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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Executive Overview
Carlisle Companies Incorporated ("Carlisle", the "Company", "we" or "our") is a diversified manufacturing company focused on achieving profitable growth internally through new product development and product line extensions, and externally through acquisitions that complement our existing technologies, products and market channels. The Company has twelve operating companies and more than 13,000 employees serving a variety of niche markets. While Carlisle has offshore manufacturing operations, our markets are primarily in North America. Management focuses on continued year over year improvement in sales and earnings, return on capital employed and return on shareholders' equity. We allocate resources to our businesses based on our assessment of their ability to obtain leadership positions in the markets they serve.
Net sales from continuing operations in 2004 of $2.23 billion were 18% over 2003. The factors contributing to this increase were improved markets, new products, market share gains, selling price increases, acquisitions and, to a lesser extent, foreign exchange. Income from continuing operations, net of tax, of $118.3 million in 2004 was 34% above 2003. Selling price increases of $49.4 million partially offset $62.8 million of raw material cost increases. The Company continues to focus on recovering these costs through higher selling prices; however, the ability to realize price increases is dependent on competitive and economic conditions which may be beyond the Company's control. It is also uncertain what impact the rise in raw material costs and the future availability of raw materials will have on the markets served by Carlisle.
In keeping with the Company's commitment to align its businesses with a focus on its core competencies, in 2004 Carlisle announced plans to exit certain operations in the Industrial Components and General Industry segments. The Company has also announced plans to exit all the operations comprising the Automotive Components segment. These operations are classified as discontinued operations in the Company's financial statements.
2004 Compared to 2003
Consolidated Results of Continuing Operations - Net sales from continuing operations of $2.23 billion in 2004 exceeded 2003 sales of $1.89 billion by 18%, or $340.1 million. Strong organic sales growth (organic growth excludes the effects of acquisitions, discontinued operations and divestitures made within the most recent twelve months) of $326.4 million, or 17%, included $17.1 million of favorable changes in foreign currency rates. Acquisition growth of $23.8 million in the Industrial Components and General Industry segments was partially offset by $10.1 million for the divestiture of the Specialty Products segment's spring brake business in December 2003. The growth in net sales was primarily attributable to the Construction Materials, Industrial Components and General Industry segments.
Gross margin (net sales less cost of goods sold expressed as a percent of net sales) in 2004 was 19.0%, compared to 19.1% in 2003. The slightly lower gross margin was primarily due to significant raw material cost increases for oil-based commodities and steel products. These higher costs were partially offset by increases in sales volume and selling prices. Raw material costs were $62.8 million higher in 2004 than in 2003 and more than offset $49.4 million of selling price increases during the year. The 2004 gross margin included $1.2 million of exit and disposal costs compared to $2.6 million in 2003. Exit and disposal costs represent specific programs identified by Carlisle operations to reduce expense, improve productivity, and consolidate facilities. Although Carlisle does not have a formal restructuring plan, the Company evaluates exit and disposal opportunities on a continual basis. Plant utilization of 78% in 2004 was favorable to utilization of 73% in 2003.
Selling and administrative expenses of $221.7 million in 2004 were 8% above $204.9 million in 2003 with most of the increase attributable to variable expenses associated with sales volume and $4.7 million of external costs for compliance with Section 404 of the Sarbanes - Oxley Act of 2002. Selling and administrative expenses, as a percent of net sales, of 10.0% in 2004 were below 10.9% in 2003 reflecting the benefits of cost control measures and reorganization actions.
Research and development expenses remained flat at $16.3 million in 2004 and 2003. Increased spending in the Construction Materials segment was offset by lower expense in the General Industry segment.
Other income of $0.6 million in 2004 compared to other income of $5.7 million in 2003. The decrease was due primarily to the write-off of assets associated with the sale of the spring brake business, $2.6 million, and lower foreign currency exchange gains, $1.4 million. Other income included gains from insurance recoveries of $2.0 million in 2004 and $2.6 million in 2003. Other income in 2004 also included $2.4 million from the Company's 25% investment in a European roofing joint venture ("Icopal"), which was below the $3.0 million recognized in 2003 primarily due to reorganization expenses incurred in 2004.
Earnings before interest and income taxes ("EBIT" or "earnings") showed improvement in 2004 across all of Carlisle's reporting segments. EBIT of $185.7 million was higher than 2003 EBIT of $145.6 million due primarily to increased sales volume in most of the Company's product lines offset by the aforementioned exit and disposal activities and unrecovered raw material costs. The impact of changes in foreign currency rates on earnings was negligible.
Interest expense, net, of $15.4 million in 2004 was above $14.5 million in 2003. Lower average borrowings and the effects of interest rate swaps resulted in lower interest expense year-over-year but were offset by lower interest income and higher interest expense associated with a capital lease.
Income tax expense of $52.0 million for 2004 from continuing operations are net of a benefit of $3.7 million for favorable state and federal tax settlements resulting in an effective rate for 2004 of 30.5% as compared with an effective rate of 32.5% for 2003. The Company's effective tax rate for 2005 is currently estimated at 32.25%.
Company management has tentatively decided to participate with the U.S. Internal Revenue Service (the "IRS") in a pilot real time audit program for calendar 2005. It is entitled Compliance Assurance Process ("CAP"). Pursuant to the CAP program, material tax issues and initiatives will be disclosed to the IRS throughout the year with the objective of reaching agreement as to the proper reporting treatment. If the Company and the IRS can reach agreement on all issues, then the IRS will issue a full acceptance letter, subject only to a cursory post-filing review. Company management believes that this experimental approach will reduce tax-related uncertainties, enhance transparency and reduce administrative costs. The IRS has completed its audit of the Company's tax returns through and including the 1999 tax year.
Income from continuing operations, net of tax, in 2004 was $118.3 million, or $3.77 per diluted share, compared to 2003 Income from continuing operations, net of tax, of $88.5 million, or $2.87 per diluted share. The increase in income is primarily attributable to sales volume increases offset by raw material costs and other expenses as previously discussed.
Consolidated Results of Discontinued Operations - In the second quarter 2004, Carlisle announced plans to exit three operations in the Industrial Components, Automotive Components and General Industry segments. In the fourth quarter 2004, the Company decided to exit all of its remaining operations comprising the Automotive Components segment. Losses from discontinued operations, net of tax, were $38.7 million in 2004 and included after-tax non-cash write-offs of $25.1 million of goodwill and $3.1 million of other assets associated with the Automotive Components segment. Income from discontinued operations in 2003 was $0.4 million.
Net Income - 2004 net income of $79.6 million, or $2.54 per diluted share, was 10% below 2003 net income of $88.9 million, or $2.88 per diluted share, and included the aforementioned $38.7 million or $1.23 per diluted share of losses from discontinued operations.
Acquisitions - On June 30, 2004, the Company acquired the specialty tire and wheel business of Trintex Corporation for $32.5 million, which is included in the Industrial Components segment. Trintex Corporation is North America's leading manufacturer of semi-pneumatic tires and wheels for lawn and garden and industrial markets.
