BorgWarner Inc. — Q3 2018 Form 10-Q
Business context and reporting period. Global supplier of propulsion and vehicle-efficiency products, primarily to automotive OEMs. This unaudited filing covers the three and nine months ended September 30, 2018. Operations are reported in Engine and Drivetrain segments.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $2,478.5M | $2,416.2M | $7,956.8M | $7,212.9M |
| Gross profit / margin | $515.6M / 20.8% | $521.6M / 21.6% | $1,686.6M / 21.2% | $1,550.8M / 21.5% |
| Operating income | $278.0M | $274.6M | $924.3M | $864.2M |
| Net earnings attributable to BorgWarner | $203.8M | $184.9M | $700.7M | $586.1M |
| Diluted EPS | $0.98 | $0.88 | $3.34 | $2.77 |
- Q3 sales grew 2.6% reported and approximately 3.6% excluding weaker foreign currencies and Sevcon acquisition effects. Nine-month sales rose 10.3% reported and approximately 5.8% excluding stronger currencies and Sevcon.
- Q3 gross margin fell 0.8 percentage points, attributed primarily to material-cost inflation, tariffs, and limited ability to adjust costs amid a rapid industry-volume decline. Nine-month gross margin declined 0.3 points.
- Q3 Adjusted EBIT was $345.8M versus $348.7M; nine-month Adjusted EBIT was $1,142.1M versus $1,051.8M. Q3 Engine Adjusted EBIT margin was 15.7%, flat year over year; Drivetrain margin declined to 11.0% from 12.1%, primarily reflecting Sevcon. For nine months, Engine margin was 16.2% and Drivetrain 11.1% versus 11.7%.
- Nine-month net R&D spending rose to $337.1M from $302.8M, or 4.2% of sales in both periods.
Cash flow, balance sheet, and liquidity
- Nine-month operating cash flow was $556.3M, down from $623.9M, primarily due to working-capital changes. Investing cash outflow was $393.0M versus $570.7M, mainly because the prior-year period included the Sevcon acquisition. Financing cash outflow was $323.4M versus $106.2M, reflecting lower borrowings and higher repurchases, compensation-related payments, and dividends.
- Capital expenditures, including tooling, were $394.3M. Cash declined to $361.8M from $545.3M at year-end 2017.
- At September 30, total short-term debt and current maturities were $50.7M; long-term debt, net of current portion, was $2,085.6M. Net debt to net capital was 29.9%, versus 30.0% at year-end. The company had no borrowings under its $1.2B revolving credit facility or commercial-paper program and was in compliance with its debt-to-EBITDA covenant.
- Current assets were $3,490.6M and current liabilities $2,099.6M. The company reported $361.8M cash, including $338.1M held by foreign subsidiaries; repatriation may result in additional foreign or state and local taxes.
- Management said cash, operating cash flow, available credit, and shelf-registration capacity should cover operating needs, planned operations, and the current repurchase program.
Material changes and notable items
- Restructuring expense was $44.4M for the first nine months, versus $13.3M in 2017, mainly tied to Engine-segment emissions actions. A European voluntary termination program had about 140 employee participants and $26.9M of severance expense; further charges could be material.
- The company continued seeking a buyer for non-core pipe and thermostat product lines, with no sale agreement reached by September 30. Assets and liabilities held for sale were $64.5M and $29.9M, respectively; no further carrying-value adjustment was recorded in 2018 through the reporting date.
- The nine-month effective tax rate was 20.7%, including Tax Act measurement adjustments, foreign-tax-credit benefits, and other one-time items. Management estimated an approximately 26% full-year 2018 effective rate for ongoing operations, excluding non-comparable items.
- Foreign-currency translation reduced comprehensive income by $124.2M for the first nine months, versus a $186.6M gain in 2017, primarily because the U.S. dollar strengthened against the euro and Chinese renminbi.
- The company paid $106.3M of dividends and repurchased approximately 3.04M shares for $150M during the first nine months.
Outlook, risks, and contingencies
- Management described the 2018 outlook as positive: new-business growth and product penetration were expected to support growth above modest global industry production growth. No specific full-year sales or earnings guidance figures are provided in the filing.
- Longer-term growth drivers cited include turbocharger adoption, automated transmissions, variable cam and chain timing systems, and hybrid and electric vehicle offerings.
- Newly enacted tariffs had a modestly negative Q3 impact. Management was evaluating potential effects of additional U.S. tariffs and foreign retaliatory tariffs, including higher input costs or costs on products sold.
- Asbestos-related liabilities totaled $791.5M, with a recorded insurance receivable of $386.4M. Insurance recovery remains subject to disputes and litigation; the company estimated reasonably possible additional asbestos losses of up to approximately $100M through 2067. The SEC informed the company in July 2018 that it was investigating accounting for asbestos claims not yet asserted; the company said it was cooperating.
- Environmental liabilities accrued were $9.9M. The company was identified as a potentially responsible party at 28 hazardous-waste sites; management did not expect these matters to have a material adverse effect, while noting outcomes remain uncertain.
- Other stated risks include cyclical vehicle production, reliance on major OEMs, commodity prices and availability, supply disruptions, foreign-exchange and interest-rate movements, legal proceedings, and global economic conditions.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether Q3 gross-margin pressure from tariffs, material inflation, and volume changes persists, and whether cost actions offset it.
- Progress and potential additional costs from Engine emissions restructuring, and the status, terms, and valuation of the pipe and thermostat divestiture.
- Developments in the SEC asbestos-accounting investigation, asbestos claim experience, and the collectability and timing of disputed insurance recoveries.
- Underlying cash conversion and working-capital trends, alongside capital spending, dividends, and remaining share-repurchase authorization.
- Whether the approximately 26% ongoing full-year tax-rate estimate and the qualitative 2018 growth outlook remain achievable.