ITEM 1. BUSINESS
GENERAL
York International Corporation and its consolidated subsidiaries (the Company, which may be referred to as we, us, or our) are a global provider of heating, ventilating, air conditioning, and refrigeration (HVAC&R) products and services. Our air conditioning systems, generally used for comfort cooling, range from a one ton* unit for a small residence to large systems installed in high-rise residential and commercial buildings. We believe that we are the third largest supplier of such products in the United States and one of the leading companies in the HVAC&R industry internationally. Our refrigeration systems are used in industrial applications where process cooling is needed in manufacturing, distribution and cold storage. Additionally, we sell replacement parts, replacement equipment, and controls, and deliver various services and service solutions. We are the largest services provider to the HVAC&R industry and have leading positions in several equipment lines. Our multi-site commercial service contracts include CVS Pharmacies, Sears, Firestone, Family Dollar, Ritz Camera, Nextel and others. Our products are sold in over 125 countries and are in use in such diverse locations as the Petronas Towers in Malaysia, the British Houses of Parliament, the Tokyo World Trade Center, Pudong International Airport in Shanghai, the Pentagon, NASA's Vehicle Assembly Building at Kennedy Space Center, NASA's Johnson Space Center, the Los Angeles International Airport, the Jeddah Airport, the Dubai Airport, the Overseas Union Bank Centre in Singapore, the Sydney Opera House, the Atlantic City Convention Center, the English Channel Eurotunnel, the Hong Kong Convention and Exhibition Centre, and the Lantau Airport Railway in Hong Kong.
We were founded in 1874 in York, Pennsylvania, and over the years we have undergone various ownership changes. Since 1991, we have been an independent, publicly held company. During the 1990s, we expanded our worldwide presence through growth and acquisitions. In 1999, we further expanded our industrial refrigeration business by acquiring all of the outstanding capital stock of Sabroe A/S, a Danish company.
Headquartered in York, Pennsylvania, we have manufacturing facilities in nine states and eight foreign countries. As of December 31, 2004, we employed approximately 23,200 people worldwide. Our principal offices are located at 631 South Richland Avenue, York, Pennsylvania 17403, and our telephone number is (717) 771-7890.
STRATEGY
Our mission is to be the world's premier provider of HVAC&R systems and services. We remain focused solely within this industry. Our objectives are to deliver profitable growth, strong cash flows, and superior returns on invested capital. We focus on maintaining a competitive cost structure by controlling manufacturing and operating expenses, and investing in global standardization, information technology infrastructure and product development. We continue to emphasize further improvement in the cost, quality, and services of our supply chain.
We are uniquely positioned in the market as we own and operate our global service and parts operations and have the broadest range of air conditioning and refrigeration skills in the HVAC&R industry. Our global parts and service strategy is designed to meet demanding requirements, reduce customer down time, and leverage our national and global service capabilities to provide the best service to our customers.
- -------- * The cooling capacity of air conditioning units is measured in tons. One ton of cooling capacity is equivalent to 12,000 BTUs and is generally adequate to air condition approximately 500 square feet of residential space.
We believe that our planning processes, capital allocation, investment choices, and management incentive compensation plans are aligned with our overall objectives and are key elements in the implementation of our strategies to achieve our financial goals. In addition, we will leverage revenue growth and the benefits of prior cost saving initiatives, raise selling prices, and moderate spending on information technology projects.
In 2005, we will focus on: growing revenue within the service and parts businesses, maintaining a leadership position in the fast growing China and Middle East markets, and continuing our market share growth in the middle market product lines, controls, unitary products, and the replacement market.
ORGANIZATION
Effective January 1, 2003, we consolidated our former York Refrigeration Group and Engineered Systems Group segments and reorganized management of the combined business. Our organization is comprised of three groups, consisting of: Global Applied, Unitary Products Group, and Bristol Compressors. The Global Applied business is comprised of three geographic regions: the Americas; Europe, Middle East, and Africa (EMEA); and Asia. These three regions, Unitary Products Group and Bristol Compressors represent our reportable segments.
The following tables provide net sales by segment and geographic market:
Additional financial information about our segments, U.S. and non-U.S. operations, and export sales is incorporated herein by reference to Note 17 of Item 8. Financial Statements and Supplementary Data.
BACKLOG
The following table provides backlog by segment:
Substantially all orders are expected to be fulfilled within the next 12 months.
GLOBAL APPLIED
Global Applied designs, produces, sells, and services HVAC&R solutions worldwide. Our HVAC&R solutions are sold for both the new construction and the replacement markets for a full range of commercial buildings and various industrial applications, including: the food and beverage industry; commercial marine; and the pharmaceutical, petrochemical, textile, and electronics industries' process cooling operations. Our Global Applied products are also used in sporting venues, such as ice rinks, and we are the world leader in snowmaking equipment and snow inducers. Global Applied's service business includes both after market service and part replacement, in addition to equipment sales and rentals. The Global Applied group is comprised of three geographic regions: the Americas; EMEA; and Asia. No single customer accounted for more than 10% of revenues of the Americas, EMEA, or Asia.
The global equipment markets are driven by new construction and replacement sales in almost equal proportions. Commercial construction tends to move in the general direction of the global economies. Replacements are strongest in those areas of the world where the installed base of equipment is largest, such as North America. Replacement sales are driven by the age of the equipment, the economics of repair versus replacement (with increasing emphasis on energy efficiency), global economics driving capital investment, the potential for better energy efficiency, and greater environmental concerns of replacing old with new equipment. Demand for replacement products, repair parts, and services generally increases during summer months. The overall effect of seasonality is partially mitigated by sales of new equipment for which demand is less seasonal. We believe that developing countries offer opportunities for increasing sales of our equipment.
We focus our product development efforts by emphasizing improving energy efficiency, reducing operating noise levels, improving indoor air quality, achieving higher environmental standards, using alternative refrigerants, lowering cost, and reducing the product size. Nearly all of our Global Applied products make use of the latest controls technology to enhance all areas of performance and we are developing our next generation of controls to meet global and regional market demands. We are committed to providing a line of Global Applied products developed for regional markets that are aggressively positioned to meet local needs.
Products
Products include air-cooled and water-cooled chillers, large packaged rooftop units, indoor and outdoor air handling and ventilating equipment, variable air volume units, and mini-split and room air conditioning units primarily for high-rise residential and commercial buildings. Air handling equipment
covers all the traditional applications, as well as FlexSys, an innovative underfloor air distribution system and a new ductless system called AirFixture. Centrifugal, screw, and reciprocating compressors, condensers, evaporators, heat exchangers, industrial and marine chillers, ice makers, process refrigeration systems, and gas compression systems are used for many diverse industrial applications such as preserving food and beverages, hygienic air-cooling for pharmaceutical, healthcare, and electronics industries, and snowmaking. Many of these products are engineered and manufactured to unique customer specifications. They are operated by control systems that are designed for an individual unit, automated plant control systems, or advanced control systems for refrigerated containers. Current products utilize HCFC, HFC, HC, and natural refrigerants such as carbon dioxide and ammonia, which all meet the requirements of applicable international environmental protocols.
Services and Parts
Our Global Applied service business provides maintenance, repair and rental services, and related products, including manufactured parts and equipment, purchased parts and equipment, controls, remanufactured reciprocating compressors, and product commissioning. Our worldwide service organizations are owned and operated by us and utilize factory-trained technicians.
Brands
We market Global Applied products under the "YORK", "MILLER-PICKING", "PACE", "SABROE", "FRICK", "NOVENCO", "FRIGID COIL", "IMECO", "ACUAir", and "GRAM" brands. Service is marketed under the "YORK", "NATKIN", "UNITED MECHANICAL SERVICES", and "SABROE" brands and parts are marketed under the "YORK", "FRICK", "SABROE", "GRAM", "STAL" and "SOURCE 1" brands. Remanufactured reciprocating compressors are marketed under the "GR COMPRESSORS" and "YORK" brands.
U. S. Government
Historically, approximately 4% of the Americas' sales and approximately 1% of consolidated sales are related to contracts for the U.S. Navy, for equipment and research and development. Contracts vary in duration from less than one year to several years. If these contracts were to be terminated, we would be entitled to reimbursement of costs incurred and to a payment of a reasonable allowance for profit on work actually performed. We also sell equipment on standard commercial terms to contractors and others who incorporate our products into U.S. government projects.
Competition
All of the markets in which Global Applied participates are very competitive. Products compete on the basis of product design, reliability, quality, price, efficiency, acoustics, and post-installation service. Architects and engineers play an important part in determining which manufacturer's products will be specified and ultimately used in an application. In the domestic U.S. market, we compete primarily with Carrier, a United Technologies Corporation company; Trane Company, a division of American Standard Companies Inc.; McQuay International, a division of OYL Industries Berhad; GEA-Grasso, a division of MG Technologies AG; Baltimore Aircoil Company; Evapco; Krack Corp., a subsidiary of Ingersoll-Rand Co., Ltd; and Mycom Compressors. In the international market, we compete primarily with the above manufacturers, other local manufacturers in Europe, and a number of Asian HVAC manufacturers.
Our Global Applied service business competes in a very large but fragmented market, where individual market shares are typically in the single digit range. Most of our competition consists of thousands of independent mechanical contracting companies delivering services and purchased products. Other competitors include manufacturers such as Trane and Carrier and some non-manufacturing national companies such as Johnson Controls.
Manufacturing and Distribution
Products are manufactured in York and Waynesboro, Pennsylvania; San Antonio, Texas; Roanoke, Virginia; Albany, Missouri; Hattiesburg, Mississippi; Dixon, Illinois; Santa Fe Springs, California; Durango and Monterrey, Mexico; Sao Paulo and Curitiba, Brazil; Basildon, England; Carquefou and Nantes, France; Johannesburg, South Africa; Aarhus and Naestved, Denmark; Wuxi and Guangzhou, China; and Laem Chabang, Thailand. Many product components, such as motors, control elements, castings and refrigerant, are purchased from outside suppliers. Other components are custom manufactured by us. Using these components and design specifications, products are machined, assembled, tested, and shipped from the above locations.
Products are distributed globally through a combination of sales and service offices, sales agents, and independent distributors. Sales engineers operating out of sales and service offices around the world account for the majority of equipment sales, with the remaining portion coming from sales agents and independent distributors. Aftermarket products and services are sold from substantially all sales and service offices. Parts are also sold from major regional distribution centers in Baltimore, Maryland; Shanghai, China; Dubai, U.A.E.; Aarhus, Denmark; and Basildon, England.
Recent Developments
In 2004, Global Applied continued to enhance the packaged centrifugal chiller line by focusing on improved compressors and chiller-energy efficiency supporting a wide range of alternate refrigerants. Efforts were focused on our hermetic water-cooled screw chiller line to reduce manufacturing cost and improve reliability. New features were added to our 45 to 90 ton packaged rooftop line to cover a wider range of end use applications. An entirely new line of airhandling equipment, Solution airhandlers, was introduced in 2003 and will continue to be expanded through 2005. Solution airhandling units offer customization options, previously only available on high-end custom airhandlers, at prices more aligned to standard applications. Solution airhandlers utilize advanced specification and design software that feeds the manufacturing process and enables better flexibility, shorter lead times, and reduced costs at a given feature level. Innovative enhancements to our industrial screw compressor technologies continue to improve operating performance for the food and beverage equipment market, as well as natural gas gathering and air conditioning applications. Screw compressors are a reliable alternative to reciprocating compressors, requiring less maintenance and featuring lower overall operating costs. The Rotatune range of variable speed screw compressors was completed with the introduction of the SAB 110R series. Market acceptance of the PowerPAC ammonia chiller continues to be strong, with year-over-year increases in demand since introduction. PowerPAC chillers utilize environmentally friendly refrigerants such as ammonia that do not deplete the ozone layer, feature high efficiency and use negligible refrigerant charges.
In the service business, strong efforts to expand our position in the low-rise commercial market continued with particular emphasis on multi-site owners and the related replacement equipment. We expanded our presence in the rental chiller business in 2004 with emphasis on meeting the temporary cooling needs of our existing customer base. Global Applied continued to develop remote monitoring and diagnostic management capabilities to allow us to monitor system performance and control plant rooms remotely. These remote monitoring and diagnostic management capabilities will allow the Global Applied service business to identify additional service opportunities. In addition we began deploying YORKConnect, our service business information technology system, in North America.
UNITARY PRODUCTS GROUP
Unitary Products Group (UPG) produces heating and air conditioning solutions designed for use in residential and light commercial applications and distributes proprietary and non-proprietary parts to the aftermarket, in the U.S. and Canada. We market our UPG products to the replacement and new
construction (new installation) markets. We estimate more than half of UPG revenues in the U.S. are attributable to the replacement market. The replacement market is not affected by levels of new home construction and therefore tends to be less cyclical. The replacement market is affected by ambient temperature. Hot weather in the spring season causes existing older units to fail earlier in the season, leading customers to accelerate replacement of a unit that might otherwise be deferred in the case of a late season failure. Sales of products used in new construction are mostly dependent upon the overall growth or decline in new residential construction markets. Sales to Ferguson Electronics accounted for more than 10% of UPG's revenues in 2004.
We continually redesign our UPG product offering for lower sound ratings and greater energy efficiency on UPG's premium product line, and manufacturing cost effectiveness on their entry-level value line. In addition, our premium product line is designed to capture the essential elements of today's trends in consumer product design particularly in the replacement market.
Products
UPG's products include ducted central air conditioning and heating systems (air conditioners, heat pumps, and furnaces), and light commercial heating and cooling equipment. These products consist of split systems and packaged products. A split system consists of an outdoor unit containing a compressor and condenser; a connected indoor unit containing a heat exchanger; an electric, gas, or oil heating section; an indoor blower system; and associated controls. A packaged product is a single, self-contained unit with compressor; condenser; heat exchanger; electric, gas, or oil heating section; blower; and associated controls. These units are typically installed on rooftops or beside a structure. Ducted products distribute conditioned air throughout building structures with ductwork connected to the system's blower, whereas ductless installations provide conditioned air directly from indoor blowers.
Brands and Distribution
We market our UPG products under the "YORK", "LUXAIRE", "FRASER-JOHNSON", and "COLEMAN" brands. Service parts are sold under the "SOURCE 1" brand. "YORK" is our full line brand, which is sold through our company-owned distribution centers and exclusive independent distributors. The "YORK" brand is sold with a high level of customer service and sales support. Our other brands are sold through more than 200 non-exclusive distributors primarily for resale to contractors. We also sell unitary products in the manufactured housing industry in North America on an original equipment manufacturer basis through an exclusive distributor.
Competition
All of the markets in which UPG participates are very competitive. Unitary product manufacturers compete on the basis of price, reliability, delivery, efficiency, acoustics, and maximum market coverage. Price competition and maximum market coverage are of particular importance in residential product lines as there is often less perceived differentiation. In the U.S. market, UPG competes with three large worldwide manufacturers, Carrier, Trane, and Lennox, in addition to numerous national manufacturers such as Goodman, Rheem, Nordyne and new market entrants from Asia.
Manufacturing
Residential and light commercial products are manufactured in plants located in Norman, Oklahoma; Wichita, Kansas; and Monterrey, Mexico. Our manufacturing process relies on the purchase of certain components (including hermetic compressors, copper tubing, fan motors, fan blades, refrigerant, and control elements) from outside suppliers, and in-house fabrication of sheet metal cabinets and refrigerant coils. The various unitary products are then assembled and tested before shipment.
Recent developments
In 2004, UPG launched a new line of residential air conditioners and heat pumps to target the growing residential replacement segment. The new product line is marketed under the York "Affinity", Luxaire "Acclimate", and Coleman "Echelon" brand names, and features a swept wing fan designed to provide lower sound ratings. These product lines are capable of utilizing alternate refrigerants. Each brand has its own distinct look and feature set, allowing UPG to promote three differentiated product lines to the marketplace. The York Affinity product line was also the first air conditioner brand to offer the consumer a choice of colors for their outdoor unit. UPG is currently designing a new residential evaporator coil and air handler line designed to match the recently released air conditioner and heat pump line targeted at the residential replacement market.
In the second half of 2004, UPG launched a new furnace product line. The furnace product launch, which was the largest in UPG's history, provided differentiated designs for the York, Luxaire, and Coleman brands, differentiated features, and significantly enhanced aesthetics and serviceability. The new products also offer the "ClimaTrak" heating feature, which allows a consumer to customize their furnace airflow to the climate and geography where they reside.
Beginning in 2004, UPG initiated product development projects to ensure the residential product line will comply with the 13/13 Seasonal Energy Efficiency Ratio (13 SEER) requirements of the Department of Energy and will align with marketing strategies for 2006 and beyond. These efforts will include development of new indoor equipment (furnaces, air handlers, and evaporator coils) that will be required to complete a matching system using the higher SEER outdoor equipment. Since coil and cabinet sizes are larger in higher SEER equipment, investments are also being made in manufacturing equipment to ensure production capacities are adequate to meet the increased requirements starting in January 2006. With the investments being made in product development and manufacturing capacity, we believe UPG will be able to maintain and grow its position in the residential HVAC market.
BRISTOL COMPRESSORS
Bristol Compressors (Bristol) manufactures reciprocating compressors from 1 to 25 tons and, through its joint venture in Scroll Technologies, scroll compressors from 2 to 7 1/2 tons. A compressor is an essential part of a heat pump and/or air conditioning system. Compressors are mechanical pumps driven by electric motors, and are responsible for circulating and increasing the pressure of refrigerant. Bristol brand compressors are used in our products and are sold to original equipment manufacturers and wholesale distributors. UPG purchases compressors manufactured by Bristol and Scroll Technologies. Sales of Bristol products are directly correlated to the factors affecting demand for unitary products discussed previously in the UPG section. Approximately 75% of Bristol's revenues are attributable to sales of products to other air conditioning equipment manufacturers or wholesale distributors other than UPG. Sales to Carrier and National Factory (a Middle East manufacturer of room air conditioners) each accounted for more than 10% of Bristol's revenue in 2004.
Bristol develops compressors to match compression technology precisely to customer needs by providing quiet operation, reliability and high efficiency above the compressors offered by competitors, while maintaining competitive prices.