On May 30, 2003, Carlisle acquired Flo-Pac Corporation, a leading manufacturer of quality brooms, brushes, rotary brushes and cleaning tools in the sanitary maintenance industry for approximately $32.0 million. This acquisition is included in the General Industry segment as part of Carlisle's foodservice and sanitary maintenance business.
2003 Compared to 2002
Consolidated Results of Continuing Operations - Net sales from continuing operations of $1.89 billion in 2003 exceeded 2002 sales of $1.72 billion by 10%. Organic sales growth of $149.1 million, included $22.4 million of favorable changes in foreign currency rates. Acquisition growth of $46.9 million in the Construction Materials and General Industry segments was partially offset by the sale of Carlisle Power Transmission's European transmission belt business in December 2002. Net sales for this operation in 2002 were $33.3 million. Increased net sales in the Construction Materials and General Industry segments accounted for most of the sales increase in 2003.
Gross margin in 2003 was 19.1%, compared to 19.4% in 2002. The slightly lower gross margin in 2003 was the result of raw material cost increases, primarily in the Industrial Components segment. Plant utilization of 73% in 2003 was favorable to utilization of 67% in 2002.
Selling and administrative expenses of $204.9 million in 2003 were above 2002 expenses of $200.7 million. The divestiture of Carlisle Power Transmission's European belt business at the end of 2002 resulted in a $6.8 million reduction in 2003 expense, but was partially offset by $5.8 million of selling and administrative expense associated with the Company's acquisitions. The remaining increase in expense from 2002 was due to increased sales volume and severance costs. Selling and administrative expenses, as a percent of net sales, of 10.9% in 2003 were below 11.6% in 2002 as a result of increased sales volume, cost control measures and reorganization actions.
Research and development expenses were $16.3 million in 2003 compared with $15.8 million in 2002. The increase in spending was primarily in the General Industry segment and was partially offset by lower spending in the Industrial Components segment.
Other income of $5.7 million in 2003 compared to other expense of less than $0.1 million in 2002. Other income in 2003 included a $2.6 million gain from insurance recoveries and a $2.1 million foreign exchange gain on the settlement of long-term loans denominated in foreign currencies. Other income in 2003 also included $3.0 million from Icopal which was below the $3.8 million recognized in 2002 primarily due to the weak demand in the European roofing market.
EBIT of $145.6 million in 2003 compared favorably with 2002 EBIT of $118.7 million as a result of the previously discussed organic sales growth and other income offset by raw material cost increases, exit and disposal costs and higher selling and administrative expenses. The impact of changes in foreign currency rates on earnings was negligible.
Interest expense, net, of $14.5 million in 2003 and was below $17.2 million in 2002 as a result of reduced average borrowings, interest income from Icopal and interest income on a tax refund.
Income taxes on continuing operations of $42.6 million in 2003 reflect an effective tax rate of 32.5% compared with $35.4 million in 2002 at an effective rate of 34.9%. The lower rate in 2003 was a result of favorable federal and state audit settlements finalized in 2003 for tax returns filed through calendar year 1999. The 2002 rate excludes the effect of Statement of Financial Accounting Standard ("SFAS") 142 for goodwill impairment.
Income from continuing operations, net of tax, in 2003 was $88.5 million, or $2.87 per diluted share, compared to the 2002 income from continuing operations, net of tax, of $66.2 million, or $2.16 per diluted share. The improvement in 2003 over 2002 was due primarily to increased earnings in most of the Company's operating segments.
Consolidated Results of Discontinued Operations - Income from discontinued operations, net of tax, in 2003 was $0.4 million compared with income of $6.2 million in 2002. The decline in income was primarily related to plant closure and severance costs and specific transition costs associated with the shutdown of a plant in the Automotive Components segment and an asset impairment charge on a group of assets in the General Industry segment.
Net Income - Net income of $88.9 million, or $2.88 per diluted share in 2003, compared with income before cumulative effect of accounting change in 2002 of $72.4 million, or $2.37 per diluted share. The evaluation of goodwill in 2002, required by SFAS 142, resulted in a reduction of the carrying value of goodwill for businesses in the Transportation Products and the General Industry segments. The after-tax charge to earnings from the implementation of SFAS 142 was $43.8 million, or $1.43 per diluted share. The impact of the goodwill impairment in 2002 reduced net income of $72.4 million to $28.6 million, or $0.94 per diluted share. The goodwill reduction was reported as a change in accounting principle effective January 1, 2002.
Acquisitions - In 2002, Carlisle completed one acquisition and one divestiture. MiraDri, a leading provider of waterproofing solutions for commercial and residential applications was acquired in October 2002, and is included in the Construction Materials segment. The European power transmission belt business, which was part of the Dayco Power Transmission business, acquired by Carlisle in August 2001, was sold in December 2002. The sale of the European power transmission business resulted in a $0.8 million pre-tax loss.
Operating Segments
The following table summarizes segment net sales and EBIT. The amounts for each segment should be referred to in conjunction with the applicable discussion below.
Industrial Components
2004 Compared to 2003
Net sales in 2004 were 17% above 2003. Carlisle Tire & Wheel Company net sales in 2004 were 19% above 2003 net sales on growth in all product lines. Most of the increase in net sales was in the commercial and consumer power equipment lawn care products and all-terrain vehicles ("ATV") tires and wheels. The acquisition of Trintex, the leading manufacturer of specialty semi-pneumatic tires and wheels for the lawn and garden and industrial markets, in June 2004 added $12.5 million to the increase in net sales. Carlisle Power Transmission net sales were 10% above the full year 2003 with most of the improvement in the lawn and grounds care and agricultural markets. The Company expects the strong product demand experienced by this segment in 2004 to continue in 2005.
Segment EBIT was 5% above 2003 and did not keep pace with the sales increase due to the dramatic rise in raw material costs throughout 2004 for steel in the wheel business and oil-based commodities used in the tire manufacturing process. The unrecovered raw material cost increases in the Industrial Components segment were approximately $7.8 million in 2004. After rapid and frequent increases in raw material costs during 2004, costs had stabilized by the end of the year and are anticipated to remain flat through most of 2005.
Selling price increases implemented in 2004 at Carlisle Tire & Wheel Company were not sufficient to fully offset the rise in raw material costs. While the Company is making efforts to recover the increases in raw material costs, its ability may be limited based on competitive and economic conditions beyond its control. Production inefficiencies due to increased schedule changes to support the strong sales demand, labor shortages, the ramp up of production at the China operation and an unfavorable sales mix of lower margin products also negatively affected 2004 results. The Company expects these items to have less of an impact in 2005. Net sales and EBIT in this segment are generally higher in the first half of the year due to peak sales volume in the outdoor power equipment market.
