BorgWarner Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Financial results exclude Delphi Technologies, whose acquisition closed October 1, 2020. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data.
Financial performance
| Metric | Q3 2020 | Q3 2019 | First nine months 2020 | First nine months 2019 |
|---|---|---|---|---|
| Net sales | $2,534 | $2,492 | $6,239 | $7,609 |
| Gross profit / margin | $517 / 20.4% | $524 / 21.0% | $1,138 / 18.2% | $1,556 / 20.4% |
| Operating income | $284 | $276 | $395 | $825 |
| Net earnings attributable to BorgWarner | $111 | $194 | $142 | $526 |
| Diluted EPS | $0.53 | $0.94 | $0.69 | $2.54 |
| Operating cash flow | Not separately stated for the quarter | $808 | $824 |
Q3 sales rose 1.7% year over year, or approximately 0.8% excluding favorable currency effects. Gross margin declined 0.6 percentage points, while lower SG&A supported operating income. Net earnings attributable to BorgWarner fell despite higher operating income, notably reflecting a $51 million Q3 tax charge related primarily to final U.S. Treasury regulations. The Q3 effective tax rate was 52.6%; the nine-month rate was 50.5%.
For the first nine months, sales fell 18.0% (approximately 16.8% excluding currency and net acquisition/divestiture effects), primarily due to COVID-19-related production disruptions in the first half. Lower sales and fixed costs that could not be reduced proportionately compressed gross margin. Nine-month SG&A was $601 million versus $668 million, but SG&A as a share of sales increased to 9.6% from 8.8%.
Segments and material changes
- Q3 Engine: Sales of $1,476 million, down 2.5%; Adjusted EBIT of $225 million and margin of 15.2%, versus 15.9% a year earlier.
- Q3 Drivetrain: Sales of $1,075 million, up 8.3%, primarily on stronger demand in China; Adjusted EBIT of $131 million and margin of 12.2%, versus 10.1%.
- Nine-month performance: Engine sales decreased 20.2% and Drivetrain sales decreased 14.5%. Adjusted EBIT margins declined to 12.3% from 15.6% for Engine and to 7.7% from 10.3% for Drivetrain.
- Other expense was $142 million for the first nine months, including $72 million of restructuring expense, $58 million of acquisition-related and other transaction expenses, and $26 million of impairments. The impairments included a write-down of the Romeo investment and charges associated with announced European facility closures.
Cash, debt and liquidity
- At September 30, cash and cash equivalents were $2,121 million, compared with $832 million at December 31, 2019. Current assets were $5,165 million and current liabilities $2,199 million.
- Management reported liquidity of $3,621 million: $2,121 million cash plus an undrawn $1.5 billion revolving credit facility. The company reported covenant compliance and said it expected sufficient liquidity for the next 12 months, including under significantly lower OEM production volumes.
- Balance-sheet short-term debt and long-term debt, net of current portion, totaled approximately $2,836 million. Long-term debt, net of current portion, was $2,787 million, up from $1,674 million at year-end 2019. The increase included the June issuance of $1.1 billion of 2.650% notes due 2027, undertaken in anticipation of the acquisition and to refinance notes due in 2020.
- Nine-month operating cash flow was $808 million; investing activities used $249 million, including $262 million of capital expenditures; financing activities provided $711 million. The company ended the period with $2,121 million of cash.
- After the reporting date, the revolving facility increased to $2.0 billion upon the Delphi acquisition. BorgWarner used approximately $900 million of cash to repay Delphi Technologies debt. The filing does not state the resulting post-acquisition cash balance.
Outlook, risks and unusual items
- Management expected 2020 industry production to decline significantly in Europe, North America and China, with full-year revenue expected to decline excluding currency and net acquisition/divestiture effects. The filing provides no numerical full-year revenue or earnings guidance.
- Management described Q3 production levels, revenue and profitability as improved from the first-half disruption, but cautioned that COVID-19 could cause further adverse effects and that its future financial impact could not be reasonably estimated.
- The company anticipated $275–$300 million of primarily cash restructuring costs through 2023, including $72 million recognized by September 30, 2020, and estimated annual savings of approximately $90–$100 million by 2023. Some severance estimates were subject to labor negotiations; future restructuring actions could add costs.
- The October 1 Delphi acquisition involved approximately $2.4 billion of consideration, including 37 million BorgWarner shares valued at $1.5 billion and approximately $900 million of debt repayment; approximately $800 million of Delphi senior notes were also assumed. Acquisition accounting was incomplete, and the filing could not provide acquired asset/liability classes or pro forma revenue and earnings.
- Other notable items: the company received $110 million of insurance proceeds related to April tornado damage at its Seneca facility and expected coverage for repair, interruption and related costs. The SEC investigation into historical accounting for unasserted asbestos claims was settled in August 2020; BorgWarner paid an approximately $1 million civil penalty without admitting or denying the charges.
- Risks include continued pandemic-related production and supply disruption, automotive cyclicality and OEM concentration, foreign-exchange exposure, and challenges, costs or unanticipated liabilities in integrating Delphi. Standard & Poor’s lowered its rating to BBB with a negative outlook; Moody’s and Fitch maintained their ratings but moved outlooks to negative.
Important facts for investors to verify
- Whether post-acquisition integration realizes the expected benefits and how Delphi affects consolidated revenue, earnings, cash flow and leverage once reported.
- Whether COVID-19, OEM production levels and regional demand materially change the company’s outlook or liquidity needs.
- Actual restructuring cash costs, timing and savings versus management’s estimates, including outcomes of labor negotiations.
- The sustainability of margins and earnings given the weaker nine-month results and the Q3 tax charge; the filing estimated an approximately 32% annual effective tax rate for ongoing operations excluding specified non-comparable items.
- Developments in environmental and other legal matters. Management did not expect the disclosed matters to have a material overall effect, but noted that an adverse outcome could be material in a particular quarter.