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VALMONT INDUSTRIES INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
(Edgar Glimpses Via Acquire Media NewsEdge) MANAGEMENT'S DISCUSSION AND ANALYSIS
Forward-Looking Statements
Management's discussion and analysis, and other sections of this annual
report, contain forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These forward-looking statements are
based on assumptions that management has made in light of experience in the
industries in which the Company operates, as well as management's perceptions of
historical trends, current conditions, expected future developments and other
factors believed to be appropriate under the circumstances. These statements are
not guarantees of performance or results. They involve risks, uncertainties
(some of which are beyond the Company's control) and assumptions. Management
believes that these forward-looking statements are based on reasonable
assumptions. Many factors could affect the Company's actual financial results
and cause them to differ materially from those anticipated in the
forward-looking statements. These factors include, among other things, risk
factors described from time to time in the Company's reports to the Securities
and Exchange Commission, as well as future economic and market circumstances,
industry conditions, company performance and financial results, operating
efficiencies, availability and price of raw materials, availability and market
acceptance of new products, product pricing, domestic and international
competitive environments, and actions and policy changes of domestic and foreign
governments.
The following discussion and analysis provides information which management
believes is relevant to an assessment and understanding of our consolidated
results of operations and financial position. This discussion should be read in
conjunction with the Consolidated Financial Statements and related Notes.
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General
Change Change
2012 2011 2012 - 2011 2010 2011 - 2010
Dollars in millions, except per share amounts
Consolidated
Net sales $ 3,029.5 $ 2,661.5 13.8 % $ 1,975.5 34.7 %
Gross profit 802.5 666.8 20.4 % 519.6 28.3 %
as a percent of sales 26.5 % 25.1 % 26.3 %
SG&A expense 420.2 403.5 4.1 % 341.2 18.3 %
as a percent of sales 13.9 % 15.2 % 17.3 %
Operating income 382.3 263.3 45.2 % 178.4 47.6 %
as a percent of sales 12.6 % 9.9 % 9.0 %
Net interest expense 23.4 26.9 (13.0 )% 26.1 3.1 %
Effective tax rate 35.2 % 2.0 % 36.0 %
Net earnings 234.1 228.3 2.5 % 94.4 141.8 %
Diluted earnings per
share $ 8.75 $ 8.60 1.7 % $ 3.57 140.9 %
Engineered
Infrastructure Products
Segment
Net sales $ 833.3 $ 792.6 5.1 % $ 669.2 18.4 %
Gross profit 210.0 186.5 12.6 % 179.5 3.9 %
SG&A expense 156.0 145.7 7.1 % 127.3 14.5 %
Operating income 54.0 40.8 32.4 % 52.2 (21.8 )%
Utility Support
Structures Segment
Net sales 869.7 620.8 40.1 % 472.7 31.3 %
Gross profit 206.3 141.8 45.5 % 112.2 26.4 %
SG&A expense 77.3 71.2 8.6 % 60.5 17.7 %
Operating income 129.0 70.6 82.7 % 51.7 36.6 %
Coatings Segment
Net sales 282.1 280.8 0.5 % 208.4 34.7 %
Gross profit 104.4 93.5 11.7 % 67.8 37.9 %
SG&A expense 32.8 34.9 (6.0 )% 25.2 38.5 %
Operating income 71.6 58.6 22.2 % 42.6 37.6 %
Irrigation Segment
Net sales 750.6 665.9 12.7 % 443.4 50.2 %
Gross profit 216.1 178.6 21.0 % 118.8 50.3 %
SG&A expense 72.4 70.8 2.3 % 56.8 24.6 %
Operating income 143.7 107.8 33.3 % 62.0 73.9 %
Other
Net sales 293.9 301.4 (2.5 )% 181.8 65.8 %
Gross profit 65.7 65.9 (0.3 )% 43.4 51.8 %
SG&A expense 19.1 20.2 (5.4 )% 14.9 35.6 %
Operating income 46.6 45.7 2.0 % 28.5 60.4 %
Net corporate expense
Gross profit - 0.5 (100.0 )% (2.1 ) (123.8 )%
SG&A expense 62.6 60.7 3.1 % 56.5 7.4 %
Operating loss (62.6 ) (60.2 ) 4.0 % (58.6 ) 2.7 %
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RESULTS OF OPERATIONS
FISCAL 2012 COMPARED WITH FISCAL 2011
Overview
On a consolidated basis, the increase in net sales in fiscal 2012, as
compared with 2011, was due to the following factors:
º •
º Unit sales volumes increased approximately $353 million in fiscal
2012, as compared with 2011. All reportable segments contributed to
the higher sales volumes, with the most significant unit sales
increases within the Utility Support Structures and Irrigation
segments. Depending on the segment, unit volumes are measured in tons,
units or some other physical measure of volume.
º •
º Sales prices and mix in fiscal 2012, as compared with 2011, were
favorable, resulting in increased sales of approximately $50 million.
As many of our products are either built to order or configured to
customer specifications, sales mix can be due to a number of factors,
in addition to pricing. These factors may include product
specifications, options and other factors that may affect the unit
price at which a product is sold. In some cases, pricing and mix may
affect our cost of the product sold.
º •
º Fiscal 2012 included 52 weeks of operations, as compared with fiscal
2011, which was 53 weeks. This was the result of our fiscal year
ending the last Saturday in December. Accordingly, all fiscal 2011
operational figures were higher than had the fiscal year been 52 weeks
in length. The estimated effect of our fiscal 2011 net sales and net
earnings due to the extra week of operations was approximately
$50 million and $3 million, respectively.
Foreign currency translation factors, in the aggregate, resulted in lower
net sales and operating income in fiscal 2012, as compared with 2011. On
average, the U.S. dollar strengthened against most currencies in 2012. The most
significant currencies that contributed to this movement were the euro,
Brazilian real and the South African rand. On a segment basis, the approximate
currency effects on net sales and operating income in fiscal 2012, as compared
with 2011, were as follows (in millions of dollars):
Operating
Net Sales Income
Engineered Infrastructure Products $ (14.8 ) $ (0.6 )
Utility Support Structures 0.5 -
Coatings - -
Irrigation (15.0 ) (2.5 )
Other (5.7 ) (0.6 )
Corporate - -
Total $ (35.0 ) $ (3.7 )
The increase in gross profit margin (gross profit as a percent of sales) in
fiscal 2012, as compared with 2011, was primarily due to improved sales pricing
and mix and moderating raw material costs in 2012 as compared with 2011. Steel
prices and zinc prices in 2012 were down slightly as compared with 2011. LIFO
expense in fiscal 2012 was $10.7 lower than 2011, contributing to the
comparatively higher gross profit margin in 2012, as compared with 2011.
Selling, general and administrative (SG&A) expense in fiscal 2012, as
compared with 2011, increased mainly due to the following factors:
º •
º Increased compensation expenses of approximately $8.0 million,
associated with increased employment levels and increased employee
benefit costs;
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º •
º Increased employee incentive accruals of approximately $10.6 million,
due to improved operating results; and
º •
º Deferred compensation expense of $2.4 million incurred in fiscal 2012
associated with the increase in deferred compensation plan
liabilities. The corresponding increase in deferred compensation plan
assets was recorded as a decrease in "Other" expense.