Products
Bristol's products include both reciprocating and scroll compressors. Reciprocating compressors have one or more pistons driven by a motor that turns a crankshaft. Certain reciprocating compressors include "TS Technology", or twin-single piston system, which allows for optimum heat pump performance in both heating and cooling modes with just one compressor. Scroll compressors use fixed and orbiting spiral-shaped scrolls to compress gas, and require fewer parts than reciprocating compressors.
Brands and Distribution
We market our Bristol products under the "BRISTOL", "INFINITY" and "BENCHMARK" brands. A majority of Bristol's products are sold directly to customers by an in-house sales force. Third party sales representatives are primarily utilized for international sales.
Competition
Bristol competes directly with two U. S. manufacturers, Copeland Corporation, a subsidiary of Emerson Electric Inc., and Tecumseh, a division of Tecumseh Corporation. International competitors include L.G. Electronics, Matsushita Electric Industrial Co., Ltd., and SANYO Electric Co., Ltd. The compressor market competes primarily on price, noise levels and efficiency.
Manufacturing
Bristol products are manufactured at our factory in Bristol, Virginia, and by Scroll Technologies in Arkadelphia, Arkansas. As with our other products, Bristol products are assembled using purchased parts (including motors, castings, forgings, and electronic components) as well as parts manufactured by us. Bristol relies on a single vendor for certain components used in its compressors. Due to consolidation in the vendor's industry, there are limited alternate sources of supply. We believe an alternate source of supply is attainable in the event the current vendor is unable to supply the component. However, a change in vendors would cause a delay in production and loss of sales, which would adversely impact the results of operations of Bristol and our consolidated results of operations.
Recent Developments
Bristol introduced the "Benchmark" compressor line in 2003. Benchmark compression solutions meet or exceed efficiency and sound performance of any competitive technology, and is offered in the 1 1/2 to 3 1/2 ton reciprocating compressor range and the 3 1/2 to 5 ton scroll compressor range. The Benchmark compressor has been developed to meet the mandated 13 SEER legislation effective in 2006 for the unitary domestic market. An improvement in sound performance of Benchmark is possible due to lower vibration from a rigid low noise cylindrical housing and a unique suction muffler. Additionally, reliability is enhanced due to the product requiring less components to protect against loss of charge and indoor fan failure. Benchmark is offered with R-22 (HCFC), R-407C (HFC), and R-410A (HFC) refrigerants.
RAW MATERIALS AND PURCHASED COMPONENTS
We purchase compressors, steel, copper, aluminum, electric motors, castings, forgings, heat exchangers, electric panels, condensers, evaporators, oil, pumps, stampings, fabricated copper tubes, electronic starters and controls, aluminum fins, fan blades, capacitors, transformers, refrigerant gases, valves, fittings, and other components from many outside suppliers. Except for certain components purchased by Bristol for use in its compressors (see "Manufacturing" sub-heading under "Bristol Compressors" above), alternate sources of supply are available for all raw materials and components for which we use a single supplier. In order to hedge against certain raw material price increases, we enter into commodity forward contracts for the purchase of certain raw materials, principally copper. However, we are exposed to raw material price increases related to commodities where no forward markets exist and compressors, electric motors, and other components purchased from suppliers that may not hedge raw material prices. Additional information related to raw material and component cost increases is contained under the caption "Results of Operations" of Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition, and is incorporated herein by reference. Additional information about our commodity forward contracts contained under the caption "Market Risk" of Item 7A. Quantitative and Qualitative Disclosures About Market Risk is incorporated herein by reference.
PATENTS AND TRADEMARKS
We hold numerous patents that relate to the design and use of our products that we consider important, but not essential, to the overall conduct of our business. It is our policy to obtain patent protection for as many of our new and developmental products as possible, and to enforce such patent rights as appropriate. No patents which we consider material will expire within the next five years.
We own several trademarks that we consider important in the marketing of our products as discussed in each of the business sections. We believe that our rights in these trademarks are adequately protected and of unlimited duration.
JOINT VENTURES IN U.S. AND NON-U.S. MARKETS
In addition to our wholly-owned and majority-owned production and distribution facilities, we produce, distribute, and service products through participation in several joint ventures, which are described in the following table:
We received dividends from affiliates of $3.9 million, $2.2 million, and $2.1 million in 2004, 2003, and 2002, respectively. Our total investments in affiliates were $35.7 million and $28.2 million as of December 31, 2004 and 2003, respectively. Our sales to affiliates are less than 1% of our net sales, and our purchases from affiliates are less than 2% of our total purchases.
RESEARCH AND DEVELOPMENT
Our product development activities include ongoing research and development programs to redesign existing products to reduce manufacturing costs and to increase product efficiencies, develop electronic controls for current product offerings, and create a wide range of new products. During 2004, 2003, and 2002, we spent $47.7 million, $42.3 million, and $42.2 million, respectively, for all product development activities.
EMPLOYEES
As of December 31, 2004, we employed approximately 23,200 persons worldwide. Approximately 10,200 persons are employed in the U.S. and 13,000 persons are employed in foreign countries. Approximately 3,400 U.S. employees are covered by collective bargaining agreements that expire at various dates and generally range from three to six years. We are in current negotiations with union representatives at the UPG Wichita factory to renew the contract that expires on July 31, 2005.
REGULATIONS AND ENVIRONMENTAL MATTERS
Environmental laws that affect or could affect our U.S. operations include, among others, the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, the Occupational Safety and Health Act, the National Environmental Policy Act, the Toxic Substances Control Act, any regulations associated with these acts, and various other Federal, state, and local laws and regulations governing environmental matters.
Environmental Remediation
We have remediation activities ongoing at certain of our U.S. facilities as a result of releases that occurred in the past. From time to time, we have received notice that we are a potentially responsible party, along with other potentially responsible parties, in Superfund proceedings under the Comprehensive Environmental Response, Compensation and Liability Act for the cleanup of hazardous substances at certain sites to which potentially responsible parties are alleged to have sent waste. Our non-U.S. operations are also subject to various environmental statutes and regulations. Generally, these requirements tend to be no more restrictive than those in effect in the U.S. In 1993, the Council of European Communities agreed on European Community regulation number 1836/93 that recommended that each company voluntarily complete an ECO-Audit. We have completed these audits at our European facilities. On the basis of our historical experience and other information currently available to us, we do not believe that either our remediation activities or any Superfund proceedings will have a material adverse effect on our financial condition, ongoing results of operations, or liquidity. However, additional environmental remediation sites may be identified in the future, including properties previously disposed. Currently, we are unable to estimate the remediation cost of these sites because their existence, environmental impact and required remediation activities are not known to us.
Montreal Protocol and Clean Air Act
In September 1987, the U.S. became a signatory to an international agreement titled the Montreal Protocol on Substances that Deplete the Ozone Layer, or the Montreal Protocol. The Montreal Protocol requires its signatories to reduce production and consumption of CFCs and halons, some of which are utilized in air conditioning and refrigeration equipment. In 1988, the Environmental Protection Agency (EPA) issued regulations under the Clean Air Act implementing the Montreal Protocol in the U.S. Many other countries have also become signatories to the Montreal Protocol. The manner in which these countries implement the Montreal Protocol and regulate CFCs could differ from the approach taken in the U.S.
The Clean Air Act allows the EPA to accelerate the statutory phase-out schedule for any Class I (CFC) or Class II (HCFC) substance. In November 1992, the parties to the Montreal Protocol agreed to amend the Protocol to require the complete phase-out of CFC production by the beginning of 1996. Further, the parties agreed to a 1996 production cap on HCFCs and a complete phase-out of HCFC production by 2030. In May 1995, EPA published a final rule requiring accelerated phase-out of the production of all CFCs by 1996 and of all HCFCs by 2030.
None of our manufactured products contain Class I substances. Class I substances previously used by us have been substituted with Class II substances or substances that are currently unregulated. We continue to expect revenues from servicing, updating, and repairing existing equipment that uses Class I substances. These activities are regulated by the EPA, which imposes guidelines affecting service and maintenance of equipment that uses Class I and Class II substances. We train and license our service technicians in service and maintenance procedures that comply with the regulations. Therefore, we believe that the regulations will not have a material adverse effect on our operations. The phase-out of Class I substances will require modifications to existing air conditioning equipment as availability of recycled Class I substances decreases. Since our technology enables us to modify existing equipment for use with Class II substances, we believe that this will continue to generate additional opportunities. While we expect to derive substantial revenue from the sale of products utilizing Class II substances, it is not expected that any phase-out will have a significant impact on the sales of such products since new products that use unregulated refrigerants such as HFCs are now readily available. Nonetheless, as the supply of virgin and recycled Class II substances falls, it will be necessary to address the need to substitute permitted substances for Class II substances.
We, in conjunction with major chemical manufacturers, are continually in the process of reviewing and addressing the impact of refrigerant regulations on our products. We believe that the combination of those products that presently utilize Class II substances and those products in the field that can be retrofitted to such refrigerants provides a complete line of commercial and industrial products. Therefore, we do not foresee any material adverse impact on our business or competitive position as a result of the Montreal Protocol, the 1990 Clean Air Act amendments, or their implementing regulations. However, we believe that the implementation of severe restrictions on the production, importation, or use of refrigerants employed in larger quantities by us could have such an impact. We believe that the applied systems products that we have produced will be well positioned to utilize the next generation of refrigerants without substantial modification. If the next generation of refrigerants is incompatible with the hermetic compressors used by us and all of our competitors for unitary products, design modifications would be required.
National Appliance Energy Conservation Act
We are also subject to regulations promulgated under the National Appliance Energy Conservation Act of 1987, as amended, and various state regulations concerning the energy efficiency of our products. In 2004 the Department of Energy concluded its rule making process and established a higher minimum efficiency rating for residential air conditioning and heat pump products effective January 23, 2006. The new efficiency will be raised to a 13 SEER level, a 30% increase in energy efficiency from prior standards. We have developed and continue to develop products that will comply with these regulations, and do not believe that such regulations will have a material adverse effect on our financial condition, results of operations, or liquidity.
EXECUTIVE OFFICERS
As of March 14, 2005, our executive officers are as follows:
Mr. Myers has been President and Chief Executive Officer of the Company since February 2004. Prior thereto, he was President of the Company from June 2003 to February 2004, Executive Vice President and Chief Financial Officer of the Company from January to June 2003, Vice President and Chief Financial Officer of the Company from 2000 to 2002, Vice President Finance, Engineered Systems Group from 1998 to 2000, Corporate Controller from 1995 to 1998, Director of Finance for the Airside Products Group from 1994 to 1995, and Director of Financial Planning and Controls in 1994.
Mr. Buchwald has been Vice President of the Company and President of York Europe, Middle East, and Africa since January 2005. Prior thereto, he was Vice President, Marine and Refrigeration Products & Systems from March 2003 to December 2004, Vice President, Marine and Managing Director of York Refrigeration Marine and Controls from April 2000 to February 2003, and Vice President of Human Resources for Sabroe A/S and York Refrigeration from September 1997 to March 2000. Prior to joining the Company, he was a Senior Management Consultant with Mercuri Urval A/S in Denmark.
Mr. Campbell has been Vice President of the Company and President of York Americas since January 2003. Prior thereto, he was Vice President, North America Sales and Service from June 2002 to December 2002, Vice President, Finance, Engineered Systems Group from 2000 to 2002, Director, Finance, Europe from 1997 to 2000, and Assistant Treasurer from 1994 to 1997.
Mr. Huntington has been Vice President of the Company and President of Unitary Products Group since October 2000. Prior thereto, he was Senior Vice President, Engineering, Bristol Compressors from 1999 to 2000, Vice President, Sales and Distribution, Unitary Products Group North America from 1997 to 1999, Vice President and General Manager, Evcon Coleman Division from 1996 to 1997, and Vice President, Sales and Marketing, Evcon Industries from 1992 to 1996.
Mr. Kennedy has been Vice President of the Company and President of Bristol Compressors since March 2000. Prior thereto, he was Vice President, Human Resources from 1993 to 2000. Prior to joining the Company, he was Vice President of Human Resources for the Millipore Corporation.
Mr. Sun has been Vice President of the Company and President of York Asia Pacific since January 2005. Prior thereto, he was Vice President and General Manager, York Asia Pacific from April 2001 to December 2004, Vice President and General Manager, North Asia from January 1998 to March 2001, Vice President, People's Republic of China from 1997 to 1998, Regional Manager, People's Republic of China from 1993 to 1997, and various management positions with the Company from 1973 to 1992.
Mr. Kornblatt has been Vice President and Chief Financial Officer since June 2003. Prior thereto, he was Vice President, Finance, York Americas from June 2002 to June 2003. Prior to re-joining the Company, he was Director, Taxes, Europe for The Gillette Company from December 1998 to June 2002. He was previously Tax Director of the Company from January 1993 to December 1998. Prior to joining the Company, he was with KPMG LLP and Ernst & Whinney.
Ms. Davis has been Vice President, Secretary and General Counsel of the Company since March 1995. Prior to joining the Company, she was Vice President, General Counsel and Secretary of Joy Technologies Inc. from 1988 to 1995.
Mr. Gard has been Vice President, Human Resources since June 2003. Prior thereto, he was Director, Corporate Compensation, Benefits and Human Resource Information Systems from February 1999 to June 2003. Prior to joining the Company, he was with Millipore Corporation.
Ms. Marsteller has been Vice President, Investor Relations since March 2004. Prior to rejoining the Company, she was President of Stellar Partners, an investor relations and corporate communications consulting firm, from July 2000 to March 2004. She was previously Vice President, Investor Relations and Corporate Communications for the Company from 1997 to 2000 and Director of Investor Relations from 1992 to 1997. Prior thereto, she held various financial positions in the Unitary Products Group from 1986 to 1992. Prior to joining the Company, she held leadership positions at Honeywell, Inc. and Armco, Inc.
Mr. Spellar has been Senior Corporate Vice President of Strategy, Technology, and Market Competitiveness since January 2005. Prior thereto, he was Vice President of the Company and President of York Europe, Middle East, and Africa from January 2003 to December 2004, Vice President of the Company and President, Engineered Systems Group from 2000 to 2002, Vice President, Marketing and Strategic Accounts from 1999 to 2000, Vice President of the Company and President, Applied Systems Worldwide from 1995 to 1999, Vice President of the Company and Vice President, European Operations from 1992 to 1995, President, Frick Division from 1987 to 1992, and President of the Frick Company from 1979 to 1987.
Mr. Corcoran has been Vice President and Treasurer of the Company since March 2001. Prior thereto, he was Treasurer of the Company from 1992 to 2001. Prior to joining the Company, he was with Griffith Laboratories, AM International, and Borg-Warner Corporation.
Mr. Heck has been Chief Governance Officer and Director, Internal Audit since December 2003. Prior thereto, he was Controller from January 2000 to December 2003. Prior to joining the Company, he held various financial and audit related positions with Superior Group, Inc., LFC Financial Corp., and Deloitte, Haskins, & Sells.
Mr. Elder has been Controller since December 2003. Prior thereto, he was the Director, Financial Planning and Analysis from August 2000 to December 2003 and Manager, Financial Reporting from May 1997 to August 2000. Prior to joining the Company, he was with Hershey Foods Corporation and KPMG LLP.
WEBSITE ACCESS TO INFORMATION
We make available free of charge through our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the U.S. Securities and Exchange Commission. Our website address is: www.york.com.
ITEM 2.
ITEM 2. PROPERTIES
Our principal offices are located in York, Pennsylvania on an approximately 71 acre site owned by us. The following table lists our principal manufacturing facilities:
At the York, Pennsylvania location that we own, approximately 550,000 square feet are currently unused.
In addition to the properties described above, we lease facilities worldwide for use as sales and service offices and regional warehouses. In the ordinary course of business, we monitor the condition of our facilities to ensure that they remain adequate to meet our long-term sales goals and production plans. We believe that our properties are in good condition and adequate for our requirements. We make capital expenditures intended to upgrade existing facilities and equipment to increase production efficiency and, when appropriate, to adapt them to the requirements of manufacturing new product lines.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
As discussed in our Form 10-Q filed October 31, 2003 and our Form 10-K/A for the fiscal year ended December 31, 2003, on September 11, 2003, the City of Elyria, Ohio, the Lorain County Board of Commissioners, the Lorain County Auditor, the Lorain County Treasurer and two school districts filed suit against us in the Court of Common Pleas for Lorain County, Ohio. The plaintiffs allege that we breached two incentive agreements entered into with the City of Elyria in 1991 and 1993, respectively, by closing our plant in Elyria in 2001. The plaintiffs assert that they would have collected additional taxes had the plant remained open and are seeking approximately $3 million in allegedly lost taxes and $200 million in punitive damages. We have removed the suit to the United States District Court for the District of Ohio and intend to defend it vigorously. We believe the suit is without merit.
As is the case with many other companies, we have been named as one of many defendants in lawsuits alleging personal injury to one or more individuals as a result of exposure to asbestos contained in products previously manufactured by us or by companies from which we purchased product lines. Information concerning our asbestos litigation is incorporated herein by reference to Note 13 of Item 8. Financial Statements and Supplementary Data.
In January 2004, we received a request for documents from the staff (the "Staff") of the Enforcement Division of the Securities and Exchange Commission (the "Commission") in connection with the Staff's investigation of our approval of option exercises by three of our executives during an open window
period in the last quarter of 2003. We have provided the requested documents and have fully cooperated with the Staff's investigation. In December 2004, we received a notice from the Staff, generally known as a "Wells Notice," alleging that we violated certain federal securities laws. The Wells Notice indicated that the Staff may propose to the Commission that it file an enforcement action against us seeking an injunction and a penalty. In January 2005, we submitted a written response, generally known as a "Wells submission," denying the Staff's allegation of federal securities law violations. In response to our Wells submission, the Staff has requested additional information from us, which we intend to provide. We are unable to predict the outcome of this investigation or the outcome of any enforcement action, if commenced.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of our security holders during the fourth quarter of 2004.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the New York Stock Exchange under the symbol "YRK." On March 11, 2005, we had 5,012 holders of record of our common stock.
