INGERSOLL RAND INC. 
The following discussion contains management's discussion and analysis of our financial condition and results of operations and should be read together with "Item 6. Selected Financial Data" and our audited consolidated financial statements and related notes to our consolidated financial statements included elsewhere in this Form 10-K. This discussion contains forward-looking statements and involves numerous risks and uncertainties. Our actual results may differ materially from those anticipated in any forward-looking statements as a result of many factors, including those set forth under the "Special Note Regarding Forward-Looking Statements," "Item 1A. Risk Factors" and elsewhere in this Form 10-K.
Transaction with
InApril 2019 , our Board of Directors approved a merger that will combineGardner Denver with the industrial segment of Ingersoll-Rand plc ("Ingersoll Rand") (the "Merger"). To facilitate this Merger, Ingersoll Rand will cause specific assets and liabilities of its industrial segment to be transferred toIngersoll-Rand U.S. HoldCo, Inc. ("Ingersoll Rand Industrial "), a newly formed wholly-owned subsidiary of Ingersoll Rand, and distribute the shares of common stock ofIngersoll Rand Industrial to Ingersoll Rand's shareholders. CharmMerger Sub Inc. ("Merger Sub"), which is a newly formed wholly-owned subsidiary ofGardner Denver , will be merged with and intoIngersoll Rand Industrial , withIngersoll Rand Industrial surviving such merger as a wholly-owned subsidiary ofGardner Denver . Pursuant to the definitive agreementGardner Denver entered into with Ingersoll Rand,Ingersoll Rand Industrial and Merger Sub with respect to the Merger (the "Merger Agreement"),Gardner Denver will issue an aggregate number of shares of its common stock toIngersoll Rand Industrial stockholders which will result inIngersoll Rand Industrial stockholders owning approximately, but not less than, 50.1% of the shares ofGardner Denver common stock outstanding on a fully-diluted basis upon the closing of the Merger. The number of shares to be issued toIngersoll Rand Industrial stockholders is based on the exchange ratio set forth in the Merger Agreement. In addition, Ingersoll Rand will receive approximately$1.9 billion in cash fromIngersoll Rand Industrial that will be funded by newly-issued debt that is expected to be deemed issued under the existing Senior Secured Credit Facilities ofGardner Denver upon consummation of the merger. The Merger is expected to close onFebruary 29, 2020 . The Merger will result inGardner Denver acquiringIngersoll Rand Industrial , which includes compressed air and gas systems and services, power tools, material handling systems, fluid management systems as well as Club Car golf, utility and consumer low-speed vehicles. Following the Merger, the combined company is expected to be renamed and operate under the Ingersoll Rand name and its common stock is expected to be listed on theNew York Stock Exchange under Ingersoll Rand's existing ticker symbol "IR."
See Note 3 "Business Combinations" to our audited consolidated financial statements included elsewhere in this Form 10-K for additional information related to the transaction with Ingersoll Rand.
Executive Overview
Our Company
We are a leading global provider of mission-critical flow control and compression equipment and associated aftermarket parts, consumables and services, which we sell across multiple attractive end-markets within the industrial, energy and medical industries. We manufacture one of the broadest and most complete ranges of compressor, pump, vacuum and blower products in our markets, which, combined with our global geographic footprint and application expertise, allows us to provide differentiated product and service offerings to our customers. Our products are sold under a collection of premier, market-leading brands, includingGardner Denver ,CompAir , Nash, Emco Wheaton, Robuschi, Elmo Rietschle and Thomas, which we believe are globally recognized in their respective end-markets and known for product quality, reliability, efficiency and superior customer service. These attributes, along with over 155 years of engineering heritage, generate strong brand loyalty for our products and foster long-standing customer relationships, which we believe have resulted in leading market positions within each of our operating segments. We have sales in more than 175 countries and our diverse customer base utilizes our products across a wide array of end-markets that have favorable near- and long-term growth prospects, including industrial manufacturing, energy (with particular exposure to the North American upstream land-based market), transportation, medical and laboratory sciences, food and beverage packaging and chemical processing. Our products and services are critical to the processes and systems in which they are utilized, which are often complex and function in harsh conditions where the cost of failure or downtime is high. However, our products and services typically represent only a small portion of the costs of the overall systems or functions that they support. As a result, our customers place a high value on our application expertise, product reliability and the responsiveness of our service. To support our customers and market presence, we maintain significant global scale with 38 key manufacturing facilities, more than 30 complementary service and repair centers across six continents and approximately 6,600 employees worldwide as ofDecember 31, 2019 . The process-critical nature of our product applications, coupled with the standard wear and tear replacement cycles associated with the usage of our products, generates opportunities to support customers with our broad portfolio of aftermarket parts, consumables and services. Customers place a high value on minimizing any time their operations are offline. As a result, the availability of replacement parts, consumables and our repair and support services are key components of our value proposition. Our large installed base of products provides a recurring revenue stream through our aftermarket parts, consumables and services offerings. As a result, our aftermarket revenue is significant, representing 38% of total Company revenue and approximately 42% of our combined Industrials and Energy segments' revenue in 2019. 27
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Our Segments
We report our results of operations through three reportable segments: Industrials, Energy and Medical.
Industrials
In the Industrials segment, we design, manufacture, market and service a broad range of air compression, vacuum and blower products across a wide array of technologies and applications. Almost every manufacturing and industrial facility, and many service and process industries, use air compression and vacuum products in a variety of applications such as operation of pneumatic air tools, vacuum packaging of food products and aeration of waste water. We maintain a leading position in our markets and serve customers globally. We offer comprehensive aftermarket parts and an experienced direct and distributor-based service network world-wide to complement all of our products. In 2019, the Industrials segment generated Segment Revenue of$1,301.3 million and Segment Adjusted EBITDA of$296.6 million , reflecting a Segment Adjusted EBITDA Margin of 22.8%. Energy In the Energy segment, we design, manufacture, market and service a diverse range of positive displacement pumps, liquid ring vacuum pumps and compressors, and engineered loading systems and fluid transfer equipment, consumables, and associated aftermarket parts and services. We serve customers in the upstream, midstream, and downstream oil and gas markets, and various other markets including petrochemical processing, power generation, transportation, and general industrial. We are one of the largest suppliers in these markets and have long-standing customer relationships. Our positive displacement pumps are used in the oilfield for drilling, hydraulic fracturing, completion and well servicing. Our liquid ring vacuum pumps and compressors are used in many power generation, mining, oil and gas refining and processing, chemical processing and general industrial applications including flare gas and vapor recovery, geothermal gas removal, vacuum de-aeration, enhanced oil recovery, water extraction in mining and paper and chlorine compression in petrochemical operations. Our engineered loading systems and fluid transfer equipment ensure the safe handling and transfer of crude oil, liquefied natural gas, compressed natural gas, chemicals, and bulk materials. In 2019, the Energy segment generated Segment Revenue of$870.2 million and Segment Adjusted EBITDA of$225.1 million , reflecting a Segment Adjusted EBITDA Margin of 25.9%.
Medical
In the Medical segment, we design, manufacture and market a broad range of highly specialized gas, liquid and precision syringe pumps and compressors primarily for use in the medical, laboratory and biotechnology end markets.
Our
customers are mainly medium and large durable medical equipment suppliers that integrate our products into their final equipment for use in applications such as oxygen therapy, blood dialysis, patient monitoring, wound treatment, and others. Further, with recent acquisitions, we expanded into liquid handling components and systems used in biotechnology applications including clinical analysis instrumentation. We also have a broad range of end use deep vacuum products for laboratory science applications. In 2019, the Medical segment generated Segment Revenue of$280.4 million and Segment Adjusted EBITDA of$84.4 million , reflecting a Segment Adjusted EBITDA Margin of 30.1%.
Components of Our Revenue and Expenses
Revenues
We generate revenue from sales of our highly engineered, application-critical products and by providing associated aftermarket parts, consumables and services. We sell our products and deliver aftermarket services both directly to end-users and through independent distribution channels, depending on the product line and geography. Below is a description of our revenues by segment and factors impacting total revenues.
Industrials Revenue
Our Industrials Segment Revenues are generated primarily through sales of air
compression, vacuum and blower products to customers in multiple industries and
geographies. A significant portion of our sales in the Industrials segment are
made to independent distributors. The majority of Industrials segment revenues
are derived from short duration contracts and revenue is recognized at a single
point in time when control is transferred to the customer, generally at shipment
or when delivery has occurred or services have been rendered. Certain contracts
may involve significant design engineering to customer specifications, and
depending on the contractual terms, revenue is recognized either over the
duration of the contract or at contract completion when equipment is delivered
to the customer. Our large installed base of products in our Industrials
segment drives demand for recurring aftermarket support services primarily
composed of replacement part sales to our distribution partners and, to a lesser
extent, by directly providing replacement parts and repair and maintenance
services to end customers. Revenue for services is recognized when services are
performed.