These increases were offset to a degree by foreign exchange transaction
effects of $4.7 million. SG&A spending as a percent of sales decreased from
15.2% in fiscal 2011 to 13.9% in fiscal 2012, as we achieved leverage of the
fixed portion of SG&A expense in light of the sales increase.
The increase in operating income on a reportable segment basis in fiscal
2012, as compared with 2011, was due to improved operating performance in all
reportable segments. The most significant increases were in the Irrigation and
Utility segments.
The decrease in net interest expense in fiscal 2012, as compared with 2011,
was the net effect of lower interest expense of $4.5 million and lower interest
income of $1.0 million. The decrease in interest expense was attributable to
interest savings realized from the refinancing of our $150 million of senior
subordinated debt in June 2011 and approximately $2.8 million of expense
incurred in the second quarter of 2011 related to the refinancing of our
$150 million of senior subordinated notes. The decrease in interest income was
due to interest received on certain income tax refunds in 2011. Average
borrowing levels in 2012 were comparable with 2011.
The decrease in "Other" expenses in fiscal 2012, as compared with 2011, of
$3.0 million was mainly due to investment returns in the assets held in our
deferred compensation plan of $2.4 million. The increase in the value of these
assets was offset by a corresponding increase in our deferred compensation
liabilities, which was reflected as an increase in SG&A expense. Accordingly,
there was no effect on net earnings from these investment gains.
Our effective income tax rate in fiscal 2012 of 35.2% was higher than the
2011 effective rate of 2.0%. Our effective tax rate in 2011 was abnormally low,
mainly due to tax benefits associated with the legal entity restructuring of
Delta Ltd. in the fourth quarter of 2011. Aside from these non-recurring
benefits, our 2011 effective tax would have been approximately 33%. Our
effective tax rate in 2012 was affected by the following factors that
contributed to increased income tax expense:
º •
º In 2012, the U.K. reduced its income tax rate from 26% to 24%. As a
result, our income tax expense increased in 2012 by $4.8 million,
mainly due to the revaluation of deferred income tax assets, and;
º •
º Adjustments to the final accounting calculations related to the 2011
legal restructuring of Delta Ltd. resulted in a $2.4 million
unfavorable adjustment.
Going forward, depending on our geographic mix of earnings and currently
enacted income tax rates in the countries in which we operate, we expect our
effective tax rate to approximate 34%.
Earnings attributable to noncontrolling interests was lower in 2012, as
compared with 2011, mainly due to lower net earnings in those consolidated
operations that are less than 100% owned, the most significant of what was the
manganese dioxide operation. In addition, $2.4 million of the 2012 decrease was
due to our purchase of the noncontrolling interest in our grinding media
operation in June 2011. This operation was previously 40% owned by
noncontrolling interests.
Our cash flows provided by operations were $197.1 million in 2012, as
compared with $149.7 million in 2011. While net earnings in fiscal 2012 was
comparable with 2011, $66.0 million of fiscal 2011 earnings was due to tax
benefits resulting from the Delta Ltd. legal reorganization, which were non-cash
in nature.
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Engineered Infrastructure Products (EIP) segment
The increase in EIP segment net sales in fiscal 2012, as compared with 2011,
was due to improved sales volumes of approximately $33 million, $22 million of
favorable pricing and sales mix changes, offset to a degree by unfavorable
foreign exchange translation effects of approximately $15 million. The pricing
increases largely followed raw material inflation realized in 2011.
In the lighting product line, North American sales in 2012 were up modestly
from 2011. The increase in sales resulted from higher sales prices and favorable
sales mix. The transportation market for lighting and traffic structures
continues to be steady but not particularly strong. While a two-year extension
to the current U.S. highway funding legislation was enacted in the third quarter
of 2012, this event has not yet affected the market for lighting and traffic
structures. We also believe that state budget issues are limiting roadway
project activity. Sales in other market channels such as sales to lighting
fixture manufacturers and commercial construction projects in 2012 were
comparable with 2011. In Europe, lighting sales in fiscal 2012 were lower than
2011. We divested our Turkish and Italian operations in late 2011, resulting in
lower sales in 2012, as compared with 2011, of $17.5 million. Current economic
conditions in Europe are weak and uncertain. As a result, public spending for
streets and highways is under pressure, as governments cope with lower tax
receipts and budget deficits. However, lighting sales in local currency were
higher in 2012, as compared with 2011. Stronger sales in France, Scandinavia and
the U.K. were offset somewhat by weaker sales volumes in northern Europe.
Lighting sales in the Asia Pacific region in fiscal 2012 were comparable with
2011.
Communication product line sales in fiscal 2012 were improved over 2011.
North America sales in 2012 were $27 million higher than 2011. The increase in
sales was attributable to improved market conditions (somewhat attributable to
the build out of 4G wireless technology) and the resolution of the proposed
AT&T/T-Mobile merger, which we believe slowed sales activity for structures and
components in 2011. In China, sales of wireless communication structures in 2012
were comparable with 2011.
Sales in the access systems product line in 2012 were improved as compared
with 2011, as industrial production investments in the mining and energy
economic sectors are increasing in the Asia Pacific region.
Sales of highway safety products in 2012 were slightly higher than 2011.
While public spending on roadways in Australia did not grow in 2012,
establishment of sales channels in other countries in the Asia Pacific region
contributed to sales volume increases for the product line.
Operating income for the segment in fiscal 2012 was higher than 2011.
Improved operating income resulted from higher sales volumes, improved sales
prices and moderating raw material costs (including $2.7 million of lower LIFO
expense). These improvements were offset by factory productivity issues that
negatively affected operating income by approximately $14.3 million. The
productivity matters mainly were due to excessive start-up costs associated with
capacity expansions in the U.S. and various factory productivity matters in the
Europe and Asia Pacific regions. The increase in SG&A spending in 2012, as
compared with 2011, mainly was attributable to higher compensation costs of
$7.6 million and increased employee incentives of $5.0 million. These increases
were offset to a degree by a $3.0 million write down in a trade name recorded in
2011 and currency translation effects of $2.6 million.
Utility Support Structures (Utility) segment
In the Utility segment, the sales increase in the 2012, as compared with
2011, was primarily due to improved unit sales volumes of approximately
$239 million. In U.S. markets, investments in the electrical grid by utility
companies is increasing, resulting in improved sales of transmission and
substation structures. The effect of sales mix was favorable in 2012, as
compared with 2011, by approximately $10 million. Sales mix was mainly related
to certain large orders that were taken in 2010 and early 2011, when market
pricing was particularly low. As market conditions improved, pricing
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recovered to a degree, resulting in improved pricing and mix as the year
progressed. Sales in international markets in fiscal 2012 were improved over
2011. Sales in the Asia Pacific region are higher, offset to some extent by
lower sales in Europe and the Middle East.
