filings.toolsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
188K characters. Original on sec.gov · Markdown
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following management’s discussion and analysis of financial condition and results of operations (“MD&A”) is intended to help you understand the business operations and financial condition of the Company for the three year period ended December 31, 2016. This discussion should be read in conjunction with Item 8. Financial Statements and Supplementary Data. Our MD&A is presented in seven sections:
| • | Executive Overview |
| • | Consolidated Results of Operations |
| • | Results of Operations by Segment |
| • | Liquidity and Capital Resources |
| • | Off-Balance Sheet Arrangements and Other Matters |
| • | Significant Accounting Policies and Critical Accounting Estimates |
| • | Recently Issued Accounting Pronouncements |
Within the MD&A, “Delphi,” the “Company,” “we,” “us” and “our” refer to Delphi Automotive PLC, a public limited company which was formed under the laws of Jersey on May 19, 2011, together with its subsidiaries, including Delphi Automotive LLP, a limited liability partnership incorporated under the laws of England and Wales which was formed on August 19, 2009 for the purpose of acquiring certain assets and subsidiaries of the former Delphi Corporation (now known as DPH Holdings Corp. (“DPHH”)), and became a subsidiary of Delphi Automotive PLC in connection with the completion of the Company’s initial public offering on November 22, 2011. The former Delphi Corporation and, as the context may require, its subsidiaries and affiliates, are also referred to herein as "Old Delphi.”
As described in Note 25. Discontinued Operations to the audited consolidated financial statements included herein, on March 31, 2016 we completed the final step of our strategy to divest our former Thermal Systems business through the sale of our ownership interest in the Shanghai Delphi Automotive Air Conditioning ("SDAAC") joint venture for net cash proceeds of $62 million. Previously, on June 30, 2015 we completed the sale of the Company's wholly owned Thermal Systems business to MAHLE GmbH ("MAHLE") for net cash proceeds of approximately $660 million, and on September 24, 2015 we completed the sale of our interest in the Korea Delphi Automotive Systems Corporation ("KDAC") joint venture to a separate buyer for net cash proceeds of $70 million. The SDAAC and KDAC joint ventures were previously reported within the Thermal Systems segment. The divestiture of the Thermal Systems business positions us with a strategically focused product portfolio in high-growth spaces to meet consumer preferences for products that address the industry mega-trends of Safe, Green and Connected. Proceeds from the sale were used to fund growth initiatives, including acquisitions, as well as share repurchases. As the disposal of the Thermal Systems business represents a strategic shift that will have a major effect on the Company's operations and financial results, the assets and liabilities, operating results, and operating and investing cash flows for the previously reported Thermal Systems segment are presented as discontinued operations separate from the Company’s continuing operations for all periods presented. This Management’s Discussion and Analysis reflects the results of continuing operations, unless otherwise noted.
Executive Overview
Our Business
We are a leading global vehicle components manufacturer and provide electrical and electronic, powertrain and active safety technology solutions to the global automotive and commercial vehicle markets. We are one of the largest vehicle component manufacturers, and our customers include all 25 of the largest automotive original equipment manufacturers (“OEMs”) in the world.
Business Strategy
We believe the Company is well-positioned for growth from increasing global vehicle production volumes, increased demand for our Safe, Green and Connected products which are being added to vehicle content, and new business wins with existing and new customers. We have successfully created a competitive cost structure, continued to align our product offerings with the high-growth industry mega-trends and re-aligned our manufacturing footprint into an efficient, low-cost regional service model, allowing us to increase our profit margins.
Our achievements in 2016 included the following:
| • | Generating gross business bookings of $25.6 billion, based upon expected volumes and pricing; |
| • | Generating $1.9 billion of cash from continuing operations and net income of $1.3 billion; |
| • | Continuing our focus on diversifying our geographic, product and customer mix, resulting in 37% of our 2016 net sales generated in the North American market, 26% generated from the Asia Pacific region, which we have identified as a key market likely to experience long term growth, and 14% generated from our largest customer; |
| • | Continuing to strategically position the Company's product portfolio in high-growth spaces to meet consumer preferences for products that address the industry mega-trends of Safe, Green and Connected, including $1.5 billion invested in research & development in 2016, which includes approximately $300 million of co-investment by customers and government agencies, and through value enhancing portfolio modifications and agreements, which included: |
| • | Enhancing our leading automated driving capabilities by entering into a collaborative arrangement with Mobileye N.V. to jointly develop a complete turn-key fully autonomous driving platform, and through an additional strategic investment in Quanergy Systems, Inc.; |
| • | Complementing and enhancing our fully-reconfigurable digital display product offerings by acquiring PureDepth, Inc. ("PureDepth"), a leading provider of multi-layer display technology that enables glasses-less 3D for cluster and other applications; |
| • | Completing the final step of our strategy to divest our former Thermal Systems business through the sale of our ownership interest in the SDAAC joint venture for net cash proceeds of $62 million; and |
| • | Completing the divestiture of our non-core Mechatronics business for net cash proceeds of $197 million. |
| • | Maximizing our operational flexibility and profitability at all points in the normal automotive business cycle, by having approximately 95% of our hourly workforce based in low cost countries and approximately 14% of our hourly workforce composed of temporary employees; and |
| • | Leveraging our investment grade credit metrics to further refine our capital structure and increase our financial flexibility by successfully issuing €500 million of 12-year, 1.60% Euro-denominated senior unsecured notes and $300 million of 30-year, 4.40% senior unsecured notes, utilizing the combined proceeds to redeem our $800 million, 5.00% senior notes. |
Our strategy is to build on these accomplishments and continue to develop and manufacture innovative market-relevant products for a diverse base of customers around the globe and leverage our lean and flexible cost structure to achieve strong and disciplined earnings growth and returns on invested capital. Through our culture of innovation and world class engineering capabilities we intend to employ our rigorous, forward-looking product development process to deliver new technologies that provide solutions to OEMs. We are committed to creating value for our shareholders. We repurchased $635 million of ordinary shares in 2016. We also continued to return cash to our shareholders, paying cash dividends totaling $317 million in 2016. Our key strategic priorities include:
Targeting the right business with the right customers. We intend to be strategic in our pursuit of new business and customers in order to achieve disciplined, above-market growth. We conduct in-depth analysis of market share and product trends by region in order to prioritize research, development and engineering spend for the customers that we believe will be successful. Collaboration with customers in our 15 major technical centers around the world helps us develop innovative product solutions designed to meet their needs. As more OEMs design vehicles for global platforms, where the same vehicle architecture is shared among different regions, we are well suited to provide global design and engineering support while manufacturing these products for a specific regional market.
Leveraging our engineering and technological capabilities. We seek to leverage our strong product portfolio tied to the industry’s key mega-trends with our global footprint to increase our revenues, as well as committing to substantial annual investment in research and development to maintain and enhance our leadership in each of our product lines.
Capitalizing on our scale, global footprint and established position in emerging markets. We intend to generate sustained growth by capitalizing on the breadth and scale of our operating capabilities. Our global footprint provides us important proximity to our customers’ manufacturing facilities and allows us to serve them in every region in which they operate. We anticipate that we will continue to build upon our extensive geographic reach to capitalize on growing automotive markets, particularly in China. In addition, our presence in low cost countries positions us to realize incremental margin improvements as the global balance of automotive production shifts towards emerging markets.
Leveraging our lean and flexible cost structure to deliver profitability and cash flow. We recognize the importance of maintaining a lean and flexible cost structure in order to deliver stable earnings and cash flow in a cyclical industry. Our focus is on maximizing and optimizing manufacturing output to meet increasing production requirements with minimal additions to our fixed-cost base. Additionally, we are continuing to use a meaningful amount of temporary workers to ensure we have the appropriate operational flexibility to scale our operations so that we can maintain our profitability as industry production levels increase or contract.
Advancing and maintaining an efficient capital structure. We actively manage our capital structure in order to maintain an investment grade credit rating and healthy capital ratios to support our business and maximize shareholder value. We will continue to make adjustments to our capital structure in light of changes in economic conditions or as opportunities arise to provide us with additional financial flexibility to invest in our business and execute our strategic objectives going forward.
Pursuing selected acquisitions and strategic investments. During 2016 we continued to complete selected acquisitions and strategic investments in order to continue to enhance our product offerings and competitive position in growing market segments. We intend to continue to pursue selected transactions that leverage our technology capabilities and enhance and expand our product offerings, customer base, geographic penetration and scale to complement our current businesses.
Trends, Uncertainties and Opportunities
Economic conditions. Our business is directly related to automotive sales and automotive vehicle production by our customers. Automotive sales depend on a number of factors, including global and regional economic conditions. Although global automotive vehicle production increased 5% from 2015 to 2016, economic conditions and the resultant levels of automotive vehicle production were uneven from a regional perspective. Vehicle production increased by 2% in North America and 3% in Europe as consumer demand for vehicles increased as a result of these economies experiencing moderate improvement in 2016. Both the North American and European economies are expected to continue to experience moderate growth, resulting in essentially flat vehicle production in both regions in 2017 as compared to the increased volumes experienced in 2016. Automotive production in China increased by 15% in 2016 as compared to 2015, benefiting in part from a consumer vehicle tax reduction program. Following a partial increase in the consumer vehicle tax in 2017, vehicle production in China is expected to increase by 1% in 2017 as compared to 2016. Additionally, vehicle production in South America, our smallest region, decreased by 12% in 2016 as compared to 2015, with volumes expected to be flat in 2017 with the reduced volumes experienced in 2016, due to continued economic weakness in the region.
Economic volatility or weakness in North America, Europe or China, or continued weakness in South America, could result in a significant reduction in automotive sales and production by our customers, which would have an adverse effect on our business, results of operations and financial condition. There is also potential that geopolitical factors could adversely impact the U.S. and other economies, and specifically the automotive sector. In particular, changes to international trade agreements such as the North American Free Trade Agreement or other political pressures could affect the operations of our OEM customers, resulting in reduced automotive production in certain regions or shifts in the mix of production to higher cost regions. Increases in interest rates could also negatively impact automotive production as a result of increased consumer borrowing costs or reduced credit availability. Additionally, economic weakness may result in shifts in the mix of future automotive sales (from vehicles with more content such as luxury vehicles, trucks and sport utility vehicles toward smaller passenger cars). While our diversified customer and geographic revenue base, along with our flexible cost structure, have well positioned us to withstand the impact of industry downturns and benefit from industry upturns, shifts in the mix of global automotive production to higher cost regions or to vehicles with less content could adversely impact our profitability.
There have also been periods of increased market volatility and currency exchange rate fluctuations, both globally and most specifically within the United Kingdom ("U.K.") and Europe, as a result of the U.K. referendum held on June 23, 2016 in which voters approved an exit from the European Union ("E.U."), commonly referred to as "Brexit." As a result of the referendum, the British government will begin negotiating the terms of the U.K.’s future relationship with the E.U. including, among other matters, the terms of trade between the U.K. and the E.U. Brexit could adversely affect European and worldwide economic and market conditions and could contribute to instability in global financial and foreign exchange markets, including increased volatility in interest rates and foreign exchange rates. Although we are actively monitoring the ongoing potential impacts of Brexit and will seek to minimize its impact on our business, any of these effects of Brexit, among others, could adversely affect our business, business opportunities, results of operations, financial condition and cash flows. Approximately 5% of our annual net sales are generated in the U.K., and approximately 3% are denominated in British pounds.
Emerging markets growth. There have been periods of increased market volatility and moderations in the level of economic growth in China, which resulted in periods of lower automotive production growth rates in China than those previously experienced. Despite these recent moderations in the level of economic growth in China, rising income levels in China and other emerging markets have resulted and are expected to result in stronger growth rates in these markets over the long term. Our strong global presence, and presence in these markets, has positioned us to experience above-market growth rates over the long term. We continue to expand our established presence in emerging markets, positioning us to benefit from the expected long term growth opportunities in these regions. We are capitalizing on our long-standing relationships with the global OEMs and further enhancing our positions with the emerging market OEMs to continue expanding our worldwide leadership. We continue to build upon our extensive geographic reach to capitalize on fast-growing automotive markets. We believe that our presence in low cost countries positions us to realize incremental margin improvements as the global balance of automotive production shifts towards the emerging markets.
We have a strong presence in China, where we have operated for over 20 years, including a major manufacturing base, which has included investments in 6 new manufacturing facilities since 2012. All of our business segments have operations and sales in China. As a result, we have well-established relationships with all of the major OEMs in China. Our business in China remains sensitive to economic and market conditions that drive automotive sales volumes in China, and may be impacted if there are reductions in vehicle demand in China. However, we continue to believe there is long term growth potential in this market based on increasing long term automotive and vehicle content demand.
Market driven products. Our product offerings satisfy the OEMs’ needs to meet increasingly stringent government regulations and meet consumer preferences for products that address the mega-trends of Safe, Green and Connected, leading to increased content per vehicle, greater profitability and higher margins. With these offerings, we believe we are well-positioned to benefit from the growing demand for vehicle content and technology related to safety, fuel efficiency, emissions control, electrification, high speed data, connectivity to the global information network and automated driving technologies. Our Electrical/Electronic Architecture and Electronics and Safety segments are benefiting from the substantial increase in vehicle content, software and electrification requiring a complex and reliable electrical architecture and systems to operate, such as automated advanced driver assistance technologies, electrical vehicle monitoring, active safety systems, lane departure warning systems, integrated vehicle cockpit displays, navigation systems and technologies that enable connected infotainment in vehicles. Our ability to design a reliable electrical architecture that optimizes power distribution and/or consumption is key to satisfying the OEMs’ needs to reduce emissions while continuing to meet consumer demand for increased vehicle content and technology. In 2016 we introduced our 48-volt mild hybrid vehicle solution, which maximizes the use of 48-volt electrification to minimize the demand on the engine, improving performance while lowering CO2 emissions by more than 10%. Additionally, our Powertrain Systems segment is also focused on addressing the demand for increased fuel efficiency and emission control through products such as gasoline direct injection (GDi) fuel systems and variable valve actuation technology such as dynamic skip fire software.
Global capabilities. Many OEMs are continuing to adopt global vehicle platforms to increase standardization, reduce per unit cost and increase capital efficiency and profitability. As a result, OEMs are selecting suppliers that have the capability to manufacture products on a worldwide basis, as well as the flexibility to adapt to regional variations. Suppliers with global scale and strong design, engineering and manufacturing capabilities, are best positioned to benefit from this trend. Our global footprint enables us to serve the global OEMs on a worldwide basis as we gain market share with the emerging market OEMs. This regional model principally services the North American market out of Mexico, the South American market out of Brazil, the European market out of Eastern Europe and North Africa and the Asia Pacific market out of China, and we have continued to rotate our manufacturing footprint to low cost locations within these regions.
Our global operations are subject to certain risks inherent in doing business abroad, including unexpected changes in laws, regulations, trade or monetary or tax fiscal policy, including tariffs, quotas, customs and other import or export restrictions and other trade barriers. Existing free trade laws and regulations, such as the North American Free Trade Agreement, provide certain beneficial duties and tariffs for qualifying imports and exports, subject to compliance with the applicable classification and other requirements. Changes in laws or policies governing the terms of foreign trade, and in particular increased trade restrictions, tariffs or taxes on imports from countries where we manufacture products, such as China and Mexico, could have a material adverse affect on our business and financial results.
Product development. The automotive component supply industry is highly competitive, both domestically and internationally, and is characterized by rapidly changing technology, evolving industry standards and changes in customer needs. Our ability to anticipate changes in technology and regulatory standards and to successfully develop and introduce new and enhanced products on a timely and cost competitive basis will be a significant factor in our ability to remain competitive. To compete effectively in the automotive supply industry, we must be able to launch new products to meet our customers’ demands in a timely manner. Our innovative technologies and robust global engineering and development capabilities have well positioned us to meet the increasingly stringent vehicle manufacturer demands and consumer preferences for high-technology content in automobiles.
OEMs are increasingly looking to their suppliers to simplify vehicle design and assembly processes to reduce costs. As a result, suppliers that sell vehicle components directly to manufacturers (Tier I suppliers) have assumed many of the design, engineering, research and development and assembly functions traditionally performed by vehicle manufacturers. Suppliers that can provide fully-engineered solutions, systems and pre-assembled combinations of component parts are positioned to leverage the trend toward system sourcing.
Engineering, design & development. Our history and culture of innovation have enabled us to develop significant intellectual property and design and development expertise to provide advanced technology solutions that meet the demands of our customers. We have a team of more than 20,000 scientists, engineers and technicians focused on developing leading product solutions for our key markets, located at 15 major technical centers in Brazil, China, France, Germany, India, Luxembourg, Mexico, Poland, South Korea, the United Kingdom and the United States. We invest approximately $1.5 billion (which includes approximately $300 million co-investment by customers and government agencies) annually in research and
development, including engineering, to maintain our portfolio of innovative products, and owned/held approximately 8,500 patents and protective rights as of December 31, 2016. We also encourage “open innovation” and collaborate extensively with peers in the industry, government agencies and academic institutions. For example, in 2016 we entered into a collaborative arrangement with Mobileye N.V. to jointly develop a complete turn-key fully autonomous driving platform for our OEM customers, with the goal of being production ready for 2019. Our technology competencies are recognized by both customers and government agencies, who have co-invested approximately $300 million annually in new product development, accelerating the pace of innovation and reducing the risk associated with successful commercialization of technological breakthroughs.
