filings.toolsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
95K characters. Original on sec.gov · Markdown
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the company’s financial condition and results of operations should be read together with its consolidated financial statements and notes to the consolidated financial statements included in Item 8 of this Form 10-K.
| Page | |||||
| Business Overview | 19 | ||||
| Executive Summary – Financial Results & Outlook | 20 | ||||
| Consolidated Results and Other Information | 21 | ||||
| Segment Discussion | 27 | ||||
| Liquidity, Capital Resources and Other Financial Data | 33 | ||||
| Off-Balance Sheet Arrangements | 37 | ||||
| Critical Accounting Policies | 37 | ||||
| New Accounting Standards | 39 | ||||
| Fair Value Measurements | 40 | ||||
| Non-GAAP Financial Measures | 40 | ||||
| Supplemental Guarantee Information | 44 | ||||
BUSINESS OVERVIEW
The company's primary products in its industrial gases business are atmospheric gases (oxygen, nitrogen, argon, rare gases) and process gases (carbon dioxide, helium, hydrogen, electronic gases, specialty gases, acetylene). The company also designs, engineers, and builds equipment that produces industrial gases and offers its customers a wide range of gas production and processing services such as olefin plants, natural gas plants, air separation plants, hydrogen and synthesis gas plants and other types of plants.
Linde’s industrial gas operations are managed on a geographical basis and in 2020 83% of sales were generated by Linde's three geographic segments (Americas, EMEA and APAC) and the remaining 17% are related primarily to the Engineering segment, and to a lesser extent Other (see Note 18 to the consolidated financial statements for operating segment details).
Linde serves a diverse group of industries including healthcare, petroleum refining, manufacturing, food, beverage carbonation, fiber-optics, steel making, aerospace, chemicals and water treatment. The diversity of end-markets supports financial stability for Linde in varied business cycles.
Linde generates most of its revenues and earnings in the following geographies where the company has its strongest market positions and where distribution and production operations allow the company to deliver the highest level of service to its customers at the lowest cost.
| North and South America ("Americas") | Europe, Middle East and Africa (“EMEA”) | Asia and Pacific (“APAC”) | ||||||||||||
| United States | Germany | China & Taiwan | ||||||||||||
| Brazil | United Kingdom | Australia | ||||||||||||
| Mexico | Eastern Europe | South Korea | ||||||||||||
| Canada | India |
The company manufactures and distributes its industrial gas products through networks of thousands of production plants, pipeline complexes, distribution centers and delivery vehicles. Major pipeline complexes are primarily located in the United States. These networks are a competitive advantage, providing the foundation of reliable product supply to the company’s customer base. The majority of Linde’s business is conducted through long-term contracts which provide stability in cash flow and the ability to pass through changes in energy and feedstock costs to customers. The company has growth opportunities in all major geographies and in diverse end-markets such as energy, electronics, chemicals, metals, healthcare, food and beverage, and aerospace.
EXECUTIVE SUMMARY – FINANCIAL RESULTS & OUTLOOK
2020 Year in review
-
Sales of $27,243 million were 3% below 2019 sales of $28,228 million. Volumes decreased 2% as growth from project start-ups was more than offset by the global macroeconomic slowdown as a result of the COVID-19 pandemic. Higher pricing across all geographic segments contributed 2% to sales. Unfavorable currency translation, lower cost pass-through and the net impact of acquisitions and divestitures decreased sales by 3%.
-
Reported operating profit of $3,322 million was 13% above 2019. Adjusted operating profit of $5,797 million was 10% above 2019. The increase in both reported and adjusted operating profit was primarily driven by higher price and the benefit of cost reduction programs and other charges and productivity initiatives which more than offset the impact of lower volumes.*
-
Income from continuing operations of $2,497 million and diluted earnings per share from continuing operations of $4.70 increased from $2,183 million and $4.00, respectively in 2019. Adjusted income from continuing operations of $4,371 million and adjusted diluted earnings per share from continuing operations of $8.23 were 9% and 12%, respectively above 2019 adjusted amounts.*
-
Cash flow from operations was $7,429 million, or 27% of sales. Capital expenditures were $3,400 million; dividends paid were $2,028 million; net purchases of ordinary shares of $2,410 million; and debt borrowings, net were $1,313 million.
*A reconciliation of the adjusted amounts can be found in the "Non-GAAP Financial Measures" section in this MD&A.
2021 Outlook
Linde provides quarterly updates on operating results, material trends that may affect financial performance, and financial guidance via earnings releases and investor teleconferences. These materials are available on the company’s website, www.linde.com, but are not incorporated herein.
CONSOLIDATED RESULTS AND OTHER INFORMATION
The discussion that follows includes a comparison of our results of operations and liquidity and capital resources for the years ended December 31, 2020 and 2019. For the discussion comparing the years ended December 31, 2019 and 2018, refer to Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Form 10-K for the year ended December 31, 2019.
The following table provides summary information for 2020 and 2019. The reported amounts are GAAP amounts from the Consolidated Statements of Income. The adjusted amounts are intended to supplement investors' understanding of the company's financial information and are not a substitute for GAAP measures.
| (Millions of dollars, except per share data) Year Ended December 31, | 2020 | 2019 | Variance | ||||||||||||||
| Reported Amounts | |||||||||||||||||
| Sales | $ | 27,243 | $ | 28,228 | (3) | % | |||||||||||
| Cost of sales, exclusive of depreciation and amortization | $ | 15,383 | $ | 16,644 | (8) | % | |||||||||||
| As a percent of sales | 56.5 | % | 59.0 | % | |||||||||||||
| Selling, general and administrative | $ | 3,193 | $ | 3,457 | (8) | % | |||||||||||
| As a percent of sales | 11.7 | % | 12.2 | % | |||||||||||||
| Depreciation and amortization | $ | 4,626 | $ | 4,675 | (1) | % | |||||||||||
| Cost reduction programs and other charges (a) | $ | 506 | $ | 567 | (11) | % | |||||||||||
| Net gain on sale of businesses (b) | $ | — | $ | 164 | |||||||||||||
| Operating Profit | $ | 3,322 | $ | 2,933 | 13 | % | |||||||||||
| Operating margin | 12.2 | % | 10.4 | % | |||||||||||||
| Interest expense – net | $ | 115 | $ | 38 | 203 | % | |||||||||||
| Net pension and OPEB cost (benefit), excluding service cost | $ | (177) | $ | (32) | 453 | % | |||||||||||
| Effective tax rate | 25.0 | % | 26.3 | % | |||||||||||||
| Income from equity investments | $ | 85 | $ | 114 | (25) | % | |||||||||||
| Noncontrolling interests from continuing operations | $ | (125) | $ | (89) | 40 | % | |||||||||||
| Income from continuing operations | $ | 2,497 | $ | 2,183 | 14 | % | |||||||||||
| Diluted earnings per share from continuing operations | $ | 4.70 | $ | 4.00 | 18 | % | |||||||||||
| Diluted shares outstanding | 531,157 | 545,170 | (3) | % | |||||||||||||
| Number of employees | 74,207 | 79,886 | (7) | % | |||||||||||||
| Adjusted Amounts (c) | |||||||||||||||||
| Operating profit | $ | 5,797 | $ | 5,272 | 10 | % | |||||||||||
| Operating margin | 21.3 | % | 18.7 | % | |||||||||||||
| Income from continuing operations | $ | 4,371 | $ | 4,003 | 9 | % | |||||||||||
| Diluted earnings per share from continuing operations | $ | 8.23 | $ | 7.34 | 12 | % | |||||||||||
| Other Financial Data (c) | |||||||||||||||||
| EBITDA from continuing operations | $ | 8,033 | $ | 7,722 | 4 | % | |||||||||||
| As percent of sales | 29.5 | % | 27.4 | % | |||||||||||||
| Adjusted EBITDA from continuing operations | $ | 8,645 | $ | 8,178 | 6 | % | |||||||||||
| As percent of sales | 31.7 | % | 29.0 | % |
(a)See Note 3 to the consolidated financial statements.
(b)See Note 2 to the consolidated financial statements.
(c)Adjusted amounts and Other Financial Data are non-GAAP performance measures. A reconciliation of reported amounts to adjusted amounts can be found in the "Non-GAAP Financial Measures" section of this MD&A.
Results of Operations
The following table provides a summary of changes in consolidated sales:
| 2020 vs. 2019 | ||||||||
| % Change | ||||||||
| Factors Contributing to Changes - Sales | ||||||||
| Volume | (2) | % | ||||||
| Price/Mix | 2 | % | ||||||
| Cost pass-through | (1) | % | ||||||
| Currency | (1) | % | ||||||
| Acquisitions/divestitures | (1) | % | ||||||
| Engineering | — | % | ||||||
| (3) | % |
2020 Compared With 2019
Sales
Reported sales decreased $985 million, or 3%, for the 2020 year versus 2019. On an adjusted basis sales decreased $920 million in 2020 compared to 2019.
