BorgWarner Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Financial statements are unaudited. BorgWarner supplies engineered automotive powertrain systems and components through its Engine and Drivetrain segments. The Drivetrain segment includes Remy, acquired in November 2015.
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $2,329.2 million | $2,031.9 million | $4,597.8 million | $4,016.1 million |
| Gross profit / margin | $496.7 million / 21.3% | $429.0 million / 21.1% | $961.0 million / 20.9% | $858.0 million / 21.4% |
| Operating income | $269.4 million | $242.5 million | $533.6 million | $502.1 million |
| Net earnings attributable to BorgWarner | $164.4 million | $148.1 million | $328.5 million | $327.0 million |
| Diluted EPS | $0.76 | $0.65 | $1.51 | $1.44 |
Q2 reported sales rose 14.6%; excluding currency effects and Remy, sales increased approximately 3.5%. First-half reported sales rose 14.5%, with approximately 4.0% growth excluding those effects. Q2 gross margin improved year over year, but first-half gross margin declined. Q2 included a $7.5 million gain from the expiration of a Remy aftermarket customer contract. For the first half, adjusted EBIT was $644.8 million versus $601.5 million; reported net earnings attributable to BorgWarner were nearly flat year over year.
Segment trends: First-half Engine sales were $2,843.4 million, up 1.8% reported and approximately 3.6% excluding currency effects; Adjusted EBIT margin was 16.5% versus 16.4%. Drivetrain sales were $1,774.6 million, up 43.3% reported, largely reflecting Remy; excluding Remy and currency effects, sales rose approximately 5.1%. Drivetrain Adjusted EBIT margin declined to 10.0% from 11.6%, primarily due to Remy.
Cash flow, debt and liquidity
- First-half operating cash flow was $362.2 million, compared with $319.3 million. Investing cash outflow was $228.9 million, including $234.7 million of capital expenditures and tooling outlays. Financing cash outflow was $210.9 million; cash declined $82.7 million to $495.0 million.
- At June 30, 2016, short-term debt and notes payable were $515.3 million and long-term debt, net of current portion, was $2,119.5 million. Cash was $495.0 million. The company reported a 36.3% net-debt-to-net-capital ratio, up from 35.2% at year-end 2015.
- Cash included $485.1 million held outside the United States; repatriation could incur additional taxes. The $1 billion revolving facility (expandable to $1.25 billion) had no borrowings, and BorgWarner was in compliance with its debt-to-EBITDA covenant. Commercial paper outstanding was $270 million.
- Cash dividends declared were $0.13 per share quarterly. The company repurchased $183.8 million of treasury stock during the first half and stated that its liquidity sources were expected to support operations and its $1 billion share-repurchase program.
Outlook, commentary and notable items
- Management described the 2016 outlook as cautious: weak global vehicle-production growth was expected, partly offset by moderate net new-business sales growth; a stronger U.S. dollar could reduce reported foreign sales. Management maintained a positive long-term view, citing gasoline direct injection, automated transmissions, and variable cam and chain timing adoption.
- Ongoing-operation effective tax rate for 2016 was estimated at approximately 31%, excluding specified non-comparable items. The reported first-half effective tax rate was 32.1%.
- First-half expenses included $25.6 million of restructuring and $13.0 million of Remy transition and realignment costs. Management said Remy integration benefits and execution remain subject to risks; purchase accounting for the acquisition was not yet final.
- Warranty provisions were 0.8% of sales versus 0.3% in the comparable prior-year period, primarily reflecting Remy. The 2016 provision also included a $5.2 million reversal related to a Remy contract expiration.
- Risks include foreign-exchange movements, vehicle-production and demand changes, and Remy integration. Asbestos claims were approximately 9,300 at quarter-end. The company recorded $110.5 million of related liabilities and an equal insurance asset for unresolved claims, and expects recovery subject to ongoing insurer litigation; recovery timing is uncertain. It also reported $188.7 million in net past asbestos defense and indemnity costs expected to be recovered. Environmental accruals were $5.2 million. A continuing retiree-benefits class action has no reasonably estimable loss range; management said other ordinary-course claims were not expected to materially affect the company overall, though an individual quarter could be affected.
- A signed tax pricing agreement led to reclassification of an approximately $44 million uncertain tax benefit to current tax payable, which the company expected to pay in Q3 2016. Moody’s had revised its outlook to negative; S&P and Fitch outlooks were stable. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Most important facts for investors to verify
- How much of sales and earnings growth is sustainable organic growth versus Remy acquisition contribution and currency effects.
- Whether Drivetrain margins recover as Remy integration and restructuring progress, and whether the expected integration benefits are realized.
- Cash conversion, capital spending needs, debt levels and commercial-paper reliance, alongside the company’s share repurchases and liquidity commitments.
- Actual tax payment and cash impact from the approximately $44 million tax payable, and any changes to the estimated 2016 tax rate.
- Progress and eventual recoverability of asbestos-related insurance assets, including the pending litigation, and developments in the UAW retiree case and other contingencies.
- Whether warranty costs remain elevated and whether the contract-expiration gain and other non-recurring items affect comparisons in subsequent periods.