In the past, suppliers often incurred the initial cost of engineering, designing and developing automotive component parts, and recovered their investments over time by including a cost recovery component in the price of each part based on expected volumes. Recently, we and many other suppliers have negotiated for cost recovery payments independent of volumes. This trend reduces our economic risk.
Pricing. Cost-cutting initiatives adopted by our customers result in increased downward pressure on pricing. Our customer supply agreements generally require step-downs in component pricing over the periods of production and OEMs have historically possessed significant leverage over their outside suppliers because the automotive component supply industry is fragmented and serves a limited number of automotive OEMs. Our profitability depends in part on our ability to generate sufficient production cost savings in the future to offset price reductions.
We are focused on maintaining a low fixed cost structure that provides us flexibility to remain profitable at all points of the traditional vehicle industry production cycle. As a result, approximately 95% of our hourly workforce is located in low cost countries. Furthermore, we have substantial operational flexibility by leveraging a large workforce of temporary workers, which represented approximately 14% of the hourly workforce as of December 31, 2016. However, we will continue to adjust our cost structure and optimize our manufacturing footprint in response to changes in the global and regional automotive markets and in order to increase investment in advanced technologies and engineering, as evidenced by our on-going restructuring programs focused on the continued rotation of our manufacturing footprint to low cost locations in Europe and on reducing our global overhead costs. As we continue to operate in a cyclical industry that is impacted by movements in the global and regional economies, we continually evaluate opportunities to further refine our cost structure. Assuming constant product mix and pricing, based on our 2016 results, we estimate that our EBITDA breakeven level would be reached if we experienced a 45% downturn to current product volumes.
We have a strong balance sheet with gross debt of approximately $4.0 billion and substantial available liquidity of approximately $3.2 billion of cash and cash equivalents and available financing under our Revolving Credit Facility and committed European accounts receivable factoring facility (as defined below in Liquidity and Capital Resources) as of December 31, 2016, and no significant U.S. defined benefit or workforce postretirement health care benefits and employer-paid postretirement basic life insurance benefits (“OPEB”) liabilities. We intend to maintain strong financial discipline targeting industry-leading earnings growth, cash flow generation and return on invested capital and to maintain sufficient liquidity to sustain our financial flexibility throughout the industry cycle.
OEM product recalls. The number of vehicles recalled globally by OEMs has increased above historical levels. These recalls can either be initiated by the OEMs or influenced by regulatory agencies. Although there are differing rules and regulations across countries governing recalls for safety issues, the overall transition towards global vehicle platforms may also contribute to increased recalls outside of the U.S., as automotive components are increasingly standardized across regions. Given the sensitivity to safety issues in the automotive industry, including increased focus from regulators and consumers, we anticipate the number of automotive recalls may remain above historical levels in the near future. Although we engage in extensive product quality programs and processes, and have not experienced any significant impacts to date as a result of the recalls that have been initiated, it is possible that we may be adversely affected in the future if the pace of these recalls continues.
In September 2016, General Motors Company ("GM"), our largest customer, initiated a recall of approximately 3.64 million vehicles in the United States to enhance the airbag deployment system. Delphi supplied sensors and related control modules for the airbags in the affected vehicles in compliance with GM's product specifications and validation criteria. We have assisted with GM's implementation efforts surrounding its recall, and have recorded our best estimate of our obligations related to this matter. Although we can provide no assurances, we do not expect the cost of this matter to be material to our financial position, results of operations or cash flows.
Efficient use of capital. The global vehicle components industry is generally capital intensive and a portion of a supplier’s capital equipment is frequently utilized for specific customer programs. Lead times for procurement of capital equipment are long and typically exceed start of production by one to two years. Substantial advantages exist for suppliers that can leverage their prior investments in capital equipment or amortize the investment over higher volume global customer programs.
Industry consolidation. Consolidation among worldwide suppliers is expected to continue as suppliers seek to achieve operating synergies and value stream efficiencies, acquire complementary technologies and build stronger customer relationships as OEMs continue to expand globally. Additionally, new entrants from outside the traditional automotive industry may seek to gain access to certain vehicle component markets, as evidenced by the proposed acquisition of Harman International Industries, Incorporated by Samsung Electronics Co., Ltd., announced in November 2016. We believe companies with strong balance sheets and financial discipline are in the best position to take advantage of the industry consolidation trend. As further described below, on December 18, 2015, we completed the acquisition of HellermannTyton Group PLC ("HellermannTyton"), a leading global manufacturer of high-performance and innovative cable management solutions, which expands our product portfolio within the connected vehicle solutions market and will help us capitalize on the connected car megatrend. Given the timing of the acquisition it is not fully reflected in our 2015 results, and impacts comparability to 2016 results.
Evolution of the automotive industry. The automotive industry is increasingly evolving towards the implementation of high-technology, software-dependent components and solutions. In particular, the industry is focused on the development of advanced driver assistance technologies, with the goal of developing and introducing a commercially-viable, fully automated driving experience. We expect automated driving technologies will provide strong societal benefit as well as the opportunity for long term growth for our product offerings in this space. We are continuing to invest in the automated driving space, and have continued to develop market-leading automated driving platform solutions such as automated driving software, key active safety sensing technologies and our Multi-Domain Controller, which fuses information from sensing systems as well as mapping and navigation data to make driving decisions. We have also entered into a collaborative arrangement with Mobileye N.V. to jointly develop a complete turn-key fully autonomous driving platform for our OEM customers, with the goal of being production ready for 2019. There has also been increasing societal demand for mobility on demand ("MoD") services, such as car- and ride-sharing, and an increasing number of traditional automotive companies have made investments in the MoD space. We believe the increasing societal demand for MoD services will accelerate the development of autonomous driving technologies, strongly benefiting the MoD space. We recently entered into an agreement to develop fully-autonomous vehicles as part of an automated MoD pilot for the government of Singapore. As a result of our substantial investments and strategic partnerships, we believe we are well-aligned with industry technology trends that will result in sustainable future growth in these evolving areas.
However, there are many risks associated with these evolving areas, including the high development costs of active safety and autonomous driving technologies, the uncertain timing of customer and consumer adoption of these technologies, increased competition from entrants outside the traditional automotive industry and new and emerging regulations, such as the recently introduced autonomous vehicle guidelines published by the U.S. Department of Transportation. While we believe we are well-positioned in these markets, the high development cost of active safety and autonomous driving technologies may result in a higher risk of exposure to the success of new or disruptive technologies different than those being developed by us.
Our History and Structure
On August 19, 2009, Delphi Automotive LLP, a limited liability partnership organized under the laws of England and Wales, was formed for the purpose of acquiring certain assets and subsidiaries of Old Delphi (“the Acquisition”), which, along with certain of its U.S. subsidiaries, had filed voluntary petitions for bankruptcy in October 2005. On October 6, 2009, Delphi Automotive LLP acquired the major portion of the business of Old Delphi and issued membership interests to a group of investors consisting of certain lenders to Old Delphi, General Motors Company ("GM") and the Pension Benefit Guaranty Corporation (the “PBGC”). On March 31, 2011, all of the outstanding Class A and Class C membership interests held by GM and the PBGC were redeemed, respectively, for approximately $4.4 billion.
On May 19, 2011, Delphi Automotive PLC was formed as a Jersey public limited company, and had nominal assets, no liabilities and had conducted no operations prior to its initial public offering. On November 22, 2011, in conjunction with the completion of its initial public offering by the selling shareholders, all of the outstanding equity of Delphi Automotive LLP was exchanged for ordinary shares by its equity holders in Delphi Automotive PLC. As a result, Delphi Automotive LLP became a wholly-owned subsidiary of Delphi Automotive PLC.
Consolidated Results of Operations
Our total net sales during the year ended December 31, 2016 were $16.7 billion, an increase of 10% compared to 2015. This compares to total global OEM production increases of 5% in 2016. The increase in our total net sales is primarily attributable to continued increased volumes in the North America, Europe and Asia Pacific regions, as well as incremental sales as a result of our acquisition of HellermannTyton in December 2015. Partially offsetting these increased volumes were reduced sales in our smallest region, South America, due to continuing economic weakness resulting in continued reductions in OEM production schedules in the region. Our overall lean cost structure, along with above-market sales growth in North America,
Europe and Asia Pacific, enabled us to improve gross margins in the year ended December 31, 2016 as compared to the prior year.
The decrease in our total net sales of 2% during the year ended December 31, 2015 as compared to 2014 was primarily attributable to unfavorable foreign currency impacts, which offset increased sales volumes in North America, Europe and Asia Pacific. Partially offsetting these increases were reduced sales volumes in our smallest region, South America, due to continuing economic weakness, resulting in continued reductions in OEM production schedules in the region.
Delphi typically experiences fluctuations in revenue due to changes in OEM production schedules, vehicle sales mix and the net of new and lost business (which we refer to collectively as volume), increased prices attributable to escalation clauses in our supply contracts for recovery of increased commodity costs (which we refer to as commodity pass-through), fluctuations in foreign currency exchange rates (which we refer to as FX), contractual reductions of the sales price to the OEM (which we refer to as contractual price reductions) and engineering changes. Changes in sales mix can have either favorable or unfavorable impacts on revenue. Such changes can be the result of shifts in regional growth, shifts in OEM sales demand, as well as shifts in consumer demand related to vehicle segment purchases and content penetration. For instance, a shift in sales demand favoring a particular OEM’s vehicle model for which we do not have a supply contract may negatively impact our revenue. A shift in regional sales demand toward certain markets could favorably impact the sales of those of our customers that have a large market share in those regions, which in turn would be expected to have a favorable impact on our revenue.
We typically experience (as described below) fluctuations in operating income due to:
| • | Volume, net of contractual price reductions—changes in volume offset by contractual price reductions (which typically range from 1% to 3% of net sales) and changes in mix; |
| • | Operational performance—changes to costs for materials and commodities or manufacturing variances; and |
| • | Other—including restructuring costs and any remaining variances not included in Volume, net of contractual price reductions or Operational performance. |
The automotive component supply industry is traditionally subject to inflationary pressures with respect to raw materials and labor which may place operational and profitability burdens on the entire supply chain. We will continue to work with our customers and suppliers to mitigate the impact of these inflationary pressures in the future. In addition, we expect commodity cost volatility, particularly related to copper and petroleum-based resin products, to have a continual impact on future earnings and/or operating cash flows. As such, we continually seek to mitigate both inflationary pressures and our material-related cost exposures using a number of approaches, including combining purchase requirements with customers and/or other suppliers, using alternate suppliers or product designs, negotiating cost reductions and/or commodity cost contract escalation clauses into our vehicle manufacturer supply contracts, and hedging.
2016 versus 2015
The results of operations for the years ended December 31, 2016 and 2015 were as follows:
| Year Ended December 31, | |||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | |||||||||
| (dollars in millions) | |||||||||||
| Net sales | $ | 16,661 | $ | 15,165 | $ | 1,496 | |||||
| Cost of sales | 13,107 | 12,155 | (952 | ) | |||||||
| Gross margin | 3,554 | 21.3% | 3,010 | 19.8% | 544 | ||||||
| Selling, general and administrative | 1,145 | 1,017 | (128 | ) | |||||||
| Amortization | 134 | 93 | (41 | ) | |||||||
| Restructuring | 328 | 177 | (151 | ) | |||||||
| Operating income | 1,947 | 1,723 | 224 | ||||||||
| Interest expense | (156 | ) | (127 | ) | (29 | ) | |||||
| Other expense, net | (366 | ) | (88 | ) | (278 | ) | |||||
| Income from continuing operations before income taxes and equity income | 1,425 | 1,508 | (83 | ) | |||||||
| Income tax expense | (242 | ) | (263 | ) | 21 | ||||||
| Income from continuing operations before equity income | 1,183 | 1,245 | (62 | ) | |||||||
| Equity income, net of tax | 35 | 16 | 19 | ||||||||
| Income from continuing operations | 1,218 | 1,261 | (43 | ) | |||||||
| Income from discontinued operations, net of tax | 108 | 274 | (166 | ) | |||||||
| Net income | 1,326 | 1,535 | (209 | ) | |||||||
| Net income attributable to noncontrolling interest | 69 | 85 | (16 | ) | |||||||
| Net income attributable to Delphi | $ | 1,257 | $ | 1,450 | $ | (193 | ) |
Total Net Sales
Below is a summary of our total net sales for the years ended December 31, 2016 versus December 31, 2015.
| Year Ended December 31, | Variance Due To: | |||||||||||||||||||||||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | Volume, net of contractual price reductions | FX | Commodity pass- through | Other | Total | |||||||||||||||||||||||||
| (in millions) | (in millions) | |||||||||||||||||||||||||||||||
| Total net sales | $ | 16,661 | $ | 15,165 | $ | 1,496 | $ | 1,213 | $ | (292 | ) | $ | (127 | ) | $ | 702 | $ | 1,496 |
Total net sales for the year ended December 31, 2016 increased 10% compared to the year ended December 31, 2015. We experienced volume growth of 10% for the period, primarily as a result of increased sales in North America, Europe and Asia Pacific, which was partially offset by decreases due to unfavorable currency impacts, primarily related to the Chinese Yuan Renminbi, and contractual price reductions. Net sales also increased by a net $702 million as a result of acquisitions and divestitures, reflected in Other above, primarily resulting from the net sales of HellermannTyton for the year ended December 31, 2016, partially offset by a reduction in sales resulting from the divestiture of our Reception Systems business in the third quarter of 2015. Refer to Note 20. Acquisitions and Divestitures to the audited consolidated financial statements included herein for further information regarding acquisitions and divestitures.
Cost of Sales
Cost of sales is primarily comprised of material, labor, manufacturing overhead, freight, fluctuations in foreign currency exchange rates, product engineering, design and development expenses, depreciation and amortization, warranty costs and other operating expenses. Gross margin is revenue less cost of sales and gross margin percentage is gross margin as a percentage of net sales.
Cost of sales increased $952 million for the year ended December 31, 2016 compared to the year ended December 31, 2015, as summarized below. The Company's material cost of sales was approximately 50% of net sales in both the years ended December 31, 2016 and December 31, 2015.
| Year Ended December 31, | Variance Due To: | |||||||||||||||||||||||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | Volume (a) | FX | Operational performance | Other | Total | |||||||||||||||||||||||||
| (dollars in millions) | (in millions) | |||||||||||||||||||||||||||||||
| Cost of sales | $ | 13,107 | $ | 12,155 | $ | (952 | ) | $ | (1,158 | ) | $ | 265 | $ | 282 | $ | (341 | ) | $ | (952 | ) | ||||||||||||
| Gross margin | $ | 3,554 | $ | 3,010 | $ | 544 | $ | 55 | $ | (27 | ) | $ | 282 | $ | 234 | $ | 544 | |||||||||||||||
| Percentage of net sales | 21.3 | % | 19.8 | % |
| (a) | Presented net of contractual price reductions for gross margin variance. |
The increase in cost of sales reflects increased volumes, partially offset by improved operational performance and the impacts from currency exchange. The increase in cost of sales is also attributable to the following items in Other above:
| • | Net increased costs of $419 million resulting from the operations of the businesses acquired and divested, primarily HellermannTyton, as further described in Note 20. Acquisitions and Divestitures; |
| • | Increased warranty costs of $60 million, which includes increased reserves for expected future claims on products sold, our estimated obligations for warranty matters based on information received from, and discussions with, our customers, as well as $25 million pursuant to a settlement agreement reached in 2016 with one of our OEM customers regarding warranty claims related to certain components supplied by Delphi’s Powertrain Systems segment, partially offset by |
| • | The $141 million pre-tax gain on the divestiture of the Mechatronics business recorded during the year ended December 31, 2016, as further described in Note 20. Acquisitions and Divestitures. |
Selling, General and Administrative Expense
| Year Ended December 31, | |||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | |||||||||
| (dollars in millions) | |||||||||||
| Selling, general and administrative expense | $ | 1,145 | $ | 1,017 | $ | (128 | ) | ||||
| Percentage of net sales | 6.9 | % | 6.7 | % |
Selling, general and administrative expense (“SG&A”) includes administrative expenses, information technology costs and incentive compensation related costs. The increase in SG&A for the year ended December 31, 2016 as compared to 2015 is primarily due to the acquisition of HellermannTyton in December 2015.
Amortization
| Year Ended December 31, | |||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Amortization | $ | 134 | $ | 93 | $ | (41 | ) |
Amortization expense reflects the non-cash charge related to definite-lived intangible assets. The increase in amortization during the year ended December 31, 2016 compared to 2015 resulted primarily from the acquisition of HellermannTyton in December 2015. Refer to Note 20. Acquisitions and Divestitures to the audited consolidated financial statements included herein for further detail of our business acquisitions completed in 2016 and 2015, including details of the intangible assets recorded in each transaction.
