Financial statement analysis
AHMED3
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in millions) March 31,
2019 December 31,
2018
ASSETS Cash $ 494 $ 739 Restricted cash 23 — Receivables, net 2,065 1,988 Inventories, net 807 781 Prepayments and other current assets 280 250 Assets held for sale 50 47
Total current assets 3,719 3,805
Property, plant and equipment, net 2,895 2,904 Investments and other long-term receivables 617 592 Goodwill 1,848 1,853 Other intangible assets, net 433 439 Other non-current assets 592 502
Total assets $ 10,104 $ 10,095
LIABILITIES AND EQUITY Notes payable and other short-term debt $ 164 $ 173 Accounts payable and accrued expenses 2,056 2,144 Income taxes payable 57 59 Liabilities held for sale 22 23
Total current liabilities 2,299 2,399
Long-term debt 1,923 1,941
Other non-current liabilities: Asbestos-related liabilities 746 755 Retirement-related liabilities 292 298 Other 459 357
Total other non-current liabilities 1,497 1,410
Common stock 3 3 Capital in excess of par value 1,111 1,146 Retained earnings 5,461 5,336 Accumulated other comprehensive loss (675) (674) Common stock held in treasury (1,626) (1,585)
Total BorgWarner Inc. stockholders’ equity 4,274 4,226 Noncontrolling interest 111 119
Total equity 4,385 4,345
Total liabilities and equity $ 10,104 $ 10,095
See accompanying Notes to Condensed Consolidated Financial Statements.
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QUARTERLY
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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended
March 31, (in millions, except share and per share amounts) 2019 2018
Net sales $ 2,566 $ 2,784 Cost of sales 2,047 2,193
Gross profit 519 591
Selling, general and administrative expenses 226 253 Other expense, net 29 5
Operating income 264 333
Equity in affiliates’ earnings, net of tax (9) (10) Interest income (3) (2) Interest expense 14 16 Other postretirement income — (3)
Earnings before income taxes and noncontrolling interest 262 332
Provision for income taxes 91 95 Net earnings 171 237
Net earnings attributable to the noncontrolling interest, net of tax 11 12 Net earnings attributable to BorgWarner Inc. $ 160 $ 225
Earnings per share — basic $ 0.77 $ 1.07
Earnings per share — diluted $ 0.77 $ 1.07
Weighted average shares outstanding (millions): Basic 206.5 209.5 Diluted 207.1 210.8
See accompanying Notes to Condensed Consolidated Financial Statements.
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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended
March 31,
(in millions) 2019 2018 OPERATING Net earnings $ 171 $ 237 Adjustments to reconcile net earnings to net cash flows from operations:
Depreciation and amortization 107 109 Stock-based compensation expense 8 15 Restructuring expense, net of cash paid 7 7 Deferred income tax (benefit) provision (2) 8 Tax reform adjustments to provision for income taxes 22 — Equity in affiliates’ earnings, net of dividends received, and other 6 (11)
Net earnings adjusted for non-cash charges to operations 319 365 Changes in assets and liabilities:
Receivables (95) (187) Inventories (31) (27) Prepayments and other current assets (23) (14) Accounts payable and accrued expenses (120) (109) Prepaid taxes and Income taxes payable (12) 3 Other assets and liabilities 2 4
Net cash provided by operating activities 40 35
INVESTING Capital expenditures, including tooling outlays (117) (160) Payments for business acquired (10) — Proceeds from sale of business 23 — Payments for venture capital investment (1) (1) Proceeds from asset disposals and other 1 —
Net cash used in investing activities (104) (161)
FINANCING Net increase in notes payable — 118 Additions to long-term debt, net of debt issuance costs 11 12 Repayments of long-term debt, including current portion (26) (10) Payments for purchase of treasury stock (67) (55) Payments for stock-based compensation items (14) (14) Dividends paid to BorgWarner stockholders (35) (36) Dividends paid to noncontrolling stockholders (22) (18)
Net cash used in financing activities (153) (3) Effect of exchange rate changes on cash (5) (6) Net decrease in cash (222) (135) Cash and restricted cash at beginning of year 739 545 Cash and restricted cash at end of period $ 517 $ 410
SUPPLEMENTAL CASH FLOW INFORMATION Cash paid during the period for:
Interest $ 26 $ 31 Income taxes, net of refunds $ 68 $ 80
See accompanying Notes to Condensed Consolidated Financial Statements.
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____________________________________ * The dividends declared relate to BorgWarner common stock.
(16) Accumulated Other Comprehensive Loss
The following tables summarize the activity within accumulated other comprehensive loss during the three months ended March 31, 2019 and 2018:
(in millions)
Foreign currency
translation adjustments
Hedge instruments
Defined benefit postretirement
plans Other Total
Beginning balance, December 31, 2018 $ (441) $ — $ (235) $ 2 $ (674) Comprehensive (loss) income before reclassifications (5) — 3 — (2) Income taxes associated with comprehensive income (loss) before reclassifications (4) — 3 — (1) Reclassification from accumulated other comprehensive loss — — 3 — 3
Income taxes reclassified into net earnings — — (1) — (1)
Ending balance, March 31, 2019 $ (450) $ — $ (227) $ 2 $ (675)
(in millions)
Foreign currency
translation adjustments
Hedge instruments
Defined benefit postretirement
plans Other Total
Beginning balance, December 31, 2017 $ (294) $ (1) $ (198) $ 3 $ (490)
Adoption of accounting standards — — (14) — (14) Comprehensive income (loss) before reclassifications 62 (5) (4) — 53 Income taxes associated with comprehensive income (loss) before reclassifications 3 1 1 — 5 Reclassification from accumulated other comprehensive loss — 1 2 — 3
Income taxes reclassified into net earnings — — (1) — (1)
Ending balance, March 31, 2018 $ (229) $ (4) $ (214) $ 3 $ (444)
(17) Leases
The majority of the Company's global lease portfolio represents leases of real estate, such as manufacturing facilities, warehouses, and office buildings, while the remainder represents leases of personal property, such as vehicle leases, manufacturing and IT equipment. Most of the leases are operating leases with options to renew, with renewal terms that can extend the lease term from 1 to 5 years. The option to renew is included in the lease term if it is reasonably certain that the Company will exercise that option. Certain leases also include options to terminate or purchase the leased asset. The depreciable life of assets and leasehold improvements are limited by the expected lease term, unless there is a transfer of title or purchase option that is reasonably certain of exercise. The amount recognized in lease assets and liabilities for lease arrangements that include an option for renewal or early termination that is reasonably certain of being exercised is immaterial. Our lease agreements do not contain any material residual value guarantee or material restrictive covenants. The Company's policy is to account for the lease and non-lease components as a single lease component for all asset classes.
