BorgWarner Inc.
World Headquarters
3850 Hamlin Road
Auburn Hills, MI 48326
www.borgwarner.com
2 0 0 6 A n n u A l R e p o R t
17,400
13.1%
1,644.2
740.5
89.7
13.2%
161.0
292.5
57.4
4.17
239.6
$4,293.8
17,400
(1.6)%
1,875.4
721.1
123.3
12.2%
187.7
268.3
58.0
3.65
211.6
$4,585.4
Number of employees
Total return on BorgWarner shares
Stockholders’ equity
Debt
Cash and cash equivalents
After-tax return on invested capital
Research and development
Capital spending, including tooling outlays
Average number of shares outstanding — diluted (millions)
Net earnings per share — diluted
Net earnings
Net sales
14.1%
(2.6)%
37.5%
16.6%
(8.3)%
(12.5)%
(11.7)%
6.8%
% Change
2005
2006
financial highlights
millions of dollars, except per share and employee data the BorgWarner experience
BorgWarner deliver s better f uel e ff ic ien c y, reduced emi ss ions
and vehicle stability without sacri f ic ing perf o rmance. take a
test drive at www.borgwarner.co m
Directors
Executive Officers
F u e l E f f i c i e n c y
V e h i c l e S t a b i l i t y
R e d u c e d E m i s s i o n s
P e r f o r m a n c e
Turbochargers
i-Trac™ FWD/AWD
Advanced Turbo Actuator
Turbochargers
Advanced Turbo Actuator
Transfer Cases
Variable Cam Timing
Tire Safety System
Smart Thermal Systems
Instant Starting Systems
Engine Timing
EGR Systems
Secondary Air Systems
Dual-Clutch Modules
Active All-Wheel Drive
Tire Safety System
Variable Cam Timing
Dual-Clutch Modules
Engine Timing
EGR Systems
Variable Cam Timing
Engine Timing
Thermal Systems
Dual-Clutch Modules
Secondary Air Systems
Instant Starting Systems
Thermal Systems
Instant Starting Systems
Tire Safety System
i-Trac™ FWD/AWD
Transfer Cases
Fluid Pumps
Synchronizers
f i n a n c i a l h i g h l i g h t s
2006
2005
% Change
Net sales
Net earnings
Net earnings per share — diluted
Average number of shares outstanding — diluted (millions)
Capital spending, including tooling outlays
Research and development
After-tax return on invested capital
Cash and cash equivalents
Debt
Stockholders’ equity
Total return on BorgWarner shares
Number of employees
$4,585.4
211.6
3.65
58.0
268.3
187.7
12.2%
123.3
721.1
1,875.4
(1.6)%
17,400
$4,293.8
239.6
4.17
57.4
292.5
161.0
13.2%
89.7
740.5
1,644.2
13.1%
17,400
6.8%
(11.7)%
(12.5)%
(8.3)%
16.6%
37.5%
(2.6)%
14.1%
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.
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
General Manager,
3rd Horizon Associates LLC
Thomas T. Stallkamp (2)
Industrial Partner
Ripplewood Holdings L.L.C.
Committees of the Board
1 Executive Committee
2 Audit Committee
3 Compensation Committee
4 Corporate Governance Committee
Director and Officer
biographies available at:
www.borgwarner.com/about/officers/
Timothy M. Manganello
Chairman and
Chief Executive Officer
Robin J. Adams
Executive Vice President,
Chief Financial Officer
and Chief Administrative Officer
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 & Emissions Systems
Mary E. Brevard
Vice President,
Investor Relations and
Corporate Communications
William C. Cline
Vice President,
Acquisition Coordination
Angela J. D’Aversa
Vice President,
Human Resources
Jamal M. Farhat
Vice President and
Chief Information Officer
John J. Gasparovic
Vice President,
General Counsel and Secretary
Anthony D. Hensel
Vice President and
Treasurer
Laurene H. Horiszny
Chief Compliance Officer and
Assistant 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
Comparison of 5 Year Cumulative Total Return*
Among BorgWarner Inc., The S&P 500 Index,
The SIC Code 3714—Motor Vehicle Parts & Accessories And A Peer Group
2 5 0
2 0 0
1 5 0
1 0 0
5 0
0
2001
2002
2003
2004
2005
2006
BorgWarner
S & P 500
Peer Group
SIC Code 3714 - Motor Vehicle Parts and Accessories
* $100 invested on 12/31/01 in stock or index-including reinvestment of dividends.
Fiscal year ending December 31.
BorgWar ner Vision
BorgWarner is the recognized world leader
in advanced products and technologies
that satisfy customer needs in powertrain
components and systems solutions.
BorgWar ner B eliefs
• Respect for Each Other
• The Power of Collaboration
• Passion for Excellence
• Personal Integrity
• Responsibility to Our Communities
millions of dollars, except per share and employee data
t o o u r s t o c k h o l d e r s
“The auto industry is facing fundamental changes.
AtBorgWarner,withenvironmentallyfriendlytechnol-
ogies,globalreachandabroadcustomerbase,we
intendtobenefitfromthesechanges.”
TimManganello
When we look back on the start of the current century, I believe
that we will recognize a time of fundamental change within the
auto industry. There is a shift in the nature of how and where
vehicles are produced and the importance of powertrain
technology to the future of our planet.
As we move from 2006 into 2007, this period may well be
seen as a key marker in this time of transformation. The signs
abound: continued market share declines of the traditional North American automakers and
related restructurings, sales shifting away from sport-utility vehicles and light trucks,
additional supplier bankruptcies, challenges facing European automakers, and the
steamroller of Asian growth.
We view this time of transition as an opportunity to leverage our strengths. BorgWarner
exemplifies the best of those attributes that will allow this industry to regain momentum and
sustain itself:
• BorgWarner technology is focused on societal needs — fuel economy, emissions reduction
and better vehicle handling.
• We have built a customer base that is one of the broadest in the industry; we serve all the
global vehicle manufacturers.
Commercial Vehicles 8%
• Our manufacturing footprint spans Europe, Asia and the Americas.
Asian Transplants 5%
• We have an enviable track record of financial discipline and strength.
Other 7%
Asia 19%* (11%)**
Americas 37%* (40%)**
Europe 44%* (49%)**
*Includes NSK-Warner
** Excludes NSK-Warner
Change Brings Opportunity: BorgWarner is also a reflection of the global auto industry and
the dichotomies that exist from one region to the next. Our global sales in 2006 were up 7%
with auto industry growth only up 3%. By region, we see a more complex picture. While our
sales in the U.S. were down 5%, our sales in Europe were up 14% and our sales in Asia were
up 26%. Industry growth was -3% in North America, 2% in Europe and 8% in Asia.
For the first time in our history, our new business growth in Asia over the next three years is
expected to equal that in North America at 27% of total sales growth, with Europe at 46%.
A European automobile company is expected to be our largest customer in 2007. Our
employees in Europe now outnumber those in North America. And as purchased components
become more integral to our systems, almost fifty cents of each dollar of sales goes to
materials. We have had to match our operations and investments to the realities of these
market dynamics.
At BorgWarner, we are proud of our deep roots in the automotive industry, our history of
innovation and our BorgWarner beliefs which are fundamental to our culture. Our track
Customer and Geographic Diversity
2007 Projected Revenue by Customer*
Other 14%
BMW 1%
PSA 2%
Fiat 3%
Ford 3%
Renault 3%
Daimler 5%
VW/Audi 13%
Toyota 6%
Hyundai/Kia 5%
Honda 2%
Nissan 2%
Other 4%
Ford 7%
GM 6%
Chrysler 4%
2 0 0 6 H i g H l i g H t s
• New business of $.7 billion
from 007 though 009
is expected to provide
customer diversity and
geographic growth.
• China campus opens in
Ningbo to provide manufac-
turing and shared services
for several operations.
• Dual-clutch transmission
technology moves to Asia;
debuts in India on the
Skoda Laura. SAIC is
first in China to adopt
our innovation.
• The engine campus in Korea
expands to meet growing
demand for engine timing
systems and turbochargers.
Dividend Growth
Annual Dividend Per Share
$0.64
$0.56
$0.50
$0.36
$0.30
2 1 % C A G R
2002
2003
2004
2005
2006
New Business by 2009
By Product
Turbochargers 40%
(VTG, R2S)
Engine Timing 11%
(Including VCT)
DCT 15%
AWD 6%
Other 6%
Other 22%
Drivetrain 27%
Engine 73%
record is one that few other suppliers share and we expect our future to be even better. Our
future is about profitable growth, and profitable growth is not possible without change —
even for a successful company.
Global Expansion and Balance: The mandate for a more global perspective was confirmed
and reinforced for us by BorgWarner managers who participated in three Regional Management
Forums in Asia, Europe and the Americas conducted in 2006. Becoming a more global
company means recognizing and respecting that different regions have different issues and
needs. This means we need to manage our business with that understanding in mind.
The challenges that BorgWarner faces are becoming more region-specific than ever before. In
Asia, for example, there is a proliferation of vehicle manufacturers that need support. Our growth
is at an unprecedented level. Our focus in Asia is on the proper development and management
of resources — having the right structure and the right people in the right places, to take full
advantage of opportunities and maximize efficiencies.
In Europe, we are managing exciting growth in technologies like turbocharging, instant starting
systems and dual-clutch transmission modules, while working to sustain growth in other more
mature products, and within the confines of mature markets and infrastructures.
In North America, we also operate in a mature market with some mature products, coupled
with declining vehicle production rates and increasing health care costs. To counter these
forces, we continue to attack costs and keep improvement ideas rolling.
This diversity of challenges and opportunities has called for some fresh thinking and new
approaches to BorgWarner’s traditional, and perhaps more comfortable, ways of looking at our
industry and our business. Our vision, our thinking, and our actions remain focused, proactive
and global. Technology is our first foot forward. It drives our growth. We are fortunate that the
BorgWarner culture has always been one that welcomes innovation and competition.
We Remain Focused: We have taken aggressive actions to secure our future. These include
locating operations in emerging markets in campus environments for shared startup and
support services. We opened our China campus in Ningbo and expanded our engine campus
in Korea in 2006. India offers the next opportunity for us to implement this concept. In
mature markets, we are sizing our operations to the realities of those market places. This
includes workforce and capacity reductions in North America.
To address changing needs, we have launched a comprehensive purchased-cost-reduction
initiative aimed at aligning ourselves with the best global suppliers. Employees are embracing
consumer-driven health care plans in North America aimed at making smart employee health
care decisions and reducing costs — theirs and ours. Robust processes are being implemented
worldwide to better manage the complexity of commodity prices. Information technology is
speeding access to critical data for decision making. Advanced technology opportunities,
• BorgWarner and the U.S.
Environmental Protection
Agency partner to develop
advanced air management
technologies for clean
combustion.
• New turbocharged gas
and diesel engines for
North American vehicle
and engine makers provide
fuel economy and reduced
emissions.
• Announced dual-clutch
transmission programs
expected to produce over
.5 million units at full
launch. Replacement trans-
mission controls facility in
Tulle, France opens.
• New Porsche sports car is
launched with innovative
turbocharger, all-wheel
drive system and emission
control products from
BorgWarner.
• Acquisition of European
controls business comple-
ments our expertise in engine
and drivetrain electronics,
enhances low-volume
manufacturing.
product planning and acquisition strategies are coordinated and linked. In short, we are
changing our business model to keep pace with the changing dynamics of the auto industry.
Even this annual report reflects the spirit of global change at BorgWarner. As shareholder
reporting becomes more electronic, we are communicating with you in new ways. The DVD
with this report and our new website give you opportunities to participate in the BorgWarner
experience and our passion for powertrain. BorgWarner has many faces in many parts of the
world providing a multitude of experiences that create a common image. Our technology, our
culture and our BorgWarner pride are the building blocks of our future.
Passion for Powertrain: We believe that to succeed, we must be passionate in our commitment
to powertrain technology leadership. We have a cause. Our products address fuel economy and
emissions reduction while enhancing performance and vehicle handling. These technologies
are being used in new engines and drivetrains that can significantly reduce fuel consumption
and drive emissions down to meet ever stricter standards around the globe. From the driver’s
perspective, our cause is to create a fun, secure, driving experience without guilt. Drivers can
feel good that vehicles with our products are environmentally friendly.
To get technical, these advances are in areas like gasoline and diesel direct injected, turbocharged
engines; smart engine breathing systems; dual-clutch transmission technology; six, seven and
eight speed automatic transmissions; and active all-wheel drive torque management.
Using our technology, a family driving on holiday can go farther on a tank of diesel or
gasoline fuel. Vehicle makers can sell more fuel-efficient SUVs. China can have technology
to address its desire for cleaner air. Smaller engines can deliver more powerful acceleration.
Drivers in snow and rain can expect better control. Economical cars in emerging markets can
utilize the latest powertrain technology. The benefits are tremendous!
BorgWarner Sales
vs. Global Auto Industry
BorgWarner 12.6% CAGR
93 94 95 96 97 98 99 00 01 02 03 04 05 06
Global Production 3.3% CAGR
North American Production 1% CAGR
BorgWarner Global Sales Profile
% of Sales By Region
$ in Billions
$4.8
$5.1
As a company with ambitious growth goals, we are not settling for the status quo in any area
of our business. Each of my letters to you since I became CEO four years ago has held
caution about the coming year and also confidence. Confidence that BorgWarner can
continue to deliver value to stockholders and customers along with opportunities for
employees. Each year we have had to prove ourselves; 2007 will be no different.
16%
18%
19%
47%
$3.0
$2.7
$3.0
$3.4
$4.0
18% ➔ 25%
44% ➔ 45%
19% ➔ 15%
19% ➔ 15%
BorgWarner is a lean company. We expect a great deal from our people, and, in my opinion,
we get it. Our management team is the best in the industry; our people take pride in and
ownership of their work. The auto industry is in a time of transition, but we believe that no
auto supplier is better positioned than BorgWarner to achieve our goals and leverage our
opportunities for the future. We have the technology, customer base, global reach, financial
strength, and most importantly, the people to succeed!
‘00
‘01
‘02
‘03
‘04
‘05
‘06
‘11E
Asia
Europe
Americas (excl. Domestic 3)
Americas (Domestic 3)
Includes both consolidated and NSK-Warner sales
Timothy M. Manganello
Chairman and
Chief Executive Officer
E N G I N E G r o u p
The Engine Group develops air management strategies and products to optimize engines for fuel efficiency,
reduced emissions and enhanced performance. BorgWarner’s expertise in engine timing systems, boosting systems,
ignition systems, air and noise management, cooling and controls is the foundation for this collaboration.
Exhaust Gas
Recirculation
Variable Geometry
Turbochargers
Air Flow Systems
Key Tec h no logie s
Chain Products Global leader in the design and manufacture of chain systems for
engine timing, automatic transmissions and torque transfer, including four- and
all-wheel drive applications. Engine chain systems include chains, sprockets,
tensioners, control arms and guides, and variable cam timing phasers.
Emissions Systems A global leader in the design and supply of exhaust gas
recirculation (EGR) systems, secondary air systems (SAS), and advanced actuators
for enhanced engine performance, fuel economy, and reduced emissions.
Engine Timing
BERU Diesel
Cold-Start Technology
Variable Cam
Timing
Thermal Systems Systems for thermal management designed to improve engine
cooling, and reduce emissions and fuel consumption.
Sales
millions of dollars
02
03
04
05
06
$1,648.2M
$1,869.7M
$2,059.9M
$2,855.4M
$3,154.9M
Turbocharging Leading designer and manufacturer of turbochargers and boosting
systems for passenger cars, light trucks and commercial vehicles. Systems
enhance fuel efficiency, reduce emissions and enhance vehicle performance.
BERU Technologies BERU is a worldwide leading supplier of diesel cold-start
technology and a leading European manufacturer of ignition technology for gasoline
vehicles. BERU electronics and sensor technology provide more comfort and safety
for applications in various engine and vehicle functions.
d r I v E T r a I N G r o u p
The Drivetrain Group harnesses a legacy of more than 100 years as an industry innovator in transmission
and all-wheel drive technology. The group is leveraging its understanding of powertrain clutching technology
to develop interactive control systems and strategies for all types of torque management.
DualTronic®
Clutch Modules
i-Trac™ Torque
Management Systems
Controls Modules
Transfer Cases
Synchronizers
Friction Products
Key Tec h no logie s
Torque Management Leading global designer and producer of torque distribution
and management systems, including i-Trac™ Torque Management devices for front-
wheel drive vehicles and transfer cases for rear-wheel drive applications. These
systems enhance stability, security and drivability of passenger cars, crossover vehicles,
SUVs and light trucks. BorgWarner synchronizer systems meet the demands of
DualTronic® and manual transmissions.
