AGCO CORP /DE (AGCO) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
We are a leading manufacturer and distributor of agricultural equipment and related replacement parts throughout the world. We sell a full range of agricultural equipment, including tractors, combines, self-propelled sprayers, hay tools, forage equipment, seeding and tillage equipment, implements, and grain storage and protein production systems. Our products are widely recognized in the agricultural equipment industry and are marketed under a number of well-known brand names, including Fendt®, GSI®, Massey Ferguson®, Precision Planting® and Valtra®, supported by our FUSE® precision agriculture solutions. We distribute most of our products through a combination of approximately 3,100 dealers and distributors as well as associates and licensees. In addition, we provide retail and wholesale financing through our finance joint ventures with Rabobank.
The COVID-19 pandemic and other economic factors continue to create volatility in the global economy, initially through government-mandated facility closures, higher absentee rates, and reduced production at both our factories and the factories that supply us with parts and components, and, more recently, through supply chain disruptions and logistical challenges. In addition, we have had to incur various costs related to preventing the spread of COVID-19, including changes to our factories and other facilities and those related to enabling remote work. We expect COVID-19 to continue to impact our business, although the manner and extent to which it impacts us will depend on future developments, including the duration of the pandemic, the timing, distribution and impact of vaccinations, and possible mutations of the virus that are more contagious or resistant to current vaccines. Measures taken by governments around the world, as well as businesses, including us, and the general public in order to limit the spread of COVID-19 will impact our business as well. These factors, along with increasing industrial demand, could negatively affect production levels, particularly caused by delays in the receipts of parts and components. Supply chain issues of particular concern include a wide range of parts and components with a portion arising from the global semiconductor shortage. We may continue to face supplier bottlenecks and delays in all regions as well as challenges with freight logistics, and we continue to work to mitigate the impact of these issues in order to meet increased end-market demand.
We sell our equipment and replacement parts to our independent dealers, distributors and other customers. A large majority of our sales are to independent dealers and distributors that sell our products to end users. To the extent practicable, we attempt to sell products to our dealers and distributors on a level basis throughout the year to reduce the effect of seasonal demands on our manufacturing operations and to minimize our investment in inventories. However, retail sales by dealers to farmers are highly seasonal and are a function of the timing the planting and harvesting seasons. In certain markets, particularly in North America, there is often a time lag, which varies based on the timing and level of retail demand, between our sale of the equipment to the dealer and the dealer’s sale to a retail customer.
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Financial Highlights
The following table sets forth, for the periods indicated, the percentage relationship to net sales of certain items included in our Consolidated Statements of Operations:
| Years Ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2022(1) | 2021(1) | 2020(1) | ||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | ||
| Cost of goods sold | 76.3 | 76.9 | 77.5 | |||||
| Gross profit | 23.7 | 23.1 | 22.5 | |||||
| Selling, general and administrative expenses | 9.4 | 9.8 | 10.9 | |||||
| Engineering expenses | 3.5 | 3.6 | 3.7 | |||||
| Amortization of intangibles | 0.5 | 0.5 | 0.7 | |||||
| Impairment charges | 0.3 | — | 0.2 | |||||
| Restructuring expenses | — | 0.1 | 0.2 | |||||
| Bad debt expense | — | — | 0.2 | |||||
| Income from operations | 10.0 | 9.0 | 6.6 | |||||
| Interest expense, net | 0.1 | 0.1 | 0.2 | |||||
| Other expense, net | 1.1 | 0.5 | 0.2 | |||||
| Income before income taxes and equity in net earnings of affiliates | 8.8 | 8.5 | 6.1 | |||||
| Income tax provision | 2.3 | 1.0 | 2.1 | |||||
| Income before equity in net earnings of affiliates | 6.4 | 7.5 | 4.1 | |||||
| Equity in net earnings of affiliates | 0.5 | 0.6 | 0.5 | |||||
| Net income | 6.9 | 8.1 | 4.6 | |||||
| Net (income) loss attributable to noncontrolling interests | 0.1 | — | 0.1 | |||||
| Net income attributable to AGCO Corporation and subsidiaries | 7.0 | % | 8.1 | % | 4.7 | % |
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(1) Rounding may impact summation of amounts.
2022 Compared to 2021
Net income attributable to AGCO Corporation and subsidiaries for 2022 was $889.6 million, or $11.87 per diluted share, compared to $897.0 million, or $11.85 per diluted share, for 2021.
Net sales for 2022 were approximately $12,651.4 million, or 13.6% higher than 2021, primarily due to robust high horsepower tractor end-market demand and favorable pricing, which helped to offset the negative impacts of currency translation, supply chain constraints and inflationary pressures. Regionally, net sales were higher in all regions during 2022 compared to 2021, excluding currency translation. Income from operations was approximately $1,265.4 million in 2022 compared to approximately $1,001.4 million in 2021. The increase in income from operations during 2022 was primarily the result of higher net sales and production volumes along with significant pricing to offset inflationary cost increases. Income from operations during 2022 was impacted by impairment charges recorded during the first quarter related to our joint ventures in Russia of approximately $36.0 million. Net income per diluted share was impacted by these factors, as well as restructuring expenses.
Regionally, income from operations in Europe/Middle East (“EME”) increased by approximately $28.7 million in 2022 compared to 2021, driven primarily by higher net sales and increased production volumes as well as positive pricing realization, which offset higher material costs and engineering expenses. In our North American region, income from operations increased by approximately $40.7 million compared to the prior year. Higher net sales and production levels, as well as favorable net pricing impacts contributed to the improvement in the region and helped to offset higher engineering expenses and material cost inflation. In South America, income from operations increased approximately $241.7 million in 2022 compared to 2021. The increase reflects increased net sales and production volumes, a better sales mix and significant price realization, offsetting increasing material costs. Income from operations in our Asia/Pacific/Africa (“APA”) region increased
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approximately $3.0 million in 2022 compared to 2021, primarily due to higher net sales and an improved product mix which offset higher engineering expenses and material cost inflation.
Industry Market Conditions
Supportive farm economics are resulting in robust demand for larger agricultural equipment as farmers continue to replace aging machinery. Supply chain constraints have limited global industry production and dealer inventory levels of new and used large agricultural equipment remain below normal levels across the industry. Healthy farm income from elevated crop prices helped to offset higher fuel, fertilizer and other input costs. Future demand for agricultural equipment will be influenced by farm income, which is a function of commodity and protein prices, crop yields and government support.
In North America, industry unit retail sales of utility and high horsepower tractors decreased approximately 5.0% in 2022 compared to 2021. Industry unit retail sales of combines increased approximately 14.6% in 2022 compared to 2021. Lower sales of smaller tractors, which declined from record levels in 2021, were partially offset by increased sales of higher horsepower tractors and combines.
In Western Europe, industry unit retail sales of tractors for 2022 decreased approximately 8.5% compared to 2021. Industry unit retail sales of combines for 2022 increased approximately 10.2% compared to 2021. Industry retail tractors sales were restricted by supply chain challenges during 2022. In addition, farmer sentiment in the region has been negatively impacted by the conflict in Ukraine, input cost inflation and while lessening, looming energy concerns.
In South America, industry unit retail sales of tractors for 2022 increased approximately 3.2% compared to 2021. Industry unit retail sales of combines for 2022 decreased approximately 1.6% compared to 2021. The improved demand in tractors was primarily in Argentina and smaller South American markets, offset by modestly lower sales in Brazil despite strong demand for large agricultural equipment. Healthy crop production and continued expansion in planted acreage, as well as favorable margins, driven by supportive exchange rates, continue to support farm profitability and investments in equipment.
