NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 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 and nine months ended September 30, 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, Income Taxes (issued under Accounting Standards Update (ASU) 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, Intangibles - Goodwill and Other (issued under ASU 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, Financial Instruments - Credit Losses (issued under ASU 2016-13) which modifies the measurement of expected credit losses on certain financial instruments. The Company adopted ASU 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.
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 $68.7 million and $49.6 million at September 30, 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
2. Revenue Recognition (continued)
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 $7.2 million at September 30, 2020 and $6.7 million at December 31, 2019.
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.
The North America segment major product lines are defined as the following:
Water heaters The Company’s water heaters are open water heating systems that heat potable water. Typical applications for water heaters include residences, restaurants, hotels and motels, office buildings, laundries, car washes and small businesses. The Company sells residential and commercial water heater products and related parts through its wholesale distribution channel, which includes more than 1,300 independent wholesale plumbing distributors. The Company also sells residential water heaters and related parts through retail and maintenance, repair and operations (MRO) channels. A significant portion of the Company’s water heater sales in the North America segment is derived from the replacement of existing products.
Boilers The Company’s boilers are closed loop water heating systems used primarily for space heating or hydronic heating. The Company’s boilers are primarily used in applications in commercial settings for hospitals, schools, hotels and other large commercial buildings while residential boilers are used in homes, apartments and condominiums. The Company’s boiler distribution channel is comprised primarily of manufacturer representative firms, with the remainder of its boilers distributed through wholesale channels. The Company’s boiler sales in the North America segment are derived from a combination of replacement of existing products and new construction.
Water treatment products The Company’s water treatment products range from 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 retail and wholesale 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.
2. Revenue Recognition (continued)
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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
North America
|
|
|
|
|
|
|
|
Water heaters and related parts
|
$
|
442.5
|
|
|
$
|
415.9
|
|
|
$
|
1,287.1
|
|
|
$
|
1,310.5
|
|
Boilers and related parts
|
55.7
|
|
|
60.2
|
|
|
138.2
|
|
|
150.8
|
|
Water treatment products(1)
|
45.8
|
|
|
38.5
|
|
|
132.1
|
|
|
99.1
|
|
Total North America
|
544.0
|
|
|
514.6
|
|
|
1,557.4
|
|
|
1,560.4
|
|
Rest of World
|
|
|
|
|
|
|
|
China
|
$
|
192.0
|
|
|
$
|
189.6
|
|
|
$
|
455.7
|
|
|
$
|
626.8
|
|
All other Rest of World
|
29.4
|
|
|
30.7
|
|
|
65.6
|
|
|
74.7
|
|
Total Rest of World
|
221.4
|
|
|
220.3
|
|
|
521.3
|
|
|
701.5
|
|
Inter-segment sales
|
(5.4)
|
|
|
(6.7)
|
|
|
(17.9)
|
|
|
(20.1)
|
|
Total Net Sales
|
$
|
760.0
|
|
|
$
|
728.2
|
|
|
$
|
2,060.8
|
|
|
$
|
2,241.8
|
|
(1)Includes the results of Water-Right, Inc. and its affiliated entities (Water-Right) from April 8, 2019, the date of acquisition.
3. Acquisition
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. During the second quarter of 2020, the Company released $2.0 million of the escrow to the previous owners of Water-Right. The remaining balance of the escrow has scheduled disbursements of $1.9 million in the fourth quarter of 2020 and $0.1 million in the second quarter of 2021.
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 non-compete agreements being amortized over 7.5 years.
|
|
|
|
|
|
April 8, 2019 (dollars in millions)
|
|
Current assets, net of cash acquired
|
$
|
9.7
|
|
Property, plant and equipment
|
8.6
|
|
Intangible assets
|
60.4
|
|
Goodwill
|
31.0
|
|
Total assets acquired
|
109.7
|
|
Current liabilities
|
(2.7)
|
|
Net assets acquired
|
$
|
107.0
|
|
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. Severance and Restructuring Expenses
To align its business to current market conditions, during the three and nine months ended September 30, 2020, the Company recognized $1.6 million and $7.7 million of pre-tax severance and restructuring expenses, respectively. Charges recognized during the three months ended September 30, 2020, were comprised of $1.6 million severance costs, as well as a corresponding $0.3 million tax benefit related to these expenses. Charges recognized during the nine months ended September 30, 2020, were comprised of $6.8 million severance costs and $0.9 million of other restructuring expenses, as well as a corresponding $1.4 million tax benefit related to these expenses.
