MSA SAFETY INCORPORATED The following discussion and analysis should be read in conjunction with the historical financial statements and other financial information included elsewhere in this annual report on Form 10-K. This discussion may contain forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed in the sections of this annual report entitled "Forward-Looking Statements" and "Risk Factors."MSA Safety Incorporated ("MSA") is organized into six geographical operating segments that are aggregated into three reportable geographic segments:Americas , International and Corporate. TheAmericas segment is comprised of our operations inNorth America andLatin America geographies. The International segment is comprised of our operations of all geographies outside of theAmericas . Certain global expenses are allocated to each segment in a manner consistent with where the benefits from the expenses are derived. Please refer to Note 7-Segment Information of the consolidated financial statements in Part II Item 8 of this Form 10-K for further information. OnJuly 31, 2017 , the Company acquired 100% of the common stock ofGlobe Holding Company, LLC ("Globe") for$215 million in cash plus a working capital adjustment of$1.4 million . Based inPittsfield, NH , Globe is a leading innovator and provider of firefighter protective clothing and boots. This acquisition aligns with the Company's corporate strategy in that it strengthened our leading position in the North American fire service market. The transaction was funded through borrowings on our unsecured senior revolving credit facility. The data presented in Part II Item 6 of this Form 10-K should be read in conjunction with the following comments. Additionally, please refer to Note 13-Acquisitions of the consolidated financial statements in Part II Item 8 of this Form 10-K for further information. OnMay 20, 2019 , the Company acquired 100% of the common stock ofSierra Monitor Corporation ("SMC") in an all-cash transaction valued at$33.2 million , net of cash acquired. Based inMilpitas, California , in the heart ofSilicon Valley , SMC is a leading provider of fixed gas and flame detection instruments and Industrial Internet of Things solutions that connect and help protect high-value infrastructure assets. The acquisition enables MSA to accelerate its strategy to enhance worker safety and accountability through the use of cloud technology and wireless connectivity. This acquisition enhances a key focus of the Company's Safety io subsidiary, launched in 2018 primarily to leverage the capabilities of its portable gas detection portfolio as it relates to cloud connectivity. The transaction was funded through borrowings on our unsecured senior revolving credit facility. The data presented in Part II Item 6 of this Form 10-K should be read in conjunction with the following comments. Additionally, please refer to Note 13-Acquisitions of the consolidated financial statements in Part II Item 8 of this Form 10-K for further information. Year EndedDecember 31, 2018 Compared to Year EndedDecember 31, 2017 Discussion of our results; liquidity and capital resources; and cumulative translation adjustments for the year endedDecember 31, 2018 compared to the year endedDecember 31, 2017 can be found under Part II Item 7 of our Form 10-K for the year endedDecember 31, 2018 as filed with theSEC . 20
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BUSINESS OVERVIEW
We are a global leader in the development, manufacture and supply of safety
products that protect people and facility infrastructures. Recognized for their
market leading innovation, many MSA products integrate a combination of
electronics, mechanical systems and advanced materials to protect users against
hazardous or life-threatening situations. The Company's comprehensive product
line, which is governed by rigorous safety standards across highly regulated
industries, is used by workers around the world in a broad range of markets,
including the oil, gas and petrochemical industry, fire service, construction,
industrial manufacturing applications, utilities, mining and the military.
MSA's core products include breathing apparatus where self-contained breathing
apparatus ("SCBA") is the principal product, fixed gas and flame detection
systems, portable gas detection instruments, industrial head protection
products, firefighter helmets and protective apparel, and fall protection
devices. We are committed to providing our customers with service unmatched in
the safety industry and, in the process, enhancing our ability to provide a
growing line of safety solutions for customers in key global markets.
We tailor our product offerings and distribution strategy to satisfy distinct
customer preferences that vary across geographic regions. To best serve these
customer preferences, we have organized our business into six geographical
operating segments that are aggregated into three reportable geographic
segments: Americas , International and Corporate. In 2019, 65% and 35% of our net
sales were made by our Americas and International segments, respectively.
Americas . Our largest manufacturing and research and development facilities are
located in the United States . We serve our markets across the Americas with
manufacturing facilities in the U.S. , Mexico and Brazil . Operations in the other
countries within the Americas segment focus primarily on sales and distribution
in their respective home country markets.
International. Our International segment includes companies in Europe , Middle
East , and the Asia Pacific region. In our largest International affiliates (in
Germany , France , United Kingdom (U.K. ), Ireland and China ), we develop,
manufacture and sell a wide variety of products. In China , the products
manufactured are sold primarily in China as well as regional markets. Operations
in other International segment countries focus primarily on sales and
distribution in their respective home country markets. Although some of these
companies may perform limited production, most of their sales are of products
manufactured in our plants in Germany , France , the U.S. , U.K. , Ireland and China
or are purchased from third party vendors.