Operating income in fiscal 2012, as compared with 2011, increased due to the
increase in North America sales volume, moderating raw material costs and
leverage effects on fixed SG&A and factory expenses. These positive effects were
offset to a degree by $12.9 million of additional rework and other unanticipated
costs related to certain large orders. The increase in SG&A expense for the
segment in fiscal 2012 as compared with 2011, was mainly due to increased
employee compensation of $3.1 million and increased sales commissions of
$1.0 million, associated with the increase in business levels.
Coatings segment
Coatings segment sales to outside customers in fiscal 2012 was comparable
with 2011, as improved sales in the United States was offset to a degree by
lower sales in the Asia Pacific region. In the United States, we experienced
broad-based improved demand from customers, especially in the agriculture,
petrochemical and energy economic sectors, which included higher sales for
galvanizing services to our other segments. Asia Pacific volumes in 2012 were
down from 2011, due to slowness in the Australian industrial economy not related
to mining. Average selling prices in 2012 were comparable with 2011.
The increase in segment operating income in 2012, as compared with 2011, was
mainly due to improved productivity and operating leverage through volume
increases and lower zinc costs. The effect of lower zinc costs on segment
operating income in 2012, as compared with 2011, was approximately $5.7 million.
SG&A expenses for the segment in 2012, as compared with 2011, were slightly
lower, mainly due to a $0.9 million favorable dispute settlement with a vendor
in 2012 and a $0.8 million write down of a trade name recorded in 2011. In 2012,
we completed the insurance settlement related to the 2011 storm and fire at one
of our facilities in Australia. Settlements in 2012 totaled $1.2 million, as
compared with $1.5 million in 2011, which were recorded in operating income.
Irrigation segment
The increase in Irrigation segment net sales in 2012, as compared with 2011,
was mainly due to improved sales volumes of approximately $78 million and
favorable pricing and sales mix of approximately $23 million. These increases
were offset by unfavorable currency translation effects of approximately
$15 million in 2012, as compared with 2011. The pricing and sales mix effect was
generally due to sales price increases that took effect in the second half of
2011 to recover higher material costs in early 2011. In global markets, the
sales growth was due to very strong agricultural economies around the world.
Farm commodity prices continue to be favorable, with a positive outlook for net
farm income in most markets around the world. We believe that farm commodity
prices have been favorable due to strong demand, including consumption in the
production of ethanol and other fuels, and traditionally low inventories of
major farm commodities. We believe the drought conditions in much of the U.S.
this summer contributed to the increased demand for irrigation equipment and
related service parts in 2012. The very dry growing conditions throughout much
of the U.S. highlight the benefits of irrigation in order to maintain crop
yields under these circumstances. In international markets, the sales
improvement in fiscal 2012, as compared with 2011, was also realized in most
markets due to generally favorable economic conditions in the global farm
economy.
Operating income for the segment improved in 2012, as compared with 2011,
due to improved sales unit volumes and improved sales prices in light of stable
material costs. The higher average selling prices resulted from rising material
costs in 2011, when sales price increases lagged material cost inflation. The
stability in raw material purchase costs also resulted in $4.6 million in lower
LIFO expenses in 2012, as compared with 2011. SG&A expenses in 2012 were
comparable with fiscal 2011.
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Other
This category includes the grinding media, industrial tubing, electrolytic
manganese and industrial fasteners operations. In 2012, sales were lower than
2011, mainly due currency translation effects of $5.7 million and slightly lower
sales in grinding media. Operating income in 2012 was comparable with 2011, as
improvement in tubing was offset by lower operating earnings in our manganese
dioxide operation.
Net corporate expense
Net corporate expense in fiscal 2012 was higher than 2011, mainly due to:
º •
º higher employee incentives of $5.1 million associated with improved
net earnings and share price, which affected long-term incentive
plans, and;
º •
º higher deferred compensation expenses (approximately $2.4 million)
related to investment returns on assets in the deferred compensation
plan. These increases are offset by decreases in "Other" expense.
These increases were offset by lower corporate spending in various areas,
including lower expenses for the Delta Pension Plan of $1.2 million.
FISCAL 2011 COMPARED WITH FISCAL 2010
Acquisition of Delta plc
On May 12, 2010, we acquired Delta plc (Delta). The total amount of the
acquisition was $436.7 million and was financed by a combination of cash,
borrowings under our revolving credit agreement of $85.0 million and
$300.0 million of senior unsecured notes.
We began consolidating Delta's financial results in our consolidated
financial statements beginning on May 12, 2010. On a segment reporting basis,
Delta's operations are included in our results as follows:
Engineered Infrastructure Products (EIP) Segment-manufacture of poles,
roadway safety systems and access systems;
Utility Support Structures (Utility) Segment-manufacture of pole
structures;
Coatings Segment-galvanizing operations in Australia, the U.S. and Asia;
and
Other-manufacture of steel grinding media and electrolytic manganese
dioxide
The increases in sales and operating income by segment attributable to a
full year effect of Delta in fiscal 2011, as compared with fiscal 2010, were as
follows (in millions):
Fiscal year ended
December 31, 2011
Operating
Net Sales Income
Engineered Infrastructure Products $ 81.3 $ 6.5
Utility Support Structures 2.1 0.3
Coatings 56.8 6.8
Other 70.9 4.4
Net corporate expense - (5.8 )
Total $ 211.1 $ 12.2
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Overview
On a consolidated basis, the increase in net sales in fiscal 2011, as
compared with 2010, was primarily the result of improved sales in all reportable
segments, part of which was the result of Delta's financial results being
included in our consolidated financial statements for all of 2011. In addition,
fiscal 2011 included 53 weeks of operations, as compared with fiscal 2010, which
was 52 weeks. This was the result of our fiscal year end being on the last
Saturday in December. Accordingly, all fiscal 2011 operational figures were
higher than had fiscal 2011 been 52 weeks in length. The estimated impact on our
net sales and net earnings due to the extra week of fiscal 2011 was
approximately $50 million and $3 million, respectively.
For the company as a whole, without consideration of Delta, our 2011
increase over 2010 was mainly due to increased unit sales volumes of
approximately $400 million. On a reportable segment basis, the most significant
unit sales volume increase were in the Irrigation and Utility segments. Sales
prices overall were up modestly in fiscal 2011, as compared with 2010, mainly in
response to rising steel prices. In the aggregate, the sales increase in 2011,
as compared with 2010, due to price increases and sales mix changes was
approximately $14 million.