Of the $1.6 million expense recognized during the three months ended September 30, 2020, $0.5 million was related to the North America segment and $1.1 million was related to the Rest of World segment. Of the $7.7 million expense recognized during the nine months ended September 30, 2020, $2.7 million was related to the North America segment and $5.0 million was related to the Rest of World segment. The Company’s severance and restructuring actions were primarily completed in the nine months ended September 30, 2020.
The following table summarizes the activity in the Company’s accrual for severance and restructuring expenses incurred during the three and nine months ended September 30, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
Severance
Expenses
|
|
Restructuring
Expenses
|
|
Total
|
Accrued severance and restructuring expenses, March 31, 2020
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Charges
|
5.2
|
|
|
0.9
|
|
|
6.1
|
|
Cash Payments
|
(2.2)
|
|
|
(0.3)
|
|
|
(2.5)
|
|
Accrued severance and restructuring expenses, June 30, 2020
|
$
|
3.0
|
|
|
$
|
0.6
|
|
|
$
|
3.6
|
|
Charges
|
1.6
|
|
|
—
|
|
|
1.6
|
|
Cash Payments
|
(2.0)
|
|
|
(0.5)
|
|
|
(2.5)
|
|
Accrued severance and restructuring expenses, September 30, 2020
|
$
|
2.6
|
|
|
$
|
0.1
|
|
|
$
|
2.7
|
|
5. 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 one 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)
|
September 30,
2020
|
|
December 31, 2019
|
Liabilities
|
|
|
|
Short term: Accrued liabilities
|
$
|
11.1
|
|
|
$
|
12.0
|
|
Long term: Operating lease liabilities
|
34.9
|
|
|
38.7
|
|
Total operating lease liabilities
|
$
|
46.0
|
|
|
$
|
50.7
|
|
Less: Rent incentives and deferrals
|
(3.8)
|
|
|
(3.8)
|
|
Assets
|
|
|
|
Operating lease assets
|
$
|
42.2
|
|
|
$
|
46.9
|
|
|
|
|
|
|
|
|
|
|
Lease Term and Discount Rate
|
|
September 30, 2020
|
Weighted-average remaining lease term
|
|
10.0 years
|
Weighted-average discount rate
|
|
3.56
|
%
|
The components of lease expense were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
Three months ended
September 30,
|
Lease Expense
|
Classification
|
|
2020(1)
|
|
2019(2)
|
Operating lease expense
|
Cost of products sold
|
|
$
|
0.7
|
|
|
$
|
0.7
|
|
|
Selling, general and administrative expenses
|
|
4.1
|
|
|
4.3
|
|
(1)2020 includes short-term and variable lease expenses of $0.5 million and $0.3 million, respectively.
(2)2019 includes short-term and variable lease expenses of $0.4 million and $0.4 million, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
Nine months ended
September 30,
|
Lease Expense
|
Classification
|
|
2020(1)
|
|
2019(2)
|
Operating lease expense
|
Cost of products sold
|
|
$
|
2.2
|
|
|
$
|
2.0
|
|
|
Selling, general and administrative expenses
|
|
12.3
|
|
|
13.3
|
|
(1)2020 includes short-term and variable lease expenses of $1.5 million and $1.2 million, respectively.
(2)2019 includes short-term and variable lease expenses of $1.4 million and $1.4 million, respectively.