ASC 842 requires that the rate implicit in the lease be used if readily determinable. Generally, implicit rates are not readily determinable in our contracts and the incremental borrowing rate is used for each lease arrangement. The incremental borrowing rates are determined using rates specific to the term of the lease, economic environments where lease activity is concentrated, value of lease portfolio, and assuming full collateralization of the loans.
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All leases with an initial term of 12 months or less that do not include an option to extend or purchase the underlying asset that the Company is reasonably certain to exercise ("short-term leases") are not recorded on the consolidated balance sheet and lease expense is recognized on a straight-line basis over the lease term. The short-term lease cost for the three months ended March 31, 2019 is less than $1 million and the total remaining payments for short-term leases as of March 31, 2019 are less than $1 million.
The following table presents the operating lease assets and lease liabilities as of March 31, 2019:
Leases (in millions) Consolidated Balance Sheet Classification March 31, 2019 Assets Operating lease assets Other non-current assets $ 98 Total operating lease assets $ 98
Liabilities Current Operating lease liabilities Accounts payable and accrued expenses $ 23 Noncurrent Operating lease liabilities Other non-current liabilities 74 Total operating lease liabilities $ 97
The Company had less than $1 million of finance lease assets recorded in Property, plant and equipment, net, and less than $1 million of finance lease liabilities recorded in Long-term debt in the consolidated balance sheet at March 31, 2019.
In the three months ended March 31, 2019, the Company recorded operating lease cost of $7 million, reflected in Selling, general and administrative expenses in the consolidated statement of operations. The finance lease cost including amortization of leased assets and interest on lease liabilities was less than $1 million in the three months ended March 31, 2019. Variable costs for the three months ended March 31, 2019 are immaterial, and the Company does not have sublease income or gains/losses on sale leaseback transactions.
Maturity of Lease Liabilities (undiscounted) as of March 31, 2019 (millions of dollars) Operating Leases 2019 (excluding the three months ended March 31, 2019) $ 18 2020 20 2021 15 2022 12 2023 8 After 2023 37 Total lease payments $ 110 Less: Imputed interest 13 Present value of lease liabilities $ 97
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Total finance lease payments for each annual period from 2019 (excluding the three months ended March 31, 2019) to 2023 and years after 2023 are less than $1 million.
Total rent expense was $10 million for the three months ended March 31, 2018. Future minimum operating lease payments at December 31, 2018 were as follows:
(millions of dollars)
2019 $ 24 2020 21 2021 15 2022 13 2023 10 After 2023 38
Total minimum lease payments $ 121
Lease Term and Discount Rate March 31, 2019 Weighted-average remaining lease term (years) Operating leases 8 Finance leases 2 Weighted-average discount rate Operating leases 2.7% Finance leases 3.1%
Other Information Three Months Ended (In millions) March 31, 2019 Cash paid for amounts included in the measurement of lease liabilities Operating cash flows for operating leases $ 6
Cash paid for finance leases included in operating and financing cash flows for three months ended March 31, 2019 is less than $1 million. Non-cash transactions related to lease liabilities arising from obtaining lease assets and modification or reassessment events are immaterial for the three months ended March 31, 2019.
As of March 31, 2019, the operating and finance leases that the Company signed but have not yet commenced are immaterial.
(18) Contingencies
The Company's environmental and product liability contingencies are discussed separately below. 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 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.
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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31,
(in millions, except share and per share amounts) 2018 2017
ASSETS Cash $ 739.4 $ 545.3
Receivables, net 1,987.4 2,018.9
Inventories, net 780.8 766.3
Prepayments and other current assets 250.0 145.4
Assets held for sale 47.0 67.3
Total current assets 3,804.6 3,543.2
Property, plant and equipment, net 2,903.8 2,863.8
Investments and other long-term receivables 591.7 547.4
Goodwill 1,853.4 1,881.8
Other intangible assets, net 439.5 492.7
Other non-current assets 502.3 458.7
Total assets $ 10,095.3 $ 9,787.6
LIABILITIES AND EQUITY Notes payable and other short-term debt $ 172.6 $ 84.6
Accounts payable and accrued expenses 2,144.3 2,270.3
Income taxes payable 58.9 40.8
Liabilities held for sale 23.1 29.5
Total current liabilities 2,398.9 2,425.2
Long-term debt 1,940.7 2,103.7
Other non-current liabilities:
Asbestos-related liabilities 755.3 775.7
Retirement-related liabilities 298.3 301.6
Other 357.3 355.5
Total other non-current liabilities 1,410.9 1,432.8
Commitments and contingencies
Capital stock:
Preferred stock, $0.01 par value; authorized shares: 5,000,000; none issued and outstanding — — Common stock, $0.01 par value; authorized shares: 390,000,000; issued shares: (2018 - 246,387,057; 2017 - 246,387,057); outstanding shares: (2018- 208,214,934; 2017 - 210,812,793) 2.5 2.5 Non-voting common stock, $0.01 par value; authorized shares: 25,000,000; none issued and outstanding — —
Capital in excess of par value 1,145.8 1,118.7
Retained earnings 5,336.1 4,531.0
Accumulated other comprehensive loss (674.1) (490.0)
Common stock held in treasury, at cost: (2018 - 38,172,123 shares; 2017 - 35,574,264 shares) (1,584.8) (1,445.4)
Total BorgWarner Inc. stockholders’ equity 4,225.5 3,716.8
Noncontrolling interest 119.3 109.1
Total equity 4,344.8 3,825.9
Total liabilities and equity $ 10,095.3 $ 9,787.6
See Accompanying Notes to Consolidated Financial Statements.
