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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause a difference include, but are not limited to, those discussed under Item 1A. Risk Factors in this Annual Report on Form 10-K. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appears elsewhere in this Annual Report.
This section discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 have been excluded in this Form 10-K and can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for year ended December 31, 2019.
Overview
Organizational
Trane Technologies plc is a global climate innovator. We bring efficient and sustainable climate solutions to buildings, homes and transportation driven by strategic brands Trane® and Thermo King® and an environmentally responsible portfolio of products and services. Prior to the separation of our Industrial segment on February 29, 2020, we announced a new organizational model and business segment structure designed to enhance our regional go-to-market capabilities, aligning the structure with our strategy and increased focus on climate innovation. Under the revised structure, we created three new regional operating segments from the former climate segment, which also serve as our reportable segments.
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Our Americas segment innovates for customers in the North America and Latin America regions. The Americas segment encompasses commercial heating and cooling systems, building controls, and energy services and solutions; residential heating and cooling; and transport refrigeration systems and solutions.
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Our EMEA segment innovates for customers in the Europe, Middle East and Africa regions. The EMEA segment encompasses heating and cooling systems, services and solutions for commercial buildings, and transport refrigeration systems and solutions.
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Our Asia Pacific segment innovates for customers throughout the Asia Pacific region. The Asia Pacific segment encompasses heating and cooling systems, services and solutions for commercial buildings and transport refrigeration systems and solutions.
This model is designed to create deep customer focus and relevance in markets around the world. All prior period comparative segment information has been recast to reflect the current reportable segments.
Separation of Industrial Segment Business
On February 29, 2020 (Distribution Date), we completed our Reverse Morris Trust transaction (the Transaction) with Gardner Denver Holdings, Inc. (Gardner Denver, which changed its name to Ingersoll Rand Inc. after the Transaction) whereby we distributed Ingersoll-Rand U.S. HoldCo, Inc., which contained our former Industrial segment (Ingersoll Rand Industrial), through a pro rata distribution (the Distribution) to our shareholders of record as of February 24, 2020. Ingersoll Rand Industrial then merged into a wholly-owned subsidiary of Gardner Denver. Upon close of the Transaction, our existing shareholders received approximately 50.1% of the shares of Gardner Denver common stock on a fully-diluted basis and Gardner Denver stockholders retained approximately 49.9% of the shares of Gardner Denver on a fully diluted basis. As a result, our shareholders received .8824 shares of Gardner Denver common stock with respect to each share owned as of February 24, 2020. In connection with the Transaction, Ingersoll-Rand Services Company, an affiliate of Ingersoll Rand Industrial, borrowed an aggregate principal amount of $1.9 billion under a senior secured first lien term loan facility (Term Loan), the proceeds of which were used to make a special cash payment of $1.9 billion to a subsidiary of ours. The obligations under the Term Loan were retained by Ingersoll-Rand Services Company, which following the Transaction is a wholly-owned subsidiary of Gardner Denver.
In connection with the Transaction, we entered into several agreements covering supply, administrative and tax matters to provide or obtain services on a transitional basis for varying periods after the Distribution Date. The agreements cover services such as manufacturing, information technology, human resources and finance. Income and expenses under these agreements were not material. In accordance with several customary transaction-related agreements between us and Gardner Denver, the parties are in a process to determine final adjustments to working capital, cash and indebtedness amounts as of the Distribution Date, as well as another process to determine funding levels related to pension plans, non-qualified deferred compensation plans and retiree health benefits. As of December 31, 2020, both are ongoing in accordance with the transaction-related agreements. Upon finalization of these agreements, any adjustments will be recognized within Retained earnings.
Significant Events
COVID-19 Global Pandemic
In March 2020, the World Health Organization declared the outbreak of a respiratory disease caused by a newly discovered coronavirus, known now as COVID-19, as a global pandemic and recommended containment and mitigation measures worldwide. Beginning in the first quarter of 2020, many countries responded by implementing measures to combat the outbreak which impacted global business operations and resulted in our decision to temporarily close or limit our workforce to essential crews within many facilities throughout the world in order to ensure employee safety. In addition, our non-essential employees were instructed to work from home in compliance with global government stay-in-place protocols.
We have been adversely impacted by the COVID-19 global pandemic. Temporary facility closures beginning in the first quarter of 2020 disrupted results in the Asia Pacific region with impacts more widely felt throughout operations in the Americas and EMEA in the months thereafter. During the second quarter of 2020, we began to reopen facilities while maintaining appropriate health and safety precautions. However, the challenges in connection with the pandemic continued as we experienced lower volume, which negatively impacted revenue, and certain supply chain delays. In response, we proactively initiated cost cutting actions in an effort to mitigate the impact of the pandemic on our business. This included reducing discretionary spending, restricting travel, delaying merit-based salary increases and implementing employee furloughs in certain markets.
We continue to navigate the new realities brought about by the COVID-19 global pandemic as well as any impact on our liquidity needs and ability to access capital markets. Despite these challenges, all production facilities remain open and we continue to sell, install and service our products. During the second half of 2020, we did not experience any major delays in our supply chain and continued to focus on health and safety precautions to protect our employees and customers. In addition, during the fourth quarter of 2020 we completed several restorative actions including the reinstatement of annual merit-based salary increases and resuming all aspects of our balanced capital allocation strategy which included acquisitions and share repurchases. Operationally, our financial reporting systems, internal control over financial reporting and disclosure controls and procedures continue to operate effectively despite a remote workforce of non-essential front-line employees. We will continue to monitor the ongoing situation as it evolves globally and will assess any potential impacts to our business and financial position.
The preparation of financial statements requires management to use judgments in making estimates and assumptions based on the relevant information available at the end of each period. These estimates and assumptions have a significant effect on reported amounts of assets and liabilities, revenue and expenses, as well as the disclosure of contingencies because they may arise from matters that are inherently uncertain. The financial statements reflect our best estimates as of December 31, 2020 (including as it relates to the actual and potential future impacts of the COVID-19 global pandemic) with respect to the recoverability of our assets, including our receivables and long-lived assets such as goodwill and intangibles. However, due to significant uncertainty surrounding the COVID-19 global pandemic, management's judgment regarding this could change in the future. In addition, while our results of operations, cash flows and financial condition could be negatively impacted, the extent of the impact cannot be estimated with certainty at this time.
As part of the response to COVID-19 global pandemic, many countries implemented emergency economic relief plans as a way of minimizing the economic impact of this health crisis. We are evaluating the potential benefits from certain of these measures and will continue to monitor the plans as they are finalized and implemented. In the United States, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted on March 27, 2020 providing numerous tax provisions and other stimulus measures. We are currently applying the CARES Act to our operations, which includes the deferral of employer social security payroll tax payments under the CARES Act through January 1, 2021, with 50 percent owed on December 31, 2021 and the other half owed on December 31, 2022.
Reorganization of Aldrich and Murray
On the Petition Date, Aldrich and Murray each filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code in the Bankruptcy Court. As a result of the Chapter 11 filings, all asbestos-related lawsuits against Aldrich and Murray have been stayed due to the imposition of a statutory automatic stay applicable in Chapter 11 bankruptcy cases. Only Aldrich and Murray have filed for Chapter 11 relief. Neither Aldrich's wholly-owned subsidiary, 200 Park, Murray's wholly-owned subsidiary, ClimateLabs, Trane Technologies plc nor the Trane Companies are part of the Chapter 11 filings.
