WABCO HOLDINGS INC. This discussion summarizes the significant factors affecting the results of operations and financial condition of WABCO during the years endedDecember 31, 2019 , 2018 and 2017 and should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere herein. Certain information in this discussion and analysis regarding industry outlook, our expectations regarding the future performance of our business and other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in "Risk Factors" above. Our actual results may differ materially from those contained in any forward-looking statements. You should read the following discussion together with the sections entitled "Risk Factors", "Information Concerning Forward-Looking Statements", "Selected Financial Information", "Liquidity and Capital Resources" and consolidated financial statements and related notes thereto included elsewhere herein. Executive Overview
Due to the slowdown in global economic growth, as well as increasing geopolitical uncertainty, the worldwide production of new vehicles declined in 2019 compared to 2018 by 6%.
Our sales decreased compared to one year ago by 10.7% on a reported basis and by 7.0% excluding foreign currency translation effects. The global production of new trucks and buses shrank by an estimated 5.7% driven by significant decreases inIndia andEurope of approximately 39.7% and 8.1%, respectively. The global trailer market also declined by approximately 14.0% year over year. We continued to leverage the WABCO Operating System to drive fast and flexible actions to counteract the challenging market environment by driving profitability projects, solidly performing in delivering strong materials and conversion productivity. We took actions to optimize our variable cost structure and to decrease operating expenses, while we continued to increase our investment in engineering ensuring the successful execution of the Company's long-term strategy. As previously announced, onMarch 28, 2019 , WABCO entered into an Agreement (the Merger Agreement) and Plan of Merger withZF Friedrichshafen AG (ZF), a stock corporation organized and existing under the laws of theFederal Republic of Germany, andVerona Merger Sub Corp. , aDelaware corporation and indirect wholly owned subsidiary of ZF, pursuant to which ZF will acquire 100% of the issued and outstanding shares of WABCO common stock (the Merger). The Merger Agreement was adopted by WABCO's shareholders at theJune 27, 2019 special meeting of shareholders, whereby holders representing 68.4% of the Company's outstanding shares voted in favor of adopting the Merger Agreement.The European Commission and theUnited States Department of Justice cleared the Merger onJanuary 23, 2020 . In connection with theDepartment of Justice's review of the Merger, WABCO is divesting the Company's steering components business,R.H. Sheppard Co., Inc. , for which the Company entered into a definitive agreement to sell onJanuary 30, 2020 . Consummation of the Merger is subject to customary closing conditions and remaining regulatory approvals.
The Company suspended its share repurchase program due to the pending Merger, and we do not expect to reinstate the program in 2020.
OnSeptember 13, 2019 , Meritor, our exclusive distributor for a certain range of WABCO aftermarket products in theU.S. andCanada , and our non-exclusive distributor inMexico , exercised an option, triggered by the announcement of the Merger, to terminate the distribution agreement and sell the distribution rights back to WABCO. The Company will acquire the distribution rights from Meritor at an exercise price ranging from$225 million to$265 million , depending on the earnings of the distribution business. The purchase price for the distribution rights is payable in cash and will result in an increase to the intangible assets balance. The Company is expected to complete the acquisition in the first quarter of 2020.
Our Markets and Our Customers
Our sales are affected by changes in truck and bus (T&B) production.Europe is our largest geographic market and sales to T&B OEMs represent our largest customer group. The table below shows the relationship between our sales to European T&B OEMs, which account for approximately 44% of our global sales to T&B OEMs, and European T&B production for the last five years. Sales data is shown at a constant Euro toU.S. Dollar exchange rate for year to year comparability and to make comparisons to unit production meaningful. Over the past five years, our sales have outperformed the rate of European T&B production by an average of over 1% per year. 36
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Year to Year Change 2015 2016 2017 2018 2019 Sales to European T&B OEMs (at constant FX rates) 8 % 8 % 6 % 3 % (9 )% European T&B Production 6 % 1 % 8 % 2 % (8 )% In general, our sales track directionally with T&B builds. However, individual year to year sales changes are also influenced by other factors such as timing of orders and deliveries to T&B OEM customers, application content, new product introduction, price and introduction of new customer platforms. The level of truck build activity is influenced by general economic conditions, including interest rate levels and inflation. Our aftermarket sales account for approximately 26% of total sales and are affected by a variety of factors: content on specific vehicles and breadth of our product range, number of commercial trucks in active operation, truck age, type of vehicles built, miles driven, demand for transported goods, overall economic activity and acquisitions. On average, our aftermarket sales (based on a constant exchange rate to theU.S. Dollar rate) have grown by 7% annually for the last five years as shown in the table below.
Average
Year to Year Change 2015 2016 2017 2018 2019
Change
Aftermarket Sales (at constant FX rates) 7 % 6 % 9 % 18 % (3 )% 7 %
Distribution of WABCO's Sales by Major End-Markets, Product Types and Geography
2019 2018 2017
OE Manufacturers:
Truck & Bus products 54 % 55 % 58 %
Trailer products 10 % 10 % 9 %
Car products 5 % 5 % 6 %
Off highway 5 % 5 % 4 %
Aftermarket 26 % 25 % 23 %
100 % 100 % 100 %
Geography:
Europe 48 % 49 % 52 %
North America 24 % 23 % 18 %
South America 4 % 3 % 3 %
Asia 22 % 24 % 26 %
Other 2 % 1 % 1 %
100 % 100 % 100 %
Our largest customers are Daimler and Volvo and account for approximately 13%
and 12% of our sales, respectively. Other key customers include Ashok Leyland ,
TRATON, China National Heavy Truck Corporation (CNHTC), Cummins, Fiat (Iveco),
Hino, Paccar and TATA Motors. For the fiscal years ended December 31, 2019 , 2018
and 2017, our top 10 customers accounted for approximately 48%, 49% and 44% of
our sales, respectively.
