BorgWarner Inc. 10-Q Summary: Period Ended June 30, 2006
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2006, and the six months ended on that date. BorgWarner Inc. is a global supplier of highly engineered systems and components for powertrain applications, serving original equipment manufacturers (OEMs) and the aftermarket. The company operates through two reportable segments: Engine (turbochargers, timing systems, emissions) and Drivetrain (transfer cases, torque management, transmission components). Effective January 1, 2006, an operating facility was reclassified from the Engine segment to the Drivetrain segment.
Key Financial Metrics
| Metric (in millions) | Q2 2006 | Q2 2005 | 6 Months 2006 | 6 Months 2005 |
|---|---|---|---|---|
| Net Sales | $1,168.7 | $1,111.4 | $2,323.9 | $2,194.9 |
| Gross Profit | $231.1 | $232.4 | $454.4 | $446.1 |
| Gross Margin | 19.8% | 20.9% | 19.6% | 20.3% |
| Operating Income | $107.5 | $58.7 | $201.8 | $142.3 |
| Net Earnings | $70.2 | $35.9 | $131.5 | $113.5 |
| Diluted EPS | $1.21 | $0.63 | $2.27 | $1.99 |
| Cash from Operations (6mo) | $233.2 (2006) vs $186.1 (2005) | |||
| Total Debt (Current + Long-Term) | $685.8 (June 30, 2006) vs $740.5 (Dec 31, 2005) | |||
| Cash & Equivalents | $67.2 (June 30, 2006) vs $89.7 (Dec 31, 2005) |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 5.2% in Q2 and 5.9% for the six months ended June 30, 2006, driven by strong demand in Asia-Pacific and Europe, despite flat North American light-vehicle production in Q2.
- Profitability: Net earnings doubled in Q2 2006 compared to Q2 2005. This improvement is largely due to the absence of a $45.5 million litigation settlement charge (Crystal Springs) recorded in Q2 2005 and improved operating results.
- Margin Pressure: Gross margins declined slightly due to higher raw material costs (steel, copper, aluminum, nickel) totaling approximately $6.1 million in Q2 and $11.9 million for the six months. Cost reduction programs partially offset these increases.
- Segment Performance: The Engine segment saw sales and EBIT growth in both periods. The Drivetrain segment experienced flat sales but lower EBIT due to lower U.S. light truck/SUV production and higher material costs.
- Accounting Changes: The company adopted FAS 123R (Share-Based Payment) on January 1, 2006, resulting in a $5.9 million expense for the six months ended June 30, 2006.
Guidance, Outlook, and Risks
- Outlook: Management is cautious regarding the remainder of 2006 due to rising oil prices, geopolitical tensions, and expected weakness in North American light truck and SUV sales. Commodity cost increases are projected to reach $25 million for the full year 2006.
- Capital Expenditures: The company expects to spend between $295 million and $325 million on capital and tooling expenditures in 2006.
- Cash Flow: Net cash provided by operating activities is expected to be approximately $475 million for 2006.
- Legal Contingencies:
- Asbestos Litigation: Approximately 61,000 pending claims exist. The company has accrued $36.6 million for future resolutions, with an equal insurance receivable. Management expects 100% reimbursement from insurers.
- Environmental: An accrual of $16 million exists for environmental liabilities, including the Crystal Springs settlement (99% of claims resolved).
- Retiree Benefits: Litigation is ongoing regarding adjustments to retiree medical plans made in April 2006.
Investor Verification Checklist
- Commodity Hedging: Verify the effectiveness of hedging programs in offsetting the projected $25 million commodity cost increase for 2006.
- Asbestos Insurance Recovery: Confirm the status of the declaratory judgment action regarding insurance coverage apportionment and the solvency of secondary layer insurers.
- Retiree Benefit Litigation: Monitor the outcome of the lawsuit filed by the UAW regarding the April 2006 adjustment to retiree medical plans.
- North American Demand: Assess the impact of continued weakness in North American light truck and SUV sales on the Drivetrain segment.
- Restatement Impact: Note the restatement of the 2005 cash flow statement regarding marketable securities classification (Note 16).