BorgWarner Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; financial statements are unaudited. BorgWarner supplies automotive technologies globally through its Engine and Drivetrain segments.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $2,389.7 million | $2,329.2 million | $4,796.7 million | $4,597.8 million |
| Gross profit; margin | $514.2 million; 21.5% | $496.7 million; 21.3% | $1,031.5 million; 21.5% | $961.0 million; 20.9% |
| Operating income | $299.5 million | $269.4 million | $592.2 million | $533.6 million |
| Net earnings attributable to BorgWarner | $212.0 million | $164.4 million | $401.2 million | $328.5 million |
| Diluted EPS | $1.00 | $0.76 | $1.89 | $1.51 |
Q2 sales rose 2.6% year over year; excluding the Remy aftermarket divestiture and weaker foreign currencies, management reported growth of approximately 7.8%. First-half sales rose 4.3%, or approximately 10.2% on the same adjusted basis. First-half operating cash flow was $399.2 million, versus $362.2 million. Capital expenditures, including tooling, were $254.2 million; operating cash flow less these expenditures was $145.0 million (calculated). Cash declined to $387.1 million from $443.7 million at year-end.
At June 30, cash was $387.1 million; short-term debt and notes payable were $141.8 million, and long-term debt was $2,077.9 million. Reported net debt to net capital was 33.2%, down from 35.0% at December 31, 2016. Current assets were $3,193.2 million and current liabilities $2,106.1 million. The company had no borrowings under its revolving credit facility and reported covenant compliance.
Changes and segment results
- Gross margin improved year over year, with management citing slightly lower conversion costs from improved productivity. First-half cost of sales fell to 78.5% of sales from 79.1%.
- SG&A rose to $215.0 million in Q2 and $433.8 million for the first half, mainly reflecting higher R&D and, for the first half, stock-based compensation and other employee costs. First-half net R&D spending increased to $201.3 million from $170.3 million.
- Engine segment sales increased 2.6% in Q2 and 4.7% in the first half; adjusted EBIT margins were 16.5% in both Q2 periods and 16.5% versus 16.7% for the first half.
- Drivetrain sales increased 2.9% in Q2 and 4.0% in the first half. Adjusted EBIT margin rose to 11.9% from 10.6% in Q2 and to 11.6% from 10.2% for the first half. Management attributed improvement partly to the Remy aftermarket divestiture and conversion on higher sales.
- Q2 2016 included $19.2 million of restructuring and $7.2 million of Remy-related costs; first-half 2016 included $25.6 million and $13.0 million, respectively. The 2016 periods also included a $7.5 million contract-expiration gain. First-half 2017 included a $5.3 million lease-termination loss.
Outlook, liquidity and risks
- Management described the 2017 outlook as positive: net new business and product penetration are expected to drive growth above modest global vehicle-industry production growth, partly offset by a stronger U.S. dollar. No numerical full-year sales or earnings guidance is provided in the filing text.
- Management estimated an approximately 29% full-year 2017 effective tax rate excluding non-comparable items; the first-half reported rate was 27.9%, including $6.6 million of one-time tax benefits.
- The revolving credit facility was amended and extended to $1.2 billion, with an accordion feature up to $1.5 billion, through June 29, 2022. The company said cash, operating cash flow, available credit and shelf capacity should meet foreseeable needs. $381.8 million of cash was held outside the U.S.; repatriation could incur additional taxes.
- Asbestos liabilities were estimated at $852.7 million, including claims and estimated defense costs through 2067; the company separately reported $386.4 million of insurance assets/estimated available coverage. The estimate is subject to significant legal, claims and insurance uncertainties. The company had 9,292 pending asbestos claims at June 30.
- Environmental accruals were $6.0 million for 27 sites. Management did not expect environmental matters or other ordinary-course claims to have a material overall adverse effect, but acknowledged a particular quarter could be affected. Warranty accruals were $110.9 million, and actual claims may differ from estimates.
- On July 17, 2017, BorgWarner agreed to acquire Sevcon, an electrification technology company, for expected enterprise value of approximately $200 million; closing was expected in Q4 2017, subject to customary conditions and approvals.
- Foreign exchange, vehicle production and demand, acquisition integration, and competitive and economic conditions are identified risks. The company said its disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether sales growth and margins persist after separating currency effects, the Remy divestiture and prior-period unusual items.
- Whether working-capital needs, capital investment and cash generation remain consistent with the company’s liquidity expectations.
- Changes in asbestos claim experience, liability assumptions, insurance recoveries and the status of insurer litigation.
- Completion, cost and integration implications of the Sevcon acquisition.
- The eventual effects of adopting the new revenue-recognition standard, particularly for tooling and engineering recoveries and contracts with cancellation or pricing provisions.