Results of Operations
Net sales for 2022 were $12,651.4 million compared to $11,138.3 million for 2021, primarily as a result of improved high horsepower tractor end-market demand, which resulted in a favorable sales mix, as well as favorable pricing impacts, partially offset by unfavorable foreign currency translation. The following table sets forth, for the year ended December 31, 2022, the impact to net sales of currency translation by geographical segment (in millions, except percentages):
| Change | Change due to Currency Translation | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | $ | % | $ | % | ||||||||||||||||
| EME | $ | 6,447.3 | $ | 6,221.7 | $ | 225.6 | 3.6 | % | $ | (922.8) | (14.8) | % | |||||||||
| North America | 3,175.1 | 2,659.2 | 515.9 | 19.4 | % | (20.6) | (0.8) | % | |||||||||||||
| South America | 2,121.6 | 1,307.7 | 813.9 | 62.2 | % | 73.4 | 5.6 | % | |||||||||||||
| APA | 907.4 | 949.7 | (42.3) | (4.5) | % | (76.1) | (8.0) | % | |||||||||||||
| $ | 12,651.4 | $ | 11,138.3 | $ | 1,513.1 | 13.6 | % | $ | (946.1) | (8.5) | % |
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Regionally, net sales in EME were higher during 2022 compared to 2021, primarily due to increased sales in most major markets in the region, with the largest increases contributed by net sales growth in both tractors and combines. These positive impacts were partially offset by negative currency translation. Net sales in North America increased in 2022 compared to 2021, as a result of strong pricing and growth in net sales of high horsepower tractors, combines and precision agricultural equipment. Net sales increased in South America in 2022 compared to 2021, primarily due to significant pricing realization and higher net sales of high horsepower tractors, combines and planting equipment. In the APA region, net sales decreased in 2022 compared to 2021, primarily due to unfavorable currency translation and delays in production and corresponding shipments from our European factories.
We estimate that worldwide average price increases were approximately 11.6% and 6.6% in 2022 and 2021, respectively. Consolidated net sales of tractors and combines, which comprised approximately 63.2% of our net sales in 2022, increased approximately 17.3% in 2022 compared to 2021. Unit sales of tractors and combines increased approximately 15.6% during 2022 compared to 2021. The difference between the unit sales change and the change in net sales was primarily the result of foreign currency translation, pricing and sales mix changes.
The following table sets forth, for the years ended December 31, 2022 and 2021, the percentage relationship to net sales of certain items included in our Consolidated Statements of Operations (in millions, except percentages):
| 2022 | 2021 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| $ | % of Net Sales | $ | % ofNet Sales(1) | ||||||||||
| Gross profit | $ | 3,001.3 | 23.7 | % | $ | 2,572.3 | 23.1 | % | |||||
| Selling, general and administrative expenses | 1,186.2 | 9.4 | % | 1,088.2 | 9.8 | % | |||||||
| Engineering expenses | 444.2 | 3.5 | % | 405.8 | 3.6 | % | |||||||
| Amortization of intangibles | 60.1 | 0.5 | % | 61.1 | 0.5 | % | |||||||
| Impairment charge | 36.0 | 0.3 | % | — | — | % | |||||||
| Restructuring expenses | 6.1 | — | % | 15.3 | 0.1 | % | |||||||
| Bad debt expense | 3.3 | — | % | 0.5 | — | % | |||||||
| Income from operations | $ | 1,265.4 | 10.0 | % | $ | 1,001.4 | 9.0 | % |
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(1) Rounding may impact summation of amounts.
Gross profit as a percentage of net sales increased during 2022 compared to 2021 primarily due to the benefit of higher net sales and production levels, as well as positive pricing, which was partially offset by the impact of material cost inflation. Overall, global production hours increased approximately 5.5% during 2022 compared to 2021, primarily as a result of stronger market demand during 2022. Our production facilities continue to face supply chain and logistics disruptions as well as material and freight cost inflation. These disruptions impact our ability to produce and ship units, as well as contribute to labor inefficiencies, and result in carrying higher raw material and work in process inventory levels. We were able to meaningfully reduce work-in-process inventory levels during the fourth quarter of 2022 from higher levels during previous quarters. We expect these conditions to continue, which may impact production levels and net sales and margins in future periods.
Selling, general and administrative expenses (“SG&A expenses”) and engineering expenses, as a percentage of net sales, were lower during 2022 compared to 2021, primarily driven by the increase in net sales and the impact of foreign currency translation. The absolute level of SG&A expenses increased during 2022 following prior actions to lower expenses in 2021 as a result of the pandemic, such as reduced field sales and marketing activities and lower travel expenses. We recorded stock compensation expense of approximately $32.7 million and $26.6 million during 2022 and 2021, respectively, within SG&A expenses, as is more fully explained in Notes 1 and 10 of our Consolidated Financial Statements.
We recorded restructuring expenses of approximately $6.1 million and $15.3 million during 2022 and 2021, respectively. The restructuring expenses primarily related to severance and other related costs associated with the rationalization of certain U.S., China, South American and European manufacturing operations. See Note 3 of our Consolidated Financial Statements. Also, see below for discussion of impairment and other charges associated with our Russian joint ventures.
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Interest expense, net was $13.0 million for 2022 compared to $6.7 million for 2021 resulting primarily from increased debt levels and interest rates in 2022 as compared to 2021. See “Liquidity and Capital Resources” for further information on our available funding.
Other expense, net was $145.2 million in 2022 compared to $50.4 million in 2021. Losses on sales of receivables, primarily related to our accounts receivable sales agreements with our finance joint ventures in North America, Europe and Brazil, were approximately $71.1 million and $24.5 million in 2022 and 2021, respectively. The increase in losses was primarily the result of higher interest rates in 2022 as compared to 2021. Other expense, net also increased in 2022 as compared to 2021 due to higher foreign exchange losses. See below for discussion of charges associated with the sale of our Russian joint venture.
We recorded an income tax provision of approximately $296.6 million in 2022 compared to $108.4 million in 2021. Our tax provision and effective tax rate are impacted by the differing tax rates of the various tax jurisdictions in which we operate, permanent differences for items treated differently for financial accounting and income tax purposes, losses in jurisdictions where no income tax benefit is recorded, and provisions for unrecognized income tax benefits related to uncertain tax positions. At December 31, 2022 and 2021, we had gross deferred tax assets of $301.2 million and $291.8 million, respectively, including $45.9 million and $69.5 million, respectively, related to net operating loss carryforwards. At December 31, 2022 and 2021, we had total valuation allowances as an offset to our gross deferred tax assets of approximately $47.3 million and $47.4 million, respectively. These valuation allowances included allowances against deferred tax assets (including net operating loss carryforwards) in the U.S. and certain foreign jurisdictions. As of December 31, 2021, our income tax provision included the benefit of reversals of approximately $67.8 million and approximately $55.6 million related to valuation allowances previously established against the Company’s net deferred tax assets in the U.S. and Brazil, respectively. Improvements in income in the U.S and Brazil during 2020 and 2021, along with updated future projected income levels, supported the reversal of both of the valuation allowances. Realization of the net deferred tax assets as of December 31, 2022 will depend on generating sufficient taxable income in future periods, net of reversing deferred tax liabilities. We believe it is more likely than not that the remaining net deferred tax assets should be able to be realized. Refer to Note 6 of our Consolidated Financial Statements for further information.