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Energy Revenue
Our Energy Segment Revenues are generated primarily through sales of positive displacement pumps, liquid ring vacuum pumps, compressors and integrated systems and engineered fluid loading and transfer equipment and associated aftermarket parts, consumables and services for use primarily in upstream, midstream, downstream and petrochemical end-markets across multiple geographies. The majority of Energy segment revenues are derived from short duration contracts and revenue is recognized at a single point in time when control is transferred to the customer, generally at shipment or when delivery has occurred or services have been rendered. Certain contracts with customers in the mid- and downstream and petrochemical markets are higher sales value and often have longer lead times and involve more application specific engineering. Depending on the contractual terms, revenue is recognized either over the duration of the contract or at contract completion when equipment is delivered to the customer. Provisions for estimated losses on uncompleted contracts are recognized in the period in which such losses are determined to be probable. As a result, the timing of these contracts can result in significant variation in reported revenue from quarter to quarter. Our large installed base of products in our Energy segment drives demand for recurring aftermarket support services to customers, including replacement parts, consumables and repair and maintenance services. The mix of aftermarket to original equipment revenue within the Energy segment is impacted by trends in upstream energy activity inNorth America . Revenue for services is recognized when services are performed. In response to customer demand for faster access to aftermarket parts and repair services, we expanded our direct aftermarket service locations in our Energy segment, particularly in North American markets driven by upstream energy activity. Energy segment products and aftermarket parts, consumables and services are sold both directly to end customers and through independent distributors, depending on the product category and geography.
Medical Revenue
Our Medical Segment Revenues are generated primarily through sales of highly specialized gas, liquid and precision syringe pumps that are specified by medical and laboratory equipment suppliers for use in medical and laboratory applications. Our products are often subject to extensive collaborative design and specification requirements, as they are generally components specifically designed for, and integrated into, our customers' products. Revenue is recognized when control is transferred to the customer, generally at shipment or when delivery has occurred. Our Medical segment also has limited aftermarket revenues related to certain products.
Expenses
Cost of Sales
Cost of sales includes the costs we incur, including purchased materials, labor and overhead related to manufactured products and aftermarket parts sold during a period. Depreciation related to manufacturing equipment and facilities is included in cost of sales. Purchased materials represent the majority of costs of sales, with steel, aluminum, copper and partially finished castings representing our most significant materials inputs. Stock-based compensation expense for employees associated with the manufacture of products or delivery of services to customers is included in cost of sales. We have instituted a global sourcing strategy to take advantage of coordinated purchasing opportunities of key materials across our manufacturing plant locations. Cost of sales for services includes the direct costs we incur, including direct labor, parts and other overhead costs including depreciation of equipment and facilities, to deliver repair, maintenance and other field services to our customers.
Selling and Administrative Expenses
Selling and administrative expenses consist of (i) salaries and other employee-related expenses for our selling and administrative functions and other activities not associated with the manufacture of products or delivery of services to customers; (ii) facility operating expenses for selling and administrative activities, including office rent, maintenance, depreciation and insurance; (iii) marketing and direct costs of selling products and services to customers including internal and external sales commissions; (iv) research and development expenditures; (v) professional and consultant fees; (vi) KKR fees and expenses; (vii) expenses related to our public stock offerings and to establish public company reporting compliance; (viii) employee related stock-based compensation for our selling and administrative functions and other activities not associated with the manufacture of products or delivery of services to customers; and (ix) other miscellaneous expenses. Certain corporate expenses, including those related to our shared service centers inthe United States andEurope , that directly benefit our businesses are allocated to our business segments. Certain corporate administrative expenses, including corporate executive compensation, treasury, certain information technology, internal audit and tax compliance, are not allocated to the business segments. 29
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Amortization of Intangible Assets
Amortization of intangible assets includes the periodic amortization of intangible assets recognized when an affiliate of KKR acquired us onJuly 30, 2013 , intangible assets recognized in connection with businesses we acquired sinceJuly 30, 2013 , including customer relationships and trademarks, and internally developed software.
Impairment of Other Intangible Assets
Impairment of other intangible assets includes non-cash charges we recognized for the impairment of intangible assets other than goodwill.
Other Operating Expense, Net
Other operating expense, net includes foreign currency gains and losses, restructuring charges, certain litigation and contract settlement losses, environmental remediation and other miscellaneous operating expenses.
Provision (Benefit) for Income Taxes
The provision or benefit for income taxes includesU.S. federal, state and local income taxes and all non-U.S. income taxes. We are subject to income tax in approximately 35 jurisdictions outside ofthe United States . Because we conduct operations on a global basis, our effective tax rate depends, and will continue to depend, on the geographic distribution of our pre-tax earnings among several different taxing jurisdictions. Our effective tax rate can also vary based on changes in the tax rates of the different jurisdictions, the availability of tax credits and non-deductible items.
Items Affecting our Reported Results
General Economic Conditions and Capital Spending in the Industries We Serve
Our financial results closely follow changes in the industries and end-markets we serve. Demand for most of our products depends on the level of new capital investment and planned and unplanned maintenance expenditures by our customers. The level of capital expenditures depends, in turn, on the general economic conditions as well as access to capital at reasonable cost. In particular, demand for our Industrials products generally correlates with the rate of total industrial capacity utilization and the rate of change of industrial production. Capacity utilization rates above 80% have historically indicated a strong demand environment for industrial equipment. In our Energy segment, demand for our products that serve upstream energy end-markets are influenced heavily by energy prices and the expectation as to future trends in those prices. Energy prices have historically been cyclical in nature and are affected by a wide range of factors. In addition to energy prices, demand for our upstream energy products are positively impacted by increasing global land rig count, drilled but uncompleted wells, the level of hydraulic fracturing intensity and activity measured by horsepower utilization and lateral lengths as well as drilling and completion capital expenditures. In the midstream and downstream portions of our Energy segment, overall economic growth and industrial production, as well as secular trends, impact demand for our products. In our Medical segment we expect demand for our products to be driven by favorable trends, including the growth in healthcare spend and expansion of healthcare systems due to an aging population requiring medical care and increased investment in health solutions and safety infrastructures in emerging economies. Over longer time periods, we believe that demand for all of our products also tends to follow economic growth patterns indicated by the rates of change in the GDP around the world, as augmented by secular trends in each segment. Our ability to grow and our financial performance will also be affected by our ability to address a variety of challenges and opportunities that are a consequence of our global operations, including efficiently utilizing our global sales, manufacturing and distribution capabilities and engineering innovative new product applications for end-users in a variety of geographic markets.
Foreign Currency Fluctuations
A significant portion of our revenues, approximately 56% for the year endedDecember 31, 2019 , was denominated in currencies other than theU.S. dollar. Because much of our manufacturing facilities and labor force costs are outside ofthe United States , a significant portion of our costs are also denominated in currencies other than theU.S. dollar. Changes in foreign exchange rates can therefore impact our results of operations and are quantified when significant to our discussion. 30
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Factors Affecting the Comparability of our Results of Operations
As a result of a number of factors, our historical results of operations are not comparable from period to period and may not be comparable to our financial results of operations in future periods. Key factors affecting the comparability of our results of operations are summarized below.
Variability within Upstream Energy Markets
We sell products and services to customers in upstream energy markets, primarily inthe United States . For the upstream energy end-market, in our Energy segment, we manufacture pumps and associated aftermarket products and services used in drilling, hydraulic fracturing and well service applications. Demand for upstream energy products has historically corresponded to the supply and demand dynamics related to oil and natural gas products, and has been influenced by oil and natural gas prices, the level and intensity of hydraulic fracturing activity rig count, drilling activity and other economic factors. These factors have caused the level of demand for certain of our Energy products to change at times (both positively and negatively) and we expect these trends to continue in the future. We believe it is helpful to consider the impact of our energy exposure to upstream energy in evaluating our 2018 and 2019 Segment Revenue and Segment Adjusted EBITDA, in order to better understand other drivers of our performance during those periods, including operational improvements. For the Energy segments, we assess the impact of our exposure to upstream energy as the portion of Energy Segment Adjusted EBITDA of the business unit serving the upstream energy market.
