Item 1. Business
This annual report on Form 10-K (hereinafter, the “Annual Report”) contains certain statements that are “forward-looking statements” as that term is defined under the Private Securities Litigation Reform Act of 1995 (the “Act”) and releases issued by the Securities and Exchange Commission. The words “may,” “hope,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential,” “continue,” and other expressions which are predictions of or indicate future events and trends and which do not relate to historical matters, identify forward-looking statements. We believe that it is important to communicate our future expectations to our stockholders, and we, therefore, make forward-looking statements in reliance upon the safe harbor provisions of the Act. However, there may be events in the future that we are not able to accurately predict or control and our actual results may differ materially from the expectations we describe in our forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, the cyclicality and highly competitive nature of some of our end markets which can affect the overall demand for and pricing of our products, changes in the price of and demand for Oil & Gas in both domestic and international markets, any adverse changes in governmental policies, variability of raw material and component pricing, changes in our suppliers’ performance, fluctuations in foreign currency exchange rates, our ability to hire and maintain key personnel, our ability to continue operating our manufacturing facilities at efficient levels including our ability to prevent cost overruns and continue to reduce costs, our ability to generate increased cash by reducing our inventories, our prevention of the accumulation of excess inventory, our ability to successfully implement our acquisition, divestiture, restructuring, or simplification strategies, fluctuations in interest rates, our ability to continue to successfully defend product liability actions including asbestos-related claims, our ability to realize savings anticipated to result from the repositioning activities discussed herein, as well as the uncertainty associated with the current worldwide economic conditions and the continuing impact on economic and financial conditions in the United States and around the world as a result of terrorist attacks, current Middle Eastern conflicts and related matters. For a discussion of these risks, uncertainties and other factors, see Item 1A
Item 1A. Risk Factors.
Certain Risk Factors That May Affect Future Results
Set forth below are certain risk factors that we believe are material to our stockholders. If any of the following risks occur, our business, financial condition, results of operations and reputation could be harmed. You should also consider these risk factors when you read “forward-looking statements” elsewhere in this report. You can identify forward-looking statements by terms such as “may,” “hope,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of those terms or other comparable terminology. Forward-looking statements are only predictions and can be adversely affected if any of the following risks occur:
Some of our end-markets are cyclical, which may cause us to experience fluctuations in revenues or operating results.
We have experienced, and expect to continue to experience, fluctuations in revenues and operating results due to economic and business cycles. We sell our products principally to aerospace, military, commercial aircraft, pharmaceutical, medical, analytical equipment, Oil & Gas exploration, transmission and refining, power generation, chemical processing and maritime markets. Although we serve a variety of markets to avoid a dependency on any one, a significant downturn in any one of these markets could cause a material reduction in our revenues that could be difficult to offset. In addition, decreased market demand typically results in excess manufacturing capacity among our competitors which, in turn, results in pricing pressure. As a consequence, a significant downturn in our markets can result in lower profit margins.
In particular, our energy businesses are cyclical in nature as the worldwide demand for oil and gas fluctuates. When worldwide demand for oil and gas is depressed, the demand for our products used in maintenance and repair of existing oil and gas applications, as well as exploration or new oil and gas project applications, is reduced. As a result, we historically have generated lower revenues and profits in periods of declining demand for petrochemical products. Therefore, results of operations for any particular period are not necessarily indicative of the results of operations for any future period. Future downturns or anticipated downturns in demand for oil and gas products could have a material adverse effect on our business,
financial condition or results of operations. Similarly, although not to the same extent as the Oil & Gas markets, the aerospace, military, and maritime markets have historically experienced cyclical fluctuations in demand that also could have a material adverse effect on our business, financial condition or results of operations.
We face significant competition and, if we are not able to respond to competition, our revenues may decrease.
We face significant competition from a variety of competitors in each of our markets. Some of our competitors have substantially greater financial, marketing, personnel and other resources than we do. New competitors also could enter our markets. We consider product quality, performance, customer service, on-time delivery, price, distribution capabilities and breadth of product offerings to be the primary competitive factors in our markets. Our competitors may be able to offer more attractive pricing, duplicate our strategies, or develop enhancements to products that could offer performance features that are superior to our products. Competitive pressures, including those described above, and other factors could adversely affect our competitive position, involving a loss of market share or decreases in prices, either of which could have a material adverse effect on our business, financial condition or results of operations. In addition, some of our competitors are based in foreign countries and have cost structures and prices based on foreign currencies. The majority of our transactions are denominated in either U.S. dollar or Euro currency. Accordingly, currency fluctuations could cause our U.S. dollar and/or Euro priced products to be less competitive than our competitors’ products that are priced in other currencies.
If we cannot continue operating our manufacturing facilities at current or higher levels, our results of operations could be adversely affected.
We operate a number of manufacturing facilities for the production of our products. The equipment and management systems necessary for such operations may break down, perform poorly or fail, resulting in fluctuations in manufacturing efficiencies. Such fluctuations may affect our ability to deliver products to our customers on a timely basis, which could have a material adverse effect on our business, financial condition or results of operations. We have continuously enhanced and improved Lean manufacturing techniques as part of the CIRCOR Business System. We believe that this process produces meaningful reductions in manufacturing costs. However, continuous improvement of these techniques may cause short-term inefficiencies in production. If we ultimately are unable to continuously improve our processes, our results of operations may suffer.
Implementation of our acquisition, divestiture, restructuring, or simplification strategies may not be successful, which could affect our ability to increase our revenues or could reduce our profitability.
One of our continued strategies is to increase our revenues and expand our markets through acquisitions that will provide us with complementary Energy and Aerospace & Defense products and access to additional geographic markets. We expect to spend significant time and effort expanding our existing businesses and identifying, completing and integrating acquisitions. We expect to face competition for acquisition candidates that may limit the number of acquisition opportunities available to us and may result in higher acquisition prices. We cannot be certain that we will be able to identify, acquire or profitably manage additional companies or successfully integrate such additional companies without substantial costs, delays or other problems. Also, there can be no assurance that companies we acquire ultimately will achieve the revenues, profitability or cash flows, or generate the synergies upon which we justify our investment in them; as a result, any such under-performing acquisitions could result in impairment charges which would adversely affect our results of operations. In addition, acquisitions may involve a number of special risks, including: adverse effects on our reported operating results; use of cash; diversion of management’s attention; loss of key personnel at acquired companies; or unanticipated management or operational problems or legal liabilities.
We also continually review our current business and products to attempt to maximize our performance. We may in the future deem it appropriate to pursue the divestiture of product lines or businesses as conditions dictate. Any divestiture may result in a dilutive impact to our future earnings if we are unable to offset the dilutive impacts from the loss of revenue associated with the divested assets or businesses, as well as significant write-offs, including those related to goodwill and other intangible assets, which could have a material adverse effect on our results of operations and financial condition. A successful divestiture depends on various factors, including our ability to effectively transfer liabilities, contracts, facilities and employees to any purchaser, identify and separate the intellectual property to be divested from the intellectual property that we wish to retain, reduce fixed costs previously associated with the divested assets or business, and collect the proceeds from any divestitures. In addition, if customers of the divested business do not receive the same level of service from the new owners, this may adversely affect our other businesses to the extent that these customers also purchase other products offered by us. All of these efforts require varying levels of management resources, which may divert our attention from other business operations.
A recent focus of our Company is to simplify the way we are organized and the number of facilities we manage. We believe that such focus will reduce overhead structure, enhance operational synergies, and result in improved operating margins. Nevertheless,
we may not achieve expected cost savings from restructuring and simplification activities and actual charges, costs and adjustments due to such activities may vary materially from our estimates. Our ability to realize anticipated cost savings, synergies, margin improvement, and revenue enhancements may be affected by a number of factors, including the following: our ability to effectively eliminate duplicative overhead, rationalize manufacturing capacity, synchronize information technology systems, consolidate warehousing and distribution facilities and shift production to more economical facilities; significant cash and non-cash integration and implementation costs or charges in order to achieve those cost savings, which could offset any such savings; and our ability to avoid labor disruption in connection with integration efforts or divestitures.
If we do not realize the expected benefits or synergies of any acquisition, divestiture, restructuring, or simplification activities, our business, financial condition, results of operations and cash flow could be negatively impacted.
If we are unable to continue operating successfully overseas or to successfully expand into new international markets, our revenues may decrease.
We derive a significant portion of our revenue from sales outside the United States. In addition, one of our key growth strategies is to sell our products in international markets not significantly served by us in portions of Europe, Latin America and Asia. We market our products and services through direct sales, distributors, and technically trained commissioned representatives. We may not succeed in our efforts to further penetrate these markets. Moreover, conducting business outside the United States is subject to additional risks, including currency exchange rate fluctuations, changes in regional, political or economic conditions, trade protection measures such as tariffs or import or export restrictions, and unexpected changes in regulatory requirements. One or more of these factors could prevent us from successfully expanding our presence in these international markets and could also have a material adverse effect on our current international operations.
If we cannot pass on higher raw material or manufacturing costs to our customers, we may become less profitable.
One of the ways we attempt to manage the risk of higher raw material and manufacturing costs is to increase selling prices to our customers. The markets we serve are extremely competitive and customers may not accept price increases or may look to alternative suppliers, which may negatively impact our profitability and revenues.
If our suppliers cannot provide us with adequate quantities of materials to meet our customers’ demands on a timely basis or if the quality of the materials provided does not meet our standards, we may lose customers or experience lower profitability.
Some of our customer contracts require us to compensate those customers if we do not meet specified delivery obligations. We rely on numerous suppliers to provide us with our required materials and in many instances these materials must meet certain specifications. In addition, we continue to increase our dependence on lower cost foreign sources of raw materials, components, and, in some cases, completed products. Managing a geographically diverse supply base inherently poses significant logistical challenges. While we believe that we also have improved our ability to effectively manage a global supply base, a risk nevertheless exists that we could experience diminished supplier performance resulting in longer than expected lead times and/or product quality issues. The occurrence of such factors could have a negative impact on our ability to deliver products to customers within our committed time frames and could result in reductions of our operating and net income in future periods.
Our international activities expose us to fluctuations in currency exchange rates that could adversely affect our results of operations and cash flows.
Our international manufacturing and sales activities expose us to changes in foreign currency exchange rates. Such fluctuations could result in our (i) paying higher prices for certain imported goods and services, (ii) realizing lower prices for any sales denominated in currencies other than U.S. dollars, (iii) realizing lower net income, on a U.S. dollar basis, from our international operations due to the effects of translation from weakened functional currencies, and (iv) realizing higher costs to settle transactions denominated in other currencies. Any of these risks could adversely affect our results of operations and cash flows. Our major foreign currency exposures involve the markets in Western Europe, Canada, Brazil and Asia.
We may use forward contracts to help manage the currency risk related to certain business transactions denominated in foreign currencies. We primarily utilize forward exchange contracts with maturities of less than eighteen months. To the extent these transactions are completed, the contracts do not subject us to significant risk from exchange rate fluctuations because they offset gains and losses on the related foreign currency denominated transactions. However, there can be no assurances that we will be able to effectively utilize these forward exchange contracts in the future to offset significant risk related to fluctuations in currency exchange rates.
If we experience delays in introducing new products or if our existing or new products do not achieve or maintain market acceptance, our revenues may decrease.
Our industries are characterized by: intense competition; changes in end-user requirements; technically complex products; and evolving product offerings and introductions.
We believe our future success will depend, in part, on our ability to anticipate or adapt to these factors and to offer, on a timely basis, products that meet customer demands. Failure to develop new and innovative products or to custom design existing products could result in the loss of existing customers to competitors or the inability to attract new business, either of which may adversely affect our revenues. The development of new or enhanced products is a complex and uncertain process requiring the anticipation of technological and market trends. We may experience design, manufacturing, marketing or other difficulties, such as an inability to attract a sufficient number of qualified engineers, which could delay or prevent our development, introduction or marketing of new products or enhancements and result in unexpected expenses.
We depend on our key personnel and the loss of their services may adversely affect our business.
We believe that our success will depend on our ability to hire new talent and the continued employment of our senior management team and other key personnel. If one or more members of our senior management team or other key personnel were unable or unwilling to continue in their present positions, our business could be seriously harmed. In addition, if any of our key personnel joins a competitor or forms a competing company, some of our customers might choose to use the services of that competitor or those of a new company instead of our own. Other companies seeking to develop capabilities and products similar to ours may hire away some of our key personnel. If we are unable to maintain our key personnel and attract new employees, the execution of our business strategy may be hindered and our growth limited.
We face risks from product liability lawsuits that may adversely affect our business.
We, like other manufacturers, face an inherent risk of exposure to product liability claims in the event that the use of our products results in personal injury, property damage or business interruption to our customers. We may be subjected to various product liability claims, including, among others, that our products include inadequate or improper instructions for use or installation, or inadequate warnings concerning the effects of the failure of our products. Although we maintain strict quality controls and procedures, including the testing of raw materials and safety testing of selected finished products, we cannot be certain that our products will be completely free from defect. In addition, in certain cases, we rely on third-party manufacturers for our products or components of our products. Although we have liability insurance coverage, we cannot be certain that this insurance coverage will continue to be available to us at a reasonable cost or, if available, will be adequate to cover any such liabilities. For example, liability insurance typically does not afford coverage for a design or manufacturing defect unless such defect results in injury to person or property. We generally attempt to contractually limit liability to our customers to risks that are insurable but are not always successful in doing so. Similarly, we generally seek to obtain contractual indemnification from our third-party suppliers, and for us to be added as an additional insured party under such parties’ insurance policies. Any such indemnification or insurance is limited by its terms and, as a practical matter, is limited to the credit worthiness of the indemnifying or insuring party. In the event that we do not have adequate insurance or contractual indemnification, product liabilities could have a material adverse effect on our business, financial condition or results of operations.
We rely on information technology in our operations, and any material failure, inadequacy, interruption or security failure of that technology could harm our business, financial condition, results of operations and prospects.
We rely on information technology networks and systems, including the Internet, to process, transmit and store electronic information, and manage or support a variety of business processes, including financial transactions and records, personal identifying information, payroll data and workforce scheduling information. We purchase some of our information technology from vendors, on whom our systems depend. We rely on commercially available systems, software, tools and monitoring to provide security for the processing, transmission and storage of company and customer information. Although we have taken steps to protect the security of our information systems and the data maintained in those systems, it is possible that our safety and security measures will not prevent the systems' improper functioning or damage or the improper access or disclosure of personally identifiable information such as in the event of cyber-attacks. Security breaches, including physical or electronic break-ins, computer viruses, attacks by hackers and similar breaches can create system disruptions or shutdowns or the unauthorized disclosure of confidential information. If company, personal or otherwise protected information is improperly accessed, tampered with or distributed, we may incur significant costs to remediate possible injury to the affected parties and we may be subject to sanctions and civil or criminal penalties if we are found to be in violation of the privacy or security rules under federal, state, or international laws protecting confidential information. Any failure to maintain proper functionality and security of our information systems could interrupt our operations, damage our reputation, subject us to liability claims or
regulatory penalties and could have a material adverse effect on our business, financial condition, results of operations and prospects.
The trading price of our common stock continues to be volatile and investors in our common stock may experience substantial losses.
The trading price of our common stock may be, and, in the past, has been volatile. Our common stock could decline or fluctuate in response to a variety of factors, including, but not limited to: our failure to meet our performance estimates or performance estimates of securities analysts; changes in financial estimates of our revenues and operating results or buy/sell recommendations by securities analysts; the timing of announcements by us or our competitors concerning significant product line developments, contracts or acquisitions or publicity regarding actual or potential results or performance; fluctuation in our quarterly operating results caused by fluctuations in revenue and expenses; substantial sales of our common stock by our existing shareholders; general stock market conditions; or other economic or external factors. While we attempt in our public disclosures to provide forward-looking information in order to enable investors to anticipate our future performance, such information by its nature represents our good-faith forecasting efforts. In recent years, the unprecedented nature of credit and financial crises and economic recessions, together with the uncertain depth and duration of these crises, has rendered such forecasting more difficult. As a result, our actual results could differ materially from our forecasts which could cause further volatility in the value of our common stock.