In 2017, we expect to incur non-cash amortization charges of approximately $134 million.
Restructuring
| Year Ended December 31, | |||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | |||||||||
| (dollars in millions) | |||||||||||
| Restructuring | $ | 328 | $ | 177 | $ | (151 | ) | ||||
| Percentage of net sales | 2.0 | % | 1.2 | % |
Restructuring charges recorded during 2016 were primarily attributable to our restructuring programs which focused on the continued rotation of our manufacturing footprint to low cost locations in Europe and on reducing global overhead costs. The Company recorded employee-related and other restructuring charges related to these programs totaling approximately $328 million during the year ended December 31, 2016. These charges include $103 million for programs implemented to reduce global overhead costs, as well as $170 million for programs focused on the continued rotation of our manufacturing footprint to low cost locations in Europe, $93 million of which related to the closure of a European manufacturing site within the Powertrain Systems segment. Cash payments for this restructuring action are expected to be principally completed in 2017. Additionally, Delphi recognized non-cash asset impairment charges of $25 million during the year ended December 31, 2016 related to this plant closure, which were recorded within cost of sales. We expect to make cash payments of approximately $155 million in 2017 pursuant to these implemented restructuring programs.
During the year ended December 31, 2015, Delphi recorded employee-related and other restructuring charges totaling approximately $177 million, primarily related to Delphi's on-going restructuring programs focused on aligning manufacturing capacity with the levels of automotive production in Europe and South America, and the continued rotation of our manufacturing footprint to low cost locations within these regions. These charges included the recognition of approximately $68 million of employee-related and other costs related to the initiation of a workforce reduction at a European manufacturing site within the Powertrain Systems segment.
While the restructuring programs initiated in 2016 have been principally completed, we expect to continue to incur additional restructuring expense in 2017, primarily related to the initiation of new programs focused on the continued rotation of our manufacturing footprint to low cost locations in Europe and to reduce global overhead costs. Additionally, as we continue to operate in a cyclical industry that is impacted by movements in the global and regional economies, we continually evaluate opportunities to further adjust our cost structure and optimize our manufacturing footprint. The Company plans to implement additional restructuring activities in the future, if necessary, in order to align manufacturing capacity and other costs with prevailing regional automotive production levels and locations, to improve the efficiency and utilization of other locations and in order to increase investment in advanced technologies and engineering. Such future restructuring actions are dependent on market conditions, customer actions and other factors.
Refer to Note 10. Restructuring to the audited consolidated financial statements included herein for additional information.
Interest Expense
| Year Ended December 31, | |||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Interest expense | $ | 156 | $ | 127 | $ | (29 | ) |
The increase in interest expense for the year ended December 31, 2016 as compared to the year ended December 31, 2015 reflects the issuance of $650 million of 3.15% senior unsecured notes and $650 million of 4.25% senior unsecured notes in the fourth quarter of 2015, which issuances were conducted principally to finance a portion of the cost to acquire HellermannTyton. Partially offsetting this increase, in September 2016, Delphi issued €500 million of 1.60% Euro-denominated senior unsecured notes and $300 million of 4.40% senior unsecured notes, the combined net proceeds from which were used to redeem $800 million of 5.00% senior unsecured notes due 2023.
Refer to Note 11. Debt to the audited consolidated financial statements included herein for additional information.
Other Income, Net
| Year Ended December 31, | |||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Other expense, net | $ | (366 | ) | $ | (88 | ) | $ | (278 | ) |
As further discussed in Note 13. Commitments and Contingencies to the audited consolidated financial statements included herein, during the year ended December 31, 2016, Delphi recorded a reserve of $300 million as a result of a summary judgment ruling in the Unsecured Creditors litigation. Also during the year ended December 31, 2016, Delphi redeemed for cash the entire $800 million aggregate principal amount of 5.00% senior unsecured notes due 2023, which resulted in a loss on extinguishment of debt of approximately $70 million.
During the year ended December 31, 2015, Delphi redeemed for cash the entire aggregate principal amount outstanding of the 6.125% Senior Notes and cancelled the Senior Bridge Credit Agreement, resulting in losses on extinguishment of debt of approximately $52 million and $6 million, respectively. Delphi also incurred approximately $23 million in transaction costs related to the acquisition of HellermannTyton and, as further discussed in Note 17. Derivatives and Hedging Activities, recorded a loss of $15 million on option contracts entered into in order to hedge portions of the currency risk associated with the acquisition of HellermannTyton. Partially offsetting these expenses, Delphi recorded $8 million for certain fees earned pursuant to the transition services agreement in connection with the sale of the Company's wholly owned Thermal Systems business, and $5 million of interest income.
Refer to Note 19. Other income, net and Note 11. Debt to the audited consolidated financial statements included herein for additional information.
Income Taxes
| Year Ended December 31, | |||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Income tax expense | $ | 242 | $ | 263 | $ | 21 |
The Company’s tax rate is affected by the fact that its parent entity is a U.K. resident taxpayer, the tax rates in the U.K. and other jurisdictions in which the Company operates, the relative amount of income earned by jurisdiction and the relative amount of losses or income for which no tax benefit or expense was recognized due to a valuation allowance.
The effective tax rate was 17% and 17% for the years ended December 31, 2016 and 2015, respectively. The effective tax rate in the year ended December 31, 2016 was impacted by favorable geographic income mix in 2016 as compared to 2015, primarily due to changes in the underlying operations of the business, as well as $17 million for releases of valuation allowances as a result of the Company's determination that it was more likely than not that certain deferred tax assets would be realized. These benefits were offset by $81 million of reserve adjustments recorded for uncertain tax positions, which included reserves for ongoing audits in foreign jurisdictions, as well as for changes in estimates based on relevant new or additional evidence obtained related to certain of the Company's tax positions, including tax authority administrative pronouncements and court decisions. These reserve adjustments resulted in foreign tax credit benefits of approximately $18 million. Additionally, following a change in U.S. tax regulation during 2016, the Company recorded a tax credit benefit of approximately $16 million during the year ended December 31, 2016.
The effective tax rate in the year ended December 31, 2015 was impacted by increased tax expense of $15 million resulting from changes in judgment related to deferred tax asset valuation allowances, as well as the enactment of the U.K. Finance (No. 2) Act 2015 (the “U.K. 2015 Finance Act”) on November 18, 2015, which provides for a reduction of the corporate income tax rate from 20% to 19% effective April 1, 2017, with a further reduction to 18% effective April 1, 2020. The income tax accounting effect, including any retroactive effect, of a tax law change is accounted for in the period of enactment, which in this case was the fourth quarter of 2015. As a result, the effective tax rate was impacted by an increased tax expense of approximately $11 million for the year ended December 31, 2015 due to the resultant impact on the net deferred tax asset balances.
Equity Income
| Year Ended December 31, | |||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Equity income, net of tax | $ | 35 | $ | 16 | $ | 19 |
Equity income, net of tax reflects Delphi’s interest in the results of ongoing operations of entities accounted for as equity-method investments. Equity income increased during the year ended December 31, 2016 as compared to the year ended December 31, 2015, primarily due to improved performance of our North American joint ventures as compared to the prior period.
Income from Discontinued Operations
| Year Ended December 31, | |||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Income from discontinued operations, net of tax | $ | 108 | $ | 274 | $ | (166 | ) |
Income from discontinued operations, net of tax reflects the results of the Company's previously reported Thermal Systems segment, which has been reclassified to discontinued operations as a result of the divestiture of this business. As further described in Note 25. Discontinued Operations to the audited consolidated financial statements included herein, Delphi completed the divestitures of the wholly owned Thermal Systems business on June 30, 2015, of its 50 percent interest in KDAC on September 24, 2015 and of its 50 percent interest in SDAAC on March 31, 2016.
Income from discontinued operations, net of tax decreased during the year ended December 31, 2016 as compared to the year ended December 31, 2015. Income from discontinued operations, net of tax for the year ended December 31, 2016 was primarily attributable to the after-tax gain of $104 million recognized from the sale of the Company's interest in its SDAAC joint venture on March 31, 2016. Income from discontinued operations, net of tax for the year ended December 31, 2015 was primarily attributable to the recognition of a net after-tax gain of $271 million on the sale of the Company's wholly owned Thermal Systems business, partially offset by the net loss of $41 million on the divestiture of the Company's interest in KDAC during 2015, which included the recognition of an after-tax impairment loss on this interest of $88 million recorded within income from discontinued operations prior to the sale.
Refer to Note 25. Discontinued Operations to the audited consolidated financial statements included herein for additional information.
Results of Operations by Segment
We operate our core business along the following operating segments, which are grouped on the basis of similar product, market and operating factors:
| • | Electrical/Electronic Architecture, which includes complete electrical architecture and component products. |
| • | Powertrain Systems, which includes extensive systems integration expertise in gasoline, diesel and fuel handling and full end-to-end systems including fuel injection, combustion, electronic controls, test and validation capabilities, electric and hybrid electric vehicle power electronics, aftermarket, and original equipment service. |
| • | Electronics and Safety, which includes component and systems integration expertise in infotainment and connectivity, body controls and security systems, displays and passive and active safety electronics, as well as advanced development of software. |
| • | Eliminations and Other, which includes i) the elimination of inter-segment transactions, and ii) certain other expenses and income of a non-operating or strategic nature. |
As described in Note 25. Discontinued Operations to the audited consolidated financial statements contained herein, the Company's previously reported Thermal Systems segment has been classified as discontinued operations, which required retrospective application to balance sheet, statement of operations and certain cash flow financial information for all periods presented. Discontinued operations also includes the Company's thermal original equipment service business, the results of which were previously reported within the Powertrain Systems segment. Certain operations, primarily related to contract manufacturing services, which were previously included within the Thermal Systems segment but which were not included in
the scope of the divestiture, are reported in continuing operations and have been reclassified within the Electronics and Safety segment for all periods presented. Amounts for shared general and administrative operating expenses that were allocated to the Thermal Systems business in prior periods have been re-allocated to the Company's reportable operating segments.
As described in Note 23. Segment Reporting to the audited consolidated financial statements contained herein, effective July 1, 2016, Delphi reorganized its management reporting structure by moving its Power Electronics product line, which was historically included in the Electronics and Safety segment, to the Powertrain Systems segment. This reorganization was made to better align the product offerings of the Power Electronics product line with the Company's approach to managing the markets and customers served by this product line. Consistent with this change in the Company's management reporting structure and basis of financial information used by the chief operating decision maker, the prior period results of the Power Electronics product line have been reclassified from the Electronics and Safety segment to the Powertrain Systems segment for all periods presented. The reclassification had no impact on the consolidated financial statements.
Our management utilizes segment Adjusted Operating Income as the key performance measure of segment income or loss and for planning and forecasting purposes, as management believes this measure is most reflective of the operational profitability or loss of our operating segments. Segment Adjusted Operating Income should not be considered a substitute for results prepared in accordance with U.S. GAAP and should not be considered an alternative to net income attributable to Delphi, which is the most directly comparable financial measure to Adjusted Operating Income that is prepared in accordance with U.S. GAAP. Segment Adjusted Operating Income, as determined and measured by Delphi, should also not be compared to similarly titled measures reported by other companies.
The reconciliation of Adjusted Operating Income to Operating Income includes, as applicable, restructuring, other acquisition and portfolio project costs (which includes costs incurred to integrate acquired businesses and to plan and execute product portfolio transformation actions, including business and product acquisitions and divestitures), asset impairments and gains (losses) on business divestitures. The reconciliations of Adjusted Operating Income to net income attributable to Delphi for the years ended December 31, 2016 and 2015 are as follows:
| Electrical/Electronic Architecture | Powertrain Systems | Electronics and Safety | Eliminations and Other | Total | |||||||||||||||
| (in millions) | |||||||||||||||||||
| For the Year Ended December 31, 2016: | |||||||||||||||||||
| Adjusted operating income | $ | 1,344 | $ | 511 | $ | 368 | $ | — | $ | 2,223 | |||||||||
| Restructuring | (117 | ) | (172 | ) | (39 | ) | — | (328 | ) | ||||||||||
| Other acquisition and portfolio project costs | (41 | ) | (10 | ) | (8 | ) | — | (59 | ) | ||||||||||
| Asset impairments | — | (29 | ) | (1 | ) | — | (30 | ) | |||||||||||
| Gain (loss) on business divestitures, net | — | — | 141 | — | 141 | ||||||||||||||
| Operating income | $ | 1,186 | $ | 300 | $ | 461 | $ | — | 1,947 | ||||||||||
| Interest expense | (156 | ) | |||||||||||||||||
| Other expense, net | (366 | ) | |||||||||||||||||
| Income from continuing operations before income taxes and equity income | 1,425 | ||||||||||||||||||
| Income tax expense | (242 | ) | |||||||||||||||||
| Equity income, net of tax | 35 | ||||||||||||||||||
| Income from continuing operations | 1,218 | ||||||||||||||||||
| Income from discontinued operations, net of tax | 108 | ||||||||||||||||||
| Net income | 1,326 | ||||||||||||||||||
| Net income attributable to noncontrolling interest | 69 | ||||||||||||||||||
| Net income attributable to Delphi | $ | 1,257 |
| Electrical/Electronic Architecture | Powertrain Systems | Electronics and Safety | Eliminations and Other | Total | |||||||||||||||
| (in millions) | |||||||||||||||||||
| For the Year Ended December 31, 2015: | |||||||||||||||||||
| Adjusted operating income | $ | 1,095 | $ | 524 | $ | 352 | $ | — | $ | 1,971 | |||||||||
| Restructuring | (37 | ) | (115 | ) | (25 | ) | — | (177 | ) | ||||||||||
| Other acquisition and portfolio project costs | (26 | ) | (12 | ) | (9 | ) | — | (47 | ) | ||||||||||
| Asset impairments | (4 | ) | (9 | ) | (3 | ) | — | (16 | ) | ||||||||||
| Gain (loss) on business divestitures, net | (14 | ) | — | 6 | — | (8 | ) | ||||||||||||
| Operating income | $ | 1,014 | $ | 388 | $ | 321 | $ | — | 1,723 | ||||||||||
| Interest expense | (127 | ) | |||||||||||||||||
| Other expense, net | (88 | ) | |||||||||||||||||
| Income from continuing operations before income taxes and equity income | 1,508 | ||||||||||||||||||
| Income tax expense | (263 | ) | |||||||||||||||||
| Equity income, net of tax | 16 | ||||||||||||||||||
| Income from continuing operations | 1,261 | ||||||||||||||||||
| Income from discontinued operations, net of tax | 274 | ||||||||||||||||||
| Net income | 1,535 | ||||||||||||||||||
| Net income attributable to noncontrolling interest | 85 | ||||||||||||||||||
| Net income attributable to Delphi | $ | 1,450 |
Net sales, gross margin as a percentage of net sales and Adjusted Operating Income by segment for the years ended December 31, 2016 and 2015 are as follows:
Net Sales by Segment
| Year Ended December 31, | Variance Due To: | |||||||||||||||||||||||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | Volume, net of contractual price reductions | FX | Commodity Pass-through | Other | Total | |||||||||||||||||||||||||
| (in millions) | (in millions) | |||||||||||||||||||||||||||||||
| Electrical/Electronic Architecture | $ | 9,316 | $ | 8,180 | $ | 1,136 | $ | 626 | $ | (137 | ) | $ | (127 | ) | $ | 774 | $ | 1,136 | ||||||||||||||
| Powertrain Systems | 4,486 | 4,407 | 79 | 218 | (132 | ) | — | (7 | ) | 79 | ||||||||||||||||||||||
| Electronics and Safety | 3,014 | 2,744 | 270 | 363 | (26 | ) | — | (67 | ) | 270 | ||||||||||||||||||||||
| Eliminations and Other | (155 | ) | (166 | ) | 11 | 6 | 3 | — | 2 | 11 | ||||||||||||||||||||||
| Total | $ | 16,661 | $ | 15,165 | $ | 1,496 | $ | 1,213 | $ | (292 | ) | $ | (127 | ) | $ | 702 | $ | 1,496 |
Gross Margin Percentage by Segment
| Year Ended December 31, | |||||
| 2016 | 2015 | ||||
| Electrical/Electronic Architecture | 22.3 | % | 19.8 | % | |
| Powertrain Systems | 17.8 | % | 19.3 | % | |
| Electronics and Safety (1) | 22.7 | % | 19.7 | % | |
| Eliminations and Other | — | % | — | % | |
| Total | 21.3 | % | 19.8 | % |
| (1) | Includes a pre-tax gain of $141 million recognized on the divestiture of the Company's Mechatronics business during the year ended December 31, 2016. |
Adjusted Operating Income by Segment
| Year Ended December 31, | Variance Due To: | |||||||||||||||||||||||||||
| 2016 | 2015 | Favorable/ (unfavorable) | Volume, net of contractual price reductions | Operational performance | Other | Total | ||||||||||||||||||||||
| (in millions) | (in millions) | |||||||||||||||||||||||||||
| Electrical/Electronic Architecture | $ | 1,344 | $ | 1,095 | $ | 249 | $ | 105 | $ | 65 | $ | 79 | $ | 249 | ||||||||||||||
| Powertrain Systems | 511 | 524 | (13 | ) | (34 | ) | 128 | (107 | ) | (13 | ) | |||||||||||||||||
| Electronics and Safety | 368 | 352 | 16 | (16 | ) | 89 | (57 | ) | 16 | |||||||||||||||||||
| Eliminations and Other | — | — | — | — | — | — | — | |||||||||||||||||||||
| Total | $ | 2,223 | $ | 1,971 | $ | 252 | $ | 55 | $ | 282 | $ | (85 | ) | $ | 252 |
As noted in the table above, Adjusted Operating Income for the year ended December 31, 2016 as compared to the year ended December 31, 2015 was impacted by volume and contractual price reductions, including product mix, and operational performance improvements, as well as the following items included in Other in the table above:
| • | Increased warranty costs of $60 million, which includes increased reserves for expected future claims on products sold, our estimated obligations for warranty matters based on information received from, and discussions with, our customers, as well as $25 million pursuant to a settlement agreement reached in 2016 with one of our OEM customers regarding warranty claims related to certain components supplied by Delphi’s Powertrain Systems segment, and |
| • | $70 million of increased depreciation and amortization, not including depreciation and amortization of businesses acquired and divested; partially offset by |
| • | Net increased adjusted operating income of $95 million resulting from the operations of the businesses acquired and divested, primarily resulting from the operations of HellermannTyton, partially offset by a reduction resulting from the divestiture of our Reception Systems business in 2015. |
Consolidated Results of Operations
2015 versus 2014
The results of operations for the years ended December 31, 2015 and 2014 were as follows:
| Year Ended December 31, | |||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | |||||||||
| (dollars in millions) | |||||||||||
| Net sales | $ | 15,165 | $ | 15,499 | $ | (334 | ) | ||||
| Cost of sales | 12,155 | 12,471 | 316 | ||||||||
| Gross margin | 3,010 | 19.8% | 3,028 | 19.5% | (18 | ) | |||||
| Selling, general and administrative | 1,017 | 1,036 | 19 | ||||||||
| Amortization | 93 | 94 | 1 | ||||||||
| Restructuring | 177 | 140 | (37 | ) | |||||||
| Operating income | 1,723 | 1,758 | (35 | ) | |||||||
| Interest expense | (127 | ) | (135 | ) | 8 | ||||||
| Other expense, net | (88 | ) | (8 | ) | (80 | ) | |||||
| Income from continuing operations before income taxes and equity income | 1,508 | 1,615 | (107 | ) | |||||||
| Income tax expense | (263 | ) | (255 | ) | (8 | ) | |||||
| Income from continuing operations before equity income | 1,245 | 1,360 | (115 | ) | |||||||
| Equity income, net of tax | 16 | 20 | (4 | ) | |||||||
| Income from continuing operations | 1,261 | 1,380 | (119 | ) | |||||||
| Income from discontinued operations, net of tax | 274 | 60 | 214 | ||||||||
| Net income | 1,535 | 1,440 | 95 | ||||||||
| Net income attributable to noncontrolling interest | 85 | 89 | (4 | ) | |||||||
| Net income attributable to Delphi | $ | 1,450 | $ | 1,351 | $ | 99 |
Total Net Sales
Below is a summary of Delphi’s total net sales for the year ended December 31, 2015 versus December 31, 2014.