TRADING AND DIVIDEND INFORMATION
The high and low sales prices for which our common stock traded and the dividends declared in each quarterly period within 2004 and 2003 are as follows:
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA
(a) In 2004, we recorded a $20 million warranty charge for the Unitary Products Group furnace and inspection program. See Note 1 of Item 8. Financial Statements and Supplementary Data.
(b) In all years presented, we recorded charges to operations for restructuring and other cost reduction initiatives. Also, in 2000, we recorded charges for acquisition, integration, and restructuring activities related to the 1999 Sabroe acquisition. See Note 16 of Item 8. Financial Statements and Supplementary Data.
(c) Effective January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142. Under the Statement, we no longer amortize goodwill. Goodwill amortization expense was $24.4 million and $25.6 million in 2001 and 2000, respectively. In 2002, we recorded a transitional goodwill impairment charge of $179.4 million as a cumulative effect of a change in accounting principle. See Note 1 of Item 8. Financial Statements and Supplementary Data.
(d) In 2003, we recorded approximately $82.4 million of incremental debt, $23.9 million of incremental net machinery and equipment, $10.7 million of incremental deferred tax assets, a $15.4 million reduction to stockholders' equity, and a $32.4 million reduction to other long-term liabilities. The reduction in stockholders' equity was recorded as a cumulative effect of a change in accounting principle adjustment. See Note 1 of Item 8. Financial Statements and Supplementary Data.
(e) Certain reclassifications have been made to the 2003, 2002, 2001, and 2000 financial data to conform to the 2004 presentation.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
EXECUTIVE SUMMARY
We earn revenues and generate cash by manufacturing and selling products and services to the heating, ventilating, air conditioning and refrigeration (HVAC&R) industry. The Global Applied business designs, produces, sells and services HVAC&R solutions for commercial buildings and industrial refrigeration applications. The Unitary Products Group (UPG) produces and sells residential and light commercial heating and air conditioning systems primarily in the United States (U.S.). Bristol Compressors manufactures compressors, which are used in our UPG products and sold to original equipment manufacturers (OEM).
Our business is sensitive to many business and economic factors (see Inflation, Cyclicality, Market Risk and Seasonality sections for further discussion). Overall, our results are impacted by changes in sales volume and manufacturing costs. Changes in our sales volume are closely correlated to changes in global economies and the gross domestic product of countries and, more specifically, to worldwide commercial and residential construction markets. As these markets grow, our sales volume tends to increase. Sales volume is also impacted by our ability to increase market share. Changes in manufacturing costs (including raw materials) directly impact our gross profit margin. Our ability to successfully implement actions to reduce the impact of higher manufacturing costs or capture increased pricing in the market is key to our profitability.
U.S., European, and most Asia Pacific commercial construction markets have experienced relatively low growth over the past three years while certain international commercial markets (Middle East and China) strengthened. U.S. residential construction has grown modestly over the same period. In 2005, we expect commercial and residential construction markets to grow inline with recent historical rates. Approximately 56% of our 2004 product sales relate to new construction. We partially mitigate our exposure to changes in new construction markets by offering products that are strategic to the replacement market and offering services that are essential to maintaining equipment to prolong its life. The replacement market is mainly driven by the age of existing, installed equipment and cost benefits to be gained from newer, more efficient equipment.
The cost of raw materials has increased substantially over the last two years. Our products include raw materials, such as steel and copper, and purchased components that include steel and copper that are essential to our equipment and parts. We raised our selling prices in 2004 to partially offset increased raw material costs. Our raw material and component cost increases in excess of selling price increases were approximately $46 million for the year ended December 31, 2004. We expect raw material costs to continue increasing in 2005. In addition, we will continue with our raw material hedging programs to help offset the negative impact of rising raw material costs.
In 2005, our main priority is price realization as we anticipate raw material component costs to increase an additional $100 million over 2004 levels and continued rising energy and transportation costs. We generally expect stable to improving markets in our Global Applied regions, with stronger growth opportunities in China and the Middle East and a weaker outlook in the remainder of Europe, Middle East, and Africa (EMEA). We plan to continue growing our Global Applied business by capturing market share with our new products and focusing on our service business by leveraging our global service and parts capabilities and multi-site commercial service market in the U.S. In UPG, we expect 2004 new product introductions and price increases to improve profitability. In addition, price increases at Bristol are expected to improve profitability. Finally, investment in our information technology (IT) systems and infrastructure, continued efforts to develop more efficient manufacturing processes, leverage the global scale of our support structure, and improvements in the supply chain will contribute to meeting future financial goals.
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS 2004 AS COMPARED TO 2003
Consolidated Operations
Net sales
Our revenue growth was mainly attributable to increased Global Applied and UPG equipment volume and Global Applied service business (consisting of services, parts and replacement equipment) growth partially offset by changes in product mix at Bristol Compressors. We enacted general selling price increases throughout 2004; however, conditions were not favorable for price realization in certain markets. Selling price increases had an immaterial impact on revenue growth. The net strengthening of global currencies increased net sales by $111.8 million. International revenue grew at a faster rate than domestic U.S. net sales due to stronger exports from our U.S. factories to international projects in the Middle East and Asia and a shift in volume at Bristol from domestic OEMs to international customers. Continued strength of European currencies may impact the level of capital investment in the region causing further declines in our equipment markets and create a competitive disadvantage on products exported from our EMEA equipment business. See further discussion below under Segment Analysis.
Gross profit
Overall, gross profit grew due to increased equipment volume in Global Applied and UPG, improved factory performance, and realization of 2003 restructuring benefits. These improvements were offset by the $20 million warranty charge for the UPG furnace inspection and remediation program recorded in the second quarter of 2004 (see further discussion below under Segment Analysis); pricing pressure in EMEA and Asia; higher raw material (principally steel and copper) and component costs; and increased costs and inefficiencies related to Americas' YORKConnect deployment (service business IT system in North America). Worldwide demand for steel and copper continued to increase our raw material cost and cost of components containing these materials. While we hedge a portion of our copper and aluminum purchases and have contracts for steel purchases, we experienced cost increases for unhedged portions and components containing these raw materials, as well as surcharges on our steel purchases. Raw material and component cost increases in excess of selling price increases were approximately $46 million. We anticipate approximately $100 million of raw material cost increases in 2005 and have implemented or plan to implement selling price increases to offset these cost increases. The net strengthening of foreign currencies increased our gross profit $19.4 million or 2.5%. In 2003, cost of goods sold included $8.8 million resulting from manufacturing overhead duplication and $5.5 million of inventory write-downs related to strategic actions to rationalize our manufacturing capacity in Global Applied.
Order backlog
Global Applied increased as a result of strong orders in EMEA's marine and Middle East markets and improvements in commercial equipment markets in North America and Latin America for refrigeration and air conditioning products. Order backlog increased 3.7% due to the net strengthening of foreign currencies. UPG and Bristol backlog increased a combined 13.1%, which typically are not backlog driven businesses.
SG&A expenses
We incurred higher selling and administrative expenses related to our initiatives to improve our IT capabilities, new product development, equipment volume gains, and marketing of new products. We expect to benefit from these improvement initiatives in 2005 and beyond. These investments will enable us to better standardize our global processes and enable future growth. The IT investments will leverage our cost structure, assist in achieving operational efficiencies, and enhance supply chain capabilities. The net strengthening of foreign currencies increased our SG&A expenses $17.6 million. In addition, 2003 SG&A expenses include non-cash curtailment costs of $14 million related to the transition of certain U.S. defined benefit pension plans to defined contribution plans. These curtailment losses represent acceleration of pension expenses that would have been amortized to expense over a longer period of time.
Restructuring and other charges, net
In 2003, we initiated actions to further reduce our overall cost structure and support the implementation of our new geographic organization. In addition to cost reductions associated with the consolidation of our former Engineered Systems Group (ESG) and York Refrigeration Group (YRG) segments, additional actions included the further reduction of manufacturing capacity, elimination of certain product lines, and exiting of several small, non-core businesses. In 2004, we initiated further actions to reduce our overall manufacturing cost structure in the Americas and realign our EMEA business from a country organization to a pan European organization resulting in charges of $0.3 million and $2.1 million, respectively. In 2004 and 2003, we recorded restructuring and other charges of $1.3 million and
$97.3 million, respectively, related to these actions, including $5.5 million charged to cost of goods sold in 2003. Our 2003 restructuring initiatives resulted in savings of $31.9 million in 2004, compared to 2003. In 2004 and 2003, we recorded credits of $0.3 million and $0.5 million, respectively, related to 2000 and 2001 initiatives.
Interest expense, net
Net interest expense declined due to lower average borrowing rates. Our debt mix is 35% fixed and 65% variable. Weighted average fixed and variable interest rates were 4.9% in 2004 compared to 5.5% in 2003.
Equity in earnings of affiliates
The increase was primarily the result of improved performance of Clima Roca, our Spanish joint venture, as demand for residential HVAC equipment grew substantially and product was purchased at a lower cost from new Chinese suppliers.
Provision for income taxes
Our income tax provision of $13.4 million or effective rate of 14.1% in 2004 relates to both U.S. and non-U.S. operations. The 2004 income tax provision was lower than the U.S. statutory rate of 35% primarily due to the benefits of tax holidays in certain jurisdictions of $11.3 million, an $8.2 million tax benefit recorded in the second quarter following the conclusion of an examination by the IRS of our federal income tax returns for the years 1997 through 1999, export incentives claimed of $3.8 million, other favorable foreign rate differences of $11 million, research and development (R&D) credits of $4.7 million, $1.6 million reduction in the valuation allowance associated with a foreign tax loss carryforward, a $1.5 million benefit recorded in connection with a prior year restructuring action involving the disposition of foreign operations, and recognition of $1.3 million in foreign tax credits following enactment of the American Jobs Creation Act of 2004. These benefits were partially offset by increases to valuation allowances recorded in connection with certain foreign tax loss carryforwards of $7.7 million, operating losses in jurisdictions where no tax benefit was recognized of $6.7 million, the unfavorable tax impact of deemed and actual distributions of $8.9 million and a $2.1 million charge resulting from an adjustment in the rate at which state deferred income taxes are recorded.
Our effective tax rate decreased to 14.1% in 2004 compared to 18.9% in 2003. The decline in the effective tax rate was primarily due to the impact of the $8.2 million benefit recorded in the second quarter following the conclusion of the IRS examination of the years 1997-1999, offset by a decline in export incentive benefits of $4 million. It is anticipated that the effective tax rate will gradually increase in future years, primarily due to the phase-out of certain tax holidays, and a different geographic distribution of earnings.
Net deferred tax assets increased $25.5 million in 2004, primarily attributable to a reduction in the net deferred tax liability associated with plant, equipment, and intangible assets of $25.1 million and an
increase in deferred tax assets of $8.8 million relating to accrued expenses, offset by decreases in net deferred tax assets related to foreign tax loss carryforwards of $7.6 million. Based on our historical and current pre-tax earnings as well as projections of future taxable income, we believe it is more likely than not that we will realize the net deferred tax assets. The increase in the valuation allowance associated with U.S. state tax loss carryforwards is attributable to the increase in U.S. state tax loss carryforwards for which no benefit has been recorded. The valuation allowance on foreign tax loss carryforwards increased $9.5 million primarily due to adjustments to the beginning of the year balances resulting from continuing losses in certain jurisdictions ($7.7 million), and due to additional losses in jurisdictions where the deferred tax assets are not expected to be realized ($3.4 million), offset by the reduction of a valuation allowance in a jurisdiction due to improved operating performance ($1.6 million). Of the $40.5 million of gross deferred tax assets relating to foreign tax loss carryforwards, $5.3 million are subject to expiration limitations, and approximately $3.3 million ($1.9 million net of valuation allowance) are set to expire over the next three years. The remaining tax losses carry no expiration date.
The IRS is examining our Federal income tax returns for 2000, 2001, 2002, and 2003. Various other federal, state, and foreign tax returns are under examination by the applicable authorities. We do not anticipate any material adverse effect to our consolidated financial statements resulting from these examinations.
Cumulative effect of changes in accounting principles
On July 1, 2003 we adopted FASB Interpretation No. 46, "Consolidation of Variable Interest Entities," (FIN 46). Upon adoption we consolidated the variable interest entity used to transact our December 1999 sale-leaseback. As a result, we recorded a $15.4 million reduction to stockholder's equity. The reduction in stockholders' equity represents a reduction in retained earnings recorded as a cumulative-effect adjustment as of July 1, 2003. The retained earnings reduction represents the cumulative differences between our prior accounting of the transaction as a lease of property and the consolidation, which resulted in the reflection of the assets as owned depreciable equipment with a related debt obligation. The obligation relating to the sale-leaseback was repaid in full during the third quarter of 2003.
Segment Analysis
Global Applied
Americas benefited from volume increases for HVAC (mainly large tonnage chillers, commercial products, and air handling units) and refrigeration equipment driven by improved market conditions in North America and Latin America. EMEA sales growth is attributable to the favorable impact of foreign currency translation of $102 million; volume increases for HVAC equipment, mainly in Europe; and large chiller systems in the Middle East. Asia revenue increased primarily due to overall strong demand for commercial air conditioning equipment as China continued to grow and other regional economies resumed growth after an extended period of minimal growth. We expect China to provide further growth opportunities, however, slower growth rates may result from the Chinese government economic policy aimed at regulating expansion. Service business sales grew $79.1 million or 7.5% to $1,135.7 million, of which 3.8% is due to currency. Our service business (consisting of services, parts, and replacement equipment) continued to benefit from demand for repair and replacement work and multi-site commercial service arrangements. North American service business sales were negatively impacted by increased costs and inefficiencies due to the YORKConnect deployment in North America. We intend to continue to grow our service business as we change our business model to expand commercial service activities, offer new solutions to our customers, and improve our parts distribution. Additionally, the new business model is enabling us to successfully capture multi-site service contracts, which allow us to pull through our equipment as replacement of YORK and non-YORK equipment occurs. We will continue to focus on service business opportunities to capitalize on our installed base of equipment outside the U.S. and leverage our service business model.
Income from operations declined due to rising raw material and component cost increases net of price realization of approximately $21 million, costs and inefficiencies related to Americas' YORKConnect deployment, and pricing pressure in Asia and Europe partially offset by higher equipment volume, 2003 restructuring benefits, and improved profitability in Latin America. In 2005, we expect continued inefficiencies resulting from the deployment of YORKConnect to negatively impact income from operations in the first half of 2005 on a year over year basis. We believe the benefits of YORKConnect will be realized starting in 2006.
Unitary Products Group (UPG)
UPG revenues benefited from overall growth in the North American unitary residential heating and air conditioning market, general selling price increases enacted in the second quarter of 2004, and new product introductions, such as the "Affinity" product line. Residential, light commercial, and manufactured housing equipment volume increased year-over-year as new construction and replacement activity increased. North American unitary air conditioning industry shipments of compressor bearing units and furnaces increased 8.7% and 7.6%, respectively. UPG revenue growth compared to industry shipments indicates an overall market share gain in 2004 demonstrating market acceptance of our new products in the replacement market.
Income from operations improved mainly due to higher equipment volume, improved production efficiencies, and a positive product mix. These improvements were partially offset by increased raw material and component costs net of price increases of $9 million, investments in IT capabilities, marketing, and product development. During the first quarter of 2005, UPG raised selling prices again to counter the effect of 2005 steel and copper commodity cost increases. We expect our 2005 pricing actions to offset increasing costs above the 2004 levels.
Bristol Compressors (Bristol)
Revenue declined due to lower shipments to domestic OEMs partially offset by increased volume of lower priced applications to international customers. Reduced operating results are mainly attributable to increased raw material and component costs net of price increases of $16 million, lower priced applications to international customers, and product mix. We expect selling price increases to improve profitability in 2005. In addition, the successful introduction and market acceptance of the "Benchmark" compressor in 2005 is expected to improve Bristol's results in 2006.
General corporate expenses, eliminations, and other non-allocated items
General corporate expenses, eliminations, and other non-allocated items increased primarily due to the $20 million warranty charge for the UPG furnace inspection and remediation program discussed below; increased costs related to improving our IT capabilities of $20 million; and net decreased costs related to other non-allocated items of $1.2 million.
During the second quarter of 2004, we finalized field and factory testing to investigate failures found in heat exchangers of certain sealed combustion gas furnaces used in the manufactured housing industry. We found that installation and application factors combined with component part variation can result in excessive heat exchanger temperature, which may contribute to failures in certain furnace models manufactured in the years 1995 to 2000. We no longer produce these furnace models and our program for remediation has been approved by the U.S. Consumer Product Safety Commission. As a result, we recorded a $20 million warranty charge to cost of goods sold for the UPG furnace inspection and remediation program during the second quarter of 2004. The $20 million warranty charge represents our best estimate of inspection and repair costs within a reasonable estimated range between $13 million to $30 million. Repair cost estimates are mainly comprised of the expected cost of repair kits or new heat exchangers and installation labor. Our estimates are based upon the projected number of furnace units to be serviced (find rate), current repair costs, and the estimated number of furnace units requiring repair.
Differences between estimated and actual find rate, costs to manufacture and install repair kits or heat exchangers, and number of furnace units that require repair could have a significant impact on our quarterly results or further impact on our consolidated results of operations. We began to manufacture replacement parts and repair furnaces in the third quarter of 2004 and expect to complete the program by the end of 2006. Repair activity of $5.4 million was charged against the warranty reserve in 2004.
Charges and other expenses are as follows:
Restructuring and other charges related to the 2004 and 2003 initiatives and the 2001 and 2000 initiatives are discussed in the Consolidated Operations section above. Operating expenses in 2003 related to the Americas' cost reduction actions and consisted of costs related to the relocation of certain product lines. SG&A expenses in 2003 included a non-cash curtailment loss of $14 million related to the decision to replace our defined benefit pension plans for U.S. salaried non-bargaining and certain U.S. salaried bargaining employees with a new defined contribution plan, effective January 1, 2004.