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.
Sales
millions of dollars
02
03
04
05
06
$1,122.1M
$1,245.6M
$1,509.2M
$1,472.9M
$1,461.4M
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
I n t r o d u c t i o n
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 (“SUVs”), cross-over vehicles, vans and light trucks). Our
products are also manufactured and sold to OEMs of commercial trucks,
buses and agricultural and off-highway vehicles. We also manufacture
for 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. Effective January 1, 2006, the Company
assigned an operating facility previously reported in the Engine segment
to the Drivetrain segment due to changes in the facility’s product mix.
Prior year segment amounts have been reclassified to conform to the
current year’s presentation. 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’s products include all-wheel drive transfer
cases, torque management systems, and components and systems for
automated transmissions.
Recent Acquisitions
The Company acquired the European Transmission and Engine Controls
(“ETEC”) product lines from Eaton Corporation as of the close of business
for the quarter ended September 30, 2006 for $63.7 million, net of cash
acquired. The operating results of ETEC have been reported within the
Drivetrain segment since its acquisition.
In the first quarter of 2005, the Company acquired 69.4% of the
outstanding shares of BERU AG (“BERU”), headquartered in Ludwigsburg,
Germany, primarily from the Carlyle Group and certain family shareholders
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 from the
date of the acquisition. 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, 2006.
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
R e s u l t s o f O p e r a t i o n s
Overview
A summary of our operating results for the years ended December 31,
2006, 2005 and 2004 is as follows:
millions of dollars, except per share data
Year Ended December 31,
Net sales
Cost of sales
Gross profit
Selling, general and
administrative expenses
Restructuring expense
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 – diluted
2006
2005
2004
$4,585.4
3,735.5
849.9
$4,293.8
3,440.0
853.8
$3,525.3
2,874.2
651.1
498.1
84.7
(7.5)
274.6
(35.9)
40.2
495.9
—
34.8
323.1
(28.2)
37.1
339.0
—
3.0
309.1
(29.2)
29.7
270.3
32.4
26.3
$ 211.6
$ 3.65
314.2
55.1
19.5
$ 239.6
$ 4.17
308.6
81.2
9.1
$ 218.3
$ 3.86
A summary of major factors impacting the Company’s net earnings for
the year ended December 31, 2006 in comparison to 2005 and 2004
is as follows:
• Continued demand for our products in both Engine and Drivetrain
segments.
• Lower North American production of light trucks and SUVs.
• Continued benefits from our cost reduction programs, including
containment of selling, general & administrative expenses, which
partially offset continued raw material and energy cost increases,
rising health care costs and the costs related to global expansion.
• Restructuring expenses in the third and fourth quarters of 2006 to
•
•
adjust headcount and capacity levels, primarily in North America and
primarily in the Drivetrain segment.
Implementation of FAS 123R in 2006.
Inclusion in Engine’s results of operations of our 69.4% interest
in BERU in 2006 and 2005, and the related 2005 write-off of the
excess purchase price allocated to BERU’s in-process research and
development (“IPR&D”), order backlog and beginning inventory.
• The write-off of the excess purchase price, IPR&D, order backlog
and beginning inventory related to the 2006 acquisition of the ETEC
product lines from Eaton Corporation in Monaco.
• Gains in 2006 and 2005 from the 2005 sale of shares in AG 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 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.
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
continued
• Higher interest expense due primarily to increased debt levels from
funding the BERU and ETEC acquisitions and, to a lesser extent,
higher short-term interest rates.
• Favorable currency impact of $0.4 million, $3.1 million, and $11.0
million in 2006, 2005 and 2004, respectively.
• Adjustments to tax accounts in 2006, 2005 and 2004 upon
conclusion of certain tax audits and changes in circumstances,
including changes in tax laws.
The Company’s earnings per diluted share were $3.65, $4.17 and
$3.86 for the years ended December 31, 2006, 2005 and 2004,
respectively. The Company believes the following table is useful in
highlighting non-recurring or non-comparable items that impacted its
earnings per diluted share:
Year Ended December 31,
2006
2005
2004
Non-recurring or
non-comparable items:
Restructuring expense
Implementation of FAS 123R
One-time write-off of the excess
purchase price of in-process R&D,
order backlog and beginning
inventory associated with
acquisitions
Net gain from divestitures
Adjustments to tax accounts
Crystal Springs related settlement
Total impact to earnings per
share - diluted:
($0.82)
(0.16)
$ —
—
$ —
—
(0.04)
0.06
0.38
—
(0.21)
0.11
0.45
(0.50)
—
—
0.20
—
($0.58)
($0.16)a
$0.20
(a) 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 2006 and 2005:
Worldwide Light Vehicle Year Over Year Increase (Decrease) in Production
2005
2006
North America*
Europe*
Asia*
Total Worldwide*
BorgWarner year over year net sales change
*Data provided by CSM Worldwide.
(3.1)%
2.1%
8.1%
3.4%
6.8%
0.0%
(0.2)%
7.9%
3.9%
21.8%
Our net sales increases in 2006 and 2005 were strong in light of
the estimated worldwide market production increases of 3.4% and
3.9%, respectively. The Company’s net sales increased 6.8% in
2006 over 2005, and increased 21.8% in 2005 over 2004, or 7.3%
excluding the effect of the BERU Acquisition. The increase in 2006
was driven by solid growth in Europe and Asia partially offset by a
decline in North American sales primarily related to lower domestic
truck production. The effect of changing currency rates had a positive
impact on net sales and net earnings in 2006 and 2005. The effect of
non-U.S. currencies, primarily the Euro, increased net sales by $36.8
million and net earnings by $0.4 million in 2006. In 2005, non-U.S.
currencies, primarily the South Korean Won, added $23.9 million to
net sales and $3.1 million to net earnings. The year over year increase
in net sales excluding the favorable impact of currency was 5.9% in
2006 and 21.1% in 2005. 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 13%, 16%, and 21%; to Volkswagen of approximately
13%, 13%, and 10%; to DaimlerChrysler of approximately 11%, 12%,
and 14%; and to General Motors Corporation of approximately 9%, 9%,
and 10% for the years ended December 31, 2006, 2005 and 2004,
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 our total sales.
Our overall outlook for 2007 is positive, as we expect our sales to
grow in excess of a projected moderate global vehicle production
growth rate. The outlook for global vehicle production by region is
down moderately in North America, up moderately in Europe, and
solid growth in Asia. While expecting only moderate overall growth in
global vehicle production, we expect to benefit from strong European
and Asian automaker demand for our engine products, including
turbochargers, timing systems, ignition systems and emissions
products. Growing demand for our drivetrain products outside of
North America, including increased sales of dual-clutch transmission
products, is also a positive trend for the Company. The impact of non-
U.S. currencies is currently planned to be negligible in 2007. Assuming
no major departures from these assumptions, we expect continued
long-term sales and net earnings growth.
Results By Operating Segment
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. Effective
January 1, 2006, the Company assigned an operating facility previously
reported in the Engine segment to the Drivetrain segment due to changes
in the facility’s product mix. Prior year segment amounts have been
reclassified to conform to the current year’s presentation.
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
6
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 its 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 its 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
2006, 2005 and 2004:
Net Sales
millions of dollars
Year Ended December 31,
Engine
Drivetrain
Inter-segment eliminations
Net Sales
2006
2005
2004
$3,154.9
1,461.4
(30.9)
$ 4,585.4
$2,855.4
1,472.9
(34.5)
$4,293.8
$2,059.9
1,509.2
(43.8)
$3,525.3
Earnings Before Interest and Taxes
millions of dollars
Year Ended December 31,
Engine
Drivetrain
Segment earnings before interest
and taxes (“Segment EBIT”)
Litigation settlement expense
Restructuring expense
Corporate, including 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
2006
2005
2004
$365.8
90.6
$346.9
105.2
$273.6
115.0
456.4
452.1
388.6
—
(84.7)
(45.5)
—
—
—
(61.2)
(55.3)
(50.3)
310.5
40.2
351.3
37.1
338.3
29.7
270.3
314.2
308.6
32.4
26.3
$211.6
55.1
19.5
$239.6
81.2
9.1
$218.3
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
The Engine segment 2006 net sales were up 10.5% from 2005, with a
5.4% increase in segment EBIT over the same period. The Engine segment
continued to benefit from Asian automaker demand for turbochargers
and timing systems, European automaker demand for turbochargers,
timing systems, exhaust gas recirculation (“EGR”) valves and diesel
engine ignition systems, the continued roll-out of its variable cam timing
systems with General Motors Corporation high-value V6 engines, stronger
EGR valve sales in North America, and higher turbocharger and thermal
products sales due to stronger global commercial vehicle production. The
segment EBIT margin was 11.6% in 2006, down from 12.1% in 2005,
(which excludes the one-time write-off in 2005 of the excess purchase
price associated with BERU’s in-process R&D), due to the significant
reduction in customer production schedules in the U.S. market and
increased costs for raw materials, principally nickel.
The Engine segment 2005 net sales were up 38.6% from 2004 with
a 26.8% 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 included in this segment. Excluding
the impacts of foreign currency and BERU, sales were up 13.2% with
a 13.8% 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, which offset commodity price
increases and start up costs in South Korea and China.
For 2007, 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 increased
market penetration of our turbocharger and emissions product sales
into the commercial vehicle market in North America. Investments in
South Korea and China are expected to continue to contribute to sales
and EBIT. This growth is expected to help offset anticipated weakness in
North American light vehicle production.
The Drivetrain segment 2006 net sales decreased 0.8% from 2005
with a 13.9% decrease in segment EBIT over the same period. The
segment continued to benefit from growth outside of North America
including the continued ramp up of dual-clutch transmission and torque
transfer product sales in Europe. In the U.S., the group was negatively
impacted by lower production of light trucks and SUVs equipped with its
torque transfer products and lower sales of its traditional transmission
products. Segment EBIT margin was 6.2% in 2006, down from 7.1% in
the prior year, due to the significant reduction in customer production
schedules in the U.S. market and increased costs for raw materials.
The Drivetrain segment 2005 net sales decreased 2.4% from 2004 with
an 8.5% 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 SUVs 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
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
continued
addition to the loss of contribution margin on the lower sales volumes,
commodity price increases, as well as health care cost increases,
impacted EBIT unfavorably.
and implemented cost reduction initiatives at other subsidiaries. As a
result of the adjustments, expenses for other post employment benefits
for 2006 were slightly lower than the expenses recognized in 2005.
For 2007, the Drivetrain segment is expected to grow slightly as stagnant
demand for our rear-wheel-drive based four-wheel-drive systems in North
America is expected to be offset by content growth with our traditional
transmission products and controls in automatic transmissions in North
America, increased penetration of automatic transmissions in Europe
and Asia, including increased sales of dual-clutch transmission products,
and the continued ramp-up of 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, expenses not directly attributable to the individual segments
and equity in affiliates’ earnings. This net expense was $61.2 million in
2006, $55.3 million in 2005 and $50.3 million in 2004. Included in the
2006 amount is $12.7 million related to the implementation of FAS 123R.
Other Factors Affecting Results of Operations
The following table details our results of operations as a percentage
of sales:
Year Ended December 31,
2006
2005
2004
Net sales
Cost of sales
Gross profit
Selling, general and
administrative expenses
Restructuring expense
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
100.0%
81.5
18.5
100.0%
80.1
19.9
100.0%
81.5
18.5
10.9
1.8
(0.2)
6.0
(0.8)
0.9
5.9
0.7
0.6
4.6%
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%
Gross profit as a percentage of net sales was 18.5%, 19.9% and 18.5%
in 2006, 2005 and 2004, respectively. Our gross profit in 2006 was
negatively impacted by significant declines in customer production
levels in the U.S. market. Our gross profit also continued to be negatively
impacted by higher raw material costs including nickel, steel, copper,
aluminum and plastic resin in 2006. Raw material costs increased
approximately $45.0 million as compared to 2005, of which nickel was
the single largest contributor. Our focused cost reduction and commodity
hedging programs in our operations partially offset these higher raw
material and energy costs.
The rising cost of providing pension and other post employment benefits
continues to impact our industry. To partially address this issue, the
Company adjusted certain retiree medical plans effective April 1, 2006,
Selling, general and administrative expenses (“SG&A”) as a percentage
of net sales were 10.9%, 11.5% and 9.6% in 2006, 2005 and 2004
respectively. The decrease in SG&A in 2006 was the result of cost
cutting efforts, a reduction in incentive related compensation and $10.4
million in one-time write-offs in 2005 related to the acquisition of BERU.
We expect that the growth in sales will continue to outpace the future
increases in SG&A spending due to our 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 our SG&A
expenses. R&D spending, net of customer reimbursements, was $187.7
million, or 4.1% of sales in 2006, compared to $161.0 million, or 3.8%
of sales in 2005, and $123.1 million, or 3.5% of sales in 2004. We
currently intend to 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 intend to 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 current 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.
Restructuring expense of $84.7 million in 2006 was the result of declines
in customer production levels in the U.S., customer restructurings and a
subsequent evaluation of our headcount levels in North America and our
long-term capacity needs.
On September 22, 2006, the Company announced the reduction of
its North American workforce by approximately 850 people, or 13%,
spread across its 19 operations in the U.S., Canada and Mexico. This
third quarter reduction of the North American workforce addressed
an immediate need to adjust employment levels to meet customer
restructurings and significantly lower production schedules going
forward. In addition to employee related costs of $6.7 million, the
Company recorded $4.8 million of asset impairment charges related
to the North American restructuring. The third quarter restructuring
expenses broken out by segment were as follows: Engine $7.3 million,
Drivetrain $3.6 million and Corporate $0.6 million.
During the fourth quarter, the Company evaluated the competitiveness
of its North American facilities, as well as its long-term capacity needs.
As a result, the Company will be closing its Drivetrain plant in Muncie,
Indiana and has adjusted the carrying values of other assets, primarily
related to its four-wheel drive transfer case product line. Production
activity at the Muncie facility is scheduled to cease no later than the
expiration of the current labor contract in 2009. As a result of the
fourth quarter restructuring, the Company recorded employee related
costs of $14.8 million, asset impairments of $51.6 million and pension
curtailment expense of $6.8 million. The fourth quarter restructuring
expenses broken out by segment were as follows: Engine $5.9 million
and Drivetrain $67.3 million.
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
related to the 30.6% minority interest in BERU, in addition to the
earnings growth in our Asian majority-owned subsidiaries.
L i q u i d i t y a n d C a p i t a l R e s o u 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
Total debt to capital ratio
2006
2005
% change
$ 151.7
569.4
721.1
162.1
1,875.4
$2,758.6
26.1%
$ 299.9
440.6
740.5
136.1
1,644.2
$2,520.8
29.4%
(2.6)%
9.4%
Stockholders’ equity increased by $231.2 million in 2006. The increase
was primarily attributable to net income of $211.6 million, net foreign
currency translation and hedged instrument adjustments of $91.4 million
and stock option exercises of $27.1 million. These factors were somewhat
offset by the implementation of FAS 158 of $98.5 million and dividend
payments to BorgWarner Shareholders of $36.7 million. In relation to the
U.S. Dollar, the currencies in foreign countries where we conduct business,
particularly the Euro, Korean Won and British Pound strengthened, causing
the currency translation component of other comprehensive income
to increase in 2006. The $19.4 million decrease in debt was primarily
due to higher operating cash flows, partially offset by the $63.7 million
acquisition of the ETEC product lines from Eaton Corporation.
Operating Activities
Net cash provided by operating activities was $442.1 million, $396.5
million and $426.6 million in 2006, 2005 and 2004, respectively. The
$45.6 million increase from 2005 to 2006 was primarily due to lower
cash tax payments of $37.7 million and $28.4 million more in dividends
received from NSK-Warner. The $30.1 million decrease from 2004 to
2005 was primarily 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 employment related
liabilities with cash in 2005 instead of the $25.8 million of Company
stock used in 2004. The $442.1 million of net cash provided by
operating activities in 2006 consists of net earnings of $211.6 million,
increased for non-cash charges of $337.5 million and partially offset by
a $107.0 million increase in net operating assets and liabilities. Non-
cash charges are primarily comprised of $256.6 million in depreciation
and amortization expense, net restructuring expense of $79.4 million,
and $12.7 million due to the implementation of FAS 123R.
