2005 Financial Review
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies
Basis of Presentation
The Brink’s Company (along with its subsidiaries, the “Company”) conducts business in the security industry, through two wholly owned subsidiaries:
- Brink’s, Incorporated (“Brink’s”)
- Brink’s Home Security, Inc. (“BHS”)
In November 2005, the Company’s Board of Directors approved the sale of BAX Global Inc. (“BAX Global”), a wholly owned freight and transportation subsidiary of the Company. Accordingly, BAX Global’s results of operations have been reported as discontinued operations for all periods presented. BAX Global’s assets and liabilities in 2005 have been classified as held for sale. In January 2006, the Company sold BAX Global for $1.1 billion in cash, subject to final sales price adjustments. In prior years, the Company sold its natural resource businesses and interests, and the results of these operations have also been reported as discontinued operations. The Company has significant liabilities associated with its former coal operations and expects to have significant ongoing expenses and cash outflows related to these obligations. See note 5.
Principles of Consolidation
The consolidated financial statements include the accounts of The Brink’s Company and the subsidiaries it controls. Control is determined based on ownership rights or, when applicable, based on whether the Company is considered the primary beneficiary of a variable interest entity. The Company’s interest in 20%- to 50%-owned companies that are not controlled are accounted for using the equity method (“equity affiliates”), unless the Company does not sufficiently influence the management of the investee. Other investments are accounted for as cost-method investments or as available-for-sale marketable securities. All material intercompany accounts and transactions have been eliminated in consolidation.
Revenue Recognition
Brink’s. Revenue is recognized when services are performed. Services related to armored car transportation, ATM servicing, cash logistics and coin sorting and wrapping are performed in accordance with the terms of customer contracts, which have contract prices that are fixed and determinable. Brink’s assesses the customer’s ability to meet the contractual terms, including payment terms, before entering into contracts. Customer contracts are automatically extended after the initial contract period until either party terminates the agreement.
BHS. Monitoring revenues are recognized monthly as services are provided pursuant to the terms of subscriber contracts, which have contract prices that are fixed and determinable. BHS assesses the subscriber’s ability to meet the contract terms, including payment terms, before entering into the contract. Nonrefundable installation revenues and a portion of the related direct costs of acquiring new subscribers (primarily sales commissions) are deferred and recognized over an estimated 15 year subscriber relationship period. When an installation is identified for disconnection, any unamortized deferred revenues and deferred costs related to that installation are recognized at that time.
BAX Global. Revenues related to transportation services are recognized, together with related variable transportation costs, on the date shipments depart from facilities en route to destination locations. BAX Global and its customer agree to the terms of the shipment, including pricing, prior to shipment. Pricing terms are fixed and determinable, and BAX Global only agrees to shipments when it believes that the collectibility of related billings is reasonably assured. Export freight service revenues are shared among the origin and destination countries.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, demand deposits and investments with original maturities of three months or less.
Trade Accounts Receivable
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses on the Company’s existing accounts receivable. The Company determines the allowance based on historical write-off experience using industry and customer specific data. The Company reviews its allowance for doubtful accounts quarterly. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Through December 15 2005, the Company had an accounts receivable securitization program (described in note 13). Transfers of receivables under this program were accounted for as a sale.
Property and Equipment
Purchased property and equipment are recorded at cost. Depreciation is calculated principally on the straight-line method based on the estimated useful lives of individual assets or classes of assets.
Leased property and equipment meeting capital lease criteria are capitalized at the present value of the related lease payments. Amortization is calculated on the straight-line method based on the lease term.
Leasehold improvements are recorded at cost. Amortization is calculated principally on the straight-line method over the lesser of the estimated useful life of the leasehold improvement or lease term. Renewal periods are included in the lease term when the renewal is determined to be reasonably assured.
| Estimated Useful Lives (a) | Years |
| Buildings | 10 to 25 |
| Building leasehold improvements | 3 to 10 |
| Security systems | 15 |
| Vehicles | 3 to 12 |
| Capitalized software | 3 to 6 |
| Other machinery and equipment | 3 to 20 |
| Machinery and equipment leasehold improvements | 3 to 10 |
- (a)
- Excludes BAX Global.