Corporate. The Corporate segment primarily consists of general and
administrative expenses incurred in our corporate headquarters, costs associated
with corporate development initiatives, legal expense, interest expense, foreign
exchange gains or losses, and other centrally-managed costs. Corporate general
and administrative costs comprise the majority of the expense in the Corporate
segment. During the years ended December 31, 2019 , 2018 and 2017 corporate
general and administrative costs were $37.3 million , $31.2 million , and $37.6
million , respectively.
Year Ended December 31, 2019 Compared to Year Ended December 31, 2018
Net Sales Dollar Percent
Increase Increase
(In millions) 2019 2018 (Decrease) (Decrease)
Consolidated
Net Sales . Net sales for the year endedDecember 31, 2019 , were$1.40 billion , an increase of$43.9 million , from$1.36 billion for the year endedDecember 31, 2018 . Constant currency sales increased by 5% for the year endedDecember 31, 2019 . Please refer to the Net Sales table below for a reconciliation of the year over year sales change. 21
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Year Ended December 31, 2019 versus
Net Sales December 31, 2018
(Percent Change) Americas International Consolidated
GAAP reported sales change 7.1% (3.4)% 3.2%
Currency translation effects 0.7% 4.2% 2.0%
Constant currency sales change 7.8% 0.8% 5.2%
Note: Constant currency sales change is a non-GAAP financial measure provided by the Company to give a better understanding of the Company's underlying business performance. Constant currency sales change is calculated by removing the percentage impact from currency translation effects from the overall percentage change in net sales. Net sales for theAmericas segment were$915.1 million for the year endedDecember 31, 2019 , an increase of$60.8 million , or 7%, compared to$854.3 million for the year endedDecember 31, 2018 . During 2019, constant currency sales in theAmericas segment increased 8% compared to the prior year period, driven primarily by growth across the portfolio. Net sales for the International segment were$486.9 million for the year endedDecember 31, 2019 , a decrease of$16.9 million , or 3%, compared to$503.8 million for the year endedDecember 31, 2018 . Constant currency sales in the International segment increased 1% during 2019, as we recognized higher sales throughout our industrial and gas detection product portfolio partially offset by lower breathing apparatus sales and weaker non-core sales primarily inEurope on lower ballistic helmet sales. The decline in breathing apparatus sales year-over-year was driven by a large non-recurring order in our Pacific Asia region during 2018. Refer to Note 7-Segment Information to the consolidated financial statements in Part II Item 8 of this Form 10-K, for information regarding sales by product group. We are planning for mid-single digit revenue growth on a constant currency basis for the full year of 2020. Gross profit. Gross profit for the year endedDecember 31, 2019 was$636.6 million , an increase of$24.7 million , or 4.0%, compared to$611.9 million for the year endedDecember 31, 2018 . The ratio of gross profit to net sales was 45.4% in 2019 compared to 45.1% in 2018. The higher gross profit ratio during 2019 is primarily attributable to new product launches and pricing initiatives, partially offset by higher non-cash charges associated with LIFO accounting and costs associated with our acquisition of SMC, notably the amortization of the step-up value of inventory. See Note 13-Acquisitions of the consolidated financial statements in Part II Item 8 of this Form 10-K. Selling , general and administrative expenses. Selling, general and administrative expenses were$330.5 million for the year endedDecember 31, 2019 , an increase of$5.7 million , or 1.8%, compared to$324.8 million for the year endedDecember 31, 2018 . Selling, general and administrative expenses were 23.6% of net sales in 2019 compared to 23.9% of net sales in 2018. The decrease was the result of ongoing productivity improvements in theAmericas segment and savings from restructuring programs in the International Segment, partially offset by higher costs associated with our SMC acquisition. The following table presents a reconciliation of the year-over-year expense change for selling, general, and administrative expenses. Year EndedDecember 31, 2019
versus
Selling, general, and administrative expensesDecember 31, 2018 (Percent Change) Consolidated GAAP reported change 1.8% Currency translation effects 2.0% Constant currency change 3.8%
Less: Acquisitions and related strategic transaction costs
(3.0)%
Organic constant currency change 0.8%
Note: Organic constant currency change is a non-GAAP financial measure provided
by the Company to give a better understanding of the Company's underlying
business performance. Organic constant currency change in selling, general, and
administrative expenses is calculated by removing the percentage impact from
acquisitions and related strategic transaction costs as well as currency
translation effects from the overall percentage change in GAAP selling, general,
and administrative expense. Management believes excluding acquisitions and
currency translation effects provide investors with a greater level of clarity
into spending levels on a year-over-year basis.
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Research and development expense. Research and development ("R&D") expense was
$57.8 million for the year ended December 31, 2019 , an increase of $5.1 million ,
or 9.8%, compared to $52.7 million for the year ended December 31, 2018 .
Research and development expense was 4.1% of net sales in 2019, compared to 3.9%
of net sales in 2018. We continue to develop new products for global safety
markets, including the recently launched V-Gard H1 Safety Helmet and V-Series
family of fall protection products. In 2020, MSA plans to launch its connected
firefighter ecosystem powered by LUNAR as well as the Altair io 360 Gas
Detector, an area monitor that operates with the simplicity of a smart-home
device. We capitalized approximately $5.0 million and $1.6 million of software
development costs during the years ended December 31, 2019 and 2018,
respectively.
