regulations for the minimum annual required contribution and Internal Revenue Service regulations for the maximum annual allowable tax deduction. We are committed to making the required minimum contributions and expect to contribute a total of approximately $0.1 million to our U.S. qualified pension plans during 2021. Furthermore, we expect to contribute a total of approximately $3.3 million to our postretirement life insurance benefit plans during 2021. Future contributions are dependent upon various factors including the performance of the plan assets, benefit payment experience and changes, if any, to current funding requirements. Therefore, no amounts were included in the “Contractual Obligations” table related to expected plan contributions. We generally expect to fund all future contributions to our plans with cash flows from operating activities.
Our non-U.S. pension plans are funded in accordance with local laws and income tax regulations. We expect to contribute a total of approximately $8.2 million to our non-U.S. qualified pension plans during 2021. No amounts have been included in the “Contractual Obligations” table related to these plans due to the same reasons indicated above.
Disclosure of amounts in the “Contractual Obligations” table regarding expected benefit payments in future years for our pension plans and other postretirement benefit plans cannot be properly reflected due to the ongoing nature of the obligations of these plans. We currently anticipate the annual benefit payments for the U.S. plans to be in the range of approximately $29.7 million to $42.1 million for the next several years, and the annual benefit payments for the non-U.S. plans to be in the range of approximately $13.1 million to $16.8 million for the next several years.
Contingencies
We are a party to various legal proceedings, lawsuits and administrative actions, which are of an ordinary or routine nature for a company of our size and in our sector. We believe that such proceedings, lawsuits and administrative actions will not materially adversely affect our operations, financial condition, liquidity or competitive position. We have accrued liabilities and other liabilities on our consolidated balance sheet, including a total litigation reserve of $131.4 million as of December 31, 2020 with respect to potential liability arising from our asbestos-related litigation. Other than our asbestos-related litigation reserves, we only have de minimis accrued liabilities and other liabilities on our consolidated balance sheet with respect to other legal proceedings, lawsuits and administrative actions. A more detailed discussion of certain of these proceedings, lawsuits and administrative actions is set forth in “Item 3. Legal Proceedings.”
Critical Accounting Policies
Accounting policies discussed in this section are those that we consider to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. Certain of these policies include estimates and assumptions. These estimates reflect our best judgment about current, and for some estimates, future economic and market conditions and their effect based on information available as of the date of these financial statements. If these conditions change from those expected, it is reasonably possible that the judgments and estimates described below could change, which may result in future impairments of goodwill, intangibles and long-lived assets, increases in reserves for contingencies, establishment of valuation allowances on deferred tax assets and increase in tax liabilities, among other effects. Also see Note 1 “Summary of Significant Accounting Policies” to our audited consolidated financial statements included elsewhere in this Form 10-K, which discusses the significant accounting policies that we have selected from acceptable alternatives.
Business Combinations
We apply the acquisition method of accounting with respect to the identifiable assets and liabilities of a business combination and record the assets acquired and liabilities assumed at their estimated fair values as of the acquisition date. The excess of the cost of the acquired business and the fair value of the assets acquired and liabilities assumed is recognized as goodwill. Estimates of fair value represent management’s best estimate of assumptions and about future events and uncertainties, including
significant judgments related to future cash flows, discount rates, competitive trends, margin and revenue growth assumptions including royalty rates and customer attrition rates, market comparables and others. Inputs used are generally obtained from historical data supplemented by current and anticipated market conditions and growth rates.
Significant judgment is required in estimating the fair value of identifiable intangible assets and in assigning their respective useful lives. The fair value estimates are based on historical information and on future expectations and assumptions deemed reasonable by management, but which are inherently uncertain. See Note 3 “Business Combinations” to our consolidated financial statements included elsewhere in this Form 10-K for further information regarding the fair value determination of each of the classes of identifiable intangible assets. Determining the useful life of an intangible asset also requires judgment. Certain intangibles are expected to have indefinite lives while certain other identifiable intangible assets have determinable lives. The useful lives of identifiable intangibles with determinable useful lives is based on a variety of factors, including but not limited to, the competitive environment, product cycles, order life cycles, historical customer attrition rates, market share, operating plans and the macroeconomic environment. The costs of determinable-lived intangible assets are amortized to expense over the estimated useful life.