Restructuring and Other Business Transformation Initiatives
We continue to implement business transformation initiatives. A key element of those business transformation initiatives was restructuring programs within our Industrials, Energy and Medical segments as well as at the Corporate level. Restructuring charges, program related facility reorganization, relocation and other costs, and related capital expenditures were impacted most significantly. We announced a restructuring program in the third quarter of 2018 that primarily involves workforce reductions and facility consolidations. For the years endedDecember 31, 2019 and 2018,$17.1 million and$12.7 million , respectively were charged to expense related to this restructuring program.
Acquisitions
Part of our strategy for growth is to acquire complementary flow control and compression equipment businesses, which provide access to new technologies or geographies or improve our aftermarket offerings. InJune 2017 , within our Industrials segment, we acquired a leading North American manufacturer of gas compression equipment and solutions for vapor recovery, biogas and other process and industrial applications for approximately$20.4 million , net of cash acquired (inclusive of an indemnity holdback of$1.9 million ). InFebruary 2018 , we acquired a leading global manufacturer of turbo vacuum technology systems and optimization solutions for industrial applications in our Industrials segment for total consideration, net of cash acquired, of approximately$94.9 million . InMay 2018 , we acquired a leading manufacturer of plungers and other well service pump consumable products in our Energy segment for total consideration, net of cash acquired, of approximately$21.0 million (inclusive of cash payments of$18.8 million , a$2.0 million promissory note and a$0.2 million holdback). InNovember 2018 , we acquired a leading manufacturer of rotary screws and piston compressors and associated aftermarket parts in our Industrials segment for total consideration, net of cash acquired, of$16.1 million (inclusive of cash payments of$14.8 million and a$1.3 million holdback). InDecember 2018 , we acquired a leading manufacturer of specialty industrial pumps and associated aftermarket parts in our Industrials segment for total consideration of$58.5 million , net of cash acquired (inclusive of cash payments of$57.8 million and a$0.7 million holdback). InJuly 2019 , we acquired a company which specializes in customized pump solutions for liquid handling processes for use in medical, process and industrial applications, in our Medical segment for total consideration, net of cash acquired, of$10.0 million (inclusive of cash payments of$5.6 million , a$1.6 million holdback and up to$2.8 million in contingent earn-out provisions). InAugust 2019 , we acquired a provider of vacuum pumps, blowers and compressors in our Industrials segment for total consideration, net of cash acquired, of$7.0 million (inclusive of cash payments of$5.9 million and a$1.1 million deferred payment). The revenues for these acquisitions subsequent to the respective dates of acquisition included in our financial results were$137.6 million $96.2 million and$13.9 million for the years endedDecember 31, 2019 , 2018 and 2017, respectively. The operating income for these acquisitions subsequent to their respective dates of acquisition, including organic growth since acquisition, included in our financial results was$19.1 million ,$8.3 million and$1.4 million for the years endedDecember 31, 2019 , 2018 and 2017, respectively. 31
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See Note 3 "Business Combinations" to our audited consolidated financial
statements included elsewhere in this Form 10-K for further discussion around
the outstanding holdbacks for the years ended
Stock-Based Compensation Expense
For the year ended
For the year endedDecember 31, 2019 , we incurred stock-based compensation expense of approximately$19.2 million which was increased by$3.9 million due to costs associated with employer taxes. See Note 17 "Stock-Based Compensation" to our audited consolidated financial statements included elsewhere in this Form 10-K for further discussion around our stock-based compensation expense.
Income Taxes
OnDecember 22, 2017 , the 2017 Tax Cuts and Jobs Act ("Tax Act") was enacted into law. The new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effectiveJanuary 1, 2018 , among others. We are required to recognize the effect of the tax law changes, including the determination of the transition tax, the remeasurement of ourU.S. deferred tax assets and liabilities as well as the reassessment of the net realizability of our deferred tax assets and liabilities, in the period of enactment. InDecember 2017 , theSEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118"), which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. As a result, we previously provided a provisional estimate of the effect of the Tax Act in our financial statements for 2017 and through the first nine months of 2018. In the fourth quarter of 2018, we completed our accounting for all of the enactment-date income tax effects of the Tax Act by increasing the total benefit taken in 2017 of$95.3 million to$96.5 million . Due to the Tax Act, the totalU.S. deferred changed from a tax benefit of$89.6 million in 2017 to$74.5 million in 2018, with a 2018 measurement-period adjustment of$15.1 million and the ASC 740-30 (formerly APB 23) liability, related to the permanent reinvestment of earnings in foreign subsidiaries assertion, changed from a tax benefit of$69.0 million in 2017 to$72.5 million in 2018, with a 2018 measurement-period adjustment of$3.5 million . The provisional one-time transition tax of$63.3 million in 2017 decreased to$50.5 million in 2018, with a 2018 measurement-period adjustment of$12.8 million . The total$1.2 million benefit had a (0.3)% impact to the overall rate in 2018. The Tax Act creates a new requirement that certain income (i.e., GILTI) earned by controlled foreign corporations ("CFC") must be included currently in the gross income of the CFCs'U.S. shareholder. GILTI is the excess of the shareholder's "net CFC tested income" over the net deemed tangible income return, which is currently defined as the excess of (1) 10% of the aggregate of theU.S. shareholder's pro rata share of the qualified business asset investment of each CFC with respect to which it is aU.S. shareholder over (2) the amount of certain interest expense taken into account in the determination of net CFC-tested income. UnderU.S. GAAP, we are allowed to make an accounting policy election of either (1) treating taxes due on futureU.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the "period cost method") or (2) factoring such amounts into a company's measurement of its deferred taxes (the "deferred method"). The Company has determined that it will follow the period cost method (option 1 above) going forward. The tax provision for the twelve month period endedDecember 31, 2019 reflects this decision. All of the additional calculations and rule changes found in the Tax Act have been considered in the tax provision for the year endedDecember 31, 2019 . The Company recorded a tax expense of$2.0 million in 2019 for the GILTI provisions of the Tax Act that were effective for the first time during 2018.
See Note 15 "Income Taxes" to our audited consolidated financial statements included elsewhere in this Form 10-K.
Outlook
Industrials Segment
The mission-critical nature of our Industrials products across manufacturing processes drives a demand environment and outlook that are correlated with global and regional industrial production, capacity utilization and long-term GDP growth. In the fourth quarter of 2019, we booked$307.6 million of orders in our Industrials segment, a decrease of 4.6% over the fourth quarter of 2018, or a 3.1% decrease on a constant currency basis. 32
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Energy Segment
Our Energy segment has a diverse range of equipment and associated aftermarket parts, consumables and services for a number of market sectors with both energy exposure, spanning upstream, midstream, downstream and petrochemical applications. Our upstream products demand environment and outlook are influenced heavily by the supply and demand dynamics related to oil and natural gas products, and has been influenced by oil and natural gas prices, the level and intensity of hydraulic fracturing activity, global land rig count, drilled but uncompleted wells and other economic factors. These factors have caused the level of demand for certain of our upstream products to change at times (both positively and negatively) and we expect these trends to continue in the future. We believe we are well positioned to continue to benefit given our market position, diverse range of equipment, aftermarket parts and consumables and our service presence, despite the current demand environment. Our midstream and downstream products demand environment and outlook are relatively stable with attractive, long-term growth trends influenced by long-term GDP growth and the continued increase in the production and transportation of hydrocarbon. Demand for our petrochemical industry products correlates with capital expenditures related to growth and maintenance of petrochemical plants as well as activity levels therein. Advancements in the development of unconventional natural gas resources inNorth America over the past decade have resulted in the abundant availability of locally-sourced natural gas as feedstock for petrochemical plants inNorth America , supporting long-term growth.
In the fourth quarter of 2019, we booked
Medical Segment
In 2020, we believe that demand for products and services in the Medical space will continue to benefit from attractive secular growth trends in the aging population requiring medical care, emerging economies modernizing and expanding their healthcare systems and increased investment globally in health solutions. In addition, we expect growing demand for higher healthcare efficiency, requiring premium and high performance systems. In the fourth quarter of 2019 we booked$63.7 million of orders in our Medical segment, a decrease of 3.2% over 2018, or a 1.8% decrease on a constant currency basis.
How We Assess the Performance of Our Business
We manage operations through the three business segments described above. In
addition to our consolidated GAAP financial measures, we review various non-GAAP
financial measures, including Adjusted EBITDA, Adjusted Net Income and Free Cash
Flow.
