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} | https://cdla.io/permissive-1-0/ | [] | overall_image/4ac4e84afb1e87fa5d61a0ad9e21f7b6bc2be4849826e6bbef037847481dd8bf.png | GE Capital continuing losses increased $1.2 billion primarily due to an impairment of goodwill of $0.8 billion (pre-tax), volume declines, higher mark-to-market effects and other impairments, including $0.5 billion (pre-tax) on the GECAS fixed-wing aircraft portfolio as a result of COVID-19 and related market impacts, lower gains, debt tender costs, the SEC settlement charge and the nonrecurrence of a 2019 tax reform enactment adjustment. These increased losses were partially offset by the nonrecurrence of a $1.0 billion pre-tax charge identified through the completion of our 2019 annual insurance premium deficiency review, higher tax benefits including the tax benefit related to the BioPharma sale and lower excess interest cost. Gains were $0.4 billion and $0.7 billion in 2020 and 2019, respectively.
AVIATION AND GECAS 737 MAX. Aviation develops, produces, and sells LEAP aircraft engines to Boeing, Airbus and COMAC through CFM International (CFM), a company jointly owned by GE and Safran Aircraft Engines, a subsidiary of the Safran Group of France. The LEAP-1B engine is the exclusive engine for the Boeing 737 MAX. In March 2019, global regulatory authorities ordered a temporary fleet grounding of the Boeing 737 MAX. In May 2020, Boeing resumed production of the 737 MAX. In November 2020, the U.S. Federal Aviation Administration (FAA) lifted the grounding notice for the 737 MAX and Boeing commenced aircraft deliveries to customers in compliance with FAA regulatory requirements in December 2020. A number of other global regulators since the FAA's action have also lifted the orders that suspended 737 MAX operations for airlines under their jurisdictions. Aviation commercial equipment backlog as of December 31, 2020 includes approximately 9,600 LEAP engines, including the impact of approximately 1,500 LEAP-1B unit order cancellations in 2020. See the Segment Operations - Aviation section for further information. During 2020, CFM and Boeing reached an agreement to align production rates for 2020 and secure payment terms for engines delivered in 2019 and 2020. In 2020, Aviation received payments, net of progress collections, of $0.5 billion for engines delivered in 2019. A final payment of $0.2 billion, net of progress collections, is expected to be received in the first quarter of 2021 for engines delivered in 2019. CFM and Boeing continue to work closely to ensure a successful reentry into service, with a strong commitment to safety while navigating industry disruption.
During 2020, GECAS agreed with Boeing to restructure its 737 MAX orderbook including previously canceled positions, resulting in 77 orders now remaining. As of December 31, 2020, GECAS owned 29 of these aircraft, 26 of which are contracted for lease to airlines that remain obligated to make contractual rental payments. In addition, GECAS has made pre-delivery payments to Boeing related to 77 of these aircraft on order and has made financing commitments to acquire a further 16 aircraft under purchase and leaseback contracts with airlines.
As of December 31, 2020, we have approximately $1.7 billion of net assets ($3.2 billion of assets and $1.5 billion of liabilities) related to the 737 MAX program that primarily comprised Aviation accounts receivable offset by progress collections and GECAS pre-delivery payments and owned aircraft subject to lease. No impairment charges were incurred related to the 737 MAX aircraft and related balances, as we continue to believe these assets are recoverable over their contractual or useful lives. We continue to monitor 737 MAX return to service and return to delivery developments with our airline customers, lessees and Boeing.
LEAP continues to be a strong engine program for us, and we delivered 815 LEAP engines for Boeing and Airbus platforms in the year.
SEGMENT OPERATIONS. Segment revenues include sales of products and services by the segment. Industrial segment profit is determined based on performance measures used by our Chief Operating Decision Maker (CODM), who is our Chief Executive Officer (CEO), to assess the performance of each business in a given period. In connection with that assessment, the CEO may exclude matters, such as charges for impairments, significant, higher-cost restructuring programs, manufacturing footprint rationalization and other similar expenses, acquisition costs and other related charges, certain gains and losses from acquisitions or dispositions, and certain litigation settlements. See the Corporate Items and Eliminations section for additional information about costs excluded from segment profit.
Segment profit excludes results reported as discontinued operations and the portion of earnings or loss attributable to noncontrolling interests of consolidated subsidiaries, and as such only includes the portion of earnings or loss attributable to our share of the consolidated earnings or loss of consolidated subsidiaries.
Interest and other financial charges, income taxes and non-operating benefit costs are excluded in determining segment profit for the industrial segments. Interest and other financial charges, income taxes, non-operating benefit costs and GE Capital preferred stock dividends are included in determining segment profit (which we sometimes refer to as net earnings) for the Capital segment. Other income is included in segment profit for the industrial segments.
Certain corporate costs, such as those related to shared services, employee benefits, and information technology, are allocated to our segments based on usage. A portion of the remaining corporate costs is allocated based on each segment’s relative net cost of operations.
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} | https://cdla.io/permissive-1-0/ | [] | overall_image/1a3a7f01270557d311b6447f10fd1edf37eb86f9a1e575c7421f5748478c66d4.png | Claim reserve activity included incurred claims of $1,801 million, $1,873 million and $2,106 million, of which $(1) million, $(36) million and $(46) million related to the recognition of adjustments to prior year claim reserves arising from our periodic reserve evaluation in the years ended December 31, 2020, 2019 and 2018, respectively. Paid claims were $1,728 million, $1,626 million and $1,937 million in the years ended December 31, 2020, 2019 and 2018, respectively.
Reinsurance recoveries are recorded as a reduction of insurance losses and annuity benefits in our consolidated Statement of Earnings (Loss) and amounted to $350 million, $362 million and $324 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Reinsurance recoverables, net of allowances of $1,510 million and $1,355 million, are included in non-current Other GE Capital receivables in our consolidated Statement of Financial Position, and amounted to $2,552 million and $2,416 million at December 31, 2020 and 2019, respectively. The vast majority of our remaining net reinsurance recoverables are secured by assets held in a trust for which we are the beneficiary.
2020 Premium Deficiency Testing. We completed our annual premium deficiency testing in the aggregate across our run-off insurance portfolio in the third quarter of 2020. The results of our testing indicated there was a positive margin of less than 2% of the recorded future policy benefit reserves, excluding Other adjustments, at September 30, 2020. As a result, the assumptions updated in connection with the premium deficiency recognized in 2019 remain locked-in and will remain so unless another premium deficiency occurs in the future.
We also noted our projections as of third quarter 2020 indicate the present value of projected earnings in each future year to be positive, and therefore, no further adjustments to our future policy benefit reserves were required at this time.
Considering the results of the 2020 premium deficiency test which resulted in a small margin, any future net adverse changes in our assumptions may reduce the margin or result in a premium deficiency requiring an increase to future policy benefit reserves. Any future net favorable changes to these assumptions could result in a lower projected present value of future cash flows and additional margin in our premium deficiency test and higher income over the remaining duration of the portfolio, including higher investment income.
Statutory accounting practices, not GAAP, determine the required statutory capital levels of our insurance legal entities and, therefore, may affect the amount or timing of capital contributions that may be required from GE Capital to its insurance legal entities. Statutory accounting practices are set forth by the National Association of Insurance Commissioners (NAIC) as well as state laws, regulation and general administrative rules and differ in certain respects from GAAP. The 2020 premium deficiency testing described above was performed on a GAAP basis. The adverse impact on our statutory additional actuarial reserves (AAR) arising from our revised assumptions in 2017, including the collectability of reinsurance recoverables, is expected to require GE Capital to contribute approximately $14,500 million additional capital to its run-off insurance operations in 2018-2024. For statutory accounting purposes, the Kansas Insurance Department (KID) approved our request for a permitted accounting practice to recognize the 2017 AAR increase over a seven-year period. GE Capital provided capital contributions to its insurance subsidiaries of $2,000 million, $1,900 million and $3,500 million in the first quarters of 2020, 2019 and 2018, respectively. GE Capital expects to provide further capital contributions of approximately $7,000 million through 2024 (of which approximately $2,000 million is expected to be contributed in the first quarter of 2021 pending completion of our December 31, 2020 statutory reporting process, which includes asset adequacy testing), subject to ongoing monitoring by KID. GE is a party to capital maintenance agreements with its run-off insurance subsidiaries under which GE is required to maintain their statutory capital levels at 300% of their year-end Authorized Control Level risk-based capital requirements as defined from time to time by the NAIC.
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] | overall_image/d195df832a206b6d3ab111682117129d1ace9ac110af90454aba64b38d1a50aa.png | The compensation assumption is used to estimate the annual rate at which pay of plan participants will grow. If the rate of growth assumed increases, the size of the pension obligations will increase, as will the amount recorded in Accumulated other comprehensive income (loss) (AOCI) in our consolidated Statement of Financial Position and amortized into earnings in subsequent periods.
The expected return on plan assets is the estimated long-term rate of return that will be earned on the investments used to fund the benefit obligations. To determine the expected long-term rate of return on pension plan assets, we consider our asset allocation, as well as historical and expected returns on various categories of plan assets. In developing future long-term return expectations for our principal benefit plans’ assets, we formulate views on the future economic environment, both in the U.S. and abroad. We evaluate general market trends and historical relationships among a number of key variables that impact asset class returns such as expected earnings growth, inflation, valuations, yields and spreads, using both internal and external sources. We also take into account expected volatility by asset class and diversification across classes to determine expected overall portfolio results given our asset allocation. Based on our analysis, we have assumed a 6.25% long-term expected return on our GE Pension Plan assets for cost recognition in 2020, as compared to 6.75% in 2019 and 2018.
The Society of Actuaries issued new mortality improvement tables in 2020 and new mortality base and improvement tables in 2019. We updated mortality assumptions in the U.S. accordingly. These changes in assumptions decreased the December 31, 2020 and 2019 U.S. pension and retiree benefit plans' obligations by $180 million and $529 million, respectively.
The healthcare trend assumptions apply to our pre-65 retiree medical plans. Our post-65 retiree plan has a fixed subsidy and therefore is not subject to healthcare inflation.
We evaluate these critical assumptions at least annually on a plan and country-specific basis. We periodically evaluate other assumptions involving demographics factors such as retirement age and turnover, and update them to reflect our actual experience and expectations for the future. Actual results in any given year will often differ from actuarial assumptions because of economic and other factors. Differences between our actual results and what we assumed are recorded in Accumulated other comprehensive income each period. These differences are amortized into earnings over the remaining average future service of active participating employees or the expected life of inactive participants, as applicable.
SENSITIVITIES TO KEY ASSUMPTIONS. Fluctuations in discount rates can significantly impact pension cost and obligations. A 25 basis point decrease in discount rate would increase principal pension plan cost in the following year by about $220 million and would increase the principal pension projected benefit obligation at year-end by about $2,400 million. The deficit sensitivity to the discount rate is lower than the projected benefit obligation sensitivity as a result of the liability hedging program incorporated in the plan's asset allocation. A 50 basis point decrease in the expected return on assets would increase principal pension plan cost in the following year by about $250 million.
THE COMPOSITION OF OUR PLAN ASSETS. The fair value of our pension plans' investments is presented below. The inputs and valuation techniques used to measure the fair value of these assets are described in Note 1 and have been applied consistently.
<img src='content_image/1043766.jpg'>
(a) Primarily represented investment-grade bonds of U.S. issuers from diverse industries. (b)
Primarily represented investments in residential and commercial mortgage-backed securities, non-U.S. corporate and government bonds and U.S. government, federal agency, state and municipal debt.
GE Pension Plan investments with a fair value of $2,721 million and $2,838 million at December 31, 2020 and 2019, respectively, were classified within Level 3 and primarily relate to real estate. The remaining investments were substantially all considered Level 1 and 2. Other pension plans investments with a fair value of $97 million and $105 million at December 31, 2020 and 2019, respectively, were classified within Level 3. Principal retiree benefit plan investments with a fair value of $134 million and $289 million at December 31, 2020 and 2019, respectively, comprised equity and debt securities which are considered Level 1 and 2. There were no Level 3 principal retiree benefit plan investments held in 2020 and 2019. Plan assets that were measured at fair value using NAV as practical expedient were excluded from the fair value hierarchy.
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] | overall_image/2f2b4e7f7e1dc93900170389d2ae150e1c2895b556c7d13a0a5c3a03e6dbb425.png | ## NOTE 20. FAIR VALUE MEASUREMENTS
Our assets and liabilities measured at fair value on a recurring basis include debt securities mainly supporting obligations to annuitants and policyholders in our run-off insurance operations, our remaining equity interest in Baker Hughes and derivatives.
## ASSETS AND LIABILITIES MEASURED AT FAIR VALUE ON A RECURRING BASIS
<img src='content_image/1042693.jpg'>
(a) Included debt securities classified within Level 3 of $4,185 million of U.S. corporate and $976 million of Mortgage and asset-backed securities at December 31, 2020, and $3,977 million of U.S. corporate and $330 million of Government and agencies securities at December 31, 2019.
(b) See Notes 3 and 21 for further information on the composition of our investment securities and derivative portfolios.
(c) Primarily represents the liabilities associated with certain of our deferred incentive compensation plans.
(d) The netting of derivative receivables and payables is permitted when a legally enforceable master netting agreement exists. Amounts include fair value adjustments related to our own and counterparty non-performance risk.
LEVEL 3 INSTRUMENTS. The majority of our Level 3 balances comprised debt securities classified as available-for-sale with changes in fair value recorded in Other comprehensive income.
<img src='content_image/1042706.jpg'>
(a) Primarily included net unrealized gains (losses) of $323 million and $404 million in Other comprehensive income for the years ended December 31, 2020 and 2019, respectively.
(b) Included $745 million of Mortgage and asset-backed securities for the year ended December 31, 2020, and $975 million of U.S. corporate debt securities for the year ended December 31, 2019.
Substantially all of these Level 3 securities are fair valued using non-binding broker quotes or other third-party sources that utilize a number of different unobservable inputs not subject to meaningful aggregation.
## NOTE 21. FINANCIAL INSTRUMENTS
The following table provides information about assets and liabilities not carried at fair value and excludes finance leases, equity securities without readily determinable fair value and non-financial assets and liabilities. Substantially all of these assets are considered to be Level 3 and the vast majority of our liabilities’ fair value are considered Level 2.
<img src='content_image/1042707.jpg'>
The higher fair value in relation to carrying value for borrowings at December 31, 2020 compared to December 31, 2019 was driven primarily by a decline in market interest rates. Unlike the carrying amount, the estimated fair value of borrowings included $898 million and $1,106 million of accrued interest at December 31, 2020 and 2019, respectively.
Assets and liabilities that are reflected in the accompanying financial statements at fair value are not included in the above disclosures; such items include cash and equivalents, investment securities and derivative financial instruments.
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} | https://cdla.io/permissive-1-0/ | [] | overall_image/c6cb113496cc44221bd8d05817c36c401931b75fb924589d825c29bd6e1a4309.png | LEGAL MATTERS. In the normal course of our business, we are involved from time to time in various arbitrations, class actions, commercial litigation, investigations and other legal, regulatory or governmental actions, including the significant matters described below that could have a material impact on our results of operations. In many proceedings, including the specific matters described below, it is inherently difficult to determine whether any loss is probable or even reasonably possible or to estimate the size or range of the possible loss, and accruals for legal matters are not recorded until a loss for a particular matter is considered probable and reasonably estimable. Given the nature of legal matters and the complexities involved, it is often difficult to predict and determine a meaningful estimate of loss or range of loss until we know, among other factors, the particular claims involved, the likelihood of success of our defenses to those claims, the damages or other relief sought, how discovery or other procedural considerations will affect the outcome, the settlement posture of other parties and other factors that may have a material effect on the outcome. For these matters, unless otherwise specified, we do not believe it is possible to provide a meaningful estimate of loss at this time. Moreover, it is not uncommon for legal matters to be resolved over many years, during which time relevant developments and new information must be continuously evaluated.
Alstom legacy legal matters. On November 2, 2015, we acquired the Thermal, Renewables and Grid businesses from Alstom. Prior to the acquisition, the seller was the subject of two significant cases involving anti-competitive activities and improper payments: (1) in January 2007, Alstom was fined €65 million by the European Commission for participating in a gas insulated switchgear cartel that operated from 1988 to 2004 (that fine was later reduced to €59 million), and (2) in December 2014, Alstom pled guilty in the United States to multiple violations of the Foreign Corrupt Practices Act and paid a criminal penalty of $772 million. As part of GE’s accounting for the acquisition, we established a reserve amounting to $858 million for legal and compliance matters related to the legacy business practices that were the subject of these and related cases in various jurisdictions, including the previously reported legal proceedings in Slovenia that are described below. The reserve balance was $858 million and $875 million at December 31, 2020 and December 31, 2019, respectively.
Regardless of jurisdiction, the allegations relate to claimed anti-competitive conduct or improper payments in the pre-acquisition period as the source of legal violations and/or damages. Given the significant litigation and compliance activity related to these matters and our ongoing efforts to resolve them, it is difficult to assess whether the disbursements will ultimately be consistent with the reserve established. The estimation of this reserve involved significant judgment and may not reflect the full range of uncertainties and unpredictable outcomes inherent in litigation and investigations of this nature, and at this time we are unable to develop a meaningful estimate of the range of reasonably possible additional losses beyond the amount of this reserve. Damages sought may include disgorgement of profits on the underlying business transactions, fines and/or penalties, interest, or other forms of resolution. Factors that can affect the ultimate amount of losses associated with these and related matters include the way cooperation is assessed and valued, prosecutorial discretion in the determination of damages, formulas for determining fines and penalties, the duration and amount of legal and investigative resources applied, political and social influences within each jurisdiction, and tax consequences of any settlements or previous deductions, among other considerations. Actual losses arising from claims in these and related matters could exceed the amount provided.
In connection with alleged improper payments by Alstom relating to contracts won in 2006 and 2008 for work on a state-owned power plant in Šoštanj, Slovenia, the power plant owner in January 2017 filed an arbitration claim for damages of approximately $430 million before the International Chamber of Commerce Court of Arbitration in Vienna, Austria. In February 2017, a government investigation in Slovenia of the same underlying conduct proceeded to an investigative phase overseen by a judge of the Celje District Court. In September 2020, the relevant Alstom legacy entity was served with an indictment, which we had anticipated as we are working with the parties to resolve these matters.
Shareholder and related lawsuits. Since November 2017, several putative shareholder class actions under the federal securities laws have been filed against GE and certain affiliated individuals and consolidated into a single action currently pending in the U.S. District Court for the Southern District of New York (the Hachem case). In October 2019, the lead plaintiff filed a fifth amended consolidated class action complaint naming as defendants GE and current and former GE executive officers. It alleges violations of Sections 10(b) and 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934 related to insurance reserves and accounting for long-term service agreements and seeks damages on behalf of shareholders who acquired GE stock between February 27, 2013 and January 23, 2018. GE filed a motion to dismiss in December 2019. In January 2021, the court granted defendants’ motion to dismiss as to the majority of the claims. Specifically, the court dismissed all claims related to insurance reserves, as well as all claims related to accounting for long-term service agreements, with the exception of certain claims about historic disclosures related to factoring in the Power business that survive as to GE and its former CFO Jeffrey S. Bornstein. All other individual defendants have been dismissed from the case. In addition, the court denied the plaintiffs’ request to amend their complaint again.
Since February 2018, multiple shareholder derivative lawsuits have also been filed against current and former GE executive officers and members of GE’s Board of Directors and GE (as nominal defendant). Six shareholder derivative lawsuits are currently pending: the Bennett case, which was filed in Massachusetts state court; the Cuker, Lindsey, Priest and Tola cases, which were filed in New York state court; and the Burden case, which was filed in the U.S. District Court for the Southern District of New York. These lawsuits have alleged violations of securities laws, breaches of fiduciary duties, unjust enrichment, waste of corporate assets, abuse of control and gross mismanagement, although the specific matters underlying the allegations in the lawsuits have varied. The allegations in the Bennett, Lindsey, Priest, Tola and Burden cases relate to substantially the same facts as those underlying the securities class action described above, and the allegations in the Cuker case relate to alleged corruption in China. The plaintiffs seek unspecified damages and improvements in GE’s corporate governance and internal procedures. The Bennett case has been stayed pending final resolution of another shareholder derivative lawsuit (the Gammel case) that was previously dismissed. In August 2019, the Cuker plaintiffs filed an amended complaint, and GE in September 2019 filed a motion to dismiss the amended complaint. The Lindsey case has been stayed by agreement of the parties.
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] | overall_image/a13bebb11e3743d8f6e625b19db4d8ebb89711253ea8dca885d552bde418b7c7.png | • Expertise: Each client is assigned a designated HR specialist for day-to-day and strategic guidance. Clients can also access data- driven benchmarks in areas such as turnover and overtime, staffing and understanding profit leaks, and have their ADP HR expert help tailor recommendations to continue to drive their business forward.
ADP Comprehensive Services. Leveraging our market-leading ADP Workforce Now platform, ADP Comprehensive Services partners with clients of all types and sizes to tackle their HR, talent, benefits administration and pay challenges with help from our proven expertise, deep experience and best practices. ADP Comprehensive Services is flexible – enabling clients to partner with us for managed services for one, some or all areas across HR, talent, benefits administration and pay. We provide outsourced execution that combines processes, technology and a robust service and support team that acts as an extension of our client’s in-house resources – s o their HCM and pay operations are executed with confidence.
ADP Comprehensive Outsourcing Services (ADP COS). Enabled by ADP Vantage HCM, ADP COS is designed for large business outsourcing for payroll, HR administration, workforce management, benefits administration and talent management. With COS, the day- to-day payroll process becomes our responsibility, freeing up clients to address critical issues like employee engagement and retention. The combination of technology, deep expertise and data-driven insights that COS offers is powerful, allowing clients to focus on strategy and results.
ADP Recruitment Process Outsourcing Services (ADP RPO ® ). ADP RPO provides deep talent insights to help drive targeted recruitment strategies for attracting top talent. With global, customizable recruitment services, ADP RPO enables organizations to find and hire the best candidates for hourly, professional or executive positions. In addition, we also deliver market analytics, sourcing strategies, candidate screening, selection and on-boarding solutions to help organizations connect their talent strategy to their business's priorities.
## Global Solutions
Our premier global solutions consist of multi-country and local in- country solutions for employers of any type or size. We partner with clients to help them navigate the most complex HR and payroll scenarios using tailored and scalable technology supported by our deep compliance expertise.
ADP Global Payroll is a solution for multinational organizations of all sizes, empowering them to harmonize HCM strategies in 140 countries globally. This improves visibility, control and operational efficiency, giving organizations the insight and confidence to adapt to changing local needs, while helping to drive overall organizational agility and engagement.
We also offer comprehensive HCM solutions on local, country-specific platforms. These suites of services offer various combinations of payroll services, HR management, time and attendance management, talent management and benefits management, depending on the country in which the solution is provided.
We pay over 14 million workers outside the United States with our local in-country solutions and with ADP GlobalView, ADP Celergo and ADP Streamline – our simplified and intuitive multi-country payroll solutions. As part of our global payroll services, we supply year-end regulatory and legislative tax statements and other forms to our clients’ employees. Our global talent management solutions elevate the employee experience, from recruitment to ongoing employee engagement and development. Our comprehensive HR solutions combined with our deep expertise make our clients’ global HR management strategies a reality. Our configurable, automated time and attendance tools help global clients understand the work being performed and the resources being used, and help ensure the right people are in the right place at the right time.
## MARKETS AND SALES
Our HCM solutions are offered in 140 countries and territories across North America, Latin America, Europe, Asia and Africa. The most material markets for HCM Solutions, Global Solutions and HRO Solutions (other than PEO) are the United States, Canada and Europe. In each market, we have both country-specific solutions and multi- country solutions, for employers of all sizes and complexities. The major components of our offerings throughout these geographies are payroll, HR outsourcing and time and attendance management. In addition, we offer wage and tax collection and remittance services in the United States, Canada, the United Kingdom, Australia, India and China. Our PEO business offers services exclusively in the United States.
<img src='content_image/1041317.jpg'>
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} | https://cdla.io/permissive-1-0/ | [] | overall_image/214151f053601123b281918f35fa83cf9d12075c7975077ca09496b8de01b590.png | ## A disruption of the data centers or cloud-computing services that we utilize could have a materially adverse effect on our business
We host our applications and serve our clients with data centers that we operate, and with data centers that are operated, and cloud- computing services that are provided, by third-party vendors. If any of these data centers or cloud-computing services fails, becomes disabled or is disrupted, even for a limited period of time, our businesses could be disrupted and we could suffer financial loss, liability to clients, loss of clients, regulatory intervention or damage to our reputation, any of which could have a material adverse effect on our results of operation or financial condition. In addition, our third-party vendors may cease providing data center facilities or cloud-computing services, elect to not renew their agreements with us on commercially reasonable terms or at all, breach their agreements with us or fail to satisfy our expectations, which could disrupt our operations and require us to incur costs which could materially adversely affect our results of operation or financial condition.
## If we fail to protect our intellectual property rights, it could materially adversely affect our business and our brand
Our ability to compete and our success depend, in part, upon our intellectual property. We rely on patent, copyright, trade secret and trademark laws, and confidentiality or license agreements with our employees, customers, vendors, partners and others to protect our intellectual property rights. We may need to devote significant resources, including cybersecurity resources, to monitoring our intellectual property rights. In addition, the steps we take to protect our intellectual property rights may be inadequate or ineffective, or may not provide us with a significant competitive advantage. Our intellectual property could be wrongfully acquired as a result of a cyber-attack or other wrongful conduct by third parties or our personnel. Litigation brought to protect and enforce our intellectual property rights could be costly and time-consuming. Furthermore, our efforts to enforce our intellectual property rights may be met with defenses, counterclaims, and countersuits attacking the validity and enforceability of our intellectual property rights, which may be successful.
## We may be sued by third parties for infringement of their proprietary rights, which could have a materially adverse effect on our business, financial condition or results of operations
There is considerable intellectual property development activity in our industry. Third parties, including our competitors, may own or claim to own intellectual property relating to our products or services and may claim that we are infringing their intellectual property rights. We may be found to be infringing upon such rights, even if we are unaware of their intellectual property rights. Any claims or
litigation could cause us to incur significant expenses and, if successfully asserted against us or if we decide to settle, could require that we pay substantial damages or ongoing royalty payments, obtain licenses, modify applications, prevent us from offering our services, or require that we comply with other unfavorable terms. We may also be obligated to indemnify our customers, vendors or partners in connection with any such claim or litigation. Even if we were to prevail in such a dispute, any litigation regarding our intellectual property could be costly and time- consuming.
## If we fail to upgrade, enhance and expand our technology and services to meet client needs and preferences, the demand for our solutions and services may materially diminish
Our businesses operate in industries that are subject to rapid technological advances and changing client needs and preferences. In order to remain competitive and responsive to client demands, we continually upgrade, enhance, and expand our technology, solutions and services. If we fail to respond successfully to technology challenges and client needs and preferences, the demand for our solutions and services may diminish. In addition, investment in product development often involves a long return on investment cycle. We have made and expect to continue to make significant investments in product development. We must continue to dedicate a significant amount of resources to our development efforts before knowing to what extent our investments will result in products the market will accept. In addition, our business could be adversely affected in periods surrounding our new product introductions if customers delay purchasing decisions to evaluate the new product offerings. Furthermore, we may not execute successfully on our product development strategy, including because of challenges with regard to product planning and timing and technical hurdles that we fail to overcome in a timely fashion.
## We may not realize or sustain the expected benefits from our business transformation initiatives, and these efforts could have a materially adverse effect on our business, operations, financial condition, results of operations and competitive position
We have been and will be undertaking certain transformation initiatives, which are designed to streamline our organization, extend our world-class distribution and strengthen our talent and culture, while supporting our revenue growth, margin improvement and productivity. If we do not successfully manage and execute these initiatives, or if they are inadequate or ineffective, we may fail to meet our financial goals and achieve anticipated benefits, improvements may be delayed, not sustained or not realized and our business, operations and competitive position could be adversely affected. These initiatives, or our failure to successfully manage them, could result in
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] | overall_image/578b38af782050de9c722042231169795ec6dba0ed40b4858847481973c8a8d8.png | ## Item 6. Selected Financial Data
The information set forth below should be read in conjunction with “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and related notes included in this Annual Report on Form 10-K.
(Dollars and shares in millions, except per share amounts)
<img src='content_image/1056281.jpg'>
*Prior period total revenues and total costs of revenues r eflect the impact of the revision to PEO revenues for comparability. Refer to Note 1 to our Consolidated Financial Statements for more information on this revision.
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(Tabular dollars are presented in millions, except per share amounts)
Prior period total revenues and total costs of revenues reflect the impact of the revision to PEO revenues for comparability. Refer to Note 1 to our Consolidated Financial Statements for more information on this revision.
The following section discusses our year ended June 30, 2020 (“fiscal 2020”), as compared to year ended June 30, 2019 (“fiscal 2019”). A detailed review of our fiscal 2019 performance compared to our fiscal 2018 performance is set forth in Part II, Item 7 of our Form 10-K for the fiscal year ended June 30, 2019.
## FORWARD-LOOKING STATEMENTS
This document and other written or oral statements made from time to time by ADP may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Statements that are not historical in nature and which may be identified by the use of words like “expects,” “assumes,” “projects,” “anticipates,” “estimates,” “we believe,” “could” “is designed to” and other words of similar meaning, are forward- looking statements. These statements are based on management’s expectations and assumptions and depend upon or refer to future events or conditions and are subject to risks and uncertainties that may cause actual results to differ materially from those expressed. Factors that could cause actual results to differ materially from those contemplated by the forward-looking statements or that could contribute to such difference include: ADP's success in obtaining, and retaining clients, and selling additional services to clients; the pricing of products and services; the success of our new solutions; compliance with existing or new legislation or regulations; changes in, or interpretations of, existing legislation or regulations; overall market, political and economic conditions, including interest rate and foreign currency trends; competitive conditions; our ability to maintain our current credit ratings and the impact on our funding costs and profitability; security or cyber breaches, fraudulent acts, and system interruptions and failures; employment and wage levels; changes in technology; availability of skilled technical associates; the impact of new acquisitions and divestitures; and the adequacy, effectiveness and success of our business transformation initiatives; and the impact of and uncertainties related to major natural disasters or catastrophic events, including the coronavirus (“ COVID-19 ” ) pandemic. ADP disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. These risks and uncertainties, along with the risk factors discussed under “Item 1A. Risk Factors,” and in other written or oral statements made from time to time by ADP, should be considered in evaluating any forward-looking statements contained herein.