On a reported and adjusted basis, sales decreased 3%. Volume decreased sales by 2% primarily driven by the impact of the macroeconomic slowdown, partially offset by new project start-ups. Higher pricing across all geographic segments contributed 2% to sales. Currency translation decreased sales by 1%, largely in the Americas, driven by the weakening of the Brazilian real against the U.S. dollar. Cost pass-through decreased sales by 1% with minimal impact on operating profit. The impact of merger-related divestitures decreased sales by $65 million in 2020. These sales have been excluded from the adjusted numbers.
Cost of sales, exclusive of depreciation and amortization
Cost of sales, exclusive of depreciation and amortization, decreased $1,261 million, or 8%, for the year primarily due to lower volumes and the impact of productivity initiatives. Cost of sales, exclusive of depreciation and amortization, was 56.5% and 59.0% of sales, respectively, in 2020 compared to 2019. The decrease as a percentage of sales was due primarily to the impact of cost reduction programs and productivity initiatives and the impact of lower cost pass-through.
Selling, general and administrative expenses
Selling, general and administrative expense ("SG&A") decreased $264 million, or 8%, in 2020 to $3,193 million. SG&A was 11.7% of sales in 2020 versus 12.2% in 2019. Currency impacts decreased SG&A by approximately $34 million in 2020. Excluding currency impacts, underlying SG&A decreased driven by the impact of cost reduction programs and productivity initiatives.
Depreciation and amortization
Reported depreciation and amortization expense decreased $49 million, or 1%, versus 2019. The decrease is primarily due to currency translation impacts.
On an adjusted basis, depreciation and amortization expense decreased $29 million, or 1%, versus 2019. The decrease is primarily due to currency translation impacts which decreased depreciation and amortization by approximately $39 million in 2020 slightly offset by new project start ups primarily in APAC and the Americas.
Cost reduction programs and other charges
Linde recorded cost reduction programs and other charges of $506 million and $567 million for 2020 and 2019, respectively, primarily associated with the company's cost reduction program, which represents charges for achieving synergies and cost efficiencies related to the merger. 2019 also included an asset impairment of approximately $73 million related to a joint venture in APAC resulting from an unfavorable arbitration ruling (see Note 3 to the consolidated financial statements).
On an adjusted basis, these costs have been eliminated in both periods.
Operating profit
Reported operating profit increased $389 million in 2020, or 13%. On an adjusted basis, operating profit increased $525 million, or 10%, for 2020 versus 2019.
On a reported basis, operating profit increased $389 million, or 13% in 2020. The increase in the year was driven by higher price and the benefit of cost reduction programs and productivity initiatives. Cost reduction programs and other charges
were $506 million in 2020 and $567 million in 2019. 2019 also included a $164 million one time net gain on sale of business.
On an adjusted basis, which excludes the impacts of purchase accounting, cost reduction programs and other charges and net gains from merger-related divestitures in 2019, operating profit increased $525 million, or 10%. Operating profit growth was driven by higher price and the benefit of cost reduction programs and productivity initiatives which were partially offset by lower volumes, unfavorable currency impacts and cost inflation. A discussion of operating profit by segment is included in the segment discussion that follows.
Interest expense - net
Reported interest expense – net in 2020 increased $77 million, or 203%, versus 2019 and included a $16 million charge for the early redemption of bonds due in 2021 (see Note 11 to the consolidated financial statements). On an adjusted basis interest expense increased $50 million, or 37% in 2020 as compared to 2019.
On both a reported and adjusted basis, the increase year over year included the impact of unfavorable foreign currency revaluation on unhedged intercompany loans and lower interest income, partially offset by a lower effective borrowing rate.
Net pension and OPEB cost (benefit), excluding service cost
Reported net pension and OPEB cost (benefit), excluding service cost was a benefit of $177 million in 2020 versus a benefit of $32 million in 2019. 2020 included pension settlement charges of $6 million while 2019 included pension settlement charges of $97 million and a net $8 million curtailment charge (see Note 16 to the consolidated financial statements). Excluding the impact of these charges, the net pension and OPEB benefit, excluding service cost increased $46 million in 2020, as the benefit of lower interest cost due to the low discount rate environment more than offset higher amortization of deferred losses.
Effective tax rate
The reported effective tax rate ("ETR") for 2020 was 25.0% versus 26.3% in 2019. The decrease in the reported ETR is primarily due to higher tax benefits from share option exercises and higher tax expense in 2019 related to divestitures.
On an adjusted basis, the ETR for 2020 was 23.8% versus 24.0% in 2019. The decrease in the adjusted ETR is primarily due to higher tax benefits from share option exercises.
Income from equity investments
Reported income from equity investments for 2020 was $85 million as compared to $114 million in 2019. On an adjusted basis, income from equity investments for 2020 was $142 million versus $171 million in 2019. The decrease in the reported and adjusted income from equity investments was primarily driven by unfavorable foreign currency revaluation impacts on an unhedged loan of an investment in EMEA.
Noncontrolling interests from continuing operations
At December 31, 2020, noncontrolling interests from continuing operations consisted primarily of noncontrolling shareholders’ investments in APAC (primarily in China) and surface technologies.
Reported noncontrolling interests from continuing operations increased $36 million to $125 million in 2020 from $89 million in 2019, primarily driven by the noncontrolling interest impact of $33 million for an asset impairment charge in the third quarter 2019 related to a joint venture in APAC.
Adjusted noncontrolling interests from continuing operations increased $8 million in 2020 as compared to 2019.
Income from continuing operations
Reported income from continuing operations increased $314 million, or 14%, primarily due to higher overall operating profit and a lower effective tax rate.
On an adjusted basis, which excludes the impacts of purchase accounting and other non-GAAP adjustments, income from continuing operations increased $368 million, or 9%, in 2020 versus 2019. The increase was primarily due to higher adjusted operating profit partially offset by higher interest expense and lower equity income.
Diluted earnings per share from continuing operations
Reported diluted earnings per share from continuing operations increased $0.70, or 18%, in 2020 as compared to 2019.
On an adjusted basis, diluted EPS of $8.23 in 2020 increased 12% versus 2019, primarily due to higher income from continuing operations and lower diluted shares outstanding.
Employees
The number of employees at December 31, 2020 was 74,207, a decrease of 5,679 employees from December 31, 2019 primarily driven by cost reduction actions and divestitures.
Other Financial Data
EBITDA increased to $8,033 million in 2020 from $7,722 million in 2019. Adjusted EBITDA from continuing operations increased to $8,645 million for 2020 as compared to $8,178 million in 2019 primarily due to higher income from continuing operations versus the prior year period.
See the "Non-GAAP Financial Measures" section for definitions and reconciliations of these non-GAAP measures to reported GAAP amounts.
Other Comprehensive Income (Loss)
Other comprehensive income for the year ended December 31, 2020 of $157 million resulted primarily from currency translation adjustments of $595 million largely offset by a decrease in the funded status of the company's retirement obligations of $469 million driven by the low discount rate environment. The translation adjustments reflect the impact of translating local currency foreign subsidiary financial statements to U.S. dollars, and are largely driven by the movement of the U.S. dollar against major currencies including the Euro, the Chinese yuan and the British pound. See the "Currency" section of the MD&A for exchange rates used for translation purposes and Note 7 to the consolidated financial statements for a summary of the currency translation adjustment component of accumulated other comprehensive income by segment.
Related Party Transactions
The company’s related parties are primarily unconsolidated equity affiliates. The company did not engage in any material transactions involving related parties that included terms or other aspects that differ from those which would be negotiated with independent parties.
Environmental Matters
Linde’s principal operations relate to the production and distribution of atmospheric and other industrial gases, which historically have not had a significant impact on the environment. However, worldwide costs relating to environmental protection may continue to grow due to increasingly stringent laws and regulations, and Linde's ongoing commitment to rigorous internal standards. In addition, Linde may face physical risks from climate change and extreme weather.
Climate Change
Linde operates in jurisdictions that have, or are developing, laws and/or regulations to reduce or mitigate the perceived adverse effects of greenhouse gas ("GHG") emissions and faces a highly uncertain regulatory environment in this area. For example, the U.S. Environmental Protection Agency ("EPA") has promulgated rules requiring reporting of GHG emissions, and Linde and many of its suppliers and customers are subject to these rules. EPA has also promulgated regulations to restrict GHG emissions, including final rules regulating GHG emissions from light-duty vehicles and certain large manufacturing facilities, many of which are Linde suppliers or customers. In addition to these developments in the United States, several other countries worldwide have already implemented carbon taxation or trading systems which impact the company's customers and Linde operations, among those regulations in China, Singapore and the European Union. Among other impacts, such regulations are expected to raise the cost of energy, which is a significant cost for Linde. Nevertheless, Linde's long-term customer contracts routinely provide rights to recover increased electricity, natural gas, and other costs that are incurred by the company as a result of climate change regulation.