Impairment of Goodwill and Other Identified Intangible Assets
We test goodwill for impairment annually in the fourth quarter of each year using data as of October 1 of that year and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Upon adoption of ASU 2019-04, the impairment test consists of comparing the fair value of the reporting unit to the carrying value of the reporting unit. An impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; provided, the loss recognized cannot exceed the total amount of goodwill allocated to the reporting unit. If applicable, we consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss. We determined fair values for all of the reporting units using a combination of the income and market multiples approaches which are weighted 75% and 25%, respectively.
Under the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. We use our internal forecasts to estimate future cash flows and include an estimate of long-term future growth rates based on our most recent views of the long-term outlook for each business. Actual results may differ from those assumed in our forecasts. We derive our discount rates using a capital asset pricing model and analyzing published rates for industries relevant to our reporting units to estimate the cost of equity financing. We use discount rates that are commensurate with the risks and uncertainty inherent in the respective businesses and in our internally developed forecasts. Discount rates used in our 2020 reporting unit valuations ranged from 8.5% to 9.5%. Additionally, we assumed 3.0% terminal growth rates for all reporting units, except a single reporting unit in which we determined it most appropriate to assume an 2.0% terminal growth rate due to it being closely aligned to the GDP percentage growth rate.
Under the market multiples approach, fair value is determined based on multiples derived from the stock prices of publicly traded guideline companies to develop a business enterprise value (“BEV”) for our reporting units. The application of the market multiples method entails the development of book value multiples based on the market value of the guideline companies. The multiples are developed by first calculating the market value of equity of the guideline companies and then adjusting these multiples for cash and debt to arrive at a BEV multiple. Identifying appropriate guideline companies and computing appropriate market multiples is subjective. We considered various public companies that had reasonably similar qualitative factors as our reporting units while also considering quantitative factors such as revenue growth, profitability and total assets.
The excess of the estimated fair value over carrying value (expressed as a percentage of carrying value) for two of our reporting units were between 4% and 6%, primarily due to the timing of the acquisition of Ingersoll Rand Industrial relative to our annual impairment test. For all other reporting units, this excess was a minimum of 25%. With each reporting unit’s fair value in excess of its carrying value, no goodwill impairment was recorded.
We annually test intangible assets with indefinite lives for impairment utilizing a discounted cash flow valuation referred to as the relief from royalty method. We estimated forecasted revenues for a period of five years with discount rates ranging from 9.0% to 10.0%, terminal growth rates of 2.0 % to 3.0%, and royalty rates ranging from 1.0% to 4.0%. As a result of this test, the Company recognized an impairment in 2020 of $19.9 million to reduce the carrying value of two tradenames in the Industrial Technologies and Services segment.
We review identified intangible assets with defined useful lives and subject to amortization for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Determining whether an impairment
loss occurred requires comparing the carrying amount to the sum of undiscounted cash flows expected to be generated by the asset.
Also see Note 8 “Goodwill and Other Intangible Assets” to our audited consolidated financial statements included elsewhere in this Form 10-K.
Income Taxes
Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions, including evaluating uncertainties. We review our tax positions quarterly and adjust the balances as new information becomes available.
On December 22, 2017, the Tax Act was enacted into law and the new legislation contains several key tax provisions that affected the Company, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. The Company was required to recognize the effect of the Tax Act in the period of enactment. This included the determination of the transition tax, remeasurement of the Company’s U.S. deferred tax assets and liabilities as well as the reassessment of the net realizability of the Company’s deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Job Act (“SAB 118”), which allowed the Company to record provisional amounts during a measurement period not to extend more than one year subsequent to the enactment date. As a result, the Company previously provided a provisional estimate of the effect of the Tax Act in its financial statements for 2017 and through the first nine months of 2018. In the fourth quarter of 2018, the Company completed its accounting for all of the enactment-date income tax effects of the Tax Act and increased the total benefit taken in 2017 of $95.3 million to $96.5 million. Due to the Tax Act, the total U.S. deferred changed from a tax benefit of $89.6 million in 2017 to $74.5 million in 2018, with a 2018 measurement-period adjustment of $15.1 million. The ASC 740-30 (formally APB 23) liability reduction, relating to the permanently reinvested earnings in foreign subsidiaries assertion, changed from a tax benefit of $69.0 million in 2017 to $72.5 million in 2018, with a 2018 measurement-period adjustment of $3.5 million due to the policy change that occurred in 2018. The provisional one-time transition tax of $63.3 million in 2017 decreased to $50.5 million in 2018, with a 2018 measurement-period adjustment of $12.8 million. The total $1.2 million benefit had a (0.3)% impact to the overall rate in 2018.
