Accounting Policies

9 Months Ended

Oct. 02, 2011

Accounting Policies

Accounting Policies

2. Accounting Policies

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Goodwill and Long-Lived Assets

The changes in the carrying amount of goodwill by geographic segment are as follows:

	North America			Europe			China		Total
	(in millions)
Gross balance at January 1, 2011	$	213.8		$	228.1		$	8.1	$	450.0
Accumulated impairment losses	(22.0		)	—			—		(22.0		)
Net goodwill at January 1, 2011	191.8			228.1			8.1		428.0
Acquired	4.3			65.7			4.3		74.3
Effect of change in exchange rates used for translation	—			(1.8		)	0.3		(1.5		)
Gross balance at October 2, 2011	$	218.1		$	292.0		$	12.7	$	522.8
Accumulated impairment losses	(22.0		)	—			—		(22.0		)
Net goodwill at October 2, 2011	$	196.1		$	292.0		$	12.7	$	500.8

On April 29, 2011, the Company completed the acquisition of Danfoss Socla S.A.S. (Socla) and the related water controls business of certain other entities controlled by Danfoss A/S, in a share and asset purchase transaction. The aggregate consideration paid was EUR 120.0 million, less EUR 3.4 million in estimated working capital and related adjustments.   The net consideration paid of EUR 116.6 million is subject to final working capital and related adjustments. The Company is accounting for the transaction as a business combination. The Company completed a preliminary purchase price allocation that resulted in the recognition of $74.3 million in goodwill and $41.9 million in intangible assets.  Intangible assets consist primarily of customer relationships with estimated lives of 10 years and trade names with either 20-year lives or indefinite lives.  See Note 12 for additional information regarding the Socla acquisition.

Goodwill and intangible assets not subject to amortization are tested for impairment at least annually or more frequently if events or circumstances indicate that it is “more likely than not” that goodwill might be impaired, such as a change in business conditions. The Company performs its annual impairment assessment of goodwill and intangible assets not subject to amortization in the fourth quarter of each year.

Intangible assets with estimable lives and other long-lived assets are reviewed 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 intangible assets with estimable lives and other long-lived assets are measured by a comparison of the carrying amount of an asset or asset group to future net undiscounted pretax cash flows expected to be generated by the asset or asset group. If these comparisons indicate that an asset is not recoverable, the impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the related estimated fair value. Estimated fair value is based on either discounted future pretax operating cash flows or appraised values, depending on the nature of the asset. The Company determines the discount rate for this analysis based on the weighted average cost of capital based on the market and guideline public companies for the related business and does not allocate interest charges to the asset or asset group being measured.  Significant management judgment is required to estimate future operating cash flows.

Intangible assets include the following:

	October 2, 2011
	GrossCarryingAmount		AccumulatedAmortization			NetCarryingAmount
	(in millions)
Patents	$	16.7	$	(10.4	)	$	6.3
Customer relationships	151.9		(54.0		)	97.9
Technology	19.9		(6.8		)	13.1
Other	20.2		(6.2		)	14.0
Total amortizable intangibles	208.7		(77.4		)	131.3
Indefinite-lived intangible assets	48.3		—			48.3
Total	$	257.0	$	(77.4	)	$	179.6

During the nine months ended October 2, 2011, the Company recorded a $0.3 million impairment of a trade name in our European segment and subsequently reclassified the $2.1 million trade name value to amortizable intangibles.

Aggregate amortization expense for amortizable intangible assets for the third quarters of 2011 and 2010 was $4.2 million and $3.6 million, respectively, and for the nine-month periods of 2011 and 2010 was $13.5 million and $10.2 million, respectively. Additionally, future amortization expense for the next five years on amortizable intangible assets approximates $4.8 million for the remainder of 2011, $17.6 million for 2012, $16.2 million for 2013, $16.2 million for 2014 and $15.8 million for 2015. Amortization expense is provided on a straight-line basis over the estimated useful lives of the intangible assets. The weighted-average remaining life of total amortizable intangible assets is 12.0 years. Patents, customer relationships, technology and other amortizable intangibles have weighted-average remaining lives of 7.3 years, 7.5 years, 14.2 years and 21.9 years, respectively. Intangible assets not subject to amortization consist of certain trademarks and trade names.

Stock-Based Compensation and Chief Executive Officer Separation Costs

The Company maintains three stock incentive plans under which key employees and non-employee members of the Company’s Board of Directors have been granted incentive stock options (ISOs) and nonqualified stock options (NSOs) to purchase the Company’s Class A Common Stock. Only one plan, the 2004 Stock Incentive Plan, is currently available for the grant of new stock options, which are currently being granted only to employees. Stock options granted under prior plans became exercisable over a five-year period at the rate of 20% per year and expire ten years after the date of grant. Under the 2004 Stock Incentive Plan, options become exercisable over a four-year period at the rate of 25% per year and expire ten years after the grant date. ISOs and NSOs granted under the plans may have exercise prices of not less than 100% and 50% of the fair market value of the Class A Common Stock on the date of grant, respectively. The Company’s current practice is to grant all options at fair market value on the grant date. The Company issued 280,000 and 282,500 options to key employees under the 2004 Stock Incentive Plan in the third quarter and in the first nine months of 2011 and 2010, respectively.

