UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2012
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 1-4801
BARNES GROUP INC.
(Exact name of registrant as specified in its charter)
Delaware |  | 06-0247840 | ||
(State of incorporation) | (I.R.S. Employer Identification No.) | |||
123 Main Street, Bristol, Connecticut | 06010 | |||
(Address of Principal Executive Office) | (Zip Code) | |||
(860) 583-7070
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, $0.01 Par Value | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x | Accelerated filer o | |
Non-accelerated filer o | Smaller reporting company o | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the voting stock (Common Stock) held by non-affiliates of the registrant as of the close of business on June 29, 2012 was approximately $1,222,060,627 based on the closing price of the Common Stock on the New York Stock Exchange on that date. The registrant does not have any non-voting common equity.
The registrant had outstanding 54,322,257 shares of common stock as of February 15, 2013.
Documents Incorporated by Reference
Portions of the registrant’s definitive proxy statement to be delivered to stockholders in connection with the Annual Meeting of Stockholders to be held May 3, 2013 are incorporated by reference into Part III.
Barnes Group Inc.
Index to Form 10-K
Year Ended December 31, 2012
Page | ||
Part I | ||
Item 1. | ||
Item 1A. | ||
Item 1B. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Part II | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Item 7A. | ||
Item 8. | ||
Item 9. | ||
Item 9A. | ||
Item 9B. | ||
Part III | ||
Item 10. | ||
Item 11. | ||
Item 12. | ||
Item 13. | ||
Item 14. | ||
Part IV | ||
Item 15. | ||
This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. See “FORWARD-LOOKING STATEMENTS” under Part I - Item 1 "Business" of this Annual Report on Form 10-K.
PART I
Item 1. Business
BARNES GROUP INC. (1)
Barnes Group Inc. is an international aerospace and industrial manufacturer and service provider, serving a wide range of end markets and customers. The products and services provided by Barnes Group are used in far-reaching applications that provide transportation, communication, manufacturing and technology to the world. These vital needs are met by our skilled workforce, a critical resource of Barnes Group. Founded in 1857 and headquartered in Bristol, Connecticut, Barnes Group was organized as a Delaware corporation in 1925. We have paid cash dividends to stockholders on a continuous basis since 1934. As of December 31, 2012, we had approximately 5,100 employees at over 70 locations worldwide. We operate under three global business segments: Aerospace, Industrial and Distribution.
In the first quarter of 2013, the Company entered into a definitive agreement to sell its Barnes Distribution North America business (“BDNA”) to MSC Industrial Direct Co., Inc. subject to certain adjustments. BDNA, which currently comprises the majority of the Company's Distribution segment results, reported 2012 sales of approximately $300 million. See Note 21 of the Consolidated Financial Statements.
Also in the first quarter of 2013, the Company is realigning its reportable business segments by transferring the Associated Spring Raymond business ("Raymond"), its remaining business within the Distribution segment, to the Industrial segment. Raymond sells, among other products, springs that are manufactured by one of the Industrial businesses. Accordingly, the Company's financial results, beginning in the first quarter of 2013, will be reported in two reportable business segments: Aerospace and Industrial. All previously reported segment information will be adjusted on a retrospective basis to reflect this change beginning in the first quarter of 2013.
AEROSPACE
Aerospace produces precision-machined and fabricated components and assemblies for original equipment manufacturer ("OEM") turbine engine, airframe and industrial gas turbine builders throughout the world, and the military. Aerospace also provides jet engine component overhaul and repair ("MRO") services for many of the world's major turbine engine manufacturers, commercial airlines and the military. MRO activities include the manufacture and delivery of aerospace aftermarket spare parts, including the revenue sharing programs (“RSPs”) under which the Company receives an exclusive right to supply designated aftermarket parts over the life of the related aircraft engine program, and component repairs.
Aerospace's OEM business competes with both the leading jet engine OEMs and a large number of machining and fabrication companies. Competition is based mainly on quality, engineering and technical capability, product breadth, timeliness, service and price. Aerospace's machining and fabrication operations, with facilities in Arizona, Connecticut, Michigan, Ohio, Utah and Singapore, produce critical engine and airframe components through technically advanced processes.
The Aerospace aftermarket business competes with aerospace OEMs, service centers of major commercial airlines and other independent service companies for the repair and overhaul of turbine engine components. The manufacturing and supplying of aerospace aftermarket spare parts, including those related to the RSPs, are dependent upon the reliable and timely delivery of high-quality components. Aerospace's aftermarket facilities, located in Connecticut, Ohio and Singapore, specialize in the repair and refurbishment of highly engineered components and assemblies such as cases, rotating air seals, shrouds and honeycomb air seals. Sales by Aerospace to its largest customer, General Electric, accounted for approximately 54% of its sales in 2012. Sales to its next two largest customers in 2012 accounted for approximately 19% of its total sales.
INDUSTRIAL
Industrial is a global supplier of engineered components for critical applications focused on providing solutions for a diverse industrial and transportation customer base. It is equipped to produce virtually every type of precision spring, from fine hairsprings for electronics and instruments to large heavy-duty springs for machinery. It is also a leading manufacturer and supplier of precision mechanical products, including precision mechanical springs, compressor reed valves and nitrogen gas
_____________________
(1) | As used in this annual report, “Company,” “Barnes Group,” “we” and “ours” refer to the registrant and its consolidated subsidiaries except where the context requires otherwise, and “Aerospace,” “Industrial” and “Distribution” refer to the registrant’s segments, not to separate corporate entities. |
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products. Industrial also manufactures high-precision punched and fine-blanked components used in transportation and industrial applications, nitrogen gas springs and manifold systems used to precisely control stamping presses, and retention rings that position parts on a shaft or other axis.
During the third quarter of 2012, the Company completed the acquisition of Synventive Molding Solutions (“Synventive”), a leading designer and manufacturer of highly engineered and customized hot runner systems and components - the enabling technology for many complex injection molding applications. See Note 3 to the Consolidated Financial Statements of this Annual Report on Form 10-K ("Annual Report") for more information. The Synventive business has been integrated into our Industrial segment.
Industrial has a diverse customer base with products purchased by durable goods manufacturers located around the world in industries including transportation, consumer products, farm equipment, telecommunications, medical devices, home appliances and electronics. Long-standing customer relationships enable Industrial to participate in the design phase of components and assemblies through which customers receive the benefits of manufacturing research, testing and evaluation. Products are sold primarily through its direct sales force and a global distribution channel.
Industrial competes with a broad base of large and small companies engaged in the manufacture and sale of custom metal components and assemblies and competes on the basis of quality, service, reliability of supply, engineering and technical capability, product breadth, innovation, design, and price. Industrial has manufacturing, sales, assembly, and distribution operations in the United States, Brazil, Canada, China, Czech Republic, France, Germany, India, Italy, Japan, Mexico, Netherlands, Portugal, Singapore, Slovakia, South Korea, Sweden, Switzerland, Thailand and Turkey. Sales by Industrial to its three largest customers accounted for approximately 17% of its sales in 2012.
DISTRIBUTION
Distribution provides value-added logistics support services including inventory management, technical sales, and supply chain solutions for maintenance, repair, operating, and production supplies and services. The global operations are engaged in supplying, servicing and engineering of maintenance, repair and operating components. Activities include logistics support through vendor-managed inventory and technical sales for stocked replacement parts and other products, catalog offerings and custom solutions. Key business drivers include a value proposition centered on customer service, delivery, multiple sales channels, procurement systems, and strong customer relationships.
During the fourth quarter of 2011, the Company sold its Barnes Distribution Europe businesses (the "BDE" business). The BDE business was comprised of the Company's European KENT, Toolcom and BD France distribution businesses that were reported within the segment formerly referred to as Logistics and Manufacturing Services.
Distribution has sales, distribution, and assembly operations in the United States, Brazil, Canada, China, France, Mexico, Singapore, Spain and the United Kingdom. Products and services are available in more than 30 countries. The Distribution segment faces active competition throughout the world. The products and services offered are not unique, and its competitors provide substantially similar products and services. Competition comes from local, regional, and national maintenance and repair supply distributors and specialty manufacturers of springs, gas struts and engineered hardware. Service alternatives, timeliness and reliability of supply, price, technical capability, product breadth, quality and overall customer service are important competitive factors.
FINANCIAL INFORMATION
The backlog of the Company’s orders believed to be firm at the end of 2012 was $677 million as compared with $582 million at the end of 2011. Of the 2012 year-end backlog, $548 million was attributable to Aerospace and $129 million was attributable to Industrial. Approximately one-third of the year-end backlog is scheduled to be shipped after 2013. The remainder of the Company’s backlog is scheduled to be shipped during 2013.
We continue to have a global manufacturing footprint to service our worldwide customer base. The global economies have a significant impact on the financial results of the business as we have significant operations outside of the United States. For an analysis of our revenue from sales to external customers, operating profit and assets by business segment, as well as revenues from sales to external customers and long-lived assets by geographic area, see Note 18 of the Consolidated Financial Statements of this Annual Report.
RAW MATERIALS
The principal raw materials used to manufacture our products are high-grade steel spring wire and flat rolled steel, stainless steel, titanium and inconel as well as special materials such as cobalt and other complex aerospace alloys. Many of the products distributed by our business are made of steel, copper or brass. Prices for steel, titanium and inconel, as well as other
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specialty materials, have periodically increased due to higher demand and, in some cases, reduction of the availability of materials. If this combination of events occurs, the availability of certain raw materials used by us or in products sold by us may be negatively impacted.
RESEARCH AND DEVELOPMENT
Although most of the products manufactured by us are custom parts made to customers’ specifications, we are engaged in continuing efforts aimed at discovering and implementing new knowledge that is useful in developing new products or services and significantly improving existing products or services. We spent approximately $9 million, $6 million and $6 million in 2012, 2011 and 2010, respectively, on research and development activities.
PATENTS AND TRADEMARKS
The Company is a party to certain licenses and holds a number of patents, trademarks and trade names, some of which are important to certain business units. The Company does not believe, however, that any of these licenses, patents, trademarks or trade names is individually significant to the Company or any of our three segments.
EXECUTIVE OFFICERS OF THE COMPANY
For information regarding the Executive Officers of the Company, see Part III, Item 10 of this Annual Report.
ENVIRONMENTAL
Compliance with federal, state, and local laws, as well as those of other countries, which have been enacted or adopted regulating the discharge of materials into the environment or otherwise relating to the protection of the environment has not had a material effect, and is not expected to have a material effect, upon our capital expenditures, earnings, or competitive position.
AVAILABLE INFORMATION
Our Internet address for our website is www.BGInc.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports are available without charge on our website as soon as reasonably practicable after they are filed with, or furnished to, the Securities and Exchange Commission. In addition, we have posted on our website, and will make available in print to any stockholder who makes a request, our Corporate Governance Guidelines, our Code of Business Ethics and Conduct and the charters of the Audit Committee, Compensation and Management Development Committee and Corporate Governance Committee (the responsibilities of which include serving as the nominating committee) of the Company’s Board of Directors.
FORWARD-LOOKING STATEMENTS
Certain of the statements in this Annual Report may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are made based upon management's good faith expectations and beliefs concerning future developments and their potential effect upon the Company and can be identified by the use of words such as "anticipated," "believe," "expect," "plans," "strategy," "estimate," "project," and other words of similar meaning in connection with a discussion of future operating or financial performance. These forward-looking statements may relate to, among others, the expected impact of the Synventive acquisition on the Company’s financial results, business performance and product offerings; and the impact of the acquisition on the Company’s fiscal revenue, non-GAAP results and GAAP results. These forward-looking statements do not constitute guarantees of future performance and are subject to a variety of risks and uncertainties that may cause actual results to differ materially from those expressed in the forward-looking statements. These include, but are not limited to: the impact of the pending divestiture of the Barnes Distribution North America business to MSC Industrial Direct Co., Inc.; the effects of disruption from the Synventive transaction; difficulty maintaining relationships with employees, customers, distributors, suppliers, business partners or governmental entities; the success of integration strategy implementation; the ability to recruit and retain key personnel and execute effective executive transitions; difficulties leveraging market opportunities; difficulties providing solutions that meet the needs of customers; rapid technological and market change; the ability to protect intellectual property rights; higher risks in international operations and markets; the impact of increased competition; currency fluctuations; litigation; and other risks and uncertainties which are described in this Annual Report, including, among others, uncertainties arising from the current or worsening conditions in financial markets; future financial performance of the industries or customers that we serve; changes in market demand for our products and services; inability to realize expected sales or profits from existing backlog; integration of acquired businesses, including Synventive; restructuring costs or savings; the impact of the divestiture in 2011 of our Barnes Distribution Europe businesses and any other future strategic actions, including acquisitions, joint ventures, divestitures, restructurings, or strategic business realignments, and our ability to achieve the financial and operational targets set in connection with any such actions;
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introduction or development of new products or transfer of work; changes in raw material or product prices and availability; foreign currency exposure; our dependence upon revenues and earnings from a small number of significant customers; a major loss of customers; the outcome of pending and future claims or litigation or governmental, regulatory proceedings, investigations, inquiries, and audits; uninsured claims and litigation; outcome of contingencies; future repurchases of common stock; future levels of indebtedness; and numerous other matters of global, regional or national scale, including those of a political, economic, business, competitive, environmental, regulatory and public health nature. The Company assumes no obligation to update our forward-looking statements.
Item 1A. Risk Factors
Our business, financial condition or results of operations could be materially adversely affected by any of the following risks. Please note that additional risks not presently known to us may also materially impact our business and operations.
RISKS RELATED TO OUR BUSINESS
We depend on revenues and earnings from a small number of significant customers. Any bankruptcy of or loss, cancellation, reduction or delay in purchases by these customers could harm our business. In 2012, our net sales to General Electric and its subsidiaries accounted for 17% of our total sales and approximately 54% of Aerospace's net sales. Additionally, approximately 19% of Aerospace's sales in 2012 were to its next two largest customers. Approximately 17% of Industrial's sales in 2012 were to its three largest customers. Some of our success will depend on the business strength and viability of those customers. We cannot assure you that we will be able to retain our largest customers. A tightening in the credit markets may affect our customers’ ability to raise debt or equity capital. This may reduce the amount of liquidity available to our customers which may limit their ability to purchase products. Some of our customers may in the future reduce their purchases due to economic conditions or shift their purchases from us to our competitors, in-house or to other sources. Some of our long-term sales agreements provide that until a firm order is placed by a customer for a particular product, the customer may unilaterally reduce or discontinue its projected purchases without penalty, or terminate for convenience. The loss of one or more of our largest customers, any reduction, cancellation or delay in sales to these customers (including a reduction in aftermarket volume in our RSPs), our inability to successfully develop relationships with new customers, or future price concessions we make to retain customers could significantly reduce our sales and profitability.
We have significant indebtedness that could affect our operations and financial condition. At December 31, 2012, we had consolidated debt obligations of $646.6 million, representing approximately 45% of our total capital (indebtedness plus stockholders’ equity) as of that date. Our level of indebtedness, proportion of variable rate debt obligations and the significant debt servicing costs associated with that indebtedness may adversely affect our operations and financial condition as well as the value or trading price of our outstanding equity securities and debt securities. For example, our indebtedness could require us to dedicate a substantial portion of our cash flows from operations to payments on our debt, thereby reducing the amount of our cash flows available for working capital, capital expenditures, investments in technology and research and development, acquisitions, dividends and other general corporate purposes; limit our flexibility in planning for, or reacting to, changes in the industries in which we compete; place us at a competitive disadvantage compared to our competitors, some of whom have lower debt service obligations and greater financial resources than we do; limit our ability to borrow additional funds; or increase our vulnerability to general adverse economic and industry conditions. In addition, conditions in the worldwide credit markets may limit our ability to expand our credit lines beyond current bank commitments.
Economic weakness and uncertainty could adversely affect our operations and financial condition. Prolonged slow growth or a downturn, worsening or broadening of adverse conditions in the worldwide and domestic economies could affect purchases of our products, and create or exacerbate credit issues, cash flow issues and other financial hardships for us and for our suppliers and customers. Depending upon their severity and duration, these conditions could have a material adverse impact on our business, liquidity, financial condition and results of operations.
Our failure to meet certain financial covenants required by our debt agreements may materially and adversely affect our assets, financial position and cash flows. A majority of our debt arrangements require us to maintain certain debt and interest coverage ratios and limit our ability to incur debt, make investments or undertake certain other business activities. These requirements could limit our ability to obtain future financing and may prevent us from taking advantage of attractive business opportunities. Our ability to meet the financial covenants or requirements in our debt arrangements may be affected by events beyond our control, and we cannot assure you that we will satisfy such covenants and requirements. A breach of these covenants or our inability to comply with the restrictions could result in an event of default under our debt arrangements which, in turn, could result in an event of default under the terms of our other indebtedness. Upon the occurrence of an event of default under our debt arrangements, after the expiration of any grace periods, our lenders could elect to declare all amounts outstanding under our debt arrangements, together with accrued interest, to be immediately due and payable. If this were to happen, we cannot assure you that our assets would be sufficient to repay in full the payments due under those arrangements or
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our other indebtedness.
