2 0 0 4 A N N U A L R E P O R T
What product leadership
means to me
and me.
A t
B o r g W a r n e r
,
t h e r e a r e m a n y d e f
i n i
t
i o n s o f
P R O D U C T L E A D E R S H I P –––––––––—— 1 7 , 1 2 7
t o b e e x a c t .
and me.
and me.
Product leadership means growing at a rate
that is almost triple that of our industry.
B o r g W a r n e r S a l e s
v s . G l o b a l
A u t o I n d u s t r y
1 9 9 3
I N D E X : 1 9 9 3 = 1 0 0
BorgWarner
58
Industry
134
2 0 0 4
1
04
F i n a n c i a l H i g h l i g h t s
millions of dollars, except per share data
2004
2003
% Change
Net sales
Net earnings
Net earnings per share — diluted
Average number of shares outstanding — diluted (millions)
Capital spending
Research and development
Cash and cash equivalents
Debt
Stockholders’ equity
Total stockholder return
$3,525.3
$3,069.2
14.9%
218.3
174.9
24.8%
20.6%
3.20
54.6
172.0
19.1%
118.2
113.1
4.1%
103.1%
655.5
(10.8)%
1,534.2
1,260.4
21.7%
29.5%
70.7%
3.86
56.5
204.9
123.1
229.7
584.5
t o o u r s t o c k h o l d e r s
2
3
“ Our technology, our customer diversity, our financial discipline and our
staunch commitment to Product Leadership in every aspect of our busi-
ness have built a foundation that continues to prove strong enough to
support our ambitious growth plan. BorgWarner’s record performance
in 2004 affirms my view that there is no other automotive supplier
better positioned for continued global growth.”
F R O M L E F T T O R I G H T :
Alfred Weber
Cynthia A. Niekamp
Robin J. Adams
Vice President,
President and
General Manager
Emissions/Thermal
Systems
Vice President,
President and
General Manager
TorqTransfer Systems
Executive
Vice President,
Chief Financial
Officer and
Chief Administrative
Officer
Roger J. Wood
Vice President,
President and
General Manager
Morse TEC
Timothy M. Manganello
Mark A. Perlick
F. Lee Wilson
Chairman and
Chief Executive Officer
Vice President,
President and
General Manager
Transmission
Systems
Vice President,
President and
General Manager
Turbo Systems
BorgWarner’s performance during 2004 dis-
The Beru acquisition is expected to be accretive
customer base. Because of tremendous growth with custom-
from the board in April 2005. I also want to welcome David
tinguishes us from other auto systems suppliers
in 2005 and enhance our diesel and controls
ers like Honda, Hyundai/Kia and VW/Audi, our sales are well
Brown, CEO of Owens Corning, as the newest member of
as we continue to lay the groundwork for our
technology, as well as expand our customer
balanced. This strategic focus proves beneficial as market
the board. We look forward to his contributions.
global growth.
base and geographic presence – all reasons we
shares among the global automakers shift in favor of our
In an industry with little growth, our sales were up
have previously cited for making acquisitions.
faster growing customers.
Implementing Initiatives
15% to a record $3.5 billion. Earnings hit another record high.
New business amounting to $1.4 billion is expected to
We further enhanced our strong and talented management
A stock split in May signaled our continued confidence in the
come on stream over the next three years. About 66%
team with key appointments from within the company and by
future of the company. We increased our dividend for the
is expected to be engine-related products such as turbo-
attracting exceptional outside talent. To help manage the
third time in the past three years. By year-end, BorgWarner
chargers, engine timing systems, variable cam timing
complexities of our more global business, we strengthened
stock had chalked up 29 52-week highs.
modules and emissions/thermal products. The other 34%
the role of the CFO to include administration and created a
is expected to be in transmission modules and all-wheel
new position for global supply chain management and
Focused Growth
drive systems.
emerging markets.
We have strengthened our Engine and Drivetrain focus with
the creation of technology leadership positions in each
group, the continued development of new products and the
acquisition of a majority stake in Beru AG on January 4, 2005.
As a global business, we serve customers throughout the
Our Board of Directors is actively engaged in guiding our
world. In addition to supporting the domestic automakers
business. I want to thank Bill Butler for his leadership and
the success of the company.
in North America, we have significantly diversified our
wise counsel as a board member since 1997. Bill retires
Since becoming chief operating officer in 2002, and now as
CEO, I have challenged our people to broaden the competi-
tive gap between us and other suppliers in three key areas.
These are quality and cost improvement, the use of elec-
tronic controls strategies, and harnessing the power of
collaboration and teamwork -- all with a focus on our vision
of Product Leadership. I am proud of our achievements in
each area. We are demonstrating that Product Leadership
is everyone’s job, and each employee has a role to play in
“Our strategic focus proves beneficial as
market shares among the global automakers shift
in favor of our faster growing customers.”
L
A
B
O
L
G
4
5
Our collaboration has led to better, more cost-efficient
powertrains of the future. BorgWarner knows more about
processes, including information technology and supply
product launches, a successful move of our corporate head-
powertrains than any other supplier, but we need to make
chain management.
quarters to Auburn Hills, Michigan, an effective acquisition
sure we are leveraging that expertise where it counts. Our
process and unprecedented quality and workplace safety
acquisition of Beru shares will help us advance in this area.
results. In addition, we are leveraging our infrastructure
within the Engine and Drivetrain groups on two Korean
Structuring for Future Growth
campuses and a single manufacturing campus in China.
We are also focused on structuring ourselves for global
Over the past few years, we have been building a robust and
disciplined cost reduction process. This process touches all
aspects of our business and was the reason we could
manage through a situation as daunting as steep increases
growth. There is a difference between operating in multiple
countries and being a truly global company. We realize that
we must operate differently than we have in the past. Good
examples are our expansions in China and Korea. At our
This report looks at those qualities that bring us together as
BorgWarner people and that differentiate us from others in
the industry: our continuing ability to supply innovative tech-
nology; our diversity – both in terms of our customer base
B o rg W a r n e r V i s i o n
BorgWarner is the recognized world leader
and our geographic presence; our manufacturing excellence;
in advanced products and technologies
and our financial discipline.
The auto industry expects to face another challenging year
in 2005, with uncertainty about production, high commodity
that satisfy customer needs in powertrain
components and systems solutions.
“ I have challenged our people to broaden the competitive gap between us and other suppliers in three key
areas. These are quality and cost improvement, the use of electronic controls strategies, and harnessing
the power of collaboration and teamwork – all with a focus on our vision of Product Leadership.”
B o rg W a r n e r B e l i e f s
(cid:127) Respect for Each Other
(cid:127) The Power of Collaboration
(cid:127) Passion for Excellence
in steel and other raw materials costs in 2004. We operate
new engine and drivetrain campuses in Korea, and in China,
prices and shifting market shares among our customers. At
in a very cost-competitive environment and must continually
at our recently opened office in Shanghai and expanding
BorgWarner, we will continue to manage through these
(cid:127) Personal Integrity
adjust our cost structure to the realities of our marketplace.
Ningbo manufacturing compound, we are sharing space and
issues with a focus on delivering the results our stockholders
We have made progress in harnessing our expertise in
mechanical functioning of engines and torque management
support services. In the past, we would have established
have come to expect.
individual operations by product line.
through software controls strategies. This expertise is a
Our new business model is reaching beyond emerging
major differentiator between BorgWarner and our competi-
market opportunities to the rest of our business. We want
tors for most of our product lines. Computer control is the
to preserve the best of our entrepreneurial heritage while
“brainpower” of the powertrain, and is the critical element of
taking advantage of the benefits of common systems and
Timothy M. Manganello
Chairman and CEO
(cid:127) Responsibility to Our Communities
b u s i n e s s p r o f i
l e
engine group
6
The Engine Group develops strategies and products to manage engines for fuel efficiency, reduced
emissions and enhanced performance. BorgWarner’s expertise in engine timing systems, boosting
systems, air and noise management, cooling and controls is the foundation for this collaboration.
S A L E S
m i l l i o n s o f d o l l a r s
$1,568.3
$1,426.6
$1,648.2
$1,869.7
$2,217.0
7
00
01
02
03
04
2004 Highligh ts
Strong demand boosted Engine Group sales 19% with an 18% increase in earnings before interest
and taxes. The group continues to benefit from European and Asian automaker demand for
turbochargers, timing systems and emission products, and from stronger commercial vehicle
production in both Europe and North America. During the year, the group expanded its presence
in Korea to manufacture engine timing systems for Hyundai’s high-volume gasoline engines and
formed a joint venture for the manufacture and sale of turbochargers. New business awards from
Asian and European automakers expanded the group’s customer base. The acquisition of
a major stake in Beru in January 2005 further enhances the group.
Growth Drivers a nd O pp or t un i t i e s
• Stricter emission regulations for Europe, North America and Asia
• Continued growth of diesel engines in European passenger cars
• Tighter emission regulations related to commercial diesels
• Engine downsizing for improved fuel consumption and emissions in gasoline engines
• Electronic controls and growth of “smart systems”
• Engine timing systems moving from belts to chains
• Development of variable cam timing systems
• Growth of overhead cam engines
• Systems integration; alternative technologies
Key Technologie s
Chain Products Global leader in the design and manufacture of automotive chain systems
for engine timing, automatic transmission and torque transfer including four- and all-wheel
drive applications. Fully integrated timing chain system supplier including chains, sprockets,
tensioners, control arms and guides, and variable cam timing phasers.
Boosting Systems Leading designer and manufacturer of turbochargers and boosting
systems for the passenger car and commercial vehicle markets.
Emissions and Thermal Systems Leading designer and supplier of components and
systems for engine air and thermal management designed to control emissions and
reduce fuel consumption.
Beru Technologies World’s leading supplier of diesel cold-start technology and a leading
European supplier of ignition technology for gasoline vehicles. Electronics and sensing technology
is focused on creating intelligent sensor products for various engine and vehicle functions.
Prod uc tio n Plants and
Tec hnic al Centers
Americas
Asheville, North Carolina ✦ ✴
Auburn Hills, Michigan ✴
Cadillac, Michigan ✦
Campinas, Brazil ✦
Civac-Jiutepec, Mexico ✦ (cid:127)
Cortland, New York ✦
Dixon, Illinois ✦
Fletcher, North Carolina ✦
Guadalajara, Mexico ✦
Ithaca, New York ✦
Marshall, Michigan ✴
Sallisaw, Oklahoma ✦
Simcoe, Ontario, Canada ✦
Water Valley, Mississippi ✦
Asia
Aoyama, Japan ✦
Changwon, South Korea ✦
Chennai, India ✦
Chennai, India (JV) ✦
Chungju-City, South Korea (JV) ✦ (cid:127)
Hitachinaka City, Japan (JV) ✦
Kakkalur, India (JV) ✦
Nabari City, Japan ✦ ✴
Ningbo, China (JV) ✦
Pune, India (JV) ✦ (cid:127)
Pyongtaek, South Korea ✦
Shihung-City, South Korea ✦ (cid:127)
Tainan Shien, Taiwan ✦
Europe
Arcore, Italy ✦ ✴
Biassono, Italy ✦ (cid:127)
Bretten, Germany ✦ (cid:127)
Bradford, England ✦
Chazelles, France ✦ (cid:127)
Diss, England ✦ (cid:127)
Kandel, Germany (JV) ✦ (cid:127)
Kirchheimbolanden, Germany ✦ ✴
La Ferté-Macé, France ✦ (cid:127)
Ludwigsburg, Germany ✦ ✴ (cid:127)
Markdorf, Germany ✦ ✴
Muggendorf, Germany ✦ (cid:127)
Neuhaus, Germany ✦ (cid:127)
Oroszlany, Hungary ✦
Rijswijk, Netherlands (JV) ✦ (cid:127)
Tiszakécske, Hungary ✦ (cid:127)
Tralee, Ireland ✦ (cid:127)
Vitoria, Spain ✦ (cid:127)
✦
✴
(cid:127)
PR ODUCT I ON PLANTS
T ECH NI CAL CENTERS
BER U L OCAT IONS
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Our chain timing systems prolong
engine life, increase fuel effi ciency
and reduce emissions in today’s
demanding new diesel applications.
Our patented variable cam timing
system uses camshaft oscillation to
achieve twice the emissions reduction
and three times the fuel effi ciency
improvement in the federal EPA cycle
than competitive technologies.
BorgWarner’s air pump technology
reduces hydrocarbon emissions by
as much as 41%. Our air pumps are
available in a full range of fl ow capa-
bilities, are compact in size, and can
be engine or vehicle mounted.
Visctronic thermal management
technology for engine cooling
is a patented, revolutionary
system which utilizes precision
electronic controls to improve
engine cooling and fuel economy
in light, medium, heavy-duty and
off-highway vehicles.
Direct tire pressure monitoring
systems measure temperature
and pressure inside the tire and
transmit the data to the driver.
Legislation is mandating their use
in North America for enhanced
vehicle stability.
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a
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-
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BorgWarner’s boosting systems
for gasoline engines, including
new direct injected systems,
provide power, pickup and real
driver enjoyment with fuel
economy improvement up to 15%.
BorgWarner provides exhaust gas
recirculation technology to support
the most stringent emissions
reductions. Our EGR valve offers a
wide range of integration and high
temperature solutions.
Our boosting systems for diesel
engines are key enabling technolo-
gies for modern, high-performing
clean diesel engines. Advances
include new variable geometry
turbine designs and regulated
two-stage devices.
We bring increased power and
durability, noise reduction and
more compact packaging to the
growing market for both single
and double overhead cam timing
in gasoline engines.
Glow plugs are a standard feature
in modern passenger car diesels.
With the Beru Instant Start System
(ISS), diesel engines start more
quickly and safely than ever before
thanks to optimized glow plugs
and an electronic controller which
individually regulates each plug.
b u s i n e s s p r o f i
l e
drivetrain group
8
The Drivetrain Group harnesses our 100-year legacy as an industry innovator in transmission and four-
wheel drive technology. The group is leveraging this understanding of powertrain clutching technology
to develop interactive control systems and strategies for all types of torque management.
S A L E S
m i l l i o n s o f d o l l a r s
$980.0
$937.2
$1,245.6
$1,122.1
$1,358.6
9
00
01
02
03
04
2004 Highlight s
Sales were up 9% and earnings before interest and taxes improved 9% driven by demand for
transmission and all-wheel drive systems, especially among Asian and European automakers.
Productivity efforts helped to offset the impact of higher commodity pricing. Important new
all-wheel drive business for both rear-wheel and front-wheel drive systems was won with two
automakers in North America. In Europe, fuel-efficient DualTronic transmission technology was
made available on five additional Volkswagen/Audi vehicles.
Growth Drivers an d Oppo r tu n i t i e s
• Introduction of new automated (dual clutch) transmission systems for Europe and Asia
• Introduction of new generation five-, six- and seven-speed automatic transmissions
• Evolution from component to modular sourcing
• Increased consumer demand for automatic transmissions – Europe, Korea, China
• Subsystems for continuously variable transmissions (CVT)
• Substitution of modular wet starting clutches for torque converters
• Growing popularity of all-wheel drive passenger cars and crossover vehicles
• Application of electronically controlled torque management devices in
all-wheel drive vehicles
• Expanded customer base in rear-wheel drive based all-wheel drive segment
• Increased global penetration of all-wheel drive
• Growing focus on improved shiftability within manual transmissions
• Emerging market for new generation Pre-emptive Torque Management (PTM)
Key Technolo gies
Transmission Products “Shift quality” components and systems including one-way clutches,
transmission bands, friction plates and clutch pack assemblies; controls including transmission
solenoids, control modules and integrated mechatronic control systems. BorgWarner is a trusted
supplier to virtually every automatic transmission manufacturer in the world.
Torque Management Leading global designer and producer of torque distribution and manage-
ment systems including rear-wheel four-wheel drive transfer cases, front-wheel all-wheel drive
InterActive Torque Management (ITM) devices, electronic control units (ECU) and synchronizer
systems. These systems enhance vehicle stability, drivability, shift quality and handling.
P ro d u c t i o n P l a n t s a n d
Te chnical Centers
Americas
Auburn Hills, Michigan ✴
Bellwood, Illinois ✦
Frankfort, Illinois ✦
Livonia, Michigan ✦
Addison, Illinois ✦
Longview, Texas ✦
Muncie, Indiana ✦
Seneca, South Carolina ✦
Asia
Beijing, China (JV) ✦
Eumsung, South Korea ✦
Eumsung, South Korea (JV) ✦
Fukuroi City, Japan (JV) ✦ ✴
Pune, India (JV) ✦
Sirsi, India (JV) ✦
Europe
Arnstadt, Germany ✦
Heidelberg, Germany ✦
Ketsch, Germany ✦ ✴
Margam, Wales ✦
Tulle, France ✦
✦
✴
PR ODUCT ION PLANTS
T ECH NI CAL CENTERS
s
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Our broad line of clutch products
assures smooth and effi cient
shifting, especially when combined
with our friction elements. New
clutch designs are especially critical
in today’s compact, six-speed
automatic transmissions.
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Advanced electrohydraulic control
modules, transmission solenoids
and mechatronic control systems
help improve fuel economy and
emissions and provide responsive,
fun-to-drive vehicle performance.
Our synchronizers meet the
demanding requirements of the
modern transmission, whether
manual, automated or dual clutch.
These compact, high-performance
systems generate much higher
torque levels than conventional
synchronizers.
Patented ITM technology electroni-
cally senses when a vehicle’s front
wheels slip, and transfers power
to the rear wheels for better han-
dling, stability and fl exibility than
that provided by passive, mechani-
cal all-wheel drive systems.
e
s
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The system enables practical
and effi cient launch and shifting
solutions for hybrid powertrains,
new six-speed planetary transmis-
sions, dual clutch transmissions
and continuously variable trans-
missions.
BorgWarner transfer cases refl ect
the trend toward smarter, more
sophisticated algorithms and
controls. Increasingly, automak-
ers are leveraging 4x4 systems
to augment vehicle handling and
stability programs.
Our patented Pre-emptive Torque
Management technology for pre-
mium all-wheel drive applications
enhances vehicle traction, handling
and stability, and provides high-
torque accuracy using advanced,
BorgWarner-developed controls.
Added automatic transmission
speeds, the shift from compo-
nents to subsystems and clutch
packs for all-wheel drive systems
create demand for friction
products. We supply “shift quality”
components and systems to every
automatic transmission maker.
P R O D U C T L E A D E R S H I P You can see it in the eyes of our people. You can feel it in the air
at each of our locations. You can even hear it. It’s the sound that comes from hitting on all cylinders.
That magic moment when all the pieces
fall into place, the stars align and the
spark of automotive engine-uity ignites.
At BorgWarner, it’s the result of a
century of delivering innovation.
It comes from every employee not
only understanding that rich history, but
embracing it. It motivates us to do a
great job – and then do it even better the next time. On the following pages you will read of just a few
examples of BorgWarner individuals who are pushing the envelope, walking the walk and making a real
difference. To each of them, Product Leadership isn’t a slogan, I T ’ S A C A L L T O A C T I O N .
12
F re e m a n S h e n
Country Manager
BorgWarner
Shanghai, China
P R O D U C T L E A D E R S H I P M E A N S G L O B A L P R E S E N C E
“ Our technology
13
and reputation
give us exciting
opportunities
in China.”
Asian markets like China, India and
Korea are the new growth frontiers for
BorgWarner. We have been in China since
1993, India since 1995 and Korea since
the late 1980s. While each country is
unique, they share common needs. Our
customers desire local engineering and
manufacturing as they embrace new tech-
nologies for reduced emissions, fuel effi-
ciency and driving comfort. Their goal
is to meet European engine emissions
requirements for both local and export
markets and to produce transmissions
In Korea, we are doing business from
that will please the most demanding
engine and drivetrain campuses. A com-
customers anywhere in the world.
mon BorgWarner manufacturing campus
Local leaders like Freeman Shen, along
with multi-national teams, are changing
the way BorgWarner thinks and works
as it structures for global growth. With
BorgWarner for five years, previously
heading the Emissions/Thermal opera-
tions in China, Freeman believes that
our technology not only sets us apart, it
allows us to attract good people needed
to drive our growth.
in China is under construction and our
Shanghai office opened in December
2004. We are starting small and proceed-
ing cautiously. Synergies from sharing
services as we enter or build our presence
in emerging markets offer other oppor-
tunities for collaboration and cost savings.
As we build our business in these areas,
we are also developing local suppliers that
can serve us around the world. Assuring
quality is a top priority.
i n c r e a s i n g
5-fold
Our sales in China, India and Korea are expected to increase about five-fold over the next five years
from a small base today. As they build roads and cars for new drivers, these countries will be the
fastest growing in the auto industry. As a global powertrain product leader, we are well positioned to
take full advantage of this growth and that in other emerging markets.