The Tax Act creates a new requirement that certain income (i.e., Global intangible low taxed income (“GILTI”)) earned by controlled foreign corporations (“CFC”) must be included currently in the gross income of the CFCs’ U.S. shareholder. GILTI is the excess of the shareholder’s “net CFC tested income” over the net deemed tangible income return, which is currently defined as the excess of (1) 10% of the aggregate of the U.S. shareholder’s pro rata share of the qualified business asset investment of each CFC with respect to which it is a U.S. shareholder over (2) the amount of certain interest expense taken into account in the determination of net CFC-tested income.
Under U.S. GAAP, the Company is allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the “period cost method”) or (2) factoring such amounts into a company’s measurement of its deferred taxes (the “deferred method”). The Company has determined that it will follow the period cost method (option 1 above) going forward. The tax provision for the year ended December 31, 2020 reflects this decision. All of the additional calculations and rule changes found in the Tax Act have been considered in the tax provision for the year ended December 31, 2020. The Company recorded a tax expense of $5.3 million in 2020 for the GILTI provisions of the Tax Act that were effective for the first time during 2018.
Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carryforwards. We evaluate the recoverability of these future tax deductions and credits by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These sources of income rely heavily on estimates. To the extent we do not consider it more likely than not that a deferred tax asset will be recovered, a valuation allowance is established. Amounts recorded for deferred tax assets related to tax attribute carryforwards, net of valuation allowances, were $40.7 million and $12.7 million as of December 31, 2020 and 2019, respectively, with the increase related to the Ingersoll Rand Industrial acquisition.
Loss Contingencies
Loss contingencies are uncertain and unresolved matters that arise in the ordinary course of business and result from events or actions by others that have the potential to result in a future loss. Such contingencies include, but are not limited to, asbestos and silica related litigation, environmental obligations, litigation, regulatory proceedings, product quality and losses resulting from other events and developments.
When a loss is considered probable and reasonably estimable, we record a liability in the amount of our best estimate for the ultimate loss. When there appears to be a range of possible costs with equal likelihood, liabilities are based on the low-end of such range. However, the likelihood of a loss with respect to a particular contingency is often difficult to predict and determining a meaningful estimate of the loss or a range of loss may not be practicable based on the information available and the potential effect of future events and decisions by third parties that will determine the ultimate resolution of the contingency. In particular, as it relates to estimating asbestos and silica contingencies, there are a number of key variables and assumptions including the number and type of new claims to be filed each year, the resolution or outcome of these claims, the average cost of resolution of each new claim, the amount of insurance available, allocation methodologies, the contractual terms with each insurer with whom we have reached settlements, the resolution of coverage issues with other excess insurance carriers with whom we have not yet achieved settlements and the solvency risk with respect to our insurance carriers. Moreover, it is not uncommon for such matters to be resolved over many years, during which time relevant developments and new information must be continuously evaluated to determine both the likelihood of potential loss and whether it is possible to reasonably estimate a range of possible loss. When a loss is probable but a reasonable estimate cannot be made, disclosure is provided.
Disclosure also is provided when it is reasonably possible that a loss will be incurred or when it is reasonably possible that the amount of a loss will exceed the recorded provision. We regularly review all contingencies to determine whether the likelihood of loss has changed and to assess whether a reasonable estimate of the loss or range of loss can be made. As discussed above, development of a meaningful estimate of loss or a range of potential loss is complex when the outcome is directly dependent on negotiations with or decisions by third parties, such as regulatory agencies, the court system and other interested parties. Such factors bear directly on whether it is possible to reasonably estimate a range of potential loss and boundaries of high and low.
Recent Accounting Pronouncements
See Note 2 “New Accounting Standards” to our audited consolidated financial statements included elsewhere in this Form 10-K for a discussion of recent accounting standards.
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