2003 Compared to 2002
The 1% increase in net sales in 2003 from 2002 was a result of organic net sales growth of $41.1 million or 7%, partially offset by the divestiture of Carlisle Power Transmission's European belt business, which contributed $33.3 million of net sales in 2002. The organic net sales growth of 7% at Carlisle Tire & Wheel Company was primarily a result of higher ATV and consumer outdoor power equipment sales.
Carlisle Tire & Wheel Company accounted for the majority of the increase in 2003 EBIT on improved sales volume, a favorable sales mix, and higher production volume. This was partially offset by higher costs for major raw material commodities, including natural rubber, synthetic rubber, and steel. Carlisle Power Transmission results in 2003 were marginally ahead of 2002 and included $0.7 million of exit and disposal costs.
Construction Materials
2004 Compared to 2003
Net sales in 2004 were 25% above 2003 with growth in all product lines. Sales of insulation products and ethylene propylene diene terpolymer ("EPDM") and thermoplastic polyolefin ("TPO") membrane and accessories accounted for 73% of the increase in net sales. The strong growth in insulation was driven by special programs that encourage the use of Carlisle insulation and increased demand for total system warranties. Since mid-year 2004, the commercial roofing market has shown positive growth. Harsh winters in key EPDM markets, coupled with a resurgence of new construction, fueled demand. Overall market conditions continue to look favorable for another strong year in commercial roofing; however, the Company's growth is impacted by interest rates, weather conditions and raw material cost inflation.
The 22% improvement in 2004 EBIT was primarily a result of increased sales volume and selling price increases, partially offset by product mix, increasing raw material costs and lower earnings at Icopal. Icopal earnings of $2.4 million in 2004 were 20% below 2003 earnings of $3.0 million, primarily due to reorganization expenses incurred in the beginning of 2004. Net sales and EBIT in this segment are generally higher in the second and third quarters of the year due to increased construction activity during these periods. Selling price increases have been announced in an effort to offset higher raw material costs; however, the full extent of these increases remains uncertain. The rise in the costs and availability of raw materials are expected to apply pressure to future operating results. Specifically, EPDM polymer used in the manufacture of EPDM roofing membranes and MDI, a key ingredient used in the manufacture of insulation products, may have supply constraints in 2005. We expect continued upward pressure on the price of these and other key raw materials in the coming year.
2003 Compared to 2002
Most of the 19% increase in 2003 net sales over 2002 was attributable to organic sales growth of 13%, with accretive growth from acquisitions accounting for the remaining 6%. The organic sales growth was primarily due to sales of domestic roofing membranes, insulation products and residential roofing tiles. Carlisle SynTec benefited from higher precipitation and lower temperatures during the winter on the east coast, conditions not seen in approximately three years. Heavy spring rain also contributed to increased re-roofing demand. In addition, as the economy showed signs of recovery in the second half of 2003, commercial construction continued its momentum from the first half of the year. Overall, 2002 was a difficult year for the Construction Materials segment as commercial construction in the United States was down 16%, and industry shipments of EPDM roofing membrane declined approximately 15%. Carlisle SynTec was able to mitigate this decline in demand with higher sales of TPO roofing membrane and increased sales of niche products.
The 16% improvement in 2003 segment EBIT was primarily a result of increased sales volume and a $2.6 million gain on insurance recoveries on fire losses at two small coatings and waterproofing manufacturing plants. These gains were classified as "other income, net" on the Company's Consolidated Statements of Earnings and Comprehensive Income. Partially offsetting this increase was a $0.8 million earnings decline related to Icopal.
Transportation Products
2004 Compared to 2003
Net sales in 2004 were 23% above 2003, with most of the increase in sales of large construction, pneumatic bulk, commercial, live-bottom and stainless steel tank trailers. Demand was strong in 2004, in spite of selling price increases implemented during the year. The majority of competitors increased selling prices to some degree and related industries such as truck and equipment manufacturers also increased selling prices. Demand in 2005 is expected to be equal to or slightly above demand in 2004.
Segment EBIT in 2004 was 39% above 2003. Sales volume, selling price increases and improved absorption of fixed overhead costs were partially offset by steep rises in steel prices and other raw materials and an unfavorable sales mix of lower margin trailers. The cost of steel products in 2004 was dramatically higher than in 2003. While we experienced significant raw material cost increases for steel in 2004, these costs had stabilized at the end of the year. Significant increases in the cost of steel are not currently anticipated in 2005; however, steel supply and pricing may have an adverse effect on future earnings in this segment.
2003 Compared to 2002
Segment net sales in 2003 were slightly above 2002 as a result of higher demand for steel dump, small construction, and specialized trailers. Segment EBIT in 2003 was 5% below 2002. The lower EBIT reflected an unfavorable sales mix of low-margin products.
Specialty Products
2004 Compared to 2003
Net sales in 2004 were 4% above 2003. Net sales in 2003 included $10.1 million of sales from Carlisle Motion Control's spring brake business which was divested in December, 2003. Organic net sales growth was 12% for the full year 2004. Higher sales of braking systems for off-highway and industrial equipment accounted for most of the increase. Orders are expected to remain strong in the industrial and off-highway brake markets with many customers anticipating continued growth in 2005. The trucking industry is projecting higher new truck build rates, and aftermarket demand for truck blocks is also anticipated to grow as the tonnage of products transported by truck increases in 2005.
EBIT in 2004 was 24% above 2003 results. The improvement was primarily a result of operating and manufacturing efficiencies attributable to the consolidation of the business units in this segment under one management team. This improvement was partially offset by the $2.6 million write-off of assets associated with the sale of the spring brake business. The businesses in this segment experienced higher raw material costs in 2004; however, this trend showed signs of slowing at the end of 2004.
2003 Compared to 2002
Net sales in 2003 were 6% higher than 2002. Most of the increase was due to higher sales of on-highway products to the heavy-duty truck and trailer and brake and axle manufacturers, and aftermarket distribution. The negative EBIT in 2002 was primarily related to the Carlisle Motion Control operation. Weak demand in the industrial and mobile equipment markets, lower aftermarket sales, reduced production levels, a pension curtailment charge and other exit and disposal expenses associated with closing its Ridgway, Pennsylvania facility, and startup costs at its South Hill, Virginia facility, contributed to the unfavorable results at Carlisle Motion Control.
General Industry (All Other)
2004 Compared to 2003
Net sales in General Industry in 2004 were 14% above 2003. Net sales at Carlisle Process Systems accounted for most of the increase in this segment and were 23% above 2003 as a result of increased purchases of capital equipment for cheese processing equipment. Carlisle FoodService net sales were 16% above 2003 with the acquisition of Flo-Pac in May 2003 accounting for half of the increase. Organic sales growth of 8% was a result of increased demand for foodservice products. Net sales at Tensolite in 2004 were 15% above last year on increased sales in all product lines. Carlisle Walker net sales in 2004 were slightly above 2003 as a result of higher sales in the equipment group. Johnson Truck Bodies 2004 net sales were 3% below 2003 due to reduced demand for insulated temperature-controlled truck bodies and trailers.