Maturities of lease liabilities were as follows:
|
|
|
|
|
|
(dollars in millions)
|
September 30, 2020
|
2020
|
$
|
3.3
|
|
2021
|
11.6
|
|
2022
|
9.6
|
|
2023
|
5.4
|
|
2024
|
4.4
|
|
After 2024
|
23.1
|
|
Total lease payments
|
57.4
|
|
Less: imputed interest
|
(11.4)
|
|
Present value of operating lease liabilities
|
$
|
46.0
|
|
6. Inventories
The following table presents the components of the Company’s inventory balances:
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
September 30,
2020
|
|
December 31, 2019
|
Finished products
|
$
|
143.0
|
|
|
$
|
136.8
|
|
Work in process
|
22.1
|
|
|
21.7
|
|
Raw materials
|
161.3
|
|
|
168.3
|
|
Inventories, at FIFO cost
|
326.4
|
|
|
326.8
|
|
LIFO reserve
|
(23.8)
|
|
|
(23.8)
|
|
Inventories
|
$
|
302.6
|
|
|
$
|
303.0
|
|
7. 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
September 30,
|
|
2020
|
|
2019
|
Balance at July 1,
|
$
|
136.0
|
|
|
$
|
134.0
|
|
Expense
|
12.4
|
|
|
11.0
|
|
Claims settled
|
(12.5)
|
|
|
(11.6)
|
|
Balance at September 30,
|
$
|
135.9
|
|
|
$
|
133.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
Nine Months Ended
September 30,
|
|
2020
|
|
2019
|
Balance at January 1,
|
$
|
134.3
|
|
|
$
|
139.4
|
|
Expense
|
38.2
|
|
|
31.8
|
|
Claims settled
|
(36.6)
|
|
|
(37.8)
|
|
Balance at September 30,
|
$
|
135.9
|
|
|
$
|
133.4
|
|
8. 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 September 30, 2020. At its option, the Company either maintains cash balances or pays fees for bank credit and services.
9. 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
September 30,
|
|
Nine Months Ended
September 30,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Denominator for basic earnings per share - weighted average shares
|
161,411,049
|
|
|
164,298,458
|
|
|
161,496,697
|
|
|
166,296,444
|
|
Effect of dilutive stock options and share units
|
1,068,629
|
|
|
1,244,787
|
|
|
1,020,004
|
|
|
1,265,777
|
|
Denominator for diluted earnings per share
|
162,479,678
|
|
|
165,543,245
|
|
|
162,516,701
|
|
|
167,562,221
|
|
10. Stock Based Compensation
The Company adopted the A. O. Smith Combined Incentive Compensation Plan (the Plan) effective January 1, 2007. The Plan was most recently reapproved by stockholders on April 15, 2020. 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 September 30, 2020 was 3,397,491 which includes 2,400,000 additional shares that were authorized on April 15, 2020 at the Company’s annual meeting of stockholders. 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 September 30, 2020 and 2019 was $1.1 million and $1.5 million, respectively. Total stock based compensation expense recognized in the nine months ended September 30, 2020 and 2019 was $11.5 million and $12.3 million, respectively.