For example, in recent years the stock market as a whole experienced dramatic price and volume fluctuations. In the past, securities class action litigation has often been instituted against companies following periods of volatility in the market price of their securities. This type of litigation could result in substantial costs and a diversion of management attention and resources.
If our internal control over financial reporting do not comply with the requirements of the Sarbanes-Oxley Act, our business and stock price could be adversely affected.
If either management or our independent registered public accounting firm identifies one or more material weaknesses in internal control over financial reporting that exist as of the end of our fiscal year, the material weakness(es) will be reported either by management in its self assessment or by our independent registered public accounting firm in its report or both, which may result in a loss of public confidence and could have an adverse affect on our business and our stock price. This could also result in significant additional expenditures responding to the Section 404 internal control audit and a diversion of management attention.
The costs of complying with existing or future governmental regulations on importing and exporting practices and of curing any violations of these regulations, could increase our expenses, reduce our revenues or reduce our profitability.
We are subject to a variety of laws and international trade practices including regulations issued by the United States Bureau of Industry and Security, the Department of Homeland Security, the Department of State and the Department of Treasury. We cannot predict the nature, scope or effect of future regulatory requirements to which our international trading practices might be subject or the manner in which existing laws might be administered or interpreted. Future regulations could limit the countries into which certain of our products may be sold or could restrict our access to, and increase the cost of obtaining products from, foreign sources. In addition, actual or alleged violations of such regulations could result in enforcement actions and/or financial penalties that could result in substantial costs.
Our debt agreements limit our ability to issue equity, make acquisitions, incur debt, pay dividends, make investments, sell assets, merge or raise capital.
Our revolving credit facility agreement, dated May 2, 2011, governs our indebtedness. This agreement includes provisions which place limitations on certain activities including our ability to: issue shares of our common stock; incur additional indebtedness; create any liens or encumbrances on our assets or make any guarantees; make certain investments; pay cash dividends above certain limits; or dispose of or sell assets or enter into a merger or a similar transaction.
Various restrictions and agreements could hinder a takeover of us which is not supported by our board of directors or which is leveraged.
Our amended and restated certificate of incorporation and amended and restated by-laws, as well as the Delaware General Corporation Law, contain provisions that could delay or prevent a change in control in a transaction that is not approved by our board of directors or that is on a leveraged basis or otherwise. These include provisions creating a staggered board, limiting the shareholders’ powers to remove directors, and prohibiting shareholders from calling a special meeting or taking action by
written consent in lieu of a shareholders’ meeting. In addition, our board of directors has the authority, without further action by the shareholders, to set the terms of and to issue preferred stock. Issuing preferred stock could adversely affect the voting power of the owners of our common stock, including the loss of voting control to others.
Delaying or preventing a takeover could result in our shareholders ultimately receiving less for their shares by deterring potential bidders for our stock or assets.
If we fail to manufacture and deliver high quality products, we may lose customers.
Product quality and performance are a priority for our customers since many of our product applications involve caustic or volatile chemicals and, in many cases, involve processes that require precise control of fluids. Our products are used in the aerospace, military, commercial aircraft, pharmaceutical, medical, analytical equipment, Oil & Gas exploration, transmission and refining, power generation, chemical processing and maritime industries. These industries require products that meet stringent performance and safety standards. If we fail to maintain and enforce quality control and testing procedures, our products will not meet these stringent performance and safety standards. Substandard products would seriously harm our reputation, resulting in both a loss of current customers to our competitors and damage to our ability to attract new customers, which could have a material adverse effect on our business, financial condition or results of operations.
A change in international governmental policies or restrictions could result in decreased availability and increased costs for certain components and finished products that we purchase from sources in foreign countries, which could adversely affect our profitability.
Like most manufacturers of fluid control products, we attempt, where appropriate, to reduce costs by seeking lower cost sources of certain components and finished products. Many such sources are located in developing countries such as the People’s Republic of China, India and Taiwan, where a change in governmental approach toward U.S. trade could restrict the availability to us of such sources. In addition, periods of war or other international tension could interfere with international freight operations and hinder our ability to purchase such components and products. A decrease in the availability of these items could hinder our ability to timely meet our customers’ orders. We attempt, when possible, to mitigate this risk by maintaining alternate sources for these components and products and by maintaining the capability to produce such items in our own manufacturing facilities. However, even when we are able to mitigate this risk, the cost of obtaining such items from alternate sources or producing them ourselves is often considerably greater, and a shift toward such higher cost production could therefore adversely affect our profitability.
We, along with our customers and vendors, face the uncertainty in the public and private credit markets and in general economic conditions in the United States and around the world.
In recent years there has been at times disruption and general slowdown of the public and private capital and credit markets in the United States and around the world. Such conditions can adversely affect our revenue, results of operations and overall financial growth. Our business can be affected by a number of factors that are beyond our control such as general geopolitical, economic and business conditions and conditions in the financial services market, which each could materially impact our business, financial condition, results of operations, cash flow, capital resources and liquidity. Additionally, many lenders and institutional investors, at times, have reduced funding to borrowers, including other financial institutions. Although we do not currently anticipate a need to access the credit markets for new financing in the short-term, a constriction on future lending by banks or investors could result in higher interest rates on future debt obligations or could restrict our ability to obtain sufficient financing to meet our long-term operational and capital needs or could limit our ability in the future to consummate strategic acquisitions. Any uncertainty in the credit markets could also negatively impact the ability of our customers and vendors to finance their operations which, in turn, could result in a decline in our sales and in our ability to obtain necessary raw materials and components, thus potentially having an adverse effect on our business, financial condition or results of operations.
A resurgence of terrorist activity and/or political instability around the world could cause economic conditions to deteriorate and adversely impact our businesses.
In the past, terrorist attacks have negatively impacted general economic, market and political conditions. In particular, the 2001 terrorist attacks, compounded with changes in the national economy, resulted in reduced revenues in the aerospace and general industrial markets in 2002 and 2003. Although economic conditions have improved considerably, additional terrorist acts, acts of war or political instability (wherever located around the world) could cause damage or disruption to our business, our facilities or our employees which could significantly impact our business, financial condition or results of operations. The potential for future terrorist attacks, the national and international responses to terrorist attacks, political instability, and other acts of war or hostility, including the recent and current conflicts in Iraq, Afghanistan and the Middle East, have created many economic and political uncertainties, which could adversely affect our business and results of operations in ways that cannot
presently be predicted. In addition, with manufacturing facilities located worldwide, including facilities located in the United States, Western Europe, the People’s Republic of China, Morocco, Brazil and India, we may be impacted by terrorist actions not only against the United States but in other parts of the world as well. In some cases, we are not insured for losses and interruptions caused by terrorist acts and acts of war.
The costs of complying with existing or future environmental regulations and curing any violations of these regulations could increase our expenses or reduce our profitability.
We are subject to a variety of environmental laws relating to the storage, discharge, handling, emission, generation, use and disposal of chemicals, solid and hazardous waste and other toxic and hazardous materials used to manufacture, or resulting from the process of manufacturing, our products. We cannot predict the nature, scope or effect of future regulatory requirements to which our operations might be subject or the manner in which existing or future laws will be administered or interpreted. Future regulations could be applied to materials, products or activities that have not been subject to regulation previously. The costs of complying with new or more stringent regulations, or with more vigorous enforcement of these or existing regulations could be significant.
Environmental laws require us to maintain and comply with a number of permits, authorizations and approvals and to maintain and update training programs and safety data regarding materials used in our processes. Violations of these requirements could result in financial penalties and other enforcement actions. We also could be required to halt one or more portions of our operations until a violation is cured. Although we attempt to operate in compliance with these environmental laws, we may not succeed in this effort at all times. The costs of curing violations or resolving enforcement actions that might be initiated by government authorities could be substantial.
New regulations related to “conflict minerals” may cause us to incur additional expenses and could limit the supply and increase the cost of certain metals used in manufacturing our products.
On August 22, 2012, the SEC adopted a new rule requiring disclosures by public companies of specified minerals, known as conflict minerals, that are necessary to the functionality or production of products manufactured or contracted to be manufactured. The new rule, became effective for 2013 and requires a disclosure report to be filed by May 31, 2014, requires companies to perform due diligence, disclose and report whether or not such minerals originate from the Democratic Republic of Congo or an adjoining country. The new rule could affect sourcing at competitive prices and availability in sufficient quantities of certain minerals used in the manufacture of our products, including tantalum, tin, gold and tungsten. The
number of suppliers who provide conflict-free minerals may be limited. In addition, there may be material costs associated with complying with the disclosure requirements, such as costs related to determining the source of certain minerals used in our products, as well as costs of possible changes to products, processes, or sources of supply as a consequence of such verification activities. As our supply chain is complex, we may not be able to sufficiently verify the origins of the relevant minerals used in our products through the due diligence procedures that we implement, which may harm our reputation. In addition, we may encounter challenges to satisfy those customers who require that all of the components of our products be certified as conflict-free, which could place us at a competitive disadvantage if we are unable to do so.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
We maintain 20 major manufacturing facilities worldwide, including operations located in the United States, Western Europe, Morocco, India, Brazil and the People’s Republic of China. We also maintain sales offices or warehouses from which we ship finished goods to customers, distributors and commissioned representative organizations. Our executive office is located in Burlington, Massachusetts and is leased.
Our Energy segment has major manufacturing facilities located in the United States, Italy, the United Kingdom, Brazil, Germany, India, the Netherlands and the People’s Republic of China. Properties in Nerviano, Italy and Spartanburg, South Carolina are leased. Our Aerospace & Defense segment has major manufacturing facilities located in the United States, France, the United Kingdom and Morocco. Properties in Hauppauge, New York, Corona, California and Cambridge, United Kingdom are leased.
In general, we believe that our properties, including machinery, tools and equipment, are in good condition, are well maintained, and are adequate and suitable for their intended uses. Our manufacturing facilities generally operate five days per week on one or two shifts. We believe our manufacturing capacity could be increased by working additional shifts and weekends and by successful implementation of our on-going Lean manufacturing initiatives. We believe that our current facilities in mature markets will meet our near-term production requirements without the need for additional facilities.
Item 3.
Item 3. Legal Proceedings.
During the third quarter of 2011, we commenced arbitration proceedings against T.M.W. Corporation (“TMW”), the seller from which we acquired the assets of Castle Precision Industries in August 2010, seeking to recover damages from TMW for breaches of certain representations and warranties made by TMW in the Asset Purchase Agreement dated August 3, 2010 relative to such acquisition. On January 24, 2014 we reached a settlement on the TMW arbitration where it was agreed that TMW would waive all rights to amounts due from us under a contingent consideration promissory note established at the time of acquisition, resulting in a gain of approximately $2.2 million during the first quarter of 2014.
In late 2013 our former parent, Watts Water Technologies, Inc. (“Watts”), notified us of a claim in the approximate aggregate amount of $4.2 million. In its claim Watts contends, pursuant to the Distribution Agreement dated October 1, 1999 which governed the spinoff of CIRCOR from Watts, that we are partially responsible for retrospective insurance premium adjustments and deductibles paid by Watts to insurers under certain legacy insurance policies that covered both Watts and CIRCOR subsidiaries prior to our 1999 spinoff. The claim also includes both interest paid to insurers as well as attorneys’ fees spent by Watts in disputing its contractual obligations. We are vigorously contesting this claim and believe that any resolution of this matter will not have a material adverse effect on our financial condition or results of operations.
Asbestos-related product liability claims continue to be filed against two of our subsidiaries-Spence Engineering Company, Inc. (“Spence”), the stock of which we acquired in 1984; and Circor Instrumentation Technologies, Inc. (f/k/a Hoke Incorporated) (“Hoke”), the stock of which we acquired in 1998. Due to the nature of the products supplied by these entities, the markets they serve and our historical experience in resolving these claims, we do not believe that these asbestos-related claims will have a material adverse effect on the financial condition, results of operations or liquidity of Spence or Hoke, or our financial condition, consolidated results of operations or liquidity of the Company.
We are currently involved in various other legal claims and legal proceedings, some of which may involve substantial dollar amounts. Periodically, we review the status of each significant matter and assess our potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and the determination as to whether an exposure can be reasonably estimated. Because of uncertainties related to these matters, accruals are based on the best information available at the time. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material adverse effect on our business, results of operations and financial position.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
Part II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “CIR.” Quarterly share prices and dividends declared and paid are incorporated herein by reference to Note 18 to the consolidated financial statements included in this Annual Report.
Our board of directors is responsible for determining our dividend policy. Although we currently intend to continue paying quarterly cash dividends, the timing and level of such dividends will necessarily depend on our board of directors’ assessments of earnings, financial condition, capital requirements and other factors, including restrictions, if any, imposed by our lenders.
See “Liquidity and Capital Resources” under the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further information.
As of February 14, 2014, there were 17,611,451 shares of our common stock outstanding and we had 70 holders of record of our common stock. We believe the number of beneficial owners of our common stock was substantially greater on that date.
Set forth below is a table and line graph comparing the percentage change in the cumulative total stockholder return on the Company’s common stock, based on the market price of the Company’s common stock with the total return of companies included within the Standard & Poor’s 500 Composite Index and both a current and former peer group of companies engaged in the valve, pump, fluid control and related industries for the five-year period commencing December 31, 2008 and ending December 31, 2013. The calculation of total cumulative return assumes a $100 investment in the Company’s common stock, the Standard & Poor’s 500 Composite Index and the peer groups on December 31, 2008 and the reinvestment of all dividends. The historical information set forth below is not necessarily indicative of future performance.
During early 2013, two of the companies previously listed in our peer group (Gardner Denver Inc. and Robbins & Meyers, Inc.) were acquired and ceased to be publicly listed. As a result, we engaged in an analysis to determine our most appropriate peer group. This analysis considered several factors including similarities in end markets, product lines, geographic coverage, and overlapping investment analyst coverage. Consequently, we have determined that the most appropriate peer group consists of those companies denominated below as “Current Peer Group.”
Item 6.
Item 6. Selected Financial Data.
The following table presents certain selected financial data that has been derived from our audited consolidated financial statements and related notes and should be read along with the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and notes included in this Annual Report.
The consolidated statements of income and consolidated statements of cash flows data for the years ended December 31, 2013, 2012 and 2011, and the consolidated balance sheet data as of December 31, 2013 and 2012 are derived from, and should be read in conjunction with, our audited consolidated financial statements and the related notes included in this Annual Report. The consolidated statements of income and consolidated statements of cash flows data for the years ended December 31, 2010 and 2009, and the consolidated balance sheet data as of December 31, 2011, 2010 and 2009, are derived from our audited consolidated financial statements not included in this report.
Selected Financial Data
(In thousands, except per share data)
(1)
The statement of income data for the year ended December 31, 2013 includes inventory restructuring charges of $0.6 million, impairment charges of $6.9 million relating to indefinite lived intangible assets, and special charges, net of recoveries of $8.6 million. See Notes to consolidated Financial statements No. 4 & No. 7 for additional details. The statement of income data for the year ended December 31, 2012 includes inventory restructuring of $4.2 million, impairment charges of $10.3 million, and special charges of $5.3 million. No special or impairment charges were included in the statement of income data for the years ended December 31, 2011 and 2010. The statement of income data for the year ended December 31, 2009 includes special recoveries of $1.7 million relating to a 2007 asset sale within our Energy segment and impairment charges of $0.5 million consisting of the impairment of two trade names. The statement of income data for the years ended December 31, 2011, 2010, and 2009 include Leslie asbestos and bankruptcy costs of $0.7 million, $32.8 million, and $54.1 million, respectively, primarily within our Energy segment.