Results of Operations
Approximately 77% of our sales are outside the United States and therefore,
changes in exchange rates can have a significant impact on the reported results
of our operations, which are presented in U.S. Dollars. Year-over-year changes
in sales and expenses for 2019 compared with 2018 and 2018 compared with 2017
are presented both with and without the effects of foreign currency translation.
Changes in sales and expenses excluding foreign exchange effects are calculated
using current year sales and expenses translated at prior year exchange rates.
Presenting changes in sales and expenses excluding the effects of foreign
currency translation is not in conformity with U.S. Generally Accepted
Accounting Principles (U.S. GAAP), but we analyze this data because it is useful
to us in understanding the operating performance of our business. We believe
this data is also useful to shareholders for the same reason. The changes in
sales and expenses excluding the effects of foreign exchange translation are not
meant to be a substitute for measurements prepared in conformity with U.S. GAAP,
nor to be considered in isolation.
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Management believes that presenting these non-U.S. GAAP financial measures is useful to shareholders because it enhances their understanding of how management assesses the operating performance of the Company's business.
Results of Operations for 2019 Compared with 2018
The following table is a summary of sales, cost of sales, gross profit,
operating expenses and other selected results of operations for the periods
indicated.
Year ended Excluding Foreign
December 31, Exchange Translation **
% change 2019 adjusted % change
(Amounts in millions) 2019 2018 reported amount adjusted
Sales $ 3,421.4 $ 3,831.0 (10.7 )% $ 3,563.9 (7.0 )%
Cost of sales 2,429.4 2,658.5 (8.6 )% 2,526.7 (5.0 )%
Gross profit 992.0 1,172.5 (15.4 )% 1,037.2 (11.5 )%
Operating expenses 654.9 660.0 (0.8 )% 683.7 3.6 %Other non-operating expense, net (26.2 ) (42.3 ) (38.1 )%
(29.0 ) (31.4 )%
Interest expense, net (0.1 ) (7.5 ) (98.7 )% 0.2 (102.7 )%
Income tax expense 53.4 49.3 8.3 % 55.3 12.2 %
Net income attributable to
noncontrolling interests 13.6 20.3 (33.0 )% 13.8 (32.0 )%
** Amounts translated using 2018 average exchange rates for comparability
Sales
Our sales for 2019 were
Total sales inEurope , our largest market, decreased 11.5% (6.4% excluding foreign currency translation effects) for the full year 2019, while the production of new trucks and buses decreased 8.1%. Our sales to truck and bus OEMs also declined 13.6% (8.6% excluding foreign currency translation effects) impacted by an unfavorable customer mix partially offset by an increased content per vehicle for EBS, E-APU and wheel end products, partially offset by continued phase out of AMT at a major gear box supplier. The production of trailers inEurope dropped by 18.1%, however our sales were down 14.0% (8.5% excluding foreign currency translation effects), outperforming this market. Sales inNorth America decreased 5.3% (4.6% excluding foreign currency translation effects). Our sales to truck and bus OEMs decreased 2.8% (1.9% excluding foreign currency translation effects). Although the truck and bus market grew by 4.3%, we were not able to offset the headwinds from an unfavorable customer mix and insourcing of a product at major OEMs. Our sales in car products were impacted by a strong decline in the production of passenger cars in theU.S. and additionally impacted by a phase out of vacuum pump technology. Total sales inSouth America increased 9.4% (18.3% excluding foreign currency translation effects), while the truck and bus production increased 3.1%. Our sales to truck and bus OEMs increased by 6.8% (15.2% excluding foreign currency translation effects). Our outperformance in this market included a share of market gain in braking controls and wheel end products.
Total sales in
Total sales inChina decreased by 12.1% (8.3% excluding foreign currency translation effects). Our sales to truck and bus OEMs declined by 5.2% (0.8% excluding foreign currency translation effects) despite the overall growing production of new trucks and buses by 2.1% year over year. Although the penetration of EBS at buses increased we were not able to fully offset the impact from pricing, some market share loss at a major customer and a negative customer mix. Lower demand in the Chinese light commercial vehicle market in combination with the vacuum pump technology phase out, as well as weak off-highway and trailer markets contributed additionally to the sales decline compared to 2018. 38
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Total sales inIndia decreased 39.1% (36.7% excluding foreign currency translation effects) driven by a 39.7% decrease in vehicle production, which was driven by the continued economic uncertainty, reduced truck utilization and reduction of truck inventories at OEMs. Our sales to truck and bus OEMs declined by 44.4% (41.9% excluding foreign currency translation effects). Total sales inKorea increased 6.2% (12.0% excluding foreign currency translation effects), outperforming the production of trucks and buses which increased 0.2%. Our sales to truck and bus OEMs grew by 30.4% (37.4% excluding foreign currency translation effects) driven by a safety stock accumulation for a new platform launch at a major OEM. Sales inJapan increased 1.7% (0.4% excluding foreign currency translation effects) compared to a decrease in truck and bus production of 8.7% supported by a favorable model mix and a share of market gain in braking controls at a major OEM. WABCO's aftermarket sales, included in the geographic numbers provided above, decreased 6.7% (2.8% excluding foreign currency translation effects) in 2019. Our aftermarket sales inEurope declined by 9.5% (4.4% excluding foreign currency translation effects) on a year over year basis, which was a result of an overall market drop as well as a one time campaign in 2018. We are also facing a decline inIndia of 14.5% (12.1% excluding foreign currency translation effects) due to the sharp economic decline in the country, resulting in stock reductions at distributors. Softening U.S. market conditions contributed to a decline inNorth America of 3.8% (3.8% excluding foreign currency translation effects).