The goal of these Chapter 11 filings is an efficient and permanent resolution of all current and future asbestos claims through court approval of a plan of reorganization, which would establish, in accordance with section 524(g) of the Bankruptcy Code, a trust to pay all asbestos claims. Such a resolution, if achieved, would likely include a channeling injunction to enjoin asbestos claims resolved in the Chapter 11 cases from being filed or pursued against us or our affiliates. The Chapter 11 cases remain pending as of December 31, 2020.
From an accounting perspective, we no longer have control over Aldrich and Murray as of the Petition Date as their activities are subject to review and oversight by the Bankruptcy Court. Therefore, Aldrich and its wholly-owned subsidiary 200 Park and
Murray and its wholly-owned subsidiary ClimateLabs were deconsolidated as of the Petition Date and their respective assets and liabilities were derecognized from our Consolidated Financial Statements. As a result, we recorded an equity investment for an aggregate of $53.6 million within Other noncurrent assets in the Consolidated Balance Sheet. Simultaneously, we recognized a liability of $248.8 million within Other noncurrent liabilities in the Consolidated Balance Sheet related to our obligation under the Funding Agreements. The liability recorded may be subject to change based on the facts and circumstances of the Chapter 11 proceedings.
As a result of these actions, we recognized an aggregate loss of $24.9 million in our Consolidated Statements of Comprehensive Income. A gain of $0.9 million related to Murray and its wholly-owned subsidiary ClimateLabs was recorded within Other income/ (expense), net and a loss of $25.8 million related to Aldrich and its wholly-owned subsidiary 200 Park was recorded within Discontinued operations, net of tax. Additionally, the deconsolidation resulted in an investing cash outflow of $41.7 million in our Consolidated Statements of Cash Flows, of which $10.8 million was recorded within continuing operations.
Issuance of Senior Notes
In March 2019, we issued $1.5 billion principal amount of senior notes in three tranches through Trane Technologies Luxembourg Finance S.A., an indirect, wholly-owned subsidiary. The tranches consist of $400 million aggregate principal amount of 3.500% senior notes due 2026, $750 million aggregate principal amount of 3.800% senior notes due 2029 and $350 million aggregate principal amount of 4.500% senior notes due 2049.
Trends and Economic Events
We are a global corporation with worldwide operations. As a global business, our operations are affected by worldwide, regional and industry-specific economic factors as well as political and social factors wherever we operate or do business. Our geographic diversity and the breadth of our product and services portfolios have helped mitigate the impact of any one industry or the economy of any single country on our consolidated operating results.
Given our broad range of products manufactured and geographic markets served, management uses a variety of factors to predict the outlook for our company. We monitor key competitors and customers in order to gauge relative performance and the outlook for the future. We regularly perform detailed evaluations of the different market segments we are serving to proactively detect trends and to adapt our strategies accordingly. In addition, we believe our order rates are indicative of future revenue and thus are a key measure of anticipated performance.
Current economic conditions are uncertain as a result of the COVID-19 global pandemic, impacting both the global Heating, Ventilation and Air Conditioning (HVAC) and Transport end-markets as well as limiting visibility in the factors used to predict the outlook for our company. Entering 2021, market conditions are expected to improve as vaccine distribution expands across the geographies where we serve our customers.
We believe we have a solid foundation of global brands that are highly differentiated in all of our major product lines. Our geographic and product diversity coupled with our large installed product base provides growth opportunities within our service, parts and replacement revenue streams. In addition, we are investing substantial resources to innovate and develop new products and services which we expect will drive our future growth.
Results of Operations
In connection with the completion of the Transaction, we do not beneficially own any Ingersoll Rand Industrial shares of common stock and no longer consolidate Ingersoll Rand Industrial in our financial statements. As a result, the following Management’s Discussion and Analysis of Financial Condition and Results of Operations presents the results of Ingersoll Rand Industrial as a discontinued operation for periods prior to the Distribution date. In addition, the assets and liabilities of Ingersoll Rand Industrial have been recast to held-for-sale at December 31, 2019.
Year Ended December 31, 2020 Compared to the Year Ended December 31, 2019 - Consolidated Results
| Dollar amounts in millions | 2020 | 2019 | Period Change | 2020 % of Revenues | 2019 % of Revenues | |||||||||||||||||||||||||||
| Net revenues | $ | 12,454.7 | $ | 13,075.9 | $ | (621.2) | ||||||||||||||||||||||||||
| Cost of goods sold | (8,651.3) | (9,085.5) | 434.2 | 69.5% | 69.5% | |||||||||||||||||||||||||||
| Gross profit | 3,803.4 | 3,990.4 | (187.0) | 30.5% | 30.5% | |||||||||||||||||||||||||||
| Selling and administrative expenses | (2,270.6) | (2,320.3) | 49.7 | 18.2% | 17.7% | |||||||||||||||||||||||||||
| Operating income | 1,532.8 | 1,670.1 | (137.3) | 12.3% | 12.8% | |||||||||||||||||||||||||||
| Interest expense | (248.7) | (242.8) | (5.9) | |||||||||||||||||||||||||||||
| Other income/(expense), net | 4.1 | (28.4) | 32.5 | |||||||||||||||||||||||||||||
| Earnings before income taxes | 1,288.2 | 1,398.9 | (110.7) | |||||||||||||||||||||||||||||
| Benefit (provision) for income taxes | (296.8) | (238.6) | (58.2) | |||||||||||||||||||||||||||||
| Earnings from continuing operations | 991.4 | 1,160.3 | (168.9) | |||||||||||||||||||||||||||||
| Discontinued operations, net of tax | (121.4) | 268.2 | (389.6) | |||||||||||||||||||||||||||||
| Net earnings | $ | 870.0 | $ | 1,428.5 | $ | (558.5) |
Net Revenues
Net revenues for the year ended December 31, 2020 decreased by 4.8%, or $621.2 million, compared with the same period of 2019. The components of the period change are as follows:
| Volume | (5.5) | % | |||
| Pricing | 0.8 | % | |||
| Currency translation | (0.1) | % | |||
| Total | (4.8) | % |
During 2020, we were impacted by the economic environment resulting from the COVID-19 global pandemic; however, strong operational results during the second half of the year mitigated a challenging first half. The decrease in Net revenues is primarily related to lower volumes across each of our segments. Temporary facility closures beginning in the first quarter of 2020 disrupted results in the Asia Pacific region with impacts more widely felt throughout operations in the Americas and EMEA in the months thereafter. Unfavorable foreign currency exchange rate movements further contributed to the year-over-year decrease, partially offset by improved pricing. Refer to the “Results by Segment” below for a discussion of Net Revenues by segment.
Gross Profit Margin
Gross profit margin for the year ended December 31, 2020 remained flat at 30.5% compared to the same period of 2019. Gross profit margin was favorably impacted by improved pricing, cost containment initiatives and deflation. However, these favorable impacts were offset by unfavorable product mix due to lower volumes on higher margin products and the under absorption of fixed production overhead costs.
Selling and Administrative Expenses
Selling and administrative expenses for the year ended December 31, 2020 decreased by 2.1%, or $49.7 million, compared with the same period of 2019. Due to the COVID-19 global pandemic, we initiated cost containment actions in order to mitigate its impacts on our business including reduced discretionary spending, employee furloughs in certain regions and a six-month delay to annual merit-based salary increases. These amounts were partially offset by higher spending on restructuring and transformation initiatives associated with the completion of the Transaction. However, selling and administrative expenses as a percentage of net revenues for the year ended December 31, 2020 increased 50 basis points from 17.7% to 18.2% primarily due to lower comparable revenue year-over-year.