| Year Ended December 31, | Variance Due To: | |||||||||||||||||||||||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | Volume, net of contractual price reductions | FX | Commodity pass-through | Other | Total | |||||||||||||||||||||||||
| (in millions) | (in millions) | |||||||||||||||||||||||||||||||
| Total net sales | $ | 15,165 | $ | 15,499 | $ | (334 | ) | $ | 900 | $ | (1,153 | ) | $ | (140 | ) | $ | 59 | $ | (334 | ) |
Total net sales for the year ended December 31, 2015 decreased 2% compared to the year ended December 31, 2014. We experienced volume growth of 8% for the period, primarily as a result of increased sales in North America, Europe and Asia Pacific, which was offset by decreases due to unfavorable currency impacts, primarily related to the Euro, and contractual price reductions. Net sales also increased by a net $59 million as a result of the impact of our acquisitions and divestitures, reflected in Other above, primarily resulting from the net sales of the Antaya and Unwired businesses that were acquired in the fourth quarter of 2014, partially offset by a reduction in sales resulting from the divestiture of our Reception Systems business in the third quarter of 2015.
Cost of Sales
Cost of sales is primarily comprised of material, labor, manufacturing overhead, freight, fluctuations in foreign currency exchange rates, product engineering, design and development expenses, depreciation and amortization, warranty costs and other operating expenses. Gross margin is revenue less cost of sales and gross margin percentage is gross margin as a percentage of net sales.
Cost of sales decreased $316 million for the year ended December 31, 2015 compared to the year ended December 31, 2014, as summarized below. The Company's material cost of sales was approximately 50% of net sales in both the year ended December 31, 2015 and December 31, 2014.
| Year Ended December 31, | Variance Due To: | |||||||||||||||||||||||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | Volume (a) | FX | Operational performance | Other | Total | |||||||||||||||||||||||||
| (dollars in millions) | (in millions) | |||||||||||||||||||||||||||||||
| Cost of sales | $ | 12,155 | $ | 12,471 | $ | 316 | $ | (956 | ) | $ | 897 | $ | 321 | $ | 54 | $ | 316 | |||||||||||||||
| Gross margin | $ | 3,010 | $ | 3,028 | $ | (18 | ) | $ | (56 | ) | $ | (256 | ) | $ | 321 | $ | (27 | ) | $ | (18 | ) | |||||||||||
| Percentage of net sales | 19.8 | % | 19.5 | % |
| (a) | Presented net of contractual price reductions for gross margin variance. |
The decrease in cost of sales reflects improved operational performance and the impacts from currency exchange, partially offset by increased volumes before contractual price reductions for the period. The decrease in cost of sales is also attributable to the following items in Other above:
| • | A decrease of $140 million in commodity costs; partially offset by |
| • | Net increased costs of $38 million resulting from the operations of the businesses acquired and divested, as further described in Note 20. Acquisitions and Divestitures; |
| • | An increase of $12 million in warranty costs; and |
| • | The net loss of $8 million recorded on business divestitures in 2015, comprised of $47 million in losses incurred on the exit of our Argentina businesses, partially offset by the $39 million gain resulting from the sale of the Reception Systems businesses, as further described in Note 20. Acquisitions and Divestitures. |
Selling, General and Administrative Expense
| Year Ended December 31, | |||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | |||||||||
| (dollars in millions) | |||||||||||
| Selling, general and administrative expense | $ | 1,017 | $ | 1,036 | $ | 19 | |||||
| Percentage of net sales | 6.7 | % | 6.7 | % |
Selling, general and administrative expense (“SG&A”) includes administrative expenses, information technology costs and incentive compensation related costs, and was consistent as a percent of sales during the year ended December 31, 2015 compared to 2014. An increase in information technology costs and costs incurred for business acquisitions and other product portfolio projects during the year ended December 31, 2015 was offset by reduced incentive compensation costs and amounts paid to other service providers as compared to the prior year.
Amortization
| Year Ended December 31, | |||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Amortization | $ | 93 | $ | 94 | $ | 1 |
Amortization expense reflects the non-cash charge related to definite-lived intangible assets primarily recognized as part of the Acquisition and resulting from our business acquisitions. The consistency in amortization during the year ended December 31, 2015 compared to 2014 reflects the continued amortization of our definite-lived intangible assets over their estimated useful lives. Refer to Note 20. Acquisitions and Divestitures to the audited consolidated financial statements included herein for further detail of our business acquisitions completed in 2014 and 2015, including details of the intangible assets recorded in each transaction.
Restructuring
| Year Ended December 31, | |||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | |||||||||
| (dollars in millions) | |||||||||||
| Restructuring | $ | 177 | $ | 140 | $ | (37 | ) | ||||
| Percentage of net sales | 1.2 | % | 0.9 | % |
Restructuring charges recorded during 2015 were primarily related to on-going restructuring programs, which included workforce reductions as well as plant closures, which were focused on aligning our manufacturing capacity with the automotive production levels in Europe and South America and the continued rotation of our manufacturing footprint to low cost locations within these regions. These charges included the recognition of approximately $68 million of employee-related and other costs related to the initiation of a plant closure of a European manufacturing site within the Powertrain Systems segment in the fourth quarter of 2015.
Restructuring expenses recorded during the year ended December 31, 2014 were primarily attributable to the expenses incurred in conjunction with our on-going restructuring programs focused on aligning our manufacturing capacity and footprint with the automotive production levels in Europe and South America. These charges included the recognition of employee-related and other costs of $35 million during the year ended December 31, 2014 for the initiation of a new restructuring program at a European manufacturing site within the Powertrain Systems segment in the second quarter of 2014.
Refer to Note 10. Restructuring to the audited consolidated financial statements included herein for additional information.
Interest Expense
| Year Ended December 31, | |||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Interest expense | $ | 127 | $ | 135 | $ | 8 |
The decrease in interest expense for the year ended December 31, 2015 as compared to the year ended December 31, 2014 reflected a reduction in interest expense from the redemption of the 6.125% Senior Notes, partially offset by the issuance of €700 million of 1.50% 2015 Euro-denominated Senior Notes in February 2015 and the issuance of the $1.3 billion 2015 Senior Notes in November 2015.
Refer to Note 11. Debt to the audited consolidated financial statements included herein for additional information.
Other Income, Net
| Year Ended December 31, | |||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Other (expense) income, net | $ | (88 | ) | $ | (8 | ) | $ | (80 | ) |
During the year ended December 31, 2015, Delphi redeemed for cash the entire aggregate principal amount outstanding of the 6.125% Senior Notes and cancelled the Senior Bridge Credit Agreement, resulting in losses on extinguishment of debt of approximately $52 million and $6 million, respectively. Delphi also incurred approximately $23 million in transaction costs related to the acquisition of HellermannTyton and, as further discussed in Note 17. Derivatives and Hedging Activities, recorded a loss of $15 million on option contracts entered into in order to hedge portions of the currency risk associated with the acquisition of HellermannTyton. Partially offsetting these expenses, Delphi recorded $8 million for certain fees earned pursuant to the transition services agreement in connection with the sale of the Company's wholly owned Thermal Systems business, and $5 million of interest income.
During the year ended December 31, 2014, Delphi repaid a portion of the Tranche A Term Loan and redeemed the 5.875% Senior Notes, resulting in a loss on extinguishment of debt of $34 million. Additionally, during the year ended
December 31, 2014, Delphi incurred approximately $6 million in transaction costs related to its 2014 acquisitions. Partially offsetting these expenses during the year ended December 31, 2014, Delphi recorded $10 million of interest income and also reached a final settlement with its insurance carrier related to a business interruption insurance claim, and received proceeds from the settlement of approximately $14 million, net of related costs and expenses.
Refer to Note 19. Other income, net and Note 11. Debt to the audited consolidated financial statements included herein for additional information.
Income Taxes
| Year Ended December 31, | |||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Income tax expense | $ | 263 | $ | 255 | $ | (8 | ) |
The Company’s tax rate is affected by the fact that its parent entity is a U.K. resident taxpayer, the tax rates in the U.K. and other jurisdictions in which the Company operates, the relative amount of income earned by jurisdiction and the relative amount of losses or income for which no tax benefit or expense was recognized due to a valuation allowance.
The effective tax rate was 17% and 16% for the years ended December 31, 2015 and 2014, respectively. The effective tax rate in the year ended December 31, 2015 was impacted by increased tax expense of $15 million resulting from changes in judgment related to deferred tax asset valuation allowances, as well as the enactment of the UK Finance (No. 2) Act 2015 (the “UK 2015 Finance Act”) on November 18, 2015, which provides for a reduction of the corporate income tax rate from 20% to 19% effective April 1, 2017, with a further reduction to 18% effective April 1, 2020. The income tax accounting effect, including any retroactive effect, of a tax law change is accounted for in the period of enactment, which in this case was the fourth quarter of 2015. As a result, the effective tax rate was impacted by an increased tax expense of approximately $11 million for the year ended December 31, 2015 due to the resultant impact on the net deferred tax asset balances. Additionally, the effective tax rate in the year ended December 31, 2015 was impacted by unfavorable geographic income mix in 2015 as compared to 2014, primarily due to changes in the underlying operations of the business, offset by tax planning initiatives and the resulting favorable impact on foreign tax credits.
The effective tax rate in the year ended December 31, 2014 was impacted by favorable geographic income mix in 2014 as compared to 2013, primarily due to changes in the underlying operations of the business as well as tax planning initiatives, and the resulting favorable impact on foreign tax credits. These favorable impacts were offset by net increases resulting from changes in judgment related to deferred tax asset valuation allowances of $18 million in 2014.
Equity Income
| Year Ended December 31, | |||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Equity income, net of tax | $ | 16 | $ | 20 | $ | (4 | ) |
Equity income, net of tax reflects Delphi’s interest in the results of ongoing operations of entities accounted for as equity-method investments. Equity income decreased during the year ended December 31, 2015 as compared to the year ended December 31, 2014, which was primarily attributable to declines in performance at certain of our joint ventures in 2015 as compared to 2014.
Income from Discontinued Operations
| Year Ended December 31, | |||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | |||||||||
| (in millions) | |||||||||||
| Income from discontinued operations, net of tax | $ | 274 | $ | 60 | $ | 214 |
Income from discontinued operations, net of tax reflects the results of the Company's previously reported Thermal Systems segment, which have been reclassified to discontinued operations as a result of the sale of this business. Income from discontinued operations, net of tax increased during the year ended December 31, 2015 as compared to the year ended December 31, 2014 primarily due the recognition of a net gain of $271 million from the sale of the Company's wholly owned Thermal Systems business. This gain was partially offset by the net loss of $41 million on the divestiture of the Company's interest in KDAC, which includes the $88 million impairment of this interest that was recorded prior to the sale. As further described in Note 25. Discontinued Operations, post-closing adjustments have been recorded subsequent to the closing of the sale of the wholly owned Thermal Systems business.
Refer to Note 25. Discontinued Operations to the audited consolidated financial statements included herein for additional information.
Results of Operations by Segment
As described in Note 25. Discontinued Operations to the audited consolidated financial statements contained herein, the Company's previously reported Thermal Systems segment has been classified as discontinued operations, which required retrospective application to balance sheet, statement of operations and certain cash flow financial information for all periods presented. Discontinued operations also includes the Company's thermal original equipment service business, the results of which were previously reported within the Powertrain Systems segment. Certain operations, primarily related to contract manufacturing services, which were previously included within the Thermal Systems segment but which were not included in the scope of the divestiture, are reported in continuing operations and have been reclassified within the Electronics and Safety segment for all periods presented. Amounts for shared general and administrative operating expenses that were allocated to the Thermal Systems business in prior periods have been re-allocated to the Company's reportable operating segments.
Effective July 1, 2016, Delphi reorganized its management reporting structure by moving its Power Electronics product line, which was historically included in the Electronics and Safety segment, to the Powertrain Systems segment. This reorganization was made to better align the product offerings of the Power Electronics product line with the Company's approach to managing the markets and customers served by this product line. Consistent with this change in the Company's management reporting structure and basis of financial information used by the chief operating decision maker, the prior period results of the Power Electronics product line have been reclassified from the Electronics and Safety segment to the Powertrain Systems segment for all periods presented. The reclassification had no impact on the consolidated financial statements.