Our fiscal 2011 sales and operating income in comparison to 2010 were
enhanced by foreign currency translation. On average, the U.S. dollar was weaker
than most global currencies in 2011 as compared with 2010. These effects by
segment were as follows (in millions of dollars):
Operating
Net Sales Income
Engineered Infrastructure Products $ 30.0 $ 2.7
Utility Support Structures 3.5 0.2
Coatings 10.3 1.3
Irrigation 3.4 0.5
Other 13.8 1.7
Corporate - (1.2 )
Total $ 61.0 $ 5.2
The decrease in gross profit margin (gross profit as a percent of sales) in
fiscal 2011, as compared with 2010, was due to higher average raw material costs
in 2011 as compared with 2010. In particular, steel prices rose significantly in
the first quarter of 2011 before moderating somewhat in the following two
quarters. Average zinc costs also were higher in 2011 than in 2010. These higher
costs were not recovered entirely through increased selling prices, mainly due
to a competitive selling price environment, especially in the EIP and Utility
segments. In the aggregate, we estimate that the impact of these factors in
2011, as compared with 2010, was approximately $29 million.
Selling, general and administrative (SG&A) spending in fiscal 2011, as
compared with 2010, increased due to the following factors:
º •
º Expenses associated with the full year Delta operations
($32.5 million) in our consolidated accounts in 2011;
º •
º Increased employee incentive accruals of $20.9 million, due to
improved operating results, and;
º •
º Increased compensation expenses of $12.1 million, associated with
increased employment levels and salary increases.
These increases were somewhat offset by $13.2 million in lower acquisition
and integration costs in the fiscal 2011, as compared with 2010, associated with
the Delta acquisition.
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The increase in operating income on a reportable segment basis in 2011, as
compared with 2010, was due to improved operating performance in the Irrigation,
Utility and Coatings segments reported improved operating income in fiscal 2011,
as compared with 2010. The EIP segment operating income in 2011 was lower than
fiscal 2010. The "Other" category also reported improved operating profit in
2011, as the grinding media, tubing and manganese dioxide operations were
improved over 2010. Currency translation effects also contributed to the
increase in operating income in fiscal 2011, as compared with 2010, of
approximately $5.2 million.
The increase in interest expense in fiscal 2011, as compared with 2010, was
attributable to:
º •
º $2.8 million of expense incurred when we redeemed our senior
subordinated debt;
º •
º $5.0 million of expense related to the full year effect of interest
expense associated with the $300 million in senior unsecured notes
issued in April 2010, less;
º •
º $2.9 million of bank fees incurred in the first quarter of fiscal 2010
to provide the required bridge loan funding commitment for the Delta
acquisition and the full year effect of interest income from Delta's
cash balances (approximately $2 million).
The increase in "Other" expense in fiscal 2011, as compared with 2010, was
mainly due to investment losses in the assets held in our deferred compensation
plan of $1.5 million. The decrease in the value of these assets was offset by a
corresponding decrease in our deferred compensation liabilities, which were
reflected as a decrease in net corporate expense. Accordingly, there was no
effect on net earnings from these investment losses. In addition, we incurred
approximately $1.5 million of currency translation losses due the dissolution of
our joint venture in Turkey.
Our effective income tax rate in fiscal 2011 was substantially lower than
2010. This reduction was mainly due to tax benefits associated with a legal
restructuring of Delta in the fourth quarter of 2011. The restructuring was
completed to gain certain operational efficiencies and resulted in an aggregate
income tax benefit of $66.0 million related to an increase in the tax basis of
assets in Australia and removing valuation allowances to certain U.K. deferred
tax assets associated with tax loss carryforwards. The restructuring will allow
us to generate U.K.-based income sufficient to utilize those tax loss
carryforwards. See "Critical Accounting Policies-Income Taxes" for a more
detailed discussion of the legal restructuring and the associated tax. In 2010,
we realized an unfavorable effect in 2010 related to non-deductibility of a
portion of the Delta acquisition expenses (approximately $3.2 million). In 2011,
the following items resulted in favorable effects to income taxes:
º •
º income tax benefits associated with our 2011 acquisition of the
remaining 40% of Donhad that we did not own ($4.1 million);
º •
º income tax provisions in our South African manganese dioxide operation
that were no longer needed due to a favorable tax authority ruling
($3.2 million);
º •
º net effect of certain income tax contingencies in 2011 that were
reduced due to expiration of statutes of limitation ($1.4 million).
Aside from these events that are non-recurring in nature, we believe our
effective tax rate in fiscal 2011 and 2010 would have been approximately
32.0-33.0%.
Earnings attributable to noncontrolling interests was higher in 2011, as
compared with 2010, mainly due to improved earnings in our manganese dioxide
operation, which is 45% owned by noncontrolling interests. Earnings in
non-consolidated subsidiaries improved in 2011, as compared with 2010, as our
49% owned manganese materials operation experienced improved profitability.
The improvement in net earnings and earnings per share in 2011, as compared
with 2010, were mainly attributed to the improved operating income and the tax
benefits associated with the legal entity restructuring in 2011 ($66.0 million
and $2.49 per share, respectively). See "Critical Accounting
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Policies-Income Taxes" for a more detailed discussion of the legal restructuring
and the associated tax effects.
Our cash flows provided by operations were approximately $149.7 million in
2011, as compared with $152.2 million in 2010. While net earnings increased in
2011, as compared with 2010, operating cash flow was slightly lower than 2010
due mainly to the following factors:
º •
º higher levels of working capital to support increased business
activity in the Utility and Irrigation segments in 2011;
º •
º the income tax benefits associated with the legal entity restructuring
completed in the fourth quarter of 2011 ($66.0 million) were non-cash
in nature, and;
º •
º contributions to the Delta Pension Plan of $11.9 million in 2011.
Engineered Infrastructure Products (EIP) segment
The increase in net sales in fiscal 2011 as compared with 2010 was mainly
due to the full year effect of the Delta operations and currency translation
effects. Global lighting markets continue to experience relatively weak demand,
resulting in increased price competition, despite higher raw material prices. In
the Lighting product line, 2011 North American sales in 2011 were down slightly
as compared with 2010. Market conditions in North America continue to be weak,
especially in the transportation market, where funding is through federal, state
and local governments. We believe sales demand in the transportation market was
dampened by the lack of a long-term federal highway funding legislation and
state budget deficits, as the lack of long-term funding legislation does not
give the various states ample visibility to implement long-term initiatives.
Furthermore, highway spending sponsored under the federal program requires the
various states to provide part of required funding. Many states are in budget
deficits, which may constrain their ability to access federal matching funds to
implement roadway projects. Sales in other market channels helped to offset the
lower transportation market sales in 2011, as compared with 2010. In Europe,
sales unit volumes were approximately $22 million higher in fiscal 2011, as
compared with 2010. However, sales pricing and product mix generally were
unfavorable in light of higher material costs, due to weaker infrastructure
spending in Europe related to budget deficit control measures and public debt
issues.
Communication product line sales in fiscal 2011 were comparable to 2010.
North America sales were slightly higher in 2011 than 2010. While market
conditions were generally more favorable in 2011 as compared with 2010, we
believe uncertainty surrounding the AT&T/T-Mobile merger has caused demand for
communication structures and components to slow down in the last half of 2011.
In China, sales of wireless communication structures were slightly higher in
fiscal 2011, as compared with 2010. In 2010, annual supply contracts with
Chinese wireless carriers were settled later than in the past and 2011 was more
in line with what we believe is a more normal demand pattern.