(2)
Includes capital leases obligations of: $0.3 million, $0.5 million, $0.6 million, $0.4 million and $0.6 million as of December 31, 2013, 2012, 2011, 2010 and 2009, respectively.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This annual report on Form 10-K (hereinafter, the “Annual Report”) contains certain statements that are “forward-looking statements” as that term is defined under the Private Securities Litigation Reform Act of 1995 (the “Act”) and releases issued by the SEC. The words “may,” “hope,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential,” “continue,” and other expressions which are predictions of or indicate future events and trends and which do not relate to historical matters, identify forward-looking statements. We believe that it is important to communicate our future expectations to our stockholders, and we, therefore, make forward-looking statements in reliance upon the safe harbor provisions of the Act. However, there may be events in the future that we are not able to accurately predict or control and our actual results may differ materially from the expectations we describe in our forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, the cyclicality and highly competitive nature of some of our end- markets which can affect the overall demand for and pricing of our products, changes in the price of and demand for Oil & Gas in both domestic and international markets, any adverse changes in governmental policies, variability of raw material and component pricing, changes in our suppliers’
performance, fluctuations in foreign currency exchange rates, our ability to hire and maintain key personnel, our ability to continue operating our manufacturing facilities at efficient levels including our ability to prevent cost overruns and continue to reduce costs, our ability to generate increased cash by reducing our inventories, our prevention of the accumulation of excess inventory, our ability to successfully implement our acquisition, divestiture, restructuring, or simplification strategies, fluctuations in interest rates, our ability to continue to successfully defend product liability actions including asbestos-related claims, as well as the uncertainty associated with the current worldwide economic conditions and the continuing impact on economic and financial conditions in the United States and around the world as a result of terrorist attacks, current Middle Eastern conflicts and related matters. For a discussion of certain of these risks, uncertainties and other factors, see Item 1A "Risk Factors." We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
Company Overview
CIRCOR International, Inc. designs, manufactures and markets valves and other highly engineered products and sub-systems used in the Oil & Gas, power generation, aerospace, defense and industrial markets. Within our major product groups, we develop, manufacture, sell and service a portfolio of fluid-control products, sub-systems and technologies that enable us to fulfill our customers’ unique fluid-control application needs.
During the fourth quarter of 2013 we changed our organizational structure to simplify the way the Company is managed and better align our business with our end markets. As part of this organizational change, the Company announced that it would consolidate its segment and reporting structure from three to two. The first segment is Energy, which will include all of the businesses from the existing Energy segment and a majority of the former ‘Flow Technologies’ businesses. The primary markets served in the new Energy segment are Oil & Gas: upstream, mid-stream and downstream; as well as the global power generation market. The second segment is Aerospace & Defense, which will include all of the former Aerospace segment businesses plus the UK-based defense-oriented businesses from the former Flow Technologies segment.
Regarding our 2013 results, we had consolidated revenues of $857.8 million, with Energy representing 77% of total revenue and Aerospace & Defense representing 23%. Operating income increased 49% to $69.2 million inclusive of 2013 and 2012 inventory restructuring, impairment, and special charges of $16.1 million and $19.8 million respectively, which are associated with productivity benefits we expect to realize through 2014. Cash flow provided by operating activities for 2013 was $72.2 million.
As we look to 2014, we expect the North American and emerging markets to improve modestly and Europe to experience slow growth, with the exception of North Sea activities. We believe that there will be improved growth in most of the Energy markets we serve specifically the power generation markets within Asia, and we believe Aerospace & Defense markets will experience modest growth. We intend to continue focusing on both organic and acquisition growth opportunities and investing in technologies that help to solve our customers’ problems. Attracting and retaining talented personnel, including the development of a global operations and supply chain management organization, will be an important part of our strategy during 2014. In addition we expect to further simplify CIRCOR and improve Operational Excellence by aligning people, processes and technology and reducing complexity, facilities and suppliers. We believe our cash flow from operations and financing capacity is adequate to support these activities.
Basis of Presentation
All significant intercompany balances and transactions have been eliminated in consolidation. Certain prior period financial statement amounts have been reclassified to conform to currently reported presentations. We monitor our business in two segments: Energy and Aerospace & Defense.
We operate and report financial information using a 52-week fiscal year ending December 31. The data periods contained within our Quarterly Reports on Form 10-Q reflect the results of operations for the 13-week, 26-week and 39-week periods which generally end on the Sunday nearest the calendar quarter-end date.
Critical Accounting Policies
The following discussion of accounting policies is intended to supplement the section “Summary of Significant Accounting Policies” presented in Note 2 to our consolidated financial statements. These policies were selected because they are broadly applicable within our operating units. The expenses and accrued liabilities or allowances related to certain of these policies are initially based on our best estimates at the time of original entry in our accounting records. Adjustments are recorded when our actual experience, or new information concerning our expected experience, differs from underlying initial estimates. These adjustments could be material if our actual or expected experience were to change significantly in a short period of time. We
make frequent comparisons of actual experience and expected experience in order to mitigate the likelihood of material adjustments.
There have been no significant changes from the methodology applied by management for critical accounting estimates previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.
Revenue Recognition
Revenue is recognized when products are delivered, title and risk of loss have passed to the customer, persuasive evidence of an arrangement exists, no significant post-delivery obligations remain, the price to the buyers is fixed or determinable and collection of the resulting receivable is reasonably assured. We have limited long-term arrangements with customers, representing less than 1% of our revenue, requiring delivery of products or services over extended periods of time and revenue and profits on certain of these arrangements are recognized in accordance with the percentage of completion method of accounting. Shipping and handling costs invoiced to customers are recorded as components of revenues and the associated costs are recorded as cost of revenues.
Allowance for Inventory
We typically analyze our inventory aging and projected future usage on a quarterly basis to assess the adequacy of our inventory allowances. We provide inventory allowances for excess, slow-moving, and obsolete inventories determined primarily by estimates of future demand. The allowance is measured on an item-by-item basis determined based on the difference between the cost of the inventory and estimated market value. The provision for inventory allowance is a component of our cost of revenues. Assumptions about future demand are among the primary factors utilized to estimate market value. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.
Our net inventory balance was $199.4 million as of December 31, 2013, compared to $198.0 million as of December 31, 2012. Our inventory allowance as of December 31, 2013 was $21.3 million, compared to $22.3 million as of December 31, 2012. Our provision for inventory obsolescence was $5.1 million, $8.3 million, and $4.2 million, for 2013, 2012, and 2011, respectively. Included in the inventory obsolescence charge for the twelve months ended December 31, 2013 is $0.3 million and $0.4 million of restructuring related inventory obsolescence charges for the Energy and Aerospace & Defense segments, respectively. We believe our inventory allowances remain adequate with the net realizable value of our inventory being higher than our current inventory cost after allowance.
If there were to be a sudden and significant decrease in demand for our products, significant price reductions, or if there were a higher incidence of inventory obsolescence for any reason, including a change in technology or customer requirements, we could be required to increase our inventory allowances and our gross profit could be adversely affected.
Inventory management remains an area of focus as we balance the need to maintain adequate inventory levels to ensure competitive lead times against the risk of excess or obsolete inventory.
Penalty Accruals
Some of our customer agreements, primarily in our project related businesses and large aerospace programs, contain late shipment penalty clauses whereby we are contractually obligated to pay consideration to our customers if we do not meet specified shipment dates. The accrual for estimated penalties is shown as a reduction of revenue and is based on several factors including historical customer settlement experience and management’s assessment of specific shipment delay information. Accruals related to these potential late shipment penalties as of December 31, 2013 and 2012 were $10.3 million and $8.6 million, respectively. As we conclude performance under these agreements, the actual amount of consideration paid to our customers may vary from the amounts we currently have accrued.
Concentrations of Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and trade receivables. A significant portion of our revenue and receivables are from customers who are either in or service the energy, aerospace and industrial markets. We perform ongoing credit evaluations of our customers and maintain allowances for potential credit losses. During 2013, 2012, and 2011, the Company did not experience any significant losses related to the collection of our accounts receivable. For the years ended December 31, 2013, 2012 and 2011, we had no customers from which we derived revenues that exceeded 5% of our consolidated revenues.
Acquisition Accounting
In connection with our acquisitions, we assess and formulate a plan related to the future integration of the acquired entity. This process begins during the due diligence phase and is concluded within twelve months of the acquisition. We account for business combinations under the purchase method, and accordingly, the assets and liabilities of the acquired businesses are recorded at their estimated fair value on the acquisition date with the excess of the purchase price over their estimated fair value recorded as goodwill. We determine acquisition related asset and liability fair values through established valuation techniques for industrial manufacturing companies and utilize third party valuation firms to assist in the valuation of certain tangible and intangible assets.
Legal Contingencies
We are currently involved in various legal claims and legal proceedings, some of which may involve substantial dollar amounts. Periodically, we review the status of each significant matter and assess our potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and the determination as to whether an exposure can be reasonably estimated. Because of uncertainties related to these matters, accruals are based on the best information available at the time. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material adverse effect on our business, results of operations and financial position. For more information related to our outstanding legal proceedings, see “Contingencies, Commitments and Guarantees” in Note 14 of the accompanying consolidated financial statements as well as “Legal Proceedings” in Part I, Item 3 hereof.
Impairment Analysis
In accordance with Accounting Standard Codification ("ASC") 350, Intangibles-Goodwill and Other, we utilize each of our operating segments as our goodwill reporting units as we have discrete financial information that is regularly reviewed by operating segment management and the businesses within each segment have similar economic characteristics. For the year-ended December 31, 2013, the Company’s two reporting units were Energy and Aerospace & Defense with respective goodwill balances of $52.9 million and $22.9 million.
Goodwill is measured as the excess of the cost of acquisition over the sum of the amounts assigned to identifiable tangible and intangible assets acquired less liabilities assumed. Goodwill and indefinite-lived intangible assets are recorded at cost; intangible assets with definitive lives are amortized over their useful lives. For goodwill and intangible assets with indefinite lives, we perform an impairment assessment at the reporting unit level on an annual basis as of the end of our October month end or more frequently if circumstances warrant. Our annual impairment assessment is a two-step process. The first step requires a comparison of the implied fair value of each of our reporting units to the respective carrying value. If the carrying value of a reporting unit is higher than its fair value, there is an indication that impairment may exist and the second step of the evaluation must be performed. In the second step, the potential impairment is calculated by comparing the implied fair value of the reporting unit’s goodwill with the carrying value of the goodwill. If the carrying value of the reporting unit’s goodwill is greater than the implied fair value of its goodwill, an impairment loss will be recognized for the excess.
Determining the fair value of a reporting unit is subjective and requires the use of significant estimates and assumptions. With the assistance of an independent third-party appraisal firm, we estimate the fair value of our reporting units using an income approach based on the present value of future cash flows. We believe this approach yields the most appropriate evidence of fair value. We also utilize the comparable company multiples method and market transaction fair value method to validate the fair value amount we obtain using the income approach. The key assumptions utilized in our discounted cash flow model include our estimates of future cash flows from operating activities offset by estimated capital expenditures of the reporting unit, the estimated terminal value for each reporting unit, a discount rate based on a weighted average cost of capital, overall economic conditions, and our assessment of our current market capitalization. Any unfavorable material changes to these key assumptions could potentially impact our fair value determinations. As discussed elsewhere in this Form 10-K regarding risks and other factors that may cause our results to vary materially, some of our end markets are cyclical and we face significant competition. As such, we may experience fluctuations in revenues and operating results resulting in the non-achievement of our estimated growth rates, operating performance and working capital estimates utilized in our discounted cash flow models.
In fiscal year 2013 when we performed our step one analysis, the fair value of each of our reporting units exceeded the respective carrying amount, and no goodwill impairments were recorded. The fair values utilized for our 2013 goodwill assessment exceeded the carrying amounts by approximately 283% and 95% for our Energy and Aerospace & Defense reporting units, respectively. The growth rate assumptions utilized were consistent with growth rates within the markets that
we serve. Actual 2013 results were substantially consistent overall with estimates and assumptions made for purposes of our goodwill impairment analysis performed in October. If our results significantly vary from our estimates, related projections, or business assumptions in the future due to changes in industry or market conditions, we may be required to record impairment charges. By way of example, a 10% reduction in our Aerospace & Defense reporting unit projected cash flows would not result in the fair value being lower than the carrying value.
The goodwill recorded on the consolidated balance sheet as of December 31, 2013 was $75.9 million compared with $77.4 million as of December 31, 2012 with the only change being due to foreign currency fluctuations. Net intangible assets as of December 31, 2013 were $35.7 million compared to $45.2 million as of December 31, 2012. The total amount of non-amortizing assets, net of impairment was $17.0 million and $23.6 million, as of December 31, 2013 and 2012, respectively.
Indefinite-lived intangible assets, such as trade names, are generally recorded and valued in connection with a business acquisition. These assets are reviewed at least annually for impairment, or more frequently if facts and circumstances warrant. We also utilized a fair value calculation to evaluate these assets.
See Notes 2 and 7 of the accompanying consolidated financial statements for further information on our goodwill and annual impairment analysis.
Income Taxes
Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance. Our effective tax rates differ from the statutory rate due to the impact of research and development ("R&D") tax credits, domestic manufacturing deduction, state taxes and the tax impact of non-U.S. operations. Our effective tax rate was 26.4%, 26.2%, and 27.0% for the fiscal years ended December 31, 2013, 2012 and 2011, respectively.
For 2014, we expect an effective income tax rate of approximately 28.0%, which excludes any potential R&D benefit. On January 2, 2013, the President of the United States signed legislation that retroactively extended the R&D tax credit for two years, from January 1, 2012 through December 31, 2013. Furthermore, the Company utilized the 2013 R&D credit in 2013. Accordingly, the Company recorded the entire benefit of the R&D tax credit attributable to 2012 during 2013. Our future effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates and vice versa or if the R&D credit is not extended in future years. Changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws or interpretations thereof may also adversely affect our future effective tax rate. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.
Deferred tax assets and liabilities are determined based upon the differences between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates that will be in effect when these differences reverse. Valuation allowances are provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
In 2013, net deferred income tax assets decreased compared to 2012, primarily due to utilization of deferred tax assets of our Italian subsidiary. We maintained a total valuation allowance of $13.9 million and $13.5 million at December 31, 2013 and December 31, 2012, respectively, for deferred income tax assets due to uncertainties related to our ability to utilize these assets. Such deferred income tax assets consist of certain foreign tax credits, foreign deferred tax assets, state net operating losses, and state tax credits carried forward. The valuation allowance is based on estimates of taxable income in each of the jurisdictions in which we operate and the period over which our deferred tax assets will be recoverable. If market conditions improve and future results of operations exceed our current expectations, our existing tax valuation allowances may be adjusted, resulting in future tax benefits. Alternatively, if market conditions deteriorate or future results of operations are less than expected, future assessments may result in a determination that some or all of the deferred tax assets are not realizable. Consequently, we may need to establish additional tax valuation allowances for all or a portion of the gross deferred tax assets, which may have a material adverse effect on our results of operations and financial condition. The Company has had a history of domestic and foreign taxable income, is able to avail itself of federal tax carryback provisions, has future taxable temporary differences and projects future domestic and foreign taxable income. We believe that after considering all of the available objective evidence, it is more likely than not that the results of future operations will generate sufficient taxable income to realize the remaining net deferred tax assets.
Except for the Company’s Dutch subsidiary, undistributed earnings of foreign subsidiaries are generally considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal and state income taxes has been recorded. No provision is required for the undistributed earnings of the Dutch subsidiary.
It is the Company’s policy to record estimated interest and penalties as income tax expense and tax credits as a reduction in income tax expense. The Company recognizes both interest and penalties as part of the income tax provision. As of December 31, 2013 and December 31, 2012, accrued interest and penalties were $0.7 million and $0.9 million, respectively.
As of December 31, 2013, the liability for uncertain income tax positions was $1.6 million excluding interest of $0.7 million. Due to the high degree of uncertainty regarding the timing of potential future cash flows associated with these liabilities, we are unable to make a reasonably reliable estimate of the amount and period in which these liabilities might be paid.
Pension Benefits
We maintain two pension benefit plans, a qualified noncontributory defined benefit plan and a nonqualified, noncontributory defined benefit supplemental plan that provides benefits to certain former highly compensated officers and employees. To date, the supplemental plan remains an unfunded plan. These plans include significant pension benefit obligations which are calculated based on actuarial valuations. Key assumptions are made in determining these obligations and related expenses, including expected rates of return on plan assets and discount rates. Benefits are based primarily on years of service and employees’ compensation.
As of July 1, 2006, in connection with a revision to our retirement plan, we froze the pension benefits of our qualified noncontributory plan participants. Under the revised plan, such participants generally do not accrue any additional benefits under the defined benefit plan after July 1, 2006 and instead receive enhanced benefits associated with our defined contribution 401(k) plan in which substantially all of our U.S. employees are eligible to participate.