The fair value of each share issued under the 2004 Stock Incentive Plan is estimated on the date of grant, using the Black-Scholes-Merton Model, based on the following weighted average assumptions:

	2011		2010
Expected life (years)	6.0		6.0
Expected stock price volatility	40.9	%	41.3	%
Expected dividend yield	1.5	%	1.3	%
Risk-free interest rate	1.6	%	1.9	%

The above assumptions were used to determine the weighted average grant-date fair value of stock options of $10.19 and $12.36 in 2011 and 2010, respectively.

The Company has also granted shares of restricted stock to key employees and stock awards to non-employee members of the Company’s Board of Directors under the 2004 Stock Incentive Plan, which vest either immediately, over a one-year period, or over a three-year period at the rate of one-third per year. The restricted stock awards are amortized to expense on a straight-line basis over the vesting period. The Company issued 107,786 and 104,975 shares of restricted stock under the 2004 Stock Incentive Plan in third quarters of 2011 and 2010, respectively.  The Company issued 109,186 and 104,975 shares of restricted stock under the 2004 Stock Incentive Plan in the first nine months of 2011 and 2010, respectively.

The Company also has a Management Stock Purchase Plan that allows for the purchase of restricted stock units (RSUs) by key employees.  On an annual basis, key employees may elect to receive a portion of their annual incentive compensation in RSUs instead of cash.  Each RSU represents one share of Class A Common Stock and is purchased by the employee at 67% of the fair market value of the Company’s Class A Common Stock on the date of grant.  RSUs vest annually over a three-year period from the grant date and receipt of the shares underlying RSUs is deferred for a minimum of three years or such greater number of years as is chosen by the employee.  An aggregate of 2,000,000 shares of Class A Common Stock may be issued under the Management Stock Purchase Plan. The Company granted 96,454 RSUs and 158,473 RSUs in the first nine months of 2011 and 2010, respectively.

The fair value of each RSU issued under the Management Stock Purchase Plan is estimated on the date of grant, using the Black-Scholes-Merton Model, based on the following weighted average assumptions:

	2011		2010
Expected life (years)	3.0		3.0
Expected stock price volatility	44.9	%	45.6	%
Expected dividend yield	1.2	%	1.5	%
Risk-free interest rate	1.2	%	1.5	%

The above assumptions were used to determine the weighted average grant-date fair value of RSUs of $16.25 and $12.81 in 2011 and 2010, respectively.

A more detailed description of each of these stock and stock option plans can be found in Note 13 of Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

On January 26, 2011, Patrick S. O’Keefe resigned from his positions of Chief Executive Officer, President and Director. The Company recorded a charge in the first quarter of 2011 of $6.3 million related to his separation agreement, consisting of $3.3 million in expected cash severance and a non-cash charge of $3.0 million for the modification of his stock options and restricted stock awards.

Shipping and Handling

The Company’s shipping costs included in selling, general and administrative expenses were $9.2 million and $8.6 million for the third quarters of 2011 and 2010, respectively, and were $28.4 million and $25.7 million for the first nine months of 2011 and 2010, respectively.

Research and Development

Research and development costs included in selling, general and administrative expenses were $5.3 million and $4.3 million for the third quarters of 2011 and 2010, respectively, and were $16.0 million and $14.0 million for the first nine months of 2011 and 2010, respectively.

Taxes, Other than Income Taxes

Taxes assessed by governmental authorities on sale transactions are recorded on a net basis and excluded from sales in the Company’s consolidated statements of operations.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. 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.

New Accounting Standards

In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-05, “Comprehensive Income.” This ASU intends to enhance comparability and transparency of other comprehensive income components. The guidance provides an option to present total comprehensive income, the components of net income and the components of other comprehensive income in a single continuous statement or two separate but consecutive statements. This ASU eliminates the option to present other comprehensive income components as part of the statement of changes in stockholders’ equity. The provisions of this ASU will be applied retrospectively for interim and annual periods beginning after December 15, 2011. Early application is permitted. The Company is currently evaluating the adoption of this new ASU, but does not expect the adoption to have a material impact on its consolidated financial statements.

In September 2011, accounting guidance was issued by FASB in Accounting Standards Codification (ASC) Topic 350, “Intangibles — Goodwill and Other”. This guidance amends the requirements for goodwill impairment testing. The Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then performing the two-step impairment test is unnecessary. The Company intends to adopt this new standard effective with its annual goodwill impairment testing date of October 30, for the year ending December 31, 2011.