SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
QUARTERLY REPORT
Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarter ended September 30, 2003
Commission file number: 1-12162
(Exact name of registrant as specified in its charter)
Delaware 13-3404508
State or other jurisdiction of (I.R.S. Employer
Incorporation or organization Identification No.)
200 South Michigan Avenue, Chicago, Illinois 60604
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (312) 322-8500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12-b2 of the Exchange Act).
YES X NO
On September 30, 2003 the registrant had 27,426,555 shares of Common Stock
outstanding.
BORGWARNER INC.
FORM 10-Q
NINE MONTHS ENDED September 30, 2003
INDEX
Page No.
PART I. Financial Information
Item 1. Financial Statements
Introduction 2
Condensed Consolidated Balance Sheets at
September 30, 2003 and December 31, 2002 3
Consolidated Statements of Operations for the three
months ended September 30, 2003 and 2002 4
Consolidated Statements of Operations for the nine
months ended September 30, 2003 and 2002 5
Consolidated Statements of Cash Flows for the nine
months ended September 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures
About Market Risks 22
Item 4. Controls and Procedures 22
PART II. Other Information
Item 1. Legal Proceedings 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 24
BORGWARNER INC.
FORM 10-Q
NINE MONTHS ENDED SEPTEMBER 30, 2003
PART I.
ITEM 1.
BorgWarner Inc. and Consolidated Subsidiaries'
Financial Statements
The financial statements of BorgWarner Inc. and Consolidated Subsidiaries (the
"Company") have been prepared in accordance with the instructions to Form 10-Q
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The
statements are unaudited but include all adjustments, consisting only of
recurring items, except as noted, which the Company considers necessary for a
fair presentation of the information set forth herein. The results of
operations for the three and nine months ended September 30, 2003 are not
necessarily indicative of the results to be expected for the entire year. The
following financial statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations should be read in conjunction with
the Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2002, as updated by the Company's Current Report on Form 8-K, dated July 2,
2003.
BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(millions of dollars except share data)
September 30, December 31,
2003 2002
-------- -----------
ASSETS
Cash and cash equivalents $ 106.8 $ 36.6
Receivables, net 381.0 292.1
Inventories 198.4 180.3
Deferred income taxes 11.4 11.4
Investments in businesses held
for sale 29.7 14.2
Prepayments and other current
assets 25.9 31.9
-------- ----------
Total current assets 753.2 566.5
Property, plant, and equipment
at cost 1,578.3 1,467.8
Less accumulated depreciation (650.7) (572.9)
------- ----------
Net property, plant and equipment 927.6 894.9
Tooling, net of amortization 87.2 82.0
Investments and advances 160.7 153.1
Goodwill 844.0 827.0
Deferred income taxes 45.8 51.2
Other noncurrent assets 121.0 108.2
-------- ----------
Total other assets 1,258.7 1,221.5
-------- ----------
Total assets $ 2,939.5 $2,682.9
========= ==========
LIABILITIES & STOCKHOLDERS' EQUITY
Notes payable and current portion
of long-term debt $ 12.8 $ 14.4
Accounts payable and accrued
expenses 448.8 435.6
Income taxes payable 25.3 1.2
--------- ----------
Total current liabilities 486.9 451.2
Long-term debt 635.0 632.3
Long-term liabilities:
Retirement-related liabilities 488.1 478.3
Other 135.1 125.2
-------- --------
Total long-term liabilities 623.2 603.5
Minority interest in consolidated
subsidiaries 15.0 14.5
Commitments and contingencies - -
Capital stock:
Preferred stock, $.01 par value; authorized
shares: 5,000,000; none issued - -
Common stock, $.01 par value; authorized
shares: 50,000,000; issued shares: 2003,
27,572,072; 2002, 27,398,891; outstanding
shares: 2003, 27,426,555; 2002,
26,580,004 0.3 0.3
Non-voting common stock, $.01 par value;
authorized shares: 25,000,000; none issued
and outstanding - -
Capital in excess of par value 746.6 737.7
Retained earnings 446.2 335.8
Management shareholder note - (2.0)
Accumulated other comprehensive loss (7.7) (54.5)
Common stock held in treasury, at cost:
2003, 145,517 shares; 2002, 818,887 (6.0) (35.9)
-------- --------
Total stockholders' equity 1,179.4 981.4
--------- --------
Total liabilities and stockholders'
equity $ 2,939.5 $2,682.9
========= ==========
See accompanying Notes to Consolidated Financial Statements
BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(millions of dollars except per share amounts)
Three Months Ended
September 30,
2003 2002
------ -------
Net sales $ 725.2 $ 684.0
Cost of sales 595.9 556.1
------ ------
Gross profit 129.3 127.9
Selling, general and administrative
expenses 72.7 73.2
Other, net 0.1 (0.2)
------ ------
Operating income 56.5 54.9
Equity in affiliate earnings,
net of tax (3.6) (4.5)
Interest expense and finance charges 8.1 9.3
------ -------
Earnings before income taxes 52.0 50.1
Provision for income taxes 14.2 16.4
Minority interest, net of tax 1.9 1.8
------- -------
Net earnings $ 35.9 $ 31.9
======= ========
Net earnings per share Basic $ 1.32 $ 1.19