We believe Adjusted EBITDA and Adjusted Net Income are helpful supplemental
measures to assist us and investors in evaluating our operating results as they
exclude certain items whose fluctuation from period to period do not necessarily
correspond to changes in the operations of our business. Adjusted EBITDA
represents net income (loss) before interest, taxes, depreciation, amortization
and certain non-cash, non-recurring and other adjustment items. We believe that
the adjustments applied in presenting Adjusted EBITDA are appropriate to provide
additional information to investors about certain material non-cash items and
about non-recurring items that we do not expect to continue at the same level in
the future. Adjusted Net Income is defined as net income (loss) including
interest, depreciation and amortization of non-acquisition related intangible
assets and excluding other items used to calculate Adjusted EBITDA and further
adjusted for the tax effect of these exclusions.
We use Free Cash Flow to review the liquidity of our operations. We measure Free
Cash Flow as cash flows from operating activities less capital expenditures. We
believe Free Cash Flow is a useful supplemental financial measure for us and
investors in assessing our ability to pursue business opportunities and
investments and to service our debt. Free Cash Flow is not a measure of our
liquidity under GAAP and should not be considered as an alternative to cash
flows from operating activities.
Management and our board of directors regularly use these measures as tools in
evaluating our operating and financial performance and in establishing
discretionary annual compensation. Such measures are provided in addition to,
and should not be considered to be a substitute for, or superior to, the
comparable measures under GAAP. In addition, we believe that Adjusted EBITDA,
Adjusted Net Income and Free Cash Flow are frequently used by investors and
other interested parties in the evaluation of issuers, many of which also
present Adjusted EBITDA, Adjusted Net Income and Free Cash Flow when reporting
their results in an effort to facilitate an understanding of their operating and
financial results and liquidity.
Adjusted EBITDA, Adjusted Net Income and Free Cash Flow should not be considered
as alternatives to net income (loss) or any other performance measure derived in
accordance with GAAP, or as alternatives to cash flow from operating activities
as a measure of our liquidity. Adjusted EBITDA, Adjusted Net Income and Free
Cash Flow have limitations as analytical tools, and you should not consider such
measures either in isolation or as substitutes for analyzing our results as
reported under GAAP.
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Included in our discussion of our consolidated and segment results below are changes in revenues and Adjusted EBITDA on a Constant Currency basis. Constant Currency information compares results between periods as if exchange rates had remained constant period over period. We define Constant Currency revenues and Adjusted EBITDA as total revenues and Adjusted EBITDA excluding the impact of foreign exchange rate movements and use it to determine the Constant Currency revenue and Adjusted EBITDA growth on a year-over-year basis. Constant Currency revenues and Adjusted EBITDA are calculated by translating current period revenues and Adjusted EBITDA using corresponding prior period exchange rates. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a Constant Currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP.
For further information regarding these measures, see "Item 6. Selected Financial Data."
Results of Operations
Consolidated results should be read in conjunction with segment results and the Segment Information notes to our audited consolidated financial statements included elsewhere in this Form 10-K, which provide more detailed discussions concerning certain components of our consolidated statements of operations.
All
intercompany accounts and transactions have been eliminated within the consolidated results.
This section discusses our results of operations for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 . For a discussion and analysis of the year endedDecember 31, 2018 , compared to the same in 2017, please refer to the "Management's Discussion and Analysis of Financial Condition" and "Results of Operations" included in Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2018 , filed with theSEC onFebruary 27, 2019 . Consolidated Results of Operations for the Years EndedDecember 31, 2019 and 2018 Year Ended December 31, 2019 2018 Consolidated Statements of Operations Revenues$ 2,451.9 $ 2,689.8 Cost of sales 1,540.2 1,677.3 Gross profit 911.7 1,012.5 Selling and administrative expenses 436.4 434.6 Amortization of intangible assets 124.3 125.8 Impairment of other intangible assets - - Other operating expense, net 75.7 9.1 Operating income 275.3 443.0 Interest expense 88.9 99.6 Loss on extinguishment of debt 0.2 1.1 Other income, net (4.7 ) (7.2 ) Income before income taxes 190.9 349.5 Provision for income taxes 31.8 80.1 Net income$ 159.1 $ 269.4 Percentage of Revenues Gross profit 37.2 % 37.6 % Selling and administrative expenses 17.8 % 16.2 % Operating income 11.2 % 16.5 % Net income 6.5 % 10.0 % Adjusted EBITDA(1) 23.0 % 25.3 % Other Financial Data Adjusted EBITDA(1)$ 564.8 $ 681.8 Adjusted net income(1) 332.4 394.7 Cash flows - operating activities 343.3 444.5 Cash flows - investing activities (54.3 ) (235.0 ) Cash flows - financing activities (11.5 ) (373.0 ) Free cash flow(1) 300.1 392.3
(1) See "Item 6. Selected Financial Data" for a reconciliation to the most
directly comparable GAAP measure.
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Revenues
Revenues for 2019 were$2,451.9 million , a decrease of$237.9 million , or 8.8%, compared to$2,689.8 million in 2018. The decrease in revenues was due primarily to lower revenues from upstream exposed markets (8.8% or$235.6 million ) and the unfavorable impact of foreign currencies (2.4% or$65.2 million ), partially offset by improved pricing (1.4% or$36.8 million ) and higher volume in our Industrials and Medical segments including acquisitions (1.1% or$28.9 million ). The percentage of consolidated revenues derived from aftermarket parts and services was 37.8% in 2019 compared to 39.2% in 2018.
Gross Profit
Gross profit in 2019 was$911.7 million , a decrease of$100.8 million , or 10.0%, compared to$1,012.5 million in 2018, and as a percentage of revenues was 37.2% in 2019 and 37.6% in 2018. The decrease in gross profit reflects primarily the lower revenues from upstream energy exposed markets, the unfavorable impact of foreign currencies and higher materials and other manufacturing costs, partially offset by improved pricing. The slight decrease in gross profit as a percentage of revenues primarily reflects the unfavorable impact of foreign currencies and higher materials and other manufacturing costs in our Industrials and Medical segments, partially offset by improved pricing.
Selling and Administrative Expenses
Selling and administrative expenses were$436.4 million in 2019, an increase of$1.8 million , or 0.4%, compared to$434.6 million in 2018. Selling and administrative expenses as a percentage of revenues increased to 17.8% in 2019 from 16.2% in 2018. This increase in selling and administrative expenses was primarily due to increased stock based compensation expense and other employee-related expenses, partially offset by lower professional and consultant fees.
Amortization of Intangible Assets
Amortization of intangible assets was$124.3 million in 2019, a decrease of$1.5 million compared to$125.8 million in 2018. The decrease was primarily due to intangibles that became fully amortized in 2019, partially offset by the amortization of intangibles acquired in 2018 and 2019.
Other Operating Expense, Net
Other operating expense, net was$75.7 million in 2019, an increase of$66.6 million compared to$9.1 million in 2018. The increase was primarily due to increased acquisition related expenses and non-cash charges of$44.0 million , foreign currency transaction losses of$8.1 million in 2019 compared to gains of$1.9 million in 2018, increased restructuring costs of$4.4 million and lower shareholder litigation settlement recoveries of$3.5 million .
Interest Expense
Interest expense was$88.9 million in 2019, a decrease of$10.7 million compared to$99.6 million in 2018. The decrease was primarily due to reduced debt as a result of prepayments in 2018 and 2019, partially offset by an increased weighted-average rate of 5.4% in 2019 compared to 5.2% in 2018.
Other Income, Net
Other income, net, was$4.7 million in 2019, a decrease of$2.5 million compared to$7.2 million in 2018. The decrease in other income, net was primarily due to an increase of$4.6 million in the other components of net periodic benefit cost and a decrease of$0.8 million in other financing income, partially offset by increased gains on postretirement plan investments of$2.9 million .
Provision for Income Taxes
The provision for income taxes was$31.8 million resulting in a 16.7% effective tax rate in 2019 compared to a provision of$80.1 million resulting in a 22.9% effective tax provision rate in 2018. The decrease in the tax provision and the decrease in the effective tax rate is primarily due to a decrease in pretax book income and an increase in a benefit related to equity compensation. 35
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Net Income
Net income was$159.1 million in 2019 compared to net income of$269.4 million in 2018. The decrease in net income was primarily due to lower gross profit on lower revenues and higher other operating expense, net, partially offset by lower interest expense and a lower provision for income taxes.
Adjusted EBITDA
Adjusted EBITDA decreased$117.0 million to$564.8 million in 2019 compared to$681.8 million in 2018. Adjusted EBITDA as a percentage of revenues decreased 230 basis points to 23.0% in 2019 from 25.3% in 2018. The decrease in Adjusted EBITDA was primarily due to lower revenue in upstream energy exposed markets in our Energy segment of$110.4 million , higher selling and administrative expenses of$19.4 million , the unfavorable impact of foreign currencies of$15.6 million , higher materials and other manufacturing costs in our Industrials and Medical segments of$12.4 million and higher volume including acquisitions being offset by the dilutive impact of acquisitions in our Industrials segment of$7.4 million , partially offset by improved pricing of$36.8 million and higher volume in other markets in our Energy segment and in our Medical segment including acquisitions of$10.7 million .