The 2004 EBIT in the General Industry segment was 93% above 2003. Improved EBIT at Carlisle Process Systems, Carlisle Walker and Tensolite accounted for the increase. Carlisle Process Systems accounted for most of the EBIT increase due to higher sales, improved margins through manufacturing efficiencies and reduced selling and administrative expenses. Most of the increase in EBIT at Carlisle Walker was the result of operational improvements and the closure of unprofitable operations in 2003. Tensolite EBIT in 2004 was significantly above 2003 as a result of increased sales volume in 2004 and exit and disposal costs incurred in 2003. Carlisle FoodService experienced a slight decrease in EBIT in 2004 compared to 2003 as a result of increased freight expense, unfavorable operating efficiencies and unrecovered raw material cost increases. EBIT at Johnson Truck Bodies in 2004 was approximately half of 2003's results and was primarily the result of an unfavorable sales mix, and the inability to pass along price increases to customers to offset the significant increase in raw material costs. Segment EBIT in 2004 included $1.2 million of exit and disposal costs compared to $3.2 million in 2003.
2003 Compared to 2002
General Industry net sales in 2003 were 14% above 2002 net sales with Carlisle Process Systems, Johnson Truck Bodies and Carlisle FoodService accounting for most of the growth. The improvement at Carlisle Process Systems was a result of increased demand for cheese and powder equipment. Johnson Truck Bodies net sales in 2003 were more than 50% above 2002 net sales due to exceptionally strong demand for insulated temperature-controlled truck bodies and trailers. Carlisle FoodService's 2003 net sales increased 10% from 2002 as a result of acquiring Flo-Pac in May 2003. The 2003 economic recovery was not experienced in the foodservice equipment and supply industry as overall restaurant traffic was below prior year levels and spending in the institutional non-commercial market segment was lower in 2003. Carlisle Walker net sales in 2003 were slightly below net sales in 2002 due to lower demand in the equipment group. Tensolite's sales in 2003 were slightly less than 2002 due to the continued downturn in the commercial aerospace and telecommunications industries.
Segment earnings in 2003 improved 50% over 2002. Most of the EBIT improvement in 2003 was at Johnson Truck Bodies due to the increase in 2003 net sales volume over 2002. The higher earnings at Tensolite reflect productivity improvements, better utilization of manufacturing capacity, and lower selling and administrative expenses. The earnings improvement at Carlisle FoodService was due to the acquisition of Flo-Pac. The EBIT loss at Carlisle Process Systems included reorganization costs and a $2.2 million charge at a European operation to correct previously reported earnings in calendar year 2002. The Carlisle Walker EBIT loss was primarily the result of plant closure and reorganization costs. Segment EBIT included $3.2 million of charges for exit and disposal costs in 2003 compared to $4.6 million in 2002.
Balance Sheet
Receivables of $227.4 million at December 31, 2004 increased $11.2 million from $216.2 million at December 31, 2003. The increase was a result of higher sales volume, partially offset by a $53.0 million increase in the utilization of the Company's accounts receivable securitization program bringing total receivables sold through the program to $120.0 million at December 31, 2004.
Inventories were $315.5 million as of December 31, 2004. The $63.5 million increase from December 31, 2003 of $252.0 million was primarily in the Industrial Components and Construction Materials segments and was the result of a planned building of inventories to meet the projected demand in the first half of 2005.
Goodwill, net of $291.3 million at December 31, 2004 was $29.0 million above December 31, 2003 and is primarily the result of acquiring Trintex in June 2004.
Non-current assets held for sale of $50.5 million at December 31, 2004 were 51% below $100.9 million at December 31, 2003. The reduction is primarily due to the $40.3 million write-off of goodwill and the $4.4 million write-down of an investment in a joint venture at Carlisle Engineered Products.
Accounts payable of $168.0 million at December 31, 2004 was $23.4 million above $144.6 million at December 31, 2003 due primarily to higher capital spending and increased purchases of materials and supplies to keep pace with the increase in sales volume.
Accrued expenses of $117.6 million at the end of 2004 were $15.0 million below December 31, 2003 of $132.6 million largely as a result of lower accruals for taxes due to the timing of tax payments.
Other long-term liabilities of $88.4 million in 2004 were $15.9 million below $104.3 million at December 31, 2003. The decrease was primarily a result of lower pension liabilities.
Capital expenditures of $72.3 million in 2004 were 83% above $39.6 million in 2003. Major capital expenditures in 2004 included new plants to produce insulation products and TPO membrane for Carlisle SynTec, capacity expansion for the manufacture of transmission belts for Carlisle Power Transmission, plant expansions for the manufacture of tires for Carlisle Tire & Wheel Company and a distribution center in Nevada for Carlisle FoodService. Capital expenditures in 2003 included new plants to produce coating and waterproofing products and insulation products for Carlisle SynTec, capacity expansion for the manufacture of transmission belts in China for Carlisle Power Transmission, and the installation of a fully integrated ERP system at several operations at Carlisle Tire & Wheel Company.
Liquidity and Capital Resources
Sources and Uses of Cash
* Reflects certain reclassifications necessary to conform to current year presentation. See Note 1 to the Consolidated Financial Statements in Item 8.
2004 Compared to 2003:
Cash provided by operating activities for the twelve month period ended December 31, 2004 increased by $6.5 million over the same period ended December 31, 2003. Contributing to the increase was a $29.8 million improvement in income from continuing operations, net of tax, and $86.0 million resulting from an increase in the utilization of the Company's securitization program. Partially offsetting these items was a $107.9 million increase in working capital requirements (for purposes of this discussion, the increase in working capital is defined as the year-over-year changes in current and long-term receivables, inventories, accounts payable and accrued expenses, income taxes and long-term liabilities as presented in the Company's Consolidated Statements of Cash Flows) due primarily to an increase in receivables driven by higher sales volume and the planned building of inventories to meet projected demand in the first half of 2005.
The increase of cash used in investing activities of $23.8 million was primarily attributed to an increase in capital expenditures of $32.7 million related primarily to the construction of new production facilities for the Construction Materials segment and the expansion of production facilities for tire and belt products in the Industrial Components segment. Partially offsetting increased capital spending were proceeds received from the sale of properties acquired from the acquisition of Flo-Pac in May 2003.
The decrease in cash used in financing activities was primarily attributed to an increase in borrowings of short-term credit lines. The Company borrowed $26.1 million in 2004 compared to payments on short-term credit lines of $45.6 million in 2003. Also affecting cash used in financing activities was the use of $18.9 million for the repurchase of common shares into treasury.
2003 Compared to 2002:
The decrease in cash provided by operating activities of $113.5 million for the twelve month period ended December 31, 2003 as compared with the same period ended December 31, 2002 was primarily attributed to a $69.9 million reduction in the utilization of the Company's securitization program and a $50.4 million increase in working capital requirements primarily attributed to an increase in current and long-term receivables and an increase in inventories driven by higher sales volumes. Tax refunds of approximately $21.0 million and the receipt of $7.8 million from the termination of interest rate swaps contributed to the 2002 operating cash flow.