V C T C a m P h a s e r w i t h
Va r i a b l e F o rc e S o l e n o i d
I n t e r A c t i v e To rq u e
M a n a g e m e n t 1
Tu r b o c h a rg e r
B V 5 0
Collaboration and synergy are key focuses as we continue to grow faster than the auto industry
by capitalizing on powertrain growth trends around the world. Our acquisition of the majority
stake in Beru further expands our global breadth, especially in Europe. Beru expertise will also
add depth to our Engine Group strategy for air management and improved combustion.
Combined Sales 2005e
Asia
17%
Europe
38%
45%
Americas
P R O D U C T L E A D E R S H I P M E A N S C O L L A B O R A T I O N , S Y N E R G Y
14
“We sustain
our culture by
integrating our
vision into our
daily work lives.”
One of a three-person team, she strives
to provide her employee customers with
more than they expect. Product leadership
and its focus on safety and quality are not
just slogans. People like Michelle integrate
them into the fabric of daily life and deci-
sion making at BorgWarner, changing and
shaping our culture to allow us to grow.
How does a lean, decentralized company
Every company has products and people,
like BorgWarner spur growth and make
but it is the unique combination of these –
the most of its people and resources
the chemistry and the culture – that make
around the world? Through synergies,
one different from the other. Whether it’s
each business unit retains the best of
innovative approaches to sharing services
its entrepreneurial spirit while sharing
or creating new ways to do business,
the benefits of common services like
people like Michelle help nurture the talent
human resources, information technology,
we need to succeed.
supply chain management and finance.
Through collaboration, we want to create
a BorgWarner that is more than just the
sum of its parts.
Support services people like Michelle
Hartman are in the front lines of this effort.
I n t e r A c t i v e To rq u e
M a n a g e m e n t 2
B i n a r y
O i l P u m p
S e c o n d a r y
A i r P u m p
M i c h e l l e H a r t m a n
Human Resources Generalist
BorgWarner TorqTransfer Systems
Seneca, South Carolina, USA
16
K u n i h i k o M i s h i m a
Engineering Supervisor
Morse TEC
Nagoya, Japan
P R O D U C T L E A D E R S H I P M E A N S C U S T O M E R D I V E R S I T Y
“ Local support
17
for automakers
builds our global
customer base.”
In the past five years BorgWarner has
won new business that gives it one of the
broadest customer bases in the industry.
This transition reflects years of work
behind the scenes, building relationships
and demonstrating and proving our tech-
nology to customers like Honda, Hyundai
and VW/Audi. Kunihiko Mishima and his
fellow engineers have been in the forefront
of this endeavor, designing customized
chain products for the needs of Japanese
keys to earning this business. According
automakers as they develop more efficient
to Kunihiko, it requires around-the-clock
engines that benefit from the durability of
communications and sharing of technol-
chain timing systems.
ogy and experience.
With global customers come global
BorgWarner benefits from being a “local”
programs, like the family of four-cylinder
company for our customers, wherever
gasoline engines produced by the Global
they may be. In Japan, our chain products
Engine Alliance, a joint venture between
business and our major joint venture for
Hyundai, DaimlerChrysler and Mitsubishi;
transmission products have operated in
or VW/Audi’s gasoline 4-cylinder world
that country since the mid-1960s. We
engine to be built in China. Consistent
have been in Germany for over 50 years.
quality and manufacturing of our engine
This local presence, along with leading
products, coordinated with facilities in
technology, continues to allow us to
North America, Europe and Asia, are
balance our sales growth with the shifting
market shares of our customers.
Our understanding of powertrain function sets us apart from our competitors. Our expertise
is showcased in intelligent all-wheel drive systems like those used by Hyundai, in our new
transmission technology being rolled out by Volkswagen/Audi, and in variable cam timing that
will be introduced by General Motors in 2006 models.
Tr a n s m i s s i o n
C o n t ro l M o d u l e
E n g i n e T i m i n g
S y s t e m
A i r F l o w
S y s t e m
18
P R O D U C T L E A D E R S H I P M E A N S V A L U E - A D D E D T E C H N O L O G Y
“Technology
must create
value for our
customers.”
When it comes to industry leading prod-
ucts such as turbochargers, engineers like
Uwe Muenkel know that technology alone
is not enough. Product leadership means
solving commercial problems, providing
improved benefits and creating value for
customers all at the same time. Whether
they are developing new products like
our regulated two-stage turbocharger for
BMW or creating new applications from
existing products, our engineers must
blend innovation and speed to market with
process and cost discipline.
This is an exciting time for Uwe and his col-
leagues. The pace of change in and around
the powertrain is driving BorgWarner
growth. We add value as a partner in the
development of new engines and drive-
trains for efficient power generation
and torque management. The result is
increased content for us, and better fuel
economy and reduced emissions for our
vehicle maker customers.
Uwe’s ten years in the fast-growing turbo-
charger business have taught him that it
takes more than technology to manage
and drive growth. He and his colleagues
face the challenge of developing the
innovators of tomorrow while dealing
with the relentless demands of customers.
Within BorgWarner technical facilities
around the world, seasoned engineers
work to nurture those with less experi-
ence, allowing ideas to flourish. Our goal:
to continuously reinvent ourselves.
B e r u I n s t a n t S t a r t
S y s t e m
D i e s e l E x h a u s t
G a s R e c i rc u l a t i o n
R e g u l a t e d Tw o - S t a g e
Tu r b o c h a rg e r
In the next ten years, worldwide diesel engine penetration is expected to grow 82%, from 11
million units to 19 million units. Europe will likely remain the largest diesel market with 31%
growth, while diesel engines in Asia are expected to more than double. BorgWarner is expected
to benefit from this growth through products like turbochargers, diesel exhaust gas recircula-
tion valves and diesel cold start and ignition technologies from Beru.
19
U w e M u e n k e l
Director of Passenger Car
Research & Development
BorgWarner Turbo Systems
Kirchheimbolanden, Germany
20
21
P R O D U C T L E A D E R S H I P M E A N S M A N U F A C T U R I N G E X C E L L E N C E
R e g i n a D u n a g a n
Team Leader
BorgWarner Transmission Systems
Bellwood, Illinois, USA
“ My job is to
deliver quality
products. With
me, it’s personal.”
Like thousands of employees through-
out BorgWarner’s worldwide network of
facilities, Regina Dunagan takes her job
personally. Their commitment to continu-
ous improvement translated into a 13%
increase in sales per employee in 2004.
A team leader in a cell that makes clutch
packs, Regina’s top priority is assuring
product quality. She knows that manufac-
turing is the backbone of the company’s
success and that product leadership
means being the best at what we do. At
Through training, new equipment and
the end of her day, she wants to know that
production optimization techniques, out-
she did her best, and that her fellow work-
put of her plant has doubled over the past
ers feel the same way.
few years.
In her 21 years with the company’s trans-
Manufacturing flexibility is key. In the com-
mission business, Regina has seen a lot of
petitive auto industry, productivity improve-
changes. The most dramatic is the move
ments need to outpace cost increases and
from manual assembly to the flexibility of
low value-added manufacturing processes
today’s automated processes. She works
are outsourced. Our people know that
on products that move all over the world.
better productivity helps secure the future
of the company and that our compensation
systems reward them for their success.
G O A L S / B E N C H M A R K S
BorgWarner
2004
N
A
J
B
E
F
R
A
M
Safety
Cost Savings
Quality
%%%%%%
A disciplined, robust process at BorgWarner tracks such critical metrics as cost, quality and
safety. The process challenges each operation to account for, cover and neutralize all their
costs, both on the positive and negative sides. This process addresses the need to offset
increasing costs for commodities and employee welfare, and price pressures inherent in a
competitive marketplace.
C l u t c h P a c k
A s s e m b l y
G e m i n i C h a i n
S y s t e m
4 W D
Tr a n s f e r C a s e
Drivetrain 2014
Demand for front-wheel all-wheel drive systems and six-speed automatic
and dual clutch transmissions are expected to drive growth. The number of
automated transmissions in Europe is expected to triple in ten years.
Front-wheel all-wheel drive penetration could grow 34% in the next five years.
22
C u s t o m e r D i v e r s i t y
2 0 0 5 E s t i m a t e d C o m b i n e d S a l e s *
PSA 2%
ZF 2%
Caterpillar 2%
Honda 4%
Hyundai/Kia 6%
Renault/Nissan 6%
Toyota 7%
VW/Audi 10%
* Incl udes Beru and NSK-Warner
1% BMW
2% International
2% John Deere
19% All Others
16% Ford
11% DaimlerChrysler
10% GM
Engine 2014
In the next ten years, gasoline engines are expected to experience 34% growth
worldwide; diesel engine penetration is anticipated to grow 82%. The need for
improved fuel economy and reduced emissions will drive growth.
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
I N T R O D U C T I O N
Overview
BorgWarner Inc.
and Consolidated Subsidiaries
25
BorgWarner Inc. and Consolidated Subsidiaries (the Company) is a
leading global supplier of highly engineered systems and components
primarily for powertrain applications. Our products help improve
vehicle performance, fuel efficiency, air quality and vehicle stabil-
ity. They are manufactured and sold worldwide, primarily to original
equipment manufacturers (OEMs) of light vehicles (i.e. passenger
cars, sport-utility vehicles, vans and light-trucks). Our products are
also manufactured and sold to OEMs of commercial trucks, buses
and agricultural and off-highway vehicles. We operate manufacturing
facilities serving customers in the Americas, Europe and Asia, and
are an original equipment supplier to every major OEM in the world.
The Company’s products fall into two reportable operating seg-
ments: Drivetrain and Engine. The Drivetrain segment is comprised
of all-wheel drive transfer cases, torque management systems and
components and systems for automatic transmissions. The Engine
Segment is comprised of turbochargers, timing chain systems, air
management, emissions and thermal systems.
Stock Split
On April 21, 2004 the Company’s stockholders approved an amend-
ment to the Company’s Restated Certificate of Incorporation to
increase the number of authorized shares of common stock from
50,000,000 to 150,000,000. The approval of the amendment
allowed the Company to proceed with its two-for-one stock split on
May 17, 2004 to stockholders of record on May 3, 2004. All prior
year share and per share amounts disclosed in this document have
been restated to reflect the two-for-one stock split.
Beru Transaction
On January 4, 2005, the Company acquired 62.2% of the outstand-
ing shares of Beru Aktiengesellschaft (Beru), headquartered in
Ludwigsburg, Germany, from the Carlyle Group and certain family
shareholders. In conjunction with the acquisition, the Company
launched a tender offer for the remaining outstanding shares of
Beru. The tender offer period officially ended on January 24, 2005.
Presently the Company holds 69.42% of the shares of Beru at a cost
of approximately €415 million. Beru is a leading global automotive
supplier of diesel cold starting technology (glow plugs and instant
starting systems); gasoline ignition technology (spark plugs and igni-
tion coils); and electronic and sensor technology (tire pressure sen-
sors, diesel cabin heaters and selected sensors). Beginning in 2005,
the Company will report the operating results of Beru within the
Engine segment. The Company has not included a separate discus-
sion of the Beru operations in the outlook for 2005, although many
of the same factors that impact the Company’s other operations can
be expected to impact the business of Beru. In addition, the impact
of Beru on the Company’s future results will be affected by the alloca-
tion of the excess purchase price over the net book value of assets
acquired between intangible assets and goodwill.
A summary of our operating results by segment for the years ended
December 31, 2004, 2003 and 2002 is as follows:
millions of dollars, except per share data
Year ended December 31,
Drivetrain
Engine
Segment earnings before
interest and taxes
Corporate
Consolidated earnings before
2004
2003
2002
$106.9
$98.4
$99.9
281.7
239.6
215.9
388.6
338.0
315.8
(50.3)
(48.0)
(44.3)
interest and taxes
338.3
290.0
271.5
Interest expense and finance charges
29.7
33.3
37.7
Earnings before income taxes
308.6
256.7
233.8
Provision for income taxes
Minority interest, net of tax
81.2
9.1
73.2
8.6
77.2
6.7
Net earnings before cumulative effect
of accounting change
218.3
174.9
149.9
Cumulative effect of change in
accounting principle, net of tax
—
—
(269.0)
Net earnings/(loss)
$218.3 $174.9 $(119.1)
Per share data – assuming dilution:
Earnings per share before
cumulative effect of
accounting change
$3.86
$3.20
$2.79
Cumulative effect of accounting change
—
—
(5.01)
Earnings/(loss) per share
$3.86
$3.20
$(2.22)
A summary of major factors impacting the Company’s net earnings
for the years ended December 31, 2004 in comparison to 2003 and
2002 is as follows:
• Continued demand for our products in both Drivetrain and Engine
segments.
• Continued results of our cost reduction programs, including
containment of selling, general & administrative expenses, which
helped to offset our commodity cost increases and start up costs
incurred for our expansion in Korea and China.
• Lower interest expenses due to lower debt levels.
• Favorable currency impact of $11.0 million in 2004 and $14.5 mil-
lion in 2003.
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
26
R E S U LT S O F O P E R AT I O N S
Net Sales
The table below summarizes the overall worldwide global light vehicle
production percentage changes for 2004 and 2003:
WORLDWIDE LIGHT VEHICLE
YEAR OVER YEAR CHANGE IN PRODUCTION*
North America
Europe
Japan and Korea
Total World-wide
2004
(0.7)%
5.0%
3.9%
5.2%
2003
(3.0)%
1.4%
(0.7)%
(1.6)%
Results By Operating Segment
The following tables present net sales and earnings before interest and
income taxes (EBIT) by segment for the years 2004, 2003 and 2002.
NET SALES
millions of dollars
Year ended December 31,
Drivetrain
Engine
2004
2003
2002
$1,358.6 $1,245.6 $1,122.1
2,217.0
1,869.7
1,648.2
Inter-segment eliminations
(50.3)
(46.1)
(39.2)
Net sales
$3,525.3 $3,069.2 $2,731.1
*Data provided by CSM Worldwide.
EARNINGS BEFORE INTEREST AND TAXES (EBIT)
BorgWarner Year Over Year Net Sales Change
14.9%
12.4%
Our net sales increase in 2004 and 2003 was strong compared to the
estimated worldwide market production increase of approximately
5.2% in 2004 and decrease of (1.6)% in 2003. The Company’s net
sales increased 14.9% from 2003 and increased 12.4% from 2002 to
2003. The increase in 2004 was driven by both of our operating seg-
ments from higher demand for turbochargers, especially in Europe;
new DualTronic™ transmissions; all-wheel drive systems; and timing
chain systems in Asia and Europe. The effect of changing currency
rates also had a positive impact on net sales and net earnings in
2004. The effect of non-U.S. currencies, primarily the Euro, U.K.
Pound, Japanese Yen and Korean Won, added $114.0 million to net
sales in 2004 and $161.9 million in 2003. The year over year increase
in net sales excluding the favorable impact of currency was 11.1% in
2004 and 6.5% in 2003.
Consolidated net sales included sales to Ford Motor Company of
approximately 21%, 23%, and 26%; to DaimlerChrysler of approxi-
mately 14%, 17%, and 20%; and to General Motors Corporation of
approximately 10%, 12%, and 12% for the years ended December
31, 2004, 2003 and 2002, respectively. Sales to Volkswagen were
approximately 10% in 2004. Both of our operating segments had
significant sales to all four of the customers listed above. Such sales
consisted of a variety of products to a variety of customer locations
and regions. No other single customer accounted for more than 10%
of consolidated sales in any year of the periods presented.
Over the past several years as our major customers have continued
to consolidate, we have increased our sales to several other global
OEMs, bringing us more in line with our customers’ share of the
global vehicle market. As a result, sales to Ford, DaimlerChrysler and
General Motors have become a smaller percentage of total sales.
Our overall outlook for 2005 is positive. Sales are expected to grow
in excess of a projected flat to slightly positive global production rate
and we expect to benefit from the continuation of several trends:
change in Europe to diesel engines, which utilize turbochargers and
certain Beru products; shift in Europe to automatic transmissions;
and the switch from timing belts to timing chains in Asia and Europe.
Each of these trends is positive for the Company. Assuming no major
changes to the above assumptions, the Company expects continued
long-term sales and net earnings growth.
millions of dollars
Year ended December 31,
Drivetrain
Engine
Segment earnings before interest
and taxes
Corporate
Consolidated earnings before
interest and taxes
Interest expense and finance
charges
2004
2003
2002
$106.9
$ 98.4
$ 99.9
281.7
239.6
215.9
388.6
(50.3)
338.0
(48.0)
315.8
(44.3)
$338.3
$290.0
$271.5
29.7
33.3
37.7
Earnings before income taxes
$308.6
$256.7
$233.8
The Drivetrain segment net sales increased 9.1% from 2003 to
2004; EBIT increased 8.6% for the same period. The sales increase
was the result of strong global demand for transmission compo-
nents and all-wheel drive systems. The Company’s new DualTronic™
transmission product continues to ramp-up volume in Europe. The
increase in EBIT was due to increased volume and continued focus on
cost reductions in our operations. These positive trends were offset
by commodity price increases of approximately $20 million, which is
primarily steel, and start up costs.
The Drivetrain segment net sales increased 11.0% from 2002 to 2003,
but EBIT declined 1.5% for the same period. The sales gains were
due to all-wheel drive transfer case programs with General Motors,
increased sales of the Company’s Interactive Torque Management ™
all-wheel drive systems to Honda and Hyundai, and steady demand
for transmission components and systems, especially with increased
automatic transmission adoption in Europe. These sales gains were
offset by declines in North American automotive production. The
decrease in EBIT was due to start-up costs for the Company’s new
DualTronic™ transmission product, including the opening of a new
assembly facility in Europe. Profitability also suffered from a less
favorable product mix and an increase in pension and retiree health
care costs over the previous year.
In 2005, growth in the Drivetrain segment is expected to be flat as
demand for traditional light-trucks will be about the same as in 2004.
Sport-utility vehicles are expected to decline, while sales of front-
wheel-drive based all-wheel-drive systems are expected to increase.
Transmission products will benefit from increased penetration of auto-
matic transmissions in Europe and Asia, and the continued ramp-up of
DualTronic™ transmission modules in Europe.
BorgWarner Inc.
and Consolidated Subsidiaries
27
The Engine segment 2004 net sales increased 18.6% over 2003 and
EBIT increased 17.6% over the same period. This segment benefited
from strong demand for the Company’s turbochargers for European
passenger cars and commercial vehicles. The segment EBIT was
impacted by increased volume, productivity and positive currency
impact, which offset commodity price increases of approximately
$20 million and start up costs in Korea and China.
The Engine segment 2003 net sales increased 13.4% over 2002 and
EBIT increased 11.0% over the same period. This segment benefited
from continued demand for the Company’s turbochargers for European
passenger cars and commercial vehicles as well as continued growth
of our timing chain and emissions products. The EBIT was impacted
by increased productivity and production in the turbocharger business,
which translated into higher profitability. This was partially offset by
start up costs for Variable Cam Timing systems, which will launch in
2004 and for new Korean operations.
For 2005, the Engine Group expects to deliver continued growth from
further penetration of diesel engines in Europe, which will continue
to boost demand for turbochargers and Beru technologies, and the
launch of our first high-volume variable cam timing (VCT) system.
Investments in Korea and China are expected to begin to contribute
to results. This growth is expected to help offset anticipated weak-
ness in North American light vehicle production.
Corporate is the difference between calculated total Company EBIT
and the total from the segments and represents corporate headquar-
ters expenses and expenses not directly attributable to the individual
segments and includes equity in affiliate earnings. This net expense
was $50.3 million in 2004, $48.0 million in 2003, and $44.3 million in
2002. The main reasons for the increase from 2003 to 2004 was an
increase in our environmental spending related to the Crystal Springs,
Mississippi site and the $3.7 million write down of a note relating to the
sale of Kuhlman Electric Corporation, which were mostly offset by stron-
ger equity earnings from NSK-Warner. The increase from 2002 to 2003
was due to higher pension and post retirement health care costs for
discontinued operations, which are recorded at the corporate level.
Other Factors Af fecting Results of Operations
The following table details our results of operations as a percentage
of sales:
Year Ended December 31,
2004
2003
2002
Net sales
Cost of sales
Gross profit
Selling, general and
administrative expenses
Other, net
Operating income
100.0%
100.0%
100.0%
81.5
18.5
9.6
0.1
8.8
80.9
19.1
79.7
20.3
10.3
11.1
—
8.8
—
9.2
Equity in affiliate earnings, net of tax
-0.8
- 0.7
- 0.7
Interest expense and finance charges
Earnings before income taxes
Provision for income taxes
Minority interest, net of tax
Net earnings before cumulative effect
of accounting change
0.8
8.8
2.3
0.3
1.1
8.4
2.4
0.3
1.4
8.5
2.8
0.2
6.2%
5.7%
5.5%
Gross Profit for 2004 was 18.5% down from 19.1% in 2003 and down
from 20.3% in 2002. The decrease in gross profit in 2004 was due
to several factors, including significant commodity price increases,
including steel, a change in sales mix and geographic expansion.