======= ========
Net earnings per share Diluted $ 1.30 $ 1.18
======= ========
Average shares outstanding (in thousands)
Basic 27,247 26,756
Diluted 27,532 26,989
Dividends declared per share $ 0.18 $ 0.15
======= =======
See accompanying Notes to Consolidated Financial Statements
BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(millions of dollars except per share amounts)
Nine Months Ended
September 30,
2003 2002
-------- ---------
Net sales $ 2,270.4 $ 2,030.3
Cost of sales 1,842.8 1,621.6
-------- ---------
Gross profit 427.6 408.7
Selling, general and administra-
tive expenses 233.4 224.3
Other, net 0.2 (0.6)
------- --------
Operating income 194.0 185.0
Equity in affiliate earnings,
net of tax (15.3) (13.9)
Interest expense and finance
charges 25.8 28.7
------- --------
Earnings before income taxes 183.5 170.2
Provision for income taxes 52.3 56.2
Minority interest, net of tax 6.3 4.9
------- -------
Net earnings before cumulative
effect of accounting change 124.9 109.1
Cumulative effect of change in
accounting principle, net of tax - (269.0)
------- --------
Net earnings/(loss) $ 124.9 $(159.9)
========= =========
Net earnings/(loss) per share Basic
Net earnings per share before
cumulative effect
of accounting change $ 4.64 $ 4.10
Cumulative effect of accounting
change - (10.11)
------- --------
Net earnings/(loss) per share $ 4.64 $ (6.01)
========= ==========
Net earnings/(loss) per share Diluted
Net earnings per share before cumulative effect
of accounting change $ 4.59 $ 4.07
Cumulative effect of accounting
change - (10.03)
------ -------
Net earnings/(loss) per share $ 4.59 $ (5.96)
========= =========
Average shares outstanding (in thousands)
Basic 26,918 26,602
Diluted 27,191 26,835
Dividends declared per share $ 0.54 $ 0.45
See accompanying Notes to Consolidated Financial Statements
BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(millions of dollars)
Nine Months Ended
September 30,
2003 2002
Operating
Net earnings/(loss) $ 124.9 $(159.9)
Non-cash charges (credits) to operations:
Depreciation 90.5 80.8
Amortization of tooling 25.6 21.2
Cumulative effect of change in accounting
principle, net of tax - 269.0
Employee retirement benefit contributions 9.9 17.3
Other, including equity in affiliate earnings,
net of tax (2.0) (13.8)
------ -------
Net earnings adjusted for non-cash charges 248.9 214.6
Changes in assets and liabilities, net of effects of
acquisitions and divestitures:
Increase in receivables (72.0) (76.3)
Increase in inventories (12.0) (24.9)
(Increase) decrease in prepayments
and other current assets 9.6 (13.3)
Increase (decrease) in accounts payable
and accrued expenses (0.5) 43.7
Increase in income taxes payable 24.3 24.1
Net change in other long-term assets
and liabilities 22.1 (0.8)
------ -------
Net cash provided by operating activities 220.4 167.1
Investing
Capital expenditures (104.1) (81.4)
Tooling outlays, net of customer
reimbursements (28.8) (17.3)
Net proceeds from asset disposals 1.8 9.0
Proceeds from sale of businesses 5.4 2.6
Tax refunds related to businesses sold - 20.5
Investment in unconsolidated subsidiaries (14.4) -
Contingent valuation payment on acquired
business (12.8) -
------ -------
Net cash used in investing activities (152.9) (66.6)
Financing
Net decrease in notes payable (2.5) (24.0)
Additions to long-term debt 0.4 2.3
Reductions in long-term debt (7.9) (65.1)
Payments for purchase of treasury stock (2.5) -
Proceeds from stock options exercised 28.1 9.6
Dividends paid (14.5) (11.9)
------- -------
Net cash provided (used) in financing
activities 1.1 (89.1)
Effect of exchange rate changes on cash and
cash equivalents 1.6 2.0
-------- --------
Net increase in cash and cash equivalents 70.2 13.4
Cash and cash equivalents at beginning
of period 36.6 32.9
--------- -------
Cash and cash equivalents at end of period $106.8 $ 46.3
========= ========
Supplemental Cash Flow Information
Net cash paid/(refunded) during the period for:
Interest $ 27.4 $ 31.2
Income taxes 16.6 (12.6)
Non-cash financing transactions:
Issuance of common stock for Executive Stock
Performance Plan 3.3 1.2
See accompanying Notes to Consolidated Financial Statements
BORGWARNER INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) Research and development costs charged to expense for the three and
nine months ended September 30, 2003 were $29.0 million and $87.4
million. Research and development costs charged to expense for the
three and nine months ended September 30, 2002 were $26.8 million and
$79.1 million.
(2) Inventories consisted of the following (millions of dollars):
September 30, December 31,
2003 2002
Raw materials $ 80.9 $ 85.3
Work in progress 80.4 57.6
Finished goods 37.1 37.4
----- ------
Total inventories $ 198.4 $ 180.3
======== ========
(3) The Company accounts for its stock based employee compensation plans
under the recognition and measurement principles of Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. No stock-based employee
compensation cost is reflected in net income for stock options, as all
options granted under those plans had an exercise price equal to or in
excess of the market value of the underlying common stock on the date of
grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," to all stock-based employee compensation awards.
