The BorgWarner Difference
2 0 0 5 a n n u a l r e p o r t
innovat iv e
t ec h nol o g y
g l obal
pr e senc e
cust ome r
div ersit y
a cultur e of
col l aborat ion
man ufactur ing
exc e l l e nc e
f inanc ial
disc ipl ine
The B or gWar ner Dif f er e nc e
sets us apart and drives our continued
success. We focus our powertrain innovation,
manufacturing expertise, customer and
geographic diversity, collaborative culture
and financial discipline on the challenges
of improving fuel economy, reducing
emissions, optimizing performance and
enhancing vehicle stability.
2 0 0 5 a n n u a l r e p o r t
Fi nanc ia l Hig h lig hts
millions of dollars, except per share and employee data
2005
2004
% Change
Net sales
Net earnings
Net earnings per share — diluted
Average number of shares outstanding — diluted (millions)
Capital spending
Research and development
After-tax return on invested capital
Cash and cash equivalents
Debt
Stockholders’ equity
Total stockholder return
Number of employees
$4,293.8
239.6
4.17
57.4
246.7
161.0
13.2%
89.7
740.5
1,644.2
13.1%
17,400
$3,525.3
218.3
3.86
56.5
204.9
123.1
13.1%
229.7
584.5
1,534.2
28.8%
14,500
21.8%
9.8%
8.0%
20.4%
30.8%
(60.9)%
26.7%
7.2%
1
t o o u r s t o c k h o l d e r s
“ In an industry under siege, BorgWarner’s performance is one of the
few bright spots. How do we distinguish ourselves and continue to
deliver above-industry growth in sales and profitability?”
It may sound simplistic, but I
attribute our performance to our
culture and the pride it engenders
in our people throughout the
world.
Ours is a culture of:
– Entrepreneurial innovation
with roots in the birth of the
auto industry
– A global presence built over
50 years
– Customer diversity that is
unparalleled in the industry
– A fierce commitment to financial
discipline born out of a leveraged
buyout background
– Manufacturing expertise blended with
a robust cost-control focus
The past year was one in which
a number of suppliers went
bankrupt, credit ratings for two
of the largest auto companies in
the world were reduced to junk-
bond status and fuel prices surged.
Any real industry growth came
in regions like China, India and
Korea or was associated with Asian
and European technology leaders.
Setting the Pace
Our accomplishments in this
difficult environment reinforce
the value of the BorgWarner
Difference.
Our 2005 sales were up 22% to a
record $4.3 billion. Earnings hit
another record high. For the fourth
consecutive year, we increased our
dividend and our stock performed
at the top of our peer group. Over
the next three years, we expect to
launch new business amounting to
$1.6 billion. We continue to benefit
from offering the most diverse range
of powertrain technologies in the
industry.
We strengthened the Engine Group
with the January 2005 acquisition
of a majority stake in ignition
technology leader Beru. New
product launches like variable cam
timing, and turbochargers for the
Korean market and new turbo direct-
injected gasoline engines set the pace
for the future. Our thermal business
benefited from a strong commercial
vehicle market. The alignment of
our emissions and turbocharger
businesses will better integrate
BorgWarner strategies for efficient
combustion.
New products and applications in
our Drivetrain Group during 2005
partially offset the weakness in
all-wheel drive sales for traditional
light trucks and sport-utility
vehicles. It was a great year for
our fuel-efficient DualTronic
transmission technology as it
expanded into the VW/Audi family
of vehicles as an automatic option
in 14 models. The technology was
awarded the prestigious Automotive
News PACE Award. In addition,
we announced three new European
programs, and two new European
customers for this technology.
Total BorgWarner DualTronic
technology programs announced
to date represent an expected 1.5
million transmissions per year at
full production volumes, or possibly
10% of the European vehicle market.
Expansions were begun in 2005 at
our new manufacturing campus in
Ningbo, China, where we are sharing
facilities and support services to
enhance efficiency and collaboration
among our businesses. Localized
manufacturing to serve Korean
turbocharger and all-wheel drive
customers also got underway during
the year. In France, we broke ground
for a larger facility for our successful
drivetrain controls business.
Our customer diversity expanded
along with the growth of global
vehicle makers, even as we continued
to serve the needs of North
American automakers. Some 75%
of 2005 sales, and about 85% of our
$1.6 billion three-year pipeline of
new business, are to non- “Detroit
three” programs.
2 0 0 5 a n n u a l r e p o r t
Timothy M. Manganello
Chairman and Chief Executive Officer
The Road Ahead
Ours is a future based on a vision of
product leadership. As the turmoil
in our industry deepens, it is clear to
us that we need to continue to refine
the BorgWarner Difference. We have
laid out a three-part plan to do so,
focused on global growth through
technology, operational efficiencies
and functional synergies.
While we have had operations
in various parts of the world like
Germany and Japan for as long as
50 years, and have had a presence in
regions like Korea, India and China
for 10 or more years, we are working
on managing BorgWarner as a
more effective global entity. Key
issues facing us are global talent
development, collaboration wherever
possible, expansion of common
business practices and development
of a more global mind-set. As we
build our business through internal
growth and strategic acquisitions,
an effective global business model
is vital.
Our growth is tied to issues of
importance to many drivers
– fuel efficiency without sacrificing
performance, cleaner air and vehicle
stability. The natural disasters of
2005 brought home the realities of
a dependence on limited resources.
Populations around the world are
embracing personal transportation
and putting additional stress on
these resources. We have powertrain
technology today to keep drivers on
the road while conserving energy,
whether it is through clean diesel
technology, advanced gasoline
engines or hybrids.
Market forecasts indicate that the
fastest growing engine technologies
through 2025 are expected to be
clean diesels and a new type of
gasoline engine based on direct
injection of air and fuel. These
trends, along with an interest in
hybrids in North America, give us
confidence that we can continue
to grow faster than the auto market.
The global conversion of manual
transmissions to automatics
provides drivetrain growth. We
are developing new technology to
allow drivers in emerging markets
to benefit from the convenience of
automatics even in small, low-cost
vehicles. As rear-wheel all-wheel
drive applications mature, we
are leveraging our active torque
management expertise in the
front-wheel drive cross-over
market. At the same time, we
are expanding the reach of active
torque management and vehicle
stability to include hybrids and
two-wheel drive applications.
BorgWarner is a lean company and
we expect a great deal from our
people. Our management team is
one of the best in the industry. Our
people take ownership of their work.
This BorgWarner pride is the essence
of the BorgWarner Difference.
Our board of directors is actively
engaged with the company. I want
to thank directors Andrew Brimmer
and John Rau for their thoughtful
advice and counsel during their
terms. I am pleased to welcome
Richard Schaum and Thomas
Stallkamp to the board and look
forward to their contributions.
While ours is an industry of
challenges, we believe technology
leaders like BorgWarner will survive
and thrive. It takes tenacity and
discipline to grow in this industry.
We have a culture that, at its heart,
resonates with pride. BorgWarner
pride nourishes our determination
to tackle adversity in a difficult
environment. Ours is a culture on
which we can stake our future.
Timothy M. Manganello
Chairman and Chief Executive Officer
2
3
b u s i n e s s p r o f i l e
engine group
S A L E S
millions of dollars
$3,004.7M
$1,426.6M
$1,648.2M
$2,217.0M
$1,869.7M
01
02
03
04
05
2005 Highlights
Key Te chno lo gies
Strong global demand for turbochargers,
timing systems and emission and thermal
products, as well as the first quarter
acquisition of a majority stake in Beru,
boosted Engine Group sales 36% with
a 26% increase in segment earnings
before interest and taxes. During the year,
the group enhanced its engine-related
electronic controls capabilities with the
Beru relationship; began production of
its first high-volume variable cam timing
systems for a new family of General
Motors V6 engines; began producing
turbochargers for Hyundai/Kia Motor
Company in Korea; and announced that
it is supplying the turbocharger for the
world’s first gasoline engine to use both
direct injection and a turbocharger, the
Audi 2.0-liter Turbo FSI.
Growth Drivers and
Opportunities
• Stricter light vehicle emission regulations
for Europe, North America and Asia
• Continued diesel engine growth in European
passenger cars; new growth in Asia
• Tighter emissions regulations related
to commercial diesels
• Engine downsizing for improved fuel
consumption and emissions in gasoline
engines
• More electronic controls and growth
of “smart systems”
• Engine timing systems moving from
belts to chains
• Demand for sophisticated variable
cam timing
• Growth of overhead cam engines
• Systems integration; alternative technologies
Chain Products
Global leader in the design and manufacture
of chain systems for engine timing, auto-
matic transmissions and torque transfer,
including four- and all-wheel drive applica-
tions. Engine chain systems include chains,
sprockets, tensioners, control arms and
guides, and variable cam timing phasers.
Turbocharger Systems
Leading designer and manufacturer of
turbochargers and boosting systems for
passenger cars, light trucks and commercial
vehicles. Systems enhance fuel efficiency,
improve emissions and enhance vehicle
performance.
Emissions Systems
A leading supplier of components and
systems for engine air management
designed to reduce emissions and improve
fuel efficiency.
Thermal Systems
Systems for thermal management designed
to improve engine cooling, and reduce
emissions and fuel consumption.
Beru Technologies
Beru is a worldwide leading supplier of
diesel cold start technology and a leading
European manufacturer of ignition tech-
nology for gasoline vehicles. The electronics
and sensor technology of Beru provides
more comfort and safety for applications
in various engine and vehicle functions
with products such as direct-measuring
tire-pressure monitoring systems and
sensors for applications in engines,
powertrain and exhaust systems.
Production Plants and
Technical Centers
Americas
Asheville, North Carolina
Auburn Hills, Michigan
Cadillac, Michigan
Campinas, Brazil
Civac-Jiutepec, Mexico
Cortland, New York
Dixon, Illinois
Fletcher, North Carolina
Guadalajara, Mexico
Ithaca, New York
Marshall, Michigan
Sallisaw, Oklahoma
Simcoe, Ontario, Canada
Asia
Aoyama, Japan
Changwon, South Korea
Chennai, India
Chennai, India (JV)
Chungju-City, South Korea (JV)
Kakkalur, India (JV)
Nabari City, Japan
Ningbo, China (JV)
Pune, India (JV)
Pyongtaek, South Korea
Shihung-City, South Korea
Tainan Shien, Taiwan
E u rope
Arcore, Italy
Biassono, Italy
Bretten, Germany
Bradford, England
Chazelles, France
Diss, England
Kandel, Germany (JV)
Kirchheimbolanden, Germany
La Ferté-Macé, France
Ludwigsburg, Germany
Markdorf, Germany
Muggendorf, Germany
Neuhaus, Germany
Oroszlany, Hungary
Rijswijk, Netherlands (JV)
Tiszakécske, Hungary
Tralee, Ireland
Vitoria, Spain
(JV)
Pro duc tion Pl ants
Techn ical Centers
Beru loc atio ns
Joint Venture
Production Plants and
Technical Centers
Americas
Addison, Illinois
Auburn Hills, Michigan
Bellwood, Illinois
Frankfort, Illinois
Livonia, Michigan
Longview, Texas
Muncie, Indiana
Seneca, South Carolina
Water Valley, Mississippi
Asia
Beijing, China (JV)
Eumsung, South Korea (JV)
Fukuroi City, Japan (JV)
Ochang, South Korea
Pune, India (JV)
Sirsi, India (JV)
Europe
Arnstadt, Germany
Heidelberg, Germany
Ketsch, Germany
Margam, Wales
Tulle, France
(JV)
Production Pl ants
Technical Centers
Beru locations
Joint Venture
b u s i n e s s p r o f i l e
drivetrain group
S A L E S
millions of dollars
$1,245.6M
$1,122.1M
$937.2M
$1,358.6M
$1,333.7M
01
02
03
04
05
• Growing focus on improved shiftability
within manual transmissions
• Emerging market for new generation
Pre-emptive Torque Management
• Advent of using acceleration versus
deceleration for vehicle stability
Key Technolog i es
Transmission Products
“Shift quality” components and systems
including one-way clutches, transmission
bands, friction plates, torsional vibration
dampers and clutch module 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 management
systems, including i-Trac™ InterActive
Torque Management devices for front-wheel
drive vehicles and transfer cases for rear-wheel
drive applications. These systems enhance
stability, security and drivability of passen-
ger cars, crossover vehicles and light trucks.
Synchronizer systems meet the demands of
DualTronic and manual transmissions.
2005 Highlights
Sales were down 2% and segment earnings
before interest and taxes were down 9%
primarily due to lower North American
production of light trucks and sport-utility
vehicles equipped with our torque transfer
four-wheel drive systems, partially offset by
increased sales of DualTronic transmission
modules in Europe. During the year, the
group began supplying its i -Trac InterActive
Torque Management II system on the 2006
Honda Ridgeline – Motor Trend’s 2006
North American Truck of the Year. The
group also announced three new European
DualTronic programs, including two new
European customers, and announced it will
supply all-wheel drive transfer cases to the
new Ssangyong Kyron sport-utility vehicle
and to the new Audi Q7.
Growth Drivers and
Opportunities
• Demand for drivetrain systems and
components that improve fuel economy
• Introduction of new generation
six-, seven- and eight-speed automatic
transmissions
• Growing demand for DualTronic
transmission systems
• Increased market penetration of automatic
transmissions in traditionally manual
transmission markets – Europe and Asia
• Proliferation of interactive vehicle
handling and stability systems
• Growing global popularity of all-wheel
drive passenger cars and crossover vehicles
• Substitution of modular wet starting
clutches for torque converters
• Expanded customer base in rear-wheel
drive based all-wheel drive segment
4
5
technology
t h a t m a k e s a d i f f e r e n c e
BorgWarner’s approach to technology has its roots in powertrain product
leadership that began more than a century ago. Today, we are sharply focused
on creating the next “must have” technologies that will keep our customers at
the forefront of the automotive industry.
Our focus is fuel economy and powertrain efficiency. The BorgWarner Engine
Group develops technologies that manage air for optimal combustion. Our
Drivetrain Group leverages our clutching and controls expertise for the next
generation of efficient torque management in transmissions, all-wheel drive
and hybrid applications. Great ideas, and their effective implementation, are
the lifeblood of our company. We make significant investments in research
and development and have a unique “venture capital” fund to transform
promising ideas into high-potential, cross-business projects.
Engine timing
We bring increased power and durability, noise
reduction and compact packaging to the growing
market for both single and double overhead cam
timing in gasoline engines. In demanding new diesel
applications, our timing chain systems prolong engine
life, increase fuel efficiency and reduce emissions.
DualTronic
Clutch Module
This system enables smooth
and efficient launch of the
vehicle and executes seamless
range shifts with no inter-
ruption of engine power to
the drive wheels. The core
technologies embodied in the
DualTronic clutch module
are equally applicable to
wet clutch requirements for
traditional planetary transmis-
sions, continuously variable
transmissions, hybrid electric
vehicle transmissions, and
active all-wheel drive systems.
Exhaust Gas
Recirculation
BorgWarner provides exhaust gas
recirculation technology to support the
most stringent emissions reductions.
Our recirculation valve offers a wide
range of integration and high
temperature solutions.
Air Flow Systems
Our 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.
6
Variable Cam
Timing
Our patented variable cam
timing system uses cam-
shaft oscillation to achieve
twice the emissions reduc-
tion and three times the fuel
efficiency improvement in
the federal EPA cycle than
competitive technologies.
Turbochargers
Our boosting systems are key enabling technologies for
modern, high-performing clean diesel engines. For gasoline
engines, they provide more torque and better drivability
while improving fuel economy up to 15 percent. Advances
include new variable turbine geometry designs and
regulated two-stage devices.
7
2 0 0 5 a n n u a l r e p o r t
Beru Diesel Cold-
Start Technology
Glow plugs are a standard
feature in modern passenger
car diesels. With the Beru
Instant Start System,
diesel engines start more
quickly and safely than ever
before thanks to optimized
glow plugs and an electronic
controller which individually
regulates each plug.
Controls Modules
Advanced electrohydraulic
control modules, transmission
solenoids and mechatronic
controls systems help improve
fuel economy and emissions
and provide responsive,
fun-to-drive vehicle
performance.
i-Trac InterActive
Torque Management
Our expanding family of active
front-wheel drive products
offers customers value-based
solutions to improve stability,
traction, handling and perfor-
mance.
customer diversity
t h a t m a k e s a d i f f e r e n c e
As a global business, we serve customers throughout the world. In addition to
supporting the domestic automakers in North America, we have significantly
diversified our customer base. This strategic focus proves beneficial as market shares
among the global automakers shift in favor of our faster growing customers.
Our sales to many of the Japanese, Korean and European automakers were not of
significant size for them to be identified by name on our customer list a few short
years ago. In a few more years, the names of automakers in India and China will take
their place on our chart below as our business with them grows.
t o y o ta
(d on gfe ng )
Customer Diversity
2006 projected worldwide
revenue by customer
Hyundai/Kia 6%
Renault/Nissan 7%
Toyota 7%
GM 8%
VW/Audi 12%
DaimlerChrysler 12%
Honda 3%
BMW 2%
PSA 2%
International 2%
Caterpillar 2%
ZF 1%
John Deere 1%
All Others 21%
Ford 14%
North America
vs. Global Market
Building a diverse customer
base that is over 75% non-
North American “big three”
has been years in the making
and is a complex proposi-
tion. Key factors have been
the development and acqui-
sition of technologies that
address the needs of new
fuel-efficient engines and
transmissions, the nurturing
of relationships with Asian
automakers and a strategic
focus on change.
38%
1995
49%
2000
75%
2005
2 0 0 5 a n n u a l r e p o r t
R e n a U Lt
d aimLeRC hRysLeR
Pick A Style
Whether it is a sports car or sport-utility vehicle, mini or semi,
premium brand or basic transportation, the powertrain is likely
to sport BorgWarner technology. As a market leader in engine
and drivetrain technologies that improve fuel efficiency, air
quality, performance and vehicle stability, we serve every major
automaker in the world.
global presence
t h a t m a k e s a d i f f e r e n c e
Much of the vibrancy in our company today lies in our excitement over global
growth as we continue to align our products to meet global needs. We have
expanded our geographic manufacturing and technical facility base significantly
from less than 8% of worldwide sales outside of North America in 1997 to
almost 60% today.
We anticipate new business totaling $1.6 billion over the next three years.
Europe will account for the largest share of the expected new business at 55%,
followed by the Americas at 30% and Asia at 15%. Europe and Asia share a
similar focus on reducing emissions and adopting diesel technologies. Diesels
and hybrids are gaining popularity in North America.
Presence in Germany
Presence in China
With a BorgWarner presence going back
more than 50 years, Germany serves as the
technical nerve center of our growth in
Europe as well as for the global expansion
of technologies like turbochargers, Beru
ignition systems and tire pressure sensors,
and our DualTronic transmissions systems.
We have been in China for twelve years.
