BorgWarner Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. BorgWarner is a global supplier of engineered automotive powertrain systems and components, reported in Engine and Drivetrain segments. Unless noted otherwise, dollar amounts are in millions.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $1,884.0 | $2,032.1 | $5,900.1 | $6,313.2 |
| Gross profit / margin | $398.2 / 21.1% | $424.5 / 20.9% | $1,256.2 / 21.3% | $1,343.1 / 21.3% |
| Operating income | $237.1 | $237.7 | $739.2 | $751.5 |
| Net earnings attributable to BorgWarner | $157.4 | $166.6 | $484.4 | $515.9 |
| Diluted EPS | $0.70 | $0.73 | $2.14 | $2.25 |
- Reported sales declined 7.3% in Q3 and 6.5% year to date, primarily reflecting weaker foreign currencies, especially the euro. Excluding currency effects, Q3 sales increased approximately 3%; year-to-date sales increased approximately 4% after also excluding the Wahler and BERU Diesel acquisitions.
- Q3 gross margin improved 0.2 percentage points; nine-month gross margin was unchanged. SG&A fell to $148.0 in Q3 and $483.6 year to date; net R&D expense was $75.2 and $230.7, respectively.
- Nine-month segment results: Engine sales were $4,102.8 and Adjusted EBIT $670.3, with a 16.3% margin; Drivetrain sales were $1,821.8 and Adjusted EBIT $213.4, with an 11.7% margin. Engine sales rose approximately 6% on a comparable, currency-adjusted basis; Drivetrain sales fell approximately 2% on that basis.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $470.2, down from $546.2. Capital expenditures, including tooling, were $418.8; operating cash flow less these expenditures was approximately $51.4.
- Cash was $1,033.3 at September 30, 2015, compared with $797.8 at year-end 2014; $673.1 was held by non-U.S. subsidiaries. Management said most foreign cash was available for repatriation, potentially with additional taxes.
- Short-term debt was $74.6 and long-term debt $1,734.5, versus $623.7 and $716.3, respectively, at year-end 2014. The increase in long-term debt followed the March issuance of $1 billion in senior notes: $500 million due 2025 and $500 million due 2045. The company used proceeds partly to repay U.S. short-term debt and support its repurchase program.
- Net debt to net capital was 17.0%, up from 12.8% at year-end. The $1 billion revolving facility, expandable to $1.25 billion, had no borrowings; the commercial paper program also had no outstanding borrowings. The company was in compliance with its debt-to-EBITDA covenant. Management said available cash, operating cash flow, credit facilities and shelf capacity should meet foreseeable needs, including the share repurchase program.
- Financing cash flow was $239.5 provided, compared with $149.5 used in the prior-year period, primarily reflecting the note issuance. Investing cash use was $428.0, including $418.8 of capital expenditures and $12.6 for BERU Diesel.
Changes, outlook and notable items
- Despite lower reported sales and earnings, Q3 segment margins improved: Engine to 16.2% from 15.8%, and Drivetrain to 12.0% from 10.8%. Management cited higher light-vehicle turbocharger sales and North American all-wheel-drive sales, offset by weak China conditions and weak commercial-vehicle markets. Year-to-date Drivetrain margin edged down from 11.8% to 11.7%.
- Interest expense increased to $15.0 in Q3 and $42.6 year to date, mainly due to the March debt issuance. Equity earnings from affiliates declined, principally reflecting lower NSK-Warner earnings amid weaker China sales.
- Management described its 2015 outlook as cautious: weak global vehicle-production growth was expected, partly offset by moderate net new-business sales growth; a stronger U.S. dollar was expected to reduce the reported value of foreign-currency sales. It maintained a positive long-term view, citing growth in gasoline direct injection, automated transmissions and variable cam and chain timing systems. No specific revenue or EPS guidance was provided in the supplied filing text.
- Restructuring expense was $41.3 for the first nine months, down from $67.6; management expected approximately $9 of additional Drivetrain restructuring expense and approximately $11 related to Engine over the next year. Q3 included $3.9 of Remy transaction costs. In January, BorgWarner acquired the remaining 51% of BERU Diesel for $12.6 and recorded a $10.8 gain on its previously held interest.
- BorgWarner agreed to acquire Remy International for $29.50 per share in cash, implying approximately $1.2 billion enterprise value. Closing was expected in Q4 2015, subject to customary conditions and regulatory clearance; integration, approvals, customer retention and realization of expected benefits were identified risks.
- Foreign-currency translation losses were $202.6 year to date, largely due to the stronger U.S. dollar; the filing estimates the euro’s roughly 8% decline against the dollar since year-end increased other comprehensive loss by approximately $160.
Risks, contingencies and investor checks
- Asbestos-related claims remained a significant uncertainty: approximately 11,700 claims were pending. BorgWarner recorded $111.9 of liabilities for asserted but unresolved claims and a matching insurance asset; recovery depends on insurers and ongoing coverage litigation. It also reported $150.2 of net past costs expected to be recovered. The company cautioned that ultimate asbestos exposure cannot be estimated reliably beyond accrued amounts.
- Environmental accruals were $4.9 for 26 potentially responsible-party sites. A September 2015 confidential settlement terminated BorgWarner’s Kuhlman Electric indemnity obligations; related insurance recovery actions continue.
- The California Supreme Court denied an appeal in October 2015 after an appellate decision struck $32.5 of punitive damages from a prior asbestos verdict. Verify the remaining case outcome and any resulting financial exposure.
- Other legal matters include a continuing retiree-benefits class action for which the company said potential loss could not be reasonably estimated. Management did not expect these matters to materially affect consolidated results, financial position or cash flows, while noting possible quarter-specific effects.
- Key facts to verify: Remy acquisition closing, financing and integration risks; future sales and margins amid currency movements, China weakness and commercial-vehicle conditions; execution and cash costs of restructuring and the $1 billion repurchase authorization; asbestos insurance recoveries and litigation developments; and the effect of higher debt and interest costs on liquidity and capital allocation.