Expenditures for routine maintenance and repairs on property and equipment, including aircraft, are charged to expense. Major renewals, betterments and modifications are capitalized and amortized over the lesser of the remaining life of the asset or, if applicable, lease term. Scheduled air time and periodic engine overhaul cost are capitalized when incurred and amortized over flying time to the next scheduled maintenance date.
BHS retains ownership of most security systems installed at subscriber locations. Costs for those systems are capitalized and depreciated over the estimated lives of the assets. Costs capitalized as part of security systems include equipment and materials used in the installation process, direct labor required to install the equipment at subscriber sites, and other costs associated with the installation process. These other costs include the cost of vehicles used for installation purposes and the portion of telecommunication, facilities and administrative costs incurred primarily at BHS’ branches that are associated with the installation process. In 2005, direct labor and other costs represented approximately 68% of the amounts capitalized, while equipment and materials represented approximately 32% of amounts capitalized. In addition to regular straight-line depreciation expense each period, the Company charges to expense the carrying value of security systems estimated to be permanently disconnected based on each period’s actual disconnects and historical reconnection experience.
Part of the costs related to the development or purchase of internal-use software is capitalized and amortized over the estimated useful life of the software. Costs that are capitalized include external direct costs of materials and services to develop or obtain the software, and internal costs, including compensation and employee benefits for employees directly associated with a software development project.
Goodwill and Other Intangible Assets
Goodwill is recognized for the excess of the purchase price over the fair value of tangible and identifiable intangible net assets of businesses acquired. Intangibles assets arising from business acquisitions include covenants not to compete, customer lists and other identifiable intangibles. Intangible assets that are subject to amortization have average remaining useful lives ranging from 1 to 8 years and are amortized primarily on a straight-line basis.
Impairment of Long-Lived Assets
Goodwill is tested for impairment at least annually by comparing the carrying value of the reporting unit to its estimated fair value. The Company bases its estimates of fair value on projected future cash flows. The Company completed goodwill impairment tests during each of the last three years with no impairment charges required.
Long-lived assets besides goodwill are reviewed for impairment when events or changes in circumstances indicate the carrying value of an asset may not be recoverable.
For long-lived assets other than goodwill that are to be held and used in operations, an impairment is indicated when the estimated total undiscounted cash flow associated with the asset or group of assets is less than carrying value. If impairment exists, an adjustment is made to write the asset down to its fair value, and a loss is recorded as the difference between the carrying value and fair value.
Long-lived assets held for sale are carried at the lower of carrying value or fair value less cost to sell. Fair values are determined based on quoted market values, discounted cash flows or internal and external appraisals, as applicable.
Investments Held by VEBA Trust
Prior to January 1, 2004, the Company accounted for investments held by its Voluntary Employees’ Beneficiary Association trust (“VEBA”) as available-for-sale marketable securities and unrealized gains and losses were recognized in other comprehensive income (loss) and realized gains and losses were recognized in earnings. Realized gains and losses were computed based on the average cost method.
Effective January 1, 2004, the Company restricted the use of the assets held by its VEBA to pay only obligations of its coal-related retiree medical plan and, accordingly, began accounting for the VEBA as a plan asset. Since January 1, 2004, the VEBA is reflected as a direct offset to the liability within postretirement benefits other than pensions on the Company’s balance sheet. With the restriction in the use of the VEBA, an unrealized net gain of $4.4 million was recognized in 2004 within interest and other income, net.
Share-Based Compensation
The Company accounts for share-based compensation plans using the intrinsic value method prescribed in Accounting Principles Board Opinion (“APB”) 25, “Accounting for Stock Issued to Employees” and related interpretations. The Company grants stock options with an exercise price equal to the market price of the stock on the date of grant and, as a result, the Company has not recognized any compensation expense related to its stock option plans.
