BorgWarner Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited results; comparisons are with the corresponding 2017 periods unless noted. BorgWarner supplies automotive products globally through its Engine and Drivetrain segments.
Key financial results
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $2,694.0 million | $2,389.7 million | $5,478.3 million | $4,796.7 million |
| Gross profit / margin | $579.2 million / 21.5% | $512.9 million / 21.5% | $1,171.0 million / 21.4% | $1,029.2 million / 21.5% |
| Operating income | $312.8 million | $298.1 million | $646.3 million | $589.6 million |
| Net earnings attributable to BorgWarner | $271.8 million | $212.0 million | $496.9 million | $401.2 million |
| Diluted EPS | $1.30 | $1.00 | $2.36 | $1.89 |
| Operating cash flow | Not separately stated for quarter | Not separately stated for quarter | $305.2 million | $399.2 million |
Revenue increased 12.7% in Q2 and 14.2% in the first half. Excluding foreign currency effects and the Sevcon acquisition, management reported growth of approximately 7.3% and 6.9%, respectively. First-half capital expenditures, including tooling, were $268.7 million; operating cash flow less capital expenditures was approximately $36.5 million. Cash declined by $183.4 million in the first half.
At June 30, cash was $361.9 million, including $358.3 million held by foreign subsidiaries. Short-term debt was $70.5 million and long-term debt was $2,102.5 million. The reported net debt-to-net capital ratio was 30.9%, versus 30.0% at December 31, 2017. The $1.2 billion revolving facility and commercial paper program had no outstanding borrowings; the company was in compliance with its debt-to-EBITDA covenant.
Changes and operating drivers
- Engine segment sales rose 13.0% in Q2 and 13.9% in the first half; adjusted EBIT margins were 16.7% and 16.5%, respectively. Growth reflected turbochargers, thermal products and engine timing systems.
- Drivetrain sales rose 12.3% in Q2 and 14.7% in the first half. Adjusted EBIT margins declined to 11.2% in both periods, from 11.9% and 11.6%, respectively; management cited the Sevcon acquisition. Higher all-wheel-drive and transmission component sales supported growth.
- First-half operating cash flow fell $94.0 million year over year, primarily due to working-capital changes, partly offset by higher earnings adjusted for noncash items. Cash used in investing was $266.6 million, mainly capital expenditures.
- Foreign currency translation reduced Q2 comprehensive income by $145.5 million; management attributed the loss primarily to a stronger U.S. dollar against the euro. This translation effect is distinct from operating earnings.
Outlook, unusual items and risks
- Management described its 2018 outlook as positive: new-business sales growth is expected to exceed modest global vehicle-industry production growth. No specific full-year revenue or earnings guidance is stated in this filing. Longer-term growth drivers cited include turbocharger adoption, automated transmissions, variable cam and chain timing systems, and hybrid/electric vehicle products.
- Q2 included $31.2 million of restructuring expense; first-half restructuring expense was $38.7 million. The actions include a European emissions-business voluntary termination program, with approximately 140 employees accepting packages and about $25.3 million of Q2 severance expense. Further charges could be material. The company also recorded first-half merger, acquisition and divestiture expense of $3.2 million.
- The first-half effective tax rate was 19.4%, including one-time items and Tax Act measurement adjustments. Management estimated an approximately 26% effective tax rate for 2018 ongoing operations excluding non-comparable items. Tax adjustments contributed $0.21 per diluted share in both the Q2 and first-half non-comparable-item reconciliations; total listed non-comparable impacts were $0.11 per share for Q2 and $0.08 for the first half.
- The company announced it would restate 2015 and 2016 financial statements, and revise selected earlier-period information, following a reassessment of estimates for unasserted asbestos claims and defense costs. The filing states this restatement does not affect current-quarter or first-half 2018 results, or previously reported 2017 results.
- Asbestos liabilities were $799.9 million, with a recorded insurance receivable of $386.4 million. The company estimated reasonably possible additional asbestos losses of up to approximately $100 million through 2067. Insurance coverage is disputed in litigation, creating uncertainty around recoveries. Environmental liabilities accrued were $7.0 million.
- Other risks identified include vehicle-production and demand fluctuations, foreign exchange, acquisition integration, and potential U.S. or retaliatory tariffs that could affect input or selling costs. Management stated that liquidity sources should be sufficient for foreseeable operating needs and planned operations.
Important facts for investors to verify
- Review the forthcoming amended filings and disclosures concerning the asbestos-related restatement, including its effects on historical results and controls.
- Monitor asbestos claim assumptions, the $386.4 million insurance receivable and related coverage litigation, and any changes in estimated exposure.
- Track restructuring execution, potential additional charges, and whether Engine and Drivetrain margins improve or remain pressured.
- Assess working-capital trends, capital spending and cash conversion after the first-half decline in operating cash flow.
- Check the realization and sustainability of tax benefits underlying the reported first-half tax rate and 2018 outlook.
- Monitor tariffs, foreign exchange and vehicle-production conditions against management’s growth expectations.