The reconciliation of Adjusted Operating Income to Operating Income includes, as applicable, restructuring, other acquisition and portfolio project costs (which includes costs incurred to integrate acquired businesses and to plan and execute product portfolio transformation actions, including business and product acquisitions and divestitures), asset impairments and gains (losses) on business divestitures. The reconciliations of Adjusted Operating Income to net income attributable to Delphi for the years ended December 31, 2015 and 2014 are as follows:
| Electrical/Electronic Architecture | Powertrain Systems | Electronics and Safety | Eliminations and Other | Total | |||||||||||||||
| (in millions) | |||||||||||||||||||
| For the Year Ended December 31, 2015: | |||||||||||||||||||
| Adjusted operating income | $ | 1,095 | $ | 524 | $ | 352 | $ | — | $ | 1,971 | |||||||||
| Restructuring | (37 | ) | (115 | ) | (25 | ) | — | (177 | ) | ||||||||||
| Other acquisition and portfolio project costs | (26 | ) | (12 | ) | (9 | ) | — | (47 | ) | ||||||||||
| Asset impairments | (4 | ) | (9 | ) | (3 | ) | — | (16 | ) | ||||||||||
| Gain (loss) on business divestitures, net | (14 | ) | — | 6 | — | (8 | ) | ||||||||||||
| Operating income | $ | 1,014 | $ | 388 | $ | 321 | $ | — | 1,723 | ||||||||||
| Interest expense | (127 | ) | |||||||||||||||||
| Other expense, net | (88 | ) | |||||||||||||||||
| Income from continuing operations before income taxes and equity income | 1,508 | ||||||||||||||||||
| Income tax expense | (263 | ) | |||||||||||||||||
| Equity income, net of tax | 16 | ||||||||||||||||||
| Income from continuing operations | 1,261 | ||||||||||||||||||
| Income from discontinued operations, net of tax | 274 | ||||||||||||||||||
| Net income | 1,535 | ||||||||||||||||||
| Net income attributable to noncontrolling interest | 85 | ||||||||||||||||||
| Net income attributable to Delphi | $ | 1,450 |
| Electrical/Electronic Architecture | Powertrain Systems | Electronics and Safety | Eliminations and Other | Total | |||||||||||||||
| (in millions) | |||||||||||||||||||
| For the Year Ended December 31, 2014: | |||||||||||||||||||
| Adjusted operating income | $ | 1,060 | $ | 486 | $ | 379 | $ | — | $ | 1,925 | |||||||||
| Restructuring | (57 | ) | (55 | ) | (28 | ) | — | (140 | ) | ||||||||||
| Other acquisition and portfolio project costs | (15 | ) | (3 | ) | (2 | ) | — | (20 | ) | ||||||||||
| Asset impairments | (2 | ) | (1 | ) | (4 | ) | — | (7 | ) | ||||||||||
| Operating income | $ | 986 | $ | 427 | $ | 345 | $ | — | 1,758 | ||||||||||
| Interest expense | (135 | ) | |||||||||||||||||
| Other expense, net | (8 | ) | |||||||||||||||||
| Income from continuing operations before income taxes and equity income | 1,615 | ||||||||||||||||||
| Income tax expense | (255 | ) | |||||||||||||||||
| Equity income, net of tax | 20 | ||||||||||||||||||
| Income from continuing operations | 1,380 | ||||||||||||||||||
| Income from discontinued operations, net of tax | 60 | ||||||||||||||||||
| Net income | 1,440 | ||||||||||||||||||
| Net income attributable to noncontrolling interest | 89 | ||||||||||||||||||
| Net income attributable to Delphi | $ | 1,351 |
Net sales, gross margin as a percentage of net sales and Adjusted Operating Income by segment for the years ended December 31, 2015 and 2014 are as follows:
Net Sales by Segment
| Year Ended December 31, | Variance Due To: | |||||||||||||||||||||||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | Volume, net of contractual price reductions | FX | Commodity Pass-through | Other | Total | |||||||||||||||||||||||||
| (in millions) | (in millions) | |||||||||||||||||||||||||||||||
| Electrical/Electronic Architecture | $ | 8,180 | $ | 8,274 | $ | (94 | ) | $ | 501 | $ | (561 | ) | $ | (140 | ) | $ | 106 | $ | (94 | ) | ||||||||||||
| Powertrain Systems | 4,407 | 4,540 | (133 | ) | 276 | (412 | ) | — | 3 | (133 | ) | |||||||||||||||||||||
| Electronics and Safety | 2,744 | 2,880 | (136 | ) | 113 | (199 | ) | — | (50 | ) | (136 | ) | ||||||||||||||||||||
| Eliminations and Other | (166 | ) | (195 | ) | 29 | 10 | 19 | — | — | 29 | ||||||||||||||||||||||
| Total | $ | 15,165 | $ | 15,499 | $ | (334 | ) | $ | 900 | $ | (1,153 | ) | $ | (140 | ) | $ | 59 | $ | (334 | ) |
Gross Margin Percentage by Segment
| Year Ended December 31, | |||||
| 2015 | 2014 | ||||
| Electrical/Electronic Architecture | 19.8 | % | 19.3 | % | |
| Powertrain Systems | 19.3 | % | 19.0 | % | |
| Electronics and Safety | 19.7 | % | 19.9 | % | |
| Eliminations and Other | — | % | — | % | |
| Total | 19.8 | % | 19.5 | % |
Adjusted Operating Income by Segment
| Year Ended December 31, | Variance Due To: | |||||||||||||||||||||||||||
| 2015 | 2014 | Favorable/ (unfavorable) | Volume, net of contractual price reductions | Operational performance | Other | Total | ||||||||||||||||||||||
| (in millions) | (in millions) | |||||||||||||||||||||||||||
| Electrical/Electronic Architecture | $ | 1,095 | $ | 1,060 | $ | 35 | $ | 31 | $ | 131 | $ | (127 | ) | $ | 35 | |||||||||||||
| Powertrain Systems | 524 | 486 | 38 | (24 | ) | 91 | (29 | ) | 38 | |||||||||||||||||||
| Electronics and Safety | 352 | 379 | (27 | ) | (64 | ) | 91 | (54 | ) | (27 | ) | |||||||||||||||||
| Eliminations and Other | — | — | — | — | — | — | — | |||||||||||||||||||||
| Total | $ | 1,971 | $ | 1,925 | $ | 46 | $ | (57 | ) | $ | 313 | $ | (210 | ) | $ | 46 |
As noted in the table above, Adjusted Operating Income for the year ended December 31, 2015 as compared to the year ended December 31, 2014 was impacted by volume and contractual price reductions, including product mix and operational performance improvements, as well as the following items included in Other in the table above:
| • | $181 million of unfavorable foreign currency impacts, primarily related to the Euro; and |
| • | An increase of $12 million in warranty costs. |
Liquidity and Capital Resources
Overview of Capital Structure
Our liquidity requirements are primarily to fund our business operations, including capital expenditures and working capital requirements, as well as to fund debt service requirements, operational restructuring activities and dividends on share capital. Our primary sources of liquidity are cash flows from operations, our existing cash balance, and as necessary, borrowings under available credit facilities and issuance of long-term debt. To the extent we generate discretionary cash flow we may consider using this additional cash flow for optional prepayments of existing indebtedness, strategic acquisitions, additional share repurchases, and/or general corporate purposes. We will also continually explore ways to enhance our capital structure.
As of December 31, 2016, we had cash and cash equivalents of $0.8 billion and net debt (defined as outstanding debt less cash and cash equivalents) of $3.1 billion. We also have access to additional liquidity pursuant to the terms of the $2.0 billion Revolving Credit Facility and the €400 million European accounts receivable factoring facility, of which €350 million is available on a committed basis, as described below.
The following table summarizes our available liquidity, which includes cash, cash equivalents and funds available under our significant committed credit facilities, as of December 31, 2016. The amounts disclosed as available under the Company’s significant committed credit facilities are available without violating our existing debt covenants, which are described below.
| December 31, 2016 | |||
| (in millions) | |||
| Cash and cash equivalents | $ | 838 | |
| Revolving Credit Facility, unutilized portion (1) | 1,993 | ||
| Committed European accounts receivable factoring facility, unutilized portion (2) | 368 | ||
| Total available liquidity | $ | 3,199 |
(1) Availability reduced by $7 million in letters of credit issued under the Credit Agreement as of December 31, 2016.
(2) Based on December 31, 2016 foreign currency rates, subject to the availability of eligible accounts receivable.
We expect existing cash, available liquidity and cash flows from operations to continue to be sufficient to fund our global operating activities, including restructuring payments, any mandatory payments required under the Credit Agreement as described below, dividends on ordinary shares and capital expenditures. In addition, we expect to continue to repurchase outstanding common shares pursuant to our authorized common share repurchase program, as further described below.
We also continue to expect to be able to move funds between different countries to manage our global liquidity needs without material adverse tax implications, subject to current monetary policies and to the terms of the Credit Agreement. While a substantial portion of our operating income is generated by our non-U.S. subsidiaries, and as of December 31, 2016, the Company's cash and cash equivalents held by our non-U.S. subsidiaries totaled $799 million, we utilize a combination of strategies, including dividends, cash pooling arrangements, intercompany loan repayments and other distributions and advances to provide the funds necessary to meet our global liquidity needs. There are no significant restrictions on the ability of our subsidiaries to pay dividends or make other distributions to Delphi. If additional non-U.S. cash was needed for our U.S. operations, we would be required to accrue and pay U.S. taxes to repatriate such funds; however, based on our current liquidity needs and repatriation strategies, we do not anticipate a need to repatriate such additional amounts. Additionally, the Company is a U.K. resident taxpayer and as such is not generally subject to U.K. tax on remitted foreign earnings. As a result, we do not anticipate foreign earnings would be subject to a 35% tax rate upon repatriation to the U.K., as is the case when U.S. based companies repatriate earnings to the U.S. For further information regarding undistributed earnings of our non-U.S. subsidiaries, see Note 14. Income Taxes to the audited consolidated financial statements included in this Report.
Based on these factors, we believe we possess sufficient liquidity to fund our global operations and capital investments in 2017 and beyond.
Share Repurchases
In April 2016, the Board of Directors authorized a share repurchase program of up to $1.5 billion of ordinary shares, which commenced in September 2016 following the completion of the Company's $1.5 billion January 2015 share repurchase program. This share repurchase program provides for share purchases in the open market or in privately negotiated transactions, depending on share price, market conditions and other factors, as determined by the Company.
A summary of the ordinary shares repurchased during the years ended December 31, 2016, 2015 and 2014 is as follows:
| Year Ended December 31, | |||||||||||
| 2016 | 2015 | 2014 | |||||||||
| Total number of shares repurchased | 9,481,946 | 14,581,705 | 15,041,713 | ||||||||
| Average price paid per share | $ | 66.93 | $ | 79.48 | $ | 68.05 | |||||
| Total (in millions) | $ | 635 | $ | 1,159 | $ | 1,024 |
As of December 31, 2016, approximately $1,372 million of share repurchases remained available under the April 2016 share repurchase program. During the period from January 1, 2017 to February 2, 2017, the Company repurchased an additional $23 million worth of shares pursuant to a trading plan with set trading instructions established by the Company. As a result, approximately $1,349 million of share repurchases remain available under the April 2016 share repurchase program. All repurchased shares were retired, and are reflected as a reduction of ordinary share capital for the par value of the shares, with the excess applied as reductions to additional paid-in capital and retained earnings.
Dividends to Holders of Ordinary Shares
The Company has declared and paid cash dividends per ordinary share during the periods presented as follows:
| Dividend | Amount | ||||||
| Per Share | (in millions) | ||||||
| 2016: | |||||||
| Fourth quarter | $ | 0.29 | $ | 79 | |||
| Third quarter | 0.29 | 79 | |||||
| Second quarter | 0.29 | 79 | |||||
| First quarter | 0.29 | 80 | |||||
| Total | $ | 1.16 | $ | 317 | |||
| 2015: | |||||||
| Fourth quarter | $ | 0.25 | $ | 70 | |||
| Third quarter | 0.25 | 71 | |||||
| Second quarter | 0.25 | 72 | |||||
| First quarter | 0.25 | 73 | |||||
| Total | $ | 1.00 | $ | 286 |
In addition, in January 2017, the Board of Directors declared a regular quarterly cash dividend of $0.29 per ordinary share, payable on February 15, 2017 to shareholders of record at the close of business on February 6, 2017.
Dividends from Equity Investments
During the year ended December 31, 2016, Delphi received dividends of $17 million from one of its equity method investments. During the year ended December 31, 2015, Delphi received dividends of $17 million from one of its equity method investments. During the year ended December 31, 2014, Delphi received a dividend of $10 million from its equity method investment in KDAC, a Korean unconsolidated joint venture which was sold during the year ended December 31, 2015 and has been reclassified to discontinued operations, as further described in Note 25. Discontinued Operations to the audited consolidated financial statements included herein. The dividends were recognized as reductions to the investments and represented a return on the investments that were included in cash flows from operating activities from continuing operations and discontinued operations, respectively.
Acquisitions
PureDepth—On March 23, 2016, Delphi acquired 100% of the equity interests of PureDepth, Inc. ("PureDepth"), a leading provider of 3D display technology, for approximately $15 million. As further described in Note 20. Acquisitions and Divestitures to the audited consolidated financial statements contained herein, the acquisition was accounted for as a business combination, with the operating results of PureDepth included within the Company's Electronics and Safety segment from the date of acquisition. The Company acquired PureDepth utilizing cash on hand.
HellermannTyton—On December 18, 2015, pursuant to the terms of a recommended offer made on July 30, 2015, Delphi completed the acquisition of 100% of the issued ordinary share capital of HellermannTyton Group PLC ("HellermannTyton") a
public limited company based in the United Kingdom, and a leading global manufacturer of high-performance and innovative cable management solutions. The acquisition of HellermannTyton expands Delphi’s product portfolio within the connected vehicle solutions market and will help capitalize on the connected car megatrend. The acquisition also further strengthens Delphi’s leading position in the electrical architecture market, while providing a platform to grow in HellermannTyton’s adjacent industrial end markets, including aerospace, defense, alternative energy and mass transit.
Delphi paid 480 pence per HellermannTyton share, or approximately $1.5 billion in the aggregate, net of cash acquired. HellermannTyton had 2014 sales of approximately €600 million (approximately 6% of which were to Delphi and will be eliminated on a consolidated basis). Approximately $242 million of HellermannTyton outstanding debt to third-party creditors was assumed and subsequently paid off. Upon completing the acquisition, Delphi incurred transaction related expenses totaling approximately $23 million, which were recorded within other income (expense), net in the statement of operations in the fourth quarter of 2015. The results of operations of HellermannTyton are reported within the Electrical/Electronic Architecture segment from the date of acquisition.
Delphi financed the cash payment required to close the acquisition of HellermannTyton primarily with the net proceeds received from the offering of $1.3 billion of 2015 Senior Notes, as further described below, with the remainder of the purchase price funded with cash on hand that was received from the sale of the Company's Thermal Systems business, as further described below. Prior to the transaction closing, in connection with the offer to acquire HellermannTyton in July 2015, £540 million ($844 million using July 30, 2015 foreign currency rates) was placed on deposit for purposes of satisfying a portion of the consideration required to effect the acquisition.
Prior to the issuance of the 2015 Senior Notes, in connection with the offer to acquire HellermannTyton, on July 30, 2015, Delphi Automotive PLC and certain of its subsidiaries, certain financial institutions from time to time party thereto, as lenders and Barclays Bank PLC, as administrative agent, entered into a Senior Bridge Credit Agreement (the "Senior Bridge Credit Agreement"), pursuant to which the lenders thereunder agreed to provide a £550 million bridge term loan facility. The Senior Bridge Credit Agreement was automatically terminated on November 19, 2015 in connection with the issuance of the 2015 Senior Notes, and unamortized issuance costs of $6 million associated with the agreement were written-off to other income (expense), net during the year ended December 31, 2015. The Company did not draw on the Senior Bridge Credit Agreement.
Control-Tec—On November 30, 2015, Delphi acquired Control-Tec, LLC ("Control-Tec"), a leading provider of telematics and cloud-hosted data analytics solutions, for a purchase price of $104 million at closing, with an additional cash payment of up to $40 million due upon the achievement of certain financial performance metrics over a future 3-year period. As further described in Note 18. Fair Value of Financial Instruments to the audited consolidated financial statements contained herein, based on the results of the acquired business, Delphi will pay $20 million of contingent consideration in 2017 pursuant to the terms of the acquisition agreement. As further described in Note 20. Acquisitions and Divestitures to the audited consolidated financial statements contained herein, the acquisition was accounted for as a business combination, with the operating results of Control-Tec included within the Company's Electronics and Safety segment from the date of acquisition. The Company acquired Control-Tec utilizing cash on hand.
Ottomatika—On July 23, 2015, Delphi acquired Ottomatika, Inc. ("Ottomatika"), an automated vehicle system software developer. The Company paid $16 million at closing, with additional cash payments totaling $11 million deferred over a period of 3 years and additional contingent consideration of up to $5 million due upon the achievement of certain product development milestones over a 3-year period. As further described in Note 20. Acquisitions and Divestitures to the audited consolidated financial statements contained herein, the acquisition was accounted for as a business combination, with the operating results of Ottomatika included within the Company's Electronics and Safety segment from the date of acquisition. The Company acquired Ottomatika utilizing cash on hand.
Antaya—On October 31, 2014, Delphi acquired 100% of the share capital of Antaya Technologies Corporation ("Antaya"), a leading manufacturer of on-glass connectors to the global automotive industry for approximately $151 million. The Company paid $140 million at closing, with an additional cash payment of up to $40 million due upon the achievement of certain financial performance metrics over a future 3-year period ending October 31, 2017. As further described in Note 20. Acquisitions and Divestitures to the audited consolidated financial statements contained herein, the acquisition was accounted for as a business combination, with the operating results of Antaya included within the Company's Electrical/Electronic Architecture segment from the date of acquisition. The Company acquired Antaya utilizing cash on hand.
Unwired—On October 1, 2014, Delphi acquired 100% of the equity interests of Unwired Holdings, Inc. ("Unwired"), a media connectivity module supplier to the global automotive industry, for $191 million, net of approximately $19 million for acquired cash, excess net working capital and certain tax benefits. As further described in Note 20. Acquisitions and Divestitures to the audited consolidated financial statements contained herein, the acquisition was accounted for as a business combination, with the operating results of Unwired included within the Company's Electrical/Electronic Architecture segment from the date of acquisition. The Company acquired Unwired utilizing cash on hand.