Our operations depend on our manufacturing, distribution, sales, service facilities and information systems in various parts of the world which are subject to physical, financial, regulatory, environmental, operational and other risks that could disrupt our operations. We have a significant number of manufacturing facilities and distribution, technical service and sales centers outside the U.S. The international scope of our business subjects us to increased risks and uncertainties such as threats of war, terrorism and instability of governments; compliance with U.S. laws affecting operations outside of the U.S., such as the Foreign Corrupt Practices Act; and economic, regulatory and legal systems in countries in which we or our customers conduct business. In addition, because we depend upon our information systems to help process orders, to manage inventory and accounts receivable collections, to purchase, sell and ship products efficiently and on a timely basis, to maintain cost-effective operations, and to help provide superior service to our customers, any disruption or failure in the operation of our information systems, including from conversions or integrations, could have a material adverse effect on our business, financial condition, results of operations and cash flows. Some of our facilities are located in areas that may be affected by natural disasters, including earthquakes or tsunamis, which could cause significant damage and disruption to the operations of those facilities and, in turn, could have a material adverse effect on our business, financial condition, results of operations and cash flows. Additionally, some of our manufacturing equipment and tooling is custom-made and is not readily replaceable. Loss of such equipment or tooling could have a negative impact on our manufacturing business, financial condition, results of operations and cash flows.
Although we have obtained property damage and business interruption insurance, a major catastrophe such as an earthquake, hurricane, flood, tsunami or other natural disaster at any of our sites, or significant labor strikes, work stoppages, political unrest, or any of the events described above, some of which may not be covered by our insurance, in any of the areas where we conduct operations could result in a prolonged interruption of our business. Any disruption resulting from these events could cause significant delays in the manufacture or shipment of products or the provision of repair and other services that may result in our loss of sales and customers. Our insurance will not cover all potential risks, and we cannot assure you that we will have adequate insurance to compensate us for all losses that result from any insured risks. Any material loss not covered by insurance could have a material adverse effect on our financial condition, results of operations and cash flows. We cannot assure you that insurance will be available in the future at a cost acceptable to us or at a cost that will not have a material adverse effect on our profitability, net income and cash flows.
Further, in the ordinary course of our business, we store sensitive data, including intellectual property, our proprietary business information and that of our customers, suppliers and business partners, and personally identifiable information of our employees, in our data centers and on our networks. The secure maintenance and transmission of this information is critical to our business operations. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, and regulatory penalties, disrupt our operations, and damage our reputation, which could adversely affect our business.
The global nature of our business exposes us to foreign currency fluctuations that may affect our future revenues and profitability. We have manufacturing facilities and distribution, technical service and sales centers around the world, and the majority of our foreign operations use the local currency as their functional currency. These include, among others, the Brazilian real, British pound sterling, Canadian dollar, Chinese yuan, Euro, Korean won, Mexican peso, Singapore dollar, Swedish krona, Swiss franc and Thai baht. Since our financial statements are denominated in U.S. dollars, changes in currency exchange rates between the U.S. dollar and other currencies expose us to translation risk when the local currency financial statements are translated to U.S. dollars. Changes in currency exchange rates may also expose us to transaction risk. We may buy protecting or offsetting positions or hedges in certain currencies to reduce our exposure to currency exchange fluctuations; however, these transactions may not be adequate or effective to protect us from the exposure for which they are purchased. We have not engaged in any speculative hedging activities. Currency fluctuations may impact our revenues and profitability in the future.
Our operations and assets subject us to additional financial and regulatory risks. We have operations and assets in various parts of the world. In addition, we sell or may in the future sell our products and services to the U.S. and foreign governments and in foreign countries. Accordingly, we are subject to various risks, including: U.S. imposed embargoes of sales to specific countries; foreign import controls (which may be arbitrarily imposed or enforced); import regulations and duties; export regulations (which require us to comply with stringent licensing regimes); anti-dumping regulations; price and currency controls; exchange rate fluctuations; dividend remittance restrictions; expropriation of assets; war, civil uprisings and riots; government instability; government contracting requirements including cost accounting standards, including various procurement, security, and audit requirements, as well as requirements to certify to the government compliance with these
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requirements; the necessity of obtaining governmental approval for new and continuing products and operations; legal systems or decrees, laws, taxes, regulations, interpretations and court decisions that are not always fully developed and that may be retroactively or arbitrarily applied; and difficulties in managing a global enterprise. We have experienced inadvertent violations of some of these regulations, including export regulations, safety regulations, regulations prohibiting sales of certain products, product labeling regulations, and regulations prohibiting air transport of aerosol products, in the past, none of which has had or, we believe, will have a material adverse effect on our business. However, any significant violations of these or other regulations in the future could result in civil or criminal sanctions, and the loss of export or other licenses which could have a material adverse effect on our business. We may also be subject to unanticipated income taxes, excise duties, import taxes, export taxes, value added taxes, or other governmental assessments, and taxes may be impacted by changes in legislation in the tax jurisdictions in which we operate. In addition, our organizational and capital structure may limit our ability to transfer funds between countries, particularly into the U.S., without incurring adverse tax consequences. Any of these events could result in a loss of business or other unexpected costs that could reduce sales or profits and have a material adverse effect on our financial condition, results of operations and cash flows.
Our ability to recover our significant deferred tax assets related to tax operating loss carryforwards depends on future income. We have significant deferred tax assets related to operating loss carryforwards. The realization of these assets is dependent on our ability to generate future taxable income in the U.S. during the operating loss carryforward period. Failure to realize this tax benefit could have a material adverse effect on our financial condition and results of operations.
Changes in the availability or price of materials, products and energy resources could adversely affect our costs and profitability. We may be adversely affected by the availability or price of raw materials, products and energy resources, particularly related to certain manufacturing operations that utilize high-grade steel spring wire, stainless steel, titanium and inconel. The availability and price of raw materials and energy resources may be subject to curtailment or change due to, among other things, new laws or regulations, global economic or political events including strikes, terrorist attacks and war, suppliers’ allocations to other purchasers, interruptions in production by suppliers, changes in exchange rates and prevailing price levels. In some instances there are limited sources for raw materials and a limited number of primary suppliers for some of our products for resale. Although we are not dependent upon any single source for any of our principal raw materials or products for resale, and such materials and products have, historically, been readily available, we cannot assure you that such raw materials and products will continue to be readily available. Disruption in the supply of raw materials, products or energy resources or our inability to come to favorable agreements with our suppliers could impair our ability to manufacture, sell and deliver our products and require us to pay higher prices. Any increase in prices for such raw materials, products or energy resources could materially adversely affect our costs and our profitability. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission (the "SEC") established disclosure and reporting requirements regarding the use of “conflict” minerals mined from the Democratic Republic of Congo and adjoining countries. These requirements could adversely affect the sourcing and availability of minerals used in the manufacture of certain of our products. As a result, we may not be able to obtain certain materials or products at competitive prices. We may also incur costs to comply with these new requirements, including for due diligence regarding the sources of any conflict minerals used in our products. Further, we may face reputational risk and other challenges with our customers and suppliers if we are unable to verify sufficiently that the minerals used in our products are conflict free.
We maintain pension and other postretirement benefit plans in the U.S. and certain international locations. Our costs of providing defined benefit plans are dependent upon a number of factors, such as the rates of return on the plans’ assets, exchange rate fluctuations, future governmental regulation, global equity prices, and our required and/or voluntary contributions to the plans. Declines in the stock market, prevailing interest rates, declines in discount rates and rising medical costs may cause an increase in our pension and other postretirement benefit expenses in the future and result in reductions in our pension fund asset values and increases in our pension and other postretirement benefit obligations. These changes have caused and may continue to cause a significant reduction in our net worth and without sustained growth in the pension investments over time to increase the value of the plans’ assets, and depending upon the other factors listed above, we could be required to increase funding for some or all of these pension and postretirement plans. Also, we may be subject to significant withdrawal liability assessments if we withdraw from a multi-employer pension plan in which we participate. See Note 11 of the Consolidated Financial Statements.
Our cash is highly concentrated with certain financial institutions. At various times we have a concentration of cash in accounts with financial institutions in the U.S. and around the globe. Our holdings in certain of these institutions significantly exceeded the insured limits of the Federal Deposit Insurance Corporation or their equivalent outside the U.S. at December 31, 2012.
We carry significant inventories and a loss in net realizable value could cause a decline in our net worth. At December 31, 2012, our inventories totaled $226.2 million. Inventories are valued at the lower of cost or market based on
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managements' judgments and estimates concerning future sales levels, quantities and prices at which such inventories will be sold in the normal course of business. Accelerating the disposal process or incorrect estimates of future sales potential may necessitate future reduction to inventory values. The Company's inventories include specialty spare parts for the aerospace market. The demand for these spare parts and our ability to utilize these parts depends on the frequency and scope of repair and maintenance of aircraft engines and our ability to effectively access that market. See “Part II - Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” beginning on page 29.
We have significant goodwill and an impairment of our goodwill could cause a decline in our net worth. Our total assets include substantial goodwill. At December 31, 2012, our goodwill totaled $579.9 million. The goodwill results from our prior acquisitions, representing the excess of the purchase price we paid over the net assets of the companies acquired. We assess whether there has been an impairment in the value of our goodwill during each calendar year or sooner if triggering events warrant. If future operating performance at one or more of our reporting units does not meet expectations or fair values fall due to significant stock market declines, we may be required to reflect a non-cash charge to operating results for goodwill impairment. The recognition of an impairment of a significant portion of goodwill would negatively affect our results of operations and total capitalization, the effect of which could be material. See “Part II - Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” beginning on page 29.
We could be adversely affected by changes in interest rates. Our profitability may be adversely affected as a result of increases in interest rates. At December 31, 2012, we and our subsidiaries had approximately $646.6 million aggregate principal amount of consolidated debt obligations outstanding, of which approximately 76% had interest rates that float with the market. A 100 basis point increase in the interest rate on the floating rate debt in effect at December 31, 2012 would have resulted in an approximate $4.3 million annualized increase in interest expense.
We may not realize all of the sales expected from our existing backlog or anticipated orders. At December 31, 2012, we had $676.9 million of order backlog, the majority of which related to aerospace OEM customers. There can be no assurances that the revenues projected in our backlog will be realized or, if realized, will result in profits. We consider backlog to be firm customer orders for future delivery. From time to time, OEM customers of Aerospace and Industrial provide projections of components and assemblies that they anticipate purchasing in the future under new and existing programs. Such projections are not included in our backlog unless we have received a firm order from our customers. Our customers may have the right under certain circumstances or with certain penalties or consequences to terminate, reduce or defer firm orders that we have in backlog. If our customers terminate, reduce or defer firm orders, we may be protected from certain costs and losses, but our sales will nevertheless be adversely affected. Although we strive to maintain ongoing relationships with our customers, there is an ongoing risk that orders may be cancelled or rescheduled due to fluctuations in our customers’ business needs or purchasing budgets.
Also, our realization of sales from new and existing programs is inherently subject to a number of important risks and uncertainties, including whether our customers execute the launch of product programs on time, or at all, the number of units that our customers actually produce, the timing of production and manufacturing insourcing decisions made by our customers. In addition, until firm orders are placed, our customers generally have the right to discontinue a program or replace us with another supplier at any time without penalty. Our failure to realize sales from new and existing programs could have a material adverse effect on our net sales, results of operations and cash flows.
We may not recover all of our up-front costs related to new or existing programs. New programs require significant up-front investments for capital equipment, engineering, inventory, design and tooling. As OEMs in the transportation and aerospace industries have looked to suppliers to bear increasing responsibility for the design, engineering and manufacture of systems and components, they have increasingly shifted the financial risk associated with those responsibilities to the suppliers as well. This trend is likely to continue and is most evident in the area of engineering cost reimbursement. We cannot assure you that we will have adequate funds to make such up-front investments or to recover such costs from our customers as part of our product pricing. In the event that we are unable to make such investments, or to recover them through sales or direct reimbursement from our customers, our profitability, liquidity and cash flows may be adversely affected. In addition, we incur costs and make capital expenditures for new program awards based upon certain estimates of production volumes and production complexity. While we attempt to recover such costs and capital expenditures by appropriately pricing our products, the prices of our products are based in part upon planned production volumes. If the actual production is significantly less than planned or significantly more complex than anticipated, we may be unable to recover such costs. In addition, because a significant portion of our overall costs is fixed, declines in our customers’ production levels can adversely affect the level of our reported profits even if our up-front investments are recovered.
We may not realize all of the intangible assets related to RSPs. Our total investments in participation fees under our RSPs as of December 31, 2012 equaled $293.7 million, all of which have been paid. At December 31, 2012, the remaining
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unamortized balance of these participation fees was $239.1 million. We participate in aftermarket RSPs under which we receive an exclusive right to supply designated aftermarket parts over the life of the related aircraft engine program to a large aerospace manufacturer. As consideration, we pay participation fees, which are recorded as long-lived intangible assets and are recognized as a reduction of sales over the estimated useful life of the related engine programs which range up to 30 years. The realizability of each intangible asset is dependent upon future revenues related to the program’s aftermarket parts and is subject to impairment testing whenever events or circumstances indicate that its carrying amount may not be recoverable. The potential exists that actual revenues will not meet expectations due to a change in market conditions, including, for example, the replacement of older airplane engines with new, more fuel-efficient engines. A shortfall in future revenues may result in the failure to realize the total amount of the investments, which could adversely affect our financial condition and results of operations and cash flows. In addition, future growth and profitability could be impacted by increasing management fees, amortization of the participation fees and the expiration of the Singapore Pioneer tax status incentives on these programs.
We face risks of cost overruns and losses on fixed-price contracts. We sell certain of our products under firm, fixed-price contracts providing for a fixed price for the products regardless of the production or purchase costs incurred by us. The cost of producing products may be adversely affected by increases in the cost of labor, materials, fuel, outside processing, overhead and other factors, including manufacturing inefficiencies. Increased production costs may result in cost overruns and losses on contracts.
The departure of existing management and key personnel, a shortage of skilled employees or a lack of qualified sales professionals could materially affect our business, operations and prospects. Our executive officers are important to the management and direction of our business. Our future success depends, in large part, on our ability to retain or replace these officers and other capable management personnel. Although we believe we will be able to attract and retain talented personnel and replace key personnel should the need arise, our inability to do so could have a material adverse effect on our business, financial condition, results of operations or cash flows. Because of the complex nature of many of our products and services, we are generally dependent on an educated and highly skilled workforce, including, for example, our engineering talent. In addition, there are significant costs associated with the hiring and training of sales professionals. We could be adversely affected by a shortage of available skilled employees or the loss of a significant number of our sales professionals.
If we are unable to protect our intellectual property rights effectively, our financial condition and results of operations could be adversely affected. We own or are licensed under various intellectual property rights, including patents, trademarks and trade secrets. Our intellectual property rights may expire or be challenged, invalidated or infringed upon by third parties. Our failure to obtain or maintain intellectual property rights that convey competitive advantage, adequately protect our intellectual property or detect or prevent circumvention or unauthorized use of such property and the cost of enforcing our intellectual property rights could adversely impact our competitive position, financial condition and results of operations.
Any product liability, warranty, contractual or other claims in excess of insurance may adversely affect our financial condition. Our operations expose us to potential product liability risks that are inherent in the design, manufacture and sale of our products and the products we buy from third parties and sell to our customers, or to potential warranty, contractual or other claims. For example, we may be exposed to potential liability for personal injury, property damage or death as a result of the failure of a spring or other part in a vehicle or an aircraft component designed, manufactured or sold by us, or the failure of an aircraft component that has been serviced by us or of the components themselves, including potentially hazardous substances in a product purchased by us and sold by us to one of our customers. While we have liability insurance for certain risks, our insurance may not cover all liabilities. Additionally, insurance coverage may not be available in the future at a cost acceptable to us. Any material liability not covered by insurance or for which third-party indemnification is not available for the full amount of the loss could have a material adverse effect on our financial condition, results of operations and cash flows.
From time to time, we receive product warranty claims, under which we may be required to bear costs of repair or replacement of certain of our products. Warranty claims may range from individual customer claims to full recalls of all products in the field. We vigorously defend ourselves in connection with these matters. We cannot, however, assure you that the costs, charges and liabilities associated with these matters will not be material, or that those costs, charges and liabilities will not exceed any amounts reserved for them in our consolidated financial statements.