Accounts receivable increased a total of $57.4 million excluding the
impact of currency, 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 $32.7
million excluding the impact of currency, while our inventory turns
decreased slightly to 12.3 times from 12.5 in 2005.
Other (income) expense was $(7.5) million, $34.8 million and $3.0
million in 2006, 2005 and 2004, respectively. The 2006 income was
comprised primarily of a $(4.8) million gain from a previous divestiture
and $(3.2) million of interest income. The 2005 expense was primarily
due to the $45.5 million charge associated with the anticipated cost
of settling Crystal Springs-related alleged environmental contamination
personal injury and property damage claims, which was partially offset
by the $(4.7) million gain on the sale of businesses, primarily the
Company’s interest in AGK, and interest income of $(4.2) million. The
major items in our 2004 other (income) expense were losses from
capital asset disposals of $3.5 million, partially offset by interest
income of $(0.7) million.
Equity in affiliates’ earnings, net of tax was $35.9 million, $28.2
million and $29.2 million in 2006, 2005 and 2004, respectively. 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”). For more discussion of NSK-Warner, see
Note 7 of the Consolidated Financial Statements.
Interest expense and finance charges were $40.2 million, $37.1 million
and $29.7 million in 2006, 2005 and 2004, respectively. The increase in
2006 expense over 2005 expense was due to funding our acquisition of
the ETEC product lines from Eaton Corporation, international expansion
and rising interest rates. The increase in 2005 expense over 2004
expense 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 provision for income taxes resulted in an effective tax rate of 12.0%,
17.5% and 26.3% in 2006, 2005 and 2004, respectively. The effective
tax rate of 12.0% for 2006 differs from the U.S. statutory rate primarily
due to the following factors:
• Foreign rates which differ from those in the U.S.
• Realization of certain business tax credits including R&D and foreign
tax credits.
• Other permanent items, including equity in affiliates’ earnings and
Medicare prescription drug benefit.
• Tax effects of miscellaneous dispositions.
• Release of tax accrual accounts upon conclusion of certain tax audits.
• Adjustments to various tax accounts, including changes in tax laws.
If the effects of the tax accrual release, the other miscellaneous
dispositions, the adjustments to tax accounts and the changes in
tax laws are not taken into account, the Company’s effective tax rate
associated with its on-going business operations was approximately
26.0%. This rate was lower than the 2005 tax rate for on-going
operations of 27.8% primarily due to year-over-year reduction in U.S.
pre-tax income for on-going operations, which is taxed at a higher rate
than the Company’s global average tax rate.
Minority interest, net of tax of $26.3 million increased by $6.8 million
from 2005 and by $17.2 million from 2004. The increase is primarily
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
continued
Investing Activities
Net cash used in investing activities was $341.1 million, $700.1 million
and $257.2 million in 2006, 2005 and 2004, respectively. The majority
of the reason for the spike in 2005 was due to payments for the BERU
Acquisition. Capital expenditures, including tooling outlays (“capital
spending”) of $268.3 million in 2006, or 5.9% of sales, decreased
$24.2 million over the 2005 level of $292.5 million, or 6.8% of sales.
Selective capital spending remains an area of focus for us, both in order
to support our book of new business and for cost reduction and other
purposes. Heading into 2007, 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 6.5% of sales.
The Company acquired the ETEC product lines from Eaton Corporation as
of the close of business for the quarter ended September 30, 2006 for
$63.7 million, net of cash acquired.
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.
Financing Activities and Liquidity
million of principal and accrued interest matured on November 1, 2006
and were refinanced with the issuance of $150.0 million 5.75% Senior
Notes due November 1, 2016. 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.
Net debt repayments were $55.9 million in 2004. Proceeds from the
exercise of employee stock options were $27.1 million, $17.6 million and
$14.4 million in 2006, 2005 and 2004, respectively. The Company also
paid dividends to BorgWarner shareholders of $36.7 million, $31.8 million
and $27.9 million in 2006, 2005 and 2004, respectively.
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, the Company has $50 million available under a
shelf registration statement on file with the Securities and Exchange
Commission under which a variety of debt 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, the Company has an
investment grade credit rating of A- from Standard & Poor’s and Baa2
from Moody’s.
Net debt reductions were $35.2 million in 2006 excluding the impact
of currency translation. The Company’s 7.00% Senior Notes of $139.0
The Company’s significant contractual obligation payments at
December 31, 2006, are as follows:
millions of dollars
Other post employment benefits excluding pensions(a)
Notes payable and long-term debt
Projected interest payments(b)
Non-cancelable operating leases(c)
Capital spending obligations
Total(d)
Total
$1,582.0
724.0
371.9
73.3
59.2
$2,810.4
2007
2008-2009
2010-2011
After 2011
$ 33.7
151.7
31.7
27.7
59.2
$304.0
$ 73.2
157.1
53.9
16.5
—
$300.7
$ 79.4
5.4
47.5
13.0
—
$145.3
$1,395.7
409.8
238.8
16.1
—
$2,060.4
(a) Other post employment benefits (excluding pensions) include anticipated future payments to cover retiree medical and life insurance benefits. Since the timing and amount of payments for defined benefit
pension plans are not certain for future years, such payments have been excluded from this table. The Company expects to contribute a total of $15 million to $20 million into all defined benefit pension plans
during 2007. See Note 12 to the Consolidated Financial Statements for disclosures related to the Company’s pension and other post employment benefits.
(b) Projection is based upon actual fixed rates where appropriate, and a projected floating rate for the variable rate portion of the total debt portfolio. The floating rate projection is based upon current market
conditions and rounded to the nearest 50th basis point (0.50%), which is 4.0% for this purpose. Projection is also based upon debt being redeemed upon maturity.
(c) 2007 includes $14.4 million for the guaranteed residual value of production equipment with a lease that expires in 2007. Please see Note 16 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.
10
2006 annual report
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 commercial and legal claims, actions and complaints,
including matters involving warranty claims, 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 commercial 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 35 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, this is because either the
estimates of the maximum potential liability at a site are not large or the
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 the Company, (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,
2006, of $20.0 million. Excluding the Crystal Springs site discussed
below for which $10.8 million has been accrued, the Company has
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 pay out substantially all of the $20.0 million
accrued environmental liability over the next three to five years.
We believe that the combination of cash from operations, cash balances,
available credit facilities and the 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, 2006, 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 2006 is $73.3 million. See Note 16 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 2007. In the event the Company exercises its option not
to purchase the production equipment, the Company has guaranteed a
residual value of $14.4 million. The Company has accrued $6.0 million as
an expected loss on this guarantee.
Pension and Other Post Employment 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, 2006, all legal funding requirements had been met. The
Company contributed $17.5 million to its defined benefit pension plans
in 2006 and $26.0 million in 2005. The Company expects to contribute
a total of $15 million to $20 million in 2007.
The funded status of all pension plans improved to a net unfunded
position of $(125.4) million at the end of 2006 from a net unfunded
position of $(144.5) million at the end of 2005.
Other post employment benefits primarily consist of post employment
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 employment benefits had an unfunded status of
$(513.6) million at the end of 2006 and $(679.9) million at the end of
2005. The unfunded levels decreased due to an increase in the discount
rate assumption and changes in certain plan designs.
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.
11
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
continued
In connection with the sale of Kuhlman Electric Corporation, the
Company agreed to indemnify the buyer and Kuhlman Electric for certain
environmental liabilities, then unknown to the Company, 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 the Company that it discovered
potential environmental contamination at its Crystal Springs, Mississippi
plant while undertaking an expansion of the plant. The Company is
continuing to work with the Mississippi Department of Environmental
Quality and Kuhlman Electric to investigate and remediate to the extent
necessary, if any, historical contamination at the plant and surrounding
area. 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
approximately 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 March 2005, the FASB issued Interpretation No. 47, Accounting for
Conditional Asset Retirement Obligations - an interpretation of FASB
Statement No. 143 (“FIN 47”), 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 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
12
of polychlorinated biphenyl (“PCBs”) transformers and capacitors when
their use ceases, and the disposal of used furnace bricks and liners, and
lead-based paint in conjunction with facility renovations or demolition.
The Company currently has 17 manufacturing locations that have been
identified as containing these items. The fair value to remove and dispose
of this material has been estimated and recorded at $1.0 million and $0.8
million as of December 31, 2006 and 2005, respectively.
Product Liability
Like many other industrial companies who have historically operated
in the U.S., the Company (or parties the Company is obligated to
indemnify) 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 that were
manufactured many years ago and 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, 2006, the Company had approximately
45,000 pending asbestos-related product liability claims. Of these
outstanding claims, approximately 34,000 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 2006, of the approximately
27,000 claims resolved, only 169 (0.6%) resulted in any payment being
made to a claimant by or on behalf of the Company. 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.
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 alleged 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 arrangement. To date, the Company
has paid $16.2 million in defense and indemnity in advance of insurers’
reimbursement and has received $4.5 million in cash from insurers. The
outstanding balance of $11.7 million is expected to be fully recovered.
Timing of the recovery is dependent on final resolution of the declaratory
judgment action referred to below. At December 31, 2005, insurers owed
$3.9 million in association with these claims.
At December 31, 2006, the Company has an estimated liability of
$39.9 million for future claims resolutions, with a related asset of $39.9
million to recognize the insurance proceeds receivable by the Company
for estimated losses related to claims that have yet to be resolved.
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
likely to have a material adverse effect on the Company’s results of
operations, cash flows or financial condition.
C r i t i c a l A c c o u n t i n g P o l i c 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.
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. The Company recognized $56.4 million in impairment of
long-lived assets in 2006 as part of the restructuring expenses.
See Note 3 to the Consolidated Financial Statements for more
information regarding the 2006 impairment of long-lived assets.
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 utilizes the “two-step
impairment test” required under Financial Accounting Standard 142,
Goodwill and Other Intangibles, and requires us to make significant
assumptions and estimates about the extent and timing of future cash
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, 2005, the comparable value of the insurance receivable
and accrued liability was $41.0 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
2006
2005
Assets:
Prepayments and other current assets
Other non-current assets
Total insurance receivable
Liabilities:
Accounts payable and accrued expenses
Other non-current liabilities
Total accrued liability
$23.3
16.6
$39.9
$23.3
16.6
$39.9
$20.8
20.2
$41.0
$20.8
20.2
$41.0
The Company cannot reasonably estimate possible losses, if any, in
excess of those for which it has accrued, because it 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, the Company’s experiences in aggressively defending and
resolving claims in the past, and the Company’s significant insurance
coverage with solvent carriers as of the date of this filing, management
does not believe that asbestos-related product liability claims are
13
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
continued
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 2006, 2005
and 2004. The Company recognized goodwill impairment of $0.2 million
in 2006 related to the Drivetrain segment. No goodwill impairment was
noted in 2005 and 2004.
See Note 8 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 2006 is between $18.1
million and $29.5 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
2006, our total accrued environmental liability was $20.0 million.
See Note 15 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 current and
non-current liabilities on the balance sheet.
See Note 9 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 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.
14
Pension and Other Post Employment Defined Benefits
The Company provides post employment defined benefits to a number
of its current and former employees. Costs associated with post
employment defined benefits include pension and post employment
health care expenses for employees, retirees and surviving spouses and
dependents. The Company’s employee defined benefit pension and post
employment health 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 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 for each plan. As a sensitivity
measure for the Company’s pension plans, a decrease of 25 basis points
to the discount rate would increase the Company’s 2007 expense by
approximately $1.5 million. As for the Company’s other post employment
benefit plans, a decrease of 25 basis points to the discount rate would
increase the Company’s 2007 expense by approximately $0.8 million.
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. For sensitivity
purposes, a 25 basis point decrease in the long-term return on assets
would increase the 2007 pension expense by approximately $1.2 million.
The Company determines its health care inflation rate for its other post
employment benefit plans by evaluating the circumstances surrounding
the plan design, recent experience and health care economics. For
sensitivity purposes, a one percentage point increase in the assumed
health care cost trend would increase the Company’s projected benefit
obligation by $49.1 million at December 31, 2006, and would increase
the 2007 expense by $6.1 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 12 to the Consolidated Financial Statements for more information
regarding costs and assumptions for employee retirement benefits.
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
On January 1, 2006, the Company adopted Statement of Financial
Accounting Standards No. 123 (Revised 2004), Share-Based Payment
(“FAS 123R”), which required the Company to measure all employee
stock-based compensation awards using a fair value method and record
the related expense in the financial statements. The Company elected
to 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. All periods presented prior
to January 1, 2006 were accounted for in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees
(“APB No. 25”). Accordingly, no compensation cost was recognized for
fixed stock options prior to January 1, 2006 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. See
Note 13 to the Consolidated Financial Statements for more information
regarding the implementation of FAS 123R.
In June 2006, the FASB issued interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No.
109 (“FIN 48”). The interpretation prescribes a consistent recognition
threshold and measurement attribute, as well as clear criteria for
subsequently recognizing, derecognizing and measuring such tax
positions for financial statement purposes. FIN 48 also requires
expanded disclosure with respect to the uncertainty in income taxes.
FIN 48 is effective for the Company as of January 1, 2007. The Company
is currently assessing the potential impact on retained earnings upon
adoption. The Company expects the implementation of FIN 48 to reduce
retained earnings by zero to $25 million.
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 157, Fair Value Measurements (“FAS 157”). FAS 157
defines fair value, establishes a framework for measuring fair value in
GAAP and expands disclosures about fair value measurements. FAS 157
is effective for the Company beginning with its quarter ending March
31, 2008. The adoption of FAS 157 is not expected to have a material
impact on the Company’s consolidated financial position, results of
operations or cash flows.
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 158, Employers’ Accounting for Defined Benefit Pension
and Other Postretirement Plans – an amendment of FASB Statements No.
87, 88, 106, and 123(R) (“FAS 158”). FAS 158 requires an employer to
recognize the funded status of each defined benefit post employment
plan on the balance sheet. The funded status of all overfunded plans
are aggregated and recognized as a non-current asset on the balance
sheet. The funded status of all underfunded plans are aggregated and
recognized as a current liability, a non-current liability, or a combination
of both on the balance sheet. A current liability is the amount by which
the actuarial present value of benefits included in the benefit obligation
payable in the next 12 months exceeds the fair value of plan assets,
and is determined on a plan-by-plan basis. FAS 158 also requires the
measurement date of a plan’s assets and its obligations to be the
employer’s fiscal year-end date, for which the Company already complies.
Additionally, FAS 158 requires an employer to recognize changes in the
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 non-
U.S. jurisdictions. Significant judgment is required in determining our
worldwide provision for income taxes and recording the related 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, 2006, the Company has recorded a liability for its
best estimate of the probable loss on certain of its tax positions, which
is included in other non-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 5 to the Consolidated Financial Statements for more
information regarding income taxes.
New Accounting Pronouncements
On January 1, 2006, the Company adopted Statement of Financial
Accounting Standards No. 151, Inventory Costs - an amendment of
ARB No. 43, Chapter 4 (“FAS 151”). FAS 151 provides clarification
of accounting for abnormal amounts of idle facility expense, freight,
handling costs and wasted material. Generally, FAS 151 requires that
those items be recognized as current period charges. The adoption of
FAS 151 did not have a material impact on the Company’s consolidated
financial position, results of operations or cash flows.
1
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
continued
funded status of a defined benefit post employment plan in the year
in which the change occurs. FAS 158 is effective for the Company as
of December 31, 2006. The incremental effect of applying FAS 158
to the Company’s Consolidated Balance Sheet as of December 31,
2006 was to increase non-current deferred tax assets by $88.8 million
and retirement-related liabilities by $187.3 million and to decrease
accumulated other comprehensive income (loss) by $98.5 million. See
Note 12 to the Consolidated Financial Statements for more information
regarding the implementation of FAS 158.
Q u a l i t a t i ve a n d Q u a n t i t i ve D i s c l o s u r e
A b o u 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 2006, the amount
of net debt with fixed interest rates was 43.1% 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 2006 of
approximately $2.1 million, and $1.8 million in 2005.
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, 2006, the net fair value of these instruments would
increase by approximately $27 million if interest rates decreased and
would decrease by approximately $25 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, 2005, measured
in a similar manner, was slightly less than at December 31, 2006.
16
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 $473.4 million as
of December 31, 2006 and $478.0 million as of December 31, 2005.
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 2006 and 2005.
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 2006 and 2005.
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,” or 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 expressed, projected or implied in or by 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 its
most recently filed annual report on Form 10-K. The Company does not
undertake any obligation to update any forward-looking statement.
