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COLFAX CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide a reader of our financial statements with a narrative from the perspective of Company's management. This MD&A is divided into four main sections: ?Overview ?Results of Operations ?Liquidity and Capital Resources ?Critical Accounting Policies The following MD&A should be read together with Item 6. "Selected Financial Data", Part I, Item 1A. "Risk Factors" and the accompanying Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this Form 10-K. The MD&A includes forward-looking statements. For a discussion of important factors that could cause actual results to differ materially from the results referred to in these forward-looking statements, see "Special Note Regarding Forward-Looking Statements." Overview Please see Part I, Item 1. "Business" for a discussion of Colfax's objectives and methodologies for delivering shareholder value. We report our operations through the following reportable segments: • Gas & Fluid Handling - a global supplier of a broad range of gas- and fluid-handling products, including pumps, fluid-handling systems and controls, specialty valves, heavy-duty centrifugal and axial fans, rotary heat exchangers and gas compressors, which serves customers in the power generation, oil, gas and petrochemical, mining, marine (including defense) and general industrial and other end markets; and • Fabrication Technology - a global supplier of welding equipment and consumables, cutting equipment and consumables and automated welding and cutting systems. Certain amounts not allocated to the two reportable segments and intersegment eliminations are reported under the heading "Corporate and other." Colfax has a global geographic footprint, with production facilities in Europe, North America, South America, Asia, Australia and Africa. Through our reportable segments, we serve a global customer base across multiple markets through a combination of direct sales and third-party distribution channels. Our customer base is highly diversified and includes commercial, industrial and government customers. We employ a comprehensive set of tools that we refer to as CBS. CBS, modeled on the Danaher Business System, is our business management system. It is a repeatable, teachable process that we use to create superior value for our customers, shareholders and associates. Rooted in our core values, it is our culture. CBS provides the tools and techniques to ensure that we are continuously improving our ability to meet or exceed customer requirements on a consistent basis. Outlook We believe that we are well positioned to grow our businesses organically over the long term by enhancing our product offerings and expanding our customer base. Our business mix is expected to be well balanced between long- and short-cycle businesses, sales in emerging markets and developed nations and fore- and aftermarket products and services. Given this balance, management no longer uses indices other than general economic trends to predict the overall outlook for the Company. Instead, the individual businesses monitor key competitors and customers, including to the extent possible their sales, to gauge relative performance and outlook for the future. We face a number of challenges and opportunities, including the successful integration of new acquisitions, application and expansion of our CBS tools to improve margins and working capital management, rationalization of assets and back office functions, and consolidation of manufacturing facilities. 24 -------------------------------------------------------------------------------- We expect to continue to grow as a result of strategic acquisitions. We believe that the extensive experience of our leadership team in acquiring and effectively integrating acquisition targets should enable us to capitalize on opportunities in the future. Results of Operations The following discussion of Results of Operations addresses the comparison of the periods presented. The Company's management evaluates the operating results of each of its reportable segments based upon Net sales and segment operating income (loss), which represents Operating income before Restructuring and other related charges. Items Affecting Comparability of Reported Results Our financial performance and growth are driven by many factors, principally our ability to serve global markets, fluctuations in the relationship of foreign currencies to the U.S. dollar, general economic conditions, the global economy and capital spending levels, the availability of capital, our estimates concerning the availability of insurance proceeds to cover asbestos litigation expense and liabilities, the amount of asbestos liabilities and litigation expense, the impact of restructuring initiatives, our ability to pass cost increases on through pricing, the impact of sales mix, and our ability to continue to grow through acquisitions. These key factors have impacted our results of operations in the past and are likely to affect them in the future. Global Operations Our products and services are available worldwide. The manner in which our products and services are sold differs by region. During 2013, approximately 82% of our sales were shipped to locations outside of the U.S. Accordingly, we are affected by levels of industrial activity and economic and political factors in countries throughout the world. Our ability to grow and our financial performance will be affected by our ability to address a variety of challenges and opportunities that are a consequence of our global operations, including efficiently utilizing our global sales, manufacturing and distribution capabilities, the expansion of market opportunities in Asia, successfully completing global strategic acquisitions and engineering innovative new product applications for end users in a variety of geographic markets. However, we believe that our geographic, end market and product diversification may limit the impact that any one country or economy could have on our consolidated results. Foreign Currency Fluctuations A significant portion of our Net sales, approximately 80% for the year ended December 31, 2013 is derived from operations outside the U.S., with the majority of those sales denominated in currencies other than the U.S. dollar. Because much of our manufacturing and employee costs are outside the U.S., a significant portion of our costs are also denominated in currencies other than the U.S. dollar. Changes in foreign exchange rates can impact our results of operations and are quantified when significant to our discussion. Venezuela devalued its currency related to the U.S. dollar numerous times, and may do so again in the future. We consider the Venezuelan bolivar fuerte a highly inflationary currency under GAAP. Additionally, during the first quarter of 2014, Argentina devalued its currency relative to the U.S. dollar, which has resulted in the Argentine peso to also be considered a highly inflationary currency under GAAP. We expect to be subject to foreign currency translation losses during the first quarter of 2014 as a result of the devaluation of the Argentine peso. We may be subject to additional foreign currency translation losses depending upon whether Venezuela further devalues the bolivar, movements in exchange rates between these highly inflationary currencies and the parents' reporting currency and the amount of monetary assets and liabilities included in the balance sheets of our operations denominated in currencies considered to be highly inflationary. Economic Conditions Demand for our products depends on the level of new capital investment and planned maintenance by our customers. The level of capital expenditures depends, in turn, on the general economic conditions as well as access to capital at reasonable cost. While demand can be cyclical, we believe that our diversified operations limit the impact of a downturn in any one market on our consolidated results. Seasonality As our gas- and fluid-handling customers seek to fully utilize capital spending budgets before the end of the year, historically our shipments have peaked during the fourth quarter. Also, all of our European operations typically experience a slowdown during the July and August and December holiday season. General economic conditions may, however, impact future seasonal variations. 25 --------------------------------------------------------------------------------Pricing We believe our customers place a premium on quality, reliability, availability, design and application engineering support. Our highly engineered gas- and fluid-handling products typically have higher margins than products with commodity-like qualities. However, we are sensitive to price movements in our raw materials supply base. Our largest material purchases are for components and raw materials including steel, iron, copper and aluminum. Historically, we have been generally successful in passing raw material price increases on to our customers. While we seek to take actions to manage this risk, including commodity hedging where appropriate, such increased costs may adversely impact earnings. Sales and Cost Mix Our profit margins vary in relation to the relative mix of many factors, including the type of product, the geographic location in which the product is manufactured, the end market for which the product is designed, and the percentage of total revenue represented by consumables and aftermarket sales and services. Consumables are generally sold at lower margins in comparison to our foremarket products and equipment, whereas our aftermarket business, including spare parts and other value added services, is generally a higher margin business. Beginning in 2012, our mix of consumables and aftermarket products and services was significantly impacted by the Charter Acquisition. The mix of sales was as follows for the periods presented: Year Ended December 31, 2013 2012 2011 Foremarket and equipment 47 % 45 % 78 % Aftermarket and consumables 53 % 55 % 22 % Strategic Acquisitions We complement our organic growth with strategic acquisitions. Acquisitions can significantly affect our reported results and can complicate period to period comparisons of results. As a consequence, we report the change in our Net sales between periods both from existing and acquired businesses. Orders and order backlog are presented only for the gas- and fluid-handling segment, where this information is relevant. The change in Net sales due to acquisitions represents the change in sales due to the following acquisitions: On January 13, 2012, Colfax completed the Charter Acquisition for a total purchase price of approximately $2.6 billion. Charter is a global industrial manufacturing company focused on welding, cutting and automation and air and gas handling. The impact of the additional 12 days of operations is included in the change in Net sales due to acquisitions, in 2013. Gas and Fluid Handling On February 14, 2011, Colfax completed the acquisition of Rosscor for $22.3 million, net of cash acquired. Rosscor is a supplier of multiphase pumping technology and certain other highly engineered fluid-handling systems, with its primary operations based in Hengelo, The Netherlands. On March 28, 2011, Howden completed the acquisition of Thomassen Compression Systems BV ("Thomassen"), a leading supplier of high-powered engineered compressors to the oil, gas and petrochemical end market, for approximately €100 million. On December 6, 2011, Colfax completed the acquisition of COT-Puritech for a total purchase price, net of cash acquired, of $39.4 million which includes the fair value of estimated additional contingent cash payments of $4.3 million at the acquisition date. The additional contingent cash payments are to be paid over two years from the acquisition date subject to the achievement of certain performance goals. COT-Puritech is a national supplier of oil flushing and remediation services to power generation plants, refinery and petrochemical operations and other manufacturing sites, with its primary operations based in Canton, Ohio. 26 -------------------------------------------------------------------------------- On September 13, 2012, Colfax completed the acquisition of Co-Vent for $34.6 million. Co-Vent specializes in the custom design, manufacture, and testing of industrial fans, with its primary operations based in Quebec, Canada. As a result of this acquisition, Colfax has expanded its product offerings in the industrial fan market. On July 9, 2013, Colfax completed the acquisition of the common stock of Clarus for $13.2 million, which includes the fair value of an estimated additional contingent cash payment of $2.5 million at the acquisition date. The additional contingent payment will be paid during the year ending December 31, 2016 subject to the achievement of certain performance goals. Clarus is a domestic supplier of flushing services for marine applications primarily to U.S. government agencies, with primary operations based in Bellingham, Washington. On September 30, 2013, the Company completed the acquisitions of TLT-Babcock and Alphair for an aggregate purchase price of $55.7 million. TLT-Babcock and Alphair are suppliers of heavy duty and industrial fans in Akron, Ohio and Winnepeg, Ontario, respectively. On November 1, 2013, the Company completed the acquisition of ?KDK for $69.4 million, including the assumption of debt. ?KDK is a leading supplier of multi-stage centrifugal compressors to the oil & gas, petrochemical, power and steel industries, based in Prague, Czech Republic. On November 25, 2013, the Company increased its ownership of Sicelub, previously a less than wholly owned subsidiary in which the Company did not have a controlling interest, from 44% to 100%. Sicelub provides flushing services to Central and South American customers primarily in the oil, gas and petrochemical end market. On November 29, 2013, the Company completed the acquisition of GII for $246.0 million, including the assumption of debt, subject to certain adjustments. GII has operations around the world and will expand the Company's product offerings in the heavy duty industrial and cooling fan market. Fabrication Technology On March 3, 2011, ESAB completed the acquisition of LLC Sychevsky Electrodny Zavod ("Sychevsky"), a leading Russian electrode manufacturer based in the Smolensk region for $19.2 million. On July 1, 2011, ESAB acquired 60% of Condor Equipamentos Industriais Ltda ("Condor"), a leading Brazilian manufacturer of gas apparatus used in welding applications, for cash consideration of R$25.2 million. In May 2012, Colfax acquired the remaining 83.7% of Sibes not already owned by its ESAB business for $8.5 million, including the assumption of debt. Sibes is a leading supplier of welding electrodes to customers in Eastern Russia and strengthens ESAB's position in the attractive Russian welding consumables market, particularly in the energy and natural resources end markets. On October 31, 2012, Colfax completed the acquisition of approximately 91% of the outstanding common and investment shares of Soldex for $187.2 million. Soldex is organized under the laws of Peru and complements our existing fabrication technology segment by supplying welding products from its plants in Colombia and Peru. On August 5, 2013, Colfax completed a $14.9 million tender offer for common and investment shares of Soldex resulting in an increase in our ownership of the subsidiary from approximately 91% to 99%. 27 --------------------------------------------------------------------------------Sales, Orders and Backlog Our Net sales increased from Net sales of $3.9 billion in 2012 to $4.2 billion in 2013. The following tables present components of our consolidated Net sales and, for our gas- and fluid-handling segment, order and backlog growth: Net Sales Orders(1) Backlog at Period End $ % $ % $ % (In millions) As of and for the year ended December 31, 2012 $ 3,913.9 $ 1,996.0 $ 1,431.5 Components of Change: Existing businesses(2) 107.5 2.7 % (15.3 ) (0.8 )% (58.6 ) (4.1 )% Acquisitions(3) 246.9 6.3 % 96.4 4.8 % 231.2 16.2 % Foreign currency translation(4) (61.1 ) (1.5 )% (15.7 ) (0.7 )% (26.7 ) (1.9 )% 293.3 7.5 % 65.4 3.3 % 145.9 10.2 % As of and for the year ended December 31, 2013 $ 4,207.2 $ 2,061.4 $ 1,577.4 (1) Represents contracts for products or services, net of cancellations for the period, for our gas- and fluid-handling operating segment. (2) Excludes the impact of foreign exchange rate fluctuations and acquisitions, thus providing a measure of growth due to factors such as price, product mix and volume. (3) Represents the incremental sales and orders as a result of our acquisitions of Charter, Soldex, Co-Vent, Clarus, ?KDK, TLT-Babcock, Alphair, GII and Sicelub. The impact related to the Charter Acquisition represents 12 days of activity for ESAB and Howden as the acquisition closed on January 13, 2012. Represents the incremental order backlog as a result of our acquisitions of Clarus, ?KDK, GII, TLT-Babcock, Alphair and Sicelub. (4) Represents the difference between prior year sales and orders valued at the actual prior year foreign exchange rates and prior year sales and orders valued at current year foreign exchange rates. The increase in Net sales from existing businesses during 2013 compared to 2012 was attributable to an increase of $138.1 million in our gas- and fluid-handling segment, offset by a decrease of $30.6 million in our fabrication technology segment. Orders, net of cancellations, from existing businesses for our gas- and fluid-handling segment decreased during 2013 in comparison to 2012 due to decreases in the oil, gas and petrochemical, mining and general industrial and other end markets, offset by increases in the power generation and marine end markets. For 2012, our consolidated Net sales increased from proforma net sales of $3.8 billion in 2011 to $3.9 billion (which excludes operations acquired in the Charter Acquisition for the first 12 days of each annual period presented). The following tables present components of our proforma consolidated Net sales and, for our gas- and fluid-handling segment, proforma order and backlog growth: Net Sales Orders(1) Backlog at Period End $ % $ % $ % (In millions) Proforma as of and for the year ended December 31, 2011 $ 3,839.1 $ 1,924.6 $ 1,288.3 Components of Change: Existing businesses(2) 202.2 5.3 % 54.0 2.8 % 117.5 9.1 % Acquisitions(3) 86.5 2.2 % 100.4 5.2 % 9.4 0.7 % Foreign currency translation(4) (213.9 ) (5.6 )% (83.0 ) (4.3 )% 16.3 1.3 % 74.8 1.9 % 71.4 3.7 % 143.2 11.1 % As of and for the year ended December 31, 2012 $ 3,913.9 $ 1,996.0 $ 1,431.5 __________(1) Represents contracts for products or services, net of cancellations for the period, for our gas- and fluid-handling operating segment. (2) Excludes the impact of foreign exchange rate fluctuations and acquisitions, thus providing a measure of growth due to factors such as price, product mix and volume. (3) Represents the incremental sales, orders and order backlog as a result of acquisitions. (4) Represents the difference between sales from existing businesses valued at current year foreign exchange rates and sales from existing businesses at prior year foreign exchange rates. 28-------------------------------------------------------------------------------- The proforma increase in Net sales from existing businesses in 2012 was attributable to increases of $161.5 million and $40.7 million in our gas- and fluid-handling and fabrication technology segments, respectively. Orders, net of cancellations, from existing businesses for our gas- and fluid-handling segment increased during 2012 in comparison to 2011 primarily due to growth in the power generation and mining end markets. Business Segments As discussed further above, the Company reports results in two reportable segments: gas and fluid handling and fabrication technology. The following table summarizes Net sales by reportable segment for each of the following periods: Year Ended December 31, 2013 2012 Proforma 2011 (In millions) Gas and Fluid Handling $ 2,104.0 $ 1,901.2 $ 1,757.1 Fabrication Technology 2,103.2 2,012.7 2,082.0 Total Net sales $ 4,207.2 $ 3,913.9 $ 3,839.1 The Net sales comparisons discussed above, for 2012 in comparison to 2011, are on a proforma basis (which excludes operations acquired in the Charter Acquisition for the first 12 days of each annual period presented). Further, cost information for Charter, ESAB and Howden is not available for 2011 under the presentation required by the Exchange Act and, as such, proforma discussions for 2012 in comparison to 2011 are limited to sales. Gas and Fluid Handling We design, manufacture, install and maintain gas- and fluid-handling products for use in a wide range of markets, including power generation, oil, gas and petrochemical, mining, marine (including defense) and general industrial and other. Our gas-handling products are principally marketed under the Howden brand name. Howden's primary products are heavy-duty fans, rotary heat exchangers and compressors. The fans and heat exchangers are used in coal-fired and other types of power stations, both in combustion and emissions control applications, underground mines, steel sintering plants and other industrial facilities that require movement of large volumes of air in harsh applications. Howden's compressors are mainly used in the oil, gas and petrochemical end market. Our fluid-handling products are marketed by Colfax Fluid Handling under a portfolio of brands including Allweiler and Imo. Colfax Fluid Handling is a supplier of a broad range of fluid-handling products, including pumps, fluid-handling systems and controls, and specialty valves. The following table summarizes selected financial data for our gas- and fluid-handling segment: Year Ended December 31, 2013 2012 2011 (Dollars in millions) Net sales $ 2,104.0 $ 1,901.2 $ 693.4 Gross profit 626.7 567.1 240.1 Gross profit margin 29.8 % 29.8 % 34.6 % Restructuring and other related charges $ 10.4 $ 8.7 $ 8.6 Selling, general and administrative expense 352.6 412.6 142.7 Selling, general and administrative expense as a percentage of Net sales 16.8 % 21.7 % 20.6 % Asbestos coverage litigation expense $ 3.3 $ 13.0 $ 10.7 Segment operating income 270.7 141.5 86.7 Segment operating income margin 12.9 % 7.4 % 12.5 % The $138.1 million Net sales increase due to existing businesses, as discussed and defined under "Sales, Orders and Backlog" above, during 2013 in comparison to 2012 was primarily due to growth in the power generation, marine and general industrial and other end markets, partially offset by declines in the oil, gas and petrochemical and mining end markets. Additionally, Net sales increased by $83.9 million due to acquisition-related growth, including 12 additional days of activity in Howden, which was partially offset by a decrease of $19.2 million due to changes in foreign exchange rates. Gross profit increased during 2013 reflecting the impact of higher volumes. Gross profit margin remained consistent in 2013 with 2012 due to the positive impact of our strong 29 -------------------------------------------------------------------------------- cost control activities offset by the lower margins on the sales associated with the entities acquired in 2013. Additionally, $4.5 million of acquisition-related amortization expense was reflected in Gross profit for 2012. Selling, general and administrative expense for 2013 decreased compared to 2012 primarily due to a decrease of $56.6 million in acquisition-related amortization expense. Selling, general and administrative expense for 2013 was reduced by a $13.8 million gain to remeasure the Company's equity investment in Sicelub to fair value upon increasing the Company's ownership to 100%. Year over year fluctuations for 2012 in comparison to 2011 for selected financial data are primarily due to the addition of the Howden operations. The $161.5 million sales growth due to existing businesses, as discussed and defined under "Sales, Orders and Backlog" above, during 2012 in comparison to 2011 was primarily due to growth in all end markets, except marine. Additionally, $56.6 million of acquisition-related amortization expense and $15.1 million increased recurring intangible amortization expense in comparison to 2011 is reflected in Selling, general and administrative expense for 2012. Fabrication Technology We formulate, develop, manufacture and supply consumable products and equipment for use in the cutting and joining of steels, aluminum and other metals and metal alloys. Our fabrication technology products are principally marketed under the ESAB brand name, which we believe is a leading international welding company with roots dating back to the invention of the covered welding electrode. ESAB's comprehensive range of welding consumables includes electrodes, cored and solid wires and fluxes. ESAB's fabrication technology equipment ranges from portable units to large custom systems. Products are sold into a wide range of end markets, including wind power, shipbuilding, pipelines, mobile/off-highway equipment and mining. The following table summarizes selected financial data for our fabrication technology segment: Year Ended December 31, 2013 2012 (Dollars in millions) Net sales $ 2,103.2 $ 2,012.7 Gross profit 679.6 585.1 Gross profit margin 32.3 % 29.1 % Restructuring and other related charges $ 25.1 $ 45.2 Selling, general and administrative expense 459.9 444.9 Selling, general and administrative expense as a percentage of Net sales 21.9 % 22.1 % Segment operating income $ 219.6 $ 140.2 Segment operating income margin 10.4 % 7.0 % The $90.5 million Net sales increase during 2013 compared to 2012 was primarily the result of acquisition-related growth of $163.0 million, including 12 additional days of activity in ESAB. The $30.6 million Net sales decline due to existing businesses, as discussed and defined under "Sales, Orders and Backlog" above, during 2013 in comparison to 2012 was primarily the result of decreases in consumable volumes in Europe, Asia and North America. Net sales was also negatively impacted by $41.9 million due to the change in foreign exchange rates. Gross profit and gross profit margin for 2012 were impacted by acquisition-related inventory step-up expense of $18.7 million. In 2013, Gross profit and gross profit margin were favorably impacted by the fixed costs eliminated by several manufacturing site closings in late 2012 and the higher gross profit margins at Soldex. Additionally, Selling, general and administrative expense increased by $29.9 million due to the acquisition of Soldex. This amount includes the impact of the devaluation of the Venezuelan bolivar fuerte during the first quarter of 2013, which resulted in a foreign currency transaction loss of $2.9 million recognized in Selling, general and administrative expense for 2013. Selling, general and administrative expense was also impacted by the inclusion of an additional 12 days of ESAB operations in 2013 compared to 2012. See Note 2, "Summary of Significant Accounting Policies" in the accompanying Notes to Consolidated Financial Statements included in this Form 10-K for additional discussion regarding the devaluation of the Venezuelan bolivar fuerte. The $40.7 million sales growth due to existing businesses, as discussed and defined under "Sales, Orders and Backlog" above, during 2012 in comparison to 2011 was primarily due to increased consumable and equipment sales in the Americas, Russia and the Middle East. Year over year comparison of the other selected financial data above is not practical, as further discussed above. Additionally, Gross profit and gross profit margin for 2012 were negatively impacted by acquisition-related inventory step-up expense of $18.7 million. 30 --------------------------------------------------------------------------------Gross Profit - Total Company Year Ended December 31, 2013 2012 2011 (Dollars in millions) Gross profit $ 1,306.2 $ 1,152.1 $ 240.1 Gross profit margin 31.0 % 29.4 % 34.6 % The $154.1 million increase in Gross profit during 2013 in comparison to 2012 was attributable to increases of $59.6 million in our gas- and fluid-handling segment and $94.5 million in our fabrication technology segment. Gross profit increased during 2013 due to the non-recurrence of $21.6 million of acquisition-related inventory step-up expense incurred in 2012. The improvement in gross profit margin during the period was also due to the impact of our cost reduction efforts and favorable trends in sales price in comparison to raw material costs in our fabrication technology segment. Changes in foreign exchange rates during 2013 had an $14.7 million negative impact on Gross profit in comparison to 2012. The $912.0 million increase in Gross profit during 2012 in comparison to 2011 was attributable to increases of $585.1 million in our fabrication technology segment and $326.9 million in our gas- and fluid-handling segment, which were primarily due to the Charter Acquisition. Operating Expenses - Total Company Year Ended December 31, 2013 2012 2011 (Dollars in millions) Selling, general and administrative expense $ 861.0 $ 895.5 $ 162.8 Selling, general and administrative expense as a percentage of Net sales 20.5 % 22.9 % 23.5 % Charter acquisition-related expense $ - $ 43.6 $ 31.1 Restructuring and other related charges 35.5 60.1 9.7 Asbestos coverage litigation expense 3.3 13.0 10.7 Selling, general and administrative expense decreased $34.5 million during 2013 in comparison to 2012, primarily due to a decrease in acquisition-related amortization expense of $56.6 million, partially offset by the increase in expenses resulting from the additional 12 days of operations related to the entities acquired as part of the Charter Acquisition and the acquisitions of Soldex, Co-Vent, Clarus, ?KDK, GII, TLT-Babcock, Alphair and Sicelub. During 2012, we incurred $43.6 million of advisory, legal, valuation and other professional service fees and realized losses on acquisition-related foreign exchange derivatives in connection with the Charter Acquisition. Restructuring and other related charges decreased in 2013 in comparison to 2012 primarily as a result of the completion of several substantial cost reduction programs in the fabrication technology segment in 2012. Additionally, Asbestos coverage litigation expense decreased in 2013 as significant costs were incurred in 2012 for the preparation of our appeals submissions related to a case decided by the trial court during 2011 and for depositions and preparation for a trial related to a subsidiary's coverage which was conducted in the fourth quarter of 2012. Selling, general and administrative expense increased $732.7 million during 2012 in comparison to 2011 primarily due to the Charter Acquisition. The decrease in Selling, general and administrative expense as a percentage of Net sales during 2012 in comparison to 2011 resulted primarily from the benefit of higher sales volumes and efforts to reduce costs partially offset by $77.3 million of higher intangible amortization expense. During 2012, we incurred $12.5 million of increased advisory, legal, valuation and other professional service fees and losses on acquisition-related foreign exchange derivatives in connection with the Charter Acquisition in comparison to 2011. 31 --------------------------------------------------------------------------------Interest Expense - Total Company Year Ended December 31, 2013 2012 2011 (Dollars in millions) Interest expense $ 103.6 $ 91.6 $ 5.9 The increase in Interest expense during 2013 in comparison to 2012 was primarily attributable to the write-off of $29.4 million of certain deferred fees and original issue discount associated with the Second and Third Amendments to the Deutsche Bank Credit Agreement, as defined and further discussed under "-Liquidity and Capital Resources-Borrowing Arrangements" below, and $1.2 million of costs incurred in connection with the refinancings, partially offset by the favorable impact of lower borrowing rates associated with the Second and Third Amendments to the Deutsche Bank Credit Agreement and lower outstanding borrowing levels. Provision for Income Taxes - Total Company The effective tax rate for 2013 was 30.9%, which was lower than the U.S. federal statutory tax rate primarily due to foreign earnings where international tax rates are lower than the U.S. tax rate, a discrete credit to income tax expense of $5.1 million from a reduction to deferred tax balances in certain territories associated with the enactment of lower corporate tax rates and the reduction of a liability for unrecognized tax benefits, which resulted in a gain of $2.3 million, all of which were offset in part by other discrete tax items and losses in certain jurisdictions where a tax benefit is not expected to be recognized in 2013. During 2012, Loss before income taxes was $48.4 million and the Provision for income taxes was $90.7 million. The Provision for income taxes was impacted by two significant items. Upon completion of the Charter Acquisition, certain deferred tax assets existing at that date were reassessed in light of the impact of the acquired businesses on expected future income or loss by country and future tax planning, including the impact of the post-acquisition capital structure. This assessment resulted in an increase in our valuation allowance to provide full valuation allowances against U.S. deferred tax assets. The increased valuation allowances resulted in a non-cash increase to the Provision for income taxes for 2012 of $50.3 million. In addition, $43.6 million of Charter acquisition-related expense reflected in the Consolidated Statement of Operations is either non-deductible or was incurred in jurisdictions where no tax benefit can be recognized. These two items are the principal cause of the Provision for income taxes being significantly higher than the tax provision which would result from the application of the U.S. federal statutory rate to the reported Net loss. Liquidity and Capital Resources Overview Historically, we have financed our capital and working capital requirements through a combination of cash flows from operating activities, borrowings under our bank credit facilities and the issuances of equity. We expect that our primary ongoing requirements for cash will be for working capital, funding of acquisitions, capital expenditures, asbestos-related cash outflows and funding of our pension plans. If additional funds are needed for strategic acquisitions or other corporate purposes, we believe we could raise additional funds in the form of debt or equity. Equity Capital On May 13, 2013, we sold 7,500,000 shares of newly issued Colfax Common stock to underwriters for public resale pursuant to a shelf registration statement for an aggregate purchase price of $331.9 million. In conjunction with this issuance, we recognized $12.0 million in equity issuance costs which were recorded as a reduction to Additional paid-in capital during 2013. On September 12, 2013, we contributed 88,200 shares of newly issued Colfax Common stock to its U.S. defined benefit pension plan. In connection with the financing of the Charter Acquisition, on January 24, 2012, we sold to the BDT Investor (i) 14,756,945 shares of newly issued Colfax Common stock and (ii) 13,877,552 shares of newly created Series A perpetual convertible preferred stock, referred to as the Series A Preferred Stock, for an aggregate of $680 million (representing $24.50 per share of Series A Preferred Stock and $23.04 per share of Common stock) pursuant to the BDT Purchase Agreement with the BDT Investor as well as BDT Capital Partners Fund I-A, L.P., and Mitchell P. Rales, Chairman of our Board of Directors, and his brother, Steven M. 32 -------------------------------------------------------------------------------- Rales (for the limited purpose of tag-along sales rights provided to the BDT Investor in the event of a sale or transfer of shares of our Common stock by either or both of Mitchell P. Rales and Steven M. Rales). Pursuant to the BDT Purchase Agreement, under the terms of the Series A Preferred Stock, holders are entitled to receive cumulative cash dividends, payable quarterly, at a per annum rate of 6% of the liquidation preference (defined as $24.50, subject to customary antidilution adjustments), provided that the dividend rate shall be increased to a per annum rate of 8% if Colfax fails to pay the full amount of any dividend required to be paid on such shares until the date that full payment is made. The Series A Preferred Stock is convertible, in whole or in part, at the option of the holders at any time after the date the shares were issued into shares of Colfax Common stock at a conversion rate determined by dividing the liquidation preference by a number equal to 114% of the liquidation preference, subject to certain adjustments. The Series A Preferred Stock is also convertible, in whole or in part, at our option on or after the third anniversary of the issuance of the shares at the same conversion rate if, among other things: (i) for the preceding thirty trading days, the closing price of Colfax Common stock on the New York Stock Exchange exceeds 133% of the applicable conversion price and (ii) Colfax has declared and paid or set apart for payment all accrued but unpaid dividends on the Series A Preferred Stock. On January 24, 2012, we sold 2,170,139 shares of newly issued Colfax Common stock to each of Mitchell P. Rales and Steven M. Rales and 1,085,070 shares of newly issued Colfax Common stock to Markel Corporation ("Markel") at $23.04 per share, for an aggregate of $125 million pursuant to separate securities purchase agreements with Mitchell P. Rales, Chairman of Colfax's Board of Directors, and his brother Steven M. Rales, each of whom were beneficial owners of 20.9% of Colfax's Common stock at the time of the sale, and Markel. Thomas S. Gayner, a member of Colfax's Board of Directors, is President and Chief Investment Officer of Markel. Consideration paid to Charter shareholders included 0.1241 shares of newly issued Colfax Common stock in exchange for each share of Charter's ordinary stock, which resulted in the issuance of 20,735,493 shares of Common stock on January 24, 2012. In conjunction with the issuance of the Common and Preferred stock issued in connection with the financing of the Charter Acquisition, the Company recognized $14.7 million in equity issuance costs which were recorded as a reduction to Additional paid-in capital during 2012. On March 5, 2012, we sold 8,000,000 shares of newly issued Common stock to underwriters for public resale pursuant to a shelf registration statement for an aggregate purchase price of $272 million. Further, on March 9, 2012, the underwriters of the March 5, 2012 equity offering exercised their over-allotment option and we sold an additional 1,000,000 shares of newly issued Common stock to the underwriters for public resale pursuant to a shelf registration statement for an aggregate purchase price of $34 million. In conjunction with these issuances, we recognized $12.6 million in equity issuance costs which were recorded as a reduction to Additional paid-in capital during 2012. Borrowing Arrangements We entered into the Deutsche Bank Credit Agreement on September 12, 2011. In connection with the closing of the Charter Acquisition, the Deutsche Bank Credit Agreement was amended on January 13, 2012 and we terminated our existing credit agreement as well as Charter's outstanding indebtedness. On February 22, 2013, we entered into the Second Amendment to the Deutsche Bank Credit Agreement to, among other things, (i) reallocate the borrowing capacities of the tranches of loans, (ii) provide for an interest rate margin on the term A-1 facility, the term A-2 facility and the revolving credit subfacilities ranging from 0.75% to 1.50% per annum for base rate loans and 1.75% to 2.50% per annum for Eurocurrency rate loans, in each case, determined by the Company's leverage ratio, (iii) provide for an interest rate margin on the term A-3 facility and the term A-4 facility ranging from 1.50% to 2.25% per annum for base rate loans and 2.50% to 3.25% per annum for Eurocurrency rate loans, in each case, determined by the Company's leverage ratio and (iv) provide for an interest rate margin on the term B facility of 1.50% per annum for base rate loans and 2.50% per annum for Eurocurrency rate loans. On November 7, 2013, we entered into the Third Amendment to the Deutsche Bank Credit Agreement (the "Third Amendment"). Pursuant to the Third Amendment, the Company further amended its credit agreement to, among other things, (i) reallocate borrowing capacities of the tranches of loans as follows: a $408.7 million term A-1 facility, a $380 million term A-2 facility, a €149.7 million term A-3 facility, a €100 million term A-4 facility and two revolving credit subfacilities which total $898 million in commitments, (ii) provide for an interest rate margin on the term A-1 facility, the term A-2 facility and the revolving credit subfacilities ranging from 0.50% and 1.25% per annum for base rate loans and 1.50% to 2.25% per annum for Eurocurrency rate loans, in each case determined by the Company's leverage ratio, (iii) provide for an interest margin on the term A-3 facility 33 -------------------------------------------------------------------------------- and the term A-4 facility ranging from 0.75% to 1.50% per annum for base rate loans and 1.75% and 2.50% per annum for Eurocurrency loans, in each case, determined by the Company's leverage ratio and (iv) reset the maturity date for the term A facilities and the two revolving credit subfacilities as well as the amortization schedule for the term A facilities to a five year term commencing on November 7, 2013. In connection with the Third Amendment, the prior term B facility under the credit agreement was repaid in its entirety. In conjunction with the amendments, we recorded a charge to Interest expense in the Consolidated Statement of Operations for the year ended December 31, 2013 of $29.4 million to write-off certain deferred financing fees and original issue discount and expensed approximately $1.2 million of costs incurred in connection with the refinancing. The Company had an original issue discount of $17.7 million and deferred financing fees of $13.5 million included in its Consolidated Balance Sheet as of December 31, 2013, which will be accreted to Interest expense primarily using the effective interest method, over the life of the Deutsche Bank Credit Agreement. As of December 31, 2013, the weighted-average interest rate of borrowings under the amended Deutsche Bank Credit Agreement was 1.99%, excluding accretion of original issue discount, and there was $560.6 million available on the revolving credit subfacilities, including $199.9 million available on a letter of credit subfacility. The Company is also party to additional letter of credit facilities with total capacity of $688.7 million. Total letters of credit of $398.2 million were outstanding as of December 31, 2013. In connection with the Deutsche Bank Credit Agreement, the Company has pledged substantially all of its domestic subsidiaries' assets and 65% of the shares of certain first tier international subsidiaries as collateral against borrowings to its U.S. companies. In addition, subsidiaries in certain foreign jurisdictions have guaranteed the Company's obligations on borrowings of one of its European subsidiaries, as well as pledged substantially all of their assets for such borrowings to this European subsidiary under the Deutsche Bank Credit Agreement. The Deutsche Bank Credit Agreement contains customary covenants limiting the Company's ability to, among other things, pay dividends, incur debt or liens, redeem or repurchase equity, enter into transactions with affiliates, make investments, merge or consolidate with others or dispose of assets. In addition, the Deutsche Bank Credit Agreement contains financial covenants requiring the Company to maintain a total leverage ratio, as defined therein, of not more than 4.95 to 1.0 and a minimum interest coverage ratio, as defined therein, of 2.25 to 1.0, measured at the end of each quarter, through the year ended December 31, 2013. The minimum interest coverage ratio increases by 25 basis points each year until it reaches 3.0 to 1.0 for the year ending December 31, 2016 and each year thereafter. The maximum total leverage ratio decreases to 4.75 to 1.0 for the year ending December 31, 2014 and decreases by 25 basis points each year until it reaches 4.25 to 1.0 for the year ending December 31, 2016 and each year thereafter. The Deutsche Bank Credit Agreement contains various events of default, including failure to comply with the financial covenants referenced above, and upon an event of default the lenders may, subject to various customary cure rights, require the immediate payment of all amounts outstanding under the term loans and the revolving credit subfacilities and foreclose on the collateral. The Company is in compliance with all such covenants as of December 31, 2013. We believe that our sources of liquidity, including the Deutsche Bank Credit Agreement, are adequate to fund our operations for the next twelve months. 34 --------------------------------------------------------------------------------Cash Flows As of December 31, 2013, we had $311.3 million of Cash and cash equivalents, a decrease of $171.1 million from $482.4 million as of December 31, 2012. The following table summarizes the change in Cash and cash equivalents during the periods indicated: Year Ended December 31, 2013 2012 2011 (In millions) Net cash provided by operating activities $ 362.2 $ 174.0 $ 57.2 Purchases of fixed assets, net (71.5 ) (83.2 ) (13.6 ) Acquisitions, net of cash received (372.5 ) (1,859.6 ) (56.3 ) Loans to non-trade creditors (31.0 ) - - Other sources, net - 1.9 - Net cash used in investing activities (475.0 ) (1,940.9 ) (69.9 ) (Repayments) proceeds from borrowings, net (309.0 ) 1,159.8 29.0 Proceeds from issuance of common stock, net 324.2 756.8 3.7 Proceeds from issuance of preferred stock, net - 333.0 - Acquisition of shares held by noncontrolling interest (14.9 ) (29.3 ) - Other uses (45.3 ) (37.1 ) - Net cash (used in) provided by financing activities (45.0 ) 2,183.2 32.7 Effect of exchange rates on Cash and cash equivalents (13.3 ) (8.9 ) (5.4 ) (Decrease) increase in Cash and cash equivalents $ (171.1 ) $ 407.4 $ 14.6 Cash flows from operating activities can fluctuate significantly from period to period due to changes in working capital and the timing of payments for items such as pension funding and asbestos-related costs. Changes in significant operating cash flow items are discussed below. • Net cash received or paid for asbestos-related costs, net of insurance proceeds, including the disposition of claims, defense costs and legal expenses related to litigation against our insurers, creates variability in our operating cash flows. We had net cash outflows of $39.6 million, $24.7 million and $7.9 million during 2013, 2012 and 2011, respectively. • Funding requirements of our defined benefit plans, including pension plans and other post-retirement benefit plans, can vary significantly from period to period due to changes in the fair value of plan assets and actuarial assumptions. For 2013, 2012 and 2011 cash contributions for defined benefit plans were $46.9 million, $61.2 million and $9.3 million, respectively. Contributions for 2012 included $18.9 million of supplemental contributions to pension plans in the United Kingdom as a result of the financing of the Charter Acquisition. • During 2013, 2012 and 2011 cash payments of $47.3 million, $45.1 million and $6.8 million, respectively, were made related to our restructuring initiatives. Additionally, during 2012 and 2011 cash payments of approximately $46.1 million and $1.6 million were made for advisory, legal, valuation and other professional service fees related to the Charter Acquisition. • Changes in net working capital also affected the operating cash flows for the periods presented. We define working capital as Trade receivables, net and Inventories, net reduced by Accounts payable. During 2013, net working capital decreased $110.0 million, primarily due to a decrease in inventory and an increase in payables partially offset by an increase in receivables, which increased our cash flows from operating activities. During 2012, net working capital decreased, primarily due to a decrease in inventory and an increase in payable levels, which increased our cash flows from operating activities by $78.3 million, a significant contributor to 2012 cash flows from operating activities. During 2011, net working capital increased, primarily due to an increase in receivables, which reduced our cash flows from operating activities. During 2013, the acquisitions of GII, Clarus, ?KDK, TLT-Babcock, Alphair and Sicelub resulted in net cash outflows of $399.9 million. There were significant investing activities associated with the Charter Acquisition. The cash cost of the Charter Acquisition, which was completed in 2012, was approximately $1.7 billion, net of cash acquired. During 2011, the acquisitions of Rosscor and COT-Puritech resulted in net cash outflows of $56.3 million. During 2013, the Company also made a loan in connection with an acquisition of $31.0 million, which is expected to be repaid in 2015. 35 -------------------------------------------------------------------------------- Cash flows from financing activities for 2013 were impacted by the amendments to the Deutsche Bank Credit Agreement further discussed above under "-Borrowing Arrangements" and the May 2013 sale of newly issued Common stock further discussed above under "-Equity Capital." The sale of our Common stock in May 2013 generated $319.9 million cash inflows from financing activities. Cash flows from financing activities for 2012 were significantly impacted by the Charter Acquisition. As discussed above under "-Equity Capital," we raised $805.0 million of cash from sales of our equity securities to the BDT Investor, Steven and Mitchell Rales, and Markel. We borrowed approximately $1.8 billion of term loans, $70.3 million of which was repaid in 2012. The additional payment of borrowings under term loans of $455 million primarily represents the repayment of borrowings under our Bank of America Credit Agreement, in conjunction with the financing of the Charter Acquisition. Additionally, financing activities for 2012 included $293 million raised in a primary offering of our Common stock settled in March 2012. Cash flows from financing activities were also impacted by acquisitions of shares of less than wholly owned subsidiaries. During 2013, cash flows from financing activities included a $14.9 million acquisition of common and investment shares of Soldex resulting in an increase in our ownership of the subsidiary from approximately 91% to 99%. During 2012, cash flows from financing activities included a $29.3 million acquisition of shares in ESAB India Limited, a publicly traded, less than wholly owned subsidiary in which the Company acquired a controlling interest in the Charter Acquisition. This acquisition of shares was pursuant to a statutorily mandated tender offer triggered as a result of the Charter Acquisition. Cash flows from financing activities during 2011 included net borrowings of $29.0 million, which were primarily related to the acquisitions of Rosscor and COT-Puritech. Our Cash and cash equivalents as of December 31, 2013 includes $290.2 held in jurisdictions outside the U.S., which may be subject to tax penalties if repatriated into the U.S. and other restrictions. Contractual Obligations The following table summarizes our future contractual obligations as of December 31, 2013. Less Than More Than One Year 1-3 Years 3-5 Years 5 Years Total (In millions) Debt $ 29.4 $ 280.2 $ 1,195.2 $ - $ 1,504.8 Interest payments on debt(1) 29.2 53.9 32.5 - 115.6 Mandatorily redeemable preferred stock of a subsidiary - 31.4 - - 31.4 Dividend payment on mandatorily redeemable preferred stock of a subsidiary - 3.1 - - 3.1 Operating leases 36.5 40.2 24.6 55.9 157.2 Capital leases 4.1 1.3 - - 5.4 Purchase obligations(2) 418.8 13.1 1.1 0.4 433.4 Total $ 518.0 $ 423.2 $ 1,253.4 $ 56.3 $ 2,250.9 __________(1) Variable interest payments are estimated using a static rate of 1.99%. (2) Excludes open purchase orders for goods or services that are provided on demand, the timing of which is not certain. We have funding requirements associated with our pension and other post-retirement benefit plans as of December 31, 2013, which are estimated to be $71.7 million for the year ending December 31, 2014, of which approximately $10 million is expected to be satisfied with a contribution of Colfax Common stock, with the balance in cash. Other long-term liabilities, such as those for asbestos and other legal claims, employee benefit plan obligations, deferred income taxes and liabilities for unrecognized income tax benefits, are excluded from the above table since they are not contractually fixed as to timing and amount. 36--------------------------------------------------------------------------------Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements that provide liquidity, capital resources, market or credit risk support that expose us to any liability that is not reflected in our Consolidated Financial Statements at December 31, 2013 other than outstanding letters of credit of $398.2 million and $157.2 million of future operating lease payments. The Company and its subsidiaries have in the past divested certain of its businesses and assets. In connection with these divestitures, certain representations, warranties and indemnities were made to purchasers to cover various risks or unknown liabilities. We cannot estimate the potential liability, if any, that may result from such representations, warranties and indemnities because they relate to unknown and unexpected contingencies; however, we do not believe that any such liabilities will have a material adverse effect on our financial condition, results of operations or liquidity. Critical Accounting Policies The methods, estimates and judgments we use in applying our critical accounting policies have a significant impact on our results of operations and financial position. We evaluate our estimates and judgments on an ongoing basis. Our estimates are based upon our historical experience, our evaluation of business and macroeconomic trends and information from other outside sources, as appropriate. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what our management anticipates and different assumptions or estimates about the future could have a material impact on our results of operations and financial position. We believe the following accounting policies are the most critical in that they are important to the financial statements and they require the most difficult, subjective or complex judgments in the preparation of the financial statements. For a detailed discussion on the application of these and other accounting policies, see Note 2, "Summary of Significant Accounting Policies" in the accompanying Notes to Consolidated Financial Statements in this Form 10-K. Asbestos Liabilities and Insurance Assets Certain subsidiaries are each one of many defendants in a large number of lawsuits that claim personal injury as a result of exposure to asbestos from products manufactured with components that are alleged to have contained asbestos. Such components were acquired from third-party suppliers, and were not manufactured by any of the Company's subsidiaries nor were the subsidiaries producers or direct suppliers of asbestos. The manufactured products that are alleged to have contained asbestos generally were provided to meet the specifications of the subsidiaries' customers, including the U.S. Navy. We have projected each subsidiary's future asbestos-related liability costs with regard to pending and future unasserted claims based upon the Nicholson methodology. The Nicholson methodology is a standard approach used by experts and has been accepted by numerous courts. This methodology is based upon risk equations, exposed population estimates, mortality rates, and other demographic statistics. In applying the Nicholson methodology for each subsidiary we performed: (1) an analysis of the estimated population likely to have been exposed or claim to have been exposed to products manufactured by the subsidiaries based upon national studies undertaken of the population of workers believed to have been exposed to asbestos; (2) a review of epidemiological and demographic studies to estimate the number of potentially exposed people that would be likely to develop asbestos-related diseases in each year; (3) an analysis of the subsidiaries' recent claims history to estimate likely filing rates for these diseases and (4) an analysis of the historical asbestos liability costs to develop average values, which vary by disease type, jurisdiction and the nature of claim, to determine an estimate of costs likely to be associated with currently pending and projected asbestos claims. Our projections, based upon the Nicholson methodology, estimate both claims and the estimated cash outflows related to the resolution of such claims for periods up to and including the endpoint of asbestos studies referred to in item (2) above. It is our policy to record a liability for asbestos-related liability costs for the longest period of time that we can reasonably estimate. Accordingly, no accrual has been recorded for any costs which may be paid after the next 15 years. Projecting future asbestos-related liability costs is subject to numerous variables that are difficult to predict, including, among others, the number of claims that might be received, the type and severity of the disease alleged by each claimant, the latency period associated with asbestos exposure, dismissal rates, costs of medical treatment, the financial resources of other companies that are co-defendants in the claims, funds available in post-bankruptcy trusts, uncertainties surrounding the litigation process from jurisdiction to jurisdiction and from case to case, including fluctuations in the timing of court actions and rulings, and the impact of potential changes in legislative or judicial standards, including potential tort reform. Furthermore, any projections with respect to these variables are subject to even greater uncertainty as the projection period lengthens. These trend factors have both positive and negative effects on the dynamics of asbestos litigation in the tort system and the related best estimate of our asbestos liability, and these effects do not move in linear fashion but rather change over multiple year periods. Accordingly, we monitor these trend 37 -------------------------------------------------------------------------------- factors over time and periodically assess whether an alternative forecast period is appropriate. Taking these factors into account and the inherent uncertainties, we believe that we can reasonably estimate the asbestos-related liability for pending and future claims that will be resolved in the next 15 years and have recorded that liability as our best estimate. While it is reasonably possible that the subsidiaries will incur costs after this period, we do not believe the reasonably possible loss or range of reasonably possible loss is estimable at the current time. Accordingly, no accrual has been recorded for any costs which may be paid after the next 15 years. Defense costs associated with asbestos-related liabilities as well as costs incurred related to litigation against the subsidiaries' insurers are expensed as incurred. We assessed the subsidiaries' existing insurance arrangements and agreements, estimated the applicability of insurance coverage for existing and expected future claims, analyzed publicly available information bearing on the current creditworthiness and solvency of the various insurers, and employed such insurance allocation methodologies as we believed appropriate to ascertain the probable insurance recoveries for asbestos liabilities. The analysis took into account self-insurance retentions, policy exclusions, pending litigation, liability caps and gaps in coverage, existing and potential insolvencies of insurers as well as how legal and defense costs will be covered under the insurance policies. Each subsidiary has separate insurance coverage acquired prior to our ownership of each independent entity. In our evaluation of the insurance asset, we use differing insurance allocation methodologies for each subsidiary based upon the applicable law pertaining to the affected subsidiary. Management's analyses are based on currently known facts and a number of assumptions. However, projecting future events, such as new claims to be filed each year, the average cost of resolving each claim, coverage issues among layers of insurers, the method in which losses will be allocated to the various insurance policies, interpretation of the effect on coverage of various policy terms and limits and their interrelationships, the continuing solvency of various insurance companies, the amount of remaining insurance available, as well as the numerous uncertainties inherent in asbestos litigation could cause the actual liabilities and insurance recoveries to be higher or lower than those projected or recorded which could materially affect our financial condition, results of operations or cash flow. As of December 31, 2013, we had total asbestos liabilities, including current portion, of $409.4 million and total asbestos insurance assets, including current portion, of $395.3 million. See Note 15, "Commitments and Contingencies" in the accompanying Notes to Consolidated Financial Statements for additional information regarding our asbestos liabilities and insurance assets. Retirement Benefits Pension obligations and other post-retirement benefits are actuarially determined and are affected by several assumptions, including the discount rate, assumed annual rates of return on plan assets, and per capita cost of covered health care benefits. Changes in discount rate and differences from actual results for each assumption will affect the amounts of pension expense 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. See Note 13, "Defined Benefit Plans" in the accompanying Notes to Consolidated Financial Statements for further information. Impairment of Goodwill and Indefinite-Lived Intangible Assets Goodwill represents the costs in excess of the fair value of net assets acquired associated with our acquisitions. We evaluate the recoverability of Goodwill and indefinite-lived intangible assets annually or more frequently if an event occurs or circumstances change in the interim that would more likely than not reduce the fair value of the asset below its carrying amount. Goodwill and indefinite-lived intangible assets are considered to be impaired when the net book value of a reporting unit or asset exceeds its estimated fair value. In the evaluation of Goodwill for impairment, we first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting entity is less than its carrying value. If we determine that it is not more likely than not for a reporting unit's fair value to be less than its carrying value, a calculation of the fair value is not performed. If we determine that it is more likely than not for a reporting unit's fair value to be less than its carrying value, a calculation of the reporting entity's fair value is performed and compared to the carrying value of that entity. If the carrying value of a reporting unit exceeds its fair value, Goodwill of that reporting unit is potentially impaired and step two of the impairment analysis is performed. In step two of the analysis, an impairment loss is recorded equal to the excess of the carrying value of the reporting unit's Goodwill over its implied fair value should such a circumstance arise. 38 -------------------------------------------------------------------------------- We measure fair value of reporting units based on a present value of future discounted cash flows or a market valuation approach. The discounted cash flows model indicates the fair value of the reporting units based on the present value of the cash flows that the reporting units are expected to generate in the future. Significant estimates in the discounted cash flows model include: the weighted average cost of capital; long-term rate of growth and profitability of our business; and working capital effects. The market valuation approach indicates the fair value of the business based on a comparison of the Company against certain market information. Significant estimates in the market approach model include identifying appropriate market multiples and assessing earnings before interest, income taxes, depreciation and amortization in estimating the fair value of the reporting units. In the evaluation of indefinite-lived intangible assets for impairment, we first assess qualitative factors to determine whether it is more likely than not that the fair value of the indefinite-lived intangible asset is less than its carrying value. If we determine that it is not more likely than not for the indefinite-lived intangible asset's fair value to be less than its carrying value, a calculation of the fair value is not performed. If we determine that it is more likely than not that the indefinite-lived intangible asset's fair value is less than its carrying value, a calculation is performed and compared to the carrying value of the asset. If the carrying amount of the indefinite-lived intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. We measure the fair value of our indefinite-lived intangible assets using the "relief from royalty" method. Significant estimates in this approach include royalty and discount rates for each trade name evaluated. The analyses performed as of September 28, 2013, September 29, 2012, and October 1, 2011 indicated no impairment to be present, except for $0.2 million of impairment loss related to an indefinite-lived intangible asset included in the gas- and fluid-handling segment for the year ended December 31, 2013. This impairment results from a decline in anticipated revenue related to this asset. The impairment loss is included in Selling, general and administrative expense in the accompanying Consolidated Statements of Operations and was calculated as the difference between the fair value of the asset under the relief from royalty method and its carrying value as of the date of the impairment test. The fair value of that intangible asset of $2.8 million as of December 31, 2013 is not material to our Consolidated Financial Statements. See Note 2, "Summary of Significant Accounting Policies" in the accompanying Notes to Consolidated Financial Statements for further information. Actual results could differ from our estimates and projections, which would affect the assessment of impairment. As of December 31, 2013, we have Goodwill of $2.4 billion and indefinite lived trade names of $412.3 million that are subject to at least annual review for impairment. See Note 7, "Goodwill and Intangible Assets" in the accompanying Notes to Consolidated Financial Statements for further information. Income Taxes We account for income taxes under the asset and liability method, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion of the deferred tax asset will not be realized. In evaluating the need for a valuation allowance, we take into account various factors, including the expected level of future taxable income and available tax planning strategies. If actual results differ from the assumptions made in the evaluation of our valuation allowance, we record a change in valuation allowance through income tax expense in the period such determination is made. During 2013, the valuation allowance increased from $357.6 million to $358.4 million. Accounting Standards Codification 740, "Income Taxes" prescribes a recognition threshold and measurement attribute for a position taken in a tax return. Under this standard, we must presume the income tax position will be examined by a relevant tax authority and determine whether it is more likely than not that the income tax position will be sustained upon examination based on its technical merits. An income tax position that meets the more-likely-than-not recognition threshold is then measured to determine the amount of the benefit to be recognized in the financial statements. Liabilities for unrecognized income tax benefits are reviewed periodically and are adjusted as events occur that effect our estimates, such as the availability of new information, the lapsing of applicable statutes of limitations, the conclusion of tax audits and, if applicable, the conclusion of any court proceedings. To the extent we prevail in matters for which liabilities for unrecognized tax benefits have been established or are required to pay amounts in excess of our liabilities for unrecognized tax benefits, our effective income tax rate in a given period could be materially affected. The Company recognizes interest and penalties related to unrecognized tax benefits in the Provision for income taxes in the Consolidated Statements of Operations. Net liabilities for unrecognized income tax benefits, including accrued interest and penalties were $68.8 million as of December 31, 2013 and are included in Other liabilities in the accompanying Consolidated Balance Sheet. 39 --------------------------------------------------------------------------------Revenue Recognition We recognize revenue and costs from product sales when title passes to the buyer and all of the following criteria are met: persuasive evidence of an arrangement exists, the price is fixed or determinable, product delivery has occurred or services have been rendered, there are no further obligations to customers, and collectibility is probable. Product delivery occurs when title and risk of loss transfer to the customer. Our shipping terms vary based on the contract. If any significant obligations to the customer with respect to such sale remain to be fulfilled following shipment, typically involving obligations relating to installation and acceptance by the buyer, revenue recognition is deferred until such obligations have been fulfilled. Any customer allowances and discounts are recorded as a reduction in reported revenues at the time of sale because these allowances reflect a reduction in the sales price for the products sold. These allowances and discounts are estimated based on historical experience and known trends. Revenue related to service agreements is recognized as revenue over the term of the agreement. We recognize revenue and cost of sales on gas-handling construction projects using the "percentage of completion method" in accordance with U.S. GAAP. Under this method, contract revenues are recognized over the performance period of the contract in direct proportion to the costs incurred as a percentage of total estimated costs for the entirety of the contract. Any recognized revenues that have not been billed to a customer are recorded as a component of Trade receivables and any billings of customers in excess of recognized revenues are recorded as a component of Accounts payable. As of December 31, 2013, there were $231.3 million of revenues in excess of billings and $214.8 million of billings in excess of revenues on construction contracts in the Consolidated Balance Sheet. We have contracts in various stages of completion. Such contracts require estimates to determine the appropriate cost and revenue recognition. Significant management judgments and estimates, including estimated costs to complete projects, must be made and used in connection with revenue recognized during each period. Current estimates may be revised as additional information becomes available. The revisions are recorded in income in the period in which they are determined using the cumulative catch-up method of accounting. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. These allowances are based on recent trends of certain customers estimated to be a greater credit risk as well as general trends of the entire pool of customers. The allowance for doubtful accounts was $31.3 million and $16.5 million as of December 31, 2013 and 2012, respectively. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required. Recently Issued Accounting Pronouncements For detailed information regarding recently issued accounting pronouncements and the expected impact on our financial statements, see Note 3, "Recently Issued Accounting Pronouncements" in the accompanying Notes to Consolidated Financial Statements included in this Form 10-K. |