The geographic expansion includes new facilities in Europe and Asia
for both operating segments. We anticipate 2005 margins to be
impacted by the leveling off of commodity price increases, the con-
tinued shift from components to systems sales and continued results
from our cost reduction initiatives.
Also impacting gross margins in 2004, 2003 and 2002 is the effect
of a royalty agreement the Company entered into with Honeywell
International for certain variable turbine geometry (VTG) turbocharg-
ers after a German court ruled in favor of Honeywell in a patent
infringement action. In order to continue shipping to its OEM custom-
ers, the Company and Honeywell entered into two separate royalty
agreements, signed in July 2002 and June 2003, respectively. The
June 2003 agreement runs through 2006 with a minimum royalty for
shipments up to certain volume levels and a per unit royalty for any
units sold above these stated amounts.
The royalty agreement costs recognized under the agreements were
$14.2 million in 2004, $23.2 million in 2003 and $13.5 million in
2002. These costs were based on units shipped and were recorded
in cost of goods sold. It is anticipated that these costs will be at
minimal levels in 2005 and 2006 as the Company’s primary custom-
ers have converted most of their requirements to the next generation
VTG turbocharger.
Selling, general and administrative expenses (SG&A) as a per-
centage of net sales decreased to 9.6% from 10.3% in 2003 and
11.1% in 2002. While SG&A spending in dollars increased slightly, we
were able to slow that growth to a level below the growth in sales
through continued focus on cost controls, and leveraging the existing
infrastructure to support the increased sales.
Research and development (R&D) is a major component of the
Company’s SG&A expenses. R&D spending was $123.1 million, or
3.5% of sales in 2004, compared to $118.2 million, or 3.9% of sales
in 2003, and $109.1 million, or 4.0% of sales in 2002. We continue
to increase our spending in R&D, although the growth rate has been
somewhat lower than our sales growth rate. We also continue to invest
in a number of cross-business R&D programs, as well as a number of
other key programs, all of which are necessary for short- and long-
term growth. Our long-term target for R&D spending is approximately
4% of sales. We intend to maintain our commitment to R&D spending
while continuing to focus on controlling other SG&A costs.
Other, net decreased to $(3.0) million of loss in 2004, from $0.1 mil-
lion of income in 2003 and $0.9 million of income in 2002. The major
item was losses from capital asset disposals of $3.5 million in 2004.
Equity in affiliates earnings, net of tax increased by $9.1 million
from 2003, and by $0.6 million between 2003 and 2002. This line
item is primarily driven by the results of our 50% owned Japanese
joint venture, NSK-Warner. For more discussion of NSK-Warner, see
Note 5 of the Consolidated Financial Statements.
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
28
Interest expense, net decreased by $3.6 million in 2004 and
decreased by $4.4 million between 2003 and 2002. The decreases in
2004 and 2003 were due to lower debt levels, as we used cash gen-
erated from operations to pay off debt. In 2004, our balance sheet
debt decreased by $71.0 million. In 2003, our balance sheet debt
decreased $2.7 million excluding the fair value adjustment for inter-
est rate swaps, and we reduced the amount of securitized accounts
receivable sold by $40.0 million. We took advantage of lower inter-
est rates through the use of interest rate and cross-currency swap
arrangements described more fully in Note 7 to the Consolidated
Financial Statements.
The provision for income taxes resulted in an effective tax rate
for 2004 of 26.3% compared with rates of 28.5% in 2003 and 33.0%
for 2002. Our effective tax rates have been lower than the standard
federal and state tax rates due to the realization of certain R&D and
foreign tax credits; foreign rates, which differ from those in the U.S.;
and offset by non-deductible expenses. In addition, the Company
made an $11.4 million year-end adjustment to various tax accounts
due to changes in circumstances related to various tax items, includ-
ing changes in tax laws. The year-end adjustment resulted in a reduc-
tion in the U.S. effective tax rate for 2004. In 2005, we anticipate
our tax rate to be approximately 30% to 31% based on our current
mix of business.
L I Q U I D I T Y A N D C A P I TA L R E S O U R C E S
Net cash provided by operating activities of $426.6 million was pri-
marily used to fund $204.9 million of capital expenditures, $47.5 mil-
lion of tooling, net of customer reimbursements, pay down long-term
debt of $61.8 million, pay $27.9 million of dividends to our sharehold-
ers, and increase cash and cash equivalents by $116.6 million.
Operating Activities
Net cash provided by operating activities of $426.6 million is $119.7
million more than in 2003. The $426.6 million consists of net income
of $218.3 million, increased for non-cash charges of $222.4 million
and offset by a $17.3 million increase in net operating assets and
liabilities. Non-cash charges are primarily comprised of $177.0 million
in depreciation and amortization expense.
Accounts receivable increased a total of $84.2 million, of which $23.8
was due to currency. The remaining increase was due to higher busi-
ness levels, particularly in Europe. Certain of our European custom-
ers tend to pay slower than our North American customers. Inventory
increased by $22.1 million, but our inventory turns improved to 12.9
times from 12.3 times in 2003.
Investing Activities
Net cash used in investing activities totaled $257.2 million, compared
with $228.2 million in the prior year. Capital spending totaling $204.9
million in 2004 was $32.9 million higher than in 2003. Approximately
60% of the 2004 capital spending was related to expansion, with the
remainder for cost reduction and other purposes. Heading into 2005,
we plan to continue to spend on capital to support the launch of our
new applications and for cost reductions and productivity improve-
ment projects. Our target for capital spending is to be approximately
5.5% of sales.
The 2003 investing uses of cash includes $12.8 million of payments
to resolve a valuation dispute regarding the value of the turbocharger
business of Aktiengesellschaft Kühnle, Kopp & Kausch (AGK). The
valuation payment resulted from the settlement in 2003 of a lawsuit
brought by certain minority shareholders of AGK related to the auto-
motive turbocharger business of AGK, which the Company purchased
from AGK in 1998.
Since the settlement of the dispute, the Company extended a formal
tender offer to purchase all of the outstanding common and preferred
shares of AGK from the remaining shareholders. The Company spent
$9.0 million in 2004 and $14.4 million in 2003 to purchase additional
shares of AGK, an unconsolidated subsidiary of the Company, which
has been recorded as an “Investment in business held for sale” in
the Consolidated Balance Sheets. Effective February 17, 2005, the
Company signed a Share Transfer Agreement (STA) with Turbo Group
GmbH for the sale of its 95.42% interest in AGK. The STA will become
effective no later than seven banking days after receipt of approval
from both the German Federal Cartel Office and the Austrian Merger
Control Authority. The transaction is anticipated to close before
March 31, 2005. The estimated proceeds from the pending sale, net
of closing costs are approximately €39.8 million.
Financing Activities and Liquidit y
Stockholders’ equity increased by $273.8 million in 2004. The
increase was primarily caused by net income of $218.3 million,
along with currency translation and hedge instruments adjustments
of $28.4 million, stock option exercises of $14.4 million and stock
issuances to retirement plans of $25.8 million. These factors were
somewhat offset by dividend payments of $27.9 million. In relation to
the U.S. Dollar, the currencies in foreign countries where we conduct
business, particularly the Euro and Yen, strengthened, causing the
currency translation component of other comprehensive income to
increase in both 2004 and 2003.
Our total capitalization as of December 31, 2004 of $2,140.9 million
is comprised of short-term debt of $16.5 million, long-term debt of
$568.0 million, minority interest of $22.2 million and stockholders’
equity of $1,534.2 million. Capitalization at December 31, 2003 was
$1,934.2 million. During the year, we reduced our balance sheet debt
to debt plus equity ratio to 27.3% from 34.2% in 2003.
The Company has a new revolving credit facility, which provides for
borrowings up to $600 million through July 2009. The new facility
effective July 22, 2004, replaced the Company’s previous facility of
$350 million. Additionally, we have $300 million available under a
universal shelf registration statement on file with the Securities and
Exchange Commission through which a variety of debt and/or equity
instruments may be issued. The Company also has access to the
commercial paper market through a $50 million accounts receivable
securitization facility, which is rolled over annually. From a credit qual-
ity perspective, we have an investment grade credit rating of A- from
Standard & Poor’s and Baa2 from Moody’s.
BorgWarner Inc.
and Consolidated Subsidiaries
29
The Company’s significant contractual obligation payments at December 31, 2004, are as follows:
millions of dollars
Total
2005
2006-2007
2008-2009
After 2009
Other post retirement benefits excluding pensions(a)
Notes payable and long-term debt
Projected minimum interest costs(b)
Non-cancelable operating leases
Minimum royalty payments(c)
Total
$1,599.9
586.8
89.7
58.0
1.5
$ 30.8
16.5
26.2
29.1
1.5
$ 60.0
158.1
38.9
9.0
—
$ 61.5
152.7
20.9
7.1
—
$1,447.6
259.5
3.7
12.8
—
$2,335.9
$104.1
$266.0
$242.2
$1,723.6
(a) Other post retirement benefits (excluding pensions) include anticipated future payments to cover retiree medical and life insurance benefits. Since the timing and amount of
payments for pension plans is not certain for future years, such payments have been excluded from this table. The Company expects to contribute a total of $20 million to
$25 million into all pension plans during 2005. See Note 8 to the Consolidated Financial Statements for disclosures related to the Company’s pension and other post retire-
ment benefits.
(b) Projection is based upon an average debt portfolio interest rate of 5.00%. The calculation excludes the impact of the Beru transaction.
(c) The minimum royalty payments are related to the Honeywell royalty agreement discussed more fully in Note 12 to the Consolidated Financial Statements. The Company has
other royalty agreements that are based on sales volumes. These royalty agreements do not have minimum royalty payments and are typically cancellable and have been
excluded from the amounts in the table.
Pension and Other Post Retirement Benefits
The Company’s policy is to fund its defined benefit pension plans in
accordance with applicable U.S., U.K., German and Japanese govern-
ment regulations and to make additional contributions when manage-
ment deems it appropriate. At December 31, 2004, all legal funding
requirements had been met. The Company contributed $36.3 million
to its pension plans in 2004 and $17.1 million in 2003. The Company
expects to contribute a total of $20 million to $25 million in 2005.
The funded status of pension plans with accumulated benefit obliga-
tions in excess of plan assets improved from $(148.1) million at the
end of 2003 to $(127.8) million at the end of 2004. The improvement
was primarily due to positive returns on plan assets of $43.6 million
and company contributions of $36.3 million, which were partially off-
set by interest costs of $28.8 million, service costs of $11.7 million
and foreign currency translation of $9.7 million.
Other post retirement benefits primarily consist of post retirement
health care benefits. The Company funds these benefits as retiree
claims are incurred. Other post retirement benefits had an unfunded
status of $(537.2) million at the end of 2004, and $(537.4) million at the
end of 2003. The unfunded levels were relatively stable as increases in
the liabilities related to a decline in the interest rate assumptions used
to calculate the ending liabilities for each of the plans were offset by
benefits of the new Medicare Part D plan enacted during 2004.
The Company believes it will be able to fund the requirements of these
plans through cash generated from operations or other sources for
the foreseeable future.
The Company does not have any long-term or fixed purchase obliga-
tions for inventories.
The Company has a credit agreement that is subject to the usual
terms and conditions applied by banks to an investment grade
company. The Company was in compliance with all covenants at
December 31, 2004.
We believe that the combination of cash from operations, cash bal-
ances, available credit facilities and the universal shelf registration
will be sufficient to satisfy our cash needs for our current level of
operations and our planned operations, including the acquisition
of Beru, for the foreseeable future. We will continue to balance our
needs for internal growth, external growth, debt reduction, dividends
and share repurchase.
Of f Balance Sheet Arrangements
As of December 31, 2004, the accounts receivable securitization
facility was sized at $50 million and has been in place with its cur-
rent funding partner since January 1994. This facility sells accounts
receivable without recourse.
The Company has certain leases that are recorded as operating
leases. Types of operating leases include leases on the headquar-
ters facility, an airplane, vehicles, and certain office equipment. The
Company also has a lease obligation for production equipment at
one of it facilities. The total expected future cash outlays for all lease
obligations at the end of 2004 is $58.0 million. See Note 12 to the
Consolidated Financial Statements for more information on operating
leases, including future minimum payments.
The Company has guaranteed the residual values of the leased
production equipment. The guarantees extend through the maturity
of the underlying lease, which is in 2005. In the event the Company
exercises its option not to purchase the production equipment, the
Company has guaranteed a residual value of $16.3 million. We do not
believe we have any potential loss due to this guarantee.
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
30
O T H E R M AT T E R S
Contingencies
In the normal course of business the Company and its subsidiaries
are parties to various legal claims, actions and complaints, including
matters involving intellectual property claims, general liability and
various other risks. It is not possible to predict with certainty whether
or not the Company and its subsidiaries will ultimately be successful
in any of these legal matters or, if not, what the impact might be.
The Company’s environmental and product liability contingencies are
discussed separately below. The Company’s management does not
expect that the results in any of these legal proceedings will have
a material adverse effect on the Company’s results of operations,
financial position or cash flows.
Environmental
The Company and certain of its current and former direct and indirect
corporate predecessors, subsidiaries and divisions have been identi-
fied by the United States Environmental Protection Agency and cer-
tain state environmental agencies and private parties as potentially
responsible parties (PRPs) at various hazardous waste disposal sites
under the Comprehensive Environmental Response, Compensation
and Liability Act (Superfund) and equivalent state laws and, as such,
may presently be liable for the cost of clean-up and other remedial
activities at 39 such sites. Responsibility for clean-up and other
remedial activities at a Superfund site is typically shared among PRPs
based on an allocation formula.
Based on information available to us, which in most cases, includes:
an estimate of allocation of liability among PRPs; the probability that
other PRPs, many of whom are large, solvent public companies, will
fully pay the cost apportioned to them; currently available informa-
tion from PRPs and/or federal or state environmental agencies
concerning the scope of contamination and estimated remediation
and consulting costs; remediation alternatives; estimated legal fees;
and other factors, we have established an accrual for indicated
environmental liabilities with a balance at December 31, 2004 of
approximately $25.7 million. We expect this amount to be expended
over the next three to five years.
The Company believes that none of these matters, individually or in
the aggregate, will have a material adverse effect on its financial con-
dition or future operating results, generally either because estimates
of the maximum potential liability at a site are not large or because
liability will be shared with other PRPs, although no assurance can be
given with respect to the ultimate outcome of any such matter.
In connection with the sale of Kuhlman Electric Corporation, the
Company agreed to indemnify the buyer and Kuhlman Electric for
certain environmental liabilities relating to the past operations of
Kuhlman Electric. The liabilities at issue result from operations of
Kuhlman Electric that pre-date the Company’s acquisition of Kuhlman
Electric’s parent company, Kuhlman Corporation, in 1999. During
2000, Kuhlman Electric notified us that it discovered potential envi-
ronmental contamination at its Crystal Springs, Mississippi plant
while undertaking an expansion of the plant.
The Company has been working with the Mississippi Department of
Environmental Quality and Kuhlman Electric to investigate the extent
of and remediate the contamination. The investigation revealed the
presence of polychlorinated biphenyls (PCBs) in portions of the soil
at the plant and neighboring areas. Clean up began in 2000 and is
continuing. Kuhlman Electric and others, including the Company,
have been sued in numerous related lawsuits, in which multiple claim-
ants allege personal injury and property damage. The Company has
moved to be dismissed from some of these lawsuits. The first trial in
these lawsuits is currently scheduled to begin in March 2005.
We believe that the accrual for environmental liabilities is sufficient
to cover any potential liability associated with this matter. However,
due to the nature of environmental liability matters, there can be no
assurance that the actual amount of environmental liabilities will not
exceed the amount accrued.
Product Liabilit y
Like many other industrial companies who have historically oper-
ated in the United States, the Company (or parties the Company
indemnifies) continues to be named as one of many defendants in
asbestos-related personal injury actions. Management believes that
the Company’s involvement is limited because, in general, these
claims relate to a few types of automotive friction products, manu-
factured many years ago that contained encapsulated asbestos. The
nature of the fibers, the encapsulation and the manner of use lead
the Company to believe that these products are highly unlikely to
cause harm. At December 31, 2004, the Company had approximately
100,000 pending asbestos-related product liability claims. Of these
outstanding claims, approximately 92,000 are pending in just three
jurisdictions, where significant tort reform activities are underway.
The Company’s policy is to aggressively defend against these law-
suits and the Company has been successful in obtaining dismissal
of many claims without any payment. The Company expects that the
vast majority of the pending asbestos-related product liability claims
where it is a defendant (or has an obligation to indemnify a defendant)
will result in no payment being made by the Company or its insurers.
In 2004 of the 4,062 claims settled, only 255 (6.3%) resulted in any
payment being made to a claimant by or on behalf of the Company.
In 2003 of the 4,664 claims settled, only 273 (5.9%) resulted in any
payment being made to claimants. The settlement costs of these
claims were paid by the insurance carriers, except for the $1.0
million in 2004 as described in the paragraph below. Based upon
the encapsulated nature of the products, our experiences in aggres-
sively defending and resolving claims in the past, and our significant
insurance coverage with solvent carriers as of the date of this filing,
management does not believe that asbestos-related product liability
claims are likely to have a material adverse effect on the Company’s
results of operations, cash flows or financial condition.
Prior to June 2004, all claims were covered by the Company’s pri-
mary layer insurance coverage, and these carriers administered,
defended, settled and paid all claims under a funding agreement.
In June 2004, the Company was notified by primary layer insurance
BorgWarner Inc.
and Consolidated Subsidiaries
31
carriers of the exhaustion of their policy limits. This led the Company
to access the next available layer of insurance coverage. Since June
2004, secondary layer insurers have paid asbestos-related litigation
defense and settlement expenses pursuant to a funding agreement.
Two secondary layer insurers are currently not participating in this
arrangement until they are satisfied through an audit process, that
the primary level of insurance is exhausted. The Company therefore
paid $1.0 million in defense and settlement costs in late 2004 and
expects to recover those amounts from either these insurers, or the
primary layer insurers if the exhaustion audit shows that primary layer
insurance is still available.
The Company’s contractual relationship with the secondary layer car-
riers provides a change in circumstances and allows the Company to
take a more direct role in defending and settling claims than with the
primary carriers. Previously, the Company’s arrangement utilized the
primary layer insurance carriers’ positions to defend and negotiate
the settlements with periodic input from the Company.
At December 31, 2004, the Company recorded a liability of $40.8 mil-
lion; with a related asset of $40.8 million to recognize the insurance
proceeds receivable to the Company for estimated claim losses. For
2003, the comparable value of the insurance receivable and accrued
liability was $41.6 million.
The amounts recorded in the Consolidated Balance Sheets are
as follows:
millions of dollars
Assets:
2004
2003
Prepayments and other current assets
$13.5
$13.7
Other non-current assets
Total insurance receivable
27.3
27.9
$40.8
$41.6
both primary and additional layer insurance, and, in conjunction with
other insurers, is currently defending and indemnifying the Company
in all of its pending asbestos-related product liability claims. The
lawsuit seeks to determine the extent of insurance coverage available
to the Company including whether the available limits exhaust on a
“per occurrence” or an “aggregate” basis, and to determine how the
applicable coverage responsibilities should be apportioned. In addition
to the primary insurance available for asbestos-related claims, the
Company has substantial additional layers of insurance available for
potential future asbestos-related product claims.
Although it is impossible to predict the outcome of pending or future
claims; due to the encapsulated nature of the products, our experi-
ences in aggressively defending and resolving claims in the past, and
our significant insurance coverage with solvent carriers as of the date
of this filing, management does not believe that asbestos-related prod-
uct liability claims are likely to have a material adverse effect on the
Company’s results of operations, cash flows or financial condition.
Critical Accounting Policies
The Consolidated Financial Statements are prepared in conformity
with accounting principles generally accepted in the United States
of America. The preparation of these financial statements requires
the use of estimates, judgments and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses dur-
ing the periods presented. In preparing these financial statements,
management has made its best estimates and judgments of certain
amounts included in the financial statements, giving due consider-
ation to materiality. The significant accounting principles which man-
agement believes are the most important to aid in fully understanding
our financial results are included below. Management also believes
that all of the accounting policies are important to investors.
Liabilities:
Accounts payable and accrued expenses
$13.5
$13.7
Revenue Recognition
Long-term liabilities – other
Total accrued liability
27.3
27.9
$40.8
$41.6
The insurance receivable and accrued liability of $41.6 million in 2003
have been reclassified as outlined above and the reclassification is
not material to the Company’s Consolidated Financial Statements.
We cannot reasonably estimate possible losses, if any, in excess of
those for which we have accrued, because we cannot predict how
many additional claims may be brought against the Company (or
parties the Company has an obligation to indemnify) in the future,
the allegations in such claims, the possible outcomes, or the impact
of tort reform legislation currently being considered at the State and
Federal levels.