Management’s Responsibility for
Consolidated Financial Statements
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
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, 2006, 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 independent 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 16, 2007
Robin J. Adams
Executive Vice President,
Chief Financial Officer &
Chief Administrative Officer
1
Report of Independent
Registered Public Accounting Firm
BorgWarner Inc.
and Consolidated
Subsidiaries
1
Consolidated Statements of Operations
millions of dollars, except share and per share amounts
For the Year Ended December 31,
Net sales
Cost of sales
Gross profit
Selling, general and administrative expenses
Restructuring expense
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.
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
2006
$4,585.4
3,735.5
849.9
498.1
84.7
(7.5)
274.6
(35.9)
40.2
270.3
32.4
26.3
$ 211.6
$ 3.69
$ 3.65
57,403
57,971
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
56,708
57,398
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
55,872
56,537
1
BorgWarner Inc.
and Consolidated
Subsidiaries
2006
2005
$ 123.3
59.1
744.0
386.9
33.7
90.5
1,437.5
1,460.7
198.0
1,086.5
401.3
1,685.8
$4,584.0
$ 151.7
—
843.4
39.7
1,034.8
569.4
660.9
281.4
942.3
162.1
—
0.6
—
871.1
1,064.1
(60.3)
(0.1)
1,875.4
$4,584.0
$ 89.7
40.6
626.1
332.0
28.0
52.3
1,168.7
1,401.1
197.7
1,029.8
292.1
1,519.6
$4,089.4
$ 160.9
139.0
786.4
35.8
1,122.1
440.6
522.1
224.3
746.4
136.1
—
0.6
—
827.6
889.2
(73.1)
(0.1)
1,644.2
$4,089.4
Consolidated Balance Sheets
millions of dollars
December 31,
A s s e t s
Cash and cash equivalents
Marketable securities
Receivables
Inventories
Deferred income taxes
Prepayments and other current assets
Total current assets
Property, plant and equipment – net of accumulated depreciation
Investments and advances
Goodwill
Other non-current assets
Total other assets
Total assets
L i a b i l i t i e s a n d S t o c k h o l d e r s ’ E q u i t y
Notes payable
Current maturities of long-term debt
Accounts payable and accrued expenses
Income taxes payable
Total current liabilities
Long-term debt
Other non-current liabilities:
Retirement-related liabilities
Other
Total non-current 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: 2006, 57,697,284 and 2005, 57,138,475;
outstanding shares: 2006, 57,693,300 and 2005, 57,134,491
Non-voting common stock, $0.01 par value;
authorized shares: 25,000,000; none issued and outstanding
Capital in excess of par value
Retained earnings
Accumulated other comprehensive loss
Common stock held in treasury, at cost: 3,984 shares in 2006 and 2005
Total stockholders’ equity
Total liabilities and stockholders’ equity
See Accompanying Notes to Consolidated Financial Statements.
20
Consolidated Statements of Cash Flows
millions of dollars
For the Year Ended December 31,
O p e r a t i n g
Net earnings
Adjustments to reconcile net earnings to net cash flows from operations:
Non-cash charges (credits) to operations:
Depreciation and tooling amortization
Amortization of intangible assets and other
Restructuring expense, net of cash paid
Gain on sales of businesses, net of tax
Stock option compensation expense
Employee retirement benefits funded with common stock
Deferred income tax (benefit) provision
Equity in affiliates’ earnings, net of dividends received, minority interest and other
Net earnings adjusted for non-cash charges (credits) to operations
Changes in assets and liabilities, net of effects of acquisitions and divestitures:
Receivables
Inventories
Prepayments and other current assets
Accounts payable and accrued expenses
Income taxes payable
Other non-current assets and liabilities
Net cash provided by operating activities
I n ve s t i n g
Capital expenditures, including tooling outlays
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
Investment in unconsolidated subsidiary
Net cash used in investing activities
F i n a n c i n g
Net increase (decrease) in notes payable
Additions to long-term debt
Repayments of long-term debt
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
S u p p l e m e n t a l C a s h F l o w I n f o r m a t i o n
Net cash paid during the year for:
Interest
Income taxes
Non-cash financing transactions:
Issuance of common stock for stock performance plans
Issuance of restricted common stock for non-employee directors
Total debt assumed from business acquired
See Accompanying Notes to Consolidated Financial Statements.
21
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
2006
2005
2004
$211.6
$239.6
$218.3
239.1
17.5
79.4
(3.6)
12.7
—
(46.4)
38.8
549.1
(57.4)
(32.7)
(25.2)
(8.1)
0.5
15.9
442.1
(268.3)
(63.7)
3.6
(41.5)
28.8
—
—
(341.1)
(27.7)
289.1
(296.6)
27.1
(51.8)
(59.9)
(7.5)
33.6
89.7
$123.3
$ 45.0
83.8
$ 3.0
0.5
—
223.8
31.7
—
(6.3)
—
—
(32.4)
7.6
464.0
(79.6)
(30.1)
19.9
137.6
(61.7)
(53.6)
396.5
(292.5)
(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
177.0
1.1
—
—
—
25.8
13.8
4.7
440.7
(60.4)
(12.7)
(7.0)
113.1
36.0
(83.1)
426.6
(252.4)
—
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
—
Consolidated Statements
of Stockholders’ Equity and Comprehensive Income (Loss)
BorgWarner Inc.
and Consolidated
Subsidiaries
Number of shares
Issued
common
stock
55,229,854
—
—
Common
stock in
treasury
(72,664)
—
—
523,994
68,680
41,252
6,400
559,667
—
—
—
—
—
—
—
—
—
Issued
common
stock
$0.3
—
0.3
Capital in
excess of
par value
$756.3
—
—
millions of dollars
Stockholders’ equity
Treasury
stock
Retained
earnings
$ (1.5) $ 491.3
(27.9)
(0.3)
—
—
Accumulated
other
comprehensive
income (loss)
$ 14.0
—
—
Comprehensive
income (loss)
—
—
—
—
—
—
—
13.0
1.4
1.7
0.3
25.8
—
—
—
—
—
—
—
—
—
—
—
—
—
218.3
—
—
—
—
—
—
—
12.8
28.4
$ 218.3
12.8
28.4
56,361,167
—
(3,984)
—
$0.6
—
$797.1
—
$ (0.1) $ 681.4
(31.8)
—
712,640
48,569
16,099
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
57,138,475
—
—
(3,984)
—
—
$0.6
—
—
497,186
50,275
11,348
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
28.1
2.6
(0.2)
—
—
—
—
$827.6
—
12.7
27.1
3.0
0.7
—
—
—
—
—
—
—
—
—
—
—
—
—
—
239.6
—
—
—
$ (0.1) $ 889.2
(36.7)
—
—
—
—
—
—
—
—
—
—
—
—
—
211.6
—
—
—
$ 55.2
$ 259.5
—
—
—
—
—
$ 239.6
(30.3)
(30.3)
(0.3)
(0.3)
(97.7)
(97.7)
$(73.1)
$ 111.3
—
—
—
—
—
—
(98.5)
18.1
1.8
$ 211.6
18.1
1.8
Balance, January 1, 2004
Dividends declared
Stock split
Shares issued under stock
incentive plans
Shares issued under
executive stock plan
Restricted shares issued under
stock incentive plan
Shares issued under
retirement savings plans
Net earnings
Adjustment for minimum
pension liability
Currency translation and hedge
instruments adjustments
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 earnings
Adjustment for minimum
pension liability
Net unrealized loss on
available-for-sale securities
Currency translation and hedge
instruments adjustments
Balance, December 31, 2005
Dividends declared
FAS 123R (Note 13)
Shares issued under stock
incentive plans
Shares issued under
executive stock plan
Net issuance of restricted stock,
less amortization
Net earnings
FAS 158 incremental effect (Note 12)
Adjustment for minimum
pension liability
Net unrealized loss on
available-for-sale securities
Currency translation and hedge
instruments adjustments
Balance, December 31, 2006
—
57,697,284
—
(3,984)
—
$0.6
—
$871.1
—
—
$ (0.1) $ 1,064.1
91.4
$ (60.3)
91.4
$ 322.9
See Accompanying Notes to Consolidated Financial Statements.
22
Notes to Consolidated Financial Statements
I n t r o d u c t i o n
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. The Company’s 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.
Concentrations of risk Cash and cash equivalents are maintained with
several financial institutions. Deposits held with banks may exceed
the amount of insurance provided on such deposits. Generally, these
deposits may be redeemed upon demand and are maintained with
financial institutions of reputable credit and therefore bear minimal risk.
The Company performs ongoing credit evaluations of its suppliers and
customers and, with the exception of certain financing transactions,
does not require collateral from its customers. The Company’s customers
are primarily original equipment manufacturers of passenger cars, sport-
utility vehicles, crossover vehicles, trucks, commercial transportation
products and industrial equipment.
Some automotive parts suppliers continue to experience commodity cost
pressures and the effects of industry overcapacity. These factors have
increased pressure on the industry’s supply base, as suppliers cope with
higher commodity costs, lower production volumes and other challenges.
The Company receives certain of its raw materials from sole suppliers or
a limited number of suppliers. The inability of a supplier to fulfill supply
requirements of the Company could materially affect future operating results.
Principles of consolidation The Consolidated Financial Statements include
all 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.
23
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
Marketable securities Marketable securities 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 6 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, 2006 and 2005, total cash
proceeds from sales of accounts receivable were $600 million. The
Company paid servicing fees related to these receivables of $2.7 million,
$1.8 million and $0.9 million in 2006, 2005 and 2004, respectively.
These amounts are recorded in interest expense and finance charges
in the Consolidated Statements of Operations. At December 31, 2006
and 2005, 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 $122.1 million and
$108.0 million at December 31, 2006 and 2005, respectively. Such
inventories, if valued at current cost instead of LIFO, would have been
greater by $12.4 million in 2006 and $9.1 million in 2005.
See Note 7 to the Consolidated Financial Statements for more information
on inventories.
Pre-production costs related to long-term supply arrangements
Engineering, research and development, and other design and
development costs for products sold on long-term supply arrangements
are expensed as incurred unless the Company has a contractual guarantee
for reimbursement from the customer. Costs for molds, dies and other
tools used to make products sold on long-term supply arrangements for
which the Company either has title to the assets or has the non-cancelable
right to use the assets during the term of the supply arrangement are
capitalized in property, plant and equipment. Capitalized items specifically
designed for a supply arrangement are amortized over the shorter of the
term of the arrangement or over the estimated useful lives of the assets,
typically 3 to 5 years. Carrying values of assets capitalized according to
the foregoing policy are periodically reviewed for impairment. Costs for
molds, dies and other tools used to make products sold on long-term
supply arrangements for which the Company has a contractual guarantee
for lump sum reimbursement from the customer are capitalized in
prepayments and other current assets.
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.
Notes to Consolidated Financial Statements
continued
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 7 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. The Company recognized $56.4 million in impairment of
long-lived assets in 2006 as part of the restructuring expenses.
See Note 3 to the Consolidated Financial Statements for more
information regarding the 2006 impairment of long-lived assets.
Goodwill and other intangible assets Under Statement of Financial
Accounting Standards 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 of all of its reporting units for impairment. The fair value
of the Company’s businesses used in the determination of goodwill
impairment is computed using the expected present value of associated
future cash flows. This review requires the Company 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. The
Company also utilizes market valuation models and other financial
ratios, which require the Company to make certain assumptions and
estimates regarding the applicability of those models to its assets and
businesses. The Company believes that the assumptions and estimates
used to determine the estimated fair values of each of its reporting
units are reasonable. However, different assumptions could materially
affect the estimated fair value. The Company recognized a $0.2 million
goodwill impairment in 2006 related to the Drivetrain segment as a
result of the analysis it performed in December 2006.
See Note 3 and Note 8 to the Consolidated Financial Statements for
more information on goodwill and other intangibles.
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
24
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 current and non-current
liabilities on the balance sheet.
See Note 9 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. The Company estimates losses under
the programs using consistent and appropriate methods; however,
changes to its assumptions could materially affect its 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 11 to the Consolidated Financial Statements for more
information on derivative financial instruments.
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 14 to the Consolidated Financial Statements for more
information on other comprehensive income.
New Accounting Pronouncements On January 1, 2006, the Company
adopted Statement of Financial Accounting Standards No. 151,
Inventory Costs - an amendment of ARB No. 43, Chapter 4 (“FAS 151”).
FAS 151 provides clarification of accounting for abnormal amounts
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
benefit obligation payable in the next 12 months exceeds the fair value
of plan assets, and is determined on a plan-by-plan basis. FAS 158 also
requires the measurement date of a plan’s assets and its obligations to
be the employer’s fiscal year-end date, for which the Company already
complies. Additionally, FAS 158 requires an employer to recognize
changes in the funded status of a defined benefit post employment
plan in the year in which the change occurs. FAS 158 is effective for
the Company as of December 31, 2006. The incremental effect of
applying FAS 158 to the Company’s Consolidated Balance Sheet as of
December 31, 2006 was to increase non-current deferred tax assets by
$88.8 million and retirement-related liabilities by $187.3 million and
to decrease accumulated other comprehensive income (loss) by $98.5
million. See Note 12 to the Consolidated Financial Statements for more
information regarding the implementation of FAS 158.
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 following table presents the Company’s gross and net expenditures on
research and development (“R&D”) activities:
millions of dollars
Year Ended December 31,
Gross R&D expenditures
Customer reimbursements
Net R&D expenditures
2006
2005
2004
$219.5
(31.8)
$187.7
$194.3
(33.3)
$161.0
$154.9
(31.8)
$123.1
The Company’s net R&D expenditures are included in the selling,
general, and administrative expenses of the Consolidated Statements
of Operations. Customer reimbursements are netted against gross R&D
expenditures upon billing of services performed. The Company has
contracts with several customers at the Company’s various R&D locations.
No such contract exceeded $6 million in any of the years presented.
N O T E 3
Restructuring
The Company defines restructuring expense to include costs directly
associated with exit or disposal activities accounted for in accordance
with SFAS 146, Accounting for Costs Associated with Exit or Disposal
Activities, employee exit costs incurred as a result of an exit or disposal
activity accounted for in accordance with SFAS 88, Employers’
Accounting for Settlements and Curtailments of Defined Benefit Pension
Plans and for Termination Benefits, and SFAS 112, Employers Accounting
for Postemployment Benefits, and long-lived asset impairments
accounted for in accordance with SFAS 144, Accounting for the
Impairment or Disposal of Long-Lived Assets.
Estimates of restructuring expense are based on information available
at the time such charges are recorded. The Company utilized outside
independent appraisals and discounted cash flow analyses to estimate
fair values for recognizing the extent of the impairments of long-lived
assets. Due to the inherent uncertainty involved in estimating restructuring
of idle facility expense, freight, handling costs and wasted material.
Generally, FAS 151 requires that those items be recognized as current
period charges. The adoption of FAS 151 did not have a material impact
on the Company’s consolidated financial position, results of operations
or cash flows.
On January 1, 2006, the Company adopted Statement of Financial
Accounting Standards No. 123 (Revised 2004), Share-Based Payment
(“FAS 123R”), which required the Company to measure all employee
stock-based compensation awards using a fair value method and record
the related expense in the financial statements. The Company elected
to 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. All periods presented prior
to January 1, 2006 were accounted for in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees
(“APB No. 25”). Accordingly, no compensation cost was recognized for
fixed stock options prior to January 1, 2006 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. See
Note 13 to the Consolidated Financial Statements for more information
regarding the implementation of FAS 123R.
In June 2006, the FASB issued Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No.
109 (“FIN 48”). FIN 48 prescribes a consistent recognition threshold
and measurement attribute, as well as clear criteria for subsequently
recognizing, derecognizing and measuring such tax positions for
financial statement purposes. FIN 48 also requires expanded disclosure
with respect to the uncertainty in income taxes. FIN 48 is effective for
the Company as of January 1, 2007. The Company is currently assessing
the potential impact on retained earnings upon adoption. The Company
expects the implementation of FIN 48 to reduce retained earnings by
zero to $25 million.
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 157, Fair Value Measurements (“FAS 157”). FAS 157
defines fair value, establishes a framework for measuring fair value in
GAAP and expands disclosures about fair value measurements. FAS 157
is effective for the Company beginning with its quarter ending March
31, 2008. The adoption of FAS 157 is not expected to have a material
impact on the Company’s consolidated financial position, results of
operations or cash flows.