Cost of Sales and Gross Profit
(Amounts in millions) Cost of Sales Gross Profit Cost of sales / gross profit for the year ended December 31, 2018$ 2,658.5 $ 1,172.5 Increase/(decrease) due to: Sales pricing, volume and mix - (267.1 ) Cost of materials (151.2 ) 151.2 Cost of manufacturing workforce (7.8 ) 7.8 Streamlining costs 17.3 (17.3 ) Warranty accruals 4.4 (4.4 ) Foreign exchange translational effects (97.3 ) (45.2 ) Other 5.5 (5.5 ) Net decrease (229.1 ) (180.5 ) Cost of sales / gross profit for the year ended December 31, 2019$ 2,429.4 $ 992.0 Within cost of sales, our largest expense is material costs, which mainly represents the purchase of components and parts. The lower materials cost is due to lower volume, mix and cost absorption partially driven by the decrease in sales level, as well as our continued focus on materials productivity. Management uses material productivity as one of the internal measures of our cost reduction efforts.
The decrease in gross profit is mainly driven by lower sales volume and an unfavorable mix. Sales price reductions of approximately 1.3% also contributed to the decrease. These decreases were partially offset by reduced costs as discussed above.
Operating Expenses
Operating expenses include selling and administrative expenses, product engineering expenses and other operating expenses.
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(Amounts in millions) Operating expenses for the year endedDecember 31, 2018 $ 660.0 Increase/(decrease) due to: Labor inflation 18.7 Sell-side M&A activity (1) 18.0 Employee-related costs 1.4 Stock compensation costs (10.8 ) Streamlining (2.1 ) Headquarters relocation costs 3.9 Environmental reserve reduction (3.8 ) Foreign exchange translation (28.8 ) Other (1.6 ) Net decrease (5.1 )
Operating expenses for the year ended
(1) Consists primarily of legal and financial advisory fees related to the Merger.
Other non-operating expense, net
The non-operating expense net decreased by$16.1 million to$26.2 million in 2019 as compared to$42.3 million in 2018. This decrease was primarily driven by the recognition of an impairment loss of$5.5 million on a non-marketable equity investment in 2018 compared to a gain of$2.2 million on another non-marketable equity investment in 2019. Other contributors to the decrease include a$2.6 million loss recognized in 2018 on the prepayment of the Senior USD Notes, as well as higher gains on marketable investments realized in 2019. See Note 9 and Note 16 of Notes to the Consolidated Financial Statements.
Interest Expense, net
The Company recorded net interest expense of$0.1 million in 2019 compared to$7.5 million in 2018. This decrease was primarily due to our prepayment of the Senior USD Notes inApril 2018 . See Note 16 of Notes to the Consolidated Financial Statements for further discussion.
Income Taxes
The income tax provision for 2019 was$53.4 million on$312.8 million of pre-tax income before adjusting for noncontrolling interest, compared with an income tax provision of$49.3 million on pre-tax income of$463.7 million before adjusting for noncontrolling interest in 2018. The 2019 increase in income tax expense is primarily the result of 2018 one-time tax benefits for changes to the uncertain tax position related to the Excess Profit Ruling (EPR) / Patent Income Deduction (PID) clawback and for settlement of a transfer pricing claim betweenGermany andBelgium of$33.3 million and$11.4 million , respectively. These benefits are partially offset by the tax effect of lower pre-tax income in 2019, and one-time income tax expenses in 2018 that do not reoccur in 2019, specifically a$5.8 million net transition tax adjustment and$5.2 million deferred tax revaluation resulting from a Belgian tax rate change.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests decreased$6.7 million to$13.6 million in 2019 as compared to$20.3 million in 2018 primarily due lower net income in certain consolidated affiliate companies.
Backlog
Backlog represents sales orders that have not yet been filled as of the end of the reporting period. This amounted to$1.2 billion at the end of 2019, a decrease of 14.3% (14.7% excluding foreign currency translation effects) from the end of 2018 following the decline in sales. Backlog is not necessarily predictive of future business as it relates only to some of our products, and customers may still change orders and future delivery dates. 40
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Results of Operations for 2018 Compared with 2017
The following table is a summary of sales, cost of sales, gross profit,
operating expenses and other selected results of operations for the periods
indicated.
Year ended Excluding Foreign
December 31, Exchange Translation **
% change 2018 adjusted % change
(Amounts in millions) 2018 2017 reported amount adjusted
Sales $ 3,831.0 $ 3,304.2 15.9 % $ 3,763.7 13.9 %
Cost of sales 2,658.5 2,290.4 16.1 % 2,622.7 14.5 %
Gross profit 1,172.5 1,013.8 15.7 % 1,141.0 12.5 %
Operating expenses 660.0 578.8 14.0 % 644.5 11.4 %
Equity in net income of
unconsolidated joint ventures 1.0 23.1 (95.7 )% 1.0 (95.7 )%
Gain on remeasurement of equity
investments - 247.7 * - *
Other non operating expense, net (42.3 ) (37.2 ) 13.7 %
(37.5 ) 0.8 %
Interest expense, net (7.5 ) (16.0 ) (53.1 )% (7.4 ) (53.8 )%
Income tax expense 49.3 229.7 (78.5 )% 48.9 (78.7 )%
Net income attributable to
noncontrolling interests 20.3 16.8 20.8 % 20.8 23.8 %
* Percentage change not considered meaningful
** Amounts translated using 2017 average exchange rates for comparability
Sales
Our sales for 2018 were
Total sales inEurope , our largest market, increased 9.1% (4.7% excluding foreign currency translation effects) for the full year 2018, which was supported by strong truck and bus production of 2.4% and by a penetration increase of AMT. This was partially offset by the phase-out of a prior generation AMT at a major gearbox supplier. Sales inNorth America increased 55.5% (54.6% excluding foreign currency translation effects). Our acquisition ofR.H. Sheppard and the full consolidation of our former joint venture also contributed 38.5% to this growth as well as strong truck and bus production growth of 18.1%. Total sales inSouth America increased 16.5% (30.6% excluding foreign currency translation effects), driven primarily by truck and bus production growth of 27.1% combined with increased content per truck, partially offset by a lower growth in other customer groups. Total sales inAsia increased 5.0% (4.8% excluding foreign currency translation effects) while the vehicle production decreased by 2.1%. Total sales inChina decreased by 7.4% (9.7% excluding foreign currency