Sales in the access systems product line in Australia in 2011 were
comparable with 2010, not including the full year effect from the Delta
acquisition, as industrial construction was overall stable and mining investment
was in the early stages of project feasibility and scope. Asia sales in this
product line were higher by approximately $7.5 million in 2011 as compared with
2010, as markets in the region generally were stronger, particularly in China,
Indonesia and the Middle East.
Sales of highway safety products in 2011 were comparable with 2010 in local
currency terms, not including the full year effect from the Delta acquisition.
Floods in parts of Australia affected infrastructure spending in the first two
quarters of 2011, as public spending priorities shifted from roadway development
to supporting recovery from the floods.
Operating income for the segment in fiscal 2011 was lower as compared with
2010. While operating income was enhanced by the full year effect of the Delta
operations and currency translation
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effects, the impact of higher raw material costs, slowness in demand and very
competitive pricing conditions in most of our lighting markets hampered
operating income for the segment by approximately $19 million in 2011, as
compared with 2010. The operating income associated with the Delta operations,
aside from the full year effect of the acquisition, was comparable with 2010.
The strong Australian dollar led to pricing and margin pressures, as imported
products from outside of Australia were more competitive from a pricing
standpoint. In Europe, we were affected by competitive pricing pressures that
negatively affected segment operating profit by approximately $3.2 million in
2011, as compared with 2010. The increase in SG&A expense in fiscal 2011 was
mainly due to the acquisition of the Delta operations ($15.9 million), currency
translation effects of $4.8 million and the fourth quarter write down of the
PiRod trade name of $3.0 million.
Utility Support Structures (Utility) segment
In the Utility segment, the sales increase in fiscal 2011, as compared with
2010, was due to improved unit sales volumes in the U.S., offset to a degree by
lower sales prices in the U.S. and lower sales volumes in international markets.
In U.S. markets, electrical utility companies are increasing their investment in
the electrical grid over a relatively slow 2010. The sales pricing environment
is slowly improving but continues to be very competitive. Our sales in 2011 were
somewhat reflective of market conditions in 2010 when certain utility structures
projects were awarded at relatively low prices. In total, we experienced
slightly lower average selling prices on our 2011 sales, as compared with 2010
(approximately $14 million). In international markets, the sales decrease was
mainly due to lower project sales into emerging markets of approximately
$25 million.
Operating income in fiscal 2011, as compared with 2010, increased due to the
substantial increase in North America sales volume and associated operational
leverage. Gross profit margins were negatively affected by the competitive
pricing environment in North America and higher raw material costs. The increase
in SG&A expense for the segment in fiscal 2011 was higher than in 2010, mainly
due to increased employee incentives ($6.7 million) associated with the increase
in operating income and $2.0 million in increased compensation expenses.
Coatings segment
Net sales in the Coatings segment increased in fiscal 2011, as compared with
2010, mainly due to the full year effect of the Delta operations and currency
translation effects and improved sales volumes in North America and Asia
Pacific. Unit pricing effects on sales for the segment were not significant in
2011, as compared with 2010.
The increase in segment operating income in fiscal 2011, as compared with
2010, was mainly due to the effects of currency translation and improved
productivity and operating leverage through volume increases. Higher average
zinc costs in 2011, as compared with 2010, were largely recovered through
productivity improvements. The increase in operating income in fiscal 2011, as
compared with 2010, also was due to the effect of the acquired Delta operations.
SG&A expenses for the segment in fiscal 2011 were higher than the comparable
periods in 2010, mainly due to the effect of the Delta businesses
($7.2 million), incentives due to improved operating income ($1.0 million) and
the write down of the Industrial Galvanizers of America trade name
($0.8 million) in 2011.
In 2011, one of our galvanizing facilities in Australia incurred damages
from a storm and a fire later in the year. A property damage and business
interruption claim was filed with our insurance carrier and settlement of the
claim is ongoing. We made the necessary capital expenditures to restore the
facility and operations commenced late in the fourth quarter of 2011. The
insurance claim proceeds agreed to with the insurance carrier in 2011 exceeded
the net book value of the assets damaged. The financial effect of this event
resulted in an improvement in segment operating results in the fourth quarter of
2011 of approximately $1.5 million.
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Irrigation segment
The increase in Irrigation segment net sales in fiscal 2011, as compared
with 2010, was mainly due to improved sales volumes of approximately
$195 million. The remainder of the sales increase was associated with pricing
(to recover higher raw material costs) and favorable product mix (approximately
$20 million) and currency translation effects (approximately $3 million). In
global markets, the sales growth was due to a very strong agricultural economies
around the world. Farm commodity prices were generally favorable throughout 2011
and net farm income was at record levels in the United States and favorable in
most markets. We believe that farm commodity prices have been favorable due to
strong demand, including consumption in the production of ethanol and other
fuels, and traditionally low inventories of major farm commodities. In addition,
weather conditions in North America in 2011 were generally drier than 2010,
further enhancing demand for irrigation machines and related service parts. In
international markets, the sales improvement in fiscal 2011, as compared with
2010, was realized in most markets, particularly in Asia Pacific and South
America.
Operating income for the segment improved in 2011 over 2010, due to improved
sales unit volumes in North America and the associated operational leverage. The
most significant reasons for the increase in SG&A expense in 2011, as compared
with 2010, was related to employee compensation costs to support the increase in
sales activity and future initiatives ($5.4 million) and increased employee
incentives due to improved operating performance in 2011 ($3.0 million).
Other
This unit includes the Delta grinding media and electrolytic manganese
operations and our industrial tubing and fasteners operations. The increase in
sales in fiscal 2011, as compared with 2010, was mainly due improved sales
volumes in all of these operations and currency translation effects
(approximately $13.9 million). Fiscal 2011 operating income improved due to the
full year effect of the Delta operations, improved operating results in the
manganese dioxide and tubing operations and currency translation (approximately
$1.7 million).
Net corporate expense
Net corporate expense in fiscal 2011 was comparable to 2010. Corporate
expenses decreased in fiscal 2011, as compared with 2010, due to Delta
acquisition and integration costs that were incurred in 2010 ($13.2 million) but
not 2011 and lower deferred compensation expense ($1.5 million). These decreases
were offset somewhat by the full year effect of Delta's administration costs
($5.2 million) and higher employee incentive expense associated with improved
profitability in 2011 as compared with 2010 ($9.7 million) and increased
compensation expenses ($2.7 million).
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Working Capital and Operating Cash Flows-Net working capital was
$1,013.5 million at December 29, 2012, as compared with $844.9 million at
December 31, 2011. The increase in net working capital in 2012 mainly resulted
from increased receivables and inventories to support the increase in sales.
Operating cash flow was $197.1 million in fiscal 2012, as compared with
$149.7 million in fiscal 2011. The increase in operating cash flow in 2012
mainly was the result of the reduction in the non-cash tax benefits associated
with the Delta Ltd. legal reorganization recorded as a reduction of income tax
expense ($66.0 million) in fiscal 2011.