Interest Expense
Interest expense for the year ended December 31, 2020 increased by $5.9 million compared with the same period of 2019 due to the $1.5 billion issuance of Senior notes during the first quarter of 2019. The increase was partially offset by the redemption of 2.625% Senior notes in April 2020 of $300.0 million and repayment of commercial paper of $179.0 million during the third quarter of 2019.
Other Income/(Expense), Net
The components of Other income/(expense), net, for the years ended December 31 are as follows:
| In millions | 2020 | 2019 | ||||||||||||
| Interest income/(loss) | $ | 4.5 | $ | 0.6 | ||||||||||
| Foreign currency exchange gain (loss) | (10.0) | (9.5) | ||||||||||||
| Other components of net periodic benefit cost | (14.7) | (34.9) | ||||||||||||
| Other activity, net | 24.3 | 15.4 | ||||||||||||
| Other income/(expense), net | $ | 4.1 | $ | (28.4) |
Other income /(expense), net includes the results from activities other than normal business operations such as interest income and foreign currency gains and losses on transactions that are denominated in a currency other than an entity’s functional currency. In addition, we include the components of net periodic benefit cost for pension and post retirement obligations other than the service cost component. Other activity, net includes items associated with certain legal matters as well as asbestos-related activities through the Petition Date. During the year ended December 31, 2020, we recorded a $17.4 million adjustment to correct an overstatement of a legacy legal liability that originated in prior years and a gain of $0.9 million related to the deconsolidation of Murray and its wholly-owned subsidiary ClimateLabs within other activity, net.
Provision for Income Taxes
The 2020 effective tax rate was 23.0% which was higher than the U.S. Statutory rate of 21% due to a $36.5 million non-cash charge related to the establishment of valuation allowances on net deferred tax assets, primarily net operating losses in certain tax jurisdictions and the write-off of a carryforward tax attribute as a result of the completion of the Transaction, U.S. state and local taxes and certain non-deductible employee expenses. These amounts were partially offset by excess tax benefits from employee share-based payments, a $14.0 million benefit primarily related to a reduction in valuation allowances on deferred taxes related to net operating losses as a result of a planned restructuring in a non-U.S. tax jurisdiction and foreign tax credits as a result of revised projections of future foreign source income and earnings in non-U.S. jurisdictions, which in aggregate have a lower effective tax rate. The impact of the changes in the valuation allowances and the write-off of the carryforward tax attribute increased the effective tax rate by 1.7%. Revenues from non-U.S. jurisdictions accounted for approximately 28% of our total 2020 revenues, such that a material portion of our pretax income was earned and taxed outside the U.S. at rates ranging from 0% to 38%. When comparing the results of multiple reporting periods, among other factors, the mix of earnings between U.S. and foreign jurisdictions can cause variability in our overall effective tax rate.
The 2019 effective tax rate was 17.1% which is lower than the U.S. Statutory rate of 21% primarily due to a reduction in deferred tax asset valuation allowances for certain non-U.S. net deferred tax assets and excess tax benefits from employee share-based payments. These amounts were partially offset by U.S. state and local taxes, an increase in a deferred tax asset valuation allowance for certain state net deferred tax assets and certain non-deductible expenses. In addition, the reduction was
also driven by earnings in non-U.S. jurisdictions, which in aggregate, have a lower effective tax rate. Revenues from non-U.S. jurisdictions accounted for approximately 31% of our total 2019 revenues, such that a material portion of our pretax income was earned and taxed outside the U.S. at rates ranging from 0% to 38%. When comparing the results of multiple reporting periods, among other factors, the mix of earnings between U.S. and foreign jurisdictions can cause variability in our overall effective tax rate.
Discontinued Operations
The components of Discontinued operations, net of tax for the years ended December 31 are as follows:
| In millions | 2020 | 2019 | ||||||||||||
| Net revenues | $ | 469.8 | $ | 3,523.0 | ||||||||||
| Pre-tax earnings (loss) from discontinued operations | (136.3) | 397.5 | ||||||||||||
| Tax benefit (expense) | 14.9 | (129.3) | ||||||||||||
| Discontinued operations, net of tax | $ | (121.4) | $ | 268.2 |
Discontinued operations are retained obligations from previously sold businesses, including amounts related to Ingersoll Rand Industrial as part of the completion of the Transaction and asbestos-related activities of Aldrich through the Petition Date. In addition, the year ended December 31, 2020 includes pre-tax Ingersoll Rand Industrial separation costs primarily related to legal, consulting and advisory fees of $114.2 million and a loss of $25.8 million related to the deconsolidation of Aldrich and its wholly-owned subsidiary 200 Park. The year ended December 31, 2019 includes $94.6 million of pre-tax Ingersoll Rand Industrial separation costs.
The components of Discontinued operations, net of tax for the years ended December 31 are as follows:
| In millions | 2020 | 2019 | ||||||||||||
| Ingersoll Rand Industrial, net of tax | $ | (84.9) | $ | 227.6 | ||||||||||
| Other discontinued operations, net of tax | (36.5) | 40.6 | ||||||||||||
| Discontinued operations, net of tax | $ | (121.4) | $ | 268.2 |
Year Ended December 31, 2020 Compared to the Year Ended December 31, 2019 - Segment Results
We operate under three regional operating segments designed to create deep customer focus and relevance in markets around the world.
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Our Americas segment innovates for customers in the North America and Latin America regions. The Americas segment encompasses commercial heating and cooling systems, building controls, and energy services and solutions; residential heating and cooling; and transport refrigeration systems and solutions.
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Our EMEA segment innovates for customers in the Europe, Middle East and Africa region. The EMEA segment encompasses heating and cooling systems, services and solutions for commercial buildings, and transport refrigeration systems and solutions.
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Our Asia Pacific segment innovates for customers throughout the Asia Pacific region. The Asia Pacific segment encompasses heating and cooling systems, services and solutions for commercial buildings and transport refrigeration systems and solutions.
Management measures operating performance based on net earnings excluding interest expense, income taxes, depreciation and amortization, restructuring, unallocated corporate expenses and discontinued operations (Segment Adjusted EBITDA). Segment Adjusted EBITDA is not defined under accounting principles generally accepted in the United States of America (GAAP) and may not be comparable to similarly-titled measures used by other companies and should not be considered a substitute for net earnings or other results reported in accordance with GAAP. We believe Segment Adjusted EBITDA provides the most relevant measure of profitability as well as earnings power and the ability to generate cash. This measure is a useful financial metric to assess our operating performance from period to period by excluding certain items that we believe are not representative of our core business and we use this measure for business planning purposes. Segment Adjusted EBITDA also provides a useful tool for assessing the comparability between periods and our ability to generate cash from operations sufficient to pay taxes, to service debt and to undertake capital expenditures because it eliminates non-cash charges such as depreciation and amortization expense.