RESULTS OF OPERATIONS 2003 AS COMPARED TO 2002
Consolidated Operations
Net sales
The net strengthening of global currencies increased net sales by $177.1 million or 4.6%. Our revenue growth was mainly attributable to growth in Global Applied service business sales (services, parts and replacement equipment) while equipment sales were flat. Higher commercial equipment sales in Asia were offset by lower commercial equipment sales in the Americas and EMEA. Growth in UPG sales was more than offset by a reduction in Bristol revenue. Continued strong residential new construction markets aided UPG growth, and Bristol sales were down due to lower sales to international OEMs and the loss of certain applications at U.S. OEMs. See further discussion below under Segment Analysis. The net strengthening of global currencies, primarily those in our EMEA region, resulted in 8.8% of the increase in non-U.S. sales.
Gross profit
The net strengthening of global currencies increased gross profit by $34 million. Increased profits also resulted from continued sales growth in Asia due primarily to economic growth in China, sales increases in the service business, and UPG sales growth and factory efficiencies resulting from prior restructuring actions. These improvements were offset by lower commercial equipment sales and competitive margin pressures in EMEA due to continued market softness; lower volume in Bristol, resulting in less absorption of fixed costs; and significant increases in the cost of steel. In 2003, cost of goods sold included $8.8 million resulting from manufacturing overhead duplication and $5.5 million of inventory write-downs related to strategic actions to rationalize our manufacturing capacity in Global Applied. In 2002, cost of goods sold included $0.1 million of restructuring charges, $6.8 million of costs related to cost reduction actions, and $0.8 million related to a discontinued product line.
Order backlog
Order backlog increased 6.8% due to the net strengthening of foreign currencies. The remaining improvement in Global Applied backlog is the result of continued strong orders in Asia, mainly China, and some improvement in North America commercial equipment markets. UPG and Bristol decreased a combined 1.4%, which typically are not backlog driven businesses.
SG&A expenses
The net strengthening of global currencies increased SG&A expenses $26 million or 4.5%. In 2003, SG&A expenses included $14 million of curtailment costs related to the transition of certain U.S. defined benefit pension plans to defined contribution plans. These curtailment losses represent acceleration of pension expenses that would have been amortized to expense over a longer period of time. This change is not expected to significantly alter pension expense or funding requirements in the short-term; however, we expect to benefit by reducing volatility in our pension expense and future funding requirements. Other increases include higher compensation expense, pension, medical and insurance costs, and continued investment in IT to improve our overall business systems and infrastructure.
Restructuring and other charges, net
In 2003, we initiated actions to further reduce our overall cost structure and support the implementation of our new geographic organization. These actions included the further reduction of manufacturing capacity, the elimination of certain product lines, the exiting of several small, non-core businesses, and the write-down of assets associated with a European joint venture, as well as cost reductions associated with the consolidation of our former ESG and YRG segments. In 2003, we recorded restructuring and other charges of $91.4 million, consisting of $91.9 million related to the 2003 actions and $0.5 million of cost reversals related to our prior years' restructuring actions. Included in the $91.4 million are $35.8 million of asset write-downs, $28 million of severance costs, $14.1 million of contractual and other
obligation costs of which $9.7 million relates to a product liability settlement associated with a discontinued product line, and $13.5 million of other costs. Other charges to operations included $5.5 million charged to cost of goods sold as discussed above. These charges are more fully discussed in Note 16 of Item 8. Financial Statements and Supplementary Data.
In 2000, we initiated a cost reduction process, which included plant closures and divestitures, product line and facility rationalizations, SG&A expense reductions, and other actions. In 2001, we expanded the scope of the cost reduction process to include additional plant closings and staff reductions. In 2002, we recorded a credit of $0.1 million related to these cost reduction actions.
Gain (loss) on divestiture
In 2002, we sold our air conditioning operations in Australia for $12.1 million. The sale resulted in a loss of $10.3 million. There was no similar transaction in 2003 and finalization of the Australia sale resulted in a gain of $0.3 million.
Interest expense, net
Net interest expense decreased due to lower average debt levels and a shift of debt from fixed to floating as a result of paying off $100 million of senior notes (interest rate of 6.75%) in March 2003. Lower average debt levels were somewhat offset by slightly higher average borrowing rates mainly due to higher interest rates in some non-U.S. markets and the increase in debt associated with the termination of our 1999 equipment sale-leaseback.
Equity in earnings of affiliates
The increase in equity in earnings of affiliates was primarily the result of improved performance of our Scroll Technologies joint venture.
Provision for income taxes
Our income tax provision of $2.7 million or effective rate of 18.9% in 2003 relates to both U.S. and non-U.S. operations. The 2003 income tax provision was lower than the U.S. statutory rate of 35% primarily due to the benefits of tax holidays in certain jurisdictions of $15.4 million, export incentives claimed of $7.8 million, other favorable foreign rate differences of $2.4 million, and R&D credits of $2.3 million. These benefits were partially offset by restructuring actions for which the tax benefit was less than the U.S. statutory rate of $14.7 million, operating losses in jurisdictions where no tax benefit was recognized of $3.6 million, and the unfavorable tax impact of deemed and actual distributions of $6.1 million.
Our effective tax rate decreased to 18.9% in 2003 compared to 24.1% in 2002. The decline in the effective tax rate was primarily due to the impact of export incentive benefits of $7.8 million on income before income taxes and cumulative effect of changes in accounting principles of $14.1 million in 2003 as compared to export incentive benefits of $3 million on income before income taxes and cumulative
effect of changes in accounting principles of $106.9 million in 2002. The impact of export incentive benefits was partially offset by an increase in taxes on foreign earnings in 2003.
Net deferred tax assets increased $49.9 million in 2003, primarily attributable to benefits associated with certain U.S. carry forward items, including U.S. foreign tax credits of $14 million; U.S. federal and state tax losses of $8.3 million; and U.S. R&D credits of $3.9 million; increases in deferred tax assets of $6.9 million and $5.6 million relating to inventories and warranties, respectively; and a decrease in deferred tax liabilities of $10.7 million associated with adoption of FIN 46.
Cumulative effect of changes in accounting principles
On July 1, 2003 we adopted FIN 46, as discussed above in the Results of Operation 2004 as Compared to 2003.
Segment Analysis
Global Applied
The net strengthening of global currencies, almost entirely in EMEA, increased net sales by $172 million or 6%. Our service business sales (service, parts, and replacement equipment) increased 15% to $1,057 million, of which 6% was due to currency. Commercial equipment sales were flat with higher sales levels in Asia offset by lower sales in the Americas and EMEA. Our pricing for large commercial equipment in the U.S. stabilized during 2003. Growth in Asia was mainly the result of the growing Chinese economy and to a lesser extent a mild recovery in other Asian economies. European commercial equipment markets declined in 2003.
The net strengthening of global currencies increased income from operations by $8.2 million, almost entirely in EMEA. Americas' increase is directly related to improved performance in Latin American countries where significant actions were taken to reduce operating costs by combining our former ESG and YRG businesses and improvement in markets, mainly Argentina. Additionally, improved equipment performance in Americas resulted from higher refrigeration product sales mainly to the food and beverage industry and cost reductions resulting from the relocation of assembly of large tonnage products, somewhat offset by continued large tonnage volume declines. Asia growth resulted from continued sales growth of equipment due mainly to China's economic growth and our strong market share in China. These increases were offset by declines in EMEA. Our EMEA decrease is primarily in the UK, Italy, Sweden and Germany, and is a direct result of lower equipment sales and competitive margin pressures in product and service markets.
Unitary Products Group (UPG)
UPG residential product sales improved, aided by the strength of the new home construction markets, and our light commercial sales were flat following spending patterns in commercial building. In 2003, we experienced an additional decline in sales of manufactured housing products. The manufactured housing market has declined steadily over the past three years. Overall, our air conditioning market share was generally flat compared to 2002.
The increase in income from operations was primarily due to $7.8 million related to improvements in production and logistics efficiencies in our Wichita factory and $20 million due to a more positive product mix, volume, and better pricing versus 2002. These increases were somewhat offset by $13.3 million of increased costs for steel and other operating expenses. Also included in the improvement was a 2002 write-off of a $5.9 million receivable related to a distributor that became insolvent.
Bristol Compressors (Bristol)
The decline in Bristol sales is primarily related to an 18% decrease in sales to international OEM customers and to a lesser extent, lower shipments to U.S. OEM manufacturers. In 2003, our new Benchmark compressor was introduced. Income from operations declined due to the continued decreases in larger applications and reductions in sales volume partially offset by steel cost increases.
General corporate expenses, eliminations and other non-allocated items
The increase in general corporate expenses, eliminations, and other non-allocated items was primarily due to $13.3 million for postretirement medical expenses, $10.5 million for incentive compensation expense, $6.4 million for IT project spending, and a net $5.6 million increase in other corporate and non-allocated costs including pension, insurance, minority interest, and corporate departments.
Charges and other expenses are as follows:
Restructuring and other charges related to the 2003 initiatives and the 2001 and 2000 initiatives are discussed in the Consolidated Operations section above. Operating expenses in 2003 related to the Americas' cost reduction actions and consisted of costs related to the relocation of certain product lines. SG&A expenses in 2003 included non-cash curtailment costs of $14 million related to the transition of certain U.S. defined benefit pension plans to defined contribution plans. In 2002, SG&A expenses included executive retirement costs of $2.3 million.
LIQUIDITY AND CAPITAL RESOURCES
Our significant liquidity and capital funding needs are working capital, operating expenses, capital expenditures, debt repayments, restructuring costs, dividends to our shareholders, contractual obligations, and commercial commitments. Liquidity and capital resource needs are met through cash flows from operations, borrowings under our credit agreements and bank lines of credit, financing of trade receivables, and credit terms from suppliers, which approximate receivable terms to our customers. Additional sources of cash include customer deposits and progress payments.
We believe that we will be able to satisfy our principal and interest payment obligations and our working capital and capital expenditure requirements from operating cash flows together with the availability under the uncommitted credit lines and committed bank lines of credit. Uncommitted credit lines and committed bank lines of credit support seasonal working capital needs and are available for general corporate purposes. Since certain of our long-term debt obligations and our revolving trade receivables facility bear interest at floating rates, our interest costs are sensitive to changes in prevailing interest rates.
In the ordinary course of business, we enter into various types of transactions that involve contracts and financial instruments. We enter into these financial instruments to manage financial market risk, including foreign exchange, commodity price, and interest rate risk. Financial instruments are more fully discussed in Note 11 of Item 8. Financial Statements and Supplementary Data and under the caption "Market Risk" below.
The following tables summarize our contractual obligations and other commercial commitments as of December 31, 2004:
(a) Unconditional payments of $43.9 million are included in IT service contracts and have been excluded from the caption "Unconditional purchase obligations." We are currently renegotiating one of our information technology service contracts and expect to significantly reduce our future contractual obligation. This service contract represents $382 million of total information technology service contracts as of December 31, 2004.
(b) We own 50% of a small refrigeration company and are contingently obligated to purchase the remaining 50% no later than 2014. Our purchase commitment can be accelerated under certain circumstances. The purchase price will be determined based upon the profitability of the company but cannot be less than $5 million, which amount is included in the table.
(c) We and another company participate in a manufacturing joint venture, Scroll Technologies (Scroll). We have guaranteed our share of the indebtedness of Scroll. In the event Scroll would default on its debt obligation, we are required to assume 50% of Scroll's outstanding debt.
We have postretirement and postemployment benefit obligations to certain employees and former employees. We are obligated to make contributions to our pension plans and postretirement health and life insurance plans. We are unable to determine the amount of plan contributions due to the inherent uncertainties of obligations of this type, including timing, interest rate charges, investment performance and amounts of benefit payments. Consequently, contributions are not included in the contractual obligations table above. We expect to contribute $19.3 million to postretirement and postemployment plans in 2005. These plans and our estimates of future contributions and benefit payments are more fully described in Note 12 of Item 8. Financial Statements and Supplementary Data.
As of December 31, 2004, our accrued postretirement and postemployment obligations were $245.5 million. In determining these obligations we make a number of estimates such as discount rate, rate of compensation increase, expected return on plan assets, and rate of increasing health care costs. Changes
in our assumptions could have a significant impact on our financial position, results of operations, and liquidity. A one-percentage point change in the discount rate would impact postretirement and postemployment benefit expense by approximately $8.2 million, and impact postretirement and postemployment benefit obligation by approximately $112.3 million. A one-percentage point change in the estimated rate of return on plan assets would impact postretirement and postemployment benefit expense by approximately $4.8 million. A one-percentage point increase in assumed health care cost trend rates would have increased our expense in 2004 $1.3 million and increased our postretirement benefit obligations $20.5 million.
WORKING CAPITAL
During 2004, the Euro and other European currencies appreciated significantly against the U.S. dollar. The impact of the net strengthening of foreign currencies on working capital is quantified within the respective captions below where significant.
Receivables
Receivables increased due to the overall increase in sales, foreign currency translation ($32.3 million), and mix of international sales with longer payment terms, partially offset by initiatives to improve cash collections. Average days sales outstanding remained at 50 days due to the offsetting effects of increased sales and cash collection initiatives.
Inventories
The rise in inventory levels was due to increased production to support current backlog in Global Applied, increased steel and copper commodity costs, foreign currency translation ($18.1 million), and strategies to manage business and component cost risk. We attempt to reduce the business risk related to inefficient IT implementations by increasing finished goods inventory prior to implementation. At the end of the third quarter, UPG manufactured additional finished goods inventory in order to meet demand in the event the implementation of the IT system caused production slow-downs. In addition, we partially mitigated the impact of expected higher component costs by purchasing additional components prior to the effective date of announced vendor price increases. In the fourth quarter of 2004, Bristol purchased additional motors to reduce the impact of vendor price increases that went into effect on January 1, 2005. Inventory turns decreased to 6.3 from 6.5 due to the aforementioned factors.
Prepayments and Other Current Assets
Prepayments and other current assets increased mainly due to appreciation in our foreign currency forward and commodity swap contracts ($10.2 million) and short term deferred income taxes ($5.8 million) partially offset by reduced prepaid insurance ($13.7 million). The fair value of our foreign currency forward and commodity swap contracts increased due to changes in foreign currency and commodity market prices. Our financial instruments are more fully described in Note 11 of Item 8. Financial Statements and Supplementary Data. Our deferred taxes are more fully described in Note 14 of Item 8. Financial Statements and Supplementary Data.
Accounts Payable and Accrued Expenses
The increase is due to foreign currency translation ($40.1 million); higher trade payables related to higher inventory levels; increased variable accrued expenses resulting from sales growth; and the current portion of the accrual for the UPG furnace and inspection remediation program. These increases were partially offset by a net decrease in restructuring accruals ($14.9 million). Restructuring accruals were the direct result of the 2004 and 2003 restructuring initiatives. Remaining accruals are expected to be utilized in 2005. Other payables and accruals increased due to increases in IT infrastructure spending and freight costs.
CASH FLOWS
Our operating cash flows funded our liquidity and capital resource needs in 2004, 2003 and 2002. We expect 2005 operating cash flows to be slightly higher than 2004. Seasonal working capital needs of approximately $100 million in the first half of 2005 are expected to be satisfied by a combination of uncommitted credit lines and committed bank lines of credit from our $400 million Five Year Credit Agreement. Positive net cash flow will be first applied to pay down committed lines of credit to ensure maximum availability of committed sources of capital.
Operating Activities
We generated $128.9 million of cash from operating activities in 2004. Net cash flows of $21.7 million were consumed from the change in assets and liabilities net of effects from acquisitions and divestitures. Remaining cash flows of $150.6 million were generated from our results of operations. Operating cash flows were utilized to fund our investing and financing activities.
We have consumed cash flows from the change in assets and liabilities net of effects from acquisitions and divestitures of $21.7 million in 2004, and generated $41.3 million, and $76.4 million, in 2003 and 2002, respectively. Our use of cash in 2004 reflects working capital increases, as discussed above. These increases in working capital were primarily in receivables and inventory, offset partially by increases in accounts payable and accrued expenses. In 2005, we do not expect to generate cash flows from reductions in working capital due to continued increases in raw material and component costs and the continued growth of our business.
Investing Activities
Cash used in investing activities of $80.1 million was mainly comprised of capital expenditures of $82.7 million for IT systems and replacement of manufacturing equipment. Capital expenditures are expected to be $95 million in 2005, an increase of $12.3 million mainly due to increased investment in manufacturing equipment to produce 13 SEER unitary products.
Financing Activities
Cash used in financing activities of $56 million included $46.4 million of net debt payments and $33.2 million of common stock dividend payments partially offset by proceeds from issuance of common
stock of $23.6 million. Net debt payments are consistent with our stated goals to reduce debt obligations. We do not anticipate the issuance of additional senior notes or purchase of our common stock during 2005. We paid annual cash dividends of $0.80 per share in 2004 and $0.60 per share in 2003 and 2002. We currently expect 2005 dividends to be consistent with 2004. Proceeds from issuance of common stock represents cash received from employee stock purchases and exercise of stock options under our employee stock plans. Employee stock plans include the 1992 Employee Stock Purchase Plan (ESPP), as amended, the 2002 Omnibus Stock Plan (2002 Plan), and the Amended and Restated 1992 Omnibus Stock Plan (1992 Plan). The ESPP authorizes employees to purchase up to 3 million shares of our common stock, inclusive of 0.5 million shares authorized by the stockholders in May 2004. The 2002 Plan was approved by shareholders in May 2002 and authorized the issuance of up to 3.8 million shares of our common stock as stock option or restricted stock awards. As of December 31, 2004, 0.4 million and 1.9 million shares remained available for purchase or grant under the ESPP and 2002 Plan, respectively. The 1992 Plan, which authorized the issuance of up to 8.4 million shares, expired in August 2002 and the remaining shares of 0.9 million were cancelled.
Our financing activities have used cash of $56 million, $114.8 million, and $133.2 million in 2004, 2003, and 2002, respectively. The declining trend is mainly attributable to the changes in working capital discussed above. As our business grows and we make additional investments, less cash is used by financing activities.