## NON-GAAP FINANCIAL MEASURES
In addition to our U.S. GAAP results, we use adjusted results and other non-GAAP metrics to evaluate our operating performance in the absence of certain items and for planning and forecasting of future periods. Adjusted EBIT, adjusted EBIT margin, adjusted net earnings, adjusted diluted earnings per share, adjusted effective tax rate and organic constant currency are all non-GAAP financial measures. Please refer to the accompanying financial tables in the “Non-GAAP Financial Measures” section for a discussion of why ADP believes these measures are important and for a reconciliation of non-GAAP financial measures to their comparable GAAP financial measures.
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] | overall_image/86b2230e4f100c748fd54e0e28ecdc2c55605a3857a6ee7b92a9c62f8d701149.png | resulting in annual growth of negative 1.0% for fiscal 2020. In addition, we saw deterioration in Employer Services retention in fiscal 2020 of 20 basis points to 90.5% due to an increase in out-of-business losses.
While the challenges presented by COVID-19 may affect the timing of our execution of parts of our strategy, we remain on a transformation journey, and our initiatives are yielding efficiencies and are focused on changing how we work. In fiscal 2020, we executed on our Workforce Optimization program and Procurement Transformation initiatives. For fiscal 2021, we are moving forward with a digital implementation and servicing initiative that leverages many of the capabilities we highlighted at our February 2020 Innovation Day. Despite a challenging end to fiscal 2020, we continued to deliver profit growth during the year ended June 30, 2020. We will continue to monitor macro trends based on externally and internally available data and are using these indicators to drive real-time decisions as we remain committed to our long-term strategy.
We have a strong business model, a highly cash generative business with low capital intensity, and offer a suite of products that provide critical support to our clients’ HCM functions. We generate sufficient free cash flow to satisfy our cash dividend and our modest debt obligations, which enables us to absorb the impact of downturns and remain steadfast in our reinvestments, our longer term strategy, and our commitments to shareholder friendly actions. We are committed to building upon our past successes by investing in our business through enhancements in research and development and by driving meaningful transformation in the way we operate. Our financial condition remains solid at June 30, 2020 and we remain well positioned to support our associates and our clients.
## RESULTS AND ANALYSIS OF CONSOLIDATED OPERATIONS
## Total Revenues
For the year ended June 30, respectively:
<img src='content_image/1044212.jpg'>
Revenues for f iscal 2020 increased due to new business started from New Business Bookings, partially offset by business losses. Our revenue growth includes one percentage point of pressure from foreign currency. Re fer to “Analysis of Reportable Segments” for additional discussion of the increases in revenue for both of our reportable segments, Employer Services and Professional Employer Organization (“PEO”) Services.
Total revenues in fiscal 2020 include interest on funds held for clients of $545.2 million, as compared to $561.9 million in fiscal 2019. The decrease in the consolidated interest earned on funds held for clients resulted from the decrease in our average interest rate earned to 2.1% in fiscal 2020, as compared to 2.2% in fiscal 2019. The decrease is partially offset by an increase in our average client funds balances of 2.1% to $26.0 billion in fiscal 2020 as compared to fiscal 2019.
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] | overall_image/b424848a8d6a47dc5266cf2183a95e7e3b1552af91bdb70d629992319226d3a5.png | quarterly dividends, share repurchases, and capital expenditures for the foreseeable future. Our financial condition remains solid at June 30, 2020 and have sufficient liquidity as note above; howev er, given the uncertainty in the rapidly changing market and economic conditions related to the COVID-19 pandemic, we will continue to evaluate the nature and extent of the impact to our financial condition and liquidity.
For client funds liquidity, we have the ability to borrow through our financing arrangements under our U.S. short-term commercial paper program and our U.S., Canadian and United Kingdom short-term reverse repurchase agreements, together with our $9.7 billion of committed credit facilities and our ability to use corporate liquidity when necessary to meet short-term funding requirements related to client funds obligations. Please see “Quantitative and Qualitative Disclosures about Market Risk” for a further discussion of the risks, including with respect to the COVID-19 pandemic, related to our client funds extended investment strategy. See Note 8 of our Consolidated Financial Statements for a description of our short-term financing including commercial paper.
## Operating, Investing and Financing Cash Flow s
Our cash flows from operating, investing, and financing activities, as reflected in the Statements of Consolidated Cash Flows for the years ended 2020 and 2019 are summarized as follows:
<img src='content_image/1053590.jpg'>
Net cash flows provided by operating activities in fiscal 2020 and fiscal 2019 include cash payments for reinsurance agreements of $215. 0 million and $218.0 million, respectively, which represent the policy premium for t he entire fiscal year. The increase in operating cash provided is primarily due to growth in our business supplemented by a growth in non-cash expenses within operating activities and net favorable change in the components of working capital as comp ared to fiscal 2019.
Net cash flows from investing activities changed due to the timing of proceeds and purchases of corporate and client funds marketable securities of $5,256.9 million, proceeds from the sale of assets and lower payments related to acquisitions of business, partially offset by payments related to acquisitions of intangibles and payments related to capital expenditures in fi scal 2020.
Net cash flows from financing activities changed due to a ne t decrease in the cash flow from client funds obligations of $ 4,909.2 million, which is due to the timing of impounds from our clients and payments to our clients' employees and other payees, more cash returned to shareholders via dividends and share repurchases and a net repayment of reverse repurchase agreements in fiscal 2020.
We purchased approximately 6 .2 million shares of our common stock at an average p rice per share of $160.61 during fisc al 2020, as compared to purchases of 6.5 million shares at an average price per share of $143.02 during fiscal 2019. From time to time, the Company may repurchase shares of its common stock under its authorized share repurchase program. The Company considers several factors in determining when to execute share repurchases, including, among other things, actual and potential acquisition activity, cash balances and cash flows, issuances due to employee benefit plan activity, and market conditions.
## Capital Resources and Client Fund Obligations
On July 15, 2020, the Company gave notice to the current holders of our intention to redeem the $1.0 billion 2.25% Senior Notes due September 15, 2020 on the call date of August 15, 2020. It is the Company's intent to issue new long-term notes to fund this redemption and which also may be used for general corporate purposes. If necessary in the interim, the Company intends to issue commercial paper to fund the Notes’ redemption until such time as the new notes are issued.
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] | overall_image/960714ab3da61bea87fc87143ee50e8c6c6ebd33a6cba3f08436e508eaaee58a.png | We have $2.0 billion of senior unsecured notes with maturity dates in 2020 and 2025. We may from time to time revisit the long-term debt market to refinance existing debt, finance investments including acquisitions for our growth, and maintain the appropriate capital structure. However, there can be no assurance that volatility in the global capital and credit markets would not impair our ability to access these markets on terms acceptable to us, or at all. See Note 9 of our Consolidated Financial Statements for a description of our notes.
Our U.S. short-term funding requirements related to client funds are sometimes obtained on an unsecured basis through the issuance of commercial paper, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. In June 2020, the Company decreased its U.S. short-term commercial paper program to provide for the issuance of up to $9.7 billion from $10.3 billion in aggregate maturity value. Our c ommercial paper program is rated A-1+ by Standard and Poor’s and Prime-1 (“P-1”) by Moody’s. These ratings denote the highest quality commercial paper securities. Maturities of commercial paper can range from overnight to up to 364 days. At June 30, 2020 and 2019, we had no commercial paper borrowing outstanding. Details of the borrowings under the commercial paper program are as follows:
<img src='content_image/1057284.jpg'>
Our U.S., Canadian, and United Kingdom short-term funding requirements related to client funds obligations are sometimes obtained on a secured basis through the use of reverse repurchase agreements, which are collateralized principally by government and government agency securities, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. These agreements generally have terms ranging from overnight to up to five business days. We have successfully borrowed through the use of reverse repurchase agreements on an as-needed basis to meet short-term funding requirements related to client funds obligations. At June 30, 2020 and 2019, the Company had $13.6 million and $262.0 million, respectively, of outstanding obligations related to the reverse repurchase agreements. Details of the reverse repurchase agreements are as follows:
<img src='content_image/1057283.jpg'>
We vary the maturities of our committed credit facilities to limit the refinancing risk of any one facility. We have a $3.2 billion , 364-day credit agreement that matures in June 2021 with a one year term-out option. In addition, we have a five-year $3.75 billion credit facility and a five-year $2.75 billion credit facility maturing in June 2023 and June 2024, respectively, each with an accordion feature under which the aggregate commitment can be increased by $500 million, subject to the availability of additional commitments. The primary uses of the credit facilities are to provide liquidity to the commercial paper program and funding for general corporate purposes, if necessary. We had no borrowings thr ough June 30, 2020 under the credit facilities. We believe that we currently meet all conditions set forth in the revolving credit agreements to borrow thereunder, and we are not aware of any conditions that would prevent us from borrowing part or all of the $9.7 billion available to us under the revolving credit agreements. See Note 8 of our Consolidated Financial Statements for a description of our short-term financing including credit facilities.
Our investment portfolio does not contain any asset-backed securities with underlying collateral of sub-prime mortgages, alternative-A mortgages, sub-prime auto loans or sub-prime home equity loans, collateralized debt obligations, collateralized loan obligations, credit default swaps, derivatives, auction rate securities, structured investment vehicles or non-investment grade fixed-income securities. We own AAA-rated senior tranches of primarily fixed rate auto loan, credit card, equipment lease, and rate reduction receivables, secured predominantly by prime collateral. All collateral on asset-backed securities is performing as expected. In addition, we own senior debt directly issued by Federal Home Loan Banks and Federal Farm Credit Banks. Our client funds investment strategy is structured to allow us to average our way through an interest rate cycle by laddering the maturities of our investments out to five years (in the case of the extended portfolio) and out to ten years (in the case of the long portfolio). This investment strategy is supported by our short-term financing arrangements necessary to satisfy short-term funding requirements relating to client funds obligations. See Note 4 of our Consolidated Financial Statements for a description of our corporate investments and funds held for clients.
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## Quantitative and Qualitative Disclosures about Market Risk
Our overall investment portfolio is comprised of corporate investments (cash and cash equivalents, and long-term marketable securities) and client funds assets (funds that have been collected from clients but have not yet remitted to the applicable tax authorities or client employees).
Our corporate investments are invested in cash and cash equivalents and highly liquid, investment-grade marketable securities. These assets are available for our regular quarterly dividends, share repurchases, capital expenditures and/or acquisitions, as well as other corporate operating purposes. All of our long-term fixed-income securities are classified as available-for-sale securities.
Our client funds assets are invested with safety of principal, liquidity, and diversification as the primary objectives. Consistent with those objectives, we also seek to maximize interest income and to minimize the volatility of interest income. Client funds assets are invested in highly liquid, investment-grade marketable securities, with a maximum maturity of 10 years at the time of purchase, and money market securities and other cash equivalents.
We utilize a strategy by which we extend the maturities of our investment portfolio for funds held for clients and employ short-term financing arrangements to satisfy our short-term funding requirements related to client funds obligations. Our client funds investment strategy is structured to allow us to average our way through an interest rate cycle by laddering the maturities of our investments out to five years (in the case of the extended portfolio) and out to ten years (in the case of the long portfolio). As part of our client funds investment strategy, we use the daily collection of funds from our clients to satisfy other unrelated client funds obligations, rather than liquidating previously-collected client funds that have already been invested in available-for-sale securities. In circumstances where we experience a reduction in employment levels due to a slowdown in the economy, we may make tactical decisions to sell certain securities in order to reduce the size of the funds held for clients to correspond to client fund obligations. We minimize the risk of not having funds collected from a client available at the time such client’s obligation becomes due by impounding, in virtually all instances, the client’s funds in advance of the timing of payment of such client’s obligation. As a result of this practice, we have consistently maintained the required level of client funds assets to satisfy all of our obligations.
There are inherent risks and uncertainties involving our investment strategy relating to our client funds assets. Such risks include liquidity risk, including the risk associated with our ability to liquidate, if necessary, our available-for-sale securities in a timely manner in order to satisfy our client funds obligations. However, our investments are made with the safety of principal, liquidity, and diversification as the primary goals to minimize the risk of not having sufficient funds to satisfy all of our client funds obligations. We also believe we have significantly reduced the risk of not having sufficient funds to satisfy our client funds obligations by consistently maintaining access to other sources of liquidity, including our corporate cash balances, available borrowings under our $ 9.7 billion commercial paper program (rated A-1+ by Standard and Poor’s and P-1 by Moody’s, the highest possible short-term credit ratings), and our ability to engage in reverse repurchase agreement transactions and available borrowings under our $9.7 billion committed credit facilities. The reduced availability of financing during periods of economic turmoil, including the COVID-19 pandemic, even to borrowers with the highest credit ratings, may limit our ability to access short-term debt markets to meet the liquidity needs of our business. In addition to liquidity risk, our investments are subject to interest rate risk and credit risk, as discussed below.
We have established credit quality, maturity, and exposure limits for our investments. The minimum allowed credit rating at time of purchase for corporate, Canadian government agency and Canadian provincial bonds is BBB, for asset-backed securities is AAA, and for municipal bonds is A. The maximum maturity at time of purchase for BBB-rated securities is 5 years, for single A rated securities is 7 years, and for AA-rated and AAA-rated securities is 10 years. Time deposits and commercial paper must be rated A-1 and/or P-1. Money market funds must be rated AAA/Aaa-mf.
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## RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See Note 1, Recently Issued Accounting Pronouncements, of Notes to the Consolidated Financial Statements for a discussion of recent accounting pronouncements.
## CRITICAL ACCOUNTING POLICIES
Our Consolidated Financial Statements and accompanying notes have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires management to make estimates, judgments, and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and other comprehensive income. We continually evaluate the accounting policies and estimates used to prepare the Consolidated Financial Statements. The estimates are based on historical experience and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates made by management. In addition, as the duration and severity of COVID-19 pandemic are uncertain, certain of our estimates could require further judgment or modification and therefore carry a higher degree of variability and volatility. As events continue to evolve, our estimates may change materially in future periods. Certain accounting policies that require significant management estimates and are deemed critical to our results of operations or financial position are Revenue Recognition (including Deferred Costs), Goodwill and Income Taxes. Refer to Note 1, Summary of Significant Accounting Policies, of Notes to the Consolidated Financial Statements for discussion of our policies for Revenue Recognition (including Deferred Costs), Goodwill and Income Taxes.
Goodwill. Goodwill represents the excess of purchase price over the value assigned to the net tangible and identifiable intangible assets of businesses acquired. Goodwill is tested annually for impairment or more frequently when an event or circumstance indicates that goodwill might be impaired.
The Company’s annual goodwill impairment assessment as of June 30, 2020 was performed for all reporting units using a quantitative approach by comparing the fair value of each reporting unit to its carrying value. We estimated the fair value of each reporting unit using, as appropriate, the income approach, which is derived using the present value of future cash flows discounted at a risk-adjusted weighted-average cost of capital, and the market approach, which is based upon using market multiples of companies in similar lines of business. Significant assumptions used in determining the fair value of our reporting units include projected revenue growth rates, profitability projections, working capital assumptions, the weighted average cost of capital, the determination of appropriate market comparison companies, and terminal growth rates. Several of these assumptions including projected revenue growth rates and profitability projections are dependent on our ability to upgrade, enhance, and expand our technology and services to meet client needs and preferences. As such, the determination of fair value requires management to make significant estimates and assumptions related to forecasts of future revenue and operating margins. Based upon the quantitative assessment, the Company has concluded that goodwill is not impaired. As the assumptions used in the income approach and market approach can have a material impact on the fair value determinations, we performed a sensitivity analysis and determined that a one percentage point increase in the weighted-average cost of capital would not result in an impairment of goodwill for all reporting units and their fair values substantially exceeded their carrying values.
## Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information called for by this item is provided under the caption “Quantitative and Qualitative Disclosures About Market Risk” under “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation.”
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} | https://cdla.io/permissive-1-0/ | [] | overall_image/8c9540cca46e4489a1313cc0dbab00bd76cd6fb139229984e4d5f042abaec38c.png | • We tested the effectiveness of general information technology controls over the applications relevant to the money movement reconciliation process.
• We tested the effectiveness of (1) management’s controls over the client funds obligation data reconciliation and (2) management’s control to reconcile the consolidated client funds obligations to the corresponding consolidated funds held for clients balance.
• We involved data specialists to (1) independently reperform management’s client funds obligation reconciliation and (2) perform data analyses to identify and evaluate recurring and new adjustments to the data extracts in the current period.
• For a selection of client funds obligations transactions, we evaluated whether the funds were impounded prior to June 30, 2020, agreed the liability to the corresponding asset balance, and evaluated whether the funds were properly included or excluded from the client funds obligations.
• We made a selection of adjustments identified by management’s reconciliation of the transactional data to the client funds obligations balance reported at period end and evaluated whether the adjustments were supported and appropriate to reconcile and validate the client funds obligations balance reported at period end.
• We made a selection of disbursements to third parties subsequent to the balance sheet date to evaluate whether they were properly included or excluded from client funds obligations.
• We tested the Company’s reconciliation of the consolidated client funds obligations to funds held for clients.
/s/ Deloitte & Touche LLP
Parsippany, New Jersey August 5, 2020
We have served as the Company’s auditor since 1968.
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] | overall_image/bbb7f48eb9d16cc72aeb0a0395564e69187a451a6b2ece1e6b0ed9d918336170.png | ## Consolidated Balance Sheets
(In millions, except per share amounts)
<img src='content_image/1056367.jpg'>
(A) As of June 30, 2020, $13.6 million of long-term marketable securities have been pledged as collateral under the Company's reverse repurchase agreements. As of June 30, 2019, $261.4 million of long-term marketable securities and $0.6 million of cash and cash equivalents have been pledged as collateral under the Company's reverse repurchase agreements (see Note 8).
See notes to the Consolidated Financial Statements.
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"content_image/1041577.jpg"
] | overall_image/5a02646ed9387519d7c299ab184ed78c75fdc669592cf004acb4fabfb509f8e8.png | ## Statements of Consolidated Stockholders' Equity
(In millions, except per share amounts)
<img src='content_image/1041577.jpg'>
(A) During fiscal 2018, the Company adopted ASU 2018-02 and reclassified stranded tax effects attributable to the Tax Cuts and Jobs Act (the "Act") from AOCI to retained earnings. The fiscal 2018 Consolidated Balance Sheets reflect the reclassification out of accumulated other comprehensive (loss)/income into retained earnings.
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Incremental Costs of Obtaining a Contract
Incremental costs of obtaining a contract (e.g., sales commissions) that are expected to be recovered are capitalized and amortized on a straight-line basis over a period of three to eight years, depending on the Company's business unit. Incremental costs of obtaining a contract include only those costs the Company incurs to obtain a contract that it would not have incurred if the contract had not been obtained. These costs are included in selling, general and administrative expenses.
Costs to fulfill a Contract
The Company capitalizes costs incurred to fulfill its contracts that i) relate directly to the contract ii) are expected to generate resources that will be used to satisfy the Company's performance obligations under the contract and iii) are expected to be recovered through revenue generated under the contract. Costs incurred to implement clients on our solutions (e.g. direct labor) are capitalized and amortized on a straight-line basis over the expected client relationship period if the Company expects to recover those costs. The expected client relationship period ranges from three to eight years. These costs are included in operating expenses.
The Company has estimated the amortization periods for the deferred costs by using its historical retention by business units to estimate the pattern during which the service transfers.
E. Cash and Cash Equivalents. Highly liquid investment securities with a maturity of ninety days or less at the time of purchase are considered cash equivalents. The fair value of our cash and cash equivalents approximates carrying value.
F. Corporate Investments and Funds Held for Clients. All of the Company's marketable securities are considered to be “available-for-sale” and, accordingly, are carried on the Consolidated Balance Sheets at fair value. Unrealized gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of accumulated other comprehensive income (loss) on the Consolidated Balance Sheets until realized. Realized gains and losses from the sale of available-for-sale securities are determined on an aggregate approach basis and are included in other (income)/expense, net on the Statements of Consolidated Earnings.
If the fair value of an available-for-sale debt security is below its amortized cost, the Company assesses whether it intends to sell the security or if it is more likely than not the Company will be required to sell the security before recovery. If either of those two conditions is met, the Company would recognize a charge in earnings equal to the entire difference between the security's amortized cost basis and its fair value. If the Company does not intend to sell a security or it is not more likely than not that it will be required to sell the security before recovery, the unrealized loss is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in accumulated other comprehensive income (loss).
Premiums and discounts are amortized or accreted over the life of the related available-for-sale security as an adjustment to yield using the effective- interest method. Dividend and interest income are recognized when earned.
G. Fair Value Measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date and is based upon the Company’s principal, or most advantageous, market for a specific asset or liability.
U.S. GAAP provides for a three-level hierarchy of inputs to valuation techniques used to measure fair value, defined as follows:
Level 1 Fair value is determined based upon quoted prices for identical assets or liabilities that are traded in active markets.
Level 2 Fair value is determined based upon inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability, including:
· quoted prices for similar assets or liabilities in active markets;
· quoted prices for identical or similar assets or liabilities in markets that are not active;
· inputs other than quoted prices that are observable for the asset or liability; or
· inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3 Fair value is determined based upon inputs that are unobservable and reflect the Company’s own assumptions about the assumptions that market participants would use in pricing the asset or liability based upon the best information
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] | overall_image/4a5a814df20d7099560e8a083c055488de25935e8018ebdd2ac8e305d2d68239.png | N. Earnings per Share (“EPS”). The Company computes EPS in accordance with ASC 260.
The calculations of basic and diluted EPS are as follows:
<img src='content_image/1027219.jpg'>
Options to purchase 1.2 million, 0.7 million, and 0.9 million shares of common stock for fiscal 2020, 2019, and 2018, respectively, were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive.
O. Stock-Based Compensation. The Company recognizes stock-based compensation expense in net earnings based on the fair value of the award on the date of the grant, and in the case of international units settled in cash, adjusts this fair value based on changes in the Company's stock price during the vesting peri od. Restricted stock units and restricted stock awards are valued based on the closing price of the Company's common stock on the date of the grant and, in the case of performance based restricted stock units and restricted stock, are adjusted for changes to probabilities of achieving performance targets. International restricted stock units are settled in cash and are marked-to-market based on changes in the Company's stock price. S ee Note 10 for additional information on the Company's stock-based compensation programs.
P. Internal Use Software. Expenditures for major software purchases and software developed or obtained for internal use are capitalized and amortized generally over a three to five-year period on a straight-line basis. Software developed as part of the Company's next-generation platforms are depreciated over ten years. The Company begins to capitalize costs incurred for computer software developed for internal use when the preliminary development efforts are successfully completed, management has authorized and committed to funding the project, and it is probable that the project will be completed and the software will be used as intended. Capitalization ceases when a computer software project is substantially complete and ready for its intended use.
The Company's policy provides for the capitalization of external direct costs of materials and services associated with developing or obtaining internal use computer software. In addition, the Company also capitalizes certain payroll and payroll-related costs for employees who are directly associated with internal use computer software projects. The amount of capitalizable payroll costs with respect to these employees is limited to the time directly spent on such projects. Costs associated with preliminary project stage activities, training, maintenance, and all other post- implementation stage activities are expensed as incurred. The Company also expenses internal costs related to minor upgrades and enhancements, as it is impractical to separate these costs from normal maintenance activities.
Fees related to cloud-based subscriptions for which the Company has the right to take possession of the software at any time during the hosting period (without significant penalty) and can run the software on internal hardware, or through contract with a third party vendor to host the software, is recognized as an intangible asset and capitalized following the Internal Use Software guidance under ASC 350-40. Subscriptions where the Company accesses the software through the cloud but cannot take
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] | overall_image/a5a3af21208494dd9b362ef7830b4060c8a50f934ad47931ee33700f8ad36afd.png | The balance is as follows:
<img src='content_image/1036727.jpg'>
(1) The amount of total deferred costs amortized during the twelve months ended June 30, 2020, June 30, 2019, and June 30, 2018 were $915.0 million , $874.0 million, and $837.4 million, respectively.
## NOTE 3. OTHER (INCOME)/EXPENSE, NET
Other (income)/expense, net consists of the following:
<img src='content_image/1036733.jpg'>
In fiscal 2020, the Company recorded impairment charges of $2 5.3 million as a r esult of recognizing certain owned facilities at fair value given intent to sell and accordingly classified as held for sale. In addition, the Company vacated certain leased locations early and recorded total impairment charges of $4.6 million to operating right-of-use assets and certain related fixed assets associated with the vacated locations. In fiscal 2019, the Company wrote down $12.1 million of internally developed software which was determined to have no future use due to redundant software identified as part of a recent acquisition.
In fiscal 2019, the Company recognized a gain of $1 5.7 million in relation to the sale of an investment held at cost acquired in prior years and subsequently sold during fiscal 2019.
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] | overall_image/a740b49075c93a489b99f69e240a99e08e3bbda472fa1056afc6172754ade7fb.png | ## NOTE 9. DEBT
The Company has fixed-rate notes with 5-year and 10-year maturities for an aggregate principal amount of $2.0 billion (collectively the “Notes”). The Notes are senior unsecured obligations, and interest is payable in arrears, semi-annually.
The principal amounts and associated effective interest rates of the Notes and other debt as of June 30, 2020 and 2019 are as follows:
<img src='content_image/1033460.jpg'>
The effective interest rates for the Notes include the interest on the Notes and amortization of the discount and debt issuance costs.
As of June 30, 2020, the fair value of the Notes, based on Level 2 inputs, was $2,124.7 million. For a description of the fair value hierarchy and the Company's fair value methodologies, including the use of an independent third-party pricing service, see Note 1 “Summary of Significant Accounting Policies.”
In anticipation of the refinancing of our fixed-rate 2.25% notes due September 15, 2020, from December 3, 2019 through March 4, 2020, the Company entered into a series of treasury rate lock transactions, with an aggregate notional amount totaling $400.0 million, to hedge its exposure to changes in interest rates through the completion of the refinancing. The derivative contracts entered into during fiscal 2020 have been designated as cash-flow hedges and will be terminated upon completion of the refinancing. Changes in the derivative’s fair value are recorded each period in other comprehensive income with a corresponding current asset or liability and, upon settlement, the aggregate amount in accumulated other comprehensive income will be amortized into net income over the term of the future debt instrument. Refer to Note 13 for the impact to accumulated other comprehensive income. There are no cash flows associated with the derivative until settlement occurs with the counter-parties.
On July 15, 2020, the Company gave notice to the current holders of our intention to redeem the $1.0 billion 2.25% Senior Notes due September 15, 2020 on the call date of August 15, 2020. It is the Company's intent to issue new long-term notes to fund this redemption and which also may be used for general corporate purposes. If necessary in the interim, the Company intends to issue commercial paper to fund the Notes’ redemption until such time as the new Notes are issued.
## NOTE 10. EMPLOYEE BENEFIT PLANS
## A. Stock-based Compensation Plans. Stock-based compensation consists of the following:
• Stock Options. Stock options are granted to employees at exercise prices equal to the fair market value of the Company's common stock on the dates of grant. Stock options generally vest ratably over 4 years and have a term of 10 years. Compensation expense is measured based on the fair value of the stock option on the grant date and recognized on a straight-line basis over the vesting period. Stock options are forfeited if the employee ceases to be employed by the Company prior to vesting. The Company determines the fair value of stock options issued using a binomial option-pricing model. The binomial option-pricing model considers a range of assumptions related to volatility, dividend yield, risk-free interest rate, and employee exercise behavior. Expected volatilities utilized in the binomial option-pricing model are based on a combination of implied market volatilities, historical volatility of the Company's stock price, and other factors. Similarly, the dividend yield is based on historical experience and expected future changes. The risk-free rate is derived from the U.S. Treasury yield curve in effect at the time of grant. The binomial option-pricing model also incorporates exercise and forfeiture assumptions based on an analysis of historical data. The expected life of a stock option grant is derived from the output of the binomial model and represents the period of time that options granted are expected to be outstanding.
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] | overall_image/dedbe868d3ab458d738b7d46f0eb30a00b3c23f3e2a34dd89a60cdb748571be5.png | The significant components of deferred income tax assets and liabilities and their balance sheet classifications are as follows:
<img src='content_image/1049681.jpg'>
There are $38.8 million and $64.0 million of long-term deferred tax assets included in other assets on the Consolidated Balance Sheets at June 30, 2020 and 2019, respectively.
Income taxes have not been provided on undistributed earnings of certain foreign subsidiaries in an aggregate amount of approximately $274.1 million as the Company considers such earnings to be permanently reinvested outside of the United States. As of June 30, 2020, it is not practicable to estimate the unrecognized tax liability that would occur upon distribution.
The Company has estimated foreign net operating loss carry-forwards of approximately $55.3 million as of June 30, 2020, of which $0.9 million expire through June 2025 and $54.4 million have an indefinite utilization period. As of June 30, 2020, the Company has approximately $58.7 million of federal net operating loss carry-forwards from acquired companies. The net operating losses have an annual utilization limitation pursuant to section 382 of the Internal Revenue Code and expire through June 2036.
The Company has state net operating loss carry-forwards of approximately $374.8 million as of June 30, 2020, which expire through June 2039. The Company has recorded valuation allowances of $12.0 million and $31.6 million at June 30, 2020 and 2019, respectively, to reflect the estimated amount of domestic and foreign deferred tax assets that may not be realized.
Income tax payments were approximately $677.1 million, $6 33.8 million, and $529.7 million for fiscal 2020, 2019, and 2018, respectively.
As of June 30, 2020, 2019, and 2018 the Company's liabilities for unrecognized tax benefits, which include interest and penalties, were $62.3 million, $54.2 million, and $45.2 million respectively. The amount that, if recognized, would impact the effective tax rate is $49.9 million, $43.3 million, and $36.1 million, respectively. The remainder, if recognized, would principally impact deferred taxes.
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] | overall_image/c447e47b4fde1927f23b32ac17715596d009328fafb0abbc2755aaab0d6247cd.png | managers with optimizing schedules to boost productivity and minimize under- and over-staffing. We also offer analytics and reporting tools that provide clients with insights, benchmarks and performance metrics so they can better manage their workforce. In addition, industry-specific modules are available for labor forecasting, budgeting, activity and task management, grant and project tracking, and tips management.