Investing Cash Flows-Capital spending in fiscal 2012 was $97.1 million, as
compared with $83.1 million in fiscal 2011. A significant portion of the capital
spending ($39.0 million) for 2012 was to expand our capacity for Utility
projects. We expect our capital spending for the 2013 fiscal year to be
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approximately $110 million. The major sources of capital spending in fiscal 2013
will be additional production capacity in the Irrigation and Utility Support
Structures segments. Of the $110 million of planned capital spending,
approximately 50% relates to projects that have been approved. Investing cash
flows for fiscal 2012 included $45.7 million for the Pure Metal Galvanizing
acquisition.
Financing Cash Flows-Our total interest-bearing debt was flat at
$486.2 million as of December 29, 2012 and December 31, 2011. Financing cash
flows in 2011 included approximately $25.3 million to acquire the remaining 40%
of the shares of Donhad Pty. Ltd.
Sources of Financing and Capital
We have historically funded our growth, capital spending and acquisitions
through a combination of operating cash flows and debt financing. We have an
internal long-term objective to maintain long-term debt as a percent of invested
capital at or below 40%. At December 29, 2012, our long-term debt to invested
capital ratio was 23.9%, as compared with 26.8% at December 31, 2011. Subject to
our level of acquisition activity and steel industry operating conditions (which
could affect the levels of inventory we need to fulfill customer commitments),
we plan to maintain this ratio below 40% in 2013.
Our debt financing at December 29, 2012 consisted primarily of long-term
debt. We also maintain certain short-term bank lines of credit totaling
$75.6 million, $62.8 million of which was unused at December 29, 2012. Our
long-term debt principally consists of:
º •
º $450 million face value ($463 million carrying value) of senior
unsecured notes that bear interest at 6.625% per annum and are due in
April 2020. We are allowed to repurchase the notes at specified
prepayment premiums. These notes are guaranteed by certain of our
subsidiaries.
º •
º $400 million revolving credit agreement with a group of banks. We may
increase the credit facility by up to an additional $200 million at
any time, subject to participating banks increasing the amount of
their lending commitments. The interest rate on our borrowings will
be, at our option, either:
º (a)
º LIBOR (based on a 1, 2, 3 or 6 month interest period, as selected
by us) plus 125 to 225 basis points (inclusive of facility fees),
depending on our ratio of debt to earnings before taxes,
interest, depreciation and amortization (EBITDA), or;
º (b)
º the higher of
º •
º The higher of (a) the prime lending rate and (b) the Federal
Funds rate plus 50 basis points plus in each case, 25 to 125
basis points (inclusive of facility fees), depending on our
ratio of debt to EBITDA, or
º •
º LIBOR (based on a 1 week interest period) plus 125 to 225
basis points (inclusive of facility fees), depending on our
ratio of debt to EBITDA
At December 29, 2012, we had no outstanding borrowings under the revolving
credit agreement. The revolving credit agreement has a termination date of
August 15, 2017 and contains certain financial covenants that may limit our
additional borrowing capability under the agreement. At December 29, 2012, we
had the ability to borrow $384.9 million under this facility, after
consideration of standby letters of credit of $15.1 million associated with
certain insurance obligations.
These debt agreements contain covenants that require us to maintain certain
coverage ratios and may limit us with respect to certain business activities,
including capital expenditures. Our key debt covenants are as follows:
º •
º Interest-bearing debt is not to exceed 3.50x EBITDA of the prior four
quarters; and
º •
º EBITDA over the prior four quarters must be at least 2.50x our
interest expense over the same period.
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At December 29, 2012, we were in compliance with all covenants related to
these debt agreements. The key covenant calculations at December 29, 2012 were
as follows:
Interest-bearing debt $ 486,192
EBITDA-last four quarters 462,417
Leverage ratio 1.05
EBITDA-last four quarters $ 462,417
Interest expense-last four quarters 31,625
Interest earned ratio 14.62
The calculation of EBITDA-last four quarters is presented under the column
for fiscal 2012 in footnote (b) to the table "Selected Five-Year Data" in
Item 6-Selected Financial Data.
Our businesses are cyclical, but we have diversity in our markets, from a
product, customer and a geographical standpoint. We have demonstrated the
ability to effectively manage through business cycles and maintain liquidity. We
have consistently generated operating cash flows in excess of our capital
expenditures. Based on our available credit facilities, recent issuance of
senior unsecured notes and our history of positive operational cash flows, we
believe that we have adequate liquidity to meet our needs for fiscal 2013 and
beyond.
We have not made any provision for U.S. income taxes in our financial
statements on approximately $586.2 million of undistributed earnings of our
foreign subsidiaries, as we intend to reinvest those earnings. Of our cash
balances at December 29, 2012, $365.9 million is held in entities outside the
United States. If we need to repatriate foreign cash balances to the United
States to meet our cash needs, income taxes would be paid to the extent that
those cash repatriations were undistributed earnings of our foreign
subsidiaries. The income taxes that we would pay if cash were repatriated
depends on the amounts to be repatriated and from which country. If all of our
cash outside the United States were to be repatriated to the United States, we
estimate that we would pay approximately $44.2 million in income taxes to
repatriate that cash.
FINANCIAL OBLIGATIONS AND FINANCIAL COMMITMENTS
We have future financial obligations related to (1) payment of principal and
interest on interest-bearing debt, (2) Delta pension plan contributions,
(3) operating leases and (4) purchase obligations. These obligations at
December 29, 2012 were as follows (in millions of dollars):
Contractual Obligations Total 2013 2014 - 2015 2016 - 2017 After 2017
Long-term debt $ 460.1 $ 0.2 $ 0.5 $ 0.2 $ 459.2
Interest 254.2 29.9 59.8 59.8 104.7
Delta pension plan
contributions 177.4 17.7 35.5 35.5 88.7
Operating leases 118.6 21.7 37.5 21.7 37.7
Unconditional purchase
commitments 36.0 36.0 - - -
Total contractual cash
obligations $ 1,046.3 105.5 133.3 117.2 690.3
Long-term debt mainly consisted of $450.0 million principal amount of senior
unsecured notes. At December 29, 2012, we had no outstanding borrowings under
our bank revolving credit agreement. Obligations under these agreements may be
accelerated in event of non-compliance with debt covenants. The Delta pension
plan contributions are related to estimated cash funding commitments to the plan
with the plan's trustees, which are currently being negotiated in conjunction
with a triennial valuation. Operating leases relate mainly to various production
and office facilities and are in the normal course of business.
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Unconditional purchase obligations relate to purchase orders for zinc,
aluminum and steel, all of which we plan to use in 2013, and certain capital
investments planned for 2013. We believe the quantities under contract are
reasonable in light of normal fluctuations in business levels and we expect to
use the commodities under contract during the contract period.
At December 29, 2012, we had approximately $45.2 million of various
long-term liabilities related to certain income tax, environmental and other
matters. These items are not scheduled above because we are unable to make a
reasonably reliable estimate as to the timing of any potential payments.