Equity in net earnings of affiliates, which is primarily comprised of income from our AGCO Finance joint ventures, was $64.1 million in 2022 compared to $65.6 million in 2021. The decrease was primarily due to a write-down of our investment in our Russian finance joint venture of approximately $4.8 million recorded during the first quarter of 2022. The Russian finance joint venture was sold during the three months ended December 31, 2022. See “Finance Joint Ventures” for further information regarding our finance joint ventures and their results of operations and Note 5 of our Consolidated Financial Statements for further information.
We previously invested in two joint ventures that operated in Russia primarily for the manufacture and distribution of equipment and parts. Beginning in 2018, our Russian joint venture partner became subject to sanctions by the United States. Subsequent to the commencement of these sanctions, we obtained time-limited general licenses from the Office of Foreign Assets Control (“OFAC”) of the U.S. Department of Treasury that permitted us to continue our participation, which, following the most recent extension, expired on May 25, 2022. Following that expiration, we “blocked” our interest in our Russian manufacturing joint venture through a process acceptable to OFAC, which had the effect of suspending our role in that joint venture. During the three months ended March 31, 2022, we assessed the fair value of our gross assets related to the joint ventures for potential impairments and recorded asset impairment charges of approximately $36.0 million. During the three months ended December 31, 2022, we sold our interest in the Russian distribution joint venture and, as a result, approximately $11.4 million of foreign currency losses accumulated in the joint venture previously recognized within “Accumulated other comprehensive loss” were therefore recorded in “Other expense, net” associated with the divestiture.
2021 Compared to 2020
A comparison of the results of operations for 2021 versus that of 2020 was included in our Annual Report on Form 10-K for the year ended December 31, 2021.
AGCO Finance Joint Ventures
Our AGCO Finance joint ventures provide both retail financing and wholesale financing to our dealers in the United States, Canada, Europe, Brazil, Argentina and Australia. The joint ventures are owned by AGCO and Rabobank. The majority of the assets of the finance joint ventures consist of finance receivables. The majority of the liabilities consist of notes payable and accrued interest. Under the various joint venture agreements, Rabobank provides financing to the finance joint ventures, primarily through lines of credit. We do not guarantee the debt obligations of the joint ventures. In the United States and
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Canada, we guarantee certain minimum residual values to those joint ventures upon expiration of certain eligible leases between the finance joint ventures and end users. We also have other guarantees with our other finance joint ventures which are not material. See “Commitments and Off-Balance Sheet Arrangements” and Note 12 to our Consolidated Financial Statements for additional information.
As of December 31, 2022, our capital investment in the finance joint ventures, which is included in “Investment in affiliates” on our Consolidated Balance Sheets, was approximately $390.2 million compared to approximately $359.2 million as of December 31, 2021. The total finance portfolio in our finance joint ventures was approximately $11.8 billion and $10.9 billion as of December 31, 2022 and 2021, respectively. The total finance portfolio as of December 31, 2022 and 2021 included approximately $9.5 billion and $9.2 billion, respectively, of retail receivables and $2.3 billion and $1.7 billion of wholesale receivables from AGCO dealers as of December 31, 2022 and 2021, respectively. The wholesale receivables either were sold directly to AGCO Finance without recourse from our operating companies, or AGCO Finance provided the financing directly to the dealers. During 2022, we did not make additional investments in our finance joint ventures, and we received dividends of approximately $27.0 million from certain of our finance joint ventures. During 2021, we did not make additional investments in our finance joint ventures, and we received dividends of approximately $84.4 million from certain of our finance joint ventures. Our share in the earnings of the finance joint ventures, included in “Equity in net earnings of affiliates” within our Consolidated Statements of Operations, was approximately $63.0 million and $64.4 million for the years ended December 31, 2022 and 2021, respectively. In addition, during the year ended December 31, 2022, we recorded a write-down of our investment in our Russian finance joint venture of approximately $4.8 million, reflected within “Equity in net earnings of affiliates” in our Consolidated Statements of Operations. The Russian finance joint venture was sold during the three months ended December 31, 2022.
Outlook
Our operations are subject to the cyclical nature of the agricultural industry. Sales of our equipment are affected by, among other things, changes in net cash farm income, farm land values, weather conditions, the demand for agricultural commodities, commodity and protein prices and general economic conditions.
Global industry demand for farm equipment, driven by continued strong commodity prices and healthy farm economics, is expected to be flat to moderately higher during 2023 in most major markets. Our net sales are expected to increase in 2023 compared to 2022, resulting from improved sales volumes and pricing, partially offset by negative foreign currency translation. Gross and operating margins are expected to improve from 2022 levels, reflecting the impact of higher net sales and production volumes as well as pricing initiatives to offset material cost inflation. Engineering expenses and other technology investments are expected to increase in 2023 compared to 2022 to support our product development plans as well as our precision agriculture and digital initiatives.
Our outlook is also based on current estimates of supplier component deliveries, and the ability of the Company’s supply chain to deliver parts and components on schedule is currently difficult to predict. If supply chain performance worsens, our results of operations will be adversely impacted. Refer to “Risk Factors” for further discussion of the COVID-19 pandemic, supply chain and logistic disruptions and other factors.
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Liquidity and Capital Resources
Our financing requirements are subject to variations due to seasonal changes in inventory and receivable levels. In addition, unusual events such as the recent supply chain disruptions can result in increases in inventories and, consequentially, our financing requirements. Internally generated funds are supplemented when necessary from external sources, primarily our credit facility and accounts receivable sales agreement facilities. We believe that the following facilities, together with available cash and internally generated funds, will be sufficient to support our working capital, capital expenditures and debt service requirements for the foreseeable future (in millions):
| December 31, 2022 | ||
|---|---|---|
| Credit facility, expires 2027 | $ | 200.0 |
| 1.002% Senior term loan due 2025(1) | 267.3 | |
| Senior term loans due between 2023 and 2028(1) | 341.6 | |
| 0.800% Senior Notes Due 2028(1) | 641.5 | |
| Other long-term debt | 5.1 |
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(1) The amounts above are gross of debt issuance costs of an aggregate amount of approximately $3.6 million.
In December 2022, we, certain of our subsidiaries and Rabobank, and other named lenders, entered into an amendment to our credit facility providing for a $1.25 billion multi-currency unsecured revolving credit facility (“credit facility”), which replaced our former $800.0 million multi-currency unsecured revolving credit facility. The amendment provided an additional $450.0 million in borrowing capacity. An initial borrowing under the credit facility was used to repay and retire a $240.0 million short-term multi-currency revolving credit facility with Rabobank that was due to mature on March 31, 2023. The credit facility consists of a $325.0 million U.S. dollar tranche and a $925.0 million multi-currency tranche for loans denominated in U.S. Dollars, Euros or other currencies to be agreed upon. The credit facility matures on December 19, 2027. Interest accrues on amounts outstanding for any borrowings denominated in U.S. dollars, at the our option, at either (1) the Secured Overnight Financing Rate (“SOFR”) plus 0.1% plus a margin ranging from 0.875% to 1.875% based on our credit rating, or (2) the base rate, which is the highest of (i) the Prime Rate, (ii) the Federal Funds Effective Rate plus 0.5%, and (iii) Term SOFR for a one-month tenor plus 1.0%, plus a margin ranging from 0.000% to 0.875% based on our credit rating. Interest accrues on amounts outstanding for any borrowings denominated in Euros at the Euro Interbank Offered Rate (“EURIBOR”) plus a margin ranging from 0.875% to 1.875% based on our credit rating. As of December 31, 2022, we had $200.0 million outstanding borrowings under the revolving credit facility and had the ability to borrow $1,050.0 million.