A declaratory judgment action was filed in January 2004 in the Circuit
Court of Cook County, Illinois by Continental Casualty Company and
related companies (CNA) against the Company and certain of its other
historical general liability insurers. CNA provided the Company with
The Company recognizes revenue upon shipment of product when
title and risk of loss pass to the customer. Although the Company may
enter into long-term supply agreements with its major customers,
each shipment of goods is treated as a separate sale and the price is
not fixed over the life of the agreements.
Sales of Receivables
The Company securitizes and sells certain receivables through third
party financial institutions without recourse. The amount sold can
vary each month based on the amount of underlying receivables. In
the fourth quarter of 2003, the Company reduced the maximum size
of the facility from $90 million to $50 million. In the fourth quarter of
2002, the Company reduced the maximum size of the facility from
$120 million to $90 million.
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
32
Impairment of Long-Lived Assets
Other Loss Accruals and Valuation Allowances
The Company periodically reviews the carrying value of its long-lived
assets, whether held for use or disposal, including other intangible
assets, when events and circumstances warrant such a review. This
review is performed using estimates of future cash flows. If the carry-
ing value of a long-lived asset is considered impaired, an impairment
charge is recorded for the amount by which the carrying value of the
long-lived asset exceeds its fair value. Management believes that the
estimates of future cash flows and fair value assumptions are reason-
able; however, changes in assumptions underlying these estimates
could affect the evaluations.
Goodwill
The Company annually reviews its goodwill for impairment in the
fourth quarter of each year for all of its reporting units, or when
events and circumstances warrant such a review. This review
requires us to make significant assumptions and estimates about the
extent and timing of future cash flows, discount rates, and growth
rates. The cash flows are estimated over a significant future period
of time, which makes those estimates and assumptions subject to an
even higher degree of uncertainty. We also utilize market valuation
models and other financial ratios, which require us to make certain
assumptions and estimates regarding the applicability of those mod-
els to our assets and businesses. We believe that the assumptions
and estimates used to determine the estimated fair values of each of
our reporting units are reasonable. However, different assumptions
could materially affect the estimated fair value. The goodwill impair-
ment test was performed in November 2004, and no impairment was
found. Amortization continues to be recorded for other intangible
assets with definite lives.
Environmental Accrual
We work with outside experts to determine a range of potential
liability for environmental sites. The ranges for each individual site
are then aggregated into a loss range for the total accrued liability.
Management’s estimate of the loss range for 2004 is between $21.3
million and $69.9 million. We record an accrual at the most probable
amount unless one cannot be determined; in which case we record
the accrual at the low end of the range. At the end of 2004, our total
accrued environmental liability was $25.7 million.
Product Warrant y
Provisions for estimated expenses related to product warranty are
made at the time products are sold. These estimates are established
using historical information about the nature, frequency, and average
cost of warranty claims as related to the warranty provisions of our
sales agreements with customers. We actively study trends of war-
ranty claims and take action to improve product quality and minimize
warranty claims. We believe that the warranty accrual is appropriate;
however, actual claims incurred could differ from the original esti-
mates, requiring adjustments to the accrued liability.
The Company has numerous other loss exposures, such as customer
claims, workers’ compensation claims, litigation, and recoverability
of assets. Establishing loss accruals or valuation allowances for
these matters requires the use of estimates and judgment in regards
to the risk exposure and ultimate realization. We estimate losses
under the programs using consistent and appropriate methods;
however, changes to our assumptions could materially affect our
recorded liabilities for loss.
Pension and Other Post Retirement Benefits
The Company provides post retirement benefits to a substantial por-
tion of its employees. Costs associated with post retirement benefits
include pension and post retirement health care expenses for employ-
ees, retirees and surviving spouses and dependents. The Company’s
employee pension and post retirement heath care expenses are
dependent on management’s assumptions used by actuaries in
calculating such amounts. These assumptions include discount
rates, health care cost trend rates, inflation, long-term return on plan
assets, retirement rates, mortality rates and other factors. Health
care cost trend assumptions are developed based on historical cost
data, the near-term outlook, and an assessment of likely long-term
trends. The inflation assumption is based on an evaluation of external
market indicators. Retirement and mortality rates are based primarily
on actual plan experience.
The Company’s approach to establishing the discount rate is based
upon corporate bond indices. In the United States, the discount rate
assumption is based upon the Moody’s Aa Corporate Bond Index as
of December 31, 2004, rounded up or down to the nearest 25 basis
points. Based on this approach, at December 31, 2004, the Company
lowered the discount rate for its U.S. pension and other benefit plans
to 5.75% from 6.00% at December 31, 2003. For the U.K. plans, the
discount rate assumption is based on the iBoxx AA rated bonds. At
December 31, 2004, the discount rate used was 5.75%. For other
locations, similar indices and methods are used.
The Company determines its expected return on plan asset assump-
tions by evaluating both historical returns as well as estimates of
future returns. Specifically, the Company analyzed the average his-
torical broad market returns for various periods of time over the past
100 years for equities and over a 30-year period for fixed income
securities, and adjusted the computed amount for any expected
changes in the long-term outlook for the equity and fixed income
markets. The Company’s expected return on assets was based on
expected equity and fixed income returns weighted by the percent-
age of assets allocated to each plan. The Company’s estimate of the
long-term rate of return on assets for its U.S. pension is 8.75% for
2004 and 2003, and 9.5% for 2002. The Company does not antici-
pate a change in the long-term rate of return on assets for pension
benefits in 2005. For the U.K. plan, the expected return is based upon
the relative weight of equity and debt investments, and the recent
performance of those investments. The Company’s estimate of the
long-term rate of return on assets for its U.K. pension is 6.75% for
2004 and 2003, and 7.0% for 2002.
BorgWarner Inc.
and Consolidated Subsidiaries
33
See Note 8 to the Consolidated Financial Statements for more
information regarding costs and assumptions for employee retire-
ment benefits.
Derivatives
The Company recognizes that certain normal business transactions
generate risk. Example of risks include exposure to exchange risk
related to transactions denominated in currencies other than the
functional currency, changes in cost of major raw materials and sup-
plies, and changes in interest rates. It is the objective and responsibil-
ity of the Company to assess the impact of these transactions risks,
and offer protection from selected risks through various methods
including financial derivatives. All derivative instruments held by the
Company are designated as hedges, have high correlation with the
underlying exposure and are highly effective in offsetting underlying
price movements. Accordingly, gains and losses from changes in
derivative fair values are matched with the underlying transactions.
The Company does not engage in any derivative transactions for
purposes other than hedging specific risks.
New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (FASB)
issued Interpretation (FIN) No. 46, “Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51,” which was revised in
December 2003. FIN No. 46R requires that the assets, liabilities and
results of the activity of variable interest entities be consolidated into
the financial statements of the entity that has the controlling financial
interest. FIN No. 46R also provides the framework for determining
whether a variable interest entity should be consolidated. For the
Company, this Interpretation, as revised, was effective January 1,
2004. The Company has no variable interest entities required to be
consolidated as a result of adopting FIN No. 46R.
In December 2003, the Medicare Prescription Drug Improvement
and Modernization Act of 2003 (Medicare Act) introduced a pre-
scription drug benefit under Medicare, as well as a federal subsidy
to sponsors of retiree health care benefit plans. In January 2004,
the FASB issued FASB Staff Position (FSP) No. 106-1, “Accounting
Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement, and Modernization Act of 2003.” FSP 106-1 permits
a sponsor of a post retirement health care plan that provides a pre-
scription drug benefit to make a one-time election to defer account-
ing for the effects of the Medicare Act if there is insufficient data,
time or guidance available to ensure appropriate accounting. The
Company is a sponsor of post retirement health care plans that pro-
vide prescription benefits and, in accordance with the one-time elec-
tion under FSP 106-1, elected to defer accounting for the Medicare
Act. In May 2004, the FASB issued FSP 106-2, “Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003,” which supersedes
FSP 106-1, to address the accounting and disclosure requirements
related to the Medicare Act. This FSP was adopted by the Company
beginning with its third quarter ended September 30, 2004. The
effect of the adoption was to reduce the Company’s 2004 post retire-
ment benefits expense by $6.8 million.
In November 2004, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 151, “Inventory Costs” which is an amendment
of ARB No.43, Chapter 4. This statement provides clarification of
accounting for abnormal amounts of idle facility expense, freight,
handling costs and wasted material. Generally, this statement
requires that those items be recognized as current period charges.
SFAS 151 will be effective for the Company on January 1, 2006. The
Company is currently evaluating the impact that the adoption of SFAS
151 will have on its consolidated financial position, results of opera-
tions and cash flows.
In December 2004, the FASB issued FSP 109-1, “Application of
FASB Statement No. 109, Accounting for Income Taxes, to the Tax
Deduction on Qualified Production Activities Provided by the American
Jobs Creation Act of 2004” (AJCA), and FSP 109-2 “Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision
within the AJCA.” These two FSPs provide guidance on the applica-
tion of the new provisions of the AJCA, which was signed into law on
October 22, 2004.
The AJCA provides a deduction for income from qualified domestic
production activities, which will be phased in from 2005 through
2010. In return, the AJCA provides for a two-year phase-out of the
existing extra-territorial income exclusion (ETI) for foreign sales that
was viewed to be inconsistent with international trade protocols by
the European Union. Under the guidance in FSP 109-1, the deduction
will be treated as a “special deduction” as described in SFAS 109.
As such, the special deduction has no effect on deferred tax assets
and liabilities existing at the enactment date. Rather, the impact of
this deduction will be reported in the period in which the deduction is
claimed on our tax return. The Company expects the net effect of the
phase out of the ETI and the phase in of this new deduction will not
have a material impact on its effective tax rate.
FSP 109-2 provides guidance on the accounting for the deduction of
85% of certain foreign earnings that are repatriated, as defined in the
AJCA. The Company may elect to apply this provision to qualifying
earnings repatriations in 2005. Under the guidance set forth in FSP
109-2, the Company is allowed time beyond the financial reporting
period of enactment to evaluate the effect of the AJCA on its plan for
reinvestment or repatriation of foreign earnings. The Company has
started an evaluation of the effects of the repatriation provision; how-
ever, the Company does not expect to be able to complete this evalua-
tion until after the U.S. Congress or the Treasury Department provides
additional clarifying language on key elements of the provision. The
Company expects to complete its evaluation of the effects of the
repatriation provision within a reasonable period of time following the
publication of the additional clarifying language. The range of possible
amounts that the Company is considering for repatriation under this
provision is between zero and $74 million. The related range of income
tax effects of such repatriation cannot be reasonably estimated until
guidance is issued by Congress or the Treasury Department.
In December 2004, the FASB issued SFAS No. 123R, “Shared-Based
Payment” which requires companies to measure and recognize com-
pensation expense for all share-based payments at fair value. Share-
based payments include stock option grants and certain transactions
under other Company stock plans. The Company grants options to
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Management’s Responsibility for
Consolidated Financial Statements
Report of Independent Registered
Public Accounting Firm
34
35
purchase common stock of the Company to some of its employees
and directors under various plans at prices equal to the market value
of the stock on the dates the options are granted. SFAS 123R will be
effective for the Company beginning July 1, 2005. The Company is
currently evaluating the impact that the adoption of SFAS 123R will
have on its consolidated financial position, results of operations and
cash flows.
Qualitative and Quantitative Disclosure
About Market Risk
The Company’s primary market risks include fluctuations in interest
rates and foreign currency exchange rates. We are also affected by
changes in the prices of commodities used or consumed in our manu-
facturing operations. Some of our commodity purchase price risk is
covered by supply agreements with customers and suppliers. Other
commodity purchase price risk is addressed by hedging strategies,
which include forward contracts. The Company enters into derivative
instruments only with high credit quality counterparties and diversi-
fies its positions across such counterparties in order to reduce its
exposure to credit losses. We do not engage in any derivative instru-
ments for purposes other than hedging specific risks.
We have established policies and procedures to manage sensitivity
to interest rate, foreign currency exchange rate and commodity
purchase price risk, which include monitoring the level of exposure
to each market risk.
Interest Rate Risk
Interest rate risk is the risk that we will incur economic losses due to
adverse changes in interest rates. The Company manages its interest
rate risk by balancing its exposure to fixed and variable rates while
attempting to minimize its interest costs. The Company selectively
uses interest rate swaps to reduce market value risk associated with
changes in interest rates (fair value hedges). At the end of 2004,
the amount of net debt with fixed interest rates was 62% of total
debt, including the impact of the interest rate swaps. Our earnings
exposure related to adverse movements in interest rates is primar-
ily derived from outstanding floating rate debt instruments that are
indexed to floating money market rates. A 10% increase or decrease
in the average cost of our variable rate debt would result in a change
in pre-tax interest expense for 2004 of approximately $1.3 million,
and $1.0 million in 2003.
We also measure interest rate risk by estimating the net amount by
which the fair value of all of our interest rate sensitive assets and
liabilities would be impacted by selected hypothetical changes in
market interest rates. Fair value is estimated using a discounted cash
flow analysis. Assuming a hypothetical instantaneous 10% change in
interest rates as of December 31, 2004, the net fair value of these
instruments would increase by approximately $23.8 million if interest
rates decreased and would decrease by approximately $21.9 mil-
lion if interest rates increased. Our interest rate sensitivity analysis
assumes a constant shift in interest rate yield curves. The model,
therefore, does not reflect the potential impact of changes in the
relationship between short-term and long-term interest rates. Interest
rate sensitivity at December 31, 2003, measured in a similar manner,
was slightly greater than at December 31, 2004.
Foreign Currency Exchange Rate Risk
Foreign currency risk is the risk that we will incur economic losses
due to adverse changes in foreign currency exchange rates.
Currently, our most significant currency exposures relate to the Euro,
the Japanese Yen, the British Pound, the Hungarian Forint and the
South Korean Won. We mitigate our foreign currency exchange rate
risk principally by establishing local production facilities in markets
we serve, by invoicing customers in the same currency as the source
of the products and by funding some of our investments in foreign
markets through local currency loans and cross currency swaps.
Such non-U.S. Dollar debt was $324.6 million as of December 31,
2004 and $184.0 million as of December 31, 2003. We also monitor
our foreign currency exposure in each country and implement strate-
gies to respond to changing economic and political environments.
In addition, the Company periodically enters into forward currency
contracts in order to reduce exposure to exchange rate risk related
to transactions denominated in currencies other than the functional
currency. In the aggregate, our exposure related to such transactions
was not material to our financial position, results of operations or
cash flows in both 2004 and 2003.
Commodit y Price Risk
Commodity price risk is the possibility that we will incur economic
losses due to adverse changes in the cost of raw materials used in
the production of our products. Commodity forward and option con-
tracts are executed to offset our exposure to the potential change
in prices mainly for various non-ferrous metals and natural gas
consumption used in the manufacturing of automotive components.
As of December 31, 2004, and 2003, we had contracts with a total
notional value of $3.4 and $1.1 million, respectively.
Disclosure Regarding Forward-Looking Statements
Statements contained in this Management’s Discussion and Analysis
of Financial Condition and Results of Operations may contain forward-
looking statements as contemplated by the 1995 Private Securities
Litigation Reform Act that are based on management’s current
expectations, estimates and projections. Words such as “expects,”
“anticipates,” “intends,” “plans,” “believes,” “estimates,” variations
of such words and similar expressions are intended to identify such
forward-looking statements. Forward-looking statements are subject
to risks and uncertainties, many of which are difficult to predict and
generally beyond the control of the Company, which could cause
actual results to differ materially from those projected or implied in
the forward-looking statements. Such risks and uncertainties include:
fluctuations in domestic or foreign automotive production, the contin-
ued use of outside suppliers, fluctuations in demand for vehicles con-
taining BorgWarner products, general economic conditions, as well
as other risks detailed in the Company’s filings with the Securities and
Exchange Commission, including the Cautionary Statements filed as
Exhibit 99.1 to the Form 10-K for the fiscal year ended December 31,
2004. The Company does not undertake any obligation to update any
forward-looking statement.
The information in this report is the responsibility of management.
BorgWarner Inc. and Consolidated Subsidiaries (the “Company”) has
in place reporting guidelines and policies designed to ensure that
the statements and other information contained in this report pres-
ent a fair and accurate financial picture of the Company. In fulfilling
this management responsibility, we make informed judgments and
estimates conforming with accounting principles generally accepted
in the United States of America.
The accompanying Consolidated Financial Statements have been
audited by Deloitte & Touche LLP, independent auditors. Management
has made available all the Company’s financial records and related
information deemed necessary by Deloitte & Touche LLP. Furthermore,
management believes that all representations made by it to Deloitte &
Touche LLP during its audit were valid and appropriate.
Management is responsible for maintaining a comprehensive system
of internal control through its operations that provides reasonable
assurance that assets are protected from improper use, that mate-
rial errors are prevented or detected within a timely period and
that records are sufficient to produce reliable financial reports. The
system of internal control is supported by written policies and proce-
dures that are updated by management as necessary. The system is
reviewed and evaluated regularly by the Company’s internal auditors
as well as by the independent auditors in connection with their annual
audit of the financial statements. The independent auditors conduct
their evaluation in accordance with auditing standards generally
accepted in the United States of America and perform such tests
of transactions and balances as they deem necessary. Management
considers the recommendations of its internal auditors and indepen-
dent auditors concerning the Company’s system of internal control
and takes the necessary actions that are cost-effective in the circum-
stances. Management believes that, as of December 31, 2004, the
Company’s system of internal control was effective to accomplish the
objectives set forth in the first sentence of this paragraph.
The Company’s Finance and Audit Committee, composed entirely of
directors of the Company who are not employees, meets periodically
with the Company’s management and independent auditors to review
financial results and procedures, internal financial controls and
internal and external audit plans and recommendations. In carrying
out these responsibilities, the Finance and Audit Committee and the
independent auditors have unrestricted access to each other with or
without the presence of management representatives.
Timothy M. Manganello
Chairman and
Chief Executive Officer
March 7, 2005
Robin J. Adams
Executive Vice President,
Chief Financial Officer &
Chief Administrative Officer
To The Board of Directors and Stockholders of BorgWarner Inc.:
We have audited the consolidated balance sheets of BorgWarner
Inc. and Consolidated Subsidiaries (the Company) as of December
31, 2004 and 2003, and the related consolidated statements of
operations, cash flows, and stockholders’ equity and comprehensive
income for each of the three years in the period ended December
31, 2004. These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion
on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain rea-
sonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting prin-
ciples used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of BorgWarner Inc. and
Consolidated Subsidiaries at December 31, 2004 and 2003, and
the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2004 in conformity
with accounting principles generally accepted in the United States
of America.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of the Company’s internal control over financial report-
ing as of December 31, 2004, based on the criteria established in
Internal Control—Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission and our
report dated March 7, 2005 expressed an unqualified opinion on
management’s assessment of the effectiveness of the Company’s
internal control over financial reporting and an unqualified opin-
ion on the effectiveness of the Company’s internal control over
financial reporting.
Detroit, Michigan
March 7, 2005
Consolidated Statements of Operations
Consolidated Balance Sheets
36
millions of dollars, except per share amounts
For the Year Ended December 31,
2004
2003
2002
Net sales
Cost of sales
Gross profit
Selling, general and administrative expenses
Other, net
Operating income
Equity in affiliates earnings, net of tax
Interest expense and finance charges
Earnings before income taxes
Provision for income taxes
Minority interest, net of tax
Net earnings before cumulative effect of accounting change
Cumulative effect of change in accounting principle, net of tax
Net earnings/(loss)
Earnings/(loss) per share – basic:
Earnings per share before cumulative effect of accounting change
Cumulative effect of change in accounting principle
Earnings/(loss) per share – basic
Earnings/(loss) per share – diluted:
Earnings per share before cumulative effect of accounting change
Cumulative effect of change in accounting principle
Earnings/(loss) per share – diluted
Average shares outstanding (thousands):
Basic
Diluted
See Accompanying Notes to Consolidated Financial Statements.