Movimento—On January 3, 2017, Delphi acquired 100% of the equity interests of Movimento Group ("Movimento"), a leading provider of Over-the-Air software and data management for the automotive sector, for a purchase price of $40 million at closing and an additional cash payment of up to $10 million contingent upon the achievement of certain performance metrics over a future 2-year period. As further described in Note 20. Acquisitions and Divestitures to the audited consolidated financial statements contained herein, the acquisition will be accounted for as a business combination, with the operating results of Movimento included within the Company's Electronics and Safety segment from the date of acquisition. The Company acquired Movimento utilizing cash on hand.
Divestitures
Mechatronics—On December 30, 2016, Delphi completed the sale of its Mechatronics business, which was previously reported within the Company's Electronics and Safety segment, for net cash proceeds of approximately $197 million. The net sales of this business in 2016 prior to the divestiture were approximately $290 million. Delphi recognized a pre-tax gain on the divestiture of $141 million within cost of sales in the fourth quarter of 2016.
Thermal Systems—On June 30, 2015 the Company closed the sale of its wholly owned Thermal Systems business to MAHLE GmbH ("MAHLE"). The Company received net cash proceeds of approximately $660 million and recognized an after-tax gain on the divestiture of $271 million in 2015. Post-closing adjustments of $3 million, primarily related to the settlement of contingent liabilities, were recorded as a reduction to the gain on the divestiture during the year ended December 31, 2016. Proceeds received from the sale were used to fund growth initiatives, including acquisitions, as well as share repurchases.
On September 24, 2015, the Company closed the sale of its 50 percent interest in its Korea Delphi Automotive Systems Corporation ("KDAC") joint venture, which was accounted for under the equity method and was principally reported as part of the Thermal Systems segment, to the joint venture partner. The Company received cash proceeds of $70 million and recognized a gain on the divestiture of $47 million, net of tax expense, within income from income from discontinued operations during the three months ended September 30, 2015. For the year ended December 31, 2015, the Company recorded a net loss of $41 million on the KDAC divestiture within income from discontinued operations, which includes the $88 million impairment loss recorded in the first quarter of 2015.
On March 31, 2016, Delphi closed the sale of its 50 percent interest in its Shanghai Delphi Automotive Air Conditioning ("SDAAC") joint venture to one of Delphi's joint venture partners, Shanghai Aerospace Automobile Electromechanical Co., Ltd ("SAAE"). The Company received cash proceeds of $62 million, net of tax, transaction costs and $29 million of cash divested, and recognized an after-tax gain on the divestiture of $104 million within income from discontinued operations during the year ended December 31, 2016. The financial results of SDAAC, which were consolidated by Delphi, were historically reported as part of the Thermal Systems segment.
Accordingly, the Thermal Systems business has been classified as discontinued operations. Refer to Note 25. Discontinued Operations to the audited consolidated financial statements contained herein for further disclosure related to the Company's discontinued operations and the related assets and liabilities classified as held for sale. The disposal of the Thermal Systems business did not have a material impact on our liquidity or capital resources, and we have not had significant continuing involvement with the divested Thermal Systems business following the closing of the transactions.
Reception Systems—On July 31, 2015, Delphi completed the sale of its Reception Systems business, which was previously reported within the Electronics and Safety segment, and received net cash proceeds of approximately $25 million. The net sales of this business were approximately $55 million for the six months ended June 30, 2015. Delphi recognized a pre-tax gain on the divestiture of $39 million within cost of sales in the third quarter of 2015.
Argentina Businesses—On April 21, 2015, Delphi completed the exit of its Electrical Wiring business located in Argentina, which was previously reported within the Electrical/Electronic Architecture segment. Delphi recognized a loss on the divestiture of this business of $14 million within cost of sales in the second quarter of 2015, which included a cash payment by Delphi to the buyer of $7 million. On December 10, 2015, Delphi completed the exit of its Electronics business located in Argentina, which was previously reported within the Electronics and Safety segment. The net sales of this business in 2015 prior to the divestiture were approximately $34 million. Delphi recognized a loss on the divestiture of this business of $33 million within cost of sales in the fourth quarter of 2015, which included a cash payment by Delphi to the buyer of $7 million.
Credit Agreement
Delphi Automotive PLC and its wholly-owned subsidiary Delphi Corporation entered into a credit agreement (the "Credit Agreement") with JPMorgan Chase Bank, N.A., as administrative agent (the "Administrative Agent"), under which it maintains senior secured credit facilities currently consisting of a term loan (the “Tranche A Term Loan”) and a revolving credit facility of $2.0 billion (the “Revolving Credit Facility”). The Credit Agreement was entered into in March 2011 and has been subsequently amended and restated on several occasions, most recently on August 17, 2016. The 2016 amendment extended the maturity of the Revolving Credit Facility and the Tranche A Term Loan from 2018 to 2021, increased the capacity of the
Revolving Credit Facility from $1.5 billion to $2.0 billion and permitted Delphi Automotive PLC to act as a borrower on the Revolving Credit Facility. A loss on debt extinguishment of $3 million was recorded within other income (expense), net in the consolidated statement of operations during the year ended December 31, 2016 in conjunction with the 2016 amendment.
The Tranche A Term Loan and the Revolving Credit Facility mature on August 17, 2021. Delphi is obligated to make quarterly principal payments, beginning December 31, 2017, throughout the term of the Tranche A Term Loan according to the amortization schedule in the Credit Agreement. The Credit Agreement also contains an accordion feature that permits Delphi to increase, from time to time, the aggregate borrowing capacity under the Credit Agreement by up to an additional $1 billion (or a greater amount based upon a formula set forth in the Credit Agreement) upon Delphi's request, the agreement of the lenders participating in the increase, and the approval of the Administrative Agent and existing lenders.
As of December 31, 2016, there were no amounts drawn on the Revolving Credit Facility and approximately $7 million in letters of credit issued under the Credit Agreement. Letters of credit issued under the Credit Agreement reduce availability under the Revolving Credit Facility. The maximum amount drawn under the Revolving Credit Facility during the year ended December 31, 2016 to manage intra-month working capital requirements was $272 million.
Loans under the Credit Agreement bear interest, at Delphi's option, at either (a) the Administrative Agent’s Alternate Base Rate (“ABR” as defined in the Credit Agreement) or (b) the London Interbank Offered Rate (the “Adjusted LIBO Rate” as defined in the Credit Agreement) (“LIBOR”) plus in either case a percentage per annum as set forth in the table below (the “Applicable Rate”). The Applicable Rates under the Credit Agreement on the specified dates are set forth below:
| December 31, 2016 | December 31, 2015 | ||||||||||
| LIBOR plus | ABR plus | LIBOR plus | ABR plus | ||||||||
| Revolving Credit Facility | 1.10 | % | 0.10 | % | 1.00 | % | 0.00 | % | |||
| Tranche A Term Loan | 1.25 | % | 0.25 | % | 1.00 | % | 0.00 | % |
The Applicable Rate under the Credit Agreement may increase or decrease from time to time based on changes in the Company's credit ratings. Accordingly, the interest rate will fluctuate during the term of the Credit Agreement based on changes in the ABR, LIBOR or future changes in the Company's corporate credit ratings. The Credit Agreement also requires that Delphi pay certain facility fees on the Revolving Credit Facility and certain letter of credit issuance and fronting fees.
The interest rate period with respect to LIBOR interest rate options can be set at one-, two-, three-, or six-months as selected by Delphi in accordance with the terms of the Credit Agreement (or other period as may be agreed by the applicable lenders). Delphi may elect to change the selected interest rate option in accordance with the provisions of the Credit Agreement. As of December 31, 2016, Delphi selected the one-month LIBOR interest rate option on the Tranche A Term Loan, and the rate effective as of December 31, 2016, as detailed in the table below, was based on the Company's current credit rating and the Applicable Rate for the Credit Agreement:
| Borrowings as of | ||||||||
| December 31, 2016 | Rates effective as of | |||||||
| Applicable Rate | (in millions) | December 31, 2016 | ||||||
| Tranche A Term Loan | LIBOR plus 1.25% | $ | 400 | 2.00 | % |
Borrowings under the Credit Agreement are prepayable at Delphi's option without premium or penalty.
The Credit Agreement contains certain covenants that limit, among other things, the Company’s (and the Company’s subsidiaries’) ability to incur certain additional indebtedness or liens or to dispose of substantially all of its assets. In addition, the Credit Agreement requires that the Company maintain a consolidated leverage ratio (the ratio of Consolidated Total Indebtedness to Consolidated EBITDA, each as defined in the Credit Agreement) of less than 3.50 to 1.0. The Credit Agreement also contains events of default customary for financings of this type. The Company was in compliance with the Credit Agreement covenants as of December 31, 2016.
As of December 31, 2016, all obligations under the Credit Agreement were borrowed by Delphi Corporation and jointly and severally guaranteed by its direct and indirect parent companies, subject to certain exceptions set forth in the Credit Agreement. Refer to Note 22. Supplemental Guarantor and Non-Guarantor Condensed Consolidating Financial Statements for additional information.
Senior Unsecured Notes
On May 17, 2011, Delphi Corporation issued $500 million of 5.875% senior unsecured notes due 2019 (the "5.875% Senior Notes") and $500 million of 6.125% senior unsecured notes due 2021 (the “6.125% Senior Notes”) (collectively, the "2011 Senior Notes") in a transaction exempt from registration under Rule 144A and Regulation S of the Securities Act of 1933
(the “Securities Act”). The net proceeds of approximately $1 billion as well as cash on hand were used to pay down amounts outstanding under the Credit Agreement. In May 2012, Delphi Corporation completed a registered exchange offer for all of the 2011 Senior Notes. No proceeds were received by Delphi Corporation as a result of the exchange. In March 2014, Delphi redeemed for cash the entire $500 million aggregate principal amount outstanding of the 5.875% Senior Notes, financed by a portion of the proceeds received from the issuance of the 2014 Senior Notes, as defined below. In March 2015, Delphi redeemed for cash the entire $500 million aggregate principal amount outstanding of the 6.125% Senior Notes, financed by a portion of the proceeds from the issuance of the 2015 Euro-denominated Senior Notes, as defined below. As a result of the redemption of the 2011 Senior Notes, Delphi recognized losses on debt extinguishment of approximately $52 million during the year ended December 31, 2015 and $33 million during the year ended December 31, 2014 within other income (expense), net in the consolidated statement of operations.
On February 14, 2013, Delphi Corporation issued $800 million of 5.00% senior unsecured notes due 2023 (the “2013 Senior Notes”) in a transaction registered under the Securities Act. The proceeds were primarily utilized to prepay our term loan indebtedness under the Credit Agreement. Delphi paid approximately $12 million of issuance costs in connection with the 2013 Senior Notes. Interest was payable semi-annually on February 15 and August 15 of each year to holders of record at the close of business on February 1 or August 1 immediately preceding the interest payment date. In September 2016, Delphi redeemed for cash the entire $800 million aggregate principal amount outstanding of the 2013 Senior Notes, primarily financed by the proceeds from the issuance of the 2016 Euro-denominated Senior Notes and the 2016 Senior Notes, each as defined below. As a result of the redemption of the 2013 Senior Notes, Delphi recognized a loss on debt extinguishment of approximately $70 million during the year ended December 31, 2016 within other income (expense), net in the consolidated statement of operations.
On March 3, 2014, Delphi Corporation issued $700 million in aggregate principal amount of 4.15% senior unsecured notes due 2024 (the "2014 Senior Notes") in a transaction registered under the Securities Act. The 2014 Senior Notes were priced at 99.649% of par, resulting in a yield to maturity of 4.193%. The proceeds were primarily utilized to redeem the 5.875% Senior Notes and to repay a portion of the Tranche A Term Loan. Delphi paid approximately $6 million of issuance costs in connection with the 2014 Senior Notes. Interest is payable semi-annually on March 15 and September 15 of each year to holders of record at the close of business on March 1 or September 1 immediately preceding the interest payment date.
On March 10, 2015, Delphi Automotive PLC issued €700 million in aggregate principal amount of 1.50% Euro-denominated senior unsecured notes due 2025 (the “2015 Euro-denominated Senior Notes”) in a transaction registered under the Securities Act. The 2015 Euro-denominated Senior Notes were priced at 99.54% of par, resulting in a yield to maturity of 1.55%. The proceeds were primarily utilized to redeem the 6.125% Senior Notes, and to fund growth initiatives, such as acquisitions, and share repurchases. Delphi incurred approximately $5 million of issuance costs in connection with the 2015 Euro-denominated Senior Notes. Interest is payable annually on March 10. The Company has designated the 2015 Euro-denominated Senior Notes as a net investment hedge of the foreign currency exposure of its investments in certain Euro-denominated wholly owned subsidiaries. Refer to Note 17. Derivatives and Hedging Activities to the audited consolidated financial statements contained herein for further information.
On November 19, 2015, Delphi Automotive PLC issued $1.3 billion in aggregate principal amount of senior unsecured notes in a transaction registered under the Securities Act, comprised of $650 million of 3.15% senior unsecured notes due 2020 (the "3.15% Senior Notes") and $650 million of 4.25% senior unsecured notes due 2026 (the "4.25% Senior Notes") (collectively, the “2015 Senior Notes”). The 3.15% Senior Notes were priced at 99.784% of par, resulting in a yield to maturity of 3.197%, and the 4.25% Senior Notes were priced at 99.942% of par, resulting in a yield to maturity of 4.256%. The proceeds were primarily utilized to fund a portion of the cash consideration for the acquisition of HellermannTyton, as further described in Note. 20. Acquisitions and Divestitures to the audited consolidated financial statements contained herein, and for general corporate purposes, including the payment of fees and expenses associated with the HellermannTyton acquisition and the related financing transaction. Delphi incurred approximately $8 million of issuance costs in connection with the 2015 Senior Notes. Interest on the 3.15% Senior Notes is payable semi-annually on May 19 and November 19 of each year to holders of record at the close of business on May 4 or November 4 immediately preceding the interest payment date. Interest on the 4.25% Senior Notes is payable semi-annually on January 15 and July 15 of each year to holders of record at the close of business on January 1 or July 1 immediately preceding the interest payment date.
On September 15, 2016, Delphi Automotive PLC issued €500 million in aggregate principal amount of 1.60% Euro-denominated senior unsecured notes due 2028 (the “2016 Euro-denominated Senior Notes”) in a transaction registered under the Securities Act. The 2016 Euro-denominated Senior Notes were priced at 99.881% of par, resulting in a yield to maturity of 1.611%. The proceeds, together with proceeds from the 2016 Senior Notes described below, were utilized to redeem the 2013 Senior Notes. Delphi incurred approximately $4 million of issuance costs in connection with the 2016 Euro-denominated Senior Notes. Interest is payable annually on September 15. The Company has designated the 2016 Euro-denominated Senior Notes as a net investment hedge of the foreign currency exposure of its investments in certain Euro-denominated wholly-owned subsidiaries. Refer to Note. 17. Derivatives and Hedging Activities for further information.
On September 20, 2016, Delphi Automotive PLC issued $300 million in aggregate principal amount of 4.40% senior unsecured notes due 2046 (the “2016 Senior Notes”) in a transaction registered under the Securities Act. The 2016 Senior Notes were priced at 99.454% of par, resulting in a yield to maturity of 4.433%. The proceeds, together with proceeds from the 2016 Euro-denominated Senior Notes, were utilized to redeem the 2013 Senior Notes. Delphi incurred approximately $3 million of issuance costs in connection with the 2016 Senior Notes. Interest is payable semi-annually on April 1 and October 1 of each year to holders of record at the close of business on March 15 or September 15 immediately preceding the interest payment date.
Although the specific terms of each indenture governing each series of senior notes vary, the indentures contain certain restrictive covenants, including with respect to Delphi's (and Delphi's subsidiaries) ability to incur liens, enter into sale and leaseback transactions and merge with or into other entities. As of December 31, 2016, the Company was in compliance with the provisions of all series of the outstanding senior notes.
The 2013 Senior Notes and the 2014 Senior Notes were issued by Delphi Corporation. The 2014 Senior Notes are, and prior to their redemption, the 2013 Senior Notes were, fully and unconditionally guaranteed, jointly and severally, by Delphi Automotive PLC and by certain of Delphi Automotive PLC's direct and indirect subsidiaries which are directly or indirectly 100% owned by Delphi Automotive PLC, subject to customary release provisions (other than in the case of Delphi Automotive PLC). The 2015 Euro-denominated Senior Notes, 2015 Senior Notes, 2016 Euro-denominated Senior Notes and 2016 Senior Notes issued by Delphi Automotive PLC are fully and unconditionally guaranteed, jointly and severally, by certain of Delphi Automotive PLC's direct and indirect subsidiaries (including Delphi Corporation), which are directly or indirectly 100% owned by Delphi Automotive PLC, subject to customary release provisions. Refer to Note 22. Supplemental Guarantor and Non-Guarantor Condensed Consolidating Financial Statements for additional information.