As required in the recognition and disclosure provisions of ASC Topic 715, Compensation - Retirement Benefits, the Company recognizes the over-funded or under-funded status of defined benefit post-retirement plans in its balance sheet, measured as the difference between the fair value of plan assets and the benefit obligation (the projected benefit obligation for pension plans and the accumulated post-retirement benefit obligation for other post-retirement plans). The change in the funded status of the plan is recognized in the year in which the change occurs through other comprehensive income. These provisions also require plan assets and obligations to be measured as of the Company’s balance sheet date. See Note 13 of the accompanying consolidated financial statements for further information on our benefit plans.
Assets of our qualified pension plan are comprised of equity investments of companies in the United States with large and small market capitalizations, fixed income securities issued by the United States government, or its agencies, and certain international equities. There are no shares of our common stock in the plan assets.
The expected long-term rate of return on plan assets used to estimate pension expenses was 7.00% for 2013 and 2012. For the qualified plan, the discount rate used to estimate the net pension expense was 4.70% for 2013 and 3.85% for 2012. For the nonqualified plan, the discount rate used to estimate the net pension expenses for 2013 was 4.30% and for 2012 was 3.35%.
Unrecognized actuarial gains and losses in excess of the 10% corridor (defined as the threshold above which gains or losses need to be amortized) are being recognized over approximately a twenty-six year period for the qualified plan, and a twenty year period for the nonqualified plan, which represents the weighted average expected remaining life of the employee group. Unrecognized actuarial gains and losses arise from several factors including experience and assumption changes in the obligations and from the difference between expected returns and actual returns on plan assets.
The fair value of our defined benefit plans’ assets at December 31, 2013 was less than the estimated projected benefit obligations. The fair value of plan assets increased $4.7 million to $38.3 million as of December 31, 2013. The Company’s net pension liability decreased $9.6 million to $9.5 million as of December 31, 2013. See Note 13 of the accompanying consolidated financial statements for further information on our benefit plans.
During 2013, we made $1.6 million in cash contributions to our qualified defined benefit pension plan and $0.4 million of cash payments for our non-qualified supplemental plan. In 2014, we expect to make voluntary cash contributions of approximately $1.6 million to our qualified plan and $0.4 million in payments for our non-qualified plan, although global capital market and interest rate fluctuations and other future funding requirements may impact cash contribution amounts.
We will continue to evaluate our expected long-term rates of return on plan assets and discount rates at least annually and make adjustments as necessary; such adjustments could change the pension and post-retirement obligations and expenses in the future. If the actual operation of the plans differ from the assumptions, additional contributions by us may be required. If we are
required to make significant contributions to fund the defined benefit plans, reported results could be adversely affected and our cash flow available for other uses may be reduced.
Results of Operations for the Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012
The following tables set forth the results of operations, percentage of net revenue and the period-to-period percentage change in certain financial data for the years ended December 31, 2013 and December 31, 2012:
Net Revenues
Net revenues for the year ended December 31, 2013 increased by $12.3 million, or 1%, to $857.8 million from $845.6 million for the year ended December 31, 2012. The change in net revenues for the year ended December 31, 2013 was attributable to the following:
Our Energy segment accounted for 77% of net revenues for the year ended December 31, 2013 compared to 78% for the year ended December 31, 2012 with the Aerospace & Defense segment accounting for the remainder.
Energy segment revenues increased slightly, for the year ended December 31, 2013 compared to the same period in 2012. The increase was primarily driven by a favorable foreign currency impact of $3.7 million partially offset by organic declines. Organic revenue decreases of 4% in the North American short-cycle business driven in large part by lower rig counts year over year, were partially offset by increases in large international projects (4%). Increased shipments from our power group and instrumentation and sampling businesses were offset by lower shipments from our Brazilian business. Energy segment orders decreased $22.5 million (3%) to $691.7 million for the twelve months ended December 31, 2013 compared to $714.2 million for the same period in 2012, primarily due to lower North American short-cycle orders (4%) driven in large part by lower rig counts in North America and higher inventory levels at our distribution customers partially offset by higher orders from our instrumentation and sampling business (1%).
Aerospace & Defense segment revenues increased by $10.7 million (6%) for the year ended December 31, 2013 compared to the same period in 2012 primarily as a result of organic increases of $10.1 million plus favorable foreign currency fluctuations of $0.6 million. The organic increases were primarily due to higher sales across most of our businesses as we began delivering products for our new programs. Aerospace & Defense orders remained consistent at $189.6 million for the twelve months ended December 31, 2013 and the same period in 2012.
Operating Income (Loss)
The change in operating income (loss) for the year ended December 31, 2013 compared to the year ended December 31, 2012 was as follows:
Inventory restructuring, impairment, and special charges for the twelve months ended December 31, 2013 and December 31, 2012 were as follows:
Impairment Charges
During fourth quarter of 2013, in connection with a change to our organizational structure to simplify the way the Company is managed as well as other evolving business factors, we determined that certain Aerospace & Defense trade name intangible assets had no future usage and should be impaired. This resulted in an indefinite-lived intangible asset impairment charge during the year ended December 31, 2013 of $6.9 million.
During the year ended December 31, 2012 we recorded intangible asset impairment charges of $2.2 million and $8.2 million for the Energy and Aerospace & Defense segments, respectively. These impairment charges were primarily a result of restructuring activities at operations in Brazil and California.
See Note 7 to the consolidated financial statements for further information on impairment of intangible assets.
Special Charges / (Recoveries)
During the twelve months ended December 31, 2013 we incurred $8.6 million of special charges, net of recoveries. These charges of $5.4 million and $5.2 million for the Energy and Aerospace & Defense segments, respectively, were associated with restructuring actions that were announced in both 2013 and 2012. In addition we incurred $1.1 million of Corporate special compensation-related charges associated with the retirement of our former CFO. These special charges were offset by special recoveries associated with an arbitration recovery of $3.2 million in the Energy segment. For additional information on the special charges (recoveries) net, see note 4 of the accompanying consolidated financial statements.
During the twelve months ended December 31, 2012 we incurred $5.3 million in special charges; $2.5 million associated with our 2012 Announced Restructuring and $2.7 million associated with the separation of our former CEO.
Operating income increased 49%, or $22.6 million, to $69.2 million for the year ended December 31, 2013 compared to $46.5 million for the same period in 2012.
Operating income for our Energy segment increased $23.0 million, or 34%, to $90.8 million for the year ended December 31, 2013 compared to the same period in 2012. The increase in operating income was primarily driven by higher organic increases of $19.3 million, favorable foreign currency impacts of $1.1 million and lower inventory restructuring, impairment, and special charges of $2.6 million in 2013 compared to 2012. Operating margins improved 340 basis points to 13.7% on essentially flat revenue growth. Organic operating margins increased 280 basis points primarily driven by higher shipments and favorable pricing within our large international project business (approximately 290 basis points) and power businesses (approximately 90 basis points). These organic increases were partially offset by decreased revenue in the North American short cycle market (approximately 100 basis points) driven primarily by lower rig counts year over year.
Operating income for the Aerospace & Defense segment increased $1.4 million, or 29%, to $6.2 million for the year ended December 31, 2013 compared to the same period in 2012. Operating income improved primarily due to $2.1 million of operational improvements offset by higher inventory restructuring, impairment, and special charges of $0.5 million in 2013 compared to 2012. Organically operating income increased $1.0 million primarily due to increased shipments in our UK-based defense businesses, productivity from restructuring actions, partially offset by increased new program development and start- up costs and factory reorganization costs associated with landing gear production.
Corporate operating expenses increased $1.8 million, or 7%, to $27.8 million, for the year ended December 31, 2013 compared to the same period in 2012, primarily due to higher incentive and share based compensation and professional fees partially offset by lower special charges.
Interest Expense, Net
Interest expense, net, decreased $1.1 million to $3.2 million for the year ended 2013 compared to $4.3 million for the year ended December 31, 2012. This decrease in interest expense was primarily due to lower interest charges from lower international borrowings.
Other Expense, Net
Other expense, net, was $2.0 million for the year ended December 31, 2013 compared to $0.5 million in the same period of 2012 due largely as a result of unfavorable foreign exchange expenses associated with the remeasurement of foreign currency balances.
Provision for Income Taxes
The effective tax rate was 26.4% for the year ended December 31, 2013 compared to 26.2% for the same period of 2012. The primary driver of the lower 2012 tax rate was higher foreign source income which is taxed at a lower rate than U.S. income.
Net Income
Net income increased $16.3 million to $47.1 million for the year ended December 31, 2013, compared to $30.8 million for the same period in 2012.
Results of Operations for the Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011
The following tables set forth the results of operations, percentage of net revenue and the period-to-period percentage change in certain financial data for the years ended December 31, 2012 and December 31, 2011:
Net Revenue
Net revenues for the year ended December 31, 2012 increased by $23.2 million, or 3%, to $845.6 million from $822.3 million for the year ended December 31, 2011. The change in net revenues for the year ended December 31, 2012 was attributable to the following:
Our Energy segment accounted for 78% of net revenues for the year ended December 31, 2012 compared to 75% for the year ended December 31, 2011.
Energy segment revenues increased by $38.7 million, or 6%, for the year ended December 31, 2012 compared to the same period in 2011. The increase was primarily driven by $55 million (9%) of organic growth across most markets with large increases in the short-cycle North American market (6%), large international project shipments (2%), and Brazil (1%), partially offset by lower pipeline shipments (1%). In addition, this year over year increase was due to $1.5 million in additional revenue from the first quarter 2011 acquisition of Valvulas S.F. Industria e Comercio Ltda. (“SF Valves”) located in Brazil. Partially offsetting the increase was unfavorable foreign currency fluctuations of $17.9 million (3%). Orders for this segment increased $93.5 million to $714.2 million for the year ended December 31, 2012 compared to $620.6 million for the year ended December 31, 2011 primarily due to improvements in North American short-cycle orders and large international projects. Backlog for our Energy segment has increased $46.3 million to $266.0 million as of December 31, 2012 compared to $219.7 million as of December 31, 2011. The increases in backlog were primarily due to higher order levels within our large international project business.
Aerospace & Defense segment revenues decreased by $15.5 million (8%) for the year ended December 31, 2012 compared to the same period in 2011. The decrease was primarily due to a net organic decline of $11.7 million (6%), primarily due to lower shipments to Light Emitting Diode ("LED") equipment producers (11%), offset by growth across most other Aerospace & Defense businesses with the exception of landing gear programs. Orders for this segment decreased $38.4 million to $189.6 million for the year ended December 31, 2012 compared to $227.9 million for the year ended December 31, 2011 primarily due to a $26.0 million multi-year military landing gear order placed in the third quarter of 2011 and lower LED orders. Order backlog increased $0.9 million to $181.1 million as of December 31, 2012 compared to $177.8 million as of December 31, 2011 primarily due to higher European commercial bookings, partially offset by landing gear overhaul decline as we exited this part of the business as part of our restructuring activities.
Operating Income
The change in operating income for the year ended December 31, 2012 compared to the year ended December 31, 2011 was as follows:
The inventory restructuring, impairment, and special charges for the twelve months ended December 31, 2012 were as follows; there were no inventory restructuring, impairment, or special charges recorded in 2011:
Leslie Asbestos and Bankruptcy Related Charges, Net
Asbestos and bankruptcy related charges are primarily associated with our subsidiary Leslie Controls, Inc. (“Leslie”) in the Energy segment. There were no ongoing costs associated with Leslie’s asbestos litigation for the year ended December 31, 2012. The $0.7 million bankruptcy related charges for the year ended December 31, 2011 was comprised of bankruptcy related professional fees.
On April 28, 2011, Leslie emerged from Chapter 11 bankruptcy protection. Under the terms of the bankruptcy plan, all current and future asbestos related claims against Leslie, as well as all current and future derivative claims against CIRCOR, are now permanently channeled to a trust for which Leslie bears no further financial liability. See “Item 3. Legal Proceedings” in our Annual Report on Form 10-K for the Fiscal Year ended December 31, 2012 for additional information.
Impairment Charges
Intangible impairment charges of $2.2 million and $8.2 million were recorded during the year ended December 31, 2012 in our Energy and Aerospace segments, respectively. The impairment charges were primarily the result of restructuring activities at operations in Brazil and California. We did not record any impairment charges during the year ended December 31, 2011. For additional information on the impairment charges, see Note 7 of the accompanying consolidated financial statements.
Special Charges
Special charges associated with restructuring actions of $2.0 million and $0.5 million were recorded during the year ended December 31, 2012 in our Energy and Aerospace & Defense segments, respectively. We also recorded $2.7 million of CEO separation costs as special charges in Corporate expenses during the year ended December 31, 2012. We did not record any special charges during the year ended December 31, 2011. For additional information on the special charges, see Note 4 of the accompanying consolidated financial statements.
Operating income decreased 17%, or $9.8 million, to $46.5 million for the year ended December 31, 2012 compared to $56.3 million for the same period in 2011.
Operating income for our Energy segment increased $16.3 million (32%) to $67.8 million for the year ended December 31, 2012 compared to the same period in 2011. Operating margins increased 200 basis points to 10.3% on a revenue increase of 6%, compared to 2011. The increase in operating income was primarily driven by improved pricing and favorable penalty reserve adjustments with respect to large international projects, increased revenue primarily in the North American short-cycle market, and foreign exchange. These items were partially offset by organic increases in selling, general and administrative expenses and restructuring related charges at our Brazil operations of $5.1 million.
Operating income for the Aerospace & Defense segment decreased $18.0 million (79%) to $4.8 million for the year ended December 31, 2012 compared to the same period in 2011. Operating income declined due to impairment charges and other restructuring related costs of $11.9 million at our California operations as well as inefficiencies at our California operations and higher costs supporting new programs, including initial production-related variances, totaling $6.7 million. In addition, operating income was negatively impacted by lower LED equipment market revenue (11%) partially offset by higher shipment volume across the other Aerospace & Defense businesses.
Corporate operating expenses increased $8.0 million (44%) to $26.0 million, for the year ended December 31, 2012 compared to the same period in 2011, largely due to CEO separation costs of $2.7 million, a favorable settlement of a long-standing litigation matter recognized as income in the third quarter of 2011 as well as higher professional fees and variable compensation for the year ended December 31, 2012.
Interest Expense, Net
Net interest expense increased $0.3 million to $4.3 million for the year ended 2012 compared to $3.9 million for the year ended 2011. This increase in interest expense was primarily due to higher interest charges from higher international borrowings.
Other Expense, Net
Other expense, net, was $0.5 million for the year ended December 31, 2012 compared to $2.2 million in the same period of 2011. The difference of $1.7 million was largely the result of lower foreign exchange expenses associated with the remeasurement of foreign currency balances.
Provision for Income Taxes
The effective tax rate was 26.2% for the year ended December 31, 2012 compared to 27.0% for the same period of 2011. The primary driver of the higher 2011 tax rate was higher U.S. income which is taxed at a higher rate than foreign source income.
Net Income
Net income decreased $5.8 million to $30.8 million for the year ended December 31, 2012, compared to $36.6 million for the same period in 2011. The decrease was primarily due to the restructuring activities that resulted in restructuring inventory charges of $4.2 million, impairment charges of $10.3 million, and special charges of $5.3 million. These 2012 inventory restructuring, impairment, and special charges were partially offset primarily by higher Energy segment operating income.
Liquidity and Capital Resources
Our liquidity needs arise primarily from capital investment in machinery, equipment and the improvement of facilities, funding working capital requirements to support business growth initiatives, acquisitions, dividend payments, pension funding obligations and debt service costs. We have historically generated cash from operations and remain in a strong financial
position, with resources available for reinvestment in existing businesses, strategic acquisitions and managing our capital structure on a short and long-term basis.
The following table summarizes our cash flow activities for the twelve month periods indicated (in thousands):
During the year ended December 31, 2013, we generated $72.2 million in cash flow from operating activities compared to $60.5 million during the twelve months ended December 31, 2012. The $11.7 million increase in cash generated from operating activities was primarily due to a $16.3 million increase in net income and $6.6 million decrease in deferred taxes primarily due to utilization of deferred tax assets of our Italian subsidiary. These increases were partially offset by lower 2013 intangible impairment charges of $3.5 million, a 2013 gain on return of acquisition price of $3.4 million, and an increase of $2.9 million used for operating assets and liabilities. During the twelve months ended December 31, 2013 we used approximately $7.2 million in cash from operating assets and liabilities compared to using $4.3 million during the same period in 2012.