Restructuring charges. During the year ended December 31, 2019 , the Company
recorded restructuring charges of $13.8 million , primarily related to footprint
rationalization and other restructuring programs associated with our ongoing
initiatives to drive profitable growth in our International segment. Included as
part of restructuring charges in 2019, we recognized a non-cash settlement
charge of $2.5 million for the termination of our pension plan in the United
Kingdom . This compared to charges of $13.2 million during the year ended
December 31, 2018 , primarily related to severance costs for staff reductions
associated with our ongoing initiatives to drive profitable growth in Europe and
the legal and operational realignment of our U.S. and Canadian operations.
Currency exchange. Currency exchange losses were $19.8 million during the year
ended December 31, 2019 , compared to $2.3 million during the year ended
December 31, 2018 . The increase in currency exchange losses was primarily due to
the recognition of non-cash cumulative translation losses of approximately $15.3
million as a result of the approval of our plan to close our South Africa
affiliates during the first quarter of 2019. This charge is related to the
historical translation of the elements of the financial statements for the
business from the functional currency to the U.S. Dollar. The translation impact
has been historically recorded as currency translation adjustment, a separate
component of accumulated other comprehensive loss within the shareholders'
equity section of the Consolidated Balance Sheet. The remaining currency
exchange losses in both periods were related to foreign currency exposure on
unsettled inter-company balances. Refer to Note 17-Derivative Financial
Instruments of the consolidated financial statements in Part II Item 8 of this
Form 10-K for information regarding our currency exchange rate risk management
strategy.
Product liability and other operating expense. Product liability and other
operating expense during the year ended December 31, 2019 was $28.4 million
compared to $45.3 million for the year ended December 31, 2018 . The expense in
both periods primarily relates to an increase in our reserve for cumulative
trauma product liability claims resulting from the Company's revision of its
estimates of potential liability for cumulative trauma product liability claims
as part of its annual review process, as well as defense costs incurred for
uninsured asserted cumulative trauma product liability claims. Please refer to
Note 19-Contingencies of the consolidated financial statements in Part II Item 8
of this Form 10-K for additional information.
GAAP operating income. Consolidated operating income for the year ended
December 31, 2019 was $186.2 million compared to $173.5 million for the year
ended December 31, 2018 . The increase in operating results was driven by higher
sales volumes and lower product liability and other operating expense partially
offset by higher currency exchange losses, as well as higher R&D costs related
to new product launches.
Adjusted operating income. Americas adjusted operating income for the year ended
December 31, 2019 was $226.6 million , an increase of $19.8 million , or 10%,
compared to $206.8 million for the year ended December 31, 2018 . The increase
was related to the higher level of sales and margin expansion driven by new
product launches and pricing initiatives as well as savings realized from
previously executed restructuring programs.
International adjusted operating income for the year ended December 31, 2019 was
$59.9 million , consistent with adjusted operating income of $59.9 million for
the year ended December 31, 2018 . Despite realizing a lower level of sales, cost
reduction programs helped to maintain adjusted operating income and improved
adjusted operating margin.
Corporate segment adjusted operating loss for the year ended December 31, 2019
was $35.6 million , an increase of $3.7 million , or 12%, compared to an operating
loss of $31.9 million for the year ended December 31, 2018 , primarily due to
higher professional service expenses partially offset by lower legal expenses.
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The following tables represent a reconciliation from GAAP operating income to
adjusted operating income (loss) and adjusted EBITDA. Adjusted operating margin
% is calculated as adjusted operating income (loss) divided by net sales and
adjusted EBITDA margin % is calculated as adjusted EBITDA divided by net sales.
Year Ended December 31, 2019
(In thousands) Americas International Corporate Consolidated
Net sales $ 915,118 $ 486,863 $ - $ 1,401,981
GAAP operating income 186,230
Restructuring charges (Note 2) 13,846
Currency exchange losses, net 19,814
Product liability expense (Note 19) 26,619
Strategic transaction costs (Note 13) 4,400
Adjusted operating income (loss) 226,596 59,910 (35,597 ) 250,909
Adjusted operating margin % 24.8 % 12.3 %
Depreciation and amortization 24,691 12,938 391 38,020
Adjusted EBITDA 251,287 72,848 (35,206 ) 288,929
Adjusted EBITDA % 27.5 % 15.0 %
Year Ended December 31, 2018
(In thousands) Americas International Corporate Consolidated
Net sales $ 854,287 $ 503,817 $ - $ 1,358,104
GAAP operating income 173,479
Restructuring charges (Note 2) 13,247
Currency exchange losses, net 2,330
Product liability expense (Note 19) 45,327
Strategic transaction costs (Note 13) 421
Adjusted operating income (loss) 206,839 59,866 (31,901 ) 234,804
Adjusted operating margin % 24.2 % 11.9 %
Depreciation and amortization 24,143 13,303 406 37,852
Adjusted EBITDA 230,982 73,169 (31,495 ) 272,656
Adjusted EBITDA % 27.0 % 14.5 %
Note: Adjusted operating income (loss) and adjusted EBITDA are a non-GAAP
financial measures used by the chief operating decision maker to evaluate
segment performance and allocate resources. Adjusted operating income (loss) is
reconciled above to the nearest GAAP financial measure, Operating income (loss),
and excludes restructuring, currency exchange, product liability expense and
strategic transaction costs. Adjusted EBITDA is reconciled above to the nearest
GAAP financial measure, Operating income (loss) and excludes depreciation and
amortization expense.