In June 2022, we entered into an uncommitted revolving credit facility that allows us to borrow up to €100.0 million (or approximately $106.9 million as of December 31, 2022). The credit facility expires on December 31, 2026. Any loans will bear interest at the EURIBOR plus a credit spread. As of December 31, 2022, we had no outstanding borrowings under the revolving credit facility and had the ability to borrow €100.0 million (or approximately $106.9 million).
In April 2022, we entered into a short-term multi-currency revolving credit facility of €225.0 million with Rabobank. We borrowed $240.0 million in U.S. dollars (or approximately €225.0 million as of April 26, 2022), with a maturity date of March 31, 2023. As previously mentioned, during December 2022, we repaid the $240.0 million outstanding borrowings under the facility in U.S. dollars.
On October 6, 2021, we issued €600.0 million (or approximately $641.5 million as of December 31, 2022) of senior notes at an issue price of 99.993%. The notes mature on October 6, 2028, and interest is payable annually, in arrears, at 0.800%. The senior notes contain covenants restricting, among other things, the incurrence of certain secured indebtedness. The senior notes are subject to both optional and mandatory redemption in certain events.
In October 2018, we entered into a multi-currency revolving credit facility of $800.0 million. The credit facility matures on October 17, 2023. As previously mentioned, during December 2022, we amended our credit facility agreement and replaced the $800.0 million multi-currency revolving credit facility with a new $1.25 billion credit facility.
On April 15, 2020, we borrowed €117.5 million and $133.8 million under a term loan facility that had been added to our multi-currency revolving credit facility. We repaid the two loans on February 16, 2021 (for an aggregate amount of approximately $276.0 million as of that date). The term loans matured on April 8, 2022.
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On January 25, 2019, we borrowed €250.0 million (or approximately $267.3 million as of December 31, 2022) from the European Investment Bank. The loan matures on January 24, 2025. Interest is payable on the term loan at 1.002% per annum, payable semi-annually in arrears.
In October 2016, we borrowed an aggregate amount of €375.0 million through a group of seven related term loan agreements. These agreements had maturities ranging from October 2019 to October 2026. Of the 2016 term loans, we repaid an aggregate amount of €56.0 million (or approximately $61.1 million) of two of these term loans in October 2019. Additionally, we repaid €192.0 million (or approximately $223.8 million) upon maturity of two 2016 senior term loans in October 2021. On April 19, 2022, we repaid €1.0 million (or approximately $1.1 million) of one of our 2016 senior term loans due October 2023. In August 2018, we borrowed an additional aggregate amount of €338.0 million through a group of another seven related term loan agreements. In August 2021, we repaid two of our 2018 senior term loans upon maturity with an aggregate amount of €72.0 million (or approximately $85.5 million). On February 1, 2022, we repaid an additional amount of €72.5 million (or approximately $81.7 million) of one of our 2018 senior term loans due August 2023 with existing cash on hand. The provisions of the term loan agreements are substantially identical in nature with the exception of interest rate terms and maturities. In aggregate, as of December 31, 2022, we had indebtedness of approximately €319.5 million (or approximately $341.6 million) under six remaining term loan agreements with remaining maturities ranging from August 2023 to August 2028. Two of the term loan agreements in the aggregate amount of €173.0 million (or approximately $184.9 million net of debt issuance costs, as of December 31, 2022) will mature in August and October 2023. As of December 31, 2022, for the term loans with a fixed interest rate, interest is payable in arrears on an annual basis, with interest rates ranging from 0.90% to 2.26% and maturity dates between August 2023 and August 2028. For the term loan with a floating interest rate, interest is payable in arrears on a semi-annual basis, with an interest rate based on the EURIBOR plus a margin of 1.10% and a maturity date of August 2025.
As of December 31, 2022 and 2021, we had short-term borrowings due within one year of approximately $8.9 million and $90.8 million, respectively.
We are in compliance with the financial covenants contained in these facilities and expect to continue to maintain such compliance. Should we ever encounter difficulties, our historical relationship with our lenders has been strong and we anticipate their continued long-term support of our business. Refer to Note 7 to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data,” for additional information regarding our current facilities, including the financial covenants contained in each debt instrument.
Our accounts receivable sales agreements in North America, Europe and Brazil permit the sale, on an ongoing basis, of a majority of our receivables to our U.S., Canadian, European and Brazilian finance joint ventures. The sales of all receivables are without recourse to us. We do not service the receivables after the sales occur, and we do not maintain any direct retained interest in the receivables. These agreements are accounted for as off-balance sheet transactions and have the effect of reducing accounts receivable and short-term liabilities by the same amount. As of December 31, 2022 and 2021, the cash received from receivables sold under the U.S., Canadian, European and Brazilian accounts receivable sales agreements for the years then ended was approximately $1.8 billion and $1.3 billion, respectively.
In addition, we sell certain trade receivables under factoring arrangements to other financial institutions around the world. As of December 31, 2022 and 2020, the cash received from these arrangements for the years then ended was approximately $226.0 million and $215.4 million, respectively.
Our finance joint ventures in Europe, Brazil and Australia also provide wholesale financing directly to our dealers. The receivables associated with these arrangements also are without recourse to us. As of December 31, 2022 and 2021, these finance joint ventures had approximately $69.5 million and $42.6 million, respectively, of outstanding accounts receivable associated with these arrangements. These arrangements are accounted for as off-balance sheet transactions. In addition, we sell certain trade receivables under factoring arrangements to other financial institutions around the world. These arrangements are also accounted for as off-balance sheet transactions.
In order to efficiently manage our liquidity, we generally pay vendors in accordance with negotiated terms. To enable vendors to obtain payment in advance of our payment due dates to them, we have established programs in certain markets with financial institutions under which the vendors have the option to be paid by the financial institutions earlier than the payment due dates. When vendors receive early payments, they receive discounted amounts and we then pay the financial institutions the face amounts of the invoices on the payment due dates. We do not reimburse vendors for any costs they incur for participation in the programs. Amounts owed to the financial institutions are presented as “Accounts payable” in our Consolidated Balance Sheets. Should we not be able to negotiate extended payment terms with our vendors, or should financial institutions no longer
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be willing to participate in early payment programs with us, we would expect to have sufficient liquidity to timely pay our vendors without any material impact on us or our financial position.
Our debt to capitalization ratio, which is total indebtedness divided by the sum of total indebtedness and stockholders’ equity, was 27.3% at December 31, 2022 compared to 29.7% at December 31, 2021.
Cash Flows
Cash flows provided by operating activities were approximately $838.2 million during 2022 compared to approximately $660.2 million during 2021. The increase during 2022 primarily was due to increases in accounts payable and accrued expenses compared to 2021. Supply chain disruptions resulted in higher raw material and work-in-process inventory levels during the course of 2022, although we were able to reduce work-in-process inventories during the fourth quarter of 2022 by approximately $277.6 million. However, inventory levels as of December 31, 2022 were higher than at December 31, 2021. Free cash flow, which is defined as “Net cash provided by operating activities” less “Purchases of property, plant and equipment”, was approximately $449.9 million during 2022, as compared to approximately $390.4 million during 2021, despite capital expenditures of approximately $388.3 million during 2022 compared to $269.8 million during 2021.