Three Months Ended
September 30,
2003 2002
Net earnings, as reported $ 35.9 $ 31.9
Add:
Stock-based employee compensation
expense included in net income,
net of income tax 0.6 0.5
Deduct:
Total stock based employee
compensation expense determined
under fair value based methods
for all awards, net of tax effects (2.3) (2.1)
------- --------
Pro forma net earnings $ 34.2 $ 30.3
Net earnings per share
Basic as reported $ 1.32 $ 1.19
Basic pro forma 1.26 1.13
Diluted as reported 1.30 1.18
Diluted pro forma 1.24 1.12
Nine Months Ended
September 30,
2003 2002
Net earnings/(loss), as reported $ 124.9 $ (159.9)
Add:
Stock-based employee compensation
expense included in net income,
net of income tax 3.2 2.5
Deduct:
Total stock based employee compensation
expense determined under fair value
based methods for all awards, net of
tax effects (7.0) (7.2)
------- -------
Pro forma net earnings/(loss) $ 121.1 $ (164.6)
Net earnings/(loss)per share
Basic as reported $ 4.64 $ (6.01)
Basic pro forma 4.50 (6.19)
Diluted as reported 4.59 (5.96)
Diluted pro forma 4.45 (6.13)
In calculating earnings per share, earnings are the same for the basic
and diluted calculations. Shares increased for diluted earnings per
share by 285,000 and 233,000 for the three months ended, and 273,000 and
233,000 for the nine months ended, September 30, 2003 and 2002,
respectively, due to the effects of stock options and shares issuable
under the Executive Stock Performance Plan.
(4) The Company's provision for income taxes is based upon estimated
annual tax rates for the year applied to federal, state and foreign
income. The effective rate for 2003 differed from the U.S. statutory
rate primarily due to a) state income taxes, b) foreign rates which
differ from those in the U.S. and c) realization of certain business tax
credits, including foreign tax credits and research and development
credits. In 2002, the Company completed a change in the ownership
structure of its foreign operations for strategic business purposes. An
indirect result of this change was lower tax rates on the income of
certain of the Company's foreign operations. The Company expects its
effective tax rate for 2003 to be approximately 28.5% on the basis of
which the three and nine month income statements are presented.
(5) Following is a summary of notes payable and long-term debt:
September 30, 2003 December 31,2002
Current Long-Term Current Long-Term
DEBT (millions of dollars)
Bank borrowings and other $ 6.2 $42.9 $ 8.0 $40.4
Term loans due through 2011
(at an average rate of 3.3% at
September 30, 2003 and 3.2% at
December 31, 2002) 6.6 32.1 6.4 31.5
7% Senior Notes due 2006,
net of unamortized discount
($139 million converted to floating
rate of 2.9% by interest rate swap) - 139.4 - 139.3
6.5% Senior Notes due 2009,
net of unamortized discount
($100 million converted to floating
rate of 3.3% by interest rate swap) - 164.7 - 164.9
8% Senior Notes due 2019,
net of unamortized discount
($75 million converted to floating
rate of 3.7% by interest rate swap) - 133.9 - 134.2
7.125% Senior Notes due 2029,
net of unamortized discount - 122.0 - 122.0
------ ----- ------ -----
Total notes payable and
long-term debt $ 12.8 $635.0 $ 14.4 $632.3
======== ====== ====== ======
The Company has a revolving credit facility that provides for borrowings
up to $350 million through July, 2005. At September 30, 2003, there were
no borrowings outstanding under the facility. At December 31, 2002, there
were no borrowings outstanding under the facility and the Company had $7.1
million of obligations under standby letters of credit.
The credit agreement contains numerous financial and operating covenants
including, among others, covenants requiring the Company to maintain
certain financial ratios and restricting its ability to incur additional
indebtedness. The Company is in compliance with its credit agreement
covenants as of September 30, 2003.
(6) The Company has entered into interest rate and currency swaps to
manage interest rate and foreign currency risk. A summary of these
instruments outstanding at September 30, 2003 follows (currency in
millions):
Notional Interest rates (b) Floating interest Hedge Type
Amount Receive Pay Rate basis
- ---------- ------- -------- ----- ----------
Interest Rate Swaps (a) (Millions)
Fixed to floating Fair value $139 7.0% 2.9% 6 month LIBOR+1.7%
Fixed to floating Fair value $100 6.5% 3.3% 6 month LIBOR+2.1%
Fixed to floating Fair value $ 75 8.0% 3.8% 6 month LIBOR+2.6%
Cross Currency Swaps (mature in 2006)
Floating $ Cash Flow $90 2.2% - 6 mo. USD LIBOR+1.0%
floating(Y) Investment (Y)11,108 - 1.3% 6 mo. JPY LIBOR+1.2%
a) The maturity of the swaps corresponds with the maturity of the hedged
item as noted in the debt summary, unless otherwise indicated.
b) Interest rates are as of September 30, 2003.
The ineffective portion of the cross currency swap was not material. The
fair value of the interest rate swaps at September 30, 2003 was $17.2
million. Cross currency swaps were recorded at their fair value of $(9.7)
million.
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 with maturities of less than twelve months, which qualify as
cash flow hedges. These instruments are intended to offset the effect of
changes in commodity prices on forecasted purchases. The fair value of
the commodity derivative instruments at September 30, 2003 was $(0.4)
million.
The Company uses foreign exchange forward contracts to hedge future
purchases of materials consumed in the production process, and the
receivables related to sales through December 2005. Foreign currency
contracts require the Company, at a future date, to either buy or sell
foreign currency in exchange for primarily U.S. dollars, Euros, and
British Pound Sterling. Contracts outstanding as of September 30, 2003
will mature over the next 2.25 years and have sales contract notional
amounts of $38.4 million and 40.4 million Euro.