Our business, financial condition, results of operations and cash flows could be adversely impacted by strikes or work stoppages. Approximately 13% of our U.S. employees are covered by collective bargaining agreements and more than 60% of our non-U.S. employees are covered by collective bargaining agreements or statutory trade union agreements. In 2013, we are scheduled to negotiate national health care and pension collective bargaining agreements with unionized employees at our Bristol, CT, Corry, PA, and Saline, MI locations, which collectively cover approximately 275 employees. In addition, we have annual negotiations in Brazil and Mexico and, collectively, these negotiations also cover approximately 290 employees in
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those two countries. We also expect to have negotiations in 2013 with two of our German locations, our Singapore location, and our Sweden location, which cover approximately 315, 49, 240 and 300 employees, respectively. Although we believe that our relations with our employees are good, we cannot assure you that we will be successful in negotiating new collective bargaining agreements or that such negotiations will not result in significant increases in the cost of labor, including healthcare, pensions or other benefits. Any potential strikes or work stoppages, and the resulting adverse impact on our relationships with customers, could have a material adverse effect on our business, financial condition, results of operations or cash flows. Similarly, a protracted strike or work stoppage at any of our major customers, suppliers or other vendors could materially adversely affect our business.
Changes in accounting guidance and taxation requirements could affect our financial results. New accounting guidance that may become applicable to us from time to time, or changes in the interpretations of existing guidance, could have a significant effect on our reported results for the affected periods. In addition, our products are subject to import and excise duties and/or sales or value-added taxes in many jurisdictions in which we operate. Increases in indirect taxes could affect our products’ affordability and therefore reduce our sales. We are also subject to income tax in numerous jurisdictions in which we generate revenues. Changes in tax laws, tax rates or tax rulings may have a significant adverse impact on our effective tax rate. Among other things, our tax liabilities are affected by the mix of pretax income or loss among the tax jurisdictions in which we operate and the repatriation of foreign earnings to the U.S. We must exercise judgment in determining our worldwide provision for income taxes, interest and penalties; accordingly, future events could change management’s assessment of these amounts.
RISKS RELATED TO THE INDUSTRIES IN WHICH WE OPERATE
A general economic downturn could adversely affect our business and financial results. All of our businesses are impacted by the health of the economies in which they operate. A decline in economies in which we operate could reduce demand for our products and services or increase pricing pressures, thereby having an adverse impact on our business, financial condition, results of operations and cash flows. We derive a large portion of our sales from the transportation industry. The operation of our business within that industry subjects us to the pressures applicable to all companies operating in it, including unfavorable pricing pressures. While the precise effects of instability in the transportation industry are difficult to determine, they may negatively impact our business, financial condition, results of operations and cash flows.
We operate in very competitive markets. We may not be able to compete effectively with our competitors, and competitive pressures could adversely affect our business, financial condition and results of operations. Our three global business segments compete with a number of larger and smaller companies in the markets we serve. Some of our competitors have greater financial, production, research and development, or other resources than we do. Within Aerospace, certain of our OEM customers compete with our repair and overhaul business. Some of our OEM customers in the aerospace industry also compete with us where they have the ability to manufacture the components and assemblies that we supply to them but have chosen, for capacity limitations, cost considerations or other reasons, to outsource the manufacturing to us. Our three business segments compete on the basis of price, service, quality, reliability of supply, technology, innovation and design. A majority of the products sold by Distribution are not unique, and its competitors carry substantially similar products. We must continue to make investments to maintain and improve our competitive position. We cannot assure you that we will have sufficient resources to continue to make such investments or that we will be successful in maintaining our competitive position. Our competitors may develop products or services, or methods of delivering those products or services that are superior to our products, services or methods. Our competitors may also adapt more quickly than us to new technologies or evolving customer requirements. Pricing pressures could cause us to adjust the prices of certain of our products to stay competitive. We cannot assure you that we will be able to compete successfully with our existing or future competitors. Also, if consolidation of our existing competitors occurs, we expect the competitive pressures we face to increase. Our failure to compete successfully could adversely affect our business, financial condition, results of operations and cash flows.
Our customers’ businesses are generally cyclical. Weaknesses in the industries in which our customers operate could impact our revenues and profitability. The industries to which we sell tend to decline in response to overall declines in industrial production. Aerospace is heavily dependent on the commercial aerospace industry, which is cyclical and a long cycle industry. Industrial and Distribution are dependent on the transportation industry, and general industrial and tooling markets, all of which are also cyclical. Many of our customers have historically experienced periodic downturns, which often have had a negative effect on demand for our products.
Original equipment manufacturers in the aerospace and transportation industries have significant pricing leverage over suppliers and may be able to achieve price reductions over time. Additionally, we may not be successful in our efforts to raise prices on our customers. There is substantial and continuing pressure from OEMs in the transportation industries, including automotive and aerospace, to reduce the prices they pay to suppliers. We attempt to manage such downward pricing pressure, while trying to preserve our business relationships with our customers, by seeking to reduce our
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production costs through various measures, including purchasing raw materials and components at lower prices and implementing cost-effective process improvements. Our suppliers have periodically resisted, and in the future may resist, pressure to lower their prices and may seek to impose price increases. If we are unable to offset OEM price reductions, our profitability and cash flows could be adversely affected. In addition, OEMs have substantial leverage in setting purchasing and payment terms, including the terms of accelerated payment programs under which payments are made prior to the account due date in return for an early payment discount. OEMs can unexpectedly change their purchasing policies or payment practices, which could have a negative impact on our short-term working capital.
Demand for our defense-related products depends on government spending. A portion of Aerospace's sales are derived from the military market, including single-sourced and dual-sourced sales. The military market is largely dependent upon government budgets and is subject to governmental appropriations. Although multi-year contracts may be authorized in connection with major procurements, funds are generally appropriated on a fiscal year basis even though a program may be expected to continue for several years. Consequently, programs are often only partially funded and additional funds are committed only as further appropriations are made. We cannot assure you that maintenance of or increases in defense spending will be allocated to programs that would benefit our business. Moreover, we cannot assure you that new military aircraft programs in which we participate will enter full-scale production as expected. A decrease in levels of defense spending or the government’s termination of, or failure to fully fund, one or more of the contracts for the programs in which we participate could have a material adverse effect on our financial position and results of operations.
The consolidation occurring in the industries in which we operate could adversely affect our business and financial results. The industries in which we operate have been experiencing consolidation. There has been consolidation of both suppliers and the customers we serve. Supplier consolidation is in part attributable to OEMs more frequently awarding long-term sole source or preferred supplier contracts to the most capable suppliers in an effort to reduce the total number of suppliers from whom components and systems are purchased. We cannot assure you that our business, financial condition, results of operations or cash flows will not be adversely impacted as a result of consolidation by our competitors or customers.
The aerospace industry is highly regulated. Complications related to aerospace regulations may adversely affect the Company. A substantial portion of our income is derived from our aerospace businesses. The aerospace industry is highly regulated in the U.S. by the Federal Aviation Administration, or FAA, and in other countries by similar regulatory agencies. We must be certified by these agencies and, in some cases, by individual OEMs in order to engineer and service systems and components used in specific aircraft models. If material authorizations or approvals were delayed, revoked or suspended, our business could be adversely affected. New or more stringent governmental regulations may be adopted, or industry oversight heightened, in the future, and we may incur significant expenses to comply with any new regulations or any heightened industry oversight.
Environmental regulations impose costs and regulatory requirements on our operations. Environmental compliance may be more costly than we expect, and we may be subject to material environmental-based claims in the future. Our past and present business operations and past and present ownership and operations of real property and the use, sale, storage and handling of chemicals and hazardous products subject us to extensive and changing U.S. federal, state and local environmental laws and regulations, as well as those of other countries, pertaining to the discharge of materials into the environment, enforcement, disposition of wastes (including hazardous wastes), the use, shipping, labeling, and storage of chemicals and hazardous materials, building requirements, or otherwise relating to protection of the environment. We have experienced, and expect to continue to experience, costs to comply with environmental laws and regulations. In addition, new laws and regulations, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination or the imposition of new clean-up requirements could require us to incur costs or become subject to new or increased liabilities that could have a material adverse effect on our business, financial condition, results of operations and cash flows.
We use and generate hazardous substances and wastes in our operations. In addition, many of our current and former properties are or have been used for industrial purposes. Accordingly, we monitor hazardous waste management and applicable environmental permitting and reporting for compliance with applicable laws at our locations in the ordinary course of our business. We may be subject to potential material liabilities relating to any investigation and clean-up of our locations or properties where we delivered hazardous waste for handling or disposal that may be contaminated or which may have been contaminated prior to our purchase, and to claims alleging personal injury.
High jet fuel and other energy prices may impact our operating results. Fuel costs constitute a significant portion of operating expenses for companies in the aerospace industry. Widespread disruption to oil production, refinery operations and pipeline capacity in certain areas of the U.S. can increase the price of jet fuel significantly. Conflicts in the Middle East, an important source of oil for the U.S. and other countries where we do business, cause prices for fuel to be volatile and often significantly higher than historic levels. Because we and many of our customers are in the aerospace industry, increased fuel costs could have a material adverse effect on our financial condition or results of operations. The price of energy generally
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impacts the cost of operating our manufacturing and distribution operations. We have experienced significant increases in energy costs, and energy costs could continue to rise, which would result in higher transportation, freight and other operating costs. We cannot guarantee that we will be able to pass along energy costs to our customers through increased prices.
Our products and services may be rendered obsolete by new products, technologies and processes. Our manufacturing operations focus on highly engineered components which require extensive engineering and research and development time. Our competitive advantage may be adversely impacted if we cannot continue to introduce new products ahead of our competition, or if our products are rendered obsolete by other products or by new, different technologies and processes. Additionally, we may face increased or unexpected costs associated with new product introduction including the use of additional resources such as personnel.
RISKS RELATED TO RESTRUCTURING, ACQUISITIONS, DIVESTITURES AND JOINT VENTURES
Our acquisition and divestiture strategies and our restructuring activities may not be successful. We have made a number of acquisitions in the past and we anticipate that we may, from time to time, acquire additional businesses, assets or securities of companies that we believe would provide a strategic fit with our businesses. A significant portion of the industries that we serve are mature industries. As a result, our future growth may depend in part on the successful acquisition and integration of businesses into our existing operations. We may not be able to identify and successfully negotiate suitable acquisitions, obtain financing for future acquisitions on satisfactory terms, obtain regulatory approvals or otherwise complete acquisitions in the future. We have also in the past divested assets and businesses. We may in the future engage in discussions with potential acquirers of certain of our assets or businesses in order to meet our strategic objectives, but we cannot provide any assurance that we will be successful in finding suitable purchasers for any such desired sale of such assets or businesses.
We will need to integrate any acquired businesses with our existing operations. We cannot assure you that we will effectively assimilate the business or product offerings of acquired companies into our business or product offerings or realize anticipated operational synergies. In connection with the integration of acquired operations or the conduct of our overall business strategies, we may periodically restructure our businesses and/or sell assets or portions of our business. Integrating the operations and personnel of acquired companies into our existing operations may result in difficulties, significant expense and accounting charges, disrupt our business or divert management’s time and attention.
Acquisitions involve numerous other risks, including potential exposure to unknown liabilities of acquired companies and the possible loss of key employees and customers of the acquired business. In connection with acquisitions or joint venture investments outside the U.S., we may enter into derivative contracts to purchase foreign currency in order to hedge against the risk of foreign currency fluctuations in connection with such acquisitions or joint venture investments, which subjects us to the risk of foreign currency fluctuations associated with such derivative contracts. Additionally, our final determinations and appraisals of the fair value of assets acquired and liabilities assumed in our acquisitions may vary materially from earlier estimates. We cannot assure you that the fair value of acquired businesses will remain constant.
The acquisition of Synventive exposes the Company to a number of risks and uncertainties, the occurrence of any of which could materially adversely affect our business, cash flows, financial condition and results of operations as well as the market price of our common stock. Such risks and uncertainties include risks relating to the integration of Synventive's business with the Company, the financial performance of Synventive and risks associated with incurring additional indebtedness.
We may not realize the anticipated benefits of the Synventive acquisition. Our ability to realize such benefits will depend on our ability to successfully and efficiently integrate Synventive's business, which involves products and services, markets and geographies that are new to the Company, into our business, in addition to an increased scale of our international operations. Difficulties of integration could include coordinating and consolidating separate systems, integrating the management of the acquired business, retaining market acceptance of Synventive's products and services, maintaining employee morale and retaining key employees, and implementing our enterprise resource planning systems and operational procedures and disciplines. Any such difficulties may make it more difficult to maintain relationships with employees, customers, business partners and suppliers. In addition, even if integration is successful, the financial performance of the acquired business may not be as expected and there can be no assurance we will realize anticipated revenue and earnings enhancements from the Synventive acquisition.
In addition, our management has spent, and will continue to spend, a significant amount of its time and efforts directed toward the integration of Synventive, which time and efforts otherwise could have been spent on our other businesses and other opportunities that could have been beneficial to us.
Finally, we have incurred a substantial amount of additional indebtedness which could have an adverse effect on our financial health and make it more difficult for us to obtain additional financing in the future. The additional debt we incurred to fund the acquisition purchase price may have an adverse effect on our financial condition and may limit our ability to obtain
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any necessary financing in the future for working capital, capital expenditures, future acquisitions, debt service requirements or other purposes. Additionally, we may not be able to generate sufficient cash flow or otherwise obtain funds necessary to meet these additional debt obligations. Any default under the Credit Agreement could result in the acceleration of the repayment obligations to our lenders, as well as the acceleration of all of our outstanding debt.
The realization of any of the foregoing risks may materially adversely affect our business, cash flows, financial condition, results of operations or the market price of our common stock.
In accordance with applicable SEC guidance, management's report on internal control over financial reporting excludes the assessment of Synventive. We plan to fully evaluate the internal controls of Synventive and any subsequently acquired companies, then implement a standardized framework of internal controls at those acquired businesses. We cannot provide assurance that we will be able to provide a report that contains no significant deficiencies or material weaknesses with respect to Synventive or any other acquisitions.
If we engage in a divestiture of assets or a business, we cannot be certain that our business, operating results and financial condition will not be materially and adversely affected. A successful divestiture depends on various factors, including our ability to effectively transfer liabilities, contracts, facilities and employees to any purchaser, identify and separate the intellectual property to be divested from the intellectual property that we wish to retain, reduce fixed costs previously associated with the divested assets or business, and collect the proceeds from any divestitures. In addition, if customers of the divested business do not receive the same level of service from the new owners, this may adversely affect our other businesses to the extent that these customers also purchase other products offered by us. All of these efforts require varying levels of management resources, which may divert our attention from other business operations. If we do not realize the expected benefits or synergies of any divestiture transaction, our consolidated financial position, results of operations and cash flows could be negatively impacted. In addition, divestitures of businesses involve a number of risks, including the
diversion of management and employee attention, significant costs and expenses, the loss of customer relationships, and a decrease in revenues and earnings associated with the divested business. Furthermore, divestitures potentially involve significant post-closing separation activities, which could involve the expenditure of material financial resources and significant employee resources. Any divestiture may result in a dilutive impact to our future earnings if we are unable to offset the dilutive impact from the loss of revenue associated with the divestiture, as well as significant write-offs, including those related to goodwill and other intangible assets, which could have a material adverse effect on our results of operations and financial condition.
We may not achieve expected cost savings from restructuring activities and actual charges, costs and adjustments due to restructuring activities may vary materially from our estimates. Our ability to realize anticipated cost savings, synergies and revenue enhancements may be affected by a number of factors, including the following: our ability to effectively eliminate duplicative back office overhead and overlapping sales personnel, rationalize manufacturing capacity, synchronize information technology systems, consolidate warehousing and distribution facilities and shift production to more economical facilities; significant cash and non-cash integration and implementation costs or charges in order to achieve those cost savings, which could offset any such savings and other synergies resulting from our acquisitions or divestitures; and our ability to avoid labor disruption in connection with integration efforts or divestitures.
Any joint ventures or teaming arrangements we enter into may not be successful. We may enter into joint ventures or teaming arrangements. Partners with whom we share control may at any time have economic, business or legal interests or goals that are inconsistent with our goals or the goals of the joint venture or arrangement. Our joint venture or teaming arrangements may require us to pay certain costs or to make certain capital investments and we may have little control over the amount or the timing of these payments and investments. In addition, our joint venture or teaming partners may be unable to meet their economic or other obligations and we may be required to fulfill those obligations alone. Our failure or the failure of an entity in which we have a joint venture interest or teaming arrangement to adequately manage the risks associated with any acquisitions, joint ventures or teaming arrangements could have a material adverse effect on our financial condition or results of operations. We cannot assure you that any of our joint ventures or teaming arrangements will be profitable or that forecasts regarding joint venture or teaming activities will be accurate. In particular, risks and uncertainties associated with our joint ventures and teaming arrangements include, among others, the joint venture’s or teaming partner’s ability to operate its business successfully, to develop appropriate standards, controls, procedures and policies for the growth and management of the joint venture or teaming arrangement and the strength of the their relationships with employees, suppliers and customers.
Item 1B. Unresolved Staff Comments
None.
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Item 2. Properties
We operate 28 manufacturing facilities throughout the world, 17 of which are part of the Industrial segment and 11 of which are part of the Aerospace segment. Fourteen of the facilities are in the United States; the balance are located in Asia, Brazil, Europe, and Mexico. Seventeen of the facilities are owned; the balance are leased.
In addition to its manufacturing facilities, Industrial has 29 facilities engaged in activities related to its manufacturing operations, including sales, assembly, development and distribution, all of which are leased. Five of these facilities are located in the United States; the balance are located in Asia, Brazil, Canada, Europe and Mexico.
The Distribution segment operates 11 distribution centers: 8 in the United States, and the balance in Canada. Three of the distribution centers are owned; the balance are leased. Distribution also has 10 sales and support facilities, nine of which are leased. Two of the facilities are in the United States; the balance are located in Brazil, Canada, China, Europe, Mexico, and Singapore. Distribution also has one global sourcing office in China.
The Company’s corporate office in Bristol, Connecticut is owned.
Item 3. Legal Proceedings
The Company was named in a lawsuit arising out of an alleged breach of contract and implied warranty by a customer of Toolcom Suppliers Limited (“Toolcom”), a business previously included within the former Logistics and Manufacturing Services segment, related to the sale of certain products prior to the Company’s 2005 acquisition of Toolcom. In 2006, the plaintiff filed the lawsuit in civil court in Scotland and asserted that certain products sold were not fit for a particular use and claims approximately 5.5 million pounds sterling (approximately $8.9 million at December 31, 2012) in damages, plus interest at the statutory rate of 8% per annum and costs. The court found that Toolcom was in breach of contract and implied warranty, and ordered Toolcom to pay a portion of the plaintiff’s attorneys’ fees. The court has not made determinations as to causation and damages. In the third quarter 2012, the customer provided to the Company additional information regarding its claim, increasing the amount of damages, including lost profits, that the customer allegedly suffered as a result of the Company's breach of contract and implied warranty, and the amount of interest due on the claim. Although the Company intends to vigorously defend its position, based on reviews of the currently available information and acknowledging the uncertainties of litigation, management has provided for what it believes to be a reasonable estimate of loss exposure. While it is currently not possible to determine the ultimate outcome of this matter, the Company believes that any ultimate losses would not be expected to have a material adverse effect on the Company’s consolidated financial position or cash flows, but could be material to the consolidated results of operations of any one period.
In addition, we are subject to litigation from time to time in the ordinary course of business and various other suits, proceedings and claims are pending against us and our subsidiaries. While it is not possible to determine the ultimate disposition of each of these proceedings and whether they will be resolved consistent with our beliefs, we expect that the outcome of such proceedings, individually or in the aggregate, will not have a material adverse effect on our financial condition or results of operations.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a) | Market Information |
The Company’s common stock is traded on the New York Stock Exchange under the symbol “B”. The following table sets forth, for the periods indicated, the low and high sales intra-day trading price per share, as reported by the New York Stock Exchange, and dividends declared and paid.
2012 | ||||||||||||
Low | High | Dividends | ||||||||||
Quarter ended March 31 | $ | 23.99 | $ | 28.35 | $ | 0.10 | ||||||
Quarter ended June 30 | 22.30 | 28.63 | 0.10 | |||||||||
Quarter ended September 30 | 21.62 | 26.38 | 0.10 | |||||||||
Quarter ended December 31 | 19.71 | 25.53 | 0.10 | |||||||||
2011 | ||||||||||||
Low | High | Dividends | ||||||||||
Quarter ended March 31 | $ | 19.64 | $ | 22.00 | $ | 0.08 | ||||||
Quarter ended June 30 | 20.22 | 25.85 | 0.08 | |||||||||
Quarter ended September 30 | 18.70 | 25.82 | 0.08 | |||||||||
Quarter ended December 31 | 17.47 | 25.15 | 0.10 | |||||||||
Stockholders
As of February 8, 2013, there were approximately 4,899 holders of record of the Company’s common stock. A significant number of the outstanding shares of common stock which are beneficially owned by individuals or entities are registered in the name of a nominee of The Depository Trust Company, a securities depository for banks and brokerage firms. The Company believes that there are approximately 10,981 beneficial owners of its common stock.
Dividends
Payment of future dividends will depend upon the Company’s financial condition, results of operations and other factors deemed relevant by the Company’s Board of Directors, as well as any limitations resulting from financial covenants under the Company’s credit facilities or debt indentures. See the table above for dividend information for 2012 and 2011.
Securities Authorized for Issuance Under Equity Compensation Plans
For information regarding Securities Authorized for Issuance Under Equity Compensation Plans, see Part III, Item 12 of this Annual Report.
Performance Graph
A stock performance graph based on cumulative total returns (price change plus reinvested dividends) for $100 invested on December 31, 2007 is set forth below.
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2007 | 2008 | 2009 | 2010 | 2011 | 2012 | |||||||||||||||||||
BGI | $ | 100.0 | $ | 44.7 | $ | 54.2 | $ | 67.5 | $ | 79.9 | $ | 75.7 | ||||||||||||
S&P 600 | $ | 100.0 | $ | 68.9 | $ | 86.6 | $ | 109.3 | $ | 110.4 | $ | 128.5 | ||||||||||||
Russell 2000 | $ | 100.0 | $ | 66.2 | $ | 84.2 | $ | 106.9 | $ | 102.4 | $ | 119.2 | ||||||||||||
The performance graph does not include a published industry or line-of-business index or peer group of similar issuers because the Company is in multiple lines of business and does not believe a meaningful published index or peer group can be reasonably identified. Accordingly, as permitted by Securities and Exchange Commission (“SEC”) rules, the graph includes the S&P 600 Small Cap Index and the Russell 2000 Index, which are comprised of issuers with generally similar market capitalizations to that of the Company.
(c) | Issuer Purchases of Equity Securities |
Period | Total Number of Shares (or Units) Purchased | Average Price Paid Per Share (or Unit) | Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs(2) | |||||||||
October 1-31, 2012 | 1,109 | $ | 24.35 | — | 3,800,000 | ||||||||
November 1-30, 2012 | — | $ | — | — | 3,800,000 | ||||||||
December 1-31, 2012 | — | $ | — | — | 3,800,000 | ||||||||
Total | 1,109 | (1) | $ | 24.35 | — | ||||||||
________________________
(1) | All acquisitions of equity securities during the fourth quarter of 2012 were the result of the operation of the terms of the Company's stockholder-approved equity compensation plans and the terms of the equity rights granted pursuant to those plans to pay for the related income tax upon issuance of shares. The purchase price of a share of stock used for tax withholding is the market price on the date of issuance. |
(2) | The program was publicly announced on October 20, 2011 authorizing repurchase of up to 5.0 million shares of common stock. |
15
Item 6. Selected Financial Data
2012 (5) | 2011(6) | 2010 (6) | 2009 (6) | 2008 (6) | |||||||||||||||
Per common share (1) | |||||||||||||||||||
Income from continuing operations | |||||||||||||||||||
Basic | $ | 1.80 | $ | 1.66 | $ | 0.97 | $ | 0.79 | $ | 1.85 | |||||||||
Diluted | 1.78 | 1.64 | 0.96 | 0.79 | 1.79 | ||||||||||||||
Net income | |||||||||||||||||||
Basic | 1.74 | 1.17 | 0.96 | 0.72 | 1.53 | ||||||||||||||
Diluted | 1.72 | 1.16 | 0.95 | 0.72 | 1.48 | ||||||||||||||
Dividends declared and paid | 0.40 | 0.34 | 0.32 | 0.48 | 0.62 | ||||||||||||||
Stockholders’ equity (at year-end) | 14.76 | 13.29 | 13.23 | 12.50 | 11.46 | ||||||||||||||
Stock price (at year-end) | 22.46 | 24.11 | 20.67 | 16.90 | 14.50 | ||||||||||||||
For the year (in thousands) | |||||||||||||||||||
Net sales | $ | 1,229,959 | $ | 1,169,355 | $ | 1,028,617 | $ | 923,353 | $ | 1,232,196 | |||||||||
Operating income | 136,556 | 127,555 | 86,398 | 63,475 | 153,670 | ||||||||||||||
As a percent of net sales | 11.1 | % | 10.9 | % | 8.4 | % | 6.9 | % | 12.5 | % | |||||||||
Income from continuing operations | $ | 98,297 | $ | 91,573 | $ | 53,978 | $ | 42,830 | $ | 99,736 | |||||||||
As a percent of net sales | 8.0 | % | 7.8 | % | 5.2 | % | 4.6 | % | 8.1 | % | |||||||||
Net income | $ | 95,249 | $ | 64,715 | $ | 53,278 | $ | 39,001 | $ | 82,578 | |||||||||
As a percent of net sales | 7.7 | % | 5.5 | % | 5.2 | % | 4.2 | % | 6.7 | % | |||||||||
As a percent of average stockholders’ equity (2) | 12.6 | % | 8.4 | % | 7.7 | % | 6.2 | % | 11.6 | % | |||||||||
Depreciation and amortization | $ | 57,360 | $ | 58,904 | $ | 52,770 | $ | 51,487 | $ | 52,403 | |||||||||
Capital expenditures | 37,787 | 37,082 | 28,759 | 30,502 | 51,869 | ||||||||||||||
Weighted average common shares outstanding – basic | 54,626 | 55,215 | 55,260 | 53,880 | 53,989 | ||||||||||||||
Weighted average common shares outstanding – diluted | 55,224 | 55,932 | 55,925 | 54,206 | 55,813 | ||||||||||||||
Year-end financial position (in thousands) | |||||||||||||||||||
Working capital | $ | 418,645 | $ | 332,316 | $ | 167,344 | $ | 213,392 | $ | 288,351 | |||||||||
Goodwill | 579,905 | 366,104 | 384,241 | 373,564 | 361,930 | ||||||||||||||
Other intangible assets, net | 383,972 | 272,092 | 290,798 | 303,689 | 316,817 | ||||||||||||||
Property, plant and equipment, net | 233,097 | 210,784 | 218,434 | 224,963 | 235,035 | ||||||||||||||
Total assets | 1,868,596 | 1,440,365 | 1,403,257 | 1,351,990 | 1,435,355 | ||||||||||||||
Long-term debt and notes payable | 646,613 | 346,052 | 357,718 | 351,468 | 465,961 | ||||||||||||||
Stockholders’ equity | 800,118 | 722,400 | 712,119 | 684,713 | 598,574 | ||||||||||||||
Debt as a percent of total capitalization (3) | 44.7 | % | 32.4 | % | 33.4 | % | 33.9 | % | 43.8 | % | |||||||||
Statistics | |||||||||||||||||||
Employees at year-end (4) | 5,110 | 4,387 | 4,352 | 4,310 | 4,969 | ||||||||||||||
________________________
(1) | Income from continuing operations and net income per common share are based on the weighted average common shares outstanding during each year. Stockholders’ equity per common share is calculated based on actual common shares outstanding at the end of each year. |
(2) | Average stockholders' equity is calculated based on the month-end stockholders equity balances between December 31, 2011 and December 31, 2012 (13 month average). |
(3) | Debt includes all interest-bearing debt and total capitalization includes interest-bearing debt and stockholders’ equity. |
(4) The number of employees at each year-end includes employees of continuing operations and excludes employees of the discontinued operations.
(5) During 2012, the Company completed the acquisition of Synventive Molding Solutions ("Synventive"). The results of Synventive, from the
acquisition on August 27, 2012, have been included within the Company's Consolidated Financial Statements for the period ended December 31,
2012.
(6) During 2011, the Company sold the Barnes Distribution Europe business within the segment formerly referred to as Logistics and Manufacturing Services. During 2008, the Company exited certain non-core businesses within its former Logistics and Manufacturing Services segment in the United Kingdom. The results of these businesses have been segregated and treated as discontinued operations in the Company's Consolidated Financial Statements. All previously reported financial information has been adjusted on a retrospective basis to reflect the discontinued operations.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
In the first quarter of 2013, the Company entered into a definitive agreement to sell its Barnes Distribution North America business (“BDNA”) to MSC Industrial Direct Co., Inc., subject to certain adjustments. BDNA, which currently comprises the majority of the Company's Distribution segment results, reported 2012 sales of approximately $300.0 million. See Note 21 of the Consolidated Financial Statements.
Also in the first quarter of 2013, the Company is realigning its reportable business segments by transferring the Associated Spring Raymond business ("Raymond"), its remaining business within the Distribution segment, to the Industrial segment. Raymond sells, among other products, springs that are manufactured by one of the Industrial businesses. Accordingly, the Company's financial results, beginning in the first quarter of 2013, will be reported in two reportable business segments: Aerospace and Industrial. All previously reported segment information will be adjusted on a retrospective basis to reflect this change beginning in the first quarter of 2013.
In the first quarter of 2012, the Company realigned its organizational structure by aligning its strategic business units into three reportable business segments: Aerospace, Industrial and Distribution.
During the fourth quarter of 2011, the Company completed the sale of its Barnes Distribution Europe businesses (the "BDE" business). The BDE business was comprised of the Company's European KENT, Toolcom and BD France distribution businesses that were reported within the segment formerly referred to as Logistics and Manufacturing Services.
All previously reported financial information has been adjusted on a retrospective basis to reflect the segment realignment in 2012 and the discontinued operations for all years presented.
2012 Highlights
During the third quarter of 2012, the Company completed its acquisition of Synventive Molding Solutions ("Synventive”). Synventive is a leading designer and manufacturer of highly engineered and customized hot runner systems and components and provides related services. The acquisition has been integrated into the Industrial segment. The financial results of Synventive, from the date of the acquisition on August 27, 2012, are included within consolidated financial statements of the Company for the year ended December 31, 2012. The Company funded the purchase price of the acquisition from cash on hand and borrowings under the Credit Facility.
Additionally during the third quarter of 2012, the Company executed a $250.0 million accordion feature that was available under the Company's existing $500.0 million amended and restated revolving credit agreement (the "Credit Agreement" or "Credit Facility") with Bank of America, N.A. as administrative agent, increasing the available amount under the Credit Facility to $750.0 million.
The Company achieved sales of $1,230.0 million in 2012, an increase of $60.6 million, or 5.2%, from 2011. In the Aerospace segment, sales increased primarily as a result of growth in the OEM and aftermarket repair and overhaul manufacturing businesses. This growth was partially offset by a decline in sales within the aftermarket RSP spare parts business. In Industrial, the acquisition of Synventive provided sales of $60.0 million while organic sales increases were more than offset by the impact of foreign currency translation. In Distribution, organic sales declined slightly as customers continued to manage costs and inventory levels and as the Company rationalized several underperforming accounts. Foreign currency translation also had a negative impact on sales at Distribution.
Operating income increased 7.1% from $127.6 million in 2011 to $136.6 million in 2012 and operating margin improved to 11.1% from 10.9% in 2011. Operating income primarily benefited from the profit contribution of the acquired Synventive business, partially offset by $5.9 million of short-term purchase accounting adjustments and transaction costs related to the acquisition.
The Company focused on profitable sales growth both organically and through acquisition, in addition to productivity improvements, as key strategic objectives in 2012. Management continued its focus on cash flow and working capital management in 2012 and generated $136.4 million in cash flow from operations. The Company continued to make significant investments in working capital during 2012, primarily as a result of improving business conditions in certain end-markets.
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Management Objectives
Management continues to focus on three areas of development: employees, processes and strategy which, in combination, are expected to generate long-term value for the Company's stockholders. The Company's strategies for growth include both organic growth from new products, services, markets and customers, and growth from acquisitions. The Company's strategies for profitability include worldwide application of lean principles, productivity and process initiatives, such as production realignment, and efficiency and cost-saving measures.
Acquisitions and strategic relationships have historically been a key growth driver for the Company, and it continues to seek alliances which foster long-term business relationships and expand geographic reach. The Company continually evaluates its existing portfolio to optimize product offerings and maximize value. The acquisition of Synventive in August 2012 represented a significant addition to the Company's portfolio.
Our Business
Barnes Group consists of three operating segments: Aerospace, Industrial and Distribution. In each of these businesses, Barnes Group is among the leaders in the market niches served and has highly recognized brands for many of the products it sells or manufactures.
The Aerospace segment produces precision-machined and fabricated components and assemblies for original equipment manufacturer (“OEM”) turbine engine, airframe and industrial gas turbine builders throughout the world, and for the military. Aerospace provides jet engine component overhaul and repair services for many of the world's major turbine engine manufacturers, commercial airlines and the military. In addition, it manufactures aerospace aftermarket spare parts and provides repair services for aircraft engine components.