Total other expense, net. Other expense for the year ended December 31, 2019 was
$2.5 million , a decrease of $8.6 million , or 77.6%, compared to $11.1 million
for the year ended December 31, 2018 due to lower interest expense primarily as
a result of a favorable adjustment related to a foreign uncertain tax position
for which the statute of limitations has expired, higher pension income and the
absence of the loss on extinguishment of debt recognized in 2018. Lower discount
rates are expected to drive an $8 million unfavorable swing in pension expense
in 2020, compared to 2019. The majority of this impact will be reflected in the
Other income, net line on our Consolidated Statement of Income. The increase in
expense is non-cash. Our U.S. qualified plan remains overfunded and our funding
status is expected to improve in 2020 based on higher returns on our investments
in 2019.
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Income taxes. The reported effective tax rate for the year endedDecember 31, 2019 was 25.1%, which included a benefit of 2.6% for share-based payments, an expense of 1.8% due to non-deductible foreign currency exchange losses on entity closures, an expense of 1.9% due to nondeductible compensation and expense related to an increase in profitability in higher tax jurisdictions. This compared to a reported effective tax rate for the year endedDecember 31, 2018 , of 22.9%, which included a benefit of 1.6% for certain share-based payments and a charge of 1.1% associated with exit taxes related to ourU.S. , Canadian, and European realignment. We are subject to regular review and audit by both foreign and domestic tax authorities. While we believe our tax positions will be sustained, the final outcome of tax audits and related litigation may differ materially from the tax amounts recorded in our consolidated financial statements. During 2018, the Company recorded$1.8 million of foreign income tax reserves related to legal and operational realignment of ourU.S. , Canadian and European operations. As ofDecember 31, 2018 , the Company had completed its accounting for all of the enactment-date income tax effects of the Tax Cuts and Jobs Act of 2017 (the "Act"). Accordingly, we reduced our estimate for the one-time transition tax by$2.0 million and increased our estimate for the revaluation ofU.S. deferred tax assets and liabilities by$2.5 million and a$2.0 million increase associated with prepaid taxes for updated regulations related to the Act. Net income attributable toMSA Safety Incorporated . Net income was$136.4 million for the year endedDecember 31, 2019 , or$3.48 per diluted share, compared to$124.2 million , or$3.18 per diluted share, for the year endedDecember 31, 2018 , as a result of the factors described above. Non-GAAP Financial Information We may provide information regarding financial measures such as organic constant currency changes, financial measures excluding the impact of acquisitions and related strategic transaction costs, adjusted operating income, adjusted operating margin percentage, adjusted EBITDA and adjusted EBITDA margin percentage, which are not recognized terms underU.S. GAAP and do not purport to be alternatives to net sales, selling, general and administrative expense, operating income or net income as a measure of operating performance. We believe that the use of these non-GAAP financial measures provide investors with additional useful information and provide a more complete understanding of the underlying results. Because not all companies use identical calculations, these presentations may not be comparable to similarly titled measures from other companies. For more information about these non-GAAP measures and a reconciliation to the nearestU.S. GAAP measure, please refer to the reconciliations referenced above in Management's Discussion & Analysis section and in Note 7-Segment Information of the consolidated financial statements in Part II Item 8 of this Form 10-K. We may also provide financial information on a constant currency basis, which is a non-GAAP financial measure. These references to a constant currency basis do not include operational impacts that could result from fluctuations in foreign currency rates, which are outside of management's control. To provide information on a constant currency basis, the applicable financial results are adjusted by translating current and prior period results in local currency to a fixed foreign exchange rate. This approach is used for countries where the functional currency is the local country currency. This information is provided so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby facilitating period-to-period comparisons of business performance. Constant currency information is not recognized underU.S. GAAP and it is not intended as an alternative toU.S. GAAP measures. LIQUIDITY AND CAPITAL RESOURCES Our main source of liquidity is operating cash flows, supplemented by borrowings. Our principal liquidity requirements are for working capital, capital expenditures, principal and interest payments on debt, dividend payments, and acquisitions. AtDecember 31, 2019 , approximately 32% of our long-term debt is at fixed interest rates with repayment schedules through 2031. The remainder of our long-term debt is at variable rates on an unsecured revolving credit facility that is due in 2023. AtDecember 31, 2019 , approximately 78% of our borrowings are denominated in US dollars, which limits our exposure to currency exchange rate fluctuations. AtDecember 31, 2019 , we had cash, cash equivalents and restricted cash totaling$152.5 million , which included$117.6 million of cash, cash equivalents and restricted cash held by our foreign subsidiaries. Cash, cash equivalents and restricted cash increased$11.9 million during the year endedDecember 31, 2019 compared to an increase of$2.7 million during 2018. We continue to employ a balanced capital allocation strategy that prioritizes growth investments, funding our dividend and servicing debt obligations. 25
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Our unsecured senior revolving credit facility provides for borrowings up to$600.0 million through 2023 and is subject to certain commitment fees. This credit facility has sub-limits for the issuance of letters of credit, swingline borrowings and foreign currency denominated borrowings; and may be used for general corporate purposes, including working capital, permitted acquisitions, capital expenditures and repayment of existing indebtedness. Loans under the revolving facility will bear interest at a variable rate based on LIBOR or the federal funds rate at the Company's option. Our weighted average interest rate was 2.77% in 2019. AtDecember 31, 2019 ,$361.3 million of the$600.0 million senior revolving credit facility was unused, including letters of credit. The Company currently has access to approximately$663.0 million of capital atDecember 31, 2019 . Refer to Note 11-Short and Long-Term Debt to the consolidated financial statements in Part II Item 8 of this Form 10-K. Operating activities. Operating activities provided cash of$165.0 million in 2019, compared to providing cash of$263.9 million in 2018. The decrease in operating cash flows during the period was primarily attributable lower collections on insurance receivables and a higher use of cash for working capital to support our higher level of sales and backlog. We made product liability payments of$33.5 million , net of collections on insurance receivables, in the year endedDecember 31, 2019 , while we collected$40.1 million from insurance companies, net of product liability settlements paid, in the same period of 2018 largely the result of resolving a long outstanding carrier. Historically, cumulative trauma liability payments were funded with the Company's operating cash flow, pending resolution of disputed insurance coverage. For more than a decade, we have funded product liability settlements from operating cash flow. The vast majority of the insurance receivables and notes receivables - insurance companies balances atDecember 31, 2019 , is attributable to reimbursement believed to be due under the terms of signed agreements with insurers and are not currently subject to litigation. While the timing of cash flows for product liability and insurance receivables can and do vary from quarter to quarter, we have been successful in establishing cash flow streams that have allowed us to fund these liabilities without a material impact on our capital allocation priorities. Investing activities. Investing activities used cash of$64.2 million for the year endedDecember 31, 2019 , compared to using$84.4 million in 2018. The acquisition ofSierra Monitor Corporation , purchase of short-term investments, net of proceeds from maturities and capital expenditures drove cash outflows from investing activities during the year endedDecember 31, 2019 . Purchases of short-term investments and capital expenditures drove cash outflows from investing in the same period in 2018. During 2019 we spent$36.6 million on capital expenditures including approximately$5.0 million associated with software development, which was a$3.4 million increase compared to 2018. We expect capital expenditures to approximate$45 million in 2020, within the Company's annual capital expenditure expectations of 2.5% - 3.5% of revenue. Financing activities. Financing activities used cash of$84.6 million for the year endedDecember 31, 2019 , compared to using cash of$163.3 million in 2018. During 2019, we had net payments on long-term debt of$16.5 million compared to net payments of$107.7 million in the same period in 2018. InAugust 2018 , we repaid our 5.41% 2006 Senior Notes in the amount of$28.0 million , which included$1.5 million related to a make-whole provision and accrued interest through the date of repayment. We made dividend payments of$63.5 million during 2019, compared to$57.2 million during 2018. Dividends paid on our common stock during 2019 were$1.64 per share. Dividends paid on our common stock in 2018 were$1.49 . Restricted cash balances were$0.3 million atDecember 31, 2019 compared to$0.5 million atDecember 31, 2018 and were primarily used to support letter of credit balances. The MSA Board of Directors has authorized the Company to repurchase up to$100.0 million in shares of MSA common stock. There were$3.3 million in repurchases made in 2019 and no share repurchases in 2018. The program seeks to offset equity dilution associated with employee stock compensation. The Board of Directors did not set a time limitation on the repurchase program. CUMULATIVE TRANSLATION ADJUSTMENTS The year-end position of theU.S. dollar relative to international currencies resulted in a translation loss of$1.6 million being recorded to cumulative translation adjustments for the year endedDecember 31, 2019 compared to a loss of$29.8 million in 2018. The translation loss during 2019 was primarily related to the strengthening of theU.S. dollar relative to the euro. The translation loss in 2018 was primarily related to the strengthening of theU.S. dollar relative to the euro and British pound. During the year endedDecember 31, 2019 , we recognized approximately$19.8 million of currency exchange losses, net, in our Consolidated Statement of Income of which$15.3 million relates to non-cash currency exchange losses due primarily to an approved plan to close ourSouth Africa affiliates. This charge is related to the historical translation of the elements of the financial statements for the business from the functional currency to theU.S. Dollar. The translation impact has been 26