(7) The Company and certain of its current and former direct and indirect
corporate predecessors, subsidiaries and divisions have been identified by
the United States Environmental Protection Agency (EPA) and certain state
environmental agencies and private parties as potentially responsible
parties (PRPs) at various 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 43 such
sites. Responsibility for clean-up and other remedial activities at a
Superfund site is typically shared among PRPs based on an allocation
formula.
Based on the 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
costs; remediation alternatives; estimated legal fees; and other factors,
the Company has established a reserve for indicated environmental
liabilities with a balance at September 30, 2003 of approximately $17.6
million. The Company expects this amount to be expended over the next
three to five years.
The Company believes that none of these matters, individually or in the
aggregate, will have a material adverse effect on its financial condition
or future operating results, generally either because estimates of the
maximum potential liability at a site are not large or because liability
will be shared with other PRPs, although no assurance can be given with
respect to the ultimate outcome of any such matter.
In connection with the sale of Kuhlman Electric Corporation, the Company
agreed to indemnify the buyer and Kuhlman Electric for certain
environmental liabilities relating to the past operations of Kuhlman
Electric. During 2000, Kuhlman Electric notified the Company that it
discovered potential environmental contamination at its Crystal Springs,
Mississippi plant while undertaking an expansion of the plant.
The Company has been working with the Mississippi Department of
Environmental Quality, the EPA and Kuhlman Electric to investigate the
extent of the contamination. The investigation has revealed the presence
of Polychlorinated Biphenyls (PCBs) in portions of the soil at the plant
and neighboring areas. Kuhlman Electric and others, including the Company,
have been sued in several related lawsuits, which claim personal injury
and property damage. The Company has moved to be dismissed from some of
these lawsuits.
The Company believes that its reserve for environmental liabilities is
sufficient to cover any potential liability associated with these matters.
However, due to the nature of environmental liability matters, there can
be no assurance that the actual amount of environmental liabilities will
not exceed the amount reserved.
In 2002, the Company entered into a lease obligation for $28.3 million in
principal for machinery and equipment. In 2003, additional machinery and
equipment was added to the lease bringing the total lease obligation to
$30.3 million. The lease payments are expected to be $3.5 million in
2003. The lease extends until December 2005 and is being accounted for as
an operating lease. The Company has guaranteed the residual values of the
leased machinery and equipment. The guarantees extend through the
maturity of the underlying lease. In the event the Company does not
exercise its option to purchase the machinery and equipment, the Company
has guaranteed a residual value of $16.3 million.
The Company provides warranties on some of its products. The warranty
terms are typically from one to three years. Provisions for estimated
expenses related to product warranty are made at the time products are
sold. These estimates are established using historical information about
the nature, frequency, and average cost of warranty claims. Management
actively studies trends of warranty claims and takes action to improve
vehicle quality and minimize warranty claims. Management believes that
the warranty reserve is appropriate; however, actual claims incurred could
differ from the original estimates, requiring adjustments to the reserve.
The reserve is recorded in both long-term and short-term liabilities on
the balance sheet.
Below is a table that shows the activity in the warranty accrual accounts
(in millions):
For the nine
months ended September 30,
2003
Beginning balance $ 23.7
Provisions 8.1
Incurred (4.6)
-------
Ending balance $ 27.2
=========
(8) Comprehensive income/(loss) is a measurement of all changes in
stockholders' equity that result from transactions and other economic
events other than transactions with stockholders. For the Company, this
includes foreign currency translation adjustments, changes in the minimum
pension liability adjustment and net earnings(loss). The amounts
presented as other comprehensive income/(loss), net of related taxes, are
added to net income resulting in comprehensive income/(loss).
The following summarizes the components of other comprehensive income/
(loss) on a pretax and after-tax basis for the periods ended September 30,
(in millions) Three Months Ended
2003 2002
Income Income
Tax After- Tax After-
Pretax Effect tax Pretax Effect tax
Foreign currency
translation
adjustment $ 3.3$(4.0) $ (0.7) $11.9 $ (2.7) $9.2
Net earnings as reported 35.9 31.9
----- -----
Total comprehensive income $ 35.2 $41.1
====== ======
(in millions) Nine Months Ended
2003 2002
Income Income
Tax After- Tax After-
Pretax Effect tax Pretax Effect tax
Foreign currency
translation
adjustment $ 50.8 $(4.0) $ 46.8 $ 32.3 $(7.9) $24.4
Net earnings/(loss)
as reported 124.9 (159.9)
------- ------
Total comprehensive
income/(loss) $171.7 $(135.5)
======= =========
The components of accumulated other comprehensive income/(loss), net of
tax, in the Condensed Consolidated Balance Sheets are as follows:
(in millions) September 30, December 31,
2003 2002
Foreign currency translation adjustment $ 53.5 $ 6.7
Minimum pension liability adjustment (61.2) (61.2)
------- --------
Accumulated other comprehensive loss $ (7.7) $(54.5)
======= ========
(9) The following tables show sales, earnings before interest and taxes
and total assets for the Company's reportable business segments (in
millions of dollars.