The increase in cash used in investing activities in 2003 over 2002 is due primarily to higher capital expenditures and acquisition spending. Also reflected in this increase are proceeds of $10.7 million in 2002 related to the sale of property, equipment and businesses. Cash generated from operations as well as $15.8 million in proceeds received from the sale of treasury shares and the exercise of stock options allowed the Company to reduce debt by $42.9 million during 2003.
Debt Instruments, Guarantees and Covenants
The following table quantifies certain contractual cash obligations and commercial commitments at December 31, 2004:
The above table does not include $88.4 million of other long-term liabilities. Other long-term liabilities consist primarily of pension, post-retirement, deferred income tax and warranty obligations. Due to factors such as return on plan assets, disbursements, contributions, and timing of warranty claims, it is not estimable when these will become due.
The Company has entered into long-term purchase agreements expiring December 31, 2006 for certain key raw materials. Commitments are variable based on changes in commodity price indices. Based on prices at December 31, 2004, commitments under these agreements total approximately $39.8 million.
Carlisle maintains a $250.0 million revolving credit facility, of which $246.5 million was available at December 31, 2004. The Company also maintains with various financial institutions $25.0 million in committed lines of credit and a $55.0 million uncommitted line of credit. As of December 31, 2004, $55.8 million was available under these lines. At December 31, 2004, $5.0 million was available under the Company's $125.0 million receivables facility.
At December 31, 2004, letters of credit amounting to $45.6 million were outstanding, primarily to provide security under insurance arrangements and certain borrowings.
The Company has financial guarantee lines in place for certain of its operations in Asia and Europe to facilitate working capital needs, customer performance and payment and warranty obligations. At December 31, 2004, the Company had issued guarantees of $17.3 million, of which $10.8 million represents amounts recorded in current liabilities. The fair value of these guarantees is estimated to equal the amount of the guarantees at December 31, 2004, due to their short-term nature.
Under the Company's various debt and credit facilities, the Company is required to meet various restrictive covenants and limitations, including certain net worth and cash flow ratios, all of which were complied with in 2004 and 2003.
Off-Balance Sheet Arrangements
As previously discussed, Carlisle maintains a receivables securitization program with a financial institution whereby it sells on a continuous basis an undivided interest in certain eligible trade accounts receivable. The Company has formed a wholly-owned, special purpose, bankruptcy-remote subsidiary ("SPV") for the sole purpose of buying and selling receivables generated by the Company. The financial position and results of operations of the SPV are consolidated with the Company. The trade accounts receivable are transferred to the SPV, irrevocably and without recourse, and the SPV may from time to time sell an undivided interest in these receivables of up to $125.0 million. In accordance with generally accepted accounting principles, the Company recognizes the transactions under this program as a true sale, whereas creditors and rating agencies may view advances on the sale of such interests as a liability. At December 31, 2004 and 2003, the Company had received $120.0 million and $67.0 million, respectively, related to sales under this program. Carlisle entered into the securitization program in September 2001 to increase the diversity of its capital funding and to reduce its cost of capital.
Cash Management
Capital expenditures in 2005 are expected to be between $70 million and $90 million, reflecting continuing manufacturing expansions in the Construction Materials segment. The Company also expects to contribute approximately $5.2 million to its pension plans in 2005. Contributions to these plans in 2004 totaled $9.5 million. Cash contributions to the Company's defined contribution plans were $5.9 in 2004. Contributions in 2005 are expected to approximate $8.0 million.
The Company is committed to paying dividends to its Shareholders and has increased its dividend rate annually for the past 28 years. The Company also plans to pay down debt to the extent possible.
The Company announced the reactivation of its share repurchase program in August 2004. In the fourth quarter 2004, the Company repurchased 324,600 shares on the open market at a total cost of approximately $18.9 million. At this time, the Company has authority to repurchase an additional 1,051,845 shares. Additional shares may be repurchased at management's direction. The decision to repurchase shares will depend on price, availability and other corporate developments. Purchases may occur from time to time and no maximum purchase price has been set.
As previously discussed, some of the Company's segments experience higher net sales and EBIT in the first half of the year which could impact the timing of cash generated from operating activities. The Company believes that its operating cash flows, credit facilities, accounts receivable securitization program, lines of credit, and leasing programs provide adequate liquidity and capital resources to fund ongoing operations, expand existing lines of business and make strategic acquisitions. However, the ability to maintain existing credit facilities and access the capital markets can be impacted by economic conditions outside the Company's control. The Company's cost to borrow and capital market access can be impacted by debt ratings assigned by independent rating agencies, based on certain credit measures such as interest coverage, funds from operations and various leverage ratios.
Market Risk
Carlisle is exposed to the impact of changes in interest rates and market values of its debt instruments, changes in raw material prices and foreign currency fluctuations. From time to time the Company may manage its interest rate exposure through the use of interest rate swaps to reduce volatility of cash flows, impact on earnings and to lower its cost of capital. During 2003, the Company executed $75 million in notional amount interest rate swaps, which have been designated as fair value hedges. The purpose of these contracts is to hedge the market risk associated with Carlisle's fixed rate debt. The Company continues to monitor its interest rate risk and will execute and terminate hedges as appropriate.
The Company's operations use certain commodities such as plastics, carbon black, synthetic and natural rubber and steel. As such, the Company's cost of operations is subject to fluctuations as the markets for these commodities change. The Company monitors these risks, but currently has no derivative contracts in place to hedge these risks.
International operations are exposed to translation risk when the local currency financial statements are translated into U.S. dollars. Carlisle monitors this risk, but at December 31, 2004 had no translation risk hedges in place. International operations are also exposed to the fluctuation of exchange rates on the revaluation of monetary assets and liabilities denominated in foreign currencies. Overall, currency valuation risk is considered minimal; however, at December 31, 2004 the Company did have currency hedges in place with a total notional amount of $6.9 million for the purpose of hedging cash flow risk associated with certain customer payment schedules. Less than 13% of the Company's 2004 revenues are in currencies other than the U.S. dollar.
Environmental
Carlisle management recognizes the importance of the Company's responsibility with regard to environmental compliance. Programs are in place to monitor and test facilities and surrounding property and, where practical, to recycle materials. Carlisle has not incurred material charges relating to environmental matters in 2004 or in prior years, and none are currently anticipated.
Backlog
Total backlog from continuing operations at December 31, 2004 of $410.2 million was 10% above $374.6 million in 2003. Most of the increase was in the Construction Materials and the Transportation Products segments and was partially offset by a decrease in backlog in the General Industry segment. The decrease in the backlog in the General Industry segment was at Carlisle Process Systems and related to a $70.0 million order received in December 2003 for a new 300,000 square foot cheese and whey production facility to be constructed in Clovis, New Mexico. This project was approximately 42% complete at December 31, 2004. Due to the nature of the orders at Carlisle Process Systems, backlog can include capital equipment orders for a period of twelve to twenty-four months.