$3,525.3
2,874.2
651.1
339.0
3.0
309.1
(29.2)
29.7
308.6
81.2
9.1
218.3
—
$ 218.3
$ 3.91
—
$ 3.91
$ 3.86
—
$ 3.86
$3,069.2
2,482.5
586.7
316.9
(0.1)
269.9
(20.1)
33.3
256.7
73.2
8.6
174.9
—
$ 174.9
$ 3.23
—
$ 3.23
$ 3.20
—
$ 3.20
$2,731.1
2,176.5
554.6
303.5
(0.9)
252.0
(19.5)
37.7
233.8
77.2
6.7
149.9
(269.0)
$ (119.1)
$ 2.82
(5.05)
$ (2.23)
$ 2.79
(5.01)
$ (2.22)
55,872
56,537
54,116
54,604
53,250
53,708
millions of dollars
December 31,
A S S E T S
Cash and cash equivalents
Receivables
Inventories
Deferred income taxes
Investment in business held for sale
Prepayments and other current assets
Total current assets
Land
Buildings
Machinery and equipment
Capital leases
Construction in progress
Less accumulated depreciation
Net property, plant and equipment
Tooling, net of amortization
Investments and advances
Goodwill
Other noncurrent assets
Total other assets
Total assets
L I A B I L I T I E S A N D S T O C K H O L D E R S ’ EQ U I T Y
Notes payable and current portion of long-term debt
Accounts payable and accrued expenses
Income taxes payable
Total current liabilities
Long-term debt
Long-term liabilities:
Retirement-related liabilities
Other
Total long-term liabilities
Minority interest in consolidated subsidiaries
Capital stock:
Preferred stock, $0.01 par value; authorized shares: 5,000,000; none issued
Common stock, $0.01 par value; authorized shares: 150,000,000;
issued shares: 2004, 56,361,167 and 2003, 55,229,854;
outstanding shares: 2004, 56,357,183; 2003, 55,157,190
Non-voting common stock, $0.01 par value; authorized shares: 25,000,000;
none issued and outstanding
Capital in excess of par value
Retained earnings
Accumulated other comprehensive income
Common stock held in treasury, at cost: 2004, 3,984 shares; 2003, 72,664 shares
Total stockholders’ equity
Total liabilities and stockholders’ equity
See Accompanying Notes to Consolidated Financial Statements.
BorgWarner Inc.
and Consolidated Subsidiaries
2004
2003
37
$ 229.7
499.1
223.4
22.6
44.2
55.3
1,074.3
45.0
358.2
1,352.3
1.1
103.0
1,859.6
782.4
1,077.2
102.1
193.7
860.8
221.0
1,377.6
$3,529.1
$ 16.5
608.0
39.3
663.8
568.0
498.0
242.9
740.9
22.2
—
0.6
—
797.1
681.4
55.2
(0.1)
1,534.2
$3,529.1
$ 113.1
414.9
201.3
32.8
32.0
44.2
838.3
42.3
327.4
1,216.0
2.8
77.2
1,665.7
680.4
985.3
90.5
177.3
852.0
197.1
1,316.9
$3,140.5
$ 10.0
474.0
—
484.0
645.5
503.0
230.4
733.4
17.2
—
0.3
—
756.3
491.3
14.0
(1.5)
1,260.4
$3,140.5
Consolidated Statements of Cash Flows
Consolidated Statements of Stockholders’ Equity and Comprehensive Income
BorgWarner Inc.
and Consolidated Subsidiaries
38
millions of dollars
For the Year Ended December 31,
O P E R AT I N G
Net earnings/(loss)
Adjustments to reconcile net earnings/(loss) to net cash flows from operations:
Non-cash charges (credits) to operations:
Depreciation
Amortization of tooling
Cumulative effect of change in accounting principle, net of tax
Employee retirement benefits funded with common stock
Deferred income tax provision
Equity in affiliate earnings, net of dividends received, minority interest and other
Net earnings adjusted for non-cash charges
Changes in assets and liabilities, net of effects of divestitures:
(Increase) in receivables
(Increase) in inventories
(Increase) decrease in prepayments
Increase (decrease) in accounts payable and accrued expenses
Increase (decrease) in income taxes payable
Net change in other long-term assets and liabilities
Net cash provided by operating activities
I N V E S T I N G
Capital expenditures
Tooling outlays, net of customer reimbursements
Net proceeds from asset disposals
Proceeds from sale of businesses
Tax refunds related to businesses sold
Contingent valuation payment on acquired business
Investment in unconsolidated subsidiary
Net cash used in investing activities
F I N A N C I N G
Net increase (decrease) in notes payable
Additions to long-term debt
Repayments of long-term debt
Payments for purchase of treasury stock
Proceeds from stock options exercised
Dividends paid
Net cash used in financing activities
Effect of exchange rate changes on cash and cash equivalents
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
S U P P L E M E N TA L C A S H F L O W I N FO R M AT I O N
Net cash paid/(refunded) during the year for:
Interest
Income taxes
Non-cash financing transactions:
Issuance of common stock for Executive Stock Performance Plan
Issuance of restricted common stock for non-employee directors
See Accompanying Notes to Consolidated Financial Statements.
2004
2003
2002
$ 218.3
$ 174.9
$(119.1)
138.8
38.2
—
25.8
13.8
5.8
440.7
(60.4)
(12.7)
(7.0)
113.1
36.0
(83.1)
426.6
(204.9)
(47.5)
4.2
—
—
—
(9.0)
(257.2)
5.3
0.6
(61.8)
—
14.4
(27.9)
(69.4)
16.6
116.6
113.1
$ 229.7
$ 29.3
35.0
$ 1.7
0.3
124.5
36.8
—
12.9
40.0
(3.7)
385.4
(90.4)
(9.1)
7.3
(0.3)
(0.2)
14.2
306.9
(172.0)
(42.4)
8.0
5.4
—
(12.8)
(14.4)
(228.2)
(5.5)
0.3
(16.1)
(2.5)
39.3
(19.4)
(3.9)
1.7
76.5
36.6
$ 113.1
$ 34.5
24.4
$ 3.3
—
108.1
29.3
269.0
20.8
30.4
(4.1)
334.4
(67.4)
(29.3)
(3.4)
(14.7)
14.1
27.7
261.4
(138.4)
(27.7)
12.3
3.3
20.5
—
—
(130.0)
(22.8)
2.3
(85.3)
(18.1)
9.8
(16.0)
(130.1)
2.4
3.7
32.9
$ 36.6
$ 39.5
(11.0)
$ 1.2
—
millions of dollars
Number of shares
Stockholders’ equity
Issued
common
stock
Common
stock in
treasury
Issued
common
stock
Capital in
excess of
par value
Management
shareholder
notes
Treasury
stock
Accumulated
other
Retained comprehensive
income/(loss)
earnings
39
Comprehensive
income/(loss)
Balance, January 1, 2002
Purchase of treasury stock
Dividends declared
Shares issued under stock
incentive plans
Shares issued under
executive stock plan
Shares issued under
retirement savings plans
Net loss
Adjustment for minimum
pension liability
Currency translation and hedge
instruments adjustment
Balance, December 31, 2002
Purchase of treasury stock
Dividends declared
Management shareholder notes
Shares issued under stock
incentive plans
Shares issued under
executive stock plan
Shares issued under
retirement savings plans
Net income
Adjustment for minimum
pension liability
Currency translation and hedge
instruments adjustment
Balance, December 31, 2003
Dividends declared
Stock split
Shares issued under stock
incentive plans
Shares issued under
54,079,936
—
—
(1,349,598)
(770,000)
—
—
435,264
—
46,560
717,846
—
—
—
—
—
—
—
54,797,782
—
—
—
(1,637,774)
(83,860)
—
—
—
1,517,208
—
131,762
432,072
—
—
—
—
—
—
—
55,229,854
—
(72,664)
—
$0.3 $715.7 $(27.6)
(18.1)
—
—
—
—
—
—
—
—
—
—
—
0.9
8.9
0.3
0.9
20.8
—
—
—
—
—
—
—
$0.3 $737.7 $(35.9)
(2.5)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
5.3
34.0
0.4
2.9
12.9
—
—
—
—
—
—
—
$0.3 $756.3 $ (1.5)
—
—
—
$(2.0) $470.9
—
(16.0)
—
—
—
—
—
—
—
—
—
—
—
(119.1)
—
—
$(2.0) $335.8
—
(19.4)
—
—
—
2.0
—
—
—
—
—
—
—
—
—
174.9
—
—
$ —
—
$491.3
(27.9)
—
—
0.3
—
—
—
(0.3)
523,994
68,680
—
13.0
1.4
executive stock plan
41,252
Restricted shares issued under
stock incentive plan
Shares issued under
6,400
retirement savings plans
559,667
Net income
Adjustment for minimum
pension liability
Currency translation and hedge
instruments adjustment
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1.7
0.3
25.8
—
—
—
—
—
—
—
—
—
$(53.1)
—
—
—
—
—
—
—
—
—
—
$(119.1)
(42.3)
(42.3)
40.9
40.9
$(54.5) $(120.5)
—
—
—
—
—
—
—
—
—
—
—
—
$ 174.9
0.7
0.7
67.8
67.8
$ 14.0
—
$ 243.4
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
218.3
— $ 218.3
—
—
12.8
12.8
28.4
28.4
BALANCE, DECEMBER 31, 2004 56,361,167
(3,984)
$0.6 $797.1 $ (0.1)
$ —
$681.4
$ 55.2 $ 259.5
See Accompanying Notes to Consolidated Financial Statements.
Notes to Consolidated Financial Statements
40
INTRODUCTION
BorgWarner Inc. and Consolidated Subsidiaries (the “Company”) is a
leading global supplier of highly engineered systems and components
primarily for powertrain applications. These products are manufac-
tured and sold worldwide, primarily to original equipment manufac-
turers of passenger cars, sport-utility vehicles, trucks, commercial
transportation products and industrial equipment. Our products fall
into two reportable operating segments: Drivetrain and Engine.
NOTE 1
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following paragraphs briefly describe the Company’s significant
accounting policies.
Use of estimates The preparation of financial statements in con-
formity with accounting principles generally accepted in the United
States of America requires management to make estimates and
assumptions. These estimates and assumptions affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Principles of consolidation The Consolidated Financial Statements
include all significant majority-owned subsidiaries. All intercompany
accounts and transactions have been eliminated in consolidation.
Cash and cash equivalents Cash and cash equivalents are valued
at cost, which approximates fair market value. It is the Company’s
policy to classify investments with original maturities of three months
or less as cash and cash equivalents.
Accounts receivable The Company securitizes and sells certain
receivables through third party financial institutions without recourse.
The amount sold can vary each month based on the amount of underly-
ing receivables. In the fourth quarter of 2003, the Company reduced
the maximum size of the facility from $90 million to $50 million. In the
fourth quarter of 2002, the Company reduced the maximum size of the
facility from $120 million to $90 million.
During the year ended December 31, 2004, total cash proceeds from
sales of accounts receivable were $600 million. The Company paid
servicing fees of $0.9 million, $1.3 million, and $2.5 million in 2004,
2003, and 2002, respectively, related to these receivables. These
amounts are recorded in interest expense and finance charges in
the Consolidated Statements of Operations. At December 31, 2004
and 2003, the Company had sold $50 million of receivables under a
Receivables Transfer Agreement for face value without recourse.
Inventories Inventories are valued at the lower of cost or market.
Cost of U.S. inventories is determined by the last-in, first-out (LIFO)
method, while the foreign operations use the first-in, first-out (FIFO) or
average-cost methods. Inventory held by U.S. operations was $106.1
million in 2004 and $97.1 million in 2003. Such inventories, if valued
at current cost instead of LIFO, would have been greater by $6.6 mil-
lion in 2004 and $3.6 million in 2003.
Property, plant and equipment and depreciation Property, plant
and equipment are valued at cost less accumulated depreciation.
Expenditures for maintenance, repairs and renewals of relatively
minor items are generally charged to expense as incurred. Renewals
of significant items are capitalized. Depreciation is computed gener-
ally on a straight-line basis over the estimated useful lives of the
assets. Useful lives for buildings range from 15 to 40 years and
useful lives for machinery and equipment range from 3 to 12 years.
For income tax purposes, accelerated methods of depreciation are
generally used.
Goodwill and other intangible assets The Company adopted
Statement of Financial Accounting Standards (SFAS) No. 142,
“Goodwill and Other Intangible Assets,” effective January 1, 2002.
Under SFAS No. 142, goodwill is no longer amortized; however, it
must be tested for impairment at least annually. Under the transi-
tional provisions of this statement, the Company allocated goodwill to
its reporting units and performed the two-step impairment analysis.
The fair value of the Company’s businesses used in determination of
the goodwill impairment was computed using the expected present
value of associated future cash flows. As a result of this analysis, the
Company determined that goodwill associated with its Emissions/
Thermal Systems business unit was impaired due to fundamental
changes in their served markets, particularly the medium and heavy
truck markets, and weakness at a major customer. A resulting pre-
tax charge of $345 million, $269 million after tax, was recorded.
The impairment loss was recorded in the first quarter of 2002 as
a cumulative effect of change in accounting principle. The changes
in the carrying amount of goodwill for the twelve months ended
December 31, 2002, 2003 and 2004, are as follows:
millions of dollars
Drivetrain
Engine
Total
Balance at January 1, 2002
Change in accounting principle
Translation adjustment
Balance at December 31, 2002
Contingent valuation payment
on acquired business
Translation adjustment
$133.7 $1,026.9 $1,160.6
(345.0)
(345.0)
11.4
11.4
—
—
$133.7 $ 693.3 $ 827.0
—
0.6
12.8
11.6
12.8
12.2
Balance at December 31, 2003
Translation adjustment
$134.3 $ 717.7
8.5
0.3
$ 852.0
8.8
Balance at December 31, 2004
$134.6 $ 726.2
$ 860.8
In the fourth quarter of each year, or when events and circumstances
warrant such a review, the Company reviews the goodwill for all of
its reporting units for impairment. This review requires us to make
significant assumptions and estimates about the extent and timing of
future cash flows, discount rates and growth rates. The cash flows
are estimated over a significant future period of time, which makes
those estimates and assumptions subject to an even higher degree of
uncertainty. We also utilize market valuation models and other finan-
cial ratios, which require us to make certain assumptions and esti-
mates regarding the applicability of those models to our assets and
businesses. We believe that the assumptions and estimates used to
determine the estimated fair values of each of our reporting units are
reasonable. However, different assumptions could materially affect
the estimated fair value. The goodwill impairment test was performed
in November 2004. The results of that analysis did not indicate an
impairment of the book value of the Company’s goodwill.
BorgWarner Inc.
and Consolidated Subsidiaries
41
The Company had intangible assets, primarily trade names, with a
cost of $14.7 million, less accumulated amortization of $9.8 million
and $8.7 million at December 31, 2004 and 2003, respectively. The
intangible assets are being amortized on a straightline basis over
their legal lives, which range from 10 to 15 years. Annual amortiza-
tion expense recognized was $1.1 million in each of the years 2004,
2003, and 2002. The estimated future annual amortization expense
for each of the successive years 2005 through 2008 is $1.2 million.
Revenue recognition The Company recognizes revenue upon ship-
ment of product when title and risk of loss pass to the customer.
Although the Company may enter into long-term supply agreements
with its major customers, each shipment of goods is treated as a sep-
arate sale and the price is not fixed over the life of the agreements.
Product warranties The Company provides warranties on some of
its products. The warranty terms are typically from one to three years.
Provisions for estimated expenses related to product warranty are made
at the time products are sold. These estimates are established using
historical information about the nature, frequency, and average cost of
warranty claims. Management actively studies trends of warranty claims
and takes action to improve product quality and minimize warranty
claims. Management believes that the warranty accrual is appropriate;
however, actual claims incurred could differ from the original estimates,
requiring adjustments to the accrual. The accrual is represented in both
long-term and short-term liabilities on the balance sheet.
Below is a table that shows the activity in the warranty accrual
accounts:
Financial instruments Financial instruments consist primarily of
investments in cash, short-term securities and receivables, and obli-
gations under accounts payable, and debt instruments. The Company
believes that the fair value of the financial instruments approximates
the carrying value, except as noted in Note 6.
millions of dollars
Beginning balance
Provisions
Payments
Ending balance
2004
2003
2002
$28.7
10.2
(12.5)
$23.7 $ 19.5
14.2
12.4
(7.4)
(10.0)
$26.4
$28.7 $ 23.7
The Company received corporate bonds with a face value of $30.3
million as partial consideration for the sales of Kuhlman Electric
and Coleman Cable in 1999. These bonds were recorded at their
estimated fair market value of $12.9 million using valuation tech-
niques that considered cash flows discounted at current market
rates and management’s best estimates of credit quality. In 2001,
the sale agreement with Coleman Cable was renegotiated, resulting
in the exchange of the corporate bonds along with a purchase price
receivable, for $3 million in cash and a $2 million note, which was
fully collected in 2002. During the first quarter of 2004 the Kuhlman
Electric agreement was renegotiated whereby the Company received
a payment of $2.5 million and a new note from Kuhlman Electric
Corporation. The maturity of this new note is April 2012. The face
value of the note is $4.5 million at December 31, 2004.
Derivative financial instruments The Company recognizes that
certain normal business transactions generate risk. Examples of risks
include exposure to exchange rate risk related to transactions denomi-
nated in currencies other than the functional currency, changes in cost
of major raw materials and supplies, and changes in interest rates. It is
the objective and responsibility of the Company to assess the impact
of these transaction risks, and offer protection from selected risks
through various methods including financial derivatives. All derivative
instruments held by the Company are designated as hedges, have high
correlation with the underlying exposure and are highly effective in
offsetting underlying price movements. Accordingly, gains and losses
from changes in derivative fair values are matched with the underlying
transactions. The Company does not engage in any derivative transac-
tions for purposes other than hedging specific risks.
Foreign currency The financial statements of foreign subsidiaries
are translated to U.S. Dollars using the period-end exchange rate for
assets and liabilities and an average exchange rate for each period
for revenues, expenses, and capital expenditures. The local cur-
rency is the functional currency for substantially all the Company’s
foreign subsidiaries. Translation adjustments for foreign subsidiaries
are recorded as a component of accumulated other comprehensive
income in stockholders’ equity.
Classified in the Consolidated
Balance Sheets as:
Accounts payable and accrued expenses $16.1
$17.6 $ 14.4
Other long term liability
$10.3
$11.1
$ 9.3
Stock based compensation SFAS No. 123, “Accounting for Stock-
Based Compensation” and SFAS No. 148, “Accounting for Stock-
Based Compensation – Transition and Disclosure,” encourage, but
do not require, companies to record compensation cost for stock-
based employee compensation plans at fair value. The Company
has chosen to continue to account for stock-based compensation in
accordance with Accounting Principles Board Opinion (APB) No. 25,
“Accounting for Stock Issued to Employees,” and related interpreta-
tions. Accordingly, no compensation cost has been recognized for
fixed stock options because the exercise prices of the stock options
equal the market value of the Company’s common stock at the date
of grant, which is the measurement date. Further disclosure about
the Company’s stock compensation plans can be found in Note 9. The
following table illustrates the effect on the Company’s net earnings/
(loss) and net earnings/(loss) per share if the Company had applied
the fair value recognition provision of SFAS No. 123.
millions of dollars, except per share data
2004
2003
2002
Net earnings/(loss), as reported
Add: Stock-based employee
compensation expense included
in net income, net of income tax
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of income tax
$218.3 $174.9 $(119.1)
1.6
2.7
4.5
(7.7)
(7.7)
(10.7)
Pro forma net earnings/(loss)
$212.2 $169.9 $(125.3)
Earnings/(loss) per share:
Basic – as reported
Basic – pro forma
Diluted – as reported
Diluted – pro forma
$ 3.91 $ 3.23 $ (2.23)
$ 3.80 $ 3.14 $ (2.36)
$ 3.86 $ 3.20 $ (2.22)
$ 3.75 $ 3.11 $ (2.34)
Notes to Consolidated Financial Statements
42
New accounting pronouncements In January 2003, the Financial
Accounting Standards Board (FASB) issued Interpretation (FIN) No.
46, “Consolidation of Variable Interest Entities, an Interpretation of
ARB No. 51,” which was revised in December 2003. FIN No. 46R
requires that the assets, liabilities and results of the activity of vari-
able interest entities be consolidated into the financial statements of
the entity that has the controlling financial interest. FIN No. 46R also
provides the framework for determining whether a variable interest
entity should be consolidated. For the Company, this Interpretation,
as revised, was effective January 1, 2004. The Company has no
variable interest entities required to be consolidated as a result of
adopting FIN No. 46R.
In December 2003, the Medicare Prescription Drug Improvement
and Modernization Act of 2003 (Medicare Act) introduced a pre-
scription drug benefit under Medicare, as well as a federal subsidy
to sponsors of retiree health care benefit plans. In January 2004,
the FASB issued FASB Staff Position (FSP) No. 106-1, “Accounting
Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement, and Modernization Act of 2003.” FSP 106-1 permits
a sponsor of a post retirement health care plan that provides a pre-
scription drug benefit to make a one-time election to defer account-
ing for the effects of the Medicare Act if there is insufficient data,
time or guidance available to ensure appropriate accounting. The
Company is a sponsor of post retirement health care plans that pro-
vide prescription benefits and, in accordance with the one-time elec-
tion under FSP 106-1, elected to defer accounting for the Medicare
Act. In May 2004, the FASB issued FSP No. 106-2, “Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003,” which supersedes
FSP 106-1, to address the accounting and disclosure requirements
related to the Medicare Act. The FSP was effective for the Company
beginning with its third quarter ended September 30, 2004. The
effect of the adoption was to reduce the Company’s 2004 post retire-
ment benefits expense by $6.8 million.