Adjusted Net Income
Adjusted Net Income decreased$62.3 million to$332.4 million in 2019 compared to$394.7 million in 2018. The decrease was primarily due to lower Adjusted EBITDA, partially offset by a lower income tax provision, as adjusted and lower interest expense. Segment Results We classify our businesses into three segments: Industrials, Energy and Medical. Our Corporate operations (as described below) are not discussed separately as any results that had a significant impact on operating results are included in the consolidated results discussion above. We evaluate the performance of our segments based on Segment Revenues and Segment Adjusted EBITDA. Segment Adjusted EBITDA is indicative of operational performance and ongoing profitability. Our management closely monitors Segment Adjusted EBITDA to evaluate past performance and identify actions required to improve profitability.
The segment measurements provided to, and evaluated by, the chief operating decision maker are described in Note 22 "Segment Information" to our audited consolidated financial statements included elsewhere in this Form 10-K.
Included in our discussion of our segment results below are changes in Segment Revenues and Segment Adjusted EBITDA on a Constant Currency basis. Constant Currency information compares results between periods as if exchange rates had remained constant period over period. We define Constant Currency as changes in Segment Revenues and Segment Adjusted EBITDA excluding the impact of foreign exchange rate movements. We use these measures to determine the Constant Currency Segment Revenues and Segment Adjusted EBITDA growth on a year-on-year basis. Constant Currency Segment Revenues and Segment Adjusted EBITDA are calculated by translating current period Segment Revenues and Segment Adjusted EBITDA using prior period exchange rates. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP.
Segment Results for Years Ended
The following tables display Segment Revenues, Segment Adjusted EBITDA and Segment Adjusted EBITDA Margin (Segment Adjusted EBITDA as a percentage of Segment Revenues) for each of our Segments and illustrates, on a percentage basis, the impact of foreign currency fluctuations on Segment Revenues and Segment Adjusted EBITDA growth.
Industrials Segment Results
Constant Currency
Years Ended December 31, Percent Change Percent Change
2019 2018 2019 vs. 2018 2019 vs. 2018
Segment Revenues $ 1,301.3 $ 1,303.3 (0.2 )% 3.1 %
Segment Adjusted EBITDA $ 296.6 $ 288.2 2.9 % 6.2 %
Segment Margin 22.8 % 22.1 % 70 bps
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2019 vs. 2018
Segment Revenues for 2019 were$1,301.3 million , a decrease of$2.0 million , or 0.2%, compared to$1,303.3 million in 2018. The decrease in Segment Revenues was primarily due to unfavorable impact of foreign currencies (3.3% or$42.4 million ), partially offset by improved pricing (2.3% or$29.8 million ) and higher volume including acquisitions (0.8% or$10.6 million ). The percentage of Segment Revenues derived from aftermarket parts and service was 31.4% in 2019 compared to 31.5% in 2018. Segment Adjusted EBITDA in 2019 was$296.6 million , an increase of$8.4 million , or 2.9%, from$288.2 million in 2018. Segment Adjusted EBITDA Margin increased 70 bps to 22.8% from 22.1% in 2018. The increase in Segment Adjusted EBITDA was due primarily to improved pricing of$29.8 million and lower selling and administrative expenses of$5.1 million , partially offset by the unfavorable impact of foreign currencies of$9.6 million , higher material and other manufacturing costs of$9.5 million , and higher volume including acquisitions offset by the dilutive impact of acquisitions$7.4 million . Energy Segment Results Constant Currency Years Ended December 31, Percent Change Percent Change 2019 2018 2019 vs. 2018 2019 vs. 2018 Segment Revenues$ 870.2 $ 1,121.1 (22.4 )% (20.8 )% Segment Adjusted EBITDA$ 225.1 $ 337.8 (33.4 )% (32.3 )% Segment Margin 25.9 % 30.1 % (420) bps 2019 vs. 2018 Segment Revenues for 2019 were$870.2 million , a decrease of$250.9 million , or 22.4%, compared to$1,121.1 million in 2018. The decrease in Segment Revenues was primarily due to lower revenues from upstream energy exposed markets (21.0% or$235.6 million ), the unfavorable impact of foreign currencies (1.3% or$14.9 million ) and lower volume in other markets in our Energy segment (0.3% or$2.8 million ), partially offset by improved pricing in other markets in our Energy segment (0.2% or$2.4 million ). The percentage of Segment Revenues derived from aftermarket parts and service was 58.7% in 2019 compared to 56.6% in 2018. Segment Adjusted EBITDA in 2019 was$225.1 million , a decrease of$112.7 million , or 33.4%, from$337.8 million in 2018. Segment Adjusted EBITDA Margin decreased 420 bps to 25.9% from 30.1% in 2018. The decrease in Segment Adjusted EBITDA was due primarily to lower revenues from upstream energy exposed markets of$110.4 million , the unfavorable impact of foreign currencies of$3.9 million and higher selling and administrative expenses of$2.8 million , partially offset by improved pricing in other markets in our Energy segment of$2.4 million . Medical Segment Results Constant Currency Years Ended December 31, Percent Change Percent Change 2019 2018 2019 vs. 2018 2019 vs. 2018 Segment Revenues$ 280.4 $ 265.4 5.7 % 8.6 % Segment Adjusted EBITDA$ 84.4 $ 75.0 12.5 % 16.3 % Segment Margin 30.1 % 28.3 % 180 bps 2019 vs. 2018 Segment Revenues for 2019 were$280.4 million , an increase of$15.0 million , or 5.7%, compared to$265.4 million in 2018. The increase in Segment Revenues was primarily due to higher volume including acquisitions (6.9% or$18.3 million ) and improved pricing (1.7% or$4.6 million ), partially offset by unfavorable impact of foreign currencies (3.0% or$7.9 million ). The percentage of Segment Revenues derived from aftermarket parts and service was 2.6% in 2019 compared to 3.3% in 2018. Segment Adjusted EBITDA in 2019 was$84.4 million , an increase of$9.4 million , or 12.5%, from$75.0 million in 2018. Segment Adjusted EBITDA Margin increased 180 bps to 30.1% from 28.3% in 2018. The increase in Segment Adjusted EBITDA was due primarily to higher volume including acquisitions of$9.1 million , improved pricing of$4.6 million and lower selling and administrative costs of$1.4 million , partially offset by higher material and other manufacturing costs of$2.9 million and unfavorable impact of foreign currencies of$2.7 million . 37
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Unaudited Quarterly Results of Operations
(in millions, except per share amounts) Year EndedDecember 31, 2019 (1)
Year Ended
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Revenues $ 620.3 $ 629.1 $ 596.7 $ 605.8 $ 619.6 $ 668.2 $ 689.3 $ 712.7
Gross profit 230.5 234.4 221.5 225.3 231.9 249.3 262.4 268.9
Operating
income 80.2 74.6 72.9 47.6 89.8 101.4 117.7 134.1
Net income 47.1 44.9 41.3 25.8 42.4 60.3 72.2 94.5
Weighted
average shares,
basic 201.6 203.4 204.2 204.8 201.6 201.8 201.9 201.1
Weighted
average shares,
diluted 207.7 208.9 209.0 209.4 209.9 209.6 209.1 207.7
Basic earnings
per share 0.23 0.22 0.20 0.13 0.21 0.30 0.36 0.47
Diluted
earnings per
share 0.23 0.21 0.20 0.12 0.20 0.29 0.35 0.45
Adjusted
EBITDA(2) 140.1 147.6 142.2 134.9 148.2 161.6 182.2 189.8
(1) See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations - Factors Affecting the Comparability of our Results of
Operations."