Linde anticipates continued growth in its hydrogen business due to increased focus on air quality. Hydrogen production plants and a large number of other manufacturing and electricity-generating plants have been identified in California and the European Union as a source of carbon dioxide emissions and these plants are subject to cap-and-trade regulations in those jurisdictions. Linde believes it will be able to mitigate the costs of these regulations through the terms of its product supply contracts. However, legislation that limits GHG emissions may impact growth by increasing capital, compliance, operating and maintenance costs and/or decreasing demand.
To manage business risks from current and potential GHG emission regulation as well as physical consequences of climate change, Linde actively monitors current developments, evaluates the direct and indirect business risks, and takes appropriate actions. Among others, actions include: increasing relevant resources and training; maintaining contingency plans; obtaining advice and counsel from expert vendors, insurance providers and industry experts; incorporating GHG provisions in commercial agreements; and conducting regular reviews of the business risks with management. Although there are considerable uncertainties, Linde believes that the business risk from potential regulations can be effectively managed through its commercial contracts. Additionally, Linde does not anticipate any material effects regarding its plant operations or business arising from potential physical risks of climate change.
Linde continuously seeks opportunities to optimize energy use and GHG footprint through research and development in customer applications and rigorous operational energy efficiency, investment in renewable energy, and purchasing hydrogen as a chemical byproduct where feasible. Linde maintains related performance improvement targets and reports progress against these targets regularly to business management and annually to Linde's Board of Directors.
At the same time, Linde may benefit from business opportunities arising from governmental regulation of GHG and other emissions; uncertain costs of energy and certain natural resources; the development of renewable energy alternatives; and new technologies that help extract natural gas, improve air quality, increase energy efficiency and mitigate the impacts of climate change. Linde continues to develop new applications that can lower emissions, including GHG emissions, in Linde's processes and help customers lower energy consumption and increase product throughput. Stricter regulation of water quality in emerging economies such as China provide a growing market for a number of gases, e.g., oxygen for wastewater treatment. Increased concern about drought in areas such as California and Australia may create additional markets for carbon dioxide for desalination. Renewable fuel standards in the European Union and U.S. create a market for second-generation biofuels which use industrial gases such as oxygen, carbon dioxide, and hydrogen.
Costs Relating to the Protection of the Environment
Environmental protection costs in 2020 were not significant. Linde anticipates that future annual environmental protection expenditures will be similar to 2020, subject to any significant changes in existing laws and regulations. Based on historical results and current estimates, management does not believe that environmental expenditures will have a material adverse effect on the consolidated financial position, the consolidated results of operations or cash flows in any given year.
Legal Proceedings
See Note 17 to the consolidated financial statements for information concerning legal proceedings.
Retirement Benefits
Pensions
The net periodic benefit cost (benefit) for the U.S. and international pension plans was a benefit of $28 million in 2020 and costs of $107 million and $24 million in 2019 and 2018, respectively. 2019 net periodic pension cost included pension settlement charges of $97 million related to lump sum payments, which were triggered by either a change in control provision or merger-related divestitures, and a net curtailment charge of $8 million for termination benefits, primarily in connection with a defined benefit pension plan freeze. Settlement charges were $6 million and $14 million for 2020 and 2018, respectively.
The funded status (pension benefit obligation ("PBO") less the fair value of plan assets) for the U.S. plans was a deficit of $436 million and $504 million at December 31, 2020 and 2019, respectively. The funded status for international plans was a deficit of $2,334 million and $1,801 million at December 31, 2020 and 2019, respectively. In the U.S., the benefit from the actual return on assets more than offset the impact of unfavorable liability experience, primarily resulting from the low discount rate environment. For the international plans, the unfavorable impact of lower discount rates outweighed favorable plan asset returns.
Global pension contributions were $91 million in 2020, $94 million in 2019, and $87 million in 2018. At a minimum, Linde contributes to its pension plans to comply with local regulatory requirements (e.g., ERISA in the U.S.). Discretionary contributions in excess of the local minimum requirements are made based on many factors, including long-term projections of the plans' funded status, the economic environment, potential risk of overfunding, pension insurance costs and alternative uses of cash. Changes to these factors can impact the timing of discretionary contributions from year to year. Estimated required contributions for 2021 are currently expected to be in the range of $70 million to $80 million.
Linde assumes expected returns on plan assets for 2021 of 7.00% and 5.27% for the U.S. and international plans, respectively, which are consistent with the long-term expected returns on its investment portfolios.
Excluding the impact of any settlements, 2021 consolidated pension expense is expected to be a benefit of approximately $36 million. The benefit derived from the expected return on assets assumption for Linde's most significant plans is anticipated to more than offset the expense from service and interest cost accruals and the higher amortization of deferred losses.
Refer to the Critical Accounting Policies section and Note 16 to the consolidated financial statements for a more detailed discussion of the company’s retirement benefits, including a description of the various retirement plans and the assumptions used in the calculation of net periodic benefit cost (benefit) and funded status.
Insurance
Linde purchases insurance to limit a variety of property and casualty risks, including those related to property, business interruption, third-party liability and workers’ compensation. Currently, the company self retains up to $10 million per occurrence for vehicle liability in the United States, $5 million per occurrence for workers' compensation and general liability. In addition, the company self retains risk up to €5 million at its various properties worldwide for property damage resulting from fire, flood and other perils effecting its properties along with a separate €5 million deductible on all business interruption resulting from a major peril loss. To mitigate its aggregate loss potential above these retentions, the company purchases catastrophic insurance coverage from highly rated insurance companies. The company does not currently operate or participate in any captive insurance companies or other non-traditional risk transfer alternatives.
At December 31, 2020 and 2019, the company had recorded a total of $71 million and $66 million, respectively, representing an estimate of the retained liability for the ultimate cost of claims incurred and unpaid as of the balance sheet dates. The estimated liability is established using statistical analysis and is based upon historical experience, actuarial assumptions and professional judgment. These estimates are subject to the effects of trends in loss severity and frequency and are subject to a significant degree of inherent variability. If actual claims differ from the company’s estimates, they will be adjusted at that time and financial results could be impacted.
Linde recognizes estimated insurance proceeds relating to damages at the time of loss only to the extent of incurred losses. Any insurance recoveries for business interruption and for property damages in excess of the net book value of the property are recognized only when realized or pending payments confirmed by its insurance companies.
SEGMENT DISCUSSION
Linde’s operations consist of two major product lines: industrial gases and engineering. As further described in the following paragraph, Linde’s industrial gases operations are managed on a geographic basis, which represents three of the company's reportable segments - Americas, EMEA (Europe/Middle East/Africa), and APAC (Asia/South Pacific); a fourth reportable segment which represents the company's Engineering business, designs and manufactures equipment for air separation and other industrial gas applications specifically for end customers and is managed on a worldwide basis operating in all geographic segments. Other consists of corporate costs and a few smaller businesses which individually do not meet the quantitative thresholds for separate presentation.
The industrial gases product line centers on the manufacturing and distribution of atmospheric gases (oxygen, nitrogen, argon, rare gases) and process gases (carbon dioxide, helium, hydrogen, electronic gases, specialty gases, acetylene). Many of these products are co-products of the same manufacturing process. Linde manufactures and distributes nearly all of its products and manages its customer relationships on a regional basis. Linde’s industrial gases are distributed to various end-markets within a regional segment through one of three basic distribution methods: on-site or tonnage; merchant or bulk; and packaged or cylinder gases. The distribution methods are generally integrated in order to best meet the customer’s needs and very few of its products can be economically transported outside of a region. Therefore, the distribution economics are specific to the various geographies in which the company operates and are consistent with how management assesses performance.
The company’s measure of profit/loss for segment reporting purposes is segment operating profit. Segment operating profit is defined as operating profit excluding purchase accounting impacts of the Linde AG merger, intercompany royalties, and items not indicative of ongoing business trends. This is the manner in which the company’s Chief Operating Decision Maker ("CODM") assesses performance and allocates resources.