Our future growth will be generated from
a common BorgWarner manufacturing
campus under construction in Ningbo
and a country headquarters in Shanghai,
as well as from operations in Beijing.
Presence in South Korea
Presence in India
Korean operations began in 1989 with
transmission products and expanded to
thermal products in 1994. Most recent
localizations to serve the fast-growing
Korean automakers have been all-wheel
drive systems, and turbochargers and chain
products manufactured on a shared campus.
BorgWarner operations in India provide a
solid base for growth. With our first ven-
ture going back about ten years, we now
produce all our engine family products and
four-wheel drive systems in that country for
applications that range from motorcycles
and SUVs to commercial vehicles.
2 0 0 5 a n n u a l r e p o r t
75%
of vehicles
will shift more
efficiently
with automatic
transmissions
by 2020.
Shifting for Fuel Efficiency
There is a global shift underway to automatic transmissions. New clutching and
controls technology helps improve fuel efficiency while providing a great driving
experience. In Europe, automatics will increase to 45% of the market in 2014 from
less than 20% today. Worldwide, almost 75% of vehicles will shift more efficiently
with automatic transmissions by 2020.
Fuel
Economy
.
S
.
U
E
P
O
R
U
E
N
A
P
A
J
Reduced
Emissions
Balancing Emissions
and Fuel Economy
Emissions standards around the
world are beginning to converge,
providing additional growth
opportunities for BorgWarner.
The challenge is to balance the
need to improve fuel economy
with the regional regulations for
emissions reductions, all without
sacrificing vehicle performance.
Cleaner Combustion
Predicted
Global engine trends over the next
twenty years predict a strong future
for advanced internal combustion
engines for light vehicles. Fast
growing segments are clean diesels
and direct injection gasoline
engines. Our air management
and combustion products will
help advance the efficiency and
performance of these engines.
We also participate in powertrains
used in hybrids and other alterna-
tive fuel engines.
estimated
number of
engines
in millions
32
15
14
1
2005 2025
2005 2025
Gasoline
Direct
injection
Diesel
10
11
2 0 0 5 a n n u a l r e p o r t
Every BorgWarner employee plays a role in the company’s
ability to achieve its vision of Product Leadership. From product
design, engineering and manufacturing to purchasing, sales and
support services, we work individually and collaboratively to do
the best possible work every day, no matter what our job.
Walking the Talk
The BorgWarner Beliefs are part of our cultural heritage
and strength. Countless examples, large and small, of how
we “walk the talk” are evident at each of our locations the
world over, along with numerous visual reminders.
a corporate culture
t h a t m a k e s a d i f f e r e n c e
At the heart of the BorgWarner Difference is a decentralized, entrepreneurial
culture that engenders our employees’ pride in the company for which
they work and in the contribution that each of them makes. Profit and loss
responsibility lies within our individual manufacturing locations as does
ownership of and accountability for results. We have a long tradition of
workforce flexibility which lends stability to the top line and enables
us to retain top talent. Our pride is a unique, intangible resource.
BorgWa r ne r V ision
BorgWarner is the recognized
world leader in advanced products
and technologies that satisfy
customer needs in powertrain
components and systems solutions.
BorgWar n er B el ie f s
• Respect for Each Other
• The Power of Collaboration
• Passion for Excellence
• Personal Integrity
• Responsibility to Our Communities
A Matter
of Pride
A 2005 survey of our
global managers told us
that they are proud of
BorgWarner’s technology
leadership in the indus-
try, believe our portfolio
of products is well-
positioned to drive future
growth and understand
their role in driving
the creation of
shareholder value.
12
13
S h a n g h a i , C h i n a
all of us and all we do manufacturing
t h a t m a k e s a d i f f e r e n c e
True product leadership is product technology married to manufacturing
excellence. This combination is a key competitive advantage and the reason
we can survive and thrive in a price-conscious industry. The past few years
at BorgWarner have seen the evolution of a robust and disciplined produc-
tivity process that touches all aspects of our business and 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. With
a focus on economics combined with the adoption of BorgWarner
Production System principles, we strive to continually improve our
productivity to address the realities of our marketplace.
18
Locations
in Asia
2i
Locations
in the Americas
23
Loc ations
in Euro pe
Global Presence
Fuel economy, reduced emissions
and improved vehicle stability are
becoming points of sharp focus
for every automaker, as drivers
and governing bodies all over
the world demand continuous
improvement in these areas.
Our global manufacturing
presence enables us to leverage
our technology and infrastructure
worldwide, penetrating new
markets with new technologies,
and gaining share with existing
products.
2 0 0 5 a n n u a l r e p o r t
Local Customer Support
BorgWarner’s local presence is dictated by business needs in those
regions. This approach enables us to provide local support to our
customers wherever they are in the world and maximizes efficiency.
Pune, India
Ochang, South Korea
17,400
e m p l o y e e s
62
l o c a t i o n s
17
c o u n t r i e s
A s i a
Bellwood, Illinois, U.S.A.
Arcore, Italy
Kakkalur, India
Ketsch, Germany
Oroszlany, Hungary
Ningbo, China
Campinas, Brazil
Sallisaw, Oklahoma, U.S.A.
Kirchheimbolanden, Germany
E u r o p e
N o r t h
A m e r i c a
Manufacturing Excellence
Leading-edge technology and manufacturing
excellence are fundamental to who we are as a
company. The emphasis on product preeminence
is a tangible attribute of every BorgWarner opera-
tion worldwide.
14
15
2 0 0 5 a n n u a l r e p o r t
2 0 0 5 a n n u a l r e p o r t
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
BorgWarner Inc.
and Consolidated
Subsidiaries
financial discipline
t h a t m a k e s a d i f f e r e n c e
A history of financial discipline is another key differentiator for BorgWarner.
We base our business decisions on a targeted 15% after-tax return on invest-
ment. Compensation at all levels of the company is linked to the creation
of economic value – focused on generating returns greater than the cost of
capital. This fosters alignment between the goals of employees, managers and
shareholders, and enables us to leverage our sales growth into earnings growth
even in the face of external pressures.
Since becoming a public company in 1993, our growth has averaged 13%
annually compared with industry growth of 3%. We attribute this not only to
a growing diversity of customers who value our technology, but to strong fiscal
management that enables us to make the most of our assets.
BorgWarner Sales vs.
Global Auto Industry
co m p o u n d e d a n n ua l g row t h r at e
93
96
99
02
05
BorgWarner
13%
Global
Production 3%
North American
Production 1%
BorgWarner’s growth has significantly outpaced that of the
industry over the past decade and is expected to continue in 2006.
After-Tax Return on Invested Capital*
11.5%
12.3%
13.1%
13.2%
8.8%
01
02
03
04
05
* ro l l i n g f o u r qua rt e r s
I n t r oduc t ion
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 stability.
They are manufactured and sold worldwide, primarily to original
equipment manufacturers (OEMs) of light vehicles (i.e. passenger
cars, sport-utility vehicles, cross-over vehicles, vans and light-trucks).
Our products are also manufactured and sold to OEMs of commer-
cial trucks, buses and agricultural and off-highway vehicles. We also
manufacture and sell our products into the aftermarket for light and
commercial vehicles. We operate manufacturing facilities serving
customers in the Americas, Europe and Asia, and are an original
equipment supplier to every major automaker in the world.
The Company’s products fall into two reportable operating segments:
Engine and Drivetrain. The Engine segment’s products include
turbochargers, timing chain systems, air management, emissions
systems, thermal systems, as well as diesel and gas ignition systems.
The Drivetrain segment is comprised of all-wheel drive transfer cases,
torque management systems, and components and systems for auto-
mated transmissions.
Beru Transaction
On January 4, 2005, the Company acquired 62.2% of the
outstanding 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, which ended in February 2005. Presently, the Company holds
69.4% of the shares of Beru at a gross cost of $554.8 million, or
$477.2 million net of cash and cash equivalents acquired (the Beru
Acquisition). 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). The operating results of Beru have been
reported within the Engine segment for 2005. The Company considers
the Beru Acquisition to be material to the results of operations,
financial position and cash flows from the date of acquisition through
December 31, 2005 and believes that the internal controls and
procedures of Beru have a material effect on internal control over
financial reporting. Throughout 2005 the company went through a
process to coordinate the internal control processes at Beru and has
extended its Sarbanes-Oxley Act Section 404 compliance program to
include Beru at December 31, 2005. See Note 18 to the Consolidated
Financial Statements for a discussion of this transaction and related
restatement of the 2005 interim consolidated financial statements.
R e s u lt s of O pe r a t ion s
Overview
A summary of our operating results for the years ended December 31,
2005, 2004 and 2003 is as follows:
millions of dollars, except per share data
Year Ended December 31,
Engine
Drivetrain
Segment earnings before
interest and taxes
Corporate,
including litigation settlement
and equity in affiliates earnings
Consolidated earnings before
interest and taxes
Interest expense and finance charges
Earnings before income taxes and
minority interest
Provision for income taxes
Minority interest, net of tax
Net earnings
Per share data – assuming dilution:
2005
2004
2003
$354.5 $281.7
106.9
97.6
$239.6
98.4
452.1
388.6
338.0
(100.8)
(50.3)
(48.0)
351.3
37.1
338.3
29.7
290.0
33.3
314.2
55.1
19.5
308.6
81.2
9.1
$239.6 $218.3
$ 4.17 $ 3.86
256.7
73.2
8.6
$174.9
$ 3.20
A summary of major factors impacting the Company’s net earnings
for the year ended December 31, 2005 in comparison to 2004 and
2003 is as follows:
• Continued demand for our products in both Engine and Drivetrain
segments.
• Lower domestic production of light trucks and sport-utility vehicles
equipped with torque transfer products.
• Continued benefits of our cost reduction programs, including
containment of selling, general & administrative expenses, which
partially offset continued raw material and energy cost increases,
rising healthcare costs and the costs related to global expansion.
• Inclusion in Engine’s results of operations of 69.4% interest in Beru
(acquired in January and February 2005) and the related write-off of
the excess purchase price allocated to Beru’s in-process research and
development (IPR&D), order backlog and beginning inventory.
• Gain from the 2005 sale of shares in Aktiengesellschaft Kühnle,
Kopp & Kausch (AGK), an unconsolidated subsidiary carried on
the cost basis.
• Recognition in 2005 of a $45.5 million charge related to the
anticipated cost of settling all alleged Crystal Springs related
environmental contamination personal injury and property damage
claims. See Contingencies in Management’s Discussion and
Analysis for more information on Crystal Springs.
• Higher interest expense due primarily to increased debt levels from
funding our Beru Acquisition and, to a lesser extent, higher short-
term interest rates.
• Favorable currency impact of $3.1 million in 2005 and $11.0
million in 2004.
• Release of tax accrual accounts upon conclusion of certain tax audits.
16
17
Management’s Discussion and Analysis
of Financial Condition and Results of Operations continued
The following table is provided for comparison with results from
prior reporting periods. It details a number of non-recurring items
that impacted earnings in 2005 and reconciles non-U.S. Generally
Accepted Accounting Principle (GAAP) amounts to the most directly
comparable U.S. GAAP amounts:
millions of dollars, except per share data amounts
For the Year Ended December 31, 2005
Non-U.S. GAAP:
BorgWarner base business
Beru’s contribution to net earnings
Base business plus Beru
One-time write-off of the excess purchase
price associated with Beru’s IPR&D,
order backlog and beginning inventory
Net gain from divestitures
Adjustments to tax accruals
Crystal Springs related settlement
U.S. GAAP
Net
Earnings
$238.7
9.7
248.4
(12.1)
6.3
25.7
(28.7)
$239.6
Diluted
Earnings
Per Share
(1)
$4.16
0.17
4.33
(0.21)
0.11
0.45
(0.50)
$4.17
(1) Does not add due to rounding and quarterly changes in the number of weighted-average
outstanding diluted shares.
Net Sales
The table below summarizes the overall worldwide global light vehicle
production percentage changes for 2005 and 2004:
Worldwide Light Vehicle Year over Year change in
Production*
North America
Europe
Japan, South Korea and China
Total Worldwide
*Data provided by CSM Worldwide.
2005
2004
0.0%
(0.2)%
7.9%
3.9%
(0.7)%
3.7%
5.0%
4.7%
BorgWarner Year Over Year Net Sales Change
21.8%
14.9%
Our net sales increases in 2005 and 2004 were strong compared to
the estimated worldwide market production increase of approximately
3.9% in 2005 and approximately 4.7% in 2004. The Company’s net
sales increased 21.8% in 2005 from 2004, or 7.3% excluding the
effect of the Beru Acquisition, and increased 14.9% in 2004 from
2003. The increase in 2005 was driven by European and Asian
automaker demand for turbochargers, timing systems and emissions
products, stronger commercial vehicle production in both Europe and
North America, and sales growth of Drivetrain products outside of
North America, including increased sales of dual-clutch transmission
products. Sales in 2005 were negatively impacted by lower domestic
production of light trucks and sport-utility vehicles equipped with
BorgWarner torque transfer products. The effect of changing currency
rates also had a positive impact on net sales and net earnings in 2005
and 2004. The effect of non-U.S. currencies, primarily the South Korean
Won, added $23.9 million to net sales and $3.1 million to net earnings
in 2005. In 2004, non-U.S. currencies, primarily the Euro, British Pound
and Japanese Yen added $114.0 million to net sales and $11.0 million
to net earnings. The year over year increase in net sales excluding the
favorable impact of currency was 21.1% in 2005 and 11.1% in 2004.
Excluding the favorable impacts of both currency and the Beru
Acquisition, the year over year increase in net sales was 6.6% in 2005.
Consolidated net sales included sales to Ford Motor Company of
approximately 16%, 21%, and 23%; to Volkswagen of approximately
13%, 10%, and 8%; to DaimlerChrysler of approximately 12%, 14%,
and 17%; and to General Motors Corporation of approximately 9%,
10%, and 12% for the years ended December 31, 2005, 2004 and
2003, respectively. 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 the demand for our technologies in
Europe and Asia has grown, 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 2006 is positive. BorgWarner sales are
expected to grow in excess of a projected moderate global vehicle
production growth rate. The outlook for North American and
European vehicle production is flat, but solid growth is anticipated
in the Asian market. We expect to benefit from strong European and
Asian automaker demand for turbochargers, timing systems, ignition
systems and emissions products, as well as stronger commercial
vehicle production in both Europe and North America. Growing
demand for drivetrain products outside of North America, including
increased sales of dual-clutch transmission products, is also a positive
trend for the Company. Sales growth outside of the U.S. is expected
to be partially offset by weaker foreign currencies in 2006. Assuming
no major changes to the above assumptions, we expect continued
long-term sales and net earnings growth.
R e s u lt s B y O pe r a t i ng S e g m e n t
The Company’s business is comprised of two operating segments:
Engine and Drivetrain. These reportable segments are strategic
business groups, which are managed separately as each represents
a specific grouping of related automotive components and systems.
The Company allocates resources to each segment based upon the
projected after-tax return on invested capital (ROIC) of its business
initiatives. The ROIC is comprised of projected earnings before
interest and taxes (EBIT) adjusted for taxes compared to the projected
average capital investment required.
EBIT is considered a “non-GAAP financial measure.” Generally, a
non-GAAP financial measure is a numerical measure of a company’s
financial performance, financial position or cash flows that excludes
(or includes) amounts that are included in (or excluded from) the most
directly comparable measure calculated and presented in accordance
with GAAP. EBIT is defined as earnings before interest, taxes and
minority interest. “Earnings” is intended to mean net earnings as
presented in the Consolidated Statements of Operations under GAAP.
The Company believes that EBIT is useful to demonstrate the
operational profitability of our segments by excluding interest and
taxes, which are generally accounted for across the entire Company
on a consolidated basis. EBIT is also one of the measures used by
the Company to determine resource allocation within the Company.
Although the Company believes that EBIT enhances understanding
of our business and performance, it should not be considered an
alternative to, or more meaningful than, net earnings or cash flows
from operations as determined in accordance with GAAP.
The following tables present net sales and EBIT by segment for the
years 2005, 2004 and 2003:
Net Sales
millions of dollars
Year Ended December 31,
Engine
Drivetrain
Inter-segment eliminations
Net Sales
2005
2004
2003
$3,004.7 $2,217.0 $1,869.7
1,358.6
1,333.7
(50.3)
(44.6)
1,245.6
(46.1)
$ 4,293.8 $3,525.3 $3,069.2
Earnings Before Interest and Taxes (EBIT)
millions of dollars
Year Ended December 31,
Engine
Drivetrain
Segment earnings before interest
and taxes (Segment EBIT)
Corporate, including litigation
settlement and equity in
affiliates’ earnings
Consolidated earnings before
interest and taxes (EBIT)
Interest expense and finance charges
Earnings before income taxes
and minority interest
Provision for income taxes
Minority interest, net of tax
Net earnings
2005
2004
2003
$ 354.5 $ 281.7 $ 239.6
98.4
106.9
97.6
452.1
388.6
338.0
(100.8)
(50.3)
(48.0)
351.3
37.1
338.3
29.7
290.0
33.3
314.2
55.1
19.5
256.7
73.2
8.6
$ 239.6 $ 218.3 $ 174.9
308.6
81.2
9.1
The Engine segment 2005 net sales were up 35.5% from 2004 with
a 25.8% increase in segment EBIT over the same period. The 2005
increases were, in part, due to the inclusion of our majority stake
in Beru whose operating results are now included in this segment.
Excluding the impacts of foreign currency and Beru, sales were up
11.9% with a 13.2% increase in segment EBIT. The Engine segment
continued to benefit from European and Asian automaker demand
for turbochargers, timing systems and emissions products, and from
stronger commercial vehicle production in both Europe and North
America. The segment EBIT was impacted by increased volume,
productivity, positive currency impact and reduced royalty expenses to
Honeywell, which offset commodity price increases of approximately
$24.0 million and start up costs in South Korea and China.
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
The Engine segment 2004 net sales increased 18.6% from 2003 and
segment EBIT increased 17.6% 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 (VCT)
systems launched in 2004 and for new South Korean operations.
For 2006, the Engine segment 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 continued ramp-up of our first high-volume VCT system.
Investments in South Korea and China are expected to begin to
contribute to sales and EBIT. This growth is expected to help offset
anticipated weakness in North American light vehicle production.
The Drivetrain segment 2005 net sales decreased 1.8% from 2004
with an 8.7% decrease in segment EBIT over the same period. The
sales and segment EBIT decreases were primarily due to weaker
North American production of light trucks and sport-utility vehicles
equipped with our torque transfer products. Partially offsetting
those decreases was the continued ramp-up of the Company’s
DualTronic™ transmission modules in Europe. In addition to the loss
of contribution margin on the lower sales volumes, commodity price
increases of approximately $23.0 million, as well as health care cost
increases, impacted EBIT unfavorably. The Company continues to
focus on its cost reduction efforts to help offset these cost challenges.