Our working capital requirements are seasonal, with investments in working capital typically building in the first half of the year and then reducing in the second half of the year. We had $1,651.3 million in working capital at December 31, 2022, as compared with $1,559.5 million at December 31, 2021. Accounts receivable and inventories, combined, at December 31, 2022 were approximately $825.8 million higher than at December 31, 2021, primarily due to higher net sales and production levels, as well as the significant impact of supply chain constraints during 2022.
Share Repurchase Program and Dividends
We did not purchase any shares directly or enter into any accelerated share repurchase agreements during 2022. As of December 31, 2022, the remaining amount authorized to be repurchased under board-approved share repurchase authorizations was approximately $110.0 million, which has no expiration date. In August and November 2021, we entered into two accelerated share repurchase (“ASR”) agreements with financial institutions to repurchase an aggregate of $135.0 million of shares of our common stock. We received approximately 952,204 shares in these transactions as of December 31, 2021. On January 19, 2022, we received additional 113,824 shares upon final settlement of our November 2021 ASR agreement. All shares received under the ASR agreements were retired upon receipt, and the excess of the purchase price over par value per share was recorded to a combination of “Additional paid-in capital” and “Retained earnings” within the our Consolidated Balance Sheets. In addition, on April 28, 2022, our Board of Directors approved an increase to our quarterly dividend commencing in the second quarter of 2022 by 20% to $0.24 per common share and declared a special variable dividend of $4.50 per common share that was paid during the second quarter of 2022. During 2021, our Board of Directors declared and we paid a special variable dividend of $4.00 per common share.
Contractual Obligations and Cash Requirements
Our material cash requirements include the following contractual and other obligations:
Indebtedness – As of December 31, 2022, we had approximately $194.5 million of payments due as of the year ended December 31, 2023, related to indebtedness and certain short-term obligations, in addition to approximately $35.4 million of interest payments associated with indebtedness we expect to pay during 2023. Our projected amount of interest payments includes assumptions regarding the future fluctuations in interest rates, as well as borrowings under our revolving credit facility and other variable debt instruments. Indebtedness amounts reflect the principal amount of our senior term loan, senior notes, credit facility and certain short-term borrowings, gross of any debt issuance costs. Refer to the discussion above and Note 7 of the Consolidated Financial Statements for additional information regarding our indebtedness. In addition, we expect to pay approximately $125.7 million of discounts on the sales of receivables related to our finance joint ventures. The projected amount of discounts paid includes significant assumptions regarding future amounts of receivables sold to our finance joint ventures as well as future fluctuations in interest rates.
Capital and operating lease obligations – As of December 31, 2022, we had approximately $0.8 million and $47.8 million of payments due during the year ended December 31, 2023, related to capital and operating lease obligations, respectively. Refer to Note 17 of the Consolidated Financial Statements for additional information regarding our lease obligations.
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Unconditional purchase obligations – As of December 31, 2022, we had approximately $209.2 million of outstanding purchase obligations payable during the year ended December 31, 2023. Unconditional purchase obligations generally do not vary materially year to year.
Other short-term and long-term obligations – As of December 31, 2022, we had approximately $10.4 million of income tax liabilities related to uncertain income tax provisions connected with ongoing income tax audits in various jurisdictions that we expects to pay or settle within the next 12 months. Additionally, we had approximately $36.3 million of estimated future minimum contribution requirements under our U.S. and non-U.S. defined benefit pension and postretirement plans due during the year ended December 31, 2023. Refer to Notes 6 and 8 of the Consolidated Financial Statements for additional information regarding our uncertain tax positions and pension and postretirement plans, respectively. These obligations comprise a majority of our other short-term and long-term obligations.
Commitments and Off-Balance Sheet Arrangements
Guarantees
We maintain a remarketing agreement with our finance joint venture in the United States, whereby we are obligated to repurchase up to $6.0 million of repossessed equipment each calendar year. We believe any losses that might be incurred on the resale of this equipment will not materially impact our financial position or results of operations, due to the fact that the repurchase obligations would be equivalent to the fair value of the underlying equipment.
At December 31, 2022, we guaranteed indebtedness owed to third parties of approximately $29.2 million, primarily related to dealer and end-user financing of equipment. Such guarantees generally obligate us to repay outstanding finance obligations owed to financial institutions if dealers or end users default on such loans through 2028. Losses under such guarantees historically have been insignificant. In addition, we generally would expect to be able to recover a significant portion of the amounts paid under such guarantees from the sale of the underlying financed farm equipment, as the fair value of such equipment is expected to offset a substantial portion of the amounts paid. We also guarantee indebtedness owed to certain of our finance joint ventures if dealers or end users default on loans. Losses under such guarantees historically have been insignificant and the guarantees are not material. We believe the credit risk associated with all of these guarantees is not material to our financial position or results of operations.
In addition, at December 31, 2022, we had accrued approximately $18.6 million of outstanding guarantees of residual values that may be owed to our finance joint ventures in the United States and Canada due upon expiration of certain eligible operating leases between the finance joint ventures and end users. The maximum potential amount of future payments under the guarantee is approximately $191.3 million.
Other
At December 31, 2022, we had outstanding designated and non-designated foreign exchange contracts with a gross notional amount of approximately $4,318.8 million. The outstanding contracts as of December 31, 2022 range in maturity through March 2023. We also had outstanding designated steel commodity contracts with a gross notional amount of approximately $0.9 million that range in maturity through April 2023. See Note 11 of our Consolidated Financial Statements for additional information.
As discussed in “Liquidity and Capital Resources,” we sell a majority of our wholesale accounts receivable in North America, Europe and Brazil to our U.S., Canadian, European and Brazilian finance joint ventures. We also sell certain accounts receivable under factoring arrangements to financial institutions around the world. We have determined that these facilities should be accounted for as off-balance sheet transactions.
Contingencies
We are party to various claims and lawsuits arising in the normal course of business. We closely monitor these claims and lawsuits and frequently consult with our legal counsel to determine whether they may, when resolved, have a material adverse effect on our financial position or results of operations and accrue and/or disclose loss contingencies as appropriate. See Note 12 of our Consolidated Financial Statements for further information.
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Related Parties
In the ordinary course of business, we engage in transactions with related parties. See Note 14 of our Consolidated Financial Statements for information regarding related party transactions and their impact to our consolidated results of operations and financial position.
Foreign Currency Risk Management
We have significant manufacturing locations in the United States, France, Germany, Finland, Italy, China and Brazil, and we purchase a portion of our tractors, combines and components from third-party foreign suppliers, primarily in various European countries and in Japan. We also sell products in approximately 140 countries throughout the world. The majority of our net sales outside the United States are denominated in the currency of the customer location, with the exception of sales in Middle East, Africa, Asia and parts of South America, where net sales are primarily denominated in British pounds, Euros or the United States dollar.
We also are subject to the risk of the imposition of limitations by governments on international transfers of funds. For example, in recent years, the Argentine government has substantially limited the ability of companies to transfer funds out of Argentina. As a consequence of these limitations, the spread between the official government exchange rate and the exchange rates resulting implicitly from certain capital market operations, usually effected to obtain U.S. dollars, has broadened significantly. The net monetary assets of our operations in Argentina denominated in pesos at the official government rate were approximately 4.1 billion (or approximately $23.0 million) as of December 31, 2022, inclusive of approximately 6.8 billion pesos (or approximately $38.1 million) in cash and cash equivalents. In addition, we have an obligation to reimburse AGCO Capital Argentina S.A., one of our finance joint ventures with Rabobank, up to $10 million under a guarantee related to the ability of AGCO Capital Argentina S.A. to transfer funds out of Argentina. The finance joint venture in Argentina has net monetary assets denominated in pesos at the official government rate of approximately 4.1 billion (or approximately $22.9 million) as of December 31, 2022, of which a majority is cash and cash equivalents. Future impairments and charges are possible in connection with these exposures.