Net Sales
Three Months Ended September 30,
2003 2002
Inter- Inter-
Customer segment Net Customer segment Net
Drivetrain $ 284.3$ - $ 284.3 $ 277.5 $ - $ 277.5
Engine 440.8 10.5 451.4 406.5 10.1 416.6
Inter-segment
eliminations - (10.5) (10.5) - (10.1) (10.1)
Consolidated $725.2 $ - $ 725.2 $ 684.0 $ - $ 684.0
Net Sales
Nine Months Ended September 30,
2003 2002
Inter- Inter-
Customer segment Net Customer segment Net
Drivetrain $915.3 $ - $ 915.3 $ 819.5 $ - $ 819.5
Engine 1,355.1 33.7 1,388.8 1,210.8 29.3 1,240.1
Inter-segment
eliminations - (33.7) (33.7) - (29.3) (29.3)
Consolidated $2,270.4 $ - $2,270.4 $2,030.3 $ - $2,030.3
Earnings Before Earnings Before
Interest & Taxes Interest & Taxes
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
Drivetrain $ 16.7 $ 22.2 $ 66.5 $ 71.7
Engine 55.6 47.9 178.3 158.7
------ ------ ------ ------
72.3 70.1 244.8 230.4
Corporate (12.2) (10.7) (35.5) (31.5)
------ ------- ------- ------
Consolidated 60.1 59.4 209.3 198.9
Interest expense and
finance charges (8.1) (9.3) (25.8) (28.7)
------ ------- ------ ------
Earnings before income
taxes $ 52.0 $50.1 $ 183.5 $170.2
======= ===== ====== ========
Total Assets
September 30, December 31,
2003 2002
Drivetrain $755.9 $ 678.1
Engine 1,878.5 1,739.9
-------- --------
2,634.4 2,418.0
Corporate 305.1 264.9
-------- ---------
Consolidated $2,939.5 $2,682.9
========== ==========
(10) Charges of $28.4 million were incurred in the fourth quarter of 2001.
These charges primarily included adjustments to the carrying value of
certain assets and liabilities related to businesses acquired and disposed
of over the prior three years, non-employee related exit costs for certain
non-production facilities the Company had previously sold or no longer
needed and non-recurring product quality related charges. The 2001
charges include $8.4 million of environmental remediation costs related to
sold businesses and $12 million of product quality costs for issues with
products that were sold by acquired businesses prior to acquisition, all
of which have been fixed in the currently produced products. Of the $28.4
million of pretax charges, $5.0 million represents non-cash charges.
Approximately $3.3 million was spent in 2001, $8.4 million was transferred
to environmental reserves in 2001, $8.4 million was spent in 2002, $2.3
million was spent in the first nine months of 2003, and the remaining $1.0
million is expected to be spent over the next three months. The Company
expects to fund the total cash outlay of these actions with cash flow from
operations.
The roll-forward for the balance of the other exit costs and non-recurring
charges are detailed in the following table.
Other Exit Costs and
Charges
(in millions of dollars)
Balance, December 31, 2002 $ 3.3
Expended 2.3
------
Balance, September 30, 2003 $ 1.0
======
(11) 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, up to a maximum
of $90 million. During the nine months ended September 30, 2003, the
amount of receivables sold remained constant at $90 million and total cash
proceeds from sales of accounts receivable were $810.0 million. For the
nine months ended September 30, 2003, the Company paid a servicing fee of
$1.1 million related to these receivables, which is included in interest
expense and finance charges. At September 30, 2003 and December 31, 2002,
the Company had sold $90 million of receivables under a Receivables
Transfer Agreement for face value without recourse.
(12) In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 142, effective January 1, 2002, specifies
that goodwill and certain intangible assets will no longer be amortized
but instead will be subject to periodic impairment testing. SFAS No. 142
also requires that, upon adoption, goodwill be allocated to the Company's
reporting units and a two-step impairment analysis be performed.
The Company adopted SFAS No. 142 effective January 1, 2002. Under the
transitional provisions of the SFAS, the Company allocated goodwill to its
reporting units and performed the two-step impairment analysis. The fair
value of the Company's businesses used in determination of the goodwill
impairment was computed using the expected present value of associated
future cash flows. As a result of this analysis, the Company determined
that goodwill associated with its Cooling Systems and Air/Fluid Systems
operating businesses was impaired due to fundamental changes in their
served markets, particularly the medium and heavy truck markets, and
weakness at a major customer. As a result a charge of $269 million, net
of taxes of $76 million, was recorded. The impairment loss was recorded
in the first quarter of 2002 as a cumulative effect of change in
accounting principle. The changes in the carrying amount of goodwill (in
millions of dollars) for the nine months ended September 30, 2003, are as
follows:
Drivetrain Engine Total
Balance at December 31, 2002
Contingent valuation
payment on acquired
business $128.0 $699.0 $827.0
- 12.8 12.8
Translation adjustment 0.3 3.9 4.2
-------- ------- --------
Balance at
September 30, 2003 $128.3 $715.7 $844.0
(13) In June 2002, the FASB issued Statement No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities." This standard
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment
to an exit or disposal plan. Examples of costs covered by the standard
include lease termination costs and certain employee severance costs that
are associated with a restructuring, discontinued operation, plant
closing, or other exit or disposal activity. SFAS No. 146 is to be
applied prospectively to exit or disposal activities initiated after
December 31, 2002. The adoption of SFAS No. 146 did not have any impact
on the Company's results of operations, financial position or cash flows.