The Industrial segment is a global supplier of high quality engineered components for critical applications serving diverse end markets such as transportation, energy, electronics, medical and consumer products. It is equipped to produce virtually every type of precision spring, from fine hairsprings for electronics and instruments to large heavy-duty springs for machinery as well as precision-machined and fabricated components. Industrial is a leading manufacturer and supplier of precision mechanical products, including mechanical springs, compressor reed valves and nitrogen gas products. It also manufactures high-precision punched and fine-blanked components used in transportation and industrial applications, nitrogen gas springs and manifold systems used to precisely control stamping presses, and retention rings that position parts on a shaft or other axis. Additionally, through our recent Synventive acquisition, Industrial is a leading designer and manufacturer of highly engineered and customized hot runner systems and components - the enabling technology for many complex injection molding applications.
The Distribution segment is an industry leader in logistics support through vendor managed inventory and technical sales for maintenance, repair, operating and production supplies, as well as the design, assembly and distribution of engineered supplies for the global industrial base.
Key Performance Indicators
Management evaluates the performance of its reportable segments based on the operating profit of the respective businesses, which includes net sales, cost of sales, selling and administrative expenses and certain components of other income and other expenses, as well as the allocation of corporate overhead expenses. Management also uses an internal measurement tool called PPAT, or Performance Profit After Tax. PPAT is an economic value added (“EVA®”) -like metric that calculates operating profit after tax, less a charge for the capital employed by the business. Management utilizes PPAT in economic decision-making, such as capital expenditures, investments in growth initiatives, customer pricing decisions, and evaluation of acquisitions.
All segments have standard key performance indicators (“KPIs”), a number of which are focused on customer metrics (on-time-delivery and quality), internal effectiveness and efficiency metrics (sales per employee, cost of quality, days working capital and controllable expenses), employee-related metrics (total recordable incident rate and lost time incident rate), and specific KPIs on profitable growth.
Key Industry Data
In each segment, management tracks a variety of economic and industry data as indicators of the health of a particular sector.
18
At Aerospace, management of the aftermarket aerospace operations monitors the number of aircraft in the active fleet, the number of planes temporarily or permanently taken out of service, aircraft utilization rates for the major airlines, engine shop visits, airline profitability, aircraft fuel costs and traffic growth. The aerospace OEM business regularly tracks orders and deliveries for each of the major aircraft manufacturers, as well as engine purchases made for new aircraft. Management also monitors annual appropriations for the U.S. military related to new aircraft purchases and maintenance.
At Industrial, key data for the manufacturing operations include the Federal Reserve’s Industrial Production Index ("the IPI"); the production of light vehicles, both in the U.S. and globally; worldwide light vehicle new model introductions and existing model refreshes; tooling build schedules; durable goods orders; compressor build forecasts; and global industrial capital expenditures.
At Distribution, the business reviews data supplied by the Institute for Supply Management’s PMI Composite Index and the IPI, which are monthly indicators of the health of U.S. manufacturing activity. Management tracks similar indices in Canada and for the European-based business.
RESULTS OF OPERATIONS
Sales
($ in millions) | 2012 | 2011 | $ Change | % Change | 2010 | ||||||||||||||
Aerospace | $ | 390.5 | $ | 382.5 | $ | 8.0 | 2.1 | % | $ | 334.2 | |||||||||
Industrial | 497.0 | 440.5 | 56.5 | 12.8 | % | 374.1 | |||||||||||||
Distribution | 350.7 | 355.3 | (4.6 | ) | (1.3 | )% | 329.5 | ||||||||||||
Intersegment sales | (8.3 | ) | (8.9 | ) | 0.6 | 6.6 | % | (9.1 | ) | ||||||||||
Total | $ | 1,230.0 | $ | 1,169.4 | $ | 60.6 | 5.2 | % | $ | 1,028.6 | |||||||||
2012 vs. 2011:
Barnes Group reported net sales of $1,230.0 in 2012, an increase of $60.6 million, or 5.2%, from 2011, driven primarily by a sales contribution of $60.0 million from the Synventive acquisition. The sales increase also reflects $15.1 million of organic sales growth primarily at Aerospace and Industrial. The strengthening of the U.S. dollar against foreign currencies as compared to 2011 decreased net sales by $14.5 million in 2012. The Company’s international sales increased 5.9% year-over-year while domestic sales increased 4.6%. The Company's international sales in 2012 increased 9.2% from 2011 excluding the impact of foreign currency translation on sales.
2011 vs. 2010:
In 2011, the Company reported net sales of $1,169.4 million, an increase of $140.7 million, or 13.7%, over 2010 net sales of $1,028.6 million. The sales increase reflected $120.8 million of organic sales growth primarily at Aerospace and Industrial. Additionally, sales increased by the positive impact of foreign currency translation of $19.9 million in 2011 as the U.S. dollar weakened against certain foreign currencies, primarily in Europe, Brazil and Canada. The Company’s international sales increased 19.9% year-over-year and domestic sales increased 9.1%. The Company's international sales in 2011 increased 13.8% from 2010 excluding the impact of foreign currency translation on sales.
Expenses and Operating Income
($ in millions) | 2012 | 2011 | $ Change | % Change | 2010 | |||||||||||||||
Cost of sales | $ | 812.2 | $ | 772.4 | $ | 39.8 | 5.2 | % | $ | 678.2 | ||||||||||
% sales | 66.0 | % | 0.6593182885 | 66.1 | % | 65.9 | % | |||||||||||||
Gross profit (1) | $ | 417.8 | 350,431,000 | $ | 397.0 | $ | 20.8 | 5.2 | % | $ | 350.4 | |||||||||
% sales | 34.0 | % | 33.9 | % | 34.1 | % | ||||||||||||||
Selling and administrative expenses | $ | 281.2 | $ | 269.4 | $ | 11.8 | 4.4 | % | $ | 264.0 | ||||||||||
% sales | 22.9 | % | 23.0 | % | 25.7 | % | ||||||||||||||
Operating income | $ | 136.6 | $ | 127.6 | $ | 9.0 | 7.1 | % | $ | 86.4 | ||||||||||
% sales | 11.1 | % | 10.9 | % | 8.4 | % | ||||||||||||||
__________________
(1) | Sales less cost of sales |
19
2012 vs. 2011:
Cost of sales in 2012 increased 5.2% from 2011 primarily as a result of increased sales. The increase in sales approximated the percentage increase in cost of sales and gross profit margin improved by 10 basis points to 34.0%. The acquisition of Synventive resulted in a higher percentage of sales, as well as higher gross profit as a percentage of sales, being driven by Industrial. Increased gross profit was partially offset by higher pension costs and the impact of short-term purchase accounting adjustments related to the acquisition. Selling and administrative expenses increased 4.4% from 2011 and slightly decreased as a percentage of sales. The increase in expenses reflects the sales resulting from the acquisition and acquisition-related costs, partially offset by lower incentive compensation costs.
2011 vs. 2010:
Cost of sales in 2011 increased 13.9% from 2010 primarily as a result of increased sales. The percentage increase in cost of sales was slightly more than the percentage increase in sales and resulted in a reduction in gross profit margin of 20 basis points to 33.9%. Gross profit as a percentage of sales improved at Aerospace and Distribution, however the reduction in total gross margin reflects a shift to a higher percentage of sales from the Industrial segment. Selling and administrative expenses increased 2.0% from 2010 and decreased as a percentage of sales. The increase in expenses reflects the higher sales as well as higher employee related costs including incentive compensation and retirement benefit costs. These increases were partially offset by lower costs related to commissions and the utilization of temporary personnel. Costs of sales and selling and administrative expenses were also impacted by the lower cost structures from previous actions.
Interest expense
2012 vs. 2011:
Interest expense in 2012 increased $2.0 million to $12.2 million from 2011, primarily a result of higher borrowings under the variable rate Credit Facility in part to fund the acquisition of Synventive.
2011 vs. 2010:
Interest expense in 2011 decreased $9.7 million to $10.3 million from 2010. The decrease in 2011 resulted from lower average interest rates and lower debt discount amortization related to the 3.75% Convertible Notes as compared to the 2010 period. The lower average interest rates reflected the shift to a significantly higher percentage of variable rate debt due to the retirement of the 7.80% Notes and the redemption of the 3.75% Convertible Notes, which were funded with the variable rate Credit Facility, and the expiration of the 2008 interest rate swap agreements.
Other expense (income), net
2012 vs. 2011:
Other expense (income), net in 2012 was $2.7 million compared to $0.4 million in 2011. Foreign currency transaction losses increased from $0.2 million in 2011 to $2.1 million in 2012.
2011 vs. 2010:
Other expense (income), net in 2011 was $0.4 million compared to $2.6 million in 2010. Foreign currency transaction losses decreased from $1.7 million in 2010 to $0.2 million in 2011.
Income Taxes
2012 vs. 2011:
The Company’s effective tax rate from continuing operations was 19.2% in 2012 compared with 21.7% in 2011. The effective tax rate for 2011 included the recognition of $1.8 million of discrete tax expense related to tax adjustments for earlier years. The decrease in the 2012 effective tax rate from continuing operations was driven primarily by the absence of this discrete item, the impact of a decrease in the repatriation of a portion of current year foreign earnings to the U.S. and the impact of tax rate changes in certain foreign jurisdictions, partially offset by a change in the mix of earnings attributable to higher-taxing jurisdictions or jurisdictions where losses could not be benefited in 2012. During 2012, the Company repatriated a dividend from a portion of the current year foreign earnings to the U.S. in the amount of $8.0 million compared to $17.5 million in 2011. This decrease in the dividend reduced tax expense by $4.8 million and decreased the annual effective tax rate
20
by 3.9 percentage points compared to 2011.
In 2013, the Company expects that the effective tax rate from continuing operations will increase principally due to the forecasted mix of earnings, the expiration of additional RSP pioneer tax status certificates and the impact of certain foreign tax law changes.
2011 vs. 2010:
The Company’s effective tax rate from continuing operations was 21.7% in 2011 compared with 15.4% in 2010. The increase in the effective tax rate from 2010 was primarily driven by the shift in the mix of income to higher-taxing jurisdictions and the impact of the increased repatriation of a portion of current year earnings to the U.S. During 2011, the Company repatriated a dividend from a portion of the current year foreign earnings to the U.S. in the amount of $17.5 million compared to $7.5 million in 2010. This incremental dividend increased tax expense by $3.9 million and increased the annual effective tax rate by 3.3 percentage points compared to 2010.
See Note 13 of the Consolidated Financial Statements for a reconciliation of the U.S. federal statutory income tax rate to the consolidated effective income tax rate.
In connection with an IRS audit for the tax years 2000 through 2002, the IRS proposed adjustments to these tax years of approximately $16.5 million, plus a potential penalty of 20% of the tax assessment plus interest. The adjustment relates to the federal taxation of foreign income of certain foreign subsidiaries. The Company filed an administrative protest of these adjustments. In the third quarter of 2009, the Company was informed that its protest was denied and a tax assessment was received from the Appeals Office of the IRS. In November 2009, the Company filed a petition against the IRS in the U.S. Tax Court contesting the tax assessment received. As expected, a trial was held in the first quarter of 2012 and all briefs were filed in the third quarter of 2012. A decision is expected in the first half of 2013. Depending on the outcome, an appeal by either party is possible. The Company continues to believe its tax position on the issues raised by the IRS is correct and the Company plans to continue to take appropriate actions to vigorously defend its position. The Company believes it should prevail on this issue. While any additional impact on the Company's liability for income taxes cannot presently be determined, the Company continues to believe it is adequately provided for and the outcome is not expected to have a material effect on the consolidated financial position, but could be material to the consolidated results of operations or cash flows of any one period.
Discontinued Operations
During the fourth quarter of 2011, the Company completed the sale of its Barnes Distribution Europe businesses (the "BDE business") to Berner SE (the "Purchaser"), headquartered in Kunzelsau, Germany, in a cash transaction pursuant to a Share and Asset Purchase Agreement ("SPA"). The Company received gross proceeds of $33.4 million, which represents the initial stated purchase price, and which yielded net cash proceeds of $22.5 million after transaction costs, employee transaction related costs, closing adjustments and net cash sold, of which €9.0 million was placed in escrow. The funds would be released from escrow on August 31, 2012 unless there were any then pending claims. Cash related to a pending claim would remain in escrow until a final determination of the claim had been made.
In August 2012, the Purchaser provided a notice of breach of various warranties to the Company. The Company rejected the Purchaser's notice and demanded release of the full escrow on August 31, 2012. The Purchaser refused to release the full escrow, and only €3.9 million plus interest was released whereas €5.1 million ($6.7 million at December 31, 2012) plus interest remains in escrow. The Company objected to the retention of the escrow and expects to prevail in this matter. The Company recorded the restricted cash in other assets at December 31, 2012 and in prepaid expenses and other current assets at December 31, 2011.
The results of the BDE business have been segregated and presented as discontinued operations. In 2011, the Company recorded a $26.9 million loss from discontinued operations which included pre-tax income of $1.0 million, a $26.7 million loss related to the transaction and $1.2 million of tax expense. The 2011 loss related to the transaction included a $16.8 million goodwill impairment charge related to the BDE business and $8.2 million of transaction and employee transaction related costs associated with the sale. In 2012, the Company recorded a $3.0 million loss from discontinued operations, primarily due to adjustments to retained liabilities. See Note 2 of the Consolidated Financial Statements.
21
Income and Income Per Share
(in millions, except per share) | 2012 | 2011 | Change | % Change | 2010 | ||||||||||||||
Income from continuing operations | $ | 98.3 | $ | 91.6 | $ | 6.7 | 7.3 | % | $ | 54.0 | |||||||||
Loss from discontinued operations, net of income taxes | (3.0 | ) | (26.9 | ) | 23.8 | 88.7 | % | (0.7 | ) | ||||||||||
Net income | $ | 95.2 | $ | 64.7 | $ | 30.5 | 47.2 | % | $ | 53.3 | |||||||||
Per common share: | |||||||||||||||||||
Basic: | |||||||||||||||||||
Income from continuing operations | $ | 1.80 | $ | 1.66 | $ | 0.14 | 8.4 | % | $ | 0.97 | |||||||||
Loss from discontinued operations, net of income taxes | (0.06 | ) | (0.49 | ) | 0.43 | 87.8 | % | (0.01 | ) | ||||||||||
Net income | $ | 1.74 | $ | 1.17 | $ | 0.57 | 48.7 | % | $ | 0.96 | |||||||||
Diluted: | |||||||||||||||||||
Income from continuing operations | $ | 1.78 | $ | 1.64 | $ | 0.14 | 8.5 | % | $ | 0.96 | |||||||||
Loss from discontinued operations, net of income taxes | (0.06 | ) | (0.48 | ) | 0.42 | 87.5 | % | (0.01 | ) | ||||||||||
Net income | $ | 1.72 | $ | 1.16 | $ | 0.56 | 48.3 | % | $ | 0.95 | |||||||||
Weighted average common shares outstanding: | |||||||||||||||||||
Basic | 54.6 | 55.2 | (0.6 | ) | (1.1 | )% | 55.3 | ||||||||||||
Diluted | 55.2 | 55.9 | (0.7 | ) | (1.3 | )% | 55.9 | ||||||||||||
In 2012, basic and diluted income from continuing operations per common share increased 8.4% and 8.5%, respectively. The increases were attributable to the increase in income from continuing operations year over year and lower weighted average common shares outstanding. Basic weighted average shares outstanding decreased as a result of 700,000 and 1,509,156 shares repurchased during 2012 and 2011, respectively, as part of the publicly announced repurchase programs. The decrease was offset in part by additional shares issued for employee stock plans. Diluted weighted average shares outstanding decreased primarily as a result of the decrease in basic weighted average shares outstanding.
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Financial Performance by Business Segment
Aerospace
($ in millions) | 2012 | 2011 | $ Change | % Change | 2010 | ||||||||||||||
Sales | $ | 390.5 | $ | 382.5 | $ | 8.0 | 2.1 | % | $ | 334.2 | |||||||||
Operating profit | 63.3 | 62.6 | 0.6 | 1.0 | % | 52.4 | |||||||||||||
Operating margin | 16.2 | % | 16.4 | % | 15.7 | % | |||||||||||||
2012 vs. 2011:
Aerospace recorded sales of $390.5 million in 2012, a 2.1% increase from 2011, primarily as a result of growth in the OEM manufacturing and aftermarket repair and overhaul businesses. This growth was partially offset by a decline in sales within the aftermarket RSP spare parts business.
Operating profit at Aerospace increased 1.0% from 2011 to $63.3 million. Operating profit benefited from higher sales in the OEM manufacturing business and lower levels of incentive compensation. Operating profit was negatively affected by the profit impact of lower sales in the highly profitable aftermarket RSP spare parts business and an inventory valuation adjustment within the aftermarket repair and overhaul business.
Outlook:
Sales in the Aerospace OEM business are impacted by the general state of the aerospace market driven by the worldwide economy and are driven by its order backlog through its participation in certain strategic commercial and military engine and airframe programs. Backlog in this business grew to $540.8 million at December 31, 2012 from $469.3 million at December 31, 2011, with more than 50% of this backlog expected to be shipped in the next 12 months. The aerospace OEM business may be impacted by adjustments of customer inventory levels, commodity availability and pricing, changes in the content levels on certain platforms including insourcing, changes in production schedules of specific engine and airframe programs, as well as the pursuit of new programs. Sales levels in the aerospace aftermarket repair and overhaul business are expected to reflect long-term trends towards improving maintenance, repair and overhaul activity, but may be negatively impacted by short-term fluctuations in demand. Incremental management fees within the aftermarket RSP spare parts business are dependent on future sales volumes and are treated as a reduction to sales. Management fees increase once during the life of each individual program, generally in the fourth or later years of each program. Management continues to believe its aerospace aftermarket business is competitively positioned based on strong customer relationships including long-term RSP agreements and long-term maintenance and repair contracts in the repair and overhaul business, expanded capabilities and current capacity levels.
Management is focused on growing operating profit at Aerospace primarily through organic sales growth, productivity initiatives, new product introductions and continued cost management. Operating profit is expected to continue to be affected by the profit impact of changes in sales volume, mix and pricing, particularly as it relates to the highly profitable aftermarket RSP spare parts business, and investments made in each of its businesses. Management actively manages commodity price increases through pricing actions and other productivity initiatives. Costs associated with increases in new product introductions may also negatively impact operating profit.
2011 vs. 2010:
Aerospace recorded sales of $382.5 million in 2011, a 14.5% increase from 2010, with both the aftermarket and OEM businesses experiencing sales growth. The aerospace aftermarket business benefited from increased levels of overhaul and repair activity during 2011. A significant growth in sales contrasted the trend of deferred maintenance throughout 2010.
Operating profit at Aerospace increased 19.5% from 2010 to $62.6 million. This increase was driven primarily by the profit impact of higher sales volumes, partially offset by incremental management fees related to the aerospace aftermarket RSP spare parts business which increase once during the life of the program, generally in the fourth or later years of each program. Employee related costs also increased during 2011, primarily due to higher levels of incentive compensation, which increased in 2011 as compared to 2010 as a result of the level of achievement of the Company's pre-established 2011 performance targets.
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Industrial
($ in millions) | 2012 | 2011 | $ Change | % Change | 2010 | ||||||||||||||
Sales | $ | 497.0 | $ | 440.5 | $ | 56.5 | 12.8 | % | $ | 374.1 | |||||||||
Operating profit | 43.9 | 39.1 | 4.8 | 12.3 | % | 29.4 | |||||||||||||
Operating margin | 8.8 | % | 8.9 | % | 7.9 | % | |||||||||||||
2012 vs. 2011:
Sales at Industrial were $497.0 million in 2012, an increase of 12.8% from 2011. The acquisition of Synventive provided $60.0 million of sales and organic sales increased by $9.9 million during 2012. The impact of foreign currency translation decreased sales by approximately $13.4 million as the U.S. dollar strengthened against foreign currencies.
Operating profit in 2012 at Industrial was $43.9 million, an increase of 12.3% from 2011. Operating profit benefited primarily from the profit contribution of the acquired Synventive business. Operating profit results were partially offset by $5.9 million in short-term purchase accounting adjustments and transaction costs related to the Synventive acquisition.
Outlook:
In the Industrial manufacturing businesses, management is focused on generating organic sales growth by leveraging the benefits of the diversified products and industrial end-markets in which its businesses have a global presence and introducing new products. The Company also remains focused on sales growth through acquisition. The Synventive acquisition, for example, enhances the Company's core manufacturing capabilities, adds innovative products and services and is expected to expand the Company's global marketplace presence into geographic regions and end-markets where it had limited access. Our ability to generate sales growth in the global markets served by these businesses is subject to economic conditions. Order activity in certain end-markets, including transportation, may provide extended sales growth. Strategic investments are expected to provide incremental benefits in the long term.
Operating profit is largely dependent on the sales volumes and mix within all businesses of the segment. Management continues to focus on improving profitability through leveraging organic sales growth, acquisitions, pricing initiatives, productivity and process improvements. Management actively manages commodity price increases through pricing and productivity initiatives. Costs associated with increases in new product introductions and the integration of and within the Synventive business may negatively impact operating profit.
2011 vs. 2010:
Sales at Industrial were $440.5 million in 2011, an increase of 17.8% from 2010. Organic sales increases of $49.7 million resulted mainly from increases in North America and Europe and from improvements in the transportation industry, including automotive. The impact of foreign currency translation increased sales by approximately $16.7 million in 2011.
Operating profit in 2011 at Industrial was $39.1 million compared to $29.4 million in 2010, primarily due to the profit impact of higher sales levels in 2011 combined with productivity improvements and lean initiatives. Operating profit increases were partially offset by higher costs associated with investments in new product introductions and the outsourcing of certain manufacturing processes.
Distribution
($ in millions) | 2012 | 2011 | $ Change | % Change | 2010 | ||||||||||||||
Sales | $ | 350.7 | $ | 355.3 | $ | (4.6 | ) | (1.3 | )% | $ | 329.5 | ||||||||
Operating profit | 29.4 | 25.8 | 3.6 | 13.9 | % | 4.6 | |||||||||||||
Operating margin | 8.4 | % | 7.3 | % | 1.4 | % | |||||||||||||
2012 vs. 2011:
Distribution recorded sales of $350.7 million in 2012, a 1.3% decrease from 2011. Organic sales declined by $3.4 million as customers continued to manage costs and inventory levels and the business focused on more profitable accounts.
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The impact of foreign currency translation decreased sales by approximately $1.1 million as the U.S. dollar strengthened against foreign currencies.
Operating profit at Distribution increased 13.9% from 2011 to $29.4 million. This increase was driven by lower employee related costs, primarily due to incentive compensation which decreased in 2012 as compared to 2011 as a result of the level of achievement of the Company's pre-established 2012 performance targets, customer mix and lower cost structures, partially offset by higher pension costs and the profit impact of lower sales volumes.
Outlook:
Organic sales levels in the Distribution segment are largely dependent upon the economy in the regions served, the retention of its customers and continuation of existing sales volumes to such customers, and the effectiveness and size of its sales force. Both near-term and long-term economic conditions remain uncertain as customers within our Distribution businesses continue to manage costs and inventory levels. Management continues to focus on profitable sales mix and believes future sales growth may result from improvements in economic and end-market conditions, pricing initiatives, and investments in market penetration activities and sales force productivity initiatives.
Management is focused on growing operating profit at Distribution primarily through leveraging organic sales growth, productivity initiatives and continued cost management. Operating profit is expected to be affected by the profit impact of the changes in sales volume and sales mix. Management actively manages supplier price increases through pricing actions and other productivity initiatives.
2011 vs. 2010:
Distribution recorded sales of $355.3 million in 2011, a 7.8% increase from 2010. Organic sales improved by $22.6 million, while the impact of foreign currency translation increased sales by approximately $3.2 million as the U.S. dollar weakened against foreign currencies. Sales growth occurred primarily in the North American businesses as the industrial and transportation end-markets showed improvements throughout 2011.
Operating profit at Distribution increased to $25.8 million from $4.6 million in 2010. This increase was primarily driven by the profit impact of higher sales volumes. Productivity improvements, including the favorable impact of lower cost structures in the North American business, also contributed to the increase in operating profit. Operating profit increases were partially offset by higher levels of incentive compensation.
LIQUIDITY AND CAPITAL RESOURCES
Management assesses the Company's liquidity in terms of its overall ability to generate cash to fund its operating and investing activities. Of particular importance in the management of liquidity are cash flows generated from operating activities, capital expenditure levels, dividends, capital stock transactions, effective utilization of surplus cash positions overseas and adequate lines of credit.
The Company's ability to generate cash from operations in excess of its internal operating needs is one of its financial strengths. Management continues to focus on cash flow and working capital management, and anticipates that operating activities in 2013 will generate sufficient cash. The Company closely monitors its cash generation, usage and preservation including the management of working capital to generate cash.
Effective April 5, 2011, the Company exercised its right to redeem the remaining $92.5 million principal amount of the 3.75% Convertible Notes under their indenture agreement. Of the total $92.5 million principal amount, $11.9 million of these notes were redeemed with accrued interest through the redemption date. The remaining $80.6 million of these notes were surrendered for conversion. The Company elected to pay cash to holders of the 3.75% Convertible Notes surrendered for conversion, including the value of any residual shares of common stock that were payable to the holders electing to convert their notes into an equivalent share value, resulting in a total cash payment of $90.4 million including a premium on conversion of $9.8 million which reduced the equity component by $6.1 million, net of tax of $3.7 million. As a result of this transaction, the Company recaptured $40.2 million of previously deducted contingent convertible debt interest which resulted in a $15.3 million reduction in short-term deferred tax liabilities as well as a reduction of tax loss carryforwards reflected in long-term deferred tax assets. The Company used borrowings under its Credit Facility to finance this redemption.
The Company's 3.375% Convertible Notes are subject to redemption at their par value at any time, at the option of the Company, on or after March 20, 2014. The note holders may also require the Company to redeem some or all of the 3.375%
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Convertible Notes on March 15th of 2014, 2017 and 2022. Accordingly, the 3.375% Convertible Notes, classified as long-term debt at December 31, 2012, are expected to be classified as current portion of long-term debt at March 31, 2013. Payment on the 3.375% Convertible Notes, if required by note holders, is expected to be financed through internal cash, borrowings and the sale of debt or equity securities, or a combination thereof.
Operating cash flow may be supplemented with external borrowings to meet near-term business expansion needs and the Company's current financial commitments. On September 27, 2011, the Company entered into the Credit Agreement with Bank of America, N.A. as the administrative agent. The Credit Agreement increased the borrowing availability of the Credit Facility from $400 million to $500 million and extended the expiration date of the Credit Agreement by four years from September 2012 to September 2016. In July 2012, the bank syndicate made available an additional $250.0 million, bringing the total borrowings available under the Credit Facility to $750.0 million. At December 31, 2012, borrowings and availability under the Credit Facility were $589.2 million and $160.8 million, respectively, subject to covenants in the Credit Agreement. The Company has assessed its Credit Facility and currently expects that its bank syndicate, comprised of 17 banks, will continue to support its Credit Facility which matures in September 2016. At December 31, 2012, additional borrowings of $195.4 million of Total Debt, as defined in the Credit Agreement, and $92.5 million of Senior Debt, as defined in the Credit Agreement, would have been allowed under the covenants. Borrowings bear interest at LIBOR plus a spread ranging from 1.10% to 1.70%, depending on the Company's leverage ratio at the time of the borrowing. At December 31, 2012, the $589.2 million was borrowed at an interest rate of 1.97%. The Company paid fees and expenses of $1.0 million in conjunction with the increase of the Credit Facility to $750.0 million; the fees are being amortized into interest expense through its maturity. Additional funds may be used, as needed, to support the Company's ongoing growth initiatives. The Company believes its credit facilities and access to capital markets, coupled with cash generated from operations, are adequate for its anticipated future requirements.
The Company's borrowing capacity is limited by various debt covenants under the Credit Agreement. The Company's most restrictive financial covenant is the Senior Debt Ratio which requires the Company to maintain a ratio of Consolidated Senior Debt, as defined in the Credit Agreement, to Consolidated EBITDA, as defined, of not more than 3.25 times at the end of each fiscal quarter ending on or before September 30, 2013, after which the ratio will decrease to 3.00 times. The actual ratio at December 31, 2012 was 2.81 times. In addition, the Credit Agreement requires the Company to maintain a ratio of Consolidated Total Debt, as defined in the Credit Agreement, to Consolidated EBITDA of not more than 4.00 times for each fiscal quarter ending on or before September 30, 2013, and thereafter of not more than 3.75 times at the end of any fiscal quarter, and a ratio of Consolidated EBITDA to Consolidated Cash Interest Expense, as defined in the Credit Agreement, of not less than 4.25 times for each fiscal quarter ending on or before September 30, 2013, and thereafter of not less than 4.50 times at the end of any fiscal quarter. The Company closely monitors compliance with its various debt covenants and at December 31, 2012, the Company was in compliance with all covenants.
The Company had $2.8 million in borrowings under short-term bank credit lines at December 31, 2012.
In April 2012, the Company entered into five-year interest rate swap agreements (the "2012 interest rate swaps")transacted with three banks which together convert the interest on the first $100.0 million of borrowings under the Company’s Credit Agreement from a variable rate plus the borrowing spread to a fixed rate of 1.03% plus the borrowing spread. The 2012 interest rate swaps mitigate the Company's exposure to variable interest rates. At December 31, 2012, the Company's total borrowings were comprised of approximately 24% fixed rate debt and 76% variable rate debt compared to 16% fixed rate debt and 84% variable rate debt as of December 31, 2011. The Company's balance of variable debt increased as a result of the Synventive acquisition. The percentage of variable rate debt to total debt decreased as the 2012 interest rate swaps remained effective at December 31, 2012. The Company did not maintain any interest rate swap agreements at December 31, 2011.
The funded status of the Company's pension plans is dependent upon many factors, including returns on invested assets, discount rates, the level of market interest rates and benefit obligations. The funded status of the pension plans declined by $7.7 million in 2012, primarily as a result of an increase in the projected benefit obligations ("PBO's") following an update of certain actuarial assumptions, including assumptions related to the discount rate, inflation rate and mortality rate for certain plans. The impact of this PBO increase was partially offset by an increase in the fair value of the plan assets. The Company recorded a $15.7 million non-cash after-tax decrease in stockholders' equity (through other non-owner changes to equity) to record the current adjustment for changes in the funded status of its pension and postretirement benefit plans as required under the applicable accounting standards for defined benefit pension and other postretirement plans. In 2012, the Company made approximately $22.4 million in contributions to its various defined benefit pension plans. This included the required minimum contributions to its qualified U.S. pension plans, in addition to supplemental contributions of $3.7 million. The Company expects to contribute approximately $5.9 million to its various defined benefit pension plans in 2013. See Note 11 of the Consolidated Financial Statements.
At December 31, 2012, the Company held $86.4 million in cash and cash equivalents. Substantially all of this cash was
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held by foreign subsidiaries. Cash and cash equivalents held by foreign subsidiaries may continue to increase in the near term. These amounts are available primarily to fund international investments. During 2012, the Company repatriated $8.0 million of current year foreign earnings to the U.S.
The purchase price of Synventive was financed primarily with borrowings under the Company's Credit Facility. Any future acquisitions are expected to be financed through internal cash, borrowings and the sale of debt or equity securities, or a combination thereof. Additionally, we may from time to time seek to retire or repurchase our outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.
Cash Flow
($ in millions) | 2012 | 2011 | $ Change | % Change | 2010 | ||||||||||||||
Operating activities | $ | 136.4 | $ | 121.0 | $ | 15.4 | 12.7 | % | $ | 65.8 | |||||||||
Investing activities | (332.8 | ) | (30.6 | ) | (302.2 | ) | NM | (30.3 | ) | ||||||||||
Financing activities | 219.3 | (40.2 | ) | 259.5 | NM | (39.3 | ) | ||||||||||||
Exchange rate effect | 1.0 | (1.2 | ) | 2.2 | NM | (0.1 | ) | ||||||||||||
Increase (decrease) in cash | $ | 23.9 | $ | 49.1 | $ | (25.2 | ) | (51.4 | )% | $ | (4.0 | ) | |||||||
________________________
NM – Not meaningful
Operating activities are a significant source of cash flow for the Company, generating $136.4 million in cash during 2012 compared to $121.0 million in 2011. During 2012, operating cash flows were positively impacted by improved operating performance and a reduction in cash used for working capital generated by lower levels of sales growth relative to 2011. In 2011, higher levels of sales growth resulted in increases in receivables and inventories, which generated higher uses of cash in the comparable period. Operating cash flows were negatively impacted in 2012 by higher cash payments for accrued employee incentive compensation, which were earned in 2011 and paid in the first quarter of 2012. The cash generated from operations in the 2012 and 2011 periods was primarily used for capital expenditures, the repurchase of Company stock and the payment of dividends.
