BorgWarner Inc. 10-Q Summary: Quarter Ended September 30, 2006
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2006, and the nine-month period ended on the same date. BorgWarner Inc. is a global supplier of powertrain systems and components for light vehicles, commercial trucks, and off-highway vehicles. The company operates through two reportable segments: Engine (turbochargers, timing systems, emissions) and Drivetrain (transfer cases, torque management, transmission components). The company is a large accelerated filer with 57,551,060 shares of Common Stock outstanding as of the period end.
Key Financial Metrics
| Metric (Millions) | Q3 2006 | Q3 2005 | 9M 2006 | 9M 2005 |
|---|---|---|---|---|
| Net Sales | $1,059.8 | $1,050.9 | $3,383.7 | $3,245.8 |
| Gross Profit | $183.3 | $208.2 | $637.7 | $654.3 |
| Gross Margin | 17.3% | 19.8% | 18.8% | 20.2% |
| Operating Income | $60.6 | $90.5 | $262.4 | $232.8 |
| Net Earnings | $39.2 | $61.4 | $170.7 | $174.9 |
| Diluted EPS | $0.68 | $1.07 | $2.95 | $3.05 |
| Cash from Operations (9M) | $270.7 (2006) vs $260.8 (2005) | |||
| Total Debt (Current + Long-Term) | $763.0 (Sep 30, 2006) vs $739.9 (Dec 31, 2005) | |||
| Cash & Equivalents | $67.0 (Sep 30, 2006) vs $89.7 (Dec 31, 2005) |
Material Changes vs. Prior Period
- Revenue: Q3 net sales increased 0.8% year-over-year, driven by foreign currency impacts (+$30M) and growth in Asia-Pacific and Europe, offsetting an 8% decline in North American light-vehicle production. Nine-month sales rose 4.2%.
- Margins: Gross margins compressed significantly (17.3% in Q3 vs. 19.8% prior year) due to higher raw material costs (nickel, steel, copper, aluminum) totaling approximately $13M in Q3 and $25M for the nine months. Nickel was the primary driver.
- Restructuring: The company incurred a one-time $11.5 million restructuring expense in Q3 2006 (absent in Q3 2005) following a 13% reduction (approx. 850 jobs) in its North American workforce due to declining auto production. This included $6.7M in termination benefits and $4.8M in asset impairments.
- Acquisition: BorgWarner acquired the European Transmission and Engine Controls (ETEC) product lines from Eaton Corporation for $64.4 million (net of cash) in Q3 2006. This transaction is reflected in the balance sheet but had no impact on the Q3 income statement.
- Accounting Changes: The adoption of FAS 123R (Share-Based Payment) reduced net earnings by $2.5M in Q3 and $6.7M for the nine months ended September 30, 2006.
Guidance, Outlook, and Risks
- Outlook: Management remains cautious for the remainder of 2006 due to volatile commodity prices and weak North American light truck/SUV sales. Commodity cost increases are now projected at $40M for the full year (up $15M from prior guidance), with $25M already incurred.
- Cash Flow: The company expects net cash provided by operating activities to be approximately $425 million for the full year 2006. Capital spending is expected to range between $280M and $310M.
- Debt & Liquidity: The company maintains an investment-grade credit rating (A- from S&P, Baa2 from Moody's), though S&P revised its outlook to "negative" in late September 2006. A $139M senior note matures November 1, 2006, which management plans to refinance. The company has a $600M revolving credit facility with $90M outstanding.
- Legal & Contingencies:
- Asbestos Litigation: Approximately 50,000 pending claims exist. The company has accrued $34.8M in liabilities, fully offset by an insurance receivable of the same amount. Management expects 100% reimbursement from insurers.
- Environmental: An accrual of $14.9M exists for environmental liabilities, including a $5.2M accrual for the Crystal Springs site. A $44.4M settlement regarding this site was largely paid in 2005 and early 2006.
- Retiree Benefits: A subsidiary (DTP) is involved in litigation regarding a 2006 adjustment to retiree medical benefits. The company believes it has the right to adjust the plan.
Investor Verification Checklist
- Raw Material Hedging: Verify the effectiveness of commodity hedging programs given the significant nickel price volatility and the $40M full-year cost increase projection.
- North American Volume: Monitor North American light truck and SUV production schedules, as the Drivetrain segment is heavily exposed to this weakness.
- Refinancing Risk: Confirm the successful refinancing of the $139M senior notes maturing November 1, 2006, and monitor credit rating outlooks.
- Insurance Recovery: Review the status of the declaratory judgment action regarding asbestos insurance coverage to ensure the $34.8M receivable remains fully recoverable.
- Restructuring Savings: Track the realization of cost savings from the 13% North American workforce reduction to offset margin pressure.