Management’s Discussion and AnalysisApplication of Critical Accounting PronouncementsThe application of accounting principles requires the use of assumptions, estimates and judgments which are the responsibility of management. Management makes estimates and judgments based on, among other things, knowledge of operations, markets, historical trends and likely future changes, similarly situated businesses and, when appropriate, the opinions of advisors with knowledge and experience in certain fields. Many assumptions, estimates and judgments are straightforward; other assumptions are not. Reported results could have been materially different had the Company used a different set of assumptions, estimates and judgments for certain accounting principle applications. Deferred Tax Assets and Tax ContingenciesIt is common for companies to record expenses and accruals before expenses and costs are paid. In the U.S. and most other countries and tax jurisdictions, many deductions for tax return purposes cannot be taken until the expenses are paid. Similarly, certain tax credits and tax loss carryforwards cannot be used until future periods when sufficient taxable income is generated. In these circumstances, under GAAP, companies accrue for the tax benefit expected to be received in future years if, in the judgment of management, it is “more likely than not” that the company will receive the tax benefits. These benefits (deferred tax assets) are often offset, in whole or in part, by the effects of deferred tax liabilities which relate primarily to deductions available for tax return purposes under existing tax laws and regulations before expenses are reported as expenses under GAAP. As of December 31, 2003, the Company has $347.8 million of net deferred tax assets on its consolidated balance sheet. For more details associated with this net balance, see note 18 to the accompanying consolidated financial statements. Since there is no absolute assurance that these assets will be ultimately realized, management annually reviews the Company’s deferred tax positions to determine if it is more likely than not that the assets will be realized. Periodic reviews include, among other things, the nature and amount of the tax income and expense items, the expected timing when certain assets will be used or liabilities will be required to be reported and the reliability of historical profitability of businesses expected to provide future earnings. Furthermore, management considers tax-planning strategies it can use to increase the likelihood that the tax assets will be realized. These strategies are also considered in the periodic reviews. If after conducting the periodic review, management determines that the realization of the tax asset does not meet the “more-likely-than-not” criteria, an offsetting valuation allowance is recorded thereby reducing net earnings and the deferred tax asset in that period. For these reasons and since changes in estimates can materially affect net earnings, management believes the accounting estimate related to deferred tax asset valuation reserves is a “critical accounting estimate.” Approximately 85% of the deferred tax assets before valuation allowance at December 31, 2003 relates to the U.S. federal tax jurisdiction. Due to its expectation that the historical profitability of the Company’s U.S. portion of the Business and Security Services operations will continue and the lengthy period over which certain of the recorded expenses will become available for deduction on tax returns, management has concluded that it is more likely than not that these net deferred tax assets will be realized. The Company’s expectation of future profitability in the U.S. includes a projected improvement in the U.S. operations of BAX Global even though losses have been recorded in the last several years. The Company projects BAX Global’s results in the U.S. will improve materially as the U.S. economy strengthens and the demand for expedited freight grows. The Company’s expectations for future profitability within the U.S. also include the benefit of the elimination of losses from the former coal operations. For U.S. state jurisdictions and non-U.S. jurisdictions, the Company has evaluated its ability to fully utilize the net deferred tax assets on an individual jurisdiction basis. Due to a recent history of losses in certain jurisdictions and doubts about whether future operating performance will be sufficiently profitable to realize deferred tax assets, the Company has recorded a $38.5 million valuation allowance at December 31, 2003, including $27.9 million recorded in 2003. Should tax statutes, the timing of deductibility of expenses, or expectations for future performance change, the Company could decide to revise its valuation allowances, which would increase or decrease tax expense, possibly materially. Goodwill and Property and Equipment ValuationsAt December 31, 2003, the Company has $873 million of property and equipment and $244 million of goodwill, net of accumulated depreciation and amortization. The Company reviews the assets for possible impairment using the guidance in SFAS No. 142, “Goodwill and Other Intangible Assets,” for goodwill and SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” for property and equipment and other long-lived assets. The review for impairment requires the use of significant judgments about the future performance of the Company’s operating subsidiaries. Goodwill is reviewed for impairment at least annually. The Company estimates the fair value of Brink’s and BAX Global, the two reporting units that have goodwill, primarily using estimates of future cash flows. The fair value of the reporting unit is compared to its carrying value to determine if an impairment exists. At December 31, 2003, net goodwill was $78 million at Brink’s and $166 million at BAX Global. To determine if an impairment exists related to property and equipment, the Company compares estimates of the future undiscounted net cash flows of the asset to its carrying value when there is a triggering event for a review. For purposes of assessing impairment, assets are grouped at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets. Due to a history of profitability and cash flow, the carrying values of long-lived assets of Brink’s are believed to be appropriate. Each quarter, when BHS customers disconnect their monitoring service, BHS records an impairment charge related to the carrying value of the related home