The table below presents sales and operating profit information about reportable segments and Other for the years ended December 31, 2020 and 2019.
| (Millions of dollars) Year Ended December 31, | 2020 | 2019 | Variance | ||||||||||||||
| Sales | |||||||||||||||||
| Americas | $ | 10,459 | $ | 10,989 | (5) | % | |||||||||||
| EMEA | 6,449 | 6,643 | (3) | % | |||||||||||||
| APAC | 5,687 | 5,779 | (2) | % | |||||||||||||
| Engineering | 2,851 | 2,799 | 2 | % | |||||||||||||
| Other | 1,797 | 1,953 | (8) | % | |||||||||||||
| Total segment sales | $ | 27,243 | $ | 28,163 | (3) | % | |||||||||||
| Merger-related divestitures | — | 65 | |||||||||||||||
| Total Sales | $ | 27,243 | $ | 28,228 | |||||||||||||
| Operating Profit | |||||||||||||||||
| Americas | $ | 2,773 | $ | 2,577 | 8 | % | |||||||||||
| EMEA | 1,465 | 1,367 | 7 | % | |||||||||||||
| APAC | 1,277 | 1,184 | 8 | % | |||||||||||||
| Engineering | 435 | 390 | 12 | % | |||||||||||||
| Other | (153) | (246) | 38 | % | |||||||||||||
| Segment operating profit | 5,797 | 5,272 | 10 | % | |||||||||||||
| Reconciliation to reported operating profit : | |||||||||||||||||
| Cost reduction programs and other charges (Note 3) | (506) | (567) | |||||||||||||||
| Merger-related divestitures | — | 16 | |||||||||||||||
| Net gain on sale of businesses | — | 164 | |||||||||||||||
| Purchase accounting impacts - Linde AG | (1,969) | (1,952) | |||||||||||||||
| Total operating profit | $ | 3,322 | $ | 2,933 |
Americas
| (Dollar amounts in millions) | Variance | |||||||||||||||||||
| Year Ended December 31, | 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||
| Sales | $ | 10,459 | $ | 10,989 | (5) | % | ||||||||||||||
| Operating profit | $ | 2,773 | $ | 2,577 | 8 | % | ||||||||||||||
| As a percent of sales | 26.5 | % | 23.5 | % |
| 2020 vs. 2019 | ||||||||
| % Change | ||||||||
| Factors Contributing to Changes - Sales | ||||||||
| Volume | (2) | % | ||||||
| Price/Mix | 2 | % | ||||||
| Cost pass-through | (1) | % | ||||||
| Currency | (3) | % | ||||||
| Acquisitions/Divestitures | (1) | % | ||||||
| (5) | % |
The Americas segment includes Linde’s industrial gases operations in approximately 20 countries including the United States, Canada, Mexico and Brazil.
Sales
Sales for the Americas segment decreased $530 million, or 5%, in 2020 versus 2019. Higher pricing contributed 2% to sales. Lower volumes, primarily related to the manufacturing and metals end markets, of 2%, were partially offset by new project start-ups and higher volumes related to the healthcare end market. Unfavorable currency translation decreased sales by 3%, primarily driven by the weakening of the Brazilian real, Mexican peso and Canadian dollar against the U.S. Dollar. Lower cost past-through, primarily natural gas, decreased sales by 1% with minimal impact on operating profit.
Operating Profit
Operating profit in the Americas segment increased $196 million, or 8%, in 2020 versus 2019. Operating profit increased due primarily to higher pricing and cost reduction and productivity initiatives, partially offset by lower volumes and unfavorable currency translation impacts.
EMEA
| (Dollar amounts in millions) | Variance | |||||||||||||||||||
| Year Ended December 31, | 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||
| Sales | $ | 6,449 | $ | 6,643 | (3) | % | ||||||||||||||
| Operating profit | $ | 1,465 | $ | 1,367 | 7 | % | ||||||||||||||
| As a percent of sales | 22.7 | % | 20.6 | % |
| 2020 vs. 2019 | ||||||||
| % Change | ||||||||
| Factors Contributing to Changes - Sales | ||||||||
| Volume | (3) | % | ||||||
| Price/Mix | 2 | % | ||||||
| Cost pass-through | (1) | % | ||||||
| Currency | — | % | ||||||
| Acquisitions/Divestitures | (1) | % | ||||||
| (3) | % |
The EMEA segment includes Linde's industrial gases operations in approximately 45 European, Middle Eastern and African countries including Germany, France, Sweden, the Republic of South Africa, and the U.K.
Sales
EMEA segment sales decreased $194 million, or 3%, in 2020 versus 2019. Volumes decreased 3% driven by lower volumes to the manufacturing and metals end-markets. Higher price contributed 2% to sales and cost pass-through decreased sales by 1%. Sales decreased 1% related to the divestiture of a non-core business in Scandinavia.
Operating Profit
Operating Profit for the EMEA segment increased $98 million, or 7%, in 2020 versus 2019 driven primarily by higher price and the impact of cost reduction programs, partially offset by lower volumes.
APAC
| (Dollar amounts in millions) | Variance | |||||||||||||||||||
| Year Ended December 31, | 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||
| Sales | $ | 5,687 | $ | 5,779 | (2) | % | ||||||||||||||
| Operating profit | $ | 1,277 | $ | 1,184 | 8 | % | ||||||||||||||
| As a percent of sales | 22.5 | % | 20.5 | % |
| 2020 vs. 2019 | ||||||||||||||
| % Change | ||||||||||||||
| Factors Contributing to Changes - Sales | ||||||||||||||
| Volume/Equipment | (2) | % | ||||||||||||
| Price/Mix | 1 | % | ||||||||||||
| Cost pass-through | (1) | % | ||||||||||||
| Currency | — | % | ||||||||||||
| Acquisitions/Divestitures | — | % | ||||||||||||
| (2) | % |
The APAC segment includes Linde's industrial gases operations in approximately 20 Asian and South Pacific countries and regions including China, Australia, India, South Korea and Taiwan.
Sales
Sales for the APAC segment decreased $92 million, or 2%, in 2020 versus 2019. Volumes decreased 2% as lower volumes to the manufacturing end-market and a prior year equipment sale more than offset the contribution of new project start-ups. Higher price increased sales by 1%. Cost pass-through decreased sales by 1% with minimal impact on operating profit.
Operating Profit
Operating profit in the APAC segment increased $93 million, or 8%, in 2020 versus 2019, driven primarily by higher price and the impact of cost reduction programs, partially offset by lower volumes.
Engineering
| (Dollar amounts in millions) | Variance | |||||||||||||||||||
| Year Ended December 31, | 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||
| Sales | $ | 2,851 | $ | 2,799 | 2 | % | ||||||||||||||
| Operating profit | $ | 435 | $ | 390 | 12 | % | ||||||||||||||
| As a percent of sales | 15.3 | % | 13.9 | % |
| 2020 vs. 2019 | ||||||||
| % Change | ||||||||
| Factors Contributing to Changes - Sales | ||||||||
| Volume/Price | — | % | ||||||
| Currency | 2 | % | ||||||
| 2 | % |
Sales
Engineering segment sales increased $52 million, or 2%, in 2020 versus 2019, driven by favorable currency impacts.
Operating profit
Engineering segment operating profit increased $45 million, or 12%, in 2020 versus 2019. The increase in operating profit for the year is due to project execution and the impact of productivity initiatives.
Other
| (Dollar amounts in millions) | Variance | |||||||||||||||||||
| Year Ended December 31, | 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||
| Sales | $ | 1,797 | $ | 1,953 | (8) | % | ||||||||||||||
| Operating profit | $ | (153) | $ | (246) | 38 | % | ||||||||||||||
| As a percent of sales | (8.5) | % | (12.6) | % |
| 2020 vs. 2019 | ||||||||||||||
| % Change | ||||||||||||||
| Factors Contributing to Changes - Sales | ||||||||||||||
| Volume/Price | (9) | % | ||||||||||||
| Cost pass-through | 1 | % | ||||||||||||
| Currency | — | % | ||||||||||||
| Acquisitions/Divestitures | — | % | ||||||||||||
| (8) | % |
Other consists of corporate costs and a few smaller businesses including: Surface Technologies, GIST, global helium wholesale, and Electronic Materials; which individually do not meet the quantitative thresholds for separate presentation.
Sales
Sales for Other decreased $156 million, or 8%, in 2020 versus 2019, primarily due to lower volumes largely due to surface technologies and to a lesser extent helium, partially offset by higher price largely related to helium and cost pass through.
Operating profit
Operating profit in Other increased $93 million, or 38%, in 2020 versus 2019, due primarily to the impact of cost reduction and productivity initiatives.
Currency
The results of Linde’s non-U.S. operations are translated to the company’s reporting currency, the U.S. dollar, from the functional currencies used in the countries in which the company operates. For most foreign operations, Linde uses the local currency as its functional currency. There is inherent variability and unpredictability in the relationship of these functional currencies to the U.S. dollar and such currency movements may materially impact Linde’s results of operations in any given period.
To help understand the reported results, the following is a summary of the significant currencies underlying Linde’s consolidated results and the exchange rates used to translate the financial statements (rates of exchange expressed in units of local currency per U.S. dollar):
| Percent of 2020 | Statements of Income | Balance Sheets | |||||||||||||||||||||||||||
| Consolidated | Average Year Ended December 31, | December 31, | |||||||||||||||||||||||||||
| Currency | Sales | 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||||||
| Euro | 22 | % | 0.88 | 0.89 | 0.82 | 0.89 | |||||||||||||||||||||||
| Chinese yuan | 8 | % | 6.90 | 6.90 | 6.53 | 6.96 | |||||||||||||||||||||||
| British pound | 6 | % | 0.78 | 0.78 | 0.73 | 0.75 | |||||||||||||||||||||||
| Australian dollar | 4 | % | 1.45 | 1.44 | 1.30 | 1.42 | |||||||||||||||||||||||
| Brazilian real | 3 | % | 5.11 | 3.94 | 5.20 | 4.03 | |||||||||||||||||||||||
| Canadian dollar | 3 | % | 1.34 | 1.33 | 1.27 | 1.30 | |||||||||||||||||||||||
| Taiwan dollar | 3 | % | 29.46 | 30.90 | 28.09 | 29.99 | |||||||||||||||||||||||
| Mexican peso | 2 | % | 21.35 | 19.24 | 19.91 | 18.93 | |||||||||||||||||||||||
| Korean won | 2 | % | 1,178 | 1,165 | 1,087 | 1,156 | |||||||||||||||||||||||
| Indian rupee | 2 | % | 74.08 | 70.40 | 73.07 | 71.38 | |||||||||||||||||||||||
| Republic of South African rand | 1 | % | 16.37 | 14.43 | 14.69 | 14.00 | |||||||||||||||||||||||
| Swedish kroner | 1 | % | 9.18 | 9.45 | 8.23 | 9.37 | |||||||||||||||||||||||
| Thailand bhat | 1 | % | 31.28 | 31.04 | 29.96 | 29.71 | |||||||||||||||||||||||
LIQUIDITY, CAPITAL RESOURCES AND OTHER FINANCIAL DATA
| (Millions of dollars) Year Ended December 31, | 2020 | 2019 | |||||||||
| Net Cash Provided by (Used for) | |||||||||||
| Operating Activities | |||||||||||
| Income from continuing operations (including noncontrolling interests) | $ | 2,622 | $ | 2,272 | |||||||
| Non-cash charges (credits): | |||||||||||
| Add: Cost reduction programs and other charges, net of payments (a) | 258 | (236) | |||||||||
| Add: Amortization of merger-related inventory step-up | — | 12 | |||||||||
| Less: Net gain on sale of businesses, net of tax | — | (108) | |||||||||
| Add: Depreciation and amortization | 4,626 | 4,675 | |||||||||
| Add (Less): Deferred income taxes | (369) | (303) | |||||||||
| Add (Less): non-cash charges and other | 285 | (32) | |||||||||
| Income from continuing operations adjusted for non-cash charges and other | 7,422 | 6,280 | |||||||||
| Less: Pension contributions | (91) | (94) | |||||||||
| Add (Less): Working capital | 364 | (160) | |||||||||
| Add (Less): Other | (266) | 93 | |||||||||
| Net cash provided by operating activities | $ | 7,429 | $ | 6,119 | |||||||
| Investing Activities | |||||||||||
| Capital expenditures | $ | (3,400) | $ | (3,682) | |||||||
| Acquisitions, net of cash acquired | (68) | (225) | |||||||||
| Divestitures and asset sales, net of cash divested | 482 | 5,096 | |||||||||
| Net cash provided by (used for) investing activities | $ | (2,986) | $ | 1,189 | |||||||
| Financing Activities | |||||||||||
| Debt increases (decreases) – net | $ | 1,313 | $ | (1,260) | |||||||
| Issuances (purchases) of ordinary shares – net | (2,410) | (2,586) | |||||||||
| Cash dividends – Linde plc shareholders | (2,028) | (1,891) | |||||||||
| Noncontrolling interest transactions and other | (220) | (3,260) | |||||||||
| Net cash (used) for financing activities | $ | (3,345) | $ | (8,997) | |||||||
| Effect of exchange rate changes on cash | $ | (44) | $ | (77) | |||||||
| Cash and cash equivalents, end-of-period | $ | 3,754 | $ | 2,700 |
(a)See Note 3 to the consolidated financial statements.
Cash increased $1,054 million in 2020 versus 2019. The primary sources of cash in 2020 were cash flows from operations of $7,429 million, net debt issuances of $1,313 million and proceeds from divestitures and asset sales of $482 million. The primary uses of cash included capital expenditures of $3,400 million, net purchases of ordinary shares of $2,410 million, and cash dividends to shareholders of $2,028 million. Noncontrolling interest transactions and other of $3,260 million in 2019 included a payment of approximately $3.2 billion related to the cash-merger squeeze-out of the 8% of Linde AG shares completed on April 8, 2019 (see Note 14 to the consolidated financial statements).
Cash Flows From Operations
2020 compared with 2019
Cash flows from operations was $7,429 million, or 27% of sales, an increase of $1,310 million from $6,119 million, or 22% of sales in 2019. The increase was driven by higher net income adjusted for non-cash charges, better working capital management, and lower merger and synergy related cash outflows. Cost reduction programs and other charges of $506 million and $567 million for the years ended December 31, 2020 and 2019 were offset by related cash outflows of $248 million and $803 million, respectively.
Investing
2020 compared with 2019
Net cash used for investing activities was $2,986 million in 2020 versus net cash provided by investing activities of $1,189 million in 2019. The decrease was primarily driven by lower proceeds from merger-related divestitures, partially offset by lower capital expenditures and acquisitions.
Capital expenditures in 2020 were $3,400 million, a decrease of $282 million from 2019. Capital expenditures during 2020 related primarily to investments in new plant and production equipment for growth. Approximately 41% of the capital expenditures were in the Americas segment with 35% in the APAC segment and the rest primarily in the EMEA segment.
At December 31, 2020, Linde's sale of gas backlog of large projects under construction was approximately $3.6 billion. This represents the total estimated capital cost of large plants under construction.
Acquisition expenditures in 2020 were $68 million, a decrease of $157 million from 2019 and related primarily to acquisitions in the Americas and APAC.
Divestitures and asset sales in 2020 totaled $482 million as compared to $5,096 million in 2019. The 2020 period includes net proceeds from merger-related divestitures of $98 million from the sale of selected assets of Linde China and proceeds of approximately $130 million related to the divestiture of a non-core business in Scandinavia. The 2019 period includes net proceeds from merger-related divestitures of $3.4 billion from the sale of Linde AG's Americas business, $1.2 billion from the sale of Linde South Korea and approximately $200 million each from the sale of the legacy Praxair and legacy Linde India selected assets (see Note 2 to the consolidated financial statements).
Financing
Linde’s financing strategy is to secure long-term committed funding by issuing public notes and debentures and commercial paper backed by a long-term bank credit agreement. Linde’s international operations are funded through a combination of local borrowing and intercompany funding to minimize the total cost of funds and to manage and centralize currency exchange exposures. As deemed necessary, Linde manages its exposure to interest-rate changes through the use of financial derivatives (see Note 12 to the consolidated financial statements and Item 7A. Quantitative and Qualitative Disclosures About Market Risk).
Cash used for financing activities was $3,345 million in 2020 compared to $8,997 million in 2019. Cash provided by debt was $1,313 million in 2020 versus cash used for debt of $1,260 million in 2019 primarily due to bond issuances in 2020 and increased commercial paper borrowings, net of bond repayments. Net purchases of ordinary shares were $2,410 million in 2020 versus $2,586 million in 2019. Cash dividends increased to $2,028 million in 2020 versus $1,891 million in 2019 driven primarily by a 10% increase in dividends per share from $3.50 per share to $3.85 per share. The 2019 period also includes an
outflow of approximately $3.2 billion relating to the cash-merger squeeze-out of the 8% of Linde AG shares completed on April 8, 2019 (See Note 14 to the consolidated financial statements).
The company believes that it has sufficient operating flexibility, cash reserves, and funding sources to maintain adequate amounts of liquidity to meet its business needs around the world. At December 31, 2020, Linde's credit ratings as reported by Standard & Poor’s and Moody’s were A-1 and P-1 for short-term debt, respectively, and A and A2 for long-term debt, respectively.
Note 11 to the consolidated financial statements includes information with respect to the company’s debt activity in 2020, current debt position, debt covenants and the available credit facilities; and Note 12 includes information relating to derivative financial instruments. Linde's credit facilities are with major financial institutions and are non-cancelable until maturity. Therefore, the company believes the risk of the financial institutions being unable to make required loans under the credit facilities, if requested, to be low. Linde’s major bank credit and long-term debt agreements contain standard covenants. The company was in compliance with these covenants at December 31, 2020 and expects to remain in compliance for the foreseeable future.
The company maintains a $5 billion unsecured and undrawn revolving credit agreement with no associated financial covenants. No borrowings were outstanding under the credit agreement as of December 31, 2020. The company does not anticipate any limitations on its ability to access the debt capital markets and/or other external funding sources and remains committed to its strong ratings from Moody’s and Standard & Poor’s.
Linde’s total net debt outstanding at December 31, 2020 was $12,400 million, $1,144 million higher than $11,256 million at December 31, 2019. The December 31, 2020 net debt balance includes $15,048 million in public securities, $1,106 million representing primarily worldwide bank borrowings, net of $3,754 million of cash. Linde’s global effective borrowing rate was approximately 2% for 2020.
In May 2020, Linde issued €750 million of 0.250% notes due 2027 and €750 million 0.550% notes due 2032. In August, 2020, Linde issued $700 million of 1.100% notes due 2030 and $300 million of 2.000% notes due 2050. In September 2020, the company repaid €1,000 million in 1.75% notes and $300 million of 2.25% notes that became due. In December 2020, the company repaid $500 million of 4.05% notes and $500 million of 3.00% notes that were due in 2021 resulting in a $16 million interest charge (see Note 11 to the consolidated financial statements).
On January 25, 2021, the company’s board of directors approved the additional repurchase of $5.0 billion of its ordinary shares. For additional information related to the share repurchase programs, see Part II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
OFF-BALANCE SHEET ARRANGEMENTS
As discussed in Note 17 to the consolidated financial statements, at December 31, 2020, Linde had undrawn outstanding letters of credit, bank guarantees and surety bonds entered into in connection with normal business operations and they are not reasonably likely to have a material impact on Linde’s consolidated financial condition, results of operations, or liquidity.
CRITICAL ACCOUNTING POLICIES
The policies discussed below are considered by management to be critical to understanding Linde’s financial statements and accompanying notes prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). Their application places significant importance on management’s judgment as a result of the need to make estimates of matters that are inherently uncertain. Linde’s financial position, results of operations and cash flows could be materially affected if actual results differ from estimates made. These policies are determined by management and have been reviewed by Linde’s Audit Committee.
Revenue Recognition
Long-Term Construction Contracts
The company designs and manufactures equipment for air separation and other varied gas production and processing plants manufactured specifically for end customers. Revenue from sale of equipment is generally recognized over time as Linde has an enforceable right to payment for performance completed to date and performance does not create an asset with alternative use. For contracts recognized over time, revenue is recognized primarily using a cost incurred input method. Costs incurred to date relative to total estimated costs at completion are used to measure progress toward satisfying performance obligations. Costs incurred include material, labor, and overhead costs and represent work contributing and proportionate to the transfer of control to the customer. Contract modifications are typically accounted for as part of the existing contract and are recognized as a cumulative adjustment for the inception-to-date effect of such change. We assess performance as progress towards completion is achieved on specific projects, earnings will be impacted by changes to our forecast of revenues and costs on these projects.
Pension Benefits
Pension benefits represent financial obligations that will be ultimately settled in the future with employees who meet eligibility requirements. Because of the uncertainties involved in estimating the timing and amount of future payments, significant estimates are required to calculate pension expense and liabilities related to the company’s plans. The company utilizes the services of independent actuaries, whose models are used to facilitate these calculations.
Several key assumptions are used in actuarial models to calculate pension expense and liability amounts recorded in the financial statements. Management believes the three most significant variables in the models are the expected long-term rate of return on plan assets, the discount rate, and the expected rate of compensation increase. The actuarial models also use assumptions for various other factors, including long-term inflation rates, employee turnover, retirement age, and mortality. Linde management believes the assumptions used in the actuarial calculations are reasonable, reflect the company’s experience and expectations for the future and are within accepted practices in each of the respective geographic locations in which it operates. Actual results in any given year will often differ from actuarial assumptions because of economic and other factors. The sensitivities to each of the key assumptions presented below exclude the impact of special items that occurred during the year.
The weighted-average expected long-term rates of return on pension plan assets were 7.00% for U.S. plans and 5.31% for international plans for the year ended December 31, 2020 (7.27% and 5.15%, respectively at December 31, 2019). The expected long-term rate of return on the U.S. and international plan assets is estimated based on the plans' investment strategy and asset allocation, historical capital market performance and, to a lesser extent, historical plan performance. A 0.50% change in these expected long-term rates of return, with all other variables held constant, would change Linde’s pension expense by approximately $42 million.
The company has consistently used a market-related value of assets rather than the fair value at the measurement date to determine annual pension expense. The market-related value recognizes investment gains or losses over a five-year period. As a result, changes in the fair value of assets from year to year are not immediately reflected in the company’s annual pension expense. Instead, annual pension expense in future periods will be impacted as deferred investment gains or losses
are recognized in the market-related value of assets over the five-year period. The consolidated market-related value of assets was $9,408 million, or $555 million lower than the fair value of assets of $9,963 million at December 31, 2020. These net deferred investment losses of $555 million will be recognized in the calculation of the market-related value of assets ratably over the next four years and will impact future pension expense. Future actual investment gains or losses will impact the market-related value of assets and, therefore, will impact future annual pension expense in a similar manner.
Discount rates are used to calculate the present value of plan liabilities and pension costs and are determined annually by management. The company measures the service and interest cost components of pension and OPEB expense for significant U.S. and international plans using the spot rate approach. U.S. plans that do not use the spot rate approach continue to determine discount rates by using a cash flow matching model provided by the company's independent actuaries. The model includes a portfolio of corporate bonds graded Aa or better by at least half of the ratings agencies and matches the U.S. plans' projected cash flows to the calculated spot rates. Discount rates for the remaining international plans are based on market yields for high-quality fixed income investments representing the approximate duration of the pension liabilities on the measurement date. Refer to Note 16 to the consolidated financial statements for a summary of the discount rates used to calculate plan liabilities and benefit costs, and to the Retirement Benefits section of the Consolidated Results and Other Information section of this MD&A for a further discussion of 2020 benefit costs. A 0.50% reduction in discount rates, with all other variables held constant, would increase Linde’s pension expense by approximately $42 million whereas a 0.50% increase in discount rates would result in a decrease of $12 million. A 0.50% reduction in discount rates would increase the PBO by approximately $1,054 million whereas a 0.50% increase in discount rates would have a favorable impact to the PBO of approximately $932 million.
The weighted-average expected rate of compensation increase was 3.25% for U.S. plans and 2.55% for international plans at December 31, 2020 (3.25% and 2.46%, respectively, at December 31, 2019). The estimated annual compensation increase is determined by management every year and is based on historical trends and market indices. A 0.50% change in the expected rate of compensation increase, with all other variables held constant, would change Linde’s pension expense by approximately $8 million and would impact the PBO by approximately $70 million.
Asset Impairments
Goodwill and Other Indefinite-Lived Intangibles Assets
At December 31, 2020, the company had goodwill of $28,201 million and $1,992 million of other indefinite-lived intangible assets. Goodwill represents the aggregate of the excess consideration paid for acquired businesses over the fair value of the net assets acquired. Indefinite-lived other intangibles relate to the Linde name.
The company performs a goodwill impairment test annually or more frequently if events or circumstances indicate that an impairment loss may have been incurred.
The impairment tests performed during the fourth quarter of 2020 indicated no impairment. At December 31, 2020, Linde’s enterprise value was approximately $150 billion (outstanding shares multiplied by the year-end stock price plus net debt, and without any control premium) while its total capital was approximately $62 billion.
The impairment test allows an entity to first assess qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than carrying value. If it is determined that it is more likely than not that the fair value of a reporting unit is less than carrying value then the company will estimate and compare the fair value of its reporting units to their carrying value, including goodwill. Reporting units are determined based on one level below the operating segment level.
Management believes that the quantitative and qualitative factors used to perform its annual goodwill impairment assessment are appropriate and reasonable. Although the 2020 assessment indicated that it is more likely than not that the fair value of each reporting unit exceeded its carrying value, changes in circumstances or conditions affecting this analysis could have a significant impact on the fair value determination, which could then result in a material impairment charge to the company's results of operations. Reporting units with greater concentration of Linde AG assets fair valued during the 2018 Praxair, Inc. and Linde AG merger are at greater risk of impairment in future periods.
Other indefinite-lived intangible assets from Linde AG recently fair valued are evaluated for impairment on an annual basis or more frequently if events and circumstances indicate that an impairment loss may have been incurred, and no impairments were indicated.
See Notes 9 and 10 to the consolidated financial statements.
Long-Lived Assets
Long-lived assets, including property, plant and equipment and finite-lived other intangible assets, are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of an individual asset or asset group may not be recoverable. For purposes of this test, asset groups are determined based upon the lowest level for which there are independent and identifiable cash flows. Based upon Linde's business model an asset group may be a single plant and related assets used to support on-site, merchant and packaged gas customers. Alternatively, the asset group may a collection of distribution related assets (cylinders, distribution centers, and stores) or be a pipeline complex which includes multiple interdependent plants and related assets connected by pipelines within a geographic area used to support the same distribution methods.
Income Taxes
At December 31, 2020, Linde had deferred tax assets of $2,270 million (net of valuation allowances of $243 million), and deferred tax liabilities of $8,706 million. At December 31, 2020, uncertain tax positions totaled $452 million (see Note 1 and Note 5 to the consolidated financial statements). Income tax expense was $847 million for the year ended December 31, 2020, or about 25.0% of pre-tax income (see Note 5 to the consolidated financial statements for additional information related to taxes).
In the preparation of consolidated financial statements, Linde estimates income taxes based on diverse legislative and regulatory structures that exist in various jurisdictions where the company conducts business. Deferred income tax assets and liabilities represent tax benefits or obligations that arise from temporary differences due to differing treatment of certain items for accounting and income tax purposes. Linde evaluates deferred tax assets each period to ensure that estimated future taxable income will be sufficient in character (e.g. capital gain versus ordinary income treatment), amount and timing to result in their recovery. A valuation allowance is established when management determines that it is more likely than not that a deferred tax asset will not be realized to reduce the assets to their realizable value. Considerable judgments are required in establishing deferred tax valuation allowances and in assessing exposures related to tax matters. As events and circumstances change, related reserves and valuation allowances are adjusted to income at that time. Linde’s tax returns are subject to audit and local taxing authorities could challenge the company’s tax positions. The company’s practice is to review tax filing positions by jurisdiction and to record provisions for uncertain income tax positions, including interest and penalties when applicable. Linde believes it records and/or discloses such potential tax liabilities as appropriate and has reasonably estimated its income tax liabilities and recoverable tax assets. If new information becomes available, adjustments are charged or credited against income at that time. Management does not anticipate that such adjustments would have a material adverse effect on the company’s consolidated financial position or liquidity; however, it is possible that the final outcomes could have a material impact on the company’s reported results of operations.
Contingencies
The company accrues liabilities for non-income tax contingencies when management believes that a loss is probable and the amounts can be reasonably estimated, while contingent gains are recognized only when realized or realizable. If new information becomes available or losses are sustained in excess of recorded amounts, adjustments are charged against income at that time. Management does not anticipate that in the aggregate such losses would have a material adverse effect on the company’s consolidated financial position or liquidity; however, it is possible that the final outcomes could have a material impact on the company’s reported results of operations.
Linde is subject to various claims, legal proceedings and government investigations that arise from time to time in the ordinary course of business. These actions are based upon alleged environmental, tax, antitrust and personal injury claims, among others (see Note 17 to the consolidated financial statements). Such contingencies are significant and the accounting requires considerable management judgments in analyzing each matter to assess the likely outcome and the need for establishing appropriate liabilities and providing adequate disclosures. Linde believes it records and/or discloses such contingencies as appropriate and has reasonably estimated its liabilities.
NEW ACCOUNTING STANDARDS
See Note 1 to the consolidated financial statements for information concerning new accounting standards and the impact of the implementation of these standards on the company’s financial statements.
FAIR VALUE MEASUREMENTS
Linde does not expect changes in the aggregate fair value of its financial assets and liabilities to have a material impact on the consolidated financial statements. See Note 13 to the consolidated financial statements.
NON-GAAP FINANCIAL MEASURES
The following non-GAAP measures are intended to supplement investors’ understanding of the company’s financial information by providing measures which investors, financial analysts and management use to help evaluate the company’s financial leverage and operating performance. Special items which the company does not believe to be indicative of on-going business performance are excluded from these calculations so that investors can better evaluate and analyze historical and future business trends on a consistent basis. Definitions of these non-GAAP measures may not be comparable to similar definitions used by other companies and are not a substitute for similar GAAP measures.
The non-GAAP measures in the following reconciliations are presented in this MD&A.
Adjusted Amounts
| (Dollar amounts in millions, except per share data) | ||||||||
| Year Ended December 31, | 2020 | 2019 | ||||||
| Adjusted Sales | ||||||||
| Reported Sales | $ | 27,243 | $ | 28,228 | ||||
| Less: Merger-related divestitures (d) | — | (65) | ||||||
| Adjusted Sales | $ | 27,243 | $ | 28,163 | ||||
| Adjusted Operating Profit and Operating Margin | ||||||||
| Reported operating profit | $ | 3,322 | $ | 2,933 | ||||
| Less: Merger-related divestitures (d) | — | (16) | ||||||
| Add: Cost reduction programs and other charges | 506 | 567 | ||||||
| Less: Net gain on sale of businesses | — | (164) | ||||||
| Add: Purchase accounting impacts - Linde AG (c) | 1,969 | 1,952 | ||||||
| Total adjustments | 2,475 | 2,339 | ||||||
| Adjusted operating profit | $ | 5,797 | $ | 5,272 | ||||
| Reported percentage change | 13 | % | ||||||
| Adjusted percentage change | 10 | % | ||||||
| Reported sales | $ | 27,243 | $ | 28,228 | ||||
| Adjusted sales | $ | 27,243 | $ | 28,163 | ||||
| Reported operating margin | 12.2 | % | 10.4 | % | ||||
| Adjusted operating margin | 21.3 | % | 18.7 | % | ||||
| Adjusted Depreciation and amortization | ||||||||
| Reported depreciation and amortization | $ | 4,626 | $ | 4,675 | ||||
| Less: Purchase accounting impacts - Linde AG (c) | (1,920) | (1,940) | ||||||
| Adjusted depreciation and amortization | $ | 2,706 | $ | 2,735 | ||||
| Adjusted Other Income (Expense) - net | ||||||||
| Reported Other Income (Expense) - net | $ | (61) | $ | 68 |
| Add: Purchase accounting impacts - Linde AG (c) | (49) | — | ||||||
| Adjusted Other Income (Expense) - net | $ | (12) | $ | 68 | ||||
| Adjusted Net Pension and OPEB Cost (Benefit), Excluding Service Cost | ||||||||
| Reported net pension and OPEB cost (benefit), excluding service cost | $ | (177) | $ | (32) | ||||
| Add: Pension settlement charges | (6) | (107) | ||||||
| Adjusted Net Pension and OPEB cost (benefit), excluding service costs | $ | (183) | $ | (139) | ||||
| Adjusted Interest Expense - Net | ||||||||
| Reported interest expense - net | $ | 115 | $ | 38 | ||||
| Add: Purchase accounting impacts - Linde AG (c) | 85 | 96 | ||||||
| Less: Bond Redemption | (16) | — | ||||||
| Adjusted interest expense - net | $ | 184 | $ | 134 | ||||
| Adjusted Income Taxes (a) | ||||||||
| Reported income taxes | $ | 847 | $ | 769 | ||||
| Add: Purchase accounting impacts - Linde AG (c) | 399 | 450 | ||||||
| Add: Pension settlement charges | 1 | 26 | ||||||
| Add: Cost reduction programs and other charges | 130 | 83 | ||||||
| Less: Merger-related divestitures (d) | — | (5) | ||||||
| Less: Net gain on sale of businesses | — | (56) | ||||||
| Less: Bond Redemption | 4 | — | ||||||
| Total adjustments | 534 | 498 | ||||||
| Adjusted income taxes | $ | 1,381 | $ | 1,267 | ||||
| Adjusted Effective Tax Rate (a) | ||||||||
| Reported income before income taxes and equity investments | $ | 3,384 | $ | 2,927 | ||||
| Less: Merger-related divestitures (d) | — | (16) | ||||||
| Add: Pension settlement charge | 6 | 107 | ||||||
| Add: Purchase accounting impacts - Linde AG (c) | 1,884 | 1,856 | ||||||
| Add: Cost reduction programs and other charges | 506 | 567 | ||||||
| Less: Bond Redemption | 16 | — | ||||||
| Less: Net gain on sale of businesses | — | (164) | ||||||
| Total adjustments | 2,412 | 2,350 | ||||||
| Adjusted income before income taxes and equity investments | $ | 5,796 | $ | 5,277 | ||||
| Reported Income taxes | $ | 847 | $ | 769 | ||||
| Reported effective tax rate | 25.0 | % | 26.3 | % | ||||
| Adjusted income taxes | $ | 1,381 | $ | 1,267 | ||||
| Adjusted effective tax rate | 23.8 | % | 24.0 | % | ||||
| Income from Equity Investments | ||||||||
| Reported income from equity investments | $ | 85 | $ | 114 | ||||
| Add: Purchase accounting impacts - Linde AG (c) | 57 | 57 | ||||||
| Adjusted income from equity investments | $ | 142 | $ | 171 |
| Adjusted Noncontrolling Interests from Continuing Operations | ||||||||
| Reported noncontrolling interests from continuing operations | $ | (125) | $ | (89) | ||||
| Add: Cost reduction programs and other charges | (4) | (35) | ||||||
| Add: Purchase accounting impacts - Linde AG (c) | (57) | (54) | ||||||
| Total adjustments | (61) | (89) | ||||||
| Adjusted noncontrolling interests from continuing operations | $ | (186) | $ | (178) | ||||
| Adjusted Income from Continuing Operations (b) | ||||||||
| Reported income from continuing operations | $ | 2,497 | $ | 2,183 | ||||
| Add: Pension settlement charge | 5 | 81 | ||||||
| Less: Merger-related divestitures (d) | — | (12) | ||||||
| Add: Cost reduction programs and other charges | 372 | 449 | ||||||
| Less: Net gain on sale of business | — | (108) | ||||||
| Add: Purchase accounting impacts - Linde AG (c) | 1,485 | 1,410 | ||||||
| Less: Bond Redemption | 12 | — | ||||||
| Total adjustments | 1,874 | 1,820 | ||||||
| Adjusted income from continuing operations | $ | 4,371 | $ | 4,003 | ||||