translation effects) which was primarily driven by a 8.0% decrease in truck and bus production with a stronger negative impact on sales from the lower share of tractor trucks in the 2018 truck production as well as supply chain constraints. Total sales inIndia increased 29.1% (34.8% excluding foreign currency translation effects) due to the 23.5% increase in the production of new trucks and buses, ramping up volumes of steering sales at a major customer as well as continued sales growth from market share gains in automatic slack adjusters, air processing products and others. Total sales inKorea decreased 7.2% (9.6% excluding foreign currency translation effects), driven by a decrease in truck and bus production of 21.5%.Japan increased 2.6% (1.0% excluding foreign currency translation effects) despite a decrease in the truck and bus production of 3.8%, outperforming the market by the ramp up of recent product launches. WABCO's global aftermarket sales, included in the geographic numbers provided above, increased 21.4% (19.7% excluding foreign currency translation effects). This increase, excluding foreign currency translation effects, was supported by acquisitions which contributed 13.5% as well as continued success of the Company's aftermarket strategies. 41
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Cost of Sales and Gross Profit
(Amounts in millions) Cost of Sales Gross Profit Cost of sales / gross profit for the year ended December 31, 2017$ 2,290.4 $ 1,013.8 Increase/(decrease) due to: Sales pricing, volume and mix - 237.2 Cost of materials 152.3 (152.3 ) Cost of manufacturing workforce 24.4 (24.4 ) U.S. acquisitions 145.1 77.1 Streamlining costs (4.4 ) 4.4 Foreign exchange translational effects 35.9 31.5 Other 14.8 (14.8 ) Net increase 368.1 158.7 Cost of sales / gross profit for the year ended December 31, 2018$ 2,658.5 $ 1,172.5 Within cost of sales, our largest expense is material costs, which mainly represents the purchase of components and parts. The increased materials cost is primarily driven by our higher sales and partially offset through our continued focus on productivity including a supplier-related productivity settlement of$9.1 million . Inefficiencies due to supply chain constraints also contributed to increases in our costs of sales. Management uses material productivity as one of the internal measures of our cost reduction efforts.
The increase in gross profit is mainly driven by the higher sales volume, partially offset by sales price reductions of approximately 1.2%. The increase in gross profit was also partially offset by the higher cost of sales as discussed above.
Operating Expenses
Operating expenses include selling and administrative expenses, product
engineering expenses and other operating expenses.
(Amounts in millions)
Operating expenses for the year ended
Increase/(decrease) due to: Labor inflation 15.6 Incentive compensation (5.3 ) Incremental costs fromU.S. acquisitions (1) 37.8 Streamlining 7.0 Pension and post retirement benefit costs 3.3 Foreign exchange translation 15.5 Indemnification costs (2) (14.9 ) Research and development investments, net 15.9 Other 6.3 Net increase 81.2
Operating expenses for the year ended
(1) Includes costs incurred related to the
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(2) The indemnification costs relate primarily to accruals recorded in 2017 inBrazil under an indemnification agreement with Trane (formerly American Standard). See Note 17 of Notes to the Consolidated Financial Statements for further discussion.
Equity in Net Income of
Equity in net income of unconsolidated joint ventures decreased$22.1 million to$1.0 million in 2018 as compared to$23.1 million in 2017. This decrease was primarily driven by the acquisition and consolidation of previously unconsolidated joint ventures during the fourth quarter of 2017.
Gain on remeasurement of equity investments
The gain on remeasurement of equity method investments recorded in 2017 included gains resulting from the step up of equity method investments to their acquisition date fair values. See Note 23 of Notes to the Consolidated Financial Statements for additional information.
Other non-operating expense, net
The non-operating expense net increased by$5.1 million to$42.3 million in 2018 as compared to$37.2 million in 2017, primarily driven by the recognition of an impairment loss of$5.5 million on a non-marketable equity investment. See Note 9 of Notes to the Consolidated Financial Statements.
Interest Expense, net
The Company recorded net interest expense of$7.5 million in 2018 compared to$16.0 million in 2017. This decrease was primarily due to our prepayment of the Senior USD Notes inApril 2018 . See Note 16 of Notes to the Consolidated Financial Statements for further discussion.
Income Taxes
The income tax provision for 2018 was$49.3 million on$463.7 million of pre-tax income before adjusting for noncontrolling interest, compared with an income tax provision of$229.7 million on pre-tax income of$652.6 million before adjusting for noncontrolling interest in 2017. The 2018 decrease in income tax expense is primarily the result of the$33.3 million net benefit for changes to the uncertain tax position related to the Excess Profit Ruling (EPR) / Patent Income Deduction (PID) clawback and the$10.6 million benefit for change in valuation allowances, partially offset by higher pre-tax income, excluding a one-time item related to the 2017 remeasurement gain on equity investments of$247.7 million . The 2017 income tax provision included the one-time provisional estimate ofU.S. transition tax of$100.0 million , a net$18.6 million benefit for remeasurement of deferred tax assets and liabilities resulting fromU.S. and Belgian tax reforms and a$91.4 million deferred income tax expense related to the remeasurement gain on the Meritor WABCO equity investment.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests increased
Backlog
Backlog represents sales orders that have not yet been filled as of the end of the reporting period. This amounted to$1.4 billion at the end of 2018, an increase of 20.9% (23.0% excluding foreign currency translation effects) from the end of 2017 following the growth in our business. Backlog is not necessarily predictive of future business as it relates only to some of our products, and customers may still change orders and future delivery dates.
Liquidity and Capital Resources
We employ several means to manage our liquidity, and we are not dependent upon
any one source of funding. Our sources of financing include cash flows from
operations, cash and cash equivalents, our senior unsecured debt and revolving
credit facilities.