Carlisle defines backlog as open orders (including both cancelable and non-cancelable orders) which can be shipped within a range of several days to two years. This definition of backlog is applied to all of the Company's various segments. Backlog is dependant on market conditions, which vary greatly between industries and throughout the year. While management utilizes this measurement to monitor and plan future operations, its variant nature is considered in conjunction with other operational and market conditions.
Discontinued Operations and Assets Held for Sale
In 2004, in ongoing efforts to streamline its businesses, the Company identified two operations and a segment it plans to exit. The two operations included the plastic components operation of Carlisle Tire & Wheel Company in the Industrial Components segment and the pottery business of Carlisle FoodService in the General Industry segment. Additionally, the Company decided to exit its automotive business consisting entirely of Carlisle Engineered Products in the Automotive Components segment. The Company is actively marketing these operations and conducting other actions required to complete the sale of these operations in 2005. All operations met the criteria in accordance with Statement of Financial Accounting Standard No. 144, "Accounting for the Impairment of Disposal of Long-Lived Assets."
Total assets held for sale by segment at December 31 were as follows:
The major classes of assets and liabilities held for sale at December 31 included in the Company's Consolidated Balance Sheets were as follows:
Net sales and (loss) income before income taxes from discontinued operations by segment were as follows:
In 2004, the Industrial Components segment included a $1.8 million charge related to a customer settlement and a $2.1 million write-down to fair value of assets held for sale. The settlement related to products produced at the plastic components operation of Carlisle Tire and Wheel Company. The settlement is final and no further costs are anticipated with this issue.
In 2004, the Automotive Components segment included a $40.3 million write-down for the impairment of its entire balance of goodwill based on management's estimate of fair value at December 31, 2004. Additionally, the Automotive Components segment included a $4.4 million write-down of an investment in a joint venture. The General Industry segment included a $0.6 million write-down to fair value of assets held for sale.
In 2003, the General Industry segment included a $0.9 million impairment charge recorded in accordance with SFAS 144.
Exit and Disposal Activities
The following table represents the effects of exit and disposal activities not related to discontinued operations on the Company's Consolidated Statements of Earnings for the years ended December 31:
Exit and disposal activities by type of charge for the years ended December 31 were as follows:
Liabilities were substantially paid in the period incurred and no significant liabilities remained as of December 31, 2004 related to these activities.
Exit and disposal activities by segment were as follows:
Industrial Components - Approximately $0.2 million of the 2004 exit and disposal costs, and all of 2003 costs for the Industrial Components segment relate to the consolidation of the management teams of Carlisle Tire & Wheel Company and Carlisle Power Transmission and a plant closure. Activities under this plan included employee terminations of $0.7 million and relocation costs of $0.2 million. Annual savings are expected to approximate $0.4 million.
The remaining $0.7 million of exit and disposal costs in 2004 related to the write-down of impaired fixed assets related to an upcoming facility closure. The Company estimates it will spend an additional $1.3 million related to this closure for a total expected cost of $2.0 million. These remaining costs will consist mainly of relocation and termination benefits. Annual savings are estimated at $4.6 million.
Specialty Products - Exit and disposal activities in the Specialty Products segment in 2004 relate primarily to the Company's Ridgway, Pennsylvania facility, closed in the first quarter 2002. The total cost of this closure through December 31, 2004 was $2.4 million; of which $2.3 million was incurred in 2002 and the remaining $0.1 million in 2004. Of the total amount incurred, $1.5 million was paid for moving and relocation expenses and $0.9 million related to pension and other costs. The Company believes these activities are complete and does not expect to incur additional costs.
Other exit and disposal activities during 2004 and 2003 of $0.3 million and $0.6 million, respectively, included the closure of a testing facility and warehouse, costs associated with the sale of its spring brake business in December 2003, and termination benefits associated with the consolidation of the management teams of Carlisle Industrial Brake and Friction and Carlisle Motion Control. The Company believes these activities are complete and does not expect to incur additional costs.
The result of these exit and disposal costs is estimated to save approximately $0.5 million annually.
General Industry - Exit and disposal activities in the General Industry segment in 2004 related primarily to the consolidation of the Flo-Pac operations, acquired in May 2003, into Carlisle FoodService and the relocation of a textile operation within the Carlisle FoodService organization. The plan to purchase Flo-Pac included the sale of real property acquired, the termination of employees, and the relocation of equipment and employees to other facilities. The total cost of $2.0 million included $0.9 million which was recorded as goodwill in accordance with Emerging Issues Task Force ("EITF") 95-3, Recognition of Liabilities in Connection with a Business Combination. Of the remaining $1.1 million, $0.6 million was incurred in 2003 and $0.5 million was spent in 2004 through the project's completion in the second quarter. The majority of the costs not applicable to EITF 95-3, related to relocation costs and severance of employees at existing locations. The relocation of the manufacturing equipment at a textile operation in Carlisle FoodService was completed in 2004 at a cost of $0.4 million. The costs related primarily to termination benefits, moving expenses and training costs. Total savings are estimated at $0.4 million annually.
The remaining exit and disposal activities in 2004 in the General Industry segment related primarily to the consolidation of operations within Carlisle Process Systems.
Exit and disposal activities of $3.2 million in 2003 in the General Industry segment included expenses associated with the aforementioned acquisition of Flo-Pac, the consolidation of operations within Carlisle Process Systems and Carlisle FoodService, the shut down of a Tensolite facility in Mexico and remaining costs associated with closing Tensolite's Vermont facility initiated in 2001. The majority of these costs related to termination benefits of $1.3 million, contract termination costs of $1.0 million, fixed asset write-downs of $0.5 million, and rent payments of $0.3 million. The Company estimates its savings at approximately $1.1 million annually from the shut down of the Mexico facility and $0.6 million annually from the consolidation of its Process Systems operations.
The $4.6 million of exit and disposal activities in the General Industry segment in 2002 related to the closing of a Tensolite cable plant in Andover, Massachusetts. The majority of the costs related to the write-off of inventory and fixed assets totaling $2.1 million and $1.5 million, respectively. Additional costs of $1.0 million related to moving and relocation expenses and termination benefits. Total savings are estimated at $2.3 million annually.
Critical Accounting Policies
Carlisle's significant accounting policies are more fully described in the Notes to Consolidated Financial Statements. Certain of Carlisle's accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, terms of existing contracts, our observation of trends in the industry, information provided by our customers and information available from other outside sources, as appropriate. The Company considers certain accounting policies related to revenue recognition, estimates of reserves for receivables and inventory, deferred revenue and extended product warranty, valuation of long-lived assets, self-insurance retention, and pensions and other post-retirement plans to be critical policies due to the estimation processes involved.
Revenue Recognition. Almost all of Carlisle's consolidated revenues are recognized when persuasive evidence of an arrangement exists, goods have been shipped (or services have been rendered), the customer takes ownership and assumes risk of loss, collection is probable, and the sales price is fixed or determinable. Provisions for discounts and rebates to the customers and other adjustments are provided for at the time of sale as a deduction to revenue. Approximately 7% of 2004 revenue was recognized under the percentage-of-completion method. The products sold under the percentage-of-completion method tend to be sold pursuant to long-term, generally fixed-priced contracts that may extend up to 24 months in duration. The percentage-of-completion method results in the recognition of consistent profit margins over the life of a contract. Amounts recognized in revenue under this method are calculated using the percentage of construction cost completed, on a cumulative cost-to-total cost basis. Cumulative revenues recognized may be less or greater than cumulative costs and profits billed at any point in time during a contract's term.
Allowance for Doubtful Accounts. Carlisle performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customer's current credit worthiness, as determined by the review of their credit information. Allowances for doubtful accounts are estimated based on the evaluation of potential losses related to customer receivable balances. Estimates are developed by using standard quantitative measures based on historical losses, adjusting for current economic conditions and, in some cases, evaluating specific customer accounts for risk of loss. The reserve for doubtful accounts was $6.2 million at December 31, 2004 and $6.8 million at December 31, 2003. Changes in economic conditions in specific markets in which the Company operates could have an effect on reserve balances required.
Inventories. Carlisle values its inventories at the lower of the actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory. Cost of inventories includes raw materials, direct labor and manufacturing overhead based on practical capacity. In 2004, 53% of the cost of inventories was determined by the last-in, first-out method as compared to 54% in 2003. The remainder was determined by the first-in, first-out method. The Company regularly reviews inventory quantities on hand for excess and obsolete inventory based on estimated forecasts of product demand and production requirements for the next twelve months and issues related to specific inventory items. A significant increase in the demand for products could result in a short-term increase in the cost of inventory purchases while a significant decrease in demand could result in an increase in the amount of excess inventory on hand.
Deferred Revenue and Extended Product Warranty. The Company offers extended warranty contracts on sales of certain products; the most significant being those offered on its installed roofing systems within the Construction Materials segment. The life of these warranties range from five to thirty years. All revenue for the sale of these contracts is deferred and amortized on a straight-line basis over the life of the contracts. Current costs of services performed under these contracts are expensed as incurred. The Company also records a loss and a corresponding reserve if the total expected costs of providing services under the contract exceed unearned revenues. The Company estimates total expected warranty costs using standard quantitative measures based on historical claims experience and management judgment.
Valuation of Long-Lived Assets and Acquired Intangibles. Carlisle adopted SFAS 142 effective January 1, 2002. SFAS 142 requires annual valuations of each applicable underlying business as described below. The business valuation reviews conducted in 2002 resulted in a reduction of the carrying value of goodwill for the Transportation Products segment and the General Industry segment. The goodwill reduction was reported as a cumulative effect of a change in accounting principle retroactive to the beginning of 2002 and resulted in a transitional charge to earnings, net of tax, of $43.8 million, or $1.43 per share (diluted). With the adoption of this standard, beginning in 2002, goodwill is not amortized. At December 31, 2004 and December 31, 2003, total assets included $291.3 million and $262.3 million of goodwill, respectively.
As a result of SFAS 142, the Company no longer amortizes goodwill but instead performs a review of goodwill for impairment annually, or earlier, if indicators of potential impairment exist. The fair value of the assets, including goodwill balances, is determined based on discounted estimated future cash flows. The assumptions used to estimate fair value include management's best estimates of future growth rates, capital expenditures, discount rates, and market conditions. If the estimated fair value of a business unit with goodwill is determined to be less than its book value, the Company is required to estimate the fair value of all identifiable assets and liabilities of that business unit. This requires valuation of certain internally developed and unrecognized assets. Once this process is complete, the amount of goodwill impairment, if any, can be determined. These valuations can be significantly affected by estimates of future performance and discount rates over a relatively long period of time, market price valuation multiples and marketplace transactions in related markets. These estimates will likely change over time. Some of our businesses operate in cyclical industries and the valuation of these businesses can be expected to fluctuate as a result of their cyclicality. SFAS 142 does not permit retroactive application to years prior to adoption. Therefore, earnings beginning in 2002 tend to be higher than earlier periods as a result of this accounting change, except for the effects of the impairment provision in current results. We believe it is inappropriate to conclude whether the likelihood of any impairment charge resulting from subsequent annual reviews is more likely in any business segment compared to another segment. Any resulting impairment loss could have an adverse impact on our financial condition and results of operations.
Self Insurance Retention. The Company maintains self retained liabilities for workers' compensation, medical, general liability and property claims up to applicable retention limits. Retention limits are between $0.5 million and $1.0 million per occurrence for general liability, $0.5 million per occurrence for workers' compensation, $0.1 million per occurrence for property and up to $0.5 million for medical claims. The Company is insured for losses in excess of these limits.
Pensions and Other Post-Retirement Plans. Carlisle maintains defined benefit retirement plans for the majority of its employees. The annual net periodic expense and benefit obligations related to these plans are determined on an actuarial basis. This determination requires assumptions to be made concerning the discount rate, long-term return on plan assets and increases to compensation levels. These assumptions are reviewed periodically by management in consultation with its independent actuary. Changes in the assumptions to reflect actual experience can result in a change in the net periodic expense and accrued benefit obligations. The defined benefit plans' assets consist primarily of publicly-listed common stocks and corporate bonds, and the market value of these assets is determined under the fair value method. At December 31, 2004, plan assets were allocated 66% in equity securities, 32% in fixed income securities and 2% in cash. The Company uses a September 30 measurement date for valuation purposes. Deviations of actual results as compared to expected results are recognized over a five-year period. The expected rate of return on plan assets was 8.75% for the 2004 valuation. While the Company believes 8.75% is a reasonable expectation based on the plan assets' mix of fixed income and equity investments, significant differences in actual experience or significant changes in the assumptions used may materially affect the pension obligations and future expense. The effects of a 0.25% increase or decrease in the expected rate of return would change the Company's estimated 2005 pension expense by less than $0.3 million. The assumed discount rate was 6.0% for the 2004 valuation. The effects of a 0.25% increase or decrease in the assumed discount rate would change the Company's total pension benefit obligation by less than $5.5 million. The Company changed its method of setting the discount rate for the 2004 valuation to one based on a projected yield to provide for a better matching of the expected future retirement plan cash flows with projected yields. The discount rate in prior years' valuations was assumed to be the Moody's Aa Corporate Bond Yield at the valuation date. The Company has used an assumed rate of compensation increase of 3.50% for the 2004 valuation. This rate is not expected to change in the foreseeable future and is slightly higher than the Company's actual rate of compensation increase over the past few years.
