BorgWarner Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with Q1 2018 unless noted. BorgWarner supplies automotive components and systems globally through its Engine and Drivetrain segments, primarily to vehicle manufacturers.
Financial performance
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Net sales | $2.566 billion | $2.784 billion |
| Gross profit / margin | $519 million / 20.2% | $591 million / 21.2% |
| Operating income | $264 million | $333 million |
| Net earnings attributable to BorgWarner | $160 million | $225 million |
| Diluted EPS | $0.77 | $1.07 |
| Operating cash flow | $40 million | $35 million |
| Capital expenditures, including tooling | $117 million | $160 million |
- Reported sales fell 7.8%; excluding weaker foreign currencies, sales declined approximately 3.3%. Cost of sales rose to 79.8% of sales from 78.8%, and SG&A was $226 million versus $253 million.
- Segment sales and adjusted EBIT both declined: Engine sales were $1.598 billion and adjusted EBIT $241 million; Drivetrain sales were $982 million and adjusted EBIT $105 million. Adjusted EBIT margins fell to 15.1% for Engine and 10.7% for Drivetrain, from 16.3% and 11.2%, respectively.
- Cash and restricted cash totaled $517 million at quarter-end, including $494 million cash and $23 million restricted cash. Cash and restricted cash decreased $222 million during the quarter.
- Debt at March 31 was $164 million of notes payable and short-term debt plus $1.923 billion of long-term debt. Net debt to net capital was 26.6%, compared with 24.0% at year-end 2018. The company reported $1.2 billion of combined revolving-credit/commercial-paper capacity, with no borrowings under either program, and was in compliance with its debt covenant.
Material changes and unusual items
- Sales declines reflected weaker vehicle industry volumes and currency effects. Management attributed lower gross margin primarily to lower revenue, material-price inflation, and recently enacted tariffs. Segment results also faced supplier-insolvency costs in Engine and launch costs in Drivetrain.
- Other expense was $29 million, including $14 million of restructuring expense and a $14 million charge for a final unfavorable arbitration decision relating to a prior acquisition. Q1 2018 other expense was $5 million and included a $4 million commercial settlement gain.
- The effective tax rate was 34.7%, including a $22 million tax expense from final U.S. transition-tax regulations. Excluding identified non-comparable items, management estimated an approximately 26% annual effective tax rate for 2019. Management estimated non-comparable items reduced Q1 2019 diluted EPS by $0.22.
- The company adopted lease accounting on January 1, 2019, recording approximately $104 million of right-of-use assets and $103 million of lease liabilities, with no effect on earnings or cash flows.
- BorgWarner acquired Rinehart Motion Systems and AM Racing for approximately $15 million to expand specialty electric and hybrid propulsion capabilities. It also completed the sale of its thermostat product lines on April 1, 2019, after quarter-end; $23 million of proceeds received before closing was restricted at March 31.
Outlook, risks, and contingencies
- Based on the midpoint of guidance, management expected flat 2019 revenue growth excluding foreign currency and the net impact of acquisitions and divestitures, with new-business sales growth expected to offset declining global vehicle production. The filing provides no clear numerical full-year revenue or earnings guidance in the supplied text.
- Management cited long-term opportunities in turbochargers, automated transmissions, variable cam technology, and hybrid and electric vehicles, while noting commitment to product development and strategic investment.
- Key risks include cyclical automotive and truck production, reliance on major OEM customers, commodity prices and availability, supply disruptions, foreign exchange and interest-rate movements, global economic uncertainty, information systems, and legal and regulatory matters.
- Asbestos liabilities were estimated at $795 million at March 31, 2019, with estimated insurance coverage of $386 million; the company disclosed possible additional losses of up to approximately $100 million. Insurance coverage remains subject to disputes and litigation. The SEC is investigating the company’s accounting for asbestos claims not yet asserted; BorgWarner said it is cooperating.
- Environmental accruals were $9 million for 28 sites. Management did not expect environmental or other ordinary-course claims to have a material adverse effect, while noting outcomes are uncertain. Additional Engine restructuring charges could be material.
Important facts for investors to verify
- Whether the expected offset from new business to declining vehicle production supports the flat organic revenue outlook, particularly given Q1 volume declines across both segments.
- How much of the lower earnings reflects recurring operating pressure versus the arbitration charge, restructuring, and transition-tax adjustment.
- Cash conversion, working-capital needs, planned investment, and capital returns; Q1 operating cash flow was $40 million while cash and restricted cash fell by $222 million.
- Developments in the SEC asbestos-accounting investigation, insurance-coverage litigation, and any changes to recorded asbestos liabilities or recoveries.
- Completion and final purchase accounting for the acquisition, and the financial impact of the thermostat divestiture.