Other Financing
Receivable factoring—Delphi maintains a €400 million European accounts receivable factoring facility, of which €350 million is available on a committed basis. This facility is accounted for as short-term debt and borrowings are subject to the availability of eligible accounts receivable. Collateral is not required related to these trade accounts receivable. This program matures on August 31, 2017, and will automatically renew on a non-committed, indefinite basis unless terminated by either party. Borrowings bear interest at LIBOR plus 1.05% for borrowings denominated in pounds sterling and Euro Interbank Offered Rate ("EURIBOR") plus 0.80% for borrowings denominated in Euros. No amounts were outstanding on the European accounts receivable factoring facility as of December 31, 2016 or December 31, 2015. The maximum amount drawn under the European facility during the year ended December 31, 2016 to manage working capital requirements was $436 million.
The Company has entered into arrangements with various financial institutions to sell eligible trade receivables from certain aftermarket customers in North America. These arrangements can be terminated at any time subject to prior written notice. The receivables under these arrangements are sold without recourse to the Company and are therefore accounted for as true sales. During the years ended December 31, 2016 and 2015, $123 million and $100 million of receivables were sold under these arrangements, and expenses of $3 million and $2 million, respectively, were recognized within interest expense.
In addition, in 2016 and 2015 one of the Company’s European subsidiaries factored, without recourse, receivables related to certain foreign research tax credits to a financial institution. These transactions were accounted for as true sales of the receivables, and the Company therefore derecognized approximately $26 million from other long-term assets and $27 million from other current assets in the consolidated balance sheet as of December 31, 2016 and December 31, 2015, respectively, as a result of these transactions.
Capital leases and other—As of December 31, 2016 and December 31, 2015, approximately $42 million and approximately $77 million, respectively, of other debt issued by certain non-U.S. subsidiaries and capital lease obligations were outstanding.
Government programs—Delphi commonly seeks manufacturing development and financial assistance incentive programs that may be awarded by government entities. Delphi has numerous technology development programs that are competitively awarded from agencies of the U.S. Federal Government, primarily from the U.S. Department of Energy (“DOE”). We received approximately $3 million from Federal agencies in the year ended December 31, 2016 for work performed. These programs supplement our internal research and development funds and directly support our product focus of Safe, Green and Connected. We continue to pursue many technology development programs by bidding on competitively procured programs from DOE, as well as the U.S. Department of Transportation (“DOT”). Some of these programs were bid with us being the lead or “Prime Contractor”, and some were bid with us as a “Subrecipient” to the Prime Contractor. For the year ended December 31, 2016, Delphi was awarded four new programs with over $6 million of U.S. Government funds that will be received over the next 48 months.
Contractual Commitments
The following table summarizes our expected cash outflows resulting from financial contracts and commitments as of December 31, 2016, with amounts denominated in foreign currencies translated using foreign currency rates as of December 31, 2016. We have not included information on our recurring purchases of materials for use in our manufacturing operations. These amounts are generally consistent from year to year, closely reflect our levels of production, and are not long-term in nature. The amounts below exclude the gross liability for uncertain tax positions of $188 million as of December 31, 2016. We do not expect a significant payment related to these obligations to be made within the next twelve months. We are not able to provide a reasonably reliable estimate of the timing of future payments relating to the non-current portion of obligations associated with uncertain tax positions. For more information, refer to Note 14. Income Taxes to the audited consolidated financial statements included herein. The amounts below also exclude the reserve of $300 million for the Unsecured Creditors litigation, as further described in Note 13. Commitments and Contingencies to the audited consolidated financial statements included herein, as this matter remains subject to ongoing litigation and the timing of any related settlements are uncertain.
| Payments due by Period | |||||||||||||||||||
| Total | 2017 | 2018 & 2019 | 2020 & 2021 | Thereafter | |||||||||||||||
| (in millions) | |||||||||||||||||||
| Debt and capital lease obligations (excluding interest) | $ | 4,004 | $ | 12 | $ | 54 | $ | 1,016 | $ | 2,922 | |||||||||
| Estimated interest costs related to debt and capital lease obligations | 1,155 | 118 | 235 | 208 | 594 | ||||||||||||||
| Operating lease obligations | 358 | 91 | 115 | 74 | 78 | ||||||||||||||
| Contractual commitments for capital expenditures | 130 | 130 | — | — | — | ||||||||||||||
| Other contractual purchase commitments, including information technology | 220 | 127 | 62 | 27 | 4 | ||||||||||||||
| Total | $ | 5,867 | $ | 478 | $ | 466 | $ | 1,325 | $ | 3,598 |
In addition to the obligations discussed above, certain of our non-U.S. subsidiaries sponsor defined benefit pension plans, some of which are funded. We have minimum funding requirements with respect to certain of our pension obligations and may periodically elect to make discretionary contributions to the plans in support of risk management initiatives. We will also have payments due with respect to our other postretirement benefit obligations. We do not fund our other postretirement benefit obligations and payments are made as costs are incurred by covered retirees. Refer to Note 12. Pension Benefits to the audited consolidated financial statements included herein for additional detail regarding our expected contributions to our pension plans and expected distributions to participants in future periods.
Capital Expenditures
Supplier selection in the auto industry is generally finalized several years prior to the start of production of the vehicle. Therefore, current capital expenditures are based on customer commitments entered into previously, generally several years ago when the customer contract was awarded. As of December 31, 2016, we had approximately $130 million in outstanding cancellable and non-cancellable capital commitments. Capital expenditures by operating segment and geographic region for the periods presented were:
| Year Ended December 31, | |||||||||||
| 2016 | 2015 | 2014 | |||||||||
| (in millions) | |||||||||||
| Electrical/Electronic Architecture | $ | 458 | $ | 353 | $ | 326 | |||||
| Powertrain Systems | 171 | 201 | 322 | ||||||||
| Electronics and Safety | 131 | 102 | 82 | ||||||||
| Eliminations and Other (1) | 68 | 48 | 49 | ||||||||
| Total capital expenditures | $ | 828 | $ | 704 | $ | 779 | |||||
| North America | $ | 288 | $ | 247 | $ | 214 | |||||
| Europe, Middle East & Africa | 338 | 245 | 290 | ||||||||
| Asia Pacific | 193 | 202 | 253 | ||||||||
| South America | 9 | 10 | 22 | ||||||||
| Total capital expenditures | $ | 828 | $ | 704 | $ | 779 |
| (1) | Eliminations and Other includes capital expenditures amounts attributable to corporate administrative and support functions, including corporate headquarters and certain technical centers. |
Cash Flows
Intra-month cash flow cycles vary by region, but in general we are users of cash through the first half of a typical month and we generate cash during the latter half of a typical month. Due to this cycle of cash flows, we may utilize short-term financing, including our Revolving Credit Facility and European accounts receivable factoring facility, to manage our intra-month working capital needs. Our cash balance typically peaks at month end.
We utilize a combination of strategies, including dividends, cash pooling arrangements, intercompany loan structures and other distributions and advances to provide the funds necessary to meet our global liquidity needs. We utilize a global cash pooling arrangement to consolidate and manage our global cash balances, which enables us to efficiently move cash into and out of a number of the countries in which we operate.
Operating activities—Net cash provided by operating activities from continuing operations totaled $1,941 million and $1,667 million for the year ended December 31, 2016 and 2015, respectively. Cash flow from operating activities from continuing operations for the year ended December 31, 2016 consisted primarily of net earnings from continuing operations of $1,218 million, increased by $839 million for non-cash charges for depreciation and amortization, pension and other postretirement benefit expenses and extinguishment of debt, partially offset by $101 million related to changes in operating assets and liabilities, net of restructuring and pension contributions. Cash flow from operating activities from continuing operations for the year ended December 31, 2015 consisted primarily of net earnings from continuing operations of $1,261 million, increased by $673 million for non-cash charges for depreciation and amortization, pension and other postretirement benefit expenses and extinguishment of debt, partially offset by $336 million related to changes in operating assets and liabilities, net of restructuring and pension contributions.
Net cash provided by operating activities from continuing operations totaled $2,045 million for the year ended December 31, 2014, which consisted of net earnings from continuing operations of $1,380 million, increased by $662 million for non-cash charges for depreciation and amortization, pension and other postretirement benefit expenses and extinguishment of debt, partially offset by $54 million related to changes in operating assets and liabilities, net of restructuring and pension contributions.
Investing activities—Net cash used in investing activities from continuing operations totaled $574 million and $1,630 million for the years ended December 31, 2016 and 2015, respectively. The decrease in usage is primarily attributable to $1,654 million that was paid for business acquisitions in 2015, principally HellermannTyton, as compared to $15 million paid for business acquisitions in 2016. This decrease was partially offset by $124 million of increased capital expenditures during the year ended December 31, 2016 as compared to 2015, as well as a reduction in proceeds received from divestitures. During 2015, net proceeds of $730 million were received from the sales of our wholly owned Thermal Systems business and KDAC joint venture, as compared to net proceeds of $48 million received from the sale of discontinued operations and $197 million received from the sale of the Mechatronics business during the year ended December 31, 2016.
Net cash used in investing activities from continuing operations totaled $1,112 million for the year ended December 31, 2014 which resulted primarily from capital expenditures of $779 million and $345 million paid for business acquisitions, partially offset by proceeds from the sale of property / investments of $15 million.
Financing activities—Net cash used in financing activities totaled $1,081 million and $284 million for the years ended December 31, 2016 and 2015, respectively. Cash flows used in financing activities for the year ended December 31, 2016 primarily included the net proceeds of approximately $852 million received from the issuance of the 2016 Euro-denominated Senior Notes and the 2016 Senior Notes, which were primarily utilized to redeem the $800 million 2013 Senior Notes, as well as $634 million paid to repurchase ordinary shares and $317 million of dividend payments. During the year ended December 31, 2015, net proceeds of $1.3 billion were received from the issuance of the 2015 Senior Notes in order to fund a portion of the acquisition of HellermannTyton, and net proceeds of $753 million were received from the issuance of the 2015 Euro-denominated Senior Notes, which were partially utilized to redeem the 6.125% Senior Notes. Additionally, $1,159 million was paid to repurchase ordinary shares and $286 million of dividend payments were made in 2015.
Net cash used in financing activities totaled $1,398 million for the year ended December 31, 2014. Net proceeds of approximately $691 million received from the issuance of the 2014 Senior Notes were primarily used to redeem the 5.875% Senior Notes and to repay a portion of the Tranche A Term Loan. Additionally, $1,024 million was paid to repurchase ordinary shares and $301 million of dividend payments were made.
Off-Balance Sheet Arrangements and Other Matters
We do not engage in any off-balance sheet financial arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Pension Benefits
Certain of our non-U.S. subsidiaries sponsor defined benefit pension plans, which generally provide benefits based on negotiated amounts for each year of service. Our primary non-U.S. plans are located in France, Germany, Mexico, Portugal and the United Kingdom ("U.K."). The U.K. and certain Mexican plans are funded. In addition, we have defined benefit plans in South Korea, Turkey and Italy for which amounts are payable to employees immediately upon separation. The obligations for these plans are recorded over the requisite service period. We anticipate making pension contributions and benefit payments of approximately $65 million for non-U.S. plans in 2017.
Delphi sponsors a Supplemental Executive Retirement Program (“SERP”) for those employees who were U.S. executives of DPHH prior to September 30, 2008 and were still U.S. executives of Delphi on October 7, 2009, the effective date of the program. This program is unfunded. Executives receive benefits over 5 years after an involuntary or voluntary separation from Delphi. The SERP is closed to new members and was frozen effective September 30, 2008. There are no required contributions for the SERP in 2017, although we anticipate making benefit payments of approximately $11 million for the SERP in 2017.
Refer to Note 12. Pension Benefits to the audited consolidated financial statements included herein for further information on (1) historical benefit costs of the pension plans, (2) the principal assumptions used to determine the pension benefit expense and the actuarial value of the projected benefit obligation for the U.S. and non-U.S. pension plans, (3) a sensitivity analysis of potential changes to pension obligations and expense that would result from changes in key assumptions and (4) funding obligations.
Environmental Matters
We are subject to the requirements of U.S. federal, state and local, and non-U.S., environmental and safety and health laws and regulations. These include laws regulating air emissions, water discharge, hazardous materials and waste management. We have an environmental management structure designed to facilitate and support our compliance with these requirements globally. Although it is our intent to comply with all such requirements and regulations, we cannot provide assurance that we are at all times in compliance. Environmental requirements are complex, change frequently and have tended to become more stringent over time. Accordingly, we cannot assure that environmental requirements will not change or become more stringent over time or that our eventual environmental remediation costs and liabilities will not be material.
Certain environmental laws assess liability on current or previous owners or operators of real property for the cost of removal or remediation of hazardous substances. In addition to clean-up actions brought by U.S. federal, state, local and non-U.S. agencies, plaintiffs could raise personal injury or other private claims due to the presence of hazardous substances on or from a property. At this time, we are involved in various stages of investigation and cleanup related to environmental remediation matters at certain of our present and former facilities. In addition, there may be soil or groundwater contamination at several of our properties resulting from historical, ongoing or nearby activities.
As of December 31, 2016 and 2015, the undiscounted reserve for environmental investigation and remediation was approximately $6 million (of which $1 million was recorded in accrued liabilities and $5 million was recorded in other long-term liabilities) and $4 million (of which $1 million was recorded in accrued liabilities and $3 million was recorded in other long-term liabilities). Additionally, as of December 31, 2015, approximately $6 million of undiscounted reserve for environmental investigation and remediation attributable to discontinued operations was included within liabilities held for sale. Delphi cannot ensure that environmental requirements will not change or become more stringent over time or that its eventual environmental remediation costs and liabilities will not exceed the amount of its current reserves. In the event that such liabilities were to significantly exceed the amounts recorded, Delphi’s results of operations could be materially affected.
Legal Proceedings
For a description of our legal proceedings, see Item 3. Legal Proceedings and Note 13. Commitments and Contingencies to the audited consolidated financial statements included herein.
Significant Accounting Policies and Critical Accounting Estimates
Our significant accounting policies are described in Note 2. Significant Accounting Policies to the audited consolidated financial statements included herein. Certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, terms of existing contracts, our evaluation of trends in the industry, information provided by our customers and information available from other outside sources, as appropriate.
We consider an accounting estimate to be critical if:
| • | It requires us to make assumptions about matters that were uncertain at the time we were making the estimate, and |
| • | Changes in the estimate or different estimates that we could have selected would have had a material impact on our financial condition or results of operations. |
Acquisitions
In accordance with accounting guidance for the provisions in FASB ASC 805, Business Combinations, we allocate the purchase price of an acquired business to its identifiable assets and liabilities based on estimated fair values. The excess of the purchase price over the amount allocated to the assets and liabilities, if any, is recorded as goodwill. In addition, an acquisition may include a contingent consideration component, such as our acquisition agreements for Antaya, Ottomatika and Control-Tec. The fair value of the contingent consideration is estimated as of the date of the acquisition and is recorded as part of the purchase price. This estimate is updated in future periods and any changes in the estimate, which are not considered an adjustment to the purchase price, are recorded in our consolidated statements of operations.
We use all available information to estimate fair values. We typically engage outside appraisal firms to assist in the fair value determination of identifiable intangible assets and any other significant assets or liabilities. We adjust the preliminary purchase price allocation, as necessary, up to one year after the acquisition closing date as we obtain more information regarding asset valuations and liabilities assumed.
Our purchase price allocation methodology contains uncertainties because it requires management to make assumptions and to apply judgment to estimate the fair value of acquired assets and liabilities. Management estimates the fair value of assets and liabilities based upon quoted market prices, the carrying value of the acquired assets and widely accepted valuation techniques, including discounted cash flows and market multiple analyses. Unanticipated events or circumstances may occur which could affect the accuracy of our fair value estimates, including assumptions regarding industry economic factors and business strategies.
Other estimates used in determining fair value include, but are not limited to, future cash flows or income related to intangibles, market rate assumptions, actuarial assumptions for benefit plans and appropriate discount rates. Our estimates of fair value are based upon assumptions believed to be reasonable, but that are inherently uncertain, and therefore, may not be realized. Accordingly, there can be no assurance that the estimates, assumptions, and values reflected in the valuations will be realized, and actual results could vary materially.
Warranty Obligations and Product Recall Costs
Estimating warranty obligations requires us to forecast the resolution of existing claims and expected future claims on products sold. We base our estimate on historical trends of units sold and payment amounts, combined with our current understanding of the status of existing claims and discussions with our customers. The key factors which impact our estimates are (1) the stated or implied warranty period; (2) OEM source; (3) OEM policy decisions regarding warranty claims; and (4) OEMs seeking to hold suppliers responsible for product warranties. These estimates are re-evaluated on an ongoing basis. Actual warranty obligations could differ from the amounts estimated requiring adjustments to existing reserves in future periods. Due to the uncertainty and potential volatility of the factors contributing to developing these estimates, changes in our assumptions could materially affect our results of operations.