security systems estimated to be permanently disconnected based on historical reconnection experience. BHS makes estimates about future reconnection experience in its estimate of impairment charges. Future reconnection experience is estimated using historical data. Should the estimate of future reconnection experience change, BHS’s impairment charges would be affected. BAX Global had a profit in 2003 and 2002 and a loss in 2001. Changes to the Company’s operations, resources used, and cost structure in 2000 reduced the level of fixed costs in the Intra-America network. In management’s opinion, the changes implemented at BAX Global and a return to more normal levels of global economic performance will result in substantial improvement in operating performance and cash flow over time. Based on this judgment, the Company prepared multi-year projections of cash flows for BAX Global, which it used in the impairment analysis for goodwill and long-lived assets. This analysis did not indicate an impairment in goodwill or long-lived assets. If actual cash flows are significantly lower than projected cash flows, future impairment tests may result in an impairment of a portion or all of BAX Global’s goodwill ($166 million at December 31, 2003). Withdrawal LiabilitiesThe Company has recorded a $52.0 million estimate for probable withdrawal obligations from two coal-related multi-employer pension plans. The liability, an estimate of the Company’s share of any unfunded liability of the plans, is developed using the formulas designated by plan documents and by law. The Company’s actual withdrawal liability, if any, will depend on the funded status of the multi-employer pension plans at the time that the Company actually withdraws from the plans. A withdrawal from the plans is triggered by the elimination of or a significant reduction in the hours worked by employees working under UMWA labor agreements. The estimated withdrawal liabilities at December 31, 2003 are based on the funded status of the plans as of June 30, 2003, the most recent plan measurement date. The estimate may change materially each year until the Company actually withdraws from the plans. Changes in this estimate are recorded in discontinued operations. Employee and Retiree Benefit ObligationsThe Company provides its employees and retirees benefits arising from both Company-sponsored plans (e.g. defined benefit pension plans) and statutory requirements (e.g. medical benefits for otherwise ineligible former employees and nonemployees under the Health Benefit Act). Certain of these benefit obligations require payments to be made by the Company or by trusts funded by the Company over long periods of time. The primary benefits which require cash payments over an extended period of years are:
As is normal for these benefits, cash payments will be made for periods ranging from the current year to over seventy years from now for certain benefits. The amount of the cash payments and related expenses will be affected over time by inflation, investment returns and market interest rates, changes in the numbers of plan participants and changes in the benefit obligations and/or laws and regulations covering the benefit obligations. GAAP requires that the Company reevaluate all significant benefit obligations at least annually, and as a result of these reevaluations, the Company records increases or decreases in liabilities and associated expenses over time as required under GAAP. Below are the critical assumptions that determine the carrying values of liabilities and the resulting annual expense. The plans that are affected by the assumptions discussed are identified parenthetically in the relevant title. Discount Rate (Pension Plans, Postretirement Medical Benefits Under Company-Sponsored Plans and “Black Lung” Benefits)The discount rate is used to determine the present value of future payments. This rate reflects returns expected from high-quality bonds and will fluctuate over time with market interest rates. In general, the Company’s liability changes in an inverse relationship to interest rates, i.e. the lower the discount rate, the higher the associated liability for the noted benefit obligations. The Company selects a discount rate for its pension liabilities after reviewing published long-term yield information for a small number of high-quality fixed-income securities (Moody’s AA bond yields) and yields for the broader range of long-term high-quality securities. After considering these factors, the Company selected a discount rate of 6.25% for the valuation as of December 2003. A year ago when market interest rates were higher, the discount rate was 6.75%. Valuations of plan obligations at each year end and calculations of net periodic expenses for the following year can be materially changed based on the level of market rates and the resulting discount rate chosen. Below are tables reflecting changes in liability values as of December 31, 2003 and estimated expenses for 2004 based on 100 basis point differences in the discount rate. Plan Obligations at December 31, 2003
Projected 2004 Expense
Under government regulations, funding requirements for the Company’s primary U.S. pension plan are determined using a different set of assumptions than is used for financial accounting purposes. Near-term funding requirements would, therefore, not be affected unless interest rates declined sharply. Return on Assets (Pension Plan)The Company’s primary U.S. defined benefit pension plan had assets at December 31, 2003 of approximately $542 million. This pension plan’s assets are invested primarily using actively managed accounts with asset allocation targets of 47.5% domestic equities and 22.5% international equities, which include a broad array of market cap sizes and investment styles, and 30% fixed income securities. The Company’s policy does not permit certain investments, including investments in The Brink’s Company common stock, unless part of a commingled fund, or derivative instruments unless used for hedging purposes. Fixed-income investments must have an investment grade rating at the time of purchase. The plan rebalances its assets on a quarterly basis if actual allocations of assets exceed predetermined limits. Among other factors, the performance of asset groups and investment managers will affect the long-term rate of return. Pension accounting principles require companies to use estimates of expected asset returns over long periods of time. The Company selects