Had compensation costs for the Company’s stock option plans been determined based on the fair value of awards at the grant dates consistent with the optional recognition provision of SFAS 123, “Accounting for Stock Based Compensation,” net income and net income per share would have been the pro forma amounts indicated below:
| Years Ended December 31, | ||||
| (In millions, except per share amounts) | 2005 | 2004 | 2003 | |
| Net income | ||||
| As reported | $ | 142.4 | 121.5 | 29.4 |
| Less share-based compensation expense determined under the fair value method, net of related tax effects | (4.1) | (3.6) | (4.7) | |
| Pro forma | $ | 138.3 | 117.9 | 24.7 |
| Net income per share | ||||
| Basic, as reported | $ | 2.53 | 2.23 | 0.55 |
| Basic, pro forma | 2.46 | 2.16 | 0.47 | |
| Diluted, as reported | $ | 2.50 | 2.20 | 0.55 |
| Diluted, pro forma | 2.43 | 2.13 | 0.46 | |
In these tables, the fair value of each stock option grant is estimated at the time of grant using the Black-Scholes option-pricing model. If a different option-pricing model had been used, results may have been different. The fair value of options that vest entirely at the end of a fixed period, generally three years, is estimated using a single option approach and amortized on a straight line basis over the total vesting period. The fair value of options that vest ratably over three years is estimated using a multiple-option approach and amortized on a straight-line basis over each separate vesting period. Forfeitures are recognized when they occur.
The assumptions used and the resulting weighted-average grant-date estimates of fair value for options granted are as follows:
| Years Ended December 31, | ||||
| 2005 | 2004 | 2003 | ||
| Options granted | ||||
| In millions | 0.7 | 0.9 | 0.6 | |
| Weighted-average exercise price per share | $ | 35.95 | 31.88 | 15.24 |
| Weighted-average assumptions | ||||
| Expected dividend yield | 0.4% | 0.5% | 0.5% | |
| Expected volatility | 34% | 32% | 37% | |
| Risk-free interest rate | 3.8% | 3.3% | 2.3% | |
| Expected term (in years) | 4.1 | 3.8 | 4.0 | |
| Fair value estimates | ||||
| In millions | $ | 7.8 | 8.3 | 3.0 |
| Weighted-average per share | $ | 11.21 | 8.84 | 4.69 |
Postretirement Benefits Other Than Pensions
The Company has postretirement benefit obligations other than pensions provided under Company-sponsored plans. In addition, the Company is obligated to pay premiums to the United Mine Workers Association Combined Benefit Fund (the “Combined Fund”) pursuant to rules established by the Coal Industry Retiree Health Benefit Act of 1992 (the “Health Benefit Act”) as further discussed in note 4.
Postretirement benefits for Company-sponsored plans are accounted for in accordance with SFAS 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” which requires employers to accrue the cost of retirement benefits during the period of employees’ service with the Company. Actuarial gains and losses are deferred. The portion of the deferred gains or losses that exceeds 10% of the greater of the accumulated postretirement benefit obligation or plan assets at the beginning of the year is amortized into earnings over the average remaining life expectancy for inactive participants.
Postretirement benefit obligations to the Combined Fund are recorded as a liability when they are probable and estimable in accordance with Emerging Issues Task Force (“EITF”) 92-13, “Accounting for Estimated Payments in Connection with the Coal Industry Retiree Health Benefit Act of 1992.”
Income Taxes
Deferred tax assets and liabilities are recorded to recognize the expected future tax benefits or costs of events that have been reported in different years for financial statement purposes than tax purposes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which these items are expected to reverse. Management periodically reviews recorded deferred tax assets to determine if it is more-likely-than-not they will be realized. If management determines it is not more-likely-than-not a deferred tax asset will be realized, an offsetting valuation allowance is recorded, reducing earnings and the deferred tax asset in that period.
Foreign Currency Translation
The Company’s consolidated financial statements are reported in U.S. dollars. A substantial amount of the Company’s business is transacted in other currencies due to the large number of countries in which the Company operates. In addition, the Company’s foreign subsidiaries maintain their records primarily in the currency of the country within which they operate. Accordingly, income, expense and balance sheet values must be translated into U.S. dollars. The value of assets and liabilities of foreign subsidiaries are translated into U.S. dollars using rates of exchange at the balance sheet date and resulting cumulative translation adjustments are recorded in other comprehensive income (loss). Revenues and expenses are translated at rates of exchange in effect during the year. Transaction gains and losses and translation adjustments relating to subsidiaries in countries with highly inflationary economies are included in net income. No subsidiaries operated in highly inflationary economies for the three years ended December 31, 2005.
Derivative Instruments and Hedging Activities
All derivative instruments are recorded in the consolidated balance sheets at fair value. If the derivative has been designated as a cash flow hedge, changes in the fair value are recognized in other comprehensive income (loss) until the hedged transaction is recognized in earnings.
Concentration of Credit Risks
Financial instruments which potentially subject the Company to concentrations of credit risks are principally cash and cash equivalents and accounts receivables. Cash and cash equivalents are held by major financial institutions. The Company routinely assesses the financial strength of significant customers and this assessment, combined with the large number and geographic diversity of its customers, limits the Company’s concentration of risk with respect to accounts receivable.
Use of Estimates
In accordance with U.S. generally accepted accounting principles (“GAAP”), management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements. Actual results could differ materially from those estimates. The most significant estimates used by management are related to goodwill and other long-lived assets, pension and other postretirement benefit obligations, and deferred tax assets.
Reclassifications
Certain prior-year amounts have been reclassified to conform to the current year’s financial statement presentation and to reflect the retrospective adoption of certain accounting standards, discussed below.
New Accounting Standards
Adopted Standards
In March 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”), an interpretation of SFAS 143, “Asset Retirement Obligations.” FIN 47 clarifies that the term “conditional asset retirement obligation” as used in SFAS 143 includes a legal obligation associated with the retirement of a tangible long-lived asset in which the timing and/or method of settlement is conditional on a future event that may or may not be within the control of the entity. An entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated, even if conditional on a future event. The Company has conditional asset retirement obligations primarily associated with leased facilities. The Company adopted FIN 47 on December 31, 2005 and recognized the following:
| (In millions) | ||
| Adjustment at December 31, 2005 | ||
| Increase in assets (a): | ||
| Leasehold improvements | $ | 3.8 |
| Noncurrent deferred income tax asset | 0.9 | |
| 4.7 | ||
| Increase in liabilities - asset retirement obligations (b) | (10.1) | |
| Cumulative effect of change in accounting principle, net of tax (c) | $ | (5.4) |
- (a)
- Includes $1.1 million of assets held for sale.
- (b)
- Includes $2.1 million of liabilities held for sale.
- (c)
- Includes $1.0 million of cumulative effect of change in accounting principle, net of tax, related to BAX Global.
If the Company had adopted FIN 47 on January 1, 2003 income from continuing operations and net income, and the respective per share amounts, would have been the following on a pro forma basis in the three years ended 2005.
| Years Ended December 31, | ||||
| (In millions) | 2005 | 2004 | 2003 | |
| Net income, as reported | $ | 142.4 | 121.5 | 29.4 |
| Add back cumulative effect | 5.4 | - | - | |
| Less total depreciation and interest accretion expense, net of tax | (1.6) | (1.0) | (1.0) | |
| Pro forma net income | $ | 146.2 | 120.5 | 28.4 |
| Net income per common share: | ||||
| Basic: | ||||
| As reported | $ | 2.53 | 2.23 | 0.55 |
| Pro forma | 2.60 | 2.21 | 0.54 | |
| Diluted: | ||||
| As reported | $ | 2.50 | 2.20 | 0.55 |
| Pro forma | 2.57 | 2.18 | 0.53 | |
The pro forma amounts were measured using the same information, assumptions and interest rates used to measure the liability for conditional asset retirement obligations recognized upon adoption of FIN 47.
