THE GORMAN-RUPP COMPANY (Amounts in tables in thousands of dollars, except for per share data)
Executive Overview The following discussion of Results of Operations includes certain non-GAAP financial data and measures such as adjusted earnings before interest, taxes, depreciation and amortization and adjusted earnings per share amounts which exclude non-cash pension settlement charges in 2020 and 2018. Management utilizes these adjusted financial data and measures to assess comparative operations against those of prior periods without the distortion of non-comparable factors.The Gorman-Rupp Company believes that these non-GAAP financial data and measures also will be useful to investors in assessing the strength of the Company's underlying operations from period to period. Provided below is a reconciliation of adjusted earnings per share amounts and adjusted earnings before interest, taxes, depreciation and amortization. 2020 2019
2018
Adjusted earnings per share: Reported earnings per share - GAAP basis$ 0.97 $ 1.37 $ 1.53 Plus pension settlement charge 0.14 -
0.08
Non-GAAP adjusted earnings per share
Adjusted earnings before interest, taxes, depreciation and amortization: Reported net income - GAAP basis$ 25,188 $ 35,815 $ 39,979 Plus interest 18 1 1 Plus income taxes 6,058 9,351 10,337 Plus depreciation and amortization 12,692 13,749
14,484
Non-GAAP earnings before interest, taxes, depreciation and amortization 43,956 58,916
64,801
Plus pension settlement charge 4,583 -
2,852
Non-GAAP adjusted earnings before interest, taxes, depreciation and amortization$ 48,539 $ 58,916 $ 67,653 The Gorman-Rupp Company ("we", "our", "Gorman-Rupp" or the "Company") is a leading designer, manufacturer and international marketer of pumps and pump systems for use in diverse water, wastewater, construction, dewatering, industrial, petroleum, original equipment, agriculture, fire protection, heating, ventilating and air conditioning (HVAC), military and other liquid-handling applications. The Company attributes its success to long-term product quality, applications and performance combined with timely delivery and service, and continually seeks to develop initiatives to improve performance in these key areas.
We regularly invest in training for our employees, in new product development and in modern manufacturing equipment, technology and facilities all designed to increase production efficiency and capacity and drive growth by delivering innovative solutions to our customers. We believe that the diversity of our markets is a major contributor to the generally stable financial growth we have produced for more than 85 years. The Company places a strong emphasis on cash flow generation and maintaining excellent liquidity and financial flexibility. This focus has afforded us the ability to reinvest our cash resources and preserve a strong balance sheet to position us for future acquisition and product development opportunities. The Company had no bank debt as ofDecember 31, 2020 . The$154.5 million of aggregate cash generated by operating activities over the past three years was utilized primarily to pay dividends, including a special dividend of$2.00 per share paid onDecember 10, 2018 , and the purchase of productivity-enhancing capital equipment. The Company's cash position increased$27.6 million during 2020 to$108.2 million atDecember 31, 2020 .