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We believe the combination of expected cash flows, the funding received from our senior unsecured debt and the revolving credit facilities being committed until 2024 will provide us with adequate liquidity to support the Company's operations. The Company also has the ability to access a wide range of additional external financing instruments. Specifically for 2020, we expect our capital spending to remain consistent with prior year. As ofDecember 31, 2019 , there were no outstanding borrowings on the revolving credit facility. Outside of our capital expenditures, cash flows related to our senior unsecured debt, subsequent installments of the transition tax payable, acquisitions including the purchase of the distribution rights from Meritor and short term debt repayments, our overall cash flow is expected to be in line with the Company's 2019 cash flow profile. TheU.S. Tax reform will provide a higher flexibility regarding the use of our foreign cash inthe United States which may reduce the overall financing needs of the Company. As ofDecember 31, 2019 ,$867.2 million of the$891.8 million of cash and cash equivalents on the consolidated balance sheets was held by foreign subsidiaries. The Company considers the earnings of substantially all of its subsidiaries outside ofEurope andBrazil to be permanently reinvested outsidethe United States . As ofDecember 31, 2018 ,$491.0 million of the$503.8 million of cash and cash equivalents on the consolidated balance sheets was held by foreign subsidiaries for which earnings are no longer permanently reinvested outsidethe United States . The Company was notified that Meritor has exercised their put option for WABCO to purchase the distribution rights for the aftermarket products inthe United States andCanada for an amount between$225 million and$265 million , payable in cash in early 2020. The Company believes its available cash on-hand and availability under its existing credit facilities adequately provide for the funding of this acquisition.
Cash Flows for 2019 Compared with 2018
Operating activities - Net cash provided by operating activities was$439.9 million and$468.5 million for the years endedDecember 31, 2019 and 2018, respectively. Cash flow from operating activities consisted primarily of net income including noncontrolling interests of$259.4 million , increased by non-cash elements of$187.7 million comprising depreciation, pension and post-retirement benefit expenses, amortization, stock compensation, and deferred tax benefits. This was partially offset by$7.2 million related to changes in operating assets and liabilities, including$16.6 million of payments made related to costs associated with the Merger. Cash flow from operating activities for 2018 consisted primarily of net income including noncontrolling interests of$414.4 million , decreased by non-cash elements of$208.5 million comprising depreciation, amortization, stock compensation, deferred tax benefits, pension and post-retirement benefit expenses. Investing activities - Net cash used in investing activities amounted to$10.4 million in 2019 compared to$246.5 million in 2018. Aside from net capital expenditures in tooling, equipment and software of$153.6 million and$132.1 million in 2019 and 2018, respectively, we had investing cash flows related to our investments and redemptions in repurchase agreements and short-term investments as follow: December 31, 2019 December 31, 2018 (Amounts in millions) Repurchase Short-term Repurchase Short-term Agreements Investments Total Agreements Investments Total Investments$ 113.3 $ 633.2$ 746.5 $ 161.2 $ 526.0 $ 687.2 Sales and redemptions 198.4 693.5 891.9 210.3 374.9 585.2
Net cash received/(invested) $ 85.1 $ 60.3
In 2019, we paid$0.4 million towards the remaining payment for the 2018 acquisition of Asset Trackr. This is in comparison to to$8.6 million paid in 2018, of which$6.4 million related to additional cash paid for the 2017 acquisition ofR.H. Sheppard and$2.2 million for the acquisition of Asset Trackr. We also invested$1.8 million in unconsolidated joint ventures in 2019 compared to$3.8 million in 2018. Financing activities - Net cash used by financing activities decreased from$827.1 million in 2018 to$39.0 million in 2019. We had no net borrowings or repayments under our revolving credit facilities in 2019. We also had no additional borrowings or prepayments of long-term debt in 2019. This is compared to net repayments under the revolving credit facilities of$385.4 million in 2018, as well as prepayment of$500.0 million of the Senior USD Notes partially offset by proceeds received from the Schuldschein Loans of approximately$368.5 million . We also repurchased shares for a total of$30.6 million in 2019 compared to$300.0 million in 2018. Certain of these shares were repurchased under a 10b5-1 stock repurchase plan during the period betweenAugust 20, 2018 andDecember 20, 2018 . 44
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We received$1.2 million of stock option proceeds and paid$5.0 million related to employee taxes for equity award vestings in 2019 compared to$0.6 million and$5.1 million in 2018, respectively. Dividends paid to noncontrolling interests amounted to$7.4 million and$5.7 million in 2019 and 2018, respectively. In 2019, we also had$2.8 million of Net proceeds from noncontrolling interest shareholders.
Cash Flows for 2018 Compared with 2017
Operating activities - Net cash provided by operating activities was$468.5 million and$421.5 million for the years endedDecember 31, 2018 and 2017, respectively. Cash flow from operating activities consisted primarily of net income including noncontrolling interests of$414.4 million , increased by non-cash elements of$208.5 million comprising depreciation, pension and post-retirement benefit expenses, amortization, stock compensation, and deferred tax benefits. This was partially offset by$154.4 million related to changes in operating assets and liabilities, including$32.3 million of payments made related toU.S. transition taxes. Cash flow from operating activities for 2017 consisted primarily of net income including noncontrolling interests of$422.9 million , decreased by non-cash elements of$98.9 million comprising depreciation, amortization, stock compensation, deferred tax benefits, pension and post-retirement benefit expenses, as well as a$247.7 million for a non-cash gain recognized on the remeasurement of our equity investments. This was offset by an accrual of$196.4 million forU.S. transition taxes payable, as well as$106.0 million related to changes in operating assets and liabilities as well as pension contributions. Investing activities - Net cash used in investing activities amounted to$246.5 million for 2018 compared to$488.2 million in 2017. Aside from net capital expenditures in tooling, equipment and software of$132.1 million and$110.5 million in 2018 and 2017, respectively, we had investing cash flows related to our investments and redemptions in repurchase agreements and short-term investments as follow: December 31, 2018 December 31, 2017 (Amounts in millions) Repurchase Short-term Repurchase Short-term Agreements Investments Total Agreements Investments Total Investments$ 161.2 $ 526.0 $ 687.2 $ 312.2 $ 223.0$ 535.2 Sales and redemptions 210.3 374.9 585.2 318.4 230.0 548.4
Net cash received/(invested) $ 49.1
7.0 $ 13.2
We also paid $6.4 million in 2018 as additional cash payment related to the 2017
acquisition of R.H. Sheppard , as well as $2.2 million to acquire Asset Trackr,
and we invested $3.8 million in unconsolidated joint ventures. This is in
comparison to 2017 when we paid $382.7 million net of cash acquired for the
acquisition of Sheppard, Meritor WABCO and WABCO Automotive South Africa.