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 158, Employers’ Accounting for Defined Benefit Pension
and Other Postretirement Plans – an amendment of FASB Statements
No. 87, 88, 106, and 132(R) (“FAS 158”). FAS 158 requires an
employer to recognize the funded status of each defined benefit
post employment plan on the balance sheet. The funded status of all
overfunded plans are aggregated and recognized as a non-current asset
on the balance sheet. The funded status of all underfunded plans are
aggregated and recognized as a current liability, a non-current liability,
or a combination of both on the balance sheet. A current liability is the
amount by which the actuarial present value of benefits included in the
2
Notes to Consolidated Financial Statements
continued
expenses, actual amounts paid for such activities may differ from amounts
initially recorded. Accordingly, the Company may record revisions of
previous estimates by adjusting previously established reserves.
On September 22, 2006, the Company announced the reduction of
its North American workforce by approximately 850 people, or 13%,
spread across its 19 operations in the U.S., Canada and Mexico. This
third quarter reduction of the North American workforce addressed
an immediate need to adjust employment levels to meet customer
restructurings and significantly lower production schedules going
forward. In addition to the $6.7 million of employee related costs, the
Company recorded $4.8 million of asset impairment charges related to
the North American restructuring. The restructuring expenses broken out
by segment were as follows: Engine $7.3 million, Drivetrain $3.6 million
and Corporate $0.6 million.
During the fourth quarter, the Company evaluated the competitiveness of
its North American facilities, as well as its long-term capacity needs. As a
result, the Company will be closing its Drivetrain plant in Muncie, Indiana
and has adjusted the carrying values of other assets, primarily related to
its four-wheel drive transfer case product line. Production activity at the
Muncie facility is scheduled to cease no later than the expiration of the
current labor contract in 2009. As a result of the fourth quarter restructuring,
the Company recorded employee related costs of $14.8 million, asset
impairments of $51.6 million and pension curtailment expense of $6.8
million. The fourth quarter restructuring expenses broken out by segment
were as follows: Engine $5.9 million and Drivetrain $67.3 million.
The following table summarizes all restructuring expense for the twelve
months ended December 31, 2006:
millions of dollars
Third quarter provision
Fourth quarter provision
Total provision
Employee
Related Costs
Asset
Impairments
$ 6.7
14.8
$21.5
$ 4.8
51.6
$56.4
Other
Total
$ —
6.8
$6.8
$11.5
73.2
$84.7
N o t e 5
Income Taxes
For the twelve months ended December 31, 2006, the following table
summarizes restructuring expense by segment:
millions of dollars
Drivetrain Group
Engine Group
Corporate
Total provision
Employee
Related Costs
Asset
Impairments
$17.1
3.8
0.6
$21.5
$47.0
9.4
—
$56.4
Other
Total
$6.8
—
—
$6.8
$70.9
13.2
0.6
$84.7
The following table displays a rollforward of the restructuring accruals
recorded within the Company’s Consolidated Balance Sheet and the
related cash flow activity for 2006:
millions of dollars
Employee
Related Costs
Asset
Impairments
Total provision
Cash payments
Non-cash impact on 2006
$21.5
(5.3)
$16.2
$56.4
—
$56.4
Other
Total
$6.8
—
$6.8
$84.7
(5.3)
$79.4
The remaining $16.2 million in employee related costs is expected to be
paid out through 2009.
NOTE 4
Other (Income) Expense
Items included in other (income) expense consist of:
millions of dollars
Year Ended December 31,
Interest income
Net gain on sale of businesses
Net (gain) loss on asset disposals
Crystal Springs related settlement
(Note 15)
Other
Total other (income) expense
2006
2005
2004
$(3.2)
(4.8)
1.0
—
(0.5)
$(7.5)
$ (4.2)
(4.7)
(1.4)
$(0.7)
—
3.5
45.5
(0.4)
$34.8
—
0.2
$ 3.0
Earnings before income taxes and the provision for income taxes are presented in the following table.
millions of dollars
Year Ended December 31,
Earnings before taxes
Provision for income taxes:
Current:
Federal/foreign
State
Total current
Deferred
Total provision for income taxes
Effective tax rate
2006
Non-U.S.
U.S.
Total
U.S.
2005
Non-U.S.
Total
U.S.
2004
Non-U.S.
Total
$ (27.2)
$297.5
$270.3
$ 46.8
$267.4
$314.2
$117.8
$190.8
$308.6
(11.1)
2.2
(8.9)
(27.4)
$ (36.3)
(133.5)%
87.7
—
87.7
(19.0)
$ 68.7
76.6
2.2
78.8
(46.4)
$ 32.4
(10.0)
2.9
(7.1)
(17.9)
$(25.0)
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
23.1%
12.0%
(53.4)%
30.0%
17.5%
12.4%
34.9%
26.3%
26
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
Following are the gross components of deferred tax assets and liabilities
as of December 31, 2006 and 2005.
millions of dollars
2006
2005
Current deferred tax assets:
Foreign tax credits
Research and development credits
Employee related
Inventory
Warranties
Litigation & 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 employment benefits
Other comprehensive income
Employee related
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 & intangibles
Other comprehensive income
Lease obligation – production equipment
Other
Total non-current deferred tax liabilities
Total
Valuation allowances
Net deferred tax asset (liability)
$ 2.0
—
16.5
2.8
3.3
3.8
2.9
2.9
$ 34.2
$ 3.5
1.6
8.9
—
4.0
9.8
0.2
1.0
$ 29.0
$ —
(0.9)
$ (0.9)
$ (5.4)
(1.7)
$ (7.1)
$ 108.9
121.4
9.3
3.4
8.3
23.6
14.6
10.9
10.0
1.0
$ 311.4
$(171.6)
(39.5)
(3.5)
(6.0)
(4.9)
$(225.5)
$ 119.2
(17.0)
$ 102.2
$ 96.1
44.6
7.6
5.4
3.6
23.2
12.2
6.5
5.1
5.2
$ 209.5
$(173.2)
(47.6)
(8.9)
(6.9)
(2.2)
$(238.8)
$ (7.4)
(10.8)
$ (18.2)
The deferred tax assets and liabilities recognized in the Company’s
Consolidated Balance Sheets are as follows:
millions of dollars
Deferred income taxes – current assets
Deferred income taxes – current liabilities
Other non-current assets
Other non-current liabilities
Net deferred tax asset (liability)
(current and non-current)
2006
2005
$ 33.7
(0.4)
176.9
(108.0)
$ 28.0
(6.1)
65.6
(105.7)
$ 102.2
$ (18.2)
The provision for income taxes resulted in an effective tax rate for 2006
of 12.0% compared with rates of 17.5% in 2005 and 26.3% in 2004.
The effective tax rate of 12.0% for 2006 differs from the U.S. statutory
rate primarily due to: a) foreign rates which differ from those in the U.S.;
b) realization of certain business tax credits including R&D and foreign
tax credits; c) other permanent items, including equity in affiliates’
earnings and Medicare prescription drug benefit; d) the tax effects of
other miscellaneous dispositions; e) the release of tax accrual accounts
upon conclusion of certain tax audits; and f) adjustments to various
tax accounts, including changes in tax laws, primarily in Europe. If the
effects of the tax accrual release, the other miscellaneous dispositions,
the adjustments to tax accounts and the changes in tax laws are not
taken into account, the Company’s effective tax rate associated with its
on-going business operations was approximately 26.0%. This rate was
lower than the 2005 tax rate for on-going operations of 27.8% primarily
due to year-over-year reduction in U.S. pre-tax income for on-going
operations, which is taxed at a higher rate than the Company’s global
average tax rate.
In June 2006, the FASB issued Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No.
109 (“FIN 48”). FIN 48 prescribes a consistent recognition threshold
and measurement attribute, as well as clear criteria for subsequently
recognizing, derecognizing and measuring such tax positions for financial
statement purposes. FIN 48 also requires expanded disclosure with
respect to the uncertainty in income taxes. FIN 48 is effective for the
Company as of January 1, 2007. The Company is currently assessing
the potential impact on retained earnings upon adoption. The Company
expects the implementation of FIN 48 to reduce retained earnings by
zero to $25 million.
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
2006
2005
2004
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
Affiliates’ earnings
Accrual adjustment and settlement
of prior year tax matters
Changes in tax laws
Medicare prescription drug benefit
Capital loss limitation, net
Restructuring
Non-temporary differences and other
Provision for income taxes as reported
$94.6
$110.0
$108.0
(8.8)
(1.5)
(1.0)
(11.3)
(22.9)
(10.4)
(3.8)
5.7
(5.0)
(3.2)
$32.4
(11.0)
1.7
(4.2)
(9.6)
(26.7)
—
(2.6)
(3.5)
—
1.0
$ 55.1
3.6
2.1
(6.2)
(10.2)
(6.0)
—
—
—
—
(10.1)
$ 81.2
2
Notes to Consolidated Financial Statements
continued
The deferred income taxes – current assets are primarily comprised
of amounts from the U.S., Brazil, France, Hungary, Japan and the U.K.
The deferred income taxes – current liabilities are primarily comprised
of amounts from Mexico. The other non-current assets are primarily
comprised of amounts from the U.S. and Korea. The other non-current
liabilities are primarily comprised of amounts from Germany, Hungary,
Italy, Japan, Monaco and the U.K.
The Company has a U.S. capital loss carryforward of $28.8 million, which
will expire in 2010 and 2011. A valuation allowance of $10.4 million has
been recorded for the tax effect of some of this loss carryforward.
The foreign tax credits of $25.6 million will expire beginning in 2012 through
2016. The R&D tax credits of $14.6 million will expire beginning in 2022
through 2026. The Company also has deferred tax assets for minimum tax
credits of $1.0 million, which can be carried forward indefinitely.
At December 31, 2006, certain non-U.S. subsidiaries have net operating
loss carryforwards totaling $45.0 million that are available to offset
future taxable income. Carryforwards of $9.8 million expire at various
dates from 2009 through 2016 and the balance has no expiration date.
A valuation allowance of $6.6 million has been recorded for the tax
effect on $19.8 million of the loss carryforwards. Any benefit resulting
from the utilization of $5.6 million of the operating loss carryforwards
will be applied to reduce goodwill related to the BERU Acquisition.
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 $702.1
million in 2006, 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.
NOT E 6
Marketable Securities
As of December 31, 2006 and 2005, the Company had $59.1
million and $40.6 million, respectively, of highly liquid investments in
marketable securities, primarily bank notes. The securities are carried
at fair value with the unrealized gain or loss, net of tax, reported in
other comprehensive income. As of December 31, 2006 and 2005,
$45.5 million and $27.7 million of the contractual maturities are
within one to five years and $13.6 million and $12.9 million are due
beyond five years, respectively. The Company does not intend to hold
these investments until maturity; rather, they are available to support
current operations if needed. Gross proceeds from sales of marketable
securities were $29.4 million and $58.2 million in 2006 and 2005,
respectively. Net realized gains of $0.6 million and $0.3 million, based
on specific identification of securities sold, have been reported in other
income for the years ended December 31, 2006 and 2005, respectively.
2
2006
2005
N OTE 7
Balance Sheet Information
Detailed balance sheet data are as follows:
millions of dollars
December 31,
Receivables:
Customers
Other
Gross receivables
Bad debt allowance(a)
Net receivables
Inventories:
Raw material and supplies
Work in progress
Finished goods
FIFO inventories
LIFO reserve
Net inventories
Other current assets:
Product liability insurance receivable
Prepaid tax
Prepaid insurance
Other
Total other current assets
Property, plant and equipment:
Land
Buildings
Machinery and equipment
Capital leases
Construction in progress
Total property, plant and equipment
Accumulated depreciation
Tooling, net of amortization
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
$ 666.0
85.8
751.8
(7.8)
$ 744.0
$ 207.4
100.0
91.9
399.3
(12.4)
$ 386.9
23.3
14.5
1.4
51.3
$ 90.5
$ 43.6
508.7
1,687.8
1.1
112.8
2,354.0
(988.4)
$1,365.6
95.1
$1,460.7
$ 178.9
19.1
$ 198.0
$ 60.4
16.6
176.9
120.4
27.0
$ 401.3
Accounts payable and accrued expenses:
Trade payables
Payroll and related
Environmental
Product liability accrual
Product warranties
$ 534.7
113.2
11.2
23.3
34.6
10.7
12.9
11.7
10.9
0.4
79.8
Total accounts payable and accrued expenses $ 843.4
Dividends payable to minority shareholders
Current deferred income taxes, net
Other
Customer related accruals
Insurance
Interest
$ 567.1
67.3
$ 634.4
(8.3)
$ 626.1
$ 163.9
84.9
92.3
341.1
(9.1)
$ 332.0
20.8
7.7
1.1
22.7
$ 52.3
$ 43.6
443.7
1,529.4
1.1
141.6
2,159.4
(864.5)
$1,294.9
106.2
$1,401.1
$ 189.1
8.6
$ 197.7
$ 70.6
20.2
65.6
99.7
36.0
$ 292.1
$ 450.0
107.9
26.1
20.8
25.4
16.4
22.1
15.1
8.8
6.1
87.7
$ 786.4
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
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. In 2006, the Company recognized
an additional $4.8 million as a gain from this previous divestiture.
N OTE 8
Goodwill and Other Intangibles
The changes in the carrying amount of goodwill for the twelve months
ended December 31, 2004, 2005 and 2006, are as follows:
millions of dollars
Drivetrain
Engine
Total
Balance at January 1, 2004
Translation adjustment
Balance at December 31, 2004
BERU acquisition
Translation adjustment
Balance at December 31, 2005
ETEC acquisition
Goodwill impairment
Translation adjustment
Balance at December 31, 2006
$134.3
0.3
$134.6
—
(0.5)
$134.1
21.9
(0.2)
1.4
$157.2
$717.7
8.5
$726.2
204.7
(35.2)
$895.7
—
—
33.6
$929.3
$ 852.0
8.8
$ 860.8
204.7
(35.7)
$1,029.8
21.9
(0.2)
35.0
$1,086.5
The Company’s other intangible assets, primarily from acquisitions, are
valued based on independent appraisals and consist of the following:
in millions
December 31, 2006
Amortized intangible assets
Patented technology
Unpatented technology
Customer relationships
Distribution network
Miscellaneous
Total amortized intangible assets
Unamortized trade names
Total intangible assets
December 31, 2005
Amortized intangible assets
Patented technology
Unpatented technology
Customer relationships
Distribution network
Miscellaneous
Total amortized intangible assets
Unamortized trade names
Total intangible assets
Gross
Carrying Accumulated
Amortization
Amount
Net
Carrying
Amount
$ 10.5
5.7
80.0
34.8
14.7
$145.7
15.6
$161.3
$ 9.4
1.1
54.5
31.2
14.7
$110.9
14.0
$124.9
$ 1.8
0.7
12.6
13.9
11.9
$40.9
—
$40.9
$ 0.8
0.3
5.7
6.6
11.8
$25.2
—
$25.2
$ 8.7
5.0
67.4
20.9
2.8
$104.8
15.6
$120.4
$ 8.6
0.8
48.8
24.6
2.9
$ 85.7
14.0
$ 99.7
millions of dollars
December 31,
Other non-current liabilities:
Environmental accruals
Product warranties
Deferred income taxes, net
Product liability accrual
Self-insurance
Lease residual value
Employee costs
Other
Total other non-current liabilities
(a)Bad debt allowance:
Beginning balance
Acquisitions
Provision
Write-offs
Currency translation
Ending balance
2006
2005
$ 8.8
25.4
108.0
16.6
8.7
6.0
8.5
99.4
$ 281.4
$ (8.3)
(0.1)
(0.8)
2.0
(0.6)
$ (7.8)
$ 13.0
18.6
105.7
20.2
8.4
—
—
58.4
$ 224.3
$ (10.9)
(3.0)
(2.4)
6.8
1.2
$ (8.3)
Interest costs capitalized during 2006 and 2005 were $8.5 million and
$6.9 million, respectively. As of December 31, 2006 and December 31,
2005, accounts payable of $36.0 million and $41.6 million, respectively,
were related to property, plant and equipment purchases. As of
December 31, 2006 and December 31, 2005, specific assets of $21.3
million and $32.6 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 $41.1 million,
$12.7 million and $23.9 million in 2006, 2005 and 2004, respectively.
Following are summarized financial data for NSK-Warner, translated using
the ending or periodic rates as of and for the years ended November 30,
2006, 2005 and 2004 (unaudited):
millions of dollars
2006
2005
2004
Balance sheets:
Current assets
Non-current assets
Current liabilities
Non-current liabilities
Statements of operations:
Net sales
Gross profit
Net income
$256.8
136.8
128.6
19.7
$535.4
111.6
54.7
$236.7
168.7
120.8
18.4
$471.8
94.5
55.6
$242.3
180.7
126.2
18.5
$443.5
97.3
52.6
The equity of NSK-Warner as of November 30, 2006, was $245.2 million,
there was no debt and their cash and securities were $91.1 million.
