BorgWarner Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. Amounts are in U.S. dollars; financial statement figures are in millions unless stated otherwise. BorgWarner supplies engineered automotive powertrain systems and components through its Engine and Drivetrain segments.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $1,856.4 | $1,818.8 | $3,768.9 | $3,549.2 |
| Gross profit | $383.2 | $357.1 | $779.0 | $699.9 |
| Gross margin | 20.6% | 19.6% | 20.7% | 19.7% |
| Operating income | $193.5 | $228.3 | $419.2 | $407.6 |
| Net earnings attributable to BorgWarner | $120.6 | $162.0 | $278.6 | $286.5 |
| Diluted EPS | $1.00 | $1.31 | $2.28 | $2.30 |
Q2 sales rose 2.1% year over year; six-month sales increased 6.2%. Management said sales growth excluding currency effects and specified acquisitions or dispositions was approximately 10% for Q2 and 11% for the first half. Q2 operating margin was approximately 10.4%, versus 12.6% a year earlier; the comparison was affected by a disposal write-down in 2012 and a patent-settlement gain in 2011. For the first half, operating margin was approximately 11.1%, versus 11.5%.
- Segments: Q2 Engine sales were $1,269.6, down 2.2% reported, while Drivetrain sales were $593.9, up 13.0%. Adjusted EBIT margins improved to 16.6% from 15.2% for Engine and 9.2% from 7.4% for Drivetrain. First-half adjusted EBIT was $536.1, up from $454.2.
- Cash flow: First-half operating cash flow was $310.1, compared with $249.6. Investing cash outflow was $184.3, including capital expenditures and tooling of $188.4. Operating cash flow less capital expenditures was approximately $121.7, a derived measure. Cash increased $122.3 to $481.9.
- Liquidity and debt: Current assets were $2,420.5 and current liabilities $1,513.3 (current ratio approximately 1.6). Total debt was approximately $1,153.2, versus $1,329.1 at year-end 2011; cash was $481.9. Management reported debt net of cash to capital of 18.6%, down from 28.3%. The $650 revolving facility had $280 outstanding; the company reported covenant compliance and expected continued compliance.
- Other: The reported weighted-average interest rate on borrowings was 3.9%, down from 5.9% at year-end 2011. The company estimated its 2012 annual effective tax rate at approximately 29%; ongoing-business rate was raised from 26% to 27%.
Material changes and unusual items
- In Q2 BorgWarner signed an agreement to sell its spark plug business to Federal-Mogul. It recorded a $37.9 loss, primarily a write-down of purchase-accounting adjustments, and expected to close the sale in Q3 2012, with additional restructuring-related costs anticipated.
- The prior-year comparison included a $29.1 net gain from a patent-infringement settlement with Honeywell. Management’s non-comparable-item analysis estimated these items and tax adjustments reduced diluted EPS by $0.36 in Q2 2012 versus a $0.19 benefit in Q2 2011; for the first half, the respective impacts were a $0.33 reduction and a $0.19 benefit.
- The 3.50% convertible notes were settled in April using approximately 11.4 million treasury shares. BorgWarner also settled the call-option portion of the associated bond hedge, receiving approximately 6.5 million shares. It reported a July 2012 settlement of half the remaining warrants, with the rest scheduled to mature through October.
- First-half share repurchases were $200.3. The board increased the repurchase authorization to 24.8 million shares; 4.6 million authorized shares remained available at June 30.
Outlook, risks and contingencies
Management described its 2012 outlook as generally positive despite weakening global economic conditions. It expected global vehicle production to increase from 2011, with European production declining, and anticipated BorgWarner sales growth above global production growth due to wider adoption of its products. It cited fuel-efficiency and emissions trends, product development, and strategic investment as long-term growth drivers. The filing provides no numerical full-year sales or earnings guidance.
- Approximately $476.9 of the $481.9 cash balance was held by foreign subsidiaries. Repatriating funds could trigger additional taxes; the company changed its repatriation assumptions for some subsidiaries and recorded a $9.0 tax expense.
- About 16,000 asbestos-related claims were pending. The company accrued $67.4 for asserted but unresolved claims and recorded a matching insurance asset, while recovery of $132.3 relating to prior costs depends on insurer litigation or settlements. Management could not estimate potential losses beyond amounts accrued.
- Environmental liabilities were accrued at $4.6 for 35 identified sites. A retiree-benefit class action remained pending, and the company said it could not reasonably estimate a potential loss. Management did not expect the disclosed claims to have a material adverse effect, but noted uncertainty in outcomes.
- Other risks include changes in vehicle production and demand, general economic conditions, foreign exchange movements, and other risks described in the company’s prior Form 10-K. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Completion timing and final proceeds for the spark plug sale, plus the amount and timing of related restructuring costs.
- Whether operating performance and segment margins remain strong after separating recurring results from the disposal charge, prior-year settlement gain, currency effects, and portfolio changes.
- Cash availability and tax consequences associated with foreign-held funds, as well as debt levels, revolver usage, and covenant headroom.
- Developments in asbestos insurance recovery and pending litigation, including the difference between recorded liabilities and potential additional exposure.
- Actual 2012 vehicle production, especially in Europe, and whether sales growth continues to exceed industry production growth.