BorgWarner Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. Amounts are in U.S. dollars; financial figures are in millions except per-share data. BorgWarner is a global automotive systems and components supplier, reporting in Engine and Drivetrain segments. Results are unaudited interim results and are not necessarily indicative of the full year.
Financial performance
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net sales | $2,268.6 | $1,984.2 |
| Gross profit / margin | $464.3 / 20.5% | $429.0 / 21.6% |
| Operating income | $264.2 | $259.6 |
| Net earnings attributable to BorgWarner | $164.1 | $178.9 |
| Diluted EPS | $0.75 | $0.79 |
| Cash from operations | $34.4 | $32.7 |
| Capital expenditures, including tooling | $104.3 | $140.0 |
- Sales grew 14.3% year over year. Excluding Remy, acquired in 2015, and foreign-currency effects, sales increased approximately 4.5%.
- Gross margin fell to 20.5% from 21.6%; excluding Remy, Q1 2016 gross margin was 20.9%. Management cited higher conversion costs, including product-launch and start-up costs.
- Operating income rose modestly, but net earnings attributable to BorgWarner and diluted EPS declined. Higher interest expense, tax expense, and non-comparable items contributed to the year-over-year comparison.
- Adjusted EBIT was $317.2, versus $301.4. Engine sales were $1,399.2 and adjusted EBIT was $233.4; Drivetrain sales were $879.2 and adjusted EBIT was $83.8. Drivetrain adjusted EBIT margin declined to 9.5% from 11.6%, primarily reflecting Remy; Engine margin was 16.7% in both periods.
- Cash decreased to $392.3 at March 31 from $577.7 at year-end. Investing used $103.2 and financing used $124.8; cash declined $185.4 overall. Receivables and other working-capital movements affected operating cash flow.
Debt, liquidity, and capital allocation
- Balance-sheet notes payable and other short-term debt were $466.5; long-term debt was $2,131.9. Net debt to net capital increased to 37.0% from 35.2% at December 31, 2015.
- The company had no borrowings under its $1 billion revolving credit facility, expandable to $1.25 billion, and was in compliance with its debt-to-EBITDA covenant. Commercial paper outstanding was $175.0. The combined current borrowing capacity under the facility and commercial-paper program is capped at $1 billion.
- Cash held by foreign subsidiaries was $377.8; repatriation could result in additional taxes. Management stated available cash, operating cash flow, credit facilities, and shelf capacity should meet foreseeable needs, including the share-repurchase program.
- Q1 cash uses included $79.5 for treasury-stock purchases and $28.2 in dividends to BorgWarner shareholders. The quarterly dividend declared was $0.13 per share. The company had a $1 billion, three-year repurchase authorization.
- Moody’s changed its outlook to negative during Q1; S&P and Fitch outlooks were stable. The filing states no debt agreement requires accelerated repayment following a ratings downgrade.
Material changes and unusual items
- The 2015 Remy acquisition materially increased Drivetrain sales and included rotating electrical products. Q1 2016 included $5.8 of Remy-related transition and realignment expense. Purchase-price allocations were still preliminary.
- Other expense was $11.7 versus $1.2, including restructuring expense of $6.4 and Remy-related expense of $5.8. Q1 2015 included a $10.8 gain on the previously held BERU Diesel interest.
- Interest expense and finance charges increased to $21.3 from $10.0, primarily due to senior-note issuances in 2015. The Q1 effective tax rate was 31.7%; management estimated an approximately 31% annual rate for ongoing 2016 operations, excluding specified non-comparable items.
- Foreign-currency translation generated a $68.4 comprehensive-income gain, compared with a $249.8 loss in Q1 2015; this affected other comprehensive income, not operating earnings.
Outlook, risks, and contingencies
- Management described the 2016 outlook as cautious: weak global vehicle-production growth is expected, partly offset by moderate sales growth from new business; a stronger U.S. dollar could reduce reported foreign-currency sales. No specific full-year revenue or earnings guidance is provided in the filing text.
- Management cited long-term opportunities in direct-injection gasoline engines, automated transmissions, and variable cam and chain timing systems, and reaffirmed investment in product development and strategic capital projects.
- Key stated risks include vehicle-production and demand fluctuations, economic conditions, currency movements, and the ability to integrate Remy and realize anticipated benefits, including customer and employee retention.
- Product warranty accrual was $116.4, up from $107.9 at year-end; warranty provisions were 1.1% of sales versus 0.3% in Q1 2015, primarily related to Remy. Actual claims could differ from estimates.
- Asbestos-related claims remained a significant contingency: approximately 9,400 were pending. The company recorded a $106.0 liability and matching insurance asset for asserted but unresolved claims; recovery timing depends on insurance litigation, with proceeds not expected before resolution anticipated after March 31, 2017. The company also reported $174.2 of net past costs expected to be recovered from insurers.
- Environmental liabilities accrued were $5.1, with substantially all expected to be paid over five years. Management did not expect other commercial or legal claims to materially affect overall results, financial position, or cash flows, though a particular quarter could be affected.
- Management reported disclosure controls as effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of reported sales growth and Drivetrain profitability is attributable to Remy versus organic growth, and whether integration benefits and expected synergies are being realized.
- Whether gross-margin pressure, launch costs, and Drivetrain margin dilution persist, and whether the estimated additional $11 of restructuring expense is incurred.
- Cash conversion and working-capital requirements, given low quarterly operating cash flow, declining cash, and capital spending.
- Debt, covenant headroom, refinancing needs, and the potential effects of the negative Moody’s outlook; also the availability and tax cost of foreign cash.
- Developments in asbestos insurance litigation and recovery timing, warranty claims, and other legal contingencies.
- Actual 2016 vehicle-production trends, currency effects, new-business growth, and any subsequent numerical guidance.