(2) Set forth below are the reconciliations of Net Income to Adjusted EBITDA
Year Ended December 31, 2019 Year Ended
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Net Income 47.1 44.9 41.3 25.8 42.4 60.3 72.2 94.5
Plus:
Interest expense 22.4 22.4 23.2 20.9 26.0 26.1 24.4 23.1
Provision for
income taxes 12.0 8.3 9.0 2.5 23.4 17.2 22.6 16.9
Depreciation and
amortization
expense 45.5 44.4 43.1 45.1 45.0 45.3 44.4 45.7
Restructuring
and related
business
transformation
costs (a) 4.1 2.0 9.9 9.6 4.5 8.4 12.3 13.6
Acquisition
related expenses
and non-cash
charges (b) 1.6 17.1 15.9 20.0 4.6 5.7 2.8 3.6
Environmental
remdiation loss
reserve (c) 0.1 - - - - - - -
Expenses related
to public stock
offerings(d) - - - - 1.4 0.5 0.3 0.7
Establish public
company
financial
reporting
compliance(e) 0.6 - - - 0.8 1.1 1.3 1.1
Stock-based
compensation(f) 9.3 7.1 0.5 6.2 2.7 (0.8 ) 1.1 (5.3 )
Loss on
extinguishment
of debt(g) - 0.2 - - - 0.2 0.9 -
Foreign currency
transaction
losses (gains),
net 3.1 0.6 (0.6 ) 5.0 2.6 (2.4 ) (0.8 ) (1.3 )
Shareholder
litigation
settlement
recoveries(h) (6.0 ) - - - (4.5 ) - - (5.0 )
Other
adjustments(i) 0.3 0.6 (0.1 ) (0.2 ) (0.7 ) - 0.7 2.2
Adjusted EBITDA 140.1 147.6 142.2 134.9 148.2 161.6 182.2 189.8
(a) Restructuring and related business transformation costs consist of (i)
restructuring charges, (ii) severance, sign-on, relocation and executive
search costs, (iii) facility reorganization, relocation and other costs, (iv)
information technology infrastructure transformation, (v) gains and losses on
asset disposals, (vi) consultant and other advisor fees and (vii) other
miscellaneous costs.
(b) Represents costs associated with successful and/or abandoned acquisitions,
including third-party expenses, post-closure integration costs (including
certain incentive and non-incentive cash compensation costs) and non-cash
charges and credits arising from fair value purchase accounting adjustments.
(c) Represents estimated environmental remediation costs and losses related to a
former production facility.
(d) Represents certain expenses related to our secondary offerings.
(e) Represents third party expenses to comply with the requirements of
Sarbanes-Oxley and the accelerated adoption of the new accounting standards
(ASC 606 - Revenue from Contracts with Customers and ASC 842 - Leases) in the
first quarter of 2018 and 2019 respectively, one year ahead of the required
adoption dates for a private company.
(f) Represents stock-based compensation expense recognized for stock options
outstanding for the year ended
by
Represents stock-based compensation expense recognized for the year endedDecember 31, 2018 of$2.8 million , reduced by$5.1 million primarily due to a decrease in the estimated accrual for employer taxes related to DSUs as a result of a lower per share stock price.
(g) Represents losses on extinguishment of portions of the
amendment of the revolving credit facility and losses reclassified from AOCI
into income related to the amendment of the interest rate swaps in
conjunction with the debt repayment.
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(h) Represents insurance recoveries of the Company's shareholder litigation
settlement in 2014.
(i) Includes (i) non-cash impact of net LIFO reserve adjustments, (ii) effects of
amortization of prior service costs and amortization of losses in pension and
other postemployment (''OPEB'') expense, (iii) certain legal and compliance
costs and (iv) other miscellaneous adjustments.
Liquidity and Capital Resources
Our investment resources include cash generated from operations and borrowings under our Revolving Credit Facility and the Receivables Financing Agreement.
For a description of our material indebtedness, see Note 10 "Debt" to our audited consolidated financial statements included elsewhere in this Form 10-K.
As of
As of
Liquidity
A substantial portion of our liquidity needs arise from debt service
requirements, and from the ongoing cost of operations, working capital and
capital expenditures.
Year Ended December 31,
2019 2018
Cash and cash equivalents $ 505.5 $ 221.2
Short-term borrowings and current maturities of long-term debt $ 7.6 $ 7.9
Long-term debt 1,603.8 1,664.2
Total debt $ 1,611.4 $ 1,672.1
We can increase the borrowing availability under the Senior Secured Credit
Facilities by up to $250.0 million in the form of additional commitments under
the Revolving Credit Facility and/or incremental term loans plus an additional
amount so long as we do not exceed a specified senior secured leverage ratio. We
can incur additional secured indebtedness under the Term Loan Facilities if
certain specified conditions are met under the credit agreement governing the
Senior Secured Credit Facilities. Our liquidity requirements are significant
primarily due to debt service requirements. See Note 10 "Debt" to our audited
consolidated financial statements included elsewhere in this Form 10-K for
further details.
Our principal sources of liquidity have been existing cash and cash equivalents,
cash generated from operations and borrowings under the Senior Secured Credit
Facilities and the Receivables Financing Agreement. Our principal uses of cash
will be to provide working capital, meet debt service requirements, fund capital
expenditures and finance strategic plans, including possible acquisitions. We
may also seek to finance capital expenditures under capital leases or other debt
arrangements that provide liquidity or favorable borrowing terms. We continue to
consider acquisition opportunities, but the size and timing of any future
acquisitions and the related potential capital requirements cannot be predicted.
In the event that suitable businesses are available for acquisition upon
acceptable terms, we may obtain all or a portion of the necessary financing
through the incurrence of additional long-term borrowings. As market conditions
warrant, we may from time to time, seek to repay loans that we have borrowed,
including the borrowings under the Senior Secured Credit Facilities. Based on
our current level of operations and available cash, we believe our cash flow
from operations, together with availability under the Revolving Credit Facility
and the Receivables Financing Agreement, will provide sufficient liquidity to
fund our current obligations, projected working capital requirements, debt
service requirements and capital spending requirements for the foreseeable
future. Our business may not generate sufficient cash flows from operations or
future borrowings may not be available to us under our Revolving Credit Facility
or the Receivables Financing Agreement in an amount sufficient to enable us to
pay our indebtedness, or to fund our other liquidity needs. Our ability to do so
depends on, among other factors, prevailing economic conditions, many of which
are beyond our control. In addition, upon the occurrence of certain events, such
as a change in control, we could be required to repay or refinance our
indebtedness. We may not be able to refinance any of our indebtedness, including
the Senior Secured Credit Facilities, on commercially reasonable terms or at
all. Any future acquisitions, joint ventures, or other similar transactions may
require additional capital and there can be no assurance that any such capital
will be available to us on acceptable terms or at all.
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The majority of our cash is in jurisdictions outside ofthe United States . We do not assert ASC 740-30 (formerly APB 23) indefinite reinvestment of our historical non-U.S. earnings or future non-U.S. earnings. The Company records a deferred foreign tax liability to cover all estimated withholding, state income tax and foreign income tax associated with repatriating all non-U.S. earnings back tothe United States . Our deferred income tax liability as ofDecember 31, 2019 is$7.8 million which consists mainly of withholding taxes. Working Capital For the Years Ended December 31, 2019 2018Net Working Capital Current assets$ 1,543.9 $ 1,331.2 Less: Current liabilities 574.6 596.4 Net working capital $ 969.3 $ 734.8Operating Working Capital Accounts receivable and contract assets $ 488.1 $ 545.0 Plus: Inventories (excluding LIFO) 489.5 510.7 Less: Accounts payable 322.9 340.0 Less: Contract liabilities 51.7 69.6 Operating working capital $ 603.0 $ 646.1 Net working capital increased$234.5 to$969.3 as ofDecember 31, 2019 from$734.8 million as ofDecember 31, 2018 . Operating working capital decreased$43.1 million to$603.0 as ofDecember 31, 2019 from$646.1 million as ofDecember 31, 2018 . Operating working capital as ofDecember 31, 2019 was 24.6% of 2019 revenues as compared to 24.0% as ofDecember 31, 2018 as a percentage of 2018 revenues. The decrease in operating working capital was primarily due to lower accounts receivable and lower inventories, partially offset by higher contract assets, lower accounts payable and lower contract liabilities. The decrease in accounts receivable was primarily due to lower sales in 2019 compared to 2018. The decrease in inventory was due to concerted supply chain optimization initiatives. The increase in contract assets was due to the timing of revenue recognition and billing on our overtime contracts. The decrease in contract liabilities was due to the timing of customer milestone payments for in-process engineered to order contracts. The decrease in accounts payable was primarily due to the timing of vendor cash disbursements.
Cash Flows
The following table reflects the major categories of cash flows for the years
ended
Year Ended December 31,
2019 2018
Cash flows - operating activities
(235.0 )
Cash flows - financing activities (11.5 ) (373.0 )
Free cash flow (1) 300.1 392.3
(1) See "Item 6. Selected Financial Data" for a reconciliation to the most
directly comparable GAAP measure.
Operating activities
Cash provided by operating activities decreased$101.2 to$343.3 in 2019 from$444.5 million in 2018, due to lower net income (excluding non-cash charges for depreciation and amortization, non-cash restructuring charges, stock-based compensation expense, foreign currency transaction losses (gains), net, net losses (gains) on asset dispositions, loss on the extinguishment of debt, non-cash change in the LIFO reserve and deferred income taxes) and from cash generated by reduced operating working capital. Operating working capital generated cash of$38.7 million in 2019 compared to generating cash of$54.9 million in 2018. Changes in account receivables generated cash of$54.7 million in 2019 compared to generating cash of$13.2 million in 2018. Changes in contract assets used cash of$9.1 million in 2019 compared to using cash of$19.9 million in 2018. Changes in inventory generated cash of$18.7 million in 2019 compared to using cash of$13.0 million in 2018. Changes in accounts payable used cash of$9.2 million in 2019 compared to generating cash of$69.6 million in 2018. Changes in contract liabilities used cash of$16.4 million in 2019 compared to generating cash of$5.0 million in 2018. 40
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Investing activities
Cash flows used by investing activities included capital expenditures of$43.2 million (1.8% of consolidated revenues) and$52.2 million (1.9% of consolidated revenues) in 2019 and 2018, respectively. We currently expect capital expenditures to total approximately$45.0 million to$55.0 million in 2020. Cash paid in business combinations was$12.0 million in 2019 and$186.3 million in 2018. Net proceeds from the disposal of property, plant and equipment were$0.9 million and$3.5 million in 2019 and 2018, respectively.
Financing activities
Cash used in financing activities of$11.5 million in 2019 reflects repayments of long-term borrowings of$32.8 million , purchases of treasury stock of$18.6 million , payments of$2.3 million for contingent consideration and$0.5 million of debt issuance cost payments, partially offset by proceeds from stock option exercises of$42.7 million associated with approved stock-based compensation plans. Cash used in financing activities of$373.0 million in 2018 reflects repayments of long-term borrowings of$337.6 million , purchases of treasury stock of$40.7 million , payments of$1.4 million for contingent consideration and$0.1 million of other items, partially offset by proceeds from stock option exercises of$6.8 million associated with approved stock-based compensation plans.
Free cash flow
Free cash flow decreased$92.2 million to$300.1 million in 2019 from$392.3 million in 2018 due to decreased cash provided by operating activities of$101.2 million , partially offset by a decrease in capital expenditures of$9.0 million in 2019 compared to 2018.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are materially likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Contractual Obligations
The following table summarizes our future minimum payments as ofDecember 31, 2019 for all contractual obligations for years subsequent to the year endedDecember 31, 2019 . Payments Due by Period More than Contractual Obligations Total 2020 2021-2022 2023-2024 5 years Debt$ 1,601.6 $ 6.9 $ 13.9 $ 1,580.8 $ - Estimated interest payments(1) 313.9 83.4 123.8 101.6 5.1 Finance leases 17.9 0.7 1.6 2.1 13.5 Operating leases 58.1 16.9 22.0 11.6 7.6 Purchase obligations(2) 186.7 162.6 23.3 0.3 0.5 Total$ 2,178.2 $ 270.5 $ 184.6 $ 1,696.4 $ 26.7
(1) Estimated interest payments for long-term debt were calculated as follows:
for fixed-rate debt and term debt, interest was calculated based on
applicable rates and payment dates; for variable-rate debt and/or non-term
debt, interest rates and payment dates were estimated based on management's
determination of the most likely scenarios for each relevant debt instrument.
(2) Purchase obligations consist primarily of agreements to purchase inventory or
services made in the normal course of business to meet operational
requirements. The purchase obligation amounts do not represent the entire
anticipated purchases in the future, but represent only those items for which
we are contractually obligated as of
these amounts will not provide a complete and reliable indicator of our
expected future cash outflows.
Total pension and other postretirement benefit liabilities recognized on our
consolidated balance sheet as of December 31, 2019 were $101.9 million . The
total pension and other postretirement benefit liabilities are included in our
consolidated balance sheet line items "Accrued liabilities" and "Pensions and
other postretirement benefits." Because these liabilities are impacted by, among
other items, plan funding levels, changes in plan demographics and assumptions
and investment return on plan assets, these liabilities do not represent
expected liquidity needs. Accordingly, we did not include these liabilities in
the "Contractual Obligations" table above.
We fund our U.S. qualified pension plans in accordance with the Employee
Retirement Income Security Act of 1974 regulations for the minimum annual
required contribution and Internal Revenue Service regulations for the maximum
annual allowable tax deduction. We are committed to making the required minimum
contributions and expect to contribute a total of approximately $0.1 million to
our U.S. qualified pension plans during 2020. Furthermore, we expect to
contribute a total of approximately $0.3 million to our postretirement life
insurance benefit plans during 2020. Future contributions are dependent upon
various factors including the performance of the plan assets, benefit payment
experience and changes, if any, to current funding requirements. Therefore, no
amounts were included in the "Contractual Obligations" table related to expected
plan contributions. We generally expect to fund all future contributions to our
plans with cash flows from operating activities.
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Our non-U.S. pension plans are funded in accordance with local laws and income tax regulations. We expect to contribute a total of approximately$5.0 million to our non-U.S. qualified pension plans during 2019. No amounts have been included in the "Contractual Obligations" table related to these plans due to the same reasons indicated above. Disclosure of amounts in the "Contractual Obligations" table regarding expected benefit payments in future years for our pension plans and other postretirement benefit plans cannot be properly reflected due to the ongoing nature of the obligations of these plans. We currently anticipate the annual benefit payments for theU.S. plans to be in the range of approximately$4.5 million to$5.4 million for the next several years, and the annual benefit payments for the non-U.S. plans to be in the range of approximately$10.2 million to$12.2 million for the next several years.
Contingencies
We are a party to various legal proceedings, lawsuits and administrative actions, which are of an ordinary or routine nature for a company of our size and in our sector. We believe that such proceedings, lawsuits and administrative actions will not materially adversely affect our operations, financial condition, liquidity or competitive position. We have accrued liabilities and other liabilities on our consolidated balance sheet, including a total litigation reserve of$118.1 million as ofDecember 31, 2019 with respect to potential liability arising from our asbestos-related litigation. Other than our asbestos-related litigation reserves, we only have de minimis accrued liabilities and other liabilities on our consolidated balance sheet with respect to other legal proceedings, lawsuits and administrative actions. A more detailed discussion of certain of these proceedings, lawsuits and administrative actions is set forth in "Item 3. Legal Proceedings."
Critical Accounting Estimates
Accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. Certain of these estimates include determining fair value. All of these estimates reflect our best judgment about current, and for some estimates, future economic and market conditions and their effect based on information available as of the date of these financial statements. If these conditions change from those expected, it is reasonably possible that the judgments and estimates described below could change, which may result in future impairments of goodwill, intangibles and long-lived assets, increases in reserves for contingencies, establishment of valuation allowances on deferred tax assets and increase in tax liabilities, among other effects. Also see Note 1 "Summary of Significant Accounting Policies" to our audited consolidated financial statements included elsewhere in this Form 10-K, which discusses the significant accounting policies that we have selected from acceptable alternatives.
Impairment of
We test goodwill for impairment annually in the fourth quarter of each year using data as ofOctober 1 of that year and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Upon adoption of ASU 2019-04, the impairment test consists of comparing the fair value of the reporting unit to the carrying value of the reporting unit. An impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value; provided, the loss recognized cannot exceed the total amount of goodwill allocated to the reporting unit. If applicable, we consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss. We determined fair values for all of the reporting units using a combination of the income and market multiples approaches which are weighted 75% and 25%, respectively. Under the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. We use our internal forecasts to estimate future cash flows and include an estimate of long-term future growth rates based on our most recent views of the long-term outlook for each business. Actual results may differ from those assumed in our forecasts. We derive our discount rates using a capital asset pricing model and analyzing published rates for industries relevant to our reporting units to estimate the cost of equity financing. We use discount rates that are commensurate with the risks and uncertainty inherent in the respective businesses and in our internally developed forecasts. Discount rates used in our 2019 reporting unit valuations ranged from 9.0% to 10.0%. Additionally, we assumed 3.0% terminal growth rates for all reporting units. Under the market multiples approach, fair value is determined based on multiples derived from the stock prices of publically traded guideline companies to develop a business enterprise value ("BEV") for our reporting units. The application of the market multiples method entails the development of book value multiples based on the market value of the guideline companies. The multiples are developed by first calculating the market value of equity of the guideline companies and then adjusting these multiples for cash and debt to arrive at a BEV multiple. Identifying appropriate guideline companies and computing appropriate market multiples is subjective. We considered various public companies that had reasonably similar qualitative factors as our reporting units while also considering quantitative factors such as revenue growth, profitability and total assets. 42
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For all reporting units, the excess of the estimated fair value over carrying value (expressed as a percentage of carrying value) was a minimum of 42.9%. With each reporting unit's fair value in excess of its carrying value, no goodwill impairment was recorded.