In November 2002, the FASB issued Interpretation No. 45 "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others" (FIN 45), which expands previously
issued accounting guidance and disclosure requirements for certain
guarantees. FIN 45 requires the Company to recognize an initial liability
for fair value of an obligation assumed by issuing the guarantee. The
provision for initial recognition and measurement of the liability is
applied on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 did not have any impact on the
Company's financial position, operating results or liquidity and resulted
in additional disclosures in the Company's Consolidated Financial
Statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting
for Stock-Based Compensation Transition and Disclosure an amendment of FASB
Statement No. 123." This Statement amends FASB Statement No. 123 to
provide alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation and amends the disclosure requirements to require prominent
disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect
of the method used on reported results. The Company adopted SFAS No. 148
on January 1, 2003. See Note 3 for the required new disclosures.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," (FIN 46). FIN 46 requires that the assets,
liabilities and results of the activity of variable interest entities be
consolidated into the financial statements of the entity that has the
controlling financial interest. FIN 46 also provides the framework for
determining whether a variable interest entity should be consolidated
based on voting interest or significant financial support provided to it.
For the Company, this Interpretation is effective immediately for variable
interest entities created after January 31, 2003 and effective October 1,
2003, for variable interest entities created before February 1, 2003. The
Company does not expect the adoption of FIN 46 to have any impact on its
2003 Consolidated Financial Statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities," which amends and
clarifies accounting and reporting for certain derivative instruments.
This statement is effective for contracts entered into or modified after
June 30, 2003, and for hedging relationships designated after June 30,
2003, and is to be applied prospectively. The adoption of SFAS No. 149 did
not have any impact on the Company's financial position, operating results
or liquidity and resulted in additional disclosures in the Company's
Consolidated Financial Statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity," which establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. This statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after
June 15, 2003. The adoption of SFAS No. 150 did not have any impact on the
Company's financial position, operating results or cash flows.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
BorgWarner Inc. and Consolidated Subsidiaries (the "Company") is a leading
global supplier of highly engineered systems and components for powertrain
applications. Its products help improve vehicle performance, fuel
efficiency, handling and air quality. Its products are manufactured and
sold worldwide, primarily to original equipment manufacturers (OEMs) of
passenger cars, sport utility vehicles, trucks, and commercial
transportation products. The Company operates manufacturing facilities
serving customers in the Americas, Europe and Asia, and is an original
equipment supplier to every major OEM in the world.
RESULTS OF OPERATIONS
The Company's products fall into two reportable operating segments:
Drivetrain and Engine. The following tables present net sales and earnings
before interest and taxes (EBIT) by segment for the three and nine months
ended September 30, 2003 and 2002 in millions of dollars.
Net Sales Three Months Nine Months
September 30, September 30
2003 2002 2003 2002
Drivetrain $ 284.3 $ 277.5 $ 915.3 $819.5
Engine 451.4 416.6 1,388.8 1,240.1
Inter-segment
eliminations (10.5) (10.1) (33.7) (29.3)
-------- -------- ------- ------
Net sales $ 725.2 $ 684.0 $2,270.4 $2,030.3
EBIT Three Months Nine Months
September 30, September 30,
2003 2002 2003 2002
Drivetrain $ 16.7 $ 22.2 $ 66.5 $ 71.7
Engine 55.6 47.9 178.3 158.7
------ ------ ------- ------
Segment EBIT $ 72.3 $ 70.1 $244.8 $230.4
======= ======= ======== =======
Consolidated sales for the third quarter ended September 30, 2003 totaled
$725.2 million, a 6.0% increase over the third quarter of 2002. This
increase was favorable compared to the total automotive market, where the
North American market experienced production decreases of 5% and the
European market had production decreases of 2%. Geographically, the
Company's sales increases were in Europe and Asia. North America sales
declined by 2.5%, about half of the total industry production decline in
that region. Sales increased an additional $28.5 million due to stronger
currencies, primarily in Europe. Turbochargers and automatic
transmissions are the products most affected by currency fluctuations in
Europe, Asia, and the Americas.
Third quarter net income increased from $31.9 million to $35.9 million, a
12.5% increase. The increase in income was due to several factors:
higher volume of sales, lower interest expense, favorable currency impact,
and a lower tax rate. The currency impact added approximately $2.1
million to income, or $0.08 per share, compared to the prior year. The
tax rate year to date was 28.5% compared to 33.0% for the prior year. In
the third quarter, the company recorded a year to date adjustment to bring
the year to date rate down from 29% to 28.5%. This was due to continuing
profitability improvement in our foreign operations, particularly from
Europe.
The Drivetrain business' revenue increased 2.5%, but EBIT decreased $5.5
million, or 24.8% from 2002. These sales gains were due to four wheel
drive transfer case programs with General Motors, increased sales of the
Company's Interactive Torque Management (TM) all-wheel drive systems to
Honda and Hyundai, and steady demand for transmission components and
systems, especially with increased automatic transmission penetration in
Europe. These sales gains offset declines in European and North American
automotive production. The decrease in EBIT was due to start up
investments and costs for the Company's new DualTronic product, including
the opening of a facility in Germany. Profitability also suffered from a
less favorable product mix and an increase in pension and retiree health
care costs over the previous year.
The Engine business' third quarter 2003 sales and EBIT increased 8.4% and
16.1% from third quarter 2002, respectively. This group benefited from
continued demand for the Company's turbochargers for European passenger
cars and commercial vehicles. This offset the chain and emissions
portions of the group, which experienced softness as a result of weaker
auto production. The EBIT was impacted by increased productivity and
production in the turbocharger business, which translated to higher
profitability. This was partially offset by start up costs for Variable
Cam Timing systems, which will launch during 2004, and for new Korea
operations.