In November 2004, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 151, “Inventory Costs” which is an amendment
of ARB No.43, Chapter 4. This statement provides clarification of
accounting for abnormal amounts of idle facility expense, freight,
handling costs and wasted material. Generally, this statement
requires that those items be recognized as current period charges.
SFAS 151 will be effective for the Company on January 1, 2006. The
Company is currently evaluating the impact that the adoption of SFAS
151 will have on its consolidated financial position, results of opera-
tions and cash flows.
In December 2004, the FASB issued FSP 109-1, “Application of
FASB Statement No. 109, Accounting for Income Taxes, to the Tax
Deduction on Qualified Production Activities Provided by the American
Jobs Creation Act of 2004” (AJCA), and FAS 109-2 “Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision
within the AJCA”. These two FSPs provide guidance on the applica-
tion of the new provisions of the AJCA, which was signed into law on
October 22, 2004.
The AJCA provides a deduction for income from qualified domestic
production activities, which will be phased in from 2005 through
2010. In return, the AJCA provides for a two-year phase-out of the
existing extra-territorial income exclusion (ETI) for foreign sales that
was viewed to be inconsistent with international trade protocols by
the European Union. Under the guidance in FSP 109-1, the deduction
will be treated as a “special deduction” as described in SFAS 109.
As such, the special deduction has no effect on deferred tax assets
and liabilities existing at the enactment date. Rather, the impact of
this deduction will be reported in the period in which the deduction is
claimed on our tax return. The Company expects the net effect of the
phase out of the ETI and the phase in of this new deduction will not
have a material impact on its effective tax rate.
FSP 109-2 provides guidance on the accounting for the deduction of
85% of certain foreign earnings that are repatriated, as defined in the
AJCA. The Company may elect to apply this provision to qualifying
earnings repatriations in 2005. Under guidance set forth in FAS 109-2,
the Company is allowed time beyond the financial reporting period of
enactment to evaluate the effect of the AJCA on its plan for reinvest-
ment or repatriation of foreign. The Company has started an evalua-
tion of the effects of the repatriation provision; however, the Company
does not expect to be able to complete this evaluation until after
the U.S. Congress or the Treasury Department provides additional
clarifying language on key elements of the provision. The Company
expects to complete its evaluation of the effects of the repatriation
provision within a reasonable period of time following the publication
of the additional clarifying language. The range of possible amounts
that the Company is considering for repatriation under this provision is
between zero and $74 million. The related range of income tax effects
of such repatriation cannot be reasonably estimated until guidance is
issued by Congress or the Treasury Department.
In December 2004, the FASB issued SFAS No. 123R, “Shared-Based
Payment” which requires companies to measure and recognize com-
pensation expense for all share-based payments at fair value. Share-
based payments include stock option grants and certain transactions
under other Company stock plans. The Company grants options to
purchase common stock of the Company to some of its employees
and directors under various plans at prices equal to the market value
of the stock on the dates the options are granted. SFAS 123R will be
effective for the Company beginning July 1, 2005. The Company is
currently evaluating the impact that the adoption of SFAS 123R will
have on its consolidated financial position, results of operations and
cash flows.
Reclassification Certain prior period amounts have been reclassi-
fied to conform to the current year’s presentation and are not mate-
rial to the Company’s Consolidated Financial Statements.
BorgWarner Inc.
and Consolidated Subsidiaries
43
NOTE 2
RESEARCH AND DEVELOPMENT COSTS
NOTE 3
OTHER INCOME
The Company spent approximately $123.1 million, $118.2 million,
and $109.1 million in 2004, 2003 and 2002, respectively, on
research and development (R&D) activities. R&D costs are included
primarily in the selling, general, and administrative expenses of
the Consolidated Statements of Operations. Not included in these
amounts were customer-sponsored R&D activities of approximately
$31.8 million, $22.3 million, and $14.2 million in 2004, 2003, and
2002, respectively.
Items included in other income consist of:
millions of dollars
Year Ended December 31,
Gain on sale of business
Interest income
Loss on asset disposals, net
Other
2004
2003
2002
$ —
0.7
(3.5)
(0.2)
$ 0.5
0.8
(1.7)
0.5
$ —
1.7
(1.5)
0.7
$(3.0)
$ 0.1
$0.9
NOTE 4
INCOME TA XES
Earnings before income taxes and the provision for income taxes are presented in the following table. The earnings before income taxes amounts
for 2003 and 2002 have been presented to conform to the 2004 U.S. versus non-U.S. presentation.
millions of dollars
Earnings before taxes
Provision for income taxes:
Current:
Federal/foreign
State
Deferred
2004
U.S. Non-U.S.
Total
U.S.
2003
Non-U.S.
Total
U.S. Non-U.S.
Total
2002
$117.8 $190.8 $308.6
$120.5 $136.2 $256.7
$163.7
$70.1 $233.8
1.4
2.2
3.6
11.1
63.8
—
63.8
2.7
65.2
2.2
67.4
13.8
18.5
1.6
20.1
18.5
13.1
—
13.1
21.5
31.6
1.6
33.2
40.0
11.1
3.1
14.2
44.8
10.6
—
10.6
7.6
21.7
3.1
24.8
52.4
Total provision for income taxes
$ 14.7
$ 66.5
$ 81.2
$ 38.6
$ 34.6
$ 73.2
$ 59.0
$18.2
$ 77.2
Effective tax rate
12.4%
34.9%
26.3%
32.0%
25.4%
28.5%
36.0%
26.0%
33.0%
The provision for income taxes resulted in an effective tax rate for
2004 of 26.3% compared with rates of 28.5% in 2003 and 33.0%
in 2002. Our effective tax rates have been lower than the standard
federal and state tax rates due to the realization of certain R&D and
foreign tax credits; foreign rates, which differ from those in the U.S.;
and offset by non-deductible expenses. In addition, the Company made
an $11.4 million year-end adjustment to various tax accounts due
to changes in circumstances related to various tax items, including
changes in tax laws. The year-end adjustment resulted in a reduction in
the U.S. effective tax rate for 2004.
The analysis of the variance of income taxes as reported from income
taxes computed at the U.S. statutory rate for consolidated opera-
tions is as follows:
millions of dollars
2004
2003
2002
Income taxes at U.S. statutory
rate of 35%
Increases (decreases) resulting from:
Income from non-U.S. sources
including withholding taxes
Business tax credits, net
Affiliate earnings
Non-temporary differences and other
$108.0
$ 89.8
$81.8
3.6
(6.2)
(10.2)
(14.0)
(8.5)
(6.3)
(7.0)
5.2
(2.2)
(4.7)
(6.8)
9.1
Provision for income taxes as reported
$ 81.2
$ 73.2
$77.2
Notes to Consolidated Financial Statements
44
Following are the gross components of deferred tax assets and liabili-
ties as of December 31, 2004 and 2003:
millions of dollars
2004
2003
Current deferred tax assets:
Foreign tax credits
Research and development credits
Employee related
Warranties
Other
$ 9.0
6.0
5.1
—
2.5
$ 7.1
7.6
5.8
5.7
6.6
Total current deferred tax assets
$ 22.6 $ 32.8
Non-current deferred tax assets:
Pension and other post retirement benefits
Other comprehensive income
Employee related
Goodwill
Litigation and environmental
Warranties
Foreign tax credits
Research and development credits
Other
Non-current deferred tax assets
Non-current deferred tax liabilities:
Fixed assets
Lease obligation – production equipment
Other
Non-current deferred tax liabilities
$ 92.1 $ 90.4
33.1
8.7
13.9
7.9
—
—
—
1.0
36.3
9.0
3.5
9.2
7.7
2.6
4.9
5.3
$ 170.6 $ 155.0
$(163.4) $(163.8)
—
—
(9.0)
(7.0)
$(179.4) $(163.8)
Net deferred tax asset (current and non-current)
$ 13.8 $ 24.0
The deferred tax assets (current and non-current) and liabilities recog-
nized in the Company’s Consolidated Balance Sheets are as follows:
millions of dollars
Deferred income taxes – current assets
Other non-current assets
Other long-term liabilities
Net deferred tax asset
(current and non-current)
2004 2003
$ 22.6 $ 32.8
48.5
(57.3)
51.8
(60.6)
$ 13.8 $ 24.0
The other non-current assets are primarily comprised of amounts
from the U.S., France and Korea. The other long-term liabilities are
primarily comprised of amounts from Germany, Italy, U.K., Japan,
and Canada. The non-current deferred tax asset in 2003 of $48.5
million was previously presented as a reduction of the non-current
deferred tax liability; this amount has been reclassified to other
non-current assets on the 2003 Consolidated Balance Sheets and
the reclassification is not material to the Company’s Consolidated
Financial Statements.
The foreign tax credits will expire beginning in 2012 through 2014.
The R&D tax credits will expire beginning in 2022 through 2024. The
company also has deferred tax assets for minimum tax credits of
$3.2 million, which can be carried forward indefinitely.
No deferred income taxes have been provided on the excess of the
amount for financial reporting over the tax basis of investments
in foreign subsidiaries or foreign corporate joint ventures totaling
$353.9 million in 2004, as these amounts are essentially permanent
in nature. The excess amount will become taxable on a repatriation
of assets or sale or liquidation of the investment. It is not practicable
to determine the unrecognized deferred tax liability on the excess
amount because the actual tax liability on the excess amount, if any,
is dependent on circumstances existing when remittance occurs.
NOTE 5
BALANCE SHEET INFORMATION
Detailed balance sheet data are as follows:
millions of dollars
December 31,
Receivables:
Customers
Other
Gross receivables
Less allowance for losses
Net receivables
Inventories:
Raw material
Work in progress
Finished goods
Total inventories
Investments and advances:
NSK-Warner
Other
Total investments and advances
Other non-current assets:
Deferred pension assets
Product liability insurance receivable
Deferred income taxes, net
Other
2004
2003
$453.9
56.1
510.0
10.9
$374.6
46.0
420.6
5.7
$499.1
$414.9
$104.6
69.8
49.0
$95.5
65.1
40.7
$223.4
$201.3
$188.2
5.5
$172.1
5.2
$193.7
$177.3
$113.1
27.3
51.8
28.8
$90.8
27.9
48.5
29.9
Total other non-current assets
$221.0
$197.1
Accounts payable and accrued expenses:
Trade payables
Payroll and related
Insurance
Warranties
Product liability accrual
Other
Total accounts payable and
accrued expenses
Other long-term liabilities:
Environmental accruals
Warranties
Deferred income taxes, net
Product liability accrual
Other
$390.6
74.5
25.2
16.1
13.5
88.1
$300.0
63.7
24.0
17.6
13.7
55.0
$608.0
$474.0
$ 25.7
10.3
60.6
27.3
119.0
$ 19.6
11.1
57.3
27.9
114.5
Total other long-term liabilities
$242.9
$230.4
NSK-Warner
The Company has a 50% interest in NSK-Warner, a joint venture based
in Japan that manufactures automatic transmission components. The
Company’s share of the earnings or losses reported by NSK-Warner
is accounted for using the equity method of accounting. NSK-Warner
has a fiscal year-end of March 31. The Company’s equity in the earn-
ings of NSK-Warner consists of the 12 months ended November 30
so as to reflect earnings on as current a basis as is reasonably
BorgWarner Inc.
and Consolidated Subsidiaries
45
feasible. NSK-Warner is the joint venture partner with a 40% interest
in the Drivetrain Group’s Korean subsidiary, BorgWarner Transmission
Systems Korea Inc. Dividends received from NSK-Warner were $23.9
million in 2004, $9.7 million in 2003, and $8.4 million in 2002.
Following are summarized financial data for NSK-Warner, translated
using the ending or periodic rates as of and for the years ended
November 30, 2004, 2003 and 2002 (unaudited):
millions of dollars
2004
2003
2002
Balance sheets:
Current assets
Non-current assets
Current liabilities
Non-current liabilities
Statements of operations:
Net sales
Gross profit
Net income
$242.3
180.7
126.2
18.5
$210.7 $176.0
151.0
85.2
10.7
173.3
108.8
14.8
$443.5
97.3
52.6
$356.5 $303.8
69.8
34.0
71.4
34.5
Investment in business held for sale
The Company’s investment in Aktiengesellschaft Kühnle, Kopp
& Kausch (AGK), an unconsolidated subsidiary of the Company,
has been recorded in “Investment in business held for sale” in the
Consolidated Balance Sheets. Effective February 17, 2005, the
Company signed a Share Transfer Agreement (STA) for the sale of
its 95.42% interest in AGK with Turbo Group GmbH. The STA will
become effective no later than seven (7) banking days after receipt
of approval from both the German Federal Cartel Office and the
Austrian merger control authority. The transaction is anticipated to
close before March 31, 2005. The proceeds, net of closing costs,
are expected to be approximately €39.8 million. The investment is
carried on a cost basis, with dividends received from AGK applied
against the carrying value of the asset.
Following is summarized balance sheet data as of September 30, 2004
and 2003 for AGK (unaudited), which is the latest available. The assets
and liabilities reported in Euros were translated using the respective
year-end exchange rate:
The equity of NSK-Warner as of November 30, 2004, was $278.3
million, there was no debt and their cash and securities were
$92.4 million.
Purchases from NSK-Warner for the years ended December 31,
2004, 2003 and 2002 were $19.9 million, $16.9 million and $15.1
million, respectively.
millions of dollars
Current assets
Non-current assets
Current liabilities
Non-current liabilities
2004
2003
$132.3
65.7
79.7
54.0
$79.9
57.9
43.7
41.6
NOTE 6
NOTES PAYABLE AND LONG-TERM DEBT
Following is a summary of notes payable and long-term debt. The weighted average interest rate on all borrowings for 2004 and 2003 was 5.1%
and 4.9%, respectively.
millions of dollars
December 31,
Bank borrowings and other
Term loans due through 2011 (at an average rate of 3.3% in 2004 and 3.3% in 2003)
7% Senior Notes due 2006, net of unamortized discount ($139 million converted to
floating rate of 4.5% by interest rate swap at December 31, 2004)
6.5% Senior Notes due 2009, net of unamortized discount ($100 million converted to
floating rate of 5.2% by interest rate swap at December 31, 2004)
8% Senior Notes due 2019, net of unamortized discount ($75 million converted to
floating rate of 5.4% by interest rate swap at December 31, 2004)
7.125% Senior Notes due 2029, net of unamortized discount
Carrying amount of notes payable and long-term debt
Impact of derivatives on debt(a)
Total notes payable and long-term debt
2004
2003
Current
Long-Term
Current
Long-Term
$ 9.2
7.3
$ 6.1
26.9
$ 2.9
7.1
$ 42.5
31.4
—
—
—
—
16. 5
—
139.0
136.1
133.9
119.1
561.1
6.9
—
—
—
—
10.0
—
139.4
164.7
133.9
122.1
634.0
11.5
$16.5
$568.0
$10.0
$645.5
(a) The $11.5 million impact of derivatives on debt from the interest rate swaps as of December 31, 2003 has been reclassified to long-term debt with a corresponding non-current
asset. The reclassification is not material to the Company’s Consolidated Financial Statements.
Notes to Consolidated Financial Statements
BorgWarner Inc.
and Consolidated Subsidiaries
46
Annual principal payments required as of December 31, 2004 are as
follows (in millions of dollars):
NOTE 7
FINANCIAL INSTRUMENTS
2005
2006
2007
2008
2009
after 2009
Total payments
Less: Unamortized discounts
Total
$ 16.5
151.4
6.7
6.7
146.0
259.5
586.8
(2.3)
$584.5
The Company has a revolving credit facility, which provides for
borrowings up to $600 million through July 2009. This new facility
effective July 22, 2004 replaced the Company’s previous facility
of $350 million. At December 31, 2004 and December 31, 2003
there were no borrowings outstanding and no obligations under
standby letters of credit under the facility. The credit agreement is
subject to the usual terms and conditions applied by banks to an
investment grade company. The Company was in compliance with
all covenants at December 31, 2004 and expects to be compliant
in future periods.
The Company’s financial instruments include cash and cash equiva-
lents, trade receivables, trade payables and notes payable. Due to
the short-term nature of these instruments, the book value approxi-
mates fair value. The Company’s financial instruments also include
long-term debt, interest rate and currency swaps, commodity swap
contracts, and foreign currency forward contracts.
As of December 31, 2004 and 2003, the estimated fair values of
the Company’s senior unsecured notes totaled $589.0 million and
$635.0 million, respectively. The estimated fair values were $60.9
million higher in 2004, and $74.9 million higher in 2003, than their
respective carrying values. Fair market values are developed by
the use of estimates obtained from brokers and other appropriate
valuation techniques based on information available as of year-end.
The fair value estimates do not necessarily reflect the values the
Company could realize in the current markets.
The Company manages its interest rate risk by balancing its exposure to
fixed and variable rates while attempting to minimize its interest costs.
The Company selectively uses interest rate swaps to reduce market
value risk associated with changes in interest rates (fair value hedges).
We also selectively use cross-currency swaps to hedge the foreign cur-
rency exposure associated with our net investment in certain foreign
operations (net investment hedges). A summary of these instruments
outstanding at December 31, 2004 follows (currency in millions):
Interest rate swaps(a)
Fixed to floating
Fixed to floating
Fixed to floating
Cross currency swap (matures in 2006)
Floating $
to floating ¥
Cross currency swap (matures in 2009)
Floating $
to floating €
Cross currency swap (matures in 2019)
Floating $
to floating €
Hedge Type
Fair value
Fair value
Fair value
Net investment
Net investment
Net investment
Notional
Amount
$139
$100
$ 75
$125
¥14,930
$75
€57
$75
€61
Interest Rates(b)
Receive
Pay
Floating Interest
Rate Basis
7.0%
6.5%
8.0%
4.2%
—
5.4%
—
5.4%
—
4.5%
5.2%
5.4%
—
1.7%
—
4.8%
—
4.8%
6 month LIBOR+1.7%
6 month LIBOR+2.4%
6 month LIBOR+2.6%
6 mo. USD LIBOR+1.4%
6 mo. JPY LIBOR+1.6%
6 mo. USD LIBOR+2.6%
6 mo. EURIBOR+2.6%
6 mo. USD LIBOR+2.6%
6 mo. EURIBOR+2.6%
(a) The maturity of the swaps corresponds with the maturity of the hedged item as noted in the debt summary, unless otherwise indicated.
(b) Interest rates are as of December 31, 2004.
As of December 31, 2004 and December 31, 2003, the fair value of
the fixed to floating interest rate swaps was $6.9 million and $11.5
million, respectively and are recorded in the Company’s Consolidated
Balance Sheets as Other non-current assets with a corresponding
adjustment to the carrying value of the hedged debt. The change
in fair value of the swaps exactly offsets the change in fair value of
the hedged debt with no net impact on earnings. The cross currency
swaps were recorded at their fair value of $(33.1) at December 31,
2004 and $(4.2) million at December 31, 2003. Fair value is based
on quoted market prices for contracts with similar maturities and the
ineffective portion of all swaps was not significant.
The Company also entered into certain commodity derivative
instruments to protect against commodity price changes related
to forecasted raw material and supplies purchases. The primary
purpose of the commodity price hedging activities is to manage the
volatility associated with these forecasted purchases. The Company
utilizes forward and option contracts, which are designated as cash
flow hedges. These instruments are intended to offset the effect
of changes in commodity prices on forecasted purchases. As of
December 31, 2004 the Company had commodity swap contracts
with a total notional value of $3.4 million. The fair market value of the
swap contracts was $0.4 million as of December 31, 2004, which is
deferred in other comprehensive income and will be reclassified and
matched into income as the underlying operating transactions are
realized. As of December 31, 2003, the Company had commodity
swap contracts with a total notional value of $1.1 million and a fair
market value of $0.1 million as of December 31, 2003, which was
deferred in other comprehensive income. During the twelve months
ended December 31, 2004 and 2003, hedge ineffectiveness associ-
ated with these contracts was not significant.
The Company uses foreign exchange forward contracts to protect
against exchange rate movements for forecasted cash flows for
purchases, operating expenses or sales transactions designated in
currencies other than the functional currency of the operating unit.
Most contracts mature in less than one year, however certain long-
term commitments are covered by forward currency arrangements
to protect against currency risk through the second quarter of 2009.
Foreign currency contracts require the Company, at a future date, to
either buy or sell foreign currency in exchange for the operating units
local currency. At December 31, 2004 contracts were outstanding
to buy or sell U.S. Dollars, Euros, British Pounds Sterling, Canadian
Dollars and Hungarian Forints. Gains and losses arising from these
contracts are unrealized in other comprehensive income and will be
millions of dollars
Change in projected benefit obligation:
Projected benefit obligation at beginning of year
Service cost
Interest cost
Plan participants’ contributions
Actuarial (gain)/loss
Currency translation
Curtailments
Benefits paid
47
reclassified and matched into income as the underlying operating
transactions are realized. As of December 31, 2004 unrealized gains
amounted to $8.8 million, ($4.2 million maturing in less than one
year) and unrealized losses amounted to $(4.1) million ($(3.2) million
maturing in less than one year). As of December 31, 2003 unrealized
gains amounted to $3.6 million and unrealized losses amounted to
$(3.3) million. Hedge ineffectiveness associated with these contracts
during 2003 and 2004 was not significant.