Financing activities - Net cash used by financing activities amounted to $827.1
million for 2018 compared to net cash provided of $260.6 million for 2017. The
main driver of this lower net cash flow from financing activities is the $500.0
million
prepayment of the Senior USD Notes and net repayments under the revolving credit
facilities of $385.4 million , partially offset by proceeds received from the
Schuldschein Loans of approximately $368.5 million .We also repurchased shares
for a total of $300.0 million in 2018 compared to $120.0 million in 2017.
Certain of these shares were repurchased under a 10b5-1 stock repurchase plan
during the period between August 20, 2018 and December 20, 2018 .
We received $0.6 million of stock option proceeds and withheld $5.1 million of
shares related to employee tax payments made for equity award vestings in 2018
compared to $9.5 million and $4.9 million in 2017, respectively. Dividends paid
to noncontrolling interests amounted to $5.7 million and $7.1 million in 2018
and 2017, respectively.
Senior Unsecured Debt
Schuldschein Loans
On March 22, 2018 the Company, through a European subsidiary, entered into a
series of six individual senior unsecured loan agreements with an aggregate
principal amount of €300.0 million (collectively, the Schuldschein Loans), as
follows:
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(Amounts in millions) Face value Coupon Maturity date
Fixed rate term loan -
Series A € 10.0 0.85% March 31, 2021
Fixed rate term loan -
Series B 60.0 1.15% March 31, 2022
Fixed rate term loan -
Series C 80.0 1.43% March 31, 2023
Floating rate term loan
- Series A 50.0 6-month EURIBOR plus 80 bps March 31, 2021
Floating rate term loan
- Series B 60.0 6-month EURIBOR plus 90 bps March 31, 2022
Floating rate term loan
- Series C 40.0 6-month EURIBOR plus 100 bps March 31, 2023
€ 300.0
Senior Notes (EUR and USD)
On November 15, 2016 , the Company issued €440.0 million in aggregate principal
amount of senior unsecured notes (the Senior EUR Notes ), comprised of €190.0
million of 0.84% senior unsecured notes due 2023, €80.0 million of 1.20% senior
unsecured notes due 2026 and €170.0 million of 1.36% senior unsecured notes due
2028. The Company paid $1.4 million of debt issuance costs in connection with
these senior unsecured notes. Interest on these notes is payable semi-annually
on January 1 and July 1 of each year, and commenced on July 1, 2017 .
On June 25, 2015 , the Company issued $500.0 million in aggregate principal
amount of senior unsecured notes (the Senior USD Notes). The Company prepaid the
entire outstanding principal amount on April 30, 2018 . and recognized a loss on
debt extinguishment of $2.3 million net of taxes, of which the pretax amount,
$2.6 million , was recorded in other non-operating expenses in the consolidated
statement of operations.
Credit Facilities
EffectiveJune 28, 2018 , the Company amended its existing multi-currency unsecured revolving credit facility, increasing the maximum principal amount of borrowings under the facility from$400 million to$600 million (the 2018 Facility), with an option to increase up to additional$250.0 million . The 2018 Facility also extended the scheduled maturity date of our revolving credit facility toJune 28, 2023 , subject to two one-year extension options, of which the first one was exercised onMay 28, 2019 and extended the maturity date toJune 28, 2024 . As ofDecember 31, 2019 , there were no outstanding borrowings on the revolving credit facility.
Derivative Instruments and Hedging Activities
The Company designated borrowings under its revolving credit facilities and SeniorEUR Notes to partially hedge the foreign currency exposure of its net investment in certain Euro-denominated wholly-owned subsidiaries. As ofDecember 31, 2019 and 2018, the Company designated Euro-denominated loans of €440.0 million (approximately$493.5 million atDecember 31, 2019 exchange rate) and €440.0 million (approximately$503.6 million atDecember 31, 2018 exchange rate) as hedges of its net investment in these subsidiaries. For the years endedDecember 31, 2019 and 2018, the Company recorded a gain of$9.0 million , net of taxes of$2.5 million , and a gain of$16.8 million , net of taxes of$4.7 million , respectively, in cumulative translation adjustment within accumulated other comprehensive income. FromJuly 2017 , WABCO entered into a number ofInternational Swaps and Derivatives Association (ISDA) Master Agreements with multiple derivative counterparties. An ISDA Master Agreement is a bilateral trading agreement between two parties that allow both parties to enter into over-the-counter derivative contracts. The ISDA Master Agreement contains a Schedule to the Master Agreement and a Credit Support Annex, which governs the maintenance, reporting, collateral management and default process (netting provisions in the event of a default and/or a termination event). Under an ISDA Master Agreement, the Company may, under certain circumstances, offset with the counterparty certain derivative financial instruments' payables and/or receivables with collateral held and/or posted and create one single net payment. The provisions of the ISDA Master Agreement typically permit a single net payment in the event of default including the bankruptcy or insolvency of the counterparty.