The following discussion compares our results for each of our three reportable segments for the year ended December 31, 2020 compared to the year ended December 31, 2019.
| Dollar amounts in millions | 2020 | 2019 | % Change | |||||||||||||||||||||||
| Americas | ||||||||||||||||||||||||||
| Net revenues | $ | 9,685.9 | $ | 10,059.5 | (3.7) | % | ||||||||||||||||||||
| Segment Adjusted EBITDA | 1,677.7 | 1,742.1 | (3.7) | % | ||||||||||||||||||||||
| Segment Adjusted EBITDA as a percentage of net revenues | 17.3 | % | 17.3 | % | ||||||||||||||||||||||
| EMEA | ||||||||||||||||||||||||||
| Net revenues | $ | 1,648.1 | $ | 1,762.6 | (6.5) | % | ||||||||||||||||||||
| Segment Adjusted EBITDA | 265.7 | 267.7 | (0.7) | % | ||||||||||||||||||||||
| Segment Adjusted EBITDA as a percentage of net revenues | 16.1 | % | 15.2 | % | ||||||||||||||||||||||
| Asia Pacific | ||||||||||||||||||||||||||
| Net revenues | $ | 1,120.7 | $ | 1,253.8 | (10.6) | % | ||||||||||||||||||||
| Segment Adjusted EBITDA | 188.8 | 182.8 | 3.3 | % | ||||||||||||||||||||||
| Segment Adjusted EBITDA as a percentage of net revenues | 16.8 | % | 14.6 | % | ||||||||||||||||||||||
| Total Net revenues | $ | 12,454.7 | $ | 13,075.9 | (4.8) | % | ||||||||||||||||||||
| Total Segment Adjusted EBITDA | 2,132.2 | 2,192.6 | (2.8) | % |
Americas
Net revenues for the year ended December 31, 2020 decreased by 3.7% or $373.6 million, compared with the same period of 2019. The components of the period change are as follows:
| Volume | (4.4) | % | |||
| Pricing | 1.0 | % | |||
| Currency translation | (0.3) | % | |||
| Total | (3.7) | % |
During 2020, the Americas region was impacted by the economic environment resulting from the COVID-19 global pandemic; however, strong operational results during the second half of the year mitigated a challenging first half. The decrease in Net revenues primarily related to lower volumes in each of our businesses during the first half of 2020. In addition, unfavorable foreign currency exchange rate movements further contributed to the year-over-year decrease, partially offset by favorable pricing.
Segment Adjusted EBITDA margin for the year ended December 31, 2020 remained flat at 17.3% compared to the same period of 2019. Improved pricing, cost containment initiatives, deflation and lower spending on investments were offset by unfavorable product mix, lower volumes and under absorption of fixed production overhead costs.
EMEA
Net revenues for the year ended December 31, 2020 decreased by 6.5% or $114.5 million, compared with the same period of 2019. The components of the period change are as follows:
| Volume | (8.0) | % | |||
| Pricing | 0.3 | % | |||
| Currency translation | 1.2 | % | |||
| Total | (6.5) | % |
During 2020, the EMEA region was heavily impacted by the economic environment resulting from the COVID-19 global pandemic. The decrease in Net revenues primarily related to lower volumes, partially offset by favorable foreign currency exchange rate movements and improved pricing.
Segment Adjusted EBITDA margin for the year ended December 31, 2020 increased by 90 basis points to 16.1% compared to 15.2% for the same period of 2019. The increase was primarily driven by cost containment initiatives, lower spending on investments, favorable foreign currency exchange rate movements and improved pricing. These amounts were partially offset by lower volumes, unfavorable product mix and under absorption of fixed production overhead costs.
Asia Pacific
Net revenues for the year ended December 31, 2020 decreased by 10.6% or $133.1 million, compared with the same period of 2019. The components of the period change are as follows:
| Volume | (11.5) | % | |||
| Pricing | 0.5 | % | |||
| Currency translation | 0.4 | % | |||
| Total | (10.6) | % |
During 2020, the Asia Pacific region was heavily impacted by the economic environment resulting from the COVID-19 global pandemic. The decrease in Net revenues primarily related to lower volumes since the beginning of the year, partially offset by improved pricing and favorable foreign currency exchange rate movements.
Segment Adjusted EBITDA margin for the year ended December 31, 2020 increased by 220 basis points to 16.8% compared to 14.6% for the same period of 2019. The increase was primarily driven by cost containment initiatives, improved pricing and deflation. These amounts were partially offset by lower volumes, unfavorable product mix and under absorption of fixed production overhead costs.
Liquidity and Capital Resources
We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. In doing so, we review and analyze our current cash on hand, the number of days our sales are outstanding, inventory turns, capital expenditure commitments and income tax payments. Our cash requirements primarily consist of the following:
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Funding of working capital
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Funding of capital expenditures
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Dividend payments
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Debt service requirements
Our primary sources of liquidity include cash balances on hand, cash flows from operations, proceeds from debt offerings, commercial paper, and borrowing availability under our existing credit facilities. We earn a significant amount of our operating income in jurisdictions where it is deemed to be permanently reinvested. Our most prominent jurisdiction of operation is the U.S. We expect existing cash and cash equivalents available to the U.S. operations, the cash generated by our U.S. operations, our committed credit lines as well as our expected ability to access the capital and debt markets will be sufficient to fund our U.S. operating and capital needs for at least the next twelve months and thereafter for the foreseeable future. In addition, we expect existing non-U.S. cash and cash equivalents and the cash generated by our non-U.S. operations will be sufficient to fund our non-U.S. operating and capital needs for at least the next twelve months and thereafter for the foreseeable future. The maximum aggregate amount of unsecured commercial paper notes available to be issued, on a private placement basis, under the commercial paper program is $2.0 billion, of which we had no outstanding balance as of December 31, 2020.
As of December 31, 2020, we had $3,289.9 million of cash and cash equivalents on hand, of which $2,471.2 million was held by non-U.S. subsidiaries. Cash and cash equivalents held by our non-U.S. subsidiaries are generally available for use in our U.S. operations via intercompany loans, equity infusions or via distributions from direct or indirectly owned non-U.S. subsidiaries for which we do not assert permanent reinvestment. As a result of the Tax Cuts and Jobs Act in 2017, additional repatriation opportunities to access cash and cash equivalents held by non-U.S. subsidiaries have been created. In general, repatriation of cash to the U.S. can be completed with no significant incremental U.S. tax. However, to the extent that we repatriate funds from non-U.S. subsidiaries for which we assert permanent reinvestment to fund our U.S. operations, we would be required to accrue and pay applicable non-U.S. taxes. As of December 31, 2020, we currently have no plans to repatriate funds from subsidiaries for which we assert permanent reinvestment.
Share repurchases are made from time to time in accordance with management's balanced capital allocation strategy, subject to market conditions and regulatory requirements. In October 2018, our Board of Directors authorized the repurchase of up to $1.5
billion of our ordinary shares under a share repurchase program (2018 Authorization) upon completion of the prior authorized share repurchase program. No material amounts were repurchased under this program in 2018. During the year ended December 31, 2019, we repurchased and canceled approximately $750 million of our ordinary shares leaving approximately $750 million remaining under the 2018 Authorization. During the year ended December 31, 2020, we repurchased and canceled approximately $250 million of our ordinary shares leaving approximately $500 million remaining under the 2018 Authorization. Additionally, through February 9, 2021, we repurchased approximately $100 million of our ordinary shares under the 2018 Authorization. In February 2021, our Board of Directors authorized the repurchase of up to $2.0 billion of our ordinary shares under a new share repurchase program (2021 Authorization) upon completion of the 2018 Authorization.
In June 2018, we announced an increase in our quarterly share dividend from $0.45 to $0.53 per ordinary share. This reflected an 18% increase that began with our September 2018 payment and an 83% increase since the beginning of 2016. In February 2021, we announced an 11% increase in our quarterly share dividend from $0.53 to $0.59 per ordinary share that will begin with our March 2021 payment.