NOTE 8
RETIREMENT BENEFIT PLANS
The Company has a number of defined benefit pension plans and
other post retirement benefit plans covering eligible salaried and
hourly employees. The other post retirement benefit plans, which
provide medical and life insurance benefits, are unfunded plans.
The measurement date for all plans is December 31. The following
provides a reconciliation of the plans’ benefit obligations, plan assets,
funded status and recognition in the Consolidated Balance Sheets.
Pension benefits
2004
2003
U.S.
Non-U.S.
U.S.
Non-U.S.
Other post
retirement benefits
2004
2003
$316.5
2.4
17.3
—
(8.3)
—
—
(22.6)
$217.1
9.3
11.5
0.3
12.2
17.9
—
(8.1)
$283.2
2.5
18.5
—
33.9
—
—
(21.6)
$ 159.9
7.5
9.5
0.3
21.1
24.7
—
(5.9)
$ 537.4
6.0
28.8
—
(2.1)
—
—
(32.9)
$ 446.5
5.3
29.7
—
89.2
—
(0.8)
(32.5)
Projected benefit obligation at end of year
$305.3
$260.2
$316.5
$ 217.1
$ 537.2
$ 537.4
Change in plan assets:
Fair value of plan assets at beginning of year
Actual return on plan assets
Employer contribution
Plan participants’ contribution
Currency translation
Benefits paid
$288.0
34.7
24.3
—
—
(22.6)
$103.4
8.9
12.0
0.3
8.2
(8.1)
$245.7
52.9
11.0
—
—
(21.6)
$ 77.8
15.1
6.1
0.3
10.0
(5.9)
Fair value of plan assets at end of year
$324.4
$124.7
$288.0
$ 103.4
Funded status:
Funded status at end of year
Unrecognized net actuarial (gain) loss
Unrecognized transition obligation (asset)
Unrecognized prior service cost
Net amount recognized
Amounts recognized in the Consolidated
Balance Sheets consist of:
Prepaid benefit cost
Accrued benefit liability
Additional minimum liability
Intangible asset
Accumulated reduction in stockholders equity
$ 19.1
79.1
—
7.5
$(135.5)
57.2
—
0.3
$ (28.5)
101.2
—
9.0
$(113.7)
45.2
0.2
0.4
$(537.2)
203.7
—
(2.1)
$(537.4)
214.4
—
(2.3)
$105.7
$ (78.0)
$ 81.7
$ (67.9)
$(335.6)
$(325.3)
$105.7
—
(63.2)
7.2
56.0
$ —
(78.0)
(21.2)
0.2
21.0
$ 81.7
—
(80.5)
8.7
71.8
$ —
(67.9)
(22.8)
0.4
22.4
$ —
(335.6)
—
—
—
$ —
(325.3)
—
—
—
Net amount recognized
$105.7
$ (78.0)
$ 81.7
$ (67.9)
$(335.6)
$(325.3)
Total accumulated benefit obligation for all plans
$301.8
$229.6
$316.2
$ 194.9
Notes to Consolidated Financial Statements
48
The funded status of pension plans included above with accumu-
lated benefit obligations in excess of plan assets at December 31 is
as follows:
The weighted average asset allocations of the Company’s funded pen-
sion plans at December 31, 2004 and 2003, and target allocations by
asset category, are as follows:
millions of dollars
Accumulated benefit obligation
Plan assets
Deficiency
Pension deficiency by country:
United States
United Kingdom
Germany
Japan
Total pension deficiency
2004
2003
$(449.7) $(418.1)
(321.9)
(270.0)
$(127.8) $(148.1)
$ (19.4) $ (56.7)
(30.0)
(55.5)
(5.9)
(29.0)
(72.5)
(6.9)
$(127.8) $(148.1)
percent
Cash, real estate and other
Fixed income securities
Equity securities
2004
Target
2003 Allocation
7%
4%
0-15%
33
60
33
63
30-45
50-70
100% 100%
The Company’s investment strategy is to maintain actual asset weight-
ings within a preset range of target allocations. The Company believes
these ranges represent an appropriate risk profile for the planned
benefit payments of the plans based on the timing of the estimated
benefit payments. Within each asset category, separate portfolios
are maintained for additional diversification. Investment managers are
retained within each asset category to manage each portfolio against
its benchmark. Each investment manager has appropriate investment
guidelines. In addition, the entire portfolio is evaluated against a rel-
evant peer group. The pension plans did not hold any Company securi-
ties as investments as of December 31, 2004 and 2003.
The Company expects to contribute a total of $20 million to $25 million into all of its pension plans during 2005. The Company’s net periodic
pension benefit cost was $16.7 million in 2004, $23.2 million in 2003 and $6.8 million in 2002. See table below for a breakout between U.S. and
non-U.S. plans.
millions of dollars
For the Year Ended December 31,
2004
Pension benefits
2003
2002
Other post retirement benefits
2002
2003
2004
U.S.
Non-U.S.
U.S.
Non-U.S.
U.S.
Non-U.S.
Components of net periodic benefit cost:
Service cost
Interest cost
Expected return on plan assets
Amortization of unrecognized transition obligation
Amortization of unrecognized prior service cost
Amortization of unrecognized loss
$ 2.4
17.3
(26.1)
—
1.5
5.2
$ 9.3
11.5
(7.3)
0.3
0.2
2.4
$ 2.5
18.5
(20.7)
—
1.5
7.8
$ 7.5
9.5
(5.7)
0.3
0.2
1.8
$ 2.1
18.8
(25.5)
—
1.5
2.1
$ 5.5
7.5
(5.4)
(0.1)
0.2
0.1
$ 6.0
28.8
—
—
(0.2)
8.6
$ 5.3
29.7
—
—
(0.2)
5.9
$ 5.0
28.8
—
—
(0.1)
4.0
Net periodic benefit cost/(benefit)
$ 0.3
$16.4
$ 9.6
$13.6
$ (1.0)
$ 7.8
$43.2
$40.7
$37.7
The Company’s weighted-average assumptions used to determine the
benefit obligations for our defined benefit pension and other post retire-
ment plans as of December 31, 2004 and 2003 were as follows:
percents
2004
2003
U.S. plans
Discount rate
Rate of compensation increase
Non-U.S. plans
Discount rate
Rate of compensation increase
5.75
3.50
5.04
3.36
6.00
3.50
5.49
3.40
The Company’s weighted-average assumptions used to determine
the net periodic benefit cost (income) for our defined benefit pension
and other post retirement benefit plans for the three years ended
December 31, 2004 were as follows:
percents
2004
2003
2002
U.S. plans
Discount rate
Rate of compensation increase
Expected return on plan assets
Non-U.S. plans
Discount rate
Rate of compensation increase
Expected return on plan assets
6.00
3.50
8.75
5.49
3.40
6.62
6.75
4.50
8.75
5.45
3.36
6.82
7.25
4.50
9.50
5.46
3.39
6.43
The return on assets assumption was developed through analysis
of historical market returns, current market conditions, target allo-
cations among asset classes and past experience. Overall, it was
projected that the U.S. funds could achieve an 8.75% net return over
time, based upon the targeted asset allocation. This assumes no
benefit from manager selection strategies.
BorgWarner Inc.
and Consolidated Subsidiaries
49
The estimated future benefit payments for the pension and other post
retirement benefits are as follows:
NOTE 9
STOCK INCENTIVE PLANS
millions of dollars
Year
2005
2006
2007
2008
2009
2010–2014
Pension
benefits
$ 31.5
31.7
32.0
32.4
33.1
175.7
Other
post retirement
benefits
$ 30.8
29.7
30.3
30.8
30.7
162.3
The weighted-average rate of increase in the per capita cost of cov-
ered health care benefits is projected to be 8.0% in 2005 decreasing
to 4.5% by the year 2009. A one-percentage point change in the
assumed health care cost trend would have the following effects:
millions of dollars
Effect on post retirement benefit obligation
Effect on total service and interest
cost components
One percentage point
increase decrease
$70.0 $(55.7)
$ 5.7 $ (4.5)
Under the Company’s 1993 Stock Incentive Plan, the Company
granted options to purchase shares of the Company’s common stock
at the fair market value on the date of grant. The options vest over
periods up to three years and have a term of ten years from date of
grant. As of December 31, 2003, there were no options available for
future grants under the 1993 plan. The 1993 plan expired at the end
of 2003 and was replaced by the Company’s 2004 Stock Incentive
Plan. Under the 2004 Stock Incentive Plan, the numbers of shares
available for grant are 2,700,000. As of December 31, 2004, there
are 2,990,205 outstanding options under the 1993 and 2004 Stock
Incentive Plans. On July 28, 2004, the Company issued a total of 6,400
restricted shares of common stock to its non-employee directors
under the 2004 Stock Incentive Plan.
The Company accounts for stock options in accordance with APB
Opinion No. 25, “Accounting for Stock Issued to Employees.”
Accordingly, no compensation cost has been recognized for fixed
stock options because the exercise price of the stock options
exceeded or equaled the market value of the Company’s common
stock at the date of grant, which is the measurement date.
A summary of the plan’s shares under option at December 31, 2004,
2003 and 2002 follows:
2004
2003
2002
Shares
(thousands)
Weighted-average
exercise price
Shares
(thousands)
Weighted-average
exercise price
Shares
(thousands)
Weighted-average
exercise price
Outstanding at beginning of year
Granted
Exercised
Forfeited
Outstanding at end of year
2,680
1,063
(593)
(160)
2,990
$26.44
44.56
24.22
26.74
$33.30
3,650
682
(1,518)
(134)
2,680
$23.29
32.74
21.80
25.03
$26.44
2,986
1,232
(434)
(134)
3,650
$22.34
25.34
22.61
23.13
$23.29
Options exercisable at year-end
793
$23.78
554
$22.57
1,188
$22.61
Options available for future grants
1,637
The following table summarizes information about stock options outstanding at December 31, 2004:
Range of
exercise prices
$12.78-21.13
$24.14-26.56
$26.94-44.56
$12.78-44.56
Number outstanding
(thousands)
Options outstanding
Weighted-average
remaining contractual life
Weighted-average
exercise price
Number exercisable
(thousands)
Weighted-average
exercise price
Options exercisable
156
1,106
1,728
2,990
5.0
7.1
9.0
8.1
$18.31
25.14
39.88
$33.30
156
575
62
793
$18.31
24.90
27.18
$23.78
The weighted average fair value at date of grant for options granted
during 2004, 2003, and 2002 were $16.28, $11.91, and $10.13,
respectively, and were estimated using the Black-Scholes options
pricing model with the following weighted average assumptions:
2004
2003
2002
Risk-free interest rate
4.14%
Dividend yield
1.26%
Volatility factor
32.89%
Weighted average expected life 6.5 years
3.58%
1.27%
34.38%
4.34%
1.32%
33.66%
6.5 years 6.5 years
Executive Stock Performance Plan The Company has an Executive
Stock Performance Plan that provides payouts to members of senior
management at the end of successive three-year periods based on
the Company’s performance in terms of total stockholder return
relative to a peer group of automotive companies. Payouts earned
are payable 40% in cash and 60% in the Company’s common stock.
For the three-year measurement periods ended December 31, 2004,
2003 and 2002, the amounts expensed under the plan and the
related share issuances were as follows:
Notes to Consolidated Financial Statements
50
Expense ($ millions)
Number of shares*
2004
2003
2002
$2.0
$ 4.5
48,569 41,252 131,762
$2.7
*Shares are issued in February of the following year.
Estimated shares issuable under the plan are included in the compu-
tation of diluted earnings per share as earned. Under the terms of
the Executive Stock Performance Plan, the final three-year period for
which awards have been granted was for the three-year period begin-
ning January 1, 2004 and ending on December 31, 2006.
NOTE 10
OTHER COMPREHENSIVE INCOME
The components of accumulated other comprehensive income/(loss),
net of tax, in the Consolidated Balance Sheets are as follows:
millions of dollars
2004
2003
Foreign currency translation adjustments, net
Market value of hedge instruments, net
Minimum pension liability adjustment, net
$ 99.7 $ 74.3
3.2
(47.7)
0.2
(60.5)
Accumulated other comprehensive income
$ 55.2
$ 14.0
The change in the components of other comprehensive income/(loss)
in the Consolidated Statements of Stockholders’ Equity are as follows:
millions of dollars
2004
2003
2002
Foreign currency translation adjustments
Market value of hedge instruments
Income taxes
Net foreign currency translation
$10.7 $67.6 $ 55.9
—
(15.0)
4.7
13.0
0.4
(0.2)
and hedge instruments adjustment
28.4
67.8
40.9
Minimum pension liability adjustment
Income taxes
17.2
(4.4)
1.1
(0.4)
(65.4)
23.1
Net minimum pension liability adjustment
12.8
0.7
(42.3)
Other comprehensive income/(loss)
$41.2
$68.5 $ (1.4)
NOTE 11
CONTINGENCIES
In the normal course of business the Company and its subsidiaries
are parties to various legal claims, actions and complaints, including
matters involving intellectual property claims, general liability and
various other risks. It is not possible to predict with certainty whether
or not the Company and its subsidiaries will ultimately be successful
in any of these legal matters or, if not, what the impact might be.
The Company’s environmental and product liability contingencies are
discussed separately below. The Company’s management does not
expect that the results in any of these legal proceedings will have
a material adverse effect on the Company’s results of operations,
financial position or cash flows.
Environmental The Company and certain of its current and former
direct and indirect corporate predecessors, subsidiaries and divisions
have been identified by the United States Environmental Protection
Agency (EPA) and certain state environmental agencies and private
parties as potentially responsible parties (PRPs) at various hazard-
ous waste disposal sites under the Comprehensive Environmental
Response, Compensation and Liability Act (Superfund) and equivalent
state laws and, as such, may presently be liable for the cost of clean-
up and other remedial activities at 39 such sites. Responsibility for
clean-up and other remedial activities at a Superfund site is typically
shared among PRPs based on an allocation formula.
Based on information available to the Company, which in most cases,
includes: an estimate of allocation of liability among PRPs; the prob-
ability that other PRPs, many of whom are large, solvent public com-
panies, will fully pay the cost apportioned to them; currently available
information from PRPs and/or federal or state environmental agen-
cies concerning the scope of contamination and estimated remedia-
tion and consulting costs; remediation alternatives; estimated legal
fees; and other factors, the Company has established a reserve for
indicated environmental liabilities with a balance at December 31,
2004 of approximately $25.7 million. The Company expects this
amount to be expended over the next three to five years.
The Company believes that none of these matters, individually or in
the aggregate, will have a material adverse effect on its financial con-
dition or future operating results, generally either because estimates
of the maximum potential liability at a site are not large or because
liability will be shared with other PRPs, although no assurance can be
given with respect to the ultimate outcome of any such matter.
In connection with the sale of Kuhlman Electric Corporation, the
Company agreed to indemnify the buyer and Kuhlman Electric for cer-
tain environmental liabilities relating to the past operations of Kuhlman
Electric. The liabilities at issue result from operations of Kuhlman
Electric that pre-date the Company’s acquisition of Kuhlman Electric’s
parent company, Kuhlman Corporation, during 1999. During 2000,
Kuhlman Electric notified the Company that it discovered potential
environmental contamination at its Crystal Springs, Mississippi plant
while undertaking an expansion of the plant.
The Company has been working with the Mississippi Department of
Environmental Quality and Kuhlman Electric to investigate the extent of
and remediate the contamination. The investigation revealed the pres-
ence of polychlorinated biphenyls (PCBs) in portions of the soil at the
plant and neighboring areas. Clean up began in 2000 and is continuing.
Kuhlman Electric and others, including the Company, have been sued in
numerous related lawsuits, in which multiple claimants allege personal
injury and property damage. The Company has moved to be dismissed
from some of these lawsuits. The first trial in these lawsuits is currently
scheduled to begin in March 2005.
The Company believes that the accrual for environmental liabilities and
any insurance recoveries are sufficient to cover any potential liability
associated with this matter. However, due to the nature of environmen-
tal liability matters, there can be no assurance that the actual amount
of environmental liabilities will not exceed the amount accrued.
BorgWarner Inc.
and Consolidated Subsidiaries
51
Product Liability Like many other industrial companies who have
historically operated in the United States, the Company (or parties
the Company indemnifies) continues to be named as one of many
defendants in asbestos-related personal injury actions. Management
believes that the Company’s involvement is limited because, in
general, these claims relate to a few types of automotive friction
products, manufactured many years ago that contained encapsulated
asbestos. The nature of the fibers, the encapsulation and the manner
of use lead the Company to believe that these products are highly
unlikely to cause harm. At December 31, 2004, the Company had
approximately 100,000 pending asbestos-related product liability
claims. Of these outstanding claims, approximately 92,000 are pend-
ing in just three jurisdictions, where significant tort reform activities
are underway. The Company’s policy is to aggressively defend against
these lawsuits and the Company has been successful in obtaining dis-
missal of many claims without any payment. The Company expects
that the vast majority of the pending asbestos-related product liability
claims where it is a defendant (or has an obligation to indemnify a
defendant) will result in no payment being made by the Company or
its insurers. In 2004 of the 4,062 claims settled, only 255 (6.3%)
resulted in any payment being made to a claimant by or on behalf of
the Company. In 2003 of the 4,664 claims settled, only 273 (5.9%)
resulted in any payment being made to claimants. The settlement
costs of these claims were paid by the insurance carriers, except for
the $1.0 million in 2004 as described in the paragraph below. Based
upon the encapsulated nature of the products, our experiences in
aggressively defending and resolving claims in the past, and our
significant insurance coverage with solvent carriers as of the date of
this filing, management does not believe that asbestos-related prod-
uct liability claims are likely to have a material adverse effect on the
Company’s results of operations, cash flows or financial condition.
Prior to June 2004, all claims were covered by the Company’s pri-
mary layer insurance coverage, and these carriers administered,
defended, settled and paid all claims under a funding agreement.
In June 2004, the Company was notified by primary layer insurance
carriers of the exhaustion of their policy limits. This led the Company
to access the next available layer of insurance coverage. Since June
2004, secondary layer insurers have paid asbestos-related litigation
defense and settlement expenses pursuant to a funding agreement.
Two secondary layer insurers are currently not participating in this
arrangement, until they are satisfied through an audit process, that
the primary level of insurance is exhausted. The Company therefore
paid $1.0 million in defense and settlement costs in late 2004 and
expects to recover those amounts from either these insurers, or the
primary layer insurers if the exhaustion audit shows that primary layer
insurance is still available.
The Company’s contractual relationship with the secondary layer car-
riers provides a change in circumstances and allows the Company to
take a more direct role in defending and settling claims than with the
primary carriers. Previously, the Company’s arrangement utilized the
primary layer insurance carriers’ positions to defend and negotiate
the settlements with periodic input from the Company.
At December 31, 2004, the Company recorded a liability of $40.8 mil-
lion; with a related asset of $40.8 million to recognize the insurance
proceeds receivable to the Company for estimated claim losses. For
2003, the comparable value of the insurance receivable and accrued
liability is $41.6 million.
The amounts recorded in the Consolidated Balance Sheets are
as follows:
millions of dollars
2004
2003
Assets:
Prepayments and other current assets
Other non-current assets
Total insurance receivable
Liabilities:
Accounts payable and accrued expenses
Long-term liabilities – other
Total accrued liability
$13.5 $13.7
27.9
27.3
$40.8 $41.6
$13.5 $13.7
27.9
27.3
$40.8 $41.6
The insurance receivable and accrued liability of $41.6 million in 2003
have been reclassified as outlined above and the reclassification is
not material to the Company’s Consolidated Financial Statements.
We cannot reasonably estimate possible losses, if any, in excess of
those for which we have accrued, because we cannot predict how
many additional claims may be brought against the Company (or
parties the Company has an obligation to indemnify) in the future,
the allegations in such claims, the possible outcomes, or the impact
of tort reform legislation currently being considered at the State and
Federal level.
A declaratory judgment action was filed in January 2004 in the Circuit
Court of Cook County, Illinois by Continental Casualty Company and
related companies (CNA) against the Company and certain of its other
historical general liability insurers. CNA provided the Company with
both primary and additional layer insurance, and, in conjunction with
other insurers, is currently defending and indemnifying the Company
in all of its pending asbestos-related product liability claims. The
lawsuit seeks to determine the extent of insurance coverage available
to the Company including whether the available limits exhaust on a
“per occurrence” or an “aggregate” basis, and to determine how the
applicable coverage responsibilities should be apportioned. In addition
to the primary insurance available for asbestos-related claims, the
Company has substantial additional layers of insurance available for
potential future asbestos-related product claims.