We manage our transactional foreign currency exposure by hedging foreign currency cash flow forecasts and commitments arising from the anticipated settlement of receivables and payables and from future purchases and sales. Where naturally offsetting currency positions do not occur, we hedge certain, but not all, of our exposures through the use of foreign currency contracts. Our translation exposure resulting from translating the financial statements of foreign subsidiaries into United States dollars may be partially hedged from time to time. When practical, this translation impact is reduced by financing local operations with local borrowings. Our hedging policy prohibits use of foreign currency contracts for speculative trading purposes.
The total notional value of our foreign currency instruments was $4,318.8 million and $3,981.9 million as of December 31, 2022 and 2021, respectively, inclusive of both those instruments that are designated and qualified for hedge accounting and non-designated derivative instruments. We enter into cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, and we enter into foreign currency contracts to economically hedge receivables and payables on our balance sheets that are denominated in foreign currencies other than the functional currency. In addition, we use derivative and non-derivative instruments to hedge a portion of our net investment in foreign operations against adverse movements in exchange rates. See Note 11 of our Consolidated Financial Statements for further information about our hedging transactions and derivative instruments.
Assuming a 10% change relative to the currency of the hedge contracts, the fair value of the foreign currency instruments could be negatively impacted by approximately $18.5 million as of December 31, 2022. Due to the fact that these instruments are primarily entered into for hedging purposes, the gains or losses on the contracts would largely be offset by losses and gains on the underlying firm commitment or forecasted transaction.
Interest Rate Risk
Our interest expense is, in part, sensitive to the general level of interest rates. We manage our exposure to interest rate risk through our mix of floating rate and fixed rate debt. From time to time, we enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. See Notes 7 and 11 of our Consolidated Financial Statements for additional information.
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Based on our floating rate debt and our accounts receivable sales facilities outstanding at December 31, 2022, a 10% increase in interest rates, would have increased, collectively, “Interest expense, net” and “Other expense, net” for the year ended December 31, 2022 by approximately $7.3 million.
Recent Accounting Pronouncements
See Note 1 of our Consolidated Financial Statements for information regarding recent accounting pronouncements and their impact to our consolidated results of operations and financial position.
Critical Accounting Estimates
We prepare our Consolidated Financial Statements in conformity with U.S. generally accepted accounting principles. In the preparation of these financial statements, we make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities, the 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. The significant accounting policies followed in the preparation of the financial statements are detailed in Note 1 of our Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data.” We believe that our application of the policies discussed below involves significant levels of judgment, estimates and complexity.
Due to the levels of judgment, complexity and period of time over which many of these items are resolved, actual results could differ from those estimated at the time of preparation of the financial statements. Adjustments to these estimates would impact our financial position and future results of operations.
Discount and Sales Incentive Allowances
We provide various volume bonus and sales incentive programs with respect to our products. These sales incentive programs include reductions in invoice prices, reductions in retail financing rates, dealer commissions and dealer incentive allowances. In most cases, incentive programs are established and communicated to our dealers on a quarterly basis. The incentives are paid either at the time of the cash settlement of the receivable (which is generally at the time of retail sale), at the time of retail financing, at the time of warranty registration, or at a subsequent time based on dealer purchase volumes. The incentive programs are product line specific and generally do not vary by dealer. The cost of sales incentives associated with dealer commissions and dealer incentive allowances is estimated based upon the terms of the programs and historical experience, is based on a percentage of the sales price, and estimates for sales incentives are made and recorded at the time of sale for expected incentive programs using the expected value method. These estimates are reassessed each reporting period and are revised in the event of subsequent modifications to incentive programs, as they are communicated to dealers. The related provisions and accruals are made on a product or product-line basis and are monitored for adequacy and revised at least quarterly in the event of subsequent modifications to the programs. Interest rate subsidy payments, which are a reduction in retail financing rates, are recorded in the same manner as dealer commissions and dealer incentive allowances. Volume discounts are estimated and recognized based on historical experience, and related reserves are monitored and adjusted based on actual dealer purchase volumes and the dealers’ progress towards achieving specified cumulative target levels. Estimates of these incentives are based on the terms of the programs and historical experience. All incentive programs are recorded and presented as a reduction of revenue, due to the fact that we do not receive a distinct good or service in exchange for the consideration provided. In the United States and Canada, reserves for incentive programs related to accounts receivable not sold to our U.S. and Canadian finance joint ventures are recorded as “Accounts receivable allowances” within our Consolidated Balance Sheets due to the fact that the incentives are paid through a reduction of future cash settlement of the receivable. Globally, reserves for incentive programs that will be paid in cash or credit memos, as is the case with most of our volume discount programs, as well as sales incentives associated with accounts receivable sold to our finance joint ventures, are recorded within “Accrued expenses” within our Consolidated Balance Sheets.
At December 31, 2022, we had recorded an allowance for discounts and sales incentives of approximately $638.4 million that will be paid either through a reduction of future cash settlements of receivables and through credit memos to our dealers or through reductions in retail financing rates paid to our finance joint ventures. If we were to allow an additional 1% of sales incentives and discounts at the time of retail sale for those sales subject to such discount programs, our reserve would increase by approximately $28.5 million as of December 31, 2022. Conversely, if we were to decrease our sales incentives and discounts by 1% at the time of retail sale, our reserve would decrease by approximately $28.5 million as of December 31, 2022.
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Deferred Income Taxes and Uncertain Income Tax Positions
We recorded an income tax provision of approximately $296.6 million in 2022 compared to $108.4 million in 2021 and $187.7 million in 2020. Our tax provision and effective tax rate are impacted by the differing tax rates of the various tax jurisdictions in which we operate, permanent differences for items treated differently for financial accounting and income tax purposes, losses in jurisdictions where no income tax benefit is recorded and provisions for unrecognized income tax benefits related to uncertain tax positions.
As of December 31, 2021, our income tax provision included the benefit of reversals of approximately $67.8 million and approximately $55.6 million related to valuation allowances previously established against the Company’s net deferred tax assets in the U.S and Brazil, respectively. Improvements in income in the U.S and Brazil during 2020 and 2021, along with updated future projected income levels, supported the reversal of both of the valuation allowances. We maintain a valuation allowance to reserve a portion of our net deferred tax assets in the U.S. and certain foreign jurisdictions. A valuation allowance is established when it is more likely than not that some portion or all of the deferred tax assets may not be realized. We assessed the likelihood that our deferred tax assets should be recovered from estimated future taxable income and the current economic climate, as well as available tax planning strategies and determined that the adjustment to the valuation allowance was appropriate. We believe it is more likely than not that we should be able to realize our remaining net deferred tax assets, net of the valuation allowance, in future years.
At December 31, 2022 and 2021, we had gross deferred tax assets of $301.2 million and $291.8 million, respectively, including $45.9 million and $69.5 million, respectively, related to net operating loss carryforwards. At December 31, 2022 and 2021, we had total valuation allowances as an offset to our gross deferred tax assets of $47.3 million and $47.4 million, respectively. These valuation allowances are held against deferred tax assets (including net operating loss carryforwards) in the U.S and certain foreign jurisdictions. Realization of the remaining deferred tax assets as of December 31, 2022 depends on generating sufficient taxable income in future periods, net of reversing deferred tax liabilities. We believe it is more likely than not that the remaining net deferred tax assets should be able to be realized.