The Drivetrain segment 2004 net sales increased 9.1% from 2003,
with an 8.6% increase in segment EBIT over the same period. The
sales increase was the result of strong global demand for transmission
components and all-wheel drive systems. The Company’s new
DualTronic™ transmission modules continued 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 were primarily steel and start up costs.
The Drivetrain segment is expected to grow slightly in 2006 as
stagnant demand for our rear-wheel-drive based four-wheel-drive
systems in North America is expected to be offset by higher sales of
front-wheel-drive based all-wheel-drive systems, increased penetration
of automatic transmissions in Europe and Asia, including increased
sales of dual-clutch transmission products, and new rear-wheel-drive
based four-wheel-drive programs outside of North America.
Corporate is the difference between calculated total Company
EBIT and the total of the segments’ EBIT. It represents corporate
headquarters expenses and expenses not directly attributable to the
individual segments and also includes equity in affiliate earnings.
This net expense was $100.8 million in 2005, $50.3 million in 2004
and $48.0 million in 2003. The primary driver of the $50.5 million
increase in 2005 from 2004 was the $45.5 million charge associated
with the anticipated cost of settling all Crystal Springs related alleged
18
19
Management’s Discussion and Analysis
of Financial Condition and Results of Operations continued
environmental contamination personal injury and property damage
claims. The $2.3 million increase in 2004 from 2003 was due to
higher pension and post retirement health care costs for discontinued
operations, which are recorded at the corporate level.
Ot her Fac tor s A ffec t ing R esu lts of Oper at ions
The following table details our results of operations as a percentage
of sales:
Year Ended December 31,
2005
2004
2003
Net sales
Cost of sales
Gross profit
Selling, general and
administrative expenses
Other (income) expense
Operating income
Equity in affiliate earnings, net of tax
Interest expense and finance charges
Earnings before income taxes
and minority interest
Provision for income taxes
Minority interest, net of tax
Net earnings
100.0%
80.1
19.9
100.0%
81.5
18.5
100.0%
80.9
19.1
11.5
0.8
7.6
(0.7)
0.9
7.4
1.3
0.5
5.6%
9.6
0.1
8.8
(0.8)
0.8
8.8
2.3
0.3
6.2%
10.3
—
8.8
(0.7)
1.1
8.4
2.4
0.3
5.7%
Gross Profit for 2005 was 19.9%, up from 18.5% in 2004 and up
from 19.1% in 2003. The increase in gross profit in 2005 was largely
due to the Beru Acquisition. Excluding the impact of Beru, the
Company’s gross margin decreased slightly to 18.0% in 2005 from
18.5% in 2004. The decrease in gross margin is due to several factors,
including higher raw material, health care and energy costs, a change
in sales mix and geographic expansion. The geographic expansion
includes new facilities in Europe and Asia for both operating segments.
We anticipate 2006 margins to be impacted by higher raw material,
health care and energy costs, the continued shift from components to
systems sales and continued results from our cost reduction initiatives.
Also impacting gross margins in 2005, 2004 and 2003 is the effect
of a royalty agreement the Company entered into with Honeywell
International for certain variable turbine geometry (VTG)
turbochargers after a German court ruled in favor of Honeywell in a
patent infringement action. In order to continue shipping to its OEM
customers, 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 $1.9
million in 2005, $14.2 million in 2004 and $23.2 million in 2003.
These costs were based on units shipped and were recorded in cost of
goods sold. It is anticipated that these costs will again be at minimal
levels in 2006 as the Company’s primary customers have converted
most of their requirements to the next generation VTG turbocharger.
Selling, general and administrative expenses (SG&A) as a
percentage of net sales increased to 11.5% in 2005. The increase in
SG&A spending in 2005 is due primarily to the acquisition of Beru.
Excluding the impact of Beru, SG&A spending in 2005 was 9.4%
of sales, down slightly from 9.6% in 2004 and 10.3% in 2003. We
expect that the growth in sales will continue to outpace the future
increases in SG&A spending due to the Company’s ongoing 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 $161.0 million,
or 3.8% of sales in 2005, compared to $123.1 million, or 3.5% of
sales in 2004, and $118.2 million, or 3.9% of sales in 2003. Beru is
responsible for $32.0 million of the $37.9 million increase in R&D
spending over 2004. We continue to increase our spending in R&D,
although the growth rate in the future may not necessarily match
the rate of our sales growth. 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 expectation for R&D spending is approximately 4.0%
of sales. We intend to maintain our commitment to R&D spending
while continuing to focus on controlling other SG&A costs.
Other (income) expense increased to a loss of $34.8 million in
2005, from a loss of $3.0 million in 2004 and $(0.1) million of income
in 2003. The 2005 loss was primarily due to the $45.5 million charge
associated with the anticipated cost of settling all Crystal Springs
related alleged environmental contamination personal injury and
property damage claims, which was offset in part by the $6.3 million
gain on the sale of businesses, primarily the Company’s interest in
AGK, and interest income of $4.2 million. The major item in 2004
was losses from capital asset disposals of $3.5 million.
Equity in affiliates earnings, net of tax of $28.2 million in
2005 decreased by $1.0 million from 2004, and increased by $9.1
million in 2004 from 2003. This line item is primarily driven by the
results of our 50% owned Japanese joint venture, NSK-Warner, and
our 32.6% owned Indian joint venture, Turbo Energy Limited (TEL).
Equity in affiliate earnings in 2005 was negatively impacted by net
adjustments to the carrying values of our equity investments that were
partially offset by improved operating results of both NSK-Warner
and TEL. For more discussion of NSK-Warner, see Note 6 of the
Consolidated Financial Statements.
Interest expense and finance charges increased by $7.4 million
in 2005 from 2004 and decreased by $3.6 million in 2004 from 2003.
The increase in 2005 was due primarily to the $156.0 million increase
in debt levels from funding the Beru Acquisition and, to a lesser extent,
higher short-term interest rates. The decrease in 2004 was due to lower
debt levels, as we used cash generated from operations to pay off debt.
In 2004, our balance sheet debt decreased $71.0 million excluding
the fair value adjustment for interest rate swaps, and we reduced the
amount of securitized accounts receivable sold by $40.0 million. We
took advantage of lower interest rates through the use of interest rate
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
and cross-currency swap arrangements described more fully in Note 10
to the Consolidated Financial Statements.
The provision for income taxes resulted in an effective tax rate for
2005 of 17.5% compared with rates of 26.3% in 2004 and 28.5% in
2003. The effective tax rate of 17.5% for 2005 differs from the U.S.
statutory rate primarily due to the following factors:
• The release of tax accrual accounts upon conclusion of certain tax
audits.
• The tax effects of the disposition of AGK and other miscellaneous
dispositions.
• Foreign rates which differ from those in the U.S.
• The realization of certain business tax credits including R&D and
foreign tax credits.
• Other permanent items, including equity in affiliates earnings.
If the effects of the tax accrual release, the Crystal Springs related
settlement, the one-time amortization of certain Beru accounting
items, the disposition of AGK and other miscellaneous dispositions
are not taken into account, the Company’s effective tax rate associated
with its on-going business operations was approximately 27.8%.
This rate was lower than the 2004 tax rate for on-going operations
of 30.0% due to changes in the mix of global pre-tax income among
taxing jurisdictions including withholding taxes.
Minority interest, net of tax of $19.5 million increased by $10.4
from 2004 and by $10.9 million from 2003. The increase is primarily
related to the 30.6% minority interest in Beru, in addition to the
earnings growth in our Asian majority-owned subsidiaries.
L iqu i di t y a n d C a p i t a l R e s ou r c e s
Capitalization
millions of dollars
Notes payable and current
portion of long-term debt
Long-term debt
Total debt
Minority interest in
consolidated subsidiaries
Total stockholders’ equity
Total capitalization
2005
2004 % change
$ 299.9 $ 16.5
568.0
584.5
440.6
740.5
22.2
136.1
1,644.2
1,534.2
$2,520.8 $2,140.9
26.7%
17.7%
Total debt to capital ratio
29.4%
27.3%
Stockholders’ equity increased by $110.0 million in 2005. The
increase was primarily caused by net income of $239.6 million, along
with stock option exercises of $17.6 million. These factors were
somewhat offset by currency translation adjustments of $97.4
million, hedge instrument adjustments of $0.3 million, and dividend
payments of $31.8 million. In relation to the U.S. Dollar, the
currencies in foreign countries where we conduct business,
particularly the Euro and Japanese Yen, weakened, causing the
currency translation component of other comprehensive income to
decrease in 2005. The $156.0 million increase in debt was primarily
due to the funding of the Beru Acquisition at a cost of $554.8
million, $477.2 million net of cash and cash equivalents acquired.
Operating Activities Net cash provided by operating activities of
$396.5 million is $30.1 million less than in 2004, primarily as a result
of higher cash tax payments of $86.5 million in 2005 versus 2004,
payment of $28.5 million of Crystal Springs related settlements in 2005
and the funding of post retirement related liabilities with cash in 2005
instead of the $25.8 million of Company stock used in 2004. The
$396.5 million consists of net earnings of $239.6 million, increased for
non-cash charges of $224.4 million and offset by a $67.5 million increase
in net operating assets and liabilities. Non-cash charges are primarily
comprised of $255.5 million in depreciation and amortization expense.
Accounts receivable, excluding the impact of currency and the Beru
Acquisition, increased a total of $79.6 million due to higher business
levels, particularly in Europe. Certain of our European customers
tend to have longer payment terms than our North American
customers. Inventory increased by $30.1 million excluding the impact
of currency and Beru, while our inventory turns decreased slightly to
12.5 times from 12.9 in 2004.
Investing Activities Net cash used in investing activities totaled
$700.1 million, compared with $257.2 million in the prior year. The
majority of the increase was due to payments for the Beru Acquisition.
Capital spending of $246.7 million in 2005, or 5.7% of sales, increased
$41.8 million over the 2004 level of $204.9 million, or 5.8% of sales.
Selective capital spending remains an area of focus for the Company,
both in order to support our book of new business and for cost
reduction and other purposes. Heading into 2006, we plan to continue
to spend capital to support the launch of our new applications and for
cost reductions and productivity improvement projects. Our target for
capital spending is approximately 5.5% of sales.
On March 11, 2005, the Company completed the sale of its holdings
in AGK for $57.0 million to Turbo Group GmbH. The proceeds, net
of closing costs, were approximately $54.2 million, resulting in a gain
of $10.1 million on the sale.
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 AGK. The valuation payment resulted from the settlement
in 2003 of a lawsuit brought by certain minority shareholders of AGK
related to the automotive turbocharger business of AGK, which the
Company purchased from AGK in 1998.
Financing Activities and Liquidity In 2005 the Company
financed the $554.8 million Beru Acquisition ($477.2 million net
of cash and cash equivalents acquired) and subsequently repaid
$160.2 million of those borrowings. See Note 18 to the Consolidated
Financial Statement for a discussion of the transaction. Net debt
repayments were $55.9 million and $21.3 million in 2004 and 2003,
respectively. Proceeds from the exercise of employee stock options
provided $17.6 million, $14.4 million and $39.3 million in 2005,
2004 and 2003, respectively. The Company also paid dividends,
including payments to minority shareholders, of $40.0 million, $27.9
million and $19.4 million in 2005, 2004 and 2003, respectively.
20
21
Management’s Discussion and Analysis
of Financial Condition and Results of Operations continued
The Company has a revolving multi-currency credit facility, which
provides for borrowings up to $600 million through July 2009. The
credit facility 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 for all periods presented. In addition
to the credit facility, 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 could 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
quality perspective, we have an investment grade credit rating of
A- from Standard & Poor’s and Baa2 from Moody’s.
The Company’s significant contractual obligation payments at
December 31, 2005, are as follows:
millions of dollars
Total
2006
2007-2008
2009-2010
After 2010
Other post retirement benefits excluding pensions ( a)
Notes payable and long-term debt
Projected minimum interest costs ( b)
Non-cancelable operating leases (c)
Capital spending obligations
Total (d)
$2,273.4
742.7
102.9
69.7
59.1
$3,247.8
$ 34.1
299.9
27.4
28.4
59.1
$448.9
$ 74.3
17.8
42.5
15.1
—
$149.7
$ 81.3
164.8
26.1
13.0
—
$285.2
$2,083.7
260.2
6.9
13.2
—
$2,364.0
(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 are not certain for future years, such payments have been excluded from this table. The Company expects to contribute a total of $25 million to $30 million into all pension plans during 2006.
See Note 11 to the Consolidated Financial Statements for disclosures related to the Company’s pension and other post retirement benefits.
(b) Projection is based upon an average debt portfolio interest rate of 5.00%.
(c) 2006 includes $16.6 million for the guaranteed residual value of production equipment with a lease that expires in 2006. Please see Note 15 to the Consolidated Financial Statements for details
concerning this lease.
(d) The Company does not have any long-term or fixed purchase obligations for inventories.
We believe that the combination of cash from operations, cash
balances, 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 for the foreseeable future.
We will continue to balance our needs for internal growth, external
growth, debt reduction, dividends and share repurchase.
Off Balance Sheet Arrangements As of December 31, 2005, the
accounts receivable securitization facility was sized at $50 million and
has been in place with its current 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 headquarters
facility, an airplane, vehicles, and certain office equipment. The
Company also has a lease obligation for production equipment at one
of its facilities. The total expected future cash outlays for all lease
obligations at the end of 2005 is $69.7 million. See Note 15 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 2006. In the event the Company
exercises its option not to purchase the production equipment, the
Company has guaranteed a residual value of $16.6 million. The
equipment is currently fully utilized and we do not believe we have
any potential loss due to this guarantee.
Pension and Other Post Retirement Benefits The Company’s
policy is to fund its defined benefit pension plans in accordance
with applicable government regulations and to make additional
contributions when management deems it appropriate. At December
31, 2005, all legal funding requirements had been met. The Company
contributed $26.0 million to its pension plans in 2005 and $36.3
million in 2004. The Company expects to contribute a total of $25
million to $30 million in 2006.
The funded status of all pension plans decreased from an unfunded
position of $(116.4) million at the end of 2004 to $(144.5) million
at the end of 2005. The main reason for the $28.1 million increase
in the net underfunding is the inclusion of the Beru pension plans in
2005. Beru’s pension plans, like our other pension plans in Germany,
are unfunded plans.
Other post retirement benefits primarily consist of post retirement
health care benefits for certain employees and retirees of the
Company’s U.S. operations. The Company funds these benefits as
retiree claims are incurred. Other post retirement benefits had an
unfunded status of $(679.9) million at the end of 2005, and $(537.2)
million at the end of 2004. The unfunded levels increased due to
the decrease in the discount rate assumption and the increase in the
health care inflation assumption. These increases were somewhat
offset by changes in certain plan designs during 2005.
The Company believes it will be able to fund the requirements of
these plans through cash generated from operations or other available
sources of financing for the foreseeable future.
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
O t h e r M a t 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 identified by the United States Environmental Protection
Agency and certain 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 38 such sites. Responsibility for clean-up
and other remedial activities at a Superfund site is typically shared
among PRPs based on an allocation formula.
The Company believes that none of these matters, individually or in the
aggregate, will have a material adverse effect on its results of operations,
financial position, or cash flows, 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.
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
information 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, the Company has established an accrual for indicated
environmental liabilities with a balance at December 31, 2005, of
approximately $38.3 million. Included in the total accrued liability
is the $16.1 million anticipated cost to settle all outstanding claims
related to Crystal Springs described below, which was recorded in
the second quarter of 2005. For the other 37 sites, we have accrued
amounts that do not exceed $3.0 million related to any individual
site and management does not believe that the costs related to any
of these other individual sites will have a material adverse effect on
the Company’s results of operations, cash flows or financial condition.
The Company expects to expend substantially all of the $38.3 million
environmental accrued liability over the next three to five years.
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 environmental contamination at its Crystal Springs,
Mississippi plant while undertaking an expansion of the plant.
Kuhlman Electric and others, including the Company, were sued
in numerous related lawsuits, in which multiple claimants alleged
personal injury and property damage.
The Company and other defendants, including the Company’s
subsidiary, Kuhlman Corporation, entered into a settlement in July
2005 regarding approximately 90% of personal injury and property
damage claims relating to the alleged environmental contamination.
In exchange for, among other things, the dismissal with prejudice
of these lawsuits, the defendants agreed to pay a total sum of up to
$39.0 million in settlement funds. The settlement was paid in three
approximately equal installments. The first two payments of $12.9
million were made in the third and fourth quarters of 2005 and the
remaining installment of $13.0 million was paid in the first quarter
of 2006.
The same group of defendants entered into a settlement in October
2005 regarding approximately 9% of personal injury and property
damage claims relating to the alleged environmental contamination. In
exchange for, among other things, the dismissal with prejudice of these
lawsuits, the defendants agreed to pay a total sum of up to $5.4 million
in settlement funds. The settlement was paid in two approximately
equal installments in the fourth quarter of 2005 and the first quarter
of 2006. With this settlement, the Company and other defendants have
resolved about 99% of the known personal injury and property damage
claims relating to the alleged environmental contamination. The cost of
this settlement has been recorded in other income in the Consolidated
Statements of Operations.
Conditional Asset Retirement Obligations In 2005, the FASB
issued Interpretation (FIN) No. 47, “Accounting for Conditional
Asset Retirement Obligations” an interpretation of Statement of
Financial Accounting Standards (SFAS) 143, which requires the
Company to recognize legal obligations to perform asset retirements
in which the timing and (or) method of settlement are conditional
on a future event that may or may not be within the control of the
entity. Certain government regulations require the removal and
disposal of asbestos from an existing facility at the time the facility
undergoes major renovations or is demolished. The liability exists
because the facility will not last forever, but it is conditional on
future renovations, even if there are no immediate plans to remove
the materials, which pose no health or safety hazard in their current
condition. Similarly, government regulations require the removal or
closure of underground storage tanks (USTs) when their use ceases,
the disposal of polychlorinated biphenyl (PCBs) transformers and
capacitors when their use ceases, and the disposal of lead-based paint in
conjunction with facility renovations or demolition. We currently have
11 manufacturing locations within our Company, which have been
22
23
Management’s Discussion and Analysis
of Financial Condition and Results of Operations continued
identified as containing asbestos-related building materials, USTs,
PCB transformers or capacitors, or lead-based paint. The fair value to
remove and dispose of this material has been estimated and recorded at
$0.8 million as of December 31, 2005.
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. As of December 31, 2005, the Company
had approximately 67,000 pending asbestos-related product liability
claims. Of these outstanding claims, approximately 58,000 are
pending 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 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
2005, of the approximately 38,000 claims resolved, only 295 (0.8%)
resulted in any payment being made to a claimant by or on behalf of
the Company. In 2004 of the 4,062 claims resolved, only 255 (6.3%)
resulted in any payment being made to a claimant by or on behalf
of the Company.