Off-Balance Sheet Arrangements
We did not engage in any off-balance sheet financial arrangements as of
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Contractual Obligations
We had$32.8 million of streamlining liabilities as ofDecember 31, 2019 . While we expect approximately$14.7 million of payments to be made in 2020, we are unable to estimate the timing of all future payments. See Note 6 of Notes to the Consolidated Financial Statements for further discussion. The following table summarizes our expected cash outflows resulting from our contractual obligations as ofDecember 31, 2019 . Some of the figures are based on our estimates and assumptions about these obligations. The obligations we will actually pay in future periods may vary from those reflected in the table. Payments due by period (Amounts in millions) Total 2020 2021 and 2022 2023 and 2024 Beyond 2024 Debt obligations (1)$ 876.7 $ 9.1 $ 218.1 $ 357.0$ 292.5 Lease obligations (2) 108.1 29.4 35.5 18.0 25.2 Purchase obligations (3) 225.0 225.0 - - - Pension and post-retirement contributions (4) 300.0 27.7 56.5 59.6 156.2 Purchase of distribution rights (5) 265.0 265.0 - - - Transition tax payable (6) 157.7 4.0 32.4 70.7 50.6 Total$ 1,932.5 $ 560.2 $ 342.5 $ 505.3$ 524.5
(1) Includes principal and interest payments due on our senior unsecured debt.
For floating rate debt, interest payments were calculated based on the
applicable interest rates as of
denominated in a foreign currency were calculated using the local currency
foreign exchange rates in effect at
Notes to the Consolidated Financial Statements for additional information.
(2) Includes future rental commitments under all non-cancelable operating leases
in effect at
(3) In the normal course of business we expect to purchase approximately
billion in 2020 of materials and services, and estimate that on average no
more than approximately
form of legally binding commitments. We spent approximately
2017, respectively.
(4) Amounts represent undiscounted projected benefit payments over the next ten
years and represent our best estimate of future contributions to our pension
and post-retirement benefit plans. The expected benefit payments have been
estimated based on the same assumptions that were used to measure our
accumulated benefit obligation as of
attributable to estimated future service of current employees.
(5) Relates to the purchase of the distribution rights from Meritor for WABCO
aftermarket products in
price will be determined in early 2020 and could be for an amount less than
$265 million .
(6) Includes a one-time repatriation tax resulting from the Tax Cuts and Jobs
Act. The Tax Cuts and Jobs Act permits the Company to pay the tax liability
interest free over a period of up to eight years.
Capital Expenditures
We believe our capital spending in recent years has been sufficient to maintain efficient production capacity, to implement important product and process redesigns and to expand capacity to meet increased demand. Productivity projects have freed up capacity in our manufacturing facilities and are expected to continue to do so. We expect to continue investing to expand and modernize our existing facilities and invest in our facilities to create capacity for new product development. Specifically for 2020, we expect our capital spending to remain at levels consistent with prior year as previously discussed.
Pending Adoptions of Recently Issued Accounting Standards
Refer to Note 3 of Notes to the Consolidated Financial Statements for a complete
description of recent accounting standards which we have not yet been required
to implement and which may be applicable to our operations.
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Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance withU.S. GAAP. The preparation of financial statements in conformity with those accounting principles requires us to make judgments and estimates that affect the amounts reported in the consolidated financial statements and accompanying notes. Those judgments and estimates have a significant effect on the consolidated financial statements because they result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Actual results could differ from those estimates. We frequently reevaluate our judgments and estimates that are based upon historical experience and on various other assumptions that we believe to be reasonable under the circumstances.
We believe that of our significant accounting policies, the ones that may involve a higher degree of uncertainty, judgment and complexity pertain to revenue recognition, goodwill, recoverability of other long-lived assets, pension and post-retirement benefits, warranties, business combinations, income taxes and contingencies. See Note 2 of Notes to the Consolidated Financial Statements for additional discussion of our accounting policies.
Revenue Recognition - Revenue under ASC 606 Revenue from Contracts with Customers, is recognized when control of a product or service is transferred to a customer. The majority of our sales are derived from OEM customers. Revenue from the sale of serial production parts that are produced to industry standards for OEM customers is recognized at a point-in-time when control of the parts transfers to customers based on the shipping terms as these parts typically have an alternative use or the underlying contracts do not contain an enforceable right to payment prior to shipment depending on jurisdiction. In instances where customization services are performed for the OEM, and if the sales meet the over-time revenue recognition criteria, we will use the cost-to-cost method to recognize revenue. Under this method, progress is measured based in the ratio of actual costs incurred relative to the total estimated costs. Most OEM serial production contracts include a provision for volume discounts, and in certain markets, we provide customers with discounts not stated in the contract. In those instances where there is a valid expectation for the customers to receive a discount, the amount of variable consideration which is included in the transaction price may be constrained, and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized under the contract will not occur in a future period. The sale of aftermarket parts and spare parts are relatively homogeneous and revenue is recognized at a point-in-time when control transfers to the customer based on shipping terms. Aftermarket contracts include variable consideration related to discounts, bonuses and product returns. Revenue recognition for aftermarket parts and spare parts is not subject to the variable consideration constraint. FMS sales include contracts for products, services, or a combination of products and services. The payment for products and certain services is fixed, with consideration being variable for the Software-as-a-Service (SAAS) performance obligation until the number of activated devices is known. Allocation of the transaction price to each performance obligation using stand alone selling price (SSP). When SSP does not exist, the company estimates the SSP based on the adjusted market approach. Revenue for hardware is recognized at a point-in-time and over-time for services as they are provided under the contract. Management exercises significant judgments as it relates to the FMS revenue recognition in such areas as determining performance obligations, variable consideration, allocation of the transaction price and timing of revenue recognition. Prior to the adoption of ASC 606, revenue was allocated to multiple element arrangements based upon the relative selling prices of each deliverable. In applying the relative selling price method, the Company determined the selling price for each deliverable using vendor specific objective evidence (VSOE), if it existed, or third-party evidence (TPE) of selling price. If neither VSOE nor TPE of selling price existed for a deliverable, the best estimate of selling price (BESP) was used for that element. BESP represented the price at which the Company would transact a sale if the element were sold on a standalone basis. The Company determined BESP for an element by considering multiple factors including, but not limited to, the Company's go-to-market strategy, pricing practices, internal costs, gross margin, market conditions and geographies. Revenue allocated to each element was then recognized when the other revenue recognition criteria are met for that element.Goodwill - The Company has a significant amount of goodwill on its balance sheet that is not amortized, but subject to impairment tests each fiscal year onOctober 1 or more often when events or circumstances indicate that the carrying amount of goodwill may not be recoverable. The Company's impairment tests utilize the two-step approach. The first step of the goodwill impairment test compares fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired and thus the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test shall be performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount 48
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of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess.