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ANNUAL
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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, (in millions, except share and per share amounts) 2018 2017 2016 Net sales $ 10,529.6 $ 9,799.3 $ 9,071.0 Cost of sales 8,300.2 7,683.7 7,142.3
Gross profit 2,229.4 2,115.6 1,928.7
Selling, general and administrative expenses 945.7 899.1 818.0 Other expense, net 93.8 144.5 137.5
Operating income 1,189.9 1,072.0 973.2
Equity in affiliates’ earnings, net of tax (48.9) (51.2) (42.9) Interest income (6.4) (5.8) (6.3) Interest expense and finance charges 58.7 70.5 84.6 Other postretirement income (9.4) (5.1) (4.9)
Earnings before income taxes and noncontrolling interest 1,195.9 1,063.6 942.7
Provision for income taxes 211.3 580.3 306.0 Net earnings 984.6 483.3 636.7
Net earnings attributable to the noncontrolling interest, net of tax 53.9 43.4 41.7 Net earnings attributable to BorgWarner Inc. $ 930.7 $ 439.9 $ 595.0
Earnings per share — basic $ 4.47 $ 2.09 $ 2.78
Earnings per share — diluted $ 4.44 $ 2.08 $ 2.76
Weighted average shares outstanding (thousands): Basic 208,197 210,429 214,374 Diluted 209,496 211,548 215,328
See Accompanying Notes to Consolidated Financial Statements.
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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year Ended December 31, (in millions of dollars) 2018 2017 2016 Net earnings attributable to BorgWarner Inc. $ 930.7 $ 439.9 $ 595.0
Other comprehensive (loss) income Foreign currency translation adjustments (147.6) 236.5 (109.1) Hedge instruments* 1.6 (6.3) 7.0 Defined benefit postretirement plans* (23.0) 0.5 (8.2) Other* (1.1) 1.4 (1.6)
Total other comprehensive (loss) income attributable to BorgWarner Inc. (170.1) 232.1 (111.9)
Comprehensive income attributable to BorgWarner Inc.* 760.6 672.0 483.1
Net earnings attributable to noncontrolling interest, net of tax* 53.9 43.4 41.7 Other comprehensive (loss) income attributable to the noncontrolling interest* (7.9) 11.4 (5.1)
Comprehensive income $ 806.6 $ 726.8 $ 519.7 ____________________________________ * Net of income taxes.
See Accompanying Notes to Consolidated Financial Statements.
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BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, (in millions of dollars) 2018 2017 2016 OPERATING Net earnings $ 984.6 $ 483.3 $ 636.7 Adjustments to reconcile net earnings to net cash flows from operations: Non-cash charges (credits) to operations:
Asset impairment and loss on divestiture 25.6 71.0 127.1 Asbestos-related adjustments 22.8 — (48.6) Gain on sale of building (19.4) — — Depreciation and amortization 431.3 407.8 391.4 Stock-based compensation expense 52.9 52.7 43.6 Restructuring expense, net of cash paid 33.0 27.0 12.0 Deferred income tax (benefit) provision (57.2) 41.8 6.8 Tax reform adjustments to provision for income taxes (12.6) 273.5 — Equity in affiliates’ earnings, net of dividends received, and other (15.0) (32.0) (17.0)
Net earnings adjusted for non-cash charges to operations 1,446.0 1,325.1 1,152.0 Changes in assets and liabilities:
Receivables (42.9) (167.9) (137.5) Inventories (53.3) (84.5) (36.5) Prepayments and other current assets (18.7) 0.5 8.8 Accounts payable and accrued expenses (76.1) 232.8 134.9 Prepaid taxes and income taxes payable (84.7) (42.8) (14.2) Other assets and liabilities (43.8) (82.9) (71.8)
Net cash provided by operating activities 1,126.5 1,180.3 1,035.7 INVESTING Capital expenditures, including tooling outlays (546.6) (560.0) (500.6) Proceeds from sale of businesses, net of cash divested — — 85.8 Proceeds from asset disposals and other 36.0 4.5 10.6 Payments for businesses acquired, including restricted cash, net of cash acquired — (185.7) — Proceeds from (payments for) settlement of net investment hedges 2.1 (8.5) — Payments for venture capital investment (6.0) (2.6) —
Net cash used in investing activities (514.5) (752.3) (404.2) FINANCING Net decrease in notes payable (34.2) (88.3) (129.1) Additions to debt, net of debt issuance costs 58.7 3.0 4.6 Repayments of debt, including current portion (65.7) (19.3) (193.6) Payments for debt issuance cost — (2.4) — Proceeds from interest rate swap termination — — 8.9 Payments for purchase of treasury stock (150.0) (100.0) (288.0) (Payments for) proceeds from stock-based compensation items (15.2) (2.1) 6.7 Dividends paid to BorgWarner stockholders (141.5) (124.1) (113.4) Dividends paid to noncontrolling stockholders (35.5) (29.3) (29.9)
Net cash used in financing activities (383.4) (362.5) (733.8) Effect of exchange rate changes on cash (34.5) 36.1 (31.7)
Net increase (decrease) in cash 194.1 101.6 (134.0) Cash at beginning of year 545.3 443.7 577.7 Cash at end of year $ 739.4 $ 545.3 $ 443.7
SUPPLEMENTAL CASH FLOW INFORMATION Cash paid during the year for:
Interest $ 83.6 $ 92.0 $ 100.3 Income taxes, net of refunds $ 315.7 $ 279.8 $ 300.5
Non-cash investing transactions
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Liabilities assumed from business acquired $ — $ 18.0 $ —
See Accompanying Notes to Consolidated Financial Statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
recorded a loss on divestiture of $127.1 million in the year ended December 31, 2016. Refer to Note 19, "Recent Transactions," to the Consolidated Financial Statements for more information.