We continue to actively manage and strengthen our business portfolio to meet the current and future needs of our customers. We achieve this partly through engaging in research and development and sustaining activities and partly through acquisitions. Each year, we make a significant investment in new product development and new technology innovation as they are key factors in achieving our strategic objectives as a leader in the climate sector. We also focus on partnering with our suppliers and technology providers to align their investment decisions with our technical requirements. In addition, we have a strong focus on sustaining activities, which include costs incurred to reduce production costs, improve existing products, create custom solutions for customers and provide support to our manufacturing facilities. Combined, these costs account for approximately two percent of net revenues each year.
In pursuing our business strategy, we routinely conduct discussions, evaluate targets and enter into agreements regarding possible acquisitions, divestitures, joint ventures and equity investments. Since 2018, we have acquired several businesses and entered into a joint venture that complements existing products and services further enhancing our product portfolio. In addition, we completed a Reverse Morris Trust transaction with Gardner Denver whereby we separated Ingersoll Rand Industrial from our business portfolio, transforming the Company into a global climate innovator. We recognized separation-related costs of $114.2 million during the year ended December 31, 2020 and $94.6 million during the year ended December 31, 2019. These expenditures were incurred in order to facilitate the transaction and are included within Discontinued operations, net of tax.
We incur ongoing costs associated with restructuring initiatives intended to result in improved operating performance, profitability and working capital levels. Actions associated with these initiatives may include workforce reductions, improving manufacturing productivity, realignment of management structures and rationalizing certain assets. Post separation, we intend to reduce costs by $140 million through 2021 and an additional $160 million by 2023 for a total of $300 million in total annual savings. We believe that our existing cash flow, committed credit lines and access to the capital markets will be sufficient to fund share repurchases, dividends, research and development, sustaining activities, business portfolio changes and ongoing restructuring actions.
Certain of our subsidiaries entered into Funding Agreements with Aldrich and Murray pursuant to which those subsidiaries are obligated, among other things, to pay the costs and expenses of Aldrich and Murray during the pendency of the Chapter 11 cases to the extent distributions from their respective subsidiaries are insufficient to do so and to provide an amount for the funding for a trust established pursuant to section 524(g) of the Bankruptcy Code, to the extent that the other assets of Aldrich and Murray are insufficient to provide the requisite trust funding.
As the COVID-19 global pandemic impacts both the broader economy and our operations, we will continue to assess our liquidity needs and our ability to access capital markets. A continued worldwide disruption could materially affect economies and financial markets worldwide, resulting in an economic downturn that could affect demand for our products, our ability to obtain financing on favorable terms and otherwise adversely impact our business, financial condition and results of operations. The COVID-19 global pandemic created substantial volatility in the short-term credit markets during the first half of 2020. A recurrence in volatility due to a resurgence in the COVID-19 global pandemic could impact the cost of our credit facilities, the cost of any borrowing we might make under those facilities or the cost of any commercial paper we may issue, to the extent we were to either draw on our facilities or issue commercial paper. See Part I, Item 1A Risk Factors for more information.
Liquidity
The following table contains several key measures of our financial condition and liquidity at the periods ended December 31:
| In millions | 2020 | 2019 | ||||||||||||||||||
| Cash and cash equivalents | $ | 3,289.9 | $ | 1,278.6 | ||||||||||||||||
| Short-term borrowings and current maturities of long-term debt (1) | 775.6 | 650.3 | ||||||||||||||||||
| Long-term debt | 4,496.5 | 4,922.9 | ||||||||||||||||||
| Total debt | 5,272.1 | 5,573.2 | ||||||||||||||||||
| Total Trane Technologies plc shareholders’ equity | 6,407.7 | 7,267.6 | ||||||||||||||||||
| Total equity | 6,427.1 | 7,312.4 | ||||||||||||||||||
| Debt-to-total capital ratio | 45.1 | % | 43.3 | % |
(1) The $300.0 million of 2.625% Senior notes due in May 2020 were redeemed in April 2020.
Debt and Credit Facilities
Our short-term obligations primarily consists of current maturities of long-term debt. In addition, we have outstanding $343.0 million of fixed rate debentures that contain a put feature that the holders may exercise on each anniversary of the issuance date. If exercised, we are obligated to repay in whole or in part, at the holder’s option, the outstanding principal amount (plus accrued and unpaid interest) of the debentures held by the holder. We also maintain a commercial paper program which is used for general corporate purposes. Under the program, the maximum aggregate amount of unsecured commercial paper notes available to be issued, on a private placement basis, is $2.0 billion as of December 31, 2020. We had no commercial paper outstanding at December 31, 2020 and December 31, 2019. See Note 8 to the Consolidated Financial Statements for additional information regarding the terms of our short-term obligations.
Our long-term obligations primarily consist of long-term debt with final maturity dates ranging between 2021 and 2049. In addition, we maintain two $1.0 billion senior unsecured revolving credit facilities, one of which matures in March 2022 and the other in April 2023. The facilities provide support for our commercial paper program and can be used for working capital and other general corporate purposes. Total commitments of $2.0 billion were unused at December 31, 2020 and December 31, 2019. See Note 8 to the Consolidated Financial Statements and further below in Supplemental Guarantor Financial Information for additional information regarding the terms of our long-term obligations and their related guarantees.
Cash Flows
The following table reflects the major categories of cash flows for the years ended December 31, respectively. For additional details, please see the Consolidated Statements of Cash Flows in the Consolidated Financial Statements.
| In millions | 2020 | 2019 | ||||||||||||||||||
| Net cash provided by (used in) continuing operating activities | $ | 1,766.2 | $ | 1,523.7 | ||||||||||||||||
| Net cash provided by (used in) continuing investing activities | (338.5) | (281.8) | ||||||||||||||||||
| Net cash provided by (used in) continuing financing activities | 884.3 | 272.0 |
Operating Activities
Net cash provided by continuing operating activities for the year ended December 31, 2020 was $1,766.2 million, of which net income provided $1,422.5 million after adjusting for non-cash transactions. Changes in other assets and liabilities, net provided $343.7 million. Net cash provided by continuing operating activities for the year ended December 31, 2019 was $1,523.7 million, of which net income provided $1,594.0 million after adjusting for non-cash transactions. Changes in other assets and liabilities, net used $70.3 million. The year-over-year increase in net cash provided by continuing operating activities was primarily driven by improved working capital whereby lower inventory and higher outstanding accounts payable balances more than offset higher accounts receivable and lower earnings in the current year.
Investing Activities
Cash flows from investing activities represents inflows and outflows regarding the purchase and sale of assets. Primary activities associated with these items include capital expenditures, proceeds from the sale of property, plant and equipment, acquisitions, investments in joint ventures and divestitures. During the year ended December 31, 2020, net cash used in investing activities from continuing operations was $338.5 million. The primary drivers of the usage was attributable to the acquisition of businesses, which totaled $182.8 million, net of cash acquired and $146.2 million of capital expenditures. In addition, as a result of the deconsolidation of Murray and its wholly-owned subsidiary ClimateLabs under the Chapter 11 bankruptcy filing, the assets and liabilities of these entities were derecognized, which resulted in a cash outflow of $10.8
million. During the year ended December 31, 2019, net cash used in investing activities from continuing operations was $281.8 million. The primary drivers of the usage was attributable to $205.4 million of capital expenditures and the acquisition of several businesses, which totaled $83.4 million, net of cash acquired.