Purchases from NSK-Warner for the years ended December 31, 2006, 2005
and 2004 were $23.0 million, $25.4 million and $19.9 million, respectively.
2
Notes to Consolidated Financial Statements
continued
Amortization of other intangible assets was $17.5 million for the year ended
December 31, 2006. Amortization of other intangible assets was $31.7
million for the year ended December 31, 2005, including non-recurring
charges directly attributable to the BERU Acquisition. The estimated
useful lives of the Company’s amortized intangible assets range from 4 to
12 years. The Company utilizes the straight line method of amortization,
recognized over the estimated useful lives of the assets. The estimated
future annual amortization expense, primarily for acquired intangible assets,
is as follows: $16.5 million in 2007, $16.5 million in 2008, $16.2 million in
2009, $9.3 million in 2010 and $9.3 million in 2011.
A roll-forward of the gross carrying amounts for the years ended December 31,
2006 and 2005 is presented below.
millions of dollars
Beginning balance
Acquisitions
Translation adjustment
Ending balance
2006
2005
$124.9
22.8
13.6
$ 161.3
$ 14.7
126.2
(16.0)
$124.9
A roll-forward of accumulated amortization for the years ended December 31,
2006 and 2005 is presented below.
millions of dollars
Beginning balance
Provisions
Non-recurring charges
Translation adjustment
Ending balance
NOT E 9
Product Warranty
2006
2005
$ 25.2
17.5
(3.5)
1.7
$ 40.9
$ 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, 2006 and 2005 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 non-current liabilities
Total product warranty liability
NOT E 10
Notes Payable and Long-Term Debt
2006
2005
$44.0
0.1
36.8
(26.4)
5.5
$60.0
$34.6
25.4
$60.0
$26.4
12.0
30.0
(20.3)
(4.1)
$44.0
$25.4
18.6
$44.0
Following is a summary of notes payable and long-term debt. The weighted
average interest rate on all borrowings outstanding as of December 31,
2006 and 2005 was 4.9% and 4.7%, respectively.
millions of dollars
December 31,
Bank borrowings and other
Term loans due through 2013
(at an average rate of 3.0% in
2006 and 3.2% in 2005)
5.75% Senior Notes due 11/01/16,
net of unamortized discount(a)
7.00% Senior Notes due 11/01/06,
net of unamortized discount(a)
6.50% Senior Notes due 2/15/09,
net of unamortized discount(a)
8.00% Senior Notes due 10/01/19,
net of unamortized discount(a)
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
Total notes payable and
long-term debt
2006
2005
Current Long-Term
Current Long-Term
$131.8 $ 5.9 $136.2 $21.0
19.9
23.1
24.3
30.4
—
149.0
—
—
—
139.0
—
—
— 136.4
— 136.2
— 133.9
— 133.9
— 119.2
— 119.1
151.7
—
567.5
1.9
299.5
0.4
440.6
—
$151.7 $569.4 $299.9 $440.6
(a) The Company entered into several interest rate swaps, which have the effect of converting $325.0
million and $314.0 million of these fixed rate notes to variable rates as of December 31, 2006
and 2005, respectively. The weighted average effective interest rates for these borrowings, including
the effects of outstanding swaps as noted in Note 11, were 4.5% and 4.8% as of December 31,
2006 and 2005, respectively.
Annual principal payments required as of December 31, 2006 are as
follows (in millions of dollars):
2007
2008
2009
2010
2011
After 2011
Total Payments
Less: Unamortized Discounts
Total
$151.7
9.8
147.3
3.2
2.2
409.8
$724.0
(2.9)
$721.1
The Company has a multi-currency revolving credit facility, which
provides for borrowings up to $600 million through July 2009. At
December 31, 2006, there were no borrowings outstanding under the
facility. 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,
2006 and expects to be compliant in future periods. The Company’s
7.00% Senior Notes of $139.0 million matured on November 1, 2006.
These notes were refinanced with the issuance of $150.0 million 5.75%
Senior Notes due November 1, 2016. At December 31, 2006 and
2005, the Company had outstanding letters of credit of $27.0 million
and $25.7 million, respectively. The letters of credit typically act as
a guarantee of payment to certain third parties in accordance with
specified terms and conditions.
As of December 31, 2006 and 2005, the estimated fair values of the
Company’s senior unsecured notes totaled $572.7 million and $574.7
30
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
million, respectively. The estimated fair values were $34.2 million higher
in 2006 and $46.6 million higher in 2005 than their respective carrying
values. Fair market values are developed by the use of estimates
obtained from brokers and other appropriate valuation techniques
based on information available as of year-end. The fair value estimates
do not necessarily reflect the values the Company could realize in the
current markets.
As of December 31, 2006, the fair value of the fixed to floating interest
rate swaps was recorded as a non-current asset of $1.9 million. 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. No hedge ineffectiveness was
recognized in relation to fixed to floating swaps.
NOT E 11
Financial Instruments
The Company’s financial instruments include cash and cash equivalents,
marketable securities, trade receivables, trade payables, and notes
payable. Due to the 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. All derivative contracts
are placed with counterparties that have a credit rating of “A-“ or better.
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).
The Company also selectively uses cross-currency swaps to hedge the
foreign currency exposure associated with our net investment in certain
foreign operations (net investment hedges).
A summary of these instruments outstanding at December 31, 2006
follows (currency in millions):
Interest rate swaps
Fixed to floating
Fixed to floating
Fixed to floating
Cross currency swap
Floating $ to floating €
Floating $ to floating ¥
Floating $ to floating €
Hedge Type
Fair value
Fair value
Fair value
Net investment
Net investment
Net investment
Notional
Amount
Maturity(a)
$100
$150
$75
$100
$150
$75
February 15, 2009
November 1, 2016
October 1, 2019
February 15, 2009
November 1, 2016
October 1, 2019
(a) The maturity of the swaps corresponds with the maturity of the hedged item as noted in the debt
summary, unless otherwise indicated.
Effectiveness for interest rate and cross currency swaps is assessed
at the inception of the hedging relationship. If specified criteria for
the assumption of effectiveness are not met at hedge inception,
effectiveness is assessed quarterly. Ineffectiveness is measured
quarterly and results are recognized in earnings.
The interest rate swaps that are fair value hedges were determined to be
exempt from ongoing tests of their effectiveness as hedges at the time
of the hedge inception. This determination was made based upon the
fact that the swaps matched the underlying debt terms for the following
factors: notional amount, fixed interest rate, interest settlement dates,
and maturity date. Additionally, the fair value of the swap was zero at the
time of inception, the variable rate is based on a benchmark, with no
floor or ceiling, and the interest bearing liability is not pre-payable at a
price other than its fair value.
31
As of December 31, 2006, the fair value of the cross currency swaps
was recorded as a non-current asset of $1.7 million and a non-current
liability of $(5.5) million. As of December 31, 2005, the fair value of
the cross currency swaps was recorded as a current asset of $3.9
million and a current liability of $(5.1) million, and a non-current asset
of $14.9 million and a non-current liability of $(33.1) million. Hedge
ineffectiveness of $0.8 million was recognized as of December 31, 2006
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, 2006, the Company had forward and option commodity contracts
with a total notional value of $19.1 million. As of December 31, 2006,
the Company was holding commodity derivatives with a negative fair
market value of $(2.0) million ($(1.9) million losses maturing in less
than one year). To the extent that derivative instruments are deemed
to be effective as defined by FAS 133, gains and losses arising from
these contracts are deferred in other comprehensive income. Such gains
and losses will be reclassified into income as the underlying operating
transactions are realized. Gains and losses that do not qualify for
deferral treatment have been credited/charged to income as they are
recognized. As of December 31, 2005, the Company had commodity
forward contracts with a total notional value of $5.8 million. The fair
market value of the forward contracts was $2.1 million ($2.0 million
maturing in less than one year) as of December 31, 2005. Losses not
qualifying for deferral associated with these contracts as of December
31, 2006 amounted to $(0.1) million. As of December 31, 2005, gains
and losses not qualifying for deferral were insignificant.
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
commitments are covered by forward currency arrangements to protect
against currency risk through 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, 2006,
contracts were outstanding to buy or sell U.S. Dollars, Euros, British
Pounds Sterling, South Korean Won, Japanese Yen and Hungarian
Forints. To the extent that derivative instruments are deemed to be
effective as defined by FAS 133, gains and losses arising from these
contracts are deferred in other comprehensive income.
The Company has a number of defined benefit pension plans and
other post employment 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 employment benefit
plans, which provide medical and life insurance benefits, are unfunded
plans. The pension and other post employment benefit plans in the U.S.
have been closed to new employees since 1995. The measurement date
for all plans is December 31.
Effective April 1, 2006, a subsidiary of the Company, BorgWarner
Diversified Transmission Products Inc. (“DTP”), changed its retiree medical
benefits program to provide certain participating retirees with continued
access to group health coverage while reducing its subsidy of the program.
DTP has filed a declaratory judgment action to affirm its right to adjust the
benefit. Litigation over the right to adjust retiree benefits is commonplace.
DTP believes it is within its right to adjust the benefit under the plans, and
that it will be successful in the declaratory judgment action, although there
can be no guarantee of success in any litigation.
This plan change (negative amendment) is being amortized over the average
remaining service life to retirement eligibility of active plan participants.
During the fourth quarter, the Company evaluated the competitiveness
of its North American facilities, as well as its long-term capacity
needs. As a result, the Company will be closing its Drivetrain plant in
Muncie, Indiana and has adjusted the carrying values of other assets,
primarily related to its four-wheel drive transfer case product line. One
of the impacts of this fourth quarter restructuring was the Company’s
recognition of a $6.8 million pension curtailment expense. See Note 3
for further details on the Company’s 2006 restructuring activities.
As a result of the adjustments, as well as implementing cost reduction
initiatives at other subsidiaries, expenses for other post employment
benefits for the full year 2006 were slightly lower than the expense
recognized in the full year 2005.
The following table summarizes the expenses for the Company’s defined
contribution and defined benefit pension plans and the other post
employment defined benefit plans.
millions of dollars
2006
2005
2004
Defined contribution pension expense
Defined benefit pension expense
Other post employment benefit expenses
Total
$23.7
24.1
47.2
$95.0
$23.1
17.6
48.8
$89.5
$22.4
16.7
43.2
$82.3
Notes to Consolidated Financial Statements
continued
Such gains and losses will be reclassified into income as the underlying
operating transactions are realized. Any gains or losses not qualifying
for deferral are credited/charged to income as they are recognized. As
of December 31, 2006, the Company was holding foreign exchange
derivatives with a positive market value of $5.1 million ($4.5 million
maturing in less than one year) and derivatives with a negative
market value of $(0.1) million (all maturing in less than one year). As
of December 31, 2005, the Company was holding foreign exchange
derivatives with a positive market value of $3.0 million ($1.6 million
maturing in less than one year). Derivative contracts with negative value
amounted to $(1.6) million ($(1.4) million maturing in less than one
year). Gains not qualifying for deferral associated with these contracts
as of December 31, 2006 amounted to $0.7 million. As of December 31,
2005, losses not qualifying for deferral amounted to $(0.5) million.
NOT E 12
Retirement Benefit Plans
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 158, Employers’ Accounting for Defined Benefit Pension
and Other Postretirement Plans – an amendment of FASB Statements No.
87, 88, 106, and 123(R) (“FAS 158”). FAS 158 requires an employer to
recognize the funded status of each defined benefit post employment
plan on the balance sheet. The funded status of all overfunded plans is
aggregated and recognized as a non-current asset on the balance sheet.
The funded status of all underfunded plans is aggregated and recognized
as a current liability, a non-current liability, or a combination of both on
the balance sheet. A current liability is the amount by which the actuarial
present value of benefits included in the benefit obligation payable in the
next 12 months exceeds the fair value of plan assets, and is determined
on a plan-by-plan basis. FAS 158 also requires the measurement date
of a plan’s assets and its obligations to be the employer’s fiscal year-
end date, as to which the Company already complies. Additionally, FAS
158 requires an employer to recognize changes in the funded status of
a defined benefit post employment plan in the year in which the change
occurs. FAS 158 was effective for the Company as of December 31,
2006. The incremental effect of applying FAS 158 to the Company’s
Consolidated Balance Sheet as of December 31, 2006 was to increase
non-current deferred tax assets by $88.8 million and retirement-
related liabilities by $187.3 million and to decrease accumulated other
comprehensive income (loss) by $98.5 million.
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 $23.7 million in 2006, $23.1 million in 2005,
and $22.4 million in 2004.
32
2006 annual report
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
Curtailment loss
Actuarial (gain) loss
Currency translation
Acquisition/business combination
Other
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
Other
Benefits paid
Fair value of plan assets at end of year
Funded status:
Funded status at end of year
Unrecognized net actuarial loss
Unrecognized transition obligation
Unrecognized prior service cost (benefit)
Net amount recognized
Amounts recognized in the Consolidated
Balance Sheets consist of:
Non-current assets
Current liabilities
Non-current liabilities
Intangible asset
Accumulated reduction in stockholders’ equity in 2005
Net amount recognized
Amounts recognized in accumulated other
comprehensive loss in 2006 consist of:
Net actuarial loss
Net prior service cost (credit)
Net transition obligation
Net amount recognized in 2006
Amounts recognized in accumulated other
comprehensive loss in 2006 consist of:
Other minimum pension liability adjustment
Incremental effect of applying FAS 158
Net amount recognized in 2006
Pension benefits
2006
2005
U.S.
Non-U.S.
U.S.
Non-U.S.
Other post
employment benefits
2006
2005
$316.1
2.5
16.7
—
—
4.4
(9.5)
—
—
—
(25.1)
$305.1
$332.6
42.1
—
—
—
—
(25.1)
$349.6
$ 299.9
12.8
14.1
0.3
—
—
(7.9)
36.8
—
2.6
(13.7)
$305.3
2.5
16.9
—
(2.8)
—
17.6
—
—
—
(23.4)
$ 260.2
12.1
13.7
0.3
—
—
23.9
(34.8)
35.5
—
(11.0)
$ 679.9
10.8
31.0
—
(66.5)
—
(105.4)
—
—
—
(36.2)
$ 537.2
7.9
30.6
—
(22.6)
—
165.9
—
—
—
(39.1)
$ 344.9
$316.1
$ 299.9
$ 513.6
$ 679.9
$ 138.9
11.0
17.5
0.3
19.3
1.7
(13.7)
$324.4
21.6
10.0
—
—
—
(23.4)
$ 124.7
22.6
16.0
0.3
(13.7)
—
(11.0)
$ 175.0
$332.6
$ 138.9
$ 44.5
$(169.9)
$ 16.5
98.4
—
3.6
$(161.0)
58.7
0.3
—
$(513.6)
$(679.9)
356.8
—
(22.2)
$ 44.5
$(169.9)
$118.5
$(102.0)
$(513.6)
$(345.3)
$ 60.3
—
(15.8)
$ 0.1
(4.8)
(165.2)
$ 67.3
$ —
(32.0)
3.3
79.9
(144.8)
—
42.8
$ —
(33.7)
(479.9)
$ —
(345.3)
$44.5
$(169.9)
$118.5
$(102.0)
$(513.6)
$(345.3)
$ 68.8
0.2
—
$69.0
$ 54.5
—
0.3
$ 54.8
$ 56.2
12.8
$69.0
$ 37.6
17.2
$ 54.8
$ 230.2
(72.9)
—
$ 157.3
$ —
157.3
$157.3
Total accumulated benefit obligation for all plans
$305.1
$ 327.1
$315.9
$ 282.2
33
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
2006
2005
$(555.0)
387.0
$(168.0)
$(519.8)
343.6
$(176.2)
$ (15.8)
(19.7)
(115.4)
(17.1)
$(168.0)
$ (32.0)
(30.7)
(97.9)
(15.6)
$(176.2)
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, 2006 and 2005.
The Company expects to contribute a total of $15 million to $20 million
into all of its defined benefit pension plans during 2007.