OFF BALANCE SHEET ARRANGEMENTS
We have operating lease obligations to unaffiliated parties on leases of
certain production and office facilities and equipment. These leases are in the
normal course of business and generally contain no substantial obligations for
us at the end of the lease contracts. We also maintain standby letters of credit
for contract performance on certain sales contracts.
MARKET RISK
Changes in Prices
Certain key materials we use are commodities traded in worldwide markets and
are subject to fluctuations in price. The most significant materials are steel,
aluminum, zinc and natural gas. Over the last several years, prices for these
commodities have been volatile. The volatility in these prices was due to such
factors as fluctuations in supply and demand conditions, government tariffs and
the costs of steel-making inputs. We have also experienced volatility in natural
gas prices in the past several years. Our main strategies in managing these
risks are a combination of fixed price purchase contracts with our vendors to
reduce the volatility in our purchase prices and sales price increases where
possible. We use natural gas swap contracts on a limited basis to mitigate the
impact of rising gas prices on our operating income.
Risk Management
Market Risk-The principal market risks affecting us are exposure to interest
rates, foreign currency exchange rates and natural gas. We normally do not use
derivative financial instruments to hedge these exposures (except as described
below), nor do we use derivatives for trading purposes.
Interest Rates-Our interest-bearing debt at December 29, 2012 was mostly
fixed rate debt. Our notes payable and a small portion of our long-term debt
accrue interest at a variable rate. Assuming average interest rates and
borrowings on variable rate debt, a hypothetical 10% change in interest rates
would have affected our interest expense in 2012 and 2011 by approximately
$0.1 million and $0.1 million, respectively. Likewise, we have excess cash
balances on deposit in interest-bearing accounts in financial institutions. An
increase or decrease in interest rates of ten basis points would have impacted
our annual interest earnings in 2012 by approximately $0.4 million.
Foreign Exchange-Exposures to transactions denominated in a currency other
than the entity's functional currency are not material, and therefore the
potential exchange losses in future earnings, fair value and cash flows from
these transactions are not material. From time to time, as market conditions
indicate, we will enter into foreign currency contracts to manage the risks
associated with anticipated future transactions and current balance sheet
positions that are in currencies other than the functional currencies of our
operations. At December 29, 2012, there were no significant open foreign
currency contracts. Much of our cash in non-U.S. entities is denominated in
foreign currencies, where fluctuations in exchange rates will impact our cash
balances in U.S. dollar terms. A hypothetical 10% change in the value of the
U.S. dollar would impact our reported cash balance by approximately
$32.4 million in 2012 and $34.0 million in 2011.
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We manage our investment risk in foreign operations by borrowing in the
functional currencies of the foreign entities where appropriate. The following
table indicates the change in the recorded value of our most significant
investments at year-end assuming a hypothetical 10% change in the value of the
U.S. Dollar.
2012 2011
(in millions)
Australian dollar $ 27.3 $ 26.7
Chinese renminbi 13.9 12.7
Canadian dollar 8.8 3.7
Euro 6.8 6.0
Brazilian real 3.3 2.5
U.K. pound 2.3 5.4
Commodity risk-Natural gas is a significant commodity used in our factories,
especially in our Coatings segment galvanizing operations, where natural gas is
used to heat tanks that enable the hot-dipped galvanizing process. Natural gas
prices are volatile and we mitigate some of this volatility through the use of
derivative commodity instruments. Our current policy is to manage this commodity
price risk for 0-50% of our U.S. natural gas requirements for the upcoming
6-12 months through the purchase of natural gas swaps based on NYMEX futures
prices for delivery in the month being hedged. The objective of this policy is
to mitigate the impact on our earnings of sudden, significant increases in the
price of natural gas. At December 29, 2012, we have open natural gas swaps for
70,000 MMBtu.
CRITICAL ACCOUNTING POLICIES
The following accounting policies involve judgments and estimates used in
preparation of the consolidated financial statements. There is a substantial
amount of management judgment used in preparing financial statements. We must
make estimates on a number of items, such as provisions for bad debts,
warranties, contingencies, impairments of long-lived assets, and inventory
obsolescence. We base our estimates on our experience and on other assumptions
that we believe are reasonable under the circumstances. Further, we re-evaluate
our estimates from time to time and as circumstances change. Actual results may
differ under different assumptions or conditions. The selection and application
of our critical accounting policies are discussed annually with our audit
committee.
Allowance for Doubtful Accounts
In determining an allowance for accounts receivable that will not ultimately
be collected in full, we consider:
º •
º age of the accounts receivable
º •
º customer credit history
º •
º customer financial information
º •
º reasons for non-payment (product, service or billing issues).
If our customer's financial condition was to deteriorate, resulting in an
impaired ability to make payment, additional allowances may be required.
Warranties
All of our businesses must meet certain product quality and performance
criteria. We rely on historical product claims data to estimate the cost of
product warranties at the time revenue is
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recognized. In determining the accrual for the estimated cost of warranty
claims, we consider our experience with:
º •
º costs to correct the product problem in the field, including labor
costs
º •
º costs for replacement parts
º •
º other direct costs associated with warranty claims
º •
º the number of product units subject to warranty claims
In addition to known claims or warranty issues, we estimate future claims on
recent sales. The key assumptions in our estimates are the rates we apply to
those recent sales (which is based on historical claims experience) and our
expected future warranty costs for products that are covered under warranty for
an extended period of time. Our provision for various product warranties was
approximately $15.3 million at December 29, 2012. If our estimate changed by
50%, the impact on operating income would be approximately $7.6 million. If our
cost to repair a product or the number of products subject to warranty claims is
greater than we estimated, then we would have to increase our accrued cost for
warranty claims.
Inventories
We use the last-in first-out (LIFO) method to determine the value
approximately 43% of our inventory. The remaining 57% of our inventory is valued
on a first-in first-out (FIFO) basis. In periods of rising costs to produce
inventory, the LIFO method will result in lower profits than FIFO, because
higher more recent costs are recorded to cost of goods sold than under the FIFO
method. Conversely, in periods of falling costs to produce inventory, the LIFO
method will result in higher profits than the FIFO method.
In 2012, we experienced lower costs to produce inventory than in the prior
year, due mainly to lower cost for steel and steel-related products. This
resulted in lower cost of goods sold (and higher operating income) in 2012 of
approximately $3.7 million, than had our entire inventory been valued on the
FIFO method. In 2011 and 2010, we experienced higher costs compared to previous
years and operating income was lower by approximately $7.0 million and
$3.0 million, respectively, than had our entire inventory been valued on the
FIFO method.
We write down slow-moving and obsolete inventory by the difference between
the value of the inventory and our estimate of the reduced value based on
potential future uses, the likelihood that overstocked inventory will be sold
and the expected selling prices of the inventory. If our ability to realize
value on slow-moving or obsolete inventory is less favorable than assumed,
additional inventory write downs may be required.
Depreciation, Amortization and Impairment of Long-Lived Assets
Our long-lived assets consist primarily of property, plant and equipment,
goodwill and intangible assets acquired in business acquisitions. We have
assigned useful lives to our property, plant and equipment and certain
intangible assets ranging from 3 to 40 years.
We identified eleven reporting units for purposes of evaluating goodwill and
we annually evaluate our reporting units for goodwill impairment during the
third fiscal quarter, which usually coincides with our strategic planning
process. We assess the value of our reporting units using after-tax cash flows
from operations (less capital expenses) discounted to present value and as a
multiple of earnings before interest, taxes, depreciation and amortization
(EBITDA). The key assumptions in the discounted cash flow analysis are the
discount rate and the projected cash flows. We also use sensitivity analysis to
determine the impact of changes in discount rates and cash flow forecasts on the
valuation of the reporting units. As allowed for under current accounting
standards, we rely on our previous valuations
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for the annual impairment testing provided that the following criteria for each
reporting unit are met: (1) the assets and liabilities that make up the
reporting unit have not changed significantly since the most recent fair value
determination and (2) the most recent fair value determination resulted in an
amount that exceeded the carrying amount of the reporting unit by a substantial
margin.
The valuation of our reporting units exceeded their respective carrying
values. Accordingly, no further valuation of our reporting units was necessary.
If our assumptions on discount rates and future cash flows change as a result of
events or circumstances, and we believe these assets may have declined in value,
then we may record impairment charges, resulting in lower profits. Our reporting
units are all cyclical and their sales and profitability may fluctuate from year
to year. In the evaluation of our reporting units, we look at the long-term
prospects for the reporting unit and recognize that current performance may not
be the best indicator of future prospects or value, which requires management
judgment.
Our indefinite-lived intangible assets consist of trade names. We assess the
values of these assets apart from goodwill as part of the annual impairment
testing. We use the relief-from-royalty method to evaluate our trade names,
under which the value of a trade name is determined based on a royalty that
could be charged to a third party for using the trade name in question. The
royalty, which is based on a reasonable rate applied against estimated future
sales, is tax-effected and discounted to present value. The most significant
assumptions in this evaluation include estimated future sales, the royalty rate
and the after-tax discount rate. For our evaluation purposes, the royalty rates
used vary between 0.5% and 1.5% of sales and the after-tax discount rate of
17.5% to 18.5%, which we estimate to be the after-tax cost of capital for such
assets. The Company's trade names were tested for impairment in the third
quarter of 2012 and the Company determined that the value of its trade names
were not impaired. In 2011, the Company determined the PiRod and Industrial
Galvanizers of America trade names were impaired. The evaluations of these trade
names were completed in the fourth quarter of 2011, which resulted in a write
down of $3.8 million.
Income Taxes
We record valuation allowances to reduce our deferred tax assets to amounts
that are more likely than not to be realized. We consider future taxable income
expectations and tax-planning strategies in assessing the need for the valuation
allowance. If we estimate a deferred tax asset is not likely to be fully
realized in the future, a valuation allowance to decrease the amount of the
deferred tax asset would decrease net earnings in the period the determination
was made. Likewise, if we subsequently determine that we are able to realize all
or part of a net deferred tax asset in the future, an adjustment reducing the
valuation allowance would increase net earnings in the period such determination
was made.
At December 29, 2012, we had approximately $161.3 million in deferred tax
assets relating mainly to operating loss and tax credit carryforwards, with a
valuation allowance of $121.0 million. As a result of a legal entity
restructuring within the Delta group in fiscal 2011, we released of a portion of
valuation allowances previously established. Prior to the legal entity
restructuring, because these tax losses were generated in the U.K. and Delta had
no operations or future income taxable in the U.K., Delta historically did not
establish a value on its financial statements for deferred tax assets associated
with net operating losses and book and tax basis differences in its pension plan
liability. Also, at December 29, 2012, $113.2 million in valuation allowances
remain in the Delta entities related to capital loss carryforwards, which are
unlikely ever to be realized. If circumstances related to our deferred tax
assets change in the future, we may be required to increase or decrease the
valuation allowance on these assets, resulting in an increase or decrease in
income tax expense and a reduction or increase in net income.
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During 2012 we recorded $0.9 million in income tax expense on $3.7 million
of undistributed earnings of foreign subsidiaries which we determined are not
permanently invested. Foreign subsidiaries not considered permanently invested
had total cash of $16.0 million at December 29, 2012. We have not made any U.S.
income tax provision in our financial statements for $586.2 million of
undistributed earnings of our foreign subsidiaries, as we intend to reinvest
those earnings. Foreign subsidiaries considered permanently invested had total
cash of $353.9 million at December 29, 2012. If circumstances change and we
determine that we are not permanently invested, we would need to record an
income tax expense on our financial statements for the resulting income tax that
would be paid upon repatriation. The amount of that income tax would depend on
how much of those earnings were repatriated but could range from a low of
$44.2 million to a high of $129.5 million.
We are subject to examination by taxing authorities in the various countries
in which we operate. The tax years subject to examination vary by jurisdiction.
We regularly consider the likelihood of additional income tax assessments in
each of these taxing jurisdictions based on our experiences related to prior
audits and our understanding of the facts and circumstances of the related tax
issues. We include in current income tax expense any changes to accruals for
potential tax deficiencies. If our judgments related to tax deficiencies differ
from our actual experience, our income tax expense could increase or decrease in
a given fiscal period.
Pension Benefits
Delta Ltd. maintains a defined benefit pension plan for qualifying employees
in the United Kingdom. There are no active employees as members in the plan.
Independent actuaries assist in properly measuring the liabilities and expenses
associated with accounting for pension benefits to eligible employees. In order
to use actuarial methods to value the liabilities and expenses, we must make
several assumptions. The critical assumptions used to measure pension
obligations and expenses are the discount rate and expected rate of return on
pension assets.
We evaluate our critical assumptions at least annually. Key assumptions are
based on the following factors:
º •
º Discount rate is based on the yields available on AA-rated corporate
bonds with durational periods similar to that of the pension
liabilities.
º •
º Expected return on plan assets is based on our asset allocation mix
and our historical return, taking into consideration current and
expected market conditions. Most of the assets in the pension plan are
invested in corporate bonds, the expected return of which are
estimated based on the yield available on AA rated corporate bonds.
The long-term expected returns on equities are based on historic
performance over the long-term.
º •
º Inflation is based on the estimated change in the consumer price index
("CPI") or the retail price index ("RPI"), depending on the relevant
plan provisions.
The following tables present the key assumptions used to measure pension expense
for 2013 and the estimated impact on 2013 pension expense relative to a change
in those assumptions:
Assumptions Pension
Discount rate 4.60 %
Expected return on plan assets 4.20 %
Inflation-CPI 2.70 %
Inflation-RPI 3.20 %
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Increase
in Pension
Assumptions In Millions of Dollars Expense
0.50% increase in discount rate $ 0.4
0.50% decrease in expected return on plan assets $ 2.6
0.50% increase in inflation $ 1.6
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required is included under the captioned paragraph, "Risk
Management" on page 38 of this report.
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