The recoverability of goodwill is performed at the entity level as the Company operates as one reportable segment and one reporting unit. The plants, engineering, technical support, distribution centers and other support functions are shared among various product families and serve all distribution channels with many customers. In order to approximate the fair value of the reporting unit for purposes of testing recoverability, the Company uses the total market capitalization of the Company, a market approach, which is then compared to the total book value of the Company. In the event the Company's fair value has fallen below book value, the Company will compare the estimated fair value of goodwill to its book value. If the book value of goodwill exceeds the estimated fair value of goodwill, the Company will recognize the difference as an impairment loss in operating income. There has been no impairment of goodwill during 2019, and the Company's goodwill was not at risk for failing the first step of its impairment test. Recoverability of Other Long-lived Assets - The Company makes judgments about the recoverability of long-lived assets, including fixed assets and finite-lived intangible assets whenever events or changes in circumstances indicate that an impairment may exist. If circumstances indicate an impairment may exist, we use an estimate of the undiscounted value of expected future operating cash flows to determine whether the long-lived assets are impaired. Long-lived assets will be evaluated for impairment either individually or in asset groups where their cash flows are largely independent of cash flows generated from other long-lived assets. If the aggregate undiscounted cash flows are less than the carrying amount of the assets, the resulting impairment charge to be recorded is calculated based on the excess of the carrying amount of the assets over the fair value of such assets, with the fair value generally determined based on an analysis of discounted cash flows. Pension and Post-Retirement Benefits - The Company has significant pension and post-retirement benefit costs and liabilities that are developed from actuarial valuations. Inherent in these valuations are key assumptions including discount rates, expected return on plan assets, mortality rates, merit and promotion increases and the health care cost trend rate. The Company is required to consider current market conditions, including changes in interest rates and health care costs, in making its assumptions. Changes in the related pension and post-retirement benefit costs or liabilities may occur in the future due to changes in the assumptions. The assumptions as to the expected long-term rates of return on plan assets are based upon the composition of plan assets, historical long-term rates of return on similar assets and current and expected market conditions. The discount rate used forU.S. plans reflects the market rate for high-quality fixed-income investments on the Company's annual measurement date (December 31 ) and is subject to change each year. The discount rate was determined by matching, on an approximate basis, the coupons and maturities for a portfolio of corporate bonds (rated AA or better) to the expected future plan benefit payments. The discount rates used for plans outsidethe United States are based on a combination of relevant indices regarding highly-rated corporate and government securities, the duration of the liability and appropriate judgment. See the disclosures about pension and post-retirement obligations, the composition of plan assets, assumptions and other matters in Note 15 of Notes to the Consolidated Financial Statements. Warranties - Products sold by WABCO are covered by a basic limited warranty with terms and conditions that vary depending upon the product and country in which it was sold. The limited warranty covers the equipment, parts and labor (in certain cases) necessary to satisfy the warranty obligation generally for a period of two years. Estimated product warranty expenses are accrued in cost of goods sold at the time the related sale is recognized. Estimates of warranty expenses are based primarily on warranty claims experience and specific customer contracts. Warranty expenses include accruals for basic warranties for product sold, as well as accruals for product recalls, service campaigns and other related events when they are known and estimable, less costs recoverable from suppliers related to warranty claims. To the extent we experience changes in warranty claim activity or costs associated with servicing those claims, our warranty accrual is adjusted accordingly. Warranty accrual estimates are updated based upon the most current warranty claims information available. The Company's warranty costs net of recoveries as a percentage of sales totaled 1.0% in 2019, 0.8% in 2018 and 0.9% in 2017. We do not expect this percentage to change materially in the near future. See Note 17 of Notes to the Consolidated Financial Statements for a three-year summary of warranty costs. Income Taxes - Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect management's best estimate of current and future taxes to be paid. We are subject to income taxes inthe United States and numerous foreign jurisdictions. Significant judgments and estimates are required in the determination of the consolidated income tax expense. The impact of mix ofU.S. versus foreign earnings may have a material impact on the effective tax rate given that tax rates in certain foreign jurisdictions (primarilyBelgium ,China ,Germany ,India ,the Netherlands ,Poland andSwitzerland ) vary from theU.S. statutory tax rate. See Note 18 of Notes to the Consolidated Financial Statements for Reconciliation of Effective Income Tax Rate. Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to 49
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recover our deferred tax assets in the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. In projecting future taxable income, we begin with historical results adjusted for the results of discontinued operations and incorporate assumptions about the amount of future state, federal, and foreign pretax operating income adjusted for items that do not have tax consequences. The assumptions about future taxable income require the use of significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative operating income (loss). The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. ASC 740, Income Taxes states that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits. We record unrecognized tax benefits as liabilities in accordance with ASC 740 and adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the unrecognized tax benefit liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information is available Contingencies - We are subject to proceedings, lawsuits and other claims related to products and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable and reasonably possible losses. A determination of the amount of liability to be recorded, if any, for these contingencies is made after careful analysis of each individual issue. It is reasonably possible that the Company could incur losses in excess of the amounts accrued. Although this amount cannot be estimated, we believe that any additional losses would not have a material adverse impact on the consolidated financial statements.
Seasonality
Our operations are directly related to the commercial vehicle industry. We may
experience seasonal variations in the demand for our products to the extent that
OEM vehicle production fluctuates, such as during July, August and December when
North American and European OEM plants may close for summer shutdowns and
holiday periods. Shut-down periods in the rest of the world may vary by country.
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