BorgWarner Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2012. Amounts are in millions of dollars except per-share data. BorgWarner supplies engineered automotive powertrain systems and components through its Engine and Drivetrain segments.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $1,695.2 | $1,791.8 | $5,464.1 | $5,341.0 |
| Gross profit / margin | $343.7 / 20.3% | $350.8 / 19.6% | $1,122.7 / 20.5% | $1,050.7 / 19.7% |
| Operating income | $163.0 | $198.8 | $582.2 | $606.4 |
| Net earnings attributable to BorgWarner | $101.1 | $141.6 | $379.7 | $428.1 |
| Diluted EPS | $0.85 | $1.15 | $3.15 | $3.45 |
- Reported Q3 sales declined 5.4%; excluding fourth-quarter 2011 dispositions and weaker foreign currencies, sales increased approximately 2%. Nine-month reported sales rose 2.3%; on the company’s stated adjusted basis, they increased approximately 8%.
- For the first nine months, operating cash flow was $542.6 versus $473.1; capital expenditures including tooling were $283.0 versus $274.1. The difference between operating cash flow and capital expenditures was $259.6, compared with $199.0 in 2011.
- Cash was $621.5 at September 30, 2012, including $617.8 held by foreign subsidiaries. Total debt was approximately $1,102.8, comprising $231.0 short-term debt and $871.8 long-term debt including its current portion. The company reported a debt-net-of-cash-to-capital ratio of 13.4%, down from 28.3% at year-end 2011.
- The $650 revolving credit facility had $180.0 drawn, with capacity to increase to $1 billion. The company was in covenant compliance and expected to remain compliant. Weighted-average borrowing costs were 4.3%, versus 5.9% at year-end 2011.
Material changes and operating drivers
- Q3 gross margin improved to 20.3% from 19.6%, reflecting lower conversion costs; material costs remained about 50% of sales. Nine-month gross margin rose to 20.5% from 19.7%.
- Q3 Engine sales declined 7.2% reported, but increased approximately 1% excluding dispositions and currency effects; segment Adjusted EBIT margin improved to 15.8% from 15.0%. Drivetrain sales declined 0.8% reported but grew approximately 5% excluding currency effects; its margin improved to 8.3% from 8.1%.
- For nine months, Drivetrain sales increased 12.2% reported and approximately 16% excluding the Haldex acquisition and currency effects; its Adjusted EBIT margin rose to 9.2% from 7.4%. Engine’s nine-month margin rose to 16.1% from 15.0%.
- Q3 interest expense and finance charges fell to $5.0 from $18.5; nine-month expense fell to $32.7 from $57.4, primarily following settlement of convertible notes in April 2012 and higher capitalized interest.
- Net income fell despite improved gross margins. Q3 included $27.4 of restructuring expense, $1.8 of spark-plug-sale-related expense, and tax adjustments. The company estimated that non-comparable items reduced Q3 diluted EPS by $0.34; nine-month non-comparable items reduced EPS by $0.67, versus a $0.19 benefit in 2011.
Outlook, commentary, and risks
- Management described its 2012 outlook as cautious because of weakening global economic conditions, particularly in Europe. It expected global vehicle production to increase year over year, but European production to decline; higher adoption of BorgWarner products was expected to support company sales growth.
- The company maintained a positive long-term outlook, citing global adoption of direct-injection engines, automated transmissions, and variable cam and chain timing systems. It stated that continued R&D investment and strategic capital spending support product development and growth.
- The estimated 2012 U.S. GAAP effective tax rate was approximately 31%, including tax audit settlements and a change in the assertion on repatriation of certain foreign earnings. The estimated rate for ongoing operations was 27%.
- The spark-plug business sale to Federal-Mogul was completed in Q3; BorgWarner received $55.2 in cash. The nine-month disposal loss was $39.7. Q3 restructuring charges of $27.4 included $16.9 in employee termination benefits, expected to be paid within 12 months, and $10.5 of other charges.
- Risks include vehicle-production and demand fluctuations, economic conditions, foreign exchange, and pending litigation. The company reported approximately 16,000 pending asbestos-related claims; it expects insurance recovery but says timing depends on insurer litigation or settlements. It also reported environmental accruals of $4.7 and an unresolved retiree-benefits case for which potential loss could not be estimated.
- Management said available operating cash, cash balances, credit facilities, and shelf-registration capacity should meet planned needs for the foreseeable future. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported.
Investor verification points
- Verify the durability of underlying sales growth after separating currency, the spark-plug disposal, and the Haldex acquisition, especially given European market weakness.
- Assess whether improved gross and segment margins can offset lower reported Q3 earnings, restructuring costs, and the higher estimated tax rate.
- Review the use and accessibility of foreign-held cash, including potential tax costs of repatriation, and monitor debt, revolver utilization, and covenant headroom.
- Track the cash costs and completion of BERU-related restructuring, as well as the final accounting and proceeds from the spark-plug sale.
- Monitor asbestos insurance recoveries and the related coverage litigation, the UAW retiree-benefits case, and environmental and other contingencies.