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historically recorded as currency translation adjustment, a separate component of accumulated other comprehensive loss within the shareholders' equity section of the Consolidated Balance Sheet. Brexit has caused, and may continue to create, volatility in global stock markets and regional and global economic uncertainty particularly in theU.K. financial and banking markets. Weakening of economic conditions or economic uncertainties tend to harm our business, and if such conditions worsen in theU.K. or in the rest ofEurope , it may have an adverse effect on our consolidated operations and sales. The Company continues to monitor the economic situation related to Brexit and current analysis indicates that exposure in our supply chain related to additional duties and sourcing costs is not material. We have approximately$45 million of annual sales denominated in the British pound which are subject to exchange rate risk associated with any volatility in the British pound. We have long-term debt of$78.4 million atDecember 31, 2019 that is denominated in British pounds. Because the debt is denominated in local currency, the value of the debt and local cash flows are aligned with respect to movements in the exchange rate between the British pound andU.S. dollar. COMMITMENTS AND CONTINGENCIES We are obligated to make future payments under various contracts, including debt and lease agreements. Our significant cash obligations as ofDecember 31, 2019 , are as follows: (In millions) Total 2020 2021 2022 2023 2024 Thereafter Long-term debt$ 349.9 $ 20.0 $ 20.0 $ -$ 245.2 $ 8.1 $ 56.6 Operating leases 65.0 11.0 9.1 6.0 4.7 3.6 30.6 Transition tax 6.7 0.1 0.8 1.5 1.9 2.4 - Totals$ 421.6 $ 31.1 $ 29.9 $ 7.5 $ 251.8 $ 14.1 $ 87.2 The significant obligations table does not include obligations to taxing authorities due to uncertainty surrounding the ultimate settlement of amounts and timing of these obligations. We expect to meet our 2020 and 2021 debt service obligations through cash provided by operations. Approximately$237.1 million of debt payable in 2023 relates to our unsecured senior revolving credit facility. We expect to generate sufficient operating cash flow to make payments against this amount each year. To the extent that a balance remains when the facility matures in 2023, we expect to refinance the remaining balance through new borrowing facilities. Interest expense on fixed rate debt over the next five years is expected to be approximately$3.7 million in 2020,$2.9 million in 2021,$2.2 million in 2022,$2.1 million in 2023, and$1.8 million in 2024. We expect total interest expense for 2020 to be between$12 million -$14 million . The Company had outstanding bank guarantees and standby letters of credit with banks as ofDecember 31, 2019 totaling$8.6 million , of which$1.9 million relate to the senior revolving credit facility. These letters of credit serve to cover customer requirements in connection with certain sales orders and insurance companies. No amounts were drawn on these arrangements atDecember 31, 2019 . The Company is also required to provide cash collateral in connection with certain arrangements. AtDecember 31, 2019 , the Company has$0.3 million of restricted cash in support of these arrangements. We expect to make net contributions of$7.6 million to our pension plans in 2020 which are primarily associated with our International segment. We have not been required to make contributions to ourU.S. based qualified defined benefit pension plan in many years. We have purchase commitments for materials, supplies, services and property, plant and equipment as part of our ordinary conduct of business. Please refer to Note 19 to the consolidated financial statements in Part II Item 8 of this Form 10-K for further discussion on the Company's product liabilities. CRITICAL ACCOUNTING POLICIES AND ESTIMATES We prepare our consolidated financial statements in accordance withU.S. generally accepted accounting principles (GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosures. We evaluate these estimates and judgments on an on-going basis based on historical experience and various assumptions that we believe to be reasonable under the circumstances. However, different amounts could be reported if we had used different assumptions and in light of different facts and circumstances. Actual amounts could differ from the estimates and judgments reflected in our consolidated financial statements. A summary of the Company's significant accounting policies is included in Note 1-Significant Accounting Policies to the consolidated financial statements in Part II, Item 8 of this Form 10-K. 27
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We believe that the following are the more critical judgments and estimates used
in the preparation of our consolidated financial statements.
Cumulative trauma product liability. We face an inherent business risk of
exposure to product liability claims arising from the alleged failure of our
products to prevent the types of personal injury or death against which they are
designed to protect. Product liability claims are categorized as either single
incident or cumulative trauma.
Single incident product liability claims involve incidents of short duration
that are typically known when they occur and involve observable injuries, which
provide an objective basis for quantifying damages. The Company estimates its
liability for single incident product liability claims based on expected
settlement costs for asserted single incident product liability claims and an
estimate of costs for single incident product liability claims incurred but not
reported ("IBNR"). Single incident product liability exposures are evaluated on
an annual basis, or more frequently if changing circumstances warrant.
Adjustments are made to the reserve as appropriate.
