ITEM 1. BUSINESS
Our Company
Ingredion Incorporated (“Ingredion”) is a leading global ingredients solutions provider. We turn corn, tapioca, potatoes, grains, fruits, and vegetables into value-added ingredients and biomaterials for the food, beverage, brewing and other industries. Ingredion was incorporated as a Delaware corporation in 1997 and its common stock is traded on the New York Stock Exchange under the ticker symbol “INGR.”
For purposes of this report, unless the context otherwise requires, all references herein to the “Company,” “Ingredion,” “we,” “us,” and “our” shall mean Ingredion Incorporated and its consolidated subsidiaries.
We are principally engaged in the production and sale of starches and sweeteners for a wide range of industries, and are managed geographically on a regional basis. Our operations are classified into four reportable business segments: North America, South America, Asia-Pacific and Europe, Middle East, and Africa (“EMEA”). Our North America segment includes businesses in the U.S., Mexico, and Canada. Our South America segment includes businesses in Brazil, the Southern Cone of South America (which includes Argentina, Peru, Chile, and Uruguay), Colombia, and Ecuador. Our Asia-Pacific segment includes businesses in South Korea, Thailand, China, Australia, Japan, New Zealand, Indonesia, Singapore, the Philippines, Malaysia, India, and Vietnam. Our EMEA segment includes businesses in Pakistan, Germany, the United Kingdom and South Africa.
We supply a broad range of customers in many diverse industries around the world, including the food, beverage, brewing and other industries, as well as the global animal feed markets.
Our product lines include starches and sweeteners, animal feed products and edible corn oil. Our starch-based products include both food-grade and industrial starches, and biomaterials. Our sweetener products include glucose syrups, high maltose syrups, high fructose corn syrup, caramel color, dextrose, polyols, maltodextrins, and glucose and syrup solids. Our products are derived primarily from the processing of corn and other starch-based materials, such as tapioca, potato, and rice. We are in the process of expanding our plant-based protein product lines, including pulse-based concentrates, flours and isolates, with $185 million of investments through 2020.
Our manufacturing process is based on a capital-intensive, two-step process that involves the wet-milling and processing of starch-based materials, primarily corn. During the front-end process, the starch-based materials are steeped in a water-based solution and separated into starch and co-products such as animal feed and corn oil. The starch is then either dried for sale or further processed to make starches, sweeteners and other ingredients that serve the particular needs of various industries.
We believe our approach to production and service, which focuses on local management and production improvements of our worldwide operations, provides us with a unique understanding of the cultures and product requirements in each of the geographic markets in which we operate, bringing added value to our customers through innovative solutions. At the same time, we believe that our corporate functions allow us to identify synergies and maximize the benefits of our global presence.
Geographic Scope and Operations
Our North America segment consists of operations in the U.S., Mexico, and Canada. The region’s facilities include 22 plants producing a wide range of starches, sweeteners, gum acacia, and fruit and vegetable concentrates.
Our South America segment includes operations in Brazil, Colombia, the Southern Cone of South America, and Ecuador. The segment includes nine plants that produce regular, modified, waxy, and tapioca starches, high fructose and high maltose syrups and syrup solids, dextrins and maltodextrins, dextrose, specialty starches, caramel color, sorbitol, and vegetable adhesives.
Our Asia-Pacific segment manufactures corn-based products in South Korea, China, and Australia. Also, we manufacture tapioca-based products in Thailand, from which we supply not only our Asia-Pacific segment but the rest of our global network. The region’s facilities include eight plants that produce modified, specialty, regular, waxy, tapioca and rice starches, dextrins, glucose, high maltose syrup, dextrose, high fructose corn syrup, and caramel color.
Our EMEA segment includes five plants that produce modified and specialty starches, glucose and dextrose in Pakistan, Germany, and the United Kingdom.
Additionally, we utilize a network of tolling manufacturers in various regions in the production cycle of certain specialty starches. In general, these tolling manufacturers produce certain basic starches for us, and we in turn complete the manufacturing process of starches through our finishing channels.
We utilize our global network of manufacturing facilities to support key global product lines.
In general, demand for our products is balanced throughout the year. However, demand for sweeteners in South America is greater in the first and fourth quarters (its summer season) while demand for sweeteners in North America is greater in the second and third quarters. Due to the offsetting impact of these demand trends, we do not experience material seasonal fluctuations in our net sales on a consolidated basis.
Products
Our portfolio of products is generally classified into the following categories: Starch Products, Sweetener Products, and Co-products and others. Within these categories, a portion of our products are considered Specialty Ingredients. We describe these three general product categories in more detail below, along with a broader discussion of specialty ingredients within the product portfolio.
Starch Products: Our starch products represented approximately 46 percent, 46 percent, and 44 percent of our net sales for 2019, 2018 and 2017, respectively. Starches are an important component in a wide range of processed foods, where they are used for adhesion, clouding, dusting, expansion, fat replacement, freshness, gelling, glazing, mouthfeel, stabilization, and texture. Cornstarch is sold to cornstarch packers for sale to consumers. Starches are also used in paper production to create a smooth surface for printed communications and to improve strength in recycled papers. Specialty starches are used for enhanced drainage, fiber retention, oil and grease resistance, improved printability, and biochemical oxygen demand control. The textile industry uses starches and specialty starches for sizing (abrasion resistance) to provide size and finishes for manufactured products. Industrial starches are used in the production of construction materials, textiles, adhesives, pharmaceuticals, and cosmetics, as well as in mining, water filtration, and oil and gas drilling. Specialty starches are used for biomaterial applications including biodegradable plastics, fabric softeners and detergents, hair and skin care applications, dusting powders for surgical gloves, and in the production of glass fiber and insulation.
Sweetener Products: Our sweetener products represented approximately 36 percent, 36 percent, and 38 percent of our net sales for 2019, 2018 and 2017, respectively. Sweeteners include products such as glucose syrups, high maltose syrup, high fructose corn syrup, dextrose, polyols, maltrodextrin, glucose syrup solids, and non-GMO (genetically modified organism) syrups. Our sweeteners are used in a wide variety of food and beverage products, such as baked goods, snack foods, canned fruits, condiments, candy and other sweets, dairy products, ice cream, jams and jellies, prepared mixes, table syrups, soft drinks, fruit-flavored drinks, beer, and many others. These sweetener products also offer functionality in addition to sweetness, such as texture, body and viscosity; help control freezing points, crystallization, and browning; add humectancy (ability to add moisture) and flavor; and act as binders. Our high maltose syrups speed the fermentation process, allowing brewers to increase capacity without adding capital. Dextrose has a wide range of applications in the food and confection industries, in solutions for intravenous (“IV”) and other pharmaceutical applications, and numerous industrial applications like wallboard, biodegradable surface agents, and moisture control agents. Our specialty sweeteners provide affordable, natural, reduced calorie and sugar-free solutions for our customers.
Co-products and others: Co-products and others accounted for approximately 18 percent of our net sales for each of 2019, 2018 and 2017. Refined corn oil (from germ) is sold to packers of cooking oil and to producers of margarine,
salad dressings, shortening, mayonnaise, and other foods. Corn gluten feed is sold as animal feed. Corn gluten meal is sold as high-protein feed for chickens, pet food, and aquaculture. Our other products include fruit and vegetable products, such as concentrates, purees, and essences, as well as pulse proteins and hydrocolloids systems and blends.
Specialty Ingredients within the product portfolio: We consider certain of our products to be specialty ingredients. Specialty ingredients comprised approximately 30 percent of our net sales for 2019, up from 29 percent and 28 percent in 2018 and 2017, respectively. These ingredients deliver more functionality than our other products and add additional customer value. Our specialty ingredients are aligned with growing market and consumer trends such as health and wellness, clean-label, simple ingredients, affordability, indulgence, and sustainability.
We drive growth for our specialty ingredients portfolio by leveraging the following five growth platforms: Starch-based Texturizers, Clean and Simple Ingredients, Sugar Reduction and Specialty Sweeteners, Food Systems, and Plant-based Proteins.
Starch-based Texturizers: Ingredients that support the structure and texture behind great eating experiences. Products are made from corn, potato, rice, tapioca and offer a multitude of textures, functionalities, and stability during processing and shelf life to a broad range of food products.
Clean and Simple Ingredients: Functional ingredients that address the clean label trend for finished products made with shorter lists of highly consumer-accepted food ingredients. From food and beverages to pet food and personal care, consumers are looking for clean, simple, natural, and authentic products that they can identify and trust. The broad portfolio of clean label ingredients includes: starches, sweeteners, flours, nutrition ingredients, emulsifiers and fruit and vegetable concentrates.
Sugar Reduction and Specialty Sweeteners: Solutions that provide sweetness and functional replacement for sugar in reduced-calorie and sugar-free foods and beverages without sacrificing quality and consistency. These specialty ingredients are made from a variety of GMO and non-GMO raw material bases and include ingredients, such as naturally based stevia sweeteners, polyols, dextrose and allulose, a rare sugar.
Food Systems: Deliver proven ingredient combinations to accelerate product development enabling customers to get to market faster. A Food System can address a world of functional challenges, including: mouthfeel/texture for dairy and alternative dairy products, thickening of sauces, stabilization in high-protein drinks, gelling for fruit fillings, film formers for candy shells, foaming and frothing, adding soluble fibers and nutritional ingredients, adhering particles to breads and emulsification of flavors.
Plant-based Proteins: Specialty pulse-based protein ingredients that bring solutions to the world made from lentils, chickpeas, fava beans and peas. They add protein, dietary fiber, micronutrients and texture to food and beverages.
Competition
The starch and sweetener industry is highly competitive. Many of our products are viewed as basic ingredients that compete with virtually identical products and derivatives manufactured by other companies in the industry. The U.S. is a highly competitive market with operations by other starch processors, several of which are divisions of larger enterprises. Some of these competitors, unlike us, have vertically integrated their starch processing and other operations. Competitors include ADM Corn Processing Division (“ADM,” a division of Archer-Daniels-Midland Company), Cargill, Inc. (“Cargill”), Tate & Lyle Ingredients Americas, Inc. (“Tate & Lyle”), and several others. Our operations in Mexico and Canada face competition from U.S. imports and local producers including ALMEX, a Mexican joint venture between ADM and Tate & Lyle. In South America, Cargill has starch processing operations in Brazil and Argentina. We also face competition from Roquette Frères S.A. (“Roquette”) primarily in our North America region.
Many smaller local corn and tapioca refiners also operate in many of our markets. Competition within our markets is largely based on price, quality, and product availability.
Several of our products also compete with products made from raw materials other than corn. High fructose corn syrup and monohydrate dextrose compete principally with cane and beet sugar products. Co-products such as corn oil and gluten meal compete with products of the corn dry milling industry and with soybean oil, soybean meal, and other products. Fluctuations in prices of these competing products may affect prices of, and profits derived from, our products.
Customers
We supply a broad range of customers in over 60 industries worldwide. The following table provides the approximate percentage of total net sales by industry for each of our industries served in 2019:
No customer accounted for 10 percent or more of our net sales in 2019, 2018, or 2017.
Raw Materials
Corn (primarily yellow dent) is the primary basic raw material we use to produce starches and sweeteners. The supply of corn in the U.S. has been, and is anticipated to continue to be, adequate for our domestic needs. The price of corn, which is determined by reference to prices on the Chicago Board of Trade, fluctuates as a result of various factors including: farmers’ planting decisions, climate, domestic and foreign government policies (including those related to the production of ethanol), livestock feeding, shortages or surpluses of world grain supplies, and trade agreements. We use starch from potato processors as the primary raw material to manufacture ingredients derived from potato-based starches. We also use tapioca, gum, rice, and sugar as raw materials.
Corn is also grown in other areas of the world, including China, Brazil, Europe, Argentina, Mexico, South Africa, Canada, Pakistan, and Australia. Our subsidiaries outside the U.S. utilize both local supplies of corn and corn imported from other geographic areas, including the U.S. The supply of corn for these subsidiaries is also generally expected to be adequate for our needs. Corn prices for our non-U.S. affiliates generally fluctuate as a result of the same factors that affect U.S. corn prices.
We also utilize specialty grains such as waxy and high amylose corn in our operations. In general, the planning cycle for our specialty grain sourcing begins three years in advance of the anticipated delivery of the specialty corn since the necessary seed must be grown in the season prior to grain contracting. In order to secure these specialty grains at the time of our anticipated needs, we contract with certain farmers to grow the specialty corn approximately two years in advance of delivery. These specialty grains have a higher cost due to their more limited supply and require longer planning cycles to mitigate the risk of supply shortages.
Due to the competitive nature of our industry and the availability of substitute products not produced from corn, such as sugar from cane or beets, end-product prices may not necessarily fluctuate in a manner that correlates to raw material costs of corn.
We follow a policy of hedging our exposure to commodity price fluctuations with commodities futures and options contracts primarily for certain of our North American corn purchases. We use derivative hedging contracts to protect the gross margin of our firm-priced business in North America. Other business may or may not be hedged at any given time based on management’s judgment as to the need to fix the costs of our raw materials to protect our profitability.
Outside of North America, we generally enter into short-term commercial sales contracts and adjust our selling prices based upon the local raw material costs. See Item 7A. Quantitative and Qualitative Disclosures about Market Risk, in the section entitled “Commodity Costs” for additional information.
Other raw materials used in our manufacturing processes include starch from potato processors as the primary raw material to manufacture ingredients derived from potato-based starches. In addition, we use tapioca, particularly in certain of our production processes in the Asia-Pacific region. While the price of tapioca fluctuates from time-to-time as a result of growing conditions, the supply of tapioca has been, and is anticipated to continue to be, adequate for our production needs in the various markets in which we operate. In addition to corn, potato, and tapioca, we use pulses, gum, rice, and sugar as raw materials, among others.
Research and Development
We have a global network of more than 400 scientists working in 30 Ingredion Idea Labs® innovation centers with headquarters in Bridgewater, New Jersey. Activities at Bridgewater include plant science and physical, chemical and biochemical modifications to food formulations, food sensory evaluation, and development of non-food applications such as starch-based biopolymers. In addition, we have product application technology centers that direct our product development teams worldwide to create product application solutions to better serve the ingredient needs of our customers. Product development activity is focused on developing product applications for identified customer and market needs. Through this approach, we have developed value-added products for use by customers in various industries. We usually collaborate with customers to develop the desired product application either in the customers’ facilities, our technical service laboratories, or on a contract basis. These efforts are supported by our marketing, product technology, and technology support staff. R&D expense was approximately $44 million in 2019, $46 million in 2018, and $43 million in 2017. Our R&D expense represents investment in new product development and innovation. Our R&D is further supplemented by technical support services to assist our customers with application development and co-creation.
Sales and Distribution
Our salaried sales personnel, who are generally dedicated to customers in a geographic region, sell our products directly to manufacturers and distributors. In addition, we have staff that provide technical support to our sales personnel on an industry basis. We generally contract with trucking companies to deliver our bulk products to customer destinations. In North America, we generally use trucks to ship to nearby customers. For those customers located considerable distances from our plants, we use either rail or a combination of railcars and trucks to deliver our products. We generally lease railcars for terms of three to ten years.
Patents, Trademarks, and Technical License Agreements
We own more than 750 patents and patents pending, which relate to a variety of products and processes, and a number of established trademarks under which we market our products. We also have the right to use other patents and trademarks pursuant to patent and trademark licenses. We do not believe that any individual patent or trademark is material to our business. There is no currently pending challenge to the use or registration of any of our patents or trademarks that would have a material adverse impact on us or our results of operations if decided against us.
Employees
As of December 31, 2019, we had approximately 11,000 employees, of whom approximately 2,600 were located in the U.S. Approximately 31 percent of our U.S. employees and 36 percent of our non-U.S. employees are unionized.
Government Regulation and Environmental Matters
As a manufacturer and marketer of food items and items for use in the pharmaceutical industry, our operations and the use of many of our products are subject to various federal, state, foreign and local statutes and regulations, including the Federal Food, Drug and Cosmetic Act and the Occupational Safety and Health Act. We and many of our products are also subject to regulation by various government agencies, including the U.S. Food and Drug Administration. Among
other things, applicable regulations prescribe requirements and establish standards for product quality, purity, and labeling. Failure to comply with one or more regulatory requirements can result in a variety of sanctions, including monetary fines. No such fines of a material nature were imposed on us in 2019. We may also be required to comply with federal, state, foreign, and local laws regulating food handling and storage. We believe these laws and regulations have not negatively affected our competitive position.
Our operations are also subject to various federal, state, foreign, and local laws and regulations with respect to environmental matters, including air and water quality, and other regulations intended to protect public health and the environment. We operate industrial boilers that fire natural gas, coal, or biofuels to operate our manufacturing facilities and they, along with product dryers, are our primary source of greenhouse gas emissions. In Argentina, we are in discussions with local regulators addressing our possible undertaking to conduct studies of possible environmental remediation programs at our Chacabuco plant. We are unable to predict the outcome of these discussions, but do not believe that the ultimate cost of remediation will be material. Based on current laws and regulations and the enforcement and interpretations thereof, we do not expect that the costs of future environmental compliance will be a material expense, although there can be no assurance that we will remain in compliance or that the costs of remaining in compliance will not have a material adverse effect on our future financial condition and results of operations.
During 2019, we spent approximately $12 million for environmental control and wastewater treatment equipment to be incorporated into existing facilities and in planned construction projects. We currently anticipate that we will invest approximately $10 million for environmental facilities and programs in each of 2020 and 2021.
Other
Our Internet address is www.ingredion.com. We make available, free of charge through our Internet website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. These reports are made available as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission. Our corporate governance guidelines, board committee charters and code of ethics are posted on our website, the address of which is www.ingredion.com, and each is available in print to any shareholder upon request in writing to Ingredion Incorporated, 5 Westbrook Corporate Center, Westchester, Illinois 60154, Attention: Corporate Secretary. The contents of our website are not incorporated by reference into this report.
Information about our Executive Officers
Set forth below, as of January 31, 2020, are the names and ages of all of our executive officers, indicating their positions and offices with the Company and other business experience. Our executive officers are elected annually by the Board to serve until the next annual election of officers and until their respective successors have been elected and have qualified, or until their earlier resignation or removal by the Board.
ITEM 1A.
ITEM 1A. RISK FACTORS
Our business and assets are subject to varying degrees of risk and uncertainty. The following are factors that we believe could cause our actual results to differ materially from expected and historical results. Additional risks that are currently unknown to us may also impair our business or adversely affect our financial condition or results of operations. In addition, forward-looking statements within the meaning of the federal securities laws that are contained in this Form 10-K or in our other filings or statements may be subject to the risks described below as well as other risks and uncertainties. See the cautionary notice regarding forward-looking statements in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Changes in consumer preferences and perceptions may lessen the demand for our products, which could reduce our sales and profitability and harm our business.
Food products are often affected by changes in consumer tastes, national, regional and local economic conditions and demographic trends. For instance, changes in prevailing health or dietary preferences causing consumers to avoid food products containing sweetener products, including high fructose corn syrup, in favor of foods that are perceived as being more healthy, could reduce our sales and profitability, and such reductions could be material. Increasing concern among consumers, public health professionals and government agencies about the potential health concerns associated with obesity and inactive lifestyles (reflected, for instance, in taxes designed to combat obesity, which have been imposed recently in North America) represent a significant challenge to some of our customers, including those engaged in the food and soft drink industries.
Current economic conditions may adversely impact demand for our products, reduce access to credit and cause our customers and others with whom we do business to suffer financial hardship, all of which could adversely impact our business, results of operations, financial condition, and cash flows.
Economic conditions in South America, the European Union, and many other countries and regions in which we do business have experienced various levels of weakness over the last few years, and may remain challenging for the foreseeable future. General business and economic conditions that could affect us include barriers to trade (including as a result of Brexit, tariffs, duties, and border taxes, among other factors), the strength of the economies in which we operate, unemployment, inflation, and fluctuations in debt markets. While currently these conditions have not impaired our ability to access credit markets and finance our operations, there can be no assurance that there will not be a further deterioration in the financial markets.
There could be a number of other effects from these economic developments on our business, including reduced consumer demand for products, pressure to extend our customers’ payment terms, insolvency of our customers resulting in increased provisions for credit losses, decreased customer demand, including order delays or cancellations, and counterparty failures negatively impacting our operations.
