BorgWarner Inc. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011. BorgWarner supplies engineered automotive powertrain systems and components through its Engine and Drivetrain segments. Figures are in millions of dollars except per-share data.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Net sales | $1,818.8 | $1,421.7 | $3,549.2 | $2,708.5 |
| Gross profit / margin | $357.1 / 19.6% | $275.4 / 19.4% | $699.9 / 19.7% | $513.9 / 19.0% |
| Operating income | $228.3 | $117.3 | $407.6 | $223.9 |
| Net earnings attributable to BorgWarner | $162.0 | $82.8 | $286.5 | $159.0 |
| Diluted EPS | $1.31 | $0.68 | $2.30 | $1.31 |
- Q2 sales rose 27.9%; management said growth was approximately 15% excluding Haldex and favorable currency effects (about $135 million). First-half sales rose 31.0%, or approximately 20% excluding Haldex, Dytech and currency effects (about $141 million).
- Q2 gross margin improved 0.2 percentage points; first-half gross margin improved 0.7 points. Management attributed the improvement chiefly to better manufacturing-cost leverage and cost management.
- First-half cash from operations was $249.6, versus $208.3 in 2010. Investing used $356.0, including $159.9 of capital expenditures and $203.7 paid for Haldex. Cash declined $77.5 to $372.4. Operating cash flow less capital expenditures was $89.7.
- At June 30, current assets were $2,305.7 and current liabilities $1,936.6. Total debt, including short-term debt and current maturities, was approximately $1,448.9; cash was $372.4. Debt-to-capital was 36.7%, versus 33.8% at year-end 2010.
- Engine segment Q2 sales were $1,297.9 and Adjusted EBIT $197.2; Drivetrain sales were $525.7 and Adjusted EBIT $38.9. First-half Drivetrain Adjusted EBIT declined 4.2% despite higher sales.
Changes, unusual items and management commentary
- On January 31, 2011, BorgWarner acquired Haldex Traction Systems for consideration of $214.9, expanding its all-wheel-drive product portfolio. The business is included in Drivetrain.
- Q2 2011 included a $29.1 net gain from settling patent litigation with Honeywell; Q2 2010 included a $28.0 environmental-litigation charge and an $8.0 BERU-Eichenauer acquisition gain. Management identified these and tax adjustments as nonrecurring or non-comparable items; their net disclosed diluted-EPS impact was $0.19 in 2011 and $(0.10) in 2010.
- SG&A increased in dollars but declined as a share of sales. Net R&D expense rose 40.3% in Q2 to $64.7 and 42.2% in the first half to $125.7 as the company continued product-development investment.
- Interest expense and finance charges increased, primarily because of higher debt levels. The estimated 2011 annual effective tax rate was 23.7%; management estimated about 24% for ongoing operations, above 2010’s 22%, primarily due to greater profitability in higher-tax jurisdictions.
- The company amended and extended its revolving credit facility on June 30: capacity increased to $650, with an accordion feature up to $1 billion, and maturity extends to June 30, 2016. Borrowings were $225.0; the company reported covenant compliance and expected continued compliance.
Outlook, risks and contingencies
- Management’s 2011 outlook was positive: it expected global vehicle production to exceed 2010 levels and BorgWarner sales growth to outpace production growth. No specific revenue or earnings guidance range was provided.
- Longer-term growth drivers cited include greater adoption of direct-injection engines, automated transmissions, and variable cam and chain timing systems. Management said cash, operating cash flow, available credit and shelf capacity should meet foreseeable operating and planned needs.
- Risks include changes in vehicle production and demand, economic conditions, events in Japan, and execution of growth and acquisition plans. These forward-looking statements are subject to uncertainties and are not guarantees of results.
- Environmental liabilities accrued were $12.3, with most expected to be paid over three to five years. Approximately 16,000 asbestos-related claims were pending; the company expects substantial insurance recovery but notes recovery timing depends on insurer disputes and settlements. A retiree-benefits class action continues, and potential loss could not be reasonably estimated.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the period; integration review of Haldex controls was ongoing.
Most important facts for investors to verify
- How much of reported sales growth and margin improvement is organic and sustainable after acquisition and currency effects?
- Whether Drivetrain profitability improves, and whether Haldex delivers expected growth and returns.
- Cash conversion and working-capital trends, given increased receivables and inventory and substantial acquisition and capital spending.
- Debt and refinancing exposure, especially the $358.3 carrying value of convertible notes due April 2012, and compliance with credit-facility covenants.
- Whether the Honeywell settlement and tax adjustments distort comparisons with ongoing earnings, and whether asbestos-insurance recoveries and other contingencies develop as management expects.