Prior to June 2004, the settlement and defense costs associated with
all claims were covered by the Company’s primary layer insurance
coverage, and these carriers administered, defended, settled and paid
all claims under a funding agreement. In June 2004, primary layer
insurance carriers notified the Company 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. The Company paid $2.9 million in
2005 and $1.0 million in 2004 as a result of the funding agreement
for claims that have been resolved. The Company is expecting to fully
recover these amounts. Recovery is dependent on the completion of
an audit proving the exhaustion of primary insurance coverage and
the successful resolution of the declaratory judgment action referred
to below. At December 31, 2005 an amount of $3.9 million was owed
by insurance carriers in respect of claims settled and funded by the
Company in advance of the insurers’ reimbursement. This amount
has been submitted to carriers for reimbursement and the Company
expects to be fully reimbursed.
At December 31, 2005, the Company has an estimated liability of
$41.0 million for future claims resolutions, with a related asset of
$41.0 million to recognize the insurance proceeds receivable by the
Company for estimated losses related to claims that have yet to be
resolved. Insurance carrier reimbursement of 100% is expected based
on the Company’s experience, its insurance contracts and decisions
received to date in the declaratory judgment action referred to below.
At December 31, 2004, the comparable value of the insurance
receivable and accrued liability was $40.8 million.
The amounts recorded in the Condensed Consolidated Balance
Sheets related to the estimated future settlement of existing claims are
as follows:
millions of dollars
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
2005
2004
$20.8
20.2
$41.0
$13.5
27.3
$40.8
$20.8
20.2
$41.0
$13.5
27.3
$40.8
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 both primary and additional layer insurance, and, in conjunction
with other insurers, is currently defending and indemnifying the
Company in 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. On
August 15, 2005, the Court issued an interim order regarding the
apportionment matter. The interim order has the effect of making
insurers responsible for all defense and settlement costs pro rata to
time-on-the-risk, with the pro-ration method to hold the insured
harmless for periods of bankrupt or unavailable coverage. Appeals
of the interim order were denied. However, the issue is reserved for
appellate review at the end of the action. 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. As such, the Company continues to
believe that its coverage is sufficient to meet foreseeable liabilities.
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
Although it is impossible to predict the outcome of pending or future
claims or the impact of tort reform legislation being considered at
the State and Federal levels, due to 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 product liability claims are likely to have a material
adverse effect on the Company’s results of operations, cash flows or
financial condition.
C r i t ic a l A c c ou n t i ng Pol ic i e s
The consolidated financial statements are prepared in conformity
with GAAP. In preparing these financial statements, management has
made its best estimates and judgments of certain amounts included
in the financial statements, giving due consideration to materiality.
Critical accounting policies are those that are most important to
the portrayal of the Company’s financial condition and results of
operations. These policies require management’s most difficult,
subjective or complex judgments in the preparation of the financial
statements and accompanying notes. Management makes estimates
and assumptions about the effect of matters that are inherently
uncertain, relating to the reporting of assets, liabilities, revenues,
expenses and the disclosure of contingent assets and liabilities. Our
most critical accounting policies are discussed below.
Revenue Recognition 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.
Impairment of Long-Lived Assets 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 carrying 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 reasonable; however, changes in
assumptions underlying these estimates could affect the evaluations.
Long-lived assets held for sale are recorded at the lower of their
carrying amount or fair value less cost to sell. Significant judgements
and estimates used by management when evaluating long-lived assets
for impairment include (i) an assessment as to whether an adverse
event or circumstance has triggered the need for an impairment
review; and (ii) undiscounted future cash flows generated by the asset.
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
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 December 2005, 2004 and 2003
and no impairment was found each time. Amortization continues to
be recorded for other intangible assets with definite lives.
See Note 7 to the Consolidated Financial Statements for more
information regarding goodwill.
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 2005
is between $36.5 million and $50.8 million. We record an accrual
at the most probable amount within the range unless one cannot be
determined; in which case we record the accrual at the low end of the
range. At the end of 2005, our total accrued environmental liability
was $38.3 million.
See Note 14 to the Consolidated Financial Statements for more
information regarding environmental accrual.
Product Warranty 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 claim settlements; as well as
product manufacturing and industry developments and recoveries
from third parties. 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.
See Note 8 to the Consolidated Financial Statements for more
information regarding product warranty.
Other Loss Accruals and Valuation Allowances 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 accrued
liabilities for loss or asset valuation allowances.
24
25
Management’s Discussion and Analysis
of Financial Condition and Results of Operations continued
Pension and Other Post Retirement Defined Benefits The
Company provides post retirement defined benefits to a substantial
portion of its current and former employees. Costs associated with
post retirement defined benefits include pension and post retirement
health care expenses for employees, retirees and surviving spouses and
dependents. The Company’s employee defined benefit 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 reviews its actuarial assumptions on an annual basis
and makes modifications to the assumptions based on current rates
and trends when appropriate. The effects of the modifications are
recorded currently or amortized over future periods in accordance
with U.S. GAAP.
The Company’s approach to establishing the discount rate is based upon
the market yields of high-quality corporate bonds, with appropriate
consideration of each plan’s defined benefit payment terms and duration
of the liabilities. The discount rate assumption is typically rounded
up or down to the nearest 25 basis points. Based on this approach,
at December 31, 2005, the Company lowered the discount rate for
its U.S. pension and other defined benefit plans to 5.50% from
5.75% at December 31, 2004. The decrease of 25 basis points in the
discount rate increased the Company’s U.S. pension plan projected
benefit obligation by approximately $7.9 million at December 31,
2005 and is expected to increase pension expense in fiscal year 2006
by approximately $0.6 million. The decrease of 25 basis points in the
discount rate increased the Company’s other post retirement benefit
obligation by $20.0 million at December 31, 2005 and is expected
to increase the other post retirement expense by approximately $1.7
million in 2006. As a sensitivity measure for the non-U.S. defined
benefit pension plans, a decrease of 25 basis points would increase
the Company’s projected benefit obligation by approximately $14.6
million at December 31, 2005, and would increase the non-U.S.
pension expense by approximately $1.8 million in 2006.
The Company determines its expected return on plan asset
assumptions by evaluating estimates of future market returns and
the plans’ asset allocation. The Company also considers the impact
of active management of the plans’ invested assets. The Company’s
expected return on assets assumption reflects the asset allocation of
each plan. The Company’s assumed long-term rate of return on assets
for its U.S. pension plans was 8.75% for 2005, 2004 and 2003. The
Company does not anticipate a change in the long-term rate of return
on assets for pension benefits for 2006. The Company’s assumed long-
term rate of return on assets for its U.K. pension plan was 6.75% for
2005, 2004 and 2003. The Company anticipates increasing its assumed
long-term rate of return on U.K. plan assets to 7.25% for 2006, due to
both recent and long-term asset performance. This change is expected
to decrease pension expense by $0.7 million in 2006. For sensitivity
purposes, a 25 basis point decrease in the long-term return on assets
would increase total pension expense by $1.2 million in 2006.
The Company determines its health care inflation rate for its other
post retirement benefit plans by evaluating the circumstances
surrounding the plan design, recent experience and health care
economics. For December 31, 2005 the health care inflation
assumption has changed from 8% in 2005 (grading down to 4.5%
by 2009) to 10% for 2006 (grading down to 5% by 2011). This
change has increased the Company’s other post retirement benefit
obligation by approximately $93.5 million at December 31, 2005
and is expected to increase other post retirement benefit expense in
fiscal year 2006 by approximately $14.4 million.
Based on the information provided by its independent actuaries and
other relevant sources, the Company believes that the assumptions
used are reasonable; however, changes in these assumptions, or
experience different from that assumed, could impact the Company’s
financial position, results of operations, or cash flows.
See Note 11 to the Consolidated Financial Statements for more
information regarding costs and assumptions for employee retirement
benefits.
Income Taxes The Company accounts for income taxes in
accordance with SFAS No. 109, “Accounting for Income Taxes.”
Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The
Company records a valuation allowance that primarily represents
foreign operating and other loss carryforwards for which utilization
is uncertain. Management judgment is required in determining
the Company’s provision for income taxes, deferred tax assets and
liabilities and the valuation allowance recorded against the Company’s
net deferred tax assets. In calculating the provision for income taxes
on an interim basis, the Company uses an estimate of the annual
effective tax rate based upon the facts and circumstances known
at each interim period. In determining the need for a valuation
allowance, the historical and projected financial performance of the
operation recording the net deferred tax asset is considered along
with any other pertinent information. Since future financial results
may differ from previous estimates, periodic adjustments to the
Company’s valuation allowance may be necessary.
The Company is subject to income taxes in the U.S. and numerous
foreign jurisdictions. Significant judgment is required in determining
our worldwide provision for income taxes and recording the related
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
assets and liabilities. In the ordinary course of our business, there
are many transactions and calculations where the ultimate tax
determination is less than certain. We are regularly under audit by
the various applicable tax authorities. Accruals for tax contingencies
are provided for in accordance with the requirements of SFAS No. 5
“Accounting for Contingencies”. The Company’s federal and certain
state income tax returns and certain non-U.S. income tax returns are
currently under various stages of audit by applicable tax authorities.
Although the outcome of tax audits is always uncertain, management
believes that it has appropriate support for the positions taken on
its tax returns and that its annual tax provisions included amounts
sufficient to pay assessments, if any, which may be proposed by the
taxing authorities. At December 31, 2005, the Company has recorded
a liability for its best estimate of the probable loss on certain of its tax
positions, the majority of which is included in other current liabilities.
Nonetheless, the amounts ultimately paid, if any, upon resolution of
the issues raised by the taxing authorities may differ materially from
the amounts accrued for each year.
See Note 4 to the Consolidated Financial Statements for more
information regarding income taxes.
New Accounting Pronouncements In November 2004, the
Financial Accounting Standards Board (FASB) issued 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 becomes effective for
the Company on January 1, 2006. The Company does not expect that
this pronouncement will have a material impact on its consolidated
financial position, results of operations and cash flows.
In December 2004, the FASB issued SFAS No. 123(R), “Shared-Based
Payment” (FAS 123R) which requires companies to measure and
recognize compensation expense for all share-based payments at fair
value. In addition, the FASB has issued a number of supplements to
FAS 123R to guide the implementation of this new accounting
pronouncement. 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. FAS 123R will be effective for the Company beginning
January 1, 2006. The Company will use the modified prospective
transition method, which requires that compensation cost be
recognized in the financial statements for all awards granted after the
date of adoption as well as for existing awards for which the requisite
service has not been rendered as of the date of adoption and requires
that prior periods not be restated. FAS 123R also requires an entity to
calculate the pool of excess tax benefits available to absorb tax
deficiencies recognized subsequent to adopting FAS 123R (the APIC
Pool). The Company is currently evaluating acceptable methods for
calculating its APIC Pool. The Company expects that the
implementation of this pronouncement will lower 2006 earnings by
approximately ($0.16) to ($0.18) per diluted share. For 2005, stock
option expense would increase by approximately ($.05) to ($.07) per
diluted share if the Company adopted FAS 123R as of January 1,
2005 due to the appreciation of the stock price during the past few
years and increases in the number of incentive stock options issued.
In March 2005, the FASB issued FIN No. 47, “Accounting for
Conditional Asset Retirement Obligations” an interpretation of SFAS
143 (the Interpretation). FIN 47 clarifies the manner in which
uncertainties concerning the timing and the method of settlement of
an asset retirement obligation should be accounted for. In addition,
the Interpretation clarifies the circumstances under which fair value
of an asset retirement obligation is considered subject to reasonable
estimation. The Interpretation is effective no later than the end of
fiscal years ending after December 15, 2005. The Company recorded
a $0.8 million loss accrual upon adoption of this pronouncement in
December 2005.
Q u a l i t a t i v e a n d Q u a n t i t i v e D i s c l o s u r e
A b ou t M a r k e t R i s k
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
manufacturing 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 diversifies its positions across such counterparties in order
to reduce its exposure to credit losses. We do not engage in any
derivative instruments for purposes other than hedging specific
operating 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 2005, the amount of net debt with
fixed interest rates was 50% of total debt, including the impact of
the interest rate swaps. Our earnings exposure related to adverse
movements in interest rates is primarily 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 2005 of approximately $1.8 million, and $1.3 million in 2004.
26
27
Management’s Discussion and Analysis
of Financial Condition and Results of Operations continued
Management’s Responsibility for Consolidated
Report of Independent Registered
Financial Statements
Public Accounting Firm
BorgWarner Inc.
and Consolidated
Subsidiaries
2 0 0 5 a n n u a l r e p o r t
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, 2005, the net fair value of these
instruments would increase by approximately $22.2 million if interest
rates decreased and would decrease by approximately $20.5 million 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, 2004, measured in a similar manner, was slightly
greater than at December 31, 2005.
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 British Pound, the Euro, the
Hungarian Forint, the Japanese Yen, and the South Korean Won.
We mitigate our foreign currency exchange rate risk principally
by establishing local production facilities and related supply chain
participants in the 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 $478.0
million as of December 31, 2005 and $324.6 million as of December
31, 2004. We also monitor our foreign currency exposure in each
country and implement strategies 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 2005 and 2004.
Commodity 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 contracts 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
vehicle components. In the aggregate, our exposure related to such
transactions was not material to our financial position, results of
operations or cash flows in both 2005 and 2004.
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 continued use
of outside suppliers, fluctuations in demand for vehicles containing
BorgWarner products, general economic conditions, as well as
other risks detailed in the Company’s filings with the Securities
and Exchange Commission, including the factors identified under
Item 1A, “Risk Factors,” in the Form 10-K for the fiscal year ended
December 31, 2005. The Company does not undertake any obligation
to update any forward-looking statement.
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,
2005 and 2004, 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, 2005.
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
reasonable 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 principles
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 as of December 31, 2005 and 2004,
and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2005, 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 reporting as of
December 31, 2005, based on the criteria established in Internal Control
—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report (not
presented in this Annual Report to Stockholders) dated February 17,
2006 expressed an unqualified opinion on management’s assessment
of the effectiveness of the Company’s internal control over financial
reporting and an unqualified opinion on the effectiveness of the
Company’s internal control over financial reporting.
Detroit, Michigan
February 17, 2006
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 present
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, an independent registered public
accounting firm. 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 material
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
procedures 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 registered public
accounting firm in connection with their annual audit of the
financial statements. The independent registered public accounting
firm conducts their evaluation in accordance with the standards of
the Public Company Accounting Oversight Board (United States)
and performs such tests of transactions and balances as they deem
necessary. Management considers the recommendations of its
internal auditors and independent registered public accounting firm
concerning the Company’s system of internal control and takes
the necessary actions that are cost-effective in the circumstances.
Management believes that, as of December 31, 2005, 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 Audit Committee, composed entirely of directors of the
Company who are not employees, meets periodically with the Company’s
management and independant registered public accounting firm to
review financial results and procedures, internal financial controls
and internal and external audit plans and recommendations. In carrying
out these responsibilities, the Audit Committee and the independent
registered public accounting firm have unrestricted access to each other
with or without the presence of management representatives.
Timothy M. Manganello
Chairman and
Chief Executive Officer
February 17, 2006
Robin J. Adams
Executive Vice President,
Chief Financial Officer &
Chief Administrative Officer
28
29
Consolidated Statements of Operations
BorgWarner Inc.
and Consolidated
Subsidiaries
Consolidated Balance Sheets
millions of dollars, except per share amounts
For the Year Ended December 31,
Net sales
Cost of sales
Gross profit
Selling, general and administrative expenses
Other (income) expense
Operating income
Equity in affiliates earnings, net of tax
Interest expense and finance charges
Earnings before income taxes and minority interest
Provision for income taxes
Minority interest, net of tax
Net earnings
Earnings per share – basic
Earnings per share – diluted
Average shares outstanding (thousands):
Basic
Diluted
See Accompanying Notes to Consolidated Financial Statements.
2005
$4,293.8
3,440.0
853.8
495.9
34.8
323.1
(28.2)
37.1
314.2
55.1
19.5
$ 239.6
$ 4.23
$ 4.17
2004
$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
$ 3.91
$ 3.86
2003
$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
$ 3.23
$ 3.20
56,708
57,398
55,872
56,537
54,116
54,604
millions of dollars
December 31,
Assets
Cash and cash equivalents
Marketable securities
Receivables
Inventories
Deferred income taxes
Investment in business held for sale
Prepayments and other current assets
Total current assets
Property, plant and equipment – net of accumulated depreciation
Tooling – net
Investments and advances
Goodwill
Other non-current assets
Total other assets
Total assets
Liabilities and Stockholders’ Equity
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: 2005, 57,138,475 and 2004, 56,361,167;
outstanding shares: 2005, 57,134,491 and 2004, 56,357,183
Non-voting common stock, $0.01 par value;
authorized shares: 25,000,000; none issued and outstanding
Capital in excess of par value
Unearned compensation on restricted stock
Retained earnings
Accumulated other comprehensive (loss) income
Common stock held in treasury, at cost: 3,984 shares in 2005 and 2004
Total stockholders’ equity
Total liabilities and stockholders’ equity
See Accompanying Notes to Consolidated Financial Statements.
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
2005
2004
$ 89.7
40.6
626.1
332.0
28.0
–
52.3
1,168.7
1,294.9
106.2
197.7
1,029.8
292.1
1,625.8
$4,089.4
$ 299.9
786.4
35.8
1,122.1
440.6
522.1
224.3
746.4
136.1
—
0.6
—
828.7
(1.1)
889.2
(73.1)
(0.1)
1,644.2
$4,089.4
$ 229.7
—
499.1
223.4
22.6
44.2
55.3
1,074.3
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
30
31
Consolidated Statements of Cash Flows
BorgWarner Inc.
and Consolidated
Subsidiaries
Consolidated Statements of Stockholders’ Equity and Comprehensive income
BorgWarner Inc.
and Consolidated
Subsidiaries
2 0 0 5 a n n u a l r e p o r t
millions of dollars
For the Year Ended December 31,
Oper ating
Net earnings
Adjustments to reconcile net earnings to net cash flows from operations:
Non-cash charges (credits) to operations:
Depreciation
Amortization of tooling
Amortization of intangible assets and other
Net gain on sale of businesses, net of tax
Gain on asset disposals
Employee retirement benefits funded with common stock
Deferred income tax (benefit) 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 acquisitions and divestitures:
(Increase) in receivables
(Increase) in inventories
(Increase) decrease in prepayments and other current assets
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
Investing
Capital expenditures
Tooling outlays, net of customer reimbursements
Payments for business acquired, net of cash and cash equivalents acquired
Net proceeds from asset disposals
Purchases of marketable securities
Proceeds from sales of marketable securities
Proceeds from sale of businesses
Contingent valuation payment on acquired business
Investment in unconsolidated subsidiary
Net cash used in investing activities
Financing
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, including minority shareholders
Net cash provided by (used in) financing activities
Effect of exchange rate changes on cash and cash equivalents
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental Cash Flow Information
Net cash paid 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
Total debt assumed from business acquired
See Accompanying Notes to Consolidated Financial Statements.