During the fourth quarter of 2018, the Company recorded a gain of $19.4 million related to the sale of a building at a manufacturing facility located in Europe.
During the years ended December 31, 2018, 2017 and 2016, the Company recorded $5.8 million, $10.0 million and $23.7 million of merger, acquisition and divestiture expenses. The merger, acquisition and divestiture expense in the year ended December 31, 2018 primarily related to professional fees associated with divestiture activities for the non-core pipe and thermostat product lines. Refer to Note 20, "Assets and Liabilities Held For Sale," to the Consolidated Financial Statements for more information. The merger and acquisition expense in the years ended December 31, 2017 and 2016 primarily related to the acquisition of Sevcon and Remy, respectively. Refer to Note 19, "Recent Transactions," to the Consolidated Financial Statements for more information.
During the first quarter of 2017, the Company recorded a loss of $5.3 million related to the termination of a long term property lease for a manufacturing facility located in Europe.
During the fourth quarter of 2016, the Company recorded an intangible asset impairment loss of $12.6 million related to Engine segment Etatech’s ECCOS intellectual technology. The ECCOS intellectual technology impairment was due to the discontinuance of interest from potential customers during the fourth quarter of 2016 that significantly lowered the commercial feasibility of the product line.
During the year ended December 31, 2018, the Company recorded a gain of approximately $4.0 million related to the settlement of a commercial contract for an entity acquired in the 2015 Remy acquisition.
NOTE 5 INCOME TAXES
Earnings before income taxes and the provision for income taxes are presented in the following table.
Year Ended December 31, (millions of dollars) 2018 2017 2016 Earnings before income taxes: U.S. $ 220.0 $ 203.0 $ 27.5 Non-U.S. 975.9 860.6 915.2
Total $ 1,195.9 $ 1,063.6 $ 942.7
Provision for income taxes: Current:
Federal $ 17.1 $ 36.4 $ 37.4 State 5.4 4.6 6.1 Foreign 258.8 247.4 251.7
Total current 281.3 288.4 295.2 Deferred:
Federal (39.6) 323.7 23.5 State (8.5) 2.1 (0.8) Foreign (21.9) (33.9) (11.9)
Total deferred (70.0) 291.9 10.8 Total provision for income taxes $ 211.3 $ 580.3 $ 306.0
The provision for income taxes resulted in an effective tax rate of 17.7%, 54.6% and 32.5% for the years ended December 31, 2018, 2017 and 2016, respectively. An analysis of the differences between the effective
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
tax rate and the U.S. statutory rate for the years ended December 31, 2018, 2017 and 2016 is presented below.
On December 22, 2017, the Tax Act was enacted into law, which significantly changed existing U.S. tax law and included many provisions applicable to the Company, such as reducing the U.S. federal statutory tax rate, imposing a one-time transition tax on deemed repatriation of deferred foreign income, and adopting a territorial tax system. The Tax Act reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. The Tax Act also includes a provision to tax Global Intangible Low-Taxed Income (“GILTI”) of foreign subsidiaries, a special tax deduction for Foreign-Derived Intangible Income (“FDII”), and a Base Erosion Anti-Abuse (“BEAT”) tax measure that may tax certain payments between a U.S. corporation and its subsidiaries. These additional provisions of the Tax Act were effective beginning January 1, 2018.
In accordance with guidance provided by Staff Accounting Bulletin No 118 (SAB 118), as of December 31, 2017, we had not completed our accounting for the tax effects of the Tax Act and had recorded provisional estimates for significant items including the following: (i) the effects on our existing deferred balances, including executive compensation, (ii) the one-time transition tax, and (iii) our indefinite reinvestment assertion. The measurement period begins in the reporting period that includes the Tax Act’s enactment date and ends when the additional information is obtained, prepared, or analyzed to complete the accounting requirements under ASC Topic 740. The measurement period should not extend beyond one year from the enactment date. In light of the treatment of foreign earnings under the Tax Act, we reconsidered our indefinite reinvestment position and concluded we would no longer assert indefinite reinvestment with respect to our foreign unremitted earnings as of December 31, 2017. We recognized income tax expense of $273.5 million for the year ended December 31, 2017 for the significant items we could reasonably estimate associated with the Tax Act. This amount was comprised of (i) a revaluation of our U.S. deferred tax assets and liabilities at December 31, 2017, resulting in a tax charge of $74.7 million, including $11.0 million for executive compensation (ii) a one-time transition tax resulting in a tax charge of $104.7 million and (iii) a tax charge of $94.1 million for additional provisional deferred tax liabilities with respect to the expected future remittance of foreign earnings.
For the year ended December 31, 2018, the Company completed its accounting for the tax effects of the Tax Act. The final SAB 118 adjustments resulted in: (i) an increase in the Company's existing deferred tax asset balances of $12.9 million, including $8.7 million for executive compensation (ii) a tax charge of $7.6 million for the one-time transition tax, and (iii) a decrease in the deferred tax liability associated with our indefinite reinvestment assertion of $7.3 million. The total impact to tax expense from these adjustments was a net tax benefit of $12.6 million. Compared to the year ended December 31, 2017, this additional tax benefit from the final adjustments was a result of further analysis performed by the Company and the issuance of additional regulatory guidance.
We have made an accounting policy election to treat the future tax impacts of the GILTI provisions of the Tax
Act as a period cost to the extent applicable.
In January 2019, the U.S. Department of the Treasury and the Internal Revenue Service issued final Section 965 regulations subsequent to the reporting period which provide additional guidance related to the calculation of the one-time transition tax. The tax effect of this subsequent event will be recorded in 2019 is not material.