Stock Options
The stock options granted in the nine months ended September 30, 2020 and 2019 have three year pro rata vesting from the date of grant. Stock options are issued at exercise prices equal to the fair value of the Company’s Common Stock on the date of grant. For active employees, all options granted in 2020 and 2019 expire ten years after the date of grant. The Company’s stock options are expensed ratably over the three year vesting period; however, included in stock option expense for the three and nine months ended September 30, 2020 and 2019 was expense associated with the accelerated vesting of stock option awards for certain employees who either are retirement eligible or become retirement eligible during the vesting period. Stock based compensation expense attributable to stock options in the three months ended September 30, 2020 and 2019 was $0.5 million and $0.7 million, respectively. Stock based compensation expense attributable to stock options in the nine months ended September 30, 2020 and 2019 was $5.7 million and $5.9 million, respectively. Changes in options, all of which relate to the Company’s Common Stock, were as follows for the nine months ended September 30, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
Avg. Per
Share
Exercise
Price
|
|
Number of
Options
|
|
Average
Remaining
Contractual
Life
|
|
Aggregate
Intrinsic
Value
(dollars in
millions)
|
Outstanding at January 1, 2020
|
$
|
37.64
|
|
|
2,728,350
|
|
|
|
|
|
Granted
|
42.50
|
|
|
798,560
|
|
|
|
|
|
Exercised
|
17.15
|
|
|
(348,873)
|
|
|
|
|
|
Forfeited
|
48.98
|
|
|
(79,451)
|
|
|
|
|
|
Outstanding at September 30, 2020
|
40.91
|
|
|
3,098,586
|
|
|
7 years
|
|
$
|
39.9
|
|
Exercisable at September 30, 2020
|
37.28
|
|
|
1,842,806
|
|
|
6 years
|
|
$
|
30.6
|
|
The weighted-average fair value per option at the date of grant during the nine months ended September 30, 2020 and 2019 using the Black-Scholes option-pricing model was $8.17 and $10.83, respectively. Assumptions were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
2020
|
|
2019
|
Expected life (years)
|
5.7
|
|
5.5
|
Risk-free interest rate
|
1.5
|
%
|
|
2.7
|
%
|
Dividend yield
|
2.1
|
%
|
|
1.6
|
%
|
Expected volatility
|
23.7
|
%
|
|
22.8
|
%
|
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.
10. Stock Based Compensation (continued)
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 172,426 and 139,892 share units under the plan in the nine months ended September 30, 2020 and 2019, respectively. The share units were valued at $7.3 million and $6.9 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 vesting period; however, included in share unit expense in the three and nine months ended September 30, 2020 and 2019 was expense associated with accelerated vesting of share unit awards for certain employees who either are retirement eligible or will become retirement eligible during the vesting period. Stock based compensation expense attributable to share units of $0.6 million and $0.8 million was recognized in the three months ended September 30, 2020 and 2019, respectively. Stock based compensation expense attributable to share units of $5.8 million and $6.4 million was recognized in the nine months ended September 30, 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 nine months ended September 30, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Units
|
|
Weighted-Average
Grant Date Value
|
Issued and unvested at January 1, 2020
|
366,102
|
|
|
$
|
49.92
|
|
Granted
|
172,426
|
|
|
42.50
|
|
Vested
|
(100,735)
|
|
|
49.21
|
|
Forfeited
|
(12,861)
|
|
|
51.35
|
|
Issued and unvested at September 30, 2020
|
424,932
|
|
|
46.95
|
|
11. Pensions
The following table presents the components of the Company’s net pension income.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Service cost
|
$
|
0.4
|
|
|
$
|
0.4
|
|
|
$
|
1.1
|
|
|
$
|
1.3
|
|
Interest cost
|
5.7
|
|
|
8.0
|
|
|
17.2
|
|
|
23.7
|
|
Expected return on plan assets
|
(13.0)
|
|
|
(14.3)
|
|
|
(39.0)
|
|
|
(43.1)
|
|
Amortization of unrecognized loss
|
5.2
|
|
|
4.4
|
|
|
15.1
|
|
|
12.4
|
|
Amortization of prior service cost
|
(0.1)
|
|
|
(0.2)
|
|
|
(0.3)
|
|
|
(0.4)
|
|
Defined benefit plan income
|
$
|
(1.8)
|
|
|
$
|
(1.7)
|
|
|
$
|
(5.9)
|
|
|
$
|
(6.1)
|
|
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.
12. 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.