In connection with our defined benefit pension plans, adverse changes in investment returns earned on pension assets and discount rates used to calculate pension and related liabilities or changes in required pension funding levels may have an unfavorable impact on future pension expenses and cash flows.
In addition, volatile worldwide economic conditions and market instability may make it difficult for us, our customers, and our suppliers to accurately forecast future product demand trends, which could cause us to produce excess products that could increase our inventory carrying costs. Alternatively, this forecasting difficulty could cause a shortage of products that could result in an inability to satisfy demand for our products.
Our reliance on certain industries for a significant portion of our sales could have a material adverse effect on our business.
Approximately 54 percent of our 2019 sales were made to companies engaged in the food industry and approximately 10 percent were made to companies in the beverage industry. Additionally, sales to the animal nutrition and brewing industry represented approximately 9 percent and approximately 8
percent, respectively, of our 2019 net sales. If our food customers, beverage customers, animal feed customers, or brewing industry customers were to substantially decrease their purchases, our business might be materially adversely affected.
The uncertainty of acceptance of products developed through biotechnology could affect our profitability.
The commercial success of agricultural products developed through biotechnology, including genetically modified corn, depends in part on public acceptance of their development, cultivation, distribution and consumption. Public attitudes can be influenced by claims that genetically modified products are unsafe for consumption or that they pose unknown risks to the environment, even if such claims are not based on scientific studies. These public attitudes can influence regulatory and legislative decisions about biotechnology. The sale of our products, which may contain genetically modified corn, could be delayed or impeded because of adverse public perception regarding the safety of our products and the potential effects of these products on human health, the environment, and animals.
Our future growth could be negatively impacted if we fail to introduce sufficient new products and services.
While we do not believe that any individual patent or trademark is material to our business, a portion of our growth comes from innovation in products, processes, and services. We cannot guarantee that our research and development efforts will result in new products and services at a rate or of a quality sufficient to meet expectations.
Government policies and regulations could adversely affect our operating results.
Our operating results could be affected by changes in trade, monetary and fiscal policies, laws and regulations, and other activities of the U.S. and foreign governments, agencies, and similar organizations. These conditions include but are not limited to changes in a country’s or region’s economic or political conditions, modification or termination of trade agreements or treaties promoting free trade, creation of new trade agreements or treaties, trade regulations affecting production, pricing and marketing of products, local labor conditions and regulations, reduced protection of intellectual property rights, changes in the regulatory or legal environment, restrictions on currency exchange activities, currency exchange rate fluctuations, burdensome taxes and tariffs, and other trade barriers. International risks and uncertainties, including changing social and economic conditions as well as terrorism, political hostilities, and war, could limit our ability to transact business in these markets and could adversely affect our revenues and operating results.
Our operations could be adversely affected by actions taken in connection with cross-border disputes by the governments of countries in which we conduct business.
We operate in a highly competitive environment and it may be difficult to preserve operating margins and maintain market share.
We operate in a highly competitive environment. Competition in markets in which we compete is largely based on price, quality, and product availability. Many of our products compete with virtually identical or similar products manufactured by other companies in the starch and sweetener industry. In the U.S., our competitors include divisions of larger enterprises that have greater financial resources than we do. Some of these competitors, unlike us, have vertically integrated their corn refining and other operations. Many of our products also compete with products made from raw materials other than corn, including cane and beet sugar. Fluctuation in prices of these competing products may affect prices of, and profits derived from, our products. In addition, government programs supporting sugar prices indirectly impact the price of corn sweeteners, especially high fructose corn syrup. Furthermore, co-products such as corn oil and gluten meal compete with products of the corn dry milling industry and with soybean oil, soybean meal, and other products, the price of some of which may be affected by government programs such as tariffs or quotas.
Due to market volatility, we cannot assure that we can adequately pass potential increases in the cost of corn and other raw materials on to customers through product price increases or purchase quantities of corn and other raw materials at prices sufficient to sustain or increase our profitability.
The price and availability of corn and other raw materials is influenced by economic and industry conditions, including supply and demand factors such as crop disease and severe weather conditions, such as drought, floods, or frost, that are difficult to anticipate and which we cannot control.
Raw material and energy price fluctuations, and supply interruptions and shortages could adversely affect our results of operations.
Our finished products are made primarily from corn. Purchased corn and other raw material costs account for between 40 percent and 65 percent of finished product costs. Some of our products are based upon specific varieties of corn that are produced in significantly less volumes than yellow dent corn. These specialty grains are higher-cost due to their more limited supply and require planning cycles of up to three years in order for us to receive our desired amounts of specialty corn. We also manufacture certain starch-based products from potatoes. Our current potato starch requirements constitute a material portion of the total available North American supply. It is possible that, in the long term, continued growth in demand for potato starch-based ingredients and new product development could result in capacity constraints. Also, we utilize tapioca in the manufacturing of starch products primarily in Thailand, as well as pulses, gum, rice and other raw materials around the world. A significant supply disruption or sharp increase in any of these raw material prices that we are unable to recover through pricing increases to our customers could have an adverse impact on our growth and profitability.
Energy costs represent approximately 9 percent of our finished product costs. We use energy primarily to create steam required for our production processes and to dry products. We consume coal, natural gas, electricity, wood, and fuel oil to generate energy.
The market prices for our raw materials may vary considerably depending on supply and demand, world economies, trade agreements and tariffs, and other factors. We purchase these commodities based on our anticipated usage and future outlook for these costs. We cannot assure that we will be able to purchase these commodities at prices that we can adequately pass on to customers to sustain or increase profitability.
In North America, we sell a large portion of our finished products derived from corn at firm prices established in supply contracts typically lasting for periods of up to one year. In order to minimize the effect of volatility in the cost of corn related to these firm-priced supply contracts, we enter into corn futures and options contracts, or take other hedging positions in the corn futures market. These derivative contracts typically mature within one year. At expiration, we settle the derivative contracts at a net amount equal to the difference between the then-current price of the commodity and the derivative contract price. The fluctuations in the fair value of these hedging instruments may adversely affect our cash flow. We fund any unrealized losses or receive cash for any unrealized gains on futures contracts on a daily basis. While the corn futures contracts or hedging positions are intended to minimize the effect of volatility of corn costs on operating profits, the hedging activity can result in losses, some of which may be material.
An inability to contain costs could adversely affect our future profitability and growth.
Our future profitability and growth depends on our ability to contain operating costs and per unit product costs and to maintain and implement effective cost control programs, while at the same time maintaining competitive pricing and superior quality products, customer service, and support. Our ability to maintain a competitive cost structure depends on continued containment of manufacturing, delivery, freight, and administrative costs, as well as the implementation of cost-effective purchasing programs for raw materials, energy, and related manufacturing requirements.
If we are unable to contain our operating costs and maintain the productivity and reliability of our production facilities, our profitability and growth could be adversely affected.
Increased interest rates could increase our borrowing costs.
We may issue debt securities to finance acquisitions, capital expenditures, and working capital, or for other general corporate purposes. An increase in interest rates in the general economy could result in an increase in our borrowing costs for these financings, as well as under any existing debt that bears interest at an unhedged floating rate.
Climate change and future costs of environmental compliance may be material.
Our business could be affected in the future by national and global regulation or taxation of greenhouse gas emissions, as well as the potential effects of climate change. Changes in precipitation extremes, droughts and water availability have the potential to impact Ingredion's agricultural supply as well as the availability of water for our manufacturing operations. Globally, a number of countries have instituted or are considering climate change legislation and regulations. Ingredion continues to assess the impact of climate change, regulatory pressures and changing consumer behaviors on our business strategy. It is difficult at this time to estimate the likelihood of passage or predict the potential impact of any additional legislation. Potential consequences could include increased energy, transportation, and raw materials costs, and we may be required to make additional investments in our facilities and equipment.
We may not successfully identify and complete acquisitions or strategic alliances on favorable terms or achieve anticipated synergies relating to any acquisitions or alliances, and such acquisitions could result in unforeseen operating difficulties and expenditures and require significant management resources.
We regularly review potential acquisitions of complementary businesses, technologies, services, or products, as well as potential strategic alliances. We may be unable to find suitable acquisition candidates or appropriate partners with which to form partnerships or strategic alliances. Even if we identify appropriate acquisition or alliance candidates, we may be unable to complete such acquisitions or alliances on favorable terms, if at all. In addition, the process of integrating an acquired business, technology, service, or product into our existing business and operations may result in unforeseen operating difficulties and expenditures. Integration of an acquired company also may require significant management resources that otherwise would be available for ongoing development of our business. Moreover, we may not realize the anticipated benefits of any acquisition or strategic alliance, and such transactions may not generate anticipated financial results. Future acquisitions could also require us to issue equity securities, incur debt, assume contingent liabilities, or amortize expenses related to intangible assets, any of which could harm our business.
Operating difficulties at our manufacturing plants could adversely affect our operating results.
Producing starches and sweeteners through corn refining is a capital intensive industry. We have 44 plants and have preventive maintenance and de-bottlenecking programs designed to maintain and improve grind capacity and facility reliability. If we encounter operating difficulties at a plant for an extended period of time or start-up problems with any capital improvement projects, we may not be able to meet a portion of sales order commitments and could incur significantly higher operating expenses, both of which could adversely affect our operating results. We also use boilers to generate steam required in our production processes. An event that impaired the operation of a boiler for an extended period of time could have a significant adverse effect on the operations of any plant in which such event occurred.
Also, we are subject to risks related to such matters as product safety and quality; compliance with environmental, health and safety and food safety regulations; and customer product liability claims. The liabilities that could result from these risks may not always be covered by, or could exceed the limits of, our insurance coverage related to product liability and food safety matters. In addition, negative publicity caused by product liability and food safety matters may damage our reputation. The occurrence of any of the matters described above could adversely affect our revenues and operating results.
We operate a multinational business subject to the economic, political, and other risks inherent in operating in foreign countries and with foreign currencies.
We have operated in foreign countries and with foreign currencies for many years. Our results are subject to foreign currency exchange fluctuations. Our operations are subject to political, economic, and other risks. There has been
and continues to be significant political uncertainty in some countries in which we operate. Economic changes, terrorist activity, and political unrest may result in business interruption or decreased demand for our products. Protectionist trade measures and import and export licensing requirements could also adversely affect our results of operations. Our success will depend in part on our ability to manage continued global political and economic uncertainty.
We primarily sell products derived from world commodities. Historically, we have been able to adjust local prices relatively quickly to offset the effect of local currency devaluations versus the U.S. dollar, although we cannot guarantee our ability to do this in the future. For example, due to pricing controls on many consumer products imposed in the recent past by the Argentine government, it takes longer than it had previously taken to achieve pricing improvement in response to currency devaluations versus the U.S. dollar in that country. The anticipated strength in the U.S. dollar may continue to provide some challenges, as it could take an extended period of time to fully recapture the impact of foreign currency devaluations versus the U.S. dollar, particularly in South America.
We may hedge transactions that are denominated in a currency other than the currency of the operating unit entering into the underlying transaction. We are subject to the risks normally attendant to such hedging activities.
Our information technology systems, processes, and sites may suffer interruptions, security breaches, or failures which may affect our ability to conduct our business.
Our operations rely on certain key information technology systems, which are dependent on services provided by third parties, provide critical data connectivity, information, and services for internal and external users. These interactions include, but are not limited to: ordering and managing materials from suppliers, risk management activities, converting raw materials to finished products, inventory management, shipping products to customers, processing transactions, summarizing and reporting results of operations, human resources benefits and payroll management, complying with regulatory, legal and tax requirements, and other processes necessary to manage our business. Increased information technology security and social engineering threats and more sophisticated computer crime, including advanced persistent threats, pose potential risks to the security of our information technology systems, networks and services, as well as the confidentiality, availability and integrity of our third-party and employee data. We have put in place security measures to protect ourselves against cyber-based attacks and disaster recovery plans for our critical systems. However, if our information technology systems are breached, damaged, or cease to function properly due to any number of causes, such as catastrophic events, power outages, security breaches, or cyber-based attacks, and if our disaster recovery plans do not effectively mitigate the risks on a timely basis, we may encounter significant disruptions that could interrupt our ability to manage our operations, cause loss of valuable data and actual or threatened legal actions, and cause us to suffer damage to our reputation, all of which may adversely impact our revenues, operating results, and financial condition. Our recent malware incident which lasted from October 2019 to December 2019 is one example of this type of risk, although this particular incident did not result in any material impact to our revenues, operating results, or financial condition.
The costs to address the foregoing security problems and security vulnerabilities before or after a cyber incident could be significant. Remediation efforts may not be successful and could result in interruptions, delays or cessation of service and loss of existing or potential customers that may impede our sales, manufacturing or other critical functions. Breaches of our security measures and the unapproved dissemination of proprietary information or sensitive or confidential data about us or our customers or other third parties could expose us, our customers or other third parties affected to a risk of loss or misuse of this information, result in regulatory enforcement, litigation and potential liability for us, damage our brand and reputation or otherwise harm our business. We rely in certain limited capacities on third-party data management providers and other vendors whose possible security problems and security vulnerabilities may have similar effects on us.
Our profitability could be negatively impacted if we fail to maintain satisfactory labor relations.
As of December 31, 2019, approximately 31 percent of our U.S. employees and 36 percent of our non-U.S. employees were members of unions. Strikes, lockouts, or other work stoppages or slowdowns involving our unionized employees could have a material adverse effect on us.
Natural disasters, war, acts and threats of terrorism, pandemics, and other significant events could negatively impact our business.
The economies of any countries in which we sell or manufacture products or purchase raw materials could be affected by natural disasters. Such natural disasters could include, among others, earthquakes, floods, or severe weather; war, acts of war, or terrorism; or the outbreak of an epidemic or pandemic; such as the ongoing coronavirus outbreak emanating from China at the beginning of 2020. Any such natural disaster could result in asset write-offs, decreased sales and overall reduced cash flows.
The recognition of impairment charges on goodwill or long-lived assets could adversely impact our future financial position and results of operations.
We have $1.2 billion of total intangible assets as of December 31, 2019, consisting of $801 million of goodwill and $437 million of other intangible assets, which constitute 13 percent and 7 percent, respectively, of our total assets as of such date. Additionally, we have $2.6 billion of long-lived assets, or 44 percent of our total assets, as of December 31, 2019.
We perform an annual impairment assessment for goodwill and our indefinite-lived intangible assets, and as necessary, for other long-lived assets. If the results of such assessments were to show that the fair value of these assets were less than the carrying values, we could be required to recognize a charge for impairment of goodwill or long-lived assets, and the amount of the impairment charge could be material. We continue to monitor our reporting units in struggling economies and recent acquisitions for challenges in these businesses that may negatively impact the fair value of these reporting units.
The future occurrence of a potential indicator of impairment, such as a significant adverse change in the business climate that would require a change in our assumptions or strategic decisions made in response to economic or competitive conditions, could require us to perform an assessment prior to the next required assessment date of July 1, 2020.
Changes in our tax rates or exposure to additional income tax liabilities could impact our profitability.
We are subject to income taxes in the U.S. and in various other foreign jurisdictions. Our effective tax rates could be adversely affected by changes in the mix of earnings by jurisdiction, changes in tax laws, or tax rates changes in the valuation of deferred tax assets and liabilities and material adjustments from tax audits.
The Tax Cuts and Jobs Act (“TCJA”), which was enacted in December 2017, significantly altered existing U.S. tax law and includes numerous and complex provisions that substantially affect our business. The U.S. Treasury Department and the Internal Revenue Service continue to interpret and issue guidance on provisions of the TCJA that could differ from the way in which we interpret some of the provisions. Consequently, we may make adjustments to our provision for income taxes based on differences in interpretation in the periods in which guidance is issued.
Significant changes in the tax laws of the U.S. and numerous foreign jurisdictions in which we do business could result from the base erosion and profit shifting (“BEPS”) project undertaken by the Organization for Economic Cooperation and Development (“OECD”). An OECD-led coalition of 44 countries is contemplating changes to long-standing international tax norms that determine each country’s right to tax cross-border transactions. These contemplated changes, as adopted by countries in which we do business, could increase tax uncertainty and the risk of double taxation, thereby adversely affecting our provision for income taxes.
The recoverability of our deferred tax assets, which are predominantly in Brazil, Canada, Germany, Mexico, and the U.S., is dependent upon our ability to generate future taxable income in these jurisdictions. In addition, the amount of income taxes we pay is subject to ongoing audits in various jurisdictions and a material assessment by a governing tax authority could affect our profitability and cash flows.
We may not have access to the funds required for future growth and expansion.
We may need additional funds to grow and expand our operations. We expect to fund our capital expenditures from operating cash flow to the extent we are able to do so. If our operating cash flow is insufficient to fund our capital expenditures, we may either reduce our capital expenditures or utilize our general credit facilities. For further strategic growth through mergers or acquisitions, we may also seek to generate additional liquidity through the sale of debt or equity securities in private or public markets or through the sale of assets. We cannot provide any assurance that our cash flows from operations will be sufficient to fund anticipated capital expenditures or that we will be able to obtain additional funds from financial markets or from the sale of assets at terms favorable to us. If we are unable to generate sufficient cash flows or raise sufficient additional funds to cover our capital expenditures or other strategic growth opportunities, we may not be able to achieve our desired operating efficiencies and expansion plans, which may adversely impact our competitiveness and, therefore, our results of operations. Our working capital requirements, including margin requirements on open positions on futures exchanges, are directly affected by the price of corn and other agricultural commodities, which may fluctuate significantly and change quickly.
Volatility in the stock market, fluctuations in quarterly operating results, and other factors could adversely affect the market price of our common stock.
The market price for our common stock may be significantly affected by factors such as our announcement of new products or services or such announcements by our competitors; technological innovation by us, our competitors or other vendors; quarterly variations in our operating results or the operating results of our competitors; general conditions in our or our customers’ markets; and changes in earnings estimates by analysts or reported results that vary materially from such estimates. In addition, the stock market has experienced significant price fluctuations that have affected the market prices of equity securities of many companies that have been unrelated to the operating performance of any individual company.
No assurance can be given that we will continue to pay dividends, or as to the amount of any dividend we pay.
The payment of dividends, as well as the amount of any dividends, is at the discretion of our Board of Directors and will be subject to our financial results and the availability of statutory surplus funds to pay dividends.
Our profitability may be affected by other factors beyond our control.
Our operating income and ability to increase profitability depend to a large extent upon our ability to price finished products at a level that will cover manufacturing and raw material costs and provide an acceptable profit margin. Our ability to maintain appropriate price levels is determined by a number of factors largely beyond our control, such as aggregate industry supply and market demand, which may vary from time to time, and the economic conditions of the geographic regions in which we conduct our operations.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We own or lease (as noted below), directly and through our consolidated subsidiaries, 44 manufacturing facilities. In addition, we lease our corporate headquarters in Westchester, Illinois and our research and development facility in Bridgewater, New Jersey.
The following list details the locations of our manufacturing facilities within each of our four reportable business segments as of February 1, 2020:
(a)Facility is leased.
(b)Facility is partially owned and partially leased.
We believe our manufacturing facilities are sufficient to meet our current production needs. We have preventive maintenance and de-bottlenecking programs designed to further improve grind capacity and facility reliability.
We have electricity co-generation facilities at our plants in London, Ontario, Canada; Cardinal, Ontario, Canada; Bedford Park, Illinois, U.S.; Winston-Salem, North Carolina, U.S.; San Juan del Rio and Mexico City, Mexico; Cali, Colombia; Cornwala, Pakistan; and Balsa Nova and Mogi-Guacu, Brazil, that provide electricity at a lower cost than is available from third parties. We generally own and operate these co-generation facilities, except for the facilities at our Mexico City, Mexico; and Balsa Nova and Mogi-Guacu, Brazil locations, which are owned by, and operated pursuant to co-generation agreements with third parties.
In recent years, we have made significant capital expenditures to update, expand and improve our facilities, spending $328 million in 2019. We believe these capital expenditures will allow us to operate efficient facilities for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company’s subsidiary, National Starch and Chemical (Thailand) Co. Ltd., self-reported to the Rayong Provincial Department of Industry of the Ministry of Industry (the “DIW”) an administrative error in registering one of its waste transporters in Thailand. The DIW notified National Starch and Chemical (Thailand) Co. Ltd. of failure to comply with Section 8 (5) of the Factory Act in connection with the waste transporter and, in May 2019, imposed fines on a per shipment basis totaling THB 3,330,000, or approximately $107,000. There was no assertion by the DIW or the Ministry of Industry that any harm had been caused to the environment. The fines were paid in May 2019 and this administrative error is not expected to reoccur.
We are currently subject to claims and suits arising in the ordinary course of business, including labor matters, certain environmental proceedings, and other commercial claims. We also routinely receive inquiries from regulators and other government authorities relating to various aspects of our business, including with respect to compliance with laws and regulations relating to the environment, and at any given time, we have matters at various stages of resolution with the applicable governmental authorities. The outcomes of these matters are not within our complete control and may not be known for prolonged periods of time. We do not believe that the results of currently known legal proceedings and inquires will be material to us. There can be no assurance, however, that such claims, suits or investigations or those arising in the future, whether taken individually or in the aggregate, will not have a material adverse effect on our financial condition or results of operations.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Trading: Shares of our common stock are traded on the New York Stock Exchange under the ticker symbol “INGR.”
Holders: The number of holders of record of our common stock was 3,633 at January 31, 2020.
Dividends: We have a history of paying quarterly dividends. The amount and timing of the dividend payment, if any, is based on a number of factors including estimated earnings, financial position and cash flow. The payment of a dividend, as well as the amount of any dividend, is solely at the discretion of our Board of Directors. Future dividend payments will be subject to our financial results and the availability of funds and statutory surplus to pay dividends.
Issuer Purchases of Equity Securities: The following table summarizes information with respect to our purchases of our common stock during the fourth quarter of 2019.
On December 12, 2014, the Board of Directors authorized a stock repurchase program permitting us to purchase up to 5.0 million of our outstanding shares of common stock from January 1, 2015, through December 31, 2019. On October 22, 2018, the Board of Directors authorized a new stock repurchase program permitting us to purchase up to an additional 8.0 million of our outstanding shares of common stock from November 5, 2018 through December 31, 2023. At December 31, 2019, we have 5.9 million shares available for repurchase under the stock repurchase programs.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data is provided below.
(a)Includes Western Polymer LLC (“Western Polymer”) from March 1, 2019 forward.
(b)Includes TIC Gums Incorporated at December 31, 2016 for balance sheet data only.
(c)Includes Penford Corporation (“Penford”) from March 11, 2015 forward and Kerr Concentrates, Inc. (“Kerr”) from August 3, 2015 forward.
(d)Includes after-tax restructuring expenses of $44 million, including $22 million of net restructuring related expenses as part of the Cost Smart Cost of sales program and $22 million of employee-related and other costs, including professional services, associated with our Cost Smart SG&A program. Additionally, includes after-tax income of $11 million, related to other matters and $2 million of after-tax acquisition/integration expenses.
(e)Includes after-tax restructuring charges of $51 million consisting of costs associated with the Cost Smart Cost of sales program in relation to the cessation of wet-milling at the Stockton, California plant, employee-related severance and other costs in relation to the Cost Smart SG&A program, other costs related to the North America Finance Transformation initiative, and other costs related to abandonment of certain assets related to our leaf extraction process in Brazil. Additionally, includes after-tax charge of $3 million to the provision for income taxes related to the enactment of the TCJA in December 2017.
(f)Includes after-tax restructuring charges of $31 million consisting of employee-related severance and other costs associated with the restructuring in Argentina, restructuring charges related to the abandonment of certain assets related to our leaf extraction process in Brazil, employee-related severance and other costs associated with the Finance Transformation initiative, and other restructuring charges including employee-related severance costs in North America and a refinement of estimates for prior year restructuring activities. Additionally, includes after-tax charge of $23 million to the provision for income taxes related to the enactment of the TCJA in December 2017, $6 million related to the flow-through of costs primarily associated with the sale of TIC Gums inventory that was adjusted to fair value at the acquisition date in accordance with business combination accounting rules, and $3 million associated with the integration of acquired operations, partially offset by a tax benefit of $10 million due to deductible foreign exchange loss resulting from the tax settlement between the U.S. and Canada, and a $6 million after-tax gain from an insurance settlement primarily related to capital reconstruction.
(g)Includes after-tax restructuring charges of $14 million consisting of employee severance-related charges and other costs associated with the execution of global IT outsourcing contracts, severance-related costs attributable to our optimization initiatives in North America and South America, and additional charges pertaining to our 2015 Port Colborne plant sale. Additionally, includes after-tax costs of $2 million associated with the integration of acquired operations and $27 million associated with an income tax matter.
(h)Includes after-tax charges for impaired assets and restructuring costs of $18 million, after-tax costs of $7 million relating to the acquisition and integration of both Penford and Kerr, after-tax costs of $6 million relating to the sale of Penford and Kerr inventory that was adjusted to fair value
at the respective acquisition dates in accordance with business combination accounting rules, after-tax costs of $4 million relating to a litigation settlement and an after-tax gain from the sale of a plant of $9 million.
(i)Includes non-controlling interest.
(j)During the three months ended December 31, 2019, the Company changed its presentation of net sales. The change is applied retrospectively to all periods presented. For the year ended December 31, 2016, Net sales was previously reported as $5,704 million and adjusted as $6,022 million. For the year ended December 31, 2015, Net sales was reported as $5,621 million and adjusted as $5,958 million. See Note 2 of the Notes to the Consolidated Financial Statements.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are a major supplier of high-quality food and industrial ingredient solutions to customers around the world. We have 44 manufacturing plants located in North America, South America, Asia-Pacific and Europe, the Middle East and Africa (“EMEA”), and we manage and operate our businesses at a regional level. We believe this approach provides us with a unique understanding of the cultures and product requirements in each of the geographic markets in which we operate, bringing added value to our customers. Our ingredients are used by customers in the food, beverage, brewing, and animal feed industries, among others.
Our growth strategy is centered on delivering value-added ingredient solutions for our customers. The foundation of our strategy is operating excellence, which includes our focus on safety, quality and continuous improvement. We see growth opportunities in three areas: first, we are working to expand our current business through organic growth; second, we are focused on broadening our ingredient portfolio with on-trend products through internal and external business development; finally, we look for growth from geographic expansion as we pursue extension of our reach to new locations. The ultimate goal of these strategies and actions is to deliver increased shareholder value.
Critical success factors in our business include managing our significant manufacturing costs, including costs for corn, other raw materials, and utilities. In addition, due to our global operations we are exposed to fluctuations in foreign currency exchange rates. We use derivative financial instruments, when appropriate, for the purpose of minimizing the risks and costs associated with fluctuations in certain raw material and energy costs, foreign exchange rates, and interest rates. Also, the capital intensive nature of our business requires that we generate significant cash flow over time in order to selectively reinvest in our operations and grow organically, as well as through strategic acquisitions and alliances. We utilize certain key financial metrics relating to return on invested capital and financial leverage to monitor our progress toward achieving our strategic business objectives (see section entitled “Key Financial Performance Metrics”).
The financial results of 2019 for operating income, net income and diluted earnings per common share declined from 2018. Operating income declined in 2019 from 2018 primarily due to lower operating results in all segments. The main drivers of the operating income decline were commodity margin pressures, higher production and supply chain costs, and unfavorable currency translation.
In July 2018, we announced a $125 million savings target for our Cost Smart program, designed to improve profitability, further streamline our global business, and deliver increased value to shareholders. We set Cost Smart savings targets to include an anticipated $75 million in cost of sales savings, including freight, and $50 million in anticipated SG&A savings by year end 2021.
Our Cost Smart program and other initiatives resulted in restructuring charges in 2019. During the year ended December 31, 2019, we recorded $57 million of pre-tax restructuring charges. We recorded $29 million for our Cost Smart Cost of sales program. We recorded $15 million of restructuring charges in relation to the closure of the Lane Cove, Australia production facility, consisting of $10 million of accelerated depreciation, $4 million of employee-related severance, and $1 million of other costs. We expect to incur additional expense of $10 million to $12 million in 2020 in relation to the closure, excluding potential proceeds from the sale of land and equipment. Additionally, during the year ended December 31, 2019, we recorded $3 million of employee-related expenses primarily related to the South America operations restructuring. Finally, we recorded $11 million of other costs, including professional services, during the year ended December 31, 2019, primarily in North America including other costs of $2 million in relation to the prior year cessation of wet-milling at the Stockton, California plant. We do not expect to incur any additional costs in relation to the cessation of wet-milling at the Stockton, California plant. We recorded pre-tax restructuring charges of $28 million for the year ended December 31, 2019 for the Cost Smart SG&A program. These costs include $15 million, of other costs, including professional services, and $13 million of employee-related severance for the year ended December 31, 2019. These charges were recorded primarily in the Company’s North America and South America operations, and include $2 million of other costs associated with the Finance Transformation initiative in Latin America for the year ended December
31, 2019. The Company expects to continue to incur additional charges in 2020 related to the Cost Smart SG&A program, however, it does not expect to incur any additional restructuring costs related to its Finance Transformation initiative.
Our cash provided by operating activities decreased to $680 million for the year ended December 31, 2019, from $703 million in the prior year primarily due to lower current year net earnings. Our cash used for financing activities decreased during the year ended December 31, 2019, compared to the prior year, primarily due to the repurchase of 5.8 million shares of our outstanding common stock in 2018 offset by our debt repayments in 2019.
As previously announced on October 15, 2019 and November 19, 2019, we detected suspicious activity affecting several servers within certain data centers on our network. Immediately, we took steps to identify and contain the situation, which included engaging a third-party consultant. We assessed the impact of the incident and did not identify any impact to our financial reporting systems nor any material impacts to our Key Financial Performance Metrics discussed below. We incurred immaterial costs to perform these necessary remediation efforts during the three months ended December 31, 2019. We are not aware of any evidence that any customer, supplier, or employee data has been improperly accessed, misused or transferred by any third party. The remediation work related to this incident was completed in December 2019.
We currently expect that our available cash balances, future cash flow from operations, access to debt markets, and borrowing capacity under our credit facilities will provide us with sufficient liquidity to fund our anticipated capital expenditures, dividends, and other investing and financing activities for the foreseeable future. Our future cash flow needs will depend on many factors, including our rate of revenue growth, the timing and extent of our expansion into new markets, the timing of introductions of new products, potential acquisitions of complementary businesses and technologies, continuing market acceptance of our new products, and general economic and market conditions. We may need to raise additional capital or incur indebtedness to fund our needs for less predictable strategic initiatives, such as acquisitions.
Results of Operations
We have significant operations in four reporting segments: North America, South America, Asia-Pacific and EMEA. For most of our foreign subsidiaries, the local foreign currency is the functional currency. Accordingly, revenues and expenses denominated in the functional currencies of these subsidiaries are translated into U.S. dollars at the applicable average exchange rates for the period. Fluctuations in foreign currency exchange rates affect the U.S. dollar amounts of our foreign subsidiaries’ revenues and expenses. In the second quarter of 2018, the Argentine peso rapidly devalued relative to the U.S. dollar, which along with increased inflation, resulted in a three-year cumulative inflation in that country which exceeded 100 percent as of June 30, 2018. As a result, we adopted highly inflationary accounting as of July 1, 2018, for our Argentina affiliate in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). Under highly inflationary accounting, our affiliate’s functional currency becomes the U.S. dollar, and its income statement and balance sheet will be measured in U.S. dollars using both current and historical rates of exchange. The effect of changes in exchange rates on Argentine peso-denominated monetary assets and liabilities will be reflected in earnings in Financing costs. The impact of all foreign currency exchange rate changes, where significant, is provided below.
We acquired Western Polymer LLC (“Western Polymer”) and Sun Flour Industry Co., Ltd. (“Sun Flour”) on March 1, 2019, and March 9, 2017, respectively. The results of the acquired businesses are included in our consolidated financial results from the respective acquisition dates forward. While we identify fluctuations due to the acquisitions, our discussion below also addresses results of operations excluding the impact of the acquisitions and the results of the acquired businesses, where appropriate, to provide a more comparable and meaningful analysis.
2019 Compared to 2018 - Consolidated
Net Income attributable to Ingredion. Net income attributable to Ingredion for 2019 decreased to $413 million from $443 million in 2018. Our results for 2019 included $35 million of one-time after-tax net costs, driven primarily by after-tax restructuring costs of $44 million. The restructuring charges consist of costs associated with our Cost Smart Cost of sales program and our Cost Smart SG&A program (see Note 5 of the Notes to the Consolidated Financial Statements for additional information).
Our results for 2018 included $54 million of one-time after-tax net costs, driven primarily by after-tax restructuring costs of $51 million. The restructuring charges consist of costs associated with our Cost Smart Cost of sales program in relation to the cessation of wet-milling at the Stockton, California plant, costs related to the Cost Smart SG&A program, including employee-related severance and other costs for restructuring projects in the South America, Asia-Pacific, and North America segments, costs related to the Latin America and North America Finance Transformation initiatives, and costs related to the cessation of our leaf extraction process in Brazil. During the year ended December 31, 2018, we adjusted our provisional amounts related to enactment of the Tax Cuts and Jobs Act ("TCJA") and recognized an incremental $3 million of tax expense related to the TCJA.
Net sales. Net sales were slightly down for the year ended December 31, 2019 as compared to the year ended December 31, 2018. Changes in foreign currency exchange rates and volume reduction due to the cessation of Stockton wet milling were partially offset by favorable price/product mix.
Cost of sales. Cost of sales for year ended December 31, 2019 were flat when compared to the year ended December 31, 2018 primarily due to higher net corn costs. Our gross profit margin was 21 percent and 22 percent for the years ended December 31, 2019, and 2018, respectively. The gross profit margin decrease primarily reflected higher raw material costs.
Operating expenses. Operating expenses were flat when comparing the year ended December 31, 2019, to the year ended December 31, 2018. This was primarily driven by lower selling costs, offset by higher general administrative costs. Operating expenses, as a percentage of gross profit, were 46 percent for the year ended December 31, 2019, as compared to 45 percent for the year ended December 31, 2018.
Other income, net. Our change in other income, net for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was as follows:
In January 2019, the Company’s Brazilian subsidiary received a favorable decision from the Federal Court of Appeals in Sao Paulo, Brazil, related to certain indirect taxes collected in prior years. As a result of the decision, the Company expects to be entitled to indirect tax credits against its Brazilian federal tax payments in 2020 and future years. The Company finalized its calculation of the amount of the credits and interest due from the favorable decision, concluding that the Company could be entitled to approximately $86 million of credits spanning a period from 2005 to 2018. The Department of Federal Revenue of Brazil, however, issued an Internal Ruling in which it charged that the Company is entitled to only $22 million of the calculated indirect tax credits and interest for the period from 2005 to 2014. The Brazil National Treasury has filed a motion for clarification with the Brazilian Supreme Court, asking the Court, among other things, to modify the lower court’s decision to approve the Internal Ruling, which could impact the decision in favor of the Company. Due to the uncertainty arising from the issuance of the Internal Ruling, the Company recorded $22 million of credits in 2019 in accordance with ASC 450, Contingencies. The $22 million of future tax credits, which was recorded in the Consolidated Income Statement in Other income, resulted in additional deferred income taxes of $8 million. The income taxes will be paid as and when the tax credits are utilized. The Company continues to monitor the pending decisions within the Brazilian courts that may result in changes to the calculations and the timing of the recording of any additional gains and receipt of the benefits.
Financing costs, net. Our financing costs, net for the year ended December 31, 2019 decreased $5 million from the year ended December 31, 2018, driven by a reduction in foreign currency losses, partly offset by higher interest expense.
Provision for income taxes. Our effective income tax rates for the years ended December 31, 2019 and 2018 were 27.1 percent and 26.9 percent, respectively.
The increase in the effective tax rate was primarily driven by a reduction in the excess tax benefit related to share-based payment awards. This was offset by the revaluation of the Mexican Peso versus the U.S. dollar which impacted the U.S. dollar denominated balances held in Mexico compared to the devaluation of the Mexican Peso versus the U.S. dollar, in the prior year. Additionally, the effective tax rate was reduced from the prior year due to relatively lower valuation allowances on Argentine net operating losses.
Net income attributable to non-controlling interests. Net income attributable to non-controlling interests for the year ended December 31, 2019, was flat when compared to the year ended December 31, 2018.
2019 Compared to 2018 - North America
Net sales. Our decrease in net sales of 1 percent for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was driven by a 2 percent decrease in volume, offset by a 1 percent improvement in price/product mix.
Operating income. Our operating income decreased $23 million for the year ended December 31, 2019, as compared to the year ended December 31, 2018, due to higher net cost of corn and production costs, which were partially offset by favorable pricing.
2019 Compared to 2018 - South America
Net sales. Our decrease in net sales of 3 percent for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was driven by currency devaluations of 20 percent in Argentina and Brazil, partly offset by a 15 percent increase in price/product mix and 2 percent increase in volume.
Operating income. Our decrease in operating income of $3 million for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was primarily driven by foreign exchange impacts and higher net corn costs, which were partially offset by favorable pricing actions.
2019 Compared to 2018 - Asia-Pacific
Net sales. Our decrease in net sales of 2 percent for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was driven by unfavorable currency translation.
Operating income. Our decrease in operating income of $17 million for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was driven by higher regional input costs, increased net corn cost in Australia, and foreign exchange impacts.
2019 Compared to 2018 - EMEA
Net sales. Our decrease in net sales of 2 percent for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was driven unfavorable foreign exchange of 11 percent, offset by volume growth of 2 percent and improved price/product mix of 7 percent.
Operating income. Our decrease in operating income of $17 million for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was driven by higher raw material costs and unfavorable foreign exchange impacts, driven primarily by the Pakistan rupee, which was partially offset by improved price mix.
2018 Compared to 2017 - Consolidated
Net Income attributable to Ingredion. Net income attributable to Ingredion for 2018 decreased to $443 million from $519 million in 2017. Our results for 2018 included $54 million of one-time after-tax net costs, driven primarily by after-tax restructuring costs of $51 million. The restructuring charges consist of costs associated with our Cost Smart Cost of sales program in relation to the cessation of wet-milling at the Stockton, California plant, costs related to the Cost Smart SG&A program, including employee-related severance and other costs for restructuring projects in the South America, Asia-Pacific, and North America segments, costs related to the Latin America and North America Finance Transformation initiatives, and costs related to the cessation of our leaf extraction process in Brazil (see Note 5 of the Notes to the Consolidated Financial Statements for additional information). During the year ended December 31, 2018, we adjusted our provisional amounts related enactment of the TCJA and recognized an incremental $3 million of tax expense related to the TCJA.
Our results for 2017 included $47 million of one-time after-tax net costs, driven primarily by restructuring costs of $31 million. The restructuring charges consisted of costs associated with the restructuring in Argentina, charges related to the abandonment of certain assets related to our leaf extraction process in Brazil, costs associated with the Finance Transformation initiative, and other pre-tax restructuring charges including employee-related severance costs in North America and a refinement of estimates for prior year restructuring activities (see Note 5 of the Notes to the Consolidated Financial Statements for additional information). Our after-tax net results also included a net $23 million charge to the provision for income taxes related to the enactment of the TCJA in December 2017, a $6 million charge relating to the flow-through of costs primarily associated with the sale of TIC Gums inventory that was adjusted to fair value at the acquisition date in accordance with business combination accounting rules, and a $3 million charge associated with the integration of acquired operations, partially offset by a tax benefit of $10 million due to a deductible foreign exchange loss resulting from the tax settlement between the U.S. and Canada and a $6 million gain from an insurance settlement primarily related to capital reconstruction.
Net sales. Net sales increased 1 percent for the year ended December 31, 2018, as compared to the year ended December 31, 2017. Volume growth of 1 percent driven by specialty products and favorable price/product mix of 3 percent were offset by unfavorable currency translation of 3 percent.
Cost of sales. Cost of sales for 2018 increased 3 percent to $4.5 billion from $4.4 billion in 2017 primarily due to higher raw material and manufacturing expenses. Our gross profit margin was 22 percent and 24 percent for the years ended December 31, 2018, and 2017, respectively. The gross profit margin decrease primarily reflected higher raw material costs and manufacturing expenses.
Operating expenses. Our decrease in operating expenses of 1 percent for the year ended December 31, 2018, as compared to the year ended December 31, 2017, was primarily driven by lower general administrative costs, partially offset by higher selling and research and development expenses. Operating expenses, as a percentage of gross profit, were 45 percent for the year ended December 31, 2018, as compared to 42 percent for the year ended December 31, 2017.
Other income, net. Our change in other income, net for the year ended December 31, 2018, as compared to the year ended December 31, 2017, was as follows:
Financing costs, net. Our financing costs, net for the year ended December 31, 2018 increased $13 million from the year ended December 31, 2017, primarily driven by unfavorable currency translation, including the impact of highly inflationary accounting related to Argentina.
Provision for income taxes. Our effective income tax rates for the years ended December 31, 2018 and 2017 were 26.9 percent and 30.8 percent, respectively.
The TCJA introduced numerous changes in the U.S. federal tax laws. Changes that have a significant impact on our effective tax rate are a reduction in the U.S. corporate tax rate from 35 percent to 21 percent, the imposition of a U.S. tax on our global intangible low-taxed income (“GILTI”) and the foreign-derived intangible income (“FDII”) deduction. The TCJA also provided for a one-time transition tax on the deemed repatriation of cumulative foreign earnings as of December 31, 2017, and eliminated the tax on dividends from our foreign subsidiaries by allowing a 100-percent dividends received deduction.
On December 22, 2017, Staff Accounting Bulletin No. 118 (“SAB 118”) was issued to provide guidance on the application of GAAP to situations in which the registrant does not have all the necessary information available, prepared or analyzed (including computations) in sufficient detail to complete the accounting for the income tax effects of the TCJA.
In the fourth quarter of 2017, we calculated a provisional impact of the TCJA in accordance with SAB 118 and our understanding of the TCJA, including published guidance as of December 31, 2017. During the third and fourth quarter of 2018, we recorded $2 million and $1 million, respectively, of net incremental tax expense as we finalized our TCJA expense based on additional guidance from federal and state regulatory agencies. (See Note 9 of the Notes to the Consolidated Financial Statements for additional information.) The following table summarizes the provisional and final net tax expense impact of the TCJA:
Additionally, we had been pursuing relief from double taxation under the U.S.-Canada tax treaty for the years 2004 through 2013. In the third quarter of 2017, the two countries finalized the agreement, which eliminated the double taxation, and we paid $63 million to the U.S. Internal Revenue Service to settle the liability. As a result of that agreement, we were entitled to a net tax benefit of $10 million primarily due to a foreign exchange loss deduction on our 2017 U.S. federal income tax return, or 1.3 percentage points on the effective tax rate. As a result of the final settlement, we received refunds totaling $42 million from Canadian revenue agencies and recorded $2 million, or 0.3 percentage points on the effective tax rate, of interest through tax expense in 2018.
We use the U.S. dollar as the functional currency for our subsidiaries in Mexico. In 2017, a decline in value of the Mexican peso versus the U.S. dollar increased tax expense by $4 million or 0.5 percentage points on the effective tax rate. This impact was largely associated with foreign currency translation gains and losses for local tax purposes on net-U.S.-dollar-monetary assets held in Mexico for which there was no corresponding gain or loss in pre-tax income.
During 2018, we increased the valuation allowance on the net deferred tax assets in Argentina by $6 million, or 1.0 percentage points on the effective tax rate, compared to $16 million, or 2.0 percentage points on the effective tax rate in 2017.
Without the impact of the items described above, our effective tax rate would have been approximately 25.1 percent and 28.1 percent for 2018 and 2017, respectively. The remaining year-over-year decrease in the effective income tax rate is primarily attributable to the impact of U.S. tax reform.
Net income attributable to non-controlling interests. Net income attributable to non-controlling interests for the year ended December 31, 2018, decreased $2 million from the year ended December 31, 2017, primarily due to unfavorable currency translation at our non-wholly-owned operation in Pakistan.
2018 Compared to 2017 - North America
Net sales. Net sales remained relatively flat for the year ended December 31, 2018, as compared to the year ended December 31, 2017. Volume growth for specialty and Mexico was primarily offset by volume declines for sweeteners in the U.S. and Canada.
Operating income. Our decrease in operating income of $109 million for the year ended December 31, 2018, as compared to the year ended December 31, 2017, was driven by higher production and supply chain costs, lower sweetener demand in the U.S. and Canada, and commodity margin pressures.
2018 Compared to 2017 - South America
Net sales. Net sales remained relatively flat for the year ended December 31, 2018, as compared to the year ended December 31, 2017. The decrease was driven by currency devaluations of 19% in Argentina and Brazil, partly offset by a 13% increase in price/product mix from price increases used to offset higher raw material costs and foreign currency fluctuations.
Operating income. Our increase in operating income of $18 million for the year ended December 31, 2018, as compared to the year ended December 31, 2017, was primarily driven by improved operational efficiencies and the lapping
of the 2017 Argentina manufacturing optimization project, partially offset by unfavorable currency translation reflecting a weaker Brazilian real and Argentine peso.
2018 Compared to 2017 - Asia-Pacific
Net sales. Our increase in net sales of 8 percent for the year ended December 31, 2018, as compared to the year ended December 31, 2017, was driven by volume growth of 3 percent, favorable currency translation of 3 percent, and a 2 percent increase in price/product mix due to favorable pricing to offset higher tapioca costs.
Operating income. Our decrease in operating income of $11 million for the year ended December 31, 2018, as compared to the year ended December 31, 2017, was driven by a delay in the pass-through of higher tapioca costs, partially offset by specialty volume growth.
2018 Compared to 2017 - EMEA
Net sales. Our increase in net sales of 5 percent for the year ended December 31, 2018, as compared to the year ended December 31, 2017, was driven by volume growth of 6 percent, a 3 percent increase in price/product mix, partially offset by unfavorable currency translation of 4 percent.
Operating income. Our increase in operating income of $2 million for the year ended December 31, 2018, as compared to the year ended December 31, 2017, was driven by specialty and core volume growth and improved price/product mix, partly offset by unfavorable currency translation in Pakistan and higher raw material costs.
Liquidity and Capital Resources
At December 31, 2019, our total assets were $6.0 billion, as compared to $5.7 billion at December 31, 2018. The increase was driven principally by continued capital investment in growth platforms. Total equity increased to $2.7 billion at December 31, 2019, from $2.4 billion at December 31, 2018. This increase primarily reflects our current year earnings.
On April 12, 2019, we amended and restated the Term Loan Credit Agreement that was set to mature on April 25, 2019 (“Term Loan”) of $165 million to establish a 24-month senior unsecured term loan credit facility in an amount up to $500 million that matures on April 12, 2021. We used the $500 million of borrowings under the new facility to pay down the amounts outstanding under our revolving credit facility described below and to pay off the Term Loan balance.
All borrowings under the amended term loan credit agreement for the new facility (“Amended Term Loan Credit Agreement”) will bear interest at a variable annual rate based on the London Interbank Offered Rate (“LIBOR”) or a base rate, at our election, subject to the terms and conditions thereof, plus, in each case, an applicable margin. We are required to pay a fee on the unused availability under the Amended Term Loan Credit Agreement. The Amended Term Loan Credit Agreement contains customary representations, warranties, covenants and events of default, including covenants restricting the incurrence of liens, the incurrence of indebtedness by our subsidiaries and certain fundamental changes involving the Company and our subsidiaries, subject to certain exceptions in each case. We must also maintain a specified consolidated leverage ratio and consolidated interest coverage ratio. As of December 31, 2019, we were in compliance with these financial covenants. The occurrence of an event of default under the Amended Term Loan Credit Agreement could result in all loans and other obligations being declared due and payable and the term loan credit facility being terminated.
On October 11, 2016, we entered into a five-year, senior, unsecured $1 billion revolving credit agreement (the “Revolving Credit Agreement”) that replaced our previously existing $1 billion senior unsecured revolving credit facility.
Subject to certain terms and conditions, we may increase the amount of the revolving credit facility under the Revolving Credit Agreement by up to $500 million in the aggregate. We may also obtain up to two one-year extensions of the maturity date of the Revolving Credit Agreement at our request and subject to the agreement of our lenders. All committed pro rata borrowings under the revolving credit facility will bear interest at a variable annual rate based on either the LIBOR or base rate, at our election, subject to the terms and conditions thereof, plus, in each case, an applicable margin based on our leverage ratio (as reported in the financial statements delivered pursuant to the Revolving Credit Agreement) or our credit rating. Subject to specified conditions, we may designate one or more of our subsidiaries as additional borrowers under the Revolving Credit Agreement provided that we guarantee all borrowings and other obligations of any such subsidiaries thereunder.
The Revolving Credit Agreement contains customary representations, warranties, covenants, events of default and other terms and conditions, including covenants restricting liens, subsidiary debt and mergers, subject to certain exceptions in each case. We must also comply with a leverage ratio covenant and an interest coverage ratio covenant. As of December 31, 2019, we were in compliance with these financial covenants. The occurrence of an event of default under the Revolving Credit Agreement could result in all loans and other obligations under the agreement being declared due and payable and the revolving credit facility being terminated. As of December 31, 2019, there were $10 million in borrowings outstanding under the Revolving Credit Agreement, with an additional $990 million available for use under the Revolving Credit Agreement as of the end of the year. In addition to the credit facilities described above, we have a number of short-term credit facilities consisting of operating lines of credit outside of the U.S.
As of December 31, 2019, we had total debt outstanding of $1.8 billion. As of December 31, 2019, our total debt consisted of the following:
The Company’s long-term debt matures as follows: $600 million in 2020, $500 million in 2026, and $250 million in 2037. The Company’s Term Loan of $405 million matures in 2021. The Company’s long-term debt as of December 31, 2019 includes the 5.62% senior notes due March 25, 2020 and 4.625% senior notes due November 1, 2020. The Company has the ability and intent to refinance such senior notes on a long-term basis using the revolving credit facility or other sources prior to the maturity date.
We, as the parent company, guarantee certain obligations of our consolidated subsidiaries. As of December 31, 2019, such guarantees aggregated $57 million. We believe that such consolidated subsidiaries will meet their financial obligations as they become due.
Historically, the principal source of our liquidity has been our internally generated cash flow, which we supplement as necessary with our ability to borrow under our credit facilities and to raise funds in the capital markets. In addition to borrowing availability under our Revolving Credit Agreement, we also have approximately $585 million of unused operating lines of credit in the various foreign countries in which we operate.
The weighted average interest rate on our total indebtedness was approximately 4.3 percent and 4.8 percent for 2019 and 2018, respectively.
Net Cash Flows
A summary of operating cash flows for 2019, 2018, and 2017 is shown below:
Cash provided by operations was $680 million in 2019, as compared with $703 million in 2018. The decrease in 2019 was primarily due to lower current year net earnings versus the prior year. Cash provided by operations in 2018 decreased compared to 2017 primarily due to lower net earnings in 2018 and the change in deferred income tax provision.
To manage price risk related to corn purchases, we use derivative instruments, consisting of corn futures and options contracts, to lock in our corn costs associated with firm-priced customer sales contracts. As the market price of these commodities fluctuate, our derivative instruments change in value and we fund any unrealized losses or receive cash for any unrealized gains related to outstanding commodity futures and option contracts. We plan to continue to use derivative instruments to hedge such price risk and, accordingly, we will be required to make cash deposits to or be entitled to receive cash from our margin accounts depending on the movement in the market price of the underlying commodities.
Listed below are our primary investing and financing activities for 2019, 2018, and 2017:
On December 27, 2019, our board of directors declared a quarterly cash dividend of $0.63 per share of common stock. This dividend was paid on January 27, 2020, to stockholders of record at the close of business on January 2, 2020.
We paid $328 million of capital expenditures and mechanical stores purchases to update, expand and improve our facilities in 2019. In April 2019, we acquired Western Polymer for $42 million.
We paid $657 million during 2018 to repurchase common stock. We purchased 1.8 million shares of our common stock in open market transactions for $202 million during the second, third and fourth quarters of 2018. Additionally on November 5, 2018, we entered into a Variable Timing Accelerated Share Repurchase (“ASR”) program with JPMorgan (“JPM”). Under the ASR program, we paid $455 million on November 5, 2018 and acquired 4 million shares of our common stock having an approximate value of $423 million on that date. On February 5, 2019, we settled the difference between the initial price and average daily volume-weighted average price (“VWAP”) less the agreed upon discount during the term of the agreement. The final VWAP was $98.04 per share, which was less than originally paid. We settled the difference in cash, resulting in JPM returning $63 million of the upfront payment to us on February 6, 2019 as an inflow to cash from financing activities, and lowering the total cost of repurchasing the 4 million shares of common stock to $392 million.
We have not provided foreign withholding taxes, state income taxes, and federal and state taxes on foreign currency gains/losses on accumulated undistributed earnings of certain foreign subsidiaries because these earnings are considered to be permanently reinvested. It is not practicable to determine the amount of the unrecognized deferred tax liability related to the undistributed earnings. We do not anticipate the need to repatriate funds to the U.S. to satisfy domestic liquidity needs arising in the ordinary course of business, including liquidity needs associated with our domestic debt service requirements. Approximately $248 million of our total cash and cash equivalents and short-term investments of $264 million at December 31, 2019, were held by our operations outside of the U.S.
Hedging and Financial Risk
Hedging: We are exposed to market risk stemming from changes in commodity prices (primarily corn and natural gas), foreign-currency exchange rates, and interest rates. In the normal course of business, we actively manage our exposure to these market risks by entering into various hedging transactions, authorized under established policies that place controls on these activities. These transactions utilize exchange-traded derivatives or over-the-counter derivatives with investment grade counterparties. Our hedging transactions may include, but are not limited to, a variety of derivative financial instruments such as commodity-related futures, options and swap contracts, forward currency-related contracts and options, interest rate swap agreements, and Treasury lock agreements (“T-Locks”). See Note 6 of the Notes to the Consolidated Financial Statements for additional information.
Commodity Price Risk: Our principal use of derivative financial instruments is to manage commodity price risk in North America relating to anticipated purchases of corn and natural gas to be used in our manufacturing process. We periodically enter into futures, options and swap contracts for a portion of our anticipated corn and natural gas usage, generally over the following 12 to 24 months, in order to hedge price risk associated with fluctuations in market prices. Unrealized gains and losses associated with marking our commodities-based cash flow hedge derivative instruments to market are recorded as a component of other comprehensive income (“OCI”). As of December 31, 2019, our Accumulated other comprehensive loss account (“AOCI”) included $11 million of net losses (net of income tax benefit of $5 million) related to these derivative instruments. It is anticipated that $9 million of net losses (net of income tax benefit of $3 million) will be reclassified into earnings during the next 12 months. We expect the net losses to be offset by changes in the underlying commodities costs.
Foreign Currency Exchange Risk: Due to our global operations, including operations in many emerging markets, we are exposed to fluctuations in foreign-currency exchange rates. As a result, we have exposure to translational foreign-exchange risk when our foreign operations’ results are translated to U.S. dollars and to transactional foreign-exchange risk when transactions not denominated in the functional currency of the operating unit are revalued into U.S. dollars. We primarily use derivative financial instruments such as foreign-currency forward contracts, swaps and options to manage our foreign currency transactional exchange risk. We enter into foreign-currency derivative instruments that are designated as both cash flow hedging instruments as well as instruments not designated as hedging instruments as defined by ASC 815, Derivatives and Hedging. As of December 31, 2019, we had foreign currency forward sales contracts with an aggregate notional amount of $621 million and foreign currency forward purchase contracts with an aggregate notional amount of $356 million not designated as hedging instruments.
As of December 31, 2019, we had foreign-currency forward sales contracts with an aggregate notional amount of $374 million and foreign-currency forward purchase contracts with an aggregate notional amount of $541 million designated as cash flow hedging instruments. The amount included in AOCI relating to these hedges at December 31, 2019, was $3 million of net gains (net of income tax expense of $1 million). It is anticipated that $3 million of net gains (net of income tax expense of $1 million) will be reclassified into earnings during the next 12 months.
We have significant operations in Argentina. In the second quarter of 2018, the Argentine peso rapidly devalued relative to the U.S. dollar, which along with increased inflation, indicated that the three-year cumulative inflation in that country exceeded 100 percent as of June 30, 2018. As a result, we elected to adopt highly inflationary accounting as of July 1, 2018 for our affiliate, Ingredion Argentina S.A. Under highly inflationary accounting, our affiliate’s functional currency is the U.S. dollar, and its income statement and balance sheet are measured in U.S. dollars using both current and
historical rates of exchange. The effect of changes in exchange rates on Argentine-peso-denominated monetary assets and liabilities is reflected in earnings in financing costs.
Interest Rate Risk: We occasionally use interest rate swaps and T-Locks to hedge our exposure to interest rate changes, to reduce the volatility of our financing costs, or to achieve a desired proportion of fixed versus floating rate debt, based on current and projected market conditions. We did not have any T-Locks outstanding as of December 31, 2019.
As of December 31, 2019, our AOCI account included $1 million of net losses (net of an insignificant amount of income tax benefit) related to settled T-Locks. These deferred losses are being amortized to financing costs over the terms of the senior notes with which they are associated. It is anticipated that $1 million of these net losses (net of an insignificant amount of income tax benefit) will be reclassified into earnings during the next 12 months.
As of December 31, 2019, we have an interest rate swap agreement that effectively converts the interest rates on $200 million of our $400 million of 4.625% senior notes due November 1, 2020, to variable rates. This swap agreement calls for us to receive interest at the fixed coupon rate of the notes and to pay interest at a variable rate based on the six-month U.S. dollar LIBOR plus a spread. We have designated this interest rate swap agreement as a hedge of the changes in fair value of the underlying debt obligation attributable to changes in interest rates and account for it as a fair value hedge. The fair value of the interest rate swap agreement was a $1 million loss at December 31, 2019, and is reflected in the Consolidated Balance Sheet within Other assets, with an offsetting amount recorded in Long-term debt to adjust the carrying amount of the hedged debt obligations.
Contractual Obligations and Off-Balance Sheet Arrangements
The table below summarizes our significant contractual obligations as of December 31, 2019. Information included in the table is cross-referenced to the Notes to the Consolidated Financial Statements elsewhere in this report, as applicable.
(a)The purchase obligations relate principally to raw material and power supply sourcing agreements, including take or pay contracts, which help to provide us with adequate power and raw material supply at certain of our facilities.
(b)The above table does not reflect unrecognized income tax benefits of $22 million, the timing of which is uncertain. See Note 9 of the Notes to the Consolidated Financial Statements for additional information with respect to unrecognized income tax benefits.
Key Financial Performance Metrics
We use certain key financial performance metrics to monitor our progress towards achieving our long-term strategic business objectives. These metrics relate to our ability to drive profitability, create value for shareholders, and monitor our financial leverage. We assess whether we are achieving our profitability and value creation objectives by measuring our Adjusted Return on Invested Capital (“Adjusted ROIC”). We monitor our financial leverage by regularly reviewing our ratio of net debt to adjusted earnings before interest, taxes, depreciation and amortization (“Net Debt to Adjusted EBITDA”) and our Net Debt to Capitalization percentage to assure that we are properly financed. We believe these metrics provide valuable managerial information to help us run our business and are useful to investors.
The metrics Adjusted ROIC and Net Debt to Adjusted EBITDA include certain information (Adjusted Operating Income, net of tax and Adjusted EBITDA, respectively) that is not calculated in accordance with GAAP. We also have presented below the most comparable metrics calculated using components determined in accordance with GAAP. Management uses these non-GAAP financial measures internally for strategic decision-making, forecasting future results, and evaluating current performance. Management believes that the non-GAAP financial metrics provide a more consistent comparison of our operating results and trends for the periods presented. These non-GAAP financial measures are used in addition to and in conjunction with results presented in accordance with GAAP and reflect an additional way of viewing aspects of our operations that, when viewed with our GAAP results, provides a more complete understanding of factors and trends affecting our business. These non-GAAP measures should be considered as a supplement to, and not as a substitute for, or superior to, the corresponding measures calculated in accordance with GAAP.
In accordance with our long-term objectives, we set certain objectives relating to these key financial performance metrics that we strive to meet. As of December 31, 2019, we achieved all of our established objectives identified as described below. However, no assurance can be given that we will continue to meet our financial performance metric targets. See Item 1A. Risk Factors and Item 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Exposure: We are exposed to interest rate risk on our variable rate debt and price risk on our fixed rate debt. As of December 31, 2019, approximately 62 percent or $1.2 billion of our total debt is fixed rate debt and 38 percent or approximately $697 million of our total debt is variable rate debt subject to changes in short-term rates, which could affect our interest costs. We assess market risk based on changes in interest rates utilizing a sensitivity analysis that measures the potential change in earnings, fair values and cash flows based on a hypothetical 1 percentage point change in interest rates at December 31, 2019. A hypothetical increase of 1 percentage point in the weighted average floating interest rate would increase our annual interest expense by approximately $3 million. See Note 7 of the Notes to the Consolidated Financial Statements for further information.
At December 31, 2019 and 2018, the carrying and fair values of long-term debt were as follows:
A hypothetical change of 1 percentage point in interest rates would change the fair value of our fixed rate debt at December 31, 2019, by approximately $71 million. Since we have no current plans to repurchase our outstanding fixed rate instruments before their maturities, the impact of market interest rate fluctuations on our long-term debt is not expected to have a significant effect on our consolidated financial statements.
We have an interest rate swap agreement that effectively converts the interest rates on $200 million of our $400 million 4.625% senior notes due November 1, 2020, to variable rates. This swap agreement calls for us to receive interest at the fixed coupon rate of the respective notes and to pay interest at a variable rate based on the six-month U.S. dollar LIBOR rate plus a spread. We have designated this interest rate swap agreement as a hedge of the changes in fair value of the underlying debt obligations attributable to changes in interest rates and account for it as a fair value hedge. The fair value of the interest rate swap agreements was a $1 million loss at December 31, 2019, and is reflected in the Consolidated Balance Sheet within Other assets, with an offsetting amount recorded in long-term debt to adjust the carrying amount of the hedged debt obligations.
Raw Material, Energy, and Other Commodity Exposure: Our finished products are made primarily from corn. In North America, we sell a large portion of finished products at firm prices established in supply contracts typically lasting for periods of up to one year. In order to minimize the effect of volatility in the cost of corn related to these firm-priced supply contracts, we enter into corn futures contracts or take other hedging positions in the corn futures market. These contracts typically mature within one year. At expiration, we settle the derivative contracts at a net amount equal to the difference between the then-current price of corn and the futures contract price. While these hedging instruments are subject to fluctuations in value, changes in the value of the underlying exposures we are hedging generally offset such fluctuations. While the corn futures contracts or other hedging positions are intended to minimize the volatility of corn costs on operating profits, occasionally the hedging activity can result in losses, some of which may be material. Outside of North America, sales of finished products under long-term, firm-priced supply contracts are not material.
Energy costs represent approximately 9 percent of our cost of sales. The primary use of energy is to create steam in the production process and to dry product. We consume coal, natural gas, electricity, wood, and fuel oil to generate energy. The market prices for these commodities vary depending on supply and demand, world economies and other factors. We purchase these commodities based on our anticipated usage and the future outlook for these costs. We cannot
assure that we will be able to purchase these commodities at prices that we can adequately pass on to customers to sustain or increase profitability. We use derivative financial instruments, such as over-the-counter natural gas swaps, to hedge portions of our natural gas costs generally over the following 12 to 24 months, primarily in our North American operations.
At December 31, 2019, we had outstanding futures and option contracts that hedged the forecasted purchase of approximately 98 million bushels of corn. We also had outstanding swap and option contracts that hedged the forecasted purchase of approximately 30 million mmbtu’s of natural gas at December 31, 2019. Based on our overall commodity hedge position at December 31, 2019, a hypothetical 10 percent decline in market prices applied to the fair value of the instruments would result in a charge to other comprehensive income of approximately $1 million, net of income tax benefit. Any change in the fair value of the contracts, real or hypothetical, would be substantially offset by an inverse change in the value of the underlying hedged item.
Foreign Currencies: Due to our global operations, we are exposed to fluctuations in foreign currency exchange rates. As a result, we have exposure to translational foreign exchange risk when our foreign operation results are translated to U.S. dollars and to transactional foreign exchange risk when transactions not denominated in the functional currency of the operating unit are revalued.
We selectively use derivative instruments such as forward contracts, currency swaps and options to manage transactional foreign exchange risk. Based on our overall foreign currency transactional exposure at December 31, 2019, we estimate that a hypothetical 10 percent decline in the value of the U.S. dollar would have resulted in a transactional foreign exchange gain of approximately $4 million. At December 31, 2019, our accumulated other comprehensive loss account included in the equity section of our Consolidated Balance Sheet includes a cumulative translation loss of approximately $1.1 billion. The aggregate net assets of our foreign subsidiaries where the local currency is the functional currency approximated $1.4 billion at December 31, 2019. A hypothetical 10 percent decline in the value of the U.S. dollar relative to foreign currencies would have resulted in a reduction to our cumulative translation loss and a credit to other comprehensive income of approximately $157 million.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Ingredion Incorporated:
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Ingredion Incorporated and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income (loss), equity and redeemable equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Change in Accounting Principle
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for leases effective January 1, 2019 due to the adoption of Accounting Standards Update 2016-02, Leases (Topic 842), and its subsequent amendments.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, 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 consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (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 audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements 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 included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
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.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgment. The communication of a critical audit matter 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 matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Evaluation of the pension and other postretirement employee benefit obligations (OPEB)
As discussed in Note 10 to the consolidated financial statements, the Company’s estimated pension benefit obligations totaled $641 million as of December 31, 2019. The Company’s OPEB includes plans in the US, Brazil and Canada, which are fully unfunded liabilities. As of December 31, 2019, the Company had a net liability of $69 million related to the Company’s other postretirement benefit plans. The pension and OPEB obligations are measured at the actuarial present value of the vested benefits to which employees are currently entitled based on the employee’s expected date of separation or retirement. The determination of the Company’s pension and OPEB obligations is dependent, in part, on the selection of certain estimates and actuarial assumptions, including discount rates.
We identified the evaluation of the pension and OPEB obligations to be a critical audit matter. Significant auditor judgment was required to evaluate the actuarial models and methodology used by the Company to determine the obligations and to evaluate the discount rates used. Small changes in the discount rates would impact the measurement of the pension and OPEB obligations.
The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s pension and OPEB obligations process, including controls related
to the assessment of the actuarial models and the development of the discount rates. We involved an actuarial professional with specialized skill and knowledge, who assisted in:
●understanding and assessing the actuarial models and methodology used by the Company to determine the obligations,
●the evaluation of the Company’s discount rates, by assessing changes in the discount rates from the prior year and comparing it to the change in published indices, and evaluating the discount rates based on the pattern of cash flows; and
●the evaluation of the selected yield curve, the consistency of the yield curve with the prior year, and the spot rates, to further assess the discount rates.
/s/ KPMG LLP
We have served as the Company’s auditor since 1997.
Chicago, IL
February 19, 2020
Ingredion Incorporated (“Ingredion”)
Consolidated Statements of Income
See the Notes to the Consolidated Financial Statements.
Ingredion Incorporated (“Ingredion”)
Consolidated Statements of Comprehensive Income (Loss)
See the Notes to the Consolidated Financial Statements.
Ingredion Incorporated (“Ingredion”)
Consolidated Balance Sheets
See the Notes to the Consolidated Financial Statements.
Ingredion Incorporated (“Ingredion”)
Consolidated Statements of Equity and Redeemable Equity
See the Notes to the Consolidated Financial Statements.
Ingredion Incorporated (“Ingredion”)
Consolidated Statements of Cash Flows
See the Notes to the Consolidated Financial Statements.
Ingredion Incorporated (“Ingredion”)
Notes to Consolidated Financial Statements
NOTE 1 - Description of the Business
Ingredion Incorporated (individually and together with its consolidated subsidiaries, “the Company”) was founded in 1906 and became an independent and public company as of December 31, 1997. The Company primarily manufactures and sells sweeteners, starches, nutrition ingredients, and biomaterial solutions derived from the wet milling and processing of corn and other starch-based materials to a wide range of industries, both domestically and internationally.
NOTE 2 - Summary of Significant Accounting Policies
Basis of presentation: The consolidated financial statements consist of the accounts of the Company, including all significant subsidiaries. Intercompany accounts and transactions are eliminated in consolidation.
The preparation of the accompanying consolidated financial statements in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”) requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenues and expenses. Such estimates include the value of purchase consideration, valuation of accounts receivable, inventories, goodwill, intangible assets and other long-lived assets, legal contingencies, guarantee obligations, and assumptions used in the calculation of income taxes, and pension and other postretirement benefits, among others. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. Management will adjust such estimates and assumptions when facts and circumstances dictate. Foreign currency devaluations, corn price volatility, access to credit markets, and adverse changes in the global economic environment have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in these estimates will be reflected in the financial statements in future periods.
Assets and liabilities of foreign subsidiaries, other than those whose functional currency is the U.S. dollar, are translated at current exchange rates with the related translation adjustments reported in equity as a component of accumulated other comprehensive income (loss). Income statement accounts are translated at the average exchange rate during the period. However, significant non-recurring items related to a specific event are recognized at the exchange rate on the date of the significant event. The U.S. dollar is the functional currency for the Company’s subsidiaries in Mexico and as of July 1, 2018, in Argentina. In the second quarter of 2018, the Argentine peso rapidly devalued relative to the U.S. dollar, which along with increased inflation, resulted in a three-year cumulative inflation that exceeded 100 percent, as of June 30, 2018. As a result, the Company elected to adopt highly inflationary accounting as of July 1, 2018, for its Argentina affiliate in accordance with GAAP. Under highly inflationary accounting, the Argentina affiliate’s functional currency becomes the U.S. dollar. For foreign subsidiaries where the U.S. dollar is the functional currency, monetary assets and liabilities are translated at current exchange rates with the related adjustment included in net income. Non-monetary assets and liabilities are translated at historical exchange rates.
Cash and cash equivalents: Cash equivalents consist of all instruments purchased with an original maturity of three months or less, and which have virtually no risk of loss in value.
Accounts receivable, net: Accounts receivable, net, consist of trade and other receivables carried at approximate fair value, net of an allowance for doubtful accounts based on specific identification of material amounts at risk and a general reserve based on historical collection experience.
Inventories: Inventories are stated at the lower of cost or net realizable value. Costs are predominantly determined using the weighted average method.
Investments: Investments are included in Other assets in the Consolidated Balance Sheets. The Company holds equity and cost method investments, and marketable securities as of December 31, 2019. Investments in which the Company is able to exercise significant influence, but do not represent a controlling interest, are accounted for under the equity method; such investments are carried at cost, adjusted to reflect the Company’s proportionate share of income or
loss, less dividends received. Investments in the common stock of affiliated companies over which the Company does not exercise significant influence are accounted for under the cost method. The marketable securities are carried at fair value with unrealized gains and losses recorded to Other income, net in accordance with Accounting Standards Codification (“ASC”) 825.
Leases: The Company leases rail cars, office space, and certain machinery and equipment. The Company determines if an arrangement is a lease at inception of the agreement and classifies its leases based on the terms of the related lease agreement and the criteria contained in Financial Accounting Standards Board (“FASB”) ASC Topic 842, Leases, and related interpretations. See also Note 8 of the Notes to the Consolidated Financial Statements for additional information.
Property, plant and equipment and depreciation: Property, plant and equipment (“PP&E”) are stated at cost less accumulated depreciation. Depreciation is generally computed on the straight-line basis over the estimated useful lives of depreciable assets, which range from 25 to 50 years for buildings and from two to 25 years for all other assets. Where permitted by law, accelerated depreciation methods are used for tax purposes. The Company recognized depreciation expense of $191 million, $217 million, and $179 million for the years ended December 31, 2019, 2018, and 2017, respectively. The Company reviews the recoverability of the net book value of PP&E for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If this review indicates that the carrying values will not be recovered, the carrying values would be reduced to fair value and an impairment loss would be recognized. As required under GAAP, the impairment analysis for long-lived assets occurs before the goodwill impairment assessment described below. No PP&E impairment was recognized in the year ended December 31, 2019 related to the Company’s annual impairment testing.
The following table summarizes the Company’s PP&E and accumulated depreciation for the periods presented:
Goodwill and other intangible assets: Goodwill ($801 million and $791 million at December 31, 2019 and 2018, respectively) represents the excess of the cost of an acquired entity over the fair value assigned to identifiable assets acquired and liabilities assumed. The Company also has other intangible assets of $437 million and $460 million at December 31, 2019 and 2018, respectively. The original carrying value of goodwill and accumulated impairment charges by reportable business segment at December 31, 2019 was as follows:
The following table summarizes the Company’s other intangible assets for the periods presented:
Definite-lived intangible assets are stated at cost less accumulated amortization. Amortization is computed on the straight-line basis over the estimated useful lives of definite-lived intangible assets. Amortization expense related to intangible assets was $29 million, $30 million, and $30 million for the years ended December 31, 2019, 2018, and 2017, respectively. The Company reviews the recoverability of the net book value of definite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If this review indicates that the carrying values will not be recovered, the carrying values would be reduced to fair value and an impairment loss would be recognized.
Based on acquisitions completed through December 31, 2019, intangible asset amortization expense for the next five years is shown below.
The Company assesses indefinite-lived intangible assets and goodwill for impairment annually (or more frequently if impairment indicators arise). The Company has chosen to perform this annual impairment assessment as of July 1 of each year.
In testing indefinite-lived intangible assets for impairment, the Company first assesses qualitative factors to determine whether it is more-likely-than-not that the fair value of an indefinite-lived intangible asset is impaired. After assessing the qualitative factors, if the Company determines that it is more-likely-than-not that the fair value of an indefinite-lived intangible asset is greater than its carrying amount, then it would not be required to compute the fair value of the indefinite-lived intangible asset. In the event the qualitative assessment leads the Company to conclude otherwise, then it would be required to determine the fair value of the indefinite-lived intangible assets and perform a quantitative impairment test in accordance with ASC Topic 350-30, General Intangibles Other than Goodwill. In performing the qualitative analysis, the Company considers various factors including net sales derived from these intangibles and certain market and industry conditions. Based on the results of its assessment, the Company concluded that as of July 1, 2019, there were no impairments in its indefinite-lived intangible assets.
In testing goodwill for impairment, the Company first assesses qualitative factors in determining whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount. After assessing the qualitative factors, if the Company determines that it is more-likely-than-not that the fair value of a reporting unit is greater than its
carrying amount then the Company does not perform the two-step impairment test. If the Company concludes otherwise, then it performs the first step of the two-step impairment test as described in ASC Topic 350. In the first step (“Step One”), the fair value of the reporting unit is compared to its carrying value. If the fair value of the reporting unit exceeds the carrying value of its net assets, goodwill is not considered impaired and no further testing is required. If the carrying value of the net assets exceeds the fair value of the reporting unit, a second step (“Step Two”) of the impairment assessment is performed in order to determine the implied fair value of a reporting unit's goodwill. Determining the implied fair value of goodwill requires a valuation of the reporting unit's tangible and intangible assets and liabilities in a manner similar to the allocation of purchase price in a business combination. If the carrying value of the reporting unit's goodwill exceeds the implied fair value of its goodwill, goodwill is deemed impaired and is written down to the extent of the difference. Based on the results of the annual assessment, the Company concluded that as of July 1, 2019, there were no impairments in its reporting units.
Revenue recognition: The Company accounts for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers, which is more fully described in Note 4 of the Notes to the Consolidated Financial Statements.
Hedging instruments: Derivative financial instruments used by the Company consist of commodity futures and option contracts, forward currency contracts and options, interest rate swap agreements and Treasury lock agreements (“T-Locks”). See also Note 6 of the Notes to the Consolidated Financial Statements for additional information.
On the date a derivative contract is entered into, the Company designates the derivative as a hedge of variable cash flows to be paid related certain forecasted transactions (“a cash flow hedge”), as a hedge of the fair value of certain firm commitments (“a fair value hedge”), or as a non-designated hedging instrument as defined by ASC 815, Derivatives and Hedging. This process includes linking all derivatives that are designated as cash flow or fair value hedges to specific assets and liabilities on the Consolidated Balance Sheets, or to specific firm commitments or forecasted transactions. These hedges are accounted for using ASC Topic 815. For all hedging relationships, the Company documents the hedging relationships and its risk-management objective and strategy for undertaking the hedge transactions, the hedging instrument, the hedged item, the nature of the risk being hedged, how the hedging instrument’s effectiveness in offsetting the hedged risk will be assessed and a description of the method of measuring ineffectiveness. The Company also formally assesses both, at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows or fair values of hedged items. When it is determined that a derivative is not highly effective as a hedge or has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively.
The Company discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the cash flows or fair value of the hedged item, the derivative is de-designated as a hedging instrument because it is unlikely that a forecasted transaction will occur, or management determines that designation of the derivative as a hedging instrument is no longer appropriate. When hedge accounting is discontinued, the Company continues to carry the derivative on the Consolidated Balance Sheets at its fair value, and gains and losses that were included in AOCI are recognized in earnings in the same line item affected by the hedged transaction and in the same period or periods during which the hedged transaction affects earnings, or in the month a hedge is determined to be ineffective.
Share-based compensation: The Company has a stock incentive plan that provides for share-based employee compensation, including the granting of stock options, shares of restricted stock, restricted stock units, and performance shares to certain key employees. Compensation expense is recognized in the Consolidated Statements of Income for the Company’s share-based employee compensation plan. The plan is more fully described in Note 11 of the Notes to the Consolidated Financial Statements.
Earnings per common share: Basic earnings per common share (“EPS”) is computed by dividing net income attributable to the Company by the weighted average number of shares outstanding. Diluted EPS is calculated using the treasury stock method, computed by dividing net income attributable to the Company by the weighted average number of shares outstanding, including the dilutive effect of outstanding stock options and other instruments associated with long-term incentive compensation plans.
Risks and uncertainties: The Company operates domestically and internationally. In each country, the business and assets are subject to varying degrees of risk and uncertainty. The Company insures its business and assets in each country against insurable risks in a manner that it deems appropriate. Because of this geographic dispersion, the Company
believes that a loss from non-insurable events in any one country would not have a material adverse effect on the Company’s operations as a whole. Additionally, the Company believes there is no significant concentration of risk with any single customer or supplier whose failure or non-performance would materially affect the Company’s results.
Recently Adopted Accounting Standards
ASU No. 2016-02, Leases (Topic 842)
In February 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842), which supersedes Topic 840, Leases. The Company adopted this updated standard as of January 1, 2019, using the modified retrospective approach and the effective date as its date of initial application. The Company elected the package of three practical expedients permitted under the transition guidance, which among other things allowed the Company to carry forward the historical lease classification of existing leases and to not reassess expired contracts for leases. The practical expedient for hindsight to determine lease term was not elected by the Company. The standard resulted in the initial recognition of $170 million of total operating lease liabilities and $161 million of operating lease assets on the Consolidated Balance Sheet on January 1, 2019. The standard did not materially impact the Consolidated Statement of Income or Consolidated Statement of Cash Flows. The disclosures required by the recently adopted accounting standard are included in Note 8 of the Notes to the Consolidated Financial Statements.
ASU No. 2017-12 and ASU 2018-16, Derivatives and Hedging (Topic 815)
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This Update modifies accounting guidance for hedge accounting by making more hedge strategies eligible for hedge accounting, amending presentation and disclosure requirements, and changing how companies assess ineffectiveness. The intent is to simplify the application of hedge accounting and increase transparency of information about an entity’s risk management activities. The amended guidance is effective for annual periods beginning after December 15, 2018, with early adoption permitted. The Company completed its assessment of these updates adopted on January 1, 2019, including potential changes to existing hedging arrangements, and determined the adoption of the guidance did not have a material impact on the Company’s Consolidated Financial Statements.
In October 2018, the FASB issued ASU 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as Benchmark Interest Rate for Hedge Accounting Purposes. This Update permits use of the OIS rate based on the SOFR as a U.S. benchmark interest rate for hedge accounting purposes. The guidance should be adopted on a prospective basis. This Update is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Update did not have a material impact on the Company’s Consolidated Financial Statements.