2005
2004
2003
$239.6
$218.3
$174.9
Number of shares
Stockholders’ equity
Issued
common
stock
Common
stock in
treasury
Issued
common
stock
Capital in
excess of
par value
Treasury
stock
Management
shareholder
notes
Unearned
compensation
on restricted
stock
Accumulated
other
Retained comprehensive Comprehensive
income/(loss)
income/(loss)
earnings
millions of dollars
185.6
38.2
31.7
(6.3)
(0.5)
—
(32.4)
8.1
464.0
(79.6)
(30.1)
19.9
137.6
(61.7)
(53.6)
396.5
(246.7)
(45.8)
(477.2)
9.5
(52.3)
58.2
54.2
—
—
(700.1)
136.2
168.7
(160.2)
—
17.6
(40.0)
122.3
41.3
(140.0)
229.7
$ 89.7
$ 41.5
121.5
$ 2.6
0.9
30.0
138.8
38.2
1.1
—
—
25.8
13.8
4.7
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
1.1
—
—
12.9
40.0
(4.8)
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
—
—
523,994
68,680
executive stock plan
41,252
Balance, January 1, 2003
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
Restricted shares issued under
stock incentive plan
Shares issued under
retirement savings plans
Net income
Adjustment for minimum
pension liability
Currency translation and hedge
instruments adjustment
Balance, December 31, 2004
Dividends declared
Shares issued under stock
incentive plans
Shares issued under
executive stock plan
Net issuance of restricted stock,
less amortization
Net income
Adjustment for minimum
pension liability
Net unrealized loss on
available-for-sale securities
Currency translation and hedge
instruments adjustment
54,797,782
—
—
—
(1,637,774)
(83,860)
—
—
$0.3
—
—
—
$737.7
—
—
—
$ (35.9)
(2.5)
—
—
$(2.0)
—
—
2.0
$ — $335.8
—
(19.4)
—
—
—
—
$(54.5)
—
—
—
—
1,517,208
—
131,762
432,072
—
—
—
—
—
—
—
—
—
—
—
—
—
5.3
34.0
0.4
2.9
12.9
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
174.9
—
—
—
—
—
—
—
—
—
—
$ 174.9
—
—
—
—
0.7
0.7
67.8
67.8
55,229,854
—
—
$0.3
(72,664)
—
—
— 0.3
$756.3
—
—
$ (1.5)
—
—
$ —
—
—
$ — $491.3
(27.9)
(0.3)
—
—
$ 14.0
—
—
$ 243.4
—
—
—
—
—
—
—
—
6,400
559,667
—
—
—
56,361,167
—
(3,984)
—
712,640
48,569
16,099
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
$0.6
—
—
—
—
—
—
—
—
13.0
1.4
1.7
0.3
25.8
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
218.3
—
—
—
—
—
—
—
—
—
—
—
—
—
$ 218.3
12.8
12.8
28.4
28.4
$797.1
—
$ (0.1)
—
$ —
—
$ — $ 681.4
(31.8)
—
$ 55.2 $ 259.5
—
—
28.1
2.6
0.9
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(1.1)
—
—
239.6
—
—
—
—
—
—
—
$ 239.6
—
—
(30.3)
(30.3)
—
—
(0.3)
(0.3)
—
—
(97.7)
(97.7)
Balance, December 31, 2005 57,138,475
(3,984)
$0.6
$828.7
$ (0.1)
$ —
$(1.1) $ 889.2
$ (73.1) $ 111.3
See Accompanying Notes to Consolidated Financial Statements.
32
33
Notes to Consolidated Financial Statements
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 manufactured
and sold worldwide, primarily to original equipment manufacturers of
passenger cars, sport-utility vehicles, crossover vehicles, trucks, commercial
transportation products and industrial equipment. Our products fall into
two reportable operating segments: Engine and Drivetrain.
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 conformity
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 inter-company
accounts and transactions have been eliminated in consolidation.
Revenue recognition 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.
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 all highly liquid investments with original maturities of three
months or less as cash and cash equivalents.
Marketable securities The marketable securities acquired as a part of
the Beru Acquisition are classified as available-for-sale. These investments
are stated at fair value with any unrealized holding gains or losses, net of
tax, included as a component of stockholders’ equity until realized.
See Note 5 to the Consolidated Financial Statements for more information on
marketable securities.
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 underlying receivables.
The maximum size of the facility has been set at $50 million since the
fourth quarter of 2003.
During the years ended December 31, 2005 and 2004, total cash proceeds
from sales of accounts receivable were $600 million. The Company paid
servicing fees related to these receivables of $1.8 million, $0.9 million and
$1.3 million in 2005, 2004 and 2003, respectively. These amounts are
recorded in interest expense and finance charges in the Consolidated
Statements of Operations. At December 31, 2005 and 2004, 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 $108.0 million in 2005
and $106.1 million in 2004. Such inventories, if valued at current cost
instead of LIFO, would have been greater by $9.1 million in 2005 and
$6.6 million in 2004.
See Note 6 to the Consolidated Financial Statements for more information on
inventories.
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 generally 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.
See Note 6 to the Consolidated Financial Statements for more information on
property, plant and equipment and depreciation.
Impairment of long-lived assets 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 carrying 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 reasonable;
however, changes in assumptions underlying these estimates could affect the
evaluations. Long-lived assets held for sale are recorded at the lower of their
carrying amount or fair value less cost to sell. Significant judgments and
estimates used by management when evaluating long-lived assets for
impairment include (i) an assessment as to whether an adverse event or
circumstance has triggered the need for an impairment review; and (ii)
undiscounted future cash flows generated by the asset.
Goodwill and other intangible assets Under Statement of Financial
Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible
Assets,” goodwill is no longer amortized; however, it must be tested for
impairment at least annually. 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. The fair value of the
Company’s businesses used in determination of the goodwill impairment is
computed using the expected present value of associated future cash flows.
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
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
financial ratios, which require us to make certain assumptions and estimates
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 results of
the analysis performed in December 2005 did not indicate an impairment
of the book value of the Company’s goodwill.
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 interpretations. 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.
See Note 7 to the Consolidated Financial Statements for more information on
goodwill and other intangibles.
See Note 12 to the Consolidated Financial Statements for more information
on the Company’s stock compensation plans.
Product warranty 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 claim
settlements; as well as product manufacturing and industry developments
and recoveries from third parties. 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.
See Note 8 to the Consolidated Financial Statements for more information on
product warranties.
Other loss accruals and valuation allowances 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 regard 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 accrued liabilities for loss or asset valuation allowances.
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 denominated 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. Virtually 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 qualifying hedge
fair values are matched with the underlying transactions. All hedge
instruments are carried at their fair value based on quoted market prices for
contracts with similar maturities. The Company does not engage in any
derivative transactions for purposes other than hedging specific risks.
See Note 10 to the Consolidated Financial Statements for more information on
derivative financial instruments.
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
The following table illustrates the effect on the Company’s net earnings
and net earnings per share if the Company had applied the fair value
recognition provision of SFAS No. 123:
millions of dollars, except per share data
2005
2004
2003
Net earnings 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
Pro forma net earnings
Earnings per share:
Basic – as reported
Basic – pro forma
Diluted – as reported
Diluted – pro forma
$239.6
$218.3 $174.9
5.5
1.6
2.7
(12.2)
$232.9
(7.7)
(7.7)
$212.2 $169.9
$ 4.23
$ 4.11
$ 4.17
$ 4.06
$ 3.91 $ 3.23
$ 3.80 $ 3.14
$ 3.86 $ 3.20
$ 3.75 $ 3.11
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 currency 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.
See Note 13 to the Consolidated Financial Statements for more information
on other comprehensive income.
New accounting pronouncements In November 2004, the Financial
Accounting Standards Board (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 becomes
effective for the Company on January 1, 2006. The Company does not
expect the adoption of SFAS 151 to have a material impact on its
consolidated financial position, results of operations and cash flows.
In December 2004, the FASB issued SFAS No. 123(R), “Shared-Based
Payment” (FAS 123R) which requires companies to measure and
recognize compensation expense for all share-based payments at fair value.
In addition, the FASB has issued a number of supplements to FAS 123R
to guide the implementation of this new accounting pronouncement.
34
35
Notes to Consolidated Financial Statements continued
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 January 1, 2006. The Company will use the modified prospective
transition method, which requires that compensation cost be recognized in
the financial statements for all awards granted after the date of adoption as
well as for existing awards for which the requisite service has not been
rendered as of the date of adoption and requires that prior periods not be
restated. FAS 123R also requires an entity to calculate the pool of excess tax
benefits available to absorb tax deficiencies recognized subsequent to
adopting FAS 123R (the APIC Pool). The Company is currently evaluating
acceptable methods for calculating its APIC Pool.The Company expects
that the implementation of this pronouncement will lower 2006 earnings
by approximately ($0.16) to ($0.18) per diluted share. For 2005, stock
option expense would increase by approximately ($.05) to ($.07) per
diluted share if the Company adopted FAS 123R as of January 1, 2005
due to the appreciation of the stock price during the past few years and
increases in the number of incentive stock options issued.
In March 2005, the FASB issued Interpretation (FIN) No. 47, “Accounting
for Conditional Asset Retirement Obligations” an interpretation of
SFAS 143 (the Interpretation). FIN 47 clarifies the manner in which
uncertainties concerning the timing and the method of settlement of an
asset retirement obligation should be accounted for. In addition, the
Interpretation clarifies the circumstances under which fair value of an
asset retirement obligation is considered subject to reasonable estimation.
The Interpretation is effective no later than the end of fiscal years ending
after December 15, 2005. The Company recorded a $0.8 million loss
NOTE 4
Income Taxes
accrual upon adoption of this pronouncement in December 2005.
Reclassification Certain prior period amounts have been reclassified
to conform to the current year’s presentation and are not material to
the Company’s consolidated financial statements.
NOTE 2
Research and Development Costs
The Company spent approximately $161.0 million, $123.1 million, and
$118.2 million in 2005, 2004 and 2003, 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 $33.3 million,
$31.8 million, and $22.3 million in 2005, 2004, and 2003, respectively.
NOTE 3
Other (Income) Expense
Items included in other (income) expense consist of:
millions of dollars
Year Ended December 31,
Net gain on sale of businesses
Interest income
Net (gain)/loss on asset disposals
Crystal Springs related settlement
Other
Total other (income) expense
2005
2004
2003
$ (4.7)
(4.2)
(1.4)
45.5
(0.4)
$34.8
$ —
(0.7)
3.5
—
0.2
$3.0
$(0.5)
(0.8)
1.7
—
(0.5)
$(0.1)
Earnings before income taxes and the provision for income taxes are presented in the following table. The earnings before income taxes amounts for 2003
have been presented to conform to the 2004 and 2005 U.S. versus non-U.S. presentation.
millions of dollars
U.S. Non-U.S.
Total
U.S.
2005
2004
Non-U.S.
Total
U.S.
2003
Non-U.S.
Total
Earnings before taxes
Provision for income taxes:
Current:
Federal/foreign
State
Total current
Deferred
Total provision for income taxes
Effective tax rate
$ 46.8
$267.4
$314.2
$117.8
$190.8
$308.6
$120.5 $136.2 $256.7
(10.0)
2.9
(7.1)
(17.9)
$(25.0)
(53.4)%
94.6
—
94.6
(14.5)
$ 80.1
84.6
2.9
87.5
(32.4)
$ 55.1
1.4
2.2
3.6
11.1
$ 14.7
63.8
—
63.8
2.7
$ 66.5
65.2
2.2
67.4
13.8
$ 81.2
18.5
1.6
20.1
18.5
$ 38.6
13.1
—
13.1
21.5
$ 34.6
31.6
1.6
33.2
40.0
$ 73.2
30.0%
17.5%
12.4%
34.9%
26.3%
32.0%
25.4%
28.5%
The provision for income taxes resulted in an effective tax rate for 2005 of
17.5% compared with rates of 26.3% in 2004 and 28.5% in 2003. The
effective tax rate of 17.5% for 2005 differs from the U.S. statutory rate
primarily due to a) the release of tax accrual accounts upon conclusion of
certain tax audits, b) the tax effects of the disposition of Aktiengesellschaft
Kühnle Kopp and Kausch (AGK) and other miscellaneous dispositions,
c) foreign rates which differ from those in the U.S. d) realization of
certain business tax credits including R&D and foreign tax credits, and
e) other permanent items including equity in affiliates earnings. If the
effects of the tax accrual release, the disposition of AGK and other
miscellaneous dispositions are not taken into account, the Company’s
effective tax rate associated with its on-going business operations was
2 0 0 5 a n n u a l r e p o r t
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
approximately 27.8%. This rate was lower than the 2004 tax rate for
on-going operations of 30.0% due to changes in the mix of global
pre-tax income among taxing jurisdictions including witholding taxes.
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 application 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
does not expect the net effect of the phase out of the ETI and the phase
in of this new deduction to 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 has elected to apply this provision (“the election”)
to qualifying earnings repatriated in 2005.
The Company has decided on a plan for reinvestment of repatriated
foreign earnings (as a result of the repatriation provision) and obtained
approval for the repatriation plan from the Board of Directors on July
26, 2005. The Company repatriated foreign earnings of $72.2 million
from its non-US subsidiaries during 2005. Of the $72.2 million, the
Company made an election under the AJCA with respect to $15.0
million to pay down its US debt obligations and invest in R&D. The
election had a de minimis effect on income tax expense for 2005.
The analysis of the variance of income taxes as reported from income
taxes computed at the U.S. statutory rate for consolidated operations is
as follows:
millions of dollars
2005
2004
2003
Following are the gross components of deferred tax assets and liabilities
as of December 31, 2005 and 2004.
millions of dollars
2005
2004
Current deferred tax assets:
Foreign tax credits
Research and development credits
Employee related
Warranties
Litigation and environmental
Net operating loss carryforwards
Other
Total current deferred tax assets
Current deferred tax liabilities:
Inventory
Other
Total current deferred tax liabilities
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
Capital loss carryforwards
Net operating loss carryforwards
Other
Total non-current deferred tax assets
Non-current deferred tax liabilities:
Fixed assets
Goodwill and intangibles
Other comprehensive income
Lease obligation – production equipment
Other
Total non-current deferred tax liabilities
Total
Valuation allowances
Net deferred tax asset (liability)
$ 3.5 $ 9.0
6.0
5.1
—
—
1.4
1.1
$ 29.0 $ 22.6
1.6
8.9
4.0
9.8
0.2
1.0
$ (5.4)
(1.7)
$ (7.1)
—
—
—
$ 96.1 $ 92.1
36.3
9.0
3.5
9.2
7.7
2.6
4.9
—
—
5.3
$ 209.5 $ 170.6
44.6
7.6
—
5.4
3.6
23.2
12.2
6.5
5.1
5.2
$(173.2) $(163.4)
—
—
(9.0)
(7.0)
$(238.8) $(179.4)
(47.6)
(8.9)
(6.9)
(2.2)
$ (7.4) $ 13.8
—
$ (18.2) $ 13.8
(10.8)
Income taxes at U.S. statutory
rate of 35%
Increases (decreases) resulting from:
Income from non-U.S. sources
including withholding taxes
State taxes, net of federal benefit
Business tax credits, net
Affiliate earnings
Accrual adjustment and settlement
of prior year tax matters
Medicare prescription drug benefit
Capital loss limitation
Non-temporary differences and other
$110.0
$108.0
$89.8
The deferred tax assets and liabilities recognized in the Company’s
Consolidated Balance Sheets are as follows:
(11.0)
1.7
(4.2)
(9.6)
(26.7)
(2.6)
(3.5)
1.0
3.6
2.1
(6.2)
(10.2)
(6.0)
—
—
(10.1)
(8.5)
1.0
(6.3)
(7.0)
—
—
—
4.2
millions of dollars
Deferred income taxes – current assets
Deferred income taxes – current liabilities
Other non-current assets
Other long-term liabilities
Net deferred tax asset (liabilities)
(current and non-current)
2005
2004
$ 28.0
(6.1)
65.6
(105.7)
$ 22.6
—
51.8
(60.6)
$(18.2)
$ 13.8
Provision for income taxes as reported
$ 55.1
$ 81.2
$73.2
36
xx
37
xx
Notes to Consolidated Financial Statements continued
The deferred income taxes – current assets are primarily comprised of
amounts from the U.S., France, and Japan. The deferred income taxes –
current liabilities are primarily comprised of amounts from Germany.
The other non-current assets are primarily comprised of amounts from
the U.S. The other long-term liabilities are primarily comprised of
amounts from Germany, Italy, Japan and the U.K.
The Company has a U.S. capital loss carryforward of $17.0 million,
which will expire in 2010. A valuation allowance of $6.5 million has
been recorded for the tax effect of this loss carryforward.
The foreign tax credits will expire beginning in 2012 through 2015.
The R&D tax credits will expire beginning in 2022 through 2025. The
Company also has deferred tax assets for minimum tax credits of $2.0
million, which can be carried forward indefinitely.
At December 31, 2005, certain non-U.S. subsidiaries have net
operating loss carryforwards totaling $17.0 million that are available to
offset future taxable income. Carryforwards of $3.6 million expire at
various dates from 2007 through 2010 and the balance has no
expiration date. A valuation allowance of $4.3 million has been
recorded for the tax effect on $12.9 million of the loss carryforwards.
Any benefit resulting from the utilization of $5.0 million of the
operating loss carryforwards will be applied to reduce goodwill.
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 $552.2
million in 2005, 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
Marketable Securities
As of December 31, 2005, the Company had $40.6 million of highly
liquid investments in marketable securities, primarily bank notes,
acquired as part of the Beru Acquisition. The securities are carried at
fair value with the unrealized gain or loss, net of tax, reported in other
comprehensive income. Although $27.7 million of the contractual
maturities are within one to five years and $12.9 million are due
beyond five years, the Company does not intend to hold these
investments until maturity. Gross proceeds from sales of marketable
securities were $58.2 million in 2005. Net realized gains of $0.3
million, based on specific identification of securities sold, have been
reported in other income for the year ended December 31, 2005.