Compliance Solutions. ADP’s Compliance Solutions provides industry-leading expertise in payment compliance and employment- related tax matters that complement the payroll, HR and ERP systems of its clients. In our fiscal year ended June 30, 2020, in the United States, we processed and delivered more than 69 million employee year-end tax statements, and moved more than $2.2 trillion in client funds to taxing and other agencies and to our clients’ employees and other payees.
• ADP SmartCompliance. In the United States, ADP SmartCompliance integrates client data delivered from our integrated HCM platforms or third-party payroll, HR and financial systems into a single, cloud- based solution. Our specialized teams use the data to work with clients to help them manage changing and complex regulatory landscapes and improve business processes. ADP SmartCompliance includes HCM-related compliance solutions such as Employment Tax and Wage Payments, as well as Tax Credits, Health Compliance, Wage Garnishments, Employment Verifications, Unemployment Claims and W-2 Management.
• ADP SmartCompliance Employment Tax. As part of our full-service employment tax services in the United States, we prepare and file employment tax returns on our clients’ behalf and, in connection with these stand-alone services, collect employment taxes from clients and remit these taxes to more than 8,000 federal, state and local tax agencies.
• ADP SmartCompliance Wage Payments. In the United States, we offer compliant pay solutions for today's workforce, including electronic payroll disbursement options such as payroll cards, digital accounts and direct deposit, as well as traditional payroll checks, which can be integrated with clients’ ERP and payroll systems.
<img src='content_image/1033027.jpg'>
Human Resources Management. Commonly referred to as Human Resource Information Systems, ADP’s Human Resources Management Solutions provide employers with a single system of record to support the entry, validation, maintenance, and reporting of data required for effective HR management, including employee names, addresses, job types, salary grades, employment history, and educational background.
Insurance Services. ADP’s Insurance Services business, in conjunction with our licensed insurance agency, Automatic Data Processing Insurance Agency, Inc., facilitates access in the United States to workers’ compensation and group health insurance for small and mid-sized clients through a variety of insurance carriers. Our automated Pay-by-Pay® premium payment program calculates and collects workers’ compensation premium payments each pay period, simplifying this task for employers.
Retirement Services. ADP Retirement Services helps employers in the United States administer various types of retirement plans, such as traditional and Roth 401(k)s, profit sharing (including new comparability), SIMPLE and SEP IRAs, and executive deferred compensation plans. ADP Retirement Services offers a full service 401(k) plan program which provides recordkeeping and administrative services, combined with an investment platform offered through ADP Broker-Dealer, Inc. that gives our clients’ employees access to a wide range of non-proprietary investment options and online tools to monitor the performance of their investments. In addition, ADP Retirement Services offers investment management services to retirement plans through ADP Strategic Plan Services, LLC, an SEC registered investment adviser under the Investment Advisers Act of 1940. ADP Retirement Services also offers trustee services through a third party.
<img src='content_image/1033026.jpg'>
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] | overall_image/b42201d67a00198e83adb5edb7127edb9a88453ca7c428233c36c3c95277da72.png | ## NOTE 15. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
Summarized quarterly results of our operations for the fiscal years ended June 30, 2020 and June 30, 2019 are as follows:
<img src='content_image/1039002.jpg'>
<img src='content_image/1039003.jpg'>
(A) The prior period amounts presented have been revised to correct the amounts previously reported on a gross basis to a net basis by reducing PEO revenues and operating expenses for associated costs of an equal amount of $12.9 million, $13.5 million, $19.2 million and $19.4 million for the first quarter, second quarter, third quarter and fourth quarter, respectively. Refer to Note 1 to our consolidated financial statements for more information on this revision.
## NOTE 16. SUBSEQUENT EVENTS
On July 15, 2020, the Company gave notice to the current holders of its intention to redeem the $1.0 billion 2.25% Senior Notes due September 15, 2020 on the call date of August 15, 2020, discussed in Note 9. There are no other subsequent events for disclosure.
## Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
## Item 9A. Controls and Procedures
Attached as Exhibits 31.1 and 31.2 to this Annual Report on Form 10-K are certifications of ADP's Chief Executive Officer and Chief Financial Officer, which are required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section should be read in conjunction with the report of Deloitte & Touche LLP that appears in this Annual Report on Form 10-K and is hereby incorporated herein by reference.
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} | https://cdla.io/permissive-1-0/ | [] | overall_image/a2f844dc36ea83aabca891abbc82493fd271c6eb5ff78a1319bb060b5e245c40.png | To the Board of Directors and Stockholders of Automatic Data Processing, Inc. Roseland, New Jersey
## Opinion on Internal Control over Financial Reporting
## REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have audited the internal control over financial reporting of Automatic Data Processing, Inc. and subsidiaries (the “Company”) as of June 30, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended June 30, 2020, of the Company and our report dated August 5, 2020, expressed an unqualified opinion on those financial statements and included an explanatory paragraph regarding the Company’s adoption of a new accounting standard.
## Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
## Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Deloitte & Touche LLP
Parsippany, New Jersey
August 5, 2020
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] | overall_image/d97f75f5eca8958983acb9971f690952ce96d31b770fa359931c8664d613c536.png | ## Item 10. Directors, Executive Officers and Corporate Governance
## Part III
The executive officers of the Company, their ages, positions, and the period during which they have been employed by ADP are as follows:
<img src='content_image/1052763.jpg'>
Brock Albinson joined ADP in 2007. Prior to his appointment as Corporate Controller and Principal Accounting Officer in March 2015, he served as Assistant Corporate Controller from December 2011 to February 2015, as Vice President, Corporate Finance from January 2011 to December 2011, and as Vice President, Financial Policy from March 2007 to January 2011.
John Ayala joined ADP in 2002. Prior to his appointment as President, Employer Services North America, he served as President, Major Account Services and ADP Canada from January 2017 to February 2020, as President, Small Business Services, Retirement Services and Insurance Services from July 2014 to December 2016, as Vice President, Client Experience and Continuous Improvement from November 2012 to June 2014, as Senior Vice President, Services and Operations - Small Business Services from February 2012 to October 2012, as President, TotalSource from July 2011 to January 2012, and as Senior Vice President, Service and Operations, TotalSource from June 2008 to June 2011.
Maria Black joined ADP in 1996. Prior to her appointment as President, Worldwide Sales and Marketing, she served as President, Small Business Solutions and Human Resources Outsourcing from January 2017 to February 2020, as President, ADP TotalSource from July 2014 to December 2016, as General Manager, ADP United Kingdom from April 2013 to June 2014, and as General Manager, Employer Services - TotalSource Western Central Region from January 2008 to March 2013.
Michael A. Bonarti joined ADP in 1997. He has served as Corporate Vice President, General Counsel and Secretary since July 2010.
Laura Brown joined ADP in 2000. Prior to her appointment as President, Major Account Services and ADP Canada in March 2020, she served as Senior Vice President/General Manager, Next Gen Human Capital Management from March 2019 to March 2020, as Senior Division Vice President, Major Account Services from September 2016 to March 2019, and Division Vice President/General Manager, Small Business Services from April 2014 to August 2016.
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Deborah L. Dyson joined ADP in 1988. Prior to her appointment as President, National Accounts Services in August 2017, she served as Corporate Vice President, Client Experience and Continuous Improvement from July 2014 to June 2018, as Division Vice President / General Manager, Employer Services - Major Account Services South Service Center from July 2012 to June 2014, and as Division Vice President / General Manager, Employer Services - Major Account Services Northwest Service Center from July 2006 to June 2012.
Michael C. Eberhard joined ADP in 1998. He has served as Vice President and Treasurer since November 2009.
Sreeni Kutam joined ADP in 2014. Prior to his appointment as Chief Human Resources Officer in June 2018, he served as Interim Chief Human Resources Officer from January 2018 to June 2018, as Division Vice President, Human Resources, Major Account Services from May 2016 to January 2018, and as Vice President, HR Strategy and Planning from January 2014 to April 2016. Prior to joining ADP, he was an HR consultant.
Matthew Levin joined ADP in November 2018 as Chief Strategy Officer. Prior to joining ADP, he was a Managing Partner of Psilos Group Managers from January 2017 to October 2018. Prior to joining Psilos Group Managers, he was Executive Vice President and Head of Global Strategy of Aon plc from August 2011 to December 2016.
Don McGuire joined ADP in 1998. Prior to his appointment as President, Employer Services International in June 2018, he served as President, Global Enterprise Solutions EMEA/Streamline from July 2016 to June 2018, as Senior Vice President, General Manager, Asia Pacific Region from December 2012 to June 2016, and as General Manager, ADP United Kingdom/Ireland from September 2007 to December 2012.
Brian Michaud joined ADP in 1991. Prior to his appointment as President, Human Resources Outsourcing in February 2020, he served as Senior Vice President, TotalSource from August 2016 to February 2020, as Senior Vice President, Client Services from June 2015 to August 2016, and as General Manager, Northeast from September 2011 to June 2015.
Dermot J. O’Brien joined ADP in 2012. Prior to his appointment as Chief Transformation Officer in January 2018, he served as Chief Human Resources Officer from April 2012 to January 2018.
Douglas Politi joined ADP in 1992. Prior to his appointment as President, Compliance Solutions in February 2013, he served as Senior Vice President, CFO Suite (AVS) from October 2011 to January 2013, and as Senior Vice President, Retirement Services from September 2006 to September 2011.
Carlos A. Rodriguez joined ADP in 1999. Prior to his appointment in November 2011 to President and Chief Executive Officer, he served as President and Chief Operating Officer from May 2011 to November 2011, and as President, Employer Services International - National Account Services, ADP Canada, and GlobalView and Employer Services International, from March 2010 to May 2011.
Stuart Sackman joined ADP in 1992. Prior to his appointment as Corporate Vice President, Global Shared Services in July 2018, he served as Corporate Vice President, Global Product and Technology from March 2015 to June 2018, as Corporate Vice President and General Manager of Multinational Corporations Services from June 2012 to February 2015, and as Division Vice President and General Manager of the National Account Services’ East National Service Center from February 2008 to May 2012.
Donald Weinstein joined ADP in 2006. Prior to his appointment as Corporate Vice President, Global Product and Technology in July 2018, he served as Chief Strategy Officer from December 2015 to June 2018, as Senior Vice President, Product Management from October 2010 to November 2015, and as Division Vice President, Strategy & Marketing from September 2007 to September 2010.
Kathleen A. Winters joined ADP in April 2019 as Chief Financial Officer. Prior to joining ADP, she was Chief Financial Officer and Treasurer of MSCI Inc. from May 2016 to March 2019. Prior to joining MSCI Inc., she served in various positions of increasing responsibility at Honeywell International, Inc. from 2002 to 2016, most recently as Vice President and Chief Financial Officer of the Performance Materials and Technologies operating segment.
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See “Election of Directors” in the Proxy Statement for the Company’s 2020 Annual Meeting of Stockholders, which information is incorporated herein by reference.
## Code of Ethics
ADP has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer and persons performing similar functions. The code of ethics may be viewed online on ADP’s website at www.adp.com under “Investor Relations” in the “Corporate Governance” section. Any amendment to or waivers from the code of ethics will be disclosed on our website within four business days following the date of the amendment or waiver.
## Audit Committee; Audit Committee Financial Expert
See “Corporate Governance - Committees of the Board of Directors” and “Audit Committee Report” in the Proxy Statement for the Company’s 2020 Annual Meeting of Stockholders, which information is incorporated herein by reference.
## Item 11. Executive Compensation
See “Corporate Governance,” “Compensation Discussion and Analysis,” “Compensation Committee Report,” “Compensation of Executive Officers” and “Compensation of Non-Employee Directors” in the Proxy Statement for the Company’s 2020 Annual Meeting of Stockholders, which information is incorporated herein by reference.
## Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
See “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” in the Proxy Statement for the Company’s 2020 Annual Meeting of Stockholders, which information is incorporated herein by reference.
## Item 13. Certain Relationships and Related Transactions, and Director Independence
See “Election of Directors” and “Corporate Governance” in the Proxy Statement for the Company’s 2020 Annual Meeting of Stockholders, which information is incorporated herein by reference.
## Item 14. Principal Accounting Fees and Services
See “Independent Registered Public Accounting Firm's Fees” in the Proxy Statement for the Company's 2020 Annual Meeting of Stockholders, which information is incorporated herein by reference.
## Item 15. Exhibits, Financial Statement Schedules
## (a) Financial Statements and Financial Statement Schedules
## 1. Financial Statements
## Part IV
The following report and Consolidated Financial Statements of the Company are contained in Part II, Item 8 hereof:
Report of Independent Registered Public Accounting Firm
Statements of Consolidated Earnings - years ended June 30, 2020, 2019 and 2018
Statements of Consolidated Comprehensive Income - years ended June 30, 2020, 2019 and 2018
Consolidated Balance Sheets - June 30, 2020 and 2019
Statements of Consolidated Stockholders' Equity - years ended June 30, 2020, 2019 and 2018
Statements of Consolidated Cash Flows - years ended June 30, 2020, 2019 and 2018
Notes to Consolidated Financial Statements
## 2. Financial Statement Schedules
All other Schedules have been omitted because they are inapplicable, are not required or the information is included elsewhere in the financial statements or notes thereto.
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10.13 French Sub Plan under the 2008 Omnibus Award Plan effective as of January 26, 2012 - incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2012 (Management Compensatory Plan)
10.14 Amended French Sub Plan under the 2008 Omnibus Award Plan effective as of April 6, 2016 (Management Compensatory Plan) - incorporated by reference to Exhibit 10.22 to the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2016 (Management Compensatory Plan)
10.15 Form of Deferred Stock Unit Award Agreement under the 2008 Omnibus Award Plan - incorporated by reference to Exhibit 10.33 to the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2012 (Management Compensatory Plan)
10.16 Form of Stock Option Grant Agreement under the 2008 Omnibus Award Plan (Form for Employees) - incorporated by reference to Exhibit 10.29 to the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2014 (Management Compensatory Plan)
10.17 Form of Restricted Stock Award Agreement under the 2008 Omnibus Award Plan (Form for Corporate Officers) - incorporated by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2015 (Management Compensatory Plan)
10.18 Form of Stock Option Grant under the 2008 Omnibus Award Plan (Form for Corporate Officers) - incorporated by reference to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2015 (Management Compensatory Plan)
10.19 Form of Performance Stock Unit Award Agreement under the 2008 Omnibus Award Plan (Form for Corporate Officers) - incorporated by reference to Exhibit 10.33 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2016 (Management Compensatory Plan)
10.20 Form of Stock Option Grant Agreement under the 2008 Omnibus Award Plan (Form for Corporate Officers) - incorporated by reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2016 (Management Compensatory Plan)
10.21 Form of Performance Stock Unit Award Agreement under the 2008 Omnibus Award Plan for grants beginning September 1, 2017 (Management Compensatory Plan) - incorporated by reference to Exhibit 10.33 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2017 (Management Compensatory Plan)
10.22 Form of Stock Option Grant Agreement under the 2008 Omnibus Award Plan for grants beginning September 1, 2017 (Management Compensatory Plan) - incorporated by reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2017 (Management Compensatory Plan)
10.23 Form of Restricted Stock and Restricted Stock Unit Award Agreement under the 2008 Omnibus Award Plan for grants beginning September 1, 2017 (Management Compensatory Plan) - incorporated by reference to Exhibit 10.35 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2017 (Management Compensatory Plan)
10.24 Form of Restricted Stock and Restricted Stock Unit Award Agreement under the 2008 Omnibus Award Plan for grants beginning September 1, 2018 (Management Compensatory Plan) - incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2018 (Management Compensatory Plan)
10.25 Automatic Data Processing, Inc. 2018 Omnibus Award Plan (the "2018 Omnibus Award Plan") - incorporated by reference to Appendix B to the Company’s Definitive Proxy Statement on Form Schedule 14A dated September 20, 2018 (Management Compensatory Plan)
10.26 Form of Stock Option Grant Agreement under the 2018 Omnibus Award Plan (Management Compensatory Plan) - incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated November 6, 2018 (Management Compensatory Plan)
10.27 Form of Restricted Stock and Restricted Stock Unit Award Agreement under the 2018 Omnibus Award Plan (Management Compensatory Plan) - incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K dated November 6, 2018 (Management Compensatory Plan)
10.28 Form of Performance Stock Unit Award Agreement under the 2018 Omnibus Award Plan (Management Compensatory Plan) - incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K dated November 6, 2018 (Management Compensatory Plan)
10.29 French Sub Plan under the 2018 Omnibus Award Plan (Adopted January 15, 2019) (Management Compensatory Plan) - incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 2018 (Management Compensatory Plan)
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] | overall_image/2bc2af421e6f7ea9dfe51c9ae95eeefd06d529ad44a6343e646f19e5b93b3ee5.png | ☒
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
# For the Fiscal Year Ended February 1, 2020
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from to
(State or other jurisdiction of incorporation or organization)
# UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Tennessee
Genesco Park, 1415 Murfreesboro Pike Nashville, Tennessee
(Address of principal executive offices)
Registrant’s telephone number, including area code: (615) 367-7000
(Exact name of registrant as specified in its charter)
Securities Registered Pursuant to Section 12(b) of the Act:
Commission File No. 1-3083
Washington, D.C. 20549
# FORM 10-K
(Mark One)
# Genesco Inc.
37217-2895
(Zip Code)
62-0211340
(I.R.S. Employer Identification No.)
<img src='content_image/1056613.jpg'>
Securities Registered Pursuant to Section 12(g) of the Act: Employees’ Subordinated Convertible Preferred Stock
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232-405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer; an accelerated filer; a non-accelerated filer; a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☒
Non-accelerated filer ¨ (Do not check if smaller reporting company)
Accelerated filer ¨
Smaller reporting company ☐
Emerging Growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) Yes ☐ No x
The aggregate market value of common stock held by nonaffiliates of the registrant as of August 3, 2019, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $579,000,000. The market value calculation was determined using a per share price of $36.50, the price at which the common stock was last sold on the New York Stock Exchange on such date. For purposes of this calculation, shares held by nonaffiliates excludes only those shares beneficially owned by officers, directors, and shareholders owning 10% or more of the outstanding common stock (and, in each case, their immediate family members and affiliates).
As of March 13, 2020, 14,691,257 shares of the registrant’s common stock were outstanding.
Documents Incorporated by Reference
Portions of the proxy statement for the June 25, 2020 annual meeting of shareholders are incorporated into Part III by reference.
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## Our business is intensely competitive and increased or new competition could have a material adverse effect on us.
The retail footwear and accessory markets are intensely competitive. We currently compete against a diverse group of retailers, including other regional and national specialty stores, department and discount stores, small independents and e-commerce retailers, as well as our own vendors who are increasingly selling direct to consumers, which sell products similar to and often identical to those we sell. Our branded businesses, selling footwear at wholesale, also face intense competition, both from other branded wholesale vendors and from private label initiatives of their retailer customers. A number of different competitive factors could have a material adverse effect on our business, including:
• increased operational efficiencies of competitors;
• competitive pricing strategies;
• expansion by existing competitors;
• expansion of direct-to-consumer by our vendors;
• entry by new competitors into markets in which we currently operate; and
• adoption by existing retail competitors of innovative store formats or sales methods.
## Investments and Infrastructure Risks
## We face a number of risks in opening new stores and renewing leases on existing stores.
We expect to open new stores, both in regional malls, where most of the operational experience of our U.S. businesses lies, and in other venues including outlet centers, major city street locations, airports and tourist destinations. We cannot offer assurances that we will be able to open as many stores as we have planned, that any new store will achieve similar operating results to those of our existing stores or that new stores opened in markets in which we operate will not have a material adverse effect on the revenues and profitability of our existing stores. In addition to the risks already discussed for existing stores, the success of our planned expansion will be dependent upon numerous factors, many of which are beyond our control, including the following:
• our ability to identify suitable markets and individual store sites within those markets;
• the competition for suitable store sites;
• our ability to negotiate favorable lease terms for new stores and renewals (including rent and other costs) with landlords in part due to the consolidation in the commercial real estate market;
• our ability to obtain governmental and other third-party consents, permits and licenses needed to construct and operate our stores;
• the ability to build and remodel stores on schedule and at acceptable cost;
• the availability of employees to staff new stores and our ability to hire, train, motivate and retain store personnel;
• the effect of changes to laws and regulations, including minimum wage, over-time, and employee benefits laws on store expense.
• the availability of adequate management and financial resources to manage an increased number of stores;
• our ability to adapt our distribution and other operational and management systems to an expanded network of stores; and
• unforseen events, such as COVID-19, could prevent or delay store openings and impact our liquidity needed for store openings.
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] | overall_image/1f54f4d96c34612da815ccc9371dac4daa50ec239a0a35d10af85e98cfde3566.png | ## ITEM 6, SELECTED FINANCIAL DATA
Financial Summary - We completed the sale of Lids Sports Group on February 2, 2019. The operating results in the table below have been adjusted to reflect Lids Sports Group in discontinued operations for all periods prior to Fiscal 2020. See Item 8, Note 16 to our Consolidated Financial Statements included in this Annual Report on Form 10-K for additional information about discontinued operations.
<img src='content_image/1030931.jpg'>
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For discussion of results of operations and financial condition pertaining to Fiscal 2019 and Fiscal 2018, see our Annual Report on Form 10-K for the fiscal year ended February 2, 2019, Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.
## Summary of Results of Operations
Our net sales increased 0.4% during Fiscal 2020 compared to Fiscal 2019. The increase reflected a 3% increase in Journeys Group sales, partially offset by a 2% decrease in Schuh Group sales, a 4% decrease in Johnston & Murphy Group sales and a 15% decrease in Licensed Brands sales. Excluding the impact of lower exchange rates, net sales increased 1% during Fiscal 2020. Gross margin increased as a percentage of net sales from 47.8% in Fiscal 2019 to 48.4% in Fiscal 2020, reflecting gross margin increases as a percentage of net sales in all of our business segments. Selling and administrative expenses were flat as a percentage of net sales at 44.0% in Fiscal 2020 and Fiscal 2019, reflecting decreased expenses as a percentage of net sales in Journeys Group and Schuh Group, offset by increased expenses as a percentage of net sales in Johnston & Murphy Group and Licensed Brands, while Corporate expenses were flat. Operating income increased as a percentage of net sales from 3.7% in Fiscal 2019 to 3.8% in Fiscal 2020, reflecting increased earnings in Journeys Group and Schuh Group, partially offset by decreased earnings in Johnston & Murphy Group, Licensed Brands and Corporate in Fiscal 2020.
## Significant Developments
## Outbreak of COVID-19
The outbreak of COVID-19 continues to grow in the U.S., U.K. and globally, and related government and private sector responsive actions may adversely affect our business operations. It is impossible to predict the effect and ultimate impact of the COVID-19 pandemic as the situation is rapidly evolving. The spread of COVID-19 has caused public health officials to recommend precautions to mitigate the spread of the virus, especially when congregating in heavily populated areas, such as malls and shopping centers. In consideration of the health and well-being of our employees, customers and communities, and in support of efforts to contain the spread of the virus, we temporarily closed our North American stores on March 18, 2020. In addition, on March 23, 2020, our stores in the United Kingdom and Ireland were closed and on March 26, 2020, our UK e-commerce business was temporarily closed. Our e-commerce operations across all of our North American brands remain open and ready to serve our customers. We will continue to evaluate the timing of reopening our stores and UK e-commerce operations until such time as the stores can be opened safely and in compliance with applicable laws and regulations, as developments continue to occur in this rapidly changing environment. There is significant uncertainty around the breadth and duration of these store closures and other business disruptions related to COVID-19, as well as its impact on the U.S. and U.K. economies, consumer willingness to visit malls and shopping centers, and employee willingness to staff our stores once they re-open. While we anticipate our future results to be adversely impacted, the extent to which COVID-19 impacts our future results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of COVID-19 and the actions taken to contain it or treat its impact.
## The Acquisition of Togast
Effective January 1, 2020, we completed the acquisition of substantially all the assets and the assumption of certain liabilities of Togast. Togast specializes in the the design, sourcing and sale of licensed footwear. We also entered into a new U.S. footwear license agreement with Levi Strauss & Co. for the license of Levi's$^{® }$footwear for men, women and children in U.S. concurrently with the Togast acquisition. The acquisition expands our portfolio to include footwear licenses for Bass$^{®}$, ADIO and FUBU, among others. Togast operates in our Licensed Brands segment.
## The Sale of Lids Sports Group
We announced in February of 2018 that we were initiating a formal process to explore the sale of our Lids Sports Group business. On December 14, 2018, we entered into a definitive agreement for the sale of Lids Sports Group to FanzzLids Holdings, a holding company controlled and operated by affiliates of Ames Watson Capital, LLC. The sale was completed on February 2, 2019 for $93.8 million cash, which consisted of a sales price of $100.0 million and working capital adjustments of $6.2 million. Because the effective date of closing was a Saturday and we did not receive the cash proceeds until February 4, 2019, the purchase price is reflected in accounts receivable at February 2, 2019. We recorded a loss on the sale of Lids Sports Group of $98.3 million, net of tax, on the sale of these assets, representing the sales price less the value of the Lids Sports Group assets sold and other miscellaneous charges, including divestiture transaction costs, offset by a tax benefit
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## Common Stock Repurchases
We repurchased 4,570,015 shares at a cost of $189.4 million during Fiscal 2020 as part of three authorizations totaling $325.0 million approved by the Board of Directors. We have $89.7 million remaining as of February 1, 2020 under our current $100.0 million share repurchase authorization. We repurchased 968,375 shares at a cost of $45.9 million during Fiscal 2019. We repurchased 275,300 shares at a cost of $16.2 million during Fiscal 2018.
## Environmental and Other Contingencies
We are subject to certain loss contingencies related to environmental proceedings and other legal matters, including those disclosed in Item 8, Note 14, "Legal Proceedings and Other Matters", to our Consolidated Financial Statements included in this Annual Report on Form 10-K.
## Financial Market Risk
The following discusses our exposure to financial market risk.
Outstanding Debt – We have $14.4 million of outstanding U.S. revolver borrowings at a weighted average interest rate of 2.13% as of February 1, 2020. A 100 basis point increase in interest rates would increase annual interest expense by $0.1 million on the $14.4 million revolver borrowings. On March 19, 2020, we borrowed $150.0 million under our Credit Facility as a precautionary measure to ensure funds are available to meet our obligations for a substantial period of time in response to the COVID-19 outbreak. Subsequently, we have borrowed an additional $34.3 million under our Credit Facility. In addition, as of March 24, 2020, we have borrowed £19.0 million on our U.K. A&R Agreement.
Cash and Cash Equivalents – Our cash and cash equivalent balances are invested primarily in institutional money market funds. We did not have significant exposure to changing interest rates on invested cash at February 1, 2020. As a result, we consider the interest rate market risk implicit in these investments at February 1, 2020 to be low.
Summary – Based on our overall market interest rate exposure at February 1, 2020, we believe that the effect, if any, of reasonably possible near- term changes in interest rates on our consolidated financial position, results of operations or cash flows for Fiscal 2020 would not be material.
Accounts Receivable – Our accounts receivable balance at February 1, 2020 is concentrated in our wholesale businesses, which sell primarily to department stores and independent retailers across the United States. In the wholesale businesses, one customer accounted for 26%, three customers each accounted for 9% and one customer accounted for 6% of our total trade receivables balance, while no other customer accounted for more than 5% of our total trade receivables balance as of February 1, 2020. We monitor the credit quality of our customers and establish an allowance for doubtful accounts based upon factors surrounding credit risk of specific customers, historical trends and other information, as well as customer specific factors; however, credit risk is affected by conditions or occurrences within the economy and the retail industry, as well as company-specific information.
Foreign Currency Exchange Risk – We are exposed to translation risk because certain of our foreign operations utilize the local currency as their functional currency and those financial results must be translated into United States dollars. As currency exchange rates fluctuate, translation of our financial statements of foreign businesses into United States dollars affects the comparability of financial results between years. Schuh Group's net sales and operating income for Fiscal 2020 were negatively impacted by $12.8 million and positively impacted by $0.3 million, respectively, due to the change in foreign exchange rates.
## New Accounting Principles
Descriptions of recently issued accounting pronouncements, if any, and the accounting pronouncements adopted by us during Fiscal 2020 are included in Note 2 to the Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data".
## Inflation
We do not believe inflation has had a material impact on sales or operating results during periods covered in this discussion.
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As a result of the economic and business impact of COVID-19, we may be required to revise certain accounting estimates and judgments such as, but not limited to, those related to the valuation of goodwill, long-lived assets and deferred tax assets, which could have a material adverse affect on our financial position and results of operations.
## Inventory Valuation
In our footwear wholesale operations and our Schuh Group segment, cost for inventory that we own is determined using the first-in, first-out ("FIFO") method. Net realizable value is determined using a system of analysis which evaluates inventory at the stock number level based on factors such as inventory turn, average selling price, inventory level, and selling prices reflected in future orders for footwear wholesale. We provide a valuation allowance when the inventory has not been marked down to net realizable value based on current selling prices or when the inventory is not turning and is not expected to turn at satisfactory levels.
In our retail operations, other than the Schuh Group segment, we employ the retail inventory method, applying average cost-to-retail ratios to the retail value of inventories. Under the retail inventory method, valuing inventory at the lower of cost or market is achieved as markdowns are taken or accrued as a reduction of the retail value of inventories.
Inherent in the retail inventory method are subjective judgments and estimates, including merchandise mark-on, markups, markdowns and shrinkage. These judgments and estimates, coupled with the fact that the retail inventory method is an averaging process, could produce a range of cost figures. To reduce the risk of inaccuracy and to ensure consistent presentation, we employ the retail inventory method in multiple subclasses of inventory with similar gross margins, and analyze markdown requirements at the stock number level based on factors such as inventory turn, average selling price and inventory age. In addition, we accrue markdowns as necessary. These additional markdown accruals reflect all of the above factors as well as current agreements to return products to vendors and vendor agreements to provide markdown support. In addition to markdown allowances, we maintain reserves for shrinkage and damaged goods based on historical rates.
Inherent in the analysis of both wholesale and retail inventory valuation are subjective judgments about current market conditions, fashion trends and overall economic conditions. Failure to make appropriate conclusions regarding these factors may result in an overstatement or understatement of inventory value. A change of 10% from the recorded amounts for markdowns, shrinkage and damaged goods would have changed inventory by $0.7 million at February 1, 2020.
## Impairment of Long-Lived Assets
We periodically assess the realizability of our long-lived assets, other than goodwill, and evaluate such assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Asset impairment is determined to exist if estimated future cash flows, undiscounted and without interest charges, are less than the carrying amount. Inherent in the analysis of impairment are subjective judgments about future cash flows. Failure to make appropriate conclusions regarding these judgments may result in an overstatement or understatement of the value of long-lived assets.
We annually assess our goodwill and indefinite lived trade names for impairment and on an interim basis if indicators of impairment are present.
Our annual assessment date of goodwill and indefinite lived trade names is the first day of the fourth quarter.
In accordance with ASC 350, we have the option first to assess qualitative factors to determine whether events and circumstances indicate that it is more likely than not that goodwill is impaired. If, after such assessment, we conclude that the asset is not impaired, no further action is required.
However, if we conclude otherwise, we are required to determine the fair value of the asset using a quantitative impairment test. The quantitative impairment test for goodwill compares the fair value of each reporting unit with the carrying value of the reporting unit with which the goodwill is associated. If the fair value of the reporting unit is less than the carrying value of the reporting unit, an impairment charge would be recorded for the amount, if any, in which the carrying value exceeds the reporting unit's fair value. We estimate fair value using the best information available, and compute the fair value derived by a combination of the market and income approach. The market approach is based on observed market data of comparable companies to determine fair value. The income approach utilizes a projection of a reporting unit’s estimated operating results and cash flows that are discounted using a weighted-average cost of capital that reflects current market conditions. A key assumption in our fair value estimate is the weighted average cost of capital utilized for discounting our cash flow projections in our income approach. The projection uses our best estimates of economic and market conditions over the projected period including growth rates in sales, costs, estimates of future expected changes in operating margins and cash expenditures. Other significant estimates and assumptions include terminal value growth rates, future estimates of capital expenditures and changes in future working capital requirements. For additional information regarding impairment of long- lived assets, see Item 8, Note 3, "Goodwill and Other Intangible
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] | overall_image/15b4e50df9db7df5258ac11b5b4ad47e4332003f3e7ddf0653cb464a40dd35f8.png | ## Leases
We recognize lease assets and corresponding lease liabilities for all operating leases on the Consolidated Balance Sheets as described under ASU No. 2016-02, “Leases (Topic 842).” We evaluate renewal options and break options at lease inception and on an ongoing basis, and include renewal options and break options that we are reasonably certain to exercise in our expected lease terms for calculations of the right-of-use assets and liabilities. Approximately 2% of our leases contain renewal options. To determine the present value of lease payments not yet paid, we estimate incremental borrowing rates corresponding to the reasonably certain lease term. As most of our leases do not provide a determinable implicit rate, we estimate our collateralized incremental borrowing rate based upon a synthetic credit rating and yield curve analysis at the lease commencement or modification date in determining the present value of lease payments. For lease payments in foreign currencies, the incremental borrowing rate is adjusted to be reflective of the risk associated with the respective currency. See Item 8, Note 8, "Leases", to our Consolidated Financial Statements included in this Annual Report on Form 10-K for additional information related to leases.
## ITEM 7A, QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We incorporate by reference the information regarding market risk appearing under the heading “Financial Market Risk” in Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations."
## ITEM 8, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
## INDEX TO FINANCIAL STATEMENTS
<img src='content_image/1035743.jpg'>
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## Opinion on the Financial Statements
## Report of Independent Registered Public Accounting Firm
We have audited the accompanying consolidated balance sheets of Genesco Inc. (the Company) as of February 1, 2020 and February 2, 2019, the related consolidated statements of operations, comprehensive income, cash flows and equity for each of the three fiscal years in the period ended February 1, 2020, and the related notes and financial statement schedule listed in the Index at Item 15 (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at February 1, 2020 and February 2, 2019, and the results of its operations and its cash flows for each of the three fiscal years in the period ended February 1, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of February 1, 2020, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated April 1, 2020 expressed an unqualified opinion thereon.
## Adoption of New Accounting Standards
As discussed in Notes 1, 2 and 8 to the consolidated financial statements, the Company changed its method of accounting for leases in fiscal 2020 due to the adoption of Accounting Standard Update (“ASU”) 2016-02, “Leases (Topic 842)”. See below for discussion of our related critical audit matter.
## Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
## Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
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## Summary of Significant Accounting Policies, Continued
## Property and Equipment
## Genesco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Property and equipment are recorded at cost and depreciated or amortized over the estimated useful life of related assets. Depreciation and amortization expense are computed principally by the straight-line method over the following estimated useful lives:
Buildings and building equipment
Computer hardware, software and equipment
Furniture and fixtures
20-45 years
3-10 years
10 years
Depreciation expense related to property and equipment was approximately $49.4 million, $52.1 million and $51.5 million for Fiscal 2020, 2019 and 2018, respectively.
## Leases
We recognize lease assets and corresponding lease liabilities for all operating leases on the Consolidated Balance Sheets as described under ASC 842. We evaluate renewal options and break options at lease inception and on an ongoing basis, and include renewal options and break options that we are reasonably certain to exercise in our expected lease terms for calculations of the right-of-use assets and liabilities. Approximately 2% of our leases contain renewal options. To determine the present value of lease payments not yet paid, we estimate incremental borrowing rates corresponding to the reasonably certain lease term. As most of our leases do not provide a determinable implicit rate, we estimate our collateralized incremental borrowing rate based upon a synthetic credit rating and yield curve analysis at the lease commencement or modification date in determining the present value of lease payments. For lease payments in foreign currencies, the incremental borrowing rate is adjusted to be reflective of the risk associated with the respective currency. Operating lease assets represent our right to use an underlying asset and are based upon the operating lease liabilities adjusted for prepayments or accrued lease payments, initial direct costs, lease incentives, and impairment, if any, of operating lease assets. We test right-of-use assets for impairment in the same manner as long-lived assets.
Net lease costs are included within selling and administrative expenses on the Consolidated Statements of Operations.
## Asset Retirement Obligations
An asset retirement obligation represents a legal obligation associated with the retirement of a tangible long-lived asset that is incurred upon the acquisition, construction, development, or normal operation of that long-lived asset. Our asset retirement obligations are primarily associated with leasehold improvements that we are contractually obligated to remove at the end of a lease to comply with the lease agreement. We recognize asset retirement obligations at the inception of a lease with such conditions if a reasonable estimate of fair value can be made. Asset retirement obligations are recorded in accrued expenses and other accrued liabilities and deferred rent and other long-term liabilities in our Consolidated Balance Sheets and are subsequently adjusted for changes in estimated asset retirement obligations. The associated estimated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and depreciated over its useful life.
Our Consolidated Balance Sheets include asset retirement obligations related to leases of $11.1 million and $10.9 million as of February 1, 2020 and February 2, 2019, respectively.
## Impairment of Long-Lived Assets
We periodically assess the realizability of our long-lived assets, other than goodwill, and evaluate such assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Asset impairment is determined to exist if estimated future cash flows, undiscounted and without interest charges, are less than the carrying amount. Inherent in the analysis of impairment are subjective judgments about future cash flows. Failure to make appropriate conclusions regarding these judgments may result in an overstatement or understatement of the value of long-lived assets.
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## Summary of Significant Accounting Policies, Continued
## Genesco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
with retailers and changes are made to the estimates as agreements are reached. Actual amounts for markdowns have not differed materially from estimates.
## Cooperative Advertising
Cooperative advertising funds are made available to most of our wholesale footwear customers. In order for retailers to receive reimbursement under such programs, the retailer must meet specified advertising guidelines and provide appropriate documentation of expenses to be reimbursed. Our cooperative advertising agreements require that wholesale customers present documentation or other evidence of specific advertisements or display materials used for our products by submitting the actual print advertisements presented in catalogs, newspaper inserts or other advertising circulars, or by permitting physical inspection of displays. Additionally, our cooperative advertising agreements require that the amount of reimbursement requested for such advertising or materials be supported by invoices or other evidence of the actual costs incurred by the retailer.
## Vendor Allowances
From time to time, we negotiate allowances from our vendors for markdowns taken or expected to be taken. These markdowns are typically negotiated on specific merchandise and for specific amounts. These specific allowances are recognized as a reduction in cost of sales in the period in which the markdowns are taken. Markdown allowances not attached to specific inventory on hand or already sold are applied to concurrent or future purchases from each respective vendor.
We receive support from some of our vendors in the form of reimbursements for cooperative advertising and catalog costs for the launch and promotion of certain products. The reimbursements are agreed upon with vendors and represent specific, incremental, identifiable costs incurred by us to sell the vendor’s specific products. Such costs and the related reimbursements are accumulated and monitored on an individual vendor basis, pursuant to the respective cooperative advertising agreements with vendors. Such cooperative advertising reimbursements are recorded as a reduction of selling and administrative expenses in the same period in which the associated expense is incurred. If the amount of cash consideration received exceeds the costs being reimbursed, such excess amount would be recorded as a reduction of cost of sales.
Vendor reimbursements of cooperative advertising costs recognized as a reduction of selling and administrative expenses were $8.0 million, $7.8 million and $8.7 million for Fiscal 2020, 2019 and 2018, respectively. During Fiscal 2020, 2019 and 2018, our vendor reimbursements of cooperative advertising received were not in excess of the costs incurred.
## Foreign Currency Translation
The functional currency of our foreign operations is the applicable local currency. The translation of the applicable foreign currency into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date. Income and expense accounts are translated at monthly average exchange rates. The unearned gains and losses resulting from such translation are included as a separate component of accumulated other comprehensive loss within shareholders' equity. Gains and losses from certain foreign currency transactions were not material for Fiscal 2020, 2019 or 2018.
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We adopted ASC 606 in the first quarter of Fiscal 2019 using the modified retrospective method by recognizing the cumulative effect of $4.4 million as an adjustment to the opening balance of retained earnings at February 4, 2018. The adoption of this standard did not have a material impact on our Consolidated Financial Statements and related disclosures.
## New Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU No. 2016-13, " Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments " , which requires entities to use a forward-looking approach based on expected losses to estimate credit losses on certain types of financial instruments, including trade receivables. The FASB has subsequently issued updates to the standard to provide additional clarification on specific topics. This guidance will be effective for us in the first quarter of the year ending January 30, 2021 ("Fiscal 2021") with early adoption permitted. We do not expect this guidance to have a material impact on our Consolidated Financial Statements. However, we are also evaluating how COVID-19 will impact this standard.
## Note 3 Goodwill and Other Intangible Assets
The fair value of the assets acquired and liabilities assumed are recorded based on their estimated fair values at acquisition.
In connection with acquisitions, we record goodwill on our Consolidated Balance Sheets. This asset is not amortized but is subject to an impairment test at least annually, based on current market information as well as projected future cash flows from the acquired business discounted at a rate commensurate with the risk we consider to be inherent in our current business model. We perform the impairment test annually at the beginning of our fourth quarter, or more frequently if events or circumstances indicate that the value of the asset might be impaired.
Our identifiable intangible assets with finite lives are trademarks, customer lists, backlog and a vendor contract. They are subject to amortization based upon their estimated useful lives. Finite-lived intangible assets are evaluated for impairment using a process similar to that used to evaluate other definite-lived long-lived assets, a comparison of the fair value of the intangible asset with its carrying amount. An impairment loss is recognized for the amount by which the carrying value exceeds the fair value of the asset. No significant impairment charges for ongoing operations were recognized in Fiscal 2020, 2019 or 2018. Impairment charges, if recognized, are included in asset impairments and other, net on the Consolidated Statements of Operations.
## Goodwill
Effective January 1, 2020, we completed the acquisition of substantially all of the assets, and assumption of certain liabilities, of Togast for an aggregate base purchase price of $33.5 million, which was paid in full in cash at the closing, with an additional two-part earnout provision of up to an additional $17.0 million in cash following our Fiscal 2022 and an additional $17.0 million in cash following our Fiscal 2024, contingent upon the acquired business achieving certain earnings targets over multi-year periods, plus a potential further payment following Fiscal 2022 of 10% of earnings in excess of the earnings target. The two-part earnout provision is largely subject to the payees' post acquisition service requirement and therefore will be recorded as compensation expense and not reported as a component of the purchase price for the acquisition. Togast specializes in the design, sourcing and sale of licensed footwear. We also entered into a new U.S. footwear license agreement with Levi Strauss & Co. for the license of Levi's$^{®}$ footwear for men, women, and children in the U.S. The Togast purchase includes footwear licenses for Bass$^{®}$, ADIO and FUBU, among others. Togast operates within the Licensed Brands segment.
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We had approximately 22,050 employees at February 1, 2020, approximately 150 of whom were employed in corporate staff departments and the balance in operations. Retail stores employ a substantial number of part-time employees, and approximately 16,400 of our employees were part- time at February 1, 2020.
## Seasonality
Our business is seasonal with our investment in inventory and accounts receivable normally reaching peaks in the spring and fall of each year and a significant portion of our net sales and operating earnings generated during the fourth quarter.
## Environmental Matters
Our former manufacturing operations and the sites of those operations as well as the sites of our current operations are subject to numerous federal, state, and local laws and regulations relating to human health and safety and the environment. These laws and regulations address and regulate, among other matters, wastewater discharge, air quality and the generation, handling, storage, treatment, disposal, and transportation of solid and hazardous wastes and releases of hazardous substances into the environment. In addition, third parties and governmental agencies in some cases have the power under such laws and regulations to require remediation of environmental conditions and, in the case of governmental agencies, to impose fines and penalties. Several of the facilities owned by us (currently or in the past) are located in industrial areas and have historically been used for extensive periods for industrial operations such as tanning, dyeing, and manufacturing. Some of these operations used materials and generated wastes that would be considered regulated substances under current environmental laws and regulations. We are currently involved in certain administrative and judicial environmental proceedings relating to our former facilities. See Note 14 to the Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data".
## Available Information
We file reports with the Securities and Exchange Commission (“SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q and other reports from time to time. We are an electronic filer and the SEC maintains an internet site at http://www.sec.gov that contains the reports, proxy and information statements, and other information filed electronically. Our website address, which is provided as an inactive textual reference only, is http://www.genesco.com. We make available free of charge through the website annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Copies of the charters of each of our Audit Committee, Compensation Committee, Nominating and Governance Committee as well as our Corporate Governance Guidelines and Code of Ethics along with position descriptions for our board of directors (the "Board of Directors" or the "Board") and Board committees are also available free of charge through the website. The information provided on our website is not part of this report, and is therefore not incorporated by reference unless such information is otherwise specifically incorporated elsewhere in this report.
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## Genesco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
We lease our office space and all of our retail store locations, transportation equipment and other equipment under various noncancelable operating leases. The leases have varying terms and expire at various dates through 2034. The store leases in the United States, Puerto Rico and Canada typically have initial terms of approximately 10 years. The store leases in the United Kingdom and the Republic of Ireland typically have initial terms of between 10 and 15 years. Our lease portfolio includes leases with fixed base rental payments, rental payments based on a percentage of retail sales over contractual amounts and others with predetermined fixed escalations of the minimum rentals based on a defined consumer price index or percentage. Generally, most of the leases require us to pay taxes, insurance, maintenance costs and contingent rentals based on sales. We evaluate renewal options and break options at lease inception and on an ongoing basis, and include renewal options and break options that we are reasonably certain to exercise in our expected lease terms for calculations of our right-of-use assets and liabilities. Approximately 2% of our leases contain renewal options. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.
The lease on our Nashville office expires in April 2022. On February 10, 2020, we announced plans for our new corporate headquarters in Nashville, Tennessee. We entered into a lease agreement for approximately 199,000 square feet of office space which will replace our current corporate headquarters office lease. The term of the lease is 15 years, with two options to extend for an additional period of five years each.
Under ASC 842, for store, office and equipment leases beginning in Fiscal 2020 and later, we have elected to not separate fixed lease components and non-lease components. Accordingly, we include fixed rental payments, common area maintenance costs, promotional advertising costs and other fixed costs in our measurement of lease liabilities.
Our leases do not provide an implicit rate, so the incremental borrowing rate, based on the information available at commencement or modification date, is used in determining the present value of lease payments. The incremental borrowing rate represents an estimate of the interest rate we would incur at lease commencement to borrow an amount equal to the lease payments on a collateralized basis over the term of a lease within a particular currency environment. For operating leases that commenced prior to the date of adoption of the new lease accounting guidance, we used the incremental borrowing rate that corresponded to the initial lease term as of the date of adoption.
Net lease costs are included within selling and administrative expenses on the Consolidated Statements of Operations. The table below presents the components of lease cost for operating leases for the year ended February 1, 2020.
<img src='content_image/1051568.jpg'>
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] | overall_image/93208b6ba65f492df36a79c73f0c0a42e77d204ee8bd879d3be23c5b6200cb84.png | ## Note 8 Leases, Continued
## Genesco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following table reconciles the maturities of undiscounted cash flows to our operating lease liabilities recorded on the Consolidated Balance Sheets at February 1, 2020:
<img src='content_image/1031445.jpg'>
Our weighted-average remaining lease term and weighted-average discount rate for operating leases as of February 1, 2020 are:
<img src='content_image/1031444.jpg'>
## Prior Period Comparative Disclosures
Under the optional transition method, for leases that existed prior to and at the adoption of the new standard, we continue to present comparative prior period lease amounts in accordance with ASC 840, "Leases". As of February 2, 2019 future minimum rental commitments were:
<img src='content_image/1031443.jpg'>
Leasehold improvements are recorded at their gross costs including items reimbursed by landlords. The reimbursements are recorded as deferred rent and amortized as a reduction of rent expense over the initial lease term. Tenant allowances of $22.5 million and deferred rent of $48.6 million at February 2, 2019 are included in other long-term liabilities on the Consolidated Balance Sheets.
Total rent expense was $202.6 million and $203.1 million for Fiscal 2019 and 2018, respectively. Total contingent rent was not material for Fiscal 2019 and 2018.
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] | overall_image/4a4db08fe82ea44ccdf841718f32b4849b48c571b75ef557455b5410a154c943.png | ## Note 9
## Equity
## Non-Redeemable Preferred Stock
## Genesco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
<img src='content_image/1045118.jpg'>
## Subordinated Serial Preferred Stock:
Our charter permits the Board of Directors to issue Subordinated Serial Preferred Stock (3,000,000 shares, in aggregate, are authorized) in as many series, each with as many shares and such rights and preferences as the board may designate. We have shares authorized for $2.30 Series 1, $4.75 Series 3, $4.75 Series 4, Series 6 and $1.50 Subordinated Cumulative Preferred stocks in amounts of 64,368 shares, 40,449 shares, 53,764 shares, 800,000 shares and 5,000,000 shares, respectively. All of these preferred stocks were mandatorily redeemed by us in Fiscal 2014. As a result, there are no outstanding shares for any preferred issues of stock other than Employees' Subordinated Convertible Preferred stock shown in the table above.
## Employees’ Subordinated Convertible Preferred Stock:
Stated and liquidation values are 88 times the average quarterly per share dividend paid on common stock for the previous eight quarters (if any), but in no event less than $30 per share. Each share of this issue of preferred stock is convertible into one share of common stock and has one vote per share.
## Common Stock:
Common stock-$1 par value. Authorized: 80,000,000 shares; issued: February 1, 2020 – 15,185,670 shares; February 2, 2019 –19,591,048 shares. There were 488,464 shares held in treasury at February 1, 2020 and February 2, 2019. Each outstanding share is entitled to one vote. At February 1, 2020, common shares were reserved as follows: 34,440 shares for conversion of preferred stock and 916,680 shares for the Second Amended and Restated 2009 Genesco Inc. Equity Incentive Plan (the "2009 Plan").
For the year ended February 1, 2020, 270,173 shares of common stock were issued as restricted shares as part of the 2009 Plan; 25,368 shares were issued to directors in exchange for their services; 55,598 shares were withheld for taxes on restricted stock vested in Fiscal 2020; 77,013 shares of restricted stock were forfeited in Fiscal 2020; and 1,707 shares were issued in miscellaneous conversions of Employees’ Subordinated Convertible Preferred Stock. In addition, the Company repurchased and retired 4,570,015 shares of common stock at an average weighted market price of $41.44 for a total of $189.4 million. We have $89.7 million remaining under our current $100.0 million share repurchase authorization.
For the year ended February 2, 2019, 353,633 shares of common stock were issued as restricted shares as part of the 2009 Plan; 36,421 shares were issued to directors in exchange for their services; 69,762 shares were withheld for taxes on restricted stock vested in Fiscal 2019; 153,646 shares of restricted stock were forfeited in Fiscal 2019; and 524 shares were issued in miscellaneous conversions of Employees’ Subordinated Convertible Preferred Stock. In addition, the Company repurchased and retired 968,375 shares of common stock at an average weighted market price of $47.45 for a total of $45.9 million.
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For the year ended February 3, 2018, 356,224 shares of common stock were issued as restricted shares as part of the 2009 Plan; 30,620 shares were issued to directors in exchange for their services; 50,957 shares were withheld for taxes on restricted stock vested in Fiscal 2018; 23,581 shares of restricted stock were forfeited in Fiscal 2018; and 975 shares were issued in miscellaneous conversions of Employees’ Subordinated Convertible Preferred Stock. In addition, the Company repurchased and retired 275,300 shares of common stock at an average weighted market price of $58.71 for a total of $16.2 million.
## Restrictions on Dividends and Redemptions of Capital Stock:
Our charter provides that no dividends may be paid and no shares of capital stock acquired for value if there are dividend or redemption arrearages on any senior or equally ranked stock. Exchanges of subordinated serial preferred stock for common stock or other stock junior to such exchanged stock are permitted.
## Note 10 Income Taxes
On December 22, 2017, the Tax Cuts and Jobs Act (the “Act”) was enacted in the United States. The Act includes a number of changes to existing U.S. tax laws that impact us including the reduction of the U.S. corporate income tax rate from 35% to 21% for tax years beginning after December 31, 2017. The Act also provides for a one-time transition tax on indefinitely reinvested foreign earnings and the acceleration of depreciation for certain assets placed into service after September 27, 2017, as well as prospective changes beginning in 2018, including the elimination of certain domestic deductions and credits and additional limitations on the deductibility of executive compensation. Our Fiscal 2020 and 2019 financial results reflected all tax effects from the Act.
The changes to existing U.S. tax laws as a result of the Act, which have the most significant impact on our provision for income taxes as of February 1, 2020 and February 2, 2019 are as follows:
## Reduction of the U.S. Corporate Income Tax Rate
We measure deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Accordingly, our deferred tax assets and liabilities were adjusted to reflect the reduction in the U.S. corporate income tax rate from 35% to 21%, resulting in a $5.3 million increase in income tax expense for the year ended February 3, 2018 and a corresponding $5.3 million decrease in net deferred tax assets as of February 3, 2018.
## Transition Tax on Foreign Earnings
We recognized a provisional income tax expense of $4.5 million for the year ended February 3, 2018 related to the one-time transition tax on indefinitely reinvested foreign earnings.
The adjustments to the deferred tax assets and liabilities and the liability for the transition tax on indefinitely reinvested foreign earnings, including the analysis of our ability to fully utilize foreign tax credits associated with the transition tax, were provisional amounts estimated based on information reviewed as of February 3, 2018. We recorded an additional expense of $1.3 million in Fiscal 2019, as the one-time transition tax of $5.8 million was finalized.
## Global Intangible Low-Taxed Income ("GILTI")
The Act established new tax rules designed to tax U.S. companies on GILTI earned by foreign subsidiaries. We elected to treat any future GILTI tax liabilities as period costs and will expense those liabilities in the period incurred. Therefore, we will not record deferred taxes associated with the GILTI provision for the Act. Because of tax losses in foreign jurisdictions, there was no liability for GILTI in any period.
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] | overall_image/46a28665bc7698e3dce1dfc623ad74d8a0dcb396698fb75ccb3165a5da40da61.png | ## Note 12
## Earnings Per Share
## Genesco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities to issue common stock were exercised or converted to common stock.
Weighted-average number of shares used for earnings per share is as follows:
<img src='content_image/1036494.jpg'>
## Note 13
## Share-Based Compensation Plans
We have share-based compensation covering certain members of management and non-employee directors. The fair value of employee restricted stock is determined based on the closing price of our stock on the date of grant. Forfeitures for restricted stock are recognized as they occur.
## Stock Incentive Plan
Under the 2009 Plan, which was originally effective June 22, 2011, we may grant options, restricted shares, performance awards and other stock- based awards to our employees, consultants and directors for up to 2.6 million shares of common stock. Under the 2009 Plan, the exercise price of each option equals the market price of our stock on the date of grant, and an option’s maximum term is 10 years. Options granted under the plan primarily vest 25% per year over four years. Restricted share grants deplete the shares available for future grants at a ratio of 2.0 shares per restricted share grant.
For Fiscal 2020, 2019 and 2018, we did not recognize any stock option related share-based compensation for our stock incentive plan as all such amounts were fully recognized in earlier periods. We did not capitalize any share-based compensation cost.
As of February 1, 2020, we do not have any options outstanding under our stock incentive plan. As of February 1, 2020, there was no unrecognized compensation costs related to stock options under the 2009 Plan. On February 5, 2020, our new chief executive officer was issued a one-time grant of stock options under the 2009 Plan with a grant date fair value of $500,000. Compensation costs related to these stock options will begin in the first quarter of our Fiscal 2021 since the grant was made on the first day on Fiscal 2021.
## Restricted Stock Incentive Plans
## Director Restricted Stock
The 2009 Plan permits grants to non-employee directors on such terms as the Board of Directors may approve. Restricted stock awards were made to independent directors on the date of the annual meeting of shareholders in each of Fiscal 2020, 2019 and 2018. The shares granted in each award vested on the first anniversary of the grant date, subject to the director's continued service through that date. In all cases, the director is restricted from selling, transferring, pledging or assigning the shares for three years from the grant date unless he or she earlier leaves the board.
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] | overall_image/2c414718420561e2a7bb8d3e30987127a38c749248e3de7d60c31c2c586f63e1.png | ## Note 13 Share-Based Compensation Plans, Continued
## Genesco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
A summary of the status of our nonvested shares of our employee restricted stock as of February 1, 2020 is presented below:
<img src='content_image/1054648.jpg'>
As of February 1, 2020, we had $19.0 million of total unrecognized compensation costs related to nonvested share-based compensation arrangements for restricted stock discussed above. That cost is expected to be recognized over a weighted average period of 1.79 years.
## Note 14 Legal Proceedings and Other Matters
## Environmental Matters
New York State Environmental Matters In August 1997, the New York State Department of Environmental Conservation (“NYSDEC”) and the Company entered into a consent order whereby we assumed responsibility for conducting a remedial investigation and feasibility study and implementing an interim remedial measure with regard to the site of a knitting mill operated by a former subsidiary of ours from 1965 to 1969. The United States Environmental Protection Agency (“EPA”), which assumed primary regulatory responsibility for the site from NYSDEC, issued a Record of Decision in September 2007. The Record of Decision specified a remedy of a combination of groundwater extraction and treatment and in-situ chemical oxidation.
In September 2015, the EPA adopted an amendment to the Record of Decision eliminating the separate ground-water extraction and treatment systems and the use of in-situ oxidation from the remedy adopted in the Record of Decision. The amendment provides for the continued operation and maintenance of the existing wellhead treatment systems on wells operated by the Village of Garden City, New York (the "Village"). It also requires us to perform certain ongoing monitoring, operation and maintenance activities and to reimburse EPA's future oversight cost, involving future costs to us estimated to be between $1.7 million and $2.0 million, and to reimburse EPA for approximately $1.25 million of interim oversight costs. On August 15, 2016, the Court entered a Consent Judgment implementing the remedy provided for by the amendment.
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] | overall_image/5ab273fdb643e672836412fc25c033b2f1daf438935e0c49210f8aabb564fe51.png | ## ITEM 10, DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
## PART III
Certain information required by this item is incorporated herein by reference to the sections entitled “Election of Directors,” “Corporate Governance” and “Delinquent Section 16(a) Reports” in our definitive proxy statement for our annual meeting of shareholders to be held June 25, 2020, to be filed with the Securities and Exchange Commission. Pursuant to General Instruction G(3), certain information concerning our executive officers appears under Part I, Item 4A, “Executive Officers of the Registrant” in this report.
We have a code of ethics (the “Code of Ethics”) that applies to all of our directors, officers (including our chief executive officer, chief financial officer and chief accounting officer) and employees. We have made the Code of Ethics available and intend to post any legally required amendments to, or waivers of, such Code of Ethics on our website at http://www.genesco.com. Our website address is provided as an inactive textual reference only. The information provided on our website is not a part of this report, and therefore is not incorporated herein by reference.
## ITEM 11, EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the sections entitled “Director Compensation,” “Compensation Committee Report” and “Executive Compensation” in our definitive proxy statement for our annual meeting of shareholders to be held June 25, 2020, to be filed with the Securities and Exchange Commission.
## ITEM 12, SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Certain information required by this item is incorporated herein by reference to the section entitled “Security Ownership of Officers, Directors and Principal Shareholders” in our definitive proxy statement for our annual meeting of shareholders to be held June 25, 2020, to be filed with the Securities and Exchange Commission.
The following table provides certain information as of February 1, 2020 with respect to our equity compensation plans:
## EQUITY COMPENSATION PLAN INFORMATION*
<img src='content_image/1058022.jpg'>
(1) Restricted stock units issued to certain employees at no cost. (2)
Such shares may be issued as restricted shares or other forms of stock-based compensation pursuant to our stock incentive plans.
* For additional information concerning our equity compensation plans, see the discussion in Note 13 Share-Based Compensation Plans.
## ITEM 13, CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated herein by reference to the section entitled “Election of Directors” in our definitive proxy statement for our annual meeting of shareholders to be held June 25, 2020, to be filed with the Securities and Exchange Commission.
## ITEM 14, PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated herein by reference to the section entitled “Audit Matters” in our definitive proxy statement for our annual meeting of shareholders to be held June 25, 2020, to be filed with the Securities and Exchange Commission.
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d. Amendment and Restatement Agreement, dated March 19, 2020, between Schuh Limited, as Parent, and others as Borrowers and Guarantors and Lloyds Bank PLC, as Arranger, Agent and Security Trustee. Incorporated by reference to Exhibit 10.1 to the current report on Form 8-K filed March 24, 2020 (File No. 1- 3083).
e. Form of Split-Dollar Insurance Agreement with Executive Officers. Incorporated by reference to Exhibit (10)a to the Company’s Annual Report on Form 10-K for the fiscal year ended February 1, 1997 (File No.1-3083).
f. Genesco Inc. 2005 Equity Incentive Plan Amended and Restated as of October 24, 2007. Incorporated by reference to Exhibit (10)d to the Company’s Annual Report on Form 10-K for the fiscal year ended February 2, 2008 (File No.1-3083).
g. Genesco Inc. Second Amended and Restated 2009 Equity Incentive Plan. Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K, filed June 28, 2016 (File No. 1-3083)
h. Genesco Inc. Third Amended and Restated EVA Incentive Compensation Plan.
i. Form of Incentive Stock Option Agreement. Incorporated by reference to Exhibit (10)c to the Company’s Quarterly Report on Form 10-Q for the quarter ended October 29, 2005 (File No.1-3083).
j. Form of Non-Qualified Stock Option Agreement. Incorporated by reference to Exhibit (10)d to the Company’s Quarterly Report on Form 10-Q for the quarter ended October 29, 2005 (File No.1-3083).
k. Form of Restricted Share Award Agreement for Executive Officers. Incorporated by reference to Exhibit (10)e to the Company’s Quarterly Report on Form 10-Q for the quarter ended October 29, 2005 (File No.1-3083).
l. Form of Restricted Share Award Agreement for Officers and Employees. Incorporated by reference to Exhibit (10)f to the Company’s Quarterly Report on Form 10-Q for the quarter ended October 29, 2005 (File No.1- 3083).
m. Form of Restricted Share Award Agreement. Incorporated by reference to Exhibit (10)a to the Company’s Quarterly Report on Form 10-Q for the quarter ended August 1, 2009 (File No. 1-3083).
n. Form of Indemnification Agreement For Directors. Incorporated by reference to Exhibit (10)m to the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 1993 (File No.1-3083).
o. Form of Non-Executive Director Indemnification Agreement. Incorporated by reference to Exhibit (10.1) to the current report on Form 8-K filed November 3, 2008 (File No. 1-3083).
p. Form of Officer Indemnification Agreement. Incorporated by reference to Exhibit (10.2) to the Company’s Quarterly Report on Form 10-Q for the quarter ended November 1, 2008 (File No.1-3083).
q. Form of Employment Protection Agreement between the Company and certain executive officers dated as of February 26, 1997. Incorporated by reference to Exhibit (10)p to the Company’s Annual Report on Form 10-K for the fiscal year ended February 1, 1997 (File No.1-3083).
r. First Amendment to Form of Employment Protection Agreement. Incorporated by reference to Exhibit (10)s to the Company’s Annual Report on Form 10-K for the fiscal year ended January 30, 2010 (File No.1-3083).
s. Form of Employment Protection Agreement between the Company and certain executive officers dated as of October 30, 2019. Incorporated by reference to Exhibit 10.1 to the current report on Form 8-K filed October 31, 2019 (File No. 1-3083).
t. Genesco Inc. Deferred Income Plan dated as of July 1, 2000. Incorporated by reference to Exhibit (10)p to the Company’s Annual Report on Form 10-K for the fiscal year ended January 29, 2005. Amended and Restated Deferred Income Plan dated August 22, 2007. Incorporated by reference to Exhibit (10)r to the Company’s Annual Report on Form 10-K for the fiscal year ended February 2, 2008 (File No.1-3083).
u. The Schuh Group Limited 2015 Management Bonus Scheme. Incorporated by reference to Exhibit (10)a to the Company’s Quarterly Report on Form 10-Q for the quarter ended July 30, 2011 (File No.1-3083).
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## Our future success also depends on our ability to respond to changing consumer preferences, identify and interpret consumer trends, and successfully market new products.
The industry in which we operate is subject to rapidly changing consumer preferences. The continued popularity of our footwear and the development of new lines and styles of footwear with widespread consumer appeal, including consumer acceptance of our footwear, requires us to accurately identify and interpret changing consumer trends and preferences, and to effectively respond in a timely manner. Continuing demand and market acceptance for both existing and new products are uncertain and depend on the following factors:
• substantial investment in product innovation, design and development;
• commitment to product quality; and
• significant and sustained marketing efforts and expenditures, including with respect to the monitoring of consumer trends in footwear specifically and in fashion and lifestyle categories generally.
In assessing our response to anticipated changing consumer preferences and trends, we frequently must make decisions about product designs and marketing expenditures several months in advance of the time when actual consumer acceptance can be determined. As a result, we may not be successful in responding to shifting consumer preferences and trends with new products that achieve market acceptance. Because of the ever- changing nature of consumer preferences and market trends, a number of companies in our industry experience periods of rapid growth, followed by declines, in revenue and earnings. If we fail to identify and interpret changing consumer preferences and trends, or are not successful in responding to these changes with the timely development or sourcing of products that achieve market acceptance, we could experience excess inventories and higher than normal markdowns, returns, order cancellations or an inability to profitably sell our products.
## Our results may be adversely affected by declines in consumer traffic in malls.
The majority of our stores are located within shopping malls and depend to varying degrees on consumer traffic in the malls to generate sales.
Declines in mall traffic, whether caused by a shift in consumer shopping preferences or by other factors, such as COVID-19, may negatively impact our ability to maintain or grow our sales in existing stores, which could have an adverse effect on our financial condition or results of operations.
## Our results of operations are subject to seasonal and quarterly fluctuations.
Our business is seasonal, with a significant portion of our net sales and operating income generated during the fourth quarter, which includes the holiday shopping season. Because of this seasonality, we have limited ability to compensate for shortfalls in fourth quarter sales or earnings by changes in our operations or strategies in other quarters. Our quarterly results of operations also may fluctuate significantly based on such factors as:
• the timing of new store openings and renewals;
• the amount of net sales contributed by new and existing stores;
• the timing of certain holidays and sales events;
• changes in quarter end dates due to the 53 week year;
• changes in our merchandise mix;
• weather conditions that affect consumer spending; and
• actions of competitors, including promotional activity.
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Financial Statement Schedule
February 1, 2020
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Valuation and Qualifying Accounts
## Schedule 2
<img src='content_image/1029743.jpg'>
(1) Reflects adjustment of merchandise inventories to realizable value. Charged to Profit and Loss column represents increases to the allowance and the Reductions column represents decreases to the allowance based on quarterly assessments of the allowance.
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] | overall_image/767bc220b839109057e4809fdc01b66c0f97f8b5c29ebc0fd16e650396d60437.png | ## Notes to the Consolidated Financial Statements (continued)
## E. I. du Pont de Nemours and Company
The following average number of stock options were antidilutive, and therefore not included in the dilutive earnings per share calculations:
<img src='content_image/1032290.jpg'>
## NOTE 11 - ACCOUNTS AND NOTES RECEIVABLE - NET
<img src='content_image/1032289.jpg'>
$^{1.}$ Accounts receivable – trade is net of allowances of $85 million at December 31, 2018 and $10 million at December 31, 2017. Allowances are equal to the estimated uncollectible amounts. That estimate is based on historical collection experience, current economic and market conditions, and review of the current status of customers' accounts. $^{2.}$ Notes receivable – trade primarily consists of receivables within the agriculture product line for deferred payment loan programs for the sale of seed products to
customers. These loans have terms of one year or less and are primarily concentrated in North America. The company maintains a rigid pre-approval process for extending credit to customers in order to manage overall risk and exposure associated with credit losses. As of December 31, 2018 and 2017, there were no significant past due notes receivable which required a reserve, nor were there any significant impairments related to current loan agreements. $^{3.}$ Other includes receivables in relation to value added tax, fair value of derivative instruments, indemnification assets, related parties (see Note 7 for further information),
and general sales tax and other taxes. No individual group represents more than ten percent of total receivables.
Accounts and notes receivable are carried at amounts that approximate fair value.
## NOTE 12 - INVENTORIES
<img src='content_image/1032288.jpg'>
As a result of the Merger, a fair value step-up of $3,840 million was recorded for inventories. Of this amount, $1,563 million and $1,434 million was recognized in cost of goods sold within (loss) income from continuing operations for the year ended December 31, 2018 and the period September 1 through December 31, 2017, respectively. See Note 3 for additional information regarding the Merger.
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] | overall_image/f29134baf54dfabf665869b3c64ceb7fba0ddd84ae964487449fa14ad63f68a0.png | Total estimated amortization expense for the next five fiscal years is as follows:
## E. I. du Pont de Nemours and Company Notes to the Consolidated Financial Statements (continued)
<img src='content_image/1052173.jpg'>
## NOTE 15 - SHORT-TERM BORROWINGS, LONG-TERM DEBT AND AVAILABLE CREDIT FACILITIES
The following tables summarize the company's short-term borrowings and capital lease obligations and long-term debt:
<img src='content_image/1052174.jpg'>
The estimated fair value of the company's short-term borrowings, including interest rate financial instruments, was determined using Level 2 inputs within the fair value hierarchy, as described in Note 1 and Note 21. Based on quoted market prices for the same or similar issues, or on current rates offered to the company for debt of the same remaining maturities, the fair value of the company's short-term borrowings and capital lease obligations was $2,160 million and $2,780 million at December 31, 2018 and 2017, respectively.
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The company assesses the payment/performance risk by assigning default rates based on the duration of the guarantees. These default rates are assigned based on the external credit rating of the counterparty or through internal credit analysis and historical default history for counterparties that do not have published credit ratings. For counterparties without an external rating or available credit history, a cumulative average default rate is used.
In certain cases, the company has recourse to assets held as collateral, as well as personal guarantees from customers and suppliers. Assuming liquidation, these assets are estimated to cover approximately 17 percent of the $90 million of guaranteed obligations of customers and suppliers. Set forth below are the company's guaranteed obligations at December 31, 2018.
The following tables provide a summary of the final expiration and maximum future payments for each type of guarantee:
<img src='content_image/1049405.jpg'>
1. Existing guarantees for select customers, as part of contractual agreements. The terms of the guarantees are equivalent to the terms of the customer loans that are primarily made to finance customer invoices. Of the total maximum future payments, $89 million had terms less than a year. 2. Existing guarantees for non-consolidated affiliates' liquidity needs in normal operations.
3.
The company provides guarantees related to leased assets specifying the residual value that will be available to the lessor at lease termination through sale of the assets to the lessee or third parties.
## Operating Leases
The company uses various leased facilities and equipment in its operations. The terms for these leased assets vary depending on the lease agreement.
Future minimum lease payments under non-cancelable operating leases are $242 million, $128 million, $90 million, $66 million and $44 million for the years 2019, 2020, 2021, 2022 and 2023, respectively, and $85 million for subsequent years and are not reduced by non-cancelable minimum sublease rentals due in the future in the amount of $2 million. Net rental expense under operating leases was $271 million, $105 million, $179 million and $242 million for the year ended December 31, 2018, for periods September 1 through December 31, 2017 and January 1 through August 31, 2017, and the year ended December 31, 2016, respectively.
## Litigation
The company is subject to various legal proceedings arising out of the normal course of its current and former business operations, including product liability, intellectual property, commercial, environmental and antitrust lawsuits. It is not possible to predict the outcome of these various proceedings. Although considerable uncertainty exists, management does not anticipate that the ultimate disposition of these matters will have a material adverse effect on the company's results of operations, consolidated financial position or liquidity. However, the ultimate liabilities could be material to results of operations in the period recognized.
PFOA Liabilities
Historical DuPont is a party to legal proceedings relating to the use of PFOA (collectively, perfluorooctanoic acids and its salts, including the ammonium salt) by its former Performance Chemicals segment, which separated from DuPont in July 2015 through the spin-off of all the issued and outstanding stock of Chemours. While it is reasonably possible that the company could incur liabilities related to PFOA, any such liabilities are not expected to be material. As discussed in Note 4 and below, the company is indemnified by Chemours under the Chemours Separation Agreement, as amended. The company has recorded a liability of $20 million and an indemnification asset of $20 million at December 31, 2018, primarily related to testing drinking water in and around certain historic company sites and offering treatment or an alternative supply of drinking water if tests indicate the presence of PFOA in drinking water at or greater than the national health advisory level established from time to time by the EPA.
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## E. I. du Pont de Nemours and Company
The tax benefit recorded in Stockholders' Equity was $33 million for the year ended December 31, 2016. Included in the amount was a tax benefit of $21 million for the year ended December 31, 2016 associated with stock compensation programs. The remainder consists of amounts recorded within other comprehensive loss as shown in the table above.
## NOTE 18 - PENSION PLANS AND OTHER POST EMPLOYMENT BENEFITS
The company offers various long-term benefits to its employees. Where permitted by applicable law, the company reserves the right to change, modify or discontinue the plans.
As a result of the Merger, the company re-measured its pension and OPEB plans. The remeasurement of the company’s pension and OPEB plans is included in the fair value measurement of Historical DuPont’s assets and liabilities as a result of the application of purchase accounting in connection with the Merger. In addition, net losses and prior service benefits recognized in accumulated other comprehensive loss were eliminated. Historical Dow and Historical DuPont did not merge their pension plans and OPEB plans as a result of the Merger. See Note 3 for details on the Merger.
## Defined Benefit Pension Plans
The company has both funded and unfunded noncontributory defined benefit pension plans covering a majority of the U.S. employees and a number of other countries. The principal U.S. pension plan is the largest pension plan held by Historical DuPont. Most employees hired on or after January 1, 2007 are not eligible to participate in the U.S. defined benefit pension plans. The benefits under these plans are based primarily on years of service and employees' pay near retirement. In November 2016, the company announced that it will freeze the pay and service amounts used to calculate pension benefits for active employees who participate in the U.S. pension plans on November 30, 2018. Therefore, as of November 30, 2018, employees participating in the U.S. pension plans no longer accrue additional benefits for future service and eligible compensation received. These changes resulted in a $527 million decline in the projected benefit obligation, which is reflected in actuarial loss (gain) in the change in projected benefit obligations and recognition of a $25 million pre-tax curtailment gain during the fourth quarter of 2016. The decline in the projected benefit obligation is primarily due to the decrease in expected future compensation.
The company's funding policy is consistent with the funding requirements of federal laws and regulations. Pension coverage for employees of the company's non-U.S. consolidated subsidiaries is provided, to the extent deemed appropriate, through separate plans. Obligations under such plans are funded by depositing funds with trustees, covered by insurance contracts, or remain unfunded. The company made a discretionary contribution of $1,100 million in the third quarter of 2018 to its principal U.S. pension plan. During the period January 1 through August 31, 2017, the company made total contributions of $2,900 million to its principal U.S. pension plan funded through the May 2017 Debt Offering; short-term borrowings, including commercial paper issuance; and cash flow from operations. See Note 15 for further discussion related to the May 2017 Debt Offering. The company contributed $230 million to the principal U.S. pension plan in 2016. The company does not expect to make cash contributions to this plan in 2019.
The company made total contributions of $103 million, $34 million, $67 million and $121 million to its funded pension plans other than the principal U.S. pension plan for the year ended December 31, 2018, for periods September 1 through December 31, 2017 and January 1 through August 31, 2017, and the year ended December 31, 2016, respectively. Additionally, the company made total contributions of $105 million, $34 million, $57 million and $184 million to its remaining plans with no plan assets for the year ended December 31, 2018, for periods September 1 through December 31, 2017 and January 1 through August 31, 2017, and the year ended December 31, 2016, respectively. Historical DuPont expects to contribute approximately $190 million to its funded pension plans other than the principal U.S. pension plan and its remaining plans with no plan assets in 2019.
The company’s remeasurement of its pension plans at the Merger Effectiveness Time resulted in an increase in the underfunded status of $560 million. In connection with the remeasurement, the company updated the weighted average discount rate to 3.42 percent at August 31, 2017 from 3.80 percent as of December 31, 2016.
The workforce reductions in 2016 related to a 2016 global cost savings and restructuring plan triggered curtailments for certain of the company's pension plans, including the principal U.S. pension plan. For the principal U.S. pension plan, the company recorded curtailment losses of $63 million during the year ended December 31, 2016. The curtailment losses were driven by the changes in the benefit obligation based on the demographics of the terminated positions partially offset by accelerated recognition of a portion of the prior service benefit.
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## E. I. du Pont de Nemours and Company Notes to the Consolidated Financial Statements (continued)
The estimated future benefit payments, reflecting expected future service, as appropriate, are presented in the following table:
<img src='content_image/1031410.jpg'>
## Plan Assets
All pension plan assets in the U.S. are invested through a single master trust fund. The strategic asset allocation for this trust fund is approved by management. The general principles guiding U.S. pension asset investment policies are those embodied in the Employee Retirement Income Security Act of 1974 ("ERISA"). These principles include discharging Historical DuPont's investment responsibilities for the exclusive benefit of plan participants and in accordance with the "prudent expert" standard and other ERISA rules and regulations. Historical DuPont establishes strategic asset allocation percentage targets and appropriate benchmarks for significant asset classes with the aim of achieving a prudent balance between return and risk. Strategic asset allocations in other countries are selected in accordance with the laws and practices of those countries. Where appropriate, asset liability studies are utilized in this process. U.S. plan assets and a portion of non-U.S. plan assets are managed by investment professionals employed by Historical DuPont. The remaining assets are managed by professional investment firms unrelated to the company. Historical DuPont's pension investment professionals have discretion to manage the assets within established asset allocation ranges approved by management of the company. Additionally, pension trust funds are permitted to enter into certain contractual arrangements generally described as "derivatives". Derivatives are primarily used to reduce specific market risks, hedge currency and adjust portfolio duration and asset allocation in a cost-effective manner.
In connection with pension contributions of $2,900 million to its principal U.S. pension plan during the period of January 1, 2017 through August 31, 2017, an investment policy study was completed for the principal U.S. pension plan. The study resulted in new target asset allocations being approved for the U.S. pension plan with resulting changes to the expected return on plan assets. The long-term rate of return on assets decreased from 8 percent to 6.25 percent.
The weighted-average target allocation for plan assets of the company's pension plans is summarized as follows:
<img src='content_image/1031409.jpg'>
Global equity securities include varying market capitalization levels. U.S. equity investments are primarily large-cap companies. Global fixed income investments include corporate-issued, government-issued and asset-backed securities. Corporate debt investments include a range of credit risk and industry diversification. U.S. fixed income investments are weighted heavier than non-U.S. fixed income securities. Other investments include cash and cash equivalents, hedge funds, real estate and private market securities such as interests in private equity and venture capital partnerships.
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## Notes to the Consolidated Financial Statements (continued)
## E. I. du Pont de Nemours and Company
The company issues nonvested RSUs that serially vest over a three-year period and, upon vesting, convert one-for-one to DowDuPont Common Stock. A retirement-eligible employee retains any granted awards upon retirement provided the employee has rendered at least six months of service following the grant date. Additional RSUs are also granted periodically to key senior management employees. These RSUs generally vest over periods ranging from three to five years. The fair value of all stock-settled RSUs is based upon the market price of the underlying common stock as of the grant date. The awards have the same terms and conditions as were applicable to such equity awards immediately prior to the Merger closing date.
The company grants PSUs to senior leadership. As a result of the Merger, the EIP provisions required PSUs to be converted into RSUs based on the number of PSUs that would vest by assuming that target levels of performance are achieved. Service requirements for vesting in the RSUs replicate those inherent in the exchanged PSUs.
Vesting for PSUs granted in 2016 and for the period January 1, 2017 through August 31, 2017 was based upon total shareholder return ("TSR") relative to peer companies. Vesting for PSUs granted in 2015 was equally based upon change in operating net income relative to target and TSR relative to peer companies. Operating net income is net income attributable to Historical DuPont excluding income from discontinued operations after taxes, significant after tax benefits (charges), and non-operating pension and OPEB costs. Non-operating pension and OPEB costs includes all of the components of net periodic benefit cost from continuing operations with the exception of the service cost component. Performance and payouts are determined independently for each metric. The actual award, delivered as DowDuPont Common Stock, can range from zero percent to 200 percent of the original grant. The weighted-average grant-date fair value of PSUs granted for the period January 1 through August 31, 2017, subject to the TSR metric, was $91.56, and estimated using a Monte Carlo simulation. The weighted-average grant-date fair value of the PSUs, subject to the revenue metric, was based upon the market price of the underlying common stock as of the grant date.
In accordance with the Merger Agreement, PSUs converted to RSUs based on an assessment of the underlying market conditions in the PSUs at the greater of target or actual performance levels as of the closing date. As the actual performance levels were not in excess of target as of the closing date, all PSUs converted to RSUs based on target and there was no incremental benefit from the Merger Agreement when compared to Historical DuPont’s EIP.
In November 2017, DowDuPont granted PSUs to senior leadership that vest partially based on the realization of cost savings in connection with the DowDuPont Cost Synergy Program, as well as DowDuPont’s ability to complete the Intended Business Separations. Performance and payouts are determined independently for each metric. The actual award, delivered in DowDuPont Common Stock, can range from zero percent to 200 percent of the original grant. The weighted-average grant-date fair value of the PSUs granted in November 2017 of $71.16 was based upon the market price of the underlying common stock as of the grant date. There were no PSUs granted for the year ended December 31, 2018.
Nonvested awards of RSUs and PSUs are shown below.
<img src='content_image/1060313.jpg'>
The total fair value of stock units vested during for the year ended December 31, 2018, for the periods September 1 through December 31, 2017 and January 1 through August 31, 2017, and the year ended December 31, 2016 was $128 million, $9 million, $84 million and $83 million, respectively. The weighted-average grant-date fair value of stock units granted for the year ended December 31, 2018, for the periods September 1 through December 31, 2017 and January 1 through August 31, 2017, and the year ended December 31, 2016 was $70.37, $70.02, $76.41, and $59.50, respectively.
As of December 31, 2018, $71 million of total unrecognized pre-tax compensation expense related to RSUs and PSUs is expected to be recognized over a weighted average period of 1.45 years.
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] | overall_image/542c58cee40b1741aa700dc6d6d8461c1a68d29ba6d979b692ffa535e9cdf936.png | ## NOTE 23 - QUARTERLY FINANCIAL DATA
## Notes to the Consolidated Financial Statements (continued)
## E. I. du Pont de Nemours and Company
<img src='content_image/1058056.jpg'>
<img src='content_image/1058057.jpg'>
2017, fourth quarter 2017, first quarter 2018, second quarter 2018, third quarter 2018, and fourth quarter 2018, respectively, related to the amortization of inventory step-up as a result of the Merger and the acquisition of the H&N Business. See Note 3 for additional information. 2. See Note 6 for additional information.
3. See Note 14 for additional information.
4.
Includes a tax benefit of $2,262 million in the fourth quarter 2017 related to The Act and a benefit related to an internal entity restructuring associated with the Intended Business Separations. Includes tax (charges) benefits of $(102) million, $(7) million, $46 million, and $(167) million in the first quarter 2018, second quarter 2018, third quarter 2018, and fourth quarter 2018, respectively, related to The Act. See Note 9 for additional information. 5. Includes a tax charge of $(75) million in the third quarter 2018 related to the establishment of a full valuation allowance against the net deferred tax asset position of a
legal entity in Brazil. See Note 9 for additional information. 6. Includes a loss on early extinguishment of debt of $(81) million in the fourth quarter 2018 related to the retirement of some of the company's notes payable. See Note 15
for additional information. 7. Includes loss from discontinued operations after taxes related to the Divested Ag Business of $(5) million in the first quarter 2018. See Note 4 for additional information.
8.
Integration and separation costs were $170 million, $201 million, and $210 million in the first quarter 2017, second quarter 2017, and the period July 1 - August 31, 2017, respectively. In the Predecessor periods, costs are recorded in selling, general and administrative expenses. See Note 3 for additional information. 9. First quarter 2017 included a gain of $162 million recorded in sundry income - net associated with the sale of the company's global food safety diagnostic business. See
Note 4 for additional information. 10. First quarter 2017 included a tax benefit of $53 million, as well as a $47 million benefit on associated accrued interest reversals (recorded in sundry income (expense) -
net), related to a reduction in the company’s unrecognized tax benefits due to the closure of various tax statutes of limitations. 11. Includes income (loss) from discontinued operations after taxes primarily related to the Divested Ag Business of $160 million, $137 million, $29 million, $(20) million, and
$(57) million, in the first quarter 2017, second quarter 2017, the period July 1 - August 31, 2017, the period September 1 - September 30, 2017, and fourth quarter 2017, respectively. Additionally, includes income (loss) from discontinued operations after taxes primarily related to Chemours of $(217) million and $10 million, in the first quarter 2017 and second quarter 2017, respectively. See Note 4 for additional information. 12. Due to quarterly changes in the share count and the allocation of income to participating securities, the sum of the four quarters may not equal the earnings
per share amount calculated for the year.
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## Part I
The company is subject to various litigation matters, including, but not limited to, product liability, patent infringement, antitrust claims, and claims for third party property damage or personal injury stemming from alleged environmental torts. Information regarding certain of these matters is set forth below and in Note 16 to the Consolidated Financial Statements.
## Litigation
## PFOA: Environmental and Litigation Proceedings
For purposes of this report, the term PFOA means collectively perfluorooctanoic acid and its salts, including the ammonium salt and does not distinguish between the two forms. Information related to this matter is included in Note 16 to the Consolidated Financial Statements under the heading PFOA.
## Fayetteville Works Facility, Fayetteville, North Carolina
In August 2017, the U.S. Attorney’s Office for the Eastern District of North Carolina served the company with a grand jury subpoena for testimony and the production of documents related to alleged discharges of GenX from the Fayetteville Works facility into the Cape Fear River. Historical DuPont has been served with additional subpoenas relating to the same issue and in the second quarter 2018, received a subpoena expanding the scope to any PFCs discharged from the Fayetteville Works facility into the Cape Fear River. Additional information related to this matter is included in Note 16 to the Consolidated Financial Statements under the heading Fayetteville Works Facility, North Carolina.
## La Porte Plant, La Porte, Texas - Crop Protection - Release Incident Investigations
On November 15, 2014, there was a release of methyl mercaptan at the company’s La Porte facility. The release occurred at the site’s Crop Protection unit resulting in four employee fatalities inside the unit. Historical DuPont continues to cooperate with governmental agencies, including the U.S. Environmental Protection Agency ("EPA"), the Chemical Safety Board and the Department of Justice ("DOJ"), which are still conducting investigations. These investigations could result in sanctions and civil or criminal penalties against the company. In the second quarter 2018, Historical DuPont, the DOJ and EPA reached a resolution-in-principle, for $3.1 million, regarding certain EPA civil claims. The resolution-in- principle was approved by the court in the third quarter 2018 and has been paid.
## Environmental Proceedings
The company believes it is remote that the following matters will have a material impact on its financial position, liquidity or results of operations. The descriptions are included per Regulation S-K, Item 103(5)(c) of the Securities Exchange Act of 1934.
## La Porte Plant, La Porte, Texas - EPA Multimedia Inspection
The EPA conducted a multimedia inspection at the La Porte facility in January 2008. Historical DuPont, the EPA and the DOJ began discussions in the Fall 2011 relating to the management of certain materials in the facility's waste water treatment system, hazardous waste management, flare and air emissions. These discussions continue.
## Sabine Plant, Orange, Texas - EPA Multimedia Inspection
In June 2012, Historical DuPont began discussions with the EPA and the DOJ related to a multimedia inspection that the EPA conducted at the Sabine facility in March 2009 and December 2015. The discussions involve the management of materials in the facility's waste water treatment system, hazardous waste management, flare and air emissions, including leak detection and repair. These discussions continue.
## Divested Neoprene Facility, La Place, Louisiana - EPA Compliance Inspection
In 2016, the EPA conducted a focused compliance investigation at the Denka Performance Elastomer LLC (“Denka”) neoprene manufacturing facility in La Place, Louisiana. Historical DuPont sold the neoprene business, including this manufacturing facility, to Denka in the fourth quarter of 2015. Subsequent to this inspection, the EPA, the DOJ, the Louisiana Department of Environmental Quality ("LDEQ"), Historical DuPont and Denka began discussions in the spring of 2017 relating to the inspection conclusions and allegations of noncompliance arising under the Clean Air Act, including leak detection and repair. These discussions, which include potential settlement options, continue.
## ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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## ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
## CAUTIONARY STATEMENTS ABOUT FORWARD-LOOKING STATEMENTS
This communication contains “forward-looking statements” within the meaning of the federal securities laws, including Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In this context, forward-looking statements often address expected future business and financial performance and financial condition, and often contain words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “see,” “will,” “would,” “target,” similar expressions, and variations or negatives of these words.
Forward-looking statements by their nature address matters that are, to varying degrees, uncertain, including statements about the Intended Business Separations, the separations and distributions. Forward-looking statements, including those related to the ability of Historical DuPont, Historical Dow and DowDuPont to complete, or to make any filing or take any other action required to be taken to complete, the separations and distributions, are not guarantees of future results and are subject to risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed in any forward-looking statements. Forward-looking statements also involve risks and uncertainties, many of which are beyond the control of Historical DuPont, Historical Dow and DowDuPont. Some of the important factors that could cause DowDuPont’s, Historical Dow’s or Historical DuPont’s actual results (including DowDuPont’s agriculture business, materials science business or specialty products business as conducted by and through Historical Dow and Historical DuPont) to differ materially from those projected in any such forward-looking statements include, but are not limited to: (i) ability and costs to achieve all the expected benefits, including anticipated cost and growth synergies, from the integration of Historical Dow and Historical DuPont and the Intended Business Separations, (either directly or as conducted through Historical Dow and Historical DuPont); (ii) the incurrence of significant costs in connection with the integration of Historical Dow and Historical DuPont and the Intended Business Separations; (iii) risks outside the control of DowDuPont, Historical Dow and Historical DuPont which could impact the decision of the DowDuPont Board of Directors to proceed with the Intended Business Separations, including, among others, global economic conditions, instability in credit markets, declining consumer and business confidence, fluctuating commodity prices and interest rates, volatile foreign currency exchange rates, tax considerations, a full or partial shutdown of the U.S. federal government, and other challenges that could affect the global economy, specific market conditions in one or more of the industries of the businesses proposed to be separated, and changes in the regulatory or legal environment and the requirement to redeem $12.7 billion of DowDuPont notes if the Intended Business Separations are abandoned or delayed beyond May 1, 2020; (iv) potential liability arising from fraudulent conveyance and similar laws in connection with the separations and distributions; (v) disruptions or business uncertainty, including from the Intended Business Separations, could adversely impact financial performance and ability to retain and hire key personnel; (vii) potential inability to access the capital markets; and (viii) risks to DowDuPont’s, Historical Dow’s and Historical DuPont’s business, operations and results of operations from: the availability of and fluctuations in the cost of feedstocks and energy; balance of supply and demand and the impact of balance on prices; failure to develop and market new products and optimally manage product life cycles; ability, cost and impact on business operations, including the supply chain, of responding to changes in market acceptance, rules, regulations and policies and failure to respond to such changes; outcome of significant litigation, environmental matters and other commitments and contingencies; failure to appropriately manage process safety and product stewardship issues; global economic and capital market conditions, including the continued availability of capital and financing, as well as inflation, interest and currency exchange rates; changes in political conditions, including trade disputes and retaliatory actions; business or supply disruptions; security threats, such as acts of sabotage, terrorism or war, natural disasters and weather events and patterns which could result in a significant operational event, adversely impact demand or production; ability to discover, develop and protect new technologies and to protect and enforce intellectual property rights; failure to effectively manage acquisitions, divestitures, alliances, joint ventures and other portfolio changes; unpredictability and severity of catastrophic events, including, but not limited to, acts of terrorism or outbreak of war or hostilities, as well as management’s response to any of the aforementioned factors. A detailed discussion of some of the significant risks and uncertainties which may cause results and events to differ materially from such forward-looking statements is included in the section titled “Risk Factors” (Part I, Item 1A of this Form 10-K).