Although it is impossible to predict the outcome of pending or future
claims; due to the encapsulated nature of the products, our experi-
ences in aggressively defending and resolving claims in the past, and
our significant insurance coverage with solvent carriers as of the date
of this filing, management does not believe that asbestos-related prod-
uct liability claims are likely to have a material adverse effect on the
Company’s results of operations, cash flows or financial condition.
Notes to Consolidated Financial Statements
52
NOTE 12
LEASES AND COMMITMENTS
NOTE 13
STOCK SPLIT
Certain assets are leased under long-term operating leases. These
include production equipment at one plant, rent for the corporate
headquarters, and an airplane. Most leases contain renewal options
for various periods. Leases generally require the Company to pay
for insurance, taxes and maintenance of the leased property. The
Company leases other equipment such as vehicles and certain office
equipment under short-term leases. Total rent expense was $18.0
million in 2004, $13.4 million in 2003, and $11.4 million in 2002. The
Company does not have any material capital leases.
The Company has guaranteed the residual values of certain leased
production equipment at one of its facilities. The guarantees extend
through the maturity of the underlying lease, which is in 2005. In the
event the Company exercised its option not to purchase the produc-
tion equipment, the Company has guaranteed a residual value of
$16.3 million. We do not believe we have any loss exposure due to
this guarantee.
Future minimum operating lease payments at December 31, 2004
were as follows:
millions of dollars
2005
2006
2007
2008
2009
After 2009
Total minimum lease payments
$29.1
4.7
4.3
3.8
3.3
12.8
$58.0
The Company entered into two separate royalty agreements with
Honeywell International for certain variable turbine geometry (VTG)
turbochargers in order to continue shipping to its OEM customers
after a German court ruled in favor of Honeywell in a patent infringe-
ment action. The two separate royalty agreements were signed in July
2002 and June 2003, respectively. The July 2002 agreement was
effective immediately and expired in June 2003. The June 2003 agree-
ment was effective July 2003 and covers the period through 2006
with a minimum royalty for shipments up to certain volume levels and
a per unit royalty for any units sold above these stated amounts.
The royalty costs recognized under the agreements were $14.2 mil-
lion in 2004, $23.2 million in 2003 and $13.5 million in 2002. These
costs were all recognized as part of cost of goods sold. These costs
will be at minimal levels in 2005 and 2006 as the Company’s primary
customers have converted most of their requirements to the next
generation VTG turbocharger.
On April 21, 2004 the Company’s stockholders approved an amend-
ment to the Company’s Restated Certificate of Incorporation to
increase the number of authorized shares of common stock from
50,000,000 to 150,000,000. The approval of the amendment
allowed the Company to proceed with its two-for-one stock split on
May 17, 2004 to stockholders of record on May 3, 2004. All prior
year share and per share amounts disclosed in this document have
been restated to reflect the two-for-one stock split.
NOTE 14
EARNINGS PER SHARE
In calculating earnings per share, earnings are the same for the basic
and diluted calculations. Shares increased for diluted earnings per
share by 665,000, 488,000, and 458,000 for 2004, 2003 and 2002,
respectively, due to the effects of stock options and shares issuable
under the executive stock performance plan.
NOTE 15
SUBSEQUENT EVENT
On January 4, 2005, the Company acquired 62.2% of the outstand-
ing shares of Beru Aktiengesellschaft (Beru), headquartered in
Ludwigsburg, Germany, from the Carlyle Group and certain family
shareholders. In conjunction with the acquisition, the Company
launched a tender offer for the remaining outstanding shares of
Beru. The tender offer period officially ended on January 24, 2005.
Presently the Company holds 69.42% of the shares of Beru at a cost
of approximately €415 million. Beru is a leading global automotive
supplier of diesel cold starting technology (glow plugs and instant
starting systems); gasoline ignition technology (spark plugs and
ignition coils); and electronic and sensor technology (tire pressure
sensors, diesel cabin heaters and selected sensors). Beginning in
2005, the Company will report Beru within the Engine segment.
The Company has not included a separate discussion of the Beru
operations in the outlook for 2005, although many of the same fac-
tors that impact the Company’s other operations can be expected
to impact the business of Beru. In addition, the impact of Beru on
the Company’s future results will be affected by the allocation of the
excess purchase price over the net book value of assets acquired
between intangible assets and goodwill.
NOTE 16
OPERATING SEGMENTS AND RELATED INFORMATION
The Company’s business is comprised of two operating segments:
Drivetrain and Engine. These reportable segments are strategic busi-
ness units, which are managed separately because each represents
a specific grouping of automotive components and systems. The
Company evaluates the operating segments’ performance based
upon return on invested capital. The return on invested capital is com-
prised of earnings before income and taxes and the average capital
invested in each operating segment. Inter-segment sales, which are
not significant, are recorded at market prices. This footnote presents
summary segment information.
BorgWarner Inc.
and Consolidated Subsidiaries
53
Net sales
Inter-
segment
$ —
50.3
(50.3)
—
—
Net
$1,358.6
2,217.0
(50.3)
3,525.3
—
Earnings
before
interest
and taxes
$106.9
281.7
—
388.6
(50.3)
Year end
assets
Depr./
amort.
Long-lived
asset
expenditures(b)
$ 810.0
2,208.4
—
3,018.4
510.7(a)
$ 66.1
107.3
—
173.4
3.6
$ 75.3
167.7
—
243.0
9.4
$3,525.3
$ —
$3,525.3
$338.3
$3,529.1
$177.0
$252.4
$3,069.2
$ —
$3,069.2
$290.0
$3,140.5
$161.3
$214.4
Net sales
Inter-
segment
$ 0.1
46.0
(46.1)
—
—
Net
$1,245.6
1,869.7
(46.1)
3,069.2
—
29.7
$308.6
Earnings
before
interest
and taxes
$ 98.4
239.6
—
338.0
(48.0)
Year end
assets
Depr./
amort.
Long-lived
asset
expenditures(b)
$ 778.8
1,925.1
—
2,703.9
436.6(a)
$ 60.1
93.8
—
153.9
7.4
$ 66.4
133.3
—
199.7
14.7
Net sales
Inter-
segment
$ —
39.2
(39.2)
—
—
Net
$1,122.1
1,648.2
(39.2)
2,731.1
—
33.3
$256.7
Earnings
before
interest
and taxes
$ 99.9
215.9
—
315.8
(44.3)
Year end
assets
Depr./
amort.
Long-lived
asset
expenditures(b)
$ 733.8
1,712.5
—
2,446.3
236.6(a)
$ 50.0
81.3
—
131.3
6.1
$ 54.4
91.8
—
146.2
19.9
Operating Segments
millions of dollars
Customers
2004
Drivetrain
Engine
Inter-segment eliminations
Total
Corporate
Consolidated
Interest expense and finance charges
Earnings before income taxes
2003
Drivetrain
Engine
Inter-segment eliminations
Total
Corporate
Consolidated
Interest expense and finance charges
Earnings before income taxes
$1,358.6
2,166.7
—
3,525.3
—
$1,245.5
1,823.7
—
3,069.2
—
millions of dollars
Customers
millions of dollars
Customers
2002
Drivetrain
Engine
Inter-segment eliminations
Total
Corporate
Consolidated
Interest expense and finance charges
Earnings before income taxes
$1,122.1
1,609.0
—
2,731.1
—
$2,731.1
$ —
$2,731.1
$271.5
$2,682.9
$137.4
$166.1
37.7
$233.8
(a) Corporate assets, including equity in affiliates, are net of trade receivables securitized and sold to third parties, and include cash, marketable securities, deferred income
taxes and investments and advances.
(b) Long-lived asset expenditures includes capital expenditures and tooling outlays, net of customer reimbursements.
Notes to Consolidated Financial Statements
Selected Financial Data
54
Geographic Information
No country outside the U.S., other than Germany and the United
Kingdom, accounts for as much as 5% of consolidated net sales,
attributing sales to the sources of the product rather than the
location of the customer. Also, the Company’s 50% equity invest-
ment in NSK-Warner (see Note 5) amounting to $188.2 million at
December 31, 2004 is excluded from the definition of long-lived
assets, as are goodwill and certain other non-current assets.
millions of dollars
United States
Europe:
Germany
United Kingdom
Other Europe
Total Europe
Other foreign
Total
2004
Net sales
2003
2002
2004
Long-lived assets
2003
2002
$1,964.9
$1,889.2
$1,859.1
$ 637.1
$ 636.9
$643.0
834.1
186.0
237.1
1,257.2
303.2
637.7
146.3
167.7
951.7
228.3
453.4
129.1
106.9
689.4
182.6
278.7
39.5
106.1
424.3
117.9
234.6
36.4
78.3
349.3
89.6
182.3
28.1
44.3
254.7
80.8
$3,525.3
$3,069.2
$2,731.1
$1,179.3
$1,075.8
$978.5
Sales to Major Customers
Consolidated sales included sales to Ford Motor Company of
approximately 21%, 23%, and 26%; to DaimlerChrysler of approxi-
mately 14%, 17%, and 20%; and to General Motors Corporation of
approximately 10%, 12%, and 12% for the years ended December
31, 2004, 2003 and 2002, respectively. Sales to Volkswagen were
approximately 10% in 2004. Both of our operating segments had
significant sales to all four of the customers listed above. Such sales
consisted of a variety of products to a variety of customer locations
and regions. No other single customer accounted for more than 10%
of consolidated sales in any year of the periods presented.
Interim Financial Information (Unaudited)
The following information includes all adjustments, as well as normal
recurring items, that the Company considers necessary for a fair
presentation of 2004 and 2003 interim results of operations. Certain
2004 and 2003 quarterly amounts have been reclassified to conform
to the annual presentation.
millions of dollars, except per share amounts
Quarter Ended,
Net sales
Cost of sales
Gross profit
Selling, general and
administrative expenses
Other, net
Operating income
Equity in affiliate earnings, net of tax
Interest expense, net
Income before income taxes
Provision for income taxes
Minority interest, net of tax
2004
2003
Mar-31
Jun-30
Sep-30
Dec-31
Year 2004
Mar-31
Jun-30
Sep-30
Dec-31
Year 2003
$903.1 $893.2 $839.8 $889.2 $3,525.3
2,874.2
730.5 723.4 694.7
725.5
$775.7 $769.5 $725.2
595.9
622.8
624.2
$798.8
639.7
$3,069.2
2,482.5
172.6 169.8 145.1
163.7
651.1
151.5
146.7
129.3
159.1
586.7
94.7
0.3
77.6
(6.5)
7.5
76.6
22.9
2.6
87.8
0.6
81.4
(8.4)
7.7
82.1
24.6
2.8
77.4
(0.5)
68.2
(6.2)
7.5
66.9
20.1
2.0
79.1
2.7
81.9
(8.1)
7.0
83.0
13.5
1.8
339.0
3.0
309.1
(29.2)
29.7
308.6
81.2
9.1
83.6
—
67.9
(6.4)
9.0
65.3
18.9
2.2
77.0
0.1
69.6
(5.2)
8.7
66.1
19.2
2.1
72.7
0.1
56.5
(3.6)
8.1
52.0
14.2
1.9
83.5
(0.4)
76.0
(4.8)
7.5
73.3
20.9
2.4
316.9
(0.1)
269.9
(20.1)
33.3
256.7
73.2
8.6
Net earnings
$ 51.1 $ 54.7 $ 44.8 $ 67.7 $ 218.3
$ 44.2 $ 44.8 $ 35.9
$ 50.0
$ 174.9
Earnings/(loss) per share – basic
$ 0.92 $ 0.98 $ 0.80 $ 1.20 $ 3.91
$ 0.83 $ 0.83 $ 0.66 $ 0.91 $ 3.23
Earnings/(loss) per share – diluted
$ 0.91 $ 0.97 $ 0.79 $ 1.19 $ 3.86
$ 0.82 $ 0.83 $ 0.65 $ 0.90 $ 3.20
BorgWarner Inc.
and Consolidated Subsidiaries
55
millions of dollars, except per share data
For the Year Ended December 31,
S TAT E M E N T O F O P E R AT I O N S D ATA
Net sales
Cost of sales
Gross profit
Selling, general and administrative expenses
Goodwill amortization
Other, net
Restructuring and other non—recurring charges
Operating income
Equity in affiliate earnings, net of tax
Interest expense, net
Earnings before income taxes
Provision for income taxes
Minority interest, net of tax
Net earnings before cumulative effect of accounting change
Cumulative effect of change in accounting principle, net of tax
2004
2003
2002
2001
2000
$3,525.3
2,874.2
$3,069.2
2,482.5
$2,731.1
2,176.5
$2,351.6
1,890.8
$2,645.9
2,090.7
651.1
339.0
—
3.0
—
309.1
(29.2)
29.7
308.6
81.2
9.1
218.3
—
586.7
316.9
—
(0.1)
—
269.9
(20.1)
33.3
256.7
73.2
8.6
174.9
—
554.6
303.5
—
(0.9)
—
252.0
(19.5)
37.7
233.8
77.2
6.7
149.9
(269.0)a
460.8
249.7
42.0
(2.1)
28.4b
142.8
(14.9)
47.8
109.9
39.7
3.8
66.4
—
555.2
258.7
43.3
(8.1)
62.9c
198.4
(15.7)
62.6
151.5
54.8
2.7
94.0
—
Net earnings/(loss)
$ 218.3
$ 174.9
$ (119.1)
$ 66.4
$ 94.0
Earnings/(loss) per share — basic
$ 3.91
$ 3.23
$(2.23)a
$ 1.26b
$ 1.78c
Average shares outstanding (thousands) — basic
55,872
54,116
53,250
52,630
52,782
Earnings/(loss) per share — diluted
$ 3.86
$ 3.20
$ (2.22)a
$ 1.26b
$ 1.77c
Average shares outstanding (thousands) — diluted
56,537
54,604
53,708
52,926
52,974
Cash dividend declared per share
$0.50
$ 0.36
$ 0.30
$ 0.30
$ 0.30
B A L A N C E S H E E T D ATA (at end of period)
Total assets
Total debt
$3,529.1
584.5
$3,140.5
655.5
$2,682.9
646.7
$2,770.9
737.0
$2,739.6
794.8
(a) In 2002, upon the adoption of SFAS No. 142, the Company recorded a $269.0 million after tax charge for cumulative effect of accounting principle related to goodwill.
This charge was $5.01 per diluted share.
(b) In 2001, the Company recorded $28.4 million in non-recurring charges. Net of tax, this totaled $19.0 million or $0.36 per diluted share.
(c) In 2000, the Company recorded $62.9 million in restructuring and other non-recurring charges. Net of tax, this totaled $38.7 million or $0.74 per diluted share.
Corporate Information
Directors
Executive Officers
56
Company Information
BorgWarner Inc.
World Headquarters
3850 Hamlin Road
Auburn Hills, MI 48326
248-754-9200
www.borgwarner.com
Stock Listing
Shares are listed and traded on the New York Stock Exchange.
Ticker symbol: BWA.
Fourth Quarter 2004
Third Quarter 2004
Second Quarter 2004
First Quarter 2004
Fourth Quarter 2003
Third Quarter 2003
Second Quarter 2003
First Quarter 2003
Certifications
High
Low
$54.68
48.77
45.08
49.32
$ 42.75
36.68
33.13
27.70
$39.50
40.73
38.35
39.84
$ 34.14
31.72
23.68
21.66
(cid:127) BorgWarner filed as an exhibit to its Annual Report on Form 10-K
the CEO and CFO certifications as required by Section 302 of
the Sarbanes-Oxley Act.
(cid:127) BorgWarner also submitted the required annual CEO certification
to the NYSE.
Dividends
The current dividend practice established by the Board of Directors is
to declare regular quarterly dividends. The last such dividend of 14
cents per share of common stock was declared on November 10,
2004, payable February 15, 2005, to stockholders of record on
February 1, 2005. The current practice is subject to review and
change at the discretion of the Board of Directors.
Stockholder Services
Mellon Investor Services is the transfer agent, registrar and
dividend dispersing agent for BorgWarner common stock.
Mellon Investor Services for BorgWarner
85 Challenger Road
Ridgefield Park, NJ 07660
www.melloninvestor.com
Communica tions concerning stock transfer, change of address, lost
stock certificates or proxy statements for the annual meeting should
be directed to Mellon Investor Services at 800-851-4229.
Dividend Reinvestment and Stock Purchase Plan
The BorgWarner Dividend Reinvestment and Stock Purchase Plan
has been established so that anyone can make direct purchases
of BorgWarner common stock and reinvest dividends. We pay the
brokerage commissions on purchases. Questions about the plan can
be directed to Mellon at 800-851-4229. To receive a prospectus and
enrollment package, contact Mellon at 800-842-7629.
Annual Meeting of Stockholders
The 2005 annual meeting of stockholders will be held on Wednesday,
April 27, 2005, beginning at 9:00 a.m. at the BorgWarner World
Headquarters at 3850 Hamlin Road, Auburn Hills, Michigan.
Stockholders
As of December 31, 2004, there were 2,877 holders of record and
an estimated 18,000 beneficial holders.
Investor Information
Visit www.borgwarner.com for a wide range of company information.
For investor information, including the following, click on Investor
Information.
(cid:127) BorgWarner News Releases
(cid:127) BorgWarner Stock Quote
(cid:127) Earnings Release Conference Call Calendar
(cid:127) Webcasts
(cid:127) Analyst Coverage
(cid:127) Stockholder Services
(cid:127) Corporate Governance
(cid:127) BorgWarner In The News Articles
(cid:127) Annual Reports
(cid:127) Proxy Statement and Card
(cid:127) Dividend Reinvestment/Stock Purchase Plan
(cid:127) Financials and SEC Filings
(including the Annual Report on Form 10-K)
(cid:127) Request Information Form
News Release Sign-up
At our Investor Information web page, you can sign up to receive
BorgWarner’s news releases. Here’s how to sign up:
1. Go to www.borgwarner.com
2. Click Investor Information
3. Click News
4. Click News Release Sign-up and follow the instructions
Investor Inquiries
Investors and securities analysts requiring financial reports, interviews
or other information should contact Mary E. Brevard, Vice President of
Investor Relations and Corporate Communications at BorgWarner
World Headquarters, 248-754-0882.
BorgWarner Inc. owns U.S. trademark registrations for: BorgWarner, ,
, and Visctronic. BorgWarner owns the following trademarks:
ITM, InterActive Torque Management, Pre-emptive Torque Management, Morse Gemini,
DualTronic and Regulated Two-Stage Turbocharger (R2S).
Timothy M. Manganello
Chairman and
Chief Executive Officer
Robin J. Adams
Executive Vice President,
Chief Financial Officer
and Chief Administrative Officer
Cynthia A. Niekamp
Vice President,
President and General Manager
TorqTransfer Systems
Mark A. Perlick
Vice President,
President and General Manager
Transmission Systems
Alfred Weber
Vice President,
President and General Manager
Emissions/Thermal Systems
F. Lee Wilson
Vice President,
President and General Manager
Turbo Systems
Mary E. Brevard
Vice President,
Investor Relations and
Corporate Communications
William C. Cline
Vice President,
Acquisition Coordination
and Special Projects
Angela J. D’Aversa
Vice President,
Human Resources
Jamal M. Farhat
Vice President and
Chief Information Officer
Anthony D. Hensel
Vice President and
Treasurer
Laurene H. Horiszny
Vice President,
General Counsel and Secretary
Roger J. Wood
John J. McGill
Vice President,
President and General Manager
Morse TEC
Vice President,
Global Supply Chain and
Champion of Emerging
Market Utilization
Jeffrey L. Obermayer
Vice President and
Controller
Christopher H. Vance
Vice President,
Business Development
and M&A
Phyllis O. Bonanno (2)
Dr. Andrew F. Brimmer (2)
President and Chief Executive Officer
International Trade Solutions, Inc.
President
Brimmer & Company, Inc.
David T. Brown
William E. Butler (3,4)
President, Chief Executive Officer
and Director
Owens Corning
Chairman and Chief Executive Officer
Retired
Eaton Corporation
Jere A. Drummond (1,3,4)
Paul E. Glaske (3,4)
Vice Chairman, Retired
BellSouth Corporation
Chairman, President and
Chief Executive Officer, Retired
Blue Bird Corporation
Timothy M. Manganello (1)
Alexis P. Michas (1,2)
Chairman and Chief Executive Officer
BorgWarner Inc.
Managing Partner
Stonington Partners, Inc.
Ernest J. Novak, Jr. (2)
Managing Partner, Retired
Ernst and Young
John Rau (2,3)
President and Chief Executive Officer
Miami Corporation
Committees of the Board
as of March 2005
1 Executive Committee
2 Finance and Audit Committee
3 Compensation Committee
4 Corporate Governance Committee
BorgWarner Inc.
World Headquarters
3850 Hamlin Road
Auburn Hills, MI 48326
www.borgwarner.com