Carlisle also has a limited number of unfunded post-retirement benefit programs that provide certain retirees with medical and prescription drug coverage. The annual net periodic expense and benefit obligations of these programs are also determined on an actuarial basis and are subject to assumptions on the discount rate and increases in compensation levels. The Company uses a September 30 measurement date for valuation purposes. The discount rate used for the 2004 valuation was 6.00%. The effects of a 1% increase or decrease in assumed health care cost trend rates would not be material. Like the defined benefit retirement plans, these plans' assumptions are reviewed periodically by management in consultation with its independent actuary. Changes in the assumptions can result in a change in the net periodic expense and accrued benefit obligations.
New Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46(R) ("FIN 46R"), Consolidation of Variable Interest Entities. This interpretation addresses the consolidation of Variable Interest Entities ("VIE") as defined by FIN 46R. VIEs are entities to which the usual condition of consolidation (ownership of a majority voting interest) does not apply. This interpretation focuses on financial interests that indicate control. It concludes that in the absence of clear control through voting interests, a company's exposure (variable interest) to the economic risks and potential rewards from the variable interest entity's assets and activities are the best evidence of control. Variable interests are rights and obligations that convey economic gains or losses from changes in the values of the VIE's assets and liabilities. Variable interests may arise from financial instruments, service contracts, nonvoting ownership interests and other arrangements. If a company holds a majority of the variable interests of an entity, it would be considered the primary beneficiary. The primary beneficiary would be required to include assets, liabilities and the results of operations of the VIE in its financial statements. The Company was required to apply FIN 46R to variable interests in VIEs created after December 31, 2003. For VIEs created prior to January 1, 2004, the Company was required to adopt the provisions of this announcement by March 31, 2004. The adoption of this pronouncement did not have an impact on the Company's statement of earnings or financial position.
In May 2004, FASB issued FASB Staff Position ("FSP") No. 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. In December 2003, the President of the United States (the "President") signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act"). The Act provides for a 28% tax-free subsidy on certain prescription drug claims for sponsors of retiree health care plans with drug benefits that are at least actuarially equivalent to those to be offered under Medicare Part D. Because of existing caps on employer costs for the majority of the groups participating in its postretirement medical plan, the Company does not anticipate it will be eligible for this subsidy. Due to the size of the liability for those groups that may be eligible, any reduction in the liability as a result of the Act is not expected to be material.
In November 2004, FASB issued Statement of Financial Accounting Standard No. 151 ("SFAS 151"), Inventory Costs - An Amendment of ARB No. 43, Chapter 4. This statement amends Accounting Research Bulletin No. 43 ("ARB 43"), Chapter 4, "Inventory Pricing", to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal" as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005 and is required to be adopted by the Company as of January 1, 2006. The Company is currently evaluating the impact of this standard, but its adoption is not expected to have a material impact on the Company's statement of earnings or financial position.
In December 2004, FASB issued SFAS No. 123(R), Share Based Payment. This statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires the expensing of all share-based payments, including the issuance of stock options, based on the fair value of the award at the grant date. Additionally, the new standard requires the use of a fair-value measurement methodology which takes into consideration the special nature of its awards, including early exercise provisions. Currently, for presentation of the pro-forma effect on Net Income of stock-based compensation arrangements as required by SFAS 123, the Company estimates the fair value of its awards using the Black-Scholes method.
The Company is required to adopt this standard as of July 1, 2005 and will elect to expense its share-based awards using the modified prospective method as provided by SFAS 123(R). This method requires the expensing of share-based awards issued on or after the date of adoption as well as the unvested portion of awards issued before the date of adoption. The Company is currently evaluating alternatives for measuring the fair value of new awards. The pretax amount of unvested awards as calculated under the Black-Scholes method as of December 31, 2004 to be expensed upon adoption is $0.3 million in 2005 and less than $0.1 million in 2006. As previously discussed, the Company has not yet determined the methodology it will use in estimating fair value of new awards; however, it expects the expense per option granted to be lower than that presented in current pro-forma disclosures under SFAS 123.
In December 2004, FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets - an amendment of APB Opinion No. 29. SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, "Accounting for Nonmonetary Transactions," and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The Company is required to adopt this standard as of January 1, 2006 and does not expect its adoption to have a material impact on the Company's statement of earnings or financial position.
On October 22, 2004, the American Jobs Creation Act ("the Act") was signed into law by the President. This Act includes a tax deduction of up to 9% (when fully phased-in) of the lesser of (a) "qualified production activities income," as defined in the Act, or (b) taxable income (after the deduction for the utilization of any net operating loss carryforwards). This tax deduction is limited to 50 percent of W-2 wages paid by the taxpayer. The Act also provides for a special one-time tax deduction of 85 percent of certain foreign earnings that are repatriated (as defined in the Act) in either an enterprise's last tax year that began before the enactment date, or the first tax year that begins during the one-year period beginning on the date of enactment.
In December 2004 FASB issued FASB Staff Position No. FAS 109-1, Application of FASB Statement No. 109, Accounting for Income Taxes to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004. The FSP would require that the tax deduction be accounted for as a special deduction in the period earned, not as a tax-rate reduction.
In December 2004, FASB also issued FASB Staff Position FAS 109-2 ("FSP 109-2"), Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (the "Act"). FSP No. 109-2 provides guidance under FASB Statement No. 109, Accounting for Income Taxes ("SFAS 109"), with respect to recording the potential impact of the repatriation provisions of the Act on income tax expense and deferred tax liability. The FSP permits an enterprise time beyond the financial reporting period of enactment to evaluate the effect of the Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. The Company has not yet completed its evaluation of the impact of the repatriation provisions and accordingly has not adjusted its tax expense or deferred tax liability to reflect the repatriation provisions of the Act; however, the range of possible amounts of undistributed earnings being evaluated for repatriation was between $25 million and $35 million as of December 31, 2004. The incremental U.S. tax, after accounting for the dividend received deduction as provided by section 965 of the Internal Revenue Code, is estimated to be between $1.0 million and $1.5 million.
Forward-Looking Statements
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are made based on known events and circumstances at the time of publication, and as such, are subject in the future to unforeseen risks and uncertainties. It is possible that the Company's future performance may differ materially from current expectations expressed in these forward-looking statements, due to a variety of factors such as: increasing price and product/service competition by foreign and domestic competitors, including new entrants; technological developments and changes; the ability to continue to introduce competitive new products and services on a timely, cost effective basis; the Company's mix of products/services; increases in raw material costs which cannot be recovered in product pricing; domestic and foreign governmental and public policy changes including environmental regulations; threats associated with and efforts to combat terrorism; protection and validity of patent and other intellectual property rights; the successful integration and identification of the Company's strategic acquisitions; the cyclical nature of the Company's businesses; and the outcome of pending and future litigation and governmental proceedings. In addition, such statements could be affected by general industry and market conditions and growth rates, and general domestic and international economic conditions including interest rate and currency exchange rate fluctuations. Further, any conflict in the international arena may adversely affect the general market conditions and the Company's future performance. The Company undertakes no duty to update forward-looking statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Information concerning market risk is set forth in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations under the heading "Market Risk.
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