Financing Activities
Cash flows from financing activities represent inflows and outflows that account for external activities affecting equity and debt. Primary activities associated with these actions include paying dividends to shareholders, repurchasing our own shares, issuing our stock and debt transactions. During the year ended December 31, 2020, net cash provided by financing activities from continuing operations was $884.3 million. The primary driver of the inflow related to the receipt of a special cash payment of $1.9 billion pursuant to the completion of the Transaction. This amount was partially offset by dividends paid to ordinary shareholders of $507.3 million, the repayment of long term debt of $307.5 million and the repurchase of $250.0 million in ordinary shares. During the year ended December 31, 2019, net cash provided by financing activities from continuing operations was $272.0 million. The primary driver of the inflow related to the issuance of $1.5 billion of senior notes during the period. This amount was partially offset by the repurchase of $750.1 million in ordinary shares and dividends paid to ordinary shareholders of $510.1 million.
Free Cash Flow
Free cash flow is a non-GAAP measure and defined as net cash provided by (used in) continuing operating activities, less capital expenditures, plus cash payments for restructuring and transformation costs. This measure is useful to management and investors because it is consistent with management's assessment of our operating cash flow performance. The most comparable GAAP measure to free cash flow is net cash provided by (used in) continuing operating activities. Free cash flow may not be comparable to similarly-titled measures used by other companies and should not be considered a substitute for net cash provided by (used in) continuing operating activities in accordance with GAAP.
A reconciliation of net cash provided by (used in) continuing operating activities to free cash flow the years ended December 31 is as follows:
| In millions | 2020 | 2019 | ||||||||||||
| Net cash provided by (used in) continuing operating activities | $ | 1,766.2 | $ | 1,523.7 | ||||||||||
| Capital expenditures | (146.2) | (205.4) | ||||||||||||
| Cash payments for restructuring | 68.9 | 45.3 | ||||||||||||
| Transformation costs paid | 25.4 | 4.3 | ||||||||||||
| Free cash flow (1) | $ | 1,714.3 | $ | 1,367.9 |
(1) Represents a non-GAAP measure.
Pension Plans
Our investment objective in managing defined benefit plan assets is to ensure that all present and future benefit obligations are met as they come due. We seek to achieve this goal while trying to mitigate volatility in plan funded status, contribution and expense by better matching the characteristics of the plan assets to that of the plan liabilities. Our approach to asset allocation is to increase fixed income assets as the plan's funded status improves. We monitor plan funded status and asset allocation regularly in addition to investment manager performance. In addition, we monitor the impact of market conditions on our defined benefit plans on a regular basis. None of our defined benefit pension plans have experienced a significant impact on their liquidity due to market volatility. See Note 12 to the Consolidated Financial Statements for additional information regarding pensions.
Supplemental Guarantor Financial Information
Trane Technologies plc (Plc or Parent Company) and certain of its 100% directly or indirectly owned subsidiaries provide guarantees of public debt issued by other 100% directly or indirectly owned subsidiaries. The following table shows our guarantor relationships as of December 31, 2020:
| Parent, issuer or guarantors (1) | Notes issued | Notes guaranteed | ||||||
| Trane Technologies plc (Plc) | None | All registered notes and debentures | ||||||
| Trane Technologies Irish Holdings Unlimited Company (TT Holdings) | None | All notes issued by TT Lux and TTC HoldCo | ||||||
| Trane Technologies Lux International Holding Company S.à.r.l. (TT International) | None | All notes issued by TT Lux and TTC HoldCo | ||||||
| Trane Technologies Global Holding Company Limited (TT Global) | None | All notes issued by TT Lux and TTC HoldCo | ||||||
| Trane Technologies Luxembourg Finance S.A. (TT Lux) | 3.550% Senior notes due 2024 3.500% Senior notes due 2026 3.800% Senior notes due 2029 4.650% Senior notes due 2044 4.500% Senior notes due 2049 | All notes and debentures issued by TTC HoldCo and TTC | ||||||
| Trane Technologies HoldCo Inc. (TTC HoldCo) | 2.900% Senior notes due 2021 4.250% Senior notes due 2023 3.750% Senior notes due 2028 5.750% Senior notes due 2043 4.300% Senior notes due 2048 | All notes issued by TT Lux | ||||||
| Trane Technologies Company LLC (TTC) | 9.000% Debentures due 2021 7.200% Debentures due 2021-2025 6.480% Debentures due 2025 Puttable debentures due 2027-2028 | All notes issued by TT Lux and TTC HoldCo |
(1) Plc is formerly known as Ingersoll-Rand plc
TT Holdings is formerly known as Ingersoll-Rand Irish Holdings Unlimited Company
TT International is formerly known as Ingersoll-Rand Lux International Holding Company S.à.r.l
TT Global is formerly known as Ingersoll-Rand Global Holding Company Limited
TT Lux is formerly known as Ingersoll-Rand Luxembourg Finance S.A
TTC HoldCo is a new entity as of June 30, 2020
TTC is the successor to Ingersoll-Rand Company
Each subsidiary debt issuer and guarantor is owned 100% directly or indirectly by the Parent Company. Each guarantee is full and unconditional, and provided on a joint and several basis. There are no significant restrictions of the Parent Company, or any guarantor, to obtain funds from its subsidiaries, such as provisions in debt agreements that prohibit dividend payments, loans or advances to the parent by a subsidiary. The following tables present summarized financial information for the Parent Company and subsidiary debt issuers and guarantors on a combined basis (together, "obligor group") after elimination of intercompany transactions and balances based on the Company’s legal entity ownerships and guarantees outstanding at December 31, 2020. Our obligor groups are as follows: obligor group 1 consists of Plc, TT Holdings, TT International, TT Global, TT Lux, TTC HoldCo and TTC; obligor group 2 consists of Plc, TT Lux and TTC.
Summarized Statement of Comprehensive Income (Loss)
| Year ended December 31, 2020 | |||||||||||
| In millions | Obligor group 1 | Obligor group 2 | |||||||||
| Net revenues | $ | — | $ | — | |||||||
| Gross profit (loss) | — | — | |||||||||
| Intercompany interest and fees | (88.7) | 48.2 | |||||||||
| Earnings (loss) from continuing operations | (493.1) | (375.2) | |||||||||
| Discontinued operations, net of tax | (152.2) | (113.3) | |||||||||
| Net earnings (loss) | (645.3) | (488.5) | |||||||||
| Less: Net earnings attributable to noncontrolling interests | — | — | |||||||||
| Net earnings (loss) attributable to Trane Technologies plc | $ | (645.3) | $ | (488.5) |
Summarized Balance Sheet
| December 31, 2020 | |||||||||||
| In millions | Obligor group 1 | Obligor group 2 | |||||||||
| ASSETS | |||||||||||
| Intercompany receivables | $ | 458.4 | $ | 1,254.7 | |||||||
| Current assets | 1,523.7 | 2,200.5 | |||||||||
| Intercompany notes receivable | 1,331.9 | 1,331.9 | |||||||||
| Noncurrent assets | 2,195.0 | 1,967.2 | |||||||||
| LIABILITIES & EQUITY | |||||||||||
| Intercompany payables | 5,572.2 | 3,599.6 | |||||||||
| Current liabilities | 6,880.3 | 4,539.1 | |||||||||
| Intercompany notes payable | 2,249.7 | — | |||||||||
| Noncurrent liabilities | 7,729.6 | 3,430.5 |
Capital Resources
Based on historical performance and current expectations, we believe our cash and cash equivalents balance, the cash generated from our operations, our committed credit lines and our expected ability to access capital markets will satisfy our working capital needs, capital expenditures, dividends, share repurchases, upcoming debt maturities, and other liquidity requirements associated with our operations for the foreseeable future.