BORROWINGS AND AVAILABILITY
Total indebtedness was $565 million as of December 31, 2004, primarily consisting of $500 million of senior notes and $31.8 million outstanding under domestic bank lines. The senior notes mature at dates ranging from 2006 to 2012 and carry fixed rates ranging from 5.8% to 6.7% ($200 million of which was swapped to floating rates).
The following table summarizes the terms of our lines of credit:
(a) Availability is reduced for outstanding borrowings and bank guarantee and letters of credit usage.
(b) The one-month LIBOR (London Interbank Offering Rate) rate was 2.38% and 1.10% as of December 31, 2004 and December 31, 2003, respectively.
(c) We renewed our 364-Day Credit Agreement in March 2005.
We expect to renew the Five Year Credit Agreement prior to expiration. If we are unable to renew or replace the agreement, any amounts outstanding, including amounts outstanding under domestic bank lines, will be reported in current liabilities in our consolidated balance sheet and reduce our working capital.
The Five Year Credit Agreement and 364-Day Credit Agreement (collectively, the Agreements) contain financial covenants requiring us to maintain certain financial ratios and standard provisions limiting leverage and liens. We were in compliance with these financial covenants as of December 31, 2004 and 2003. We have access to bank lines of credit and have the ability to borrow under the Agreements as long as we continue to meet the financial covenants or until expiration of these arrangements. The primary financial covenants are the earnings before interest, taxes, depreciation, and amortization (EBITDA) interest coverage and the debt to capital ratio, as defined under the Agreements. As of December 31, 2004, our EBITDA interest coverage was 5.16 times, exceeding the minimum requirement of 3.5 times. As of December 31, 2004, our debt to capital ratio, as defined in the Agreements, was 39%, below the maximum allowed of 50%.
We also maintain an annually renewable revolving facility under which we sell certain trade receivables. (See Off-Balance Sheet Arrangements section below.)
OFF-BALANCE SHEET ARRANGEMENTS
Our off-balance sheet arrangements are comprised of a trade receivable revolving facility and operating leases.
Trade Receivable Revolving Facility
Pursuant to the terms of an annually renewable revolving facility, we sell certain of our trade receivables to a wholly-owned consolidated subsidiary, York Receivables Funding LLC (YRFLLC). In turn, YRFLLC sells, on a revolving basis, undivided ownership interests in the purchased trade receivables to bank administered asset-backed commercial paper vehicles. In May 2004, we amended the facility, increasing the availability from $150 million to $200 million. We continue to service sold trade receivables. No servicing asset or liability has been recognized as our cost to service sold trade receivables approximates the servicing income.
In accordance with the facility, YRFLLC has sold $135 million and $150 million of undivided interests in trade receivables as of December 31, 2004 and 2003, respectively, resulting in a reduction of receivables reflected in our consolidated balance sheets. The discount rate on trade receivables sold was 2.38% and 1.12% as of December 31, 2004 and 2003, respectively. The program fee on trade receivables sold was 0.40% and 0.50% as of December 31, 2004 and 2003, respectively.
The bank-administered commercial paper vehicles that purchase the YRFLLC trade receivables provide a lower cost of funds than the committed credit lines. We expect to renew the revolving facility at a level equal to or greater than $200 million.
The trade receivable balances reflect the seasonal nature of the business segments in which we are a competitor. Receivable balances reach a peak in the second quarter then continue to decline until the end of the first quarter. On a seasonal basis the total receivable balance has trended downward for the past two years and as a result we have reduced the amount outstanding accordingly. We believe the trade receivable program is an effective source of financing at current competitive rates. While we do not anticipate making major changes to this agreement, we do not believe any changes would have a significant impact on our liquidity.
Operating Leases
Operating leases provide us with the flexibility to use property, plant and equipment without assuming ownership and related debt. Operating leases reduce our risk associated with disposal and residual fair value of property, plant and equipment at the end of the lease. Our contractual obligations under operating leases are included in the summary of contractual obligations in the "Liquidity and Capital Resources" section above.
OUTLOOK
Overall, we expect 2005 revenues and net income to exceed 2004 results without considering the effects of new accounting standards. We anticipate 2005 net income to improve in dollars and as a percent of net sales. We expect increased revenue in our service business (services, parts and replacement equipment) within Global Applied; modest growth in Asia, Americas, and UPG; and stability at Bristol partially offset by an overall decline in EMEA equipment revenue. Our expectations are challenged by the continual rise in commodity costs, principally steel and copper. We have announced general selling price increases that we expect will mitigate the expected rise in raw material and component costs. We expect incremental raw material and component cost increases in 2005 of $100 million above 2004 levels, without considering realization of selling price increases. Our pricing actions are expected to fully offset expected rising commodity costs.
Global Applied
We have positioned our service business for further growth as a result of our large installed base, service capabilities and our focus on multi-site commercial service arrangements. Our service business sales are expected to grow 10% or more in 2005 as we leverage our service business model. Inefficiencies resulting from the deployment of YORKConnect are expected to continue to negatively impact income from operations in the first half of 2005 on a year over year basis. We believe the benefits of YORKConnect will be realized starting in 2006.
We expect continued growth and market share gain in the middle market product lines. Americas is expected to continue benefiting from new air handling and chiller products introduced in 2004 and strength in Latin American economies. Pricing for large commercial equipment in the United States is expected to remain consistent with 2004 levels based upon current backlog and slightly higher new orders. Anticipated Asia growth is mainly the result of the growing Chinese economy. China's economic and commercial construction expansion continues to drive demand for large commercial equipment and, as a result, our sales growth rate in China is expected to be twice the growth rate of the Chinese economy again in 2005. Large commercial equipment sales are expected to be robust in the Middle East as substantial investments are being made in the region. European commercial equipment markets declined in 2003 and 2004 and are expected to continue to decline in 2005 due to general economic conditions. We expect pricing pressures in EMEA and China.
Unitary Products Group
UPG growth is expected from continued strength in the U.S. light commercial and residential markets and replacement markets demand for our recently introduced products. Residential construction and replacement activity was strong in 2004 and we expect our residential sales to be in line with market expectations in 2005.
Bristol
Bristol revenue is expected to remain at 2004 levels as sales of the new "Benchmark" compressor begin to replace older compressor technologies. The expectation is that Bristol will ship fewer compressors to international OEMs, but price increases will offset this revenue reduction.
Information Technology Projects
We expect investments in business applications and global IT infrastructure to remain consistent with 2004. These investments will leverage our cost structure, achieve operational efficiencies, and enhance supply chain capabilities. These investments are necessary to standardize global processes and enable future growth.
Financing Costs and Income Taxes
We expect higher net interest expense due to rising average borrowing rates. Our tax rate is expected to be 27% for 2005 based upon current estimated income levels and employed tax strategies. Our tax rate does not include the effects, if any, from the special one-time dividends received deduction on the repatriation of certain foreign earnings as allowed by the American Jobs Creation Act of 2004.
Cash Flow
We anticipate positive cash flow of approximately $55 million in 2005 before dividends, acquisitions, divestitures, and net debt payments. We expect capital expenditures to be approximately $95 million and depreciation and amortization expense of approximately $79 million. The higher level of capital spending is directly related to manufacturing equipment to produce 13 SEER unitary products. In addition, we currently anticipate paying annual dividends of approximately $34 million in 2005 consistent with 2004.
Other
As a result of the appreciation of our common stock price, we expect an increase in our average shares outstanding in 2005 due to the dilutive impact of stock options.
INFLATION
We believe inflation, other than rising raw material costs, has not had a significant impact on our consolidated results of operations for the periods presented. We were able to substantially offset the effect of inflation through our cost reduction programs implemented in 2003. We do not anticipate inflation having a significant impact on our future consolidated results of operations. However, as we enter 2005, steel and copper prices continue to increase, and represent an inflationary risk. See discussion on commodity price risk in the Market Risk section (Item 7a.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
We are exposed to market risk associated with changes in foreign currency exchange rates, certain commodity prices, and interest rates.
We do not typically hedge our market risk exposures beyond three years and do not anticipate any material changes in our primary market risk exposures in 2005. We do not hold or issue derivative instruments for trading purposes.
We mitigate the risk that the counter-party to currency, commodity, and interest rate financial instruments will fail to perform by only entering into financial instruments with major international financial institutions. Financial instruments are more fully discussed in Note 11 of Item 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Exchange Act Rules 13a - 15(f). Our internal control over financial reporting is 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. Our internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
(ii) 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 authorization of management and directors of the Company; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our 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.
Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under that framework we concluded our internal control over financial reporting, as of December 31, 2004, was effective. KPMG LLP, an independent registered public accounting firm, has issued an attestation report, included herein, on our assessment of the effectiveness of our internal control over financial reporting, as of December 31, 2004.
York International Corporation
March 14, 2005
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders York International Corporation:
We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting that York International Corporation maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). York International Corporation's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
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.
In our opinion, management's assessment that York International Corporation maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, York International Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of York International Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive income (loss), cash flows and stockholders' equity for each of the years in the three-year period ended December 31, 2004, and our report dated March 14, 2005 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Harrisburg, Pennsylvania March 14, 2005
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders York International Corporation:
We have audited the accompanying consolidated balance sheets of York International Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive income (loss), cash flows and stockholders' equity for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of York International Corporation and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of York International Corporation's internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 14, 2005 expressed an unqualified opinion on management's assessment of, and the effective operation of, internal control over financial reporting.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for variable interest entities in 2003 and its method of accounting for goodwill and other intangible assets in 2002.
/s/ KPMG LLP
Harrisburg, Pennsylvania March 14, 2005
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
The accompanying notes are an integral part of these statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
York International Corporation (the Company, which may be referred to as we, us, or our) is a global provider of heating, ventilating, air conditioning, and refrigeration (HVAC&R) products and services. We market our products and services throughout the world, and our customers range from residential contractors to design builders, commercial contractors, building owners, and original equipment manufacturers. Effective January 1, 2003, we consolidated our former York Refrigeration Group (YRG) and Engineered Systems Group (ESG) segments and reorganized management of the combined business. Our new organization consists of: Global Applied, Unitary Products Group, and Bristol Compressors. The Global Applied business is comprised of three geographic regions: the Americas; Europe, Middle East, and Africa (EMEA); and Asia. Global Applied's three geographic regions, Unitary Products Group, and Bristol Compressors represent our reportable segments.
USE OF ESTIMATES
Preparation of the consolidated financial statements, in conformity with accounting principles generally accepted in the United States of America (U.S.), requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Our actual results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of York International Corporation and its wholly-owned and majority-owned subsidiaries. We eliminate all significant intercompany transactions.
CASH AND CASH EQUIVALENTS
We consider all highly liquid investments with original maturities of three months or less to be cash equivalents.
RECEIVABLES
We offer trade terms to our customers in the normal course of business. Receivables are reported at original carrying value net of the allowance for doubtful receivables. Trade terms are extended to customers based upon credit worthiness and general economic and market conditions. We record an allowance for doubtful receivables based upon our historical experience of bad debts and when collection of specific receivables is not probable and can be estimated.
INVENTORIES
We state inventories at the lower of cost or market using the last-in, first-out (LIFO) or first-in, first-out (FIFO) method.
In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 151, "Inventory Costs." This standard amends the guidance in Accounting Research Bulletin (ARB) No. 43, and requires the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material to be treated as current-period charges. In addition, the standard requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The standard is effective for inventory costs
incurred beginning July 1, 2005. This standard is not expected to materially impact our consolidated financial statements.
PROPERTY, PLANT, AND EQUIPMENT
We state property, plant, and equipment at cost, less accumulated depreciation. Maintenance and repairs are expensed as incurred. Significant improvements and renewals are capitalized and depreciated. Depreciation is computed generally on a straight-line basis over the estimated useful lives of the assets as follows:
Buildings 15-30 years Machinery and equipment 3-12 years
GOODWILL
We do not amortize goodwill, instead we test segment goodwill for impairment in the fourth quarter of each year. Goodwill is tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a segment below its carrying amount. We identify potential goodwill impairment by comparing the fair value of a segment with its carrying amount, including goodwill. Fair value is determined using a discounted cash flow and market-multiple approach. If the fair value of a segment exceeds its carrying amount, goodwill of the segment is not considered impaired. If the carrying amount of a segment exceeds its fair value, the amount of goodwill impairment loss, if any, must be measured. The amount of goodwill impairment loss is measured by comparing the implied fair value of segment goodwill with the carrying amount of that goodwill. If the carrying amount of segment goodwill exceeds the implied fair value of goodwill, an impairment loss is recognized as an operating expense. No impairment of goodwill was recorded in 2004, 2003, or 2002. See Cumulative Effect of Changes in Accounting Principles regarding the impact of adopting SFAS No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142).
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS
We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of an asset or asset group to be held and used is measured by comparing the carrying amount to future net cash flows expected to be generated. If the carrying amount exceeds estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount exceeds fair value. Assets or asset groups to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
We provide postretirement and postemployment benefits to certain of our employees and former employees. These benefits include pension, salary continuance, severance, life insurance, and health care. Benefits are accrued over the employees' service periods or at the date of the event triggering the benefit.
Information related to the adoption of FASB Staff Position No. FAS 106-2, "Accounting and Disclosure Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003," is presented in Note 12.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We apply SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," an amendment to SFAS No. 133, in accounting for derivatives and hedging activities. These statements
require that all derivative instruments be recognized in the balance sheet at fair value and establish criteria for the designation of hedges and the determination of effectiveness of hedging relationships for fair value and cash flow hedges.
We are exposed to market risk associated with changes in interest rates, foreign currency exchange rates, and certain commodity prices. To enhance our ability to manage these market risks, we enter into derivative instruments for periods consistent with the related underlying hedged exposures. The changes in fair value of these hedging instruments are offset in part or in whole by corresponding changes in fair value or cash flows of the underlying hedged exposures. We mitigate the risk that the counter-party to these derivative instruments will fail to perform by only entering into derivative instruments with major financial institutions. We do not typically hedge our market risk exposures beyond three years and do not hold or issue derivative instruments for trading purposes.
The recognized amount in cost of goods sold due to the discontinuance of ineffective commodity cash flow hedges was a gain of $0.4 million for the year ended December 31, 2003. No gain or loss was recognized in the year ended December 31, 2004 as we did not discontinue any commodity cash flow hedges. Certain derivative instruments are not designated as hedging instruments as they hedge immaterial exposures.
Currency Rate Hedging
We manufacture and sell our products in a number of countries throughout the world, and therefore, are exposed to movements in various currencies against the U.S. dollar and against the currencies in which we manufacture. Through our currency hedging activities, we seek to minimize the risk that cash flows resulting from the sale of products, manufactured in a currency different from the currency used by the selling subsidiary, will be affected by changes in foreign currency exchange rates. Foreign currency derivative instruments (forward contracts) are matched to the underlying foreign currency exposures and are executed to minimize foreign exchange transaction costs.
Changes in fair value of foreign currency derivative instruments, qualifying as cash flow hedges, are reported in accumulated other comprehensive losses. The gains or losses on these hedges are reclassified to earnings as the underlying hedged items affect earnings. As of December 31, 2004, we forecasted that $2.4 million of net losses in accumulated other comprehensive losses will be reclassified into earnings within the next twelve months.
Hedge of Net Investment
We issued Danish Kroner denominated, retail notes as a hedge to protect the value of a portion of our net investment in a Danish subsidiary. Hedges of a net investment are accounted for under SFAS No. 52, "Foreign Currency Translation." Under SFAS No. 52, the gains or losses on a foreign - denominated, nonderivative financial instrument designated as a hedge of a net investment are recorded in foreign currency translation adjustments within accumulated other comprehensive losses. The gains and losses are accounted for in a similar manner as the foreign denominated net assets, offsetting a portion of the change in net assets due to foreign currency fluctuations. We redeemed the 250 million Danish Kroner retail notes in October 2004.
Commodity Price Hedging
We purchase raw material commodities and are at risk for fluctuations in the market price of those commodities. In connection with the purchase of major commodities, principally copper for manufacturing requirements, we enter into commodity swap contracts to effectively fix our cost of the commodity. These contracts require each settlement between us and our counterparty to coincide with cash market purchases of the actual commodity.
Changes in the fair value of commodity derivative instruments qualifying as cash flow hedges are reported in accumulated other comprehensive losses. The gains or losses are reclassified to earnings as the underlying hedged items affect earnings. As of December 31, 2004, we forecasted that $15.9 million of net gains in accumulated other comprehensive losses will be reclassified into earnings within the next twelve months.
Interest Rate Hedging
We manage our interest rate risk by entering into both fixed and variable rate debt. In addition, we enter into interest rate swap contracts in order to achieve a balanced mix of fixed and variable rate indebtedness. Under these contracts, we agree to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated from an agreed upon referenced notional amount. The notional amounts are not exchanged and no other cash payments are made unless the contract is terminated prior to maturity.
We have designated our outstanding interest rate swap contracts as fair value hedges of an underlying fixed rate debt obligation. The fair value of these contracts is recorded in other long-term assets or liabilities with a corresponding increase or decrease in the fixed rate debt obligation. The change in fair values of both the fair value hedge instruments and the underlying debt obligations are recorded as equal and offsetting unrealized gains and losses in the net interest expense component of our consolidated statements of operations. All existing fair value hedges are determined to be 100% effective under SFAS No. 133, as amended. As a result, there is no impact on current earnings resulting from hedge ineffectiveness.
REVENUE RECOGNITION
In the normal course of business, we sell HVAC&R products and services. Our products and services include individual sales of products, long-term contracts, extended warranty and maintenance arrangements, and other services, such as repair work, installation, and rental. We also sell our products and services in bundled arrangements.
Revenue from the sale of products is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the sale price is fixed or determinable, and collectibility is reasonably assured. Properly executed and authorized contracts, purchase orders or point of sale receipts provide evidence that an arrangement exists and the sale price is fixed or determinable. Delivery occurs when title and the risks and rewards of ownership transfer to the customer pursuant to shipping terms. Collectibility is determined based upon a customer's credit worthiness. Revenue under long-term contracts is recognized on a percentage of completion or completed contracts basis. Percent complete is determined as the ratio of costs incurred to date to the total estimated costs under the contract. Revenue under extended warranty and maintenance agreements is recognized over the terms of the agreements on a straight-line basis, unless the costs to perform under the agreements are incurred on other than a straight-line basis. Under those circumstances, revenue under extended warranty and maintenance agreements is recognized in proportion to the costs expected to be incurred. Service revenues are recognized upon performance of the service. Rental revenue is recognized over the term of the agreement on a straight-line basis.
Our bundled arrangements represent agreements under which we sell multiple products, multiple services, or multiple products and services. These arrangements include general rights of return for our failure to perform as specified under the terms of the agreements. On July 1, 2003, we adopted Emerging Issues Task Force (EITF) Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." This requires that we divide bundled arrangements into separate deliverables. Revenue is allocated to each deliverable based upon the relative fair value of all elements or the fair value of undelivered elements. Revenue is recognized for each deliverable as described above. We adopted EITF Issue No. 00-21 prospectively; therefore, it was only applied to bundled arrangements entered into after
June 30, 2003. Prior to July 1, 2003, we recognized revenue under bundled arrangements in a similar manner. The adoption did not have a material impact to our consolidated financial statements.
We record amounts billed to customers for shipping and handling in net sales and the related shipping and handling costs in cost of goods sold.
PRODUCT RELATED EXPENSES
We charge advertising, research and development, and other product-related costs to expense as incurred. Advertising expense was $30.2 million, $27.5 million, and $23.6 million in 2004, 2003, and 2002, respectively. Research and development (R&D) costs were $47.7 million, $42.3 million, and $42.2 million in 2004, 2003, and 2002, respectively. We record warranty liabilities at the time of product sale. Estimated warranty costs are based upon the historical trend of warranty claims and specifically identifiable claims and include estimated costs for labor and parts. Warranty expense was $83.7 million, $81.2 million, and $64.9 million in 2004, 2003, and 2002, respectively and is a component of cost of goods sold. Changes in our warranty liability for the years ended December 31, 2004 and 2003 were as follows:
Warranties include standard warranties and extended warranty contracts sold to customers to increase the warranty period beyond the standard period. Extended warranty contracts sold are reflected as accruals for warranties issued and amortized revenue is reflected as payments made under warranties in the above table.
During 2004, we finalized field and factory testing to investigate failures found in heat exchangers of certain sealed combustion gas furnaces used in the manufactured housing industry. We found that installation and application factors combined with component part variation can result in excessive heat exchanger temperatures, which may contribute to failures in certain furnace models manufactured in the years 1995 to 2000. We no longer produce these furnace models and our program for remediation has been approved by the U.S. Consumer Product Safety Commission. As a result, we recorded a $20 million warranty charge to cost of goods sold for the Unitary Products Group furnace inspection and remediation program in 2004. The $20 million warranty charge represents our best estimate of inspection and repair costs within a reasonable estimated range of $13 million to $30 million. Repair cost estimates are mainly comprised of the expected cost of repair kits or new heat exchangers and installation labor. Our estimates are based upon the projected number of furnace units to be serviced (find rate), current repair costs, and the estimated number of furnace units requiring repair. Differences between estimated and actual find rate, costs to manufacture and install repair kits or heat exchangers, and number of furnace units that require repair could have a significant impact on our quarterly results or further impact on our consolidated results of operations. We began to manufacture replacement parts and repair furnaces in the third quarter of 2004 and expect to complete the program by the end of 2006. Repair activity of $5.4 million was charged against the warranty reserve in 2004.
RESTRUCTURING
On January 1, 2003, we adopted SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The statement addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." Under the statement, we recognize liabilities at fair value for costs associated with exit or disposal activities only when the liability is incurred. Prior to January 1, 2003, we recognized costs when we committed to an exit or disposal plan in accordance with EITF Issue No. 94-3.
Information related to our restructuring activities is presented in Note 16.
INCOME TAXES
We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Earnings of foreign operations are reinvested in the business and no provision for domestic income tax or foreign withholding tax is made on such earnings until distributed.
In October 2004, the American Jobs Creation Act of 2004 became law. The act provides tax relief to U.S. domestic manufacturers by providing a tax deduction up to nine percent (when fully phased-in) of the lesser of (a) "qualified production activities income," as defined in the act, or (b) taxable income after the deduction of the utilization of net operating loss carryforwards. In December 2004, the FASB issued Staff Position No. FAS 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004," effective upon issuance. The standard provides guidance that the deduction should be accounted for as a special deduction in accordance with SFAS No. 109. We believe the impact of adoption will be immaterial to our consolidated financial statements.
In addition to the tax deduction provided by the American Jobs Creation Act of 2004, the act also allows a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer. In December 2004, the FASB issued Staff Position No. FAS 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" (FSP 109-2). The staff position allows companies time beyond the financial reporting period of enactment to evaluate the effect of the act on its plan for reinvestment or repatriation of foreign earnings and requires disclosures for reasons why a company has not completed its evaluation of the repatriation provision for purposes of applying SFAS No. 109 (see Note 14 regarding our evaluation of the effect of the act).
CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES
On July 1, 2003 we adopted FASB Interpretation No. 46, "Consolidation of Variable Interest Entities," an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." Upon adoption we consolidated the variable interest entity used to transact our December 1999 sale-leaseback. As a result, we recorded approximately $82.4 million of incremental debt, $23.9 million of incremental net machinery and equipment, $10.7 million of incremental deferred tax assets, a $15.4 million reduction to stockholders' equity, and a $32.4 million reduction to other long-term liabilities. The reduction in stockholders' equity represents a reduction in retained earnings recorded as a cumulative-effect adjustment as of July 1, 2003 in our consolidated statement of operations. The retained earnings reduction represents the cumulative differences between our prior accounting of the transaction as a lease of equipment and the consolidation, which resulted in the reflection of the assets as owned
depreciable equipment with a related debt obligation. The obligation relating to the sale-leaseback was repaid in full during the third quarter of 2003.
Upon adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," we were required to perform a transitional goodwill impairment test as of January 1, 2002. The transitional goodwill impairment test indicated an impairment existed in one of our segments. The projected financial performance of our former York Refrigeration Group, which included the entities acquired in the Sabroe acquisition, was insufficient to support the related goodwill. As a result, we recognized a non-cash transitional goodwill impairment charge of $179.4 million. As required, the transitional goodwill impairment charge was recorded as a cumulative effect of a change in accounting principle in our consolidated statement of operations as of January 1, 2002.
EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is based upon the weighted average common shares outstanding during the period. Diluted earnings (loss) per share is based upon the weighted average outstanding common shares and common share equivalents.
FOREIGN CURRENCY TRANSLATION
The functional currency for the majority of our foreign operations is the applicable local currency. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in foreign currency translation adjustments in accumulated other comprehensive losses. Gains or losses resulting from foreign currency transactions are included in our results of operations.
ACCOUNTING FOR STOCK-BASED COMPENSATION
We apply the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for our stock-based compensation plans. Accordingly, no compensation expense has been recognized for the stock-based compensation plans other than for restricted stock and performance-based awards. Had compensation expense for all stock and employee stock purchase plans been determined based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed under SFAS No. 123, "Accounting for Stock-Based Compensation," as amended, our net income (loss) and earnings (loss) per share would have been adjusted to the pro forma amounts as follows:
Since the determination of fair value of all stock options granted includes variable factors, including volatility, and additional stock option grants are expected to be made each year, the above pro forma disclosures are not representative of pro forma effects on reported net income and earnings per share for future years.
The per share weighted average fair value of stock options granted during 2004, 2003, and 2002 is calculated as $14.49, $7.74, and $15.13, respectively, on the date of grant using the Black-Scholes option-pricing model. The weighted average assumptions based on the date of grant are as follows:
Information related to stock-based compensation awards is presented in Note 18 along with the additional disclosures required under SFAS No. 123.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment." This standard addresses the accounting for share-based compensation in which we exchange employee services for (a) our equity instruments or (b) liabilities that are based on the fair value of our equity instruments or that may be settled by the issuance of our equity instruments. Under the standard, we will recognize compensation cost for share-based compensation issued to or purchased by employees under our stock-based compensation plans using a fair-value-based method effective July 1, 2005. The impact the standard will have on our consolidated financial statements is not known at this time, however, it may reduce net income and earnings per share similar to the amounts disclosed above.
GUARANTEES
On December 31, 2002, we adopted FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." The interpretation elaborates on the disclosures to be made in our interim and annual financial statements
about obligations under certain guarantees. Effective January 1, 2003, we recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The interpretation did not have a material impact on our consolidated financial statements.
Information related to our guarantees is presented in Note 13 along with the additional disclosures required.
COMMITMENTS AND CONTINGENCIES
Liabilities for loss contingencies, including environmental remediation costs, arising from claims, assessments, litigation, fines, and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment or remediation can be reasonably estimated. Recoveries for environmental remediation cost from third parties, which are probable of realization, are separately recorded, and are not offset against the related environmental liability.
Information related to our commitments and contingencies is presented in Note 13.
RECLASSIFICATIONS
Certain reclassifications have been made to the 2003 and 2002 consolidated financial statements to conform to the 2004 presentation.
These reclassifications include adjustments to current and deferred income tax assets and liabilities, current portions of postretirement benefits, other receivables, accrued expenses, and other miscellaneous items. Additionally, the presentation of cash flows from the sale of trade receivables were reclassified as operating activities.
NOTE 2-RECEIVABLES, NET
Receivables, net consists of:
Pursuant to the terms of an annually renewable revolving facility, we sell certain of our trade receivables to a wholly-owned, consolidated subsidiary, York Receivables Funding LLC (YRFLLC). In turn, YRFLLC sells, on a revolving basis, undivided ownership interests in the purchased trade receivables to bank-administered asset-backed commercial paper vehicles. In May 2004, we amended the facility, increasing the availability from $150 million to $200 million. We continue to service sold trade receivables. No servicing asset or liability has been recognized as our cost to service sold trade receivables approximates the servicing income.
In accordance with the facility, YRFLLC has sold $135 million and $150 million of undivided interests in the trade receivables as of December 31, 2004 and 2003, respectively, resulting in a reduction of receivables reflected in our consolidated balance sheets. The discount rate on trade receivables sold was 2.38% and 1.12% as of December 31, 2004 and 2003, respectively. The program fee on trade receivables sold was 0.40% and 0.50% as of December 31, 2004 and 2003, respectively.
NOTE 3--INVENTORIES
Inventories valued under the LIFO method comprised approximately 20% and 21% of the December 31, 2004 and 2003 totals, respectively. If valued under the FIFO method, inventories would have been greater by $13.8 million and $11.1 million as of December 31, 2004 and 2003, respectively.
NOTE 4--PREPAYMENTS AND OTHER CURRENT ASSETS
Prepayments and other current assets consist of:
NOTE 5--INVESTMENTS IN AFFILIATES
We own interests in affiliate operations located in the U.S., Spain, Malaysia, Saudi Arabia, Denmark, Japan, Korea, and South Africa. These investments are accounted for using the equity method and total $35.7 million and $28.2 million as of December 31, 2004 and 2003, respectively. Dividends received from affiliates were $3.9 million, $2.2 million, and $2.1 million in 2004, 2003, and 2002, respectively. Our sales to affiliates are less than 1% of our net sales, and our purchases from affiliates are less than 2% of our total purchases.
NOTE 6--PROPERTY, PLANT, AND EQUIPMENT, NET
Property, plant, and equipment, net consists of:
Amortization of plant and equipment under capital leases has been included in accumulated depreciation and amortization. Accumulated amortization was $1.9 million and $2.2 million as of December 31, 2004 and 2003, respectively.
NOTE 7--GOODWILL
The changes in the carrying amount of goodwill for the years ended December 31, 2004 and 2003 by segment, are as follows:
As discussed in Note 1, we perform an annual goodwill impairment test in the fourth quarter of each year. No impairment of goodwill was required as a result of this annual test in 2004, 2003, or 2002.
NOTE 8--INTANGIBLES, NET
The following table summarizes the major intangible asset classes subject to amortization included in our consolidated balance sheets as of December 31, 2004 and 2003:
Amortization expense for trade names and trademarks and other intangible assets was $1.6 million, $1.7 million, and $1.2 million for the years ended December 31, 2004, 2003, and 2002, respectively. Estimated amortization expense for trade names and trademarks and other intangible assets for the fiscal years indicated is as follows:
NOTE 9--ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of:
NOTE 10--NOTES PAYABLE AND LONG-TERM DEBT
Notes payable and long-term debt consists of:
The domestic bank lines are classified as long-term, as they are supported by our Five Year Credit Agreement, which matures on May 29, 2006.
Annual principal payments on long-term debt are as follows for the fiscal years indicated:
Interest expense is net of interest income of $9.5 million, $9 million, and $8.2 million in 2004, 2003, and 2002, respectively.
The following table summarizes the terms of our lines of credit:
(a) Availability is reduced for outstanding borrowings and bank guarantee and letters of credit usage.
(b) The one-month LIBOR (London Interbank Offering Rate) rate was 2.38% and 1.10% as of December 31, 2004 and December 31, 2003, respectively.
(c) We renewed our 364-Day Credit Agreement in March 2005.
The Five Year Credit Agreement and 364-Day Credit Agreement contain financial covenants requiring us to maintain certain financial ratios and standard provisions limiting leverage and liens. We were in compliance with the financial covenants as of December 31, 2004 and 2003.
NOTE 11--FINANCIAL INSTRUMENTS
FOREIGN CURRENCY INSTRUMENTS
The following table reflects the notional and estimated fair values of forward currency contracts outstanding as of December 31, 2004 and 2003. Foreign currency amounts were translated at current exchange rates as of the balance sheet date. Fair values reflect the estimated net amount that we would pay to terminate the contracts, as of the reporting date, based on quoted market prices.
The following table summarizes our contractual amounts of forward currency contracts as of December 31, 2004 and 2003. Foreign currency amounts were translated at current exchange rates as of the reporting date. The "buy" amounts represent the U.S. dollar equivalent of commitments to purchase currencies and the "sell" amounts represent the U.S. dollar equivalent of commitments to sell currencies.
COMMODITY CONTRACTS
The following table reflects the pounds hedged, notional amount, and estimated fair value of our commodity hedging contracts for copper outstanding as of December 31, 2004 and 2003.
(in thousands)
INTEREST RATE INSTRUMENTS
The following table reflects our interest rate swap contracts to pay variable interest and receive a blended fixed rate of interest of 6.213%, on a notional amount of $200 million ($100 million related to senior notes due August 2006 and $100 million related to senior notes due November 2012). The variable interest is based on the six-month LIBOR rate and is reset biannually. The applicable LIBOR rate was 2.20% and 1.18% as of December 31, 2004 and 2003, respectively.
OTHER FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair values of our other financial instruments are as follows:
The fair values of each of our long-term debt instruments are based on the amount of future cash flows associated with each instrument discounted using our current borrowing rate for similar debt instruments of comparable maturity.
NOTE 12--POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
PENSION PLANS
A majority of our U.S. employees participate in noncontributory pension plans, and some of our non-U.S. employees participate in contributory or noncontributory pension plans. Plans covering salaried and management employees generally provide pension benefits that are based on employees' compensation. Effective January 1, 2004, we replaced our defined benefit pension plans for U.S. salaried non-bargaining and certain U.S. salaried bargaining employees with a new defined contribution plan. Plans covering hourly employees and union members generally provide stated benefit amounts for each year of service. Contributions to the plans are based upon the projected unit credit actuarial funding method. We use a December 31 measurement date for our pension plans. We also have a supplemental benefit plan for certain members of senior management.
The following table sets forth the funded status and amounts recognized in our consolidated balance sheets:
Net periodic benefit cost under our defined benefit pension plans includes the following components:
Other information related to our defined benefit pension plans is as follows:
Pension plan weighted-average asset allocations at December 31, 2004 and 2003 and target allocations, by asset category are as follows:
Our investment policies seek to provide for growth of capital with a moderate level of volatility by investing assets in accordance with the above target allocations. Our investment performance and policies are reviewed by our Pension Investment Committee.
Our expected long term rate of investment return is based on the expected returns of each of the asset categories, weighted based on the median of the target allocation for each category. Equity securities are expected to return 10% -11% over the long-term, while fixed income and other is expected to return 4% - 6%. Based on historical experience, we expect our plan assets to provide a modest additional return, when compared to their respective benchmarks.
Assumptions are as follows:
We expect to contribute $5.9 million and $5.9 million to our U.S. and non-U.S. plans, respectively, in 2005.
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
DEFINED CONTRIBUTION PLANS
Effective January 1, 2004, certain U.S. employees participate in a defined contribution plan. We will contribute a cash amount to the plan on an annual basis, commencing in 2005, based on employees' eligible earnings, vesting service, and age. We recorded expense for this plan of approximately $9.7 million in 2004, which we expect to contribute in 2005.
Certain employees also participate in various investment plans. Under the plans, the employees may voluntarily contribute a percentage of their compensation. We contribute a cash amount based on participants' contributions. Our contributions were approximately $3.8 million, $1.6 million, and $1.6 million in 2004, 2003, and 2002, respectively. We expect to contribute approximately $4 million to our investment plans in 2005. We recorded expense of approximately $4.1 million, $1.7 million, and $1.6 million in 2004, 2003, and 2002, respectively.
POSTRETIREMENT HEALTH AND LIFE INSURANCE PLANS
We have several unfunded postretirement health and life insurance plans covering certain U.S. employees who were hired before February 1, 1993 and retire under the normal, early, or disability retirement provisions of any one of our U.S. defined benefit pension plans. Former employees who retired prior to February 1, 1993, contribute to the cost of the plans, although we pay the majority of the cost. Employees retiring after February 1, 1993, contribute to the cost of the plans based on an indexed service-related premium.
We use a December 31 measurement date for our postretirement health and life insurance plans.
