BorgWarner Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. Comparisons are with Q1 2017 unless noted. BorgWarner supplies vehicle components and systems globally through its Engine and Drivetrain segments.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $2,784.3 million | $2,407.0 million | +15.7%; approximately +6.6% excluding foreign exchange and Sevcon acquisition |
| Gross profit / margin | $591.8 million / 21.3% | $516.3 million / 21.4% | Margin down 0.1 percentage point |
| Operating income | $333.5 million | $291.5 million | +14.4% |
| Net earnings attributable to BorgWarner | $225.1 million | $189.2 million | +19.0% |
| Diluted EPS | $1.07 | $0.89 | +20.2% |
| Operating cash flow | $34.7 million | $60.3 million | Down $25.6 million |
| Capital expenditures, including tooling | $160.4 million | $130.9 million | Up $29.5 million |
Operating cash flow less capital expenditures was approximately negative $125.7 million, compared with negative $70.6 million in Q1 2017. Management attributed lower operating cash flow principally to working-capital changes. Cash fell to $409.7 million from $545.3 million at December 31, 2017.
At March 31, 2018, short-term debt was $194.0 million and long-term debt was $2,131.5 million, for total reported debt of approximately $2,325.5 million. Net debt was approximately $1,915.8 million; the net-debt-to-net-capital ratio rose to 32.3% from 30.0% at year-end. The company reported $1.2 billion of combined capacity under its revolving credit facility and commercial paper program, with $80.0 million outstanding under commercial paper and no revolver borrowings. It was in compliance with its debt-to-EBITDA covenant.
Segments and material changes
- Engine: Sales were $1,716.1 million, up 14.8% reported and approximately 4.9% excluding foreign exchange and acquisition effects. Adjusted EBIT was $280.2 million; margin declined to 16.3% from 16.5%, mainly due to emissions-business operating inefficiencies.
- Drivetrain: Sales were $1,082.9 million, up 17.1% reported and approximately 9.2% excluding foreign exchange and acquisition effects. Adjusted EBIT was $121.0 million; margin declined to 11.2% from 11.3%, primarily reflecting the Sevcon acquisition.
- Both segments’ sales benefited from stronger foreign currencies and acquisition activity. Management cited higher Engine sales of light-vehicle turbochargers, thermal products and timing systems, and higher Drivetrain sales of all-wheel-drive systems and transmission components.
- Net R&D spending increased to $116.7 million from $96.4 million. SG&A was $253.4 million versus $219.0 million, while remaining 9.1% of sales.
Outlook, risks and unusual items
- Management described its 2018 outlook as positive. It expects net new-business sales growth to exceed modest global vehicle-industry production growth. The filing gives no quantified full-year revenue or earnings guidance.
- Longer-term growth drivers cited include turbocharger adoption, automated transmissions, variable cam and chain timing systems, and hybrid and electric vehicle products. Management intends to continue product-development and strategic capital investment.
- Q1 included $7.5 million of restructuring expense, chiefly related to Engine emissions actions and Drivetrain footprint rationalization, and $2.2 million of acquisition/divestiture-related expense. A roughly $4 million commercial-settlement gain partly offset these items. Further restructuring charges for the remaining European emissions business could be material.
- The company continued efforts to sell non-core pipes and thermostat product lines. They remained classified as held for sale; no impairment was recorded in Q1 2018. A $71.0 million impairment had been recorded in 2017.
- Asbestos liabilities were $813.6 million, with a recorded insurance receivable of $386.4 million. The company estimated reasonably possible additional asbestos losses of up to approximately $100 million beyond recorded amounts. Insurance recoveries remain subject to disputes and litigation. Environmental liabilities accrued were $8.3 million.
- Management said ordinary commercial and legal claims are not expected to materially affect consolidated results, financial position or cash flows, though an adverse outcome could be material in a particular quarter. Other risks include vehicle-production and demand fluctuations, economic conditions, foreign-exchange exposure, and acquisition integration and benefits.
- The effective tax rate was 28.6%; excluding non-comparable items, management estimated an approximately 28% annual effective tax rate for 2018. Accounting for certain Tax Cuts and Jobs Act effects remained provisional, with no adjustment recorded in Q1.
- Revenue recognition guidance was adopted January 1, 2018 using the modified retrospective method; management expected ongoing effects on sales and net income to be immaterial. The adoption increased opening retained earnings by a net $1.9 million.
Important facts for investors to verify
- Whether underlying sales growth excluding currency and Sevcon continues, and whether segment margins recover from Q1 declines.
- How working capital, elevated capital spending and cash conversion develop through the year.
- Progress on emissions restructuring and the planned divestiture of the pipes and thermostat businesses, including any further charges.
- Changes in asbestos claim estimates, potential additional losses, insurance disputes and collection of the recorded insurance receivable.
- Debt, net-debt-to-net-capital ratio, access to liquidity and compliance with the credit covenant.
- Whether provisional tax estimates or other accounting estimates change in later filings.