Investing activities in 2012 primarily consisted of the cash outflow of $296.6 million to fund the Synventive acquisition. See Note 3 of the Consolidated Financial Statements. Capital expenditures in 2012 were $37.8 million compared to $37.1 million in 2011. The Company expects capital spending in 2013 to approximate $50 million. Investing activities in 2012 also include the release of $4.9 million of escrow funds related to the 2011 sale of the BDE business. During 2011, net cash proceeds of $22.5 million, less $11.7 million classified as restricted cash, from the sale of the BDE business are included in investing activities. See Note 2 of the Consolidated Financial Statements. Investing activities in 2011 also included the acquisition of a hydro-pneumatic suspensions business from Curtiss-Wright Antriebstechnik GmbH for 3.1 million Swiss francs ($3.5 million).
Cash provided by financing activities in 2012 included a net increase in borrowings of $252.7 million compared to a net decrease of $12.1 million in 2011. In the 2012 period, net borrowings were primarily used to fund the Synventive acquisition. Payments on long term debt in 2012 include the payment of $45.2 million of debt that was assumed in the Synventive acquisition primarily using cash on hand held by foreign subsidiaries. The 2011 period includes the redemption of the remaining $92.5 million principal amount of the 3.75% Convertible Notes including a $9.8 million premium paid upon conversion for those notes surrendered for conversion. The redemption, including the premium, was funded by borrowings under the revolving Credit Facility.
Proceeds from the issuance of common stock decreased $21.5 million in the 2012 period from the 2011 period primarily as a result of higher stock option exercises in the 2011 period. During the 2012 period, the Company repurchased 0.7 million shares of the Company's stock at a cost of $19.0 million. Stock repurchases of 1.5 million shares during the 2011 period cost $34.1 million. Total cash used to pay dividends was $21.7 million in 2012 compared to $18.6 million in 2011. In addition, cash provided by financing activities in the 2012 and 2011 periods was partially offset by $1.4 million and $8.1 million in excess tax benefits recorded for current year tax deductions related to employee stock plan activity which occurred in the current year for 2012 and in the current year and prior years for 2011. Cash used by financing activities in the 2012 and 2011 periods also include $1.0 million and $2.0 million of deferred financing fees paid in connection with the Credit Agreement in 2012 and 2011, respectively.
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Debt Covenants
Borrowing capacity is limited by various debt covenants in the Company's Credit Agreement. As of December 31, 2012, the most restrictive borrowing capacity covenant in any agreement requires the Company to maintain a maximum ratio of Consolidated Senior Debt, as defined, to Consolidated EBITDA, as defined, of not more than 3.25 times for the four fiscal quarters then ending. The Company's Credit Agreement also contain other financial covenants that require the maintenance of a certain other debt ratio, Consolidated Total Debt, as defined, to Consolidated EBITDA of not more than 4.00 times and a certain interest coverage ratio, Consolidated EBITDA to Consolidated Cash Interest Expense, as defined, of at least 4.25 times, at December 31, 2012. Following is a reconciliation of Consolidated EBITDA, as defined, to the Company's net income (in millions):
2012 | |||
Net income | $ | 95.2 | |
Add back: | |||
Interest expense | 12.2 | ||
Income taxes | 23.4 | ||
Depreciation and amortization | 57.4 | ||
Loss from discontinued operations, net of tax | 3.0 | ||
Adjustment for acquired businesses | 19.7 | ||
Other adjustments | 0.3 | ||
Consolidated EBITDA, as defined | $ | 211.3 | |
Consolidated Senior Debt, as defined, as of December 31, 2012 | $ | 594.1 | |
Ratio of Consolidated Senior Debt to Consolidated EBITDA | 2.81 | ||
Maximum | 3.25 | ||
Consolidated Total Debt, as defined, as of December 31, 2012 | $ | 649.7 | |
Ratio of Consolidated Total Debt to Consolidated EBITDA | 3.08 | ||
Maximum | 4.00 | ||
Consolidated Cash Interest Expense, as defined, as of December 31, 2012 | $ | 14.0 | |
Ratio of Consolidated EBITDA to Consolidated Cash Interest Expense | 15.09 | ||
Minimum | 4.25 | ||
Other adjustments primarily represent net gains on the sale of assets and due diligence and transaction expenses as permitted under the Credit Agreement. The adjustment for acquired businesses reflects the unaudited pre-acquisition operations of Synventive for the eight-month period ended August 27, 2012. Consolidated Total Debt excludes the debt discount related to the 3.375% Convertible Notes. The Company's financial covenants are measured as of the end of each fiscal quarter. At December 31, 2012, additional borrowings of $195.4 million of Total Debt and $92.5 million of Senior Debt would have been allowed under the covenants. Senior Debt includes primarily the borrowings under the Credit Facility and the borrowings under the lines of credit. The Company's unused credit facilities at December 31, 2012 were $160.8 million.
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Contractual Obligations and Commitments
At December 31, 2012, the Company had the following contractual obligations and commitments:
($ in millions) | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More than 5 Years | |||||||||||||||
Long-term debt obligations (1) | $ | 649.7 | $ | 4.5 | $ | 56.0 | $ | 589.2 | $ | — | ||||||||||
Estimated interest payments under long-term obligations (2) | 44.3 | 13.2 | 22.8 | 8.3 | — | |||||||||||||||
Operating lease obligations | 30.9 | 11.7 | 12.2 | 3.5 | 3.5 | |||||||||||||||
Purchase obligations (3) | 136.8 | 129.7 | 6.9 | 0.2 | — | |||||||||||||||
Expected pension contributions (4) | 5.9 | 5.9 | — | — | — | |||||||||||||||
Expected benefit payments – other postretirement benefit plans (5) | 42.7 | 5.1 | 9.7 | 9.1 | 18.8 | |||||||||||||||
Total | $ | 910.3 | $ | 170.1 | $ | 107.6 | $ | 610.3 | $ | 22.3 | ||||||||||
________________________
(1) | Long-term debt obligations represent the required principal payments under such agreements and exclude the debt discount related to convertible notes. |
(2) | Interest payments under long-term debt obligations have been estimated based on the borrowings outstanding and market interest rates as of December 31, 2012. |
(3) | The amounts do not include purchase obligations reflected as current liabilities on the consolidated balance sheet. The purchase obligation amount includes all outstanding purchase orders as of the balance sheet date as well as the minimum contractual obligation or termination penalty under other contracts. |
(4) | The amount included in “Less Than 1 Year” reflects anticipated contributions to the Company’s various pension plans. Anticipated contributions beyond one year are not determinable. |
(5) | The amounts reflect anticipated future benefit payments under the Company’s various other postretirement benefit plans based on current actuarial assumptions. Expected benefit payments do not extend beyond 2022. See Note 11 of the Consolidated Financial Statements. |
The above table does not reflect unrecognized tax benefits as the timing of the potential payments of these amounts cannot be determined. See Note 13 of the Consolidated Financial Statements.
OTHER MATTERS
Inflation
Inflation generally affects the Company through its costs of labor, equipment and raw materials. Increases in the costs of these items have historically been offset by price increases, commodity price escalator provisions, operating improvements, and other cost-saving initiatives.
Critical Accounting Policies
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant accounting policies are disclosed in Note 1 of the Consolidated Financial Statements. The most significant areas involving management judgments and estimates are described below. Actual results could differ from such estimates.
Inventory Valuation: Inventories are valued at the lower of cost, determined on a first-in, first-out basis, or market. Provisions are made to reduce excess or obsolete inventories to their estimated net realizable value. Loss provisions, if any, on aerospace contracts are established when estimable. Loss provisions are based on the projected excess of manufacturing costs over the net revenues of the products or group of related products under contract. The Company carries a certain amount of inventory which is industry-specific including spare parts for the aerospace market. The process for evaluating the value of excess and obsolete inventory often requires the Company to make subjective judgments and estimates concerning future sales levels, access to applicable markets, quantities and prices at which such inventory will be sold in the normal course of business. Accelerating the disposal process or incorrect estimates of future sales potential may necessitate future adjustments to these provisions.
Business Acquisitions and Goodwill: Assets and liabilities acquired in a business combination are recorded at their estimated fair values at the acquisition date. At December 31, 2012, the Company had $579.9 million of goodwill, representing the cost of acquisitions in excess of fair values assigned to the underlying net assets of acquired companies. Goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to impairment testing annually or earlier if an
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event or change in circumstances indicates that the fair value of a reporting unit may have been reduced below its carrying value. Management completes its annual impairment assessment during the second quarter of each year.
The assessment of goodwill involves the estimation of the fair value of reporting units. The Company has determined that its reporting units are businesses with discrete financial information reviewed by segment management one level below the operating segment level and which are aggregated when those components have similar economic characteristics. Management estimates the fair value of each reporting unit primarily using the income approach, which reflects management’s cash flow projections, and also evaluates the fair value using a market approach. These methodologies used in the current year are consistent with those used in the prior year. Management believes the cash flow projections utilized and/or market multiples are reasonable and consistent with the expectations of market participants. Inherent in management’s development of cash flow projections are assumptions and estimates, including those related to future earnings and growth and the weighted average cost of capital. Many of the factors used in assessing fair value are outside the control of management, and these assumptions and estimates can change in future periods as a result of both Company-specific and overall economic conditions. Future cash flows can be affected by changes in the global economy and local economies, industries and markets in which the Company sells products or services, and the execution of management’s plans. There can be no assurance that future events will not result in impairment of goodwill or other intangible assets.
In the second quarter of 2012, management performed its annual impairment testing based on the information available as of the date of the assessment. Based on this assessment, there was no goodwill impairment and the fair values of each of the Company’s reporting units were substantially in excess of their carrying values. The Company determined during the fourth quarter of 2012 that the estimated fair value of its Heinz Hänggi reporting unit, which is part of the Industrial segment and has approximately $102 million of goodwill, decreased from the second quarter of 2012 due in part to declining economic conditions in Europe. The estimated fair value as a percentage of carrying value approximated 111%, as such the fair value of the reporting unit did not significantly exceed its carrying value. Revenue and operating income growth assumptions and the risk-adjusted discount rate, which represents the weighted-average cost of capital, have the most significant influence on the estimation of the fair value at this reporting unit.
Under the income approach, revenue and operating income growth rate assumptions were used to estimate cash flows in future periods. Growth rates were based on current levels of backlog, the retention of existing customers and the ability to attain new customers through new product introductions. If operating profit growth assumptions for our Heinz Hänggi reporting unit decline by approximately 10% per annum, the reporting unit may not pass step one and step two could result in a non-cash goodwill impairment charge. Management utilized a discount rate of 11.5% to estimate the present value of future cash flows. The discount rate was based upon a build-up of market data from similar companies and reflected uncertainty related to the Company's ability to achieve its forecasted results. Holding all other assumptions constant, an increase in the rate used to discount the expected future cash flows of approximately 100 basis points would reduce the fair value such that the reporting unit would not pass step one, and step two could result in a non-cash goodwill impairment charge. The factors that affect the level of estimated cash flows within this reporting unit include, but are not limited to: 1) declines in our market share and customer demand assumptions based on our competition, 2) our ability to successfully launch new product introductions, 3) delays in orders placed by existing customers, 4) the ongoing impacts of the European economic environment, including potential declines in pricing, reductions in volume or fluctuations in exchange rates within the regions served by Heinz Hänggi and 5) increases to the risk-adjusted weighted-average cost of capital.
Management's judgment and assumptions are required in performing the impairment tests for all reporting units with goodwill. While management expects future operating improvements to result from improving end-market conditions, new product introductions and further market penetration, there can be no assurance that such expectations will be met or that the fair value of the reporting unit will continue to exceed its carrying value. If its fair value were to fall below its carrying value, a non-cash impairment charge to income from operations could result.
Revenue Sharing Programs: The Company participates in aftermarket RSPs under which the Company receives an exclusive right to supply designated aftermarket parts over the life of the related aircraft engine program. As consideration, the Company has paid participation fees, which are recorded as long-lived intangible assets, and are recognized as a reduction of sales over the estimated useful life of the related engine programs which range up to 30 years. The carrying value of these intangible assets is $239.1 million at December 31, 2012. The Company records amortization of the related long-lived intangible asset as sales dollars are being earned based on a proportional sales dollar method. Specifically, this method amortizes each intangible asset as a reduction to revenue based on the proportion of sales under a program in a given period to the estimated aggregate sales dollars over the life of that program. This method reflects the pattern in which economic benefits are realized.
The recoverability of each intangible asset is subject to significant estimates about future revenues related to the program’s aftermarket parts. The Company evaluates these intangible assets for impairment and updates amortization rates on
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an agreement by agreement basis. The intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Annually, the Company evaluates the remaining useful life of these assets to determine whether events and circumstances warrant a revision to the remaining periods of amortization. Management updates revenue projections, which includes comparing actual experience against projected revenue and industry projections. The potential exists that actual revenues will not meet expectations due to a change in market conditions. A shortfall in future revenues may indicate a triggering event requiring an impairment test of the intangible asset or require the Company to accelerate amortization expense prospectively dependent on the level of the shortfall. The Company has not identified any impairment of these intangible assets. See Note 6 of the Consolidated Financial Statements.
Pension and Other Postretirement Benefits: Accounting policies and significant assumptions related to pension and other postretirement benefits are disclosed in Note 11 of the Consolidated Financial Statements.
The following table provides a breakout of the current targeted mix of investments, by asset classification, along with the historical rates of return for each asset class and the long-term projected rates of return for the U.S. plans.
Target Asset Mix % | Annual Return % | ||||||
Historical (1) | Long- Term Projection | ||||||
Asset class | |||||||
Large cap growth | 17 | 9.8 | 9.9 | ||||
Large cap value | 17 | 11.4 | 11.0 | ||||
Mid cap equity | 12 | 12.3 | 12.0 | ||||
Small cap growth | 7 | 7.1 | 7.3 | ||||
Small cap value | 7 | 11.6 | 11.4 | ||||
Non-U.S. equity | 10 | 9.5 | 8.4 | ||||
Real estate-related | 5 | 11.8 | 9.0 | ||||
Fixed income | 20 | 8.1 | 6.5 | ||||
Cash | 5 | 4.7 | 3.1 | ||||
Weighted average | 10.3 | 9.0 | |||||
________________________
(1) | Historical returns based on the life of the respective index, approximately 30 years. |
The historical rates of return were calculated based upon compounded average rates of return of published indices. The 25% aggregate target for fixed income and cash investments (in aggregate) is lower than the fixed income and cash component of a typical pension trust. The fixed income investments include a higher-than-average component of yield-aggressive investments, including high-yield corporate bonds. Based on the overall historical and projected rates of return of the targeted asset mix, management is using the long-term rate of return on its U.S. pension assets of 9.0%. The long-term rates of return for non-U.S. plans were selected based on actual historical rates of return of published indices that were used to measure the plans’ target asset allocations. Historical rates were then discounted to consider fluctuations in the historical rates as well as potential changes in the investment environment.
The discount rate used for the Company’s U.S. pension plans reflects the rate at which the pension benefits could be effectively settled. At December 31, 2012, the Company selected a discount rate of 4.25% based on a bond matching model for its U.S. pension plans. Market interest rates have decreased in 2012 as compared with 2011 and, as a result, the discount rate used to measure pension liabilities decreased from 5.05% at December 31, 2011. The discount rates for non-U.S. plans were selected based on bond matching models or on indices of high-quality bonds using criteria applicable to the respective countries.
A one-quarter percentage point change in the assumed long-term rate of return on the Company’s U.S. pension plans as of December 31, 2012 would impact the Company’s 2013 pre-tax income by approximately $0.9 million annually. A one-quarter percentage point decrease in the discount rate on the Company's U.S. pension plans as of December 31, 2012 would decrease the Company’s 2013 pre-tax income by approximately $1.4 million annually. The Company reviews these and other assumptions at least annually.
The Company recorded a $15.7 million non-cash after-tax decrease in stockholders equity (through other non-owner changes to equity) to record the current year adjustment for changes in the funded status of its pension and postretirement benefit plans as required under accounting for defined benefit and other postretirement plans. This decrease in stockholders
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equity resulted primarily from losses related to changes in actuarial assumptions, offset in part by favorable variances between expected and actual returns on pension plan assets. During 2012, the fair value of the Company’s pension plan assets increased by $47.2 million and the projected benefit obligation increased $54.9 million. The change in the projected benefit obligation included a $48.0 million (pre-tax) increase due to actuarial losses that resulted primarily from the reduction to the discount rate used to measure pension liabilities. Changes to other actuarial assumptions in 2012, including mortality and inflation rates, did not have a material impact on our stockholders equity or projected benefit obligation. The performance of the pension plan assets improved in 2012, partially offsetting the impact of the lower discount rate. Actual pre-tax return on total pension plan assets was $46.9 million compared with an expected pre-tax return on pension assets of $32.8 million. Approximately $2.1 million and $2.6 million of pension plan asset increases and projected benefit obligation increases, respectively, relate to the transfer of the defined benefit pension plan of the acquired Synventive business. Pension expense for 2013 is expected to increase to approximately $11.9 million, an increase of $3.6 million from 2012, primarily as a result of an increase in the amortization of actuarial losses from previous asset performance and changes in certain actuarial assumptions, primarily a lower discount rate. The 2013 expense estimate does not include potential future settlement costs.