We recognize income tax benefits from uncertain tax positions only when there is a more than 50% likelihood that the tax positions will be sustained upon examination by the taxing authorities based on the technical merits of the positions. As of December 31, 2022 and 2021, we had approximately $281.7 million and $246.4 million, respectively, of gross unrecognized tax benefits, all of which would impact our effective tax rate if recognized. As of December 31, 2022 and 2021, we had approximately $10.4 million and $40.1 million, respectively, of current accrued taxes related to uncertain income tax positions connected with ongoing tax audits in various jurisdictions that we expect to settle or pay in the next 12 months. At December 31, 2022 and 2021, the Company had approximately $274.1 million and $196.7 million, respectively, of accrued taxes reflected in “Other noncurrent liabilities”, and approximately $2.8 million of deferred tax assets and $9.6 million of deferred tax liabilities, respectively, related to uncertain tax positions that it expects to settle or pay beyond 12 months, reflected in “Deferred tax assets” and “Deferred tax liabilities,” respectively, in the Company’s Consolidated Balance Sheets. We recognize interest and penalties related to uncertain income tax positions in income tax expense. As of December 31, 2022 and 2021, we had accrued interest and penalties related to unrecognized tax benefits of approximately $25.8 million and $32.7 million, respectively. See Note 6 of our Consolidated Financial Statements for further discussion of our uncertain income tax positions.
Pensions
We sponsor defined benefit pension plans covering certain employees, principally in the United Kingdom, the United States, Germany, Switzerland, Finland, France, Norway and Argentina. Our primary plans cover certain employees in the United States and the United Kingdom.
In the United States, we sponsor a funded, qualified defined benefit pension plan for our salaried employees, as well as a separate funded qualified defined benefit pension plan for our hourly employees. Both plans are closed to new entrants and frozen, and we fund at least the minimum contributions required under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code to both plans. In addition, we maintain an unfunded, nonqualified defined benefit pension plan for certain senior executives, which is our Executive Nonqualified Pension Plan (“ENPP”). The ENPP also is closed to new entrants, and, during 2021, we amended the ENPP to freeze future salary benefit accruals as of December 31, 2024 and to eliminate a lifetime annuity feature for participants reaching age 65 subsequent to December 31, 2022.
In the United Kingdom, we sponsor a funded defined benefit pension plan that provides an annuity benefit based on participants’ final average earnings and service. Participation in this plan is limited to certain older, longer service employees and existing retirees. This plan is closed to new participants.
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See Note 8 of our Consolidated Financial Statements for additional information regarding costs and assumptions for employee retirement benefits.
Nature of Estimates Required. The measurement date for all of our benefit plans is December 31. The measurement of our pension obligations, costs and liabilities is dependent on a variety of assumptions provided by management and used by our actuaries. These assumptions include estimates of the present value of projected future pension payments to all plan participants, taking into consideration the likelihood of potential future events such as salary increases and demographic experience. These assumptions may have an effect on the amount and timing of future contributions.
Assumptions and Approach Used. The assumptions used in developing the required estimates include, but are not limited to, the following key factors:
| • Discount rates | • Inflation |
|---|---|
| • Salary growth | • Expected return on plan assets |
| • Retirement rates and ages | • Mortality rates |
For the years ended December 31, 2022 and 2021, we used a globally consistent methodology to set the discount rate in the countries where our largest benefit obligations exist. In the United States, the United Kingdom and the Euro Zone, we constructed a hypothetical bond portfolio of high-quality corporate bonds and then applied the cash flows of our benefit plans to those bond yields to derive a discount rate. The bond portfolio and plan-specific cash flows vary by country, but the methodology in which the portfolio is constructed is consistent. In the United States, the bond portfolio is large enough to result in taking a “settlement approach” to derive the discount rate, in which high-quality corporate bonds are assumed to be purchased and the resulting coupon payments and maturities are used to satisfy our U.S. pension plans’ projected benefit payments. In the United Kingdom and the Euro Zone, the discount rate is derived using a “yield curve approach,” in which an individual spot rate, or zero coupon bond yield, for each future annual period is developed to discount each future benefit payment and, thereby, determine the present value of all future payments. We use a spot yield curve to determine the discount rate applicable in the United Kingdom to measure the U.K. pension plan’s service cost and interest cost. Under the settlement and yield curve approaches, the discount rate is set to equal the single discount rate that produces the same present value of all future payments.
The other key assumptions and methods were set as follows:
•Our inflation assumption is based on an evaluation of external market indicators.
•The salary growth assumptions reflect our long-term actual experience, the near-term outlook and assumed inflation.
•The expected return on plan asset assumptions reflects asset allocations, investment strategy, historical experience and the views of investment managers, and reflects a projection of the expected arithmetic returns over ten years.
•Determination of retirement rates and ages as well as termination rates, based on actual plan experience, actuarial standards of practice and the manner in which our defined benefit plans are being administered.
•The mortality rates for the U.K. defined benefit pension plan were updated during 2022 to reflect the latest expected improvements in the life expectancy of the plan participants. The mortality rates for the U.S. defined benefit pension plans were unchanged from 2021, which reflected the Society of Actuaries’ most recent findings on the topic of mortality.
•The fair value of assets used to determine the expected return on assets does not reflect any delayed recognition of asset gains and losses.
The effects of actual results differing from our assumptions are accumulated and amortized over future periods and, therefore, generally affect our recognized expense in such periods.
Our U.S. and U.K. defined benefit pension plans, including our ENPP, comprised approximately 84% of our consolidated projected benefit obligation as of December 31, 2022. The effects of a 25 basis point change in certain actuarial
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assumptions on the 2023 net annual pension and ENPP costs and related benefit obligations as of December 31, 2022 would be as follows:
| Year-end Benefit Obligation | 2023 Net Annual Pension Cost | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 25 basis point increase | 25 basis point decrease | 25 basis point increase | 25 basis point decrease | |||||||||||
| Discount rate: | ||||||||||||||
| U.S. qualified defined benefit pension plans and ENPP | $ | (2.5) | $ | 2.6 | $ | 0.1 | $ | (0.1) | ||||||
| U.K. defined benefit pension plans | (10.5) | 11.1 | (0.2) | 0.2 |
| 2023 Net Annual Pension Cost | ||||||
|---|---|---|---|---|---|---|
| 25 basis point increase | 25 basis point decrease | |||||
| Long-term rate of return on plan assets: | ||||||
| U.S. qualified defined benefit pension plans and ENPP | $ | (0.1) | $ | 0.1 | ||
| U.K. defined benefit pension plans | (1.2) | 1.2 |
Unrecognized actuarial net losses related to our defined benefit pension plans and ENPP were $270.0 million as of December 31, 2022 compared to $291.7 million as of December 31, 2021. The decrease in unrecognized net actuarial losses between years primarily resulted from higher discount rates at December 31, 2022 compared to December 31, 2021. The unrecognized net actuarial losses will be impacted in future periods by actual asset returns, discount rate changes, currency exchange rate fluctuations, actual demographic experience and certain other factors. For some of our defined benefit pension plans, these losses, to the extent they exceed 10% of the greater of the plan’s liabilities or the fair value of assets (“the gain/loss corridor”), will be amortized on a straight-line basis over the periods discussed as follows. For our U.S. salaried, U.S. hourly and U.K. defined benefit pension plans, the population covered is predominantly inactive participants, and losses related to those plans, to the extent they exceed the gain/loss corridor, will be amortized over the average remaining lives of those participants while covered by the respective plan. For our ENPP, the population is predominantly active participants, and losses related to the plan will be amortized over the average future working lifetime of the active participants expected to receive benefits. As of December 31, 2022, the average amortization periods were as follows:
| ENPP | U.S. Plans | U.K. Plan | |||
|---|---|---|---|---|---|
| Average amortization period of losses related to defined benefit pension plans | 7 years | 14 years | 19 years |
Unrecognized prior service cost related to our defined benefit pension plans was $32.5 million as of December 31, 2022 compared to $7.1 million as of December 31, 2021. During 2022, the Company updated its estimate of current assumptions, interpretations and approach affecting the Company’s defined benefit pension obligations related to certain defined benefit plans resulting in a revision of its estimate of prior service cost of approximately $25.5 million during 2022. The 2021 balance also reflects the 2021 plan amendment to the Company’s ENPP, as previously discussed. The 2021 amendment resulted in both a curtailment gain and a net prior service credit.