New Accounting Standards
In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This Update simplifies the subsequent measurement of goodwill as the Update eliminates Step 2 from the goodwill impairment test. Under the Update, an entity will continue to perform its annual, or interim, goodwill impairment test to determine if the fair value of a reporting unit is greater than its carrying amount. An entity should then recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value using the results of its Step 1 assessment, with the loss recognized not to exceed the total amount of goodwill allocated to that reporting unit. This Update is effective for annual periods beginning after December 15, 2019, with early adoption permitted. The Company will adopt ASU 2017-04 at the beginning of its 2020 fiscal year and the Update will not have a material impact on the Company’s Consolidated Financial Statements upon adoption.
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 us to measure and recognize expected credit losses for financial assets held and not accounted for at fair value through net income. This Update is effective for annual periods beginning after December 15, 2019, with early adoption permitted. The Company will adopt ASU 2016-13 at the beginning of its 2020 fiscal year and the Update will not have a material impact on the Company’s Consolidated Financial Statements upon adoption.
Presentation of Net Sales
During the three months ended December 31, 2019, the Company changed its presentation of shipping and handling costs. These costs were previously included as a reduction to Net sales in the Consolidated Statements of Income. The Company is now presenting these expenses within Cost of sales in the Consolidated Statements of Income. The change in presentation was applied retrospectively to all periods presented in the Consolidated Statements of Income. The change in presentation had no effect on Gross profit, Operating income, Net income, or earnings per share. The Consolidated Balance Sheets, Consolidated Statements of Comprehensive Income, Consolidated Statements of Equity and Redeemable Equity, and Consolidated Statements of Cash Flows are not affected by this change in presentation. Total shipping and handling costs in for the year ended December 31, 2019 were $466 million.
The effect of the adjustment is as follows:
NOTE 3 - Acquisitions
On March 1, 2019, the Company completed its acquisition of Western Polymer LLC (“Western Polymer”), a privately-held, U.S.-based company headquartered in Moses Lake, Washington, that produces native and modified potato starches for industrial and food applications for $42 million, net of cash acquired of $4 million. The acquisition will expand the Company's potato starch manufacturing capacity, enhance processing capabilities, and broaden its higher-value specialty ingredients business and customer base. The results of the acquired operation are included in the Company’s consolidated results from the acquisition date forward within the North America business segment.
A preliminary allocation of the purchase price to the assets acquired and liabilities assumed was made based on available information and incorporating management’s best estimates. The assets acquired and liabilities assumed in the transaction are generally recorded at their estimated acquisition date fair values, while transaction costs associated with the acquisition are expensed as incurred. As of December 31, 2019, $13 million of goodwill and intangible assets, and $29 million of net tangible assets have preliminarily been recorded. Goodwill represents the amount by which the purchase price exceeds the estimated fair value of the net assets acquired. Goodwill and intangible assets are open to be finalized as of December 31, 2019 pending finalization of tax matters. The goodwill results from synergies and other operational benefits expected to be derived from the acquisition. The goodwill related to Western Polymer is tax-deductible due to the structure of the acquisition.
Pro-forma results of operations for the acquisition made in the year ended December 31, 2019 have not been presented as the effect of the acquisition would not be material to the Company’s results of operations for any periods presented.
The Company incurred $3 million, $ - , and $4 million of pre-tax acquisition and integration costs in the years ended December 31, 2019, 2018, and 2017, respectively, associated with its acquisitions.
NOTE 4 - Revenue Recognition
The Company applies the provisions of ASC 606-10, Revenue from Contracts with Customers. The Company recognizes revenue under the core principle to depict the transfer of products to customers in an amount reflecting the consideration the Company expects to receive. In order to achieve that core principle, the Company applies the following five-step approach: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when a performance obligation is satisfied.
The Company identified customer purchase orders, which in some cases are governed by a master sales agreement, as the contracts with its customers. For each contract, the Company considers the transfer of products, each of which is distinct, to be the identified performance obligation. In determining the transaction price for the performance obligation, the Company evaluates whether the price is subject to adjustment to determine the consideration to which the Company expects to be entitled. The pricing model can be fixed or variable within the contract. The variable pricing model is based on historical commodity pricing and is determinable prior to completion of the performance obligation. Additionally, the Company has certain sales adjustments for volume incentive discounts and other discount arrangements that reduce the transaction price. The reduction of transaction price is estimated using the expected value method based on an analysis of historical volume incentives or discounts, over a period of time considered adequate to account for current pricing and business trends. Historically, actual volume incentives and discounts relative to those estimated and included when determining the transaction price have not materially differed. Volume incentives and discounts are accrued at the
satisfaction of the performance obligation and accounted for in Accounts payable and Accrued liabilities in the Consolidated Balance Sheets. These amounts are not significant as of December 31, 2019, and 2018. The product price as specified in the contract, net of any discounts, is considered the standalone selling price as it is an observable input which depicts the price as if sold to a similar customer in similar circumstances. Payment is received shortly after the performance obligation is satisfied; therefore, the Company has elected the practical expedient under ASC 606-10-32-18 to not assess whether a contract has a significant financing component.
Revenue is recognized when the Company’s performance obligation is satisfied and control is transferred to the customer, which occurs at a point in time, either upon delivery to an agreed upon location or to the customer. Further, in determining whether control has transferred, the Company considers if there is a present right to payment and legal title, along with risks and rewards of ownership having transferred to the customer.
Shipping and handling activities related to contracts with customers represent fulfillment costs and are recorded in Cost of sales. Taxes assessed by governmental authorities and collected from customers are accounted for on a net basis and excluded from net sales. The Company applies a practical expedient to expense costs to obtain a contract as incurred as most contracts are one year or less. These costs primarily include the Company’s internal sales force compensation. Under the terms of these programs, these are generally earned and the costs are recognized at the time the revenue is recognized.
From time to time the Company may enter into long-term contracts with its customers. Historically, the contracts entered into by the Company do not result in significant contract assets or liabilities. Any such arrangements are accounted for in Other assets or Accrued liabilities in the Consolidated Balance Sheets. There were no significant contract assets or liabilities as of December 31, 2019, and 2018.
The Company is principally engaged in the production and sale of starches and sweeteners for a wide range of industries, and is managed geographically on a regional basis. The Company’s operations are classified into four reportable business segments: North America, South America, Asia-Pacific and Europe, Middle East and Africa (“EMEA”). The nature, amount, timing and uncertainty of the Company’s Net sales are managed by the Company primarily based on its geographic segments. Each region’s product sales are unique to each region and have unique risks.
NOTE 5 - Restructuring and Impairment Charges
In the year ended December 31, 2019, the Company recorded $57 million of pre-tax restructuring charges. Pre-tax restructuring charges of $28 million were recorded for the year ended December 31, 2019 for the Cost Smart SG&A program. These costs include $15 million, of other costs, including professional services, and $13 million of employee-related severance for the year ended December 31, 2019. These charges were recorded primarily in the Company’s North America and South America operations, and include $2 million of other costs associated with the Finance Transformation initiative in Latin America for the year ended December 31, 2019. The Company expects to continue to incur additional charges in 2020 related to the Cost Smart SG&A program.
Additionally, for the year ended December 31, 2019, the Company recorded $29 million for its Cost Smart Cost of sales program. During the year ended December 31, 2019, the Company recorded $15 million of restructuring charges in relation to the closure of the Lane Cove, Australia production facility, consisting of $10 million of accelerated depreciation, $4 million of employee-related severance, and $1 million of other costs. The Company expects to incur additional expense of $10 million to $12 million in 2020 in relation to the closure, excluding potential proceeds from the sale of land and equipment. Additionally, during the year ended December 31, 2019, the Company recorded $3 million of employee-related expenses primarily related to South America operations restructuring. The Company also recorded $11 million of other costs, including professional services, during the year ended December 31, 2019, primarily in North America including other costs of $2 million in relation to the prior year cessation of wet-milling at the Stockton, California
plant. The Company does not expect to incur any additional costs in relation to the cessation of wet-milling at the Stockton, California plant.
In the year ended December 31, 2018, the Company recorded $64 million of pre-tax restructuring charges. During the second quarter of 2018, the Company introduced its Cost Smart program, designed to improve profitability, further streamline its global business and deliver increased value to shareholders through anticipated savings in cost of sales, including freight, and SG&A. For the year ended December 31, 2018, the Company recorded $49 million of restructuring expenses as part of the Cost Smart Cost of sales program in relation to the cessation of wet-milling at the Stockton, California plant, consisting of $34 million of accelerated depreciation, $8 million of mechanical stores, $3 million of employee-related severance and $4 million of other costs.
As part of its Cost Smart SG&A program, during the third quarter of 2018, the Company announced a Finance Transformation initiative in Latin America to strengthen organizational capabilities and drive efficiencies to support the growth strategy of the Company. The Company recorded $4 million of employee-related severance and other costs for the year ended December 31, 2018, in relation to this initiative. In addition, restructuring expenses of $7 million ($6 million employee-related severance and $1 million of consulting costs) were recorded as part of the Cost Smart SG&A program for the year ended December 31, 2018 in the South America, Asia-Pacific, and North America segments.
Additionally, for the year ended December 31, 2018, the Company recorded $3 million of other restructuring costs associated with the North America Finance Transformation initiative as well as $1 million of other restructuring costs related to the leaf extraction process in Brazil.
A summary of the Company’s severance accrual at December 31, 2019, is as follows (in millions):
Of the $15 million severance accrual at December 31, 2019, $14 million is expected to be paid within the next 12 months.
The Company assesses goodwill and other indefinite-lived intangible assets for impairment annually, or more frequently if impairment indicators arise. No goodwill or indefinite-lived intangible asset impairment was recognized in the years ended December 31, 2019, 2018, or 2017 related to the Company’s annual impairment testing.
NOTE 6 - Financial Instruments, Derivatives and Hedging Activities
The Company is exposed to market risk stemming from changes in commodity prices (primarily corn and natural gas), foreign currency exchange rates and interest rates. In the normal course of business, the Company actively manages its exposure to these market risks by entering into various hedging transactions, authorized under established policies that place controls on these activities. These transactions utilize exchange-traded derivatives or over-the-counter derivatives with investment grade counterparties. Derivative financial instruments currently used by the Company consist of commodity-related futures, options, and swap contracts, foreign currency-related forward contracts, and interest rate swaps.
Commodity price hedging: The Company’s principal use of derivative financial instruments is to manage commodity price risk relating to anticipated purchases of corn and natural gas to be used in the manufacturing process, generally over the next 12 to 24 months. The Company maintains a commodity-price risk management strategy that uses derivative instruments to minimize significant, unanticipated earnings fluctuations caused by commodity-price volatility. To manage price risk related to corn purchases primarily in North America, the Company uses corn futures and option contracts that trade on regulated commodity exchanges to lock-in corn costs associated with fixed-priced customer sales contracts. The Company also uses over-the-counter natural gas swaps in North America to hedge a portion of its natural gas usage. These derivative financial instruments limit the impact that volatility resulting from fluctuations in market prices will have on corn and natural gas purchases. The Company’s natural gas derivatives and the majority of its corn derivatives have been designated as cash flow hedging instruments.
The Company enters into certain corn derivative instruments that are not designated as hedging instruments as defined by ASC 815, Derivatives and Hedging. Therefore, the realized and unrealized gains and losses from these instruments are recognized in cost of sales during each accounting period. These derivative instruments also mitigate commodity price risk related to anticipated purchases of corn.
For commodity hedges designated as cash flow hedges, unrealized gains and losses associated with marking the commodity hedging contracts to market (fair value) are recorded as a component of other comprehensive income (“OCI”) and included in the equity section of the Consolidated Balance Sheets as part of AOCI. These amounts are subsequently reclassified into earnings in the same line item affected by the hedged transaction and in the same period or periods during which the hedged transaction affects earnings, or in the month a hedge is determined to be ineffective. The Company assesses the effectiveness of a commodity hedge contract based on changes in the contract’s fair value. The changes in the market value of such contracts have historically been, and are expected to continue to be, highly effective at offsetting changes in the price of the hedged items. Gains and losses from cash flow hedging instruments reclassified from AOCI to earnings are reported as Cash provided by operating activities on the Consolidated Statements of Cash Flows.
As of December 31, 2019, the Company had outstanding futures and option contracts that hedged the forecasted purchase of approximately 98 million bushels of corn. The Company had outstanding swap and option contracts that hedged the forecasted purchase of approximately 30 million mmbtu’s of natural gas at December 31, 2019.
Foreign currency hedging: Due to the its global operations, including operations in many emerging markets, the Company is exposed to fluctuations in foreign currency exchange rates. As a result, the Company has exposure to translational foreign-exchange risk when the results of its foreign operations are translated to U.S. dollars and to transactional foreign-exchange risk when transactions not denominated in the functional currency are revalued. The Company’s foreign-exchange risk management strategy uses derivative financial instruments such as foreign currency forward contracts, swaps and options to manage its transactional foreign exchange risk. The Company enters into foreign currency derivative instruments that are designated as both cash flow hedging instruments as well as instruments not designated as hedging instruments as defined by ASC 815, Derivatives and Hedging, in order to mitigate transactional foreign-exchange risk. Gains and losses from derivative financial instruments not designated as hedging instruments are marked to market in earnings during each accounting period.
The notional value of the Company’s foreign currency derivatives not designated as hedging instruments included forward sales contracts of $621 million as of both December 31, 2019 and 2018. The notional value of the Company’s foreign currency derivatives not designated as hedging instruments also included purchase contracts with notional value of $356 million and $165 million as of December 31, 2019 and 2018, respectively.
The notional value of the Company’s foreign currency cash flow hedging instruments included forward sales contracts of $374 million and $345 million as well as forward purchase contracts of $541 million and $275 million as of December 31, 2019, and 2018, respectively.
Interest rate hedging: The Company assesses its exposure to variability in interest rates by identifying and monitoring changes in interest rates that may adversely impact future cash flows and the fair value of existing debt instruments, and by evaluating hedging opportunities. The Company’s risk management strategy is to monitor interest rate risk attributable to both the Company’s outstanding and forecasted debt obligations as well as the Company’s offsetting hedge positions. Derivative financial instruments that have been used by the Company to manage its interest rate risk consist of interest rate swaps and T-Locks.
The Company has an interest rate swap agreement that converts the interest rates on $200 million of its $400 million of 4.625% senior notes due November 1, 2020, to variable rates. This swap agreement calls for the Company to receive interest at the fixed coupon rate of the respective notes and to pay interest at a variable rate based on the six-month U.S. dollar London Interbank Offered Rate (“LIBOR”) plus a spread. The Company has designated this interest rate swap agreement as a hedge of the changes in fair value of the underlying debt obligations attributable to changes in interest rates and accounts for it as a fair value hedging instrument. The change in fair value of an interest rate swap designated as a hedging instrument that effectively offsets the variability in the fair value of outstanding debt obligations is reported in earnings. This amount offsets the gain or loss (the change in fair value) of the hedged debt instrument that is attributable to changes in interest rates (the hedged risk), which is also recognized in earnings.
The Company periodically enters into T-Locks to hedge its exposure to interest rate changes. The T-Locks are designated as hedges of the variability in cash flows associated with future interest payments caused by market fluctuations in the benchmark interest rate until the fixed interest rate is established, and are accounted for as cash flow hedges. Accordingly, changes in the fair value of the T-Locks are recorded to AOCI until the consummation of the underlying debt offering, at which time any realized gain (loss) is amortized to earnings over the life of the debt. The Company did not have any T-Locks outstanding as of December 31, 2019, or 2018.
The derivative instruments designated as cash flow hedges included in AOCI as of December 31, 2019 and 2018 are reflected below:
The fair value and balance sheet location of the Company’s derivative instruments, presented gross in the Consolidated Balance Sheets, are reflected below:
Additional information pertaining to the Company’s fair value hedges is presented below:
Additional information relating to the Company’s derivative instruments is presented below:
As of December 31, 2019, AOCI included $7 million of net losses (net of income taxes of $2 million) on T-Locks, foreign currency hedges, and commodities-related derivative instruments designated as cash flow hedges that are expected to be reclassified into earnings during the next 12 months. Cash flow hedges discontinued during the years ended December 31, 2019 or 2018 were not significant.
Fair Value Measurements: Presented below are the fair values of the Company’s financial instruments and derivatives for the periods presented:
(a)Level 1 inputs consist of quoted prices (unadjusted) in active markets for identical assets or liabilities.
(b)Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly for substantially the full term of the financial instrument. Level 2 inputs are based on 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, or inputs other than quoted prices that are observable for the asset or liability or can be derived principally from or corroborated by observable market data.
(c)Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.
The carrying values of cash equivalents, short-term investments, accounts receivable, accounts payable, and short-term borrowings approximate fair values. Commodity futures, options, and swap contracts are recognized at fair value. Foreign currency forward contracts, swaps, and options are also recognized at fair value. The fair value of the Company’s Long-term debt is estimated based on quotations of major securities dealers who are market makers in the securities.
NOTE 7 - Financing Arrangements
The Company had total debt outstanding of $1.8 billion and $2.1 billion at December 31, 2019 and 2018, respectively. Short-term borrowings at December 31, 2019 and 2018 consist primarily of amounts outstanding under various unsecured local country operating lines of credit.
On April 12, 2019, the Company amended and restated the Term Loan Credit Agreement that was set to mature on April 25, 2019 (“Term Loan”) of $165 million to establish a 24-month senior unsecured term loan credit facility in an amount up to $500 million that matures on April 12, 2021. The Company used the $500 million of borrowings under the new facility to pay down amounts outstanding under its revolving credit facility and to pay off the Term Loan balance.
All borrowings under the amended term loan credit agreement for the new facility (“Amended Term Loan Credit Agreement”) bear interest at a variable annual rate based on LIBOR or a base rate, at the Company’s election, subject to the terms and conditions thereof, plus, in each case, an applicable margin. The Company is required to pay a fee on the unused availability under the Amended Term Loan Credit Agreement. The Amended Term Loan Credit Agreement contains customary representations, warranties, covenants and events of default, including covenants restricting the incurrence of liens, the incurrence of indebtedness by the Company’s subsidiaries and certain fundamental changes involving the Company and its subsidiaries, subject to certain exceptions in each case. The Company must also maintain a specified consolidated leverage ratio and consolidated interest coverage ratio. As of December 31, 2019, the Company was in compliance with these financial covenants. The occurrence of an event of default under the Amended Term Loan Credit Agreement could result in all loans and other obligations being declared due and payable and the term loan credit facility being terminated.
On October 11, 2016, the Company entered into a new five-year, senior, unsecured $1 billion revolving credit agreement (the “Revolving Credit Agreement”) that replaced its previously existing $1 billion senior unsecured revolving credit facility.
Subject to certain terms and conditions, the Company may increase the amount of the revolving credit facility under the Revolving Credit Agreement by up to $500 million in the aggregate. The Company may also obtain up to two one-year extensions of the maturity date of the Revolving Credit Agreement at its requests and subject to the agreement of the lenders. All committed pro rata borrowings under the revolving credit facility bear interest at a variable annual rate based on the LIBOR or base rate, at the Company’s election, subject to the terms and conditions thereof, plus, in each case, an applicable margin based on the Company’s leverage ratio (as reported in the financial statements delivered pursuant to the Revolving Credit Agreement) or the Company’s credit rating. Subject to specified conditions, the Company may designate one or more of its subsidiaries as additional borrowers under the Revolving Credit Agreement provided that the Company guarantees all borrowings and other obligations of any such subsidiaries thereunder.
The Revolving Credit Agreement contains customary representations, warranties, covenants, events of default, terms and conditions, including covenants restricting on liens, subsidiary debt and mergers, subject to certain exceptions in each case. The Company must also comply with a leverage ratio covenant and an interest coverage ratio covenant. As of December 31, 2019, the Company was in compliance with these financial covenants. The occurrence of an event of default under the Revolving Credit Agreement could result in all loans and other obligations under the agreement being declared due and payable and the revolving credit facility being terminated.
As of December 31, 2019, there were $10 million in borrowings outstanding under the Revolving Credit Agreement. In addition to borrowing availability under its Revolving Credit Agreement, the Company has approximately $585 million of unused operating lines of credit in the various foreign countries in which it operates.
Presented below are the Company’s debt carrying amounts, net of related discounts, premiums, and debt issuance costs, and fair values as of December 31, 2019 and 2018:
The Company’s long-term debt matures as follows: $600 million in 2020, $500 million in 2026, and $250 million in 2037. The Company’s Term Loan of $405 million matures in 2021. The Company’s long-term debt as of December 31, 2019 includes the 5.62% senior notes due March 25, 2020 and 4.625% senior notes due November 1, 2020. The Company has the ability and intent to refinance such senior notes on a long-term basis using the revolving credit facility or other sources prior to the maturity date.
The Company guarantees certain obligations of its consolidated subsidiaries. The amount of the obligations guaranteed aggregated $57 million at December 31, 2019 and 2018.
NOTE 8 - Leases
The Company determines if an arrangement is a lease at inception of the agreement. Operating leases are included in operating lease assets, and current and non-current operating lease liabilities in the Company’s Consolidated Balance Sheets. Lease assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Lease assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of the Company’s leases do not provide an implicit rate, the Company uses an incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The operating lease asset value includes in its calculation any prepaid lease payments made and any lease incentives received from the arrangement as a reduction of the asset. The Company’s lease terms may include options to extend or terminate the lease, and the impact of these options are included in the lease liability and lease asset calculations when the exercise of the option is at the Company’s sole discretion and it is reasonably certain that the Company will exercise that option. The Company will not separate lease and non-lease components for its leases when it is impracticable to separate the two, such as leases with variable payment arrangements. Leases with an initial term of 12 months or less are not recorded on the balance sheet.
The Company has operating leases for certain rail cars, office space, warehouses, and machinery and equipment. The commencement date used for the calculation of the lease obligations recorded is the latter of the commencement date of the new standard (January 1, 2019) or the lease start date. Certain of the leases have options to extend the life of the lease, which are included in the liability calculation when the option is at the sole discretion of the Company and it is reasonably certain that the Company will exercise the option. The Company has certain leases that have variable payments
based solely on output or usage of the leased asset. These variable operating lease assets are excluded from the Company’s balance sheet presentation and expensed as incurred. The Company currently has no finance leases.
Lease expense for lease payments is recognized on a straight-line basis over the lease term. The components of lease expense were as follows:
The following is a reconciliation of future undiscounted cash flows to the operating lease liabilities and the related operating lease assets as presented on the Company’s Consolidated Balance Sheet as of December 31, 2019.
Additional information related to the Company’s operating leases is listed below. The standard resulted in the initial recognition of $170 million of total operating lease liabilities. The right-of-use assets obtained in exchange for lease liabilities for the year ended December 31, 2019 includes the initial recognition of $161 million of operating lease assets as part of the adoption of the new lease standard.
As the Company has not restated prior-year information for its adoption of ASC Topic 842, the following presents its future minimum lease payments for operating leases under ASC Topic 840 on December 31, 2018:
NOTE 9 - Income Taxes
The components of income before income taxes and the provision for income taxes are shown below:
Deferred income taxes are provided for the tax effects of temporary differences between the financial reporting basis and tax basis of assets and liabilities. Significant temporary differences as of December 31, 2019 and 2018 are summarized as follows:
Of the $24 million of tax-effected net operating loss carryforwards as of December 31, 2019, approximately $9 million are for state loss carryforwards and approximately $15 million are for foreign loss carryforwards. Of the $26 million of tax-effected net operating loss carryforwards as of December 31, 2018, approximately $11 million are for state loss carryforwards and approximately $15 million are for foreign loss carryforward. Income tax accounting requires that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. In making this assessment, management considers the level of historical taxable income, scheduled reversal of deferred tax liabilities, tax planning strategies, tax carryovers and projected future taxable income. As of December 31, 2019, the Company maintained valuation allowances of $9 million for state loss carryforwards, $4 million for state credits, $1 million for state section 163(j) limitations, $1 million for foreign tax credits and $13 million for foreign loss carryforwards all of which management has determined will more likely than not expire prior to realization. As of December 31, 2018, the Company maintains valuation allowances of $11 million for state loss carryforwards, $3 million for state credits and $14 million for foreign loss carryforwards all of which management has determined will more likely than not expire prior to realization. In addition, the Company maintains valuation allowances on foreign subsidiaries’ net deferred tax assets of $1 million and $3 million, for the years ended December 31, 2019 and 2018, respectively.
A reconciliation of the U.S. federal statutory tax rate to the Company’s effective tax rate follows:
The Company has significant operations in Mexico, Pakistan and Colombia where the 2019 statutory tax rates are 30 percent, 29 percent and 33 percent, respectively. In addition, the Company's subsidiary in Brazil has a statutory tax rate of 34 percent before local incentives that vary each year.
The Tax Cuts and Jobs Act (“TCJA”) was enacted on December 22, 2017. The TCJA introduced numerous changes in the U.S. federal tax laws. Changes that have a significant impact on the Company’s effective tax rate are a reduction in the U.S. corporate tax rate from 35 percent to 21 percent, the imposition of a U.S. tax on global intangible low-taxed income (“GILTI”) and the foreign-derived intangible income (“FDII”) deduction. The TCJA also provided for a one-time transition tax on the deemed repatriation of cumulative foreign earnings as of December 31, 2017 and eliminated the tax on dividends from foreign subsidiaries by allowing a 100-percent dividends received deduction.
On December 22, 2017, Staff Accounting Bulletin No. 118 (“SAB 118”) was issued to provide guidance on the application of GAAP to situations in which the registrant does not have all the necessary information available, prepared or analyzed (including computations) in sufficient detail to complete the accounting for the income tax effects of the TCJA.
In the fourth quarter of 2017, the Company calculated a provisional impact of the TCJA in accordance with SAB 118 and its understanding of the TCJA, including published guidance as of December 31, 2017. During the third and fourth quarter of 2018, the Company recorded $2 million and $1 million, respectively, of net incremental tax expense, as the Company finalized its TCJA expense based on additional guidance from federal and state regulatory agencies. The following table summarizes the provisional and final impact of the TCJA:
Pro-forma results related to TCJA have not been presented, as the effect would not be material to the Company’s results for the periods presented.
Under a provision in the TCJA, all of the undistributed earnings of the Company’s foreign subsidiaries were deemed to be repatriated at December 31, 2017 and were subjected to a transition tax. As a result, a provisional transition tax liability of $21 million, or 2.7 percentage points on the effective tax rate, was recorded in income from continuing operations in the fourth quarter of 2017. During the third quarter of 2018, the Company finalized the transition tax analysis and recorded an incremental $4 million liability, or 0.6 percentage points on the effective tax rate.
As a result of the reduction in the U.S. corporate tax rate, the Company recorded a tax benefit of $38 million, or 4.9 percentage points on the effective tax rate, due to the remeasurement of its U.S. net deferred tax liabilities, in the fourth quarter of 2017.
Due to a change in the U.S. tax treatment of dividends received from foreign subsidiaries, in the fourth quarter of 2017, the Company recorded a provisional tax liability of $33 million, or 4.3 percentage points on the effective tax rate, for foreign dividend withholding and state income taxes payable upon the distribution of unremitted earnings from certain foreign subsidiaries from which it expected to receive cash distributions in 2018 and beyond. During the second half of 2018, the Company finalized the provision for taxes on unremitted earnings and recorded an additional $2 million liability, or 0.3 percentage points on the effective rate.
The net impact of the TCJA on the Company’s 2017 tax expense included a provisional tax liability of $7 million, or 0.9 percentage points on the effective tax rate (included in other items, net), for the difference in its 2017 tax expense as calculated with and without the changes triggered by the TCJA. During the second half of 2018, the Company finalized other items, net and recorded a net $3 million benefit, or 0.4 percentage points on the effective tax rate.
In the fourth quarter of 2018, the Company made an accounting election to treat taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the “period cost method”)
The Company had been pursuing relief from double taxation under the U.S.-Canada tax treaty for the years 2004 through 2013. During the fourth quarter of 2016, a tentative settlement was reached between the U.S. and Canada and, consequently, the Company established a net reserve of $24 million, including interest thereon, recorded as a $70 million cost and a $46 million benefit, or 3.2 percentage points on the effective tax rate. In addition, as a result of the settlement, for the years 2014 through 2016, the Company had established a net reserve of $7 million, or 1.0 percentage points on the effective tax rate in 2016. In the third quarter of 2017, the two countries finalized the agreement, which eliminated the double taxation, and the Company paid $63 million to the U.S. Internal Revenue Service to settle the liability. As a result of that agreement, the Company was entitled to a net tax benefit of $10 million primarily due to a foreign exchange loss deduction on its 2017 U.S. federal income tax return, or 1.3 percentage points on the effective tax rate. As a result of the final settlement, the Company received refunds totaling $42 million from Canadian revenue agencies and recorded $2 million, or 0.3 percentage points on the effective tax rate, of interest and penalties through tax expense in 2018.
During 2019, the Company increased the valuation allowance on the net deferred tax assets in Argentina. As a result, the Company recorded a valuation allowance in the amount of $2 million, or 0.3 percentage points on the effective tax rate, compared to $6 million, or 1.0 percentage points on the effective tax rate, and $16 million, or 2.0 percentage points on the effective tax rate in 2018 and 2017, respectively.
As of December 31, 2017, for U.S. tax purposes all of the undistributed earnings and profits of the Company’s foreign subsidiaries were deemed to be repatriated and subjected to a transition tax. In addition, during 2017 and 2018 the Company recorded a liability of $33 million and $2 million, respectively, for foreign withholding and state income taxes on certain unremitted earnings from foreign subsidiaries. However, the Company has not provided for foreign withholding taxes, state income taxes and federal and state taxes on foreign currency gains/losses on distributions of approximately $3.0 billion of unremitted earnings of the Company’s foreign subsidiaries as such amounts are considered permanently reinvested. It is not practicable to estimate the additional income taxes, including applicable foreign withholding taxes that would be due upon the repatriation of these earnings.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits, excluding interest and penalties, for 2019 and 2018 is as follows:
Of the $22 million of unrecognized tax benefits as of December 31, 2019, $5 million represents the amount that, if recognized, could affect the effective tax rate in future periods. The remaining $17 million includes an offset of $15 million for an income tax receivable and $1 million of federal benefit created as part of the U.S.-Canada tax settlement described previously. The remaining benefit is a $1 million foreign tax credit.
The Company accounts for interest and penalties related to income tax matters within the provision for income taxes. The Company has accrued $2 million of interest expense related to the unrecognized tax benefits as of December 31, 2019. The accrued interest expense was $2 million as of December 31, 2018.
The Company is subject to U.S. federal income tax as well as income tax in multiple states and non-U.S. jurisdictions. The U.S. federal tax returns are subject to audit for the years 2016 through 2019. In general, the Company’s foreign subsidiaries remain subject to audit for years 2013 and later.
It is also reasonably possible that the total amount of unrecognized tax benefits including interest and penalties will increase or decrease within 12 months of December 31, 2019. The Company believes it is reasonably possible approximately $9 million of unrecognized tax benefits may be recognized within 12 months of December 31, 2019 as a result of a lapse of the statute of limitations, of which $2 million, could affect the effective tax rate. The Company has classified none of the unrecognized tax benefits as current because they are not expected to be resolved within the next 12 months.
NOTE 10 - Benefit Plans
The Company and its subsidiaries sponsor noncontributory defined benefit pension plans (qualified and non-qualified) covering a substantial portion of employees in the U.S. and Canada, and certain employees in other foreign countries. Plans for most salaried employees provide pay-related benefits based on years of service. Plans for hourly employees generally provide benefits based on flat dollar amounts and years of service. The Company’s general funding policy is to make contributions to the plans in amounts that comply with minimum funding requirements and are within the limits of deductibility under current tax regulations. Certain foreign countries allow income tax deductions without regard to contribution levels, and the Company’s policy in those countries is to make contributions required by the terms of the applicable plan.
Included in the Company’s pension obligation are nonqualified supplemental retirement plans for certain key employees. Benefits provided under these plans are unfunded and payments to plan participants are made directly by the Company.
The Company also provides healthcare and/or life insurance benefits for retired employees in the U.S., Canada, and Brazil. Healthcare benefits for retirees outside of the U.S., Canada, and Brazil are generally covered through local government plans.
Pension Obligation and Funded Status: The changes in pension benefit obligations and plan assets during the years ended December 31, 2019 and 2018, as well as the funded status and the amounts recognized in the Company’s Consolidated Balance Sheets related to the Company’s pension plans at December 31, 2019, and 2018, were as follows:
Amounts recognized in the Consolidated Balance Sheets as of December 31, 2019 and 2018, were as follows:
Amounts recognized in accumulated other comprehensive loss, excluding tax effects, that have not yet been recognized as components of net periodic benefit cost at December 31, 2019 and 2018, were as follows:
The decrease in the net amount recognized in accumulated comprehensive loss at December 31, 2019, for the U.S. plans as compared to December 31, 2018, is mainly due to the actual return on assets exceeding the expected return on assets. This is partially offset by the effect of the decrease in discount rates used to measure the Company’s obligations under its U.S. pension plans.
The increase in the net amount recognized in accumulated comprehensive loss at December 31, 2019, for the Non-U.S. plans, as compared to December 31, 2018, is mainly due to the decrease in discount rates used to measure the Company’s obligations under its Non-U.S. pension plans. This is partially offset by the actual return on assets exceeding the expected return on assets.
The accumulated benefit obligation for all defined benefit pension plans was $601 million and $543 million at December 31, 2019 and 2018, respectively.
Information about plan obligations and assets for plans with an accumulated benefit obligation in excess of plan assets is as follows:
All U.S. plans and most non-U.S. plans value the vested benefit obligation based on the actuarial present value of the vested benefits to which employees are currently entitled based on employees’ expected date of separation or retirement.
Components of net periodic benefit cost consist of the following for the years ended December 31, 2019, 2018, and 2017:
The service cost component of net periodic benefit cost is presented within either cost of sales or operating expenses on the Consolidated Statements of Income. The interest cost, expected return on plan assets, amortization of actuarial loss, amortization of prior service credit and settlement loss components of net periodic benefit cost are presented as other, non-operating income on the Consolidated Statements of Income.
For the U.S. plans, the Company estimates that net periodic benefit cost for the year ending December 31, 2020 will include approximately $1 million relating to the amortization of the prior service credit included in accumulated other comprehensive loss as of December 31, 2019.
For the non-U.S. plans, the Company estimates that net periodic benefit cost for the year ending December 31, 2020 will include approximately $2 million relating to the amortization of its accumulated actuarial loss.
Actuarial gains and losses in excess of 10 percent of the greater of the projected benefit obligation or the market-related value of plan assets are recognized as a component of net periodic benefit cost over the average remaining service period of a plan’s active employees for active defined benefit pension plans and over the average remaining life of a plan’s active employees for frozen defined benefit pension plans.
Total amounts recorded in other comprehensive income and net periodic benefit cost was as follows:
The following weighted average assumptions were used to determine the Company’s obligations under the pension plans:
The following weighted average assumptions were used to determine the Company’s net periodic benefit cost for the pension plans:
For the year ended December 31, 2019, the Company assumed an expected long-term rate of return on assets of 5.30 percent for U.S. plans and approximately 3.86 percent for Canadian plans. In developing the expected long-term rate of return assumption on plan assets, which consist mainly of U.S. and Canadian debt and equity securities, management evaluated historical rates of return achieved on plan assets and the asset allocation of the plans, input from the Company’s independent actuaries and investment consultants, and historical trends in long-term inflation rates. Projected return estimates made by such consultants are based upon broad equity and bond indices.
The discount rate reflects a rate of return on high-quality fixed income investments that match the duration of the expected benefit payments. The Company has typically used returns on long-term, high-quality corporate AA bonds as a benchmark in establishing this assumption. The Company elects to use a full yield curve approach in the estimation of these components of benefit cost by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows.
Plan Assets: The Company’s investment policy for its pension plans is to balance risk and return through diversified portfolios of fixed income securities, equity instruments, and short-term investments. Maturities for fixed income securities are managed such that sufficient liquidity exists to meet near-term benefit payment obligations. For U.S. pension plans, the weighted average target range allocation of assets was 15-25 percent in equities and 75-85 percent in fixed income inclusive of other short-term investments. The asset allocation is reviewed regularly, and portfolio investments are rebalanced to the targeted allocation when considered appropriate.
The Company’s weighted average asset allocation as of December 31, 2019, and 2018, for U.S. and non-U.S. pension plan assets is as follows:
The fair values of the Company’s plan assets by asset category and level in the fair value hierarchy are as follows:
(a)This category consists of both passively and actively managed equity index funds that track the return of large capitalization U.S. equities.
(b)This category consists of both passively and actively managed equity index funds that track an index of returns on international developed market equities.
(c)This category consists of an actively managed fixed income index fund that invests in a diversified portfolio of fixed-income corporate securities with maturities generally exceeding 10 years.
(d)This category consists of an actively managed fixed income index fund that invests in a diversified portfolio of fixed-income U.S. treasury securities with maturities generally exceeding 10 years.
(e)This category represents cash or cash equivalents.
(f)This category consists of an actively managed equity index fund that tracks against an index of large capitalization Canadian equities.
(g)This category consists of an actively managed equity index fund that tracks against real estate investment trusts and real estate operating companies.
(h)This category consists of both passively and actively managed fixed income index funds that track the return of intermediate duration government and investment grade corporate bonds.
(i)This category consists of both passively and actively managed fixed income index funds that track the return of government bonds and investment grade corporate bonds.
(j)This category mainly consists of investment products provided by insurance companies that offer returns that are subject to a minimum guarantee and mutual funds.
(k)This category consists of both passively and actively managed fixed income index funds that track the return of government bonds, investment grade corporate bonds and hedge funds.
(l)This category consists of both passively and actively managed equity index funds that track an index of returns on international developed market equities as well as infrastructure assets.
All significant pension plan assets are held in collective trusts by the Company’s U.S. and non-U.S. plans. The fair values of shares of collective trusts are based upon the net asset values of the funds reported by the fund managers based on quoted market prices of the underlying securities as of the balance sheet date and are considered to be Level 2 fair value measurements. This may produce a fair value measurement that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company believes its valuation methods are appropriate and consistent with those of other market participants, the use of different methodologies could result in different fair value measurements at the reporting date.
In the year ended December 31, 2019, the Company made cash contributions of $1 million and $7 million to its U.S. and non-U.S. pension plans, respectively. The Company anticipates that in the year ending December 31, 2020 it will make cash contributions of $1 million and $3 million to its U.S. and non-U.S. pension plans, respectively. Cash contributions in subsequent years will depend on a number of factors including the performance of plan assets.
The following benefit payments, which reflect anticipated future service, as appropriate, are expected to be made:
The Company and certain subsidiaries also maintain defined contribution plans. The Company makes matching contributions to these plans that are subject to certain vesting requirements and are based on a percentage of employee contributions. Amounts charged to expense for defined contribution plans totaled $20 million, $21 million, and $22 million in the years ended December 31, 2019, 2018, and 2017, respectively.
Postretirement Benefit Plans: The Company’s postretirement benefit plans currently are not funded. The information presented below includes plans in the U.S., Brazil, and Canada. The changes in the benefit obligations of the plans during the years ended December 31, 2019 and 2018, and the amounts recognized in the Company’s Consolidated Balance Sheets at December 31, 2019, and 2018, are as follows:
Amounts recognized in the Consolidated Balance Sheets consist of:
Amounts recognized in accumulated other comprehensive loss (income), excluding tax effects, that have not yet been recognized as components of net periodic benefit cost at December 31, 2019 and 2018, were as follows:
Components of net periodic benefit cost consisted of the following for the years ended December 31, 2019, 2018, and 2017:
The service cost component of net periodic benefit cost is presented within either cost of sales or operating expenses on the Consolidated Statements of Income. The interest cost and amortization of prior service credit components of net periodic benefit cost are presented as other, non-operating income on the Consolidated Statements of Income.
The Company estimates that postretirement benefit expense for these plans for the year ending December 31, 2020 will include approximately $2 million relating to the amortization of the prior service credit as well as approximately $1 million relating to the amortization of its accumulated actuarial loss included in accumulated other comprehensive income as of December 31, 2019.