NOTE 6
Balance Sheet Information
Detailed balance sheet data are as follows:
millions of dollars
December 31,
Receivables:
Customers
Other
Gross receivables
Bad debt allowance
Net receivables
Inventories:
Raw material and supplies
Work in progress
Finished goods
FIFO inventories
LIFO reserve
Net inventories
Property, plant and equipment
Land
Buildings
Machinery and equipment
Capital leases
Construction in progress
Total property, plant and equipment
Accumulated depreciation
Property, plant and equipment-net
Investments and advances:
Investment in equity affiliates
Other investments and advances
Total investments and advances
Other non-current assets:
Deferred pension assets
Product liability insurance receivable
Deferred income taxes, net
Other intangible assets
Other
Total other non-current assets
Accounts payable and accrued expenses:
Trade payables
Payroll and related
Environmental
Product liability accrual
Warranties
Insurance
Customer related accruals
Interest
Dividends payable to minority shareholders
Current deferred income taxes
Other
Total accounts payable and
accrued expenses
Other long-term liabilities:
Environmental accruals
Warranties
Deferred income taxes, net
Product liability accrual
Other
Total other long term liabilities
2005
2004
$ 567.1 $ 453.9
56.1
510.0
(10.9)
$ 626.1 $ 499.1
67.3
$ 634.4
(8.3)
$ 163.9 $ 107.6
71.9
50.5
230.0
(6.6)
$ 332.0 $ 223.4
84.9
92.3
341.1
(9.1)
$ 43.6 $ 45.0
358.2
1,352.3
1.1
103.0
1,859.6
(782.4)
$1,294.9 $1,077.2
443.7
1,529.4
1.1
141.6
2,159.4
(864.5)
$ 189.1 $ 189.5
4.2
$ 197.7 $ 193.7
8.6
$ 70.6 $ 113.1
27.3
51.8
4.9
23.9
$ 292.1 $ 221.0
20.2
65.6
99.7
36.0
$ 450.0 $ 390.6
74.5
0.0
13.5
16.1
25.2
4.5
9.6
2.4
—
71.6
107.9
26.1
20.8
25.4
16.4
22.1
15.1
8.8
6.1
87.7
$ 786.4 $ 608.0
$ 13.0 $ 25.7
10.3
60.6
27.3
119.0
$ 224.3 $ 242.9
18.6
105.7
20.2
66.8
2 0 0 5 a n n u a l r e p o r t
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
Interest costs capitalized during 2005 and 2004 were $6.9 million and
$4.3 million, respectively. As of December 31, 2005 and December 31,
2004 accounts payable of $41.6 million and $37.3 million, respectively,
were related to property, plant and equipment purchases. As of
December 31, 2005 and December 31, 2004 specific assets of $32.6
million and $38.7 million, respectively, were pledged as collateral under
certain of the Company’s long-term debt agreements.
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
earnings of NSK-Warner consists of the 12 months ended November
30 so as to reflect earnings on as current a basis as is reasonably feasible.
NSK-Warner is the joint venture partner with a 40% interest in the
Drivetrain Group’s South Korean subsidiary, BorgWarner Transmission
Systems Korea Inc. Dividends received from NSK-Warner were $12.7
million in 2005, $23.9 million in 2004, and $9.7 million in 2003.
Following are summarized financial data for NSK-Warner, translated
using the ending or periodic rates as of and for the years ended
November 30, 2005, 2004 and 2003 (unaudited):
millions of dollars
2005
2004
2003
Balance sheets:
Current assets
Non-current assets
Current liabilities
Non-current liabilities
Statements of operations:
Net sales
Gross profit
Net income
$236.7
168.7
120.8
18.4
$242.3 $210.7
173.3
180.7
108.8
126.2
14.8
18.5
$471.8
94.5
55.6
$443.5 $356.5
71.4
34.5
97.3
52.6
The equity of NSK-Warner as of November 30, 2005, was $266.2
million, there was no debt and their cash and securities were $92.2
million.
Purchases from NSK-Warner for the years ended December 31, 2005,
2004 and 2003 were $25.4 million, $19.9 million and $16.9 million,
respectively.
Investment in business held for sale
On March 11, 2005, the Company completed the sale of its holdings
in AGK for $57.0 million to Turbo Group GmbH. BorgWarner Europe
Inc. acquired the stake in AGK, a turbomachinery company, from
Penske Corporation in 1997. Since that time, AGK was treated as an
unconsolidated subsidiary of the Company and recorded in
“Investment in business held for sale” in the Consolidated Balance
Sheets. The investment was carried on a cost basis, with dividends
received from AGK applied against the carrying value of the asset. The
proceeds, net of closing costs, were approximately $54.2 million,
resulting in a pre-tax gain of approximately $10.1 million on the sale.
NOTE 7
Goodwill and Other Intangibles
The changes in the carrying amount of goodwill for the twelve months
ended December 31, 2003, 2004 and 2005, are as follows:
millions of dollars
Drivetrain
Engine
Total
Balance at January 1, 2003
Contingent valuation payment
on acquired business
Translation adjustment
Balance at December 31, 2003
Translation adjustment
Balance at December 31, 2004
Beru acquisition
Translation adjustment
$133.7
$ 693.3
$ 827.0
—
0.6
$134.3
0.3
$ 134.6
—
(0.5)
12.8
11.6
$717.7
8.5
$ 726.2
204.7
(35.2)
12.8
12.2
$ 852.0
8.8
$ 860.8
204.7
(35.7)
Balance at December 31, 2005
$ 134.1
$ 895.7
$1,029.8
The Company’s other intangible assets, primarily from acquisitions,
are valued based on independent appraisals and consisted of the
following:
in millions
Gross
carrying
amount
Accumulated
Amortization
Net
carrying
amount
December 31, 2005
Amortized intangible assets
Patented technology
Unpatented technology
Customer relationships
Distribution network
Miscellaneous
$ 9.4
1.1
54.5
31.2
14.7
Total amortized intangible asset $110.9
$ 14.0
Unamortized trade names
$124.9
Total intangible asset
December 31, 2004
Amortized intangible assets
Patented technology
Unpatented technology
Customer relationships
Distribution network
Miscellaneous
Total amortized intangible asset
Unamortized trade names
Total intangible asset
$ —
—
—
—
14.7
14.7
—
$ 14.7
$ 0.8
0.3
5.7
6.6
11.8
$25.2
—
$25.2
$ —
—
—
—
9.8
9.8
—
$ 9.8
$ 8.6
0.8
48.8
24.6
2.9
$85.7
$14.0
$99.7
$ —
—
—
—
4.9
4.9
—
$ 4.9
Amortization of other intangible assets was approximately $31.7 mil-
lion for the year ended December 31, 2005, including non-recurring
charges directly attributable to the Beru Acquisition, and $1.1 million
for the year ended December 31, 2004. The estimated useful lives of
the Company’s amortized intangible assets range from 4 to 12 years.
The estimated future annual amortization expense, primarily for
acquired intangible assets, is as follows: $14.5 million in 2006, $12.9
million in 2007, $12.7 million in 2008, $12.2 million in 2009 and
$6.1 million in 2010.
38
xx
39
xx
Notes to Consolidated Financial Statements continued
A roll-forward of accumulated amortization at December 31, 2005 is
presented below.
NOTE 8
Product Warranty
millions of dollars
Beginning Balance
Provisions
Non-recurring charges
Translation adjustment
Ending balance
2005
$ 9.8
31.7
(15.5)
(0.8)
$ 25.2
The changes in the carrying amount of the Company’s total product
warranty liability for the years ended December 31, 2005 and 2004
were as follows:
millions of dollars
Beginning balance
Acquisition
Provisions
Payments
Translation adjustment
Ending balance
Classified in the Consolidated Balance sheets as:
Accounts payable and accrued expenses
Other long term liability
2005
2004
$ 26.4
12.0
30.0
(20.3)
(4.1)
$ 44.0
$ 28.7
—
10.2
(13.4)
0.9
$ 26.4
$ 25.4
$ 18.6
$ 16.1
$ 10.3
NOTE 9
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 2005 and 2004 was 4.9% and
5.1%, respectively.
millions of dollars
December 31,
Bank borrowings and other
Term loans due through 2013 (at an average rate of 3.2% in 2005 and 3.3% in 2004)
7% Senior Notes due 11/01/06, net of unamortized discount ($139 million converted to
floating rate of 6.4% by interest rate swap at 12/31/05)
6.5% Senior Notes due 2/15/09, net of unamortized discount ($100 million converted to
floating rate of 7.1% by interest rate swap at 12/31/05)
8% Senior Notes due 10/01/19, net of unamortized discount ($75 million converted to
floating rate of 7.3% by interest rate swap at 12/31/05)
7.125% Senior Notes due 02/15/29, 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
2005
2004
Current
Long-Term
Current
Long-Term
$136.2
24.3
$21.0
30.4
$ 9.2
7.3
$ 6.1
26.9
139.0
—
—
136.2
—
—
299. 5
0.4
$299.9
133.9
119.1
440.6
—
$440.6
—
—
—
—
16.5
—
$16.5
139.0
136.1
133.9
119.1
561.1
6.9
$568.0
Annual principal payments required as of December 31, 2005 are as
follows (in millions of dollars):
2006
2007
2008
2009
2010
After 2010
Total Payments
Less: Unamortized discounts
Total
$299.9
10.3
7.5
161.7
3.1
260.2
$742.7
(2.2)
$740.5
The Company has a multi-currency revolving credit facility, which
provides for borrowings up to $600 million through July 2009. At
December 31, 2005, $15.0 million of borrowings under the facility
were outstanding. 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, 2005
and expects to be compliant in future periods. The 7% Senior Notes
with a face value of $139.0 million mature in November 2006.
Management plans to refinance this amount at that time. At December
31, 2005 and 2004, the Company had outstanding letters of credit of
$25.7 million and $23.7 million, respectively. The letters of credit
typically act as a guarantee of payment to certain third parties in
accordance with specified terms and conditions.
2 0 0 5 a n n u a l r e p o r t
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
As of December 31, 2005 and 2004, the estimated fair values of the
Company’s senior unsecured notes totaled $574.7 million and $589.0
million, respectively. The estimated fair values were $46.6 million higher in
2005, and $60.9 million higher in 2004, 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 inform-
ation available as of year-end. The fair value estimates do not necessarily
reflect the values the Company could realize in the current markets.
NOTE 10
Financial Instruments
short-term nature of these instruments, the book value approximates
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.
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
currency exposure associated with our net investment in certain foreign
operations (net investment hedges).
The Company’s financial instruments include cash and cash equivalents,
trade receivables, trade payables, and notes payable. Due to the
A summary of these instruments outstanding at December 31, 2005
follows (currency in millions):
Interest rate swaps(a)
Fixed to floating
Fixed to floating
Fixed to floating
Cross currency swap (matures 11/01/06)
Floating $
to floating ¥
Cross currency swap (matures 2/15/09)
Floating $
to floating €
Cross currency swap (matures in 10/01/19)
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
$100
€75
$75
€61
Interest Rates(b)
Receive
Pay
Floating Interest
Rate Basis
7.0%
6.5%
8.0%
6.1%
—
7.1%
—
7.3%
—
6.4%
7.1%
7.3%
—
1.7%
—
5.0%
—
5.2%
6 mo. USD LIBOR +1.7%
6 mo. USD LIBOR +2.4%
6 mo. USD LIBOR +2.6%
6 mo. USD LIBOR +1.4%
6 mo. JPY LIBOR +1.6%
6 mo. USD LIBOR +2.4%
6 mo. EURIBOR +2.4%
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, 2005.
As of December 31, 2005, the fair value of the fixed to floating interest
rate swaps was recorded as a current asset of $1.0 million and a current
liability of $(0.6) million, and a non-current asset of $2.9 million and a
non-current liability of $(2.9) million. As of December 31, 2004, the
fair value of the fixed to floating interest rate swaps was recorded as a
non-current asset of $6.9 million. No hedge ineffectiveness was
recognized in relation with fixed to floating swaps.
The cross currency swaps were recorded at their fair values of $3.9
million included in other current assets, $14.9 million included in non-
current assets and $(5.1) million included in other current liabilities at
December 31, 2005 and $(33.1) million in other non-current liabilities
at December 31, 2004. Hedge ineffectiveness of $0.1 million was
recognized as of December 31, 2005 in relation to cross currency
swaps. Fair value is based on quoted market prices for contracts with
similar maturities.
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 primarily
utilizes forward and option contracts, which are designated as cash flow
hedges. As of December 31, 2005 the Company had forward and option
commodity contracts with a total notional value of $5.8 million. The
fair market value of the swap contracts was $2.1 million ($2.0 million
maturing in less than one year) as of December 31, 2005, 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, 2004 the Company had commodity
forward contracts with a total notional value of $3.4 million. The fair
market value of the forward contracts was $0.4 million as of December
31, 2004, which was deferred in other comprehensive income. During
the twelve months ended December 31, 2005 and 2004, hedge
ineffectiveness associated with these contracts was not significant.
The Company uses foreign exchange forward and option 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
40
xx
41
xx
Notes to Consolidated Financial Statements continued
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, 2005 contracts were outstanding to buy or sell U.S.
Dollars, Euros, British Pounds Sterling, South Korean Won, Japanese Yen
and Hungarian Forints. Gains and losses arising from these contracts are
deferred in other comprehensive income and will be reclassified and
matched into income as the underlying operating transactions are
realized. As of December 31, 2005 unrealized gains amounted to $3.0
million, ($1.6 million maturing in less than one year) and unrealized
losses amounted to $(1.6) million ($(1.4) million maturing in less than
one year). As of December 31, 2004 unrealized gains amounted to $8.8
million and unrealized losses amounted to $(4.1) million. Hedge
ineffectiveness associated with these contracts during 2005 amounted to
a loss of $(0.5) million. Hedge ineffectiveness associated with these
contracts during 2004 was not significant.
NOTE 11
Retirement Benefit Plans
The Company sponsors various defined contribution savings plans
primarily in the U.S. that allow employees to contribute a portion of
their pre-tax and/or after-tax income in accordance with plan specified
guidelines. Under specified conditions, the Company will make
contributions to the plans and/or match a percentage of the employee
contributions up to certain limits. Total expense related to the defined
contribution plans was $23.1 million in 2005, $22.4 million in 2004,
and $21.1 million in 2003.
The Company has a number of defined benefit pension plans and other
post retirement benefit plans covering eligible salaried and hourly
employees and their dependents. The defined pension benefits provided
are primarily based on (i) years of service and (ii) average compensation
or a monthly retirement benefit amount. The Company provides
defined benefit plans in the U.S., U.K., Germany, Japan, South Korea,
Italy, France, and Mexico. The other post retirement benefit plans,
which provide medical and life insurance benefits, are unfunded plans.
The pension and other post retirement benefit plans in the U.S. have
been closed to new employees since 1995. The measurement date for all
plans is December 31.
The following table summarizes the expenses for the Company’s defined
contribution and defined benefit pension plans and the other post
retirement defined benefits plans.
millions of dollars
2005
2004
2003
Defined contribution pension expense
Defined benefit pension expense
Other post retirement benefit expenses
Total
$23.1
17.6
48.8
$89.5
$22.4
16.7
43.2
$82.3
$21.1
23.2
40.7
$85.0
2 0 0 5 a n n u a l r e p o r t
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
The following provides a reconciliation of the plans’ benefit obligations, plan assets,
funded status and recognition in the Consolidated Balance Sheets.
millions of dollars
Change in projected benefit obligation:
Projected benefit obligation at beginning of year
Service cost
Interest cost
Plan participants’ contributions
Plan amendments
Actuarial (gain)/loss
Currency translation
Acquisitions/business combination
Benefits paid
Projected benefit obligation at end of year
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
Fair value of plan assets at end of year
Funded status:
Funded status at end of year
Unrecognized net actuarial (gain)/loss
Unrecognized transition obligation (asset)
Unrecognized prior service cost (benefit)
Net amount recognized
Amounts recognized in the Consolidated
Balance Sheets consist of:
Prepaid benefit cost
Accrued benefit liability
Intangible asset
Accumulated reduction in stockholders equity
Net amount recognized
Pension benefits
2005
2004
U.S.
Non-U.S.
U.S.
Non-U.S.
Other post
retirement benefits
2005
2004
$305.3
2.5
16.9
—
(2.8)
17.6
—
—
(23.4)
$316.1
$324.4
21.6
10.0
—
—
(23.4)
$332.6
$ 16.5
98.4
—
3.6
$118.5
$ 260.2
12.1
13.7
0.3
—
23.9
(34.8)
35.5
(11.0)
$316.5
2.4
17.3
—
—
(8.3)
—
—
(22.6)
$ 217.1
9.3
11.5
0.3
—
12.2
17.9
—
(8.1)
$ 537.2
7.9
30.6
—
(22.6)
165.9
—
—
(39.1)
$ 537.4
6.0
28.8
—
—
(2.1)
—
—
(32.9)
$ 299.9
$305.3
$ 260.2
$ 679.9
$ 537.2
$ 124.7
22.6
16.0
0.3
(13.7)
(11.0)
$288.0
34.7
24.3
—
—
(22.6)
$ 103.4
8.9
12.0
0.3
8.2
(8.1)
$ 138.9
$324.4
$ 124.7
$(161.0)
58.7
0.3
—
$ 19.1
79.1
—
7.5
$(135.5)
57.2
—
0.3
$(679.9)
356.8
—
(22.2)
$(537.2)
203.7
—
(2.1)
$(102.0)
$105.7
$ (78.0)
$(345.3)
$(335.6)
$ 67.3
(32.0)
3.3
79.9
—
$
(144.8)
—
42.8
$105.7
(63.2)
7.2
56.0
$ —
(99.2)
0.2
21.0
$ —
(345.3)
—
—
$ —
(335.6)
—
—
$118.5
$(102.0)
$105.7
$ (78.0)
$(345.3)
$(335.6)
Total accumulated benefit obligation for all plans
$315.9
$ 282.2
$301.8
$ 229.6
During 2005, the Company implemented amendments to certain pension and post retirement health care plans. These amendments decreased the
pension obligation by $2.8 million and the post retirement health care obligation by $22.6 million. These amendments are being recognized over the
remaining service lives of the affected employees.
42
xx
43
xx
The weighted-average asset allocations of the Company’s funded
pension plans at December 31, 2005 and 2004, and target allocations
by asset category are as follows:
The Company’s weighted-average assumptions used to determine the
benefit obligations for our defined benefit pension and other post
retirement plans as of December 31, 2005 and 2004 were as follows:
Notes to Consolidated Financial Statements continued
The funded status of pension plans included above with accumulated
benefit obligations in excess of plan assets at December 31 is as follows:
millions of dollars
Accumulated benefit obligation
Plan assets
Deficiency
Pension deficiency by country:
United States
United Kingdom
Germany
Other
Total pension deficiency
2005
2004
$(519.8) $(449.7)
343.6
321.9
$(176.2) $(127.8)
$ (32.0) $ (19.4)
(29.0)
(72.5)
(6.9)
$(176.2) $(127.8)
(30.7)
(97.9)
(15.6)
percent
U.S. Plans
Cash, real estate and other
Fixed income securities
Equity securities
Non-U.S. Plans
Cash, real estate and other
Fixed income securities
Equity securities
2005
2004
Target
Allocation
10%
33
57
9%
33
58
100% 100%
1%
35
64
0%
35
65
100% 100%
0-15%
25-45
45-65
0-10%
30-40
60-70
The Company’s investment strategy is to maintain actual asset
weightings 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 relevant peer group. The pension plans did not
hold any Company securities as investments as of December 31, 2005
and 2004.
