BorgWarner Inc. — Q2 2015 Form 10-Q
Business context and period: BorgWarner supplies engineered automotive powertrain systems and components to global vehicle manufacturers and aftermarket customers. This unaudited filing covers the three and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods. Its reporting segments are Engine and Drivetrain.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $2,031.9 million | $2,197.0 million | $4,016.1 million | $4,281.1 million |
| Gross profit / margin | $429.0 million / 21.1% | $472.8 million / 21.5% | $858.0 million / 21.4% | $918.6 million / 21.5% |
| Operating income | $242.5 million | $280.6 million | $502.1 million | $513.8 million |
| Net earnings attributable to BorgWarner | $148.1 million | $190.2 million | $327.0 million | $349.3 million |
| Diluted EPS | $0.65 | $0.83 | $1.44 | $1.52 |
| Operating cash flow | — | $319.3 million | $326.2 million | |
| Capital expenditures, including tooling | — | $285.0 million | $257.3 million |
Q2 sales fell 7.5% reported, but increased approximately 4% excluding mainly adverse foreign-currency effects. First-half sales fell 6.2% reported; excluding currency and the Wahler and BERU Diesel acquisitions, sales increased approximately 4%. Q2 cost of sales rose to 78.9% of sales from 78.5%; first-half cost of sales was 78.6% versus 78.5%.
Q2 Adjusted EBIT was $300.1 million, down from $330.8 million. Engine Adjusted EBIT margin held at 16.1%; Drivetrain margin declined to 11.5% from 12.6%. For the first half, segment margins were 16.4% for Engine (16.3% prior year) and 11.6% for Drivetrain (12.2% prior year).
Financial position and material changes
- Cash was $1,107.9 million at June 30, 2015, up from $797.8 million at year-end 2014. Cash held outside the U.S. was $681.2 million; repatriation could create additional taxes.
- Short-term debt was $72.1 million and long-term debt, net of current portion, was $1,731.7 million. The company issued $1.0 billion of senior notes in March: $500 million due 2025 at 3.375% and $500 million due 2045 at 4.375%. The reported net debt-to-net capital ratio increased to 15.6% from 12.8%.
- The company had no borrowings under its $1 billion revolving credit facility or commercial paper program at quarter-end; it reported compliance with its debt-to-EBITDA covenant and expected continued compliance. Ratings were Moody’s Baa1, S&P BBB+ and Fitch BBB+, all with stable outlooks.
- First-half investing cash outflow was $295.1 million, versus $361.7 million in 2014, principally reflecting the prior-year Wahler acquisition, partly offset by higher capital spending. Financing cash inflow was $322.1 million, principally reflecting the note issuance. Cash increased $310.1 million in the first half.
- First-half foreign-currency translation reduced other comprehensive income by $165.6 million, mainly reflecting the stronger U.S. dollar against the euro. Q2 translation adjustments were positive $84.2 million.
Outlook, commentary and notable items
- Management characterized its 2015 outlook as cautious, anticipating weak global vehicle-production growth, with strong net new business-related sales growth partly offset by a stronger U.S. dollar. No numerical full-year sales or earnings guidance is provided in the filing text.
- Management cited long-term growth drivers including global adoption of gasoline direct injection, automated transmissions in Europe and Asia-Pacific, and variable cam and chain timing systems. It said continued R&D and strategic capital investment remain important.
- Management estimated ongoing 2015 annual effective tax rate at approximately 29.5%, excluding identified non-comparable items. First-half reported effective tax rate was 30.6%.
- Restructuring expense was $19.9 million in Q2 and $32.0 million for the first half, compared with $15.0 million and $54.5 million, respectively, in 2014. Management estimated additional restructuring expense of approximately $13 million over the next year for Drivetrain and $14 million over the next two years for Engine. A $10.8 million first-half gain resulted from acquiring the remaining 51% of BERU Diesel.
- On July 13, 2015, after quarter-end, BorgWarner agreed to acquire Remy International for $29.50 per share in cash, implying enterprise value of approximately $1.2 billion. Closing was expected in Q4 2015, subject to customary conditions, including shareholder and regulatory approvals.
- Contingencies include approximately 12,000 pending asbestos-related claims. The company reported $169.3 million of net past defense and indemnity costs expected to be recovered from insurers, plus $113.0 million in recorded claims liabilities matched by insurance assets; recovery timing depends on insurance litigation, expected to continue beyond June 30, 2016. A California appellate ruling in July 2015 struck $32.5 million in punitive damages from a prior asbestos verdict; the litigation outcome remains uncertain. Environmental accruals were $5.5 million, with payment expected substantially over five years.
- Management stated that adverse outcomes in ordinary commercial and legal matters are not expected to materially affect consolidated results, position or cash flows, though a particular quarter could be affected. Loss exposure in the ongoing retiree-benefits litigation could not be reasonably estimated.
Important facts for investors to verify
- Whether underlying sales growth and Engine performance can offset Drivetrain weakness, currency pressure and reduced reported earnings.
- Remy transaction approvals, closing, financing, integration costs and realization of expected strategic benefits.
- Debt and interest-cost effects following the $1.0 billion note issuance, along with liquidity, covenant compliance and planned share repurchases.
- Actual restructuring spending and progress against management’s estimated future charges.
- Asbestos insurance recoveries, litigation developments and whether recorded liabilities and matching insurance assets remain appropriate.