During the year ended December 31, 2013, we used $13.3 million for investing activities as compared to $17.6 million during the twelve months ended December 31, 2012. The reduction of cash used for investing activities was directly related to the $3.4 million return of acquisition price. Financing activities used $19.2 million during the year ended December 31, 2013, which included a net $19.7 million of repayment of borrowings and $2.7 million in dividend payments to shareholders, partially offset by stock option exercise proceeds and tax effect of share-based compensation of $3.1 million.
As of December 31, 2013, total debt was $49.6 million compared to $70.5 million at December 31, 2012 due to repayments on existing borrowings including our credit facility. Total debt as a percentage of total shareholders’ equity was 10.4% as of December 31, 2013 compared to 16.9% as of December 31, 2012.
On May 2, 2011, we entered into a five year unsecured credit agreement (“2011 Credit Agreement”) that provides for a $300.0 million revolving line of credit. The 2011 Credit Agreement includes a $150.0 million accordion feature for a maximum facility size of $450.0 million. The 2011 Credit Agreement also allows for additional indebtedness not to exceed $80 million. We anticipate borrowing under the 2011 Credit Agreement to fund potential acquisitions, to support our organic growth initiatives and working capital needs, and for general corporate purposes. As of December 31, 2013, we had borrowings of $41.8 million outstanding under our credit facility and $42.4 million outstanding under letters of credit.
Certain of our loan agreements contain covenants that require, among other items, maintenance of certain financial ratios and also limit our ability to: enter into secured and unsecured borrowing arrangements; issue dividends to shareholders; acquire and dispose of businesses; invest in capital equipment; transfer assets among domestic and international entities; participate in certain higher yielding long-term investment vehicles; and issue additional shares of our stock. The two primary financial covenants are leverage ratio and interest coverage ratio. We were in compliance with all financial covenants related to our existing debt obligations at December 31, 2013 and we believe it is reasonably likely that we will continue to meet such covenants in the near future.
The ratio of current assets to current liabilities was 2.84:1 at December 31, 2013 compared to 2.43:1 at December 31, 2012. The increase in the current ratio was primarily due to increases in cash due to increased revenues year over year and reductions in accounts payable and other accrued expenses compared to December 31, 2012. As of December 31, 2013, cash and cash equivalents totaled $102.2 million, substantially all of which was held in foreign bank accounts. This compares to $61.7 million of cash and cash equivalents as of December 31, 2012 substantially all of which was held in foreign bank accounts. The cash and cash equivalents located at our foreign subsidiaries may not be repatriated to the United States or other jurisdictions without significant tax implications. We believe that our U.S. based subsidiaries, in the aggregate, will generate positive operating cash flows and in addition we may utilize our 2011 Credit Facility for U.S. based subsidiary cash needs. As a result, we believe that we will not need to repatriate cash from our foreign subsidiaries with earnings that are indefinitely reinvested.
In 2014, we expect to generate positive cash flow from operating activities sufficient to support our capital expenditures and pay dividends of approximately $2.7 million based on our current dividend practice of paying $0.15 per share annually. Based on our expected cash flows from operations and contractually available borrowings under our credit facility, we expect to have sufficient liquidity to fund working capital needs and future growth. We continue to search for strategic acquisitions; a larger acquisition may require additional borrowings and/or the issuance of our common stock.
The following table summarizes our significant contractual obligations and commercial commitments at December 31, 2013 that affect our liquidity:
The interest on certain of our other debt balances, with scheduled repayment dates between 2013 and 2017 and interest rates ranging between 1.42% and 15.92%, have been included in the "Interest payments on debt" line within the Contractual Cash Obligations schedule. The most significant of our debt balances is the $41.8 million in outstanding borrowings under the 2011 Credit Agreement. Interest associated with this outstanding balance ranges from 1.42% to 3.75% as well as other fees. Capital lease obligations of $0.2 million and $0.2 million are included in the “Current portion of long-term debt” and “Long-term debt, less current portion” line items, respectively.
The most significant of our commercial contract commitments relate to approximately $92.1 million of commitments related to open purchase orders, $16.8 million of which extend to 2015 and beyond. The remaining $1.5 million in commitments primarily relate to loan commitment fees and employment agreements.
In 2013 and 2012, we contributed $1.6 million to our qualified defined benefit pension plan in addition to $0.4 million in payments to our non-qualified supplemental plan each year. In 2014, we expect to make plan contributions totaling $2.0 million, consisting of $1.6 million in contributions to our qualified plan and payments of $0.4 million for our non-qualified plan. The estimates for plan funding for future periods may change as a result of the uncertainties concerning the return on plan assets, the number of plan participants, and other changes in actuarial assumptions. We anticipate fulfilling these commitments through our generation of cash flow from operations.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors.
New Accounting Standards
None.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Market Risk
The Oil & Gas markets historically have been subject to cyclicality depending upon supply and demand for crude oil, its derivatives and natural gas. When oil or gas prices decrease, expenditures on maintenance and repair decline rapidly and outlays for exploration and in-field drilling projects decrease and, accordingly, demand for valve products is reduced. However, when oil and gas prices rise, maintenance and repair activity and spending for facilities projects normally increase and we benefit from increased demand for valve products. However, oil or gas price increases may be considered temporary in nature or not driven by customer demand and, therefore, may result in longer lead times for increases in petrochemical sales orders. As a result, the timing and magnitude of changes in market demand for oil and gas valve products are difficult to predict. Similarly, although not to the same extent as the Oil & Gas markets, the general industrial, chemical processing, aerospace, military and maritime markets have historically experienced cyclical fluctuations in demand. These fluctuations may have a material adverse effect on our business, financial condition or results of operations.
Foreign Currency Exchange Risk
The Company is exposed to certain risks relating to its ongoing business operations including foreign currency exchange rate risk and interest rate risk. The Company currently uses derivative instruments to manage foreign currency risk on certain business transactions denominated in foreign currencies. To the extent the underlying transactions hedged are completed, these forward contracts do not subject us to significant risk from exchange rate movements because they offset gains and losses on the related foreign currency denominated transactions. These forward contracts do not qualify as hedging instruments and, therefore, do not qualify for fair value or cash flow hedge treatment. Any unrealized gains and losses on our contracts are recognized as a component of other expense in our consolidated statements of income.
As of December 31, 2013, we had fourteen forward contracts with amounts as follows (in thousands):
This compares to twelve forward contracts as of December 31, 2012. The fair value asset of the derivative forward contracts as of December 31, 2013 and December 31, 2012 was approximately $0.1 million and $0.5 million, respectively and is included in prepaid expenses and other current assets on our balance sheet. The unrealized foreign exchange gains or losses for the year ended December 31, 2013, 2012 and 2011 are less than $0.5 million for each year and are included in other income or expense in our consolidated statements of income.
We have determined that the majority of the inputs used to value our foreign currency forward contracts fall within Level 2 of the fair value hierarchy, found under ASC Topic 820.1, Fair Value Measurement. The credit valuation adjustments, such as estimates of current credit spreads to evaluate the likelihood of default by ourselves and our counterparties are Level 3 inputs. However, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our foreign currency forward contracts and determined that the credit valuation adjustments are not significant to the overall valuation. As a result, we have determined that our derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Our consolidated financial statements and the accompanying notes related thereto included in this annual report on Form 10-K are hereby incorporated by reference herein.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively) have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this annual report on Form 10-K. Based on this evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to give reasonable assurance that information we disclose in reports that we file or submit under the Securities and Exchange Act of 1934 is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure and that such information is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2013 that could materially affect, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2013.
Our internal control over financial reporting as of December 31, 2013 has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report which is included herein.
Item 9B.
Item 9B. Other Information.
None.
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required under this item is incorporated by reference to the Company’s definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company’s fiscal year ended December 31, 2013.
Item 11.
Item 11. Executive Compensation.
The information required under this item is incorporated by reference to the Company’s definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company’s fiscal year ended December 31, 2013.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Except for the information required by Section 201(d) of Regulation S-K which is set forth below, the information required under this item is incorporated by reference to the Company’s definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company’s fiscal year ended December 31, 2013.
EQUITY COMPENSATION PLAN INFORMATION
(1)
Reflects 55,081 stock options, and 220,072 restricted stock units under the Company’s Amended and Restated 1999 Stock Option and Incentive Plan.
(2)
Reflects stock options issued as an inducement equity award our CEO on April 9, 2013. This award was granted pursuant to the inducement award exemption under Section 303A.08 of the NYSE Listed Company Manual. Details of this grant, including vesting terms, are set forth in Footnote 11, Share-Based Compensation.
(3)
Reflects 100,000 stock options and 18,908 restricted stock units issued to our CFO on December 2, 2013. These awards were granted pursuant to the inducement award exemption under Section 303A.08 of the NYSE Listed Company Manual. Details of these grants are set forth in Footnote 11, Share-Based Compensation.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required under this item is incorporated by reference to the Company’s definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company’s fiscal year ended December 31, 2013.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information required under this item is incorporated by reference to the Company’s definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of the Company’s fiscal year ended December 31, 2013.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements
The financial statements filed as part of the report are listed in Part II, Item 8 of this report on the Index to Consolidated Financial Statements.
(a)(2) Financial Statement Schedules
Page
Schedule II Valuation and Qualifying Accounts
All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not material, and therefore have been omitted.
(a)(3) Exhibits
Exhibit
No.
Description and Location
Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession:
*
Filed with this report.
**
Furnished with this report.
§
Indicates management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of CIRCOR International, Inc.:
We have audited the accompanying consolidated balance sheets of CIRCOR International, Inc. ( a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2013. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CIRCOR International, Inc. and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2013, based on criteria established in the 1992 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 27, 2014 expressed an unqualified opinion.
/s/ Grant Thornton LLP
Boston, Massachusetts
February 27, 2014
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of CIRCOR International, Inc.:
We have audited the internal control over financial reporting of CIRCOR International, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2013, based on criteria established in the 1992 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in the 1992 Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2013, and our report dated February 27, 2014 expressed an unqualified opinion on those financial statements.
/s/ Grant Thornton LLP
Boston, Massachusetts
February 27, 2014
CIRCOR INTERNATIONAL, INC.
Consolidated Balance Sheets
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
CIRCOR INTERNATIONAL, INC.
Consolidated Statements of Income
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
CIRCOR INTERNATIONAL, INC.
Statements of Consolidated Comprehensive Income
(in thousands)
(1)
Net of an income tax effect of $2.7 million, $(1.7) million and $(3.3) million for the years ended December 31, 2013, 2012 and 2011, respectively.
(2)
Net of an income tax effect of $0.3 million, $0.2 million and $0.1 million for the years ended December 31, 2013, 2012 and 2011, respectively.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
CIRCOR INTERNATIONAL, INC.
Consolidated Statements of Shareholders’ Equity
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
CIRCOR INTERNATIONAL, INC.
Notes to Consolidated Financial Statements
(1) Description of Business
CIRCOR International, Inc. (“CIRCOR” or the “Company” or “we”) designs, manufactures and distributes a broad array of valves and related fluid-control products and certain services to a variety of end-markets for use in a wide range of applications to optimize the efficiency and/or ensure the safety of fluid-control systems. We have a global presence and operate 20 major manufacturing facilities that are located in the United States, Western Europe, Morocco, Brazil, India and the People’s Republic of China.
We have organized our business segment reporting structure into two segments: Energy and Aerospace & Defense:
Our Energy Segment-is a global provider of integrated flow control solutions in the expanding and evolving Oil & Gas industries, specializing in highly engineered valves and pipeline products and services. We are focused on satisfying our customers’ mission-critical application needs by utilizing advanced technologies that can withstand extreme temperatures and pressures, from land-based to sub-sea and in between. Energy is growing its product offering in the severe service sector, which includes applications such as process control, oil sands, pressure control, mainline pipeline, power steam generation systems and process systems.
Our Aerospace & Defense Segment-is a growing industry leader with primary focus areas of fluid controls, actuation systems, landing gear systems, pneumatic controls and electro-mechanical controls. Aerospace & Defense sub-systems, components and products are flying on most commercial and military aircraft, including single and twin-aisle air transport, business and regional jets, military transports and fighters, and commercial and military rotorcraft. Other markets include unmanned aircraft, shipboard applications, military ground vehicles and space.
(2) Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of CIRCOR and its subsidiaries. The results of companies acquired during the year (if any) are included in the consolidated financial statements from the date of acquisition. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of these financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. Some of the more significant estimates relate to acquisition accounting, inventory valuation, depreciation, share-based compensation, amortization and impairment of long-lived assets, pension obligations, income taxes, penalty accruals for late shipments, asset valuations, environmental liability, and product liability. While management believes that the estimates and assumptions used in the preparation of the financial statements are appropriate, actual results could differ materially from those estimates.
Fair Value
Financial Accounting Standards Board (“FASB”) ASC Topic 820, Fair Value Measurement, defines fair value and includes a framework for measuring fair value and disclosing fair value measurements in financial statements. Fair value is a market-based measurement rather than an entity-specific measurement. The fair value hierarchy makes a distinction between assumptions developed based on market data obtained from independent sources (observable inputs) and the reporting entity’s own assumptions (unobservable inputs). This fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). We utilize fair value measurements for forward currency contracts, guarantee and indemnification obligations, pension plan assets, and certain intangible assets.
Revenue Recognition
Revenue is recognized when products are delivered, title and risk of loss have passed to the customer, persuasive evidence of an arrangement exists, no significant post delivery obligations remain, the price to the buyers is fixed or determinable and collection of the resulting receivable is reasonably assured. We have limited long-term arrangements, representing less than 1% of our revenue, requiring delivery of products or services over extended periods of time and revenue and profits on certain of
these arrangements are recognized in accordance with the percentage of completion method of accounting. Shipping and handling costs invoiced to customers are recorded as components of revenues and the associated costs are recorded as cost of revenues.
Cost of Revenue
Cost of revenue primarily reflects the costs of manufacturing and preparing products for sale and, to a much lesser extent, the costs of performing services. Cost of revenue is primarily comprised of the cost of materials, inbound freight, production, direct labor and overhead, which are expenses that directly result from the level of production activity at the manufacturing plant. Additional expenses that directly result from the level of production activity at the manufacturing plant include: purchasing and receiving costs, inspection costs, warehousing costs, internal transfer costs, utility expenses, property taxes, depreciation of production building and equipment assets, salaries and benefits paid to plant manufacturing management and maintenance supplies.
Cash, Cash Equivalents, and Short-term Investments
Cash and cash equivalents consist of amounts on deposit in checking and savings accounts with banks and other financial institutions. In 2013 and 2012, short-term investments primarily consist of guaranteed investment certificates. As of December 31, 2013, cash and cash equivalents totaled $102.2 million, substantially all of which was held in foreign bank accounts. This compares to $61.7 million of cash and cash equivalents as of December 31, 2012, of which substantially all was held in foreign bank accounts. Short-term investments as of December 31, 2013 and 2012 totaled $0.1 million, all of which is held in foreign bank accounts.
Inventories
Inventories are stated at the lower of cost or market. Cost is generally determined on the first-in, first-out (“FIFO”) basis. Where appropriate, standard cost systems are utilized for purposes of determining cost; the standards are adjusted as necessary to ensure they approximate actual cost. Estimates for obsolescence or slow moving inventory are maintained based on current economic conditions, historical sales quantities and patterns and, in some cases, the risk of loss on specifically identified inventories. Such inventories are recorded at estimated realizable value net of the cost of disposal.