The Company expects to contribute a total of $25 million to $30
million into all of its defined benefit pension plans during 2006.
See the table below for a breakout between U.S. and non-U.S.
pension plans.
millions of dollars
For the Year Ended December 31,
2005
Pension benefits
2004
2003
Other post retirement
benefits
U.S. Non-U.S.
U.S. Non-U.S.
U.S. Non-U.S.
2005
2004
2003
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 (benefit)
Amortization of unrecognized loss
Net periodic benefit cost/(benefit)
$ 2.6
16.9
(28.0)
—
1.1
4.7
$ (2.7)
$12.1
13.7
(8.1)
—
0.3
2.3
$20.3
$ 2.4
17.3
(26.1)
—
1.5
5.2
$ 0.3
$ 9.3
11.5
(7.3)
0.3
0.2
2.4
$16.4
$ 2.5
18.5
(20.7)
—
1.5
7.8
$ 9.6
$ 7.5
9.5
(5.7)
0.3
0.2
1.8
$13.6
$ 7.9
30.6
—
—
(2.4)
12.7
$48.8
$ 6.0 $ 5.3
29.7
28.8
—
—
—
—
(0.2)
(0.2)
5.9
8.6
$43.2 $40.7
2 0 0 5 a n n u a l r e p o r t
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
long-term rate of return on assets for its U.K. pension plan was 6.75%
for 2005, 2004 and 2003. The Company anticipates increasing its
assumed long-term rate of return on U.K. plan assets to 7.25% for
2006, due to both recent and long-term asset performance and the
plan’s asset allocation.
The estimated future benefit payments for the pension and other post
retirement benefits are as follows:
Pension
benefits
Other
post retirement benefits
millions of dollars
Year
2006
2007
2008
2009
2010
2011-2015
U.S.
Non-U.S.
$ 23.3
23.1
22.9
22.9
22.9
114.7
$10.4
10.4
11.8
11.5
11.8
68.1
w/o Medicare With Medicare
Part D
reimbursements
Part D
reimbursements
$ 36.7
39.0
41.0
42.7
45.0
251.8
$ 34.1
36.3
38.0
39.6
41.7
234.2
The weighted-average rate of increase in the per capita cost of covered
health care benefits is projected to be 10.0% in 2006 decreasing to
5.0% by the year 2011. 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
$98.0
$(80.3)
$ 4.4
$ (5.8)
percent
U.S. plans
Discount rate
Rate of compensation increase
Non-U.S. plans
Discount rate
Rate of compensation increase
2005
2004
5.50
3.50
4.43
2.95
5.75
3.50
5.04
3.36
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, 2005 were as follows:
percent
2005
2004
2003
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
5.75
3.50
8.75
5.04
3.36
6.63
6.00
3.50
8.75
5.49
3.40
6.62
6.75
4.50
8.75
5.45
3.36
6.82
The Company determines its expected return on plan asset assumptions
by evaluating estimates of future market returns and the plans’ asset
allocation. The Company also considers the impact of active
management of the plans’ invested assets. The Company’s expected
return on assets assumption reflects the asset allocation of each plan.
The Company’s assumed long-term rate of return on assets for its U.S.
pension plans was 8.75% for 2005, 2004 and 2003. The Company
does not anticipate a change in the long-term rate of return on U.S.
plan assets for pension benefits for 2006. The Company’s assumed
44
xx
45
xx
Notes to Consolidated Financial Statements continued
NOTE 12
Stock Incentive Plans
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 number of shares originally authorized for grant
was 2,700,000. As of December 31, 2005, there are a total of 3,209,000
outstanding options under the 1993 and 2004 Stock Incentive Plans.
Under the 2004 Stock Incentive Plan, the Company issues restricted
shares of common stock to its non-employee directors that vest and
become unrestricted shares in one to three years from the date of grant.
The Company issued 16,099 such shares in 2005 and 6,400 in 2004.
The market value of the Company’s common stock determines the
value of the restricted stock. The value of the awards are recorded as
unearned compensation on restricted stock in a separate component of
stockholders’ equity, which is amortized as compensation expense over
the restriction periods. During 2005, $0.2 million was charged to
compensation expense under the plan.
The Company accounts for stock options in accordance with APB 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 plans’ shares under option at December 31, 2005,
2004 and 2003 follows:
2005
2004
2003
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
Options exercisable at year-end
Options available for future grants
2,995
968
(713)
(41)
3,209
876
569
$33.24
58.08
26.04
31.43
$42.41
$26.02
2,685
1,063
(593)
(160)
2,995
$26.39
44.56
24.22
26.74
$33.24
3,650
687
(1,517)
(135)
2,685
$23.29
32.74
21.80
25.03
$ 26.39
793
$23.78
554
$ 22.57
The following table summarizes information about stock options outstanding at December 31, 2005:
Range of
exercise prices
$16.34-21.13
$24.14-26.56
$26.94-58.08
Options outstanding
Options exercisable
Number outstanding
(thousands)
Weighted-average
remaining contractual life
Weighted-average
exercise price
Number exercisable
(thousands)
Weighted-average
exercise price
94
589
2,526
3,209
4.0
6.1
8.7
8.1
$18.45
$25.20
$ 47.32
$ 42.41
94
575
207
876
$18.45
$25.17
$ 31.85
$ 26.02
The weighted average fair value at date of grant for options granted
during 2005, 2004, and 2003 were $14.63, $16.28, and $11.91,
respectively, and were estimated using the Black-Scholes options pricing
model with the following weighted average assumptions:
2005
2004
2003
Risk-free interest rate
Dividend yield
Volatility factor
Weighted average expected life
4.07%
1.09%
27.02%
4.0 years
4.14%
1.26%
32.89%
6.5 years
3.58%
1.27%
34.38%
6.5 years
The expected lives of the awards are based on historical exercise patterns
and the terms of the options. The assumption for weighted average
expected lives was adjusted in 2005 based on a third-party evaluation of
the Company’s historical exercise patterns, which revealed that the awards
have been exercised earlier in recent years. The risk-free interest rate is
based on zero coupon treasury bond rates corresponding to the expected
life of the awards. The expected volatility assumption was derived by
referring to changes in the Company’s historical common stock prices
over the same timeframe as the expected life of the awards. The expected
dividend yield of stock is based on the Company’s historical dividend
yield. The Company has no reason to believe that future stock volatility
or the expected dividend yield is likely to differ from historical patterns.
Stock compensation plans During 2005, the Company adopted a
Performance Share Plan that provides payouts to members of senior
management at the end of successive three-year periods based on the
Company’s performance in terms of total shareholder return relative to
a peer group of automotive companies. Payouts earned are payable 40%
in cash and 60% in the Company’s common stock. The Performance
Share Plan replaces, and is very similar in structure, to the Executive
Stock Performance Plan that was in effect during 2003 and 2004. For
the three-year measurement periods ended December 31, 2005, 2004
and 2003, the amounts expensed under the plans and the related share
issuances were as follows:
Expense ($ millions)
Number of shares*
2005
2004
2003
$8.8
$2.0
54,806 48,569
$2.7
41,252
*Shares are issued in February of the following year.
The increase in expense in 2005 in comparison to 2004 and 2003 was
primarily related to the Company stock’s performance measured by
total shareholder return relative to its peer group. Estimated shares
issuable under the plans are included in the computation 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 period beginning January 1, 2004 and ending
on December 31, 2006. The Performance Share Plan is a provision of
the 2004 Stock Incentive Plan, which expires on December 31, 2014.
46
xx
47
xx
2 0 0 5 a n n u a l r e p o r t
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
NOTE 13
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
2005
2004
Foreign currency translation adjustments, net
Market value of hedge instruments, net
Unrealized loss on available-for-sale securities, net
Minimum pension liability adjustment, net
Accumulated other comprehensive income/(loss)
$ 2.3 $ 99.7
3.2
2.9
—
(0.3)
(78.0)
(47.7)
$(73.1) $ 55.2
The changes in the components of other comprehensive income/(loss)
in the Consolidated Statements of Stockholders’ Equity are as follows:
millions of dollars
2005
2004
2003
Foreign currency translation adjustments
Market value change of hedge instruments
Income taxes
Net foreign currency translation
$ (97.4) $10.7 $67.6
0.4
(0.2)
(1.1)
0.8
4.7
13.0
and hedge instruments adjustment
(97.7)
28.4
67.8
Unrealized loss on
available-for-sale securities
Income taxes
Net unrealized loss on
available-for-sale securities
Minimum pension liability adjustment
Income taxes
Net minimum pension liability adjustment
(0.4)
0.1
(0.3)
(45.7)
15.4
(30.3)
17.2
(4.4)
12.8
1.1
(0.4)
0.7
Other comprehensive income/(loss)
$(128.3) $41.2 $68.5
NOTE 14
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.
Notes to Consolidated Financial Statements continued
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 and certain
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 38 such sites. Responsibility for clean-up and other
remedial activities at a Superfund site is typically shared among
PRPs based on an allocation formula.
The Company believes that none of these matters, individually or
in the aggregate, will have a material adverse effect on its financial
condition 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.
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 information
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,
the Company has established an accrual for indicated environmental
liabilities with a balance at December 31, 2005, of approximately
$38.3 million. Included in the total accrued liability is the $16.1
million anticipated cost to settle all outstanding claims related to
Crystal Springs described below, which was recorded in the second
quarter of 2005. For the other 37 sites, we have accrued amounts
that do not exceed $3.0 million related to any individual site and
management does not believe that the costs related to any of these other
individual sites will have a material adverse effect on the Company’s
results of operations, cash flows or financial condition. The Company
expects to expend substantially all of the $38.3 million environmental
accrued liability over the next three to five years.
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, during 1999. During
2000, Kuhlman Electric notified us that it discovered potential
environmental contamination at its Crystal Springs, Mississippi plant
while undertaking an expansion of the plant. 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 and other defendants, including the Company’s subsidiary
Kuhlman Corporation, entered into a settlement in July 2005 regarding
approximately 90% of personal injury and property damage claims
relating to the alleged environmental contamination. In exchange for,
among other things, the dismissal with prejudice of these lawsuits, the
defendants agreed to pay a total sum of up to $39.0 million in settlement
funds. The settlement was paid in three approximately equal installments.
The first two payments of $12.9 million were made in the third and
fourth quarters of 2005 and the remaining installment of $13.0 million
was paid in the first quarter of 2006.
The same group of defendants entered into a settlement in October
2005 regarding approximately 9% of personal injury and property
damage claims relating to the alleged environmental contamination. In
exchange for, among other things, the dismissal with prejudice of these
lawsuits, the defendants agreed to pay a total sum of up to $5.4 million
in settlement funds. The settlement was paid in two approximately
equal installments in the fourth quarter of 2005 and the first quarter of
2006. With this settlement, the Company and other defendants have
resolved about 99% of the known personal injury and property damage
claims relating to the alleged environmental contamination. The cost of
this settlement has been recorded in other income in the Consolidated
Statements of Operations.
Conditional Asset Retirement Obligations
In 2005, the FASB issued Interpretation (FIN) No. 47, “Accounting for
Conditional Asset Retirement Obligations” an interpretation of SFAS
143, which requires the Company to recognize legal obligations to
perform asset retirements in which the timing and (or) method of
settlement are conditional on a future event that may or may not be
within the control of the entity. Certain government regulations require
the removal of asbestos from an existing facility at the time the facility
undergoes major renovations or is demolished. The liability exists
because the facility will not last forever, but it is conditional on future
renovations, even if there are no immediate plans to remove the
materials which pose no health or safety hazard in their current
condition. Similarly, government regulations require the removal or
closure of underground storage tanks (USTs) when their use ceases, the
disposal of polychlorinated biphenyl (PCBs) transformers and
capacitors when their use ceases, and the disposal of lead-based paint in
conjunction with facility renovations or demolition. We currently have
11 manufacturing locations within our Company, which have been
identified as containing asbestos-related building materials, USTs, PCB
transformers or capacitors, or lead-based paint. The fair value of special
handling costs to remove, transport and dispose of this material has
been estimated and recorded at $0.8 million as of December 31, 2005.
2 0 0 5 a n n u a l r e p o r t
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
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. As of December 31,
2005, the Company had approximately 67,000 pending asbestos-
related product liability claims. Of these outstanding claims,
approximately 58,000 are pending 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 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
2005, of the approximately 38,000 claims resolved, only 295 (0.8%)
resulted in any payment being made to a claimant by or on behalf of
the Company. In 2004 of the 4,062 claims resolved, only 255 (6.3%)
resulted in any payment being made to a claimant by or on behalf of
the Company.
Prior to June 2004, the settlement and defense costs associated with all
claims were covered by the Company’s primary layer insurance
coverage, and these carriers administered, defended, settled and paid all
claims under a funding agreement. In June 2004, primary layer
insurance carriers notified the Company 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. The Company has paid $2.9 million in 2005 and
$1.0 million in 2004 as a result of the funding agreement for claims
that have been resolved. The Company is expecting to fully recover
these amounts. Recovery is dependent on the completion of an audit
proving the exhaustion of primary insurance coverage and the successful
resolution of the declaratory judgment action referred to below. At
December 31, 2005 an amount of $3.9 million was owed by insurance
carriers in respect of claims settled and funded by the Company in
advance of the insurers’ reimbursement. This amount has been
submitted to carriers for reimbursement and the Company expects to
be fully reimbursed.
At December 31, 2005, the Company has an estimated liability of
$41.0 million for future claims resolutions, with a related asset of $41.0
million to recognize the insurance proceeds receivable by the Company
for estimated losses related to claims that have yet to be resolved.
Insurance carrier reimbursement of 100% is expected based on the
Company’s experience, its insurance contracts and decisions received to
date in the declaratory judgment action referred to below. At December
31, 2004, the comparable value of the insurance receivable and accrued
liability was $40.8 million.
The amounts recorded in the Condensed Consolidated Balance Sheets
related to the estimated future settlement of existing claims are as follows:
millions of dollars
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
2005
2004
$20.8 $13.5
27.3
20.2
$41.0 $40.8
$20.8 $13.5
27.3
20.2
$41.0 $40.8
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
both primary and additional layer insurance, and, in conjunction with
other insurers, is currently defending and indemnifying the Company
in 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. On August
15, 2005, the Court issued an interim order regarding the
apportionment matter. The interim order has the effect of making
insurers responsible for all defense and settlement costs pro rata to
time-on-the-risk, with the pro-ration method to hold the insured
harmless for periods of bankrupt or unavailable coverage. Appeals of the
interim order were denied. However, the issue is reserved for appellate
review at the end of the action. 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. As such, the Company continues to believe that
its coverage is sufficient to meet foreseeable liabilities.
Although it is impossible to predict the outcome of pending or future
claims or the impact of tort reform legislation being considered at
the State and Federal levels, due to 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 product liability claims are likely to have a material
adverse effect on the Company’s results of operations, cash flows or
financial condition.
48
xx
49
xx
Notes to Consolidated Financial Statements continued
NOTE 15
Leases and Commitments
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 $21.9 million in 2005,
$18.0 million in 2004, and $13.4 million in 2003. 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 2006. In the
event the Company exercises its option not to purchase the production
equipment, the Company has guaranteed a residual value of $16.6
million. We do not believe we have any loss exposure due to this
guarantee.
Future minimum operating lease payments at December 31, 2005 were
as follows:
millions of dollars
2006
2007
2008
2009
2010
After 2010
Total minimum lease payments
$28.4(a)
7.8
7.3
6.8
6.2
13.2
$ 69.7
(a) 2006 includes $16.6 million for the guaranteed residual value of production equipment with a lease
that expires in 2006.
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 infringement
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 agreement 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 $1.9 million in
2005, $14.2 million in 2004 and $23.2 million in 2003. These costs were all
recognized as part of cost of goods sold. These costs will remain at minimal
levels in 2006 as the Company’s primary customers have converted most of
their requirements to the next generation VTG turbocharger.
NOTE 16
Stock Split
On April 21, 2004 the Company’s stockholders approved an
amendment 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 17
Earnings Per Share
Earnings per share of common stock outstanding were computed as
follows:
in millions except per share amounts
2005
2004
2003
Basic earnings per share
$ 239.6 $ 218.3 $ 174.9
Net income
54.116
55.872
Shares of common stock outstanding
Earnings per share of common stock $ 4.23 $ 3.91 $ 3.23
56.708
Diluted earnings per share
Net income
Shares of common stock outstanding
Effect of dilutive securities:
$ 239.6 $ 218.3 $ 174.9
54.116
55.872
56.708
Stock options
0.690
0.665
0.488
Shares of common stock outstanding
including dilutive shares
Earnings per share of common stock
57.398
54.604
56.537
$ 4.17 $ 3.86 $ 3.20
Options to purchase 966,087 shares of common stock at $58.08 per
share awarded in July 2005 were outstanding at September 30, 2005,
but were not included in the computation of third quarter 2005 diluted
EPS because the options’ exercise price was greater than the average
market price of the common shares for the period. All options to
purchase the Company’s common stock outstanding at the end of
2005, were included in the fourth quarter 2005 computation of diluted
EPS as the average market price of the Company’s common shares for
the period was greater than the exercise price of the options.
NOTE 18
Acquisition of Beru Aktiengesellschaft
On January 4, 2005, the Company acquired 62.2% of the outstanding
shares of 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, which ended in February 2005. Presently,
the Company holds 69.4% of the shares of Beru at a gross cost of
approximately $554.8 million, or $477.2 million net of cash and cash
equivalents acquired. 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). The acquisition gives the Company
additional access to the growing diesel market and enhances sensor and
engine electronics expertise. In addition, Beru’s technology and product
expertise complements and strengthens the Company’s market presence
with global automakers. The Company’s Consolidated Financial
Statements include the operating results of Beru within the Engine
segment from the date of the acquisition.