the expected long-term rate of return assumption using advice from its investment advisor and its actuary considering the plan’s asset allocation targets and expected overall investment manager performance and a review of its most recent ten-year historical average compounded rate of return. After following the above process, the Company selected 8.75% as its expected long-term rate of return as of December 31, 2003 and 2002. It is unlikely that in any given year the actual rate of return will be the same as the assumed long-term rate of return. In general, if actual returns exceed the expected long-term rate of return, future levels of expense will go down and vice-versa. Over the last ten years, the annual returns of the Company’s primary pension plan have fluctuated from a high of a 28% gain (2003) to a low of a 9% loss (2002) and averaged 10% over the period. During that time period there were six years in which returns exceeded the assumed long-term rate of return and four years, including the three years ended December 31, 2002, with returns below the assumed long-term rate of return. If the Company were to use a different long-term rate of return assumption, it would affect annual pension expense but would have no immediate effect on funding requirements. For every hypothetical change of 100 basis points in the assumed long-term rate of return on plan assets, the Company’s U.S. annual pension plan expense in 2003 would increase or decrease by approximately $5 million before tax. The reduction (or “credit”) to pension expense associated with the assumed investment return fluctuates based on the level of plan assets (over time, the higher the level of assets, the higher the credit and vice versa) and the assumed rate of return (the higher the rate, the higher the credit and vice versa). Plan assets for the Company’s U.S. defined benefit plan increased by approximately $111 million in 2003; $24 million since December 31, 2000 as a result of losses in 2001 and 2002. The Company calculates expected investment returns by applying the expected long-term rate of return to the market-related value of plan assets. The market-related value of the plan assets is different from the actual or fair-market value of the assets. The actual or fair-market value is the value of the assets at a point in time that are available to make payments to pensioners and to cover any transaction costs. The market-related value recognizes changes in fair-value on a straight-line basis over five years. This spreading reduces the effects of year-over-year volatility in the financial markets. The Company had significant investment losses in the three years ending December 31, 2002 that have not yet fully affected pension expense. The Company expects its pension expense will increase in the next several years because of the amortization of the net investment losses. This will be partially offset by the return earned in 2003. Inflation Assumptions on Salary Levels (Pension Plan) and Medical Inflation (Postretirement Medical Benefits, Health Benefit Act Medical Benefits)Pension expense and liabilities will vary with the expected rate of salary increases – the higher or lower the annual increase, the higher or lower the liability and expense. The Company expects its salary increase assumption to remain at or about 5%, assuming current rates of inflation. Changes in medical inflation will affect liability and expense amounts differently for the three plans noted. There is a direct link between medical inflation and expected spending for postretirement medical benefits under the Company-sponsored plan for 2004 and for later years. Future cash payments associated with the Health Benefit Act will reflect only a portion of the effect of medical inflation as a result of statutory limitations on premium growth. For the retiree medical plan the Company assumed inflation rates of 9% for 2004, and expects these rates will decline to 5% by 2009 for the Company-sponsored plans. The average annual increase in the plan for the last three years has been below 9%. Health Benefit Act liabilities were assumed to have a 4.5% inflation rate. The average annual premium increases over the last three years have been below 4.5%. Because of the volatility of medical inflation it is likely that there will be future adjustments, although the direction and extent of these adjustments cannot be predicted at the present time. Numbers of Participants (All Plans)The valuations of all of these benefit plans are affected by the life expectancy of the participants. Accordingly, the Company relies on actuarial information to predict the number and life expectancy of participants. Further, due to the complexity of the contractual relationship with the UMWA for postretirement medical benefits and the application of regulations associated with the Health Benefit Act, the Company’s related liability and expense has and will continue to fluctuate as mortality rates change, as new participants are made known to the Company and as the Company and others investigate the application of the regulations. As a result, the Company’s liabilities under its plans will vary as the expected number and life expectancy of participants change. Changes in LawsThe Company’s valuations of its liabilities are determined under existing laws and regulations. Changes in laws and regulations which affect the ultimate level of liabilities and expense are reflected once the changes are final and their impact can be reasonably estimated. Recent changes in laws that provide government subsidies for amounts paid for pharmaceuticals for Medicare-eligible medical plan participants are expected to reduce the Company’s liability. Changes in black lung regulations in 2000 could increase the Company’s total liability. Changes in laws directed at changing the funding available for medical benefits related to nonemployee beneficiaries under the Health Benefit Act could significantly reduce the Company’s ultimate liability for certain postretirement medical benefits. Workers’ CompensationBesides the effects of changes in medical costs, workers’ compensation costs are affected by the severity and types of injuries, changes in state regulations and their application and the quality of programs which assist an employee’s return to work. The Company’s liability for future payments for workers’ compensation claims is evaluated annually with the assistance of its actuary. |
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