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 became law. The act provides for prescription drug benefits to retirees and federal subsidies to sponsors of certain retiree health-care plans. In May 2004, the FASB issued Staff Position No. FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" (FSP 106-2), effective for the first interim or annual period beginning after June 15, 2004. We have determined that one of our postretirement benefit plans providing prescription drug benefits are actuarially equivalent to Medicare Part D and have elected to recognize the effects of the act by implementing the provisions of FSP 106-2 retroactively as of January 1, 2004. We have reduced our accumulated postretirement benefit obligation (APBO) for the effect of the subsidy related to benefits attributed to past service by $7.8 million. This is reflected as a decrease in unrecognized net actuarial losses and will be amortized over current and future periods. In addition, the subsidy will reduce interest costs on the APBO. The total effect of the subsidy on the measurement of net periodic benefit cost for 2004 was $1.3 million, consisting of lower amortization of actuarial losses of $0.8 million and lower interest costs of $0.5 million.
The following table sets forth the funded status and amounts recognized in our consolidated balance sheets:
Net periodic benefit cost includes the following components:
We expect to contribute $7.5 million to our postretirement health and life insurance plans in 2005. The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
Assumptions are as follows:
Assumed health care cost trend rates at December 31 are as follows:
Assumed health care cost trend rates have an effect on the amounts reported for the health care plan. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
NOTE 13--COMMITMENTS AND CONTINGENCIES
LEASES
We have numerous non-cancelable leases with terms exceeding one year. As of December 31, 2004, lease commitments for all such operating leases are as follows:
Total rental expense was $46.8 million, $51.1 million, and $45.2 million in 2004, 2003, and 2002, respectively.
GUARANTEES
We issue various types of guarantees in the normal course of business. As of December 31, 2004, we have the following guarantees outstanding:
Standby letters of credit and surety bonds are issued to guarantee our performance under contractual obligations. The most significant of these obligations is collateral to insurance companies for our insurance programs. In the event we fail to pay insurance claims, the issuing bank or surety may be asked to release some or all of this collateral to the insurance companies. Standby letters of credit and surety bonds have a term of one year and automatically renew. As of December 31, 2004, our consolidated balance sheet included liabilities of $42.9 million related to these insurance programs.
Performance guarantees provided by standby letters of credit and performance bonds are issued to certain customers to guarantee the operation of the equipment we sell or to guarantee our ability to complete a contract. These performance guarantees have various terms, generally less than one year.
Commercial letters of credit are issued to certain suppliers to guarantee our payment for purchases under favorable trade terms. Once our suppliers provide the proper documentation, the issuing bank charges our account and pays the commercial letters of credit on our behalf. Commercial letters of credit have a term of one year or less.
The debt obligations of our subsidiaries are reflected in our consolidated balance sheets. In order to obtain favorable terms, guarantees of subsidiary debt are issued to local lending institutions requiring the parent company to repay the debt should our subsidiaries default on their debt obligations. There is a similar guarantee of affiliate debt relating to our 50% owned joint venture, Scroll Technologies. In the event Scroll Technologies would default on its debt obligation, we are required to assume 50% of
Scroll's outstanding debt ($20.6 million as of December 31, 2004). The guarantee of affiliate debt is for the entire term of the borrowing ending in January 2012.
LITIGATION
We are subject to contingencies, including legal proceedings and claims arising out of the ordinary course of business that cover a range of matters, including, among others, product liability, contract and employment claims, warranty, environmental, intellectual property, and property tax disputes. We believe that such claims and litigation have been adequately provided for or are covered by insurance and that the resolution of such matters will not have a material effect on our financial position, ongoing results of operations, or liquidity. However, if a claim results in a judgment against us or we ultimately settle a claim, the amount of such judgment and/or settlement may be material to our results of operations in an individual quarter.
Asbestos-related litigation
As is the case with many other companies, we have been named as one of many defendants in lawsuits alleging personal injury to one or more individuals as a result of exposure to asbestos contained in products previously manufactured by us or by companies from which we purchased product lines. We believe our exposure to losses related to asbestos claims is minimal based upon the asbestos content of former products and the availability of insurance and indemnifications. We do not believe that it is reasonably possible that losses in excess of amounts recorded will be material to our consolidated financial statements.
In February 2004 one of our insurance carriers filed a declaratory judgment action in the Circuit Court of Cook County, Illinois against our former parent and affiliates, certain excess insurance carriers and us. The insurance carrier provides us with primary and excess insurance, and defended and indemnified us in nearly all of our asbestos-related claims. The lawsuit seeks to determine the extent of insurance coverage available to us including whether the available limits exhaust on a "per occurrence" or an aggregate basis, and to determine how the applicable coverage responsibilities should be apportioned to all excess insurance carriers. The insurers are not seeking to recover amounts paid on behalf of us prior to February 2004.
During the second half of 2004, we began to operate under an interim cost-sharing arrangement between the insurance carrier, certain excess insurance carriers, our former parent, several former affiliates and us. The proposed interim cost-sharing arrangement establishes a process by which future asbestos-related costs, formerly paid in full by the insurance carrier, can be paid. Our negotiated share of these costs is approximately 13% of total asbestos-related costs. This represents the share of costs that would have been paid by excess insurance carriers that have gone bankrupt or have been unwilling to participate in the proposed interim cost-sharing arrangement.
As of December 31, 2004, we have recorded a liability of $2.3 million for the estimated loss of known open asbestos-related claims and a receivable of $1.9 million for estimated recoveries from our insurance carriers. We estimate our losses based upon our historical experience of actual losses incurred. Estimating asbestos losses is subject to numerous uncertainties, including but not limited to: the variable rate at which new claims are filed; the impact of bankruptcies of other companies currently or historically defending asbestos claims; the uncertainties surrounding the litigation process from jurisdiction to jurisdiction and from case to case; and unknown detail of each individual claim such as the plaintiff's employment history, severity and type of injury, age, and other key factors. We estimate our recoveries based upon the terms of the proposed interim cost-sharing arrangement and availability of other insurance and indemnification coverage. We believe the likelihood that the declaratory judgment action filed against us resulting in no recovery of asbestos-related costs is remote. Our assessment is based upon the merits of the complaints and defenses available to us. However, if the declaratory
judgment action results in an adverse judgment against us, it may impair the receivable we have recorded for insurance recoveries.
The following table presents a summary of asbestos-related claims activity for the years ended December 31, 2004 and 2003:
During 2004, the number of new claims filed increased. We believe the increase in new claims resulted from the practice of plaintiff's bar filing lawsuits based upon available databases. The history of asbestos lawsuits filed against us and settlements by our insurance carriers likely placed us in these databases. Our experience to date with these new claims and plaintiff attorneys has generally indicated a lack of exposure to our products and has resulted in dismissals. We incurred settlement costs of $0.8 million and $0.1 million for claims settled in 2004 and 2003, respectively, of which nearly all were paid by the insurance carrier.
Certain open claims and portions of open claims are not covered by insurance or indemnifications if the exposure period falls within years of no coverage or are related to companies that were acquired without insurance. We do not believe the resolution of these claims will have a material impact to our consolidated financial statements.
We have not recognized any losses for unasserted asbestos claims. As indicated above, our experiences to date with new claims have generally indicated a lack of exposure to our products and results in dismissals in a significant number of cases. Therefore, we do not consider unasserted claims for purposes of estimating our asbestos-related loss contingencies, as we have no reason to believe the manifestation of claims by potential claimants will have a material impact to our consolidated financial statements.
OTHER COMMITMENTS
We have outstanding purchase obligations as of December 31, 2004 as follows:
(a) Included within our IT service contracts are unconditional payments in the amount of $43.9 million. We are currently renegotiating one of our information technology service contracts and expect to significantly reduce our future contractual obligation. This service contract represents $382 million of total information technology service contracts as of December 31, 2004.
(b) We own 50% of a small refrigeration company and are contingently obligated to purchase the remaining 50% no later than 2014. Our purchase commitment can be accelerated under certain circumstances. The purchase price will be determined based upon the profitability of the company but cannot be less than $5 million.
NOTE 14--INCOME TAXES
Components of earnings and taxes consist of:
Provision for income taxes differed from the amounts computed by applying the U.S. Federal income tax rate of 35% to income before income taxes and cumulative effect of changes in accounting principles as a result of the following:
In 2004, taxes on foreign earnings were favorably impacted by tax holidays in certain foreign jurisdictions ($11.3 million), other favorable rate variances ($11 million), the reduction in the valuation allowance recorded in connection with a foreign tax loss carryforward ($1.6 million), a tax benefit recorded in connection with a prior year restructuring action involving the disposition of foreign operations ($1.5 million), and recognition of certain foreign tax credits following enactment of the
American Jobs Creation Act of 2004 ($1.3 million), offset by increases to valuation allowances recorded in connection with certain foreign tax loss carryforwards ($7.7 million), operating losses in jurisdictions where no tax benefit was recognized ($6.7 million), and the unfavorable tax impact of deemed and actual distributions ($8.9 million). In 2003, taxes on foreign earnings was impacted by tax holidays in certain foreign jurisdictions ($15.4 million) and other favorable rate variances ($2.4 million), offset by foreign restructuring actions for which the tax benefit was less than the statutory rate ($14.7 million), operating losses in jurisdictions where no tax benefit was recognized ($3.6 million), and the unfavorable tax impact of deemed and actual distributions ($6.1 million). In 2002, taxes on foreign earnings were primarily impacted by tax holidays in certain foreign jurisdictions ($16.2 million) and other favorable rate variances ($3.5 million), offset by the unfavorable impact of deemed and actual distributions ($6 million) and a loss on the disposition of a foreign operation that yielded no tax benefit ($3.7 million). Included within state income taxes-deferred in 2004 is a $2.1 million charge associated with an adjustment in the rate at which state deferred taxes are recorded. Included within the other items in 2004 is an $8.2 million tax benefit recorded during the second quarter, following the conclusion of an examination by the IRS of our federal income tax returns for the years 1997, 1998, and 1999. Other items also consist primarily of R&D credits of $4.7 million, $2.3 million, and $2 million for years 2004, 2003, and 2002, respectively.
The provision for income taxes reported above excludes the tax benefit of $10.7 million related to the 2003 cumulative effect of a change in accounting principle associated with the adoption of FIN 46 related to variable interest entities. This tax benefit was recorded at applicable U.S. federal and state income tax rates. No tax benefit was applied to the 2002 cumulative effect of a change in accounting principle associated with the adoption of SFAS No. 142, because the goodwill was not tax deductible.
Several foreign subsidiaries continue to operate under separate tax holiday arrangements as granted by certain foreign jurisdictions. The nature and extent of such arrangements vary, and the benefits of such arrangements phase out in future years according to the specific terms and schedules as set forth by the particular taxing authorities having jurisdiction over the arrangements.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 2004 and 2003 are presented below:
Deferred tax assets and liabilities are included in the consolidated balance sheet line items as of December 31, 2004 and 2003 as follows:
Based on our historical and current pre-tax earnings as well as projections of future taxable income, we believe it is more likely than not that we will realize the net deferred tax assets. The increase in the valuation allowance associated with U.S. state tax loss carryforwards is attributable to the increase in U.S. state tax loss carryforwards for which no benefit has been recorded. The valuation allowance on foreign tax loss carryforwards increased $9.5 million primarily due to adjustments to the beginning of the year balances resulting from continuing losses in certain jurisdictions ($7.7 million), and due to additional losses (net of expiring losses) in jurisdictions where the deferred tax assets are not expected to be realized ($3.4 million), offset by the reduction of a valuation allowance in a jurisdiction, due to
improved operating performance ($1.6 million). Of the $40.5 million of gross deferred tax assets relating to foreign tax loss carryforwards, $5.3 million are subject to expiration limitations, and approximately $3.3 million ($1.9 million net of valuation allowance) are set to expire over the next three years. The remaining tax losses carry no expiration date.
Foreign tax credit carryforwards of $4.8 million, $6.6 million, $1.5 million, and $9.7 million expire in 2010, 2011, 2012, and 2013, respectively. Of the $13.9 million in R&D credit carryforwards, $0.6 million of this amount is set to expire in 2020; the remainder expires in subsequent years.
The IRS is examining our Federal income tax returns for 2000, 2001, 2002, and 2003. Various other federal, state, and foreign tax returns are under examination by the applicable authorities. We do not anticipate any material adverse effect to our consolidated financial statements resulting from these examinations.
Neither income taxes nor foreign withholding taxes have been provided on $342 million and $286 million of cumulative undistributed earnings of foreign subsidiaries and affiliates at December 31, 2004 and 2003, respectively. These earnings are considered permanently invested in the businesses and, under the tax laws, are not subject to such taxes until distributed as dividends. If the earnings were not considered permanently invested, approximately $82 million and $71 million of deferred income taxes, consisting of foreign withholding taxes and additional U.S. tax net of foreign tax credits, would have been provided at December 31, 2004 and 2003, respectively.
On October 22, 2004, the American Jobs Creation Act (AJCA) was signed into law in the U.S. The AJCA includes a temporary deduction from U.S. taxable income of 85% of certain foreign earnings that are repatriated to the U.S., as defined in the AJCA. We may elect to apply this provision to qualifying earnings repatriations in 2005 only. We have begun an evaluation of the effects of the repatriation provision of the AJCA; however, we are awaiting the issuance of further regulatory guidance expected from the Treasury Department and final resolution on a technical corrections bill that has been introduced in Congress with respect to certain provisions in the AJCA. We expect to complete our evaluation within a reasonable period of time following the publication of the Treasury guidance and resolution on the proposed legislation. The range of possible amounts that we are considering for repatriation under the AJCA is between zero and $342 million. The related potential range of income tax is between zero and $43 million. Pursuant to FSP 109-2, as it has not become apparent that we will repatriate any foreign earnings, and the earnings are considered permanently reinvested, no income taxes or foreign withholding taxes have been provided.
NOTE 15--ACQUISITIONS AND DIVESTITURES
We made cash payments of $0.4 million, $6 million, and $2.2 million during 2004, 2003, and 2002, respectively, related to the acquisition of several small businesses. In 2002, we sold air conditioning operations in Australia for $12.1 million; the sale resulted in a loss of $10.3 million. Finalization of the Australia sale resulted in a gain of $0.3 million in 2003. In 2004 and 2003, there were no similar transactions.
NOTE 16--CHARGES TO OPERATIONS
In 2004, 2003, and 2002, we incurred costs (credits) by segment as follows:
2003 and 2004 Initiatives
In 2003, we initiated actions to further reduce our overall cost structure and support the implementation of our new geographic organization. These actions include the further reduction of manufacturing capacity, the elimination of certain product lines, the exiting of several small, non-core businesses, and the write-down of assets associated with a European joint venture, as well as cost reductions associated with the consolidation of our former ESG and YRG segments.
During 2004, we initiated additional actions to support the implementation of our new geographic organization in EMEA and further reduced the production in one Americas manufacturing facility. These additional actions were mainly comprised of severance and are expected to be completed by December 2005.
Charges included write-downs for the impairment of assets relating to businesses or facilities to be closed or divested, severance and other accruals relating to planned reductions in workforce throughout the Company, and estimated costs related to the elimination of certain product lines. Workforce reductions included the severance of approximately 1,300 salary and wage employees.
2000 and 2001 Initiatives
In 2000, we initiated a cost reduction process, which included plant closures and divestitures, product line and facility rationalizations, selling, general, and administrative expense reductions, and other
actions. In 2001, we expanded the scope of the cost reduction process to include additional plant closings and staff reductions. As of December 31, 2002, all of the 2000 and 2001 actions were substantially complete.
Detail of activity relating to the 2003 and 2004 initiatives and the 2000 and 2001 initiatives in the years ended December 31, 2004, 2003, and 2002 is as follows:
NOTE 17--SEGMENT INFORMATION
Our global business operates in the HVAC&R industry. Effective January 1, 2003, we consolidated our former YRG and ESG segments and reorganized management of the combined business. Our new organization consists of Global Applied, Unitary Products Group, and Bristol Compressors. The Global Applied business is comprised of three geographic regions: the Americas; Europe, Middle East, and Africa (EMEA); and Asia. Global Applied's three geographic regions, Unitary Products Group, and Bristol Compressors represent our reportable segments. Amounts for the year ended December 31, 2002 were reclassified to conform to the current presentation.
Global Applied designs, produces, markets, and sells HVAC&R equipment and solutions and provides maintenance and service of equipment manufactured by us and by others. Types of equipment include air-cooled and water-cooled chillers, large packaged rooftop units, indoor and outdoor air handling and ventilating equipment, variable air volume units, centrifugal, screw, and reciprocating compressors, condensers, evaporators, heat exchangers, industrial and marine chillers, ice makers, mini-splits, process
refrigeration systems, hygienic air distribution systems, gas compression systems, and control equipment to monitor and control the entire system. Heating and air conditioning solutions are provided for buildings ranging from small office buildings and fast food restaurants to large commercial and industrial complexes. Refrigeration systems are provided for industrial applications in the food and beverage, electronics, chemical, and petroleum industries. Cooling and refrigeration systems are also supplied for use on naval, commercial, and passenger vessels. Products within Global Applied are similar in nature. Products produced in our factories are utilized in both air conditioning and refrigeration applications depending on customers needs. The end use application is the determining factor in labeling a product as refrigeration or air conditioning. As part of the integration of our former YRG and ESG segments, we sell our full line of HVAC&R products through one sales channel, regardless of the application. Also within Global Applied, we sell services in the form of inspection, service, repair, maintenance, commissioning of equipment, and other service activities.
The following table summarizes net sales, excluding intragroup sales, by product and service category within the Global Applied segment:
Unitary Products Group (UPG) produces heating and air conditioning solutions for buildings ranging from private homes and apartments to small commercial buildings. UPG products include ducted central air conditioning and heating systems (air conditioners, heat pumps, and furnaces), and light commercial heating and cooling equipment.
Bristol Compressors (Bristol) manufactures reciprocating and scroll compressors for our use and for sale to original equipment manufacturers and wholesale distributors. Bristol purchases an essential component from one vendor. Due to consolidation in the vendor's industry, there are limited alternate sources of supply. We believe an alternate source of supply is attainable in the event the current vendor is unable to supply the component. However, a change in vendors would cause a delay in manufacturing and loss of sales, which would adversely impact the results of operations of Bristol and our consolidated results of operations.