As discussed above, in light of the treatment of foreign earnings under the Tax Act, we reconsidered our indefinite reinvestment position with respect to our foreign unremitted earnings in 2017 and we are no longer asserting indefinite reinvestment with respect to our foreign unremitted earnings. The Company has recorded a deferred tax liability of $57.4 million with respect to our foreign unremitted earnings at December 31, 2018. With respect to certain book versus tax basis differences not represented by undistributed earnings of approximately $300 million as of December 31, 2018, the Company continues to assert indefinite reinvestment of these basis differences. These basis differences would become taxable upon the sale or
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
liquidation of the foreign subsidiaries. The Company's best estimate of the unrecognized deferred tax liability on these basis differences is approximately $30 million as of December 31, 2018.
The following table provides a reconciliation of tax expense based on the U.S. statutory tax rate to final tax expense.
Year Ended December 31, (millions of dollars) 2018 2017 2016 Income taxes at U.S. statutory rate of 21% (35% for 2016 and 2017) $ 251.2 $ 372.3 $ 330.0 Increases (decreases) resulting from:
State taxes, net of federal benefit 5.6 2.3 1.8 U.S. tax on non-U.S. earnings 36.5 170.6 32.2 Affiliates' earnings (10.3) (17.9) (15.0) Foreign rate differentials 27.5 (100.2) (93.3) Tax holidays (28.0) (31.0) (25.5) Net tax on remittance of foreign earnings (21.5) 80.3 21.8 Tax credits (26.0) (24.2) (3.2) Reserve adjustments, settlements and claims 32.5 8.0 11.6 Valuation allowance adjustments (10.6) 12.2 (2.7) Non-deductible transaction costs 2.6 10.9 8.3 Changes in accounting methods and filing positions (29.8) (1.9) 0.3 Impact of transactions (0.1) 4.0 16.3 Other foreign taxes 8.4 8.1 12.9 Revaluation of U.S. deferred taxes (4.2) 63.7 — Impact of FDII (15.3) — — Other (7.2) 23.1 10.5
Provision for income taxes, as reported $ 211.3 $ 580.3 $ 306.0
The change in the effective tax rate for 2018, as compared to 2017, was primarily due to items related to the Tax Act. The Tax Act includes a reduction in the US income tax rate from 35% to 21%, as of January 1, 2018. Tax expense includes a provision for GILTI of $28.9 million, net of foreign tax credits and a tax benefit for FDII of $15.3 million that was not applicable in 2017. The one-time transition tax that resulted in a tax charge of $104.7 million in 2017 was not applicable in 2018. There was also a tax charge of $74.7 million related to a revaluation of U.S. deferred tax assets and liabilities, including $11.0 million for executive compensation in 2017 and the initial tax charge of $94.1 million related to the Company’s change in indefinite reinvestment assertion with respect to the expected future remittance of undistributed foreign earnings in 2017.
The Company's provision for income taxes for the year ended December 31, 2018, includes reductions of income tax expense of $15.0 million related to restructuring expense, $0.3 million related to merger, acquisition and divestiture expense, $5.5 million related to the asbestos-related adjustments, and $7.7 million related to asset impairment expense, offset by increases to tax expense of $0.9 million and $5.8 million related to a gain on 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 $12.6 million related to final adjustments made to measurement period provisional estimates associated with the Tax Act, $22.0 million related to a decrease in our deferred tax liability due to a tax benefit for certain foreign tax credits now available due to actions the Company took during the year, $9.1 million related to valuation allowance releases, $2.8 million related to tax reserve adjustments, and $29.8 million related to changes in accounting methods and tax filing positions for prior years primarily related to the Tax Act.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The Company's provision for income taxes for the year ended December 31, 2017, includes reductions of income tax expense of $10.1 million, $1.0 million, $18.2 million and $3.8 million related to the restructuring expense, merger and acquisition expense, asset impairment expense and other one-time adjustments, respectively, discussed in Note 4, "Other Expense, Net," to the Consolidated Financial Statements.
The Company's provision for income taxes for the year ended December 31, 2016, includes reductions of income tax expense of $22.7 million, $8.6 million, $6.0 million and $4.4 million associated with a loss on divestiture, other one-time adjustments, restructuring expense and intangible asset impairment loss, respectively, discussed in Note 4, "Other Expense," to the Consolidated Financial Statements. The provision also includes additional tax expenses of $17.5 million associated with asbestos-related adjustments and $2.2 million associated with a gain on the release of certain Remy light vehicle aftermarket liabilities due to the expiration of a customer contract.
A roll forward of the Company's total gross unrecognized tax benefits for the years ended December 31, 2018 and 2017, respectively, is presented below.
(millions of dollars) 2018 2017 2016 Balance, January 1 $ 92.0 $ 91.1 $ 127.3
Additions based on tax positions related to current year 24.1 16.8 16.1 Additions/(reductions) for tax positions of prior years 17.7 (2.4) 1.6 Reductions for closure of tax audits and settlements (7.7) (19.9) (45.7) Reductions for lapse in statute of limitations — (0.8) (5.0) Translation adjustment (5.7) 7.2 (3.2)
Balance, December 31 $ 120.4 $ 92.0 $ 91.1
The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense. The amount recognized in income tax expense for 2018 and 2017 is $10.4 million and $6.4 million, respectively. The Company has an accrual of approximately $31.5 million and $22.6 million for the payment of interest and penalties at December 31, 2018 and 2017, respectively. As of December 31, 2018, approximately $111.6 million represents the amount that, if recognized, would affect the Company's effective income tax rate in future periods. This amount includes a decrease in U.S. federal income taxes which would occur upon recognition of the state tax benefits and U.S. foreign tax credits included therein. The Company estimates that payments of approximately $9.7 million will be made in the next 12 months for assessed tax liabilities from certain taxing jurisdictions and has reclassified this amount to current in the balance sheet as shown in Note 6, "Balance Sheet Information," to the Consolidated Financial Statements.