Total amounts recorded in other comprehensive income and net periodic benefit cost was as follows:
The following weighted average assumptions were used to determine the Company’s obligations under the postretirement plans:
The following weighted average assumptions were used to determine the Company’s net postretirement benefit cost:
The discount rate reflects a rate of return on high-quality fixed-income investments that match the duration of expected benefit payments. The Company has typically used returns on long-term, high-quality corporate AA bonds as a benchmark in establishing this assumption.
The healthcare cost trend rates used in valuing the Company’s postretirement benefit obligations are established based upon actual healthcare trends and consultation with actuaries and benefit providers. The following assumptions were used as of December 31, 2019:
The sensitivities of service cost and interest cost and year-end benefit obligations to changes in healthcare cost trend rates for the postretirement benefit plans as of December 31, 2019, are as follows:
The following benefit payments, which reflect anticipated future service, as appropriate, are expected to be made under the Company’s postretirement benefit plans:
Multi-employer Plans: The Company participates in and contributes to one multi-employer benefit plan under the terms of collective bargaining agreements that cover certain union-represented employees and retirees in the U.S. The plan covers medical and dental benefits for active hourly employees and retirees represented by the U.S. Steel Workers Union for certain U.S. locations.
The risks of participating in this multi-employer plan are different from single-employer plans. This plan receives contributions from two or more unrelated employers pursuant to one or more collective bargaining agreements and the assets contributed by one employer may be used to fund the benefits of all employees covered within the plan.
The Company is required to make contributions to this plan as determined by the terms and conditions of the collective bargaining agreements and plan terms. For the years ended December 31, 2019, 2018, and 2017, the Company made regular contributions of $13 million, $12 million, and $13 million, respectively, to this multi-employer plan. The Company cannot currently estimate the amount of multi-employer plan contributions that will be required in the year ending December 31, 2020 and future years, but these contributions could increase due to healthcare cost trends. The collective bargaining agreements associated with this plan expire during 2020 through 2024.
NOTE 11 - Equity
Preferred stock: The Company has authorized 25 million shares of $0.01 par value preferred stock, none of which were issued or outstanding at December 31, 2019 and 2018.
Treasury stock: On October 22, 2018, the Board of Directors authorized a new stock repurchase program permitting the Company to purchase up to 8 million of its outstanding shares of common stock from November 5, 2018 through December 31, 2023. The parameters of the Company’s stock repurchase program are not established solely with reference to the dilutive impact of shares issued under the Company’s stock incentive plan. However, the Company expects that, over time, share repurchases will offset the dilutive impact of shares issued under the stock incentive plan.
On November 5, 2018, the Company entered into a Variable Timing Accelerated Share Repurchase (“ASR”) program with JPMorgan (“JPM”). Under the ASR program, the Company paid $455 million on November 5, 2018 and acquired 4 million shares of its common stock having an approximate value of $423 million on that date. On February 5, 2019, the Company and JPM settled the difference between the initial price and average daily volume-weighted average price (“VWAP”) less the agreed upon discount during the term of the agreement. The final VWAP was $98.04 per share, which was less than originally paid. The Company settled the difference in cash, resulting in JPM returning $63 million of the upfront payment to the Company on February 6, 2019, and lowering the total cost of repurchasing the 4 million
shares of common stock to $392 million. The Company adjusted Additional paid-in capital and Treasury stock by $32 million and $31 million, respectively, during the first quarter of 2019 for this inflow of cash.
In the year ended December 31, 2019, the Company did not repurchase shares of common stock. In the year ended December 31, 2018, the Company repurchased 5.8 million shares of common stock in open market transactions at a net cost of $594 million.
Set forth below is a reconciliation of common stock share activity for the years ended December 31, 2019, 2018, and 2017:
Share-based payments: The following table summarizes the components of the Company’s share-based compensation expense for the last three years:
The Company has a stock incentive plan (“SIP”) administered by the compensation committee of its Board of Directors that provides for the granting of stock options, restricted stock, restricted stock units, and other share-based awards to certain key employees. A maximum of 8 million shares were originally authorized for awards under the SIP. As
of December 31, 2019, 2.8 million shares were available for future grants under the SIP. Shares covered by awards that expire, terminate or lapse will again be available for the grant of awards under the SIP.
Stock Options: Under the Company’s SIP, stock options are granted at exercise prices that equal the market value of the underlying common stock on the date of grant. The options have a 10-year term and are exercisable upon vesting, which occurs over a three-year period at the anniversary dates of the date of grant. Compensation expense is generally recognized on a straight-line basis for all awards over the employee’s vesting period or over a one-year required service period for certain retirement eligible executive level employees. The Company estimates a forfeiture rate at the time of grant and updates the estimate throughout the vesting of the stock options within the amount of compensation costs recognized in each period.
The Company granted non-qualified options to purchase 247 thousand shares and 215 thousand shares for the years ended December 31, 2019, and 2018, respectively. The fair value of each option grant was estimated using the Black-Scholes option-pricing model with the following assumptions:
The expected life of options represents the weighted average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and the Company’s historical exercise patterns. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the grant date for the period corresponding to the expected life of the options. Expected volatility is based on historical volatilities of the Company’s common stock. Dividend yields are based on current dividend payments.
A summary of stock option transactions for the year follows:
For the years ended December 31, 2019, 2018 and 2017, cash received from the exercise of stock options was $6 million, $10 million, and $20 million, respectively. As of December 31, 2019, the unrecognized compensation cost related to non-vested stock options totaled $2 million, which is expected to be amortized over the weighted-average period of approximately 1.5 years.
Additional information pertaining to stock option activity is as follows:
Restricted Stock Units: The Company has granted restricted stock units (“RSUs”) to certain key employees. The RSUs are subject to cliff vesting, generally after three years provided the employee remains in the service of the Company. Compensation expense is generally recognized on a straight-line basis for all awards over the employee’s vesting period or over a one-year required service period for certain retirement eligible executive level employees. The Company estimates a forfeiture rate at the time of grant and updates the estimate throughout the vesting of the RSUs within the
amount of compensation costs recognized in each period. The fair value of the RSUs is determined based upon the number of shares granted and the quoted market price of the Company’s common stock at the date of the grant.
The following table summarizes RSU activity for the year:
The total fair value of RSUs that vested in the years ended December 31, 2019, 2018, and 2017 was $16 million, $15 million, and $18 million, respectively.
At December 31, 2019, the total remaining unrecognized compensation cost related to RSUs was $14 million which will be amortized on a weighted-average basis over approximately 1.8 years. Recognized compensation cost related to unvested RSUs is included in Share-based payments subject to redemption in the Consolidated Balance Sheets and totaled $23 million and $26 million at December 31, 2019 and 2018, respectively.
Performance Shares: The Company has a long-term incentive plan for senior management in the form of performance shares. Historically these performance shares vested based solely on the Company’s total shareholder return as compared to the total shareholder return of its peer group over the three-year vesting period. Beginning with the performance share grants in the year ended December 31, 2019, the vesting of the performance shares will be based on two performance metrics. Fifty percent of the performance shares awarded will vest based on the Company’s total shareholder return as compared to the total shareholder return of its peer group, and the remaining fifty percent will vest based on the calculation of the Company’s three-year average Return on Invested Capital (“ROIC”) against an established ROIC target.
For the performance shares awarded in the first quarter of 2019, based on the Company’s total shareholder return, the number of shares that ultimately vest can range from zero to 200 percent of the awarded grant depending on the Company’s total shareholder return as compared to the total shareholder return of its peer group. The share award vesting will be calculated at the end of the three-year period and is subject to approval by management and the Compensation Committee of the Board of Directors. Compensation expense is based on the fair value of the performance shares at the grant date, established using a Monte Carlo simulation model. The total compensation expense for these awards is amortized over a three-year graded vesting schedule.
For the performance shares awarded in the first quarter of 2019, based on ROIC, the number of shares that ultimately vest can range from zero to 200 percent of the awarded grant depending on the Company’s ROIC performance against the target. The share award vesting will be calculated at the end of the three-year period and is subject to approval by management and the Compensation Committee. Compensation expense is based on the market price of the Company’s common stock on the date of the grant and the final number of shares that ultimately vest. The Company will estimate the potential share vesting at least annually to adjust the compensation expense for these awards over the vesting period to reflect the Company’s estimated ROIC performance versus the target. The total compensation expense for these awards is amortized over a three-year graded vesting schedule.
The Company awarded 70 thousand, 27 thousand, and 38 thousand performance shares in the years ended December 31, 2019, 2018 and 2017, respectively. The weighted average fair value of the shares granted during the years ended December 31, 2019, 2018 and 2017 was $92.57, $141.91, and $114.08, respectively.
The performance share award granted in the year ended December 31, 2016 vested in the first quarter of 2019, achieving a zero percent payout of the granted performance shares. As of December 31, 2019, the performance awards granted in the year ended December 31, 2017 are estimated to pay out at zero percent, respectively. There were three thousand shares cancelled during the year ended December 31, 2019.
As of December 31, 2019, the unrecognized compensation cost relating to these plans was $4 million, which will be amortized over the remaining requisite service periods of 1.8 years. Recognized compensation cost related to these unvested awards is included in share-based payments subject to redemption in the Consolidated Balance Sheets and totaled $9 million and $10 million at December 31, 2019 and 2018, respectively.
Other share-based awards under the SIP: Under the compensation agreement with the Board of Directors, $120,000 of a non-employee director’s annual retainer and 50 percent of the additional retainers paid to the Lead Director and the Chairmen of committees of the Board of Directors are awarded in shares of common stock or, if a director elects to defer all or a portion of his or her common stock or cash compensation, in shares of restricted stock units. These restricted units cannot be transferred until a date not less than six months after the director’s termination of service from the Board of Directors at which time the restricted units will be settled by delivering shares of common stock with fractional shares to be paid in cash. The compensation expense relating to this plan included in the Consolidated Statements of Income was approximately $1 million in the years ended December 31, 2019, 2018, and 2017. At December 31, 2019, there were approximately 210 thousand restricted stock units outstanding under this plan at a carrying value of approximately $13 million.
Accumulated Other Comprehensive Loss: A summary of accumulated other comprehensive income (loss) for the years ended December 31, 2017, 2018, and 2019, is presented below:
Supplemental Information: The following table provides the computation of basic and diluted earnings per common share (“EPS”) for the periods presented.
Approximately 1.1 million, 0.5 million, and 0.3 million share-based awards of common stock were excluded in the years ended December 31, 2019, 2018, and 2017, respectively, from the calculation of the weighted average number of shares outstanding for diluted EPS because their effects were anti-dilutive.
NOTE 12 - Segment Information
The Company is principally engaged in the production and sale of starches and sweeteners for a wide range of industries, and is managed geographically on a regional basis. The Company’s operations are classified into four reportable business segments: North America, South America, Asia-Pacific, and EMEA. Its North America segment includes businesses in the U.S., Mexico, and Canada. The Company’s South America segment includes businesses in Brazil, Colombia, Ecuador, and the Southern Cone of South America, which includes Argentina, Peru, Chile, and Uruguay. Its Asia-Pacific segment includes businesses in South Korea, Thailand, China, Australia, Japan, Indonesia, Singapore, the Philippines, India, Malaysia, New Zealand, and Vietnam. The Company’s EMEA segment includes businesses in Pakistan, Germany, the United Kingdom, South Africa, and Kenya. Net sales by product are not presented because to do so would be impracticable.
(a)The year ended December 31, 2019 includes $57 million of restructuring expenses, including $29 million of net restructuring related expenses as part of the Cost Smart Cost of sales program and $28 million of employee-related and other costs, including professional services, associated with the Cost Smart SG&A program. The year ended December 31, 2018 includes $49 million of restructuring expenses as part of the Cost Smart Cost of sales program in relation to the cessation of wet-milling at the Stockton, California plant, $11 million of restructuring costs related to Cost Smart SG&A program, $3 million of costs related to the North America finance transformation program, and $1 million of costs related to the leaf extraction process in Brazil. The year ended December 31, 2017 includes $17 million of employee-related severance and other costs associated with the restructuring in Argentina, $13 million of restructuring of related to the leaf extraction process in Brazil, $6 million of employee-related severance and other costs associated with the Finance Transformation initiative, and $2 million of other restructuring charges including employee-related severance costs in North America and a refinement of estimates for prior year restructuring activities.
(b)During the year ended December 31, 2019, the Company recorded a $22 million pre-tax benefit for the favorable judgement received by Ingredion from the Federal Court of Appeals in Brazil related to certain indirect taxes collected in prior years. As a result of the decision, the Company expects to be entitled to credits against its Brazilian federal tax payments in 2020 and future years. The benefit recorded represents the Company's current estimate of the credits and interest due from the favorable decision in accordance with ASC 450, Contingencies. This benefit was offset by other adjusted charges during the period.
(a)For purposes of presentation, North America includes Corporate assets.
(a)For purposes of presentation, North America includes Corporate activities of depreciation, amortization, capital expenditures, and mechanical stores purchase, respectively.
(b)Represents spare parts used in the production process. Such spare parts are recorded in PP&E as part of machinery and equipment until they are utilized in the manufacturing process and expensed as a period cost.
The following table presents net sales to unaffiliated customers by country of origin for the last three years:
The following table presents long-lived assets (excluding intangible assets and deferred income taxes) by country as of December 31:
NOTE 13 - Commitments and Contingencies
In January 2019, the Company’s Brazilian subsidiary received a favorable decision from the Federal Court of Appeals in Sao Paulo, Brazil, related to certain indirect taxes collected in prior years. As a result of the decision, the Company expects to be entitled to indirect tax credits against its Brazilian federal tax payments in 2020 and future years. The Company finalized its calculation of the amount of the credits and interest due from the favorable decision, concluding
that the Company could be entitled to approximately $86 million of credits spanning a period from 2005 to 2018. The Department of Federal Revenue of Brazil, however, issued an Internal Ruling in which it charged that the Company is entitled to only $22 million of the calculated indirect tax credits and interest for the period from 2005 to 2014. The Brazil National Treasury has filed a motion for clarification with the Brazilian Supreme Court, asking the Court, among other things, to modify the lower court’s decision to approve the Internal Ruling, which could impact the decision in favor of the Company. Due to the uncertainty arising from the issuance of the Internal Ruling, the Company recorded $22 million of credits in 2019 in accordance with ASC 450, Contingencies. The $22 million of future tax credits, which was recorded in the Consolidated Income Statement in Other income, resulted in additional deferred income taxes of $8 million. The income taxes will be paid as and when the tax credits are utilized. The Company continues to monitor the pending decisions within the Brazilian courts that may result in changes to the calculations and the timing of the recording of any additional gains and receipt of the benefits.
The Company is currently subject to claims and suits arising in the ordinary course of business, including labor matters, certain environmental proceedings, and other commercial claims. The Company also routinely receive inquiries from regulators and other government authorities relating to various aspects of its business, including with respect to compliance with laws and regulations relating to the environment, and at any given time, the Company has matters at various stages of resolution with the applicable governmental authorities. The outcomes of these matters are not within the Company’s complete control and may not be known for prolonged periods of time. The Company does not believe that the results of currently known legal proceedings and inquires will be material to it. There can be no assurance, however, that such claims, suits or investigations or those arising in the future, whether taken individually or in the aggregate, will not have a material adverse effect on the Company’s financial condition or results of operations.
NOTE 14 - Supplementary Information
Consolidated Balance Sheets
Consolidated Statements of Income
(a)Interest capitalized amounted to $5 million, $3 million, and $4 million in the years ended December 31, 2019, 2018, and 2017, respectively.
Consolidated Statements of Cash Flow
Quarterly Financial Data (Unaudited)
Summarized quarterly financial data is as follows:
(a)In the first quarter of 2019, the Company recorded $3 million in after-tax, net restructuring costs and $1 million in after-tax, net acquisition/integration costs.
(b)In the second quarter of 2019, the Company recorded $7 million in after-tax, net restructuring costs.
(c)In the third quarter of 2019, the Company recorded $22 million in after-tax, net restructuring cost and $2 million in after-tax charges for other tax matters.
(d)In the fourth quarter of 2019, the Company recorded $13 million in after-tax, other income related to other matters, $12 million in after-tax, net restructuring costs, and $1 million in after-tax, acquisition/integration costs.
(e)In the first quarter of 2018, the Company recorded $3 million in after-tax, net restructuring costs.
(f)In the second quarter of 2018, the Company recorded $5 million in after-tax, net restructuring costs and $2 million in after-tax, interest penalty related to an income tax settlement.
(g)In the third quarter of 2018, the Company recorded $27 million in after-tax, net restructuring costs, $2 million in after-tax charges for the refinement of provisional charges related to the enactment of the TCJA, and $2 million after-tax gain related to a refinement of reserve for an income tax settlement.
(h)In the fourth quarter of 2018, the Company recorded $16 million in after-tax, net restructuring costs and $1 million in after-tax charges for the refinement of provisional charges related to the enactment of the TCJA.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, including our Chief Executive Officer and our Chief Financial Officer, performed an evaluation of the effectiveness of our disclosure controls and procedures as of December 31, 2019. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of December 31, 2019, our disclosure controls and procedures (a) are effective in providing reasonable assurance that all material information required to be filed in this report has been recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (b) are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
There have been no changes in our internal control over financial reporting during the quarter ended December 31, 2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. This system of internal controls is designed to provide reasonable assurance that assets are safeguarded and transactions are properly recorded and executed in accordance with management’s authorization.
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 our assets.
2.Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in conformity with accounting principles generally accepted in the U.S., and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors.
3.Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our financial statements.
Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework of Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The scope of the assessment included all of the subsidiaries of the Company. Based on the evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2019. The effectiveness of our internal control over financial reporting has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report included in the Consolidated Financial Statements filed with this report.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information required by this Item 10 is incorporated herein by reference to the Company’s definitive proxy statement for the Company’s 2020 Annual Meeting of Stockholders (the “Proxy Statement”), including the information in the Proxy Statement appearing under the headings “Proposal 1. Election of Directors” and “The Board and Committees.” The information regarding executive officers required by Item 401 of Regulation S-K is included in Part 1 of this report under the heading “Information about our Executive Officers.”
The Company has adopted a code of ethics that applies to its principal executive officer, principal financial officer, and controller. The code of ethics is posted on the Company’s Internet website, which is found at www.ingredion.com. The Company intends to disclose on its website, within any period that may be required under SEC rules, any amendments to, or waivers under, a provision of its code of ethics that applies to the Company’s principal executive officer, principal financial officer or controller that relates to any element of the code of ethics definition enumerated in Item 406(b) of Regulation S-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this Item 11 is incorporated herein by reference to the Proxy Statement, including the information in the Proxy Statement appearing under the headings “Executive Compensation,” “Compensation Committee Report,” “Director Compensation” and “Compensation Committee Interlocks and Insider Participation.”
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information required by this Item 12 is incorporated herein by reference to the Proxy Statement, including the information in the Proxy Statement appearing under the headings “Equity Compensation Plan Information as of December 31, 2019” and “Security Ownership of Certain Beneficial Owners and Management.”
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information required by this Item 13 is incorporated herein by reference to the Proxy Statement, including the information in the Proxy Statement appearing under the headings “Review and Approval of Transactions with Related Persons,” “Certain Relationships and Related Transactions” and “Independence of Board Members.”
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information required by this Item 14 is incorporated herein by reference to the Proxy Statement, including the information in the Proxy Statement appearing under the heading “2019 and 2018 Audit Firm Fee Summary.”
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15(a)(1) Consolidated Financial Statements
Financial Statements (see the Index to the Consolidated Financial Statements on page 51 of this report).
Item 15(a)(2) Financial Statement Schedules
All financial statement schedules have been omitted because the information either is not required or is otherwise included in the consolidated financial statements and notes thereto.
Item 15(a)(3) Exhibits
The following list of exhibits includes both exhibits submitted with this Form 10-K as filed with the SEC and those incorporated by reference from other filings.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit to this form pursuant to Item 15(b) of this report.
ITEM 16. FORM 10-K SUMMARY
None.
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.
INGREDION INCORPORATED
Date: February 19, 2020
By:
/s/ James P. Zallie
James P. Zallie
President and Chief Executive Officer
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, in the capacities indicated and on the dates indicated.
*By:
/s/ Janet M. Bawcom
Janet M. Bawcom
Attorney-in-fact
Date: February 19, 2020