The weighted-average asset allocations of the Company’s funded pension
plans at December 31, 2006 and 2005, and target allocations by asset
category are as follows:
percent
2006
2005
Target
Allocation
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
12%
32
56
100% 100%
10%
33
57
2%
34
64
100%
1%
35
64
100%
0-15%
25-45
45-65
0-10%
30-40
60-70
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,
Components of net periodic benefit cost:
Service cost
Interest cost
Expected return on plan assets
SFAS 88 event (Note 3)
Amortization of unrecognized transition obligation
Amortization of unrecognized prior service cost (benefit)
Amortization of unrecognized loss
Other
Net periodic benefit cost (benefit)
2006
Pension benefits
2005
2004
Other post employment
benefits
U.S.
Non-U.S.
U.S.
Non-U.S.
U.S.
Non-U.S.
2006
2005
2004
$ 2.5
16.7
(28.4)
6.8
—
0.9
6.4
—
$ 4.9
$12.8
14.1
(10.9)
—
—
0.1
2.6
0.5
$19.2
$ 2.6
16.9
(28.0)
—
—
1.1
4.7
—
$12.1
13.7
(8.1)
—
—
0.3
2.3
—
$ (2.7) $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
$ 10.8
31.0
—
—
—
(15.8)
21.2
—
$ 47.2
$ 7.9
30.6
—
—
—
(2.4)
12.7
—
$48.8
$ 6.0
28.8
—
—
—
(0.2)
8.6
—
$43.2
34
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
2007. The Company’s assumed long-term rate of return on assets for its
U.K. pension plan was 7.25% for 2006 and 6.75% for 2005 and 2004.
The Company does not anticipate a change in the long-term rate of
return on U.K. pension plan assets for 2007.
The estimated future benefit payments for the pension and other post
employment benefits are as follows:
Pension
Benefits
millions of dollars
Year
2007
2008
2009
2010
2011
2012-2016
U.S.
Non-U.S.
$ 24.9
24.8
25.5
25.5
24.9
115.0
$13.4
13.5
13.0
13.5
13.9
82.0
Other
Post Employment Benefits
w/o Medicare
Part D
reimbursements
With Medicare
Part D
reimbursements
$ 37.2
39.3
41.6
43.6
44.3
217.8
$ 33.7
35.6
37.6
39.4
40.0
195.0
The weighted-average rate of increase in the per capita cost of covered
health care benefits is projected to be 9% in 2007 decreasing to 5% 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 other post employment benefit obligation
Effect on total service and interest
cost components
One percentage point
Decrease
Increase
$49.1
$(41.1)
$ 6.1
$ (4.9)
N OTE 13
Stock Incentive Plans
On January 1, 2006, the Company adopted Statement of Financial
Accounting Standards No. 123 (Revised 2004), Share-Based Payment
(“FAS 123R”), which required the Company to measure all employee
stock-based compensation awards using a fair value method and record
the related expense in the financial statements. The Company elected
to 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. All periods presented prior
to January 1, 2006 were accounted for in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees
(“APB No. 25”). Accordingly, no compensation cost was recognized for
fixed stock options prior to January 1, 2006 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.
In October 2005, the FASB issued FASB Staff Position (“FSP”) No.
123R-2, Practical Accommodation to the Application of Grant Date as
Defined in FASB Statement No. 123R (“FSP 123R-2”), to provide guidance
on determining the grant date for an award as defined in FAS 123R. FSP
123R-2 stipulates that assuming all other criteria in the grant date
definition are met, a mutual understanding of the key terms and conditions
of an award to an individual employee is presumed to exist upon the
The estimated net loss for the defined benefit pension plans that will
be amortized from accumulated other comprehensive income into
net periodic benefit cost over the next fiscal year is $6.0 million. The
estimated net loss and prior service credit for the other defined benefit
postretirement plans that will be amortized from accumulated other
comprehensive income into net periodic benefit cost over the next fiscal
year are $15.2 million and $(15.8) million, respectively.
The Company’s weighted-average assumptions used to determine
the benefit obligations for its defined benefit pension and other post
employment plans as of December 31, 2006 and 2005 were as follows:
percent
2006
2005
U.S. pension plans:
Discount rate
Rate of compensation increase
U.S. other post employment plans:
Discount rate
Rate of compensation increase
Non-U.S. pension plans:
Discount rate
Rate of compensation increase
5.94
3.50
6.00
N/A
4.68
2.95
5.50
3.50
5.50
N/A
4.43
2.95
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,
2006 were as follows:
percent
2006
2005
2004
U.S. pension plans
Discount rate
Rate of compensation increase
Expected return on plan assets
U.S. other post employment plans
Discount rate
Rate of compensation increase
Expected return on plan assets
Non-U.S. pension plans
Discount rate
Rate of compensation increase
Expected return on plan assets
5.50
3.50
8.75
5.50
N/A
N/A
4.43
2.95
7.10
5.75
3.50
8.75
5.75
N/A
N/A
5.04
3.36
6.63
6.00
3.50
8.75
6.00
N/A
N/A
5.49
3.40
6.62
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 for each plan.
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 2006, 2005 and 2004. The Company does not anticipate
a change in the long-term rate of return on U.S. pension plan assets for
3
Notes to Consolidated Financial Statements
continued
award’s approval in accordance with the relevant corporate governance
requirements, provided that the key terms and conditions of an award
(a) cannot be negotiated by the recipient with the employer because the
award is a unilateral grant, and (b) are expected to be communicated to
an individual recipient within a relatively short time period from the date of
approval. The Company has applied the principles set forth in FSP 123R-2
in connection with its adoption of FAS 123R on January 1, 2006.
Paragraph 81 of FAS 123R requires an entity to calculate the pool of excess
tax benefits available to absorb tax deficiencies recognized subsequent to
adopting Statement 123R (termed the “APIC Pool”). In November 2005,
the FASB issued FSP No. 123R-3, Transition Election Related to Accounting
for the Tax Effects of Share-Based Payment Awards (“FSP 123R-3”), to
provide an alternative transition election related to accounting for the tax
effects of share-based payment awards to employees to the guidance
provided in Paragraph 81 of FAS 123R. The Company elected to adopt
the transition method described in FSP 123R-3. Utilizing the calculation
method described in FSP 123R-3, the Company calculated its APIC pool as
of January 1, 2006 associated with stock options that were fully vested as
of December 31, 2005. The impact on the APIC Pool for stock options that
are partially vested at, or granted subsequent to, December 31, 2005 are
being determined in accordance with FAS 123R.
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, which was
amended at the Company’s 2006 Annual Stockholders Meeting, among
other things, to increase the number of shares available for issuance
under the plan. Under the BorgWarner Inc. Amended and Restated
2004 Stock Incentive Plan (“2004 Stock Incentive Plan”), the number
of shares authorized for grant is 5,000,000. As of December 31, 2006,
there were a total of 3,471,367 outstanding options under the 1993 and
2004 Stock Incentive Plans.
The adoption of FAS 123R reduced income before income taxes and net
earnings by $12.7 million and $9.4 million ($0.16 per basic and diluted
share) for the year ended December 31, 2006. The adoption affected both
operating activities ($12.7 million non-cash charge) and financing activities
($3.3 million tax benefit) of the Statement of Cash Flows for the year
ended December 31, 2006. Total unrecognized compensation cost related
to nonvested stock options at December 31, 2006 is $20.7 million. This
cost is expected to be recognized over the next three years. On a weighted
average basis, this cost is expected to be recognized over 1.0 year.
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, Accounting for Stock-Based
Compensation, for the prior periods presented:
millions, except per share amounts
2005
2004
Net earnings as reported
Add: Stock-based employee compensation
expense included in net earnings, 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
$239.6
$218.3
5.5
1.6
(12.2)
$ 232.9
(7.7)
$212.2
Earnings per share:
Basic - as reported
Basic - pro forma
Earnings per share:
Diluted - as reported
Diluted - pro forma
$ 4.23
$ 4.11
$ 3.91
$ 3.80
$ 4.17
$ 4.06
$ 3.86
$ 3.75
A summary of the plans’ shares under option at December 31, 2006, 2005 and 2004 follows:
2006
2005
2004
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
3,209
854
(497)
(95)
3,471
1,213
2,182
$42.41
58.18
32.65
50.00
$47.48
$33.19
2,995
968
(713)
(41)
3,209
876
$33.24
58.08
26.04
31.43
$42.41
$26.02
2,685
1,063
(593)
(160)
2,995
793
$26.39
44.56
24.22
26.74
$ 33.24
$ 23.78
The following table summarizes information about stock options outstanding at December 31, 2006:
Range of
exercise prices
$16.34-19.80
$24.14-33.04
$44.30-58.18
Options outstanding
Options exercisable
Number outstanding
(thousands)
Weighted-average remaining
contractual life (years)
Weighted-average
exercise price
Number exercisable
(thousands)
Weighted-average
exercise price
66
761
2,644
3,471
3.5
5.6
8.6
7.8
36
$18.05
$28.64
$ 53.64
$ 47.48
66
761
386
1,213
$18.05
$28.64
$ 44.76
$ 33.19
The weighted average fair value at date of grant for options granted
during 2006, 2005, and 2004 were $17.81, $14.63, and $16.28,
respectively, and were estimated using the Black-Scholes options pricing
model with the following weighted average assumptions:
Risk-free interest rate
Dividend yield
Volatility factor
Weighted average expected life
2006
2005
2004
5.04%
1.10%
29.06%
4.8 years
4.07%
1.09%
27.02%
4.0 years
4.14%
1.26%
32.89%
6.5 years
The expected lives of the awards are based on historical exercise
patterns and the terms of the options. 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 the expected
dividend yield or the future stock volatility is likely to differ from
historical patterns.
Restricted Stock 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 ratably at the end of each
year from the date of grant over a period of three years. The Company
issued 11,348 and 16,099 such shares in 2006 and 2005, respectively.
The market value of the Company’s common stock at the date of grant
determines the value of the restricted stock. The value of the awards
are recorded as unearned compensation within capital in excess of
par value in stockholders’ equity, and is amortized as compensation
expense over the restriction periods. The Company recognized
compensation expense of $0.6 million and $0.2 million in 2006 and
2005, respectively, related to restricted stock.
Stock Compensation Plans The 2004 Stock Incentive Plan provides for
awarding of performance shares to members of senior management
at the end of successive three-year periods based on the Company’s
performance in terms of total shareholder return relative to a peer group
of automotive companies. Awards earned are payable 40% in cash and
60% in the Company’s common stock. For the three-year measurement
periods ended December 31, 2006, 2005 and 2004, the amounts
expensed under the plan and the related share issuances were as follows:
2006
2005
2004
Expense ($ millions)
Number of shares*
*Shares are issued in February of the following year.
$2.2
39,085
$8.8
50,275
$2.0
48,569
The higher expense in 2005 in comparison to 2006 and 2004 was
primarily related to the Company stock’s performance measured by total
shareholder return relative to its peer group during 2005. Estimated
shares issuable under the plans are included in the computation of
diluted earnings per share as earned.
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
N OTE 14
Other Comprehensive Income (Loss)
The components of accumulated other comprehensive income (loss), net
of tax, in the Consolidated Balance Sheets are as follows:
millions of dollars
2006
2005
Foreign currency translation adjustments, net
Market value of hedge instruments, net
Unrealized gain (loss) on available-for-sale securities, net
Minimum pension liability adjustment, net
Accumulated other comprehensive loss
$ 2.3
$ 96.5
2.9
0.1
(0.3)
1.5
(158.4)
(78.0)
$(60.3) $ (73.1)
The changes in the components of other comprehensive income (loss) in
the Consolidated Statements of Stockholders’ Equity are as follows:
millions of dollars
Foreign currency translation adjustments
Market value change of hedge instruments
Income taxes
Net foreign currency translation
and hedge instruments adjustment
Unrealized loss on
available-for-sale securities
Income taxes
Net unrealized loss on
available-for-sale securities
Implementation of FAS 158 (Note 12)
Income taxes
Net implementation of FAS 158
Minimum pension liability adjustment
Income taxes
Net minimum pension liability adjustment
Other comprehensive income (loss)
2006
2005
2004
$ 94.2 $ (97.4)
(1.1)
0.8
(4.4)
1.6
$10.7
4.7
13.0
91.4
(97.7)
28.4
1.9
(0.1)
(0.4)
0.1
—
—
1.8
(187.3)
88.8
(98.5)
28.9
(10.8)
18.1
(0.3)
—
—
—
(45.7)
15.4
(30.3)
$ 12.8 $(128.3)
—
—
—
—
17.2
(4.4)
12.8
$41.2
N OTE 15
Contingencies
In the normal course of business, the Company and its subsidiaries are
parties to various commercial and legal claims, actions and complaints,
including matters involving warranty claims, 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 commercial and 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
3
Notes to Consolidated Financial Statements
continued
liable for the cost of clean-up and other remedial activities at 35 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, this is because either the
estimates of the maximum potential liability at a site are not large or the
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 the Company (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,
2006, of $20.0 million. Excluding the Crystal Springs site discussed
below for which $10.8 million has been accrued, the Company has
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 pay out substantially all of the $20.0 million
accrued environmental 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, then unknown to the Company, 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 the Company that it discovered
potential environmental contamination at its Crystal Springs, Mississippi
plant while undertaking an expansion of the plant. The Company is
continuing to work with the Mississippi Department of Environmental
Quality and Kuhlman Electric to investigate and remediate to the extent
necessary, if any, historical contamination at the plant and surrounding
area. 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 $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
3
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
approximately 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 March 2005, the FASB issued Interpretation No. 47, Accounting for
Conditional Asset Retirement Obligations – an interpretation of FASB
Statement No. 143 (“FIN 47”), 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 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 (“PCB”) transformers and capacitors when
their use ceases, and the disposal of used furnace bricks and liners, and
lead-based paint in conjunction with facility renovations or demolition.
The Company currently has 17 manufacturing locations that have been
identified as containing these items. The fair value to remove and dispose
of this material has been estimated and recorded at $1.0 million and $0.8
million as of December 31, 2006 and 2005, respectively.
Product Liability
Like many other industrial companies that have historically operated
in the U.S., the Company (or parties the Company is obligated to
indemnify) 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 that were
manufactured many years ago and 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, 2006, the Company had approximately
45,000 pending asbestos-related product liability claims. Of these
outstanding claims, approximately 34,000 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
2006, of the approximately 27,000 claims resolved, only 169 (0.6%)
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
resulted in any payment being made to a claimant by or on behalf of
the Company. 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.
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 arrangement. In June 2004, primary layer
insurance carriers notified the Company of the alleged 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 arrangement. To date, the Company has paid
$16.2 million in defense and indemnity in advance of insurers’
reimbursement and has received $4.5 million in cash from insurers. The
outstanding balance of $11.7 million is expected to be fully recovered.
Timing of the recovery is dependent on final resolution of the declaratory
judgment action referred to below. At December 31, 2005, insurers
owed $3.9 million in association with these claims.
At December 31, 2006, the Company has an estimated liability of
$39.9 million for future claims resolutions, with a related asset of
$39.9 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, 2005, the comparable value of the insurance
receivable and accrued liability was $41.0 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
Other non-current liabilities
Total accrued liability
2006
2005
$23.3
16.6
$39.9
$20.8
20.2
$41.0
$23.3
16.6
$39.9
$20.8
20.2
$41.0
The Company cannot reasonably estimate possible losses, if any, in
excess of those for which it has accrued, because it 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, the Company’s experiences in aggressively defending and
resolving claims in the past, and the Company’s 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.
N OTE 16
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 $22.4 million in 2006,
$21.9 million in 2005, and $18.0 million in 2004. 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 2007. In the event the
Company exercises its option not to purchase the production equipment,
the Company has guaranteed a residual value of $14.4 million. The
Company has accrued $6.0 million as an expected loss on this guarantee.
Future minimum operating lease payments at December 31, 2006 were
as follows:
millions of dollars
2007
2008
2009
2010
2011
After 2011
Total minimum lease payments
$27.7(a)
8.5
8.0
6.8
6.2
16.1
$ 73.3
(a) 2007 includes $14.4 million for the guaranteed residual value of production equipment with a lease
that expires in 2007.
3
Notes to Consolidated Financial Statements
continued
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 $1.5 million in 2006,
$1.9 million in 2005 and $14.2 million in 2004. These costs were all
recognized as part of cost of goods sold.
NOT E 17
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.