12. Segment Results (continued)
The following table presents the Company’s segment results:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Net sales
|
|
|
|
|
|
|
|
North America
|
$
|
544.0
|
|
|
$
|
514.6
|
|
|
$
|
1,557.4
|
|
|
$
|
1,560.4
|
|
Rest of World
|
221.4
|
|
|
220.3
|
|
|
521.3
|
|
|
701.5
|
|
Inter-segment
|
(5.4)
|
|
|
(6.7)
|
|
|
(17.9)
|
|
|
(20.1)
|
|
|
$
|
760.0
|
|
|
$
|
728.2
|
|
|
$
|
2,060.8
|
|
|
$
|
2,241.8
|
|
Segment earnings
|
|
|
|
|
|
|
|
North America(1)
|
$
|
133.1
|
|
|
$
|
121.6
|
|
|
$
|
365.6
|
|
|
$
|
360.5
|
|
Rest of World(2)
|
16.7
|
|
|
4.1
|
|
|
(31.3)
|
|
|
38.8
|
|
Inter-segment
|
—
|
|
|
—
|
|
|
(0.3)
|
|
|
(0.1)
|
|
|
149.8
|
|
|
125.7
|
|
|
334.0
|
|
|
399.2
|
|
Corporate expense
|
(10.9)
|
|
|
(9.8)
|
|
|
(35.7)
|
|
|
(34.1)
|
|
Interest expense
|
(1.6)
|
|
|
(3.1)
|
|
|
(6.3)
|
|
|
(8.5)
|
|
Earnings before income taxes
|
137.3
|
|
|
112.8
|
|
|
292.0
|
|
|
356.6
|
|
Provision for income taxes
|
31.9
|
|
|
25.5
|
|
|
67.1
|
|
|
77.9
|
|
Net earnings
|
$
|
105.4
|
|
|
$
|
87.3
|
|
|
$
|
224.9
|
|
|
$
|
278.7
|
|
(1)includes severance and restructuring expenses of:
|
$
|
0.5
|
|
|
$
|
—
|
|
|
$
|
2.7
|
|
|
$
|
—
|
|
(2)includes severance and restructuring expenses of:
|
$
|
1.1
|
|
|
$
|
—
|
|
|
$
|
5.0
|
|
|
$
|
—
|
|
13. Fair Value Measurements
ASC 820, Fair Value Measurements, 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.
The following table presents assets (liabilities) measured at fair value on a recurring basis (dollars in millions):
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurement Using
|
September 30,
2020
|
|
December 31, 2019
|
Quoted prices in active markets for identical assets (Level 1)
|
$
|
131.1
|
|
|
$
|
177.4
|
|
Significant other observable inputs (Level 2)
|
(0.4)
|
|
|
6.9
|
|
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 nine months ended September 30, 2020.
14. 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 all of its hedging instruments as 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.
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)
|
September 30, 2020
|
|
December 31, 2019
|
|
Buy
|
|
Sell
|
|
Buy
|
|
Sell
|
British pound
|
$
|
—
|
|
|
$
|
0.3
|
|
|
$
|
—
|
|
|
$
|
1.3
|
|
Canadian dollar
|
—
|
|
|
44.1
|
|
|
—
|
|
|
49.7
|
|
Euro
|
28.5
|
|
|
—
|
|
|
36.0
|
|
|
—
|
|
Mexican peso
|
20.1
|
|
|
—
|
|
|
18.6
|
|
|
—
|
|
Total
|
$
|
48.6
|
|
|
$
|
44.4
|
|
|
$
|
54.6
|
|
|
$
|
51.0
|
|
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 after-tax gains and losses of the contracts as of September 30, 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 one year.
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 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
14. Derivative Instruments (continued)
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 $(0.8) million and $(0.1) million of after-tax losses associated with hedges of a net investment in non-U.S. subsidiaries in currency translation adjustment in other comprehensive income in the three and nine months ended September 30, 2020, respectively. The Company recognized $2.7 million and $1.8 million of 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 and nine months ended September 30, 2019, respectively. The contractual amount of the Company's foreign currency forward contracts that are designated as net investment hedges is $50.0 million as of September 30, 2020.