Cumulative trauma product liability claims involve exposures to harmful
substances (e.g., silica, asbestos and coal dust) that occurred years ago and
may have developed over long periods of time into diseases such as silicosis,
asbestosis, mesothelioma, or coal worker's pneumoconiosis. MSA LLC's combined
cumulative trauma product liability reserve is based upon estimates of its
liability for asserted cumulative trauma product liability claims not yet
resolved and for IBNR cumulative trauma product liability claims. In addition,
in connection with finalizing and reporting the Company's results of operations,
management works annually (unless significant changes in trends or new
developments warrant an earlier review) with an outside valuation consultant and
outside legal counsel to review MSA LLC's potential exposure to all cumulative
trauma product liability claims, including asserted cumulative trauma product
liability claims not yet resolved and IBNR cumulative trauma product liability
claims. The process for estimating asserted cumulative trauma product liability
claims not yet resolved takes into account available facts for those claims
including the number and composition of such claims, outcomes of matters
resolved during current and prior periods, and variances associated with
different groups of claims, plaintiffs' counsel, and venues, as well as any
other relevant information. The process for estimating IBNR claims involves a
number of key judgments and assumptions, including as to the number and types of
claims that may be asserted, the period in which claims may be asserted and
resolved, the percentage of claims that may be dismissed without payment, the
average cost to resolve claims on which a payment is made, the manner in which
MSA LLC will defend claims, and the medical and legal environments that will be
applicable to the assertion, evaluation, and resolution of claims in the future.
Each of these factors may increase or decrease significantly within an
individual period depending on, among other things, the timing of claims filings
or settlements, or litigation outcomes during a particular period that are
especially favorable or unfavorable to MSA LLC . We accordingly consider MSA
LLC's claims experience over multiple periods and/or whether there are changes
in MSA LLC's claims experience and trends that are likely to continue for a
significant time into the future in determining whether to make an adjustment to
the reserve, rather than evaluating such factors solely in the short term.
Income taxes. We recognize deferred tax assets and liabilities using enacted tax
rates to record the tax effect of temporary differences between the book and tax
basis of recorded assets and liabilities. We record valuation allowances to
reduce deferred tax assets to the amounts that we estimate are probable to be
realized. When assessing the need for valuation allowances, we consider
projected future taxable income and prudent and feasible tax planning
strategies. Should a change in circumstances lead to a change in our judgments
about the realizability of deferred tax assets in future years, we adjust the
related valuation allowances in the period that the change in circumstances
occurs.
We record an estimated income tax liability based on our best judgment of the
amounts likely to be paid in the various tax jurisdictions in which we operate.
We record tax benefits related to uncertain tax positions taken or expected to
be taken on a tax return when such benefits meet a more likely than not
threshold. We recognize interest related to unrecognized tax benefits in
interest expense and penalties in operating expenses. The tax liabilities
ultimately paid are dependent on a number of factors, including the resolution
of tax audits, and may differ from the amounts recorded. Tax liabilities are
adjusted through income when it becomes probable that the actual liability
differs from the amount recorded.
Pensions and other post-retirement benefits. We sponsor certain pension and
other post-retirement benefit plans. Accounting for the net periodic benefit
costs and credits for these plans requires us to estimate the cost of benefits
to be provided well into the future and to attribute these costs over the
expected work life of the employees participating in these plans. These
estimates require our judgment about discount rates used to determine these
obligations, expected returns on plan assets, rates of future compensation
increases, rates of increase in future health care costs, participant withdrawal
and mortality rates and participant retirement ages. Differences between our
estimates and actual results may significantly affect the cost of our
obligations under these plans and could cause net periodic benefit costs and
credits to change materially from year-to-year. Discount rates and plan asset
valuations are point-in-time measures. The discount rate assumptions used in
determining projected benefit obligations for our U.S. and foreign plans were
based on the spot rate method at December 31, 2019 .
Expected returns on plan assets are based on our historical returns by asset
class.
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The following table summarizes the impact of changes in significant actuarial
assumptions on our
Impact of Changes in Actuarial Assumptions
Change in Discount Change in Expected
Rate Return Change in Market Value of Assets
(In thousands) 1% (1)% 1% (1)% 5% (5)%
(Decrease) increase in net
benefit cost $ (6,076 ) $ 7,656 $ (4,578 ) $ 4,578 $ (824 ) $ 824
(Decrease) increase in projected
benefit obligation (79,403 ) 99,473 - - - -
Increase (decrease) in funded
status 79,403 (99,473 ) - - 25,793 (25,793 )
Revenue Recognition. Revenue from the sale of products is recognized when there
is persuasive evidence of an arrangement and control passes to the customer,
which generally occurs either when product is shipped to the customer or, in the
case of most U.S. distributor customers, when product is delivered to the
distributor's delivery site. We establish our shipping terms according to local
practice and market characteristics. We do not ship product unless we have an
order or other documentation authorizing shipment to our customers. Our payment
terms vary by the type and location of our customer and the products offered.
The term between invoicing and when payment is due is not significant.
Revenue is measured as the amount of consideration we expect to receive in
exchange for transferring goods or providing services. Amounts billed and due
from our customers are classified as receivables on the Consolidated Balance
Sheet. We make appropriate provisions for uncollectible accounts receivable
which have historically been insignificant in relation to our net sales. Certain
contracts with customers, primarily distributor customers, have an element of
variable consideration that is estimated when revenue is recognized under the
contract to the extent that it is material to the individual contract. Variable
consideration includes volume incentive rebates, performance guarantees, price
concessions and returns. Rebates are based on achieving a certain level of
purchases and other performance criteria that are documented in established
distributor programs. These rebates are estimated based on projected sales to
the customer and accrued as a reduction of net sales as they are earned by the
customer. The rebate accrual is reviewed monthly and adjustments are made as the
estimate of projected sales changes. Product returns, including an adjustment
for restocking fees if it is material, are estimated based on historical return
experience and revenue is adjusted. Sales, value add and other taxes collected
with revenue-producing activities and remitted to governmental authorities are
excluded from revenue.
Depending on the terms of the arrangement, we may defer revenue for which we
have a future obligation, including training and extended warranty and technical
services, until such time that the obligation has been satisfied. We use an
observable price, or a cost plus margin approach when one is not available, to
determine the stand-alone selling price for separate performance obligations. We
have elected to recognize the cost for shipping and handling as an expense when
control of the product has passed to the customer. These costs are included
within the Cost of Products Sold line on the Consolidated Statement of Income.
Amounts billed to customers for shipping and handling are included in net sales.
We typically receive interim milestone payments under certain contracts,
including our fixed gas and flame detection projects, as work progresses. For
some of these contracts, we may be entitled to receive an advance payment.
Revenue for these contracts is generally recognized as control passes to the
customer, which is a point in time upon shipment of the product, and if
applicable, acceptance by the customer. We recognize a liability for these
advance payments in excess of revenue recognized and present it as contract
liabilities on the Consolidated Balance Sheet. The advance payment is typically
not considered a significant financing component because it is used to meet
working capital demands that can be higher in the early stages of a contract and
to protect us from the other party failing to adequately complete some or all of
its obligations under the contract. In some cases, the customer retains a small
portion of the contract price, typically 10%, until completion of the contract,
which we present as contract assets on the Consolidated Balance Sheet.
Accordingly, during the period of contract performance, billings and costs are
accumulated on the Consolidated Balance Sheet as contract assets or contract
liabilities, but no income is recognized until completion of the project and
control has passed to the customer. As of December 31, 2019 , there were no
material contract assets or contract liabilities recorded on the Consolidated
Balance Sheet.
Goodwill and Indefinite-lived Intangible Assets. On October 1st of each year, or
more frequently if indicators of impairment exist or if a decision is made to
sell a business, we evaluate goodwill for impairment. A significant amount of
judgment is involved in determining if an indicator of impairment has occurred.
Such indicators may include a decline in expected cash flows, a significant
adverse change in the business climate, unanticipated competition, slower growth
rates, or negative developments in equity and credit markets, among others.
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All goodwill is assigned to and evaluated for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment. For goodwill impairment testing purposes, we consider our operating segments to be our reporting units. The evaluation of impairment involves using either a qualitative or quantitative approach as outlined in Accounting Standards Codification (ASC) Topic 350. The qualitative evaluation is an assessment of factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value, including goodwill. Factors considered as part of the qualitative assessment include entity-specific industry, market and general economic conditions. In 2019, we elected to bypass the qualitative evaluation for all of our reporting units and performed a two-step quantitative test atOctober 1, 2019 . Quantitative testing involves comparing the estimated fair value of each reporting unit to its carrying value. We estimate reporting unit fair value using a weighted average of fair values determined by discounted cash flow (DCF) and market approach methodologies, as we believe both are equally important indicators of fair value. A number of significant assumptions and estimates are involved in the application of the DCF model, including sales volumes and prices, costs to produce, tax rates, capital spending, discount rates, and working capital changes. Cash flow forecasts are generally based on approved business unit operating plans for the early years and historical relationships in later years. The betas used in calculating the individual reporting units' weighted average cost of capital (WACC) rate are estimated for each reporting unit based on peer data. The market approach methodology measures value through an analysis of peer companies. The analysis entails measuring the multiples of EBITDA at which peer companies are trading. In the event the carrying value is in excess of the estimated fair value of a reporting unit per the weighted average of the DCF and market approach models, an impairment loss equal to such excess would be recognized, which could materially and adversely affect reported consolidated results of operations and shareholders' equity. AtOctober 1, 2019 , based on our quantitative test, the fair values of all of our reporting units exceeded their carrying value by at least 93%. Intangible assets with indefinite lives are also subject to impairment testing onOctober 1st of each year, or more frequently if indicators of impairment exist. The impairment test compares the fair value of the intangible assets with their carrying amounts. We performed a quantitative assessment of the indefinite lived trade name intangible asset as outlined in ASC 350 by comparing the estimated fair value of the trade name intangible asset to its carrying value. We estimate the fair value using the relief from royalty income approach. A number of significant assumptions and estimates are involved in the application of the relief from royalty model, including sales volumes and prices, royalty rates and tax rates. Forecasts are based on sales generated by the underlying trade name assets and are generally based on approved business unit operating plans for the early years and historical relationships in later years. AtOctober 1, 2019 , based on our quantitative test, the fair value of the trade name asset exceeded their carrying value by approximately 25%. RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING STANDARDS See Note 1-Significant Accounting Policies of the consolidated financial statements in Part II Item 8 of this Form 10-K. 30
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