| Adjusted Diluted EPS from Continuing Operations (b) | ||||||||
| Reported diluted EPS from continuing operations | $ | 4.70 | $ | 4.00 | ||||
| Add: Pension settlement charge | 0.01 | 0.16 | ||||||
| Add: Cost reduction programs and other charges | 0.70 | 0.83 | ||||||
| Less: Merger-related divestitures (d) | — | (0.03) | ||||||
| Less: Net gain on sale of business | — | (0.21) | ||||||
| Less: Bond Redemption | 0.02 | — | ||||||
| Add: Purchase accounting impacts - Linde AG | 2.80 | 2.59 | ||||||
| Total adjustments | 3.53 | 3.34 | ||||||
| Adjusted diluted EPS from continuing operations | $ | 8.23 | $ | 7.34 | ||||
| Reported percentage change | 18 | % | ||||||
| Adjusted percentage change | 12 | % | ||||||
| Adjusted EBITDA and % of Sales | ||||||||
| Income from continuing operations | $ | 2,497 | $ | 2,183 | ||||
| Add: Noncontrolling interests related to continuing operations | 125 | 89 | ||||||
| Add: Net pension and OPEB cost (benefit), excluding service cost | (177) | (32) | ||||||
| Add: Interest expense | 115 | 38 | ||||||
| Add: Income taxes | 847 | 769 | ||||||
| Add: Depreciation and amortization | 4,626 | 4,675 | ||||||
| EBITDA from continuing operations | 8,033 | 7,722 | ||||||
| Less: Merger-related divestitures (d) | — | (16) | ||||||
| Less: Net gain on sale of business | — | (164) | ||||||
| Add: Cost reduction programs and other charges | 506 | 567 | ||||||
| Add: Purchase accounting impacts - Linde AG | 106 | 69 |
| Total adjustments | 612 | 456 | ||||||
| Adjusted EBITDA from continuing operations | $ | 8,645 | $ | 8,178 | ||||
| Reported sales | $ | 27,243 | $ | 28,228 | ||||
| Adjusted sales | $ | 27,243 | $ | 28,163 | ||||
| % of sales | ||||||||
| EBITDA from continuing operations | 29.5 | % | 27.4 | % | ||||
| Adjusted EBITDA from continuing operations | 31.7 | % | 29.0 | % |
| (a) The income tax expense (benefit) on the non-GAAP pre-tax adjustments was determined using the applicable tax rates for the jurisdictions that were utilized in calculating the GAAP income tax expense (benefit) and included both current and deferred income tax amounts. | |||||||||||||||||||||||||||||||||||||||||
| (b) Net of income taxes which are shown separately in “Adjusted Income Taxes and Effective Tax Rate”. | |||||||||||||||||||||||||||||||||||||||||
| (c) The company believes that its non-GAAP measures excluding Purchase accounting impacts - Linde AG are useful to investors because: (i) the business combination was a merger of equals in an all-stock merger transaction, with no cash consideration, (ii) the company is managed on a geographic basis and the results of certain geographies are more heavily impacted by purchase accounting than others, causing results that are not comparable at the reportable segment level, therefore, the impacts of purchasing accounting adjustments to each segment vary and are not comparable within the company and when compared to other companies in similar regions, (iii) business management is evaluated and variable compensation is determined based on results excluding purchase accounting impacts, and; (iv) it is important to investors and analysts to understand the purchase accounting impacts to the financial statements. A summary of each of the adjustments made for Purchase accounting impacts - Linde AG are as follows: Adjusted Operating Profit and Margin: The purchase accounting adjustments for the periods presented relate primarily to depreciation and amortization related to the fair value step up of fixed assets and intangible assets (primarily customer related) acquired in the merger and the allocation of fair value step-up for ongoing Linde AG asset disposals (reflected in Other Income/(Expense)). Adjusted Interest Expense - Net: Relates to the amortization of the fair value of debt acquired in the merger. Adjusted Income Taxes and Effective Tax Rate: Relates to the current and deferred income tax impact on the adjustments discussed above. The income tax expense (benefit) on the non-GAAP pre-tax adjustments was determined using the applicable tax rates for the jurisdictions that were utilized in calculating the GAAP income tax expense (benefit) and included both current and deferred income tax amounts. Adjusted Income from Equity Investments: Represents the amortization of increased fair value on equity investments related to depreciable and amortizable assets. Adjusted Noncontrolling Interests from Continuing Operations: Represents the noncontrolling interests’ ownership portion of the adjustments described above determined on an entity by entity basis. | |||||||||||||||||||||||||||||||||||||||||
| (d) To adjust for the results of Praxair's merger-related divestitures. |
Net Debt and Adjusted Net Debt
Net debt is a financial liquidity measure used by investors, financial analysts and management to evaluate the ability of a company to repay its debt. Purchase accounting impacts have been excluded as they are non-cash and do not have an impact on liquidity.
| December 31, 2020 | December 31, 2019 | ||||||||||
| (Millions of dollars) | |||||||||||
| Debt | $ | 16,154 | $ | 13,956 | |||||||
| Less: cash and cash equivalents | (3,754) | (2,700) | |||||||||
| Net debt | 12,400 | 11,256 | |||||||||
| Less: purchase accounting impacts - Linde AG | (121) | (195) | |||||||||
| Adjusted net debt | $ | 12,279 | $ | 11,061 |
SUPPLEMENTAL GUARANTEE INFORMATION
On June 6, 2020, the company filed a Form S-3 Registration Statement with the SEC (the "Registration Statement").
Linde plc may offer debt securities, preferred shares, depositary shares and ordinary shares under the Registration Statement, and debt securities exchangeable for or convertible into preferred shares, ordinary shares or other debt securities. Debt securities of Linde plc may be guaranteed by Linde Inc. (previously Praxair, Inc.) and/or Linde GmbH (previously Linde AG). Linde plc may provide guarantees of debt securities offered by its wholly owned subsidiaries Linde, Inc. or Linde Finance under the Registration Statement.
Linde Inc. is a wholly owned subsidiary of Linde plc. Linde Inc. may offer debt securities under the Registration Statement. Debt securities of Linde Inc. will be guaranteed by Linde plc, and such guarantees by Linde plc may be guaranteed by Linde GmbH. Linde, Inc. may also provide (i) guarantees of debt securities offered by Linde plc under the Registration Statement and (ii) guarantees of the guarantees provided by Linde plc of debt securities of Linde Finance offered under the Registration Statement.
Linde Finance B.V. is a wholly owned subsidiary of Linde plc. Linde Finance may offer debt securities under the Registration Statement. Linde plc will guarantee debt securities of Linde Finance offered under the Registration Statement. Linde GmbH and Linde, Inc. may guarantee Linde plc’s obligations under its downstream guarantee.
Linde GmbH is a wholly owned subsidiary of Linde plc. Linde GmbH may provide (i) guarantees of debt securities offered by Linde plc under the Registration Statement and (ii) upstream guarantees of downstream guarantees provided by Linde plc of debt securities of Linde, Inc. or Linde Finance offered under the Registration Statement.
In September 2019, Linde plc provided downstream guarantees of all of the pre-business combination Linde, Inc. and Linde Finance notes, and Linde GmbH and Linde, Inc., respectively, provided upstream guarantees of Linde plc’s downstream guarantees.
For further information about the guarantees of the debt securities registered under the Registration Statement (including the ranking of such guarantees, limitations on enforceability of such guarantees and the circumstances under which such guarantees may be released), see “Description of Debt Securities – Guarantees” and “Description of Debt Securities – Ranking” in the Registration Statement, which subsections are incorporated herein by reference.
The company has elected to comply with Rule 13-01 of SEC Regulation S-X in advance of the effective date of January 4, 2021, as permitted by the Adopting Release.
The following tables present summarized financial information for Linde plc, Linde, Inc., Linde GmbH and Linde Finance on a combined basis, after eliminating intercompany transactions and balances between them and excluding investments in and equity in earnings from non-guarantor subsidiaries.
| (Millions of dollars) | |||||||||||
| Statement of Income Data | Twelve Months Ended December 31, 2020 | Twelve Months Ended December 31, 2019 | |||||||||
| Sales | $ | 6,772 | $ | 6,510 | |||||||
| Operating profit | 760 | 592 | |||||||||
| Net income | 660 | 2,271 | |||||||||
| Transactions with non-guarantor subsidiaries | 2,082 | 3,533 | |||||||||
| Balance Sheet Data (at period end) | |||||||||||
| Current assets (a) | $ | 3,117 | $ | 2,137 | |||||||
| Long-term assets (b) | 17,892 | 20,421 | |||||||||
| Current liabilities (c) | 8,265 | 6,897 | |||||||||
| Long-term liabilities (d) | 38,188 | 35,338 | |||||||||
| (a) From current assets above, amount due from non-guarantor subsidiaries | $ | 937 | $ | 619 | |||||||
| (b) From long-term assets above, amount due from non-guarantor subsidiaries | 4,553 | 7,725 | |||||||||
| (c) From current liabilities above, amount due to non-guarantor subsidiaries | 1,053 | 737 | |||||||||
| (d) From long-term liabilities above, amount due to non-guarantor subsidiaries | 22,419 | 21,242 | |||||||||
Previous: Item 6. SELECTED FINANCIAL DATA · Next: Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK