UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2020 .
or
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 1-475
(Exact name of registrant as specified in its charter)
| |
| |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
| |
| |
| (Address of principal executive office) |
(Zip Code) |
(414 ) 359-4000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class |
Trading Symbol |
Name of Each Exchange on Which Registered | ||
| |
|
|
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
☒
☐
NoIndicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation Yes No
S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒
☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated
filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2
of the Exchange Act.| |
☒ |
Accelerated Filer |
☐ | |||
| Non-accelerated filer |
☐ |
Smaller reporting company |
| |||
| Emerging growth company |
|
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule ☒ No
12b-2
of the Act.) ☐
Yes Class A Common Stock Outstanding as of April 30, 2020 – 26,044,733 shares
Common Stock Outstanding as of April 30, 2020 135,095,634 shares
–
Index
A. O. Smith Corporation
| Page |
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| Part I. |
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| 3 |
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| 3 |
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| 4 |
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| 5 |
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| 6 |
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| 7- 21 |
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| Item 2. |
22-26 |
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| Item 3. |
26 |
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| Item 4. |
27 |
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| Part II. |
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| Item 1. |
27 |
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| Item 1A. |
28 |
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| Item 2. |
29 |
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| Item 6. |
29 |
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| 30 |
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| 31 |
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2
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
A. O. SMITH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(dollars in millions, except for per share data)
(unaudited)
| Three Months Ended March 31, |
||||||||
| 2020 |
2019 |
|||||||
| Net sales |
$ |
|
$ |
|
||||
| Cost of products sold |
|
|
||||||
| Gross profit |
|
|
||||||
| Selling, general and administrative expenses |
|
|
||||||
| Interest expense |
|
|
||||||
| Other income |
( |
) | ( |
) | ||||
| Earnings before provision for income taxes |
|
|
||||||
| Provision for income taxes |
|
|
||||||
| Net Earnings |
$ | |
$ | |
||||
| Net Earnings Per Share of Common Stock |
$ | |
$ | |
||||
| Diluted Net Earnings Per Share of Common Stock |
$ | |
$ | |
||||
| Dividends Per Share of Common Stock |
$ | |
$ | |
||||
A. O. SMITH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(dollars in millions)
(unaudited)
| Three Months Ended March 31, |
||||||||
| 2020 |
2019 |
|||||||
| Net earnings |
$ |
|
$ | |
||||
| Other comprehensive (loss) earnings |
||||||||
| Foreign currency translation adjustments |
( |
) | |
|||||
| Unrealized net gains (losses) on cash flow derivative instruments, less related income tax provision of $( |
|
( |
) | |||||
| Adjustment to pension liability, less related income tax provision of $( |
|
|
||||||
| Comprehensive Earnings |
$ | |
$ |
|
||||
See accompanying notes to unaudited condensed consolidated financial statements.
3
A. O. SMITH CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in millions)
| (unaudited) March 31, 2020 |
December 31, 2019 |
|||||||
| Assets |
||||||||
| Current Assets |
||||||||
| Cash and cash equivalents |
$ | |
$ | |
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| Marketable securities |
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| Receivables |
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| Inventories |
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| Other current assets |
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| Total Current Assets |
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| Property, plant and equipment |
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|
||||||
| Less accumulated depreciation |
( |
) | ( |
) | ||||
| Net property, plant and equipment |
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|
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| Goodwill |
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||||||
| Other intangibles |
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| Operating lease assets |
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| Other assets |
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| Total Assets |
$ | |
$ | |
||||
| Liabilities |
||||||||
| Current Liabilities |
||||||||
| Trade payables |
$ | |
$ | |
||||
| Accrued payroll and benefits |
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| Accrued liabilities |
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| Product warranties |
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| Debt due within one year |
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| Total Current Liabilities |
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| Long-term debt |
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| Pension liabilities |
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| Long-term operating lease liabilities |
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| Other liabilities |
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| Total Liabilities |
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| Stockholders’ Equity |
||||||||
| Class A Common Stock, $ |
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| Common Stock, $ |
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|
||||||
| Capital in excess of par value |
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|
||||||
| Retained earnings |
|
|
||||||
| Accumulated other comprehensive loss |
( |
) | ( |
) | ||||
| Treasury stock at cost |
( |
) | ( |
) | ||||
| Total Stockholders’ Equity |
|
|
||||||
| Total Liabilities and Stockholders’ Equity |
$ | |
$ | |
||||
See accompanying notes to unaudited condensed consolidated financial statements
4
A. O. SMITH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in millions)
(unaudited)
| Three Months Ended March 31, |
||||||||
| 2020 |
2019 |
|||||||
| Operating Activities |
||||||||
| Net earnings |
$ | |
$ | |
||||
| Adjustments to reconcile net earnings to cash provided by (used in) operating activities: |
||||||||
| Depreciation and amortization |
|
|
||||||
| Stock based compensation expense |
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|
||||||
| Net changes in operating assets and liabilities: |
||||||||
| Current assets and liabilities |
( |
) | ( |
) | ||||
| Noncurrent assets and liabilities |
( |
) | ( |
) | ||||
| Cash Provided by Operating Activities |
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| Investing Activities |
||||||||
| Capital expenditures |
( |
) | ( |
) | ||||
| Investments in marketable securities |
( |
) | ( |
) | ||||
| Net proceeds from sale of marketable securities |
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| Cash Provided by Investing Activities |
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| Financing Activities |
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| Long-term debt incurred |
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| Common stock repurchases |
( |
) | ( |
) | ||||
| Net payments from stock option activity |
( |
) | ( |
) | ||||
| Dividends paid |
( |
) | ( |
) | ||||
| Cash Used i n Financing Activities |
( |
) | ( |
) | ||||
| Net increase in cash and cash equivalents |
|
|
||||||
| Cash and cash equivalents - beginning of period |
|
|
||||||
| Cash and Cash Equivalents - End of Period |
$ | |
$ | |
||||
See accompanying notes to unaudited condensed consolidated financial statements
5
A. O. SMITH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(dollars in millions)
(unaudited)
| Three Months Ended March 31, |
||||||||
| 2020 |
2019 |
|||||||
| Class A Common Stock |
||||||||
| Balance at the beginning of the year |
$ | |
$ | |
||||
| Balance at end of period |
$ | |
$ | |
||||
| Common Stock |
||||||||
| Balance at the beginning of the year |
$ | |
$ | |
||||
| Balance at end of period |
$ | |
$ | |
||||
| Capital in Excess of Par Value |
||||||||
| Balance at the beginning of the year |
$ | |
$ | |
||||
| Issuance of share units |
( |
) | ( |
) | ||||
| Vesting of share units |
( |
) | ( |
) | ||||
| Stock based compensation expense |
|
|
||||||
| Exercises of stock options |
( |
) | |
|||||
| Stock incentives |
|
|
||||||
| Balance at end of period |
$ | |
$ | |
||||
| Retained Earnings |
||||||||
| Balance at the beginning of the year |
$ | |
$ | |
||||
| Net earnings |
|
|
||||||
| Cash dividends on stock |
( |
) | ( |
) | ||||
| Balance at end of period |
$ | |
$ | |
||||
| Accumulated Other Comprehensive Loss (see Note 15) |
$ | ( |
) | $ | ( |
) | ||
| Treasury Stock |
||||||||
| Balance at the beginning of the year |
$ | ( |
) | $ | ( |
) | ||
| Exercise of stock options |
( |
) | ( |
) | ||||
| Shares repurchased |
( |
) | ( |
) | ||||
| Vesting of share units |
|
|
||||||
| Balance at end of period |
$ | ( |
) | $ | ( |
) | ||
| Total Stockholders’ Equity |
$ | |
$ | |
||||
See accompanying notes which are an integral part of these statements.
6
A. O. SMITH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2020
(unaudited)
1. |
Basis of Presentation |
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and footnotes required for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2020 are not necessarily indicative of the results expected for the full year. It is suggested the accompanying condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form
10-K
for the year ended December 31, 2019 filed with the SEC on February 24, 2020.Recent Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board (FASB) amended Accounting Standards Codification (ASC) 740, (issued under Accounting Standards Update (ASU)
Income Taxes
2019-12,
“Simplifying the Accounting for Income Taxes”). This amendment removes certain exceptions to the general principles of ASC 740, and clarifies and amends existing guidance to improve consistent application. The amendment requires adoption on January 1, 2021, with early adoption permitted. The Company does not expect that the adoption of ASU 2019-12
will have a material impact on its consolidated balance sheets, statements of earnings or statements of cash flows.In January 2017, the FASB amended ASC 350, and Other (issued under ASU
Intangibles – Goodwill
2017-04,
“Simplifying the Test for Goodwill Impairment”). This amendment simplifies the test for goodwill impairment by only requiring an entity to perform an annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount that the carrying amount exceeds the reporting unit’s fair value. Any loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The Company adopted the amendment on January 1, 2020 and the adoption of ASU 2017-04
did not have an impact on its consolidated balance sheets, statements of earnings or statements of cash flows. In June 2016, the FASB issued ASC 326, (issued under ASU
Financial Instruments – Credit Losses
2016-13)
which modifies the measurement of expected credit losses on certain financial instruments. The Company adopted 2016-13
on January 1, 2020 and the adoption did not have a material impact on its consolidated balance sheets, statements of earnings or statements of cash flows. 7
2. |
Revenue Recognition |
Substantially all of the Company’s sales are from contracts with customers for the purchase of its products. Contracts and customer purchase orders are used to determine the existence of a sales contract. Shipping documents are used to verify shipment. For substantially all of its products, the Company transfers control of products to the customer at the point in time when title and risk are passed to the customer, which generally occurs upon shipment of the product. Each unit sold is considered an independent, unbundled performance obligation. The Company’s sales arrangements do not include other performance obligations that are material in the context of the contract.
The nature, timing and amount of revenue for a respective performance obligation are
consistent
for each customer. The Company measures the sales transaction price based upon the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. Sales and value added taxes are excluded from the measurement of transaction price. The Company’s payment terms for the majority of its customers are 30 to 90 days from shipment. Additionally, certain customers in China pay the Company prior to the shipment of products resulting in a customer deposits liability of $65.2 million and $49.6 million at March 31, 2020 and December 31, 2019, respectively. The Company assesses the collectability of customer receivables based on the creditworthiness of a customer as determined by credit checks and analysis, as well as the customer’s payment history. In determining the allowance for doubtful accounts, the Company also considers various factors including the aging of customer accounts and historical write-offs. In addition, the Company monitors other risk factors including forward-looking information when establishing adequate allowances for doubtful accounts, which reflects the current estimate of credit losses expected to be incurred over the life of the receivables. The Company’s allowance for doubtful accounts was $7.5 million and $6.7 million at March 31, 2020 and December 31, 2019, respectively.
Rebates and incentives are based on pricing agreements and are tied to sales volume. The amount of revenue is reduced for variable consideration related to customer rebates which are calculated using expected values and are based on program specific factors such as expected rebate percentages based on expected volumes. In situations where the customer has the right to return eligible products, the Company reduces revenue for its estimates of expected product returns, which are primarily based on an analysis of historical experience. Changes in such accruals may be required if actual sales volume differs from estimated sales volume or if future returns differ from historical experience. Shipping and handling costs billed to customers are included in net sales and the related costs are included in cost of products sold and are activities performed to fulfill the promise to transfer products.
Disaggregation of Net Sales
The Company is comprised of two reporting segments: North America and Rest of World. The Rest of World segment is primarily comprised of China, Europe and India. Both segments manufacture and market comprehensive lines of residential and commercial gas and electric water heaters, boilers, tanks and water treatment products. Both segments primarily manufacture and market in their respective regions of the world. The Rest of World segment also manufactures and markets
in-home
air purification products in China.As each segment manufactures and markets products in its respective region of the world, the Company has determined that geography is the primary factor in reporting its sales. The Company further disaggregates its North America segment sales by major product line as each of North America’s major product lines is sold through distinct distribution channels and these product lines may be impacted differently by certain economic factors. Within the Rest of World segment, particularly in China and India, the Company’s major customers purchase across the Company’s product lines, utilizing the same distribution channel regardless of product type. In addition, the impact of economic factors is unlikely to be differentiated by product line in the Rest of World segment.
8
2. |
Revenue Recognition (continued) |
The North America segment major product lines are defined as the following:
Water heaters
Boilers
Water treatment
products
point-of-entry
water softeners, solutions for problem well water, and whole-home water filtration products to on-the-go
filtration bottles and point-of-use
carbon and reverse osmosis products. Typical applications for the Company’s water treatment products include residences, restaurants, hotels and offices. The Company sells water treatment products through its wholesale and retail distribution channels, similar to water heater products and related parts. The Company’s water treatment products are also sold through independent water quality dealers
as well as directly to consumers including through internet sales channels. A portion of the Company’s sales of water treatment products in the North America segment
is comprised of replacement filters.The following table disaggregates the Company’s net sales by segment. As described above, the Company’s North America segment sales are further disaggregated by major product line. In addition, the Company’s Rest of World segment sales are disaggregated by China and all other Rest of World.
9
2. |
Revenue Recognition ( continued ) |
(dollars in millions)
Three Months Ended March 31, |
||||||||
2020 |
2019 |
|||||||
North America |
||||||||
Water heaters and related parts |
$ | $ | ||||||
Boilers and related parts |
||||||||
Water treatment products (1) |
||||||||
Total North America |
||||||||
Rest of World |
||||||||
China |
$ | $ | ||||||
All other Rest of World |
||||||||
Total Rest of World |
||||||||
Inter-segment sales |
( |
) | ( |
) | ||||
Total Net Sales |
$ | $ | ||||||
(1)
Includes the results of Water-Right, Inc. and its affiliated entities (Water-Right) from April 8, 2019, the date of acquisition 3. |
Acquisitions |
On April 8, 2019 , the Company acquired 100 percent of the shares of Water-Right, a Wisconsin-based water treatment company. With the addition of Water-Right, the Company grew its North America water treatment platform. Water-Right is included in the Company’s North America segment for reporting purposes.
The Company paid an aggregate cash purchase price of $107.0 million, net of cash acquired. In addition, the Company established a $4.0 million escrow to satisfy any potential obligations of the former owners of Water-Right, should they arise.
The following table summarizes the allocation of the fair value of the assets acquired and liabilities assumed at the date of acquisition of Water-Right for purposes of allocating the purchase price. Significant assumptions used to estimate the fair value of intangible assets acquired include discount rates and certain assumptions that form the basis of the forecasted results, including revenue growth rates, attrition rates and royalty rates. The $60.4 million of acquired identifiable intangible assets was comprised of the following: $40.2 million of customer relationships being amortized over 20 years, $19.0 million of trademarks not subject to amortization, and $1.2 million of 7.5 years.
non-compete
agreements being amortized over April 8, 2019 (dollars in millions) |
||||
Current assets, net of cash acquired |
$ | |||
Property, plant and equipment |
||||
Intangible assets |
||||
Goodwill |
||||
Total assets acquired |
||||
Current liabilities |
( |
) | ||
Net assets acquired |
$ | |||
10
3. |
Acquisitions (continued) |
As required under ASC 805 Business Combinations, Water-Right’s
results
of operations have been included in the Company’s consolidated financial statements from April 8, 2019, the date of acquisition. 4. |
Leases |
The Company’s lease portfolio consists of operating leases for
buildings
and equipment, such as forklifts and copiers, primarily in the United States and China. The Company defines a lease as a contract that gives the Company the right to control the use of a physical asset for a stated term. The Company pays the lessor for that right, with a series of payments defined in the contract and a corresponding right of use operating lease asset and liability are recorded. The Company has elected not to record leases with an initial term of 12 months or less on its condensed consolidated balance sheet. To determine balance sheet amounts, required legal payments are discounted using the Company’s incremental borrowing rate as of the inception of the lease. The incremental borrowing rate is the rate of interest that the Company would incur if it were to borrow, on a collateralized basis, an amount equal to the value of the leased item over a similar term, in a similar economic environment. Variable lease components not based on an index or rate are excluded from the measurement of the lease asset and liability and expensed as incurred for all asset classes. Certain leases include one or more options to renew or terminate. Renewal terms can extend the lease term from to five years and options to terminate can be effective within one year . The exercise of lease renewal or termination is at the Company’s discretion and when it is determined to be reasonably certain to renew or terminate, the option is reflected in the measurement of lease asset and liability. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants or material subleases. Cash flows associated with leases are materially consistent with the expense recorded in the condensed consolidated statement of earnings.
Supplemental balance sheet information related to leases was as follows:
(dollars in millions)
| March 31, 2020 |
December 31, 2019 |
|||||||
| Liabilities |
||||||||
| Short term: Accrued liabilities |
$ | |
$ | |
||||
| Long term: Operating lease liabilities |
|
|
||||||
| Total operating lease liabilities |
$ | |
$ | |
||||
| Less: Rent incentives and deferrals |
( |
) | ( |
) | ||||
| Assets |
||||||||
| Operating lease assets |
$ | |
$ | |
||||
11
4. |
Leases (continued) |
| Lease Term and Discount Rate |
March 31, 2020 |
|||
| Weighted-average remaining lease term |
|
|||
| Weighted-average discount rate |
% |
|||
The components of lease expense were as follows:
| (dollars in millions) |
||||||||||
| Three months ended March 31, |
||||||||||
| Lease Expense |
Classification |
2020 (1) |
2019 (2) |
|||||||
| Operating lease expense |
Cost of products sold |
$ | |
$ | |
|||||
| Selling, general and administrative expenses |
|
|
||||||||
(1) |
2020 includes short-term and variable lease expenses of $ |
(2) |
2019 includes short-term and variable lease expenses of $ |
Maturities of lease liabilities were as follows:
| (dollars in millions) |
||||
| March 31, 2020 |
||||
| 2020 |
$ | |
||
| 2021 |
|
|||
| 2022 |
|
|||
| 2023 |
|
|||
| 2024 |
|
|||
| After 2024 |
|
|||
| Total lease payments |
|
|||
| Less: imputed interest |
( |
) | ||
| Present value of operating lease liabilities |
$ | |
||
5. |
Inventories |
The following table presents the components of the Company’s inventory balances:
| (dollars in millions) |
||||||||
| March 31, 2020 |
December 31, 2019 |
|||||||
| Finished products |
$ | |
$ | |
||||
| Work in process |
|
|
||||||
| Raw materials |
|
|
||||||
| Inventories, at FIFO cost |
|
|
||||||
| LIFO reserve |
( |
) | ( |
) | ||||
| Net inventory |
$ | |
$ | |
||||
12
6. |
Product Warranties |
The Company offers warranties on the sales of certain of its products with terms that are consistent with the market and records an accrual for the estimated future claims. The following table presents the Company’s warranty liability activity.
| (dollars in millions) |
||||||||
| Three Months Ended March 31, |
||||||||
| 2020 |
2019 |
|||||||
| Balance at January 1 |
$ | |
$ | |
||||
| Expense |
|
|
||||||
| Claims settled |
( |
) | ( |
) | ||||
| Balance at March 31 |
$ | |
$ | |
||||
7. |
Long-Term Debt |
The Company has a $500 million multi-year multi-currency revolving credit agreement with a group of nine banks, which expires on December 15, 2021 . The facility has an accordion provision which allows it to be increased up to $700 million if certain conditions (including lender approval) are satisfied.
Borrowings under bank credit lines and commercial paper borrowings are supported by the $500 million revolving credit agreement. As a result of the long-term nature of this facility, the Company’s commercial paper and credit line borrowings are classified as long-term debt at March 31, 2020. At its option, the Company either maintains cash balances or pays fees for bank credit and services.
8. |
Earnings per Share of Common Stock |
The numerator for the calculation of basic and diluted earnings per share is net earnings. The following table sets forth the computation of basic and diluted weighted-average shares used in the earnings per share calculations:
| Three Months Ended March 31, |
||||||||
| 2020 |
2019 |
|||||||
| Denominator for basic earnings per share - weighted average shares |
|
|
||||||
| Effect of dilutive stock options and share units |
|
|
||||||
| Denominator for diluted earnings per share |
|
|
||||||
13
9. |
Stock Based Compensation |
The Company adopted the A. O. Smith Combined Incentive Compensation Plan (the “Plan”) effective January 1, 2007. The Plan was reapproved by stockholders on April 16, 2012. The Plan is a continuation of the A. O. Smith Combined Executive Incentive Compensation Plan which was originally approved by stockholders in 2002. The number of shares available for granting of options or share units at March 31, 2020 was 951,461 . Upon stock option exercise or share unit vesting, shares are issued from treasury stock.
Total stock based compensation expense recognized in the three months ended March 31, 2020 and 2019 was $9.0 million and $8.7 million, respectively.
Stock Options
The stock options granted in the three months ended March 31, 2020 and 2019 have three year ten years 4.5 million and $4.3 million, respectively.
Changes in options, all of which relate to the Company’s Common Stock, were as follows for the three months ended March 31, 2020:
| Weighted- Avg. Per Exercise |
Number of |
Average Remaining Contractual Life |
Aggregate Intrinsic Value (dollars in millions) |
|||||||||||||
| Outstanding at January 1, 2020 |
$ | |
|
|||||||||||||
| Granted |
|
|
||||||||||||||
| Exercised |
|
( |
) | |||||||||||||
| Forfeited |
|
( |
) | |||||||||||||
| Outstanding at March 31, 2020 |
|
|
|
$ | |
|||||||||||
| Exercisable at March 31, 2020 |
|
|
|
$ | |
|||||||||||
| Three Months Ended March 31, |
||||||||
| 2020 |
2019 |
|||||||
| Expected life (years) |
|
|
||||||
| Risk-free interest rate |
|
% | |
% | ||||
| Dividend yield |
|
% | |
% | ||||
| Expected volatility |
|
% | |
% | ||||
14
9. |
Stock Based Compensation (continued) |
The expected lives of options for purposes of these models are based on historical exercise behavior. The risk-free interest rates for purposes of these models are based on the U.S. Treasury yield curve in effect on the date of grant for the respective expected lives of the option. The expected dividend yields for purposes of these models are based on the dividends paid in the preceding four quarters divided by the grant date market value of the Common Stock. The expected volatility for purposes of these models are based on the historical volatility of the Common Stock.
Restricted Stock and Share Units
Participants may also be awarded shares of restricted stock or share units under the Plan. Share units vest three years after the date of grant. The Company granted 169,407 and 136,647 share units under the plan in the three months ended March 31, 2020 and 2019, respectively. The share units were valued at $7.2 million and $6.8 million at the date of issuance in 2020 and 2019, respectively, based on the price of the Company’s Common Stock at the date of grant. The share units are recognized as compensation expense ratably over the three-year 4.5 million and $4.4 million was recognized in the three months ended March 31, 2020 and 2019, respectively. Certain
non-U.S.-based
employees receive the cash value of the share price at the vesting date in lieu of shares. Unvested cash-settled awards are remeasured at each reporting period.A summary of share unit activity under the plan is as follows for the three months ended March 31, 2020:
| Number of Units |
Weighted-Average Grant Date Value |
|||||||
| Issued and unvested at January 1, 2020 |
|
$ | |
|||||
| Granted |
|
|
||||||
| Vested |
( |
) | |
|||||
| Forfeited |
( |
) | |
|||||
| Issued and unvested at March 31, 2020 |
|
|
||||||
15
10. |
Pensions |
The following table presents the components of the Company’s net pension income.
| Three Months Ended March 31, |
||||||||
| 2020 |
2019 |
|||||||
| Service cost |
$ | |
$ | |
||||
| Interest cost |
|
|
||||||
| Expected return on plan assets |
( |
) | ( |
) | ||||
| Amortization of unrecognized loss |
|
|
||||||
| Amortization of prior service cost |
( |
) | ( |
) | ||||
| Defined benefit plan income |
$ | ( |
) | $ | ( |
) | ||
The service cost component of net periodic benefit cost is presented within cost of products sold and selling, general and administrative expenses within the condensed consolidated statements of earnings while the other components of pension income are reflected in other income. The Company was not required to and did not make a contribution to its U.S. pension plan in 2019. The Company is not required to make a contribution in 2020.
11. |
Segment Results |
The Company is comprised of two reporting segments: North America and Rest of World. The Rest of World segment is primarily comprised of China, Europe and India. Both segments manufacture and market comprehensive lines of residential and commercial gas and electric water heaters, boilers, tanks, and water treatment products. Both segments primarily manufacture and market in their respective regions of the world. The Rest of World segment also manufactures and markets
in-home
air purification products in China.The following table presents the Company’s segment results:
| (dollars in millions) |
||||||||
| |
Three Months Ended March 31, |
|||||||
| 2020 |
2019 |
|||||||
| Net sales |
||||||||
| North America |
$ | |
$ | |
||||
| Rest of World |
|
|
||||||
| Inter-segment |
( |
) | ( |
) | ||||
| $ | |
$ | |
|||||
| Segment earnings ( losses ) |
||||||||
| North America |
$ | |
$ | |
||||
| Rest of World |
( |
) | |
|||||
| |
|
|||||||
| Corporate expense |
( |
) | ( |
) | ||||
| Interest expense |
( |
) | ( |
) | ||||
| Earnings before income taxes |
|
|
||||||
| Provision for income taxes |
|
|
||||||
| Net earnings |
$ | |
$ | |
||||
16
12. |
Fair Value Measurements |
ASC 820, , among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring basis or nonrecurring basis. ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. Assets and liabilities measured at fair value are based on the market approach which are prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
Fair Value Measurements
The following table presents assets measured at fair value on a recurring basis.
(dollars in millions) |
||||||||
Fair Value Measurement Using |
March 31, 2020 |
December 31, 2019 |
||||||
Quoted prices in active markets for identical assets (Level 1) |
$ | $ | ||||||
Significant other observable inputs (Level 2) |
||||||||
Items measured at fair value were comprised of the Company’s marketable securities (Level 1) and derivative instruments (Level 2). There were no changes in the Company’s valuation techniques used to measure fair values on a recurring basis during the three months ended March 31, 2020.
13. |
Derivative Instruments |
The Company utilizes certain derivative instruments to enhance its ability to manage currency exposure as well as raw materials price risk. Derivative instruments are entered into for periods consistent with the related underlying exposures and do not constitute positions independent of those exposures. The Company does not enter into contracts for speculative purposes. The contracts are executed with major financial institutions with no credit loss anticipated for failure of the counterparties to perform.
Cash Flow Hedges
With the exception of its net investment hedges, the Company designates that all of its hedging instruments are cash flow hedges. For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), gains or losses on the derivative instrument are reported as a component of other comprehensive loss, net of tax, and are reclassified into earnings in the same line item associated with the forecasted transaction and in the same period or periods during which the hedged transaction affects earnings.
Foreign Currency Forward Contracts
The Company is exposed to foreign currency exchange risk as a result of transactions in currencies other than the functional currency of certain subsidiaries. The Company utilizes foreign currency forward purchase and sale contracts to manage the volatility associated with foreign currency purchases, sales and certain intercompany transactions in the normal course of business. Principal currencies for which the Company utilizes foreign currency forward contracts include the British pound, Canadian dollar, Euro and Mexican peso.
17
13. |
Derivative Instruments (continued) |
Gains and losses on these instruments are recorded in accumulated other comprehensive loss, net of tax, until the underlying transaction is recorded in earnings. When the hedged item is realized, gains or losses are reclassified from accumulated other comprehensive loss to the consolidated statement of earnings. The assessment of effectiveness for forward contracts is based on changes in the forward rates. These hedges have been determined to be effective. The majority of the amounts in accumulated other comprehensive loss for cash flow hedges are expected to be reclassified into earnings within one year. The following table summarizes, by currency, the contractual amounts of the Company’s foreign currency forward contracts that are designated as cash flow hedges.
(dollars in millions)
March 31, 2020 |
December 31, 2019 |
|||||||||||||||
Buy |
Sell |
Buy |
Sell |
|||||||||||||
British pound |
$ | — |
$ | $ | — |
$ | ||||||||||
Canadian dollar |
— |
— |
||||||||||||||
Euro |
— |
— |
||||||||||||||
Mexican peso |
— |
— |
||||||||||||||
Total |
$ | $ | $ | $ | ||||||||||||
Commodity Futures Contracts
In addition to entering into supply arrangements in the normal course of business, the Company also enters into futures contracts to fix the cost of certain raw material purchases, principally steel, with the objective of minimizing changes in cost due to market price fluctuations. The hedging strategy for achieving this objective is to purchase steel futures contracts on the New York Metals Exchange (NYMEX) and copper futures contracts on the open market of the London Metals Exchange (LME) or over the counter contracts based on the LME.
With NYMEX, the Company is required to make cash deposits on unrealized losses on steel derivative contracts.