2 0 0 5 a n n u a l r e p o r t
2 0 0 5 a n n u a l r e p o r t
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
Purchase Price Allocation
The purchase price has been allocated to the assets acquired and
liabilities assumed based on estimated fair values as of the acquisition
date as set forth below:
millions of dollars
Initial
Allocation
Adjustments
Final
Allocation
Marketable securities
$ —
Other current assets, net of cash acquired 190.1
249.1
Property, plant and equipment
200.4
Goodwill
Intangible assets:
Tradenames (indefinite useful life)
Unpatented technology
14.5
$ 52.9
14.5
(13.1)
4.3
$ 52.9
204.6
236.0
204.7
1.0
15.5
(estimated useful life of 4 years)
1.2
—
1.2
Customer relationships
(estimated useful lives of 5-10 years)
98.1
(3.0)
95.1
Patents
(estimated useful life of 12 years)
10.5
—
10.5
Sales order backlog
(estimated useful life of 3 months)
2.3
3.2
Acquired in-process
research & development (“IPR&D”) 10.3
Total intangible assets
Other non-current assets
Total assets
Current liabilities
Deferred income taxes
Other long-term liabilities
Minority interests
Total Liabilities
136.9
30.6
807.1
(81.8)
(108.1)
(73.0)
(114.8)
(377.7)
(4.8)
(3.6)
(5.4)
49.6
(51.4)
26.5
13.7
9.4
(1.8)
5.5
5.5
133.3
25.2
856.7
(133.2)
(81.6)
(59.3)
(105.4)
(379.5)
Total purchase price, net of cash
and cash equivalents acquired
Cash and cash equivalents acquired
Gross purchase price
429.4
130.5
$ 559.9
477.2
47.8
77.6
(52.9)
$ (5.1) $ 554.8
50
51
Notes to Consolidated Financial Statements continued
The excess of the purchase price over the fair values of assets acquired
and liabilities assumed has been allocated to goodwill. Management
used a variety of assessments for evaluating the fair values of the assets
and liabilities acquired, including independent appraisals. The
Company knew at the time of the preliminary asset allocation that a
more comprehensive, detailed, thorough and integrated review would
be needed of the following items during the allocation process: current
assets, property, plant and equipment, sales order backlog, in-process
research and development (“IPR&D”), customer relationships, current
liabilities and goodwill. This was due to the numerous legal entities,
joint ventures, and the multi-national scope of Beru; and the fact that
the Company holds only a majority position in a German publicly
traded company, (which reports in German statutory accounting
principles at several locations, before converting their results into
International Financial Reporting Standards (IFRS) for reporting to
their shareholders as opposed to US GAAP), and also management’s
commitment to fulfill the requirements of SFAS 141. Upon completion
of the third party valuation specialists’ work and review by the Company’s
management in the fourth quarter of 2005, we finalized all adjustments
related to the acquisition. The change in the gross purchase price from
the initial allocation reflects the finalization of all transaction payments
and investing activities, including the currency impact thereon.
Of the $133.3 million of acquired intangible assets, approximately $5.5
million has been allocated to IPR&D and was also considered as part of
a third party preliminary valuation. The Company identified and valued
five core IPR&D projects. Each of the five core projects generally
consists of several sub-projects that have not reached technological
feasibility. Three of the core projects concern the market for diesel
engines, one for gasoline engines and another for a product that can be
used in diesel and gasoline engines. Management believes no alternative
future uses of the technology are possible for each of these projects in
the combined entity. Per paragraph 5 of FASB Interpretation No. 4, the
fair value of the IPR&D was written off at the date of acquisition. The
write-off is included in SG&A expense in the Consolidated Statements
of Operations for the year ended December 31, 2005. In addition,
purchase accounting adjustments of $5.5 million and $4.7 million
related to sales order backlog and beginning inventory, respectively,
were fully amortized during 2005.
Restatement of Marketable Securities
In the preparation of the Company’s 2005 annual financial statements,
the Company determined that marketable securities which are part of
the Beru Acquisition, which amounted to $46.4 million, $53.9 million
and $46.3 million as of March 31, June 30, and September 30, 2005,
respectively, and had previously been reported as cash and cash equiv-
alents in the Company’s interim financial statements included in the
quarterly filings during 2005, should have been reported as marketable
securities. The Company will correct its interim financial statements for
the first three quarters of fiscal 2005 when filing its Quarterly Reports
on Form 10-Q for the first three quarters of fiscal 2006.
This restatement has no impact on current assets or total assets, but
does impact our presentation in the interim Consolidated Statements of
Cash Flows. The effects of this restatement on the previously reported
interim Consolidated Statements of Cash Flows were to change (a) the
net (increase)/decrease in marketable securities to $4.2 million, $(7.1)
million, and $0.2 million for the March 31, June 30, and September
30, 2005 reporting periods, respectively, from $0.0 in each period,
respectively; (b) payments for businesses acquired, net of cash and cash
equivalents to $477.2 million in each of the three reporting periods from
the $429.4 million previously reported; (c) net cash used in investing
activities to $(478.7) million, $(547.5) million, and $(604.5) million,
respectively, for the periods ended March 31, June 30, and September
30, 2005 from $(435.1) million, $(492.6) million, and $(556.9)
million, respectively, for the same periods; (d) effect of exchange rate
changes on cash and cash equivalents to $(11.3) million, $(16.5)
million, and $(15.3) million, respectively, for the periods ended March
31, June 30, and September 30, 2005 from $(8.5) million, $(17.5)
million and $(16.6) million, respectively, for the same three periods; and
(e) cash and cash equivalents at end of period to $116.8 million, $92.7
million and $93.2 million, respectively, for the periods ended March 31,
June 30, and September 30, 2005 from $163.2 million, $146.6 million,
and $139.5 million, respectively, for the same three periods.
Pro Forma Financial Information
The following pro forma information assumes the Beru Acquisition
occurred as of the beginning of each year presented. Adjustments have
been made to exclude non-recurring charges directly attributable to the
acquisition, including the immediate write-off of the purchase price
allocation associated with Beru’s in-process research and development
and the full amortization of the sales order backlog and the beginning
inventory written up in purchase accounting. The recurring adjustments
reflected in the pro forma statements include the amortization of the
amounts allocated to customer relationships, patents, technology,
property, plant and equipment and the Company’s acquisition financing
costs. The pro forma results are not necessarily indicative of the results
that actually would have been obtained had the acquisition been in
effect for the periods presented or that may be obtained in the future.
(Pro forma, unaudited, in millions,
except per share amounts)
Net sales
Net earnings
2005
2004
2003
$4,293.8
$ 251.7
$4,008.4
$ 231.1
$3,462.9
$ 192.5
Earnings per share – basic
Earnings per share – diluted
4.44
$
$ 4.38
$
4.14
$ 4.09
$
$
3.56
3.53
BorgWarner Inc.
and Consolidated
Subsidiaries
NOTE 19
Operating Segments and Related Information
The Company’s business is comprised of two operating segments: Engine
and Drivetrain. These reportable segments are strategic business units,
which are managed separately because each represents a specific grouping
of automotive components and systems. The Company evaluated the
operating segments’ performance based upon return on invested capital.
The return on invested capital is comprised of earnings before interest
and income 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.
Operating Segments
millions of dollars
Customers
Intersegment
Net
Earnings before
interest and taxes
Year end Depreciation/
amortization
assets
Long-lived
asset
expenditures
(b)
Net Sales
2005
Engine
Drivetrain
Inter-segment eliminations
Total
Corporate
Consolidated
Interest expense and finance charges
Earnings before income taxes
Provision for income taxes
Minority interest, net of tax
Net earnings
2004
Engine
Drivetrain
Inter-segment eliminations
Total
Corporate
Consolidated
Interest expense and finance charges
Earnings before income taxes
Provision for income taxes
Minority interest, net of tax
Net earnings
2003
Engine
Drivetrain
Inter-segment eliminations
Total
Corporate
Consolidated
Interest expense and finance charges
Earnings before income taxes
Provision for income taxes
Minority interest, net of tax
Net earnings
$2,960.1
1,333.7
—
4,293.8
—
$4,293.8
$ 44.6
—
(44.6)
—
—
—
$3,004.7
1,333.7
(44.6)
4,293.8
—
$4,293.8
$2,166.7
1,358.6
—
3,525.3
—
$3,525.3
$ 50.3
—
(50.3)
—
—
—
$2,217.0
1,358.6
(50.3)
3,525.3
—
$3,525.3
$1,823.7
1,245.5
—
3,069.2
—
$3,069.2
$ 46.0
0.1
(46.1)
—
—
—
$1,869.7
1,245.6
(46.1)
3,069.2
—
$3,069.2
$3,088.5
918.8
—
4,007.3
82.1(a)
$179.3
65.9
—
245.2
10.3
$209.1
68.2
—
277.3
19.5
$4,089.4
$255.5
$296.8
(c)
$2,208.4
810.0
—
3,018.4
510.7 (a)
$3,529.1
$107.3
66.1
—
173.4
4.7
$178.1
$167.7
75.3
—
243.0
9.4
$252.4
$1,925.1
778.8
—
2,703.9
436.6 (a)
$ 3,140.5
$ 93.8
60.1
—
153.9
8.5
$162.4
$133.3
66.4
—
199.7
14.7
$214.4
$ 354.5
97.6
—
452.1
(100.8)
$ 351.3
37.1
$ 314.2
55.1
19.5
$ 239.6
$ 281.7
106.9
—
388.6
(50.3)
$ 338.3
29.7
$ 308.6
81.2
9.1
$ 218.3
$ 239.6
98.4
—
338.0
(48.0)
$ 290.0
33.3
$ 256.7
73.2
8.6
$ 174.9
(a) Corporate assets, including equity in affiliates, are net of trade receivables securitized and sold to third parties, and include cash, cash equivalents, deferred income taxes and investments and advances.
(b) Long-lived assets expenditures include capital expenditures and tooling outlays, net of customer reimbursements.
(c) Amount differs from those shown on Consolidated Statement of Cash Flows by $4.3 million related to expenditures which have not yet been funded.
52
53
Notes to Consolidated Financial Statements continued
Selected Financial Data
2 0 0 5 a n n u a l r e p o r t
BorgWarner Inc.
and Consolidated
Subsidiaries
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 investment in NSK-Warner (see Note 6) amounting to
$175.3 million at December 31, 2005 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
2005
Net sales
2004
2003
2005
Long-lived assets
2004
2003
$1,929.6
$1,964.9
$1,889.2
$ 661.8
$ 637.1
$ 636.9
1,405.7
173.2
379.4
1,958.3
405.9
834.1
186.0
237.1
1,257.2
303.2
637.7
146.3
167.7
951.7
228.3
457.4
43.6
107.0
608.0
131.3
278.7
39.5
106.1
424.3
117.9
234.6
36.4
78.3
349.3
89.6
$4,293.8
$3,525.3
$3,069.2
$1,401.1
$1,179.3
$1,075.8
Sales to Major Customers
Consolidated sales included sales to Ford Motor Company of
approximately 16%, 21%, and 23%; to Volkswagen of approximately
13%, 10%, and 8%; to DaimlerChrysler of approximately 12%, 14%,
and 17%; and to General Motors Corporation of approximately 9%,
10%, and 12% for the years ended December 31, 2005, 2004 and
2003, respectively. Both of our operating segments had significant sales
to all four of the customers listed above. Accounts receivable from these
customers at December 31, 2005 comprised approximately 29% of
total accounts receivable. 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
2005 and 2004 interim results of operations. Certain 2005 and 2004 quarterly amounts have been reclassified to conform to the annual presentation.
millions of dollars, except per share data
For the Year Ended December 31,
St a t e m e n t of O p e r a t ion s Da t a
Net sales
Cost of sales
Gross profit
Selling, general and administrative expenses
Goodwill amortization
Other (income) expense
Restructuring and other non–recurring charges
Operating income
Equity in affiliate earnings, net of tax
Interest expense, net
Earnings before income taxes and minority interest
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
Average shares outstanding (thousands) — basic
Earnings/(loss) per share — diluted
Average shares outstanding (thousands) — diluted
2005
2004
2003
2002
2001
$4,293.8
3,440.0
$3,525.3
2,874.2
$3,069.2
2,482.5
$2,731.1
2,176.5
$2,351.6
1,890.8
853.8
495.9
—
34.8
—
323.1
(28.2)
37.1
314.2
55.1
19.5
239.6
—
$ 239.6
$ 4.23
56,708
$ 4.17
57,398
651.1
339.0
—
3.0
—
309.1
(29.2)
29.7
308.6
81.2
9.1
218.3
—
$ 218.3
$ 3.91
55,872
$ 3.86
56,537
586.7
316.9
—
(0.1)
—
269.9
(20.1)
33.3
256.7
73.2
8.6
174.9
—
$ 174.9
$ 3.23
54,116
$ 3.20
54,604
554.6
303.5
—
(0.9)
—
252.0
(19.5)
37.7
460.8
249.7
42.0
(2.1)
28.4(b)
142.8
(14.9)
47.8
233.8
77.2
6.7
149.9
(269.0)(a)
$ (119.1)
109.9
39.7
3.8
66.4
—
$ 66.4
$
(2.23)(a) $ 1.26(b)
52,630
53,250
$
(2.22)(a) $
53,708
1.26(b)
52,926
Cash dividend declared per share
$
0.58
$
0.50
$ 0.36
$ 0.30
$ 0.30
B a l a n c e S h e e t Da t a
Total assets
Total debt
$4,089.4
740.5
$3,529.1
584.5
$3,140.5
655.5
$2,682.9
646.7
$2,770.9
737.0
millions of dollars, except per share amounts
Quarter Ended
Net sales
Cost of sales
Gross profit
Selling, general and
administrative expenses
Other (income) expense
Operating income
Equity in affiliate earnings, net of tax
Interest expense, net
Income before income taxes
and minority interest
Provision for income taxes
Minority interest, net of tax
Net earnings
Mar-31
Jun-30
Sep-30
Dec-31
Year
Mar-31
Jun-30
Sep-30
Dec-31
Year
This charge was $5.01 per diluted share.
2005
2004
(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.
$1,083.5 $1,111.4 $1,050.9
842.7
208.2
879.0
232.4
869.8
213.7
$1,048.0 $4,293.8
3,440.0
853.8
848.5
199.5
$ 903.1
730.5
172.6
$ 893.2
723.4
169.8
$ 839.8
694.7
145.1
$ 889.2 $3,525.3
725.5 2,874.2
651.1
163.7
(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.
134.2
(4.1)
83.6
(4.0)
9.3
131.6
42.1
58.7
(8.0)
9.9
120.0
(2.3)
90.5
(5.7)
9.6
110.1
(0.9)
90.3
(10.5)
8.3
495.9
34.8
323.1
(28.2)
37.1
94.7
0.3
77.6
(6.5)
7.5
87.8
0.6
81.4
(8.4)
7.7
77.4
(0.5)
68.2
(6.2)
7.5
79.1
2.7
81.9
(8.1)
7.0
339.0
3.0
309.1
(29.2)
29.7
78.3
(0.3)
1.0
86.6
19.6
5.6
$ 77.6 $ 35.9 $ 61.4
56.8
12.8
8.1
92.5
23.1
4.8
$ 64.6
314.2
55.1
19.5
$ 239.6
76.6
22.9
2.6
$ 51.1
82.1
24.6
2.8
$ 54.7
66.9
20.1
2.0
$ 44.8
83.0
13.5
1.8
308.6
81.2
9.1
$ 67.7 $ 218.3
Earnings/(loss) per share – basic
Earnings/(loss) per share – diluted
$ 1.38 $ 0.64 $ 1.08 $ 1.13 $ 4.23
$ 1.36 $ 0.63 $ 1.07 $ 1.12 $ 4.17
$ 0.92
$ 0.91
$ 0.98 $ 0.80 $ 1.20 $ 3.91
$ 0.97 $ 0.79 $ 1.19 $ 3.86
54
55
Corporate Information
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 2005
Third Quarter 2005
Second Quarter 2005
First Quarter 2005
Fourth Quarter 2004
Third Quarter 2004
Second Quarter 2004
First Quarter 2004
High
$61.73
61.07
56.07
54.50
$54.68
48.77
45.08
49.32
Low
$53.46
53.41
44.85
48.13
$39.50
40.73
38.35
39.84
Certifications
• 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.
• 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 16 cents per share of common stock was declared
on November 16, 2005, payable February 15, 2006, to stock-
holders of record on February 1, 2006. 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
480 Washington Boulevard
Jersey City, NJ 07310
www.melloninvestor.com
Communications 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 pur-
chases 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 2006 annual meeting of stockholders will be held on
Wednesday, April 26, 2006, beginning at 9:00 a.m. at the
BorgWarner World Headquarters at 3850 Hamlin Road,
Auburn Hills, Michigan.
Stockholders
As of December 31, 2005, there were 2,773 holders of record
and an estimated 16,000 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.
• BorgWarner News Releases
• BorgWarner Stock Quote
• Earnings Release Conference Call Calendar
• Webcasts
• Analyst Coverage
• Stockholder Services
• Corporate Governance
• BorgWarner In The News Articles
• Annual Reports
• Proxy Statement and Card
• Dividend Reinvestment/Stock Purchase Plan
• Financials and SEC Filings
(including the Annual Report on Form 10-K)
• 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 thanks its customers for the use of their names and logos.
BorgWarner Inc. owns U.S. trademark registrations for: BorgWarner, ,
, DualTronic and Visctronic. BorgWarner owns the following
trademarks: i -Trac, InterActive Torque Management I & II, Pre-emptive Torque
Management and Regulated Two-Stage. Beru is a protected mark of Beru AG.
56
2 0 0 5 a n n u a l r e p o r t
Committees of the Board
1 Executive Committee
2 Audit Committee
3 Compensation Committee
4 Corporate Governance Committee
E x e c u t i v e O f f i c e r s
Timothy M. Manganello
Chairman and
Chief Executive Officer
Robin J. Adams
Executive Vice President,
Chief Financial Officer
and Chief Administrative Officer
Mary E. Brevard
Vice President,
Investor Relations and
Corporate Communications
William C. Cline
Vice President,
Acquisition Coordination
Bernd W. Matthes
Vice President,
President and General Manager
Transmission Systems
Cynthia A. Niekamp
Vice President,
President and General Manager
TorqTransfer Systems
Alfred Weber
Vice President,
President and General Manager
Morse TEC
President and General Manager
Thermal Systems
Roger J. Wood
Vice President,
President and General Manager
Turbo Systems
President and General Manager
Emissions Systems
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
John J. McGill
Vice President,
Supply Chain Management
Jeffrey L. Obermayer
Vice President and
Controller
Mark A. Perlick
Vice President, Technology
Christopher H. Vance
Vice President,
Business Development
and M&A
D i r e c t o r s
Robin J. Adams
Executive Vice President,
Chief Financial Officer and
Chief Administrative Officer
BorgWarner Inc.
Phyllis O. Bonanno (3)
President and Chief Executive Officer
International Trade Solutions, Inc.
Dr. Andrew F. Brimmer (2)
President
Brimmer & Company, Inc.
David T. Brown (3)
President, Chief Executive Officer
and Director
Owens Corning
Jere A. Drummond (1, 3, 4)
Vice Chairman, Retired
BellSouth Corporation
Paul E. Glaske (4)
Chairman, President and
Chief Executive Officer, Retired
Blue Bird Corporation
Timothy M. Manganello (1)
Chairman and Chief Executive Officer
BorgWarner Inc.
Alexis P. Michas (1, 4)
Managing Partner
Stonington Partners, Inc.
Ernest J. Novak, Jr. (2)
Managing Partner, Retired
Ernst and Young
Richard O. Schaum (2)
Executive Vice President, Retired
Product Development
DaimlerChrysler Corporation
Vice President, Automotive
Society of Automotive Engineers
Thomas T. Stallkamp
Industrial Partner
Ripplewood Holdings L.L.C.
BorgWarner Inc.
World Headquarters
3850 Hamlin Road
Auburn Hills, MI 48326
www.borgwarner.com