Consolidated gross margin for the third quarter of 2003 was 17.8%, down
0.9 percentage points from the 2002 margin of 18.7%. The gross margin was
negatively impacted due to higher growth in our lower margin products and
due to the launch costs of our new products. Selling, general and
administrative (SG&A) costs decreased $0.5 million and decreased as a
percentage of sales from 10.7% to 10.0% of sales. This decrease was due to
cost control efforts across the company. The SG&A category includes
substantially all the Company's spending on R&D. For the third quarter of
2003, R&D spending totaled $29.0 million, or 4.0% of sales, versus $26.8
million, or 3.9% of sales for the third quarter of 2002.
Third quarter interest expense decreased $1.2 million from third quarter
2002 as a result of lower interest rates. The Company was able to take
advantage of lower floating interest rates through the use of interest
rate swaps, described more fully in Note Six to the Financial Statements.
At September 30, 2003, the amount of debt with fixed interest rates was
44% of total debt. Equity in affiliate earnings, which consist primarily
of the Company's 50% share of NSK-Warner in Japan, were slightly down due
to slightly weaker auto production in Japan.
The Company's provision for income taxes is based on estimated annual tax
rates for the year applied to federal, state and foreign income. The
effective rate for 2003 differed from the U.S. statutory rate primarily
due to a) state income taxes, b) foreign rates which differ from those in
the U.S. and c) realization of certain business tax credits, including
foreign tax credits and research and development credits. In 2002, the
Company completed a change in the ownership structure of certain of its
foreign operations for strategic business purposes. An indirect result of
this change was lower tax rates on the income of certain of the Company's
foreign operations. The Company expects its effective tax rate for 2003
to be approximately 28.5% compared to 33% in 2002.
Net income was $35.9 million for the third quarter, or $1.30 per diluted
share, an increase of 12.5% over the previous year's third quarter.
Shares outstanding increased due to the exercise of options and
contributions to benefit plans.
For the remainder of 2003, the Company remains concerned about production
rates, particularly in North America. This holds true for both the light
vehicle market and the commercial truck market. Despite these concerns,
the Company maintains a positive long-term outlook for its business and is
committed to ongoing strategic investments in capital and new product
development to enhance its product leadership strategy.
FINANCIAL CONDITION AND LIQUIDITY
As of September 30, 2003, debt increased from year-end 2002 by $1.1
million, mainly due to foreign currency exchange rate changes. Cash and
cash equivalents increased by $70.2 million. Capital spending for the
nine months was $104.1 million compared with $81.4 million last year.
Careful capital spending remains an area of focus for the Company. The
Company expects to spend $150 million on capital in 2003, but this
expectation is subject to ongoing review based on market conditions.
As of September 30, 2003 and December 31, 2002, the Company had sold $90.0
million of receivables under a Receivables Transfer Agreement for face
value without recourse.
The Company believes that the combination of cash from operations and
available credit facilities will be sufficient to satisfy its cash needs
for the current level of operations and planned operations for the
remainder of 2003.
OTHER MATTERS
Litigation
As discussed more fully in Note 7 to the Consolidated Financial
Statements, various claims and suits seeking money damages arising in the
ordinary course of business and involving environmental liabilities have
been filed against the Company. In each of these cases, the Company
believes it has a defendable position and has made adequate provisions to
protect the Company from material losses. The Company believes that it
has established adequate provisions for litigation liabilities in its
financial statements in accordance with generally accepted accounting
principles in the United States of America.
In connection with the sale of Kuhlman Electric Corporation, the Company
agreed to indemnify the buyer and Kuhlman Electric for certain
environmental liabilities relating to the past operations of Kuhlman
Electric. During 2000, Kuhlman Electric notified the Company that it
discovered potential environmental contamination at its Crystal Springs,
Mississippi plant while undertaking an expansion of the plant.
The Company has been working with the Mississippi Department of
Environmental Quality, the EPA and Kuhlman Electric to investigate the
extent of the contamination. The investigation has revealed the presence
of PCBs in portions of the soil at the plant and neighboring areas.
Kuhlman Electric and others, including the Company, have been sued in
several related lawsuits, which claim personal and property damage. The
Company has moved to be dismissed from some of these lawsuits.
The Company believes that the reserve for environmental liabilities is
sufficient to cover any potential liability associated with this matter.
However, due to the nature of environmental liability matters, there can
be no assurance that the actual amount of environmental liabilities will
not exceed the amount reserved.
Dividends
On October 17, 2003, the Company declared a $0.18 per share dividend to be
paid on November 17, 2003 to shareholders of record as of November 3,
2003.
Critical Accounting Policies
The Company has identified critical accounting policies that, as a result
of the judgments, uncertainties, uniqueness and complexities of the
underlying accounting standards and operations involved, could result in
material changes to its financial condition or results of operations under
different conditions or using different assumptions. The Company's most
critical accounting policies are related to sales of receivables, product
warranty, goodwill and other intangible assets, pension and other
postretirement benefits, and impairment of long-lived assets. Details
regarding the Company's use of these policies are described in the 2002
Annual Report on 10-K filed with the Securities and Exchange Commission.
There have been no material changes to these policies since December 31,
2002.