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## ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued
## Note on Financial Presentation
In connection with the Merger Transaction, the company applied the acquisition method of accounting as of September 1, 2017 and the Consolidated Financial Statements reflect the related adjustments. Historical DuPont's Consolidated Financial Statements for periods following the close of the Merger are labeled “Successor” and reflect DowDuPont’s basis in the fair values of the assets and liabilities of Historical DuPont. All periods prior to the closing of the Merger reflect the historical accounting basis in Historical DuPont's assets and liabilities and are labeled “Predecessor.” The Consolidated Financial Statements and Notes to the Consolidated Financial Statements include a black line division between the columns titled "Predecessor" and "Successor" to signify that the amounts shown for the periods prior to and following the Merger are not comparable. In addition, the company has elected to make certain changes in presentation to harmonize its accounting and reporting with that of DowDuPont in the Successor periods. See Note 1 to the Consolidated Financial Statements for further discussion of these changes and Note 3 to the Consolidated Financial Statements for additional information regarding the Merger Transaction.
## Results
Net sales were $26.3 billion for the year ended December 31, 2018, compared to $7.1 billion for the period September 1 through December 31, 2017, and $17.3 billion for the period January 1 through August 31, 2017. The $1.9 billion increase was primarily driven by local pricing and portfolio gains across all regions. (Loss) income from continuing operations before taxes was $(4.8) billion, $(1.6) billion and $1.8 billion for the year ended December 31, 2018 and for the periods September 1 through December 31, 2017 and January 1 through August 31, 2017, respectively. The year ended December 31, 2018 results include a goodwill impairment charge of $4.5 billion, increased transaction costs related to the Merger and Intended Business Separations, higher amortization related to the fair value step up of other intangible assets, and higher depreciation related to the fair value step up of property, plant and equipment. These increased costs are partially offset by higher sales and benefits from cost synergies. Pension and other post employment benefits ("OPEB") (benefits) costs for the year ended December 31, 2018 were $(228) million, as compared to $(83) million and $373 million for the period September 1 through December 31, 2017 and January 1 through August 31, 2017, respectively. Activity in the Successor periods benefited from significantly lower amortization of net losses from accumulated other comprehensive loss ("AOCL").
## Analysis of Operations
## DowDuPont Contribution and Historical DuPont’s Offer to Purchase Debt Securities
In contemplation of the Intended Business Separations and to achieve the respective credit profiles of each of the intended future companies, DowDuPont completed a series of financing transactions in the fourth quarter of 2018, which included an offering of senior unsecured notes and the establishment of new term loan facilities (the “financing transactions”).
On November 13, 2018, Historical DuPont launched a tender offer (the “Tender Offer”) to purchase $6.2 billion aggregate principal amount of its outstanding debt securities (the “Tender Notes”). The Tender Offer expired on December 11, 2018 (the “Expiration Date”). At the Expiration Date, $4,409 million aggregate principal amount of the Tender Notes had been validly tendered and was accepted for payment. In exchange for such validly tendered Tender Notes, Historical DuPont paid a total of $4,849 million, which included breakage fees and all applicable accrued and unpaid interest on such Tender Notes. DowDuPont contributed cash (generated from its notes offering) to Historical DuPont to fund the settlement of the Tender Offer and payment of associated fees. Historical DuPont recorded a loss from early extinguishment of debt of $81 million, primarily related to the difference between the redemption price and the par value of the notes, mostly offset by the write-off of unamortized step-up related to the fair value step-up of Historical DuPont’s debt. DowDuPont has announced its intent to use a portion of the remaining proceeds from the financing transaction to further reduce outstanding liabilities of Historical DuPont that would otherwise be attributable to Corteva.
## Agriculture Reporting Unit Goodwill and Indefinite-lived Asset Impairments
During the third quarter of 2018, the company was required to perform an interim impairment test of its goodwill and indefinite-lived intangible assets for the agriculture reporting unit. As a result of the analysis performed, the company recorded pre-tax, non-cash impairment charges of $4,503 million for goodwill and $85 million for certain indefinite-lived assets for the year ended December 31, 2018. The charges were recognized in goodwill impairment charge and restructuring and asset related charges - net, respectively, in the Consolidated Statement of Operations.
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## ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued
For the year ended December 31, 2018, Historical DuPont recorded a pre-tax charge of $322 million, of which $318 million was recognized in restructuring and asset related charges - net and $4 million was recognized in sundry income (expense) - net in the company's Consolidated Statements of Operations. This charge consisted of severance and related benefit costs of $219 million, contract termination costs of $40 million and asset related charges of $63 million. For the period September 1 through December 31, 2017, Historical DuPont recorded a pre-tax charge of $187 million, recognized in restructuring and asset related charges - net in the company's Consolidated Statements of Operations. This charge consisted of severance and related benefit costs of $153 million, contract termination costs of $31 million and asset related charges of $3 million. Actions associated with the Synergy Program, including employee separations, are expected to be substantially complete by the end of 2019. Additional details related to this plan can be found on page 25 of this report and Note 6 to the Consolidated Financial Statements.
Future cash payments related to this program are anticipated to be approximately $255 million to $305 million, primarily related to the payment of severance and related benefits and contract termination costs. It is possible that additional charges and future cash payments could occur in relation to the restructuring actions. The company anticipates including savings associated with these actions within DowDuPont's cost synergy commitment of $3.6 billion associated with the Merger Transaction. Additional details related to this plan can be found in Note 6 to the Consolidated Financial Statements.
## 2017 Restructuring Program
During the first quarter 2017, Historical DuPont committed to take actions to improve plant productivity and better position its product lines for productivity and growth before and after the anticipated closing of the Merger Transaction (the "2017 restructuring program"). In connection with these actions, the company incurred pre-tax charges of $313 million during the period from January 1 through August 31, 2017 recognized in restructuring and asset related charges - net in the company's Consolidated Statements of Operations. The charges primarily relate to the second quarter closure of the safety and construction product line at the Cooper River manufacturing site located near Charleston, South Carolina. The actions associated with this plan were substantially complete as of December 31, 2017. Additional details related to this plan can be found on page 25 of this report and Note 6 to the Consolidated Financial Statements.
## FMC Transactions
On March 31, 2017, the company and FMC Corporation ("FMC") entered into a definitive agreement (the "FMC Transaction Agreement"). Under the FMC Transaction Agreement, and effective upon the closing of the transaction on November 1, 2017, FMC acquired the crop protection business and R&D assets that Historical DuPont was required to divest in order to obtain European Commission approval of the Merger Transaction, (the "Divested Ag Business") and Historical DuPont agreed to acquire certain assets relating to FMC’s Health and Nutrition segment, excluding its Omega-3 products (the "H&N Business") (collectively, the "FMC Transactions"). The sale of the Divested Ag Business meets the criteria for discontinued operations and as such, earnings are included within (loss) income from discontinued operations after income taxes for all periods presented.
On November 1, 2017, the company completed the FMC Transactions through the disposition of the Divested Ag Business and the acquisition of the H&N Business. The fair value as determined by the company of the H&N Business was $1,970 million. The FMC Transactions included a cash consideration payment to Historical DuPont of approximately $1,200 million, which reflects the difference in value between the Divested Ag Business and the H&N Business, as well as favorable contracts with FMC of $495 million. The carrying value of the Divested Ag Business approximated the fair value of the consideration received, thus no resulting gain or loss was recognized on the sale. Refer to Note 3 and 4 to the Consolidated Financial Statements for further information.
## Separation of Performance Chemicals
On July 1, 2015, Historical DuPont completed the separation of its Performance Chemicals segment through the spin-off of all of the issued and outstanding stock of The Chemours Company. In connection with the separation, the company and Chemours entered into a Separation Agreement and a Tax Matters Agreement as well as certain ancillary agreements. In accordance with generally accepted accounting principles in the U.S. ("GAAP"), the results of operations of its former Performance Chemicals segment are presented as discontinued operations and, as such, are included within (loss) income from discontinued operations after income taxes in the Consolidated Statements of Operations for all periods presented. Additional details regarding the separation and other related agreements can be found in Note 4 to the Consolidated Financial Statements.
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## ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued
## 2017 versus 2016
Sundry income (expense) - net was an income of $224 million and expense of ($113) million for the period September 1 through December 31, 2017 and for the period January 1 through August 31, 2017, respectively. Sundry income (expense) - net was income of $667 million for the year ended December 31, 2016. The 2017 charges are described above. The year ended December 31, 2016 included a pre-tax gain of $369 million associated with the sale of Historical DuPont ("Shenzhen") Manufacturing Limited entity, royalty income of $170 million, a net exchange loss of $106 million and a non-operating pension and other post employment cost of $40 million. In the Successor periods, royalty income is included in net sales. See Note 1 to the Consolidated Financial Statements for further discussion of the changes in presentation.
See Note 8 to the Consolidated Financial Statements for additional information.
## Loss on Early Extinguishment of Debt
The company recorded a loss from early extinguishment of debt of $81 million for the year ended December 31, 2018, primarily related to the difference between the redemption price and the aggregate amount of the Tender Notes purchased in the Tender Offer, mostly offset by the write- off of unamortized step-up related to the fair value step-up of Historical DuPont’s debt. Additional information regarding the company’s Early Tender Settlement can be found on pages 20 and 29 of this report and Note 15 to the Consolidated Financial Statements for additional.
## Interest Expense 2018 versus 2017
Interest expense was $331 million for the year ended December 31, 2018, $107 million for the period September 1 through December 31, 2017, and $254 million for the period January 1 through August 31, 2017. The change was primarily driven by amortization of the step-up of debt as a result of push-down accounting, partially offset by higher borrowing rates.
## 2017 versus 2016
Interest expense was $107 million for the period September 1 through December 31, 2017, $254 million for the period January 1 through August 31, 2017, and $370 million for the year ended December 31, 2016. The change was primarily driven by amortization of the step-up of debt as a result of push-down accounting, partially offset by higher debt balances.
## Provision for Income Taxes on Continuing Operations 2018
For the year ended December 31, 2018, the company’s effective tax rate of (4.6) percent on pre-tax loss from continuing operations of $4,793 million was unfavorably impacted by the non-tax-deductible impairment charge for the agriculture reporting unit and corresponding $75 million tax charge associated with a valuation allowance recorded against the net deferred tax asset position of a legal entity in Brazil, costs associated with the Merger with Dow (including a $74 million net tax charge on repatriation activities to facilitate the Intended Business Separations), a $121 million net tax charge related to completing its accounting for the tax effects of the Act (see Note 9 of the Consolidated Financial Statements for additional detail), and the impacts related to the non-tax-deductible amortization of the fair value step-up in DuPont’s inventories as a result of the Merger.
## 2017
For the period September 1 through December 31, 2017, the company’s effective tax rate of 168.5 percent on pre-tax loss from continuing operations of $1,586 million was favorably impacted by a provisional net benefit of $2,001 million that the company recognized due to the enactment of The Act, a net benefit of $261 million related to an internal legal entity restructuring associated with the Intended Business Separations, as well as geographic mix of earnings. Those impacts were partially offset by the non-tax deductible amortization of the fair value step- up in Historical DuPont’s inventories as a result of the Merger, certain net exchange losses recognized on the remeasurement of the net monetary asset positions which were not tax deductible in their local jurisdictions, as well as the tax impact of costs associated with the Merger with Historical Dow and restructuring and asset related charges.
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## The Intended Business Separations
## Part I
DowDuPont has formed two wholly owned subsidiaries: Dow Holdings Inc., to serve as a holding company for its materials science business, and Corteva, Inc., to serve as a holding company for its agriculture business.
In furtherance of the Intended Business Separations, DowDuPont is engaged in a series of internal reorganization and realignment steps (the “Internal Reorganization”) to realign its businesses into three subgroups: agriculture, materials science and specialty products. As part of the Internal Reorganization, the assets and liabilities aligned with the materials science business will be transferred or conveyed to legal entities that will ultimately be subsidiaries of Dow Holdings Inc. and the assets and liabilities aligned with the agriculture business will be transferred or conveyed to legal entities that will ultimately be subsidiaries of Corteva Inc.
Following the Internal Reorganization, DowDuPont expects to distribute its materials science and agriculture businesses through two separate U.S. federal tax-free spin-offs in which DowDuPont stockholders, at the time of such spin-offs, will receive a pro rata dividend of the shares of the capital stock of Dow Holdings Inc. and of Corteva, Inc., as applicable (the “distributions”). The materials science business after the consummation of the applicable Internal Reorganization will be referred to as “Dow” and the agriculture business after the consummation of the applicable Internal Reorganization will be referred to as “Corteva”. Following the separation and distribution of Dow, which is targeted to occur on April 1, 2019, DowDuPont, as the remaining company, will continue to hold the agriculture and specialty products businesses. DowDuPont is then targeted to complete the separation and distribution of Corteva on June 1, 2019, resulting in DowDuPont holding the specialty products businesses of the combined Company. After the distribution of Corteva, it is expected that DowDuPont will become known as "DuPont". Historical DuPont after the separations and distributions will hold the agriculture business and be a subsidiary of Corteva Inc.
## Agriculture Reporting Unit Goodwill and Indefinite-lived Asset Impairments
During the third quarter of 2018, the company was required to perform an interim impairment test of its goodwill and indefinite-lived intangible assets for the agriculture reporting unit. As a result of the analysis performed, the company recorded pre-tax, non-cash impairment charges of $4,503 million for goodwill and $85 million for certain indefinite-lived assets for the year ended December 31, 2018. The charges were recognized in goodwill impairment charge and restructuring and asset related charges - net, respectively, in the Consolidated Statement of Operations.
## DowDuPont Contribution and Historical DuPont’s Offer to Purchase Debt Securities
On November 13, 2018, Historical DuPont launched a tender offer (the “Tender Offer”) to purchase $6.2 billion aggregate principal amount of its outstanding debt securities (the “Tender Notes”). At December 1, 2018, the expiration date for the Tender Offer, $4,409 million aggregate principal amount of the Tender Notes had been validly tendered and was accepted for payment. Additional details related to this plan can be found in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, on page 18 of this report and Note 15 to the Consolidated Financial Statements.
## Tax Reform
On December 22, 2017, the Tax Cuts and Jobs Act (“The Act”) was enacted. The Act reduces the US federal corporate income tax rate from 35 percent to 21 percent, requires companies to pay a one-time transition tax (“transition tax”) on earnings of foreign subsidiaries that were previously tax deferred, creates new provisions related to foreign sourced earnings, eliminates the domestic manufacturing deduction and moves to a territorial system. At December 31, 2017, the company had not yet completed its accounting for the tax effects of enactment of The Act. However, the Company made a reasonable estimate of the effects on its existing deferred tax balances and the one-time transition tax. In accordance with Staff Accounting Bulletin 118 ("SAB 118"), income tax effects of The Act were refined upon obtaining, preparing, or analyzing additional information during the measurement period. At December 31, 2018, the Company had completed its accounting for the tax effects of The Act. Additional details related to The Act can be found in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, on page 18 of this report and Note 9 to the Consolidated Financial Statements.
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The company entered into a trust agreement in 2013 (as amended and restated in 2017) that established and requires Historical DuPont to fund a trust (the "Trust") for cash obligations under certain nonqualified benefit and deferred compensation plans upon a change in control event as defined in the Trust agreement. Under the Trust agreement, the consummation of the Merger was a change in control event. As a result, in November 2017, the company contributed $571 million to the Trust. In the fourth quarter of 2017, $13 million was distributed to Historical DuPont according to the Trust agreement and at December 31, 2017, the balance in the Trust was $558 million. During the year ended December 31, 2018, $68 million was distributed to Historical DuPont according to the Trust agreement and at December 31, 2018, the balance in the Trust was $500 million.
The company's cash, cash equivalents and marketable securities at December 31, 2018 and 2017 are $4.5 billion and $8.2 billion, respectively, of which $3.9 billion at December 31, 2018 and $7.9 billion at December 31, 2017 was held by subsidiaries in foreign countries, including United States territories. The decrease in cash held by subsidiaries in foreign countries is due to the repatriation activities discussed below. For each of its foreign subsidiaries, the company makes an assertion regarding the amount of earnings intended for permanent reinvestment, with the balance available to be repatriated to the United States.
The Act requires companies to pay a one-time transition tax on earnings of foreign subsidiaries, a majority of which were previously considered permanently reinvested by the company (see Note 9 to the Consolidated Financial Statements for further details of The Act). A tax liability was accrued for the estimated U.S. federal tax on all accumulated unrepatriated earnings through December 31, 2017 in accordance with The Act (i.e., "transition tax"). The cash held by foreign subsidiaries for permanent reinvestment is generally used to finance the subsidiaries' operational activities and future foreign investments. At December 31, 2018, management believed that sufficient liquidity is available in the United States. The company has the ability to repatriate additional funds to the US, which could result in an adjustment to the tax liability for foreign withholding taxes, foreign and/or U.S. state income taxes and the impact of foreign currency movements. It is not practicable to calculate the unrecognized deferred tax liability on undistributed foreign earnings due to the complexity of the hypothetical calculation. During 2018, in connection with the Intended Business Separations, the company repatriated certain funds from its non-U.S. subsidiaries that were not needed to finance local operations. During the year ended December 31, 2018, the company recorded net tax expense of $74 million associated with foreign withholding tax incurred in connection with these repatriation activities.
<img src='content_image/1024673.jpg'>
Cash provided by operating activities was $848 million for the year ended December 31, 2018, primarily driven by earnings after goodwill impairment and inventory step-up amortization offset by transaction costs, pension contributions, changes in working capital and tax payments. Cash provided by operating activities was $4,196 million for the period September 1 through December 31, 2017, primarily driven by seasonal cash flows related to the agriculture product line and a tax refund related to voluntary pension contributions made in the Predecessor period, partially offset by transaction costs and the PFOA multi-district litigation settlement, which was primarily paid in September. Cash used for operating activities was $3,949 million for the period January 1 through August 31, 2017, primarily driven by pension contributions of $3,024 million, seasonal cash flows related to the agriculture product line, transaction costs and tax payments, partially offset by earnings. Cash provided by operating activities was $3,357 million for the year ended December 31, 2016, primarily due to earnings offset by tax payments, pension contributions and transaction costs.
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Within the U.S., the company establishes strategic asset allocation percentage targets and appropriate benchmarks for significant asset classes with the aim of achieving a prudent balance between return and risk. Strategic asset allocations in other countries are selected in accordance with the laws and practices of those countries. Where appropriate, asset-liability studies are also taken into consideration. The long-term expected return on plan assets in the U.S. is based upon historical real returns (net of inflation) for the asset classes covered by the investment policy, expected performance, and projections of inflation and interest rates over the long-term period during which benefits are payable to plan participants. Consistent with prior years, the long-term expected return on plan assets in the U.S. reflects the asset allocation of the plan and the effect of the company's active management of the plan's assets. In connection with pension contributions of $2,900 million to its principal U.S. pension plan for the period of January 1, 2017 through August 31, 2017, an investment policy study was completed for the principal U.S. pension plan. The study resulted in new target asset allocations for the U.S. pension plan with resulting changes to the expected return on plan assets. The long-term rate of return on assets decreased from 8.00 percent for the Predecessor period to 6.25 percent for the Successor periods in 2017.
In determining annual expense for the principal U.S. pension plan, the company uses a market-related value of assets rather than its fair value. Accordingly, there may be a lag in recognition of changes in market valuation. As a result, changes in the fair value of assets are not immediately reflected in the company's calculation of net periodic pension cost. Generally, the market-related value of assets is calculated by averaging market returns over 36 months, however, as a result of the Merger, for the Successor periods, the market-related value of assets was calculated by averaging market returns from September 1, 2017 through the respective year ends.
The following table shows the market-related value and fair value of plan assets for the principal U.S. pension plan:
<img src='content_image/1052153.jpg'>
participants who elected a limited-time opportunity to receive a lump sum payout. See further discussion under "Long-term Employee Benefits" beginning on page 40.
For plans other than the principal U.S. pension plan, pension expense is determined using the fair value of assets.
The following table highlights the potential impact on the company's pre-tax earnings due to changes in certain key assumptions with respect to the company's pension and OPEB plans, based on assets and liabilities at December 31, 2018:
<img src='content_image/1052154.jpg'>
Additional information with respect to pension and OPEB expenses, liabilities and assumptions is discussed under "Long-term Employee Benefits" beginning on page 40 and in Note 18 to the Consolidated Financial Statements.
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## Environmental Matters
Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. At December 31, 2018, the company had accrued obligations of $381 million for probable environmental remediation and restoration costs, including $54 million for the remediation of Superfund sites. As remediation activities vary substantially in duration and cost from site to site, it is difficult to develop precise estimates of future site remediation costs. The company's estimates are based on a number of factors, including the complexity of the geology, the nature and extent of contamination, the type of remedy, the outcome of discussions with regulatory agencies and other Potentially Responsible Parties ("PRPs") at multi-party sites and the number of and financial viability of other PRPs. Therefore, considerable uncertainty exists with respect to environmental remediation and costs, and, under adverse changes in circumstances, it is reasonably possible that the ultimate cost with respect to these particular matters could range up to $750 million above that amount. Consequently, it is reasonably possible that environmental remediation and restoration costs in excess of amounts accrued could have a material impact on the company’s results of operations, financial condition and cash flows. It is the opinion of the company’s management, however, that the possibility is remote that costs in excess of the range disclosed will have a material impact on the company’s results of operations, financial condition or cash flows. For further discussion, see Environmental Matters in Management’s Discussion and Analysis of Financial Condition and Results of Operations and Notes 1 and 16 to the Consolidated Financial Statements.
## Legal Contingencies
The company's results of operations could be affected by significant litigation adverse to the company, including product liability claims, patent infringement and antitrust claims, and claims for third party property damage or personal injury stemming from alleged environmental torts. The company records accruals for legal matters when the information available indicates that it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Management makes adjustments to these accruals to reflect the impact and status of negotiations, settlements, rulings, advice of counsel and other information and events that may pertain to a particular matter. Predicting the outcome of claims and lawsuits and estimating related costs and exposure involves substantial uncertainties that could cause actual costs to vary materially from estimates. In making determinations of likely outcomes of litigation matters, management considers many factors. These factors include, but are not limited to, the nature of specific claims including unasserted claims, the company's experience with similar types of claims, the jurisdiction in which the matter is filed, input from outside legal counsel, the likelihood of resolving the matter through alternative dispute resolution mechanisms, and the matter's current status. Considerable judgment is required in determining whether to establish a litigation accrual when an adverse judgment is rendered against the company in a court proceeding. In such situations, the company will not recognize a loss if, based upon a thorough review of all relevant facts and information, management believes that it is probable that the pending judgment will be successfully overturned on appeal. A detailed discussion of significant litigation matters is contained in Note 16 to the Consolidated Financial Statements.
## Indemnification Assets
On July 1, 2015, Historical DuPont completed the separation of its Performance Chemicals segment through the spin-off of all of the issued and outstanding stock of The Chemours Company (the "Chemours Separation"). In connection with the Chemours Separation, the company and Chemours entered into a Separation Agreement (as amended, the "Chemours Separation Agreement"). Pursuant to the Chemours Separation Agreement discussed in Note 4 to the Consolidated Financial Statements, the company is indemnified by Chemours against certain litigation, environmental, workers' compensation, and other liabilities that arose prior to the separation. The term of this indemnification is indefinite and includes defense costs and expenses, as well as monetary and non-monetary settlements and judgments. In connection with the recognition of liabilities related to these indemnified matters, the company records an indemnification asset when recovery is deemed probable. In assessing the probability of recovery, the company considers the contractual rights under the Chemours Separation Agreement and any potential credit risk. Future events, such as potential disputes related to recovery as well as the solvency of Chemours, could cause the indemnification assets to have a lower value than anticipated and recorded. The company evaluates the recovery of the indemnification assets recorded when events or changes in circumstances indicate the carrying values may not be fully recoverable.
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## ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued
## Prepaid Royalties
The company’s agriculture product line currently has certain third party biotechnology trait license agreements, which require up-front and variable payments subject to the licensor meeting certain conditions. These payments are reflected as other current assets and other assets and are amortized to cost of goods sold as seeds containing the respective trait technology are utilized over the life of the license. At December 31, 2018, the balance of prepaid royalties reflected in other current assets and other assets was $239 million and $1,139 million, respectively. The company evaluates the carrying value of the prepaid royalties when events or changes in circumstances indicate the carrying value may not be recoverable. The recoverability of the prepaid royalties and the rate of royalty amortization expense recognized are based on the company’s strategic plans which include various assumptions and estimates including product portfolio, market dynamics, farmer preferences, growth rates and projected planted acres. Changes in factors and assumptions included in the strategic plans, including potential changes to the product portfolio in favor of internally developed biotechnology, could impact the recoverability and/or rate of recognition of the relevant prepaid royalty.
## Off-Balance Sheet Arrangements
## Certain Guarantee Contracts
Information with respect to the company's guarantees is included in Note 16 to the Consolidated Financial Statements. Historically, the company has not had to make significant payments to satisfy guarantee obligations; however, the company believes it has the financial resources to satisfy these guarantees.
## Contractual Obligations
Information related to the company's significant contractual obligations is summarized in the following table:
<img src='content_image/1053780.jpg'>
$^{2.}$
Excludes unamortized debt step-up premium of $78 million and unamortized debt fees of $2 million. $^{3.}$
Represents enforceable and legally binding agreements in excess of $1 million to purchase goods or services that specify fixed or minimum quantities; fixed, minimum or variable price provisions; and the approximate timing of the agreement. $^{4.}$ The company's contractual obligations do not reflect an offset for recoveries associated with indemnifications by Chemours in accordance with the Chemours Separation
Agreement. Refer to Notes 4 and 16 to the Consolidated Financial Statements for additional detail related to the indemnifications. $^{5.}$ Represents undiscounted remaining payments under Historical DuPont Pioneer license agreements ($806 million on a discounted basis).
$^{6.}$ Primarily represents employee-related benefits other than pensions and other post employment benefits.
$^{7.}$
Due to uncertainty regarding the completion of tax audits and possible outcomes, the timing of certain payments of obligations related to unrecognized tax benefits cannot be made and have been excluded from the table above. See Note 9 to the Consolidated Financial Statements for additional detail.
The company expects to meet its contractual obligations through its normal sources of liquidity and believes it has the financial resources to satisfy the contractual obligations that arise in the ordinary course of business.
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## DowDuPont Cost Synergy Program
In September and November 2017, DowDuPont and the company approved post-merger restructuring actions to achieve targeted cost synergies under the DowDuPont Cost Synergy Program (the “Synergy Program”), adopted by the DowDuPont Board of Directors. The Synergy Program is designed to integrate and optimize the organization following the Merger and in preparation for the Intended Business Separations. Based on all actions approved to date under the Synergy Program, Historical DuPont expects to record total pre-tax restructuring charges of $575 million to $675 million, comprised of approximately $370 million to $400 million of severance and related benefits costs; $80 million to $100 million of costs related to contract terminations; and $125 million to $175 million of asset related charges. The company anticipates including savings associated with these actions within DowDuPont's cost synergy commitment of $3.6 billion associated with the Merger Transaction. Additional details related to this plan can be found in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, on page 18 of this report and Note 6 to the Consolidated Financial Statements.
## 2017 Restructuring Program
During the first quarter 2017, Historical DuPont committed to take actions to improve plant productivity and better position its product lines for productivity and growth before and after the anticipated closing of the Merger Transaction (the "2017 restructuring program"). In connection with these actions, the company incurred pre-tax charges of $313 million for the period January 1 through August 31, 2017 recognized in restructuring and asset related charges - net in the company's Consolidated Statements of Operations. The charge is comprised of $279 million of asset related charges and $34 million in severance and related benefit costs. These charges primarily relate to the second quarter closure of the safety and construction product line at the Cooper River manufacturing site located near Charleston, South Carolina. The asset related charges mainly consist of accelerated depreciation associated with the closure. The actions associated with this plan are substantially complete. The company anticipates including savings associated with these actions within the targeted cost synergies associated with the Merger Transaction. Additional details related to this plan can be found in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, on page 18 of this report and Note 6 to the Consolidated Financial Statements.
## Spin-off of Performance Chemicals
On July 1, 2015, Historical DuPont completed the separation of its Performance Chemicals segment through the spin-off of all of the issued and outstanding stock of The Chemours Company. In connection with the separation, the company and Chemours entered into a Separation Agreement and a Tax Matters Agreement as well as certain ancillary agreements. In accordance with generally accepted accounting principles in the U.S. ("GAAP"), the results of operations of its former Performance Chemicals segment are presented as discontinued operations and, as such, are included within (loss) income from discontinued operations after income taxes in the Consolidated Statements of Operations for all periods presented. Additional details regarding the separation and other related agreements can be found in Note 4 to the Consolidated Financial Statements.
## Segment Information
Effective with the Merger, Historical DuPont’s business activities are components of its parent company’s business operations. Historical DuPont’s business activities, including the assessment of performance and allocation of resources, are reviewed and managed by DowDuPont. Information used by the chief operating decision maker of Historical DuPont relates to the company in its entirety. Accordingly, there are no separate reportable business segments for Historical DuPont under Accounting Standards Codification ("ASC") Topic 280 “Segment Reporting” and Historical DuPont's business results are reported in this Form 10-K as a single operating segment.
## Principal Product Information
Subsidiaries and affiliates of Historical DuPont conduct manufacturing, seed production and/or selling activities and some are distributors of products manufactured by the company. The following describes the company’s principal product lines including major brands and technologies:
## Agriculture
The agriculture product line offers a broad portfolio of products and services that are specifically targeted to achieve gains in crop yields and productivity for the global production agriculture industry. The agriculture product line includes hybrid corn seed and soybean seed varieties, primarily under the Pioneer$^{®}$ brand name, as well as canola, sunflower, sorghum, wheat and rice seed, silage inoculants, weed, insect and disease control products, as well as agronomic software. Seed sales amounted to 27 percent, 15 percent, 34 percent and 29 percent of the company's total consolidated net sales for the year ended December 31, 2018, the period September 1 through December 31, 2017, the period January 1 through August 31, 2017, and the year ended December 31, 2016, respectively.
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## ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued
In 2019, the company expects to contribute approximately $190 million to its funded pension plans other than the principal U.S. pension plan and its remaining plans with no plan assets, and about $240 million for its OPEB plans. The company does not expect to make contributions to the principal U.S. pension plan in 2019. The amount and timing of actual future contributions will depend on applicable funding requirements, discount rates, investment performance, plan design, and various other factors, including the Internal Reorganization, separations and distributions.
The company's income can be significantly affected by pension and defined contribution charges/(benefits) as well as OPEB costs. The following table summarizes the extent to which the company's income for the year ended December 31, 2018, for the period September 1 through December 31, 2017, for the period January 1 through August 31, 2017, and for the year ended December 31, 2016 was affected by pre-tax charges related to long-term employee benefits:
<img src='content_image/1055629.jpg'>
December 31, 2017 and January 1 through August 31, 2017 and for the year ended December 31, 2016, respectively.
The above charges (benefit) for pension and OPEB are determined as of the beginning of each period. Activities for the period ended December 31, 2018 and for the period September 1 through December 31, 2017 benefited from the absence of the amortization of net losses from AOCL. Long- term employee benefit expense in 2016 include a $382 million curtailment gain as a result of changes made to the U.S. Pension and OPEB benefits in 2016 described above. See "Pension Plans and Other Post Employment Benefits" under the Critical Accounting Estimates section beginning on page 33 of this report for additional information on determining annual expense.
For 2019, long term employee benefit expense from continuing operations is expected to increase by about $30 million. The increase is mainly due to lower expected return on plan assets.
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## ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued
## Environmental Matters
The company operates global manufacturing, product handling and distribution facilities that are subject to a broad array of environmental laws and regulations. Such rules are subject to change by the implementing governmental agency, and the company monitors these changes closely. Company policy requires that all operations fully meet or exceed legal and regulatory requirements. In addition, the company implements voluntary programs to reduce air emissions, minimize the generation of hazardous waste, decrease the volume of water use and discharges, increase the efficiency of energy use and reduce the generation of persistent, bioaccumulative and toxic materials. Management has noted a global upward trend in the amount and complexity of proposed chemicals regulation. The costs to comply with complex environmental laws and regulations, as well as internal voluntary programs and goals, are significant and will continue to be significant for the foreseeable future.
Pre-tax environmental expenses charged to income from continuing operations are summarized below:
<img src='content_image/1058591.jpg'>
About 66 percent of total pre-tax environmental expenses charged to income from continuing operations for the year ended December 31, 2018 resulted from operations in the U.S. Based on existing facts and circumstances, management does not believe that year-over-year changes, if any, in environmental expenses charged to current operations will have a material impact on the company's financial position, liquidity or results of operations. Annual expenditures in the near term are not expected to vary significantly from the range of such expenditures experienced in the past few years. Longer term, expenditures are subject to considerable uncertainty and may fluctuate significantly.
## Environmental Operating Costs
As a result of its operations, the company incurs costs for pollution abatement activities including waste collection and disposal, installation and maintenance of air pollution controls and wastewater treatment, emissions testing and monitoring, and obtaining permits. The company also incurs costs related to environmental related research and development activities including environmental field and treatment studies as well as toxicity and degradation testing to evaluate the environmental impact of products and raw materials.
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The Registrant meets the conditions set forth in General Instruction I(1)(a), (b) and (d) of Form 10-K (as modified by a grant of no-action relief dated February 12, 2018) and is therefore filing this form with the reduced disclosure format and has omitted the information called for by this Item pursuant to General Instruction I(2)(c) of Form 10-K.
## ITEM 11. EXECUTIVE COMPENSATION
The Registrant meets the conditions set forth in General Instruction I(1)(a), (b) and (d) of Form 10-K (as modified by a grant of no-action relief dated February 12, 2018) and is therefore filing this form with the reduced disclosure format and has omitted the information called for by this Item pursuant to General Instruction I(2)(c) of Form 10-K.
## ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The Registrant meets the conditions set forth in General Instruction I(1)(a), (b) and (d) of Form 10-K (as modified by a grant of no-action relief dated February 12, 2018) and is therefore filing this form with the reduced disclosure format and has omitted the information called for by this Item pursuant to General Instruction I(2)(c) of Form 10-K.
## ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The Registrant meets the conditions set forth in General Instruction I(1)(a), (b) and (d) of Form 10-K (as modified by a grant of no-action relief dated February 12, 2018) and is therefore filing this form with the reduced disclosure format and has omitted the information called for by this Item pursuant to General Instruction I(2)(c) of Form 10-K.
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## Packaging and Specialty Plastics
The packaging and specialty plastics product line specializes in resins and films used in packaging and industrial polymer applications, sealants and adhesives and sporting goods. Key brands and technologies include DuPont™ Surlyn$^{®}$ ionomer resins, Bynel$^{®}$ coextrudable adhesive resins, Elvax$^{®}$ EVA resins, Nucrel$^{® }$Elvaloy$^{®}$polymer modifiers and Elvaloy$^{®}$ copolymer resins.
## Electronics and Imaging
The electronics and imaging product line supplies differentiated materials and systems for consumer electronics, photovoltaics ("PV"), displays and advanced printing that enable superior performance and lower total cost of ownership for customers. The company targets growth opportunities in circuit and semiconductor fabrication and packaging materials, PV materials, display materials, packaging graphics, and digital printing.
## Industrial Biosciences
The industrial biosciences product line offers a broad portfolio of bio-based products, including enzymes that add value and functionality to processes and products across a broad range of markets such as animal nutrition, detergents, food manufacturing, ethanol production and industrial applications. The product line also includes DuPont™ Sorona ® PTT renewably sourced polymer for use in carpet and apparel fibers and clean technologies offerings to help reduce sulfur and other emissions, formulate cleaner fuels, and dispose of liquid waste.
## Nutrition and Health
The nutrition and health product line offers a wide range of sustainable, bio-based ingredients, providing innovative solutions including the wide-range of DuPont™ Danisco ® food ingredients such as cultures and probiotics, notably Howaru$^{®}$, pharmaceutical excipients, emulsifiers, texturants, natural sweeteners such as Xivia®, Supro® soy-based food ingredients, and pharmaceutical ingredients for the formulation of excipients. These ingredients hold leading market positions based on industry leading innovation, knowledge and experience, relevant product portfolios and close-partnering with the world's food manufacturers and pharmaceutical companies. In November 2016, Historical DuPont announced an investment to expand probiotics production capacity in the United States, due to the rapidly growing global demand for probiotics. Phase one was complete as of the end of 2017. The second phase represents an investment of approximately $100 million to increase Historical DuPont's probiotics production capacity by an additional 70 percent and is expected to be complete in the first quarter of 2019.
## Safety and Construction
The safety and construction product line offers innovation engineered products and integrated systems for a number of industry verticals including construction, worker safety, energy, oil and gas and transportation. The product line addresses the growing global needs of businesses, governments, and consumers for solutions that make life safer, healthier and better. Key brands and technologies include DuPont™ Kevlar$^{® }$fiber, DuPont™ Nomex$^{®}$ fiber and paper, DuPont™ Tyvek$^{®}$ protective materials, DuPont™ Tychem$^{®}$ protective suits and DuPont™ Corian$^{®}$ solid and quartz surfaces.
## Transportation and Advanced Polymers
The transportation and advanced polymers product line offers a broad range of polymer-based materials and expert application development assistance to enhance the performance, reduce the total system cost and optimize the sustainability of their products. The portfolio of high performance renewably-sourced and sustainable polymers includes engineering resins, adhesives, lubricants and parts used by customers to fabricate components for mechanical, chemical and electrical systems. Key brands and technologies include DuPont™ Zytel ® long chain nylon polymers, Zytel$^{®}$ HTN nylon resins, Zytel$^{®}$ nylon resins, Crastin$^{®}$ PBT polymer resins, Rynite$^{®}$ PET polymer resins, Delrin$^{®}$ acetal resins, Hytrel ® polyester thermoplastic elastomer resins, Vespel ® parts and shapes, Vamac ® ethylene acrylic elastomer and Kalrez ® perfluoroelastomer.
See Note 5 to the Consolidated Financial Statements for net sales by major product line.
Sales by geographic region are included within Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations", "Analysis of Operations" and Note 22 to the Consolidated Financial Statements.
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/s/PricewaterhouseCoopers LLP Philadelphia, Pennsylvania February 11, 2019
We have served as the Company’s auditor since 1954.$^{ }$
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## Principles of Consolidation and Basis of Presentation
## E. I. du Pont de Nemours and Company Notes to the Consolidated Financial Statements (continued)
The accompanying Consolidated Financial Statements of E. I. du Pont de Nemours and Company (“Historical DuPont” or “the company”) were prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The significant accounting policies described below, together with the other notes that follow, are an integral part of the Consolidated Financial Statements.
DowDuPont Inc. ("DowDuPont") was formed on December 9, 2015 to effect an all-stock, merger of equals strategic combination between The Dow Chemical Company ("Historical Dow") and Historical DuPont (the "Merger Transaction"). On August 31, 2017 at 11:59 pm ET, (the "Merger Effectiveness Time") pursuant to the Agreement and Plan of Merger, dated as of December 11, 2015, as amended on March 31, 2017 (the "Merger Agreement"), Historical Dow and Historical DuPont each merged with wholly owned subsidiaries of DowDuPont ("Mergers") and, as a result of the Mergers, Historical Dow and Historical DuPont became subsidiaries of DowDuPont (collectively, the "Merger"). Prior to the Merger, DowDuPont did not conduct any business activities other than those required for its formation and matters contemplated by the Merger Agreement. DowDuPont intends to pursue, subject to certain customary conditions, including, among others, the effectiveness of registration statements filed with the U.S. Securities and Exchange Commission ("SEC") and approval by the Board of Directors of DowDuPont, the separation of the combined company's agriculture business, specialty products business and materials science business through a series of tax-efficient transactions (collectively, the "Intended Business Separations" and the transactions to accomplish the Intended Business Separations, the "separations").
On February 26, 2018, DowDuPont announced the corporate brand names that each company plans to assume once the Intended Business Separations occur. Materials science will be called Dow, agriculture will be called Corteva$^{TM}$ Agriscience, and specialty products will be called DuPont.
For purposes of DowDuPont's financial statement presentation, Historical Dow was determined to be the accounting acquirer in the Merger and Historical DuPont's assets and liabilities are reflected at fair value as of the Merger Effectiveness Time. In connection with the Merger and the related accounting determination, Historical DuPont has elected to apply push-down accounting and reflect in its financial statements the fair value of its assets and liabilities. Historical DuPont's Consolidated Financial Statements for periods following the close of the Merger are labeled “Successor” and reflect DowDuPont’s basis in the fair values of the assets and liabilities of Historical DuPont. All periods prior to the closing of the Merger reflect the historical accounting basis in Historical DuPont's assets and liabilities and are labeled “Predecessor.” The Consolidated Financial Statements and footnotes include a black line division between the columns titled "Predecessor" and "Successor" to signify that the amounts shown for the periods prior to and following the Merger are not comparable. See Note 3 for additional information on the Merger.
Transactions between DowDuPont, Historical DuPont, Historical Dow and their affiliates and other associated companies are reflected in the Successor consolidated financial statements and disclosed as related party transactions when material. Related party transactions with DowDuPont are included in Note 7.
As a condition of the regulatory approval for the Merger Transaction, the company was required to divest certain assets related to its crop protection business and research and development ("R&D") organization, specifically the company’s Cereal Broadleaf Herbicides and Chewing Insecticides portfolios, including Rynaxypyr$^{®}$, Cyazypyr$^{®}$ and Indoxacarb as well as the crop protection R&D pipeline and organization, excluding seed treatment, nematicides, and late-stage R&D programs. On March 31, 2017, the company entered into a definitive agreement (the "FMC Transaction Agreement") with FMC Corporation ("FMC"). Under the FMC Transaction Agreement, FMC would acquire the crop protection business and R&D assets that Historical DuPont was required to divest in order to obtain European Commission ("EC") approval of the Merger Transaction as described above, (the "Divested Ag Business") and Historical DuPont agreed to acquire certain assets relating to FMC’s Health and Nutrition segment, excluding its Omega-3 products (the "H&N Business") (collectively, the "FMC Transactions").
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## Part I
The company's operations could be affected by various risks, many of which are beyond its control. Based on current information, the company believes that the following identifies the most significant risk factors that could affect its operations. Past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods.
The Benefits of the Merger and the Intended Business Separations May Not be Fully Realized. Combining the Businesses of Historical DuPont and Historical Dow May Be More Difficult, Costly or Time-Consuming than Expected, Which May Adversely Affect Historical DuPont's Results.
The success of the Merger ultimately depends on, among other things, DowDuPont's ability to combine and separate the Historical DuPont and Historical Dow businesses in a manner that facilitates the Intended Business Separations, and realizes anticipated synergies.
Since the Merger, Historical DuPont has benefited from and expects to continue to benefit from significant cost synergies at both the product line and corporate levels through the Synergy Program which is designed to integrate and optimize the organization, including through the achievement of production cost efficiencies, enhancement of the agricultural supply chain, elimination of duplicative agricultural research and development programs, optimization of the combined company’s global footprint across manufacturing, sales and research and development in the materials science business, optimizing manufacturing processes in the electronics space, the reduction of corporate and leveraged services costs, and the realization of significant procurement synergies. In connection with the Synergy Program, Historical DuPont expects to record total pretax restructuring charges of $575 million to $675 million, comprised of approximately $370 million to $400 million of severance and related benefit costs; $80 million to $100 million of costs related to contract terminations; and $125 million to $175 million of asset related charges.
Management also expects the combined company will achieve growth synergies and other meaningful savings and benefits as a result of the Intended Business Separations.
Combining Historical DuPont and Historical Dow's independent businesses and preparing for the Intended Business Separations, including the Internal Reorganization, are complex, costly and time-consuming processes and the company's management as well as that of Historical Dow and DowDuPont may face significant implementation challenges, many of which may be beyond the control of management, including, without limitation:
• ongoing diversion of the attention of management from the operation of the combined company’s business as a result of the Intended Business Separations;
• impact of portfolio changes between materials science and specialty products on integration and separation preparation activities;
• difficulties in achieving anticipated cost savings, synergies, business opportunities and growth prospects;
• the possibility of faulty assumptions underlying expectations regarding the integration or separation process, including with respect to the intended tax efficient transactions;
• unanticipated issues in integrating, replicating or separating information technology, communications programs, financial procedures and operations, and other systems, procedures and policies;
• difficulties in managing a larger combined company, addressing differences in business culture and retaining key personnel;
• unanticipated changes in applicable laws and regulations;
• managing tax costs or inefficiencies associated with integrating the operations of the combined company and the intended tax efficient separation transactions; and
• coordinating geographically separate organizations.
Some of these factors will be outside of the control of DowDuPont, Historical DuPont and Historical Dow, and any one of them could result in increased costs and diversion of management’s time and energy, as well as decreases in the amount of expected revenue which could materially impact business, financial condition and results of operations. The Internal Reorganization and Intended Businesses Separation processes and other disruptions may also adversely affect the combined company’s relationships with employees, suppliers, customers, distributors, licensors and others with whom Historical DuPont and Historical Dow have business or other dealings, and difficulties in integrating the businesses or regulatory functions of Historical DuPont and Historical Dow could harm the reputation of DowDuPont, Historical DuPont and Historical Dow.
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The significant fair value adjustments included in the allocation of purchase price are discussed below.
## Inventories
Inventory is primarily comprised of finished products of $4,927 million, semi-finished products of $3,055 million and raw materials and stores and supplies of $823 million. The fair value of finished goods was calculated as the estimated selling price, adjusted for costs of the selling effort and a reasonable profit allowance relating to the selling effort. The fair value of semi-finished inventory was primarily calculated as the estimated selling price, adjusted for estimated costs to complete the manufacturing, estimated costs of the selling effort, as well as a reasonable profit margin on the remaining manufacturing and selling effort. The fair value of raw materials and stores and supplies was determined to approximate the historical carrying value. For inventory accounted for under the FIFO method and average cost method, the fair value step-up of inventory will be recognized in costs of goods sold as the inventory is sold. For inventory accounted for under the LIFO method, the fair value of inventory becomes the LIFO base layer inventory. The pre-tax amounts of inventory step-up recognized for the year ended December 31, 2018 and the period September 1 through December 31, 2017, were $1,563 million and $1,538 million, respectively. For the year ended December 31, 2018, the pre-tax amount is reflected in cost of goods sold within (loss) income from continuing operations before income taxes in the Consolidated Statement of Operations. For the period September 1 through December 31, 2017, $1,434 million was reflected in costs of goods sold within (loss) income from continuing operations before income taxes and $104 million was reflected in (loss) income from discontinued operations after income taxes in the Consolidated Statement of Operations.
## Property, Plant & Equipment
Property, plant and equipment is comprised of machinery and equipment of $7,344 million, buildings of $2,418 million, construction in progress of $995 million and land and land improvements of $927 million. The fair value of property and equipment was primarily determined using a market approach for land and certain types of equipment, and a replacement cost approach for other property and equipment. The market approach for certain types of equipment represents a sales comparison that measures the value of an asset through an analysis of sales and offerings of comparable assets. The replacement cost approach used for all other depreciable property and equipment measures the value of an asset by estimating the cost to acquire or construct comparable assets and adjusts for age and condition of the asset.
## Goodwill
The excess of the consideration for the Merger over the net fair value of assets and liabilities was recorded as goodwill. The Merger resulted in the recognition of $45,497 million of goodwill, none of which is deductible. Goodwill largely consists of expected cost synergies resulting from the Merger and the Intended Business Separations, the assembled workforce of Historical DuPont, and future technology and customers.
## Other Intangible Assets
Other intangible assets primarily consist of acquired customer related assets, developed technology, trademarks and tradenames, and germplasm. The customer-related value was determined using the excess earnings method while the developed technology, trademarks and trade names, and germplasm values were primarily determined utilizing the relief from royalty method. Both the excess earnings and relief from royalty methods are forms of the income approach. Refer to Note 14 for further information on other intangible assets.
## Deferred Income Tax Assets and Liabilities
The deferred income tax assets and liabilities include the expected future federal, state, and foreign tax consequences associated with temporary differences between the fair values of the assets acquired and liabilities assumed and the respective tax bases. Tax rates utilized in calculating deferred income taxes generally represent the enacted statutory tax rates at the Merger Effectiveness Time in the jurisdictions in which legal title of the underlying asset or liability resides. Refer to Note 9 for further information related to the remeasurement of deferred income tax assets and liabilities as a result of the enactment of the U.S. Tax Cuts and Jobs Act in December 2017.
Deferred income tax assets include a $172 million adjustment to derecognize certain deferred income tax assets on historical net operating losses that will not be fully realized as a result of the Merger. Deferred income tax liabilities include a $546 million adjustment reflecting a change in determination as to the reinvestment strategy of certain foreign operations of the company.
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## Notes to the Consolidated Financial Statements (continued)
## E. I. du Pont de Nemours and Company
Integration and separation costs have been and are expected to be significant. These costs to date primarily have consisted of financial advisory, information technology, legal, accounting, consulting, and other professional advisory fees associated with the preparation and execution of activities related to the Merger and the Intended Business Separations. These costs are recorded within integration and separation costs in the Successor periods and the costs are recorded within selling, general and administrative expenses in the Predecessor periods within the Consolidated Statements of Operations.
<img src='content_image/1026906.jpg'>
## H&N Business
On November 1, 2017, the company completed the FMC Transactions through the acquisition of the H&N Business and the disposition of the Divested Ag Business. The acquisition was integrated into the nutrition and health product line to enhance Historical DuPont’s position as a leading provider of sustainable, bio-based food ingredients and allow for expanded capabilities in the pharma excipients space. The company accounted for the acquisition in accordance with ASC 805, which requires the assets acquired and liabilities assumed to be recognized on the balance sheet at their fair values as of the acquisition date.
The following table summarizes the fair value of consideration exchanged as a result of the FMC Transactions:
<img src='content_image/1026905.jpg'>
2.The FMC Transactions include a cash consideration payment to Historical DuPont of approximately $1,200 million, which reflected the difference in value between the Divested Ag Business and the H&N Business, subject to certain customary inventory and net working capital adjustments. 3.Upon closing and pursuant to the terms of the FMC Transaction Agreement, Historical DuPont entered into favorable supply contracts with FMC. Historical DuPont
recorded these contracts as intangible assets recognized at the fair value of off-market contracts. Refer to Notes 4 and 14 for additional information.
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## Notes to the Consolidated Financial Statements (continued)
## E. I. du Pont de Nemours and Company
On December 22, 2017, the Tax Cuts and Jobs Act (“The Act”) was enacted. The Act reduces the U.S. federal corporate income tax rate from 35 percent to 21 percent, requires companies to pay a one-time transition tax (“transition tax”) on earnings of certain foreign subsidiaries that were previously tax deferred, creates new provisions related to foreign sourced earnings, eliminates the domestic manufacturing deduction and moves to a territorial system. At December 31, 2017, the Company had not completed its accounting for the tax effects of The Act; however, as described below, the company made a reasonable estimate of the effects on its existing deferred tax balances and the one-time transition tax. In accordance with Staff Accounting Bulletin 118 ("SAB 118"), income tax effects of The Act were refined upon obtaining, preparing, or analyzing additional information during the measurement period. At December 31, 2018, the company had completed its accounting for the tax effects of The Act.
• As a result of The Act, the company remeasured its U.S. federal deferred income tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21 percent. The company recorded a cumulative benefit of $2,755 million ($2,716 million benefit in the year ended December 31, 2017 and $39 million benefit in the year ended December 31, 2018) to the provision for (benefit from) income taxes on continuing operations with respect to the remeasurement of the company's deferred tax balances. Of the $39 million benefit booked in the year ended December 31, 2018, $114 million relates to the company's discretionary pension contribution in 2018, which was deducted on a 2017 tax return. The remaining charges relate to purchase accounting adjustments made throughout 2018.
• The Act requires a mandatory deemed repatriation of post-1986 undistributed foreign earnings and profits (“E&P”), which results in a one- time transition tax. The company recorded a cumulative charge of $859 million ($715 million charge in the year ended December 31, 2017 and $144 million charge in the year ended December 31, 2018) to the provision for (benefit from) income taxes on continuing operations with respect to the one-time transition tax.
• In the year ended December 31, 2018, the company recorded an indirect impact of The Act related to prepaid tax on the intercompany sale of inventory. The amount recorded related to inventory was a $16 million charge to provision for income taxes on continuing operations.
• For tax years beginning after December 31, 2017, The Act introduces new provisions for U.S. taxation of certain global intangible low-taxed income (“GILTI”). The company has made the policy election to record any liability associated with GILTI in the period in which it is incurred.
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## E. I. du Pont de Nemours and Company
<img src='content_image/1023561.jpg'>
Pre-tax loss from continuing operations for the year ended December 31, 2018 includes a non-deductible $4,503 million non-cash goodwill impairment charge associated with the agriculture reporting unit, of which $3,193 million related to the U.S. and the remaining $1,310 million related to foreign operations.
In connection with the Merger, pre-tax loss from continuing operations for the year ended December 31, 2018 and the period September 1 through December 31, 2017 includes depreciation and amortization associated with the fair value that was allocated to the company’s tangible and intangible assets as well as costs of $1,628 million and $1,469 million, respectively, recognized in cost of goods sold related to the fair value step-up of inventories (See Note 3 for further information).
Additionally, global pre-tax earnings from continuing operations for the year ended December 31, 2018, the period September 1 through December 31, 2017, the period January 1 through August 31, 2017, and the year ended December 31, 2016 includes transaction costs associated with the Merger of $1,375 million, $314 million, $581 million, and $386 million, respectively.
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<img src='content_image/1051369.jpg'>
2. The company has corrected its valuation allowance (with a corresponding reduction in tax loss and credit carryforwards) in the amount of $238 million as a result of a change in the Delaware state apportionment methodology. 3. During the year ended December 31, 2018, the company established a full valuation allowance against the net deferred tax asset position of a legal entity in Brazil due to
revised financial projections, resulting in tax expense of $75 million. See Note 14 for additional information.
<img src='content_image/1051367.jpg'>
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] | overall_image/37b8f6835ac0d1acadaeb73b197fddccc96981dbd00558ec095a16d49c813c31.png | ## PART II
## Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities:
Refer to page 142 of IBM’s 2020 Annual Report to Stockholders, which is incorporated herein by reference solely as it relates to this item.
IBM common stock is listed on the New York Stock Exchange and the NYSE Chicago under the symbol “IBM.” There were 373,649 common stockholders of record at February 10, 2021.
The following table provides information relating to the company’s repurchase of common stock for the fourth quarter of 2020.
<img src='content_image/1030270.jpg'>
* On October 30, 2018, the Board of Directors authorized $4.0 billion in funds for use in the company’s common stock repurchase program. The company stated that it would repurchase shares on the open market or in private transactions depending on market conditions. The common stock repurchase program does not have an expiration date. This table does not include shares tendered to satisfy the exercise price in connection with cashless exercises of employee stock options or shares tendered to satisfy tax withholding obligations in connection with employee equity awards.
The company suspended its share repurchase program at the time of the Red Hat closing in mid-2019. At December 31, 2020 there was approximately $2.0 billion in authorized funds remaining for purchases under this program.
## Item 6. Selected Financial Data:
We have early adopted the recent amendment to Regulation S-K Item 301, which eliminates Selected Financial Data.
## Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations:
Refer to pages 18 through 64 of IBM’s 2020 Annual Report to Stockholders, which are incorporated herein by reference.
## Item 7A. Quantitative and Qualitative Disclosures About Market Risk:
Refer to the section titled “Market Risk” on pages 63 and 64 of IBM’s 2020 Annual Report to Stockholders, which is incorporated herein by reference.
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Refer to pages 68 through 140 of IBM’s 2020 Annual Report to Stockholders, which are incorporated herein by reference. Also refer to the Financial Statement Schedule on page S-1 of this Form 10-K. We have early adopted the recent amendment to Regulation S-K Item 302, which replaces the current requirement for quarterly tabular disclosure with a principles-based requirement for material retrospective changes.
## Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure:
Not applicable.
## Item 9A. Controls and Procedures:
The company’s management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, the effectiveness of the company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the company’s disclosure controls and procedures were effective as of the end of the period covered by this report.
Refer to “Report of Management” and “Report of Independent Registered Public Accounting Firm” on pages 65 to 67 of IBM’s 2020 Annual Report to Stockholders, which are incorporated herein by reference. There has been no change in the company’s internal control over financial reporting that occurred during the fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.
## Item 9B. Other Information:
Due to retirement, Sidney Taurel will not stand for re-election at the company's annual meeting of stockholders on April 27, 2021. As a result, Article III, Section 2 of the company's By-Laws was amended to decrease the number of directors to twelve, effective April 27, 2021. The full text of IBM's By-Laws, as amended effective April 27, 2021, is included as Exhibit 3.2 to this report.
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If the employment of a participant terminates, other than as a result of the death or disability of a participant, all unexercised, deferred and unpaid awards shall be canceled immediately, unless the award agreement provides otherwise. In the event of the death of a participant or in the event a participant is deemed by the company to be disabled and eligible for benefits under the terms of the IBM Long-Term Disability Plan (or any successor plan or similar plan of another employer), the participant’s estate, beneficiaries or representative, as the case may be, shall have the rights and duties of the participant under the applicable award agreement. In addition, unless the award agreement specifies otherwise, the Committee may cancel, rescind, suspend, withhold or otherwise limit or restrict any unexpired, unpaid, or deferred award at any time if the participant is not in compliance with all applicable provisions of the awards agreement and the 2001 Plan. In addition, awards may be cancelled if the participant engages in any conduct or act determined to be injurious, detrimental or prejudicial to any interest of the company.
## PWCC Acquisition Long-Term Performance Plan (the “PWCC Plan”)
The PWCC Plan was adopted by the Board of Directors in connection with the company’s acquisition of PricewaterhouseCoopers Consulting (‘‘PwCC’’) from PricewaterhouseCoopers LLP, as announced on October 1, 2002. The PWCC Plan has been and will continue to be used solely to fund awards for employees of PwCC who have become employed by the company as a result of the acquisition. Awards for senior executives of the company will not be funded from the PWCC Plan. The terms and conditions of the PWCC Plan are substantively identical to the terms and conditions of the 2001 Plan, described above.
## IBM Red Hat Acquisition Long-Term Performance Plan (the “Red Hat Plan”)
The Red Hat Plan was adopted by the Board of Directors in connection with the company’s acquisition of Red Hat, Inc. on July 9, 2019. The Red Hat Plan has been and will continue to be used solely to fund awards for employees who were not employed by IBM immediately prior to the closing of the acquisition. Awards for senior executives of the company will not be funded from the Red Hat Plan. The terms and conditions of the Red Hat Plan are substantively identical to the terms and conditions of the 2001 Plan, described above.
## Amended and Restated Deferred Compensation and Equity Award Plan (the “DCEAP”)
The DCEAP was adopted in 1993 and amended and restated effective January 1, 2014. Under the Amended and Restated DCEAP, non-management directors receive Promised Fee Shares in connection with deferred annual retainer payments. Each Promised Fee Share is equal in value to one share of the company’s common stock. Upon a director’s retirement or other completion of service as a director, amounts deferred into Promised Fee Shares are payable in either cash and/or shares of the company’s stock either as lump sum or installments pursuant to the director’s distribution election. For additional information about the DCEAP, see ‘‘2020 Director Compensation Narrative’’ in IBM’s definitive Proxy Statement to be filed with the Securities and Exchange Commission and delivered to stockholders in connection with the Annual Meeting of Stockholders to be held April 27, 2021.
## Item 13. Certain Relationships and Related Transactions, and Director Independence:
Refer to the information under the captions “IBM Board of Directors,” “Governance and Board—Committees of the Board” and “Governance and Board—Certain Transactions and Relationships” in IBM’s definitive Proxy Statement to be filed with the SEC and delivered to stockholders in connection with the Annual Meeting of Stockholders to be held April 27, 2021, all of which information is incorporated herein by reference.
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Refer to the information under the captions “Report of the Audit Committee of the Board of Directors” and “Audit and Non-Audit Fees” in IBM’s definitive Proxy Statement to be filed with the SEC and delivered to stockholders in connection with the Annual Meeting of Stockholders to be held April 27, 2021, all of which information is incorporated herein by reference.
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Thomas Buberl Director Michael L. Eskew Director David N. Farr Director Alex Gorsky Director Michelle Howard Director Andrew N. Liveris Director F. William McNabb III Director Martha E. Pollack Director Joseph R. Swedish Director Sidney Taurel Director Peter R. Voser Director Frederick H. Waddell Director
By: /s/ FRANK SEDLARCIK
Frank Sedlarcik Attorney-in-fact February 23, 2021
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## REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANCIAL STATEMENT SCHEDULE
Our audits of the consolidated financial statements referred to in our report dated February 23, 2021 appearing in the 2020 Annual Report to Stockholders of International Business Machines Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP New York, New York February 23, 2021
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## Risks Related to Our Business
Downturn in Economic Environment and Client Spending Budgets Could Impact the Company’s Business: If overall demand for IBM’s products and solutions decreases, whether due to general economic conditions, including those associated with the COVID-19 pandemic, or a shift in client buying patterns, the company’s revenue and profit could be impacted.
Failure of Innovation Initiatives Could Impact the Long-Term Success of the Company: IBM has been moving into areas, including those that incorporate or utilize hybrid cloud, artificial intelligence, blockchain, IoT, quantum and other disruptive technologies, in which it can differentiate itself through responsible innovation, by leveraging its investments in R&D and attracting a successful developer ecosystem. If IBM is unable to continue its cutting-edge innovation in a highly competitive and rapidly evolving environment or is unable to commercialize such innovations, expand and scale them with sufficient speed and versatility or is unable to attract a successful developer ecosystem, the company could fail in its ongoing efforts to maintain and increase its market share and its profit margins.
Damage to IBM’s Reputation Could Impact the Company’s Business: IBM has one of the strongest brand names in the world, and its brand and overall reputation could be negatively impacted by many factors, including if the company does not continue to be recognized for its industry leading technology and solutions and as a hybrid cloud and AI leader. IBM’s reputation is potentially susceptible to damage by events such as significant disputes with clients, product defects, internal control deficiencies, delivery failures, cybersecurity incidents, government investigations or legal proceedings or actions of current or former clients, directors, employees, competitors, vendors, alliance partners or joint venture partners. If the company’s brand image is tarnished by negative perceptions, its ability to attract and retain customers, talent and ecosystem partners could be impacted.
Risks from Investing in Growth Opportunities Could Impact the Company’s Business: The company continues to invest significantly in key strategic areas to drive revenue growth and market share gains. Client adoption rates and viable economic models are less certain in the high-value, highly competitive, and rapidly-growing segments. Additionally, emerging business and delivery models may unfavorably impact demand and profitability for our other products or services. If the company does not adequately and timely anticipate and respond to changes in customer and market preferences, competitive actions, emerging business models and ecosystems, the client demand for our products or services may decline or IBM’s costs may increase.
IBM’s Intellectual Property Portfolio May Not Prevent Competitive Offerings, and IBM May Not Be Able to Obtain Necessary Licenses: The company’s patents and other intellectual property may not prevent competitors from independently developing products and services similar to or duplicative to the company’s, nor can there be any assurance that the resources invested by the company to protect its intellectual property will be sufficient or that the company’s intellectual property portfolio will adequately deter misappropriation or improper use of the company’s technology. In addition, the company may be the target of aggressive and opportunistic enforcement of patents by third parties, including non-practicing entities. Also, there can be no assurances that IBM will be able to obtain from third parties the licenses it needs in the future. The company’s ability to protect its intellectual property could also be impacted by changes to existing laws, legal principles and regulations governing intellectual property, including the ownership and protection of patents.
Certain of the company’s offerings incorporate or utilize open source and other third-party software licensed with limited or no warranties, indemnification, or other contractual protections for IBM. Further, if open source code that IBM utilizes is no longer maintained, developed or enhanced by the relevant community of independent open source software programmers, most of whom we do not employ, we may be unable to develop new technologies, adequately enhance our existing technologies or meet customer requirements for innovation, quality and price.
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The Company’s Business Could Be Impacted by Its Relationships with Critical Suppliers: IBM’s business employs a wide variety of components (hardware and software), supplies, services and raw materials from a substantial number of suppliers around the world. Certain of the company’s businesses rely on a single or a limited number of suppliers, including for server processor technology for certain semiconductors. Changes in the business condition (financial or otherwise) of these suppliers could subject the company to losses and affect its ability to bring products to market. Further, the failure of the company’s suppliers to deliver components, supplies, services and raw materials in sufficient quantities, in a timely manner, and in compliance with all applicable laws and regulations could adversely affect the company’s business. In addition, any defective components, supplies or materials, or inadequate services received from suppliers could reduce the reliability of the company’s products and services and harm the company’s reputation.
Product and Service Quality Issues Could Impact the Company’s Business and Operating Results: The company has rigorous quality control standards and processes intended to prevent, detect and correct errors, malfunctions and other defects in its products and services. If errors, malfunctions, defects or disruptions in service are experienced by customers or in the company’s operations there could be negative consequences that could impact customers’ business operations and harm the company’s business’s operating results.
The Company Could Be Impacted by Its Business with Government Clients: The company’s customers include numerous governmental entities within and outside the U.S., including the U.S. Federal Government and state and local entities. Some of the company’s agreements with these customers may be subject to periodic funding approval. Funding reductions or delays could adversely impact public sector demand for our products and services. Also, some agreements may contain provisions allowing the customer to terminate without cause and providing for higher liability limits for certain losses. In addition, the company could be suspended or debarred as a governmental contractor and could incur civil and criminal fines and penalties, which could negatively impact the company’s results of operations, financial results and reputation.
The Company’s Reliance on Third Party Distribution Channels and Ecosystems Could Impact Its Business: The company offers its products directly and through a variety of third party distributors, resellers and ecosystem partners. Changes in the business condition (financial or otherwise) of these distributors, resellers and ecosystem partners could subject the company to losses and affect its ability to bring its products to market. As the company moves into new areas, distributors, resellers and ecosystem partners may be unable to keep up with changes in technology and offerings, and the company may be unable to recruit and enable appropriate partners to achieve growth objectives. In addition, the failure of third party distributors, resellers and ecosystem partners to comply with all applicable laws and regulations may prevent the company from working with them and could subject the company to losses and affect its ability to bring products to market.
## Risks Related to Cybersecurity and Data Privacy
Cybersecurity and Privacy Considerations Could Impact the Company’s Business: There are numerous and evolving risks to cybersecurity and privacy, including risks originating from intentional acts of criminal hackers, hacktivists, nation states and competitors; from intentional and unintentional acts of customers, contractors, business partners, vendors, employees and other third parties; and from errors in processes or technologies, as well as the risks associated with an increase in the number of customers, contractors, business partners, vendors, employees and other third parties working remotely as a result of the COVID-19 pandemic. Computer hackers and others routinely attack the security of technology products, services, systems and networks using a wide variety of methods, including ransomware
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Delaware
(State of incorporation)
[ x ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
# UNITED STATES SECURITIES AND EXCHANGE COMMISSION
# For The Fiscal Year Ended December 31, 2018
(Exact name of registrant as specified in its charter)
390 Park Avenue, New York, New York 10022-4608
(Address of principal executive offices)
Registrant’s telephone numbers:
Investor Relations----------------(212) 836-2758 Office of the Secretary-----------(212) 836-2732
WASHINGTON, D.C. 20549
Commission File Number 1-3610
# FORM 10-K
OR
# ARCONIC INC.
(I.R.S. Employer Identification No.)
(Zip code)
25-0317820
<img src='content_image/1030996.jpg'>
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ✓ No .
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes No ✓ .
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes ✓ No .
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ✓ No .
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. []
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ✓ ]
Smaller reporting company []
Accelerated filer []
Emerging growth company []
Non-accelerated filer []
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No ✓ .
The aggregate market value of the outstanding common stock, other than shares held by persons who may be deemed affiliates of the registrant, as of the last business day of the registrant’s most recently completed second fiscal quarter was approximately $8 billion. As of February 15, 2019, there were 484,940,842 shares of common stock, par value $1.00 per share, of the registrant outstanding.
Documents incorporated by reference.
Part III of this Form 10-K incorporates by reference certain information from the registrant’s definitive Proxy Statement for its 2019 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A (Proxy Statement).
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] | overall_image/5c6ab1a23c73a14c40287741fd6b42c7e42364755f85871de34c8a52bd5dc538.png | Building and Construction Systems (BCS). BCS provides building and construction architectural framing products and aluminum curtain wall and front entry systems.
For additional discussion of the Transportation and Construction Solutions segment’s business, see “Results of Operations—Segment Information” in Part II, Item 7. (Management’s Discussion and Analysis of Financial Condition and Results of Operations) and Note C to the Consolidated Financial Statements in Part II, Item 8. (Financial Statements and Supplementary Data).
In April 2018, the Company completed the sale of its Latin America Extrusions business to a subsidiary of Hydro Extruded Solutions AS. The sale is part of Arconic’s continued drive to streamline its business portfolio, reduce complexity and further focus on its higher-margin products and profitable growth.
On July 31, 2018, the Company announced that it had initiated a sale process of its BCS business, as part of the Company’s ongoing strategy and portfolio review that commenced in January 2018.
## Transportation and Construction Solutions Principal Facilities $^{1}$
<img src='content_image/1038636.jpg'>
$^{1}$ Principal facilities are listed, and do not include 8 locations that serve as sales and administrative offices, distribution centers or warehouses. In addition to the facilities listed above, TCS has 20 service centers. These centers perform light manufacturing, such as assembly and fabrication of certain products.
$^{2}$ Leased property or partially leased property.
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Raul v. Albaugh, et al. As previously reported, on June 22, 2018, a derivative complaint was filed nominally on behalf of Arconic by a purported Arconic shareholder against all current members of Arconic’s Board of Directors, Klaus Kleinfeld and Ken Giacobbe, naming Arconic as a nominal defendant, in the United States District Court for the District of Delaware. The complaint raises similar allegations as the consolidated amended complaint in Howard , as well as allegations that the defendants improperly authorized the sale of Reynobond PE for unsafe uses, and asserts claims under Section 14(a) of the Securities Exchange Act of 1934 and Delaware state law. On July 13, 2018, the parties filed a stipulation agreeing to stay this case until the final resolution of the Howard case, the Grenfell Tower public inquiry in London, and the investigation by the London Metropolitan Police Service and on June 23, 2018, the Court approved the stay.
While the Company believes that these cases are without merit and intends to challenge them vigorously, there can be no assurances regarding the ultimate resolution of these matters. Given the preliminary nature of these matters and the uncertainty of litigation, the Company cannot reasonably estimate at this time the likelihood of an unfavorable outcome or the possible loss or range of losses in the event of an unfavorable outcome. The Board of Directors has also received letters, purportedly sent on behalf of shareholders, reciting allegations similar to those made in the federal court lawsuits and demanding that the Board authorize the Company to initiate litigation against members of management, the Board and others. The Board of Directors has appointed a Special Litigation Committee of the Board to review and make recommendations to the Board regarding the appropriate course of action with respect to these shareholder demand letters. The Special Litigation Committee and the Board are continuing to consider the appropriate responses to the shareholder demand letters in view of developments in proceedings concerning the Grenfell Tower fire.
Other. In addition to the matters discussed above, various other lawsuits, claims, and proceedings have been or may be instituted or asserted against Arconic, including those pertaining to environmental, product liability, safety and health, employment, tax and antitrust matters. While the amounts claimed in these other matters may be substantial, the ultimate liability cannot currently be determined because of the considerable uncertainties that exist. Therefore, it is possible that the Company’s liquidity or results of operations in a period could be materially affected by one or more of these other matters. However, based on facts currently available, management believes that the disposition of these other matters that are pending or asserted will not have a material adverse effect, individually or in the aggregate, on the results of operations, financial position or cash flows of the Company.
## Commitments
Purchase Obligations. Arconic has entered into purchase commitments for raw materials, energy and other goods and services, which total $770 in 2019, $169 in 2020, $27 in 2021, $24 in 2022, $8 in 2023, and $5 thereafter.
Operating Leases. Certain land and buildings, plant equipment, vehicles, and computer equipment are under operating lease agreements. Total expense for all leases was $144 in 2018, $113 in 2017, and $110 in 2016. Under long-term operating leases, minimum annual rentals are $94 in 2019, $74 in 2020, $54 in 2021, $40 in 2022, $30 in 2023, and $87 thereafter.
Guarantees. At December 31, 2018, Arconic had outstanding bank guarantees related to tax matters, outstanding debt, workers’ compensation, environmental obligations, energy contracts, and customs duties, among others. The total amount committed under these guarantees, which expire at various dates between 2019 and 2026 was $37 at December 31, 2018.
Pursuant to the Separation and Distribution Agreement between Arconic and Alcoa Corporation, Arconic was required to provide certain guarantees for Alcoa Corporation, which had a combined fair value of $6 and $8 at December 31, 2018 and 2017, respectively, and were included in Other noncurrent liabilities and deferred credits on the accompanying Consolidated Balance Sheet. Arconic was required to provide payment guarantees for Alcoa Corporation issued on behalf of a third party related to project financing for Alcoa Corporation’s aluminum complex in Saudi Arabia. During the third quarter of 2018, Arconic was released from this guarantee. Furthermore, Arconic was required to provide guarantees related to two long-term supply agreements for energy for Alcoa Corporation facilities in the event of an Alcoa Corporation payment default. In October 2017, Alcoa Corporation announced that it had terminated one of the two agreements, the electricity contract with Luminant
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10(h) Alcoa Internal Revenue Code Section 162(m) Compliant Annual Cash Incentive Compensation Plan, as Amended and Restated, incorporated by reference to Exhibit 10(b) to the Company’s Current Report on Form 8-K (Commission file number 1-3610) dated May 11, 2016.
10(i) 2004 Summary Description of the Alcoa Incentive Compensation Plan, incorporated by reference to exhibit 10(g) to the Company’s Quarterly Report on Form 10-Q (Commission file number 1-3610) for the quarter ended September 30, 2004.
10(i)(1) Incentive Compensation Plan of Alcoa Inc., as revised and restated effective November 8, 2007, incorporated by reference to exhibit 10(k)(1) to the Company’s Annual Report on Form 10-K (Commission file number 1-3610) for the year ended December 31, 2007.
10(i)(2) Amendment to Incentive Compensation Plan of Alcoa Inc., effective December 18, 2009, incorporated by reference to exhibit 10(n)(2) to the Company’s Annual Report on Form 10-K (Commission file number 1-3610) for the year ended December 31, 2009.
10(j) Arconic Employees’ Excess Benefits Plan C (formerly referred to as the Alcoa Inc. Employees’ Excess Benefits Plan, Plan C), as amended and restated effective August 1, 2016, incorporated by reference to exhibit 10(j) to the Company’s Annual Report on Form 10-K (Commission file number 1-3610) for the year ended December 31, 2016.
10(j)(1) First Amendment to Arconic Employees’ Excess Benefits Plan C (as amended and restated effective August 1, 2016), effective January 1, 2018, incorporated by reference to exhibit 10(l)(1) to the Company’s Annual Report on Form 10-K (Commission file number 1-3610) for the year ended December 31, 2017.
10(j)(2) Second Amendment to Arconic Employees’ Excess Benefits Plan C (as amended and restated effective August 1, 2016), effective January 1, 2018, incorporated by reference to exhibit 10(l)(2) to the Company’s Annual Report on Form 10-K (Commission file number 1-3610) for the year ended December 31, 2017.
10(j)(3) Third Amendment to Arconic Employees’ Excess Benefits Plan C (as amended and restated effective August 1, 2016), incorporated by reference to exhibit 10.1 to the Company’s Current Report on Form 8-K (Commission file number 1-3610) dated January 8, 2018.
10(k) Deferred Fee Plan for Directors, as amended effective July 9, 1999, incorporated by reference to exhibit 10(g)(1) to the Company’s Quarterly Report on Form 10-Q (Commission file number 1-3610) for the quarter ended June 30, 1999.
10(l) Amended and Restated Deferred Fee Plan for Directors, effective November 1, 2016, incorporated by reference to exhibit 10(c) to the Company’s Quarterly Report on Form 10-Q (Commission file number 1-3610) for the quarter ended September 30, 2016.
10(m) Non-Employee Director Compensation Policy, effective February 6, 2019.
10(n) Fee Continuation Plan for Non-Employee Directors, incorporated by reference to exhibit 10(k) to the Company’s Annual Report on Form 10-K (Commission file number 1-3610) for the year ended December 31, 1989.
10(n)(1) Amendment to Fee Continuation Plan for Non-Employee Directors, effective November 10, 1995, incorporated by reference to exhibit 10(i)(1) to the Company’s Annual Report on Form 10-K (Commission file number 1-3610) for the year ended December 31, 1995.
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"content_image/1030954.jpg"
] | overall_image/3374e59fec349615005709fb9ef755e2fde0018bfa8c18af120864014c44d1d0.png | ## SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
February 21, 2019
## ARCONIC INC.
By
Paul Myron Vice President and Controller (Also signing as Principal Accounting Officer)
/s/ Paul Myron
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
<img src='content_image/1030954.jpg'>
James F. Albaugh, Amy E. Alving, Christopher L. Ayers, Arthur D. Collins, Jr., Elmer L. Doty, Rajiv L. Gupta, David P. Hess, Sean O. Mahoney, David J. Miller, E. Stanley O’Neal, and Ulrich R. Schmidt, each as a Director, on February 21, 2019, by Paul Myron, their Attorney-in-Fact.*
*By
/s/ Paul Myron
Paul Myron Attorney-in-Fact
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} | https://cdla.io/permissive-1-0/ | [] | overall_image/cadda3c8131d406cdaa5cff92b3ba19b3ac20d5d5b6ec59b0fea2ef185234f86.png | While Arconic intends to continue committing substantial financial resources and effort to the development of innovative new products and services, it may not be able to successfully differentiate its products or services from those of its competitors or match the level of research and development spending of its competitors, including those developing technology to displace Arconic’s current products. In addition, Arconic may not be able to adapt to evolving markets and technologies or achieve and maintain technological advantages. There can be no assurance that any of Arconic’s new products or services, development programs or technologies will be commercially adopted or beneficial to Arconic.
## Arconic could be adversely affected by changes in the business or financial condition or the loss of a significant customer or customers.
A significant downturn or deterioration in the business or financial condition or loss of a key customer or customers supplied by Arconic could affect Arconic’s financial results in a particular period. Arconic’s customers may experience delays in the launch of new products, labor strikes, diminished liquidity or credit unavailability, weak demand for their products, or other difficulties in their businesses. Arconic’s customers may also change their business strategies or modify their business relationships with Arconic, including to reduce the amount of Arconic’s products they purchase or to switch to alternative suppliers. If Arconic is unsuccessful in replacing business lost from such customers, profitability may be adversely affected.
## Arconic could encounter manufacturing difficulties or other issues that impact product performance, quality or safety, which could affect Arconic’s reputation, business and financial statements.
The manufacture of many of Arconic’s products is a highly exacting and complex process. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols, specifications and procedures, including those related to quality or safety, problems with raw materials, supply chain interruptions, natural disasters, labor unrest and environmental factors. Such problems could have an adverse impact on the Company’s ability to fulfill orders or on product quality or performance. Product manufacturing or performance issues could result in recalls, customer penalties, contract cancellation and product liability exposure, including if any of our products are non- compliant or are used in an unintended and/or unapproved manner that results in injuries or other damages. Because of approval and license requirements applicable to manufacturers and/or their suppliers, alternatives to mitigate manufacturing disruptions may not be readily available to the Company or its customers. Accordingly, manufacturing problems, product defects or other risks associated with our products, including their use or application, could result in significant costs to and liability for Arconic that could have a material adverse effect on its business, financial condition or results of operations, including the payment of potentially substantial monetary damages, fines or penalties, as well as negative publicity and damage to the Company’s reputation, which could adversely impact product demand and customer relationships.
## Arconic’s business depends, in part, on its ability to meet increased program demand successfully and to mitigate the impact of program cancellations, reductions and delays.
Arconic is currently under contract to supply components for a number of new and existing commercial, general aviation, military aircraft and aircraft engine programs and is the sole supplier of aluminum sheet for a number of aluminum-intensive automotive vehicle programs. Many of these programs are scheduled for production increases over the next several years. If Arconic fails to meet production levels or encounters difficulty or unexpected costs in meeting such levels, it could have a material adverse effect on the Company’s business, financial condition or results of operations. Similarly, program cancellations, reductions or delays could also have a material adverse effect on Arconic’s business.
## Arconic could be adversely affected by reductions in defense spending.
Arconic’s products are used in a variety of military applications, including military aircraft and armored vehicles. Although many of the programs in which Arconic participates extend several years, they are subject to annual funding through congressional appropriations. Changes in military strategy and priorities, or reductions in defense spending, may affect current and future funding of these programs and could reduce the demand for Arconic’s products, which could adversely affect Arconic’s business, financial condition or results of operations.
## Arconic’s global operations and status as a public company expose the Company to risks that could adversely affect Arconic’s business, financial condition, results of operations, cash flows or the market price of its securities.
Arconic has operations or activities in numerous countries and regions outside the United States, including Europe, Brazil, Canada, China, Japan, and Russia. As a result, the Company’s global operations are affected by economic, political and other conditions in the foreign countries in which Arconic does business as well as U.S. laws regulating international trade, including:
• economic and commercial instability risks, including those caused by sovereign and private debt default, corruption, and changes in local government laws, regulations and policies, such as those related to tariffs, sanctions and trade barriers, taxation, exchange controls, employment regulations and repatriation of earnings;
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• war or terrorist activities;
• kidnapping of personnel;
• major public health issues such as an outbreak of a pandemic or epidemic (such as Sudden Acute Respiratory Syndrome, Avian Influenza, H7N9 virus, or the Ebola virus), which could cause disruptions in Arconic’s operations or workforce;
• difficulties enforcing intellectual property and contractual rights in certain jurisdictions;
• changes in trade and tax laws that may result in our customers being subjected to increased taxes, duties and tariffs and reduce their willingness to use our services in countries in which we are currently manufacturing their products;
• rising labor costs;
• labor unrest, including strikes;
• compliance with antitrust and competition regulations;
• compliance with foreign labor laws, which generally provide for increased notice, severance and consultation requirements compared to U.S. laws;
• aggressive, selective or lax enforcement of laws and regulations by national governmental authorities;
• compliance with the Foreign Corrupt Practices Act (“FCPA”) and other anti-bribery and corruption laws;
• compliance with U.S. laws concerning trade, including the International Traffic in Arms Regulations (“ITAR”), the Export Administration Regulations (“EAR”), and the sanctions, regulations and embargoes administered by the U.S. Department of Treasury’s Office of Foreign Asset Controls (“OFAC”);
• imposition of currency controls;
• adverse tax audit rulings; and
• unexpected events, including fires or explosions at facilities, and natural disasters.
Although the effect of any of the foregoing factors is difficult to predict, any one or more of them could adversely affect Arconic’s business, financial condition, or results of operations. While Arconic believes it has adopted appropriate risk management, compliance programs and insurance arrangements to address and reduce the risks associated with these factors, such measures may provide inadequate protection against costs or liabilities that may arise from such events.
As a public company, Arconic is subject to, among other things, the reporting requirements of the Securities Exchange Act of 1934, as amended, the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act and the regulations of the New York Stock Exchange. Arconic’s failure to comply with applicable law could subject it to penalties under federal securities laws, expose it to lawsuits and restrict its ability to access financing. Under the Sarbanes-Oxley Act, Arconic must maintain effective disclosure controls and procedures and internal control over financial reporting. There can be no assurance that Arconic’s internal control over financial reporting will be effective in the future or that a material weakness will not be discovered with respect to a prior period for which the Company had previously believed that internal controls were effective. Any failure to maintain effective disclosure controls and procedures or internal control over financial reporting could result in adverse regulatory consequences and/or a loss of investor confidence, which could limit the Company’s ability to access the global capital markets and could have a material adverse effect on the Company’s business, financial condition or the market price of Arconic securities.
## A material disruption of Arconic’s operations, particularly at one or more of the Company’s manufacturing facilities, could adversely affect Arconic’s business.
If Arconic’s operations, particularly one of the Company’s manufacturing facilities, were to be disrupted as a result of significant equipment failures, natural disasters, power outages, fires, explosions, terrorism, theft, sabotage, adverse weather conditions, public health crises, labor disputes or other reasons, the Company may be unable to effectively meet its obligations to or demand from its customers, which could adversely affect Arconic’s financial performance.
Interruptions in production could increase the Company’s costs and reduce its sales. Any interruption in production capability could require the Company to make substantial capital expenditures or purchase alternative material at higher costs to fill customer orders, which could negatively affect Arconic’s profitability and financial condition. Arconic maintains property damage insurance that the Company believes to be adequate to provide for reconstruction of facilities and equipment, as well as business interruption insurance to mitigate losses resulting from significant production interruption or shutdown caused by an insured loss. However, any recovery under Arconic’s insurance policies may not offset the lost profits or increased costs that may be experienced during the disruption of operations, which could adversely affect Arconic’s business, results of operations, financial condition and cash flow.
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A downgrade of Arconic’s credit ratings by one or more rating agencies could adversely impact the market price of Arconic’s securities; adversely affect existing financing (for example, a downgrade by S&P or Moody’s would subject Arconic to higher costs under Arconic’s Five-Year Revolving Credit Agreement and certain of its other revolving credit facilities); limit access to the capital (including commercial paper) or credit markets or otherwise adversely affect the availability of other new financing on favorable terms, if at all; result in more restrictive covenants in agreements governing the terms of any future indebtedness that the Company incurs; increase the cost of borrowing or fees on undrawn credit facilities; result in vendors or counterparties seeking collateral or letters of credit from Arconic; or otherwise impair Arconic’s business, financial condition, liquidity and results of operations.
## Arconic’s business and growth prospects may be negatively impacted by limits in its capital expenditures.
Arconic requires substantial capital to invest in growth opportunities and to maintain and prolong the life and capacity of its existing facilities. Insufficient cash generation or capital project overruns may negatively impact Arconic’s ability to fund as planned its sustaining and return-seeking capital projects. Over the long term, Arconic’s ability to take advantage of improved market conditions or growth opportunities in its businesses may be constrained by earlier capital expenditure restrictions, which could adversely affect the long-term value of its business and the Company’s position in relation to its competitors.
## An adverse decline in the liability discount rate, lower-than-expected investment return on pension assets and other factors could affect Arconic’s results of operations or amount of pension funding contributions in future periods.
Arconic’s results of operations may be negatively affected by the amount of expense Arconic records for its pension and other postretirement benefit plans, reductions in the fair value of plan assets and other factors. Arconic calculates income or expense for its plans using actuarial valuations in accordance with accounting principles generally accepted in the United States of America (GAAP).
These valuations reflect assumptions about financial market and other economic conditions, which may change based on changes in key economic indicators. The most significant year-end assumptions used by Arconic to estimate pension or other postretirement benefit income or expense for the following year are the discount rate applied to plan liabilities and the expected long-term rate of return on plan assets. In addition, Arconic is required to make an annual measurement of plan assets and liabilities, which may result in a significant charge to shareholders’ equity. For a discussion regarding how Arconic’s financial statements can be affected by pension and other postretirement benefits accounting policies, see “Critical Accounting Policies and Estimates-Pension and Other Postretirement Benefits” in Part II, Item 7. (Management’s Discussion and Analysis of Financial Condition and Results of Operations) and Note G to the Consolidated Financial Statements-Pension and Other Postretirement Benefits in Part II, Item 8. (Financial Statements and Supplementary Data). Although GAAP expense and pension funding contributions are impacted by different regulations and requirements, the key economic factors that affect GAAP expense would also likely affect the amount of cash or securities Arconic would contribute to the pension plans.
Potential pension contributions include both mandatory amounts required under federal law and discretionary contributions to improve the plans’ funded status. The Moving Ahead for Progress in the 21st Century Act (“MAP-21”), enacted in 2012, provided temporary relief for employers like Arconic who sponsor defined benefit pension plans related to funding contributions under the Employee Retirement Income Security Act of 1974 by allowing the use of a 25-year average discount rate within an upper and lower range for purposes of determining minimum funding obligations. In 2014, the Highway and Transportation Funding Act (HATFA) was signed into law. HATFA extended the relief provided by MAP-21 and modified the interest rates that had been set by MAP-21. In 2015, the Bipartisan Budget Act of 2015 (BBA 2015) was signed into law. BBA 2015 extends the relief period provided by HAFTA. Arconic believes that the relief provided by BBA 2015 will moderately reduce the cash flow sensitivity of the Company’s U.S. pension plans’ funded status to potential declines in discount rates over the next several years. However, higher than expected pension contributions due to a decline in the plans’ funded status as a result of declines in the discount rate or lower-than-expected investment returns on plan assets could have a material negative effect on the Company’s cash flows. Adverse capital market conditions could result in reductions in the fair value of plan assets and increase the Company’s liabilities related to such plans, which could adversely affect Arconic’s liquidity and results of operations.
## Unanticipated changes in Arconic’s tax provisions or exposure to additional tax liabilities could affect Arconic’s future profitability.
Arconic is subject to income taxes in both the United States and various non-U.S. jurisdictions. Its domestic and international tax liabilities are dependent upon the distribution of income among these different jurisdictions. Changes in applicable domestic or foreign tax laws and regulations, or their interpretation and application, including the possibility of retroactive
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Subsets and Splits