The Company and/or one of its subsidiaries files income tax returns in the U.S. federal, various state jurisdictions and various foreign jurisdictions. In certain tax jurisdictions, the Company may have more than one taxpayer. The Company is no longer subject to income tax examinations by tax authorities in its major tax jurisdictions as follows:
Tax jurisdiction Years no longer subject to audit Tax jurisdiction Years no longer subject to audit U.S. Federal 2014 and prior Japan 2015 and prior China 2012 and prior Mexico 2012 and prior France 2015 and prior Poland 2013 and prior Germany 2011 and prior South Korea 2012 and prior Hungary 2013 and prior
In the U.S., certain tax attributes created in years prior to 2015 were subsequently utilized. Even though the U.S. federal statute of limitations has expired for years prior to 2015, the years in which these tax attributes were created could still be subject to examination, limited to only the examination of the creation of the tax attribute.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The components of deferred tax assets and liabilities as of December 31, 2018 and 2017 consist of the following:
December 31, (millions of dollars) 2018 2017 Deferred tax assets:
Employee compensation 23.9 26.4 Other comprehensive loss 63.9 54.5 Research and development capitalization 91.8 76.4 Net operating loss and capital loss carryforwards 83.8 74.6 Pension and other postretirement benefits 18.8 19.1 Asbestos-related 172.7 167.1 Other 155.2 146.6
Total deferred tax assets $ 610.1 $ 564.7 Valuation allowance (86.3) (95.9)
Net deferred tax asset $ 523.8 $ 468.8 Deferred tax liabilities:
Goodwill and intangible assets (183.3) (193.9) Fixed assets (117.5) (104.6) Unremitted foreign earnings (57.4) (98.5) Other (19.2) (12.0)
Total deferred tax liabilities $ (377.4) $ (409.0) Net deferred taxes $ 146.4 $ 59.8
At December 31, 2018, certain non-U.S. subsidiaries have net operating loss carryforwards totaling $222.7 million available to offset future taxable income. Of the total $222.7 million, $155.1 million expire at various dates from 2019 through 2038 and the remaining $67.6 million have no expiration date. The Company has a valuation allowance recorded against $143.3 million of the $222.7 million of non-U.S. net operating loss carryforwards. Certain U.S. subsidiaries have state net operating loss carryforwards totaling $824.9 million which are partially offset by a valuation allowance of $756.8 million. The state net operating loss carryforwards expire at various dates from 2019 to 2038. Certain U.S. subsidiaries also have state tax credit carryforwards of $19.8 million which are partially offset by a valuation allowance of $17.9 million. Certain non-U.S. subsidiaries located in China had tax exemptions or tax holidays, which reduced local tax expense approximately $28.0 million and $31.0 million in 2018 and 2017, respectively. The tax holidays for these subsidiaries are issued in three year terms with expirations for certain subsidiaries ranging from 2018 to 2020. The Company is in the process of renewing the tax holidays for certain subsidiaries that expired as of December 31, 2018.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Derivatives designated as net investment hedge instruments as defined by ASC Topic 815 held during the period resulted in the following gains and (losses) recorded in Interest expense and finance charges on components excluded from the assessment of effectiveness:
(in millions) Year Ended December 31, Net investment hedges 2018 2017 2016 Foreign currency $ 0.6 $ 1.3 $ — Cross-currency swaps $ 8.7 $ — $ —
There were no gains and (losses) recorded in income related to components excluded from the assessment of effectiveness for foreign currency denominated debt designated as net investment hedges. There were no gains and losses reclassified from AOCI for net investment hedges during the periods presented.
Year Ended December 31, (in millions) 2018 2017 2016
Contract Type Location Gain (loss) on
swaps Gain (loss) on
borrowings Gain (loss) on
swaps Gain (loss) on
borrowings Gain (loss) on
swaps Gain (loss) on
borrowings
Interest rate swap
Interest expense and finance charges $ — $ — $ — $ — $ 8.5 $ (8.5)
Derivatives not designated as hedging instruments are used to hedge remeasurement exposures of monetary assets and liabilities denominated in currencies other than the operating units' functional currency. The gains and (losses) recorded in income from derivative instruments not designated as hedging instruments were immaterial for the periods presented.
NOTE 12 RETIREMENT BENEFIT PLANS
The Company sponsors various defined contribution savings plans, primarily in the U.S., that allow employees to contribute a portion of their pre-tax and/or after-tax income in accordance with plan specified guidelines. Under specified conditions, the Company will make contributions to the plans and/or match a percentage of the employee contributions up to certain limits. Total expense related to the defined contribution plans was $34.9 million, $33.5 million and $28.3 million in the years ended December 31, 2018, 2017 and 2016, respectively.
The Company has a number of defined benefit pension plans and other postretirement employee benefit plans covering eligible salaried and hourly employees and their dependents. The defined pension benefits provided are primarily based on (i) years of service and (ii) average compensation or a monthly retirement benefit amount. The Company provides defined benefit pension plans in France, Germany, Ireland, Italy, Japan, Mexico, Monaco, South Korea, Sweden, U.K. and the U.S. The other postretirement employee benefit plans, which provide medical benefits, are unfunded plans. Our U.S. and U.K. defined benefit plans are frozen and no additional service cost is being accrued. All pension and other postretirement employee benefit plans in the U.S. have been closed to new employees. The measurement date for all plans is December 31.
The following table summarizes the expenses for the Company's defined contribution and defined benefit pension plans and the other postretirement defined employee benefit plans.
Year Ended December 31, (millions of dollars) 2018 2017 2016 Defined contribution expense $ 34.9 $ 33.5 $ 28.3 Defined benefit pension expense 8.5 12.5 10.1 Other postretirement employee benefit expense 0.1 0.5 1.4
Total $ 43.5 $ 46.5 $ 39.8
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following provides a roll forward of the plans’ benefit obligations, plan assets, funded status and recognition in the Consolidated Balance Sheets.