The one year .
after-tax
gains and losses of the contracts as of March 31, 2020 were recorded in accumulated other comprehensive loss and will be reclassified into cost of products sold in the period in which the underlying transaction is recorded in earnings. The after-tax
gains and losses on the contracts will be reclassified within Net Investment Hedges
The Company enters into certain foreign currency forward contracts to hedge the exposure to a portion of the Company’s net investments in certain 0.8 million and $1.3 million of 50.0 million as of March 31, 2020.
non-U.S.
subsidiaries against the effect of exchange rate fluctuations on the translation of foreign currency balances to the U.S. dollar. For the derivative instruments that are designated and qualify as net investment hedges, gains and losses are reported in other comprehensive loss where they offset gains and losses recorded on the Company’s net investments in its non-U.S.
subsidiaries. These hedges are determined to be effective. The Company recognized $after-tax
gains associated with hedges of a net investment in non-U.S.
subsidiaries in currency translation adjustment in other comprehensive income in the three months ended March 31, 2020 and 2019, respectively. The contractual amount of the Company’s foreign currency forward contracts that are designated as net investment hedges is $18
13. |
Derivative Instruments (continued) |
The following tables present the impact of derivative contracts on the Company’s financial statements.
| Fair value of derivatives designated as hedging instruments under ASC 815: |
||||||||||
| (dollars in millions) |
||||||||||
| Balance Sheet Location |
March 31, 2020 |
December 31, 2019 |
||||||||
| Foreign currency contracts |
Other current assets |
$ |
|
$ |
|
|||||
| Accrued liabilities |
( |
) |
( |
) | ||||||
| Commodities contracts |
Accrued liabilities |
( |
) |
— |
||||||
| Total derivatives designated as hedging instruments |
$ |
|
$ |
|
||||||
The effect of cash flow hedges on the condensed consolidated statement of earnings:
Three Months Ended March 31 (dollars in millions):
| Derivatives in ASC 815 cash flow hedging relationships |
Amount of gain (loss) recognized in other comprehensive loss on derivatives |
Location of gain (loss) reclassified from accumulated other comprehensive loss into earnings |
Amount of gain (loss) reclassified from accumulated other comprehensive loss into earnings |
|||||||||||||||
| |
2020 |
2019 |
|
2020 |
2019 |
|||||||||||||
| Foreign currency contracts |
$ | |
$ | |
Cost of products sold |
$ | |
$ | — |
| ||||||||
| Commodities contracts |
( |
) | ( |
) | Cost of products sold |
— |
— |
|||||||||||
| $ | |
$ | ( |
) | $ | |
$ | — |
||||||||||
14. |
Income Taxes |
The effective income tax rate for the three months ended March 31, 2020 was 23.6 percent compared to 20.0 percent for the three months ended March 31, 2019. The higher effective income tax rate for the three months ended March 31, 2020 compared to the effective income tax rate for the three months ended March 31, 2019 was primarily due to
a change in geographic
earnings mix. As of March 31, 2020, the Company had $9.7 million of unrecognized tax benefits of which $0.8 million would affect its effective income tax rate if recognized. The Company recognizes potential interest and penalties related to unrecognized tax benefits as a component of income tax expense.
The Company’s U.S. federal income tax returns for 2016 -2020 are subject to audit. The Company is subject to state and local income tax audits for tax years 2002 -2020 . The Company is subject to 2014 -2020 .
non-U.S.
income tax examinations for years 19
15. |
Changes in Accumulated Other Comprehensive Loss by Component |
| (dollars in millions) |
|
|
||||||
| |
|
| ||||||
| Three Months Ended March 31, |
||||||||
| 2020 |
2019 |
|||||||
| Cumulative foreign currency translation |
||||||||
| Balance at beginning of period |
$ | ( |
) | $ | ( |
) | ||
| Other comprehensive ( income before reclassifications loss ) |
( |
) | |
|||||
| Balance at end of period |
( |
) | ( |
) | ||||
| Unrealized net gain (loss) on cash flow derivatives |
||||||||
| Balance at beginning of period |
|
( |
) | |||||
| Other comprehensive loss before reclassifications |
|
( |
) | |||||
| Realized gains on derivatives reclassified to cost of products sold (net of income tax provision of $ $ |
( |
) | — |
|||||
| Balance at end of period |
|
( |
) | |||||
| Pension liability |
||||||||
| Balance at beginning of period |
( |
) | ( |
) | ||||