Penalty Accruals
Certain customer agreements, primarily in our project related businesses and large aerospace programs, contain late shipment penalty clauses whereby we are contractually obligated to pay consideration to our customers if we do not meet specified shipment dates. The accrual for estimated penalties is shown as a reduction of revenue and is based on several factors including historical customer settlement experience and management’s assessment of specific shipment delay information. Accruals related to these potential late shipment penalties as of December 31, 2013 and 2012 were $10.3 million and $8.6 million, respectively. As we conclude performance under these agreements, the actual amount of consideration paid to our customers may vary from the amounts we currently have accrued.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Depreciation is generally provided on a straight-line basis over the estimated useful lives of the assets, which typically range from 3 to 50 years for buildings and improvements, 3 to 10 years for manufacturing machinery and equipment, computer equipment and software, and furniture and fixtures. Motor vehicles are depreciated over a range of 2 to 6 years. Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the asset. Repairs and maintenance costs are expensed as incurred.
The Company reports depreciation of property, plant and equipment in cost of revenue and selling, general and administrative expenses based on the nature of the underlying assets. Depreciation primarily related to the production of inventory is recorded in cost of revenue. Depreciation related to selling and administrative functions is reported in selling, general and administrative expenses.
Business Acquisitions
ASC Topic 805, Business Combinations, provides guidance regarding business combinations and requires acquisition-date fair value measurement of identifiable assets acquired, liabilities assumed, and non-controlling interests in the acquiree. For more detailed information, refer to Note 3, Business Acquisitions.
Goodwill and Intangible Assets
In accordance with ASC 350, Intangibles-Goodwill and Other, we utilize each of our operating segments as our goodwill reporting units as we have discrete financial information that is regularly reviewed by operating segment management and the businesses within each segment have similar economic characteristics. For the year-ended December 31, 2013, the Company’s two reporting units were Energy and Aerospace & Defense with respective goodwill balances of $52.9 million and $22.9 million.
Goodwill is measured as the excess of the cost of acquisition over the sum of the amounts assigned to identifiable tangible and intangible assets acquired less liabilities assumed. Goodwill and intangible assets are recorded at cost; intangible assets with definitive lives are amortized over their useful lives. For goodwill and intangible assets with indefinite lives, we perform an impairment assessment at the reporting unit level on an annual basis as of the end of our October month end or more frequently if circumstances warrant. Our annual impairment assessment is a two-step process. The first step requires a comparison of the implied fair value of each of our reporting units to the respective carrying value. If the carrying value of a reporting unit is higher than its fair value, there is an indication that impairment may exist and the second step of the evaluation must be performed. In the second step, the potential impairment is calculated by comparing the implied fair value of the reporting unit’s goodwill with the carrying value of the goodwill. If the carrying value of the reporting unit’s goodwill is greater than the implied fair value of its goodwill, an impairment loss will be recognized for the excess.
Determining the fair value of a reporting unit is subjective and requires the use of significant estimates and assumptions. With the assistance of an independent third-party appraisal firm, we estimate the fair value of our reporting units using an income approach based on the present value of future cash flows. We believe this approach yields the most appropriate evidence of fair value. We also utilize the comparable company multiples method and market transaction fair value method to validate the fair value amount we obtain using the income approach. The key assumptions utilized in our discounted cash flow model include our estimates of future cash flows from operating activities offset by estimated capital expenditures of the reporting unit, the estimated terminal value for each reporting unit, a discount rate based on a weighted average cost of capital, overall economic conditions, and our assessment of our current market capitalization. Any unfavorable material changes to these key assumptions could potentially impact our fair value determinations. As discussed elsewhere in this Form 10-K regarding risks and other factors that may cause our results to vary materially, some of our end markets are cyclical and we face significant competition. As such, we may experience fluctuations in revenues and operating results resulting in the non-achievement of our estimated growth rates, operating performance and working capital estimates utilized in our discounted cash flow models.
In fiscal year 2013 when we performed our step one analysis, the fair value of each of our reporting units exceeded the respective carrying amount, and no goodwill impairments were recorded. The fair values utilized for our 2013 goodwill assessment exceeded the carrying amounts by approximately 283% and 95% for our Energy and Aerospace & Defense reporting units, respectively. The growth rate assumptions utilized were consistent with growth rates within the markets that we serve. Actual 2013 results were substantially consistent overall with estimates and assumptions made for purposes of our goodwill impairment analysis performed in October. If our results significantly vary from our estimates, related projections, or business assumptions in the future due to changes in industry or market conditions, we may be required to record impairment charges. By way of example, a 10% reduction in our Aerospace & Defense reporting unit projected cash flows would not result in the fair value being lower than the carrying value.
The goodwill recorded on the consolidated balance sheet as of December 31, 2013 was $75.9 million compared with $77.4 million as of December 31, 2012 with the only change being due to foreign currency fluctuations. Net intangible assets as of December 31, 2013 were $35.7 million compared to $45.2 million as of December 31, 2012. The total net amount of non-amortizing assets was $17.0 million and $23.6 million, as of December 31, 2013 and 2012, respectively.
Indefinite-lived intangible assets, such as trade names, are generally recorded and valued in connection with a business acquisition. These assets are reviewed at least annually for impairment, or more frequently if facts and circumstances warrant. We also utilized a fair value calculation to evaluate these intangibles.
Impairment of Other Long-Lived Assets
In accordance with ASC 360, Plant, Property, and Equipment, we perform impairment analyses of our other long-lived assets, such as property, plant and equipment, whenever events and circumstances indicate that they may be impaired. When the undiscounted future cash flows are expected to be less than the carrying value of identified asset groupings being reviewed for impairment, the asset groupings are written to fair value.
See Note 7 to the consolidated financial statements for further information on impairment of other long-lived assets.
Advertising Costs
Our accounting policy is to expense advertising costs, principally in selling, general and administrative expenses, when incurred. Our advertising costs for the years ended December 31, 2013, 2012 and 2011 were $2.1 million, $3.0 million and $2.5 million, respectively.
Research and Development
Research and development expenditures are expensed when incurred and are included in selling, general and administrative expenses. Our research and development expenditures for the years ended December 31, 2013, 2012 and 2011 were $6.5 million, $8.4 million and $6.1 million, respectively.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if we anticipate that it is more likely than not that we may not realize some or all of a deferred tax asset.
For our Dutch operating subsidiary undistributed earnings are generally not considered to be indefinitely reinvested, and because our effective tax rate in the Netherlands is higher than the current U.S. tax rates, no additional provision for U.S. federal and state income taxes is needed. The undistributed earnings of our other foreign subsidiaries are considered to be indefinitely reinvested and accordingly, no provision for U.S. federal and state income taxes has been recorded.
In accordance with the provisions of FASB ASC Topic 740, Income Taxes, the Company initially recognizes the financial statement effect of a tax position when, based solely on its technical merits, it is more likely than not (a likelihood of greater than fifty percent) that the position will be sustained upon examination by the relevant taxing authority. Those tax positions failing to qualify for initial recognition are recognized in the first interim period in which they meet the more likely than not standard, are resolved through negotiation or litigation with the taxing authority, or upon expiration of the statute of limitations. De-recognition of a tax position that was previously recognized occurs when an entity subsequently determines that a tax position no longer meets the more likely than not threshold of being sustained.
Under ASC Topic 740, only the portion of the liability that is expected to be paid within one year is classified as a current liability. As a result, liabilities expected to be resolved without the payment of cash (e.g., due to the expiration of the statute of limitations) or are not expected to be paid within one year are classified as non-current. It is the Company’s policy to record estimated interest and penalties as income tax expense and tax credits as a reduction in income tax expense.
Environmental Compliance and Remediation
Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to existing conditions caused by past operations, which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. In accordance with ASC 450, Contingencies, estimated costs are based upon current laws and regulations, existing technology and the most probable method of remediation.
Foreign Currency Translation
Our international subsidiaries operate and report their financial results using local functional currencies. Accordingly, all assets and liabilities of these subsidiaries are translated into United States dollars using exchange rates in effect at the end of the relevant periods, and revenues and costs are translated using weighted average exchange rates for the relevant periods. The resulting translation adjustments are presented as a separate component of other comprehensive income. We do not provide for U.S. income taxes on foreign currency translation adjustments since we do not generally provide for such taxes on undistributed earnings of foreign subsidiaries. Our net foreign exchange losses recorded for the years ended December 31, 2013, 2012 and 2011 were $1.8 million, $0.5 million, and $2.2 million, respectively.
Earnings Per Common Share
Basic earnings per common share are calculated by dividing net income by the number of weighted average common shares outstanding. Diluted earnings per common share is calculated by dividing net income by the weighted average common shares outstanding and assumes the conversion of all dilutive securities when the effects of such conversion would not be anti-dilutive.
Earnings per common share and the weighted average number of shares used to compute net earnings per common share, basic and assuming full dilution, are reconciled below (in thousands, except per share data):
Certain stock options to purchase common shares and restricted stock units (RSUs) were anti-dilutive. There were 23,390 anti-dilutive options and RSUs for the year ended December 31, 2013 with exercise prices ranging from $29.37 to $79.33. There were 279,075 anti-dilutive options and RSUs for the year ended December 31, 2012 with exercise prices ranging from $29.37 to $60.83. There were 173,771 anti-dilutive options and RSUs for the year ended December 31, 2011 with exercise prices ranging from $30.91 to $60.83.
As of December 31, 2013, there were no outstanding restricted stock units that contain rights to nonforfeitable dividend equivalents and are considered participating securities that are included in our computation of basic and fully diluted earnings per share. There is no difference in the earnings per share amounts between the two class method and the treasury stock method, which is why we continue to use the treasury stock method.
Derivative Financial Instruments
The Company is exposed to certain risks relating to its ongoing business operations including foreign currency exchange rate risk and interest rate risk. The Company currently uses derivative instruments to manage foreign currency risk on certain business transactions denominated in foreign currencies. To the extent the underlying transactions hedged are completed, these forward contracts do not subject us to significant risk from exchange rate movements because they offset gains and losses on the related foreign currency denominated transactions. These forward contracts do not qualify as hedging instruments and, therefore, do not qualify for fair value or cash flow hedge treatment. Any unrealized gains and losses on our contracts are recognized as a component of other expense in our consolidated statements of income.
Pension Benefits
Pension obligations and other post-retirement benefits are actuarially determined and are affected by several assumptions including the discount rate and projected annual rates of return on plan assets. Changes in discount rate and differences from actual results will affect the amounts of pension and other post-retirement expense recognized in future periods. These assumptions may also have an effect on the amount and timing of future cash contributions. The Company recognizes the over-funded or under-funded status of defined benefit post-retirement plans in its balance sheet, measured as the difference between the fair value of plan assets and the benefit obligation (the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for other post-retirement plans). The change in the funded status of the plan is recognized in the year in which the change occurs through other comprehensive income. These provisions also require plan assets and obligations to be measured as of the Company’s balance sheet date.
Share-Based Compensation
Share-based compensation costs are based on the grant date fair value estimated in accordance with the provisions of ASC 718, Compensation - Stock Compensation, and these costs are recognized over the requisite vesting period. For all of our non-market condition stock option grants, the fair value of each grant was estimated at the date of grant using the Black-Scholes option pricing model. Black-Scholes utilizes assumptions related to volatility, the risk-free interest rate, the dividend yield and employee exercise behavior. Expected volatilities utilized in the model are based on the historic volatility of the Company’s
stock price. The risk free interest rate is derived from the U.S. Treasury Yield curve in effect at the time of the grant. The model incorporates exercise and post-vesting forfeiture assumptions based on an analysis of historical data.
Market condition stock option awards are not granted under the Company's 1999 Stock Plan and include both a service period and a market performance vesting condition. The stock options vest if certain stock price targets are met based on the stock price closing at or above 60 consecutive trading days. Vested options may be exercised 25% at the time of vesting, 50% one year from the date of vesting and 100% two years from the date of vesting. These market condition stock option awards are being expensed utilizing a graded method and are subject to forfeiture in the event of employment termination (whether voluntary or involuntary) prior to vesting. To the extent that the market conditions above (stock price targets) are not met, those options will not vest and will forfeit 5 years from grant date. The Company used a Monte Carlo simulation option pricing model to value these option awards.
See Note 11 to the consolidated financial statements for further information on share-based compensation.
New Accounting Standards
None.
Reclassifications
Certain items in the prior period footnote disclosures have been reclassified to conform to currently reported presentations.
Subsequent events
The Company evaluated the December 31, 2013 financial statements for subsequent events through the date that the financial statements were available to be issued and noted no material events requiring either recognition as of December 31, 2013 or disclosure herein, other than noted below.
During the third quarter of 2011, we commenced arbitration proceedings against T.M.W. Corporation (“TMW”), the seller from which we acquired the assets of Castle Precision Industries in August 2010, seeking to recover damages from TMW for breaches of certain representations and warranties made by TMW in the Asset Purchase Agreement dated August 3, 2010 relative to such acquisition. On January 24, 2014 we reached a settlement on the TMW arbitration where it was agreed that TMW would waive all rights to amounts due from us under a contingent consideration promissory note established at the time of acquisition, resulting in a gain of approximately $2.2 million during the first quarter of 2014.
(3) Business Acquisitions and Divestitures
Our growth strategy includes strategic acquisitions that complement and extend our broad array of valves and fluid control products and services. Our acquisitions typically have well established brand recognition and are well known within the industry. We have historically financed our acquisitions from available cash or credit lines.
On February 4, 2011, we acquired the stock of Valvulas S.F. Industria e Comercio Ltda. (“SF Valves”), a Sao Paulo, Brazil based manufacturer of valves for the energy market. SF Valves is reported in our Energy segment. We placed approximately $9.0 million in an escrow account to secure certain indemnification and purchase price obligations of the seller. The excess of the purchase price over the fair value of the net identifiable assets of $14.0 million was recorded as goodwill and will not be deductible for Brazilian tax purposes.
The following table reflects the balance sheet line item estimated fair values recorded in connection with the acquisition of SF Valves as of its respective acquisition date (in millions):
The following table reflects unaudited pro forma consolidated net revenue, net income, and earnings per share with respect to the 2011 results, which are unaudited on the basis that the SF Valves acquisition took place and was recorded at the beginning of 2011 (in thousands, except per share data). Since SF Valves was acquired in 2011 there is no proforma impact on the years ended December 31, 2013 and 2012.
The 2011 unaudited pro forma consolidated condensed results of operations may not be indicative of the actual results that would have occurred had the acquisition been consummated at the beginning of the period, or of future operations of the consolidated companies under our ownership and management.
The following tables provide reconciliations of the net cash paid and goodwill recorded for the acquisition during the year ended December 31, 2011 (in thousands). We did not have any acquisitions in 2013 nor 2012.
(4) Special Charges
During the third quarter of 2012 we announced restructuring actions in the Energy and Aerospace & Defense segments including actions to consolidate facilities, shift expenses to lower cost regions, and exited some non-strategic product lines ("2012 Announced Restructuring").
During the fourth quarter of 2012 we recorded special charges of $2.7 million associated with the separation of our Chief Executive Officer. These charges primarily related to one time cash payments, equity award modification charges as well as executive search fees ("CEO Separation").
On July 12, 2013 we reached a settlement associated with arbitration in connection with an Energy segment business and received a refund of a portion of the purchase price which resulted in a gain of approximately $3.2 million during the third quarter of 2013. This gain was recorded as a special recovery during the third quarter of 2013 ("Energy Settlement").
On August 1, 2013 and October 31, 2013 we announced additional restructuring actions associated with our Energy and Aerospace & Defense segments under which we will simplify the manner in which we manage our businesses ("2013 Announced Restructuring"). Under these restructurings we will consolidate facilities, shift expenses to lower cost regions, exit certain non-strategic product lines, and also consolidate our group structure from three groups to two, reducing management layers and administrative expenses.
In addition during 2013 we announced that our Chief Financial Officer would be retiring and recorded special charges of $1.1 million primarily related to one time cash payments and equity award modifications (“CFO retirement”).
During the twelve months ended December 31, 2013 we incurred $8.6 million of special charges, net of recoveries, associated with the 2012 Announced Restructuring, 2013 Announced Restructuring, Energy Settlement, and CFO retirement. The following table summarizes our special charges by type and business segment (in thousands):
During the twelve months ended December 31, 2012 we incurred $5.3 million in special charges associated with our 2012 Announced Restructuring and CEO Separation. The following table summarizes our special charges by expense type and business segment (in thousands).
The following table summarizes our 2012 Announced Restructuring related special charges incurred from the end of the third quarter of 2012 through December 31, 2013. Charges with this action began in the third quarter of 2012.