Pension benefits Other postretirement Year Ended December 31, employee benefits
2018 2017 Year Ended December 31, (millions of dollars) US Non-US US Non-US 2018 2017 Change in projected benefit obligation: Projected benefit obligation, January 1 $ 283.3 $ 628.8 $ 282.5 $ 528.2 $ 107.0 $ 119.9
Service cost — 17.9 — 18.0 0.1 0.1 Interest cost 8.5 12.0 8.9 11.0 2.9 3.2 Plan participants’ contributions — 0.3 — 0.3 — — Plan amendments — 1.7 — — — (0.7) Settlement and curtailment — (4.3) — (3.7) — — Actuarial (gain) loss (18.2) 4.9 8.7 (7.8) (6.7) 2.2 Currency translation — (29.4) — 63.4 — — Acquisition — — 4.0 37.0 — — Benefits paid (20.7) (19.6) (20.8) (17.6) (16.8) (17.7)
Projected benefit obligation, December 31 $ 252.9 $ 612.3 $ 283.3 $ 628.8 $ 86.5 $ 107.0 Change in plan assets: Fair value of plan assets, January 1 $ 240.1 $ 483.4 $ 229.5 $ 393.8
Actual return on plan assets (10.7) (18.1) 23.5 30.7 Employer contribution 7.0 18.8 4.0 14.3 Plan participants’ contribution — 0.3 — 0.3 Settlements — (4.3) — (3.6) Currency translation — (22.0) — 46.8 Acquisition — — 3.8 18.1 Other — — — 0.6 Benefits paid (20.6) (19.6) (20.7) (17.6)
Fair value of plan assets, December 31 $ 215.8 $ 438.5 $ 240.1 $ 483.4
Funded status $ (37.1) $ (173.8) $ (43.2) $ (145.4) $ (86.5) $ (107.0) Amounts in the Consolidated Balance Sheets consist of: Non-current assets $ — $ 16.7 $ — $ 23.2 $ — $ — Current liabilities (0.5) (4.4) (0.1) (3.9) (11.0) (13.2) Non-current liabilities (36.6) (186.1) (43.1) (164.7) (75.5) (93.8)
Net amount $ (37.1) $ (173.8) $ (43.2) $ (145.4) $ (86.5) $ (107.0) Amounts in accumulated other comprehensive loss consist of: Net actuarial loss $ 113.1 $ 193.0 $ 111.0 $ 159.0 $ 13.2 $ 20.8 Net prior service (credit) cost (5.8) 2.2 (6.6) 0.8 (11.8) (15.8)
Net amount* $ 107.3 $ 195.2 $ 104.4 $ 159.8 $ 1.4 $ 5.0
Total accumulated benefit obligation for all plans $ 252.9 $ 583.3 $ 283.3 $ 602.0 ________________ * AOCI shown above does not include our equity investee, NSK-Warner. NSK-Warner had an AOCI loss of $9.2 million and $9.7
million at December 31, 2018 and 2017, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The funded status of pension plans with accumulated benefit obligations in excess of plan assets at December 31 is as follows:
December 31, (millions of dollars) 2018 2017 Accumulated benefit obligation $ (649.9) $ (681.2) Plan assets 449.9 494.8
Deficiency $ (200.0) $ (186.4)
Pension deficiency by country: United States $ (37.1) $ (43.2) Germany (95.4) (75.7) Other (67.5) (67.5)
Total pension deficiency $ (200.0) $ (186.4)
The weighted average asset allocations of the Company’s funded pension plans and target allocations by asset category are as follows:
December 31, Target
Allocation 2018 2017 U.S. Plans:
Real estate and other 11% 11% 0% - 15% Fixed income securities 56% 53% 45% - 65% Equity securities 33% 36% 25% - 45%
100% 100% Non-U.S. Plans:
Real estate and other 8% 8% 0% - 10% Fixed income securities 55% 44% 43% - 65% Equity securities 37% 48% 30% - 56%
100% 100%
The Company's investment strategy is to maintain actual asset weightings within a preset range of target allocations. The Company believes these ranges represent an appropriate risk profile for the planned benefit payments of the plans based on the timing of the estimated benefit payments. In each asset category, separate portfolios are maintained for additional diversification. Investment managers are retained in each asset category to manage each portfolio against its benchmark. Each investment manager has appropriate investment guidelines. In addition, the entire portfolio is evaluated against a relevant peer group. The defined benefit pension plans did not hold any Company securities as investments as of December 31, 2018 and 2017. A portion of pension assets is invested in common and commingled trusts.
The Company expects to contribute a total of $15 million to $25 million into its defined benefit pension plans during 2019. Of the $15 million to $25 million in projected 2019 contributions, $4.0 million are contractually obligated, while any remaining payments would be discretionary.
Refer to Note 10, "Fair Value Measurements," to the Consolidated Financial Statements for more detail surrounding the fair value of each major category of plan assets, as well as the inputs and valuation techniques used to develop the fair value measurements of the plans' assets at December 31, 2018 and 2017.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
See the table below for a breakout of net periodic benefit cost between U.S. and non-U.S. pension plans:
Pension benefits Other postretirement employee
benefits Year Ended December 31, 2018 2017 2016 Year Ended December 31, (millions of dollars) US Non-US US Non-US US Non-US 2018 2017 2016 Service cost $ — $ 17.9 $ — $ 18.0 $ — $ 16.2 $ 0.1 $ 0.1 $ 0.2 Interest cost 8.5 12.0 8.9 11.0 9.6 12.5 2.9 3.2 4.0 Expected return on plan assets (13.6) (27.0) (13.2) (23.8) (15.0) (24.3) — — — Settlements, curtailments and other — 0.3 — 0.3 — — — — — Amortization of unrecognized prior service (credit) cost (0.8) 0.1 (0.8) — (0.8) 0.6 (4.1) (4.1) (4.9) Amortization of unrecognized loss 4.2 6.9 4.2 7.9 5.1 6.2 1.2 1.3 2.1
Net periodic (income) cost $ (1.7) $ 10.2 $ (0.9) $ 13.4 $ (1.1) $ 11.2 $ 0.1 $ 0.5 $ 1.4
The components of net periodic benefit cost other than the service cost component are included in Other postretirement income in the Condensed Consolidated Statements of Operations.
