BorgWarner Inc. — 2019 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2019. This is an annual report, not a standalone fourth-quarter filing; selected Q4 figures are noted below. Unless stated otherwise, amounts are in U.S. dollars.
Business context
BorgWarner supplies propulsion and vehicle-efficiency technologies to global automakers and other customers. Its two reporting segments are Engine, including turbochargers, timing, emissions and thermal products, and Drivetrain, including transmission, all-wheel-drive and rotating electrical products. Approximately 83% of 2019 sales were for light vehicles. Ford and Volkswagen represented approximately 15% and 11% of sales, respectively.
Financial performance and liquidity
| Metric | 2019 | 2018 |
|---|---|---|
| Net sales | $10.168 billion | $10.530 billion |
| Gross profit / margin | $2.101 billion / 20.7% | $2.230 billion / 21.2% |
| Operating income / margin | $1.303 billion / 12.8% | $1.190 billion / 11.3% |
| Net earnings attributable to BorgWarner | $746 million | $931 million |
| Diluted EPS | $3.61 | $4.44 |
| Operating cash flow | $1.008 billion | $1.126 billion |
| Capital expenditures, including tooling | $481 million | $546 million |
| Cash and cash equivalents, year-end | $832 million | $739 million |
| Total debt, selected financial data | $1.960 billion | $2.114 billion |
Revenue declined 3.4% year over year; excluding foreign-exchange effects and the net impact of acquisitions and divestitures, it increased 0.7%. Cost of sales rose to 79.3% of sales from 78.8%, and gross margin narrowed by 0.5 percentage points. Management cited lower revenue, tariffs and supplier cost reductions that did not keep pace with customer price deflation. Operating income increased despite lower sales, principally reflecting the unusual gain on derecognition of a subsidiary described below. Segment Adjusted EBIT, a non-GAAP measure, fell to $1.438 billion from $1.515 billion.
Engine sales were $6.214 billion and Adjusted EBIT was $995 million, down 3.6% and 4.3%, respectively. Drivetrain sales were $4.015 billion and Adjusted EBIT was $443 million, down 3.0% and 6.7%. Segment Adjusted EBIT margins were 16.0% for Engine and 11.0% for Drivetrain; Drivetrain margin was pressured by launch costs.
Year-end current assets were $3.836 billion and current liabilities were $2.329 billion. The company had a $1.2 billion revolving credit facility and a $1.2 billion commercial-paper program, with no borrowings outstanding under either at year-end; their combined borrowing capacity is capped at $1.2 billion. The company reported compliance with its debt-to-EBITDA covenant. Standard & Poor’s and Fitch rated the debt BBB+ and Moody’s rated it Baa1; following the Delphi announcement, S&P placed the company on CreditWatch negative and Moody’s changed its outlook to negative.
Q4 2019 sales were $2.559 billion versus $2.574 billion in Q4 2018; net earnings attributable to BorgWarner were $220 million versus $230 million, and diluted EPS was $1.06 versus $1.10.
Material changes and unusual items
- Net earnings fell 19.9% and diluted EPS fell 18.7%. The effective tax rate increased to 37% from 17.7%; management attributed the 2019 rate in part to a $173 million tax expense from reversing deferred tax assets associated with Morse TEC and tax-law adjustments. Management estimated a 26% effective rate for ongoing operations, excluding specified non-comparable items.
- In October 2019, BorgWarner transferred Morse TEC, which held asbestos-related liabilities and related insurance assets, to Enstar and contributed approximately $172 million in cash to the subsidiary. The transaction generated a $177 million pretax accounting gain, offset by $173 million of tax expense, for a $4 million after-tax gain. The company removed the related asbestos balances from its balance sheet and stated it had no obligation for previously recorded liabilities following the transfer. The agreement includes an indemnity from Morse TEC to BorgWarner.
- 2019 non-comparable items reduced diluted EPS by a net $0.52, including restructuring expense ($0.26), pension settlement loss ($0.10), unfavorable arbitration loss ($0.07), and merger, acquisition and divestiture costs ($0.05); the Morse TEC gain added $0.02 per share.
- Restructuring expense was $72 million in 2019. The company expects primarily cash restructuring costs of $275–$300 million through 2023 and annual savings of approximately $90–$100 million by 2023.
- Cash flow from operations declined by $118 million; management cited cash outflow related to the Morse TEC derecognition, partly offset by working-capital changes. Financing cash use increased to $420 million, principally due to higher debt repayments.
Outlook, risks and contingencies
Management described its 2020 outlook as cautious, expecting flat to modestly declining revenue excluding foreign-currency effects and the net impact of acquisitions and divestitures, as new-business growth is partly offset by declining global vehicle production. Long-term growth drivers cited include turbocharger adoption, automated transmissions, all-wheel drive, and hybrid and electric vehicle products. Long-term R&D spending is expected to remain 4%–4.5% of sales.
On January 28, 2020, after year-end, BorgWarner agreed to acquire Delphi Technologies in an all-stock transaction valued at approximately $3.3 billion. The transaction was expected to close in the second half of 2020, subject to shareholder, regulatory and other conditions. Delphi shareholders would receive 0.4534 BorgWarner shares per share; existing BorgWarner shareholders were expected to own approximately 84% of the combined company. Management expected to fund associated fees and expenses with available cash.
Key disclosed risks include automotive production cyclicality and global economic weakness; customer concentration and OEM pricing pressure; tariffs, commodity costs and supplier interruptions; foreign-exchange exposure and international operations; shifts away from diesel and the need to adapt to electrification and other technologies; cybersecurity and IT disruptions; product warranty, environmental and legal claims; pension funding sensitivity; and successful completion and integration of the Delphi acquisition. The filing also reports an SEC investigation, opened in 2018, concerning historical accounting for asbestos claims not yet asserted; BorgWarner stated it was cooperating. At year-end, it reported environmental accruals of $3 million and potential responsibility at 14 hazardous-waste sites. The auditor issued an unqualified opinion on the financial statements and internal control; worldwide income taxes were identified as a critical audit matter.
Most important facts for investors to verify
- Whether Delphi Technologies’ approvals, regulatory conditions, closing timeline, financing implications and expected strategic benefits were realized.
- Whether restructuring costs, timing and projected annual savings track management’s $275–$300 million and $90–$100 million estimates.
- How much of 2019 earnings and operating-income growth reflects recurring performance versus unusual transactions, tax items and other non-comparable adjustments; review the GAAP-to-non-GAAP reconciliations.
- Whether the Morse TEC transfer and indemnity fully resolve BorgWarner’s asbestos exposure, and the status and potential consequences of the SEC investigation.
- How global production, tariffs, customer price reductions, launch costs and currency movements affect sales, segment margins and cash generation.
- Debt maturities, cash availability, ratings outlook and liquidity needs after the planned acquisition; also monitor warranty accruals and pension obligations.