BORGWARNER INC. INTRODUCTION
BorgWarner Inc. and Consolidated Subsidiaries (the "Company") is a global product leader in clean and efficient technology solutions for combustion, hybrid and electric vehicles. Our products help improve vehicle performance, propulsion efficiency, stability and air quality. These products are manufactured and sold worldwide, primarily to original equipment manufacturers ("OEMs") of light vehicles (passenger cars, sport-utility vehicles ("SUVs"), vans and light trucks). The Company's products are also sold to other OEMs of commercial vehicles (medium-duty trucks, heavy-duty trucks and buses) and off-highway vehicles (agricultural and construction machinery and marine applications). We also manufacture and sell our products to certain Tier One vehicle systems suppliers and into the aftermarket for light, commercial and off-highway vehicles. The Company operates manufacturing facilities serving customers inEurope , theAmericas andAsia and is an original equipment supplier to every major automotive OEM in the world. The Company's products fall into two reporting segments: Engine and Drivetrain. The Engine segment's products include turbochargers, timing systems, emissions systems and thermal systems. The Drivetrain segment's products include transmission systems, torque transfer systems and rotating electrical components.
Proposed Acquisition of Delphi Technologies PLC
OnJanuary 28, 2020 , the Company entered into a definitive agreement to acquire Delphi Technologies PLC ("Delphi Technologies") in an all-stock transaction valued at approximately$3.3 billion , based on the closing price ofBorgWarner stock onJanuary 27, 2020 . Refer to Note 23, "Subsequent Event," to the Consolidated Financial Statements in Item 8 of this report for more information. The Company expects to pay fees, costs and expenses associated with the transaction with available cash. The following discussion and analysis of financial condition and results of operations does not address matters associated with the anticipated acquisition. 31 --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
A detailed comparison of the Company's 2017 operating results to its 2018
operating results can be found in the Management's Discussion and Analysis of
Financial Condition and Results of Operations section in the Company's 2018
Annual Report on Form 10-K filed
A summary of our operating results for the years ended
Year Ended December 31,
(in millions, except per share data) 2019 2018
Net sales $ 10,168 $ 10,530
Cost of sales 8,067 8,300
Gross profit 2,101 2,230
Selling, general and administrative expenses 873 946
Other (income) expense, net (75 ) 94
Operating income 1,303 1,190
Equity in affiliates' earnings, net of tax (32 ) (49 )
Interest income (12 ) (6 )
Interest expense 55 59
Other postretirement expense (income) 27 (10 )
Earnings before income taxes and noncontrolling interest 1,265 1,196
Provision for income taxes 468 211
Net earnings 797 985Net earnings attributable to the noncontrolling interest, net of tax
51 54
Net earnings attributable to BorgWarner Inc. $ 746 $ 931
Earnings per share - diluted $ 3.61 $ 4.44
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Non-comparable items impacting the Company's earnings per diluted share and net earnings
The Company's earnings per diluted share were$3.61 and$4.44 for the years endedDecember 31, 2019 and 2018, respectively. The non-comparable items presented below are calculated after tax using the corresponding effective tax rate and the weighted average number of diluted shares for each of the years then ended. The Company believes the following table is useful in highlighting non-comparable items that impacted its earnings per diluted share: Year Ended December 31, Non-comparable items: 2019 2018 Restructuring expense$ (0.26 ) $ (0.24 ) Pension settlement loss (0.10 ) - Unfavorable arbitration loss (0.07 ) - Merger, acquisition and divestiture expense (0.05 ) (0.03 ) Asset impairment and loss on divestiture (0.03 ) (0.09 ) Officer stock awards modification (0.01 ) (0.04 ) Gain on derecognition of subsidiary 0.02 - Asbestos-related adjustments - (0.08 ) Gain on sale of building -
0.07
Gain on commercial settlement - 0.01 Tax reform adjustments - 0.06 Tax adjustments (0.02 ) 0.30
Total impact of non-comparable items per share - diluted:
A summary of non-comparable items impacting the Company's net earnings for the
years ended
Year ended
• The Company recorded restructuring expense of
related to actions to reduce structural costs. Refer to Note 16,
"Restructuring," to the Consolidated Financial Statements in Item 8 of
this report for more information. Over the course of the next few years,
the Company plans to take additional actions to reduce existing structural
costs. These actions are expected to result in primarily cash
restructuring costs in the
end of 2023. The resulting annual cost savings are expected to be in the
range of approximately
plans to utilize these savings to sustain the Company's strong operating
margin profile and long-term cost competitiveness.
• During the year ended December 31, 2019 , the Company settled
approximately
by liquidating approximately
pension de-risking disbursement made to an insurance company. Pursuant to
this agreement, the insurance company unconditionally and irrevocably
guarantees all future payments to certain participants that were receiving
payments from the
investment risk associated with the assets that were delivered as part of
this transaction. Additionally, during 2019, the Company discharged
certain U.S. pension plan obligations by making lump-sum payments of $15
million to former employees of the Company. As a result, the Company
settled $65 million of projected pension obligation by liquidating an
equivalent amount of pension plan assets and recorded a non-cash
settlement loss of
unamortized losses.
• During the year ended December 31, 2019 , the Company recorded $14
million of expenses related to the receipt of a final unfavorablearbitration decision associated with the resolution of a matter related to
a previous acquisition.
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• During the year ended
million of expenses, primarily professional fees, related to the Company's
strategic acquisition and divestiture activities, including the transfer
of Morse TEC, the anticipated acquisition of Delphi Technologies, and the
20% equity interest in
for the non-core pipes and thermostat product lines.
• During the year ended December 31, 2019 , the Company recorded an
additional loss on sale of
finalization of the purchase price adjustments related to the sale of the
non-core pipes and thermostat product lines. Refer to Note 20, "Assets and
Liabilities Held for Sale," to the Consolidated Financial Statements in
Item 8 of this report for more information.
• During the year ended
gain on the derecognition of
assets from the Consolidated Balance Sheet. In addition, the Company
recorded tax expense as a result of the reversal of the previously
recorded deferred tax assets related to the asbestos liabilities of
million, resulting in an after-tax gain of
"Recent Transactions," to the Consolidated Financial Statements in Item 8
of this report for more information.
• The Company's provision for income taxes for the year ended
2019, includes reductions to tax expense of
restructuring and merger, acquisition and divestiture expense and
million related to pension settlement loss. This rate also includes
increases to tax expense of
related to the calculation of the one-time transition tax partially offset
by reductions to tax expense of
and
Year ended
• The Company recorded restructuring expense of$67 million related to Engine and Drivetrain segment actions designed to improve future profitability and competitiveness, primarily related to employee termination benefits, professional fees, and manufacturing footprint rationalization activities. • During the year endedDecember 31, 2018 , the Company recorded an asset impairment expense of$26 million to adjust the net book value of the pipes and thermostat product lines to fair value less costs to sell. Additionally, the Company recorded$6 million of merger, acquisition and
divestiture expense primarily related to professional fees associated with
divestiture activities for the non-core pipes and thermostat product
lines. Refer to Note 20, "Assets and Liabilities Held for Sale," to the
Consolidated Financial Statements in Item 8 of this report for more
information.
• The Company recorded net restricted stock and performance share unit
compensation expense of
the Company modified the vesting provisions of restricted stock and
performance share unit grants made to retiring executive officers to allow
certain of the outstanding awards, that otherwise would have been
forfeited, to vest upon retirement. Refer to Note 13, "Stock-Based
Compensation," to the Consolidated Financial Statements in Item 8 of this
report for more information.
• During the year ended December 31, 2018 , the Company recordedasbestos-related adjustments resulting in an increase to Other Expense of
of
asbestos-related claims asserted but not yet resolved and potential claims
not yet asserted. Refer to Note 15, "Contingencies," to the Consolidated
Financial Statements in Item 8 of this report for more information.
• During the fourth quarter of 2018, the Company recorded a gain of $19
million related to the sale of a building at a manufacturing facility
located in Europe .
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• During the year ended
approximately $4 million related to the settlement of a commercial
contract for an entity acquired in the 2015 Remy acquisition.
• The Company's provision for income taxes for the year ended
2018 includes reductions of income tax expense of
restructuring expense,
adjustments, and
increases to tax expense of
commercial settlement and a gain on the sale of a building, respectively,
discussed in Note 4, "Other Expense, Net," to the Consolidated Financial
Statements. The provision for income taxes also includes reductions of
income tax expense of $13 million related to final adjustments made tomeasurement period provisional estimates associated with the Tax Cuts and
Jobs Act (the "Tax Act"),
deferred tax liability due to a tax benefit for certain foreign tax
credits now available due to actions the Company took during the year,
million related to valuation allowance releases,
reserve adjustments, and
methods and tax filing positions for prior years primarily related to the
Tax Act. Refer to Note 5, "Income Taxes," to the Consolidated Financial
Statements in Item 8 of this report for more information.
Net sales for the year endedDecember 31, 2019 totaled$10,168 million , a 3.4% decrease from the year endedDecember 31, 2018 . Excluding the impact of weaker foreign currencies and the net impact of acquisitions and divestitures, net sales increased 0.7%. The following table details our results of operations as a percentage of net sales: Year Ended December 31, (percentage of net sales) 2019 2018 Net sales 100.0 % 100.0 % Cost of sales 79.3 78.8 Gross profit 20.7 21.2 Selling, general and administrative expenses 8.6 9.0 Other (income) expense, net (0.7 ) 0.9 Operating income 12.8 11.3 Equity in affiliates' earnings, net of tax (0.3 ) (0.5 ) Interest income (0.1 ) (0.1 ) Interest expense 0.5 0.6 Other postretirement expense (income) 0.3 (0.1 ) Earnings before income taxes and noncontrolling interest 12.4 11.4 Provision for income taxes 4.6 2.0 Net earnings 7.8 9.4
Net earnings attributable to the noncontrolling interest, net of tax
0.5 0.5
Net earnings attributable toBorgWarner Inc. 7.3 %
8.9 %
Cost of sales as a percentage of net sales was 79.3% and 78.8% in the years endedDecember 31, 2019 and 2018, respectively. The Company's material cost of sales was approximately 55% of net sales in the years endedDecember 31, 2019 and 2018. Gross profit as a percentage of net sales was 20.7% and 21.2% in the years endedDecember 31, 2019 and 2018, respectively. The reduction of gross margin in 2019 compared to 2018 was primarily due to the impact of lower revenue, the increased cost from tariffs and supplier cost reductions not keeping pace with normal customer price deflation. 35 -------------------------------------------------------------------------------- Selling, general and administrative expenses ("SG&A") was$873 million and$946 million , or 8.6% and 9.0% of net sales for the years endedDecember 31, 2019 and 2018, respectively. The decrease in SG&A expenses was primarily due to stock-based compensation expense and cost control measures. Research and development ("R&D") costs, net of customer reimbursements, were$413 million , or 4.1% of net sales, in the year endedDecember 31, 2019 , compared to$440 million , or 4.2% of net sales, in the year endedDecember 31, 2018 . The decrease of R&D costs, net of customer reimbursements, in the year endedDecember 31, 2019 compared with the year endedDecember 31, 2018 was primarily due to cost control measures and an increase in customer reimbursements. We will continue to invest in a number of cross-business R&D programs, as well as a number of other key programs, all of which are necessary for short- and long-term growth. Our current long-term expectation for R&D spending remains in the range of 4% to 4.5% of net sales.
Other (income) expense, net was
Equity in affiliates' earnings, net of tax was$32 million and$49 million in the years endedDecember 31, 2019 and 2018, respectively. This line item is driven by the results of our 50%-owned Japanese joint venture, NSK-Warner KK, and our 32.6%-owned Indian joint venture,Turbo Energy Private Limited ("TEL"). The decrease in equity in affiliates' earnings in the year endedDecember 31, 2019 was due to lower industry volumes and cost pressures in a reduced market. Interest expense and finance charges were$55 million and$59 million in the years endedDecember 31, 2019 and 2018, respectively. The decrease in interest expense for the year endedDecember 31, 2019 compared with the year endedDecember 31, 2018 was primarily due to lower debt levels. Provision for income taxes the provision for income taxes resulted in an effective tax rate of 37% for the year endedDecember 31, 2019 , compared with the rate of 17.7% for the year endedDecember 31, 2018 . As ofDecember 31, 2018 , the Company has completed its accounting for the tax effects of the Tax Act. For further details, see Note 5, "Income Tax," to the Consolidated Financial Statements in Item 8. The effective tax rate of 37% for the year endedDecember 31, 2019 includes an increase in income tax expense of$173 million related to the derecognition of the Morse TEC asbestos-related deferred tax assets and$22 million due to theU.S. Department of the Treasury's issuance of the final regulations in the first quarter of 2019 related to the calculation of the one-time transition tax. This rate also includes reductions of income tax expense of$19 million related to restructuring expense,$11 million for a global realignment plan,$8 million related to other one-time adjustments and$6 million related to pension settlement loss. Excluding the impact of these non-comparable items, the Company's annual effective tax rate associated with ongoing operations is 26% for the year endedDecember 31, 2019 . The effective tax rate of 17.7% for the year endedDecember 31, 2018 includes reductions of income tax expense of$15 million related to restructuring expense,$6 million related to the asbestos-related adjustments, and$8 million related to asset impairment expense, offset by increases to tax expense of$1 million and$6 million related to a gain on commercial settlement and a gain on the sale of a building, respectively, discussed in Note 4, "Other (Income) Expense, Net," to the Consolidated Financial Statements. The provision for income taxes also includes reductions of income tax expense of$13 million related to final adjustments made to measurement period provisional estimates associated with the Tax Act,$22 million related to a decrease in our deferred tax liability due to a tax benefit for certain 36 -------------------------------------------------------------------------------- foreign tax credits now available due to actions the Company took during the year,$9 million related to valuation allowance releases,$3 million related to tax reserve adjustments, and$30 million related to changes in accounting methods and tax filing positions for prior years primarily related to the Tax Act. Excluding the impact of these non-comparable items, the Company's annual effective tax rate associated with ongoing operations for 2018 was 23.8%. Net earnings attributable to the noncontrolling interest, net of tax of$51 million for the year endedDecember 31, 2019 decreased by$3 million compared to the year endedDecember 31, 2018 . The decrease was due to lower industry volumes resulting in lower sales and earnings by the Company's joint ventures.
Results By Reporting Segment
The Company's business is comprised of two reporting segments: Engine and Drivetrain. These segments are strategic business groups, which are managed separately as each represents a specific grouping of related automotive components and systems.
The Company allocates resources to each segment based upon the projected
after-tax return on invested capital ("ROIC") of its business initiatives. ROIC
is comprised of Adjusted EBIT after deducting notional taxes compared to the
projected average capital investment required. Adjusted EBIT is comprised of
earnings before interest, income taxes and noncontrolling interest ("EBIT")
adjusted for restructuring, goodwill impairment charges, affiliates' earnings
and other items not reflective of ongoing operating income or loss.
Adjusted EBIT is the measure of segment income or loss used by the Company. The Company believes Adjusted EBIT is most reflective of the operational profitability or loss of our reporting segments.
The following tables show segment information and Adjusted EBIT for the Company's reporting segments.
Year Ended December 31,
(in millions) 2019 2018
Engine $ 6,214 $ 6,447
Drivetrain 4,015 4,140
Inter-segment eliminations (61 ) (57 )
Net sales $ 10,168 $ 10,530
37
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Adjusted Earnings Before Interest, Income Taxes and Noncontrolling Interest
("Adjusted EBIT")
Year Ended December 31,
(in millions) 2019 2018
Engine $ 995 $ 1,040
Drivetrain 443 475
Adjusted EBIT 1,438 1,515
Gain on derecognition of subsidiary (177 ) -
Restructuring expense 72 67
Unfavorable arbitration loss 14 -
Merger, acquisition and divestiture expense 11 6
Asset impairment and loss on divestiture 7 25
Officer stock awards modification 2 8
Asbestos-related adjustments - 23
Gain on sale of building - (19 )
Lease termination settlement - -
Other income - (4 )
Corporate, including stock-based compensation 206 219
Equity in affiliates' earnings, net of tax (32 ) (49 )
Interest income (12 ) (6 )
Interest expense 55 59
Other postretirement expense (income) 27 (10 )
Earnings before income taxes and noncontrolling interest 1,265
1,196
Provision for income taxes 468 211
Net earnings 797 985Net earnings attributable to the noncontrolling interest, net of tax
51 54
Net earnings attributable to BorgWarner Inc. $ 746 The Engine segment's net sales for the year endedDecember 31, 2019 decreased$233 million , or 3.6%, and segment Adjusted EBIT decreased$45 million , or 4.3%, from the year endedDecember 31, 2018 . Excluding the impact of weakening foreign currencies, primarily the Euro, Chinese Renminbi, and Korean Won, and the net impact of acquisitions and divestitures, net sales increased 1.3% from the year endedDecember 31, 2018 . The increase in sales was due to higher sales of light vehicle turbochargers and engine timing systems, which was partially offset by weaker commercial vehicle markets around the world. The segment Adjusted EBIT margin was 16.0% for the year endedDecember 31, 2019 , compared to 16.1% in the year endedDecember 31, 2018 . The Drivetrain segment's net sales for the year endedDecember 31, 2019 decreased$125 million , or 3.0%, and segment Adjusted EBIT decreased$32 million , or 6.7%, from the year endedDecember 31, 2018 . Excluding the impact of weakening foreign currencies, primarily the Euro, Chinese Renminbi, and Korean Won, net sales were flat from the year endedDecember 31, 2018 . The segment Adjusted EBIT margin was 11.0% in the year endedDecember 31, 2019 , compared to 11.5% in the year endedDecember 31, 2018 . The Adjusted EBIT margin decrease was primarily due to startup costs for launches. Corporate represents headquarters' expenses not directly attributable to the individual segments. This net expense was$206 million and$219 million for the years endedDecember 31, 2019 and 2018, respectively. The decrease in Corporate expenses in 2019 compared to 2018 is primarily due to lower costs associated with stock-based compensation and cost control initiatives. 38 --------------------------------------------------------------------------------
Outlook
Our overall outlook for 2020 is cautious. Net new business-related sales growth, due to increased penetration ofBorgWarner products around the world, is expected to be partially offset by declining global industry production expected in 2020. The Company expects flat to modestly declining revenue in 2020, excluding the impact of foreign currencies and the net impact of acquisitions and divestitures. The Company maintains a positive long-term outlook for its global business and is committed to new product development and strategic capital investments to enhance its product leadership strategy. The several trends that are driving the Company's long-term growth are expected to continue, including the increased turbocharger adoption inNorth America andAsia , the increased adoption of automated transmissions inAsia-Pacific , and increased global penetration of all-wheel drive. The Company's long-term growth is also expected to benefit from the adoption of product offerings for hybrid and electric vehicles.
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains various liquidity sources including cash and cash equivalents and the unused portion of our multi-currency revolving credit agreement. AtDecember 31, 2019 , the Company had$832 million of cash and cash equivalents, of which$562 million of cash and cash equivalents was held by our subsidiaries outside ofthe United States . Cash and cash equivalents held by these subsidiaries is used to fund foreign operational activities and future investments, including acquisitions. The vast majority of cash and cash equivalents held outsidethe United States is available for repatriation. The Tax Act reduced theU.S. federal corporate tax rate from 35 percent to 21 percent and required companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred. As ofJanuary 1, 2018 , funds repatriated from foreign subsidiaries are generally no longer taxable forU.S. federal tax purposes. In light of the treatment of foreign earnings under the Tax Act, the Company recorded a liability for theU.S. federal and applicable state income tax liabilities calculated under the provisions of the deemed repatriation of foreign earnings. A deferred tax liability has been recorded for substantially all estimated legally distributable foreign earnings. The Company uses itsU.S. liquidity primarily for various corporate purposes, including but not limited to debt service, share repurchases, dividend distributions, acquisitions and divestitures and other corporate expenses. The Company has a$1.2 billion multi-currency revolving credit facility, which includes a feature that allows the Company's facility to be increased to$1.5 billion with bank approval. The facility provides for borrowings throughJune 29, 2022 . The Company has one key financial covenant as part of the credit agreement which is a debt to EBITDA ("Earnings Before Interest, Taxes, Depreciation and Amortization") ratio. The Company was in compliance with the financial covenant atDecember 31, 2019 and expects to remain compliant in future periods. AtDecember 31, 2019 andDecember 31, 2018 , the Company had no outstanding borrowings under this facility. The Company's commercial paper program allows the Company to issue short-term, unsecured commercial paper notes up to a maximum aggregate principal amount outstanding of$1.2 billion . Under this program, the Company may issue notes from time to time and use the proceeds for general corporate purposes. The Company had no outstanding borrowings under this program as ofDecember 31, 2019 andDecember 31, 2018 .
The total current combined borrowing capacity under the multi-currency revolving
credit facility and commercial paper program cannot exceed
In addition to the credit facility, the Company's universal shelf registration
provides the ability to issue various debt and equity instruments subject to
market conditions.
39
-------------------------------------------------------------------------------- OnFebruary 6, 2019 ,April 25, 2019 ,July 25, 2019 andNovember 13, 2019 , the Company's Board of Directors declared quarterly cash dividends of$0.17 per share of common stock. These dividends were paid onMarch 15, 2019 ,June 17, 2019 ,September 16, 2019 andDecember 16, 2019 . From a credit quality perspective, the Company had a credit rating of BBB+ from bothStandard & Poor's and Fitch Ratings and Baa1 from Moody's as ofDecember 31, 2019 with a stable outlook from all rating agencies. OnJanuary 28, 2020 , the Company entered into a definitive agreement to acquire Delphi Technologies. Due to uncertainties surrounding this anticipated transaction, Moody's adjusted their outlook to negative andStandard & Poor's placed the Company on CreditWatch with negative implications. The Company's current outlook from Fitch Ratings remained stable. None of the Company's debt agreements require accelerated repayment in the event of a downgrade in credit ratings.
Capitalization
Total equity increased by$499 million in the year endedDecember 31, 2019 as follows: (in millions) Balance,January 1, 2019 $ 4,345 Net earnings 797 Purchase of treasury stock (100 ) Stock-based compensation 27 Other comprehensive loss (55 ) Noncontrolling interest contributions 4
Dividends declared to
$ 4,844 Operating Activities Net cash provided by operating activities was$1,008 million and$1,126 million in the years endedDecember 31, 2019 and 2018, respectively. The decrease for the year endedDecember 31, 2019 compared with the year endedDecember 31, 2018 primarily reflected the cash outflow related to the derecognition of a subsidiary, partially offset by changes in working capital.
Investing Activities
Net cash used in investing activities was$489 million and$514 million in the years endedDecember 31, 2019 and 2018, respectively. The decrease in the year endedDecember 31, 2019 compared with the year endedDecember 31, 2018 was primarily due to lower capital expenditures, including tooling outlays in 2019. Year-over-year capital spending decrease of$65 million during the year endedDecember 31, 2019 was primarily due to timing of the investment activity in the Engine segment. Financing Activities Net cash used in financing activities was$420 million and$383 million in the years endedDecember 31, 2019 and 2018, respectively. The increase in the year endedDecember 31, 2019 compared with the year endedDecember 31, 2018 was primarily driven by higher debt repayments, partially offset by lower share repurchases. 40
-------------------------------------------------------------------------------- The Company's significant contractual obligations atDecember 31, 2019 are as follows: (in millions) Total 2020 2021-2022 2023-2024 After 2024 Other postretirement employee benefits, excluding pensions (a)$ 68 $ 10 $ 18 $ 15 $ 25 Defined benefit pension plans (b) 55 4 11 10 30 Notes payable and long-term debt 1,973 286 565 1 1,121 Projected interest payments 757 66 113 95 483 Non-cancelable operating leases 97 20 28 16 33 Capital spending obligations 102 102 - - - Total$ 3,052 $ 488 $ 735 $ 137 $ 1,692 ________________
(a) Other postretirement employee benefits, excluding pensions, include
anticipated future payments to cover retiree medical and life insurance
benefits. Amount contained in "After 2024" column includes estimated payments
through 2029. Refer to Note 12, "Retirement Benefit Plans," to the
Consolidated Financial Statements in Item 8 of this report for disclosures
related to the Company's other postretirement employee benefits.
(b) Since the timing and amount of payments for funded defined benefit pension
plans are usually not certain for future years such potential payments are
not shown in this table. Amount contained in "After 2024" column is for
unfunded plans and includes estimated payments through 2029. Refer to Note
12, "Retirement Benefit Plans," to the Consolidated Financial Statements in
Item 8 of this report for disclosures related to the Company's pension
benefits.
We believe that the combination of cash from operations, cash balances,
available credit facilities, and the universal shelf registration capacity will
be sufficient to satisfy our cash needs for our current level of operations and
our planned operations for the foreseeable future. We will continue to balance
our needs for internal growth, external growth, debt reduction and cash
conservation.
Pension and Other Postretirement Employee Benefits
The Company's policy is to fund its defined benefit pension plans in accordance with applicable government regulations and to make additional contributions when appropriate. AtDecember 31, 2019 , all legal funding requirements had been met. The Company contributed$26 million ,$26 million and$18 million to its defined benefit pension plans in the years endedDecember 31, 2019 , 2018 and 2017, respectively. The Company expects to contribute a total of$10 million to$20 million into its defined benefit pension plans during 2020. Of the$10 million to$20 million in projected 2020 contributions,$4 million are contractually obligated, while any remaining payments would be discretionary. The funded status of all pension plans was a net unfunded position of$212 million and$211 million atDecember 31, 2019 and 2018, respectively. Of these amounts,$107 million and$95 million atDecember 31, 2019 and 2018, respectively, were related to plans inGermany , where there is not a tax deduction allowed under the applicable regulations to fund the plans; hence the common practice is to make contributions as benefit payments become due. Other postretirement employee benefits primarily consist of postretirement health care benefits for certain employees and retirees of the Company'sU.S. operations. The Company funds these benefits as retiree claims are incurred. Other postretirement employee benefits had an unfunded status of$81 million and$87 million atDecember 31, 2019 and 2018, respectively. The Company believes it will be able to fund the requirements of these plans through cash generated from operations or other available sources of financing for the foreseeable future.
Refer to Note 12, "Retirement Benefit Plans," to the Consolidated Financial Statements in Item 8 of this report for more information regarding costs and assumptions for employee retirement benefits.
41
--------------------------------------------------------------------------------OTHER MATTERS
Contingencies
In the normal course of business, the Company is party to various commercial and legal claims, actions and complaints, including matters involving warranty claims, intellectual property claims, general liability and various other risks. It is not possible to predict with certainty whether or not the Company will ultimately be successful in any of these commercial and legal matters or, if not, what the impact might be. The Company's environmental and product liability contingencies are discussed separately below. The Company's management does not expect that an adverse outcome in any of these commercial and legal claims, actions and complaints will have a material adverse effect on the Company's results of operations, financial position or cash flows, although it could be material to the results of operations in a particular quarter.
Environmental
The Company and certain of its current and former direct and indirect corporate predecessors, subsidiaries and divisions have been identified by theUnited States Environmental Protection Agency and certain state environmental agencies and private parties as potentially responsible parties ("PRPs") at various hazardous waste disposal sites under the Comprehensive Environmental Response, Compensation and Liability Act ("Superfund") and equivalent state laws and, as such, may presently be liable for the cost of clean-up and other remedial activities at 14 such sites. Responsibility for clean-up and other remedial activities at a Superfund site is typically shared among PRPs based on an allocation formula. The Company believes that none of these matters, individually or in the aggregate, will have a material adverse effect on its results of operations, financial position or cash flows. Generally, this is because either the estimates of the maximum potential liability at a site are not material or the liability will be shared with other PRPs, although no assurance can be given with respect to the ultimate outcome of any such matter.
Refer to Note 15, "Contingencies," to the Consolidated Financial Statements in Item 8 of this report for further details and information respecting the Company's environmental liability.
CRITICAL ACCOUNTING POLICIES
The consolidated financial statements are prepared in conformity with accounting principles generally accepted inthe United States ("GAAP"). In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. Critical accounting policies are those that are most important to the portrayal of the Company's financial condition and results of operations. Some of these policies require management's most difficult, subjective or complex judgments in the preparation of the financial statements and accompanying notes. Management makes estimates and assumptions about the effect of matters that are inherently uncertain, relating to the reporting of assets, liabilities, revenues, expenses and the disclosure of contingent assets and liabilities. Our most critical accounting policies are discussed below. Revenue recognition The Company recognizes revenue when performance obligations under the terms of a contract are satisfied, which generally occurs with the transfer of control of our products. Although the Company may enter into long-term supply arrangements with its major customers, the prices and volumes are not fixed over the life of the arrangements, and a contract does not exist for purposes of applying Accounting Standards Codification ("ASC") Topic 606 until volumes are contractually known. For most of our products, transfer of control occurs upon shipment or delivery; 42 -------------------------------------------------------------------------------- however, a limited number of our customer arrangements for our highly customized products with no alternative use provide us with the right to payment during the production process. As a result, for these limited arrangements, revenue is recognized as goods are produced and control transfers to the customer. Revenue is measured at the amount of consideration we expect to receive in exchange for transferring the good. The Company continually seeks business development opportunities and at times provides customer incentives for new program awards. Customer incentive payments are capitalized when the payments are incremental and incurred only if the new business is obtained and these amounts are expected to be recovered from the customer over the term of the new business arrangement. The Company recognizes a reduction to revenue as products that the upfront payments are related to are transferred to the customer, based on the total amount of products expected to be sold over the term of the arrangement (generally 3 to 7 years). The Company evaluates the amounts capitalized each period end for recoverability and expenses any amounts that are no longer expected to be recovered over the term of the business arrangement. Impairment of long-lived assets, including definite-lived intangible assets The Company reviews the carrying value of its long-lived assets, whether held for use or disposal, including other amortizing intangible assets, when events and circumstances warrant such a review under ASC Topic 360. In assessing long-lived assets for an impairment loss, assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. In assessing long-lived assets for impairment, management generally considers individual facilities the lowest level for which identifiable cash flows are largely independent. A recoverability review is performed using the undiscounted cash flows if there is a triggering event. If the undiscounted cash flow test for recoverability identifies a possible impairment, management will perform a fair value analysis. Management determines fair value under ASC Topic 820 using the appropriate valuation technique of market, income or cost approach. If the carrying value of a long-lived asset is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value. Management believes that the estimates of future cash flows and fair value assumptions are reasonable; however, changes in assumptions underlying these estimates could affect the valuations. Significant judgments and estimates used by management when evaluating long-lived assets for impairment include: (i) an assessment as to whether an adverse event or circumstance has triggered the need for an impairment review; (ii) undiscounted future cash flows generated by the asset; and (iii) fair valuation of the asset. Events and conditions that could result in impairment in the value of our long-lived assets include changes in the industries in which we operate, particularly the impact of a downturn in the global economy, as well as competition and advances in technology, adverse changes in the regulatory environment, or other factors leading to reduction in expected long-term sales or profitability. Assets and liabilities held for sale The Company classifies assets and liabilities (disposal groups) to be sold as held for sale in the period in which all of the following criteria are met: management, having the authority to approve the action, commits to a plan to sell the disposal group; the disposal group is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such disposal groups; an active program to locate a buyer and other actions required to complete the plan to sell the disposal group have been initiated; the sale of the disposal group is probable, and transfer of the disposal group is expected to qualify for recognition as a completed sale within one year, except if events or circumstances beyond the Company's control extend the period of time required to sell the disposal group beyond one year; the disposal group is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. 43
-------------------------------------------------------------------------------- The Company initially measures a disposal group that is classified as held for sale at the lower of its carrying value or fair value less any costs to sell. Any loss resulting from this measurement is recognized in the period in which the held for sale criteria are met. Conversely, gains are not recognized on the sale of a disposal group until the date of sale. The Company assesses the fair value of a disposal group, less any costs to sell, each reporting period it remains classified as held for sale and reports any subsequent changes as an adjustment to the carrying value of the disposal group, as long as the new carrying value does not exceed the carrying value of the disposal group at the time it was initially classified as held for sale. Additionally, depreciation is not recorded during the period in which the long-lived assets, included in the disposal group, are classified as held for sale. Upon determining that a disposal group meets the criteria to be classified as held for sale, the Company reports the assets and liabilities of the disposal group, if material, in the line items assets held for sale and liabilities held for sale in the Consolidated Balance Sheet.
Refer to Note 20, "Assets and Liabilities Held for Sale," to the Consolidated Financial Statements in Item 8 of this report for more information.
Goodwill and other indefinite-lived intangible assets During the fourth quarter of each year, the Company qualitatively assesses its goodwill assigned to each of its reporting units. This qualitative assessment evaluates various events and circumstances, such as macro economic conditions, industry and market conditions, cost factors, relevant events and financial trends, that may impact a reporting unit's fair value. Using this qualitative assessment, the Company determines whether it is more-likely-than-not the reporting unit's fair value exceeds its carrying value. If it is determined that it is not more-likely-than-not the reporting unit's fair value exceeds the carrying value, or upon consideration of other factors, including recent acquisition, restructuring or divestiture activity or to refresh the fair values, the Company performs a quantitative, "step one," goodwill impairment analysis. In addition, the Company may test goodwill in between annual test dates if an event occurs or circumstances change that could more-likely-than-not reduce the fair value of a reporting unit below its carrying value. Similar to goodwill, the Company can elect to perform the impairment test for indefinite-lived intangibles other than goodwill (primarily trade names) using a qualitative analysis, considering similar factors as outlined in the goodwill discussion in order to determine if it is more-likely-than-not that the fair value of the trade names is less than the respective carrying values. If the Company elects to perform or is required to perform a quantitative analysis, the test consists of a comparison of the fair value of the indefinite-lived intangible asset to the carrying value of the asset as of the impairment testing date. The Company estimates the fair value of indefinite-lived intangibles using the relief-from-royalty method, which it believes is an appropriate and widely used valuation technique for such assets. The fair value derived from the relief-from-royalty method is measured as the discounted cash flow savings realized from owning such trade names and not being required to pay a royalty for their use. During the fourth quarter of 2019, the Company performed an analysis on each reporting unit. Based on the factors above, the Company elected to perform quantitative, "step one," goodwill impairment analyses, on three reporting units. This requires the Company to make significant assumptions and estimates about the extent and timing of future cash flows, discount rates and growth rates. The basis of this goodwill impairment analysis is the Company's annual budget and long-range plan ("LRP"). The annual budget and LRP includes a five-year projection of future cash flows based on actual new products and customer commitments and assumes the last year of the LRP data is a fair indication of the future performance. Because the LRP is estimated over a significant future period of time, those estimates and assumptions are subject to a high degree of uncertainty. Further, the market valuation models and other financial ratios used by the Company require certain assumptions and estimates regarding the applicability of those models to the Company's facts and circumstances. 44
-------------------------------------------------------------------------------- The Company believes the assumptions and estimates used to determine the estimated fair value are reasonable. Different assumptions could materially affect the estimated fair value. The primary assumptions affecting the Company'sDecember 31, 2019 goodwill quantitative, "step one," impairment review are as follows:
• Discount rate: the Company used a 10.7% weighted average cost of capital
("WACC") as the discount rate for future cash flows. The WACC is intended
to represent a rate of return that would be expected by a market
participant.
• Operating income margin: the Company used historical and expected
operating income margins, which may vary based on the projections of the
reporting unit being evaluated.
• Revenue growth rate: the Company used a global automotive market industry
growth rate forecast adjusted to estimate its own market participation for
product lines.
In addition to the above primary assumptions, the Company notes the following
risks to volume and operating income assumptions that could have an impact on
the discounted cash flow models:
• The automotive industry is cyclical, and the Company's results of
operations would be adversely affected by industry downturns.
• The Company is dependent on market segments that use our key products and
would be affected by decreasing demand in those segments.
• The Company is subject to risks related to international operations.
Based on the assumptions outlined above, the impairment testing conducted in the fourth quarter of 2019 indicated the Company's goodwill assigned to the reporting units that were quantitatively assessed were not impaired and contained fair values substantially higher than the reporting units' carrying values. Additionally, for the reporting units quantitatively assessed, sensitivity analyses were completed indicating that a one percentage point increase in the discount rate, a one percentage point decrease in the operating margin, or a one percentage point decrease in the revenue growth rate assumptions would not result in the carrying value exceeding the fair value.
Refer to Note 7, "
Product warranties The Company provides warranties on some, but not all, of its
products. The warranty terms are typically from one to three years. Provisions
for estimated expenses related to product warranty are made at the time products
are sold. These estimates are established using historical information about the
nature, frequency and average cost of warranty claim settlements as well as
product manufacturing and industry developments and recoveries from third
parties. Management actively studies trends of warranty claims and takes action
to improve product quality and minimize warranty claims. Management believes
that the warranty accrual is appropriate; however, actual claims incurred could
differ from the original estimates, requiring adjustments to the accrual:
Year Ended December 31,
(in millions) 2019 2018
Net sales $ 10,168 $ 10,530
Warranty provision $ 72 $ 68 Warranty provision as a percentage of net sales 0.7 % 0.6 %
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The following table illustrates the sensitivity of a 25 basis point change (as a
percentage of net sales) in the assumed warranty trend on the Company's accrued
warranty liability:
December 31,
(in millions) 2019 2018
25 basis point decrease (income)/expense
AtDecember 31, 2019 , the total accrued warranty liability was$116 million . The accrual is represented as$63 million in current liabilities and$53 million in non-current liabilities on our Consolidated Balance Sheet.
Refer to Note 8, "Product Warranty," to the Consolidated Financial Statements in Item 8 of this report for more information regarding product warranties.
Asbestos Like many other industrial companies that have historically operated inthe United States , the Company, or parties that the Company is obligated to indemnify, has been named as one of many defendants in asbestos-related personal injury actions. Morse TEC, a former wholly-owned subsidiary of the Company, was the obligor for the Company's recorded asbestos-related liabilities and the policyholder of the related insurance assets. OnOctober 30, 2019 , the Company transferred 100% of its equity interests toEnstar Holdings (US) LLC . In the fourth quarter of 2019, the Company derecognized Morse TEC and removed asbestos obligations, related insurance assets and associated deferred tax assets from the Consolidated Balance Sheet. With the assistance of a third-party actuary, the Company estimated the liability and corresponding insurance recovery for pending and future claims not yet asserted to extend throughDecember 31, 2064 with a runoff through 2074 and defense costs. This estimate was based on the Company's historical claim experience and estimates of the number and resolution cost of potential future claims that may be filed based on anticipated levels of unique plaintiff asbestos-related claims in theU.S. tort system against all defendants. As with any estimates, actual experience may differ. This estimate was not discounted to present value. The Company believed thatDecember 31, 2074 was a reasonable assumption as to the last date on which it was likely to have resolved all asbestos-related claims, based on the nature and useful life of the Company's products and the likelihood of incidence of asbestos-related disease in theU.S. population generally. The Company assessed the sufficiency of its estimated liability for pending and future claims not yet asserted and defense costs by evaluating actual experience regarding claims filed, settled and dismissed, and amounts paid in claim resolution costs. In addition to claims experience, the Company considered additional quantitative and qualitative factors such as changes in legislation, the legal environment, and the Company's defense strategy. The Company continued to have additional excess insurance coverage available for potential future asbestos-related claims. In connection with the Company's review of its asbestos-related claims, the Company also reviewed the amount of its potential insurance coverage for such claims, taking into account the remaining limits of such coverage, the number and amount of claims on the Company's insurance from co-insured parties, ongoing litigation against the Company's insurance carriers, potential remaining recoveries from insolvent insurance carriers, the impact of previous insurance settlements, and coverage available from solvent insurance carriers not party to the coverage litigation.
Refer to Note 15, "Contingencies," to the Consolidated Financial Statements in Item 8 of this report for more information regarding management's judgments applied in the recognition and measurement of asbestos-related assets and liabilities.
Pension and other postretirement defined benefits The Company provides postretirement defined benefits to a number of its current and former employees. Costs associated with postretirement defined
46
--------------------------------------------------------------------------------benefits include pension and postretirement health care expenses for employees, retirees and surviving spouses and dependents.
The Company's defined benefit pension and other postretirement plans are accounted for in accordance with ASC Topic 715. The determination of the Company's obligation and expense for its pension and other postretirement employee benefits, such as retiree health care, is dependent on certain assumptions used by actuaries in calculating such amounts. Certain assumptions, including the expected long-term rate of return on plan assets, discount rate, rates of increase in compensation and health care costs trends are described in Note 12, "Retirement Benefit Plans," to the Consolidated Financial Statements in Item 8 of this report. The effects of any modification to those assumptions are either recognized immediately or amortized over future periods in accordance with GAAP. In accordance with GAAP, actual results that differ from assumptions used are accumulated and generally amortized over future periods. The primary assumptions affecting the Company's accounting for employee benefits under ASC Topics 712 and 715 as ofDecember 31, 2019 are as follows:
• Expected long-term rate of return on plan assets: The expected long-term rate
of return is used in the calculation of net periodic benefit cost. The
required use of the expected long-term rate of return on plan assets may
result in recognized returns that are greater or less than the actual returns
on those plan assets in any given year. Over time, however, the expected
long-term rate of return on plan assets is designed to approximate actual
earned long-term returns. The expected long-term rate of return for pension
assets has been determined based on various inputs, including historical
returns for the different asset classes held by the Company's trusts and its
asset allocation, as well as inputs from internal and external sources
regarding expected capital market return, inflation and other variables. The
Company also considers the impact of active management of the plans' invested
assets. In determining its pension expense for the year ended
2019, the Company used long-term rates of return on plan assets ranging from
1.75% to 5.9% outside of the
Actual returns on
Actual returns onU.K. pension assets were 9.5% and -3.1% for the years endedDecember 31, 2019 and 2018, respectively, compared to the expected rate of return assumption of 5% for the year endedDecember 31, 2019 and 6% for the year ended in 2018.
Actual returns on German pension assets were 21.0% and -4.2% for the years ended
• Discount rate: The discount rate is used to calculate pension and other
postretirement employee benefit ("OPEB") obligations. In determining the
discount rate, the Company utilizes a full-yield approach in the estimation
of service and interest components by applying the specific spot rates along
the yield curve used in the determination of the benefit obligation to the
relevant projected cash flows. The Company used discount rates ranging from
0.74% to 9.0% to determine its pension and other benefit obligations as of
health care plans. The
pension plan has been closed for new participants since 1989 (1999 for our
U.S. health care plan).
• Health care cost trend: For postretirement employee health care plan
accounting, the Company reviews external data and Company-specific historical
trends for health care cost to determine the
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-------------------------------------------------------------------------------- health care cost trend rate assumptions. In determining the projected benefit obligation for postretirement employee health care plans as ofDecember 31, 2019 , the Company used health care cost trend rates of 6.25%, declining to an ultimate trend rate of 5% by the year 2025. While the Company believes that these assumptions are appropriate, significant differences in actual experience or significant changes in these assumptions may materially affect the Company's pension and OPEB and its future expense. The following table illustrates the sensitivity to a change in certain assumptions for Company sponsoredU.S. and non-U.S. pension plans on its 2020 pre-tax pension expense: Impact on U.S. 2020 Impact on Non-U.S. pre-tax pension 2020 pre-tax pension (in millions) (expense)/income (expense)/income One percentage point decrease in discount rate $ - * $ (7 ) One percentage point increase in discount rate $ - * $ 7 One percentage point decrease in expected return on assets $ (2 ) $ (5 ) One percentage point increase in expected return on assets $ 2 $ 5 ________________
* A one percentage point increase or decrease in the discount rate would have a
negligible impact on the Company's
The sensitivity to a change in the discount rate assumption related to the Company's total 2020 U.S. OPEB expense is expected to be negligible, as any increase in interest expense will be offset by net actuarial gains.
The following table illustrates the sensitivity to a one-percentage point change
in the assumed health care cost trend related to the Company's OPEB obligation
and service and interest cost:
One Percentage Point
(in millions) Increase Decrease
Effect on other postretirement employee benefit obligation $ 5
$ (5 ) Effect on total service and interest cost components $ -
$ -
Refer to Note 12, "Retirement Benefit Plans," to the Consolidated Financial Statements in Item 8 of this report for more information regarding the Company's retirement benefit plans.
Restructuring Restructuring costs may occur when the Company takes action to
exit or significantly curtail a part of its operations or implements a
reorganization that affects the nature and focus of operations. A restructuring
charge can consist of severance costs associated with reductions to the
workforce, costs to terminate an operating lease or contract, professional fees
and other costs incurred related to the implementation of restructuring
activities.
The Company generally records costs associated with voluntary separations at the
time of employee acceptance. Costs for involuntary separation programs are
recorded when management has approved the plan for separation, the employees are
identified and aware of the benefits they are entitled to and it is unlikely
that the plan will change significantly. When a plan of separation requires
approval by or consultation with the relevant labor organization or government,
the costs are recorded upon agreement. Costs associated with benefits that are
contingent on the employee continuing to provide service are accrued over the
required service period.
Income taxes The Company accounts for income taxes in accordance with ASC Topic
740. Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying
amounts of existing assets and liabilities and their respective tax
48
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bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled.
Accounting for income taxes is complex, in part because the Company conducts
business globally and therefore files income tax returns in numerous tax
jurisdictions. Management judgment is required in determining the Company's
worldwide provision for income taxes and recording the related assets and
liabilities, including accruals for unrecognized tax benefits. In calculating
the provision for income taxes on an interim basis, the Company uses an estimate
of the annual effective tax rate based upon the facts and circumstances known at
each interim period. In determining the need for a valuation allowance, the
historical and projected financial performance of the operation recording the
net deferred tax asset is considered along with any other pertinent information.
Since future financial results may differ from previous estimates, periodic
adjustments to the Company's valuation allowance may be necessary.
The Company is subject to income taxes in the U.S. at the federal and state
level and numerous non-U.S. jurisdictions. The determination of accruals for
unrecognized tax benefits includes the application of complex tax laws in a
multitude of jurisdictions across the Company's global operations. Management
judgment is required in determining the accruals for unrecognized tax benefits.
In the ordinary course of the Company's business, there are many transactions
and calculations where the ultimate tax determination is less than certain.
Accruals for unrecognized tax benefits are established when, despite the belief
that tax positions are supportable, there remain certain positions that do not
meet the minimum probability threshold, which is a tax position that is
more-likely-than-not to be sustained upon examination by the applicable taxing
authority. The Company has certain U.S. state income tax returns and certain
non-U.S. income tax returns which are currently under various stages of audit by
applicable tax authorities. At December 31, 2019 , the Company has a liability
for tax positions the Company estimates are not more-likely-than-not to be
sustained based on the technical merits, which is included in other current and
non-current liabilities. Nonetheless, the amounts ultimately paid, if any, upon
resolution of the issues raised by the taxing authorities may differ materially
from the amounts accrued for each year.
The Tax Act that was signed into law in December 2017 constitutes a major change
to the U.S. tax system. The impact of the Tax Act on the Company is based on
management's current interpretations of the Tax Act, recently issued regulations
and related analysis. The Company's tax liability may be materially different
based on regulatory developments. In future periods, our effective tax rate
could be subject to additional uncertainty as a result of regulatory
developments related to the Tax Act.
Refer to Note 5, "Income Taxes," to the Consolidated Financial Statements in Item 8 of this report for more information regarding income taxes.
New Accounting Pronouncements
Refer to Note 1, "Summary of Significant Accounting Policies," to the Consolidated Financial Statements in Item 8 of this report for more information regarding new applicable accounting pronouncements.
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