Also, in connection with the 2012 Announced Restructuring special charges noted above, we recorded $1.2 million and $3.6 million of restructuring related inventory obsolescence charges since the third quarter of 2012 for the Energy and Aerospace & Defense segments, respectively.
We do not anticipate any additional special charges to be incurred associated with the 2012 Announced Restructurings.
The following table summarizes our 2013 Announced Restructuring related special charges incurred during the twelve months of 2013. Charges with this action began in the third quarter of 2013.
Additional special charges that we expect to be recorded with the 2013 Announced Restructuring actions are included in the projected amounts below.
We expect to incur additional restructuring related special charges between $2.9 million and $3.2 million that are primarily facility and employee related during 2014 (between $2.6 million and $2.9 million for the Energy segment and $0.3 million for the Aerospace & Defense segment) to complete these restructuring actions. These restructuring activities are expected to be funded with cash generated from operations. These expected 2014 restructuring related special charges will be offset by the TMW settlement which will be recorded as a special recovery of $2.2 million during the first quarter of 2014.
(5) Inventories
Inventories consist of the following (in thousands):
(6) Property, Plant and Equipment
Property, plant and equipment consist of the following (in thousands):
Depreciation expense for the years ended December 31, 2013, 2012, and 2011 was $16.0 million, $15.7 million, and $15.1 million, respectively.
(7) Goodwill and Other Intangible Assets
The following table shows goodwill by segment as of December 31, 2013 and 2012 (in thousands):
The tables below present gross intangible assets and the related accumulated amortization (in thousands):
The table below presents estimated future amortization expense for intangible assets recorded as of December 31, 2013 (in thousands):
In 2013, the fair value of each of our reporting units exceeded the respective carrying value, and no goodwill impairments were recorded. The fair values utilized for our 2013 goodwill assessment, which were assessed as of the end of October, exceeded the carrying value by approximately 283% and 95% for the Energy and Aerospace & Defense reporting units, respectively. For the years ended December 31, 2012 and December 31, 2011, we did not record any goodwill impairment charges. We again assessed the goodwill factors as of December 31, 2013 and determined there were no indications of impairments.
The annual impairment testing over our non-amortizing intangible assets is also completed as of the end of October and consists of a comparison of the fair value of the intangible assets with carrying amounts.
During the quarter ended December 31, 2013, in connection with a change to our organizational structure to simplify the way the Company is managed as well as other evolving business factors, we discontinued use of certain Aerospace & Defense trade names that we determined had no future economic life and should be impaired. This resulted in Aerospace & Defense segment intangible asset impairment charges during the year ended December 31, 2013 of $6.9 million, included in the impairment charges line on our consolidated statements of income. The recording of this impairment charge and ongoing new program startup costs were indicators of potential impairment that triggered impairment analysis of the long-lived and intangible assets of our California Aerospace & Defense operations. We performed an ASC 360, Plant, Property, and Equipment, impairment analyses for our California operations as part of our fourth quarter closing process, which resulted in no additional asset impairment charges as the fair value of the California operations exceeded the carrying value.
During the year ended December 31, 2012 we recorded intangible asset impairment charges of $2.2 million and $8.2 million for the Energy and Aerospace & Defense segments, respectively. These impairment charges were primarily a result of restructuring activities at operations in Brazil and California.
(8) Income Taxes
The significant components of our deferred income tax liabilities and assets are as follows (in thousands):
The above components of deferred income taxes are classified in the consolid ated balance sheets as follows:
The provision (benefit) for income taxes is based on the following pre-tax income (loss) (in thousands):
The provision (benefit) for income taxes consists of the following (in thousands):
Actual income taxes reported from operations are different from those that would have been computed by applying the federal statutory tax rate to income before income taxes. The reasons for these differences are as follows:
With regard to the deferred tax assets, we maintained a total valuation allowance of $13.9 million and $13.5 million at December 31, 2013 and 2012, respectively. We had foreign tax credits of $17.7 million, foreign net operating losses of $15.1 million, state net operating losses of $69.7 million and state tax credits of $1.8 million at December 31, 2013. At December 31, 2012, we had foreign tax credits of $20.7 million, foreign net operating losses of $22.0 million, state net operating losses of $69.1 million and state tax credits of $1.5 million. The foreign tax credits, if not utilized, will expire partially in 2015 and the remainder in 2021. The state net operating losses and state tax credits, if not utilized, will expire between 2014 and 2033. The $13.9 million valuation allowance as of December 31, 2013 is comprised of $5.7 million related to foreign credit carry-forwards, $5.0 million related to foreign deferred tax assets and $3.2 million related to state income tax benefits.
The valuation allowance on foreign tax credits is $5.7 million in 2013 which is a reduction of $1.0 million from 2012 as a result of a projected increase in foreign source income. The valuation allowance is based on estimates of taxable income in each of the jurisdictions in which we operate and the period over which our deferred tax assets will be recoverable.
If market conditions improve and future results of operations exceed our current expectations, our existing tax valuation allowances may be adjusted, resulting in future tax benefits. Alternatively, if market conditions deteriorate or future results of operations are less than expected, future assessments may result in a determination that some or all of the deferred tax assets are not realizable. Consequently, we may need to establish additional tax valuation allowances for a portion or all of the gross deferred tax assets, which may have a material adverse effect on our results of operations and financial condition. The Company has had a history of domestic and foreign taxable income, is able to avail itself of federal tax carryback provisions, has future taxable temporary differences and is forecasting future domestic and foreign taxable income. We believe that after considering all of the available objective evidence, it is more likely than not that the results of future operations will generate sufficient taxable income for the Company to realize the remaining net deferred tax assets.
On January 2, 2013, the President of the United States signed legislation that retroactively extended the research and development (R&D) tax credit for two years, from January 1, 2012 through December 31, 2013. Accordingly, the Company recorded the entire benefit of the R&D tax credit attributable to 2012 during 2013.
The Company files income tax returns in the U.S. federal, state and local jurisdictions and in foreign jurisdictions. The Company is no longer subject to examination by the Internal Revenue Service for years prior to 2010 and is no longer subject to examination by the tax authorities in foreign and state jurisdictions prior to 2006. The Company is currently under examination for income tax filings in the US and foreign jurisdictions.
As of December 31, 2013, the liability for uncertain income tax positions was $1.6 million excluding interest of $0.7 million. As of December 31, 2013 and December 31, 2012, accrued interest and penalties were $0.7 million and $0.9 million, respectively. Due to the high degree of uncertainty regarding the timing of potential future cash flows associated with these liabilities, we are unable to make a reasonably reliable estimate of the amount and period in which these liabilities might be paid.
The following is a reconciliation of the Company’s total gross unrecognized tax benefits for the years ended December 31, 2013 and 2012 (in thousands). Approximately $0.9 million as of December 31, 2013 represents the amount that if recognized would affect the Company’s effective income tax rate in future periods. The table below does not include interest and penalties of $0.7 million and $0.9 million as of December 31, 2013 and 2012, respectively.
Undistributed earnings of our foreign subsidiaries amounted to $177.1 million at December 31, 2013 and $138.6 million at December 31, 2012. During our fiscal years ended December 31, 2013 and December 31, 2012, we repatriated no cash to the U.S, except as noted below.
For our Dutch operating subsidiary undistributed earnings are not considered to be indefinitely reinvested and because our effective tax rate in the Netherlands is higher than the current U.S. tax rates, no additional provision for U.S. federal and state income taxes is needed. The undistributed earnings of our other foreign subsidiaries are considered to be indefinitely reinvested and accordingly, no provision for U.S. federal and state income taxes has been recorded. During 2013, we repatriated $2.0 million from our Dutch operations subsidiary.
(9) Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following (in thousands):
(10) Financing Arrangements
Long-term debt consists of the following (in thousands):
On May 2, 2011, we entered into a five year unsecured credit agreement (“2011 Credit Agreement”) that provides for a $300.0 million revolving line of credit. The 2011 Credit Agreement includes a $150.0 million accordion feature for a maximum facility size of $450.0 million. The 2011 Credit Agreement also allows for additional indebtedness not to exceed $80.0 million. We anticipate using the 2011 Credit Agreement to fund potential acquisitions, to support our organic growth initiatives and working capital needs, and for general corporate purposes. We capitalized $2.0 million in debt issuance costs that will be amortized over the five year life of the agreement. As of December 31, 2013, we had borrowings of $42.4 million of which $41.8 million was outstanding under our 2011 credit agreement.
Certain of our loan agreements contain covenants that require, among other items, maintenance of certain financial ratios and also limit our ability to: enter into secured and unsecured borrowing arrangements; issue dividends to shareholders; acquire and dispose of businesses; transfer assets among domestic and international entities; participate in certain higher yielding long-term investment vehicles; and issue additional shares of our stock. The two primary financial covenants are leverage ratio and interest coverage ratio. We were in compliance with all financial covenants related to our existing debt obligations at December 31, 2013 and December 31, 2012.
At December 31, 2013, minimum principal payments required during each of the next five years and thereafter are as follows (in thousands):
(11) Share-Based Compensation
As of December 31, 2013, we have one share-based compensation plan. The Amended and Restated 1999 Stock Option and Incentive Plan (the “1999 Stock Plan”), which was adopted by our Board of Directors and approved by our shareholders, permits the grant of the following types of awards to our officers, other employees and non-employee directors: incentive stock options; non-qualified stock options; deferred stock awards; restricted stock awards; unrestricted stock awards; performance share awards; cash-based awards; stock appreciation rights and dividend equivalent rights. The 1999 Stock Plan provides for the issuance of up to 3,000,000 shares of common stock (subject to adjustment for stock splits and similar events). New options granted under the 1999 Stock Plan could have varying vesting provisions and exercise periods. Options granted vest in periods ranging from one to five years and expire 10 years after the grant date. Restricted stock units granted generally vest from two to six years. Vested restricted stock units will be settled in shares of our common stock. As of December 31, 2013, there were 355,081 stock options (including the CEO and CFO stock option awards noted below) and 238,980 restricted stock units outstanding. In addition, there were 456,857 shares available for grant under the 1999 Stock Plan as of December 31, 2013. As of December 31, 2013, there were no outstanding restricted stock units that contain rights to nonforfeitable dividend equivalents and are considered participating securities that are included in our computation of basic and fully diluted earnings per share. There is no difference in the earnings per share amounts between the two class method and the treasury stock method, which is why we continue to use the treasury stock method.
For all of our stock options granted prior to 2013, the fair value of each grant was estimated at the date of grant using the Black-Scholes option pricing model. Black-Scholes utilizes assumptions related to volatility, the risk-free interest rate and the dividend yield and employee exercise behavior. Expected volatilities utilized in the model are based on the historic volatility of the Company’s stock price. The risk free interest rate is derived from the U.S. Treasury Yield curve in effect at the time of the grant.
In 2013, we granted 300,000 stock option awards compared with 68,943 in 2012 and 64,755 in 2011. On April 9, 2013, the Company granted stock options to purchase 200,000 shares of common stock to its newly appointed President and Chief Executive Officer at an exercise price of $41.17 per share ("CEO Option Award"). On December 2, 2013, the Company granted stock options to purchase 100,000 shares of common stock to its newly appointed Executive Vice President and Chief Financial Officer at an exercise price of $79.33 per share ("CFO Option Award"). Both of these option awards were granted outside of the Company's 1999 Stock Plan and include both a service period and a market performance vesting condition. The stock options will vest if the following stock price targets are met based on the stock price closing at or above these targets for 60 consecutive trading days:
Vested options for both of these awards may be exercised 25% at the time of vesting, 50% one year from the date of vesting and 100% two years from the date of vesting. On August 8, 2013, the $50.00 Stock Price Target for the CEO option award was met, therefore, 50,000 options have vested and 12,500 are currently exercisable. These stock option awards are being expensed utilizing a graded method and are subject to forfeiture in the event of employment termination (whether voluntary or involuntary) prior to vesting. Both option awards have a 10 year term but to the extent that the market conditions above (Stock Price Targets) are not met, these options will not vest and will forfeit 5 years from grant date. The Company used a Monte Carlo simulation option pricing model to fair value these option awards.
The fair value of stock options granted during the year ended December 31, 2013 of $20.15 was estimated using the following weighted-average assumptions:
We account for Restricted Stock Unit (“RSU”) Awards by expensing the grant date fair value to selling, general and administrative expenses ratably over vesting periods ranging from two to six years. During the years ended December 31, 2013 and December 31, 2012 we granted 154,235 and 142,338 RSU Awards with approximate fair values of $47.50 and $33.78 per RSU Award, respectively. Of the 154,235 RSU Awards granted during 2013, 18,908 were not granted under the Company's 1999 Stock Plan. During 2012 and 2013, the Company granted performance-based RSUs as part of the overall mix of RSU Awards. These performance-based RSUs include metrics for achieving Return on Invested Capital and Adjusted Operating Margin with target payouts ranging from 0% to 200%. Of the 154,235 RSUs granted during 2013, 35,329 are performance-based RSU awards. This compares to 30,705 performance-based RSU awards granted in 2012.
The CIRCOR Management Stock Purchase Plan, which is a component of the 1999 Stock Plan, provides that eligible employees may elect to receive restricted stock units in lieu of all or a portion of their pre-tax annual incentive bonus and, in
some cases, make after-tax contributions in exchange for restricted stock units (“RSU MSPs”). In addition, non-employee directors may elect to receive restricted stock units in lieu of all or a portion of their annual directors’ fees. Each RSU MSP represents a right to receive one share of our common stock after a three-year vesting period. RSU MSPs are granted at a discount of 33% from the fair market value of the shares of common stock on the date of grant. This discount is amortized as compensation expense, to selling, general and administrative expenses, over a four-year period. RSU MSPs totaling 28,463 and 34,534 with per unit discount amounts representing fair values of $13.90 and $10.81 were granted under the CIRCOR Management Stock Purchase Plan during December 31, 2013 and December 31, 2012, respectively.
Compensation expense related to our share-based plans for the year ended December 31, 2013 was $5.2 million of which $4.7 million was recorded as selling, general, and administrative expense and $0.5 million was recorded as special charges in our statement of income. The special charge portion was related to the separation of our previous CFO. Compensation expense for 2012 and 2011 was $4.4 million and $3.8 million respectively, and was recorded as selling, general and administrative expense.
As of December 31, 2013, there was $12.2 million of total unrecognized compensation costs related to our outstanding share-based compensation arrangements. That cost is expected to be recognized over a weighted average period of 2.2 years. This compares to $4.8 million for both 2012 and 2011, respectively. The year over year increase in total unrecognized compensation costs relates to the equity awards for the newly appointed CEO and CFO of $3.0 million and $4.4 million, respectively.
A summary of the status of all stock options granted to employees and non-employee directors as of December 31, 2013, 2012, and 2011 and changes during the years are presented in the table below:
The weighted average contractual term for stock options outstanding and exercisable as of December 31, 2013 was 9.1 years and 7.3 years, respectively. The aggregate intrinsic value of stock options exercised during the years ended December 31, 2013, 2012 and 2011 was $1.8 million, $0.4 million and $0.7 million, respectively. The aggregate fair value of stock-options vested during the years ended December 31, 2013, 2012 and 2011 was $0.8 million, $0.3 million and $0.0 million, respectively. The aggregate intrinsic value of stock options outstanding and exercisable as of December 31, 2013 was $10.7 million and $1.5 million, respectively. As of December 31, 2013, there was $5.2 million of total unrecognized compensation costs related to stock options that is expected to be recognized over a weighted average period of 2.5 years.
The following table summarizes information about stock options outstanding at December 31, 2013 :
A summary of the status of all RSU Awards granted to employees and non-employee directors as of December 31, 2013, 2012, and 2011 and changes during the year are presented in the table below (RSUs in thousands):
The aggregate intrinsic value of RSU Awards settled during the 12 months ended December 31, 2013, 2012 and 2011 was $4.0 million, $4.2 million, and $5.6 million, respectively. The aggregate fair value of RSU Awards vested during the 12 months ended December 31, 2013, 2012 and 2011 was $2.6 million, $3.9 million and $3.4 million, respectively. The aggregate intrinsic value of RSU Awards outstanding and exercisable as of December 31, 2013 was $14.2 million and $0.0 million, respectively. As of December 31, 2013, there was $6.7 million of total unrecognized compensation costs related to RSU awards that is expected to be recognized over a weighted average period of 1.9 years.