Income Taxes: As of December 31, 2012, the Company had recognized $63.9 million of deferred tax assets, net of valuation reserves, principally in the United States. The realization of these benefits is dependent in part on the amount and timing of future taxable income in the jurisdictions where deferred tax assets reside. For those jurisdictions where the expiration date of tax loss carryforwards or the projected operating results indicate that realization is not likely, a valuation allowance is provided. Management believes that sufficient taxable income should be earned in the future to realize deferred income tax assets, net of valuation allowances recorded.
The United States deferred tax assets include significant tax operating loss carryforwards. If it became more likely than not that the deferred tax assets would expire unused, the Company would record a valuation allowance to reflect this fact. The Company is not in a cumulative loss position in the U.S. over the last three years (defined as pre-tax book income plus permanent tax items) and does not currently project to be in a cumulative loss position through 2013. The valuation of deferred tax assets requires significant judgment. Management’s assessment that these deferred tax assets will be realized represents its estimate of future results; however, there can be no assurance that such expectations will be met. Changes in management’s assessment of achieving sufficient future taxable income could materially increase the Company’s tax expense and could have a material adverse impact on the Company’s financial condition and results of operations. Management plans to continue to assess the need for a valuation allowance in the future.
Additionally, the Company is exposed to certain tax contingencies in the ordinary course of business and, accordingly, records those tax liabilities in accordance with the guidance for accounting for uncertainty in income taxes. For those tax positions where it is more likely than not that a tax benefit will be sustained, the Company has recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized. For those income tax positions where it is more likely than not that a tax benefit will not be sustained, no tax benefit has been recognized in the financial statements. See Note 13 of the Consolidated Financial Statements.
Stock-Based Compensation: The Company accounts for its stock-based employee compensation plans at fair value on the grant date and recognizes the related cost in its consolidated statement of income in accordance with accounting standards related to share-based payments. The fair values of stock options are estimated using the Black-Scholes option-pricing model based on certain assumptions. The fair values of service and performance based share awards are estimated based on the fair market value of the Company’s stock price on the grant date. The fair value of market based performance share awards are estimated using the Monte Carlo valuation method. See Note 12 of the Consolidated Financial Statements.
Recent Accounting Changes
In February 2013, the Financial Accounting Standards Board ("FASB") amended its guidance related to the presentation of other comprehensive income. The amended guidance requires that companies present information related to reclassification adjustments from accumulated other comprehensive income in their annual financial statements within a single note or on the face of the financial statements. The provisions of this amended guidance will be effective for the Company beginning in the first quarter of 2013 and will be applied retrospectively.
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EBITDA
Earnings before interest expense, income taxes, and depreciation and amortization (“EBITDA”) for 2012 was $188.1 million compared to $160.4 million in 2011. EBITDA is a measurement not in accordance with generally accepted accounting principles (“GAAP”). The Company defines EBITDA as net income plus interest expense, income taxes, and depreciation and amortization which the Company incurs in the normal course of business. The Company does not intend EBITDA to represent cash flows from operations as defined by GAAP, and the reader should not consider it as an alternative to net income, net cash provided by operating activities or any other items calculated in accordance with GAAP, or as an indicator of the Company’s operating performance. The Company’s definition of EBITDA may not be comparable with EBITDA as defined by other companies. The Company believes EBITDA is commonly used by financial analysts and others in the industries in which the Company operates and, thus, provides useful information to investors. Accordingly, the calculation has limitations depending on its use.
Following is a reconciliation of EBITDA to the Company’s net income (in millions):
2012 | 2011 | |||||||
Net income | $ | 95.2 | $ | 64.7 | ||||
Add back: | ||||||||
Interest expense | 12.2 | 10.3 | ||||||
Income taxes | 23.3 | 26.5 | ||||||
Depreciation and amortization | 57.4 | 58.9 | ||||||
EBITDA | $ | 188.1 | $ | 160.4 | ||||
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the potential economic loss that may result from adverse changes in the fair value of financial instruments. The Company’s financial results could be impacted by changes in interest rates and foreign currency exchange rates, and commodity price changes. The Company uses financial instruments to hedge its exposure to fluctuations in interest rates and foreign currency exchange rates. The Company does not use derivatives for speculative or trading purposes.
The Company’s long-term debt portfolio consists of fixed-rate and variable-rate instruments and is managed to reduce the overall cost of borrowing while also minimizing the effect of changes in interest rates on near-term earnings. The Company’s primary interest rate risk is derived from its outstanding variable-rate debt obligations. Financial instruments have been used by the Company to hedge its exposures to fluctuations in interest rates. The Company previously had two, three-year interest rate swap agreements which together converted the interest on the first $100.0 million of the Company's one-month LIBOR-based borrowings from a variable rate plus the borrowing spread to a fixed rate of 2.947% plus the borrowing spread and were accounted for as cash flow hedges. These agreements matured in the first quarter of 2011. In April 2012, the Company entered into five-year interest rate swap agreements transacted with three banks which together convert the interest on the first $100.0 million of borrowings under the Company’s Credit Agreement from a variable rate plus the borrowing spread to a fixed rate of 1.03% plus the borrowing spread for the purpose of mitigating its exposure to variable interest rates. At December 31, 2012, the result of a hypothetical 100 basis point increase in the average cost of the Company’s variable-rate debt would have reduced annual pretax profit by $4.3 million.
At December 31, 2012, the fair value of the Company’s fixed-rate debt was $59.1 million, compared with its carrying amount of $56.7 million. The Company estimates that a 100 basis point decrease in market interest rates at December 31, 2012 would have increased the fair value of the Company’s fixed-rate debt to $59.6 million.
The Company has manufacturing, sales and distribution facilities around the world and thus makes investments and conducts business transactions denominated in various currencies. The currencies of the locations where the Company’s business operations are conducted include the U.S. dollar, Brazilian real, British pound sterling, Canadian dollar, Chinese yuan, Euro, Hong Kong dollar, Japanese yen, Korean won, Mexican peso, Singapore dollar, Swedish kroner, Swiss franc and Thai baht. The Company is exposed primarily to financial instruments denominated in currencies other than the functional currency at its international locations. A 10% adverse change in all currencies at December 31, 2012 would have resulted in a $0.1 million loss in the fair value of those financial instruments. At December 31, 2012, the Company held $86.4 million of cash and cash equivalents and €5.1 million ($6.7 million) of restricted cash held in escrow, substantially all of which is held by foreign subsidiaries. This includes cash proceeds from the sale of the BDE business that was received in 2011, the majority of which was not in the local functional currency. The Company maintained forward currency contracts at December 31, 2012 to reduce the foreign currency exposure related to the proceeds.
Foreign currency commitments and transaction exposures are managed at the operating units as an integral part of their businesses in accordance with a corporate policy that addresses acceptable levels of foreign currency exposures. At December 31, 2012, the Company did not hedge its foreign currency net investment exposures.
Additionally, to reduce foreign currency exposure, management generally maintains the majority of foreign cash and short-term investments in functional currency and uses forward currency contracts for non-functional currency denominated monetary assets and liabilities and anticipated transactions in an effort to reduce the effect of the volatility of changes in foreign exchange rates on the income statement. In historically weaker currency countries, such as Brazil and Mexico, management assesses the strength of these currencies relative to the U.S. dollar and may elect during periods of local currency weakness to invest excess cash in U.S. dollar-denominated instruments.
The Company’s exposure to commodity price changes relates to certain manufacturing operations that utilize high-grade steel spring wire, stainless steel, titanium and other specialty metals and the distribution operations which distribute products made of steel, copper and brass. The Company attempts to manage its exposure to price increases through its procurement and sales practices.
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Item 8. Financial Statements and Supplementary Data
BARNES GROUP INC.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
Years Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Net sales | $ | 1,229,959 | $ | 1,169,355 | $ | 1,028,617 | ||||||
Cost of sales | 812,192 | 772,398 | 678,186 | |||||||||
Selling and administrative expenses | 281,211 | 269,402 | 264,033 | |||||||||
1,093,403 | 1,041,800 | 942,219 | ||||||||||
Operating income | 136,556 | 127,555 | 86,398 | |||||||||
Interest expense | 12,238 | 10,271 | 19,984 | |||||||||
Other expense (income), net | 2,671 | 395 | 2,609 | |||||||||
Income from continuing operations before income taxes | 121,647 | 116,889 | 63,805 | |||||||||
Income taxes | 23,350 | 25,316 | 9,827 | |||||||||
Income from continuing operations | 98,297 | 91,573 | 53,978 | |||||||||
Loss from discontinued operations, net of income taxes of $(87), $1,164 and $931 respectively (Note 2) | (3,048 | ) | (26,858 | ) | (700 | ) | ||||||
Net income | $ | 95,249 | $ | 64,715 | $ | 53,278 | ||||||
Per common share: | ||||||||||||
Basic: | ||||||||||||
Income from continuing operations | $ | 1.80 | $ | 1.66 | $ | 0.97 | ||||||
Loss from discontinued operations, net of income taxes | (0.06 | ) | (0.49 | ) | (0.01 | ) | ||||||
Net income | $ | 1.74 | $ | 1.17 | $ | 0.96 | ||||||
Diluted: | ||||||||||||
Income from continuing operations | $ | 1.78 | $ | 1.64 | $ | 0.96 | ||||||
Loss from discontinued operations, net of income taxes | (0.06 | ) | (0.48 | ) | (0.01 | ) | ||||||
Net income | $ | 1.72 | $ | 1.16 | $ | 0.95 | ||||||
Dividends | $ | 0.40 | $ | 0.34 | $ | 0.32 | ||||||
Weighted average common shares outstanding: | ||||||||||||
Basic | 54,626,453 | 55,214,586 | 55,259,732 | |||||||||
Diluted | 55,224,457 | 55,931,882 | 55,925,187 | |||||||||
See accompanying notes.
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BARNES GROUP INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Year Ended December 31, | |||||||||||
2012 | 2011 | 2010 | |||||||||
Net income | $ | 95,249 | $ | 64,715 | $ | 53,278 | |||||
Other comprehensive income (loss), net of tax | |||||||||||
Unrealized (loss) gain on hedging activities, net of tax (1) | (635 | ) | 381 | 1,446 | |||||||
Foreign currency translation adjustments, net of tax (2) | 24,678 | 2,514 | 16,973 | ||||||||
Defined benefit pension and other postretirement benefits, net of tax (3) | (15,741 | ) | (41,355 | ) | (5,517 | ) | |||||
Total other comprehensive income (loss), net of tax | 8,302 | (38,460 | ) | 12,902 | |||||||
Total comprehensive income | $ | 103,551 | $ | 26,255 | $ | 66,180 | |||||
(1) Net of tax of $(513), $232 and $857 for the years ended December 31, 2012, 2011 and 2010, respectively.
(2) Net of tax of $1,262, $(296) and $861 for the years ended December 31, 2012, 2011 and 2010, respectively.
(3) Net of tax of $(7,994), $(25,605) and $(2,340) for the years ended December 31, 2012, 2011 and 2010, respectively.
See accompanying notes.
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BARNES GROUP INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
December 31, | ||||||||
2012 | 2011 | |||||||
Assets | ||||||||
Current assets | ||||||||
Cash and cash equivalents | $ | 86,356 | $ | 62,505 | ||||
Accounts receivable, less allowances (2012 – $2,858; 2011 – $2,898) | 253,202 | 200,460 | ||||||
Inventories | 226,220 | 216,520 | ||||||
Deferred income taxes | 33,906 | 28,829 | ||||||
Prepaid expenses and other current assets | 18,856 | 21,680 | ||||||
Total current assets | 618,540 | 529,994 | ||||||
Deferred income taxes | 29,961 | 47,661 | ||||||
Property, plant and equipment, net | 233,097 | 210,784 | ||||||
Goodwill | 579,905 | 366,104 | ||||||
Other intangible assets, net | 383,972 | 272,092 | ||||||
Other assets | 23,121 | 13,730 | ||||||
Total assets | $ | 1,868,596 | $ | 1,440,365 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Current liabilities | ||||||||
Notes and overdrafts payable | $ | 3,795 | $ | 12,364 | ||||
Accounts payable | 99,037 | 92,524 | ||||||
Accrued liabilities | 96,364 | 92,250 | ||||||
Long-term debt – current | 699 | 540 | ||||||
Total current liabilities | 199,895 | 197,678 | ||||||
Long-term debt | 642,119 | 333,148 | ||||||
Accrued retirement benefits | 159,103 | 152,696 | ||||||
Deferred income taxes | 48,707 | 20,662 | ||||||
Other liabilities | 18,654 | 13,781 | ||||||
Commitments and contingencies (Note 19) | ||||||||
Stockholders’ equity | ||||||||
Common stock – par value $0.01 per share | ||||||||
Authorized: 150,000,000 shares | ||||||||
Issued: at par value (2012 – 59,202,029 shares; 2011 – 58,593,802 shares) | 592 | 586 | ||||||
Additional paid-in capital | 332,588 | 316,251 | ||||||
Treasury stock, at cost (2012 – 4,999,556 shares; 2011 – 4,254,350 shares) | (99,756 | ) | (79,569 | ) | ||||
Retained earnings | 633,446 | 560,186 | ||||||
Accumulated other non-owner changes to equity | (66,752 | ) | (75,054 | ) | ||||
Total stockholders’ equity | 800,118 | 722,400 | ||||||
Total liabilities and stockholders’ equity | $ | 1,868,596 | $ | 1,440,365 | ||||
See accompanying notes.
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BARNES GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years Ended December 31, | ||||||||||||
2012 | 2011 | 2010 | ||||||||||
Operating activities: | ||||||||||||
Net income | $ | 95,249 | $ | 64,715 | $ | 53,278 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
Depreciation and amortization | 57,360 | 58,904 | 52,770 | |||||||||
Amortization of convertible debt discount | 2,211 | 2,158 | 5,727 | |||||||||
(Gain) loss on disposition of property, plant and equipment | (178 | ) | (379 | ) | 266 | |||||||
Stock compensation expense | 8,819 | 8,319 | 7,655 | |||||||||
Withholding taxes paid on stock issuances | (1,150 | ) | (1,124 | ) | (440 | ) | ||||||
Loss on the sale of businesses | 799 | 26,128 | — | |||||||||
Changes in assets and liabilities, net of the effects of acquisitions/divestitures: | ||||||||||||
Accounts receivable | (4,160 | ) | (24,707 | ) | (35,891 | ) | ||||||
Inventories | 5,404 | (12,384 | ) | (24,006 | ) | |||||||
Prepaid expenses and other current assets | (4,341 | ) | 59 | (3,139 | ) | |||||||
Accounts payable | (5,493 | ) | 615 | 12,466 | ||||||||
Accrued liabilities | (9,659 | ) | 11,226 | 11,456 | ||||||||
Deferred income taxes | 9,446 | 5,386 | (1,566 | ) | ||||||||
Long-term retirement benefits | (16,438 | ) | (18,367 | ) | (12,135 | ) | ||||||
Other | (1,492 | ) | 475 | (681 | ) | |||||||
Net cash provided by operating activities | 136,377 | 121,024 | 65,760 | |||||||||
Investing activities: | ||||||||||||
Proceeds from disposition of property, plant and equipment | 854 | 3,620 | 1,498 | |||||||||
(Payments for) proceeds from the sale of businesses, net of cash sold | (438 | ) | 22,492 | — | ||||||||
Change (investment) in restricted cash | 4,900 | (11,664 | ) | — | ||||||||
Capital expenditures | (37,787 | ) | (37,082 | ) | (28,759 | ) | ||||||
Business acquisitions, net of cash acquired | (296,560 | ) | (3,495 | ) | — | |||||||
Other | (3,776 | ) | (4,483 | ) | (3,038 | ) | ||||||
Net cash used by investing activities | (332,807 | ) | (30,612 | ) | (30,299 | ) | ||||||
Financing activities: | ||||||||||||
Net change in other borrowings | (8,852 | ) | 7,168 | 347 | ||||||||
Payments on long-term debt | (114,411 | ) | (411,661 | ) | (359,542 | ) | ||||||
Proceeds from the issuance of long-term debt | 376,000 | 392,390 | 359,917 | |||||||||
Premium paid on convertible debt redemption | — | (9,803 | ) | — | ||||||||
Proceeds from the issuance of common stock | 7,061 | 28,579 | 5,746 | |||||||||
Common stock repurchases | (19,037 | ) | (34,066 | ) | (28,100 | ) | ||||||
Dividends paid | (21,662 | ) | (18,629 | ) | ||||||||