We annually test intangible assets with indefinite lives for impairment utilizing a discounted cash flow valuation referred to as the relief from royalty method. We estimated forecasted revenues for a period of five years with discount rates ranging from 9.0% to 10.0%, a terminal growth rate of 3.0%, and royalty rates ranging from 3.0% to 4.0%. We review identified intangible assets with defined useful lives and subject to amortization for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Determining whether an impairment loss occurred requires comparing the carrying amount to the sum of undiscounted cash flows expected to be generated by the asset.
Also see Note 8 "
Income Taxes
Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions, including evaluating uncertainties. We review our tax positions quarterly and adjust the balances as new information becomes available. OnDecember 22, 2017 , the Tax Act was enacted into law and the new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effectiveJanuary 1, 2018 , among others. We are required to recognize the effect of the tax law changes, including the determination of the transition tax, the remeasurement of ourU.S. deferred tax assets and liabilities as well as the reassessment of the net realizability of our deferred tax assets and liabilities in the period of enactment. InDecember 2017 , theSEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118"), which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. As a result, we previously provided a provisional estimate of the effect of the Tax Act in our financial statements for 2017 and through the first nine month period of 2018. In the fourth quarter of 2018, we completed our accounting for all of the enactment-date income tax effects of the Tax Act by increasing the total benefit taken in 2017 of$95.3 million to$96.5 million . The totalU.S. deferred change due to the Tax Act went from a tax benefit of$89.6 million in 2017 to$74.5 million in 2018, with a 2018 measurement-period adjustment of$15.1 million . The ASC 740-30 (formerly APB 23) liability related to the permanent reinvestment of earnings in foreign subsidiaries assertion, changed from a tax benefit of$69.0 million in 2017 to$72.5 million in 2018, with a 2018 measurement-period adjustment of$3.5 million resulting from a reduction in distributable profits due to restructuring and repatriations and the change in policy that occurred in 2018. The provisional one-time transition tax of$63.3 million in 2017 decreased to$50.5 million in 2018, with a 2018 measurement-period adjustment of$12.8 million . The total$1.2 million benefit had a (0.3)% impact to the overall rate in 2018. The Tax Act creates a new requirement that certain income (i.e., GILTI) earned by CFCs must be included currently in the gross income of the CFCs'U.S. shareholder. GILTI is the excess of the shareholder's "net CFC tested income" over the net deemed tangible income return, which is currently defined as the excess of (1) 10% of the aggregate of theU.S. shareholder's pro rata share of the qualified business asset investment of each CFC with respect to which it is aU.S. shareholder over (2) the amount of certain interest expense taken into account in the determination of net CFC-tested income. UnderU.S. GAAP, we are allowed to make an accounting policy choice of either (1) treating taxes due on futureU.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the "period cost method") or (2) factoring such amounts into a company's measurement of its deferred taxes (the "deferred method"). We determined that we will follow the period cost method (option 1 above) going forward. The tax provision for the year endedDecember 31, 2019 reflects this decision. All of the additional calculations and rule changes found in the Tax Act have been considered in the tax provision for year endedDecember 31, 2019 . The Company recorded a tax expense of$2.0 million in 2019 for the GILTI provisions of the Tax Act that were effective for the first time during 2018. 43
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Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carryforwards. We evaluate the recoverability of these future tax deductions and credits by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These sources of income rely heavily on estimates. To the extent we do not consider it more likely than not that a deferred tax asset will be recovered, a valuation allowance is established. Amounts recorded for deferred tax assets related to tax attribute carryforwards, net of valuation allowances, were$12.7 million and$3.5 million as ofDecember 31, 2019 and 2018, respectively.
Stock-Based Compensation
We account for stock-based compensation plans under the fair value recognition
and measurement provisions in accordance with applicable accounting standards,
which require all stock-based payments to employees and non-employees, including
grants of stock options and deferred stock units ("DSU"), to be measured based
on the grant date fair value of the awards.
The fair value of each stock option grant is estimated using the
Black-Scholes-Merton valuation model. The model requires certain assumptions
including the estimated expected term of the stock options, the risk-free
interest rate and the assumed volatility, of which certain assumptions are
highly complex and subjective. The expected option life represents the period of
time that the options granted are expected to be outstanding based on
management's best estimate of the timing of a liquidity event and the
contractual term of the stock option. As there is not sufficient trading history
of our common stock, we use a group of our competitors which we believe are
similar to us, adjusted for our capital structure, in order to estimate
volatility. Our exercise price is the stock price on the date in which shares
were granted.
Concurrent with the Company's initial public offering in May of 2017, the
Company's Board authorized the grant of 5.5 million DSUs to all permanent
employees that had not previously received stock-based awards under the 2013
Plan. The DSUs vested immediately upon grant, however contain restrictions such
that the employee may not sell or otherwise realize the economic benefits of the
award until certain dates through April 2019 . The fair value of each DSU grant
under the Stock-Based Compensation Plan is estimated on the date of grant or
modification using the Finnerty discount for lack of marketability pricing
model. The discount for lack of marketability is commensurate with the period
of sale restrictions related to the Company's initial public offering.
Prior to our initial public offering, our stock price was calculated based on a
combination of the income approach and the market approach. Under the income
approach, specifically the discounted cash flow method, forecasted cash flows
are discounted to the present value at a risk-adjusted discount rate. The
valuation analyses determine discrete free cash flows over several years based
on forecast financial information provided by management and a terminal value
for the residual period beyond the discrete forecast, which are discounted at an
appropriate rate to estimate our enterprise value. Under the market approach,
specifically the guideline public company method, we select publicly traded
companies with similar financial and operating characteristics as us and
calculate valuation multiples based on the guideline public company's financial
information and market data. Subsequent to the initial public offering, the
estimation of our stock price is no longer necessary as we rely on the market
price to determine the market value of our common stock. For additional
information related to the assumptions used, see Note 17 "Stock-Based
Compensation Plans" to our audited consolidated financial statements included
elsewhere in this Form 10-K.
Loss Contingencies
Loss contingencies are uncertain and unresolved matters that arise in the
ordinary course of business and result from events or actions by others that
have the potential to result in a future loss. Such contingencies include, but
are not limited to, asbestos and silica related litigation, environmental
obligations, litigation, regulatory proceedings, product quality and losses
resulting from other events and developments.
When a loss is considered probable and reasonably estimable, we record a
liability in the amount of our best estimate for the ultimate loss. When there
appears to be a range of possible costs with equal likelihood, liabilities are
based on the low-end of such range. However, the likelihood of a loss with
respect to a particular contingency is often difficult to predict and
determining a meaningful estimate of the loss or a range of loss may not be
practicable based on the information available and the potential effect of
future events and decisions by third parties that will determine the ultimate
resolution of the contingency. In particular, as it relates to estimating
asbestos and silica contingencies, there are a number of key variables and
assumptions including the number and type of new claims to be filed each year,
the resolution or outcome of these claims, the average cost of resolution of
each new claim, the amount of insurance available, allocation methodologies, the
contractual terms with each insurer with whom we have reached settlements, the
resolution of coverage issues with other excess insurance carriers with whom we
have not yet achieved settlements and the solvency risk with respect to our
insurance carriers. Moreover, it is not uncommon for such matters to be
resolved over many years, during which time relevant developments and new
information must be continuously evaluated to determine both the likelihood of
potential loss and whether it is possible to reasonably estimate a range of
possible loss. When a loss is probable but a reasonable estimate cannot be made,
disclosure is provided.
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Disclosure also is provided when it is reasonably possible that a loss will be incurred or when it is reasonably possible that the amount of a loss will exceed the recorded provision. We regularly review all contingencies to determine whether the likelihood of loss has changed and to assess whether a reasonable estimate of the loss or range of loss can be made. As discussed above, development of a meaningful estimate of loss or a range of potential loss is complex when the outcome is directly dependent on negotiations with or decisions by third parties, such as regulatory agencies, the court system and other interested parties. Such factors bear directly on whether it is possible to reasonably estimate a range of potential loss and boundaries of high and low.
Recent Accounting Pronouncements
See Note 2 "New Accounting Standards" to our audited consolidated financial statements included elsewhere in this Form 10-K for a discussion of recent accounting standards.
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