NOT E 18
Earnings Per Share
Earnings per share of common stock outstanding were computed as follows:
in millions except per share amounts
2006
2005
2004
Basic earnings per share:
Net earnings
Shares of common stock outstanding
Basic earnings per share
$ 211.6
57.403
$ 239.6
56.708
$ 218.3
55.872
of common stock
$ 3.69
$ 4.23
$ 3.91
Diluted earnings per share:
Net earnings
Shares of common stock outstanding
Effect of dilutive securities:
$ 211.6
57.403
$ 239.6
56.708
$ 218.3
55.872
Stock options
0.568
0.690
0.665
Shares of common stock outstanding
including dilutive shares
Diluted earnings per share
of common stock
57.971
57.398
56.537
$ 3.65
$ 4.17
$ 3.86
N OTE 19
Recent Acquisitions
The Company acquired the ETEC product lines from Eaton Corporation as
of the close of business for the quarter ended September 30, 2006 for
$63.7 million, net of cash acquired. The operating results of ETEC have
been reported within the Drivetrain segment since its acquisition.
In the first quarter of 2005, the Company acquired 69.4% of the
outstanding shares of BERU AG (“BERU”), headquartered in Ludwigsburg,
Germany, primarily from the Carlyle Group and certain family shareholders
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 from the date of
the acquisition. 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, 2006.
N OTE 20
Operating Segments and Related Information
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
automotive components and systems. Effective January 1, 2006, the
Company assigned an operating facility previously reported in the Engine
segment to the Drivetrain segment due to changes in the facility’s product
mix. Prior year segment amounts have been reclassified to conform to the
current year’s presentation.
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
income taxes (“EBIT”) adjusted for income 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, income 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 income 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.
40
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
The following tables show net sales and segment earnings before interest and income taxes for the Company’s reportable operating segments.
Operating Segments
millions of dollars
Customers
Intersegment
Net
Earnings before
interest and taxes
Year end
assets
Depreciation/
amortization
Long-lived
asset
expenditures
(b)
Net Sales
2006
Engine
Drivetrain
Inter-segment eliminations
Total
Corporate
Consolidated
Restructuring expense
Interest expense and finance charges
Earnings before income taxes
Provision for income taxes
Minority interest, net of tax
Net earnings
2005
Engine
Drivetrain
Inter-segment eliminations
Total
Corporate
Consolidated
Litigation settlement expense
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
$3,124.0
1,461.4
—
4,585.4
—
$4,585.4
$ 30.9
—
(30.9)
—
—
$3,154.9
1,461.4
(30.9)
4,585.4
—
$ —
$4,585.4
$2,820.9
1,472.9
—
4,293.8
—
$4,293.8
$ 34.5
—
(34.5)
—
—
$ —
$2,855.4
1,472.9
(34.5)
4,293.8
—
$4,293.8
$2,016.1
1,509.2
—
3,525.3
—
$3,525.3
$ 43.8
—
(43.8)
—
—
$ —
$2,059.9
1,509.2
(43.8)
3,525.3
—
$3,525.3
$3,103.1
1,191.0
—
4,294.1
289.9(a)
$166.7
84.1
—
250.8
5.8
$165.1
84.7
—
249.8
12.9
$4,584.0
$256.6
$262.7
(c)
$2,925.5
1,081.8
—
4,007.3
82.1(a)
$4,089.4
$170.1
75.1
—
245.2
10.3
$255.5
$201.3
76.0
—
277.3
19.5
$296.8
(c)
$2,045.0
973.4
—
3,018.4
510.7 (a)
$3,529.1
$ 98.7
74.7
—
173.4
4.7
$178.1
$158.3
84.7
—
243.0
9.4
$252.4
$ 365.8
90.6
—
456.4
(61.2)
$ 395.2
$ 84.7
40.2
270.3
32.4
26.3
$ 211.6
$ 346.9
105.2
—
452.1
(55.3)
$ 396.8
$ 45.5
37.1
$ 314.2
55.1
19.5
$ 239.6
$ 273.6
115.0
—
388.6
(50.3)
$ 338.3
29.7
$ 308.6
81.2
9.1
$ 218.3
(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 ($5.6) million and $4.3 million, respectively, related to expenditures which are included in accounts payable.
41
Notes to Consolidated Financial Statements
continued
Geographic Information
No country outside the U.S., other than Germany, Hungary 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 7) amounting to $157.7 million, $175.3 million and $188.2
million at December 31, 2006, 2005 and 2004, respectively, are excluded
from the definition of long-lived assets, as are goodwill and certain other
non-current assets.
millions of dollars
United States
Europe:
Germany
Hungary
United Kingdom
Other Europe
Total Europe
South Korea
Other foreign
Total
2006
Net sales
2005
2004
2006
Long-lived assets
2005
2004
$1,819.4
$1,929.6
$1,964.9
$ 603.3
$ 661.8
$ 637.1
1,567.0
230.7
200.8
253.4
2,251.9
224.3
289.8
$4,585.4
1,405.7
193.9
173.2
185.5
1,958.3
160.3
245.6
$4,293.8
834.1
92.0
186.0
145.1
1,257.2
110.2
193.0
$3,525.3
534.0
27.9
47.4
120.0
729.3
457.4
25.0
43.6
82.0
608.0
56.0
100.3
$1,488.9
41.7
89.6
$1,401.1
278.7
25.0
39.5
81.1
424.3
32.5
85.4
$1,179.3
Sales to Major Customers
Consolidated sales included sales to Ford Motor Company of
approximately 13%, 16%, and 21%; to Volkswagen of approximately
13%, 13%, and 10%; to DaimlerChrysler of approximately 11%, 12%,
and 14%; and to General Motors Corporation of approximately 9%, 9%,
and 10% for the years ended December 31, 2006, 2005 and 2004,
respectively. Both of the Company’s operating segments had significant
sales to all four of the customers listed above. Accounts receivable from
these customers at December 31, 2006 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 2006 and 2005 interim results of operations. Certain
2006 and 2005 quarterly amounts have been reclassified to conform to
the annual presentation.
millions of dollars, except per share amounts
Quarter Ended
Net sales
Cost of sales
Gross profit
Selling, general and
administrative expenses
Restructuring expense
Other (income) expense
Operating income
Equity in affiliate earnings, net of tax
Interest expense and finance charges
Income before income taxes
and minority interest
Provision (benefit) for income taxes
Minority interest, net of tax
Net earnings
Mar-31
Jun-30
Sep-30
Dec-31
Year
Mar-31
Jun-30
2006
2005
Sep-30
Dec-31
Year
$1,155.2 $1,168.7 $1,059.8 $1,201.7 $4,585.4
3,735.5
876.5
849.9
183.3
937.6
231.1
931.9
223.3
989.5
212.2
$ 1,083.5
869.8
213.7
$ 1,111.4
879.0
232.4
$ 1,050.9
842.7
208.2
$ 1,048.0 $4,293.8
3,440.0
853.8
848.5
199.5
129.5
124.3
(0.5)
94.3
(10.0)
9.4
(0.7)
107.5
(8.5)
9.9
116.8
11.5
(5.6)
60.6
(7.8)
9.5
127.5
73.2
(0.7)
12.2
(9.6)
11.4
498.1
84.7
(7.5)
274.6
(35.9)
40.2
134.2
131.6
120.0
110.1
495.9
(4.1)
83.6
(4.0)
9.3
42.1
58.7
(8.0)
9.9
(2.3)
90.5
(5.7)
9.6
(0.9)
90.3
(10.5)
8.3
34.8
323.1
(28.2)
37.1
94.9
26.6
7.0
270.3
32.4
26.3
$ 61.3 $ 70.2 $ 39.2 $ 40.9 $ 211.6
10.4
(37.8)
7.3
106.1
29.7
6.2
58.9
13.9
5.8
78.3
(0.3)
1.0
$ 77.6
56.8
12.8
8.1
$ 35.9
86.6
19.6
5.6
$ 61.4
92.5
23.1
4.8
$ 64.6
314.2
55.1
19.5
$ 239.6
Earnings per share – basic
$ 1.07 $ 1.22 $ 0.68 $ 0.71 $ 3.69
$ 1.38
$ 0.64
$ 1.08
$ 1.13 $ 4.23
Earnings per share – diluted
$ 1.06 $ 1.21 $ 0.68 $ 0.70 $ 3.65
$ 1.36
$ 0.63
$ 1.07
$ 1.12 $ 4.17
42
2006 annual report
BorgWarner Inc.
and Consolidated
Subsidiaries
Selected Financial Data
millions of dollars, except per share data
For the Year Ended December 31,
S t a t e m e n t o f O p e r a t i o n s D a t a
Net sales
Cost of sales
Gross profit
Selling, general and administrative expenses
Other (income) expense
Restructuring expense
Operating income
Equity in affiliates’ 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
2006
2005
(b)
2004
2003
2002
$4,585.4
3,735.5
849.9
498.1
(7.5)
84.7
274.6
(35.9)
40.2
270.3
32.4
26.3
211.6
—
$ 211.6
$ 3.69
57,403
$ 3.65
57,971
$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
—
$ 239.6
$ 4.23
56,708
$ 4.17
57,398
$3,525.3
2,874.2
651.1
339.0
3.0
—
309.1
(29.2)
29.7
308.6
81.2
9.1
218.3
—
$ 218.3
$ 3.91
55,872
$ 3.86
56,537
$3,069.2
2,482.5
586.7
316.9
(0.1)
—
269.9
(20.1)
33.3
256.7
73.2
8.6
174.9
—
$ 174.9
$
3.23
54,116
$
3.20
54,604
$2,731.1
2,176.5
554.6
303.5
(0.9)
—
252.0
(19.5)
37.7
233.8
77.2
6.7
149.9
(269.0)
$ (119.1)
(a)
(a)
$ (2.23)
53,250
(a)
$
(2.22)
53,708
Cash dividend declared per share
$
0.64
$
0.58
$ 0.50
$ 0.36
$ 0.30
B a l a n c e S h e e t D a t a
Total assets
Total debt
$4,584.0
721.1
$4,089.4
740.5
$3,529.1
584.5
$3,140.5
655.5
$2,682.9
646.7
(a) In 2002, upon the adoption of SFAS No. 142, the Company recorded a $269.0 million after tax charge for cumulative effect of accounting principle related to goodwill.
This charge was $5.01 per diluted share.
(b) Results include BERU, acquired in the first quarter.
43
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 2006
Third Quarter 2006
Second Quarter 2006
First Quarter 2006
Fourth Quarter 2005
Third Quarter 2005
Second Quarter 2005
First Quarter 2005
Certifications
High
$61.58
65.35
67.47
61.77
$61.73
61.07
56.07
54.50
Low
$55.83
50.46
58.48
53.22
$53.46
53.41
44.85
48.13
• 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 New York Stock Exchange.
Dividends
The current dividend practice established by the Board of Directors is to
declare regular quarterly dividends. The last such dividend of 17 cents
per share of common stock was declared on November 15, 2006, pay-
able February 15, 2007, to stockholders of record on February 1, 2007.
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 purchases
of BorgWarner common stock and reinvest dividends. We pay the
brokerage commissions on purchases. Questions about the plan can
be directed to Mellon at 800-851-4229. To receive a prospectus and
enrollment package, contact Mellon at 800-842-7629.
Annual Meeting of Stockholders
The 2007 annual meeting of stockholders will be held on Wednesday,
April 25, 2007, beginning at 9:00 a.m. at the BorgWarner World
Headquarters at 3850 Hamlin Road, Auburn Hills, Michigan.
Stockholders
As of December 31, 2006, there were 2,664 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.
• Annual Reports
• SEC Filings
• Request Information
• Shareholder Services
• Webcast and Presentations
• Analyst Coverage
• Contact Investor Relations
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 Request Information
4. Click Sign-up for Email Alerts
Investor Inquiries
Investors and securities analysts requiring financial reports, interviews
or other information should contact Kenneth P. Lamb, Manager of Investor
Relations at BorgWarner World Headquarters, 248-754-0884.
BorgWarner Inc. owns U.S. trademark registrations for: BorgWarner, ,
, DualTronic and Visctronic. BorgWarner owns the follow-
ing trademarks: i -Trac, InterActive Torque Management, Pre-emptive Torque
Management and Regulated Two-Stage. BERU is a protected mark of BERU AG.
44
BorgWarner deliver s better f uel e ff ic ien c y, reduced emi ss ions
and vehicle stability without sacri f ic ing perf o rmance. take a
test drive at www.borgwarner.co m
Directors
Executive Officers
F u e l E f f i c i e n c y
V e h i c l e S t a b i l i t y
R e d u c e d E m i s s i o n s
P e r f o r m a n c e
Turbochargers
i-Trac™ FWD/AWD
Advanced Turbo Actuator
Turbochargers
Advanced Turbo Actuator
Transfer Cases
Variable Cam Timing
Tire Safety System
Smart Thermal Systems
Instant Starting Systems
Engine Timing
EGR Systems
Secondary Air Systems
Dual-Clutch Modules
Active All-Wheel Drive
Tire Safety System
Variable Cam Timing
Dual-Clutch Modules
Engine Timing
EGR Systems
Variable Cam Timing
Engine Timing
Thermal Systems
Dual-Clutch Modules
Secondary Air Systems
Instant Starting Systems
Thermal Systems
Instant Starting Systems
Tire Safety System
i-Trac™ FWD/AWD
Transfer Cases
Fluid Pumps
Synchronizers
f i n a n c i a l h i g h l i g h t s
2006
2005
% Change
Net sales
Net earnings
Net earnings per share — diluted
Average number of shares outstanding — diluted (millions)
Capital spending, including tooling outlays
Research and development
After-tax return on invested capital
Cash and cash equivalents
Debt
Stockholders’ equity
Total return on BorgWarner shares
Number of employees
$4,585.4
211.6
3.65
58.0
268.3
187.7
12.2%
123.3
721.1
1,875.4
(1.6)%
17,400
$4,293.8
239.6
4.17
57.4
292.5
161.0
13.2%
89.7
740.5
1,644.2
13.1%
17,400
6.8%
(11.7)%
(12.5)%
(8.3)%
16.6%
37.5%
(2.6)%
14.1%
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.
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
General Manager,
3rd Horizon Associates LLC
Thomas T. Stallkamp (2)
Industrial Partner
Ripplewood Holdings L.L.C.
Committees of the Board
1 Executive Committee
2 Audit Committee
3 Compensation Committee
4 Corporate Governance Committee
Director and Officer
biographies available at:
www.borgwarner.com/about/officers/
Timothy M. Manganello
Chairman and
Chief Executive Officer
Robin J. Adams
Executive Vice President,
Chief Financial Officer
and Chief Administrative Officer
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 & Emissions Systems
Mary E. Brevard
Vice President,
Investor Relations and
Corporate Communications
William C. Cline
Vice President,
Acquisition Coordination
Angela J. D’Aversa
Vice President,
Human Resources
Jamal M. Farhat
Vice President and
Chief Information Officer
John J. Gasparovic
Vice President,
General Counsel and Secretary
Anthony D. Hensel
Vice President and
Treasurer
Laurene H. Horiszny
Chief Compliance Officer and
Assistant 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
Comparison of 5 Year Cumulative Total Return*
Among BorgWarner Inc., The S&P 500 Index,
The SIC Code 3714—Motor Vehicle Parts & Accessories And A Peer Group
2 5 0
2 0 0
1 5 0
1 0 0
5 0
0
2001
2002
2003
2004
2005
2006
BorgWarner
S & P 500
Peer Group
SIC Code 3714 - Motor Vehicle Parts and Accessories
* $100 invested on 12/31/01 in stock or index-including reinvestment of dividends.
Fiscal year ending December 31.
BorgWar ner Vision
BorgWarner is the recognized world leader
in advanced products and technologies
that satisfy customer needs in powertrain
components and systems solutions.
BorgWar ner B eliefs
• Respect for Each Other
• The Power of Collaboration
• Passion for Excellence
• Personal Integrity
• Responsibility to Our Communities
millions of dollars, except per share and employee data
BorgWarner Inc.
World Headquarters
3850 Hamlin Road
Auburn Hills, MI 48326
www.borgwarner.com
2 0 0 6 A n n u A l R e p o R t
17,400
13.1%
1,644.2
740.5
89.7
13.2%
161.0
292.5
57.4
4.17
239.6
$4,293.8
17,400
(1.6)%
1,875.4
721.1
123.3
12.2%
187.7
268.3
58.0
3.65
211.6
$4,585.4
Number of employees
Total return on BorgWarner shares
Stockholders’ equity
Debt
Cash and cash equivalents
After-tax return on invested capital
Research and development
Capital spending, including tooling outlays
Average number of shares outstanding — diluted (millions)
Net earnings per share — diluted
Net earnings
Net sales
14.1%
(2.6)%
37.5%
16.6%
(8.3)%
(12.5)%
(11.7)%
6.8%
% Change
2005
2006
financial highlights
millions of dollars, except per share and employee data the BorgWarner experience