In July 2005 the FASB issued FASB Staff Position (“FSP”) APB 18-1, “Accounting by an Investor for Its Proportionate Share of Accumulated Other Comprehensive Income of an Investee Accounted for under the Equity Method in Accordance with APB Opinion 18 upon a Loss of Significant Influence.” FSP APB 18-1 requires an investor’s proportionate share of an investee’s equity adjustments for other comprehensive income to be offset against the carrying value of the investment at the time significant influence is lost. FSP APB 18-1 requires comparative financial statements be retrospectively adjusted to reflect the provisions of the FSP APB 18-1. The Company adopted FSP APB 18-1 on October 1, 2005. The carrying value (before the effect of FSP APB 18-1) of Brink’s cost method investment that was previously accounted for under the equity method was $8.9 million at December 31, 2005 and 2004. Cumulative currency losses of $14.5 million at December 31, 2005 and 2004 were reclassified from accumulated other comprehensive loss and increased the carrying value of the Company’s related investment to $23.4 million. This reclassification had no effect on net income.
Effective January 1, 2004, the Company adopted FASB Interpretation 46 (revised December 2003), “Consolidation of Variable Interest Entities,” which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through a means other than voting rights. The implementation of this new standard did not have a material effect on the Company’s results of operations or financial position.
Effective December 31, 2003, the Company adopted SFAS 132R, “Employers’ Disclosure about Pensions and Other Postretirement Benefits.” SFAS 132R does not change the way liabilities are valued and expenses are calculated for those plans. The standard requires, among other things, additional disclosures about the assets held in employer sponsored plans, disclosures relating to plan asset investment policy and practices and disclosure of expected contributions to be made to the plans and expected benefit payments to be made by the plans.
In December 2004, the FASB issued FSP FAS 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004." The American Jobs Creation Act introduced a limited-time 85% dividends-received deduction on the repatriation of foreign earnings to U.S. taxpayers, provided certain criteria are met. FSP FAS 109-2 provides accounting and disclosure guidance for the repatriation provision. FSP FAS 109-2 was effective immediately and the required disclosures have been included in note 17 to the Company’s consolidated financial statements.
Standards not yet adopted
In December 2004, the FASB issued SFAS 123R, “Share-Based Payment.” SFAS 123R is a revision of SFAS 123 and supersedes APB 25. SFAS 123R eliminates the use of the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based on the fair value of those awards. Compensation expense related to stock options that are subject to continued vesting upon retirement will be recognized over the period of employment up to the retirement-eligible date. The Company is required to adopt SFAS 123R effective January 1, 2006. SFAS 123R permits companies to adopt its requirements using either a “modified prospective” method or a “modified retrospective” method. Under the “modified prospective” method, compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS 123R for all share-based payments granted after that date, and based on the requirements of SFAS 123 for all unvested awards granted prior to the effective date of SFAS 123R. Under the “modified retrospective” method, the requirements are the same as under the “modified prospective” method, except that entities also are allowed to restate financial statements of previous periods based on pro forma disclosures made in accordance with SFAS 123. The Company will apply the modified prospective method upon adoption of SFAS 123R.
Based on current estimates, the Company believes that it will record in continuing operations pretax expense of between $8 million and $10 million during 2006 for stock option grants issued under these plans. The actual 2006 expense will be different from the estimate because the number of options to be granted in 2006 and other variables assumed in estimating the fair value of the 2006 grants are not currently known. The Company believes that a significant portion of the estimated 2006 expense will be recorded in the third quarter.