Capital expenditures were $146.2 million, $205.4 million and $284.7 million for the years ended December 31, 2020, 2019 and 2018, respectively. Our investments continue to improve manufacturing productivity, reduce costs, provide environmental enhancements, upgrade information technology infrastructure and security and advanced technologies for existing facilities. The capital expenditure program for 2021 is estimated to be approximately one to two percent of revenues, including amounts approved in prior periods. Many of these projects are subject to review and cancellation at our option without incurring substantial charges.
For financial market risk impacting the Company, see Item 7A. "Quantitative and Qualitative Disclosure About Market Risk."
Capitalization
In addition to cash on hand and operating cash flow, we maintain significant credit availability under our Commercial Paper Program. Our ability to borrow at a cost-effective rate under the Commercial Paper Program is contingent upon maintaining an investment-grade credit rating. As of December 31, 2020, our credit ratings were as follows, remaining unchanged from 2019:
| Short-term | Long-term | |||||||||||||
| Moody’s | P-2 | Baa2 | ||||||||||||
| Standard and Poor’s | A-2 | BBB |
The credit ratings set forth above are not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal by the assigning rating organization. Each rating should be evaluated independently of any other rating.
Our public debt does not contain financial covenants and our revolving credit lines have a debt-to-total capital covenant of 65%. As of December 31, 2020, our debt-to-total capital ratio was significantly beneath this limit.
Contractual Obligations
The following table summarizes our contractual cash obligations by required payment period:
| In millions | Less than 1 year | 1 - 3 years | 3 - 5 years | More than 5 years | Total | |||||||||||||||||||||||||||
| Long-term debt | $ | 775.8 | (a) | $ | 715.8 | $ | 665.1 | $ | 3,150.0 | $ | 5,306.7 | |||||||||||||||||||||
| Interest payments on long-term debt | 231.4 | 415.1 | 345.7 | 1,641.6 | 2,633.8 | |||||||||||||||||||||||||||
| Purchase obligations | 735.2 | — | — | — | 735.2 | |||||||||||||||||||||||||||
| Operating leases | 152.0 | 192.3 | 69.6 | 34.5 | 448.4 | |||||||||||||||||||||||||||
| Total contractual cash obligations | $ | 1,894.4 | $ | 1,323.2 | $ | 1,080.4 | $ | 4,826.1 | $ | 9,124.1 |
(a)Includes $343.0 million of debt redeemable at the option of the holder. The scheduled maturities of these bonds range between 2027 and 2028.
Future expected obligations under the Funding agreement and our pension and postretirement benefit plans, income taxes, environmental and product liability matters have not been included in the contractual cash obligations table above.
Pensions
At December 31, 2020, we had a net unfunded liability of $548.2 million, which consists of noncurrent pension assets of $72.8 million and current and non-current pension benefit liabilities of $621.0 million. It is our objective to contribute to the pension plans to ensure adequate funds are available in the plans to make benefit payments to plan participants and beneficiaries when required. We currently expect that we will contribute approximately $56 million to our enterprise plans worldwide in 2021. The timing and amounts of future contributions are dependent upon the funding status of the plan, which is expected to vary as a result of changes in interest rates, returns on underlying assets, and other factors. Therefore, pension contributions have been excluded from the preceding table. See Note 12 to the Consolidated Financial Statements for additional information regarding pensions.
Postretirement Benefits Other than Pensions
At December 31, 2020, we had postretirement benefit obligations of $389.1 million. We fund postretirement benefit costs principally on a pay-as-you-go basis as medical costs are incurred by covered retiree populations. Benefit payments, which are net of expected plan participant contributions and Medicare Part D subsidy, are expected to be approximately $37 million in 2021. Because benefit payments are not required to be funded in advance, and the timing and amounts of future payments are dependent on the cost of benefits for retirees covered by the plan, they have been excluded from the preceding table. See Note 12 to the Consolidated Financial Statements for additional information regarding postretirement benefits other than pensions.
Income Taxes
At December 31, 2020, we have total unrecognized tax benefits for uncertain tax positions of $65.4 million and $14.6 million of related accrued interest and penalties, net of tax. The liability has been excluded from the preceding table as we are unable to reasonably estimate the amount and period in which these liabilities might be paid. See Note 18 to the Consolidated Financial Statements for additional information regarding income taxes, including unrecognized tax benefits.
Contingent Liabilities
We are involved in various litigation, claims and administrative proceedings, including those related to the Funding Agreements and environmental and product liability matters. We believe that these liabilities are subject to the uncertainties inherent in estimating future costs for contingent liabilities, and will likely be resolved over an extended period of time. Because the timing and amounts of potential future cash flows are uncertain, they have been excluded from the preceding table. See Note 22 to the Consolidated Financial Statements for additional information regarding contingent liabilities.
Critical Accounting Policies
Management’s Discussion and Analysis of Financial Condition and Results of Operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). The preparation of financial statements in conformity with those accounting principles requires management to use judgment in making estimates and assumptions based on the relevant information available at the end of each period. These estimates and assumptions have a significant effect on reported amounts of assets and liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities because they result primarily from the need to make estimates and assumptions on matters that are inherently uncertain. Actual results may differ from these estimates. If updated information or actual amounts are different from previous estimates, the revisions are included in our results for the period in which they become known.
The following is a summary of certain accounting estimates and assumptions made by management that we consider critical.
- Goodwill and indefinite-lived intangible assets – We have significant goodwill and indefinite-lived intangible assets on our balance sheet related to acquisitions. These assets are tested and reviewed annually during the fourth quarter for impairment or when there is a significant change in events or circumstances that indicate that the fair value of an asset is more likely than not less than the carrying amount of the asset. In addition, an interim impairment test is completed upon a triggering event or when there is a reorganization of reporting structure or disposal of all or a portion of a reporting unit.
The determination of estimated fair value requires us to make assumptions about estimated cash flows, including profit margins, long-term forecasts, discount rates and terminal growth rates. We developed these assumptions based on the market and geographic risks unique to each reporting unit. The estimates of fair value are based on the best information available as of the date of the assessment, which primarily incorporates management assumptions about expected future cash flows.
Annual Goodwill Impairment Test
Impairment of goodwill is assessed at the reporting unit level and begins with a qualitative assessment to determine if it is more likely than not that the fair value of each reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the goodwill impairment test under Financial Accounting Standards Board (FASB) Accounting Standard Codification (ASC) 350, "Intangibles-Goodwill and Other" (ASC 350). For those reporting units that bypass or fail the qualitative assessment, the test compares the carrying amount of the reporting unit to its estimated fair value. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired. To the extent that the carrying value of the reporting unit exceeds its estimated fair value, an impairment loss would be recognized for the amount by which the reporting unit's carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill in that reporting unit.
As quoted market prices are not available for our reporting units, the calculation of their estimated fair value is determined using three valuation techniques: a discounted cash flow model (an income approach), a market-adjusted multiple of earnings and revenues (a market approach), and a similar transactions method (also a market approach). The discounted cash flow approach relies on our estimates of future cash flows and explicitly addresses factors such as timing, growth and margins, with due consideration given to forecasting risk. The multiple of earnings and revenues approach reflects the market's expectations for future growth and risk, with adjustments to account for differences between the guideline publicly traded companies and the subject reporting units. The similar transactions method considers prices paid in transactions that have recently occurred in our industry or in related industries. These valuation techniques are weighted 50%, 40% and 10%, respectively.