In addition to our ordinary warranty provisions with customers, we are also at risk for product recall costs, which are costs incurred when a customer or the Company recalls a product through a formal campaign soliciting return of that product. In addition, the National Highway Traffic Safety Administration ("NHTSA") has the authority, under certain circumstances, to require recalls to remedy safety concerns. Product recall costs typically include the cost of the product being replaced as well as the customer’s cost of the recall, including labor to remove and replace the recalled part. The Company accrues for costs related to product recalls as part of our warranty accrual at the time an obligation becomes probable and can be reasonably estimated. Actual costs incurred could differ from the amounts estimated, requiring adjustments to these reserves in future periods. It is possible that changes in our assumptions or future product recall issues could materially affect our financial position, results of operations or cash flows.
Legal and Other Contingencies
We are involved from time to time in various legal proceedings and claims, including commercial or contractual disputes, product liability claims, government investigations, product warranties and environmental and other matters, that arise in the normal course of business. We routinely assess the likelihood of any adverse judgments or outcomes related to these matters, as well as ranges of probable losses, by consulting with internal personnel involved with such matters as well as with outside legal counsel handling such matters. We have accrued for estimated losses for those matters where we believe that the likelihood of a loss has occurred, is probable and the amount of the loss is reasonably estimable. The determination of the amount of such reserves is based on knowledge and experience with regard to past and current matters and consultation with internal personnel involved with such matters and with outside legal counsel handling such matters. The amount of such reserves may change in the future due to new developments or changes in circumstances. The inherent uncertainty related to the outcome of these matters can result in amounts materially different from any provisions made with respect to their resolution.
Restructuring
Accruals have been recorded in conjunction with our restructuring actions. These accruals include estimates primarily related to employee termination costs, contract termination costs and other related exit costs in conjunction with workforce reduction and programs related to the rationalization of manufacturing and engineering processes. Actual costs may vary from these estimates. These accruals are reviewed on a quarterly basis and changes to restructuring actions are appropriately recognized when identified.
Pensions
We use actuarial estimates and related actuarial methods to calculate our obligation and expense. We are required to select certain actuarial assumptions, which are determined based on current market conditions, historical information and consultation with and input from our actuaries and asset managers. Refer to Note 12. Pension Benefits to the audited consolidated financial statements included herein for additional details. The key factors which impact our estimates are (1) discount rates; (2) asset return assumptions; and (3) actuarial assumptions such as retirement age and mortality which are determined as of the current year measurement date. We review our actuarial assumptions on an annual basis and make modifications to the assumptions based on current rates and trends when appropriate. Experience gains and losses, as well as the effects of changes in actuarial assumptions and plan provisions are recognized in other comprehensive income. Cumulative actuarial gains and losses in excess of 10% of the projected benefit obligation (“PBO”) for a particular plan are amortized over the average future service period of the employees in that plan.
The principal assumptions used to determine the pension expense and the actuarial value of the projected benefit obligation for the U.S. and non-U.S. pension plans were:
Assumptions used to determine benefit obligations at December 31:
| Pension Benefits | |||||||||||
| U.S. Plans | Non-U.S. Plans | ||||||||||
| 2016 | 2015 | 2016 | 2015 | ||||||||
| Weighted-average discount rate | 2.70 | % | 2.70 | % | 2.83 | % | 3.81 | % | |||
| Weighted-average rate of increase in compensation levels | N/A | N/A | 3.86 | % | 3.67 | % |
Assumptions used to determine net expense for years ended December 31:
| Pension Benefits | |||||||||||||||||
| U.S. Plans | Non-U.S. Plans | ||||||||||||||||
| 2016 | 2015 | 2014 | 2016 | 2015 | 2014 | ||||||||||||
| Weighted-average discount rate | 2.70 | % | 2.50 | % | 3.00 | % | 3.81 | % | 3.67 | % | 4.58 | % | |||||
| Weighted-average rate of increase in compensation levels | N/A | N/A | N/A | 3.67 | % | 3.65 | % | 3.85 | % | ||||||||
| Weighted-average expected long-term rate of return on plan assets | N/A | N/A | N/A | 5.84 | % | 6.34 | % | 6.35 | % |
We select discount rates by analyzing the results of matching each plan’s projected benefit obligations with a portfolio of high-quality fixed income investments rated AA- or higher by Standard and Poor’s.
Delphi does not have any U.S. pension assets; therefore no U.S. asset rate of return calculation was necessary for 2016, 2015 or 2014. The primary funded non-U.S. plans are in the United Kingdom and Mexico. For the determination of 2016
expense, we assumed a long-term expected asset rate of return of approximately 5.75% and 7.50% for the United Kingdom and Mexico, respectively. We evaluated input from local actuaries and asset managers, including consideration of recent fund performance and historical returns, in developing the long-term rate of return assumptions. The assumptions for the United Kingdom and Mexico are primarily conservative long-term, prospective rates. To determine the expected return on plan assets, the market-related value of approximately 50% of our plan assets is actual fair value. The expected return on the remainder of our plan assets is determined by applying the expected long-term rate of return on assets to a calculated market-related value of these plan assets, which recognizes changes in the fair value of the plan assets in a systematic manner over five years.
Effective January 1, 2016, the Company changed the method used to estimate the service and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans that utilize a yield curve approach. Historically, the Company estimated these service and interest cost components utilizing a single weighted-average discount rate derived from the yield curve used to measure the projected benefit obligation at the beginning of the period. The Company elected to utilize a full yield curve approach in the estimation of these components by applying the specific spot rates along the yield curve used in the determination of the projected benefit obligation to the relevant projected cash flows. The Company made this change to provide a more precise measurement of service and interest costs by improving the correlation between projected benefit cash flows to the corresponding spot yield curve rates. This change does not affect the measurement of the total benefit obligations. The Company has accounted for this change as a change in accounting estimate and accordingly accounted for it on a prospective basis. The reduction in service and interest costs associated with this change in estimate for the year ended December 31, 2016 was less than $10 million.
Our pension expense for 2017 is determined at the December 31, 2016 measurement date. For purposes of analysis, the following table highlights the sensitivity of our pension obligations and expense to changes in key assumptions:
| Change in Assumption | Impact on Pension Expense | Impact on PBO | ||
| 25 basis point (“bp”) decrease in discount rate | + $8 million | + $101 million | ||
| 25 bp increase in discount rate | - $7 million | - $94 million | ||
| 25 bp decrease in long-term expected return on assets | + $3 million | — | ||
| 25 bp increase in long-term expected return on assets | - $3 million | — |
The above sensitivities reflect the effect of changing one assumption at a time. It should be noted that economic factors and conditions often affect multiple assumptions simultaneously and the effects of changes in key assumptions are not necessarily linear. The above sensitivities also assume no changes to the design of the pension plans and no major restructuring programs.
Based on information provided by our actuaries and asset managers, we believe that the assumptions used are reasonable; however, changes in these assumptions could impact our financial position, results of operations or cash flows. Refer to Note 12. Pension Benefits to the audited consolidated financial statements included herein for additional information.
Accounts Receivable Allowance
Establishing valuation allowances for doubtful accounts requires the use of estimates and judgment in regard to the risk exposure and ultimate realization. The allowance for doubtful accounts is established based upon analysis of trade receivables for known collectability issues, including bankruptcies, and aging of receivables at the end of each period. Changes to our assumptions could materially affect our recorded allowance.
Valuation of Long-Lived Assets, Intangible Assets and Investments in Affiliates and Expected Useful Lives
We monitor our long-lived and definite-lived assets for impairment indicators on an ongoing basis based on projections of anticipated future cash flows, including future profitability assessments of various manufacturing sites when events and circumstances warrant such a review. If impairment indicators exist, we perform the required impairment analysis by comparing the undiscounted cash flows expected to be generated from the long-lived assets to the related net book values. If the net book value exceeds the undiscounted cash flows, an impairment loss is measured and recognized. An impairment loss is measured as the difference between the net book value and the estimated fair value of the long-lived assets. Even if an impairment charge is not required, a reassessment of the useful lives over which depreciation or amortization is being recognized may be appropriate based on our assessment of the recoverability of these assets. We estimate cash flows and fair value using internal budgets based on recent sales data, independent automotive production volume estimates and customer commitments and review of appraisals. The key factors which impact our estimates are (1) future production estimates; (2) customer preferences and decisions; (3) product pricing; (4) manufacturing and material cost estimates; and (5) product life / business retention. Any differences in actual results from the estimates could result in fair values different from the estimated fair values, which could materially impact our future results of operations and financial condition. We believe that the
projections of anticipated future cash flows and fair value assumptions are reasonable; however, changes in assumptions underlying these estimates could affect our valuations.
Goodwill and Intangible Assets
We periodically review goodwill for impairment indicators. We review goodwill for impairment annually in the fourth quarter or more frequently if events or changes in circumstances indicate that goodwill might be impaired. The Company performs the goodwill impairment review at the reporting unit level. We perform a qualitative assessment (step 0) of whether it is more likely than not that a reporting unit's fair value is less than its carrying amount. If not, no further goodwill impairment testing is performed. If so, we perform the step 1 and step 2 tests discussed hereafter. Our qualitative assessment involves significant estimates, assumptions, and judgments, including, but not limited to, macroeconomic conditions, industry and market conditions, financial performance of the Company, reporting unit specific events and changes in the Company's share price.
If the fair value of the reporting unit is greater than its carrying amount (step 1), goodwill is not considered to be impaired and the second step is not required. We estimate the fair value of our reporting units using a combination of a future discounted cash flow valuation model and, if possible, a comparable market transaction model. Estimating fair value requires the Company to make judgments about appropriate discount rates, growth rates, relevant comparable company earnings multiples and the amount and timing of expected future cash flows. If the fair value of the reporting unit is less than its carrying amount, an entity must perform the second step to measure the amount of the impairment loss, if any. The second step requires a reporting unit to compare its implied fair value of goodwill to its carrying amount. If the carrying amount of goodwill exceeds its implied fair value, the reporting unit would recognize an impairment loss for that excess. We estimate implied fair value of goodwill in the same way as goodwill is recognized in a business combination. We estimate fair value of the reporting unit’s identifiable net assets excluding goodwill is compared to the fair value of the reporting unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.
We review indefinite-lived intangible assets for impairment annually or more frequently if events or changes in circumstances indicate the assets might be impaired. Similar to the goodwill assessment described above, the Company first performs a qualitative assessment of whether it is more likely than not that an indefinite-lived intangible asset is impaired. If necessary, the Company then performs a quantitative impairment test by comparing the estimated fair of the asset, based upon its forecasted cash flows, to its carrying value. Other intangible assets with definite lives are amortized over their useful lives and are subject to impairment testing only if events or circumstances indicate that the asset might be impaired, as described above.
Inventories
Inventories are stated at the lower of cost, determined on a first-in, first-out basis, or market, including direct material costs and direct and indirect manufacturing costs. Refer to Note 3. Inventories to the audited consolidated financial statements included herein. Obsolete inventory is identified based on analysis of inventory for known obsolescence issues, and, as of December 31, 2016, the market value of inventory on hand in excess of one year’s supply is generally fully-reserved.
From time to time, payments may be received from suppliers. These payments from suppliers are recognized as a reduction of the cost of the material acquired during the period to which the payments relate. In some instances, supplier rebates are received in conjunction with or concurrent with the negotiation of future purchase agreements and these amounts are amortized over the prospective agreement period.
Income Taxes
Deferred tax assets and liabilities reflect temporary differences between the amount of assets and liabilities for financial and tax reporting purposes. Such amounts are adjusted, as appropriate, to reflect changes in tax rates expected to be in effect when the temporary differences reverse. A valuation allowance is recorded to reduce our deferred tax assets to the amount that is more likely than not to be realized. Changes in tax laws or accounting standards and methods may affect recorded deferred taxes in future periods.
When establishing a valuation allowance, we consider future sources of taxable income such as “future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards” and “tax planning strategies.” A tax planning strategy is defined as “an action that: is prudent and feasible; an enterprise ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused; and would result in realization of deferred tax assets.” In the event we determine it is more likely than not that the deferred tax assets will not be realized in the future, the valuation adjustment to the deferred tax assets will be charged to earnings in the period in which we make such a determination. The valuation of deferred tax assets requires judgment and accounting for the
deferred tax effect of events that have been recorded in the financial statements or in tax returns and our future projected profitability. Changes in our estimates, due to unforeseen events or otherwise, could have a material impact on our financial condition and results of operations.
We calculate our current and deferred tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed in subsequent years. Adjustments based on filed returns are recorded when identified. The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities. Our estimate of the potential outcome of any uncertain tax issue is subject to management’s assessment of relevant risks, facts, and circumstances existing at that time. We use a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. We record a liability for the difference between the benefit recognized and measured and tax position taken or expected to be taken on our tax return. To the extent that our assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. We report tax-related interest and penalties as a component of income tax expense. We do not believe there is a reasonable likelihood that there will be a material change in the tax related balances or valuation allowance balances. However, due to the complexity of some of these uncertainties, the ultimate resolution may be materially different from the current estimate. Refer to Note 14. Income Taxes to the audited consolidated financial statements included herein for additional information.
Fair Value Measurement of Derivative Instruments
In determining the fair value of our derivatives, we utilize valuation techniques as prescribed by FASB ASC 820-10, Fair Value Measurements and Disclosures, and also prioritize the use of observable inputs. The availability of observable inputs varies amongst derivatives and depends on the type of derivative and how actively traded the derivative is. For many of our derivatives, the valuation does not require significant management judgment as the valuation inputs are readily observable in the market. For other derivatives, however, valuation inputs are not as readily observable in the market, and significant management judgment may be required.
All derivative instruments are required to be reported on the balance sheet at fair value unless the transactions qualify and are designated as normal purchases or sales. Changes in fair value are reported currently through earnings unless they meet hedge accounting criteria. Our derivative exposures are with counterparties with long-term investment grade credit ratings. We estimate the fair value of our derivative contracts using an income approach based on valuation techniques to convert future amounts to a single, discounted amount. Estimates of the fair value of foreign currency and commodity derivative instruments are determined using exchange traded prices and rates. We also consider the risk of non-performance in the estimation of fair value, and include an adjustment for non-performance risk in the measure of fair value of derivative instruments. The non-performance risk adjustment reflects the full credit default spread (“CDS”) applied to the net commodity and foreign currency exposures by counterparty. When we are in a net derivative asset position, the counterparty CDS rates are applied to the net derivative asset position. When we are in a net derivative liability position, estimates of peer companies’ CDS rates are applied to the net derivative liability position.
In certain instances where market data is not available, we use management judgment to develop assumptions that are used to determine fair value. This could include situations of market illiquidity for a particular currency or commodity or where observable market data may be limited. In those situations, we generally survey investment banks and/or brokers and utilize the surveyed prices and rates in estimating fair value.
As of December 31, 2016 and 2015, we were in a net derivative liability position of $37 million and $129 million, respectively, and there were no adjustments recorded for nonperformance risk based on the application of peer companies’ CDS rates and because Delphi’s exposures were to counterparties with investment grade credit ratings. Refer to Note 17. Derivatives and Hedging Activities to the audited consolidated financial statements included herein for more information.
Share-Based Compensation
The Delphi Automotive PLC Long Term Incentive Plan, as amended and restated effective April 23, 2015 (“PLC LTIP”) allows for the grant of share-based awards for long-term compensation to the employees, directors, consultants and advisors of the Company (further discussed in Note 21. Share-Based Compensation to the audited consolidated financial statements included herein). Grants of restricted stock units (“RSUs”) to Delphi's executives have been made under the PLC LTIP in each year from 2012 to 2016, and are expected to continue to be made annually. The RSU awards include a time-based vesting portion and a performance-based vesting portion. The performance-based vesting portion includes performance and market conditions in addition to service conditions. We determine the grant date fair value of the RSUs based on the closing price of the Company's ordinary shares on the date of the grant of the award and a contemporaneous valuation performed by an independent valuation specialist with respect to certain market conditions that impact the performance-based vesting portion of the RSUs. We recognize compensation expense based upon the grant date fair value of the awards applied to the Company's best estimate of ultimate performance against the respective targets on a straight-line basis over the requisite vesting period of the awards, adjusted for an estimate for forfeitures. The performance conditions require management to make assumptions regarding the likelihood of achieving certain performance goals. Changes in these performance assumptions, as well as
differences in actual results from management's estimates, could result in estimated or actual fair values different from previously estimated fair values, which could materially impact the Company's future results of operations and financial condition.
Refer to Note 21. Share-Based Compensation to the audited consolidated financial statements included herein for additional information.
Recently Issued Accounting Pronouncements
Refer to Note 2. Significant Accounting Policies to the audited consolidated financial statements included herein for a complete description of recent accounting standards which we have not yet been required to implement which may be applicable to our operations. Additionally, the significant accounting standards that have been adopted during the year ended December 31, 2016 are described.
Previous: Item 6. SELECTED FINANCIAL DATA · Next: Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK