Item 1. Business
General
Dana Incorporated (Dana) is headquartered in Maumee, Ohio and was incorporated in Delaware in 2007. We are a global provider of high technology drive and motion products, sealing solutions, thermal-management technologies and fluid-power products and our customer base includes virtually every major vehicle and engine manufacturer in the global light vehicle, medium/heavy vehicle and off-highway markets. As of December 31, 2018 we employed approximately 30,900 people, operated in 33 countries and had 135 major facilities around the world.
The terms “Dana,” “we,” “our” and “us” are references to Dana. These references include the subsidiaries of Dana unless otherwise indicated or the context requires otherwise.
Overview of our Business
We have aligned our organization around four operating segments: Light Vehicle Driveline Technologies (Light Vehicle), Commercial Vehicle Driveline Technologies (Commercial Vehicle), Off-Highway Drive and Motion Technologies (Off-Highway) and Power Technologies. These operating segments have global responsibility and accountability for business commercial activities and financial performance.
External sales by operating segment for the years ended December 31, 2018, 2017 and 2016 are as follows:
Refer to Segment Results of Operations in Item 7 and Note 21 to our consolidated financial statements in Item 8 for further financial information about our operating segments.
Our business is diversified across end-markets, products and customers. The following table summarizes the markets, products and largest customers of each of our operating segments as of December 31, 2018:
* Via a directed supply relationship
** Includes MAN AG, a majority-owned subsidiary of Volkswagen AG
Geographic Operations
We maintain administrative and operational organizations in North America, Europe, South America and Asia Pacific to support our operating segments, assist with the management of affiliate relations and facilitate financial and statutory reporting and tax compliance on a worldwide basis. Our operations are located in the following countries:
Our non-U.S. subsidiaries and affiliates manufacture and sell products similar to those we produce in the United States. Operations outside the U.S. may be subject to a greater risk of changing political, economic and social environments, changing governmental laws and regulations, currency revaluations and market fluctuations than our domestic operations. See the discussion of risk factors in Item 1A.
Item 1A. Risk Factors
We are impacted by events and conditions that affect the light vehicle, medium/heavy vehicle and off-highway markets that we serve, as well as by factors specific to Dana. Among the risks that could materially adversely affect our business, financial condition or results of operations are the following, many of which are interrelated.
Risk Factors Related to the Markets We Serve
A downturn in the global economy could have a substantial adverse effect on our business.
Our business is tied to general economic and industry conditions as demand for vehicles depends largely on the strength of the economy, employment levels, consumer confidence levels, the availability and cost of credit and the cost of fuel. These factors have had and could continue to have a substantial impact on our business.
We expect global market conditions in 2019 to result in overall sales that are comparable to 2018. We expect the North America economic climate will be down modestly from its 2018 peak. The medium/heavy truck market in North America is expected to be mixed in 2019 with Class 8 demand stable to modestly up and Classes 5-7 down compared to 2018. In the light vehicle market, light truck demand is expected to be comparable to slightly weaker than 2018. The economy in Europe is expected to improve modestly, with both off-highway and on-highway market demand showing modest improvement compared to this past year. Continued economic improvement in Brazil is expected to provide stable to improving production levels in our key South America market segments in 2019. We expect the rate of growth in Asia Pacific to be modest in 2019, with the off-highway and light truck markets being comparable to up slightly compared to 2018, while the 2019 medium/heavy truck market is expected to be somewhat weaker. Adverse developments in the economic conditions of any of these markets could reduce demand for new vehicles, causing our customers to reduce their vehicle production and, as a result, demand for our products would be adversely affected.
Certain political developments occurring the past three years have provided increased economic uncertainty. The United Kingdom's decision in 2016 to exit the European Union has not had significant economic ramifications to date; however, transition details continue to develop and could have potential economic implications in the United Kingdom and elsewhere. Political climate changes in the U.S., including tax reform legislation, easing of regulatory requirements and potential trade policy actions, are likely to impact economic conditions in the U.S. and various countries, the cost of importing into the U.S. and the competitive landscape of our customers, suppliers and competitors.
Adverse global economic conditions could also cause our customers and suppliers to experience severe economic constraints in the future, including bankruptcy, which could have a material adverse impact on our financial position and results of operations.
Rising interest rates could have a substantial adverse effect on our business
In a number of markets, including the U.S., we have seen interest rates rise after years of historically low rates. Rising interest rates could have a dampening effect on overall economic activity, the financial condition of our customers and the financial condition of the end customers who ultimately create demand for the products we supply, all of which could negatively affect demand for our products. An increase in interest rates could also make it difficult for us to obtain financing at attractive rates, impacting our ability to execute on our growth strategies or future acquisitions.
The proposed phase out of the London Interbank Offer Rate (LIBOR) could have an adverse effect on our business
Our revolving credit facility, current term loan and committed financing associated with our acquisition of the Drive Systems segment of the Oerlikon Group utilize LIBOR to set the interest rate on any outstanding borrowings. In July 2017, the head of the United Kingdom Financial Conduct Authority announced the desire to phase out the use of LIBOR by the end of 2021. There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate. As such, the potential effect of any such event on our cost of capital cannot yet be determined. In addition, any further changes or reforms to the determination or supervision of LIBOR may result in a sudden or prolonged increase or decrease in reported LIBOR, which could have an adverse impact on extensions of credit held by us and could have a material adverse effect on our business, financial condition and results of operations.
We could be adversely impacted by the loss of any of our significant customers, changes in their requirements for our products or changes in their financial condition.
We are reliant upon sales to several significant customers. Sales to our ten largest customers accounted for 58% of our overall sales in 2018. Changes in our business relationships with any of our large customers or in the timing, size and continuation of their various programs could have a material adverse impact on us.
The loss of any of these customers, the loss of business with respect to one or more of their vehicle models on which we have high component content, or a significant decline in the production levels of such vehicles would negatively impact our business, results of operations and financial condition. Pricing pressure from our customers also poses certain risks. Inability on our part to offset pricing concessions with cost reductions would adversely affect our profitability. We are continually bidding on new business with these customers, as well as seeking to diversify our customer base, but there is no assurance that our efforts will be successful. Further, to the extent that the financial condition of our largest customers deteriorates, including possible bankruptcies, mergers or liquidations, or their sales otherwise decline, our financial position and results of operations could be adversely affected.
We may be adversely impacted by changes in international legislative and political conditions.
We operate in 33 countries around the world and we depend on significant foreign suppliers and customers. Further, we have several growth initiatives that are targeting emerging markets like China and India. Legislative and political activities within the countries where we conduct business, particularly in emerging markets and less developed countries, could adversely impact our ability to operate in those countries. The political situation in a number of countries in which we operate could create instability in our contractual relationships with no effective legal safeguards for resolution of these issues, or potentially result in the seizure of our assets. We operate in Argentina, where trade-related initiatives and other government restrictions limit our ability to optimize operating effectiveness. At December 31, 2018, our net asset exposure related to Argentina was approximately $20, including $7 of net fixed assets.
We may be adversely impacted by changes in trade policies and proposed or imposed tariffs, including but not limited to, the imposition of new tariffs by the U.S. government on imports to the U.S. and/or the imposition of retaliatory tariffs by foreign countries.
Section 232 of the Trade Expansion Act of 1962, as amended (the Trade Act), gives the executive branch of the U.S. government broad authority to restrict imports in the interest of national security by imposing tariffs. During 2018, the U.S. government concluded that imported steel and aluminum threaten to impair the national security and imposed tariffs on steel and aluminum imported from certain countries. Certain foreign countries have responded with retaliatory tariffs. The U.S. government is currently investigating imported passenger vehicles and automotive parts to determine if they are weakening our internal economy and may impair national security. Section 301 of the Trade Act gives the executive branch broad authority to impose tariffs against countries that make unjustified, unreasonable, or discriminatory trade actions. During 2018, the U.S. government concluded that China’s trade policies harm U.S. business and workers and threaten the long-term competitiveness of the U.S. and has imposed tariffs on numerous Chinese imports. China has responded with retaliatory tariffs. In November 2018, the U.S., Mexico and Canada executed the U.S.-Mexico-Canada Agreement (USMCA), the successor agreement to the North American Free Trade Agreement (NAFTA). The agreement submitted for ratification includes the imposition of tariffs on vehicles that do not meet regional raw material (steel and aluminum), part and labor content requirements.
Tariffs imposed on imported steel and aluminum could raise the costs associated with manufacturing our products. We continue to work with our customers to recover a portion of our increased costs, and with our suppliers to defray costs, associated with these tariffs. While we have been successful in the past recovering a significant portion of costs increases, there is no assurance that cost increases resulting from trade policies and tariffs will not adversely impact our profitability. Our sales may also be adversely impacted if tariffs are assessed directly on the products we produce or on our customers’ products containing content sourced from us.
We may be adversely impacted by the strength of the U.S. dollar relative to the currencies in the other countries in which we do business.
Approximately 56% of our sales in 2018 were from operations located in countries other than the U.S. Currency variations can have an impact on our results (expressed in U.S. dollars). Currency variations can also adversely affect margins on sales of our products in countries outside of the U.S. and margins on sales of products that include components obtained from affiliates or other suppliers located outside of the U.S. Strengthening of the U.S. dollar against the euro and currencies of other countries in which we have operations has had and could continue to have an adverse effect on our results reported in U.S. dollars. We use a combination of natural hedging techniques and financial derivatives to mitigate foreign currency exchange rate risks. Such hedging activities may be ineffective or may not offset more than a portion of the adverse financial impact resulting from currency variations.
We may be adversely impacted by new laws, regulations or policies of governmental organizations related to increased fuel economy standards and reduced greenhouse gas emissions, or changes in existing ones.
The markets and customers we serve are subject to substantial government regulation, which often differs by state, region and country. These regulations, and proposals for additional regulation, are advanced primarily out of concern for the environment (including concerns about global climate change and its impact) and energy independence. We anticipate that the number and extent of these regulations, and the costs to comply with them, will increase significantly in the future.
In the U.S., vehicle fuel economy and greenhouse gas emissions are regulated under a harmonized national program administered by the National Highway Traffic Safety Administration and the Environmental Protection Agency (EPA). Other governments in the markets we serve are also creating new policies to address these same issues, including the European Union, Brazil, China and India. These government regulatory requirements could significantly affect our customers by altering their global product development plans and substantially increasing their costs, which could result in limitations on the types of vehicles they sell and the geographical markets they serve. Any of these outcomes could adversely affect our financial position and results of operations.
Company-Specific Risk Factors
We have taken, and continue to take, cost-reduction actions. Although our process includes planning for potential negative consequences, the cost-reduction actions may expose us to additional production risk and could adversely affect our sales, profitability and ability to retain and attract employees.
We have been reducing costs in all of our businesses and have discontinued product lines, exited businesses, consolidated manufacturing operations and positioned operations in lower cost locations. The impact of these cost-reduction actions on our sales and profitability may be influenced by many factors including our ability to successfully complete these ongoing efforts, our ability to generate the level of cost savings we expect or that are necessary to enable us to effectively compete, delays in implementation of anticipated workforce reductions, decline in employee morale and the potential inability to meet operational targets due to our inability to retain or recruit key employees.
We depend on our subsidiaries for cash to satisfy the obligations of the company.
Our subsidiaries conduct all of our operations and own substantially all of our assets. Our cash flow and our ability to meet our obligations depend on the cash flow of our subsidiaries. In addition, the payment of funds in the form of dividends, intercompany payments, tax sharing payments and otherwise may be subject to restrictions under the laws of the countries of incorporation of our subsidiaries or the by-laws of the subsidiary.
Labor stoppages or work slowdowns at Dana, key suppliers or our customers could result in a disruption in our operations and have a material adverse effect on our businesses.
We and our customers rely on our respective suppliers to provide parts needed to maintain production levels. We all rely on workforces represented by labor unions. Workforce disputes that result in work stoppages or slowdowns could disrupt operations of all of these businesses, which in turn could have a material adverse effect on the supply of, or demand for, the products we supply our customers.
We could be adversely affected if we are unable to recover portions of commodity costs (including costs of steel, other raw materials and energy) from our customers.
We continue to work with our customers to recover a portion of our material cost increases. While we have been successful in the past recovering a significant portion of such cost increases, there is no assurance that increases in commodity costs, which can be impacted by a variety of factors, including changes in trade laws and tariffs, will not adversely impact our profitability in the future.
We could be adversely affected if we experience shortages of components from our suppliers or if disruptions in the supply chain lead to parts shortages for our customers.
A substantial portion of our annual cost of sales is driven by the purchase of goods and services. To manage and minimize these costs, we have been consolidating our supplier base. As a result, we are dependent on single sources of supply for some components of our products. We select our suppliers based on total value (including price, delivery and quality), taking into
consideration their production capacities and financial condition, and we expect that they will be able to support our needs. However, there is no assurance that adverse financial conditions, including bankruptcies of our suppliers, reduced levels of production, natural disasters or other problems experienced by our suppliers will not result in shortages or delays in their supply of components to us or even in the financial collapse of one or more such suppliers. If we were to experience a significant or prolonged shortage of critical components from any of our suppliers, particularly those who are sole sources, and were unable to procure the components from other sources, we would be unable to meet our production schedules for some of our key products and to ship such products to our customers in a timely fashion, which would adversely affect our sales, profitability and customer relations.
Adverse economic conditions, natural disasters and other factors can similarly lead to financial distress or production problems for other suppliers to our customers which can create disruptions to our production levels. Any such supply-chain induced disruptions to our production are likely to create operating inefficiencies that will adversely affect our sales, profitability and customer relations.
Our profitability and results of operations may be adversely affected by program launch difficulties.
The launch of new business is a complex process, the success of which depends on a wide range of factors, including the production readiness of our manufacturing facilities and manufacturing processes and those of our suppliers, as well as factors related to tooling, equipment, employees, initial product quality and other factors. Our failure to successfully launch material new or takeover business could have an adverse effect on our profitability and results of operations.
We use important intellectual property in our business. If we are unable to protect our intellectual property or if a third party makes assertions against us or our customers relating to intellectual property rights, our business could be adversely affected.
We own important intellectual property, including patents, trademarks, copyrights and trade secrets, and are involved in numerous licensing arrangements. Our intellectual property plays an important role in maintaining our competitive position in a number of the markets that we serve. Our competitors may develop technologies that are similar or superior to our proprietary technologies or design around the patents we own or license. Further, as we expand our operations in jurisdictions where the protection of intellectual property rights is less robust, the risk of others duplicating our proprietary technologies increases, despite efforts we undertake to protect them. Developments or assertions by or against us relating to intellectual property rights, and any inability to protect these rights, could have a material adverse impact on our business and our competitive position.
We could encounter unexpected difficulties integrating acquisitions and joint ventures.
We acquired businesses in recent years, and we expect to complete additional acquisitions and investments in the future that complement or expand our businesses. The success of this strategy will depend on our ability to successfully complete these transactions or arrangements, to integrate the businesses acquired in these transactions and to develop satisfactory working arrangements with our strategic partners in the joint ventures. We could encounter unexpected difficulties in completing these transactions and integrating the acquisitions with our existing operations. We also may not realize the degree or timing of benefits anticipated when we entered into a transaction.
Several of our joint ventures operate pursuant to established agreements and, as such, we do not unilaterally control the joint venture. There is a risk that the partners’ objectives for the joint venture may not be aligned with ours, leading to potential differences over management of the joint venture that could adversely impact its financial performance and consequent contribution to our earnings. Additionally, inability on the part of our partners to satisfy their contractual obligations under the agreements could adversely impact our results of operations and financial position.
We could be adversely impacted by the costs of environmental, health, safety and product liability compliance.
Our operations are subject to environmental laws and regulations in the U.S. and other countries that govern emissions to the air; discharges to water; the generation, handling, storage, transportation, treatment and disposal of waste materials; and the cleanup of contaminated properties. Historically, environmental costs related to our former and existing operations have not been material. However, there is no assurance that the costs of complying with current environmental laws and regulations, or those that may be adopted in the future, will not increase and adversely impact us.
There is also no assurance that the costs of complying with current laws and regulations, or those that may be adopted in the future, that relate to health, safety and product liability matters will not adversely impact us. There is also a risk of warranty and product liability claims, as well as product recalls, if our products fail to perform to specifications or cause property
damage, injury or death. (See Notes 16 and 17 to our consolidated financial statements in Item 8 for additional information on product liabilities and warranties.)
A failure of our information technology infrastructure could adversely impact our business and operations.
We recognize the increasing volume of cyber attacks and employ commercially practical efforts to provide reasonable assurance that the risks of such attacks are appropriately mitigated. Each year, we evaluate the threat profile of our industry to stay abreast of trends and to provide reasonable assurance our existing countermeasures will address any new threats identified. Despite our implementation of security measures, our IT systems and those of our service providers are vulnerable to circumstances beyond our reasonable control including acts of terror, acts of government, natural disasters, civil unrest and denial of service attacks which may lead to the theft of our intellectual property, trade secrets or business disruption. To the extent that any disruption or security breach results in a loss or damage to our data or an inappropriate disclosure of confidential information, it could cause significant damage to our reputation, affect our relationships with our customers, suppliers and employees, lead to claims against the company and ultimately harm our business. Additionally, we may be required to incur significant costs to protect against damage caused by these disruptions or security breaches in the future.
We participate in certain multi-employer pension plans which are not fully funded.
We contribute to certain multi-employer defined benefit pension plans for our union-represented employees in the U.S. in accordance with our collective bargaining agreements. Contributions are based on hours worked except in cases of layoff or leave where we generally contribute based on 40 hours per week for a maximum of one year. The plans are not fully funded as of December 31, 2018. We could be held liable to the plans for our obligation, as well as those of other employers, due to our participation in the plans. Contribution rates could increase if the plans are required to adopt a funding improvement plan, if the performance of plan assets does not meet expectations or as a result of future collectively bargained wage and benefit agreements. (See Note 12 to our consolidated financial statements in Item 8 for additional information on multi-employer pension plans.)
Changes in interest rates and asset returns could increase our pension funding obligations and reduce our profitability.
We have unfunded obligations under certain of our defined benefit pension and other postretirement benefit plans. The valuation of our future payment obligations under the plans and the related plan assets are subject to significant adverse changes if the credit and capital markets cause interest rates and projected rates of return to decline. Such declines could also require us to make significant additional contributions to our pension plans in the future. A material increase in the unfunded obligations of these plans could also result in a significant increase in our pension expense in the future.
We may incur additional tax expense or become subject to additional tax exposure.
Our provision for income taxes and the cash outlays required to satisfy our income tax obligations in the future could be adversely affected by numerous factors. These factors include changes in the level of earnings in the tax jurisdictions in which we operate, changes in the valuation of deferred tax assets and liabilities, changes in our plans to repatriate the earnings of our non-U.S. operations to the U.S. and changes in tax laws and regulations.
In December 2017, the U.S. introduced broad ranging tax reform with the passage of the Tax Cuts and Jobs Act ("Act") legislation. Among the tax reforms was a reduction of the corporate tax rate from 35% to 21%. Although the tax reform in the U.S. reduced the statutory tax rate to 21% for 2018, the effects of the lower rate were offset in part by the effects of increased nondeductible expenses and the global intangible low taxed income (“GILTI”) provisions which result in a certain amount of foreign earnings being subjected to U.S. tax. Considering the exclusion of foreign subsidiary dividends from taxation in the U.S., we believe the Act will provide some greater flexibility to repatriate future earnings of our foreign operations.
Our income tax returns are subject to examination by federal, state and local tax authorities in the U.S. and tax authorities outside the U.S. The results of these examinations and the ongoing assessments of our tax exposures could also have an adverse effect on our provision for income taxes and the cash outlays required to satisfy our income tax obligations.
Our ability to utilize our net operating loss carryforwards may be limited.
Net operating loss carryforwards (NOLs) approximating $362 were available at December 31, 2018 to reduce future U.S. income tax liabilities. Our ability to utilize these NOLs may be limited as a result of certain change of control provisions of the U.S. Internal Revenue Code of 1986, as amended (Code). The NOLs are treated as losses incurred before the change of control upon emergence from Chapter 11 and are limited to annual utilization of $84. There can be no assurance that trading in our
shares will not effect another change in control under the Code, which could further limit our ability to utilize our available NOLs. Such limitations may cause us to pay income taxes earlier and in greater amounts than would be the case if the NOLs were not subject to limitation.
An inability to provide products with the technology required to satisfy customer requirements would adversely impact our ability to successfully compete in our markets.
The vehicular markets in which we operate are undergoing significant technological change, with increasing focus on electrified and autonomous vehicles. These and other technological advances could render certain of our products obsolete. Maintaining our competitive position is dependent on our ability to develop commercially-viable products and services that support the future technologies embraced by our customers.
Failure to appropriately anticipate and react to the cyclical and volatile nature of production rates and customer demands in our business can adversely impact our results of operations.
Our financial performance is directly related to production levels of our customers. In several of our markets, customer production levels are prone to significant cyclicality, influenced by general economic conditions, changing consumer preferences, regulatory changes, and other factors. Oftentimes the rapidity of the downcycles and upcycles can be severe. Successfully executing operationally during periods of extreme downward and upward demand pressures can be challenging. Our inability to recognize and react appropriately to the production cycles inherent in our markets can adversely impact our operating results.
Our continued success is dependent on being able to retain and attract requisite talent.
Sustaining and growing our business requires that we continue to retain, develop and attract people with the requisite skills. With the vehicles of the future expected to undergo significant technological change, having qualified people savvy in the right technologies will be a key factor in our ability to develop the products necessary to successfully compete in the future. As a global organization, we are also dependent on our ability to attract and maintain a diverse work force that is fully engaged supporting our company’s objectives and initiatives.
Failure to maintain effective internal controls could adversely impact our business, financial condition and results of operations.
Regulatory provisions governing the financial reporting of U.S. public companies require that we maintain effective disclosure controls and internal controls over financial reporting across our operations in 33 countries. Effective internal controls are designed to provide reasonable assurance of compliance, and, as such, they can be susceptible to human error, circumvention or override, and fraud. Failure to maintain adequate, effective internal controls could result in potential financial misstatements or other forms of noncompliance that have an adverse impact on our results of operations, financial condition or organizational reputation. Our 2018 acquisition was exempt from certain regulatory internal control compliance requirements this past year, but is required to be compliant in 2019.
Developments in the financial markets or downgrades to Dana's credit rating could restrict our access to capital and increase financing costs.
At December 31, 2018, Dana had consolidated debt obligations of $1,801, with cash and marketable securities of $531 and unused revolving credit capacity of $579. Our ability to grow the business and satisfy debt service obligations is dependent, in part, on our ability to gain access to capital at competitive costs. External factors beyond our control can adversely affect capital markets - either tightening availability of capital or increasing the cost of available capital. Failure on our part to maintain adequate financial performance and appropriate credit metrics can also affect our ability to access capital at competitive prices.
Risk Factors Related to our Securities
Provisions in our Restated Certificate of Incorporation and Bylaws may discourage a takeover attempt.
Certain provisions of our Restated Certificate of Incorporation and Bylaws, as well as the General Corporation Law of the State of Delaware, may have the effect of delaying, deferring or preventing a change in control of Dana. Such provisions, including those governing the nomination of directors, limiting who may call special stockholders’ meetings and eliminating stockholder action by written consent, may make it more difficult for other persons, without the approval of our board of
directors, to make a tender offer or otherwise acquire substantial amounts of common stock or to launch other takeover attempts that a stockholder might consider to be in such stockholder’s best interest.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
As of December 31, 2018, we operated in 33 countries and had 135 major facilities housing manufacturing and distribution operations, service and assembly operations, technical and engineering centers and administrative offices. In addition to the seven stand-alone technical and engineering centers in the table above, we have twelve technical and engineering centers housed within manufacturing sites. We lease 65 of these facilities and own the remainder. We believe that all of our property and equipment is properly maintained.
Our world headquarters is located in Maumee, Ohio. This facility and other facilities in the greater Detroit, Michigan and Maumee, Ohio areas house functions that have global or North American regional responsibility for finance and accounting, treasury, risk management, legal, human resources, procurement and supply chain management, communications and information technology.
Item 3.
Item 3. Legal Proceedings
We are a party to various pending judicial and administrative proceedings that arose in the ordinary course of business. After reviewing the currently pending lawsuits and proceedings (including the probable outcomes, reasonably anticipated costs and expenses and our established reserves for uninsured liabilities), we do not believe that any liabilities that may result from these proceedings are reasonably likely to have a material adverse effect on our liquidity, financial condition or results of operations. Legal proceedings are also discussed in Note 16 to our consolidated financial statements in Item 8.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market information - Our common stock trades on the New York Stock Exchange (NYSE) under the symbol "DAN."
Holders of common stock - Based on reports by our transfer agent, there were approximately 2,945 registered holders of our common stock on January 31, 2019.
Reference is made to the Equity Compensation Plan Information section of Item 12 for certain information regarding our equity compensation plans.
Stockholder return - The following graph shows the cumulative total shareholder return for our common stock since December 31, 2013. The graph compares our performance to that of the Standard & Poor’s 500 Stock Index (S&P 500) and the Dow Jones US Auto Parts Index. The comparison assumes $100 was invested at the closing price on December 31, 2013. Each of the returns shown assumes that all dividends paid were reinvested.
Performance chart
Index
Issuer's purchases of equity securities - Our Board of Directors approved an expansion of our existing common stock share repurchase program from $100 to $200 on March 24, 2018. The program expires on December 31, 2019. We repurchase shares utilizing available excess cash either in the open market or through privately negotiated transactions. The stock repurchases are subject to prevailing market conditions and other considerations. No shares of our common stock were repurchased under the program during the fourth quarter of 2018. Approximately $175 remained available under the program for further share repurchases as of December 31, 2018.
Annual meeting - We will hold an annual meeting of shareholders on May 1, 2019.
Item 6.
Item 6. Selected Financial Data
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Dollars in millions)
Management's discussion and analysis of financial condition and results of operations should be read in conjunction with the financial statements and accompanying notes in Item 8.
Management Overview
We are a global provider of high-technology products to virtually every major vehicle and engine manufacturer in the world. We also serve the stationary industrial market. Our technologies include drive and motion products (axles, driveshafts, planetary hub drives, power-transmission products, transmissions, electric motors, inverters, controls and tire-management products); sealing solutions (gaskets, seals, heat shields and fuel-cell plates); thermal-management technologies (transmission and engine oil cooling, battery and electronics cooling and exhaust-gas heat recovery); and fluid-power products (pumps, valves, motors and controls). We serve our global light vehicle, medium/heavy vehicle and off-highway markets through four business units - Light Vehicle Driveline Technologies (Light Vehicle), Commercial Vehicle Driveline Technologies (Commercial Vehicle), Off-Highway Drive and Motion Technologies (Off-Highway) and Power Technologies, which is the center of excellence for sealing and thermal-management technologies that span all customers in our on-highway and off-highway markets. We have a diverse customer base and geographic footprint which minimizes our exposure to individual market and segment declines. In 2018, 50% of our sales came from North American operations and 50% from operations throughout the rest of the world. Our sales by operating segment were Light Vehicle - 44%, Commercial Vehicle - 20%, Off-Highway - 22% and Power Technologies - 14%.
Operational and Strategic Initiatives
Our enterprise strategy builds on our strong technology foundation and leverages our resources across the organization while maintaining a customer centric focus, expanding our global markets, and accelerating the commercialization of new technology as we evolve into the era of vehicle electrification.
Central to our strategy is leveraging our core operations by sharing our capabilities, technology, assets and knowledge across the enterprise, leading to improved execution and increased customer satisfaction. Through streamlining and rationalizing our manufacturing activities we have significantly improved our profitability and margins, and we believe additional opportunities remain to further optimize our manufacturing footprint and improve our cost performance. Leveraging investments across multiple end markets and making disciplined, value enhancing acquisitions will allow us to bring product to market faster, grow our top-line sales and enhance financial returns.
Strengthening customer centricity and expanding global markets are key elements of our strategy that focus on market penetration. Foundational to growing the business is directing the entire organization to putting the customer at the center of our value system and shifting from transactional to relationship-based interactions. These relationships are built on a foundation of providing unparalleled technology with exceptional quality, delivery and value. With even stronger relationships we will be better positioned to support our customers’ most important global and flagship programs and capitalize on future growth opportunities.
We continue to enhance and expand our global footprint, optimizing it to capture growth across all of our end markets. Specifically, our manufacturing and technology center footprint positions us to support customers globally - an important factor as many of our customers are increasingly focused on common solutions for global platforms. Our acquisition of the Brevini operations in 2017 (see Acquisitions section below) provided us with operational presence in eight additional countries, while also providing us with additional opportunities to leverage our global footprint to support the needs across all our businesses. Shortly following the acquisition, we were able to consolidate certain Brevini activities in China, allowing us to utilize an acquired facility to support our Power Technologies business in China.
While growth opportunities are present in each region of the world, we have a primary focus on building our presence and local capability in the Asia Pacific region. Over the last few years, we have opened two new engineering facilities in the region, gear manufacturing facilities in India and Thailand, and are currently developing a new light vehicle assembly facility in China that is scheduled to commence operations in 2019.
In addition to Asia, we see further growth opportunity in Eastern Europe. A new gear manufacturing facility in Hungary commenced operations in 2018. This is our third facility in the country and will give us the capability to cost effectively manufacture gears, one of our core technologies, and efficiently service our customers within the region.
The final two elements of our enterprise strategy, commercializing new technology and accelerating hybridization and electrification, focus on opportunities for product expansion. Bringing new innovations to market as industry leading products will drive growth as our new products and technology provide our customers with cutting-edge solutions, address end user needs and capitalize on key market trends. An example is our industry leading electronically disconnecting all-wheel drive technology, which we believe is the most fuel efficient rapidly disconnecting system in the market, which will be utilized on a Ford Motor Company global vehicle platform - opening up new commercial channels for us in the passenger car, crossover and sport utility vehicle markets. The above-referenced new assembly facility in China will support this new program. We are continuing to re-purpose our internal resources to focus additional efforts on advancing technologies that will support our electrification initiatives, while also advancing additive manufacturing and other disruptive technologies.
Initiatives to capitalize on evolving hybridization and electrification vehicle trends are a core ingredient of our current strategy. In addition to our current technologies in battery cooling and fuel cells, this element of our strategy is leveraging our electronics controls expertise across all our business units and applications such as advanced vehicle hybridization and electrification initiatives. We are working with customers to develop new solutions for those markets where electrification will be adopted first such as hybrids, buses and urban delivery vehicles. These new solutions, which include advanced electric propulsion systems with fully integrated motors and controls, are included in our recently launched Spicer® Electrified™ portfolio of products. Working with our joint venture partner, our latest integrated e-axle was launched during the first quarter
of 2018 in a bus application in China. Our investment in TM4 Inc. (TM4) in June 2018 (see Acquisitions section below) adds electric motors, power inverters and control systems to our product portfolio enhancing our range of hybrid and electric vehicle solutions for customers across all three of our end markets.
The development and implementation of our enterprise strategy is positioning Dana to grow profitably due to increased customer focus as we leverage our core capabilities, expand into new markets, develop and commercialize new technologies including for hybrid and electric vehicles.
Capital Structure Initiatives
In addition to investing in our business, we plan to continue prioritizing the allocation of capital to reduce debt and maintain a strong financial position. In January 2018, we announced our intention to drive toward investment grade metrics as part of a balanced approach to our capital allocation priorities and our goal of further strengthening our balance sheet.
Shareholder return actions - When evaluating capital structure initiatives, we balance our growth opportunities and shareholder value initiatives with maintaining a strong balance sheet and access to capital. Our strong financial position has enabled us to simplify our capital structure while providing returns to our shareholders in the form of cash dividends and a reduction in the number of shares outstanding. From program inception in 2012 through December 31, 2017, we returned $1,481 of cash to shareholders by redeeming all of our preferred stock and repurchasing common shares. We repurchased approximately 74 million shares, inclusive of the common share equivalent reduction resulting from redemption of preferred shares. With the availability under the previous authorization having expired, our Board of Directors authorized a new $200 share repurchase program effective in 2018 which expires at the end of 2019. During 2018, we used cash of $25 to repurchase common shares under the current program. We declared and paid quarterly common stock dividends over the past five and a half years, raising the dividend from five cents to six cents per share in the second quarter of 2015. In recognition of our strong financial performance and confidence in our financial outlook, our Board approved an additional four cents per share increase in the quarterly dividend to ten cents per share in 2018.
Financing actions - We have taken advantage of the lower interest rate environment to complete refinancing transactions that resulted in lower effective interest rates while extending maturities. In 2017, we completed a $400 2025 note offering and entered into a $275 floating rate term loan. The proceeds of these issuances were used to repay higher cost international debt and to repay $450 of 2021 notes. In connection with amending our credit agreement to effectuate the term loan, we also increased our revolving credit facility by $100, providing us with $600 of back-up liquidity through 2022. Additionally, in 2017 we commenced the process of terminating one of our U.S. pension plans. This action allows us to effectively eliminate pension obligations for the terminated plan and the associated future funding risk associated with interest rate and other market developments. We expect the termination action to be completed in 2019.
Other Initiatives
Aftermarket opportunities - We have a global group dedicated to identifying and developing aftermarket growth opportunities that leverage the capabilities within our existing businesses - targeting increased future aftermarket sales. In January 2016, we completed the acquisition of Magnum® Gaskets' (Magnum) aftermarket distribution business, providing us access to new customers for sealing products and an additional aftermarket channel for other products. Powered by recognized brands such as
Dana®, Spicer®, Victor Reinz®, Glaser®, GWB®, Thompson®, Tru-Cool®, SVL®, and Transejes™, Dana delivers a broad range of aftermarket solutions - including genuine, all makes, and value lines - servicing passenger, commercial and off-highway vehicles across the globe.
Selective acquisitions - Although transformational opportunities like the GKN plc driveline business transaction that we pursued in 2018 will be considered when strategically and economically attractive, our acquisition focus is principally directed at “bolt-on” or adjacent acquisition opportunities that have a strategic fit with our existing core businesses, particularly opportunities that support our enterprise strategy and enhance the value proposition of our product offerings. Any potential acquisition will be evaluated in the same manner we currently consider customer program opportunities and other uses of capital - with a disciplined financial approach designed to ensure profitable growth and increased shareholder value.
Re-focusing advanced technology resources - When we obtained Variglide® planetary variator technology through an acquisition in 2012, the intended market focus was continuously variable transmissions for combustion engine vehicle applications. With potential key customers for this technology shifting their focus to electrification and other areas, we determined that it was appropriate to fully impair the related $20 in-process research and development intangible asset that was recorded as part of the 2012 acquisition.
Acquisitions
SME - On January 11, 2019, we acquired a 100% ownership interest in the S.M.E. S.p.A. (SME). SME designs, engineers, and manufactures low-voltage AC induction and synchronous reluctance motors, inverters, and controls for a wide range of off-highway electric vehicle applications, including material handling, agriculture, construction, and automated-guided vehicles. The addition of SME's low-voltage motors and inverters, which are primarily designed to meet the evolution of electrification in off-highway equipment, significantly expands Dana's electrified product portfolio.
We paid $88 at closing, consisting of $62 in cash on hand and a note payable of $26 which allows for net settlement of potential contingencies as defined in the purchase agreement. The note is payable in five years and bears annual interest of 5%.
Oerlikon Drive Systems - On July 30, 2018, we entered into a definitive agreement to purchase the Drive Systems segment of the Oerlikon Group (Oerlikon Drive Systems). Oerlikon Drive Systems is a global manufacturer of high-precision gears, planetary hub drives for wheeled and tracked vehicles, and products, controls, and software that support vehicle electrification across the mobility industry. The business employs approximately 5,900 people and operates 10 manufacturing and engineering facilities in China, India, Italy, the United Kingdom, and the United States, with two additional facilities under construction in China. The results of operations of Oerlikon Drive Systems will be reported in our Off-Highway operating segment from the date of acquisition.
Under the terms of the agreement, we will acquire Oerlikon Drive Systems for approximately 625 Swiss francs, inclusive of required settlements of outstanding debt obligations Oerlikon Drive Systems has with Oerlikon Group. Committed financing has been arranged to complete the transaction. We entered into a Swiss franc notional deal contingent forward to economically hedge the purchase price. Subject to customary regulatory approval, the acquisition is expected to close in the first quarter of 2019.
TM4 - On June 22, 2018, we acquired a 55% ownership interest in TM4 from Hydro-Québec. TM4 designs and manufactures motors, power inverters and control systems for electric vehicles, offering a complementary portfolio to Dana's electric gearboxes and thermal-management technologies for batteries, motors and inverters. The transaction establishes Dana as the only supplier with full e-Drive design, engineering and manufacturing capabilities - offering electro mechanical propulsion solutions to each of our end markets. TM4's technology and advanced manufacturing facility in Boucherville, Quebec will add to our global technical centers, and their 50% interest in a China joint venture provides an opportunity to enhance our position in the fastest growing market for electric vehicles. Inclusive of the joint venture, TM4 has approximately 140 employees. Dana is consolidating TM4 as the governing documents provide Dana with a controlling financial interest. The TM4 acquisition added $11 of sales and de minimis adjusted EBITDA in 2018. The results of operations of the TM4 business are reported in our Commercial Vehicle operating segment from the date of acquisition.
Cash on hand of $125 was used to acquire the interest in TM4. Reference is made to Note 2 of the consolidated financial statements in Item 8 for the allocation of purchase consideration to assets acquired and liabilities assumed.
USM - Warren - On March 1, 2017, we completed the purchase of Warren Manufacturing LLC (USM - Warren), which holds certain assets and liabilities of the former Warren, Michigan production unit of U.S. Manufacturing Corporation (USM). With this transaction, we acquired proprietary tube-manufacturing processes and light-weighting intellectual property for axle tubes
and shafts. Significant content was previously purchased from USM. Vertically integrating this content strengthens the supply chain for several of our most strategic customers. The new product and process technologies for light-weighting will assist our customers in achieving their sustainability and fuel efficiency goals. The USM - Warren acquisition added $96 of sales and $12 of adjusted EBITDA in 2017. The results of operations of the USM - Warren business are reported within our Light Vehicle operating segment.
We paid $104 for this business at closing, including $25 to effectively settle trade payable obligations originating from product purchases Dana made from USM prior to the acquisition. No debt was assumed with this transaction which was funded using cash on hand. Post-closing purchase price adjustments for working capital and other items, which totaled less than $1, were received in last year's third quarter. Reference is made to Note 2 of the consolidated financial statements in Item 8 for the allocation of purchase consideration to assets acquired and liabilities assumed.
BFP and BPT - On February 1, 2017, we acquired 80% ownership interests in Brevini Fluid Power S.p.A. (BFP) and Brevini Power Transmission S.p.A. (BPT) from Brevini Group S.p.A. (Brevini). The acquisition expands our Off-Highway operating segment product portfolio to include technologies for tracked vehicles, doubling our addressable market for off-highway driveline systems and establishing Dana as the only off-highway solutions provider that can manage the power to both move the equipment and perform its critical work functions. This acquisition also brings a platform of technologies that can be leveraged in our light and commercial vehicle end markets, helping to accelerate our hybridization and electrification initiatives. The BFP and BPT acquisitions added $401 of sales and $40 of adjusted EBITDA in 2017. The results of operations of these businesses are reported within our Off-Highway operating segment.
We paid $181 at closing using cash on hand and assumed debt of $181 as part of the transaction. In December 2017, a purchase price reduction of $9 was agreed under the sale and purchase agreement provisions for determination of the net indebtedness and net working capital levels of BFP and BPT as of the closing date. In connection with the acquisition of BFP and BPT, Dana agreed to purchase certain real estate being leased by BPT from a Brevini affiliate for €25. Completion of the real estate purchase and receipt of the purchase price adjustment occurred in this year's second quarter with a net cash payment of $20. Reference is made to Note 2 of the consolidated financial statements in Item 8 for the allocation of purchase consideration to assets acquired and liabilities assumed.
On August 8, 2018, we entered into an agreement to acquire Interfind S.p.A.'s, formerly Brevini Group S.p.A., remaining 20% ownership interests in BFP and BPT and to settle all claims between the parties. We paid $43 to acquire Interfind S.p.A.'s remaining ownership interests and received $10 in settlement of all pending and future claims.
SIFCO - On December 23, 2016, we acquired strategic assets of the commercial vehicle steer axle systems and related forged components businesses of SIFCO. The acquisition enables us to enhance our vertically integrated supply chain, which will further improve our cost structure and customer satisfaction by leveraging SIFCO's extensive experience and knowledge of sophisticated forged components. In addition to strengthening our position as a central source for products that use forged and machined parts throughout the region, this acquisition enables us to better accommodate the local content requirements of our customers, which reduces their import and other region-specific costs.
As part of the acquisition, we added two manufacturing facilities and approximately 1,400 employees. The strategic assets were acquired by Dana free and clear of any liens, claims or encumbrances and without assumption of any legacy liabilities of SIFCO. We had sales of $86 in 2016 resulting from business conducted under the previous supply agreement with SIFCO. The additional business relationships obtained as a result of the acquisition generated incremental sales of $44 in 2017. The results of operations of the SIFCO related business are reported within our Commercial Vehicle operating segment.
The SIFCO purchase price was $70, with the payment of $10 of the purchase price deferred until December 2017 pending any claims under indemnification provisions of the purchase agreement. In December 2017, the parties to the SIFCO transaction entered into a settlement agreement. Under this agreement, $3 was paid to the seller with the remaining deferred purchase price of $7 being retained by Dana to settle indemnification claims. During 2018, claim settlements reduced the retained purchase price by $3. After the settlement of all indemnification claims, any remaining deferred purchase price will be paid to the seller.
Magnum - On January 29, 2016, we acquired the aftermarket distribution business of Magnum, a U.S.-based supplier of gaskets and sealing products for automotive and commercial vehicle applications, for a cash payment of $18. Assets acquired included trademarks and trade names, customer relationships and goodwill. The results of operations of Magnum are reported within our Power Technologies operating segment.
Divestitures
Brazil Suspension Components Operations - In December 2017, we entered into an agreement to divest our Brazil suspension components business (the disposal group). This business was non-core to our enterprise strategy and under-performing financially. As such, we agreed to divest the business for no consideration and contribute $10 of additional cash to the business prior to closing. We classified the disposal group as held for sale at December 31, 2017, recognizing a $27 loss to adjust the carrying value of the net assets to fair value and to recognize the liability for the additional cash required to be contributed to the business prior to closing. During the first quarter of 2018, we made the required cash contribution to the disposal group. After being unable to complete the transaction with the counterparty to the December 2017 agreement, we entered into an agreement with another third party in June 2018. The transaction with the new counterparty closed in July 2018 and we received cash proceeds of $2. We reversed $3 of the previously recognized $27 pre-tax loss, inclusive of the proceeds received in July 2018, during the second quarter of 2018. Reference is made to Note 3 of our consolidated financial statements in Item 8 for additional information. Sales of the divested business approximated $23 in 2017 and $12 in 2018 through the date of sale.
Nippon Reinz - On November 30, 2016, we sold our 53.7% interest in Nippon Reinz Co. Ltd. (Nippon Reinz) to Nichias Corporation. Dana received net cash proceeds of $5 and recognized a pre-tax loss of $3 on the divestiture of Nippon Reinz, inclusive of the derecognition of the related noncontrolling interest. Nippon Reinz had sales of $42 in 2016 through the transaction date.
Dana Companies - On December 30, 2016, we completed the divestiture of Dana Companies, LLC (DCLLC), a consolidated wholly-owned limited liability company that was established as part of our reorganization in 2008 to hold and manage personal injury asbestos claims retained by the reorganized Dana Corporation, which was merged into DCLLC. The assets of DCLLC at time of sale included cash and marketable securities along with the rights to insurance coverage in place to satisfy a significant portion of its liabilities. We received net cash proceeds of $29 at closing on December 30, 2016, with $3 retained by the purchaser subject to the satisfaction of certain future conditions. We recognized a pre-tax loss of $77 in 2016 upon completion of the transaction. We received payment of the retained $3 in the second quarter of 2017 and recognized such amount as income. Following completion of the sale, Dana has no obligation with respect to current or future asbestos claims. The sale of this business also enhanced our available liquidity since the net proceeds from the sale are available for use in our core businesses.
Segments
We manage our operations globally through four operating segments. Our Light Vehicle and Power Technologies segments primarily support light vehicle original equipment manufacturers (OEMs) with products for light trucks, SUVs, CUVs, vans and passenger cars. The Commercial Vehicle segment supports the OEMs of on-highway commercial vehicles (primarily trucks and buses), while our Off-Highway segment supports OEMs of off-highway vehicles (primarily wheeled vehicles used in construction, mining and agricultural applications).
Trends in Our Markets
Global Vehicle Production
North America
Light vehicle markets - Improving economic conditions during the past few years have contributed to strong light vehicle sales and production levels in North America. Overall economic conditions in North America have been relatively favorable with improving employment levels, strong consumer confidence levels and comparatively low/stable fuel prices. Strong sales levels the past few years have significantly reduced the built-up demand to replace older vehicles. As such, the overall North America light vehicle market began to show signs of weakening demand levels in 2017, with total light vehicle sales declining about 2% from 2016. To date, these effects have been most notable in passenger car sales which declined about 5% in 2016 and another 9% in 2017. Light vehicle sales in 2018 were down slightly compared with 2017, with higher light truck sales being offset by lower passenger car sales. Helped by continued low fuel prices, light truck market demand has been relatively strong. In the full frame light truck segment where many of our programs are focused, sales increased about 6% in 2016 and another 3% in 2017. Full frame light truck sales for 2018 were about 3% higher than 2017. Production levels have generally been reflective of light vehicle sales. Production of approximately 17.8 million light vehicles in 2016 declined about 4% to 17.1 million units in 2017. Light vehicle production of 17.0 million units in 2018 was comparable with 2017. Light vehicle engine production was impacted more by the developments in the passenger car segment, with production in 2017 declining about 7% versus 2016 after increasing 3% year-over-year in 2016. Light vehicle engine production increased about 3% in 2018 compared to 2017. In the key full frame light truck segment, production levels in 2017 increased about 3% compared to 2016 following an increase of 7% in 2016 from the preceding year. 2018 full frame truck production was about 4% higher compared to 2017. Days' supply of total light vehicles in the U.S. at the end of December the past three years has been around 61 to 62 days. In the full frame light truck segment, days supply in inventory at December 31, 2018 approximated 72 days, up from 64 days at December 31, 2017 and 65 days at the end of December 2016.
The North America light truck markets are expected to decline in 2019, with the effect of stable manufacturing and construction environments being offset by the impact of rising interest rates, less pent-up demand, increasing demand for used vehicles and higher levels of consumer debt. We expect Dana sales to continue to benefit from our net new business backlog as
additional key customer programs commence production in 2019, more than offsetting lower overall light truck demand. Our current outlook for 2019 has full frame light truck production at 4.3 to 4.6 million vehicles, up 2% to down 5% compared with 2018 production of about 4.5 million vehicles. We expect light vehicle engine production in 2019 to be 14.7 to 15.0 million units, down 2 to 4% compared to 2018.
Medium/heavy vehicle markets - The commercial vehicle market is similarly impacted by many of the same macroeconomic developments impacting the light vehicle market. Production levels in the heavy truck segment were scaled back in 2016 in response to there being more trucks in service than required for freight demand. Class 8 production in 2016 declined 29% from 2015 while medium duty Classes 5-7 production was relatively stable. With the improving economic conditions in 2017 and scaled down build in 2016, there was increased freight-hauling demand and a strengthening order book for new trucks. Class 8 unit production was up about 12% from 2016 while medium-duty production was about 6% higher. As expected, strong demand has continued into 2018, with Class 8 production up 25% and medium-duty truck production being up 10% compared to 2017.
Class 8 order levels continue to be solid, positioning 2019 to be a strong production year. With the strong Class 8 order book and an expectation that the North America economic environment will continue to be strong in 2019, our outlook for 2019 Class 8 production in North America is 325,000 to 345,000 trucks, a level which is up about 2 to 8% compared with the 2018 build level. After two years of consecutive growth in the medium duty segment, we expect full year 2019 production to be in the range of 255,000 to 265,000 vehicles, down 2 to 6% from 2018.
Markets Outside of North America
Light vehicle markets - Signs of an improved overall European economy have been evident, albeit mixed at times, during the past few years. Reflective of a modestly improved economy, light vehicle production levels have increased with light vehicle engine production being up about 3% in both 2016 and 2017, and light truck production being higher by 9 to 10% in 2016 and 2017. Overall market stability continued in 2018 as light vehicle engine production was down 4% and light truck production was up 4%. The United Kingdom's decision to withdraw from the European Union, along with political developments in other European countries, continues to cast an element of uncertainty around continued economic improvement in the region. At present, we expect overall stable to improving economic conditions across the entire region in 2019. Our full year 2019 outlook expects an increase in light truck and light vehicle engine production of around 3 to 7% from 2018. The economic climate in many South American markets the past few years has been weak, volatile and challenging. After significant production declines in 2014 and 2015, there were signs that demand levels had bottomed out in 2016. Production levels in 2017 and 2018 were reflective of an improving market, with light vehicle engine production up 14% and 16% and light truck production up 26% and 7%, respectively. At present, we expect further economic recovery in the region in 2019. Our full year 2019 outlook has light truck production down 2% to up 14% from 2018, with light vehicle engine production up 7 to 11% compared to this past year. The Asia Pacific markets have been relatively strong the past few years. Light truck production increased 14% in 2016 and was up another 7% in 2017, while light vehicle engine production increased 7% in 2016 and another 4% in 2017. Production leveled off in 2018, with both light truck and light vehicle engine production being flat compared to 2017 levels. Our full year 2019 outlook for the Asia Pacific light vehicle markets is for continued strong production levels, with the light truck segment up 3 to 7% from 2018 and light engine production being up 5 to 7%.
Medium/heavy vehicle markets - Some of the same factors referenced above that affected light vehicle markets outside of North America similarly affected the medium/heavy markets. A strengthening European market the past three years contributed to medium/heavy truck production increasing 7% in 2016, 5% in 2017 and another 4% in 2018. Our 2019 full year outlook anticipates continued strong production at levels relatively comparable with 2018. A weakening South America economic climate beginning in 2014 led to a significant decline in medium/heavy truck production in 2015 and 2016. As with the light vehicle markets, improving economic conditions in the region led to medium/heavy truck production increasing 27% in 2017 and an additional 27% in 2018. We expect economic conditions to be relatively stable in 2019, with medium/heavy truck production being down 7% to up 2% compared to 2018. A stronger than expected China market and an improving India market contributed to increases in medium/heavy truck production in the Asia Pacific region of about 20% in 2016 and another 23% in 2017. Production levels in 2017 were driven partly by regulatory changes in China limiting axle load and weight. With some pre-buy in 2017 having likely occurred during the second half of 2017 as a result of the China regulatory actions and some weakening in this past year's China market, 2018 medium/heavy truck production was down 2% from 2017. Our full year 2019 outlook reflects a continued downward trend with medium/heavy truck production being down 5 to 15% from 2018, reflecting modal transportation shifts and technology advances putting downward pressure on medium/heavy truck demand.
Off-Highway Markets - Our off-highway business has a large presence outside of North America, with more than 75% of its sales coming from Europe and more than 10% from South America and Asia Pacific combined. We serve several segments of the diverse off-highway market, including construction, agriculture, mining and material handling. Our largest markets are the
construction/mining and agricultural equipment segments which had been relatively weak for several years until beginning to rebound in 2017. Global demand in the agriculture market was down about 11% in 2014, 7% in 2015 and 5% in 2016. The construction/mining segment weakened about 4% in 2014, 11% in 2015 and 3% in 2016. These markets began to rebound in 2017 along with general economic recovery in several global markets, and in particular the European markets where this segment has a significant presence. During 2017, global production levels in the construction/mining and agriculture segments increased by about 8% and 2%. The uplift in market demand continued in 2018 with global production levels in the construction/mining and agriculture segments increasing an additional 13% and 1%, respectively. With generally stable to improving economic conditions in all regions, further strengthening of demand is expected in 2019. Our 2019 outlook has production in the construction/mining segment flat to up 4% and the agriculture segment being down 2% to up 5% from 2018.
Foreign Currency
With 56% of our sales coming from outside the U.S., international currency movements can have a significant effect on our sales and results of operations. The euro zone countries and Brazil accounted for 46% and 9% of our 2018 non-U.S. sales, respectively, while Thailand, Mexico and China each accounted for 7%. Although sales in Argentina and South Africa are each less than 5% of our non-U.S. sales, exchange rate movements of those countries have been volatile and significantly impacted sales from time to time. Translation of our international activities at average exchange rates in 2016 as compared to average rates in 2015 reduced sales by $173. A weaker Argentine peso, British pound, Mexican peso, South African rand and Brazilian real reduced sales by $70, $23, $19, $18 and $11, while the euro was relatively stable in 2016. International currencies strengthened against the U.S. dollar in 2017, increasing 2017 sales by $54. A stronger euro, Brazilian real, Thai baht and South African rand more than offset a weaker Argentine peso. Overall international currencies continued to strengthen against the U.S. dollar in 2018, with sales increasing by $16 principally due to a stronger euro, Thai baht and Chinese renminbi, partially offset by a weaker Brazilian real, Argentine peso and Indian rupee. Based on our current sales and exchange rate outlook for 2019, we expect overall stability in international currencies with a modest reduction to sales. At sales levels in our current outlook for 2019, a 5% movement on the euro would impact our annual sales by approximately $110. A 5% change on the Brazilian real, Thai baht, Mexican peso, Chinese yuan, British pound and Indian rupee rates would impact our annual sales in each of those countries by approximately $10 to $20.
During the second quarter of 2018, we determined that Argentina's economy met the GAAP definition of a highly inflationary economy. In assessing Argentina's economy as highly inflationary we considered its three-year cumulative inflation rate along with other factors. As a result, effective July 1, 2018, the U.S. dollar is the functional currency for our Argentine operations, rather than the Argentine peso. Beginning July 1, 2018, peso-denominated monetary assets and liabilities are remeasured into U.S. dollars using current Argentine peso exchange rates with resulting translation gains or losses included in results of operations. Nonmonetary assets and liabilities are remeasured into U.S. dollar using historic Argentine peso exchange rates. Reference is made to Note 1 of our consolidated financial statements in Item 8 for additional information.
International Markets
Trade actions initiated by the U.S. imposing tariffs on imports have been met with retaliatory tariffs by other countries, adding a level of tension and uncertainty to the global economic environment. In November 2018, the U.S., Mexico and Canada executed the U.S.-Mexico-Canada Agreement (USMCA), the successor agreement to the North American Free Trade Agreement. The draft agreement submitted for ratification includes the imposition of tariffs on vehicles that do not meet regional raw material (steel and aluminum), part and labor content requirements. These and other actions are likely to impact trade policies with other countries and the overall global economy. The United Kingdom's decision to exit the European Union ("Brexit") continues to provide some uncertainty and potential volatility around European currencies, along with uncertain effects of future trade and other cross-border activities of the United Kingdom with the European Union and other countries.
The Brazil market is an important market for our Commercial Vehicle segment, representing about 19% of this segment's 2018 sales. Our medium/heavy truck sales in Brazil account for approximately 79% of our total sales in the country. Reduced market demand resulting from the weak economic environment in Brazil in 2015 led to production levels in the light vehicle and medium/heavy duty truck markets that were lower by about 22% and 44% from 2014. Continued weakness in 2016 resulted in further reductions in medium/heavy truck production of about 20% and a light vehicle production decline of around 10%. As a consequence, sales by our operations in Brazil for 2016 approximated $200, down from about $500 in 2014. In response to the challenging economic conditions in this country, we implemented restructuring and other cost reduction actions and reduced costs to the extent practicable. As discussed in Note 2 to our consolidated financial statements in Item 8, we completed a transaction in December 2016 that provided us with the underlying assets and personnel supporting our pre-existing business with a supplier along with some incremental business. With this transaction, we have enhanced our competitive position in the market and should benefit as the Brazilian markets continue to recover. The Brazilian economy rebounded in 2017, leading to increased medium/heavy truck and light truck production of more than 25% from 2016 in each
of those segments. Economic improvement and increased production continued in 2018. Sales in 2018 were up 15% from 2017 as medium/heavy truck production was 27% higher than 2017 and light truck production was up about 7% from last year. Further economic improvement and increased production is expected in 2019.
As indicated above, Argentina has experienced significant inflationary pressures the past few years, contributing to significant devaluation of its currency among other economic challenges. Our Argentine operation supports our Light Vehicle operating segment. Our sales in Argentina for 2018 of approximately $125 are less than 2% of our consolidated sales and our net asset exposure related to Argentina was approximately $20, including $7 of net fixed assets, at December 31, 2018.
Commodity Costs
The cost of our products may be significantly impacted by changes in raw material commodity prices, the most important to us being those of various grades of steel, aluminum, copper and brass. The effects of changes in commodity prices are reflected directly in our purchases of commodities and indirectly through our purchases of products such as castings, forgings, bearings and component parts that include commodities. During 2018, commodity prices have been impacted by recently imposed tariffs. Suppliers directly impacted by the tariffs are attempting to pass through the cost of the tariffs while suppliers not subject to the tariffs are advantaging themselves by raising prices. Most of our major customer agreements provide for the sharing of significant commodity price changes with those customers based on the movement in various published commodity indexes. Where such formal agreements are not present, we have historically been successful implementing price adjustments that largely compensate for the inflationary impact of material costs. Material cost changes will customarily have some impact on our financial results as customer pricing adjustments typically lag commodity price changes.
Prices for commodities such as steel and aluminum have risen over the past year, in part due to strong global demand and more recently due to imposition of tariffs on these products. Higher commodity prices reduced year-over-year earnings in 2018 by approximately $115, as compared to year-over-year earnings reductions of $70 from higher commodity prices in 2017. Material recovery and other pricing actions increased earnings $80 compared to last year, whereas pricing and recovery actions increased year-over-year earnings in 2017 by $11.
U.S. Tax Reform
In December 2017, the U.S. introduced broad ranging tax reform with the passage of the Tax Cuts and Jobs Act ("Act") legislation. Among the tax reforms was a reduction of the corporate tax rate from 35% to 21%. Historically, we've recognized a net deferred tax asset in the U.S. for items providing future net reductions of taxable income. These deferred tax assets are valued based on the corporate tax rate expected to be available when the deductions are taken. With enactment of the lower corporate tax rate in the U.S. in 2017, we recorded a charge to tax expense in the fourth quarter of 2017 to reduce the value of these net deferred tax assets. The effect of the rate reduction on net deferred tax assets in combination with other provisions of the Act resulted in a net non-cash increase in 2017 income tax expense of $186. Among the tax reform provisions was a transitional U.S. tax assessed on undistributed earnings of foreign operations. Since we were able to utilize existing tax attributes to offset this transitional tax liability, adoption of the Act's provisions did not give rise to any cash taxes.
Although the tax reform in the U.S. reduced the statutory tax rate to 21% beginning in 2018, the effects of the lower rate are offset in part by the effects of increased nondeductible expenses and the global intangible low taxed income (“GILTI”) provisions which result in a certain amount of foreign earnings being subjected to U.S. tax. Considering the exclusion of foreign subsidiary dividends from taxation in the U.S., we believe the Act will provide some greater flexibility to repatriate future earnings of our foreign operations.
Sales, Earnings and Cash Flow Outlook
*
Assumes Oerlikon Drive Systems acquisition transaction closes during the first quarter of 2019.
Adjusted EBITDA and adjusted free cash flow are non-GAAP financial measures. See the Non-GAAP Financial Measures discussion below for definitions of our non-GAAP financial measures and reconciliations to the most directly comparable U.S. generally accepted accounting principles (GAAP) measures. We have not provided a reconciliation of our adjusted EBITDA outlook to the most comparable GAAP measure of net income. Providing net income guidance is potentially misleading and not practical given the difficulty of projecting event driven transactional and other non-core operating items that are included in net income, including restructuring actions, asset impairments and certain income tax adjustments. The accompanying reconciliations of these non-GAAP measures with the most comparable GAAP measures for the historical periods presented are indicative of the reconciliations that will be prepared upon completion of the periods covered by the non-GAAP guidance.
We experienced declines in total sales in 2016 due to weaker international currencies relative to the U.S. dollar. Adjusted for currency, sales in 2016 were relatively comparable to the prior year, with new customer programs largely offsetting the impacts of overall weaker end user demand across our global businesses. We experienced uneven end user markets, with some being relatively strong and others somewhat weak, and the conditions across the regions of the world differing quite dramatically. The 24% increase in sales during 2017 was driven primarily by acquisitions and stronger market demand. Acquisitions, net of divestitures, added $500 of sales, while stronger market demand and contributions from new customer programs increased sales by $829 - an organic increase of 14%. In 2017, international currencies were relatively stable, providing a $54 benefit to sales. Sales increased an additional $934, or 13%, in 2018, reflecting continued strong market demand and the contribution of net new business backlog. Strong off-highway, commercial vehicle and light truck demand combined with net new business of about $300, drove 2018 organic growth of $861, or 12%. International currencies and acquisition and divestiture activities had a negligible impact on 2018 sales. Our 2019 sales outlook is $8,950 to $9,350, with sales growth coming principally from our anticipated acquisition of Oerlikon Drive Systems and the realization of $350 of net new business backlog. We expect impact of international currencies to be negligible, consistent with this past year.
Adjusted EBITDA margin as a percent of sales remained relatively constant at around 11% in 2016 despite certain markets being weak and volatile. We continue to focus on margin improvement through right sizing and rationalizing our manufacturing operations, leveraging resources across the global organization, implementing other cost reduction initiatives and ensuring that customer programs are competitively priced. We achieved adjusted EBITDA margin growth in 2017 as we benefited from the operating leverage attributable to increased sales volumes, while at the same time integrating several acquisitions. Increased commodity prices adversely impacted 2018 earnings and adjusted EBITDA margin. Although we recovered a substantial share of the increased cost, with the customary lag from incurrence of the higher cost to recovery, approximately $35 was not recovered by the end of 2018. Much of the adverse earnings impact of higher commodity costs and supply chain pressures of operating at strong levels of market demand were offset with material cost savings, acquisition synergies and other cost reductions. As such, our adjusted EBITDA margin for 2018 was 11.8%, a 20 basis point improvement over 2017. At our current sales outlook for 2019, we expect full year 2019 adjusted EBITDA to approximate $1,085 to $1,165. Adjusted EBITDA Margin is expected to exceed 12%, as we benefit from higher margin net new business and synergies related to our acquisition of Oerlikon Drive Systems more than offsetting higher commodity costs and increased investment we expect to make in 2019 to support our electrification strategy.
We have generated positive adjusted free cash flow in recent years while increasing capital spending to support organic business growth through launching new business with customers. Reduced adjusted free cash flow in 2016 was primarily attributable to our continued success in being awarded significant new customer programs. Although many of the program wins were not scheduled to begin production until 2018, certain of these programs required capital investment beginning in 2016. As such, cash used for capital investments in 2016 was $62 higher than in 2015. As planned, an elevated level of capital spending at around 5.5% of sales continued into 2017 to support new customer programs. Despite an increase in capital spending of $71 in 2017, free cash increased by $99, primarily from a stronger earnings performance which contributed to increased operating cash flows of $170. Adjusted free cash flow increased $82 in 2018, with benefits from increased operating earnings and lower required capital investment being partially offset by higher working capital requirements associated with increased sales and production levels. We expect to generate adjusted free cash flow of approximately $275, or 3% of sales for 2019. The benefit of continued growth in adjusted EBITDA in 2019 will be partially offset by higher integration costs associated with our anticipated acquisition of Oerlikon Drive Systems. We expect capital spending in 2019 to be around 4% of sales, consistent with 2018. While required capital spending to support new customer programs has begun to dissipate, we are expecting additional capital investment associated with the Oerlikon Drive Systems acquisition.
Among our operational and strategic initiatives are increased focus on and investment in product technology - delivering products and technology that are key to bringing solutions to issues of paramount importance to our customers. Our success on this front is measured, in part, by our sales backlog - net new business received that will be launching in the future and adding to our base annual sales. This backlog excludes replacement business and represents incremental sales associated with new programs for which we have received formal customer awards. At December 31, 2018, our sales backlog of net new business for the 2019 through 2021 period was $700. We expect to realize $350 of our sales backlog in 2019, with incremental sales
backlog of $200 and $150 being realized in 2020 and 2021, respectively. Our three-year sales backlog at December 31, 2018 reflects continued new business wins, as the expected impact of revised market volumes and currency effects were minimal.
Consolidated Results of Operations
Summary Consolidated Results of Operations (2018 versus 2017)
Sales - The following table shows changes in our sales by geographic region.
Sales in 2018 were $934 higher than in 2017. Stronger international currencies increased sales by $16, principally due to a stronger euro, Thai baht and Chinese renminbi, partially offset by a weaker Brazilian real, Argentine peso and Indian rupee. The acquisitions of the Brevini and USM operations which occurred in the first quarter of 2017 and TM4 which occurred in the second quarter of 2018, net of the divestiture of the Brazil suspension components business in the third quarter of 2018, generated a year-over-year increase in sales of $57. The organic sales increase of $861, or 12%, resulted from stronger light truck markets, strengthening global off-highway demand, stronger medium/heavy truck markets and contributions from new business. Pricing actions, including material commodity price and inflationary cost recovery added sales of $80.
The North America organic sales increase of 10% was driven principally by stronger production levels on certain of our key light truck programs. Overall full-frame light truck production was up 4% compared with last year. In addition, certain of our key programs had higher production levels, with one of these programs producing outgoing model vehicles along with new model vehicles during this year's first quarter. Stronger medium/heavy truck production in 2018 of about 18%, with Class 8 trucks up more than 25% and Classes 5-7 up about 10%, also contributed to higher organic sales.
A stronger euro increased sales in Europe due to currency effects. Excluding currency and acquisition effects, sales in Europe were 10% higher than in 2017. With our significant Off-Highway presence in the region, increased market demand in this segment was a major contributor. Organic sales in this operating segment were up about 16% compared with 2017.
A weaker Brazilian real and Argentina peso reduced South America sales in 2018. However, more than offsetting this reduction was an organic increase in sales of 26%. Continued economic recovery in the Brazilian market was a major factor. The region overall experienced stronger production levels, with light truck production up about 7% and medium/heavy truck production higher by about 27%.
Asia Pacific sales in 2018 were 16% higher than last year. Currency translation increased sales by $6, driven by a stronger Thai baht and Chinese renminbi, partially offset by a weaker Indian rupee. Excluding currency and acquisition effects, sales increased 15% due primarily to stronger light truck production levels, off-highway market demand and contributions from new customer programs.
Cost of sales and gross margin - Cost of sales for 2018 increased $843, or 14%, when compared to 2017. Similar to the factors affecting sales, the increase was primarily due to higher overall sales volumes and inclusion of a full twelve months of the businesses acquired in the first quarter of 2017. Cost of sales as a percent of 2018 sales was 60 basis points higher than in the previous year. The increased cost of sales as a percent of sales was largely attributable to higher commodity prices which increase material costs by about $115, an increase in engineering and development expense of $32, higher depreciation expense of $39 attributable to increased capital spending over the past few years in support of significant new customer programs which launched this year and premium supply chain costs and other manufacturing inefficiencies associated with higher demand levels. Partially offsetting these higher costs were continued material cost savings of $70, incremental costs of $14 in 2017 resulting from recognizing acquired inventory at fair value as part of business combination accounting, cost attributable to acquisition cost synergies from acquisition integration, and overall better cost absorption on higher production volumes.
Gross margin of $1,157 for 2018 increased $91 from 2017. Gross margin as a percent of sales was 14.2% in 2018, 60 basis points lower than in 2017. The decline in margin as a percent of sales was driven principally by the cost of sales factors referenced above.
Selling, general and administrative expenses (SG&A) - SG&A expenses in 2018 were $499 (6.1% of sales) as compared to $508 (7.0% of sales) in 2017. Inclusion of a full twelve months of the businesses acquired in the first quarter of 2017 and six months of TM4 acquired in second quarter of 2018 contributed $9 of expense. Salaries and benefits expense decreased by $32, with of lower year-over-year incentive compensation partially offset by higher salary expense. Higher discretionary spending was $14, in part due to increased software technology investments and customer support related costs. Contributing to lower SG&A as a percent of sales were acquisition synergies along with disciplined cost performance despite higher sales volumes.
Amortization of intangibles - The reduction of $3 in amortization expense was primarily attributable to certain customer related intangibles becoming fully amortized.
Restructuring charges, net - During 2018, we initiated headcount and cost reduction initiatives across our operating segments and corporate functions. Restructuring charges of $25 in 2018 include charges of $14 related to a voluntary retirement program in North America, $5 associated with headcount reduction actions in our operations and corporate functions in Brazil, $9 of severance and benefits costs related to SG&A cost reduction initiatives primarily in Europe and North America and $4 related to previously announced actions. In response to continued market recovery in our Off-Highway business in Europe, management re-evaluated the economic conditions of our global Off-Highway business and determined that $7 of the previously approved restructuring actions were no longer economically prudent. During 2017, we approved plans to implement certain headcount reduction initiatives in our Off-Highway business as part of the BPT and BFP acquisition integration, resulting in the recognition of $14, primarily for severance and benefits costs. Including costs associated with the actions approved during 2017 and costs associated with previously announced initiatives, net of the reversal described below, restructuring expense during 2017 was $14. During the fourth quarter of 2017, in response to better-than-expected market recovery in our Off-Highway business in Europe, management re-evaluated the economic conditions of our global Off-Highway business and determined that a portion of the previously approved 2016 restructuring program was no longer economically prudent. This change in facts and circumstances led to the decision to reverse $8 of previously accrued liabilities.
Impairment of indefinite-lived intangible asset - During the second quarter of 2018, we wrote off the in-process research and development intangible asset recognized as part of a 2012 acquisition. Refer to the Other Initiatives section in Item 7 and Note 4 of the consolidated financial statements in Item 8 for additional information.
Gain (loss) on disposal group held for sale - See Note 3 of the consolidated financial statements in Item 8 for a discussion of the divestiture of our Brazil suspension components business.
Other expense, net - The following table shows the major components of other expense, net.
Strategic transaction expenses in 2018 were primarily attributable to our bid to acquire the driveline business of GKN plc., our acquisition of an ownership interest in TM4, our pending acquisition of Oerlikon Drive Systems and integration costs associated with our acquisitions of BFP and BPT, and were partially offset by a $40 transaction breakup fee associated with the GKN plc. transaction. Strategic transaction expenses in 2017 are primarily attributable to our acquisitions of USM - Warren, BFP and BPT.
As described in Note 1 to our consolidated financial statements in Item 8, in connection with the adoption of new accounting and reporting requirements for defined employee benefit plans, non-service cost components are now classified as other expense, net. Such amounts were previously classified as cost of sales or SG&A expense. The comparative 2017 statement of operations has been revised to reflect the new classification of these costs.
Loss on extinguishment of debt - As discussed in Note 14 to our consolidated financial statements in Item 8, we redeemed $100 of our September 2021 Notes, repaid indebtedness of our BPT and BFP subsidiaries and repaid certain bank debt in Brazil during the second quarter of 2017, and we redeemed the remaining $350 of our September 2021 Notes in the third quarter of 2017. We incurred redemption premiums of $15 in connection with these repayments and wrote off $4 of previously deferred financing costs associated with the debt that was extinguished.
Interest income and interest expense - Interest income was $11 in 2018 and 2017. Interest expense decreased from $102 in 2017 to $96 in 2018 primarily due to a lower average interest rate on borrowings. During 2017, through debt refinancing and cross-currency swaps, we achieved lower overall interest rates. Average effective interest rates, inclusive of amortization of debt issuance costs, approximated 5.2% and 5.5% in 2018 and 2017.
Income tax expense - Income taxes were an expense of $78 in 2018 and $283 in 2017. During 2018, we recognized a benefit of $44 related to U.S. state law changes and the development and implementation of a tax planning strategy which adjusted federal tax credits, along with federal and state net operating losses and the associated valuation allowances. We also recognized benefits of $11 relating to the reversal of a provision for an uncertain tax position, $5 relating to the release of valuation allowances in the US based on improved income projections and $7 due to permanent reinvestment assertions. Partially offsetting these benefits was $5 of expense to settle outstanding tax matters in a foreign jurisdiction. With the enactment of the Tax Cuts and Jobs Act occurring in December 2017 in the U.S., provisions of this tax reform legislation were required to be recognized in 2017. The most significant 2017 impact of this legislation was the reduction of net deferred tax assets to reflect expected realization at the lower U.S. corporate tax rate of 21% rather than the previous rate of 35%. The net impact of recognizing the required elements of the new tax reform legislation was an increase in tax expense of $186 in 2017. During 2017, continued improvement in our profit outlook enabled us to release $27 of valuation allowances on state deferred tax assets. See Note 18 to our consolidated financial statements in Item 8 of Part II for further disclosures around these items.
Excluding the effects of the items referenced in the preceding paragraph, our effective tax rates were 28% in 2018 and 33% in 2017. These rates vary from the applicable U.S. federal statutory rate of 21% and 35% in these periods primarily due to establishment, release and adjustment of valuation allowances in several countries, nondeductible expenses, deemed income, local tax incentives in several countries outside the U.S., different statutory tax rates outside the U.S. and withholding taxes related to repatriations of international earnings.
In countries where our history of operating losses does not allow us to satisfy the “more likely than not” criterion for recognition of deferred tax assets, we have generally recognized no income tax on the pre-tax income or losses as valuation
allowance adjustments offset the associated tax effects. We believe that it is reasonably possible that a valuation allowance of up to $24 related to a subsidiary in Brazil will be released in the next twelve months.
Equity in earnings of affiliates - Net earnings from equity investments was $24 in 2018 compared with $19 in 2017. Equity in earnings from Bendix Spicer Foundation Break, LLC (BSFB) was $7 in 2018 and $9 in 2017. Equity in earnings from Dongfeng Dana Axle Co., Ltd. (DDAC) was $15 in 2018 and $9 in 2017, inclusive of a $4 charge for asset transfer and conversion of certain assets.
Segment Results of Operations (2018 versus 2017)
Light Vehicle
Light Vehicle sales in 2018, exclusive of currency effects and increased sales of $18 from the acquisition of USM - Warren on March 1, 2017, were 12% higher than 2017. While North America full frame truck production was up 4% compared with 2017, we experienced a significant volume-related sales increase from one of our largest customer programs for which production continued on the outgoing model during the first quarter of 2018 concurrent with production of the new model vehicle. Stronger light truck production levels in Europe, South America and Asia Pacific also contributed to higher sales volumes. Customer pricing and cost recovery impacts provided year-over-year increase in sales of $36.
Light Vehicle segment EBITDA increased by $39 in 2018. Higher sales volumes provided a year-over-year benefit of $83. The year-over-year performance-related earnings reduction resulted from increased commodity costs of $40, higher engineering and development costs of $15, with premium freight, cost performance, operating inefficiencies and other items reducing segment earnings by $64. Net pricing and material recovery of $36, material cost savings of $31 and lower new program start-up and launch-related costs of $9 provided a partial offset.
Commercial Vehicle
Excluding currency effects, Commercial Vehicle sales increased 17% compared to 2017. The volume-related increase was primarily attributable to higher production levels in North America where Class 8 production was up about 26% and Classes 5-7 production was up 10%. With the improving economy in Brazil, our sales volumes in 2018 benefited from higher year-over-year production levels in that country of around 27%. Also contributing to the higher sales volume was higher production in Europe during 2018. Customer pricing and cost recovery actions increased year-over-year sales by $20.
Commercial Vehicle segment EBITDA increased by $30 in 2018. Higher sales volumes increased 2018 earnings by $35. Higher commodity costs decreased performance-related earnings by $35, with net pricing and material recovery actions providing a partial offset of $20. Higher year-over-year material cost savings of $14 and cost performance and improved operating efficiency of $11 were partially offset by increased engineering and development costs of $11.
Off-Highway
Off-Highway sales in 2018, exclusive of currency effects and increased sales of $38 from the acquisition of the Brevini BFP and BPT operations on February 1, 2017, were 16% higher than 2017, primarily from higher global end-market demand. Customer pricing and cost recovery actions increased year-over-year sales by $26.
Off-Highway segment EBITDA increased by $73 in 2017. Increased market demand was the primary driver of the volume and mix earnings improvement. The performance-related improvement was due primarily to net pricing and material recovery of $26, material cost savings of $17 and lower warranty costs of $5, partially offset by higher commodity costs of $25, increased engineering and development costs of $6 and cost performance and operating inefficiencies of $6.
Power Technologies
Power Technologies primarily serves the light vehicle market but also sells product to the medium/heavy truck and off-highway markets. Net of currency effects, 2018 sales were 1% lower than 2017, primarily due to programs that were scheduled to roll off in this year, along with weaker passenger car demand.
Segment EBITDA decreased by $19 compared to 2017. The performance-related deterioration resulted from higher commodity costs of $15, increased engineering spend of $3 and cost performance and operating inefficiencies of $8, partially offset by material cost savings of $8.
Summary Consolidated Results of Operations (2017 versus 2016)
As described in Note 1 to our consolidated financial statements in Item 8, in connection with the adoption of new accounting and reporting requirements for defined employee benefit plans, non-service cost components are now classified as other income (expense), net. Such amounts were previously classified as cost of sales or selling, general and administrative expenses. The comparative 2017 and 2016 statement of operations have been revised to reflect the new classification of these costs.
Sales - The following table shows changes in our sales by geographic region.
Sales in 2017 were $1,383 higher than in 2016. Stronger international currencies increased sales by $54. The acquisitions of BFP, BPT, SIFCO, USM - Warren and Magnum in 2016 and 2017 generated a year-over-year increase in sales of $542, with the divestiture of Nippon Reinz resulting in a reduction of $42. The organic sales increase of $829 resulted primarily from stronger light truck markets, strengthening global off-highway demand, stronger medium/heavy truck markets in Europe and South America, and contributions from new business.
The North America sales increase from acquisitions in 2017 relates primarily to the USM - Warren purchase, with a lesser amount being added by the BFP, BPT and Magnum transactions. The organic sales increase of 14% was driven principally by stronger production levels on certain of our key light truck programs, with stronger medium/heavy truck production and off-highway demand levels also providing some contribution.
Excluding currency effects and the increase in sales of $294 attributable to the BFP and BPT acquisitions, 2017 sales in Europe were 13% higher than in 2016. Stronger off-highway market demands were a primary driver of the organic sales
increase, although each of our operating segments experienced increased organic sales, primarily from higher production/demand levels.
In South America, 2017 sales benefited from a stronger Brazil real, however, that was largely offset by a weaker Argentina peso. The acquisition-related sales increase resulted from the SIFCO and BPT acquisitions. Excluding these effects, sales were up 31% from 2016. The organic sales increase in the region was driven largely by stronger 2017 production levels, with light truck and medium/heavy truck production each up more than 25% from the preceding year.
Asia Pacific sales in 2017 were 17% higher than 2016. Sales increased by $67 from the BPT and BFP acquisitions, more than offsetting the $42 reduction attributable to the Nippon-Reinz divestiture. Sales in this region also benefited from a stronger India rupee and Thailand baht. The organic sales increase of 11% in this region was due primarily to stronger light vehicle production levels and off-highway market demand, along with contributions from new customer programs.
Cost of sales and gross margin - Cost of sales for 2017 increased $1,152, or 23%, when compared to 2016. Similar to the factors affecting sales, the increase was primarily due to higher overall sales volumes and the inclusion of acquired businesses. Cost of sales attributed to net acquisitions, which included $14 of incremental cost assigned to inventory as part of business combination accounting, amounted to $423, or 84.8% of the sales of those businesses. Excluding the effects of acquisitions and divestitures, cost of sales as a percent of sales declined from 85.7% of sales in 2016 to 85.2% of sales in 2017 - a reduction of 50 basis points. This reduction in cost of sales as a percent of sales was largely attributable to better fixed cost absorption on the higher production volume. Cost of sales also benefited from material cost savings of approximately $67 and a reduction in warranty expense of $8. The benefit from higher production levels and other items was partially offset by increased material commodity prices of $70, start-up/launch costs of $30 and engineering and development expense of $24.
Gross margin of $1,066 for 2017 increased $231 from 2016. Gross margin as a percent of sales was 14.8% in 2017, 50 basis points higher than in 2016. Acquisitions net of divestitures added $76 of gross margin. The margin improvement as a percent of sales was driven principally by the cost of sales factors referenced above.
Selling, general and administrative expenses (SG&A) - SG&A expenses in 2017 were $508 (7.0% of sales) as compared to $401 (6.9% of sales) in 2016. SG&A attributed to net acquisitions was $73. Excluding the increase associated with acquisitions and divestitures, SG&A expenses as a percent of sales were 6.5% of sales, 40 basis points lower than the same period of 2016. The $34 year-over-year increase exclusive of net acquisitions was principally due to an increase in salary and benefits expenses of $43 primarily relating to increased compensation expense resulting from better performance in relation to incentive targets in 2017. Selling costs and other discretionary spending were $9 lower than in 2016.
Amortization of intangibles - The increase of $3 in amortization expense was primarily attributable to amortization of the intangibles acquired in the acquisitions completed in late 2016 and the first quarter of 2017.
Restructuring charges, net - During 2017, we approved additional plans to implement certain headcount reduction initiatives in our Off-Highway business as part of the BPT and BFP acquisition integration, resulting in the recognition of $14, primarily for severance and benefits costs, during 2017. Including costs associated with the newly approved actions during 2017 and costs associated with previously announced initiatives, net of the reversal described below, restructuring expense during 2017 was $14. During the fourth quarter of 2017, in response to better-than-expected market recovery in our Off-Highway business in Europe, management re-evaluated the economic conditions of our global Off-Highway business and determined that a portion of the previously approved 2016 restructuring program is no longer economically prudent. This change in facts and circumstances led to the decision to reverse $8 of previously accrued liabilities. Restructuring charges of $36 in 2016 included $14 of costs attributable to headcount reductions in our Off-Highway segment and $10 for headcount reductions in our Brazil Commercial Vehicle business that were taken in connection with our acquisition of the SIFCO business. The remaining amount was attributable to the planned closure of our Commercial Vehicle manufacturing facility in Glasgow, Kentucky, headcount reduction actions at our corporate facilities in the U.S. and employee separation and exit costs associated with previously announced actions.
Loss on disposal group held for sale - Reference is made to Note 3 of the consolidated financial statements in Item 8 for a discussion of the pending divestiture of our Brazil suspension components business.
Loss on sale of subsidiaries - Reference is made to Note 3 of the consolidated financial statements in Item 8 for a discussion of the 2016 divestitures of DCLLC and Nippon Reinz.
Other income (expense), net - The following table shows the major components of other income (expense), net.
The higher level of strategic transaction expenses in 2017 is primarily attributable to costs incurred in connection with acquiring and integrating the BFP, BPT and USM businesses beginning in the first quarter of 2017. Amounts attributable to previously divested/closed operations in 2017 includes the receipt of the remaining proceeds on our December 2016 divestiture of DCLLC. See Note 19 to our consolidated financial statements in Item 8 for additional information. In 2016, DCLLC received a recovery of $8 of costs previously incurred on behalf of other participants in a consortium that existed to administer certain legacy personal injury claims and realized gains of $7 from the sale of portfolio investments.
Loss on extinguishment of debt - As discussed in Note 14 to our consolidated financial statements in Item 8, we redeemed $100 of our September 2021 Notes, repaid indebtedness of our BPT and BFP subsidiaries and repaid certain bank debt in Brazil during the second quarter of 2017, and we redeemed the remaining $350 of our September 2021 Notes in the third quarter of 2017. We incurred redemption premiums of $15 in connection with these repayments and wrote off $4 of previously deferred financing costs associated with the debt that was extinguished. In the second quarter of 2016, we redeemed our February 2021 Notes, incurring a redemption premium of $12, and also restructured our domestic revolving credit facility. In connection with these transactions, we wrote off $5 of previously deferred financing costs.
Interest income and interest expense - Interest income was $11 in 2017 and $13 in 2016. Interest expense was $102 in 2017 and $113 in 2016. A lower average interest rate on borrowings was partially offset by higher average debt levels in 2017. Average debt levels were higher in 2017 in part due to debt of $181 assumed in connection with the acquisition of BFP and BPT. As discussed in Note 14 to our consolidated financial statements in Item 8, we completed several financing transactions since May 2016 which in combination with cross-currency swaps effectively resulted in euro-denominated obligations at lower interest rates. Average effective interest rates, inclusive of amortization of debt issuance costs, approximated 5.5% and 6.5% in 2017 and 2016.
Income tax expense (benefit) - Income taxes were an expense of $283 in 2017 and a benefit of $424 in 2016. With the enactment of the Tax Cuts and Jobs Act occurring in December 2017 in the U.S., provisions of this tax reform legislation were required to be recognized in 2017. The most significant 2017 impact of this legislation was the reduction of net deferred tax assets to reflect expected realization at the lower U.S. corporate tax rate of 21% rather than the previous rate of 35%. The net impact of recognizing the required elements of the new tax reform legislation was an increase in tax expense of $186 in 2017. During 2017, continued improvement in our profit outlook enabled us to release $27 of valuation allowances on state deferred tax assets. In 2016, we determined that most of the valuation allowances against U.S. deferred taxes were no longer required. Release of these valuation allowances resulted in a $501 income tax benefit. Additionally, developments in Brazil led to our assessment that an allowance against certain deferred taxes in that country was appropriate, and we recognized tax expense of $25 to establish this valuation allowance. See Note 18 to our consolidated financial statements in Item 8 of Part II for further disclosures around these items.
Excluding the effects of the items referenced in the preceding paragraph, our effective tax rates were 33% in 2017 and 24% in 2016. These rates vary from the applicable U.S. federal statutory rate of 35% in these periods primarily due to valuation allowances in several countries and lower statutory tax rates outside the U.S. In 2016, a benefit of $58 for a reduction of accrued taxes on earnings of foreign operations resulting from legal entity restructuring and a revised determination as to permanent reinvestment contributed to a lower effective tax rate. These benefits were offset by tax expense of $17 on dividends and other income attributable to foreign operations, $30 of expense recognized to establish provisions associated with uncertain tax positions and $11 of amortization of a prepaid tax asset that was written off to retained earnings on January 1, 2017 in connection with the adoption of new guidance relating to intra-entity transfers.
In countries where our history of operating losses does not allow us to satisfy the “more likely than not” criterion for recognition of deferred tax assets, we have generally recognized no income tax on the pre-tax income or losses as valuation allowance adjustments offset the associated tax effects. Following the release of valuation allowances on our U.S. deferred tax assets in the fourth quarter of 2016, tax effects relating to U.S. income in 2017 are no longer being offset by adjustments to the valuation allowance.
Equity in earnings of affiliates - Net earnings from equity investments was $19 in 2017 compared with $14 in 2016. Equity in earnings from BSFB was $9 in 2017 and $7 in 2016. Equity in earnings from DDAC was $9 in 2017, inclusive of a $4 charge for asset transfer and conversion of certain assets, and $7 in 2016.
Segment Results of Operations (2017 versus 2016)
Light Vehicle
Light Vehicle sales in 2017, exclusive of currency and the increased sales from the acquisition of USM - Warren on
March 1, 2017, were 18% higher than 2016. The volume-related sales increase was driven primarily by stronger production levels, content increases and favorable model mix on certain of our significant full frame light truck programs in North America, resulting in sales growth that exceeded overall higher 2017 North America full frame light truck production of 3%. Sales in this segment also benefited from increased production levels in Europe, South America and Asia Pacific and new customer programs, including the transfer of a program previously supported by our Commercial Vehicle segment that moved to Light Vehicle in mid-2016 when the axle used to support the program was replaced with an axle produced by the Light Vehicle segment. This program increased Light Vehicle 2017 sales by approximately $50. Customer pricing and cost recovery impacts increased sales by $14.
Light Vehicle segment EBITDA increased by $80 in 2017. Higher sales volumes provided a benefit of $92, while the acquisition of USM - Warren contributed $12. The year-over-year performance-related earnings reduction in 2017 was driven by $37 of increased commodity costs and $30 of incremental new program start-up and launch-related costs. Partially offsetting these higher costs were pricing and material recovery actions that increased segment EBITDA by $14 and material cost initiatives that provided increased savings of $32. The remaining performance-related reduction of $1 was attributable to higher engineering investment and increased incentive compensation net of other earnings improvement actions.
Commercial Vehicle
Currency effects which increased sales in 2017 were primarily due to a stronger euro and Brazilian real. The increased sales from acquisition in 2017 relate to the purchase of SIFCO business late in 2016, as described above. After adjusting for the effects of currency and acquisitions, sales in our Commercial Vehicle segment increased 7% in 2017. The volume-related increase was primarily attributable to higher production levels in North America, where Class 8 production was up 12% and Classes 5-7 production was up 6%. Also contributing to the higher sales volume were production increases of 28% in South
America and 5% in Europe. Partially offsetting the increased production levels was the transfer of a program having sales of about $50 to the Light Vehicle segment which began supplying the axle for the program in mid-2016.
Commercial Vehicle segment EBITDA increased by $20 in 2017. Although sales benefited from currency translation, segment EBITDA was negatively impacted by currency transaction losses. Higher sales volumes increased 2017 earnings by $20. The performance-related improvement in segment EBITDA resulted primarily from pricing and material recovery actions which provided a benefit of $12, a reduction in warranty expense of $8 and material cost savings actions of $12, more than offsetting increases in material commodity costs of $14 and in incentive compensation and other costs of $12.
Off-Highway
The operations of the BFP and BPT businesses acquired on February 1, 2017 added $401 to this segment's sales in 2017. Currency effects provided higher sales of $19, principally due to a stronger euro compared to 2016. After adjusting for these two items, sales in 2017 were higher by 21%, reflecting significantly higher global end-market demand.
Off-Highway 2017 segment EBITDA increased by $83, with the BFP and BPT operations contributing $40 and higher sales volumes providing an increase of $41. Year-over-year performance-related earnings in 2017 were reduced by increased engineering and development expenses of $14, lower pricing, net of material recovery, of $10, and higher commodity costs of $6. Substantially offsetting these reductions to earnings were material cost savings of $13 and improved earnings from restructuring and other cost savings actions.
Power Technologies
Power Technologies primarily serves the light vehicle market but also sells product to the medium/heavy truck and off-highway markets. Net of currency effects and the reduction in sales resulting from the Nippon Reinz divestiture in the fourth quarter of 2016, sales in 2017 increased 7%, primarily due to overall stronger market demand and new customer programs.
Segment EBITDA increased by $10 in 2017, with higher sales volumes providing an earnings benefit of $26 and the divestiture of Nippon Reinz reducing earnings by $5. A reduction of $12 in year-over-year third performance-related earnings was driven by higher commodity costs of $13, customer pricing reductions of $5 and other net cost increases of $4. Partially offsetting these reductions to earnings was savings from material cost reduction initiatives of $10.
Non-GAAP Financial Measures
Adjusted EBITDA
We have defined adjusted EBITDA as net income before interest, taxes, depreciation, amortization, equity grant expense, restructuring expense, non-service cost components of pension and other postretirement benefits (OPEB) costs and other adjustments not related to our core operations (gain/loss on debt extinguishment, pension settlements, divestitures, impairment, etc.). Adjusted EBITDA is a measure of our ability to maintain and continue to invest in our operations and provide shareholder returns. We use adjusted EBITDA in assessing the effectiveness of our business strategies, evaluating and pricing potential acquisitions and as a factor in making incentive compensation decisions. In addition to its use by management, we also believe adjusted EBITDA is a measure widely used by securities analysts, investors and others to evaluate financial performance of our company relative to other Tier 1 automotive suppliers. Adjusted EBITDA should not be considered a substitute for earnings before income taxes, net income or other results reported in accordance with GAAP. Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies.
The following table provides a reconciliation of net income to adjusted EBITDA.
*
Other includes stock compensation expense, non-service cost components of pension and OPEB costs, strategic transaction expenses, net of transaction breakup fees, acquisition related inventory adjustments, impairment of indefinite-lived intangible asset, loss on extinguishment of debt, loss on sale of subsidiaries and other items. See Note 21 to our consolidated financial statements in Item 8 for additional details. Non-service cost components of pension and OPEB costs were excluded from adjusted EBITDA in 2018 concurrent with adoption of ASU 2017-07 which required such cost to be classified outside of operating income. While prior period amounts have been reclassified on our consolidated statement of operations for U.S. GAAP reporting purposes, we did not adjust prior period adjusted EBITDA on the basis of materiality. Had we conformed adjusted EBITDA for 2017 and 2016, adjusted EBITDA would have been $842 and $656, respectively.
Free Cash Flow and Adjusted Free Cash Flow
We have defined free cash flow as cash provided by operating activities less purchases of property, plant and equipment. We have defined adjusted free cash flow as cash provided by operating activities excluding discretionary pension contributions less purchases of property, plant and equipment. We believe these measures are useful to investors in evaluating the operational cash flow of the company inclusive of the spending required to maintain the operations. Free cash flow and adjusted free cash flow are not intended to represent nor be an alternative to the measure of net cash provided by operating activities reported under GAAP. Free cash flow and adjusted free cash flow may not be comparable to similarly titled measures reported by other companies.
The following table reconciles net cash flows provided by operating activities to adjusted free cash flow.
Liquidity
The following table provides a reconciliation of cash and cash equivalents to liquidity, a non-GAAP measure, at December 31, 2018:
Cash deposits are maintained to provide credit enhancement for certain agreements and are reported as part of cash and cash equivalents. For most of these deposits, the cash may be withdrawn if a comparable security is provided in the form of letters of credit. Accordingly, these deposits are not considered to be restricted.
Marketable securities are included as a component of liquidity as these investments can be readily liquidated at our discretion.
The components of our December 31, 2018 consolidated cash balance were as follows:
A portion of the non-U.S. cash and cash equivalents is utilized for working capital and other operating purposes. Several countries have local regulatory requirements that restrict the ability of our operations to repatriate this cash. Beyond these restrictions, there are practical limitations on repatriation of cash from certain subsidiaries because of the resulting tax withholdings and subsidiary by-law restrictions which could limit our ability to access cash and other assets.
The principal sources of liquidity available for our future cash requirements are expected to be (i) cash flows from operations, (ii) cash and cash equivalents on hand and (iii) borrowings from our Revolving Facility. We believe that our overall liquidity and operating cash flow will be sufficient to meet our anticipated cash requirements for capital expenditures, working capital, debt obligations, common stock repurchases and other commitments during the next twelve months. While uncertainty surrounding the current economic environment could adversely impact our business, based on our current financial position, we believe it is unlikely that any such effects would preclude us from maintaining sufficient liquidity.
At December 31, 2018, we had no outstanding borrowings under the Revolving Facility but we had utilized $21 for letters of credit. We had availability at December 31, 2018 under the Revolving Facility of $579 after deducting the outstanding letters of credit.
At December 31, 2018, we were in compliance with the covenants of our financing agreements. Under the Revolving Facility and our senior notes, we are required to comply with certain incurrence-based covenants customary for facilities of these types. The incurrence-based covenants in the Revolving Facility permit us to, among other things, (i) issue foreign subsidiary indebtedness, (ii) incur general secured indebtedness subject to a pro forma first lien net leverage ratio not to exceed 1.50:1.00 in the case of first lien debt and a pro forma secured net leverage ratio of 2.50:1.00 in the case of other secured debt and (iii) incur additional unsecured debt subject to a pro forma total net leverage ratio not to exceed 3.50:1.00. We may also make dividend payments in respect of our common stock as well as certain investments and acquisitions subject to a pro forma total net leverage ratio of 2.75:1.00. In addition, the Revolving Facility is subject to a financial covenant requiring us to maintain a first lien net leverage ratio not to exceed 2.00:1.00. The indentures governing the senior notes include other incurrence-based covenants that may subject us to additional specified limitations.
Our Board of Directors approved an expansion of our existing common stock share repurchase program from $100 to $200 on March 24, 2018. The share repurchase program expires on December 31, 2019. We plan to repurchase shares utilizing available excess cash either in the open market or through privately negotiated transactions. The stock repurchases are subject
to prevailing market conditions, available growth opportunities and other considerations. During 2018, we paid $25 to acquire 1,055,000 shares of common stock in the open market.
On July 30, 2018, we entered into a definitive agreement to purchase Oerlikon Drive Systems for approximately 625 Swiss francs, inclusive of required settlements of outstanding debt obligations Oerlikon Drive Systems has with Oerlikon Group. Committed financing has been arranged to complete the transaction. Subject to customary regulatory approval, the acquisition is expected to close in the first quarter of 2019.
On January 11, 2019, we acquired a 100% ownership interest in SME. We paid $88 at closing, consisting of $62 in cash on hand and a note payable of $26. The note is payable in five years and bears annual interest at 5%.
From time to time, depending upon market, pricing and other conditions, as well as our cash balances and liquidity, we may seek to acquire our senior notes or other indebtedness or our common stock through open market purchases, privately negotiated transactions, tender offers, exchange offers or otherwise, upon such terms and at such prices as we may determine (or as may be provided for in the indentures governing the notes), for cash, securities or other consideration. There can be no assurance that we will pursue any such transactions in the future, as the pursuit of any alternative will depend upon numerous factors such as market conditions, our financial performance and the limitations applicable to such transactions under our financing and governance documents.
Cash Flow
The table above summarizes our consolidated statement of cash flows.
Operating activities - Exclusive of working capital, other cash provided by operations was $681 during 2018 compared to $562 during 2017 and $435 during 2016. The increase in 2018 is principally due to an increased level of operating earnings, lower year-over-year cash paid for interest of $14 and cash paid for strategic transaction expenses of $15, partially offset by higher year-over-year cash paid for income taxes of $58. The increase in 2017 is principally due to an increased level of operating earnings in 2017. Partially offsetting the higher operating earnings was an increased cash use of $20 for acquisition-related costs, including costs incurred to complete the transactions and post-acquisition related integration costs.
Working capital used cash of $113 in 2018, $8 in 2017 and $51 in 2016. Cash of $113 in 2018, $141 in 2017 and $86 in 2016 was used to finance increased receivables. The higher level of cash required for receivables in 2018 and 2017 was primarily due to higher year-over-year sales. Higher inventories consumed cash of $110 in 2018, $146 in 2017 and $13 in 2016. The higher use of cash in 2018 is reflective of higher material costs and increased safety stock of certain materials to satisfy customer requirements. The higher level of cash used to finance increased inventory in 2017 was due primarily to the stronger year-over-year volume levels. Increases in accounts payable and other net liabilities provided cash of $110 in 2018, $279 in 2017 and $48 in 2016. Cash provided by accounts payable and other liabilities in 2018 was reduced by the payment of higher incentive compensation accrued in 2017. In addition to higher volume levels, the cash generated in 2017 from increased levels of accounts payable and other liabilities was also reflective of changes in payment practices and lengthening of payment terms with suppliers. The use of cash in 2016 for receivables reflected increased sales levels in November and December compared to 2015. Except for this increase in receivables in 2016, there were no significant uses or sources of cash from working capital components in 2016 and 2015 as organic sales levels were relatively comparable with the preceding years.
Investing activities - Expenditures for property plant and equipment were $325, $393 and $322 in 2018, 2017 and 2016. Higher levels of capital spending in 2016 and 2017 resulted from our increased new business sales backlog, including the launch of two of our largest customer programs which both required new investment. Although still at elevated levels, capital expenditures have decreased from the 2017 peak, with lower requirements to support new business launches with customers. In 2018, we paid $125 to acquire a 55% ownership interest in TM4 and, pursuant to our purchase and sale agreement for the BFP and BPT acquisitions in 2017, we made a net payment of $20 to complete a required purchase of real estate and settle purchase price adjustment amounts owed by the seller. During 2018, we completed the sale of our Brazil suspension components
business resulting in a net cash outflow of $6, as the cash transferred to the buyer in the transaction exceeded the proceeds received from the buyer. During 2017, we paid $106, net of cash acquired, to purchase an 80% ownership interest in BFP and BPT, and we used cash of $78 to acquire the USM - Warren business. During 2016, we paid $18 to acquire the aftermarket distribution business of Magnum and $60 to acquire the strategic assets of SIFCO's commercial vehicle steer axle systems and related forged components businesses. In 2016, we received net proceeds of $5 and $29 related to the sale of our Nippon Reinz and DCLLC subsidiaries. During all three years, purchases of marketable securities were largely funded by proceeds from sales and maturities of marketable securities.
Financing activities - During 2018, we paid $43 to acquire Brevini's remaining 20% ownership interests in BFP and BPT. Also during 2018, Yulon Motor Co., Ltd. (Yulon) paid $22 to acquire a direct ownership interest in two of our consolidated operating subsidiaries. Yulon's ownership interest in the two consolidated operating subsidiaries did not change as a result of the transactions, as it previously owned the same percentages indirectly through a series of consolidated holding companies. The $22, less withholding taxes, was returned to Yulon in the form of a dividend in 2018. During 2017, our European subsidiary, Dana Financing Luxembourg S.à r.l., completed the issuance of $400 of its April 2025 Notes and paid financing costs of $6 related to the notes. We paid financing costs of $3 related to our Term Facility and Revolving Facility and drew the entire $275 available under the Term Facility. We redeemed all $450 of our September 2021 Notes at a $14 premium, repaid indebtedness of a wholly-owned subsidiary in Brazil at a premium of $1 and repaid indebtedness of our BPT and BFP subsidiaries. In 2016, Dana Financing Luxembourg S.à r.l. completed the issuance of $375 of its June 2026 Notes and paid financing costs of $7 related to the notes. We paid financing costs of $3 to enter our Revolving Facility and a premium of $12 to redeem all of our February 2021 Notes. Also during 2016, we made scheduled repayments of $32 and took out $66 of additional long-term debt at international locations. We used cash of $25 and $81 to repurchase common shares under share repurchase programs in 2018 and 2016. We used $58, $35 and $35 for dividend payments to common stockholders in 2018, 2017 and 2016. The increase in dividends paid to common stockholders in 2018 was due to our Board approving an additional four cents per share increase in the quarterly dividend. Distributions to noncontrolling interests totaled $42, $12 and $17 in 2018, 2017 and 2016. Distributions to noncontrolling interest in 2018 includes the dividend to Yulon discussed above.
Off-Balance Sheet Arrangements
In connection with the divestiture of our Structural Products business in 2010, leases covering three U.S. facilities were assigned to a U.S. affiliate of the new owner, Metalsa S.A. de C.V. (Metalsa). Under the terms of the sale agreement, we guarantee the affiliate’s performance under the leases, which run through June 2025, including approximately $6 of annual payments. In the event of a required payment by Dana as guarantor, we are entitled to pursue full recovery from Metalsa of the amounts paid under the guarantee and to take possession of the leased property.
Contractual Obligations
We are obligated to make future cash payments in fixed amounts under various agreements. The following table summarizes our significant contractual obligations as of December 31, 2018.
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Notes:
(1)
Principal payments on long-term debt and capital lease obligations in place at December 31, 2018.
(2)
Interest payments are based on long-term debt and capital leases in place at December 31, 2018 and the interest rates applicable to such obligations.
(3)
Operating leases related to real estate, manufacturing and material handling equipment, vehicles and other assets.
(4)
Unconditional purchase obligations are comprised of commitments for the procurement of fixed assets, the purchase of raw materials and the fulfillment of other contractual obligations.
(5)
This amount represents estimated 2019 minimum required contributions to our global defined benefit pension plans. We have not estimated pension contributions beyond 2019 due to the significant impact that return on plan assets and changes in discount rates might have on such amounts.
(6)
This amount represents estimated payments under our non-U.S. retiree health care programs. Obligations under the non-U.S. retiree health care programs are not fixed commitments and will vary depending on various factors, including the level of participant utilization and inflation. Our estimates of the payments to be made in the future consider recent payment trends and certain of our actuarial assumptions.
(7)
We are not able to reasonably estimate the timing of payments related to uncertain tax positions because the timing of settlement is uncertain. The above table does not reflect unrecognized tax benefits at December 31, 2018 of $107. See Note 18 to our consolidated financial statements in Item 8 for additional discussion.
(8)
On July 30, 2018, we entered into a definitive agreement to purchase Oerlikon Drive Systems. Subject to customary regulatory approvals, the acquisition is expected to close in the first quarter of 2019. The amount presented has not been reduced by the amount of cash and cash equivalents expected to be on Oerlikon Drive Systems' balance sheet on the date of acquisition.
At December 31, 2018, we maintained cash balances of $5 on deposit with financial institutions primarily to support property insurance policy deductibles, certain employee retirement obligations and specific government approved environmental remediation efforts.
Contingencies
For a summary of litigation and other contingencies, see Note 16 to our consolidated financial statements in Item 8. Based on information available to us at the present time, we do not believe that any liabilities beyond the amounts already accrued that may result from these contingencies will have a material adverse effect on our liquidity, financial condition or results of operations.
Critical Accounting Estimates
The preparation of our consolidated financial statements in accordance with GAAP requires us to use estimates and make judgments and assumptions about future events that affect the reported amounts of assets, liabilities, revenue, expenses and the related disclosures. Considerable judgment is often involved in making these determinations. Critical estimates are those that require the most difficult, subjective or complex judgments in the preparation of the financial statements and the accompanying notes. We evaluate these estimates and judgments on a regular basis. We believe our assumptions and estimates are reasonable and appropriate. However, the use of different assumptions could result in significantly different results and actual results could differ from those estimates. The following discussion of accounting estimates is intended to supplement the Summary of Significant Accounting Policies presented as Note 1 to our consolidated financial statements in Item 8.
Income taxes - Accounting for income taxes is complex, in part because we conduct business globally and therefore file income tax returns in numerous tax jurisdictions. Significant judgment is required in determining the income tax provision, uncertain tax positions, deferred tax assets and liabilities and the valuation allowances recorded against our net deferred tax assets. A valuation allowance is provided when, in our judgment based upon available information, it is more likely than not that a portion of such deferred tax assets will not be realized. To make this assessment, we consider the historical and projected future taxable income or loss by tax jurisdiction. We consider all components of comprehensive income and weigh the positive and negative evidence, putting greater reliance on objectively verifiable historical evidence than on projections of future profitability that are dependent on actions that have not taken place as of the assessment date. We also consider changes to historical profitability of actions that occurred through the date of assessment and objectively verifiable effects of material forecasted events that would have a sustained effect on future profitability, as well as the effect on historical profits of nonrecurring events. We also incorporate the changes to historical and prospective income from tax planning strategies expected to be implemented.
Tax reform legislation in the U.S. was signed into law in December 2017 with enactment of the Tax Cuts and Jobs Act ("Act"). This legislation represents a fundamental and dramatic shift in U.S. taxation, with many provisions of the Act differing significantly from previous U.S. tax law. With enactment occurring late in 2017, companies with calendar reporting years did not have extensive time to analyze the impacts of the legislation. Applying the effects of a lower corporate tax rate to deferred tax assets and liabilities, evaluating the one-time transition tax on undistributed earnings of foreign operations, examining the implications of changes to net operating loss and other credit carryforwards and considering other provisions of the Act in a relatively compressed time frame necessitated significant estimation and judgment. Following the guidance of the U.S. Securities and Exchange Commission's Staff Accounting Bulletin No. 118, we made reasonable estimates of the Act's provisions and recorded a non-cash charge to the fourth quarter 2017 tax expense of $186 to reflect these effects. This provisional estimate was impacted based on further analysis of the Act's requirements. Given the Act's broad and complex changes, further clarification, interpretation and regulatory guidance affected the assumptions we used in making our reasonable estimate.
In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is less than certain. We are regularly under audit by the various applicable tax authorities. Although the outcome of tax audits is always uncertain, we believe that we have appropriate support for the positions taken on our tax returns and that our annual tax provisions include amounts sufficient to pay assessments, if any, upon final determination by the taxing authorities. Nonetheless, the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year. See additional discussion of our deferred tax assets and liabilities in Note 18 to our consolidated financial statements in Item 8.
Retiree benefits - Accounting for pension benefits and other postretirement benefits (OPEB) involves estimating the cost of benefits to be provided well into the future and attributing that cost to the time period each employee works. These plan expenses and obligations are dependent on assumptions developed by us in consultation with our outside advisers such as actuaries and other consultants and are generally calculated independently of funding requirements. The assumptions used, including inflation, discount rates, investment returns, life expectancies, turnover rates, retirement rates, future compensation levels and health care cost trend rates, have a significant impact on plan expenses and obligations. These assumptions are regularly reviewed and modified when appropriate based on historical experience, current trends and the future outlook. Changes in one or more of the underlying assumptions could result in a material impact to our consolidated financial statements in any given period. If actual experience differs from expectations, our financial position and results of operations in future periods could be affected.
Mortality rates are based in part on the company's plan experience and actuarial estimates. The inflation assumption is based on an evaluation of external market indicators, while retirement and turnover rates are based primarily on actual plan experience. Health care cost trend rates are developed based on our actual historical claims experience, the near-term outlook and an assessment of likely long-term trends. For our largest plans, discount rates are based upon the construction of a yield curve which is developed based on a subset of high-quality fixed-income investments (those with yields between the 40th and 90th percentiles). The projected cash flows are matched to this yield curve and a present value developed which is then calibrated to develop a single equivalent discount rate. Pension benefits are funded through deposits with trustees that satisfy, at a minimum, the applicable funding regulations. For our largest defined benefit pension plans, expected investment rates of return are based on input from the plans’ investment advisers and actuary regarding our expected investment portfolio mix, historical rates of return on those assets, projected future asset class returns, the impact of active management and long-term market conditions and inflation expectations. We believe that the long-term asset allocation on average will approximate the targeted allocation and we regularly review the actual asset allocation to periodically re-balance the investments to the targeted allocation when appropriate. OPEB and the majority of our non-U.S. pension benefits are funded as they become due.
Actuarial gains or losses may result from changes in assumptions or when actual experience is different from that which was expected. Under the applicable standards, those gains and losses are not required to be immediately recognized in our results of operations as income or expense, but instead are deferred as part of AOCI and amortized into our results of operations over future periods.
U.S. retirement plans - Our U.S. defined benefit pension plans comprise 80% of our consolidated defined benefit pension obligations at December 31, 2018. These plans are frozen and no service-related costs are being incurred. Changes in our net obligations are principally attributable to changing discount rates and the performance of plan assets. In part to reduce our exposure to fluctuations in unfunded pension obligations, our Board of Directors approved in October 2017 the termination of a U.S. defined benefit pension plan. At December 31, 2018, this plan had benefit obligations of $938 and assets of $773. The benefit obligations have been valued at the amount expected to be required to settle the obligations utilizing assumptions regarding the portion of obligations expected to be settled through participant acceptance of lump sum payments or annuities and the cost to purchase annuities. Increasing the plan's obligations to reflect the expected settlement value resulted in an actuarial loss of $69 that was charged to OCI in 2017. Ultimate plan termination is subject to prevailing market conditions and other considerations, including interest rates and annuity pricing. In the event that approvals are received and we proceed with effecting termination of the plan, settlement of the obligations is expected to occur in the first half of 2019. For our other pension plans, benefit obligations are valued using discount rates established annually in consultation with our outside actuarial advisers using the same yield curve approach described above. Rising discount rates decrease the present value of future pension obligations - a 25 basis point increase in the discount rate would decrease our U.S. pension liability by about $33. As indicated above, when establishing the expected long-term rate of return on our U.S. pension plan assets, we consider historical performance and forward looking return estimates reflective of our portfolio mix and investment strategy. Based on the most recent analysis of projected portfolio returns, we concluded that the use of a 6.0% expected return in 2018 is appropriate for our U.S. pension plans where termination is not anticipated. With the asset portfolio of the plan being terminated having a larger proportion of cash and fixed income investments, a rate of return of 3.8% through the expected settlement date in the first half of 2019 was considered appropriate. See Note 12 to the consolidated financial statements in Item 8 for information about the investing and allocation objectives related to our U.S. pension plan assets.
During 2018, we adopted a custom mortality table using historical mortality experience for our U.S. pension plans. These custom mortality tables are projected generationally from 2015 using the Society of Actuaries (SOA) projection scale, MP-2018, modified to use a 0.75% long-term improvement rate (LTIR) being achieved by 2027. Using the plan-specific mortality tables did not have a material effect on our pension obligations as we have been modifying the SOA tables for several years.
In 2016, we began using a full yield curve approach to estimate the service (where applicable) and interest components of the annual cost of our pension and other postretirement benefit plans. The new method estimates interest and service expense using the specific spot rates, from the yield curve, that relate to projected cash flows. Prior to 2016, we had estimated interest and service expense using the discount rate underlying the calculation of the related projected benefit obligation at the end of the preceding year. That rate was a weighted-average rate derived from the corresponding yield curve. The full yield curve approach, which we believe is more precise, reduced interest expense for our pension plans in the U.S. by approximately $14 in 2016 and $11 in 2017. The determination of the projected benefit obligation at year end is unchanged, however, so the actuarial gain or loss is affected by the amount of the change in interest and service expense.
At December 31, 2018, we have $542 of unrecognized losses relating to our U.S. pension plans. Actuarial gains and losses, which are primarily the result of changes in the discount rate and other assumptions and differences between actual and expected asset returns, are deferred in AOCI and amortized to expense following the corridor approach. We use the average remaining service period of active participants unless almost all of the plan’s participants are inactive, in which case we use the average remaining life expectancy of inactive participants. The plan being terminated has deferred actuarial losses of $370 at December 31, 2018. The unrecognized actuarial losses of this plan that remain when the obligations are settled in 2019 will be recognized as expense at that time.
Actuarial gains and losses can also impact required cash contributions. Based on the current funded status of our U.S. plans, there are no minimum contribution requirements for 2018. For the U.S. plan being terminated, to effectuate the expected settlement in 2019, Dana will be required to fund any plan obligations in excess of assets. Based on the plan obligation settlement assumptions and asset values at December 31, 2018, the unfunded plan obligations are $165. The actual cash requirement at settlement will vary from this amount based on the actual cost of annuities and participant settlement elections relative to those assumed for year-end 2018 valuation and the actual return on assets compared to the 3.8% expected annual rate of return.
See Note 12 to our consolidated financial statements in Item 8 for additional discussion of our pension and OPEB obligations.
Goodwill and other indefinite-lived intangible assets - Our goodwill and other indefinite-lived intangible assets are tested for impairment annually as of October 31 for all of our reporting units, and more frequently if events or circumstances warrant such a review. We make significant assumptions and estimates about the extent and timing of future cash flows, growth rates and discount rates. The cash flows are estimated over a significant future period of time, which makes those estimates and assumptions subject to a high degree of uncertainty. We also utilize market valuation models which require us to make certain assumptions and estimates regarding the applicability of those models to our assets and businesses. We use our internal forecasts, which we update quarterly, to make our cash flow projections. These forecasts are based on our knowledge of our customers’ production forecasts, our assessment of market growth rates, net new business, material and labor cost estimates, cost recovery agreements with customers and our estimate of savings expected from our restructuring activities.
The most likely factors that would significantly impact our forecasts are changes in customer production levels and loss of significant portions of our business. We believe that the assumptions and estimates used in the assessment of the goodwill and other indefinite-lived intangible assets as of October 31, 2018 were reasonable.
Long-lived assets with definite lives - We perform impairment assessments on our property, plant and equipment and our definite-lived intangible assets whenever events and circumstances indicate that the carrying amounts of the assets may not be recoverable. When indications are present, we compare the estimated future undiscounted net cash flows of the operations to which the assets relate to the carrying amounts of such assets. We utilize the cash flow projections discussed above for property, plant and equipment and amortizable intangibles. We group the assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities and evaluate the asset group against the undiscounted future cash flows using the life of the primary assets. If the carrying amounts of the long-lived assets are not recoverable from future cash flows and exceed their fair value, an impairment loss is recognized to reduce the carrying amounts of the long-lived assets to their fair value. Fair value is determined based on discounted cash flows, third party appraisals or other methods that provide appropriate estimates of value. Determining whether a triggering event has occurred,
performing the impairment analysis and estimating the fair value of the assets require numerous assumptions and a considerable amount of management judgment.
Investments in affiliates - We had aggregate investments in affiliates of $208 at December 31, 2018 and $163 at December 31, 2017. We monitor our investments in affiliates for indicators of other-than-temporary declines in value on an ongoing basis in accordance with GAAP. If we determine that an other-than temporary decline in value has occurred, we recognize an impairment loss, which is measured as the difference between the recorded carrying value and the fair value of the investment. Fair value is generally determined using the discounted cash flows (an income approach) or guideline public company (a market approach) methods.
Warranty - Costs related to product warranty obligations are estimated and accrued at the time of sale with a charge against cost of sales. Warranty accruals are evaluated and adjusted as appropriate based on occurrences giving rise to potential warranty exposure and associated experience. Warranty accruals and adjustments require significant judgment, including a determination of our involvement in the matter giving rise to the potential warranty issue or claim, our contractual requirements, estimates of units requiring repair and estimates of repair costs. If actual experience differs from expectations, our financial position and results of operations in future periods could be affected.
Contingency reserves - We have numerous other loss exposures, such as product liability and warranty claims and matters involving litigation. Establishing loss reserves for these matters requires the use of estimates and judgment regarding risk of exposure and ultimate liability. Product liability and warranty claims are generally estimated based on historical experience and the estimated costs associated with specific events giving rise to potential field campaigns or recalls. In the case of legal contingencies, estimates are made of the likely outcome of legal proceedings and potential exposure where reasonably determinable based on the information presently known to us. New information and other developments in these matters could materially affect our recorded liabilities.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to fluctuations in foreign currency exchange rates, commodity prices for products we use in our manufacturing and interest rates. To reduce our exposure to these risks, we maintain risk management controls to monitor these risks and take appropriate actions to attempt to mitigate such forms of market risks.
Foreign currency exchange rate risk - Our foreign currency exposures are primarily associated with intercompany and third party sales and purchase transactions, cross-currency intercompany loans and external debt. We use forward contracts to manage our foreign currency exchange rate risk associated with a portion of our forecasted foreign currency-denominated sales and purchase transactions and with certain foreign currency-denominated assets and liabilities. We also use currency swaps, including fixed-to-fixed cross-currency interest rate swaps, to manage foreign currency exchange rate risk associated with our intercompany loans and external debt. Foreign currency exposures are reviewed quarterly, at a minimum, and natural offsets are considered prior to entering into derivative instruments.
Changes in the fair value of derivative instruments treated as cash flow hedges are reported in other comprehensive income (loss) (OCI). Deferred gains and losses are reclassified to earnings in the same period in which the underlying transactions affect earnings. Specifically, with respect to the cross-currency interest rate swap, to the extent we recognize an exchange gain or loss on the underlying external debt, we reclassify an offsetting portion from OCI to earnings in the same period.
Changes in the fair value of derivative instruments not treated as cash flow hedges are recognized in earnings in the period in which those changes occur. Changes in the fair value of derivative instruments associated with product-related transactions are recorded in cost of sales, while those associated with non-product transactions are recorded in other income (expense), net. See Note 15 to our consolidated financial statements in Item 8.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Dana Incorporated
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Dana Incorporated and its subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, including the related notes and schedule of valuation and qualifying accounts and reserves for each of the three years in the period ended December 31, 2018 appearing under Item 15(a)(3) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As described in Management’s Report on Internal Control over Financial Reporting, management has excluded TM4 Inc. (TM4) from its assessment of internal control over financial reporting as of December 31, 2018 because it was acquired by the Company in a purchase business combination during 2018. We have also excluded TM4 from our audit of internal control over financial reporting. TM4 is a subsidiary whose total assets and total revenues excluded from management’s assessment and our audit of internal control over financial reporting represent approximately 1.2% and approximately 0.1%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2018.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
We have served as the Company’s auditor since 1916.
Dana Incorporated
Consolidated Statement of Operations
(In millions, except per share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
Dana Incorporated
Consolidated Statement of Comprehensive Income
(In millions)
The accompanying notes are an integral part of the consolidated financial statements.
Dana Incorporated
Consolidated Balance Sheet
(In millions, except share and per share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
Dana Incorporated
Consolidated Statement of Cash Flows
(In millions)
The accompanying notes are an integral part of the consolidated financial statements.
Dana Incorporated
Consolidated Statement of Stockholders’ Equity
(In millions)
The accompanying notes are an integral part of the consolidated financial statements.
Dana Incorporated
Index to Notes to the Consolidated
Financial Statements
Notes to the Consolidated Financial Statements
(In millions, except share and per share amounts)
Note 1. Organization and Summary of Significant Accounting Policies
General
Dana Incorporated (Dana) is headquartered in Maumee, Ohio and was incorporated in Delaware in 2007. We are a global provider of high technology drive and motion products, sealing solutions, thermal-management technologies and fluid-power products and our customer base includes virtually every major vehicle and engine manufacturer in the global light vehicle, medium/heavy vehicle and off-highway markets.
The terms "Dana," "we," "our" and "us," when used in this report are references to Dana. These references include the subsidiaries of Dana unless otherwise indicated or the context requires otherwise.
Summary of significant accounting policies
Basis of presentation - Our consolidated financial statements include the accounts of all subsidiaries where we hold a controlling financial interest. All significant intercompany balances and transactions have been eliminated in consolidation. Investments in 20 to 50%-owned affiliates, which are not required to be consolidated, are generally accounted for under the equity method. Equity in earnings of these investments is presented separately in the consolidated statement of operations, net of tax. Investments in less-than-20%-owned companies are generally included in the financial statements at the cost of our investment. Dividends, royalties and fees from these cost basis affiliates are recorded in income when received.
In the fourth quarter of 2017, we identified an error in the classification of a third-party ownership interest in a subsidiary of Brevini Power Transmission S.p.A. Based on put and call provisions provided for in the agreement between the parties, the third-party ownership interest should have been classified as a redeemable noncontrolling interest. This balance sheet error was corrected in December 2017 by increasing redeemable noncontrolling interests and reducing noncontrolling interests by $3. The purchase consideration allocation presented in Note 2 and the initial fair value of redeemable noncontrolling interests of acquired businesses presented in Note 9 include this correction.
Held for sale - We classify long-lived assets or disposal groups as held for sale in the period: management commits to a plan to sell; the long-lived asset or disposal group is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such long-lived assets or disposal groups; an active program to locate a buyer and other actions required to complete the plan to sell have been initiated; the sale is probable within one year; the asset or disposal group is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Long-lived assets and disposal groups classified as held for sale are measured at the lower of their carrying amount or fair value less costs to sell.
Discontinued operations - The results of operations of a component or a group of components that either has been disposed of or is classified as held for sale is reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on operations and financial results.
Estimates - Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP), which require the use of estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. We believe our assumptions and estimates are reasonable and appropriate. However, due to the inherent uncertainties in making estimates, actual results could differ from those estimates.
Fair value measurements - A three-tier fair value hierarchy is used to prioritize the inputs to valuation techniques used to measure fair value. The three levels of inputs are as follows: Level 1 inputs (highest priority) include unadjusted quoted prices in active markets for identical instruments. Level 2 inputs include quoted prices for similar instruments that are observable either directly or indirectly. Level 3 inputs (lowest priority) include unobservable inputs in which there is little or no market data, which require management to develop its own assumptions. Classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
The inputs we use in our valuation techniques include market data or assumptions that we believe market participants would use in pricing an asset or liability, including assumptions about risk when appropriate. Our valuation techniques include a combination of observable and unobservable inputs. When available, we use quoted market prices to determine the fair value
(market approach). In the absence of active markets for the identical assets or liabilities, such measurements involve developing assumptions based on market observable data and, in the absence of such data, we consider the amount and timing of estimated future cash flows and assumed discount rates reflecting varying degrees of credit risk that is consistent with what market participants would use in a hypothetical transaction that occurs at the measurement date (income approach). Fair values may not represent actual values of the financial instruments that could be realized as of the balance sheet date or that will be realized in the future.
Cash and cash equivalents - Cash and cash equivalents includes cash on hand, demand deposits and short-term cash investments that are highly liquid in nature and have maturities of three months or less when purchased.
Marketable securities - Our investments in marketable securities reported in the accompanying balance sheet are classified as available for sale and carried at fair value. We recorded unrealized gains and losses in accumulated other comprehensive income (loss) (AOCI) through the end of 2017 but recorded them in net income beginning in 2018 to comply with new accounting guidance. Realized gains and losses are recorded using the specific identification method.
Inventories - Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average or first-in, first-out (FIFO) cost method.
Property, plant and equipment - Property, plant and equipment are recorded at cost. Depreciation is recognized over the estimated useful lives using primarily the straight-line method for financial reporting purposes and accelerated depreciation methods for federal income tax purposes. Useful lives of newly acquired assets are generally twenty to thirty years for buildings and building improvements, five to ten years for machinery and equipment, three to five years for tooling and office equipment and three to ten years for furniture and fixtures. If assets are impaired, their value is reduced via an increase in accumulated depreciation.
Pre-production costs related to long-term supply arrangements - The costs of tooling used to make products sold under long-term supply arrangements are capitalized as part of property, plant and equipment and amortized over their useful lives if we own the tooling or if we fund the purchase but our customer owns the tooling and grants us the irrevocable right to use the tooling over the contract period. If we have a contractual right to bill our customers, costs incurred in connection with the design and development of tooling are carried as a component of other accounts receivable until invoiced. Design and development costs related to customer products are deferred if we have an agreement to collect such costs from the customer; otherwise, they are expensed when incurred. At December 31, 2018, the machinery and equipment component of property, plant and equipment includes $31 of our tooling related to long-term supply arrangements. The increase during 2018 reflects the start of production for our recently awarded customer contracts. Also at December 31, 2018, trade and other accounts receivable includes $53 of costs related to tooling that we have a contractual right to collect from our customers.
Goodwill - We test goodwill for impairment annually as of October 31 and more frequently if events occur or circumstances change that would warrant an interim review. Goodwill impairment testing is performed at the reporting unit level, which is the operating segment in the case of our Off-Highway and Commercial Vehicle goodwill. We estimate the fair value of the reporting unit in the first step using various valuation methodologies, including projected future cash flows and multiples of current earnings. If the estimated fair value of the reporting unit exceeds its carrying value, the goodwill is considered not impaired. If the carrying value of the reporting unit exceeds its estimated fair value, then the second step of the test would be required to determine the implied fair value of the goodwill and any resulting impairment. The estimated fair value of our reporting units were greater than their carrying values at October 31, 2018. No impairment of goodwill occurred during the three years ended December 31, 2018.
Intangible assets - Intangible assets include the value of core technology, trademarks and trade names, customer relationships and intangible assets used in research and development activities. Core technology and customer relationships have definite lives while intangible assets used in research and development activities and substantially all of our trademarks and trade names have indefinite lives. Definite-lived intangible assets are amortized over their useful life using the straight-line method of amortization and are periodically reviewed for impairment indicators. Amortization of core technology is charged to cost of sales. Amortization of trademarks and trade names and customer relationships is charged to amortization of intangibles. Intangible assets used in research and development activities have an indefinite life until completion of the associated research and development efforts. Upon completion of development, the assets are amortized over their useful life; if the project is abandoned, the assets are written off immediately. Indefinite-lived intangible assets are tested for impairment annually and more frequently if impairment indicators exist. See Note 4 for more information about intangible assets.
Investments in affiliates - Investments in affiliates include investments accounted for under the equity and cost methods. We monitor our investments in affiliates for indicators of other-than-temporary declines in value on an ongoing basis in accordance
with GAAP. Indicators include, but are not limited to, current economic and market conditions, operating performance of the affiliate, including current earnings trends and undiscounted cash flows, and other affiliate-specific information. If we determine that an other-than-temporary decline in value has occurred, we recognize an impairment loss, which is measured as the excess of the investment's recorded carrying value over its fair value. The fair value determination, particularly for investments in privately-held companies, requires significant judgment to determine appropriate estimates and assumptions. Changes in these estimates and assumptions could affect the calculation of the fair value of the investments and determination of whether any identified impairment is other than temporary. See Note 22 for further information about our investment in affiliates.
Tangible asset impairments - We review the carrying value of amortizable long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to the undiscounted future net cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds their fair value. Assets to be disposed of are reported at the lower of their carrying amount or fair value less costs to sell and are no longer depreciated.
Other long-lived assets and liabilities - We discount our workers’ compensation obligations by applying blended risk-free rates that are appropriate for the duration of the projected cash flows. The use of risk-free rates is considered appropriate given that other risks affecting the volume and timing of payments have been considered in developing the probability-weighted projected cash flows. The blended risk-free rates are revised annually to consider incremental cash flow projections.
Financial instruments - The carrying values of cash and cash equivalents, trade receivables and short-term borrowings approximate fair value. Notes receivable are carried at fair value, which considers the contractual call or selling price, if applicable. Borrowings under our credit facilities are carried at historical cost and adjusted for principal payments and foreign currency fluctuations.
Derivatives - Foreign currency forward contracts and currency swaps are carried at fair value. We enter into these contracts to manage our exposure to the impact of currency fluctuations on certain foreign currency-denominated assets and liabilities and on a portion of our forecasted purchase and sale transactions. On occasion, we also enter into net investment hedges to protect the translated U.S. dollar value of our investment in certain foreign subsidiaries. We also periodically enter into fixed-to-fixed cross-currency swaps on foreign currency-denominated external or intercompany debt instruments to reduce our exposure to foreign currency exchange rate risk. Such fixed-to-fixed cross-currency swaps are designated as cash flow hedges. We do not use derivatives for trading or speculative purposes and we do not hedge all of our exposures.
For derivative instruments designated as cash flow hedges, at the cash flow hedge’s inception and on an ongoing basis, the company formally assesses whether the cash flow hedging instruments have been highly effective in offsetting changes in the cash flows of the hedged transactions and whether those cash flow hedging instruments may be expected to remain highly effective in future periods. Changes in the fair value of currency-related contracts treated as cash flow hedges are deferred and included as a component of other comprehensive income (loss) (OCI). For our fixed-to-fixed cross-currency swaps, a review of critical terms is performed each period to establish that an assumption of effectiveness remains appropriate. Deferred gains and losses are reclassified to earnings in the same periods in which the underlying transactions affect earnings.
Changes in the fair value of contracts not treated as cash flow hedges or as net investment hedges are recognized in other income (expense), net in the period in which those changes occur. Changes in the fair value of contracts treated as net investment hedges are recorded in the cumulative translation adjustment (CTA) component of OCI. Amounts recorded in CTA are deferred until such time as the investment in the associated subsidiary is substantially liquidated.
We may also use fixed-to-floating or floating-to-fixed interest rate swaps to manage exposure to fluctuations in interest rates and to adjust the mix of our fixed-rate and variable-rate debt. As a fair value hedge of the underlying debt, changes in the fair values of the swap and the underlying debt are recorded in interest expense. No such fixed-to-floating or floating-to-fixed swaps were outstanding at December 31, 2018. See Note 15 for additional information.
Cash flows associated with designated derivatives are classified within the same category as the item being hedged on the consolidated statement of cash flows. Cash flows associated with undesignated derivatives are included in the investing category on the consolidated statement of cash flows.
Warranty - Costs related to product warranty obligations are estimated and accrued at the time of sale with a charge against cost of sales. Warranty accruals are evaluated and adjusted as appropriate based on occurrences giving rise to potential warranty exposure and associated experience. Warranty accruals and adjustments require significant judgment, including a determination
of our involvement in the matter giving rise to the potential warranty issue or claim, our contractual requirements, estimates of units requiring repair and estimates of repair costs.
Environmental compliance and remediation - Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to existing conditions caused by past operations that do not contribute to our current or future revenue generation are expensed. Liabilities are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. We consider the most probable method of remediation, current laws and regulations and existing technology in determining our environmental liabilities.
Pension and other postretirement defined benefits - Net pension and postretirement benefits expenses and the related liabilities are determined on an actuarial basis. These plan expenses and obligations are dependent on management’s assumptions developed in consultation with our actuaries. We review these actuarial assumptions at least annually and make modifications when appropriate. With the input of independent actuaries and other relevant sources, we believe that the assumptions used are reasonable; however, changes in these assumptions, or experience different from that assumed, could impact our financial position, results of operations or cash flows.
Postemployment benefits - Costs to provide postemployment benefits to employees are accounted for on an accrual basis. Obligations that do not accumulate or vest are recorded when payment is probable and the amount can be reasonably estimated. For those obligations that accumulate or vest and the amount can be reasonably estimated, expense and the related liability are recorded as service is rendered.
Equity-based compensation - We measure compensation cost arising from the grant of share-based awards to employees at fair value. We recognize such costs in income over the period during which the requisite service is provided, usually the vesting period. The grant date fair value is estimated using valuation techniques that require the input of management estimates and assumptions.
Revenue recognition - Sales are recognized when products are shipped and risk of loss has transferred to the customer. See Recently adopted accounting pronouncements in this note for a description of the current practice and Note 20 for additional information regarding the related impact on our segment reporting. We accrue for warranty costs, sales returns and other allowances based on experience and other relevant factors when sales are recognized. Adjustments are made as new information becomes available. Shipping and handling fees billed to customers are included in sales, while costs of shipping and handling are included in cost of sales. Taxes collected from customers are excluded from revenues and credited directly to obligations to the appropriate governmental agencies.
Foreign currency translation - The financial statements of subsidiaries and equity affiliates outside the U.S. located in non-highly inflationary economies are measured using the currency of the primary economic environment in which they operate as the functional currency, which typically is the local currency. Transaction gains and losses resulting from translating assets and liabilities of these entities into the functional currency are included in other income (expense), net or in equity in earnings of affiliates. When translating into U.S. dollars, income and expense items are translated at average monthly rates of exchange, while assets and liabilities are translated at the rates of exchange at the balance sheet date. Translation adjustments resulting from translating the functional currency into U.S. dollars are deferred and included as a component of AOCI in stockholders’ equity. For operations whose functional currency is the U.S. dollar, nonmonetary assets are translated into U.S. dollars at historical exchange rates and monetary assets are translated at current exchange rates.
We believe that Argentina's economy met the GAAP definition of a highly inflationary economy during the second quarter of 2018. As such, effective July 1, 2018 we began to remeasure the financial statements of our Argentine subsidiaries as if their functional currency was the U.S. dollar. In assessing Argentina's economy as highly inflationary we considered its three-year cumulative inflation rate along with other factors. We believe the National Wholesale Price Index (WPI) provides the most reliable calculation of cumulative inflation for Argentina as the WPI has consistently provided national coverage and historically has been viewed as the most relevant and reliable measure by practitioners. Argentina's three-year cumulative inflation rate through May 2018 based on the WPI was 109%. In addition, management considered the Central Bank of Argentina increasing annual interest rates to 30% in April 2018 and further increasing them to 40% in May 2018, the Argentine government requesting financial assistance from the International Monetary Fund and the significant depreciation of the Argentine peso against the U.S. dollar during the second quarter of 2018.
Income taxes - In the ordinary course of business there is inherent uncertainty in quantifying our income tax positions. We assess our income tax positions and record tax assets or liabilities for all years subject to examination based upon management’s evaluation of the facts and circumstances and information available at the reporting dates. For those tax positions where it is more likely than not that a tax benefit will be sustained, we have recorded the largest amount of tax benefit
with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. Where applicable, the related interest cost has also been recognized as a component of the income tax provision.
Research and development - Research and development costs include expenditures for research activities relating to product development and improvement. Salaries, fringes and occupancy costs, including building, utility and overhead costs, comprise the vast majority of these expenses and are expensed as incurred. Research and development expenses were $103, $102 and $81 in 2018, 2017 and 2016.
Recently adopted accounting pronouncements
On January 1, 2018, we adopted Accounting Standard Update (ASU) 2017-12, Derivatives and Hedging - Targeted Improvements to Accounting for Hedging Activities, guidance that addresses effectiveness testing requirements, income statement presentation and disclosure and hedge accounting qualification criteria. Adoption of this standard results in a prospective change to the presentation of certain hedging-related gains and losses in our consolidated statement of operations. Effective with our permitted early adoption of this standard on January 1, 2018, realized gains and losses on forecasted transactions are recorded in the financial statement line item to which the underlying forecasted transaction relates (e.g., sales or cost of sales). Adoption also simplifies our ongoing effectiveness testing and reduces the complexity of hedge accounting requirements for new hedging contracts. The adoption of this standard, including the change in presentation within the consolidated statement of operations, did not have a material impact.
On January 1, 2018, we adopted ASU 2017-07, Retirement Benefits - Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, guidance that changed the reporting of pension and other postretirement benefits (OPEB) costs in the income statement. The service cost components of net periodic pension and OPEB costs continue to be included in cost of sales and selling, general and administrative expenses as part of compensation cost and remain eligible for capitalization in inventory and other assets. The non-service components are now reported in other income (expense), net and are not eligible for capitalization. The impact of the new guidance on inventory at December 31, 2018 was not material. For 2017, we reclassified net pension and OPEB costs of $4 from cost of sales and $3 from selling, general and administrative expenses to other income (expense), net to conform to the 2018 presentation. For 2016, we reclassified net pension and OPEB income of $9 from cost of sales and net pension and OPEB costs of $5 from selling, general and administrative expenses to other income (expense), net. We used the practical expedient in the guidance to quantify these impacts, which disregards the potential change in capitalized costs during the period. See Note 20 for information regarding the related impact on our segment reporting.
On January 1, 2018, we adopted ASU 2016-18, Statement of Cash Flows - Restricted Cash, guidance that requires the statement of cash flows to explain the change during the period in the total cash, cash equivalents and amounts generally described as restricted cash. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning and ending total amounts shown on the statement of cash flows. Retrospective presentation is required. For 2016 and 2017, this change resulted in a $9 and $9 increase in cash, cash equivalents and restricted cash at the beginning of the period and a $7 increase at the end of 2017 as presented on our consolidated statement of cash flow. In addition, removing the change in restricted cash from the consolidated statement of cash flows resulted in a change of $2 in our net cash used in investing activities for 2017. See Note 7 for additional information.
On January 1, 2018, we adopted ASU 2016-01, Financial Instruments - Recognition and Measurement of Financial Assets and Financial Liabilities, an amendment that addresses the recognition, measurement, presentation and disclosure of certain financial instruments. Investments in equity securities that were classified as available-for-sale and carried at fair value, with changes in fair value reported in OCI, are now carried at fair value determined on an exit price notion and changes in fair value are now reported in net income. The new guidance also affects the assessment of deferred tax assets related to available-for-sale securities, the accounting for liabilities for which the fair value option is elected and the disclosures of financial assets and financial liabilities in the notes to the financial statements. The adoption resulted in a release of the deferred gain in AOCI directly to retained earnings of $2.
Effective January 1, 2018, we adopted ASU 2014-09, Revenue - Revenue from Contracts with Customers, which requires companies to recognize revenue in a manner that depicts the transfer of promised goods or services to customers in amounts that reflect the consideration a company expects to be entitled to in exchange for those goods or services. We have elected to use the modified retrospective approach to transition to the new standard. Comparative prior periods have not been restated. We assessed our products in combination with the provisions of our current customer contracts to determine the cumulative effect of initially applying ASU 2014-09. Based on our assessment, the adoption date financial statement impact was limited to
balance sheet reclassifications required to establish the refund asset, refund liability and contract liability concepts provided for in ASU 2014-09. There was no cumulative effect adjustment required to be recorded to retained earnings. The cumulative effects of the changes made to our January 1, 2018 consolidated balance sheet for the adoption of ASU 2014-09 were as follows:
The following table shows the impact adopting ASC 606 had on our consolidated balance sheet as of December 31, 2018:
See Note 20 for additional information.
During the third quarter of 2018, we early adopted ASU 2018-02, Income Statement - Reporting Comprehensive Income, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This guidance allows entities the option of reclassifying stranded income tax effects resulting from the Tax Cuts and Jobs Act (the “Act”) from AOCI to retained earnings in their consolidated financial statements. As a result of the Act, deferred taxes were adjusted to reflect the reduction of the historical corporate income tax rate to the newly enacted corporate income tax rate by means of a credit or charge to income from continuing operations, leaving the tax effects of items within AOCI stranded at historical tax rates. This guidance would have been effective January 1, 2019 without early adoption. The guidance is to be applied either in the period of adoption or retrospectively to each period that was affected by the change in the corporate tax rate under the Act. Due to the immaterial amount of the stranded tax effects, we have elected not to reclassify the income tax effects from AOCI to retained earnings.
We also adopted the following standards during 2018, none of which had a material impact on our financial statements or financial statement disclosures:
Recently issued accounting pronouncements
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software, Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This guidance allows for capitalization of implementation costs associated with certain cloud computing arrangements. This guidance becomes effective January 1, 2020 and early adoption is permitted. The guidance is to be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. We do not expect the adoption of this guidance to impact our consolidated financial statements.
In August 2018, the FASB issued ASU 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General, Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans. The guidance eliminated certain disclosures about defined benefit plans, added new disclosures, and clarified other requirements. This guidance becomes effective January 1, 2020 and early adoption is permitted. There were no changes to interim disclosure requirements. Adoption of this guidance will not have a material effect on our annual financial statement disclosures.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The guidance removed or modified some disclosures while others were added. The removal and amendment of certain disclosures can be adopted immediately with retrospective application. The additional disclosure guidance becomes effective January 1, 2020. Adoption of this guidance will not have a material effect on our financial statement disclosures.
In July 2017, the FASB issued ASU 2017-11, Earnings Per Share, Distinguishing Liabilities from Equity, Derivatives and Hedging - (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. This guidance is intended to reduce the complexity associated with accounting for certain financial instruments with characteristics of liabilities and equity. Specifically, a down round feature would no longer cause a freestanding equity-linked financial instrument (or an embedded conversion option) to be considered "not indexed to an entity's own stock" and therefore accounted for as a derivative liability at fair value with changes in fair value recognized in current earnings. Down round features are most often found in warrants and conversion options embedded in debt or preferred equity instruments. In addition, the guidance re-characterized the indefinite deferral of certain provisions on distinguishing liabilities from equity to a scope exception with no accounting effect. This guidance becomes effective January 1, 2019 and early adoption is permitted. We do not presently issue any equity-linked financial instruments and therefore this guidance has no impact on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, Goodwill - Simplifying the Test for Goodwill Impairment, guidance that simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 of the goodwill impairment test. The new guidance quantifies goodwill impairment as the amount by which the carrying amount of a reporting unit, including goodwill, exceeds its fair value, with the impairment loss limited to the total amount of goodwill allocated to that reporting unit. This guidance becomes effective January 1, 2020 and will be applied on a prospective basis. Early adoption is permitted for impairment tests performed after January 1, 2017. We do not expect the adoption of this guidance to impact our consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Credit Losses - Measurement of Credit Losses on Financial Instruments, new guidance for the accounting for credit losses on certain financial instruments. This guidance introduces a new approach to estimating credit losses on certain types of financial instruments and modifies the impairment model for available-for-sale debt securities. This guidance, which becomes effective January 1, 2020, is not expected to have a material impact on our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases, its new lease accounting standard. The primary focus of the standard is on the accounting by lessees. This standard requires lessees to recognize a right-of-use asset and a lease liability for virtually all leases (other than leases that meet the definition of a short-term lease) on the balance sheet. The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from current GAAP. Operating leases will result in straight-line expense while finance leases will result in a front-loaded expense pattern in the income statement. Quantitative and qualitative disclosures are required to provide insight into the extent of revenue and expense recognized and expected to be recognized from leasing arrangements. Approximately three-fourths of our global lease portfolio represents leases of real estate, including manufacturing, assembly and office facilities, while the remainder represents leases of personal property, including manufacturing, material handling and IT equipment.
We expect the adoption of this new standard will result in the recording of leased assets and lease liabilities for our operating leases of approximately $190 as of January 1, 2019. We expect to take advantage of the transition relief provided by the amendment to ASU 2016-02 which allows us to elect not to restate 2017 and 2018 comparative periods upon adoption and continue to apply ASC 840 to such periods. With respect to the available practical expedients, we expect to elect the primary package of expedients whereby we will reassess neither the existence, nor the classification nor the amount and treatment of initial direct costs of existing leases. We do not expect to apply hindsight to the evaluation of lease options (e.g., renewal) and, accordingly, do not expect to utilize the practical expedient that would allow such an approach. Finally, we plan to separate the lease components from the non-lease components of each lease arrangement and, therefore, do not expect to elect the expedient that would enable us not to separate them. This guidance becomes effective January 1, 2019 with early adoption permitted.
Note 2. Acquisitions
SME - On January 11, 2019, we acquired a 100% ownership interest in the S.M.E. S.p.A. (SME). SME designs, engineers, and manufactures low-voltage AC induction and synchronous reluctance motors, inverters, and controls for a wide range of off-highway electric vehicle applications, including material handling, agriculture, construction, and automated-guided vehicles. The addition of SME's low-voltage motors and inverters, which are primarily designed to meet the evolution of electrification in off-highway equipment, significantly expands Dana's electrified product portfolio.
We paid $88 at closing, consisting of $62 in cash on hand and a note payable of $26 which allows for net settlement of potential contingencies as defined in the purchase agreement. The note is payable in five years and bears annual interest of 5%. Due to the recentness of the transaction, we are currently not able to provide an allocation of the purchase price to the fair value of the assets acquired and liabilities assumed.
TM4 - On June 22, 2018, we acquired a 55% ownership interest in TM4 Inc. (TM4) from Hydro-Québec. TM4 designs and manufactures motors, power inverters, and control systems for electric vehicles, offering a complementary portfolio to Dana's electric gearboxes and thermal-management technologies for batteries, motors, and inverters. The transaction establishes Dana as the only supplier with full e-Drive design, engineering, and manufacturing capabilities - offering electro-mechanical propulsion solutions to each of its end markets. The transaction further strengthens Dana's position in China, the world's fastest-growing market for electric vehicles. TM4 owns a 50% interest in Prestolite E-Propulsion Systems Limited (PEPS), a joint venture in China with Prestolite Electric Beijing Limited, which offers electric mobility solutions throughout China and Asia. The terms of the agreement provide Hydro-Québec with the right to put all, and not less than all, of its shares in TM4 to Dana at fair value any time after June 22, 2021.
We paid $125 at closing, using cash on hand. The purchase consideration and the related allocation to the acquisition date fair values of the assets acquired and liabilities assumed are presented in the following table:
Goodwill recognized in this transaction is primarily attributable to synergies expected to arise after the acquisition and the assembled workforce and is not deductible for tax purposes. The provisional fair values assigned to intangibles include $14 allocated to developed technology and $10 allocated to trademarks and trade names. We used the relief from royalty method, an income approach, to value developed technology and the trademarks and trade names. We used a replacement cost method to value fixed assets. We used a combination of the discounted cash flow, an income approach, and the guideline public company
method, a market approach, to value the equity method investment in PEPS. The developed technology intangible assets are being amortized on a straight-line basis over ten years, and property, plant and equipment is being depreciated on a straight-line basis over useful lives ranging from five to six years. The trademarks and trade names are considered indefinite-lived intangible assets.
Dana is consolidating TM4 as the governing documents provide Dana with a controlling financial interest. The results of operations of the business are reported in our Commercial Vehicle operating segment from the date of acquisition. Transaction related expenses associated with completion of the acquisition totaling $5 were charged to other income (expense), net. The pro forma effects of this acquisition would not materially impact our reported results for any period presented, and as a result no pro forma financial statements are presented. During 2018, the business contributed sales of $11.
USM - Warren - On March 1, 2017, we acquired certain assets and liabilities relating to the Warren, Michigan production unit of U.S. Manufacturing Corporation (USM). The production unit acquired is in the business of manufacturing axle housings, extruded tubular products and machined components for the automotive industry. The acquisition will increase Dana's revenue from light and commercial vehicle manufacturers and will vertically integrate a significant element of Dana's supply chain. It also provides Dana with new lightweight product and process technologies.
USM contributed certain assets and liabilities relating to its Warren, Michigan production unit to Warren Manufacturing LLC (USM - Warren), a newly created legal entity, and Dana acquired all of the company units of USM - Warren. The company units were acquired by Dana free and clear of any liens. We paid $104 at closing, including $25 to effectively settle trade payable obligations originating from product purchases Dana made from USM prior to the acquisition, and received $1 in the third quarter of 2017 for purchase price adjustments determined under the terms of the agreement. The acquisition has been accounted for as a business combination. The purchase consideration and the related allocation to the acquisition date fair values of the assets acquired and liabilities assumed are presented in the following table:
Goodwill recognized in this transaction is primarily attributable to synergies expected to arise after the acquisition and the assembled workforce and is deductible for tax purposes. Intangibles includes $30 allocated to customer relationships and $3 allocated to developed technology. We used the relief from royalty method, an income approach, to value developed technology. We used the multi-period excess earnings method, an income approach, to value customer relationships. We used a replacement cost method to value fixed assets. The developed technology and customer relationship intangible assets are being amortized on a straight-line basis over eighteen and eleven years, respectively, and property, plant and equipment is being depreciated on a straight-line basis over useful lives ranging from one to seventeen years.
The results of operations of the business are reported in our Light Vehicle operating segment from the date of acquisition. We incurred transaction related expenses to complete the acquisition in 2017 totaling $5, which were charged to other income (expense), net. The pro forma effects of this acquisition would not materially impact our reported results for any period presented, and as a result no pro forma financial statements are presented. During 2017, the business contributed sales of $96.
BFP and BPT - On February 1, 2017, we acquired 80% ownership interests in Brevini Fluid Power S.p.A. (BFP) and Brevini Power Transmission S.p.A. (BPT) from Brevini Group S.p.A. (Brevini). The acquisition expands our Off-Highway operating segment product portfolio to include technologies for tracked vehicles, doubling our addressable market for off-highway driveline systems and establishing Dana as the only off-highway solutions provider that can manage the power to both move the equipment and perform its critical work functions. This acquisition also brings a platform of technologies that can be
leveraged in our light and commercial-vehicle end markets, helping to accelerate our hybridization and electrification initiatives.
We paid $181 at closing, using cash on hand, and refinanced a significant portion of the debt assumed in the transaction during the first half of 2017. In December 2017, a purchase price reduction of $9 was agreed under the sale and purchase agreement provisions for determination of the net indebtedness and net working capital levels of BFP and BPT as of the closing date. The terms of the agreement provided Dana the right to call half of Brevini’s noncontrolling interests in BFP and BPT, and Brevini the right to put half of its noncontrolling interests in BFP and BPT to Dana, assuming Dana did not exercise its call right, after the 2017 BFP and BPT financial statements had been approved by the board of directors. Further, Dana had the right to call Brevini’s remaining noncontrolling interests in BFP and BPT, and Brevini the right to put its remaining noncontrolling interests in BFP and BPT to Dana, assuming Dana does not exercise its call right, after the 2019 BFP and BPT financial statements had been approved by the board of directors. The call and put prices were based on the amount Dana paid to acquire its initial 80% interest in BFP and BPT subject to adjustment based on the actual EBITDA and free cash flows, as defined in the agreement, of BFP and BPT. In connection with the acquisition of BFP and BPT, Dana agreed to purchase certain real estate being leased by BPT from a Brevini affiliate for €25. Completion of the real estate purchase and receipt of the purchase price adjustment occurred in the second quarter of 2018 with a net cash payment of $20. The purchase consideration and the related allocation to the acquisition date fair values of the assets acquired and liabilities assumed are presented in the following table:
Goodwill recognized in this transaction is primarily attributable to synergies expected to arise after the acquisition and the assembled workforce and is not deductible for tax purposes. Intangibles includes $29 allocated to customer relationships and $12 allocated to trademarks and trade names. We used the multi-period excess earnings method, an income approach, to value the customer relationships. We used the relief from royalty method, an income approach, to value trademarks and trade names. We used a replacement cost method to value fixed assets. We used a discounted cash flow approach to value the redeemable noncontrolling interests, inclusive of the put and call provisions. We used both discounted cash flow and cost approaches to value the noncontrolling interests. The customer relationships and trademarks and trade names intangible assets are being amortized on a straight-line basis over seventeen years, and property, plant and equipment is being depreciated on a straight-line basis over useful lives ranging from three to thirty years.
The results of operations of the businesses are reported in our Off-Highway operating segment from the date of acquisition. Transaction related expenses in 2017 associated with completion of the acquisition totaling $7 were charged to other income (expense), net. The pro forma effects of this acquisition would not materially impact our reported results for any period
presented, and as a result no pro forma financial statements are presented. During 2017, the businesses contributed sales of $401.
On August 8, 2018, we entered into an agreement to acquire Interfind S.p.A.'s, formerly Brevini Group S.p.A., remaining 20% ownership interests in BFP and BPT and to settle all claims between the parties. We paid $43 to acquire Interfind S.p.A.'s remaining ownership interests and received $10 in settlement of all pending and future claims. See Note 9 for additional information.
SIFCO - On December 23, 2016, we acquired strategic assets of SIFCO S.A.'s (SIFCO) commercial vehicle steer axle systems and related forged components businesses. The acquisition enables us to enhance our vertically integrated supply chain, which will further improve our cost structure and customer satisfaction by leveraging SIFCO's extensive experience and knowledge of sophisticated forged components. In addition to strengthening our position as a central source for products that use forged and machined parts throughout the region, this acquisition enables us to better accommodate the local content requirements of our customers, which reduces their import and other region-specific costs.
SIFCO contributed the strategic assets to SJT Forjaria Ltda., a newly created legal entity, and Dana acquired all of the issued and outstanding quotas of SJT Forjaria Ltda. The strategic assets were acquired by Dana free and clear of any liens, claims or encumbrances. The acquisition was funded using cash on hand and has been accounted for as a business combination. Dana paid $60 at closing and paid $3 of previously deferred consideration during the fourth quarter of 2017. On December 19, 2017, Dana and SIFCO reached an agreement providing for Dana to retain the remaining $7 of deferred consideration to satisfy indemnification claims as they arise. During 2018, claim settlements reduced the retained purchase price by $2. Once all indemnification claims have been satisfied, any remaining deferred consideration will be paid to SIFCO. The purchase consideration and the related allocation to the acquisition date fair values of the assets acquired are presented in the following table:
Goodwill recognized in this transaction is primarily attributable to synergies expected to arise after the acquisition and the assembled workforce, and is deductible for tax purposes. Intangibles includes $2 allocated to developed technology and $1 allocated to trade names. We used the relief from royalty method, an income approach, to value developed technology and trade names. We used a replacement cost method to value fixed assets. The developed technology and trade name intangible assets are being amortized on a straight-line basis over seven and five years, respectively, and property, plant and equipment is being depreciated on a straight-line basis over useful lives ranging from three to ten years.
The results of operations of the business are reported in our Commercial Vehicle operating segment from the date of acquisition. As a result of the acquisition, we incurred transaction related expenses totaling $5, which were charged to other income (expense), net. The pro forma effects of this acquisition would not materially impact our reported results for any period presented, and as a result no pro forma financial statements were presented.
Magnum - On January 29, 2016, we acquired the aftermarket distribution business of Magnum® Gaskets (Magnum), a U.S.-based supplier of gaskets and sealing products for automotive and commercial-vehicle applications, for a cash payment of $18. Assets acquired included trademarks and trade names, customer relationships and goodwill. The results of operations of Magnum are reported within our Power Technologies operating segment. We acquired Magnum using cash on hand. The pro forma effects of this acquisition would not materially impact our reported results for any period presented, and as a result no pro forma financial statements were presented.
Note 3. Disposal Groups and Divestitures
Disposal group held for sale - In December 2017, we entered into an agreement to divest our Brazil suspension components business (the disposal group) for no consideration to an unaffiliated company. The results of operations of the Brazil suspension components business are reported within our Commercial Vehicle operating segment. To effectuate the sale, Dana was obligated to contribute $10 of additional cash to the business prior to closing. We classified the disposal group as held for sale at December 31, 2017, recognizing a $27 loss to adjust the carrying value of the net assets to fair value and to recognize the liability for the additional cash required to be contributed to the business prior to closing. During the first quarter of 2018, we made the required cash contribution to the disposal group. After being unable to complete the transaction with the counterparty to the December 2017 agreement, we entered into an agreement with another third party in June 2018. The transaction with the new counterparty closed in July 2018 and we received cash proceeds of $2. We reversed $3 of the previously recognized $27 pre-tax loss, inclusive of the proceeds received in July 2018, during the second quarter of 2018. The carrying amounts of the major classes of assets and liabilities of our Brazil suspension components business were as follows:
Divestiture of Dana Companies - On December 30, 2016, we completed the divestiture of Dana Companies, LLC (DCLLC), a consolidated wholly-owned limited liability company that was established as part of our reorganization in 2008 to hold and manage personal injury asbestos claims retained by the reorganized Dana Corporation which was merged into DCLLC. DCLLC had net assets of $165 at the time of sale including cash and cash equivalents, marketable securities and rights to insurance coverage in place to satisfy a significant portion of its liabilities. We received cash proceeds of $88 - $29 net of cash divested - with $3 retained by the purchaser subject to the satisfaction of certain future conditions. We recognized a pre-tax loss of $77 in 2016 upon completion of the transaction. During the second quarter of 2017 the conditions associated with the retained purchase price were satisfied. Dana received the remaining proceeds and recognized $3 of income in other income (expense), net. Following completion of the sale, Dana has no obligation with respect to current or future asbestos claims.
Divestiture of Nippon Reinz - On November 30, 2016, we sold our 53.7% interest in Nippon Reinz Co. Ltd. (Nippon Reinz) to Nichias Corporation. Dana received net cash proceeds of $5 and recognized a pre-tax loss of $3 on the divestiture of Nippon Reinz, inclusive of the $12 gain on derecognition of the noncontrolling interest. Nippon Reinz had sales of $42 in 2016 through the transaction date.
Note 4. Goodwill and Other Intangible Assets
Goodwill -The change in the carrying amount of goodwill in 2018 was due to the acquisition of a 55% interest in TM4 and currency fluctuation. The change in the carrying amount of goodwill in 2017 was primarily due to the acquisitions of USM - Warren and 80% interests in BFP and BPT and currency fluctuation. See Note 2 for additional information on recent acquisitions. Based on our October 31, 2018 impairment assessment, the fair value of our reporting units are higher than their carrying values, indicating no impairment.
Changes in the carrying amount of goodwill by segment -
Non-amortizable intangible assets - Our non-amortizable intangible assets include trademarks and trade names. Trademarks and trade names consist of the Dana®, Spicer® and TM4® trademarks and trade names utilized in our Commercial Vehicle and Off-Highway segments. We value trademarks and trade names using a relief from royalty method which is based on revenue streams. No impairment was recorded during the three years ended December 31, 2018 in connection with the required annual assessment for trademarks and trade names.
During the third quarter of 2012, we entered a strategic alliance with Fallbrook Technologies Inc. (Fallbrook). The transaction with Fallbrook was accounted for as a business combination and the original purchase price allocation included $20 of intangible assets used in research and development activities, which had been classified as indefinite-lived. Since the third quarter of 2012, we have been working with several customers to commercialize the continuously variable planetary (CVP) technology primarily in combustion engine applications. During the second quarter of 2018 key customers notified us of their intention to redirect their development efforts to electrification and cease further development efforts of the CVP technology in combustion engine applications. While we have not abandoned the CVP technology, we determined that it was more likely than not that the fair value of the related intangible assets was less than their carrying amount. We used the multi-period excess earnings method, an income approach, to fair value the assets used in research and development activities. Given the lack of adequate identifiable future revenue streams, it was determined that the $20 of intangible assets used in research and development activities was fully impaired during the second quarter of 2018.
Amortizable intangible assets - Our amortizable intangible assets include core technology, customer relationships and a portion of our trademarks and trade names. Trademarks and trade names includes the Brevini® trademark and trade name utilized in our Off-Highway segment. Core technology includes the proprietary know-how and expertise that is inherent in our products and manufacturing processes. Customer relationships include the established relationships with our customers and the related ability of these customers to continue to generate future recurring revenue and income.
These assets are tested for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. We group the assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities and evaluate the asset group against the undiscounted future cash flows. We use our internal forecasts, which we update quarterly, to develop our cash flow projections. These forecasts are based on our knowledge of our customers’ production forecasts, our assessment of market growth rates, net new business, material and labor cost estimates, cost recovery agreements with customers and our estimate of savings expected from our restructuring activities. The most likely factors that would significantly impact our forecasts are changes in customer production levels and loss of significant portions of our business. Our valuation is applied over the life of the primary assets within the asset groups. If the undiscounted cash flows do not indicate that the carrying amount of the asset group is recoverable, an impairment charge is recorded if the carrying amount of the asset group exceeds its fair value based on discounted cash flow analyses or appraisals. There were no impairments recorded during the three years ended December 31, 2018.
Components of other intangible assets -
The net carrying amounts of intangible assets, other than goodwill, attributable to each of our operating segments at December 31, 2018 were as follows: Light Vehicle Driveline (Light Vehicle) - $28, Commercial Vehicle - $54, Off-Highway - $73 and Power Technologies - $9.
Amortization expense related to amortizable intangible assets -
The following table provides the estimated aggregate pre-tax amortization expense related to intangible assets for each of the next five years based on December 31, 2018 exchange rates. Actual amounts may differ from these estimates due to such factors as currency translation, customer turnover, impairments, additional intangible asset acquisitions and other events.
Note 5. Restructuring of Operations
Our restructuring activities have historically included rationalizing our operating footprint by consolidating facilities, positioning operations in lower cost locations and reducing overhead costs. In recent years, our focus has primarily been headcount reduction initiatives to reduce operating costs. Restructuring expense includes costs associated with current and previously announced actions and is comprised of contractual and noncontractual separation costs and exit costs, including costs associated with lease continuation obligations and certain operating costs of facilities that we are in the process of closing.
During 2018, we implemented headcount and cost reduction initiatives across our operating segments and corporate functions. Restructuring charges of $25 in 2018 were primarily comprised of severance and benefit costs related to a voluntary retirement program in North America, headcount reduction actions in our operations and corporate functions in Brazil and administrative cost reduction initiatives primarily in Europe and North America. In response to continued market recovery in our Off-Highway business in Europe, management re-evaluated the economic conditions of our global Off-Highway business and determined that $7 of the previously approved restructuring actions are no longer economically prudent.
During 2017, we approved plans to implement certain headcount reduction initiatives in our Off-Highway business as part of the BFP and BPT acquisition integration, resulting in the recognition of $14, primarily for severance and benefits costs, during 2017. Including costs associated with the newly approved actions during 2017 and costs associated with previously announced initiatives, net of the reversal described below, restructuring expense during 2017 was $14, including $8 of severance and benefits costs and $6 of exit costs. During the fourth quarter of 2017, in response to better-than-expected market recovery in our Off-Highway business in Europe, management re-evaluated the economic conditions of our global Off-
Highway business and determined that a portion of the previously approved 2016 restructuring program is no longer economically prudent. This change in facts and circumstances led to the decision to reverse $8 of previously accrued liabilities.
During 2016, we implemented various headcount reduction initiatives across our businesses, including the first-quarter 2016 announcement of the planned closure of our Commercial Vehicle manufacturing facility in Glasgow, Kentucky. During the second half of 2016, we also approved and began to implement other headcount reduction initiatives, the most significant of which were associated with our Off-Highway business in Europe and our Commercial Vehicle and Light Vehicle businesses in Brazil, in response to continued market weakness in those businesses at that time. Additionally, in conjunction with the SJT Forjaria Ltda. acquisition in December 2016, we approved plans to eliminate certain redundant positions as one of our initial steps toward the integration of the SJT Forjaria Ltda. operations into our Commercial Vehicle business in that region. Including costs associated with these actions and with other previously announced initiatives, total restructuring expense during 2016 was $36, including $33 of severance and benefits costs and $3 of exit costs.
Accrued restructuring costs and activity, including noncurrent portion -
At December 31, 2018, accrued employee termination benefits include costs to reduce approximately 300 employees over the next year. The exit costs relate primarily to lease continuation obligations.
Cost to complete - The following table provides project-to-date and estimated future restructuring expenses for completion of our approved restructuring initiatives for our business segments at December 31, 2018.
The future cost to complete primarily includes exit costs through 2021, including lease continuation costs, equipment transfers and other costs which are required to be recognized as closures are finalized or as incurred during the closure.
Note 6. Inventories
Inventory components at December 31 -
Note 7. Supplemental Balance Sheet and Cash Flow Information
Supplemental balance sheet information at December 31 -
Cash, cash equivalents and restricted cash at -
Supplemental cash flow information -
Note 8. Stockholders' Equity
Preferred Stock
We are authorized to issue 50,000,000 of Dana preferred stock, par value $0.01 per share. There were no preferred shares outstanding at December 31, 2018 or 2017.
Common Stock
We are authorized to issue 450,000,000 shares of Dana common stock, par value $0.01 per share. At December 31, 2018, there were 153,005,588 shares of our common stock issued and 144,663,403 shares outstanding, net of 8,342,185 in treasury shares. Treasury shares include those shares withheld at cost to satisfy tax obligations from stock awards issued under our stock compensation plan in addition to share repurchases noted below.
Our Board of Directors declared a quarterly cash dividend of ten cents per share of common stock in each quarter of 2018. Aggregate 2018 declared dividends total $59 and paid cash dividends total $58. Dividends accrue on restricted stock units (RSUs) granted under our stock compensation program and will be paid in cash or additional units when the underlying units vest.
Share repurchase program - On March 24, 2018 our Board of Directors approved an expansion of our existing common stock share repurchase program to $200. The program expires on December 31, 2019. Under the program, we spent $25 to repurchase 1,055,000 shares of our common stock during the second quarter of 2018 through open market transactions. Approximately $175 remained available under the program for future share repurchases as of December 31, 2018. Our common stock share repurchase program of up to $1,700 approved in 2016 expired on December 31, 2017.
Changes in equity -
During the first quarter of 2018, a wholly-owned subsidiary of Dana purchased the ownership interest in Dana Spicer (Thailand) Limited (a non wholly-owned consolidated subsidiary of Dana) held by ROC Spicer, Ltd. (a non wholly-owned consolidated subsidiary of Dana). Dana maintained its controlling financial interest in Dana Spicer (Thailand) Limited and accordingly accounted for the purchase as an equity transaction. The excess of the fair value of the consideration paid over the carrying value of the investment attributable to the noncontrolling interest in ROC Spicer, Ltd. was recognized as additional noncontrolling interest with a corresponding reduction of the additional paid-in capital of Dana. During the third quarter of 2018, Yulon Motor Co., Ltd. (Yulon) purchased a direct ownership interest in two of our consolidated operating subsidiaries. Yulon's ownership interest in the two consolidated operating subsidiaries did not change as a result of the transactions, as it previously owned the same percentages indirectly through a series of consolidated holding companies. The cash received from Yulon was recognized as additional noncontrolling interest. The amount received, less withholding taxes, was returned to Yulon in the form of a dividend in the fourth quarter of 2018.
Changes in each component of AOCI of the parent -
___________________________________________________
Notes:
(a)
For 2018, realized gains and losses from currency-related forward contracts associated with forecasted transactions or from other derivative instruments treated as cash flow hedges are reclassified from AOCI into the same line item in the consolidated statement of operations in which the underlying forecasted transaction or other hedged item is recorded. See Note 15 for additional details. For 2017 and 2016, reclassifications from AOCI were included in other income (expense), net.
(b)
See Note 12 for additional details.
Note 9. Redeemable Noncontrolling Interests
In connection with the acquisition of a controlling interest in TM4 from Hydro-Québec on June 22, 2018, we recognized $102 for Hydro-Québec's 45% redeemable noncontrolling interest. The terms of the agreement provide Hydro-Québec with the
right to put all, and not less than all, of its shares to Dana at fair value any time after June 22, 2021. See Note 2 for additional information.
In connection with the acquisition of a controlling interest in BFP and BPT from Brevini on February 1, 2017, we recognized $44 for Brevini's 20% redeemable noncontrolling interests. The terms of the agreement provided Dana the right to call Brevini's noncontrolling interests in BFP and BPT, and Brevini the right to put its noncontrolling interests in BFP and BPT to Dana, assuming Dana did not exercise its call rights, at dates and prices defined in the agreement. The call and put prices were based on the amount Dana paid to acquire its initial ownership interest in BFP and BPT subject to adjustment based on the actual EBITDA and free cash flows, as defined in the agreement, of BFP and BPT.
On August 8, 2018, we entered into an agreement to acquire Brevini's remaining 20% ownership interests in BFP and BPT and to settle all claims between the parties. We paid $43 to acquire Brevini's remaining ownership interests and received $10 in settlement of all pending and future claims. AOCI attributable to Brevini's redeemable noncontrolling interests was reclassified to AOCI of the parent company. The difference between the carrying value of Brevini's redeemable noncontrolling interests and the cash paid was recorded to additional paid-in capital of the parent company. See Note 2 for additional information.
Redeemable noncontrolling interests reflected as of the balance sheet date are the greater of the redeemable noncontrolling interest balances adjusted for comprehensive income items and distributions or the redemption values. Redeemable noncontrolling interest adjustments of redemption value are recorded in retained earnings. During 2017 there was a $6 adjustment to reflect a redemption value in excess of carrying value. See Note 10 for additional information.
Reconciliation of changes in redeemable noncontrolling interests -
Note 10. Earnings per Share
Reconciliation of the numerators and denominators of the earnings per share calculations -
The share count for diluted earnings per share is computed on the basis of the weighted-average number of common shares outstanding plus the effects of dilutive common stock equivalents (CSEs) outstanding during the period. We excluded 0.2 million, 0.1 million and 1.7 million CSEs from the calculations of diluted earnings per share for the years 2018, 2017 and 2016 as the effect of including them would have been anti-dilutive.
Note 11. Stock Compensation
2017 Omnibus Incentive Plan
The 2017 Omnibus Incentive Plan (the Plan) authorizes the grant of stock options, stock appreciation rights (SARs), RSUs and performance share units (PSUs) through April 2027. Cash-settled awards do not count against the maximum aggregate number. At December 31, 2018, there were 5.6 million shares available for future grants. Shares of common stock to be issued under the Plan are made available from authorized and unissued Dana common stock.
Award activity - (shares in millions)
* Weighted-average per share
Compensation expense is generally measured based on the fair value at the date of grant and is recognized on a straight-line basis over the vesting period. For options and SARs, we use an option-pricing model to estimate fair value. For RSUs and PSUs, the fair value is based on the closing market price of our common stock at the date of grant. Awards that are settled in cash are subject to liability accounting. Accordingly, the fair value of such awards is remeasured at the end of each reporting period until settled or expired. We had accrued $2 and $7 for cash-settled awards at December 31, 2018 and 2017. We issued 0.7 million and 0.2 million shares of common stock based on vesting of RSUs and PSUs during 2018. At December 31, 2018, the total unrecognized compensation cost related to the nonvested awards granted and expected to vest was $20. This cost is expected to be recognized over a weighted-average period of 1.7 years.
Stock options and stock appreciation rights - The exercise price of each option or SAR equals the closing market price of our common stock on the date of grant. Options and SARs generally vest over three years and their maximum term is ten years. Shares issued upon the exercise of options are recorded as common stock and additional paid-in capital at the option price. SARs are settled in cash for the difference between the market price on the date of exercise and the exercise price. We have not granted stock options or SARs since 2013. All outstanding awards are fully vested and exercisable. At December 31, 2018, the outstanding awards have an aggregate intrinsic value of $1 and a weighted-average remaining contractual life of 3.1 years.
Restricted stock units and performance shares units - Each RSU or PSU granted represents the right to receive one share of Dana common stock or, at the election of Dana (for units awarded to board members) or for employees located outside the U.S. (for employee awarded units), cash equal to the market value per share. All RSUs contain dividend equivalent rights. RSUs granted to non-employee directors vest on the first anniversary date of the grant and those granted to employees generally cliff vest fully after three years. PSUs granted to employees vest if specified performance goals are achieved during the respective performance period, generally three years.
The number of PSUs that ultimately vest is contingent on achieving specified return on invested capital targets, specified total shareholder return targets relative to peer companies or specified margin targets. For the portion of the PSU award based on the return on invested capital performance or margin metric, we estimated the fair value at grant date based on the closing market price of our common stock at the date of grant adjusted for the value of assumed dividends over the period because the award is not dividend protected. The estimated grant date value is accrued over the performance period and adjusted as
appropriate based on performance relative to the target. For the portion of the PSU award based on shareholder returns, we estimated the fair value at grant date using various assumptions as part of a Monte Carlo simulation. The expected term represents the period from the grant date to the end of the performance period. The risk-free interest rate was based on U.S. Treasury constant maturity rates at the grant date. The dividend yield was calculated by dividing the expected annual dividend by the average stock price over the prior year. The expected volatility was based on historical volatility using daily stock price observations.
Cash incentive awards - Our 2017 Omnibus Incentive Plan provides for cash incentive awards. We make awards annually to certain eligible employees designated by Dana, including certain executive officers. Awards under the plan are based on achieving certain financial performance goals. The performance goals of the plan are established annually by the Board of Directors.
Under the 2018 and 2017 annual incentive programs, participants were eligible to receive cash awards based on achieving earnings and cash flow performance goals. The 2016 annual incentive program is based on earnings and working capital performance goals. Our 2017 and 2016 long-term incentive programs each have a three-year contractual vesting period and include a performance-based cash component. For the 2017 and 2016 long-term incentive programs the vesting of the performance-based cash component is based on achieving a return on invested capital target measured on an average basis over the contractual period. The 2017 award also has a component that is based on achieving a margin target in the third year of the program that was established at the grant date. We accrued $33, $77 and $41 of expense in 2018, 2017 and 2016 for the expected cash payments under these programs.
Note 12. Pension and Postretirement Benefit Plans
We sponsor various defined benefit, qualified and nonqualified, pension plans covering eligible employees. Other postretirement benefits (OPEB), including medical and life insurance, are provided for certain employees upon retirement.
We also sponsor various defined contribution plans that cover the majority of our employees. Under the terms of the qualified defined contribution retirement plans, employee and employer contributions may be directed into a number of diverse investments. None of these qualified defined contribution plans allow direct investment in our stock.
Components of net periodic benefit cost (credit) and other amounts recognized in OCI -
Our U.S. defined benefit pension plans are frozen and no additional service cost is being accrued. The estimated net actuarial loss for the defined benefit pension plans that will be amortized from AOCI into benefit cost in 2019 is $21 for our U.S. plans and $6 for our non-U.S. plans. We use the corridor approach for purposes of systematically amortizing deferred gains or losses as a component of net periodic benefit cost into the income statement in future reporting periods. The amortization period used is generally the average remaining service period of active participants in the plan unless almost all of the plan’s participants are inactive, in which case we use the average remaining life expectancy of the inactive participants. No portion of the estimated net actuarial gain related to OPEB plans will be amortized from AOCI into benefit cost in 2019.
In October 2017, upon authorization by the Dana Board of Directors, we commenced the process of terminating one of our U.S. defined benefit pension plans. Ultimate plan termination is subject to prevailing market conditions and other considerations, including interest rates and annuity pricing. Settlement of the plan obligations is expected to occur in the first half of 2019. At December 31, 2018, this plan had benefit obligations of $938 and assets of $773. The benefit obligations have been valued at the amount expected to be required to settle the obligations, using assumptions regarding the portion of obligations expected to be settled through participant acceptance of lump sum payments or annuities and the cost to purchase those annuities. Increasing this plan's obligations to reflect the expected settlement value resulted in an actuarial loss of $69 that was charged to OCI in 2017. At December 31, 2018, this plan had unrecognized actuarial losses of $370. If the settlement is effected as expected in 2019, the plan's deferred actuarial losses remaining in AOCI at that time will be recognized as expense.
Funded status - The following tables provide reconciliations of the changes in benefit obligations, plan assets and funded status.
Amounts recognized in the balance sheet -
Amounts recognized in AOCI -
The 2018 actuarial loss of $11 on the U.S plans was largely the result of the expected return on assets exceeding the actual asset return. Additionally, a custom mortality table was developed during 2018 using our historical mortality experience. These custom mortality tables are projected generationally from 2015 using the Society of Actuaries projection scale, MP-2018, modified to use a 0.75% long-term improvement rate, being attained in 2027.
Excluding the actuarial loss of $69 for remeasurement of the benefit obligations of the plan being terminated at expected settlement value, we recognized an actuarial gain of $47 on the U.S. plans in 2017 as the return on assets exceeding the expected rate more than offset the effect of the lower discount rates used to value our December 31, 2017 pension obligations and the impact of using spot rates to determine pension service and interest expense, as discussed previously. In the fourth quarter of 2017, the Society of Actuaries continued its trend of frequent updates, issuing new U.S. mortality scales (MP-2017) based on historical data through 2014 and preliminary data for 2015. After studying the new data and consulting with our actuarial advisers, we concluded that adopting MP-2017, modified to reflect a long-term improvement rate of 0.75% being attained in 2026, was appropriate. This change in assumption did not have a significant impact on the 2017 valuation.
Aggregate funding levels - The following table presents information regarding the aggregate funding levels of our defined benefit pension plans at December 31:
Fair value of pension plan assets -
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Notes:
(a)
Certain assets are measured at fair value using the net asset value (NAV) per share (or its equivalent) practical expedient and have not been classified in the fair value hierarchy.
(b)
This category comprises a combination of small-, mid- and large-cap equity stocks that are allocated at the investment manager's discretion. Investments include common and preferred securities as well as equity funds that invest in these instruments.
(c)
This category represents a combination of high-yield and investment grade corporate bonds, sovereign bonds, Yankee bonds, asset-backed securities and U.S. government bonds. Investments include fixed income funds that invest in these instruments.
(d)
This category comprises contracts placed with insurance companies where the underlying assets are invested in fixed interest securities.
(e)
Other assets in the U.S. represent interest rate derivatives which had a market value of $(10) at December 31, 2017.
Valuation Methods
Equity securities - The fair value of equity securities held directly by the trust is based on quoted market prices. When the equity securities are held in commingled funds that are not publicly traded, the fair value of our interest in the fund is its NAV as determined by quoted market prices for the underlying holdings.
Fixed income securities - The fair value of fixed income securities held directly by the trust is based on a bid evaluation process with input from independent pricing sources. When the fixed income securities are held in commingled funds that are not publicly traded, the fair value of our interest in the fund is its NAV as determined by a similar valuation of the underlying holdings.
Insurance contracts - The values shown for insurance contracts are the amounts reported by the insurance company and approximate the fair values of the underlying investments.
Real estate - The investments in real estate represent ownership interests in commingled funds and partnerships that invest in real estate. The investment managers determine the NAV of these ownership interests using the fair value of the underlying real estate which is obtained via independent third party appraisals prepared on a periodic basis. Assumptions used to value the properties are updated quarterly. For the component of the real estate portfolio under development, the investments are carried at cost until they are completed and valued by a third party appraiser.
Cash and cash equivalents - The fair value of cash and cash equivalents is set equal to its amortized cost.
The methods described above may produce a fair value that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we believe the valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.
Investment policy - Target asset allocations of U.S. pension plans are established through an investment policy, which is updated periodically and reviewed by an Investment Committee, comprised of certain company officers. The investment policy allows for a flexible asset allocation mix which is intended to provide appropriate diversification to lessen market volatility while assuming a reasonable level of economic risk.
Our policy recognizes that properly managing the relationship between pension assets and pension liabilities serves to mitigate the impact of market volatility on our funding levels. The investment policy permits plan assets to be invested in a number of diverse categories, including a Growth Portfolio, an Immunizing Portfolio and a Liquidity Portfolio. These sub-portfolios are intended to balance the generation of incremental returns with the management of overall risk.
The Growth Portfolio is invested in a diversified pool of assets in order to generate an incremental return with an acceptable level of risk. The Immunizing Portfolio is a hedging portfolio that may be comprised of fixed income securities and overlay positions. This portfolio is designed to offset changes in the value of the pension liability due to changes in interest rates. The Liquidity Portfolio is a cash portfolio designed to meet short-term liquidity needs and reduce the plans’ overall risk. As a result of our diversification strategies, there are no significant concentrations of risk within the portfolio of investments.
The allocations among portfolios are adjusted as needed to meet changing objectives and constraints and to manage the risk of adverse changes in the unfunded positions of our plans. Following approval of the plan of termination by our Board of Directors in October 2017, the Investment Committee established new targets for the assets of the subject plan. At December 31, 2018, the plan that we expect to terminate had targets of 0% in the Growth Portfolio (U.S. and non-U.S. equities,
high-yield fixed income, real estate, emerging market debt and cash), 98% in the Immunizing Portfolio (long duration U.S. Treasury strips, corporate bonds and cash) and 2% in the Liquidity Portfolio (cash and short-term securities) while the remaining U.S. plans had targets of 45% for the Growth Portfolio, 53% for the Immunizing Portfolio and 2% for the Liquidity Portfolio. The assets held at December 31, 2018 by the plan we expect to terminate were invested 5% in the Growth Portfolio, 94% in the Immunizing Portfolio and 1% in the Liquidity Portfolio while the assets held by the remaining U.S. plans were invested 42% in the Growth Portfolio, 56% in the Immunizing Portfolio and 2% in the Liquidity Portfolio. The Investment Committee is in the process of implementing the adjustments to the asset allocation.
Significant assumptions - The significant weighted-average assumptions used in the measurement of pension benefit obligations at December 31 of each year and the net periodic benefit cost for each year are as follows:
The pension plan discount rate assumptions are evaluated annually in consultation with our outside actuarial advisers. Long-term interest rates on high quality corporate debt instruments are used to determine the discount rate. For our largest plans, discount rates are developed using a discounted bond portfolio analysis, with appropriate consideration given to defined benefit payment terms and duration of the liabilities. As disclosed previously, the obligations of the U.S. plan being terminated have been remeasured at expected settlement value. Based on the timing and settlement payments, the U.S. plan being terminated has an implied discount rate of 3.46%. In the above table, the discount rate used to determine U.S. pension obligations at the end of 2017 and 2018 does not consider the plan we expect to terminate.
We had historically estimated the interest and service cost components of net periodic benefit cost for pension and other postretirement benefits using a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation of the plan at the most recent remeasurement date. At December 31, 2015, we changed the method used to estimate those interest and service components for pension and other postretirement benefit plans that utilize a yield curve approach. The new method uses a full yield curve approach to estimate the interest and service components by applying the specific spot rates along the yield curve used in the most recent remeasurement of the benefit obligation to the relevant projected cash flows. We believe this method improves the correlation between the projected cash flows and the corresponding interest rates and provides a more precise measurement of interest and service costs. Since the remeasurement of total benefit obligations is not affected, the resulting reduction in periodic benefit cost is offset by an increase in the actuarial loss.
The expected rate of return on plan assets was selected on the basis of our long-term view of return and risk assumptions for major asset classes. We define long-term as forecasts that span at least the next ten years. Our long-term outlook is influenced by a combination of return expectations by individual asset class, actual historical experience and our diversified investment strategy. We consult with and consider the opinions of financial professionals in developing appropriate capital market assumptions. Return projections are also validated using a simulation model that incorporates yield curves, credit spreads and risk premiums to project long-term prospective returns. The appropriateness of the expected rate of return is assessed on an annual basis and revised if necessary. We have a high percentage of total assets in fixed income securities since the benefit accruals are frozen for all of our U.S. pension plans. Based on this assessment, we have selected a 6.00% expected return on asset assumption for 2019 for our U.S. plans not being terminated. The asset portfolio of the U.S. plan expected to be terminated has a higher proportion of assets invested in fixed income investments. As such, we selected an expected rate of 3.80% for this plan.
The significant weighted-average assumptions used in the measurement of OPEB obligations at December 31 of each year and the net periodic benefit cost for each year are as follows:
The discount rate selection process was similar to the process used for the pension plans. Assumed health care cost trend rates have a significant effect on the health care obligation. To determine the trend rates, consideration is given to the plan design, recent experience and health care economics.
A one-percentage-point change in assumed health care cost trend rates would have the following effects for 2018:
Estimated future benefit payments and contributions - Expected benefit payments by our pension and OPEB plans for each of the next five years and for the following five-year period are as follows:
Pension benefits are funded through deposits with trustees that satisfy, at a minimum, the applicable funding regulations. OPEB benefits are funded as they become due. Projected contributions to be made during 2019 to the defined benefit pension plans are $16 for our non-U.S. plans. Based on the current funded status of our U.S. plans, there are no minimum contributions required for 2019. 2019 benefit payments include the impact of the termination of the U.S. defined benefit pension plan discussed above.
Multi-employer pension plans - We participate in the Steelworkers Pension Trust (SPT) multi-employer pension plan which provides pension benefits to all of our U.S. employees represented by the United Steelworkers and United Automobile Workers unions. Contributions are made in accordance with our collective bargaining agreements and rates are generally based on hours worked. The collective bargaining agreements expire August 18, 2021. The trustees of the SPT have provided us with the latest data available for the plan year ended December 31, 2018. As of that date, the plan is not fully funded. We could be held liable to the plan for our obligations as well as those of other employers as a result of our participation in the plan. Contribution rates could increase if the plan is required to adopt a funding improvement plan or a rehabilitation plan, if the performance of plan assets does not meet expectations or as a result of future collectively bargained wage and benefit agreements. If we choose to stop participating in the plan, we may be required to pay the plan an amount based on the underfunded status of the plan, referred to as a withdrawal liability.
The Pension Protection Act (PPA) defines a zone status for each plan. Plans in the green zone are at least 80% funded, plans in the yellow zone are at least 65% funded and plans in the red zone are generally less than 65% funded. The SPT plan has utilized extended amortization provisions to amortize its losses from 2008. The plan recertified its zone status after using the extended amortization provisions as allowed by law. The SPT plan has not implemented a funding improvement or rehabilitation plan, nor are such plans pending. Our contributions to the SPT exceeded 5% of the total contributions to the plan.
Note 13. Marketable Securities
U.S. government securities include bonds issued by government-sponsored agencies and Treasury notes. Corporate securities include primarily debt securities. Other consists of investments in mutual and index funds. U.S. government securities, corporate debt and certificates of deposit maturing in one year or less, after one year through five years and after five years through ten years total $15, $3 and $3 at December 31, 2018.
Note 14. Financing Agreements
Long-term debt at December 31 -
*
In conjunction with the issuance of the April 2025 Notes we entered into 8-year fixed-to-fixed cross-currency swaps which have the effect of economically converting the April 2025 Notes to euro-denominated debt at a fixed rate of 3.850%. In conjunction with the issuance of the June 2026 Notes we entered into 10-year fixed-to-fixed cross-currency swaps which have the effect of economically converting the June 2026 Notes to euro-denominated debt at a fixed rate of 5.140%. See Note 15 for additional information.
Interest on the senior notes is payable semi-annually and interest on the Term Facility is payable quarterly. Other indebtedness includes borrowings from various financial institutions, capital lease obligations and the unamortized fair value adjustment related to a terminated interest rate swap. See Note 15 for additional information on the terminated interest rate swap.
Scheduled principal payments on long-term debt, including capital leases at December 31, 2018 -
Senior notes activity - On September 18, 2017, we redeemed the remaining $350 of our September 2021 Notes at a price equal to 102.688% plus accrued and unpaid interest. The $13 loss on extinguishment of debt includes the $10 redemption premium and the $3 write-off of previously deferred financing costs associated with the September 2021 Notes.
On April 4, 2017, Dana Financing Luxembourg S.à r.l., a wholly-owned subsidiary of Dana, issued $400 in senior notes (April 2025 Notes) at 5.750%, which are guaranteed by Dana. The April 2025 Notes were issued through a private placement and will not be registered under the U.S. Securities Act of 1933, as amended (the Securities Act). The April 2025 Notes were offered only to qualified institutional buyers in reliance on Rule 144A under the Securities Act and, outside the United States, only to non-U.S. investors in reliance on Regulation S under the Securities Act. The April 2025 Notes rank equally with Dana's other unsecured senior notes. Interest on the notes is payable on April 15 and October 15 of each year. The April 2025 Notes will mature on April 15, 2025. Net proceeds of the offering totaled $394. Financing costs of $6 were recorded as deferred costs and are being amortized to interest expense over the life of the April 2025 Notes. The proceeds from the offering were used to repay indebtedness of our BPT and BFP subsidiaries, repay indebtedness of a wholly-owned subsidiary in Brazil, redeem $100 of our September 2021 Notes and for general corporate purposes. The September 2021 Notes were redeemed on April 4, 2017 at a price equal to 104.031% plus accrued and unpaid interest. The $6 loss on extinguishment of debt includes the $4 redemption premium and the $1 write-off of previously deferred financing costs associated with the September 2021 Notes and the $1 redemption premium associated with the repayment of indebtedness of a wholly-owned subsidiary in Brazil. In conjunction with the issuance of the April 2025 Notes, we entered into 8-year fixed-to-fixed cross-currency swaps which have the effect of economically converting the April 2025 Notes to euro-denominated debt at a fixed rate of 3.850%. See Note 15 for additional information.
On June 23, 2016, we redeemed all of our February 2021 Notes at a price equal to 103.375% plus accrued and unpaid interest. The $16 loss on extinguishment of debt includes the $12 redemption premium and the $4 write-off of previously deferred financing costs associated with the February 2021 Notes.
On May 27, 2016, Dana Financing Luxembourg S.à r.l., a wholly-owned subsidiary of Dana, issued $375 in senior notes (June 2026 Notes). The June 2026 Notes were issued through a private placement and will not be registered under the U.S. Securities Act of 1933, as amended (the Securities Act). The June 2026 Notes were offered only to qualified institutional buyers in reliance on Rule 144A under the Securities Act and, outside the United States, only to non-U.S. investors in reliance on Regulation S under the Securities Act. The June 2026 Notes rank equally with Dana's other unsecured senior notes. Interest on the notes is payable on June 15 and December 15 of each year. The June 2026 Notes will mature on June 1, 2026. Net proceeds of the offering totaled $368. Financing costs of $7 were recorded as deferred costs and are being amortized to interest expense over the life of the notes. The proceeds from the offering were used to redeem our February 2021 Notes, to pay related fees and expenses and for general corporate purposes.
Senior notes redemption provisions - We may redeem some or all of the senior notes at the following redemption prices (expressed as percentages of principal amount), plus accrued and unpaid interest to the redemption date, if redeemed during the 12-month period commencing on the anniversary date of the senior notes in the years set forth below:
Prior to December 15, 2019, we may redeem some or all of the December 2024 Notes at a price equal to the principal amount thereof, plus accrued and unpaid interest, plus a “make-whole” premium. We have not separated the make-whole premium from the underlying debt instrument to account for it as a derivative instrument as the economic characteristics and the risks of this embedded derivative are clearly and closely related to the economic characteristics and risks of the underlying debt.
At any time prior to April 15, 2020, we may redeem up to 35% of the aggregate principal amount of the April 2025 Notes in an amount not to exceed the amount of proceeds of one or more equity offerings, at a price equal to 105.750% of the principal amount thereof, plus accrued and unpaid interest, if any, to the redemption date, provided that at least 50% of the original aggregate principal amount of the April 2025 Notes remains outstanding after the redemption.
Prior to April 15, 2020, we may redeem some or all of the April 2025 Notes at a redemption price of 100.000% of the aggregate principal amount thereof, plus accrued and unpaid interest, if any, to the redemption date plus a “make-whole” premium. We have not separated the make-whole premium from the underlying debt instrument to account for it as a derivative instrument as the economic characteristics and the risks of this embedded derivative are clearly and closely related to the economic characteristics and risks of the underlying debt.
At any time prior to June 1, 2019, we may redeem up to 35% of the aggregate principal amount of the June 2026 Notes in an amount not to exceed the amount of proceeds of one or more equity offerings, at a price equal to 106.500% of the principal amount thereof, plus accrued and unpaid interest, if any, to the redemption date, provided that at least 50% of the original aggregate principal amount of the June 2026 Notes remains outstanding after the redemption.
Prior to June 1, 2021, we may redeem some or all of the June 2026 Notes at a redemption price of 100.000% of the aggregate principal amount thereof, plus accrued and unpaid interest, if any, to the redemption date plus a “make-whole” premium. We have not separated the make-whole premium from the underlying debt instrument to account for it as a derivative instrument as the economic characteristics and the risks of this embedded derivative are clearly and closely related to the economic characteristics and risks of the underlying debt.
Credit agreement - On August 17, 2017, we entered into an amended credit and guaranty agreement comprised of a $275 term facility (the Term Facility) and a $600 revolving credit facility (the Revolving Facility) both of which mature on August 17, 2022. On September 14, 2017, we drew the entire amount available under the Term Facility. Net proceeds from the Term Facility draw totaled $274. Financing costs of $1 were recorded as deferred cost and are being amortized to interest expense over the life of the Term Facility. We are required to make equal quarterly installments on the last day of each fiscal quarter of 1.5625% of the initial aggregate principal amount of the Term Facility commencing on September 30, 2018. We may prepay some or all of Term Facility without penalty. Any prepayments made on the Term Facility would be applied against the required quarterly installments. The proceeds from the Term Facility were used to repay our September 2021 Notes and for general corporate purposes. The Revolving Facility amended our previous revolving credit facility. In connection with the Revolving Facility, we paid $2 in deferred financing costs to be amortized to interest expense over the life of the facility. Deferred financing costs on our Revolving Facility are included in other noncurrent assets.
The Term Facility and the Revolving Facility are guaranteed by all of our wholly-owned domestic subsidiaries subject to certain exceptions (the guarantors) and grants a first-priority lien on substantially all of the assets of Dana and the guarantors, subject to certain exceptions.
Advances under the Term Facility and Revolving Facility bear interest at a floating rate based on, at our option, the base rate or Eurodollar rate (each as described in the revolving credit agreement) plus a margin as set forth below:
We have elected to pay interest on our advance under the Term Facility at the Eurodollar Rate. The interest rates on the Term Facility, inclusive of the applicable margin, was 4.27238% as of December 31, 2018.
Commitment fees are applied based on the average daily unused portion of the available amounts under the Revolving Facility as set forth below:
Up to $275 of the Revolving Facility may be applied to letters of credit, which reduces availability. We pay a fee for issued and undrawn letters of credit in an amount per annum equal to the applicable margin for Eurodollar rate advances based on a quarterly average availability under issued and undrawn letters of credit under the Revolving Facility and a per annum fronting fee of 0.125%, payable quarterly.
At December 31, 2018, we had no outstanding borrowings under the Revolving Facility but we had utilized $21 for letters of credit. We had availability at December 31, 2018 under the Revolving Facility of $579 after deducting the outstanding letters of credit.
Debt covenants - At December 31, 2018, we were in compliance with the covenants of our financing agreements. Under the Term Facility, Revolving Facility and the senior notes, we are required to comply with certain incurrence-based covenants customary for facilities of these types and, in the case of the Term Facility and Revolving Facility, a maintenance covenant requiring us to maintain a first lien net leverage ratio not to exceed 2.00 to 1.00.
Note 15. Fair Value Measurements and Derivatives
In measuring the fair value of our assets and liabilities, we use market data or assumptions that we believe market participants would use in pricing an asset or liability including assumptions about risk when appropriate. Our valuation techniques include a combination of observable and unobservable inputs.
Fair value measurements on a recurring basis - Assets and liabilities that are carried in our balance sheet at fair value are as follows:
Fair Value Level 1 assets and liabilities reflect quoted prices in active markets. Fair Value Level 2 assets and liabilities reflect the use of significant other observable inputs.
Fair value of financial instruments - The financial instruments that are not carried in our balance sheet at fair value are as follows:
*
The carrying value includes the unamortized portion of a fair value adjustment related to a terminated interest rate swap at both dates. The carrying value and fair value also include a financial liability associated with certain build-to-suit lease arrangements at December 31, 2017.
The fair value of our senior notes and Term Facility are estimated based upon a market approach (Level 2) while the fair value of our other indebtedness is based upon an income approach (Level 2). The fair value of the Term Facility approximates its carrying value as it is a floating-rate facility. See Note 14 for additional information about financing arrangements.
Fair value measurements on a nonrecurring basis - Certain assets are measured at fair value on a nonrecurring basis. These are long-lived assets that are subject to fair value adjustments only in certain circumstances. These assets include intangible assets and property, plant and equipment which may be written down to fair value when they are held for sale or as a result of impairment.
Interest rate derivatives - Our portfolio of derivative financial instruments periodically includes interest rate swaps designed to mitigate our interest rate risk. As of December 31, 2018, no fixed-to-floating interest rate swaps remain outstanding. However, a $6 fair value adjustment to the carrying amount of our December 2024 Notes, associated with a fixed-to-floating interest rate swap that had been executed but was subsequently terminated during 2015, remains deferred at December 31, 2018. This amount is being amortized as a reduction of interest expense through the period ending December 2024, the scheduled maturity date of the December 2024 Notes. Approximately $1 was amortized as a reduction of interest expense during 2018.
Foreign currency derivatives - Our foreign currency derivatives include forward contracts associated with forecasted transactions, primarily involving the purchases and sales of inventory through the next eighteen months, as well as currency swaps associated with certain recorded external notes payable and intercompany loans receivable and payable. Periodically, our foreign currency derivatives also include net investment hedges of certain of our investments in foreign operations.
In 2017, in conjunction with the issuance of €281 of euro-denominated intercompany notes payable, issued by certain of our Luxembourg subsidiaries (the "Luxembourg Intercompany Notes") and payable to USD-functional Dana, Inc., we executed fixed-to-fixed cross-currency swaps with the same critical terms as the Luxembourg Intercompany Notes. The risk management objective of these swaps is to eliminate the variability in the functional-currency-equivalent cash flows due to changes in the euro / U.S. dollar exchange rates associated with the forecasted principal and interest payments.
In 2017, in conjunction with the issuance of the $400 of U.S. dollar-denominated April 2025 Notes by euro-functional Dana Financing Luxembourg S.à r.l., we executed fixed-to-fixed cross-currency swaps with the same critical terms as the April 2025 Notes to eliminate the variability in the functional-currency-equivalent cash flows due to changes in the U.S. dollar / euro exchange rates associated with the forecasted principal and interest payments.
In 2016, in conjunction with the issuance of the $375 of U.S. dollar-denominated June 2026 Notes by euro-functional Dana Financing Luxembourg S.à r.l., we executed fixed-to-fixed cross-currency swaps with the same critical terms as the June 2026 Notes to eliminate the variability in the functional-currency-equivalent cash flows due to changes in the U.S. dollar / euro exchange rates associated with the forecasted principal and interest payments.
All of the underlying designated financial instruments, and any subsequent replacement debt, have been designated as the hedged items in each respective cash flow hedge relationship, as shown in the table below. Designated as cash flow hedges of the forecasted principal and interest payments of the underlying designated financial instruments, or subsequent replacement debt, all of the swaps economically convert the underlying designated financial instruments into the functional currency of each respective holder. The impact of the interest rate differential between the inflow and outflow rates on all fixed-to-fixed cross-currency swaps is recognized during each period as a component of interest expense.
The following fixed-to-fixed cross-currency swaps were outstanding at December 31, 2018:
All of the swaps are expected to be highly effective in offsetting the corresponding currency-based changes in cash outflows related to the underlying designated financial instruments. Based on our qualitative assessment that the critical terms of all of the underlying designated financial instruments and all of the associated swaps match and that all other required criteria have been met, we do not expect to incur any ineffectiveness. As effective cash flow hedges, changes in the fair value of the swaps will be recorded in OCI during each period. Additionally, to the extent the swaps remain effective, the appropriate portion of AOCI will be reclassified to earnings each period as an offset to the foreign exchange gain or loss resulting from the remeasurement of the underlying designated financial instruments. See Note 14 for additional information about the June 2026 Notes and the April 2025 Notes. To the extent the swaps are no longer effective, changes in their fair values will be recorded in earnings.
The total notional amount of outstanding foreign currency forward contracts, involving the exchange of various currencies, was $1,007 at December 31, 2018 and $306 at December 31, 2017. The total notional amount of outstanding foreign currency swaps, including the fixed-to-fixed cross-currency swaps, was $1,097 at December 31, 2018 and $1,112 at December 31, 2017.
The following currency derivatives were outstanding at December 31, 2018:
During the third quarter of 2018, we entered into a Swiss franc notional deal contingent forward to economically hedge the purchase price relating to the planned acquisition of the Drive Systems segment of the Oerlikon Group.
Cash flow hedges - With respect to contracts designated as cash flow hedges, changes in fair value during the period in which the contracts remain outstanding are reported in OCI to the extent such contracts remain effective. Effectiveness is measured by using regression analysis to determine the degree of correlation between the change in the fair value of the derivative instrument and the change in the associated foreign currency exchange rates. Changes in fair value of contracts not designated as cash flow hedges or as net investment hedges are recognized in other income (expense), net in the period in which the changes occur. Realized gains and losses from currency-related forward contracts associated with forecasted transactions or from other derivative instruments, including those that have been designated as cash flow hedges and those that have not been designated, are recognized in the same line item in the consolidated statement of operations in which the underlying forecasted transaction or other hedged item is recorded. Accordingly, amounts are potentially recorded in sales, cost of sales or, in certain circumstances, other income (expense), net.
The following table provides a summary of the impact on AOCI of derivative instruments that have been designated as cash flow hedges:
The following table provides a summary of the location and amount of gains or losses recognized in the consolidated statement of operations associated with cash flow hedging relationships:
The amounts reclassified from AOCI into income for the cross-currency swaps represent an offset to a foreign exchange loss on our foreign currency-denominated intercompany and external debt instruments.
Certain of our hedges of forecasted transactions have not formally been designated as cash flow hedges. As undesignated forward contracts, the changes in the fair value of such contracts are included in earnings for the duration of the outstanding forward contract. Any realized gain or loss on the settlement of such contracts is recognized in the same period and in the same line item in the consolidated statement of operations as the underlying transaction. The following table provides a summary of the location and amount of gains or losses recognized in the consolidated statement of operations associated with undesignated hedging relationships.
Net investment hedges - We periodically designate derivative contracts or underlying non-derivative financial instruments as net investment hedges. With respect to contracts designated as net investment hedges, we apply the forward method, but for non-derivative financial instruments designated as net investment hedges, we apply the spot method. Under both methods, we report changes in fair value in the CTA component of OCI during the period in which the contracts remain outstanding to the extent such contracts and non-derivative financial instruments remain effective.
In 2017, we designated the principal amount of an existing non-derivative Mexican peso-denominated intercompany note payable (the "MXN-denominated intercompany note") by Dana European Holdings Luxembourg S.à r.l. to Dana de Mexico Corporacion S. de R.L. de C.V., one of our Mexican subsidiaries, as a net investment hedge of the equivalent portion of the investment in the associated Mexican operations. During the third quarter of 2018 the intercompany note was repaid and no additional net investment hedges are outstanding. On a cumulative basis, a deferred loss of $4 has been recorded in the CTA component of AOCI for this non-derivative instrument. Amounts recorded in CTA remain deferred in AOCI until such time as the investments in the associated subsidiaries are substantially liquidated.
Amounts to be reclassified to earnings - Deferred gains or losses associated with effective cash flow hedges of forecasted transactions are reported in AOCI and are reclassified to earnings in the same periods in which the underlying transactions affect earnings. Amounts expected to be reclassified to earnings assume no change in the current hedge relationships or to December 31, 2018 exchange rates. Deferred gains of $2 at December 31, 2018 are expected to be reclassified to earnings during the next twelve months, compared to deferred losses of $4 at December 31, 2017. Amounts reclassified from AOCI to earnings arising from the discontinuation of cash flow hedge accounting treatment were not material during 2018.
Note 16. Commitments and Contingencies
Product liabilities - We had accrued $19 and $7 for product liability costs at December 31, 2018 and 2017. We had also recognized $24 and $9 as expected amounts recoverable from third parties at the respective dates. The increases in the liability and recoverable amounts at December 31, 2018 largely reflect the recognition of the estimated cost, net of payments made, and
the expected recovery of an insured matter. Payments made to claimants have preceded the recovery of amounts from third parties, resulting in a recoverable amount in excess of the total liability at December 31, 2018. We estimate these liabilities based on current information and assumptions about the value and likelihood of the claims against us.
Environmental liabilities - Accrued environmental liabilities were $10 and $8 at December 31, 2018 and 2017. We consider the most probable method of remediation, current laws and regulations and existing technology in estimating our environmental liabilities.
Guarantee of lease obligations - In connection with the divestiture of our Structural Products business in 2010, leases covering three U.S. facilities were assigned to a U.S. affiliate of Metalsa. Under the terms of the sale agreement, we will guarantee the affiliate’s performance under the leases, which run through June 2025, including approximately $6 of annual payments. In the event of a required payment by Dana as guarantor, we are entitled to pursue full recovery from Metalsa of the amounts paid under the guarantee and to take possession of the leased property.
Other legal matters - We are subject to various pending or threatened legal proceedings arising out of the normal course of business or operations. In view of the inherent difficulty of predicting the outcome of such matters, we cannot state what the eventual outcome of these matters will be. However, based on current knowledge and after consultation with legal counsel, we believe that any liabilities that may result from these proceedings will not have a material adverse effect on our liquidity, financial condition or results of operations.
Lease commitments - Cash obligations under future minimum rental commitments under operating leases and net rental expense at December 31, 2018 are shown in the table below. Operating lease commitments are primarily related to facilities.
Note 17. Warranty Obligations
We record a liability for estimated warranty obligations at the dates our products are sold. We record the liability based on our estimate of costs to settle future claims. Adjustments to our estimated costs at time of sale are made as claim experience and other new information becomes available. Obligations for service campaigns and other occurrences are recognized as adjustments to prior estimates when the obligation is probable and can be reasonably estimated.
Changes in warranty liabilities -
Note 18. Income Taxes
Income tax expense (benefit) -
We record interest and penalties related to uncertain tax positions as a component of income tax expense or benefit. Net interest expense for the periods presented herein is not significant.
Income before income taxes -
Income tax audits - We conduct business globally and, as a result, file income tax returns in multiple jurisdictions that are subject to examination by taxing authorities throughout the world. With few exceptions, we are no longer subject to U.S. federal, state and local or foreign income tax examinations for years before 2009.
We are currently under audit by U.S. and foreign authorities for certain taxation years. When the issues related to these periods are settled, the total amounts of unrecognized tax benefits for all open tax years may be modified. Audit outcomes and the timing of the audit settlements are subject to uncertainty and we cannot make an estimate of the impact on our financial position at this time.
U.S. tax reform legislation - On December 22, 2017, the Tax Cuts and Jobs Act ("Act") was signed into law in the U.S. The Act includes a broad range of tax reforms, certain of which were required by GAAP to be recognized upon enactment. The U.S. Securities and Exchange Commission has issued Staff Accounting Bulletin 118 (SAB 118), which provides guidance on accounting for the tax effects of the Act. SAB 118 provides a measurement period that should not extend beyond one year from the enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Act.
Based on our historical financial performance in the U.S., at December 31, 2017, we had a significant net deferred tax asset position. As such, with the Act's reduction of the corporate tax rate from 35% to 21%, we remeasured our net deferred tax assets at the lower corporate rate of 21% and recognized tax expense to adjust net deferred tax assets to the reduced value. The Act introduced provisions that fundamentally change the U.S. approach to taxation of foreign earnings. Under the Act, qualified dividends of foreign subsidiaries are no longer subject to U.S. tax. Under the previously-existing tax rules, dividends from foreign operations were subjected to U.S. tax, and if not considered permanently reinvested, we had recognized expense and recorded a liability for the tax expected to be incurred upon receipt of the dividend of these foreign earnings. Although the Act excludes dividends of foreign subsidiaries from taxation, it included a provision for a mandatory deemed dividend of undistributed foreign earnings at tax rates of 15.5% or 8% ("transition tax") depending on the nature of the foreign operations' assets. Companies may utilize tax attributes (including net operating losses and tax credits) to offset the transition tax. The estimated net effect of applying the provisions of the Act on our 2017 results of operations was a non-cash charge to tax expense of $186. Our analysis of this provisional amount continued throughout the year as additional guidance and
interpretations of the Act were issued, and we completed our accounting for the provisions of the Act in the fourth quarter of 2018, with no material adjustment required.
Beginning in 2018, the Act may also trigger a taxable deemed dividend to the extent that the annual earnings of our foreign subsidiaries exceed a specified threshold, based on the value of tangible foreign operating assets. The deemed dividend, if any, from this global intangible low-taxed income (GILTI) may be offset by the use of other tax attributes in that year, and specifically, the GILTI rules may impact the amount of cash tax savings that net operating losses provide. The SEC staff has indicated that a company should make and disclose certain policy elections related to accounting for GILTI. As to whether we will recognize deferred taxes for basis differences expected to reverse as GILTI or account for the effect of GILTI as a period cost when incurred, we intend to account for the tax effect of GILTI as a period cost. As to the realizability of the tax benefit provided by net operating losses, we are electing to utilize the tax law ordering approach.
Effective tax rate reconciliation -
During 2018, we recognized a benefit of $44 related to U.S. state law changes and the development and implementation of a tax planning strategy which adjusted federal tax credits, along with federal and state net operating losses and the associated valuation allowances. We also recognized benefits of $11 relating to the reversal of a provision for an uncertain tax position, $5 relating to the release of valuation allowances in the US based on improved income projections and $7 due to permanent reinvestment assertions. Partially offsetting these benefits was $5 of expense to settle outstanding tax matters in a foreign jurisdiction.
The net effect in 2017 of applying the U.S. tax reform provisions of the Act was tax expense of $186. This impact, which increased the effective rate for 2017 by 49%, was principally attributable to the reduction of net deferred tax assets to reflect the reduced corporate tax rate. Foreign tax credits of $49 which were generated in 2017 but not utilized to offset the transition tax are included as a benefit in the credits and incentives component of the effective rate reconciliation, with an offsetting expense of $49 in the valuation allowance component to recognize that such credits are not likely to be realized.
In the fourth quarter of 2016, we determined that valuation allowances against certain U.S. deferred taxes were no longer required. Release of these valuation allowances resulted in $501 of tax benefit. Valuation allowances against U.S. deferred tax assets primarily related to state operating loss carryforwards and other credits were retained. In the fourth quarter of 2017, based on our improved financial performance and outlook, we determined that release of an additional $27 was appropriate and recognized a tax benefit of this amount. Developments in Brazil in 2016 led to our determination that an allowance against certain deferred taxes in that country was appropriate, and we recognized tax expense of $25 in 2016 to establish this valuation allowance.
Foreign income repatriation - Prior to the U.S. tax reform provisions enacted with passage of the Act, we provided for U.S. federal income and non-U.S. withholding taxes on the earnings of our non-U.S. operations that are not considered to be permanently reinvested. As indicated above, with passage of the Act, dividends of earnings from non-U.S. operations are generally no longer subjected to U.S. income tax. Accordingly, in the fourth quarter of 2017, we reduced the previously recorded liability for U.S. income tax on expected repatriations of non-U.S. earnings. We continue to analyze and adjust the estimated impact of the non-U.S. income and withholding tax liabilities based on the amount and source of these earnings, as well as the expected means through which those earnings may be taxed. We recognized a net benefit of $7 in 2018, net expense of $2 in 2017, and a net benefit of $58 in 2016 related to future income taxes and non-U.S. withholding taxes on repatriations
from operations that are not permanently reinvested. We also paid withholding taxes of $11, $7 and $6 during 2018, 2017 and 2016 related to the actual transfer of funds to the U.S. The unrecognized tax liability associated with the operations in which we are permanently reinvested is $11 at December 31, 2018.
The earnings of our certain non-U.S. subsidiaries may be repatriated to the U.S. in the form of repayments of intercompany borrowings. Certain of our international operations had intercompany loan obligations to the U.S. totaling $1,040 at the end of 2018. Included in this amount are intercompany loans and related interest accruals with an equivalent value of $21 which are denominated in a foreign currency and considered to be permanently invested.
Valuation allowance adjustments - We have recorded valuation allowances in several entities where the recent history of operating losses does not allow us to satisfy the “more likely than not” criterion for the recognition of deferred tax assets. Consequently, there is no income tax expense or benefit recognized on the pre-tax income or losses in these jurisdictions as valuation allowances are adjusted to offset the associated tax expense or benefit.
When evaluating the need for a valuation allowance we consider all components of comprehensive income, and we weigh the positive and negative evidence, putting greater reliance on objectively verifiable evidence than on projections of future profitability that are dependent on actions that have not occurred as of the assessment date. We also consider changes to the historical financial results due to activities that were either new to the business or not expected to recur in the future, in order to identify the core earnings of the business. A sustained period of profitability, after considering changes to the historical results due to implemented actions and nonrecurring events, along with positive expectations for future profitability are necessary to reach a determination that a valuation allowance should be released. We believe it is reasonably possible that a valuation allowance of up to $24 related to a subsidiary in Brazil will be released in the next twelve months.
At December 31, 2016, we retained a valuation allowance of $137 against deferred tax assets in the U.S. primarily related to state operating loss carryforwards and other credits which do not meet the more likely than not criterion for releasing the valuation allowance. Based on our financial performance and outlook, we determined that $5 and $27 of this allowance met the more-likely-than not standard for release in 2018 and 2017.
Deferred tax assets and liabilities - Temporary differences and carryforwards give rise to the following deferred tax assets and liabilities.
Carryforwards - Our deferred tax assets include benefits expected from the utilization of net operating loss (NOL), capital loss and credit carryforwards in the future. The following table identifies the net operating loss deferred tax asset components and the related allowances that existed at December 31, 2018. Due to time limitations on the ability to realize the benefit of the carryforwards, additional portions of these deferred tax assets may become unrealizable in the future.
In addition to the NOL carryforwards listed in the table above, we have deferred tax assets related to capital loss carryforwards of $40 which are fully offset with valuation allowances at December 31, 2018. We also have deferred tax assets of $232 related to other credit carryforwards which are partially offset with $95 of valuation allowances at December 31, 2018. The capital losses can be carried forward indefinitely while the other credits are generally available for 10 to 20 years.
The use of our $362 U.S. federal NOL as of December 31, 2018 is subject to limitation due to the change in ownership of our stock upon emergence from bankruptcy. Generally, the application of the relevant Internal Revenue Code (IRC) provisions will release the limitation on $84 of pre-change NOLs each year, allowing pre-change losses to offset post-change taxable income. However, there can be no assurance that trading in our shares will not effect another change in ownership under the IRC which could further limit our ability to utilize our available NOLs.
Unrecognized tax benefits - Unrecognized tax benefits are the difference between a tax position taken, or expected to be taken, in a tax return and the benefit recognized for accounting purposes. Interest income or expense, as well as penalties relating to income tax audit adjustments and settlements, are recognized as components of income tax expense or benefit. Interest of $11 and $11 was accrued on the uncertain tax positions at December 31, 2018 and 2017.
Reconciliation of gross unrecognized tax benefits -
The 2017 decrease related to prior years tax positions includes $23 that resulted from the reduction of the U.S. income tax rate from 35% to 21% since these positions represent a reduction of U.S. net operating losses. We anticipate that our gross unrecognized tax benefits will decrease by $16 in the next twelve months upon the expected completion of examinations in various jurisdictions. The settlement of these matters will not impact the effective tax rate. Gross unrecognized tax benefits of $86 would impact the effective tax rate if recognized. If other open matters are settled with the IRS or other taxing jurisdictions, the total amounts of unrecognized tax benefits for open tax years may be modified.
Note 19. Other Income (Expense), Net
Foreign exchange gains and losses on cross-currency intercompany loan balances that are not of a long-term investment nature are included above. Foreign exchange gains and losses on intercompany loans that are permanently invested are reported in OCI.
Strategic transaction expenses relate primarily to costs incurred in connection with acquisition and divestiture related activities, including costs to complete the transaction and post-closing integration costs. Strategic transaction expenses in 2018 were primarily attributable to our bid to acquire the driveline business of GKN plc., our acquisition of an ownership interest in TM4, our pending acquisition of the Drive Systems segment of the Oerlikon Group and integration costs associated with our acquisitions of BFP and BPT, and were partially offset by a $40 transaction breakup fee associated with the GKN plc. transaction. Strategic transaction expenses in 2017 are primarily attributable to our acquisitions of USM - Warren, BFP and BPT. Strategic transaction expenses in 2016 are primarily attributable to our acquisition of SJT Forjaria Ltda. and our divestitures of DCLLC and Nippon Reinz. See Notes 2 and 3 for additional information.
Amounts attributable to previously divested/closed operations includes the receipt of the remaining proceeds on our December 2016 divestiture of DCLLC during the second quarter of 2017. See Note 3 for additional information. During 2016, DCLLC received $8 as recovery of costs previously incurred on behalf of other participants in a consortium that existed to administer certain legacy personal injury claims, and they sold investments which generated $7 of gain.
Note 20. Revenue from Contracts with Customers
We generate revenue from selling production parts to original equipment manufacturers (OEMs) and service parts to OEMs and aftermarket customers. While we provide production and service parts to certain OEMs under awarded multi-year programs, these multi-year programs do not contain any commitment to volume by the customer. As such, individual customer releases or purchase orders represent the contract with the customer. Our customer contracts do not provide us with an enforceable right to payment for performance completed to date throughout the contract term. As such, we recognize part sales revenue at the point in time when the parts are shipped, and risk of loss has transferred to the customer. We have elected to continue to include shipping and handling fees billed to customers in revenue, while including costs of shipping and handling in costs of sales. Taxes collected from customers are excluded from revenues and credited directly to obligations to the appropriate government agencies. Payment terms with our customers are established based on industry and regional practices and generally do not exceed 180 days.
Certain of our customer contracts include rebate incentives. We estimate expected rebates and accrue the corresponding refund liability, as a reduction of revenue, at the time covered product is sold to the customer based on anticipated customer purchases during the rebate period and contractual rebate percentages. Under prior accounting guidance rebate reserves were reflected as a reduction of accounts receivable - trade as rebates are generally net settled through the issuance of a credit to the customer's account. Refund liabilities are included in other accrued liabilities on our consolidated balance sheet. We provide standard fitness for use warranties on the products we sell, accruing for estimated costs related to product warranty obligations at time of sale. See Note 17 for additional information.
Contract liabilities are primarily comprised of cash deposits made by customers with cash in advance payment terms. Generally, our contract liabilities turn over frequently given our relatively short production cycles. Contract liabilities were $12 and $9 at December 31, 2018 and January 1, 2018. Contract liabilities are included in other accrued liabilities on our consolidated balance sheet.
Disaggregation of revenue -
The following table disaggregates revenue for each of our operating segments by geographical market:
Note 21. Segments, Geographical Area and Major Customer Information
We are a global provider of high-technology products to virtually every major vehicle and engine manufacturer in the world. We also serve the stationary industrial market. Our technologies include drive and motion products (axles, driveshafts, planetary hub drives, power-transmission products, tire-management products, transmissions, and motors, power inverters and controls systems for electric vehicles); sealing solutions (gaskets, seals, heat shields, and fuel-cell plates); thermal-management technologies (transmission and engine oil cooling, battery and electronics cooling, and exhaust-gas heat recovery); and fluid-power products (pumps, valves, motors, and controls). We serve our global light vehicle, medium/heavy vehicle and off-highway markets through four operating segments - Light Vehicle Driveline Technologies (Light Vehicle), Commercial Vehicle Driveline Technologies (Commercial Vehicle), Off-Highway Drive and Motion Technologies (Off-Highway) and Power Technologies, which is the center of excellence for sealing and thermal-management technologies that span all customers in our on-highway and off-highway markets. These operating segments have global responsibility and accountability for business commercial activities and financial performance.
Dana evaluates the performance of its operating segments based on external sales and segment EBITDA. Segment EBITDA is a primary driver of cash flows from operations and a measure of our ability to maintain and continue to invest in our operations and provide shareholder returns. Our segments are charged for corporate and other shared administrative costs. Segment EBITDA may not be comparable to similarly titled measures reported by other companies.
Segment information -
Upon our adoption of ASU 2017-07 on January 1, 2018, we changed our measurement of segment profit to exclude the non-service cost components of pension and OPEB costs. See Note 1 for additional information on ASU 2017-07. Prior period segment EBITDA amounts have not been recast due to the insignificance of the adjustments. Had the prior period amounts been recast to conform with the current presentation, segment EBITDA for 2017 and 2016 would have been $359 and $275 for Light Vehicle, $119 and $98 for Commercial Vehicle, $213 and $130 for Off-Highway and $173 and $163 for Power Technologies.
Net assets include accounts receivable, inventories, other current assets, goodwill, intangibles, investments in affiliates, other noncurrent assets, net property, plant and equipment, accounts payable and current accrued liabilities.
Reconciliation of segment EBITDA to consolidated net income -
Reconciliation of segment net assets to consolidated total assets -
Geographic information - Of our 2018 consolidated net sales, the U.S., Italy and Germany account for 44%, 12% and 6%, respectively. No other country accounted for more than 5% of our consolidated net sales during 2018. Sales are attributed to the location of the product entity recording the sale. Long-lived assets represent property, plant and equipment.
Sales to major customers - Ford is the only individual customer to whom sales have exceeded 10% of our consolidated sales in each of the past three years. Sales to Ford were $1,646 (20%) in 2018, $1,553 (22%) in 2017 and $1,300 (22%) in 2016. Sales to FCA exceeded the threshold in 2018 at $911 (11%).
Note 22. Equity Affiliates
We have a number of investments in entities that engage in the manufacture of vehicular parts - primarily axles, driveshafts and wheel-end braking systems - supplied to OEMs.
Dividends received from equity affiliates were $20, $16 and $11 in 2018, 2017 and 2016.
Equity method investments exceeding $5 at December 31, 2018 -
Our equity method investments in DDAC, PEPS, Bendix Spicer Foundation Brake, LLC and Axles India Limited are included in the net assets of our Commercial Vehicle operating segment. Our equity method investment in Taiway Ltd. is included in the net assets of our Light Vehicle segment.
The carrying value of our equity method investments at December 31, 2018 was $61 more than our share of the affiliates’ book value, including $53 attributable to goodwill. The difference between the investment carrying value and the amount of underlying equity in assets, excluding goodwill, is being amortized on a straight-line basis over the underlying assets’ estimated useful lives of five to forty-five years.
Dana Incorporated
Quarterly Results (Unaudited)
(In millions, except per share amounts)
_________________________________________________________
Note: Gross margin is net sales less cost of sales.
Net income for the second quarter of 2018 includes a $20 pre-tax charge to fully impair intangible assets used in research and development activities. The net loss for the fourth quarter of 2017 includes a $27 pre-tax charge to adjust carrying value of our Brazil suspension components business to fair value and to recognize the liability for the additional cash required to be contributed to the business prior to closing and a tax charge of $186 to recognize the estimated effects of U.S. tax reform legislation enacted on December 22, 2017. Net income for the third and second quarters of 2017 includes a $13 and $6 pre-tax loss on extinguishment of debt.
Dana Incorporated
Schedule II
Valuation and Qualifying Accounts and Reserves
(In millions)
Amounts deducted from assets in the balance sheets -
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Disclosure controls and procedures - Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, (the Exchange Act)) as of the end of the period covered by this report. Based on such evaluations, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective.
Management's report on internal control over financial reporting - Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Considering Securities and Exchange Commission guidance, management excluded from its assessment of internal control over financial reporting TM4 Inc. (TM4) acquired on June 22, 2018. TM4's total assets and total revenues excluded from management's assessment represented approximately 1.2% and 0.1%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2018. Based on this evaluation, management has concluded that, as of December 31, 2018, our internal control over financial reporting was effective.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the effectiveness of our internal control over financial reporting as of December 31, 2018, as stated in its report which is included herein.
Changes in internal control over financial reporting - There has been no change in our internal control over financial reporting during the quarter ended December 31, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Dana has adopted Standards of Business Conduct that apply to all of its officers and employees worldwide. Dana also has adopted Standards of Business Conduct for the Board of Directors. Both documents are available on Dana’s Internet website at http://www.dana.com/investors.
The remainder of the response to this item will be included under the sections captioned “Corporate Governance,” “Board Leadership Structure," "Succession Planning,” “Information About the Nominees,” “Risk Oversight,” “Committees and Meetings of Directors,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” of Dana’s definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 2019, which sections are hereby incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The response to this item will be included under the sections captioned “Compensation Committee Interlocks and Insider Participation,” “Compensation of Executive Officers,” “Compensation Discussion and Analysis,” “Compensation of Directors,” “Officer Stock Ownership Guidelines,” “Compensation Committee Report,” “Summary Compensation Table,” “Grants of Plan-Based Awards at Fiscal Year-End,” “Outstanding Equity Awards at Fiscal Year-End,” “Option Exercises and Stock Vested During Fiscal Year,” “Pension Benefits,” “Nonqualified Deferred Compensation at Fiscal Year-End,” “Executive
Agreements” and “Potential Payments and Benefits Upon Termination or Change in Control” of Dana’s definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 2019, which sections are hereby incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The response to this item will be included under the section captioned “Security Ownership of Certain Beneficial Owners and Management” of Dana’s definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 2019, which section is hereby incorporated herein by reference.
Equity Compensation Plan Information
The following table contains information at December 31, 2018 about shares of stock which may be issued under our equity compensation plans, all of which have been approved by our shareholders.
________________________________________
Notes:
(1)
In addition to stock options, restricted stock units and performance shares have been awarded under Dana's equity compensation plans and were outstanding at December 31, 2018.
(2)
Calculated without taking into account the 2.5 shares of common stock subject to outstanding restricted stock and performance share units that become issuable as those units vest since they have no exercise price and no cash consideration or other payment is required for such shares.
Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence
The response to this item will be included under the sections captioned “Director Independence and Transactions of Directors with Dana,” “Transactions of Executive Officers with Dana” and “Information about the Nominees” of Dana’s definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 2019, which sections are hereby incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The response to this item will be included under the section captioned "Independent Registered Public Accounting Firm" of Dana's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 1, 2019, which section is hereby incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on this 15th day of February 2019 by the following persons on behalf of the registrant and in the capacities indicated, including a majority of the directors.
Signature
Title
/s/ James K. Kamsickas
President and Chief Executive Officer
James K. Kamsickas
(Principal Executive Officer)
/s/ Jonathan M. Collins
Executive Vice President and Chief Financial Officer
Jonathan M. Collins
(Principal Financial Officer)
/s/ James D. Kellett
Vice President and Chief Accounting Officer
James D. Kellett
(Principal Accounting Officer)
/s/ Rachel A. Gonzalez*
Director
Rachel A. Gonzalez
/s/ Virginia A. Kamsky*
Director
Virginia A. Kamsky
/s/ Michael J. Mack, Jr.*
Director
Michael J. Mack, Jr.
/s/ Raymond E. Mabus, Jr.*
Director
Raymond E. Mabus, Jr.
/s/ R. Bruce McDonald*
Director
R. Bruce McDonald
/s/ Diarmuid B. O'Connell*
Director
Diarmuid B. O'Connell
/s/ Keith E. Wandell*
Non-Executive Chairman and Director
Keith E. Wandell
*By:
/s/ Douglas H. Liedberg
Douglas H. Liedberg, Attorney-in-Fact