The Company generated
Capital expenditures for 2021 are planned to be in the range of$15-$20 million primarily for building improvements and machinery and equipment purchases, and are expected to be financed through internally-generated funds. Net sales for 2020 were$349.0 million compared to$398.2 million for 2019, a decrease of 12.4% or$49.2 million . Domestic sales decreased 10.3% or$28.4 million while international sales decreased 17.0% or$20.8 million compared to 2019. Sales have decreased across most of our markets primarily as a result of the COVID-19 pandemic, along with a slowdown in the oil and gas industry. 15 -------------------------------------------------------------------------------- Gross profit was$89.6 million for 2020, resulting in gross margin of 25.7%, compared to gross profit of$102.7 million and gross margin of 25.8% for 2019. Gross margin decreased 10 basis points largely due to an unfavorable LIFO impact of 60 basis points compared to 2019 and decreased 120 basis points from the loss of leverage on fixed labor and overhead attributable to lower sales volume. Largely offsetting these items were lower material costs of 170 basis points compared to 2019. SG&A expenses were$53.8 million and 15.4% of net sales for 2020 compared to$58.8 million and 14.8% of net sales for 2019. SG&A expenses decreased 8.6% or$5.0 million due to reduced payroll related and travel expenses combined with overall expense management. SG&A expenses as a percentage of sales increased 60 basis points primarily as a result of loss of leverage from lower sales volume. Operating income was$35.8 million for 2020, resulting in an operating margin of 10.2%, compared to operating income of$43.8 million and operating margin of 11.0% for 2019. Operating margin decreased 80 basis points primarily as a result of loss of leverage from lower sales volume. Other income (expense), net was$4.5 million of expense for 2020 compared to income of$1.3 million for the same period in 2019. The increase to expense was due primarily to non-cash pension settlement charges of$4.6 million . Net income was$25.2 million for 2020 compared to$35.8 million in 2019, and earnings per share were$0.97 for 2020 and$1.37 for 2019. Earnings per share in 2020 included a non-cash pension settlement charge of$0.14 per share. In 2019, earnings benefited from a favorable LIFO impact of$0.04 per share. The Company's backlog of orders was$113.1 million atDecember 31, 2020 compared to$105.0 million atDecember 31, 2019 , an increase of 7.7%. Approximately 91% of the Company's backlog of unfilled orders is scheduled to be shipped during 2021, with the remainder principally during the first half of 2022. Incoming orders decreased 8.7% for the full year and decreased 4.3% for the fourth quarter of 2020 compared to the same periods in 2019. Incoming orders were down across most markets the Company serves driven primarily by the COVID-19 pandemic and a slowdown in the oil and gas industry. However, incoming orders for the fourth quarter of 2020 increased 16.0% compared to the third quarter of 2020. OnJanuary 28, 2021 , the Board of Directors authorized the payment of a quarterly dividend of$0.155 per share, representing the 284th consecutive quarterly dividend to be paid by the Company. During 2020, the Company again paid increased dividends and thereby attained its 48th consecutive year of increased dividends. These consecutive years of increases continue to positionGorman-Rupp in the top 50 of allU.S. public companies with respect to number of years of increased dividend payments. The regular dividend yield atDecember 31, 2020 was 1.9%. The Company currently expects to continue its exceptional history of paying regular quarterly dividends and increased annual dividends. However, any future dividends will be reviewed individually and declared by our Board of Directors at its discretion, dependent on our assessment of the Company's financial condition and business outlook at the applicable time. Outlook Despite the unprecedented global challenges of COVID-19, we ended 2020 in strong financial condition and well positioned for the future. While the ongoing impact of the global pandemic on the economy remains uncertain, we are prepared for the eventual recovery. We have continued to focus on our long-term strategic initiatives across our diverse markets, built on our strong inventory position while also maintaining our highly skilled workforce. We begin 2021 with an increase in backlog from the same time last year, however we expect sales during the first half of the year to continue to be challenging due to the worldwide pandemic. During this time we will continue to manage our SG&A expenses, while at the same time remaining focused on initiatives that will contribute to our long term growth. Our balance sheet, cash position and ongoing positive cash flow allow us to continue to look for the right opportunities that will supplement our growth for new and existing products and markets. Our outlook for the longer term remains very positive. 16 --------------------------------------------------------------------------------
Results of Operations - 2020 Compared to 2019:
Net Sales Year Ended December 31, 2020 2019 $ Change % Change Net sales$ 348,967 $ 398,179 $ (49,212 ) (12.4 )% Net sales for 2020 were$349.0 million compared to$398.2 million for 2019, a decrease of 12.4% or$49.2 million . Domestic sales decreased 10.3% or$28.4 million while international sales decreased 17.0% or$20.8 million compared to 2019. Sales have decreased across most of our markets primarily as a result of the COVID-19 pandemic, along with a slowdown in the oil and gas industry. Sales in our water markets decreased 9.4% or$25.9 million in 2020 compared to 2019. Sales in the agriculture market increased$1.5 million . This increase was offset by decreases in the construction market of$11.3 million driven primarily by softness in oil and gas drilling activity. Decreases in the repair market of$5.6 million , municipal market of$5.3 million , and fire protection market of$5.2 million were a result of the COVID-19 pandemic. Sales in our non-water markets decreased 18.9% or$23.3 million in 2020 compared to 2019 primarily as a result of the COVID-19 pandemic, along with reduced demand from midstream and downstream oil and gas customers and softness in oil and gas drilling activity. Sales in the OEM market decreased$8.3 million , sales in the industrial market decreased$7.8 million and sales in the petroleum market decreased$7.2 million . International sales were$102.1 million in 2020 compared to$122.9 million in 2019 and represented 29% and 31% of total sales for the Company, respectively. International sales decreased most notably in the fire protection and all non-water markets.
Cost of Products Sold and Gross Profit
Year Ended
December 31,
2020 2019 $ Change % Change
Cost of products sold $ 259,412 $ 295,504 $ (36,092 ) (12.2 )%
% of Net sales 74.3 % 74.2 %
Gross margin 25.7 % 25.8 %
Gross profit was $89.6 million for 2020, resulting in gross margin of 25.7%,
compared to gross profit of $102.7 million and gross margin of 25.8% for 2019.
Gross margin decreased 10 basis points largely due to an unfavorable LIFO impact
of 60 basis points compared to 2019 and decreased 120 basis points from the loss
of leverage on fixed labor and overhead attributable to lower sales volume.
Largely offsetting these items were lower material costs of 170 basis points
compared to 2019.
17--------------------------------------------------------------------------------
Selling, General and Administrative (SG&A) Expenses
Year Ended
December 31,
2020 2019 $ Change % Change
Selling, general and administrative expenses $ 53,802 $ 58,835 $ (5,033 ) (8.6 )%
% of Net sales 15.4 % 14.8 %
SG&A expenses were $53.8 million and 15.4% of net sales for 2020 compared to
$58.8 million and 14.8% of net sales for 2019. SG&A expenses decreased 8.6% or
$5.0 million due to reduced payroll related and travel expenses combined with
overall expense management. SG&A expenses as a percentage of sales increased 60
basis points primarily as a result of loss of leverage from lower sales volume.
Operating Income
Year Ended
December 31,
2020 2019 $ Change % Change
Operating income $ 35,753 $ 43,840 $ (8,087 ) (18.4 )%
% of Net sales 10.2 % 11.0 %
Operating income was $35.8 million for 2020, resulting in an operating margin of
10.2%, compared to operating income of $43.8 million and operating margin of
11.0% for 2019. Operating margin decreased 80 basis points primarily as a result
of loss of leverage from lower sales volume.
Net Income
Year Ended
December 31,
2020 2019 $ Change % Change
Income before income taxes $ 31,246 $ 45,166 $ (13,920 ) (30.8 )%
% of Net sales 8.9 % 11.3 %
Income taxes $ 6,058 $ 9,351 $ (3,293 ) (35.2 )%
Effective tax rate 19.4 % 20.7 %
Net income $ 25,188 $ 35,815 $ (10,627 ) (29.7 )%
% of Net sales 7.2 % 9.0 %
Earnings per share $ 0.97 $ 1.37 $ (0.40 ) (29.2 )%
The Company's effective tax rate was 19.4% for 2020 compared to 20.7% for 2019.
The effective tax rate for 2020 was impacted by an increased benefit from
credits and permanent items over a lower pretax income as well as a favorable
tax rate benefit on foreign operations. We expect our effective tax rate for
2021 to be between 21.0% and 23.0%.
The decrease of $10.6 million in net income in 2020 compared to 2019 was due
primarily to lower sales volume and a non-cash pension settlement charge of $3.7
million net of income taxes. Net income in 2019 included a favorable LIFO impact
of $0.9 million .
Earnings per share in 2020 included a non-cash pension settlement charge of
18
--------------------------------------------------------------------------------Results of Operations - 2019 Compared to 2018:
Net Sales Year Ended December 31, 2019 2018 $ Change % Change Net sales$ 398,179 $ 414,334 $ (16,155 ) (3.9 )% Net sales for 2019 were$398.2 million compared to$414.3 million for 2018, a decrease of 3.9% or$16.1 million . Domestic sales increased 1.3% or$3.5 million while international sales decreased 13.8% or$19.6 million compared to 2018. Of the total decrease in net sales during 2019,$2.9 million was due to unfavorable currency translation. Sales in our water markets decreased 4.1% or$11.7 million in 2019 compared to 2018. Sales in the municipal market increased$3.7 million due primarily to large volume custom pumps for flood control, and sales in the repair market increased$0.4 million . This increase was offset by decreased sales in the fire protection market of$9.6 million driven primarily by softness in international markets and decreased sales in the construction market of$4.2 million driven primarily by softness in the upstream oil and gas activity. In addition, sales in the agriculture market decreased$2.0 million . Sales in our non-water markets decreased 3.5% or$4.4 million in 2019 compared to 2018. Sales in the petroleum market increased$1.7 million driven primarily by midstream and downstream oil and gas customers. This increase was offset by decreased sales in the industrial market and OEM market of$4.4 million and$1.7 million , respectively, due primarily to reduced capital spending related to oil and gas. International sales were$122.9 million in 2019 compared to$142.5 million in 2018 and represented 31% and 34% of total sales for the Company, respectively. International sales decreased most notably in the fire protection, construction and municipal markets.
Cost of Products Sold and Gross Profit
Year Ended
December 31,
2019 2018 $ Change % Change
Cost of products sold $ 295,504 $ 304,413 $ (8,909 ) (2.9 )%
% of Net sales 74.2 % 73.5 %
Gross margin 25.8 % 26.5 %
Gross profit was $102.7 million for 2019, resulting in gross margin of 25.8%,
compared to gross profit of $109.9 million and gross margin of 26.5% for 2018.
Gross margin decreased 70 basis points largely as a result of loss of leverage
on fixed labor and overhead from lower sales volume, and higher healthcare costs
of 50 basis points. Partially offsetting these items was a favorable LIFO impact
of 130 basis points compared to 2018 due to lower inventory levels as compared
to amounts in inventory at December 31, 2018 .
Selling, General and Administrative (SG&A) Expenses
Year Ended
December 31,
2019 2018 $ Change % Change
Selling, general and administrative expenses $ 58,835 $ 59,282 $ (447 ) (0.8 )%
% of Net sales 14.8 % 14.3 %
SG&A expenses were $58.8 million and 14.8% of net sales for 2019 compared to
$59.3 million and 14.3% of net sales for 2018. In 2018, a special cash bonus
paid to all employees impacted SG&A expenses by $1.3 million or 30 basis points.
Excluding this special cash bonus, SG&A expenses increased slightly by 1.4% or
$0.8 million and increased 80 basis points as a percentage of sales primarily as
a result of loss of leverage from lower sales volume.
19
--------------------------------------------------------------------------------
Operating Income
Year Ended
December 31,
2019 2018 $ Change % Change
Operating income $ 43,840 $ 50,639 $ (6,799 ) (13.4 )%
% of Net sales 11.0 % 12.2 %
Operating income was $43.8 million for 2019, resulting in an operating margin of
11.0%, compared to operating income of $50.6 million and operating margin of
12.2% for 2018. In 2018, a special cash bonus paid to all employees impacted
operating margin by $1.3 million or 30 basis points. Excluding this special cash
bonus, operating margin decreased 150 basis points primarily as a result of loss
of leverage from lower sales volume and higher healthcare costs of 70 basis
points, partially offset by a favorable LIFO impact of 130 basis points.
Net Income
Year Ended
December 31,
2019 2018 $ Change % Change
Income before income taxes $ 45,166 $ 50,316 $ (5,150 ) (10.2 )%
% of Net sales 11.3 % 12.1 %
Income taxes $ 9,351 $ 10,337 $ (986 ) (9.5 )%
Effective tax rate 20.7 % 20.5 %
Net income $ 35,815 $ 39,979 $ (4,164 ) (10.4 )%
% of Net sales 9.0 % 9.6 %
Earnings per share $ 1.37 $ 1.53 $ (0.16 ) (10.5 )%
The Company's effective tax rate increased slightly to 20.7% for 2019 from 20.5%
for 2018. The effective tax rate for 2019 benefitted by 100 basis points
primarily from higher research and development tax credits. The effective tax
rate for 2018 benefited by 120 basis points from pension plan contributions
eligible for tax deduction at the 35.0% federal corporate tax rate for 2017
rather than the 21.0% rate for 2018.
The decrease in net income in 2019 compared to 2018 was due primarily to lower
international sales volume and a slowdown in oil and gas related spending. Net
income in 2019 included a favorable LIFO impact of $0.9 million , net of income
taxes. Net income in 2018 included an unfavorable LIFO impact of $3.1 million ,
net of income taxes, a non-cash pension settlement charge of $2.2 million , net
of income taxes, and a special cash bonus paid to all employees of $1.0 million ,
net of income taxes.
Earnings per share for 2019 included a favorable LIFO impact of $0.04 per share.
Earnings per share for 2018 included an unfavorable LIFO impact of $0.12 per
share, non-cash pension settlement charges of $0.08 per share and a special cash
bonus paid to all employees with an impact of $0.04 per share.
Liquidity and Sources of Capital
Cash and cash equivalents totaled$108.2 million and there was no outstanding bank debt atDecember 31, 2020 . In addition, atDecember 31, 2020 , the Company had$24.5 million of borrowing capacity available in bank lines of credit after deducting$6.5 million in outstanding letters of credit primarily related to customer orders. The Company was in compliance with its debt covenants, including limits on additional borrowings and maintenance of certain operating and financial ratios, at all times in 2020 and 2019. 20 -------------------------------------------------------------------------------- Capital expenditures for 2021, which are expected to consist principally of machinery and equipment purchases and building improvements, are estimated to be in the range of$15 -$20 million and are expected to be financed through internally generated funds. During 2020, 2019 and 2018, the Company financed its capital improvements and working capital requirements principally through internally generated funds.
We expect to continue to generate cash in excess of our operating needs. We believe we have adequate funds on hand and sufficient borrowing capacity to execute our financial and operating strategy.
The Company expects to contribute up to
Free cash flow, a non-GAAP measure for reporting cash flow, is defined by the Company as adjusted earnings before interest, income taxes and depreciation and amortization, less capital expenditures and dividends. The Company believes free cash flow provides investors with an important perspective on cash available for investments, acquisitions and working capital requirements.
The following table reconciles adjusted earnings before interest, income taxes and depreciation and amortization as reconciled above to free cash flow:
2020 2019 2018
Non-GAAP adjusted earnings before interest, taxes, depreciation and amortization$ 48,539 $ 58,916 $ 67,653 Less capital expenditures (7,999 ) (10,912 ) (10,947 ) Less cash dividends (15,394 ) (14,370 ) (65,551 ) Non-GAAP free cash flow$ 25,146 $ 33,634 $ (8,845 ) Financial Cash Flow Year Ended December 31, 2020 2019 2018 Beginning of period cash and cash equivalents$ 80,555 $ 46,458 $ 79,680 Net cash provided by operating activities 51,162 62,174
41,210
Net cash used for investing activities (7,704 ) (10,847 ) (7,468 ) Net cash used for financing activities (16,136 ) (17,363 ) (65,551 ) Effect of exchange rate changes on cash 326 133 (1,413 ) Net increase (decrease) in cash and cash equivalents 27,648 34,097 (33,222 ) End of period cash and cash equivalents$ 108,203 $ 80,555 $ 46,458 The change in cash provided by operating activities in 2020 compared to 2019 was primarily due to lower income in 2020 compared to 2019 driven by decreased sales. Cash outflows increased due to a reduction in accounts payable primarily from reduced SG&A spend, increased inventory to prepare for customer demand, and increased pension contributions. These cash outflows were offset by cash inflows from reduced accounts receivable driven by decreased sales and a higher deferred tax provision. The change in cash provided by operating activities in 2019 compared to 2018 was primarily due to lower inventories driven by a planned inventory reduction and a decrease in accounts receivable driven by lower sales volume. In addition, prepaid income taxes decreased and the Company did not make any pension contributions in 2019. These positive effects on cash flow were offset by a decrease in commissions payable driven by lower sales volume. 21 -------------------------------------------------------------------------------- During 2020, investing activities of$7.7 million primarily consisted of$8.0 million of capital expenditures for buildings, machinery and equipment. During 2019, investing activities of$10.8 million primarily consisted of$10.9 million of capital expenditures for buildings, machinery and equipment. During 2018, investing activities of$7.5 million primarily consisted of a$3.0 million decrease in short-term investments and$10.9 million of capital expenditures for machinery and equipment offset by$0.5 million of proceeds from the sale of property, plant and equipment. During 2020, financing activities of$16.1 million consisted of dividend payments of$15.4 million . During 2019, financing activities of$17.4 million consisted of dividend payments of$14.4 million and a privately-arranged market value purchase of Company shares in the amount of$2.5 million from a Rupp family estate. Net cash used for financing activities consisted of dividend payments of$65.6 million during 2018, including$52.2 million related to a special dividend. The Company currently expects to continue its exceptional history of paying regular quarterly dividends and increased annual dividends. However, any future dividends will be reviewed individually and declared by our Board of Directors at its discretion, dependent on our assessment of the Company's financial condition and business outlook at the applicable time. Contractual Obligations Capital commitments in the table below include contractual commitments to purchase machinery and equipment that have been approved by the Board of Directors. The capital commitments do not represent the entire anticipated purchases in the future, but represent only those substantive items for which the Company is contractually obligated as ofDecember 31, 2020 . Also, the Company has operating leases and two financing leases for certain offices, manufacturing facilities, land, office equipment and automobiles. Rental expenses relating to these leases were$0.9 million in 2020 and$1.0 million in both 2019 and 2018. The following table summarizes the Company's contractual obligations atDecember 31, 2020 : Payment Due By Period Less More than 1-3 3-5 than Total 1 Year Years Years 5 Years Capital commitments$ 27 $ 27 $ - $ - $ - Leases 1,750 751 895 98 6 Total$ 1,777 $ 778 $ 895 $ 98 $ 6
Critical Accounting Policies
The accompanying Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted inthe United States . When more than one accounting principle, or the method of its application, is generally accepted, management selects the principle or method that is appropriate in the Company's specific circumstances. Application of these accounting principles requires management to make estimates about the future resolution of existing uncertainties; as a result, actual results could differ from these estimates. In preparing these Consolidated Financial Statements, management has made its best estimates and judgments of the amounts and disclosures included in the Consolidated Financial Statements, giving due regard to materiality. The Company does not believe there is a great likelihood that materially different amounts would be reported under different conditions or using different assumptions pertaining to the accounting policies described below. 22 --------------------------------------------------------------------------------
Revenue Recognition
The Company accounts for revenue in accordance with Accounting Standards
Codification ("ASC") 606, "Revenue from Contracts with Customers," under which
the unit of account is a performance obligation. Substantially all of our
revenue is derived from fixed-price customer contracts and the majority of our
customer contracts have a single performance obligation. A performance
obligation is a promise in a contract to transfer a distinct good or service to
a customer. For customer contracts with multiple performance obligations, the
Company allocates revenue to each performance obligation based on its relative
standalone selling price, which is generally determined based on standalone
selling prices charged to customers or using expected cost plus margin.
The transaction price for a customer contract is allocated to each distinct performance obligation and recognized as revenue when, or as, the Company's performance obligation is satisfied. All of the Company's performance obligations, and associated revenue, are generally satisfied at a point in time, with the exception of certain highly customized pump products, which are satisfied over time as work progresses.
Accounting for long-term contracts involves the use of various techniques to estimate total contract revenue and costs. For long-term contracts, the Company estimates the profit on a contract as the difference between the total estimated revenue and expected costs to complete a contract and recognizes that profit as performance obligations are satisfied. Contract estimates are based on various assumptions to project the outcome of future events that could span longer than one year. These assumptions include labor productivity and availability, the complexity of the work to be performed, the cost and availability of materials and the performance of subcontractors as applicable. As a significant change in one or more of these estimates could affect the profitability of our contracts, the Company reviews and updates its contract-related estimates regularly. Adjustments in estimated profit on contracts are accounted for under the cumulative catch-up method. Under this method, the impact of the adjustment on profit recorded to date on a contract is recognized in the period the adjustment is identified. Revenue and profit in future periods of contract performance are recognized using the adjusted estimate.
Allowance for Doubtful Accounts
The Company evaluates the collectability of its accounts receivable based on a combination of factors including both current and historical information. In circumstances where the Company is aware of a specific customer's inability to meet its financial obligations to the Company (e.g., bankruptcy filings, substantial downgrading of credit scores), the Company records a specific allowance for bad debts against amounts due to reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company recognizes allowances for bad debts primarily based on the length of time the receivables are past due. If circumstances change (e.g., an unexpected material adverse change in a large customer's ability to meet its financial obligations), the Company's estimates of the recoverability of amounts due could be reduced by a material amount. Historically, the Company's collection history has been good.
Inventories and Related Allowance
Inventories are valued at the lower of cost or market value and have been reduced by an allowance for excess and obsolete inventories. The estimated allowance is based on a variety of factors, including historical inventory usage and management evaluations. Historically, the Company has not experienced substantive write-offs due to obsolescence. The Company uses the last-in, first-out (LIFO) method for the majority of its inventories.
23
--------------------------------------------------------------------------------Product Warranties
A liability is established for estimated future warranty and service claims based on historical claims experience and specific product failures.
Pension Plan and Other Postretirement Benefit Plans
The Company recognizes the obligations associated with its defined benefit pension plan and defined benefit health care plans in its Consolidated Financial Statements. The measurement of liabilities related to its pension plan and other postretirement benefit plans is based on management's assumptions related to future events including interest rates, return on pension plan assets, rate of compensation increases and health care cost trend rates. Actual pension plan asset performance will either reduce or increase pension losses included in Accumulated other comprehensive loss, which ultimately affects net income. The discount rates used to determine the present value of future benefits are based on estimated yields of investment grade fixed income investments. The discount rates used to value pension plan obligations were 1.97% and 2.83% atDecember 31, 2020 and 2019, respectively. The discount rates used to value postretirement obligations were 2.25% and 3.08% atDecember 31, 2020 and 2019, respectively. The discount rates were determined by constructing a zero-coupon spot yield curve derived from a universe of high-quality bonds as of the measurement date. The expected rate of return on pension assets is designed to be a long-term assumption that will be subject to year-to-year variability. The rate for 2020 was 5.36% and 2019 was 5.37%. Actual pension plan asset performance will either reduce or increase unamortized losses included in Accumulated other comprehensive loss, which will ultimately affect net income. The assumed rate of compensation increase was 3.50% in 2020 and 2019. Substantially all retirees elect to take lump sum settlements of their pension plan benefits. When interest rates are low as they have been the last five years, this subjects the Company to the risk of exceeding an actuarial threshold computed on an annual basis and triggering a GAAP-required non-cash pension settlement loss, which occurred in 2020 and 2018.
The assumption used for the rate of increase in medical costs over the next five years was 5% in 2020 and unchanged in 2019.
Income Taxes InJanuary 2018 , FASB released guidance on accounting for the global intangible low-taxed income ("GILTI") tax. The guidance indicates that either accounting for deferred taxes related to GILTI tax inclusions or treating the GILTI tax as a period cost are both acceptable methods subject to an accounting policy election. The Company has elected to account for the GILTI tax in the period in which it is incurred. The basic principles related to accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity's financial statements or tax returns. Realization of the Company's deferred tax assets is principally dependent upon the Company's achievement of projected future taxable income, which management believes will be sufficient to fully utilize the deferred tax assets recorded, with the exception of deferred tax associated with certain state tax credits for which a valuation allowance has been recognized. The Company is subject to income taxes in theU.S. federal and various state, local and foreign jurisdictions. Income tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few exceptions, the Company is no longer subject toU.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for the years before 2016. 24 -------------------------------------------------------------------------------- The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense for all periods presented. The Company accrued approximately$0.2 million ,$0.3 million and$0.2 million for the payment of interest and penalties atDecember 31, 2020 , 2019 and 2018, respectively.
The Company accounts for goodwill in a purchase business combination as the excess of the cost over the fair value of net assets acquired. Business combinations can also result in other intangible assets being recognized. Amortization of intangible assets, if applicable, occurs over their estimated useful lives.
Goodwill is tested annually for impairment as ofOctober 1 , or whenever events or changes in circumstances indicate there may be a possible permanent loss of value in accordance with ASC 350, "Intangibles -Goodwill and Other."Goodwill is tested for impairment at the reporting unit level and is based on the net assets for each reporting unit, including goodwill and intangible assets. The Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing a quantitative impairment assessment is unnecessary. In assessing the qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we identify and assess relevant drivers of fair value and events and circumstances that may impact the fair value and the carrying amount of the reporting unit. The identification of relevant events and circumstances and how these may impact a reporting unit's fair value or carrying amount involve significant judgments and assumptions. The judgments and assumptions include the identification of macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, Company-specific events and share price trends and making the assessment on whether each relevant factor will impact the impairment test positively or negatively and the magnitude of any such impact. When performing a quantitative assessment of goodwill impairment if necessary, or in years where we elect to do so, a discounted cash flow model is used to estimate the fair value of each reporting unit, which considers forecasted cash flows discounted at an estimated weighted-average cost of capital. The forecasted cash flows are based on the Company's long-term operating plan and the weighted-average cost of capital is an estimate of the overall after-tax rate of return. Other valuation techniques including comparative market multiples are used when appropriate. Discount rate assumptions are based on an assessment of the risk inherent in the future cash flows of the respective reporting units. The Company performed a qualitative analyses as ofOctober 1, 2020 and 2019 for all of its reporting units except for one and concluded that it is more likely than not that the fair value of the reporting units continues to exceed the respective carrying amounts. The Company performed a quantitative impairment analysis as ofOctober 1, 2020 for theNational Pump Company ("National") reporting unit and concluded that National's fair value exceeded its carrying value by approximately 31% and therefore was not impaired. A sensitivity analysis was performed for the National reporting unit, assuming a hypothetical 100 basis point decrease in the expected long-term growth rate or a hypothetical 100 basis point increase in the weighted average cost of capital, and both scenarios independently yielded an estimated fair value for the National reporting unit above carrying value. If National fails to experience growth or revises its long-term projections downward, it could be subject to impairment charges in the future.Goodwill relating to the National reporting unit is$13.6 million , 3.4% of the Company'sDecember 31, 2020 total assets. See Note 10 to the Consolidated Financial Statements,Goodwill and Other Intangible Assets. 25 -------------------------------------------------------------------------------- Other indefinite-lived intangible assets primarily consist of trademarks and trade names. The fair value of these assets is also tested annually for impairment as ofOctober 1 , or whenever events or changes in circumstances indicate there may be a possible permanent loss of value. The fair value of these assets is determined using a royalty relief methodology similar to that employed when the associated assets were acquired, but using updated estimates of future sales, cash flows and profitability. For 2020 and 2019, the fair value of all indefinite lived intangible assets exceeded the respective carrying values. Finite-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount may not be recovered through future net cash flows generated by the assets. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future net undiscounted cash flows estimated to be generated by such assets. The Company was not aware of any events or changes in circumstances that indicate the carrying value of its finite-lived assets may not be recoverable. See Note 10 to the Consolidated Financial Statements,Goodwill and Other Intangible Assets. Other Matters
Certain transactions with related parties occur in the ordinary course of business and are not considered to be material to the Company's consolidated financial position, net income or cash flows.
The Company does not have any off-balance sheet arrangements, financings or other relationships with unconsolidated "special purpose entities."
The Company is not a party to any long-term debt agreements, or any material leases or purchase obligations.
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