New Accounting Pronouncements
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This standard requires
companies to recognize costs associated with exit or disposal activities
when they are incurred rather than at the date of a commitment to an exit
or disposal plan. Examples of costs covered by the standard include lease
termination costs and certain employee severance costs that are associated
with a restructuring, discontinued operation, plant closing, or other exit
or disposal activity. SFAS No. 146 is to be applied prospectively to exit
or disposal activities initiated after December 31, 2002. The adoption of
SFAS No. 146 did not have any impact on the Company's results of
operations, financial position or cash flows.
In November 2002, the FASB issued Interpretation No. 45 "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others" (FIN 45), which expands previously
issued accounting guidance and disclosure requirements for certain
guarantees. FIN 45 requires the Company to recognize an initial liability
for fair value of an obligation assumed by issuing the guarantee. The
provision for initial recognition and measurement of the liability is
applied on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 did not have any impact on the
Company's financial position, operating results or liquidity and resulted
in additional disclosures in the Company's Consolidated Financial
Statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting
for Stock-Based Compensation Transition and Disclosure an amendment of FASB
Statement No. 123." This Statement amends FASB Statement No. 123 to
provide alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation and amends the disclosure requirements to require prominent
disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect
of the method used on reported results. The Company adopted SFAS No. 148
on January 1, 2003. See Note 3 for the required new disclosures.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," (FIN 46). FIN 46 requires that the assets,
liabilities and results of the activity of variable interest entities be
consolidated into the financial statements of the entity that has the
controlling financial interest. FIN 46 also provides the framework for
determining whether a variable interest entity should be consolidated
based on voting interest or significant financial support provided to it.
For the Company, this Interpretation is effective immediately for variable
interest entities created after January 31, 2003 and effective July 1,
2003, for variable interest entities created before February 1, 2003. The
Company does not expect the adoption of FIN 46 to have any impact on its
2003 Consolidated Financial Statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities," which amends and
clarifies accounting and reporting for certain derivative instruments.
This statement is effective for contracts entered into or modified after
June 30, 2003, and for hedging relationships designated after June 30,
2003, and is to be applied prospectively. The adoption of SFAS No. 149 did
not have any impact on the Company's financial position, operating results
or liquidity and resulted in additional disclosures in the Company's
Consolidated Financial Statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity," which establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. This statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after
June 15, 2003. The adoption of SFAS No. 150 did not have any impact on the
Company's financial position, operating results or cash flows.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Statements contained in this Management's Discussion and Analysis of
Financial Condition and Results of Operations may contain forward-looking
statements as contemplated by the 1995 Private Securities Litigation
Reform Act that are based on management's current expectations, estimates
and projections. Words such as "expects," "anticipates," "intends,"
"plans," "believes," "estimates," variations of such words and similar
expressions are intended to identify such forward-looking statements.
Forward-looking statements are subject to risks and uncertainties, which
could cause actual results to differ materially from those projected or
implied in the forward-looking statements. Such risks and uncertainties
include: fluctuations in domestic or foreign vehicle production, the
continued use of outside suppliers, fluctuations in demand for vehicles
containing the Company's products, general economic conditions, as well as
other risks detailed in the Company's filings with the Securities and
Exchange Commission, including the Cautionary Statements filed as Exhibit
99.1 to the Form 10-K for the fiscal year ended December 31, 2002.
Item 3. Quantitative and Qualitative Disclosure About Market Risks
There have been no material changes to the Company's exposures to market
risk since December 31, 2002.
Item 4. Controls and Procedures
The Company's management, including the Chief Executive Officer and Chief
Financial Officer, have conducted an evaluation of the effectiveness of
disclosure controls and procedures as of the end of the period covered by
this report. Based on that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that the disclosure controls and
procedures are effective in ensuring that information required to be
disclosed in reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms. There
have been no changes in internal controls over financial reporting that
occurred during the period covered by this report that have materially
affected, or are likely to materially affect our internal controls over
financial reporting.
PART II
Item 1. Legal Proceedings
The Company is a party to various judicial and administrative proceedings
which are considered to be routine and incidental to its business.
Management does not believe that the results of any of these proceedings
are reasonably likely to have a material adverse effect on the Company's
liquidity, financial condition or results of operations.
Item 6. Exhibits and Reports on Form 8-K
Exhibits
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification by Chief Executive
Officer.
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification by Chief Financial
Officer.
Exhibit 32 Section 1350 Certifications.
Reports on Form 8-K
On July 1, 2003, the Company filed a report on Form 8-K/A, attaching a
reconciliation of non-GAAP measures previously disclosed with the most
directly comparable GAAP measures.
On July 2, 2003, the Company filed a report on Form 8-K, filing a revised
presentation of its Selected Financial Data, Management's Discussion and
Analysis of Financial Condition and Results of Operation and Financial
Statements and Supplementary Data included in its form 10-K for 2002. In
addition, the Form 8-K provided updated disclosure regarding its patent
dispute with Honeywell International Inc.
On July 21, 2003, the Company filed a report on Form 8-K, furnishing a
copy of a news release relating to its earnings for the second quarter of
2003.
On July 29, 2003, the Company filed a report on Form 8-K, announcing the
appointment of Ernest J. Novak, Jr. to its Board of Directors.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, hereunto duly authorized.
BorgWarner Inc.
(Registrant)
By /s/ William C. Cline
(Signature)
William C. Cline
Vice President and Controller
(Principal Accounting Officer)
Date: November 13, 2003