Interim Goodwill Impairment Test
During the first quarter of 2020, we announced a new organizational model and business segment structure. Under the revised structure, we created three new regional operating segments (which also serve as our reportable segments) previously reported under our former climate segment. In connection with the new segment structure, we performed an interim goodwill impairment assessment immediately prior to the reorganization becoming effective, the results of which did not indicate any goodwill impairment. We then reassigned our goodwill among the newly designated reporting units using a relative fair value approach and immediately performed a second goodwill impairment assessment under the new reporting structure. The results did not indicate any goodwill impairment. We relied on the guideline public company method, specifically a market-adjusted multiple of earnings and revenues approach, to calculate the fair value of the new reporting units.
Other Indefinite-lived intangible assets
Impairment of other intangible assets with indefinite useful lives is first assessed using a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired. This assessment is used as a basis for determining whether it is necessary to calculate the fair value of an indefinite-lived intangible asset. For those indefinite-lived assets where it is required, a fair value is determined on a relief from royalty methodology (income approach) which is based on the implied royalty paid, at an appropriate discount rate, to license the use of an asset rather than owning the asset. The present value of the after-tax cost savings (i.e., royalty relief) indicates the estimated fair value of the asset. Any excess of the carrying value over the estimated fair value would be recognized as an impairment loss equal to that excess.
- Asbestos matters – Prior to the Petition Date, certain of our wholly-owned subsidiaries and former companies were named as defendants in asbestos-related lawsuits in state and federal courts. We recorded a liability for our actual and anticipated future claims as well as an asset for anticipated insurance settlements. We performed a detailed analysis and projected an estimated range of the total liability for pending and unasserted future asbestos-related claims. In accordance with ASC 450, "Contingencies" (ASC 450), we recorded the liability at the low end of the range as we believed that no amount within the range is a better estimate than any other amount. Our key assumptions underlying the estimated asbestos-related liabilities included the number of people occupationally exposed and likely to develop asbestos-related diseases such as mesothelioma and lung cancer, the number of people likely to file an asbestos-related personal injury claim against us, the average settlement and resolution of each claim and the percentage of claims resolved with no payment. Asbestos-related defense costs were excluded from the asbestos claims liability and were recorded separately as services were incurred. None of our existing or previously-owned businesses were a producer or manufacturer of asbestos. We recorded certain income and expenses associated with our asbestos liabilities and corresponding insurance recoveries within Discontinued operations, net of tax, as they related to previously divested businesses, except for amounts associated with asbestos liabilities and corresponding insurance recoveries of Murray and its predecessors, which were recorded within continuing operations.
- Revenue recognition – Revenue is recognized when control of a good or service promised in a contract (i.e., performance obligation) is transferred to a customer. Control is obtained when a customer has the ability to direct the use of and obtain substantially all of the remaining benefits from that good or service. A majority of our revenues are recognized at a point-in-time as control is transferred at a distinct point in time per the terms of a contract. However, a portion of our revenues are recognized over time as the customer simultaneously receives control as we perform work under a contract. For these arrangements, the cost-to-cost input method is used as it best depicts the transfer of control to the customer that occurs as we incurs costs. We adopted Accounting Standard Update (ASU) No. 2014-09, "Revenue from Contracts with Customers" (ASC 606), on January 1, 2018 using the modified retrospective approach. Refer to Note 3, "Summary of Significant Accounting Policies" and Note 13, "Revenue" for additional information related to the adoption of ASC 606.
The transaction price allocated to performance obligations reflects our expectations about the consideration we will be entitled to receive from a customer. To determine the transaction price, variable and noncash consideration are assessed as well as whether a significant financing component exists. We include variable consideration in the estimated transaction price when it is probable that significant reversal of revenue recognized would not occur when the uncertainty associated with variable consideration is subsequently resolved. We consider historical data in determining our best estimates of variable consideration, and the related accruals are recorded using the expected value method.
We enter into sales arrangements that contain multiple goods and services, such as equipment, installation and extended warranties. For these arrangements, each good or service is evaluated to determine whether it represents a distinct performance obligation and whether the sales price for each obligation is representative of standalone selling price. If available, we utilize observable prices for goods or services sold separately to similar customers in similar circumstances to evaluate relative standalone selling price. List prices are used if they are determined to be representative of standalone selling prices. Where necessary, we ensure that the total transaction price is then allocated to the distinct performance obligations based on the determination of their relative standalone selling price at the inception of the arrangement.
We recognize revenue for delivered goods or services when the delivered good or service is distinct, control of the good or service has transferred to the customer, and only customary refund or return rights related to the goods or services exist. For extended warranties and long-term service agreements, revenue for these distinct performance obligations are recognized over time on a straight-line basis over the respective contract term.
- Income taxes – Deferred tax assets and liabilities are determined based on temporary differences between financial reporting and tax bases of assets and liabilities, applying enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. We recognize future tax benefits, such as net operating losses and tax credits, to the extent that realizing these benefits is considered in our judgment to be more likely than not. We regularly review the recoverability of our deferred tax assets considering our historic profitability, projected future taxable income, timing of the reversals of existing temporary differences and the feasibility of our tax planning strategies. Where appropriate, we record a valuation allowance with respect to a future tax benefit.
The provision for income taxes involves a significant amount of management judgment regarding interpretation of relevant facts and laws in the jurisdictions in which we operate. Future changes in applicable laws, projected levels of taxable income, and tax planning could change the effective tax rate and tax balances recorded by us. In addition, tax authorities periodically review income tax returns filed by us and can raise issues regarding our filing positions, timing and amount of income or deductions, and the allocation of income among the jurisdictions in which we operate. A significant period of time may elapse between the filing of an income tax return and the ultimate resolution of an issue raised by a revenue authority with respect to that return. We believe that we have adequately provided for any reasonably foreseeable resolution of these matters. We will adjust our estimate if significant events so dictate. To the extent that the ultimate results differ from our original or adjusted estimates, the effect will be recorded in the provision for income taxes in the period that the matter is finally resolved.
- Employee benefit plans – We provide a range of benefits to eligible employees and retirees, including pensions, postretirement and postemployment benefits. Determining the cost associated with such benefits is dependent on various actuarial assumptions including discount rates, expected return on plan assets, compensation increases, mortality, turnover rates and healthcare cost trend rates. Actuarial valuations are performed to determine expense in accordance with GAAP. Actual results may differ from the actuarial assumptions and are generally accumulated and amortized into earnings over future periods. We review our actuarial assumptions at each measurement date and make modifications to the assumptions based on current rates and trends, if appropriate. The discount rate, the rate of compensation increase and the expected long-term rates of return on plan assets are determined as of each measurement date. We believe that the assumptions utilized in recording our obligations under our plans are reasonable based on input from our actuaries, outside investment advisors and information as to assumptions used by plan sponsors.
Changes in any of the assumptions can have an impact on the net periodic pension cost or postretirement benefit cost. Estimated sensitivities to the expected 2021 net periodic pension cost of a 0.25% rate decline in the two basic
assumptions are as follows: the decline in the discount rate would increase expense by approximately $4.8 million and the decline in the estimated return on assets would increase expense by approximately $7.6 million. A 0.25% rate decrease in the discount rate for postretirement benefits would increase expected 2021 net periodic postretirement benefit cost by $0.5 million.
Recent Accounting Pronouncements
See Note 3 to the Consolidated Financial Statements for a discussion of recent accounting pronouncements.
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