The following table provides our segment operating results, assets, and other items:
General corporate expenses and charges and other expenses are not allocated to the individual segments for management reporting purposes. General corporate expenses include certain incentive compensation, pension, medical, and insurance costs; corporate administrative costs; development costs for IT applications and infrastructure; the $20 million warranty charge recorded in 2004 discussed in Note 1; and other corporate costs. Charges and other expenses include restructuring and other charges, operating expenses related to cost reduction actions, a curtailment loss related to the decision to replace our defined benefit pension plans for U.S. salaried non-bargaining and certain U.S. salaried bargaining employees with a new defined contribution plan, effective January 1, 2004, costs related to a discontinued product line and executive retirement costs. Non-allocated assets primarily consist of prepaid pension benefit cost, net deferred tax assets, LIFO inventory reserves, and other corporate assets. For management reporting purposes, intersegment sales are recorded on a cost-plus or market price basis. Business segment management compensation is based on segment earnings before interest and taxes, segment net capital employed, and consolidated earnings per share.
Our net sales to the U.S. and to non-U.S. countries are as follows:
No single non-U.S. country or single customer accounts for greater than 10% of our net sales.
Information related to U.S. and non-U.S. sales to outside customers, based on the location of the assets generating the sales, is as follows:
Included in U.S. sales are export sales of $252.4 million, $255.5 million, and $284.9 million in 2004, 2003, and 2002, respectively.
The location of our net property, plant, and equipment is as follows:
NOTE 18--STOCKHOLDERS' EQUITY
EMPLOYEE STOCK PURCHASE PLAN
We provide an employee stock purchase plan that authorizes employees to purchase up to 3 million shares of our common stock, inclusive of 0.5 million shares authorized by the stockholders in May 2004. The purchase price is 85% of the lower of the fair market value of shares at the beginning or end of the period. No compensation expense is recorded in connection with employee purchases of shares. As of December 31, 2004, 0.4 million shares were available for employee purchases. Employees purchased shares under the plan as follows:
MANAGEMENT STOCK PURCHASE PLAN
In 2003, we established a management stock purchase plan that allows eligible employees to defer a percentage of their annual incentive compensation as vested restricted stock units. We provide a 25% restricted stock unit match which vests over a three-year period. Common stock is issued on the third anniversary from the contribution date or upon employee termination. Deferrals of annual incentive compensation are expensed in the respective incentive period. Matching contributions are expensed over the vesting period. Approximately 43 thousand restricted stock units were issued under the management stock purchase plan in 2004.
STOCK PLANS
In 2002, our shareholders approved a stock plan that will expire in 2012. As a result, we are authorized to issue up to 3.8 million shares of our common stock through stock option and restricted stock awards. Under a former stock plan, which was originally approved in 1992 and expired in 2002, we issued stock options and restricted stock awards of 7.5 million shares. The general terms of both stock plans are similar. Awards can be granted only to our directors and employees. The exercise price of stock options cannot be less than the fair market value of our common stock on the grant date. The maximum term of stock options is 10 years. Restricted stock awards cannot exceed 3% of our issued and outstanding common stock. We determine the price of restricted stock awards at the time of grant. We also determine vesting requirements of stock option and restricted stock awards at the time of grant.
In 2004, 2003, and 2002, 208 thousand, 136 thousand, and 30 thousand restricted shares, respectively, were granted to key employees. Accordingly, unearned compensation of $7.8 million, $3.2 million and $0.7 million was recorded as a charge to stockholders' equity in 2004, 2003 and 2002, respectively.
Information regarding stock options under our stock plans is as follows (shares in thousands):
ACCUMULATED OTHER COMPREHENSIVE LOSSES
Accumulated other comprehensive losses net of tax, consist of:
NOTE 19--EARNINGS (LOSS) PER SHARE RECONCILIATION OF SHARES OUTSTANDING
Net income (loss) as set forth in our consolidated statements of operations is used in the computation of basic and diluted earnings (loss) per share information. Reconciliations of shares used in the computations of earnings (loss) per share are as follows:
SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
Notes regarding quarterly results:
- - In the third quarter of 2004, we retroactively adopted a new accounting standard related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. As a result, the first and second quarter net (loss) income and (loss) earnings per share were restated. See Note 12 to our consolidated financial statements. In the second quarter of 2004, we recorded a $20 million warranty charge for the Unitary Products Group furnace inspection and remediation program. See Note 1.
- - In the third quarter of 2003, we recorded a $15.4 million reduction to stockholders' equity as a cumulative effect of a change in accounting principle adjustment. See Note 1.
- - We recorded net restructuring and other charges of $16.1 million, $33.1 million, $12.1 million, and $30.1 million in the first, second, third, and fourth quarters of 2003, respectively. In the fourth quarter of 2004, we recorded net restructuring charges of $1 million. See Note 16.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As of December 31, 2004, we carried out an evaluation, under the supervision and with the participation of company management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective.
(b) Management's Report on Internal Control Over Financial Reporting
Our management's report on internal control over financial reporting is set forth in Item 8. Financial Statements and Supplementary Data on page 47 and is incorporated by reference herein.
(c) Changes in Internal Control Over Financial Reporting
During the quarter ended September 30, 2004, we implemented new information technology systems at three Global Applied sites and in our service business in North America. In the quarter ended December 31, 2004, we implemented a new information technology system in our UPG business. As a result, certain changes have been made to our internal control over financial reporting. There were no other changes in our internal control over financial reporting that occurred during the fourth quarter of 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information contained under the caption "Election of Directors" in our definitive 2005 Proxy Statement is incorporated herein by reference in response to this item. See Item 1 above for information concerning executive officers.
Our Employee Code of Conduct, which applies to all employees, including our principal executive officer, principal financial officer, and principal accounting officer, is posted on our website at www.york.com. The Employee Code of Conduct is compliant with Item 406 of Regulation S-K as required by the SEC. We intend to disclose any amendments to or waivers of any provisions of the Employee Code of Conduct granted to our principal executive officer, principal financial officer, principal accounting officer, and persons performing similar functions, on our website.
The Board of Directors has adopted charters for its Nominating and Governance Committee, Compensation Committee, and Audit Committee. The Board of Directors also adopted Corporate Governance Guidelines. The Corporate Governance Guidelines and each of the charters are available on our website at www.york.com. These items are also available upon request to the Vice President, Secretary and General Counsel at York International Corporation, 631 South Richland Avenue, York, PA 17403, or telephone (717) 771-7890.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information contained under the caption "Executive Compensation" in our definitive 2005 Proxy Statement is incorporated herein by reference in response to this item.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information contained under the captions "Election of Directors," "Executive Compensation," and "Ownership of Common Stock" in our definitive 2005 Proxy Statement is incorporated herein by reference in response to this item.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information contained under the caption "Ownership of Common Stock" in our definitive 2005 Proxy Statement is incorporated herein by reference in response to this item.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information contained under the caption "Independent Accountants" in our definitive 2005 Proxy Statement is incorporated herein by reference in response to this item.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) The following financial statements of York International Corporation and subsidiaries are incorporated herein by reference to pages 47 to 92 of Form 10-K:
Consolidated Balance Sheets - as of December 31, 2004 and 2003
Consolidated Statements of Operations - years ended December 31, 2004, 2003, and 2002
Consolidated Statements of Comprehensive Income (Loss) - years ended December 31, 2004, 2003, and 2002
Consolidated Statements of Cash Flow - years ended December 31, 2004, 2003, and 2002
Consolidated Statements of Stockholders' Equity - years ended December 31, 2004, 2003, and 2002
Notes to Consolidated Financial Statements
(2) The following financial statement schedule for York International Corporation and subsidiaries is included herein:
II Valuation and Qualifying Accounts - years ended December 31, 2004, 2003, and 2002; (Page 103 of Form 10-K)
All other schedules are omitted as they are not applicable.
Report of Independent Registered Public Accounting Firm Covering Financial Statement Schedule; (Page 102 of Form 10-K)
(3) The exhibits filed in response to Item 601 of Regulation S-K are as follows:
EXHIBIT NUMBER DESCRIPTION
3.1 Amended and Restated Certificate of Registrant (Incorporated by reference to Exhibit 4.1 to the Registrant's Registration Statement in Form S-3, File No. 33-91292, filed on June 7, 1995)
3.2 Certificate of Amendment to the Amended and Restated Certificate of Incorporation dated May 3, 1996 (Incorporated by reference to Exhibit 3.2 to the Annual Report on Form 10-K for the year ended December 31, 1996, File No. 1-10863)
3.3 By-Laws of Registrant, restated as of December 17, 1996 (Incorporated by reference to Exhibit 3.3 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, File No. 1-10863)
4.1 Indenture effective as of June 1, 1998 between the Registrant and State Street Bank and Trust Company, a Massachusetts chartered trust company, as Trustee (Incorporated by reference to Exhibit 4 to the Registrant's Form 8-K, File No. 1-10863, filed on May 28, 1998)
4.2 Senior Indenture dated as of August 9, 2001 between the Registrant and the Bank of New York, as Trustee (Incorporated by reference to Exhibit 4.2 to the Registrant's Registration Statement filed on Form S-3, File No. 333-59678, filed on April 27, 2001)
4.3 Five Year Credit Agreement, dated as of May 29, 2001, among York International Corporation, as borrower, the initial lenders and initial issuing bank named therein, as initial lenders and initial issuing bank, Citibank, N.A., as administrative agent, The Chase Manhattan Bank, as syndication agent, Bank of Tokyo-Mitsubishi, First Union National Bank, and Fleet National Bank, as documentation agents, and JP Morgan Securities, Inc. and Salomon Smith Barney Inc., as joint lead arrangers and joint bookrunners. (Incorporated by reference to Exhibit 4.3 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, File No. 1-10863)
4.4 Amendment No. 1 to the Five Year Credit Agreement, dated as of May 29, 2002, among York International Corporation, the lenders named therein, as lenders, and Citibank, N.A., as administrative agent for the lenders. (Incorporated by reference to Exhibit 4.2 to Registrant's Form 10-Q for the quarter ended June 30, 2002, File No. 1-10863)
4.5 Amendment No. 2 to The Five Year Credit Agreement, dated as of March 14, 2003, among York International Corporation, the lenders named therein, as lenders, and Citibank, N.A., as administrative agent for the lenders (Incorporated by reference to Exhibit 4.2 to Registrant's Form 10-Q for the quarter ended March 31, 2003, File No. 1-10863)
4.6 Purchase and Sale Agreement, dated as of December 21, 2001, between York International Corporation and Bristol Compressors, Inc., as originators, and York Receivables Funding LLC (Incorporated by reference to Exhibit 4.7 to Registrant's Annual Report on Form 10-K for the year ended December 31, 2001, File No. 1-10863)
4.7 364-Day Revolving Credit Agreement, dated as of March 11, 2005, among York International Corporation, as borrower, Citibank, N.A., as administrative agent, J.P. Morgan Chase Bank, N.A., as syndication agent, Bank of America, N.A., Bank of Tokyo Mitsubishi Trust Company, BNP Paribas and Nordea Bank Finland PLC, as co-documentation agents, and a syndicate of 14 lenders described therein (Incorporated by reference to Exhibit 10.1 to the Registrant's Form 8-K Current Report filed on March 14, 2005, File No. 1-10863)
4.8 Amended and Restated Receivables Purchase Agreement dated as of May 17, 2004 among York Receivables Funding LLC, as seller, York International Corporation, as initial servicer, Gotham Funding Corporation, as a conduit purchaser, The Bank of Tokyo-Mitsubishi, LTD., New York Branch, as agent for the Gotham Purchaser Group, Liberty Street Funding Corp., as a conduit purchaser, The Bank of Nova Scotia, as agent for the Liberty Street Purchaser Group, and The Bank of Tokyo-Mitsubishi, LTD., New York Branch as administrator (Incorporated by reference to Exhibit 4.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, File No. 1-10863)
4.9 Amendment No. 1 to Amended and Restated Receivables Purchase Agreement, dated October 1, 2004, among, York International Corporation, York Receivables Funding LLC, The Members of Various Purchaser Groups from time to time party hereto, and The Bank of Tokyo-Mitsubishi, LTD., as administrator (filed herewith)
4.10 Amendment No. 2 to Amended and Restated Receivables Purchase Agreement, dated December 16, 2004, among, York International Corporation, York Receivables Funding LLC, The Members of Various Purchaser Groups from time to time party hereto, and The Bank of Tokyo-Mitsubishi, LTD., as administrator (filed herewith)
*10.1 Registrant's Amended and Restated 1992 Omnibus Stock Plan (Incorporated by reference to Exhibit 10.1 to Registrant's Annual Report on Form 10-Q for the quarter ended March 31, 1997, File No. 1-10863)
*10.2 Amendment No. 1 to the York International Corporation Amended and Restated 1992 Omnibus Stock Plan, dated February 16, 1999 (Incorporated by reference to Exhibit 10.15 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 1-10863)
*10.3 Amendment No. 2 to the York International Corporation Amended and Restated 1992 Omnibus Stock Plan, dated February 9, 2000 (Incorporated by reference to Exhibit 10.22 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 1-10863)
*10.4 Amendment No. 3 to the York International Corporation Amended and Restated 1992 Omnibus Stock Plan, effective July 27, 2000 (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000, File No. 1-10863)
*10.5 York International Corporation Supplemental Executive Retirement Plan (Incorporated by reference to Exhibit 10.12 to Registrant's Annual Report on form 10-K for the year ended December 31, 1993, File No. 1-10863)
*10.6 Amendment No. 1 to the York International Corporation Supplemental Executive Retirement Plan, effective January 1, 1997 (Incorporated by reference to Exhibit 10.17 to Registrant's Annual Report on Form 10-K/A for the year ended December 31, 2003, File No. 1-10863)
*10.7 Amendment No. 2 to the York International Corporation Supplemental Executive Retirement Plan (Incorporated by reference to Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003)
*10.8 York International Corporation Amended and Restated Executive Deferred Compensation Plan, effective July 1, 2001 (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, File No. 1-10863)
*10.9 First Amendment to the York International Corporation Executive Deferred Compensation Plan (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, File No. 1-10863)
*10.10 Second Amendment to the York International Corporation Executive Deferred Compensation Plan, dated December 3, 2003 (Incorporated by reference to Exhibit 10.12 to Registrant's Annual Report on Form 10-K/A for the year ended December 31, 2003, File No. 1-10863)
*10.11 York International Corporation Management Stock Purchase Plan (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, File No. 1-10863)
*10.12 Form of Restricted Stock Agreement by and between Registrant and certain of its employees, dated March 26, 2003 (Incorporated by reference to Exhibit 10.14 to Registrant's Annual Report on Form 10-K/A for the year ended December 31, 2003, File No. 1-10863)
*10.13 Employment Agreement between York International Corporation and Michael R. Young, dated December 29, 1999 (Incorporated by reference to Exhibit 10.19 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 1-10863)
*10.14 Employment Agreement between York International Corporation and Kam Leong, dated December 29, 1999 (Incorporated by reference to Exhibit 10.19 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2002, File No. 1-10863)
*10.15 Retirement Agreement between York International Corporation and Michael R. Young, dated October 6, 2003 (Incorporated by reference to Exhibit 10.22 to the Registrant's Annual Report on Form 10-K/A for the year ended December 31, 2003, File No. 1-10863)
*10.16 Form of Amendment No. 1 to Employment Agreement between the Registrant and certain of its key executives. (Incorporated by reference to Exhibit 10.4 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, File No. 1-10863)
*10.17 Employment Agreement between York International Corporation and C. David Myers, dated December 31, 2003 (Incorporated by reference to Exhibit 10.25 to the Registrant's Annual Report on Form 10-K/A for the year ended December 31, 2003, File No. 1-10863)
*10.18 Employment Agreement between York International Corporation and Thomas F. Huntington, dated December 31, 2003 (Incorporated by reference to Exhibit 10.26 to the Registrant's Annual Report on Form 10-K/A for the year ended December 31, 2003, File No. 1-10863)
*10.19 Employment Agreement between York International Corporation and Peter C. Spellar, dated December 31, 2003 (Incorporated by reference to Exhibit 10.28 to the Registrant's Annual Report on Form 10-K/A for the year ended December 31, 2003, File No. 1-10863)
*10.20 Form of Employment Agreement between York International Corporation and certain other key executives, dated December 31, 2003 (Incorporated by reference to Exhibit 10.29 to the Registrant's Annual Report on Form 10-K/A for the year ended December 31, 2003, File No. 1-10863)
*10.21 Employment Agreement between York International Corporation and David Kornblatt, dated March 24, 2004 (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, File No. 1-10863)
*10.22 Employment Agreement between York International Corporation and Iain A. Campbell, dated March 24, 2004 (Incorporated by reference to Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, File No. 1-10863)
*10.23 Employment Agreement between York International Corporation and Jeffrey D. Gard, dated March 24, 2004 (Incorporated by reference to Exhibit 10.3 to Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, File No. 1-10863)
*10.24 York International Corporation Amended and Restated 2002 Incentive Compensation Plan (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, File No. 1-10863)
*10.25 York International Corporation Amended and Restated 2002 Omnibus Stock Plan (Incorporated by reference to Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, File No. 1-10863)
*10.26 Form of Director Restricted Stock Agreement (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, File No. 1-10863)
*10.27 Form of Executive Officer Restricted Stock Agreement (Incorporated by reference to Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, File No. 1-10863)
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.
YORK INTERNATIONAL CORPORATION
/S/ C. David Myers --------------------------------- C. DAVID MYERS PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: March 14, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on this 14th day of March 2005.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders York International Corporation:
Under date of March 14, 2005, we reported on the consolidated balance sheets of York International Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive income (loss), cash flows and stockholders' equity for each of the years in the three-year period ended December 31, 2004, as contained in Item 8. Financial Statements and Supplementary Data. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule, Valuation and Qualifying Accounts. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
Harrisburg, Pennsylvania March 14, 2005
SCHEDULE II
YORK INTERNATIONAL CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
(in thousands)
Warranties include standard warranties and extended warranty contracts sold to customers to increase the warranty period beyond the standard period. Extended warranty contracts sold are reflected in COLUMN C: ADDITIONS COSTS AND EXPENSES and amortized revenue is reflected in COLUMN D: DEDUCTIONS in the above schedule.
EXHIBIT INDEX