The estimated net loss for the defined benefit pension plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year is $14.1 million. The estimated net loss and prior service credit for the other postretirement employee benefit plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year are $0.6 million and $3.6 million, respectively.
The Company's weighted-average assumptions used to determine the benefit obligations for its defined benefit pension and other postretirement employee benefit plans as of December 31, 2018 and 2017 were as follows:
December 31, (percent) 2018 2017 U.S. pension plans:
Discount rate 4.24 3.55 Rate of compensation increase N/A N/A
U.S. other postretirement employee benefit plans: Discount rate 4.05 3.32 Rate of compensation increase N/A N/A
Non-U.S. pension plans: Discount rate 2.28 2.25 Rate of compensation increase 2.99 2.98
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The Company's weighted-average assumptions used to determine the net periodic benefit cost/(income) for its defined benefit pension and other postretirement employee benefit plans for the years ended December 31, 2018 and 2017 were as follows:
Year Ended December 31, (percent) 2018 2017 U.S. pension plans:
Discount rate - service cost 3.55 3.94 Effective interest rate on benefit obligation 3.13 3.26 Expected long-term rate of return on assets 6.00 6.01 Average rate of increase in compensation N/A N/A
U.S. other postretirement plans: Discount rate - service cost 2.65 2.68 Effective interest rate on benefit obligation 2.86 2.85 Expected long-term rate of return on assets N/A N/A Average rate of increase in compensation N/A N/A
Non-U.S. pension plans: Discount rate - service cost 2.71 2.55 Effective interest rate on benefit obligation 1.98 1.96 Expected long-term rate of return on assets 5.73 5.68 Average rate of increase in compensation 2.98 3.00
The Company's approach to establishing the discount rate is based upon the market yields of high-quality corporate bonds, with appropriate consideration of each plan's defined benefit payment terms and duration of the liabilities. 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 determines its expected return on plan asset assumptions by evaluating estimates of future market returns and the plans' asset allocation. The Company also considers the impact of active management of the plans' invested assets.
The estimated future benefit payments for the pension and other postretirement employee benefits are as follows:
Pension benefits Other
postretirement employee benefits
(millions of dollars)
Year U.S. Non-U.S. 2019 $ 22.5 $ 19.6 $ 11.0 2020 19.8 21.7 10.3 2021 18.9 21.9 9.5 2022 18.3 22.6 9.1 2023 17.8 23.8 8.0 2024-2028 84.2 134.0 28.9
The weighted-average rate of increase in the per capita cost of covered health care benefits is projected to be 6.50% in 2019 for pre-65 and post-65 participants, decreasing to 5.0% by the year 2025. A one-percentage point change in the assumed health care cost trend would have the following effects:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
One Percentage Point
(millions of dollars) Increase Decrease Effect on other postretirement employee benefit obligation $ 5.5 $ (4.9) Effect on total service and interest cost components $ 0.2 $ (0.2)
NOTE 13 STOCK-BASED COMPENSATION
The Company has granted restricted common stock and restricted stock units (collectively, "restricted stock") and performance share units as long-term incentive awards to employees and non-employee directors under the BorgWarner Inc. 2014 Stock Incentive Plan, as amended ("2014 Plan") and the BorgWarner Inc. 2018 Stock Incentive Plan ("2018 Plan"). The Company's Board of Directors adopted the 2018 Plan as a replacement to the 2014 Plan in February 2018, and the Company's stockholders approved the 2018 Plan at the annual meeting of stockholders on April 25, 2018. After stockholders approved the 2018 Plan, the Company could no longer make grants under the 2014 Plan. The shares that were available for issuance under the 2014 Plan were cancelled upon approval of the 2018 Plan. The 2018 Plan authorizes the issuance of a total of 7 million shares, of which approximately 6.9 million shares were available for future issuance as of December 31, 2018.
Stock Options A summary of the plans’ shares under option at December 31, 2018, 2017 and 2016 is as follows:
Shares
(thousands) Weighted average
exercise price
Weighted average remaining contractual
life (in years)
Aggregate intrinsic value
(in millions)
Outstanding at January 1, 2016 1,267 $ 16.59 0.9 $ 33.7 Exercised (794) $ 16.07 $ 14.4
Outstanding at December 31, 2016 473 $ 17.47 0.1 $ 10.4 Exercised (473) $ 17.47 $ 10.4
Outstanding at December 31, 2017 — $ — 0.0 $ — Exercised — $ — $ —
Outstanding at December 31, 2018 — $ — 0.0 $ —
Options exercisable at December 31, 2018 — $ — 0.0 $ —
Proceeds from stock option exercises for the years ended December 31, 2018, 2017 and 2016 were as follows:
Year Ended December 31,
(millions of dollars) 2018 2017 2016 Proceeds from stock options exercised — gross $ — $ 8.3 $ 12.7 Tax benefit — 8.2 0.3
Proceeds from stock options exercised, net of tax $ — $ 16.5 $ 13.0
Restricted Stock The value of restricted stock is determined by the market value of the Company’s common stock at the date of grant. In 2018, restricted stock in the amount of 717,833 shares and 19,656 shares was granted to employees and non-employee directors, respectively. The value of the awards is recognized as compensation expense ratably over the restriction periods. As of December 31, 2018, there was $29.3 million of unrecognized compensation expense that will be recognized over a weighted average period of approximately 2 years.
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