As of December 31, 2022, our unfunded or underfunded obligations related to our defined benefit pension plans and ENPP were approximately $82.9 million, primarily related to our defined benefit pension plans in Europe and the United States. In 2022, we contributed approximately $34.1 million towards those obligations, and we expect to fund approximately $34.6 million in 2023. Future funding is dependent upon compliance with local laws and regulations and changes to those laws and regulations in the future, as well as the generation of operating cash flows in the future. We currently have an agreement in place with the trustees of the U.K. defined benefit plan that obligates us to fund approximately £16.0 million per year (or approximately $19.4 million) towards that obligation through December 2023. The funding arrangement is based upon the current funded status and could change in the future as discount rates, local laws and regulations, and other factors change.
See Note 8 of our Consolidated Financial Statements for more information regarding the investment strategy and concentration of risk.
Goodwill, Other Intangible Assets and Long-Lived Assets
We test goodwill for impairment, at the reporting unit level, annually and when events or circumstances indicate that fair value of a reporting unit may be below its carrying value. A reporting unit is an operating segment or one level below an
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operating segment, for example, a component. We combine and aggregate two or more components of an operating segment as a single reporting unit if the components have similar economic characteristics. Our reportable segments are not our reporting units.
Goodwill is evaluated for impairment annually as of October 1st using a qualitative assessment or a quantitative one-step assessment. If we elect to perform a qualitative assessment and determine the fair value of our reporting units more likely than not exceeds their carrying value of net assets, no further evaluation is necessary. For reporting units where we perform a one-step quantitative assessment, we compare the fair value of each reporting unit to its respective carrying value of net assets, including goodwill. If the fair value of the reporting unit exceeds its carrying value of net assets, the goodwill is not considered impaired. If the carrying value of net assets is higher than the fair value of the reporting unit, an impairment charge is recorded in the amount by which the carrying value exceeds the reporting unit’s fair value.
We utilize a combination of valuation techniques, including an income approach, whereby the present value of future expected operating net cash flows are calculated using a discount rate; and a guideline public company method, whereby EBITDA and revenue multiples are derived from the market prices of stocks of companies that are engaged in the same or similar lines of business and that are actively traded on a free and open market. Assumptions included in these approaches can positively and negatively impact the results of our assessments such as interest rates, sales and margin growth rates, tax rates, cost structures, market share, pricing, capital expenditures, working capital levels and the use of control premiums. For all reporting units, a 10 percent decrease in the estimated fair value would have resulted in a $6.8 million impairment reducing the carrying value of goodwill.
We review our long-lived assets, which include intangible assets subject to amortization, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The evaluation for recoverability is performed at a level where independent cash flows may be attributed to either an asset or asset group. If we determine that the carrying amount of an asset or asset group is not recoverable based on the expected undiscounted future cash flows of the asset or asset group, an impairment loss is recorded equal to the excess of the carrying amounts over the estimated fair value of the long-lived assets. Estimates of future cash flows are based on many factors, including current operating results, expected market trends and competitive influences. We also evaluate the amortization periods assigned to our intangible assets to determine whether events or changes in circumstances warrant revised estimates of useful lives. Assets to be disposed of by sale are reported at the lower of the carrying amount or fair value, less estimated costs to sell.
We make various assumptions, including assumptions regarding future cash flows, market multiples, growth rates and discount rates, in our assessments of the impairment of goodwill, other indefinite-lived intangible assets and long-lived assets. The assumptions about future cash flows and growth rates are based on the current and long-term business plans of the reporting unit or related to the long-lived assets. Discount rate assumptions are based on an assessment of the risk inherent in the future cash flows of the reporting unit or long-lived assets. These assumptions require significant judgments on our part, and the conclusions that we reach could vary significantly based upon these judgments.
The results of our goodwill and long-lived assets impairment analyses conducted as of October 1, 2022 and 2021 indicated that no other indicators of impairment existed and no reduction in the carrying amount of goodwill and long-lived assets was required related to our other reporting units.
Our goodwill impairment analysis conducted as of October 1, 2022 also indicated that the fair value in excess of the carrying value of our grain and protein production systems Europe/Middle East reporting unit was approximately 5.9%. In response to weakening market conditions and resulting operating results, new management was put in place over the global grain and protein systems productions systems business in 2022, and from that time, full strategic reviews and operating decisions of the business have been conducted and launched, including several restructuring initiatives aimed at lowering operating costs, improving product portfolios and enhancing customer support, which management believes will result in improved long-term operating results. If market conditions and our overall results do not improve, we may incur an impairment charge related to this reporting units in the future under the one-step process described above. The goodwill associated with these reporting units as of December 31, 2022 was approximately $59.0 million.
Numerous facts and circumstances are considered when evaluating the carrying amount of our goodwill. The fair value of a reporting unit is impacted by the reporting unit’s expected financial performance, which is dependent upon the agricultural industry and other factors that could adversely affect the agricultural industry, including but not limited to, declines in the general economy, increases in farm input costs, weather conditions, lower commodity and protein prices and changes in the availability of credit. The estimated fair value of the individual reporting units is assessed for reasonableness by reviewing a variety of indicators evaluated over a reasonable period of time.
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As of December 31, 2022, we had approximately $1,310.8 million of goodwill. While our annual impairment testing in 2022 supported the carrying amount of this goodwill, we may be required to re-evaluate the carrying amount in future periods, thus utilizing different assumptions that reflect the then current market conditions and expectations, and, therefore, we could conclude that an impairment has occurred.
Recoverable Indirect Taxes
Our Brazilian operations incur value added taxes (“VAT”) on certain purchases of raw materials, components and services. These taxes are accumulated as tax credits and create assets that are reduced by the VAT collected from our sales in the Brazilian market. We regularly assess the recoverability of these tax credits, and establishes reserves when necessary against them, through analyses that include, amongst others, the history of realization, the transfer of tax credits to third parties as authorized by the government, anticipated changes in the supply chain and the future expectation of tax debits from our ongoing operations. We believe that these tax credits, net of established reserves are realizable. Our assessment of realization of these tax assets involves significant judgments on our part, and the conclusions that we reach could vary significantly based upon these judgments. We recorded approximately $94.6 million and $114.4 million, respectively, of VAT tax credits, net of reserves, as of December 31, 2022 and 2021.