The following table summarizes information about RSU Awards outstanding at December 31, 2013:
A summary of the status of all RSU MSPs granted to employees and non-employee directors as of December 31, 2013, 2012, and 2011 and changes during the year are presented in the table below (RSUs in thousands):
The aggregate intrinsic value of RSU MSPs settled during the twelve months ended December 31, 2013, 2012, and 2011 was $0.7 million, $1.8 million and $0.5 million, respectively. The aggregate fair value of RSU MSPs vested during the twelve months ended December 31, 2013, 2012, and 2011 was $0.2 million, $0.8 million and $0.6 million, respectively. The aggregate intrinsic value of RSU MSPs outstanding as of December 31, 2013 was $3.5 million. As of December 31, 2013 there was $0.3 million of total unrecognized compensation costs related to RSU MSPs that is expected to be recognized over a weighted average period of 1.2 years.
The following table summarizes information about RSU MSPs outstanding at December 31, 2013:
While not included in the share-based compensation tables above, the Company also grants Cash Settled Stock Unit Awards to its international participants. These Cash Settled Stock Unit Awards typically cliff-vest in three years and are settled in cash based on the Company's closing stock price at the time of vesting. As of December 31, 2013, there were 40,330 Cash Settled Stock Unit Awards outstanding compared with 51,647 Cash Settled Stock Unit Awards as of December 31, 2012. During 2013, the aggregate cash used to settle Cash Settled Stock Unit Awards was $1.1 million. As of December 31, 2013, the Company had $1.7 million in accrued expenses and current liabilities for Cash Settled Stock Unit Awards compared with $1.4 million as of December 31, 2012. Cash Settled Stock Unit related compensation costs for the twelve month periods ended December 31, 2013, 2012, and 2011 totaled $1.5 million, $0.3 million, and $0.5 million, respectively and was recorded as selling, general and administrative expense in our consolidated statements of income.
(12) Concentrations of Risk
Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and trade receivables. A significant portion of our revenue and receivables are from customers who are either in or service the energy, aerospace, defense and industrial markets. We perform ongoing credit evaluations of our customers and maintain allowances for potential credit losses. During 2013, 2012 and 2011, the Company has not experienced any significant losses related to the collection of our accounts receivable. For the years ended December 31, 2013, 2012 and 2011, we had no customers from which we derive revenues that exceed the threshold of 5% of the Company’s consolidated revenues.
(13) Employee Benefit Plans
We maintain two pension benefit plans, a qualified noncontributory defined benefit plan and a nonqualified, noncontributory defined benefit supplemental plan that provides benefits to certain retired highly compensated officers and employees. To date, the supplemental plan remains an unfunded plan. These plans include significant pension benefit obligations which are calculated based on actuarial valuations. Key assumptions are made in determining these obligations and related expenses, including expected rates of return on plan assets and discount rates. Benefits are based primarily on years of service and employees’ compensation.
As of July 1, 2006, in connection with a revision to our retirement plan, we froze the pension benefits of our qualified noncontributory plan participants. Under the revised plan, such participants generally do not accrue any additional benefits under the defined benefit plan after July 1, 2006.
During 2013, we made $1.6 million in cash contributions to our qualified defined benefit pension plan, in addition to $0.4 million in payments for our non-qualified supplemental plan. In 2014, we expect to make cash contributions of approximately $1.6 million to our qualified plan and payments of $0.4 million for our non-qualified plan. Contributions to the qualified plan may differ based on a re-assessment of this plan’s funded status during 2014 based on separate IRS cash funding calculations. Capital market and interest rate fluctuations will also impact future funding requirements.
Additionally, substantially all of our U.S. employees are eligible to participate in a 401(k) savings plan. Under this plan, we make a Company contribution and match a specified percentage of employee contributions, subject to certain limitations.
The components of net benefit expense for the benefit plans are as follows (in thousands):
The weighted average assumptions used in determining the net periodic benefit cost and benefit obligations and net benefit cost for the pension plans are shown below:
The amounts reported for net periodic pension cost and the respective benefit obligation amounts are dependent upon the actuarial assumptions used. The Company reviews historical trends, future expectations, current market conditions, and external data to determine the assumptions. The actuarial assumptions used to determine the net periodic pension cost are based upon the prior year’s assumptions used to determine the benefit obligation.
We derive our discount rate utilizing a commonly known pension discount curve, discounting future projected benefit obligation cash flows to arrive at a single equivalent rate. For fiscal year end 2013 benefit obligations, we utilized a weighted average basis given the level of yield on high-quality corporate bond interest rates at fiscal year-end 2013. The effect of the discount rate change lowered our projected benefit obligation at December 31, 2013 by approximately $5.0 million and will have an insignificant impact on our 2014 pension expense.
In selecting the expected long-term rate of return on assets for the qualified plan, we considered the average rate of earnings expected on the funds invested or to be invested to provide for the benefits of these plans. This included considering the pension asset allocation and the expected returns likely to be earned over the life of the plans.
The funded status of the defined benefit plans and amounts recognized in the balance sheets, measured as of December 31, 2013 and December 31, 2012 are as follows (in thousands):
The following information is presented as of December 31, 2013 and 2012 (in thousands):
As of December 31, 2013, the benefit payments expected to be paid in each of the next five years and the aggregate for the five fiscal years thereafter are as follows (in thousands):
The fair values of the Company’s pension plan assets at December 31, 2013 and 2012, utilizing the fair value hierarchy are as follows (in thousands):
The Company’s pension plan assets are measured at fair value. For pension assets, fair value is principally determined using a market approach based on quoted prices or other relevant information from observable market transactions involving identical or comparable assets.
All assets as of December 31, 2013 and 2012 are classified as Level 1 and are comprised of mutual funds held and are traded on the open market where quoted prices are determinable and available daily. The investments are valued using a market approach based on prices obtained from the primary or secondary exchanges on which they are traded.
Our investment objectives for the portfolio of the plans’ assets are to approximate the return of a composite benchmark comprised of 50% of the Barclays Capital Aggregate Bond Index, 15% of the Morgan Stanley Capital International EAFE Index, 5% of the Morgan Stanley Capital International Emerging Markets Index, 5% of the Absolute Return Index, and 25% of the Russell 1000 Index. We also seek to maintain a level of volatility (measured as standard deviation of returns) which approximates that of the composite benchmark returns. Realigning among asset classes will occur periodically as global markets change. Portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate performance. We do not invest our pension assets directly in CIRCOR common stock. The long-term target allocations for plan assets are 55% in equities and 45% in fixed income, although the actual plan asset allocations may be within a range around these targets.
(14) Contingencies, Commitments and Guarantees
During the third quarter of 2011, we commenced arbitration proceedings against T.M.W. Corporation (“TMW”), the seller from which we acquired the assets of Castle Precision Industries in August 2010, seeking to recover damages from TMW for breaches of certain representations and warranties made by TMW in the Asset Purchase Agreement dated August 3, 2010 relative to such acquisition. On January 24, 2014 we reached a settlement on the TMW arbitration where it was agreed that TMW would waive all rights to amounts due from us under a contingent consideration promissory note established at the time of acquisition, resulting in a gain of approximately $2.2 million during the first quarter of 2014.
In late 2013 our former parent, Watts Water Technologies, Inc. (“Watts”), notified us of a claim in the approximate aggregate amount of $4.2 million. In its claim Watts contends, pursuant to the Distribution Agreement dated October 1, 1999 which governed the spinoff of CIRCOR from Watts, that we are partially responsible for retrospective insurance premium adjustments and deductibles paid by Watts to insurers under certain legacy insurance policies that covered both Watts and CIRCOR subsidiaries prior to our 1999 spinoff. The claim also includes both interest paid to insurers as well as attorneys’ fees spent by Watts in disputing its contractual obligations. We are vigorously contesting this claim and believe that any resolution of this matter will not have a material adverse effect on our financial condition or results of operations.
Asbestos-related product liability claims continue to be filed against two of our subsidiaries-Spence Engineering Company, Inc. (“Spence”), the stock of which we acquired in 1984; and Circor Instrumentation Technologies, Inc. (f/k/a Hoke Incorporated) (“Hoke”), the stock of which we acquired in 1998. Due to the nature of the products supplied by these entities, the markets they serve and our historical experience in resolving these claims, we do not believe that these asbestos-related claims will have a material adverse effect on the financial condition, results of operations or liquidity of Spence or Hoke, or our financial condition, consolidated results of operations or liquidity of the Company.
We are currently involved in various other legal claims and legal proceedings, some of which may involve substantial dollar amounts. Periodically, we review the status of each significant matter and assess our potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and the determination as to whether an exposure can be reasonably estimated. Because of uncertainties related to these matters, accruals are based on the best information available at the time. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material adverse effect on our business, results of operations and financial position.
Standby Letters of Credit
We execute standby letters of credit, which include bid bonds and performance bonds, in the normal course of business to ensure our performance or payments to third parties. The aggregate notional value of these instruments was $42.4 million at December 31, 2013. Our historical experience with these types of instruments has been good and no claims have been paid in the current or past four fiscal years. We believe that the likelihood of demand for payments relating to the outstanding instruments is remote. These instruments generally have expiration dates ranging from less than 1 month to 5 years from December 31, 2013.
The following table contains information related to standby letters of credit instruments outstanding as of December 31, 2013 (in thousands):
Operating Lease Commitments
Rental expense under operating lease commitments amounted to: $7.4 million, $7.8 million and $7.7 million for the years ended December 31, 2013, 2012 and 2011, respectively. Minimum rental commitments due under non-cancelable operating leases, primarily for office and warehouse facilities were as follows at December 31, 2013 (in thousands):
Commercial Contract Commitment
As of December 31, 2013, we had approximately $92.1 million of commercial contract commitments related to open purchase orders. In addition, we had $1.5 million of commitments associated primarily with certain loans.
Insurance
We maintain insurance coverage of a type and with such limits as we believe are customary and reasonable for the risks we face and in the industries in which we operate. While many of our policies do contain a deductible, the amount of such deductible is typically not material, and is generally less than $0.3 million per occurrence. Our accruals for insured liabilities are not discounted and take into account these deductibles and are based on claims filed and reported as well as estimates of claims incurred but not yet reported.
(15) Guarantees and Indemnification obligations
As permitted under Delaware law, we have agreements whereby we indemnify certain of our officers and directors for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. However, we have directors and officers’ liability insurance policies that limit our exposure for events covered under the policies and should enable us to recover a portion of any future amounts paid. As a result of the coverage under these insurance policies, we believe the estimated fair value of these indemnification agreements is minimal and, therefore, have no liabilities recorded from those agreements as of December 31, 2013.
We record provisions for the estimated cost of product warranties, primarily from historical information, at the time product revenue is recognized. While we engage in extensive product quality programs and processes, our warranty obligation is affected by product failure rates, utilization levels, material usage, service delivery costs incurred in correcting a product failure, and supplier warranties on parts delivered to us. Should actual product failure rates, utilization levels, material usage, service delivery costs or supplier warranties on parts differ from our estimates, revisions to the estimated warranty liability would be required. Our warranty liabilities are included in accrued expenses and other current liabilities on our consolidated balance sheets.
The following table sets forth information related to our product warranty reserves for the years ended December 31, 2013 and 2012 (in thousands):
Warranty obligations increased $0.9 million from $3.3 million as of December 31, 2012 to $4.2 million as of December 31, 2013, primarily due to lower claim settlements year over year.
(16) Fair Value
Financial Instruments
The carrying amounts of cash and cash equivalents, trade receivables and trade payables approximate fair value because of the short maturity of these financial instruments. Short-term investments (principally guaranteed investment certificates) are carried at cost which approximates fair value at the balance sheet date. The fair value of our variable rate debt approximates its carrying amount.
Foreign Currency Contracts
The Company is exposed to certain risks relating to its ongoing business operations including foreign currency exchange rate risk and interest rate risk. The Company currently uses derivative instruments to manage foreign currency risk on certain business transactions denominated in foreign currencies. To the extent the underlying transactions hedged are completed, these forward contracts do not subject us to significant risk from exchange rate movements because they offset gains and losses on the related foreign currency denominated transactions. These forward contracts do not qualify as hedging instruments and, therefore, do not qualify for fair value or cash flow hedge treatment. Any unrealized gains and losses on our contracts are recognized as a component of other expense in our consolidated statements of income.
As of December 31, 2013, we had fourteen forward contracts with amounts as follows (in thousands):
This compares to twelve forward contracts as of December 31, 2012. The fair value asset of the derivative forward contracts as of December 31, 2013 and December 31, 2012 was approximately $0.1 million and $0.5 million, respectively and is included in prepaid expenses and other current assets on our balance sheet. The unrealized foreign exchange gains (losses) for the year ended December 31, 2013, 2012 and 2011 are less than $0.5 million for each year and are included in other (income) expense in our consolidated statements of income.
We have determined that the majority of the inputs used to value our foreign currency forward contracts fall within Level 2 of the fair value hierarchy, found under ASC Topic 820.1, Fair Value Measurement. The credit valuation adjustments, such as estimates of current credit spreads to evaluate the likelihood of default by ourselves and our counterparties are Level 3 inputs. However, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our foreign currency forward contracts and determined that the credit valuation adjustments are not significant to the overall
valuation. As a result, we have determined that our derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
(17) Segment Information
During the fourth quarter of 2013, we changed our organizational structure to simplify the way the Company is managed better align our business with our customer and end markets. As part of this organizational change, the Company announced that it would consolidate its segment and reporting structure from three to two. The first segment is Energy, which will include all of the businesses from the existing Energy segment and a majority of the former ‘Flow Technologies’ businesses. The primary markets served in the new Energy segment are Oil & Gas: upstream, mid-stream and downstream; as well as the global power generation market. The second segment is Aerospace & Defense, which will include all of the former Aerospace segment businesses plus the UK based defense-oriented businesses from the former Flow Technologies segment.
The following table presents certain reportable segment information (in thousands):
Each reporting segment is individually managed and has separate financial results that are reviewed by our chief operating decision-maker. Each segment contains related products and services particular to that segment. Refer to Note 1 for further discussion of the products included in each segment.
In calculating operating income (loss) from operations for individual reporting segments, certain administrative expenses incurred at the corporate level for the benefit of other reporting segments were allocated to the segments based upon specific identification of costs, employment related information or net revenues.
Corporate / Eliminations are reported on a net “after allocations” basis. Inter-segment intercompany transactions affecting net operating profit have been eliminated within the respective operating segments.
The operating loss reported in the Corporate / Eliminations column in the preceding table consists primarily of the following corporate expenses: compensation and fringe benefit costs for executive management and other corporate staff; corporate development costs (relating to mergers and acquisitions); human resource development and benefit plan administration expenses; legal, accounting and other professional and consulting fees; facilities, equipment and maintenance costs; and travel and various other administrative costs. The above costs are incurred in the course of furthering the business prospects of the Company and relate to activities such as: implementing strategic business growth opportunities; corporate governance; risk management; treasury; investor relations and shareholder services; regulatory compliance; and stock transfer agent costs.
The total assets for each reportable segment have been reported as the Identifiable Assets for that segment, including inter-segment intercompany receivables, payables and investments in other CIRCOR companies. Identifiable assets reported in Corporate / Eliminations include both corporate assets, such as cash, deferred taxes, prepaid and other assets, fixed assets, as well as the elimination of all inter-segment intercompany assets. The elimination of intercompany assets results in negative amounts reported in Corporate/Eliminations for Identifiable Assets. Corporate Identifiable Assets after elimination of intercompany assets were $51.5 million, $39.9 million, and $44.1 million as of December 31, 2013, 2012 and 2011, respectively.
All intercompany transactions have been eliminated, and inter-segment revenues are not significant. The following tables present net revenue and long-lived assets by geographic area. The net revenue amounts are based on shipments to each of the respective areas.
(18) Quarterly Financial Information (Unaudited, in thousands, except per share information)
Schedule II - Valuation and Qualifying Accounts
CIRCOR INTERNATIONAL, INC.
(1)
Uncollectible accounts written off, net of recoveries.