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
|
|
September 30,
2020
|
|
December 31,
2019
|
Foreign currency contracts
|
Other current assets
|
|
$
|
0.8
|
|
|
$
|
8.4
|
|
|
Accrued liabilities
|
|
(1.2)
|
|
|
(1.5)
|
|
Total derivatives designated as hedging instruments
|
|
$
|
(0.4)
|
|
|
$
|
6.9
|
|
The effect of cash flow hedges on the condensed consolidated statement of earnings:
Three Months Ended September 30 (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
|
|
$
|
1.4
|
|
|
$
|
(1.1)
|
|
|
Cost of products sold
|
|
$
|
0.4
|
|
|
$
|
(0.1)
|
|
Commodities contracts
|
|
(0.1)
|
|
|
—
|
|
|
Cost of products sold
|
|
—
|
|
|
(0.6)
|
|
|
|
$
|
1.3
|
|
|
$
|
(1.1)
|
|
|
|
|
$
|
0.4
|
|
|
$
|
(0.7)
|
|
Nine Months Ended September 30 (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
|
|
$
|
2.2
|
|
|
$
|
(0.6)
|
|
|
Cost of products sold
|
|
$
|
1.7
|
|
|
$
|
(0.1)
|
|
Commodities contracts
|
|
(0.2)
|
|
|
(0.5)
|
|
|
Cost of products sold
|
|
—
|
|
|
(1.4)
|
|
|
|
$
|
2.0
|
|
|
$
|
(1.1)
|
|
|
|
|
$
|
1.7
|
|
|
$
|
(1.5)
|
|
15. Income Taxes
The Company’s effective income tax rates for the three and nine months ended September 30, 2020 were 23.2 percent and 23.0 percent, respectively. The Company estimates that its annual effective income tax rate for the full year 2020 will be between 23.0 and 23.5 percent. The effective income tax rates for the three and nine months ended September 30, 2019 were 22.6 percent and 21.8 percent, respectively. The change in the effective income tax rate for the nine months ended September 30, 2020 compared to the effective income tax rate for the nine months ended September 30, 2019 was primarily due to a change in geographic earnings mix.
As of September 30, 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 non-U.S. income tax examinations for years 2014-2020.
16. Commitments and Contingencies
The Company maintains a commercial relationship with a supply-chain service provider (the Provider) in connection with the Company’s business in China. In this capacity, the Provider offers order-entry, warehousing and logistics support. The Provider also offers asset-backed financing to certain of the Company’s distributors in China to facilitate their working capital needs. To facilitate its financing support business, the Provider has collateralized lending facilities in place with multiple Chinese banks under which the Company has agreed to repurchase inventory if both requested by the banks and certain defined conditions are met, primarily related to the aging of the distributors’ notes.
The Provider is required to indemnify the Company for any losses the Company would incur in the event of an inventory repurchase under these arrangements. Potential losses under the repurchase arrangements represent the difference between the repurchase price and net proceeds from the resale of product plus costs incurred in the process, less related distributor rebates.
Before considering any reduction of distributor rebate accruals of $6.4 million and $14.1 million as of September 30, 2020 and December 31, 2019, respectively, and from the resale of the related inventory, the gross amount the Company would be obligated to repurchase, which would be contingent on the default of all of the outstanding loans, was approximately $9.1 million and $23.1 million as of September 30, 2020 and December 31, 2019, respectively. The Company’s reserves for estimated losses under repurchase arrangements were immaterial as of September 30, 2020 and December 31, 2019.
17. Changes in Accumulated Other Comprehensive Loss by Component
Changes to accumulated other comprehensive loss by component are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
Three Months Ended
September 30,
|
|
|
2020
|
|
|
2019
|
|
Cumulative foreign currency translation
|
|
|
|
|
|
Balance at beginning of period
|
$
|
(80.5)
|
|
|
|
$
|
(59.1)
|
|
|
Other comprehensive gain (loss) before reclassifications
|
15.7
|
|
|
|
(21.9)
|
|
|
Balance at end of period
|
(64.8)
|
|
|
|
(81.0)
|
|
|
Unrealized net (loss) gain on cash flow derivatives
|
|
|
|
|
|
Balance at beginning of period
|
(0.3)
|
|
|
|
(0.1)
|
|
|
Other comprehensive gain (loss) before reclassifications
|
1.0
|
|
|
|
(0.8)
|
|
|
Realized (gains) losses on derivatives reclassified to cost of products sold (net of income tax provision (benefit) of $0.1 and ($0.2) in 2020 and 2019, respectively)
|
(0.3)
|
|
|
|
0.5
|
|
|
Balance at end of period
|
0.4
|
|
|
|
(0.4)
|
|
|
Pension liability
|
|
|
|
|
|
Balance at beginning of period
|
(275.0)
|
|
|
|
(279.2)
|
|
|
Other comprehensive (loss) gain before reclassifications
|
(0.9)
|
|
|
|
(4.1)
|
|
|
Amounts reclassified from accumulated other comprehensive loss:(1)
|
3.8
|
|
|
|
3.1
|
|
|
Balance at end of period
|
(272.1)
|
|
|
|
(280.2)
|
|
|
Accumulated other comprehensive loss, end of period
|
$
|
(336.5)
|
|
|
|
$
|
(361.6)
|
|
|
(1) Amortization of pension items:
|
|
|
|
|
|
Actuarial losses
|
$
|
5.2
|
|
(2)
|
|
$
|
4.4
|
|
(2)
|
Prior year service cost
|
(0.1)
|
|
(2)
|
|
(0.2)
|
|
(2)
|
|
5.1
|
|
|
|
4.2
|
|
|
Income tax benefit
|
(1.3)
|
|
|
|
(1.1)
|
|
|
Reclassification net of income tax benefit
|
$
|
3.8
|
|
|
|
$
|
3.1
|
|
|
(2)These accumulated other comprehensive loss components are included in the computation of net periodic pension cost. See Note 11 - Pensions for additional details.
17. Changes in Accumulated Other Comprehensive Loss by Component (continued)
Changes to accumulated other comprehensive loss by component are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
Nine Months Ended
September 30,
|
|
|
2020
|
|
|
2019
|
|
Cumulative foreign currency translation
|
|
|
|
|
|
Balance at beginning of period
|
$
|
(66.2)
|
|
|
|
$
|
(64.9)
|
|
|
Other comprehensive income (loss) before reclassifications
|
1.4
|
|
|
|
(16.1)
|
|
|
Balance at end of period
|
(64.8)
|
|
|
|
(81.0)
|
|
|
Unrealized net gain (loss) on cash flow derivatives
|
|
|
|
|
|
Balance at beginning of period
|
0.2
|
|
|
|
(0.7)
|
|
|
Other comprehensive gain before reclassifications
|
1.5
|
|
|
|
(0.8)
|
|
|
Realized (gains) losses on derivatives reclassified to cost of products sold (net of income tax provision (benefit) of $0.4 and $(0.4) in 2020 and 2019, respectively)
|
(1.3)
|
|
|
|
1.1
|
|
|
Balance at end of period
|
0.4
|
|
|
|
(0.4)
|
|
|
Pension liability
|
|
|
|
|
|
Balance at beginning of period
|
(282.3)
|
|
|
|
(285.2)
|
|
|
Other comprehensive (loss) gain before reclassifications
|
(0.9)
|
|
|
|
(4.1)
|
|
|
Amounts reclassified from accumulated other comprehensive loss:(1)
|
11.1
|
|
|
|
9.1
|
|
|
Balance at end of period
|
(272.1)
|
|
|
|
(280.2)
|
|
|
Accumulated other comprehensive loss, end of period
|
$
|
(336.5)
|
|
|
|
$
|
(361.6)
|
|
|
(1) Amortization of pension items:
|
|
|
|
|
|
Actuarial losses
|
$
|
15.1
|
|
(2)
|
|
$
|
12.4
|
|
(2)
|
Prior year service cost
|
(0.3)
|
|
(2)
|
|
(0.4)
|
|
(2)
|
|
14.8
|
|
|
|
12.0
|
|
|
Income tax benefit
|
(3.7)
|
|
|
|
(2.9)
|
|
|
Reclassification net of income tax benefit
|
$
|
11.1
|
|
|
|
$
|
9.1
|
|
|
(2)These accumulated other comprehensive loss components are included in the computation of net periodic pension cost. See Note 11 - Pensions for additional details.
PART I - FINANCIAL INFORMATION